Chapter 1 Conceptual framework for preparation and presentation of financial statements

The principal areas covered by the framework are as follows:(a) Components of financial statements

(b) Objectives of financial statements

(c) Assumptions underlying financial statements

(d) Qualitative characteristics of financial statements

(e) Elements of financial statements

(f) Criteria for recognition of elements in financial statements

(g) Principles of measurement of financial elements

(h) Concepts of Capital and Capital Maintenance

Components of Financial Statements

Balance Sheet portrays value of economic resources controlled by an enterprise.

Profit & Loss A/c presents the result of operations of an enterprise for an accounting period.

Cash Flow Statement shows the way an enterprise has generated cash and the way they have been used in an accounting period.

Notes and Schedules present supplementary information explaining different items of financial statements.

Qualitative Characteristics

1. Understandability : The financial statements should present information in a manner as to be readily understandable by the users with reasonable knowledge of business and economic activities.

2. Relevance: The financial statements should contain relevant information only.Information, which is likely to influence the economic decisions by the users, is said to be relevant. .

3. Reliability/Neutrality : To be useful, the information must be reliable; i.e. must be free from material error and bias. The information provided are not likely to be reliable unless:

(a) Transactions and events reported are faithfully represented.

(b) Transactions and events are reported in terms of their substance and economic reality not merely on the basis of their legal form. This principle is called the principle of 'substance over form'.

(c) The reporting of transactions and events are neutral, i.e. free from bias.

(d) Prudence is exercised in reporting uncertain outcome of transactions or events.

4. Comparability :The financial statements should permit both inter-firm and intra-firm comparison.

5. True and Fair view : Financial statements are required to show a true and fair view of the performance, financial position and cash flows of an enterprise.

Elements of Financial Statements

These five financial elements are Assets, Liabilities, Equity, Income/gains and Expenses/ losses.

An item of financial element, (asset, liability, equity, expense or income) is recognised infinancial statements if both the following criteria are met:

(a) It is probable that any future economic benefit associated with the item will flow to orfrom the enterprise. And

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(b) It has a cost or value that can be measured reliably.

Capital MaintenanceCapital refers to net assets of a business. Since a business uses its assets for its operations, a fall in net assets will usually mean a fall in its activity level. It is therefore important for any business to maintain its net assets in such a way, as to ensure continued operations at least at the same level year after year. In other words, dividends should not exceed profit after appropriate provisions for depreciation.

A business must ensure that Retained Profit (RP) is not negative, i.e. closing equity should not be less than capital to be maintained,

In order to check maintenance of capital, i.e. whether or not retained profit is negative, we can use any of the following three bases:

Financial capital maintenance at historical cost: Under this convention, opening and closing assets are stated at respective historical costs to ascertain opening and closing equity.

Financial capital maintenance at current purchasing power: Under this convention, opening and closing equity at historical costs are restated at closing prices using average price indices. .

Physical capital maintenance at current costs: Under this convention, the historical costs of opening and closing assets are restated at closing prices using specific price indices applicable to each asset.

Example (Financial capital maintenance at historical costs)

A trader commenced business on 01/01/2010 with Rs. 12,000 represented by 6,000 units of a certain product at Rs. 2 per unit. During the year 2010 he sold these units at Rs. 3 per unit and had withdrawn Rs. 6,000.

Thus:Opening Equity = Rs. 12,000 represented by 6,000 units at Rs. 2 per unit.

Closing Equity = Rs. 12,000 (Rs. 18,000 – Rs. 6,000) represented entirely by cash.

Retained Profit = Rs. 12,000 – Rs. 12,000 = Nil

The trader can start year 2011 by purchasing 6,000 units at Rs. 2 per unit once again for selling them at Rs. 3 per unit. The whole process can repeat endlessly if there is no change in purchase price of the product.

Example (Financial capital maintenance at current purchasing power)In the previous example, suppose that the average price indices at the beginning and at the end of year are 100 and 120 respectively.

Opening equity at closing price = (Rs. 12,000 / 100) x 120 = Rs. 14,400 (= 6,000 x Rs. 2.40)

Closing Equity at closing price = Rs. 12,000 (Rs. 18,000 – Rs. 6,000) represented entirely by cash.Retained Profit = Rs. 12,000 – Rs. 14,400 = (-) Rs. 2,400

The negative retained profit indicates that the trader has failed to maintain his capital. The available fund Rs. 12,000 is not sufficient to buy 6,000 units again at increased price Rs. 2.40 per unit. In fact, he should have restricted his drawings to Rs. 3,600 (Rs. 6,000 – Rs. 2,400).

Example (Physical capital maintenance)

In the previous example, suppose that the price of the product at the end of year is Rs. 2.50 per unit. In other words, the specific price index applicable to the product is 125.

Current cost of opening stock = (Rs. 12,000 / 100) x 125 = 6,000 x Rs. 2.50 = Rs. 15,000

Current cost of closing cash = Rs. 12,000 (Rs. 18,000 – Rs. 6,000)

Opening equity at closing current costs = Rs. 15,000

Closing equity at closing current costs = Rs. 12,000

Retained Profit = Rs. 12,000 – Rs. 15,000 = (-) Rs. 3,000

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The negative retained profit indicates that the trader has failed to maintain his capital. The available fund Rs. 12,000 is not sufficient to buy 6,000 units again at increased price Rs. 2.50 per unit. The drawings should have been restricted to Rs. 3,000 (Rs. 6,000 – Rs. 3,000).

Chapter 2 Departmental a/c

Departmental a/cs are prepared for internal reporting purpose. if a business consists of several activities or department or division for carrying on separate function then departmental a/cs are prepared to ascertain the performance of each department.

BHEL

14 Manufacturing units 4 Power sector regionsi.e. total 18 divisions

Following a/cs are opened- Departmental Trading and P&L a/c, General P&L a/c

Allocation of common expenses

Common expenses mean expenses incurred by H.O. and benefit is shared by all the departments.

Sales related expenses – Turnover/sales ratio (excluding inter-department sales) e.g. Bad debts, discounts, advertisement, carriage outward

Rent, repair & maintenance – Floor area of each departmentLighting – No. of light points in each departmentEmployee related expenses – No. of employees in each department.If basis of allocation not given then such expenses are charged to General P&L a/c.

Inter–Department Transfer means when one department supplies goods or provides service to another department.

1. When transfer is made at cost – No stock reserve2. When transfer is made at selling price – Then stock reserve would be created.

i.e. unrealized profit on unsold stock at the end of year would be eliminatedJournal entry- at the end of the year Next year – At the beginning of year stock reserve will be reversed

General P&L a/c Dr. Stock reserve a/c Dr.To Stock reserve a/c To General P&L a/c

Content ratio – means content of internal transfer in total input excluding opening stock.

Internal transfer ×100Total input (excluding opening stock)

Retail DepartmentRetail department sells goods to outsiders. If goods are transferred to other department then it is done through centralized office. In case of Retail Department, following accounts are prepared:

Memorandum Stock a/c (at Retail price)To Balance b/d: Cost Mark-up

By SalesBy ShortageBy Mark-up a/c (loading on shortage)

To Purchase (cost) By Mark-up a/c (Mark down)To Mark-up a/c (loading) By Transfer to other department To Transfer from other department By Mark-up a/c (loading)To Mark-up a/c (loading) By Balance c/d

Cost Mark-up

Memorandum Mark-up a/c

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To Profit By Balance b/dTo Memorandum stock a/c By Memorandum stock a/c To Balance c/d

Chapter 3 Branch Accounts

Domestic Branch Foreign Branch

Domestic Branch

(I) Dependent (ii) Independent

Depended branch – Where books are maintained by H.O.

Independent branch – Where books are maintained by branch. A separate trial balance of branch is prepared and merged with H.O. trial balance at the end of the year. Transaction between H.O. and branch is recorded through inter-branch / inter-unit a/c

In H.O. books – Branch a/c, In Branch books – H.O. a/c

Balance of branch a/c in H.O books and H.O. a/c in branch books must be tallied before the preparation of final a/cs.

Reason for disagreement – Goods in transit, cash in transit, collection of branch debtors directly by H.O., allocation of H.O expenses to branch, not recorded by branch.

Dependent branch-Methods for maintaining the books of depended branch

1. Debtors methods (branch a/c)

2. Stock & debtors (necessary ledgers a/c)

3. Final a/c method (Branch Trading & P & L a/c)

4. Whole sale branch method (when H.O. supplies goods to retail branch at whole sale price and retail branch sales the goods to customers at retail price.

1. Debtors methods- When HO supplies goods at cost

Branch a/c (at cost price)To Balance b/d Cash xx Stock xx Debtors xx Furniture etc. xxTo goods sent to branch xxLess: return xxTo Bank (exps. paid by H.O.)To Bank (amount paid by H.O. for expenses/for purchase of assets)To Creditors (direct purchase)To Balance c/d Creditors xx Other liabilities xxTo Net profit

xx

xxxxxx

xx

By Balance b/d Creditors xx Other liabilities xxBy Bank (remittance to H.O.)By Balance c/d Stock in hand xx Stock in transit xx Debtors xx Cash xx Other assets etc. xx

xxxx

xx

Note – Debtors related expenses (e.g. discount, bad debts, sales return), Petty expenses by branch already gets adjusted because of opening and closing balance in branch a/c. Similarly, depreciation on fixed assets automatically gets adjusted.

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When HO supplies goods at invoice price

Then stock reserve will be created on opening and closing stock and loading on goods sent to branch will be eliminated.

Branch a/c (at Invoice price)To Balance b/d Cash xx Stock xx Debtors xx Furniture etc. xxTo goods sent to branch xxLess: return xxTo Bank (exps. paid by H.O.)To Bank (amount paid by H.O. for expenses/for purchase of assets)To Creditors (direct purchase)To Balance c/d Creditors xx Other liabilities xxTo Stock reserve (Closing)To Net profit

xx

xxxxxx

xx

xxxx

By Balance b/d Creditors xx Other liabilities xxBy Stock reserve (opening)By Goods sent to branch (loading)By Bank (remittance to H.O.) By Balance c/d Stock in hand xx Stock in transit xx Debtors xx Cash xx Other assets etc. xx

xxxxxxxx

xx

2. Stock & debtors method – When HO supplies goods at cost

Branch stock a/c (like trading a/c) (at cost price)To Balance b/dTo Goods sent to branch xxLess: return xxTo Direct purchase To Branch P&L (B/f)

xx

xxxxxx

By Bank (cash sales)By Branch debtors (credit sales) xx Less: return xx By Branch P&L (shortage etc.)By Balance c/d

xx

xxxxxx

Branch debtorsTo Balance b/dTo Branch stock (credit sales)

xxxx

By Bank By Bad debts By Discount By Branch stock (sales return)By Balance c/d

xxxxxxxxxx

Branch expenses a/cTo expenses: Paid by Branch Paid by H.O.To Bad debtsTo discount

xxxxxxxx

By Branch P&L xx

Branch P&L a/cTo Branch expensesTo Net Profit

xxxx

By Branch stock xx

When HO supplies goods at invoice price

Branch stock a/c (like trading a/c) (at invoice price)To Balance b/dTo Goods sent to branch xxLess: return xx

xx

xx

By Bank (cash sales)By Branch debtors (credit sales) xx Less: return xx

xx

xx

5

To Direct purchase To Branch P&L (B/f)

xxxx

By Branch P&L (shortage etc.)By Balance c/d

xxxx

(If branch stock a/c at invoice price then branch stock adjustment a/c will be prepared to eliminate loading )

Branch stock adjustment a/cTo Stock reserve (closing)To Branch P&L a/c

xxxx

By Stock reserve (opening)By Goods sent to branch (loading)

xxxx

Branch debtorsTo Balance b/dTo Branch stock (credit sales)

xxxx

By Bank By Bad debts By Discount By Branch stock (sales return)By Balance c/d

xxxxxxxxxx

Branch expenses a/cTo expenses: Paid by Branch Paid by H.O.To Bad debtsTo discount

xxxxxxxx

By Branch P&L xx

Branch P&L a/cTo Branch expensesTo Net Profit

xxxx

By Branch stock xx

3. Final accounts methodBranch Trading and P&L a/c

To Opening stockTo Goods sent to branch xxLess: return xxTo Direct purchaseTo Gross profit c/dTo Expenses: Paid by Branch Paid by H.O.To Bad debtsTo DiscountTo Net Profit

xx

xxxxxx

xxxxxxxx

By Sales Cash xx Credit xx Less: return xxBy Closing stock

By Gross profit b/d

xxxx

xx

4. Whole sale branch method- Branch Trading & P&L a/c (at WSP), Branch stock reserve a/c or- Branch stock a/c (at WSP), Branch P&L a/c & Branch stock reserve a/c.

Branch stock reserve-Closing stock and opening stock at branch will be at whole sale price, therefore, Branch stock reserve will be created in H.O. books to eliminate the profit.

Journal entry – For closing stock reserve

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H.O. P&L a/c Dr.To Stock reserve

Next year- closing stock reserve will become open stock reserve and reversal entry would be passed.

Stock reserve a/c Dr.To H.O. P&L a/c

Independent branch

Accounting for fixed assets – Accounting for branch fixed assets may be maintained either at the H.O. or at the branch.

If a/cs are maintained by Branch If a/cs are maintained by H.O.

Branch Books H. O. Books H. O. Books Branch Books

Purchase of Fixed asset by H.O.

Asset a/c Dr

To H.O.

Branch Dr

To Bank

Branch Asset Dr

To Bank

No entry

Purchase of Fixed asset by Branch

Asset a/c Dr

To Bank

No entry Branch Asset Dr

To Branch

H.O. Dr

To Bank

On providing depreciation

Dep. a/c Dr

To Asset a/c

No entry Branch Dr

To Branch Asset

Dep. a/c Dr

To H.O.

Incorporation of branch balance in H.O. books

1. Separate final a/c method

2. Abridged consolidated method

3. Detailed consolidated method

Separate final a/c method

- Prepare separate Trading and P&L a/c, Balance sheet of Branch, H.O. and combined

- Transfer the net profit/loss of branch to H.O. a/c.

Branch books H.O. Books

P&L a/c Dr. Branch a/c Dr.

To H.O. a/c To P&L a/c

Note – H. O. a/c in branch books and branch a/c in H.O. books will show net amount due or receivable like debtors or creditors

Abridged consolidated methods

- Prepare separate Trading and P&L a/c of Branch.

- Transfer the net profit/loss, assets and liabilities of Branch to H.O. a/c.

- Prepare Trading and P&L a/c of H.O. after incorporating Branch profit/loss.

-Prepare H.O. B/S after incorporating Branch assets & liabilities.

Journal entryBranch books H.O. booksFor transfer of profit/loss P&L a/c Dr. To H.O.

For transfer of branch assets H.O. a/c Dr.

Branch a/c Dr. To P&L a/c

Assets a/c Dr.

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To Assets

For transfer of branch liabilities Liabilities a/c Dr. To H.O.

To Branch a/c

Branch a/c Dr. To Liabilities

Note – As a result of these entries H.O. a/c in branch books and branch a/c in H.O. books will be completely closed.

Detailed consolidated methods

- Transfer whole trial balance of branch to H.O. a/c - Prepare consolidated Trading and P&L a/c, B/S of H.O.Branch books H.O. booksTransfer of trading a/c items H.O a/c Dr. To Opening stock To Purchase To Goods sent to branch a/c To Direct expenses To Sales return

Sales a/c Dr.Purchase return a/c Dr.Closing stock a/c Dr. To H.O. a/c

Transfer of P&L items H.O. a/c Dr. To Expenses a/c

Income a/c Dr. To H.O. a/c

For transfer of branch assets H.O. a/c Dr. To Assets

For transfer of branch liabilities Liabilities a/c Dr. To H.O.

Opening stock a/c Dr.Purchase a/c Dr.Goods sent to branch a/c Dr.Direct expenses a/c Dr.Sales return a/c Dr. To Branch a/c

Branch a/c Dr. To Sales To Purchase return To Closing stock

Expenses a/c Dr. To Branch a/c

Branch a/c Dr. To Income a/c

Assets a/c Dr. To Branch a/c

Branch a/c Dr. To Liabilities

Note – After transfer, H.O. a/c in branch books and branch a/c in H.O. books will be completely closed.

Foreign branch

Foreign branch is generally independent branch and maintains complete record of all transactions in the foreign currency.

Conversion of Trial balance of foreign branch into H.O. currency

Items Exchange/conversion rateOpening stockFixed assets, Depreciation, InvestmentCurrent assets, Current liabilities,

Opening rateAt the time when they were purchased

Closing rate

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Short term & Long term loan

Income/ExpensesH.O. & Branch transaction

Average rateRefers H.O. balance

Exchange difference will be transferred to P&L A/c

Note: If closing stock of branch is missing then prepare Branch stock A/c / Branch trading a/c in foreign currency to calculate

Chapter 4 Financial Statements of Banking Companies

Recognition of Income

Performing assets (PA) - Accrual basisNon-Performing assets (NPA) - Cash basis

NPA- An assets become non-performing “when it ceases to generate income for a bank.

e.g. (i) A term loan is treated as NPA if interest and/or instalments of principal remains over due for a period of more than 90 days.

(ii) A cash credit/overdraft account is treated as NPA if it remains out of order for a period of more than 90 days.

An account is treated an ‘out of order’ if any of the following conditions is satisfied:

(a) the outstanding balance remains continuously in excess of the sanctioned limit.

(b) though the outstanding balance is less than the sanctioned limit but(i) there are no credits continuously for more than 90 days as on the date of balance sheet or(ii) credits during the aforesaid periods are not enough to cover the interest debited during the same period.

(iii) Bills purchased and discounted are treated as NPA if they remain overdue and unpaid for a period of more than 90 days.

Advances- Banks have to classify their advances into four broad groups:

(i) Standard Assets—Standard assets is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset is treated as PA.

(ii) Sub-standard Assets—which has remained NPA for a period not exceeding 12 months.

(iii) Doubtful Assets—which has remained NPA for a period exceeding 12 months.

(iv) Loss Assets—A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspectors but the amount has not been written off.

Security having Significant Realisable Value

It has been clarified that where the realisable value of security is significant, the credit facility should not be treated as loss assets.To illustrate, suppose, as on March 31, 2011, the bank or the internal/external auditor or the RBI inspection identifies a particular credit facility as a loss asset where the amount outstanding is Rs 1.00 lakh and the salvage value of the security is Rs. 0.01 lakh. In such a case, the facility should be treated as a loss asset and provision should be made for Rs. 1.00 lakh (and not Rs. 0.99 lakh).If, on the other hand, the realisable value of the security is`Rs. 0.80 lakh and the bank or the internal or external auditor or the RBI inspection has not treated the security as unrealisable, the credit facility should be treated as doubtful and not as a loss asset.

Rate of Provision

1. Standard asset- Direct Advance to Agriculture & SME 0.25%

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- Advance to commercial real estate sector 1%- Others 0.40%

2. Sub-standard asset (if Q. silent assume fully secured)- Secured portion 15%- Unsecured portion 25%- Unsecured portion in respect of infrastructure loan 20%

where escrow a/c is available3. Doubtful assets (if Q. silent assume fully secured)

- Secured portion:Doubtful upto 1 year 25%More than 1 & upto 3 year 40%More than 3 year 100%

- Unsecured portion 100%4. Loss/Non-recoverable asset 100%

Advance covered/guaranteed by Deposit insurance & credit guarantee corporation (DICGC)/ Export credit guarantee corporation(ECGC)

In that case provision is made only for uncovered/balance portion.

In case bank also holds security in respect of advance guaranteed by DICGC/ECGC then first of all realizable value of security should be deducted from the advance then guarantee portion should be adjusted.

Rebate on bills discountedIt is an advance/unearned income. It refers to the discount received by bank on discounting of bills which pertains to next financial year.e.g. discount received on bills discounted Rs. 9000. Period of bill is 6 months out of which 2 months falls in next year

Ans: Rebate on bills discounted = 9000/6*2 = 3000/-

Bills for collection

Bills/ cheques received by bank from customers for the purpose of collection/clearing.

Bills for collection (Assets) a/cTo Balance b/dTo Bill for collection (liabilities) a/c (Bills received for collection)

By Bills for collection (liabilities) a/c (Bills collected) By Bills for collection (liabilities) a/c (Bills dishonoured)By Balance c/d

Bills for collection (Liabilities) a/cTo Bills for collections (assets) a/c (Bills collected) To Bills for collections (assets) a/c (Bills dishonoured)To Balance c/d

By Balance b/dBy Bills for collections (assets) a/c (Bills received for collection)

These a/cs are prepared for reconciliation purpose. Bills for collection a/c is shown in B/s after schedule-12.

Acceptance, Endorsement and Other obligation a/cTo Constituents liabilities for By Balance b/d

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acceptance, endorsement etc. (paid off by clients)To Constituents liabilities for acceptance, endorsement etc. (Honoured by bank)To Balance c/d(acceptance not satisfied)

(acceptance not satisfied)

By constituents liabilities for acceptance, endorsement etc.(acceptance given during the year)

When bank accepts or endorses bills on behalf of its customers. e.g. acceptance of bills of exchange, issue of bank guarantees, letter of credit. Constituents mean customers or clients.

Capital adequacy ratio It is the ratio that RBI uses to watch bank’s health. it is measure of how much capital has been used to support the bank’s risk assets. All commercial bank (excluding regional rural banks) should maintain capital adequacy ratio of 9%.

If CAR is less than 9% than bank has to improve it.

Capital fund consists of Tier I and Tier II capitalTier I capital Tier II capitalEquity share capitalReserve (excluding revaluation reserve)Capital reserve arising due to sale of assetsLess:Intangible assets (e.g. goodwill)Misc exps. (not w/off)P & L (Dr. balance)50% of investments in subsidiaries companyDeferred Tax assets

Preference share capital Revaluation reserve × 45%Undisclosed reserveLess:50% of investment in subsidiaries company

Risk weight assigned to various items of B/sRisk weight

1 Cash in hand & balance with RBI 02 Balance in current account with other banks 20%3 Claims on bank 20%4 Investments:

In Govt. Securities In other approved securities Guaranteed by CG/SGIn other approved securities not Guaranteed by CG/SGInvestments in Government guaranteed securities of Government Undertakings which do not form part of the approved market borrowing programme.Investments in bonds issued by other banksInvestments in securities which are guaranteed by banksOther investments

00

20%

20%

20%20%

100%

5 Loans and Advance:Guaranteed by CG/SGAdvances against term deposits, Life policies, NSCs, IVPs and KVPs where adequate margin is available.

0

0

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Loans and Advances granted to staff of banks which are fully covered by superannuation benefits and mortgage of flat/house.Granted to PSUOthers

20%100%100%

6 Advance covered by DICGC/ECGC 50%7 Premises furniture & fixtures (net of depreciation) 100%8 Other assets 100%9 Advance Tax and TDS 010

Off Balance sheet Items:e.g. Contingent liabilities

Credit conversion factor 100%

Profit & Loss A/cSchedule Amount

Income :Interest earned Other income Total (A)Expenditure : Interest expendedOperating expenses Provision & contingencies Total (B) Net Profit/(Loss) (A-B)Add: profit/(Loss) brought forward from B/sProfit available for appropriation Less : Transfer to statutory reserve @ 25% of net profit Transfer to other reserve Proposed dividend etc.Balance carried forward to Balance sheet

1314

1516

xxxxxx

xxxxxxxx

Interest earned Other income1. Interest / Discount 2. Income on investmentAdd: opening bal. of rebate an bills discounted Less: closing Bal. of rebate on bills discounted

Provision and contingencies:Provision for doubtful debts (advance)Provision for taxation Others provisions (e.g. provision for diminution in value of investment)

Commission/brokerageProfit on sale of fixed asset/investmentsLess: loss on sale of FA/investmentsProfit on exchange transaction Less: loss on exchange transaction

Format of Balance sheetSchedule Amount

Capital & liabilitiesShare capital Reserve & surplusDeposits BorrowingsOther liabilities & provision

12345

xxxxxxxxxx

12

TotalAssets Cash & balance with RBIBalance with banks, money at call and short noticeInvestmentsAdvances Fixed assets Other assets TotalContingent liabilities Bills for collection

67891011

12

xx

xxxxxxxxxxxxxxxxxx

Advances

Bills purchased & discounted ××Cash credit & overdraft ××Term loan ××

Secured by tangible assets ××Secured by bank/Govt. Guarantees ××Unsecured ××

Cash reserve ratio—every bank should maintain with RBI CRR of 4.75% of demand and time liabilities i.e. deposits.

Statutory liabilities ratio—every bank should maintain SLR of 25% of its demand and time liabilities i.e. deposits in the form of cash in hand, Cash with other banks, Money at call & short notice, Gold, Unencumbered approved securities.

Money at call & short notice—deposits repayable within 15 days lent in the inter-bank call money market.

Interest application

1. When financial position of the customer is good

Customer loan a/c Dr.To Interest a/c

2. When there is any doubt regarding customer’s ability to pay

Customer loan a/c Dr.To Interest suspense a/c

Interest suspense a/c will be shown in liability side of B/S in Schedule 5: Other liabilities and provisions.

On realization of interest

Interest suspense a/c Dr. To Interest a/c (realized portion)To Customer loan a/c (unrealized portion)

For example

On 31st march 2009, there is an unsecured loan of Rs. 8,00,000 to Sh. Pankaj in the loan ledger of SBI bank. It is found on enquiry that the financial position of the borrower is bad and doubtful. Interest on the said loan has accrued Rs. 80,000 and is yet to be recorded. During 2009-10, the bank is able to realize only 80 paise in a rupee on account of customer’s bankruptcy. Show how the transactions would be recorded in the books of the bank.

Ans31-03-2009 Pankaj loan a/c Dr. 80,000

To Interest suspense a/c 80,000

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2009-10 Bank a/c Dr. (800000+80000) x 80% 7,04,000

To Pankaj loan a/c 7,04,000

Interest suspense a/c Dr. 80,000

To Interest a/c 64,000

To Pankaj loan a/c 16,000

Bad debts a/c Dr. 1,60,000

To Pankaj loan a/c 1,60,000

Chapter 5 Financial statements of Insurance companies

Life insurance v/s General insurance – Life insurance contract are long term contracts running over no. of years but General insurance contract are only for one year though renewable every year.

Life insurance actually called assurance since life can not be replaced.

Financial statements of General insurance companies

Form B- Revenue A/c

Schedule Fire Marine Others1 Premium earned 12 Interest/Dividend/Rent (gross)3 Profit/Loss on sale of investments 4 Other Income

Total (A)1 Claim incurred 22 Commission 33 Operating expenses 4

Total (B) Operating profit (A-B)

Premium earned:- Claims incurred :-

Direct business XX+ Re-insurance accepted XX- Re-insurance ceded XX Net Premium XX+ Open bal of Unexpired Risk Reserve - Closing bal of Unexpired Risk Reserve

Direct business+ Re-insurance accepted- Re-insurance ceded + Surveyor Expenses + Legal exps. In connection with claims

Commission:- Unexpired risk reserve

Direct business

+ Re-insurance accepted

- Re-insurance ceded

Marine insurance 100% of net premium

Fire & other insurance 50% of net premium

Note: (i) If P&L a/c is not asked then all income & exps. will be shown in Revenue a/c.

(ii) If P&L a/c is not asked then provision for tax will be deducted from Operating profit.

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(iii) If Provision for tax is not given then Provision for tax= Indian tax + TDS.

(iv) Foreign tax is a part of operating exps.

Re-insurance- When insurer feels that he has undertaken larger risk. In that case he may transfer some risk to other insurance company through re-insurance.

Unexpired risk reserve- Generally risk under all policies do not expire at the end of F.Y. Many policies expire in next F.Y. it is very time consuming to calculate unexpired portion of premium under each policies. Therefore a fixed % age of premium income is transferred to create reserve for unexpired risk.

Moreover, insurance company may also maintain additional reserve.

Form-B P & L A/c1 Operating profit/loss

Fire Marine Others

2 Interest/Dividend/Rent (Gross)3 Profit/Loss on sale of investments4 Other income

Total (A)1 Provision (other than Tax)

- Provision for diminution in value of investment- Provision for Bad debts- Others

2 Other exps. (not w/off in Revenue a/c)Total (B)

Profit before Tax (A-B) Less: Provision for Tax

Profit after Tax

Financial statements of Life insurance companies

Valuation Balance sheet

Net Liabilities as per actuarial valuation Surplus (B/f)

Life Assurance fund

Statement showing Net Profit for valuation period

Surplus as per Valuation B/sAdd: Interim bonus Add/Less: Adjustments for loss on investment to be w/off, provision for taxation etc. Total surplus Less: surplus at the beginning of period

Distribution of surplus

Total surplusLess: surplus to be carried forward

xxxx

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Surplus available for distribution Share of shareholder @ 5% Share of policyholder @ 95% xxLess: interim bonus already paid xx Amount due to policyholders

xxxx

xx

Note- As per LIC Act, 95% of surplus is distributed to policyholders as bonus and 5% to shareholders.

Bonus can be distributed – in cash or by reduction of premium or on maturity of policy (i.e. Reversionary bonus)

Interim bonus- Bonus paid to policyholders for a period for which valuation is not completed.

Life Assurance fund- which is retained to meet the aggregate liabilities on all policies outstanding. Liabilities of all outstanding policies are computed by experts called actuaries.

Journal entries

Life Assurance fund a/c Dr.To P & L a/c

(Transfer of profit / surplus as per valuation B/s)

P & L a/c Dr.To Investment fluctuation reserve

(Loss on valuation of investment)

P & L a/c Dr.To Provision for taxTo General reserve

P & L a/c Dr.To Bonus payable in cash

P & L a/c Dr.To Life Assurance fund

(Transfer of reversionary bonus to LAF)

Consideration for Annuities granted- Iumpsum money received by an insurance company to give annuities in future.

Annuities-Specified amount is paid annually to the insured from the date he attains a specified age till his death.

Surrender value-In case policy holder is unable to pay further premium or he is in need of money then he may surrender his right under the policy. Insurance company will pay him surrender value of policy.

Paid up policy- if an insured is unable to pay further premium then he may discontinue the payment and convert the policy into paid-up policy. Insured amount in that case will be reduced as follows: No. of premium paid X Sum insured

Total no. of premium Form A- Revenue A/c (policyholders a/c)

Schedule Amount1 Premium 12 Interest/Dividend/Rent (gross)3 Profit/Loss on sale of investments 4 Other Income

Total (A)1 Commission 22 Operating expenses 33 Provision for tax4 Provision (other than tax)

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-Provision for diminution in value of investment -provision for bad debts-Others

Total (B)1 Benefit paid 42 Interim bonus paid 3 Change in valuation of liabilities in respect of life policies as per

actuarial valuationTotal (C)

Surplus/Deficit (A-B-C)Less: Transfer to shareholders a/c Transfer to other reserves Balance transferred to B/s

Premium :- Claims / benefit paid :- Direct business+ Re-insurance accepted- Re-insurance ceded + Consideration for annuities granted + Bonus in reduction of premium

Direct business+ Re-insurance accepted- Re-insurance ceded + Surveyor Expenses+ Legal exps in connection with claims + Annuity paid+ Surrender value + Bonus in reduction of premium

Form A - P & L A/c (Shareholders a/c)

1 Amount transferred from policyholders A/c2 Interest/Dividend/Rent (gross)3 Profit/Loss on sale of investments4 Other income

Total (A)1 Provision (other than tax)

- Provision for diminution in value of investment- Provision for Bad debts- Others

2 Other exps.Total (B)

Profit before Tax (A-B)Less: Provision for Tax Profit After Tax

Format of Balance Sheet- Both for Life Insurance and General InsuranceSchedule Amount

Sources of fund:Share capital 5 ××Reserve and surplus 6 ××Fair value change a/c - ××Borrowings 7 ××

Total ××Application of fund:Investments 8 ××Loans 9 ××Fixed Assets 10 ××

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Current Assets: (A) ×× Cash and Bank 11 ×× Advance and other current assets 12 ××

Total (A) ××Current liabilities: (B) 13 ××Provisions (B) 14 ××

Total (B) ×× Net current assets (A-B) ××Misc. Exps. (not written off) 15 ××P & L (Dr.) - ××

Total ××Note-Provision for unexpired risk will be shown under the head provisions.

Chapter 6 FINANCIAL STATEMENT OF ELECTRICITY COMPANIES

Electricity supply companies are governed by Indian Electricity Act 1910, Electricity (Supply) act 1948, Indian Electricity Rules 1956 and state legislations relating to electricity supply.

Double entry systemis a system of recording of transactions in the books.

Double accounts systemis a system of presenting of annual financial statements of public utility companies (formed by special act of parliament) e.g. electricity companies, railways companies.

Replacement of assetsUnder double account system, when an asset is replaced then its original cost is not disturbed but its value is increased by addition/extension to the assets. An amount equal to present/current cost of replacement is treated as revenue expenditure.

Present/current cost- that would have been incurred had the old asset been constructed now.

Journal entriesNew assets a/c Dr.Replacement a/c Dr. (present/current cost)

To Bank

New asset a/c Dr. (value of old material used in new assets)To Replacement a/c

Bank a/c Dr. (sale of scrap)To Replacement a/c

Revenue a/c Dr. (transfer of balance of replacement a/c)To Replacement a/c

CAPITAL BASE

ICAI – SAD DTCI Intangible assets (including preliminary exps.)C Cost of Fixed assets & Capital WIP less amount contributed by consumers A Average monthly current assets (excluding debtors)I Investments from contingency reserveLess:S State electricity board loan & other loans approved by State Govt.

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A Accumulated depreciation/Amortization of intangible assetD DebenturesD Development reserveT Tariff & Dividend control reserveC Consumer deposits/Security deposit of consumers/Consumer rebate reserve a/c / Licensee a/c

Reasonable returnCapital base x (RBI bank rate + 2%) (Note: If bank rate missing assume 10%) xx

Add: Income on Investments (excluding Investments from contingency reserve) xx

Add: 0.5% of SDD xx

Clear profitNet profit after tax less Contribution to Development reserve and Contingency reserve

Disposal of SurplusGross surplus = Clear profit – Reasonable return (RR) xxAmount refundable = Clear profit – 120% of RR xx

Net surplus xx1/3rd of net surplus or 5% of RR (whichever is lower) at the discretion of company xx

Balance xx50% of Balance to Tariff & Dividend control reserve xx50% of Balance to Consumer Rebate Reserve a/c xx

Statement of Share capital & Loan capitalParticulars Opening

balance Addition during the Year

Deletion during the year

Closing balance

Share CapitalSecurity premiumCapital reserveSecured & Unsecured loan

Statement of Capital expenditureParticulars Opening

balance Addition during the Year

Deletion during the year

Closing balance

Intangible assets (Including preliminary exps) Tangible assets

Statement of Operating expensesAll expenses (except Interest on loans/Debentures & Provision for tax) xx

Statement of operating revenueAll income (except Income on investments, share transfer fee) xxLess: Operating expenses xx

Net Revenue xx

Statement of Net Revenue & Appropriation a/cTo Interest on loans/debenturesTo Provision for TaxTo Proposed dividendTo Transfer to Development reservesTo Transfer to Contingency reservesTo Transfer to other reservesTo Refund to consumerTo TDCR

By Balance b/dBy Net revenueBy Income on investmentsBy Share transfer fee

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To Consumer Rebate Reserve a/cTo Balance c/d

Balance SheetCapital & LoanReservesCurrent Liability & Provisions

Fixed assetsInvestmentsCurrent assetsMisc. expenses (not w/off)

Clear profitNet Revenue as per statement of operating revenue xxAdd: Income on investments, Share transfer fee xxLess: Interest on loans/debentures, Provision for Tax (xx)Net profit after tax xxLess: Contribution to Development reserve & Contingency reserve (xx)

Clear profit xx

Chapter 7 Amalgamation/Absorption/External reconstruction (AS-14)

Amalgamation when two or more existing companies are combined into new company.e.g. X Ltd. + Y Ltd. = Z Ltd. (new company)

Absorption when one existing company takes over another existing company.e.g. X Ltd takes over Y Ltd

External reconstruction when a new company is formed and takes over the existing company (e.g. revival of sick company)

e.g. Y Ltd new company formed and takes over X LtdType of amalgamation

(i) Amalgamation in the nature of merger (ii) Amalgamation in the nature of purchase

Amalgamation in the nature of merger

If all the following conditions are satisfied:(i) All assets* & liabilities* are taken over by new company at book value.(ii) Shareholders holding atleast 90% equity shares of old company become equity shareholders of new

company.(iii) Purchase consideration to such shareholders is paid in equity shares only. (cash can be paid for fractional

shares)(iv) New company carry on same business of old company.

Note: Here assets* include Misc exps.(not w/off), P&L (Dr.bal) & liabilities* include Reserves also.

Amalgamation in the nature of purchase- If any of the above conditions is not satisfied.

Accounting treatment

AS-14 deals with accounting to be made in the books of transferee company i.e. purchasing company. Therefore, accounting in the books of transferor company has to be made as per the common practice.

This AS is not applicable where transferor company is not dissolved.

In case of merger- Pooling of interest method, In case of Purchase- Purchase method

Computation of Purchase consideration

Net payment method ( 1st preference) (Both Merger & Purchase) - As per AS-14, payment to shareholders (equity + preference) is considered as PC. Payment can be made in any form i.e. shares, debentures, cash etc.

Net assets method (In Merger) - Purchase Consideration = Share capital

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Net assets method (In purchase) (also called intrinsic value, break up value, net worth per share, book value per share).

Assets* taken over (Agreed Value/Book value) xxLess: Liabilities taken over (payable value/BV) xxPurchase consideration xxLess: Preference share capital xxNet assets available for equity share holders xx

No. of equity shares xxIntrinsic value xx

*Note- Here assets include goodwill if MV/AV is given but does not include Misc exps (not w/off), P&L (Dr. bal.)

Reserve & Surplus (shareholders fund)P&L (cr. bal), general reserve, capital reserve, securities premium, dividend equalization reserve, capital redemption reserve, insurance reserve, debenture sinking fund etc.Note: if any fund denotes liability to third party then it should be included in liabilities. e.g. Provident fund, gratuity fund, workmen profit–sharing fund, workmen saving bank a/c, workmen compensation fund (upto the amount of claim) superannuation fund etc.

Books of Purchasing company

In case of Merger In case of Purchase

Business merger Dr. (PC) To Liquidator of vendor company

Assets Dr. (BV) To Liabilities (BV) To Reserves (BV) To Business merger(Difference of PC & Share Capital (Equity+ Preference) will be adjusted from reserves excluding statutory reserves.

Liquidator of vendor company Dr. To Equity share capital To Preference share capital To Securities premium To Debentures To Cash

For Liquidation exps-

General reserve/P&L a/c Dr. To Cash

Business Purchase Dr. (PC) To Liquidator of vendor company

Assets Dr. (AV) Goodwill Dr. (B/f) To Liabilities (AV) To Business purchase To Capital Reserve (B/f)

Liquidator of vendor company Dr. To Equity share capital To Preference share capital To Securities premium To Debentures To Cash

For Liquidation exps-

Goodwill/Capital reserve a/c Dr. To Cash

Statutory reserveInvestment allowance reserve, shipping reserve, export profit reserve, tea development reserve, foreign project reserve, site restoration fund etc.In case of Merger- No entry since already taken over by new companyIn case of PurchaseAmalgamation adjustment a/c Dr.

To statutory reserve(Amalgamation adjustment a/c will be shown in B/S under the head Misc exps (not w/off).When SR is no longer required or period of maintenance them is over then reversal entry would be made.Statutory reserve a/c Dr.

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To Amalgamation adjustment a/c

Inter company owing- e.g. Debtors-Creditors, B/R-B/P, Unrealized profit on stock

Entry will be made in the books of purchasing company. There will be no effect on PC.

In case of Merger In case of Purchase

General reserve / P&L a/c Dr. Goodwill / Capital reserve / P&L a/c Dr.

To Stock To Stock

Closing of Books of Vendor/Old Company

Open realisation a/c

Transfer all assets & liabilities to realisation a/c at book value (whether taken over or not)

Open cash a/c (if not taken over)

Transfer Equity share capital, reserve & surplus, Misc exps.(not w/off), P&L (Dr. Bal) to Equity shareholders a/c.

Transfer Preference share capital to Preference shareholders a/c.

Raise the PC - Purchasing company Dr.

To Realisation a/c

Realise the PC

Realise the assets & pay off the liabilities (not taken over)

Bank a/c Dr. Realisation a/c Dr.

To Realisation a/c To Bank a/c

(Assets not taken over sold) (Liabilities not taken over paid off)

Payment of Liquidation/realisation expenses (if paid by vendor company)

Realisation a/c Dr.

To Bank a/c

If realization exps. are first to be paid by vendor company and afterwards re-imbursed by purchasing company.

On payment On re-imbursement

Purchasing company Dr. Bank a/c Dr.

Realisation a/c Dr. To purchasing company

To Bank a/c

Difference in Preference shareholders a/c will be transferred to realisation a/c.

Difference in realisation a/c will be transferred to equity shareholders a/c.

Inter-company holding

1. When purchasing company holds shares of vendor company.

PC means payment to be made to external shareholders

Books of purchasing company- Adjustment

While making entry for assets taken over, Investments held in vendor company will be credited/cancelled.

Books of vendor company- No effect

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2. When vendor company holds shares of purchasing company.

Calculate total no of shares to be issued to vendor company xxLess: Shares already held by vendor company xx

PC xx

Books of purchasing company- Adjustment

Investments held by vendor company will not be taken over by purchasing company.

Books of vendor company- Adjustment

Investments held by vendor company will be given to equity shareholders at market value/intrinsic value through realization a/c.

When Amalgamation takes place during the yearThen prepare revised balance sheet on the date of amalgamation and start the same procedure.

Chapter 8 INTERNAL RECONSTRUCTION

is a process by which assets, liabilities & capital of a company are re-organized/restructured/reconstructed by:

Revaluation of assets; Re-assessment of liabilities; Writing/off the losses; and Reduction in value of capital

Such a process is called internal reconstruction since it is carried out without liquidating the company. “And reduced” word is added with the B/S of company if court so orders.

Alteration of Share Capital –

Sub-division and consolidation of shares –

e.g. Sub-division of one share of Rs. 100 into 10 shares of Rs. 10 each.

Consolidation of 10 share of Rs. 10 each into one share of Rs. 100 each.

Conversion of shares into stock and stock into shares (shares must be fully paid-up)

Reason of conversion – Any amount of stock may be transferred.

- Capital reduction a/c / capital reconstruction a/c

- Reduction in value of shares

- Reduction in paid-up value

Share capital a/c Dr.

To Capital reduction a/c

Reduction in face value (e.g. exchange, convert, new value of share given)

Share capital a/c (Rs. old) Dr.

To Share capital a/c (Rs. new)

To Capital reduction a/c

Note – On issue of new shares, premium is transferred to securities premium a/c not in capital reduction a/c.

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- Reduction in value of assets

Capital reduction a/c Dr.

To Assets a/c

- Increase in value of assets

Assets a/c Dr.

To Capital reduction a/c

Reduction in liabilities

Liabilities a/c Dr.

To Capital reduction a/c

Increase in liabilities

Capital reduction a/c Dr.

To Liabilities

Payment of reconstruction expenses

Capital reduction a/c Dr.

To Bank

Payment of unrecorded liability

Capital reduction a/c Dr.

To Bank/Share capital

Arrear of preference share dividend appearing in B/S- as usual same entry as in case of payment/ waiver of liabilities.

Arrear of preference share dividend not appearing in B/S i.e. when preference share dividend is shown as contingent liability.

On payment

Capital reduction a/c Dr.

To Bank/Share capital

On waiver- No entry

Balance of capital reduction a/c is utilized to write/off

(i) Misc. expenses (not w/off)

(ii) P&L (Dr. Bal.)

(iii) Goodwill

(iv) Other assets as mentioned in the question for writing/off.

If there is any balance in capital reduction then it is transferred to capital reserve a/c.

If capital reduction a/c falls shorts then amount from reserve & surplus should be transferred to capital reduction a/c in following preference:

(i) Capital reserve

(ii) Securites premium

(iii) Other reserves ( e.g. P&L, General reserve)

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If reserve & surplus are not enough then difference will be transferred to Goodwill a/c.

Chapter 9 Liquidation of Companies

Liquidation/winding up of a company is the process whereby its life is ended.

A administrator called liquidator is appointed and he takes over the control of the company, collect its assets, pay its liabilities and finally distributes any surplus among the members.

Statement of affairs – When a company is liquidated then a statement of affair is submitted to the liquidator within 21 days from the date of winding-up.

Statement of affair is prepared by board of directors on estimation basis.

Statement of affair consists of 8 list.

Statement of affairs

Assets not specifically pledged (as per list A)

Cash in hand and cash at bankCalls in arrear (excluding uncalled capital)B/R, Debtors, Stock, L&B, P&M, Furniture etc.

Assets specifically pledged (as per list B)Assets ERV Secured loan/creditors Deficiency Surplus (including interest) (rank as unsecured)

Total assets available for preferential creditors, Debenture holders having floating charge & unsecured creditors Preferential creditors (as per list C) Balance

Debenture holders having floating charge (as per list D) Debenture Interest outstanding BalanceUnsecured creditors (as per list E) Balance

Preference shares holders (as per list F)Paid-up preference shares capital (including calls is arrear realisable)Arrears of preference shares dividend Balance

Equity shares holders (as per list G)Paid-up equity shares capital (including calls is arrear realisable)

Estimated realisable value (ERV)

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Estimated surplus/deficiency (as per list H)

Deficiency account (as per list H) It explains how the deficiency as per statement of affairs has taken place

Items increasing deficiency:

Payment of contingent liability ××

P&L (Dr.) balance ××

Misc. expense (not w/off) ××

Loss on realisation of assets ×× ××

(excluding calls in arrear)

Items reducing deficiency:

P&L (Cr.) balance ××

Reserves ××

Profit on realisation of assets ×× ××

××

Note –

1. If Balance sheet not given then prepare B/S to calculate accumulated profit/loss2. Liquidation exps/cost of winding up/liquidator remuneration are not included in statement of affairs.3. Calls in advance is included in unsecured creditors.

Preferential Creditors (Sec. 530 of companies act)

- Workmen dues.- Govt. Taxes – only those that became due within 12 month before the commencement of winding-up.- Wages/Salary to employees upto 20,000/- per employee but maximum for 4 month due within 12 months before the commencement of winding up.- Retirement benefits of employees.- Compensation to employees under workmen compensation act.- Investigation expenses upon investigation of affairs of company.Note- Employee does not includes a person employed in managerial capacity e.g. directors of company

Overriding preferential creditors – (Sec.529A of companies act)

(a) Workmen’s due and(b) Secured creditors to the extent could not be paid due to equal charge in favor of workmen

Note- In case of winding up of company, workmen dues and secured creditors shall be paid in full. If assets are insufficient then they shall be paid proportionately.

Liquidator’s final statement of Account

Receipts Amount Payment Amount

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To Cash in hand

To Cash at bank

To Assets realized (less cost of collection)

To Surplus from asset realized:

Assets specifically pledged xx2Less: Secured loan/creditors xx

To Equity shareholders(Calls)

xxxx

xx1

xx3

xx

By Liquidation expenses

By Liquidator’s remuneration

By Preferential creditors

By Debenture holders having floating charges

Debentures xx

Interest outstanding xx

By Unsecured creditors

By Preference shareholders

-Preference share capital xx -Preference dividend arrears xxBy Equity shareholders

xxxxxx

xxxxxx

xxxx

Liquidators Remuneration

Following situations may be given in question for calculating liquidators remuneration:a) Percentage (%) of assets realized-

Liquidators Remuneration= % of (1+3)

b) Percentage (%) of all assets/ gross assets/ total assets realized-

Liquidators Remuneration= % of (1+2)

Note: Cash in hand & Cash at bank will not be included in assets realized/all assets realized.

c) Percentage (%) of payment to members/shareholders.Liquidators Remuneration= % × Balance available for Equity+Preference share holders %+100

d) Percentage (%) of payment to equity shareholders. Liquidators Remuneration= % × Balance available for Equity share holders

%+100

Final payment to different class of Equity shareholders

When Face value of equity shares is same but paid up value is different

Calculate surplus available for Equity share holders xxAdd: Notional calls on partly paid up shares xx

Amount refundable xxDivide by Total no of shares xxRefund per share xx

When Face value as well as paid up value of equity shares is different

Calculate surplus available for Equity share holders xxAdd: Notional calls on partly paid up shares xx

Amount refundable xxDistribute the amount refundable in paid up capital ratio after adjusting notional call.

Appointment of ReceiverDebenture holders having floating charges may appoint the receiver in certain circumstances. e.g. if company fails to pay interest on due date.

Receiver’s Receipts & Payment Account27

Receipts Amount Payment AmountTo Assets realized (less cost of collection)To Surplus from asset realized:Assets specifically pledged. xxLess: Secured loan/creditors xx

xx

xx

By Receiver’s expensesBy Receiver’s remunerationBy Preferential creditorsBy Debenture holders having floating charges Debentures xx Interest outstanding xxBy Surplus transferred to Liquidator

xxxxxx

xxxx

Contributories – mean person liable to contribute to the assets of company in the event of its being wound-up.e.g. in case of death – legal representative

List ‘A’ contributions – Present shareholdersList ‘B’ contributories – Past shares holders i.e. shareholders who had transferred/disposed off their shares within last 12 month before the date of winding-up.

Liability of ‘A’ list contributories is primary.

If ‘A’ list contributories fail to make payments then ‘B’ list contributories are called for payment.

‘B’ list contributories are liable for lower of following:

1. Unpaid amount on shares2. Creditors outstanding at the time of ceasing to be member.

Chapter 10 Partnership

Dissolution of firm

Dissolution of partnership – When a partner dies/retires/becomes insolvent then remaining partners may continue the business. In such case there will be new partnership. That is called dissolution of partnership.

Dissolution of firm – When business also comes to an end then it is called dissolution of firm

A firm stand dissolved in following cases

1. When all partner agree that firm should be dissolved 2. When all partners except one become insolvent3. When business of firm becomes illegal 4. Expiry of term for which firm was formed5. Completion of venture for which firm was formed6. In case partnership at will, a partner gives notice of dissolution 7. When court orders dissolution

Accounting treatment

1. Open realisation a/c and transfer all assets & liabilities at book value except cash & bank balance 2. Realise the assets and pay off the liabilities through realisation a/c3. Pay realisation expenses4. Transfer realisation profit/loss to partners capital a/c is PSR

Insolvency of a partner (Garner v/s Murray rule)

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When a partner is unable to pay his debt due to firm then he is said to be insolvent.

1. Loss on realisation should be brought in cash by all solvent partner.2. Loss on account of insolvency of partner should be borne by the solvent partners in their capital ratio. if any solvent partner has negative capital then he will not bear any loss.

Capital ratio - In case of fixed capital, no adjustment will be made. Ratio of fixed capital will be taken.

In case of fluctuating capital, Ratio should be calculated on the basis of correct capital i.e. (capital after all adjustment before profit/loss on realisation) immediately before dissolution.

Insolvency of all partnersWhen the liabilities of firm cannot be paid in full out of firm assets as well as personal assets of the partners then all the partners are said to be insolvent.

In that case, Creditors a/c is not transferred to realisation a/c.

- Creditors is paid directly from the available amount and Unsatisfied portion is transferred to deficiency a/c

- Close the partners’ capital a/c

- Transfer deficiency in partner’s capital a/c to deficiency a/c

Note – Private assets of each partner are applied first to pay off his private debts and balance if any is applied to pay off the firm debts.

Amalgamation , Conversion and Sale of firm

Amalgamation – Where two or more existing firm amalgamated into a new firm.

Conversion – Where firm is converted into a company

Sale – Where business of a firm is acquired/purchased by a new firm/company

Accounting treatmentSame entries/treatment will be made as in case of amalgamation, absorption & external reconstruction chapter.

Calculate PC

Close the books of firms by opening realisation a/c

Transfer all assets & liabilities to realisation a/c at book value (whether taken over or not)

Open cash a/c (if not taken over)

Transfer reserve & surplus, accumulated losses, partner’s capital to partner’s capital a/c

Raise the PC

Realise the assets & pay off the liabilities (not taken over)

Pay the realisation expensive

Transfer profit/loss on realisation to partner’s capital a/c in PSR ratio

Distribute the PC in agreed ratio

If no agreement about distribution then distribute PC in final claim ratio

Piecemeal distributionGenerally asset sold upon dissolution of partnership are realized only in small installment over a period of time.In this situation, choice is either to distribute whatever is collected or wait till the whole amount is collected. Usually first choice is adopted.

Order of payment:-1. Realisation exps. paid / provided for

2. Outside liabilities proportionately (e.g. Bank loan, creditors, partners spouse loan)

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3. Partners’ loan

4. Adequate provision for contingent liabilities

5. Partners’ capital

Note:1. If an “asset specifically pledged” is realized then payment is first made to secured creditors.

2. If an “asset not specifically pledged” is realized then payment is made to all the creditors proportionately.

( whether secured or unsecured ).

Distribution of cash to partners’ capital a/c1. Maximum loss method

- In this method, each installment realized is considered as final payment to partners.

- Maximum possible loss is computed & distributed to partners in PSR.

- Any deficiency in partners capital a/c is borne by other partners in capital ratio assuming that partner is insolvent.

(i.e. Garner v/s Murrey rule ).

2. Highest relative capital method/ Proportionate capital methodIn this method, partner who has excess capital in proportion to his PSR is first paid off.

Excess capital =

Divide the capital by PSR

Less: Proportionate capital as per PSR taking lowest as base

Note: Answer in both methods will be same. If question is silent then use maximum loss method.

Chapter 11 REDEMPTION OF DEBENTURES

Debenture is a certificate issued by the company under its seal acknowledging a debt due to its holder.

Issue of debentures for consideration other than case

Vender a/c Dr.

To Debentures

Issue of debentures for cash

On receipt of Application money On Allotment

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

On due of Allotment/First call/Final call money On receipt of allotment/call money

Debenture allotment/Call a/c Dr. Bank a/c Dr.To Debenture a/c To Debenture allotment/Call a/c

If allotment is made at premium If allotment is made at discount

Debenture allotment a/c Dr. Debenture allotment a/c Dr.To Debenture a/c Discount on issue of debenture a/c Dr.To Securities Premium a/c To Debenture a/c

When full/ whole amount is received on application

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

Or Combined entry may be made Bank a/c Dr.

To Debenture a/c

Special casesWhen debentures are issued at Par & repayable at Par

On issue On redemptionBank a/c Dr. Debenture a/c Dr.

To Debentures To Bank

If debenture are issued at premium & repayable at par 100-110-100

On Issue Bank a/c Dr. 110 To Debenture 100 To Sec. Premium 10

On Redemption Debenture a/c Dr. 100 To Bank 100

If debentures are issued at discount & repayable at par 100-90-100

Bank a/c Dr. 90Discount a/c Dr. 10 To Debenture a/c 100

Debenture a/c Dr. 100 To Bank 100

If debenture are issued at par & repayable at premium 100-100-110

On Issue On redemption Bank a/c Dr. 110 Debenture a/c Dr. 100Loss on issue on debenture a/c Dr. 10 Premium on red. of deb. a/c Dr. 10

To Debenture a/c 100 To Bank 110To Premium on redemption of deb. 10

If debenture are issued at discount & repayable at premium 100-90-110

On Issue On redemption

Bank a/c Dr. 90Discount on issue on deb. a/c Dr. 10 Debenture a/c Dr. 100Loss on issue on debenture a/c Dr. 10 Premium on red. of deb. a/c Dr. 10

To Debenture a/c 100 To Bank 110To Premium on redemption of deb. 10

Redemption on debenture – Redemption can be made in variety of ways like

Through conversion Purchase In open marketRedemption in cash/lumpsum paymentThrough sinking fund/debenture redemption fund

Purchase in open market - Company may purchase its own debentures from stock market either for:

1. Immediate cancellation

Debenture a/c Dr.Deb. Interest a/c Dr.

To Bank

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To Profit or Loss on cancellation a/c

Profit or Loss on cancellation a/c Dr.To Capital reserve a/c

2. As an investment (to be cancelled when required)

On purchase On cancellation

Investment in own debenture a/c Dr. Debenture a/c Dr.Interest on own debenture a/c Dr. To Investment in own debenture

To Bank To Profit or Loss on cancellation

On payment of Debenture Interest

Debenture interest a/c Dr.To BankTo Interest on own debenture a/c

Note: Loss on cancellation is transferred to P & L a/c, Profit on cancellation is transferred to Capital reserve a/c Profit on sale of investment is transferred to P & L a/c.

If there is profit on cancellation and loss on cancellation then net amount is transferred to P&L a/c if there is loss or Capital reserve a/c if there is profit.

Cum-Interest – Interest is included in purchase price Ex-Interest – Interest will be paid separately

Sinking Fund/Debenture Redemption Fund

On annual appropriationP & L a/c

To S.F. a/c

On purchase of investmentsS.F. Investments a/c Dr.

To Bank

On receipt of interestBank a/c Dr.

To S.F. a/c

Profit/Loss on sale of S.F. investments, Profit/Loss on cancellation of own debenture made out of S.F. and premium on redemption of debenture will be transferred to S.F. a/c

On redemption of whole debentures, balance of S.F. a/c is transferred to General reserve a/c. if part debentures are redeemed then an amount equal to face value of debentures redeemed is transferred to General reserve a/c and balance will appear in B/S.

Non-cumulative S.F. InvestmentsInterest received on S.F. investments will not be re-invested i.e. will not be credited to S.F. a/c rather it will be credited to P&L a/c.

Chapter 12 Underwriting of Shares and Debenture

In simple word, underwriting is an insurance of public issue of shares/debentures.

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When a company offers shares/debentures to public then it enters into an underwriting contract with the underwriter who may be individual, partnership firm, company, bank, financial institution etc.

Under the underwriting contract, underwriter undertakes to subscribe the shares/debentures of company if not subscribed by the public. For this, he charges commission which is called underwriting commission.

Type of underwriting

1. Complete underwriting – When whole issue is underwritten by the underwriter

2. Partial underwriting – When only part issue is underwritten by the underwriter

3. Firm underwriting – When underwriter commits to take specified no. of shares/debentures.

In firm underwriting, underwriter has to take specified no. of shares/debentures even if issue is over subscribed.

4. Partial underwriting along with firm underwriting - Unless otherwise agreed, individual underwriter does not get the benefit of firm underwriting in determination of number of shares/debentures to be taken up by him.

For example, A underwrites 60% of an issue of 10,000 shares of Rs. 10 each of XY Co. Ltd. and also applies for 1,000 shares, ‘firm’. The underwriting commission is agreed to at the rate of 2.5 percent.

In case there are marked applications for 4,800 shares, he will have to take up 2,200 shares, i.e. 1,000 shares for which he applied ‘firm’ and 1,200 shares to meet his liability of underwriting contract.

If, on the other hand, the underwriting contract has provided that an abatement would be allowed in respect of shares taken up ‘firm’, the liability of A in the above-mentioned case would only be for 1,200 shares in total.

Underwriting commission (Sec. 76 of Companies act)

1. Rate of underwriting commission can not exceed 2.5% of issue price in case of debentures and 5% of issue price in case of shares.

2. Underwriting commission cannot be paid if issue is privately placed.

In other words, commission can be paid only if shares/debentures are offered to public.

Note- Private Placement means issue of shares/debentures to relatives, friends, associates etc.

Marked application – Underwriters issue shares application forms to public which bear their stamp. This helps the company in identifying the application received through various underwriters.

Unmarked application – Application forms which do not bear stamp of any underwriters or which are directly received by company

Joint underwriting -

Where underwriting has been done by two or more person then liability of each underwriter is computed as follows:

Statement of Liability of Underwriter

A B C Gross Liability (i.e. shares underwritten)Less: Firm underwriting Marked application Unmarked application (in GL ratio)

Less: Surplus of underwriter (in GL ratio)

Net liability Add: Firm underwriting Total liability

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Chapter 13 Employees Stock Option Plan/Buy back of Securities

ESOPIt gives right to the employees to purchase the shares of company at a pre-determined price.

Vesting periodis the period between grant of option and date on which all the specified vesting conditions are to be satisfied.

Vesting conditionsare the conditions which must be satisfied by the employees to become entitled to ESOP. e.g. minimum service period, achievement of targets etc.

Unvested option lapsedwhen vesting conditions are not met during vesting period. e.g. target not achieved, resignation by employee etc.

Vested option lapsedwhen vesting conditions are met but employee does not purchase the shares within maximum exercisable period.

Maximum exercisable periodPeriod during which options must be purchased by the employees. It starts after the vesting period is over.

Accounting treatment

Expenses to be recognized

(No. of option given – Unvested option lapsed at the end of year) x (MP-EP) X Vesting period expired xx

Total Vesting period

Less: exps. already recognized xx xx

On 31st March

*Employee compensation exps. a/c Dr. see note (i)To Employee stock option outstanding a/c

P & L a/c Dr.To Employee compensation exps. a/c

*Note- (i) when vesting period is not given, directly exercisable period is given then this entry will be made at the beginning of the year i.e. on the date of grant of option.

(ii) Employee stock option outstanding a/c will appear under the head “Share Capital” until the options are exercised/lapsed.

(ii) there will be no entry for unvested options lapsed

When options are purchased by the employees

Bank a/c Dr. (EP)ESO outstanding a/c Dr. (MP-EP)

To Equity share capital a/cTo Securities premium a/c (MP-FV)

When vested options lapsed / when exps. already recognized to be reversed.

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Employee stock option outstanding a/c Dr.*To General reserve a/c

* Employee compensation exps a/c wil be credited if vested option lapsed in same year.

Buy-Back of shares – Section 77A of Companies act

Condition of buy-back

1. A company may purchase its own shares out of

(i) Securities premium a/c

(ii) Free reserve i.e. reserves available for dividend (e.g. General reserve, P&L)

(iii) Proceeds of issue of new share (but not same kind of shares) & other specified securities e.g. ESOP

2. The buy-back should be authorized by its articles.

3. Shares to be bought back should be fully paid-up.

4. A special resolution has been passed in general meeting of the company authorising the buy-back.

5. The buy-back should not exceed 25% of the total paid up capital and free reserves of the company. Further, the

buy–back of equity shares in any F.Y. shall not exceed 25% of its total paid up equity capital in that financial year.

6. The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy-

back.

When shares are bought back from reserves and securities premium a/c then an amount equal to nominal / face value of shares is transfer to capital redemption reserve (CRR) a/c.

Premium on redemption of share is first adjusted from securities premium a/c. If it falls short then P&L a/c.

Redemption of Preference shares

Section 80 of Companies act, 1956

Preference share should be fully paid-up

Redemption can be made out of

(i) Issue of new share (ii) Free reserve i.e. reserves available for dividend

Free reserve –General reserve, P&L etc. but does not include capital reserve & securities premium a/c

When preference shares are redeemed from reserves then an amount equal to nominal / face value of preference share is transfer to capital redemption reserve (CRR) a/c

Premium on redemption of preference share is first adjusted from securities premium a/c. If it falls short then P&L a/c.

Accounting for Bonus issue

SEBI guidelines

Bonus issue can be made out of

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Capital redemption reserve

Capital reserve (realised in cash)

Securities premium (realised in cash)

Free reserves excluding revaluation reserves (e.g. General reserve, P&L)

Bonus issue should not be in lieu of dividend.

Before bonus issue partly paid up shares should be made fully paid up.

Bonus shares should be fully paid up.

Bonus issue should be made to Equity share holders only.

If company has convertible debentures then necessary shares should be earmarked for them. These shares may be

issued at the time of conversion.

Examination Questions

CHAPTER-1

Q. 1 ( May 2007, Nov 2008, 2011)

What are the qualitative characteristics of the financial statements which improve the usefulness of the information furnished therein?

Q. 2 (May 2008)

“One of the characteristics of financial statements is neutrality”- Do you agree with this statement?

CHAPTER-4

Q. 1 (Nov 1999, May 2001)Write a short note on Non-Performing Assets.

Q. 2 (May 2000, Nov 2000)Write a short note on Classification of advances in the case of a Banking Company.

Q. 3 (Nov 2000, 2003)Write a short note on Acceptances and endorsements

Q. 4 (May 2010)Mention the conditions when a cash credit overdraft account is treated as out of order.

CHAPTER-5

Q. 1 (Nov 1999, Nov 2004)Write a short note on Unexpired Risks Reserve.

Q. 2 (Nov 2000)Write a short note on Reinsurance.

Q. 3 (May 2000, 2006)Give computation of “premium income,” “claims expense” and “commission expense” in the case of an insurance company.

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Q. 4 (May 2010)Briefly explain the “Reserve for unexpired risk” under general insurance business. What are the percentage of such reserve to be created under IRDA act

.CHAPTER-6Q. 1 (Nov 2002, May 2007)Write a short note on Reasonable returns in electricity supply companies.Q. 2 (May 1999)Write short note on Main features of double account system of presentation of financial information in case of public utility companies.Q. 3 ( Nov 2001)Write a short note on receipt and payment on capital account and general balance sheet.

CHAPTER-7

Q. 1 (May 2001, Nov 2006, 2009)What are the conditions, which, according to AS 14 on Accounting for Amalgamations, must be satisfied for an amalgamation in the nature of merger?

Q. 2 (May 2002)Distinguish between (i) the pooling of interests method and (ii) the purchase method of recording transactions relating to amalgamation.

Ans:(i) The pooling of interests method is applied in case of an amalgamation in the nature of merger whereas purchase method is applied in the case of an amalgamation in the nature of purchase.

(ii) In the pooling of interests method, all the reserves of the transferor company are also recorded by the transferee company in its books of account while in the purchase method the transferee company records in its books of account only the assets and liabilities taken over..(iii) Under the pooling of interests method, the difference between the consideration paid and the share capital of the transferor company is adjusted in the general reserve or other reserves of the transferee company. Under the purchase method, the difference between the consideration and net assets taken over is treated by the transferee company as goodwill or capital reserve.

(iv) Under the pooling of interests method, the statutory reserves are recorded by the transferee company like all other reserves without opening amalgamation adjustment account. In the purchase method, while incorporating statutory reserves the transferee company has to open amalgamation adjustment account debiting it with the amount of the statutory reserves being incorporated.

Q. 3 (May 2004, 2009, Nov 2007)Briefly explain the methods of accounting for amalgamation as per AS-14.

Q. 4 (May 2009)Give the journal entry to be passed for accounting of unrealized profit on stock under amalgamation.

Q. 5 (May 2012)Briefly explain type of amalgamation.

CHAPTER-9

Q. 1 (May 2000)

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Overriding preferential payments under section 529A of the Companies Act, 1956.Q. 2 (May 2001, Nov 2008)What is meant by B List of Contributories and what is the the liability of contributories included in the list.

CHAPTER-10

Q. 1 (May 2010)What is piecemeal payment methods under partnership dissolution? Briefly explain the two methods followed for determining the order in which payment are made.

CHAPTER-12

Q. 1 (May 2004, Nov 2005)Write a short note on Firm underwriting and Partial underwriting along with firm underwriting.

Q. 2 (Nov 2007, 2010)What do you understand by the term “firm underwriting”

CHAPTER-13

Q. 1 (Nov 2001)Explain the Conditions to be fulfilled by a Company to buy-back its equity shares.

Q. 2 (Nov 2009)Explain Employees stock option scheme.

FORMAT OF BALANCE SHEET (AS PER REVISED SCHEDULE VI)

Balance Sheet as at 31st March, 2011

Particulars Note No

Figures as at the end of

current reporting

period

Figures as at the end of previous reporting

period

       

I. EQUITY AND LIABILITIES      

       

(1) Shareholder's Funds      

(a) Share Capital      

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(b) Reserves and Surplus      

(c) Money received against share warrants      

(2) Share application money pending allotment      

       

(3) Non-Current Liabilities      

(a) Long-term borrowings      

(b) Deferred tax liabilities (Net)      

(c) Other Long term liabilities      

(d) Long term provisions      

       

(4) Current Liabilities      

(a) Short-term borrowings      

(b) Trade payables      

(c) Other current liabilities      

(d) Short-term provisions      

Total      

II.Assets      

(1) Non-current assets      

(a) Fixed assets      

(i) Tangible assets      

(ii) Intangible assets      

(iii) Capital work-in-progress      

(iv) Intangible assets under development      

(b) Non-current investments      

(c) Deferred tax assets (net)      

(d) Long term loans and advances      

(e) Other non-current assets      

       

(2) Current assets      

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(a) Current investments      

(b) Inventories      

(c) Trade receivables      

(d) Cash and cash equivalents      

(e) Short-term loans and advances      

(f) Other current assets      

Total      

STATEMENT OF PROFIT AND LOSS (AS PER REVISED SCHEDULE VI)

Profit and Loss statement for the year ended 31st March, 2011

Particulars Note NoFigures as at the

end of current reporting period

Figures as at the end of previous reporting period

       I. Revenue from operations      II. Other Income      

III. Total Revenue (I +II)      IV. Expenses:      Cost of materials consumed      Purchase of Stock-in-Trade      Changes in inventories of finished goods, work-in-progress and Stock-in-Trade      Employee benefit expense      Financial costs      Depreciation and amortization expense      Other expenses      

Total Expenses             V. Profit before exceptional and extraordinary items and tax (III - IV)           VI. Exceptional Items             VII. Profit before extraordinary items and tax (V - VI)             VIII. Extraordinary Items             IX. Profit before tax (VII - VIII)      

       X. Tax expense:       (1) Current tax       (2) Deferred tax             

XI. Profit(Loss) from the perid from continuing operations (VII-VIII)    

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       XII. Profit/(Loss) from discontinuing operations             XIII. Tax expense of discounting operations             

XIV. Profit/(Loss) from Discontinuing operations (XII - XIII)             XV. Profit/(Loss) for the period (XI + XIV)      

       XVI. Earning per equity share:       (1) Basic       (2) Diluted      

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