Accounts and Auditing

CA.
Praveen Tawania Edition 2015
Objectives To maintain SYSTEMATIC ACCOUNTING RECORDS

To ascertain FINANCIAL POSITION
To ascertain the FINANCIAL PERFORMANCE
To COMMUNICATE information to users.
Functions Measurement
Forecasting
Decision Making
Comparison and Evaluation
Control
Government Regulation and Taxation.
OBJECTIVES AND FUNCTIONS OF ACCOUNTING
ADVANTAGES & LIMITATIONS OF ACCOUNTING

Advantages Facilitates the maintenance of systematic records.
Facilitates the ascertainment of financial performance.
Facilitates the ascertainment of financial position.
Facilitates the communication of information to users.
Facilitates the compliance with legal requirements. Facilitates

the CONTROL OVER ASSETS.
ASSISTS THE MANAGEMENT.
Limitations Ignores qualitative elements. (Non-Monetary terms) Not
free from bias.
Ignores the price level changes.
Danger of window dressing.
BOOK-KEEPING AND ACCOUNTING

S. Book-keeping Accounting
No.
1. It is a process concerned with recording It is a process concerned with summarising

of transactions. of the recorded transactions.
2.
It constitutes as a base for accounting. It is considered as a language of the
business.
3. Financial statements do not form part of
this process. Financial statements are prepared in this
process on the basis of book-keeping records.
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CA. Praveen Tawania Edition 2015
4. Managerial decisions cannot be taken Management takes decisions on the basis of

with the help of these records. these records.
5.
There is no sub-field of book-keeping. It has several sub-fields like financial
accounting, management accounting etc.
6. Financial position of the business
cannot be ascertained through Financial position of the business is
bookkeeping records. ascertained on the basis of the accounting
reports.
BRANCHES OF ACCOUNTING/SUB-FIELDS OF ACCOUNTING
1. Financial Accounting.
2. Corporate Accounting.
3. Cost Accounting.
4. Management Accounting.
5. Social Responsibility Accounting.
6. Human resource Accounting.
ROLE OF ACCOUNTANT IN SOCIETY
1. Maintenance of Books of Account

2. Statutory Audit
3. Internal Audit
4. Taxation
5. Management Accounting and Consultancy Services
6. Financial Advice Investments, Insurance, Business Expansion, Investigations etc.
7. Other Services
a) Secretarial Work
b) Share Registration Work
c) Company Formation
d) Official Receiver, Liquidator
e) Arbitrations
f) Accountant and Information Services
OBJECTIVE TYPE QUESTIONS:

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1. Which of the following is not a sub-field of Accounting?

a) Management Accounting b) Cost Accounting
c) Financial Accounting d) Book-Keeping
2. Purpose of an accounting system include all the following except:

a) Interpret and record the effects of business transaction.
b) Classify the effects of transactions to facilitate the preparation of reports.
c) Summarize and communicate information to decision makers.
d) Dictate the specific types of business enterprise transactions that the enterprises
may engage in.
3. Book-keeping is mainly concerned with

a) Recording of financial data.
b) Designing the systems in recording, classifying and summarising the recorded
data.
c) Interpreting the data for internal and external users.
d) None of the above.
4. All of the following are functions of Accounting except

a) Decision Making b) Measurement
c) Forecasting d) Ledger Posting
5. Financial statements are part of

a) Accounting b) Book Keeping
c) All of Above d) None of the Above
6. Financial position of the business is ascertained on the basis of

a) Records prepared under book-keeping process.
b) Trial balance.
c) Accounting reports.
7. Users of accounting information include

a) Creditors b) Lenders
c) Customers d) All of the above
8. Financial statements do not consider

a) Assets expressed in monetary terms.
b) Liabilities expressed in monetary terms.
c) Only assets expressed in non-monetary terms.
d) Assets and liabilities expressed in non-monetary terms
9. On January 1, Sohan paid rent of Rs. 5,000. This can be classified as

a) An event b) A transaction
c) A transaction as well as an event. d) Neither a transaction nor an event.
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10. On March 31, 2006 after sale of goods worth Rs. 2,000, he is left with the closing stock of
Rs. 10,000. This is
a) An event b) A transaction
c) A transaction as well as an event. d) Neither a transaction nor an event.
[Ans. 1. (d), 2. (d) , 3. (a), 4. (d), 5. (a), 6. (c), 7. (d), 8. (d), 9. (b), 10. (a)]
NOTES

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CHAPTER-1
Accounting An Introduction
Unit-2 ACCOUNTING
CONCEPTS, PRINCIPLES
AND CONVENTIONS

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ACCOUNTING CONCEPTS
Accounting concepts define the assumptions on the basis of which financial statements of a business
entity are prepared. These accounting concepts lay the foundation on the basis of which the accounting
principles are formulated.
ACCOUNTING PRINCIPLES
1. Based on real assumptions.

2. Simple, understandable and explanatory.
3. Followed consistently.
4. Reflect future predictions.
5. Informational for the users.
ACCOUNTING CONVENTIONS
1. Accounting conventions emerge out of accounting practices, commonly known as

accounting principles, adopted by various organizations over a period of time.
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2. These conventions are derived by usage and practice.

3. The accountancy bodies of the world may change any of the convention to improve the
quality of accounting information.
4. Accounting conventions need not have universal application.
BASIS OF ACCOUNTING
Accrual Method of recording transaction by which revenue, cost, asset, liability are reflected
(Mercantile) in the accounts for the period in which they accrue.
Notes:
1. Companies Act, 1956 Companies are required to follow accrual basis of
accounting only.
2. Prepaid /outstanding/accrual/unaccrued revenue and expenses are found
under accrual basis.
Cash Basis Method of recording transaction by which revenue, cost, asset, liability are
reflected in the accounts for the period in which actual receipts or payments are
made.
Hybrid Basis Method of recording transaction by which revenue is recorded on accrual basis and
cost on cash basis.
ACCOUNTING PRINCIPLES
Fundamental As per AS-1:
Accounting 1. Going Concern
Assumptions (FAA) 2. Consistency
3. Accrual
Accounting Entity
Principle PERSONAL TRANSACTIONS AND
Distinction is made between
BUSINESS TRANSACTIONS and transactions of one business and
other business entity.
Money Measurement Only those transactions which are CAPABLE OF BEING EXPRESSED
Concept
IN MONEY are recorded.
Accounting Period LIFE OF ENTERPRISE IS ARTIFICIALLY SPLIT

The economic
Concept (Periodicity
INTO PERIODIC INTERVALS which are known as accounting periods.
Concept)

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NEITHER THE INTENTION NOR

Going Concern Concept It is assumed that enterprise has
THE NECESSITY OF LIQUIDATION or of curtailing materiality the
scale of its operations.
Consistency Concept SAME ACCOUNTING POLICY IS FOLLOWED from one accounting

period to another.
Prudence Concept NOT ANTICIPATED PROFITS

The enterprise should but should
PROVIDE FOR ALL POSSIBLE LOSSES.
Notes: Prudence Principle is an exception to Consistency and Full Disclosure
Principle.
Full Disclosure DISCLOSE ALL RELEVANT AND

Financial Statements must
Principle RELIABLE INFORMATION.
Materiality Principle All RELEVANT ITEMS, the knowledge of which might influence the
decision of users of financial statements should be disclosed.
E.g. Accounting of small calculator as an expense and not as an asset.

Qualitative
Characteristics of 1. Understandability 7. Substance over Form
Accounting 2. RELIABILITY 8. Neutrality
Information/Financial 3. RELEVANCE 9. Prudence
Statements 4. Comparability 10. Full, Fair and adequate disclosure
5. Materiality 11. Completeness
6. Faithful Representation
Accrual Concept Under accrual concept, the effects of transactions and other events are
recognised on MERCANTILE BASIS i.e., when they occur (and not as cash or
a cash equivalent is received or paid) and they are recorded in the accounting
records and reported in the financial statements of the periods to which they
relate.
Cost Concept (Historic) - asset is recorded at the price paid to acquire it, that is, at cost; and this cost
is the basis for all subsequent accounting for the asset.
Realisation Concept - revenue is considered as earned on the date when it is realised. In other words,
revenue realised (either by sale of goods or by rendering services) during an accounting period should
only be taken in the income statement (Profit and Loss Account).
Example: Mr. X purchased a piece of land on 1.4.82 paying Rs. 4,000. Its current market value is Rs.
200,000 on 31.03.2014.
The accountant shows the land at Rs. 4,000 following cost concept & show the land at Rs. 200,000
following Realisation Concept. Now-a-days the revaluation of assets has become a widely accepted
practice when the change in value is of permanent nature. Accountants adjust such value change
through creation of capital reserve.
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Dual Aspect Concept One entry consists of debit to one or more accounts and another entry consists
of credit to one or more accounts. However, the total amount debited always equals the total amount
credited.
(1) It increases one Asset and decreases other Asset;

(2) It increases an Asset and simultaneously increases Liability; (3) It decreases
one Asset, increases another Asset;
(4) It decreases one Asset, decreases a Liability.
(5) It increases one Liability, decreases other Liability;
(6) It increases a Liability, increases an Asset;
(7) It decreases Liability, increases other Liability;
(8) It decreases Liability, decreases an Asset.
Matching Concept - the expenses which are actually incurred during a specific activity period, in order
to earn the revenue for the said period must be matched against the revenue which are realised for that
period.
Examples of the application of the convention of conservatism
(a) Making the provision for doubtful debts and discount on debtors in anticipation of actual bad
debts and discount,
(b) Valuing the stock in trade at market price or cost price whichever is less,
(c) Creating provision against fluctuation in the price of investments,
(d) Charging of small capital items, like crockery, to revenue,
(e) Adopting written-down-value method of depreciation as against straight-line method. The
written-down-value method of depreciation is more conservative in a approach.
(f) Amortization of intangible assets like goodwill which has indefinite life, (g) Showing joint life
policy at surrender value as against the amount paid,
(h) Not providing for discount on creditors,
(i) Taking into consideration claims intimated but not accepted as a loss for calculating profit for a
general insurance company,
(j) Considering the loss relating to premium on the redemption of debentures when they are issued
at par or at discount but redeemable at premium, at the time of their issue.
OTHER TERMS
Expenditure Expenditure is the cost incurred in acquiring of asset or service in the form of outflow
or depletion of asset or incurrence of liability. It may be expired or unexpired.
Expense Expense (expired cost) is that portion of expenditure which has not been consumed
during current accounting period. It may be utilized cost or lost cost.
Asset Asset (unexpired cost) is that portion of expenditure which has not been consumed
during current accounting period.
Revenue Revenue refers to amount charged for goods sold or services rendered or permitting
others to use the enterprises resources yielding interest, royalty or dividend.

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1. All the following items are classified as fundamental accounting assumptions except
a) Consistency b) Business Entity
c) Going Concern d) Accrual
2. Two primary qualitative characteristics of financial statements are

a) Understandability and materiality. b) Relevance and reliability.
c) Relevance and understandability. d) Materiality and reliability.
3. Kanika Enterprises follows the written down value method of depreciating machinery
year after year due to
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a) Comparability b) Convenience
c) Consisitency d) All of the Above
4. A purchased a car for Rs. 5,00,000, making a down payment of Rs. 1,00,000 and signing a
Rs. 4,00,000 bill payable due in 60 days. As a result of this transaction
a) Total assets increased by Rs. 5,00,000.
b) Total liabilities increased by Rs. 4,00,000.
c) Total assets increased by Rs. 4,00,000.
d) Total assets increased by Rs. 4,00,000 with corresponding increase in liabilities
by Rs. 4,00,000.
5. Mohan purchased goods for Rs.15,00,000 and sold 4/5th of the goods amounting
Rs.18,00,000 and met expenses amounting Rs. 2,50,000 during the year, 2005. He counted
net profit as Rs. 3,50,000. Which of the accounting concept was followed by him?
a) Entity b) Periodicity
c) Matching d) Conservatism
6. A businessman purchased goods for Rs. 25,00,000 and sold 80% of such goods during the
accounting year ended 31st March, 2005. The market value of the remaining goods was
Rs. 4,00,000. He valued the closing stock at cost. He violated the concept of
a) Money Measurement b) Conservatism
c) Cost d) Periodicity
7. Capital brought in by the proprietor is an example of

a) Increase in asset and increase in liability.
b) Increase in liability and decrease in asset.
c) Increase in asset and decrease in liability.
d) Increase in one asset and decrease in another asset.
8. Assets are held in the business for the purpose of
a) Resale b) Conversion into cash
c) Earning Revenue d) None of the Above
9. Revenue from sale of products, is generally, realized in the period in which

a) Cash is collected b) Sale is made
c) Products are manufactured d) None of the Above
10. The concept of conservatism when applied to the balance sheet results in
a) Understatement of assets. b) Overstatement of assets.
c) Overstatement of Capital. d) None of the Above
11. Decrease in the amount of creditors results in

a) Increase in Cash b) Decrease in Cash
c) Decrease in Assets d) No Change in Assets
12. The determination of expenses for an accounting period is based on the principle of
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a) Objectivity b) Materiality
c) Matching d) Periodicity
13. Economic life of an enterprise is split into the periodic interval as per
a) Periodicity b) Matching
c) Going Concern d) Accrual
14. If an individual asset is increased, there will be a corresponding

a) Increase of another asset or increase of capital.
b) Decrease of another asset or increase of liability.
c) Decrease of specific liability or decrease of capital.
d) Increase of drawings and liability.
15. Purchase of machinery for cash

a) Decreases total assets. b) Increases total assets
c) Retains total assets unchanged d) Decreases total liabilities.
16. Consider the following data pertaining to Alpha Ltd.:

Cost of machinery purchased on 1st April, 2009 10,00,000
Installation charges 1,00,000
Market value as on 31st March, 2010 12,00,000
While finalizing the annual accounts, if the company values the machinery at Rs. 12,00,000.
Which of the following concepts is violated by the Alpha Ltd.?
a) Cost b) Matching
c) Accrual d) Periodicity
17. A proprietor, Mr. A has reported a profit of Rs. 1,25,000 at the end of the financial year
after taking into consideration the following amount:
(i) The cost of an asset of Rs. 25,000 has been taken as an expense.
(ii) Mr. A is anticipating a profit of Rs. 10,000 on the future sale of a car shown as an
asset in his books.
(iii) Salary of Rs. 7,000 payable in the financial year has not been taken into account.
(iv) Mr. A purchased an asset for Rs. 75,000 but its fair value on the date of purchase
was Rs. 85,000. Mr. A recorded the value of asset in his books by Rs. 85,000.
On the basis of the above facts answer the following questions from the given choices:
(i) What is the correct amount of profit to be reported in the books?

a) Rs. 125,000 b) Rs. 135,000
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c) Rs. 150,000 d) Rs. 133,000
(ii) Which measurement base should be followed in the statement?

a) Historical Cost b) Current Cost
c) Replacement Cost d) Present Value
(iii) Which concept should be followed in the statement?

a) Conservatism b) Materiality
c) Historical Cost d) Accrual
(iv) Which concept should be followed in the statement

a) Materiality b) Historical Cost
c) Current Cost d) Accrual
[Ans. 1. (b), 2 (b), 3 (c), 4 (d), 5 (c), 6 (b), 7 (a)], 8 (c), 9 (b), 10 (a), 11 (b), 12 (c), 13 (c), 14 (b),
15 (c), 16 (a), 17 (i)-(d), (ii)-(a), (iii)-(b), (iv)-(d)]

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NOTES

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CHAPTER-1
Accounting An Introduction
Unit-3
ACCOUNTING STANDARDS, POLICIES

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ACCOUNTING STANDARDS
Meaning An Accounting Standard is selective set of accounting policies or broad
guidelines regarding the principles and methods to be chosen out of
several alternatives.
Objectives To harmonize the diverse accounting policies and practices.
Advantages Reduction in Variations.
Disclosure beyond the required law.
Facilitates Comparison.
Arguments against AS Restriction on choice of alternative treatment.
Rigidity.
Cannot override the statute.
Who issues the AS in Accounting Standards Board of
India? The Institute of Chartered Accountants of India (ICAI)
How many AS have been Thirty Two (32)
issued so far?

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At present how many AS At present Thirty One (31) AS are in force

are in force?
Since AS-8 has been withdrawn on issue of AS-26 on Intangible Assets.
Why is it essential to It is essential to standardize Accounting Principles and Policies in order to

Standardize Accounting ensure transparency, consistency, comparability.
Principles and Policies?
ACCOUNTING POLICIES
Meaning Accounting Policy refers to accounting principles and methods of applying
those principles adopted by the enterprise in the preparation of financial
statements.
Consideration in Primary Consideration: True & Fair View of Financial Statements
Selection of Accounting
Policies Secondary Consideration: Prudence, Substance over form, Materiality
Examples Method of Providing Depreciation, Methods of Valuation of Stock.
When is a change in A change in Accounting Policy is recommended
Accounting Policy
recommended?
1. To comply with law.
2. To comply with AS.

3. To ensure more appropriate presentation of financial
statements.
FAA as per AS-1 Going Concern, Consistency and Accrual
Is Disclosure required if FAA has been followed? No Disclosure is required.

Accounting Principles 1. Accounting Policies for making provision of doubtful debts & valuation
applicable to of inventory at lower of cost or net realizable value are as per Prudence
Accounting Polices Principle.
2. Accounting Policy of treating the cost calculation expense is as per
Materiality Principle.
3. Accounting Policy of using WDV method year after year is as per
Consistency Principle.
ACCOUNTING EQUATION
Meaning It is a statement of equality between the resources and sources which finance
the resources.
Expression of
Accounting Equation 1. Total Assets = Total Equities
2. Assets = Internal Equity + External Equity
3. Assets = Capital + Liabilities
Capital Capital = Assets Liabilities

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Closing Capital Closing Capital = Opening Capital + Profit + Additional Capital Drawings
1. Profit
Transactions which 2. Additional Capital (in cash or in kind)
increase the Capital
1. Loss
Transactions which 2. Drawings (in cash or in kind)
decrease the Capital
Effect of Net Profit Net Profit is always reflected in higher cash balance and/or debtors balances.
Effect of Net Loss Net Loss is always reflected in lower Net Worth i.e. Capital.
ACCOUNTING AS A MEASUREMENT DISCIPLINE

Measurement 1. Identification of objects and events.
discipline deals with 2. Selection of standard or scale to be used.
3. Evaluation of dimension of standard or scale.
Valuation of
Principles or 1. Historical Cost Base.
Measurement Bases 2. Current Cost Base.
3. Realizable Value Base.
4. Present Value Base.
Examples of 1. Doubtful Debts.

Accounting Estimates 2. Useful Life of Depreciable Asset.
3. Residual Value of Depreciable Asset.
Changes in Changes in Accounting Estimates means differences arising between certain

Accounting Estimates parameters estimated earlier and
1. Re-estimated during current period, or
2. Actual results achieve during current period.
No Retrospective Changes in Accounting Estimate cannot be given retrospective effect.
Effect
List of Accounting Standards
AS 1 : Disclosure of Accounting Policies
AS 2 : Valuation of Inventory

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AS 3 : Cash Flow Statement
AS 4 : Contingencies and Events occurring after Balance Sheet Date
AS 5 : Net Profit or Loss for the period, prior period and changes in accounting estimates
AS 6 : Depreciation Accounting
AS 7 : Accounting for Construction Contracts
AS 8 : Accounting for Research and Development (withdrawn)
AS 9 : Revenue Recognition
AS10: Accounting for Fixed Assets
AS 11: Accounting for Effect of Changes in Foreign Exchange Rates
AS 12: Accounting for Government Grants
AS 13: Accounting for Investments
As 14: Accounting for Amalgamations
AS 15: Accounting for Retirement Benefits in the Financial Statements of Employers
AS 16: Accounting for Borrowing Costs
AS 17: Segmental Reporting
AS 18: Related Party Disclosures
AS 19: Leases
AS 20: Earnings Per Share
AS 21: Consolidated Financial Statements
AS 22: Accounting for Taxes on Income
As 23: Accounting for Investment in Associates in Consolidated Financial Statements
AS 24: Discontinuing Operations
AS 25: Interim Financial Statements
AS 26: Intangible Assets
AS 27: Financial Reporting of Joint Ventures
AS 28: Impairment of Assets
AS 29: Provisions, Contingent Liabilities and Contingent Assets
AS 30: Financial Instruments: Recognition and Measurement
AS 31: Financial Instruments: Presentation
AS 32: Financial Instruments: Disclosures

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1. Accounting Standards in India are issued by

a) Central Govt. b) State Govt.
c) ICAI d) RBI
2. Accounting Standards
a) Harmonise accounting policies.
b) Eliminate the non-comparability of financial statements.
c) Improve the reliability of financial statements.
d) All of the Above
3. How many Accounting Standards have been issued by ICAI?

a) 25 b) 31 c) 32 d) 22
4. It is essential to standardize the accounting principles and policies in order to ensure

a) Transparency. b) Consistency.
c) Comparability. d) All of the above.
5. All of the following are limitations of Accounting Standards except

a) The choice between different alternative accounting treatments is difficult.
b) There may be trend towards rigidity.
c) Accounting Standards cannot override the statute.
d) All of the Above.
6. A change in accounting policy is justified

a) To comply with accounting standard.
b) To ensure more appropriate presentation of the financial statement of the enterprise. c)
To comply with law.
d) All of the Above.
7. Accounting policy for inventories of Xeta Enterprises states that inventories are valued at
the lower of cost determined on weighted average basis or not realizable value. Which
accounting principle in followed in adopting the above policy?
a) Materiality. b) Prudence.
c) Substance over form. d) All of the Above.
8. The areas wherein different accounting policies can be adopted are

a) Providing depreciation. b) Valuation of Inventories
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c) Valuation of Investments d) All of the Above
9. Selection of an inappropriate accounting policy decision may

a) Overstate the performance and financial position of a business entity.
b) Understate/overstate the performance and financial position of a business entity.
c) Overstate the performance a business entity.
d) Understate financial position a business entity.
10. Accounting policies refer to specific accounting

a) Principles. b) Methods of applying those principles.
c) Both (a) and (b). d) None of the above.
11. Measurement discipline deals with

a) Identification of objects and events.
b) Selection of scale.
c) Evaluation of dimension of measurement scale.
d) All of the above.
12. All of the following are valuation principles except

a) Historical Cost b) Present Value
c) Future Value d) Realisable Value
13. Book value of machinery on 31st March, 2010 Rs. 10,00,000

Market value as on 31st March, 2010 Rs. 11,00,000
As on 31st March, 2006, if the company values the machinery at Rs. 11,00,000, which of
the following valuation principle is being followed?
a) Historical Cost b) Present Value
c) Realisable Value d) Current Cost
[Ans. 1 (c), 2 (d), 3 (c), 4 (d), 5 (d), 6 (d), 7 (b), 8 (d), 9 (b), 10 (c), 11 (d), 12 (c), 13 (c)]
Case:- A Ltd. Purchased a machinery amounting Rs. 500,000 on 1st April, 2001. On 31st
March, 2007, the similar machinery could be purchased for Rs. 10,00,000 but the
realizable value of the machinery (purchased on 01.04.2001) was estimated at Rs.
600,000. The present discounted value of the future net cash inflows that the machinery
was expected to generate in the normal course of business, was calculated at Rs. 700,000.
What is the Current Cost, Present Value, Historical Cost and Realizable Value of
Machinery?
Ans:- The Current Cost of Machinery is Rs. 10,00,000

The Present Value of Machinery is Rs. 700,000 The Historical
Cost of Machinery is Rs. 500,000 The Realizable Value of
Machinery is Rs. 600,000

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NOTES

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CHAPTER-2
Accounting Process
Unit-1 ACCOUNTING
PROCESS 1
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JOURNAL ENTRIES & LEDGERS
AN ACCOUNT
Meaning An Account is a summary of relevant transactions at one place relating to a
particular head.
Classification of Traditional Approach Personal, Real and Nominal.
Accounts
Modern Approach/
Accounting Equation Approach - (A=L+C) Assets, Capital, Liabilities, Expense
and Revenue.
Classification of Accounts
1. Personal Accounts: These accounts deal with transactions relating to persons or an

organization. It can be classified as:
(a) Natural Persons: Mr. S. Sharma, Triveni & Sons, etc.
(b) Artificial Persons: State Bank of India, ITC Ltd, CC & FC, Royal Calcutta Golf Club, etc.
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(c) Representative Persons: Outstanding Expenses (representing liability for expenses to

supplies) ; Prepaid Salary (representating employees) etc.
2. Impersonal Accounts: There accounts do not relate to any persons are known as impersonal
accounts.
(a) Real Accounts: It is an accounts relating to assets and properties.
Eg: Land, Building, Plant, Machinery, Cash, Bank, Stock, etc.
(b) Nominal Accounts: It is an account relating to expenses, losses, incomes and gains.
They do not have any physical existence except names.
E.g: Sales, Purchases, Salary, Wages, Rent, Interest, Repairs, Travelling, etc.
DOUBLE ENTRY SYSTEM OF BOOK KEEPING
Meaning It refers to a system of accounting under which both the aspects (debit or credit) of
every transaction are recorded in the accounts involved.
Two fold aspect of transaction is called dual aspect or duality of transaction.

Advantages 1. Arithmetical Accuracy of ledger accounts through the device of Trial
Balance.
2. Ascertainment of Financial Position.
3. Ascertainment of Financial Performance.
4. Comparability of Financial Statements.
DEBIT AND CREDIT
Origin of Debit and The terms of debit and credit have their origin from the terms debito and credito
Credit General as used by lucafrapacioli.
Debit is derived from the latin word debitum, which means `what we will
receive. It is the destination, who enjoys the benefit. Credit is derived from
the latin word credre which means `what we will have to pay. It is the
source, who sacrifices for the benefit.
Meaning of Debit Debit in relation to assets and expense represents an increase but in relation to
liabilities, capital, revenue represents a decrease.
Meaning of Credit Credit in relation to assets and expense represents an decrease but in relation to
liabilities, capital, revenue represents a increase.
Equality Every debit has an equal amount of credit.

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RULES OF DEBIT AND CREDIT Traditional Approach
Types of Accounts Rules of Debit Rules of Credit

For Personal Accounts Debit the Receiver Credit the Giver
For Real Accounts Debit What Comes in Credit What Goes out
For Nominal Accounts Debit the Expenses and Losses Credit the Gains and Incomes
Items Account Nature

(a) Land Real Asset (Tangible)
(b) Building Real Asset (Tangible)
(c) Patent Rights Real Asset (Tangible)
(d) Trade Marks Real Asset (Tangible)
(e) Bad debt Nominal Loss
(f) Depreciation Nominal Loss
(g) Interest Received Nominal Income
(h) Advertising Nominal Expense
(i) Creditors Personal Liability (Payable)
(J) Debtors Personal Asset (Receivable)
(k) Discount Allowed Nominal Loss
(l) Sales Nominal Income
(m) Bank Overdraft Personal Liability
(n) Loan to Ram Personal Asset
(o) Discount Received Nominal Gains
(p) Carriage on Purchase Nominal Expense
(q) Royalty on Sales Nominal Expense
(r) Goodwill Real Asset (Intangible)
(s) Drawings Personal Asset (For the Business)
(t) Purchase Nominal Expense
RULES OF DEBIT AND CREDIT Accounting Equation Approach
Types of Accounts Rules of Debit Rules of Credit

For Assets A/c Debit the Increase Credit the Decrease
For Liabilities A/c Debit the Decrease Credit the Increase
For Capital A/c Debit the Decrease Credit the Increase
For Revenue A/c Debit the Decrease Credit the Increase
For Expense A/c Debit the Increase Credit the Decrease
JOURNAL Also Called Subsidiary Book
Meaning Journal is a book of prime entry in which transactions are recorded in

chronological order. (i.e. order of occurrence).
Journalising Journalising is a process of recording transactions in journal.
Journal Entry Journal Entry is an entry made in journal.
Advantages 1. Chronological Record.
2. Explanation of transaction.

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3. Recording of both aspects.
Limitations 1. Time and cost consuming.

2. No prompt information.
3. No internal check.
4. Bulky and voluminous.
Note:- All columns (except ledger folio L.F. column) are recorded at the time of journalising but L.F. column is
recorded at the time of posting.
JOURNAL
Date Particulars L.F. Dr. Amount Cr. Amount
(Rs.) (Rs.)
SIMPLE AND COMPOUND JOURNAL ENTRY
Simple Journal Entry A Journal entry for a transaction involving only two accounts. (One Debit and One
Credit)
Compound Journal A single journal entry for a transaction involving more than two accounts. (i.e.
Entry one debit and two or more credits or two or more debits and one credit or two
or more debits and credits)
If journal entries are recorded in several pages then both the amount column of each page should be
totalled and the balance should be written at the end of that page with the name "Carried forward" in the
particulars column and the same total should be carried forward at the beginning of the next page with
the words "Brought forward" in the particulars column
COMPOSITE JOURNAL ENTRY
Composite Journal When journal entry for two or more transactions are combined, it is called
Entry composite journal entry.
Rent Account Dr. 100
Salary Account Dr. 200
To Cash Account 300
(Being expense paid)

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OPENING ENTRY
Meaning A journal entry by means of which the balances of various assets, liabilities and
capital appearing in the Balance Sheet of previous accounting period are brought
forward in the books of current accounting period are known as Opening Entry.
Recording of While passing an opening entry:

Opening Entry All Assets (individually) are debited.
All Liabilities account (individually) is credited.
Net Worth (excess of assets over liabilities) is credited to Capital account.
Posting of Opening At the time of posting of an opening entry-

Entry The words To Balance b/f are recorded in particulars column of all
Assets Accounts and
The words By Balance b/f are recorded in particulars column of all
Liabilities Accounts and Capital Accounts.

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LEDGER AND POSTING
After recording the transactions in the journal, recorded entries are classified and grouped into by
preparation of accounts and the book, which contains all set of accounts (viz. personal, real and nominal
accounts), is known as Ledger.
Separate account is opened in ledger book for each account and entries from ledger posted to
respective account accordingly.
It is a practice to use words 'To' and 'By' while posting transactions in the ledger. The word 'To'
is used in the particular column with the accounts written on the debit side while 'By' is used
with the accounts written in the particular column of the credit side.
Meaning Ledger is a principal book which contains all the accounts by which
transactions recorded in the books of original entry are transferred.
Ledger is also called a book of final entry as ledger is the ultimate

destination of all transactions.
Form of Ledger A Ledger may be kept in the form of bound book, CDs or any other device.
Utilities of a Ledger 1. It provides complete information about all accounts in one book.
2. It enables to ascertain what are the main items of revenues/expenses.
3. It enables to ascertain which are the assets and of what values.
4. It enables to ascertain which are the liabilities and of what accounts.
5. It facilitates the preparation of Final Accounts.
Meaning of Posting Posting is the process of transferring the transactions recorded in the books of
original entry in the concerned accounts.
Purpose of Posting Posting helps us to ascertain the net effect of various transactions during a given
period on a particular account.
LEDGER ACCOUNT
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
(Rs.) (Rs.)
BALANCING
Balancing of an Account It is a process of ascertaining the difference between total of

debit and total of credit appearing in an account.
Balance of an Account Balance of an account is the difference between total of debit and
total of credit appearing in an account.
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Purpose of Balancing of an Balancing of an account is necessary to ascertain net effect of all

Account transactions posted to an account during a given period.
Recording of Balance of an While balancing an account, the balance of an account is recorded in
Account shorter side.
Nature of Balance of an account The balance of an account is always known by the balance of higher
side.
Accounts which are balanced Normally Personal and Real accounts are balanced.
OBJECTIVE TYPE QUESTIONS: JOURNAL ENTRIES

I(i). The rent paid to landlord is credited to
a) Landlords Account b) Rent Account
c) Cash Account d) None of the Above
(ii). In case of a debt becoming bad, the amount should be credited to

a) Debtors Account b) Bad Debts Account
c) Cash Account d) Sales Account
(iii). Sunset Tours has a Rs. 3,500 account receivable from Mohan. On January 20, the Rotary
makes a partial payment of Rs. 2100 to Sunset Tours. The journal entry made on January
20 by Sunset Tours to record this transaction includes:
a) A credit to the cash received account of Rs. 2,100.
b) A credit to the Accounts receivable account of Rs. 2,100.
c) A debit to the cash account of Rs. 1,400.
d) A debit to the Accounts receivable account of Rs. 1,400.
(iv). Which financial statement represents the accounting equation, assets = Liabilities +
Owners equity:
a) Income Statement b) Statement of Cash Flows
c) Balance Sheet d) None of the Above
(v). Which account is the odd one out?

a) Office furniture & Equipment. b) Freehold Land & Buildings
c) Stock of Materials d) Plant and Machinery
(vi). The debts written off as bad, if recovered subsequently are

a) credited to Bad Debts Recovered A/c b) credited to Debtors Account
c) debited to Profit & Loss Account d) None of the above
[Ans: 1: (i)-(c), (ii)-(a), (iii)-(b), (iv)-(c), (v)-(c), (vi)-(a)]
II From the given information, choose the most appropriate answer.

1(i). Classify each of the following items under: Prepaid Salary Account
a) Personal Account b) Real Account
c) Nominal Account d) None of the Above

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(ii). Bills Payable Account

(iii). Rent Account

(iv). Proprietors Account

(iv). Patent Account

[Ans. 1: (i)-(a), (ii)-(a), (iii)-(c), (iv)-(a), (v)-(b)]
2(i). Classify each of the following items under: Salaries

a) Revenue (R) b) Expense (E)
c) Assets (A) d) Liability (L)
(ii). Equipment
(iii). Accounts Payable

(iv). Membership Fees Earned

(v). Stock
(vi). Accounts Receivable


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(vii). Building
(viii). Profits
[Ans.2: (i)-(b), (ii)-(c), (iii)-(d), (iv)-(a), (v)-(c), (vi)-(c), (vii)-(c), (viii)-(d)]
3. In each of the following, indicate the alternative which you consider to be correct:
(a). In Double Entry System of Book-keeping every business transaction affects:
a) Two accounts. b) Two sides of the same account
c) the same a/c on two different dates. d) All of the above
(b). A sale of goods to Ram for cash should be debited to:

a) Ram b) Cash
c) Sales d) Capital
(c). A withdrawal of cash from business by the proprietor should be credited to:
a) Drawings Account b) Capital Account
c) Cash Account d) Purchase Account
[Ans:3: (a)(i), (b)(ii), (c)(iii)]
OBJECTIVE TYPE QUESTIONS: LEDGERS AND POSTING
(i). The process of transferring the debit and credit items from a Journal to their respective
accounts in the ledger is termed as
a) Posting b) Purchase
c) Balancing of an account d) arithmetically accuracy test
(ii). The technique of finding the net balance of an account after considering the totals of both
debits and credits appearing in the account is known as
a) Posting b) Purchase
c) Balancing of an account d) arithmetically accuracy test
(iii). Journal and ledger records transactions in

a) a chronological order and analytical order respectively.
b) an analytical order and chronological order respectively.
c) a chronological order only
d) an analytical order only.

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(iv). Ledger book is popularly known as

a) secondary book of accounts
b) principal book of accounts
c) subsidiary book of accounts
d) none of the above
(v). At the end of the accounting year all the nominal accounts of the ledger book are
a) balanced but not transferred to profit and loss account
b) not balanced and also the balance is not transferred to the profit and loss account
c) balanced and the balance is transferred to the balance sheet
d) not balanced and their balance is transferred to the profit and loss account.
[Ans: (i)-(a), (ii)-(c), (iii)-(a), (iv)-(b), (v)-(d)]
POINTS TO BE NOTED
Cash Transactions A transaction is said to be a cash transaction when the word Cash is used
or name of part is not used.
Cases when Purchase 1. Goods taken away by Proprietor.
Account is credited with 2. Goods taken away by Employees.
Cost of Goods and not 3. Goods Stolen/misappropriated by an employee.
with Sales Price 4. Goods Stolen/destroyed by fire.
5. Goods distributed as charity/free samples.
6. Goods used in making furniture/machine.
Bad Debts Recovered Receipt of Cash from a Debtor whose account was previously written off as
Account bad is credited to Bad Debts Recovered A/c and not to Debtors Personal
Account.
NOTES

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CHAPTERAccounting
Process ----- Error! Bookmark not
defined.
Unit -Error! Bookmark not defined.
ACCOUNTING
PROCESS ------------------------------ 7
SUBSIDIARY BOOKS, TRIAL BALANCE

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SUBSIDIARY BOOKS
Meaning Subsidiary Books (Special Journal)

are the books of original entry (or prime entry) which are used to record
the specific transactions of similar nature for the first time on the basis of
source of documents. Subsidiary books are the part of journal.
Advantages 1. Facilitate division of work.

2. Permit the installation of internal check system.
3. Permit the use of specialized skill.
4. Result in Time and Labour saving in journalising and posting.
Types 1. Cash Journal (i.e. Cash Book).

2. Goods Journal (Purchases Book, Sales Book, Purchase Return Book, Sales
Return Book).
3. Bills Journals (Bills Receivable Book, Bills Payable Book).
4. Journal Proper.

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MEANING OF CASH BOOK
As Special Journal Cash Book is a Special Journal which is used to record all receipts and payments
for the first time on the basis of source documents.
As a Ledger Cash Book is a Ledger as it serves the purpose of Cash Account. Cash
Book is both journal and ledger.
TYPES OF CASH BOOK
Single Column It records only Cash Receipts and Cash Payments.

Cash Book with It records Cash Receipts and Cash Discount Allowed in debit side and Cash
Discount Column Payments and Cash Discount Received in credit side.
Three Column Cash It records Cash Receipts, Bank Receipts, and Cash Discount Allowed on debit side
Book and Cash Payments, Bank Payments, Cash Discount Received on credit side.
Petty Cash Book It records the payments of Petty Cash Expenses.
DISCOUNTS IN CASH BOOK
Which discount is recorded in Cash In Cash Book, Cash Discount is recorded and not the trade
Book? discount.
Recording of Cash Discount Allowed On Debit Side.
Recording of Cash Discount Received On Credit Side.
Posting of discount column on Dr. side Total of discount column on credit side of three column cash
book is posted to the debit of Discount Received Account.
Posting of discount column on Cr. side Total of discount column on credit side of three column cash
book is posted to the credit of Discount Received Account.
Totaling of Discount Columns Discount Columns are merely totaled and never balanced.
BALANCING OF CASH BOOK
Cash Book with Only Cash Columns are balanced but not Discount Columns.
Discount Column
Three Columns Only Cash and Bank Columns are balanced but not Discount Columns.
Cash Book
Nature of Balance 1. Single Column Cash Book shows only a debit balance.
2. Bank Column of Cash Book may show either debit balance or credit
balance.

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CONTRA ENTRY
Meaning If the debit side as well as credit aspect of a transaction are recorded in cash book
itself, it is called Contra Entry.
Examples 1. Cash Deposit into Bank.
2. Cash Withdrawal from Bank.
Recording Contra Entries are passed only when Three Column Cash book is maintained.
Posting Contra Entries are never posted in the ledger.
RECORDING OF DISHONOUR/ENDORSEMENT
When Cheque received from It is recorded in bank column on credit side.

customer is returned dishonoured
When Discounted Bill Receivable is It is recorded in bank column on credit side.
dishonoured
When Cheque received is endorsed It is recorded on both the sides of Cash Book.
PETTY CASH BOOK
Meaning It records the payments of petty cash expenses.

Posting Periodic totals if various heads of expenses are individually posted to the
debit of the concerned accounts in the ledger.
Imprest System Under Imprest System, the chief cashier makes reimbursement of amount
spent by petty cashier and petty cashier again has the same amount of cash
at the end as in the beginning.
Balance The balance in Petty Cash Book is an asset.
PURCHASES BOOK (INVOICE BOOK/BOUGHT BOOK)
Meaning Purchase Book is one of the subsidiary books which is used to record the credit
purchases of goods on the basis of purchase invoices received from suppliers.
Posting of An individual transaction of purchase book is posted to credit of Suppliers
Individual Account.
transactions
Posting of Total of The total of Purchase Book is posted to the debit of Purchases A/c.
Purchase Book
Purchases A/c Purchases A/c shows all purchases of goods (whether for cash or on credit).
SALES BOOK (DAY BOOK/SOLD BOOK)
Meaning Sales Book is one of the subsidiary books which is used to record the credit sales
of goods on the basis of sales invoices issued to customers.

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Posting of An individual transaction of sales book is posted to debit of Customers Account.

Individual
transactions
Posting of Total of The total of Sales Book is posted to the credit of Sales A/c.
Sales Book
Sales Account Sales Account shows all the sales of goods (whether for cash or on credit).
PURCHASES RETURN BOOK (RETURN OUTWARD BOOK)
Meaning Purchase Return Book is one of the subsidiary books which is used to record
the return of goods purchased on credit on the basis of debit notes issued to
the suppliers.
Posting of Individual An individual transaction of purchase return book is posted to the debit of
Transactions Suppliers Account.
Posting of Total of The Total of Purchases Return Book is posted to the credit of Purchase Return
Purchase Return Book Account.
Purchases Return Purchases Return Account shows return of goods.
Account
SALES RETURN BOOK (RETURN INWARD BOOK)
Meaning Sales Return Book is one of the subsidiary books which is used to record the
return of goods sold on credit on the basis of credit notes issued to the customers.
Posting of An individual transaction of sales return book is posted to the credit of Customers
Individual Account.
Transactions
Posting of Total of The Total of Sales Return Book is posted to the debit of Sales Return Account.
Sales Return Book
Sales Return Sales Return Account shows return of goods.
Account
BILLS RECEIVABLE BOOK
Meaning Bills Receivable Book is one of the subsidiary books which is used to record the
details of bills receivable in favour of a person who is maintaining the Bills
Receivable Book on the basis of bills of exchange received.
Posting of An individual transaction of Bills Receivable book is posted to the credit of
Individual Debtors Account.
Transactions

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Posting of Total of The Total of Bills Receivable Book is posted to the debit of Bills Receivable
Bills Receivable Account.
Book
Bills Receivable A/c Bills Receivable Account shows the amount of Bills Receivable received.
BILLS PAYABLE BOOK
Meaning Bills Payable Book is one of the subsidiary books which is used to record the
details of bills payable accepted by a person who is maintaining the Bills
Payable Book on the basis of bills of exchange accepted.
Posting of Individual An individual transaction of Bills Payable Book is posted to the debit of
Transactions Creditors Account.
Posting of Total of Bills The Total of Bills Payable Book is posted to the credit of Bills Payable Account.
Payable Book
Bills Payable A/c Bills Payable Account shows the amount of Bills Payable accepted.
JOURNAL PROPER
Meaning Journal Proper is one of the subsidiary books which is used to record those
transactions which cannot be recorded in any other subsidiary books
RECORDING OF SOME TRANSACTIONS
Trade Discount Allowed/received Not recorded in any of the subsidiary books.

Cash Discount allowed/received In Two/Three Column Cash Book.
A dishonour of Bill Receivable In Journal Proper
A dishonour of Discounted Bills Receivable In Three Column Cash Book
An endorsement of Bills Receivable to a creditor In Journal Proper
An endorsement of Cheque to a creditor In Three Column Cash Book
Return of Goods sold for cash In Cash Book and not in Sales Return Book.
TRIAL BALANCE
Meaning It is a statement which shows the balances of all accounts in the ledger and
Cash & Bank Balances.
When Trial Balance is A T.B. is prepared on a particular date and not for a particular period.
prepared?
Main Objectives of Trial To ascertain the arithmetical accuracy of ledger accounts.
Balance To help in locating errors of commission and errors of partial
omission.
To facilitate the preparation of financial statements.

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Not a Conclusive Proof A T.B. merely checks the arithmetical accuracy of books of accounts and is not
of Accuracy of Books a conclusive proof of accuracy of books of accounts since certain errors may
Limitation of remain still undetected inspite of a tallied T.B.
Accounting
(i) Transaction has not been entered at all in the journal.
(ii) A wrong amount has been written in both columns of the journal.
(iii) A wrong account has been mentioned in the journal.
(iv) An entry has not at all been posted in the ledger.
(v) Entry is posted twice in the ledger.
Still, the preparation of the trial balance is very useful; without it, the preparation of financial
statement, the profit and loss account and the balance sheet, would be difficult.
METHODS OF PREPARING TRIAL BALANCE
1. Total Method
Under this method, every ledger account is totaled and that total amount (both of debit side and
credit side) is transferred to trial balance. In this method, trial balance can be prepared as soon
as ledger account is totaled. Time taken to balance the ledger accounts is saved under this
method as balance can be found out in the trial balance itself. The difference of totals of each
ledger account is the balance of that particular account. This method is not commonly used as it
cannot help in the preparation of the financial statements.
RAM (LEDGER) ACCOUNT
Dr. Cr.
(Rs.) (Rs.)
To Sales 10,000
To Sales 12,000 By Balance c/d 22,000
Total 22,000 Total 22,000
TRIAL BALANCE
AS AT
S. No. Ledger Accounts L.F. Total Dr. Total Cr.
Column Column
Amount (Rs.) Amount (Rs.)
Ram Account 22,000 22,000
2. Balance Method
Under this method, every ledger account is balanced and those balances only are carry forward
to the trial balance. This method is used commonly by the accountants and helps in the
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preparation of the financial statements. Financial statements are prepared on the basis of the
balances of the ledger accounts.
RAM (LEDGER) ACCOUNT
Dr. Cr.
(Rs.) (Rs.)
To Sales 10,000
To Sales 12,000 By Balance c/d 22,000
Total 22,000 Total 22,000
TRIAL BALANCE
AS AT
S. No. Ledger Accounts L.F. Dr. Amount Cr. Amount
(Rs.) (Rs.)
Ram Account 22,000
3. Total and Balance Method

Under this method, the above two explained methods are combined. Under this method
statement of trial balance contains seven columns instead of five columns.
TRIAL BALANCE
AS AT
S. Ledger Accounts L.F. Total Balance
No. Dr. Column Cr. Column Dr. Cr.
Amount Amount Amount Amount
(Rs.) (Rs.) (Rs.) (Rs.)
Ram Account 22,000 22,000 22,000
The under mentioned points may be noted:
1. A trial balance is prepared as on a particular date which should be mentioned at the top.
2. In the second column the name of the account is written.
3. In the fourth column the total of the debit side of the account concerned or the debit balance, if
any is entered.
4. In the next column, the total of the credit side or the credit balance is written.
5. The two columns are totalled at the end.
6. The first and third column needs no explanation.

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ADJUSTED TRIAL BALANCE
THROUGH SUSPENSE If the trial balance do not agree after transferring the balance of all ledger
ACCOUNT accounts including cash and bank balance and also errors are not located
timely, then the trial balance is tallied by transferring the difference of debit
and credit side to an account known as suspense account.
This is a temporary account opened to proceed further and to prepare the

financial statements timely.
RULES OF PREPARING TRIAL BALANCE
DEBIT COLUMN OF TB The Balances of Assets Account, Expense Account, Losses, Drawings, Cash &
Bank.
CREDIT COLUMN OF TB The Balances of Liabilities Account, Income Account, Profits, Capital.

(i). A trial balance will not balance if
a) correct journal entry is posted twice.
b) the purchase on credit basis is debited to purchases and credited to cash.
c) Rs. 500 cash payment to creditors is debited to creditors for Rs. 50 and credited to
cash as Rs. 500.
(ii). Rs. 1, 500 received from sub-tenant for rent and entered correctly in the cash book is
posted to the debit of the rent account. In the trial balance
a) The debit total will be greater by Rs. 3,000 that the credit total.
b) The debit total will be greater by Rs. 1,500 than the credit total.
c) Subject to other entries being correct the total will agree.
(iii). After the preparation of ledgers, the next step is the preparation of
a) trading accounts b) trial balance
c) profit & loss account d) none of the above
(iv). After preparing the trial balance the accountant finds that the total of debit side is
short by Rs. 1,500. This difference will be
a) credited to suspense account
b) debited to suspense account
c) adjusted to any of the debit balance account
d) adjusted to any of the credit balance account
(v). S. No. Account heads Debit (Rs.) Credit (Rs.)

1. Sales 15,000.00
2. Purchases 10,000.00
3. Miscellaneous Expenses 2,500.00
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4. Salaries 2,500.00
Total 12,500.00 17,500.00
The difference in trial balance is due to
a) wrong placing of sales account
b) wrong placing of salaries account
c) wrong placing of miscellaneous expenses account
d) Wrong placing of all accounts
[Ans: (i)-(c), (ii)-(a), (iii)-(b), (iv)-(b), (v)-(b)]
OBJECTIVE TYPE QUESTIONS: SUBSIDIARY BOOKS

(i). The debit note issued are used to prepare
a) Sales Return Book b) Purchase Return Book
c) Sales Book d) Purchases Book
(ii). An allowance of Rs. 50 was offered for an early payment of cash of Rs. 1,050.
a) Sales Book b) Cash Book
c) Journal Proper d) Purchases Book
(iii). A second hand motor car was purchased on credit from B Brothers for Rs. 10,000.
a) Journal Proper b) Sales Book
c) Cash Book d) Purchases Book
(iv). Goods were sold on credit basis to A Brothers for Rs. 1,000.
a) Cash Book b) Journal Proper
c) Sales Book d) Bills Receivable Book
(v). Accounting for partial recovery from Mr. C of an amount of Rs. 2,000 earlier written
off as bad debt.
a) Journal Proper b) Sales Book
c) Purchases Book d) Cash Book
(vi). Credit purchase of stationery worth Rs. 5,000 by a stationery dealer.

a) Purchase Book b) Sales Book
c) Cash Book d) Journal Proper

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(vii). A bills receivable of Rs. 1,000, which was received from a debtor in full settlement for a
claim of Rs. 1,100, is dishonoured.
a) Purchases Return Book b) Bills Receivable Book
c) Purchases Book d) Journal Proper
(viii). Purchased goods from E worth Rs. 5,000 on credit basis.

a) Bills Receivable Book b) Purchases Book
c) Journal Proper d) Purchase Return Book
(ix). Unpaid salary for Rs. 340 is to be provided for in the accounts.
(x). A debit note for Rs. 2,000 issued to Mr. F for goods returned by us is to be accounted
For
(xi). Goods Outward Journal is meant for recording all returns of goods
a) Sold on Credit b) Purchase on credit
c) Purchase on Cash d) None of the above
(xii). The total of the purchases day book is posted periodically to the debit of:
a) Purchase account b) Cash book
c) Journal Proper d) None of these
(xiii). Purchases day book records:
a) All Cash Purchases b) All Credit Purchases
c) Credit purchases of goods in trade d) None of these
[Ans 1: (i)-(b), (ii)-(b), (iii)-(a), (iv)-(c), (v)-(d), (vi)-(a), (vii)-(d), (viii)-(b), (ix)-(c), (x)-(d), (xi)-(b),
(xii)-(a), (xiii)-(b)]
2. Choose the most appropriate answer from the given options :
(i). In Purchases Book the record is in respect of

a) Cash Purchases of goods b) credit purchases of goods
c) all purchase of goods d) None of the above
(ii). The Sales Returns Book records

a) the return of goods purchased b) return of anything purchased
c) return of goods sold d) None of the above
(iii). The Sales Book

a) is a part of Journal b) is a part of ledger
c) is a part of the balance sheet d) None of the above
(iv). The weekly or monthly total of the purchase Book is

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a) posted to the debit of the Purchases b) posted to the debit of the Sales Account,
Account,
c) posted to the credit of the Purchases d) None of the above Account.
(v). The total of the Sales Book is posted to

a) the credit of the Sales Account, b) credit of the Purchases Account
c) credit of the Capital Account d) Cash Book
[Ans: 2: (i), (b); (ii), (c); (iii), (a); (iv), (a); (v), (a)]
OBJECTIVE TYPE QUESTIONS: TRIAL BALANCE
1. Choose the most appropriate answer from the given choices.

(i). The total of discounts column on the debit side of the cash book, recording cash discount
deducted by customers when paying their accounts, is posted to the
(a) credit of the discount allowed account. (b) debit of the discount received
account. (c) credit of the discount received account. (d) debit of the discount allowed
account.
(ii). Which of the following is the kind of a cash book ?
(a) Simple column cash book (b) Double column cash book
(c) Three Column Cash Book (d) All of the above
(iii). Cash book is a type of __________ but treated as a ____________ of accounts.

(a) Subsidiary book, principal book (b) Principal book, subsidiary book
(c) Subsidiary book, subsidiary book (d) Principal book, principal book
(iv). Which of the following is not a column of a three-column cash book?

(a) Cash Column (b) Bank Column (c) Petty Cash Column (d)
Discount Column
(v). Salaries due for the month of March will appear

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(a) on the receipt side of the cash book (b) on the payment side of the cash book
(c) as a contra entry (d) nowhere in the cash book
(vi). Contra entries are passed only when

(a) double-column cash book is prepared (b) three-column cash book is prepared
(c) simple cash book is prepared (d) none of the above
2. Choose the most appropriate answer from the given choices.
(i). The Cash Book records

(a) all cash receipts (b) all cash receipts
(c) all cash receipts and payments (d) cash and credit sale of goods.
(ii). (ii) The balance in the petty cash book is

(a) an expense (b) a profit
(c) an asset (d) a liability
(iii). If Ram has sold goods for cash, the entry will be recorded
(a) in Cash Book (b) in the Sales Book
(c) in the Journal (d) in the Stock Book
[Ans: 1: (i), (d); (ii), (d); (iii), (a); (iv), (c); (v), (d), (vi), (b), 2(i), (c), (ii), (c), (iii), (a)]
NOTES

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CHAPTER-2
Accounting Process
Unit-3 ACCOUNTING
PROCESS 3
CAPITAL & REVENUE
EXPENDITURES AND RECEIPTS

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CAPITAL EXPENDITURE
Meaning Capital Expenditure is an expenditure which is incurred 1.

To acquire or bring into existence an asset, or
2. To acquire or bring into existence an advantage or benefit of enduring nature,
or
3. To increase the productivity or earning capacity.
Accounting Capital Expenditure is debited to Respective Asset Account.
Treatment
Examples Expenses incurred before the asset is put to use,
Repairs of a newly purchased old machine,
Purchase of new machine.
REVENUE EXPENDITURE
Meaning Capital Expenditure is an expenditure which is incurred
1. To maintain productivity or earning capacity of business.

2. To carry out operating activity in normal course of business.
Accounting Revenue Expenditure is debited to Trading/P&L Account.
Treatment

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.
Examples 1. Expenses incurred after the asset is put to use.

2. Expenses for replacement of worn out part of machine.
3. Repairs of an existing machine.
DEFERRED REVENUE EXPENDITURE
Meaning Deferred Revenue Expenditure is an expenditure for which payment has been made
or liability has been incurred but carry forward on the assumption that it will be of
benefit over subsequent period or periods.
Accounting Deferred Revenue Expenditure should be written off over 3-5 years.
Treatment
The written off portion is debited to P & L Account and unwritten off portion is shown
on the Asset side of Balance Sheet.
Example Heavy Advertisement Expenditure to launch a new product.
CAPITAL RECEIPT
Meaning Capital Receipt refers to that receipt which doesnt arise in normal course of business.
Accounting It is credited to Respective Account.

Treatment
Examples 1. Raising Issue of Share Capital.
2. Insurance Claim received for machinery damaged by fire.
3. Subsidy received from government for purchase of machinery.
4. Premium received on issue of shares.
REVENUE RECEIPT
Meaning Revenue Receipt refers to that receipt which arises in normal course of
business.
Accounting It is credited to Trading Account/P & L Account.
Treatment
Examples 1. Sale of Land and Building by real estate dealer.
2. Raising of Loan by a person engaged in business of finance and banking.
3. Sale of Shares and Debentures by a dealer in securities.
CONSIDERATIONS IN DETERMINING CAPITAL AND REVENUE EXPENDITURES
Nature of business For a trader dealing in furniture, purchase of furniture is revenue expenditure
but for any other trade, the purchase of furniture should be treated as capital
expenditure and shown in the balance sheet as asset.
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Recurring nature of If the frequency of an expense is quite often in an accounting year then it is said
expenditure to be an expenditure of revenue nature while non-recurring expenditure is
infrequent in nature and do not occur often in an accounting year.
Monthly salary or rent is the example of revenue expenditure as they are

incurred every month while purchase of assets is not the transaction done
regularly therefore, classified as capital expenditure unless materiality criteria
defines it as revenue expenditure.
Purpose of expenses Expenses for repairs of machine may be incurred in course of normal
maintenance of the asset. Such expenses are revenue in nature. On the other
hand, expenditure incurred for major repair of the asset so as to increase its
productive capacity is capital in nature.
However, determination of the cost of maintenance and ordinary repairs which

should be expensed, as opposed to a cost which ought to be capitalised, is not
always simple.
Effect on revenue The expenses which help to generate income/revenue in the current period are
generating capacity revenue in nature and should be matched against the revenue earned in the
of business current period.
On the other hand, if expenditure helps to generate revenue over more than one
accounting period, it is generally called capital expenditure.
When expenditure on improvements and repair of a fixed asset is done, it has

to be charged to Profit and Loss Account if the expected future benefits from
fixed assets do not change, and it will be included in book value of fixed asset,
where the expected future benefits from assets increase.
Materiality of the Relative proportion of the amount involved is another important consideration
amount involved in distinction between revenue and capital. Even, if expenditure does not
increase the productive capacity of an asset, it may be capitalised because the
amount is material or expenditure may increase the asset value and yet to be
expensed because the amount is immaterial.
Illustration 1
State with reasons whether the following statements are 'True' or 'False'.
(1) Overhaul expenses of second-hand machinery purchased are Revenue Expenditure.
(2) Money spent to reduce working expenses is Revenue Expenditure.
(3) Legal fees to acquire property is Capital Expenditure.
(4) Amount spent as lawyer's fee to defend a suit claiming that the firm's factory site belonged to
the plaintiff's land is Capital Expenditure.
(5) Amount spent for replacement of worn out part of machine is Capital Expenditure.

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(6) Expense incurred on the repairs and white washing for the first time on purchase of an old
building are Revenue Expenses.
(7) Expenses in connection with obtaining a license for running the cinema is Capital Expenditure.
(8) Amount spent for the construction of temporary huts, which were necessary for construction of
the Cinema House and were demolished when the cinema house was ready, is Capital Expenditure.
(9) Heavy advertising to introduce a new product or to explore a new market is Capital Expenditure.
Solution:
(1) False: Overhaul expenses are incurred to put second-hand machinery in working condition to
derive endurable long-term advantage. So it should be capitalised.
(2) False: It may be reasonably presumed that money spent for reducing revenue expenditure
would have generated long-term benefits to the entity. It becomes part of intangible fixed assets if it is
in the form of technical know-how and tangible fixed assets if it is in the form of additional replacement
of any of the existing tangible fixed assets. So this is capital expenditure.
(3) True: Legal fee paid to acquire any property is part of the cost of that property. It is incurred to
possess the ownership right of the property and hence a capital expenditure.
(4) False: Legal expenses incurred to defend a suit claiming that the firm's factory site belongs to
the plaintiff is maintenance expenditure of the asset. By this expense, neither any endurable benefit can
be obtained in future in addition to that what is presently available nor the capacity of the asset will be
increased. Maintenance expenditure in relation to an asset is revenue expenditure.
(5) False: Amount spent for replacement of any worn out part of a machine is revenue expense since
it is part of its maintenance cost.
(6) False: Repairing and white washing expenses for the first time of an old building are incurred to
put the building in usable condition. These are the part of the cost of building.
Accordingly, these are capital expenditure.

(7) True: The Cinema Hall could not be started without license. Expenditure incurred to obtain the
license is pre-operative expense which is capitalised. Such expenses are amortised over a period of
time.
(8) True: Cost of temporary huts constructed which were necessary for the construction of the
cinema house is part of the construction cost of the cinema house. Therefore such costs are to be
capitalised.
(9) False: The effect of heavy advertising with regard to the launching of a new product or to explore
a new market will last generally for more than one accounting period. But it does not create any
property of tangible or intangible nature and so the expenditure is spread over the period for which its
effect would remain. This type of expenditure items are termed as deferred revenue expenditure.

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Illustration 2
State with reasons whether the following are Capital or Revenue Expenditure:
(1) Expenses incurred in connection with obtaining a license for starting the factory for Rs. 10,000.
(2) Rs. 1,000 paid for removal of stock to a new site.
(3) Rings and Pistons of an engine were changed at a cost of Rs. 5,000 to get fuel efficiency.
(4) Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) Rs. 8,000 for installing telephone in
the office.
(5) A factory shed was constructed at a cost of Rs. 1,00,000. A sum of Rs. 5,000 had been incurred
in the construction of temporary huts for storing building material.
Solution:
(1) Money paid Rs. 10,000 for obtaining license to start a factory is a capital expenditure. This is an
item of expenditure incurred to acquire the right to carry on business.
(2) Rs. 1,000 paid for removal of stock to a new site is revenue expenditure. This is neither bringing
enduring benefit nor enhancing the value of the asset.
(3) Rs. 5,000 spent in changing Rings and Pistons of an engine to get fuel efficiency is capital
expenditure. This is an expenditure on improvement of a fixed asset. It results in increasing
profitearning capacity of the business by cost reduction.
(4) Money deposited with MTNL for installation of telephone in office is not expenditure. This is
treated as an asset and the same is adjusted over a period of time against actual telephone bills.
(5) Cost of construction of building including cost of temporary huts is capital expenditure. Building
is fixed asset which will generate enduring benefit to the business over more than one accounting
period. Construction of temporary huts is incidental to the main construction. Such cost is also
capitalised with the cost of building.
Illustration 3
Good Pictures Ltd., construct a cinema house and incur the following expenditure during the first year
ending 30th June, 2009.
(i) Second-hand furniture worth Rs. 9,000 was purchased; repainting of the furniture costs Rs.
1,000. The furniture was installed by own workmen, wages for this being Rs. 200.
(ii) Expenses in connection with obtaining a license for running the cinema worth Rs. 20,000.
During the course of the year the cinema company was fined Rs. 1,000, for contravening rules. Renewal
fee Rs. 2,000 for next year also paid.
(iii) Fire insurance, Rs. 1,000 was paid on 1st January, 2009 for one year.

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(iv) Temporary huts were constructed costing Rs. 1,200. They were necessary for the construction
of the cinema. They were demolished when the cinema was ready.
Point out how you would classify the above items.
Solution:
(i) The total cost of the furniture should be treated as Rs. 10,200 i.e., all the amounts mentioned
should be capitalised since without such expenditure the furniture would not be available for use. If Rs.
1,000 and Rs. 200 have been respectively debited to the Repairs Account and the Wages Account, these
accounts will be credited to the Furniture Account.
(ii) License for running the cinema house is necessary, hence its cost should be capitalised. But the
fine of Rs. 1,000 is revenue expenditure. The renewal fee for the next year is also revenue expenditure
but pertains to the next year; hence, it is a prepaid expense.
(iii) Half of the insurance premium pertains to the year beginning on 1st July, 2009. Hence such
amount should be treated as prepaid expense. The remaining amount is revenue expense for the
current year.
(iv) Since the temporary huts were necessary for the construction, their cost should be added to the
cost of the cinema hall and thus capitalised.
Illustration 4
State with reasons, how you would classify the following items of expenditure:
1. Overhauling expenses of Rs. 25,000 for the engine of a motor car to get better fuel efficiency.
2. Inauguration expenses of Rs. 25 lacs incurred on the opening of a new manufacturing unit in an
existing business.
3. Compensation of Rs. 2.5 crores paid to workers, who opted for voluntary retirement.
Solution:
1. Overhauling expenses are incurred for the engine of a motor car to derive better fuel efficiency.
These expenses will reduce the running cost in future and thus the benefit is in form of endurable long-
term advantage. So this expenditure should be capitalised.
2. Inauguration expenses incurred on the opening of a new unit may help to explore more
customers. This expenditure is in the nature of revenue expenditure, as the expenditure may not
generate any enduring benefit to the business over more than one accounting period.
3. The amount paid to workers on voluntary retirement is in the nature of revenue expenditure.
Since the magnitude of the amount of expenditure is very significant, it may be better to defer it over
future years.
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Illustration 5
Classify the following expenditures and receipts as capital or revenue:
(i) Rs. 10,000 spent as travelling expenses of the directors on trips abroad for purchase of capital
assets.
(ii) Amount received from debtors during the year.
(iii) Amount spent on demolition of building to construct a bigger building on the same site.
(iv) Insurance claim received on account of a machinery damaged by fire.
Solution:
(i) Capital expenditure.
(ii) Revenue receipt.
(iii) Capital expenditure.
(iv) Capital receipt.
Illustration 6
Are the following expenditures capital in nature?
(i) M/s ABC & Co. run a restaurant. They renovate some of the old cabins. Because of this renovation
some space was made free and number of cabins was increased from 10 to 13. The total expenditure
was Rs. 20,000.
(ii) M/s New Delhi Financing Co. sold certain goods on installment payment basis. Five customers
did not pay installments. To recover such outstanding installments, the firm spent Rs. 10,000 on
account of legal expenses.
(iii) M/s Ballav & Co. of Delhi purchased a machinery from M/s Shah & Co. of Ahmedabad. M/s Ballav
& Co. spent Rs. 40,000 for transportation of such machinery.
(iv) M/s Dogra & Co. spent Rs. 1,00,000 for organising an Inter-school Hockey Tournament in Delhi.
This was for advertising their new school bag and other books and stationery which they want to
market.
(v) M/s Dogra & Co. installed a machinery for Rs. 5,00,000 on 1.1.2003. They were charging
deprecation on straight line basis taking useful life of the machine as 10 years. In December, 2009 they
found that the machine became obsolete which could not be used. The machine can fetch only Rs.
50,000.

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Solution:
(i) Renovation of cabins increased the number of cabins. This has an effect on the future revenue
generating capability of the business. Thus the renovation expense is capital expenditure in nature.
(ii) Expense incurred to recover installments due from customer do not increase the revenue
generating capability in future. It is a normal recurring expense of the business. Thus the legal expenses
incurred in this case is revenue expenditure in nature.
(iii) Expenses incurred on account of transportation of fixed asset is capital expenditure in nature.
(iv) The purpose of expenses incurred for organising the Inter-school Hockey Tournament is to
advertise for some new products. This advertisement may have some enduring effect so far as
marketability of the new products. This expense may be treated as deferred revenue expenditure.
(v) Loss arising out of obsolescence of machinery is revenue expenditure. This loss is to be charged
against revenue of the year in which such loss is recognised. In this case, loss due to obsolescence is:
Rs.
Cost 500,000
Less: Depreciation 2003-2009 350,000
Written down value at the end of 2009 150,000
Less: Estimated scrap value 50,000
This loss is revenue loss in nature.
Illustration 7
Are the following expenses capital in nature?
1. Wages paid for installation of fixed assets.
2. Expenses of trial run of a newly installed machine.

3. Money deposited with the wholesaler as security.
4. Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) Rs. 8,000 for installing Telephone in
the office.
5. Amount spent for inauguration of new selling centre.
6. Free gift to customers of a new product.
7. Diwali advance to employees.
8. Money advanced to suppliers for booking of goods.

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Solution:
1. Expenses incurred including wages for installation of any fixed asset is capital expenditure in
nature.
2. Expenses incurred for trial run of a newly installed machinery is capital expenditure in nature.
3. Money deposited as security is not an expenditure item.
4. Money deposited with MTNL for installation of telephone is not expenditure item. This is treated
as an asset.
5. Expenses incurred for inauguration of branch is treated as revenue expenditure. Sometime

heavy expenditures incurred at the inaugural are meant for advertisement purposes, which have
enduring effect on the future revenue generating capability of the business.
Such expenses may be treated as deferred revenue expenditure.
6. Free gift to customers is an advertisement expense. This is normally treated as a revenue

expenditure. In case the amount involved in such free gift is heavy in relation to the volume of sales of
the business and in case such free gift has an enduring effect on the future revenue generating capability
of the business, it is treated as deferred revenue expenditure.
7. Diwali advance to employees is not an expense item.
8. Money advanced to supplies for booking goods is not an expense item.
1. Classify the following expenditures and receipts as capital or revenue:

(i). Money spent Rs. 10,000 as traveling expenses of the directors on trips abroad for
purchase of capital assets is
(a) Capital expenditures (b) Revenue expenditures
(c) Deferred revenue expenditures (d) None of the Above
(ii). Amount of Rs. 5,000 spent as lawyers fee to defend a suit claiming that the firms
factory site belonged to the plaintiffs land is

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(iii). Entrance fee of Rs. 2,000 received by Ram and Shyam Social Club is
(a) Capital receipt (b) Revenue receipt (c) Capital expenditures
(d) Revenue expenditures
(iv). Subsidy of Rs. 40,000 received from the government for working capital by a
manufacturing concern is
(v). Insurance claim received on account of machinery damaged completely by fire is

(vi). Interest on investments received from UTI is

(vii). Amount received from IDBI as a medium term loan for augmenting working capital is
(c) Capital receipt (d) Revenue receipt
(viii). A bad debt recovered during the year will be

(c) Capital receipt (d) Revenue receipt
(ix). A second hand car is purchased for Rs. 10,000, the amount of Rs. 1,000 is spent on its
repairs, Rs. 500 is incurred to get the car registered in owners name and Rs. 1,200 is
paid as dealers commission. The amount debited to car account will be
(a) Rs. 10,000 (b) Rs. 10,500
(c) Rs. 11,500 (d) Rs.12,700
(x). Revenue from sale of products, ordinarily, is reported as part of the earning in the period
in which
(a) the sale is made. (b) the cash is collected.
(c) the products are manufactured. (d) the planning takes place.

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(xi). If repair cost is Rs. 25,000, whitewash expenses are Rs. 5,000, cost of extension of
building is Rs. 2,50,000 and cost of improvement in electrical wiring system is Rs.
19,000; the amount to be expensed is
(a) Rs. 299,000 (b) Rs. 44,000
(c) Rs. 30,000 (d) Rs. 49,000
[Ans. 1: (i)-(a), (ii)-(b), (iii)-(a), (iv)-(b), (v)-(a), (vi)-(b), (vii)-(c), (viii)-(d), (ix)-(d), (x)-(a), (xi)-(c)]
2. Out of the following which are (1) capital expenditure; (2) revenue expenditure; and (3)
deferred revenue expenditure?
(i). Rs. 1,200 spent on the repairs of machine is

(ii). Rs. 2,500 spent on the overhaul of machines purchased second-hand is

(iii). Whitewashing expenses are

(iv). Paper purchased for use as stationery is

(v). Advertising campaign to launch a new product is

[Ans: 2: (ii) is a capital expenditure and Item no. (v) is deferred revenue expenditure, and remaining
items are revenue expenditures.]

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NOTES
CHAPTER-2
Accounting Process
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Unit-4 ACCOUNTING
PROCESS 4
CONTINGENT ASSETS & LIABILITIES
RECTIFICATION OF ERRORS
CONTINGENT ASSET
Meaning Contingent Asset usually arises from unplanned or unexpected events give rise to
the possibility of inflow of economic benefits to enterprise.

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Recognition Contingent Asset is neither recognized nor disclosed in financial statements.
A contingent asset is usually disclosed in the report of the approving

authority (Board of Directors in the case of a company, and the corresponding
approving authority in the case of any other enterprise), if an inflow of economic
benefits is probable.
Contingent assets are assessed continually and if it has become virtually certain
that an inflow of economic benefits will arise, the asset and the related income
are recognised in the financial statements of the period in which the change
occurs.
Example A claim files against 3rd party.
CONTINGENT LIABILITY
Meaning Contingent Liability is an obligation which may or may not arise depending upon
the happening or non-happening of future uncertain event.
Recognition A Contingent Liability is required to be disclosed by way of note to Balance Sheet
unless possibility of outflow of resource embodying economic benefits is remote.
Example 1. Bills Discounted but not yet matured.

2. Arrears of Dividend on Cumulative Preference Shares.
PROVISION
Meaning Provision is a present liability of uncertain amount which can be measured

reliably by using a substantial degree of estimation.
Recognition Provision should be recognized in financial statements.
Example 1. Provision for Taxation.
2. Provision for Depreciation.
TREATMENT OF PRESENT/POSSIBLE OBLIGATION
Nature of Obligation Situation Present Obligation Possible Obligation

Probable Outflow and Reliable Recognize as Provision Disclose as Contingent
Estimate Liability
Probable Outflow and No Reliable Disclose as Contingent Disclose as Contingent
Estimate Liability Liability
No Probable Outflow and No Disclose as Contingent -
Reliable Estimate Liability
Note:- Provision is to be made if there is (a) Present Obligation, (b) Probable Outflow, (c) Reliable
Estimate.

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CONTINGENT LIABILITIES AND PROVISION
S. NO. PROVISION CONTINGENT LIABILITIES

1. Provision is a present liability of uncertain A Contingent liability is a possible obligation that
amount, which can be measured reliably by may or may not crystallize depending on the
using a substantial degree of estimation. occurrence or non- occurrence of one or
more uncertain future events.
2. A provision meets the recognition criteria. A contingent liability fails to meet the same.
3. Provision is recognised when (a) an Contingent liability includes present obligations
enterprise has a present obligation arising that do not meet the recognition criteria because
from past events; an outflow of resources either it is not probable that settlement of those
embodying economic benefits is obligations will require outflow of economic
probable, and (b) a reliable estimate can benefits, or the amount cannot be reliably
be made of the amount of the obligation. estimated.
4. If the management estimates that it is If the management estimates, that it is less likely
probable that the settlement of an that any economic benefit will outflow the firm
obligation will result in outflow of to settle the obligation, it discloses the obligation
economic benefits, it recognises a as a contingent liability.
provision in the balance sheet.
ACCOUNTING ASSUMPTION GOVERNING THE CLASSIFICATION

The Classification of expenditures and receipts into capital and revenue is in accordance with Going
Concern Assumption.
Let us take an example to understand the distinction between provisions and contingent iabilities. The
Central Excise Officer imposes a penalty on Alpha Ltd. for violation of a provision in the Central Excise
Act. The company goes on an appeal. If the management of the company estimates that it is probable
that the company will have to pay the penalty, it recognises a provision for the liability. On the other
hand, if the management anticipates that the judgement of the appellate authority will be in its favour
and it is less likely that the company will have to pay the penalty, it will disclose the obligation as a
contingent liability instead of recognising a provision for the same.

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(i). Contingent asset usually arises from unplanned or unexpected events that give rise to
(a) The possibility of an inflow of economic benefits to the business entity.
(b) The possibility of an outflow of economic benefits to the business entity.
(c) Either (a) or (b)
(d) None of the above.
(ii). If an inflow of economic benefits is probable then a contingent asset is disclosed

(a) in the financial statements.
(b) in the report of the approving authority (Board of Directors in the case of a
company, and the corresponding approving authority in the case of any other enterprise).
(c) In the cash flow statement.
(iii). In the case of ___________, either outflow of resources to settle the obligation is not probable
or the amount expected to be paid to settle the liability cannot be measured with sufficient
reliability.
(a) Liability.
(b) Provision.
(c) Contingent liabilities.
(d) Contingent assets.
(iv). Present liability of uncertain amount, which can be measured reliably by using a
substantial degree of estimation is termed as ________.
(a) Liability.
(b) Provision.
(c) Contingent liabilities.
(d) None of the Above.
(v). In the financial statement, contingent liability is

(a) Recognised
(b) Not Recognised
(c) Adjusted
(d) None of the Above.
[(i) (a), (ii) (b), (iii) (c), (iv) (a), (v) (a)]

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NOTES
FOR YOUR WORKING

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TRIAL BALANCE

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Meaning It is a statement which shows the balances of all accounts in the ledger and Cash &
Bank Balances.
When Trial A T.B. is prepared on a particular date and not for a particular period.
Balance is
prepared?
Main Objectives To ascertain the arithmetical accuracy of ledger accounts.
of Trial Balance To help in locating errors of commission and errors of partial omission.
To facilitate the preparation of financial statements.
Not a Conclusive A T.B. merely checks the arithmetical accuracy of books of accounts and is not a
Proof of Accuracy conclusive proof of accuracy of books of accounts since certain errors may remain
of Books still undetected inspite of a tallied T.B.
ERRORS REVEALED AND NOT REVEALED EVEN BY A TALLIED TRIAL BALANCE

not revealed 1. Errors of Principle.
Errors even by a
Tallied T.B.
Compensatory Errors.
2.
3. Errors of Complete Omission.
4.
Errors of Recording in the books of original entry.

Errors of posting involving to Wrong Account on Correct Side with
Correct Amount.
5.

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revealed 1. Errors of Partial Omission.

Errors by a
T.B.
2. Errors of Commission other than error of recording and error of posting

involving to Wrong Account on Correct Side with Correct Amount.
SUSPENSE ACCOUNT
Meaning Suspense Account is an account in which the amount of difference in

trial balance is put till the time errors are rectified.
Object The object of suspense account is to avoid the delay in preparation of
financial statements.
T/f of Difference in T.B. The difference in T.B. is transferred on the credit side of Suspense
Account (if total of debit column of T.B. exceeds the credit column) and
vice-versa.
Opening of Suspense Account On opening of Suspense Account, the words difference in T.B. are
recorded in particulars column on debit side (if debit column of T.B. is
short) or on credit side (if credit column of T.B. is short).
Balance of Suspense Account It represents the net effect of errors which still remain undetected and
is shown in the Balance Sheet in Assets Side (if debit balance) or on
Liability Side (if credit balance).
Closure of Suspense Account The Suspense Account will automatically be closed when all errors are
located and rectified.

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HOW TO RECTIFY TWO SIDED ERRORS

Two Sided Errors Two Sided errors of omission in the books of original entry are rectified by passing
of Omission a journal entry which should have been passed at the time of transaction but was
omitted to be passed.
Two Sided Errors Two Sided errors of commission are rectified by passing a journal entry giving the
of Commission appropriate debit and credit to respective accounts which were affected by the
error.
Note:- Rectifying entry for two sided errors of commission has the net effect of correct
entry (which should have been passed) and the reversal of wrong entry (which should
have not been passed).
HOW TO RECTIFY ONE SIDED ERRORS
Before transferring One Sided errors (e.g. under cast of Sales Book) are rectified by debiting or
the difference in crediting the affected account(s),
T.B. to Suspense
Account e.g. sales account with the required amount alongwith an explanatory note in
particulars column.
After transferring One Sided errors are rectified by passing a journal entry giving the appropriate
the difference in debit and credit effect to the respective accounts which were affected by the error
Trial Balance to and the suspense account.
Suspense Account
before the
preparation of Final Note:- Error involving wrong casting of subsidiary books (e.g. Sales Book) affects
Accounts only that account (e.g. Sales Account) to which total of particular subsidiary book
is posted and doesnt affect the individual personal account (e.g. Customers
Account).
Note:- Error (e.g. credit sale to Ram Rs. 17 posted as Rs. 71) involving wrong posting
of individual transaction recorded in any subsidiary books (Sales Book) affects the
individual accounts only (i.e. Ram Account).
HOW TO RECTIFY ERRORS AFTER THE PREPARATION OF FINANCIAL STATEMENTS
Errors involving P & L Adjustment Account is used to rectify all errors involving nominal accounts
Nominal Account in the subsequent year so as not to affect Profit / Loss of that period.
Errors not Errors are rectified by passing a journal entry giving the appropriate debit and
involving Nominal credit to Respective Accounts which were affected by the error.
Account
Closure of P & L The balance of P & L Adjustment Accounts transferred to Capital Account.
Adjustment
Account

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EFFECT OF ERRORS AND THEIR RECTIFICATION OF PROFIT
Case Effect of Rectification on Profit Effect of Errors on Profit

If Nominal Account is debited in Decrease in Profit Increase in Profit
rectifying entry
If Nominal Account is debited in Increase in Profit Decrease in Profit
rectifying entry
If Real/Personal Account is No effect No effect
debited/credited
ERRORS OF SOME ERROR OF OMISSION ON TRIAL BALANCE, GROSS PROFIT AND NET PROFIT
Error Effect on Rectifying Entry
Trial Balance Gross Profit Net Profit

Omission of recording No Effect Decrease Decrease Drawings A/c Dr.
goods taken by To Purchases A/c
proprietor for personal
use
Omission of recording No Effect Decrease Decrease Free Samples/Charity/ Dr.
goods distributed as Destroyed by Fire A/c Dr.
free samples/ charity/ To Purchases A/c
destroyed by fire
POINTS TO BE NOTED..MY STUDENTS

1. Assumptions at the time of Rectification
A. Unless otherwise stated in the question, rectifying entries are passed assuming that the
difference in T.B. has been transferred to Suspense Account.
B. Unless otherwise stated in the question it is assumed that rectifying entries are passed
before the preparation of financial statements.
2. Repair of newly purchased old machine should be capitalized and hence should be debited to
Machinery Account.
3. Repair of Machine should be treated as revenue nature and hence should be debited in
Repairs Account.
4. Cash Received from Ram whose account was written off as bad debt should be credited to
Bad Debts Recovered Account.
5. Cash Sales of Rs. 143 to Ram omitted to be posted is to be credited to Sales Account.
6. Rent paid to landlord Ram Rs. 1,000 is to be debited to Ram Account.
7. Both the discount column if cash book omitted to be posted. This is an error if partial
omission and will affect the T.B. and Profit.
8. Rectifying Entry for a credit side of furniture to Ram Rs. 61 posted as Rs. 16.
Ram A/c Dr. Rs. 45
To Furniture A/c Rs. 45
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STEPS TO LOCATE ERRORS
(i) The two columns of the trial balance should be totalled again. If in place of a number of accounts,
only one amount has been written in the trial balance the list of such accounts should be checked and
totalled again. List of debtors is the example from which Sundry debtors balance is derived.
(ii) It should be seen that the cash and bank balances have been written in the trial balance.
(iii) The exact difference in the trial balance should be established. The ledger should be gone
through; it is possible that a balance equal to the difference has been omitted from the trial balance.
The difference should also be halved; it is possible that balance equal to half the difference has been
written in the wrong column.
(iv) The ledger accounts should be balanced again.

(v) The casting of subsidiary books should be checked again, especially if the difference is Re. 1, Rs.
100 etc.
(vi) If the difference is very big, the balance in various accounts should be compared with the
corresponding accounts in the previous period. If the figures differ materially the cases should be seen;
it is possible that an error has been committed. Suppose the sales account for the current year shows a
balance of Rs. 32,53,000 whereas it was Rs. 36,45,000 last year; it is possible that there is an error in
the Sales Account.
(vii) Postings of the amounts equal to the difference or half the difference should be checked. It is
possible that an amount has been omitted to be posted or has been posted on the wrong side.
(viii)If there is still a difference in the trial balance, a complete checking will be necessary. The posting
of all the entries including the opening entry should be checked. It may be better to begin with the
nominal accounts.
DETECTION OF ERRORS
Errors should never be corrected by overwriting.
If immediately after making an entry it is clear that an error has been committed, it may be corrected
by neatly crossing out the wrong entry and making the correct entry.
If however the errors are located after some time, the correction should be made by making another
suitable entry, called rectification entry.
The rectification of an error depends on at which stage it is detected. An error can be detected at any
one of the following stages:

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(a) Before preparation of Trial Balance.
(b) After Trial Balance but before the final accounts are drawn.
(c) After final accounts, i.e., in the next accounting period.
Illustration
How would you rectify the following errors in the book of Rama & Co.?
1. The total to the Purchases Book has been undercast by Rs. 100.
2. The Returns Inward Book has been undercast by Rs. 50.
3. A sum of Rs. 250 written off as depreciation on Machinery has not been debited to Depreciation
Account.
4. A payment of Rs. 75 for salaries (to Mohan) has been posted twice to Salaries Account.
5. The total of Bills Receivable Book Rs. 1,500 has been posted to the credit of Bills Receivable
Account.
6. An amount of Rs. 151 for a credit sale to Hari, although correctly entered in the Sales Book, has
been posted as Rs. 115.
7. Discount allowed to Satish Rs. 25 has not been entered in the Discount Column of the Cash Book.
It has been posted to his personal account.
Solution
1. The Purchases Account should receive another debit of Rs. 100 since it was debited short
previously: "To Undercasting of Purchases Book for the month of --- Rs. 100."
2. Due to this error the Returns Inward Account has been posted short by Rs. 50 : the correct entry
will be: "To Undercasting of Returns Inward Book for the month of --- Rs. 50."

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3. The omission of the debit to the Depreciation Account will be rectified by the entry: "To
Omission of posting on Rs. 250".
4. The excess debit will be removed by a credit in the Salaries Account by the entry: "By double
posting on Rs. 75".
5. Rs. 1,500 should have been debited to the Bills Receivable Account and not credited. To correct
the mistake, the Bills Receivable Account should be debited by Rs. 3,000 by the entry: "To Wrong
posting of B/R received on Rs. 3,000"
6. Hari's personal A/c is debited Rs. 36 short the rectification entry will be: "To Wrong posting Rs.
36". Due to this error, the discount account has been debited short by Rs. 25. The required entry is : "To
Omission of discount allowed to Satish on Rs. 25."
2. Choose the most appropriate option from the given choices:
(i). Rs. 200 paid as wages for erecting a machine should be debited to
(a) Repair Account (b) Machine Account
(c) Capital Account (d) Furniture Account
(ii). On purchase of old furniture, the amount of Rs. 1,000 spent on its repair should be
debited to
(a) Repair Account (b) Furniture Account
(c) Cash Account (d) Bank Account
(iii). Goods worth Rs. 50 given as charity should be credited to

(a) Charity Account (b) Sales Account
(c) Purchases Account (d) Cash Account
(iv). Goods worth Rs. 100 taken by proprietor for domestic use should be credited to
(a) Sales Account (b) Proprietors personal expenses
(c) Purchases Account (d) Expense Account
(v). Errors of commission do not permit

(a) Correct totalling of the balance sheet (b) Correct totalling of the trial balance
(c) The trial balance to agree (d) None of the above
(vi). The preparation of a trial balance is for:

(a) Locating errors of commission; (b) Locating errors of principle
(c) Locating clerical errors. (d) All of the above

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(vii). Rs. 200 received from Smith whose account, was written off as a bad debt should be
credited to:
(a) Bad Debts Recovered account; (b) Smiths account
(c) Cash account. (d) Bad debts account
(viii). Purchase of office furniture Rs. 1,200 has been debited to General Expense Account.
It is :
(a) A Clerical error; (b) An error of principle; (c) An error of omission.
(d) Compensating error.
(ix). Sales of office furniture should be credited to

(a) Sales Account; (b) Furniture Account.
(c) Purchase Account. (d) Cash Account
[Ans: 2 : (i) (b); (ii) (b); (iii) (c); (iv) (c); (v) (c); (vi) (c); (vii) (a); (viii) (b); (ix) (b);]
II. From the given information, choose the most appropriate answer.
1. Classify the following errors under (a) Errors of omission, (b) Errors of commission and (c)
Errors of principle, (d) Compensating errors
(i) The total of sales book was not posted to the ledger.
(ii) Sales to Heena Rs. 143 was posted to Meena as Rs. 143.
(iii) Goods taken away by the proprietor for personal use not recorded anywhere.
(iv) The total of a folio in the sales book Rs. 1,000 was carried forward as Rs. 100.
(v) Repairs of newly purchased second-hand machinery debited to repairs accounts.
[Ans: 1: (i)-(a), (ii)-(b), (iii)-(a), (iv)-(b), (v)-(c)]
2. Point out the type of the errors given below: (put 1 against errors of omission, 2 against errors
of commission, 3 against errors principle, 4 if it is not an error).
(a) Sale of Rs. 120 was written in the purchases book.

(b) Salary paid to Ram, has been debited to his account.
(c) Purchase of furniture has been entered in the purchases book.
(d) Rs. 120 received from Ganesh has been debited to his account.
(e) Freight paid on machinery has been debited to the freight account.
(f) The discount columns of the cash book have not been posted.
(g) Repairs to buildings have been debited to the buildings account.
(h) The total of the Sales Book is Rs. 100 short.
(i) The sale of worth Rs. 337 has been posted as Rs. 373.
(j) The amount of a dishonoured bill has been debited to general expenses account.

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[ Ans : 2 : - 1 : (f); 2 : (a) (d) (h) (i); 3 : (b) (c) (e) (g) (j)]
III. Given below are the questions containing multiple answers. Choose the correct answer(s).
1. Which of the following errors will not be revealed by the Trial Balance:
(a) compensating errors; (b) errors of principle;
(c) wrong balancing of an account; (d) wrong totalling of an account;
[Ans : 1 : (a) and (b) will not be revealed]
2. Which of the following errors will be revealed by the Trial Balance:

(a) compensating errors; (b) errors of principle;
(c) wrong balancing of an account; (d) wrong totalling of an account;
[Ans : (c) and (d) will be revealed]
NOTES

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CHAPTER-3
BANK RECONCILIATION
STATEMENT
BANK PASS BOOK AND NATURE OF BALANCE

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Meaning Bank Pass Book is a copy of Customers Account in bank ledger.

Nature Debit balance in Cash Book means Credit balance as per pass book.
Credit balance (Overdraft) in Cash Book means Debit balance (Overdraft) as per
Pass Book.
BANK RECONCILIATION STATEMENT (BRS)
Meaning BRS is a statement showing the causes of difference in Cash book and Pass Book.
Who BRS is prepared by customer of Bank. (Bank Account Holder)
Prepares?
Why BRS is prepared to reconcile the difference in bank balance as per bank column of Cash
Prepared? Book and Pass Book.
Or
BRS is prepared with the help of Bank Statement and bank column of Cash Book.
How 1. BRS is prepared with the help of bank statement and the bank column of Cash
Prepared? Book.
2. In BRS, Positive balance is shown in (+) column and the overdraft is shown in (-
) column.
IMPORTANCE OF BRS
Bank reconciliation statement is a very important tool for internal control of cash flows.
It helps in detecting errors, frauds and irregularities occurred, if any, at the time of
passing entries in the cash book or in the pass book, whether intentionally or
unintentionally.
1. The reconciliation will bring out any errors that may have been committed
either in the cash book or in the pass book.
2. Any undue delay in the clearance of cheques will be shown up by the

reconciliation.
3. A regular reconciliation discourages the staff of the customer or even that of the
bank from embezzlement. There have been many cases when the cashiers
merely made entries in the cash book but never deposited the cash in the bank;
they were able to get away with it only because of lack of reconciliation.
4. It helps in finding out the actual position of the bank balance.

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CAUSES OF DIFFERENCE OF
BANK BALANCE IN BANK COLUMN OF THE CASH BOOK AND IN PASS BOOK
1. Timing Differences
a) Cheques issued but not yet presented for payment.

b) Cheques paid into the bank but not yet cleared.
c) Interest allowed by bank.
d) Interest and expenses charged by the bank.
e) Interest and dividends collected by the bank.
f) Direct payments by the bank.
g) Direct payment into the bank by a customer.
h) Dishonour of a bill discounted with the bank.
i) Bills collected by the bank on behalf of the customer.
2. Differences Arising Due To Errors In Recording The Entries
While recording the entries, errors can occur both in the cash-book and in the pass book.
A bank rarely commits an error but, if it does, the balance shown in pass book will naturally
differ from that shown in the cash book. Similarly, if any error is committed in the cash book
then too the balance shown in it will differ from that of the pass book.
Errors include omission of entry, wrong recording of amount, recording of entry on wrong
side of the book, wrong totaling of account or wrong balancing of the book and recording
of transactions of other party.
Balance as per Cash Book

Items shown in Plus Column Items shown in Minus Column

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1. Unpresented Cheques 1. Uncollected Cheques

2. Interest allowed by bank 2. Bank Charged and Interest charged by Bank
3. Direct collection by bank 3. Direct Payment by bank
4. Cheque deposited but omitted to be recorded 4. Cheque recorded but omitted to be banked
5. Undercast of Bank (debit) column of Cash 5. Overcast Bank (debit) column of Cash Book
Book 6. Undercast of Bank (credit) column of Cash Book
6. Overcast of Bank (credit) column of Cash 7. Undercast of Deposit Column of Pass Book
Book 8. Overcast of Withdrawal Column in Pass Book
7. Overcast of Deposit Column of Pass Book 9. Wrong debit in Pass Book
8. Undercast of Withdrawal Column in Pass 10. Dishonour of Discounted Bill
Book
Receivable/Cheque.
9. Wrong credit in Pass Book
BRS Taking Balance as per Amended Cash Book
Which Balance In Balance Sheet, Bank Balance as per Amended Cash Book appears and not as per
appears in the pass book.
Balance Sheet
Items to be 1. Correct Items which appears only in Pass Book e.g. bank charges, interest
adjusted in 2. charged or allowed by bank, direct payment or collection by bank. Rectifying
Amended Cash Entries in respect of errors of omission, commission in Cash Book e.g.
Book cheques issued but not recorded, cheque issued but recorded in cash column
/bank column, cheques issued recorded in bank column with wrong amount,
wrong balancing, wrong carry forward, or brought forward.
Items NOT to be 1. Uncollected Cheques
adjusted in 2. Unpresented Cheques
Amended Cash 3. Wrong entry in pass book
Book

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Illustration 1
From the following particulars ascertain the balance that would appear in the Bank Pass Book of A on
31st December, 2009.
(1) The bank overdraft as per Cash Book on 31st December, 2009 Rs. 6,340
(2) Interest on overdraft for 6 months ending 31st December, 2009 Rs. 160 is entered in Pass Book.
(3) Bank charges of Rs. 30 are debited in the Pass Book only.
(4) Cheques issued but not cashed prior to 31st December, 2009, amounted to Rs. 1,168.
(5) Cheques paid into bank but not cleared before 31st December, 2009 were for Rs. 2,170.
(6) Interest on investments collected by the bank and credited in the Pass Book Rs. 1,200.
Illustration 2
From the following information, prepare a Bank reconciliation statement as at 31st December, 2009
for Messrs New Steel Limited :
Rs.
(1) Bank overdraft as per Cash Book on 31st December, 2009 245,900
(2) Interest debited by Bank on 26th December, 2009 but no advice received 27,870

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(3) Cheque issued before 31st December, 2009 but not yet presented to Bank 66,000
(4) Transport subsidy received from the State Government directly by
the Bank but not advised to the company 42,500
(5) Draft deposited in the Bank, but not credited till 31st December, 2009 13,500
(6) Bills for collection credited by the Bank till 31st December, 2009 but
no advice received by the company 83,600
(7) Amount wrongly debited to company account by the Bank, for which
no details are available 7,400
Illustration 3
The bank account of Mukesh was balanced on 31st March, 2009. it showed an overdraft of Rs. 5,000.
The bank statement of Mukesh showed a credit balance of Rs. 76,750. Prepare a bank reconciliation
statement taking the following into account :
(1) Cheques issued but not presented for payment till 31.3.2009 Rs. 12,000.
(2) Cheques deposited but not collected by bank till 31.3.2009 Rs. 20,000.

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(3) Interest on term-loan Rs. 10,000 debited by bank on 31.3.2009 but not accounted in Mukesh's
book.
(4) Bank charges Rs. 250 was debited by bank during March, 2009 but accounted in the books of
Mukesh on 4.4.2009.
(5) An amount of Rs. 1,00,000 representing collection of Murukesh's cheque was wrongly credited
to the account of Mukesh by the bank in their bank statement.
Illustration 4
From the following information (as on 31.3.2009), prepare a bank reconciliation statement after
making necessary amendments in the cash book.
Amount (Rs.)
Bank balances as per the cash book (Dr.) 325,000
Cheques deposited, but not yet credited 447,500

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Cheques issued but not yet presented for payment 356,200
Bank charges debited by bank but not recorded in the cash-book 1,250
Dividend directly collected by the bank 12,500
Insurance premium paid by bank as per standing instruction not intimated 15,900
Cash sales wrongly recorded in the Bank column of the cash-book 25,500
Customer's cheque dishonoured by bank not recorded in the cash-book 13,000
Wrong credit given by the bank 15,000

Also show the bank balance that will appear in the trial balance as on 31.3.2009.
Illustration 5
On 31st March, 2009 the pass-book of a trader showed a credit balance of Rs. 1,565, but the pass book
balance was different for the following reasons from the cash book balance:
1. Cheques issued to 'X' for Rs. 600 and to 'Y' for Rs. 384 were not yet presented for payment.
2. Bank charged Rs. 35 for bank charges and 'Z' directly deposited Rs. 816 into the bank account,
which were not entered in the cash book.
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3. Two cheques one from 'A' for Rs. 515 and another from 'B' for Rs. 1,250 were collected in the
first week of April, 2009 although they were banked on 25.03.2009.
4. Interest allowed by bank Rs. 45.

Prepare a bank reconciliation statement as on 31st March, 2009.

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1. When the balance as per Cash Book is the starting point, direct deposits by customers are:
(a) Added (b) Subtracted
(c) Not required to be Adjusted (d) None of these
2. A Bank Reconciliation Statement is a

(a) Part of Cash Book; (b) Part of Bank Account
(c) Part of financial statements (d) None of these
3. When balance as per Pass Book is the starting point, interest allowed by Bank is
(a) Added (b) Subtracted
4. A Bank Reconciliation Statement is prepared with the help of: (a) Bank statement and
bank column of the Cash Book.
(b) Bank statement and cash column of the Cash Book
(c) Bank column of the Cash Book and cash column of the Cash Book (d)
None of the above.
5. Debit balance as per Cash Book of ABC Enterprises as on 31.3.2009 is Rs. 1,500. Cheques
deposited but not cleared amounts to Rs. 100 and Cheques issued but not presented of Rs. 150.
The bank allowed interest amounting Rs. 50 and collected dividend Rs. 50 on behalf of ABC
Enterprises. Balance as per pass book should be
(a) Rs. 1,600 (b) Rs. 1,450
(c) Rs. 1,850 (d) Rs. 1,650
6. The cash book showed an overdraft of Rs. 1,500, but the pass book made up to the same date
showed that cheques of Rs. 100, Rs. 50 and Rs. 125 respectively had not been presented for
payments; and the cheque of Rs. 400 paid into account had not been cleared. The balance as
per the pass book will be
(a) Rs. 1,100 (b) Rs. 2,175
(c) Rs. 1,625 (d) Rs. 1,375
7. When drawing up a Bank Reconciliation Statement, if you start with a debit balance as per the
Bank Statement, the unpresented cheques should be:
(a) Added (b) Deducted
8. A debit balance in the depositors Cash Book will be shown as:

(a) A debit balance in the Bank Statement.
(b) A credit balance in the Bank Statement.
(c) An overdrawn balance in the Bank Statement. (d) None of the above.

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9. When preparing a Bank Reconciliation Statement, if you start with a debit balance as per the
Cash Book, cheques issued but not presented within the period should be:
(a) Added (b) Deducted
10. When the balance as per Pass Book is the starting point, direct payment by bank are:
(a) Added in the bank reconciliation statement
(b) Subtracted in the bank reconciliation statement
(c) Not required to be adjusted in the bank reconciliation statement.
11. When balance as per Cash Book is the starting point, uncollected cheques are:
(a) Added in the bank reconciliation statement
(b) Subtracted in the bank reconciliation statement
12. A Bank Reconciliation Statement is prepared to know the causes for the difference between:
(a) The balances as per cash column of Cash Book and the Pass Book.
(b) The balance as per bank column of Cash Book and the Pass Book.
(c) The balance as per bank column of Cash Book and balances as per cash column of Cash
Book
13. When the balance as per Pass Book is the starting point, uncollected cheques are:
(a) Added in the bank reconciliation statement.
(b) Subtracted in the bank reconciliation statement.
14. When balance as per Cash Book is the starting point, interest charged by Bank is:
(a) Added in the bank reconciliation statement.
(b) Subtracted in the bank reconciliation statement.
15. A Bank Reconciliation Statement is prepared by

(a) The Bank
(b) The Government
(c) The Bank Account holder
(d) The user of financial statements
16.
A Bank Statement is a copy of
(a) Cash column of the cash book
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(b) Bank column of the cash book

(c) A Customers account in the banks book
(d) None of the above
17. The difference in the balances of both the cash-book and the pass-book can be because of (a)
Errors in recording the entries either in the cash-book or pass-book.
(b) Omission of same entry in both cash-book and pass-book.
(c) Debit balance of cash book is the credit balance of pass-book. (d) None of
the above
18. Direct payment to the third party on behalf of the account holder is entered in (a) The
cash-book when the amount is paid by the bank
(b) The cash-book when the entry is posted in the pass-book
(c) The pass-book when the entry is posted in the pass-book
19. Payment done by the account holder through issuing a cheque is entered in
(a) The pass-book at the time of issuing the cheque
(b) The cash-book at the time of presenting the cheque to the bank for payment
(c) The pass-book at the time of presenting the cheque to the bank for payment
(d) The cash-book when informed by the third party
20. Which of the following is not the salient feature of bank reconciliation statement?
(a) Any undue delay in the clearance of cheques will be shown up by the reconciliation
(b) Reconciliation statement will help in finding the person doing any fraud
(c) Reconciliation is done by the bankers
(d) It helps in finding out the actual position of the bank balance.
[Ans. : 1(a), 2(d), 3(b), 4(a), 5(d), 6(c), 7(a), 8(b), 9(a), 10(a), 11(b), 12(b), 13(a), 14(b), 15 (c), 16 (c),
17 (a), 18 (b), 19 (c), 20 (c)]

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NOTES

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Chapter-4 DEPRECIATION
ACCOUNTING

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MEANING
Depreciation 1. Depreciation is a permanent and continuous decrease in the book value of
fixed assets due to use, effluxion of time, obsolescence through technology
etc.
2. Depreciation is a non-cash operating expense which is to be provided
whether there are profits or losses.
3. Depreciation is concerned with historical cost and not with the fluctuations
in market price.
Depletion Depletion refers to physical deterioration of natural resources like ore deposits in
mines, oil wells.
Amortization Amortization refers to the economic deterioration of intangible assets like goodwill,
patent, trademark.
Obsolescence Obsolescence refers to economic deterioration by change in technology or taste or
fashion.

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Depreciation Depreciation Accounting is the process of allocation and not valuation.

Accounting
CAUSES OBJECTIVES AND FACTORS AFFECTING AMOUNT OF DEPRECIATION

Causes of 1. Physical wear and tear. Passage
Depreciation 2. of time.
3. Changes in economic environment.
4. Expiration of legal rights.
Objectives 1. To ascertain true financial position.

2. To ascertain true financial performance.
3. To ascertain true cost of production.
4. To comply with the legal requirements.
5. To accumulate funds for replacement of assets.
Factors Affecting 1. Historical Cost

Amount of 2. Expected Useful Life
Depreciation 3. Estimated Residual Value
Note:-All expenses incurred till the asset is put to use are treated as capital nature
and hence form part of historical cost.
TWO METHODS OF RECORDING DEPRECIATION

By Charging to Asset Account By Creating Provision for Depreciation
Account
1. Depreciation is credited to Asset Account. 1. Depreciation is credited to Provision for
2. Asset appears at its Book Value (i.e. Cost Depreciation Account.
less depreciation till date) 2. Asset appears as its Original Cost.
METHODS OF PROVIDING DEPRECIATION

Methods 1. Straight Line Method (SLM)
2. Written Down Value Method (WDV)
DIFFERENCE BETWEEN SLM AND WDV

Basis Straight Line Method Written Down Value Method
1. Basis of Depreciation is calculated at a fixed % Depreciation is calculated at a fixed %
Calculation on the ORIGINAL COST. on the original cost (in first year) and
on WRITTEN DOWN VALUE (in
subsequent years).

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2. Amount of Annual The amount of annual depreciation The amount of annual depreciation
Depreciation REMAINS CONSTANT. goes on DECREASING.
3. Book Value The book value of the asset becomes The book value of the asset DOESNT
ZERO OR EQUAL to its scrap value. BECOME ZERO.
HOW TO CALCULATE THE AMOUNT AND RATE OF DEPRECIATION UNDER VARIOUS METHODS
1. Straight Line Fixed Installment Method
Method Original Cost Method
Amount of Depreciation = Original Cost less Residual Value

Expected Useful Life of the Asset
Rate of Depreciation = Amount of Depreciation 100

Original Cost
2. Written Down Diminishing Balance Method
Value Reducing Balance Method
Amount of Depreciation = Book Value of the Asset X Rate of Depreciation
Rate of Depreciation = 1 n Scrap Value 100

Cost of Asset
Here, n = useful life of the asset in years,
3. Annuity Method Fixed Amount of Depreciation = (Original Cost Less Scrap Value) X (Value of
Annuity for a given period at a given rate of interest)
Interest on Scrap Value for a given year at a given rate of interest.

4. Depletion Method Used in case of Wasting Assets like Mineral Oil, Coal Mines etc.
Rate per Depreciation per unit = Original Cost Scrap Value

Useful Life in terms of Effective units
Amount of Depreciation = Actual Output (in units) X Rate of depreciation per

unit
5. machine Hour Rate Rate per Hour = Original Cost Scrap Value
Method Useful Life in terms of Effective hour
Amount of Depreciation = Actual Hours X Rate of depreciation per hour
6. Production Units Rate per Depreciation per unit = Original Cost Scrap Value
Method Useful Life in terms of Productive Output
Amount of Depreciation = Actual Production (in units) X Rate of depreciation
per unit

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7. Sum of Years Digits Rate of Depreciation

Method (SYD)
For 1st Year = nth year X 100 = %
Sum of years Digits
For 2 Year =
nd (n-1)th year X 100 = %
Sum of years Digits
For 3 Year =
rd (n-2)th year X 100 = %
Sum of years Digits
For nth Year = 1 X 100 = %
Sum of years Digits
Note: Sum of Year digits = n(n+1)

2
Here, n = useful life of the asset (in years)
Amount of Depreciation = (Original Cost less Estimated Scrap Value)X

Respective rate of Depreciation for the given year
8. Provision for Amount of Depreciation = (Original Cost Scrap Value) + Estimated Cost of Repairs
Repairs and Useful Life of the Asset
Renewals
RESIDUAL VALUE = SCRAP VALUE = SALVAGED VALUE
CHANGE IN METHODS OF DEPRECIATION

When can a If Adoption of new method is required:
Change in Method 1. By Statute
of Depreciation 2. To comply with AS
be made? 3. To have a more appropriate preparation & presentation of financial
statements of enterprise.
Calculation of Depreciation is recalculated as per new method from the date of asset coming into
Depreciation use.s
Treatment of The Surplus should be credited to P/L A/c
Surplus
Treatment of The Deficiency should be debited to P/L A/c
Deficiency

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FOR YOUR WORKINGS

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FOR YOUR WORKINGS
Praveen Tawania Classes Page www.facebook.com/praveentawania

.
FOR YOUR WORKINGS
1. Amit Ltd. purchased a machine on 01.01.2006 for Rs 120,000. Installation

expenses were
Rs 10,000. Residual value after 5 years Rs 5,000. On 01.07.2006, expenses for
repairs were incurred to the extent of Rs 2,000. Depreciation is provided @
10% p.a. under written down value method. Depreciation for the 4th year =
________.
(a) Rs. 25,000 (b) Rs. 13,000
(c) Rs. 10,530 (d) Rs. 9,477
2. Original cost = Rs.1,26,000; Salvage value = Nil; Useful life = 6 years.

Depreciation for the first year under sum of years digits method will be
(a) Rs. 6,000 (b) Rs. 12,000
(c) Rs. 18,000 (d) Rs. 36.000
3. Obsolescence of a depreciable asset may be caused by

I. Technological changes.
II. Improvement in production method.
III. Change in market demand for the product or service output. IV.
Legal or other restrictions.
(a) Only (I) above (b) Both (I) and (II) above
(c) All (I), (II), (III), and (IV) (d) Only (IV) above
4. Amit Ltd. purchased a machine on 01.01.2006 for Rs 120,000. Installation

expenses were
Rs 10,000. Residual value after 5 years Rs 5,000. On 01.07.2006, expenses for
repairs were incurred to the extent of Rs 2,000. Depreciation is provided
under straight line method. Depreciation rate = 10%. Annual Depreciation
= _____.
(a) Rs. 13,000 (b) Rs. 17,000
(c) Rs. 21,000 (d) Rs. 25,000
.
5. Which of the following statements is/are false?

I. The term depreciation, depletion and
amortization convey the same meaning.
II. Provision for depreciation A/c is debited when
provision for depreciation A/c is created.
III. The main purpose of charging the profit and loss A/c
with the amount of
depreciation is to spread the cost of an asset over its useful life for the purpose of
income determination.
(a) Only (I) above (b) Only (II) above

(c) Only (III) above (d) All (I) (II) and (III) above
6. Original cost = Rs 126,000. Salvage value = 6,000. Depreciation for 2nd year
by Units of
Production Method, if units produced in 2nd year was 5,000 and total
estimated production 50,000.
(a) Rs. 10,800 (b) Rs. 11,340 (c) Rs. 12,600 (d) Rs. 12,000

.
FOR YOUR WORKINGS
7. Original cost = Rs.1,26,000; Salvage value = Nil; Useful life = 6 years.

Depreciation for the fourth year under sum of years digits method will be
(a) Rs. 6,000 (b) Rs. 12,000
(c) Rs. 18,000 (d) Rs. 24,000
8. The number of production of similar units expected to be obtained from the

use of an asset by an enterprise is called as
(a) unit life (b) useful life
(c) Production life (d) Expected life
9. Which of the following is not true with regard to fixed assets?

(a) They are acquired for using them in the (b) They are not meant for resale to
earn conduct of business operations profit
(c) They can easily be converted into cash (d) Depreciation at specified rates
is to be charged on most of
the fixed assets
10. Original cost = Rs 126,000. Salvage value = 6,000. Useful Life = 6 years.
Annual depreciation under SLM =
(a) Rs. 21,000 (b) Rs. 20,000
(c) Rs. 15,000 (d) Rs. 14,000
.
11. Which of the following expenses is not included in the acquisition cost of a
plant and equipment?
(a) Cost of site preparation (b) Delivery and handling charges
(c) Installation costs (d) Financing costs incurred subsequent to the period
after plant and equipment is put
to use.
12. Original cost = Rs 1,26,000. Salvage value = 6,000. Depreciation for 2nd year
@ 10% p.a.
under WDV method =
(a) Rs. 10,800 (b) Rs. 11,340
(c) Rs. 15,000 (d) Rs. 14,000
13. For charging depreciation, on which of the following assets, the depletion
method is adopted?
(a) Plant & machinery (b) Land & building
(c) Goodwill (d) Wasting assets like mines and quarries
14. If a concern proposes to discontinue its business from March 2009 and
decides to dispose of all its assets within a period of 4 months, the Balance
Sheet as on March 31, 2009 should indicate the assets at their
(a) Historical cost (b) Land & building
(c) Cost less depreciation (d) Cost price or market value, whichever is lower
15. In the case of downward revaluation of an asset which is for the first time
revalued, the account to be debited is
(a) Fixed Asset (b) Revaluation Reserve
(c) Profit & Loss account (d) General Reserve

.
FOR YOUR WORKINGS
16. In which of the following methods, is the cost of the asset written off in equal
proportion, during its useful economic life?
(a) Straight line method (b) Written down value method
(c) Units-of-production method (d) Sum-of-the-years-digits method
17. The portion of the acquisition cost of the asset, yet to be allocated is known
as
(a) Written down value (b) Accumulated value
(c) Realisable value (d) Salvage value
18. On the basis of the information given below answer questions 18 & 19.
Original Cost = Rs 1,00,000. Life = 5 years. Expected salvage value = Rs 2,000
Depreciation for 3rd year as per straight line method is
.
(a) Rs. 12,800 (b) Rs. 19,600

(c) Rs. 20,000 (d) Rs. 20,400
19. Rate of depreciation p.a. = __________.

(a) 20.0% (b) 20.0%
(c) 19.6% (d) 19.4%
20. On the basis of the information given below answer questions 20 to 26.
On April 01, 2008 the debit balance of the machinery account of A Ltd. was
Rs.5,67,000. The machine was purchased on April 01, 2006. The company
charged depreciation at the rate of 10% per annum under diminishing
balance method. On October 01, 2008, the company acquired a new machine
at a cost of Rs.60,000 and incurred Rs.6,000 for installation of the new
machine. The company decided to change the system of providing
depreciation from the diminishing balance method to the straight-line
method with retrospective effect from April 01, 2006. The rate of
depreciation will remain the same. The company decided to make necessary
adjustments in respect of depreciation due to the change in the method in
the year 2008-2009.
Cost of machinery on 01.04.2006 = ________.

(a) Rs. 5,67,000 (b) Rs. 6,30,000
(c) Rs. 7,00,000 (d) Rs. 7,77,778
21. Depreciation provided in 2006-07 = ______.

(a) Rs. 56,700 (b) Rs. 63,000
(c) Rs. 70,000 (d) Rs. 77,778
22. Depreciation provided in 2007-08 = ______.

(a) Rs. 51,030 (b) Rs. 56,700
(c) Rs. 63,000 (d) Rs. 70,000
23. Depreciation under new method for 2006-07 and 2007-08 = _______.
(a) Rs. 1,33,400 (b) Rs. 1,26,000
(c) Rs. 1,40,000 (d) Rs. 1,55,556

.
FOR YOUR WORKINGS
24. Further depreciation to be provided = ______.

(a) Rs. 5,670 (b) Rs. 6,300
(c) Rs. 7,000 (d) Rs. 7,778
25. Depreciation for the year 2008-09 = _________.
.
(a) Rs. 3,300 (b) Rs. 7,000

(c) Rs. 10,300 (d) Rs. 73,300
26. The balance outstanding to the debit of machinery account as on March 31,
2009 after effecting the above changes was
(a) Rs. 5,45,700 (b) Rs. 5,52,700
(c) Rs. 5,46,000 (d) Rs. 5,49,400
27. On the basis of the information given below answer questions 27 & 28.
The balance in the accumulated provision for depreciation account of a
company as at the beginning of the year 2008-2009 was Rs. 2,00,000 when
the original cost of the assets amounted to Rs.10,00,000. The company
charges 10% depreciation on a straight line basis for all the assets including
those which have been either purchased or sold during the year. One such
asset costing Rs.5,00,000 with accumulated depreciation as at the beginning
of the year of Rs.80,000 was disposed off during the year.
Depreciation for the current year is

(a) Rs. 40,000 (b) Rs. 50,000
(c) Rs. 60,000 (d) Rs. 1,00,000
28. The balance of the accumulated depreciation account at the end of the year
considering the current years depreciation charge would be
(a) Rs. 2,20,000 (b) Rs. 1,70,000
(c) Rs. 1,20,000 (d) Rs. 2,50,000
29. On the basis of the information given below answer questions 29 to 34.
B Limited has been charging depreciation on the straight line method. It
charges a full year depreciation even if the machinery is utilized only for part
of the year. An equipment which was purchased for Rs.3,50,000 now stands
at Rs.2,97,500 after depreciating at the rate of 5% on a straight line basis.
Now the company decides to change the method of depreciation with
retrospective effect. The applicable reducing balance rate for this machinery
would be 8% p.a. Assuming that before the effect of this change could be
accounted, depreciation for the current year is already charged based on
straight line method and is reflected in the depreciated value of Rs.2,97,500.
Straight line depreciation per annum is

(a) Rs. 15,000 (b) Rs. 17,500
(c) Rs. 35,000 (d) Rs. 52,500
30. Number of years for which depreciation has been charged on this basis is

.
FOR YOUR WORKINGS
(a) 2 years (b) 3 years

(c) 4 years (d) 5 years
.
FOR YOUR WORKINGS

.
FOR YOUR WORKINGS
31. If 8% depreciation was charged by the

reducing balance method, WDV at the end of
1st year was
(a) Rs. 2,72,541 (b) Rs. 2,96,240
(c) Rs. 3,22,000 (d) Rs. 3,60,000

2nd year was
(a) Rs. 2,72,541 (b) Rs. 2,96,240
(c) Rs. 3,22,000 (d) Rs. 3,60,000

3rd year was
(a) Rs. 2,72,541 (b) Rs. 2,96,240
(c) Rs. 3,22,000 (d) Rs. 3,60,000
34. The extra depreciation to be provided based

on the changed method during the year is
(a) Rs. 24,959 (b) Rs. 17,500
(c) Rs. 10,500 (d) Rs. 46,763
35. On the basis of the information given below

answer questions 35 to 37.
Praveen Tawania Classes Page www.facebook.com/praveent
.
In the year 2004-2005, C Ltd. purchased a

new machine and made the following
payments in relation to it:
Rs. Rs.
Cost as per suppliers list

5,20,000
Less: Agreed discount
50,000 4,70,000
Delivery charges
10,000
Erection charges
20,000 Annual maintenance charges
30,000
Additional components to increase capacity
of the machine 40,000
Annual insurance premium
5,000
The cost of the machine is

(a) Rs.5,40,000 (b) Rs.5,45,000
(c) Rs.4,70,000 (d) Rs.5,50,000
36. If depreciation is provided @ 10% p.a. SLM,

depreciation for 3rd year will be
(a) Rs.54,000 (b) Rs.54,500
(c) Rs.47,000 (d) Rs.55,000
37. If depreciation is provided @ 10% p.a. WDV,

depreciation for 3rd year is
(a) Rs.43,740 (b) Rs.44,145
(c) Rs.38,070 (d) Rs.44,550

.
FOR YOUR WORKINGS

answer questions 38 to 42
A new machine costing Rs.1 lakh was
purchased by a company to manufacture a
special product. Its useful life is estimated to
be 5 years and scrap value at Rs.10,000. The
production plan for the next 5 years using
the above machine is as follows:
.
Year 1 5,000 units

Year 2 10,000 units
Year 3 12,000 units
Yea
r 4
20,
000
uni
ts
Yea
r 5
25,
000
uni
ts
The depreciation expenditure for the 1st

year under units-of-production method will
be
(a) Rs.6,250 (b) Rs.12,500

(c) Rs.15,000 (d) Rs.25,000
39. The depreciation expenditure for the 2nd

be
(a) Rs.6,250 (b) Rs.12,500
(c) Rs.15,000 (d) Rs.25,000
40. The depreciation expenditure for the 3rd

be
(a) Rs.6,250 (b) Rs.12,500
(c) Rs.15,000 (d) Rs.25,000
41. The depreciation expenditure for the 4th

be
(a) Rs.6,250 (b) ) Rs.12,500
(c) Rs.15,000 (d) Rs.25,000

.
FOR YOUR WORKINGS
42. The depreciation expenditure for the 5th

be
(a) Rs.6,250 (b) ) Rs.12,500
(c) Rs.15,000 (d) Rs.31,250.

answer questions 43 to 47. Consider the
following information:
I. Rate of
depreciation
under the written
down method =
20%. II. Original
cost of the asset =
Rs.1,00,000.
III. Residual value of
the asset at the end of
useful life = Rs.40,960
The estimated useful
life of the asset is
(a) 4 years (b) 5 years
(c) 6 years (d) 7 years
44. Depreciation for 1st year =

(a) Rs. 20,000 (b) Rs. 16,000
(c) Rs. 12,800 (d) Rs. 10,240
45. Depreciation for 2nd year =

(a) Rs. 20,000 (b) Rs. 16,000 (c) Rs. 12,800
(d) Rs. 10,240
.
46. Depreciation for 3rd year =

(a) Rs. 20,000 (b) Rs. 16,000
(c) Rs. 12,800 (d) Rs. 10,240
47. Depreciation for 4th year =

(a) Rs. 20,000 (b) Rs. 16,000
(c) Rs. 12,800 (d) Rs. 10,240

answer questions 48 and 49.

.
FOR YOUR WORKINGS
On October 1, 2005 two machines costing

Rs.20,000 and Rs.15,000 respectively, were
purchased. On March 31, 2009, both the
machines had to be discarded because of
damage and had to be replaced by two
machines costing Rs.25,000 and Rs.20,000
respectively.
One of the discarded machine was sold for

Rs.10,000 and against the other it was
expected that Rs.5,000 would be realized.
The firm provides depreciation @15% on
written down value method.
Depreciation for the 2007-08 year =
(a) Rs. 2,625 (b) Rs. 4,856

(c) Rs. 4,128 (d) Rs. 3,509
49. The total amount of depreciation written off

on the two machines till they were
discarded is
(a) Rs.21,000 (b) Rs.15,118
(c) Rs.13,595 (d) Rs. 18,194

answer questions 50 to 52.
In the books of D Ltd. the machinery account
shows a debit balance of Rs.60,000 as on
April 1, 2010. The machinery was sold on
September 30, 2011 for Rs.30,000. The
company charges depreciation @20% p.a.
on diminishing balance method.
.
Depreciation for 2010-11 =
(a) Rs. 6,000 (b) Rs. 9.000

(c) Rs. 4,800 (d) Rs. 12,000
51. Depreciation for 2011-12 =

(a) Rs. 6,000 (b) Rs. 9.000
(c) Rs. 4,800 (d) Rs. 12,000
52. Profit / Loss on sale =

(a) Rs. 13,200 Profit (b) Rs. 13,200 loss
(c) Rs. 6,800 profit (d) Rs. 6,800 loss

.
FOR YOUR WORKINGS
53. H Ltd. purchased a machinery on April 01,

2004 for Rs.3,00,000. It is estimated that the
machinery will have a useful life of 5 years
after which it will have no salvage value. If
the company follows sum-of-the-years-
digits method of depreciation, the amount of
depreciation charged during the year 2008-
09 was
(a) Rs.1,00,000 (b) Rs.80,000
(c) Rs.60,000 (d) Rs.20,000
54. On August 01, 2006, K Travels Ltd. bought

four Matador vans costing Rs.1,20,000 each.
The company expected to fetch a scrap value
of 25% of the cost price of the vehicles after
ten years. The vehicles were depreciated
under the fixed installment method up to
March
31, 2009. The rate of depreciation charged
up to March 31, 2009 was
(a) 10.0% (b) 9.0%
(c) 8.5% (d) 7.5%
Answers:
1.( d) 2.( d ) 3.(c) 4.(a) 5.(c) 6.(d)

7.(d) 8.(b) 9.(c) 10.(b) 11.(b)
12.( d ) 13.( d ) 14.( b ) 15.( c ) 16.( a ) 17.( a )
18.( c ) 19.( c ) 20.( c ) 21.( c ) 22.( c )
.
23.( c ) 24.( c ) 25.( d ) 26.( b ) 27.( d ) 28.( a )

29.( b ) 30.( b ) 31.( c ) 32.( b ) 33.( a )
34.( a ) 35.( a ) 36.( a ) 37.( a ) 38.( a ) 39.( b )
40.( c ) 41.( d ) 42.( d ) 43.( a ) 44.( a )
45.( b ) 46.( c ) 47.( d ) 48.( c ) 49.( b ) 50.( d )
51.( c ) 52.( b ) 53.(d ) 54.( d )

.
NOTES
CHAPTER-5
PREPARATION OF FINAL ACCOUNTS

OF SOLE PROPRIETORS

.
Unit-1 FINAL ACCOUNTS

OF NON-
MANUFACTURING
ENTITIES

.
FOR YOUR WORKINGS
.
FOR YOUR WORKINGS
.
FOR YOUR WORKINGS
.
FOR YOUR WORKINGS
.
FOR YOUR WORKINGS
.
CHAPTER-5
PREPARATION OF FINAL ACCOUNTS

OF SOLE PROPRIETORS
Unit-2 FINAL ACCOUNTS

OF MANUFACTURING
ENTITIES

.
FOR YOUR WORKINGS
FOR YOUR WORKINGS

.

.
FOR YOUR WORKINGS
1. The balance of the petty cash is

(a) an expense (b) an income

.
(c) an asset (d) a liability
2. Fixed assets are

(a) kept in the business for use over a long time for earning income
(b) meant for resale
(c) meant for conversion into cash as quickly as possible
(d) All of the above
3. Goodwill is
(a) a current asset (b) an intangible fixed asset
(c) a tangible fixed asset (d) an investment
4. Stock is
(a) included in the category of fixed assets (b) an investment
(c) a part of current assets (d) an intangible fixed asset.
5. The manufacturing account is prepared:

(a) to ascertain the profit or loss on the goods produced
(b) to ascertain the cost of the manufactured goods
(c) to show the sale proceeds from the goods produced during the year
(d) both (b) and (c).
6. A new firm commenced business on 1st January, 2009 and purchased goods costing Rs. 90,000
during the year. A sum of Rs. 6,000 was spent on freight inwards. At the end of the year the cost of
goods still unsold was Rs. 12,000. Sales during the year Rs. 1,20,000.
What is the gross profit earned by the firm?

(a) Rs. 36,000 (b)Rs. 30,000
( c) Rs. 42,000 (d) Rs. 38,000
7. From the following figures ascertain the gross profit
Rs.
Opening stock (1.1.2009) 25,000
Goods purchased during 2009 1,30,000
Freight and packing on above 5,000
Closing Stock (31.12.2009) 15,000
Sales 1,90,000
Selling expenses on sales 9,000
(a) Rs.36,000 (b) Rs. 45,000
(c) Rs. 50,000 d) Rs.59,000

.
FOR YOUR WORKINGS
8. A prepayment of insurance premium will appear in the Balance Sheet and in the Insurance Account
respectively as:

.
(a) a liability and a debit balance. (b) an asset and a debit balance
(c) an asset and a credit balance (c) None of the above
9. Under-statement of closing work in progress in the period will

(a) Understate cost of goods manufactured (b) Overstate current assets.
in that period.
(c) Overstate gross profit from sales in that (d) Understate net income in that period.
period.
10. If sales revenues are Rs. 4,00,000; cost of goods sold is Rs. 3,10,000 and operating expenses are
Rs.60,000, the gross profit is
(a) Rs. 30,000. (b) Rs. 90,000
(c) Rs. 3,40,000 (d) Rs. 60,000
11. Sales is equal to

(a) Cost of goods sold Gross profit. (b) Cost of goods sold + Gross profit.
(c) Gross profit Cost of goods sold. (d) Cost of goods sold + Net profit.
12. A Company wishes to earn a 20% profit margin on selling price. Which of the following is the profit
mark up on cost, which will achieve the required profit margin?
(a) 33% (b) 25%
(c) 20% (d) None of the above
13. If sales is Rs. 2,000 and the rate of gross profit on cost of goods sold is 25%, then the cost of goods
sold will be
(a) Rs. 2,000 (b) Rs. 1,500
(c) Rs. 1,500 (d) None of the above.
14. Sales for the year ended 31st March, 2009 amounted to Rs. 10,00,000. Sales included goods sold to
Mr. A for Rs. 50,000 at a profit of 20% on cost. Such goods are still lying in the godown at the buyers
risk. Therefore, such goods should be treated as part of
(a) Sales. (b) Closing stock
(c) Goods in transit (d) Sales return
15. The capital of a sole trader would change as a result of

(a) a creditor being paid his account by cheque (b) raw materials being purchased on credit (c)
fixed assets being purchased on credit (d) wages being paid in cash.

.
FOR YOUR WORKINGS
16. Rent paid on 1st October, 2008 for the year to 30 September, 2009 was Rs. 1,200 and rent paid on
1st October, 2009 for the year to 30 September, 2010 was Rs. 1,600. Rent payable, as shown in the
profit and loss account for the year ended 31 December 2009, would be:
(a) Rs. 1,200. (b) Rs. 1,600
(c) Rs. 1,300 (d) Rs. 1,500.

.
17. A decrease in the provision for doubtful debts would result in

(a) an increase in liabilities (b) a decrease in working capital
(c) a decrease in net profit (d) an increase in net profit
18. From the given information, choose the most appropriate answer for Ques. 18, 19 & 20
Sales Opening Purchases Closing Cost of Gross Selling Net

Stock stock goods sold profit Expenses Profit
Rs.
15,000 6,000 10,000 ? 9,000 ? 4,000 ?
The value of closing stock is
(a) Rs. 9,000 (b) Rs.4,000
(c) Rs.8,000 (d) Rs. 7,000
19. Gross profit will be

(a) Rs. 6,000 (b) Rs. 5,000
(c) Rs.8,000 (d) Rs. 7,000
20. Net profit will be

(a) Rs. 6,000 (b) Rs. 5,000
(c) Rs. 2,000 (d) Rs. 7,000
21. From the given information, choose the most appropriate answer for Questions 21 and 22
Opening Investment Drawings Capital end Net
capital by proprietor of the year profit
16,000 Nil 3,000 13,500 ?
The net profit will be
(a) Rs. 600 (b) Rs. 500
(c) Rs. 550 (d) Rs. 700
22. If in the given information, Net Loss is Rs. 1,000, then the investment made by the proprietor during
the year will be
(a) Rs.1,500 (b) Rs. 2,000
(c) Rs. 1,200 (d) Rs. 1,700
23. From the given information, choose the most appropriate answer for Questions 23 and
24: Rs. Rs.
Opening Stock 20,000 Carriage on sales 3,000
Closing Stock 18,000 Rent of office 5,000
Purchases 85,800 Sales 1,40,700

.
FOR YOUR WORKINGS
Carriage on purchases 2,300

Gross profit will be
(a) Rs. 50,000 (b) Rs. 47,600
(b) Rs. 42,600 (d) Rs. 50,600

.
24. Net profit will be

(a) Rs. 42,600 (b) Rs. 50,600
(c) Rs. 45,600 (d) Rs. 47,600
25. From the given information, choose the most appropriate answer for Questions 25 & 26: The Zed
Company, a whole seller estimates the following sales for the indicated months
June 2009 July2009 August2009
Rs. Rs. Rs.
Opening stock 4,08,000 4,34,400 4,60,800
Credit Sales 15,00,000 16,00,000 17,00,000
Cash Sales 2,00,000 2, 10,000 2,20,000
Total Sales 17,00,000 18,10,000 19,20,000
Selling price is 125% of the purchase price.
The cost of goods sold for the month of June, 2009 is:
(a) Rs. 15,20,000 (b) Rs. 14,02,500
(c) Rs. 12,75,000 (d) Rs. 13,60,000
26. Stock purchased in July, 2006 is :

(a) Rs. 16,05,000 (b) Rs. 14,74,400
(c) Rs. 14,40,000 (d) Rs. 13,82,500
27. Considering the following information answer the Questions 27, 28 and 29 given below:
1st January (Rs.) 31st Dec (Rs.)
Stock of raw materials 17,400 18,100
Work-in-progress 11,200 11,400
Stock of finished goods 41,500 40,700
During the year manufacturing overhead expenses amounted Rs. 61,100, manufacturing
wages Rs. 40,400 and purchase of raw materials Rs. 91,900. There were no other direct
expenses
The cost of raw materials consumed, issued and used were:

(a) Rs. 1,09,300 (b) Rs. 91,200
(c) Rs. 91,900 (d) Rs. 92,600
28. The manufacturing cost of finished goods produced were

(a) Rs. 1,31,600 (b) Rs. 1,93,300
(c) Rs. 1,91,900 (d) Rs. 1,92,500
29. The manufacturing cost of finished goods sold was:

(a) Rs. 1,91,700 (b) Rs. 1,92,500
(c) Rs. 1,94,000 (d) Rs. 1,93,300.
30. Capital is the difference between

(a) Income and expenses (b) Sales and Cost of goods sold

.
FOR YOUR WORKINGS
(c) Assets and liabilities (d) None of the above
1.( c ) 2.( a ) 3.( b ) 4.( c ) 5.( b ) 6.( a ) 7.( b ) 8.( c ) 9.( d ) 10.( b ) 11.( b )
12.( b ) 13.( c ) 14.( a ) 15.( d ) 16.( c ) 17.( d ) 18.( d ) 19.( a ) 20.( c ) 21.( b ) 22.( a )
23.( d ) 24.( a ) 25.( d ) 26.( b ) 27.( b ) 28.( d ) 29.( d ) 30.( c )

.
NOTES
CHAPTER-6
PARTNERSHIP ACCOUNTS

.
Unit-1 INTRODUCTION TO
MEANING OF PARTNERSHIP
The Indian Partnership Act, 1932 defines partnership as
The relationship between persons who have agreed to share the profit of a business carried on by all
or any of them acting for all.
FEATURES OF PARTNERSHIP
1. An ASSOCIATION OF TWO OR MORE PERSONS;
2. An AGREEMENT entered into by all persons concerned;
.
3. Existence of a BUSINESS;
4. The carrying on of such business by all or any one of

them acting for all; and
5. SHARING OF PROFITS of the business (including losses).
6. UNLIMITED LIABILITY of all partners.
PARTNERS AND FIRM
The persons who enter into such an agreement are called partners and the business is called a firm.
In the absence of any agreement to the contrary

1. no partner has the right to a salary,
2. no interest is to be allowed on capital,
3. no interest is to be charged on the drawings,
4. interest at the rate of 6% is to be allowed on a partners loan to the firm, and
5. profits and losses are to be shared equally.
Note: In the absence of an agreement, the interest and salary payable to a partner will be paid only if there
is profit.
ACCOUNTS
1. Fixed Capital Account Capital Account & Current Account Maintained
2. Fluctuating Capital Account Only Capital Account Maintained
.
If, for instance, there are three partners A, B, and C there will be a Capital Account for each one of the
partners, As Capital Account will be credited by the amount contributed by him as capital and similarly
Bs and Cs Capital Accounts will be credited with the amounts brought in by them respectively as
capital.
When a partner takes money out of the firms for his domestic purpose, either his Capital Account can
be debited or a separate account, named as Drawings Account, can be opened in his name and the
account may be debited.
PROFIT AND LOSS APPROPRIATION ACCOUNT
During the course of business, a partnership firm will prepare Trading Account and a Profit and
Loss Account at the end of every year.
The Profit and Loss Account will show the profit earned by the firm or loss suffered by it.
This profit or loss has to be transferred to the Capital Accounts of partners according to the terms
of the Partnership Deed or according to the provisions of the Indian Partnership Act (if there is
no Partnership Deed or if the Deed is silent on a particular point).
.
Illustration 1
A and B start business on 1st January, 2009, with capitals of Rs. 30,000 and Rs. 20,000. According to
the Partnership Deed, B is entitled to a salary of Rs. 500 per month and interest is to be allowed on
capitals at 6% per annum. The remaining profits are to be distributed amongst the partners in the ratio
of 5:3. During 2009 the firm earned a profit, before charging salary to B and interest on capital
amounting to Rs. 25,000. During the year A withdrew Rs. 8,000 and B withdrew Rs. 10,000 for domestic
purposes.
Give journal entries relating to division of profit.
.
Illustration 2
Ram, Rahim and Karim are partners in a firm. They have no agreement in respect of profit- sharing
ratio, interest on capital, interest on loan advanced by partners and remuneration payable to partners.
In the matter of distribution of profits they have put forward the following claims :
(i) Ram, who has contributed maximum capital demands interest on capital at 10% p.a. and share
of profit in the capital ratio. But Rahim and Karim do not agree.
(ii) Rahim has devoted full time for running the business and demands salary at the rate of Rs. 500
p.m. But Ram and Karim do not agree.
(iii) Karim demands interest on loan of Rs. 2,000 advanced by him at the market rate of interest
which is 12% p.a.
How shall you settle the dispute and prepare Profit and Loss Appropriation Account after transferring
10% of the divisible profit to Reserve. Net profit before taking into account any of the above claims
amounted to Rs. 45,000 at the end of the first year of their business.
Solution
There is no partnership deed. Therefore, the following provisions of The Indian Partnership Act are to
be applied for settling the dispute.
(i) No interest on capital is payable to any partner. Therefore, Ram is not entitled to interest on
capital.
(ii) No remuneration is payable to any partner. Therefore, Rahim is not entitled to any salary.
(iii) Interest on loan is payable @ 6% p.a. Therefore, Karim is to get interest @ 6% p.a. on Rs. 2,000
instead of 12%.
(iv) The profits should be distributed equally.
Illustration 3
A and B start business on 1st January, 2009, with capitals of Rs. 30,000 and Rs. 20,000. According to
the Partnership Deed, B is entitled to a salary of Rs. 500 per month and interest is to be allowed on
capitals at 6% per annum. The remaining profits are to be distributed amongst the partners in the ratio
of 5:3. During 2009 the firm earned a profit, before charging salary to B and interest on capital
amounting to Rs. 25,000. During the year A withdrew Rs. 8,000 and B withdrew Rs. 10,000 for domestic
purposes.
Prepare Profit and Loss Appropriation Account and Capital Accounts of Partners A and B.
Solution
.
INTEREST ON CAPITAL
Interest on capital of partners is calculated for the relevant period for which the amount of capital
has been used in the business.
Normally, it is charged for full year on the balance of capital at the beginning of the year unless
some fresh capital is introduced during the year.
On the additional capital introduced, interest for the relevant period of utilisation is calculated.
For example, A has Rs. 30,000 capital in the beginning of the year and introduces Rs. 10,000
during the year. If rate of interest on capital is 20 % p.a., interest on As capital is calculated as
follows:
.
In case of fixed capital accounts, interest is calculated on the balance of capital accounts only and no
interest is payable / chargeable on the balance of current accounts.
Net loss and Interest on Capital: Subject to contract between the partners, interest on capitals
is to be provided out of profits only. Thus in case of loss, no interest is provided.
But in case of insufficient profits (i.e., net profit less than the amount of interest on capital), the
amount of profit is distributed in the ratio of capital as partners get profit by way of interest on
capital only.
INTEREST ON DRAWINGS
Sometimes interest is not only allowed on the capitals, but is also charged on drawings. In such a case,
interest will be charged according to the time that elapses between the taking out of the money and the
end of the year. Suppose X, a partner, has drawn the following sum of money
On 29th February, 2009 500

On 31st March, 2009 400
On 30th June, 2009 600
On 31st October, 2009 800
Accounts are closed on 31st December every year. Interest is chargeable on drawings at 6% per annum.
Other Assumptions:
If the dates on which amounts are drawn are not given, the student will do well to charge interest for
six months on the whole of the amount on the assumption that the money was drawn evenly
throughout the year.
If withdrawals are made evenly in the beginning of each month, interest can be calculated easily for the
whole of the amount of 6-1/2 months; if withdrawals are made at the end of each month, interest
should be calculated for 5-1/2 months.
GUARANTEE OF MINIMUM PROFIT

Sometimes, one partner can enjoy the right to have minimum amount of profit in a year as per the terms
of the partnership agreement. In such case, allocation of profit is done in a normal way if the share of
partner, who has been guaranteed minimum profit, is more than the amount of guaranteed profit.
However, if share of the partner is less than the guaranteed amount, he takes minimum profit and the
excess of guaranteed share of profit over the actual share is borne by the remaining partners as per the
agreement.
.
There are three possibilities as far as share of deficiency by other partners is concerned. These are as
follows:
Excess is payable by one of the remaining partners.

Excess is payable by at least two or all the partners in an agreed ratio.
Excess is payable by remaining partners in their mutual profit sharing ratio.
If the question is silent about the nature of guarantee, the burden of guarantee is borne by the remaining
partners in their mutual profit sharing ratio.
Illustration 4
Ram and Rahim start business with capital of Rs. 50,000 and Rs. 30,000 on 1st January, 2009. Rahim is
entitled to a salary of Rs. 400 per month. Interest is allowed on capitals and is charged on drawings at
6% per annum. Profits are to be distributed equally after the above noted adjustments. During the year,
Ram withdrew Rs. 8,000 and Rahim withdrew Rs. 10,000. The profit for the year before allowing for
the terms of the Partnership Deed came to Rs. 30,000.
Assuming the capitals to be fixed, prepare the Profit and Loss Appropriation Account and the Capital
and Current Accounts relating to the partners.
Solution
.
.
FOR YOUR WORKING

.
FOR YOUR WORKING
1. Following are the essential elements of a partnership firm except:

(a) Atleast two persons. (b) There is an agreement between all partners.
(c) Equal share of profits and losses. (d) Partnership agreement is for some business.
2. Following is the difference between partnership deed and partnership agreement: (a)
Partnership deed is in writing and partnership agreement is oral.
(b) Partnership deed is signed by all the partners but partnership agreement is signed by majority of
the partners.
(c) Partnership deed is registered in the court of law whereas partnership agreement is not
registered.
(d) Partnership deed is not subject to changes unless all partners agrees to it.
Partnership agreement can be amended with the consent of more than 50% partners.
3. If a firm prefers Partners Capital Accounts to be shown at the amount introduced by the
partners as capital in firm then entries for salary, interest, drawings, interest on capital
and drawings and profits are made in
(a) Trading Account. (b) Profit and Loss Account
(c) Balance Sheet (d) Partners Current Account.
4. In the absence of any agreement, partners are liable to receive interest on their Loans @:
(a) 12% p.a. (b) 10% p.a.
(c) 8% p.a. (d) 6% p.a.
5. A partner acts as for a firm.

(a) Agent. (b) Third Party.
(c) Employee. (d) None of the above.
6. Bill and Monica are partners sharing profits and losses in the ratio of 3:2 having the capital
of Rs. 80,000 and Rs. 50,000 respectively. They are entitled to 9% p.a. interest on capital
before distributing the profits. During the year firm earned Rs. 7,800 after allowing
interest on capital. Profits apportioned among Bill and Monica is:
(a) Rs. 4,680 and Rs. 3,120 (b) Rs. 4,800 and Rs. 3,000.
(c) Rs. 5,000 and Rs. 2,800. (d) None of the above.
.
7. Ram and Shyam are partners with the capital of Rs. 25,000 and Rs. 15,000 respectively.
Interest payable on capital is 10% p.a. Find the interest on capital for both the partners
when the profits earned by the firm is Rs. 2,400.
(a) Rs. 2,500 and Rs. 1,500. (b) Rs. 1,500 and Rs. 900.
(c) Rs. 1,200 and Rs. 1,200. (d) None of the above.
8. Seeta and Geeta are partners sharing profits and losses in the ratio 4:1. Meeta was manager
who received the salary of Rs. 4,000 p.m. in addition to a commission of 5% on net profits
after charging such commission. Profits for the year is Rs. 6,78,000 before charging salary.
Find the total remuneration of Meeta.
(a) Rs. 78,000. (b) Rs. 88,000. (c) Rs. 87,000. (d) Rs. 76,000.
9. The relationship between persons who have agreed to share the profit of a business
carried on by all or any of them acting for all is known as
(a) Partnership. (b) Joint Venture.
(c) Association of Persons. (d) Body of Individuals.
10. Features of a partnership firm are:

(a) Two or more persons carrying common (b) Sharing profits and losses in the fixed business
under an agreement. ratio.
(c) Business carried by all or any of them (d) All of the above. acting for
all.
11. Firm has earned exceptionally high profits from a contract which will not be renewed. In
such a case the profit from this contract will not be included in (a) Profit sharing of
the partners. (b) Calculation of the goodwill.
(c) Both. (d) None.
12. In the absence of an agreement, partners are entitled to

(a) Salary. (b) Commission.

.
FOR YOUR WORKING
(c) Interest on Loan and Advances. (d) Profit share in capital ratio.
13. Interest on capital will be paid to the partners if provided for in the agreement but only
from
(a) Current Profits. (b) Reserves.
(c) Accumulated Profits. (d) Goodwill.
14. Partners are suppose to pay interest on drawing only when by the
(a) Provided, Agreement. (b) Permitted, Investors.
(c) Agreed, Partners. (d) Both (a) & (c) above.
15. When a partner is given Guarantee by the other partner, loss on such guarantee will be
borne by
(a) Partnership firm. (b) All the other partners.
(c) Partner who gave the guarantee. (d) Partner with highest profit sharing
ratio.
16. Guarantee given to a partner A by the other partners B & C means (a) In case of loss
A will contribute towards that loss.
(b) In case of insufficient profits A will receive only the share of profit and not minimum
guaranteed amount.
(c) In case of loss or insufficient profits A will withdraw the minimum guaranteed amount.
(d) All of the above.
17. What would be the profit sharing ratio if the partnership act is complied with?
(a) As per agreement. (b) Equally.
(c) In Capital Ratio. (d) None of the above.
.
18. Would interest on loan be allowed in the absence of any agreement or when partnership
deed is silent?
(a) No interest allowed.
(b) Allowed only if agreed by all the other partners.
(c) Will be paid only when there are sufficient profits.
(d) Allowed @ 6% p.a.
19. Profit & Loss Appropriation Account is prepared

(a) For Proprietorship firm. (b) For partnership firm.
(c) Both a and b (d) None of the above.
20. What time would be taken into consideration if equal monthly amount is drawn as
drawings at the beginning of each month?
(a) 7 months. (b) 6 months.
(c) 5 months. (d) 6.5 months.
21. Where will you record interest on drawings?

(a)Debit side of Profit & Loss Appropriation Account.
(b)Credit side of Profit & Loss Appropriation Account.
(c) Credit side of Profit & Loss Account.
(d) Credit side of Capital/Current Account only.
22. What balance does a Partners Current Account has?

(a) Debit balance. (b) Credit balance.
(c) Either a or b. (d) None of the above.
23. Is rent paid to a partner is appropriation of profits?

(a) Yes. (b) No.
(c) If partners contribution as capital is (d) If partner is a working partner?
maximum.
24. How would you close the Partners Drawings Account?

(a) By transfer to Capital or Current Account debit side.
(b) By transfer to Capital Account credit side.
(c) By transfer to Current Account credit side.
(d) Either b or c.

.
FOR YOUR WORKING
25. A, B and C had capitals of Rs. 50,000; Rs. 40,000 and Rs. 30,000 respectively for carrying
on business in partnership. The firms reported profit for the year was Rs. 80,000. As per
provisions of the Indian Partnership Act, 1932, find out the share of each partner in the
above amount after taking into account that no interest has been provided on an advance
by A of Rs. 20,000, in addition to his capital contribution.
(a) Rs. 26,267 for Partner B and C & Rs. 27,466 for partner A. (b)
Rs. 26,667 each partner.
(c) Rs. 33,333 for A, Rs. 26,667 for B and Rs. 20,000 for C.
(d) Rs. 30,000 each partner.
26. X, Y and Z are partners in a firm. At the time of division of profit for the year there was
dispute between the partners. Profits before interest on partners capital was Rs. 6,000
and X wanted interest on capital @ 20% as his capital contributions was Rs. 1,00,000 as
compared to that of Y and Z which was Rs. 75,000 and Rs. 50,000 respectively.
(a) Profits of Rs. 6,000 will be distributed equally with no interest on either Capital.
(b) X will get the interest of Rs. 20,000 and the loss of Rs. 14,000 will be shared equally.
(c) All the partners will get interest on capital and the loss of Rs. 39,000 will be shared equally.
and Y determined interest @ 24% p.a. on his loan of Rs. 80,000. There was no agreement
on this point. Calculate the amount payable to X, Y and Z respectively.
.
(a) Rs. 2,000 to each partner.

(b) Loss of Rs. 4,400 for X and Z & Y will take home Rs. 14,800.
(c) Rs. 400 for X, Rs. 5,200 for Y and Rs. 400 for Z.
(d) Rs. 2,400 to each partner.
and Z demanded minimum profit of Rs. 5,000 as his financial position was not good.
However, there was no written agreement. Profits to be distributed to X, Y and Z will be
(a) Other partners will pay Z the minimum profit and will suffer loss equally.
(b) Other partners will pay Z the minimum profit and will suffer loss in capital ratio.
(c) X & Y will take Rs. 500 each and Z will take Rs. 5,000.
(d) Rs. 2,000 to each of the partners.
29. Following are the differences between Capital Account and Current Account except:
(a) Capital Account is prepared under fixed capital method whereas current account is prepared
under fluctuating capital method.
(b) In capital account only capital introduced and withdrawn is recorded, all other transactions
between the firm and partner is recorded in the current account.
(c) Interest is sometimes paid on capital account balance but no such interest is payable on
current account balances.
(d) b and c above.
30. Following are the differences between Partnership and Joint Venture except:
(a) Joint venture is essentially planned for short term mainly for one contract/deal. However,
partnerships are normally undertaken as going concerns and are expected to last for a very
long period.
(b) The persons involved in a joint venture are called co-venturers whereas persons involved
in a partnership are called partners.
(c) Any specific statute of the Government does not govern joint ventures but the Indian
Partnership Act, 1932, governs partnerships.
(d) Memorandum of Understanding is mandatory to be drafted to spell the relationship
between the co-venturers whereas the basic relationship between the partners is defined
by the partnership deed.

.
Answers:
1.( c ) 2.( c ) 3.( d ) 4.( d ) 5.( a ) 6.( a ) 7.( b ) 8.( a ) 9.( a ) 10.( d ) 11.( b )
12.( c ) 13.( a ) 14.( d ) 15.( c ) 16.( c ) 17.( b ) 18.( d ) 19.( b ) 20.( d ) 21.( b ) 22.( c )
23.( b ) 24.( a ) 25.( a ) 26.( a ) 27.( c ) 28.( d ) 29.( a ) 30.( d )

.
NOTES

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CHAPTER-6
Unit-2
TREATMENT OF GOODWILL

.
GOODWILL
Goodwill is the value of reputation of a firm in respect of profits expected in future over and above
the normal rate of profits.
The implication of the term over and above is that there is always a certain normal rate of profits
earned by similar firms in the same locality. The excess profit earned by a firm may be due to its
locational advantage, better customer service, possession of a unique patent right, personal
reputation of the partner or for similar other reasons.
NECESSITY FOR VALUATION OF GOODWILL IN A FIRM
a) When the profit sharing ratio amongst the partners is changed;

b) When a new partner is admitted;
c) When a partner retires or dies; and
d) When the business is dissolved or sold.
METHODS FOR GOODWILL VALUATION

.
There are four methods for valuation of goodwill
1. Average profit basis,

2. Super profit basis,
3. Annuity basis, and
4. Capitalisation basis
Average Profit Basis : In this case the profits of the past few years are averaged and adjusted for any
expected change in future. For averaging the past profit, either simple average or weighted average
may be employed depending upon the circumstances. If there exists clear increasing or decreasing
trend of profits, it is better to give more weight to the profits of the recent years than those of earlier
years. But, if there is no clear trend of profit, it is better to go by simple average.
In case of average profit basis, goodwill is calculated on the basis of average profit multiplied by certain
number of years.
The implication is that such profit will be maintained for so many number of years and the partner(s)
who gains in terms of profit sharing ratio should contribute for such gains in profit to the partners who
make the sacrifice.
Super Profits : On the other hand, super profit means, excess profit that can be earned by a firm over
and above the normal profit usually earned by similar firms under similar circumstances. Under this
method, the partner who gains in terms of profit sharing ratio has to contribute only for excess profit
because normal profit he can earn by joining any partnership firm. Under super profit method, what
excess profit a partnership firm can earn is to be determined first.
The steps to be followed are given below:
a) Identify the capital employed by the partnership firm;

b) Identify the average profit earned by the partnership firm based on past few years figures;
c) Determine normal rate of return prevailing in the locality of similar firms;
d) Apply normal rate of return on capital employed to arrive at normal profit;
e) Deduct normal profit from the average profit of the firm. If the average profit of the firm is more
than the normal profit, there exists super profit and goodwill.
Annuity Method : In the super profit method explained above, time value of money is not considered.
Although it was expected that super profit would be earned in five future years, still no devaluation was
done on the value of money for the time difference. In fact when money will be received in different
points of time, its value should be different depending upon the rate of interest.

.
Capitalisation Basis : Under this basis, value of whole business is determined applying normal rate of
return. If such value (arrived at by applying normal rate of return) is higher than the capital employed
in the business, then the difference is goodwill. The steps to be followed under this method are given
below:
a) Determine the normal rate of return.

b) Find out the average profit of the partnership firm for which goodwill is to be determined.
c) Determine the capital employed by the partnership firm for which goodwill is to be determined.
d) Find out normal value of the business by dividing average profit by normal rate of return.
e) Deduct average capital employed from the normal value of the business to arrive at goodwill.

.
Illustration 1
Lee and Lawson are in equal partnership. They agreed to take Hicks as one-fourth partner. For this it
was decided to find out the value of goodwill. M/s. Lee and Lawson earned profits during 2006-2009
as follows:
Year Profits Rs.

2006 120,000
2007 125,000
2008 130,000
2009 150,000
On 31.12.2009 capital employed by M/s. Lee and Lawson was Rs. 5,00,000. Rate of normal profit is
20%. Find out the value of goodwill following various methods.
Illustration 2
The following particulars are available in respect of the business carried on by Rathore
Rs.
(1) Capital Invested 150,000
(2) Trading Results :

2006 Profit 40,000
2007 Profit 36,000
2008 Loss 6,000
2009 Profit 50,000
(3) Market Rate of interest on investment 10%

(4) Rate of risk return on capital invested in business 2%
(5) Remuneration from alternative employment of the proprietor (if not engaged in business) Rs.

.
6,000 p.a.
You are requested to compute the value of goodwill on the basis of 5 years purchase of super profit of
the business calculated on the average profits of the last four years.
VALUATION OF GOODWILL IN CASE OF ADMISSION OF A PARTNER
Whenever there is any change in the existing relationship of the partners inter se, some partners have
to sacrifice their future profit and some others would gain. Those who are sacrificing future profit
should be compensated by the others who are gaining.
The partners, who gain in terms of profit sharing ratio, have to pay for such gain as a proportion to the
value of goodwill. The partners, who lose in terms of profit sharing ratio, receive payments for the
sacrifice as a proportion to the value of goodwill.
E. g., A and B are partners sharing profits in the ratio of 3:2. If their profits are Rs. 20,000, A will get
Rs. 12,000 and B will get Rs. 8,000. If C is admitted and given one fourth share in profits, then out of Rs.
20,000 he will get Rs. 5,000. The remaining Rs. 15,000 will be divided between A and B; A will get Rs. 9,000
and B will get Rs. 6,000. Thus on Cs admission A loses Rs. 3,000 per year and B loses Rs. 2,000 per year. C
will have to compensate A and B for this loss.
Goodwill is a compensation to old partners for their sacrifice in connection with admission of a new
partner. So it is to be credited to the partners according to their profit sacrificing ratio. Whatever share
the new partner is getting, it may be sacrificed by the old partners in proportion to their old profit
sharing ratio or in different proportion.
For example, Nigam and Dhameja are in partnership sharing profits and losses equally. They agreed to
take Ghosh as one-third partner. Now one-third share of Ghosh may come out of sacrifice made by
Nigam and Dhameja equally (i.e. at their old profit sharing ratio).
As per the Accounting Standard, it is not recommended to raise goodwill account but to show the
adjustment of goodwill through partners capital accounts.

.
E.g. Nigam and Dhameja are equal partners. They agreed to take Ghosh as one-third partner. The new
profit sharing ratio is 4:2:3. Nigam and Dhameja agreed Rs. 27,000 as value of goodwill.
ACCOUNTING TREATMENT OF GOODWILL IN CASE OF ADMISSION OF A NEW PARTNER
The goodwill should be recorded in the books only when some consideration in money or
moneys worth has been paid for it.
Only purchased goodwill should be recorded in the books of the firm.
In case of admission of a partner, goodwill cannot be raised in the books of the firm because no
consideration in money or moneys worth is paid for it. If the incoming partner brings any
premium over and above his capital contribution at the time of his admission, such premium
should be distributed to other existing partners.
When a new partner is admitted to a firm, the old partners generally sacrifice in favour of the
new partner in terms of lower profit sharing ratio in the future. Therefore, the premium for
goodwill brought in by the new partner shall be given to the existing partners on the basis of
profit sacrificing ratio.
The profit sacrificing ratio is computed by deducting the new profit sharing ratio from the old
profit sharing ratio. If the difference is positive, then there is a profit sacrifice and in case the
difference is negative, then there is a gain in terms of higher future profit sharing ratio.
Example 1 : A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. They want to admit
D into partnership with one-fifth share. D brings in Rs. 30,000 as capital and Rs. 10,000 as premium for
goodwill.

.
Example 2 : A & B are equal partners. They wanted to take C as a third partner and for this purpose
goodwill was valued at Rs. 1,20,000.
Example 3 : A & B are equal partners. They wanted to admit C as 1/6th partner who brought Rs. 60,000
as goodwill. The new profit sharing ratio is 3:2:1.
Example 4 : A, B & C are equal partners. They decided to take D who brought in Rs. 36,000 as goodwill.
The new profit sharing ratio is 3:3:2:2.
Illustration 2
The following is the Balance Sheet of Yellow and Green as at 31st December, 2009:
Liabilities Rs. Assets Rs.

Creditors 20,000 Cash at Bank 10,000
Capital : Sundry Assets 55,000
Yellow 25,000
Green 20,000
65,000 65,000
The partners shared profits and losses in the ratio 3:2. On the above date, Black was admitted as partner
on the condition that he would pay Rs. 20,000 as Capital. Goodwill was to be valued at 3 years purchase
of the average of four years profits which were:
Year Rs.
2005 9,000
2006 14,000
2007 12,000
2008 13,000
The new profit sharing ratio is 6:5:5. Give journal entries and Balance Sheet if goodwill is adjusted
through partners capital accounts.

.
ACCOUNTING TREATMENT OF GOODWILL IN CASE OF CHANGE IN PROFIT SHARING RATIO
In case of change in profit sharing ratio, the value of goodwill should be determined and preferably
adjusted through capital accounts of the partners on the basis of profit sacrificing ratio.
E.g. A, B & C are equal partners. They wanted to change the profit sharing ratio into 4:3:2. Goodwill of
the Firm is Rs. 90,000. Make the necessary journal entries.
E.g. A, B and C are in partnership sharing profits and losses in the ratio of 4:3:3. They decided to change
the profit sharing ratio to 7:7:6. Goodwill of the firm is valued at Rs. 20,000. Calculate the sacrifice/gain
by the partners and make the necessary journal entry.
E.g. A, B, C and D are in partnership sharing profits and losses equally. They mutually agreed to change
the profit sharing ratio to 3:3:2:2. Goodwill of the firm is valued at Rs. 20,000. Give necessary journal
entry.
ACCOUNTING TREATMENT OF GOODWILL IN CASE OF RETIREMENT OR DEATH OF A PARTNER
In case of retirement of a partner, the continuing partners will gain in terms of profit sharing ratio.
Therefore they have to pay to retiring partner for his share of goodwill in the firm in the gaining ratio.
Similarly, in case of death of the partner, the continuing partners should bear the share of goodwill due
to the heirs of the deceased partner. For this purpose, the goodwill is valued on the date of the
retirement or death and adjusted through the capital accounts of the partners.

.
E.g. A, B & C are equal partners. C wanted to retire for which value of goodwill is considered as Rs.
90,000. Give Journal Entry.

.
FOR YOUR WORKING
.
1. The profits of last five years are Rs. 85,000; Rs. 90,000; Rs. 70,000; Rs. 1,00,000 and Rs.
80,000. Find the value of goodwill, if it is calculated on average profits of last five years on
the basis of 3 years of purchase.
(a) Rs. 85,000. (b) Rs. 2,55,000.
(c) Rs. 2,75,000. (d) Rs. 2,85,000.
2. The profits of last three years are Rs. 42,000; Rs. 39,000 and Rs. 45,000. Find out the
goodwill of two years purchase.
(a) Rs. 42,000. (b) Rs. 84,000.
(c) Rs. 1,26,000. (d) Rs. 36,000.
3. Find the goodwill of the firm using capitalization method from the following information:
Total Capital Employed in the firm Rs. 8,00,000
Reasonable Rate of Return 15%
Profits for the year Rs. 12,00,000
(a) Rs. 82,00,000 (b) Rs. 12,00,000.
(c) Rs. 72,00,000. (d) Rs. 42,00,000
4. The capital of B and D are Rs. 90,000 and Rs. 30,000 respectively with the profit sharing
ratio 3:1. The new ratio, admissible after 01.04.2006 is 5:3. The goodwill is valued Rs.
80,000 as on that date. Amount payable by a gaining partner to a scarifying partner is:
(a) B will pay to D Rs. 10,000. (b) D will pay to B Rs. 10,000.
(c) B will pay to D Rs. 80,000. (d) will pay to B Rs. 80,000
5. A, B and C are equal partners. D is admitted to the firm for one-fourth share. D brings Rs.
20,000 capital and Rs. 5,000 being half of the premium for goodwill. The value of goodwill
of the firm is
(a) Rs. 10,000 (b) Rs. 40,000.
(c) Rs. 20,000. (d) None of the above.
6. The profits for 2006-07 are Rs. 2,000; for 2007-2008 is Rs. 26,100 and for 2008-2009 is
Rs. 31,200. Closing stock for 2007-2008 and 2008-09 includes the defective items of Rs.
2,200 and Rs. 6,200 respectively which were considered as having market value NIL.
Calculate goodwill on average profit method.
(a) Rs. 23,700. (b) Rs. 17,700.
(c) Rs. 13,700. (d) Rs. 17,300.
.
FOR YOUR WORKING
7. A and B are partners with capitals of Rs. 10,000 and Rs. 20,000 respectively and sharing
profits equally. They admitted C as their third partner with one-fourth profits of the firm
on the payment of Rs. 12,000. The amount of hidden goodwill is.
(a) 6,000. (b) 10,000.
(c) 8,000. (d) None of the above.
8. X and Y share profits and losses in the ratio of 2 : 1. They take Z as a partner and the new
profit sharing ratio becomes 3 : 2 : 1. Z brings Rs. 4,500 as premium for goodwill. The full
value of goodwill will be
(a) Rs. 4,500. (b) Rs. 18,000. (c) Rs. 27,000. (d) Rs. 24,000.
9. Under average profit basis goodwill is calculated by:

(a) No. of years purchased multiplied with (b) No. of years purchased multiplied with average
profits. super profits.
(c) Summation of the discounted value of (d) Super profit divided with expected rate
expected future benefits. of return.
10. Under super profit basis goodwill is calculated by:

11. Under annuity basis goodwill is calculated by:

.
12. Under capitalisation basis goodwill is calculated by:

13. The following particulars are available in respect of the business carried on by a
partnership firm:
Trading Results:
2001 Loss Rs. 5,000
2002 Loss Rs. 10,000
2003 Profit Rs. 75,000
2004 Profit Rs. 60,000
You are required to compute the value of goodwill on the basis of 5 years purchase of
average profit of the business.
(a) Rs. 1,25,000. (b) Rs.1,50,000.
(c) Rs. 10,000. (d) Rs. 1,20,000.
14. The profits and losses for the last years are 2001-02 Losses Rs. 10,000; 2002-03 Losses Rs.
2,500; 2003-04 Profits Rs. 98,000 & 2004-05 Profits Rs. 76,000. The average capital
employed in the business is Rs. 2,00,000. The rate of interest expected from capital
invested is 12%. The remuneration of partners is estimated to be Rs. 1,000 per month not
.
FOR YOUR WORKING
charged in the above losses/profits. Calculate the value of goodwill on the basis of two
years purchase of super profits based on the average of four years.
(a) Rs. 9,000. (b) Rs. 8,750.
(c) Rs. 8,500. (d) Rs. 8,250.
15. , B and C are partners sharing profits and loss in the ratio 3:2:1. They decide to change their
profit sharing ratio to 2:2:1. To give effect to this new profit sharing ratio they decide to
value the goodwill at Rs. 30,000. Pass the necessary journal entry if Goodwill not appearing
in the old balance sheet and should not appear in the new balance sheet. (a) Bs Capital
Account Dr. Rs. 2,000 (b) Goodwill Account Dr. Rs. 30,000 Cs Capital Account Dr.
Rs. 1,000 To As Capital Account Rs. 15,000
To As Capital Account Rs. 3,000 To Bs Capital Account Rs. 10,000
To Cs Capital Account Rs. 5,000 (c) As Capital Account Dr. Rs. 12,000 (a) As
Capital Account Dr. Rs. 3,000 Bs Capital Account Dr. Rs. 12,000 To Bs
Capital Account Rs. 2,000
Cs Capital Account Dr. Rs. 6,000 To Cs Capital Account Rs. 1,000
To Goodwill Account Rs. 30,000
16. Goodwill brought in by incoming partner in cash for joining in a partnership firm is taken
away by the old partners in their ratio.
(a) Capital. (b) New Profit Sharing.
(c) Sacrificing. (d) Old Profit Sharing.
17. A & B are partners sharing profits and losses in the ratio 5:3. On admission, C brings Rs.
70,000 cash and Rs. 48,000 against goodwill. New profit sharing ratio between A, B and C
are 7:5:4. Find the sacrificing ratio as A:B
(a) 3:1. (b) 4:7.
(c) 5:4. (d) 2:1.
18. Following are the factors affecting goodwill except:

(a) Nature of business. (b) Efficiency of management.
(c) Technical know how. (d) Location of the customers.
19. Weighted average method of calculating goodwill should be followed when:

(a) Profits are uneven. (b) Profits has increasing trend.
(c) Profits has decreasing trend. (d) Either b or c.
.
20. In the absence of any provision in the partnership agreement, profits and losses are shared
(a) In the ratio of capitals. (b) Equally.
(c) In the ratio of loans given by them to the (d) None of the above.
partnership firm
21. The profits and losses for the last years are 2005-06 Losses Rs. 10,000; 2006-07 Losses Rs.
2,500; 2007-08 Profits Rs. 98,000 & 2008-09 Profits Rs. 76,000. The average capital
employed in the business is Rs. 2,00,000. The rate of interest expected from capital
invested is 12%. The remuneration of partners is estimated to be Rs. 1,000 per month.
Calculate the value of goodwill on the basis of four years purchase of super profits based
on the annuity of the four years. Take discounting rate as 10%.
(a) Rs. 13,500. (b) Rs. 13,568.
(c) Rs. 13,668. (d) Rs. 13,868.
Answers:
1.( b ) 2.( b ) 3.( c ) 4.( b ) 5.( b ) 6.( b ) 7.( a ) 8.( c ) 9.( a ) 10.( b ) 11.( c )
12.( d ) 13.( b ) 14.( b ) 15.( a ) 16.( c ) 17.( a ) 18.( d ) 19.( d ) 20.( b ) 21.( d )
.
FOR YOUR WORKING
.
NOTES
CHAPTER-6

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Unit-3
ADMISSION OF A NEW PARTNER
INTRODUCTION
New partners are admitted for the benefit of the partnership firm.
New partner is admitted either for increasing the partnership capital or for strengthening the
management of the firm.
When a new partner joins a firm, it is desirable to bring all appreciation or reduction in the value
of assets into accounts as on the date of admission. Similarly, if the books contain any liability
which has not been paid or if the books do not contain a liability which has to be paid, suitable

.
entries should be passed. The purpose of such entries is to make an updated Balance Sheet on
the date of admission.
REVALUATION ACCOUNT OR PROFIT AND LOSS ADJUSTMENT ACCOUNT
When a new partner is admitted into the partnership, assets are revalued and liabilities are reassessed.
A Revaluation Account (or Profit and Loss Adjustment Account) is opened for the purpose. This account
is debited with all reduction in the value of assets and increase in liabilities and credited with increase
in the value of assets and decrease in the value of liabilities. The difference in two sides of the account
will show profit or loss. This is transferred to the Capital Accounts of old partners in the old profit
sharing ratio. The entries to be passed are:
Revaluation Account Dr.

(individually which show a decrease)
To Assets Account with the reduction in the value of the assets
To the Liabilities with the increase in the liabilities (Individually which
have to be increased)
Assets Account (Individually) Dr. with the increase in the value of the of assets
Liabilities Accounts Dr. with the reduction in the amount liabilities To
Revaluation Account
Revaluation Account Dr. with the profit in the old profit sharing ratio.
To Capital A/cs of the old partners
or,
Capital A/cs of the old partners Dr. with the loss in old profit sharing ratio.
To Revaluation Account
As a result of the above entries, the capital account balances of the old partners will change and the assets
and liabilities will have to be adjusted to their proper values. They will now appear in the Balance Sheet
at revised figures.
Alternatively, the partners may agree that revalued figures will not be shown in the Balance Sheet and
Assets and liabilities would appear in the Balance Sheet at their old values. For this, one additional entry
is necessary.
Capital A/cs Dr. with the amount of revaluation profit in the new
profit sharing ratio.
(of all partners including newly admitted partner)
To Revaluation A/c

.
or,
Revaluation A/c Dr. with the amount of revaluation loss in the new profit sharing ratio. To
Capital A/cs
(of all partners including newly admitted partners)
RESERVES IN THE BALANCE SHEET
Whenever a new partner is admitted, any reserve etc. lying in the Balance Sheet should be transferred
to the Capital Accounts of the old partners in the old profit sharing ratio. (In examination problems it
should be done even if there are no instructions on this point).
COMPUTATION OF NEW PROFIT SHARING RATIO

.
When a new partner is admitted and there is no agreement to the contrary, it is supposed that old
partners will continue to have inter se at the old profit sharing ratio.
For example, A and B are in partnership sharing profits and losses at the ratio of 3:2. They admitted C
as 1/5 partner. Compute new profit sharing ratio.
E.g. A and B are in partnership sharing profits and losses at the ratio 3:2. They take C as a new partner.
Calculate the new profit sharing ratio if -
(i) C purchases 1/10 share from A

(ii) A and B agree to sacrifice 1/10th share to C in the ratio of 2 : 3 (iii) Simply gets
1/10th share of profit.

.

.

.
FOR YOUR WORKING
Illustration
A and B are partners of X & Co. sharing profits and losses in 3:2 ratio between themselves. On 31st
March, 2009, the balance sheet of the firm was as follows:
Balance Sheet of X & Co. as at 31.3.2009

Capital Accounts Plant & Machinery 20,000
A 37,000 Furniture & Fittings 5,000
B 28,000 Stock 15,000
Sundry Creditors 5,000 Sundry Debtors 20,000
Cash in Hand 10,000
70,000 70,000
X agrees to join the business on the following conditions as and from 1.4.2009:
(a) He will introduce Rs. 25,000 as his capital and pay Rs. 15,000 to the partners as premium for
goodwill for 1/3rd share of the future profits of the firm.
(b) A revaluation of assets of the firm will be made by reducing the value of plant and machinery
to Rs. 15,000, stock by 10%, furniture and fitting by Rs. 1,000 and by making a provision of bad and
doubtful debts at Rs. 750 on sundry debtors.
Prepare profit and loss adjustment account, capital accounts of partners including the incoming partner
X assuming that the relative ratios of the old partners will be in equal proportion after admission.
HIDDEN GOODWILL
When the value of the goodwill of the firm is not specifically given, the value of goodwill has to be
inferred as follows:
Rs.
Incoming partners capital x Reciprocal of share of incoming partner xxx

Less: Total capital after taking into consideration the capital brought in by incoming partner xxx
Value of Goodwill xxx
Illustration
A and B are partners with capitals of Rs. 7,000 each. They admit C as a partner with 1/4th share in the
profits of the firm. C brings Rs. 8,000 as his share of capital. Give the necessary journal entry to record
goodwill.

.

.
FOR YOUR WORKING
1. A and B are partners sharing profits and losses in the ratio 5:3. They admitted C and agreed
to give him 3/10th of the profit. What is the new ratio after Cs admission?
(a) 35:42:17. (b) 35:21:24.
(c) 49:22:29. (d) 34:20:12.
2. A and B are partners sharing profits in the ratio 5:3, they admitted C giving him 3/10 th
share of profit. If C acquires 1/5 from A and 1/10 from B, new profit sharing ratio will be:
(a) 5:6:3. (b) 2:4:6.
(c) 18:24:38. (d) 17:11:12
3. C was admitted in a firm with 1/4th share of the profits of the firm. C contributes Rs. 15,000
as his capital, A and B are other partners with the profit sharing ratio as 3:2. Find the
required capital of A and B, if capital should be in profit sharing ratio taking Cs as base
capital:
(a) Rs. 27,000 and Rs. 16,000 for A and B respectively.
(b) Rs. 27,000 and Rs. 18,000 for A and B respectively. (c) Rs. 32,000 and Rs. 21,000
for A and B respectively.
(d) Rs. 31,000 and Rs. 26,000 for A and B respectively.
4. A, B and C are partners sharing profits and losses in the ratio 6:3:3, they agreed to take D
into partnership for 1/8th share of profits. Find the new profit sharing ratio.
(a) 12:27:36:42. (b) 14:7:7:4.
(c) 1:2:3:4. (d) 7:5:3:1.
5. X and Y are partners sharing profits in the ratio 5:3. They admitted Z for 1/5th share of
profits, for which he paid Rs. 1,20,000 against capital and Rs. 60,000 against goodwill. Find
the capital balances for each partner taking Zs capital as base capital.
(a) Rs. 3,00,000; Rs. 1,20,000 and Rs.1,20,000. (b) Rs.3,00,000; Rs.1,20,000 and Rs.1,80,000.
(c) Rs. 3,00,000; Rs. 1,80,000 and Rs.1,20,000.
(d) Rs.3,00,000; Rs.1,80,000 and Rs.1,80,000.
6. A and B are partners sharing profits and losses in the ratio of 3:2 (As Capital is Rs. 30,000
and Bs Capital is Rs. 15,000). They admitted C and agreed to give 1/5th share of profits to
him. How much C should bring in towards his capital?
(a) Rs. 9,000. (b) Rs. 12,000.
(c) Rs. 14,500. (d) Rs. 11,250.

.
7. A and B are partners sharing the profit in the ratio of 3:2. They take C as the new partner,
who brings in Rs. 25,000 against capital and Rs. 10,000 against goodwill. New profit
sharing ratio is 1:1:1. In what ratio will this amount will be shared among the old partners
A & B.
(a) Rs. 8,000: Rs. 2,000. (b) Rs. 5,000: Rs. 5,000. (c) Old partners will not get any share in (d)
Rs. 6,000: Rs. 4,000.
the goodwill brought in by C.
who is supposed to bring Rs. 25,000 against capital and Rs. 10,000 against goodwill. New
profit sharing ratio is 1:1:1. C is able to bring Rs. 30,000 only. How this will be treated in
the books of the firm.
(a) A and B will share goodwill brought by C as Rs. 4,000: Rs. 1,000.
(b) Goodwill not brought, will be adjusted to the extent of Rs. 15,000 in old profit sharing
ratio.
(c) Both.
(d) None.
profit sharing ratio is 1:1:1. C is able to bring only his share of Capital. How this will be
treated in the books of the firm.
(a) A and B will share goodwill bought by C as 4,000:1,000.
(b) Goodwill not brought, will be adjusted to the extent of Rs. 30,000 in old profit sharing
ratio.
(c) Both.
(d) None.

.
FOR YOUR WORKING
profit sharing ratio is 1:1:1. C brought cash for his share of Capital and agreed to
compensate to A and B outside the firm.
How this will be treated in the books of the firm.

(a) Cash brought in by C will only be credited to his capital account.
(b) Goodwill will be raised to full value in old ratio.
(c) Goodwill will be raised to full value in new ratio.
(d) Cash brought by C will be credited to his account and debited with his share of
goodwill, which will be debited to A and Bs account in sacrificing ratio.
11. Profit or loss on revaluation is shared among the partners in ratio.

(a) Old Profit Sharing. (b) New Profit Sharing.
(c) Capital. (d) Equal.
12. Amit and Anil are partners of a partnership firm sharing profits in the ratio of 5:3
respectively. Atul was admitted on the following terms: Atul would pay Rs. 50,000 as
capital and Rs. 16,000 as Goodwill, for 1/5th share of profit. Machinery would be
appreciated by 10% (book value Rs. 80,000) and building would be depreciated by 20%
(Rs. 2,00,000). Unrecorded debtors of Rs. 1,250 would be brought into books now and a
creditors amounting to Rs. 2,750 died and need not to pay anything to its estate.
Find the distribution of profit/loss on revaluation between Amit, Anil and Atul.
(a) Loss Rs. 17,500: Rs. 10,500:0. (b) Loss Rs. 14,000: Rs. 8,400: Rs. 5,600.
(c) Profits Rs. 17,500: Rs. 10,500:0. (d) Profits Rs. 14,000: Rs. 8,400: Rs.
5,600.

.
13. Amit and Anil are partners of a partnership firm sharing profits in the ratio of 5:3 with
capital of Rs. 2,50,000 & Rs. 2,00,000 respectively. Atul was admitted on the following
terms: Atul would pay Rs. 50,000 as capital and Rs. 16,000 as Goodwill, for 1/5th share of
profit. Find the balance of capital accounts after admission of Atul.
(a) Rs. 2,60,000: Rs. 2,06,000: Rs. 50,000. (b) Rs. 2,20,000: Rs. 1,82,000: Rs. 66,000.
(c) Rs. 2,92,500: Rs. 2,25,500: Rs. 50,000. (d) Rs. 2,82,500: Rs. 2,19,500: Rs. 66,000.
14. A and B shares profit and losses equally. They admit C as an equal partner and assets were
revalued as follow: Goodwill at Rs. 30,000 (book value NIL). Stock at Rs. 20,000 (book
value Rs. 12,000); Machinery at Rs. 60,000 (book value Rs. 55,000). C is to bring in
Rs. 20,000 as his capital and the necessary cash towards his share of Goodwill. Goodwill
Account will not be shown in the books. Find the profit/loss on revaluation to be shared
among A, B and C.
(a) Rs. 21,500: Rs. 21,500:0. (b) Rs. 6,500: Rs. 6,500:0.
(c) Rs. 14,333: Rs. 14,333: Rs. 14,333. (d) Rs. 4,333: Rs. 4,333: Rs. 4,333.
15. A and B shares profit and losses equally. They admit C as an equal partner and goodwill
was valued as Rs. 30,000 (book value NIL). C is to bring in Rs. 20,000 as his capital and the
necessary cash towards his share of Goodwill. Goodwill Account will not remain in the
books. What will be the final effect of goodwill in the partners capital account?
(a) A & Bs account credited with Rs. 5,000 (b) All partners account credited with Rs. each.
10,000 each.
(c) Only Cs account credited with Rs. (d) Final effect will be nil in each partner.
10,000 as cash bought in for goodwill.
16. A and B having share capital of Rs. 10,000 each, share profits and losses equally. They
admit C as an equal partner and goodwill was valued as Rs. 30,000 (book value NIL). C is
to bring in Rs. 20,000 as his capital and the necessary cash towards his share of Goodwill.
Goodwill Account will not be shown in the books. If profit on revaluation is Rs. 13,000, find
the closing balance of the capital account.
(a) Rs. 31,500: Rs. 31,500: Rs. 20,000. (b) Rs. 31,500: Rs. 31,500: Rs. 30,000.
(c) Rs. 26,500: Rs. 26,500: Rs. 30,000. (d) Rs. 20,000: Rs. 20,000: Rs. 20,000.
17. Balance sheet prepared after the new partnership agreement, assets and liabilities are
recorded at:
(a) Original Value. (b) Revalued Figure.
(c) At realisable value. (d) At current cost.
18. P and Q are partners sharing Profits in the ratio of 2:1. R is admitted to the partnership
with effect from 1st April on the term that he will bring Rs. 20,000 as his capital for 1/4 th
share and pays Rs. 9,000 for goodwill, half of which is to be withdrawn by P and Q. How
much cash can P & Q withdraw from the firm (if any).

.
FOR YOUR WORKING
(a) Rs. 3,000: Rs. 1,500. (b) Rs. 6,000: Rs. 3,000.
(c) NIL. (d) None of the above.
19. P and Q are partners sharing Profits in the ratio of 2:1. R is admitted to the partnership
with effect from 1st April on the term that he will bring Rs. 20,000 as his capital for 1/4 th
share and pays Rs. 9,000 for goodwill, half of which is to be withdrawn by P and Q. If profit
on revaluation is Rs. 6,000 and opening capital of P is Rs. 40,000 and of Q is Rs. 30,000,
find the closing balance of each capital.
(a) Rs. 47,000: Rs. 33,500: Rs. 20,000. (b) Rs. 50,000: Rs. 35,000: Rs. 20,000.
(c) Rs. 40,000: Rs. 30,000: Rs. 20,000 (d) Rs. 41,000: Rs. 30,500: Rs. 29,000.
20. Adam, Brain and Chris were equal partners of a firm with goodwill Rs. 1,20,000 shown in
the balance sheet and they agreed to take Daniel as an equal partner on the term that he
should bring Rs. 1,60,000 as his capital and goodwill, his share of goodwill was evaluated
at Rs. 60,000 and the goodwill account is to be written off before admission.
What will be the treatment for goodwill?

(a) Write off the goodwill of Rs. 1,20,000 in old ratio.
(b) Cash brought in by Daniel for goodwill will be distributed among old partners in
sacrificing ratio.
(c) Both (a) & (b)
21. Which of the following asset is compulsory to revalue at the time of admission of a new
partner:
(a) Stock. (b) Fixed Assets.
(c) Investment. (d) Goodwill.

.
22. X and Y are partners sharing profits in the ratio of 3 : 1. They admit Z as a partner who
pays Rs. 4,000 as Goodwill the new profit sharing ratio being 2 : 1 : 1 among X, Y and Z
respectively. The amount of goodwill will be credited to :
(a) X and Y as Rs. 3,000 and Rs. 1,000 respectively. (b) X only
(c) Y only. (d) None of the above.
Answers:
1.( b ) 2.( d ) 3.( b ) 4.( b ) 5.( c ) 6.( d ) 7.( a ) 8.( c ) 9.( b ) 10.( a ) 11.( a )
12.( a ) 13.( a ) 14.( b ) 15.( a ) 16.( a ) 17.( b ) 18.( a ) 19.( a ) 20.( c ) 21.( d ) 22.( b )

.
NOTES
CHAPTER-6

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Unit-4
RETIREMENT OF A NEW PARTNER
INTRODUCTION
A partner may retire from the partnership firm because of old age, illness, etc.
The business of the partnership firm may not come to an end when one of the partners retires.
Other partners may continue to run the business of the firm.
Readjustment takes place in case of retirement of a partner likewise the case of admission of a
partner.
Whenever a partner retires, the continuing partners make gain in terms of profit sharing ratio.
Therefore, the remaining arrange for the amount to be paid to discharge the claims of the
retiring partners.

.
Assets and liabilities are revalued, value of goodwill is raised and surrender value of joint life
policy, if any, is taken into account. Revaluation profit and reserves are transferred to capital
and current accounts of partners. Lastly, final amount due to the retiring partner is determined
and discharged.
CALCULATION OF GAINING RATIO
On retirement of a partner, the continuing partners will gain in terms of profit sharing ratio.
For example, if A, B and C were sharing profits and losses in the ratio of 5 : 3 : 2 and B retires, then A
and C have to decide at which ratio they will share profits and losses in future. If it is decided that the
continuing partners will share profits and losses in future at the ratio of 3:2, then A gains 1/10th [(3/5)-
(5/10)] and C gains 2/10 [(2/5)-(2/10)]. So the gaining ratio between A and C is 1:2. If A and C decide
to continue at the ratio 5:2, this indicates that they are dividing the gained share in the previous profit
sharing ratio.
Example: Amir, Jamir and Samir are in partnership sharing profits and losses at the ratio of 3:2:1. Now
Amir wants to retire and Jamir and Samir want to continue at the ratio of 3:2. In this case, Jamir gains
8/30th of share of partnership (3/5 less 2/6) whereas Samir gains 7/30th (2/5 less 1/6) share of the
partnership. So gaining ratio between Jamir and Samir is 8:7. On the other hand, if Jamir and Samir
would decide to continue sharing profits and losses at the ratio of 2:1, then Jamir would gain 2/6th
share of partnership i.e. [(2/3)(2/6)], and Samir would gain 1/6th share of partnership i.e. [(1/3)
(1/6)]. So it appears that in such a case gaining ratio of Jamir and Samir would be 2:1. i.e., the existing
profit sharing ratio between them.
REVALUATION OF ASSETS AND LIABILITIES ON RETIREMENT OF A PARTNER
On retirement of a partner, it is required to revalue assets and liabilities just as in the case of admission
of a partner. If there is revaluation profit, then such profit should be distributed amongst the existing
partners including the retiring partner at the existing profit sharing ratio.
On the other hand, if there is loss on revaluation that is also to be distributed to all the partners
including the retiring partner at the existing profit sharing ratio. To arrive at, profit or loss on
revaluation of assets and liabilities, a Revaluation Account or Profit and Loss Adjustment Account is
.
opened. Revaluation Account or Profit and Loss Adjustment Account is closed automatically by transfer
of profit or loss balance to the Partners Capital Accounts.
If it is decided that revalued figures of assets and liabilities will not appear in the balance sheet of the
continuing partners, then a journal entry should be passed with the amount payable or chargeable to
the retiring partner which the continuing partners will share at the ratio of gain.
RESERVE APPEARING IN BALANCE SHEET
On the retirement of a partner any undistributed profit or reserve standing at the Balance Sheet is to
be credited to the Partners Capital Accounts in the old profit sharing ratio.
Alternatively, only the retiring partners share may be transferred to his Capital Account if the others
continue at the same profit sharing ratio.
FINAL PAYMENT TO A RETIRING PARTNER
The following adjustments are necessary in the Capital A/c:
1. Transfer of reserve,
2. Transfer of goodwill,
3. Transfer of profit/loss on revaluation.
After adjustment of the above mentioned items, the Capital Account balance standing to the credit of
the retiring partner represents amount to be paid to him. The continuing partners may discharge the
whole claim at the time of retirement. Then the journal entry will appear as follows:
Retiring Partners Capital A/c Dr.

To Bank A/c
Sometimes the retiring partner agrees to retain some portion of his claim in the partnership as loan.
The journal entry will be as follows:
Retiring partners Capital A/c Dr.

To Retiring Partners Loan A/c
To Bank A/c
Illustration 1
A and B partners in a business sharing profit and losses as A-3/5ths and B-2/5ths. Their balance
sheet as on 1st January, 2009 is given below:
Balance Sheet of X & Co. as at 31.3.2009


.
Capital Accounts Plant & Machinery 20,000

A 20,000 Stock 16,000
B 15,000 Sundry Debtors 15,000
Reserves 15,000 Bank 6,000
Sundry Creditors 7,500 Cash in Hand 500
57,500 57,500
B retires from the business owing to illness and A takes it over. The following revaluation was
made:
(1) The goodwill of the firm is valued at Rs. 25,000.
(2) Depreciate Plant & Machinery by 7.5% and stock by 15%.
(3) Doubtful debts provision is raised against debtors at 5% and a discount reserve against
creditors at 2%.
You are asked to journalise the above transactions in the books of the firm and close the Partners
Accounts as on 1st January 2009. Give also the opening Balance Sheet of A.
PAYING A PARTNERS LOAN IN INSTALMENT
Paying a partners loan is only a matter of arranging finance.
.
It is stated that the loan is to be paid off in so many equal instalments and that the balance is to
carry interest.
In such case what should be done is that the loan should be divided into equal parts.
The interest for the period should be calculated and the payment should consist of the instalment
on account of the loan plus interest for the period.
E.g. A partners loan stands at Rs. 30,000 and that it has to be paid in four annual equal instalments and
that the loan is to carry interest at 6% per annum. The annual instalment on account of loan comes to
Rs. 7,500. For the first year the first interest is Rs. 1,800 i.e. 6% on Rs. 30,000. In the first year the
amount to be paid will be Rs. 9,300. Balance of Rs. 22,500 will now be left. Next year the interest will
be Rs. 1,350. The amount to be paid therefore will be Rs. 7,500 plust interest viz., Rs.
8,850.
The loan account will appear in the books as under.
FOR YOUR WORKING

.
JOINT LIFE POLICY

A partnership firm may decide to take a Joint Life Insurance Policy on the lives of all partners. The firm
pays the premium and the amount of policy is payable to the firm on the death of any partner or on the
maturity of policy whichever is earlier. The objective of taking such a policy is to minimise the financial
hardships to the event of payment of a large sum to the legal representatives of a deceased partner or
to the retiring partner.
.
1. When premium paid is treated as an EXPENSE: When premium is treated as an

expense then it is closed every year by transferring to profit and loss account. In this case
complete amount received from the insurance company either on a surrender of policy or on
the death of the partner becomes a gain.
Accounting entries are:

(a) On payment of premium
Joint Life Policy Insurance Premium A/c Dr.
To Bank A/c
(b) On charging to Profit and Loss Account
Profit and Loss Account Dr.
To Joint Life Policy Insurance Premium A/c
(c) On maturity of the Policy
Insurance Company/ Bank Account Dr.
To Partners Capital A/cs (individually)
(Including the account of the representative of a deceased partner)
2. When premium paid is treated as an ASSET: In this case insurance premium paid
is first debited to life policy account and credited to bank account. At the end of the year the
amount in excess of surrender value is treated as a loss and is transferred to Profit and Loss
Account. In this case the amount received from the insurance company in excess of the
surrender value results in a gain at the time of receipt of such amount which is transferred to
Capital Accounts of the partners in the profit sharing ratio.
3. Creation of JOINT POLICY RESERVE Account: Under this method, premium paid is
debited to policy account and credited to bank account. At the end of the year, amount equal to
premium is transferred from Profit and Loss Appropriation Account to Policy Reserve Account.
After this, policy account is brought down to its surrender value by debiting the life policy
reserve account with amount which exceeds the surrender value of the policy. Thus, in this
method, policy account appears on the assets side and policy reserve account appears on the
liabilities side of the Balance Sheet until it is realised. Both these accounts appear in the Balance
Sheet at the surrender value of the policy. This method is different from the method discussed
in (2) above only in respect of reserve account.
On the death of a partner Joint Life Policy Reserve Account is transferred to Joint Life Policy Account
and then the balance is transferred to Partners Capital Accounts.
Illustration 1
Red, White and Black shared profits and losses in the ratio of 5:3:2. They took out a joint life Policy in
2005 for Rs. 50,000, a premium of Rs. 3,000 being paid annually on 10th June. The surrender value of

.
the policy on 31st December of various years was as follows: 2005 nil; 2006 Rs. 900: 2007 Rs. 2,000;
2008 Rs. 3,600.
Black retires on 15th April, 2009.

Prepare ledger accounts assuming no Joint Life Policy Account is maintained.
.
Illustration 2
Red, White and Black shared profits and losses in the ratio of 5: 3: 2. They took out a Joint Life Policy in
2005 for Rs. 50,000, a premium of Rs. 3,000 being paid annually on 10th June. The surrender value of
the policy on 31st December of various years was as follows: 2005 nil; 2006 Rs. 900: 2007 Rs.
2,000; 2008 Rs. 3,600.
Black retires on 15th April, 2009.

Prepare ledger accounts assuming Joint Life Policy Account is maintained on surrender value basis.

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.

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FOR YOUR WORKING
1. Retiring or outgoing partner:

(a) Is liable for firms liabilities. (b) Not liable for any liabilities of the firm. (c) Is liable for
obligations incurred before (d) Is liable for obligations incurred before his retirement. and
after his retirement.
2. A, B and C are partners with profits sharing ratio 4:3:2. B retires. If A & C shares profits of B in 5:3, then
find the new profit sharing ratio.
(a) 47:25. (b) 17:11.
(c) 31:11. (d) 14:21.
3. C, D and E are partners sharing profits and losses in the proportion of , 1/3 and 1/6. D retired and
the new profit sharing ratio between C and E is 3:2 and the Reserve of Rs. 12,000 is divided among the
partners in the ratio:
(a) Rs. 2,000: Rs. 4,000: Rs. 6,000. (b) Rs. 5,000: Rs. 5,000: Rs. 2,000.
(c) Rs. 4,000: Rs. 6,000: Rs. 2,000. (d) Rs. 6,000: Rs. 4,000: Rs. 2,000.
4. Outgoing partner is compensated for parting with firms future profits in favour of remaining partners.
In what ratio do the remaining partners contribute to such compensation amount?
(a) Gaining Ratio. (b) Capital Ratio.
(c) Sacrificing Ratio. (d) Profit Sharing Ratio.
5. Joint Life Policy is taken by the firm on the life(s) of

(a) All the partners jointly. (b) All the partners severely.
(c) On the life of all the partners and (d) Both a and b.
employees of the firm.
6. At the time of retirement of a partner, firm gets from the insurance company against the Joint Life
Policy taken jointly for all the partners.
(a) Policy Amount. (b) Surrender Value.
(c) Policy Value for the retiring partner and (d) Surrender Value for all the partners.
Surrender Value for the rest.
7. A, B and C takes a Joint Life Policy, after five years B retires from the firm. Old profit sharing ratio is
2:2:1. After retirement A and C decides to share profits equally. They had taken a Joint Life Policy of Rs.
2,50,000 with the surrender value Rs. 50,000. What will be the treatment in the partners capital
account on receiving the JLP amount if joint life policy premium is fully charged to revenue as and when
paid?
(a) Rs. 50,000 credited to all the partners in (b) Rs. 2,50,000 credited to all the partners old
ratio. in old ratio.

.
(c) Rs. 2,00,000 credited to all the partners (d) No treatment is required.
in old ratio.
8. A, B and C takes a Joint Life Policy, after five years, B retires from the firm. Old profit sharing ratio is
account on receiving the JLP amount if joint life policy is maintained at the surrender value?
(c) Rs. 2,00,000 credited to all the partners (d) No treatment is required.
in old ratio.
9. A, B and C takes a Joint Life Policy, after five years B retires from the firm. Old profit sharing ratio is
account on receiving the JLP amount if joint life policy is maintained at surrender value along with the
reserve?
(c) Rs. 2,00,000 credited to all the partners (d) Distribute JLP Reserve Account in old in old
ratio. profit sharing ratio.
10. A, B and C are partners sharing profits in the ratio 2:2:1. On retirement of B, goodwill was valued as Rs.
30,000. Find the contribution of A and C to compensate B.
(a) Rs. 20,000 and Rs. 10,000. (b) Rs. 8,000 and Rs. 4,000.
(c) They will not contribute any thing. (d) Information is insufficient for any
comment.

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FOR YOUR WORKING
11. Claim of the retiring partner is payable in the following form.

(a) Fully in cash.
(b) Fully transferred to loan account to be paid later with some interest on it.
(c) Partly in cash and partly as loan repayable later with agreed interest.
(d) Any of the above method.
12. A, B and C were partners in a firm sharing profits and losses in the ratio of 2:2:1 respectively with the
capital balance of Rs. 50,000 for A and B, for C Rs. 25,000. B declared to retirefrom the firm and balance
in reserve on the date was Rs. 15,000. If goodwill of the firm was valued as Rs. 30,000 and profit on
revaluation was Rs. 7,050 then what amount will be transferred to the loan account of B.
(a) Rs. 70,820. (b) Rs. 50,820.
(c) Rs. 25,820. (d) Rs. 58,820.
13. A, B and C are partners sharing profits and losses in the ratio of 3:2:1. C retires on a decided date and
Goodwill of the firm is to be valued at Rs. 60,000. Find the amount payable to retiring partner on
account of goodwill.
(a) Rs. 30,000. (b) Rs. 20,000.
(c) Rs. 10,000. (d) Rs. 60,000.
14. A, B and C were partners sharing profits and losses in the ratio of 3:2:1. A retired and Goodwill of the
firm is to be valued at Rs. 24,000. What will be the treatment for goodwill?
(a) Credited to Revaluation Account at Rs. (b) Adjusted through partners capital
24,000. accounts in gaining/sacrificing ratio.
(c) Only As capital account credited with (d) Only As capital account credited with

.
Rs. 12,000. Rs. 24,000.
15. A, B and C were partners sharing profits and losses in the ratio of 3:2:1. A retired and firm received the
joint life policy as Rs. 7,500 appearing in the balance sheet at Rs. 10,000. JLP is credited and cash
debited with Rs. 7,500, what will be the treatment for the balance in Joint Life Policy?
(a) Credited to partners current account in (b) Debited to revaluation account.
(c) Debited to partners capital account in (d) Either (b) or (c).
16. Balances of M/s. Ram, Rahul and Rohit sharing profits and losses in proportion to their capitals, stood
as Ram - Rs. 3,00,000; Rahul - Rs. 2,00,000 and Rohit - Rs. 1,00,000. Ram desired to retire from the firm
and the remaining partners decided to carry on, Joint life policy of the partners surrendered and cash
obtained Rs. 60,000. What will be the treatment for Joint Life Policy Account?
(a) Rs. 60,000 credited to Revaluation Account.
(b) Rs. 60,000 credited to Joint Life Policy Account.
(c) Rs. 30,000 debited to Rams Capital Account.
(d) Either (a) or (b).
17. Balances of A, B and C sharing profits and losses in proportion to their capitals, stood as A - Rs. 2,00,000;
B - Rs. 3,00,000 and C - Rs. 2,00,000; Joint Life Policy Reserve A/c Rs. 80,000 and Joint Life Policy A/c
is shown in the Balance Sheet Rs. 80,000. A desired to retire from the firm and the remaining partners
decided to carry on in equal ratio, Joint life policy of the partners surrendered and cash obtained Rs.
80,000.
What will be the treatment for Joint Life Policy Reserve A/c?
(a) Cash received credited to Revaluation Account.
(b) JLP Reserve balance credited to Partners Capital Account in old profit sharing ratio.
(c) JLP Reserve balance credited to Partners Capital Account in new profit sharing ratio.
(d) Cash received credited to Partners Capital Accounts in old profit sharing ratio.
18. Balances of A, B and C sharing profits and losses in proportionate to their capitals, stood as A - Rs.
2,00,000; B - Rs. 3,00,000 and C - Rs. 2,00,000. A desired to retire from the firm, B and C share the future
profits equally, Goodwill of the entire firm be valued at Rs. 1,40,000 and no Goodwill account being
raised.
(a) Credit Partners Capital Account with old profit sharing ratio for Rs. 1,40,000.
(b) Credit Partners Capital Account with new profit sharing ratio for Rs. 1,40,000.
(c) Credit As Account with Rs. 40,000 and debit Bs Capital Account with Rs. 10,000 and Cs
Capital Account with Rs. 30,000.
(d) Credit Partners Capital Account with gaining ratio for Rs. 1,40,000.

.
19. Balances of Ram, Hari & Mohan sharing profits and losses in the ratio 2:3:2 stood as Ram - Rs.
10,00,000; Hari - Rs. 15,00,000; Mohan - Rs. 10,00,000; Joint Life Policy Rs. 3,50,000. Hari desired to
retire from the firm and the remaining partners decided to carry on with the future profit sharing ratio
of 3:2. Joint Life Policy of the partners surrendered and cash obtained Rs. 3,50,000. What would be the
treatment for JLP A/c?
(a) Rs. 3,50,000 credited to partners capital account in new ratio.
(b) Rs. 3,50,000 credited to partners capital account in old ratio.
(c) Rs. 3,50,000 credited to partners capital account in capital ratio.
(d) Rs. 3,50,000 credited to JLP account.
Answers:
1.( c ) 2.( a ) 3.( d ) 4.( a ) 5.( d ) 6.( b ) 7.( a ) 8.( d ) 9.( d ) 10.( b ) 11.( d )
12.( a ) 13.( c ) 14.( b ) 15.( d ) 16.( b ) 17.( b ) 18.( c ) 19.( d )

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NOTES

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CHAPTER-6
Unit-5 DEATH OF A NEW

PARTNER

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Introduction
Business of a partnership firm may not come to an end due to death of a partner.
Other partners shall continue to run the business of the firm.
Assets and liabilities have to be revalued and the resultant profit or loss has to be transferred to
the capital accounts of all partners including the deceased partner.
Goodwill is dealt with exactly in the way already discussed in the case of retirement in the earlier
unit.
Treatment of joint life policy will also be same as in the case of retirement. However, in case of
death of a partner, the firm would get the joint policy value.

.
The only additional point is that as death may occur on any day, the representatives of the
deceased partner will be entitled to the partner's share of profit from the beginning of the year to
the date of death. After ascertaining the amount due to the deceased partner, it should be credited
to his Executor's Account.
The amount due to the deceased partner carries interest at the mutually agreed upon rate.
In the absence of agreement, the representatives of the deceased partner can receive, at
their option, interest at the rate of 6% per annum or the share of profits earned for the
amount due to the deceased partner.
SPECIAL TRANSACTIONS IN CASE OF DEATH: JOINT LIFE POLICY

If Joint Life Policy appears in the Balance Sheet at surrender value, then the firm will gain on the death
of a partner.
For example, A, B and C are in partnership sharing profits and losses at the ratio of 5:3:2. They took a
Joint Life Policy of Rs. 1,00,000 which is appearing in the Balance Sheet at the surrender value of Rs.
10,000,. Now, if A dies, the firm will receive Rs. 1,00,000 from the insurance company.
The journal entries will appear as follows:
(i) Bank A/c Dr. 100,000

To Joint Life Policy A/c 100,000
(Policy value received from the insurance company on As death)
(ii) Joint Life Policy A/c Dr. 90,000

To As Capital A/c 45,000
To Bs Capital A/c 27,000
To Cs Capital A/c 18,000
However, if joint life policy does not appear in the Balance Sheet, then entry (ii) is to be passed for Rs.
1,00,000 and it would appear as follows :
Joint Life Policy A/cs Dr. 100,000

To As Capital A/c 50,000
To Bs Capital A/c 30,000
To Cs Capital A/c 20,000
SPECIAL TRANSACTIONS IN CASE OF DEATH : PAYMENT OF DECEASED PARTNER'S SHARE
The basic distinction between retirement and death of a partner relates to finalisation of amount
payable to the Executor of the deceased partner. Although, revaluation of goodwill is done in the same
way as it has been done in case of retirement, in addition, the executor of the deceased partner is
entitled to share of profit upto the date of death.

.
For example, A, B and C are in partnership sharing profits and losses at the ratio of 2:2:1. A died on 15th
April, 2009. The firm closes its books of account as on 31st December every year. So the executor of A
is entitled for 3 months profit. If A's share is immediately paid off then profit for 2009 can be taken
as base for calculating 3 months profits in the year, 2009. If M/ s. A, B & C earned Rs. 96,000 in year
2008, then 3 months profit is Rs. 28,000. A's share comes to Rs. 28,000 2/5 i.e. Rs. 11,200.
Journal entry is :
Profit and Loss Suspense A/c * Dr. Rs.11,200

To A's Capital A/c Rs. 11,200
(Share of A 3 months profit in 2009
is transferred to his Capital Account on death)
* At the end of the year 2009, the Profit & Loss Suspense A/c will be transferred to Profit and Loss A/c.
FOR YOUR WORKINGS

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1. On the death of a partner, his executor is paid the share of profits of the dying partner for
the relevant period. This payment is recorded in Profit & Loss Account.
(a) Adjustment. (b) Appropriation.
(c) Suspense. (d) Reserve.
2. Revaluation account is prepared at the time of

(a) Admission of a partner (b) Retirement of a partner
(c) Death of a partner (d) All of the above
3. In the absence of proper agreement, representative of the deceased partner is entitled to

the Dead partners share in

.
(a) Profits till date, goodwill, joint life policy, share in revalued assets and liabilities. (b)
Capital, goodwill, joint life policy, interest on capital, share in revalued assets and
liabilities.
(c) Capital, profits till date, goodwill, interest on capital, share in revalued assets and liabilities.
(d) Capital, profits till date, goodwill, joint life policy, share in revalued assets and liabilities.
4. As per Section 37 of the Indian Partnership Act, 1932, the executors would be entitled at
their choice to the interest calculated from the date of death till the date of payment on
the final amount due to the dead partner at percent per annum.
(a) 7. (b) 4.
(c) 6. (d) 12.
5. A, B and C are the partners sharing profits and losses in the ratio 2:1:1. Firm has a joint
life policy of Rs. 1,20,000 and in the balance sheet it is appearing at the surrender value
i.e. Rs. 20,000. On the death of A, how this JLP will be shared among the partners.
(a) Rs. 50,000: Rs. 25,000: Rs. 25,000. (b) Rs. 60,000: Rs. 30,000: Rs. 30,000.
(c) Rs. 40,000: Rs. 35,000: Rs. 25,000. (d) Whole of Rs. 1,20,000 will be paid to A.
6. R, J and D are the partners sharing profits in the ratio 7:5:4. D died on 30th June 2006. It
was decided to value the goodwill on the basis of three years purchase of last five years
average profits. If the profits are Rs. 29,600; Rs. 28,700; Rs. 28,900; Rs. 24,000 and Rs.
26,800. What will be Ds share of goodwill?
(a) Rs. 20,700. (b) Rs. 27,600.
(c) Rs. 82,800. (d) Rs. 27,000.
7. R, J and D are the partners sharing profits in the ratio 7:5:4. D died on 30th June 2006 and
profits for the accounting year 2005-2006 were Rs. 24,000. How much share in profits for
the period 1st April 2006 to 30th June 2006 will be credited to Ds Account.
(a) Rs. 6,000. (b) Rs. 1,500.
(c) Nil. (d) Rs. 2,000.
8. If three partners A, B & C are sharing profits as 5:3:2, then on the death of a partner A,
how much B & C will pay to As executer on account of goodwill. Goodwill is to be
calculated on the basis of 2 years purchase of last 3 years average profits. Profits for last
three years are: Rs. 3,29,000; Rs. 3,46,000 and Rs. 4,05,000.
(a) Rs. 2,16,000 & Rs. 1,42,000. (b) Rs. 2,44,000 & Rs. 2,16,000.
(c) Rs. 3,60,000 & Rs. 3,60,000. (d) Rs. 2,16,000 & Rs. 1,44,000.
Answers:

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1.( c ) 2.( d ) 3.( d ) 4.( c ) 5.( a ) 6.( a ) 7.( b ) 8.( d )
CHAPTER-6
Unit-6

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DISSOLUTION OF PARTNERSHIP FIRM

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FOR YOUR WORKINGS
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FOR YOUR WORKINGS
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FOR YOUR WORKINGS
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FOR YOUR WORKINGS
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NOTES
CHAPTER-7 COMPANY
ACCOUNTS
(Under Companies Act, 2013)

.
Unit-1 INTRODUCTION TO
COMPANY ACCOUNTS
MEANING OF COMPANY
The word company is derived from the Latin word com i.e. with or together and panis i.e. bread.
Originally the word referred to an association of persons or merchant men discussing matters and
taking food together.
In law company is termed as company which is formed and registered under The Companies
Act, 2013, or an existing company formed and registered under any of the previous laws.
There must be group of persons who agree to form a company under the law and once so formed,
it becomes a separate legal entity having perpetual succession with a distinct name of its own and
a common seal.

.
Its existence is not affected by the change of members.
It is an association of persons created by law as a separate body for a special purpose.
FEATURES OF A COMPANY
1. Incorporated Association: A company comes into existence through the operation of law.
Therefore, incorporation of company under The Companies Act is must. Without such registration,
no company can come into existence. Being created by law, it is regarded as an artificial legal
person.
2. Separate Legal Entity: A company has a separate legal entity and is not affected by changes
in its membership. Therefore, being a separate business entity, a company can contract, sue and
be sued in its incorporated name and capacity.
3. Perpetual Existence : Since company has existence independent of its members, it continues
to be in existence despite the death, insolvency or change of members.
4. Common Seal: Company is not a natural person, therefore, it cannot sign the documents in the
manner as a natural person would do. In order to enable the company to sign its documents, it is
provided with a legal tool called Common Seal. The common seal is affixed on all documents by
the person authorised to do so who in turn puts his signature for and on behalf of the company.
5. Limited Liability: The liability of every shareholder of a company is limited to the amount he
has agreed to pay to the company on the shares allotted to him. If such shares are fully paidup, he
is subject to no further liability.
6. Distinction between Ownership and Management: Since the number of
shareholders is very large and may be distributed at different geographical locations, it becomes
difficult for them to carry on the operational management of the company on a dayto-day basis.
This gives rise to the need of separation of the management and ownership.
7. Not a citizen: A company is not a citizen in the same sense as a natural person is, though it is
created by the process of law. It has a legal existence but does not enjoy the citizenship rights and
duties as are enjoyed by the natural citizens.
8. Transferability of Shares: The capital is contributed by the shareholders through the
subscription of shares. Such shares are transferable by its members except in case of a private
limited company, which may have certain restrictions on such transferability.
9. Maintenance of Books: A limited company is required by law to keep a prescribed set of
account books and any failure in this regard attracts penalties.
10. Periodic Audit: A company has to get its accounts periodically audited through the chartered
accountants appointed for the purpose by the shareholders on the recommendation of board of
directors.
11. Right of Access to Information: The right of the shareholders of a company to inspect its
books of account, with the exception of books open for inspection under the Statute, is governed

.
by the Articles of Association. The shareholders have a right to seek information from the directors
by participating in the meetings of the company and through the periodic reports.
TYPES OF COMPANIES
1. GOVERNMENT COMPANY - According to Section 2(45) of the Companies Act, 2013. a

Government company means any company in which not less than 51% of the paid-up share capital
is held by the Central Government, or by any State Government or Governments, or partly by the
Central Government and partly by one or more State Governments and includes a company which
is a subsidiary of a government Company.
2. FOREIGN COMPANY - Section 2(42) of the Companies Act, 2013, A foreign company means
any company or body corporate incorporated outside India-
a) has a place of business in India whether by itself or through an agent physically or through
electronic mode, and
b) conducts any business activity in India in any other manner.
3. PRIVATE COMPANY - According to Section 2(68) of Companies Act, 2013, a private company
means a company which has a minimum paid-up share capital of one lakh rupees or such higher
paid-up capital as may be prescribed, and by its articles:
(i) Restricts the rights of members to transfer its shares.

(ii) except in case of One Person Company, limits the number of its members to 200
Provided that where two or more persons hold one or more shares in a company jointly, they shall,
for the purpose of this sub-clause, be treated as a single member:
Provided further that-

(A) persons who are in employment of the company; and
(B) persons who, having been formerly in the employment of the company, were members of
the company while in that employment and have continued to be members after the employment
ceased, shall not be included in the number of members, and
(iii) Prohibits any invitation to the public to subscribe for any securities of the company.
Shares of a Private Company are not listed on any Stock Exchange.

Private companies do not involve participation of public in general.
A public company may be a listed company or an unlisted company.
4. PUBLIC COMPANY - According to Section 2(71) of the Companies Act, 2013, public company
means a company which (a) is not a private company; (b) has a minimum paid-up share capital of
Rs.5 lakhs or such higher paid-up capital, as may be prescribed; Provided that a company which is
a subsidiary of a company, not being a private company, shall be deemed to be public company for

.
the purposes of this Act even where such subsidiary company continues to be a private company
in its articles.
5. ONE PERSON COMPANY - Under Section 2(62) of the Companies Act, 2013, defines as a
company which has only one person as a member.
6. SMALL COMPANY - Under Section 2(85) of the Companies Act, 2013, Small Company means
a company, other than a public company,-
(i) Paid-up share capital of which does not exceed 50 Lakhs or such higher amount as may be
prescribed which shall not be more than 5 crore rupees, or
(ii) Turnover of which as per its last profit and loss account does not exceed 2 crore rupees or
such higher amount as may be prescribed which shall not be more than 20 crore rupees.
7. LISTED COMPANY & UNLISTED COMPANY - Under Section 2(52) of the Companies
Act, 2013, Listed Company means a company which has any of its securities listed on any
recognised stock exchange.
The company whose shares are not listed on any recognised stock exchange, is called Unlisted
Company.
8. UNLIMITED COMPANY - Under Section 2(92) of the Companies Act, 2013, Unlimited
Company means a company not having any limit on the liability of its members.
9. COMPANY LIMITED BY SHARES - Under Section 2(22) of the Companies Act, 2013,
Company Limited by Shares means a company having the liability of its members limited by the
memorandum to the amount, if any, unpaid on the shares respectively held by them.
10. COMPANY LIMITED BY GUARANTEE - Under Section 2(21) of the Companies Act, 2013,
Company Limited by Shares means a company having the liability of its members limited by
the memorandum to such amount, as the members may respectively undertake to contribute to
the assets of the company in the event of its being wound up.
11. HOLDING COMPANY - Under Section 2(46) of The Companies Act, 2013, Holding
Company, in relation to one or more other companies, means a company of which such companies
are subsidiary companies.
12. SUBSIDIARY COMPANY - Under Section 2(87) of The Companies Act, 2013, Subsidiary
Company, as a company in which the holding company:
(i) Controls the composition of its board of directors, or

(ii) Exercises or Controls more than one-half of the total share capital either at its own or together
with one or more of its subsidiary companies:

.
A Company shall be deemed to be a subsidiary company of the holding company even if there is
indirect control through the subsidiary company(ies). The control over the composition of a
subsidiary companys Board of Directors means exercise of some power to appoint or remove all
or majority of the directors of the subsidiary company.
MAINTENANCE OF BOOKS OF ACCOUNT

Section 128 of the Companies Act, 2013 requires that: Every Company shall prepare and keep at its
registered office books of account and other relevant books and papers and financial statement for every
financial year which gives a true and fair view of the state of affairs of the company, including that of its
branch office(s) and to explain the transactions effected both at the registered office and its branches and
such books on accrual basis and according to the double-entry system of book-keeping.
Provided further that the company may keep such books of account or relevant papers in electronic mode
in such manner as may be prescribed.
PREPARATION OF FINANCIAL STATEMENTS

Under Section 129 of the Companies Act, 2013, The financial statements shall give a true and fair view of
the state of affairs of the company(s), comply with the notified AS and shall be in the forms as may be
provided for different class or classes of companies, as prescribed in Schedule III. The Board of Directors
of the company shall lay financial statements at every annual general meeting of a company.
Financial Statements as per Sec. 2(40) of the Companies Act, 2013, include:
(i) a balance sheet as at the end of the financial year;
(ii) a profit and loss account, or in the case of a company carrying on any activity not for profit, an
income and expenditure account for the financial year;
(iii) cash flow statement for the financial year;
(iv) a statement of changes in equity, if applicable; and
(v) any explanatory note annexed to, or forming part of, any document referred to in above.
Provided that the financial statement, with respect to One Person Company, Small Company and Dormant
Company, may not include the Cash Flow Statement.
Requisite of Financial Statements It shall give a true and fair view of the state of affairs of the company
as at the end of the financial year.
Provisions applicable -
(1) Specific Act is applicable, For instance only
(a) insurance company or
(b) banking company or
(c) any company engaged in generation and supply of electricity (see note) or
(d) any other class of company for which a form of Balance Sheet or Profit and Loss Account has
been prescribed under the Act governing such class of company.
(2) In case of all other companies Balance Sheet as per form set out in Part I of Schedule III and
Statement of Profit or Loss as per Part II of Schedule III.

.
Note:- The Electricity Act, 2003 does not specify any format for presentation of Financial Statements.
Therefore, Schedule III of the Companies Act, 2013 is followed by Electricity Companies in preparation of
their financial statements.
Compliance with AS As per Section 129 of the Companies Act, 2013, it is mandatory to comply with
accounting standards notified by the Central Government from time to time.
Schedule III of the Companies Act, 2013 As per Section 129 of the Companies Act, 2013, Financial
Statements shall give a true and fair view of the state of affairs of the company(s) and comply with the AS
notified under Section 133 and shall be in the form(s) as may be provided for different class or classes of
companies in Schedule III under the Act.
PART-I Format of BALANCE SHEET
Name of the Company Balance Sheet as at 31 March, 2014
Particulars Note As at 31 As at 31
No. March, 2014 March, 2013
Rs. Rs.
A EQUITY AND LIABILITIES

.
1 Shareholders funds
(a) Share capital
(b) Reserves and surplus
(c) Money received against share warrants
2 Share application money pending allotment
3 Non-current liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (net)
(c) Other long-term liabilities
(d) Long-term provisions
4 Current liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions TOTAL
B ASSETS
Non-current assets
1 (a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under
development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets
2 Current assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
TOTAL
PART-II Format of STATEMENT OF PROFIT AND LOSS

.
Name of the Company Profit and Loss Statement for the year ended 31 March,
2014
Particulars Note For the year For the year

No. ended ended
31st March, 31st March,
2014 2013
Rs. Rs.
I. Revenue from operations (gross)
II. Other income
III. Total Revenue (I+II)
IV. Expenses:
(a) Cost of materials consumed
(b) Purchases of stock-in-trade (c)
Changes in inventories of finished goods,
work-in-progress and stock-in-trade
(d) Employee benefits expense
(e) Finance costs
(f) Depreciation and amortisation expense
(g) Other expenses
Total expenses
V. Profit / (Loss) before exceptional and

extraordinary items and tax (III - IV)
VI. Exceptional items

VII. Profit / (Loss) before extraordinary items
and tax (V - VI)
VIII. Extraordinary items
IX. Profit / (Loss) before tax (VII - VIII)
X. Tax expense:
(1) Current tax
(2) Deferred tax
XI. Profit / (Loss) from continuing operations

(VII - VIII)
XII. Profit /(Loss) from discontinuing operations
XIII. Tax expense of discontinuing operations
XIV. Profit /(Loss) from discontinuing operations
(after tax) (XII - XIII)
XV. Profit / (Loss) for the period (XI + XIV)

.
XVI. Earnings per equity share:

(1) Basic
(2) Diluted
1. Which of the following statement is not a feature of a Company?

(a) Separate legal entity (b) Common Seal
(c) Perpetual Succession (d) Members have unlimited liability
2. In a Government Company, the holding of the Central Government in paid-up capital should
not be less than
(a) 25% (b) 50 %
(c) 51% (d) 75%
3. Which of the following statement is true in case of a Foreign Company?

(a) A Company incorporated in India and has place of business outside India (b) A
Company incorporated outside India and has a place of business in India.
(c) A Company incorporated in India and has a place of business in India
(d) A Company incorporated outside India and also has a place of business outside India
4. Public Companies should have a minimum paid-up capital of

(a) Rs. 5 lakhs (b) Rs. 10 lakhs
(c) Rs. 15 lakhs (d) Rs. 50 lakhs
5. Private Company shuld have a minimum paid-up capital of

(a) Rs. 1 lakhs (b) Rs. 5 lakhs
(c) Rs. 10 lakhs (d) Rs. 50 lakhs
6. Which of the following statements is not a feature of a private company?

(a) Restricts the rights of members to transfer its shares
(b) Prohibits any invitation to the public to subscribe its shares or debentures
(c) Do not involve participation of public in general
(d) Do not restricts on the number of its members to any limit
Answers:
1.( d ) 2.( c ) 3.( b ) 4.( a ) 5.( a ) 6.( d )

.
NOTES
CHAPTER-7
COMPANY ACCOUNTS
.
Unit-2
ISSUE, FORFEITURE AND REISSUE
OF SHARES
SHARE CAPITAL
1. Total capital of the company is divided into a number of small indivisible units of a fixed amount
and each such unit is called a share.
2. The fixed value of a share, printed on the share certificate, is called nominal/par/face value of a
share. However, a company can issue shares at a price different from the face value of a share. The
liability of holder of shares (called shareholders) is limited to the issue price of shares acquired by
them.

.
As per SEBI guidelines, a company is free to price its issue, if it has a three years track record of consistent
profitability and in case of new company, if it is promoted by a company with a five years track record of
consistent profitability. As the total capital of the company is divided into shares, the capital of the company
is called Share Capital.
CHART OF SHARE CAPITAL
Reserve Share Capital As per Section 65 of the Companies Act, 2013, an unlimited Company on conversion
into a limited Company may decide by passing a special resolution that a certain portion of its subscribed
uncalled capital shall not be called up except in the event of winding up of the company. Portion of the
uncalled capital which a company has decided to call only in case of liquidation of the company is called
Reserve Capital.
Reserve Capital is different from Capital reserve, Capital reserves are part of Reserves and Surplus and
refer to those reserves which are not available for declaration of dividend. These reserves may be used to

.
write off capital losses such as discount on issue of shares. These can also be used to issue bonus shares, subject
of the condition, that reserve is realized in cash.
Thus, reserve capital which is portion of the uncalled capital to be called up in the event of winding up of the
company is entirely different in nature from capital reserve which is created out of profits only.
TYPES OF SHARES
Section 43, 55 of Companies Act, 2013
ISSUE OF SHARES FOR CASH
To issue shares, private companies depend upon Private Placement of shares.

Public companies issue a Prospectus and invite general public to subscribe for shares.
A public company issues a prospectus inviting general public to subscribe for its shares. On the basis
of prospectus, applications are deposited in a scheduled bank by the interested parties alongwith
the amount payable at the time of application, in cash.

.
First installment paid alongwith application is called Application Money.

As per Section 39 of the Companies Act, 2013, Application money must be atleast 5% of the nominal
value of shares. After the closing date of the issue (the last date for filing applications), company
decides about allotment of shares in consultation with the SEBI and stock exchange concerned.
According to the Companies Act, 2013, a company cannot proceed to allot shares unless minimum
subscription is received by the company.
Minimum Subscription : A public limited company cannot make any allotment of shares unless the
amount of minimum subscription stated in the prospectus has been subscribed and the sum payable as
application money for such shares has been paid to and received by the company. The amount of
minimum subscription to be disclosed in prospectus by the Board of Directors taking into account the
following:
(a) Preliminary expenses of the company,

(b) Commission payable on issue of shares,
(c) Cost of fixed assets purchased or to be purchased,
(d) Working capital requirements of the company, and
(e) Any other expenditure for the day to day operation of the business.
As per guidelines of the Securities Exchange Board of India (SEBI), a company must receive a
minimum of 90% subscription against the entire issue (including devolvement on underwriters
in case of underwritten issue) before making any allotment of shares or debentures to the public.
It is applicable for public and right issue, and not in case of offer for sale of securities. If the Company
does not receive the minimum subscription of 90% of the issue, the entire subscription shall be
refunded to the applicants within 15 days after the date of closure of issue in case of non-
underwritten issue and 7 days after the date of closure of issue in case of underwritten.
The company reserves the right to reject or accept an application fully or partially. Successful
applicants become shareholders of the company and are required to pay the second instalment
which is known as Allotment Money and unsuccessful applicants get back their money.
However, in case of delay in refunding the money, the Company becomes liable to pay interest
on the amount of refund. Subsequent instalments, if any, to be called by the companies are known
as Calls.
As per Section 39 of the Companies Act, 2013, application money must be atleast 5% of the face
value of shares.
The minimum application moneys to be paid by an applicant alongwith the application money
shall not be less than 25% of the issue price.
According to Section 24 of the Companies Act, 2013 matters related to the issue and transfer of
securities will be administered by the SEBI and not by the Company Law Board.
The issue price of shares is generally received by the company in instalments and these instalments are
known as under:
First instalment .. Application Money

Second Instalment .. Allotment Money
Third Instalment .. First Call Money

.
Fourth Instalment .. Second Call Money and So on

Last Instalment .. Final Call Money
JOURNAL ENTRIES FOR ISSUE OF SHARES FOR CASH

Upon the issue of share capital by a company, the undermentioned entries are made in the financial books:
(1) On receipt of the application money

Bank Account Dr. (With the actual amount received.)
To Shares Application Account
(2) On allotment of share
Share Allotment Account Dr. (With the amount due on allotment.)
Share Application Account Dr. (With the application recd. on allotted shares.)
To Share Capital Account (With the amount due on allotment and application.)
(3) On receipt of allotment money
Bank Account Dr. (With the amount actually received on allotment.)
To Share Allotment Account
Sometimes separate Application and Allotment Accounts are not prepared and entries relating to
application and allotment monies are passed through a combined Application and Allotment Account.
(4) On a call being made

Share Call Account Dr. (With the amount due on the call.)
To Share Capital Account
(5) On receipt of call money
Bank Account Dr. (with the due amount actually received on call)
To Share Call Account
SUBSCRIPTION OF SHARES
Accounting for issue of shares depends upon the type of subscription. Whenever a company decides to
issue shares to public, it invites applications for subscription by issuing a prospectus.
It is not necessary that company receives applications for the number of shares to be issued by it.
There are three possibilities:
1. FULL SUBSCRIPTION
Issue is fully subscribed if the number of shares offered for subscription and the number of shares actually
subscribed by the public are same. To start discussion on accounting treatment for issue of shares, let us
assume that the issue is fully subscribed.
Illustration
A company invited applications for 10,000 equity shares of Rs. 50 each payable on application Rs. 15, on
Allotment Rs. 20, on first and final call Rs. 15. Applications are received for 10,000 shares and all the
applicants are allotted the number of shares they have applied for and installment money was duly
received by the company. Show Journal entries in the books of the company.

.
Solution:
2. UNDERSUBSCRIPTION
It means the number of shares offered for subscription is more than the number of shares subscribed by
the public. In this case, the journal entries as discussed above are passed but with one change i.e.,
calculation of application, allotment and for that matter, the call money is based on number of shares
actually applied and allotted. It must be remembered that shares can be allotted, in this case, only when
the minimum subscription is received.
Illustration
On 1st April, 2005, A Ltd. issued 43,000 shares of Rs. 100 each payable as follows:
Rs. 20 on application;
Rs. 30 on allotment;

.
Rs. 25 on 1st October, 2005; and Rs.

25 on 1st February, 2006.
By 20th May, 40,000 shares were applied for and all applications were accepted. Allotment was made on
1st June. All sums due on allotment were received on 15th July; those on 1st call were received on 20th
October. Journalise the transactions when accounts were closed on 31st March, 2006.
Solution:
3. OVER SUBSCRIPTION
In actual practice, issue of shares is either under or over subscribed. If an issue is over-subscribed, some
applications may be rejected and application money refunded and in respect of others, only a part of the
shares applied for may be allotted and the excess amount received can be utilised towards allotment or
call money which has fallen or will soon fall due for payment.
The entries are:

(1) On refund of application money to applicants to whom shares have not been allotted :
Share Application A/c Dr.
To Bank Account

.
(2) When only a part of shares applied for are allowed:

Share Application A/c Dr. (With the amount received in advance for allotment) To Share Allotment
A/c
To Share Calls-in-Advance Account
CHART OF FUND RAISING THROUGH EQUITY
SHARES ISSUED AT DISCOUNT

Section 53 of the Companies Act, 2013
The shares of a company can be issued at a discount, if issue is at an amount less than the nominal or par
value of shares. The excess of the nominal value over the issue price represents discount on the issue of
shares. For example, when a share of the nominal value of Rs. 100 is issued at Rs. 98, it is said to have been
issued at a discount of 2 per cent.

.
According to Section 53 of the Companies Act, 2013, a Company cannot issue shares at a discount except
in the case of issue of sweat equity shares (issued to employees and directors). Thus, any issue of shares
at discount shall be void.
SHARES ISSUED AT PREMIUM

Section 52 of the Companies Act, 2013
When a company issues its securities at a price more than the face value, it is said to be an issue at a
premium. Premium is the excess of issue price over face value of the security. It is quite common for the
financially strong, and well-managed companies to issue their shares at a premium, i.e. at an amount more
than the nominal or par value of shares. Thus, where a share of the nominal value of Rs.
100 is issued at Rs. 105, it is said to have been issued at a premium of 5 per cent.
When the issue is at a premium, the amount of premium may technically be called at any stage of share
capital transactions. However, premium is generally called with the amount due on allotment, sometimes
with the application of money and rarely with the call money.
ACCOUNTING TREATMENT
When shares are issued at a premium, the premium amount is credited to a separate account called
Securities Premium Account because it is not a part of share capital. Rather, it represents a gain of a
capital nature to the company.
Being a credit balance, Securities premium Account is shown under the heading, Reserves and Surplus.
However, Reserves and Surplus is shown as Shareholders Funds in the Balance Sheet as per Schedule
III. According to Section 52 of The Companies Act, 2013, Securities Premium Account may be used by the
company:
(a) Towards issue of un-issued securities of the company to be issued to members of the company as
fully paid bonus securities.
(b) To write off preliminary expenses of the company.
(c) To write off the expenses of, or commission paid, or discount allowed on any of the securities
or debentures of the company.
(d) To pay premium on the redemption of redeemable preference shares or debentures of the
company.
(e) For the purchase of own shares or other securities.
Note:- The certain class of companies whose financial statements comply with the accounting standards
as prescribed under Section 133 of the Companies Act, 2013, cant apply the securities premium account
for the purposes (b) and (d) mentioned above.
When shares are issued at a premium, the journal entries are as follows:
Share Application A/c/ Allotment A/c Dr.

To Share Capital A/c
To Securities Premium A/c

.
OVERSUBSCRIPTION AND PRO-RATA ALLOTMENT
1. Over subscription is the application money received for more than the number of shares offered
to the public by a company.
2. It usually occurs in the case of good issues and depends on many other factors like investors
confidence in the company, general economic conditions, pricing of the issue etc. When the shares
are oversubscribed, the company cannot satisfy all the applicants.
3. It means that a decision is to be made on how the shares are going to be allotted. Shares can be
allotted to the applicants by a company in any manner it thinks proper. The company may reject
some applicants in full, i.e., no shares are allotted to some applicants and application money is
refunded. Usually, multiple applications by the same persons are not considered.
4. Allotment may be given to the rest of the applicants in full, i.e., for the number of shares they have
applied for. A third alternative is that a company may allot shares to the applicants on pro-rata
basis. Pro-rata allotment means allotment in proportion of shares applied for.
For example, a company offers to the public 10,000 shares for subscription. The company receives
applications for 12,000 shares. If the shares are to be allotted on pro-rata basis, applicants for 12,000
shares are to be allotted 10,000 shares, i.e., on the 12,000 : 10,000 or 6:5 ratio. Any applicant who has
applied for 6 shares will be allotted 5 shares.
Under pro-rata allotment, the excess application money received is adjusted against the amount due on
allotment or calls. Surplus money after making adjustment against future calls is returned to the
applicants. The applicants are informed about the allotment procedure through an advertisement in
leading newspapers.
There is no separate journal entry for forfeiture of shares when there is a pro-rata allotment. But it
requires calculating the net amount due on allotment or any other call, and also the total amount forfeited.
When there is a pro-rata allotment, the total application money paid by an applicant is more than the exact
amount due on application. The excess amount is treated as an advance against allotment or any other
future calls. The net amount due on allotment or any other calls is the difference between the amount due
on allotment or any other calls and the excess amount received in application.
Accounting Entries
(a) For rejected application:
Share Application Account Dr.
To Bank Account
(b) For pro-rata allotment
Share Application Account Dr.
To Share Allotment Account

.
(Being excess application money adjusted against allotment money as per Boards Resolution
No.dated.)
Illustration
JHP Limited is a company with an authorised share capital of Rs. 10,00,000 in equity shares of Rs. 10 each,
of which 6,00,000 shares had been issued and fully paid on 30th June, 2005. The company proposed to
make a further issue of 1,00,000 of these Rs. 10 shares at a price of Rs.14 each, the arrangements for
payment being:
(a) Rs. 2 per share payable on application, to be received by 1st July, 2005;
(b) Allotment to be made on 10th July, 2005 and a further Rs. 5 per share (including the premium) to
be payable;
(c) The final call for the balance to be made, and the money received by 30th April, 2006.
Applications were received for 3,55,000 shares and were dealt with as follows:
(i) Applicants for 5,000 shares received allotment in full;
(ii) Applicants for 30,000 shares received an allotment of one share for every two applied for; no
money was returned to these applicants, the surplus on application being used to reduce the amount due
on allotment;
(iii) Applicants for 3,20,000 shares received an allotment of one share for every four applied for; the
money due on allotment was retained by the company, the excess being returned to the applicants; and
(iv) the money due on final call was received on the due date.
You are required to record these transactions (including cash items) in the Journal of JHP Limited.
Solution:-

.
CALLS-IN-ARREARS
Sometimes shareholders fail to pay the amount due on allotment or calls. The total unpaid amount on one
or more instalments is known as Calls-in-Arrears or Unpaid Calls. Such amount represents the uncollected
amount of capital from the shareholders; hence, it is shown by way of deduction from called-up capital
to arrive at paid-up value of the share capital to be shown in the balance sheet.
For recording Calls-in-Arrears, the following journal entry is recorded :
Calls-in-Arrears A/c Dr. To

Share Allotment A/c Dr. To Share
Calls A/c

.
The Articles of Association of a company usually empower the directors to charge interest at a stipulated
rate on calls-in-arrears. According to Table A interest at the rate of 5 per cent per annum is to be charged
on unpaid calls for the period intervening between the due date of the call and the time of actual payment.
However, the directors have the authority to waive the application of this rule in individual cases at their
discretion or charge at a higher rate of interest.
The journal entries for calls-in-arrears are as follows :
(i) For interest receivable on calls-in-arrears
Shareholders A/c Dr.

To Interest on calls-in-arrears A/c
(ii) For receipt of interest

Bank A/c Dr.
To Shareholders A/c
CALLS-IN-ADVANCE
Some shareholders may sometimes pay a part, or whole, of the amount not yet called up, such amount is
known as Calls-in-advance. According to Table A, interest at the rate of 6 per cent is to be paid on such
advance call money. This amount is credited in Calls-in-Advance Account.
The following entry is recorded:
Bank A/c Dr.

To Call-in-Advance A/c
When calls become actually due, calls-in-advance account is adjusted at the time of the call. For
this the following journal entry is recorded:

.
Calls-in-Advance A/c Dr. [Call amount due]

To Particular Call A/c
The balance in Calls-in-Advance account is shown as a separate item on the liabilities side of the
companys balance sheet under the heading Share Capital but is not added to the amount of paid-up
capital.
The accounting treatment of interest on Calls-in-Advance is as follows:

(i) Interest Due
Interest on Calls-in-Advance A/c Dr. To

Shareholders A/c
(ii) Payment of Interest
Shareholders A/c Dr.

To Bank A/c
(Interest paid on calls-in-advance)
Interest on calls in arrear is recoverable and that in respect of calls in advance is payable, according to
provisions in this regard in the articles of the company, at the rates mentioned therein or those to be fixed by
the directors, within the limits prescribed by the Articles. Table A prescribes 5% and 6% p.a. as the maximum
rates respectively for calls in arrears and those in advance.
Directors, however, have the right to waive the payment of interest on calls in arrear. Calls received in
advance are not entitled to any dividend. The book entries to be passed for the adjustment of such interest
are much the same as those in case of temporary borrowings or loans raised, the only difference being that
debits are raised and credits are given to Sundry Members Account (and not the individual accounts of
shareholders) in respect of interest recoverable on calls in arrear or that payable on call received in advance,
the corresponding entries being made in the Interest Receivable on Calls in Arrears and Interest Payable on
Calls in Advance, respectively.
FORFEITURE OF SHARES WHICH WERE ISSUED AT PAR
In this case, Share Capital Account will be debited with the called-up value of shares forfeited.
Allotment or Calls Account will be credited with the amount due but not paid by the shareholder(s).
(Alternatively, Calls-in-Arrears Account can be credited for all amount due, if it was transferred to Calls-
in-Arrears Account). Forfeited Shares Account or Shares Forfeiture Account will be credited with the
amount already received in respect of those shares.
Share Capital Account Dr. [No. of shares x called-up value per share]
To Forfeited Shares Account [Amount already received on forfeited shares]

.
To Share Allotment Account [If amount due, but not paid] To Share
First Call Account [If amount due, but not paid] To Share Final Call
Account [If amount due, but not paid]
Where all amounts due on allotment, first call and final call have been transferred to Calls-in- Arrears
Account, the entry will be:
Share Capital Account Dr.

To Calls-in-Arrears Account
To Forfeited Shares Account
Illustration
A Ltd forfeited 300 equity shares of Rs.10 fully called-up, held by Mr. X for non-payment of final call @ Rs.
4 each. However, he paid application money @ Rs. 2 per share and allotment money @ Rs. 4 per share.
These shares were originally issued at par. Give Journal Entry for the forfeiture. Solution:
Illustration
X Ltd forfeited 200 equity shares of Rs. 10 each, Rs. 8 called-up for non-payment of first call money @ Rs.
2 each. Application money @ Rs. 2 per share and allotment money @ Rs. 4 per share have already been
received by the company. Give Journal Entry for the forfeiture (assume that all money due is transferred
to Calls-in-Arrears Account).
Solution:
FORFEITURE OF SHARES WHICH WERE ISSUED AT A DISCOUNT
In this case also Share Capital Account will be debited with the called-up value of shares forfeited,
Allotment or Calls Account will be credited with the amount due but not paid by the shareholder(s).
(Alternatively, Calls-in-Arrears Account can be credited). Forfeited Shares Account will be credited with
the amount already received in respect of those shares.
When shares are issued at a discount, the Discount Account is debited. Therefore, at the time of forfeiture
of such share, Discount Account will be credited to cancel it.
Share Capital Account Dr. [No. of shares x called-up value per share]
To Forfeited Shares Account [Amount already received on forfeited shares]
To Share Allotment Account [If amount due, but not paid] To Share
First Call Account [If amount due, but not paid]
To Share Final Call Account [If amount due, but not paid]

.
To Discount on issue of Shares A/c [No. of Shares X Discount per Share]

(Being the forfeiture of.shares for non-payment of allotment and call(s) money as per Boards
Resolution No..dated.)
Illustration
H.P. Ltd. forfeited 200 equity shares of Rs. 10 each fully called-up for non-payment of final call @ Rs. 2 per
share. These shares were originally issued at a discount of 10%. Application, allotment and first call
money per share @ Rs. 2, Rs. 3 and Rs. 2 respectively were received in time. Give Journal Entry for the
forfeiture.
Solution:
FORFEITURE OF SHARES WHICH WERE ISSUED AT A PREMIUM

In this case, Share Capital Account will be debited with the called-up value of shares forfeited.
If the premium on such shares has not been paid by the shareholder, the Securities Premium Account will
be debited to cancel it (if it was credited earlier). Allotment, Calls and Forfeited Accounts will be credited
in the usual manner.
If the premium has already received by the company, it cannot be cancelled even if the shares are forfeited
in the future
Illustration
X Ltd. forfeited 500 equity shares of Rs.10 each fully called-up which were issued at a premium of
20%. Amount payable on shares were: on application Rs.2; on allotment Rs.5 (including premium) on
First and Final call Rs.5. Only application money was paid by the shareholders in respect of these shares.
Pass Journal Entries for the forfeiture.
Solution:

.
FORFEITURE OF FULLY PAID-UP SHARES

Forfeiture for non-payment of calls, premium, or the unpaid portion of the face value of the shares is one
of the many causes for which a share may be forfeited. But fully paid-up shares may be forfeited for
realization of debts of the shareholder if the Articles specifically provide it.
RE-ISSUE OF FORFEITED SHARES

A forfeited share is merely a share available to the company for sale and remains vested in the company
for that purpose only. Reissue of forfeited shares is not allotment of shares but only a sale. When shares
are re-issued, return of the forfeited shares need not be filed under Section 75(1) of the Companies Act,
1956.
The share, after forfeiture, in the hands of the company is subject to an obligation to dispose it of. In
practice, forfeited shares are disposed off by auction. These shares can be re-issued at any price so long
as the total amount received (from the original allottee and the second purchaser) for those shares is not
less than the amount in arrear on those shares.
Accounting Entries :
(a) Bank Account Dr. [Actual amount received]
Forfeited Shares Account Dr. [Loss on re-issue]
(Being the re-issue of.shares @ Rs. each as per Boards Resolution No. dated.) (b)
Forfeited Shares Account Dr.
To Capital Reserve Account
(Being the profit on re-issue, transferred to capital reserve).
POINTS FOR CONSIDERATION
In connection with re-issue, the following points are important:
1. Loss on re-issue should not exceed the forfeited amount.
2. If the loss on re-issue is less than the amount forfeited, the surplus should be transferred to Capital
Reserve.
3. The forfeited amount on shares not yet reissued should be shown in the Balance Sheet as an
addition to the share capital.
4. When only a portion of the forfeited shares are re-issued, then the profit made on reissue of such
shares must be transferred to Capital Reserve.
5. When the shares are re-issued at a loss, such loss is to be debited to Forfeited Shares Account.
6. If the shares are re-issued at a price which is more than the face value of the shares, the excess
amount will be credited to Securities Premium Account.
7. If the re-issued amount and forfeited amount (taken together) exceeds the face value of the shares
re-issued, it is not necessary to transfer such amount to Securities Premium Account.

.
8. When shares, originally issued at a discount, are reissued at a loss, the loss to the extent of original
discount is debited to Discount on Issue of Shares Account and the balance loss is debited to
Forfeited Shares Account.
CALCULATION OF PROFIT ON RE-ISSUE OF FORFEITED SHARES

Students will appreciate that the credit balance of forfeited shares account cannot be considered a surplus
until the shares forfeited have been re-issued, because the company may, on re-issue, allow the discount
to the new purchaser equivalent to the amount held in credit in this regard in the forfeited shares Account.
Suppose 120 shares of a nominal value of Rs. 10 have been forfeited upon which Rs. 5 per share was paid
up and transferred to Forfeited Share Account.
Afterwards, 50 shares are re-issued, Rs. 6 per share being collected to make them fully paid up; Rs. 200
out of shares forfeited will be credited to Share Capital Account to make up the deficiency on reissued
shares, and Rs. 50 will be transferred to the Capital Reserve Account being the surplus on reissue of the
50 shares. It would have in the Forfeited shares Account balance equivalent to the amount collected on
the remaining 70 forfeited shares which will be carried forward till these are re-issued.
In the above case, it has been assumed that the amount paid up on all the 120 forfeited shares was Rs. 5
per share. But in practice, shares may be forfeited on which varying amounts are out-standing. For
instance, if in the above case 70 shares were forfeited with Rs. 5 paid up thereon and 50 shares with Rs.
7.50 was paid up thereon, the credit in the forfeited Shares Account would be Rs. 725. The amount to be
credited to Capital Reserve will depend on the lot of shares re-issued; it will be Rs. 175 if the shares are
those on which Rs. 7.50 was originally paid.
Illustration
X Ltd. reissued 200 equity shares of Rs. 10 each @ Rs. 7 per share. These shares were issued originally at
a discount of 10%. Give Journal Entries for re-issue only.
Solution:

.
Illustration
Mr. Long who was the holder of 200 preference shares of Rs. 100 each, on which Rs. 75 per share has been
called up could not pay his dues on Allotment and First call each at Rs. 25 per share. The Directors forfeited
the above shares and reissued 150 of such shares to Mr. Short at Rs. 65 per share paid-up as Rs.75 per
share.
Give Journal Entries to record the above forfeiture and re-issue in the books of the company.
Solution:
ISSUE OF SHARES FOR CONSIDERATION OTHER THAN CASH
Public limited companies, generally, issue their shares for cash and use such cash to buy the various types
of assets needed in the business. Sometimes, however, a company may issue shares in a direct exchange
for land, buildings or other assets. Shares may also be issued in payment for services rendered by
promoters, lawyers in the formation of the company. In the Balance Sheet, these shares should be shown
separately.
Within one month of allotment, the company must produce before the Registrar a written contract of sale
of service in respect of which shares have been allotted.

.
Accounting Entries (a) When assets are purchased in exchange of shares

Assets Account Dr.
(b) When shares are issued to promoters

Goodwill Account Dr.
Illustration
X Co. Ltd. was incorporated with an authorized share capital of 1,00,000 equity shares of Rs. 10 each. The
directors decided to allot 10,000 shares credited as fully paid to the promoters for their services.
The company also purchased land and buildings from Y Co. Ltd for Rs. 4,00,000 payable in fully paidup
shares of the company. The balance of the shares were issued to the public, which were fully subscribed
and paid for.
You are required to pass Journal Entries and to prepare the Balance Sheet.
1. The excess price received over the par value of shares, should be credited to __________.
(a) Calls-in-advance account (b) Share capital account
(c) Reserve capital account (d) Securities premium account
2. Which of the following statements is false?

(a) The forfeited shares should not be issued at a premium
(b) At the time of forfeiture of shares, securities premium should not be debited with the
amount of premium already received

.
(c) Shares can be issued at a discount only after one year from the commencement of
business
(d) Securities premium account cannot be utilized to redeem preference shares
3. When shares are issued to promoters for the services offered by them, the account that will
be debited with the nominal value of shares is ____________.
(a) Preliminary expenses account (b) Goodwill account
(c) Asset account (d) Share capital account
4. The Securities Premium amount may be utilized by a company for - (a) Writing off any
loss on sale of fixed asset
(b) Writing off any loss of revenue nature
(c) Payment of dividends
(d) Writing off the expenses/discount on the issue of debentures.
Use the following information for questions 5 to 9
B Ltd. was registered with a share capital of Rs 1,00,00,000 divided into equity shares of Rs 10 each. It
issued 9,00,000 equity shares to the general public at par payable as to Rs. 3 on application, Rs. 3 on
allotment and balance in 2 equal calls. The public had subscribed for 8,50,000 shares. Till 31st March,
2006, only first call had been made. All the shareholders had paid up except Mr. C, a holder of 25,000
shares, who did not pay the call money.
5. How much is B Ltd.s authorized share capital?

(a) Rs. 1,00,00,000 (b) Rs. 90,00,000 (c) Rs. 85,00,000 (d) Rs. 68,00,000
6. How much is B Ltd.s issued capital?

(a) Rs. 1,00,00,000 (b) Rs. 90,00,000 (c) Rs. 85,00,000 (d) Rs. 68,00,000
7. How much is B Ltd.s subscribed capital?

(a) Rs. 1,00,00,000 (b) Rs. 90,00,000 (c) Rs. 85,00,000 (d) Rs. 68,00,000
8. How much is B Ltd.s called up capital?

(a) Rs. 1,00,00,000 (b) Rs. 90,00,000 (c) Rs. 85,00,000 (d) Rs. 68,00,000
9. How much is B Ltd.s paid up capital?

(a) Rs. 1,00,00,000 (b) Rs. 90,00,000 (c) Rs. 85,00,000 (d) Rs. 67,50,000
Use the following information for questions 10 to 23
D Ltd. issued 2,00,000 shares of Rs.100 each at a premium of Rs.20 per share payable as follows:

.
On application Rs. 20
On allotment Rs. 50 (including premium)
On first call Rs. 30
On second and final call Rs. 20
Applications were received for 3,00,000 shares and pro rata allotment was made to applicants of
2,40,000 shares. Money excess received on application of 2,40,000 shares was employed on account of
sum due on allotment as part of share capital. E, to whom 4,000 shares were allotted, failed to pay the
allotment money and on his subsequent failure to pay the first call, his shares were forfeited and F, the
holder of 6,000 shares failed to pay the two calls and his shares were forfeited after the second call. Of
the forfeited shares, 8,000 shares were reissued to G at a discount of 10%, the whole of Es forfeited
shares being reissued.
10. Amount received on application = ___________.

(a) Rs. 40,00,000 (b) Rs. 60,00,000 (c) Rs. 48,00,000 (d) Rs. 2,40,00,000
11. Application money adjusted against allotment = __________.

(a) Rs. 20,00,000 (b) Rs. 16,00,000 (c) Rs. 12,00,000 (d) Rs. 8,00,000
12. Amount refunded to shareholders = __________.

(a) Rs. 20,00,000 (b) Rs. 16,00,000 (c) Rs. 12,00,000 (d) Rs. 8,00,000
13. Total amount paid by E = _________.

(a) Rs. 80,000 (b) Rs. 1,00,000 (c) Rs. 1,44,000 (d) Rs. 96,000
14. Total amount paid by F = _________.

(a) Rs. 80,000 (b) Rs. 3,00,000 (c) Rs. 4,20,000 (d) Rs. 1,44,000
15. Total amount paid by G = _________.

(a) Rs. 7,20,000 (b) Rs. 8,00,000 (c) Rs. 8,80,000 (d) Rs. 8,64,000
16. Amount transferred to Share forfeiture account at the time of forfeiting Es shares =
(a) Rs. 80,000 (b) Rs. 1,00,000 (c) Rs. 3,00,000 (d) Rs. 96,000
17. Amount transferred to Share forfeiture account at the time of forfeiting Fs shares =
(a) Rs. 80,000 (b) Rs. 3,00,000 (c) Rs. 4,20,000 (d) Rs. 1,44,000
18. Net balance in Share Capital Account = ________.

(a) Rs. 2,00,00,000 (b) Rs. 2,08,00,000 (c) Rs. 2,04,00,000 (d) Rs. 1,98,00,000

.
19. Net balance in Securities Premium Account = ________.

(a) Rs. 39,20,000 (b) Rs. 39,28,000 (c) Rs. 39,36,000 (d) Rs. 39,44,000
20. Net balance in Share Forfeiture Account = ________.

(a) Rs. 1,00,000 (b) Rs. 3,00,000 (c) Rs. 96,000 (d) Rs. 3,96,000
21. Net balance in Capital Reserve Account = ________.

(a) Rs. 2,96,000 (b) Rs. 80,000 (c) Rs. 2,10,000 (d) Rs. 2,16,000
22. Net balance in Bank Account = ________.

(a) Rs. 2,40,00,000 (b) Rs. 2,40,12,000 (c) Rs. 2,40,24,000 (d) Rs. 2,40,36,000
23. Balance Sheet Total = _________.

(a) Rs. 2,40,00,000 (b) Rs. 2,40,12,000 (c) Rs. 2,40,24,000 (d) Rs. 2,40,36,000
24. When shares are forfeited, the share capital account is debited with ________ and the share
forfeiture account is credited with __________.
(a) Paid-up capital of shares forfeited; Called up capital of shares forfeited
(b) Called up capital of shares forfeited; Calls in arrear of shares forfeited
(c) Called up capital of shares forfeited; Amount received on shares forfeited
(d) Calls in arrears of shares forfeited; Amount received on shares forfeited
Use the following information for the questions 25 to 29
B Ltd. issued 80,000 equity shares of Rs.10 each, payable as under:
On allotment Rs. 4
On first call Rs. 2
The applications received for 1,20,000 shares were dealt with as under:
Applicants of 20,000 shares were allotted in full.
Applicants of 80,000 shares were allotted 60,000 shares pro-rata. Applications for
20,000 shares were rejected.
25. Amount received on application is _____________.

(a) Rs. 2,40,000 (b) Rs. 3,60,000 (c) Rs. 5,60,000 (d) Rs. 8,00,000
26. Total excess money received as compared to the number of shares allotted = ?

.
(a) Rs. 3,00,000 (b) Rs. 2,40,000 (c) Rs. 3,60,000 (d) Rs. 1,20,000
27. Amount to be refunded = ?

(a) Rs. Nil (b) Rs. 60,000 (c) Rs. 1,20,000 (d) Rs. 1,80,000
28. Amount of excess application money available for adjustment against allotment money =
29. Amount of excess application money available for adjustment against call money = ?
30. Amount of excess application money available for adjustment against call money = ?
(a) Cumulative preference shares (b) Participating preference shares
(c) Convertible preference shares (d) Callable preference shares

(a) Interest on calls-in-advance is paid from the date of receipt of advance to the date of relevant
call.
(b) Calls-in-advance are not entitled for any dividend.
(c) According to Table A, interest on calls-in-advance is paid at the rate of 6% p.a.
(d) Payment of interest on calls-in-advance is at the discretion of the company.
32. T Ltd. proposed to issue 6,000 equity shares of Rs.100 each at a premium of 40%. The
minimum amount of application money to be collected per share as per the Companies Act,
2013 = ?
(a) Rs. 5 (b) Rs. 6 (c) Rs. 7 (d) Rs. 8.4
33. Dividends are usually paid as a percentage of ______.

(a) Authorized share capital (b) Net profit
(c) Paid-up capital (d) Called-up capital
34. E Ltd. had allotted 10,000 shares to the applicants of 14,000 shares on pro rata basis. The
amount payable on application is Rs.2. F applied for 420 shares. The number of shares
allotted and the amount carried forward for adjustment against allotment money due from F
=?
(a) 60 shares; Rs.120 (b) 340 shares; Rs.160
(c) 320 shares; Rs.200 (d) 300 shares; Rs.240
35. O Ltd. issued 10,000 equity shares of Rs.10 each at a premium of 20% payable Rs.4 on
application (including premium), Rs.5 on allotment and the balance on first and final call. The

.
company received applications for 15,000 shares and allotment was made pro-rata. P, to
whom 3,000 shares were allotted, failed to pay the amount due on allotment. All his shares
were forfeited after the call was made. The forfeited shares were reissued to Q at par.
Assuming that no other bank transactions took place, the bank balance of the company after
effecting the above transactions = ?
(a) Rs. 1,14,000 (b) Rs. 1,32,000 (c) Rs. 1,20,000 (d) Rs. 1,00,000
36. A company forfeited 2,000 shares of Rs.10 each (which were issued at par) held by Mr. John
for non-payment of allotment money of Rs.4 per share. The called-up value per share was
Rs.9. On forfeiture, the amount debited to share capital = ?
(a) Rs. 10,000 (b) Rs. 8,000 (c) Rs. 2,000 (d) Rs. 18,000
37 If forfeited shares (which were originally issued at a discount) are reissued at a premium, the
amount of such premium will be credited to ________.
(a) Share forfeiture account (b) Securities premium account
(c) Capital reserve account (d) Discount on issue of shares account
38. The maximum capital beyond which a company is not allowed to raise funds, by issue of shares
is its _____.
(a) Issued share capital (b) Reserve share capital
(c) Authorised share capital (d) Subscribed share capital
39 As per the SEBI guidelines, on issue of shares, the application money should not be less than
(a) 2.5% of the nominal value of shares (b) 2.5% of the issue price of shares
(c) 25.0% of the nominal value of shares (d) 25.0% of the issue price of share
40. G Ltd. acquired assets worth Rs.7,50,000 from H Ltd. by issue of shares of Rs.100 at a
premium of 25%. The number of shares to be issued by G Ltd. to settle the purchase
consideration = ?
(a) 6,000 shares (b) 7,500 shares (c) 9,375 shares (d) 5,625 shares
41. D Ltd. issued 5,000 equity shares of Rs.20 each at a premium of 20% payable Rs.8 on
application (including premium), Rs.10 on allotment and the balance on first and final call.
The company received applications for 7,500 shares and allotment was made pro- rata. E, to
whom 1,500 shares were allotted, failed to pay the amount due on allotment. All her shares
were forfeited after the call was made. The forfeited shares were reissued to F at par.
Assuming that no other bank transactions took place, the bank balance of the company after
affecting the above transactions = ?
(a) Rs. 1,14,000 (b) Rs. 1,31,000 (c) Rs. 1,20,000 (d) Rs. 1,00,000
42. Declared dividend should be classified in the Balance Sheet as a _______.

.
(a) Provision (B) Current liability

(c) Reserve (d) Current asset
43. The interest on calls-in-advance is paid for the period from the _______.
(a) Date of receipt of application money to the date of appropriation
(b) Date of receipt of allotment money to the date of appropriation
(c) Date of receipt of calls-in-advance to the date of appropriation of the call
(d) Date of appropriation to the date of dividend payment
44. As per Schedule III of the Companies Act, 2013, under which of the following heads is
Premium on issue of Preference Shares shown in the balance sheet of a company?
(a) Non-Current Assets (b) Debentures
(c) Reserves and surplus (d) Current liabilities and provisions
45. The excess price received over the par value of shares, should be credited to
(a) Calls-in-advance account (b) Share capital account
(c) Reserve capital account (d) Securities premium account
46. The Securities Premium Account should be shown under

(a) Share Capital (b) Current Liabilities
(c) Current Assets (d) Reserves and Surplus
Use the following information for questions 47 and 48
D Ltd. issued 10,000 equity shares of Rs. 10 each at a premium of 20%. The share amount was
payable as:
On allotment (including premium) Rs. 5
On first call Rs. 3
Applications were received for 14,000 shares and the shares were allotted to applicants on pro-rata
basis. E, who was allotted 300 shares, failed to pay the first call. On his subsequent failure to pay the second
and final call, all his shares were forfeited. Out of the forfeited shares, 200 shares were re issued @ Rs. 9 per
share.
47. The amount transferred to Capital reserve=?

(a) Rs. 200 (b) Rs. 1,100 (c) Rs. 800 (d) Rs. 1,300
48. Balance in share forfeiture accounts=?

(a) Rs. Nil (b) Rs. 700 (c) Rs. 500 (d) Rs. 400

.
Consider the following data pertaining to W Ltd. as on March 31, 2014

Share Capital
Issued, Subscribed Called-up (20,000 shares of Rs.100 each) Rs. 20,00,000
Calls in arrear Rs. 10,000
Profit and loss account (Cr.) as on April 01, 2013 Rs. 67,000
Profit for the year Rs. 190,610
The company wants to create a Debenture Redemption Reserve and to transfer Rs.50,000 every year
out of profits to redeem the debentures. The company declared 10% dividends.
49. The amount of dividend declared = ?

(a) Rs. 1,00,700 (b) Rs. 2,25,761 (c) Rs. 1,99,000 (d) Rs. 2,00,000
50. The balance of Profit and Loss Appropriation account transferred to Balance Sheet after
effecting the above transactions = ?
(a) Rs. 6,000 (b) Rs. 68,100 (c) Rs. 8,610 (d) Rs. 6,810
51. The following statements apply to equity/preference shareholders. Which one of them
applies only to preference shareholders?
(a) Shareholders risk the loss of investment
(b) Shareholders bear the risk of no dividends in the event of losses
(c) Shareholders usually have the right to vote
(d) Dividends are usually a fixed amount in every financial year
52. A Ltd. forfeited 100 shares of Rs. 10 each, Rs. 8 called-up, Rs. 4 paid-up on application. Amount
to be forfeited is
(a) Rs. 400 (b) Rs. 600 (c) Rs. 800 (d) Rs. 200
53. The following information pertains to X Ltd.

i. Equity share capital called up Rs.5,00,000
ii. Calls in arrear Rs. 40,000 iii. Calls in advance Rs. 25,000 iv.
Proposed Dividend 15% The amount of dividend payable = ?
(a) Rs. 75,000 (b) Rs. 72,750 (c) Rs. 71,250 (d) Rs. 69,000
54. Z Ltd. issued 10,000 shares of Rs.10 each. The called up value per share was Rs.8. The
company forfeited 200 shares of Mr. A for non-payment of 1st call money of Rs.2 per share.
He paid Rs.6 for application and allotment money. On forfeiture, the share capital account
will be _________.
(a) Debited by Rs.2,000 (b) Debited by Rs.1,600
(c) Credited by Rs.1,600 (d) Debited by Rs. 1,200

.
55. B Ltd. issued shares of Rs.10 each at a discount of 10%. Mr. C purchased 30 shares and paid
Rs.2 on application but did not pay the allotment money of Rs.3. If the company forfeited his
entire shares, the forfeiture account will be credited by ______.
(a) Rs. 90 (b) Rs. 81 (c) Rs. 60 (d) Rs. 54

B Ltd. invited applications for 5,000 shares of Rs.10 each at a premium of Rs.2 per share payable
as follows:
On application Rs.5 (including premium)

On allotment Rs.4 On
final call Rs.3
Allotment was made on pro rata basis to the applicants of 6,000 shares. Mr. C to whom 60 shares
were allotted, failed to pay allotment money and call money. Mr. D the holder of 100 shares, failed
to pay call money. All these shares were forfeited after proper notice.
56. On forfeiture, the amount credited to share allotment account = ?

(a) Rs. 480 (b) Rs. 640 (c) Rs. 180 (d) Rs. 400
57. On forfeiture, the amount credited to share forfeiture account = ?
(a) Rs. 300 (b) Rs. 880 (c) Rs. 320 (d) Rs. 940
(a) Shares can be issued for cash or any other consideration
(b) In the event of over subscription, excess amount has to be refunded or a pro rata allotment is
to be made
(c) A company must receive a minimum of 90% subscription against the entire issue as per the
SEBI guidelines.
(d) The share application money is automatically converted to share capital.
59. A company invited applications for 25,000 equity shares of Rs. 10 each and received 30,000
applications along with the application money of Rs.4 per share. Which of the following
alternatives can be followed? I. Refund the excess applications.
II. Make pro rata allotment to all the applicants, and refund the excess application money. III.
Not to allot any shares to some applicants, full allotment to some of the applicants and pro
rata allotment to the rest of the applicants.
IV. Not to allot any shares to some applicants and make pro rata allotment to other
applicants.
V. Make pro rata allotment to all the applicants and adjust the excess money received
towards call money.
(a) Only (II) above (b) Both (I) and (IV) above
(c) All (I), (II), (III), (IV) and (V) above (d) Only (III) above
60. The document inviting offers from public to subscribe for the debentures or shares or
deposits of a body corporate is known as _____.
(a) Share certificate (b) Stock invest

.
(c) Fixed deposit receipt (d) Prospectus
61. As per Schedule III of the Companies Act, 2013, forfeited shares account (not yet reissued)
shown under the heading will be ______.
(a) Share Capital (b) Long-term borrowings
(c) Reserves and Surplus (d) Current Liabilities
62. The authorized capital of M Ltd. consists of both cumulative preference shares and equity
shares. Each 5% cumulative preference share has a par value Rs.100. Each equity share has
a par value Rs.10. At the end of the year 2007-08 and 2008-09, the cumulative preference
share capital balance was Rs.2,00,000 and the equity share capital balance was Rs.5,00,000.
If dividend declarations totalled Rs.8,000 and Rs.15,000 in the year 2007-08 and 2008-09
respectively, the dividends allocated to the equity share holders in the year 2008-09 = ?
(a) Rs. 3,000 (b) Rs. 5,000 (c) Rs. 10,000 (d) Rs. 12,000
63. At the time of forfeiture of shares which were originally issued at a discount, the accounting
entry involves __________.
I. A debit to Share capital account with the called-up value of shares forfeited
II. A credit to Share forfeiture account with the amount received on forfeited shares III.
A credit to Discount on issue of shares with the amount of discount allowed on forfeited
shares
IV. A credit to Calls-in-arrears with the amount due but not paid on forfeited shares
(a) Both (I) and (IV) above (b) Both (IV) and (III) above (c) Both (I) and (II) above (d) (I), (II),
(III) and (IV) above.
64. As per the Companies Act, only preference shares(not issued for infrastructural projects),
which are redeemable within ____ can be issued
(a) 24 years (b) 22 years (c) 30 years (d) 20 years
65. Which of the following is not true?

(a) Loss on reissue of shares cannot be more than the gain on forfeiture of those shares
(b) Where all the forfeited shares are not reissued the share forfeited account will show a credit
balance equal to gain on forfeiture of shares not yet re-issued
(c) When the shares are forfeited, securities premium is debited along with share capital where
premium has not been received
(d) Where forfeited shares are re-issued at premium, the amount of such premium is credited to
capital reserve account.
66. The subscribed share capital of S Ltd. is Rs.80,00,000 of Rs.100 each. There were no calls in
arrear till the final call was made. The final call made was paid on 77,500 shares. The calls in
arrear amounted to Rs.62,500. The final call per share = ?
(a) Rs. 25 (b) Rs. 7.8 (c) Rs. 20 (d) Rs. 62.5

.
67. Which of the following should be deducted from the called-up share capital to find out paid-
up capital?
(a) Calls-in-advance (b) Calls-in-arrears
(c) Share forfeiture (d) Discount on issue of shares
68. If a shareholder does not pay his dues on allotment, for the amount due, there will be a
(a) Credit balance in the share allotment account
(b) Debit balance in the share forfeiture account
(c) Credit balance in the share forfeiture account
(d) Debit balance in the share allotment account
69. The company issued shares of Rs.10 each at a premium of Rs.2 payable as:
On allotment Rs. 4 (including premium)
On first call Rs. 3
Mr. E who holds 100 shares failed to pay the first call money. The company has forfeited the
100 shares after the first call. On forfeiture, the amount debited to share capital account = ?
(a) Rs. 1,200 (b) Rs. 1,000 (c) Rs. 800 (d) Rs. 700
Solution:
1. (d) 2. (a) 3 (b) 4. (d) 5 (a)

6. (b) 7. (c) 8. (d) 9. (d) 10. (b)
11. (d) 12. (c) 13. (d) 14. (c) 15. (a)
16. (d) 17. (b) 18. (d) 19. (a) 20. (a)
21. (d) 22. (d) 23. (d) 24. (c) 25. (b)
26. (d) 27. (b) 28. (b) 29. (a) 30. (a)
31. (d) 32. (a) 33. (c) 34. (d) 35. (b)
36. (d) 37. (b) 38. (c) 39. (d) 40. (a)
41. (b) 42. (b) 43. (c) 44. (c) 45. (d)
46. (d) 47. (c) 48. (c) 49. (c) 50. (c)
51. (d) 52. (a) 53. (d) 54. (b) 55. (c)
56. (c) 57. (d) 58. (d) 59. (c) 60. (d)
61. (a) 62. (a) 63. (d) 64. (d) 65. (d)
66. (a) 67. (b) 68. (d) 69. (c)

.
NOTES

.
NOTES

.
CHAPTER-7
COMPANY ACCOUNTS
Unit-3 REDEMPTION OF
PREFERENCE SHARES

.
INTRODUCTION
1. Redemption is the process of repaying an obligation, at prearranged amounts and timings.

2. The conditions of the issue of preference shares include a call provision, i.e. a contract giving the
right to redeem preference shares within or at the end of a given time period at an agreed price.
3. These shares are issued on the terms that share holders will at a future date be repaid the amount
which they invested in the company.
4. The redemption date is the maturity date, which specifies when repayment takes place and is
usually printed on the preference share certificate.
Through the process of redemption, a company can also adjust its financial structure, for example, by
eliminating preference shares and replacing those with other securities if future growth of the company
makes such change advantageous.
PURPOSE OF ISSUING REDEEMABLE PREFERENCE SHARES
1. It is a proper way of raising finance in a dull primary market.
2. A company may face difficulty in raising share capital, as its shares are not traded on the stock
exchange. Potential investors, hesitant in putting money into shares that cannot easily be sold, may
be encouraged to invest if the shares are redeemable by the company.
3. The preference shares may be redeemed when there is a surplus of capital and the surplus
funds cannot be utilised in the business for profitable use.
4. A company may require additional capital in the medium term for a project, but the project
is expected to generate sufficient funds to enable the preference shares to be reduced.
In India, the issue and redemption of preference shares is governed by Section 55 of the Companies Act, 2013.

.
PROVISIONS OF THE COMPANIES ACT, 2013(SECTION 55)
A company limited by shares if so AUTHORISED BY ITS ARTICLES, may issue preference shares
which at the option of the company, are liable to be redeemed. It should be noted that:
a) no shares can be redeemed except OUT OF PROFIT OF THE COMPANY which would
otherwise be available for dividend OR out of proceeds of FRESH ISSUE OF SHARES
made for the purpose of redemption;
b) where any such shares are redeemed, otherwise than out of the proceeds of a fresh issue, there
shall, out of profits which would otherwise have been available for dividends, be transferred to
CAPITAL REDEMPTION RESERVE ACCOUNT, a sum equal to the nominal amount of
the shares redeemed; and the provision of the Act relating to the reduction of the share capital of
a company shall, except as provided in the section, apply as if the CRR Account were the paid-up
share capital of the company. The utilisation of CRR Account was further restricted to issuance of
fully paid-up bonus shares only to complete the picture of capitalisation.
c) In case of such class of companies, as may be prescribed and whose financial statements comply
with the accounting standards prescribed for such class of companies u/s 133, the premium, if any,
payable on redemption shall be provided for out of the profits of the company, before the shares
are redeemed.
Provided also that premium, if any, payable on redemption of any preference shares issued on or
before the commencement of this Act by any such company shall be provided for out of profits of
the company or out of the companys securities premium account, before such shares are
redeemed.
d) In case of other companies (other than (i) above), the PREMIUM PAYABLE ON
REDEMPTION must be provided for out of the profits of the company or out of the company's
securities premium account before the shares are redeemed.
e) no such shares can be redeemed unless they are FULLY PAID;

.
METHODS OF REDEMPTION OF FULLY PAID-UP SHARES

Redemption of Preference shares means repayment by the company of the obligation on account of
shares issued.
According to Companies Act, 2013, preference shares issued by a company must be redeemed
within the maximum period allowed under the Act.
A Company cannot issue irredeemable preference shares.
Out of Fresh issue of Shares or distributable profits then, transfer to CRR.
The provision is to protect the interest of outsiders to whom the amount is payable before
redemption of preference share capital.
1. REDEMPTION OF PREFERENCE SHARES BY FRESH ISSUE OF

SHARES
A company can issue new shares (equity share or preference share) and the proceeds from such
new shares can be used for redemption of preference shares.
The proceeds from issue of debentures cannot be utilised for the purpose.
Refer Section 52 of the Companies Act, 2013 (Unit 2 of Chapter 9) clause (d) allows premium on
redemption of preference shares to be adjusted against Securities Premium Account but the
redemption itself cannot be financed out of the Securities Premium Account.
Clause (d) ----- in providing for the premium payable on the redemption of any redeemable preference
shares or of any debentures of the company. Also refer note in this section.
REASONS FOR ISSUE OF NEW EQUITY SHARES
A company may prefer issue of new equity shares for the following reasons:
a) When the company has come to realise that the capital is needed permanently and it makes more
sense to issue Equity Shares in place of Redeemable Preference Shares which carry a fixed rate of
dividend.
b) When the balance of profit, which would otherwise be available for dividend, is insufficient.
c) When the liquidity position of the company is not good enough.

.
ADVANTAGES OF REDEMPTION OF PREFERENCE SHARES BY ISSUE OF FRESH EQUITY SHARES
(1) No cash outflow of money now or later.

(2) New equity shares may be valued at a premium.
(3) No capital gains tax for shareholders.
(4) Shareholders retain their equity interest.
DISADVANTAGES OF REDEMPTION OF PREFERENCE SHARES BY ISSUE OF FRESH EQUITY SHARES
(1) There is a possibility of dilution of further earnings;

(2) Share holdings in the company are changed.
1. When new shares are issued at par

Bank Account Dr.
(Being the issue of .shares of Rseach for the purpose of redemption of preference shares, as
per Board's Resolution No dated.).
2. When new shares are issued at a premium.

Bank Account Dr.
To Securities Premium Account
(Being the issue of ..shares of Rseach at a premium of Rseach for the purpose of
redemption of preference shares as per Board's Resolution No.. dated)
3 When new shares are issued at a discount

Bank Account Dr.
Discount on Issue of Shares Account Dr.
(Being the issue of ..shares of Rs.each at a discount of Rs..each for the purpose of
redemption of preference shares, as per Board's Resolution No.dated.)
4 When preference shares are redeemed at par Redeemable

Preference Share Capital Account Dr.
To Preference Shareholders Account
5 When preference shares are redeemed at a premium
Redeemable Preference Share Capital Account Dr.
Premium on Redemption of Preference Shares Account Dr. To
Preference Shareholders Account
6 When payment is made to preference shareholders Preference

Shareholders Account Dr.

.
To Bank Account
7 For adjustment of premium on redemption

Profit and Loss Account Dr. Securities
Premium Account Dr.
To Premium on Redemption of Preference Shares Account
Illustration 1
Hinduja Company Ltd. had 5,000 8% Redeemable Preference Shares of Rs. 100 each, fully paid up. The
company decided to redeem these preference shares at par by the issue of sufficient number of equity
shares of Rs. 10 each fully paid up at par. You are required to pass necessary Journal Entries including
cash transactions in the books of the company.
Illustration 2
C. Ltd. had 10,000 10% Redeemable Preference Shares of Rs. 100 each, fully paid up. The company decided
to redeem these preference shares at par, by issue of sufficient number of equity shares of Rs. 10 each at
a premium of Rs. 2 per share as fully paid up. You are required to pass necessary Journal Entries including
cash transactions in the books of the company.

.
Illustration 3
G India Ltd. had 9,000 10% redeemable Preference Shares of Rs. 10 each, fully paid up. The company
decided to redeem these preference shares at par by the issue of sufficient number of equity shares of Rs.
9 each fully paid up.
You are required to pass necessary Journal Entries including cash transactions in the books of the
company.
Illustration 4 Calculation of Minimum Fresh issue of Shares

The Board of Directors of a Company decide to issue minimum number of equity shares of Rs. 10 each at
10% discount to redeem Rs. 5,00,000 preference shares. The maximum amount of divisible profits
available for redemption is Rs. 3,00,000. Calculate the number of shares to be issued by the company to
ensure that provisions of Section 55 are not violated. Also determine the number of shares if the company
decides to issue shares in multiples of Rs. 50 only.

.
Illustration 5
The Balance Sheet of a Company on 30-06-2014 is as follows:

Particulars Rs.
EQUITIES AND LIABILITIES

1. Shareholders Funds
(a) Share Capital 7,00,000
(b) Reserves and Surplus Current 1,00,000
2. Liabilities 2,00,000
Total
10,00,000
ASSETS
1. Fixed Assets
(a) Tangible Assets
6,00,000
2. Current Assets
(a) Cash and Cash Equivalents (Bank)
Total 4,00,000
10,00,000
The share capital of the company consists of Rs. 10 each equity shares of Rs. 5,00,000 at Rs. 100 each.
Preference shares (issued on 1.4.12) of Rs. 2,00,000. Reserves and surplus comprises securities premium
of Rs. 10,000 and Profit & Loss Account of Rs. 90,000.
Compute the minimum number of equity shares of Rs. 10 each that the company must issue at par to
redeem preference shares at a premium of 10%.

.
Illustration 6 Minimum Fresh issue to Provide Funds for Redemption
The Balance Sheet of X Ltd. on 31-03-2014 is as follows:

Particulars Rs.
EQUITIES AND LIABILITIES

1. Shareholders Funds
(a) Share Capital 2,90,000
(b) Reserves and Surplus Current 48,000
2. Liabilities 56,500
Total 3,94,500
ASSETS
1. Fixed Assets
(a) Tangible Assets 3,45,000
2. (b) Non-current Investments 18,500
Current Assets
(a) Cash and Cash Equivalents (Bank) Total 31,000
10,00,000
The share capital of the company consists of Rs. 50 each equity shares of Rs. 2,25,000 at Rs. 100 each.
Preference shares of Rs. 65,000 (issued on 1.4.12). Reserves and surplus comprises Profit & Loss Account
only.
In order to facilitate the redemption of preference shares at a premium of 10%, the company decided: (a)
To sell all the investments for Rs. 15,000.
(b) To finance part of redemption from company funds, subject to, leaving a bank balance of Rs. 12,000.
(c) To issue minimum equity shares of Rs. 50 each at a premium of Rs. 10 per share to raise the balance
of funds required.
You are required to pass the necessary journal entries to record transactions and prepare the balance
sheet as on completion of the above transactions.

.

.
2. REDEMPTION OF PREFERENCE SHARES BY CAPITALISATION

OF UNDISTRIBUTED PROFITS
Another method for redemption of preference shares, as per the Companies Act, is to use the
distributable profits in place of issuing new shares.
When shares are redeemed by utilizing distributable profit, an amount equal to the face value of
shares redeemed is transferred to Capital Redemption Reserve Account by debiting the
distributable profit. In other words, some of the distributable profits are kept aside to ensure that
it can never be distributed to shareholders as dividend.
ADVANTAGES OF REDEMPTION OF PREFERENCE SHARES BY CAPITALISATION OF

UNDISTRIBUTED PROFITS
(1) No change in the percentage share holdings of the company; (2)

Future earnings are not diluted;
(3) Surplus funds can be used.
DISADVANTAGES OF REDEMPTION OF PREFERENCE SHARES BY CAPITALISATION OF

UNDISTRIBUTED PROFITS
(1) There may be a reduction in liquidity;

(2) Capital gains tax liability for preference shareholders.
3. REDEMPTION OF PREFERENCE SHARES BY COMBINATION OF

FRESH ISSUE AND CAPITALISATION OF UNDISTRIBUTED
PROFITS
A company can redeem the preference shares partly from the proceeds from new issue and partly out of
profits. In order to fill in the 'gap' between the face value of shares redeemed and the proceeds of new
issue, a transfer to be made from distributable profits (Profit & Loss Account, General Reserve and other
Free Reserves) to Capital Redemption Reserve Account.
(i) Amount to be Transferred to Capital Redemption Reserve
Face value of shares redeemed XXX

Less: Proceeds from new issue XXX

.
(ii) Proceeds to be collected from New Issue
Face value of shares redeemed XXX

Less: Profits available for distribution as dividend XXX
1. When shares are redeemed at par
Redeemable Preference Share Capital Account Dr.

(Being the amount payable on redemption of preference shares transferred to Preference
Shareholders Account)
2. When shares are redeemed at a premium
Redeemable Preference Share Capital Account Dr. Premium on Redemptions

of Preference Shares Account Dr.
(Being the amount payable on redemption transferred to Preference Shareholders Account)
3. When payment is made to preference shareholders

Preference Shareholders Account Dr.
To Bank Account
(Being the payment to preference shareholders as per terms)
4. For adjustment of premium of redemption

Profit and Loss Account Dr. Securities
Premium Account Dr.
To Premium on Redemption of Preference Shares Account
(Being the premium on redemption adjusted against Profit and Loss Account and Securities
Premium Account)
5. For transferring nominal amount of shares redeemed to Capital Redemption Reserve

Account
General Reserve Account Dr. Profit
and Loss Account Dr.
To Capital Redemption Reserve Account
(Being the amount transferred to Capital Redemption Reserve Account as per the requirement of
the Act).

.
Illustration 7
The following are the extracts from the Balance Sheet of ABC Ltd. as on 31st December, 2004.
Share capital: 40,000 Equity shares of Rs. 10 each fully paid - Rs. 4,00,000; 1,000 10% Redeemable
preference shares of Rs. 100 each fully paid Rs. 1,00,000.
Reserve & Surplus: Capital reserve Rs. 50,000; Securities premium Rs. 50,000; General reserve Rs.
75,000; Profit and Loss Account Rs. 35,000
On 1st January 2011, the Board of Directors decided to redeem the preference shares at par by utilisation
of reserve.
You are required to pass necessary Journal Entries including cash transactions in the books of the
company.
Illustration 8 Redemption of Preference Shares by Combination of Fresh Issue and Capitalisation

of Undistributed Profits
C Limited had 3,000, 12% Redeemable Preference Shares of Rs. 100 each, fully paid up. The company had
to redeem these shares at a premium of 10%.
It was decided by the company to issue the following:
(i) 25,000 Equity Shares of Rs. 10 each at par, (ii)
1,000 14% Debentures of Rs. 100 each.
The issue was fully subscribed and all amounts were received in full .The payment was duly made. The
company had sufficient profits. Show Journal Entries in the books of the company.
4. SALE OF INVESTMENTS TO PROVIDE SUFFICIENT FUNDS FOR

REDEMPTION

.
Companies may have sufficient investments, which can be sold, in the market to arrange funds for
redemption of preference shares.
REDEMPTION OF PARTLY CALLED-UP PREFERENCE SHARES
It is assumed that final call on these shares is demanded and received before proceeding with
redemption of these shares.
If information about both fully paid and partly paid preference shares is provided, then, only fully
paid shares are redeemed.
REDEMPTION OF FULLY CALLED BUT PARTLY PAID-UP PREFERENCE SHARES
WHEN CALLS-IN-ARREARS IS RECEIVED BY THE COMPANY

If the amount of unpaid calls is received by the Company before redemption, the entry passed is as under:
Bank A/c Dr.

To Calls-in-Arrears A/c
After receipt of calls in arrears, the shares become fully paid up and, then, company can proceed with
redemption in the normal course.
IN CASE OF FORFEITED SHARES

If, on getting a proper notice from the company, the shareholders fail to pay the unpaid calls, the Board of
Directors may decide to forfeit the shares and cancel these shares instead of reissuing the forfeited shares
because redemption of these shares is due immediately or in near future. In this case, entry for forfeiture
is passed as usual.
It is worth noting that to ensure replacement of capital out of proceeds of a fresh issue or out of divisible
profits, total preference share capital (including the shares forfeited and cancelled) should be considered.
However, while arranging funds for redemption, amount actually payable to shareholders is taken into
consideration.

(a) A company can redeem its preference shares
(b) Preference shareholders are creditors of a company
(c) The part of the authorized capital which can be called up only in the event of
liquidation of a company is called reserve capital
(d) Capital redemption reserve can be utilized for issuing fully paid bonus shares

.
The Balance Sheet of A Ltd. as on March 31, 2012 is as under:

Share capital: Land & Building 400,000
Equity shares of Rs.100 each 500,000 Plant & Machinery 300,000
12% Preference shares of Rs.10 each 300,000 Furniture & Fixtures 250,000
Reserves and surplus: Investments 225,000
General reserve 150,000 Sundry Debtors 100,000
Profit and loss account 250,000 Inventories 150,000
18% Debentures 200,000 Cash 50,000
Sundry creditors 50,000
Bank overdraft 25,000
14,75,000
14,75,000
The 12% preference shares are redeemable at a premium of 10%. The company wishes to maintain
the cash balance at Rs.25,000. For the purpose of redemption of preference shares, it proposed to
sell the investments for Rs.2,00,000. The company proposes to issue sufficient number of equity
shares of Rs.100 each at a premium of 5% to raise required cash resources.
2. Total cash required to effect the above decisions is __________.

(a) Rs. 330,000 (b) Rs. 355,000
(c) Rs. 25,000 (d) Rs. 105,000
3. Number of equity shares to be issued is __________.

(a) Rs. 1,500 (b) Rs. 1,000
(c) Rs. 950 (d) Rs. 1,500
4. S Ltd. issued 2,000, 10% Preference shares of Rs.100 each at par, which are redeemable at a
premium of 10%. For the purpose of redemption, the company issued 1,500 Equity Shares
of Rs.100 each at a premium of 20 % per share. At the time of redemption of Preference
Shares, the amount to be transferred by the company to the Capital Redemption Reserve
Account = ?
(a) Rs.50,000 (b) Rs.40,000
(c) Rs.2,00,000 (d) Rs.2,20,000
5. During the year 2008-2009, T Ltd. issued 20,000, 12% Preference shares of Rs.10 each at
(a) premium of 5%, which are redeemable after 4 years at par. During the year 2013-14,
as the company did not have sufficient cash resources to redeem the preference shares,
it issued 10,000, 14% debentures of Rs.10 each at a premium of 10%. At the time of

.
redemption of 12% preference shares, the amount to be transferred to capital

redemption reserve = ?
(a) Rs.90,000 ( b) Rs.1,00,000
(c) Rs.2,00,000 (d) Rs.1,10,000
6. According to section 52 of the Companies Act, 2013, the amount in the Securities Premium
A/c cannot be used for the purpose of
(a) Issue of fully paid bonus shares
(b) Writing off losses of the company
(c) Writing off preliminary expenses
(d) Writing off commission or discount on issue of shares
7. Which of the following can be utilized for redemption of preference shares?

(a) The proceeds of fresh issue of equity shares
(b) The proceeds of issue of debentures
(c) The proceeds of issue of fixed deposit
(d) All of the above
8. Which of the following statements is True?

(a) Capital redemption reserve cannot be used for writing off miscellaneous expenses and
losses
(b) Capital profit realized in cash can be used for payment of dividend
(c) Reserves created by revaluation of fixed assets are not permitted to be capitalized
(d) Dividend is payable on the calls paid in advance by shareholders.
9. Consider the following information pertaining to E Ltd.

On September 4, 2014, the company issued 12,000 7% Debentures having a face value of
Rs.100 each at a discount of 2.5%. On September 12, the company issued 25,000, 8%
Preference share of Rs.100 each. On September 29,the company redeemed 30,000, 6%
Preference shares of Rs.100 each at a premium of 5% together with one month dividend
thereon. Bank balance as on August 31, 2014 was Rs.29,25,000.
After effecting the above transactions, the Bank balance as on September 30, 2011 = ?
(a) Rs.33,15,000 (b) Rs.33,30,000
(c) Rs.33,45,000 (d) Rs.34,30,000
10. Which of the following accounts can be used for transfer to capital redemption reserve
account?
(a) General reserve account (b) Forfeited shares account
(c) Profit prior to incorporation (d) Securities premium account

.
11. Preference shares amounting to Rs.2,00,000 (already issued on 1.4.12) are redeemed at a
premium of 5%, by issue of shares amounting to Rs.1,00,000 at a premium of 10%. The
amount to be transferred to capital redemption reserve = ?
(a) Rs.1,05,000 (b) Rs.1,00,000
(c) Rs.2,00,000 (d) Rs.1,11,000
12. Securities premium cannot be used to _______.
(a) Issue bonus shares (b) Redeem preference shares
(c) Write-off preliminary expenses (d) Write-off discount on issue of shares
13. Which of the following cannot be used for the purpose of creation of capital redemption
reserve account?
(a) Profit and loss account (credit balance) (b) General reserve account
(c) Unclaimed dividend account (d) All of the above
1.( b ) 2.( b ) 3.( b ) 4.( a ) 5.( c ) 6.( b ) 7.( a ) 8.( a ) 9.( d ) 10.( a ) 11.( b )
12.( b ) 13.(c)
NOTES

.
CHAPTER-7
COMPANY ACCOUNTS
Unit-4
ISSUE OF DEBENTURES

.
INTRODUCTION
With increasing and ever growing needs of the corporate expansion and growth, equity source of
financing is not sufficient.
Hence, corporates turn to debt financing through various means. Issuing debt instruments by
offering the same for public subscription is one of the sources of financing the business activities.
Debt financing does not only helps in reducing the cost of the capital but also helps in designing
appropriate capital structure of the company.
Debenture is one of the most commonly used debt instrument issued by the company to raise funds
for the business.
MEANING
A debenture is a bond issued by a company under its seal,

acknowledging a debt and containing provisions as regards repayment of
the principal and interest.
If a charge* has been created on any or on the entire asset of the company, the nature of the charge
and the assets charged are described therein. Since the charge is not valid unless registered with
the Registrar, and the certificate registering the charge is printed on the bond. It is also customary
to create a trusteeship in favour of one or more persons in the case of mortgage debentures. The
trustees of debenture holders have all powers of a mortgage of a property and can act in whatever
way they think necessary to safeguard the interest of debenture holders.

.
*Charge is an incumbrance to meet the obligation under the Trust Deed, whereby the company agrees to
mortgage specific portion either by way of a first or second charge. Such charge implies right of lenders to
secure their payment from such asset(s) or from the liquidator in the event of winding up or from the
company when the charge becomes void.
FEATURES OF DEBENTURES
1. It is a document which EVIDENCES A LOAN MADE to a company.
2. It is a FIXED INTEREST-BEARING SECURITY where interest falls due on specific dates.
3. Interest is payable at a predetermined FIXED RATE, regardless of the level of profit.
4. The original sum is REPAID at a specified future date or it is CONVERTED INTO SHARES OR
OTHER DEBENTURES.
5. It MAY OR MAY NOT CREATE A CHARGE on the assets of a company as security.
6. It can generally be BOUGHT OR SOLD THROUGH THE STOCK EXCHANGE at a price above or
below its face value.
DISTINCTION BETWEEN DEBENTURES AND SHARES
S. NO. DEBENTURES SHARES

1. Debentureholders are the creditors of the Shareholders are the owners of the company.
company.
2. Debentureholders have no voting rights Shareholders have voting rights and
and consequently do not pose any threat to consequently control the total affairs of the
the existing control of the company. company.
3. Debenture interest is paid at a pre- Dividend on equity shares is paid at a variable

determined fixed rate. It is payable, rate which is vastly affected by the profits of the
whether there is any profit or not. company (however, dividend on preference
Debentures rank ahead of all types of shares is paid at a fixed rate).
shares for payment of the interest due on
them.
4. Interest on debentures are the charges Dividends are appropriation of profits and these
against profits and they are deductible as are not deductible in determining taxable profit
an expense in determining taxable profit of of the company.
the company.
5. There are different kinds of debentures, There are only two kinds of shares Equity
such as Secured/ Unsecured; Shares and Preference Shares.
Redeemable/ Irredeemable;
Registered/Bearer;
Convertible /Non-convertible, etc.

.
6. In the Companys Balance Sheet, In the Companys Balance Sheet, shares are shown
Debentures are shown under Secured under Share Capital.
Loans.
7. Debentures can be converted into shares as Shares cannot be converted into debentures in
per the terms of issue of debentures. any circumstances.
8. Debentures cannot be forfeited for Shares can be forfeited for non-payment of
nonpayment of call moneys. allotment and call moneys.
9. At maturity, debentureholders get back Equity shareholders cannot get back their money
their money as per the terms and before the liquidation of the company (however,
conditions of redemption. preference shareholders can get back their
money before liquidation).
10. At the time of liquidation, At the time of liquidation shareholders are paid
debentureholders are paid-off before the at last, after paying debentureholders, creditors,
shareholders. etc.
TYPES OF DEBENTURES
1. SECURITY
(a) Secured Debentures : These debentures are secured by a charge upon some or all assets of
the company. There are two types of charges: (i) Fixed charge; and (ii) Floating charge. A fixed
charge is a mortgage on specific assets. These assets cannot be sold without the consent of the
debentureholders. The sale proceeds of these assets are utilized first for repaying
debentureholders. A floating charge generally covers all the assets of the company including
future one.
(b) Unsecured or Naked Debentures : These debentures are not secured by any charge upon
any assets. A company merely promises to pay interest on due dates and to repay the amount
due on maturity date. These types of debentures are very risky from the view point of investors.
2. CONVERTIBILITY
(a) Convertible Debentures : These are debentures which will be converted into equity shares
(either at par or premium or discount) after a certain period of time from the date of its issue.
These debentures may be fully or partly convertible. In future, these debentureholders get a
chance to become the shareholders of the company.
(b) Non-Convertible Debentures : These are debentures which cannot be converted into shares
in future. As per the terms of issue, these debentures are repaid.

.
3. PERMANENCE
(a) Redeemable Debentures : These debentures are repayable as per the terms of issue, for
example, after 8 years from the date of issue.
(b) Irredeemable Debentures : These debentures are not repayable during the life time of the
company. These are also called perpetual debentures. These are repaid only at the time of
liquidation.
4. NEGOTIABILITY
(a) Registered Debentures : These debentures are payable to a registered holder whose name,
address and particulars of holding is recorded in the Register of Debentureholders. They are
not easily transferable. The provisions of the Companies Act, 2013 are to be complied with
for effecting transfer of these debentures. Debenture interest is paid either to the order of
registered holder as expressed in the warrant issued by the company or the bearer of the
interest coupons.
(b) Bearer Debentures : These debentures are transferable by delivery. These are negotiable
instruments payable to the bearer. No kind of record is kept by the company in respect of the
holders of such debentures. Therefore, the interest on it is paid to the holder irrespective of
any identity. No transfer deed is required for transfer of such debentures.
5. PRIORITY
(a) First Mortgage Debentures : These debentures are payable first out of the property
charged.
(b) Second Mortgage Debentures : These debentures are payable after satisfying the first
mortgage debentures.
ISSUE OF DEBENTURES
1. Debenture issued at par redeemable at par : When debenture are issued at par, the issue price
is equal to par value, in this regard the following entries are recorded:
(a) For receipt of application money :
Bank A/c Dr.
To Debenture Application A/c
(b) For transfer of application money to debentures account :

.
Debenture Application A/c Dr.
To % Debenture A/c
Illustration 1
Amol Ltd. Issued 40,00,000, 9% debenture of Rs. 50 each, payable on application as per term mentioned
in the prospectus and redeemable at par any time after 3 years from the date of issue.
Record necessary entries for issue of debenture in the books of Amol Ltd.
Solution:
Illustration 2
Country Crafts Ltd. Issued 20,00,000, 8% debenture of Rs.100 each at par payable as Rs.40 on application
and Rs.60 allotment, redeemable at par after 5 years from the date of issue of debenture.

.
Record necessary entries in the books of Country Crafts Ltd.
Solution:
2. Debenture issued at Discount and Redeemable at par or at discount : When debentures are issued
at discount, issue price will be less than par value. The difference between the two is considered
as loss on issue on debentures and is to be written-off over the life of debentures. The entries with
regards to issue are given below :
(a) For receipt of application money
Bank A/c Dr.
(b) At the time of making allotment

(i) Debenture Application A/c Dr.
Discount on issue of debenture A/c Dr.

To % Debenture A/c
Illustration 3
Atul Ltd. issued 1,00,00,000, 8% debenture of Rs. 100 each at a discount of 10% redeemable at par at the
end of 10th year. Money was payable as follows :
Rs. 30 on application
Rs. 60 on allotment
Record necessary journal entries regarding issue of debenture.
Solution:

.
3. Debenture Issued at Premium and Redeemable at par or at discount : When debenture are issued
at premium, the issue price is more than the par value. The premium is transferred to securities
premium account. In this regard, the following journal entries are recorded:
When premium amount is received at the time of application;
Bank A/c Dr.
(b) For transfer of application of money at the time of allotment
Debenture application A/c Dr.
To % Debentures A/c
To Securities Premium A/c
Illustration 4
Koinal Chemicals Ltd. issued 15,00,000, 10% debenture of Rs. 50 each at premium of 10%, payable as Rs.
20 on application and balance on allotment. Debentures are redeemable at par after 6 years. All the money
due on allotment was called up and received. Record necessary entries when premium money is included
in application money.
Solution:

.
4. Debenture issued at par and redeemable at a premium : In this case, the issue price is same as par
value but the redemption value is more than the par value, therefore redemption premium is
recorded as a loss on issue of debenture at the time of allotment of debenture. Following journal
entries are recorded in this regard:

Bank A/c Dr.
To Debenture application A/c

(i) Transfer of application money to debenture account
Debenture Application A/c Dr.

To % Debenture A/c
(ii) Call made consequent upon allotment.

Debenture Allotment A/c Dr.
Loss on issue of debenture A/c Dr. [Equal to Debenture Redemption Premium] To %
Debenture A/c
To Debenture redemption premium A/c
Students can note that instead of passing the separate entries, a compound entry can be
passed:
Bank A/c Dr.
Loss on issue of debenture A/c Dr. To %
Debenture A/c
To Debenture redemption premium A/c

.
Illustration 5
Modern Equipments Ltd. issued 2,00,000, 12% debenture of Rs. 1,000 payable as follows :
On application Rs. 300 On
allotment Rs. 700
The debenture were fully subscribed and all the money was duly received. As per terms of issue, the
debenture are redeemable at Rs. 1,100 per debenture. Record necessary entries regarding issue of
debenture.
Solution:
5. Debenture Issued at discount and redeemable at premium: In this situation the issue price is less
than par value but redemption value is more than par value. The difference between the
redemption price and the issue price is treated as discount/loss on issue of debenture. Suppose, a
10% debenture of Rs. 1,000 is issued at a discount of Rs. 100 and redeemable at a premium of Rs.
5 per debenture, the amount of loss will be equal to Rs.900 Rs. 1,005 = Rs. 105.
(a) For the receipt of application money

Bank A/c Dr.

(i) Transfer of application money to debenture account Debenture Application A/c
Dr.
To % Debenture A/c
(ii) Call made consequent upon allotment of debenture at discount and redeemable at
premium
Discount/Loss on issue of debenture A/c Dr. [Amount equal to the discount on issue of
debenture plus Premium on redemption] To % Debenture A/c
To Debenture Redemption Premium A/c
(c) For receipt of call made on allotment

Bank A/c Dr.
To Debenture Allotment A/c

.
Illustration 6
Agrotech Ltd. issued 1,40,00,000, 9% debentures of Rs. 100 each at a discount of 6%, redeemable at a
premium of 5% after 3 years payable as : Rs. 50 on application and Rs. 44 on allotment. Record necessary
journal entries for issue of debentures.
Solution:
6. Debenture Issued at premium and redeemable at premium: In this situation the issue price is more
than par value and also redemption value is more than par value. The premium received at the
time of issue of debentures is credited to Debenture premium account and premium paid at the
time of redemption is loss to be provided at the time of issue of debentures. Suppose, a 10%
debenture of Rs. 1,000 is issued at a premium of Rs. 100 and redeemable at a premium of Rs. 5 per
debenture. In the given case Rs. 100 is to be credited to Debenture premium account and Rs. 5 will
be the loss to be provided at the time of issue of debentures. It is to be noted that premium on
redemption of debentures is also credited by Rs.
5.
(a) For the receipt of application money

Bank A/c Dr.

(i) Transfer of application money to debenture account Debenture Application A/c
Dr.
To % Debenture A/c
(ii) Call made consequent upon allotment of debenture at discount and redeemable at
premium
Loss on issue of debenture A/c Dr. [Amount equal to the Premium
on redemption]
To % Debenture A/c
To Debenture Redemption Premium A/c
To Debenture Premium A/c

.
(c) For receipt of call made on allotment

Bank A/c Dr.
To Debenture Allotment A/c
Students can note that instead of passing the separate entries, a compound entry can be passed:
Bank A/c Dr.

Loss on issue of Debentures A/c Dr.
To % Debentures A/c
To Debenture Premium A/c
To Premium on redemption of debenture A/c
ACCOUNTING FOR ISSUE OF DEBENTURES PAYABLE IN INSTALMENTS
1. Debentures Payable in Full on Application

Where the amount due on debentures are payable in full on application, it is usual to open a separate
Debentures Application Account for each class of debentures, such as 10% Debentures Application
Account or 12% Debentures Application Account.
These accounts record moneys received from the applicants of debentures. If an issue is oversubscribed,
these accounts can be used to record the refund of moneys to the unsuccessful applicants.
At the time of allotment of debentures, the amount in Debentures Application Account is transferred to
the respective Debentures Account.
2. Debentures Issued at Par

The debentures which are issued at par are issued at the same price as their nominal value; that is, if a
debt with a nominal value of Rs. 100 is issued at par, the company receives Rs. 100.
Illustration 7
Simmons Ltd. issued 10,000, 12% debentures of Rs. 100 each at a par payable in full on application by 1st
April. Applications were received for 11,000 Debentures. Debentures were allotted on 7th April. Excess
money refunded on the same date.
You are required to pass necessary journal entries (including cash transactions) in the books of company.
Solution:

.
3. Debentures Issued at a Premium

Debentures are rarely issued at a premium. A company issues debentures at a premium when the market
rate of interest is lower than the debentures interest rate. The debentures, which are issued at a premium,
are issue at a higher price than their nominal value;
If a debenture with a nominal value of Rs. 100 is issued; 10% premium, the company receives Rs. 110
where the investor gets slightly less interest than stated in the debenture. For example, 12% Debentures
of Rs. 100 issued at a premium of 10%. The investor will get Rs. 1 p.a. for his investment of 110.
Therefore, the effective rate of interest on investment is (12/111x 100) = 10.91%.
The premium on debentures is credited to Securities Premium Account as Debentures are covered in the
definition of Securities specified in the clause (h) of section 2 of the securities Contracts (Regulation) Act.
Therefore, restriction of utilization of debentures (securities) premium will also be governed by Section 52 of
the Companies Act, 2013.
Illustration 8
Kapil Ltd. issued 10,000, 12% debentures of Rs. 100 each at a premium of 10% payable in full on
application by 1st March, 2014. The issue was fully subscribed and debentures were allotted par payable
in full on application by 1st April. Applications were received for 11,000 Debentures. Debentures were
allotted on 7th April. Excess money refunded on the same date.
You are required to pass necessary journal entries (including cash transactions) in the books of company.
Solution:

.
4. Debentures Issued at a Discount

The Companies Act does not impose any restriction on the price at which debentures can be issued. Unlike
shares, there is no maximum limit for discount on issue of debenture. This is why it is very common for
debentures to be issued at a discount. The debentures which are issued at a discount are issued at a lower
price than nominal value, that is, if a debenture with a nominal value of Rs. 100 is issued at 10% discount,
the company receives Rs. 90 only. The issue of debentures at a discount slightly increases the true rate of
interest payable. For example, 12% Debentures of Rs.100 issued at a discount of 10%. The Company will
have to pay Rs. 1 for a loan of Rs. 90. Therefore, the true rate of interest is (12/90 x 100) = 13.33%.
The company issues debentures at a discount when the market rate of interest is higher than the
debenture interest rate. Like shares, Debentures Account is credited with the nominal value. The
difference between the nominal value of debentures and cash received is transferred to Discount on Issue
of Debentures Account. In the subsequent years, Discount on Issue of Debentures is written-off
proportionately by charging to the Statement of Profit and Loss. It is considered a normal practice to
amortize discount on issue of debentures over the period of benefit, i.e., normally 3 to 5 years.
Illustration 9
X Ltd. issued 10,000, 12% debentures of Rs. 100 each at a discount of 10% payable in full on application
by 31st May, 2014. Applications were received for 12,000 Debentures. Debentures were allotted on 9th
June, 2014. Excess money refunded on the same date.
You are required to pass necessary journal entries and the ledger accounts in the books of company.
Solution:

.

.
ISSUE OF DEBENTURES AS COLLATERAL SECURITY
Collateral security means secondary or supporting security for a loan, which can be realised by the lender
in the event of the original loan not being repaid on the due date. Under this arrangement, the borrower
agrees that a particular asset or a group of assets will be realized and the proceeds there from will be
applied to repay the loan in the event that the amount due, cannot be paid.
Sometimes companies issue their own debentures as collateral security for a loan or a fluctuating
overdraft. When the loan is repaid on the due date, these debentures are at once released with the main
security. In case, the company cannot repay its loan and the interest thereon on the due date, the lender
becomes the debentureholder who can exercise all the rights of a debentureholder.
The holder of such debentures is entitled to interest only on the amount of loan, but not on the debentures.
Accounting Entries
There are two methods of showing these types of debentures in the accounts of a company.
Method 1
Under this method, no entry is made in the books of account of the company at the time of making issue
of such debentures. In the Balance Sheet, the fact of the debentures being issued and outstanding is shown
by a note under the liability secured.
Illustration
X Ltd. obtains a loan from IDBI of Rs.10,00,000, giving as collateral security of Rs.15,00,000, 14%, First
Mortgage Debentures. In the Balance Sheet of X Ltd., it is shown as follows:
Balance Sheet of X Limited as at(includes) Liabilities

Secured Loan
IDBI Loan 10,00,000
(Collaterally secured by issue of Rs. 15,00,000
14% First Mortgage Debentures)
Method 2
Under this method, the following entry is made to record the issue of such debentures:
Debentures Suspense Account Dr.
To Debentures Account
(Being the issue ofdebentures collaterallyas per Boards Resolution No..dated)
The Debentures Suspense Account will appear on the assets side of the Balance Sheet and Debentures on
the liabilities side of the Balance Sheet. When the loan is repaid, the entry is reversed in order to cancel it.
ISSUE OF DEBENTURES IN CONSIDERATION OTHER THAN FOR CASH

.
Just like shares, debentures can also be issued for consideration other than for cash, such as for purchase
of land, machinery, etc. In this case, the following entries are passed :
(a) Sundry Assets Account Dr. [Assets taken over]

To Sundry Liabilities Account [Liabilities assumed]
To Vendors Account [Purchase consideration]
(Being the assets and liabilities are taken over)
(b) Vendors Account Dr.
To Debentures Account
(Being the issue of.debentures to satisfy purchase consideration)
Illustration
X Company Limited issued 14% Debentures of the nominal value of Rs. 10,00,000 as follows:
(a) To sundry persons for cash at 90% Rs. 5,00,000 nominal.
(b) To a vendor for Rs. 2,00,000 for purchase of fixed assets Rs. 2,50,000 nominal.
(c) To the banker as collateral security for a loan of Rs. 1,00,000 Rs. 2,50,000 nominal. Pass necessary
Journal Entries.
Solution:
TREATMENT OF DISCOUNT ON ISSUE OF DEBENTURES

.
The Discount on issue of debentures is amortised over a period between the issuance date and
redemption date. It should be written-off in the following manner depending upon the terms of
redemption:
(a) If the debentures are redeemable after a certain period of time, say at the end of 5 or 10 years,
the total amount of discount should be written-off equally throughout the life of the debentures (applying
the straight line method). The main advantage of this method is that it spreads the burden of discount
equally over the years.
(b) If the debentures are redeemable at different dates, the total amount of discount should be
written-off in the ratio of benefit derived from debenture loan in any particular year (applying the sum of
the years digit method). This method is suitable when debentures are redeemed by unequal instalments.
The accounting entries would be as follows :

Profit and Loss Account Dr.
To Discount on Issue of Debentures Account
(Being the amount of discount on issue of debentures written-off)
Note: Loss on issue of debentures is also a capital loss and should be written-off in a similar manner as
discount on debentures issued. In the balance sheet, both the items (Discount and Loss) are shown as
Non-current/Current Assets depending upon the period for which it has to be written-off.
Illustration
HDC Ltd issues 10,000. 12% debentures of Rs. 100 each at Rs. 94 on 1st January, 2010. Under the terms
of issue, the debentures are redeemable at the end of 5 years from the date of the issue. Calculate the
amount of discount to be written-off in each of the 5 years.
Solution:
Illustration
HDC Ltd. issues 10,000, 12% debentures of Rs. 100 each at Rs. 94 on 1st January, 2008. Under the terms
of issue, 1/5th of the debentures are annually redeemable by drawings, the first redemption occurring on
31st December, 2010. Calculate the amount of discount to be written- off in 2008 to 2014.

.
Solution:
INTEREST ON DEBENTURES AND TAX ON INTEREST
Interest payable on coupon debenture is treated as a charge against the profits of the company.
Interest on debenture is paid periodically and is calculated at coupon rate on the nominal value of
debenture.
The company will pay interest net of tax to the debenture holders because the company is under
obligation to deduct tax at source at the rates applicable under tax rules from time to time.
The companies will deposit the tax so deducted with income tax authorities.

.
Following accounting entries are to be recorded in this regard:
1. For making interest due

Interest A/c Dr.
To Debentureholders A/c
2. For making payment of interest and deduction of tax at
source (TDS) Debentureholders A/c Dr.
To TDS Payable A/c
To Bank A/c
3. For making payment of tax deducted at source TDS payable
A/c Dr.
To Bank A/c
4. For transferring interest to profit and loss account Profit
and Loss A/c Dr.
To Interest A/c
Illustration
A Company issued 12% debentures of the face value of Rs. 200,000 at 10% discount on 1-1-2014.
Debentures interest after deducting tax at source @ 10% was payable on 30th June and 31st December
every year. All the debentures were to be redeemed after the expiry of five year period at 5% premium.
Pass journal entries for the accounting year 2014.
Solution:

.
1. Which of the following statements is true?

(a) A debenture holder is an owner of the company
(b) A debenture holder can get his money back only on the liquidation of the company
(c) A debenture issued at a discount can be redeemed at a premium
(d) A debenture holder receives interest only in the event of profits
2. Premium on redemption of debentures account is _______.

.
(a) A real account (b) A nominal account - income

(c) A personal account (d) A nominal account - expenditure

(a) At maturity, debenture holders get back their money as per the terms and conditions of
redemption
(b) Debentures can be forfeited for non payment of call money
(c) In companys balance sheet, debentures are shown under secured loans
(d) Interest on debentures is charged against profits

(a) A company can issue convertible debentures (b) Debentures cannot be secured
(c) A company can issue redeemable debentures
(d) Debentures have no right to participate in profits over and above their fixed interest
5. Debenture premium can be used to _____.

(a) Write off the discount on issue of shares (b) Write off the premium on redemption or
debentures of shares or debentures
(c) Write off capital loss (d) All of the above
6. F Ltd. purchased Machinery from G Company for a book value of Rs.4,00,000. The
consideration was paid by issue of 10% debentures of Rs.100 each at a discount of 20%. The
debenture account was credited with ______.
(a) Rs.4,00,000 (b) Rs.5,00,000
(c) Rs.3,20,000 (d) Rs.4,80,000
7. Which of the following is not a characteristic of Bearer Debentures?

(a) They are treated as negotiable instruments
(b) Their transfer requires a deed of transfer
(c) They are transferable by mere delivery
(d) The interest on it is paid to the holder irrespective of identity.
8. T Ltd. has issued 14% Debentures of Rs.20,00,000 at a discount of 10% on April 01, 2011 and
the company pays interest half-yearly on June 30, and December 31 every year. On March 31,
2013, the amount shown as interest accrued but not due in the Balance Sheet will be
(a) Rs.70,000 (b) Rs.2,10,000 (c) Rs.1,40,000 (d) Rs.2,80,000
9. On May 01, 2010 U Ltd. issued 7% 10,000 convertible debentures of Rs.100 each at a
premium of 20%. Interest is payable on September 30 and March 31 every year. Assuming
that the interest runs from the date of issue, the total amount of interest expenditure debited
to profit and loss account for the year ended March 31, 2014 will be
(a) Rs.70,000 (b) Rs.58,333

.
(c) Rs.84,000 (d) Rs.64,167
10. Which of the following is/are true with respect to debentures?

(a) They can be issued for cash
(b) They can be issued for consideration other than cash
(c) They cannot be issued as collateral security
(d) Both (a) and (b) above
11. W Ltd. issued 20,000, 8% debentures of Rs.10 each at par, which are redeemable after 5 years
at a premium of 20%. The amount of loss on redemption of debentures to be written off every
year will be
(a) Rs.40,000 (b) Rs.10,000
(c) Rs.20,000 (d) Rs.8,000
12. When debentures are issued as collateral security, the final entry for recording the
transaction in the books is __________.
(a) Credit Debentures A/c and debit Cash A/c.
(b) Debit Debenture suspense A/c and credit Cash A/c.
(c) Debit Debenture suspense A/c and credit Debentures A/c.
(d) Debit cash A/c and credit the loan A/c for which security is given
13. Which of the following is false?

(a) A company can issue redeemable debentures
(b) A company can issue debentures with voting rights
(c) A company can buy its own shares
(d) A company can buy its own debentures
14. Which of the following is false with respect to debentures?

(a) They can be issued for cash
(b) They can be issued for consideration other than cash
(c) They can be issued as collateral security
(d) They can be issued in lieu of dividends
15. Debentures can be _________.

I. Mortgage Debentures or Simple Debentures.
II. Registered Debentures or Bearer Debentures III. Redeemable
Debentures or Irredeemable Debentures.
IV. Convertible Debentures or Non-convertible Debentures.
(a) Both (I) and (II) above (b) Both (I) and (III) above
(c) Both (II) and (III) above (d) All of (I), (II), (III) and (IV) above.

.

(a) Debenture is a form of public borrowing
(b) It is customary to prefix debentures with the agreed rate of interest
(c) Debenture interest is a charge against profits
(d) The issue price and redemption value of debentures cannot differ.
17. Interest on debentures is calculated on

(a) its face value (b) its issue price
(c) its market price (d) its redemption price
18. T Ltd. purchased land and building from U Ltd. for a book value of Rs.2,00,000. The
consideration was paid by issue of 12% Debentures of Rs.100 each at a premium of 25%. The
debentures account is credited with _____________.
(a) Rs.2,60,000 (b) Rs.2,50,000
(c) Rs.2,40,000 (d) Rs.1,60,000
19. P Ltd. issued 5,000, 12% debentures of Rs.100 each at a premium of 10%, which are
redeemable after 10 years at a premium of 20%. The amount of loss on redemption of
debentures to be written off every year = ?
(a) Rs.80,000 (b) Rs.40,000
(c) Rs.10,000 (d) Rs. 8,000
20. Which of the following is true - 10% Debentures issued at a discount of 20%?
(a) The carrying amount of debentures gets reduced each year at a rate of 20% (b) Issue price and
the carrying amount of debentures are equal
(c) At the time of redemption, the debenture holder will be paid the issue price
(d) The face value and the carrying amount of debentures are equal.
21. Which of the following is false?

(a) Equity is owners stake and the debenture is a debt
(b) Rate of interest on debentures is fixed
(c) Debenture holders get preferential treatment over the equity holders at the time of liquidation
(d) Interest on debentures is an appropriation of profits.
22. Discount on issue of debentures is a ____________.

(a) Revenue loss to be charged in the year of issue
(b) Capital loss to be written off from capital reserve
(c) Capital loss to be written off over the tenure of the debentures
(d) Capital loss to be shown as goodwill

.
23. When debentures are issued as collateral security against any loan then holder of such
debentures is entitled to
(a) Interest only on the amount of loan
(b) Interest only on the face value of debentures
(c) Interest both on the amount of the loan and on the debentures (d) None of the above.
24. When debentures are redeemable at different dates, the total amount of discount on issue of
debentures should be written off
(a) Every year by applying the sum of the years digit method
(b) Every year by applying the straight line method
(c) To profit and loss account in full in the year of final or last redemption
(d) To profit and loss account in full in the year of first redemption.
1.( c ) 2.( c ) 3.( b ) 4.( b ) 5.( d ) 6.( c )
7.( b ) 8.( a ) 9.( d ) 10.( d ) 11.( d ) 12.( c )
13.( b ) 14.( d ) 15.( d ) 16.( d ) 17.( a ) 18.( d )
19.( c ) 20.( d ) 21.( d ) 22.( c ) 23.( a ) 24. ( a )

.
NOTES
PART-B

.
FUNDAMENTALS OF AUDITING
Unit-1 CONCEPT OF AUDITING

.
Super Summary PT
An Audit is an independent examination of financial or non-financial information of any entity
when such an examination is conducted with a view to express an opinion thereon.
An Audit deals with checking, verification and examination of accounts. The audit can be started
only when the accounting ends.
Principal Aspects to be Covered in Audit:
1. Review of system and procedures;

2. Review of Internal Control System;
3. Routine Checking/Arithmetical Accuracy;
4. Accounting Principles;
5. Books and Statements;
6. Verification of Assets;
7. Verification of Liabilities;
8. True and Fair View; 9. Statutory Compliance and
10. Reporting.
Benefits of Audit:
1. Satisfaction of Owner;
2. Detection and Prevention of Errors and Frauds;
3. Verification of Books of Accounts;
4. Independent Opinion;
5. Moral Check;
6. Protection of the Rights and Interests of Shareholders;
7. Reliance by Outsiders;

.
8. Ensures Compliances with Legal Requirements; 9. Reinforce and Strengthen Internal

Control System and
10. Loan Facility.

.
Limitations of an Audit:
1. Higher Cost Burden;
2. Based on Test Checks;
3. Insufficient Time;
4. Evidence Obtained by an Auditor are Persuasive rather than Conclusive;
5. Auditors cannot determine the appropriateness of Accounting Estimates because of
uncertainties involved in it and
6. Audit is based on the Information provided by Management.
Difference between Investigation and Auditing: Investigation implies systematic,

critical and special examination of the records of a business for a specific purpose whereas audit
is independent examination of financial information of any entity, when such an examination is
conducted with a view to expressing an opinion thereon.
Particulars Investigation Auditing

Meaning Investigation implies systematic, critical An audit is independent examination of
and special examination of records of a financial information of any entity,
business for a specific purpose. when such an examination is
conducted with a view to expressing an
opinion thereon.
Mandatory Voluntary Mandatory for Companies, Voluntary
Nature for others
Conducted by Any person, who may not be a Chartered Conducted by A Chartered Accountant
Accountant
Appointed By Owners or Management or even third Owners/Shareholders of the
parties may appoint the investigator. enterprise.
Protection of Work is carried out from the viewpoint of Work is carried out on behalf of the
Interests the appointed agency. owners, even if the power of
appointment is delegated to BOD.
Scope and Specific Seeks to answer only those General When compared to
Coverage questions laid down in the engagement Investigation Seeks to form an
letter. opinion on the Financial Statements.
Period Covered It can extend for a period consisting of a Generally a period of one financial
number of years. year.

.
Form of There is no statutory form of The matters to be covered in audit

Reporting Investigation report. report are sometimes presccribed by
law.

.
GLOSSARY
Connivance Agreement on a secret plot, collusion
Persuasive Intended or having the power to induce action or belief, convincing.
Conclusive Forming an end or termination: especially putting an end to doubt or question?

Conclusive proof: The evidence is conclusive
GAAP Generally Accepted Accounting Principles, a collection of rules and procedures

and conventions that define accepted accounting practice: includes broad
guidelines as well as detailed procedures.
Statutory Relating to or created by statutes: Statutory matter, Statutory law. Statute

means law enacted by a government.
Corroborative To strengthen or support with additional evidence.

.
NOTES
PART-B
.
Unit-2 TYPES OF AUDIT

.
Super Summary PT
Internal Audit: Internal audit is an evaluation and analysis of the business operation conducted by
the internal audit staff. It is the part of overall system of internal control established in an organization.
Objective of Internal Audit:

1. Proper Control;
2. Accounting System;
3. Help Management;
4. Working Review;
5. Asset Protection;
6. Internal Check;
7. Fair Statements;
8. Check Error;
9. Detect Fraud;
10. Determine Liability;
11. Help in Independent Audit;
12. Performance Appraisal;
13. Provide Suggestions;
14. New ideas, use of resources, accounting policies, special investigation.
Benefits of Internal Audit:

1. Proper Accounting System;
2. Better Management;
3. Progressive Review;
4. Effective Control;
5. Assets Protection;
6. Division of Work;
7. No Error and Fraud;
8. Fixing Responsibility;
9. Helps External Auditing;
10. Performance Improves;

.
11. Investigation;
12. Proper Use of Resources.

.
Limitations of Internal Audit:

1. Staff Shortage;
2. Time Lag;
3. Error;
4. Responsibility;
5. Duties.
Financial Audit: Independent financial audit is generally conducted to ascertain whether the balance
sheet and profit & loss account present a true and fair view of the financial position and working result
of the organization under audit.
Secretarial Audit: Secretarial Audit is a process to check compliance with the provision of
various laws and rules/regulations/ procedures, maintenance of books, records etc., by an
independent professional to ensure that the company has complied with the legal and
procedural requirement and also followed the due process.
It is essentially a mechanism to monitor compliance with the requirements of stated laws. A

company Secretary in Practice has be assigned the role of Secretarial Auditor under section
2(d)(c)(v) of the company secretaries Act, 1980.
Two objective to ensure compliances of laws applicable to a company To protect the interests
of all the stakeholders and To avoid any legal action against the company and its management.
Cost Audit: A system of audit introduced by the Government of India for the review, examination, and
appraisal of the cost accounting records and attendant information, required to be maintained by
specified industries.
Tax Audit: The objective of such audit is to assist the tax authorities in making the correct income tax
assessment of the assessee concerned. As per the Income Tax Act, 1961, every person carrying on
business whose turnover or gross receipts exceeds Rs. 1 Crore (Rs. 25 Lakhs if carrying on profession)
in the previous year shall get its accounts audited.
Bank Audit: The Banking Regulation ACT, 1949 contains the provisions relation to the maintenance of
accounts and their audit.

.

.
Co-Operative Society Audit: The management of the affairs of the Co-operative societies is in the
hands of only some of the elected members. This necessitates an independent financial audit of accounts
of co-operative societies.
Trust Audit: It is specifically provided in the relevant law or in the trust deed that the trustees shall
get the financial statements of the trust audited.
Insurance Audit: Insurance Regulatory and Development, Act 1999 contains the provision of the
maintenance of accounts and audit of the Insurance companies.
Partnership Firm Audit: At present, partnership firms in India are not legally required to get their
financial statements audited. Still, many firms get their financial statements audited.
Sole Proprietorship Audit: Like partnership firms, sole proprietary concerns are also not legally
required to get their financial statements audited by independent financial auditors.
Government Audit: It is the duty of Comptroller and Auditor General of India (C&AG) to audit the
receipts and expenditure of the Union Government and State Government.
Management Audit: It is a structures review of the systems and procedures of an

organization in order to evaluate whether they are being conducted efficiently and effectively.
Functional Audit: In this form of audit, a function is analyzed thoroughly with respect to system,
process, input and output.
Propriety Audit: Under this type of audit, the expenditure is analyzed with a view to ascertain the
cases of improper, avoidable or in fructuous expenditure even though the expenditure has been incurred
in conformity with the existing rules and regulations.

.
Efficiency Audit: Efficiency audit or performance audit is a form of audit which is being carried out
for ascertaining the efficiency/performance of a system/process/input.
GLOSSARY

.
Constructive Arm Improve or promote development
Independence Free from the influence, guidance, or control of another or others: Self- Reliant an
independent mine.
Practicing Company The member of ICSI who hold certificate of practice.

Secretary:
Check An action or influence that stops motion or expression ; a restraint
NOTES

.
PART-B
Unit-3 TOOLS OF AUDITING

.

.
Super Summary PT
An audit plan lays out the strategies to be followed to conduct an audit.
It includes the nature, timing and extent of audit procedures to be performed.
The auditor should consider the following matters while laying out an audit plan:
Terms of engagement and any statutory responsibilities.

Nature and timing of report or other communications.
Accounting policies followed by the enterprise and change in those policies.
Effect of new accounting or auditing requirements.
Identification of significant audit areas.
Setting of materiality levels for audit purposes.
Degree of reliance expected to be placed on accounting system and internal control. Nature and
extent of audit evidence.
Work of internal auditors.
Establishing and coordinating staffing requirements.
An audit programme is a set of instructions which are to be followed for proper execution of audit.
The audit programme contains the measures that are generally employed to determine what, and how
much evidence must be collected and evaluated.
It also lays down the responsibilities for the whole audit team for carrying out different tasks.
Advantages of Audit Programme
1. It ensures that all important areas are covered during audit;

2. It distributes the work among the assistants as per their competence;
3. It provides instructions to staff and reduces scope for misunderstanding;
4. It fixes the responsibility for the work done;
5. It helps in assessing the progress of work it serves as evidence against charge of negligence;
6. It serves the purpose of audit record which may be useful for future reference.
Disadvantages of Audit Programme
1. Loses its flexibility;

2. It kills the initiative of capable persons;
3. It is mechanical;
4. Not suitable for small audits: new problems arise may be over looked in the audit programme.

.

.
Remedial Actions
1. Programme should be flexible;

2. Staff should be encouraged to draw attention to any defects, and 3. The staff should be
encouraged to explore fully unusual transaction.
Audit Working Papers are the documents prepared or obtained by the auditors and retained by him
in connection with the audit. Working papers include all the evidence gathered by auditor.
Advantages of Maintenance of Working Papers -
1. Working Papers helps in proper planning and performance of audit,

2. Seniors can supervise the audit work,
3. It provide as evidence of the audit work performed.
The auditor can divide his working papers into two parts: Types of Working Papers
Permanent Audit File- The data in these file are the information, which is of continues
interest and relevance to succeeding audits.
Current Audit File- These file contains information relating to the audit of the current period.
Audit Evidence is information that is collected and used to provide a factual basis for developing
observations and concluding against audit objectives. Evidence provides grounds for believing that a
Particular thing is true or not by providing persuasive support for a fact or a pint in question. Audits
should have is true or not by providing persuasive support for a fact or a ping in question.
Audits should have sufficient appropriate evidence to support the contents of the audit report. For
evidence to be appropriate, the information must be relevant, reliable and valid. The quantity of evidence
is sufficient if when taken as a whole its weight is adequate to provide persuasive support for the
contents of the audit report.
Techniques of Obtaining Evidence (IOECA)
Inspection,
Observation,
Enquiry,
Confirmation,
Computation,

.
Analytical Review Procedures, Independent

Execution.

.
GLOSSARY
Standard of Auditing SAs are standard on auditing issued by the Institute of Chartered
(SAs) Accountants of India. They are the guidelines to conduct an audit.
Documentary Evidence Evidence in the Form of Written papers or documents.

Testimonial Evidence Something that recommends a person or thing as worthy or desirable.
Audit Risk Audit risk is the risk of the auditor providing an inappropriate opinion on
the financial statements, particularly when those financial statements
contain a material misstatement.
Analytical Review Any process by which a person or company looks at an account or financial
statement and attempts to identify any irregularities. This may involve
comparing financial and non-financial information. An analytical review is
less thorough than an audit.

.
NOTES
PART-B
.
Unit-3
AUDITOR AND RELATED PROVISIONS

.
Super Summary PT
A Person who conducts an audit is an Auditor.

.
An Auditor is a professional that accumulates and evaluates evidence to report whether the
company complies with the established set of procedures or standards.
When the auditor works for the organization, he or she is usually referred to as an internal auditor.
Whereas independent external agency is known as External auditor of the organization.
The provisions with regard to the appointment of an auditor can be divided into three categories:
Section 224:
o First auditor - By the Board of directors within one month of the date of the registration
of the company.
o Subsequent Auditor every company must appoint an auditor or auditor or

auditors at each annual general meeting.
o Filling of Casual Vacancy Casual vacancy in the office of auditor may be filled by the
Board. But where the vacancy is caused by resignation of auditor, such vacancy shall only
be filled by the company in general meeting.
Power of the Central Government to Appoint Auditors- If no auditors are

appointed or re-appointed at the annual general meeting, the Central Government may appoint a
person to fill the vacancy.
Qualification of an Auditor-
1. Only Chartered Accountant in practice within the meaning of Chartered Accountants Act,
1949 can act as an auditor of a limited company.
2. A firm whereof all the partners are practicing Chartered Accountants can be appointed by
its form name as auditor in such case any partner may act in the name of the firm.

.
Disqualification of Auditor- None of the Following shall be qualified for appointment as

auditor of as company;

.
A body corporate;
An officer on employee of the company (officer includes director manager or secretary);
A person who is a partner or who is in the employment of an officer or employee of the
company;
A person who is indebted to the company for more than Rs 1000/- or who has guaranteed
the repayment of any debt of more than Rs. 1,000/- due to the company by a their person;
A person holding any security of that company after a period of one year from the date of
commencement of the Companies (Amendment) Act, 2000 i.e. 13th December, 2000;
A person who is disqualified for appointment as auditor of the company subsidiary or
holding company, or a subsidiary of its holding company;
Statutory auditor cannot act as internal auditor of the company.

Statutory auditor can act as Tax auditor of same company.
Other Disqualifications -
If a partner is disqualified, then the firm will automatically be disqualified.
In case of insolvency or unsound mind, a person ceases to be a member of ICAI, so he will
automatically be disqualified for appointment as an auditor.
Right and power of Auditors
Right to access to books, accounts and vouchers;

Right to obtain information and explanation;
Right to sign the audit report:
Right to receive notice of and attend General Meeting,
Right to receive remuneration;
Right to visit branch office and right of access to books.

.
Duties of Auditors
An auditor to inquire whether loans and advances made by the company are properly secured
and the terms on which they have been made are not prejudicial to the company;
Book entries transaction are not prejudicial to the interests of the company;
In case of non-investment or a banking company, whether shares, debentures and other
securities have been sold at a price less than its purchase price;

.
Whether loans and advances made by the company have been shown as deposits;
No personal expense has been charged to profits;
Whether cash has actually been received in respect of any shares shown in the books to have been
allotted for cash;
Whether the books are not misleading.
Auditors Report The report must expressly state:
Whether, in his opinion and to the best of his information and according to explanation given to
him, the accounts give the information required by the Act and in required manner;
Whether the balance sheet and profit and loss account gives a true and fair view;
Whether he has obtained all the information and explanations required;
Whether, in his opinion, proper books of account as required by law have been kept by the
company, and proper returns for the purposes of his audit have been received from the branches
not visited by his;
Whether the companys balance sheet and profit and loss account are in agreement with the
books;
Whether in his opinion, the profit and loss account and balance sheet comply with the AS;
Auditors observation or comments;
In thick type or in italics the observation or comments of the auditors which have any adverse
effects on functioning of the company.
Whether are director is disqualified from appointment: reason for negative answers.

.
Essentials of Audit Report-

1. Title;
2. Addressee;
3. Identification;
4. Reference to Auditing Standards;
5. Opinion;
6. Signature; 7. Auditors Address;
8. Date of Report.
Types of Auditor opinion-

.
Unqualified opinion Where auditor does not have any reservation, objection regarding the
information under audit, then he issues an unqualified opinion. It is also known as Clean Report.
Adverse or Negative Opinion Where as a result of the examination of the books of

accounts, the auditor concludes that he does not agree with the true and fair view of financial
statements under audit.
Qualified Opinion As per this opinion subject to certain reservation or qualification

stated, the auditor agrees with the proposition stated in the financial statements.
Disclaimer of opinion It is a situation when auditor is not in a position to give his

opinion due to lack of sufficient appropriate audit evidence.

.
GLOSSARY
Body Corporate Group of persons incorporated under the Companies Act, 1956 to carry
out a specific enterprise and having limited liability.
Indebted Money borrowed an obligation to repay an amount you owe.
Annual General Statutory meeting of the directors and shareholders of a company or of

Meeting the members of a society, held once every financial year, at which the
annual report is presented required under the Companies Act, 1956 Board
Meeting Meeting of directors of the Company.

.
NOTES

.
Fill in the blanks
1. The evidence obtained by an audit is . Rather than conclusive.

2. The term Audit originated from the Latin word audire Means
3. Auditing can be defined as an .. examination of records ( Financial or non-financial)
4. If internal control system is effective checking is required and vice-versa.
5. The purpose of internal Audit is to keep proper over business activities.
6. Internal audit is conducted by
7. Internal audit is a part of ..system
8. Time lag is one of the . Of internal audit.
9. Sect6in 224 of the Companies Act 1956 contains provisions regarding the of the auditor.
10. Secretarial audit is also termed as audit.
11. A... has been assigned the role of Secretarial Auditor under section 2(2) ( c) (V) of the
Company Secretaries Act, 1980.
12. . Audit is useful for the purpose of Cost Control; Cost reduction and proper utilization of
scarce resources.
13. AT the stage the auditor sets the materiality levels.
14. While laying down an audit plan the auditor shall assess the effectiveness of accounting systems
and
15. An audit programme is a set of which are to be followed for proper execution of audit.

.
16. Audit programme is documented in the , which are the official record that contains the
planning and execution of the audit agreement.
17. The working papers are the property of the..
18. The auditor can divide his working papers into..
19. Current audit file contains information related to audit of
20. . refers to the extent to which the information bears a clear and logical relationship to
the audit criteria and objectives.
21. Documentary evidence is usually better than . Evidence.
22. Section .. of the Companies Act 1956 contains provisions regarding the appointment of the
auditor.
23. Is there are need to send any intimation of appointment to Auditor, true or false.
24. As per Section 224(1A), every auditor appointed under section 224 (1) must, within . Day of
the receipt from the company of intimation of his appointment, inform the Registrar in writing in
Form No that he has accepted the appointment or refused it.
25. A person who is indebted to the company for mare than Rs
26. The auditors report is to be laid before the company in . meeting.
27. Where auditor does not have any reservation, objection regarding the information under audit,
then he issues opinion.
28. In a situation where auditor is not in a position to collect sufficient appropriate audit evidence to
draws conclusion then auditor gives.. of opinion.

.
NOTES

.

.
DIFFERENCE BETWEEN LLP & PARTNERSHIP
S. PARTICULARS LIMITED LIABILITY PARTNERSHIP FIRM

NO. PARTNERSHIP
1. Governing Law The Limited Liability Partnership The Indian Partnership Act, 1932 and
Act, various Rules made thereunder
2008 and various Rules made
thereunder
2. Registration Compulsory Optional
3. Creation Created by law Created by contract
4. Separate Legal It is separate legal entity, separate It is not separate legal entity from
Entity from its partners/ designated partners. Partners are collectively
partners. referred as firm.
5. Perpetual It has perpetual succession. It does not have perpetual
succession succession.
6. Purchase of LLP can also purchase movable / Partnership firm cannot purchase
Property immovable property in its name movable / immoveable property in its
name. the same must be purchased in
the name of partners.
7. Common Seal It denotes the signature of the Not required
Company and LLP may have its own
common seal, if it besides to have
one.
8. Legal Proceeding LLP can also sue and be sued Only registered partnership can sue.
9. Taxation Its status in unclear, pending It is a separate taxable entity
changes in income tax act.
10. Name Suffix LLP or Limited Liability No such requirement.
Partnership has to be added to the
name.
11. Ownership of The LLP has ownership of assets and Partners have joint ownership of all
Assets Partners only have capital the assets
contribution in the LLP
12. Liability Liability of partners is limited upto Liability of partners is unlimited
their capital contribution however in
case a partners acts with an
intension to conduct fraud, they are
personally liable.
13. Agency Partners are agents of LLP Partners are agents of the firm and
Relationship each other
14. Contracts / A partner can enter into contract A partner can not enter into contract
Business with the LLP with the firm
transaction by
Partners
15. Power of Member\ The power of partners/ designated All the partners have say in the day to
Partner\ Director partners to conduct the day to day day management of the firm or as
affairs is specified by LLP agreement specified in the partnership deed if
/ LLP act. there is any
16. Dissolution by an Continuance of LLP is not affected Partnership contract can be put to an
act of partners / by the acts of its Partners. end by anyone of the members \ on
members / happening of event specified in
directors partnership act, 1932
17. Transferability of Rights/ interest of partners are Transferability of Interest subject to
interest transferable as per the provisions of the mutual consent of all the
LLP agreement. members.
ture A LLP is a body corporate formed Partnership is a relation between
and incorporated under this act and persons who have agreed to share the
which has legal entity separate from profits of business carried on by all or
that of its partners, having any of them acting for all with
perpetual succession and liability of unlimited liability.
its partner shall be limited.
nimum Capital No such requirement No such requirement
quirement
oks of Accounts Books of accounts must be prepared Not applicable
as specified in the LLP Act.
Manner of Keeping Cash basis or accrual basis Cash or accrual basis
Books of Accounts
Filing of Annual Statement of accounts and solvency Not applicable
Accounts are required to be filed with ROC
annually in the prescribed format.
Applicability of Its status in unclear, pending Accounting standard are
Accounting changes in income tax act. not applicable.
standards
Annual Return Annual Return is required to be filed Not applicable
with the ROC annually in the
prescribed format
Minimum Number Minimum two partners Minimum two partner
of Member
Maximum number No cap of maximum number of its Maximum 10 for banking business and
of Member partners 20 for other business.
Designated Minimum two designated partner No cap on the minimum number of
partner/ Director/ Managing partner
Managing Partner
Need for The designated partner need not be Managing partner shall be a partner of
Designated a partner of the company the firm
partner/
Director/
Managing Partner
to be partner/
member
Remuneration / Remuneration will be A partner is not entitled to receive any
Salary provided only if remuneration for taking part in the
provided in conduct of business
the LLP agreement.
Memorandum and LLP Agreement is a charter of the Partnership Deed is a charter of the
Articles of LLP which denotes its scope of firm which denotes its scope of
Association \ operation. operation.
Partnership deed/
Partnership
Agreement
Meetings Meeting of the Designated Partners No such requirement
have to be held at specific time
period as per the Provisions of LLP
Act.
Change in Notice of change of director is to be Notice of change of partners should
directors / given to the ROC. be given to Registrar of Firms
designated
partners/
Partners
33. Rights / Duties / Rights / Duties / obligation of Rights / Duties / obligation of directors
obligation of directors are governed are governed by partnership deed.
Partners / by Partnership Agreement
Managing Partners
/ Directors
34. Voting Rights Each partner has only one vote Not applicable
35. Transfer of Share / In case of death of partner, the legal In case of death of partner, the legal
Partnership rights heir has the right to refund of capital heir has the right to refund of capital
in case of death contribution + share in accumulated contribution + share in accumulated
profits, if any. Legal Heirs will not profits, if any. Legal Heirs will not
become partners become partners
36. Admission as A person can be admitted as a A person can be admitted as a partner
partner/ member partner with the consent of all the with the consent of all the partners.
partners.
37. Drawing Drawings are permitted as per the Drawings are permitted.
LLP agreement

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Praveen Tawania Edition 2015

Objectives To maintain SYSTEMATIC ACCOUNTING RECORDS

To COMMUNICATE information to users.

ADVANTAGES & LIMITATIONS OF ACCOUNTING

Facilitates the compliance with legal requirements. Facilitates

BOOK-KEEPING AND ACCOUNTING

1. It is a process concerned with recording It is a process concerned with summarising

4. Managerial decisions cannot be taken Management takes decisions on the basis of

BRANCHES OF ACCOUNTING/SUB-FIELDS OF ACCOUNTING

1. Maintenance of Books of Account

OBJECTIVE TYPE QUESTIONS:

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1. Which of the following is not a sub-field of Accounting?

2. Purpose of an accounting system include all the following except:

3. Book-keeping is mainly concerned with

4. All of the following are functions of Accounting except

5. Financial statements are part of

6. Financial position of the business is ascertained on the basis of

7. Users of accounting information include

8. Financial statements do not consider

9. On January 1, Sohan paid rent of Rs. 5,000. This can be classified as

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1. Based on real assumptions.

1. Accounting conventions emerge out of accounting practices, commonly known as

2. These conventions are derived by usage and practice.

Accounting Period LIFE OF ENTERPRISE IS ARTIFICIALLY SPLIT

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NEITHER THE INTENTION NOR

Consistency Concept SAME ACCOUNTING POLICY IS FOLLOWED from one accounting

Prudence Concept NOT ANTICIPATED PROFITS

Full Disclosure DISCLOSE ALL RELEVANT AND

E.g. Accounting of small calculator as an expense and not as an asset.

(1) It increases one Asset and decreases other Asset;

Examples of the application of the convention of conservatism

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OBJECTIVE TYPE QUESTIONS:

2. Two primary qualitative characteristics of financial statements are

7. Capital brought in by the proprietor is an example of

9. Revenue from sale of products, is generally, realized in the period in which

11. Decrease in the amount of creditors results in

14. If an individual asset is increased, there will be a corresponding

15. Purchase of machinery for cash

16. Consider the following data pertaining to Alpha Ltd.:

(i) What is the correct amount of profit to be reported in the books?

c) Rs. 150,000 d) Rs. 133,000

(ii) Which measurement base should be followed in the statement?

(iii) Which concept should be followed in the statement?

(iv) Which concept should be followed in the statement

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At present how many AS At present Thirty One (31) AS are in force

Why is it essential to It is essential to standardize Accounting Principles and Policies in order to

2. To comply with AS.

Is Disclosure required if FAA has been followed? No Disclosure is required.

Capital Capital = Assets Liabilities

ACCOUNTING AS A MEASUREMENT DISCIPLINE

Examples of 1. Doubtful Debts.

Changes in Changes in Accounting Estimates means differences arising between certain

List of Accounting Standards

AS 1 : Disclosure of Accounting Policies