143

CHAPTER 2

ACCOUNTING PROCESS, METHODS AND

CONTROL AND FINALISATION
OF ACCOUNTS
UNIT 5

ACCOUNTING PROCESS
Chapter Introduction
This chapter aims to provide you with an understanding of the accounting
process. You will also learn about the different types of accounts, the golden
rules of accounting and how transactions are classified on the basis of these rules.

a) Understand the accounting process.

b) Get introduced to double entry system of bookkeeping.
c) Learn about classification of accounts.
d) Understand the golden rules of accounting.
e) Get introduced to principle books and subsidiary books.
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1. Understand the accounting process.

[Learning Outcome a]
1.1 Accounting Process
Financial accounting is the process of identifying, measuring, classifying,
recording, summarising, analysing, interpreting and reporting the financial
performance and the financial position of the enterprise through financial
statements. The process stated above is called Accounting Process.
Diagram 1: Accounting Process
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Accounting process is based on certain:

9 Accounting Concepts
9 Accounting Principles and
9 Accounting Standards comprising accounting policies
for preparation and presentation of financial statements

To be precise, accounting process refers to the process of book keeping as well

as process of preparation of final accounts, that is, preparation of financial
statements.

Steps or stages of accounting process

Diagram 2: Stages of accounting process

From the above diagram we can see that accounting process covers the entire
process of commencing from obtaining information from source documents up to
the final stage of preparation of financial statements for communication of
financial results of all financial transactions effected and recorded by the
enterprise for a particular period.
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The stages of accounting process involve preparation of trial balance, profit &
loss account and _______

A Spread sheet
B Balance sheet
C Income sheet
D Profitability sheet

2. Get introduced to double entry system of bookkeeping.

[Learning Outcome b]

2.1 Bookkeeping

Bookkeeping is the foundation of financial accounting.

Bookkeeping is an activity that involves recording of financial data from

financial transactions relating to business operations in a systematic and
chronological order.

It covers procedural aspects of financial accounting and record keeping function.

Some people are mistaken in referring to ‘bookkeeping’ and ‘accounting’ as
synonymous terms. Accounting is a broad subject of which bookkeeping is the
small part but groundwork on which huge spectrum or edifice of financial
accounting rests.

2.2 Accounting systems

Diagram 3: Systems of accounting

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Single entry system

Single entry system is an accounting system for recording financial information

in which only one aspect of the transaction is recorded.

Single entry system of accounting does not follow any fixed set of rules. In this
system
9 some transactions are recorded on both sides
9 some transactions are recorded on one side
9 some transactions are not recorded at all
Hence single entry system of accounting is nothing but a mix of double entry,
single entry and no entry.
Single entry system of accounting is an incomplete form of recording financial
transactions. This system mainly maintains cash book and personal accounts of
debtors and creditors. It does not take into consideration nominal accounts and
real accounts except for cash. Hence single entry system of accounting does not
give a correct picture of the financial position of the business.

Individual and small shops or sole-proprietary business entities generally use

single entry system of bookkeeping and do most of their personal financial
accounting following this approach.

Double entry system

Double entry system of bookkeeping is used in almost all financial accounting

software for corporate houses including all insurance businesses. The double
entry bookkeeping system, which has emerged in the process of evaluation of
various accounting techniques, was codified in the 15th century by an Italian
named Lucas Pacioli.

Every financial transaction has two aspects – a debit leg and a credit leg.
Double entry system is
9 an accounting system of book keeping
9 based on a set of rules (golden rules of accounting)
9 for recording financial information
9 related to both (debit and credit) aspects of the transaction
9 in such a way that both sides are equally balanced
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A financial transaction may have

9 one debit and one credit (one-to-one) or
9 one debit and multiple credits (one-to-many) or
9 multiple debits and one credit (many-to-one) or
9 multiple debits and multiple credits (many-to-many)
In double entry system when a financial transaction is recorded, irrespective of
the number of debits or credits it may have, the total of both the sides is always
balanced.

In double entry system, two aspects are recorded for every transaction and hence
the name ‘double entry’ for this system of book keeping. The set of rules which
form the basis for classifying the aspects of a transaction are known as golden
rules of accounting.

The two aspects of every transaction are

DEBIT
and
CREDIT

The double entry accounting system records financial transactions in relation to

asset, liability, income or expense through accounting entries.
1. Asset: it is something that the company owns and adds value to the
company. Assets can generate revenue for the company or can be used for
utility purpose.
Examples: cash, land, machinery, goods, vehicle etc.
2. Liability: it is something that a company owes to others. It can be
obligations or payments due to others.
Examples: bank loans, creditors etc.
3. Income: it is the revenue earned by the business from its core activity of
selling products or offering services or from other sources.
Examples: profit earned selling products or offering services, income from
sale of assets, income from investments like bank FDs, dividend from shares
etc.
4. Expense: it is the amount spent by the business for running the day-to-day
operations of the business, marketing expenses for selling of goods and
services.
Examples: salaries paid to employees, rent paid for premises; interest paid
on loan, office expenses like printing, postage, stationery etc.
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An accounting entry in double entry bookkeeping system has two effects:

9 one of increasing account and the other of decreasing another account by
an equal amount or
9 increasing of both accounts or
9 decreasing of both accounts

i) A business purchases machinery worth Rs 2,50,000 in cash.

ii) In this case there will be increase in the machinery (asset) account by Rs
2,50,000 and decrease in cash or bank balance (asset) by the same amount of
Rs 2,50,000.
iii) The transaction has two effects. These two effects on purchase of an asset in
cash will be recorded as
9 Asset account – debit and
9 Cash account – credit
iv) The transaction will be recorded both in asset register / ledger and in cash
book.
v) In both the accounts i.e. asset account and cash account, the balances will be
modified by an equal amount after recording the single transaction i.e.
purchase of asset by cash.
vi) Now let us assume the same machinery (as mentioned in the above case) is
purchased on credit.
vii) In this case there will be increase in machinery (asset) account and also
increase in liability account or creditor’s account by an equal amount of Rs
2,50,000.
viii) When the creditor is paid off, there will be decrease in both, creditor’s
account and in cash or bank account by an equal amount of Rs 2,50,000.

Advantages of double entry system

Double entry system of accounting has some distinct advantages over the single
entry system. The advantages are as under:

1. The arithmetical accuracy of financial accounting is established through trial

balance, a summary of balances of all the ledger accounts including that of
cash and bank on a particular date.
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2. The financial results including performance of transactions recorded and the

consequent changes in the financial positions of the enterprise can be
measured and assessed systematically and logically through preparation of
financial statements including:
9 Trading A/c
9 Profit & loss A/c
9 Balance sheet
9 Income statement

3. Accounting done using double entry system provides detailed information for
analysis and management decision making.

4. Double entry system is based on a set of rules and principles and hence the
results and positions shown by financial systems are considered more
authentic and reliable. It exhibits a higher degree of true and fair view of the
financial position of the entity through financial statements.

5. Double entry system is globally and extensively used in business firms and is
based upon laid down principles and standards and hence the financial
statements of various firms in an industry are comparable both nationally and
internationally.

In which type of accounting system some transactions are recorded on both sides,
some on one side and some transactions are not recorded at all?

A Unique entry system

B Single entry system
C Double entry system
D Dual entry system
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3. Learn about classification of accounts

[Learning Outcome c]

3.1 Classification of accounts and accounting transactions

An accounting system records, retains and reproduces financial information

relating to financial transaction flows and financial position. Financial transaction
flows encompass primarily inflows on account of incomes and outflows on
account of expenses. Elements of financial position depicting the state of affairs
encompass assets such as land & building, plant & machinery, cash & bank
balances as ‘Property & Assets’ and sundry creditors, borrowings and capital as
‘Liability & Equity’. Each distinctive asset, liability, income or expense is
represented by its respective ‘account’.

1. An account is simply a record of financial inflows and outflows in relation to

the respective asset, liability, income or expense.
2. Income and expense accounts represent only the inflows and outflows
absorbed in the financial-position elements on completion of time period.
3. For the convenience of logical and systematic order of bookkeeping and for
preparation of financial statements, all transactions are recorded in the books
of accounts through the accounts of assets, liabilities, income and
expenditures.
4. Accounts are classified as
9 personal accounts
9 real accounts and
9 nominal accounts

Diagram 4: Classification of Accounts

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3.2 Personal Accounts

Personal accounts relate to:

9 individuals
9 partnership firms
9 corporate entities
9 local or statutory bodies including governments or other legal entities

Company ABC has purchased some office equipment from M/s X & Co. on
credit. So M/s X & Co. is a creditor on account of supply of goods to business
(Company ABC). M/s X & Co. is personal A/c.

When goods are sold on credit, debtor A/c is debited and sales A/c is credited.
For example Company ABC sells goods on credit to Company XYZ. In this case
Company XYZ becomes a debtor for Company ABC. This debtor A/c is personal
account in the books of the business for Company ABC.

Capital account is the account of proprietor and so it is a personal account. For

example Ajay starts a business by contributing an initial amount of Rs 25,000.
This initial Rs 25,000 will be credited to capital A/c which is a personal account
as it belongs to Ajay.

Personal accounts are of three types

1. Natural personal accounts: it relates to transactions of human beings such

as Ram A/c, X A/c, John A/c etc.

2. Artificial personal accounts: for business and financial accounting,

business entities are treated as separate legal entities. Examples: firms,
companies, co-operative societies etc.

3. Representative personal accounts: these are not in the name of any persons
or organisation but represented as persons. Examples: capital ac or drawings
A/c is a representative personal A/c.
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3.3 Impersonal Accounts

Real accounts: these relate to assets of the firm. For example accounts regarding
land, building, investment, furniture and cash & bank balance are real accounts.

Nominal accounts: these accounts relate to expenses, losses, gains, revenue etc.
like salary, wages, printing & stationery, interest paid, interest received,
commission, premium received, claims paid A/c etc.

Classification of Accounts

Account Nature Examples

Personal Business entities and Natural:
individual 9 Individuals
Artificial:
9 Firms
9 Corporate entities
9 Banks
9 Insurance companies
9 Statutory bodies etc.
Representative:
9 Capital
9 Drawings
Real Tangible assets and Tangible:
intangible assets 9 Cash
9 Bank balance
9 Plant & machinery
9 Furniture & fixtures
9 Stock
Intangible:
9 Patents
9 Goodwill
9 Copyrights
Nominal Elements of income, Income:
gains, revenue, profits, 9 Investment income
expenditure, losses etc. 9 Dividend
9 Interests on deposits
Expenditure:
9 Rent
9 Wages & Salary
9 Commission
9 Stationery etc.
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Goodwill will be classified under which type of account?

A Personal Account
B Unreal Account
C Real Account
D Nominal Account

4. Understand the golden rules of accounting

[Learning Outcome d]

4.1 Golden rules of accounting

A transaction is recorded as a ‘debit entry’ (Dr.) in one account and a ‘credit
entry (Cr)’ in the other account. The process of debiting and crediting accounts is
governed by golden rules of accounting. These golden rules imply the rules of
debit and credit for recording transactions in the books of accounts under double
entry system.

4.2 Application of rules of accounting

Type of account Debit rule Credit rule
1. Personal Debit the receiver Credit the giver
account
2. Real account Debit what comes in Credit what goes out
3. Nominal Debit all expenses and Credit all incomes,
account losses profits and gains

Personal Account: Accounting Rule:

Debit the receiver
Credit the giver

Company ABC sold goods worth Rs. 5000 to Company XYZ on credit.
In this case Company XYZ is the receiver of goods and hence as per the
accounting rule for personal account, (debit the receiver) in the books of
accounts of Company ABC, the account of Company XYZ will be debited for
Rs. 5000. The second aspect of this transaction is that goods are going out of the
company. Hence as per the accounting rule for real accounts (credit what goes
out) goods account will be credited for Rs. 5000.
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After 1 month, Company XYZ makes a cash payment of Rs. 5000 to Company
ABC. In this case Company XYZ is the giver of Rs. 5000 and hence as per the
accounting rule for personal account (credit the giver) in the books of accounts
of Company ABC, the account of Company XYZ will be credited for Rs. 5000.
The second aspect of this transaction is that cash of Rs. 5000 is coming into
Company ABC. Hence as per the accounting rule for real accounts (debit what
comes in) cash account will be debited for Rs. 5000.

Real Account: Accounting Rule:

Debit what comes in

Credit what goes out

Let us take the same example that we took for personal account

Company ABC sold goods worth Rs.5000 to Company XYZ on credit.

In this case goods worth Rs. 5000 are going out of the company.

Hence as per the accounting rule for real account, (credit what goes out) in the
books of Company ABC, goods account will be credited for Rs.5000.

After 1 month, Company XYZ makes a cash payment of Rs.5000 to Company

ABC. In this case cash of Rs.5000 is coming into Company ABC.

Hence as per the accounting rule for real account, (debit what comes in) in the
books of Company ABC, cash account will be debited for Rs.5000.

Nominal Account: Accounting Rule:

Debit all expenses and losses

Credit all incomes, revenue and gains

Company ABC paid Rs.1000 as telephone bill.

In this case, telephone bill is an expense for the company.

Hence as per the accounting rule for nominal account, (debit all expenses and
losses) in the books of Company ABC, telephone account will be debited for
Rs.1000.
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Company ABC received Rs.1000 as interest on bank deposit.

In this case, interest is an income for the company. Hence as per the accounting
rule for nominal account, (credit all incomes, revenue and gains) in the books
of Company ABC, interest account will be credit for Rs.1000.

Students should also note following fundamental aspects for better understanding
of golden rules of accounting.
1. In real account, when there is an increase in the amount of an asset, such
asset A/c is to be debited and the related account which gets reduced in
amount for the transaction is to be credited.
Example: a firm purchases a computer and makes payment by cheque for
Rs. 40,000. In this case computer A/c will be debited for Rs. 40,000 and bank
A/c will be credited for the same amount.
2. If the firm purchases the computer on credit from a firm called M/s
Electronic Systems, computer A/c will be debited for Rs.40,000 and M/s
Electronic Systems A/c (giver of the transaction) will be credited for the
same amount.
3. When M/s Electronic Systems A/c will be paid off for the price of the
computer purchased, M/s Electronic Systems (receiver of the payment) will
be debited for Rs.40,000 and bank A/c (giver of the transaction) will be
credited for the same amount.
4. According to the said rule, all expenses or losses are debited while incomes
and gains are credited. If there is reduction of expenses, expense A/c will be
credited. Similarly, if there is reduction of gains or incomes, income A/c will
be debited.

Example 1: Goods worth Rs 1000 are found defective and returned to the
supplier. Here purchase A/c will be credited and supplier A/c will be debited.
Example 2: In 2009-10, M/s PP Insurance Company ceded 20% of the total fire
premium collection of Rs 100 crores to RR Re-insurer and recovered from them
20% of the total fire claims paid for Rs.50 lakhs for the year as per reinsurance
treaty. In the books of PP Insurance Company, fire premium A/c will be debited
and M/s RR Reinsurer A/c will be credited for Rs.20 crores for cession of
premium, while re-insurer will be debited and fire claims A/c will be credit Rs 10
lakhs for recovery of claims from the reinsurer.
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To sum up, the under mentioned points deserve to be looked into:

1. Bookkeeping and accounting are done in respect of transactions

2. Transactions are different from events involving no monetary value

3. A transaction means an event which is measureable in terms of money and

causes a change in the financial position of a person, business entity and
others who maintain accounts.

4. All transactions are events while all events are not transactions.

5. Recording of a transaction consists, primarily of identification of individual

accounts involved in the transaction followed by ascertainment of debit and
credit, further followed by making journal entries in a book called ‘Journal’.

6. Records of individuals ledger accounts are kept in a book called ‘Ledger’.

7. Journal entries from ‘Journal’ are posted to the individual ledger accounts
maintained in the ‘Ledger’.

8. Balancing is done for each and every ledger account periodically, specifically
at the end of the accounting period.

9. Trial balance is prepared taking balances from the ‘ledger’ and also from the
cash and bank balances of cash book. It ensures arithmetical accuracy to
confirm the dual aspect of transactions. If the trial balance gets agreed, it
would mean that there have been corresponding credits for all the debits of
equal monetary value.

10. Adjustment entries or rectification entries and closing entries are prepared.

11. Some of the individual ledger balances from the trial balance are used for the
preparation of income statement such as profit & loss A/c while others along
with the result being either balance of loss or profit emanating from the
income statement are utilised for preparation of balance sheet or statement of
affairs.

12. Searching information through six questions serially as mentioned below can
make identification of individual ledger accounts involved in a transaction.
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a) What comes in?

b) What goes out?
c) What is the expense or loss incurred?
d) What is the income or gain made?
e) Who gives to the entity?
f) Who takes from the entity?

The questions are to be made on behalf of the entity whose accounts are being
recorded and owner’s identity must be treated as separate from the entity.

Paid Rs 300 to Pratip as his wages for Dec 2009

9 What comes in? – nothing
9 What goes out? – Cash (to be treated as one account involved)
9 What is the expense or loss? – wages (to be treated as another account)

One account is to be debited and the other account is to be credited. There may
be more than two accounts in a single transaction also. Alternatively, it may be
effected through more than one journal entry. No more questions are necessary if
prima facie minimum two accounts of equal monetary value are available that
complete the transaction. Hence the accounts are cash A/c and wages A/c and not
Pratip A/c.

13. Rules for ascertaining debit and credit may be elaborated for comprehensive
understanding which are stated below:

Rules for ascertaining debit and credit

Personal Accounts
Debtor or receivable Increases Debit
Decreases Credit

Creditor or payable Increases Credit

Decreases Debit

Real Accounts
Asset Increases Debit
Decreases Credit

Liability Increases Credit

Decreases Debit
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Nominal Accounts
Expense or loss Increases Debit
Decreases Credit

Income or gain Increases Credit

Decreases Debit

Company ABC paid Rs.1000 as telephone bill. What will be the accounting entry
in this case?

A Telephone account will be credited by Rs.1000 and company account will be

debited by Rs.1000
B Telephone account will be debited by Rs.1000 and cash account will be
credited by Rs.1000
C Cash account will be debited by Rs.1000 and telephone account will be
credited by Rs.1000
D Cash account will be credited by Rs.1000 and company account will be
debited by Rs.1000

5. Get introduced to principal books and subsidiary books.

[Learning Outcome e]

5.1 Principal books and subsidiary books

In business, separate registers are maintained for each and every class of
transactions for
9 purchase
9 sales
9 receipts and
9 payments of cash

Such registers or books are called ‘books of prime entry‘ or ‘books of original
entry’ or ‘subsidiary books’ as the transactions are recorded there initially. They
are nothing but journals. Ledgers where individual accounts are maintained are
called ‘principle books’ or ‘final books of account’.
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Diagram 5: Principal Books and Subsidiary Books

Following subsidiary books are commonly maintained in business firms.

1. Sales day book: records credits sales on a daily basis

2. Purchase day book: records credit purchases on daily basis

3. Cash book: records receipts and disbursements of cash or bank account

transactions on daily basis

4. Bank receipts day book: records all receipts of cheques and deposits into
banks where banking transactions are not recorded in cash book

5. Sales return book: records return of goods sold. This book is also referred to
as return inward book.

6. Purchases return book: records return of goods purchase. This book is also
referred to as returns outward book
7. Bills receivable book: records all receipts of bills, promissory notes
8. Bills payable book: records commitments for bills accepted
i) In insurance business, subsidiary books are:
9 premium register
9 claim payment register
9 commission register (both accrual and payment)
9 cheque dishonor register etc.
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ii) In insurance, primary books are:

9 general ledger for premium account
9 claims paid account
9 commission account
9 bank account etc

5.2 Concepts of capital & revenue: expenditure and receipts –

treatment

1. Capital and revenue

Business results can be properly ascertained if proper distinction is made

between capital and revenue transactions.

Capital transaction
A capital transaction is one, benefit of which is extended beyond one accounting
period.

Revenue transaction
A revenue transaction is one, benefit of which is exhausted within one
accounting period.

2. Receipt and expenditure

A capital transaction may either be capital receipt or capital expenditure.

Capital receipt
A capital receipt is converted into liability or capital contribution or which results
from disposal of an asset.
Capital expenditure
A capital expenditure gives rise to an item of asset usually enhancing earning
capacity.
Revenue receipt
A revenue receipt can be an income or gain
Revenue expenditure
A revenue expenditure gives rise to an expense
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Both capital receipts and capital expenditure appear in the balance sheet while
both revenue receipts and revenue expenditure appear in the profit & loss A/c.

The distinction between capital vs. revenue expenditure and capital vs. revenue
receipts is required for placing the items in the appropriate financial statements
i.e. profit & loss account of the balance sheet. Importantly, capital expenditure is
also ultimately taken into profit & loss account, but not in the year of spending. It
is spread over the period of use for generation of revenue.

Sales return book is also known as _______.

A Returns inward book

B Returns indoor book
C Returns outward book
D Returns outdoor book

Summary
¾ Accounting process refers to the process of identifying, measuring,
classifying, recording, summarising, analysing, interpreting and reporting the
financial performance and the financial position of the enterprise through
financial statements.
¾ Stages of accounting process include juournalising transactions, ledger
posting, balancing ledger; preparing trial balance, profit & loss account and
balance sheet.
¾ Accounting systems are of two types: single entry system and double entry
system.
¾ Accounts are classified into two main types: personal and impersonal
¾ Personal accounts can be natural, artificial and representative
¾ Real accounts can be tangible and intangible
¾ Nominal accounts include all expenses and losses, incomes and gains
¾ Golden rules of accounting:
9 Personal: debit the receiver and credit the giver
9 Real: debit what comes in and credit what goes out
9 Nominal: debit all expenses and losses and credit all incomes and gains
¾ Subsidiary books maintained in business include: sales book, purchase book,
cash book, bank receipts book, sales return book, purchase return book, bills
receivable, bills payable
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Answers to Test Yourself

Answer to TY 1

The correct answer is B.

The stages of accounting process involve preparation of trial balance, profit &
loss account and balance sheet.

Answer to TY 2

The correct answer is B.

In single entry system of accounting, some transactions are recorded on both

sides; some on one side and some transactions are not recorded at all.

Answer to TY 3

The correct answer is C.

Goodwill will be classified under real account.

Answer to TY 4

The correct answer is B.

Telephone account will be debited by Rs. 1000 and cash account will be credited
by Rs. 1000.

Answer to TY 5

The correct answer is A.

Sales return book is also known as returns inward book.

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Self-Examination Questions

Question 1

In bookkeeping, in systematic recording of financial transactions, which is the

first step?

A Journalising transactions with debit and credit

B Balancing of ledger accounts
C Preparation of profit & loss account
D Preparation of balance sheet

Question 2

Company ABC bought goods worth Rs 1000 from Company XYZ on cash. In
this transaction cash will be classified as which type of account?

A Personal account
B Real account
C Nominal account
D Normal account

Question 3

As per the golden rules of accounting, from the below, which one is applicable to
personal accounts?

A Debit all expenses and losses and credit all incomes and gains
B Debit what comes in and credit what goes out
C Debit the receiver and credit the giver
D Debit what goes out and credit what comes in

Question 4

Returns of purchased goods are recorded in which book?

A Returns inward book

B Returns indoor book
C Returns outdoor book
D Returns outward book
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Question 5

Bank paid interest Rs 1000 to Company XYZ, as interest on bank deposit. In this
case cash account will be _____ and interest account will be ______ in the books
of Company XYZ

A Debited, credited
B Credited, debited
C Debited, no effect
D Credited, no effect

Answers to Self-Examination Questions

Answer to SEQ 1

The correct option is A.

In bookkeeping, in systematic recording of financial transactions, the first step is

journalising transactions with debit and credit.

Answer to SEQ 2

The correct answer is B.

Company ABC bought goods worth Rs 1000 from Company XYZ on cash. In
this transaction cash will be classified as real account.

Answer to SEQ 3

The correct answer is C.

As per the golden rules of accounting, for personal accounts – Debit the receiver
and credit the giver.

Answer to SEQ 4

The correct answer is D.

Returns of purchased goods are recorded in returns outward book.

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Answer to SEQ 5

The correct answer is A.

Bank paid interest Rs 1000 to Company XYZ, as interest on bank deposit. In this
case cash account will be debited and interest account will be credited in the
books of Company XYZ.
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CHAPTER 2

ACCOUNTING PROCESS, METHODS,

CONTROL AND FINALISATION OF
ACCOUNTS
UNIT 6

ACCOUNTING METHODS AND CONTROL

Chapter Introduction
In this unit we will study the methods and procedures through which financial
data and information flow from the source documents to the stage where final
accounts are prepared.

The accounting methods and procedures include:

1. Methods of Journalising
2. Methods of Ledger Posting
3. Methods of Trial Balance Preparation and
4. Methods of Preparation of Final Accounts or Financial Statements.

Thus, to arrive at the final stage of financial accounting, an accountant has to

complete the various stages as mentioned above.

a) Explain Journals.
b) Explain how Cash Book is prepared.
c) Learn the objectives, rules and process of preparation of the trial balance.
d) Demonstrate the preparation of Final Accounts.
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1. Explain Journals.
[Learning Outcome a]
For recording and analysing business transactions of a financial nature, they are
classified into various types of accounts such as assets, liabilities, capital,
revenue and expenses. These are either debited or credited in accordance with the
rules of debit and credit applicable to the specific accounts. Applying dual aspect,
one account is debited and the other account is credited. Every transaction can be
recorded in the journal. This process of recording transactions in the journal is
known as ‘Journalising’.

The journal is the book in which transactions are recorded for the first time. It is
also known as the ‘Book of Original Record’ or ‘Book of Primary Entry’.

The following flow chart shows how journal plays an important role in the
preparation of financial statements.

Diagram 1: Important role of journal in the preparation of financial

statements

Journals are prepared in a particular form, as shown below:

JOURNAL
Date Particulars L.F Debit Credit
Amount Amount
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At the end of the journal entry, a narration or an explanation of the entry is given.

In a computer system, sometimes transactions may be directly posted in the

respective ledger account from source
documents, but posting of items in Journal proper is meant for
ledger or sub-ledger follow the rules recording all such transactions for
of journalising the transactions for which no special journal has been
accounting treatment. In a maintained in the business. E.g.
computerised system, journal machinery purchased on credit,
proper is maintained for closing outstanding expenses, pre-received
adjustment entries or rectification of income, etc.
mistakes etc.

Generally, in small business houses, one Journal Book is maintained in which all
the transactions are recorded. However, in the case of big business houses, the
transactions are quite large in number, and so the journal is divided into various
types of books called Special Journals in which transactions are recorded
depending upon the nature of transaction.

The following chart will help you to understand the different types of journals:

Diagram 2: Types of journals

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Journal entries can be either on single entry basis (one Debit A/c and one Credit
A/c) or compound entry basis (one debit and two or more credits or vice versa).
But in both the cases, the total of debits must equal the total of credits.

A firm purchased goods for Rs. 40,000 and made the payment partly in cash, Rs.
10,000, and the balance by cheque.

The journal entries for this transaction will be as follows:

Purchase A/c Dr Rs. 40,000

To Cash A/c Rs. 10,000
To Bank A/c Rs. 30,000
(Being goods purchased)

We will discuss the journalising process through examples for better

understanding.

Journalise the following transactions in the books of the business started by Mr.
Rajesh in April 2010.

1. 1st April: Mr. Rajesh commenced a business dealing in stationery with Cash
Rs.1,00,000.
2. 2nd April: he opened a bank account and deposited Rs.80,000.
3. 4th April: he purchased furniture in cash Rs.10,000.
4. 5th April: he purchased a computer for Rs.30,000 and paid by cheque.
5. 7th April: he purchased goods for Rs. 40,000 and paid by cheque.
6. 8th April: he sold goods for cash Rs.5000.
7. 9th April: he deposited Rs 5000 into the bank.
8. 10th April: he sold goods for Rs.10000 to M/s Unique Stationers who made
the payment by cheque which was deposited into the bank immediately.
9. 15th April: he purchased goods worth Rs.50000 on credit from M/S XYZ Ltd.
10. 20th April: he sold goods worth Rs.40000 to M/S P B Stores on credit.
11. 25th April: M/S P B Stores paid Rs 25000 through cheque, which was
deposited into the bank.
12. 26th April: M/S XYZ Ltd was issued a cheque for Rs.30,000 as part payment
for dues.
 171

13. 28th April; he withdrew Rs 15,000 from the bank and paid rent for Rs 5000
by cheque.
14. 29th April: he paid salary Rs 5000 to his staff.
15. 30th April: he drew Rs 5000 for personal use.
Pass the necessary journal entries in the books of the business.
Solution
Journal
In the books of the business of Rajesh
(Amount in Rs.)
Date Particulars LF Dr Cr
01.04.2010 Cash A/c Dr 1,00,000
To Capital A/c 1,00,000
(Being business commenced
with cash)
02.04.2010 Bank A/c Dr 80,000
To Cash A/c 80,000
(Being cash deposited into bank
account)
04.04.2010 Furniture A/c Dr 10,000
To Cash A/c 10,000
(Being furniture purchased)
05.04.2010 Computer A/c Dr 30,000
To Bank A/c 30,000
(Being cheque no. issued for
computer purchased)
07.04.2010 Purchase A/c Dr 40,000
To Bank A/c 40,000
(Being cheque no. issued for
goods purchased)
08.04.2010 Cash A/c Dr 5,000
To Sales A/c 5,000
(Being goods sold on cash)
09.04.2010 Bank A/c Dr 5,000
To Cash A/c 5,000
(Being cash deposited into
bank)
 172

In the books of the business of Rajesh

(Amount in Rs.)
Date Particulars LF Dr Cr
10.04.2010 Bank A/c Dr 10,000
To Sales A/c 10,000
(Being cheque for sales
proceeds deposited)
15.04.2010 Purchase A/c Dr 50,000
To M/S XYZ Ltd A/c 50,000
(Being goods purchased on
credit)
20.10.2010 M/S P.B. Stores A/c Dr 40,000
To Sales A/c 40,000
(Being goods sold on credit)
25.10.2010 Bank A/c Dr 25,000
To M/s P. B. Stores A/c 25,000
(Being cheque collected from
debtor and deposited)
26.10.2010 XYZ Ltd A/c Dr 30,000
To Bank A/c 30,000
(Being cheque no..issued to
creditor)
28.10.2010 Cash A/c Dr 15,000
To Bank A/c 15,000
(Being cash withdrawn from
bank)
28.10.2010 Rent A/c Dr 5,000
To Bank A/c 5,000
(Being rent paid by cheque)
29.10.2010 Salary A/c Dr 5,000
To Bank A/c 5,000
(Being salary paid to staff for
April 2010)
30.10.2010 Drawings A/c Dr 5,000
To Cash A/c 5,000
(Being cash drawn by
proprietor from business)
 173

In another example, we shall discuss how transactions in a general insurance

business are recorded in journals.

The following transactions took place in May 2010 in the business of Yong
General Insurance Co. Ltd:

1. Premium collected Rs. 10,000 in Fire Dept, Rs. 30,000 in Motor Dept, Rs.
10,000 in Marine Dept
2. Commission accrues on all types of business @ 10%.
3. Commission Rs. 6,000 accrued in April was paid in May, 2010 which
includes Rs. 1,000 for Fire Dept, Rs. 2,000 for Motor Dept, Rs. 1,000 for
Marine Dept and Rs. 2,000 for Misc. dept. 10%TDS on commission was
deposited.
4. Fire Claims paid for Rs. 20,000.
5. Marine Claims reported for Rs. 2,00,000.

Solution

In the books of Yong General Insurance Co Ltd: Journal

(Amount in Rs.)
Date Particulars LF Dr Cr
May 2010 Bank A/c Dr 50,000
To premium Control 50,000
A/c
(Being total premium collected
in May 2010)

May 2010 Premium Control A/c Dr 50,000

To Fire Premium A/c 10,000
To Motor Premium A/c 30,000
To Marine Premium 10,000
A/c
(Being premium collected in
May booked in respective
Dept.)
 174

In the books of Yong General Insurance Co Ltd: Journal

(Amount in Rs.)
Date Particulars LF Dr Cr
May 2010 Commission on Fire Dr 1,000
Business A/c
Commission on Motor Dr 3,000
Business A/c
Commission on Marine Dr 1,000
Business A/c
To Commission 5,000
Control A/c
(Being commission accrued in
May 2010 booked)

May 2010 Commission Control A/c Dr 6,000

To Bank A/c 5,400
To TDS on commission 600
A/c
(Being commission for April’10
paid)

May 2010 TDS on Commission A/c Dr 600

To Bank A/c 600
(Being TDS on April
Commission deposited)

May 2010 Fire Claims Paid A/c Dr 10,000

To Bank A/c 10,000
(Being fire claims paid)

May 2010 Marine Claims Outstanding Dr 2,00,000

at the End A/c
To Outstanding 2,00,000
Liability for Claims A/c
(Being marine claims in May)
 175

Journalising transactions is advantageous to the accountant in the following

ways:

9 Transactions are recorded in a chronological order; one can get complete

information about the nature and process and period of transactions occurred
as the entries in the journals are supported by proper narrations.

9 Journals facilitate proper posting of entries easily and systematically in

ledger accounts as they provide a basis for posting.

Which of the following statements related to the recording of journal entries is

correct?

A For any given journal entry, credits must exceed debits.

B Usually, credits are recorded on the left side and debits on the right side.
C The chart of accounts discloses the amount taken to the debit and credit of
the affected accounts.
D Journalisation is the process of converting transactions and events into a
debit-credit format.

2. Explain how Cash book is prepared.

[Learning Outcome b]
Cash transactions are straightway recorded chronologically in the Cash Book. On
the basis of records or entries in the cash book – on Debit and Credit sides for
receipts and payments of cash respectively - the cash book is prepared as a
Ledger Account.

The Cash Book is balanced like other accounts and the net balance is calculated
and placed in the trial balance and final statement of accounts. Though cash
book is a subsidiary book, it serves as Cash Account and Bank Account.
Thus, the Cash Book is both a subsidiary book and a principal book serving
the purpose of both types of books.

A cash book may be either the Main Cash Book or Petty Cash Book.
 176

Diagram 2: Types of Main Cash Book

2.1 Simple Cash Book

It is a single column cash book providing only one amount column on each side.
The left-hand side keeps the records of cash receipts while the right-hand side
amount column records the cash payments. Both the columns are totalled and the
balance is determined. The receipts column (debit side) is always higher than the
payments column (credit side). The excess balance on the debit side is written on
the credit side as ‘By balance c/d’, which is then taken to the Debit Side as ‘’To
Balance b/d” after the total to show the cash balance in hand at the beginning of
the next period. The following illustration will explain the concept better.

Enter the following transactions that occurred in July 2010 in a simple cash book
maintained by Mr. X for his sole proprietor business:
2010 Rs.
1 July Cash in hand 12,000
5 July Received from Rahim, a debtor 3,000
8 July Sold goods for Cash 3,000
10 July Purchased goods for cash from Prakash 2,000
15 July Sold goods to Mr. Z on credit 5,000
20 July Purchased furniture for cash 10,000
25 July Sold goods for cash 12,000
28 July Paid rent in cash 1,000
30 July Paid salary in cash 1,000
31 July Cash withdrawn for personal use 2,000
 177

Solution

Dr Cash book Cr
Date Particulars LF Amount Date Particulars LF Amount
2010
July
1 To Balance b/d 12,000 10 By Purchase 2,000
5 To Rahim 3,000 20 By Furniture 10,000
8 To Sales 3,000 28 By Rent 1,000
20 To Sales 12,000 30 By Salary 1,000
31 By Drawings 2,000
31 By Balance c/d 14,000
30,000 30,000
2010
August
1 To Balance b/d 14,000

Note: The transaction for 15 July, for sold goods to Mr. Z on credit, Rs. 5000
will not be recorded in the cash book.

2.2 Double Column Cash Book

In a double column cash book, both Cash account and Bank account are
prepared simultaneously and the double entry related to cash and bank
transactions is made in the book with a facility for cross verification at any time,
especially for reconciliation of cash and bank transactions.

Following is the format of Double Column Cash Book:

Dr Cash Book Cr
Dt Particulars L Cash Bank Dt Particulars L Cash Bank
F F

In this book, chances of errors in respect of banking transactions are reduced to

the minimum. The information regarding Cash in hand and Balance at Bank can
be obtained easily without any separate ledger of a particular bank account. In
double-column Cash Book, the following points must be kept in mind:
 178

1. All receipts are written on the receipts side—Cash in the Cash Column and
Cheques in Bank column. In the particulars column, the name of the account
in respect of which payment has been received is to be entered.

2. All payments are entered on the payment side, cash payment in the cash
column and payment by cheques in the bank column.

3. Contra Entries are made for transactions relating to cash withdrawn from
bank for office use and on cash deposited into bank. For cash withdrawn
from bank, the amount is entered in the bank column on the payment side
and in the cash column on the receipt side. Conversely, for cash deposited
into bank, the amount is entered in the bank column on the receipt side and in
the cash column on the payment side. For such contra entries, the letter “C”
should be entered in the L.F column to indicate that these are contra entries.

4. Entries for cheques dishonoured are made on the payment side of the bank
column with the name of the related party in the particulars column.

5. Closing Balance of Cash in hand and the Balance at Bank is obtained

through balancing of the Cash Account and Bank Account – which involves
determining the excess of the receipt side over the payment side for both cash
column and bank column.

The following example explains the method of preparation of the double-column

cash book.

In the books of the sole proprietor, Mr. Ramesh, prepare a double column cash
book.

2010 Rs.
1 Aug Cash in hand 22,000
Balance at Bank 25,000
5 Aug Received a cheque from Rahim, a debtor 30,000
6 Aug Cheque deposited into bank
8 Aug Sold goods for Cash 30,000
9 Aug Deposited cash into bank 20,000
10 Aug Purchased goods for cash from Prakash 20,000
15 Aug Sold goods to Mr. Z on credit * 50,000
 179

2010 Rs.
20 Aug Purchased furniture; paid in cash 10,000
and balance by cheque 20,000
25 Aug Sold goods for cash 12,000
28 Aug Paid rent by cheque 10,000
29 Aug Cash withdrawn from bank 20,000
30 Aug Paid salary in cash 10,000
31 Aug Cash withdrawn for personal use 2,000

Dr Cash Book Cr
Dt Particular L Cash Bank Dt Particulars L Cash Bank
s F F
1 To Balance 22,000 25,000 6 By Cash C 30,000
b/d A/c
5 To Rahim 30,000 9 By Cash C 20,000
A/c A/c
6 To Cash C 30,000 10 By Purchase 20,000
A/c A/c
8 To Sales 30,000 20 By 10,000 20,000
A/c Furniture
A/c
9 To Cash C 20,000 28 By Rent A/c 10,000
A/c
25 To Sales 12,000 29 By Cash C 20,000
A/c A/c
29 To Bank C 20,000 30 By Salary 10,000
A/c A/c
31 By 2,000
Drawings
A/c
31 By Balance 22,000 25,000
c/d
1,14,000 75,000 1,14,000 75,000

* 15 Aug: sold goods to Mr. Z on credit – this transaction will not be recorded in
the Cash Book as it is a credit transaction.

Note: in a Cash book, Cash A/c will always have a debit balance but Bank A/c
may have either a debit or a credit balance. Credit balance in a Bank A/c
represents Bank Overdraft.
 180

The following transactions occurred in July 2010 (up to 10th July) in Lucknow
Branch I of Good Luck General Insurance Company. The premium collected for
a day is deposited into the bank the very next day.

Rs.
1 July Cash in hand 22,000
Balance at Bank 4,50,000
2 July Premium Collection (Cash Rs. 20,000 & Cheques Rs. 2,20,000
200,000)
5 July Premium Collection (Cash Rs. 30,000 & Cheques Rs. 4,30,000
400,000)
6 July Premium Collection (Cash Rs. 50,000 & Cheque Rs. 4,50,000
400,000)
7 July Premium Collection (Cash Rs. 40,000 & Cheques Rs. 5,40,000
500,000)
7 July Remittance sent to Head Office 10,00,000
8 July Commission for June disbursed by cheque after deducting 1,44,000
TDS Rs. 16,000
8 July Premium Collection (Cash Rs. 20,000 & Cheques Rs. 5,20,000
500,000)
9 July TDS on Commission deposited 16,000
9 July Premium Collection (Cash Rs. 60,000 & Cheques Rs. 5,60,000
500,000)
10 July Remittance sent to Head Office 14,40,000
Premium Collection (Cash Rs 40000 & Cheques Rs 300,000) 3,40,000
Festival Advance paid to staff 15,000
Cash withdrawn from bank 10,000

Prepare the Cash Book and show the closing balance as on 10-07-2010. Verify
the closing balance of the Cash A/c and Bank A/c as on 10-7-2010.
Solution

Dr Cash Book Cr
Dt Particulars L Cash Bank Dt Particulars L Cash Bank
F F
1 To Balance 22,000 4,50,000 5 By Bank C 2,20,000
b/d A/c
 181

Dr Cash Book Cr
Dt Particulars L Cash Bank Dt Particulars L Cash Bank
F F
2 To 2,20,000 6 By Bank C 4,30,000
Premium A/c
control A/c
5 To Cash C 2,20,000 7 By Bank C 4,50,000
A/c A/c
To 4,30,000 By Head 10,00,000
Premium Office A/c
control A/c
6 To Cash C 4,30,000 8 By Bank C 5,40,000
A/c A/c
To 4,50,000 By Agency 1,44,000
Premium Commissio
control A/c n A/c
7 To Cash C 4,50,000 9 By Bank C 5,20,000
A/c A/c
To 5,40,000 By TDS on 16,000
Premium commission
control A/c A/c
8 To Cash C 5,40,000 10 By Bank C 5,60,000
A/c A/c
To 5,20,000 By Head 14,40,000
Premium Office A/c
control A/c
9 To Cash C 5,20,000 By Cash C 10,000
A/c A/c
To 5,60,000 By Festival 15,000
Premium Advance
control A/c A/c
10 To Cash C 5,60,000 By Balance 3,57,000 5,60,000
A/c c/d
To 3,40,000
Premium
control A/c
To Bank C 10,000
A/c
30,92,000 31,70,000 30,92,000 31,70,000
Note: sometimes in the cash book a short narration is given for every transaction.
 182

2.3 Triple Column Cash Book

Along with columns for Cash and Bank Accounts on the debit and credit side of
cash books showing cash receipts and payments and bank receipts (deposits) and
payments (withdrawals), another additional column may be added on both the
sides to record the transactions of ‘Cash Discount Allowed’ and Cash Discount
Received’.

9 ‘Cash Discount Allowed’ is related to the receipt or collection of recoveries.

When cash discount is allowed to customers, the amount collected is shown
in the Cash or Bank column as the case may be on the debit side, and the
amount of discount allowed is shown in the Discount Column on the debit
side.

9 Conversely, ‘Cash Discount Received’ is related to cash payment to

creditors. When Cash Discount is received on making payment to creditors,
the net payment is shown in the Cash Column and the discount amount is
shown in the Discount column.

Remember that unlike Cash and Bank Columns, Discount Columns are not
balanced. Debit Column of Discount is Discount Allowed A/c which is an
expense while Credit Column of Discount represents Discount Received A/c
which is an income. As Expenditure Account and Income Account are to be
shown separately, one cannot be adjusted with the other to determine the net
balance.
The total debits and total credits are shown in the monthly Trial Balance.

Following is the format of Triple Column Cash Book:

Dr Three Columnar Cash Book Cr

L L
Date Receipts Disc Cash Bank Date Payments Disc Cash Bank
F F
 183

Transactions in the books of M/S ABC & CO for the month of August 2010:

2010 Rs.
1 Aug Cash in hand 2,000
Balance at Bank 5,000
5 Aug Received cheque from Rina, a debtor, after discount of Rs. 50 2,550
6 Aug Cheque deposited into bank
8 Aug Sold goods for Cash 30,000
9 Aug Cash deposited into bank 20,000
10 Aug Purchased goods for cash from Prakash 10,000
15 Aug Sold goods to Mr. Z on credit* 50,000
20 Aug Purchased furniture and paid by cheque 10,000
25 Aug Sold goods for cash 12,000
28 Aug Paid rent by cheque 10,000

Prepare a Triple column Cash Book for the month of August 2010
Cash Book
L L
Date Receipts Disc Cash Bank Date Payments Disc Cash Bank
F F
Aug- Aug-
10 10
To Balance
1 b/d 2,000 5,000 6 By Bank C 2,550
5 To Rina 50 2,550 9 By Bank C 20,000
By
6 To Cash C 2,550 10 Purchase 10,000
By
8 To Sales 30,000 20 Furniture 10,000
9 To Cash C 20,000 28 By Rent 10,000
By
Balance
25 To Sales 12,000 31 c/d 14,000 7,550
50 46,550 27,550 46,550 27,550

* 15 Aug: sold goods to Mr. Z on credit – this transaction will not find a place in
the Cash Book.
 184

2.4 Petty cash book

There could be certain transactions such as payment for postage, local transport
or food and refreshments for the staff that may not be paid for by cheque. These
payments have to be made in cash as these are of small amounts. There may also
be a lack of systems at the receiver’s side to process such small amounts.

As indicated by the literal meaning of the word ‘petty’ i.e. insignificant or small,
petty cash transactions mean small cash transactions. Petty cash refers to the cash
that is held by the entity for small expenses.

The petty cash book has a number of columns for amount on the payment side.
Each of the amount columns is allotted to specific, common expenses. The last
column is allotted for miscellaneous expenses. At the end of the period, all
amount columns are totalled. The total of the amount paid shown in column 5 is
deducted from column 1 to calculate the petty cash balance.

Format of petty cash book

Dr Petty Cash Book Cr

Particulars

Amount Amount
Date

Voucher
received paid Analysis of Payments
No.
(Rs) (Rs)
& Telegram

Conveyance
Telephone

Stationery

Expenses
Postage

Misc.

1 2 3 4 5 6 7 8 9 10

Which of the following statements concerning the triple column cash book is
correct?

A The ledger folio column represents the third column of the cashbook
B The discount column totals should be the same to enable balancing
C The bank column can have either a debit or a credit balance
D The cash column can have a credit balance at the end of the period
 185

3. Learn the objectives, rules and process of preparation of

the trial balance.
[Learning Outcome c]
Under the double entry system, for every debit entry, there is a corresponding
credit entry of the same amount when we record a transaction for financial
accounting. Consequently, the total amount of all the debit entries should be
equal to the total of all credit entries for any particular period of accounting.

A statement showing all debit items and all credit items is prepared periodically
to verify whether the two totals i.e. the debit total and the credit total are equal.
Such debit items and credit items are taken from the general ledger after
balancing. The debit items are shown in one column and the credit items are
shown in another. This statement is called a trial balance.

Generally, a monthly trial balance is prepared to verify the arithmetical accuracy

of the recording of transactions in financial accounting.

There are two methods of preparing a trial balance.

1. Trial Balance prepared with the gross totals of the debit side and the credit
side of each ledger account and
2. Trial Balance prepared with the net balance of each ledger account. The
former is called Gross Trial Balance while the latter is called Net Trial
Balance.

Generally, Net Trial Balance is adopted in almost all cases. Trial balance
contains the net balances of Personal Accounts and Real Accounts while
Nominal Accounts are shown with gross debit totals and gross credit totals.

Financial statements are prepared on the basis of the trial balance. Nominal
Accounts are taken into Trading and Profit &Loss Account, while the balances of
Personal Accounts and Real Accounts are shown in the Balance Sheet.

Debit Balances of Personal Accounts and Real Accounts are shown on the Asset
Side and Credit Balances of these accounts are shown on the Liability Side of the
Balance Sheet.

Thus, Trial Balance is the foundation of financial statements.

 186

Diagram 2: Steps to prepare trial balance

The following example will help you to understand the method of preparation of
Trial Balance.

From the following balances of accounts of a sole proprietor business, prepare a

Trial Balance as on 31.3.2010

Rs. Rs.
Purchase of goods 3,10,000 Furniture and fittings 22,000
Sales of goods 4,20,000 Advertising & publicity 10,000
Discount on sales 20,000 Printing & stationery 10,000
Opening stock 50,000 Motor car 48,000
Cash in hand 2,100 Bad debts 2,000
Cash at bank 12,000 Cash discounts 4,000
Proprietor’s capital 2,88,600 General expenses 14,000
Drawings 4,000 Carriage inwards 22,000
Rent, rates and taxes 5,000 Carriage outwards 10,000
Salaries 32,000 Wages 20,000
Postage and telephones 11,500 Sundry creditors 40,000
Commission paid to 35,000 Sundry debtors 96,000
salesmen
Insurance premium 9,000
 187

Solution
Trial Balance as on 31.03.2010
(Amount in Rs.)
Dr Cr
Purchase of goods 3,10,000
Sales of goods 4,20,000
Discount on sales 20,000
Opening stock 50,000
Cash in hand 2,100
Cash at bank 12,000
Proprietor’s capital 2,88,600
Drawings 4,000
Rent, rates and taxes 5,000
Salaries 32,000
Postage and telephones 11,500
Commission paid to salesmen 35,000
Insurance premium 9,000
Furniture and fittings 22,000
Advertising & publicity 10,000
Printing & stationery 10,000
Motor car 48,000
Bad debts 2,000
Cash discounts 4,000
General expenses 14,000
Carriage inwards 22,000
Carriage outwards 10,000
Wages 20,000
Sundry creditors 40,000
Sundry debtors 96,000
7,48,600 7,48,600

Note: If the totals of the two amount columns of the trial balance do not agree, it
means there is some mistake in the ledger posting, and the difference is taken to
the suspense account to temporarily agree the trial balance.

A trial balance is prepared in order to:

1. confirm the arithmetical accuracy of the ledger accounts
2. help in locating errors
3. provide a basis for preparing the final accounts / financial statements
 188

A credit balance in which of the following accounts would indicate a likely

error?

A Premium received
B Share capital
C Claims incurred
D Accumulated depreciation

4. Demonstrate the preparation of Final Accounts.

[Learning Outcome d]
Preparation of Final Accounts or Financial Statements is the concluding stage of
financial accounting. Final Accounts include Trading and Profit & Loss Account
and Balance Sheet, which are drawn at the end of the accounting or trading
period to ascertain the trading or operating results and to present the state of
affairs of the business at the end of a year, after adjustment of operating results
including profit or loss during the period.

4.1 The Trading Account

The Trading Account determines the gross profit which is the difference between
the sales price of goods sold and the cost of goods sold. Gross profit represents
the difference between the sale price and the cost price of goods or services sold.

It is calculated not so much for the amount itself, as for the usefulness of
knowing the ratio the gross profit bears to the turnover (i.e. the total of sales less
returns), and the value of the ratio for comparison with similar information from
preceding business years.

The ratio of gross profit to turnover should remain fairly constant from year to
year. Fluctuations in the ratio call for an enquiry into the causes. The method of
preparation of gross profit can be easily understood from the examples shown
hereinafter.

4.2 The Profit and Loss Account

The purpose of the profit and loss account is to determine the net profit i.e., final
operating surplus available for its distribution to government, the proprietors or
partners or shareholders as the case may be.
 189

The method of preparation is briefly described as under:

1. The account is credited with the gross profit (or debited with gross loss) from
the trading account and debited with all the charges incurred in the course of
the business other than those which have already been taken to the trading
account.

2. It is also credited with any gain which is made apart from trading, such as
rent from any premises sublet interest on investments, profit on sale of
capital assets etc. The difference is the net profit or net loss, as the case may
be, for the trading period. This represents the amount available for
distribution to the proprietors of the business or other stakeholders as
mentioned above.

3. The items which are shown in a profit and loss account are grouped, with
subtotals, under rational headings, so that the trends shown by a succession
of accounts may be followed more easily. The expenses may be placed
broadly under heads such as Administrative expenses, Selling expenses,
Distribution expenses and General expenses.

4. The disposal/ distribution of the net profit varies according to the nature of
ownership of the business. In the case of a proprietorship or partnership
concern, it is transferred to the capital account(s) of the proprietor or partners
as the case may be. In the case of a limited company, however, profit and
loss account is maintained as an open account and appears separately in the
balance sheet.

5. Expenses which are virtually appropriation of profits, such as salary to

partners, interest on capital, commission to partners etc. should not be
debited to profit and loss account. These are debited to profit and loss
appropriation account. Similarly, interest on drawings is credited to profit
and loss appropriation account. The profit and loss appropriation account
begins with the closing balance of profit and loss account, i.e., net profit or
net loss.

6. The trading account, profit and loss account and profit and loss
appropriation account are usually prepared together, that is, they are
drawn as one account with three distinct parts – the first part showing the
gross profit, the second part, the net profit and the third part the distribution
of profit.
 190

The above mentioned procedure can be summarised as shown below:

Diagram 3: Procedure of preparing Profit and Loss A/c

Which of the following is NOT debited to the profit and loss account?

A Gross loss
B Net loss
C Salary paid
D Interest on loan

4.3 Balance Sheet

The last stage of final accounts is the balance sheet.

The purpose of the balance sheet is to show the financial position or state of
affairs of the business entity as at the end of the accounting period. The financial
position is exhibited by a statement of assets and liabilities.
 191

A balance sheet is drawn up from the balances of those ledger accounts (Real &
Personal Accounts) which remain open after the accounts relating to revenue and
expenses have been closed by transferring their balance to the trading and profit
and loss accounts. Such balances are relating to assets or liabilities. Thus, a
balance sheet is not an account forming part of the double entry system; it is a
statement prepared from the balances of accounts. The balances are not
transferred to the balance sheet. They remain in the accounts to appear as
opening balances of the next trading period.

The balance sheet may be regarded as a statement which shows, on one hand, the
sources from which the funds of an enterprise have been obtained and, on the
other, the ways in which these funds are used/ applied.

The Balance Sheet in a vertical form shows the sources and application of funds
during the trading period. The Funds may be derived from various sources such
as investment of the owners, borrowings, sale of assets, decrease in working
capital, profit from operation, etc. and they may be applied in the purchase of
fixed assets, drawings by owners, distribution of profits, payment of loans or
borrowings, increase in working capital, operating loss etc. The Balance Sheet
exhibits all such sources and application of funds in proper form and order to
enable the users of the Balance sheet to understand the information.

From another point of view, the balance sheet is regarded as setting out, on one
hand, the rights and properties (or assets) which an enterprise owns or possesses
and, on the other, the financial liability to be paid by the enterprise.

The balance sheet has acquired the status of a highly important accounting report,
because it serves as a valuable source of information to owners and other
stakeholders. It sets out in summary a picture of the financial position of the
business. It provides a reasonable basis for an analytical study for necessary
interpretation and critical examination of the assets and liabilities of the entity on
a particular date. If, along with the current year balances, the same assets and
liabilities as at previous balance sheet date are shown, the net changes can be
easily seen and the use of the statement as a mirror of results and as a
determinant of trading policy is enhanced. From the following illustrations, you
will see how balance sheet is prepared from the trial balance after preparation of
the Trading and Profit& Loss account.

Final Accounts of companies is discussed in unit no 9 and final accounts of

general insurance companies is discussed in unit 12.
 192

The following examples will help you understand the method of preparation of
Final Accounts.

Final accounts can be prepared from the Trial Balance illustrated in the example
given in Learning Outcome 3 along with the following information:

The following adjustments are to be made:

a) Stock on 31st March, 2010 was valued at Rs.145000.

b) The owner has taken out for personal use goods costing Rs. 5000 out of
purchases during the year.
c) Furniture purchased for Rs. 10000 was wrongly included in purchases.
d) Rs. 5000 due from a debtor included in sundry debtors has become bad.
e) Creditors include a balance of Rs. 4000 to the credit of Mr. Ram in respect of
which it has been settled that only Rs.1000 is to be paid to him.
f) Provision for bad debts to be created at 5% on sundry debtors.
g) Depreciate furniture and fittings by 10% and motor car by 25%.
h) The salesmen are entitled to a commission of 10% on sales.

Solution
Trading and Profit & Loss Account For the
Dr year ended 31st March 2010 Cr
Rs. Rs.
To Opening 50,000 By Sales 4,40,000
stock
To Purchases 3,10,000 Less: Discount 20,000 420,000
Less: Personal 5,000 By Closing stock 1,45,000
use
Less: Furniture 10,000 2,95,000
To Wages 20,000
To Carriage 22,000
inwards
To Gross Profit 1,58,000
c/d
5,45,000 5,45,000
To Rent, rates 5,000 By Gross Profit 1,58,000
and taxes b/d
To Salaries 32,000 By Discount 3,000
from Creditors
 193

Trading and Profit & Loss Account For the

Dr year ended 31st March 2010 Cr
To Postage and 11,500
telephones
To 35,000
Commission to
salesmen
Add: 5,000 40,000
Outstanding
To Insurance 9,000
premium
To Advertising 10,000
and publicity
expenses
To Printing and 10,000
stationery
To Bad debts 7,000
(2,000 + 5,000)
To cash 4,000
discounts
To General 14,000
expenses
To Carriage 10,000
outwards
To Provision 4,550
for bad debt
To
Depreciation
Motor car 12,000
Furniture and 3,200 15,200 By Net Loss 11,250
fittings transferred to
Capital A/c
1,72,250 1,72,250
 194

Balance Sheet as at 31st March 2010

Capital and Liabilities Rs. Assets Rs.
Capital Account Fixed Assets
Opening balance 2,88,600 Motor Car 48,000
Less: Net loss 11,250 Less: 12,000 36,000
Depreciation
277,350 Furniture & 22,000
fittings
Less: Drawings 9,000 2,68,350 Add: Addition 10,000
(5,000 + 4,000) during year
32,000
Less: 3,200 28,800
Depreciation
Current Current Assets
liabilities
Sundry Creditors 37,000 Stock in trade 1,45,00
(40,000 – 3,000) 0
O/s Salesman 5,000 Sundry Debtors 91,000
Commission (96,000 – 5,000)
Less: 5% 4,550 86,450
Provision for
bad debts
Cash at Bank 12,000
Cash in hand 2,100
310350 310350
 195

Prepare Trading and Profit & Loss Account and Balance Sheet as at 31st March
2010 from the following trial balance as on 31.3.2010 in the books of Mr X
Agarwal
Trial Balance as on 31.3.2010
(Amount in Rs.)
Particulars Dr Cr
Opening stock 50,000
Purchases 1,25,000
Bills receivable 13,200
Sales 2,60,000
Sales return 2,000
Purchase return 1,200
Discounts 300 250
Carriage outwards 500
Salaries 10,000
Insurance 1,200
Rent 3,000
Sundry debtors 45,000
Sundry creditors 20,000
Income-tax 900
Cash and bank 5,000
Furniture and fittings 5,000
Bad debts 2,000
Plant and machinery 80,000
Freight and duty 1,500
Wages 15,000
Provision for bad debts 1,750
Capital 81,400
Drawings 5,000
3,64,600 3,64,600
Additional information
a) Stock on 31st March, 2010 was valued at Rs. 60,000.
b) The provision for bad debts is to be maintained at 5% on sundry debtors.
c) Total bad debts to be written off during the year Rs. 3,200.
d) Outstanding liabilities for Salaries Rs. 2,000 and Wages Rs. 3,000.
e) Rent and insurance paid during the year were for 15 and 18 months
respectively.
f) Depreciate:
9 Furniture and fittings by 5%.
9 Plant and machinery by 10%.
 196

Solution:
X Agarwal
Trading and Profit & Loss Account for the year ended 31st March 2010

Dr Cr
Rs. Rs.
To Opening stock 50,000By Sales 2,60,000
To Purchases 1,25,000 Less: Returns 2,000 2,58,000
Less: Returns 1,200 1,23,800By Closing stock 60,000
To Freight and duty 1,500
To Wages 15,000
Add: Outstanding 3,000 18,000
To Gross Profit c/d 1,24,700
3,18,000 3,18,000
To Discount 300By Gross Profit b/d 1,24,700
Allowed
To Carriage 500By Discount 250
Outwards Received
To Salaries 10,000
Add: Outstanding 2,000 12,000
To Insurance 1,200
Less: Prepaid (6/18 400 800
months)
To Rent 3,000
Less: Prepaid (3/15 600 2,400
months)
To Provision for 2,190
Bad Debts 5% on
Rs.43800
Add: Bad debts 3,200
written off
5,390
Less: Existing 1,750 3,640
Provision
To Depreciation:
Plant & Machinery 8,000
Furniture & Fittings 250 8,250
To Net Profit 97,060
transferred to
Capital
1,24,950 1,24,950
 197

X Agarwal
Balance Sheet As At 31st March 2010

Capital and Liabilities Rs. Assets Rs.

Capital Account Fixed Assets
Capital A/c Op 81,400 Plant & 80,000
Balance Machinery
Add: Net Profit 97,060 Less: depreciation 8,000 72,000
1,78,460 Furniture& 5,000
Fittings
Less: Drawings 5,000 Less: depreciation 250 4,750
Less: Income tax 900 1,72,560Current Assets
Current liabilities Stock in trade 60,000
Sundry creditors 20,000Sundry debtors 45,000
Outstanding Less: Bad debt 1,200
expenses written off Rs.
(3,200 – 2,000)
Wages 3,000 43,800
Salaries 2,000 5,000Less: Provision 2,190 41,610
for bad debts
Bills Receivable 13,200
Cash and Bank 5,000
Prepaid Expenses
Insurance 400
Rent 600 1,000
1,97,560 1,97,560

Which of the following is not an element of the balance sheet?

A Income
B Assets
C Liabilities
D Equity
 198

Summary
¾ The flow of accounting from the time a transaction takes place to its
recording in the ledger may be illustrated as follows:

¾ A journal is a book of accounts in which all day-to-day transactions are

recorded in the order of their occurrence.
¾ In big business houses, a journal is classified into various special journals
which record transactions of similar and repetitive nature. All those
transactions which arise occasionally or do not find a place in any of the
special journals are recorded in the Journal proper.
¾ Do not confuse a journal entry and a journal (i.e. journal proper). A journal
entry is a way of recording a transaction in a debit / credit form. A journal
proper is a book of special transactions, which are not otherwise recorded in
the books of prime entry. These are generally the adjustment entries such as
provisions for doubtful debts, income receivable, expense payable etc.
¾ The Cash Book records all transactions related to receipts and payments
made in cash only.
¾ The Cash Book itself is a Cash Account, and hence, no separate cash account
will be maintained in the ledger.
¾ When there is a transaction that relates to both cash and bank, this will be
written on one side of the Bank Column and on other side of the Cash
Column. Such transactions are known as ‘Contra entries’.
¾ A separate cash book to record small transactions is called a petty cash book.
 199

¾ The Trial Balance may be defined as a statement containing balances of all

ledger accounts on a particular date.
¾ The Trial Balance helps to determine the arithmetical accuracy of posting in
the ledger.
¾ Final Accounts (Financial statements) are the statements that are prepared at
the end of the accounting period, which is generally one year. These include
the income statement i.e. Trading and Profit & Loss Account and Balance
Sheet.
9 Trading Account is prepared to ascertain the results, gross profit or gross
loss, of the trading activities of the business.
9 Profit and Loss Account is prepared to find out the Net Profit/Net Loss.
9 Balance Sheet is prepared to ascertain the financial position of a firm on
a particular date.

Answers to Test Yourself

Answer to TY 1

The correct option is D.

Journalisation is the process of converting transactions to their debit / credit form

and recording them in the general journal.

Option A is incorrect because for any given journal entry, whether single or
compound, debits must equal credits.
Option B is incorrect because traditionally, debits are recorded on the left side
and credits on the right side.
Option C is incorrect because the chart of accounts is a listing of accounts in use
(and their corresponding reference number).

Answer to TY 2
The correct option is C.
Bank column can have either a debit or a credit balance. Credit balance in the
Bank column is regarded as Bank overdraft.

Answer to TY 3
The correct option is C.
Claims incurred are expenses and should have debit balance.
 200

Answer to TY 4

The correct option is B.

Net loss will be recorded on the credit side of the P&L A/c as it indicates excess
of expenses over income.

Answer to TY 5
The correct option is A.
Income is an element of profit and loss account. All other items are elements of
the balance sheet.

Self Examination Questions

Question 1
A contra entry in the cashbook would include:
A Totalling up the bank and cash columns at the end of each month
B Transferring the discounts to the accounts in the general ledger
C Transferring cash into the petty cash box
D Withdrawing cash from the bank account

Question 2
The amount of cash discount allowed on a transaction will initially be recorded in
the:
A Sales day book
B Sales invoice only
C Cash book (receipts side)
D Cash book (payment side)

Question 3
A transaction which does not involve payroll, cash or credit is likely to be
recorded in:
A The journal
B The purchase day book
C The cash book
D The petty cash book
 201

Question 4

Which of the following items would appear in the trial balance as a credit
balance?

A Carriage inwards
B Carriage outwards
C Returns inwards
D Returns outwards

Question 5

Which of the following errors will not affect the arithmetical accuracy of the
Trial Balance?

A Wrong balancing of an account

B Writing an amount in the wrong account but on the correct side
C Wrong totalling of an account
D None of the above

Answers to Self Examination Questions

Answer to SEQ 1
The correct option is D.
Contra entries are:
1. Cash deposited into the bank account
2. Cash withdrawn from the bank account

Answer to SEQ 2
The correct option is C.
The amount of cash discount allowed on a transaction will initially be recorded in
the discount column on the receipts side of the cash book.

Answer to SEQ 3
The correct option is A.
A transaction which does not involve payroll, cash or credit is likely to be
recorded in the journal.
 202

Answer to SEQ 4

The correct option is D.

Return outwards i.e. purchase returns (reduction in purchases) would appear in

the trial balance as a credit balance. All other items are expenses and hence will
have a debit balance.

Answer to SEQ 5

The correct option is B.

Writing an amount in the wrong account but on the correct side will not affect the
arithmetical accuracy of the Trial Balance.
 203

CHAPTER 2

ACCOUNTING PROCESS, METHODS AND

CONTROL, AND FINALISATION OF
ACCOUNTS
UNIT 7

DEPRECIATION ACCOUNTING
Chapter Introduction
In the foregoing units, the overall concepts of preparation of final accounts and
financial statements have been discussed. That included depreciation also,
although in brief and only to the extent required. In this unit, we shall deliberate
on accounting for depreciation in detail under the captioned Learning Outcomes.

a) Define depreciation and give a brief introduction of AS 6 issued by the

ICAI.
b) Explain briefly the objectives of providing for depreciation.
c) Describe the various methods of providing for depreciation.
d) Elaborate the impact of change in the depreciation method.
e) Discuss the disposal of depreciable assets and its accounting treatment.
f) Explain the method of revaluation of depreciable assets.
 204

1. Define depreciation and give a brief introduction of AS 6

issued by the ICAI.
[Learning Outcome a]
The very basic idea that requires to be invariably kept in mind is that
depreciation is an expense chargeable to Profit and Loss Account and is
related to Fixed Assets.

In this context, the ideas of capital expenditure and revenue expenditure are
relevant to have an in-depth knowledge of depreciation. ‘Expense’ or
‘expenditure’ is nothing but the cost of the business. This cost may either be
periodic, that is pertaining to a particular accounting period, or may result in the
creation of an asset to be carried forward to the subsequent accounting periods.

1. The former or the periodic cost is referred to as ‘revenue expenditure’

which is charged to the Profit and Loss Account for writing off. Examples
are Salary, Wages, Conveyance, Travelling etc. Usually, the term ‘expense’
is used while referring to revenue expenditure.

2. The latter is called ‘capital expenditure’. Capital expenditure results in

assets such as Plant and Machinery, Furniture and Fixture, Computer and
Peripherals etc. Assets, which are subject to depreciation, are termed
‘Depreciable Assets’.

Capital expenditure increases the value of fixed assets and includes expenses
that provide benefits of an enduring nature i.e. for more than one accounting
period.

Revenue expenditure maintains property or wealth, and is incurred to acquire or

maintain current / trading assets. It includes all expenditure that provides current
benefits i.e. benefits which can be potentially realised within the accounting
period.

The difference between capital and revenue expenditure is explained with the
help of the following example:
 205

Sheilja owns a motor car. She decided to fit an AC in the car. For this, she
incurred Rs. 50,000. After a month’s time, the mud flap of the car was damaged.
She gave it for repairing; the repair charges were Rs. 500.

Here, she has incurred two types of expenses.

Rs. 50,000 for fitting the AC in car is capital expenditure because it increases
the utility of the car and the repair charge of Rs. 500 is revenue expenditure
because it is incurred to maintain the car in working condition.

The result of operations of any business or profit or loss can be ascertained only
when all the items of expenses are considered. The relevance of depreciation
assumes utmost importance in this context. It can be well appreciated that the
effective lives of assets start decreasing, once put to use. This means that after the
lapse of a certain period, the assets will cease to be useful for the business,
which, as a corollary, indicates decline in the value of the assets. This further
implies that the concerned business incurs unforeseen expenses through loss in
the value of the assets. If this expense is not taken into account, the result of
operations of the business will not reflect the true picture. Hence, this type of
expense is accounted for as “Depreciation.”

On the other hand, diminution in the value of assets will necessitate fresh capital
expenditure to keep the operations of the business running. Hence, unless some
provision is made, a time will come when the business might face lack of
capacity to replace the assets. From both aspects discussed above, providing for
depreciation has been thought of as a prudent as well as an inevitable principle in
determining the profit /loss of the business.

Let us consider one known but very important point as an eye-opener regarding
treatment of expenditure of any business organisation. One may look at it as
either an inference or a conclusion. This is nothing but the idea or view that all
expenditure is chargeable to Profit and Loss account, be it revenue or capital.
Profit and loss account, in this context, includes Manufacturing and Trading
Accounts also.

The only difference in the treatment between revenue expenditure and capital
expenditure in the matter of depreciation is that revenue expenditure is instantly
identified as a charge against profit whereas capital expenditure is written off
over a number of years, depending on the life of the asset.
 206

Primarily, assets cannot be an item of cost for a particular accounting period. But
ultimately, a capital expenditure giving rise to an asset turns into an element of
chargeable cost in instalments over a number of years, except capital expenditure
relating to land and intangible assets like goodwill etc.

Depreciation is, thus, a gradual conversion of the cost of an asset into

revenue expense to be accounted for in the accounts of a particular
accounting period.

However, capital expenditure is definitely not a ‘Deferred Revenue

Expenditure’ that is also written off over a period of years. Such ‘Deferred
Revenue Expenditure’ does not create any asset.

Deferred Revenue Expenditure is basically a revenue expenditure of higher value

and is charged against profit, not in a single accounting period, but over a period
of more than one in order to avoid distortion in the financial result for a particular
period as well as to spread the utility of the Deferred Revenue Expenditure
logically over the subsequent periods to which it extends its benefit.

Examples of deferred revenue expenditure include heavy advertisement

expenditure, underwriting commission, discount on issue of shares and
debentures, brokerage paid on purchase of shares and debentures, research
expenses and development expenses.

An organisation expects to get benefit from an advertisement for 10 years; the

advertisement cost Rs. 5,00,000.

Here, Rs. 5,00,000 is divided by 10 years and Rs. 50,000 will be shown as
revenue expenses in the profit and loss account and the balance amount of Rs.
4,50,000 will be shown in the balance sheet.

Every year, one tenth of the original and total advertising expenses will go to the
profit and loss account.

This deferred revenue account will close in the 10th year when there will be no
balance on the assets side of the balance sheet.
 207

Now, let us define depreciation in a formal way. Depreciation may be defined as

the reduction, decrease or diminution in the value of an asset during a particular
accounting period owing to various reasons such as wear and tear, efflux of time,
obsolescence and a host of others depending on the nature of the asset and its use.
While the cost of an asset is treated as a capital expenditure, the loss in the value
of the said asset during a particular period is considered revenue expenditure for
charging to Profit and Loss Account.

Extracts from Accounting Standard (AS) 6 issued by The Institute of

Chartered Accountants of India (ICAI) (that has been made mandatory for all
commercial organisations)

In its introduction, it states,

“This statement deals with depreciation accounting and applies to all depreciable
assets, except the following items to which special considerations apply:
9 Forests, plantations and similar regenerative natural resources;
9 Wasting assets, including expenditure on the exploration for and extraction
of minerals, oils, natural gas and similar non-generative resources;
9 Expenditure on research and development;
9 Livestock.

This statement also does not apply to land unless it has a limited useful life for
the enterprise.”

Definitions provided in this AS 6 are also given here for you to know the views
of the ICAI, which is the regulatory body in our country for regulation of the
profession of accountancy. The concepts will be strengthened and consolidated
by going through the following excerpts from the ICAI.

“Depreciation is a measure of the wearing out, consumption or other loss of

value of a depreciable asset arising from use, effluxion of time or obsolescence
through technology and market changes.

Depreciation is allocated so as to charge a fair portion of the depreciable amount

in each accounting period during the expected useful life of the asset.

Depreciation includes amortisation of assets whose useful life is predetermined.”

 208

“Depreciable assets are assets which are:

9 expected to be used during more than one accounting period;
9 and have a limited useful life;
9 and are held by an enterprise for use in the production or supply of goods and
services, for rental to others, or for administrative purposes;
9 and not for the purpose of sale in the ordinary course of business.”

“Useful life is
1. either the period over which a depreciable asset is expected to be used by the
enterprise;
2. or the number of production or similar units expected to be obtained from the
use of the asset by the enterprise.”

“Depreciable amount of a depreciable asset is its historical cost, or other

amount substituted for historical cost in the financial statement, less the estimated
residual value.”

To conclude this Learning Outcome, let us sum up - depreciation is an

inevitable constituent of revenue expenditure forming cost of operation of
any business where fixed assets are utilised. Depreciation accounting thus deals
with different aspects of providing for depreciation including policy, methods,
rates, and of course, the ultimate action for bringing it into the accounts of any
business organisation.

In accordance with AS 6, which of the following assets does not fit into the
definition of a depreciable asset?

A Land
B Machinery
C Building
D Coal mine
 209

2. Explain briefly the objectives of providing for

depreciation.
[Learning Outcome b]

The idea or the perception about depreciation as stated by the American Institute
of Certified Public Accountants (AICPA) deserves to be mentioned in order to
understand the primary objective of providing for depreciation in the accounts.

It runs as quoted herein.

“The cost of a productive facility is one of the costs of the services during its
economic life.

Generally accepted accounting principles require that this cost be spread over the
expected useful life of the facility in such a way as to allocate it as equitably as
possible to the periods during which services are obtained from the use of the
facility.

This procedure is known as depreciation accounting; a system of accounting

which aims to distribute the cost or other basic value of tangible capital
assets, less salvage (if any), over the estimated useful life of the unit (which
may be a group of assets) in a systematic and rational manner.

It is a process of allocation, not of valuation.”

The concept as stated above is so simple and self-explanatory that hardly any
aspect is left out for comprehension of the basic objective of accounting for
depreciation.

1. Productive facility here means an asset arising out of any capital

expenditure.

2. Another matter that merits mention here is that the incidental cost of
creation of any asset is to be added to the cost of the asset.

For Mock Test Visit:

[Link]
 210

The installation cost of a machine is to be added to the cost price of the machine
to determine the actual total cost of the machine. To put this in another way, the
acquisition cost till an asset is put to use is to be incorporated in arriving at the
total actual cost price of the particular asset.

3. Cost here means historical cost. Hence, market value has no relevance in
depreciation accounting. It may not even consider the physical deterioration
of the asset as depreciation is simply the allocation of the cost of any asset to
the periods over which the benefits are obtained from such an asset.

In short, the objectives of providing for depreciation can be summarised as

follows:

Diagram 1: Objectives of providing for depreciation

 211

1. The main objective is to allocate the used up cost of an asset in the

accounting periods in which the services of the said asset are utilised. This
will ensure recovery of the cost of the asset over its useful life from the profit
earned, treating it as a part of the cost of business operation.

2. If depreciation is not taken into account, the correct picture of profit or loss
cannot be ascertained. In the absence of depreciation, the asset will show
more value than what it stands for.

3. Provision for depreciation is also necessary to arrange for replacement of the

asset that is adopted as a policy of the management. Although depreciation is
an expenditure, it is not an outflow of cash; the provision amount saved
every year can be utilised for replacing / purchasing a new asset at the end of
the useful life of the old asset.

4. In accordance with the Companies Act, it is mandatory for a joint stock

company to provide for depreciation on fixed assets before distributing
profits for dividends.

5. By providing depreciation on fixed assets, the amount saved because of the

provision will be the retention of the expired cost of fixed assets. The
reduced amount of the asset will be retained in the business in the form of
provision for depreciation.

The main objective of providing depreciation is:

A To calculate the true profit

B To show the true financial position
C To reduce tax
D To provide funds for replacement
 212

3. Describe the various methods of providing for

depreciation.
[Learning Outcome c]
Before we discuss the various methods of providing for depreciation, three
factors on which the amount of depreciation depends must be mentioned.

For better understanding, it is relevant to quote a few lines from the

‘Explanation’ to AS 6.

‘Assessment of depreciation and the amount to be charged tin respect thereof in

an accounting period is usually based on the following three factors:

1. Historical cost or other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued;
2. Expected useful life of the depreciable asset; and
3. Estimated residual value of the depreciable asset’

At least four steps emanate from the explanation as quoted above to determine
the amount of depreciation in respect of a particular asset for a particular
accounting period. These are:

1. Determination of the historical cost of the asset that will include capital
investment in the asset in the form of money or its equivalent, cost of
acquisition, cost of installation, cost of commissioning till the asset is put to
use and other costs related to additions or improvement to the asset.

2. Making an estimate of the salvage, scrap or resale value of the asset at the
end of the useful life depends on a number of factors. Experience plays a
vital role in this matter as the nature of the asset, its use and market situation
relating to the scrap are to be considered too.

3. The next step is the determination of the difference between historical

cost as clarified earlier and the estimated salvage value.

4. The last step is the distribution of this difference over the period of its
useful life by a method that will suit the requirement of the business as per
the decision of the management.
 213

However, statutory requirements are to be kept in mind also, such as the

provisions of Companies Act, 1956 and The Income Tax Act, 1961 as amended,
and others, if any.

Coming to the core issue of methods of depreciation, there are several methods of
providing for depreciation out of which two methods are very common: the
Straight Line Method and the Diminishing Balance Method.

In selecting a method, the principle of equitable distribution of the cost of the

asset should be given essential consideration although a secondary thought of
replacement of the asset should also be kept in mind in a given situation. The
implications of profit, tax, dividend and cash flow are the important
considerations while choosing a method of depreciation.

The various methods are listed below:

Diagram 2: Methods of depreciation

As stated earlier, the first two methods are commonly used, while others are
employed in special circumstances. But the Depreciation Fund or Sinking Fund
Method is very important where the main consideration remains the replacement
of asset. Depreciation is expressed as a rate per cent per annum.

Let us deal with the accounting procedure here before elaborating the methods
with examples. Whatever method is employed, there is another important issue
that requires our attention. This is regarding the manner of reflection of the asset
in the books of account. The particular asset account may be maintained at the
Written Down Value (WDV) when depreciation is charged against the asset
account. In that case, the original cost price of the asset will not be available. In
 214

the alternative, depreciation may be charged against ‘Provision for Depreciation

Account’ in which case the original cost will remain intact but the WDV can also
be obtained by deducting the accumulated depreciation from the original cost of
the asset at a particular point of time. Examples will demonstrate the matter to
clear the concept.

Journal Entries for Depreciation Accounting

Purchase price
1. Entry when any asset is purchased:

Asset Account (Name of the Asset) Dr X

To Bank/Cash Account (Amount paid in cash or by cheque) X
To Supplier’s Account (Amount due to Party, if purchased on X
credit)
(Being asset purchased in cash/by cheque or on credit)

2. Entry for providing depreciation at the end of the accounting period or

for a particular period:

Depreciation Account Dr X
To Asset Account (If Asset is desired to be maintained at X
WDV) OR
To Provision for Depreciation Account (If original cost of the X
asset is desired to be maintained)
(Being depreciation provided on asset @ …% on … method for the
year/period ending on …)

3. Entry for transferring depreciation to Profit and Loss Account at the

end of the accounting period:

Profit and Loss Account Dr X

To Depreciation X
(Being depreciation for the accounting period transferred to Profit
and Loss Account)

4. Entry for sale/disposal of asset on loss:

Bank/Cash/Party’s Account (Amount of sale of goods) Dr X

Loss on Sale of Asset A/c (Difference between WDV and Sale Dr X
Proceeds)
To Asset Account (WDV on the date of sale/disposal) X
(Being sale proceeds of asset and loss incurred on sale accounted
for)
 215

5. Entry for transfer of loss on sale of asset to Profit and Loss Account:

Profit and Loss Account Dr X

To Loss on Sale of Asset X
(Being loss incurred on sale of asset transferred to Profit and Loss
Account)

6. Entry for sale/disposal of asset on profit:

Bank/Cash/Party’s Account (Sale proceeds) Dr X

To Asset Account (WDV on the date of sale) X
To Profit on Sale of Asset Account X
(Being asset sold and profit earned taken into account)

7. Entry for transfer of profit on sale of asset to Profit and Loss Account:

Profit on Sale of Asset Account Dr X

To Profit and Loss Account X
(Being profit earned on sale/disposal of asset transferred)

Instead of debiting the amount of loss on Sale of Asset (in case loss is incurred)
or crediting Profit on Sale of Asset (in case profit is earned), Profit and Loss
Account may be debited or credited for the amount of loss or profit on sale
respectively.

Working: Profit/Loss on Sale of Asset

Particulars Amount
(Rs.)
Cost Price of the Asset X
Less: Accumulated Depreciation on the date of disposal (X)
A: Value of the Asset → WDV on the date of sale X
B: Sale Price X
C: Profit/Loss on Sale of Asset X / (X)
 216

Notes

1. If B>A, there is profit. Conversely, if A>B, there is loss.

2. If Depreciation Fund Method is applied, ‘Provision for Depreciation
Account’ will be replaced by ‘Depreciation Fund Account’.
3. If Asset account is maintained at cost, the accumulated depreciation under
‘Provision for Depreciation Account’ or ‘Depreciation Fund Account’ is to
be transferred to Asset Account on the date of sale/disposal so as to reduce
the value of the asset to WDV for ascertaining the loss or profit on sale of the
asset.

3.1 Straight Line Method

It is considered the simplest of all the methods. Depreciation is arrived at by

deducting the salvage value from the historical cost and then dividing the
difference thus determined by the number of years of useful life. It can also be
expressed as a percentage per annum of the historical cost.

To translate into a formula, the under mentioned symbols can be used.

D = Depreciation,
HC = Historical Cost,
SV = Scrap/Salvage Value,
N = No. of years of useful life,
RD = Rate of Depreciation
Then,
D = HC- SV/N
RD = D/HC x 100

Although the Straight Line Method has a number of advantages, it suffers from
one major shortcoming. In the later years, the charge against profit becomes
disproportionate to the increasing cost of repairs. Hence, this method is not
suitable for exhausting assets like Plant and Machinery, Vehicles etc. Rather, it is
suitable for assets prone to depreciate for lapse of time such as Patents and assets
having comparatively small values like Furniture and Fixtures etc.
 217

A machine purchased for Rs. 60,000 on 01.04.2005 is expected to have a life of

five years. Estimated salvage/scrap value after the expiry of five years is Rs.
10,000. Depreciation is considered under the Straight Line Method.

Show necessary accounts.

a) If the asset account is maintained at written down value

Dr Machine Account Cr
Date Particulars Rs. Date Particulars Rs.
By
01.04.2005 To Bank A/c 60,000 31.03.2006 Depreciation 10,000
A/c
31.03.2006 By Balance c/d 50,000
60,000 60,000
By
To Balance
01.04.2006 50,000 31.03.2007 Depreciation 10,000
b/d
A/c
31.03.2007 By Balance c/d 40,000
50,000 50,000
By
To Balance
01.04.2007 40,000 31.03.2008 Depreciation 10,000
b/d
A/c
31.03.2008 By Balance c/d 30,000
40,000 40,000
By
To Balance
01.04.2008 30,000 31.03.2009 Depreciation 10,000
b/d
A/c
31.03.2009 By Balance c/d 20,000
30,000 30,000
By
To Balance
01.04.2009 20,000 31.03.2010 Depreciation 10,000
b/d
A/c
By Bank A/c -
31.03.2010 sale proceeds 10,000
of salvage
20,000 20,000
 218

Dr Depreciation Account Cr
Date Particulars Rs. Date Particulars Rs.
To Machine By Profit and
31.03.2006 10,000 31.03.2006 10,000
A/c Loss A/c
10,000 10,000
To Machine By Profit and
31.03.2007 10,000 31.03.2007 10,000
A/c Loss A/c
10,000 10,000
To Machine By Profit and
31.03.2008 10,000 31.03.2008 10,000
A/c Loss A/c
10,000 10,000
To Machine By Profit and
31.03.2009 10,000 31.03.2009 10,000
A/c Loss A/c
10,000 10,000
To Machine By Profit and
31.03.2010 10,000 31.03.2010 10,000
A/c Loss A/c
10,000 10,000

Balance Sheet (Extract): Assets side only

Balance Sheet As on 31.03.2006

Liabilities Rs. Assets Rs.
Machine 60,000
Less: Depreciation 10,000 50,000

Balance Sheet As on 31.03.2007

Liabilities Rs. Assets Rs.
Machine 50,000
Less: Depreciation 10,000 40,000

Balance Sheet As on 31.03.2008

Liabilities Rs. Assets Rs.
Machine 40,000
Less: Depreciation 10,000 30,000
 219

Balance Sheet As on 31.03.2009

Liabilities Rs. Assets Rs.
Machine 30,000
Less: Depreciation 10,000 20,000

Balance Sheet As on 31.03.2010

Liabilities Rs. Assets Rs.
Machine 20,000
Less: Depreciation 10,000
10,000
Less: Sold at
10000 NIL
salvage value

b) If the asset account is maintained at historical cost

Machine Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.04.2005 To Bank A/c 60,000 31.03.2006 By Balance c/d 60,000
60,000 60,000
01.04.2006 To Balance b/d 60,000 31.03.2007 By Balance c/d 60,000
60,000 60,000
01.04.2007 To Balance b/d 60,000 31.03.2008 By Balance c/d 60,000
60,000 60,000
01.04.2008 To Balance b/d 60,000 31.03.2009 By Balance c/d 60,000
60,000 60,000
31.03.2010
60,000 By Provision for
01.04.2009 To Balance b/d 50,000
Depreciation A/c

31.03.2010 By Bank A/c 10,000

60,000 60,000
 220

Dr Provision for Depreciation Account Cr

Date Particulars Rs. Date Particulars Rs.
31.03.2006 To Balance c/d 10,000 31.03.2006 By Depreciation 10,000
A/c
10,000 10,000
31.03.2007 To Balance c/d 20,000 01.04.2006 By Balance b/d 10,000
31.03.2007 By Depreciation 10,000
A/c
20,000 20,000
31.03.2008 To Balance c/d 30,000 01.04.2007 By Balance b/d 20,000

31.03.2008 By Depreciation 10,000

A/c
30,000 30,000
31.03.2009 To Balance c/d 40,000 01.04.2008 By Balance b/d 30,000
31.03.2009 By Depreciation 10,000
A/c
40,000 40,000
31.03.2010 To Machine A/c 50,000 01.04.2009 By Balance b/d 40,000
31.03.2010 By Depreciation 10,000
A/c
50,000 50,000

Depreciation Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
31.03.2006 To Provision for 10,000 31.03.2006 By Profit and 10,000
Depreciation A/c Loss A/c
10,000 10,000
31.03.2007 To Provision for 10,000 01.04.2006 By Profit and 10,000
Depreciation A/c Loss A/c
10,000 10,000
31.03.2008 To Provision for 10,000 01.04.2007 By Profit and 10,000
Depreciation A/c Loss A/c
10,000 10,000
31.03.2009 To Provision for 10,000 01.04.2008 By Profit and 10,000
Depreciation A/c Loss A/c
10,000 10,000
31.03.2010 To Provision for 10,000 01.04.2009 By Profit and 10,000
Depreciation A/c Loss A/c
10,000 10,000
 221

Balance Sheet (Extract): Assets side only

Balance Sheet as on 31.03.2006

Liabilities Rs. Assets Rs Rs.
Machine 60,000
Less: Provision for
10,000 50,000
Depreciation

Balance Sheet as on 31.03.2007

Liabilities Rs. Assets Rs Rs.
Machine 60,000
Less: Provision for
20,000 40,000
Depreciation

Balance Sheet as on 31.03.2008

Liabilities Rs. Assets Rs Rs.
Machine 60,000
Less: Provision for
30,000 30,000
Depreciation

Balance Sheet as on 31.03.2009

Liabilities Rs. Assets Rs Rs.
Machine 60,000
Less: Provision for
40,000 20,000
Depreciation

Balance Sheet as on 31.03.2010

Liabilities Rs. Assets Rs Rs.
Machine 20,000
Less: Provision for
10,000
Depreciation
10,000
Less: Sold at salvage
10000 NIL
value
 222

Workings

W1 Depreciation

HC= Rs. 60,000, SV= Rs. 10,000, N= 05 years

Hence,
Historical cost − Salvage value
Amount of annual depreciation =
Estimated useful life (years)
Rs. 60,000 - Rs. 10,000
=
5 years
= Rs. 10,000

W2 Rate of Depreciation

Rate of Depreciation = D/HC x100

= 10,000/60,000 x100
= 16.66% p.a.

3.2 Diminishing balance method / Reducing balance method

This method is widely used in commercial organisations. Like any other method,
it has its merits and limitations also. However, this system is more equitable than
the Straight Line Method. Since the amount of depreciation goes on decreasing
with increase in the amount of repairs, the charge against profit turns out to be a
balanced or constant figure every year. It is calculated on the cost of the assets as
reduced by the amount of annual depreciation or in other words, on the written
down value (WDV) and not on the historical original cost as in the case of
Straight Line Method. Depreciation under this method is expressed as a rate per
cent per annum on the WDV of the asset.

This method is useful for exhausting and costly assets like Plant and Machinery,
Electronic Equipment etc.
 223

A machine purchased for Rs. 30,000 on 01.04.2007 depreciates at 10% p.a. under
the Diminishing Balance method. Write up the necessary accounts for three
years.

Machine Account
Dr Cr
Date Particulars Amount Date Particulars Amount
Rs. Rs.
01.04.2007 To Bank A/c 30,000 31.03.2008 By Depreciation 3,000
A/c
31.03.2008 By Balance c/d 27,000
30,000 30,000
01.04.2008 To Balance b/d 27,000 31.03.2009 By Depreciation 2,700
A/c
31.03.2009 By Balance c/d 24,300
27,000 27,000
01.04.2009 To Balance b/d 24,300 31.03.2010 By Depreciation 2,430
A/c
31.03.2010 By Balance c/d 21,870
24,300 24,300

Depreciation Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
31.03.2008 To Machine A/c 3,000 31.03.2008 By Profit and 3,000
Loss A/c
3,000 3,000
31.03.2009 To Machine A/c 2,700 31.03.2009 By Profit and 2,700
Loss A/c
2,700 2,700
31.03.2010 To Machine A/c 2,430 31.03.2010 By Profit and 2,430
Loss A/c
2,430 2,430
 224

Working

W1 Calculation of annual depreciation

Particulars Amount
(Rs.)
Cost of the Machine 30,000
Less: Depreciation for the year 2007-08 ending on 31.03.2008 3,000
WDV as on 01.04.2008 27,000
Less: Depreciation for the year 2008-09 ending on 31.03.2009 2,700
WDV as on 01.04.2009 24,300
Less: Depreciation for the year 2009-10 ending on 31.03.2010 2,430
WDV as on 01.04.2010 21,870

As with the Straight Line Method, ‘Provision for Depreciation Account’ can
be maintained alternatively; this is not repeated for the sake of brevity.

Comparison between straight-line method and reducing balance method

Straight-line method Reducing balance method

It is relatively difficult to understand
It is simple to understand and operate.
and operate.
It charges a higher amount during
It charges a fixed amount each year to
the initial years when the machine is
the statement of comprehensive
new and efficient and a lower amount
income.
in later years.
It is suitable for assets which give the It is suitable for assets which give a
same efficiency year after year e.g. a higher efficiency in earlier years and
building is used in the same way over a lower efficiency in later years e.g.
the years. machinery used in various
manufacturing processes.
If repairs increase in later years, the The charge of depreciation plus repairs
charge of depreciation plus repairs is expected to be the same over the
increases each year (since the years. In the initial years when repairs
depreciation is constant). are low, the depreciation is high - and
in the later years when repairs are high,
the depreciation is low.
 225

In the previous examples, simple accounts are given assuming no purchase and
sales during the period.

However, in practice, there can be a different scenario. For example, assets can
be sold during the year or some can be purchased during the year. In such cases,
depreciation should be calculated on the usage of that asset not for the whole
accounting year, but for the part of the year corresponding to its use. It means if
an asset is purchased on 1 June and accounting year ends on 31 December,
depreciation will be computed for 7 months only. Likewise, if an asset is sold on
1 June, depreciation will be computed for 5 months only.

3.3 Depletion Method

This method is also known as ‘Unit Charging Method’ or ‘Output Method’.

Usually, this method is applied in the case of assets of a wasting nature as well
as intangible assets like patents, copyrights, leaseholds etc. The rate of
depreciation per unit is determined by dividing the total cost by the expected
number of output in contrast to the number of years. Annual depreciation is
obtained by multiplying the output or the number of units by the rate per unit.

The example stated below will clarify the manner of maintaining the particular
asset account.

XYZ Collieries Ltd acquired a coal mine for Rs. 9,00,000 on 01.04.2007.
Estimated output of coal is Rs. 20,00,000 tons. Expected raising of coal is 75%.
Output obtained in the years 2007–08, 2008-09 and 2009-10 are 27,000, 48,000
and 69,000 tons of coal respectively.

Prepare the coal mines account for three years.

 226

In the books of XYZ Collieries Ltd

Coal Mines Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.04.2007 To Bank A/c 9,00,000 31.03.2008 By Depreciation 16,200
A/c
31.03.2008 By Balance c/d 8,83,800
9,00,000 9,00,000
01.04.2008 To Balance b/d 8,83,800 31.03.2009 By Depreciation 28,800
A/c
31.03.2009 By Balance c/d 8,55,000
8,83,800 8,83,800
01.04.2009 To Balance b/d 8,55,000 31.03.2010 By Depreciation 41,400
A/c
31.03.2010 By Balance c/d 8,13,600
8,55,000 8,55,000
Workings
W1 Calculation of annual depreciation
Total coal (weight): 20,00,000 tons
Actual raising: 75% of 20,00,000 = 20,00,000 x 75/100
= 15,00,000 tons
W2 Rate of depreciation per ton
Rs. 9,00,000/15,00,000 tons = Rs. 0.60 per ton
Depreciation for the year 2007-2008: Rs. 27,000 x 0.60 =Rs. 16,200
Depreciation for the year 2008-2009: Rs. 48,000 x 0.60 =Rs. 28,800
Depreciation for the year 2009-2010: Rs. 69,000 x 0.60 =Rs. 41,400

3.4 Annuity Method

The annuity method takes into consideration the interest lost by the owner - the
interest that could have been earned if the amount would have been invested in
interest earning securities. Therefore, under the annuity method, the cost of the
asset and the interest at a given rate is written down every year by fixed amount.
This annual amount is determined with the help of annuity tables. The asset is
debited with the amount of interest on the diminishing value of the asset and the
amount of depreciation is ascertained with reference to the present value of the
capital investment or the original cost of the asset, usually with the help of the
Logarithmic Table. A formula can also be used to ascertain the present value.
This method is useful for long term leases.
 227

A lease was acquired with a premium of Rs. 2,00,000 on 01.04.2006 for 4 years.
Depreciation under annuity system at 5% p.a. interest is charged. Rupee 1 is the
present value of 0.282012 payable over 4 years @ 5% p.a.
Prepare Lease Account.
Lease Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.04.2006 To Bank A/c 200,000 31.03.2007 By Depreciation 56,402
A/c
31.03.2007 To interest A/c 10,000 31.03.2007 By Balance c/d 153,598
210,000 210,000
01.04.2007 To Balance b/d 153,598 31.03.2008 By Depreciation 56,402
A/c
31.03.2007 To Interest A/c 7,680 31.03.2008 By Balance c/d 104,876
161,278 161,278
01.04.2008 To Balance b/d 104,876 31.03.2009 By Depreciation 56,402
A/c
31.03.2009 To Interest A/c 5,244 31.03.2009 By Balance c/d 53,718
110,120 110,120
01.04.2009 To Balance b/d 53,718 31.03.2010 By Depreciation 56,402
A/c
31.03.2010 To Interest A/c 2,684
56,402 56,402

Workings

W1 Interest (Rate: 5% p.a.)

1st year on Rs. 2,00,000 = 200000 x 5/100 = Rs. 10,000
2nd year on Rs. 1,53,598= 153598 x 5/100 = Rs. 7,680 rounded off (r/off)
3rd year on Rs. 1,04,876= 104876 x 5/100 = Rs. 5,244 r/off
4th year on Rs. 53,718= 53718 x 5/100 = Rs. 2,684

Rs. 2,686 has been r/off to balance the lease account as the amount of annual
depreciation is Rs. 56,402 and the opening balance is Rs. 53,718 in the 4th year
 228

W2 Annual depreciation

Present Value: Re.1 and Annual Depreciation: 0.282012

Hence, if present value is Rs. 2,00,000, then annual depreciation is:

= Rs. 2,00,000 x 0.282012
= Rs. 56,402 r/off.

3.5 Depreciation Fund or Sinking Fund Method

This is a very important method especially for Plant and Machinery of very high
value where replacement is desired at the end of its effective life in order to keep
the liquidity position of a fund favourable.

An equal amount of depreciation that is computed either with the help of Annuity
Table or Logarithm Table is credited to Depreciation Fund/Sinking Fund instead
of Asset Account by debiting Depreciation Account or Profit and Loss Account
directly.

An equal amount is invested in interest earning securities in such a manner that

the annual investment together with the compound interest becomes equal to the
original cost of the asset.

At the end of the useful life of the asset, this earmarked investment is realised for
replacing the asset.

PQR Company Ltd obtained a machine for Rs. 3,00,000 with a useful life of 4
years on 01.04.2006. Replacement was to be done after 4 years by setting up a
depreciation fund, and an annual investment of Rs.70,647 would be required to
earn interest @ 4% p.a.

Prepare necessary ledger accounts assuming that the depreciation fund

investment realised Rs. 2,20,800 at the end of four years.
 229

In the books of PQR Company Ltd

Machine Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.04.2006 To Bank A/c 3,00,000 31.03.2007 By Balance c/d 3,00,000
3,00,000 3,00,000
01.04.2007 To Balance b/d 3,00,000 31.03.2008 By Balance c/d 3,00,000
3,00,000 3,00,000
01.04.2008 To Balance b/d 3,00,000 31.03.2009 By Balance c/d 3,00,000
3,00,000 3,00,000
01.04.2009 To Balance b/d 3,00,000 31.03.2010 By Depreciation 3,00,268
Fund A/c
31.03.2010 To Profit and 268
Loss A/c
3,00,268 3,00,268

Depreciation Fund Account

Dr Cr
Date Particulars Rs. Date Particulars Rs.
31.03.2007 To Balance c/d 70,647 31.03.2007 By Depreciation 70,647
A/c
70,647 70,647
01.04.2007 By Balance b/d 70,647
31.03.2008 By Depreciation 70,647
A/c
31.03.2008 To Balance c/d 1,44,120 31.03.2008 By Interest A/c 2,826
1,44,120 1,44,120
01.04.2008 By Balance b/d 1,44,120
31.03.2009 By Depreciation 70,647
A/c
31.03.2009 To Balance c/d 2,20,532 31.03.2009 By Interest A/c 5,765
2,20,532 2,20,532
01.04.2009 By Balance b/d 2,20,532
31.03.2010 By Depreciation 70,647
A/c
31.03.2010 By Interest A/c 8,821
31.03.2010 To Machine 3,00,268 31.03.2010 By Depreciation 268
A/c Investment A/c
3,00,268 3,00,268
 230

Depreciation Fund Investment Account

Dr Cr
Date Particulars Rs. Date Particulars Rs.
31.03.2007 To Bank A/c 70,647 31.03.2007 By Balance c/d 70,647
70,467 70,467
01.04.2007 To Balance b/d 70,647 31.03.2008 By Balance c/d 1,44,120
31.03.2008 To Bank A/c 73,473
(70,647 + 2,826)
1,44,120 1,44,120
01.04.2009 To Balance b/d 1,44,120 31.03.2009 By Balance c/d 2,20,532
31.03.2009 To Bank A/c 76,412
(70,647 + 5,765)
2,20,532 2,20,532
01.04.2010 To Balance b/d 2,20,532 31.03.2010 By Bank A/c 2,20,800
31.03.2010 To Depreciation 268
Fund A/c
2,20,800 2,20,800

The following three methods are used in special circumstances.

3.6 Revaluation Method

This method is selected in the case of assets in respect of which usual

depreciation methods are not applied e.g. loose tools, packages, patents,
copyrights, farmers’ livestock etc. This method is generally used by printing
press and similar business concerns. Here, depreciation is not calculated on the
original cost of an asset. Revaluation is done both at the beginning and at the
close of the accounting period. The difference thus arrived at is written off as
depreciation through Profit and Loss Account.

Depreciation = (Value of asset at the beginning + Any new purchases) – Value of

asset at the end

On April 01, 2009, Sitar Ltd commenced a business of repairing and servicing,
electronic appliances, with small tools having an estimated cost of Rs. 50,000 as
part of the opening capital.

During the year, small tools costing Rs. 15,000 were purchased on credit. On 31
March, 2010, Sitar Ltd revalued the cost of small tools at Rs. 63,000.
 231

Under the revaluation method of depreciation, depreciation charge on small tools

for the year 2009-10 will be calculated as follows:

Rs.
Opening estimated cost of small tools 50,000
Add: Purchases during the year 15,000
75,000
Less: Closing estimated cost of small tools 63,000
Depreciation for the year 2009-10 12,000

If book value / opening cost is higher than the revaluation amount, the difference
is charged to Profit and Loss account as depreciation. However, if book value /
opening cost is lower than the revaluation amount, the excess amount is ignored
and no depreciation will be charged to profit and loss account.

3.7 Insurance Policy Method

This method is similar to the sinking fund method. Under this method, premiums
are paid on a policy taken out with an insurance company. When the policy
matures, funds become available for replacement of the asset.

The policy is made usually for a period equal to the useful life of the asset and
for a sum assured that is expected to provide fund for replacement of the asset. If
annual interest is desired to be accounted for, surrender value of the policy at the
particular year-end is referred to. This is adopted in the cases of vehicles for the
uncertainty of their useful lives.

Journal entries under this method are as follows:

For the first year and subsequent years:

Insurance Policy Account Dr X

To Bank Account X
(Being premium paid at the beginning of the year)

Profit and Loss Account Dr X

To Depreciation fund Account X
(Being depreciation equal to premium charged)
 232

For the last year:

Bank Account Dr X
To Insurance Policy Account X
(Being amount of the policy received on maturity)

Insurance Policy Account Dr X

To Depreciation fund Account X
(Being transfer of the excess amount received over the total
premiums)

Depreciation fund Account Dr X

To Asset Account X
(Being depreciation fund account closed and transferred to asset
account)

Bank Account Dr X
To Asset Account X
(Being sale of scrap, if any)

Shyam Ltd took a building worth Rs. 80,000 on lease for four years, starting
from 01 January 2010. Shyam Ltd has decided to make a provision for
replacement of the lease by means of an insurance policy purchased for an annual
premium of Rs. 18,300.

Prepare the necessary accounts.

Leasehold building account

Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.01.2010 To Bank A/c 80,000 31.12.2010 By Balance c/d 80,000
80,000 80,000
01.01.2011 To Balance b/d 80,000 31.12.2011 By Balance c/d 80,000
80,000 80,000
01.01.2012 To Balance b/d 80,000 31.12.2012 By Balance c/d 80,000
80,000 80,000
01.01.2013 To Balance b/d 80,000 31.12.2013 By Depreciation 80,000
fund A/c
80,000 80,000
 233

Depreciation fund account

Dr Cr
Date Particulars Rs. Date Particulars Rs.
31.12.2010 To Balance c/d 18,300 31.12.2010 By Profit and 18,300
Loss A/c
18,300 18,300
01.01.2011 By Balance b/d 18,300
31.12.2011 To Balance c/d 36,600 31.12.2011 By Profit and 18,300
Loss A/c
36,600 36,600
01.01.2012 By Balance b/d 36,600
31.12.2012 To Balance c/d 54,900 31.12.2012 By Profit and 18,300
Loss A/c
54,900 54,900
01.01.2013 By Balance b/d 54,900
31.12.2013 By Profit and 18,300
Loss A/c
31.12.2013 To Building A/c 80,000 31.12.2013 By Depreciation 6,800
fund policy A/c
80,000 80,000

Depreciation fund policy A/c

Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.01.2010 To Bank A/c 18,300 31.12.2010 By Balance c/d 18,300
18,300 18,300
01.01.2011 To Balance b/d 18,300
To Bank A/c 18,300 31.12.2011 By Balance c/d 36,600
36,600 36,600
01.01.2012 To Balance b/d 36,600
To Bank A/c 18,300 31.12.2012 By Balance c/d 54,900
54,900 54,900
01.01.2013 To Balance b/d 54,900
To Bank A/c 18,300
To Depreciation 6,800 31.12.2013 By Bank A/c 80,000
fund A/c
80,000 80,000
 234

Comparison between the sinking fund method and the insurance policy method:

Sinking fund method Insurance policy method

Annual investments are made at the Annual premium is paid at the
end of the year. beginning of the year.
The amount to be received on The amount to be received on
maturity is not certain as it depends maturity is certain.
upon the nature of the investments
made and the market conditions.

3.8 Machine Hour Rate Method

This method, also known as service hour method, is chosen for machines where
productivity is relevant and for machines having a high cost. Depreciation is
charged on the basis of number of hours for which any particular machine is
utilised in the production process.

This method is similar to the ‘Depletion Method’, as depreciation is not charged

based on time, but on utilisation; i.e., the volume of production.

Rate per hour is calculated by dividing the historical original cost after deducting
salvage value by the expected total number of hours of the effective/useful life of
the asset.

Original cost of the asset − Scrap value

Depreciation per hour =
Life of the asset (in hours)

Suhana Co purchased a machine worth Rs. 100,000. Its estimated life is 25,000
hours and at the end of its useful life, scrap value would be Rs 10,000. In the year
2010-11, the machine runs for 6,000 hours.

Here,
Original cost of the asset − Scrap value
Depreciation per hour =
Life of the asset (in hours)
= (Rs. 100,000 – Rs. 10,000)/25,000 hours
= Rs. 3.60 per hour

Annual depreciation for the year 2010-11 = 6,000 hours x Rs. 3.60
= Rs. 21,600
 235

The amount of depreciation charged on a machine will be debited to:

A Machinery account
B Depreciation account
C Cash account
D Repair account

If the equipment account has a balance of Rs. 45,000 and its accumulated
depreciation account has a balance of Rs. 28,000, the book value of the
equipment will be:

A Rs. 45,000
B Rs. 28,000
C Rs. 17,000
D Rs. 73,000

4. Elaborate the impact of change in the depreciation

method.
[Learning Outcome d]
This is a very important aspect of depreciation accounting. The moot point is
whether any business organisation is at a liberty to switch over from one method
of depreciation to another at its own discretion. This issue and other incidental
matters connected with change in the method of depreciation have been dealt
with by Accounting Standard 6 (AS 6) issued by The Institute of Chartered
Accountants of India.

The relevant guidelines are quoted below.

 236

‘The method of depreciation is applied consistently to provide comparability of

the results of the operations of the enterprise from period to period. A change
from one method of providing depreciation to another is made only if the
adoption of the new method is required by statute or for compliance with an
accounting standard or if it is considered that the change would result in a more
appropriate preparation or presentation of the financial statements of the
enterprise. When such a change in the method of depreciation is made,
depreciation is recalculated in accordance with the new method from the date of
the asset coming into use. The deficiency or surplus arising from retrospective re-
computation of depreciation according with the new method is adjusted in the
accounts in the year in which the method of depreciation is changed. In case the
change in the method results in deficiency in depreciation in respect of past
years, the deficiency is charged in the statement of profit and loss. In case the
change in the results in surplus, the surplus is credited to the statement of profit
and loss. Such a change is treated as a change in accounting policy and its effect
is quantified and disclosed.’

The above stated guidelines leave no ambiguity as to when and how to effect any
change in the method of depreciation. It is, hence, necessary to implement any
change in the method of depreciation with retrospective effect. Evidently, the
difference between depreciation under existing method and the changed method
will have to be ascertained and necessary entries have to be incorporated.

The example given below will make the position clear:

On 01.04.2004, a firm purchased machinery for Rs.116400 and spent Rs.3600 on

its erection. On 01.10.2004, additional machinery costing Rs. 40000 was
purchased. On 1st October 2006, the machinery purchased on 01.04.2004, having
become obsolete, was auctioned for Rs. 57200, and on the same date, new
machinery was purchased at a cost of Rs.80000.

Depreciation was provided annually on 31st March every year @ 10% p.a. on
WDV. In 2007-08, however, the firm changed this method of providing
depreciation and adopted the method of providing 5% depreciation p.a. on the
original cost of the machinery.

Prepare Machinery Account as it would stand at the end of each year from 2004-
05 to 2007-08.
 237

Machinery Account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
01.04.2004 To Bank A/c – 1,16,400 31.03.2005 By Depreciation 14,000
cost A/c

01.04.2004 To Bank A/c- 3,600 31.03.2005 By balance c/d 1,46,000

Erection
01.10.2004 To Bank A/c - 40,000
Addition
1,60,000 1,60,000
01.04.2005 To Balance b/d 1,46,000 31.03.2006 By Depreciation 14,600
A/c
31.03.2006 By Balance c/d 1,31,400
1,46,000 1,46,000
01.04.2006 To Balance b/d 1,31,400 01.10.2006 By Depreciation 4,860
A/c
- On 1st Machine
01.10.2006 To Bank A/c - 80,000 01.10.2006 By Bank A/c 57,200
Addition
31.03.2007 By Profit and 35,140
Loss A/c
- Loss on Sale
31.03.2007 By Depreciation 7,420
A/c
31.03.2007 By Balance c/d 1,06,780
2,11,400 2,11,400
01.04.2007 To Balance b/d 1,06,780 31.03.2008 By Depreciation 6,000
A/c - 5% of
(40,000 + 80,000)
31.03.2008 To Profit and 6,220 31.03.2008 By Balance c/d 1,07,000
Loss A/c
- Excess
depreciation
written Back
(W3)
1,13,000 1,13,000
 238

Workings

W1 Calculation of Depreciation @ 10% p.a. on Diminishing Balance method

and Loss on sale of Machinery

Particulars Machine I Machine II Machine

Rs. Rs. III Rs.
Cost 1,20,000 40,000 80,000
Less: Depreciation for 2004-05 12,000 2,000 -
WDV as on 31.03.2005 1,08,000 38,000 -
Less: Depreciation for 2005-06 10,800 3,800 -
WDV as on 31.03.2006 97,200 34,200 -
Less: Depreciation for 2006-07 4,860 3,420 4,000
WDV as on1.10.06 for Machine I/ 92,340 30,780 76,000
31.03.2007 for others
Sale Proceeds 57,200 - -
Loss on sale of Machine I 35,140

W2 Calculation of Depreciation @ 5% p.a. on Straight Line Method and

WDV thereof

Particulars Machine II Machine

Rs. III Rs.
Cost 40,000 80,000
Depreciation – Machine II for 2 and ½ years 5,000 ---
Depreciation – Machine III for ½ year --- 2,000
WDV as on 31.03.2007 35,000 78,000

W3 Amount to be written back to Profit and Loss Account to restore the

WDV of two machines as on 31.03.2007 based on Depreciation @ 5% p.a. on
Straight Line method.

Particulars Rs.
WDV as on 31.03.2007 as per changed method (35,000 + 78,000) 1,13,000
Less: WDV as on 31.03.2007 as per earlier method (30,780 + 1,06,780
76,000)
WDV as on 31.03.2007 6,220
 239

Diagram 3: Impact of change in the method of depreciation

5. Discuss the disposal of depreciable assets and its

accounting treatment.
[Learning Outcome e]

Disposal of depreciable assets means sale, removal, destruction or exchange of

any particular asset usually when the usefulness of that asset ceases. It is sold as
an item of salvage or scrap. Sometimes, it may be exchanged for a part of the
cost with payment being made for the remaining cost.
 240

AS 6 issued by the ICAI provides for requirement of disclosure of certain

information in the financial statements. The relevant text is quoted below.
‘Where depreciable assets are disposed of, discarded, demolished or
destructed, the net surplus or deficiency, if material, is disclosed separately.’

The accounting procedure for this has been stated in Learning Outcome 3 under
the head Journal Entries for Depreciation Accounting.

Journal entries 4 to 7 represent the accounting entries required to be made in the

case of sale of assets.

However, entry nos. 4 and 6 are meant to be made when asset account is
maintained at WDV.

Entry nos. 5 and 7 are applicable to both systems of maintaining asset account.

Additional entry required to be incorporated at the time of disposal when asset

account is maintained at historical original cost are mentioned below.

Tip appended after Journal Entries under Learning Outcome 3 is to be read

with this section also.

8. Entry for transferring accumulated depreciation under ‘Provision for

Depreciation Account’ to particular asset account

Provision for Depreciation Account (Depreciation Fund A/c) Dr X

To Asset Account (Amount paid in cash or by cheque) X
To Supplier’s Account (Amount due to Party, if purchased on X
credit)
(Being accumulated depreciation in respect of the asset sold
transferred)

This entry is to be followed by either entry no.4 when the asset is sold at a loss or
entry no. 6 when the asset is sold at a profit. Furthermore, for transfer of loss on
sale of asset, entry no.5 and for transfer of profit on sale of asset, entry no.7 are
to be recorded.

When no profit or no loss is made, entry no. 4 to entry no. 7 are to be modified
by removing Profit and Loss Account from the entries. Besides, if no
money/return is obtained by any process of disposal other than sale, value of sale
proceeds is to be treated as NIL and the entire WDV is to be treated as loss on
disposal of the particular asset.
 241

Previous examples show how the accounts have been prepared in the case of
disposal by way of sale. Therefore, no example is given here.

In this context, excerpts from the contents of AS 10 of ICAI in the matter of

‘Retirement and Disposals’ of Fixed Assets are worthy of reference for
guidance:

“14.1 An item of fixed asset is eliminated from the financial statements on

disposal.

14.2 Items of fixed assets that have been retired from active use and are held for
disposal are stated at the lower of their net book value and net realizable value
and are shown separately in the financial statements. Any expected loss is
recognized immediately in the profit and loss statement.

14.3 In historical cost financial statements, gains or losses arising on disposal are
generally recognized in the profit and loss statement.

14.4 On disposal of a previously revalued item of fixed asset, the difference

between net disposal proceeds and the net book value is normally charged or
credited to the profit and loss statement except that, to the extent such a loss is
related to an increase which was previously recorded as a credit to revaluation
reserve and which has not been subsequently reversed or utilized, it is charged
directly to that account. The amount standing in revaluation reserve following the
retirement or disposal of an asset which relates to that asset may be transferred to
general reserve.”

This Learning Outcome may be read with the next Learning Outcome about
revaluation of depreciable assets.

6. Explain the method of revaluation of depreciable assets.

[Learning Outcome f]
Revaluation of depreciable assets is done at the discretion and decision of the
management of any business organisation. It should not be confused with the
‘Revaluation Method’ of charging depreciation.

Revaluation is necessitated when it is felt that the depreciation cost is not correct;
rather, it is understated or overstated so as to distort the financial picture of any
 242

business organisation. This usually happens when the market value of any asset
goes downward or upward substantially. Insufficiency in the amount of
depreciation or excess depreciation turns into the reason for not reflecting the
correct result of the business operation.

Ashiyana Ltd has purchased a builidng worth Rs. 25,00,000 at the start of the
year 2009. The company has a policy to charge 10% depreciation using the
diminishing value method on its fixed assets.

At the end of 2012, the builidng has a book value of Rs. 16,40,250. However, its
market value on the same date has been appreciated to Rs. 45,00,000.

In such cases, Ashiyana may decide to revalue its building.

Moreover, replacement of any asset might be difficult. In such a situation, the

assets of the entity may be revalued. However, it is exclusively a matter of policy
of any business entity.

Usually, revaluation is done after appraisal by competent valuers and also

by indexation and reference to current prices with periodical checking by
the appraisal method.
Unlike changes in the method of depreciation, depreciation is charged on the
revalued figure of any asset with prospective effect.
The only matter to be kept in mind is that depreciation is charged on the
revalued amount of the asset only from the date of its revaluation.

AS 6 issued by the ICAI does not deal with the treatment of the revaluation
difference arising out of substitution of historical cost by the revalued figure of
any asset. But it recognises charging of depreciation on revalued amount of any
asset. Besides, it provides for a disclosure requirement which is quoted below.

‘In case the depreciable assets are revalued, the provision for depreciation is
based on the revalued amount on the estimate of the remaining useful life of such
assets. In case the revaluation has a material effect on the amount of depreciation,
the same is disclosed separately in the year in which revaluation is carried out.’

To learn how the accounting treatment for revaluation of depreciable assets is

done, it is better to quote the relevant portion of the Accounting Standard 10 (AS
10) on ‘Accounting for Fixed Assets’ issued by the Institute of Chartered
Accountants of India (ICAI), which contains clear guidelines in this matter.
 243

‘An increase in net book value arising on revaluation of fixed assets is normally
credited directly to owner’s interests under the heading of revaluation reserves
and is regarded as not available for distribution. A decrease in net book value
arising on revaluation of fixed assets is charged to profit and loss statement
except that, to the extent that such a decrease is considered to be related to a
previous increase on revaluation that is included in revaluation reserve, it is
sometimes charged against that earlier increase. It sometimes happens that an
increase to be recorded is a reversal of a previous decrease arising on revaluation
which has been charged to profit and loss statement in which case the increase is
credited to profit and loss statement to the extent that it offsets the previously
recorded decrease.’ It is also advisable to go through the contents of AS 10 on
“Retirements and Disposals’ mentioned earlier.

Saujanya Textile Mill purchased an office building worth Rs. 30,00,000 on 1

April 1995; the estimated useful life of the building is 40 years. Depreciation is
provided on straight line basis.

The office building was revalued on 30 September 2012 at Rs. 20,00,000 and the
revaluation effects were incorporated in the books of accounts.

Calculation of surplus / deficit on revaluation

Amount (Rs.)
Cost on 1 April 1995 30,00,000
Less: Depreciation till 30 September 2012 13,12,500
(30,00,000/40 years x 17.5 years)
Book value on 30 September 2012 16,87,500
Revaluation amount on 30 September 2012 20,00,000
Surplus on revaluation 3,12,500

This surplus of Rs. 3,12,500 should be credited directly to owners’ interests

under the heading Revaluation Reserve as per the requirement of AS 10.

Depreciation charged in the Profit and Loss Account of 2012-13

Depreciation on historical cost from 1 April 2012 to 30 Rs. 3,750

September 2012 (Rs. 3,00,000/40 years x 0.5 years)
Depreciation on revalued amount from 1 October 2012 to 31 Rs. 44,444
March 2013 (Rs. 20,00,000/22.5 years x 0.5 years)
Total depreciation of 2012-13 Rs. 48,194
 244

To sum up, an increase on revaluation of a depreciable asset is credited to

revaluation reserve that is not available for distribution. If, however, such
increase occurs as a result of earlier decrease on revaluation, it is to be credited to
Profit and Loss Account to the extent of the earlier decrease. A decrease on
revaluation is debited to Profit and Loss Account. Again, if such decrease
happens on account of earlier increase and is included in the revaluation reserve,
it may be charged to revaluation reserve. Journal entries to record this are given
below.

9. When there is any increase in the net book value of an asset or profit:

Asset Account (Amount of increase in the net Book Value) Dr X

To Revaluation Reserve Account X
(Being profit on revaluation transferred to revaluation reserve)

10. When there is any increase on revaluation which is related to previous

decrease:

Asset Account (Amount of increase in the net Book Value) Dr X

To Profit and Loss Account (Amount of earlier decrease) X
To Revaluation Reserve Account (Total increase-Amount of
X
earlier decrease)
(Being profit on revaluation adjusted against previous decrease on
revaluation and balance transferred to revaluation reserve account)

11. If there is decrease on revaluation:

Profit and Loss Account (Amount of decrease) Dr X

To Asset Account X
(Being loss on revaluation transferred to Profit and Loss Account)

12. If there is decrease on revaluation that is related to previous increase

included in Revaluation Reserve Account:

Revaluation Reserve Account (Amount of previous increase) Dr X

Profit and Loss Account (Total decrease-Previous increase) Dr X
To Asset Account (Total amount of decrease) X
(Being loss on revaluation adjusted against previous increase and
balance transferred to Profit and Loss Account)
 245

The purpose of revaluation varies from organisation to organisation. Different

bases may be used in the same financial year also.

At the end of this chapter, one much debatable and frequently asked question
related to Cash Flow and Fund Flow Statements is whether depreciation is a
source of funds.

In fact, depreciation is an operating cost, which should be allocated over the

period of the useful life of an asset. Had it been a source of funds, it would mean
more inflow of funds if more depreciation is charged, which is not at all true.
Hence, it is not a source of funds.

However, there are two reasons for considering depreciation to be a source of

funds, to some extent.

1. If depreciation is not charged, an amount equal to depreciation may be

distributed as dividend.

2. Secondly, depreciation retains the original historical cost of assets within the
business and thus adds to the working capital.

It is to be noted that India is going to adopt the International Financial Reporting

Standards (IFRS) with effect from April 01, 2011. Effort is already in progress
for convergence of Accounting Standards with IFRS. For this, necessary
guidelines have to be obtained from IFRS.

Which of the following accounting standard deals with the treatment of the
revaluation difference arising out of replacement of historical cost revaluation
amount?

A AS 6
B AS 1
C AS 10
D AS 2
 246

Summary
¾ Depreciation is a gradual conversion of the cost of an asset into revenue
expense to be accounted for in the accounts of a particular accounting period.
AS 6 has made it mandatory for all commercial organisations.
¾ Depreciation is based on the following three factors:
9 Historical cost
9 Expected useful life
9 Estimated salvage / residual value
¾ In order to ascertain the correct picture of profit or loss, depreciation should
be taken into account.
¾ Accounting treatment
9 Either by charging directly to Asset Account
9 Or by creating provision for depreciation
¾ Depreciation methods:
9 Straight line method: annual depreciation is calculated on the historical
cost of the asset and hence remains uniform - suitable for assets prone to
depreciate for lapse of time, such as patents.
9 Diminishing value method: annual depreciation is calculated on the
opening balance of the Asset Account and hence reduces year by year;
this method is suitable for exhausting and costly assets like plant and
machinery, vehicles, etc.
9 Depletion method: applied to assets of wasting nature and intangible
assets like mines, patents, copyrights, leaseholds, etc.
9 Annuity method: takes into account the opportunity cost of interest, had
the monetary outlay in the asset been invested elsewhere.
9 Sinking fund method: the amount of depreciation is invested in interest
earning securities in such a manner that the annual investment together
with compound interest becomes equal to the original cost of the asset.
9 Revaluation method: depreciation is calculated as the difference between
the revalued opening balance of the asset account and closing balance of
the asset account. Suitable for assets such as loose tools, packages,
livestock, etc.
9 Insurance policy method: resembles Sinking Fund Method; the major
difference being that annual investment is made by contribution to an
Insurance Policy as premium instead of investment in securities.
9 Machine hour rate method: chosen for machines where productivity is
relevant in their performance and in the case of machines with high cost.
¾ Change in depreciation method is permitted as per AS 6. Depreciation has to
be calculated from the date the asset comes into use.
 247

¾ Where depreciable assets are disposed of, discarded, demolished or

destructed, the net surplus or deficiency, if material, is disclosed separately.
¾ Revaluation of assets is necessitated when it is felt that the depreciation cost
is not correct; rather, it is understated or overstated so as to distort the
financial picture of any business organisation.
¾ Whether depreciation is a source of funds is a controversial and debatable
question. The most acceptable answer is – it is not a source of funds.

Answers to Test Yourself

Answer to TY 1

The correct option is A.

Land is not a depreciable asset unless it has a limited useful life for the
enterprise.

Answer to TY 2

The correct option is A.

The main object of providing depreciation is to calculate true profit. Other

options are also objectives, but they are subsidiary ones.

Answer to TY 3

The correct option is B.

The amount of depreciation charged on a machine will be debited to depreciation

account and credited to machinery account.

Answer to TY 4

The correct option is C.

Book value of an equipment = Opening balance – Accumulated depreciation

= Rs. 45,000 – Rs. 28,000
= Rs. 17,000
 248

Answer to TY 5

The correct option is C.

AS 10, Accounting for Fixed Assets, deals with the treatment of the revaluation
difference arising out of substitution of historical cost by the revaluation amount
of any asset.

Self Examination Questions

Question 1

On which of the following factors are the assessment of depreciation and the
amount to be charged for it in an accounting period based on?

(i) Historical cost of the depreciable asset

(ii) Market value of the depreciable asset
(iii) Purchase date of the depreciable asset
(iv) Estimated useful life of the depreciable asset
(v) Estimated salvage value of the depreciable asset

A All of the above

B (i), (ii) and (v)
C (iii) and (iv)
D (i), (iv) and (v)

Question 2

A mine was purchased at Rs. 3,00,000 and estimated quantity of mineral in the
mine is 10,000 tonnes. In the year 2010-11, a total of 1,700 tonnes of ore was
mined. Depreciation for 2010-11 will be:

A Rs. 3,00,000
B Rs. 51,000
C Rs. 10,000
D None of the above
 249

Question 3

Sukh-Sagar Ltd owns some land and buildings for which the following details are
available:

Cost of land Rs. 50,000

Cost of buildings Rs. 1,00,000
Estimated life of buildings 20 years
Estimated residual value of buildings Rs. 2,000
Estimated residual value of land Rs. 50,000

The company uses the straight line depreciation method. Which is the correct
annual depreciation charge for this asset?

A Rs. 4,000
B Rs. 4,900
C Rs. 7,400
D Rs. 7,500

Question 4

Shivam Corporation purchased a machinery of Rs. 50,000 on 1 January 2011and

incurred an installation charges of Rs. 10,000. The depreciation is calculated at
10% on a straight line basis.

On 30 June 2013, the machinery was sold for Rs. 42,500.

If the depreciation is calculated by written down value method, the book value of
the machinery on 30 June 2013 will be more by:

A Rs. 1,170
B Rs. 3,000
C Rs. 2,500
D Rs. 2,430
 250

Question 5

Parmar Group of Industries, which has a calendar year accounting period,

purchased a new machine for Rs. 1,20,000 on April 1, 2006. At that time Parmar
Group of Industries expected to use the machine for nine years and then sell it for
Rs. 12,000. The machine was sold for Rs. 66,000 on 30 September 2011.

Assuming straight-line depreciation, no depreciation in the year of acquisition,

and a full year of depreciation in the year of withdrawal, the gain to be
recognised at the time of sale would be:

A Rs. 12,000
B Rs. 9,000
C Rs. 6,000
D NIL

Answers to Self Examination Questions

Answer to SEQ 1

The correct option is D.

Assessment of depreciation and the amount to be charged for it in an accounting

period are based on the following three factors:
9 Historical cost of the depreciable asset
9 Estimated useful life of the depreciable asset
9 Estimated salvage value of the depreciable asset

Answer to SEQ 2

The correct option is B.

Rate of depreciation = Rs. 3,00,000/10,000 tonnes = Rs. 30 per tonne

Annual depreciation = 1,700 tonnes x Rs. 30 = Rs. 51,000

Answer to SEQ 3

The correct option is B.

Land is not depreciated, so the depreciation charge for the building will be:
Rs. 1,00,000 – Rs. 2,000/20 = Rs. 4,900 p.a.
 251

Answer to SEQ 4
The correct option is A.
Difference = Rs. 46,170 – Rs. 45,000 = Rs. 1,170

SLM WDV
Method Method
Purchase price on 01 January 2011 50,000 50,000
Add: Installation cost 10,000 10,000
Cost of the machinery on 01 January 2011 60,000 60,000
Less: Depreciation on 31 December 2011 6,000 6,000
Book value of the machinery on 01 January 2012 54,000 54,000
Less: Depreciation on 31 December 2012 6,000 5,400
Book value of the machinery on 01 January 2013 48,000 48,600
Less: Depreciation on 30 June 2013 (6 months) 3,000 2,430
45,000 46,170
Answer to SEQ 5
The correct option is C.
Profit on sale of machinery
SLM
Method
Purchase price on 01 April 2006 1,20,000
Less: Depreciation on 31 December 2006 NIL
Book value of the machinery on 01 January 2007 1,20,000
Less: Depreciation on 31 December 2007 12,000
Book value of the machinery on 01 January 2008 1,08,000
Less: Depreciation on 31 December 2007 12,000
Book value of the machinery on 01 January 2009 96,000
Less: Depreciation on 31 December 2009 12,000
Book value of the machinery on 01 January 2010 84,000
Less: Depreciation on 31 December 2010 12,000
Book value of the machinery on 01 January 2011 72,000
Less: Depreciation on 30 September 2011 12,000
Book value of the machinery on 30 September 2011 60,000
Selling price of machinery 66,000
Profit on sale of machinery 6,000
W1 Annual Depreciation = (Rs. 1,20,000 – Rs. 12,000)/9 years = Rs.12,000
 252

CHAPTER 2

ACCOUNTING PROCESS, METHODS AND

CONTROL, AND FINALISATION OF
ACCOUNTS
UNIT 8

BANK RECONCILIATION STATEMENT

Chapter Introduction
Every person has a bank account. The entries of deposits and withdrawals are the
key components of bank transactions. All the transactions relating to the bank
have to be monitored properly because this helps in identifying any differences
between the cash book and bank statement. It also helps to make sure that
nobody has been stealing money directly from your bank account!
Generally, there should be no difference between the balances shown on the bank
statement and in the cash book, because all the entries should appear in both. It
may happen that on a particular date some entries are recorded in the cash book
but are not shown on the bank statement. Entities usually have a policy of
entering cheques received from any party immediately in the cash book; it
usually takes 3-4days to be processed by the bank, before it appears on the bank
statement. Similarly cheques issued by Entities are immediately entered in the
Bank Book but are presented to bank after 3-4 days. So, this is the most common
reason why there are differences between the cash book and the bank statement.
It is therefore necessary to prepare a bank reconciliation statement to discover the
differences between the bank statement and the cashbook. This will help to keep
a check on the accounts maintained by the entities and the transactions recorded
by the bank. Most organisations prepare monthly bank reconciliations to
maintain proper records.

Error!
a) Define Bank Reconciliation Statement and highlight its importance.
b) Mention the possible reasons for a difference in the cash book balance
and pass book balance.
c) Explain how Bank Reconciliation Statement is prepared.
 253

Look at the scenario

Sunil’s cash book showed a balance of Rs. 20,000, whereas the balance per the
bank statement (i.e. pass book) was Rs. 15,000. Sunil wondered why there was a
difference in the cash book balance and bank statement.

When he prepared the bank reconciliation statement, he found that he had

recorded a receipt of Rs. 5,000 from one of his customers but this transaction was
not reflected in the bank account.

So, by preparing the reconciliation statement, he located the missing amount and
was reassured about the accuracy of accounts.

1. Define Bank Reconciliation Statement and highlight its

importance.
[Learning Outcome a]
1.1 Bank reconciliation statement (BRS)

Bank Reconciliation Statement is the statement prepared by an entity that

reconciles the difference between the bank balance shown by the pass book and
the cash book balance.

The bank usually provides bank statements periodically, e.g. fortnightly,

monthly, quarterly, etc. It is prepared by an entity on a particular day (mostly
month-end) when the bank sends a bank statement. Ideally, there should not be
any difference between the two balances if all entries are recorded properly and
timely in both the books.

But there are several occasions where certain entries are recorded in any of the
books or errors of omission or commission that arise in recording entries in the
books. Some entries may have been recorded in the cash book, but not in the pass
book and vice versa at a particular point of time and recorded in the other book
subsequently.

Again, certain entries recorded in one book are not at all recorded in the other or
recorded at a different value in the other book. For all such reasons, the balance
in one book may not agree with that of the other book.
 254

Thus difference between the two books may

be classified into two groups: These differences are briefly
1. Timing Difference and covered in the next Learning
2. Difference due to errors in Outcome.
recording.
It is the bank reconciliation statement that provides a systematic process of
identifying the reasons for the difference between the balances of two books and
reconciling the difference giving reasons for necessary accounting and
administrative action.
In insurance business, 99% of transactions are carried out through the bank and
the differences between the two book balances are sometimes found to run into
crores of rupees, causing great concern to the accounts department, which has to
spend considerable time preparing the bank reconciliation statement.

1.2 Importance of BRS

1. Bank reconciliation statement is an important tool for internal control over
both administration and accounting.
2. It helps to detect many discrepancies and irregularities in financial
transactions apart from reconciliation of the two balances due to mere time
difference or errors of omission or commission.
3. Most of the scams may remain undetected for a long time. Satyam Scam and
Enron Scam are two instances of this sort. Mistakes may be intentional and
unintentional.
4. When mistakes are deliberate or intentional, the difference between the two
balances may be due to financial irregularities and fraud.
5. Proper bank reconciliation is the first and foremost tool to detect and control
fraud.

A bank reconciliation statement is:

(i) prepared by the bank and sent to its account holders
(ii) a statement sent by a bank to those customers who do not maintain a
minimum balance
(iii) not a part of the double entry system
(iv) prepared by the entity to find discrepancies
A (i)
B (ii) and (iii)
C (iii) and (iv)
D (ii) and (iv)
 255

2. Mention the possible reasons for a difference in the cash

book balance and pass book balance.
[Learning Outcome b]
As mentioned in the previous Learning Outcome, a difference in balances
between the two books, Cash Book and Pass Book, may arise due to many
reasons, which may be broadly classified into two groups:
1. Timing Difference
2. Difference due to errors in recording

Diagram 1: Reasons for differences in the balances between Cash Book and
Pass Book
 256

2.1 Timing Difference

1. Cheques paid into bank but not credited or collected by the bank

Entries are made on the debit side of the Cash Book in the bank column
immediately after the cheques are sent to the bank for deposit, but the bank
generally gives credit to the customer's account for the said deposits only after
the bank receives collections on the cheques being cleared. Thus, there will be
difference in balances of the two books at a particular point of time.

2. Cheques issued but not presented for payment

Immediately after issuing cheques, entries are made on the credit side of the Cash
Book in the Bank Column, but no entry is passed by the bank till such cheques
are presented and payment is made by the bank. Such difference of timing for
entry in two books causes difference in balances of the two books.

3. Direct payments and remittances by bank

Sometimes, banks may make payments according to standing orders on various

items such as insurance premium and remittance to some other accounts or
persons, which the customer enters in his cash book only after he receives advice
from the bank. With such entries being made in the Cash Book and Pass Book on
different dates, there arises a difference between two balances at a particular
point of time.

4. Direct deposits by customers into bank

Direct payments into bank by clients or others may remain unrecorded in the
cash book till this comes to the knowledge of the account holder. In such case,
entries are made in the Cash Book and Pass Book on different dates, creating the
timing difference.

5. Dishonour of bills

When discounted bills are dishonoured and the bank fails to collect payments on
the discounted bills or promissory notes, debit entries are passed by the bank, but
these are not entered in the cash book till it comes to the knowledge of the
account holder.
 257

6. Bills or income collected by the bank

Sometimes, the bank directly collects bills or other incomes such as dividends,
rents, interest on securities etc. on behalf of its customer’s standing instructions,
and passes credit entries in the customers' account. However, account holders
pass the entries only after they receive advice from the bank.

7. Interest or expenses debited by the bank

Banks pass the necessary debit entries in the pass book for overdraft interest or
loan interest or other expenses; the accountholders pass the necessary entries
afterwards, when they receive particulars and documents thereof.

8. Interest allowed by the bank

When the bank allows interest on deposit, a credit entry is recorded in the pass
book, but no debit entry is passed by the accountholder in his cash book, until
intimation is received by the customer (accountholder).

2.2 Difference due to errors in recording

Errors in recording entries may occur both in the Cash Book and the Pass Book.
Generally, errors arise in recording entries in the Cash Book. Banks rarely make
mistakes in recording transactions. Even if they make mistakes, their system of
preparing a daily balance sheet helps in the detection of errors and mistakes on a
daily basis, unless the mistakes are deliberate. Errors are found to occur mostly in
recording of entries in the cash book.

The following are a few examples of errors that cause a difference between
the balances of Cash book and Pass Book.

1. Cheques or cash paid into the bank and credited in the pass book but
omitted to be recorded in the cash book.

2. Up-country cheques paid into bank and credited in the pass book subject to
collection charge, but not entered in the cash book.

3. Charges, expenses and interest on overdraft debited in the pass book but
not recorded in the cash book.
 258

4. Interests on deposits allowed by the bank credited in the pass book but not
recorded in the cash book.

5. Errors in casting, balancing or carry forward either in the cash book or in

the pass book or in both.

6. Cheques dishonoured, entered in the pass book, but not entered in the cash
book

7. Recording of entries on the wrong side of the Cash Book or Pass Book

Which of the following does not cause a difference between the cash book and
the bank statement?

A Interest on bank overdraft debited in the bank account

B Cheques received and entered in the cash book, but not yet paid in to the
bank for collection
C Cheques issued and presented for payment
D A customer directly deposited a certain amount in to the bank

A cheque was issued by Matrix Ltd to Jack (supplier), it has not yet appeared on
the bank statement. This cheque is known as ________

A A dishonoured cheque
B A standing order
C An outstanding cheque
D A credit transfer
 259

3. Explain how Bank Reconciliation Statement is prepared.

[Learning Outcome c]

A statement is prepared to reconcile the difference that exists between the cash
book and the pass book. This statement is known as the Bank Reconciliation
Statement.

Diagram 2: Bank reconciliation

For preparation of a bank reconciliation statement, entries appearing in the bank

column of the cash book are compared with those appearing in the pass book.
More precisely, the entries appearing on the debit side of the cash book will be
compared with the entries appearing on the credit side (deposit column) of the
pass book and vice versa.

It should be remembered that entries appearing both in the cash book and the
pass book will cause no difference at all and hence, should be ignored.

One of the balances is taken up as the starting point and is adjusted considering
how the balance would have changed if the same entries were made in the two
books. This enables the management of business concerns to check the accuracy
of the entries made in the cash book and also to keep track of cheques either sent
to the bank for collection and remaining unclear or issued to the clients by the
customer and remaining unpresented, for an unreasonably long period.
Ultimately, the management can ascertain the cause for delay and take timely
action.
 260

Preparation of a bank reconciliation statement

Take the Cash Book Balance or Pass Book Balance as the starting point and then
check what has been done or has not been done in the other Book. For instance if
we take the Pass Book Balance as the starting Point, we would check carefully
what has been done or not done in the Cash Book and ascertain if the entries
passed in the Cash Book are also passed in the Pass Book and also if the entries
not finding a place in the Cash Book are removed from the Pass Book.
Step 1
Compare the debit side of the cash book with the deposits column of the pass
book, item by item. Note down the following:
9 cheques deposited into the bank account (appearing in the cash book)
which are not credited by the bank
9 interest credited by the bank for which there is no corresponding entry in
the cash book
9 Cheques dishonoured (not recorded in the cash book)
9 Direct credits by customers (appearing in the pass book) for which there
is no corresponding entry in the cash book
Step 2
Compare the credit side of the cash book with the withdrawals column of the
pass book. Note the following:
9 cheques issued during the period which have not been presented for
payment
9 bank charges debited by the bank for which there is no corresponding
entry in the cash book
9 Standing order payments (appearing in the pass book) for which there is
no corresponding entry in the cash book
9 Interest debited by the bank for which there is no corresponding entry in
the cash book
Step 3
Fill up the proforma of the bank reconciliation statement.

The following proforma can be used to reconcile the balances of cash book
and bank statement.

Let us see the proforma of the same in two different ways.

1. When we move from cash book balance to bank statement balance.
2. When we move from bank statement balance to cash book balance.
 261

Proforma of bank reconciliation statement when we move from cash book

balance to bank statement balance

Bank Reconciliation Statement

Rs.
Balance according to cash book X
Add: Cheque issued but not presented X
Add: Bank interest X
Add: Direct credit by customers X
X
Less: Standing order (X)
Less: Cheques deposited in bank but not credited (X)
Less: Cheques dishonoured (not recorded in cash book) (X)
Less: Bank charges (X)
Balance according to bank statement X

Proforma of bank reconciliation statement when we move from bank

statement balance to cash book balance
Bank Reconciliation Statement

Rs.
Balance according to bank statement X
Add: Cheques deposited in bank but not credited X
Add: Bank charges X
Add: Cheques dishonoured X
Add: Standing order X
X
Less: Cheque issued but not presented (X)
Less: Direct credit by customers (X)
Less: Bank interest (x)
Balance according to cash book X

The method of comparison of entries in the Cash Book with those found in the
Pass Book will be clear from the following:

Following is an extract from the Pass Book and the bank column of the Cash
Book of M/S Young & Old for the month of September 2010.
 262

Cash Book (Bank Column only)

Dr Cr
Date Particulars Amount Date Particulars Amount
2010 2010
Sept Sept
1 To Balance b/d 40,000 3 By M/s D Electronics 6,000
2 To M/S P & Co 3,500 7 By M/s Arora & Co 10,000
6 To M/S B& Co 7,600 17 By M/s Tonk & Sons 12,500
8 To Cash 3,000 24 By M/s Dilip & Sons 7,300
16 To M/s Raj & Co 4,300 25 By Cash 5,000
23 To M/S T & CO 10,500 28 By M/S B& Co 7,800
29 To M/S D & Sons 3,400 30 By Balance c/d 23,700
72,300 72,300

Pass Book (Bank of India)

Date Withdrawal Deposit/
Balance
(2010 /Debit Credit
(Rs.)
Sept) (Rs.) (Rs.)
1 Balance 40,000
5 To M/s D Electronics 6,000 34,000
8 By Cash 3,000 37,000
9 To M/s Arora & Co 10,000 27,000
10 By M/S P & CO 3,500 30,500
18 To M/s Tonk & Sons 12,500 18,000
18 By M/S B& Co 7,600 25,600
20 By M/s Raj & Co 4,300 29,900
25 To Cash 5,000 24,900
29 By Interest Collected from Govt. 2,000 26,900
Securities
30 Insurance Premium as per S/order 2,600 24,300

On examination of the Cash Book and Pass Book entries for the month of
September 2010, we find that although Cash Book and Pass Book have started
with the same balance of Rs 40000, the closing balances of both the books differ
from each other due to the following timing differences and differences arising
from errors in recording certain transactions:

1. Bank’s direct collection - Interest from Govt. Securities - and one direct
payment - Insurance Premium as per Standing Order on 29th and 30th Sept for
Rs. 2,000 and Rs. 2,600 respectively - have not been recorded in the Cash
Book by the end of the month.
 263

2. Two deposits on 23rd and 29th Sept for Rs 10500 and Rs. 3,400 respectively
have not been entered in the pass book; two cheques issued for Rs. 7,300 and
Rs. 7,800 on 24th and 28th Sept respectively have not been presented by 30th
Sept.
3. Now to prepare the Bank Reconciliation, start with one balance, then adjust
this balance with the above noted items of difference and then arrive at the
other balance.
Let us prepare the Bank Reconciliation Statement with the above-mentioned
extract from the Cash Book and Pass Book of an organisation:
M/S Young & Old
Bank Reconciliation Statement for the month of September 2010
Amount
Particulars
(Rs.)
Balance as per Cash Book 23,700
Add:
Interest Collected by bank, but not entered in Cash Book 2,000
Cheque issued to M/s Dilip & Sons, but not yet presented
7,300
to bank
Cheque issued to M/S B& Co, but not yet presented to
7,800 17,100
bank
40,800
Less:
Insurance Premium paid by bank, but not entered in Cash
2,600
Book
Cheque deposited into bank, but not encashed (M/S T &
10,500
CO)
Cheque deposited into bank, but not encashed (M/S D
3,400 16,500
&Sons)
Balance as per Pass Book 24,300

From the above illustration, we find that Bank Reconciliation is nothing but a
method to reconcile the Cash Book Balance and Pass Book Balance with
adjustment for differences being identified on the verification of Cash Book and
Pass Book.

9 If we start with the Cash Book Balance, our objective will be arriving at the
Pass Book Balance as shown above.
9 If we start with the Pass Book Balance, our objective will be arriving at the
Cash Book Balance after adjustment of all differences.
 264

To make the above aspect clearer, let us prepare a bank reconciliation statement
with the Pass Book Balance as the starting point, instead of the Cash Book
balance.

M/S Young & Old

Bank Reconciliation Statement for the month of September 2010
Amount
Particulars
(Rs.)
Balance as per Pass Book 24,300
Less:
Interest Collected by bank, but not entered in Cash Book 2,000
Cheque issued to M/s Dilip & Sons, but not yet presented
7,300
to bank
Cheque issued to M/S B& Co, but not yet presented to
7,800 17,100
bank
7,200
Add:
Insurance Premium paid by bank, but not entered in Cash
2,600
Book
Cheque deposited into bank, but not encashed (M/S T &
10,500
CO)
Cheque deposited into bank, but not encashed (M/S D
3,400 16,500
&Sons)
Balance as per Cash Book 23,700

From the above illustration, we find that if we start the bank reconciliation taking
the Cash Book Balance, we will adjust the differences following the entries
recorded in Pass Book. If we start the bank reconciliation taking the Pass Book
Balance as the starting point, we will adjust the differences following the entries
recorded in the Cash Book.

Salient aspects to be considered for preparation of Bank Reconciliation

Statement (BRS)

1. Bank Reconciliation can be started using any of the following four balances;

9 Dr Balance in Cash Book (Favourable Balance)

9 Cr. Balance in Cash Book (Adverse/ Overdraft Balance)
9 Dr Balance in Pass Book (Adverse/ Overdraft Balance)
9 Cr. Balance in Pass Book (Favourable Balance)
 265

2. When one balance is more than the other due to certain reasons already
known or not yet identified, the accountant shall verify one book with
reference to the other book.

The Debit Side of the Cash Book will be identified with the entries on the
Credit side of the Pass Book and the entries on the credit side of the Cash
Book will be compared with those on the Debit side of the Pass Book by way
of placing a tick mark before the entries.

The unticked items will be the cause of the difference.

3. The unticked items will be added to or subtracted from one balance to arrive
at the other balance in the manner mentioned in the diagram below.

Diagram 3: Causes of difference between two balances and their treatment

in BRS
 266

With the following illustrations, the above guidelines on treatments of various

causes of difference between Cash Book balance and Pass Book Balance have
been applied for preparation of bank reconciliation statements

ABC & Co’s Cash Book shows an overdraft balance of Rs. 6,34,000 on 30th June
2010, while the Pass Book balance on that date is Rs. 6,33,200.

On examination of the Cash Book and Bank statement (Pass Book), the
following discrepancies are noticed:
1. Rs. 16,000 Interest on Overdraft for the last 6 months appearing in the Bank
Statement is not entered in the Cash Book
2. Rs. 3,000 Bank Charges are not entered in the Cash Book
3. Two cheques for Rs. 1,00,000 and Rs. 16,800 issued by the firm have not
been presented to the bank.
4. Two cheques for Rs. 2,00,000 and Rs. 17,000 deposited on 29.6.10 have not
been credited in the Pass Book.
5. Rs. 1,20,000 interest on investments has been collected and credited by the
bank on 30.6.10, but is not entered in the Cash Book.

Prepare Bank Reconciliation Statement on the basis of the above

particulars.

Solution
Bank Reconciliation Statement as on 30th June 2010

Particulars Amount
Overdraft balance as per Cash Book 6,34,000
Add:
i) Overdraft Interest debited in Pass book, not entered 16,000
in Cash Book
ii) Bank Charges debited in Pass book, not entered in 3,000
Cash Book
iii) Cheques issued, but not yet presented 2,17,000 2,36,000
8,70,000
Less:
i) Cheques issued, but not yet presented 1,16,800
ii) Investment interest credited in pass book, not entered 1,20,000 2,36,800
in Cash book
Balance as per Pass Book 6,33,200
 267

XYZ & CO’s Cash Book shows a bank balance of Rs. 46,100 on 30th June 2010,
which does not agree with the Bank Statement Balance.

On examination of the Cash Book and Bank statement (Pass Book), the
following discrepancies are observed.

1. Three cheques for Rs. 40,000, Rs. 20,000 and Rs. 3,000 are credited in the
Cash Book, but are not presented before the bank.
2. Two cheques totalling Rs. 25,000 are deposited on 29.6.10, but are credited
in the Pass Book on 2.7.10.
3. Dividend Rs. 3,800 directly collected and credited in the pass book on
28.6.10 is intimated on 2.7.10.
4. Two cheques totalling Rs. 7,300, dishonoured by the bank are duly debited in
the Pass Book; dishonour intimation received by the firm on 3.7.10.
5. Bank Charges of Rs. 4,200 and one direct payment of Rs. 1,000 to Trade
Association is debited in the Pass Book, but not yet entered in the Cash
Book.
6. Bank wrongly debited a cheque of Rs. 2,700, which was not issued by XYZ
& CO.

You are required to:

(a) Prepare Bank Reconciliation Statement with given bank balance as per Cash
Book.
(b) Adjust Cash Book (Bank Column) and prepare Bank Reconciliation
Statement with bank balance as per Adjusted Cash Book.

Solution

Bank Reconciliation Statement is prepared directly with the given bank balance
as per Cash Book or Pass Book, as the case may be. Sometimes, Cash Book is
adjusted/ corrected for the mistakes and then the Bank Reconciliation Statement
is prepared. In this example, BRS with the given bank balance is shown in (a)
and BRS with the bank balance as per Adjusted Cash Book is shown in (b). But
in both the cases, bank balance as per Pass Book is the same, i.e. Rs. 72,700.
 268

(a) Bank Reconciliation Statement starting with the given bank balance as
per Cash Book

XYZ & CO’s

Bank Reconciliation Statement as on 30th June 2010

Particulars Amount Amount

Rs Rs
Bank Balance as per Cash Book 46,100
Add:
Three cheques credited in the cash book but not presented 63,000
(40,000 + 20,000 + 3,000)
Dividend directly collected by bank but not recorded in 3,800 66,800
cash book
1,12,900
Less:
Two cheques deposited into bank but not credited in Pass 25,000
book
Two cheques deposited into bank has been dishonoured by 7,300
bank but not recorded in cash book
Bank charge debited in Pass book but not recorded in Cash 4,200
Book
Paid by bank to Trade Associated but not recorded in Cash 1,000
Book
Cheque was not issued but wrongly debited by bank in Pass 2,700 40,200
Book
Bank Balance as per Pass Book 72,700

(b) Adjust Cash Book (Bank Column) and prepare Bank Reconciliation
Statement with bank balance as per Adjusted Cash Book
Dr Adjusted Cash Book (Bank Column) Cr
Date Particulars Amount Date Particulars Amount
30.6.10 To Balance B/d 46,100 30.6.10 By Cheque 7,300
dishonoured
To Dividend 3,800 By Bank Charges 4,200
By Trade 1,000
association
By Balance C/d 37,400
49,900 49,900
 269

Bank Reconciliation Statement (with bank Balance of adjusted Cash Book)

As on 30th June 2010
Particulars Amount Amount
Bank Balance As per Adjusted Cash Book 37,400
Add:
i) Cheques Issued, but Not presented (40,000 + 20,000 + 63,000 63,000
3,000)
1,00,400
Less:
i) Cheques Deposited, but not credited in Pass Book 25,000
ii) Cheques was not issued, but wrongly debited in Pass 2,700 27,700
Book
Bank Balance as per Pass Book 72,700

The cash balance of Krupa Traders was Rs. 700 (debit). The bank statement
showed a credit balance of Rs. 1,600 on 31 March 2011. The difference was
caused due to the following transactions

(i) Cheques of Rs. 500 issued, but not presented in the bank for payment
(ii) A cheque received amounted to Rs. 200, but was entered as Rs. 20
(iii) Payment of Rs. 250 from a customer was directly received by the bank
(iv) The cash book was overstated by Rs. 30

What will be the revised balance in the cash book after revising the above
transactions?

A Rs. 750
B Rs. 850
C Rs. 550
D Rs. 690

Which of the following is a timing difference that reduces the balance according
to the cash book in bank reconciliation?

A Cheques deposited but not cleared

B Cheques issued but not presented
C Bank charges
D Bank interest
 270

Summary
¾ Cash book is the record of cash and bank transactions, which is prepared by
the entity, and the pass book is the statement of accounts prepared by the
bank.
¾ Pass Book is a book issued by the Bank to an account holder. It is almost a
copy of the account of the customer / entity in the books of the bank.
¾ There can be various reasons due to which the balances of the cash book and
the pass book do not match.
¾ These reasons can be either timing differences or errors in recording.
¾ Hence, bank reconciliation statement is prepared to reconcile both the
balances.
¾ Bank reconciliation statement is a statement, not an account.
¾ Bank reconciliation statement eases checking of errors and detection of
frauds in the cash books and pass books.

Answers to Test Yourself

Answer to TY 1

The correct option is C.

The bank reconciliation statement is prepared by an entity to find discrepancies

in the cash book and the bank statement. It is a statement and not an account and
hence is not a part of the double entry system.

Answer to TY 2

The correct option is C.

Cheques issued, but not presented for payment will cause the difference between
the cash book and the bank statement.

Answer to TY 3

The correct option is C.

It is a cheque issued to Jack for payment but not yet cashed by him.
 271

Answer to TY 4

The correct option is B.

(ii) and (iv) are the errors in the cash book.

The correction in the cash book is made as follows:

Cash Book
Dr Cr
Date Receipts Rs. Date Payments Rs.
To Balance b/d 700 Overstated 30
Cheque entered with a
wrong amount (Rs.
200 - Rs. 20) 180 By Balance c/d 850
880 880

Answer to TY 5

The correct option is A.

Cheques deposited but not cleared.

Self Examination Questions

Question 1

The following information of Suraj Traders is available for the month of July
2011:
1 July Balance as per Cash Book 1,50,000
2 July Cheques paid into Bank in July 2011 but credited by the 8,000
bank in August 2011
3 July Cheques issued in July 2011 but cashed in August 2011 12,000
4 July Cheques entered in the Cash Book in July 2011 but paid 5,000
into bank in August 2011
5 July Interest allowed by the bank 3,000
6 July Interest charged by the bank 900
 272

From the above details, prepare a bank reconciliation statement as on 31st July
2011, and find out the Balance as per pass book.

A Rs. 1,50,000 balance

B Rs. 1,51,100 overdraft
C Rs. 1,51,100 balance
D Rs. 1,50,000 overdraft

Question 2

The cash book of a sole trader, Jayprakash, showed an overdraft of Rs. 3,000, but
it was not matching with the balance as per pass book on the same date. The
following reasons were revealed on the comparison of the cash book and the pass
book.
(i) Cheques of Rs. 200, Rs. 100 and Rs. 250 respectively had not been presented
for payments
(ii) Cheque of Rs. 800 paid into account had not been cleared.

The balance as per the pass book will be:

A Rs. 2,200
B Rs. 4,350
C Rs. 3,250
D Rs. 2,750

Question 3

Rishita’s cash book shows a credit balance of Rs. 8,700 for the month of January.
The balance of the bank statement does not match with that of the cash book, due
to the following reasons.

(i) Interest on an overdraft of Rs. 500 had been debited by the bank but not
recorded in the cash book.
(ii) Cheques of Rs. 5,000 issued during the month, but were not presented in the
bank until 31 January 2007. Cheques of Rs. 3,500 were deposited but not
cleared.
(iii) Interest on investments of Rs. 1,000 was directly collected by the bank.
(iv) The bank had wrongly debited Rs. 800.
 273

The balance per the bank statement is:

A Rs. 7,500 (debit)
B Rs. 9,500 (debit)
C Rs. 5,900 (credit)
D Rs. 7,500 (credit)

Question 4
The following is a bank reconciliation statement prepared by a trainee accountant
of Surya Ltd:

Rs.
Overdraft per bank statement 40,000
Add: Deposits not credited 45,000
85,000
Less: Outstanding cheques Overdraft per cash book 6,000
79,000

Assuming the bank statement balance of Rs. 40,000 to be correct, what should
the cash book balance be?
A Rs. 79,000 overdrawn
B Rs. 6,000 overdrawn
C Rs. 1,000 overdrawn
D Rs. 6,000 cash at bank

Question 5
Debit balance as per Cash Book of Shrinath Enterprises as on 31.3.2012 is Rs.
1,500.
(i) Cheques deposited but not cleared amount to Rs. 100 and cheques issued but
not presented amount to Rs. 150.
(ii) The bank allowed interest amounting Rs. 50 and collected dividend of Rs. 50
on behalf of Shrinath Enterprises.
Balance as per pass book should be:
A Rs. 1,600
B Rs. 1,450
C Rs. 1,850
D Rs. 1,650
 274

Answers to Self Examination Questions

Answer to SEQ 1

The correct option is B.

Pass book will show overdraft (debit balance) of Rs. 1,51,100.

Bank Reconciliation Statement as on July 31, 2011

Particulars Amount Amount
Balance as per Cash Book 1,50,000
Add:
Cheques issued but not cashed 12,000
Interest allowed by bank 3,000 15,000
1,65,000
Less:
Cheques deposited into bank but not yet credited 8,000
Cheques entered into Cash Book but not paid by Bank 5,000
Interest charged by Bank 900 13,900
Balance as per Pass Book 1,51,100

Answer to SEQ 2

The correct option is C.

Rs.
Credit balance as( overdraft) per cash book 3,000
Add: Cheque deposited but not cleared 800
3,800
Less: Cheques issued but not presented for payment
(200 + 100 + 250) 550
Balance as per Pass Book 3,250
 275

Answer to SEQ 3

The correct option is A.

Rs. Rs.
Overdraft balance per Cash Book 8,700
Add:
Interest on overdraft not entered in cash book 500
Cheques deposited but not cleared 3,500
Wrong debit by bank 800 4,800
13,500
Less:
Cheque issued but not presented 5,000
Interest on investment directly collected by bank 1,000 6,000
Overdraft balance per Bank Statement 7,500

Answer to SEQ 4

The correct option is C.

Here, balance according to bank statement is overdraft balance. So, Rs. 40,000 is
to be taken as (Rs. 40,000) and then we have to proceed to find the cash book
balance.

A bank reconciliation statement is prepared as follows:

Rs.
Overdraft per Bank Statement 40,000
Add: Outstanding cheques Overdraft per cash book 6,000
Less: Deposits not credited 45,000
Overdraft as per Cash Book 1,000
 276

Answer to SEQ 5

The correct option is D.

Rs. Rs.
Debit balance as per cash book 1500
Add:
Cheques issued but not presented 150
Bank allowed interest 50
Dividend collected on behalf of Shrinath 250
Enterprises 50
1,750
Less:
Cheque deposited but not cleared 100 100
Balance as per pass book 1650
 277

CHAPTER 2

ACCOUNTING PROCESS, METHODS &

CONTROL AND FINALISATION OF
ACCOUNTS
UNIT 9

INTRODUCTION TO COMPANY ACCOUNTS

Chapter Introduction
In this chapter we will discuss various aspects relating to company accounts. This
would include discussion pertaining to relevant provisions of Companies Act
regarding maintenance of proper books, issuing shares, debentures, preference
shares, underwriting of shares, calculating managerial remuneration and
preparing final accounts.
 278

a) State the legal requirements relating to preparation and presentation of

financial statements as per the provisions of the Companies Act 1956.
b) Learn about a company, along with various types of companies,
including the salient features.
c) State the provisions of the Companies Act relating to maintenance of
proper books of account.
d) Discuss the accounting treatment of share capital with respect to issue,
reissue and forfeiture.
e) Discuss buy-back of shares and study the condition for buy back of
shares.
f) Discuss the various Employee Stock Option Plans (ESOP) issued by
companies, along with their accounting treatment.
g) Discuss the accounting treatment of redemption of preference shares.
h) Discuss the treatment of issue, underwriting and redemption of
debentures.
i) Discuss the concept of bonus shares along with accounting treatment and
related provisions under the Companies Act.
j) Discuss the form and content of financial statements as required by
statute and prepare financial statements in accordance with the formats.
k) Discuss taxation and its accounting treatment in the final accounts.
l) Discuss and calculate managerial remuneration in accordance with the
provisions of the Companies Act 1956.
 279

1. State the legal requirements relating to preparation and

presentation of financial statements as per the provisions
of the Companies Act 1956.
[Learning Outcome a]
In India, the financial statements of a company are prepared in accordance with
the Indian GAAP. The Indian GAAP comprises the provisions of the Companies
Act 1956 (as amended), the mandatory Accounting Standards issued by the ICAI,
and the specific guidelines or regulations issued by any other regulatory authority
like SEBI, RBI or IRDA. In accordance with the Indian GAAP, a complete set
of financial statements of a company include the following:

9 Balance Sheet
9 Income Statement/ Profit & Loss Account
9 Cash Flow Statement
9 Notes comprising a summary of accounting policies and other explanatory
notes
9 Consolidated Financial Statements (listed companies) in accordance with AS
21 and AS 23

The said financial statements also known as general purpose financial statements
are furnished along with the auditors’ report and the Board’s report in the Annual
Report published by the company for public communication and especially for
various stakeholders including shareholders, the regulator, customers, financiers
and the Government.

1.1 Laying of annual accounts at the Annual General Meeting (AGM)

Under Section 210 of the Companies Act 1956, at every annual general meeting
of a company held in pursuance of the Section 166, the Board of Directors of the
company shall lay before the company

9 Balance Sheet as at the end of the financial year and

9 Profit& Loss account for the financial year

Under section 216 of the Companies Act, the Statement of Profit and Loss shall
be annexed to the Balance Sheet and the auditor’s report shall be attached
thereto. Section 217 provides that there shall be attached to every balance sheet
laid before a company in general meeting a report by its Board of Directors, with
respect to the following matters along with many other aspects specified therein:
 280

9 The state of affairs of the company

9 The amount, if any, which the company proposes to carry to any reserves
9 The amount, if any, which it recommends, should be paid by way of
dividend
9 Material changes and commitments, if any, affecting the financial position of
the company, which have occurred in between the date of balance sheet and
the date of report.

1.2 Form and content of a Balance Sheet and Statement of Profit and
Loss

Form and content of a Balance Sheet and Statement of Profit and Loss is
governed by the provision under Companies Act 1956, Schedule VI

Schedule VI to the Companies Act, 1956 has recently been revised and is became
applicable to all companies for the preparation of financial statements beginning
on or from 1 April 2011.

In accordance with Section 211 of the Companies Act, every balance sheet and
statement of profit and loss of a company shall give a true and fair view of the
state of affairs and profit and loss of the company for the financial year and shall
comply with the requirements of the Revised Schedule VI. The contents of
balance sheet and Statement of Profit and Loss are discussed in detail in Learning
Outcome 10.

Salient features of Revised Schedule VI:

a) The Revised Schedule VI requires that if compliance with the requirements

of the Act and / or the notified Accounting Standards requires a change in the
treatment or disclosure in the Financial Statements as compared to that
provided in the Revised Schedule VI, the requirements of the Act and / or the
notified Accounting Standards will prevail over the Schedule.

b) The Revised Schedule VI has eliminated the concept of ‘Schedule’ and such
information is now to be furnished in the Notes to Accounts.

c) All items of assets and liabilities are to be bifurcated between current and
non-current portions and presented separately on the face of the Balance
Sheet.
 281

An asset shall be classified as current when it satisfies any of the following

criteria:

a) it is expected to be realized in, or is intended for sale or consumption in, the

company’s normal operating cycle
b) it is held primarily for the purpose of being traded;
c) it is expected to be realized within twelve months after the reporting
d) date; or
e) it is cash or cash equivalent unless it is restricted from being exchanged or
used to settle a liability for at least twelve months after the reporting date.

All other assets shall be classified as non-current.

d) There is an explicit requirement to use the same unit of measurement

uniformly throughout the financial statements and notes thereon.

It should be noted that the requirements of the Revised Schedule VI however, do

not apply to companies as referred to in the proviso to Section 211 (1) and
Section 211(2) of the Act, i.e., any insurance or banking company, or any
company engaged in the generation or supply of electricity or to any other class
of company for which a form of Balance Sheet and statement of Profit and Loss
has been specified in or under any other Act governing such class of company.

Thus, company accounts are to be prepared, presented and analyzed in pursuance

of the applicable Accounting Standards and relevant regulatory norms and more
specifically, the provisions of the Companies Act, which have been discussed
more elaborately in subsequent Learning Outcomes.

At every annual general meeting the financial statements are presented to the
shareholders by the:

A Statutory Auditors
B Internal Auditors
C Company Secretary
D Board of Directors
 282

2. Learn about a company, along with various types of

companies, including the salient features.
[Learning Outcome b]

2.1 Meaning of Company

To study and appreciate company accounts properly, one needs to know what a
company stands for legally, how it differs from a firm and what are the legal
requirements to be complied with for preparation and presentation of its financial
statements.

Sec. 3(1)(i) of the Companies Act, 1956 defines the company as:

A company formed and registered under this Act or any existing company
formed and registered under any of the previous company laws specified in
Section 3(i)(ii).

A company defined in this section may mean either a private company or a

public company.

Under Section 3(i)(iii), private company means a company which has a minimum
paid-up capital of one lakh rupees or such higher capital as may be prescribed by
its articles.

Under Section 3(1)(iv), a public company means a company which:

a) is not a private company,

b) has a minimum paid-up capital of five lakh rupees or such higher paid-up
capital as may be prescribed and
c) is a private company which is a subsidiary of a company which is not a
private company.

Companies (Amendment) Act 2003 states that if a company fails to enhance its
minimum paid-up capital up to Rs.1 lakh in case of private company and Rs.5
lakhs in case of a public company, each director or manager or shareholder will
have unlimited liability.
 283

2.2 Types of companies

The various types of companies are discussed below:

1. Registered Company: is of two types- Public Company and Private

Company. A public company may be a listed company or unlisted company.
Listed companies are those which get their securities listed in any recognized
Stock Exchange in India. An unlisted company is one whose securities are
not listed on any recognized stock exchange. Private companies don’t
involve participation of public in general for funding capital. So the shares of
private companies are not listed in any stock exchange.

2. Statutory Company: Companies that come into existence and operate under
the special act passed by the State Legislature or the Parliament are called
statutory companies. Unit Trust of India, Life Insurance Corporation of India,
General Insurance Corporation of India, Reserve Bank of India. Such
companies are not required to use the word ‘Limited’ or ‘Ltd’ as part of their
name.

3. Government Company: In accordance with Section 617 of the Companies

Act 1956, a Government company is a company in which not less than 51%
of the paid capital is held by the central Government or state Governments or
by both of them jointly.

The New India Assurance Company Limited, National Insurance Company

Limited, United India Insurance Company Limited and the Oriental Insurance
Company Limited are all government companies as they are fully owned by the
Government of India.

4. Foreign Company: A foreign company is one that is incorporated or

registered outside India but is having place of business or operations in India.
LG, Samsung, Dell, Goldman Sachs, Google are all foreign companies
having their place of operations in India.

5. Holding Company: In accordance with Section 4(4) of the Companies Act

1956, a company is deemed to be a holding company if the other company is
its subsidiary company. A company shall be deemed to be a subsidiary of
another if the composition of its board of directors is controlled by that other
company.
 284

Pertinently, types of company as outlined above determine the legal requirements

and their proper compliance in respect of preparation, presentation of financial
statements, and the obligation of the board of directors for disclosures and
management report.

Diagram 1: Types of companies

2.3 Salient Features of a company

Before we proceed to discuss company accounts, it is advisable that you must

know the following salient features of a company:

1. Incorporation: a company, which is regarded as an artificial legal person

comes into existence only through the operation of law. It must be
incorporated and registered under the Companies Act to obtain its legal
personality.

2. Separate Entity: a company is a distinct legal entity separate from its

members, management and shareholders. Having a separate and distinct
entity or legal personality, it can contract, sue or be sued in its own
incorporated name and capacity.

3. Perpetual Succession: a company enjoys continuous existence and its

continuance is not affected by the death, insolvency, mental or physical
incapacity of its members. It is created under the provisions of company law
and can be wound up in accordance with the provisions of company law
alone.
 285

4. Common Seal: as a company is an artificial person, it cannot sign

documents or contracts as a natural person. A company therefore has a
common seal, which is the signature of that company and signifies common
consent of all the members. The company's seal is affixed on all the
documents executed for and on its behalf.

5. Distinction between Ownership and management: shareholders or

members who are very large in number and scattered over the country or
even over the world cannot participate in the day-to day management of the
company. So the members elect the board of directors and managers for
management of the company.

6. Limited Liability: the significance of the word “limited” or “Ltd” signifies

that the liability of every shareholder is either limited by shares or by
guarantee. The liability of its members is limited to the amount remaining
unpaid on the shares subscribed by them. Thus, in case of fully paid-up
shares, the members cannot be asked to contribute any further, if the
company goes into liquidation.

7. Transferability of Shares: a Company’s Capital is raised from the

shareholders through their subscription in shares issued by the company.
Such shares are transferable by its members except in case of private
companies where there are certain restrictions for such transfer.

8. Maintenance of Books of Accounts: a company registered under the Act is

required by law to maintain a prescribed set of books of accounts as
discussed hereinafter and any failure in this regard attracts statutory
penalties.

9. Annual Audit: a limited company is required by the Act to get its annual
accounts audited by the Chartered Accountants appointed by the shareholders
in the annual general meeting on the recommendation of the board of
directors.

10. Access to information and books: The Articles of Association govern the
shareholders’ right to inspect the company’s books of accounts with the
exception of books open for inspection under statute. Shareholders have the
right to seek information from the directors through participation in the
meeting and through the periodic reports as stipulated by the statute.
 286

Diagram 2: Salient features of a company

A foreign company is one that is:

A Incorporated or registered in India but has a place of business or operations

outside India
B Incorporated or registered outside India and has a place of business or
operations outside India
C Incorporated or registered outside India but has a place of business or
operations in India
D None of the above
 287

3. State the provisions of the Companies Act relating to

maintenance of proper books of account
[Learning Outcome c]

3.1 Legal Requirements of Company Accounts

In order that the students may be able to appreciate the provisions for statutory
books to be maintained by a company, the manner the financial statements to be
prepared and presented, the students should thoroughly study the specific chapter
dedicated to Accounts in the Companies Act 1956 (as amended now). In this
Learning Outcome, only the important requirements of the Act as regards
maintenance of accounts are discussed. In this regard the provisions of following
sections Sec. 209, S.210, S. 211, S.212, deserve special mention.

Section Particulars
Section 209 Books of account to be kept by company
Section 210 Annual accounts and Balance Sheet
Section 211 Form and contents of Balance Sheet and Statement of Profit
and Loss
Section 212 Balance sheet of holding company to include certain
particulars as to its subsidiaries

3.2 Books of Accounts to be kept by company (Section 209)

Section 209 of the Companies Act 1956 prescribes the books of accounts to be
maintained by every company at its registered office. In accordance with Section
209 of the Act every company shall keep at its registered office proper books of
accounts regarding:

a) all sums of money received and expended by the company and the matters in
respect of which the receipt and expenditure take place
b) all sales and purchases of goods of the company
c) the assets and liabilities of the company
d) such other particulars as may be required by the Central Government to
include in the books of accounts in case of a company pertaining to any class
of companies engaged in production, processing, manufacturing or mining
activities.
 288

3.3 Time limit for preservation of books of account

The sub section 4A of Section 209 requires that these books of account along
with relevant vouchers must be preserved in good order for a minimum period of
8 years in the case of existing companies. However if any company which is less
than 8 years old, books of accounts need to be preserved for the entire period
from the previous year.

3.4 Responsibility of maintaining books of account

The primary responsibility of maintenance of books of account is that of the

Managing Director or Manager and all officers or other employees who have
been given the responsibility by the Board of Directors. If the company has
neither a Managing Director nor a Manager, then all the directors are collectively
responsible.

As per Companies Act 1956, for existing companies, books of account along
with relevant vouchers must be preserved in good order for a minimum period of:

A 5 years
B 7 years
C 8 years
D 10 years

4. Discuss the accounting treatment of share capital with

respect to issue, reissue and forfeiture.
[Learning Outcome d]

The prospectus issued under Section 56 of the Companies Act, 1956 must specify
the following matters in regard to capital structure of the company as specified in
Schedule II:

a) Authorized, issued, subscribed and paid-up capital

b) Size of present issue-preferential allotment to promoters and others.
c) Paid up capital-After present issue and after conversion of debentures, if any
d) Terms of the present issue-terms of payment, terms of application and special
tax benefits
 289

4.1 Issue of shares and accounting entries

A company is required to pass the following accounting entries in the financial

books on the various stages of issue of shares.

Particulars Debit A/c Credit A/c Amount

1. Receipt of share Bank A/c Share Amount
application money application received
A/c
2. Allotment of i) Share Share Capital Total amount.
Shares Application A/c due on
A/c application
ii) Share and allotment
Allotment A/c
3. Receipt of Bank A/c Share Amount
application money Allotment A/c received
4. on Refund of Share Bank A/c Amount
application Application A/c refunded
money*
5. Allotment of a part Share Share Amount held
of shares applied-- Application A/c Allotment A/c in credit to
in case of over & Calls -in- these A/c s
subscription Advance A/c
6. On a Call being Share Call A/c Share Capital Call amount
made A/c
7. Adjustment of Calls-in- Share Call A/c Amount held
money in Calls in Advance A/c to the credit of
advance Calls in Adv.
8. Receipt of Call Bank Account Share Call A/c Amount
Amount received

Note:

* When an issue is oversubscribed, some of the application will be rejected and

application money may be refunded

+ Sometimes separate Application A/c and Allotment A/c are not prepared and
entries relating to share application and share allotment monies are passed
through a combined account called Share Application and Allotment Account.
 290

Issue of Equity Shares – Beauty Soaps Ltd

In January 2010, Beauty Soaps Ltd. invited applications for 1,50,000 equity
shares of Rs.10 each issued at Rs.12 including premium of Rs.2 payable as
follows:

On application by 1 March 2010 Rs.6 per share

On allotment by 31 March 2010 (including premium) Rs.4 per share
On First & Final Calls Rs.2 per share

The company received 1,80,000 applications and made allotment of shares in

compliance with the provisions of Section 73 of the Companies Act 1956 in the
following manner in arrangement with the authorities of a recognized stock
exchange. The Company completed the allotment process and intimated the
applicants as per Board’s Resolution dated 10 May 2010.

i) To reject applications for 8,000 shares as ineligible / incomplete

ii)To make full allotment for applications for 22,000 shares
To make pro-rata allotment for remaining applications
iii)
iv)To utilize the surplus money received on applications against the amounts
due on allotments.
v) All allotment money was received in time. The company has not yet made
First and Final Calls.

Required:

Pass the necessary journal entries to record the above financial transactions on
issue of shares. Also show the Share Application and Allotment A/c, Equity
Share Capital and Bank Account as on 31st March 2010.
 291

Solution
Beauty Soap Ltd
Journal Entries

Debit Credit
Date Particulars
Amount Amount
2010 Bank A/c Dr 10,80,000
To Share Application and
March 1 10,80,000
Allotment A/c
(Being Application money received on
1,80,000 shares @Rs.6 per share)

March 10 Share Application and Allotment A/c Dr 15,00,000

To Equity Share Capital A/c 12,00,000
To Securities Premium A/c 3,00,000
(Being application and allotment money
on 1,50,000 shares @ Rs.8 and Rs.2
being transferred to Share capital and
Securities premium respectively vide
Board’s resolution dt.10.5.2010)

March 10 Share Application and Allotment A/c Dr 48,000

To Bank Account 48,000
(Being Application money refunded on
8,000 shares as per Board’s Resolution
dt.10.5.10)

March 31 Bank A/c Dr 468,000

To Share Application and
468,000
Allotment A/c
(Being Allotment money received on
1,50,000 shares @ Rs.4 per share less
Rs,1,32,000 received in advance on
22,000 shares as application
money@Rs.6 each)

For Mock Test Visit:

[Link]
 292

Bank Account
Dr Cr
Date Date
By Share
To Share
Application
Application
March 1 10,80,000 March 10 and 48,000
and Allotment
Allotment
A/c
A/c
To Share
Application By Balance
March 1 4,68,000 March 31 15,00,000
and Allotment C/D
A/c

15,48,000 15,48,000
To Balance
15,00,000
B/D

Share Application and Allotment A/c

Dr Cr
Date Particulars Amount Date Particulars Amount
To Share By Bank
March 10 12,00,000 March 1 10,80,000
Capital A/c A/c
To Securities By Bank
March 10 3,00,000 March 31 4,68,000
Prem. A/c A/c
March 10 To Bank A/C 48,000

15,48,000 15,48,000

Equity Share Capital A/c

Dr Cr
Date Particulars Amount Date Particulars Amount
By Share
Application
By Balance
March 31 12,00,000 March 10 and 12,00,000
C/d
Allotment
A/c
12,00,000 12,00,000
By Balance
12,00,000
B/D
 293

Securities Premium A/c

Dr Cr
Date Particulars Amount Date Particulars Amount
By Share
Application
By Balance
March 31 3,00,000 March 10 and 3,00,000
C/d
Allotment
A/c
3,00,000 3,00,000
To Balance
3,00,000
B/D

4.2 Forfeiture of shares

In case any shareholder fails to pay any call money on the day appointed for
payment, the directors of the company may, with the express provisions in its
articles, proceed to forfeit the shares held by such defaulting shareholders after
serving them with prior notice in this regard.

When shares are forfeited, the defaulting shareholder’s name is removed from the
Register of members.

a) Procedure for forfeiture of shares

The authority to forfeit shares is given to the Board of Directors in the Articles of
Association of the company. The Board of Directors has to give at least fourteen
days’ notice to the defaulting members calling upon them to pay the outstanding
amount with or without interest as the case may be before the specified date. The
notice must also state that if the shareholders fail to remit the amount mentioned
therein within the stipulated period, their shares will be forfeited. If they still fail
to pay the amount within the specified period of time, the Board of Directors of
the company may decide to forfeit such shares by passing a resolution.

The decision regarding the forfeiture of shares is then communicated to the

concerned allottees and they are asked to return the allotment letters and share
certificates of the forfeited shares to the company.
 294

b) Treatment of Securities Premium A/c on forfeiture

If the shares are issued at premium, the premium amount so collected is treated in
accordance with the provisions of Section 78 of the Companies Act 1956.
According to the said provisions, premium once collected cannot be cancelled
even if that share is forfeited later on. However if a share on which premium has
become due, but has not been received, is forfeited, and then any credit given to
Securities Premium A/c is to be reversed.

James, a shareholder holding 100 shares of Rs.10 each, has paid application
money of Rs.2 per share and allotment money of Rs.3 per share, but has failed to
pay the first call of Rs.2 per share and second call of Rs.3 per share. His shares
were forfeited.
Required
Make the journal entry to record the forfeiture of shares.
Solution:

Share Capital A/c (100 × Rs.10) Dr. Rs.1,000

To Share forfeited A/c (100 × Rs.5) Rs.500
To Share First Call A/c (100 × Rs.2) Rs.200
To Share Second and Final Call A/c (100 × Rs 3) Rs.300
(Being forfeiture of 100 shares)

4.3 Reissue of forfeited shares

Furthermore, shares forfeited on non-payment of call money can be re-issued by
the company as per the provisions of the Articles. The company can reissue such
forfeited shares at any price it likes. But in no case the amount so collected on the
re-issue of shares plus the amount already collected from the defaulting member
shall be less than the amount credited as paid up on re-issue of shares.
a) Accounting treatment for reissue of forfeited shares
The forfeited shares are reissued as fully paid and at a discount. The amount of
discount allowed cannot exceed the amount that had been received on forfeited
shares on their original issue, and that the discount allowed on reissue of forfeited
shares should be debited to the ‘Share Forfeited Account’. The balance, if any,
left in the Share Forfeited Account, should be treated as capital profit and
transferred to Capital Reserve Account.
 295

PQR Ltd forfeits 200 shares of Rs.10 each on which Rs.600 had been received; it
can allow a maximum discount of Rs.600 on their reissue. An amount of Rs.600
is credited to Share Forfeited A/c. Assuming that the company reissues these
shares for Rs.1,800 as fully paid, the discount on issue of shares of Rs.200 is
provided from Share Forfeited A/c and the balance of Rs.400 is transferred to
Capital Reserve A/c.

b) Accounting entries on Forfeiture and Re-issue of shares

Particulars Debit A/c Credit A/c Amount

Forfeiture Share Capital A/c Called-up
of Shares amount
Share Calls A/c Amount due,
Share Forfeited A/c but not paid
Amount
already
collected
Re-issue of i. Bank A/c Amount
shares(On ii. Sh. Forfeited A/c actually
Discount) received
Discount
Amount
Share Capital A/c Amount paid-
up
Transfer of Share Forfeited A/c Balance in
Balance in Capital Reserve A/c Share
Share Forfeiture to
Forfeiture Capital Reserve
to Capital A/c
Reserve
A/c

Taking the same data as in the previous example of Beauty Soaps Ltd, pass the
journal entries assuming that the company called for First & Final call money on
31st May 2010. The company realized all call monies except from the member to
whom 400 shares were allotted. His shares were forfeited 30 June 2010 by the
Board of Directors as per the provisions of the Articles. These shares were
reissued at Rs. 9 per share on 30 July 2010.
 296

Solution

Journal Entries in the books of Beauty Soaps Ltd

Debit Credit
Date Particulars
Amount Amount
2010
May 31 Share First and Final Call A/c Dr 3,00,000
To Equity Share Capital A/c 3,00,000
Being amount due on 150,000 shares in
respect of First & Final Call as per
Board’s resolution
May 31 Bank A/c Dr 2,99,200
To Share First and Final Call 2,99,200
A/c
Being First &Final call money received
on 1,49,600 shares @ Rs.2 per share
June 30 Equity Share Capital A/c Dr 4,000
To Share First and Final Call 800
A/c 3,200
To Share Forfeited A/c
Being 400 shares forfeited for non-
payment of First & Final call as per
Board’s Resolution
July 30 Bank A/c Dr 3,600
Share Forfeited A/c Dr 400
To Equity Share Capital A/c 4,000
Being 400 shares reissued @ Rs.9 per
share
July 30 Share Forfeited A/c Dr 2,800
To Capital Reserves 2,800
Being balance in the Shares Forfeited
A/c Transferred to Capital Reserve
 297

4.4 Forfeiture of shares allotted on a pro-rata basis

If the shares issued by the company are over-subscribed, the company may allot
shares to applicants in the ratio of shares for which applications are entertained
by the company for allotment and the number of shares the company has offered
for subscription. This is called allotment of shares on pro-rata basis. In case of
pro-rata allotment the excess money received on applications is transferred to
Share Allotment A/c from Share Application A/c. In case a shareholder fails to
make payment on allotment and call money of shares held by him/her, the unpaid
amount will be calculated as under:

i) Number of shares applied for allotment =

Total No. of shares applied x Shares allotted to defaulter

Total shares allotted

ii) Calculate excess applications received = Number of shares applied for (as per
step i) – number of shares allotted

iii) Calculate excess application money received = Excess number of applied

shares x money called per share on application

iv) Amount unpaid on allotment = Amount due on allotment – excess

application money adjusted towards allotment

Re-issue of Shares forfeited, in case of pro-rata allotment

Super Computer Ltd issued a prospectus inviting application for 10,000 equity
shares of Rs.100 each to be issued at a premium of Rs.20 per share.
On 1 January 2009, the company received 24,000 applications. The Board
rejected 4,000 shares and refunded the application money on 1 February, 2009
when the remaining applicants were allotted shares on pro rata basis on the
following terms of payments specified in the prospectus:

On Application Rs.30
On Allotment (including premium) Rs.40
On First Call Rs.25
On Final Call Rs.25
 298

Allotment money was received in full on 15 February 2009. First Call was made
on 15 April, 2009 and received on 2 May 2009 for all but 50 shares allotted to
Mr. X. He was served the notice for payment of the amount due on allotment, but
he failed to pay on the stipulated time. His shares were forfeited on 1 September
2009 and reissued on 15 September at Rs.100 per share. Final Call was made on
1 October and received on 15 October 2009 for all but 200 shares held by Y.
Required:
Pass necessary journal entries and also show Share Capital A/c
Solution
Super Computer Ltd
Journal Entries
(Amount in Rs.)
Date Particulars Debit Credit
2009
Jan.1 Bank A/c Dr 7,20,000
To Share Application A/c 7,20,000
(Being application money received
on received 24,000 applications @
Rs.30 per share)
Feb. 1 Share Application A/c Dr 7,20,000
To Equity Share Capital A/c 3,00,000
To Share Allotment A/c 3,00,000
To Bank A/c 1,20,000
(Being Share Application money
for10,000shares transferred to
Equity Share Capital A/c, money for
10,000 shares adjusted towards
allotment money and balance money
on 4,000 shares refunded)
Feb. 1 Share Allotment A/c Dr 4,00,000
To Equity Share Capital A/c 2,00,000
To Security Premium A/c 2,00,000
(Being Allotment money of Rs.40
per share including share premium
of Rs.20 per share due on 10,000
shares)
Feb.15 Bank A/c Dr 1,00,000
To Share Allotment A/c 1,00,000
(Being Allotment money after
adjustment received in full)
 299

Super Computer Ltd

Journal Entries
(Amount in Rs.)
Date Particulars Debit Credit
2009
April 15 Share First Call A/c Dr 2,50,000 2,50,000
To Equity Share Capital A/c
(Being Share first Call money at
Rs.25 per share due on First call
made on 10,000 shares)
May 2 Bank A/c ………………………. Dr 2,48,750
Calls-in-Arrear A/c ……………. Dr 1,250
To Share First Call A/c … 2,50,000
(Being First call money received in
full except for 50 shares)
Sept 1 Equity Share Capital A/c Dr 3,750
To Calls in Arrear A/c 1,250
To Share Forfeited A/c 2,500
(Being 50shares forfeited for non-
payment of First Call money)
Sept 15 Bank A/c Dr 5,000
To Equity Share Capital A/c 3,750
To Securities Premium A/c 1,250
(Being 50shares reissued @ Rs.100
each)
Forfeited share A/c Dr 2,500
To Capital Reserve A/c 2,500
(Being profit on re-issue of forfeited
shares transferred to capital reserve)
Oct. 1 Share 2nd& Final Call A/c Dr 2,50,000
To Equity Share Call A/c 2,50,000
(Being Final Call money at Rs.25
per share due on final call made on
10,000 shares)
Oct 15 Bank A/c Dr 2,45,000 2,50,000
Calls in Arrear A/c Dr 5,000
To Share 2nd& Final Call
A/c
(Being Final Call money received in
full except of 200 shares)
 300

The balance in Share Forfeited Account after the reissue of forfeited shares is
transferred to:
A General reserve A/c
B Capital redemption reserve A/c
C Capital reserve A/c
D Revenue reserve A/c

5. Discuss buy-back of shares and study the condition for

buy back of shares
[Learning Outcome e]
5.1 Meaning of buy-back of shares

Buy-back of shares means repurchase by the company of its own shares.

Buy-back may take place either at par or premium or discount in compliance

with the provisions of Sec.77A and Sec.77B of the Companies Act 1956. With
the repurchase, the par value of shares repurchased is reduced from the equity
capital. Any excess paid on repurchase is to be debited to Reserves & Surplus
A/c.

5.2 Advantages of buy-back of shares

1. Buy–back of shares reduces equity value and increases earnings per share
(EPS) or Dividend per share (DPS).

2. It facilitates managing the surplus cash and maintaining target capital by

way of the returning the same to investors.

3. Sometimes buy-back of shares is adopted to maintain the share price in the

share market and keep the sentiments of the investors high. For example,
Bajaj Auto went on a massive buy-back in 2000 and recently Reliance Ltd
also bought back some shares to keep the sentiments of the investors high.

4. A company buys back its shares when the prices are low and reissues shares
at a later date at good prices, thus making profit.
 301

5.3 Resources of buy-back

The Companies Amendment Act 1999 under section 77A prescribes for
the sources of buying back of shares or other specified securities by a
company, which are as follows:

1. Free reserves- a company may buy back out of its free reserves but a
sum equal to the nominal value of the shares so purchased must be
deposited in the capital redemption reserves account.
2. Securities premium account
3. The proceeds of any shares or specified securities.

No buy back of any shares or securities shall be made out of the proceeds
of an earlier issue of the same kind of shares or same kind of securities.

5.4 Conditions for a buy-back

Sub clause (2) of Section 77A enshrines the conditions for a buy back, which are
as follows:

a) It should be authorised by the articles of association of the company.

b) A special resolution has been passed at the general meeting of the company
authorising the buy back.

c) If the buy-back is equal to or less than 10 percent of the total paid up equity
share capital, a resolution at the general meeting is not needed to be passed;
rather, a simple board resolution is enough.

d) Provided that no offer of buy back shall be made within three sixty five days
reckoned from the date of proceeding offer of buy back.

e) The buy-back is equal to or less than 25 percent of the total paid up equity
share capital and free reserves

f) The ratio of debt owned by the company is not more than twice the capital
and its free reserves after such buy back.

g) All the shares or other specified securities for buy back are fully paid up.
 302

h) A company cannot issue the same kind of shares or security for a period of
24 months after completion of buy-back

i) Money borrowed from bank or financial institution cannot be utilized for buy
back purpose

j) A company having defaulted in repaying fixed deposits or interest thereon or

in redemption of preference shares or debentures cannot buy back its shares.

k) A company having defaulted in filing annual returns, in preparation of

financial statements or whose accounts have failed to exhibit.

l) The buy-back of shares or other specified securities listed on any recognised

stock exchange is in accordance with the regulations made by the Securities
and Exchange Board of India in this behalf.

m) The buy back in respect of shares and other specified securities other than
those specified in the aforesaid clause is in accordance with the guidelines
specified.

5.5 Accounting Entries on Buy-Back

Particulars Debit A/c Credit A/c Amount

Shares Bought Share Capital A/c Bank A/c Nominal
Back Value of
shares bought
back
Premium Paid on Free Reserves/ Bank A/c Premium
buy back Security Premium Amount
A/c
Discount on buy- Share Capital Capital Discount
back Reserve Amount
Transfer of free Free Reserves CRR Nominal
Reserves Account value of
shares bought
back
Expenses on Buy- Buy-back Expenses Bank A/c
back
 303

Following is the Balance Sheet of Good Luck Ltd as at 31 March 2010

Balance Sheet of Good Luck Ltd as at 31 March 2010

Rs. Rs.
Authorized Capital 10,00,000 equity Shares 100,00,000
of Rs.10each
Equity and liabilities
Shareholders’ funds
Share capital 100,00,000
Subscribed& Paid-up Capital 10,00,000
equity Shares of Rs.10each -fully paid

Reserves & Surplus

Revenue reserves 2,20,00,000
Capital reserves 20,00,000
Security premium 20,00,000 2,60,00,000

Current liability 40,00,000

Total equity and liabilities 4,00,00,000

Assets
Non-current assets
Gross value 2,00,00,000
Less: depreciation (1,00,00,000) 1,00,00,000
Investments (Market Value Rs200,00,000) 50,00,000

Current assets
Trade receivables 40,00,000
Stock 50,00,000
Cash and bank balance 1,60,00,000 2,50,00,000
Total assets 4,00,00,000

The company bought back 5,00,000 equity shares of Rs.10 each at Rs.20
per share as per board resolution dated 15 April 2010 in view of huge
unutilized cash & Bank Balance.
 304

Required:

You are required to give the necessary journal entries. Also prepare the
Balance Sheet after the buy-back transactions are recorded.

Solution:

Journal Entries on Buy-back

In the books of Good Luck Company

Debit Credit
Date Particulars
Amount Amount
15/04/10 Equity Share Capital A/c ---- Dr 50,00,000
Revenue Reserves A/c ---- Dr 50,00,000
To Bank A/c 1,00,00,000
Being 5,00,000 equity shares of
Rs.10 each bought back at Rs.20
per share as per board resolution
dt.15.4.2010
15/04/10 Revenue Reserves A/c ---- Dr 50,00,000
To Capital Redemption 50,00,000
Reserves
Being transfer of free Reserves
to capital redemption Reserve to
the extent of nominal

Balance Sheet of Good Luck Ltd as at 15 April 2010 (After Buy-back)

Rs. Rs.
Authorized Capital 10,00,000 equity Shares of 100,00,000
Rs.10each
Equity and liabilities
Shareholders’ funds
Share capital 50,00,000
Subscribed& Paid-up Capital 5,00,000 equity
Shares of Rs.10each -fully paid

Reserves & Surplus

Revenue reserves 1,20,00,000
 305

Rs. Rs.
Capital reserves 20,00,000
Security premium 20,00,000
Capital redemption reserve 50,00,000 2,10,00,000

Current liability 40,00,000

Total equity and liabilities 3,00,00,000

Assets
Non-current assets
Gross value 2,00,00,000
Less: depreciation (1,00,00,000) 1,00,00,000

Investments (Market Value Rs.200,00,000) 50,00,000

Current assets
Trade receivables 40,00,000
Stock 50,00,000
Cash and bank balance 60,00,000 1,50,00,000
Total assets 3,00,00,000

According to Sub clause (2) of section 77A, one of the conditions of buyback is:

A The buy-back is equal to or less than 25% of the total paid up equity share
capital and free reserves
B The buy-back is more than 25% of the total paid up equity share capital and
free reserves
C The buy-back is equal to or less than 10% of the total paid up equity share
capital and free reserves
D The buy-back is more than 10% but less than 25 % of the total paid up equity
share capital and free reserves
 306

6. Discuss the various Employees Stock Option Plan

(ESOP) issued by companies, along with their accounting
treatment.
[Learning Outcome f]

Employee Stock Option Plan (ESOP)

6.1 Meaning

Employee Stock Option Plan known as ESOPs is an employee compensation

system providing for sharing of corporate wealth and profit by the employee.
Under the scheme an employee is given an option to buy shares of the company
at less than the market price and the employee gets the benefit when the share
prices rise. ESOPs give right to the employee to buy shares at the specified price
during specified period.

6.2 Definition

Sec 2(15A) defines the employees stock options as “ the option given to the
whole-time director, officers, or employees of the company, which gives right to
directors, officers, or employees of the company to purchase or subscribe at a
future date the securities offered by the company at a predetermined price’

Under the Employee Stock Option Scheme, a right but not an obligation is
granted to the employees to apply for the shares of the company at a pre-
determined price.

There are several ways in which employees buy shares through ESOS – they may
purchase shares out of their own funds or they borrow money from the company
to purchase shares.

In this regard the SEBI has issued detailed guidelines called SEBI (Employee
Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines 1999.
The said guidelines are applicable to all companies having their shares listed on
any recognized stock exchange in India.
 307

The guidelines provide for two schemes namely

Diagram 3: Employee stock option & stock purchase scheme

6.3 Why do companies set up ESOPs for Employees?

There are several reasons for issuing ESOPs. The major reasons include:

a) ESOPs act as a motivator to the employee and can get employees highly
involved in their jobs and focused on corporate performance.
b) ESOPs play a vital role in attracting and retaining employees, and fostering
long term attitudes.

c) As a compensation tool, ESOPs offer rewards that can exceed the

expectations of employees but are still affordable to the company as they are
highly performance driven.

d) ESOPs are also used for granting retirement benefits to employees and as
succession plan for owners.

e) Strategically, economically, financially or philosophically ESOPs are a win-

win combination.

6.4 Employee Stock Option Scheme (ESOS)

Eligibility to participate in ESOS- An employee shall be eligible to participate

in ESOS of the company (whether working in India or out of India). But
employees who are promoters or who belong to the promoter group shall not be
eligible to participate in ESOS. A director who either by himself or through
anybody corporate, directly or indirectly holds more than 10% outstanding shares
of the company is not eligible for participation in the scheme.
 308

Shareholders’ approval - The shareholders must approve the scheme by passing

a special resolution in the general meeting.

Pricing and lock-in period - The company granting ESOS will have the
freedom to determine the exercise price. There shall be a period of at least one
year between the grant of options and vesting of options. Vesting means the
process by which the employee is given right to apply for the shares of the
company in pursuance of the scheme. The option granted to the employee is
neither transferable nor can be pledged or hypothecated or mortgaged.

Accounting for ESOS

Schedule I of the SEBI (Employee Stock Option Scheme and Employee Stock
Purchase Scheme) guidelines, 1999 provides the accounting policies to be
followed for ESOS. These are discussed below:

a) The accounting value of options shall be treated as employee compensation

in the financial statements.

b) The accounting value is aggregate of the fair value of the options of all
employee stock options granted during the financial year.

c) Fair value means option discount.

d) Option discount means the excess of the market price of the share at the date
of grant of option over the exercise price of the option.

e) The accounting value of options as employee compensation shall be

amortized on a straight line basis over the vesting period.

f) When an unvested option lapses due to non-vesting of the employees, after

accounting value of the option has already been accounted for as employee
compensation, the said accounting treatment is to be reversed by credit to the
employee compensation expenses equal to the amortized portion of the
accounting value of the options thus lapsed.

g) When a vested option lapses on the expiry of the exercise period, after the
fair value of the options is accounted for employee compensation, this
accounting treatment shall be reversed by credit to employee compensation
expenses.
 309

ABC Ltd offered 1000 options for ESOS on 01 January 2007 at Rs.50 for each
share of Rs.10 each when the market price of equity was Rs.150. The vesting
period for the said ESOS is two and a half years and the maximum exercise
period is one year. 600 options have been exercised on 15 February 2010. 100
options vested but lapsed at the end of the exercise period.

Required:

Show journal entries. Also show Employee Stock Options Outstanding Account
and Deferred Employees Compensation Expenses Account.

Solution

Accounting Value of the option= Total Option Discount x No of options = 1000

(i.e. 150 - 50) x 1,000 options = Rs.1,00,000
(Amount in Rs.)
Date Particulars Debit Credit
01/01/07 Deferred Employee Compensation Dr 1,00,000
Expenses A/c
To Employee Stock Options 1,00,000
outstanding A/c
(Being grant of 1,000 options at a
discount of Rs.100 each)
31/12/07 Employee Compensation Expenses Dr 40,000
A/c
To Deferred Employee 40,000
Compensation Expenses A/c
(Being amortization of deferred
employee compensation over two
and a half years on straight line basis)
31/12/08 Employee Compensation Expenses Dr 40,000
A/c
To Deferred Employee 40,000
Compensation Expenses A/c
(Being amortization of deferred
employee compensation over two
and a half years on straight line basis)
 310

Date Particulars Debit Credit

01/02/09 Employee Stock Options outstanding A/c Dr 30,000
To Employee Compensation
Expenses A/c 24,000
To Deferred Employee
Compensation Expenses A/c 6,000
(Being reversal of employee
compensation expenses on lapse of 300
unvested options)
30/06/09 Employee Compensation Expenses A/c Dr 14,000
To Deferred Employee
Compensation Expenses A/c 14,000
Being amortization of deferred employee
compensation over two and a half years
on straight line basis
31/03/10 Cash/ Bank A/c Dr 30,000
Employee Stock Options outstanding A/c Dr 60,000
To Equity Capital A/c
To Security Premium A/c 6,000
(Being exercise of 600 options at the 84,000
specified exercise price of Rs.50 each at
accounting value of Rs.150 each)
01/07/10 Employee Stock Options outstanding A/c Dr 10,000
To Employee Compensation
Expenses A/c 10,000
(Being reversal of Compensation
accounting on lapse of 100 vested
options)

Employee Stock Options Outstanding Account

Dr. Cr.
Date Particulars Amount Date Particulars Amount
01.02.09 To Employee 24,000 1-1-07 By Deferred 1,00,000
Compensation Employee
Exp A/c Compensation
Expenses A/c
To Deferred 6,000
Employee
Compensation
Expenses A/c
 311

Dr. Cr.
Date Particulars Amount Date Particulars Amount
31.03.10 To Equity 60,000
Share Capital
&Security
Prem. A/c
01.07.10 To Deferred 10,000
Employee
Compensation
Expenses A/c
100,000 1,00,000

Deferred Employees Compensation Expenses Account

Dr. Cr.
Date Particulars Amount Date Particulars Amount
01.01.07 ESO* 1,00,000 31.12.07 Employee 40,000
outstanding Compensation
A/c Exp.
31.12.08 Employee 40,000
Compensation
Exp.
01.02.09 ESOS 6,000
Outstanding
30.6.09 Outstanding 14,000
Employee
Compensation
1,00,000 1,00,000

*ESO – Employee Stock Options

6.5 Employee Stock Purchase Scheme (ESPS)

In this scheme the company offers shares to the employees as a part of public
issue or otherwise. The criteria for eligibility, lock-in period, pricing,
shareholders’ approval as applicable to ESOS is also applicable to ESPS.
Accounting for ESPS
Schedule II of the SEBI (Employee Stock Option Scheme and Employee Stock
Purchase Scheme) guidelines, 1999 provides the accounting policies to be
followed for ESPS. These are discussed below:
a) The accounting value of the shares so issued shall be also treated as another
form of employee compensation in the financial statements of the company.
 312

b) The accounting value of the shares so issued shall be equal to the aggregate
of price discount over all shares issued under ESPS. For this purpose price
discount means the excess of the market price of the shares on the date of
issue over the price at which they are issued.

BC Ltd issued 1,000 options on 1 April 2010 for ESPS at Rs.50 for each
share of Rs.10 each when the market price of equity was Rs.150.

Solution

Accounting Value of the option = Total Option Discount x No of options

= 100 (i.e.150-50) x 1,000 options = Rs.1,00,000

Journal Entries
(Amount in Rs.)
Date Particulars Debit Credit
01.04.10 Cash/Bank A/c 50,000
Employee Compensation Expense A/c 1,00,000
To Equity Capital (paid-up) A/c 10,000
To Security Premium A/c 1,40,000
Being issue of 1,000 under ESPS at the
price of Rs.50 each while market value
being Rs.150 each

The accounting value of options granted under an Employee Stock Option Plan
shall be:

A Treated as shares issued on discount

B Treated as employee compensation in the financial statements
C Reduced from share premium account
D Reduced from Share Capital Account
 313

7. Discuss the accounting treatment of redemption of

preference shares.
[Learning Outcome g]
In this Learning Outcome, we will discuss in brief:

9 Process and purpose of issuing redeemable preference shares

9 Legal provisions in respect of redemption of redeemable preference shares
9 Methods of redemption and
9 Accounting treatment

7.1 Process and purpose of issuing redeemable preference shares

A company limited by shares if so authorised by its Articles, may issue

preference shares which at the option of the company, are liable to be redeemed.
However, there should be proper compliance of the legal aspects emerging from
various provisions of the Companies Act 1956 (as amended) while issuing
redeemable preference shares.

A company sometimes may issue redeemable preference shares for raising funds
in a dull primary market when it faces difficulty in raising equity capital. The
potential investors who are hesitant in investing in equity shares of the company
may invest in redeemable preference shares having preferential treatment of
distribution of surplus of the company over the equity shares. Such redeemable
preference shares are redeemed when the company finds surplus of capital
(overcapitalization) and cannot utilize such surplus funds in the business for a
profitable purpose.

7.2 Legal Provisions with respect to issue of preference shares

Issue and redemption of preference shares are governed by Section 80 of the

Companies Act, 1956, which provides that:

1. A company limited by shares, if authorized by its Articles, may issue

preference shares, which at the option of the company are liable to be
redeemed.
 314

2. No shares can be redeemed except out of profit of the company, which would
otherwise be available for dividend or out of proceeds of fresh issue of shares
made for the purpose of redemption.

3. No such shares can be redeemed, unless they are fully paid.

4. The premium, if payable on redemption, must be provided for out of the

profits of the company or out of the Share Premium Account of the company.

5. Where any such shares are redeemed, otherwise than out of the proceeds of a
fresh issue, there shall, out of profits, which would otherwise have been
available for dividends, be transferred to a Reserve Account called “Capital
Redemption Reserve, a sum equal to the nominal amount of the shares
redeemed.

As per the Companies (Amendment) Act 1996, a company cannot issue any
preference share, which is irredeemable or is redeemable after the expiry of a
period of twenty years from the date of its issue.

7.3 Methods of Redemption

Redemption of preference shares means repayment of the amount obtained by a

company on issuance of preference shares in compliance with the provisions of
the Companies Act 1956.

Redemption of preference shares can be done either by fresh issue of shares or

out of distributable profits being retained and transferred to Capital Redemption
Reserve Account.

Section 80 of the Companies Act 1956 deals with the process and rules of
redemption of redeemable preference shares. The underlying objective of the
legal provisions for redemption is to ensure that there is no reduction in
shareholders’ fund and outsiders’ interests are not impaired due to redemption.

The legal provisions as discussed above precisely show that redemption of

redeemable preference shares can be effected in any of the following three
methods:
 315

Diagram 4: Methods of Redemption

7.4 Accounting treatment

Accounting entries depend on the methods of redemption. We have to discuss

separately the accounting entries for each of the methods.

a) Redemption by fresh issue of shares

A fresh issue of share may be on three situations:

9 Issue at par
9 Issue at a Premium and
9 Issue at a discount

Furthermore redemption may be on two situations:

9 Redemption at par and
9 Redemption at a premium

Let us discuss here accounting entries for redemption of preference shares

keeping in view the above situations.

1 Fresh Issue at par

(a) Bank A/c Dr ….
To Share Capital Account …..
Being issue of ……shares of Rs…. each at par for
redemption of preference shares as per Board
Resolution No. dated……
 316

or Fresh Issue at a Premium

(b) Bank A/c Dr. ….
To Share Capital Account …..
To Security Premium Account …..
Being issue of…shares of Rs…. each at a premium
Rs...for redemption of preference shares as per Board
Resolution No. dated
or Fresh Issue at a Discount
(c) Bank A/c ……… Dr ….
Discount Account …………………… Dr ….
To Share Capital Account ……………… …..
(Being issue of…shares of Rs…. each at discount Rs.
for redemption of preference shares as per Board
Resolution No. dated…)
2 Redemption of preference share at par Dr
(a) Redeemable Preference Share Capital A/c -----
To Preference Shareholders Account ……… ------
or Redemption of preference share at a Premium
Redeemable Preference Share Capital A/c Dr ----
(b) Premium on Redemption of Pref. Shares A/c Dr ----
To Preference Shareholders Account ------
3 Payment to preference shareholders
Preference Shareholders Account ------------------------ Dr -----
To Bank A/c --------------------------------------- -------
4 Adjustment of Premium on Redemption
Profit & Loss Account -------------------------------- Dr -----
Security Premium Account ……………………… Dr -----
To Premium on Redemption of Pref. Shares ------
A/c---------

Redemption of Preference Share with fresh issue at a Premium

A Ltd decided to redeem its 10,000 10% Redeemable Preference shares of Rs.10
each fully paid by issue of sufficient number of equity shares of Rs.10 each at a
premium of Rs.2 each. Redemption will be at par.
Required:
Pass the necessary journal entries.
 317

Solution:
(Amount in Rs.)
Debit Credit
Bank A/c Dr. 1,20,000
To Equity Share Capital Account 1,00,000
To Security Premium Account 20,000
Being issue of 10,000shares of Rs.10 each at
a premium Rs.2 for redemption of preference
shares as per Board Resolution No. dated….
Redeemable Preference Share Capital A/c Dr. 1,00,000
To Preference Shareholders Account 1,00,000
Being amount payable on redemption of
preference shares
Preference Shareholders Account -------------- Dr. 1,00,000
To Bank A/c 1,00,000
Being amount paid on redemption of
preference shares

Note:
Amount required for redemption is Rs.100,000. Thus the face value of equity
shares to be issued for the purpose must be equal to Rs.100,000 as premium
received on such new share issue cannot be utilized for redemption of preference
shares.

In accordance with the Companies Act 1956, Share Premium account is utilized
for certain specific purposes such as:
i) Issue of bonus share
ii) Writing off Preliminary Expenses
iii) Writing off expenses or discount allowed on any issue of shares or
debentures of the company and
iv) In providing for the premium payable on the redemption of any redeemable
preference shares or debentures of the company.

Redemption of Preference Share with fresh issue at a Discount

A Ltd decided to redeem its 10,000 10% Redeemable Preference shares of Rs.10
each fully paid by issue of sufficient number of equity shares of Rs.10 each at a
discount @10%. Redemption will be at par.
 318

Required:
Pass the necessary journal entries.
Solution:
(Amount in Rs.)
Debit Credit
Bank A/c ………… Dr. 1,00,008
Discount Account ………………… Dr. 11,112
To Share Capital Account 1,11,120
Being issue of 10,000shares of Rs10 each at
discount @20%.for redemption of preference
shares as per Board Resolution No. dated…
Redeemable Preference Share Capital A/c Dr 1,00,000
To Preference Shareholders Account … 1,00,000
Being amount payable on redemption of
preference shares
Preference Shareholders Account …………… Dr 1,00,000
To Bank A/c --------------------------------- 1,00,000
Being amount paid on redemption of preference
shares

Note: When shares are redeemed by issuing shares at a discount, the proceeds
from new issue must be sufficient to cover the face value of shares redeemed.
Here the value of preference shares to be redeemed is Rs100,000.
The proceeds from each share are Rs.9 (Rs.10 less 10% Discount). Therefore the
number of shares to be issued will be calculated as:
Rs.100,000 / Rs.9 = 11,111.11 shares (Rounded off to 11,112 shares) and value
Rs.1,11,120

Calculation of Minimum Fresh Issue

The minimum number of fresh issue of shares should be calculated keeping in

view of the provisions of Section 80 of the Companies Act 1956. For this
purpose following four steps are generally followed:

1. Availability of Maximum Amount of Reserves and Surplus - Maximum

Amount of Reserves and Surplus available for redemption is to be
ascertained taking into consideration the balances of such items appearing in
the Balance Sheet and the additional information thereon before redemption
 319

2. Adjustment of Premium Payable on Redemption: Necessary adjustment

for premium payable on redemption is to be made out of profits. The adjusted
balance is then compared with the nominal value of shares to be redeemed.
After comparison, the minimum proceeds of fresh issue of shares are
determined. The minimum proceeds of fresh issue of shares = Nominal
Value of Preference Shares to be redeemed less Maximum amount of
Reserves & Surplus
3. Determination of Minimum Number of shares to be issued: Minimum
Number of shares to be issued is determined by dividing minimum proceeds
as determined above by the proceeds of one share. Minimum Number of
Shares = Minimum Proceeds complying Sec.80 of Companies Act / Proceeds
of one Share
4. Adjustment for Fractions in Minimum Number: If minimum number of
shares shows some fraction, it is to be adjusted to the next higher value, as
fraction of a share cannot be issued.
Redemption of Preference Shares with Minimum Fresh Issue

The following is the balance sheet of AVG Ltd on 30 September 2010:

Rs. Rs.
Equity and Liabilities
Equity
20,000 10% Preference Shares of Rs.100 each 20,00,000
50,000 Equity Shares of Rs.100 each 50,00,000 70,00,000
Reserves & Surplus
General Reserves 4,00,000
Profit &Loss A/c 5,00,000
Securities premium A/c 1,00,000 10,00,000
Shareholders fund 80,00,000
Non-current liabilities 20,00,000
Total equity and liabilities 1,00,00,000
Assets
Non-current assets
Fixed assets 70,00,000
Investments 20,00,000 90,00,000
Current assets
Trade receivables 4,00,000
Closing Stock 5,00,000
Cash & Bank Balance 1,00,000 10,00,000
Total assets 1,00,00,000
 320

Required:

Pass the necessary journal entries keeping in view the decision of the board for
redemption of all preference shares at 10% premium. Also prepare Balance Sheet
after redemption assuming that entire process has been completed on or before 31
October 2010.

1. Sale of 50% investments for Rs.11,00,000.

2. Issuance of minimum number of equity shares of Rs.100 each at 10%

premium.

Solution:

1. Calculation of minimum number of Equity Shares to be issued

a) Nominal Value of preference 20,00,000

shares
b) Premium payable on redemption 10% of Rs20,00,000 2,00,000
c) Security Premium as per Balance 1,00,000
Sheet
d) Security premium on fresh issue 1,10,000
e) Premium on redemption payable Nil
out of profits
f) Reserves& Surplus available for 9,00,000
redemption
g) Minimum Proceeds (a- f) (20,00,000 - 9,00,000 ) 11,00,000
h) Minimum number of shares 11,00,000 / 100 11,000shares
 321

2. Journal Entries
(Amount in Rs.)
Particulars Debit Credit
Bank A/C…………………………….. Dr 11,00,000
To Investment A/c………………. 10,00,000
To Profit on Sale of Investment…… 1,00,000
(Being Sale of 50% investments for
Rs.11,00,000)
Bank A/c Dr. 12,10,000
To Share Capital Account ………… 11,00,000
To Security Premium 1,10,000
Account………
(Being issue of 11,000shares of Rs.100each
at a premium Rs.10 for redemption of
preference shares as per Board Resolution
[Link]…)
Redeemable Preference Share Capital A/c … Dr 20,00,000
Premium on Redemption of Pref. Shares A/c Dr 2,00,000
To Preference Shareholders Account 22,00,000
(Being amount payable to Preference
Shareholders on redemption of preference
shares at premium)
Security Premium Account ……………… Dr 2,00,000
To Premium on Redemption of Pref. 2,00,000
Shares A/c------
(Being adjustment of Premium on
Redemption of Pref. Shares with Security
Premium Account)
Preference Shareholders Account 22,00,000
To Bank A/c……………………… 22,00,000
(Being payment to Preference Shareholders
for redemption)
General Reserves A/c……………………… Dr 4,00,000
Profit & Loss A/c …………………………. Dr 5,00,000
To Capital Redemption Reserves A/c 9,00,000
(Being transfer of Reserves & Surplus A/c
utilized for redemption to Capital
Redemption Reserves A/c)
 322

AVG Ltd

Balance Sheet As at 31 October 2010

Rs. Rs.
Equity and Liabilities
Equity
61,000 Equity Shares of Rs.100 each 61,00,000
Reserves & Surplus
Capital Redemption Reserve 9,00,000
Securities premium Account 10,000
Profit on Sale of Investment 1,00,000 10,10,000
Shareholders fund 71,10,000
Non-current liabilities 20,00,000
Total equity and liabilities 91,10,000
Assets
Non-current assets
Fixed assets 70,00,000
Investments 10,00,000 80,00,000
Current assets
Trade receivables 4,00,000
Closing Stock 5,00,000
Cash & Bank Balance (1,00,000+11,00,000 + 2,10,000 11,10,000
12,10,000 – 22,00,000)
Total assets 91,10,000

b) Redemption by Capitalisation of Undistributed Profits

The Companies Act also provides for redemption of preference shares by

capitalization of undistributed profits in place of fresh issue of shares as shown in
the earlier example. We need to know the provisions of the Companies Act in
regard to redemption of preference shares. The Companies Act provides that
“when any such shares are redeemed otherwise than out of the proceeds of a
fresh issue , there shall, out of profits which would otherwise have been
available for dividend, be transferred to a Reserve Fund to be called “the
Capital Redemption Reserve Account” for the sum equal to the nominal
amount of the shares redeemed”. The accounting entries have been almost
covered in the earlier illustration. From the following illustration, the accounting
entries for redemption of preference shares by Capitalization of Undistributed
Profits will be further clear to the students.
 323

Redemption of Preference Shares by Capitalization of Profits

The following is the balance sheet of XYZ Ltd on 30 September 2010

Rs. Rs.
Equity and Liabilities
Equity
10,000 7% Preference Shares of Rs.100 each 10,00,000
2,00,000 Equity Shares of Rs.10 each 20,00,000 30,00,000
Reserves & Surplus
General Reserve 8,00,000
Profit and loss A/c 1,00,000
Investment Allow. Reserve 1,00,000*
Security Premium 1,20,000 11,20,000
Shareholders fund 41,20,000
Non-current liabilities 3,80,000
Total equity and liabilities 45,00,000
Assets
Non-current assets
Fixed assets 20,00,000
Investments 10,00,000 30,00,000
Current assets
Trade receivables 2,00,000
Closing Stock 2,00,000
Cash & Bank Balance 11,00,000 15,00,000
Total assets 45,00,000

*(50% Investment Allow. Reserves is not a distributable profit)

It has been decided by the Board of Directors that 7% Preference Shares shall be
redeemed at a premium of 10%. For this purpose, a fresh issue of equity shares
will be made at par after utilizing the amount of undistributed reserves and
surplus keeping a balance of Rs.2,00,000 in General Reserves Account.

Required:

Pass necessary journal entries and prepare the Balance Sheet after redemption of
preference shares.
 324

Solution:

Computation of Minimum number of Shares to be issued:

Nominal value of preference shares to be 10,00,000

redeemed
Less: Profits Available for Distribution:
i) General Reserves (8,00,000 – 2,00,000) 6,00,000
ii) Profit & Loss A/c 1,00,000
iii) Investment Allowance Reserve 50,000
(100,000 – 50,000) 7,50,000
Proceeds for Minimum Fresh Issue 2,50,000
Number of fresh issue (2,50,000/ 10) 25,000 shares

Journal Entries on redemption of preference share

In the books of XYZ Ltd:
(Amount in Rs.)
Date Particulars Debit Credit
Bank A/c Dr 2,50,000
To Share Capital A/c 2,50,000
(Being 25,000 shares of Rs.10each
issued redemption of preference
shares as per Board Resolution No.
dated…)
Redeemable Preference Share 10,00,000
Capital A/c Dr
Premium on Redemption of Pref. 1,00,000
Shares A/c Dr 11,00,000
To Preference Shareholders
Account
(Being amount payable to
Preference Shareholders on
redemption of preference shares at
premium 10%)
Security Premium A/c Dr 1,00,000
To Premium on 1,00,000
Redemption of Pref. Shares
A/c
(Being adjustment of Premium on
Redemption of Pref. Shares with
Security Premium A/c)
 325

Journal Entries on redemption of preference share

In the books of XYZ Ltd:
(Amount in Rs.)
Date Particulars Debit Credit
Preference Shareholders A/c Dr 11,00,000
To Bank A/c 11,00,000
(Being payment to Preference
Shareholders for redemption)
General Reserves A/c Dr 6,00,000
Profit & Loss A/c Dr 1,00,000
Investment Allowance Reserves A/c Dr 50,000
To Capital Redemption 7,50,000
Reserves A/c
(Being transfer of Reserves &
Surplus A/c utilized for redemption
to Capital Redemption Reserves
A/c)

Balance Sheet of XYZ Ltd as at 31 October 2010

Rs. Rs.
Equity and Liabilities
Equity
2,25,000 Equity Shares of Rs10each 22,50,000
Reserves & Surplus
General Reserve 2,00,000
Capital Redemption Reserve 7,50,000
Investment Allow. Reserve 50,000
Security Premium 20,000 10,20,000
Shareholders fund 32,70,000
Non-current liabilities 3,80,000
Total equity and liabilities 36,50,000
ASSETS
Non-current assets
Fixed assets 20,00,000
Investments 10,00,000 30,00,000
Current assets
Trade receivables 2,00,000
Closing Stock 2,00,000
Cash & Bank Balance(11,00,000 +2,50,000 – 2,50,000 6,50,000
11,00,000)
Total assets 36,50,000
 326

The premium, if payable on redemption, must be provided for out of:

(i) Profits of the company

(ii) Share Premium Account
(iii) Capital Reserve Account
(iv) Revaluation Reserve Account

A (i) and (ii)

B (ii) and (iii)
C (iii) and (iv)
D Only (i)

8. Discuss the treatment of issue, underwriting and

redemption of debentures
[Learning Outcome h]
In the previous Learning Outcomes we studied the issue of share capital and
preference shares as a means of raising funds or capital for financing business
and business expansion. In this Learning Outcome we will study issue of
debentures and its accounting.

Debentures are one of the most commonly used debt instruments for raising
funds and supplementing capital requirements of corporates.

8.1 What is a Debenture?

Debenture is a bond issued by a company under its seal acknowledging its debt
and obligation for repayment along with the conditions and provisions for
repayment of the principal amount and interest.

More precisely, debentures are issued with or without charge created on the
assets of the company. If a charge is created on any or entire assets of the
company, the nature of charge and the assets charged are described to specify the
obligation of the company for repayment of debt.
 327

8.2 Characteristics of Debentures

i) Debenture is a document evidencing borrowings by a company.

ii) It is a fixed interest-bearing security where interest is payable at a

predetermined fixed rate on specific dates

iii) It is issued with or without charge created on assets of the company as

security

iv) It is traded on the Stock Exchange as per market availablity.

v) Debentures can classified into various types such as:

9 Secured or Unsecured
9 Redeemable or Irredeemable
9 Convertible or Non-convertible
9 Registered or Unregistered
9 First Mortgage or Second Mortgage.

Debentures issued by a company are classified on the basis of Security,

Convertibility, Permanence, Negotiability, Priority etc.

8.3 Issue of debentures

The procedure for the issue of debentures is the same as that for the issue of
shares. The intending investors apply for debentures on the basis of the
prospectus issued by the company. The company may either ask for the entire
amount to be paid on application or by means of installments on application, on
allotment and on various calls. Debentures can be issued at par, at a premium, or
at a discount. They can also be issued for consideration other than cash or as a
Collateral Security.

8.4 Accounting Entries on issue of Debentures

When a company issues debentures, it usually mentions the terms on which they
will be redeemed at their maturity. Redemption of debentures means discharge of
liability on account of debentures by repayment made to the debenture holders.
Accounting entries on issue of debentures depends on nature or types of issues.
 328

Generally debentures are issued on any of the following terms or conditions:

9 Debentures at par and redeemable at par

9 Debentures at par and redeemable a discount
9 Debentures at a discount and redeemable at par
9 Debentures at a discount and redeemable at a discount
9 Debentures at a premium and redeemable at par
9 Debentures at a premium and redeemable at a discount
9 Debentures at par and redeemable at premium
9 Debentures at discount and redeemable at a premium

Here accounting entries are discussed as illustrations.

1. Accounting Entries for Debentures at par and redeemable at par:

a) Receipt of Application Money

Bank A/c …………………………………………..…Dr
To Debenture Application and Allotment Money A/c

b) Transfer of Application money to Dentures A/c on allotment

Debenture Application and Allotment Money A/c… Dr
To Debentures A/c

8.5 Underwriting of shares and debentures

Underwriting is a contract entered by a company with certain parties, whereby

the underwriters undertake that in case of the whole or an agreed portion of the
shares or debentures are not subscribed by the public, then they will themselves
take up the shares or debentures in consideration of a commission.

Underwriting means undertaking a responsibility or giving a guarantee that the

shares or debentures offered to the public will be subscribed for in full. The
persons or institutions that give such guarantee are called underwriters.
For this service underwriters charge a commission which is generally calculated
at a specified rate on the issue price of the whole of the shares or debentures
underwritten
An underwriter may be an individual, partnership firm or company and the
underwriting commission is payable on the amount of shares or debentures
underwritten by them.
 329

In India the business of underwriting is carried on by certain specialised

institutions, some of them include:

9 Industrial Development Bank of India (IDBI)

9 Unit Trust of India (UTI)
9 Life insurance Corporation of India (LIC)
9 Industrial Finance Corporation of India (IFCI)
9 Various Nationalised banks

8.6 Legal provisions relating to underwriting commission

The consideration payable to underwriters for underwriting the issue of shares or

debentures of a company is called underwriting commission. It may be paid in
cash or in fully paid shares or debentures. Underwriting commission is generally
calculated at a specified rate on the issue price of the whole of the shares or
debentures underwritten. Section 76 of Companies Act 1956 lays down certain
conditions relating to the payment of underwriting commission which must be
complied with. These are as follows:

a) The payment of the underwriting commission must be authorized by the

Articles of Association.

b) The amount of commission paid or agreed to be paid should not exceed 5%

of the issue price and in the case of debentures it should not exceed 2.5% of
the issue price.

c) The names and addresses of the underwriters, the number of shares and
debentures underwritten by each of them and commission payable to them
should be disclosed in the Prospectus or Statement in Lieu of Prospectus.

d) A copy of the contract for the payment of underwriting commission should

be delivered to the Registrar along with the Prospectus or Statement in Lieu
of Prospectus for registration.

Underwriting is a nature of insurance against the possibility of inadequate

subscription and it is of great economic significance as it provides an assurance
to the company regarding its investment programme. The Central Government
has also permitted certain financial institutions to render various services
including underwriting of shares and debentures to help the companies for raising
funds. The prominent institutions providing this service are Industrial Finance
Corporation of India (IFCI) and Life Insurance Corporation of India.
 330

8.7 Important terminology

Before we study the underwriting process, let us understand the following terms:

a) Marked application: These applications bear the stamp of the underwriter

and the credit for these applications is given to the individual underwriter.

b) Unmarked application: These applications don’t bear the stamp of the

underwriter and are given directly to the company.

8.8 Determination of liability in respect of an underwriting agreement

Determination of liability of underwriters depends upon the nature of

underwriting agreement. The 3 main types of underwriting agreements are:

Diagram 5: Types of underwriting agreement

a) Complete underwriting

If the whole of the issue has been underwritten by one person, the underwriter is
responsible to subscribe for all the shares or debentures that have not been
subscribed by the public. In such a case, it is not necessary to ascertain the
number of applications that originated through the underwriter and those that
came directly to the company.

X Ltd issues 1,00,000 equity shares of Rs.10 each at par. The whole of the issue
is underwritten by IDBI. This is a case of full/complete underwriting.
 331

b) Partial underwriting

In case where only a part of an issue has been underwritten, or where there are a
number of underwriters, a difficulty may arise in determining the liability of each
of the underwriters. Such a difficulty may arise in deciding the basis on which
the unmarked applications are to be allotted. In this case, the applications which
have directly come to the company should be allocated among the different
underwriters.

X Ltd issues 1,00,000 equity shares of Rs.10 each at par. 80% of the issue is
underwritten by IDBI. This is a case of partial underwriting.

This can be done in two ways.

9 In one method, the unmarked applications are allotted in the proportion of

gross amount of capital underwritten.

9 Alternatively these are allocated in proportion to the gross amount of capital

underwritten as reduced by the marked applications.

By following one or the other method, the liability of the underwriter or writers
can be ascertained. This is explained with the help of the following example:

Young & Old Co Ltd of Kolkata issued 100,000 equity shares. These were
underwritten by underwriters being A, B &C; A for 40%, B 35% and C for 25%.

In all, applications for 80,000 shares were received; applications for 20,000
shares bear the stamp of A; those for 10,000 shares that of B, and those for
20,000 shares that of C.

There were also applications for 30,000 shares which did not bear any stamp. It is
decided that credit for unmarked applications is given to A, B, and C in
proportion to their gross liability.

Required:

Determine the liability of each of the underwriters.

 332

Solution:

Particulars \ Underwriters A B C
Gross Liability 40,000 35,000 25,000
Less: 30,000 unmarked applications in (12,000) (10,500) (7,500)
40:35:25
28,000 24,500 17,500
Less: Marked applications (20,000) (10,000) (20,000)
Balance 8,000 14,500 (2,500)
Credit to A & B for C’s Surplus (Ratio (1,330) (1,170) 2,500
40:35)
Actual Liability 6,670 13,330 Nil

Alternatively

The unmarked applications are allocated in proportion to the gross amount of

capital underwritten as reduced by the marked applications.

In the given case, the unmarked applications should be credited to different

underwriters in the ratio of liability after credit for marked applications has been
given - the position will be as follows:

Particulars \Underwriters A B C
Gross Liability 40,000 35,000 25,000
Less: Marked applications (20,000) (10,000) (20,000)
20,000 25,000 5,000
Less: Unmarked applications in 20:25:5 (12,000) (15,000) (3,000)
Actual Liability 8,000 10,000 2,000

Note- Under the alternative method, the underwriters’ liability in can also be
determined by simply apportioning the total number of shares yet to be
subscribed (20,000 in the above case) in the proportion of the balance of the
liability after credit for marked forms has been given.

Since the liability of each underwriter may vary widely if one or the other
method is followed, the underwriting contract should specify the method to be
followed.
 333

c) Firm Underwriting

Under firm underwriting, the underwriter provides for definite commitment to

accept a specified number of shares irrespective of the number of shares
subscribed by the public.

In such case, unless it has been otherwise agreed, the underwriter’s liability is
determined without taking into account the number of shares taken up by him.

X Ltd issues 1,00,000 equity shares of Rs.10 each at par. 80% of the issue is
underwritten by the IDBI with the definite commitment to take up 10,000 shares.
This is firm underwriting.

Firm underwriting is explained with the help of the example given below.

Global Steel Ltd came up with an issue of 2,00,000 equity shares of Rs.100 each
at par. Amounts payable on application and allotment are Rs.25 and Rs.20 per
share and the balance on call. 50,000 shares were issued to the promoters and the
balance which was offered to the public was underwritten by Asoke, Raja and
Varun equally with firm underwriting of 5,000shares.

The underwriting commission is agreed @5%. Unmarked applications are to be

credited to the underwriters equally.

Subscriptions were received for 1,29,700 shares, including the following marked
applications:

Asoke 42,500 shares

Raja 45,000 shares
Varun 35,000 shares

The underwriters applied for the number of shares as per contract on firm
underwriting.
 334

Required:
You are now required to pass journal entries for
i) Allotment of shares to the underwriters
ii) Commission due to each of them
iii) The Net Cash paid or received
Solution:
Journal Entries in the books of Global Steel Ltd
(Amount in Rs.)
Debit Credit
Bank A/c Dr 3,75,000
To Share Application A/c 3,75,000
(Being application money received on firm application
of 5,000shares @ Rs.25 per share from Asoke, Raja &
Varun)
Asoke A/c Dr 1,00,000
Raja A/c Dr 1,00,000
Varun A/c Dr 3,38,500
Share Application A/c Dr 3,75,000
To Share Capital A/c 9,13,500
(Being allotment of shares as calculated in working
note –5,000shares to Asoke,5,000shares to
Raja,10,300 shares to Varun)
Underwriting Commission A/c Dr 7,50,000
To Asoke A/c 2,50,000
To Raja A/c 2,50,000
To Varun A/c 2,50,000
(Being Underwriting Commission @5% payable on
amount of shares underwritten)
Asoke A/c Dr 1,50,000
Raja A/c Dr 1,50,000
To Bank 3,00,000
(Being amount paid to Asoke and Raja in final
settlement of commission after adjustment of amount
receivable on shares allotted to them)
 335

Journal Entries in the books of Global Steel Ltd

(Amount in Rs.)
Debit Credit
Bank A/c …….. Dr 88,500
To Varun A/c 88,500
(Being amount received from Varun in final
settlement of commission after adjustment of amount
receivable on shares allotted to him)
Workings:
1) Calculation of the liability of underwriters;
Particulars Asoke Raja Varun
Liability (No of Shares) 50,000 50,000 50,000
Less: Firm Underwriting -5,000 -5,000 -5,000
45,000 45,000 45,000
Less: Marked Application -42,500 -45,000 -35,000
2,500 NIL 10,000
Less: Unmarked Application (equally) 3,600 3,600
1,100 -6,400
Adjustment of Anand Surplus -1,100 -1,100
Net Liability excluding Firm
NIL 5,300
Underwriting
Add: Firm Underwriting 5,000 5,000 5,000
Gross Liability 5,000 5,000 10,300
Unmarked Application = 129,700- 42,500- 45,000- 35,000 = 7,200
2) Calculation of Amount payable by underwriters
Asoke Raja Varun
Gross Liability (No of Shares) as
5,000 5,000 10,300
calculated above
Amount payable @ Rs.45 per share on
2,25,000 2,25,000 4,63,500
Gross Liability
Less: Amount paid on Firm
1,25,000 1,25,000 1,25,000
application for 5,000 shares@Rs25
Balance payable 1,00,000 1,00,000 3,38,500
Underwriting Commission 2,50,000 2,50,000 2,50,000
Amount paid 1,50,000 1,50,000 -------
Amount received by the Company 88,500
 336

As this study material is intended to give special coverage on investment

accounting and investment regulations, the students must understand essential
aspects of shares and debenture issue, and underwriting thereof for developing an
integrated idea of financing as well as investment activities of the corporate
business houses, including insurance firms.

Commitment provided to accept a specified number of shares irrespective of the

number of shares subscribed by the public are known as:

A Redemption
B Full underwriting
C Firm underwriting
D None of the above

9. Discuss the concept of bonus shares along with

accounting treatment and related provision under the
Companies Act.
[Learning Outcome i]

9.1 Bonus Shares

A company may decide to distribute past undistributed profit, when there is large
amount of accumulated reserves, by way of issuing shares free of cost to its
existing shareholders. Such shares are called Bonus Shares.

Bonus shares are issued to the existing members in proportion to their

shareholding in the company. The issue of bonus shares help in ploughing back
the of profits of the company, bringing about proper balance between paid up
capital and accumulated reserves, elicit good public response to equity issue of
the public company and improves the market image of the company.
Accounting for issue of bonus shares is one of the important aspects of company
accounts. It requires compliance of lot statutory requirements and accounting
formalities, which are being discussed in brief hereunder.
 337

9.2 Provision of the Companies Act 1956 for issue of Bonus Shares
The following provisions of Companies Act need to be adhered:
a) Bonus shares can only be issued when there is a provision to this effect in the
Articles of Association (AoA) of the company. If the articles do not contain
such a provision, the company must first pass a special resolution in the
general meeting of the shareholders and make such a provision in the articles.
b) For issuing bonus shares, a resolution should first be passed by the Board of
Directors and it should then be approved by shareholders in their general
meeting.
c) The bonus issue is not made until the partly paid shares are made fully paid-
up.
d) Guidelines issued by Securities and Exchange Board of India (SEBI) must be
complied with. (discussed in detail below)

Bonus shares can be issued from following:

9 General reserves
9 Capital reserves realized in cash
9 Securities premium realized in cash

9.3 SEBI Guidelines for Issue of Bonus Shares

Securities and Exchange Board of India (Disclosure and Investor Protection)

Guidelines, 2000 contains the guidelines for bonus issue. These are discussed in
detail below:

a) No issue within 12 months - No bonus issue shall be made within 12

months of any public/right issue.

b) Out of free reserves: The bonus issue shall only be made out of free
reserves built out of genuine profits or securities premium collected in cash
only. However, SEBI guidelines relating to debentures provide that
Debenture Redemption Reserve shall be considered as general reserve for
consideration of bonus issue proposals.
 338

c) Revaluation reserve: reserves created by revaluation of fixed assets cannot

be used for issuing bonus shares. If assets are subsequently sold and the
profits are realized, such reserves could be utilised for capitalisation.

d) Bonus issue not to be in lieu of dividend: The declaration of bonus issue, in

lieu of dividend, should not be permitted.

e) Partly paid shares: The bonus issue is not made unless the partly- paid
shares, if any, existing, are made fully paid-up.

f) No default in respect of deposit/debentures: the company should not have

defaulted in payment of any interest or principal in respect its fixed deposits
and interest on debentures or redemption of debentures.

g) Statutory dues of the employees: The company should not be defaulted in

payment of its statutory dues to the employees such as contribution to PF,
gratuity, bonus, minimum wages, workmen’s compensation, retrenchment,
payment to contract labour etc.

h) Implementation of proposal : The bonus issue shall be implemented within

a period of 15 days after the date of approval of the BoD; it does not require
the shareholders’ approval for capitalisation of profits or reserves for making
bonus issue as per the AoA of the company. However, if the company is
required to get the shareholders’ approval as per AoA of the company for
capitalisation of profits or reserves, the bonus issue shall be implemented
within 2 months from the date of the meeting of the BoD

i) Provision in AoA: There should be a provision in the Articles of Association

of the company for capitalization of reserves, and, if not, the company shall
pass a resolution at its general body meeting making provisions in the
Articles of Association for capitalization.

j) Authorised capital: Consequent to the issue of bonus shares, if the

subscribed and paid-up capital exceeds the authorized share capital,
resolution shall be passed by the company at its general body meeting for
increasing the authorized capital.

k) Right of FCD/PCD holders: No company shall, pending conversion of

FCDs/PCDs, issue any shares by way of bonus unless similar benefit is
extended to the holders of such FCDs/PCDs, through reservation of shares in
proportion to such convertible part of FCDs or PCDs. The shares so reserved
may be issued at the time of conversion of such debentures on the same
terms on which the bonus issues were made.
 339

l) Reporting to SEBI: The company should file with SEBI a statement of the
bonus issue conveying the details of the bonus issue and certifying that the
bonus issue is being made as per the guidelines.

m) Certificate: The statement, as aforesaid, should be accompanied by a

certificate from the statutory auditors of the company or by a practicing
company secretary to the effect that bonus guidelines have been duly
complied with.

Journal entries

Sanction of an issue of bonus shares

Profit and Loss Account (or reserve) Dr XX
General reserve account Dr XX
Capital reserve account (realized in cash only) Dr XX
Securities premium account Dr XX
Capital redemption reserve account Dr XX
To Bonus to Shareholders Account XX

Entry for issue of shares

Bonus to Shareholders Account Dr XX
To Share Capital Account XX

AB Ltd had an issued and subscribed capital of 100,000 equity shares of Rs 10

each and the details of the reserves and surplus are as follows as on 31March,
2009

Reserves & Surplus Rs

General Reserve 1,20,000
Capital Reserve 1,00,000
Securities Premium 25,000
Profit and Loss Account 2,00,000

On 31 May, the company decided to capitalize its reserves by way of bonus at the
rate of 1 share for every 4 shares held.

Required:

Show the necessary journal entries for the bonus issue.

 340

Solution:

Bonus issue of 1 share for every 4 share = 1,00,000 shares x ¼ = 25,000 shares.

Share capital to be issued = 25,000 shares x Rs. 10 = Rs.2,50,000

Journal Entries in the books of AB Ltd

Date Particulars Debit Credit

Amount Amount
31 May Capital Reserve A/c Dr 1,00,000
Securities Premium A/c Dr 25,000
General Reserve A/c Dr 1,20,000
Profit and Loss A/c Dr 5,000
To Bonus to Shareholders A/c 2,50,000
Being bonus issue @ one share for every four shares held

31 May Bonus to Shareholders A/c Dr 2,50,000

To Equity Share Capital A/c 2,50,000
Being Capitalisation of profit

Bonus shares can be issued from following:

(i) General reserves

(ii) Securities premium realized in cash
(iii) Revaluation Reserves

A Only (i)
B Only (ii)
C (ii) and (iii)
D (i) and (ii)
 341

[Link] the form and content of financial statements as

required by statute and prepare financial statements in
accordance with the formats.
[Learning Outcome j]

10.1 Preparation of Financial Statements

The financial statement of a company must be prepared in accordance with the

provisions of the companies Act 1956, and the relevant regulations applicable to
a company and in compliance with the requirements of the applicable
Accounting Standards issued by the Institute of Chartered Accountants of India.

For example the financial statements of a bank will be prepared as per specific
regulations issued by the RBI and the financial statements of an insurance
company are governed by the specific accounting regulation issued by the IRDA.

The provisions of various sections particularly Section198, 205, 211, .212, 349,
350 are to be complied with in preparation of the financial statements of a
company. Besides above regulatory and legal requirements, the accounting
policy and accounting assumptions followed by the company shall not be
deviated without proper disclosure and the impact of such deviation must be
specified in the accounting notes.

It is mandatory under the Companies Act for all types of companies to maintain
their accounts on accrual basis and according to double entry system of
accounting As required by Accounting Standard (AS) -1 on “Disclosure of
Accounting Policies , there must be proper disclosure if fundamental accounting
assumptions viz. Going Concern, Consistency and Accrual basis are not
followed.

Similarly there are many legal requirements in preparation of financial statements

of a company. For example Section 212 of the Companies Act provides that the
balance sheet of holding company shall be accompanied by the following
documents of its subsidiary/subsidiaries:

a) a copy of the Balance Sheet of the subsidiary

b) a copy of its Statement of Profit & Loss
c) a copy of the report of its Board of Directors
d) a copy of the Report of its Auditors
e) a statement of holding company’s interest in the subsidiary
 342

While preparing the financial statements of a company the following aspects

should be kept in mind:

9 Requirements of Revised Schedule VI

9 Other statutory requirement
9 Indian Accounting Standards issued by the ICAI or IFRS as and when
applicable
9 Statements and Guidance Notes issued by the ICAI in regard to various
accounting treatment, valuation of assets or disclosure requirements.

a) Form and Contents of Balance Sheet and Profit & Loss Account
(Sec.211)

As provided by Section 211, every Balance Sheet of a company shall give a true
and fair view of the state of affairs of the company as at the end of the financial
year and shall be in the form set out in Part I of the Schedule VI or as near
thereto as circumstances admit or such other form as may be approved by the
Central Government. In preparing the balance sheet due regard shall be had to the
general instructions contained in the ‘Notes” at the end of the said Part I, for
preparation of balance sheet under.

Pertinently the aforesaid provisions of Section.211 shall not apply to any

insurance company, banking company or any company engaged in the
preparation or supply of electricity or any other class of company for which form
of balance sheet has been specified in the Act governing such class of company.

Section 211(2) further provides that every statement of profit & Loss of a
company shall give a true and fair view of the profit or loss of a company for the
financial year and shall comply with the requirements of Part II of the Schedule
VI, so far as they are applicable thereto. But the said provisions of this section
shall not apply to any insurance company or banking company engaged in
generation or supply of electricity or any other class of company for which form
of balance sheet has been specified in the Act governing such class of company.

Every statement of profit and loss account and balance sheet of the company
shall comply with the accounting standards. Here Accounting Standards mean
the standards of accounting issued by the Institute of Chartered Accountants of
India.
 343

b) Preparation of financial statements

i) Balance sheet

The Balance Sheet can now be prepared only under the vertical form as per the
revised Schedule VI. While preparing balance sheet, the companies not only
conform to the format, but also notes and general instructions given in the
Schedule VI.

ii) Statement of Profit and Loss

The name has been changed to “Statement of Profit and Loss” as against ‘Profit
and Loss Account’ as contained in the Old Schedule VI. Unlike the Old
Schedule VI, the Revised Schedule VI lays down a format for the presentation of
Statement of Profit and Loss. This format of Statement of Profit and Loss does
not mention any appropriation item on its face. Further, the Revised Schedule VI
format prescribes such ‘below the line’ adjustments to be presented under
“Reserves and Surplus” in the Balance Sheet.

The formats of balance sheet and Statement of Profit and Loss as per
Revised Schedule VI are given below:

Schedule VI
(See Section 211)

GENERAL INSTURCTIONS FOR PREPARATION OF BALANCE

SHEET AND STATEMENT OF PROFIT AND LOSS OF A COMPANY IN
ADDITION TO THE NOTES INCORPORATED ABOVE THE HEADING
OF BALANCE SHEET UNDER

GENERAL INSTRUCTIONS

1. Where compliance with the requirements of the Act including Accounting

Standards as applicable to the companies require any change in treatment or
disclosure including addition, amendment, substitution or deletion in the
head/sub-head or any changes interest, in the financial statements or
statements forming part thereof, the same shall be made and the requirements
of the Schedule VI shall stand modified accordingly.
 344

2. The disclosure requirements specified in Part I and Part II of this Schedule

are in addition to and not in substitution of the disclosure requirements
specified in the Accounting Standards prescribed under the Companies Act,
1956. Additional disclosures specified in the Accounting Standards shall be
made in the notes to accounts or by way of additional statement unless
required to be disclosed on the face of the Financial Statements. Similarly, all
other disclosures as required by the Companies Act shall be made in the
notes to accounts in addition to the requirements set out in this Schedule.

3. Notes to accounts shall contain information in addition to that presented in

the Financial Statements and shall provide where required:
a) narrative descriptions or disaggregation of items recognized in those
statements and
b) information about items that do not qualify for recognition in those
statements.

Each item on the face of the Balance Sheet and Statement of Profit and Loss
shall be cross-referenced to any related information in the notes to accounts.
In preparing the Financial Statements including the notes to accounts, a
balance shall be maintained between providing excessive detail that may not
assist users of financial statements and not providing important information
as a result of too much aggregation.

4. Depending upon the turnover of the company, the figures appearing in the
Financial Statements may be rounded off as below:

Turnover Rounding off

a) less than one hundred To the nearest hundreds, thousands,
crore rupees lakhs or millions, or decimals thereof.
b) one hundred crore rupees To the nearest, lakhs, millions or crores,
or more or decimals thereof.

Once a unit of measurement is used, it should be used uniformly in the

Financial Statements.

5. Except in the case of the first Financial Statements laid before the Company
(after its incorporation) the corresponding amounts (comparatives) for the
immediately preceding reporting period for all items shown in the Financial
Statements including notes shall also be given.

6. For the purpose of this Schedule, the terms used herein shall be as per the
applicable Accounting Standards.
 345

Notes

This part of Schedule sets out the minimum requirements for disclosure on the
face of the Balance Sheet, and the Statement of Profit and Loss (hereinafter
referred to as “Financial Statements” for the purpose of this Schedule) and Notes.
Line items, sub-line items and sub-totals shall be presented as an addition or
substitution on the face of the Financial Statements when such presentation is
relevant to an understanding of the company’s financial position or performance
or to cater to industry/sector-specific disclosure requirements or when required
for compliance with the amendments to the Companies Act or under the
Accounting Standards.

PART I - FORM OF BALANCE SHEET

Name of the Company……………
(Rupees
Balance Sheet as at ……………… in……..)
Figures as Figures as at
at the end of the end of
Note
Particulars current previous
No.
reporting reporting
period period
1 2 3 4
I. Equity and Liabilities

(1) Shareholders' Fund

a) Share Capital
b) Reserves and Surplus
c) Money received against
share warrants

(2) Share application money

pending allotment

(3) Non-current liabilities

a) Long-term borrowings
b) Deferred tax liabilities(Net)
c) Other Long-term liabilities
d) Long-term provisions
 346

(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

I Current investments
II Inventories
III Trade receivables
IV Cash and cash
equivalents
V Short-term loans and
advances
VI Other current assets

Total - -

Refer Revised Schedule VI of the Companies Act 1956 for the general
instructions for preparation of balance sheet
 347

PART II - FORM OF STATEMENT OF PROFIT AND LOSS

Name of the Company ………..
Profit and loss statement for the year ended…………….
(Rupees
in……)
Figures Figures
for the for the
current previous
Note reporting reporting
Particulars No. period 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 Benefits expense
Finance 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) for the period from
continuing operations (IX-X)
XII Profit/(loss) from discontinuing
operations
 348

XIII Tax expense of discontinuing

operations
XIV Profit/(loss) from discontinuing
operations (after tax) (XII - XIII)
XV Profit (Loss) for the period (XI +
XIV)
XVI Earnings per equity share:
(1) Basic
(2) Diluted

Refer Revised Schedule VI of the Companies Act 1956 for general

instructions for preparation of statement of profit and loss

Presentation of Final Accounts in a Summary Form

It is another form in which final statements of account are prepared. Presently

this form of financial statements is often used. Under this method assets and
liabilities and incomes and expenditure are grouped under main heads and are
shown in the balance sheet and profit and loss account respectively and other
information requiring disclosure are also disclosed in a summarised form to
comply with the requirements of Section 219(1)(b) of the Companies Act 1956.

Consequently, the statement of profit and loss accounts and balance sheet are not
loaded with details. The Balance Sheet and statement of Profit & Loss Account
can be prepared in the abridged form for the use of members and others who do
not need full statements.

Such abridged accounts are to be prepared as per form 23AB of Companies

(Central Government‘s) General Rules and Forms, 1956. The statement shall be
approved by the Board of Directors and signed on behalf of them.
 349

Form of Abridged Balance Sheet (Form no 23-AB) As per Sec 219(1) (b)
Name of the Company
Abridged Balance sheet as at …….

Particulars Figures at the end of

C/Y Fin. P/Y Fin.
Year year
I Sources of Funds
1. Shareholders’ Funds
(a) Capital
(i) Equity
(ii) Preference
(b) Reserves & Surplus
(i) Capital Reserves
(ii) Revenue Reserves
(iii) Revaluation Reserve
(iv) Surplus in Profit & Loss Account
(v) Share Premium Reserve
(vi) Investment Allowance Reserve

2. Loans Funds
(i) Debentures (Amount of convertible and
partly convertible debenture
(ii) Public Deposits
(iii) Secured Loans (Other than debentures)
(iv) Unsecured Loans
Total of (1) and (2)
II Application of Funds
1. Fixed Assets
(a) Net Block (original cost less depreciation)
(b) Capital Work in Progress
2. Investments
(a) Government securities
(b) Investment in subsidiary companies
(i) Quoted
(ii) Unquoted
(c) Others
(i) Quoted
(ii) Unquoted
 350

3. Current Assets, Loans and Advances

(a) Inventories
(b) Sundry Debtors
(c) Cash and Bank Balances
(d) Other Current Assets
(e) Loans and Advances
Less: Current Liabilities
(a) Liabilities
(b) Provisions

4. Miscellaneous Expenditure to the extent not

written off

5. Profit and Loss Account

Total (1 to 5)

Performa of Abridged Profit and Loss Account for the year ended…….

Name of the Company

Profit and Loss Account for the year ended…….

Particulars Figures as at the end

of ……
C/Y P/Y
I. Income
Sales/ Services rendered (Details as per annexure)
Dividend
Interest
Other Income (Refer Note 5)

II. Expenditure
Cost of Goods Consumed/ Sold
i) Opening Stock
ii) Purchase
Less: Closing Stock

Manufacturing Expenses
Salaries, Wages, and Other Employee Benefits
Managerial Remuneration
 351

Interest
Depreciation
Auditors’ Remuneration
Provisions for i) Doubtful Debts and
ii) Other Contingencies (to be specified)
Any Other Expenses (refer point no.5)

III. Profit / Loss before Tax (PBT)

IV. Provision for Taxation

V. Profit/ Loss After Tax

VI. Proposed Dividend;

i) Preference Share
ii) Equity Share

VII. Transfer to Reserves

Notes to the Abridged Balance Sheet and the Abridged Profit & Loss
Account

1. The amounts to be shown here should be the same as shown in the

corresponding aggregated heads in the accounts as per Schedule VI or as
close to it as possible.

2. The total amount of contingent liabilities and that of Capital commitments

should be shown separately

3. All notes forming part of the accounts as per schedule VI to which specific
attention has been drawn by the auditors or which form a subject matter of
audit qualification should be reported

4. If fixed assets are revalued, the amount of revaluation, should be shown

separately for the first five years subsequent to the date of revaluation
 352

5. Any item which constitutes 20% or more the total income or expenditure
(including provisions) should be shown separately.

6. Amount, if material, by which any items shown in the profit and loss account
are affected by any change in the basis of accounting, should be disclosed
separately.

7. If no provision is made for depreciation, the fact that no depreciation has

been made shall be stated along with the quantum of arrears of depreciation
computed in accordance with sec 205 of the Act

8. Market value of quoted investments (both of current year and also of

previous year) to be mentioned

9. Any note forming part of the accounts as per Schedule VI which is in the
nature of any explanation regarding compliance with any law should be
reproduced

10. Important ratio performance such as sales/ total assets ratio, operating profit/
capital employed ratio, return on net worth, profit/sales ratio should be
disclosed

11. Details of installed capacity and productivity of main items should be

disclosed

12. Notes in abridged balance sheet should be given the same number as in the
main balance sheet

Above stated salient features of balance sheet and the profit and loss account
should be authenticated in the same manner as the main accounts are to be
authenticated.
 353

Preparation of Financial statements

From the following Trial Balance of M/S Ma Durga Chemical Ltd prepare
financial statements for the year ended 31 March 2010.
Trial Balance as on 31 March 2010
(Amount in Rs.)
Debit Credit
Equity Shares Capital
Goodwill 26,50,000 250,00,000
(Shares of Rs100each)
Land & Building 1,54,60,000 12% Debenture
Plant & Machinery 86,00,000 Bank Loans 50,00,000
Furniture & Fixtures 55,00,000 Bills Payable 64,50,000
Trade receivables 28,70,000 Trade payables 12,50,000
Bills Receivable 15,30,000 Sales 15,60,000
Stock in Trade 68,00,000 Rent Received 447,90,000
Profit &Loss Account
Tools & Equipment’s 26,00,000 5,60,000
B/F
Loans to Directors 8,00,000 13,90,000
Discount Allowed 4,00,000
Bad Debts 3,50,000
Advertisement &
2,00,000
Publicity
Commission &
12,00,000
Brokerage
Purchases 2,31,90,000
Rent, rates & Taxes 2,50,000
Balance in Current
4,50,000
A/c
Cash in Hand 80,000
Interest on bank Loan 11,60,000
Preliminary expenses 1,00,000
Wages 90,00,000
Consumables 8,40,000
Transit Insurance 3,00,000
Trade Expenses 930,000
Freight 540,000
Debenture Interest 2,00,000
8,60,00,000 8,60,00,000
 354

Additional aspects to be considered in preparation of Financial Statements are;

9 Closing Stock is Rs.70,00,000 as on 31. 03.2010

9 Depreciation to be provided as follows; Machinery @10%, Land & Building
@5%, Furniture& Fixtures @10% and Tools & Implements @ 5%
9 Dividend proposed and declared @ 10%
9 Provision for Taxation to be made @ 30% of net profit

Solution;
M/S Ma Durga Chemical Ltd
Balance Sheet as at 31st March 2010 (In Vertical Form)
Particulars Note No Amount Rs Amount Rs
Equity and liabilities
Shareholders’ funds
(a) Share capital 1 2,50,00,000
(b) Reserves and surplus 2 21,63,900
Shareholders’ funds 2,71,63,900

Non-current liabilities
(a) Secured Loans 3 1,14,50,000 1,14,50,000

Current Liabilities
Liabilities 6 28,10,000
Provisions 7 39,03,100 67,13,100

Total Equity and liabilities 4,53,27,000

ASSETS
Non-current assets
1) Fixed Assets;
Gross block 4 3,48,10,000
Less: Depreciation (23,13,000)
Net Block 3,24,97,000 3,24,97,000

Current assets
a) Inventories 70,00,000
b) Trade Receivables 28,70,000
c) Cash and Bank Balances 5,30,000
 355

M/S Ma Durga Chemical Ltd

Balance Sheet as at 31st March 2010 (In Vertical Form)
Particulars Note No Amount Rs Amount Rs
d) Other Current Assets ---Bills
23,30,000
Receivable
e) Loans and Advances 5 1,00,000
f) Miscellaneous Esp. the extent not
1,28,30,000
written off
Total assets 1,28,30,000

4,53,27,000

M/S Ma Durga Chemical Ltd

Statement of Profit & loss Account for the year ended 31 March 2010
Note Amount Amount
Particulars
No Rs. Rs.
Income
Sales 4,47,90,000
Other Income 8 5,60,000
Expenditure 4,53,50,000
Purchases 9 2,38,30,000
Manufacturing and other expenses 10 1,31,70,000
Depreciation 11 23,13,000
Interest and other Financial Charges 12 13,60,000 (4,06,73,000)
Profit before tax (PBT) 46,77,000
Tax expense (14,03,100)
Profit for the period from
32,73,900
continuing operations

Note 1 Capital
Subscribed &Paid-up capital;
(250,000 shares of Rs.100 each) Rs.2,50,00,000
Note 2 Reserves & Surplus

Rs.
Profit for the period from continuing operations 32,73,900
Balance of profit & Loss brought forward 13,90,000
Less: Proposed Dividend (25,00,000)
Transfer to Reserves Nil
Balance carried to Balance Sheet 21,63,9000
 356

Note 3 Secured Loans

Rs.
11% Debentures 50,00,000
Loans From Bank 64,50,000
1,14,50,000

Note 4 Fixed Assets

Rs.
Gross Block
Goodwill 26,50,000
Land &Buildings 1,54,60,000
Plant & Machinery 86,00,000
Furniture &Fixture 55,00,000
Tools& Equipment 26,00,000
3,48,10,000
Less: Depreciation
Land &Building 7,73,000
Plant& Machinery 8,60,000
Furniture & Fixture 5,50,000
Tools & Equipment 1,30,000
23,13,000
Net Block 3,24,97,000

Note 5 Loans & Advances

Rs
Loans To Directors 8,00,000
Bills Receivable 15,30,000
23,30,000

Note 6 Current Liabilities

Rs.
Bills Payable 12,50,000
Trade payables 15,60,000
28,10,000
 357

Note 7 Provisions

Rs.
Provisions for Taxation 14,03,100
Proposed Dividend 25,00,000
39,03,100

Note 8 Other Income

Rs.
Rent Received Rs.5,60,000
Others Nil
5,60,000

Note 9 Purchase

Rs.
Purchase 231,90,000
Consumable Stores 8,40,000
2,40,30,000
Add: Opening Stock 68,00,000
Less: Closing Stock 70,00,000
2,38,30,000

Note 10 Manufacturing & Other Expenses

Rs.
Wages 90,00,000
Bad Debts 3,50,000
Discount Allowed 4,00,000
Rent, rates & Taxes 2,50,000
Commission & Brokerage 12,00,000
Advertisement & Publicity 2,00,000
Transit Insurance 3,00,000
Trade Expenses 9,30,000
Freight 5,40,000
1,31,70,000
 358

Note 11 Depreciation

Rs.
Land &Building; 7,73,000
Plant& Machinery 8,60,000
Furniture & Fixture 5,50,000
Tools& Equipment 1,30,000
23,13,000

Note 12 Interest & Other Financial Charges

Rs.
Interest on bank Loan 11,60,000
Debenture Interest 2,00,000
13,60,000

Certain Special items in Trial Balance

1. Calls in-Arrear

When this item generally appears in the Trial Balance, it represents the amount
not paid by the shareholders on the calls made by the company on shares. This
needs adjustment to be shown in Balance sheet. In the liability side this amount is
deducted from the Called-Up and Paid-Up Capital.

2. Unclaimed Dividend

It represents the amount of dividend not collected by the shareholders. It is to be

shown on the liability side of Balance Sheet under the head “Current Liabilities”

3. Interim Dividend

This item in Trial Balance represents dividend paid by a company before the
Annual General Meeting and generally on the basis of financial results shown by
the half-yearly accounts. Since there is no profit and loss appropriation account
under the revised Schedule VI, all appropriations including interim dividends are
shown as a movement in “Reserve and Surplus Account”
 359

4. Proposed Dividend

This item represents dividend proposed and declared by the company in the
General Meeting, which is to be paid in accordance with the provisions of sec
205 of the Companies Act 1956. This is to be shown on the liability side of
Balance Sheet under the heading “provisions”

5. Dividends Received

This represents dividend received on company’s investments in shares. If

‘dividend received’ shown in Trial Balance is the net dividend amount (net of
tax) received by the company. But this is to be adjusted for gross amount i.e
dividend plus tax deducted at source (TDS) by the company disbursing the
dividend under sec 194 of the Income Tax Act 196. For example; in the trial
balance of X Ltd, there is a credit balance of Dividend Received A/c is Rs,1,790
paid by Y Ltd after deducting tax @10% and surcharge thereupon @5%. X Ltd is
required to show the gross amount of Dividend Received in the final accounts.

Here Gross Dividend is Rs.2,000, Tax is Rs.200 and Surcharge is Rs10. To show
the gross amount, the following entry is to be passed;

Tax Deducted at Source A/c Dr Rs.210

To Dividend Received A/C Rs.210

With this adjustment entry, Dividend Received will be Rs.2000, which will be
shown in the statement of profit and loss account and Tax Deducted at Source
A/c for Rs.210 will appear on the asset side of the Balance Sheet till the same is
adjusted against total tax liability of the company.

However, at present dividends are not subject to tax at the hands of the
shareholders. The company declaring dividends pays a dividend distribution tax
along with applicable surcharge and education cess.

6. Interest Received

As in the case of Dividend Received A/C, same adjustment entry is required to

be passed for “Interest Received A/C if shown in Trial balance for the net amount
(net of tax).

Under sec.194A of the Income Tax Act 1961, banks are required to deduct tax
@20% and surcharge 5% on interest payable to a domestic company.
 360

X Ltd. received Interest from bank deposits for Rs15,800 after deduction of Tax
at source for Rs.4,200.

X Ltd is required to pass the following adjustment entry to show the gross
amount of Interest Received A/C in the final accounts if Trial Balance shows the
net amount of Rs15,800.

Tax Deducted at Source A/c Dr Rs.4,200

To Interest Received A/C Rs.4,200

With this adjustment entry, Interest Received A/c will be Rs.20,000, which will
be shown in the statement of profit and loss account and Tax Deducted at Source
A/c for Rs.4,200 will appear on the asset side of the Balance Sheet till the same is
adjusted against total tax liability of the company.

7. Interest on Debentures Issued

When a company pays interest on Debentures, it is required to deduct tax at

source.

Suppose TDS on interest is @20% and surcharge 5% . So if X Ltd pays interest

on debenture for Rs.1,00,000/- for 2009-10, it is required to deduct tax with
surcharge for Rs.21,000/- which is to be deposited by the company as per the
provisions of the Income Tax Act.

The accounting entry for payment of debenture interest for Rs.1,00,000/- will be
as under

Interest on debenture A/c Dr Rs1,00,000

To Bank A/c Rs79,000
To Income Tax Payable A/c / Tax Deducted at Source A/c Rs21,000

With this entry, Interest on Debenture A/c will be Rs100,000, which will be
shown in the statement of profit and loss account as expenses and tax deducted
at source A/c for Rs21,000 will appear on the liability side of the Balance Sheet
till the same is deposited.
 361

8. Discount & Cost of Issue of Debenture A/c

This represents Discount, Commission and other expenses incurred on issue of

debentures. This appears on the asset side of the Balance Sheet under the head
“Miscellaneous Expenditure” till the same is fully written off.

This expenditure is written off prudently over the period of the life of debentures.

This expenditure written off is shown in the Statement of Profit & Loss Account
with the following adjustment entry;

Profit & Loss A/c Dr (amount written off) XXX

To Discount & Cost of Issue of Debenture A/c XXX

The balance amount unwritten off will appear in the balance sheet.

The form and contents of Balance Sheet and Statement of Profit and loss is for
companies are prescribed by:

A Schedule VI of Companies Act

B Accounting Standards issued by ICAI
C Reserve Bank of India
D No format prescribed
 362

Financial Statements of Banks - The following are the balances (Rs in Crores) in the General ledger of Welcome Bank
Ltd as at 31st March 2010.
Particulars C/Yr 2010 P/Yr 2009 C/Yr 2010 P/Yr 2009
Cash & Bank Balances Capital & Reserves
Cash In Hand 636 686 Equity Share Capital 3,000 3,000
Cash With RBI 800 850 Reserve Fund& Reserves 2,000 1,500
Balance with Other Bank: Balance in Profit &Loss A/c 681 484
On Fixed Deposit 500 550 Deposits & Borrowings
Current Accounts 500 550 Fixed Deposits 12,000 11,000
Money at Call & Short Notice 100 100 Savings Bank Deposits 8,000 7,000
Investments Current Accounts 20,000 19,000
Securities of State Govt 1,000 1,000 Borrowings from Other Banks 1,510 1,202
Securities of State Govt 500 1,550 Other Liabilities
Shares in Listed Companies 1,900 1,950 Bills Payable 500 550
Debenture in Companies 400 400 Rebate on Bills Discounted 400 450
Investments in Gold 100 141 Unclaimed Dividend 54 16
Balances- in both Assets &
Loans & Advances:
Liabilities
Bills For Collection being Bills
Loans, Cash Credit & O/Draft 25,000 21,000 500 600
Receivable
Liabilities for Acceptances,
Bills Discounted &Purchased 14,036 13,156 700 500
Endorsements, other Obligation
Other Assets
Premises Less Depreciation 1,100 1,200
Furniture & Fixtures 373 469
Computer & Net Working 1,200 600
 363

Prepare Balance Sheet of Welcome Bank Ltd as at 31st March 2010 from the above balances

Welcome Bank Ltd

Balance Sheet as at 31st March 2010

Capital & liabilities 2010 2009 Property & Assets 2010 2009
Capital & Reserves Cash & Bank Balances
Equity Share Capital 3,000 3,000 Cash In Hand 636 686
Reserve Fund& Reserves 2,000 1,500 Cash With RBI 800 850
Balance in Profit &Loss A/c 681 484 1,436 1,536
5,681 4,984
Deposits &Borrowings Balance with Other Bank
Fixed Deposits On Fixed Deposit 500 550
Savings Bank Deposits 12,000 11,000 Current Accounts 500 550
Current Accounts 8,000 7,000 Money at Call & Short Notice 100 100
Borrowings from Other Banks 20,000 19,000 1,100 1,200
1,510 1,202 Investments
41,510 38,202 Securities of State Govt 1,000 1,000
Other Liabilities Securities of State Govt 500 1550
Bills Payable 500 550 Shares in Listed Companies 1,900 1,950
Rebate on Bills Discounted 400 450 Debenture in Companies 400 400
Unclaimed Dividend 54 16 Investments in Gold 100 141
954 1016 3,900 5,041
 364

Welcome Bank Ltd

Balance Sheet as at 31st March 2010

Capital & liabilities 2010 2009 Property & Assets 2010 2009
Bills For Collection being Bills
500 600 Loans &Advances
Receivable as per contra
Loans, Cash Credit & O/Draft 25,000 21000
Liabilities for Acceptances,
Endorsements, other Obligation as 700 500 Bills Discounted &Purchased 14,036 13,156
per contra
39,036 34,156
Other Assets
Premises Less Depreciation 1,100 1,200
Furniture & Fixtures 373 469
Computer & Net Working 1,200 600
2,673 2269
Bills For Collection being
600
Bills Receivable; contra 500

Liabilities for Acceptances,

Endorsement contra 700 500
49,345 45,302 49, 345 45,302
 365

[Link] taxation and its accounting treatment in the final

accounts.
[Learning outcome k]
While recording transactions and preparing financial statements, an accountant
has to deal accounting for taxation in the books of accounts of a company.
Therefore it is necessary that you should understand the implication of the same
and necessary accounting treatments or adjustments thereof
With respect to taxation the below mentioned items are explained to show as to
how they will be dealt with in the preparation of the final accounts:
9 Tax Deducted at Source
9 Advance Payment of Tax
9 Income Tax (Corporate Tax)
9 Provisions for Taxation
9 Deferred Tax
11.1 Tax Deducted at Source
In accordance with the provisions of Income Tax Act 1961, it is the duty of the
payer of salary, interest, dividend, etc. to deduct tax at the prescribed rates and
to deposit the tax collected to the credit of Central Government within a
specified time.
When tax is deducted by the company as per the provisions of Income Tax Act,
the following entry is passed:
Salaries/Dividends/Interest A/c Dr XXX
To Bank A/c XXX
To Tax Deducted at Source A/c XXX
(Being Salaries/Dividends/Interest paid)

X Ltd paid interest to the debenture holders of Rs.15,800 after deduction of Tax
at source for Rs.4,200/-. X Ltd is required to pass the following adjustment entry
to show the gross amount of interest paid in the final accounts.

Rs. Rs.
Interest paid A/c Dr 20,000
To Bank A/c 14,200
To Tax Deducted at Source A/c 4,200
Being interest paid after deducting tax at source
 366

Credit balance of Tax Deducted at Source A/c for Rs.4,200 will appear on the
credit side of the Trial Balance and will be shown as a current liability in the
Balance Sheet.

11.2 Advance Payment of Tax

Under Section 207 of the Income Tax Act 1961, the assesse are liable to pay
advance tax when the income exceeds a certain limit and for companies the limit
is Rs. 2,500. When advance tax is paid, following entry is passed;

Advance Payment of Tax A/c Dr XXX

To Bank A/c XXX

In the trial balance it will be shown on the debit side and in the Balance Sheet it
will appear as a current asset.

11.3 Income Tax

This represents the amount of tax payable on the assessed income. As mentioned
earlier, Advance Payment of Tax and Tax Deducted Source Tax are adjusted
deducted from the total tax payable on the assessed income and then the net
amount is paid.

The tax payable on the assessed income of the X Ltd for the financial year is
Rs100,000 while it has already paid tax in advance for Rs70,000 and has had
TDS balance with certificate for Rs10,000/- . Now the company will pay the
balance amount of Rs20000/- for which following entry will be passed

Rs. Rs.
Income Tax A/c Dr 1,00,000
To Advance Payment of Tax A/c 70,000
To Tax Deducted at Source A/c 10,000
To Bank A/c 20,000

Both Advance Payment of Tax A/c and Tax Deducted at Source A/c will appear
in the Balance Sheet under the head ‘Loans & Advances’ till assessment is
completed.
 367

11.4 Provisions for Taxation

As it takes time to get income assessed in consideration of admissibility of all

payments and taxability of all incomes, company is required to provide for tax
liability on the profits at the current rates. After determining the tax liability
based on self-assessment, the company is required to pass the following journal
entry:

Profit and Loss Account Dr XXX

To Provision for Taxation XXX

Provision for taxation appears in the liability side of the balance sheet under the
head “Provisions” in the broad head “Current Liabilities and Provisions”

Advance Payment of Tax and Provision for Taxation

Trial Balance of X Ltd as on 31 March 2009 shows Debit Balance in Advance

Payment of Tax A/c for Rs.2,00,000 and Credit Balance in Provision for
Taxation for Rs.1,30,000 for the year ended 31 March 2008.

You are provided with following information:

9 Advance Payment of Tax A/c for Rs.2,00,000 includes Rs.1,20,000 for 2007-
08
9 Actual Tax Liability for 2007-08 is Rs.1,40,000/-
9 Provisions for Taxation for 2008-09 is to be made for Rs.1,50,000

Required:

You are required to pass necessary journal entries and show relevant Ledger
Accounts Also show as to how these items will appear in the Profit and Loss
Account and the Balance Sheet as 31 March 2009.
 368

Solution

Debit Credit
Date Rs. Rs.
31-03-09 Provisions for Taxation A/c (2007- Dr 1,30,000
08)
Profit & Loss Appropriation A/c Dr 10,000
To Income Tax A/c 1,40,000
(Being tax liability for 2007-08
adjusted against Provisions for
Taxation A/c (2007-08) and tax in
excess of provision debited to Profit
& Loss Appropriation A/c)

31-03-09 Income Tax A/c Dr 1,40,000

To Advance Payment of Tax 1,20,000
A/c
To Tax Payable A/c 20,000
(Being tax liability for 2007-08
adjusted against Advance Payment of
Tax A/c and balance tax payable A/c)

31-03-09 Profit &Loss Loss A/c Dr 1,50,000

To Provisions for Taxation 1,50,000
A/c (2008-09)
(Being provisions for Taxation made
2008-09)

Provisions for Taxation A/c (2007-08)

Rs. Rs.
To Income Tax A/c 1,30,000 By Balance B/D 1,30,000
(2007-08)
1,30,000 1,30,000

Provisions for Taxation A/c (2008-09)

Rs. Rs.
To Balance C/d 1,50,000 By Profit &Loss 1,50,000
Appropriation A/c
1,50,000 1,50,000
 369

Advance Payment of Tax A/c

Rs. Rs.
To Balance b/d 2,00,000 By Income Tax A/c 120,000
By Balance c/d 80,000
2,00,000 2,00,000

Income Tax A/c

Rs. Rs.
To Advance Payment of 1,20,000 By; Provisions for Taxation 1,30,000
Tax A/c A/c (2007-08)

To Tax Payable A/c 20,000 By Profit & Loss 10,000

Appropriation A/c
1,40,000 1,40,000

Tax Payable A/c

Rs. Rs.
To Balance C/d 20,000 By Income Tax A/c 20,000
20,000 20,000

Profit &Loss A/c

Rs. Rs.
To Income Tax A/c 2007-08 10,000 By Net Profit C/d 1,60,000
To Provision for Taxation A/c 1,50,000
(2008- 09)
1,60,000 1,60,000

X Ltd
Balance Sheet as at 31 March 2009

Rs. Rs.
Capital and Liability Assets
Capital XX Fixed Asset XX
Reserves & surplus XX Investments
Current Liabilities & Current Assets Loans &
Provisions Advances
A. Current Liabilities 20,000 Advance Payment of Income 80,000
Tax Payable A/c 2007-08 Tax
B. Provisions for Tax 1,50,000
2008-09
XXX XXX
 370

11.5 Deferred Taxes –Assets and Liabilities

Current Tax

As mentioned earlier after preparation of profit and Loss Account, Tax on profit
is estimated and provided in the profit and loss appropriation account. Generally
provisions for taxation are made on current taxable income. Tax calculated on
taxable income is called ‘Current Tax’. Tax can be also calculated on accounting
income.

Taxable income is the income determined in accordance with the tax laws
(Income Tax Act 1961 and Income Tax Rules), based on which income tax is
payable for a period. Accounting income is different from taxable income.
Accounting income is the net profit for a period as reported in Profit and Loss
Account.

Tax Expenses and Deferred Tax

The difference between tax on accounting income and taxable income is called
‘Deferred tax’. Deferred tax is the effect of timing differences. The tax to be
charged to Profit and loss account is ‘Tax Expenses’ which include Current Tax
plus Deferred Tax. Deferred Tax arising out of timing difference included in the
tax expenses is shown in the Balance Sheet as ‘Deferred Tax Assets or Deferred
Tax Liabilities, as the case may be.
Deferred Tax Assets
A deferred tax asset comes into existence when taxable income is more than
accounting income and this is due to time difference. There could be many
reasons for such difference. One of the major reasons for this mismatch is the
fact that certain expenses may be deducted as per accounting principles and
practice, but they are not considered by tax authorities as deductible or
admissible expenditure. The most common example is Provision for Bad Debt in
Profit & Loss Account showing the accounting income, but such item is not
deductible as per tax laws until and unless it crystallizes. Following example will
clarify the accounting treatment of deferred tax asset.

Accounting income of a company after making provision for bad debt of Rs10-
lacs is Rs90-lacs in 2009-10, while taxable income at the end of the financial
year will be Rs1-crore. Tax authorities will allow Bad Debt as Admissible
Expenses when it will be actually established or crystallized. Tax rate is 35%.
Pass journal entry for provisions for taxation for the year 2009-10.
 371

Solution

9 Accounting Income is Rs. 90-lacs; Tax @35% on Accounting Income is Rs

31,50,000
9 Taxable income is Rs1 crore; Tax @35% on Taxable Income is Rs.
35,00,000.
9 Current Tax is Rs 35,00,000 while Tax Expenses for 2009-10 is
Rs31,50,000.

This difference of Rs 3,50,000 is deferred tax for which following adjustment

entry needs to be passed.
(Amount in Rs.)
Date Particulars Debit Credit
31.3.2010 Profit and Loss A/c 31,50,000
Deferred Tax Asset A/c 3,50,000
To Provision for Taxation A/c 35,00,000

Deferred Tax Liability

Deferred Tax Liability arises when taxable income is less than accounting
income. There could be many reasons for Taxable income to be less than
accounting income. One of the major reasons is depreciation on assets. As per
income tax laws, depreciation is charged on fixed assets on WDV basis, while in
accounts it may be on straight-line method.

In the financial statement of M/S XYZ Ltd. depreciation on fixed assets, which is
charged to Profit & Loss A/c on straight line method is Rs. 10,00,000/- while
depreciation allowed on fixed assets as per tax laws at the specified rate amounts
to is Rs. 12,00,000 in 2009-10. Accounting income is Rs. 20,00,000.
Required:
Pass necessary journal entry assuming tax rate to be 35%.
Solution
9 Accounting income is Rs. 20,00,000 Tax on Accounting income is Rs.
7,00,000.
9 Taxable income is Rs. 18,00,000; and therefore the Current Tax is Rs.
630,000.
9 Thus current tax is Rs. 6,30,000, while tax expense is Rs. 7,00,000.
 372

This time difference of Rs. 70,000/- is Tax liability for future, for which the
following journal entry will be passed
(Amount in Rs.)
Date Particulars Debit Credit
31.03.10 Profit and Loss A/c Dr 7,00,000
To Provision for Taxation A/c 6,30,000
To Deferred Tax Liability A/c 70,000
(Being tax expenses of Rs.7,00,000 with
current tax of Rs.6,30,000 provided for)

Deferred Tax - Situations and treatment

Deferred tax due to time difference originates in the current year and reverses in
the subsequent years with the difference cease to exist. There are many situations
where such time difference arises. Following are the few instances of such
situations or cases:

i) Depreciation accounting

a) Difference in rates of depreciation in financial accounting and tax laws

b) Difference in depreciation methods in financial accounting and tax laws
c) Difference in consideration of costs of asset in financial accounting and tax
laws

ii) Difference in recognition and treatment of expenditure

Certain expenses are debited to Profit & Loss Account on accrual basis, but
allowed by tax authorities for the purpose of computation of tax liability in
subsequent years as and when the expenses are paid. For example Excise duty,
cess, fees etc.

iii) Difference in recognition and treatment of Income

Sometimes incomes are recognized in accounts over the years according to

periodicity of earning and expenditure applying matching principles, but for
taxation purpose, it is considered and recognized in the year of receipt.
Sometimes certain incomes are credited to Profit & loss A/c, but taxed in the
subsequent years
 373

iv) Provisions for contingencies

Provisions for contingencies such as provision for bad debts are debited in the
profit & loss Account, but they are considered admissible as and when
crystallized.

v) Amortization of expenses

Certain expenditure like expenditure on research and development are fully

considered in one year, while in financial accounting it is spread over a period.

When taxable income is more than accounting income it gives rise to

A Deferred tax asset

B Deferred tax liability
C Current tax
D Extraordinary income

[Link] and calculate managerial remuneration in

accordance with the provisions of the Companies Act
1956.
[Learning Outcome l]

12.1 Managerial Remuneration

As per section 309 of the Act, the remuneration payable to the directors shall be
determined –

9 By the Articles of Association or

9 By Ordinary resolution or
9 By special resolution where AoA so require

Calculation of Managerial Remuneration and computation of profits as a base for

calculation of Managerial Remuneration are important aspects in financial
accounting. Schedule XIII contains detailed provision regarding calculation of
managerial remuneration.
 374

Schedule XIII is divided in three parts:

9 Part I deals with ‘Appointments’

9 Part II deals with ‘Remuneration’ and
9 Part III deals with ‘Provisions applicable to Part I and Part II of this
schedule’.

In this Learning Outcome we will discuss calculation of managerial remuneration

and determining net profits for calculation of managerial remuneration.

12.2 Legal provisions for payment of Managerial Remuneration

a) Remuneration not to exceed 11% - As per Section 198 of the Companies

Act 1956, the total remuneration payable to its directors and managers in
respect of any financial year shall not exceed 11% of the net profits.

b) Quantum of remuneration- As per Sch. XIII of the Act such remuneration

shall not exceed 5% of the net profits for a single managerial personnel. If
the company has more than one managerial personnel. Then such
remunerations shall not exceed 10% of the net profits. This limit can be
increased with the approval of Central Government only.

c) Remuneration to non-executive directors – Except with the approval of the

central Government, the remuneration of the non-executive directors shall
not exceed:

d) 1% of the net profits if a company has employed a managing director or a

whole time director or a manager

e) 3% of the net profits, if the company has not employed a managing director
or a whole time director or a manager

f) The aforesaid percentage shall be exclusive of any sitting fees payable to

directors. In other words sitting fees is not considered while computing any
of the limits of managerial remuneration. However if sitting fees is paid to
the whole time director or a managing director, then it will be considered as a
payment of remuneration to directors.

g) The net profits shall be computed in the manner laid down in Section 349 of
the Act.

h) Remuneration shall not be deducted from the gross profits.

 375

i) In case of absence of profits or inadequacy of profits, such remuneration

shall not exceed a ceiling limit of Rs. 24,00,000 per annum or Rs. 2,00,000
per month but within the limits of scale based on the effective capital of the
company as provided in the Schedule XIII of the Act.

Where the effective capital of the Monthly remuneration

Company is payable to each
managerial person shall
not exceed (in Rs.)
A Less than Rs.1 Crore 75,000
B Between Rs.1 Crore and Rs.5 Crore 1,00,000
C Between Rs.5 Crore and Rs.25 Crore 1,25,000
D Between Rs.25 Crore and Rs.50 Crore 1,50,000
E Between Rs.50 Crore and Rs.100 Crore 1,75,000
F Rs.100 Crore or more 2,00,000

Summary of different limits based on Net profits of the company is given

below:

Sr. Managerial personnel % of net

No profit
1 Whole time director or managing director (where there is 5%
one)
2 Whole time director or managing director (where there is 10%
more than one)
3 Manager 5%
4 Non-executive directors
(i) If the company has managing director or a whole time 1%
director or manager
(ii) In other case 3%
5 All managerial personnel’s together 11%

Computation of profits as a base for calculation of Managerial

Remuneration

Net profit for the purpose of calculation of Managerial Remuneration profits

should be computed as per provisions of Section 349 of the Companies Act 1956.
 376

Section 349 requires that in computing the net profits of a company in a financial
year:

i) Credits shall be given for the items specified in sub-section (2) and Credits
shall not be given for the items specified in Sub-section (3)
ii) The sums specified in sub-sec. (4) shall be deducted and those specified in
sub-sec (5) shall not be deducted.

In view of the items as specified in sub-sec (2), (3) (4), (5), profits for the
purpose can be computed in the following manner:

Computation of profit for the puprose of managerial remuneration

under Section 349 of the Companies Act.

(Please note that this is not an exhaustive list)

Sl No. Particulars Amount

(Rs)
Profit before tax as per Profit & Loss account
ADD The following if debited to the Profit & Loss account bef
arriving at the profit before tax
1 Managerial Remuneration
2 Provision for Doubtful Debts
3 Loss on Sale/disposal/discarding of Assets
4 Loss on sale of Investments
5 Write off of Investment
6 Provision for diminution in the value of Investments
7 Unserviceable Fixed Assets Written off
8 Fall in the value of Foreign Currency Monetary Assets
9 Loss on cancellation of Foreign Exchange Contracts
10 Provision for Contingencies and Unascertained Liabilities
11 Provision for loss of Subsidiary Companies
12 Lease Premiums Written off
13 Provisions for Warranty Spares/Supplies
14 Infructuous Project Expenses Written Off
15 Provision for anticipated loss in case of Contracts
16 Loss on sale of Undertaking
17 Provision for Wealth Tax
18 Voluntary Compensation Paid under VRS
 377

Sl No. Particulars Amount

(Rs)
19 Depreciation as provided in the Books
LESS The following if credited to the Profit & Loss account
for arriving at profits before tax
1 Capital Profit on sale/disposal of Fixed Assets
2 Profit on sale of Undertaking/any part thereof
3 Profit on Buy-back of Shares
4 Profit/discount on redemption of Shares or debentures
5 Profit on sale of Investments
6 Compensation received on “Non-Compete” Agreements
7 Write back of Provision for doubtful debts
8 Write back of Provision for doubtful Advances
9 Appreciation in the value of Investments
10 Compensation received on surrender of Tenancy Rights
11 Profit on Sale of Undertaking
12 Consideration received on assignment of Operating License
13 Write back of Provision for contingencies
14 Write off Bad debts against the Provision created earlier.
15 Write back of Provision for diminution in the value of
Investments
16 Excess of Expenditure over Income, i.e Loss of earlier
years computed in accordance with Sec.349.
17 Profit on sale of forfeited Shares
18 Depreciation as provided in the Books of Account
19 Profit on sale of Shares of Subsidiary /Associate
Companies

Besides the above:

a) Certain Extraordinary Items as required under Accounting Standard-5 are

shown after arriving at Profits before Tax. Such items also need to be
considered for arriving at the Profit under Section 349 of the Companies Act.

b) Bounties and Subsidies received from any Government or any Public

Authority constituted or authorised by any Government shall also be added
notwithstanding the fact that they may have been directly credited to Capital
Reserves.
 378

M/S XYZ Manufacturing Co. Ltd with authorized capital of Rs.60,00,000

consisting of 5,00,000 equity shares of Rs.10 and 1,00,000 6% preference shares
of Rs.10 each has prepared following trial balance as 31 March 2010:
Trial Balance as on 31 March 2010
(Amount in Rs.)
Dr Cr
Goodwill & patents 50,000 Equity Share Capital 50,00,000
(Rs10each)
Land & building 33,45,000 Pref. Share Capital (Rs. 5,00,000
100 each)
Plant & machinery 27,24,500 General Reserve 5,00,000
Interim dividend 1,00,000 10% Debentures 7,00,000
Calls in arrear 4,000 Trade payables 4,43,900
Preference dividend 30,000 Depreciation: Land & 74,000
Building
Investment: In quoted 4,08,000 Depreciation: Plant& 4,00,400
Share Machinery
Work-In Progress 2,00,000 Provision for Doubtful 12,700
Debts
Stock 6,74,000 Profit & Loss Account 1,35,000
01/04/2009
Trade Receivables 8,70,000 Provision for taxation 172,000
for 2008-09
Cash in hand 12,000 Sales 52,56,000
Cash at Bank 5,00,000 Income from 28,500
Investments
Preliminary expenses 7,500 Proceeds from reissue of 10,000
shares forfeited due to
calls in arrear
Discount on debenture 16,000
Debenture interest (6 35,000
months)
Works overhead 15.06,500
Direct materials purchased 18,94,800
Direct labour paid 7,11,900
Administrative expenses 71,000
Remuneration Paid to MD 41300
Directors’ Fees 4,000
Loan to Employees 27,000
1,32,32,500 1,32,32,500
 379

Following additional information is provided for preparation of financial

statements of the company for 2009-10:

1. Closing Stock valued on 31 March 2010 - Rs.6,50,000

2. Closing Work in-progress on 31 March 2010 – Rs.7,50,000

3. In 2009-10, land and building was revalued at Rs.40,00,000. New value is to

be taken into financial statement. Depreciation on land and building is to be
provided for Rs. 40,000. Depreciation on plant and machinery is to be
provided for Rs.2,00,000. But Depreciation admissible under section 350 of
the Companies Act is Rs. 2,68,000 on Plant & Machinery and Rs. 60,000 on
land &Building

4. Preliminary expenses and discount are to be written off fully in the current
financial year.

5. Directors declared a final dividend of 4% on equity shares and decided to

transfer to general reserve Rs.1 lakh.

6. Market value of investments are Rs.5,10,000

7. Taxation Liability for 2008-09 has been decided by the Tax Authority as per
Assessment order for Rs.1,70,000 which was paid off on 15 April 2010.

8. Other Provisions to be made for

a) Director Fees Rs.20,000
b) Bad Debt Rs.15,000
c) Debenture Interest to be provided for the balance 6 months
d) Auditors’ Remuneration Rs.15,000
e) Provisions for taxation to be made @35% of the current profit
f) Outstanding Liability Managerial remuneration to be provided for in
accordance with the provisions of Companies Act and the agreement in
this regard.
g) Contingent Liability against a legal action by a customer for defect in the
product causing property damage of Rs.50,000.

You are required to prepare Manufacturing Account and Profit& Loss Account
and the Balance Sheet in the prescribed format (horizontal)
 380

Solution;
M/S XYZ Manufacturing Co. Ltd
Manufacturing and Profit & Loss Account
For the year ended 31st March 2010

Particulars Rs. Particulars Rs.

To Opening Work in-progress 2,00,000 By Closing Work in-progress 7,50,000
To Direct Materials Purchased 18,94,800
By P & L Account: Cost of Goods
To Direct Labour Paid for 7,11,900 37,63,200
produced
To Works overhead 15.06,500
To Depreciation;
Plant & Machinery 200,000
Total 45,13,200 Total 45,13,200

To Stock in Trade 6,74,000 By Sales 52,56,000

To Manufacturing A/c (Cost of Goods
37,63,200 By Closing Stock 6,50,000
produced)
To Administrative Overhead 71,000 By Investment Income 28,500
To Director Fess (4000+20000) 24,000
To Debenture Interest; 70,000
(Paid Rs. 35,000 + OS Rs.35,000)
To Depreciation; Land &Building 40,000
To Provision for Bad Debt 15,000
To Auditors’ Remuneration 15,000
 381

M/S XYZ Manufacturing Co. Ltd

Manufacturing and Profit & Loss Account
For the year ended 31st March 2010

Particulars Rs. Particulars Rs.

To Discount on debentures 16,000
To Preliminary Expenses 7,500
To Managerial Remuneration
Amount Paid Rs.41,300
Add: Outstanding Liability Rs.18,565 (see
59,865
Note 2)

To Net Profit C/D 11,78,935

Total 59,34,500 Total 59,34,500

To Provisions for Taxation 4,12,627 By Balance as per last A/c 1,35,000

To Preference Dividend 30,000 By Net Profit b/d 11,78,935
To Interim Dividend 1,00,000 By Excess of Provision over 2,000
To Proposed Dividend 2,00,000 Tax Liability for 2008-09
To Transfer to General Reserve 1,00,000
To Balance transfer to Balance Sheet 4,73,308
Total 13,15,935 Total 13,15,935
 382

M/S XYZ Manufacturing Co. Ltd

Balance Sheet as at 31st March 2010

Rs. Rs.
Authorized Capital 50,00,000
5,00,000 equity shares of Rs10 each 1,00,000
6% Preference Shares of Rs10 each 10,00,000

Equity and Liabilities

Share Capital 50,00,000
Subscribed &Paid-up capital
5,00,000 equity shares of Rs10 each
6% Preference Shares of Rs10 each 5,00,000
Reserves and Surplus
Capital reserves
- On revaluation 6,55,000
- On reissue of share 6,000
6,61,000
General reserve
- Previous balance 5,00,000
- Current transfer 1,00,000
6,00,000
Profit and Loss 4,73,308 17,34,308
Total shareholders fund 72,34,308

Non-current liabilities
10% Debentures 7,00,000

Current liabilities
Trade payables 4,43,900
Tax liability (08-09) 1,70,000
Debenture interest 35,000
Outstanding Directors’ fees 20,000
Outstanding Directors’ remuneration 18,565
Outstanding audit fees 15,000
Provision for tax (2009-10) 4,12,627
Dividend outstanding 2,00,000 13,15,092
Total Equity and Liabilities 92,49,400
Assets
Non-current asset
Goodwill 50,000
 383

M/S XYZ Manufacturing Co. Ltd

Balance Sheet as at 31st March 2010
Rs. Rs.
Land &Buildings 33,45,000 38,86,000
Add: Revalution 6,55,000
40,00,000
Less: Depreciation
Previous Balance 74,000
Current 40,000
1,14,000
Plant &Machinery 27,24,500 21,24,100
Less: Depreciation
Previous Balance 4,00,400
Current 2,00,000
6,00,400
Quoted Shares in companies 4,08,000
Total non-current assets 64,68,100

Current liabilities
Work in progress 7,50,000
Finished stock 6,50,000
Trade receivables 8,70,000
Less: Prov for Bad debts (27,700) 8,42,300
Balance at Bank 5,00,000
Cash in hand 12,000
Loans to employees 27,000
Total current assets 27,81,300
Total assets 92,49,400

Notes to accounts
Contingent liability- Liability against legal Action by customer due to defect in
product causing damage to property of customer I estimated as Rs.50, 000
Workings:
W1 Computation of Profit for calculation of Managerial Remuneration
Particulars Rs. Rs.
Profit before Tax & Managerial Remuneration 12,38,800
Add:
(i) Depreciation as per P&L A/c (2,00,000 + 2,40,000
40,000)
(ii) Provision for bad debts 15,000
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Particulars Rs. Rs.

(iii) Director fees 24,000
(iv) Preliminary expenses written off 7,500 286,500
15,25,300
Less: Depreciation allowed U/S 350 (3,28,000)
(2,68,000+60,000)
Profit for Managerial Remuneration 11,97,300

Managerial Remuneration 5% of Rs11,97,300 59,865

W2 Provisions for Outstanding Liability

Rs
Managerial Remuneration payable to MD as per agreement 59,865
Less: Amount Already Paid 41,300
Liability to be provided for managerial remuneration 18,565

The total remuneration payable to its directors and managers in respect of any
financial year shall not exceed:

A 11% of the net profits

B 5% of the net profits
C 3% of the net profits
D None of the above

Summary

¾ Form and content of a Balance Sheet and Statement of Profit and Loss is
governed by the provision under Companies Act 1956, Schedule VI
¾ Schedule VI to the Companies Act, 1956 has recently been revised and is
became applicable to all companies for the preparation of financial
statements beginning on or from 1 April 2011.
¾ A company formed and registered under this Act or any existing company
formed and registered under any of the previous company laws specified in
Section 3(i)(ii).
 385

¾ Section 209 of the Companies Act 1956 prescribes the books of accounts to
be maintained by every company at its registered office. The primary
responsibility of maintenance of books of account is that of the Managing
Director or Manager and all officers or other employees who have been
given the responsibility by the Board of Directors.
¾ In case of any default for payment of call money the directors of the
company may, with the express provisions in its articles, proceed to forfeit
such shares with prior notice in this regard.
¾ The balance, if any, left after reissue of forfeited shares in the Share Forfeited
Account, should be treated as capital profit and transferred to Capital
Reserve Account.
¾ Buy-back of shares means repurchase by the company of its own shares.
Buy-back can be done provided conditions mentioned in Sub clause (2) of
Section 77A are adhered.
¾ There are several ways in which employees buy shares through ESOS – they
may purchase shares out of their own funds (known as ESPS) or they borrow
money from the company to purchase shares (known as ESOS)
¾ Issue and redemption of preference shares are governed by Section 80 of the
Companies Act, 1956. Method of redemption of preference shares include: a)
Fresh issue of shares, b) Capitalisation of undistributed profit or c)
Combination of both
¾ Underwriting means undertaking a responsibility or giving a guarantee that
the shares or debentures offered to the public will be subscribed for in full.
The persons or institutions that give such guarantee are called underwriters
¾ A company may decide to distribute past undistributed profit, when there is
large amount of accumulated reserves, by way of issuing shares free of cost
to its existing shareholders. Such shares are called Bonus Shares
¾ Provision for taxation appears in the liability side of the balance sheet under
the head “Provisions” in the broad head “Current Liabilities and Provisions”
¾ The difference between tax on accounting income and taxable income is
called ‘Deferred tax’. Deferred tax is the effect of timing differences.
¾ Schedule XIII contains detailed provision regarding calculation of
managerial remuneration.
 386

Answers to Test Yourself

Answer to TY 1

The correct option is D.

At every annual general meeting the financial statements are presented to the
shareholders by the Board of Directors.

Answer to TY 2

The correct option is C.

A foreign company is one that is incorporated or registered outside India but has
a place of business or operations in India.

Answer to TY 3

The correct option is C.

In case of existing companies, books of account along with relevant vouchers

must be preserved in good order for a minimum period of 8 years.

Answer to TY 4

The correct option is C.

The balance in Share Forfeited Account after the reissue of forfeited shares is
transferred to capital reserve account.

Answer to TY 5
The correct option is A.
According to Sub clause (2) of section 77A, buy-back of shares is equal to or less
than 25% of the total paid up equity share capital and free reserves

Answer to TY 6
The correct option is B.
The accounting value of options granted under an Employee Stock Option Plan
shall be treated as employee compensation in the financial statements.
 387

Answer to TY 7

The correct option is A.

The premium, if payable on redemption, must be provided for out of the

profits of the company or the share premium account.

Answer to TY 8

The correct option is C.

Commitment provided to accept a specified number of shares irrespective of the

number of shares subscribed by the public are known as firm underwriting.

Answer to TY 9

The correct option is D.

Answer to TY 10

The correct option is A.

The form and contents of Balance Sheet and Statement of Profit and loss is for
companies are prescribed by Schedule VI of the Companies Ac.

Answer to TY 11

The correct option is A.

When taxable income is more than accounting income, it gives rise to

Deferred Tax Asset.

Answer to TY 12

The correct option is A.

The total remuneration payable to its directors and managers in respect of

any financial year shall not exceed 11% of the net profit.
 388

Self-Examination Questions

Question 1

The Securities Premium Account is shown under

A Share Capital
B Current liabilities
C Current Assets
D Reserves and Surplus

Question 2

The excess price received over the par value of share, should be credited to:

A Calls-in-advance account
B Share Capital account
C Capital Reserve A/c
D Securities Premium A/c

Question 3

The maximum amount beyond which a company is not allowed to raise

funds by issue of shares is:

A Issued Capital
B Authorised Capital
C Paid Capital
D Subscribed Capital

Question 4

Nominal share capital is:

A that part of the authorised capital which is issued by the company.

B the amount of capital which is actually applied for by the prospective
shareholders.
C the maximum amount of share capital which a company is authorised to
issue.
D the amount actually paid by the shareholders.
 389

Question 5

A public company means a company which:

(i) is not a private company

(ii) has a minimum paid-up capital of 5 lakh rupees or such higher paid-up
capital as may be prescribed
(iii) is a private company which is a subsidiary of a company which is not a
private company

A Only (i)
B (i) and (ii)
C (ii) and (iii)
D (i), (ii) and (iii)

Question 6

If a company has employed a managing director or a whole time director or a

manager, the maximum remuneration payable to non-executive director shall be:

A 1% of the net profit

B 5% of the net profit
C 10% of the net profit
D None of the above

Answers to Self-Examination Questions

Answer to SEQ 1

The correct option is D.

The Securities premium Account is shown under reserves and surplus in the
Balance Sheet.

Answer to SEQ 2

The correct option is D.

The excess price received over the par value of share is referred to as Securities
Premium and should be credited to the Securities Premium Account
 390

Answer to SEQ 3

The correct option is B.

The maximum amount beyond which a company is not allowed to raise funds by
issue of shares is the authorised capital

Answer to SEQ 4

The correct option is C.

Nominal share capital is the maximum amount of share capital which a company
is authorised to issue.

Answer to SEQ 5

The correct option is D.

All the three points are applicable for a public company

Answer to SEQ 6

The correct option is A.

If a company has employed a managing director or a whole time director or a

manager, the maximum remuneration payable to non-executive director shall be
1% of the net profit.