financial accounting prepared by mrs. prasanna...

NEW HORIZON COLLEGE MARATHALLI, BANGALORE

(Affiliated to Bangalore University) A Recipient of Prestigious Rajyotsava State Award 2012 conferred by the Government of Karnataka

II SEM BBM STUDY MATERIAL

FINANCIAL ACCOUNTING

Prepared By

Mrs. Prasanna Prakash

Mrs. Sreeja Nair

Ring Road, Bellandur Post, Near Marathalli, Bangalore - 560 103 Tel : +91-80-6629 7777 Fax : +91-80-2844 0770

E-mail : [email protected] Web : www.newhorizonindia.edu

mailto:[email protected]

2

INDEX

SR.

NO.

TITLE PAGE NO.

1 Departmental Accounting

4 - 12

2. Insurance claims 13-18

3. Hire purchase system 19 - 31

4. Royalty 32 – 37

5 Acquisition of Business of Non- Corporate

Entities 38 – 44

6. Books for reference 45

4

CHAPTER -1 DEPARTMENTAL ACCOUNTING

INTRODUCTION:

A Departmental undertaking refers to large organization or a concern

which has a number of departments, each of which is specialized in a particular

line of activity or a particular product or service.

ADVANTAGES OF DEPARTMENTAL ACCOUNTS:

The following are the major advantages of departmental accounts:

It enables the management to know the specific results of each department, thereby

helping it in various aspects of decision making.

The profitability of each department may help the management for taking

decisions whether to drop a department or to add a new one.

The growth potentials of a department can be evaluated by having comparison

with the other departments.

The users of accounting information like shareholders, investors, creditors etc can

be provided more detailed information.

It helps the management to determine the justification of proper use of capital

invested in each department.

It helps to have comparison of various expenses of each department with previous

period or with other department of the same concern.

The information provided by departmental accounts may be helpful to the

management for future intelligent planning and control.

The departmental managers and staff can be suitably rewarded on the basis of the

departmental results.

APPORTIONMENT OF REVENUE ITEMS:

ITEMS OF DIRECT

EXPENDITURE

BASIS OF APPORTIONMENT

Freight & carriage inwards for

purchases.

Ratio of net purchases

Import duty, octroi etc on

purchases

Ratio of net purchases

Power charges Ratio of floor space occupied by

5

each department

Water charges Ratio of floor space occupied by

each department

ITEMS OF INCOME BASIS OF APPORTIONMENT

Discount received Ratio of net purchases

Commission earned on sales Ratio of net sales

Reserves for discount on creditors Ratio of net purchases.

ITEMS OF INDIRECT

EXPENDITURE

BASIS OF APPORTIONMENT

Discount allowed Net sales

Selling commission Net sales

Sales tax Net sales

Carriage outwards Net sales

Salesmen salary & commission Net sales

After sales service Net sales

Advertisement Net sales

Bad debts Net sales

Reserve for bad debts Net sales

Rent and rates Ratio of floor space occupied by

each department

Repairs and insurance Ratio of floor space occupied by

each department

Air conditioning expenses Ratio of floor space occupied by

each department

Electricity bills (lighting) Ratio of no. of light points in each

department

Insurance premium Ratio of value of subject matter

insured

Workman‘s compensation

insurance

Ratio of wages to workers of each

department

Canteen expenses Ratio of no. of workers of each

department

Recreation expenses Ratio of no. of workers of each

department

Labour welfare expenses Ratio of no. of workers of each

department

Note: If the problem specifies any particular basis for apportionment, the same

must be adopted and not the basis stated in the table above.

On preparation of departmental profit & loss A/c, the net profit or net loss of

each department can be ascertained . this profit or loss must be transferred to the

general profit and loss A/c.

6

NOTE: Common expenses and income which are not apportionable are included in

General profit and loss A/c.

Common expenses which are not apportionable among departments include:

Interest on capital

Interest on debentures

General managers salary

Audit fees

Directors fees

Bank charges

Legal charges

Office expenses which are incurred by the administration.

Common incomes which are not apportion able among departments include:

Dividend received

Transfer fees

Interest on bank deposit.

Q.1 From the following particulars prepares department trading and profit and loss

A/c and balance sheet.

Particulars Dept A Dept B

Stock on 1-04-2010 17400 14700

Purchases 35000 30000

Sales 60000 40000

Wages 8200 2700

Rent ,tax & insurance 9390 -

Sundry expenses 3600 -

Salaries 3000 -

Lighting & heating 2100 -

Discount allowed 2220 -

Discount received 650 -

Advertising 3680 -

Carriage inwards 2340 -

Furniture 3000 -

Plant & machinery 21000 -

Sundry debtors 6060 -

Capital 47660 -

Drawings 4500 -

Cash 10070 -

7

Additional information:

Internal transfer of goods from dept A at cost price of Rs420

Rent , taxes and insurance , sundry expenses, lighting & heating, salaries &

carriage inward to be distributed in the ratio of 2/3 and 1/3 to A & B.

Advertising to be apportioned equally.

Discounts allowed & received to be apportioned as per sales & purchases (ignoring

transfers).

Depreciation at 10% p.a on furniture and plant and machinery to be charged ¾ to

A dept and ¼ to B dept.

Services rendered by B dept to A dept included in wages of B dept Rs 500.

Stock on 31-3-2011 was: Dept A - 16740 Dept B - 12050.

Solutions

:

Departmental trading A/c for the year ended 31-03-2011

Particulars A B Total Particulars A B Total

To opening stock 17400 14700 32100 By sales 60000 40000 100000

To purchases 35000 30000 65000 By closing stock 16740 12050 28790

To wages 8700 2200 10900 By transfers to B 420 - 420

To transfer from A - 420 420

To carriage

inward(2:3)

1560 780 2340

To gross profit c/d 14500 3950 18450

77160 52050 129210 77160 52050 129210

|

8

Profit and loss A/c for the year ended 31-03-2011

Balancesheet as on 31-03-2011

Liabilities Amt Amt Assets Amt Amt

Capital 47660 Furniture &fittings 3000

Less drawings (4500) Less depreciation 10% 300 2700

43160

Less: net loss (7290) 35870 Plant and machinery 21000

Sundry creditors 30650 Less depreciation 2100 18900

Sundry debtors 6060

Cash in hand 10070

Closing stock 28790

66520 66520

INTER - DEPARTMENTAL TRANSFERS:

Inter departmental transfer refers to selling of goods by one department to another

department.

The accounting treatment for this depends on whether the transfer is

made at cost price or selling price to the transferring department.

When inter- departmental transfers are made at cost price to the transferring

department then in such a case, the transfer must be treated as:

(a) purchases for the transferee dept and hence must be debited to the concerned

departments trading a/c

(b) sales for the transferring dept, and hence must be credited to the concerned

departments trading a/c.

NOTE: there is no other treatment required even though the goods transferred by

one to another is not fully utilized or sold.

When inter- departmental transfers are made at selling price to the

transferring department then in such a case, the transfer must be treated as:


To rent, tax & insurance 6260 3130 9390 By gross profit

b/d

14500 3950 18450

To sundry expenses 2400 1200 3600 By discount

recd

350 300 650

To salaries 2000 1000 3000

To lighting and heating 1400 700 2100

To discount allowed(sales

ratio)

1332 888 2220

To advertising 1840 1840 3680

To depreciation on furniture 225 75 300 By net loss c/d 2182 5108 7290

To plant and machinery 1575 525 2100

17032 9358 26390 17032 9358 26390

9

(a) purchases for the transferee dept and hence must be debited to the concerned

departments trading a/c

(b) sales for the transferring dept, and hence must be credited to the

concerned departments trading a/c.

NOTE: A special adjustment is required to be made when the transfer made by

one department to another is not fully sold. When the goods transferred by one

department to another is in the closing stock of the transferee department, the

amount of profits of transferring department included in such stock must be

considered as unrealized stock.

A stock reserve must be created for unrealized profits in the closing

stock of transferee department by debiting General Profit and Loss A/c.

The amount of stock reserve so created must be deducted from closing stock under

the assets side of the balancesheet.

Q2. X ltd has 2 department A & B. From the following particulars prepare the

department trading A/c and consolidated trading A/c separately for the year ending

31-03-2011.

Particulars A B

Opening stock 20000 12000

Purchases 92000 68000

Sales 140000 112000

Wages 12000 8000

Carriage 2000 2000

Closing stock:

Purchased goods 4500 6000

Finished goods 24000 14000

Purchased goods

transferred

By B to A 10000

By A to B - 8000

Finished goods

transferred

By B to A - 35000

By A to B 40000 -

Return of finished goods

By A to B - 10000

By B to A 7000

10

You are informed that purchase goods have been transferred mutually at their

respective departmental purchase cost and finished goods at departmental market

price and that 20% of the finished stock (closing) at each department represented,

finished goods received from the other department. Calculate also rate of gross

profit and unrealized profit of A & B department of finished stock (closing).

Departmental trading A/c for the year ending 31-03-2011


To opening stock 20000 12000 32000 By sales 140000 112000 252000

To purchases 92000 68000 160000 By transfer of

purchased

goods

8000 10000 18000

To carriage 2000 2000 4000 By transfer of

finished

goods

40000 35000 75000

To wages 12000 8000 20000 By return of

finished

goods

7000 10000 17000

To transfer of

purchase goods

10000 8000 18000 By closing

stock of

purchased

goods

4500 6000 10500

To transfer of

finished goods

35000 40000 75000 By closing

stock of

finished

goods

24000 14000 38000

To return of

finished goods

10000 7000 17000

To gross profit c/d 42500 42000 84500

223500 187000 410500 223500 187000 410500

Departmental general Profit and Loss A/c for the year ending 31-03-2011

Particulars Amt Amt Particulars Amt Amt

To stock

reserve

By gross profit

Dept A 875 Dept A 42500

Dept B 1800 2675 Dept B 42000 84500

To net profit

Dept A 41625

Dept B 40200 81825

84500 84500

11

Working note:

Stock reserve for A dept = gross profit X 25% of FG of B

________________________________________

Sale + transfer of finished goods to B - returns of FG to B

= 42500

____________ X 25% of 14000

140000 +40000-10000

= 875

Stock reserve for B dept = 42000

____________ X 25% of 24000

112000 + 350000-7000

= 1800

NOTE : 20% on sales = 25% on cost.

12

CHAPTER 2: INSURANCE CLAIMS

Introduction

The stock kept in every business is subject to risk by loss of fire. To protect itself against

such loss the business takes up a fire insurance policy by paying premium. The chapter aims

at computing the loss of stock by fire(based on closing stock on the date of fire), which can

thus be claimed as compensation from the insurance company. The following steps may be

followed to start with:

1) % of Gross profit on sales- this can be computed from the gross profit and sales figure

of the trading account for the year prior to the year of fire GP * 100

Sales

2) Memorandum trading account- this trading account must be prepared from the

beginning of the year of fire up to the date of fire. The GP must be calculated based

on the same % as above and the balancing figure of this account will be the closing

stock.

3) Calculation of claim- The final claim to be lodged with the insurance company must

be calculated on the basis of the closing stock in the memorandum trading account as

Claim = Closing stock- Salvage+ fire fighting expenses.

Note: Salvage refers to goods saved from fire,

Fire fighting expenses are incurred to save goods from fire.

Example 1: (simple problem)

The premises of a trader caught fire on 01.07.2012 and the stock was damaged. The

following information is available:

Stock on 01.01.2011 Rs. 95000 Purchase return Rs.15000

Stock on 31.12.2011 Rs.150000 Sales return Rs.30000

Purchases for 2011 Rs.421000 wages Rs.65000

Sales for 2011 Rs.550000

Purchases from 01.01.2012 to 01.07.2012 is Rs.350000

Sales from 01.01.2012 to 01.07.2012 is Rs.491000

Additional information:

1) Purchases of 2012 includes Rs10000 worth of goods distributed as free samples for

advertisement and promotion

13

2) In 2012, a clerk misappropriated unrecorded cash sales Rs.4000

3)Stock worth Rs.18000 could be salvaged; fire fighting expenses incurred to save the goods

was Rs.1000.

Prepare a statement of claim to be submitted to the insurance co.

Solution: Trading account for the year ended 31.12.2011

Particulars Rs. Particulars Rs.

To, opening stock

To, purchases 421000

-Returns 15000

To wages

To, Gross profit

95000

406000

65000

104000

670000

By,Sales 550000

-returns 30000

By, closing stock

520000

150000

670000

Workings:

% gross profit on sales = 104000 *100 =20%

520000

Memorandum Trading Account from 01.01.2012 to 01.07.2012

Particulars Rs Particulars Rs

To, opening stock

To purchases 350000

-Goods given as

free sample 10000

To gross profit

(495000* 20%)

150000

99000

589000

By sales 491000

+unrecorded cash sale

4000

By, closing stock

(bal.fig)

495000

94000

589000

Statement of Claim

Value of closing stock on date of fire Rs.94000

-Salvage Rs.18000

Rs.76000

+ Fire fighting expenses Rs. 1000

Total claim Rs.75000.

14

Average Clause

It refers to a clause in the insurance agreement to discourage the under insurance of stock or

any other asset. This clause is applicable when the value of insurance policy is less than the

value of clasing stock on the date of fire.The claim can be computed as:

Claim= Stock destroyed by fire* Policy value

Stock on date of fire.

EXAMPLE 2: (problem with average clause)

A fire occurred in the premises of M/s unlucky on 15.04.2012 from where goods worth

Rs.30000 only could be saved. Goods worth Rs.26000 were also saved in damaged condition.

From the following information calculate the claim to be submitted to the insurance company

on a policy of Rs.342000.

Stock on 01.01.2011 Rs.288000

Purchases for 2011 Rs.1876000

Stock on 31.12.2011 Rs.484000

Sales for 2011 Rs.2320000

Purchases from 01.01.2012 to 14.04.2012 Rs.364000

Sales from 01.2012 to 14.04.2012 Rs.480000

Carriage inward during 2011 Rs.200000

Carriage inward during 2012 Rs.36000

Carriage outward during 2012 Rs.65000

A fire also broke out on 20th

December 2011 and destroyed stock worth Rs.100000.The firm

had a practice of valuing stock at cost less than 10%.However the policy was changed and the

stock on 31.12.2011 was valued at 10% above cost.

Solution:

Trading Account for the year ended 31.12.2011

Particulars

Rs.

Particulars

Rs.

To opening stock

(288000 x 100 )

90

To purchases

To carriage inward

To Gross profit

(bal.fig)

3,20,000

18,76,000

2,00,000

4,64,000

By Sales

By closing stock

(484000 x 100 )

110

By stock destroyed by

fire

23,20,000

4,40,000

1,00,000

28,60,000 28,60,000

15

Workings: % Gross profit on sales = 464000 x 100 =20%

2320000



To opening stock

To purchases

To carriage inward

To Gross profit

(480000 x 20 %)

440000

364000

36000

96000

By Sales

By Closing stock

(bal.fig)

480000

456000

936000 936000

Stock destroyed by fire is ----

Closing stock Rs.456000

- Salvage of goods

In good condition Rs.30000

In damaged condition Rs.26000

Rs.400000

Amount of claim = Policy value x Stock destroyed by fire

Stock on date of fire

= 342000 x 400000 =RS.300000

456000

Abnormal Line of Goods

Goods which cannot be sold at the normal price or which has a slow rate of turnover (due to

obsolescence or damage) are called as abnormal goods. It is important to note that the rate of

gross profit on sales is calculated only on the basis of normal goods. Hence a separate column

is prepared in the trading and memorandum trading account for the abnormal line of goods.

EXAMPLE:3 (problem with abnormal line of goods)

On 30th

September 2012,the stock of Armstrong Ltd.was lost in fire. Calculate amount of

claim from the following available information.

Stock at cost on 01.04.2011 Rs.37500

Stock at cost on 31.03.2012 Rs.52000

Purchases less returns for year ended 31.03.2012 Rs.253750

16

Sales less returns for year ended 31.03.2012 Rs.315000

Purchases less returns upto 30.09.2012 Rs.145000

Sales less returns upto 30.09.2012 Rs.184050

In valuing the stock on 31.03.2012 due to obsolescence, 50% of the stock originally costing

Rs.6000 had been written off. In May 2012, 3/4 th of the stock had been sold at 90% of the

original cost and it is expected that the balance of the abnormal goods will also realize the

same price. Subject to the above the gross profit remained same throughout. Stock salvaged

was Rs.7200.

Solution:

Trading Account for the year ended 31.03.2012


To opening stock

To purchases

To gross profit

37500

253750

78750

By Sales

By closing stock 52000

+Written off 3000

315000

55000

370000 370000

Workings:

% gross profit on sales = 78750 x 100 = 25%

315000


Particulars Normal Abnorma

l

Total Particulars Normal Abnormal Total

To opening

stock

To

purchases

By gross

profit

(180000 x

25%)

49000

145000

45000

6000

---

---

55000

145000

45000

By Sales

By gross

loss

By closing

stock

(6000 x ¼ x

90%)

180000

----

59000

4050

(6000x ¾

x90 %)

600

1350

184050

600

60350

239000 6000 245000 239000 6000 245000

Note: The gross loss on abnormal stock has come as balancing figure.

Calculation of amount of claim:

Closing stock on date of fire Rs.60350

Less: Salvage Rs. 7200

Amount of claim Rs. 53150

17

Important points for the chapter

1. Trading account for the year prior to the year of fire need not be prepared if the %

gross profit on sales is already provided in the question.

2. Average clause can be applied only when the insurance policy value is given in the

question.

3. Average clause is not applicable if there is no under insurance (even if policy value is

given in the question).

4. Sale of abnormal goods is separate from sale of normal goods, so the % gross profit

on sales is not applicable to the sale of abnormal goods.

5. Stock destroyed by fire (for the purpose of average clause) is the stock on the date of

fire – stock saved from fire ie.salvage.

6. If the gross profits % of several previous years are provided in the question then the

average of such %gross profits must be calculated to be applied in the memorandum

trading account.

18

CHAPTER 3:

HIRE PURCHASE SYSTEM

MEANING

Hire Purchase System refers to the system wherein, the seller of goods delivers the

goods to the buyer without transferring the ownership of goods till the last

installment is paid. Under this system the ownership will be transferred to the buyer on

payment of the last installment. If the buyer makes any default the vendor has the right

to repossess the goods and the installments already paid will be treated as the Hire

Charges. The transaction may result in purchasing of goods by the buyer or in hiring

the goods. Hence the system is called Hire Purchase System.

Features or Characteristics of Hire Purchase System

1. It is an agreement between the Hire Vendor and the Hire Purchaser.

2. Payment will be made by the hire purchaser in installments.

3. The possession of the goods passes from the seller to the buyer on signing the

agreement.

4. Ownership of the goods will be transferred to the buyer on payment of the last

installment.

5. Hire Vendor has the right to repossess the goods if there is any default in payment

of any instalments.

6. The buyer has an option to return the goods to the seller and can terminate the

agreement.

Instalment System

Instalment Payment system is a system where the buyer gets the ownership as well as

possession of the goods at the time of signing the contract and the buyer can make the

payment in instalments.

Features of Installment System

1. There will be an outright sale of goods.

2. The possession as well as ownership is passed on to the buyer right at the time of

signing the contract.

3. The buyer can make the payments by installments.

4. The seller cannot repossess the goods in case of default in payment.

5. The buyer cannot exercise the option of returning the goods and terminate the

contract

19

Difference between Hire Purchase System & Installment System

Important terms

Hire Purchaser ---- the person who obtains the possession of goods for use with an option

to either purchase it or return after use.

Hire Vendor ---- Person who owns the goods, and who parts with the possession of these

goods to the buyer with an option of Hire or Purchase.

Hire Purchase Price -----The total sum payable by the Hire Purchaser to the Hire Vendor

as per the agreement. It includes the Principal and interest.

Net Hire Purchase Price ---- Hire Purchase price less delivery charges, registration charges,

insurance if any included in the price.

Cash Price ---- It is the price of the goods at which the hire purchaser can purchase the

goods for cash. It does not include interest.

Down Payment ---- Amount which is paid at the time of taking delivery of goods.

Difference between Hire Purchase & Sale

Hire Purchase Sale

Governed by the Hire Purchase Act ,1972 Governed by the Sale of Goods Act, 1930

Ownership of goods is transferred to the

buyer on payment of all installments

Ownership of goods is transferred to the

buyer immediately.

Payment is made in Installments Makes payment in Lumpusum

Hire purchaser pays for the price of goods

and also for interest

Buyer pays only for the price of goods.

On non- payment of any installment, the

seller can repossess the goods

On non- payment of any installment , the

seller cannot take back the goods.

Buyer or Seller can terminate the contract at

any point of time.

Neither the seller nor the buyer can terminate

the contract.

Rebate: The hirer can claim rebate from the owner or hire vendor in case he decides to remit

the balance of the purchase price in lumpsum without continuing the hire purchase

Basis of Difference Hire Purchase System Installment System

Nature of contract Contract of Hiring Contract of Sale

Ownership Transferred after payment of all

installments.

Transferred immediately on

signing the contract.

Repossession of

goods

Hire vendor has the right to repossess

the goods in case of default of

payment

Seller cannot repossess the

goods in case of default of

payment.

Return of Goods Buyer can exercise the option of

return of goods

Buyer cannot exercise the option

of return of goods.

Risk of loss or

damage to goods

Risk is on the seller Risk is on the buyer

20

agreement till the last installment. In case of early remittance the hire purchaser gets rebate.

It is calculated as

Rebate = 2/3 x Hire Charges x Number of Installments due

Total Number of Installments

Example:

Calculate the amount of rebate and the balance amount to be paid on settlement

Cash Price Rs.30,000 ; Hire Purchase Price Rs.36,000 ; Number of Installments 36.

The Hire Purchaser has already paid 24 Installments. He wants to settle the remaining

balance and terminate the agreement.

Rebate = 2/3 x Hire Charges x No.of Installments due

Total No. of Installments

Hire Charges = Hire Purchase Price --- Cash Price = 36,000 – 30,000 = 6,000

Rebate = 6,000 x2/3 x 12/36 = Rs.1,333

Calculation of amount to be paid on settlement

Total No. of Installments =36; Hire Purchase Price =36,000;Installment amount

=36,000/36 =1,000; Balance Number of Installments =36- 24 =12

Balance amount payable = 12 x1,000 =12,000 Less Rebate 1,333 = 10,667

ACCOUNTING TREATEMENT

Asset Accrual Method

Under this method asset is recorded at the cash price actually paid. As the Hire Purchaser

gets the ownership only after the payment of last installment no Journal entry is passed when

the asset is purchased . Entries are passed for Down Payment and as and when the

installment becomes due.

JOURNAL ENTRIES IN THE BOOKS OF HIRE PURCHASER

Date Particulars LF Debit Credit

1. When Asset is Purchased

No Journal Entry is required

2. When the Down Payment is made

Asset A/c

Dr

To Bank A/c

3. When the Installment becomes due

Asset A/c

Dr

Interest A/c

Dr

To Hire Vendor A/c

21

4. When the Installment is paid

Hire Vendor A/c

Dr

To Bank A/c

5. When Depreciation is charged

Depreciation A/c

Dr

To Asset A/c

6. When interest & depreciation accounts are

closed by transfer to P/L A/c

P/L A/c

Dr

To Interest A/c

To Depreciation A/c

JOURNAL ENTRIES IN THE BOOKS OF HIRE VENDOR

Date Particulars LF Debit Credit

1. When the item is sold on Hire Purchase

basis

Hire Purchaser A/c

Dr

To Sales A/c

2. When the Down Payment is received

Bank A/c

Dr

To Hire Purchaser‘s A/c

3. When the Interest becomes Due

Hire Purchaser‘s A/c

Dr

To Interest A/c

4. When the Installment is received

Bank A/c

Dr

To Hire Purchaser‘s A/c

5. When the Interest account is closed

Interest A/c

Dr

To P/L A/c

UNDER ASSET ACCRUAL METHOD STEPS IN HIRE PURCHASE SYSTEM

I. Calculation of Interest

II. Depreciation

III. Calculation of Cash Price in each Installment

Ascertainment of the amount of Interest

22

1. When Rate of Interest; Total Cash Price & Installments are Given

Cash Price xxx

Less Down Payment xxx

Add Interest for the first year xxx

Less Ist Installment paid xxx

Add Interest for the second year xxx

Less 2nd

Installment paid xxx

Add interest for the last year xxx

Less last installment paid xxx

Nil

Example :

On Ist January 2010 , Alpha Ltd bought a machine from HMT Ltd. on Hire purchase

System. The Cash Price was Rs.26,350 and the payment was to be made as follows:

Rs.10,000 on signing of the agreement and the balance in 3 yearly installment of Rs.6,000

each. 5% interest is charged by the vendor. Calculate the interest for each year.

Solution :

Cash Price , Rate of Interest & Installments are given

Calculation of Amount of Interest for each year

Cash Price 26,350

Less Down Payment 10,000

Balance Due 16,350

Add interest for the year 2010 (16,350 x5/100) 818

17,168

Less I st installment paid 6,000

Balance Due 11,168

Add 5% interest for the year 2011 (11168x5/100) 558

11,726

Less II Installment Paid 6,000

Balance Due 5,726

Add interest for the year 2012 (6,000- 5,726) 274

6,000

Less III Installment paid 6,000

Nil

Note: Installments given in the question can be ‘inclusive of interest’ or ‘Exclusive of

interest’.

23

If the total payment (Down Payment + Installments) is equal to Cash Price interest is

not included in the installment (ie. Exclusive of interest). If the total payment is more

than the cash price interest is included in the installment. (ie. Inclusive of interest)

2.When Cash Price & Installments are given, but Rate of interest is not given:

Steps

1. Calculate Total interest

Total Interest = Hire Purchase Price -- Cash Price

2. Calculate the amount of Hire Purchase Price outstanding at the beginning of

each year after substracting the Down Payment.

3. Find out the ratio of outstanding amounts calculated in step II

4. Apply this ratio to the total interest and calculate the interest on each

installment.

Example:

Calculate the amount of interest and principal included in each installment:

Cash Price of the Machine Rs.15,000 ; Rs.1,500 being paid on delivery and the balance in

5 annual installments of Rs.3,000 each payable annually.

Solution: Cash Price & Installments are given but the rate of interest is not given:

First Total Interest is to be calculated

Total interest = Hire Purchase Price – Cash Price

Hire Purchase Price = Down Payment + Total installment Amount

= 1,500 + ( 5 x 3,000)= 1,500+15,000 =16,500

Total Interest =16,500—15,000 =1,500

Second Step: Calculation of amount due at the beginning of each year:

Amount due at the beginning of Ist year (16,500 – 1,500) =15,000

Amount due at the beginning of II nd year (15,000 – 3,000) =12,000

Amount due at the beginning of 3rd

year (12,000- 3,000 ) =9,000

Amount due at the beginning of 4th

year (9,000 – 3,000) =6,000

Amount due at the beginning of 5th

year ( 6,000- 3000) =3,000

Third Step ; Calculation of Ratio of Amount Due

15,000:12,000:9,000:6,000:3,000 =5:4:3:2:1

Fourth Step :Calculation of interest for each year:

1st year =1,500x5/15 =500

24

2nd

year =1,500x4/15 = 400

3rd

year =1,500 x3/15=300

4th

year = 1,500 x 2/15 =200

5th

year = 1,500 x1/15 =100

Calculation of Principal for each year

Principal =Installment – Interest

1st year 3,000- 500 = 2,500

2nd

year 3,000- 400 =2,600

3rd

year 3,000 - 300 =2,700

4th

year 3,000 – 200 = 2,800

5th

year 3,000 – 100 =2,900

II. Ascertainment of Cash Price

Some times the Cash Price will not be given in the question . To find out the cash price

two methods are there.

( i.) Without Annuity Table & (ii) With Annuity Table

a. When the installments are constant

b. When the installments are varing

Ascertainment of Cash Price without the help of Annuity Table

Under this method interest is calculated starting with the last installment

Interest= Total amount due at the time of Installment x Rate of interest

100 + rate of interest

Example : Calculate the cash price of an asset from the following:

Rs.3,000 paid at the time of agreement ; Rs.21,600 paid at the time of I year ; Rs.20,700

paid at the time of II year ; Rs.19,800 paid at the time of III year; Rs.18,900 paid at the

time of IV year ; Rate of Interest is 5% per annum ; Rate of depreciation 25% p.a.

Here the Installments are given. Rate of Interest is given. Annuity value is not given. So

to find out the Cash Price follow the first method ie. Without annuity table

Calculation of Cash Price of an Asset

Installment

Numbers

Closing

balance

Installment

Amount

Total

Amount

Interest

5/105

Opening

Balance/

Principal

IV Nil 18,900 18,900 18,900x5/105=900 18,000

III 18,000 19,800 37,800 37,800x5/105=1800 36,000

II 36,000 20,700 56,700 56,700x5/105=2700 54,000

I 54,000 21,600 75,600 75,600x5/105=3600 72,000

Add Down Payment 3,000

Cash Price 75,000

25

Note: If yearly installments are given take the same percentage of interest. When the

installments are given half yearly , rate of interest is to be divided by 2. In case of

Quarterly installments, rate of interest is to be divided by 4. For example Rate of

interest is 10% and 4 annual installments are given . in that case the rate of interest

will remain the same as 10%

( Interest =Total Amount x 10/110). Assume that the rate of interest is 10% and 4

half yearly installments are given. The effective rate of interest will be Half of 10% ie.

5% ( Interest = Total amount x 5/105). In case of Quarterly installments if the

rate of interest is given as 20%, then the effective rate of interest will be one-fourth of

20% ie.5% ( Interest = Total amount x 5/105)

Calculation of Cash Price with the help of Annuity Table

If the annuity value is given in the question Second method is to be followed

Cash Price of Installment = Annuity value x Installment

Cash Price = Cash Price of Installment + Down Payment

Example:

Calculate the Cash Price of the Machine.

Down Payment Rs.10,000; 3 Installments of Rs.10,000 each annually. Interest was

charged at 5% p.a. Given the present value of an annuity of Re.1 per annum at 5% Rs.2.7232

Cash Price of Installment =Annuity Value x Installment

= 2.7232 x 10,000 = Rs.27,232

Cash Price of the machine = Down Payment + Cash Price of Installment

= 10,000 +27,232 =Rs.37,232

Example:

X Ltd purchased a machine on hire purchase system. The payment is made as follows:

Down payment Rs.23,250 ; I Installment Rs.35,000 ; II Installment Rs.40,000 ;

III Installment Rs.20,000. The payments are made at the end of 1st year, 2

nd year and 3

rd

year respectively. Then rate of interest is 5% p.a. The annuity table shows that the present

value of Re.1 for one, two and three years is 0.952, 0.907, and 0.864 respectively. Calculate

the cash price of the machine

Calculation of Cash Price of the machine

26

Amount Present value of Re.1

@5%

Present value of installment

Down Payment 23,250 1.000 23,250

Ist Installment 35,000 0.952 33,320

2nd

installment 40,000 0.907 36,280

3rd

Installment 20,000 0.864 17,280

Total Cash Price 1,10,130

Example:

Mr Ashok purchased a machine on hire purchase system from Bhararth Motors on 1- 1-

2010. The Cash price of the machine was Rs.74,500 and the payment was to be made as

follows:

On signing of the agreement Rs.20,000 and the balance in 3 installments of Rs.20,000 each

at the end of each year. 5% interest is charged by the vendor. Mr. Ashok has decided to write

off 10% depreciation annually on the diminishing balance method. Pass the necessary

Journal entries and prepare the Ledger accounts in the books of Mr. Ashok under Asset

Accrual Method

Working Note:

Here Cash Price, Installments & Rate of interest is given. So the first method can be used

for calculation of interest.

Step I

Calculation of Interest

Cash Price of the Machine

Less Down Payment

Balance Due

Add 5% interest for the year 2010 (54,500 x5/100 )

Less First Installment paid

Balance Due

Add 5% interest for the year 2011 (37,225 x 5/100)

Less Second Installment Paid

Balance Due

Add interest (20,000 – 19086 )( in case of last installment take the

balancing figure as the interest ie. The last installment – Balance Due)

Less Third Installment paid

74,500

20,000

54,500

2,725

57,225

20,000

37,225

1,861

39,086

20,000

19,086

914

20,000

20,000

Nil

27

Step II: Calculation of Cash Price in each Installment

Cash Price = Installment – Interest

Installment Interest Principal(Cash price)

1. 20,000 2,725 17,275

2. 20.000 1,861 18,139

3. 20,000 914 19,086

Step III : Calculation of Depreciation

Depreciation @10% on Diminishing Balance Method

\ Cash Price of the machine 74,500

Less 10% for the Ist year(74,500 x10/100) 7,450

Written Down Value ( Balance) 67,050

Less 10% for the IInd year (67,050 x10/100) 6,705

WDV (Balance) 60,345

Less 10% for the IIIrd year (60,345 x10/100) 6,035

Balance 54,310

28

Journal Entries in the books of Mr. Ashok ( Hire Purchaser)

Date Particulars Debit Credit

1-1-10

31.12.10

31.12.10

31.12.10

31.12.10

31.12.11

31.12.11

31.12.11

31.12.11

31.12.12

31.12.12

31.12.12

31.12.12

Machinery Account Dr

To Bank Account

( Being Down Payment made)


Interest Account Dr

To Bharath Motors A/c

( Being First Installment Due)

Bharath Motors Account Dr

To Bank Account

( Being first installment paid )

Depreciation Account Dr

To Machinery A/c

( Being Depreciation charged )

Profit & Loss Account

Dr

To Interest Account

To Depreciation Account

( Being interest & depreciation transferred)


Interest Account

Dr

To Bharat Motors A/c

( Being second installment due)

Bharath Motors Account

Dr

To Bank Account

( Being second installment paid)

Depreciation Account

Dr

To Machinery A/c

( Being Depreciation charged)


Dr

To Interest A/c

To Depreciation A/c

(Being interest & depreciation transferred)

Machinery Account

Dr

Interest Account

Dr

To Bharath Motors

( Being third installment due)

Bharath Motors Account

Dr

To Bank Account

20,000

17,275

2,725

20,000

7,450

10,175

18,139

1,861

20,000

6,705

8,566

19,086

914

20,000

6,035

6,949

20,000

20,000

20,000

7,450

2,725

7,450

20,000

20,000

6,705

1,861

6,705

20,000

20,000

6,035

914

6,035

29

( Being third installment paid)

Depreciation Account Dr

To Machinery A/c

( Being depreciation charged)


Dr

To Interest A/c

To Depreciation A/c

( Being interest & depreciation transferred)

Ledger Accounts in the books of Hire Purchaser

Important ledger accounts to be opened are:

Asset A/c ;

Hire Vendor A/c ;

Interest A/c &

Depreciation A/c

Machinery Account

Date Particulars Amount Date Particulars Amount

1 . 1. 10

31.12.10

1 .1. 11

31.12.11

1 . 1. 12

31.12.12

To Bank

To Bharat Motors

To Balance b/d

To Bharath Motors

To Balance b/d

To Bharath Motors

20,000

17,275

37,275

29,825

18,139

47,964

41,259

19,086

60,345

31.12.10

31.12.10

31.12.11

31.12.11

31.12.12

31.12.12

By Depreciation

By Balance c/d

By Depreciation

By Balance c/d

By Depreciation

By Balance c/d

7,450

29,825

37,275

6,705

41,259

47,964

6,035

54,310

60,345 Bharath Motors Account ( Hire Vendor Account)


31.12.10

31.12.11

31.12.12

To Bank

To Bank

To Bank

20,000

20,000

20,000

20,000

20,000

20,000

31.12.10

31.12.11

31.12.12

By Machinery

By Interest

By Machinery

By Interest

By Machinery

By Interest

17,275

2,725

20,000

18,139

1,861

20,000

19,086

914

20,000

30

Depreciation Account


31.12.10

31.12.11

31.12.11

To Machinery

To Machinery

To Machinery

7,450

7,450

6,705

6,705

6,035

6,035

31.12.10

31.12.11

31.12.12

By Profit & Loss A/c



7,450

7,450

6,705

6,705

6,035

6,035

Interest Account


31.12.10

31.12.11

31.12.12

To Bharath Motors

To Bharath Motors

To Bharath Motors

2,725

2,725

1,861

1,861

914

914

31.12.10

31.12.11

31.12.12


By P/L A/c

By P/L A/c

2,725

2,725

1,861

1,861

914

914

31

CHAPTER – 4

ROYALTY ACCOUNTS

Introduction

There are some special rights over something which are possessed by some persons

For example Landlord possesses an exclusive right over the mine or Quarry in his land, A

patentee who has invented something new has the right over his patent rights, An Author

has an exclusive copy-right over the work or his writing in the form of a book.

These rights can be given to some other person on lease basis for some consideration. Here

comes the existence of royalty agreement. It is an agreement between two parties

Lessor or Landlord --- Lessee or Tenant

Patentee --- Patentor

Author --- Publisher

Royalty is a periodical sum based on output or sale payable by the lessee to the lessor for

having utilized the rights of the Lessor.

Types of Royalty

Mining Royalty, Patent Royalty, Copyright Royalty

Minimum Rent or Dead Rent: Royalty agreements are usually associated with a clause that

the lessee must pay a minimum amount in a particular period. Such minimum amount is

known as minimum rent or Dead rent.

Shortworkings

The excess of minimum rent over actual royalty is called shortworking.

Recoupment or Recovery of shortworking

Recoupment of shortworking refers to recovering the shortworking of any year, from the

surplus royalty of the succeeding years. The right of recoupment can be either Fixed or

Floating.

In case of fixed recoupment the right to recover the shortworking is permitted only over a

fixed or stipulated period. For example the right to recover shortworking is given for a period

of first 3 years or first 4 years or 5 years as the case may be. After that stipulated period the

shortworking which could not recover will become irrecoverable.

In case of floating recoupment the right to recover shortworking is permitted over a

subsequent period following the year of shortworking. For example. The shortworkings can

32

be recovered in the following two years of the year of deficit. (Next two years or subsequent

two years)

Minimum rent is applicable only when the actual royalty is less than minimum rent .

When the actual royalty is more after making the adjustment for the recovery of

shortworking the remaining amoun t is to be paid to the landlord.

For example: Minimum Rent---10,000, Actual royalty 8,000 , Shortworking is 2,000

Amount paid to landlord is 10,000

Example 2. Actual royalty Rs.15,000 ; Shortworkings to be recovered Rs. 2,000; Amount

paid to landlord Rs.13,000.

Example 3. Actual royalty Rs.20,000. Shortworking to be recovered nil. Amount paid to

landlord Rs.20,000.

Accounting Treatment

Journal Entries in the books of Lessee

(I ) When Minimum Rent Account is not required

i. For Royalties Payable (when the actual royalty is less than Minimum Rent)

Royalties A/c Dr

Shortworkings A/c Dr

To Landlord Account

ii. For Payment of Royalty

Landlord A/c Dr

To Bank Account

iii. For transfer of Royalties to P&L A/c or Production A/c

Production A/c Dr

To Royalties Account

Note: When the actual royalties is more than shortworking and the previous

year’s shortworking is to be recovered. The first journal entry will be as

follows:

Royalties A/c Dr

To Shortworking Account (recovered)

To Landlord Account

iv. For transfer of Shortworking Irrecovered to P &L A/c

P &L A/c Dr

To Shortworking A/c

(II.) When Minimum Rent Account is Required

i. For Royalties payable (When actual royalties is less than Minimum Rent)

33

Minimum Rent A/c Dr

To Landlord A/c

ii. For splitting minimum rent to Royalties & Shortworking

Royalties A/c Dr

Shortworking A/c Dr

To Minimum Rent A/c

iii. For payment of Minimum Rent

Landlord A/c Dr

To Bank A/c

iv. For transfer of Royalties to to production A/c or P& L A/c

Production A/c

To Royalties A/c

Or

Profit& Loss A/c Dr

To Royalties A/c

Example

Bihar Coal Company undertook some coal bearing land from Mr. Gupta at a royalty of Re.1.

per ton, with a minimum rent of Rs.17,000 per annum. Each year‘s excess of minimum rent

over actual royalties were recoverable during the subsequent three years. The lease, however ,

stipulated that in any year the minimum rent was not attained due to strike, the minimum rent

was to be regarded as having been reduced proportionately having regard to the length of the

stoppage. The output was as follows:

Year Production (Tons)

2005 2,000

2006 14,000

2007 19,000

2008 23,000

2009 15,000(Strike for 3 months)

2010 25,000

Pass Journal entries and prepare ledger account in the books of the Lessee.

Solution: In this question the Minimum Rent A/c is not asked to prepare. So we can

follow the first situation ( without Minimum Rent A/c). When the question specifies to

open Minimum Rent A/c the second situation to be followed. Here the terms for

recovery of shortworkings is given as subsequent three years. That is Floating

Recoupment. Another adjustment is regarding the strike. Some times in the question

some adjustments will be given about the stike. It can be --- During the strike actual

royalty may discharge all rental obligations for that year, or minimum rent will be

proportionately reduced. Make the adjustment accordingly.

34

Analysis Table

Year Output Actual

Royalty

Minimum

Rent

shortworki

ng

s.w.recove

red

s.w.Irreco

vered

Amount

paid to

landlord

2005 2000 2000 17000 15000 --- --- 17,000

2006 14000 14,000 17,000 3000 --- --- 17,000

2007 19000 19000 17000 --- 2000 --- 17000

2008 23000 23000 17000 --- 6000 7000 17000

2009 15000 15000 12750 --- 2250 750 12750

2010 25000 25000 17000 --- ---- --- 25000

Note:In the year 2009 there was a strike for 3 months . As per the information given the

minimum rent of 2009 is to be reduced proportionately. The period of strike was 3 months.

The minimum rent is to be calculated for the remaining 9 months.(17000x9/12=12750).

Here the right to recover shortworking is given as the subsequent three years. In 2005 the

shortworking is 15000 and can be recovered for the next three years that is 2006,07 & 08. In

2006 there is no surplus. In 2007 there is a surplus of 2000 and it can be recovered. In 2008

the surplus is 6000 which is used for recovering shortworking and time of recovery of2005

is over (15000-(2000+6000)= 7000 will become irrecoverable. And for 2006 three years will

be expired in 2009 and the balance of750 (3000—2250) will become irrecovered.

Journal Entries in the books of Bihar Coal Company ( Lessee)

Particulars Debit Credit

2005 Royalties A/C Dr

Shortworkings A/C Dr

To Gupta ( Landlord) A/c

( Being Royalties Due)

Gupta (Landlord) A/c Dr

To Bank

( Being the royalties Paid)

Production A/c Dr

To Royalties A/c

( Being royalties transferred to production a/c)

2006 Royalties A/c Dr

Shortworkings A/c Dr

To Gupta

Gupta A/c Dr

To Bank

Production A/c Dr

To Royalties


To Shortworkings

To Gupta

( Being royalties due and shortworkings recovered)

Gupta A/c Dr

2000

15000

17000

2000

14000

3000

17000

14000

19000

17000

17000

17000

2000

17000

17000

14000

2000

17000

35

To Bank

Production A/c Dr

To Royalties


To Shortworking

To Gupta

Gupta A/c Dr

To Bank

Production A/c Dr

To Royalties

Profit & Loss A/c Dr

To Shortworking


To Shortworking

To Gupta

Gupta A/c Dr

To Bank

Production A/c Dr

To Royalties

Profit & Loss A/c Dr

To shortworking


To Gupta

Gupta A/c Dr

To Bank

Production A/c Dr

To Royalties

19000

23000

17000

23000

7000

15000

12750

15000

750

25000

25000

25000

17000

19000

6000

17000

17000

23000

7000

2250

12750

12750

15000

750

25000

25000

25000

Ledger Accounts

Royalties Account

Year Particulars Amount year Particulars Amount

2005

2006

2007

2008

2009

2010

To Gupta

To Gupta

To Shortworking

To Gupta

To Shortworking

To Gupta

To Shortworking

To Gupta

To Gupta

2000

2000

14000

14000

2000

17000

19000

6000

17000

23000

2250

12750

15000

25000

25000

2005

2006

2007

2008

2009

2010

By Production A/c

By Production A/c

By Production A/c

By Production A/c

By Production A/c

By Production A/c

2000

2000

14000

14000

19000

19000

23000

23000

15000

15000

25000

25000

36

Gupta’s Account

Year Particulars Amount Year Particulars Amount

2005

2006

2007

2008

2009

2010

To Bank

To Bank

To Bank

To Bank

To Bank

To Bank

17,000

17000

17000

17000

17000

17000

17000

17000

12750

12750

25000

25000

2005

2006

2007

2008

2009

2010

By Royalties A/c

By Shortworking A/c

By Royalties A/c

By Shortworking A/c

By Royalties A/c

By Royalties A/c

By Royalties A/c

By Royalties A/c

2000

15000

17000

14000

3000

17000

17000

17000

17000

17000

12750

12750

25000

25000

Shortworkings Account

Year Particulars Amount Year Particulars Amount

2005

2006

2007

2008

2009

To Gupta‘s A/c

To Balance b/d

To Gupta‘s A/c

To Balance b/d

To Balance b/d

To Balance b/d

15000

15000

15000

3000

18000

18000

18000

16000

16000

3000

3000

2005

2006

2007

2008

2009

By Balance c/d

By Balance c/d

By Royalties A/c

By Balance c/d

By Royalties A/c


By Balance c/d

By Royalties A/c

By Profit & Loss

A/c

15000

15000

18000

18000

2000

16000

18000

6000

7000

3000

16000

2250

750

3000

Note: In the question if the opening stock or closing stock is given in that case read the

question carefully and find out whether the royalty is on the basis of number of units

produced or number of units sold.

No of copies sold= copies printed +Opening Stock -- closing stock

No of units produced or no of units printed= No of copies sold+ closing stock -

Opening stock

37

CHAPTER 5:

ACQUISITION OF BUSINESS OF NON- CORPORATE ENTITIES

Sale of non-corporate entities to a company refers to, the sale of a sole trading concern or a

partnership firm to a company.

Conversion of partnership firm into a company also amounts to ‗Acquisition of Business of

Non- Corporate Entities‘ for accounting purposes.

The firm which is being sold to the company is called Transferor Firm and the company

which is the purchasing the firm is called Transferee firm.

Accounting for Acquisition of non- corporate entities

The following are the steps involved in accounting for Acquisition of a firm:

1. Calculating of purchase consideration

2. Ascertaining the form of discharge of purchase consideration

3. Closing the books of Transferor firm

4. Passing incorporation entries in the books of Transferee Company and preparing

Balance Sheet.

Step no 1 - Calculating of purchase consideration

The price or consideration payable by the transferee company for taking over assets

and liabilities of the transferor firm is called ―Purchase Consideration‖

Method of calculating Purchase Consideration

The purchase consideration payable by the transferee company to the transferor firm

may be calculated under any of the following methods:

Lump sum method

Net Asset Method

Net payment Method

Lump sum Method –

Under this method, a fixed amount or a lump sum is paid by the

transferee company for the assets and liabilities taken over by the transferor

company.

Net Assets Method –

Under this method the purchase consideration can be calculated as follows:

Particulars Rs

Total Assets taken over at an agreed value by transferor company

Less: Total liabilities taken over at an agreed value

xxx

xxx

Purchase Consideration xxx

38

Net Payment method –

Under this method, actual payment made by the transferee company against each item

of liability would be specified.

Step no 2 – Ascertaining the form of discharge of purchase consideration

The purchase consideration may be discharged by the transferee company in any of the

following forms:

1) Completely in Cash

2) Completely in Shares

3) Completely in Debentures

4) Partly in cash and partly in shares

5) Partly in cash and partly in Debentures

6) Partly in Shares and partly in Debentures

7) Combination of Cash, Shares and Debentures

Step no 3 - Closing the books of the Transferor Firm

When the firm is acquired by a company, its books of accounts have to be closed. The

following is the treatment for closing the books of accounts in the firm.

1) For transfer of Assets including Cash at Book Values

Realisation A/c Dr

To Individual Assets A/c

2) For transfer of liabilities at book value

Individual liabilities A/c Dr

To Realisation A/c

3) For the amount of purchase consideration due

Transferee Company A/c Dr

To Realisation A/c

4) For Sale of Assets( not taken over by transferee company)

Bank A/c Dr

To Realisation A/c

5) For payment of Liabilities(not taken over by transferee company)

Realisation A/c Dr

To Bank A/c

6) For assets taken over by Partner‘s(not taken over by transferee company)

Partner‘s Capital A/c Dr

To Realisation A/c

39

7) For Liabilities taken over by Partner‘s(not taken over by transferee company)

Realisation A/c Dr

To Partner‘s Capital A/c

8) For payment of Expenses on Realisation

Realisation A/c Dr

To Bank A/c

9) For Profit on Realisation

Realisation A/c Dr

To Partners Capital A/c

10) For Loss on Realisation

Partner‘s Capital A/c Dr

To Realisation A/c

11) For Receipt of Purchase Consideration

Cash/Bank A/c Dr

Shares in transferee A/c Dr

Debentures in transferee A/c Dr

To Transferee Company A/c

12) For transfer of Reserve/ Undistributed Profits

Reserve A/c Dr

Profit and Loss A/c Dr

To Partner‘s Capital/Current A/c

13) For Transfer of Profit and Loss Debit Balance(loss)

Partner‘s Capital/Current A/c Dr

To Profit and Loss A/c

14) For payment of Partner‘s Loans

Partner‘s Loan A/c Dr

To Bank A/c

15) For Distribution of Cash/Shares/Debentures

Partner‘s capita A/c Dr

To Cash/Bank A/c

To Shares in Transferee Company A/c

To Debentures in Transferee Company A/c

Step no 4 – Passing Incorporation Entries and Other Entries and Preparing Balance

Sheet Entries in the books of purchasing company

1) Purchase Consideration due:

Business purchase A/c Dr

To Transferor Firm A/c

2) For assets and liabilities taken over:

Individual Asset A/c Dr

To Individual liability A/c

40

To Transferor Firm A/c

3) For discharging of purchase consideration:

Transferor Firm A/c Dr

To Cash/Bank A/c

To Shares in Transferee Company A/c

To Debentures in Transferee company A/c

To Share Premium A/c (if any)

Illustration

Mahadev and Govind are partners sharing profits and losses in the ratio 2:1 and their Balance

sheet as on 31.12.2012 is as follows .

Liabilities Amount Asset Amount

Creditors 20,000 Cash in hand 150

Bills payable 5,000 Bills receivable 2,500

Mahadev‘s Loan 10,000 Debtors 30000

Less:Reserve for 1500

Doubtful debt

28,500

Mahadev‘s capital 15,000 Stock 21,850

Govind‘s capital 10000

Reserve fund 3,000 Machinery 10,000

63000 63000

They agreed to sell the business to a limited company and the company to take over the asset

including cash and others assets is as follows:

Machinery at 8,000

Goodwill at 3,000

Debtors at 25,350

Bills receivable: 2500

Stock at17,500

Company agreed to take over the creditors at 19,500. The expenses of realizations amounted

to 150. The firm received the Rs. 20,000 of the purchase price in Rs10. Fully paid equity

shares and balance in cash. Pass necessary journal entries and prepare ledger accounts in the

book company .

41

Solution:

Calculation of purchase consideration{Net asset method}

Asset taken over value

Machinery 8,000

Goodwill 3,000

Debtors 25,350

Bills receivable: 2500

Stock 17,500

cash 150

56500

(-) Liabilities agreed

Creditors and bills payable 24500

PURCHASE CONSIDERATION 32000

Discharge of purchase consideration.

By equity Shares 20,000

By cash 12,000

32000

JOURNAL ENTRIES IN THE BOOKS OF THE FIRM

Particulars Debit Credit

Realization A/c Dr

To Machinery

To Debtors

To Bills receivable:

To Stock

To Cash

(For transfer of asset at book value)

64,500

8,000

25,350

2500

17,500

150

Creditors A/c

Bills payable A/c

Reserve for BDD A/c

To Realization A/c

(For transfer of liability at book value)

20,000

5,000

1,000

26,500

Purchase company A/c

To Realization A/c

(For amount of purchase consideration )

32,000

32,000

Realization A/c

To cash/Bank

(For expense on realization )

150

150

Mahadev‘s Capital A/c

Govind‘s Capital A/c

To Realization A/c

(For loss on realization )

4,100

2,050

6,150

Equity share in p[purchase company A/c 20,000

42

Cash A/c

To purchase company

(For receipt of purchase consideration )

12,000

32,000

Reserve fund A/c

To Mahadev‘s Capital

To Govind‘s Capital

(For transfer of reserve into P/L a/c)

3,000

2,000

1,000

Mahadev‘s loan A/c

To cash A/c

(For payment of loan)

10,000

10,000



To Equity share in purchasing company A/c

(For distribution of shares)

11,810

8,190

20,000



To Cash

1,090

790

1,850

Ledger account in the book of the firm.

Realization Account

Particular Amount Particular Amount

To Machinery

To Debtors

To Bills receivable:

To Stock

To Cash

To Cash(Expenses)

8,000

25,350

2500

17,500

150

150

By Creditors

By Bills payable

By Reserve for BDD

By Purchase Co. A/c

By Loss on realization

transferred to capital A/c

Mahadev = 6,150 x 2/3 =

4,100

Govind = 6,150 x 1/3 = 2,050

20,000

5,000

1,000

32,000

6,150

64,650 64,650

Purchasing Company A/c


To Realization A/c 32,000 By Eq. share in purchasing co.

A/c

By Cash

20,000

12,000

32,000 32,000

Equity share in purchasing company


Purchase company A/c 20,000 Mahadev‘s Capital A/c


11,808

8,192

20,000 20,000

43

Capital Account

Particular M G Particular M G

To Realization A/c

To Equity share in

purchasing company

To Cash

4,100

11,808

1,090

2,050

8,192

760

By Balance b/d

By Reserve fund

(2:1Ratio )

15,000

2,000

10,000

1,000

17,000 11,000 17,000 11,000

Mahadev‘s loan Account


To cash 10,000 By Balance b/d

10,000

10,000 10,000

Cash Account


To Balance b/d

To Purchasing Company A/c

150

12,000

By Realization A/c

ByRealizationA/c(Expenses)

ByMahadev‘s Capital A/c

ByGovind‘s Capital A/c

ByMahadev‘s Loan

150

150

1,092

758

10,000

12,150 12,150

Note 1. CALCULATION OF FINAL CAPITAL RATIO.

M G

Total credit balance 17,000 11,000

Less: Debit balance 4,100 2,050

12,900 8,950

1,290 : 895

258 : 179

Note 2. DISRIBUTION OF SHARES.

M = 2,000 x 258 = 1,181 shares of 10 each = Rs 11,810

437

G = 2,000 x 179 = 819 shares of 10 each = Rs 8190.

437

44

IMPORTANT QUESTIONS:

1. What is purchase consideration?

2. What is final claim ratio?

3. What are the modes of discharge of purchase consideration?

4. What is net asset method?

5. Elaborate the accounting steps of acquisition of business of non corporate entities by a

company.

BOOKS FOR REFERENCE

R.L GUPTA RADHASWAMY

V S RAMAN

DR. S ANIL KUMAR

financial accounting prepared by mrs. prasanna...

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