financial accounting - rectification of errors · rectification of errors after preparation of...

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Unit 30. Financial Accounting

Financial Accounting - Rectification of

Errors Financial accounting deals with recording and maintaining every monetary

transaction of an organization. However, sometimes, a few entries might be either

incorrect or used at the wrong place. In financial accounting, the process of

correcting such mistakes is known as Rectification of Errors.

Types of Errors Two most common types of errors, which are usually occurred at the time of

preparation of Financial Statements are discussed below.

Error which Effect only One Account

Omission of posting of balance in a Trial Balance.

Error of carried forward of balance.

Error of casting and posting.

Error which Effect Two or more Accounts

The nature of errors, which occur during the preparation of Financial Statements

are −

Error of posting in wrong account.

Error of principle.

Error of omission.

Methods of Rectification of Errors

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There are three types of methods used in rectification of Errors −

Replacing Correct Figure by Striking Off the Wrong Figure

For example, cash payment of Rs. 989 on the account of stationery purchased

written as Rs. 998, will be corrected as −

Cash Book

By Stationery A/c 998

989

Through Journal Entry

Normally, there are three types of errors, which can be rectified by passing Journal

Entries −

Short credited or debit in one account and excess debit or credit in another

account. For example, purchase of stationery for Rs. 989 wrongly debited to

purchase of raw material account will be corrected as follows −

Journal Entry

Stationery AccountDr.

To Purchase Account

(Being Cash purchase of stationery wrongly debited

to Purchase account, now rectified)

989

989

If, by mistake one account is debited as well as credited with wrong

amount simultaneously. For example, Cash purchase of stationery of Rs.

989 booked with an amount of Rs. 489 will be corrected as follows −

Journal Entry


To Purchase Account

(Being purchase of stationery for Rs. 989 wrongly

written as Rs. 489 now rectified)

500

500

If there is an omission of recording a transaction, it can be rectified by passing

journal entry to book that omitted transaction. For example, omission of




recording transaction of purchase of raw material for Rs. 5000 from Mr. X

will be recorded and corrected by passing the following journal Entry −

Journal Entry


To X Account

(Being omitted entry of purchase of Rs. 5000 from

Mr. X now recorded and rectified)

5000

5000

If there is a Mistake that Effects Trial Balance

Before closing the books and transferring the difference in suspense account

and

After the agreed difference is transferred into the suspense account, following

accounting treatment will be done −

o Earlier entry debited or credited with fewer amount will be rectified by

repeating that entry with difference amount to complete that amount.

For example, entry done with Rs. 500 instead of Rs. 5000 will be

rectified by doing same entry with an amount of Rs. 4500. In case,

where entry wrongly debited or credited to other account may be

rectified by doing reversal of old entry to nullify earlier effect.

If expense booked with less amount entry then −

Particular Expense Account

To Cash/Personal Account

(Being wrong amount of posting, rectified with

Difference amount Rs. 4,500 (5000-500)

Dr 4,500

4,500

If income is booked with less amount, it will be rectified as −

Cash/Personal account

To Income Account

(Being wrong amount of posting now Rectified.

4500 (5000-500)

Dr 4,500

4,500

If posting done in wrong account that will be rectified as follows −




Stationery AccountDr.**

To Office Expenses Account**

(Being wrongly debited earlier in office account, now Rectified and posted

in stationery account)

In case (ii) where difference has already been transferred to suspense account,

further amount will be debited or credited to respective account and

correspondingly suspense account will be debited or credited. Thus, these entries

would reduce/nil the balance of suspense account.

Effect of Errors on Agreement of Trial Balance

The errors by which there is no change on both side of trial balance or wrong effect

on trial balance with same amount will not lead to effect on agreement of Trial

Balance. Errors of omission, error of posting with wrong amount on both side, or

Error of principles are the example of such errors. To find out such errors is a

challenging job for any book keeper or an accountant.

Effects of Errors on Financial Statements

Effect of error depends on the nature of effected accounts. If errors relate to nominal

account, it will either increase or reduce the profit and rectification will reduce

excess profit or Loss. Effect of error on Trading and Profit account ultimately effect

the Balance-Sheet of a company too, because reduced profit or excess profit

ultimately transferred to capital account, which is a part of the Balance Sheet.

There are some errors, which effect Trading or Profit and Loss account and Balance

sheet simultaneously, like entry of depreciation will affect profit as well as value of

the Fixed Assets.

Some entry may effect on Balance sheet only like, for instance omission of entry of

cash paid to purchase fixed assets will affect Balance Sheet of a firm only.

Rectification of Errors after Preparation of Final Accounts

To remain unaffected Profit or Loss of the current financial year, the errors, which

took place in last financial years are adjusted and rotated through a Profit & Loss

adjustment account. Balance of this account directly transferred to capital account

of firm without affecting the current year profit or loss.

Financial Accounting - Capital and Revenue




One of the major aspects of preparing a correct financial statement is to distinguish

revenue and capital in regard to revenue income, revenue expenditure, revenue

payments, revenue profits, and revenue losses of the company with capital income,

capital receipts, capital profit, or capital losses.

In fact, without differentiating, we cannot think of correctness of a financial

statement. Ultimately, it will mislead the end results where no one can conclude

anything. As per this principle, a revenue item should be recorded in the Trading

and Profit & Loss account and a capital item should be recorded in the Balance-

Sheet of respective firm.

Capital Expenditure Capital expenditure is the expenditure incurred to acquire fixed assets, capital

leases, office equipment, computer equipment, software development, purchase of

tangible and intangible assets, and such kind of any value addition in business

with the purpose to enhance the income. However, to decide nature of the capital

expenditure, we need to pay attention on −

The expenditure, which benefit cannot be consumed or utilized in the same

accounting period, should be treated as capital expenditure.

Expenditure incurred to acquire Fixed Assets for the company.

Expenditure incurred to acquire fixed assets, erection and installation

charges, transportation of assets charges, and travelling expenses directly

relates to the purchase fixed assets, are covered under capital expenditure.

Capital addition to any fixed assets, which increases the life or efficiency of

those assets for example, an addition to building.

Revenue Expenditure Revenue expenditure is the expenditure incurred on the fixed assets for the

‘maintenance’ instead of increasing the earning capacity of the assets. Examples of

some of the important revenue expenditures are as follows −

Wages/Salary

Freight inward & outward

Administrative Expenditure

Selling and distribution Expenditure

Assets purchased for resale purpose




Repairs and renewal expenditure which are necessary to keep Fixed Assets

in good running and efficient conditions

Revenue Expenditure Treated as Capital Expenditure Following are the list of important revenue expenditures, but under certain

circumstances, they are treated as a capital expenditure −

Raw Material and Consumables − If those are used in making any fixed

assets.

Cartage and Freight − If those are incurred to bring Fixed Assets.

Repairs & Renewals − If incurred to enhance life of the assets or efficiency

of the assets.

Preliminary Expenditures − Expenditure incurred during the formation of a

business should be treated as capital expenditure.

Interest on Capital − If paid for the construction work before the

commencement of production or business.

Development Expenditure − In some businesses, long period of

development and heavy amount of investment are required before starting

the production especially in a Tea or Rubber plantation. Usually, these

expenditure should be treated as the capital expenditure.

Wages − If paid to build up assets or for the erection and installation of Plant

and Machinery.




Deferred Revenue Expenditure Some non-recurring and special nature of expenditure for which heavy amount

incurred and benefit for the same will spread in up-coming years, to be treated as

capital expenditure and will be shown as the assets of the firm. Part of the

expenditure should be debited to Profit & Loss account every year. For example, if

heavy amount paid for the advertisement of a product, which benefits are expected

to be received in next four years, then it should be debited as ¼ of the part in Profit

& Loss account as the revenue expenses and balance ¾ will be shown as the assets

in the Balance-Sheet.

Capital and Revenue Profit The premium received on issue of shares, and the profit on sale of fixed assets are

the major examples of capital profit and should not be treated as revenue profit.

Capital profit should be transferred to the capital reserve account, which is used

to set off capital losses in future if any.

Capital and Revenue Receipts Sale of fixed assets, capital employed or invested, and loans are the example of

capital receipts. On the other hand, sale of stock, commission received, and interest

on investment received are the main examples of revenue receipts. Revenue receipts

will be credited to the profit and loss account and on the other hand, capital

receipts will affect the Balance-sheet.




Capital and Revenue Losses Discount on issue of shares and losses on sale of fixed assets are the capital loss

and would be set off against the capital profits only. Revenue losses on normal

business activity are part of the profit and loss account.

Financial Accounting - Final Accounts Final Accounts are the accounts, which are prepared at the end of a fiscal year. It

gives a precise idea of the financial position of the business/organization to the

owners, management, or other interested parties. Financial statements are

primarily recorded in a journal; then transferred to a ledger; and thereafter, the

final account is prepared (as shown in the illustration).

Usually, a final account includes the following components −

Trading Account

Manufacturing Account

Profit and Loss Account

Balance Sheet

Now, let us discuss each of them in detail −

Trading Account Trading accounts represents the Gross Profit/Gross Loss of the concern out of sale

and purchase for the particular accounting period.

Study of Debit side of Trading Account

Opening Stock − Unsold closing stock of the last financial year is appeared

in debit side of the Trading Account as “To Opening Stock“ of the current

financial year.

Purchases − Total purchases (net of purchase return) including cash

purchase and credit purchase of traded goods during the current financial

year appeared as “To Purchases” in the debit side of Trading Account.

Direct Expenses − Expenses incurred to bring traded goods at business

premises/warehouse called direct expenses. Freight charges, cartage or

carriage charges, custom and import duty in case of import, gas, electricity

fuel, water, packing material, wages, and any other expenses incurred in this

regards comes under the debit side of Trading Account and appeared as “To

Particular Name of the Expenses”.




Sales Account − Total Sale of the traded goods including cash and credit

sales will appear at outer column of the credit side of Trading Account as “By

Sales.” Sales should be on net releasable value excluding Central Sales Tax,

Vat, Custom, and Excise Duty.

Closing Stock − Total Value of unsold stock of the current financial year is

called as closing stock and will appear at the credit side of Trading Account.

closing Stock = Opening Stock + Net Purchases - Net Sale

Gross Profit − Gross profit is the difference of revenue and the cost of

providing services or making products. However, it is

calculated before deducting payroll, taxation, overhead, and other interest

payments. Gross Margin is used in the US English and carries same meaning

as the Gross Profit.

Gross Profit = Sales - Cost of Goods Sold

Operating Profit − Operating profit is the difference of revenue and the costs

generated by ordinary operations. However, it is calculated before deducting

taxes, interest payments, investment gains/losses, and many other non-

recurring items.

Operating Profit = Gross Profit - Total Operating Expenses

Net Profit − Net profit is the difference of total revenue and the total expenses

of the company. It is also known as net income or net earnings.

Net Profit = Operating Profit - (Taxes + Interest)

Format of Trading Account

Trading Account of M/s ABC Limited

(For the period ending 31-03-2014)

Particulars Amount Particulars Amount

To Opening Stock XX By Sales XX

To Purchases XX By Closing Stock XX

To Direct Expenses XX By Gross Loss c/d XXX




To Gross Profit c/d XXX

Total XXXX Total XXXX

Manufacturing Account Manufacturing account prepared in a case where goods are manufactured by the

firm itself. Manufacturing accounts represent cost of production. Cost of

production then transferred to Trading account where other traded goods also

treated in a same manner as Trading account.

Important Point Related to Manufacturing Account

Apart from the points discussed under the section of Trading account, there are a

few additional important points that need to be discuss here −

Raw Material − Raw material is used to produce products and there may be

opening stock, purchases, and closing stock of Raw material. Raw material

is the main and basic material to produce items.

Work-in-Progress − Work-in-progress means the products, which are still

partially finished, but they are important parts of the opening and closing

stock. To know the correct value of the cost of production, it is necessary to

calculate the correct cost of it.

Finished Product − Finished product is the final product, which is

manufactured by the concerned business and transferred to trading account

for sale.

Raw Material Consumed (RMC) − It is calculated as.

RMC = Opening Stock of Raw Material + Purchases - Closing Stock

Cost of Production − Cost of production is the balancing figure of

Manufacturing account as per the format given below.

Manufacturing Account

(For the year ending……….)





To Opening Stock of Work-

in-Progress XX

By Closing Stock of Work-in-

Progress XX

To Raw Material Consumed XX By Scrap Sale XX

To Wages XXX By Cost of Production XXX

To Factory overheadxx (Balancing figure)

Power or fuelxx

Dep. Of Plantxx

Rent- Factoryxx

Other Factory Exp.xx xxx


Profit and Loss Account Profit & Loss account represents the Gross profit as transferred from Trading

Account on the credit side of it along with any other income received by the firm

like interest, Commission, etc.

Debit side of profit and loss account is a summary of all the indirect expenses as

incurred by the firm during that particular accounting year. For example,

Administrative Expenses, Personal Expenses, Financial Expenses, Selling, and

Distribution Expenses, Depreciation, Bad Debts, Interest, Discount, etc. Balancing

figure of profit and loss accounts represents the true and net profit as earned at

the end of the accounting period and transferred to the Balance Sheet.

Profit & Loss Account of M/s ………

(For the period ending ………..)


To Salaries XX By Gross Profit b/d XX




To Rent XX

To Office Expenses XX By Bank Interest received XX

To Bank charges XX By Discount XX

To Bank Interest XX By Commission Income XX

To Electricity Expenses XX By Net Loss transfer to

Balance sheet XX

To Staff Welfare Expenses XX

To Audit Fees XX

To Repair & Renewal XX

To Commission XX

To Sundry Expenses XX

To Depreciation XX

To Net Profit transfer to

Balance sheet XX


Balance Sheet A balance sheet reflects the financial position of a business for the specific period

of time. The balance sheet is prepared by tabulating the assets (fixed assets +

current assets) and the liabilities (long term liability + current liability) on a specific

date.

Assets

Assets are the economic resources for the businesses. It can be categorized as −

Fixed Assets − Fixed assets are the purchased/constructed assets, used to

earn profit not only in current year, but also in next coming years. However,

it also depends upon the life and utility of the assets. Fixed assets may be




tangible or intangible. Plant & machinery, land & building, furniture, and

fixture are the examples of a few Fixed Assets.

Current Assets − The assets, which are easily available to discharge current

liabilities of the firm called as Current Assets. Cash at bank, stock, and

sundry debtors are the examples of current assets.

Fictitious Assets − Accumulated losses and expenses, which are not actually

any virtual assets called as Fictitious Assets. Discount on issue of shares,

Profit & Loss account, and capitalized expenditure for time being are the

main examples of fictitious assets.

Cash & Cash Equivalents − Cash balance, cash at bank, and securities

which are redeemable in next three months are called as Cash & Cash

equivalents.

Wasting Assets − The assets, which are reduce or exhausted in value

because of their use are called as Wasting Assets. For example, mines,

queries, etc.

Tangible Assets − The assets, which can be touched, seen, and have volume

such as cash, stock, building, etc. are called as Tangible Assets.

Intangible Assets − The assets, which are valuable in nature, but cannot be

seen, touched, and not have any volume such as patents, goodwill, and

trademarks are the important examples of intangible assets.

Accounts Receivables − The bills receivables and sundry debtors come

under the category of Accounts Receivables.




Working Capital − Difference between the Current Assets and the Current

Liabilities are called as Working Capital.

Liability

A liability is the obligation of a business/firm/company arises because of the past

transactions/events. Its settlement/repayments is expected to result in an outflow

from the resources of respective firm.

There are two major types of Liability −

Current Liabilities − The liabilities which are expected to be liquidated by

the end of current year are called as Current Liabilities. For example, taxes,

accounts payable, wages, partial payments of long term loans, etc.

Long-term Liabilities − The liabilities which are expected to be liquidated in

more than a year are called as Long-term Liabilities. For example, mortgages,

long-term loan, long-term bonds, pension obligations, etc.

Grouping of Assets and Liabilities There may be two types of Marshalling and grouping of the assets and liabilities −

In order of Liquidity − In this case, assets and liabilities are arranged

according to their liquidity.

In order of Permanence − In this case, order of the arrangement of assets

and liabilities are reversed as followed in order of liquidity.

Financial Statements with Adjustments Entries and their

Accounting Treatment

In order to prepare a true and fair financial statement, there are some very

important adjustments those have to be done before finalization of the accounts

(as shown in the following illustration) −

Sr.No. Adjustments Accounting

Treatments

1

Closing Stock

Unsold stock at the end of Financial year

called Closing stock and valued at “Cost or

market value whichever is less”

First Treatment

Where an opening

and closing stock

adjusted through a

purchase account

and the value of




Closing Stock given

in Trial Balance −

Closing stock will be

shown as adjusted

purchase account on

the debit side of

Trading account and

will appear in the

Balance Sheet under

current Assets.

2

Outstanding Expenses

Expenses which are due or not paid called

as outstanding expenses.

Accounting

Treatment

Outstanding

expenses will be

added in Trading or

Profit & Loss

account in particular

expense account and

will appear in

liabilities side of the

Balance Sheet under

the current

liabilities.

3

Prepaid Expenses

Expenses which are paid in advance are

called as Prepaid Expenses.

Accounting

Treatment

Prepaid Expenses

will be deducted

from the particular

expenses as appear

in Trading & Profit &

Loss account and

will be shown in the

Balance Sheet under

the current assets.




4 Accrued Income

The income, which is earned during the

year, but not yet received at the end of the

Financial Year is called as Accrued Income.

Accounting

Treatment

Accrued income will

be added to a

particular income

under the Profit &

Loss account and

will be shown in the

Balance Sheet as

current assets.

5

Income Received in Advance

An income received in advance, but not

earned like advance rent etc.

Accounting

Treatment

An income to be

reduced by the

amount of advance

income in profit &

loss account and will

appear as current

liabilities in the

Balance Sheet.

6

Interest on Capital

Where an interest paid on the capital

introduced by the proprietor or partner of

the firm.

Accounting

Treatment

Debit Side of

Profit & Loss

account

Add to capital

account

(Credit side of

Capital

account).

7

Interest on Drawing Accounting

Treatment




Where an interest paid on the capital

introduced by the proprietor or partner of

the firm.

Credit Side of

Profit & Loss

account

Reduced from

capital

account (Debit

side of

Drawing

account).

8

Provision for Doubtful Debts

If there is any doubt on the recovery from

Sundry Debtors.

Accounting

Treatment

Debit Side of

Profit & Loss

Account

In a Balance

Sheet,

provision for

the Doubtful

will be

deducted from

the Sundry

Debtors’

Account.

9

Provision for Discount on Debtors

If there is any offer of discount to pay the

debtors within certain period.

Accounting

Treatment

Debit Side of

Profit & Loss

Account

In a Balance

Sheet,

provision for

the Discount

on Debtors




will be

deducted from

the Sundry

Debtors

Account.

10

Bad Debts

Unrecovered debts or irrecoverable debts

Accounting

Treatment

Debit Side of

Profit & Loss

Account

In a Balance

Sheet, Sundry

debtors will be

shown after

deducting the

Bad Debts.

11

Reserve for Discount on Creditors

If there is any chance to get discount on the

payment of sundry creditors within certain

period.

Accounting

Treatment

Credit Side of

Profit & Loss

Account

In a Balance

Sheet, Sundry

Creditors will

be shown after

deducting the

Reserve for

Discount.

12

Loss of Stock by fire

There may be three conditions in this case

Accounting

Treatment

1. If Stock is fully

insured




Credit Side of

Trading

Account

Assets side of

Balance Sheet

(With full value

of loss)

2. If Stock is

partially insured

Credit side of

Trading

Account

(With Total

value of Loss)

Debit side of

Profit & Loss

a/c

(With value of

loss

unrecoverable)

Asset Side of

Balance Sheet

( With value

recoverable)

3. If Stock is not

insured

Credit Side of

Trading

Account

Debit side of

Profit & Loss

Account




13

Reserve Fund

Accounting

Treatment

Debit side of

Profit & Loss

Account

Liabilities side

of Balance

Sheet

14

Free Sample to Customers

Accounting

Treatment

Credit side of

Trading

Account

Debit Side of

Profit & Loss

Account

15

Managerial Commission

Accounting

Treatment

Debit side of

Profit & Loss

Account

Liabilities side

of Balance

Sheet as

commission

payable

16

Goods on Sale or Approval Basis

If there is any un-approved stock lying with

the customers at the end of financial year.

Accounting

Treatment

Sales

AccountDr




To Debtors

A/c

(With Sale

Price)

Stock

AccountDr

To Trading

Account

(with cost

price)

Provision and Reserves Meaning of Provisions “Any amount written off or retained by the way of providing depreciation or

diminution in the value of assets or for providing any known liability of which the

amount cannot be determined with substantial accuracy.”

- The Institute of Chartered Accountants of India

“Liabilities which can be measured only by using a substantial degree of estimation.”

- AS-29 issued by Institute of Chartered Accountants of India

AS 29 also defines liabilities as “a present obligation of the enterprises arising from

past events, the settlement of which is expected to result in an outflow from the

enterprise of resources embodying economic benefits.”

Debiting Profit and Loss account, provisions are created and shown either

deducting assets side or on the liabilities side under relevant sub-head of Balance

Sheet.

Provision for bad and doubtful debts, Provisions for Repair & Renewals, and

Provision for discounts & depreciation are the most common examples.

Meaning of Reserves “That portion of earnings, receipts or other surplus of an enterprise (whether capital

or revenue) appropriated by the management for general or a specific purpose other

than a provision for depreciation or diminution in the value of assets or for a known

liability.”




-ICAI

Reserve is an appropriation of profits; on the other hand, Provision is a charge

against profit. Reserves are not meant to meet out contingencies or liabilities of a

business. Reserve increases working capital of a company to strengthen the

financial position.

There are two types of reserves −

Capital Reserve − Capital reserve is not readily available for distribution as

the dividends among the shareholders of the company, and it creates only

out of capital profit of the company. It is like Premium on issue of shares or

debentures and Profit prior to incorporation.

Revenue Reserve − Revenue reserves are readily available for the

distribution of profit as dividend to the shareholders of the company. Some

of the examples of this are general reserve, staff welfare fund, dividend

equalization reserve, debenture redemption reserve, contingency reserve,

and investment fluctuation reserves.

Distinction between Provisions and Reserves Reserve can be made only out of profit and provisions are the charge to profit.

Reserves reduce divisible profits and provisions reduce the profit.

Reserves, if remain un-utilized for some period can be distributed as

dividends, but provisions cannot be transferred to General Reserve for the

distribution.

Purpose of provision is very specific, but reserve is created to meet out any

probable future liabilities or losses.

Creation of provisions is legally necessary, but reserves are created to save a

concern from the future losses and liabilities.

Secret Reserves Banking Company, Insurance Company, and Electricity Companies create secret

reserves, where the public confidence is required. In this case, to create secret

reserve, assets showed at lower cost or liabilities at higher value. Some of the

examples of it are as follows −

By undervaluing goodwill or stock

By excessive depreciation




By creating excessive provisions

Showing free reserves as creditors

By charging capital expenditure to profit and loss account

Advantages of Secret Reserves Some of the important advantages are given below −

Without disclosing to its shareholders, it increases working capital of a

concern, which is a clear indication of the sound financial position.

With the help of secret reserves, directors can maintain the rate of dividends

during the unfavorable time.

Non-disclosure of a big profit is useful to avoid an un-due competition.

Limitations of Secret Reserves Major limitations or objections of secret reserves are as follows −

Due to non-disclosure of actual profit, financial statements do not presents

true and fair view of the state of affairs.

There are lots of chances of misuse of reserves by the directors for their

personal benefits.

Due to secret reserves, chances for the concealment of worst position of a

company are very high.

Company will get very lower amount of claim of insurance at the time of loss

of stock or other assets, as valuation of the assets are done at very low value

to create secret reserve.

General and Specific Reserves Specific reserves are created and utilized for the purpose only for which they are

created, like dividend equalization reserve and debenture redemption reserve.

General reserves are created for any future contingency or to utilize at the time of

expansion of a business. Purpose of creation of General reserve is to strengthen the

financial position of the company and to increase the working capital.

Sinking Fund For the purpose to repay of any liabilities or to replace any fixed assets after

particular period, sinking funds are created. For this, some amount are charged or

appropriated from the profit and loss account every year and invested in any




outside securities. Without any extra ordinary burden, replacement of an asset may

be done in a systematic manner or pay any known liability on maturity of the

sinking fund.

Investment of Reserves It is a controversial issue, whether a reserve should be invested in outside securities

or not. Thus, to decide anything, it is important to study the need and requirement

of a firm according to the financial position of a firm. Therefore, investment in

outside securities is justified only in a case where company has the extra fund to

invest.

Nature of Reserve In-spite of showing reserves on the liabilities side of a Balance Sheet, reserves are

actually not at all any liabilities of a firm. Reserve represents as accumulated

profits, which are available to disburse among the shareholders.

Measurement of Business Income One of the most significant accounting concepts is “Concept of Income”. Similarly,

measurement of a business income is also an important function of an accountant.

In General term, payment received in lieu of services or goods are called income,

for example, salary received by any employee is his income. There may be different

type of incomes like Gross income, Net income, National Income, and Personal

income, but we are here more concerned for a business income. Surplus revenue

over expenses incurred is called as “Business Income.”

Objectives of Net Income Following are the important objectives of a net income −

Historical income figure is the base for future projections.

Ascertainment of a net income is necessary to give portion of profit to

employees.

To evaluate the activities, which give higher return on scarce resources are

preferred. It helps to increase the wealth of a firm.

Ascertainment of a net income is helpful for paying dividends to the

shareholders of any company.

Return of income on capital employed, gives an idea of overall efficiency of a

business.




Definition of Income The most authentic definition is given by the American Accounting Association as

−

“The realized net income of an enterprise measures its effectiveness as an operative

unit and is the change in its net assets arising out of a (a) the excess or deficiency of

revenue compared with related expired cost, and (b) other gains or losses to the

enterprise from sales, exchange or other conversion of assets:”.

According to the American Accounting Association, to be as business income,

income should be realized. For example, to be a business income, only appreciation

in value of assets of a company is not enough, for this, asset has really been

disposed of.

Accounting Period

For the measurement of any income concerns, instead of a point of time, a span of

time is required. Creditors, investors, owners, and government, all of them require

systematic accounting reports at regular and proper intervals. The maximum

interval between reports is one year, as it helps a businessman to take any

corrective action.

An accounting period concept is directly related to matching concept and

realization concept; in the absence of any of them, we could not measure income

of the concerns. On the basis of matching concept, expenses should be determined

in a particular accounting period (usually a year) and matched with the revenue

(based on realization concept) and the result will be income or loss of the

accounting period.

Accounting Concept and Income Measurement The measurement of accounting income is the subject to several accounting

concepts and conventions. Impact of accounting concepts and convention on

measurement of the accounting income is given below −

Conservatism

Where an income of one period may be shifted to another period for the

measurement of income is called as ‘conservatism approach.’

According to the convention of conservatism, the policy of playing safe is followed

while determining a business income and an accountant seeks to ensure that the

reported profit is not over stated. Measurement of a stock at cost or market price,

whichever is less is one of the important examples as applied to measurement of




income. But it must be insured that providing excessive depreciation or excessive

provisions for a doubt full debt or excessive reserve should not be there.

Consistency

According to this concept, the principle of consistency should be followed in

accounting practice. For example, in the treatment of assets, liabilities, revenues,

and expenses to insure the comparison of accounting results of one period with

another period.

Therefore, the accounting profession and the corporate laws of most of the counties

require that financial statement must be made out on the basis that the figures

stated are consistent with those of the preceding year.

Entity Concept

Proprietor and business are the two separate and different entities according to the

entity concept. For example, an interest on capital is business expenditure, but for

a proprietor, it is an income. Thus, we cannot treat a business income as personal

income or vice-versa.

Going Concern Concept

According to this concept, it is assumed that business will continue for a long time.

Thus, charging depreciation on a Fixed Asset is based on this concept.

Accrual Concept

According to this concept, an income must be recognized in the period in which it

was realized and costs must be matched with the revenue of that period.

Accounting Period

It is desirable to adopt a calendar year or natural business year to know the results

of business.

Computation of Business Income To compute business income, following are the two methods −

Balance Sheet Approach

Comparison of the closing values (Assets minus outsider’s liabilities) of a firm with

the values at the beginning of that accounting period is called as Balance Sheet

approach. In above value, an addition to capital will be subtracted and addition of

drawings will be added while computing the business income of a firm. Since,

income is calculated with the help of Balance Sheet hence called as Balance Sheet

approach.




Transaction Approach

Transactions are mostly related to production or the purchase of goods and the

sale of goods and all these transactions directly or indirectly related to the revenue

or to the cost. Therefore, surplus collection of the revenue by selling goods, spent

over for production or purchasing the goods is the measure of income. This system

is widely followed by the enterprises where double entry system adopted.

Measurement of Business Income There are following two factors which are helpful in the estimation of an income −

Revenues − Sale of goods and rendering of services are the way to generate

revenue. Therefore, it can be defined as consideration, recovered by the

business for rendering services and goods to its customers.

Expenses − An expense is an expired cost. We can say the cost that have

been consumed in a process of producing revenue are the expired cost.

Expenses tell us - how assets are decreased as a result of the services

performed by a business.

Measurement of Revenue Measurement of the revenue is based on an accrual concept. Accounting period, in

which revenue earned, is the period of revenue accrues. Therefore, a receipt of cash

and revenue earned are the two different things. We can say that revenue is earned

only when it is actually realized and not necessarily, when it is received.

Measurement of Expenses In case of delivery of goods to its customers is a direct identification with the

revenue.

Rent and office salaries are an indirect association with the revenue.

There are four types of events (given below) that need proper consideration about

as an expense of a given period and expenditure and cash payment made in

connection with those items −

Expenditure, which are expenses of the current year.

Some expenditure, which are made prior to this period and has become

expense of the current year.

Expenditure, which is made this year, becomes expense in the next

accounting periods. For example, purchase of fixed assets and depreciation

in next up-coming years.




Expense of this year, which will be paid in next accounting years. For

example, outstanding expenses.

Matching Concept It is a problem of recognition of revenue during the year and allocation of expired

cost to the period.

Recognition of Revenue

Most frequent criteria, which are used in recognition of the revenue are as follows

−

Point of Sale − Transfer of ownership title to a buyer is point of sale, in case

of sale of commodity.

Receipt of Payment − Criteria of cash basis is widely used by the attorneys,

physicians, and other professionals in which revenue is considered to be

earned at the time of collection of cash.

Instalment Method − Instalment method is widely used in retail trading

specially in consumer durables. In this system, revenue earned is treated in

the same manner as is used in any other credit sale.

Gold Mines − The accounting period in which gold is mined is the period of

revenue earned.

Contracts − Degree of contract completion, especially in long term

construction contracts is based on percentage of completion of a contract in

a single accounting year. It is based on total estimated life of the contract.

Allocation of Costs

Matching of expired revenue and expired costs on a periodic time basis is the

satisfactory basis of allocation of cost as stated earlier.

Measurement of Costs Measurement of costs can be determined by −

Historical Costs − To determine periodic net income and financial status,

historical cost is important. Historical cost actually means - outflow of cash

or cash equivalents for goods and services acquired.

Replacement Costs − Replacing any asset at the current market price is

called as replacement cost.

Basis of Measurement of Income




Following are the two significant basis of measurement of income −

Accrual Basis − In an accrual basis accounting, incomes are recognized in a

company’s books at the time when revenue is actually earned (however, not

essentially received) and expenses is recorded when liabilities are incurred

(however, not essentially paid for). Further, expenses are compared with

revenues on the income statement when the expenses expire or title has been

transferred to the buyer, and not at the time when the expenses are paid.

Cash Basis − In a cash basis accounting, revenues and expenses are

recognized at the time of physical cash is actually received or paid out.

Change in the Basis of Accounting

We have to pass adjustment entries whenever accounting records change from cash

basis to accrual basis or vice versa specially in respect of the prepaid expenses,

outstanding expenses, accrued income, income received in advance, bad debts &

provisions, depreciation, and stock in trade.

Features of Accounting Income

Followings are the main features of accounting income −

Matching revenue with related cost or expenses is a matter of accounting

income.

Accounting income is based on an accounting period concept.

Expenses are measured in terms of a historical cost and determination of

expenses is based on a cost concept.

It is based on a realization principal.

Revenue items are considered to ascertain a correct accounting income.

Bills of Exchange and Promissory Notes “An Instrument in writing containing an unconditional order, signed by the maker,

directing a certain person, to pay a certain sum of money only to, or to the order of a

certain person or to the bearer of the instrument.”

Section 5, Negotiable Instrument Act, 1881

Essentials of Bills of Exchange Following are the essentials of a bill of exchange −

Bill of exchange should be in written.




The seller who makes the bill is termed as “Drawer,” the purchaser upon

whom the bill is drawn is known as “Drawee” and must be a person.

Bill of exchange must be carrying certain amount and only in terms of money,

and not in terms of goods or services.

Order to pay the money, should be unconditional.

Specimen of Bill

Apart from all these (given above), we also need to pay attention on the following

points −

Parties to Bill of Exchange Following are the parties of ‘Bill of Exchange −”

The Drawer − Seller of goods is termed as drawer of “bills of exchange.”

The Drawee − Drawee or purchaser is a person who accepts the bill of a

certain amount to be paid after a specific time.

The Payee − Payee and drawer may be same person who gets the payment

or may be a different person. In case of same parties, will be reduced to two

instead of three.

Important Terms Stamp − Amount in excess of certain limit should be paid and signed on

affixed revenue stamp according to above specimen. In these days, threshold

limit is INR 5,000/.




Amount − Amount of bill must be written in figure as well as in words as

shown in above specimen.

Date − Date on bill will be written on face of it as above.

Value and Terms − Both are essential part of it and must be written as shown

above.

Acceptance of Bills To make it a legal document, it must be signed by “Drawee.” Acceptance may be

general acceptance i.e. Drawee agrees with the full content of the bill without any

change and it may be conditional, which is called as qualified acceptance.

Classification of Bills of Exchange Bill of exchange may be classified as viz…

Inland Bill − Bill, which is drawn in India, both the Drawer and the Drawee

are from India and also payable in India called Inland Bill.

Foreign Bill − Bill, which is drawn outside India, drawn on a person residing

in India, payable in India or vice versa. Due date of foreign bill starts from

the date on which Drawee sees it and accepts it.

Definition of Promissory Notes As per Section 4 of the Indian Negotiable Instrument Act, 1881

“An instrument in writing (not being a Bank note or a currency note) containing an

unconditional undertaking, signed by the maker, to pay a certain sum of money only

to, or the order of a certain person, or to the bearer of the instrument.”

Difference between Promissory Notes and Bills of Exchange

Promissory Note Bill of

Exchange

It is an unconditional promise to pay

Bill of

Exchange is

unconditional

order to pay.




Debtor make the promise to pay to the creditor

Bill of

Exchange

drawn by a

seller of

goods or

services and

he makes an

order to

debtor to

make the

payment.

Foreign promissory note make in a set of one only Foreign Bills

of Exchange

drawn in a

set of three.

Promissory note payable on demand, requires stamp duty Bill of

Exchange

payable on

demand does

not require

stamp duty.

Promissory note has only two parties i.e. drawer and payee

Bill of

exchange

may have

three parties,

drawer,

drawee and

may be

payee.

Since debtor himself makes the promise to make the payment,

hence no acceptance required in this case

To be a legal

document, it

must be

accepted by

Drawee.

Advantages of Bills of Exchange and Promissory Notes




Followings are the important advantages of Bills of Exchange and Promissory Notes

−

Facilitation of the credit transactions is helpful in increasing the size of

business.

Both are the proof of purchase of goods or services in credit.

Being a legal document, both can be produced in a court, in case of its

dishonor.

Since date of payment is fixed, it is helpful for both debtors and creditors;

and, they may manage their payment schedule accordingly.

In case of any urgency of payment, creditor can get the bill discounted from

the bank.

Being a negotiable instrument, promissory note is easily transferable from

one person to another.

Accounting Treatment Bills of exchange and Promissory notes are treated as bills receivable and bills

payable in regards to accounting treatment −

Bills Receivable − If we have to receive the payment against bills of exchange

or promissory note, it will be called as “Bills Receivable” and will be shown

in the Asset side of Balance-sheet under Current Assets.

Bills Payable − Bills payable is current liabilities in hand of Drawee.

Accounting Entries − When the Bill received and retained in possession till

due date.

Accounting entries to be done in the books of Drawer and Payee as −

Sr.No. In the Books of Drawer Entries in the Books of Acceptor

1 Customer A/cDr

To Sales A/c

(Being Goods sold on

credit)

Goods Purchase A/cDr

To Supplier A/c

(Being Goods Purchased on credit)

2 Bills Receivable A/cDr Supplier A/cDr




To Customer A/c

(Being Bill accepted by

Customer)

To Bills Payable A/c

(Being Bill accepted drawn by

supplier of goods)

3 Cash/Bank A/cDr

To Bills Receivable A/c

(Being Amount of bill

received on due date)

Bills Payable A/cDr

To Cash/Bank

(Being Amount paid on due date and

bills payable received back)

When Bill is Discounted with the Bank In the Book of Drawer − The drawer of a bill may get the bill discounted from

his bank before due date of that bill. In this case, bank charges some interest

on bill amount according to waiting time. For example, if bill is drawn on 1st

January for 3 months and drawer may get bill discounted on 1st February,

in this case, bank will charge interest for two months at applicable rate say

14% and drawer of bill may pass following entry.

Cash / Bank A/c Dr

Discount A/c Dr To bills Receivable A/c (Being bill discounted with bank @ 14% p.a. discount charge debited by bank for 2 months)

In the book of Drawee − Drawee has no need to pass entry on above, he just

needs to pass the entry at the time of payment on maturity of bill as explained

earlier.

When Bill of Exchange Endorsed in Favor of a Creditor If Drawer of the bill of exchange endorsed the bill to his creditor for his own

liabilities and bill is met on maturity, following journal entries will be passed −

In the book of Drawer

Creditors A/c Dr

To bills Receivable A/c (Being bill receivable endorsed to creditor)

Note − Drawer has no need to pass any entry at the time of maturity of a Bill.

In the book of Drawee − Drawee has no need to pass any entry at the time of

endorsement of Bill. Entries will remain same as explained earlier.




Dishonor of a Bill of Exchange In case where the acceptor of a Bill of Exchange failed to pay the bill on due date

of maturity or refused to pay, it is called as dishonor of a Bill of Exchange. As a

proof of dishonor of a Bill, payee may get a certificate from a Notary Officer

appointed by the Government for this purpose. Notary officer charges some fees in

this regard called as “Noting Charges.”

Following entries will pass in the books of Drawer and Drawee −

Sr.No In the Books of Drawer

1 If bill is kept by the Drawer with himself till the date of

maturity −

Customer/Acceptor A/c Dr (with total Bill amount + Noting

Charges)

To Bills Receivable A/c(with Bill Receivable amount)

To Cash/Bank(Noting Charges paid)

(Being Bills receivable dishonor and noting charges paid)

2 If bill is discounted with the bank −


Charges)

To Bank A/c(with total Bill amount + Noting Charges)

(Being discounted Bills receivable dishonor and noting charges

paid)

3 If bill is endorsed by the Drawer in favor of a Creditor −


Charges)

To Creditor A/c(with total Bill amount + Noting Charges)

(Being endorsed Bills receivable dishonor and noting charges

paid)




Entries in the Books of Acceptor/Debtors

In all above three case acceptor will pass only one journal entry −

Bills payable A/cDr(with the bills payable amount)

Noting Charges A/cDr(with Noting Charges )

To Drawer/Creditor A/c(with total Bill amount + Noting Charges)

(Being Goods Purchase on credit)

Renewal of Bill There may be a situation when the acceptor of bill may not be in position to pay

the bill on due date and he may request drawer to cancel the old bill and draw a

new bill on him (i.e. Renewal of Bill). Drawer of bill may charge some interest on

mutually agreed terms and that amount of interest may be paid in cash or may be

included in the bill amount.

Entries in the Books of Drawer and Drawee Following accounting entries to be done in the books of Drawer and Drawee −

Sr.No. In the Books of Drawer Entries In the Books Acceptor

1 Cancellation of old bill −

Customer/Acceptor A/cDr

To Bill receivable A/c

(Being old bill cancelled)

Cancellation of old bill −

Bills Payable A/cDr

To Creditor A/c

(Being request for cancellation of

old bill accepted by Creditor)

2 Interest received in cash −

Cash A/cDr

To Interest A/c

(Being interest received on

delayed payment)

Interest paid in cash −

Interest A/cDr

To Cash A/c

(Being Interest paid on renewal of

Bill)




3 In case interest not payable

in cash −

Customer/Acceptor A/cDr

To Interest A/c

(Being Interest due on renewal

of bill)

In case interest not payable in

cash −

Interest A/cDr

To Creditor A/c

(Being Interest on renewal of bill

due)

4 On renewal of bill −

Bills Receivable A/cDr

To Customer/Acceptor A/c

(Being renewal of bill including

amount of interest)

On renewal of bill −

Supplier A/cDr

To Bills Payable A/c

(Being Bill accepted after

cancellation of a new bill

including interest)

Retiring of a Bill under Rebate Sometimes, acceptor may approach to drawer of a bill to make early payment before

due date of a bill, following journal entries will pass in this case −

Sr.No. Entry In the

Books of Drawer

Entries In the Books of Acceptor

1 Cash/Bank

A/cDr

Rebate A/cDr

To Bills

Receivable A/c

(Being Amount

of bill received

before due date

and rebate

allowed to

customer)

Payable A/cDr

To Cash/Bank A/c

To Rebate A/c

(Being Amount paid before due date on rebate)

Bill sent to Bank for Collection




To manage several numbers of bills receivable, drawer sent those bills to the bank

for collection and bank gives credit to the customer whenever a bill is collected from

a drawee. Following journal entries will be passed −

Sr.No. Entry In the Books of Drawer

1 When a bill is sent to the bank for collection −

Bills sent for Collection A/cDr

To Bank A/c

(Being bills receivable sent to the bank for collection)

2 On collection of payment by bank −

Bank A/cDr

To Bills sent for Collection A/c

(Being Collection of bills receivable by bank)

Accommodation Bill A bill of exchange may be accepted to oblige a friend or any known person at the

time of his need or to provide him a loan or else to accommodate one or more parties

is called as accommodation bill.”

Financial Accounting - Inventory Valuation The Institute of Chartered Accountant of India as per Accounting Standard-2

(Revised) defines inventory as the assets held −

For sale in the ordinary course of a business or

In the process of production for such a sale or

In the form of materials or supplies to be consumed in the production process

or in rendering of the services.

Thus, the term inventory includes −

Raw Material and supplies,

Work in progress, and

Finished goods.




Importance of Inventory Valuation Proper valuation of inventory is important because of the following three reasons −

Importance of sufficient Inventory − An inventory represents major current

asset investment of any trading or manufacturing concern. Shortage of

inventory may close down the business. Realization of profit from resale of

an inventory makes valuation of inventory. Therefore, the point is that every

business unit has to follow a proper method of inventory valuation.

To Determine True Financial Position − Proper valuation of an inventory

can only give true and fair view of the financial position of a business unit,

as it constitutes a significant portion of the current assets.

For Proper Determination of Income − Proper determination of income and

profit depends on correct valuation of the inventories. Over valuation of

closing inventory may overstate the profit figure and vice-versa. Therefore,

proper valuation of an inventory is necessary to determine the true income

and profit by the business concern.

Methods of Taking Inventory Following are the two important methods of taking inventory −

Periodic Inventory Method and

Perpetual Inventory Method

Let’s discuss each of them separately −

Periodic Inventory Method

This method of stock valuation is also known as physical stock taking method or

annual stock taking method. Under this system of taking inventories, stock is

determined by physical counting at the end of the accounting period i.e. the date

of preparation of final accounts. This system is very simple and useful in small

business organizations.

Perpetual Inventory Method

This system of inventory valuation records every movement of stock on the receipt

and issue of material reflecting running balances of different kind of inventories

through preparation of store ledgers for raw material, work-in- progress, and

finished goods. To insure the accuracy of store records, a periodic reconciliation of

records is done by taking physical inventories.




Valuation of Inventory at Lower Cost or Market

Price An inventory is valued at a cost or market price, whichever is lower to ensure that

the anticipated profit should not be accounted for and full provision for anticipated

losses should be done.

As per American Institute of Certified Public Accountants −

“A departure from the cost basis of pricing the inventory is required when the utility

of the goods is no longer as great as its cost. Where there is evidence that the utility

of goods, in their disposal in the ordinary course of business, will be less than cost,

whether due to physical deterioration, obsolescence, changes in price levels, or other

causes, the difference should be recognized as loss of the current period. This is

generally accomplished by stating such goods at a lower level commonly designated

as market.”

Methods of Valuation of Inventory The following illustration shows the methods of Valuation of Inventory −

Let’s discuss each one of the methods in detail.

First in First out (FIFO) Method

FIFO is the most popular method of an inventory valuation, which is based on

assumption that the material first received or purchased are the first to be sold or

issued. It means, closing stock is out of the last or latest received or manufactured

goods.




It will clear with a small and simple example as given below −

Date No. of Item Rate Value

Opening stock 100 10 1000

Purchased on 01-04-13 500 10 5000

Purchased on 01-07-13 500 12 6000

Purchased on 01-01-14 1000 15 15000

Total Purchases 2100 27000

Item Sold 1700

Closing stock 400 15 6000

In above example, it is assumed that closing stock of 400 items was out 1000 items

purchased on 01-01-2014.

Last in First out (LIFO) Method

As name suggests, closing stock is valued on the basis of oldest purchased or

manufactured items. First time, this method was used by the U.S.A., at the time of

Second World War to get the advantage of hike in prices. In the above example,

closing stock will be valued at 400 items @ Rs. 10 each = Rs. 4000

Note − Here 100 items from opening stock and 300 items were out of purchases

made on 01-04- 2013

Average Cost Method

Average cost method is used where identification of stock with rate or value of stock

is not possible. It is of two types Viz…

Simple Average Price Method

Weighted Average Price Method




Simple Average Price Method

Simple average price method may be explained as below −

Suppose, four types of items are in stock as follows −

500 units purchased @ Rs. 10 per unit = Rs. 5000



Total Units 1850 for = Rs. 22400

Simple average method ignored the inventory at cost, therefore the valuation of

stock of 1850 units will be = 12 × 1850 = Rs. 22,200 whereas the actual cost is Rs.

22,400

So, if we want to choose average method then weighted price method should be

followed under which valuation will be done as hereunder.

Weighted Average Price Method

In the above example, Rs. 22,400 will be divided by 1850 units and the average

price will be Rs. 12.1081.

Highest in First out (HIFO) Method

This method is based on the assumption that the highest value of material always

consumed first and closing stock will be valued at the lowest cost of purchased or

manufactured material. This method is not a popular method of valuation of

inventory and so, used only by the business units having monopoly products or

who are dealing with the cost + contract.

Base Stock Method

Base stock means — minimum level of stock maintained by a business unit to run

his business without any interruption or which is according to AS-2 issued by The

Institute of Chartered Accountants of India as “the base stock formula proceeds

on the assumption that a minimum quantity of inventory (base stock) must be held

at all times in order to carry on business.”

Note − This method can be followed only when LIFO method is used.




Inflated Price Method

This method of valuation covers normal losses, increasing price of purchases to

calculate closing value of an inventory. For example, if 550 units purchased for Rs.

2000 and due to normal loss units, remain 500 then the cost per unit will be

2000/500 = Rs. 4 per unit, and while calculating closing stock value for 100 unit,

cost will be Rs. 400 (100 × 4).

Specific Identification Method

Under this method, where identification of items with price is possible, then closing

stock will be valued accordingly.

Market Price Method

Under this method of valuation, stock is valued at current market price. It is also

called replacement price or realizable price method.

Method of Valuation of Closing Stock when it is not given

In case, where the value of closing stock is not given, we may calculate it as −

Opening stock xx

Add: Net Purchases xx

Less: Cost of Sales xx

Less: Gross Profit xx

Value of Closing stock xx

Putting value in above formula, we may also calculate the value of opening stock.

Analysis of Changes in Income The purpose of preparing a financial statement is not only to know the net income

or losses of concern for the current year, but also to know the change in net income

or losses of a firm in comparisons to the preceding years.

There are two types of financial statements, which reflect two types of profits

i.e. trading account shows the gross profit and Profit & Loss accountsshows the

net profit of the concern for a specific accounting period. Under this chapter, we

will discuss the reasons for changes in Gross Profit Ratio.




Gross Profit Ratio (GPR) Gross profit means, excess of sales over cost of goods sold. This ratio also indicates

the losses due to damage or mismanagement. More the ratio is high more it is good

for a financial health of a concern. Chances of higher net income are more in an

organization where ratio of gross profit is high (formula is given below) −

GrossProfitRatio=GrossProfitNetSalesGrossProfitRatio=GrossProfitNetSales

Higher gross profit provides leverage to the management to meet their indirect

expenses and to spare net income for the distribution of profit and to increase the

reserves.

Gross Profit Margin When Gross profit margin is presented in percentage, it is called as Gross profit

margin (formula is given below) −

GrossProfitMargin=GrossProfitNetSales×100GrossProfitMargin=GrossProfitN

etSales×100

Chances of Increase in GPR may be due to following Reasons −

Without increase in corresponding costs, if there is an increase in selling

price.

Without decrease in selling price, if there is decrease in cost of production of

products.

There may be equal decrease or increase in selling price and cost of

production without affecting gross profit of the current year.

There may be chances that the valuations of closing stocks are done with

higher price.

It is also possible that the opening stock of a concern is valued at very lower

rate.

There is a possibility that given sales are inclusive of consignment sale due

to any mistake or otherwise.

Omission of purchase invoices in the books of accounts may also be one of

the reasons for higher gross profit.

Chances of Decrease in GPR may be due to following Reasons −

If cost price remains same, but decrease in selling price.




Sale price remains same, but increase in cost of production.

Personal used goods debited to purchase account.

Closing stock may be valued at very low price.

Opening stock may be valued at very high price.

Any omission or mistake while valuation of closing stock.

It is necessary for survival and progress of any business to keep its margin of gross

profit high as much as possible to enable it to cover its operative expenses as well

as indirect expenses.

Analysis of Gross Profit Analysis of changes in gross profit is the first step in determination of a net income.

Change of gross profit in current year may be due to the following reasons −

Change in sale amount may be due to following three reasons −

o Change in selling price.

o Change in quantity sold without change in sale price.

o Change in sale price as well as quantity of goods sold.

Change in cost of goods sold may be due to following reasons −

o Change in cost of production.

o Change quantity of goods sold.

o Change in quantity as well as cost of goods sold.

Example

Make an analysis of changes from the information given below −

Particulars Year 2012

(Rs.)

Year 2013

(Rs.)

Changes (Increase or

decrease)

Sales 3,50,000 4,80,000 1,30,000

Number of Unit sold 5,000 6,000 1,000

Selling Price per Unit 70 80 10

Solution

Increase in sales amount due to price −




Increase in price per unit × Number of unit sold in current year

= 10 × 6000 = 60,000

Increase in sales amount due to Quantity −

Increase in number of unit sold × price of last year

= 1,000 × 70 = 70,000

Combined effect of change in quantity and price (A+B)

= 1, 30,000

Accounting for Consignment Due to increasing size of market, it is quite obvious that manufacturers or whole

sellers cannot approach directly to every customer around the state or nation. To

overcome this limitation, manufacturers normally appoint reliable agents at every

desired location to reach the customers directly. He makes an agreement with local

traders who can sell goods on his behalf on commission basis.

Meaning and Features of Consignment Consignment is a process under which the owner consigns/handovers his

materials to his agent/salesman for the purpose of shipping, transfer, sale etc.

Following are the points that throw more light on the nature and scope of a

consignment −

Here, ultimate ownership of the goods remains with the manufacturer or

whole seller who handovers goods to his agent for sale on commission basis.

Consignment is merely a transfer of possession of goods not an ownership.

Since ownership of goods remain with the manufacturer (consignor),

consignee (agent) is not responsible for any loss or destruction of goods.

The goods are sold on owner’s risk and hence, profit/loss goes to owner.

Consignee only gets re-imbursement of expenses incurred by him and

commission on sale made by him, because sale that proceeds, belongs to

owner (consignor).

Why is Consignment not a Sale? Following are the reasons that explain why consignment is not a sale −




Ownership − Ownership of goods need to be transferred from seller to buyer

in case of sale, but ownership of goods remains with the consignor, till the

goods are sold by the consignee.

Risk − In case of a consignment, normally, risk remains with the consignor

in the event of goods being lost or destroyed.

Relationship − The relation between a seller and a buyer will be of debtor

and creditor in case where goods are sold on credit basis. On the other hand,

the relationship between a consignor and a consignee is that of principal and

agent.

Goods Return − Usually, the sold goods cannot be returned back; however,

if there is any manufacturing defect or any other technical fault, seller is

obliged to take them back. On the other hand, consignee may return the

unsold stock of goods to consignor anytime.

Important Terms Pro-forma Invoice

Invoice implies that the sale has taken place, but pro-forma invoice is not an

invoice. Proforma invoice is a statement prepared by the consignor of goods

showing quantity, quality, and price of the goods. Such pro-forma invoice is issued

by the consignor to consignee regarding the goods before the sale actually takes

place.

Account Sale

Statement showing the details of goods received, goods sold, expenses incurred,

commission charged, remittances made, and due balance is called Account Sale

and it is remitted by the consignee to the consignor of goods on a periodic basis.

Commission

There are three types of commission payable to consignee on sale of the goods −

Simple Commission − This is usually a fixed percentage on the total sale,

calculated as per mutually agreed terms.

Over-riding Commission − In case of an extra-ordinary sale of the goods,

some specific amount is payable to consignee in the form of an incentive is

called overriding commission. Over-riding commission is also calculated on

the total sales.

Del-credere Commission − “An agreement by which an agent or factor, in

consideration of an additional premium or commission (called a del credere




commission), engages, when he sells goods on credit, to insure, warrant, or

guarantee to his principal the solvency of the purchaser, the engagement of the

factor being to pay the debt himself if it is not punctually discharged by the

buyer when it becomes due.”

C. & G. Merriam Co.

A del credere commission is paid by the consignor to his agent for taking additional

risk of recovery of debts from the consignee on an account of credit sales made by

him (agent) on consignor's behalf.

Direct Expenses

Expenses, which increases the cost of the goods and are of non-recurring nature

and incurred till the goods reach the warehouse of consignee may called direct

expenses.

Indirect Expenses

Warehouse rent, storage charges, advertisement expenses, salaries, etc. comes

under the category of the indirect expenses. The distinctions between direct and

indirect expenses are important especially at the time of valuation of the unsold

closing stock.

Advance

Amount paid in advance by a consignee to consigner as security called as advance.

Valuation of unsold Consignment Valuation of unsold stock will be done like a closing stock of a Trading concern and

should be valued at the cost or the market price whichever is low. This stock will

be valued at −

Proportionate cost price and

Proportionate direct expenses.

Here, proportionate direct expenses mean — all expenses incurred by the consignor

and the expenses of consignee, which are incurred by him till the goods reach the

warehouse.

Invoicing Goods higher than Cost Under this method, goods are charged at the cost + profit and the pro-forma invoice

also shows this higher price of such goods. To know the actual profit, at the end of

an accounting period, consignment account will be credited with excess price so




charged. Value of the stock will also be adjusted to the extent of profit element.

Main reason to adopt this policy by consignor is −

To hide actual profit from consignee.

Valuation of a stock at the consignor’s warehouse is comparatively easy in

this case.

In this case, consignor usually directs consignee to sale goods on invoice price

only. It prevents different sale price to different customers.

Loss of Goods There may be two types of losses as explained below −

Normal Loss − Normal loss may occur due to inherent characteristics of goods like

evaporation, drying up of goods, etc. It is not separately shown in the consignment

account, but included in the cost of goods sold and the closing stock by inflating

the rate per unit. To calculate the value of unsold stock, following formula is used.

Valueofclosingstock=TotalvalueofgoodssentNetquantityreceivedbyconsignee×Unsoldquanti

tyValueofclosingstock=TotalvalueofgoodssentNetquantityreceivedbyconsignee×Unsoldq

uantity

Netquantityreceived=Goodsconsignedquantity−NormallossquantityNetquantityreceived=G

oodsconsignedquantity−Normallossquantity

Abnormal Loss − An abnormal loss may occur due to any accidental reason. It is

credited to the consignment account to calculate actual profitability. Valuation of

closing stock is done on the same basis as explained earlier i.e. proportionate cost

+ proportionate direct expenses.

Abnormal Loss and Insurance

If, there is an insurance policy in respect of the consigned goods; following entries

will be passed in the books of a consignor −

Sr.No. In the Books of Consignor In the Books of Consignee

1 Payment of Insurance

Premium

(a) If insurance premium is

paid by the consignor, then

cash will be credited.

Consignment A/cDr

To Cash A/c

Or

To Consignee A/c




(b) If Insurance premium is

paid by the consignee, then

consignee’s A/c will be

credited.

(Being Insurance premium paid)

2

At the time of Abnormal Loss

Abnormal Loss A/cDr

To Consignment A/c

(Being Loss Incurred)

3

Acceptance of Claim by

Insurance Company

Insurance Company (Name of

the insurer) A/cDr

To Abnormal Loss A/c

(Being claim admitted)

4

On receipt of Claim

Bank A/cDr

To Insurance Company A/c

(Being amount of claim received)

5

In Case of Loss

Profit & Loss A/cDr

To Abnormal Loss A/c

(Being amount of Abnormal Loss

transferred)

Summary of Accounting Entries Following Accounting Entries (Except for Loss) will be done in the books of

consignor and consignee for transactions related to the consignment −

Sr.No. In the Books of Consignor In the Books of Consignee

1 When goods are sent to the

consignee

Consignment A/cDr

No need to do any Entry in this

case




To Goods Sent on Consignment

A/c

(Being Goods Sent on

Consignment)

2 Expenses Incurred by Consignor

Consignment A/cDr

To Cash/Bank A/c

(Being Expenses incurred on

consignment)

Not Applicable

3 Advance given by consignee

Cash/Bank A/cDr

To Consignee’s A/c

(Being advance received from

consignee)

Consigner A/cDr

To Bank/Cash A/c

(Being Advance amount paid

to Consignor)

4 Expenses Incurred by Consignee

Consignment A/cDr


(Being Expenses incurred by

consignee)

Consigner A/cDr

To Bank/Cash A/c

(Being Expenses incurred on

goods received on

consignment)

5 Sale by Consignee

Consignee’s A/cDr

To Consignment A/c

(Being Expenses incurred by

consignee)

Cash (for cash sale) A/cDr

Debtors (for Credit Sale) A/c

Dr

To Consignor A/c

(Being goods sold)

6 Commission to Consignee

Consignment A/cDr

Consigner A/cDr

To Commission A/c





(Being Commission on sale due to

consignee)

(Being Commission earned)

7 Remittance from Consignee

Cash/Bank A/cDr


(Being due amount received from

consignee)

Consigner A/cDr

To Bank/Cash A/c

(Being Balance due Payment

made to consignor)

8 Entry for Profit on Consignment

Profit & Loss A/cDr

To Consignment A/c

(Being Profit earned on

consignment)

Not Applicable

9 Loss on Consignment

Consignment A/cDr

To Profit & Loss A/c

(Being Loss incurred on

Consignment transferred to the

profit & Loss Account)

Not Applicable

Note − The goods sent on consignment account will be closed by transferring

balance into the Purchase account or the Trading account.

Financial Accounting - Joint Venture An association of two or more persons or we may say temporary partnership

combined for the carrying out a specific business, and divide profit or loss thereof

in agreed ratio is called a Joint Venture. Concerned parties to joint venture are

known as co-venturers. The liabilities of co-venturers are limited to their profit

sharing ratio or as per agreed terms −




Suppose ‘A’ and ‘B’ undertake the job to develop a park for a consideration of Rs.

50,000/- Lacs. Since they come together for a work on a specific project, it will

termed as joint venture and each of them (A and B) will be called as a co-venturer.

Further, this venture will automatically terminate once the project is completed.

Major Features and Characteristics of Joint Venture Following are the major features of a joint venture −

There is an agreement between two or more persons.

Joint venture is made for the specific execution of a business plan/project.

It is a temporary partnership without the use of a firm name.

Agreement for joint ventures is automatically dissolved as soon as specific

project is over.

Profit & Share are shared on the same terms and conditions agreed upon.

However, in the absence of any agreement, profit & share will be divided

equally.

Partnership and Joint Venture There are following differences between partnership and joint venture −

Partnership always carried on with firm’s name, but for the joint venture, no

such firm’s name is required.

The persons who run the business on partnership are called as partners and

the persons who agreed to take the project as joint venture are called as co-

venturers.

Normally, a partnership is constituted for a long period (including various

projects), whereas joint venture is formed to complete a specific job/project.

Partnership is governed under the Partnership Act, 1932, whereas there is no

enactment of such kind for the joint ventures. However, as a matter of fact

in law, a joint venture is treated as a partnership.

There is no limit specified for the numbers of co-venturers, but the number

of partners is limited to 10 under banking business and 20 for any other

trade or business.




Liability of a partner is unlimited and may extent of his business and personal

estate, whereas under joint venture, liabilities of co-venturers are limited to

the particular assignment or project agreed upon.

Joint Venture and Consignment Major differences between joint venture and consignment may be summarized as −

Relationship − The co-venturers of a Joint venture are the owners of a Joint

venture, whereas relationship of a consignor and consignee is of owner and

Agent.

Sharing of Profits − There is no distribution of profit between a consignor

and consignee, consignee only gets commission on sale made by him. On the

other hand, the co-venturers of a joint venture share profits as per the agreed

profit sharing ratio.

Ownership of Goods − Ownership of the goods remains with the consignor.

Consignor transfers only possession to the consignee, but every co-venturer

of a joint venture is the co-owner of the goods/project.

Contribution of Funds − Investment is done by the consignor only. On the

other hand, funds are contributed by all co-ventures in a certain agreed

proportion.

Continuity of Business − In case of a joint venture, there is no continuity of

the business once project is completed. On the other hand, if, everything goes

smooth, consignment is a continuous process.

Accounting Records To keep a record of the joint venture transactions, there are three following types

of accounting methods −

When one of the Venturers keeps Accounts,

When Separate Books of Accounts are kept for the Joint Venture, and

When Separate Books of Accounts are not kept for the Joint Venture.

Let’s discuss each of them separately −

When one of the Venturers keeps Accounts If one of the co-venturers is appointed to manage the joint venture, he is awarded

an extra commission or remuneration out of the profit for his services.




Journal Entries

When share of investment received from other co-venturers

Cash/Bank

A/cDr

To Co-

venturers

A/c

When goods are purchased

Joint

Venture

A/cDr

To Cash A/c

(in case of

cash

purchase)

Or

To Creditors

A/c (for

credit

purchase)

When expenses incurred

Joint

Venture

A/cDr

To Cash A/c

When goods are sold

Cash A/cDr

Or

Debtors

A/cDr

To Joint

Venture A/c




When commission allowed to working co-venturer

Joint

Venture

A/cDr

To

Commission

A/c

In case of Profit balance of joint venture, account will be

transferred to profit & Loss (own share of working co-

venturer) and other co-venture’s personal accounts

Joint

Venture

A/cDr

To Profit &

Loss A/c

To Co-

venturers

personal

A/c

In case of Loss

Profit &

Loss A/cDr

To Joint

Venture A/c

On settlement of accounts

All Co-

venturer

A/cDr

To

Cash/Bank

A/c

When Separate Books of Accounts are kept for the Joint Venture Under this method, all co-venturers contribute their share of investment and

deposit their shares in a Joint Bank account — newly opened for the specific

purpose of the Joint Venture. They may use this bank account to make any kind

of payments and to deposit sale proceeds or any other kind of receipts.




In addition to Bank account, a Joint venture account is also opened in the books

to keep records of all transactions routed through this account.

This category of accounts is a personal account of the each co-venturer. Thus

following three accounts are opened −

Joint Bank Account

Joint Venture Account

Personal account of co-venturers

When Separate Books of Accounts are not kept for the

Joint Venture

It is of two types −

When all venturers keep separate accounts

Memorandum joint venture method

When all Venturers keep Separate Accounts −

Separate Joint venture account and personal accounts of other co-venturers

are opened under this method of accounting.

Joint venture account is debited and bank account or creditor account is

credited on the account of goods purchased or expensed.

Joint venture account is credited and a bank account or debtor account is

debited in case of either cash sale or credit sale.

Each co-venturer debits joint venture account and credits personal accounts

of other co-venturer on the account of either goods purchased or expensed

by other co-venturers.

Joint venture account is credited and personal account of others co-venturer

account is debited in case of sale made by other co-venturers.

Joint venture account is debited and commission account is credited if,

commission is receivable, but if commission is receivable by other co-

venturer, then the concerned co-venturer account will be credited instead of

the commission account.

If unsold stock is taken, then goods account will be debited by crediting Joint

venture account. On the other hand, if unsold stock is taken by any other

co-venturer, then personal account of the co-venturer will be debited.




Balance in the joint venture accounts represents profit or loss and later that

amount of profit or loss will be transferred to the personal accounts of co-

venturers.

Note − Above transactions are possible only when all the co-venturers exchange

information’s on regular basis.

Memorandum Joint Venture Method

Important features of memorandum method are given as hereunder −

Only one personal account is opened by each co-venturer in his book named

Joint Venture account with…………… (Name of other co-venturer). Same

process will be followed by other co-venturer in his books of accounts.

Only one personal account will be opened by each co-venturer irrespective of

the fact, how many other co-venturers are exists. For example, there is a joint

venture of 4 person A,B,C, & D; now, A in his books will open only one

personal account named as Joint venture with B,C, & D account.

Each party will record only those transactions in his book, which are done by

him; the transactions done by other co-venturers will be ignored.

In addition to above said personal account, a combined account named as

“memorandum joint venture account” will also be opened.

Memorandum account is merely a combined account of personal accounts

opened by each co-venturer. Debit side of personal account will be

transferred to the memorandum account and the credit side of personal

account will be transferred to the credit side of memorandum account.

Transactions done by co-venturers among themselves including cash

received or paid by one co-venturer to other will be ignored at the time of

preparation of a memorandum account.

Balance of memorandum joint venture account will represent profit or loss of

the particular business. Further, the profit or loss will be transferred to the

individual co-venturer account in their profit sharing ratio.

Financial Accounting - Non-Trading Accounts

Some of the organizations or institutions are constituted to provide valuable

services to the society with the objective not to earn profit. These organizations




normally offer the services such as education, medical, social clubs, charitable

trusts, trade unions, etc.

However, we can summarize these organizations in the following three types of

categories −

Clubs, associations, or society’s works for the welfare of their members.

Charitable institutions like hospitals, students’ hostels, and other

educational institutions providing education to poor children as well as

illiterate young and old groups.

Professional firms of lawyers, chartered accountants, architects, doctors,

solicitors, etc.

What is Non-Trading Account? Maintenance of proper books of accounts is necessary to safeguard the money of

its members and general public from any kind of misuse or misappropriations. It

is important to know the total receipts, total payments, and also to know financial

status of an institution. Hence, the account opened and maintained for and by the

organizations discussed above is known as Non-trading account.

Normally, registration of members, minute book, cash receipt journal, cash

payment journal, etc. are main record which is maintained by these organizations/

institutions in their non-trading accounts. At the end of an accounting period,

these institutions prepares its final accounts, which include the following −

Receipt and Payment Account

Income and Expenditure Account

Balance-Sheet

Let’s discuss each of these in detail.

Receipt and Payment Account It is a real account. Basic rule of double entries is followed to prepare this account.

It is prepared from a cash book at the end of the accounting period. Every

transaction regarding the cash transactions is recorded in the Cash Book in a

chronological order. We may say that the Receipt and Payment account is a

summary of cash payment and cash receipts during the current year.

For example, if rent and salary paid on monthly basis all over the accounting

period, and donation or subscription received during the current year recorded in

a cash book date wise, but at the end of the accounting period, the Receipt and




Payment account will contain total amount of rent paid, salary paid, subscription

received and donation received. All cash receipt will be recorded on the debit side

and all cash payment will be recorded on the credit side.

Income and Expenditure Account Income and expenditure account is a nominal account and as an equivalent to

Profit and Loss account.

The essential features of an income and expenditure account are as follows −

Expenses and losses are recorded in the debit side of it and all incomes and

gains are recorded on the credit side.

Capital income and expenditure are excluded and revenue income and

expenses are included in it.

It is based on a mercantile system of accounting, therefore, the income and

expenses related to preceding years or subsequent years are excluded while

preparing the income and expenditure account.

The credit balance of an income and expenditure account shows surplus.

Further, excess of income over the expenditure and the debit balance of it

show deficit i.e. excess of the expenditure over income.

Only nominal accounts are considered in preparation of this account.

Balance Sheet The date on which a balance sheet is prepared, particulars of all the assets and

liabilities are recorded in the same manner as we do in any other profit making

firms. Its capital fund is made up of surplus income over expenditure and other

incomes capitalized in the given period of time. Sometimes, two balance sheets need

to be prepared viz…

At the beginning of the accounting year to know the opening capital fund and

At the end of the financial year to know the financial position of the organization.

Conversion of Receipt and Payment Account into

Income and Expenditure Account Following are the steps required to convert receipt and payment account into

income & expenditure account −




Opening balance and closing balance of a receipt and payment account

representing opening cash in hand, opening cash at bank, closing cash in

hand, and closing cash at bank need to be ignored.

Items of capital receipts and capital payment will be excluded while preparing

an income and expenditure account.

Revenue items of an income and expenditure will be considered only at the

time of preparation of an income & expenditure account from the receipt and

payment account.

All adjustment regarding the outstanding expenses, prepaid expenses,

provision for bad debts, provision for depreciation, income received in

advance, and income receivable will be done.

An income and expenditure relating to preceding year or subsequent year will

be ignored, and the items only related to the current year will be considered.

Method to Calculation

With the help of ledger accounts, we may calculate the value of income or expenses.

The following two examples describe the method of calculation −

Example (1) − to calculate the amount of expenses of the current year, we need to

prepare a ledger account of a particular expense and then the balancing figure of

it will represent the amount of expense for the current year.

From the following particulars, please find out the amount of rent need to be shown

in income & expenditure account −

Particulars Amount

(in Rs.)

Outstanding Rent at the beginning of the year (as on 01-04-2013) 6,000

Amount as shown in the receipt and payment account 26,000

Outstanding Rent at the end of the year (31-03-14) 4,000

Solution −

Rent Account




Date Particulars Amount Date Particulars Amount

01-04-13 By Balance b/d 6,000

To Cash Paid

(As per receipt

and payment

account)

26,000 31-03-14 By Income and

expenditure

a/c

(Balancing

Figure)*

24,000

31-03-14 To Balance C/d 4,000

Total 30,000 Total 30,000

It is very clear from the above example that the balancing figure represents rent for

the current year i.e. to be transferred and shown in the debit side of the income &

expenditure account. Following the same method, we can calculate the amount of

any other expenses.

Items Peculiar to Non-Trading Concern There are certain peculiar items in the case of non-trading concerns, which require

a special treatment −

Donations

Non-trading concerns may receive donations time to time. The treatment of

donation depends upon nature of donation.

There are two types of donation as explained below −

Specific Donation − Some donation may be received for any specific purpose,

for example, for the construction of a room or building and then donation is

termed as specific donation. The amount of such donation cannot be used

for any other purpose. It should be shown on liabilities side of the Balance-

sheet and used only for the same purpose it is meant for.

General Donation − When a donation is received for a common purpose is

termed as General Donation. If the amount of donation is small, it will be

treated as recurring income and will be recorded in the credit side of income

& expenditure account.




Donation of the big amount should be fairly treated as capital receipts and

will be shown in the liabilities side of the Balance sheet. However, donation

is of a small amount or a big amount may depend upon the size of a concern

and amount.

Legacy

Sometimes, as per the will of a person, an amount received is called as legacy. It is

as good as donation. It is of a non-recurring nature, therefore should be treated as

a capital receipt, and hence will be appeared in the liabilities side of a Balance

sheet. However, it may also be treated as an income and may be taken to income

& expenditure account.

Entrance Fees

A club or society usually charge admission fees or entrance fees for the

membership. In case of club etc., admission fees or entrance fees usually charged

as capital receipts, but in case of a hospital or educational institution, it is treated

as a recurring income.

Life Membership Fees

The life membership fees may be taken from the members of institution only once

in their lifetimes. On the basis of lifetime membership, members may enjoy certain

benefits. Amount received as the Life Membership might be transferred to the “Life

Membership Fees Account” of the institution and can be dealt in the accounts by

any of the following methods −

May be taken as liabilities side of a Balance sheet as Life Membership Fees.”

Normal subscriptions of the members may be transferred from the Life

Membership Fees account to the subscription account as an income and the

balance may be carried forward to the following years.

On the basis of average life of a member, the amount may be transferred to

the income and expenditure account annually and rest will be carried

forward towards the following years.

Sale of Scrap or Old Newspapers

Without any dispute, it will be treated as recurring income and will appear in the

credit side of an income and expenditure account.

Subscription

Subscription is the major source of an income for the non-trading concerns.

Subscriptions are received from the members of a club or institution. A receipt and




payment account records all the actual subscription received during the current

year and an income & expenditure account shows the subscriptions, which relates

to the current accounting period. Therefore, some adjustments require to calculate

the subscription of the current year.

Example (1) − to calculate the amount of Subscription for the current year, the

ledger account of a subscription account needs to be drawn and the balancing

figure of this will represent the amount of subscription of the current year.

With the following particulars, please find out the amount of subscription to be

shown in an income & expenditure account −

Particulars Amount

(in Rs.)

Outstanding subscription at the beginning of the year (as on 01-04-

2013)

6,000

Amount as shown in the receipt and payment account 26,000

Outstanding subscription at the end of the year (31-03-14) 4,000

Subscription received in advance for the next year 2,000

Solution −

Subscription Account


01-04-13 To balance b/d 6,000 31-03-14 By Cash 28,000

31-03-14 To Advance

Subscription (to be

shown as Liabilities in

Balance Sheet)

2,000




31-03-14 To Income &

Expenditure Account

(Balancing Figure)*

24,000 31-03-14 By balance

c/d

4,000


It is very clear from the above example that the balancing figure represents

subscription for the current year, which needs to be transferred to the income &

expenditure account as an income.

Special Funds

Some special funds are created by the respective institutions for specific purpose.

For example, a prize fund may be created to give the best player of the year award.

Any income relating to those funds should be added to the funds and deficit, if any

may be charged from the income & expenditure account.

Example (2) − to calculate the amount of an income related to the current year, we

need to prepare a ledger account of the particular income. Further, the balancing

figure of this account will represent the amount of an income for the current year.

From the following particulars, please find out the amount of Subscription that

needs to be shown in the Income & Expenditure account −

Particulars Amount

(in Rs.)

Outstanding Subscription at the beginning of the year (as on 01-04-

2013)

6,000

Amount as shown in the receipt and the payment account 26,000

Outstanding subscription at the end of the year (31-03-14) 4,000

Solution −

Subscription Account





01-04-13 To balance b/d 6,000

By Income and

expenditure a/c

(Balancing

Figure)*

24,000 31-03-14 By Cash (As per

receipt and

payment

account)

26,000

31-03-14 By balance c/d 4,000


It is very clear from the above example that balancing figure represents

Subscription for the current year i.e. to be transferred and shown in the credit side

of the income & expenditure account.

It is very clear from the above example that balancing figure represents

Subscription for the current year i.e. to be transferred and shown in the credit side

of the income & expenditure account.

Financial Accounting - Single Entry As we know, there are two systems of recording transactions in our books of

accounts. In the previous chapters, we have learned about the double entry system,

now let’s discuss another system of accounting i.e. Single Entry System (SES).

Meaning and Silent Features of SES For every accounting transaction, everyone does not follow the principle of double

entry system of accounts. Some of the small business units do not keep their books

of accounts as per double entry system. In simple words, single entry system of

accounts mean — the business unit, which does not follow the principle of double

entry system.

There are following two types of SES of accounts −

Pure Single Entry System − Personal accounts like sundry debtors and

sundry creditor’s accounts are maintained, but real and nominal accounts

are not opened under this system.

Popular Sense − Under this system, three types of treatment are done.

o Double entry system followed for cash received from the debtors and

the cash paid to the creditors.




o Single entry system followed for expenses paid, purchases of goods,

purchases of fixed assets etc.

o Provisional entries like bad debts, depreciation, etc. are not done.

Difference between SES and DES Single entry is an in-complete system of accounting, whereas double entry

system (DES) is a complete system of accounting transactions.

There is no reliability on books in a single entry system, whereas double entry

system is a reliable accounting system.

Checking of the arithmetical accuracy is possible in a double entry system

through preparation of trial balance, whereas it is not possible under a single

entry system.

Since, single entry system does not maintain Trading, and Profit & Loss

Account, and Balance Sheet; hence, ascertainment of the actual profit and

exact financial position of the firms is not possible, on the other hand, all

above is quite possible under the double entry system of accounting.

Limitations of SES Single entry system of accounts do not record two-fold aspects of each and

every transactions, hence, it is not a scientific system of keeping accounting

records.

Checking of the arithmetical accuracy is not possible due to non-preparation

of a trial balance. Preparation of a trial balance is not possible, because the

method of double entry system is not followed for each business transaction.

Ascertainment of the actual profit of a concern is not possible, as nominal

accounts are kept under single entry system. In the absence of nominal

accounts, Trading and Profit & Loss account cannot be prepared.

It is not possible to find the exact financial position of a firm in the absence

of real accounts, because without real accounts, it is not possible to prepare

the Balance sheet of a firm on a particular day.

Outsiders never rely on the books of accounts of a firm.

In case where owner of the business wants to sell his business, ascertainment

of exact value of the business is not possible, especially goodwill value of the

firm.

Single entry system is practiced only by the small business units.




Preparation of Statement of Affairs To know the financial position of a business, the list of assets & liabilities and

statement of affairs are prepared on the last date of accounting period. As stated

earlier, in the absence of real accounts, it is not possible to prepare a Balance sheet.

Following points are required to prepare the statement of affairs −

With the help of personal accounts, a list of debtors and creditors should be

prepared.

Stock valuation method will be either on cost or market price, whichever is

lower.

Cash book balance should be physically verified with the cash book.

Bank balance should also be reconciled with the Bank statements.

Statement of affairs should contain the income received in advance and the

expenses paid in advance.

Excess of assets over liabilities will be capital of the proprietor or firm.

Basis for the valuation of fixed assets will be the purchased voucher and any

other available evidence.

How does the Statement of affairs Differ from Balance-Sheet?

Main difference between the statement of affairs and the Balance sheet is —

reliability on first is prepared through incomplete information and on later is based

on the scientific method of the double entry system of accounts.

Ascertainment of Profit under SES We have the following two methods to ascertain the profit under single entry system

−

Statement of Affairs or Net worth Method and

Conversion Method

Net worth Method

Under the single entry system, the ascertainment of the profit can be done without

preparing a Trading and Profit & Loss account. For example,




1 To know the capital at the beginning of the year or at the last date of the

preceding accounting year, first step is to prepare the statement of affairs at

the beginning of the year.

2 One statement of affairs should be prepared on the last date of accounting

year to ascertain.

3 Drawing should be added to the amount of capital as ascertained at the end

of the year and the capital introduced if, any, during the year will be

subtracted.

4 Capital introduced if, any, during the year will be subtracted.

5 Difference of (3) – (1) will be the profit or loss for the year. If, (3) is more than

(1), then it is a profit or vice versa.

6 The amount of profit or loss as calculated by the step No. (4) above, will be

adjusted by the interest on capital and the interest on drawing (to ascertain

Net Profit of the firm).

Conversion Method

Under the conversion method system of accounting, change from the single entry

system to the double entry system on a particular date can be done by the following

procedure −

Statement of affairs should prepare on the date on which the change need to

be made. After the proper checking and verification of such balances from

available records, all the balances like cash balance, bank balance, assets,

liabilities, debtors, and creditors should appear in the statement of affairs.

An opening journal entry should be made to bring into the books as −

Journal Entry

AssetAA/cDr

AssetBA/cDr

AssetCA/cDr

LiabilitiesAA/c




LiabilitiesBA/c

LiabilitiesCA/c

Being all assets and all liabilities brought forward from the

statement of affairs a/c.

Above entry will be a base entry to open all new books under the double entry

system of accounts and all the future transactions will be booked according to the

double entry system as explained earlier.

Conversion of Books of Last Year from SES into DES

To convert books of the last year from single entry to double entry system, it will

be assumed that all the subsidiary books are maintained properly under the single

entry system. However, following procedures need to be followed −

Where Cash Book, Personal Books, and Subsidiary Books are Maintained −

Opening statement of the affairs should be prepared at the beginning of the

period.

All the impersonal accounts as appeared in the cash book should be posted

in the respective impersonal accounts, if it has not been done earlier.

New impersonal accounts need to be opened through total of the subsidiary

books. For example, with the total of sales book and purchase book, sale

account will be credited and purchase account will be debited, vice versa in

case of returns.

All the new account should be opened for the entries relating to discount,

rebates, bad debts, etc. which are not passed through the subsidiary books.

This procedure will give two-folds effect of such transaction as appeared in

the personal accounts.

Month-wise positing should be done to the ledger accounts through petty

cash book, if, maintained by the firm.

After completion of the above procedure, a trial balance should be prepared

to confirm the arithmetical accuracy of the books of accounts.

After completion of the above procedure of trial balance, Trading and Profit &

Loss account and Balance sheet should be prepared (after considering all the

adjustments like prepaid expenses, outstanding expenses, income received

in advance, or receivables as well as the provisions for depreciations,

doubtful debts etc.




Where only Cash Book and Personal Books are Maintained

In this case, a different procedure of conversion will be followed −

As described earlier, an opening statement of the affairs should be prepared

at the beginning of the period.

All the real and nominal accounts as appeared in the cash book and not

posted earlier in any account, should be posted in respective accounts.

An analysis of debit and credit side of personal accounts like debtors

accounts and creditors accounts will be done as per the method given below

−

Summary of Analysis to be Done

Sr.No. Debit side of Creditors’

Accounts

Debit side of Debtors’ Accounts

1 Bills payables

Opening balance as appeared in

opening Statement of Affairs

2 Discounts and rebates received Sale (Credit)

3 Return inward (Purchase

returns) Transfers

4 Transfers Bills receivables (Dishonored)

5 Cash paid to Creditors

6 Endorsement of Bills Receivables

in favor of Creditors

Sr.No. Credit side of Debtors’

Accounts

Credit side of Creditors’ accounts

1 Cash received

Opening balance as appeared in opening

Statement of Affairs




2 Discount Allowed Purchases (Credit)

3 Bills receivables received Transfers

4 Discount and allowances Bills payables (dishonored)

5 Transfers

6 Goods returned (Sales

returns)

7 Bad Debts

Financial Accounting - Leasing In the field of real estate, leasing is a popular term because it is advantageous to

own land and building. Today, most of the businesses run their offices on the leased

premises.

A Lease is an agreement under which lessee (the person/entity, who takes

possession of the property) get the right to use the premises for the agreed period

of time in lieu of the rent as agreed between both Lessor (owner) and lessee. Lessor

has an ownership right of assets, but still lessee has an unrestricted right to use

that asset.

Every lease contract should cover the following terms −

Period of lease.

Timing of the payment to be made along with the amount of rent.

About maintenance expenses, taxes, insurance, provision for renewal of lease

agreement.

The Accounting Standard 19, issued by the Council of the Institute of Chartered

Accountants of India, covers the disclosure of appropriate accounting policies in

the financial statements.

Standards 19 are mandatory in nature and applicable to all lease agreements

except some given below −




Lands to be used under the lease agreement.

For use of natural resources like oil, gas, timber, metal, etc.

Video recording, films, motion picture, patents, and copyrights.

Important Terms in Leasing Following important terms are commonly used in lease accounting −

Lessee − Lessee is a person who possess the right to use the asset in lieu of

agreed rent for a certain period of time (as per the lease agreement).

Lessor − Lessor is the owner who gives right to the lessee to use his

asset/property in lieu of rent for a certain period of time.

Lease Term − Usually, lease agreement is contracted for a fixed and non-

cancellable period called as lease term. It is also known as ‘Lease Period.’

Lease term may be further extended as agreed with or without further

amendment/s.

Fair Value − Fair value is an amount on which an asset can be exchanged or

it may be the value of liability settled.

Useful Life − It can be

o A period over which an asset could be used by the lessee.

o Expected number of units that can be produced by that asset.

Inception of Lease − It is the date on which principal provision of the lease

are committed to.

Residual Value − An estimated fair value of an asset at the end of the lease

term is called as residual value.

Minimum Lease Payment − Total payment to be made by lessee to lessor

during the lease terms excluding taxes, insurance, maintenance charges,

contingent rent, etc.

Contingent Rent − It is based on a factor other than passage of time, lease

payments i.e. percentage of sale, etc.

Unguaranteed Residual Value − An expected fair value at the end of the

lease period is called as Unguaranteed Residual Value.

Popularity of Leasing One of the main reasons behind the popularity of leasing is its simplicity to both

the parties i.e. lessor as well as lessee. It is beneficial in terms of its documentation




and also provides tax advantage. Selection and purchase of asset come under the

purview of leasing company, and use and rent payment of the assets are the part

of lessee.

Since lessor remains owner of the assets, so he can claim for the depreciation in

his books. Interestingly, he can enjoy the tax benefit against the depreciation.

Similarly, lessee pays the rent and records such rent in his books as expenses for

the purpose of tax benefit.

Advantages of Leasing Main advantage of leasing is given hereunder −

Lessee can use the asset without actually purchasing it, means full finance

without any margin money.

It provides flexibility in fixation of the rent and the lease period as per the

requirements.

In the Balance sheet of a lessee, leased assets are not shown as asset or

liability of the company, hence the credit capacity of the lessee remains un-

affected.

Leasing provides an opportunity to lessee to earn additional profit and to

improve earnings per share.

Deduction of a rent is eligible to claim tax benefit (as business expenditure).

Without heavy investment, lease rent can be paid out from the income

generated by the use of the assets.

Tax benefit of the depreciation may be claimed by lessor according to the

Income Tax Act.

Taking advantage of the full utilization of the asset is possible under a lease

agreement; chances of ignorance are high, where company purchases asset

as its own.

In case of a closely held company, it provides better wealth planning

solutions.

It provides protection to lessee against the inflation.

Strict provisions of the financial institutions for acquiring an asset can be

avoided through a lease agreement.

Disadvantages of Leasing




Some of the disadvantages of leasing are −

Leasing is not very much useful for some of the new businesses, as earning

through the business comes much after the investment.

Some of the incentives as provided by the state and the central government,

cannot be enjoyed due to lease agreement.

The assets, whose values are likely to appreciate, should be purchased

instead of leasing.

In case of variation clause in a lease agreement, rental structure can be

changed due to change in the rate of interest, rate of depreciation, etc.

Classification of Lease According to AS-19, following are the two categories of Leasing −

Operating lease

Finance Lease

Operating Lease

Operating lease is an agreement wherein the lessor (owner) allows the renter

(lessee) to use the agreed asset for a particular period. Usually, the lease period is

shorter than the economic life of the asset. Further, lessor does not actually

transfer the ownership rights. The Lessor gives the right to the lessee to use the

asset in return of regular payments for an agreed period of time.


As per AS-19, following are the accounting treatment in the books of lessor and

lessee −

In the books of Lessor −

Assets should be treated as the fixed assets in the Balance sheet of a lessor.

Rental income should be treated as an income in the Profit and Loss account.

Depreciation should be treated as expenses and should be debited from the

Profit & Loss account.

An initial cost can be deferred to the lease period of the asset or may be

booked as expenses in the year, in which actually incurred.

Depreciation will be charged as per AS-6.

In the books of Lessee −




Lessee should treat a rental payment as expenses in the profit and loss

account.

Finance Lease

In case where lease is able to secure for lessor the recovery of his capital outlays

plus a reasonable return on the fund invested during the lease period is called

financing lease. Finance lease in non-cancellable contract and also, lessor is not

responsible for any expenses and taxes of the leased asset.


In the books of Lessor −

Total value of the investment plus income receivable on it will be treated as

receivables in the Balance sheet.

Direct expenses may be directly debited from the profit and Loss account in

the year of expenses incurred or may be deferred up to the lease period.

In the books of Lessee −

Initial direct cost will be treated as an asset.

Fair value of the leased assets should be considered as an asset and a liability

in the finance lease.

It is an appropriate to show liability separately in the Balance sheet.

Financial Accounting - Investment Account Anyone can buy and sell securities from a stock exchange with the purpose to

increase his/her (monetary) assets. Sale and purchase of the securities is done

through banks. The stockbrokers help people in trading by paying the amount of

commission, stamp duty, and brokerage on it, which are the essential parts of

security trading.

At the time of selling of these securities, charges should be deducted from the sale,

as proceeds to get the actual sale price. Most of the time, market price is different

from the face value of securities, which depends upon different regulating factors.

If market value of the securities is equal to face value, it is called as at par; if

market value is less than face value, it is called as on discount; and if market value

is higher than face value, it is said to be on premium.

Meaning of Investment




Investment means either buying or creating an asset with the future expectation of

capital appreciation, dividends (profit), rents, interest earnings, or some

combination of these returns. However, normally, investment inherent with some

form of risk, such as investment in equities, property, and even fixed interest

securities, among other things, are the subject to inflation risk.

Further, among all these, securities are held as long term investment to earn

income. It is said to be fixed assets, but where objective of an organization is to sell

and buy securities in short term fund to utilize its surplus fund, would come under

the category of current assets.

There may be two types of securities −

Fixed Interest Securities − Holders of fixed interest securities get fixed rate

of interest.

Variable Yield Securities − Under this category, return on investment may

differ from year to year.

Investment Account Investment account is an account opened for the purpose of the investment.

Further, if the number of investment is large, a separate account for each

investment should be opened.

Accounting entry on the purchase of any investments are given as hereunder −

On purchase of investment

Investment A/cDr

To Cash/Bank A/c

(Being Investment made)

Note − Investment account is

inclusive of purchase expenses like

stamp duty, Commission, and

brokerage.

On Sale of investments

Cash/Bank A/cDr

To Investment A/c





Note − Investment account will be

credited with net realized value of

investment.

Interest and dividend account

Cash/Bank/Investment A/cDr

To Dividend/Interest A/c

(Being Interest/dividend received on

investments)

Note − Investments account will be

credited in case, interest/dividend

accrue and cash/bank account will

be debited (in case) with net realized

value of investment.

Investment Transactions We normally have the following two types of investments transactions −

Cum Dividend or Cum Interest Quotations and

Ex-Dividend or Ex-Interest Quotations

Let’s discuss these two types of investment transactions in detail.

Cum Dividend or Cum Interest Quotations

Interest and dividend on the fixed investments accrued on regular interval, but

payment of those are made only on fixed dates. Dividends are always paid to the

persons, who are shareholder at the time of payouts. Suppose a shareholder sold

his shares after keeping those shares in his hand up to ten months, then dividends

on those shares will be paid to the buyer or we can say, to new shareholder.

So, a seller at the time of selling shares normally charge value of the accrued

dividends up to the date of sale, and this is called ‘CUM DIVIDEND” or “CUM

INTEREST”. Since, the sale price is inclusive of the value of a share and interest or

dividend, therefore at the time of entry in the books of accounts, normal price of

share should be booked in the investment account and the value of dividend or

interest should be debited to dividend or interest account.

At the time of receiving dividend or interest, dividend or interests account will be

credited, debiting cash or bank account. On the other hand, in the books of seller,

normal price of the share should be credited to Investment account and the price




of accrued dividend or interest should be credited to the dividend or interest

account as the case may be.

Accounting Entries − It can be understand through the following table.

In the Books of Buyer

On purchase of investment

Investment A/cDr

Dividend or Interest A/c

To Cash/Bank A/c


On receipt of dividend or interest

Cash/Bank A/cDr

To Dividend or Interest A/c

(Being dividend or interest received)

for Accrued Interest

Accrued Interest A/cDr

To Interest A/c

(Being interest accrued)

In the Books of Seller

On Sale of investments

Cash/Bank A/cDr

To Investment A/c


(Being Investment Sold )

On receipt of dividend or Interest

Cash/Bank A/cDr


(Being dividend or interest received)

Ex-Dividend or Ex-Interest Quotations

The buyer of shares when he is quoted ex-dividend is not entitled to receive the

payment. It is the interval between the record date and the payment date during

which the stock trades without its dividend. Therefore, the person who owns the




security on the ex-dividend date will be awarded the payment, regardless of who

currently holds the stock.

Difference between Cum-dividend and Ex-Dividend

Major differences between them are given as hereunder −

Cum interest or dividend prices are inclusive of the interest or dividend

accrued at the date of purchase, whereas in case of the ex-dividend, prices

are excluding value of the dividend or interest.

The purchase price is higher than normal purchase price in case of Cum-

dividend, whereas purchase price is the real price in case of ex-dividend.

Nothing is payable additional in case of Cum-Interest, whereas separate

amount of the dividend or interest has to be paid in case of the ex-dividend

or ex-interest.

Balancing the Investment Account

Difference of debit and credit side of the investment account is Profit or Loss in

case where all the investments are sold.

In case where part of the investments are sold and the balance investments stand

unsold, it should be carried forward to the next accounting period and remaining

balance of the two sides (debit and credit) will represent profit or loss on the sale of

investment.

In case where investments are the fixed assets, then the profit or loss will be of

capital revenue or capital loss and should be treated accordingly.

Equity Share Accounts Main features of investment account regarding the equity shares are given as

hereunder −

Bonus Shares − Bonus shares are issued by the profitable companies to the

existing shareholders of the company without any additional amount.

Purpose of the bonus share is to capitalize reserves of the company. Only

number of the shares will be added in face value column, and principle or

capital column will remain unchanged.

Right Shares − Right shares are first offered to the existing shareholders of

the company as a matter of the right, hence called as right shares. As per

Companies Act, right shares can be issued after two years of the

establishment of a company or after one year of first issue.




Financial Accounting - Insolvency Accounts Insolvency is a financial stringency i.e. when an individual or an

organization/company is no longer capable to pay the debts he/it owes. Insolvency

usually leads to insolvency proceedings, in which legal action can be taken against

the insolvent, and assets may be liquidated to pay off the outstanding debts.

When a Person / Entity can be Declared Insolvent Before declaring an entity or a person as insolvent, a competent court defines two

conditions −

A person or entity should be debtor and

He/it should had done any act of insolvency.

Act of insolvency means, when a person (debtor) shows that he is not able to pay

his liabilities.

An order of adjudication must be passed by the court of law, before legally declaring

any person insolvent. To pass an order of adjudication by the court of law, a petition

should be filed by any of the creditor or creditors or by the debtor himself. Petition

by the creditor may be filled only in following conditions;

Debt should be at least for Rs. 500/- or more

Within three months of petition, an act of insolvency should be done by

debtors.

After filing the petition, the competent court will fix date of hearing and then it may

declares that the debtor is insolvent or not. If insolvency of a person starts from an

earlier date, and not from the date of adjudication passed by the court. This is

known as Doctrine of Relation Back.

Under Presidency Towns Act, to conduct the insolvency proceedings, an official is

appointed by the court is known as Official Assignee and in case of Provincial

Insolvency Act, known as Official Receiver. The property of the insolvent vests in

the official assignee or receiver to realize the assets and distribute the sale proceeds

of the assets in the manner given below −

Secured creditors will be paid in full.

Remuneration and expenses of the official receiver.

To Preferential Creditors.




To unsecured creditors + partly secured creditors to the extent remain un-

secured.

The Order of Discharge

Order of discharge is an order issued by the court of law to the insolvent. Normally,

this order releases the insolvent from all current and provable debts and liberates

him from the legal obligations imposed on as insolvent. The order of discharge is

issued on the basis of the report submitted by the official receiver and on the

application of the insolvent.

Interest

An interest @ 6% pa will be paid to the creditors for the period, after the order of

adjudication, if, any surplus remains, after full payment to the creditors.

Voluntary Transfer

As per the Presidency Towns Insolvency Act, any property transferred by the

insolvent without any consideration during the two years preceding the order of

adjudication shall be void. Under the Provincial Insolvency Act, such transfer

became inoperative, if made with two years of petition of the insolvency except

followings −

For consideration of marriage and made before and

To purchase valuable consideration in good faith.

Insolvency Law The Insolvency Act in India is based on English Bankruptcy Act and following two

acts are applicable on the Indian Territory −

The Presidency Towns Insolvency Act, 1909 − Applicable to Mumbai,

Kolkata, and Chennai.

The Provisional Insolvency Act, 1920 − Applicable to the rest of India

except Mumbai, Kolkata, and Chennai.

Above Insolvency Acts are applicable to any Individual, Partnership Firm, and

Hindu Undivided Family only. Companies Act, 1956 applies to Joint stock

companies and the term liquidation is used instead of Insolvency. In case of

insolvency, a person is not able to pay his liabilities but in case of liquidation,

company may be liquidated even it has the sufficient amount to pay its liabilities.

Insolvency Accounts




Under the Presidency Towns Insolvency Act, insolvent has to submit following

documents to the court of law −

Statement of Affairs as on date of order and

Deficiency Account.

No provision, for the submission of a Statement of Affairs under Provincial

Insolvency Act. The form of Statement of Affairs as prescribed by the rule made

under Presidency Towns Act is given below −

Statement of Affairs

(As required by the Indian Insolvency Act)

In the Court of Justice

In insolvency

To the insolvent – you are required to fill up carefully and accurately, this sheet

and the several sheets, A,B,C,D,E,F,G, and H, showing the state of your affairs on

the day on which the order of adjudication was made against you viz. the

…………day of …………..20…….

Such sheets, when filled up will constitute your Schedule and must be verified by

Oath or Declaration.

Gross

Liabilities

(Rs.)

Liabilities (as

stated and

estimated by the

debtor)

Expected

To rank

Assets (as stated

and estimated by

the debtors)

Estimated

to produce

Unsecured

Creditors as per List

A

Fully Secured

Creditors as per list

B

Less: Estimated

value of Securities

Property as per List

E, viz.

Cash at Bank

Cash in hand

Cash

deposited

with solicitor

for cost of

petition

Stock in trade




Less: Amount

thereof carried to

List C

Balance

thereofcontra

Partly secured

creditors as per List

C

Less: Estimated

value of Securities

Preferential

Creditors as per List

D (Creditors for

rent, taxes, salaries

and wages, etc.)

payable in full as

per contra

Machinery

Trade Fixture,

Fitting,

Utensils, etc.

Furniture

Life Insurance

Policies

Other

property

Book debts as per list

F, viz.

Good

Doubtful

Bad

Estimated to produce

Bills of exchange or

other similar

Securities on hand as

per List G

Estimated to produce

Surplus from

securities in the

hands of creditors

fully secured (per

contra)

Deduct: Creditors for

preferential rent,

rates, taxes, wages,

etc. (per contra)

Deficiency as per

explained in list H




I /We ………………make oath, solemnly affirm, and say, that the above statement

and the several lists hereunto annexed marked A,B,C,D,E,F,G, and H are to the

best of my/our knowledge and belief, a full and complete of my/our affairs on the

date of the abovementioned order of adjudication made against me/us.

Affirmed------------------ at. ………….this……………day of Sworn Before me.

……………………

(Signature)

Commissioner

Just like Balance sheet, the statement of affairs is divided in to two part of Assets

and Liabilities and liabilities of the insolvent are classified as −

Unsecured Creditors as per List A

Trade creditors, stridhan ornament and personal belongings etc. of lady) of Mrs.,

bills payable, bank overdraft, partly paid shares held, uncompleted contracts

guarantees given for others, etc., wages, rent, salaries, etc.

Loan from Wife

Loan taken from wife is usually treated like any other loan taken and makes wife

creditor of the insolvent. In case, it is proved that loan is paid by wife out of amount

received from insolvent, then be treated as the capital of insolvent.

Interest

@ 6% interest will be paid to the creditors after the date of adjudication, if there is

a sufficient balance left after the payments to creditors.

Fully Secured Creditors as per List B

The creditors who have sufficient securities against their claims will be included in

this list and after paying these creditors, balance amount will be shown on the

asset side of the statement of affairs as available balance to distribute among other

creditors.

Partly Un- secured Creditors as per List C

Un-paid or unsatisfied amount of the partly secured creditors will be shown as

expected to rank column as unsecured creditors, to be divided for unpaid amount.

Preferential Creditors as per List D

Following creditors comes under the category of preferential creditors and such

creditors get preference over the un-secured creditors.




As per the law, following creditors come under category of the preferential creditors

−

Government and local authority.

Salary and wages for the service rendered for four months preceding the date

of the presentation of the insolvency petition.

Under Presidency Town Insolvency Act, one month rent comes under the

category of preferential creditors, but rent is not at all comes under the

preferential creditors category as per the Provincial Insolvency Act.

The assets as shown in the statement of affairs of insolvent are classified into the

four categories as follows −

Property as per List E − Other than the bills receivable in hand and the

assets as kept by creditors as fully and partly secured debts are comes under

this list.

Property as per List F − Following are the three categories of book debts −

o Good

o Doubtful Debts

o Bad

Assets as per List G − Bills of exchange and other similar securities comes

under this list.

Deficiency Account as per List H − As name suggests, deficiency account

means the deficiency, which the insolvent debtor is not able to pay.

Important Points in Preparation of Statement of Affairs

In case of an individual insolvent, no distinction will be made between the

private assets and the business assets while preparing a Statement of Affairs.

Personal assets are included in the Statement of Affairs to pay the business

liabilities. In case of partnership firm, after paying personal liabilities from

the personal assets of the partner, surplus if any, may be included in the

statement of affairs of Partnership firm to pay the business liabilities.

Value exceeding Rs. 300/- of tools, wearing apparel, bedding, cooking

utensils, etc. will be included in the statement of affairs under the Presidency

Towns Insolvency Act. Assets, as pledged against secured and partly secured




creditors, may be shown in the statement of affairs only, if, became surplus

after paying the fully and partly secured creditors.

Fully secured assets are not shown in the ‘expected to rank’ column.

Partly secured assets after paying partly secured debts will be shown in the

column of ‘expected to rank.’

The bills discounted to be dishonored are included in the un-secured

creditors as per the list A.

Difference between Balance Sheet and Statement of Affairs Following are the main differences between Balance Sheet and Statement of Affairs

−

The value of assets is shown as books value as well as releasable value in the

statement of affairs; however, it is shown as only book value as in the case

of Balance sheet.

In the Statement of Affairs, prepaid expenses and goodwill are not included,

whereas all fictitious assets are included in the Balance sheet.

Statement of Affairs does not include capital, drawings, profit, or loss, interest

on capital, whereas Balance sheet includes all such items.

Balance sheet does not show the amount of deficiency as shown in the

Statement of Affairs.

Balance sheet is prepared at the end of accounting period, whereas Statement

of Affairs is prepared on the date on which order of adjudication is passed.

Statement of affairs is prepared as per the rule of Insolvency Act, whereas

Balance sheet is a routine work to maintain the accounting record.

Balance sheet of a firm does not include personal assets and liabilities,

whereas Statement of Affairs includes the same as discussed above in this

chapter.

Statement of Affairs includes contingent liabilities, whereas in the Balance

sheet, contingent liabilities are shown as footnote only.

Deficiency Account (List H) Specimen of Deficiency Account List H




Amount

(Rs.)

Amount

(Rs.)

Excess of Assets over liabilities i.e.

capital on ……..

Net profit arising from carrying on

business after deducting usual

trade expenses, income or profit

from other source i.e.

Interest on capital

Excess of private assets

over private liabilities

Profit on realization of any

assets

Deficiency as per statement of

Affairs

Excess of Liabilities over

assets

Net Loss arising from carrying

on business after deduction

from profit, usual trade

expenses

Bad debts as per list F

Expenses incurred since…….

Other than usual trade

expenses, viz.

House hold expenses

(Drawings)

Other Losses −

Loss on realization of

Assets

Loss through dishonor

of discounted bills

Speculation losses

Losses through betting

Excess of private liabilities

over private assets, etc.

From the above, it is clear that debit side of the deficiency account shows capital

account and credit side of the deficiency accounts shows losses and drawing and

the difference of two sides is a deficiency as shown in the Statement of affairs

Account.

Insolvency of Partnership Firm Insolvency of the partnership firm differs from the insolvency of any individual or

HUF (Hindu undivided family). The assets of an individual are used to pay the

business liabilities, but in case of partnership firm, assets of the partners are used




to pay his personal liabilities first, and then balance, if any, may be utilized to pay

the business debts. After paying the personal debts of a partner, surplus assets

will appear in the Statement of Affairs and will be shown as “Property as per List

E.”

In case, if personal asset of a partner is in possession of any creditor as security,

still such creditor will get his dues first as unsecured creditor from the firm and

then for the balance amount, he may sell the property, owned by him to recover his

dues.

Stock Exchange Transactions Stock exchange is an organized market where sale and purchase of listed securities

of all description i.e. shares, stocks, debentures, government securities, etc. are

done. It is a government approved market place where buyer and seller of securities

of all kind find each other to buy and sell securities on the market price.

Meaning of Stock Exchange “ An association, organization or body of individuals, whether incorporated or not,

established for the purpose of assisting, regulating and controlling business in

buying, selling and dealing in securities.”

- The Securities Contracts (Regulation) Act, 1956

A stock exchange is a common and authorized point of exchange, which offers the

services for stock brokers and traders to buy or sell stocks, bonds, and other

securities of such kind. Further, it also provides facilities for issue and redemption

of securities, other financial instruments, and capital events. For example,

payment of income and dividends.

Features and Characteristics of Stock Exchange Following are the main features and characteristics of a stock exchange −

Stock exchange is the market place where trading of listed securities can be

done.

Trading of un-listed securities is not allowed.

There are certain rules and regulations that need to be followed while trading.

Stock exchange is an association of persons, whether incorporated or not.

Anyone can buy or sell securities whether he is investor or speculator.




For doing business transaction i.e. sale & purchase of securities, membership

is compulsory. Non-members are not allowed to do business transactions.

Membership can be applied only when there is a vacancy in any stock

exchange and after paying the prescribed fees of respective stock exchange,

membership can be acquired. Members of stock exchange are called

as brokers and commission charged by them for the transaction done is

called as brokerage.

Only a broker (member) can buy or sell securities, therefore, investors or

speculators can do transaction through members only.

Functions and Services of Stock Exchange Followings functions are performed by Stock Exchange −

Anyone can sell and buy any industrial, financial, and Government

securities. Stock Exchange is an organized ready market to do all this.

Liquidity is provided by the stock exchange. Investors and speculators can

buy and sell their securities at any time.

Stock exchange provides collateral value to the securities that is helpful in

borrowing from the bank on easy terms.

Capital for the industrial growth is provided by the stock exchange that is

helpful for the investor to participate in the industrial development.

Price list and reports are prepared and published in the newspapers and

broadcasted through the TV channels by stock exchange. It is helpful in

knowing the true value of the investments. With the help of this, an investor

or speculator can get to know the fair market value of his securities as per

the latest market trend.

Listing of securities is encouraged by the stock exchange. Listing of securities

means — “a permission to trade” that is given by the stock exchange only

after fulfillment of the prescribed standards.

Listed companies have to provide the financial statements, reports, and other

statements time to time to stock exchange — necessary for the maintaining

the record and deciding the value of securities.

Thus, stock exchange works as the center of providing business information at one

platform.

Procedures for Dealing at Stock Exchange




Following procedures are normally followed for dealing at stock exchange −

No one can directly deal in stock exchange, therefore, any person who wants

to sell or buy securities, requires a broker through whom selling or buying of

securities can be done.

After finalization of a member or a broker, intending buyer or seller of the

securities, places an order according to his choice, mentioning tentative

quantity, and price. Thereupon, broker opens a new account for each client

and start trading in the best possible way.

After getting an order, broker tries to finalize the deal between seller and

buyer. After finalization of deal, seller and buyer of securities send a selling

and buying note respectively mentioning the detail of traded securities.

Finally, settlement of account may be done in the following three manners −

o When the settlement of account is done as per the fixed and agreed

date, it is called as “liquidation in full.”

o When only difference of agreed price and ruling price is settled on the

fixed date, it is called as “liquidation by payment of difference.”

o When a settlement is carried forward to the next settlement period, it

is known as “carried over to next settlement period”.

In case, when purchase is delayed and charge debited by the broker to purchaser

is known as “contango” (Contango charge is also known as “Badla” Charge) and in

case, where sale is delayed by the seller and charge debited by the broker is known

as “backwardation.”

Operators at Stock Exchange The following figure shows the three operators at the Stock Exchange −




Broker

As studied earlier, no one can deal directly in stock exchange and every intended

seller or buyer, who wants to sell or buy securities has to deal through members

known as brokers. Broker is duly certified by SEBI (Stock and Exchange Board of

India) under its 1992 rule. Membership of the stock exchange is restricted to

prescribed numbers of members, to financially sound persons who have sufficient

experience in dealing in securities.

A broker cannot buy or sell securities on his personal capacity. He charges

commission from the parties, sellers, and buyers and deals on the behalf of his

non-member clients.

Sub-broker

Sub-brokers are non-members of the stock exchange and deal only on behalf of the

members or registered brokers. Commission is received by sub-brokers on the

business procured by them out of total commission received by the brokers. Sub

brokers are known as “half commission men” and “remisiers” too.

Jobbers

Jobbers are the independent dealers, who deal in securities at their own. A jobber

cannot sell or buy securities on the behalf of others, but he deals in securities for

his own profit through fluctuation of the prices. Difference between sale price and

purchase price of securities is the profit of a jobber.

Important Terms used in Stock Exchange Following are the significant terms more commonly used in stock exchange −

Bull − Bulls are those brokers who strongly expect price hike of securities

and with this hope, they buy shares to sell them at later stage (when price




gets increased). Thus bull market means when buying of the securities are

on much higher side instead of selling of the securities. Bulls first buy

securities and sell when the price of securities is high.

Bear − Bear is pessimist, who expect fall in the price of certain securities. A

Bear first sells his securities and purchases at later stage when the price of

securities are low and the difference of both is his profit.

Stag − A cautious investor or speculator is known as a stag. Stag doesn’t sell

or buy shares in his hand, but he tries to buy shares of new company with a

hope that price of those shares will increase in the future.

Blue Chips − Shares of well-recognized, well-renowned, financially strong,

and well-established companies.

Cash Shares − Settlement of some of the transactions are completed in cash

are known as cash shares. These transactions are done by real and genuine

investors who want to buy or sell shares for the actual investment purpose.

Cleared Shares − Speculators are normally deals in such type of shares. In

these types of shares, settlement of the payments are done by the differential

amounts only; however, actual delivery of the securities may not be done.

Carry Over or Badla System − Speculator earns money by foreseeing the

future. If their expectations come true, they earn profit and if not, they lose

money. Speculator mostly does transactions on forward basis, when any

speculator forwards his transactions from one settlement date to another, he




has to pay charges called “Badla charge.” Transaction of these natures is

called as Badla System.

Kerb Market − Transactions that done before and after the official hours are

known as kerb market.

Short Selling − Short selling means where the large volumes of securities are

sold by the bear speculator without actually possessing.

Arbitrage − Securities are traded at the different stock exchanges and there

is normally a little difference in prices (among different stock exchanges).

Therefore, arbitrage is practiced to take advantage of different rates.

Primary Market − Primary market is the market where new securities are

issued for the capital formation in the form of a new issue or in the form of a

right issue to the existing shareholders.

Secondary Market − Secondary market is the market where subsequent

trading (sale and purchase) of securities are done called as secondary market

and the transactions are known as secondary transactions.

Group A Shares − Actively traded shares of the reputed companies are called

a Group A shares.

Group B Shares − Not actively traded shares or the shares of different stock

exchanges are called as Group B shares.

SEBI The Securities and Exchange Board of India (SEBI) is the regulatory board. It

regulates affairs of stock exchange in India, similar to Securities Exchange

Commission of the United States. To protect the rights of investors and to enforce

an orderly growth of securities market, SEBI came into existence by an Act of

Parliament known as “Securities and Exchange Board of India Act, 1992”.

OTCEI

The Over the Counter Exchange of India (OTCEI) was established in India in 1990.

It is the latest concept and a new way to do securities business in India similar to

Electronic Exchange in the United States. Brokers located at the different regions,

communicate through latest means of technologies such as Telephones, Faxes,

Mobile phones, and Computers.

Selectors are allowed to select the prices as shown on the computer screen among

the competitive markets, without the floor meeting of brokers. It is the most

efficient, economic, and courageous way of the trading of securities. The latest




market prices of the securities are displayed on the computer screens. Since, listing

of the securities is not required on OTCEI, hence it is the most suitable way for the

small and medium size companies.

Over-the-Counter Exchange of India

Brokers require and maintain following books of accounts as per the SEBI rules,

1992 −

Cash Book

Bank Book (Pass Book)

General Ledger

Client Ledger

Register of Transaction

Journal

Document Register (Showing Particulars of the Securities received and

delivered)

Members Contract Book

Duplicates of Contract Notes issued to clients

Written consent of clients

Margin Deposit Books

Register of accounts of Sub Brokers

An agreement with a Sub-Broker.

Accounts of Private Individuals Most of the private individuals never keep their accounts to record earned income

or expenditure incurred by them. It is advisable for everyone to maintain an

account to know what he has earned during a particular period, what he spent,

and what was his saving out of that income. It is helpful to track the record of

income and expenditure. It also helps to increase the income (as need arises) and

control on the expenditure.

Maintenance of Accounts by Private Individuals Private individual should keep his books on cash basis system, ignoring accrued

system in different heads like insurance premium paid, medical insurance, school




fees, taxes, household expenses, medical expenses, clothing, salary received, bank

interest, income from mutual fund, rent received, and other income received.

For all these, one should keep a cash book, which can be summarized on monthly

basis as per the abstract of cash Book given below −

Abstract Cash Book

Particulars (of Income) Amount Particulars (of

Expenditure)

Amount

To Balance b/d

To Salary

To Rent received

To Saving Bank Interest

To Interest on FDR

To Income from Investment

To Income from profession or

Business

Total

xx

xx

xx

xx

xx

xx

xx

xxxx

By Kitchen

Expenses

By Electricity

Expenses

By

School/College

fees

By Clothing

By Insurance

Premium

(Life

insurance,

medi-claim,

accidental

insurance,

other

Insurance like

fire, theft etc.)

Total

xx

xx

xx

xx

xx

xxxx

In case of professional individual, one more column can be added in the cash book

to show professional transaction and personal transaction separately. In addition

to above, an individual may keep a register to maintain the record for his assets

including car, building, investments, etc.

Maintenance of Accounts by Professionals




A cash basis of accounting is the most suitable system for any professional

including doctor, accountant, or solicitor instead of a mercantile system to fulfill

the following purposes −

To ascertain the professional income earned by him correctly for a specific

accounting period, and also to calculate the net professional income after

deducting the related expenses from the professional income.

To correctly record all items of income and expenditure.

Following records should be maintained by a professional −

Cash Book

All receipts and payments should be recorded in a cash book, and a memorandum

book should be maintained to keep record of credit transactions. The credit

transactions will be scored off at the time of actually cash receipt or at the time of

payment made and should be entered in the cash book.

A cash book can be summarized under various heads on monthly, quarterly, half

yearly, or annual basis as per the suitability and requirements.

Stock Register

Two separate stock registers should be maintained, one for resale items and other

to keep record of the items of personal use. Resale items may be medicine, surgical

items, the stationery items, electrical items, computers, and any other items or

asset.

Receipt and Expenditure Account

A receipt and expenditure account is similar to a profit and loss account; therefore,

it is prepared by the professionals to know the professional income and expenditure

for a specific period. Outstanding incomes are ignored to prepare it, but

outstanding expenses are included in it. Therefore, it is known as Receipt &

Expenditure account instead of Receipt & Payment account. It means, incomes are

recorded on a cash basis and expenditure on an accrual basis.

Maintenance of Accounts by Doctors Doctors usually maintain a register that may also be known as diary or note book

in which all the particulars of the patients including charges, fees, physical

conditions of patient, etc. are recorded. After grouping, the extracted entries of

diary are recorded in the cash book under different heads of income. Similarly,

expenses are also recorded under various heads.




In case, where the number of doctors is two or more than two and they run their

clinic in the partnership, income may be recorded in the cash book under various

heads (Doctor Wise), similar to a petty cash book pattern. Similarly, the expenses

relating to each doctor may be recorded under various heads of the expenses.

Thus, cash book, stock register, memorandum book, Receipt and expenditure

account, and Balance sheet are prepared by the doctors.

Illustration

Dr. Ortho starts his medical practice on 1st January 2013 and introduced a capital

of Rs. 300,000/. Receipt and payment account as on 31-12-2013.

Receipt Amount

(Rs.)

Payment Amount

(Rs.)

To Consultation

Charges

To Capital Introduced

2,500,000

300,000

By Clinic Rent

By Salary to Staff

By Books &

Periodicals

By Medical

Equipment

By Other expenses

By Balance c/d

Cash in hand

Cash at Bank

240,000

300,000

15,000

450,000

38,000

57,000

1,700,000

Total 28,00,000 Total 28,00,000

Outstanding salary Rs. 50,000

Medical equipment was purchased on 01-04-2013

Depreciation on Equipment is Rs. 15%

Solution −

Receipt & Expenditure Account of Dr. Ortho

For the year ended 31-12-2013




Expenditure Amount Receipt Amount

To Clinical Rent

To Salary to Staff300,000

Add: Outstanding

Salary50,000

------------

To Books & Periodicals

To Other Expenses

To Depreciation on

Equipment

To Surplus – Excess of

Receipt over Expenditure

2,40,000

350,000

15,000

38,000

50,625

1806,375

By Consultation

Charges

25,00,000

Total 25,00,000 Total 25,00,000

Dr. Ortho

Balance Sheet

As on 31-12-2013

Expenditure Amount Receipt Amount

Capital

Introduced300,000

Add:

Surplus1,806,375

_________

Outstanding Salary 2,106,375

50,000

Cash in hand

Cash at Bank

Medical

Equipment450,000

Less:

Depreciation50,625

_______

57,000

1,700,000

399,375

Total 2,156,375 Total 2,156,375




Maintenance of Accounts of Educational

Institutions Most of the educational institutions are registered under Indian Society

Registration Act, 1860. The core purpose of formation of the educational

institutions is to educate people at large and not to earn profit.

Generally, following financial transactions are being incurred by the educational

institutions −

Main Sources of Collection Types of

Expenses/Payments

Admission fees, tuition fees, Examination fees,

fines etc.

Security deposit by students

Donations from public

Grants from Government for building, prizes,

maintenance, etc.

Salary,

allowances,

and

provident

fund

contribution

to teaching

and

nonteaching

staffs.

Examination

expenses

Stationery &

printing

expenses

Distribution

of

scholarships

and stipends

Purchase

and repair of

furniture &

fixture.




Prizes

Expenses on

sports and

games

Festival and

function

expenses

Library

books,

newspaper,

magazines,

etc.

Medical

expenses-

medicine

and

examination

Audit fees

and audit

expenses

Electricity

expenses

Telephone

expenses

Laboratory

running &

maintenance

Laboratory

equipment

Building

Repair &

maintenance




Separate collection register should be maintained to record these collections from

the above mention sources. Separate ledger for students should also be maintained

for each student to record the fees — due, received, and outstanding if any.

Normally, all accounting records are maintained on the basis of financial year i.e.

from 1st April to 31st March in most of the educational institutions. Educational

institutions maintain income and expenditure account to keep the records of

surplus or deficiency and also to prepare a Balance sheet to know the financial

position of the institution.

Consolidation of Accounts of various Educational

Institutions

Consolidation of accounts is done step by step, where various institutions are run

under one society.

The given example is an illustration of the simplified procedures −

Consolidation of Fees

Institute wise consolidation will be done as hereunder −

Opening Balance of Fees Due

Add: Fees due during the current financial year

Less: Fees collected during the current Financial Year

Outstanding Fees at the end of the year

XXX

XXX

XXXXX

XXX

XXX

Illustration

Trial Balance of the Brilliant education society as on 31st March, 2013 is given as

here under, please prepare an Income and Expenditure Account and a Balance

sheet on that date −

Particulars Amount (Debit) Amount (Credit)

Cash in Hand 68,000




Cash at Bank 802,000

Scholarship Fund Investment 800,000

Miscellaneous Expenses 420,000

Interest received on Scholarship Fund 80,000

Interest Received on Investment 55,000

Investment 550,000

Sundry Creditors 236,000

Building 1,700,000

Furniture & Fixture 200,000

Addition to Furniture & Fixture 25000

Vehicles 280,000

Sundry Debtors 260,000

Capital Fund 2,400,000

Donation for Capital Fund 500,000

Entrance Fees 40,000

Course Fees 1,600,000




Examination Fees 70,000

Auditorium Rent Received 850,000

Salary 1,100,000

Printing & Stationery 50,000

Scholarship Awarded 36,000

Scholarship Fund Reserve 360,000

Government Grant Received 100,000

Total 6,291,000 6,291,000

Additional Information

Salary for one month is outstanding.

Outstanding Auditorium is Rs, 50,000/- and Rs. 25,000 received in advance.

Depreciation is to be provided at 5% on building, 10% on Furniture & Fixture,

and 15% on vehicles.

Solution

In the Books of Brilliant Education Society

Income & Expenditure Account

For the Year ended 31st March, 2013

Expenditure Amount Income Amount

To Printing & Stationery

To Salary1,100,000

(+) Outstanding

50,000 By Entrance Fees

By Examination Fees

By Course Fees

40,000

70,000

1,600,000




Salary100,000

--------------

To Miscellaneous Expenses

To Scholarship awarded

To Depreciation:

Building @ 5%85,000

Furniture & Fixture22,500

Vehicles @ 15%42,000

--------------

To Surplus of Income over

Expenditure

1,200,000

420,000

36,000

149,500

964,500

By Auditorium Rent850,000

(+) Outstanding

Rent50,000

--------------

900,000

(-) Advance Rent

Received25,000

--------------

By Government Grants

By Interest received on

scholarship fund

875,000

100,000

80,000

55,000

Total 2,820,000 Total 2,820,000

Balance Sheet

As on 31-03-2013

Liabilities Amount Assets Amount

Capital Fund2,400,000

Add: Donation500,000

---------------

2,900,000

Add: Surplus964,500

---------------

Scholarship Fund

Sundry Creditors

3,864,500

360,000

Building1,700,000

(-) Depreciation@ 5%85,000

--------------


(+) Addition25,000

--------------

225,000

(-) Depreciation @10%22,500

1,615,000




Salary outstanding

Rent received in advance

236,000

100,000

25,000

--------------

Vehicles280,000


--------------

Investments

Scholarship Fund Investment

Sundry Debtors

Rent receivable

Cash in hand

Cash at Bank

202,500

238,000

550,000

800,000

260,000

50,000

68,000

802,000

Total 4,585,500 Total 4,585,500

Maintenance of Accounts of Student Hostels Hostels are run by most of the educational institutions to provide boarding facility

to the students, coming from remote places, for their education. Hostels are usually

run on no profit basis. Government also grants some fund to these hostels to

provide cheaper living space to the students.

Like any other non-profit organization, hostels also have accountants who record

and maintain their financial transactions as −

Receipt & Payment Account


Balance Sheet




Following are the common lists of incomes and expenditures incurred by Hostels −

Main Source of Collection Types of

Expenses/Payments

Admission fees

Security (refundable at the time of entering

into the hostel)

Room rent

Electricity, water, fans, coolers, heaters &

geysers charges etc.

Government grants

Fees for reading room & common room.

Mess charges

Medical Fee.

Electricity

expenses

Water charges

Building repair

& maintenance

Grocery &

provisions for

mess

Rent for hostel

Accommodation

(In case or

rented

premises)

Salary (Warden,

watchman,

sweeper etc.)

Telephone

expenses

Newspaper and

magazines

Illustration

From the given information and Trial Balance, please prepare an Income &

Expenditure account and Balance sheet of Divya Jyoti hostels (for the girls) for the

year ending 31-03-2014 −





Opening Stock −

Food

Fuel

Drinks

Sundries

31,500

4,500

3,000

6,000

Purchases −

Food

Fuel

Drinks

Sundries

1,065,000

90,000

135,000

15,000

Wages −

Mess

Others

337,500

97,500

Annual Day Collection 10,500

Building 6,300,000



Common Room Expenses 24,000

Electricity and Water Charges 28,500

Electricity and Water Charges 42,000

Fans 75,000





General Fund 450,000

Grants-Youth welfare Departments 300,000

Heaters 7,500

Income From Investments 82,500

Indoor Games Material 22,500

Investments 750,000

Land 750,000

Medical Expenses 19,500

Mess Charges (for guests) 30,000

Mess Fees 1,770,000

Rent for fan Heater etc. 16,500

Repair & Maintenance 33,000

Room Rent 352,500

Room Service Charges 9,000

Security Deposits 400,500

Total 10,500,000 10,500,000


Depreciation to be provided @ 5% on Building, Furniture, & Fixture; and 15%

on heater and Fans.

Closing stock: Food Rs. 22,500, Fuel Rs. 7,500, Drinks Rs. 4,500, and

sundries Rs. 3,000.

Solution −




In the Books of Divya Jyoti Hostels




To Mess Expenses

Food: Opening Stock31,500

Add: Purchases1,065,000

--------------

1,096,500

Less: Closing Stock22,500

--------------

Fuel: Opening Stock4,500

Add: Purchases90,000

--------------

94,500


--------------

Drinks: Opening Stock3,000


--------------

138,000


--------------

Sundries: Opening Stock6,000


--------------

1,074,000

87,000

133,500

By Room Rent

By Rent for Heater, Fans,

etc.

By Grants-Youth Welfare

By Income From

Investments

By Annual Day Collection

By Mess Fees

By Mess Charges for

Grants

By Room Service Charges

By Electricity & Water

Charges

352,500

16,500

300,000

82,500

10,500

1,770,000

30,000

9,000

28,500




21,000


--------------

To Wages : Mess337,500

Others97,500

--------------

To Electricity & Water Charges

To Repair & Maintenance

To Indoor Games Material

To Common Room Expenses

To Medical Expenses

To Depreciation:

Building5%315,000

Furniture10%22,500

Heaters15%1,125

Fans15%11,250

--------------

To Excess of Income Over

Expenditure

18,000

435,000

42,000

33,000

22,500

24,000

19,500

3,49,875

3,61,125

Total 2,599,500 Total 2,599,500

Balance Sheet

As on 31-03-2014





Capital Fund

General Fund450,000

Add: Surplus361,125

------------

Security Deposits

7,050,000

811,125

400,500

Land

Building6,300,000


------------



------------

Heaters7,500


------------

Fans75,000


------------

Investments

Closing Stocks:

Food22,500

Fuel7,500

Drinks4,500

Sundries3,000

------------

Cash at Bank

750,000

5,985,000

202,500

6,375

63,750

750,000

37,500

466,500

Total 8,261,625 Total 8,261,625




Maintenance of Accounts of Hospitals Being a non-profit organization, hospitals also maintain Receipt & Payment

accounts, Income & Expenditure account, and Balance Sheet.

An illustration of the income and expenditure of a hospital is shown below −

Main Items of Income Types of

Expenses/Payments

Room Rent

Medical Care

Dentistry Charges

Delivery Room Charges

Anesthesia Charges

Laboratory Charges

Grants for operating needs of Hospital

Grants for fixed Assets

Donations

Miscellaneous Income

Interest on Investments

Fees from Nursing & Training School

Bed Charges

Operating Room Charges

X-ray Charges

Pharmacy Charges

Physiotherapy Charges

Electricity & Water

Charges

Pharmacy Charges

Salaries and Wages

Pharmacy Expenses

Building repair &

Maintenance

Laundry Charges

Rent for Nursing

Hostel

Accommodation (In

case or rented

premises)

Telephone Expenses

Laboratory Expenses

Surgery Expenses

Operation Tools and

Equipment Expenses

Depreciation

Illustration

A charitable hospital and pharmacy are run by Rehmat Ali trust; following are the

balances as extracted from its books for the year ended 31-03-2014 −





Consumption of

Medicines

Foodstuff

Drugs and Chemicals

Closing Stock of

Medicines

Foodstuff

Drugs and Chemicals

360,000

270,000

90,000

60,000

12,000

3,000

Salary 540,000

Electricity 315,000

Pharmacy −

Opening Stock

Purchase

Sale

Salary

Electricity

165,000

900,000

45,000

6,000

930,000


Ambulance 90,000

Telephone Expenses 78,000

Subscription 63,000

Ambulance Charges 2,400




Consumption of Housekeeping Items 2,70,000

Bank Deposits @ 15% 1,500,000

Cash in hand 105,000


Sundry Debtors 181,500

Sundry Creditors 824,100

Remuneration to Trustees 63,000


Donation 1,800,000

Fees 900,000

Rent 825,000

Food Supply 420,000

Building 960,000

Equipment 1,365,000

Total 8,401,500 8,401,500


Depreciation to be provided @ 5% on Building; 10% on Furniture; 15% on

Equipment; and 30% on Ambulance.

Closing stock of medicine at pharmacy Rs. 120,000

15% of the fees received from patients to be paid to specialist doctors.

Supply of medicines from pharmacy to the hospital Rs. 180,000 for which no

adjustment has been made in the books of accounts.




Solution −

In the Books of Rehmat Ali Trust

Income & Expenditure Account of the Pharmacy



To Opening Stock (Medicines)

To Purchase of Medicine

To Salaries

To Electricity Expenses

To Surplus of Income over

Expenditure

165,000

900,000

45,000

6,000

114,00

By Sale (Medicines)

By Medicine to

Hospital

By Closing Stock

930,000

180,000

120,000

Total 1,230,000 Total 1,230,000

Income & Expenditure Account of the Hospital



To Consumption of

Medicines360,000

Add:

Medicine from

Pharmacy180,000

------------

To Consumption of Food Stuff

To Consumption of Drugs & Chemicals

To Consumption of House Keeping

To Salaries

540,000

270,000

90,000

By Fees

By Rent

By Recovery of Food

supply

By Ambulance

Charges

By Deficit (Excess of

expenditure Over

Income)

900,000

825,000

420,000

2,400

457,350





To Subscription

To Fees to specialist 15% of fees

To Telephone Expenses

To Depreciation:

Building5%48,000

Furniture10%24,000

Equipment 15%204,750

Ambulance 30%27,000

------------

270,000

540,000

315,000

63,000

135,000

78,000

303,750

Total 2,391,750 Total 2,391,750

Income & Expenditure Account of Trust



To Deficit (Hospital A/c)

To Remuneration to Trustee

457,350

63,000

By Surplus (Pharmacy)

By Interest due on fixed deposit

By Net Deficit

114,000

225,000

181,350

Total 520,350 Total 520,350

Statement of Affairs of Rehmat Ali Trust




As on 31-03-2014


Capital Fund2,700,000

Add: Donation1,800,000

----------------

4,500,000

Less: Net Deficit (-)181,350

----------------

Sundry Creditors

Fees Payable to specialist

4,318,650

824,100

135,000

Building960,000


---------------



-------------

Equipment1,365,000


-------------

Ambulance90,000


-------------

Bank Deposits1,500,000

Add: Interest Due225,000

-------------

Closing Stocks:

Medicine60,000

Foodstuff12,000

Drugs & Medicine3,000

Pharmacy120,000

-------------

Sundry Debtors

Cash in hand

Cash at Bank

912,000

216,000

1,160,250

63,000

1,725,000

195,000

181,500

105,000




720,000

Total 5,277,750 Total 5,277,750

Financial Accounting - Co-Operative Societies

Any ten persons who are competent to contract may file an application to the

Registrar of Co-operative Societies as per Section 6 of the Co-operative Societies

Act, 1912. By law, may be framed by each society and should be registered with

the Co-operative Societies.

Effectiveness of change by the law of societies is applicable only when changes are

approved by the Registrar of Society.

Types of Society There are two types of society −

Limited liabilities society

Unlimited liabilities society

Any member is not liable to pay more than the nominal value of the share held by

him and no member can own more than 20% of the shares of society.

Today, government is encouraging co-operative societies to help society at large.

Cooperative societies are operative in various sectors like consumer, industrial,

services, marketing, etc.

Under accounting system of Co-operative societies, the term Receipt and Payment

is used for two fold aspects of double entry system.

Accounts Following accounts usually maintained by the Co-operative societies −

Day Book (Journal)

Day Book (Cash Account)

Day Book (Cash Book with Adjustment Column)

Day Book (Journal)

Day book is a book of original entries. In a day book, all types of cash or non-cash

transactions are recorded, according to the principle of double entry system.




As per the practice followed in the co-operative societies, a separate journal book

is not prepared rather all transactions are directly recorded in the day book. Day

book has two sides Receipt (debit) and payment (credit) and there are two columns

in each side of a day book, one for the cash transactions and second for the

adjustment.

Transaction for the cash receipt and cash payment are recorded in cash column

and payment side respectively. Similarly, entries are done in debit and credit side

of a day book in the adjustment column.

Day Book (Ledger for Cash Account)

Since, all the cash transactions are recorded directly in a day book, it might be

called as ledger account of cash book.

Day Book with Cash and Adjustment Columns

Specimen

Day Book with Cash and Adjustment Columns

Date Particular R.No. Cash Adjustment Date Particular R.No. L.F Cash Adjustment

Ledger

In the co-operative societies, posting of ledger is not done on the double entry

system. Receipt side of the day book on debit side of the ledger account and

payment side of the day book posted on the credit side of the ledger account.

Closing of Ledgers

In the co-operative societies, balancing of a personal account is done at the time

when any member clear his account or a new account is opened. Totals of all other

accounts (receipt and payments) are kept as it is. Balancing of receipt and payment

accounts are not required.

Receipt and Payment Account

A receipt and payment account is the summary of a day book and prepared for a

specified period. Receipt and payment account is prepared from the totals of

receipts and payment sides of the ledger accounts.




Final Accounts

Trading & Profit and Loss account and Balance sheet are prepared from the receipt

and payment accounting after consideration of the adjustment entries. Items

appear under the receipt side are treated as income, and items of the payment side

are as expenditure.

Rules Appropriated as −

First 25% of the net profit should be transferred to the reserve fund account.

As per section 35 of Co-operative Societies Act, 1912, distribution of the profit

should not be more than 6.25%.

Contribution to charitable funds as defined in section 2 of Charitable

Endowment Act, 1890, which says that contribution may be done with the

prior permission of the Registrar. Maximum contribution is restricted to 10%

of the available profit, after transferring profit to reserve account.

Unlimited liabilities, co-operative society may distribute profit only after

general or special order of the State Government.

Financial Accounting - Insurance Claims Every business entity keeps sufficient stock as per the need and size of its

respective business for smooth running of the business, but at the same time risk

of loss by fire or by means is also there. To safeguard the businesses from any

unforeseen circumstantial loss, most of the business entities buy insurance policy,

which covers loss of stock (by fire) — is known as stock policy.

In consideration of the premium, insurance company takes the responsibility to

compensate — if any loss occurs by fire or by other means, applicable under the

insurance terms. It is in the best interest of the firm to take fire insurance policy

because it covers wide range of losses (by fire) including Building damage,

Furniture and Fixture loss, Plant & Machinery destruction, etc.

Following are the important points to be considered for the estimation of stock −

Gross Profit on Sale

Gross profit is calculated by deducting net sales from the cost of goods sold. To

know the gross profit of the last year, “Trading” account of the last year should be

referred.




Memorandum Trading Account (for Current Year)

In case of fire, Memorandum Trading account is required to find the value of

estimated Stock. It is prepared with the help of Gross Profit ratio of the last year,

Opening Stock, Purchase, Sale, and Direct Expenses.

Value of Salvaged Stock

Value of stock as calculated at step-2 will be reduced by the value of salvaged stock

to arrive at the value of Insurance Claim.

Other Important Points

In case, where stock is not valued at the cost, first it will be valued at the cost

in the last year trading account and then in the memorandum account of the

current year. For example, if it is given that stock of Rs. 80,750 is valued at

85% of the cost in the last year, then first it should be valued

as (80,75085×100)=95,000(80,75085×100)=95,000 in the last year and then in

the current year memorandum Trading account.

Cost of the sample given free of cost or withdrawal of stock by proprietor or

partner of the firm for personal use, it should be adjusted in the Trading

Account of the last year as well as in the current year’s memorandum trading

account.

In case, where gross profits of the last several years are given, average gross

profit should be taken to determine the gross profit of the current year.

However, in case where clear upward trend of the gross profit or downward

trend of the gross profit is identified, weighted average gross profit or

reasonable trend of upward or downward trend should be applied to

determine the gross profit of the current year.

To find out the gross profit on normal sales, poor selling sale should be

eliminated from the sale of the current year. Similarly, poor selling items

should be eliminated from the opening and closing stock of the last years to

prepare the trading account of the current year.

Average Clause

An average clause is applied to find out the value of a claim where value of the

stock on the date of fire is more than the value of insured stock. Average clause is

applied by the insurance companies to discourage the under insurance of stock or

any other assets.

Following illustration help you to understand it in a better way −




Suppose, value of insurance policy is Rs. 1,500,000 and at the date of fire, value of

stock in hand is Rs1,800,000, out of which approx. worth of 1,200,000 stock is

destroyed, then the value of the claim admitted will be −

ValueofClaim=1,500,0001,800,000×1,200,000=1,000,000ValueofClaim=1,500,0001,800,

000×1,200,000=1,000,000

Value of stock of Rs. 1,200,000 will not be admissible to the insured, rather

admissible claim will be Rs. 1,000,000.

Illustration

Fire occurred on the business premises of ‘Style India’ on 1st April, 2014 and most

of the stock destroyed. Please ascertain the insurance claim from the following

given particulars −

Particulars Amount (Year

2013)

Amount (01 Jan to

31stMarch 2014)

Sale 2,500,000 750,000

Purchases 1,800,000 350,000

Opening Stock (01-01-

2013)

270000

Closing Stock (31-12-2013) 498,750

Direct Expenses (Freight &

wages) 150,000 30,000

Stock as on 01-01-2013, valued 10% less at the cost.

Stock as on 31-12-2013 value 5% more at the cost.

Value of stock salvaged Rs. 45,000.

Insurance policy (for fire) was for Rs. 300,000.

Solution

Trading Account of M/s Style India

(For the year ending on 31st December, 2013)





To Opening Stock

{270,00090×100}{270,00

090×100}

To Purchases

To Direct Expenses

To Gross Profit (29%)

300,00

0

1,800,

000

150,00

0

725,00

0

By Sales

ByStock=500,000105×100ByStock=50

0,000105×100

2,500,

000

475,00

0

2,975,0

00 2,975,0

00

Memorandum Trading Account of M/s Style India

(Up to 01-4-2014)


To Opening Stock

To Purchases

To Direct Expenses

To Gross Profit

(29% of 750,000)

475,000

350,000

30,000

217,500

By Sales

By Stock (Balancing Figure)

750,000

322,500

1,072,500 1,072,500

Value of Stock= Rs. 322,500

Less: Stock Salvage= Rs.45,000

Insurance Claim to be lodged will be −

ValueofClaim=300,000322,500×277,500=258,140ValueofClaim=300,000322,500×277,5

00=258,140




Here an average clause will be applied because the value of insurance policy

(Rs.300,000) is less than the value of stock (Rs. 322,500) on the date of fire.

Consequential Loss Insurance A normal fire policy only indemnifies loss of stock or assets, and fails to insure any

loss of profit suffered by the concerned business. Therefore, a consequential loss

policy should be taken to cover the Loss of profit, Loss of Fixed expenditure, etc.

Following are the important terms used in loss of profit policy −

Insured Standing Charges − Salaries to staff, Rent rates & Taxes, Wages to

skilled workers, Auditors’ fees, Directors’ fees, Advertisement Expenses,

Travelling Expenses, Interest on debentures, and unspecified expenses (not

more than 5% of the specified expenses) are the charges that have to mention

on the policy form at the time of buying policy (so that all charges get

insured).

Turnover − Turnover includes sold goods or services for which amount is

payable; it also needs to be insured.

Annual Turnover − Turnover for the last 12 months, immediately preceding

to the date of fire.

Standard Turnover − Standard turnover means, turnover for the period

corresponding with the indemnity period during the preceding accounting

year. It also needs to be adjusted to notice the trend during the accounting

year, in which incident took place.

Gross Profit − It is calculated as

Gross profit = Net profit + Insured standing charges

Net Profit − To calculate net profit — profit (excluding tax), insured standing

charges, other charges, depreciation, and other provisions of such kind need

to be adjusted.

Indemnity Period − Maximum twelve months (from the date of damage),

during which the result of the business affected due to damage. Period of

indemnity is selected by the insured person.

Computation of Claim

Following steps need to be taken to compute insurance claim on the loss of the

profit, which is occurred due to dislocation of the business −




Short Sale − Short sale means loss of sale due to the incident of fire and

subsequent dislocation of the business. The difference of standard turnover and

the actual turnover during the period of indemnity is called short sale. It is

illustrated in the following example.

Example

Calculate short sale according to the particulars given below −

Date of Fire occurs 01-06-2013

Period of dislocation of business 4 months

Standard Sale 500,00

Increased trend 15%

Actual Sale 300,000

Solution

Computation of Short Sale

Standard turnover (Rs. 50,000 + 15%)(A) 575,000

Less: Actual Sale(B) 300,000

Short Sale(A-B) 275,000

Rate of Gross Profit − It is calculated as

RateofGrossProfit=NetProfit+InsuredStandingChargesTurnover×100RateofGrossProfit=Ne

tProfit+InsuredStandingChargesTurnover×100

Note − All figures given above are related to the last accounting year.

InCaseofLoss=InsuredStandingCharges−NetLossTurnover×100InCaseofLoss=InsuredStan

dingCharges−NetLossTurnover×100

Note − All figures given above are related to the last accounting year.

In case where all the standing charges are not insured, amount of net loss need to

reduce as −




=InsuredStandingChargesAllstandingCharges×NetLoss=InsuredStandingChargesAllstan

dingCharges×NetLoss

Loss Due to Short Sale − It is calculated as

LossduetoShortSale=ShortSale×RateofGrossprofitLossduetoShortSale=ShortSale×Rateof

Grossprofit

Increased Cost of Working − Increased cost of working means, certain additional

expenses those have to be incurred by insured person to keep the business in

running condition during the indemnity period.

Least of following figures will be considered as increased cost of working −

=NetProfit+InsuredStandingChargesNetProfit+AllstandingCharges×IncreasedCostofWorkin

g=NetProfit+InsuredStandingChargesNetProfit+AllstandingCharges×IncreasedCostofW

orking

Illustration

Calculate permissible increased cost of working with following given particulars −

Net Profit 45,000

Insured Standing Charges 25,000

Uninsured Standing Charges 25,000

Short Sale 100,000

Rate of Gross Profit 15%

Increased Working Expenses 10,000

Short sale avoided through Increased Cost of Working 50,000

Solution

Least of the following will be permissible increased cost of working −

=NetProfit+InsuredStandingChargeNetProfit+AllstandingCharges×IncreasedCostofWorking

=NetProfit+InsuredStandingChargeNetProfit+AllstandingCharges×IncreasedCostofWor

king




=45,000+25,00045,000+50,000×10,000=7,368=45,000+25,00045,000+50,000×10,000=7,36

8

Shortsaleavoided×RateofGrossprofit=50,000×15%=7,500Shortsaleavoided×RateofG

rossprofit=50,000×15%=7,500

So, Rs. 7,368 will be permissible claim of the increased cost of working.

Note − Overall permissible limit of claim for short sale + increased cost of working

cannot exceed the following limit.

Maximumpermissiblelimitofclaim=StandardSale×RateofGrossprofitMaximumpermissibleli

mitofclaim=StandardSale×RateofGrossprofit

Saving in Expenses − Saving in expenses due to fire will be deducted from the

amount calculated as above.

Average Clause − In case where the value of sum insured is less than the value of

policy for which policy have been taken, average clause will be applied as applied

for the stock insurance (above).

Accounting Entries In case of loss of stock

Insurance company A/cDr

To Stock Damaged A/c

To Stock Destroyed A/c

(Being Claim admitted for stock destroyed and stock damaged)

Stock destroyed A/cDr

Stock Damaged A/cDr

To Trading A/c

(Being actual cost of stock destroyed and stock damaged to trading

account)

Bank A/cDr

To Stock Damaged A/c

(Being realization made on sale of damaged Stock)




Note − Difference of stock destroyed account and damaged account will be

transferred to Profit & Loss account)

In case of loss of Profit

Insurance company A/cDr

To Profit & Loss A/cDr

To Profit & Loss Suspense A/c

(Being Loss of profit for next year)

Bank A/cDr

To Insurance Company A/c

Government Accounting Government accounting is a scientific procedure of collecting, classifying,

recording, summarizing, and interpreting all the financial transactions including

revenues and expenditures of all the government offices. It keeps the record of

public funds.

Followings are the main objectives of the Government Accounting −

Information about Revenues − One of the most important functions of the

Government accounting is to maintain the transactions of generation and

collection of revenues during the financial year (and maintain all the past

years’ financial data). Under the ‘Right to Information Act,’ if someone asks

to have the information regarding the financial transactions of a government

office, it is oblige to provide that.

Information about Expenditures − One of the most important objectives of

the Government accounting is to provide information about the expenditures

incurred on various heads. It is checked by the Parliament in case of Central

Government and state legislature in case of the State Government.

Information about Deposits and Loans − Government has to provide

information about the loan granted by the Government to others and

repayment of the deposits.

Information about Availability of Cash − It has to provide information

about the present and the future cash availability.




Difference between Government and Commercial

Accounting There are following notable differences between the Government accounting and

the commercial accounting −

Headings Govt. Accounting Comm. Accounting

Objective Administration and management of

all the financial activities of the

government.

Maintain the records of

trading and manufacturing

of goods or to provide

services to calculate

profits.

Date Entry

System

It has single entry system — Govt.

does not work to earn profit; so, it

does not need cross-check the

accounting records.

Normally, it has double

entry system — need to

prepare Trading & Profit &

Loss account and Balance

Sheet at the end of the

accounting period.

Basis of

Accounting

statements

Accounting statements are also

prepared on the basis of single entry

system. Most of the statements are

merely statements of collections of

revenue and expenditures done,

except where the Government acts

like a banker or lender or borrower.

Accounting statements are

prepared on the basis of

double entry system.

Important Terms and Expressions of Government Finance Following are the important terms and expressions used in Government accounting

−

Demand for Grant − Without sanction from the Parliament, no expenditure

can be incurred by any Government Authority. Public Authority can request

for the grant of expenditure to the Government, this request is called

“Demand for Grant”.

Supplementary Grant − Sometimes, grants are sanctioned before the end of

the financial year, in case where annual budget might be inadequate.




Supplementary demand can be made, if need arises to meet the expenditure.

For example, amount granted for the Natural Disaster Relief fund, may be

found inadequate due to extraordinary disaster by the flood; in such a

condition, an additional grant may be asked by the concerned state or

ministry.

Treasuries − Treasuries are the units of fiscal system in India. Every Indian

States and Union Territory is divided into different districts’ headquarters

and every district headquarters has one or more than one treasury.

Treasuries are conducted by the State Bank of India as an agent of the

Reserve Bank of India. Central Government and State Government keep their

separate accounts and differences of Central and State Govt. are adjusted by

the Reserve Bank of India.

Votable and Non-votable Items − To incur some expenditures,

Parliamentary approval is not required; so, these expenditures may be

charged from the Consolidated fund or the Public account, these items are

known as Non-votable items. Some items of expenditure require sanction of

the Parliament and cannot be incurred without its grant. Thus, demand for

grant for that expenditure may be placed to the government, such items are

called as Votable Items.

Appropriation Act − After the approval of the budget proposal in the

Parliament or Legislature, an Appropriation Bill has to be introduced, when

this Bill is passed, it becomes Appropriation Act. Now, money can be

withdrawn from the Consolidated Fund of India or the concerned State to

meet the grants.

Vote on Account − In certain condition, when government has no time to

place full budget in the Parliament, then it uses the special provision of ‘Vote

on Account.’ Under this provision, government obtains the vote of the

Parliament for the amount required to incur the expenditure of the items in

demand. After sanction obtained in the Parliament, government obtains

money from the Consolidated Fund of India.

Public Accounts Committee (PAC) − Public Account Committee is formed

by the Parliament and each Legislature to scrutinize the Appropriation

account and Audit the report thereon. All the reports on financial statements

those are to be submitted to the President of Indian and in the Parliament

are examined by the Public Accounts Committee (PAC). Examination by the

PAC is similar to post-mortem of the reports. Members of the PAC are




appointed from the Opposition Parties of the Parliament. Member of the

ruling party cannot be part of this committee, as this committee is working

as a watchdog to look after the affairs of ruling party.

Local Government Accounting − Accounting of the Local government is

based on the concept of “fund accounting” and on the budget. Urban local

government entities and rural local government entities are two types of local

government entities. Accounting of the Local Government in India comprises

budget, Receipt, and payment accounts.

Government Fund Government of India has following three types of Funds for marinating the records

of all sorts of financial transactions −

Consolidated Funds of India

Contingency Funds of India

Public Account

Let’s discuss each of them succinctly −

Consolidated Funds of India

As per the Clause 1 of the Article 266 of the Indian Constitution −

“All revenues received by the Government by way of taxes like Income Tax, Central

Excise, Customs and other receipts flowing to the Government in connection with the

conduct of Government business i.e. Non-Tax Revenues are credited into the

Consolidated Fund constituted. Similarly, all loans raised by the Government by

issue of Public notifications, treasury bills (internal debt) and loans obtained from

foreign governments and international institutions (external debt) are credited into

this fund. All expenditure of the government is incurred from this fund and no amount

can be withdrawn from the Fund without authorization from the Parliament.”

Contingency Funds of India

As per the Article 267 of the Indian Constitution −

“The Contingency Fund of India records the transactions connected with Contingency

Fund set by the Government of India. The corpus of this fund is Rs. 50 crores.

Advances from the fund are made for the purposes of meeting unforeseen

expenditure which are resumed to the Fund to the full extent as soon as Parliament

authorizes additional expenditure. Thus, this fund acts more or less like an imprest

account of Government of India and is held on behalf of President by the Secretary




to the Government of India, Ministry of Finance, and Department of Economic

Affairs.”

Public Account

The Public Account is constituted under Clause 2 of Article 267 of the Indian

Constitution, which says −

“The transactions relate to debt other than those included in the Consolidated Fund

of India. The transactions under Debt, Deposits and Advances in this part are those

in respect of which Government incurs a liability to repay the money received or has

a claim to recover the amounts paid. The transactions relating to ‘Remittance’ and

`Suspense’ shall embrace all adjusting heads. The initial debits or credits to these

heads will be cleared eventually by corresponding receipts or payments. The receipts

under Public Account do not constitute normal receipts of Government. Parliamentary

authorization for payments from the Public Account is therefore not required.”

Similarly, all 29 states of India has the same structure as described above.

General Structure of Government Accounts The general structure of the government accounts is illustrated below −




Compilation of Accounts Treasury and other government departments, initially compile their receipt and

payment accounts on monthly basis for central government and state government

separately and then send to respective Accountant General of India.

Collection of revenue and disbursement are directly made by Railway, Defense, Post

& Telegraphs, Forest, and public departments and lump sum payments are made

by treasury through the departmental officers. Detail of accounts on monthly basis

is maintained by the departmental Accounts officers.

Monthly accounts submitted by the treasury and account officer are compiled by

the Accountant General, for the central government as a whole and for each state

separately. The compiled report shows progressive figure of each month from 1st

April to 31st March of every year. Complied accounts along with appropriation

accounts are submitted by Comptroller and Auditor General of India to the

President of India, to the Governor of each state, or to the Administrator of the

Union Territory accordingly.

Principles of Government Accounting Charges or expenditure on a new project like constructions, new equipment,

plant & machinery installation, maintenance, improvement, and service

should be allocated to the capital account as per the rule made by competent

authority.

Working charges of the project should be allocated to the revenue account.

In case of renewal and replacement and cost of the genuine replacement

should be charged to capital account.

In case of damage due to extraordinary calamities, charged should be debited

from the capital account or revenue account or from both. However, it will be

determined by the government according to the case and circumstances.

Capital receipts during the new project should be credited to the capital

account to reduce the capital expenditure of the project.

CAG Comptroller and Audit General (CAG) is an independent Constitutional body.

Special status has been given to safeguard his independence and enable him to

discharge his duty without fear or favor.




As per the Article 148 of the Constitution of India, the comptroller and Auditor-

General will be appointed by the President of India. The provision of removal of CAG

is the same as of the judges of the Supreme Court. He can be removed only on the

basis of proven misbehavior or incapacity.

As per the Article 150 of the Constitution of India — the accounts of the Union and

of the States shall be kept in such form as the President may prescribed, on the

advice of the Comptroller & Auditor General.

Article 151 of the Constitution provides that the audit reports of the Comptroller &

Auditor General relating to the accounts of the Union shall be submitted to the

President, who shall cause them to be laid before each House of Parliament.

Financial Accounting - Contract Account Contracts are undertaken to customer’s requirements, which is generally of

constructional. For example, construction of buildings, ships, Bridges, Roads, etc.

In all the above cases, contract account is opened. A unique number is allotted to

each contract and a separate account is maintained for each individual contract.

Features of Contract Accounting Following are the important features of a contract accounting −

Direct Costs − Direct cost is the main proportion of expenses in a contract

account. However, indirect nature of expenses is also treated as direct

expenses in a contract account.

Indirect Costs − Proportion of the indirect cost is very low in a contract

accounting such as expenses related to the head office in case of various

contracts.

Cost Control − Cost control is the main challenge in a contract account

especially in the large scale contracts. For example, control over the material

cost, labor cost, loss, damages, etc. are difficult to regulate.

Surplus Material − After completion of the constructional project, if any

material such as cement, iron and steel, marbles, etc. is remained unused,

is known as surplus material. Surplus materials are normally disposed of to

get back the invested amount.

Types of Contract There are three types of contracts, as depicted in the following figure.




Recording of Costs, Value, and Profit on Contract Recording of each contract will be done as under −

Material

Cost of “Material” will be debited from the contract account in the following

manners −

Direct purchase

Supplied from stores

Transfer from other project/contract

Contract account will be credited −

Material returned to stores

Sale proceed of surplus material

Amount will be transferred to Profit & Loss account −

Profit or Loss on sale of surplus of material

Damaged, Lost, or stolen material (except normal wastage of material that

will be charged directly to concerned contract account).

Labor

Labor or wages directly charged to concerned contract account and outstanding

wages should be debited from the contract account.




Direct Expenses

In addition to material and labor, all other expenses, which are directly attributable

to the specific contract account are called direct expenses and will be debited from

the contract account.

Plant and Machinery

Following are the two methods for charging value of Plant & machinery to a contract

account −

a) Contract account will be debited with the full value of Plant &

Machinery −

Contract A/cDr(With full value)

To Plant & Machinery A/c(With Full Value)

Contract account will be credited with the depreciated value of Plant

& Machinery at the end of the contract −

Plant & Machinery A/cDr(with Depreciated Value)

To Contract A/c

b) Contract account will be debited with hourly rate of Depreciation−

This is much better and scientific approach as compared to the first

method. On the basis of time, contract will be debited with hourly rate of

depreciation.

Indirect Expenses

The expenses, which cannot be directly charged to such contract are known as

indirect expenses.

On the basis of some percentage, these expenses may be distributed among several

contracts. For example, charges of supervisor, engineer, administrative expenses

etc.

Sub Contract

When a main or prime contractor assigns some specific work to another contractor

as part of the main contract called as sub contract. Sub-contractors are paid by

the main contractor. Sub-contractors normally do some specialized work, in which

they are specialized. Charges paid to the sub-contractor will be shown in the debit

side of the contract account.




Extra Work Charges

Any additional works in addition to the main contract, done by contractor as per

the requirement of the Contractee, may be charged to same contract account.

However, in case where volume of the extra work is not substantial; so, the amount

received in lieu of that extra work should be added to the contract price.

In case where extra work is of substantial amount, a separate contract account

should be prepared, as explained above.

Recording of Value and Profit on Contracts Certification of Work Done

During the period of contract, Contractee has to pay sums of amount to contractor

especially where a contractor is engaged in a big and long term contract. This

amount is paid on the basis of certification of work done by surveyors or architects

on behalf of the Contractee, who certified the value of the work done by the

contractor.

Usually, some percentage of the certified amounts is paid by Contractee and the

balance amount called as “retention money.” The retention amount remains with

the Contractee until the work is completed to safeguard and keep in favorable

position. Completed work, which is not certified is called “uncertified work.”

Following accounting procedure should be followed after getting certificate −

a) Contractee personal A/cDr

To Contract A/c

Note −

1. Above entry will be done with certified value

2. Balance amount in personal account will represent retention money as

debtors.

b) Contractee personal A/cDr

Retention Money A/cDr

To Contract A/c

c) Under this method, any amount received from the Contractee till the completion

of contract will be crediting to Contractee’s personal account debiting cash/bank.

Amount so received will represent advance received from Contractee and will be

shown as (work in progress less advance received) in the Balance sheet.




Profit on Incomplete Contract

Actual ascertainment of the cost is possible only after fully completion of the

contract. Therefore, it is not possible to know the profit or loss on contract till it is

completed.

However, following principles are adopted to estimate profit on uncompleted

contracts −

No profit is ascertained and transferred to profit and loss account where work

is completed up to 25% of the total contract.

In case where contract is completed from 33.33% to approximately 75%, one-

third amount of the notional profit may retain to suspense account as a

provision for future loss and balance; two third is transferred to the profit

and loss account. Sometime notional profit is further reduced in the ratio of

the cash received and the work certified, the formula is −

NotionalProfit×23×CashReceivedWorkCertifiedNotionalProfit×23×CashReceivedWo

rkCertified

In case where a contract is almost completed, proportion of an estimated

profit is transferred to the profit & loss account by one of the most popular

formula as given below −

EstimatedProfit×WorkCertifiedContractPriceEstimatedProfit×WorkCertifiedContra

ctPrice

Note − In case of any loss that should be transferred to Profit & Loss account.

Work in Progress

Uncompleted contracts at the end of the financial year, which are known as work-

inprogress will be accounted as −

Work-in-progress will be shown at the asset side of the Balance sheet on the

account of expenses incurred the un-completed contracts.

Value of the work-in-progress will be inclusive of Profit.

Cash received from the Contractee will be deducted from the value of work-

inprogress.

Contractee will be treated as a debtor only after completion of the contract.

Contractee will not be shown as creditor on account of cash received from

him.




Cost of plant and material at the site will be shown separately as “Plant at

site” and “Material at site” on the asset side of the Balance sheet.

Illustration

Please prepare a Contract Account, Contractee Account and Extract of Balance

sheet from the following information as received from M/s “Solid Building

Contractor’ for the period 01-04-2013 to 31-03-2014.

Particulars Amount

Contract Price 18,000,000

Material Issued to contract 3,060,000

Wages & Salary 4,800,000

Plant used for Contract 900,000

Other Miscellaneous Expenses 300,000

Cartage paid on Material 60,000

Loss of Plant at site 180,000

Plant returned to store on 31-03-2014 120,000

Loss of Material at site 150,000

Material in hand at site on 31-03-2014 138,000

Cash received 80% of work certified 7,680,000

Uncertified work 60,000




Depreciation on Plant 15%

Profit transferred to Profit & loss account 23rd23rd

Solution

M/s Solid Building Contractor

Contract Account

(For the period 01-04-2013 to 31-03-2014)


To Material

To Wages & Salary

To Plant

To Cartage

To Misc. Expenses

To Notional Profit c/d

3,060,000

4,800,000

900,000

60,000

300,000

1,620,000

By Material at site

By Profit & Loss A/c

Material Lost150,000

Plant Lost180,000

-----------

By Plant return to store120,000

Less: Dep.18000

-----------

By Plant at site600,000

Less: Dep.90,000

-----------

By Work In progress A/c

Work certified9,600,000

Work uncertified60,000

-----------

138,000

330,000

102,000

510,000

9,660,000




Total 107,400,000 Total 107,400,000

To Profit & Loss A/c

1,620,000×23×451,620,000×23×45

To Work in Progress A/c (Reserve)

864,000

756,000

By Notional Profit b/d 1,620,000

Total 1,620,000 Total 1,620,000

Contractee Account


To Balance c/d 7,680,000 By Cash Received 7,680,000

Total 7,680,000 Total 7,680,000

Balance-Sheet

(As on 31-03-2014)


Profit & Loss A/c864,000

Less: Loss of330,000

Plant & Material-----------

534,000

Plant720,000

Less: Dep. 15%108,000

------------

Material at site

Work-in-progress

Work Certified9,600,000

Uncertified work60,000

------------

9,660,000

Less: Reserve756,000

------------

612,000

138,000




8,904,000

Less: Cash Received7,680,000

------------

1,224,000

Modern Approach on Profit on Uncompleted Record Following are the two methods of calculating the profits on uncompleted contracts

−

Where profit is ascertained only after completion of the contract or after

substantially completion of the contract is called ‘completion contract

method.’

Under the second approach, it is ascertained at the end of each and every

accounting period on percentage basis, which comes before completion of the

entire contract.

Work-in-Progress

Work-in-progress means total expenditure incurred up to the end of financial or

accounting year known as work-in-progress account.

Following example is described for better understanding −

Illustration

Please evaluate the profit of the period by using both of the given methods −

Percentage of completion method and

The completed contract method.




Please also find the value of work-in-progress in the Balance sheet by assuming,

the contractor received Rs. 460,000 on completion of the first stage.

Stages Estimates Actual

Cost

Contract

Price

Original

(Rs.)

Revised

(Rs.)

Certified

Completed but not certified

Completed 75%

Completed 25%

Incomplete

345,000

115,000

115,000

230,000

138,000

368,000

126,500

126,500

276,000

172,500

356,500

120,750

95,450

71,300

--

460,000

172,500

149,500

345,000

161,000

943,000 1,069,500 644,000 1,288,000

Solutions −

On the Basis of Percentage of Completion Method −

Stages Actual

Cost

% of

completion

Balance

estimates

(Rs.)

Total Rs. Contract

Price

Profit or

Loss

1

2

3

4

5

356,500

120,750

95,450

71,300

--

25%

75%

100%

31,625

207,000

172,500

356,500

120,750

127,075

278,300

172,500

460,000

172,500

149,500

345,000

161,000

103,500

51,750

--

--

(11,500)

644,000 411,125 1,055,125 1,288,000 143,750

Balance Sheet





Advances 460,000 Work in Progress

(Actual cost + Profit) 644,000 + 143,750

787,750

On the Basis of Completion Contract Method −

No profit will be ascertained before the completion of contract −

Balance Sheet


Advances 460,000 Work in Progress 644,000

Cost Plus Contract

In some cases, it is not possible in advance to know the exact cost of contracts;

therefore, cost plus contract clause need to be applied, in which the value of

contract is ascertain by adding certain percentage of the profit in cost.

Escalation Clause

An Escalation clause is applied to cover up the changes in price due to change in

prices of the raw material or change in utilization of the production capacity.

Escalation clause safeguards both the contractor and the contractee against any

unfavorable change in the cost or the price.

Target Costing

Under this method of a contract, contractee gives target of the production with

target of the expenditure. Contractor cannot increase the cost of contract without

increasing the production. It means, expenditure is fixed with the target of the

production.

Departmental Accounting Departmental stores have many types of stores under a single roof, for example one

departmental store may have a cosmetic store, shoe store, stationery store,

readymade departmental store, grocery stores, medicines, and many more.

It is essential to know the profit and loss account of each departmental store at the

end of the accounting year. However, it can be done by maintaining the department

wise Trading & Profit and Loss account.

Objectives of Departmental Accounting




Following are the main objectives of the departmental accounting −

To know the financial position of each and every department separately, it is

helpful to make a comparison.

Calculate commission of the managers department wise.

Evaluate performance, planning, and control.

Advantages of Departmental Accounting Following are the advantages of a department accounting −

It is helpful in evaluating the result of each department.

It helps to know the profitability of each department.

Investors and outsiders may know the detailed information.

It is helpful in making comparison of each expenses (same department) of the

different accounting years and different expenses (other departments) of the

same accounting year.

Methods of Departmental Account There are two methods of keeping Departmental Accounts −

Separate Set of Books for each department

Accounting in Columnar Books form

Separate Set of Books for each Department

Under this method of accounting, each department is treated as a separate unit

and separate set of books are maintained for each unit. Financial results of each

unit are combined at the end of accounting year to know the overall result of the

store.

Due to high cost, this method of accounting is followed only by very big business

houses or where to do so is compulsory as per the law. Insurance business is one

of the best examples, where to follow this system is compulsory.

Accounting in Columnar Books Form

Small trading unit generally uses this system of accounting, where accounts of all

departments are maintained together by central accounts department in the

columnar books form. Under this method, sale, purchase, stock, expenses, etc. are

maintained in a columnar form.




It is necessary that to prepare a departmental Trading and Profit and Loss Account,

preparation of subsidiary books of accounts having different columns for the

different department is required. Purchase Book, Purchase Return Book, Sale

Book, Sales return books etc. are the examples of the subsidiary books.

Specimen of a Sale Book is given below −

Sales Book

Date Particulars L.F. Department

A

Department

B

Department

C

Department

D

A Trading account in columnar form is prepared to know the department wise gross

profit of the concern.

Function wise classification may also be done in a business unit like Production

department, Finance department, Purchase department, Sale department, etc.

Allocation of Department Expenses

Some expenses, which are specially incurred for a particular department may

be charged directly to the respective department. For example, hiring charges

of the transport for delivery of goods to customer may be charged to the

selling and distribution department.

Some of the expenses may be allocated according to their uses. For example,

electricity expenses may be divided according to the sub meter of each

department.

Following are the examples of some expenses, which are not directly related to any

particular department may be divide as −

Cartage Freight Inward Account − Above expenses may be divided

according to purchase of each department.

Depreciation − Depreciation may be divided according to the value of assets

employed in each department.

Repairs and Renewal Charges − Repair and renewal of the assets may be

divided according to the value of the assets used by each department.

Managerial Salary − Managerial salary should be divided according to the

time spent by the manager in each department.




Building Repair, Rents & Taxes, Building Insurance, etc. − All the

expenses related to the building should be divided according to the floor

space occupied by each department.

Selling and Distribution Expenses − All the expenses relating to selling and

distribution expenses should be divided according to the sales of each

department, such as freight outward, travelling expenses of sales personals,

salary and commission paid to salesmen, after sales services expenses,

discount and bad debts, etc.

Insurance of Plant & Machinery − The value of such Plant & Machinery in

each department is the basis of the insurance.

Employee/worker Insurance − Charges of a group insurance should be

divided according to the direct wage expenses of each department.

Power & Fuel − Power & fuel will be allocated according to the working hours

and power of the machine (i.e. Hours worked x Horse power).

Inter-Department Transfer An inter-department analysis sheet is prepared at a regular interval such as weekly

or monthly basis to record all the inter-departmental transfers of goods and

services. It is necessary, as each department is working as a separate profit center.

Transfer of the prices of such transactions can be cost base, market price, or duel

basis.

Following Journal entry will pass at the end of that period (weekly or monthly) −

Journal Entry Receiving Department A/c Dr To Supplying Department A/c

Inter-Department Transfer Price There are three types of transfer prices −

Cost based transfer price − Where the transfer price is based on standard,

actual, or total cost, or marginal cost is called cost based transfer price.

Market based transfer price − Where the goods are transferred at selling

price from one department to another is known as market based price.

Therefore, unrealized profit on the goods sold is debited from the selling

department in the form of a stock reserve for both the opening and the closing

stock.




Dual pricing system − Under this system, the goods are transferred on the

selling price by the transferor department and booked at the cost price by

the transferee department.

Illustration

Please prepare a Departmental Trading and Profit and Loss Account & General

Profit and Loss Account for the year ended 31-12-2014 of M/s Andhra & Company

where department A sells goods to department B on Normal selling price.

Particulars Dept. A Dept. B

Opening stock 175,000 -

Purchases 4,025,000 350,000

Inter Transfer of Goods - 1,225,000

Wages 175,000 280,000

Electricity Expenses 17,500 245,000

Closing Stock (at cost) 875,000 315,000

Sales 4,025,000 2,625,000

Office Expenses 35,000 28,000

Combined Expenses for both Department

Salaries (2:1 Ratio) 472,500

Printing and Stationery Expenses (3:1 Ratio) 157,500

Advertisement Expenses ( Sale Ratio) 1,400,000




Depreciation (1:3 Ratio) 21,000

Solution

M/s Andhra & Company

Departmental Trading and Profit and Loss Account


Particulars Dept. A Dept. B Particulars Dept. A Dept. B

To Opening Stock

To Purchases

To Transfer from A

To Wages

To Gross Profit c/d

175,000

4,025,000

175,000

1,750,000

--

350,000

1,225,000

280,000

1,085,000

By Sales

By Transfer to B

By Closing Stock

4,025,000

1,225,000

875,000

2,625,000

----

315,000

Total 6,125,000 2,940,000 Total 6,125,000 2,940,000


To Office Expenses

To Salaries (2:1 ratio)

To Printing &

Stationery (3:1 Ratio)

To Advertisement Exp.

( Sales Ratio 40.25 :26.25)

To Depreciation (1:3 Ratio)

To Net Profit

17,500

35,000

315,000

118,125

847,368

5,250

411,757

245,000

28,000

157,500

39,375

552,632

15,750

46,743

By Gross Profit b/d 1,750,000 1,085,000

Total 1,750,000 1,085,000 Total 1,750,000 1,085,000

General Profit and Loss Account





Particulars Dept. A Particulars Dept. B

To Stock reserve (Dept. B)

To Net Profit c/d

81,667

376,833

By Departmental Net Profit b/d

Dept. A411,757

Dept. B46,743

------------- 458,500

Total 458,500 Total 458,500

Financial Accounting - Voyage Accounting To know the financial results of a marine business, voyage accounting is prepared.

Voyage account is similar to a Profit and Loss account; all expenses are debited to

Voyage account and all incomes are credited to Voyage account. Voyage account is

prepared to ascertain the profit or Loss of voyage. It covers both inward and

outward travelling. It is very important that separate Voyage account should be

prepared for each vessel.

Income Following are the main sources of income of a Voyage −

Freight − Freight charges are the main income collected against the

transportation of the goods.

Passage Money − Passage money is collected from the passengers, in case it

is passengers’ vessel.

Primage − Primage is an additional freight in the form of surcharge on the

freight.

Expenses Following are the various ways of expenses of a vessel −

Brokerage & Commission − Brokerage and commission is calculated on the

freight charges including primage and it is paid to the charters agent.

Address commission is payable to the brokers on procurements of freight

from the different parties.

Insurance − The insurance charges on proportionate basis might be debited

from the voyage account. For example, if insurance is for one year and




journey of voyage is for three month, insurance charges will be debited from

the voyage account on 14th14th ratio.

Stores − Stores, which are purchased for voyage are debited from the voyage

account on consumption basis i.e. opening stock + purchases – closing stock.

Depreciation − Depreciation on ship is charged from the voyage account in

the proportion of the period of a journey.

Bunker Cost − Cost of water, coal, diesel, fuel, etc. used for the purpose of

voyage is called bunker cost and may debited from the voyage account.

Port Charges − Port authorities charge fees for allowing ships to use port for

the loading/unloading the cargo. This fee amount is debited from the voyage

account.

Stevedoring Charges − Loading and unloading of cargo called stevedoring

charges and should be debited from the voyage account.

Voyage in Progress At the end of the accounting year where voyage is not completed and is still in

progress, following accounting treatments are required −

Freight Received

Total freight received credited to the voyage account and the provision for

incomplete voyage is debited from the voyage account. Provision is created for the

voyage-in-progress in proportion of the incomplete journey.

Expenses

To complete matching concept, an income as well as expenses related to the

incomplete voyage might be carried forward to the next accounting year on the

respective account. Provision for the income earned should be debited from the

voyage account and provision for the expenses should also be credited to the voyage

account.

Basis of the expenses to be carried forward is as hereunder −

Expenses which are related to the freight, need to be carried forward in a

proportion to return freight. For example, if total freight is Rs. 2,500,000 out

of which return freight is Rs. 1,200,000 and total expenses are Rs. 500,000,

then expenses to be carried forward to the next accounting year — will be Rs.

240,000.

=1,200,0002,500,000×500,000=1,200,0002,500,000×500,000




In case of the standing expenses, if return journey is incomplete, ½ of the

standing charges to be carried forward.

In case where return journey is halfway back and the total expenses of voyage

given 1212 of the total expenses to be carried forward.

When the return journey is halfway back and the expenses till date are

given 13rd13rd of the expense are to be carried forward.

When one round of the trip is completed and on his half way back for single

way and total expenses of voyage are given, then 13rd13rd expenses are to be

carried forward.

When one round trip is completed and on his half way back for single way

and expenses till date are given, then 15th15th expenses are to be carried

forward.

Pro-forma

In the books of M/s Titanic Shipping Company

Voyage Account

For the period ending 31-12-2014


To Coal

Opening Stockxx

Add: Purchasesxx

---------

xxxx

Less: Closing Stockxx

---------

To Port Charges

To Captain Expenses

To Harbor Wages

To Address Commission

To Brokerage

xx

xx

xx

xx

xx

By Freight

By Primage

Xx

Xx




To Insurance Premium

To Salary & Wages

To Stores

To Deprecation

To Provision for Incomplete

Voyage

To Net Profit

(trf. To Profit & Loss A/c)

xx

xx

xx

xx

xx

xx

xx

---------

XXXX

---------

XXXX

Financial Accounting - Royalty Accounts Royalty is payable by a user to the owner of the property or something on which an

owner has some special rights. A royalty agreement is prepared between the owner

and the user of such property or rights. If payment is made to purchase the right

or property that will be treated as capital expenditure instead of a Royalty.




Payment made by the lessee on account of a royalty is normal business expenditure

and will be debited to the Royalty account. It is a nominal account and at the end

of the accounting year, balance of Royalty account need to be transferred to the

normal Trading and Profit & Loss account. Royalty, based on the production or

output, will strictly go to the Manufacturing or Production account. In case, where

the Royalty is payable on sale basis, it will be part of the selling expenses.

Types of Royalties There are following types of Royalties −

Copyright − Copyright provides a legal right to the author (of his book/s), the

photographer (on his photographs), or any such kind of intellectual works.

Copyright royalty is payable by the publisher (lessee) of a book to the author

(lessor) of that book or to the photographer, based on the sale made by the

publisher.

Mining Royalty − Lessee of a mine or quarry pays royalty to lessor of the

mine or quarry, which is generally based on the output basis.

Patent Royalty − Patent royalty is paid by the lessee to lessor on the basis

of output or production of the respective goods.

Basis of Royalty In case of the patent, publisher of the book pays royalty to the author of the book

on the basis of number of books sold. So, holder of patent gets royalty on the basis

of output and the mine owner gets royalty on the basis of production.

Important Terms Following are the important terms, which are used in Royalty agreements −




Royalty

A periodic payment, which may be based on a sale or output is called Royalty.

Royalty is payable by the lessee of a mine to the lessor, by publisher of the book to

the author of the book, by the manufacturer to the patentee, etc.

Landlord

Landlords are the persons who have the legal rights on mine or quarry or patent

right or copybook rights.

Tenet

An Author or publisher; lessee or patentor who takes out rights (usually

commercial or personal rights) from the owner on lease against the consideration

is called tenet..

Minimum Rent

According to the lease agreement, minimum rent, fixed rent, or dead rent is a type

of guarantee made by the lessee to the lessor, in case of shortage of output or

production or sale. It means, lessor will receive a minimum fix rent irrespective of

the reason/s of the shortage of production.

Payment of royalty will be minimum rent or actual royalty, whichever is higher for

example −

M/s Hyderabad publication printed a book on Java on the minimum rent of Rs.

1,000,000/- per annum royalty being payable @ Rs. 20 per book sold. In the first

year of publication, Hyderabad publication sold 75,000 copy of the books and in

the second year, number of sold books fell down to 45,000 only. Amount of royalty

will be payable as under −

Minimum

Rent Royalty

Payable

Ist Year

75,000 Books X Rs. 20 per book = Rs.

1,5,00,000

1,0,00,000 Rs. 1,5,00,000

IInd Year

45,000 Books X Rs. 20 per book = Rs.

9,00,000

1,0,00,000 Rs. 1,0,00,000




Shortworkings

Difference of minimum rent and actual royalty is known as shortworkings where

payment of Royalty is payable on the basis of minimum rent due to shortage in the

production or sale. For example, if calculated royalty is Rs. 900,000/- as per sale

of books based on the above example, but royalty payable is Rs. 1000,000 as per

minimum rent, shortworking will be Rs. 100,000 (Rs. 1,000,000 – Rs. 9,00,000).

Ground Rent

The rent, paid to the landlord for the use of land or surface on the yearly or half

yearly basis is known as Ground Rent or Surface Rent.

Right of Recouping

It may contain in the royalty agreement that excess of minimum rent paid over the

actual royalty (i.e. shortworkings), may be recoverable in the subsequent years. So,

when the royalty is in excess of the minimum rent is called the right of recoupment

(of shortworkings).

Right of recoupment will be decided for the fixed period or for the floating period.

When the right of recoupment is fixed for the certain starting years from the date

of royalty agreement, it is said to be fixed or restricted. On the other hand, when

the lessee is eligible to recoup the shortworkings in next 2 or 3 years from the year

of its commencement, it is said to be floating.

Shortworking will be shown on the asset side of Balance sheet up to allowable year

of recouping after that it will be transferred to profit & loss account (after expiry of

allowable period).

Lease Premium

An Extra payment in addition to royalty, if any, paid by lessee to lessor is called

Lease premium and will be treated as capital expenditure and it will be written off

on yearly basis through profit and loss account as per the suitable method.

TDS (Tax Deducted at sourceSource)

If there is an applicability of TDS (Tax deducted at source) as per Income Tax Act,

lessee will make the payment to lessor after deducting TDS as per applicable rate

and lessee is liable to deposit it to the credit of Central Government. Amount of

royalty will be gross amount of royalty (inclusive of TDS), that will be charged to

profit and loss account.

For example, if royalty amount is 1,000,000/-& rate of TDS is 10%, then lessee will

pay Rs. 900,000/- to lessor. Amount of royalty charge to profit and loss account




will be Rs. 1,000,000/- and balance amount of Rs. 100,000/- will be deposited in

the credit of central Government account.

Stoppage of Work

Sometime, there may be stoppage of work due to conditions beyond control like

strike, flood, etc. in this case, minimum rent is required to be revised as provided

in the agreement.

Revision of the minimum rent will be −

Reduction of minimum rent in the proportion of the stoppage of work;

On the basis of fixed percentage; or

By a fixed amount in the year of stoppage.

Sub Lease Sometime, landlord or lessor allows lessee to sublet some part of the mine or land

as a sub-lessee. In this case, lessee will become lessor for sub lessee and lessee for

main landlord.

In such a case, as Lessee, he will maintain the following books of accounts −

As a Lessee

Landlord accountAccount

Minimum Rent Account

Royalty Account

Shortworkings Recoupable

Accounts

As a Sub Lessor

Royalties receivable Receivable

accountAccount

Sub lessee Lessee

accountAccount

Shortworkings allowable

Allowable Account

Accounting Entries

When there is no royalty in the year

(a) Minimum

Rent A/cDr

To Landlord

A/c

(b)

Shortworking

A/cDr




To Minimum

Rent A/c

Where Royalties are less than minimum rent and

shortworkings are recoverable in next years.

(c) Minimum

Rent A/cDr

To Landlord

A/c

(d) Royalties

A/cDr

Shortworkings

A/cDr

To Minimum

Rent A/c

(e) Landlord

A/cDr

To Bank A/c

(f) Profit &

Loss A/cDr

To Royalty A/c

When Short workings are recouped

(g) Royalties

A/cDr

To short

workings A/c

To Landlord

A/c

(h) Landlord

A/cDr

To Bank A/c

Transfer of irrecoverable Short workings (i) Profit &

Loss A/cDr




To Short

workings A/c

Illustration

From the below given information’s, please open prepare the necessary accounts in

the books of M/s Black Diamond Limited.

Company leased a colliery on 01-01-2010 at a minimum rent of Rs. 75,000.

Royalty Rate@ Rs. 1/- per ton.

Right of recouping of shortworkings is restricted to first 3 years.

Output for the first four years of the lease was 40,000, 65,000, 1,05,000, and

90,000 tons respectively.

Solution −

Analytical Table

Year Output

(Tons)

Royalties @

Rs. 1 Per

ton

Shortworkings Surplus Recoupment Unrecoupable

Short workings

Payable to

Landlord

2010

2011

2012

2013

40,000

65,000

105,000

90,000

40,000

65,000

105,000

90,000

35,000

10,000

--

30,000

15,000

--

--

30,000

15,000

75,000

75,000

75,000

90,000

300,000 300,000 45,000 45,000 30,000 15,000 315,000

In the books Books of M/s Black Diamonds Ltd

Royalties Account


31-12-2010

31-12-2011

To Landlord A/c

To Landlord A/c

40,000

=======

65,000

31-12-2010

31-12-2011

By Production A/c

By Production A/c

40,000

=======

65,000




31-12-2012

31-12-2013

To Landlord A/c

To Landlord A/c

=======

105,000

=======

90,000

=======

31-12-2012

31-12-2013

By Production A/c

By Production A/c

=======

105,000

=======

90,000

=======

Landlord Account


31-12-2010

31-12-2011

To Bank A/c

To Bank A/c

75,000

----------

75,000

----------

75,000

----------

75,000

----------

31-12-2010

31-12-2011

By Royalties A/c

By Shortworkings A/c

By Royalties A/c

By Shortworkings A/c

40,000

35,000

----------

75,000

----------

65,000

10,000

----------

75,000

----------

31-12-2012

31-12-2012

31-12-2013

To Shortworkings A/c

To Bank A/c

To Bank A/c

30,000

75,000

----------

105,000

----------

90,000

----------

90,000

31-12-2012

31-12-2013

By Royalties A/c

By Royalties A/c

105,000

----------

105,000

----------

90,000

----------

90,000

----------




----------

Shortworkings Account


31-12-2010

01-01-2011

01-01-2012

To Landlord A/c

To Balance b/d

To Landlord A/c

To Balance b/d

35,000

----------

35,000

----------

35,000

10,000

----------

45,000

----------

45,000

----------

45,000

----------

31-12-2010

31-12-2011

31-12-2012

31-12-2010

By Balance C/d

By Balance C/d

By Landlord A/c

By Profit & Loss A/c

35,000

----------

35,000

----------

45,000

----------

45,000

----------

30,000

15,000

----------

45,000

----------


financial accounting - rectification of errors · rectification of errors after preparation of...

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