financial accounting - rectification of errors · rectification of errors after preparation of...
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Unit 30. Financial Accounting
Financial Accounting - Rectification of
Errors Financial accounting deals with recording and maintaining every monetary
transaction of an organization. However, sometimes, a few entries might be either
incorrect or used at the wrong place. In financial accounting, the process of
correcting such mistakes is known as Rectification of Errors.
Types of Errors Two most common types of errors, which are usually occurred at the time of
preparation of Financial Statements are discussed below.
Error which Effect only One Account
Omission of posting of balance in a Trial Balance.
Error of carried forward of balance.
Error of casting and posting.
Error which Effect Two or more Accounts
The nature of errors, which occur during the preparation of Financial Statements
are −
Error of posting in wrong account.
Error of principle.
Error of omission.
Methods of Rectification of Errors
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There are three types of methods used in rectification of Errors −
Replacing Correct Figure by Striking Off the Wrong Figure
For example, cash payment of Rs. 989 on the account of stationery purchased
written as Rs. 998, will be corrected as −
Cash Book
By Stationery A/c 998
989
Through Journal Entry
Normally, there are three types of errors, which can be rectified by passing Journal
Entries −
Short credited or debit in one account and excess debit or credit in another
account. For example, purchase of stationery for Rs. 989 wrongly debited to
purchase of raw material account will be corrected as follows −
Journal Entry
Stationery AccountDr.
To Purchase Account
(Being Cash purchase of stationery wrongly debited
to Purchase account, now rectified)
989
989
If, by mistake one account is debited as well as credited with wrong
amount simultaneously. For example, Cash purchase of stationery of Rs.
989 booked with an amount of Rs. 489 will be corrected as follows −
Journal Entry
Stationery AccountDr.
To Purchase Account
(Being purchase of stationery for Rs. 989 wrongly
written as Rs. 489 now rectified)
500
500
If there is an omission of recording a transaction, it can be rectified by passing
journal entry to book that omitted transaction. For example, omission of
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recording transaction of purchase of raw material for Rs. 5000 from Mr. X
will be recorded and corrected by passing the following journal Entry −
Journal Entry
Stationery AccountDr.
To X Account
(Being omitted entry of purchase of Rs. 5000 from
Mr. X now recorded and rectified)
5000
5000
If there is a Mistake that Effects Trial Balance
Before closing the books and transferring the difference in suspense account
and
After the agreed difference is transferred into the suspense account, following
accounting treatment will be done −
o Earlier entry debited or credited with fewer amount will be rectified by
repeating that entry with difference amount to complete that amount.
For example, entry done with Rs. 500 instead of Rs. 5000 will be
rectified by doing same entry with an amount of Rs. 4500. In case,
where entry wrongly debited or credited to other account may be
rectified by doing reversal of old entry to nullify earlier effect.
If expense booked with less amount entry then −
Particular Expense Account
To Cash/Personal Account
(Being wrong amount of posting, rectified with
Difference amount Rs. 4,500 (5000-500)
Dr 4,500
4,500
If income is booked with less amount, it will be rectified as −
Cash/Personal account
To Income Account
(Being wrong amount of posting now Rectified.
4500 (5000-500)
Dr 4,500
4,500
If posting done in wrong account that will be rectified as follows −
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Stationery AccountDr.**
To Office Expenses Account**
(Being wrongly debited earlier in office account, now Rectified and posted
in stationery account)
In case (ii) where difference has already been transferred to suspense account,
further amount will be debited or credited to respective account and
correspondingly suspense account will be debited or credited. Thus, these entries
would reduce/nil the balance of suspense account.
Effect of Errors on Agreement of Trial Balance
The errors by which there is no change on both side of trial balance or wrong effect
on trial balance with same amount will not lead to effect on agreement of Trial
Balance. Errors of omission, error of posting with wrong amount on both side, or
Error of principles are the example of such errors. To find out such errors is a
challenging job for any book keeper or an accountant.
Effects of Errors on Financial Statements
Effect of error depends on the nature of effected accounts. If errors relate to nominal
account, it will either increase or reduce the profit and rectification will reduce
excess profit or Loss. Effect of error on Trading and Profit account ultimately effect
the Balance-Sheet of a company too, because reduced profit or excess profit
ultimately transferred to capital account, which is a part of the Balance Sheet.
There are some errors, which effect Trading or Profit and Loss account and Balance
sheet simultaneously, like entry of depreciation will affect profit as well as value of
the Fixed Assets.
Some entry may effect on Balance sheet only like, for instance omission of entry of
cash paid to purchase fixed assets will affect Balance Sheet of a firm only.
Rectification of Errors after Preparation of Final Accounts
To remain unaffected Profit or Loss of the current financial year, the errors, which
took place in last financial years are adjusted and rotated through a Profit & Loss
adjustment account. Balance of this account directly transferred to capital account
of firm without affecting the current year profit or loss.
Financial Accounting - Capital and Revenue
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One of the major aspects of preparing a correct financial statement is to distinguish
revenue and capital in regard to revenue income, revenue expenditure, revenue
payments, revenue profits, and revenue losses of the company with capital income,
capital receipts, capital profit, or capital losses.
In fact, without differentiating, we cannot think of correctness of a financial
statement. Ultimately, it will mislead the end results where no one can conclude
anything. As per this principle, a revenue item should be recorded in the Trading
and Profit & Loss account and a capital item should be recorded in the Balance-
Sheet of respective firm.
Capital Expenditure Capital expenditure is the expenditure incurred to acquire fixed assets, capital
leases, office equipment, computer equipment, software development, purchase of
tangible and intangible assets, and such kind of any value addition in business
with the purpose to enhance the income. However, to decide nature of the capital
expenditure, we need to pay attention on −
The expenditure, which benefit cannot be consumed or utilized in the same
accounting period, should be treated as capital expenditure.
Expenditure incurred to acquire Fixed Assets for the company.
Expenditure incurred to acquire fixed assets, erection and installation
charges, transportation of assets charges, and travelling expenses directly
relates to the purchase fixed assets, are covered under capital expenditure.
Capital addition to any fixed assets, which increases the life or efficiency of
those assets for example, an addition to building.
Revenue Expenditure Revenue expenditure is the expenditure incurred on the fixed assets for the
‘maintenance’ instead of increasing the earning capacity of the assets. Examples of
some of the important revenue expenditures are as follows −
Wages/Salary
Freight inward & outward
Administrative Expenditure
Selling and distribution Expenditure
Assets purchased for resale purpose
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Repairs and renewal expenditure which are necessary to keep Fixed Assets
in good running and efficient conditions
Revenue Expenditure Treated as Capital Expenditure Following are the list of important revenue expenditures, but under certain
circumstances, they are treated as a capital expenditure −
Raw Material and Consumables − If those are used in making any fixed
assets.
Cartage and Freight − If those are incurred to bring Fixed Assets.
Repairs & Renewals − If incurred to enhance life of the assets or efficiency
of the assets.
Preliminary Expenditures − Expenditure incurred during the formation of a
business should be treated as capital expenditure.
Interest on Capital − If paid for the construction work before the
commencement of production or business.
Development Expenditure − In some businesses, long period of
development and heavy amount of investment are required before starting
the production especially in a Tea or Rubber plantation. Usually, these
expenditure should be treated as the capital expenditure.
Wages − If paid to build up assets or for the erection and installation of Plant
and Machinery.
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Deferred Revenue Expenditure Some non-recurring and special nature of expenditure for which heavy amount
incurred and benefit for the same will spread in up-coming years, to be treated as
capital expenditure and will be shown as the assets of the firm. Part of the
expenditure should be debited to Profit & Loss account every year. For example, if
heavy amount paid for the advertisement of a product, which benefits are expected
to be received in next four years, then it should be debited as ¼ of the part in Profit
& Loss account as the revenue expenses and balance ¾ will be shown as the assets
in the Balance-Sheet.
Capital and Revenue Profit The premium received on issue of shares, and the profit on sale of fixed assets are
the major examples of capital profit and should not be treated as revenue profit.
Capital profit should be transferred to the capital reserve account, which is used
to set off capital losses in future if any.
Capital and Revenue Receipts Sale of fixed assets, capital employed or invested, and loans are the example of
capital receipts. On the other hand, sale of stock, commission received, and interest
on investment received are the main examples of revenue receipts. Revenue receipts
will be credited to the profit and loss account and on the other hand, capital
receipts will affect the Balance-sheet.
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Capital and Revenue Losses Discount on issue of shares and losses on sale of fixed assets are the capital loss
and would be set off against the capital profits only. Revenue losses on normal
business activity are part of the profit and loss account.
Financial Accounting - Final Accounts Final Accounts are the accounts, which are prepared at the end of a fiscal year. It
gives a precise idea of the financial position of the business/organization to the
owners, management, or other interested parties. Financial statements are
primarily recorded in a journal; then transferred to a ledger; and thereafter, the
final account is prepared (as shown in the illustration).
Usually, a final account includes the following components −
Trading Account
Manufacturing Account
Profit and Loss Account
Balance Sheet
Now, let us discuss each of them in detail −
Trading Account Trading accounts represents the Gross Profit/Gross Loss of the concern out of sale
and purchase for the particular accounting period.
Study of Debit side of Trading Account
Opening Stock − Unsold closing stock of the last financial year is appeared
in debit side of the Trading Account as “To Opening Stock“ of the current
financial year.
Purchases − Total purchases (net of purchase return) including cash
purchase and credit purchase of traded goods during the current financial
year appeared as “To Purchases” in the debit side of Trading Account.
Direct Expenses − Expenses incurred to bring traded goods at business
premises/warehouse called direct expenses. Freight charges, cartage or
carriage charges, custom and import duty in case of import, gas, electricity
fuel, water, packing material, wages, and any other expenses incurred in this
regards comes under the debit side of Trading Account and appeared as “To
Particular Name of the Expenses”.
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Sales Account − Total Sale of the traded goods including cash and credit
sales will appear at outer column of the credit side of Trading Account as “By
Sales.” Sales should be on net releasable value excluding Central Sales Tax,
Vat, Custom, and Excise Duty.
Closing Stock − Total Value of unsold stock of the current financial year is
called as closing stock and will appear at the credit side of Trading Account.
closing Stock = Opening Stock + Net Purchases - Net Sale
Gross Profit − Gross profit is the difference of revenue and the cost of
providing services or making products. However, it is
calculated before deducting payroll, taxation, overhead, and other interest
payments. Gross Margin is used in the US English and carries same meaning
as the Gross Profit.
Gross Profit = Sales - Cost of Goods Sold
Operating Profit − Operating profit is the difference of revenue and the costs
generated by ordinary operations. However, it is calculated before deducting
taxes, interest payments, investment gains/losses, and many other non-
recurring items.
Operating Profit = Gross Profit - Total Operating Expenses
Net Profit − Net profit is the difference of total revenue and the total expenses
of the company. It is also known as net income or net earnings.
Net Profit = Operating Profit - (Taxes + Interest)
Format of Trading Account
Trading Account of M/s ABC Limited
(For the period ending 31-03-2014)
Particulars Amount Particulars Amount
To Opening Stock XX By Sales XX
To Purchases XX By Closing Stock XX
To Direct Expenses XX By Gross Loss c/d XXX
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To Gross Profit c/d XXX
Total XXXX Total XXXX
Manufacturing Account Manufacturing account prepared in a case where goods are manufactured by the
firm itself. Manufacturing accounts represent cost of production. Cost of
production then transferred to Trading account where other traded goods also
treated in a same manner as Trading account.
Important Point Related to Manufacturing Account
Apart from the points discussed under the section of Trading account, there are a
few additional important points that need to be discuss here −
Raw Material − Raw material is used to produce products and there may be
opening stock, purchases, and closing stock of Raw material. Raw material
is the main and basic material to produce items.
Work-in-Progress − Work-in-progress means the products, which are still
partially finished, but they are important parts of the opening and closing
stock. To know the correct value of the cost of production, it is necessary to
calculate the correct cost of it.
Finished Product − Finished product is the final product, which is
manufactured by the concerned business and transferred to trading account
for sale.
Raw Material Consumed (RMC) − It is calculated as.
RMC = Opening Stock of Raw Material + Purchases - Closing Stock
Cost of Production − Cost of production is the balancing figure of
Manufacturing account as per the format given below.
Manufacturing Account
(For the year ending……….)
Particulars Amount Particulars Amount
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To Opening Stock of Work-
in-Progress XX
By Closing Stock of Work-in-
Progress XX
To Raw Material Consumed XX By Scrap Sale XX
To Wages XXX By Cost of Production XXX
To Factory overheadxx (Balancing figure)
Power or fuelxx
Dep. Of Plantxx
Rent- Factoryxx
Other Factory Exp.xx xxx
Total XXXX Total XXXX
Profit and Loss Account Profit & Loss account represents the Gross profit as transferred from Trading
Account on the credit side of it along with any other income received by the firm
like interest, Commission, etc.
Debit side of profit and loss account is a summary of all the indirect expenses as
incurred by the firm during that particular accounting year. For example,
Administrative Expenses, Personal Expenses, Financial Expenses, Selling, and
Distribution Expenses, Depreciation, Bad Debts, Interest, Discount, etc. Balancing
figure of profit and loss accounts represents the true and net profit as earned at
the end of the accounting period and transferred to the Balance Sheet.
Profit & Loss Account of M/s ………
(For the period ending ………..)
Particulars Amount Particulars Amount
To Salaries XX By Gross Profit b/d XX
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To Rent XX
To Office Expenses XX By Bank Interest received XX
To Bank charges XX By Discount XX
To Bank Interest XX By Commission Income XX
To Electricity Expenses XX By Net Loss transfer to
Balance sheet XX
To Staff Welfare Expenses XX
To Audit Fees XX
To Repair & Renewal XX
To Commission XX
To Sundry Expenses XX
To Depreciation XX
To Net Profit transfer to
Balance sheet XX
Total XXXX Total XXXX
Balance Sheet A balance sheet reflects the financial position of a business for the specific period
of time. The balance sheet is prepared by tabulating the assets (fixed assets +
current assets) and the liabilities (long term liability + current liability) on a specific
date.
Assets
Assets are the economic resources for the businesses. It can be categorized as −
Fixed Assets − Fixed assets are the purchased/constructed assets, used to
earn profit not only in current year, but also in next coming years. However,
it also depends upon the life and utility of the assets. Fixed assets may be
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tangible or intangible. Plant & machinery, land & building, furniture, and
fixture are the examples of a few Fixed Assets.
Current Assets − The assets, which are easily available to discharge current
liabilities of the firm called as Current Assets. Cash at bank, stock, and
sundry debtors are the examples of current assets.
Fictitious Assets − Accumulated losses and expenses, which are not actually
any virtual assets called as Fictitious Assets. Discount on issue of shares,
Profit & Loss account, and capitalized expenditure for time being are the
main examples of fictitious assets.
Cash & Cash Equivalents − Cash balance, cash at bank, and securities
which are redeemable in next three months are called as Cash & Cash
equivalents.
Wasting Assets − The assets, which are reduce or exhausted in value
because of their use are called as Wasting Assets. For example, mines,
queries, etc.
Tangible Assets − The assets, which can be touched, seen, and have volume
such as cash, stock, building, etc. are called as Tangible Assets.
Intangible Assets − The assets, which are valuable in nature, but cannot be
seen, touched, and not have any volume such as patents, goodwill, and
trademarks are the important examples of intangible assets.
Accounts Receivables − The bills receivables and sundry debtors come
under the category of Accounts Receivables.
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Working Capital − Difference between the Current Assets and the Current
Liabilities are called as Working Capital.
Liability
A liability is the obligation of a business/firm/company arises because of the past
transactions/events. Its settlement/repayments is expected to result in an outflow
from the resources of respective firm.
There are two major types of Liability −
Current Liabilities − The liabilities which are expected to be liquidated by
the end of current year are called as Current Liabilities. For example, taxes,
accounts payable, wages, partial payments of long term loans, etc.
Long-term Liabilities − The liabilities which are expected to be liquidated in
more than a year are called as Long-term Liabilities. For example, mortgages,
long-term loan, long-term bonds, pension obligations, etc.
Grouping of Assets and Liabilities There may be two types of Marshalling and grouping of the assets and liabilities −
In order of Liquidity − In this case, assets and liabilities are arranged
according to their liquidity.
In order of Permanence − In this case, order of the arrangement of assets
and liabilities are reversed as followed in order of liquidity.
Financial Statements with Adjustments Entries and their
Accounting Treatment
In order to prepare a true and fair financial statement, there are some very
important adjustments those have to be done before finalization of the accounts
(as shown in the following illustration) −
Sr.No. Adjustments Accounting
Treatments
1
Closing Stock
Unsold stock at the end of Financial year
called Closing stock and valued at “Cost or
market value whichever is less”
First Treatment
Where an opening
and closing stock
adjusted through a
purchase account
and the value of
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Closing Stock given
in Trial Balance −
Closing stock will be
shown as adjusted
purchase account on
the debit side of
Trading account and
will appear in the
Balance Sheet under
current Assets.
2
Outstanding Expenses
Expenses which are due or not paid called
as outstanding expenses.
Accounting
Treatment
Outstanding
expenses will be
added in Trading or
Profit & Loss
account in particular
expense account and
will appear in
liabilities side of the
Balance Sheet under
the current
liabilities.
3
Prepaid Expenses
Expenses which are paid in advance are
called as Prepaid Expenses.
Accounting
Treatment
Prepaid Expenses
will be deducted
from the particular
expenses as appear
in Trading & Profit &
Loss account and
will be shown in the
Balance Sheet under
the current assets.
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4 Accrued Income
The income, which is earned during the
year, but not yet received at the end of the
Financial Year is called as Accrued Income.
Accounting
Treatment
Accrued income will
be added to a
particular income
under the Profit &
Loss account and
will be shown in the
Balance Sheet as
current assets.
5
Income Received in Advance
An income received in advance, but not
earned like advance rent etc.
Accounting
Treatment
An income to be
reduced by the
amount of advance
income in profit &
loss account and will
appear as current
liabilities in the
Balance Sheet.
6
Interest on Capital
Where an interest paid on the capital
introduced by the proprietor or partner of
the firm.
Accounting
Treatment
Debit Side of
Profit & Loss
account
Add to capital
account
(Credit side of
Capital
account).
7
Interest on Drawing Accounting
Treatment
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Where an interest paid on the capital
introduced by the proprietor or partner of
the firm.
Credit Side of
Profit & Loss
account
Reduced from
capital
account (Debit
side of
Drawing
account).
8
Provision for Doubtful Debts
If there is any doubt on the recovery from
Sundry Debtors.
Accounting
Treatment
Debit Side of
Profit & Loss
Account
In a Balance
Sheet,
provision for
the Doubtful
will be
deducted from
the Sundry
Debtors’
Account.
9
Provision for Discount on Debtors
If there is any offer of discount to pay the
debtors within certain period.
Accounting
Treatment
Debit Side of
Profit & Loss
Account
In a Balance
Sheet,
provision for
the Discount
on Debtors
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will be
deducted from
the Sundry
Debtors
Account.
10
Bad Debts
Unrecovered debts or irrecoverable debts
Accounting
Treatment
Debit Side of
Profit & Loss
Account
In a Balance
Sheet, Sundry
debtors will be
shown after
deducting the
Bad Debts.
11
Reserve for Discount on Creditors
If there is any chance to get discount on the
payment of sundry creditors within certain
period.
Accounting
Treatment
Credit Side of
Profit & Loss
Account
In a Balance
Sheet, Sundry
Creditors will
be shown after
deducting the
Reserve for
Discount.
12
Loss of Stock by fire
There may be three conditions in this case
Accounting
Treatment
1. If Stock is fully
insured
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Credit Side of
Trading
Account
Assets side of
Balance Sheet
(With full value
of loss)
2. If Stock is
partially insured
Credit side of
Trading
Account
(With Total
value of Loss)
Debit side of
Profit & Loss
a/c
(With value of
loss
unrecoverable)
Asset Side of
Balance Sheet
( With value
recoverable)
3. If Stock is not
insured
Credit Side of
Trading
Account
Debit side of
Profit & Loss
Account
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13
Reserve Fund
Accounting
Treatment
Debit side of
Profit & Loss
Account
Liabilities side
of Balance
Sheet
14
Free Sample to Customers
Accounting
Treatment
Credit side of
Trading
Account
Debit Side of
Profit & Loss
Account
15
Managerial Commission
Accounting
Treatment
Debit side of
Profit & Loss
Account
Liabilities side
of Balance
Sheet as
commission
payable
16
Goods on Sale or Approval Basis
If there is any un-approved stock lying with
the customers at the end of financial year.
Accounting
Treatment
Sales
AccountDr
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To Debtors
A/c
(With Sale
Price)
Stock
AccountDr
To Trading
Account
(with cost
price)
Provision and Reserves Meaning of Provisions “Any amount written off or retained by the way of providing depreciation or
diminution in the value of assets or for providing any known liability of which the
amount cannot be determined with substantial accuracy.”
- The Institute of Chartered Accountants of India
“Liabilities which can be measured only by using a substantial degree of estimation.”
- AS-29 issued by Institute of Chartered Accountants of India
AS 29 also defines liabilities as “a present obligation of the enterprises arising from
past events, the settlement of which is expected to result in an outflow from the
enterprise of resources embodying economic benefits.”
Debiting Profit and Loss account, provisions are created and shown either
deducting assets side or on the liabilities side under relevant sub-head of Balance
Sheet.
Provision for bad and doubtful debts, Provisions for Repair & Renewals, and
Provision for discounts & depreciation are the most common examples.
Meaning of Reserves “That portion of earnings, receipts or other surplus of an enterprise (whether capital
or revenue) appropriated by the management for general or a specific purpose other
than a provision for depreciation or diminution in the value of assets or for a known
liability.”
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-ICAI
Reserve is an appropriation of profits; on the other hand, Provision is a charge
against profit. Reserves are not meant to meet out contingencies or liabilities of a
business. Reserve increases working capital of a company to strengthen the
financial position.
There are two types of reserves −
Capital Reserve − Capital reserve is not readily available for distribution as
the dividends among the shareholders of the company, and it creates only
out of capital profit of the company. It is like Premium on issue of shares or
debentures and Profit prior to incorporation.
Revenue Reserve − Revenue reserves are readily available for the
distribution of profit as dividend to the shareholders of the company. Some
of the examples of this are general reserve, staff welfare fund, dividend
equalization reserve, debenture redemption reserve, contingency reserve,
and investment fluctuation reserves.
Distinction between Provisions and Reserves Reserve can be made only out of profit and provisions are the charge to profit.
Reserves reduce divisible profits and provisions reduce the profit.
Reserves, if remain un-utilized for some period can be distributed as
dividends, but provisions cannot be transferred to General Reserve for the
distribution.
Purpose of provision is very specific, but reserve is created to meet out any
probable future liabilities or losses.
Creation of provisions is legally necessary, but reserves are created to save a
concern from the future losses and liabilities.
Secret Reserves Banking Company, Insurance Company, and Electricity Companies create secret
reserves, where the public confidence is required. In this case, to create secret
reserve, assets showed at lower cost or liabilities at higher value. Some of the
examples of it are as follows −
By undervaluing goodwill or stock
By excessive depreciation
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By creating excessive provisions
Showing free reserves as creditors
By charging capital expenditure to profit and loss account
Advantages of Secret Reserves Some of the important advantages are given below −
Without disclosing to its shareholders, it increases working capital of a
concern, which is a clear indication of the sound financial position.
With the help of secret reserves, directors can maintain the rate of dividends
during the unfavorable time.
Non-disclosure of a big profit is useful to avoid an un-due competition.
Limitations of Secret Reserves Major limitations or objections of secret reserves are as follows −
Due to non-disclosure of actual profit, financial statements do not presents
true and fair view of the state of affairs.
There are lots of chances of misuse of reserves by the directors for their
personal benefits.
Due to secret reserves, chances for the concealment of worst position of a
company are very high.
Company will get very lower amount of claim of insurance at the time of loss
of stock or other assets, as valuation of the assets are done at very low value
to create secret reserve.
General and Specific Reserves Specific reserves are created and utilized for the purpose only for which they are
created, like dividend equalization reserve and debenture redemption reserve.
General reserves are created for any future contingency or to utilize at the time of
expansion of a business. Purpose of creation of General reserve is to strengthen the
financial position of the company and to increase the working capital.
Sinking Fund For the purpose to repay of any liabilities or to replace any fixed assets after
particular period, sinking funds are created. For this, some amount are charged or
appropriated from the profit and loss account every year and invested in any
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outside securities. Without any extra ordinary burden, replacement of an asset may
be done in a systematic manner or pay any known liability on maturity of the
sinking fund.
Investment of Reserves It is a controversial issue, whether a reserve should be invested in outside securities
or not. Thus, to decide anything, it is important to study the need and requirement
of a firm according to the financial position of a firm. Therefore, investment in
outside securities is justified only in a case where company has the extra fund to
invest.
Nature of Reserve In-spite of showing reserves on the liabilities side of a Balance Sheet, reserves are
actually not at all any liabilities of a firm. Reserve represents as accumulated
profits, which are available to disburse among the shareholders.
Measurement of Business Income One of the most significant accounting concepts is “Concept of Income”. Similarly,
measurement of a business income is also an important function of an accountant.
In General term, payment received in lieu of services or goods are called income,
for example, salary received by any employee is his income. There may be different
type of incomes like Gross income, Net income, National Income, and Personal
income, but we are here more concerned for a business income. Surplus revenue
over expenses incurred is called as “Business Income.”
Objectives of Net Income Following are the important objectives of a net income −
Historical income figure is the base for future projections.
Ascertainment of a net income is necessary to give portion of profit to
employees.
To evaluate the activities, which give higher return on scarce resources are
preferred. It helps to increase the wealth of a firm.
Ascertainment of a net income is helpful for paying dividends to the
shareholders of any company.
Return of income on capital employed, gives an idea of overall efficiency of a
business.
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Definition of Income The most authentic definition is given by the American Accounting Association as
−
“The realized net income of an enterprise measures its effectiveness as an operative
unit and is the change in its net assets arising out of a (a) the excess or deficiency of
revenue compared with related expired cost, and (b) other gains or losses to the
enterprise from sales, exchange or other conversion of assets:”.
According to the American Accounting Association, to be as business income,
income should be realized. For example, to be a business income, only appreciation
in value of assets of a company is not enough, for this, asset has really been
disposed of.
Accounting Period
For the measurement of any income concerns, instead of a point of time, a span of
time is required. Creditors, investors, owners, and government, all of them require
systematic accounting reports at regular and proper intervals. The maximum
interval between reports is one year, as it helps a businessman to take any
corrective action.
An accounting period concept is directly related to matching concept and
realization concept; in the absence of any of them, we could not measure income
of the concerns. On the basis of matching concept, expenses should be determined
in a particular accounting period (usually a year) and matched with the revenue
(based on realization concept) and the result will be income or loss of the
accounting period.
Accounting Concept and Income Measurement The measurement of accounting income is the subject to several accounting
concepts and conventions. Impact of accounting concepts and convention on
measurement of the accounting income is given below −
Conservatism
Where an income of one period may be shifted to another period for the
measurement of income is called as ‘conservatism approach.’
According to the convention of conservatism, the policy of playing safe is followed
while determining a business income and an accountant seeks to ensure that the
reported profit is not over stated. Measurement of a stock at cost or market price,
whichever is less is one of the important examples as applied to measurement of
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income. But it must be insured that providing excessive depreciation or excessive
provisions for a doubt full debt or excessive reserve should not be there.
Consistency
According to this concept, the principle of consistency should be followed in
accounting practice. For example, in the treatment of assets, liabilities, revenues,
and expenses to insure the comparison of accounting results of one period with
another period.
Therefore, the accounting profession and the corporate laws of most of the counties
require that financial statement must be made out on the basis that the figures
stated are consistent with those of the preceding year.
Entity Concept
Proprietor and business are the two separate and different entities according to the
entity concept. For example, an interest on capital is business expenditure, but for
a proprietor, it is an income. Thus, we cannot treat a business income as personal
income or vice-versa.
Going Concern Concept
According to this concept, it is assumed that business will continue for a long time.
Thus, charging depreciation on a Fixed Asset is based on this concept.
Accrual Concept
According to this concept, an income must be recognized in the period in which it
was realized and costs must be matched with the revenue of that period.
Accounting Period
It is desirable to adopt a calendar year or natural business year to know the results
of business.
Computation of Business Income To compute business income, following are the two methods −
Balance Sheet Approach
Comparison of the closing values (Assets minus outsider’s liabilities) of a firm with
the values at the beginning of that accounting period is called as Balance Sheet
approach. In above value, an addition to capital will be subtracted and addition of
drawings will be added while computing the business income of a firm. Since,
income is calculated with the help of Balance Sheet hence called as Balance Sheet
approach.
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Transaction Approach
Transactions are mostly related to production or the purchase of goods and the
sale of goods and all these transactions directly or indirectly related to the revenue
or to the cost. Therefore, surplus collection of the revenue by selling goods, spent
over for production or purchasing the goods is the measure of income. This system
is widely followed by the enterprises where double entry system adopted.
Measurement of Business Income There are following two factors which are helpful in the estimation of an income −
Revenues − Sale of goods and rendering of services are the way to generate
revenue. Therefore, it can be defined as consideration, recovered by the
business for rendering services and goods to its customers.
Expenses − An expense is an expired cost. We can say the cost that have
been consumed in a process of producing revenue are the expired cost.
Expenses tell us - how assets are decreased as a result of the services
performed by a business.
Measurement of Revenue Measurement of the revenue is based on an accrual concept. Accounting period, in
which revenue earned, is the period of revenue accrues. Therefore, a receipt of cash
and revenue earned are the two different things. We can say that revenue is earned
only when it is actually realized and not necessarily, when it is received.
Measurement of Expenses In case of delivery of goods to its customers is a direct identification with the
revenue.
Rent and office salaries are an indirect association with the revenue.
There are four types of events (given below) that need proper consideration about
as an expense of a given period and expenditure and cash payment made in
connection with those items −
Expenditure, which are expenses of the current year.
Some expenditure, which are made prior to this period and has become
expense of the current year.
Expenditure, which is made this year, becomes expense in the next
accounting periods. For example, purchase of fixed assets and depreciation
in next up-coming years.
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Expense of this year, which will be paid in next accounting years. For
example, outstanding expenses.
Matching Concept It is a problem of recognition of revenue during the year and allocation of expired
cost to the period.
Recognition of Revenue
Most frequent criteria, which are used in recognition of the revenue are as follows
−
Point of Sale − Transfer of ownership title to a buyer is point of sale, in case
of sale of commodity.
Receipt of Payment − Criteria of cash basis is widely used by the attorneys,
physicians, and other professionals in which revenue is considered to be
earned at the time of collection of cash.
Instalment Method − Instalment method is widely used in retail trading
specially in consumer durables. In this system, revenue earned is treated in
the same manner as is used in any other credit sale.
Gold Mines − The accounting period in which gold is mined is the period of
revenue earned.
Contracts − Degree of contract completion, especially in long term
construction contracts is based on percentage of completion of a contract in
a single accounting year. It is based on total estimated life of the contract.
Allocation of Costs
Matching of expired revenue and expired costs on a periodic time basis is the
satisfactory basis of allocation of cost as stated earlier.
Measurement of Costs Measurement of costs can be determined by −
Historical Costs − To determine periodic net income and financial status,
historical cost is important. Historical cost actually means - outflow of cash
or cash equivalents for goods and services acquired.
Replacement Costs − Replacing any asset at the current market price is
called as replacement cost.
Basis of Measurement of Income
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Following are the two significant basis of measurement of income −
Accrual Basis − In an accrual basis accounting, incomes are recognized in a
company’s books at the time when revenue is actually earned (however, not
essentially received) and expenses is recorded when liabilities are incurred
(however, not essentially paid for). Further, expenses are compared with
revenues on the income statement when the expenses expire or title has been
transferred to the buyer, and not at the time when the expenses are paid.
Cash Basis − In a cash basis accounting, revenues and expenses are
recognized at the time of physical cash is actually received or paid out.
Change in the Basis of Accounting
We have to pass adjustment entries whenever accounting records change from cash
basis to accrual basis or vice versa specially in respect of the prepaid expenses,
outstanding expenses, accrued income, income received in advance, bad debts &
provisions, depreciation, and stock in trade.
Features of Accounting Income
Followings are the main features of accounting income −
Matching revenue with related cost or expenses is a matter of accounting
income.
Accounting income is based on an accounting period concept.
Expenses are measured in terms of a historical cost and determination of
expenses is based on a cost concept.
It is based on a realization principal.
Revenue items are considered to ascertain a correct accounting income.
Bills of Exchange and Promissory Notes “An Instrument in writing containing an unconditional order, signed by the maker,
directing a certain person, to pay a certain sum of money only to, or to the order of a
certain person or to the bearer of the instrument.”
Section 5, Negotiable Instrument Act, 1881
Essentials of Bills of Exchange Following are the essentials of a bill of exchange −
Bill of exchange should be in written.
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The seller who makes the bill is termed as “Drawer,” the purchaser upon
whom the bill is drawn is known as “Drawee” and must be a person.
Bill of exchange must be carrying certain amount and only in terms of money,
and not in terms of goods or services.
Order to pay the money, should be unconditional.
Specimen of Bill
Apart from all these (given above), we also need to pay attention on the following
points −
Parties to Bill of Exchange Following are the parties of ‘Bill of Exchange −”
The Drawer − Seller of goods is termed as drawer of “bills of exchange.”
The Drawee − Drawee or purchaser is a person who accepts the bill of a
certain amount to be paid after a specific time.
The Payee − Payee and drawer may be same person who gets the payment
or may be a different person. In case of same parties, will be reduced to two
instead of three.
Important Terms Stamp − Amount in excess of certain limit should be paid and signed on
affixed revenue stamp according to above specimen. In these days, threshold
limit is INR 5,000/.
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Amount − Amount of bill must be written in figure as well as in words as
shown in above specimen.
Date − Date on bill will be written on face of it as above.
Value and Terms − Both are essential part of it and must be written as shown
above.
Acceptance of Bills To make it a legal document, it must be signed by “Drawee.” Acceptance may be
general acceptance i.e. Drawee agrees with the full content of the bill without any
change and it may be conditional, which is called as qualified acceptance.
Classification of Bills of Exchange Bill of exchange may be classified as viz…
Inland Bill − Bill, which is drawn in India, both the Drawer and the Drawee
are from India and also payable in India called Inland Bill.
Foreign Bill − Bill, which is drawn outside India, drawn on a person residing
in India, payable in India or vice versa. Due date of foreign bill starts from
the date on which Drawee sees it and accepts it.
Definition of Promissory Notes As per Section 4 of the Indian Negotiable Instrument Act, 1881
“An instrument in writing (not being a Bank note or a currency note) containing an
unconditional undertaking, signed by the maker, to pay a certain sum of money only
to, or the order of a certain person, or to the bearer of the instrument.”
Difference between Promissory Notes and Bills of Exchange
Promissory Note Bill of
Exchange
It is an unconditional promise to pay
Bill of
Exchange is
unconditional
order to pay.
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Debtor make the promise to pay to the creditor
Bill of
Exchange
drawn by a
seller of
goods or
services and
he makes an
order to
debtor to
make the
payment.
Foreign promissory note make in a set of one only Foreign Bills
of Exchange
drawn in a
set of three.
Promissory note payable on demand, requires stamp duty Bill of
Exchange
payable on
demand does
not require
stamp duty.
Promissory note has only two parties i.e. drawer and payee
Bill of
exchange
may have
three parties,
drawer,
drawee and
may be
payee.
Since debtor himself makes the promise to make the payment,
hence no acceptance required in this case
To be a legal
document, it
must be
accepted by
Drawee.
Advantages of Bills of Exchange and Promissory Notes
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Followings are the important advantages of Bills of Exchange and Promissory Notes
−
Facilitation of the credit transactions is helpful in increasing the size of
business.
Both are the proof of purchase of goods or services in credit.
Being a legal document, both can be produced in a court, in case of its
dishonor.
Since date of payment is fixed, it is helpful for both debtors and creditors;
and, they may manage their payment schedule accordingly.
In case of any urgency of payment, creditor can get the bill discounted from
the bank.
Being a negotiable instrument, promissory note is easily transferable from
one person to another.
Accounting Treatment Bills of exchange and Promissory notes are treated as bills receivable and bills
payable in regards to accounting treatment −
Bills Receivable − If we have to receive the payment against bills of exchange
or promissory note, it will be called as “Bills Receivable” and will be shown
in the Asset side of Balance-sheet under Current Assets.
Bills Payable − Bills payable is current liabilities in hand of Drawee.
Accounting Entries − When the Bill received and retained in possession till
due date.
Accounting entries to be done in the books of Drawer and Payee as −
Sr.No. In the Books of Drawer Entries in the Books of Acceptor
1 Customer A/cDr
To Sales A/c
(Being Goods sold on
credit)
Goods Purchase A/cDr
To Supplier A/c
(Being Goods Purchased on credit)
2 Bills Receivable A/cDr Supplier A/cDr
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To Customer A/c
(Being Bill accepted by
Customer)
To Bills Payable A/c
(Being Bill accepted drawn by
supplier of goods)
3 Cash/Bank A/cDr
To Bills Receivable A/c
(Being Amount of bill
received on due date)
Bills Payable A/cDr
To Cash/Bank
(Being Amount paid on due date and
bills payable received back)
When Bill is Discounted with the Bank In the Book of Drawer − The drawer of a bill may get the bill discounted from
his bank before due date of that bill. In this case, bank charges some interest
on bill amount according to waiting time. For example, if bill is drawn on 1st
January for 3 months and drawer may get bill discounted on 1st February,
in this case, bank will charge interest for two months at applicable rate say
14% and drawer of bill may pass following entry.
Cash / Bank A/c Dr
Discount A/c Dr To bills Receivable A/c (Being bill discounted with bank @ 14% p.a. discount charge debited by bank for 2 months)
In the book of Drawee − Drawee has no need to pass entry on above, he just
needs to pass the entry at the time of payment on maturity of bill as explained
earlier.
When Bill of Exchange Endorsed in Favor of a Creditor If Drawer of the bill of exchange endorsed the bill to his creditor for his own
liabilities and bill is met on maturity, following journal entries will be passed −
In the book of Drawer
Creditors A/c Dr
To bills Receivable A/c (Being bill receivable endorsed to creditor)
Note − Drawer has no need to pass any entry at the time of maturity of a Bill.
In the book of Drawee − Drawee has no need to pass any entry at the time of
endorsement of Bill. Entries will remain same as explained earlier.
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Dishonor of a Bill of Exchange In case where the acceptor of a Bill of Exchange failed to pay the bill on due date
of maturity or refused to pay, it is called as dishonor of a Bill of Exchange. As a
proof of dishonor of a Bill, payee may get a certificate from a Notary Officer
appointed by the Government for this purpose. Notary officer charges some fees in
this regard called as “Noting Charges.”
Following entries will pass in the books of Drawer and Drawee −
Sr.No In the Books of Drawer
1 If bill is kept by the Drawer with himself till the date of
maturity −
Customer/Acceptor A/c Dr (with total Bill amount + Noting
Charges)
To Bills Receivable A/c(with Bill Receivable amount)
To Cash/Bank(Noting Charges paid)
(Being Bills receivable dishonor and noting charges paid)
2 If bill is discounted with the bank −
Customer/Acceptor A/c Dr (with total Bill amount + Noting
Charges)
To Bank A/c(with total Bill amount + Noting Charges)
(Being discounted Bills receivable dishonor and noting charges
paid)
3 If bill is endorsed by the Drawer in favor of a Creditor −
Customer/Acceptor A/c Dr (with total Bill amount + Noting
Charges)
To Creditor A/c(with total Bill amount + Noting Charges)
(Being endorsed Bills receivable dishonor and noting charges
paid)
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Entries in the Books of Acceptor/Debtors
In all above three case acceptor will pass only one journal entry −
Bills payable A/cDr(with the bills payable amount)
Noting Charges A/cDr(with Noting Charges )
To Drawer/Creditor A/c(with total Bill amount + Noting Charges)
(Being Goods Purchase on credit)
Renewal of Bill There may be a situation when the acceptor of bill may not be in position to pay
the bill on due date and he may request drawer to cancel the old bill and draw a
new bill on him (i.e. Renewal of Bill). Drawer of bill may charge some interest on
mutually agreed terms and that amount of interest may be paid in cash or may be
included in the bill amount.
Entries in the Books of Drawer and Drawee Following accounting entries to be done in the books of Drawer and Drawee −
Sr.No. In the Books of Drawer Entries In the Books Acceptor
1 Cancellation of old bill −
Customer/Acceptor A/cDr
To Bill receivable A/c
(Being old bill cancelled)
Cancellation of old bill −
Bills Payable A/cDr
To Creditor A/c
(Being request for cancellation of
old bill accepted by Creditor)
2 Interest received in cash −
Cash A/cDr
To Interest A/c
(Being interest received on
delayed payment)
Interest paid in cash −
Interest A/cDr
To Cash A/c
(Being Interest paid on renewal of
Bill)
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3 In case interest not payable
in cash −
Customer/Acceptor A/cDr
To Interest A/c
(Being Interest due on renewal
of bill)
In case interest not payable in
cash −
Interest A/cDr
To Creditor A/c
(Being Interest on renewal of bill
due)
4 On renewal of bill −
Bills Receivable A/cDr
To Customer/Acceptor A/c
(Being renewal of bill including
amount of interest)
On renewal of bill −
Supplier A/cDr
To Bills Payable A/c
(Being Bill accepted after
cancellation of a new bill
including interest)
Retiring of a Bill under Rebate Sometimes, acceptor may approach to drawer of a bill to make early payment before
due date of a bill, following journal entries will pass in this case −
Sr.No. Entry In the
Books of Drawer
Entries In the Books of Acceptor
1 Cash/Bank
A/cDr
Rebate A/cDr
To Bills
Receivable A/c
(Being Amount
of bill received
before due date
and rebate
allowed to
customer)
Payable A/cDr
To Cash/Bank A/c
To Rebate A/c
(Being Amount paid before due date on rebate)
Bill sent to Bank for Collection
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To manage several numbers of bills receivable, drawer sent those bills to the bank
for collection and bank gives credit to the customer whenever a bill is collected from
a drawee. Following journal entries will be passed −
Sr.No. Entry In the Books of Drawer
1 When a bill is sent to the bank for collection −
Bills sent for Collection A/cDr
To Bank A/c
(Being bills receivable sent to the bank for collection)
2 On collection of payment by bank −
Bank A/cDr
To Bills sent for Collection A/c
(Being Collection of bills receivable by bank)
Accommodation Bill A bill of exchange may be accepted to oblige a friend or any known person at the
time of his need or to provide him a loan or else to accommodate one or more parties
is called as accommodation bill.”
Financial Accounting - Inventory Valuation The Institute of Chartered Accountant of India as per Accounting Standard-2
(Revised) defines inventory as the assets held −
For sale in the ordinary course of a business or
In the process of production for such a sale or
In the form of materials or supplies to be consumed in the production process
or in rendering of the services.
Thus, the term inventory includes −
Raw Material and supplies,
Work in progress, and
Finished goods.
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Importance of Inventory Valuation Proper valuation of inventory is important because of the following three reasons −
Importance of sufficient Inventory − An inventory represents major current
asset investment of any trading or manufacturing concern. Shortage of
inventory may close down the business. Realization of profit from resale of
an inventory makes valuation of inventory. Therefore, the point is that every
business unit has to follow a proper method of inventory valuation.
To Determine True Financial Position − Proper valuation of an inventory
can only give true and fair view of the financial position of a business unit,
as it constitutes a significant portion of the current assets.
For Proper Determination of Income − Proper determination of income and
profit depends on correct valuation of the inventories. Over valuation of
closing inventory may overstate the profit figure and vice-versa. Therefore,
proper valuation of an inventory is necessary to determine the true income
and profit by the business concern.
Methods of Taking Inventory Following are the two important methods of taking inventory −
Periodic Inventory Method and
Perpetual Inventory Method
Let’s discuss each of them separately −
Periodic Inventory Method
This method of stock valuation is also known as physical stock taking method or
annual stock taking method. Under this system of taking inventories, stock is
determined by physical counting at the end of the accounting period i.e. the date
of preparation of final accounts. This system is very simple and useful in small
business organizations.
Perpetual Inventory Method
This system of inventory valuation records every movement of stock on the receipt
and issue of material reflecting running balances of different kind of inventories
through preparation of store ledgers for raw material, work-in- progress, and
finished goods. To insure the accuracy of store records, a periodic reconciliation of
records is done by taking physical inventories.
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Valuation of Inventory at Lower Cost or Market
Price An inventory is valued at a cost or market price, whichever is lower to ensure that
the anticipated profit should not be accounted for and full provision for anticipated
losses should be done.
As per American Institute of Certified Public Accountants −
“A departure from the cost basis of pricing the inventory is required when the utility
of the goods is no longer as great as its cost. Where there is evidence that the utility
of goods, in their disposal in the ordinary course of business, will be less than cost,
whether due to physical deterioration, obsolescence, changes in price levels, or other
causes, the difference should be recognized as loss of the current period. This is
generally accomplished by stating such goods at a lower level commonly designated
as market.”
Methods of Valuation of Inventory The following illustration shows the methods of Valuation of Inventory −
Let’s discuss each one of the methods in detail.
First in First out (FIFO) Method
FIFO is the most popular method of an inventory valuation, which is based on
assumption that the material first received or purchased are the first to be sold or
issued. It means, closing stock is out of the last or latest received or manufactured
goods.
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It will clear with a small and simple example as given below −
Date No. of Item Rate Value
Opening stock 100 10 1000
Purchased on 01-04-13 500 10 5000
Purchased on 01-07-13 500 12 6000
Purchased on 01-01-14 1000 15 15000
Total Purchases 2100 27000
Item Sold 1700
Closing stock 400 15 6000
In above example, it is assumed that closing stock of 400 items was out 1000 items
purchased on 01-01-2014.
Last in First out (LIFO) Method
As name suggests, closing stock is valued on the basis of oldest purchased or
manufactured items. First time, this method was used by the U.S.A., at the time of
Second World War to get the advantage of hike in prices. In the above example,
closing stock will be valued at 400 items @ Rs. 10 each = Rs. 4000
Note − Here 100 items from opening stock and 300 items were out of purchases
made on 01-04- 2013
Average Cost Method
Average cost method is used where identification of stock with rate or value of stock
is not possible. It is of two types Viz…
Simple Average Price Method
Weighted Average Price Method
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Simple Average Price Method
Simple average price method may be explained as below −
Suppose, four types of items are in stock as follows −
500 units purchased @ Rs. 10 per unit = Rs. 5000
750 units purchased @ Rs. 12 per unit = Rs. 9000
600 units purchased @ Rs. 14 per unit = Rs. 8400
Total Units 1850 for = Rs. 22400
Simple average method ignored the inventory at cost, therefore the valuation of
stock of 1850 units will be = 12 × 1850 = Rs. 22,200 whereas the actual cost is Rs.
22,400
So, if we want to choose average method then weighted price method should be
followed under which valuation will be done as hereunder.
Weighted Average Price Method
In the above example, Rs. 22,400 will be divided by 1850 units and the average
price will be Rs. 12.1081.
Highest in First out (HIFO) Method
This method is based on the assumption that the highest value of material always
consumed first and closing stock will be valued at the lowest cost of purchased or
manufactured material. This method is not a popular method of valuation of
inventory and so, used only by the business units having monopoly products or
who are dealing with the cost + contract.
Base Stock Method
Base stock means — minimum level of stock maintained by a business unit to run
his business without any interruption or which is according to AS-2 issued by The
Institute of Chartered Accountants of India as “the base stock formula proceeds
on the assumption that a minimum quantity of inventory (base stock) must be held
at all times in order to carry on business.”
Note − This method can be followed only when LIFO method is used.
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Inflated Price Method
This method of valuation covers normal losses, increasing price of purchases to
calculate closing value of an inventory. For example, if 550 units purchased for Rs.
2000 and due to normal loss units, remain 500 then the cost per unit will be
2000/500 = Rs. 4 per unit, and while calculating closing stock value for 100 unit,
cost will be Rs. 400 (100 × 4).
Specific Identification Method
Under this method, where identification of items with price is possible, then closing
stock will be valued accordingly.
Market Price Method
Under this method of valuation, stock is valued at current market price. It is also
called replacement price or realizable price method.
Method of Valuation of Closing Stock when it is not given
In case, where the value of closing stock is not given, we may calculate it as −
Opening stock xx
Add: Net Purchases xx
Less: Cost of Sales xx
Less: Gross Profit xx
Value of Closing stock xx
Putting value in above formula, we may also calculate the value of opening stock.
Analysis of Changes in Income The purpose of preparing a financial statement is not only to know the net income
or losses of concern for the current year, but also to know the change in net income
or losses of a firm in comparisons to the preceding years.
There are two types of financial statements, which reflect two types of profits
i.e. trading account shows the gross profit and Profit & Loss accountsshows the
net profit of the concern for a specific accounting period. Under this chapter, we
will discuss the reasons for changes in Gross Profit Ratio.
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Gross Profit Ratio (GPR) Gross profit means, excess of sales over cost of goods sold. This ratio also indicates
the losses due to damage or mismanagement. More the ratio is high more it is good
for a financial health of a concern. Chances of higher net income are more in an
organization where ratio of gross profit is high (formula is given below) −
GrossProfitRatio=GrossProfitNetSalesGrossProfitRatio=GrossProfitNetSales
Higher gross profit provides leverage to the management to meet their indirect
expenses and to spare net income for the distribution of profit and to increase the
reserves.
Gross Profit Margin When Gross profit margin is presented in percentage, it is called as Gross profit
margin (formula is given below) −
GrossProfitMargin=GrossProfitNetSales×100GrossProfitMargin=GrossProfitN
etSales×100
Chances of Increase in GPR may be due to following Reasons −
Without increase in corresponding costs, if there is an increase in selling
price.
Without decrease in selling price, if there is decrease in cost of production of
products.
There may be equal decrease or increase in selling price and cost of
production without affecting gross profit of the current year.
There may be chances that the valuations of closing stocks are done with
higher price.
It is also possible that the opening stock of a concern is valued at very lower
rate.
There is a possibility that given sales are inclusive of consignment sale due
to any mistake or otherwise.
Omission of purchase invoices in the books of accounts may also be one of
the reasons for higher gross profit.
Chances of Decrease in GPR may be due to following Reasons −
If cost price remains same, but decrease in selling price.
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Sale price remains same, but increase in cost of production.
Personal used goods debited to purchase account.
Closing stock may be valued at very low price.
Opening stock may be valued at very high price.
Any omission or mistake while valuation of closing stock.
It is necessary for survival and progress of any business to keep its margin of gross
profit high as much as possible to enable it to cover its operative expenses as well
as indirect expenses.
Analysis of Gross Profit Analysis of changes in gross profit is the first step in determination of a net income.
Change of gross profit in current year may be due to the following reasons −
Change in sale amount may be due to following three reasons −
o Change in selling price.
o Change in quantity sold without change in sale price.
o Change in sale price as well as quantity of goods sold.
Change in cost of goods sold may be due to following reasons −
o Change in cost of production.
o Change quantity of goods sold.
o Change in quantity as well as cost of goods sold.
Example
Make an analysis of changes from the information given below −
Particulars Year 2012
(Rs.)
Year 2013
(Rs.)
Changes (Increase or
decrease)
Sales 3,50,000 4,80,000 1,30,000
Number of Unit sold 5,000 6,000 1,000
Selling Price per Unit 70 80 10
Solution
Increase in sales amount due to price −
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Increase in price per unit × Number of unit sold in current year
= 10 × 6000 = 60,000
Increase in sales amount due to Quantity −
Increase in number of unit sold × price of last year
= 1,000 × 70 = 70,000
Combined effect of change in quantity and price (A+B)
= 1, 30,000
Accounting for Consignment Due to increasing size of market, it is quite obvious that manufacturers or whole
sellers cannot approach directly to every customer around the state or nation. To
overcome this limitation, manufacturers normally appoint reliable agents at every
desired location to reach the customers directly. He makes an agreement with local
traders who can sell goods on his behalf on commission basis.
Meaning and Features of Consignment Consignment is a process under which the owner consigns/handovers his
materials to his agent/salesman for the purpose of shipping, transfer, sale etc.
Following are the points that throw more light on the nature and scope of a
consignment −
Here, ultimate ownership of the goods remains with the manufacturer or
whole seller who handovers goods to his agent for sale on commission basis.
Consignment is merely a transfer of possession of goods not an ownership.
Since ownership of goods remain with the manufacturer (consignor),
consignee (agent) is not responsible for any loss or destruction of goods.
The goods are sold on owner’s risk and hence, profit/loss goes to owner.
Consignee only gets re-imbursement of expenses incurred by him and
commission on sale made by him, because sale that proceeds, belongs to
owner (consignor).
Why is Consignment not a Sale? Following are the reasons that explain why consignment is not a sale −
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Ownership − Ownership of goods need to be transferred from seller to buyer
in case of sale, but ownership of goods remains with the consignor, till the
goods are sold by the consignee.
Risk − In case of a consignment, normally, risk remains with the consignor
in the event of goods being lost or destroyed.
Relationship − The relation between a seller and a buyer will be of debtor
and creditor in case where goods are sold on credit basis. On the other hand,
the relationship between a consignor and a consignee is that of principal and
agent.
Goods Return − Usually, the sold goods cannot be returned back; however,
if there is any manufacturing defect or any other technical fault, seller is
obliged to take them back. On the other hand, consignee may return the
unsold stock of goods to consignor anytime.
Important Terms Pro-forma Invoice
Invoice implies that the sale has taken place, but pro-forma invoice is not an
invoice. Proforma invoice is a statement prepared by the consignor of goods
showing quantity, quality, and price of the goods. Such pro-forma invoice is issued
by the consignor to consignee regarding the goods before the sale actually takes
place.
Account Sale
Statement showing the details of goods received, goods sold, expenses incurred,
commission charged, remittances made, and due balance is called Account Sale
and it is remitted by the consignee to the consignor of goods on a periodic basis.
Commission
There are three types of commission payable to consignee on sale of the goods −
Simple Commission − This is usually a fixed percentage on the total sale,
calculated as per mutually agreed terms.
Over-riding Commission − In case of an extra-ordinary sale of the goods,
some specific amount is payable to consignee in the form of an incentive is
called overriding commission. Over-riding commission is also calculated on
the total sales.
Del-credere Commission − “An agreement by which an agent or factor, in
consideration of an additional premium or commission (called a del credere
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commission), engages, when he sells goods on credit, to insure, warrant, or
guarantee to his principal the solvency of the purchaser, the engagement of the
factor being to pay the debt himself if it is not punctually discharged by the
buyer when it becomes due.”
C. & G. Merriam Co.
A del credere commission is paid by the consignor to his agent for taking additional
risk of recovery of debts from the consignee on an account of credit sales made by
him (agent) on consignor's behalf.
Direct Expenses
Expenses, which increases the cost of the goods and are of non-recurring nature
and incurred till the goods reach the warehouse of consignee may called direct
expenses.
Indirect Expenses
Warehouse rent, storage charges, advertisement expenses, salaries, etc. comes
under the category of the indirect expenses. The distinctions between direct and
indirect expenses are important especially at the time of valuation of the unsold
closing stock.
Advance
Amount paid in advance by a consignee to consigner as security called as advance.
Valuation of unsold Consignment Valuation of unsold stock will be done like a closing stock of a Trading concern and
should be valued at the cost or the market price whichever is low. This stock will
be valued at −
Proportionate cost price and
Proportionate direct expenses.
Here, proportionate direct expenses mean — all expenses incurred by the consignor
and the expenses of consignee, which are incurred by him till the goods reach the
warehouse.
Invoicing Goods higher than Cost Under this method, goods are charged at the cost + profit and the pro-forma invoice
also shows this higher price of such goods. To know the actual profit, at the end of
an accounting period, consignment account will be credited with excess price so
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charged. Value of the stock will also be adjusted to the extent of profit element.
Main reason to adopt this policy by consignor is −
To hide actual profit from consignee.
Valuation of a stock at the consignor’s warehouse is comparatively easy in
this case.
In this case, consignor usually directs consignee to sale goods on invoice price
only. It prevents different sale price to different customers.
Loss of Goods There may be two types of losses as explained below −
Normal Loss − Normal loss may occur due to inherent characteristics of goods like
evaporation, drying up of goods, etc. It is not separately shown in the consignment
account, but included in the cost of goods sold and the closing stock by inflating
the rate per unit. To calculate the value of unsold stock, following formula is used.
Valueofclosingstock=TotalvalueofgoodssentNetquantityreceivedbyconsignee×Unsoldquanti
tyValueofclosingstock=TotalvalueofgoodssentNetquantityreceivedbyconsignee×Unsoldq
uantity
Netquantityreceived=Goodsconsignedquantity−NormallossquantityNetquantityreceived=G
oodsconsignedquantity−Normallossquantity
Abnormal Loss − An abnormal loss may occur due to any accidental reason. It is
credited to the consignment account to calculate actual profitability. Valuation of
closing stock is done on the same basis as explained earlier i.e. proportionate cost
+ proportionate direct expenses.
Abnormal Loss and Insurance
If, there is an insurance policy in respect of the consigned goods; following entries
will be passed in the books of a consignor −
Sr.No. In the Books of Consignor In the Books of Consignee
1 Payment of Insurance
Premium
(a) If insurance premium is
paid by the consignor, then
cash will be credited.
Consignment A/cDr
To Cash A/c
Or
To Consignee A/c
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(b) If Insurance premium is
paid by the consignee, then
consignee’s A/c will be
credited.
(Being Insurance premium paid)
2
At the time of Abnormal Loss
Abnormal Loss A/cDr
To Consignment A/c
(Being Loss Incurred)
3
Acceptance of Claim by
Insurance Company
Insurance Company (Name of
the insurer) A/cDr
To Abnormal Loss A/c
(Being claim admitted)
4
On receipt of Claim
Bank A/cDr
To Insurance Company A/c
(Being amount of claim received)
5
In Case of Loss
Profit & Loss A/cDr
To Abnormal Loss A/c
(Being amount of Abnormal Loss
transferred)
Summary of Accounting Entries Following Accounting Entries (Except for Loss) will be done in the books of
consignor and consignee for transactions related to the consignment −
Sr.No. In the Books of Consignor In the Books of Consignee
1 When goods are sent to the
consignee
Consignment A/cDr
No need to do any Entry in this
case
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To Goods Sent on Consignment
A/c
(Being Goods Sent on
Consignment)
2 Expenses Incurred by Consignor
Consignment A/cDr
To Cash/Bank A/c
(Being Expenses incurred on
consignment)
Not Applicable
3 Advance given by consignee
Cash/Bank A/cDr
To Consignee’s A/c
(Being advance received from
consignee)
Consigner A/cDr
To Bank/Cash A/c
(Being Advance amount paid
to Consignor)
4 Expenses Incurred by Consignee
Consignment A/cDr
To Consignee’s A/c
(Being Expenses incurred by
consignee)
Consigner A/cDr
To Bank/Cash A/c
(Being Expenses incurred on
goods received on
consignment)
5 Sale by Consignee
Consignee’s A/cDr
To Consignment A/c
(Being Expenses incurred by
consignee)
Cash (for cash sale) A/cDr
Debtors (for Credit Sale) A/c
Dr
To Consignor A/c
(Being goods sold)
6 Commission to Consignee
Consignment A/cDr
Consigner A/cDr
To Commission A/c
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To Consignee’s A/c
(Being Commission on sale due to
consignee)
(Being Commission earned)
7 Remittance from Consignee
Cash/Bank A/cDr
To Consignee’s A/c
(Being due amount received from
consignee)
Consigner A/cDr
To Bank/Cash A/c
(Being Balance due Payment
made to consignor)
8 Entry for Profit on Consignment
Profit & Loss A/cDr
To Consignment A/c
(Being Profit earned on
consignment)
Not Applicable
9 Loss on Consignment
Consignment A/cDr
To Profit & Loss A/c
(Being Loss incurred on
Consignment transferred to the
profit & Loss Account)
Not Applicable
Note − The goods sent on consignment account will be closed by transferring
balance into the Purchase account or the Trading account.
Financial Accounting - Joint Venture An association of two or more persons or we may say temporary partnership
combined for the carrying out a specific business, and divide profit or loss thereof
in agreed ratio is called a Joint Venture. Concerned parties to joint venture are
known as co-venturers. The liabilities of co-venturers are limited to their profit
sharing ratio or as per agreed terms −
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Suppose ‘A’ and ‘B’ undertake the job to develop a park for a consideration of Rs.
50,000/- Lacs. Since they come together for a work on a specific project, it will
termed as joint venture and each of them (A and B) will be called as a co-venturer.
Further, this venture will automatically terminate once the project is completed.
Major Features and Characteristics of Joint Venture Following are the major features of a joint venture −
There is an agreement between two or more persons.
Joint venture is made for the specific execution of a business plan/project.
It is a temporary partnership without the use of a firm name.
Agreement for joint ventures is automatically dissolved as soon as specific
project is over.
Profit & Share are shared on the same terms and conditions agreed upon.
However, in the absence of any agreement, profit & share will be divided
equally.
Partnership and Joint Venture There are following differences between partnership and joint venture −
Partnership always carried on with firm’s name, but for the joint venture, no
such firm’s name is required.
The persons who run the business on partnership are called as partners and
the persons who agreed to take the project as joint venture are called as co-
venturers.
Normally, a partnership is constituted for a long period (including various
projects), whereas joint venture is formed to complete a specific job/project.
Partnership is governed under the Partnership Act, 1932, whereas there is no
enactment of such kind for the joint ventures. However, as a matter of fact
in law, a joint venture is treated as a partnership.
There is no limit specified for the numbers of co-venturers, but the number
of partners is limited to 10 under banking business and 20 for any other
trade or business.
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Liability of a partner is unlimited and may extent of his business and personal
estate, whereas under joint venture, liabilities of co-venturers are limited to
the particular assignment or project agreed upon.
Joint Venture and Consignment Major differences between joint venture and consignment may be summarized as −
Relationship − The co-venturers of a Joint venture are the owners of a Joint
venture, whereas relationship of a consignor and consignee is of owner and
Agent.
Sharing of Profits − There is no distribution of profit between a consignor
and consignee, consignee only gets commission on sale made by him. On the
other hand, the co-venturers of a joint venture share profits as per the agreed
profit sharing ratio.
Ownership of Goods − Ownership of the goods remains with the consignor.
Consignor transfers only possession to the consignee, but every co-venturer
of a joint venture is the co-owner of the goods/project.
Contribution of Funds − Investment is done by the consignor only. On the
other hand, funds are contributed by all co-ventures in a certain agreed
proportion.
Continuity of Business − In case of a joint venture, there is no continuity of
the business once project is completed. On the other hand, if, everything goes
smooth, consignment is a continuous process.
Accounting Records To keep a record of the joint venture transactions, there are three following types
of accounting methods −
When one of the Venturers keeps Accounts,
When Separate Books of Accounts are kept for the Joint Venture, and
When Separate Books of Accounts are not kept for the Joint Venture.
Let’s discuss each of them separately −
When one of the Venturers keeps Accounts If one of the co-venturers is appointed to manage the joint venture, he is awarded
an extra commission or remuneration out of the profit for his services.
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Journal Entries
When share of investment received from other co-venturers
Cash/Bank
A/cDr
To Co-
venturers
A/c
When goods are purchased
Joint
Venture
A/cDr
To Cash A/c
(in case of
cash
purchase)
Or
To Creditors
A/c (for
credit
purchase)
When expenses incurred
Joint
Venture
A/cDr
To Cash A/c
When goods are sold
Cash A/cDr
Or
Debtors
A/cDr
To Joint
Venture A/c
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When commission allowed to working co-venturer
Joint
Venture
A/cDr
To
Commission
A/c
In case of Profit balance of joint venture, account will be
transferred to profit & Loss (own share of working co-
venturer) and other co-venture’s personal accounts
Joint
Venture
A/cDr
To Profit &
Loss A/c
To Co-
venturers
personal
A/c
In case of Loss
Profit &
Loss A/cDr
To Joint
Venture A/c
On settlement of accounts
All Co-
venturer
A/cDr
To
Cash/Bank
A/c
When Separate Books of Accounts are kept for the Joint Venture Under this method, all co-venturers contribute their share of investment and
deposit their shares in a Joint Bank account — newly opened for the specific
purpose of the Joint Venture. They may use this bank account to make any kind
of payments and to deposit sale proceeds or any other kind of receipts.
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In addition to Bank account, a Joint venture account is also opened in the books
to keep records of all transactions routed through this account.
This category of accounts is a personal account of the each co-venturer. Thus
following three accounts are opened −
Joint Bank Account
Joint Venture Account
Personal account of co-venturers
When Separate Books of Accounts are not kept for the
Joint Venture
It is of two types −
When all venturers keep separate accounts
Memorandum joint venture method
When all Venturers keep Separate Accounts −
Separate Joint venture account and personal accounts of other co-venturers
are opened under this method of accounting.
Joint venture account is debited and bank account or creditor account is
credited on the account of goods purchased or expensed.
Joint venture account is credited and a bank account or debtor account is
debited in case of either cash sale or credit sale.
Each co-venturer debits joint venture account and credits personal accounts
of other co-venturer on the account of either goods purchased or expensed
by other co-venturers.
Joint venture account is credited and personal account of others co-venturer
account is debited in case of sale made by other co-venturers.
Joint venture account is debited and commission account is credited if,
commission is receivable, but if commission is receivable by other co-
venturer, then the concerned co-venturer account will be credited instead of
the commission account.
If unsold stock is taken, then goods account will be debited by crediting Joint
venture account. On the other hand, if unsold stock is taken by any other
co-venturer, then personal account of the co-venturer will be debited.
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Balance in the joint venture accounts represents profit or loss and later that
amount of profit or loss will be transferred to the personal accounts of co-
venturers.
Note − Above transactions are possible only when all the co-venturers exchange
information’s on regular basis.
Memorandum Joint Venture Method
Important features of memorandum method are given as hereunder −
Only one personal account is opened by each co-venturer in his book named
Joint Venture account with…………… (Name of other co-venturer). Same
process will be followed by other co-venturer in his books of accounts.
Only one personal account will be opened by each co-venturer irrespective of
the fact, how many other co-venturers are exists. For example, there is a joint
venture of 4 person A,B,C, & D; now, A in his books will open only one
personal account named as Joint venture with B,C, & D account.
Each party will record only those transactions in his book, which are done by
him; the transactions done by other co-venturers will be ignored.
In addition to above said personal account, a combined account named as
“memorandum joint venture account” will also be opened.
Memorandum account is merely a combined account of personal accounts
opened by each co-venturer. Debit side of personal account will be
transferred to the memorandum account and the credit side of personal
account will be transferred to the credit side of memorandum account.
Transactions done by co-venturers among themselves including cash
received or paid by one co-venturer to other will be ignored at the time of
preparation of a memorandum account.
Balance of memorandum joint venture account will represent profit or loss of
the particular business. Further, the profit or loss will be transferred to the
individual co-venturer account in their profit sharing ratio.
Financial Accounting - Non-Trading Accounts
Some of the organizations or institutions are constituted to provide valuable
services to the society with the objective not to earn profit. These organizations
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normally offer the services such as education, medical, social clubs, charitable
trusts, trade unions, etc.
However, we can summarize these organizations in the following three types of
categories −
Clubs, associations, or society’s works for the welfare of their members.
Charitable institutions like hospitals, students’ hostels, and other
educational institutions providing education to poor children as well as
illiterate young and old groups.
Professional firms of lawyers, chartered accountants, architects, doctors,
solicitors, etc.
What is Non-Trading Account? Maintenance of proper books of accounts is necessary to safeguard the money of
its members and general public from any kind of misuse or misappropriations. It
is important to know the total receipts, total payments, and also to know financial
status of an institution. Hence, the account opened and maintained for and by the
organizations discussed above is known as Non-trading account.
Normally, registration of members, minute book, cash receipt journal, cash
payment journal, etc. are main record which is maintained by these organizations/
institutions in their non-trading accounts. At the end of an accounting period,
these institutions prepares its final accounts, which include the following −
Receipt and Payment Account
Income and Expenditure Account
Balance-Sheet
Let’s discuss each of these in detail.
Receipt and Payment Account It is a real account. Basic rule of double entries is followed to prepare this account.
It is prepared from a cash book at the end of the accounting period. Every
transaction regarding the cash transactions is recorded in the Cash Book in a
chronological order. We may say that the Receipt and Payment account is a
summary of cash payment and cash receipts during the current year.
For example, if rent and salary paid on monthly basis all over the accounting
period, and donation or subscription received during the current year recorded in
a cash book date wise, but at the end of the accounting period, the Receipt and
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Payment account will contain total amount of rent paid, salary paid, subscription
received and donation received. All cash receipt will be recorded on the debit side
and all cash payment will be recorded on the credit side.
Income and Expenditure Account Income and expenditure account is a nominal account and as an equivalent to
Profit and Loss account.
The essential features of an income and expenditure account are as follows −
Expenses and losses are recorded in the debit side of it and all incomes and
gains are recorded on the credit side.
Capital income and expenditure are excluded and revenue income and
expenses are included in it.
It is based on a mercantile system of accounting, therefore, the income and
expenses related to preceding years or subsequent years are excluded while
preparing the income and expenditure account.
The credit balance of an income and expenditure account shows surplus.
Further, excess of income over the expenditure and the debit balance of it
show deficit i.e. excess of the expenditure over income.
Only nominal accounts are considered in preparation of this account.
Balance Sheet The date on which a balance sheet is prepared, particulars of all the assets and
liabilities are recorded in the same manner as we do in any other profit making
firms. Its capital fund is made up of surplus income over expenditure and other
incomes capitalized in the given period of time. Sometimes, two balance sheets need
to be prepared viz…
At the beginning of the accounting year to know the opening capital fund and
At the end of the financial year to know the financial position of the organization.
Conversion of Receipt and Payment Account into
Income and Expenditure Account Following are the steps required to convert receipt and payment account into
income & expenditure account −
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Opening balance and closing balance of a receipt and payment account
representing opening cash in hand, opening cash at bank, closing cash in
hand, and closing cash at bank need to be ignored.
Items of capital receipts and capital payment will be excluded while preparing
an income and expenditure account.
Revenue items of an income and expenditure will be considered only at the
time of preparation of an income & expenditure account from the receipt and
payment account.
All adjustment regarding the outstanding expenses, prepaid expenses,
provision for bad debts, provision for depreciation, income received in
advance, and income receivable will be done.
An income and expenditure relating to preceding year or subsequent year will
be ignored, and the items only related to the current year will be considered.
Method to Calculation
With the help of ledger accounts, we may calculate the value of income or expenses.
The following two examples describe the method of calculation −
Example (1) − to calculate the amount of expenses of the current year, we need to
prepare a ledger account of a particular expense and then the balancing figure of
it will represent the amount of expense for the current year.
From the following particulars, please find out the amount of rent need to be shown
in income & expenditure account −
Particulars Amount
(in Rs.)
Outstanding Rent at the beginning of the year (as on 01-04-2013) 6,000
Amount as shown in the receipt and payment account 26,000
Outstanding Rent at the end of the year (31-03-14) 4,000
Solution −
Rent Account
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Date Particulars Amount Date Particulars Amount
01-04-13 By Balance b/d 6,000
To Cash Paid
(As per receipt
and payment
account)
26,000 31-03-14 By Income and
expenditure
a/c
(Balancing
Figure)*
24,000
31-03-14 To Balance C/d 4,000
Total 30,000 Total 30,000
It is very clear from the above example that the balancing figure represents rent for
the current year i.e. to be transferred and shown in the debit side of the income &
expenditure account. Following the same method, we can calculate the amount of
any other expenses.
Items Peculiar to Non-Trading Concern There are certain peculiar items in the case of non-trading concerns, which require
a special treatment −
Donations
Non-trading concerns may receive donations time to time. The treatment of
donation depends upon nature of donation.
There are two types of donation as explained below −
Specific Donation − Some donation may be received for any specific purpose,
for example, for the construction of a room or building and then donation is
termed as specific donation. The amount of such donation cannot be used
for any other purpose. It should be shown on liabilities side of the Balance-
sheet and used only for the same purpose it is meant for.
General Donation − When a donation is received for a common purpose is
termed as General Donation. If the amount of donation is small, it will be
treated as recurring income and will be recorded in the credit side of income
& expenditure account.
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Donation of the big amount should be fairly treated as capital receipts and
will be shown in the liabilities side of the Balance sheet. However, donation
is of a small amount or a big amount may depend upon the size of a concern
and amount.
Legacy
Sometimes, as per the will of a person, an amount received is called as legacy. It is
as good as donation. It is of a non-recurring nature, therefore should be treated as
a capital receipt, and hence will be appeared in the liabilities side of a Balance
sheet. However, it may also be treated as an income and may be taken to income
& expenditure account.
Entrance Fees
A club or society usually charge admission fees or entrance fees for the
membership. In case of club etc., admission fees or entrance fees usually charged
as capital receipts, but in case of a hospital or educational institution, it is treated
as a recurring income.
Life Membership Fees
The life membership fees may be taken from the members of institution only once
in their lifetimes. On the basis of lifetime membership, members may enjoy certain
benefits. Amount received as the Life Membership might be transferred to the “Life
Membership Fees Account” of the institution and can be dealt in the accounts by
any of the following methods −
May be taken as liabilities side of a Balance sheet as Life Membership Fees.”
Normal subscriptions of the members may be transferred from the Life
Membership Fees account to the subscription account as an income and the
balance may be carried forward to the following years.
On the basis of average life of a member, the amount may be transferred to
the income and expenditure account annually and rest will be carried
forward towards the following years.
Sale of Scrap or Old Newspapers
Without any dispute, it will be treated as recurring income and will appear in the
credit side of an income and expenditure account.
Subscription
Subscription is the major source of an income for the non-trading concerns.
Subscriptions are received from the members of a club or institution. A receipt and
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payment account records all the actual subscription received during the current
year and an income & expenditure account shows the subscriptions, which relates
to the current accounting period. Therefore, some adjustments require to calculate
the subscription of the current year.
Example (1) − to calculate the amount of Subscription for the current year, the
ledger account of a subscription account needs to be drawn and the balancing
figure of this will represent the amount of subscription of the current year.
With the following particulars, please find out the amount of subscription to be
shown in an income & expenditure account −
Particulars Amount
(in Rs.)
Outstanding subscription at the beginning of the year (as on 01-04-
2013)
6,000
Amount as shown in the receipt and payment account 26,000
Outstanding subscription at the end of the year (31-03-14) 4,000
Subscription received in advance for the next year 2,000
Solution −
Subscription Account
Date Particulars Amount Date Particulars Amount
01-04-13 To balance b/d 6,000 31-03-14 By Cash 28,000
31-03-14 To Advance
Subscription (to be
shown as Liabilities in
Balance Sheet)
2,000
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31-03-14 To Income &
Expenditure Account
(Balancing Figure)*
24,000 31-03-14 By balance
c/d
4,000
Total 32,000 Total 32,000
It is very clear from the above example that the balancing figure represents
subscription for the current year, which needs to be transferred to the income &
expenditure account as an income.
Special Funds
Some special funds are created by the respective institutions for specific purpose.
For example, a prize fund may be created to give the best player of the year award.
Any income relating to those funds should be added to the funds and deficit, if any
may be charged from the income & expenditure account.
Example (2) − to calculate the amount of an income related to the current year, we
need to prepare a ledger account of the particular income. Further, the balancing
figure of this account will represent the amount of an income for the current year.
From the following particulars, please find out the amount of Subscription that
needs to be shown in the Income & Expenditure account −
Particulars Amount
(in Rs.)
Outstanding Subscription at the beginning of the year (as on 01-04-
2013)
6,000
Amount as shown in the receipt and the payment account 26,000
Outstanding subscription at the end of the year (31-03-14) 4,000
Solution −
Subscription Account
Date Particulars Amount Date Particulars Amount
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01-04-13 To balance b/d 6,000
By Income and
expenditure a/c
(Balancing
Figure)*
24,000 31-03-14 By Cash (As per
receipt and
payment
account)
26,000
31-03-14 By balance c/d 4,000
Total 30,000 Total 30,000
It is very clear from the above example that balancing figure represents
Subscription for the current year i.e. to be transferred and shown in the credit side
of the income & expenditure account.
It is very clear from the above example that balancing figure represents
Subscription for the current year i.e. to be transferred and shown in the credit side
of the income & expenditure account.
Financial Accounting - Single Entry As we know, there are two systems of recording transactions in our books of
accounts. In the previous chapters, we have learned about the double entry system,
now let’s discuss another system of accounting i.e. Single Entry System (SES).
Meaning and Silent Features of SES For every accounting transaction, everyone does not follow the principle of double
entry system of accounts. Some of the small business units do not keep their books
of accounts as per double entry system. In simple words, single entry system of
accounts mean — the business unit, which does not follow the principle of double
entry system.
There are following two types of SES of accounts −
Pure Single Entry System − Personal accounts like sundry debtors and
sundry creditor’s accounts are maintained, but real and nominal accounts
are not opened under this system.
Popular Sense − Under this system, three types of treatment are done.
o Double entry system followed for cash received from the debtors and
the cash paid to the creditors.
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o Single entry system followed for expenses paid, purchases of goods,
purchases of fixed assets etc.
o Provisional entries like bad debts, depreciation, etc. are not done.
Difference between SES and DES Single entry is an in-complete system of accounting, whereas double entry
system (DES) is a complete system of accounting transactions.
There is no reliability on books in a single entry system, whereas double entry
system is a reliable accounting system.
Checking of the arithmetical accuracy is possible in a double entry system
through preparation of trial balance, whereas it is not possible under a single
entry system.
Since, single entry system does not maintain Trading, and Profit & Loss
Account, and Balance Sheet; hence, ascertainment of the actual profit and
exact financial position of the firms is not possible, on the other hand, all
above is quite possible under the double entry system of accounting.
Limitations of SES Single entry system of accounts do not record two-fold aspects of each and
every transactions, hence, it is not a scientific system of keeping accounting
records.
Checking of the arithmetical accuracy is not possible due to non-preparation
of a trial balance. Preparation of a trial balance is not possible, because the
method of double entry system is not followed for each business transaction.
Ascertainment of the actual profit of a concern is not possible, as nominal
accounts are kept under single entry system. In the absence of nominal
accounts, Trading and Profit & Loss account cannot be prepared.
It is not possible to find the exact financial position of a firm in the absence
of real accounts, because without real accounts, it is not possible to prepare
the Balance sheet of a firm on a particular day.
Outsiders never rely on the books of accounts of a firm.
In case where owner of the business wants to sell his business, ascertainment
of exact value of the business is not possible, especially goodwill value of the
firm.
Single entry system is practiced only by the small business units.
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Preparation of Statement of Affairs To know the financial position of a business, the list of assets & liabilities and
statement of affairs are prepared on the last date of accounting period. As stated
earlier, in the absence of real accounts, it is not possible to prepare a Balance sheet.
Following points are required to prepare the statement of affairs −
With the help of personal accounts, a list of debtors and creditors should be
prepared.
Stock valuation method will be either on cost or market price, whichever is
lower.
Cash book balance should be physically verified with the cash book.
Bank balance should also be reconciled with the Bank statements.
Statement of affairs should contain the income received in advance and the
expenses paid in advance.
Excess of assets over liabilities will be capital of the proprietor or firm.
Basis for the valuation of fixed assets will be the purchased voucher and any
other available evidence.
How does the Statement of affairs Differ from Balance-Sheet?
Main difference between the statement of affairs and the Balance sheet is —
reliability on first is prepared through incomplete information and on later is based
on the scientific method of the double entry system of accounts.
Ascertainment of Profit under SES We have the following two methods to ascertain the profit under single entry system
−
Statement of Affairs or Net worth Method and
Conversion Method
Net worth Method
Under the single entry system, the ascertainment of the profit can be done without
preparing a Trading and Profit & Loss account. For example,
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1 To know the capital at the beginning of the year or at the last date of the
preceding accounting year, first step is to prepare the statement of affairs at
the beginning of the year.
2 One statement of affairs should be prepared on the last date of accounting
year to ascertain.
3 Drawing should be added to the amount of capital as ascertained at the end
of the year and the capital introduced if, any, during the year will be
subtracted.
4 Capital introduced if, any, during the year will be subtracted.
5 Difference of (3) – (1) will be the profit or loss for the year. If, (3) is more than
(1), then it is a profit or vice versa.
6 The amount of profit or loss as calculated by the step No. (4) above, will be
adjusted by the interest on capital and the interest on drawing (to ascertain
Net Profit of the firm).
Conversion Method
Under the conversion method system of accounting, change from the single entry
system to the double entry system on a particular date can be done by the following
procedure −
Statement of affairs should prepare on the date on which the change need to
be made. After the proper checking and verification of such balances from
available records, all the balances like cash balance, bank balance, assets,
liabilities, debtors, and creditors should appear in the statement of affairs.
An opening journal entry should be made to bring into the books as −
Journal Entry
AssetAA/cDr
AssetBA/cDr
AssetCA/cDr
LiabilitiesAA/c
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LiabilitiesBA/c
LiabilitiesCA/c
Being all assets and all liabilities brought forward from the
statement of affairs a/c.
Above entry will be a base entry to open all new books under the double entry
system of accounts and all the future transactions will be booked according to the
double entry system as explained earlier.
Conversion of Books of Last Year from SES into DES
To convert books of the last year from single entry to double entry system, it will
be assumed that all the subsidiary books are maintained properly under the single
entry system. However, following procedures need to be followed −
Where Cash Book, Personal Books, and Subsidiary Books are Maintained −
Opening statement of the affairs should be prepared at the beginning of the
period.
All the impersonal accounts as appeared in the cash book should be posted
in the respective impersonal accounts, if it has not been done earlier.
New impersonal accounts need to be opened through total of the subsidiary
books. For example, with the total of sales book and purchase book, sale
account will be credited and purchase account will be debited, vice versa in
case of returns.
All the new account should be opened for the entries relating to discount,
rebates, bad debts, etc. which are not passed through the subsidiary books.
This procedure will give two-folds effect of such transaction as appeared in
the personal accounts.
Month-wise positing should be done to the ledger accounts through petty
cash book, if, maintained by the firm.
After completion of the above procedure, a trial balance should be prepared
to confirm the arithmetical accuracy of the books of accounts.
After completion of the above procedure of trial balance, Trading and Profit &
Loss account and Balance sheet should be prepared (after considering all the
adjustments like prepaid expenses, outstanding expenses, income received
in advance, or receivables as well as the provisions for depreciations,
doubtful debts etc.
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Where only Cash Book and Personal Books are Maintained
In this case, a different procedure of conversion will be followed −
As described earlier, an opening statement of the affairs should be prepared
at the beginning of the period.
All the real and nominal accounts as appeared in the cash book and not
posted earlier in any account, should be posted in respective accounts.
An analysis of debit and credit side of personal accounts like debtors
accounts and creditors accounts will be done as per the method given below
−
Summary of Analysis to be Done
Sr.No. Debit side of Creditors’
Accounts
Debit side of Debtors’ Accounts
1 Bills payables
Opening balance as appeared in
opening Statement of Affairs
2 Discounts and rebates received Sale (Credit)
3 Return inward (Purchase
returns) Transfers
4 Transfers Bills receivables (Dishonored)
5 Cash paid to Creditors
6 Endorsement of Bills Receivables
in favor of Creditors
Sr.No. Credit side of Debtors’
Accounts
Credit side of Creditors’ accounts
1 Cash received
Opening balance as appeared in opening
Statement of Affairs
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2 Discount Allowed Purchases (Credit)
3 Bills receivables received Transfers
4 Discount and allowances Bills payables (dishonored)
5 Transfers
6 Goods returned (Sales
returns)
7 Bad Debts
Financial Accounting - Leasing In the field of real estate, leasing is a popular term because it is advantageous to
own land and building. Today, most of the businesses run their offices on the leased
premises.
A Lease is an agreement under which lessee (the person/entity, who takes
possession of the property) get the right to use the premises for the agreed period
of time in lieu of the rent as agreed between both Lessor (owner) and lessee. Lessor
has an ownership right of assets, but still lessee has an unrestricted right to use
that asset.
Every lease contract should cover the following terms −
Period of lease.
Timing of the payment to be made along with the amount of rent.
About maintenance expenses, taxes, insurance, provision for renewal of lease
agreement.
The Accounting Standard 19, issued by the Council of the Institute of Chartered
Accountants of India, covers the disclosure of appropriate accounting policies in
the financial statements.
Standards 19 are mandatory in nature and applicable to all lease agreements
except some given below −
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Lands to be used under the lease agreement.
For use of natural resources like oil, gas, timber, metal, etc.
Video recording, films, motion picture, patents, and copyrights.
Important Terms in Leasing Following important terms are commonly used in lease accounting −
Lessee − Lessee is a person who possess the right to use the asset in lieu of
agreed rent for a certain period of time (as per the lease agreement).
Lessor − Lessor is the owner who gives right to the lessee to use his
asset/property in lieu of rent for a certain period of time.
Lease Term − Usually, lease agreement is contracted for a fixed and non-
cancellable period called as lease term. It is also known as ‘Lease Period.’
Lease term may be further extended as agreed with or without further
amendment/s.
Fair Value − Fair value is an amount on which an asset can be exchanged or
it may be the value of liability settled.
Useful Life − It can be
o A period over which an asset could be used by the lessee.
o Expected number of units that can be produced by that asset.
Inception of Lease − It is the date on which principal provision of the lease
are committed to.
Residual Value − An estimated fair value of an asset at the end of the lease
term is called as residual value.
Minimum Lease Payment − Total payment to be made by lessee to lessor
during the lease terms excluding taxes, insurance, maintenance charges,
contingent rent, etc.
Contingent Rent − It is based on a factor other than passage of time, lease
payments i.e. percentage of sale, etc.
Unguaranteed Residual Value − An expected fair value at the end of the
lease period is called as Unguaranteed Residual Value.
Popularity of Leasing One of the main reasons behind the popularity of leasing is its simplicity to both
the parties i.e. lessor as well as lessee. It is beneficial in terms of its documentation
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and also provides tax advantage. Selection and purchase of asset come under the
purview of leasing company, and use and rent payment of the assets are the part
of lessee.
Since lessor remains owner of the assets, so he can claim for the depreciation in
his books. Interestingly, he can enjoy the tax benefit against the depreciation.
Similarly, lessee pays the rent and records such rent in his books as expenses for
the purpose of tax benefit.
Advantages of Leasing Main advantage of leasing is given hereunder −
Lessee can use the asset without actually purchasing it, means full finance
without any margin money.
It provides flexibility in fixation of the rent and the lease period as per the
requirements.
In the Balance sheet of a lessee, leased assets are not shown as asset or
liability of the company, hence the credit capacity of the lessee remains un-
affected.
Leasing provides an opportunity to lessee to earn additional profit and to
improve earnings per share.
Deduction of a rent is eligible to claim tax benefit (as business expenditure).
Without heavy investment, lease rent can be paid out from the income
generated by the use of the assets.
Tax benefit of the depreciation may be claimed by lessor according to the
Income Tax Act.
Taking advantage of the full utilization of the asset is possible under a lease
agreement; chances of ignorance are high, where company purchases asset
as its own.
In case of a closely held company, it provides better wealth planning
solutions.
It provides protection to lessee against the inflation.
Strict provisions of the financial institutions for acquiring an asset can be
avoided through a lease agreement.
Disadvantages of Leasing
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Some of the disadvantages of leasing are −
Leasing is not very much useful for some of the new businesses, as earning
through the business comes much after the investment.
Some of the incentives as provided by the state and the central government,
cannot be enjoyed due to lease agreement.
The assets, whose values are likely to appreciate, should be purchased
instead of leasing.
In case of variation clause in a lease agreement, rental structure can be
changed due to change in the rate of interest, rate of depreciation, etc.
Classification of Lease According to AS-19, following are the two categories of Leasing −
Operating lease
Finance Lease
Operating Lease
Operating lease is an agreement wherein the lessor (owner) allows the renter
(lessee) to use the agreed asset for a particular period. Usually, the lease period is
shorter than the economic life of the asset. Further, lessor does not actually
transfer the ownership rights. The Lessor gives the right to the lessee to use the
asset in return of regular payments for an agreed period of time.
Accounting Treatment
As per AS-19, following are the accounting treatment in the books of lessor and
lessee −
In the books of Lessor −
Assets should be treated as the fixed assets in the Balance sheet of a lessor.
Rental income should be treated as an income in the Profit and Loss account.
Depreciation should be treated as expenses and should be debited from the
Profit & Loss account.
An initial cost can be deferred to the lease period of the asset or may be
booked as expenses in the year, in which actually incurred.
Depreciation will be charged as per AS-6.
In the books of Lessee −
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Lessee should treat a rental payment as expenses in the profit and loss
account.
Finance Lease
In case where lease is able to secure for lessor the recovery of his capital outlays
plus a reasonable return on the fund invested during the lease period is called
financing lease. Finance lease in non-cancellable contract and also, lessor is not
responsible for any expenses and taxes of the leased asset.
Accounting Treatment
In the books of Lessor −
Total value of the investment plus income receivable on it will be treated as
receivables in the Balance sheet.
Direct expenses may be directly debited from the profit and Loss account in
the year of expenses incurred or may be deferred up to the lease period.
In the books of Lessee −
Initial direct cost will be treated as an asset.
Fair value of the leased assets should be considered as an asset and a liability
in the finance lease.
It is an appropriate to show liability separately in the Balance sheet.
Financial Accounting - Investment Account Anyone can buy and sell securities from a stock exchange with the purpose to
increase his/her (monetary) assets. Sale and purchase of the securities is done
through banks. The stockbrokers help people in trading by paying the amount of
commission, stamp duty, and brokerage on it, which are the essential parts of
security trading.
At the time of selling of these securities, charges should be deducted from the sale,
as proceeds to get the actual sale price. Most of the time, market price is different
from the face value of securities, which depends upon different regulating factors.
If market value of the securities is equal to face value, it is called as at par; if
market value is less than face value, it is called as on discount; and if market value
is higher than face value, it is said to be on premium.
Meaning of Investment
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Investment means either buying or creating an asset with the future expectation of
capital appreciation, dividends (profit), rents, interest earnings, or some
combination of these returns. However, normally, investment inherent with some
form of risk, such as investment in equities, property, and even fixed interest
securities, among other things, are the subject to inflation risk.
Further, among all these, securities are held as long term investment to earn
income. It is said to be fixed assets, but where objective of an organization is to sell
and buy securities in short term fund to utilize its surplus fund, would come under
the category of current assets.
There may be two types of securities −
Fixed Interest Securities − Holders of fixed interest securities get fixed rate
of interest.
Variable Yield Securities − Under this category, return on investment may
differ from year to year.
Investment Account Investment account is an account opened for the purpose of the investment.
Further, if the number of investment is large, a separate account for each
investment should be opened.
Accounting entry on the purchase of any investments are given as hereunder −
On purchase of investment
Investment A/cDr
To Cash/Bank A/c
(Being Investment made)
Note − Investment account is
inclusive of purchase expenses like
stamp duty, Commission, and
brokerage.
On Sale of investments
Cash/Bank A/cDr
To Investment A/c
(Being Investment made)
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Note − Investment account will be
credited with net realized value of
investment.
Interest and dividend account
Cash/Bank/Investment A/cDr
To Dividend/Interest A/c
(Being Interest/dividend received on
investments)
Note − Investments account will be
credited in case, interest/dividend
accrue and cash/bank account will
be debited (in case) with net realized
value of investment.
Investment Transactions We normally have the following two types of investments transactions −
Cum Dividend or Cum Interest Quotations and
Ex-Dividend or Ex-Interest Quotations
Let’s discuss these two types of investment transactions in detail.
Cum Dividend or Cum Interest Quotations
Interest and dividend on the fixed investments accrued on regular interval, but
payment of those are made only on fixed dates. Dividends are always paid to the
persons, who are shareholder at the time of payouts. Suppose a shareholder sold
his shares after keeping those shares in his hand up to ten months, then dividends
on those shares will be paid to the buyer or we can say, to new shareholder.
So, a seller at the time of selling shares normally charge value of the accrued
dividends up to the date of sale, and this is called ‘CUM DIVIDEND” or “CUM
INTEREST”. Since, the sale price is inclusive of the value of a share and interest or
dividend, therefore at the time of entry in the books of accounts, normal price of
share should be booked in the investment account and the value of dividend or
interest should be debited to dividend or interest account.
At the time of receiving dividend or interest, dividend or interests account will be
credited, debiting cash or bank account. On the other hand, in the books of seller,
normal price of the share should be credited to Investment account and the price
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of accrued dividend or interest should be credited to the dividend or interest
account as the case may be.
Accounting Entries − It can be understand through the following table.
In the Books of Buyer
On purchase of investment
Investment A/cDr
Dividend or Interest A/c
To Cash/Bank A/c
(Being Investment made)
On receipt of dividend or interest
Cash/Bank A/cDr
To Dividend or Interest A/c
(Being dividend or interest received)
for Accrued Interest
Accrued Interest A/cDr
To Interest A/c
(Being interest accrued)
In the Books of Seller
On Sale of investments
Cash/Bank A/cDr
To Investment A/c
To Dividend or Interest A/c
(Being Investment Sold )
On receipt of dividend or Interest
Cash/Bank A/cDr
To Dividend or Interest A/c
(Being dividend or interest received)
Ex-Dividend or Ex-Interest Quotations
The buyer of shares when he is quoted ex-dividend is not entitled to receive the
payment. It is the interval between the record date and the payment date during
which the stock trades without its dividend. Therefore, the person who owns the
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security on the ex-dividend date will be awarded the payment, regardless of who
currently holds the stock.
Difference between Cum-dividend and Ex-Dividend
Major differences between them are given as hereunder −
Cum interest or dividend prices are inclusive of the interest or dividend
accrued at the date of purchase, whereas in case of the ex-dividend, prices
are excluding value of the dividend or interest.
The purchase price is higher than normal purchase price in case of Cum-
dividend, whereas purchase price is the real price in case of ex-dividend.
Nothing is payable additional in case of Cum-Interest, whereas separate
amount of the dividend or interest has to be paid in case of the ex-dividend
or ex-interest.
Balancing the Investment Account
Difference of debit and credit side of the investment account is Profit or Loss in
case where all the investments are sold.
In case where part of the investments are sold and the balance investments stand
unsold, it should be carried forward to the next accounting period and remaining
balance of the two sides (debit and credit) will represent profit or loss on the sale of
investment.
In case where investments are the fixed assets, then the profit or loss will be of
capital revenue or capital loss and should be treated accordingly.
Equity Share Accounts Main features of investment account regarding the equity shares are given as
hereunder −
Bonus Shares − Bonus shares are issued by the profitable companies to the
existing shareholders of the company without any additional amount.
Purpose of the bonus share is to capitalize reserves of the company. Only
number of the shares will be added in face value column, and principle or
capital column will remain unchanged.
Right Shares − Right shares are first offered to the existing shareholders of
the company as a matter of the right, hence called as right shares. As per
Companies Act, right shares can be issued after two years of the
establishment of a company or after one year of first issue.
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Financial Accounting - Insolvency Accounts Insolvency is a financial stringency i.e. when an individual or an
organization/company is no longer capable to pay the debts he/it owes. Insolvency
usually leads to insolvency proceedings, in which legal action can be taken against
the insolvent, and assets may be liquidated to pay off the outstanding debts.
When a Person / Entity can be Declared Insolvent Before declaring an entity or a person as insolvent, a competent court defines two
conditions −
A person or entity should be debtor and
He/it should had done any act of insolvency.
Act of insolvency means, when a person (debtor) shows that he is not able to pay
his liabilities.
An order of adjudication must be passed by the court of law, before legally declaring
any person insolvent. To pass an order of adjudication by the court of law, a petition
should be filed by any of the creditor or creditors or by the debtor himself. Petition
by the creditor may be filled only in following conditions;
Debt should be at least for Rs. 500/- or more
Within three months of petition, an act of insolvency should be done by
debtors.
After filing the petition, the competent court will fix date of hearing and then it may
declares that the debtor is insolvent or not. If insolvency of a person starts from an
earlier date, and not from the date of adjudication passed by the court. This is
known as Doctrine of Relation Back.
Under Presidency Towns Act, to conduct the insolvency proceedings, an official is
appointed by the court is known as Official Assignee and in case of Provincial
Insolvency Act, known as Official Receiver. The property of the insolvent vests in
the official assignee or receiver to realize the assets and distribute the sale proceeds
of the assets in the manner given below −
Secured creditors will be paid in full.
Remuneration and expenses of the official receiver.
To Preferential Creditors.
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To unsecured creditors + partly secured creditors to the extent remain un-
secured.
The Order of Discharge
Order of discharge is an order issued by the court of law to the insolvent. Normally,
this order releases the insolvent from all current and provable debts and liberates
him from the legal obligations imposed on as insolvent. The order of discharge is
issued on the basis of the report submitted by the official receiver and on the
application of the insolvent.
Interest
An interest @ 6% pa will be paid to the creditors for the period, after the order of
adjudication, if, any surplus remains, after full payment to the creditors.
Voluntary Transfer
As per the Presidency Towns Insolvency Act, any property transferred by the
insolvent without any consideration during the two years preceding the order of
adjudication shall be void. Under the Provincial Insolvency Act, such transfer
became inoperative, if made with two years of petition of the insolvency except
followings −
For consideration of marriage and made before and
To purchase valuable consideration in good faith.
Insolvency Law The Insolvency Act in India is based on English Bankruptcy Act and following two
acts are applicable on the Indian Territory −
The Presidency Towns Insolvency Act, 1909 − Applicable to Mumbai,
Kolkata, and Chennai.
The Provisional Insolvency Act, 1920 − Applicable to the rest of India
except Mumbai, Kolkata, and Chennai.
Above Insolvency Acts are applicable to any Individual, Partnership Firm, and
Hindu Undivided Family only. Companies Act, 1956 applies to Joint stock
companies and the term liquidation is used instead of Insolvency. In case of
insolvency, a person is not able to pay his liabilities but in case of liquidation,
company may be liquidated even it has the sufficient amount to pay its liabilities.
Insolvency Accounts
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Under the Presidency Towns Insolvency Act, insolvent has to submit following
documents to the court of law −
Statement of Affairs as on date of order and
Deficiency Account.
No provision, for the submission of a Statement of Affairs under Provincial
Insolvency Act. The form of Statement of Affairs as prescribed by the rule made
under Presidency Towns Act is given below −
Statement of Affairs
(As required by the Indian Insolvency Act)
In the Court of Justice
In insolvency
To the insolvent – you are required to fill up carefully and accurately, this sheet
and the several sheets, A,B,C,D,E,F,G, and H, showing the state of your affairs on
the day on which the order of adjudication was made against you viz. the
…………day of …………..20…….
Such sheets, when filled up will constitute your Schedule and must be verified by
Oath or Declaration.
Gross
Liabilities
(Rs.)
Liabilities (as
stated and
estimated by the
debtor)
Expected
To rank
Assets (as stated
and estimated by
the debtors)
Estimated
to produce
Unsecured
Creditors as per List
A
Fully Secured
Creditors as per list
B
Less: Estimated
value of Securities
Property as per List
E, viz.
Cash at Bank
Cash in hand
Cash
deposited
with solicitor
for cost of
petition
Stock in trade
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Less: Amount
thereof carried to
List C
Balance
thereofcontra
Partly secured
creditors as per List
C
Less: Estimated
value of Securities
Preferential
Creditors as per List
D (Creditors for
rent, taxes, salaries
and wages, etc.)
payable in full as
per contra
Machinery
Trade Fixture,
Fitting,
Utensils, etc.
Furniture
Life Insurance
Policies
Other
property
Book debts as per list
F, viz.
Good
Doubtful
Bad
Estimated to produce
Bills of exchange or
other similar
Securities on hand as
per List G
Estimated to produce
Surplus from
securities in the
hands of creditors
fully secured (per
contra)
Deduct: Creditors for
preferential rent,
rates, taxes, wages,
etc. (per contra)
Deficiency as per
explained in list H
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I /We ………………make oath, solemnly affirm, and say, that the above statement
and the several lists hereunto annexed marked A,B,C,D,E,F,G, and H are to the
best of my/our knowledge and belief, a full and complete of my/our affairs on the
date of the abovementioned order of adjudication made against me/us.
Affirmed------------------ at. ………….this……………day of Sworn Before me.
……………………
(Signature)
Commissioner
Just like Balance sheet, the statement of affairs is divided in to two part of Assets
and Liabilities and liabilities of the insolvent are classified as −
Unsecured Creditors as per List A
Trade creditors, stridhan ornament and personal belongings etc. of lady) of Mrs.,
bills payable, bank overdraft, partly paid shares held, uncompleted contracts
guarantees given for others, etc., wages, rent, salaries, etc.
Loan from Wife
Loan taken from wife is usually treated like any other loan taken and makes wife
creditor of the insolvent. In case, it is proved that loan is paid by wife out of amount
received from insolvent, then be treated as the capital of insolvent.
Interest
@ 6% interest will be paid to the creditors after the date of adjudication, if there is
a sufficient balance left after the payments to creditors.
Fully Secured Creditors as per List B
The creditors who have sufficient securities against their claims will be included in
this list and after paying these creditors, balance amount will be shown on the
asset side of the statement of affairs as available balance to distribute among other
creditors.
Partly Un- secured Creditors as per List C
Un-paid or unsatisfied amount of the partly secured creditors will be shown as
expected to rank column as unsecured creditors, to be divided for unpaid amount.
Preferential Creditors as per List D
Following creditors comes under the category of preferential creditors and such
creditors get preference over the un-secured creditors.
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As per the law, following creditors come under category of the preferential creditors
−
Government and local authority.
Salary and wages for the service rendered for four months preceding the date
of the presentation of the insolvency petition.
Under Presidency Town Insolvency Act, one month rent comes under the
category of preferential creditors, but rent is not at all comes under the
preferential creditors category as per the Provincial Insolvency Act.
The assets as shown in the statement of affairs of insolvent are classified into the
four categories as follows −
Property as per List E − Other than the bills receivable in hand and the
assets as kept by creditors as fully and partly secured debts are comes under
this list.
Property as per List F − Following are the three categories of book debts −
o Good
o Doubtful Debts
o Bad
Assets as per List G − Bills of exchange and other similar securities comes
under this list.
Deficiency Account as per List H − As name suggests, deficiency account
means the deficiency, which the insolvent debtor is not able to pay.
Important Points in Preparation of Statement of Affairs
In case of an individual insolvent, no distinction will be made between the
private assets and the business assets while preparing a Statement of Affairs.
Personal assets are included in the Statement of Affairs to pay the business
liabilities. In case of partnership firm, after paying personal liabilities from
the personal assets of the partner, surplus if any, may be included in the
statement of affairs of Partnership firm to pay the business liabilities.
Value exceeding Rs. 300/- of tools, wearing apparel, bedding, cooking
utensils, etc. will be included in the statement of affairs under the Presidency
Towns Insolvency Act. Assets, as pledged against secured and partly secured
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creditors, may be shown in the statement of affairs only, if, became surplus
after paying the fully and partly secured creditors.
Fully secured assets are not shown in the ‘expected to rank’ column.
Partly secured assets after paying partly secured debts will be shown in the
column of ‘expected to rank.’
The bills discounted to be dishonored are included in the un-secured
creditors as per the list A.
Difference between Balance Sheet and Statement of Affairs Following are the main differences between Balance Sheet and Statement of Affairs
−
The value of assets is shown as books value as well as releasable value in the
statement of affairs; however, it is shown as only book value as in the case
of Balance sheet.
In the Statement of Affairs, prepaid expenses and goodwill are not included,
whereas all fictitious assets are included in the Balance sheet.
Statement of Affairs does not include capital, drawings, profit, or loss, interest
on capital, whereas Balance sheet includes all such items.
Balance sheet does not show the amount of deficiency as shown in the
Statement of Affairs.
Balance sheet is prepared at the end of accounting period, whereas Statement
of Affairs is prepared on the date on which order of adjudication is passed.
Statement of affairs is prepared as per the rule of Insolvency Act, whereas
Balance sheet is a routine work to maintain the accounting record.
Balance sheet of a firm does not include personal assets and liabilities,
whereas Statement of Affairs includes the same as discussed above in this
chapter.
Statement of Affairs includes contingent liabilities, whereas in the Balance
sheet, contingent liabilities are shown as footnote only.
Deficiency Account (List H) Specimen of Deficiency Account List H
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Amount
(Rs.)
Amount
(Rs.)
Excess of Assets over liabilities i.e.
capital on ……..
Net profit arising from carrying on
business after deducting usual
trade expenses, income or profit
from other source i.e.
Interest on capital
Excess of private assets
over private liabilities
Profit on realization of any
assets
Deficiency as per statement of
Affairs
Excess of Liabilities over
assets
Net Loss arising from carrying
on business after deduction
from profit, usual trade
expenses
Bad debts as per list F
Expenses incurred since…….
Other than usual trade
expenses, viz.
House hold expenses
(Drawings)
Other Losses −
Loss on realization of
Assets
Loss through dishonor
of discounted bills
Speculation losses
Losses through betting
Excess of private liabilities
over private assets, etc.
From the above, it is clear that debit side of the deficiency account shows capital
account and credit side of the deficiency accounts shows losses and drawing and
the difference of two sides is a deficiency as shown in the Statement of affairs
Account.
Insolvency of Partnership Firm Insolvency of the partnership firm differs from the insolvency of any individual or
HUF (Hindu undivided family). The assets of an individual are used to pay the
business liabilities, but in case of partnership firm, assets of the partners are used
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to pay his personal liabilities first, and then balance, if any, may be utilized to pay
the business debts. After paying the personal debts of a partner, surplus assets
will appear in the Statement of Affairs and will be shown as “Property as per List
E.”
In case, if personal asset of a partner is in possession of any creditor as security,
still such creditor will get his dues first as unsecured creditor from the firm and
then for the balance amount, he may sell the property, owned by him to recover his
dues.
Stock Exchange Transactions Stock exchange is an organized market where sale and purchase of listed securities
of all description i.e. shares, stocks, debentures, government securities, etc. are
done. It is a government approved market place where buyer and seller of securities
of all kind find each other to buy and sell securities on the market price.
Meaning of Stock Exchange “ An association, organization or body of individuals, whether incorporated or not,
established for the purpose of assisting, regulating and controlling business in
buying, selling and dealing in securities.”
- The Securities Contracts (Regulation) Act, 1956
A stock exchange is a common and authorized point of exchange, which offers the
services for stock brokers and traders to buy or sell stocks, bonds, and other
securities of such kind. Further, it also provides facilities for issue and redemption
of securities, other financial instruments, and capital events. For example,
payment of income and dividends.
Features and Characteristics of Stock Exchange Following are the main features and characteristics of a stock exchange −
Stock exchange is the market place where trading of listed securities can be
done.
Trading of un-listed securities is not allowed.
There are certain rules and regulations that need to be followed while trading.
Stock exchange is an association of persons, whether incorporated or not.
Anyone can buy or sell securities whether he is investor or speculator.
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For doing business transaction i.e. sale & purchase of securities, membership
is compulsory. Non-members are not allowed to do business transactions.
Membership can be applied only when there is a vacancy in any stock
exchange and after paying the prescribed fees of respective stock exchange,
membership can be acquired. Members of stock exchange are called
as brokers and commission charged by them for the transaction done is
called as brokerage.
Only a broker (member) can buy or sell securities, therefore, investors or
speculators can do transaction through members only.
Functions and Services of Stock Exchange Followings functions are performed by Stock Exchange −
Anyone can sell and buy any industrial, financial, and Government
securities. Stock Exchange is an organized ready market to do all this.
Liquidity is provided by the stock exchange. Investors and speculators can
buy and sell their securities at any time.
Stock exchange provides collateral value to the securities that is helpful in
borrowing from the bank on easy terms.
Capital for the industrial growth is provided by the stock exchange that is
helpful for the investor to participate in the industrial development.
Price list and reports are prepared and published in the newspapers and
broadcasted through the TV channels by stock exchange. It is helpful in
knowing the true value of the investments. With the help of this, an investor
or speculator can get to know the fair market value of his securities as per
the latest market trend.
Listing of securities is encouraged by the stock exchange. Listing of securities
means — “a permission to trade” that is given by the stock exchange only
after fulfillment of the prescribed standards.
Listed companies have to provide the financial statements, reports, and other
statements time to time to stock exchange — necessary for the maintaining
the record and deciding the value of securities.
Thus, stock exchange works as the center of providing business information at one
platform.
Procedures for Dealing at Stock Exchange
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Following procedures are normally followed for dealing at stock exchange −
No one can directly deal in stock exchange, therefore, any person who wants
to sell or buy securities, requires a broker through whom selling or buying of
securities can be done.
After finalization of a member or a broker, intending buyer or seller of the
securities, places an order according to his choice, mentioning tentative
quantity, and price. Thereupon, broker opens a new account for each client
and start trading in the best possible way.
After getting an order, broker tries to finalize the deal between seller and
buyer. After finalization of deal, seller and buyer of securities send a selling
and buying note respectively mentioning the detail of traded securities.
Finally, settlement of account may be done in the following three manners −
o When the settlement of account is done as per the fixed and agreed
date, it is called as “liquidation in full.”
o When only difference of agreed price and ruling price is settled on the
fixed date, it is called as “liquidation by payment of difference.”
o When a settlement is carried forward to the next settlement period, it
is known as “carried over to next settlement period”.
In case, when purchase is delayed and charge debited by the broker to purchaser
is known as “contango” (Contango charge is also known as “Badla” Charge) and in
case, where sale is delayed by the seller and charge debited by the broker is known
as “backwardation.”
Operators at Stock Exchange The following figure shows the three operators at the Stock Exchange −
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Broker
As studied earlier, no one can deal directly in stock exchange and every intended
seller or buyer, who wants to sell or buy securities has to deal through members
known as brokers. Broker is duly certified by SEBI (Stock and Exchange Board of
India) under its 1992 rule. Membership of the stock exchange is restricted to
prescribed numbers of members, to financially sound persons who have sufficient
experience in dealing in securities.
A broker cannot buy or sell securities on his personal capacity. He charges
commission from the parties, sellers, and buyers and deals on the behalf of his
non-member clients.
Sub-broker
Sub-brokers are non-members of the stock exchange and deal only on behalf of the
members or registered brokers. Commission is received by sub-brokers on the
business procured by them out of total commission received by the brokers. Sub
brokers are known as “half commission men” and “remisiers” too.
Jobbers
Jobbers are the independent dealers, who deal in securities at their own. A jobber
cannot sell or buy securities on the behalf of others, but he deals in securities for
his own profit through fluctuation of the prices. Difference between sale price and
purchase price of securities is the profit of a jobber.
Important Terms used in Stock Exchange Following are the significant terms more commonly used in stock exchange −
Bull − Bulls are those brokers who strongly expect price hike of securities
and with this hope, they buy shares to sell them at later stage (when price
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gets increased). Thus bull market means when buying of the securities are
on much higher side instead of selling of the securities. Bulls first buy
securities and sell when the price of securities is high.
Bear − Bear is pessimist, who expect fall in the price of certain securities. A
Bear first sells his securities and purchases at later stage when the price of
securities are low and the difference of both is his profit.
Stag − A cautious investor or speculator is known as a stag. Stag doesn’t sell
or buy shares in his hand, but he tries to buy shares of new company with a
hope that price of those shares will increase in the future.
Blue Chips − Shares of well-recognized, well-renowned, financially strong,
and well-established companies.
Cash Shares − Settlement of some of the transactions are completed in cash
are known as cash shares. These transactions are done by real and genuine
investors who want to buy or sell shares for the actual investment purpose.
Cleared Shares − Speculators are normally deals in such type of shares. In
these types of shares, settlement of the payments are done by the differential
amounts only; however, actual delivery of the securities may not be done.
Carry Over or Badla System − Speculator earns money by foreseeing the
future. If their expectations come true, they earn profit and if not, they lose
money. Speculator mostly does transactions on forward basis, when any
speculator forwards his transactions from one settlement date to another, he
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has to pay charges called “Badla charge.” Transaction of these natures is
called as Badla System.
Kerb Market − Transactions that done before and after the official hours are
known as kerb market.
Short Selling − Short selling means where the large volumes of securities are
sold by the bear speculator without actually possessing.
Arbitrage − Securities are traded at the different stock exchanges and there
is normally a little difference in prices (among different stock exchanges).
Therefore, arbitrage is practiced to take advantage of different rates.
Primary Market − Primary market is the market where new securities are
issued for the capital formation in the form of a new issue or in the form of a
right issue to the existing shareholders.
Secondary Market − Secondary market is the market where subsequent
trading (sale and purchase) of securities are done called as secondary market
and the transactions are known as secondary transactions.
Group A Shares − Actively traded shares of the reputed companies are called
a Group A shares.
Group B Shares − Not actively traded shares or the shares of different stock
exchanges are called as Group B shares.
SEBI The Securities and Exchange Board of India (SEBI) is the regulatory board. It
regulates affairs of stock exchange in India, similar to Securities Exchange
Commission of the United States. To protect the rights of investors and to enforce
an orderly growth of securities market, SEBI came into existence by an Act of
Parliament known as “Securities and Exchange Board of India Act, 1992”.
OTCEI
The Over the Counter Exchange of India (OTCEI) was established in India in 1990.
It is the latest concept and a new way to do securities business in India similar to
Electronic Exchange in the United States. Brokers located at the different regions,
communicate through latest means of technologies such as Telephones, Faxes,
Mobile phones, and Computers.
Selectors are allowed to select the prices as shown on the computer screen among
the competitive markets, without the floor meeting of brokers. It is the most
efficient, economic, and courageous way of the trading of securities. The latest
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market prices of the securities are displayed on the computer screens. Since, listing
of the securities is not required on OTCEI, hence it is the most suitable way for the
small and medium size companies.
Over-the-Counter Exchange of India
Brokers require and maintain following books of accounts as per the SEBI rules,
1992 −
Cash Book
Bank Book (Pass Book)
General Ledger
Client Ledger
Register of Transaction
Journal
Document Register (Showing Particulars of the Securities received and
delivered)
Members Contract Book
Duplicates of Contract Notes issued to clients
Written consent of clients
Margin Deposit Books
Register of accounts of Sub Brokers
An agreement with a Sub-Broker.
Accounts of Private Individuals Most of the private individuals never keep their accounts to record earned income
or expenditure incurred by them. It is advisable for everyone to maintain an
account to know what he has earned during a particular period, what he spent,
and what was his saving out of that income. It is helpful to track the record of
income and expenditure. It also helps to increase the income (as need arises) and
control on the expenditure.
Maintenance of Accounts by Private Individuals Private individual should keep his books on cash basis system, ignoring accrued
system in different heads like insurance premium paid, medical insurance, school
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fees, taxes, household expenses, medical expenses, clothing, salary received, bank
interest, income from mutual fund, rent received, and other income received.
For all these, one should keep a cash book, which can be summarized on monthly
basis as per the abstract of cash Book given below −
Abstract Cash Book
Particulars (of Income) Amount Particulars (of
Expenditure)
Amount
To Balance b/d
To Salary
To Rent received
To Saving Bank Interest
To Interest on FDR
To Income from Investment
To Income from profession or
Business
Total
xx
xx
xx
xx
xx
xx
xx
xxxx
By Kitchen
Expenses
By Electricity
Expenses
By
School/College
fees
By Clothing
By Insurance
Premium
(Life
insurance,
medi-claim,
accidental
insurance,
other
Insurance like
fire, theft etc.)
Total
xx
xx
xx
xx
xx
xxxx
In case of professional individual, one more column can be added in the cash book
to show professional transaction and personal transaction separately. In addition
to above, an individual may keep a register to maintain the record for his assets
including car, building, investments, etc.
Maintenance of Accounts by Professionals
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A cash basis of accounting is the most suitable system for any professional
including doctor, accountant, or solicitor instead of a mercantile system to fulfill
the following purposes −
To ascertain the professional income earned by him correctly for a specific
accounting period, and also to calculate the net professional income after
deducting the related expenses from the professional income.
To correctly record all items of income and expenditure.
Following records should be maintained by a professional −
Cash Book
All receipts and payments should be recorded in a cash book, and a memorandum
book should be maintained to keep record of credit transactions. The credit
transactions will be scored off at the time of actually cash receipt or at the time of
payment made and should be entered in the cash book.
A cash book can be summarized under various heads on monthly, quarterly, half
yearly, or annual basis as per the suitability and requirements.
Stock Register
Two separate stock registers should be maintained, one for resale items and other
to keep record of the items of personal use. Resale items may be medicine, surgical
items, the stationery items, electrical items, computers, and any other items or
asset.
Receipt and Expenditure Account
A receipt and expenditure account is similar to a profit and loss account; therefore,
it is prepared by the professionals to know the professional income and expenditure
for a specific period. Outstanding incomes are ignored to prepare it, but
outstanding expenses are included in it. Therefore, it is known as Receipt &
Expenditure account instead of Receipt & Payment account. It means, incomes are
recorded on a cash basis and expenditure on an accrual basis.
Maintenance of Accounts by Doctors Doctors usually maintain a register that may also be known as diary or note book
in which all the particulars of the patients including charges, fees, physical
conditions of patient, etc. are recorded. After grouping, the extracted entries of
diary are recorded in the cash book under different heads of income. Similarly,
expenses are also recorded under various heads.
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In case, where the number of doctors is two or more than two and they run their
clinic in the partnership, income may be recorded in the cash book under various
heads (Doctor Wise), similar to a petty cash book pattern. Similarly, the expenses
relating to each doctor may be recorded under various heads of the expenses.
Thus, cash book, stock register, memorandum book, Receipt and expenditure
account, and Balance sheet are prepared by the doctors.
Illustration
Dr. Ortho starts his medical practice on 1st January 2013 and introduced a capital
of Rs. 300,000/. Receipt and payment account as on 31-12-2013.
Receipt Amount
(Rs.)
Payment Amount
(Rs.)
To Consultation
Charges
To Capital Introduced
2,500,000
300,000
By Clinic Rent
By Salary to Staff
By Books &
Periodicals
By Medical
Equipment
By Other expenses
By Balance c/d
Cash in hand
Cash at Bank
240,000
300,000
15,000
450,000
38,000
57,000
1,700,000
Total 28,00,000 Total 28,00,000
Outstanding salary Rs. 50,000
Medical equipment was purchased on 01-04-2013
Depreciation on Equipment is Rs. 15%
Solution −
Receipt & Expenditure Account of Dr. Ortho
For the year ended 31-12-2013
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Expenditure Amount Receipt Amount
To Clinical Rent
To Salary to Staff300,000
Add: Outstanding
Salary50,000
------------
To Books & Periodicals
To Other Expenses
To Depreciation on
Equipment
To Surplus – Excess of
Receipt over Expenditure
2,40,000
350,000
15,000
38,000
50,625
1806,375
By Consultation
Charges
25,00,000
Total 25,00,000 Total 25,00,000
Dr. Ortho
Balance Sheet
As on 31-12-2013
Expenditure Amount Receipt Amount
Capital
Introduced300,000
Add:
Surplus1,806,375
_________
Outstanding Salary 2,106,375
50,000
Cash in hand
Cash at Bank
Medical
Equipment450,000
Less:
Depreciation50,625
_______
57,000
1,700,000
399,375
Total 2,156,375 Total 2,156,375
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Maintenance of Accounts of Educational
Institutions Most of the educational institutions are registered under Indian Society
Registration Act, 1860. The core purpose of formation of the educational
institutions is to educate people at large and not to earn profit.
Generally, following financial transactions are being incurred by the educational
institutions −
Main Sources of Collection Types of
Expenses/Payments
Admission fees, tuition fees, Examination fees,
fines etc.
Security deposit by students
Donations from public
Grants from Government for building, prizes,
maintenance, etc.
Salary,
allowances,
and
provident
fund
contribution
to teaching
and
nonteaching
staffs.
Examination
expenses
Stationery &
printing
expenses
Distribution
of
scholarships
and stipends
Purchase
and repair of
furniture &
fixture.
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Prizes
Expenses on
sports and
games
Festival and
function
expenses
Library
books,
newspaper,
magazines,
etc.
Medical
expenses-
medicine
and
examination
Audit fees
and audit
expenses
Electricity
expenses
Telephone
expenses
Laboratory
running &
maintenance
Laboratory
equipment
Building
Repair &
maintenance
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Separate collection register should be maintained to record these collections from
the above mention sources. Separate ledger for students should also be maintained
for each student to record the fees — due, received, and outstanding if any.
Normally, all accounting records are maintained on the basis of financial year i.e.
from 1st April to 31st March in most of the educational institutions. Educational
institutions maintain income and expenditure account to keep the records of
surplus or deficiency and also to prepare a Balance sheet to know the financial
position of the institution.
Consolidation of Accounts of various Educational
Institutions
Consolidation of accounts is done step by step, where various institutions are run
under one society.
The given example is an illustration of the simplified procedures −
Consolidation of Fees
Institute wise consolidation will be done as hereunder −
Opening Balance of Fees Due
Add: Fees due during the current financial year
Less: Fees collected during the current Financial Year
Outstanding Fees at the end of the year
XXX
XXX
XXXXX
XXX
XXX
Illustration
Trial Balance of the Brilliant education society as on 31st March, 2013 is given as
here under, please prepare an Income and Expenditure Account and a Balance
sheet on that date −
Particulars Amount (Debit) Amount (Credit)
Cash in Hand 68,000
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Cash at Bank 802,000
Scholarship Fund Investment 800,000
Miscellaneous Expenses 420,000
Interest received on Scholarship Fund 80,000
Interest Received on Investment 55,000
Investment 550,000
Sundry Creditors 236,000
Building 1,700,000
Furniture & Fixture 200,000
Addition to Furniture & Fixture 25000
Vehicles 280,000
Sundry Debtors 260,000
Capital Fund 2,400,000
Donation for Capital Fund 500,000
Entrance Fees 40,000
Course Fees 1,600,000
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Examination Fees 70,000
Auditorium Rent Received 850,000
Salary 1,100,000
Printing & Stationery 50,000
Scholarship Awarded 36,000
Scholarship Fund Reserve 360,000
Government Grant Received 100,000
Total 6,291,000 6,291,000
Additional Information
Salary for one month is outstanding.
Outstanding Auditorium is Rs, 50,000/- and Rs. 25,000 received in advance.
Depreciation is to be provided at 5% on building, 10% on Furniture & Fixture,
and 15% on vehicles.
Solution
In the Books of Brilliant Education Society
Income & Expenditure Account
For the Year ended 31st March, 2013
Expenditure Amount Income Amount
To Printing & Stationery
To Salary1,100,000
(+) Outstanding
50,000 By Entrance Fees
By Examination Fees
By Course Fees
40,000
70,000
1,600,000
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Salary100,000
--------------
To Miscellaneous Expenses
To Scholarship awarded
To Depreciation:
Building @ 5%85,000
Furniture & Fixture22,500
Vehicles @ 15%42,000
--------------
To Surplus of Income over
Expenditure
1,200,000
420,000
36,000
149,500
964,500
By Auditorium Rent850,000
(+) Outstanding
Rent50,000
--------------
900,000
(-) Advance Rent
Received25,000
--------------
By Government Grants
By Interest received on
scholarship fund
875,000
100,000
80,000
55,000
Total 2,820,000 Total 2,820,000
Balance Sheet
As on 31-03-2013
Liabilities Amount Assets Amount
Capital Fund2,400,000
Add: Donation500,000
---------------
2,900,000
Add: Surplus964,500
---------------
Scholarship Fund
Sundry Creditors
3,864,500
360,000
Building1,700,000
(-) Depreciation@ 5%85,000
--------------
Furniture & Fixture200,000
(+) Addition25,000
--------------
225,000
(-) Depreciation @10%22,500
1,615,000
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Salary outstanding
Rent received in advance
236,000
100,000
25,000
--------------
Vehicles280,000
(-) Depreciation @15%42,000
--------------
Investments
Scholarship Fund Investment
Sundry Debtors
Rent receivable
Cash in hand
Cash at Bank
202,500
238,000
550,000
800,000
260,000
50,000
68,000
802,000
Total 4,585,500 Total 4,585,500
Maintenance of Accounts of Student Hostels Hostels are run by most of the educational institutions to provide boarding facility
to the students, coming from remote places, for their education. Hostels are usually
run on no profit basis. Government also grants some fund to these hostels to
provide cheaper living space to the students.
Like any other non-profit organization, hostels also have accountants who record
and maintain their financial transactions as −
Receipt & Payment Account
Income & Expenditure Account
Balance Sheet
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Following are the common lists of incomes and expenditures incurred by Hostels −
Main Source of Collection Types of
Expenses/Payments
Admission fees
Security (refundable at the time of entering
into the hostel)
Room rent
Electricity, water, fans, coolers, heaters &
geysers charges etc.
Government grants
Fees for reading room & common room.
Mess charges
Medical Fee.
Electricity
expenses
Water charges
Building repair
& maintenance
Grocery &
provisions for
mess
Rent for hostel
Accommodation
(In case or
rented
premises)
Salary (Warden,
watchman,
sweeper etc.)
Telephone
expenses
Newspaper and
magazines
Illustration
From the given information and Trial Balance, please prepare an Income &
Expenditure account and Balance sheet of Divya Jyoti hostels (for the girls) for the
year ending 31-03-2014 −
Particulars Amount (Debit) Amount (Credit)
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Opening Stock −
Food
Fuel
Drinks
Sundries
31,500
4,500
3,000
6,000
Purchases −
Food
Fuel
Drinks
Sundries
1,065,000
90,000
135,000
15,000
Wages −
Mess
Others
337,500
97,500
Annual Day Collection 10,500
Building 6,300,000
Capital Fund 7,050,000
Cash at Bank 466,500
Common Room Expenses 24,000
Electricity and Water Charges 28,500
Electricity and Water Charges 42,000
Fans 75,000
Furniture & Fixture 225,000
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General Fund 450,000
Grants-Youth welfare Departments 300,000
Heaters 7,500
Income From Investments 82,500
Indoor Games Material 22,500
Investments 750,000
Land 750,000
Medical Expenses 19,500
Mess Charges (for guests) 30,000
Mess Fees 1,770,000
Rent for fan Heater etc. 16,500
Repair & Maintenance 33,000
Room Rent 352,500
Room Service Charges 9,000
Security Deposits 400,500
Total 10,500,000 10,500,000
Additional Information
Depreciation to be provided @ 5% on Building, Furniture, & Fixture; and 15%
on heater and Fans.
Closing stock: Food Rs. 22,500, Fuel Rs. 7,500, Drinks Rs. 4,500, and
sundries Rs. 3,000.
Solution −
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In the Books of Divya Jyoti Hostels
Income & Expenditure Account
For the Year ended 31st March, 2014
Expenditure Amount Income Amount
To Mess Expenses
Food: Opening Stock31,500
Add: Purchases1,065,000
--------------
1,096,500
Less: Closing Stock22,500
--------------
Fuel: Opening Stock4,500
Add: Purchases90,000
--------------
94,500
Less: Closing Stock7,500
--------------
Drinks: Opening Stock3,000
Add: Purchases135,000
--------------
138,000
Less: Closing Stock4,500
--------------
Sundries: Opening Stock6,000
Add: Purchases15,000
--------------
1,074,000
87,000
133,500
By Room Rent
By Rent for Heater, Fans,
etc.
By Grants-Youth Welfare
By Income From
Investments
By Annual Day Collection
By Mess Fees
By Mess Charges for
Grants
By Room Service Charges
By Electricity & Water
Charges
352,500
16,500
300,000
82,500
10,500
1,770,000
30,000
9,000
28,500
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21,000
Less: Closing Stock3,000
--------------
To Wages : Mess337,500
Others97,500
--------------
To Electricity & Water Charges
To Repair & Maintenance
To Indoor Games Material
To Common Room Expenses
To Medical Expenses
To Depreciation:
Building5%315,000
Furniture10%22,500
Heaters15%1,125
Fans15%11,250
--------------
To Excess of Income Over
Expenditure
18,000
435,000
42,000
33,000
22,500
24,000
19,500
3,49,875
3,61,125
Total 2,599,500 Total 2,599,500
Balance Sheet
As on 31-03-2014
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Liabilities Amount Assets Amount
Capital Fund
General Fund450,000
Add: Surplus361,125
------------
Security Deposits
7,050,000
811,125
400,500
Land
Building6,300,000
(-) Depreciation@ 5%315,000
------------
Furniture & Fixture225,000
(-) Depreciation @10%22,500
------------
Heaters7,500
(-) Depreciation @15%1,125
------------
Fans75,000
(-) Depreciation @15%11,250
------------
Investments
Closing Stocks:
Food22,500
Fuel7,500
Drinks4,500
Sundries3,000
------------
Cash at Bank
750,000
5,985,000
202,500
6,375
63,750
750,000
37,500
466,500
Total 8,261,625 Total 8,261,625
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Maintenance of Accounts of Hospitals Being a non-profit organization, hospitals also maintain Receipt & Payment
accounts, Income & Expenditure account, and Balance Sheet.
An illustration of the income and expenditure of a hospital is shown below −
Main Items of Income Types of
Expenses/Payments
Room Rent
Medical Care
Dentistry Charges
Delivery Room Charges
Anesthesia Charges
Laboratory Charges
Grants for operating needs of Hospital
Grants for fixed Assets
Donations
Miscellaneous Income
Interest on Investments
Fees from Nursing & Training School
Bed Charges
Operating Room Charges
X-ray Charges
Pharmacy Charges
Physiotherapy Charges
Electricity & Water
Charges
Pharmacy Charges
Salaries and Wages
Pharmacy Expenses
Building repair &
Maintenance
Laundry Charges
Rent for Nursing
Hostel
Accommodation (In
case or rented
premises)
Telephone Expenses
Laboratory Expenses
Surgery Expenses
Operation Tools and
Equipment Expenses
Depreciation
Illustration
A charitable hospital and pharmacy are run by Rehmat Ali trust; following are the
balances as extracted from its books for the year ended 31-03-2014 −
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Particulars Amount (Debit) Amount (Credit)
Consumption of
Medicines
Foodstuff
Drugs and Chemicals
Closing Stock of
Medicines
Foodstuff
Drugs and Chemicals
360,000
270,000
90,000
60,000
12,000
3,000
Salary 540,000
Electricity 315,000
Pharmacy −
Opening Stock
Purchase
Sale
Salary
Electricity
165,000
900,000
45,000
6,000
930,000
Furniture & Fixture 240,000
Ambulance 90,000
Telephone Expenses 78,000
Subscription 63,000
Ambulance Charges 2,400
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Consumption of Housekeeping Items 2,70,000
Bank Deposits @ 15% 1,500,000
Cash in hand 105,000
Cash at Bank 720,000
Sundry Debtors 181,500
Sundry Creditors 824,100
Remuneration to Trustees 63,000
Capital Fund 2,700,000
Donation 1,800,000
Fees 900,000
Rent 825,000
Food Supply 420,000
Building 960,000
Equipment 1,365,000
Total 8,401,500 8,401,500
Additional Information
Depreciation to be provided @ 5% on Building; 10% on Furniture; 15% on
Equipment; and 30% on Ambulance.
Closing stock of medicine at pharmacy Rs. 120,000
15% of the fees received from patients to be paid to specialist doctors.
Supply of medicines from pharmacy to the hospital Rs. 180,000 for which no
adjustment has been made in the books of accounts.
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Solution −
In the Books of Rehmat Ali Trust
Income & Expenditure Account of the Pharmacy
For the Year ended 31st March, 2014
Expenditure Amount Income Amount
To Opening Stock (Medicines)
To Purchase of Medicine
To Salaries
To Electricity Expenses
To Surplus of Income over
Expenditure
165,000
900,000
45,000
6,000
114,00
By Sale (Medicines)
By Medicine to
Hospital
By Closing Stock
930,000
180,000
120,000
Total 1,230,000 Total 1,230,000
Income & Expenditure Account of the Hospital
For the Year ended 31st March, 2014
Expenditure Amount Income Amount
To Consumption of
Medicines360,000
Add:
Medicine from
Pharmacy180,000
------------
To Consumption of Food Stuff
To Consumption of Drugs & Chemicals
To Consumption of House Keeping
To Salaries
540,000
270,000
90,000
By Fees
By Rent
By Recovery of Food
supply
By Ambulance
Charges
By Deficit (Excess of
expenditure Over
Income)
900,000
825,000
420,000
2,400
457,350
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To Electricity Expenses
To Subscription
To Fees to specialist 15% of fees
To Telephone Expenses
To Depreciation:
Building5%48,000
Furniture10%24,000
Equipment 15%204,750
Ambulance 30%27,000
------------
270,000
540,000
315,000
63,000
135,000
78,000
303,750
Total 2,391,750 Total 2,391,750
Income & Expenditure Account of Trust
For the Year ended 31st March, 2014
Expenditure Amount Income Amount
To Deficit (Hospital A/c)
To Remuneration to Trustee
457,350
63,000
By Surplus (Pharmacy)
By Interest due on fixed deposit
By Net Deficit
114,000
225,000
181,350
Total 520,350 Total 520,350
Statement of Affairs of Rehmat Ali Trust
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As on 31-03-2014
Liabilities Amount Assets Amount
Capital Fund2,700,000
Add: Donation1,800,000
----------------
4,500,000
Less: Net Deficit (-)181,350
----------------
Sundry Creditors
Fees Payable to specialist
4,318,650
824,100
135,000
Building960,000
(-) Depreciation@ 5%48,000
---------------
Furniture & Fixture240,000
(-) Depreciation @10%24,000
-------------
Equipment1,365,000
(-) Depreciation @15%204,750
-------------
Ambulance90,000
(-) Depreciation @30%27,000
-------------
Bank Deposits1,500,000
Add: Interest Due225,000
-------------
Closing Stocks:
Medicine60,000
Foodstuff12,000
Drugs & Medicine3,000
Pharmacy120,000
-------------
Sundry Debtors
Cash in hand
Cash at Bank
912,000
216,000
1,160,250
63,000
1,725,000
195,000
181,500
105,000
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720,000
Total 5,277,750 Total 5,277,750
Financial Accounting - Co-Operative Societies
Any ten persons who are competent to contract may file an application to the
Registrar of Co-operative Societies as per Section 6 of the Co-operative Societies
Act, 1912. By law, may be framed by each society and should be registered with
the Co-operative Societies.
Effectiveness of change by the law of societies is applicable only when changes are
approved by the Registrar of Society.
Types of Society There are two types of society −
Limited liabilities society
Unlimited liabilities society
Any member is not liable to pay more than the nominal value of the share held by
him and no member can own more than 20% of the shares of society.
Today, government is encouraging co-operative societies to help society at large.
Cooperative societies are operative in various sectors like consumer, industrial,
services, marketing, etc.
Under accounting system of Co-operative societies, the term Receipt and Payment
is used for two fold aspects of double entry system.
Accounts Following accounts usually maintained by the Co-operative societies −
Day Book (Journal)
Day Book (Cash Account)
Day Book (Cash Book with Adjustment Column)
Day Book (Journal)
Day book is a book of original entries. In a day book, all types of cash or non-cash
transactions are recorded, according to the principle of double entry system.
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As per the practice followed in the co-operative societies, a separate journal book
is not prepared rather all transactions are directly recorded in the day book. Day
book has two sides Receipt (debit) and payment (credit) and there are two columns
in each side of a day book, one for the cash transactions and second for the
adjustment.
Transaction for the cash receipt and cash payment are recorded in cash column
and payment side respectively. Similarly, entries are done in debit and credit side
of a day book in the adjustment column.
Day Book (Ledger for Cash Account)
Since, all the cash transactions are recorded directly in a day book, it might be
called as ledger account of cash book.
Day Book with Cash and Adjustment Columns
Specimen
Day Book with Cash and Adjustment Columns
Date Particular R.No. Cash Adjustment Date Particular R.No. L.F Cash Adjustment
Ledger
In the co-operative societies, posting of ledger is not done on the double entry
system. Receipt side of the day book on debit side of the ledger account and
payment side of the day book posted on the credit side of the ledger account.
Closing of Ledgers
In the co-operative societies, balancing of a personal account is done at the time
when any member clear his account or a new account is opened. Totals of all other
accounts (receipt and payments) are kept as it is. Balancing of receipt and payment
accounts are not required.
Receipt and Payment Account
A receipt and payment account is the summary of a day book and prepared for a
specified period. Receipt and payment account is prepared from the totals of
receipts and payment sides of the ledger accounts.
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Final Accounts
Trading & Profit and Loss account and Balance sheet are prepared from the receipt
and payment accounting after consideration of the adjustment entries. Items
appear under the receipt side are treated as income, and items of the payment side
are as expenditure.
Rules Appropriated as −
First 25% of the net profit should be transferred to the reserve fund account.
As per section 35 of Co-operative Societies Act, 1912, distribution of the profit
should not be more than 6.25%.
Contribution to charitable funds as defined in section 2 of Charitable
Endowment Act, 1890, which says that contribution may be done with the
prior permission of the Registrar. Maximum contribution is restricted to 10%
of the available profit, after transferring profit to reserve account.
Unlimited liabilities, co-operative society may distribute profit only after
general or special order of the State Government.
Financial Accounting - Insurance Claims Every business entity keeps sufficient stock as per the need and size of its
respective business for smooth running of the business, but at the same time risk
of loss by fire or by means is also there. To safeguard the businesses from any
unforeseen circumstantial loss, most of the business entities buy insurance policy,
which covers loss of stock (by fire) — is known as stock policy.
In consideration of the premium, insurance company takes the responsibility to
compensate — if any loss occurs by fire or by other means, applicable under the
insurance terms. It is in the best interest of the firm to take fire insurance policy
because it covers wide range of losses (by fire) including Building damage,
Furniture and Fixture loss, Plant & Machinery destruction, etc.
Following are the important points to be considered for the estimation of stock −
Gross Profit on Sale
Gross profit is calculated by deducting net sales from the cost of goods sold. To
know the gross profit of the last year, “Trading” account of the last year should be
referred.
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Memorandum Trading Account (for Current Year)
In case of fire, Memorandum Trading account is required to find the value of
estimated Stock. It is prepared with the help of Gross Profit ratio of the last year,
Opening Stock, Purchase, Sale, and Direct Expenses.
Value of Salvaged Stock
Value of stock as calculated at step-2 will be reduced by the value of salvaged stock
to arrive at the value of Insurance Claim.
Other Important Points
In case, where stock is not valued at the cost, first it will be valued at the cost
in the last year trading account and then in the memorandum account of the
current year. For example, if it is given that stock of Rs. 80,750 is valued at
85% of the cost in the last year, then first it should be valued
as (80,75085×100)=95,000(80,75085×100)=95,000 in the last year and then in
the current year memorandum Trading account.
Cost of the sample given free of cost or withdrawal of stock by proprietor or
partner of the firm for personal use, it should be adjusted in the Trading
Account of the last year as well as in the current year’s memorandum trading
account.
In case, where gross profits of the last several years are given, average gross
profit should be taken to determine the gross profit of the current year.
However, in case where clear upward trend of the gross profit or downward
trend of the gross profit is identified, weighted average gross profit or
reasonable trend of upward or downward trend should be applied to
determine the gross profit of the current year.
To find out the gross profit on normal sales, poor selling sale should be
eliminated from the sale of the current year. Similarly, poor selling items
should be eliminated from the opening and closing stock of the last years to
prepare the trading account of the current year.
Average Clause
An average clause is applied to find out the value of a claim where value of the
stock on the date of fire is more than the value of insured stock. Average clause is
applied by the insurance companies to discourage the under insurance of stock or
any other assets.
Following illustration help you to understand it in a better way −
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Suppose, value of insurance policy is Rs. 1,500,000 and at the date of fire, value of
stock in hand is Rs1,800,000, out of which approx. worth of 1,200,000 stock is
destroyed, then the value of the claim admitted will be −
ValueofClaim=1,500,0001,800,000×1,200,000=1,000,000ValueofClaim=1,500,0001,800,
000×1,200,000=1,000,000
Value of stock of Rs. 1,200,000 will not be admissible to the insured, rather
admissible claim will be Rs. 1,000,000.
Illustration
Fire occurred on the business premises of ‘Style India’ on 1st April, 2014 and most
of the stock destroyed. Please ascertain the insurance claim from the following
given particulars −
Particulars Amount (Year
2013)
Amount (01 Jan to
31stMarch 2014)
Sale 2,500,000 750,000
Purchases 1,800,000 350,000
Opening Stock (01-01-
2013)
270000
Closing Stock (31-12-2013) 498,750
Direct Expenses (Freight &
wages) 150,000 30,000
Stock as on 01-01-2013, valued 10% less at the cost.
Stock as on 31-12-2013 value 5% more at the cost.
Value of stock salvaged Rs. 45,000.
Insurance policy (for fire) was for Rs. 300,000.
Solution
Trading Account of M/s Style India
(For the year ending on 31st December, 2013)
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Particulars Amount Particulars Amount
To Opening Stock
{270,00090×100}{270,00
090×100}
To Purchases
To Direct Expenses
To Gross Profit (29%)
300,00
0
1,800,
000
150,00
0
725,00
0
By Sales
ByStock=500,000105×100ByStock=50
0,000105×100
2,500,
000
475,00
0
2,975,0
00 2,975,0
00
Memorandum Trading Account of M/s Style India
(Up to 01-4-2014)
Particulars Amount Particulars Amount
To Opening Stock
To Purchases
To Direct Expenses
To Gross Profit
(29% of 750,000)
475,000
350,000
30,000
217,500
By Sales
By Stock (Balancing Figure)
750,000
322,500
1,072,500 1,072,500
Value of Stock= Rs. 322,500
Less: Stock Salvage= Rs.45,000
Insurance Claim to be lodged will be −
ValueofClaim=300,000322,500×277,500=258,140ValueofClaim=300,000322,500×277,5
00=258,140
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Here an average clause will be applied because the value of insurance policy
(Rs.300,000) is less than the value of stock (Rs. 322,500) on the date of fire.
Consequential Loss Insurance A normal fire policy only indemnifies loss of stock or assets, and fails to insure any
loss of profit suffered by the concerned business. Therefore, a consequential loss
policy should be taken to cover the Loss of profit, Loss of Fixed expenditure, etc.
Following are the important terms used in loss of profit policy −
Insured Standing Charges − Salaries to staff, Rent rates & Taxes, Wages to
skilled workers, Auditors’ fees, Directors’ fees, Advertisement Expenses,
Travelling Expenses, Interest on debentures, and unspecified expenses (not
more than 5% of the specified expenses) are the charges that have to mention
on the policy form at the time of buying policy (so that all charges get
insured).
Turnover − Turnover includes sold goods or services for which amount is
payable; it also needs to be insured.
Annual Turnover − Turnover for the last 12 months, immediately preceding
to the date of fire.
Standard Turnover − Standard turnover means, turnover for the period
corresponding with the indemnity period during the preceding accounting
year. It also needs to be adjusted to notice the trend during the accounting
year, in which incident took place.
Gross Profit − It is calculated as
Gross profit = Net profit + Insured standing charges
Net Profit − To calculate net profit — profit (excluding tax), insured standing
charges, other charges, depreciation, and other provisions of such kind need
to be adjusted.
Indemnity Period − Maximum twelve months (from the date of damage),
during which the result of the business affected due to damage. Period of
indemnity is selected by the insured person.
Computation of Claim
Following steps need to be taken to compute insurance claim on the loss of the
profit, which is occurred due to dislocation of the business −
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Short Sale − Short sale means loss of sale due to the incident of fire and
subsequent dislocation of the business. The difference of standard turnover and
the actual turnover during the period of indemnity is called short sale. It is
illustrated in the following example.
Example
Calculate short sale according to the particulars given below −
Date of Fire occurs 01-06-2013
Period of dislocation of business 4 months
Standard Sale 500,00
Increased trend 15%
Actual Sale 300,000
Solution
Computation of Short Sale
Standard turnover (Rs. 50,000 + 15%)(A) 575,000
Less: Actual Sale(B) 300,000
Short Sale(A-B) 275,000
Rate of Gross Profit − It is calculated as
RateofGrossProfit=NetProfit+InsuredStandingChargesTurnover×100RateofGrossProfit=Ne
tProfit+InsuredStandingChargesTurnover×100
Note − All figures given above are related to the last accounting year.
InCaseofLoss=InsuredStandingCharges−NetLossTurnover×100InCaseofLoss=InsuredStan
dingCharges−NetLossTurnover×100
Note − All figures given above are related to the last accounting year.
In case where all the standing charges are not insured, amount of net loss need to
reduce as −
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=InsuredStandingChargesAllstandingCharges×NetLoss=InsuredStandingChargesAllstan
dingCharges×NetLoss
Loss Due to Short Sale − It is calculated as
LossduetoShortSale=ShortSale×RateofGrossprofitLossduetoShortSale=ShortSale×Rateof
Grossprofit
Increased Cost of Working − Increased cost of working means, certain additional
expenses those have to be incurred by insured person to keep the business in
running condition during the indemnity period.
Least of following figures will be considered as increased cost of working −
=NetProfit+InsuredStandingChargesNetProfit+AllstandingCharges×IncreasedCostofWorkin
g=NetProfit+InsuredStandingChargesNetProfit+AllstandingCharges×IncreasedCostofW
orking
Illustration
Calculate permissible increased cost of working with following given particulars −
Net Profit 45,000
Insured Standing Charges 25,000
Uninsured Standing Charges 25,000
Short Sale 100,000
Rate of Gross Profit 15%
Increased Working Expenses 10,000
Short sale avoided through Increased Cost of Working 50,000
Solution
Least of the following will be permissible increased cost of working −
=NetProfit+InsuredStandingChargeNetProfit+AllstandingCharges×IncreasedCostofWorking
=NetProfit+InsuredStandingChargeNetProfit+AllstandingCharges×IncreasedCostofWor
king
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=45,000+25,00045,000+50,000×10,000=7,368=45,000+25,00045,000+50,000×10,000=7,36
8
Shortsaleavoided×RateofGrossprofit=50,000×15%=7,500Shortsaleavoided×RateofG
rossprofit=50,000×15%=7,500
So, Rs. 7,368 will be permissible claim of the increased cost of working.
Note − Overall permissible limit of claim for short sale + increased cost of working
cannot exceed the following limit.
Maximumpermissiblelimitofclaim=StandardSale×RateofGrossprofitMaximumpermissibleli
mitofclaim=StandardSale×RateofGrossprofit
Saving in Expenses − Saving in expenses due to fire will be deducted from the
amount calculated as above.
Average Clause − In case where the value of sum insured is less than the value of
policy for which policy have been taken, average clause will be applied as applied
for the stock insurance (above).
Accounting Entries In case of loss of stock
Insurance company A/cDr
To Stock Damaged A/c
To Stock Destroyed A/c
(Being Claim admitted for stock destroyed and stock damaged)
Stock destroyed A/cDr
Stock Damaged A/cDr
To Trading A/c
(Being actual cost of stock destroyed and stock damaged to trading
account)
Bank A/cDr
To Stock Damaged A/c
(Being realization made on sale of damaged Stock)
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Note − Difference of stock destroyed account and damaged account will be
transferred to Profit & Loss account)
In case of loss of Profit
Insurance company A/cDr
To Profit & Loss A/cDr
To Profit & Loss Suspense A/c
(Being Loss of profit for next year)
Bank A/cDr
To Insurance Company A/c
Government Accounting Government accounting is a scientific procedure of collecting, classifying,
recording, summarizing, and interpreting all the financial transactions including
revenues and expenditures of all the government offices. It keeps the record of
public funds.
Followings are the main objectives of the Government Accounting −
Information about Revenues − One of the most important functions of the
Government accounting is to maintain the transactions of generation and
collection of revenues during the financial year (and maintain all the past
years’ financial data). Under the ‘Right to Information Act,’ if someone asks
to have the information regarding the financial transactions of a government
office, it is oblige to provide that.
Information about Expenditures − One of the most important objectives of
the Government accounting is to provide information about the expenditures
incurred on various heads. It is checked by the Parliament in case of Central
Government and state legislature in case of the State Government.
Information about Deposits and Loans − Government has to provide
information about the loan granted by the Government to others and
repayment of the deposits.
Information about Availability of Cash − It has to provide information
about the present and the future cash availability.
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Difference between Government and Commercial
Accounting There are following notable differences between the Government accounting and
the commercial accounting −
Headings Govt. Accounting Comm. Accounting
Objective Administration and management of
all the financial activities of the
government.
Maintain the records of
trading and manufacturing
of goods or to provide
services to calculate
profits.
Date Entry
System
It has single entry system — Govt.
does not work to earn profit; so, it
does not need cross-check the
accounting records.
Normally, it has double
entry system — need to
prepare Trading & Profit &
Loss account and Balance
Sheet at the end of the
accounting period.
Basis of
Accounting
statements
Accounting statements are also
prepared on the basis of single entry
system. Most of the statements are
merely statements of collections of
revenue and expenditures done,
except where the Government acts
like a banker or lender or borrower.
Accounting statements are
prepared on the basis of
double entry system.
Important Terms and Expressions of Government Finance Following are the important terms and expressions used in Government accounting
−
Demand for Grant − Without sanction from the Parliament, no expenditure
can be incurred by any Government Authority. Public Authority can request
for the grant of expenditure to the Government, this request is called
“Demand for Grant”.
Supplementary Grant − Sometimes, grants are sanctioned before the end of
the financial year, in case where annual budget might be inadequate.
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Supplementary demand can be made, if need arises to meet the expenditure.
For example, amount granted for the Natural Disaster Relief fund, may be
found inadequate due to extraordinary disaster by the flood; in such a
condition, an additional grant may be asked by the concerned state or
ministry.
Treasuries − Treasuries are the units of fiscal system in India. Every Indian
States and Union Territory is divided into different districts’ headquarters
and every district headquarters has one or more than one treasury.
Treasuries are conducted by the State Bank of India as an agent of the
Reserve Bank of India. Central Government and State Government keep their
separate accounts and differences of Central and State Govt. are adjusted by
the Reserve Bank of India.
Votable and Non-votable Items − To incur some expenditures,
Parliamentary approval is not required; so, these expenditures may be
charged from the Consolidated fund or the Public account, these items are
known as Non-votable items. Some items of expenditure require sanction of
the Parliament and cannot be incurred without its grant. Thus, demand for
grant for that expenditure may be placed to the government, such items are
called as Votable Items.
Appropriation Act − After the approval of the budget proposal in the
Parliament or Legislature, an Appropriation Bill has to be introduced, when
this Bill is passed, it becomes Appropriation Act. Now, money can be
withdrawn from the Consolidated Fund of India or the concerned State to
meet the grants.
Vote on Account − In certain condition, when government has no time to
place full budget in the Parliament, then it uses the special provision of ‘Vote
on Account.’ Under this provision, government obtains the vote of the
Parliament for the amount required to incur the expenditure of the items in
demand. After sanction obtained in the Parliament, government obtains
money from the Consolidated Fund of India.
Public Accounts Committee (PAC) − Public Account Committee is formed
by the Parliament and each Legislature to scrutinize the Appropriation
account and Audit the report thereon. All the reports on financial statements
those are to be submitted to the President of Indian and in the Parliament
are examined by the Public Accounts Committee (PAC). Examination by the
PAC is similar to post-mortem of the reports. Members of the PAC are
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appointed from the Opposition Parties of the Parliament. Member of the
ruling party cannot be part of this committee, as this committee is working
as a watchdog to look after the affairs of ruling party.
Local Government Accounting − Accounting of the Local government is
based on the concept of “fund accounting” and on the budget. Urban local
government entities and rural local government entities are two types of local
government entities. Accounting of the Local Government in India comprises
budget, Receipt, and payment accounts.
Government Fund Government of India has following three types of Funds for marinating the records
of all sorts of financial transactions −
Consolidated Funds of India
Contingency Funds of India
Public Account
Let’s discuss each of them succinctly −
Consolidated Funds of India
As per the Clause 1 of the Article 266 of the Indian Constitution −
“All revenues received by the Government by way of taxes like Income Tax, Central
Excise, Customs and other receipts flowing to the Government in connection with the
conduct of Government business i.e. Non-Tax Revenues are credited into the
Consolidated Fund constituted. Similarly, all loans raised by the Government by
issue of Public notifications, treasury bills (internal debt) and loans obtained from
foreign governments and international institutions (external debt) are credited into
this fund. All expenditure of the government is incurred from this fund and no amount
can be withdrawn from the Fund without authorization from the Parliament.”
Contingency Funds of India
As per the Article 267 of the Indian Constitution −
“The Contingency Fund of India records the transactions connected with Contingency
Fund set by the Government of India. The corpus of this fund is Rs. 50 crores.
Advances from the fund are made for the purposes of meeting unforeseen
expenditure which are resumed to the Fund to the full extent as soon as Parliament
authorizes additional expenditure. Thus, this fund acts more or less like an imprest
account of Government of India and is held on behalf of President by the Secretary
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to the Government of India, Ministry of Finance, and Department of Economic
Affairs.”
Public Account
The Public Account is constituted under Clause 2 of Article 267 of the Indian
Constitution, which says −
“The transactions relate to debt other than those included in the Consolidated Fund
of India. The transactions under Debt, Deposits and Advances in this part are those
in respect of which Government incurs a liability to repay the money received or has
a claim to recover the amounts paid. The transactions relating to ‘Remittance’ and
`Suspense’ shall embrace all adjusting heads. The initial debits or credits to these
heads will be cleared eventually by corresponding receipts or payments. The receipts
under Public Account do not constitute normal receipts of Government. Parliamentary
authorization for payments from the Public Account is therefore not required.”
Similarly, all 29 states of India has the same structure as described above.
General Structure of Government Accounts The general structure of the government accounts is illustrated below −
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Compilation of Accounts Treasury and other government departments, initially compile their receipt and
payment accounts on monthly basis for central government and state government
separately and then send to respective Accountant General of India.
Collection of revenue and disbursement are directly made by Railway, Defense, Post
& Telegraphs, Forest, and public departments and lump sum payments are made
by treasury through the departmental officers. Detail of accounts on monthly basis
is maintained by the departmental Accounts officers.
Monthly accounts submitted by the treasury and account officer are compiled by
the Accountant General, for the central government as a whole and for each state
separately. The compiled report shows progressive figure of each month from 1st
April to 31st March of every year. Complied accounts along with appropriation
accounts are submitted by Comptroller and Auditor General of India to the
President of India, to the Governor of each state, or to the Administrator of the
Union Territory accordingly.
Principles of Government Accounting Charges or expenditure on a new project like constructions, new equipment,
plant & machinery installation, maintenance, improvement, and service
should be allocated to the capital account as per the rule made by competent
authority.
Working charges of the project should be allocated to the revenue account.
In case of renewal and replacement and cost of the genuine replacement
should be charged to capital account.
In case of damage due to extraordinary calamities, charged should be debited
from the capital account or revenue account or from both. However, it will be
determined by the government according to the case and circumstances.
Capital receipts during the new project should be credited to the capital
account to reduce the capital expenditure of the project.
CAG Comptroller and Audit General (CAG) is an independent Constitutional body.
Special status has been given to safeguard his independence and enable him to
discharge his duty without fear or favor.
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As per the Article 148 of the Constitution of India, the comptroller and Auditor-
General will be appointed by the President of India. The provision of removal of CAG
is the same as of the judges of the Supreme Court. He can be removed only on the
basis of proven misbehavior or incapacity.
As per the Article 150 of the Constitution of India — the accounts of the Union and
of the States shall be kept in such form as the President may prescribed, on the
advice of the Comptroller & Auditor General.
Article 151 of the Constitution provides that the audit reports of the Comptroller &
Auditor General relating to the accounts of the Union shall be submitted to the
President, who shall cause them to be laid before each House of Parliament.
Financial Accounting - Contract Account Contracts are undertaken to customer’s requirements, which is generally of
constructional. For example, construction of buildings, ships, Bridges, Roads, etc.
In all the above cases, contract account is opened. A unique number is allotted to
each contract and a separate account is maintained for each individual contract.
Features of Contract Accounting Following are the important features of a contract accounting −
Direct Costs − Direct cost is the main proportion of expenses in a contract
account. However, indirect nature of expenses is also treated as direct
expenses in a contract account.
Indirect Costs − Proportion of the indirect cost is very low in a contract
accounting such as expenses related to the head office in case of various
contracts.
Cost Control − Cost control is the main challenge in a contract account
especially in the large scale contracts. For example, control over the material
cost, labor cost, loss, damages, etc. are difficult to regulate.
Surplus Material − After completion of the constructional project, if any
material such as cement, iron and steel, marbles, etc. is remained unused,
is known as surplus material. Surplus materials are normally disposed of to
get back the invested amount.
Types of Contract There are three types of contracts, as depicted in the following figure.
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Recording of Costs, Value, and Profit on Contract Recording of each contract will be done as under −
Material
Cost of “Material” will be debited from the contract account in the following
manners −
Direct purchase
Supplied from stores
Transfer from other project/contract
Contract account will be credited −
Material returned to stores
Sale proceed of surplus material
Amount will be transferred to Profit & Loss account −
Profit or Loss on sale of surplus of material
Damaged, Lost, or stolen material (except normal wastage of material that
will be charged directly to concerned contract account).
Labor
Labor or wages directly charged to concerned contract account and outstanding
wages should be debited from the contract account.
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Direct Expenses
In addition to material and labor, all other expenses, which are directly attributable
to the specific contract account are called direct expenses and will be debited from
the contract account.
Plant and Machinery
Following are the two methods for charging value of Plant & machinery to a contract
account −
a) Contract account will be debited with the full value of Plant &
Machinery −
Contract A/cDr(With full value)
To Plant & Machinery A/c(With Full Value)
Contract account will be credited with the depreciated value of Plant
& Machinery at the end of the contract −
Plant & Machinery A/cDr(with Depreciated Value)
To Contract A/c
b) Contract account will be debited with hourly rate of Depreciation−
This is much better and scientific approach as compared to the first
method. On the basis of time, contract will be debited with hourly rate of
depreciation.
Indirect Expenses
The expenses, which cannot be directly charged to such contract are known as
indirect expenses.
On the basis of some percentage, these expenses may be distributed among several
contracts. For example, charges of supervisor, engineer, administrative expenses
etc.
Sub Contract
When a main or prime contractor assigns some specific work to another contractor
as part of the main contract called as sub contract. Sub-contractors are paid by
the main contractor. Sub-contractors normally do some specialized work, in which
they are specialized. Charges paid to the sub-contractor will be shown in the debit
side of the contract account.
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Extra Work Charges
Any additional works in addition to the main contract, done by contractor as per
the requirement of the Contractee, may be charged to same contract account.
However, in case where volume of the extra work is not substantial; so, the amount
received in lieu of that extra work should be added to the contract price.
In case where extra work is of substantial amount, a separate contract account
should be prepared, as explained above.
Recording of Value and Profit on Contracts Certification of Work Done
During the period of contract, Contractee has to pay sums of amount to contractor
especially where a contractor is engaged in a big and long term contract. This
amount is paid on the basis of certification of work done by surveyors or architects
on behalf of the Contractee, who certified the value of the work done by the
contractor.
Usually, some percentage of the certified amounts is paid by Contractee and the
balance amount called as “retention money.” The retention amount remains with
the Contractee until the work is completed to safeguard and keep in favorable
position. Completed work, which is not certified is called “uncertified work.”
Following accounting procedure should be followed after getting certificate −
a) Contractee personal A/cDr
To Contract A/c
Note −
1. Above entry will be done with certified value
2. Balance amount in personal account will represent retention money as
debtors.
b) Contractee personal A/cDr
Retention Money A/cDr
To Contract A/c
c) Under this method, any amount received from the Contractee till the completion
of contract will be crediting to Contractee’s personal account debiting cash/bank.
Amount so received will represent advance received from Contractee and will be
shown as (work in progress less advance received) in the Balance sheet.
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Profit on Incomplete Contract
Actual ascertainment of the cost is possible only after fully completion of the
contract. Therefore, it is not possible to know the profit or loss on contract till it is
completed.
However, following principles are adopted to estimate profit on uncompleted
contracts −
No profit is ascertained and transferred to profit and loss account where work
is completed up to 25% of the total contract.
In case where contract is completed from 33.33% to approximately 75%, one-
third amount of the notional profit may retain to suspense account as a
provision for future loss and balance; two third is transferred to the profit
and loss account. Sometime notional profit is further reduced in the ratio of
the cash received and the work certified, the formula is −
NotionalProfit×23×CashReceivedWorkCertifiedNotionalProfit×23×CashReceivedWo
rkCertified
In case where a contract is almost completed, proportion of an estimated
profit is transferred to the profit & loss account by one of the most popular
formula as given below −
EstimatedProfit×WorkCertifiedContractPriceEstimatedProfit×WorkCertifiedContra
ctPrice
Note − In case of any loss that should be transferred to Profit & Loss account.
Work in Progress
Uncompleted contracts at the end of the financial year, which are known as work-
inprogress will be accounted as −
Work-in-progress will be shown at the asset side of the Balance sheet on the
account of expenses incurred the un-completed contracts.
Value of the work-in-progress will be inclusive of Profit.
Cash received from the Contractee will be deducted from the value of work-
inprogress.
Contractee will be treated as a debtor only after completion of the contract.
Contractee will not be shown as creditor on account of cash received from
him.
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Cost of plant and material at the site will be shown separately as “Plant at
site” and “Material at site” on the asset side of the Balance sheet.
Illustration
Please prepare a Contract Account, Contractee Account and Extract of Balance
sheet from the following information as received from M/s “Solid Building
Contractor’ for the period 01-04-2013 to 31-03-2014.
Particulars Amount
Contract Price 18,000,000
Material Issued to contract 3,060,000
Wages & Salary 4,800,000
Plant used for Contract 900,000
Other Miscellaneous Expenses 300,000
Cartage paid on Material 60,000
Loss of Plant at site 180,000
Plant returned to store on 31-03-2014 120,000
Loss of Material at site 150,000
Material in hand at site on 31-03-2014 138,000
Cash received 80% of work certified 7,680,000
Uncertified work 60,000
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Depreciation on Plant 15%
Profit transferred to Profit & loss account 23rd23rd
Solution
M/s Solid Building Contractor
Contract Account
(For the period 01-04-2013 to 31-03-2014)
Particulars Amount Particulars Amount
To Material
To Wages & Salary
To Plant
To Cartage
To Misc. Expenses
To Notional Profit c/d
3,060,000
4,800,000
900,000
60,000
300,000
1,620,000
By Material at site
By Profit & Loss A/c
Material Lost150,000
Plant Lost180,000
-----------
By Plant return to store120,000
Less: Dep.18000
-----------
By Plant at site600,000
Less: Dep.90,000
-----------
By Work In progress A/c
Work certified9,600,000
Work uncertified60,000
-----------
138,000
330,000
102,000
510,000
9,660,000
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Total 107,400,000 Total 107,400,000
To Profit & Loss A/c
1,620,000×23×451,620,000×23×45
To Work in Progress A/c (Reserve)
864,000
756,000
By Notional Profit b/d 1,620,000
Total 1,620,000 Total 1,620,000
Contractee Account
Particulars Amount Particulars Amount
To Balance c/d 7,680,000 By Cash Received 7,680,000
Total 7,680,000 Total 7,680,000
Balance-Sheet
(As on 31-03-2014)
Particulars Amount Particulars Amount
Profit & Loss A/c864,000
Less: Loss of330,000
Plant & Material-----------
534,000
Plant720,000
Less: Dep. 15%108,000
------------
Material at site
Work-in-progress
Work Certified9,600,000
Uncertified work60,000
------------
9,660,000
Less: Reserve756,000
------------
612,000
138,000
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8,904,000
Less: Cash Received7,680,000
------------
1,224,000
Modern Approach on Profit on Uncompleted Record Following are the two methods of calculating the profits on uncompleted contracts
−
Where profit is ascertained only after completion of the contract or after
substantially completion of the contract is called ‘completion contract
method.’
Under the second approach, it is ascertained at the end of each and every
accounting period on percentage basis, which comes before completion of the
entire contract.
Work-in-Progress
Work-in-progress means total expenditure incurred up to the end of financial or
accounting year known as work-in-progress account.
Following example is described for better understanding −
Illustration
Please evaluate the profit of the period by using both of the given methods −
Percentage of completion method and
The completed contract method.
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Please also find the value of work-in-progress in the Balance sheet by assuming,
the contractor received Rs. 460,000 on completion of the first stage.
Stages Estimates Actual
Cost
Contract
Price
Original
(Rs.)
Revised
(Rs.)
Certified
Completed but not certified
Completed 75%
Completed 25%
Incomplete
345,000
115,000
115,000
230,000
138,000
368,000
126,500
126,500
276,000
172,500
356,500
120,750
95,450
71,300
--
460,000
172,500
149,500
345,000
161,000
943,000 1,069,500 644,000 1,288,000
Solutions −
On the Basis of Percentage of Completion Method −
Stages Actual
Cost
% of
completion
Balance
estimates
(Rs.)
Total Rs. Contract
Price
Profit or
Loss
1
2
3
4
5
356,500
120,750
95,450
71,300
--
25%
75%
100%
31,625
207,000
172,500
356,500
120,750
127,075
278,300
172,500
460,000
172,500
149,500
345,000
161,000
103,500
51,750
--
--
(11,500)
644,000 411,125 1,055,125 1,288,000 143,750
Balance Sheet
Particulars Amount Particulars Amount
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Advances 460,000 Work in Progress
(Actual cost + Profit) 644,000 + 143,750
787,750
On the Basis of Completion Contract Method −
No profit will be ascertained before the completion of contract −
Balance Sheet
Particulars Amount Particulars Amount
Advances 460,000 Work in Progress 644,000
Cost Plus Contract
In some cases, it is not possible in advance to know the exact cost of contracts;
therefore, cost plus contract clause need to be applied, in which the value of
contract is ascertain by adding certain percentage of the profit in cost.
Escalation Clause
An Escalation clause is applied to cover up the changes in price due to change in
prices of the raw material or change in utilization of the production capacity.
Escalation clause safeguards both the contractor and the contractee against any
unfavorable change in the cost or the price.
Target Costing
Under this method of a contract, contractee gives target of the production with
target of the expenditure. Contractor cannot increase the cost of contract without
increasing the production. It means, expenditure is fixed with the target of the
production.
Departmental Accounting Departmental stores have many types of stores under a single roof, for example one
departmental store may have a cosmetic store, shoe store, stationery store,
readymade departmental store, grocery stores, medicines, and many more.
It is essential to know the profit and loss account of each departmental store at the
end of the accounting year. However, it can be done by maintaining the department
wise Trading & Profit and Loss account.
Objectives of Departmental Accounting
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Following are the main objectives of the departmental accounting −
To know the financial position of each and every department separately, it is
helpful to make a comparison.
Calculate commission of the managers department wise.
Evaluate performance, planning, and control.
Advantages of Departmental Accounting Following are the advantages of a department accounting −
It is helpful in evaluating the result of each department.
It helps to know the profitability of each department.
Investors and outsiders may know the detailed information.
It is helpful in making comparison of each expenses (same department) of the
different accounting years and different expenses (other departments) of the
same accounting year.
Methods of Departmental Account There are two methods of keeping Departmental Accounts −
Separate Set of Books for each department
Accounting in Columnar Books form
Separate Set of Books for each Department
Under this method of accounting, each department is treated as a separate unit
and separate set of books are maintained for each unit. Financial results of each
unit are combined at the end of accounting year to know the overall result of the
store.
Due to high cost, this method of accounting is followed only by very big business
houses or where to do so is compulsory as per the law. Insurance business is one
of the best examples, where to follow this system is compulsory.
Accounting in Columnar Books Form
Small trading unit generally uses this system of accounting, where accounts of all
departments are maintained together by central accounts department in the
columnar books form. Under this method, sale, purchase, stock, expenses, etc. are
maintained in a columnar form.
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It is necessary that to prepare a departmental Trading and Profit and Loss Account,
preparation of subsidiary books of accounts having different columns for the
different department is required. Purchase Book, Purchase Return Book, Sale
Book, Sales return books etc. are the examples of the subsidiary books.
Specimen of a Sale Book is given below −
Sales Book
Date Particulars L.F. Department
A
Department
B
Department
C
Department
D
A Trading account in columnar form is prepared to know the department wise gross
profit of the concern.
Function wise classification may also be done in a business unit like Production
department, Finance department, Purchase department, Sale department, etc.
Allocation of Department Expenses
Some expenses, which are specially incurred for a particular department may
be charged directly to the respective department. For example, hiring charges
of the transport for delivery of goods to customer may be charged to the
selling and distribution department.
Some of the expenses may be allocated according to their uses. For example,
electricity expenses may be divided according to the sub meter of each
department.
Following are the examples of some expenses, which are not directly related to any
particular department may be divide as −
Cartage Freight Inward Account − Above expenses may be divided
according to purchase of each department.
Depreciation − Depreciation may be divided according to the value of assets
employed in each department.
Repairs and Renewal Charges − Repair and renewal of the assets may be
divided according to the value of the assets used by each department.
Managerial Salary − Managerial salary should be divided according to the
time spent by the manager in each department.
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Building Repair, Rents & Taxes, Building Insurance, etc. − All the
expenses related to the building should be divided according to the floor
space occupied by each department.
Selling and Distribution Expenses − All the expenses relating to selling and
distribution expenses should be divided according to the sales of each
department, such as freight outward, travelling expenses of sales personals,
salary and commission paid to salesmen, after sales services expenses,
discount and bad debts, etc.
Insurance of Plant & Machinery − The value of such Plant & Machinery in
each department is the basis of the insurance.
Employee/worker Insurance − Charges of a group insurance should be
divided according to the direct wage expenses of each department.
Power & Fuel − Power & fuel will be allocated according to the working hours
and power of the machine (i.e. Hours worked x Horse power).
Inter-Department Transfer An inter-department analysis sheet is prepared at a regular interval such as weekly
or monthly basis to record all the inter-departmental transfers of goods and
services. It is necessary, as each department is working as a separate profit center.
Transfer of the prices of such transactions can be cost base, market price, or duel
basis.
Following Journal entry will pass at the end of that period (weekly or monthly) −
Journal Entry Receiving Department A/c Dr To Supplying Department A/c
Inter-Department Transfer Price There are three types of transfer prices −
Cost based transfer price − Where the transfer price is based on standard,
actual, or total cost, or marginal cost is called cost based transfer price.
Market based transfer price − Where the goods are transferred at selling
price from one department to another is known as market based price.
Therefore, unrealized profit on the goods sold is debited from the selling
department in the form of a stock reserve for both the opening and the closing
stock.
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Dual pricing system − Under this system, the goods are transferred on the
selling price by the transferor department and booked at the cost price by
the transferee department.
Illustration
Please prepare a Departmental Trading and Profit and Loss Account & General
Profit and Loss Account for the year ended 31-12-2014 of M/s Andhra & Company
where department A sells goods to department B on Normal selling price.
Particulars Dept. A Dept. B
Opening stock 175,000 -
Purchases 4,025,000 350,000
Inter Transfer of Goods - 1,225,000
Wages 175,000 280,000
Electricity Expenses 17,500 245,000
Closing Stock (at cost) 875,000 315,000
Sales 4,025,000 2,625,000
Office Expenses 35,000 28,000
Combined Expenses for both Department
Salaries (2:1 Ratio) 472,500
Printing and Stationery Expenses (3:1 Ratio) 157,500
Advertisement Expenses ( Sale Ratio) 1,400,000
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Depreciation (1:3 Ratio) 21,000
Solution
M/s Andhra & Company
Departmental Trading and Profit and Loss Account
For the year ended 31-12-2014
Particulars Dept. A Dept. B Particulars Dept. A Dept. B
To Opening Stock
To Purchases
To Transfer from A
To Wages
To Gross Profit c/d
175,000
4,025,000
175,000
1,750,000
--
350,000
1,225,000
280,000
1,085,000
By Sales
By Transfer to B
By Closing Stock
4,025,000
1,225,000
875,000
2,625,000
----
315,000
Total 6,125,000 2,940,000 Total 6,125,000 2,940,000
To Electricity Expenses
To Office Expenses
To Salaries (2:1 ratio)
To Printing &
Stationery (3:1 Ratio)
To Advertisement Exp.
( Sales Ratio 40.25 :26.25)
To Depreciation (1:3 Ratio)
To Net Profit
17,500
35,000
315,000
118,125
847,368
5,250
411,757
245,000
28,000
157,500
39,375
552,632
15,750
46,743
By Gross Profit b/d 1,750,000 1,085,000
Total 1,750,000 1,085,000 Total 1,750,000 1,085,000
General Profit and Loss Account
For the year ended 31-12-2014
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Particulars Dept. A Particulars Dept. B
To Stock reserve (Dept. B)
To Net Profit c/d
81,667
376,833
By Departmental Net Profit b/d
Dept. A411,757
Dept. B46,743
------------- 458,500
Total 458,500 Total 458,500
Financial Accounting - Voyage Accounting To know the financial results of a marine business, voyage accounting is prepared.
Voyage account is similar to a Profit and Loss account; all expenses are debited to
Voyage account and all incomes are credited to Voyage account. Voyage account is
prepared to ascertain the profit or Loss of voyage. It covers both inward and
outward travelling. It is very important that separate Voyage account should be
prepared for each vessel.
Income Following are the main sources of income of a Voyage −
Freight − Freight charges are the main income collected against the
transportation of the goods.
Passage Money − Passage money is collected from the passengers, in case it
is passengers’ vessel.
Primage − Primage is an additional freight in the form of surcharge on the
freight.
Expenses Following are the various ways of expenses of a vessel −
Brokerage & Commission − Brokerage and commission is calculated on the
freight charges including primage and it is paid to the charters agent.
Address commission is payable to the brokers on procurements of freight
from the different parties.
Insurance − The insurance charges on proportionate basis might be debited
from the voyage account. For example, if insurance is for one year and
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journey of voyage is for three month, insurance charges will be debited from
the voyage account on 14th14th ratio.
Stores − Stores, which are purchased for voyage are debited from the voyage
account on consumption basis i.e. opening stock + purchases – closing stock.
Depreciation − Depreciation on ship is charged from the voyage account in
the proportion of the period of a journey.
Bunker Cost − Cost of water, coal, diesel, fuel, etc. used for the purpose of
voyage is called bunker cost and may debited from the voyage account.
Port Charges − Port authorities charge fees for allowing ships to use port for
the loading/unloading the cargo. This fee amount is debited from the voyage
account.
Stevedoring Charges − Loading and unloading of cargo called stevedoring
charges and should be debited from the voyage account.
Voyage in Progress At the end of the accounting year where voyage is not completed and is still in
progress, following accounting treatments are required −
Freight Received
Total freight received credited to the voyage account and the provision for
incomplete voyage is debited from the voyage account. Provision is created for the
voyage-in-progress in proportion of the incomplete journey.
Expenses
To complete matching concept, an income as well as expenses related to the
incomplete voyage might be carried forward to the next accounting year on the
respective account. Provision for the income earned should be debited from the
voyage account and provision for the expenses should also be credited to the voyage
account.
Basis of the expenses to be carried forward is as hereunder −
Expenses which are related to the freight, need to be carried forward in a
proportion to return freight. For example, if total freight is Rs. 2,500,000 out
of which return freight is Rs. 1,200,000 and total expenses are Rs. 500,000,
then expenses to be carried forward to the next accounting year — will be Rs.
240,000.
=1,200,0002,500,000×500,000=1,200,0002,500,000×500,000
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In case of the standing expenses, if return journey is incomplete, ½ of the
standing charges to be carried forward.
In case where return journey is halfway back and the total expenses of voyage
given 1212 of the total expenses to be carried forward.
When the return journey is halfway back and the expenses till date are
given 13rd13rd of the expense are to be carried forward.
When one round of the trip is completed and on his half way back for single
way and total expenses of voyage are given, then 13rd13rd expenses are to be
carried forward.
When one round trip is completed and on his half way back for single way
and expenses till date are given, then 15th15th expenses are to be carried
forward.
Pro-forma
In the books of M/s Titanic Shipping Company
Voyage Account
For the period ending 31-12-2014
Particulars Amount Particulars Amount
To Coal
Opening Stockxx
Add: Purchasesxx
---------
xxxx
Less: Closing Stockxx
---------
To Port Charges
To Captain Expenses
To Harbor Wages
To Address Commission
To Brokerage
xx
xx
xx
xx
xx
By Freight
By Primage
Xx
Xx
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To Insurance Premium
To Salary & Wages
To Stores
To Deprecation
To Provision for Incomplete
Voyage
To Net Profit
(trf. To Profit & Loss A/c)
xx
xx
xx
xx
xx
xx
xx
---------
XXXX
---------
XXXX
Financial Accounting - Royalty Accounts Royalty is payable by a user to the owner of the property or something on which an
owner has some special rights. A royalty agreement is prepared between the owner
and the user of such property or rights. If payment is made to purchase the right
or property that will be treated as capital expenditure instead of a Royalty.
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Payment made by the lessee on account of a royalty is normal business expenditure
and will be debited to the Royalty account. It is a nominal account and at the end
of the accounting year, balance of Royalty account need to be transferred to the
normal Trading and Profit & Loss account. Royalty, based on the production or
output, will strictly go to the Manufacturing or Production account. In case, where
the Royalty is payable on sale basis, it will be part of the selling expenses.
Types of Royalties There are following types of Royalties −
Copyright − Copyright provides a legal right to the author (of his book/s), the
photographer (on his photographs), or any such kind of intellectual works.
Copyright royalty is payable by the publisher (lessee) of a book to the author
(lessor) of that book or to the photographer, based on the sale made by the
publisher.
Mining Royalty − Lessee of a mine or quarry pays royalty to lessor of the
mine or quarry, which is generally based on the output basis.
Patent Royalty − Patent royalty is paid by the lessee to lessor on the basis
of output or production of the respective goods.
Basis of Royalty In case of the patent, publisher of the book pays royalty to the author of the book
on the basis of number of books sold. So, holder of patent gets royalty on the basis
of output and the mine owner gets royalty on the basis of production.
Important Terms Following are the important terms, which are used in Royalty agreements −
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Royalty
A periodic payment, which may be based on a sale or output is called Royalty.
Royalty is payable by the lessee of a mine to the lessor, by publisher of the book to
the author of the book, by the manufacturer to the patentee, etc.
Landlord
Landlords are the persons who have the legal rights on mine or quarry or patent
right or copybook rights.
Tenet
An Author or publisher; lessee or patentor who takes out rights (usually
commercial or personal rights) from the owner on lease against the consideration
is called tenet..
Minimum Rent
According to the lease agreement, minimum rent, fixed rent, or dead rent is a type
of guarantee made by the lessee to the lessor, in case of shortage of output or
production or sale. It means, lessor will receive a minimum fix rent irrespective of
the reason/s of the shortage of production.
Payment of royalty will be minimum rent or actual royalty, whichever is higher for
example −
M/s Hyderabad publication printed a book on Java on the minimum rent of Rs.
1,000,000/- per annum royalty being payable @ Rs. 20 per book sold. In the first
year of publication, Hyderabad publication sold 75,000 copy of the books and in
the second year, number of sold books fell down to 45,000 only. Amount of royalty
will be payable as under −
Minimum
Rent Royalty
Payable
Ist Year
75,000 Books X Rs. 20 per book = Rs.
1,5,00,000
1,0,00,000 Rs. 1,5,00,000
IInd Year
45,000 Books X Rs. 20 per book = Rs.
9,00,000
1,0,00,000 Rs. 1,0,00,000
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Shortworkings
Difference of minimum rent and actual royalty is known as shortworkings where
payment of Royalty is payable on the basis of minimum rent due to shortage in the
production or sale. For example, if calculated royalty is Rs. 900,000/- as per sale
of books based on the above example, but royalty payable is Rs. 1000,000 as per
minimum rent, shortworking will be Rs. 100,000 (Rs. 1,000,000 – Rs. 9,00,000).
Ground Rent
The rent, paid to the landlord for the use of land or surface on the yearly or half
yearly basis is known as Ground Rent or Surface Rent.
Right of Recouping
It may contain in the royalty agreement that excess of minimum rent paid over the
actual royalty (i.e. shortworkings), may be recoverable in the subsequent years. So,
when the royalty is in excess of the minimum rent is called the right of recoupment
(of shortworkings).
Right of recoupment will be decided for the fixed period or for the floating period.
When the right of recoupment is fixed for the certain starting years from the date
of royalty agreement, it is said to be fixed or restricted. On the other hand, when
the lessee is eligible to recoup the shortworkings in next 2 or 3 years from the year
of its commencement, it is said to be floating.
Shortworking will be shown on the asset side of Balance sheet up to allowable year
of recouping after that it will be transferred to profit & loss account (after expiry of
allowable period).
Lease Premium
An Extra payment in addition to royalty, if any, paid by lessee to lessor is called
Lease premium and will be treated as capital expenditure and it will be written off
on yearly basis through profit and loss account as per the suitable method.
TDS (Tax Deducted at sourceSource)
If there is an applicability of TDS (Tax deducted at source) as per Income Tax Act,
lessee will make the payment to lessor after deducting TDS as per applicable rate
and lessee is liable to deposit it to the credit of Central Government. Amount of
royalty will be gross amount of royalty (inclusive of TDS), that will be charged to
profit and loss account.
For example, if royalty amount is 1,000,000/-& rate of TDS is 10%, then lessee will
pay Rs. 900,000/- to lessor. Amount of royalty charge to profit and loss account
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will be Rs. 1,000,000/- and balance amount of Rs. 100,000/- will be deposited in
the credit of central Government account.
Stoppage of Work
Sometime, there may be stoppage of work due to conditions beyond control like
strike, flood, etc. in this case, minimum rent is required to be revised as provided
in the agreement.
Revision of the minimum rent will be −
Reduction of minimum rent in the proportion of the stoppage of work;
On the basis of fixed percentage; or
By a fixed amount in the year of stoppage.
Sub Lease Sometime, landlord or lessor allows lessee to sublet some part of the mine or land
as a sub-lessee. In this case, lessee will become lessor for sub lessee and lessee for
main landlord.
In such a case, as Lessee, he will maintain the following books of accounts −
As a Lessee
Landlord accountAccount
Minimum Rent Account
Royalty Account
Shortworkings Recoupable
Accounts
As a Sub Lessor
Royalties receivable Receivable
accountAccount
Sub lessee Lessee
accountAccount
Shortworkings allowable
Allowable Account
Accounting Entries
When there is no royalty in the year
(a) Minimum
Rent A/cDr
To Landlord
A/c
(b)
Shortworking
A/cDr
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To Minimum
Rent A/c
Where Royalties are less than minimum rent and
shortworkings are recoverable in next years.
(c) Minimum
Rent A/cDr
To Landlord
A/c
(d) Royalties
A/cDr
Shortworkings
A/cDr
To Minimum
Rent A/c
(e) Landlord
A/cDr
To Bank A/c
(f) Profit &
Loss A/cDr
To Royalty A/c
When Short workings are recouped
(g) Royalties
A/cDr
To short
workings A/c
To Landlord
A/c
(h) Landlord
A/cDr
To Bank A/c
Transfer of irrecoverable Short workings (i) Profit &
Loss A/cDr
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To Short
workings A/c
Illustration
From the below given information’s, please open prepare the necessary accounts in
the books of M/s Black Diamond Limited.
Company leased a colliery on 01-01-2010 at a minimum rent of Rs. 75,000.
Royalty Rate@ Rs. 1/- per ton.
Right of recouping of shortworkings is restricted to first 3 years.
Output for the first four years of the lease was 40,000, 65,000, 1,05,000, and
90,000 tons respectively.
Solution −
Analytical Table
Year Output
(Tons)
Royalties @
Rs. 1 Per
ton
Shortworkings Surplus Recoupment Unrecoupable
Short workings
Payable to
Landlord
2010
2011
2012
2013
40,000
65,000
105,000
90,000
40,000
65,000
105,000
90,000
35,000
10,000
--
30,000
15,000
--
--
30,000
15,000
75,000
75,000
75,000
90,000
300,000 300,000 45,000 45,000 30,000 15,000 315,000
In the books Books of M/s Black Diamonds Ltd
Royalties Account
Date Particulars Amount Date Particulars Amount
31-12-2010
31-12-2011
To Landlord A/c
To Landlord A/c
40,000
=======
65,000
31-12-2010
31-12-2011
By Production A/c
By Production A/c
40,000
=======
65,000
GAUTAM SINGH STUDY MATERIAL – Additional Material 0 7830294949
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31-12-2012
31-12-2013
To Landlord A/c
To Landlord A/c
=======
105,000
=======
90,000
=======
31-12-2012
31-12-2013
By Production A/c
By Production A/c
=======
105,000
=======
90,000
=======
Landlord Account
Date Particulars Amount Date Particulars Amount
31-12-2010
31-12-2011
To Bank A/c
To Bank A/c
75,000
----------
75,000
----------
75,000
----------
75,000
----------
31-12-2010
31-12-2011
By Royalties A/c
By Shortworkings A/c
By Royalties A/c
By Shortworkings A/c
40,000
35,000
----------
75,000
----------
65,000
10,000
----------
75,000
----------
31-12-2012
31-12-2012
31-12-2013
To Shortworkings A/c
To Bank A/c
To Bank A/c
30,000
75,000
----------
105,000
----------
90,000
----------
90,000
31-12-2012
31-12-2013
By Royalties A/c
By Royalties A/c
105,000
----------
105,000
----------
90,000
----------
90,000
----------
GAUTAM SINGH STUDY MATERIAL – Additional Material 0 7830294949
THANKS FOR READING – VISIT OUR WEBSITE www.educatererindia.com
----------
Shortworkings Account
Date Particulars Amount Date Particulars Amount
31-12-2010
01-01-2011
01-01-2012
To Landlord A/c
To Balance b/d
To Landlord A/c
To Balance b/d
35,000
----------
35,000
----------
35,000
10,000
----------
45,000
----------
45,000
----------
45,000
----------
31-12-2010
31-12-2011
31-12-2012
31-12-2010
By Balance C/d
By Balance C/d
By Landlord A/c
By Profit & Loss A/c
35,000
----------
35,000
----------
45,000
----------
45,000
----------
30,000
15,000
----------
45,000
----------