Admission of a Partner. Accounting Treatment of Goodwill

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1 Admission of a Partner Meaning According to Section 31 of Indian Partnership Act 1932 "A Partner can be admitted only consent of all the Existing Partners." Adjustments required when a New Partner is Admitted a. Calculation of New Profit Sharing Ratio / Sacrificing Ratio. b. Valuation and Treatment of Goodwill. c. Revaluation of Assets and Liabilities. d. Adjustment of accumulated Profits, Reserve and Losses. e. Necessary Adjustment of Capital Accounts of Partners. Change in Profit Sharing Ratio A New Partner Acquires his share from the Old Partner in any of the following Manners; (i) In their old Profit Selling Ratio (ii) In a Particular Ratio or Surrendered Ratio (iii) In a particular fraction from some of the partner Accounting Treatment of Goodwill 1. When Goodwill (Premium) is paid by No Entry the New Partner Privately 2. When Goodwill brought in Cash by the (i) Cash/Bank A/c...Dr. New Partner To Premium for Goodwill A/c (ii) Premium for Goodwill A/c... Dr. To Sacrificing Partners' Capital A/c (In Sacrificing Ratio) To Sacrificing Partners' Current A/c s (When Capital is Fixed) 3. Goodwill Withdrawn by the Sacrificing Partners' Capital A/c s...dr. Sacrificing (Old) Partners To Cash/Bank A/c 4. Goodwill not brought in Cash New Partner's Capital or Current A/c... Dr. To Sacrificing Partners' Capital or current A/c [Sacrificing Ratio] 5. Goodwill brought in Kind Assets A/c...Dr. To Premium for Goodwill A/c 195

2 Hidden or inferred goodwill Sometimes the value of goodwill is not given at the time of admission of a new partner. In such a situation, goodwill is calculated on the basis of net worth of the business. Hidden goodwill is the excess of desired total capital of the firm over the actual combined capital of all partners. For Example Capital of L and M are ` 2,00,000 and ` 1,50,000 respectively. They admit N as a Partner for 1/5 share with ` 1,00,000 as his Capital. On the basis of N s Capital, total Capital of the Firm should be ` 5,00,000 (1,00,000 5/1). But the actual Capital of the Firm is ` 4,50,000 (2,00,000 +1,50,000 +1,00,000). Hence, Hidden Goodwill: = ` 5,00,000 - ` 4,50,000 = ` 50,000 Revaluation of Assets and Reassessment of Liabilities Accounting Entries (i) For increase in the value of Assets Assets A/c (Individually)... Dr. To Revaluation (or P & L Adjustment) A/C (ii) For a decrease in the value of Assets Revaluation A/c...Dr. To Assets A/c (Individually) (iii) For an increase in the amount of Liabilities Revaluation A/c...Dr. To Liabilities A/c (Individually) (iv) For a decrease in the amount of Liabilities Liability A/c (Individually)...Dr. To Revaluation A/c (v) For an accounting unrecorded Assets Assets A/c (Individually)...Dr. To Revaluation A/c (vi) For accounting unrecorded Liabilities Revaluation A/c...Dr. To Liability A/c (Individually) Revaluation Account Particulars ` Particulars ` To Decrease in value of assets... To increase in value of liabilities... By Increase in value of assets... By Decrease in value of liabilities... To Unrecorded liabilities... By Unrecorded assets... To Profit transfer to the old Partner's... By Loss transfer to the old Partner's... Capital A/c s (in the old ratio)... Capital A/c s (in the old ratio)

3 RESERVES AND ACCUMULATED (UNDISTRIBUTED) PROFITS /LOSSES Accounting Entries (i) For transfer of Reserves and Accumulated Profits: Profit and Loss...Dr. Reserve Fund A/c or General Reserve...Dr. Workmen Compensation Reserve...Dr. [Excess of Reserve over Actual Liabilities] Investment Fluctuation Reserve A/c...Dr. [Excess of Reserve over the difference between Book Value and market Value] To Old Partners' Capital A/c s [In old Ratio] (Being the reserve and profit transferred to old partners in their old ratio) (ii) For transfer of Reserves and Accumulated Losses: Old Partners' Capital A/c s... Dr. To Profit and Loss A/c [In old Ratio] To Deferred Revenue Expenditure A/c (Like Advertisement Expenditure) (Being the accumulated losses transferred to old partners in their old ratio Adjustment of Partners' Capital Case 1. Calculation of New Partner's Capital on the basis of Old Partners Step 1. Calculate the adjustment closing capitals of old Partners (after all adjustments have been made) Step 2. Calculate the total closing Capital of New Firm as under: Total capital of New Firm = Combined adjusted Closing Capitals of Old Partners X Reciprocal of remaining share of profit of old partners. Step 3. Calculate the proportionate Capital of New Partner as under: New Partner's Capital =Total capital of new firm x New partner's proportion of share of profit. Case 2. Adjustment of Old Partners Capital on the basis of New Partner's Capital Step 1. Calculate total capital of new firm on the basis of new partner's capital i.e. new partner's capital X Reciprocal of proportion of share profit of new partner. 197

4 Step 2. Calculate the new capital of old partners by dividing the total capital in their new profit sharing ratio. Step 3. Calculate the adjusted closing capitals of old partners (i.e. after all adjustments have been made) Step 4. Calculate the surplus /deficiency in each of the old partner's capital account by comparing the new capital with their adjusted old capital which is adjusted through cash or transferred to their Current A/c Adjustment of Surplus/Deficiency through Cash: (a) If Capital of Old Partners falls short (Deficit), bring in cash: Cash/Bank A/c...Dr. To Partners' Capital A/c s (b) If capital of old partner has a surplus, withdraw cash: Partners' Capital A/cs...Dr. To Cash/Bank A/c Adjustment of Surplus/Deficiency through Partner's Current Account: (a) If the existing capital is more than his required capital (surplus) Partner's Capital A/c...Dr. To Partner's Current A/c (b) If the existing capital is less than his required capital (deficit) Partner's Current A/c...Dr. To Partner's Capital A/c If Current Account shows a Credit Balance, it is taken to the Liabilities side of the Balance Sheet. However, if Current Account shows a Debit Balance, it is placed on the Assets side of the Balance Sheet. Retirement and Death of a Partner Meaning Retirement of a Partner means living the firm by a partner. A Partner may retire from the firm in the following conditions- I. If there is an agreement about the retirement. II. If all the partners consent to his retirement. III. If the partnership is at will, by giving a notice in writing to all the other partners in advance. 198

5 Adjustment for Retirement of a Partner (a) Finding out the New Profit-Sharing Ratio and Gain Ratio. (b) Treatment of Goodwill. (c) Revaluation of Assets and Reassessment of Liabilities. (d) Treatment related to Unrecorded Assets and Liabilities. (e) Adjustments in respect to Accumulated Profits and Losses. (f) Ascertain of Share of Profits or Losses up to the date of Retirement/Death. (g) Adjustment of Capital if required. (h) Settlement of Capital, if required. (i) Change in Profit- Sharing Ratio New Profit-Sharing Ratio The New Profit-sharing Ratio on Retirement of a Partner is the Ratio in which the continuing or remaining Partners decide to share the future Profits and Losses. New Share of a Partner = Old Share + Acquired Share Case 1. When one Partner Retires and the New Profit -Sharing Ratio among the Remaining Partners is not given. Case 2. When Remaining Partners Purchase the Share of the Retiring Partner in a Specific Ratio. Gaining Ratio Ratio in which the Continue Partner acquires the Retiring of Deceased Partners' Share. Calculation of Gaining Ratio under different situations is given below: (i) When No Agreement Exists In this case gain to the continuing partners is in the old profit-sharing ratio. (ii) When the New Profit-sharing Ratio is given In this case, the gaining ratio is calculated by deducting the old ratio from the new ratio. Gaining Ratio=New Ratio - Old Ratio Accounting Treatment of Goodwill When a Partner Retires (or Dies) his Share of Profit is acquired by the Remaining Partners. The following Entry is recorded for this purpose: Remaining Partner's A/cs...Dr. [Gaming Ratio] To Retiring Partners' Capital [Retiring Partner's Share of Goodwill] All Partners' Capital/Current A/cs...Dr. [Old Ratio] 199

6 To Goodwill (or Premium) A/c Revaluation of Assets and Reassessment of Liabilities (Same as admission) Adjustment for Reserves and Undistributed profits/losses For Distribution of Accumulated Profits: General Reserve A/c...Dr. Reserve Fund A/c...Dr. Profit and Loss A/c...Dr. To All Partners' Capital A/c s For Distribution of Accumulated Losses; All Partners' Capital A/c...Dr. To Profit and Loss A/c Accounting treatment of joint life policy; Case 1. When there is no Joint Life Policy is present in the Balance Sheet but Joint Life Policy will paper in the Balance Sheet after Retirement. Joint Life Policy A/c...Dr. (Surrender Value of J.L.P.) To All Partners'Capital A/cs (Old Ratio) Case 2. When there is no Joint Life Policy in the present Balance Sheet and Joint Life Policy will not be shown in the Balance Sheet after Retirement. In this situation adjustment is carried out through Partners' Capital Accounts by passing the following entry: Continuing Partners' Capital A/cs...Dr. (Gaining Ratio) To Retiring Partner's Capital A/c (Share of Surrender Value) Case 3. When there is Joint Life Policy in the Balance Sheet: In this case, Joint Life Policy is treated as an asset. Any Revaluation of Joint Life Policy is carried out through Revaluation Account. Calculation of amount due to the Retiring Partner (i) Capital on the date of the last Balance Sheet. (ii) Interest or salary, if any, payable to him. (iii) Share of profit or losses till the date of retirement. (i) If the amount is paid in Cash or by Cheque; (iv) Share in the profits or losses on revaluation of assets and reassessment of liabilities. (v) Share in the goodwill of the firm. (vi) Share in the general reserve or profits and losses account appearing in the Balance Sheet. 200

7 Settlement of the Account Due to the Retiring Partner Retiring Partner's Capital A/c...Dr. To Cash/BankA/c (ii) If the amount is not paid in cash; Retiring Partner's Capital A/c...Dr. To Retiring Partner's Loan A/c Construction of Retiring Partner's Loan Account (i) For Interest due; Interest on Loan A/c...Dr. To Retiring Partner's Loan A/c (ii) For payment of Instalment with Interest: Retiring Partner's Loan A/c...Dr. To Cash /Bank A/c Adjustment of partners capital in new profit sharing ratio Adjustment of Partner's Capital in New Profit Sharing Ratio (i) If Capital of Remaining Partner falls short, bring in Cash: Cash/BankA/c...Dr. To Remaining Partner's Capital A/c (ii) If capital of remaining partner has a surplus, withdraw Cash: Remaining Partner's Capital A/c...Dr. To Cash/Bank A/c (iii) If the deficit in their capital account is adjusted by transferring to their current accounts: Remaining Partner's Current A/c...Dr. To Remaining Partner's Capital A/c (iv) If the surplus in their capital accounts is adjusted by transferring to their Current Capital Account Remaining Partner's Capital A/c...Dr. To Remaining Partner's Current A/c Note: If no information is given then any surplus or deficiency should be adjusted in cash and not by transferring it to partner's current account. 201

8 Death of a Partner The Accounting Procedures on the Death of a Partner are very similar to the Retirement of a Partner. From Accounting Point of view the following point are Important; (i) Calculation of New Ratio and Gaining Ratio. (ii) Treatment of Goodwill. (iii) Revaluation of Assets and Reassessment of Liabilities. (iv) Distribution of Accumulated Profits and Losses. (v) Treatment of Joint Life Policy: Insurance amount is distributed among all partners including deceased partner in their old ratio. (vi) Interest on capital, share of profit to the deceased partner till the date of death, drawings, interest on drawings, is credited or debited to the deceased partner's account. (vii) Preparation of deceased partner's capital account and its settlement Having given effect to the above 6 points, the balance in the Deceased Partner's Capital Account is transferred to his Executor's Account and may be paid in cash or transferred to his Loan Account. Note: The Executors of the Deceased Partner are entitled to the following: (a) Balance of Capital and Current Account of the Deceased Partner. (b) Share of Accumulated Profit/Loss. (c) Share of Revaluation Profit/Loss. (d) Share of Goodwill of the Firm. (e) Share of Profit from the date of last Balance Sheet to the date of Death, (f) Share of Joint Life Policy taken by the Firm. Date of death is important/actor while calculating the balance of deceased Partner. Date is considered Date is not considered (i) To calculate Share of Profit (i) To calculate Share of Goodwill (ii) To calculate Interest on Capital (ii) To calculate Share of General Reserves (iii) To calculate Interest on Drawings (iii) To calculate Share of Joint Life Policy (iv) To calculate Interest on Deceased (iv) To calculate Share of Profit and Loss A/c Partner s loan A/c (given in Balance Sheet) 202

9 Dissolution of Firm Meaning According to section 39 of Indian Partnership Act 1932, "Dissolution of a firm means the dissolution of partnership among all the partners of the firm along the closing the firm's business". In case of dissolution of a firm the assets are realized and the liabilities are paid. Mode of Dissolution of a Firm (1) Dissolution by Mutual Agreement among the Partners. (2) Compulsory Dissolution (a) If all the Partners or all Except One Partner become Insolvent. (b) If Business of the Firm become Unlawful. (3) Dissolution on the Happening of the Certain Contingencies. (a) On the Expiry of the Term for which the Firm was Formed. (b) On the completion of venture (s) for which the firm was formed. (c) On the death of a partner; and (d) On the adjudication of a partner as an insolvent. (4) Dissolution by Notice in Case of Partnership at Will. A Court may pass order for the Dissolution of the Firm on the following Grounds when; (i) A Partner becomes a Person of Unsound Mind. (ii) A Partner is Permanently Incapacitated. (iii) A Partner is Found Guilty of Misconduct. (iv) Partnership Agreement is Breached Persistently by Some Partner. (v) The Court Finds the Dissolution of the Firm Justified. Settlement of accounts Section-48 of the Indian Partnership Act 1932, deals with the Settlement of Account at a time of Dissolution of Firm. (i) Treatment of Losses; Losses are to be paid first out of Profit, then out of Capital, and lastly if necessary by the Partners Individually in the Proposition of their Profit- Sharing Ratio. (ii) Application of Assets; The amount realized from the Assets of the Firm including any sum of money contributed by the Partners to makeup Deficiencies of Capital shall be applied in the following manner. 203

10 (a) (b) (c) (d) First to Pay Firm's Debt to the Third Parties, i.e. Outside Parties, Then to Pay Loan from Partners, Then to pay Capital of Partners. Lastly the Surplus (if any) shall be Distributed among the Partners in their Profit-sharing Ratio. Payment of Firm s Debts and private Debts; Section-49 of IPA1932 deals the following is applied in Case of Firm's Debt and Private Debt. (i) Firm's Property is applied first in payment of Firm's Debts and if there is any surplus, then the share of each Partner is applied in the payment of his Private Debts or paid to him. (ii) Partner's Private Property is applied first in payment of his Private Debts and the Surplus (if any), in payment of Firm's Debts if the Firm's Liabilities exceed the Firm's Assets. Accounting Treatment of Dissolution of a Partnership Firm The following necessary Accounts are prepared at the time of Dissolution of a Firm; (1) Realisation Account: It is a Nominal Account which is prepared at a time of Dissolution to determine the Profit or Loss on Realisation of Assets and payment of Liabilities. The following necessary Steps are adopted for Accounting Treatment of Realisation Account; Step 1. Entry for transfer of all accounts except Partner's Loan A/c, Partners' Capital A/c s, Undistributed Profit or Losses and Cash/Bank A/c given in the balance sheet: (a) For Transfer of Assets to Realisation A/c; Realisation A/c...Dr. (at its Book value) To Various Assets A/c (Individually by name) (b) For Transfer of Outside Liabilities to Realisation A/c; Various Liabilities A/c (Individually by name)...dr. (at its Book value) To Realisation A/c Step 2. Entry for collection of sale proceeds from assets (a) For Cash Sales of Assets; Cash/Bank A/c...Dr. To Realisation A/c 204

11 (b) For Assets taken over by a Partner; Partner's Capital A/c...Dr. To Realisation A/c (c) When the Assets are given away to any of the Creditors towards the Full / Partial Payment of his Dues, there may be Three Situations; (i) When a creditor accepts an asset as full and final settlement, no journal entry is required. (ii) When a creditor accepts his payment by taking over an assets and part of his payment in cash, the following entry will be made for cash payment only; Realisation A/c...Dr. To Cash/Bank A/c (iii) When a creditor accepts an asset where value is more than the amount due to him, he will pay cash. Entry will be as follows; Cash/BankA/c...Dr. To Realisation A/c Step 3. Entry for payment of Dissolution/Realisation expenses (a) For cash payment of expenses: Realisation A/c...Dr. To Cash/Bank A/c Note: Realised against assets can be more than, less than or equal to Book value of the asset. (b) For payment of expenses made by a partner or fixed amount for expenses is credited to partner's capital account: Realisation A/c...Dr. To Partner's Capital A/c (c) If any partner is to bear all expenses ofrealisation himself no journal entry is required. (d) If the realisation expenses are paid by the firm on the behalf of bearing partner: Partner's Capital A/c...Dr, To Cash/Bank A/c (e) When Realisation Expenses are borne by one Partner and paid by another Partner: Bearing Partner's Capital A/c...Dr. To Paying Partner's Capital A/c Step 4: Entry for payment of outside liabilities (a) For Cash Payment of Liabilities : Realisation A/c...Dr. To Cash/Bank A/c 205

12 (b) For Liabilities Taken Over by a Partner: RealisationA/c...Dr. To Partner's Capital A/c Step 5: Entry for Closing of Realisation Account (a) Realisation Account Shows Profit: (When the Credit Side is Bigger) Realisation A/c...Dr. (amount of profit) To Partner's Capital A/c s (share of partners'profit) (b) Realisation Account shows Loss;(When the Debit side is Bigger) Partners1 Capital A/c...Dr. (share of partners'loss) To Realisation A/c (amount of loss) Note: In the Case of Dissolution. Goodwill is like other Assets.So Same Treatment will be given as given to other assets. Realisation Account Dr. Cr. Particulars Rs. Particulars Rs. To Various Assets A/c s except Cash Bank,... By Various Liabilities A/c s except Dr. balance of Partner's Capital /Current A/c s,undistributed profit, Partner's Capital/ Loan to Partner and Fictitious Assets... Current A/c s, Loan from Partner... To Cash/Bank A/c (Payment of dissolution By Provision for any Assets, e.g., provision... expenses)... for doubtful debts, Joint Life Policy fund etc. To Cash /Bank A/c(Payment of outside and By Cash/Bank A/c (Receipt on realization... unrecorded liabilities)... of assets and unrecorded assets.) To Partner's Capital A/c (Liability taken over By Partner's Capital A/c (Assets taken... by a partner or any expenses paid by him over by a partner) or remuneration payable to him)... To Profit transferred to Partner's Capital A/c... By Loss transferred to Partner's Capital A/c... (2) Partners Loan Account If partner has given any loan to the firm it will be shown credit side of partners loan account. Partner's loan A/c...Dr. To Cash/Bank A/c (Being partner's loan paid off) 206

13 (3) Partners Capital Account Balance of partners' capital accounts and current accounts are recorded in this account. If partners have taken over firm's assets, these are recorded in the debit side of their capital accounts or if they pay liabilities of the firm, these are credited in their capital accounts. (a) On Transfer of Undistributed Profits and Reserves Profit and Loss A/c...Dr. Reserve Fund A/c To Partners' Capital A/c (b) In case of accumulated losses Partners'Capital A/c s...dr. To profit and Loss A/c Final Settlement with Partners (a) On Bringing Cash by Partners for Deficiency in Capital Cash/Bank...Dr. To Partners' Capital A/c s (b) On Payment to Partners or Closing the Partners' Capital Accounts Partners' Capital A/c s...dr. To Cash/Bank A/c (4) Cash and Bank account This is an account which show the cash balance at a time of Dissolution of the Firm. The opening balance of cash or bank will be shown on debit side of cash/ bank account. All the receipts from sale of the assets and amount brought in by partners are shown on debit side while all the payment of liabilities expenses and amount paid to partners' are shown on credit side. (i) Partner s Loan account; Partner's Loan A/c...Dr. To Cash/Bank A/c (Being partner's loan paid off) (ii) Partners' capital accounts; (a) If Capital Account shows Debit Balance: Cash/BankA/c...Dr. To Partner's Capital A/c (Being deficit amount of Capital brought in Cash) 207

14 (b) If Capital Account shows Credit Balance: Partner's Capital A/c To Cash /Bank A/c (Being final payment made to a partner) (iii) Cash or bank account: (a) For cash deposited into bank; Bank A/c To Cash A/c (b) For cash withdrawn from bank: Cash A/c To Bank A/c...Dr....Dr....Dr. Accounting Treatment of Provision and Undistributed Profit and Loss (i)transfer of Provision to Realistion Account: (a) Provision which has a credit balance will be transferred to the credit side of realisation account and the following entry will be passed: Provision for Depreciation A/c Dr Provision for Bad Debts A/c Dr. Provision for Discount on Debtors A/c Dr. Investment Fluctuation Fund A/c Dr. Joint Life Policy Fund A/c Dr. To Realisation A/c (b) Provision which has a debit balance will be transferred to the debit side of Realization account and the following entry will be passed: RealisationA/c Dr. To Provision for Discount on Creditors A/c (For provision against liabilities transferred to realisation account) (ii) Transfer of Undistributed Profit/ Losses to Partner's Capital Accounts: (a) Undistributed Profits such as General Reserve, Reserve Fund, Credit balance of Profit & Loss Account etc. are not to be transferred to Realisation Account. These accounts are transferred to partners capital or current accounts in their profit sharing ratio. The entry will be passed as follows: 208

15 General Reserve A/c Dr. Reserve Fund A/c Dr. Profit & Loss A/c Dr. Workmens' Compensation Fund Dr. To Partners Capital/Current A/c s (Being transfer of undistributed profits to partners1 accounts in their profit sharing ratio) (b) Similarly if Undistributed Losses or Fictitious Assets, i.e. Debit balance of Profit & Loss A/c, Advertisement Expenses A/c etc. are given in the Assets side of Balance Sheet, the following entry will be passed; Partners Capital /Current A/cs Dr. To Profit & Loss A/c To Advertisement Expenses A/c (Being transfer of undistributed loss to partners1 accounts in their profit sharing ratio) Accounting Treatment for Unrecorded Assets and Unrecorded Liabilities (i) Unrecorded Assets: (a) If cash is realised from Unrecorded Assets: Cash/BankA/c Dr. To Realisation A/c (b) If Unrecorded Assets are taken over by a Partner: Partner's Capital A/c Dr. To Realisation A/c Unrecorded liabilities: (a) If cash payment is made for unrecorded liabilities: Realisation A/c Dr. To Cash/Bank A/c (b) If unrecorded liability is taken over by a partner: RealisationA/c Dr. To Partner's Capital A/c Note: Both Unrecorded Assets and Unrecorded Liabilities are not transferred to Realisation Account because they have no Account in the Books. Accounting Treatment of Goodwill In the case of Dissolution of a Firm, Goodwill should be treated just like other Assets and is transferred to the Realisation account. If any amount is realised for Goodwill, Cash /Bank Account is debited and the Realisation account is credited. If Goodwill is purchased by one of the Partners, the concerned Partner's Capital Account is debited and Realization Account is credited. 209

16 Memorandum Balance Sheet This is preparing to ascertain Sundry Assets, when the Partner's' Capitals and other Liabilities are given but not the total of Sundry Assets. However, the value realised from the Assets is given. In such a case, Sundry Assets have to be ascertained. It is calculated by preparing the old Balance Sheet. The amounts of Capitals and other Liabilities are added. The same sum total is the total amount of Assets. Such a Balance Sheet is also called Memorandum Balance Sheet. UNIT 3 Accounting for Share Capital Share Capital of a Company The total Capital of the Company is divided into small units, each unit is called a Share. For Example; The total Share Capital of a Company is ` 10,00,000 is divided into 1,00,000 Units of ` 10 each then Each Unit of ` 10 is called a Share of ` 10 each. SHARE CAPITAL Meaning It is the amount that a Company can raise or has raised by Issue of Shares. Types of Share Capital (i) Authorized Capital -This is the maximum Capital for which a Company authorized to issue during its life time. It is mentioned in the Memorandum of Association. (ii) Issued Capital- It is that part of Authorized Capital which is offered for Subscription. (iii) Subscribed Capital- It is a part of Issued Capital which is Subscribed for by the Public. (iv) Called up capital - It is that part of Subscribed Capital which is called up by the Company. (v) Paid-up-Capital - It is that part of Called-up-Capital that the members of the Company have paid. (vi) Unpaid Calls or Calls-in-arrears - It is the amount which has been called for by the Company but has not been paid up by the Shareholders. (vii) Reserve capital (Section 99 of 1C A 1956) - It is the Capital which has not been called up by Company and the Company has decided not to call unless, until Company wound up. Issue of shares A Company collects its Capital by Issue of Shares. A Public Company can issue shares to the public but a private company can not issue its shares to public. A company can issue its share in two following ways; 210

17 (i) Issue of Shares for cash, and (ii) Issue of Shares for consideration other than Cash. (1) Issue of Shares for Cash Share of a Company may be issued in any of the following three ways; (i) Issue of Shares at Par: If the shares are issued for an amount equal to the face value of share, they are said to be issued at par i.e. face value of a share is ` 10 and issue price is also ` 10. Accounting treatment For Share Application money received: Bank A/c...Dr. To Share Application A/c For Allotment of Shares: Share Application A/c...Dr. To Share Capital A/c For Share Allotment money due: Share Allotment A/c...Dr. To Share Capital A/c For Share allotment money received: Bank A/c...Dr. To Share Allotment A/c For Call money due: Share (First/Final) Call A/c...Dr. To Share Capital A/c For Call money received: Bank A/c...Dr. To Share (First/Final) Call A/c (ii) Issue of shares at Premium (Section 78) When the shares are issued more than the face value, e.g. A ` 100 share may be issued at ` 105, it is said to have at premium of ` 5. Accounting Treatment (i) When amount of premium is payable with the application money: Bank A/c... Dr. [With the total application money including premium money] To Share Application A/c (ii) When the share are allotted: Share Application A/c....Dr. [With the total application money including premium] 211

18 To Share Capital A/c [With the application money Payable towards share capital] To Securities Premium A/c [With the amount of premium paid with application] (iii) Shares Issued at Discount (Section 79) When the shares are issued at a price less than its face value, e.g. A ` 10 share is issued for ` 9 then it is called issued at a 10% discount Accounting Treatment Share Allotment A/c...Dr. [With the amount due] Discount on issue of Shares A/c... Dr. [With the amount of discount] To Share Capital A/c Note: The share, whether issued at par or at a premium, or at a discount may be payable either in installments or in full on application. Accounting Entries for Issue of Shares Payable in Lump Sum: When Share are issued at par payable in one installment, are said to have been issued in lump sum. (i) BankA/c...Dr. To Share Application & Allotment A/c (Being Application & Allotment money received) (ii) Share Application & Allotment A/c...Dr. To Share Capital A/c (Being the share allotted and money transferred Share Capital A/c) Over Subscription of Shares Oversubscription means, the number of share applied is more than the number of share offered for subscription. However the company can not allot shares more than those offered for subscription. There three alternatives are followed by company; (i) Rejection of Excess Applications: In this alternative some applications are accepted in full and excess applications are rejected and their application money is refunded. For example 10,000 shares were issued while application money received for 15,000 shares, the excess 5,000 are not accepted and their application money is refunded. (ii) Partial or Pro-Rata Allotment: In this case applicants are allotted in fixed proportion. 212

19 For Example; 10,000 shares were issued while application money received for Shares; the applicants are allotted in the ratio of 10:15 or2:3. (iii) Third Alter natives: This alternatives is the combination of the above two alternatives. In this case same applications may be accepted in full and some applications may be rejected and the remaining are allotted in proportion. Under Subscriptions of Shares Under subscription means the number of shares subscribed are less than the number of shares offered for subscription. For example number of shares offered for subscription is 10,000 while number of shares applied is Calls-in-Arrears Calls-in-Arrear is that part of called-up-money which has not been paid by the shareholders till the last date fixed for the payment. Accounting Treatment: There are two alternative methods of dealing with the accounting of calls-in-arrears; (i) Without opening Call-in-Arrears Account: It is not necessary to maintain a separate account for calls-in-arrears. For example; if share first call money at ` 2 per share on 2,000 shares is called but out of this, share first call money on 1,900 shares is received. In such a case, the following entries will be made as under: (a) For share first call money due: Share First call A/c...Dr. 4,000 To Share Capital A/c 4,000 (b) For share first call money received: Bank A/c...Dr. 3,800 To Share First Call A/c 3,800 (ii) By opening Calls-in-Arrears account: In some case, a separate account for calls-in-arrears is opened. If the amount of allotment/call has not been paid by some shareholders; such amount is transferred to newly opened Callsin-Arrears Account. The above example will be represented as follows: (a) For Share First Call Money Due: Share First Call A/c...Dr. 4,000 To Share Capital A/c 4,

20 (b) For share first call money received: Bank A/c... Dr. 3,800 Calls-in-Arrears A/c... Dr. 200 To Share First Call A/c 4,000 Accounting Entries for Calls-in-Arrears The following accounting entries are passed with respect to calls-in-arrears: (i) On non-receipt of call till the day fixed: Calls-in-Arrears A/c... Dr. [With the amount not received] To Relevant Call A/c (ii) On receipt of calls-in-arrears at a subsequent date: BankA/c...Dr. [With the calls-in-arrears received] To Calls-in-Arrears A/c Interest on Calls-in-Arrears Account (iii) On making due the interest on calls-in-arrears: Sundry Members A/c...Dr. [With the amount of interest received] To Interest on Calls-in-Arrears A/c (iv) On receipt of interest on calls-in-arrears: Bank A/c... Dr. [With the amount of interest received] To Sundry Members A/c (v) On transfer of interest on calls-in-arrears A/c to profit and Loss A/c at the end of the accounting period: Interest on Calls-in-Arrears A/c... Dr. [With the amount of interest] To Profit and Loss A/c Calls-in-Advance Calls-in-Advance refer to the amount paid by shareholders in excess the amount due from them. The Journal entry passed to record this is: Bank A/c...Dr. [With the amount of calls money received in advance] To Calls-in-Advance A/c It is adjusted as and when the respective call is made due. The entry is: Calls-in-Advance A/c...Dr. To Particular Calls A/c 214

21 Interest on Calls-in-Advance (a) When interest is paid in Cash: Interest on Calls-in-Advance A/c... Dr. [With the amount of calls money received in advance] To Bank A/c (b) When interest is due: Interest on Calls-in- Advance A/c...Dr. [With the amount of interest payable] To Outstanding Interest A/c To Sundry Shareholders (members) A/c (c) On transferto ProfitandLossAccountat the endof'accountingperiod: Profit and Loss A/c... Dr. [With the total amount of interest paid on Calls-in-Advance] To Interest on Calls-in-Advance A/c Issue or Shares for Consideration other than Cash Sometimes Company purchases some assets from vendors, in exchange it can issue Fully Paid Shares. In such a case, the following journal entries are required for this purpose, (a) On Purchase of Assets; Sundry Assets A/c...Dr. To Vendor's A/c Shares can be issued to Vendors in any manner out of the following; (i)at par Vendor s A/c...Dr. To Share Capital A/c (ii) At Premium Vendor's A/c To Share Capital A/c To Securities Premium A/c...Dr. 215

22 (iii) At Discount Vendor sa/c...dr. Discount on Issue of Share A/c To Share Capital A/c (b) On Purchase of Business Sundry Assets A/c...Dr. [Agreed value of Assets] Goodwill A/c*...Dr. To Liabilities A/c [Agreed value of Liabilities] To Vendor* * [Agreed Price Payable to the Vendor] To Capital Reserve A/c*** *If purchase consideration is given and it is more than net assets, then difference shall be debits to Goodwill Account. ** Vendor is credited by Purchase Consideration payable to him. It may be given in the question; otherwise it will be equal to Net Assets, i.e. Sundry Assets minus Sundry Liabilities. ***If Purchase Consideration is given and it is less than Net Assets, then the difference shall be credited to Capital Reserve Account. NOTE: Number of shares to be issued=purchase Price /Issue price of Share Forfeiture of shares Forfeiture of Shares means the cancellation of allotment of shares due to non-payment of any call money by the Shareholder. Accounting Treatment (i) Forfeiture of shares which were origin ally issued at par; Share Capital A/c...Dr. (total amount called up) To Share Forfeiture A/c (amount already received) To Various Unpaid call A/c (amount due but not received) (ii) Forfeiture of shares which were originally issued at premium; (a) If premium has been paid by the shareholders Share Capital A/c...Dr. (Amount called up premium) To Share Allotment A/c (amount not received on allotment) To Share Call/Calls A/c (amount not received on calls) To Share Forfeiture A/c (amount received so far) 216

23 (b) If premium has not been paid by the shareholders: Share Capital A/c....Dr. (amount called up so far less premium) Securities premium A/c...Dr. (premium amount called up) To Share Allotment A/c (amount not received on allotment) To Share Call/Calls A/c (amount not received on calls) To Share Forfeiture A/c (amount received so far) (iii) Forfeiture of shares which were issued at a discount: Share Capital A/c...Dr. (amount called up so far plus discount) To Discount on Issue of Shares A/c (amount of share discount) To Share Allotment A/c (amount not received on allotment) To Share Call/Calls A/c (amount not received on calls) To Share Forfeiture A/c (amount received so far) Reissue of Forfeited Shares Forfeited shares become the property of the company and the directors have the authority to reissue them at par, at premium or at a discount. Journal Entries on Re-issue of Forfeited Shares (i) If the forfeited shares are re-issued at Par: Bank A/c...Dr. To Share Capital A/c (Being forfeited shares re-issued at par) (ii) If the forfeited shares are re-issued at premium: Bank A/c...Dr. To Share Capital A/c To Securities Premium A/c (Being forfeited shares re-issued at premium) (iii) If the forfeited shares are re-issue at discount: Bank A/c...Dr. Share Forfeiture A/c...Dr. To Share Capital A/c (Being forfeited shares re-issued at discount) Transfer of balance in the Forfeited share Account After re-issue of forfeited shares, the credit balance left in the share forfeiture account is a capital profit and therefore it is transferred to Capital Reserve A/c. 217

24 Share Forfeiture A/c...Dr. To Capital Reserve A/c (Being share forfeiture account transferred to capital reserve account). When share belonging to pro-rata category are forfeited: If the forfeited shares belonging to pro rata category are, then we faces the problem of determining the amount in arrears on allotment. For correct solution, the following steps should be taken: 1. Calculate total share applied by the shareholder whose shares are being forfeited; (Total shares applied/total shares allotted) X share allotted by the company to shareholder 2. Multiply the number of shares as calculated in (1) with the amount of application money. This gives total money sent by the shareholder with the applications. This amount is forfeited on default and credited to share forfeited account. 3. Deduct from the application money received, the amount due on application with the help of shares allotted. The result is the excess application money is available for adjustment towards allotment. 4. Calculate the amount due on allotment and deduct from it the amount sent in advance with applications. The result is the amount in arrears on allotment. This amount is credited to share allotment account at the time of making entry for forfeiture. Calculation of capital reserve when all forfeited share were not reissued = (No. of reissued share / No. of forfeited share X profit on forfeiture)-loss on forfeiture) UNIT 4 Accounting for Debentures Meaning According to section 2(12) of the Indian companies Act 1956 "Debenture includes debenture stock, bonds and other securities of the company whether constituting a charge on the company assets or not." Issue of Debenture A company can issue its Debenture in two following ways; (1) Issue of Debenture for cash, and (2) Issue of Debenture for consideration other than cash. (1) Issue of Debenture for cash Debenture of a company may be issued in any of the following three ways; (a) Issue of Debenture at par: If the Debentures are issued for an amount equal to its face value, they are said to be issued at par e.g. if a debenture of Rs. 100 is issued for Rs. 100, it will be known as issued at par. 218

25 Accounting treatment (i) For Debenture Application money received Bank A/c To Debenture Application A/c (ii) For Debenture Application Money adjusted: Debenture Application A/c To Debenture A/c (iii) For Debenture Allotment money due: Debenture Allotment A/c To Debenture A/c (iv) For Debenture allotment money received:...dr....dr....dr. Bank A/c...Dr. To Debenture Allotment A/c (V) For Call money due: Debenture Call A/c...Dr. To Debenture A/c (vi) For Call money received: Bank A/c...Dr. To Debenture Call A/c (b) Issue of Debenture at premium When the Debentures are issued more than the face value, e.g. A Rs. 100 Debenture may be issued atrs. 105, it is said to have at premium of Rs.5. Accounting Treatment (i) When amount of premium is pay able with the application money. Bank A/c... Dr. [With total application money including premium] To Debenture Application A/c (ii) When the Debentures are allotted, Debenture Application A/c...Dr. [with the total application money including premium] To Debenture A/c [With the application money Payable towards share capital] To Securities Premium A/c [With the amount of premium paid with application] 219

26 (c) Debenture Issued at Discount When the Debentures are issued at a price less than its face value, e. g. A ` 10 share is issued for ` 9 then it is called issued at a 10% discount. Debenture Allotment A/c...Dr. [With the amount due] Discount on issue of Debenture A/c... Dr. [With the amount of discount] To Debenture A/c NOTE: The Debenture, whether issued at par or at a premium, or at a discount, may be payable either in installments or in fall on application. Issue or Debentures for consideration other than cash Sometimes company purchases some assets from vendors, in exchange it can issue fully paid debentures. In such a case, the following journal entries are required for this purpose. (a) On purchase of assets: Sundry Assets A/c...Dr. To Vendor's A/c Debentures can be issued to vendors in any manner out of the following; (i) At par Vendor's A/c...Dr. To Debenture A/c (ii) At premium Vendor's A/c...Dr. To Debenture A/c To Securities Premium A/c (iii) At discount Vendor's A/c...Dr. Discount on Issue of Debenture A/c To Debenture A/c (b) On Purchase of Business Sundry Assets A/c...Dr. [Agreed value of assets] Goodwill A/c*...Dr. 220

27 To Liabilities A/c [Agreed value of liabilities] To Vendor** [Agreed price payable to the vendor] To Capital Reserve A/c*** * If purchase consideration is given and it is more than net assets, then difference shall be debits to Goodwill Account. ** Vendor is credited by purchase consideration payable to him. It may be given in the question; otherwise it will be equal to net assets, i.e. sundry assets minus sundry liabilities. *** If purchase consideration is given and it is less than net assets, then the difference shall be credited to Capital Reserve account. NOTE: Number of Debentures to be issued=amount Due to Vendor / Issue Price of Debenture Issue of Debenture as Collateral Security It means issue of debentures as an additional security. Issue of debentures as a collateral security may or may not be recorded in the books of account If it is recorded in the books of account, the entry passed is: Debenture Suspense A/c...Dr. To Debentures A/c Various Cases from the point of view of Redemption (i) When debentures are issued at par and are redeemable at par, i.e. redeemable value is equal to the face value: (a) Bank A/c...Dr. To Debenture Application A/c (b) Debenture Application A/c V...Dr; To Debenture A/c (ii) When debentures are issued at a discount but are redeemable at par: (a)bank A/c...Dr. To Debenture Application A/c (b) Debenture Application A/c Discount on issue of Debentures A/c...Dr. To Debenture A/c (iii) When debentures are issued at a premium but are redeemable at par: (a)bank A/c...Dr. To Debenture Application A/c 221

28 (b) Debenture Application A/c... Dr. To Debenture A/c To Securities Premium A/c (iv) When Debentures are issued at par but are redeemable at a premium, i.e. in excess of the nominal value. (a) Bank A/c...Dr. To Debenture Application A/c (b) Debenture Application A/c...Dr. Loss on Issue of Debentures A/c...Dr. To Debentures A/c...Dr.[For providing premium on To Premium on Redemption of Debentures A/c redemption] (v) When Debentures are issued at a discount but are redeemable at a premium: (a)bank A/c...Dr. To Debenture Application A/c (b) Debenture Application A/c...Dr. Discount on Issue of Debentures A/c...Dr. Loss on Issue of Debenture A/c... Dr. To Debenture A/c To Premium on Redemption of Debentures A/c (vi) When Debentures are issued at a premium and are redeemable at a premium: (a) Bank A/c... Dr. [With the application money received] To Debenture Application A/c (b) Debenture Application A/c....Dr. [With the application money] Loss on Issue of Debentures A/c...Dr. [With premium on redemption] To Debentures A/c [With nominal value] To Securities Premium A/c [With premium on issue] 222

29 Redemption of Debentures Meaning Redemption of Debenture means the repayment of the amount of Debentures to Debenture olders. Methods of Redemption of Debentures (i) By lump sum payment after stipulated period (ii) In Installments by draw in lots; (iii) By Purchase of own Debentures in the Open Market; (iv) By Conversion into Shares or new Debentures; (v) At the Option of the Company Journal Entries on Redemption of Debenture For the amount of Debentures due; (a) When the debentures are redeemed at par: Debenture A/c...Dr. To Debenture holders A/c (b) When the Debentures are redeemed at a premium: Debentures A/c...Dr. Debenture Redemption Premium A/c...Dr. To Debenture holders A/c (c) When the Debentures are redeemed at a discount: Debentures A/c...Dr. To Debenture holders A/c To Gain/Profit on Redemption of Debenture A/c For payment made to debenture holders: Debenture holders A/c...Dr. To Bank A/c Sources of Funds (Finance) for the Redemption of Debentures: A company may adopt any of the following options for redeeming debentures,, (1) Redemption Out of Capital 223

30 (a) For the amount of Debentures due on Redemption: Debentures A/c...Dr. Debenture Redemption Premium A/c...Dr. (if premium is payable) To Debenture holders A/c (b) For payment made to Debenture holders: Debenture holders A/c...Dr. To Bank A/c (2) Redemption out of Profit: (i) On transfer of profit to Debenture Redemption Reserve: Profit & Loss Appropriation A/c...Dr. To Debenture Redemption Reserve A/c (ii) On Redemption of Debentures: (a) For the amount of Debentures due on Redemption: Debenture A/c...Dr. To Debenture holder s A/c (b) For payment made to Debenture holders: Debenture A/c...Dr. To Bank A/c (iii) When all the Debentures are Redeemed* the balance of Debenture Redemption Reserve is transferred to General Reserve. Debenture Redemption Reserve A/c...Dr. To General Reserve A/c (3) Redemption of Debentures by Conversion in Shares or New Debentures; (i) For amount due to Debenture holders: (a) Redemption at par: Debenture A/c...Dr. To Debenture holders A/c (b) Redemption at premium: Debentures A/c...Dr. Debenture Redemption Premium A/c...Dr. To Debenture holders A/c (ii) Discharging obligation by issuing shares or Debentures: 224

31 Debenture holders A/c To Equity Share Capital A/c or To % Debentures A/c (new)...dr. (IV) Interest on own Debentures: (i) For interest on Debentures due: Interest on debentures A/c...Dr. (with total interest) To Debentures A/c (interest payable to outsiders) To Interest on Own Deb. A/c (interest payable to company itself) (ii) For payment of interest to Debenture holders: Debenture holders A/c...Dr. To Bank A/c (iii) For transfer of interest on Debentures to Profit & Loss A/c: Profit & Loss A/c...Dr. To Interest on Debentures A/c (iv) For transfer of Interest on Own Debentures to Profit & Loss A/c: Interest on Own Debentures A/c...Dr. To Profit & Loss A/c UNIT -11 FINANCIAL STATEMENTS OF A COMPANY Meaning The Financial Statements are the end product of the Financial Accounting. The Financial Statements are the Summarized Statements of Accounting Data produced at the end of the Accounting Process by an enterprise to communicate the financial information in concise and capsule form about operating results and financial position of the business to the internal and external users. Financial Statements normally include: (i) Income Statement, i.e. Profit and Loss Account; and (ii) Position Statement, i.e. Balance Sheet. Balance Sheet A company s Balance Sheet is prepared in the prescribed form, as given in Schedule VI, Part I of the Companies Act, Revised Schedule VI is given in Text Books. 225

32 FINANCIAL STATEMENT ANALYSIS Meaning Analysis of Financial Statements is a systematic process of identifying process of identifying the financial strengths and weaknesses of the firm by establishing of the firm by establishing the relationship between the items of Financial Statements. Objectives of Analyzing Financial Statements (i) To Judge the financial stability of an enterprise. (ii) To Assess solvency of the firm. (iii) To Assess profitability of the firm. (iv) To Compare intra-firm position and inter-firm position. (v) To Assess the future prospects of the enterprise. Limitations of Analysis of Financial Statements (i) Different accounting policies. (ii) Does not reflect the Price-level changes. (iii) Lack of Qualitative aspect. (iv) Not free from bias. (v) Window - Dressing. (vi) Historical analysis. TOOLS FOR FINANCIAL STATEMENT ANALYSIS Comparative Financial Statements: It Contain information of two or more Financial Statements (item wise) in columnar form. They also provide for columns to indicate the change in item amounts in absolute terms as well as in percentage. Objective or Purposes of Comparative Financial Statements (i) To know the nature of changes influencing financial position. (ii) To know the weaknesses and soundness about liquidity, profitability and solvency of the enterprise. (iii) To forecast and plan. Inter-Firm Comparison - When Financial Statements of two or more firms are compared, it is known as an inter-firm comparison. Intra-Firm comparison - The comparison of Financial Statements of two or more years of the same firm is referred to as an intra-firm comparison, 226

33 Tools for Comparison (i) Comparative Balance Sheet: Comparative Balance Sheet analysis is that study of the trend of same items group of items and computed items in two or more balance sheets of the same business enterprise on different dates. (ii) Comparative Income Statement: A Comparative Income Statement shows the operating results for a number of accounting periods so that changes in data in terms of money and percentage from one period to another may be ascertained. (iii) Common-Size Statement: In Common-Size Statement, figures reported are converted into percentages of some common base. RATIO ANALYSIS An Accounting Ratio is a Mathematical Relationship between two items or groups of items in the Financial Statements. Ratio Analysis is an important technique of Financial Analysis. It is the process of computing, determining and presenting the relationship of items and groups of items in the Financial Statements. Objectives of Ratio Analysis (i) To judge the earning capacity, financial soundness and operating efficiency of an enterprise. (ii) To simplify the accounting information. (iii) To help in comparative analysis. Major Classification of Ratios (1) Liquidity Ratios: It measures the Short-term Solvency of the Firm. (2) Solvency Ratios: It measures Long-term Solvency of the Firm. (3) Activity Ratios: It measures Efficiency as to the Utilisation of Asset of the Firm. (4) Profitability Ratios: It measures the Profitability in relation to Sales and Investment of the Firm. (1) Liquidity Ratios (i) Current Ratio This ratio shows Short-term Financial Position of the Firm. Current Ratio = Current Assets /Current Liabilities It is expressed as a Number of Times. 227