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CMA Inter – Paper 6 Financial Accounting

Your Ultimate Guide for Exam Success

This book perfectly combines precision, clarity, and exam-focused learning,
specially crafted for CMA students preparing Financial Accounting.

It offers a concise yet comprehensive approach, covering all the essential

concepts in a structured, pointwise format for easy understanding, revision,
and retention.

With approximately 200 pages, this book comprehensively covers the entire
syllabus as per the latest ICMAI Study Material (SM), ensuring that no
crucial topic is missed.

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Happy Learning!
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#008080 - Headings
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FINANCIAL ACCOUNTING - INDEX
1 Accounting Fundamentals 1

2 Bills of Exchange 39

3 Consignment 46

4 Joint Venture 56

5 Preparation of Final Accounts of Commercial Organisations 63

6 Preparation of Final Accounts of Not For Profit Organisations 70

7 Preparation of Final Accounts from Incomplete Records 76

8 Partnership Accounting 82

9 Lease Accounting (AS 19) 111

10 Branch (including Foreign Branch) Accounts 125

11 Departmental Accounts 140

147
12 Insurance Claim for Loss of Stock and Loss of Profit

13 Hire Purchase and Installment Sale Transactions 153

14 Introduction to Accounting Standards 159

15 Disclosure of Accounting Policies (AS 1) 162

16 Property, Plant and Equipment (AS 10) 166

17 The Effects of Changes in Foreign Exchange Rate (AS 11) 179

18 Accounting for Government Grants (AS 12) 185

19 Borrowing Costs (AS 16) 189

20 Accounting for Taxes on Income (AS 22) 196

1. ACCOUNTING FUNDAMENTALS
1. Accounting & Accounting Cycle

Content
1. Meaning of Accounting is the art of Recording, Classifying, Summarizing the transactions and
Accounting events which have financial Character, Analyzing, Interpreting and communicating

the result there of.

2. Accounting The Accounting Cycle is the complete process of identifying, recording,

Cycle processing, and reporting an organization's financial transactions during a period,
ending with the preparation of financial statements and closing of accounts.
Bookkeepers are responsible for managing this cycle.

Stages in Accounting Cycle

Drafting Identifying
Financial
Statements Transactions

Closing the Recording in

Books Journal

Drafting Posting to
Adjusted Trial
Balance Ledger

Adjustment Drafting
Unadjusted
Entries Trial Balance

1. Identifying Transactions
Check if an event is a financial transaction to be recorded.
2. Recording in Books of Original Entry
Record the transaction in the Books of Original Entry (Journal).
3. Posting to the Ledger
Post journal entries into the respective ledger accounts.
4. Drafting of Unadjusted Trial Balance
Prepare a Trial Balance to check if debits = credits. (Optional step)

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5. Passing of Adjustment Entries
Make adjusting entries for items like depreciation, outstanding expenses, etc.
6. Drafting of Adjusted Trial Balance
Prepare a new Trial Balance after adjustments.
7. Closing of Books
In this stage of the accounting cycle, the ledger accounts are closed and balanced (“zeroed
out”) at the end of every accounting period.
8. Drafting the Financial Statements
➢ The Income Statement is prepared with the closing balances of the nominal accounts,
while the balances of real & personal accounts get reflected in the Balance Sheet.
➢ Financial statements are prepared in the following order:
Income Statement, Statement of Retained Earnings,
Balance Sheet and Statement of Cash Flows.

2. Events & Transactions

Content
1. Introduction
➢ The primary purpose of financial accounting is to record the transactions entered into
by an organisation during an accounting period. So, transactions are the starting point
of the accounting cycle.
➢ Transactions are created through events, but all events are not transactions.
2. Event
➢ Everything that is happening in every moment of human life is an event. Simply stated,
any happening is an event.
➢ Events can be financial (e.g., buying a book, paying cab fare, receiving a cheque) & non-
financial (e.g., visiting a bookstore, going for a walk).
➢ An event may involve any number of parties, and may be complete and may be incomplete.
3. Transaction
➢ An accounting transaction is an event which has a monetary impact on the financial
position of the organisation.
➢ In order to be considered as a transaction, an event has to satisfy the following
conditions:
a. It must be measurable in terms of money.
b. It must involve at least two parties.
c. It involves a monetary exchange for a goods or service.
d. It must cause a change in the financial position of the entity

Analysis of Transactions
Content
1. ➢ observing the changes in financial position of the organisation caused by the
transactions entered into by it during an accounting period.

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➢ A change in financial position means change in one or more of the five basic elements
of accounting, they being: Assets, Liabilities, Capital/ Equity, Expenses, and Revenue.
S. Transaction Changes in Financial Position Element(s)
No Changed
1. Mr. Suman starts business Cash increases by ₹5,00,000 Asset increase
with ₹5,00,000 cash Capital increases by ₹5,00,000 Capital / Equity
increase
2. Opens bank account with Cash decreases by ₹2,00,000 Asset decrease
₹2,00,000 deposit Bank balance increases by ₹2,00,000 Asset increase
3. Borrows ₹1,20,000 from Bank balance increases by ₹1,20,000 Asset increase
the bank Bank loan increases by ₹1,20,000 Liability increase
4. Purchases equipment for Equipments increase by ₹80,000 Asset increase
₹80,000 for cash Cash decreases by ₹80,000 Asset decrease
5. Purchases goods for Purchases increase by ₹1,00,000 Expense increase
₹1,00,000 for resale out of Cash decreases by ₹60,000 Asset decrease
which 60% was paid in cash, Bank decreases by ₹30,000 Asset decrease
30% by cheque & balance Creditors increase by ₹10,000 Liability increase
was due.
6. Sells goods for ₹1,70,000 in Cash increases by ₹1,70,000 Asset increase
cash Sales increase by ₹1,70,000 Revenue increase
7. Sells goods on credit for Debtors increase by ₹80,000 Asset increase
₹80,000 Sales increase by ₹80,000 Revenue increase
8. Incurs wages of ₹20,000 Wages increase by ₹20,000 Expense increase
Cash decreases by ₹20,000 Asset decrease
9. Interest on bank loan Bank interest increases by ₹3,000 Expense increase
₹3,000 Bank balance decreases by ₹3,000 Asset decrease
10. Collects ₹20,000 from Cash increases by ₹20,000 Asset increase
customer Debtors decrease by ₹20,000 Asset decrease
11. Pays ₹8,000 to supplier Cash decreases by ₹8,000 Asset decrease
Creditors decrease by ₹8,000 Liability decrease
12. Withdraws ₹7,000 for Cash decreases by ₹7,000 Asset decrease
personal use Capital decreases by ₹7,000 Capital/Equity
decrease

3. How to record transactions?

Double Entry System

Content
1. Double Entry System of Bookkeeping is an accounting system where every transaction has
two aspects and both aspects of the transaction are recorded in the books of accounts.
2. It is a fundamental concept in modern accounting and bookkeeping.
3. This system records transactions by classifying them as debit or credit.

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4. A debit in one account always has an equal credit in another account.
5. This system is based on the accounting equation and requires:
a. Every business transaction to be recorded in at least two accounts.
b. The total debits recorded = the total credits recorded.
6. The rules for deciding debit and credit can be explained using two methods:
a. Golden Rules of Accounting (Traditional Approach)
b. Accounting Equation Method (Modern Approach)

Traditional/Golden Rules of Accounting

Personal Account Debit the receiver or who owes to business

Credit the giver or to whom business owes
Real Account Debit what comes into business
Credit what goes out of business
Nominal Account Debit all expenses or losses
Credit all income or gains
Personal Account:
➢ These are accounts related to real people like: Suresh’s A/c, Anil’s A/c, Rani’s A/c &
artificial persons (like organizations), such as: Infosys A/c, Videocon Industries A/c, ABC Bank
A/c, Charitable Trust A/c
➢ Some are representative personal accounts, which represent a group of people
Example: Salary Payable A/c – represents amounts payable to employees (we know the
individuals, but record it collectively).
Real Accounts:
➢ These accounts relate to assets, properties, or possessions.
➢ They are of two types:
✓ Tangible Real Accounts
Assets that you can see and touch (physical existence).
Examples: Cash A/c, Machinery A/c, Stock A/c, Vehicle A/c
✓ Intangible Real Accounts
Assets that cannot be seen or touched, but have value.
Examples: Goodwill A/c, Trademark A/c, Patents A/c, Copyrights A/c
Nominal Account:
➢ These accounts are related to expenses or losses and incomes or gains
Examples: Salary and Wages A/c, Rent of Rates A/c, Travelling Expenses A/c, Commission
received A/c, Loss by fire A/c etc.

Accounting Equation Method

Assets = Liabilities + Equity or,

Assets = Liabilities + [Capital + (Revenue – Expenses) – Drawings]
or, Assets + Expenses + Drawings = Liabilities + Capital + Revenue

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This equation is considered to be the foundation of the double-entry accounting system.
For Assets Increase in Assets Dr.
Decrease in Assets Cr.
For Liabilities Decrease in Liabilities Dr.
Increase in Liabilities Cr.
For Capital Decrease in Capital Dr.
Increase in Capital Cr.
For Incomes Decrease in Income Dr.
Increase in Income Cr.
For Expense Increase in Expense Dr.
Decrease in Expense Cr.
Illustrative Accounting Equation Transactions
Transaction Assets + Expenses + Drawings Liabilities + Capital +
Revenue
1. Cash introduced by Cash (Assets) increases Capital increases
proprietor
2. Purchase of goods in Inventory (Assets) increases; Cash N.A.
cash (Assets) decreases
3. Purchase of goods on Inventory (Assets) increases Creditors/Payables
credit increases
4. Sale of goods in cash Cash (Assets) increases; Inventory N.A.
(Assets) decreases
5. Sale of goods on credit Debtors / Receivables (Assets) N.A.
increases; Inventory (Assets) decreases
6. Salaries paid Salaries (Expense) increases; Cash / N.A.
Bank (Assets) decreases
7. Rent received Cash/Bank (Assets) increases Rent received
(Revenue) increases
8. Goods withdrawn by Inventory (Assets) decreases Capital decreases
proprietor

4. Journal

Meaning
➢ Journal is the book of original entry/Book of Prime Entry or Books of First Entry.
➢ Financial transactions are firstly recorded after their occurrence here.
➢ Transactions are recorded in chronological order.
➢ The word ‘Journal means’ a daily record.
➢ Journal is derived from French word ‘Jour’ which means a day.
➢ The process of recording the transactions in a journal is called ‘Journalizing’.

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➢ Every entry in the book of original entry must be followed by a narration - a short summary
which describes the particular transaction

Example of a Transaction and its Journal Entry

Roy Brothers, on 09.02.2023 goods of Rs. 50,000 were purchased. Cash was paid immediately.
Journal entry
In the books of Roy Brothers
Journal
Dr Cr
Date Particulars Voucher Ledger Folio (Rs) (Rs)
No.
09.02.2023 Purchase A/c 50,000
To Cash A/c 50,000
(Being goods purchased for cash)

Types of Journal Entries

➢ A journal entry can be a Simple journal entry or a Compound journal entry.
➢ Simple journal entry: only two accounts are affected – one account is debited and another
account is credited.
For example: cash sales, credit purchases etc.
➢ Compound journal entry: at least two debits and at least one credit or at least one debit and
two or more credit items are involved.
For example: Cash Received from Debtors with Discount Allowed, Purchase of Assets for Cash
and Cheque etc

Types of Journal
Content
The books of original entry are broadly classified into two categories:
1. Special Journal
2. General Journal

Special Journals and Their Functions

Content
Special Journal Functions
1. Cash Journal or ➢ Recording all transactions which involve cash, whether cash inflows or
Cash Book cash outflows.
➢ Records both capital and revenue transactions involving cash.
➢ Includes date, particulars, voucher number, ledger folio, and amount.
2. Purchase Journal ➢ Used to record credit purchases of goods.
/ Purchase Day

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Book or Purchase ➢ Does not record cash purchases or purchases of long-term assets (like
Book equipment, furniture, machinery etc.).
➢ Includes details such as purchase date, invoice number, amount, and
ledger folio.
➢ All entries in this book are made from the Purchase invoices.
Purchase invoice: a statement issued by the seller to the buyer of goods
Showing the details of the goods like the date of purchase, the quantity,
the rate per unit, the total amount and the terms of payment.
3. Sales ➢ Used to record credit sales of goods.
Journal/Sales ➢ Does not include cash sales or sales of long-term assets (like equipment,
Day Book or furniture, machinery etc.).
Sales Book ➢ Includes date, particulars, outward invoice number, and amount of
sales.
➢ All entries in this book are made from the Sales invoices.
Sales invoice: a statement issued by the seller of goods to the buyer of
goods reflecting the details of the goods like the date of sale, the quantity
of sale, the rate per unit, the total amount and the terms of payment, if
any.
4. Purchase Returns ➢ Used to record returns of goods purchased on credit from suppliers.
Journal/ Returns ➢ Returns arising out of cash purchases of goods, or return of any assets
Outward Day other than merchandising goods on credit does not find place in this
Book day book
➢ Entries include date, items returned, supplier name, and debit note
number.
➢ All entries in this book are made from the debit notes or credit notes.
5. Sales Returns ➢ Used to record returns of goods sold on credit to customers.
Journal/ Sales ➢ Entries include date, items returned, customer name, and credit note
Returns Day number.
Book/ Sales ➢ All entries in this day book are made from the Credit Note issued by
Returns Book. the seller of goods.
6. Bills Receivable ➢ Used to record the bills of exchange received from the customers to
Journal whom goods have been sold on credit.
➢ It records the details like the details of the customer, name of drawer,
name of acceptor, date of receipt of the bill, date of drawing of the
bill, date of acceptance of the bill, tenure of the bill, date of maturity,
ledger folio and the amount of the bill.
➢ All entries in this book are made from the bills of exchanges received
from the customers.
7. Bills Payable ➢ Used to record the bills of exchange issued to the suppliers from whom
Journal goods have been purchased on credit.

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➢ It records the details like the details of the supplier, name of drawer,
name of acceptor, date of issue of the bill, date of drawing of the bill,
date of acceptance of the bill, tenure of the bill, date of maturity,
ledger folio and the amount of the bill.
➢ All entries in this book are made from the bills of exchanges issued to
the suppliers.

General Journal (Journal Proper)

Meaning
➢ Transactions for which no specific day book is maintained are recorded here.
➢ Also known as Journal Proper
Types of Entries Recorded in Journal Proper
Type of Entry Description
1. Opening ➢ Entries made to bring forward the balances from the previous accounting
Entries period for assets, liabilities, and equity accounts.
2. Transfer ➢ Entries through which the amount of an account are transferred to
Entries another account are Transfer entries.
➢ Required when a wrong booking has been made in respect of any account or
to allocate an expense/ revenue from one account to another.
3. Closing ➢ Entries made at the end of the accounting period for closing nominal
Entries accounts (expenses and incomes) to profit determination accounts like
Income Statement or Balance Sheet.
4. Adjustment ➢ Entries passed during finalization to adhere to accounting principles
Entries (accounting concepts and accounting conventions).
5. Rectification ➢ These entries are passed for correcting the different errors that get
Entries committed while recording, posting, casting, balancing etc. in the books of
accounts.
6. Occasional / ➢ It means entries other than above for which no specific subsidiary books
Miscellaneous are maintained.
Entries

Steps in Journalising
1. Determination of Accounts involved in the transaction.
2. Classifying the accounts either as ‘Nominal, Real and Personal’ or into ‘Assets, Liabilities,
Capital, drawings, Expenses and Revenue’.
3. Appling the rules of debit and credit for the identified accounts for identifying which
account is to be debited and which accounts is to be credited.
4. Recording the details of the transaction viz. date, particulars and its narration, and also the
amount to be debited and credited.
5. Writing a brief summary of the transactions (called narration) at the end.

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Functions of the Journal
1. Historical Function:
It contains a chronological record of the transactions for future references.
2. Recording Function:
Recording the transactions based on the principles.
3. Analytical Function:
Each transaction is analysed into the debit aspect and the credit aspect.

Advantages of the Journal

1. Chronological Record
It records transactions as and when it happens. So, it is possible to get detailed day- to-day
information, and also acts as a future reference.
2. Minimising the possibility of errors
The nature of transaction and its effect on the financial position of the business is
determined by recording and analyzing into debit and credit aspect.
3. Narrative explanation of the recorded transactions
It maintains the detailed record of transactions written immediately after passing the
entry, thus provides a highlight of the transaction done.
4. Helps to classify the accounts
Journal is the basis of ledger posting and the ultimate Trial Balance.
5. Evidence in court
Information recorded in the journal which certainly serves as a proof or evidence in the
court of law.

Limitations of the Journal

➢ When a single journal is maintained, it becomes unsuitable for organizations that enter into a
large number of transactions.
➢ It is not a simple system of recording of transactions.
➢ The process of journalising is a time-consuming process.
➢ It does not facilitate internal control, because in journal transactions are recorded in
chronological order.

5. Ledger

Meaning
1. Ledger is the book of account in which transactions are recorded in respective account,
after they have been entered in the journal.
2. It contains various ‘ledger accounts’.
3. Known as the Book of Final Entry.
4. The process of recording the entry in the ledger is technically known as Posting.
5. The transactions are recorded in a chronological order.

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6. It reflects the final position of each account on any particular date.
7. It forms the basis for preparation of Trial Balance.

Ledger account format

Dr Cr
Date Particulars J.F. (Rs) Date Particulars J.F. (Rs)

Functions of Ledger
1. Permanent Storehouse:
All the transactions of a concern arranged for ready reference.
2. Summarization of Transactions:
Summarizes positive and negative changes in accounts, providing the balance at the end of
each period.
3. Business Analysis:
Enables analysis of financial status to plan future actions effectively.

Subdivisions of the Ledger

1. Personal Ledger
➢ Contains personal accounts of all debtors and creditors.
➢ It can be further sub-divided into:
a. Debtors’/Customers’/Sales ledger: Contains accounts of all customers
b. Creditors’ / Suppliers’ / Purchase/Bought ledger: Contains accounts of all the
suppliers.
2. Impersonal/General Ledger
➢ Contains the accounts other than those contained in the ‘Personal Ledger’.
➢ The types of accounts maintained in this ledger are Real, Nominal and Personal (except
Trade Debtors and Trade Creditors).

Advantages
➢ It provides complete and detailed information of all accounts of similar nature in one book.
➢ It discloses the summarised information by getting the ledger accounts balanced.

Ledger Posting
Meaning
When the transaction takes place, it is recorded in the journal in the form of journal entry & this
entry is posted again in the respective ledger accounts under double entry principle from the
journal.

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Debit and Credit Rules
Account Type Debit (Dr.) Credit (Cr.)
1. Assets Increase in assets Decrease in assets
2. Liabilities Decrease in liabilities Increase in liabilities
3. Capital Decrease in capital Increase in capital
4. Expenses Increase in expenses Decrease in expenses
5. Income/Gains Decrease in income Increase in income

Balancing of Ledger Accounts

Step Key Points
1. Definition ➢ Balancing a ledger account involves finding the net effect of all transactions
recorded in an account by totalling both the debit and credit sides.
➢ A debit balance occurs when the debit side total is higher than the credit
side.
➢ A credit balance occurs when the credit side total is higher than the debit
side.
2. Process ➢ Add up the debits and credits in the ledger. The difference is the balance of
the account at that point.
➢ Nil balance occurs when the debit total equals the credit total.
3. Importance ➢ Balancing the accounts allows for the finalization of accounts and the
preparation of the Trial Balance to ensure accuracy.
➢ Balancing is important for finalizing the financial statements and ensuring all
accounts are correctly posted.

6. Cash Book, Bank Book, Bank Reconciliation Statement

A. Cash Book
Content
1. Definition
The book of account that records all cash receipts and cash payments of an organisation is
referred to as cash book.
2. Purpose
➢ An organisation enters into many transactions during an accounting period.
➢ A majority of these involve cash either received or paid.
➢ To record only such transactions, a separate book is maintained.
➢ This book is called the Cash Book and it records only cash-related transactions.
➢ Cash transactions may be in the form of liquid cash, cheques, or online transfers.

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Features of Cash Book
Content
➢ only cash transactions are recorded
➢ All receipts of cash and payments involving cash are recoded in this book of account.
➢ Transactions are recorded in this book in chronological order
➢ The proforma of the cash book is similar to that of a ledger account i.e. having two sides –
Debit side and Credit side.
➢ It is a book of account which is a book of primary entry as-well-as a book of final entry. So, it
is referred to as journalized ledger.
➢ Its balance reflects the balance of cash available.

Types of Cash Book

Content
1. Introduction
➢ For the purpose of recording cash and bank related transactions at one place cash
book is maintained.
➢ These cash books can be broadly classified into two categories
a. Regular Cash Book and
b. Petty Cash Book.
2. Regular Cash Book/Cash Book
➢ The cash book which records all cash and sometimes bank related transactions of an
entity.
➢ Based on the number of amount columns maintained on each side of the cash book they
are classified as.
a. Single Column Cash Book
b. Double Column Cash Book
c. Triple Column Cash Book
d. Multi-Columnar Cash Book
3. Single Column Cash Book
➢ only one amount column is maintained on each side to record transactions involving
liquid cash.
➢ Usually maintained by the small organisations which do not have any bank account.
➢ The balance of this cash book represents cash-in-hand at a particular point of time.
Proforma Cash Book (Single Column)
Dr Cr
Date Particulars L.F. Cash (Rs) Date Particulars L.F. Cash (Rs)

4. Double Column Cash Book

➢ A cash book with two columns: one for cash transactions and one for bank transactions
(instead of opening a separate bank account in the ledger).

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➢ Reflects both cash-in-hand and cash-at-bank at a particular point of time.
➢ Contra Entry:
a. When a transaction involves both Bank A/c and Cash A/c, it is recorded on both
sides of the Double Column Cash Book.
Examples: Cash deposited into bank, Cash withdrawn from bank
b. The letter ‘C’ is written in the Ledger Folio (L.F.) column on both sides to indicate
a contra entry.
Proforma Cash Book (Double Column)
Dr Cr
Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank
(Rs) (Rs) (Rs) (Rs)

5. Triple Column Cash Book

➢ A cash book with Three columns each side: Cash, Bank and Discount columns
➢ The discount column
Debit side represent Discount Allowed &
Credit side represent Discount Received.
➢ There are two types of discounts:
• Trade Discount
• Cash Discount
➢ Trade Discount:
• Given by seller to buyer for bulk purchases.
• Not recorded in the books of account.
➢ Cash Discount:
• Given to encourage prompt payment.
• Recorded in the discount columns of the Triple Column Cash Book.
➢ The discount columns are not balanced; rather they are transferred to the respective
discount accounts in general ledger.
Proforma Cash Book (Triple Column)
Dr. Cr
Date Particulars L.F. Cash Bank Dis Date Particulars L.F. Cash Bank Dis
(Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

6. Multi-Columnar Cash Book

➢ A customized cash book used by businesses with huge cash transactions take place
under certain fixed heads
➢ Used by businesses like clubs, schools, colleges etc.

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Proforma Multi-columnar Cash Book
Dr. Cr.
Date Particulars Subscription Interest Date Particulars Salaries Rent &
received & wages taxes

Petty Cash Book

1. Petty Cash Book
➢ In organisations with numerous cash transactions, it's difficult for one person to handle
all cash and bank entries.
➢ To manage this, cash handling is split into two groups.
➢ Petty Cashier – manages small, frequent cash expenses.
➢ Principal/Chief Cashier – handles all other major transactions.
➢ This leads to the use of a special book called the Petty Cash Book.
➢ It records only low-value, frequent cash transactions.
➢ It helps in reducing the burden on the main cashier and ensures better control over
small expenditures.
➢ Petty cash is given using either the Ordinary System or the Imprest System.
2. Ordinary System
➢ A pre-decided lump sum is given by the Chief Cashier to the Petty Cashier.
➢ The Petty Cashier uses this to meet small day-to-day expenses.
➢ After spending the entire amount, the Petty Cashier:
▪ Submits a summary of expenses.
▪ Requests reimbursement from the Chief Cashier.
3. Imprest System
➢ Imprest System involves estimating petty expenses for a set period in advance.
➢ The estimated amount is called Imprest Cash or Imprest Float.
➢ This amount is advanced by the Chief Cashier to the Petty Cashier.
➢ The Petty Cashier uses it to meet small, recurring expenses during the period.
➢ At the end of the period, the Petty Cashier:
▪ Prepares a Statement of Petty Expenses.
▪ Submits it to the Chief Cashier.
➢ The Chief Cashier reimburses the exact amount spent, restoring the imprest amount.
Thus, at the start of every period, the same imprest balance is maintained.
➢ The petty cash book is:
▪ Usually in Single Column format.
▪ In some organisations, a multi-column format is used with predefined expense heads
on the credit side.

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B. Bank Book
Meaning
➢ A Bank Book (or Bank Journal) records all bank-related receipts and payments.
➢ It is maintained separately instead of using a bank column in the Cash Book.
➢ Large organisations prefer it due to the high volume of bank transactions.
➢ To reduce errors or missed entries, separate Bank Books can be kept for each bank account.
➢ The format is similar to a Single Column Cash Book:
Debit side → Bank Receipts
Credit side → Bank Payments
➢ Helps in easy and accurate Bank Reconciliation.
➢ The Bank Book is different from a Pass Book or Bank Statement, which are issued by the
bank and show the bank’s view of the client’s account.

Bank Reconciliation Statement

1. Purpose
➢ Ideally, the Cash Book (Bank Column) and Pass Book should show the same balance.
➢ However, in practice, differences often arise due to certain reasons (like timing
differences, unrecorded transactions, etc.).
➢ To identify and explain these differences, a Bank Reconciliation Statement (BRS) is
prepared.
➢ BRS helps in matching the balances as per the organisation's books and the bank's
records.
2. Key Features of BRS
➢ Not a part of the formal books of accounts.
➢ Prepared at regular intervals to verify accuracy of the Cash Book (Bank Column) and
Pass Book.
➢ Does not rectify any errors in the books — it only helps in identifying the causes of
differences.
➢ The main objective is to reconcile the discrepancies between the two books as on a
specific date.
3. Reason for Disagreement Between Cash Book and Pass Book
The differences mainly arise due to timing or communication gaps between entries made by
the organisation and the bank.
Common causes include:
a. Cheque issued but not yet presented for payment.
b. Cheque deposited but not yet collected/cleared by the bank.
c. Amount directly deposited into the bank account by third parties.
d. Bank charges, incidental fees, or interest on overdraft debited by the bank.
e. Interest credited by the bank on deposits.
f. Dishonour of cheques deposited.

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g. Clerical errors by the organisation or the bank.
h. Payments made by the bank as per standing instructions (e.g., EMI, insurance, rent).
Note: It is worth mentioning at this point that in this technologically advanced era many of
the abovementioned causes of disagreement has been done away with the emergence of
digital transactions.

Methods for Preparing Bank Reconciliation Statement

1. Without Amended Cash Book Method
➢ Start with either:
▪ Cash Book (Bank Column) balance, or
▪ Pass Book balance.
➢ Identify the reasons for difference between the two balances.
➢ Adjust each item causing disagreement by:
▪ Adding or
▪ Subtracting, as applicable.
➢ After adjusting all items, the resulting figure should be the balance as per the other
book.
➢ This process helps in ensuring both Cash Book and Pass Book balances are reconciled.
2. Amended Cash Book Method
➢ First, prepare an Amended Cash Book to find the corrected bank balance.
➢ Include the following in the amended cash book:
• Items already recorded in the Pass Book but not yet entered in the Cash Book.
• Errors made in the original Cash Book.
➢ Do not include:
• Errors made by the bank – these are shown only in the BRS.
➢ After preparing the Amended Cash Book:
• Use the corrected balance to prepare the BRS.
• Adjust for any remaining differences, mainly due to bank errors or timing
differences.
➢ This method ensures the Cash Book balance is accurate before reconciling it with the
Pass Book balance.

7. Trial Balance (Preparation and Scrutiny)

Content
➢ A Trial Balance is a statement prepared using ledger balances to check the arithmetical
accuracy of accounts.
➢ Its primary purpose is to ensure no mathematical errors exist in ledger posting.
➢ With the advent of computerised accounting, the need for manual trial balance preparation
has reduced significantly.
➢ It is a columnar statement with the following columns:
Serial Number

Page | 16
Name of Ledger Account
Ledger Folio (L.F.)
Debit Amount
Credit Amount
➢ If the accounting is correct and complete, the Debit and Credit columns should tally.

Trial Balance Proforma

Sl. No. Ledger Accounts L.F. Dr. Cr.
(Rs.) (Rs.)

Features of Trial Balance

➢ It is a statement, not an account.
➢ Not a part of the double-entry system.
➢ Does not appear in the formal books of accounts – prepared as a separate document.
➢ Prepared as on a particular date, not for a period.
➢ Can be prepared monthly, quarterly, half-yearly, or annually.
▪ Mandatory at the end of the accounting year before final accounts.
➢ If books are arithmetically accurate, total debit balances = total credit balances.
➢ Agreement of the Trial Balance is only a prima facie evidence,
▪ It does not guarantee complete accuracy of the books.

Advantages of a Trial Balance

➢ Checks accuracy of ledger posting – ensures both debit and credit aspects of transactions are
recorded.
➢ Confirms that amounts are arithmetically correct in the ledger.
➢ Summarises ledger balances, making it easier to prepare financial statements.
➢ Acts as a link between ledger accounts and financial statements.

Limitations of a Trial Balance

➢ Applicable only under the Double Entry System – cannot be used by entities not following this
system (e.g., small businesses).
➢ Agreement of trial balance is not conclusive proof of accuracy – it only gives prima facie
assurance.
➢ Certain errors remain undetected.

Errors Not Identified by Trial Balance

1. Error of Omission or Duplication
A transaction is completely omitted or recorded twice in the original book.
2. Error of Commission

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➢ Correct account is used, but wrong amount is posted, or
➢ Wrong account is used within the same category (e.g., personal accounts).
3. Error of Principle
Transaction is recorded against accounting principles,
e.g., Capital purchase recorded as Revenue expense.
4. Error of Original Entry
Wrong amount entered in the subsidiary book itself.
5. Compensating Errors
Two or more independent errors cancel each other, making the trial balance appear correct.

Methods of Preparing Trial Balance

1. Total Method
➢ Debit and credit totals of each ledger account are taken.
➢ Both totals are shown in the respective columns of the Trial Balance.
➢ Can be prepared without balancing the ledger accounts.
2. Balance Method
➢ Prepared only after balancing each ledger account.
➢ Only the net balance (debit or credit) of each account is shown in the Trial Balance.
➢ This is the most commonly used method.

8. Adjustments and Rectifications

A. Depreciation and Amortisation

Concept
➢ Fixed Assets are bought for long-term use in business.
➢ Over time, their value declines due to:
▪ Wear and tear
▪ Passage of time
▪ Obsolescence, etc.
➢ This gradual reduction in value is called Depreciation.
➢ Depreciation represents the expired cost of a tangible fixed asset during a period.
➢ Its purpose is to allocate the cost of the asset over its useful life.
➢ Depreciation is charged on all tangible fixed assets except freehold land,
▪ Because land has an unlimited useful life and does not wear out.

Characteristics of Depreciation
➢ It is a reduction in the book value of fixed assets (except freehold land).
➢ The reduction is permanent, gradual, and ongoing in nature.
➢ Depreciation is a continuous annual process, caused by:
Usage, or
Passage of time.

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➢ It usually occurs gradually, unless accelerated by rapid wear, damage, or technological
obsolescence.

Depreciation, Amortisation, and Depletion

Depreciation
➢ Refers to wearing out, consumption, or loss of value of a tangible asset.
➢ Caused by usage, passage of time, or obsolescence (technological or market-based).
➢ It is the systematic allocation of the cost of a tangible fixed asset over its useful life.
➢ Charged on tangible fixed assets (e.g., machinery, furniture).
➢ Not applicable to freehold land, as it has an infinite life.
Amortisation
➢ Refers to systematic writing-off of the cost of intangible assets over their useful life.
➢ Applied to assets like patents, copyrights, trademarks, goodwill.
➢ Similar to depreciation, but used for intangible (non-physical) assets.
Depletion
➢ Refers to the reduction in value of natural resources (wasting assets).
➢ Occurs due to extraction of resources like coal, oil, minerals.
Example: Coal mined from a coal field reduces the total available coal, thus representing
depletion.

Methods of Recording Depreciation

Content
There are two alternative methods of recording depreciation.
1. When depreciation is charged to the Asset Account; &
2. When Provision for Depreciation/Accumulated Depreciation Account is opened.
1. When Depreciation is charged against asset
➢ Under this method, the amount of depreciation is credited to the concerned Asset
Account.
➢ Depreciation Account, being a nominal account, is transferred to the Profit and Loss
Account at the end of every accounting period.
➢ In the Balance Sheet, asset is shown at its written down value (i.e., cost less
depreciation provided till date).
Journal entries:
➢ Depreciation A/c Dr
To Asset A/c.
(Being the depreciation on asset charged)
➢ Profit and Loss A/c Dr
To Depreciation A/c
(Being the depreciation transferred to Profit and Loss A/c)
2. Provision for Depreciation

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➢ Under this method, depreciation is not credited to the Asset Account but is credited
to Provision for Depreciation Account or Accumulated Depreciation Account.
➢ As a result, Asset Account continues to be shown at its cost.
➢ The balance of Provision for Depreciation/ Accumulated Depreciation Account shows
total depreciation till date (year after year).
➢ In the Balance Sheet, asset is shown at Cost less Provision for Depreciation.
Journal entries:
➢ Depreciation A/c
To Provision for Depreciation A/c
(Being the depreciation on asset charged)
➢ Profit and Loss A/c
To Depreciation A/c Dr. Dr.
(Being the depreciation transferred to Profit and Loss Account)
➢ For sale of assets
Cash/Bank A/c Dr
Provision for depreciation A/C Dr
To Asset A/c
Or if sale of Asset A/C is opened:
a. When asset Sold
Asset Disposal A/c Dr.
To Asset A/c (original cost)
b. Cash Realised on sale of Asset
Cash/Bank/ Debtor A/c Dr.
Provision for depreciation A/C Dr.
P/L Account Dr (in case of loss)
To Asset Sales A/c
To P/L Account (in case of profit)

Methods of Calculating Depreciation

1. Straight Line Method/ Fixed Installment Method
➢ A fixed portion of the cost of a fixed asset is allocated and charged as periodic
depreciation.
➢ Depreciation becomes an equal amount in each period.
➢ Depreciation = (V - S) / n
Where:
V = Cost of the asset
S = Residual value
n = Useful life of asset
2. Reducing Balance Method/ Diminishing Balance Method/ Written Down Value Method
➢ Depreciation is charged at a fixed rate.
➢ In first year, it is on original cost.

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➢ In subsequent years, it is on book value (WDV).
➢ Thus, amount reduces year after year.
➢ Under this method, Depreciation p.a. is calculated as under:
For newly acquired Fixed Asset = Original Cost × Rate of Depreciation
For existing Fixed Asset = Opening WDV × Rate of Depreciation
3. Sum of Years' Digit Method
➢ Depreciation is based on the sum of the asset's useful life years.
➢ The depreciation expense is higher in earlier years and decreases in later years.
➢ Depreciation = (n - 1) / Sum of Years Digit * (Cost - Residual Value)
4. Sinking Fund Method
➢ A fund is created by setting aside a fixed amount periodically to cover the cost of asset
replacement or repairs.
➢ Amount deposited periodically accumulates for future replacement.
5. Annuity Method
➢ Depreciation is calculated based on a fixed annual amount using the annuity concept,
considering interest and depreciation.
➢ Regular annual payments over the asset's useful life.
6. Insurance Policy Method
➢ An insurance policy is taken out to cover depreciation and loss, with premiums paid over
the asset's useful life.
➢ Premiums accumulate over the asset's life to compensate for depreciation.

Profit or Loss on Sale of Assets

Content
When No Provision for Depreciation Account is Maintained
Transaction Journal Entry
1. Transfer WDV of asset-to- Asset Disposal A/c Dr.
Asset Disposal Account To Asset A/c
2. Sale of the Asset Cash/Bank A/c Dr.
To Asset Disposal A/c
3. Depreciation (if any) Depreciation (P & L A/c) Dr.
To Asset Disposal A/c
4. Profit on Sale of Asset Asset Disposal A/c Dr.
To Profit & Loss A/c
5. Loss on Sale of Asset Profit & Loss A/c Dr.
To Asset Disposal A/c
Alternative Approach Adjustments through the Asset Account
Step Journal Entry
1. Sale of the Asset Cash/Bank A/c Dr.
To Assets A/c

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2. Depreciation Adjustment Depreciation (Profit & Loss A/c) Dr.
To Assets A/c
3. Profit on Sale Assets A/c Dr.
To Profit & Loss A/c
4. Loss on Sale Profit & Loss A/c Dr.
To Assets A/c

Change of Depreciation Method

Content
1. Basis of Selection
Depreciation method should reflect the pattern in which the future economic benefits of
the asset are expected to be consumed by the enterprise.
2. Annual Review
The method should be reviewed at least once every year-end.
3. Change in Depreciation Method
➢ If there’s a significant change in expected usage pattern, the method must be revised
accordingly.
➢ Such change is treated as a change in accounting estimate (as per AS 5), not a change in
policy.
4. Consistency
Once selected, the method should be consistently applied year after year.
5. Prospective Change
Any change should be done prospectively (going forward), not retrospectively.

B. Adjustment Entries
Concept
1. Purpose
Adjustment entries are passed to correct ledger balances so that they reflect the true
financial position of the organisation.
2. Timing
They are made at the end of the accounting period before preparing final accounts.
3. Reason for Adjustment
Some transactions are not yet recorded or incompletely recorded during the year — these
entries update the books.
4. Effect
They impact both the Income Statement and the Balance Sheet.
5. Basis
These entries are passed without source documents (like invoices or bills); they are based
on the need for correct matching and accrual.
6. Importance in Accounting Cycle

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Adjustments are an essential part of the accounting cycle and must be built into the system.
7. Next Step
Once all adjustment entries are passed, an Adjusted Trial Balance is prepared to generate
final financial statements.

Features of Adjustment Entries

➢ These are a special type of journal entries.
➢ These entries are recorded on the General Journal/ Journal Proper.
➢ They are passed to reflect the reality.
➢ These entries are passed to comply with the accounting principles.
➢ Adjustment entries are passed at the end of an accounting period.

Classification of Adjustment Entries

1. Pre-payments and Pre-receipts
Prepaid Expenses: Amounts paid in advance for services not yet received.
Example: Prepaid Insurance.
Unearned Revenues: Money received in advance for services not yet rendered.
Example: Subscription received in advance by a club.
2. Accruals
Accrued Expenses (Outstanding Expenses): Expenses incurred but not yet paid or recorded.
Example: Outstanding electricity bill as on 31.03.2022.
Accrued Incomes: Incomes earned but not yet received or recorded.
Example: Interest earned but not received.
3. Non-cash Expenses (Estimates)
Expenses that do not involve actual cash outflow at the time of recording, but are estimated
and provided.
Examples:
• Depreciation
• Provision for doubtful debts
• Amortisation

Adjustment Entries
Adjustment Type Adjustment Entry
1. Closing Stock Stock-in-trade A/c Dr.
To Purchases/Trading A/c
2. Goods Withdrawn by Owner Drawing A/c Dr.
To Purchases A/c
3. Goods Distributed as Free Samples Advertisement A/c Dr.
To Purchases A/c

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4. Goods distributed as free samples to Wages/Salaries A/c Dr.
employees To Purchases A/c
5. Goods-in-transit Goods-in-transit A/c Dr.
To Purchases/ Trading A/c
6. Abnormal loss of stock Abnormal Loss A/c Dr.
To Purchase/ Trading A/c
7. Stock used as stationary Stationery A/c Dr.
To Purchases/ Stock A/c
8. Materials used for constructing Fixed Fixed Assets A/c Dr.
Assets To Purchases/ Stock A/c
9. Goods sent on approval basis, pending Sales A/c Dr.
approval on Balance Sheet date To Sale or Return Suspense A/c
Stock on Sale or Return A/c Dr.
To Trading A/c
10. Outstanding Expenses Expenses A/c Dr.
To Outstanding Expenses A/c
11. Prepaid Expenses Prepaid Expenses A/c Dr.
To Expenses A/c
12. Pre-received Income Income A/c Dr.
To Pre-received Income A/c
13. Accrued Incomes Accrued Income A/c Dr.
To Income A/c
14. Depreciation on Fixed Assets Depreciation/Amortisation A/c Dr.
To Fixed Assets A/c
15. Provision for Bad Debts P/L A/c Dr.
To Provision for Bad Debts A/c
16. Provision for Discount on Debtors P/L A/c Dr.
To Provision for Discount on Debtors A/c
17. Mutual Set-off (Debtors & Creditors) Creditors A/c Dr.
To Debtors A/c

C. Accounting Treatment of Bad Debts, Provision for Doubtful Debts, Provision for Discount on
Debtors & Creditors
Classification of Debts
Content
Meaning of Debt & ➢ The amount which is receivable from a person or a concern for supplying
Debtors goods or services is called Debt.
➢ Debtors refer to those entities who take the benefit of delayed payment.
➢ On the basis of the chances of collection from the debtors, debts may
be classified into the following three categories:

Page | 24
a. Good debts,
b. Doubtful debts &
c. Bad debts.
Good Debts ➢ Amounts fully recoverable with no doubts.
➢ No provision needed.
➢ Normal business receivables.
Doubtful Debts ➢ Collection is uncertain as on the date of final accounts.
➢ Not written off immediately.
➢ Provision made (based on past experience) to match revenue and expense.
➢ Follows matching principle.
Bad Debts ➢ Amounts that are definitely irrecoverable.
➢ Treated as business loss.
➢ Journal Entry:
Bad Debts A/c Dr.
To Debtors A/c
➢ Bad Debts A/c is a Nominal Account (represents loss).
➢ Transferred to P&L A/c at year-end or Adjusted through Provision for
Doubtful Debts A/c, if provision exists.

Journal Entries for Bad Debts and Provision for Doubtful Debts
Scenario Journal Entry
1. For Bad Debts (in the 1st year) Bad Debts A/c Dr.
To Sundry Debtors A/c
2. For Creating Provision for Doubtful Profit and Loss A/c Dr.
Debts (in the 1st year) To Provision for Doubtful Debts A/c
3. Transferring Bad Debts to Profit & Profit and Loss A/c Dr.
Loss (in the 1st year) To Bad Debts A/c
4. Bad Debts (in 2nd/ Subsequent Bad Debts A/c Dr.
years) To Sundry Debtors A/c
5. For Adjusting Provision for Doubtful If Closing Provision is greater than Opening Provision:
Debts (in 2nd/ Subsequent years) Profit and Loss A/c Dr.
To Provision for Doubtful Debts A/c
If Closing Provision is less than Opening Provision:
Provision for Doubtful Debts A/c Dr.
To Profit and Loss A/c

Provision for Discount on Debtors

Content
1. Meaning
Suppliers allow cash discount for prompt payment by customers.

Page | 25
2. Purpose
➢ A provision is created to cover expected loss due to such discounts.
➢ Provision for Discount on Debtors is made on Sundry Debtors to account for likely
discounts during the accounting period.
3. Reason for Provision
➢ Customers may claim discounts for early payment of dues.
➢ Hence, a provision is created to cover the expected loss from such discounts.
4. Estimation Basis
Provision is made at an estimated rate based on:
• Past experience, and
• Closing balance of Sundry Debtors.
5. Computation
Gross Debtors xxxx
Less: Bad Debts xxxx
Less: Provision for Doubtful Debts xxxx
Good Debtors xxxx
Discount Rate %
Provision for Discount on Debtors xxxx

Accounting for Provision for Discount on Debtors

Scenario Journal Entry
For the First Year
1. Discount Allowed Discount Allowed A/c Dr.
To Sundry Debtors A/c
2. Transfer Discount Allowed to P&L Profit and Loss A/c Dr.
To Discount Allowed A/c
3. Provision for Discount on Debtors Profit and Loss A/c Dr.
To Provision for Dis on Debtors A/c
For the Second/ Subsequent Years
4. Discount Allowed Discount Allowed A/c Dr.
To Sundry Debtors A/c
5. Provision for Discount on Debtors Provision for Discount on Debtors A/c Dr.
To Discount Allowed A/c
6. Next Year Provision Estimate i. If New Provision is More than Old Provision:
Profit and Loss A/c Dr.
To Provision for Discount on Debtors A/c
ii. If New Provision is Less than Old Provision:
Provision for Discount on Debtors A/c Dr.
To Profit and Loss A/c

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Recovery of Bad Debts
Meaning
1. If the amount is recovered in a later year, it becomes an income in that year.
2. Bad debts are previously written off as loss and debited to Profit & Loss A/c.
Journal Entries for Recovery of Bad Debts
a) When Bad Debts are Recovered
Cash/Bank A/c Dr.
To Bad Debts Recovery A/c
b) When Transferred to Profit & Loss
Bad Debts Recovery A/c Dr.
To Profit & Loss A/c

Provision for Discount on Creditors

Content
1. What is Provision for Discount on Creditors?
When a business purchases goods on credit, and the supplier offers a discount for early
payment, a provision is created for this anticipated discount.
2. Why is it Created?
➢ It is created to account for discounts that might be received from creditors for early
payment.
➢ This ensures that the anticipated income is accounted for in the books.
3. How is it Reflected?
The Provision for Discount on Creditors is reflected on the liabilities side of the Balance
Sheet, deducted from the creditors balance.

Accounting Treatment for Provision for Discount on Creditors

Scenario Journal Entry
Creating Provision for Discount on Provision for Discount Received A/c Dr.
Creditors To Profit & Loss A/c
Creation and maintenance of provision on creditors is a violation to the conservatism convention
or the doctrine of prudence.

D. Rectification Entries
Content
1. Meaning of Rectification Entries
➢ Entries passed to correct accounting errors or mistakes.
➢ Also called Correction Entries.
➢ Recorded in Journal Proper.
2. Trial Balance Difference
When T.B. doesn't tally due to one-sided errors, the difference is posted to Suspense A/c
temporarily.

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3. Suspense A/c uses
➢ Only for one-sided errors (i.e., only one account affected)
➢ Example:
If Sales Book total is wrong, but individual customer accounts are correct:
▪ Only Sales A/c is over/under credited.
▪ Causes imbalance in T.B.
➢ In such cases the rectification entry will be passed through Suspense A/c.
➢ Once Error is Located:
▪ One part of the correction goes to correct account.
▪ Other part to Suspense A/c (for one-sided errors).
➢ For Two-Sided Errors:
▪ No Suspense A/c used.
▪ Entry passed by debiting correct A/c and crediting wrong A/c, or vice versa.

Types of Errors and Their Rectification

Content
Type of Error Description Rectification Method
1. Error of Entering revenue expense as capital A journal entry is passed to give
Principle expense or vice versa or entering correct effect.
revenue receipt as capital receipt or
vice versa.
2. Error of Transaction forgotten to be entered Simply, the correct entry is
Omission in books of accounts. passed.
3. Error of Entering to wrong head of account. Debit or credit wrong A/c head
Commission and post it to correct head.
4. Compensating More than one error that could Pass correcting entry
Errors compensate effect of each other.
5. Wrong Totalling Wrong totalling of subsidiary books As it affects T.B., pass through
Suspense A/c
6. Posting on Debited instead of credit or vice Pass an entry with double effect –
Wrong Side versa. one to cancel wrong side and other
to give effect on correct side
7. Posting of Amount posted differs from actual Pass entry with differential
Wrong Amount figure. amount

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Rectification of errors

Before After After

preparing preparing preparing
trial balance trial balance Final accounts

Double sided Single sided Double sided Single sided Double sided Single sided
errors errors errors errors errors errors

Errors Before and After Preparation of Trial Balance

Content
Stage Error Type Action Example Journal Entry
1. Before Double Sided 1. Identify the correct Purchased a Correct Entry:
Preparation Error entry. Building for Building A/c Dr. ₹3,00,000
of Trial 2. Identify the wrong ₹3,00,000, but To Cash A/c ₹3,00,000
Balance entry. wrongly posted Wrong Entry:
3. Rectifying Entry the to Purchase Purchase A/c Dr. ₹3,00,000
error by passing a Account. To Cash A/c ₹3,00,000
correcting entry. Rectifying Entry:
Building A/c Dr. ₹3,00,000
To Purchase A/c ₹3,00,000
Single Sided If the error is one-sided, no Purchase Correct Entry:
Error separate entry is needed. Account purchase account should be
Just rectify the account overcast by credited by ₹ 10,000.
affected by posting the ₹10,000.
correct entry.
2. After Double Sided Same as Before Trial - -
Preparation Error Balance.
of Trial Single Sided For one-sided errors, rectify Sales Day Book Sales A/c Dr. ₹1,000
Balance Error using Suspense A/c. was overcast To Suspense A/c ₹1,000
by ₹ 1,000.
3. After Double Sided ➢ Same as before Purchase a If after Trial Balance
Preparation Error preparation of Trial Plant wrongly Plant A/c Dr. ₹10,000
of Final Balance or after debited to To Purchase A/c ₹10,000
Accounts preparation of Trail Purchase
Balance. But all the Account for ₹ If after Final Account
nominal accounts are to 10,000 Plant A/c Dr. ₹10,000
be replaced by Profit To Profit and Loss Adjustment
and Loss Adjustment A/c ₹10,000
Account. And the rest
one will be same as
stated earlier.
➢ Suspense Account will
be carried forward to
the next year; and

Page | 29
➢ Real and Personal
Accounts are to be
carried forward to the
next year.
Single Sided Same principle is to be Discount If after Trial Balance
Error followed like after allowed was not Discount Allowed A/c Dr.
preparation of Trial Balance posted to To Suspense A/c
and all the nominal account discount
are to be preplaced by Profit Account. If after Final Account
and Loss Adjustment Profit and Loss Adjustment A/c Dr.
Account. To Suspense A/c

Error of Principle Trial Balance

Compensating Trial balance will

Error tally

Error
Complete Trial balance will
Ommission tally
Error of
Ommission
Trial balance will
Partial Omission
not tally

Clerical Error
Writing wrong
Trial balance will
amount in the
tally
subsidiary book

Wrong casing of Trial balance will

subsidiary book not tally

Posting wrong
Error of Trial balance will
amount in the
Commission not tally
ledger

Posting an amount Trial balance will

in the wrong side not tally

Wrong balance of Trial balance will

an account not tally

Effect of Errors on Profit or Loss

Content
1. Only Nominal Accounts affect Profit or Loss.
(e.g. Incomes, Gains, Expenses, Losses)
2. Errors involving Nominal Accounts → Affect Profit or Loss
Example: Salary paid not recorded → Understated expense → Profit overstated
3. Errors involving Real or Personal Accounts → Do NOT affect Profit or Loss
Example: Cash received from debtor not recorded → No impact on P&L

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9. Four Frameworks of Accounting

1. Conceptual Framework
A set of objectives and fundamentals that guide financial reporting. It defines the goals
and underlying concepts to recognize, measure, and report financial information.
2. Legal Framework
Governed by various statutes that control business operations and provide guidelines for
accounting practices.
3. Institutional Framework
Guidelines issued by organizations entrusted by the government, such as the Institute of
Chartered Accountants of India (ICAI).
4. Regulatory Framework
Regulations by various regulatory authorities overseeing specific sectors like banking,
insurance, and telecom.

10. Accounting Principles, Concepts and Conventions

1. Generally Accepted Accounting Principles (GAAP)

GAAP provides a common set of rules, conventions, standards, and procedures used in
accounting to ensure uniformity and consistency in financial statements.
2. Concept of Accounting Principles, Concepts, and Conventions
Accounting principles provide basic rules and standards for recording and maintaining
business transactions. Accounting concepts and conventions guide the application of these
principles.
3. Accounting Principles
Basic rules for recording business transactions and maintaining accounts. They ensure
uniformity and understandability in financial reporting.
[A] Accounting Concepts
Assumptions that define the parameters within which accounting operates, providing the
foundation for accounting principles.
[B] Accounting Conventions
Widely accepted customs, procedures, or guidelines used to apply accounting principles in
practice.

Accounting Concept
a) Entity Concept
Assumes that an organization is separate from its owners and managers, meaning the
business and personal transactions are distinct.
b) Going Concern Concept
Assumes that an organization will continue to exist indefinitely unless evidence suggests
otherwise.

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c) Accounting Period Concept
Splits the organization’s infinite life into smaller, equal periods for financial reporting (e.g.,
quarterly, annually).
d) Money Measurement Concept
Only transactions that can be expressed in monetary terms are recorded in the books of
accounts.
e) Accrual Concept
Recognizes both cash and credit transactions. Revenue and expenses are recognized when
earned or incurred, not when cash is received or paid.
f) Dual Aspect Concept
Every transaction affects at least two accounts: one with a debit and the other with a credit.
g) Matching Concept
Revenues and expenses should be recorded in the same period in which they are incurred to
measure the operating results accurately.
h) Realisation Concept
Revenue is recognized when it is reasonably certain that it will be realized, such as when
goods are delivered and billed to the customer.
i) Cost Concept
Business assets are recorded at the actual cost incurred for their acquisition, including
installation and other related costs, not at market value.

Accounting Conventions
a) Convention of Conservatism
Assumes an uncertain future and advises recognizing possible losses but not future gains.
This results in understatement of income and profits.
b) Convention of Consistency
Advocates consistent application of accounting rules and practices over time. Frequent
changes in accounting treatment can make financial information unreliable.
c) Convention of Materiality
States that only material information that influences decision-making should be recorded,
while insignificant information can be excluded.
d) Convention of Full Disclosure
Requires full and honest disclosure of all material information, whether favorable or
unfavorable, in financial statements.

11. Capital and Revenue Transactions

Capital and Revenue Expenditures

1. Distinction Between Capital and Revenue Transactions
Properly classifying transactions as either capital or revenue nature is essential for accurate
accounting.

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2. Capital and Revenue Expenditures
Capital Expenditure and Revenue Expenditure refer to how an entity’s expenses are
recognized based on the benefit and time period involved.
3. Capital Expenditure
Expenditures that provide benefits over multiple periods, usually non-recurring, and involve
acquisition or improvement of fixed assets.
4. Accounting Treatment (Capital Expenditure)
Not immediately charged against income. Instead, capitalized and gradually charged against
profit over time (e.g., depreciation).
5. Revenue Expenditure
Expenditures that provide benefits only within the current period and are recurring in
nature, necessary for regular operations.

Comparison between Capital Expenditure and Revenue Expenditure

Point of Distinction Capital Expenditure Revenue Expenditure
1. Economic Benefits are enjoyed for more than Benefits are enjoyed for only one
Benefits one accounting period. accounting period.
2. Nature Non-recurring in nature. Recurring in nature.
3. Cash Outlay Typically involves heavy cash outlay. Typically involves lower cash outlay.
4. Accounting Reflected in the Balance Sheet as Debited directly to the Income
Treatment an asset. Statement as an expense.
5. Timing of Can be incurred before or after the Always incurred after the
Incurrence commencement of operations. commencement of operations.
6. Impact on Tends to increase earning capacity Helps carry on activities in the
Earning Capacity or reduce operating expenses. current accounting period.
7. Matching A portion may be matched against The entire amount is matched against
Against Revenue revenue to determine the operating revenue to determine the operating
result. result.

Certain Rules for Identification of Capital Expenditure

1. Acquiring Long-Term Assets
Expenditure incurred for acquiring assets with a useful life of more than one accounting
period, used in operations (not for resale).
Example
a. Furniture bought by a second-hand motor car dealer for use in business (capital
expenditure).
b. Buying motor cars for resale is revenue expenditure.
2. Improving or Repairing Assets
Expenditure incurred to improve the condition of an existing asset or put it into working
condition.

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Example
a. Machine improvement: Adding transportation and installation charges to the machine’s
cost.
b. Building purchase: Registration and stamp duty added to building cost.
3. Improving Earning Capacity
Expenditure that improves the business’s earning potential or operational efficiency.
Example
Expenditure on shifting the factory to a better location for easy supply of raw materials.
4. Preliminary Expenses
Expenditure incurred before business operations commence, such as legal or organizational
setup costs.
Example
Legal charges for drafting the memorandum of association or commission paid to brokers
for raising capital.

Deferred Revenue Expenditures

1. Definition
Expenditure paid or liability incurred, expected to benefit over a future period.
➢ Heavy advertisement expenditure before launching a new product.
➢ Development expenses for a product.
2. Accounting Treatment
➢ Expense portion appears in the Income Statement.
➢ Unwritten-off portion is shown as an asset.
3. Change post-AS-26
➢ After AS-26 issuance, deferred revenue expenditure must be treated as a revenue
expense in the period incurred.
➢ Research, training, advertising, and promotional expenses are now recognized in the
accounting period incurred.

Capital and Revenue Receipts

1. Capital Receipts
Receipts obtained from non-regular operations, usually for long-term purposes, and do not
affect operating results.
Example
Issuance of new shares for raising funds (e.g., 1000 shares at 50 each raising 50,000).
Accounting Treatment
➢ Credited to capital-related accounts.
➢ Reflected in the Balance Sheet.

2. Revenue Receipts

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Receipts obtained from regular business operations, affecting profits and losses of the
business.
Example
Selling goods in the normal course of business (e.g., 1000 units sold at 20 per unit, raising
20,000).
Accounting Treatment
➢ Recognized as income in the Income Statement.
➢ Set against revenue expenses to determine profit.

Differences between Capital Receipts and Revenue Receipts

Point of Difference Capital Receipt Revenue Receipt
1. Source of Receipt Obtained from non-regular Obtained from regular day-to-day
operations (e.g., raising funds, operations (e.g., sales revenue).
issuing shares).
2. Nature Irregular and non-recurring in Recurring in nature.
nature.
3. Income Recognition Not recognized as income. Recognized as income.
4. Accounting Reflected in the Balance Sheet. Credited to the Income
Treatment Statement.
5. Impact on Operating Does not affect the operating Affects the operating result
Results result of an entity. (profits or losses).
6. Creation of Liability May result in the creation of Does not create any liability.
liability (e.g., loans raised, shares
issued).

Capital and Revenue Profits and Capital and Revenue Losses

1. Capital Profit
Profit that arises from capital receipts or transactions not related to the regular
operations of the business.
2. Revenue Profit
Profit earned from regular business operations during an accounting period, resulting from
revenue receipts and expenses.
3. Capital Loss
Loss resulting from capital receipts or non-regular activities.
4. Revenue Loss
Loss incurred from the regular operations of the business.

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Capital and Revenue Profits
1. Capital Profit
Profit arising from non-operating activities, non-recurring in nature, and related to capital
transactions.
Example
➢ Profit prior to incorporation.
➢ Premium received on the issue of shares.
➢ Profit on sale of non-current assets.
Accounting Treatment
➢ Capitalized by transferring to a Capital Reserve Account.
2. Revenue Profit
Profit arising from regular business operations, recurring in nature, and related to
operational activities.
Example
➢ Profit from sale of merchandise.
➢ Profit from providing regular services.
➢ Surplus earned by non-profit organizations.
Accounting Treatment
➢ Determined in the Income Statement.
➢ Distributed to owners or transferred to a Reserve Account.

Capital Loss vs Revenue Loss

1. Capital Loss
A loss that does not arise from the regular operations but from non-operating activities.
Example
➢ Loss from sale of assets other than inventory for less than book value. - Loss due to
extraordinary events (e.g., fire, flood).
➢ Loss from raising debt capital (e.g., debenture issued at discount).
Accounting Treatment
➢ Charged against revenue in the Income Statement or reflected as fictitious assets in
the Balance Sheet.
2. Revenue Loss
A loss that arises from the regular operating activities of the business.
Example
➢ Loss from bad debts.
➢ Discounts allowed to customers for prompt payments.
Accounting Treatment
➢ Recorded in the debit side of the Income Statement.

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Classification of Expenditures
Example 1: Capital vs Revenue Expenditure
Item Capital or Revenue Reason
Expenditure
i. Extension of railway tracks Capital Expenditure It provides long-term benefit to the
in the factory area factory and will be useful for more than
one accounting period.
ii. Wages paid to machine Revenue Expenditure It benefits only the current period as
operators wages are paid for day-to-day
operations.
iii. Installation costs of a new Capital Expenditure The machine provides benefit over
production machine multiple periods; thus, the cost of
installation is capitalized.
iv. Materials for extension to Capital Expenditure The materials are for a long-term
foremen’s offices in the improvement to the factory, benefiting
factory more than one accounting period.
v. Rent paid for the factory Revenue Expenditure The rent is a recurring expense that
benefits only the current period.
vi. Payment for computer time Revenue Expenditure It is an expenditure related to the
to operate a new stores regular business operation and benefits
control system the current period.
vii. Wages paid for building Capital Expenditure It contributes to building assets that
foremen’s offices will benefit the company for multiple
periods, thus capitalized.

Example 2: Capital vs Revenue Expenditure

Item Capital or Revenue Reason
Expenditure
i. Rs.10,000 incurred for Capital Expenditure The expenditure is to acquire a long-
obtaining a license to start the term right to carry on business.
factory
ii. Rs.1,000 paid for removal of Revenue It is related to normal business
stock to a new site Expenditure operations and does not add value to the
asset.
iii. Rs.5,000 incurred for Revenue The expenditure restores efficiency,
changing Rings and Pistons of Expenditure but does not enhance capacity, so it is a
an engine to restore full regular expense.
efficiency

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iv. Rs.2,000 spent on lawyer’s fee Revenue The expenditure is related to legal fees
to defend a suit regarding Expenditure and does not add value to the asset; it
factory title is a regular operational cost.
v. Rs.10,000 spent on advertising Revenue Advertising is treated as revenue
the introduction of a new Expenditure expenditure as per AS-26, and benefits
product only the current period.
vi. Rs.1,00,000 spent on Capital Expenditure The factory shed is a long-term asset,
constructing a factory shed and its cost is capitalized. Similarly,
costs for small huts used for storing
materials are capitalized.

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2. BILLS OF EXCHANGE
1. Negotiable Instrument

Content
1. Meaning
The term ‘Negotiable’ means transferable from one person to another.
The term ‘Instrument’ means a written document that creates a right in favour of a person.
2. Definition (Section 13(1))
“A negotiable instrument means a Promissory Note, Bill of Exchange, or Cheque, payable
either to order or to bearer.”
3. Essential Features
➢ Written Document.
➢ Entitles the holder to a certain sum of money.
➢ Freely transferable by delivery or by endorsement and delivery.
➢ The transferee gets a good title (holder in due course).
4. Legal Basis:
➢ Defined under the Negotiable Instruments Act, 1881.
➢ The Act governs the law relating to Promissory Notes, Bills of Exchange, and Cheques.

2. Bills of Exchange

Content
1. Definition
According to the Negotiable Instrument Act, 1881, ‘A bill of exchange is an instrument in
writing containing an unconditional order, signed by the maker, directing a certain person
to pay a certain sum of money only to, or to the order of, a certain person or to the bearer
of the instrument.
2. Features of Bill of Exchange
➢ In writing (can be in any language/form).
➢ Drawn on a particular date.
➢ Three parties: Drawer, Drawee, and Payee.
➢ Signed by the Drawer/maker.
➢ Unconditional and imperative order to pay.
➢ Directed to a certain person.
➢ Payable for a certain sum of money.
➢ Requires proper stamp as per law.
3. Parties Involved
Drawer: The party that issues a Bill of Exchange - Creditor, Lender or Seller. He is the
maker of the bill and his signature is necessary.

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Drawee: The party to which the order to pay is sent – Debtor, Lendee or Purchaser. The
drawee becomes the acceptor of the bill when he/she/it has written the acceptance on the
bill of exchange
Payee: Payee or the beneficiary is the party to which the bill of exchange is payable – May
be Drawer or Other Party.
4. Classification of Bills
a. Documentary Bill
Bill supported by documents (e.g. invoice, lorry receipt) proving the
sale/transaction.
b. Clean Bill
Bill not supported by any document — more risk, hence higher interest.
c. Demand Bill
Payable on demand; no fixed due date.
d. Usance Bill
Time-bound bill; payable after a certain period (e.g. 30 days, 60 days).
e. Inland Bill
Bill drawn and payable within India.
f. Foreign Bill
Bill drawn in one country and payable in another country.
g. Trade Bill
Drawn for trade purpose – sale/purchase of goods/services.
h. Accommodation Bill
Drawn without consideration to help another party raise funds.
i. Supply Bill
Drawn by a supplier or contractor on a government department.

3. Difference between Trade Bill & Accommodation Bill

Aspect Trade Bill Accommodation Bill

1. Objective Facilitates trade transactions like Drawn to help someone in need of
sale and purchase of goods. financial assistance.
2. Consideration Has a definite consideration for Drawn without consideration.
which the bill is accepted.
3. Extension of A form of credit extension for trade Not a form of credit extension.
Credit purposes.
4. Proceeds When discounted, the proceeds When discounted, proceeds may be
remain with the holder. shared between two parties in an
agreed ratio.
5. Recovery If dishonoured, the amount can be In case of dishonour, the drawer
recovered easily through court. cannot file a suit against the drawee.

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4. Maturity / Due Date of a Bill of Exchange and Days of Grace

Type of Bill Key Points Example

1. Demand Bill / At Payable immediately on A bill dated 1st July 2025, payable on
Sight / On presentation - No fixed demand, is presented on 5th July 2025 →
Presentation due date - No Days of Payment due on 5th July 2025 itself
Grace
2. After Date Bill Payable after a fixed A bill drawn on 1st July 2025 for 60 days
period from the date of after date → Due date = 30th August 2025
drawing - 3 Days of Grace Add 3 days grace → Maturity Date = 2nd
allowed September 2025
3. After Sight Bill Payable after fixed period A bill dated 1st July 2025, but accepted on
from date of acceptance - 4th July 2025 for 60 days after sight →
3 Days of Grace allowed Due date = 2nd September 2025 Add 3 days
grace → Maturity Date = 5th September
2025

5. Grace Period

Situation Rule Example

1. Period Given in Count exact calendar months - Bill dated 4 May 2025, 3 months →
Months Ignore number of days in month 4 Aug 2025 + 3 days = 7 Aug 2025
- Add 3 days grace
2. Period Given in Days Count exact number of days - Bill dated 5 June 2025, 65 days →
Exclude date of bill, include day 25 (June) + 31 (July) + 9 (Aug) = 9
of payment - Add 3 days grace Aug + 3 days = 12 Aug 2025
3. Maturity on If maturity date is National If maturity date is 26 Jan, final
National Holiday Holiday, bill is payable on date = 25 Jan
preceding working day
4. Maturity on If declared Emergency Holiday, If due on 25 July, and it's
Emergency Holiday maturity date is next working emergency holiday → final date = 26
day July

6. Concept of Bills Receivable (B/R) and Bills Payable (B/P)

Term Meaning Shown in Balance Sheet

1. Bills Receivable (B/R) When a person draws the bill and is Asset side (of Drawer)
entitled to receive payment -
Treated as an asset
2. Bills Payable (B/P) When a person accepts the bill and is Liability side (of Drawee)
liable to pay - Treated as a liability

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7. Journal Entries for Trade Bills

Sl. Transactions In the Books of Drawer (X) In the Books of Drawee (Y)
No.
1. If a bill is received by X Bills Receivable A/c Dr Drawer / X A/c Dr
from Y after acceptance To Drawee / Y A/c To Bills Payable A/c
2. If the bill is retained by No entry No entry
X till due date
3. If the bill is discounted Bank / Cash A/c Dr No entry
with a Bank Discount A/c Dr
To Bills Receivables A/c
4. If the bill is endorsed to Creditor / Z A/c Dr No entry
a Creditor (Z) Discount Allowed A/c (if any) Dr
To Bills Receivables A/c
To Discount Receivables A/c
(if any)
5. If the bill is sent to the Bills for Collection A/c Dr No entry
Bank for collection To Bills Receivables A/c
6. If the bill is retired Cash / Bank A/c Dr Bills Payable A/c Dr
before maturity Rebate Allowed A/c Dr To Cash / Bank A/c
To Bills Receivables A/c To Rebate Received A/c
To Bills for Collection A/c
(if already sent to Bank for
collection)
7. If the bill is honoured / Cash / Bank A/c Dr Bills Payable A/c Dr
paid on the due date To Bills Receivables A/c To Cash / Bank A/c
(Previously retained by X)
8. If the bill is honoured / No entry Bills Payable A/c Dr
paid on the due date To Cash / Bank A/c
(Previously discounted
with a Bank)
9. If the bill is honoured / Bank A/c Dr Bills Payable A/c Dr
paid on the due date To Bills for Collection A/c To Cash / Bank A/c
(Previously sent to the
Bank for collection)
10. If the bill is honoured / No entry Bills Payable A/c Dr
paid on the due date To Cash / Bank A/c
(Previously endorsed to
Z)

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11. If the bill is dishonoured Drawee / Y A/c Dr Bills Payable A/c Dr
/ unpaid on due date To Bills Receivables A/c Noting / Sundry Charges A/c
(Previously retained by X) To Cash / Bank A/c (if any) Dr
(For Noting charges if any) To Drawer / X A/c
12. If the bill is dishonoured Drawee / Y A/c Dr Bills Payable A/c Dr
/ unpaid on due date To Bank A/c Noting / Sundry Charges A/c
(Previously discounted To Cash / Bank A/c (if any) Dr
with a Bank) (For Noting charges if any) To Drawer / X A/c
13. If the bill is dishonoured Drawee / Y A/c Dr Bills Payable A/c Dr
/ unpaid on due date To Bills for Collection A/c Noting / Sundry Charges A/c
(Previously sent to the To Cash / Bank A/c (if any) Dr
Bank for collection) (For Noting charges if any) To Drawer / X A/c
14. If the bill is dishonoured Drawee / Y A/c Dr To Creditor / Bills Payable A/c Dr
/ unpaid on due date Z A/c (Bill value + Noting Charges Noting / Sundry Charges A/c
(Previously endorsed to if any) (if any) Dr
Z) To Drawer / X A/c
15. If the bill is renewed on Drawee / Y A/c Dr Bills Payable A/c Dr To
due date (For old bill To Bills Receivables A/c Drawer / X A/c
cancelled)
16. If the bill is renewed on Drawee / Y A/c Dr Interest (Allowed) A/c Dr
due date (For interest To Interest (Received) A/c To Drawer / X A/c
charged for delayed
payment)
17. If the bill is renewed on Cash / Bank A/c Dr Drawer / X A/c Dr
due date (For part To Drawee / Y A/c To Cash / Bank A/c
payment made in cash)
18. If the bill is renewed on Bills Receivable A/c Dr Drawer / X A/c Dr
due date (For a new bill To Drawee / Y A/c To Bills Payable A/c
drawn and accepted)

8. Dishonour of Bills

Dishonour Type Explanation Accounting Treatment

1. Dishonour by Non- Drawee refuses to accept the bill No journal entry in the books of any
Acceptance when presented. party.
2. Dishonour by Non- Drawee accepts but fails to pay on In the Books of Drawer:
Payment maturity. Drawee / Y A/c Dr
To Bills Receivables A/c
In the Books of Drawee:
Bills Payable A/c Dr
Noting Charges A/c (if any) Dr
To Drawer / X A/c

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3. Noting of a Bill Noting refers to recording the fact Noting Charges are an expense for
of dishonour by a Notary Public, the holder and are recovered from
along with a fee (Noting Fee). the responsible party.
In the Books of Holder:
Noting Charges A/c Dr
To Cash/Bank A/c
4. Dishonour due to A bill is dishonoured due to In the Books of Drawer:
Insolvency insolvency of the drawee or Bad Debts A/c Dr
acceptor. It may result in full or To Drawee / Y A/c
partial recovery. In the Books of Drawee:
Deficiency A/c Dr
To Bills Payable A/c

9. Renewal of Bills

Aspect Explanation Accounting Treatment

1. Renewal of a When the holder of a bill is unable to meet the In the Books of Drawer:
Bill payment on the due date, the drawee requests Drawee / Y A/c Dr
an extension from the drawer. If agreed, the old To Bills Receivables A/c
bill is cancelled, and a new bill with extended In the Books of Drawee:
terms is drawn. Bills Payable A/c Dr
To Drawer / X A/c
2. Interest on Interest is charged on the new bill for the In the Books of Drawer:
Renewal extended payment period. Interest A/c Dr
To Drawee / Y A/c
In the Books of Drawee:
Interest A/c Dr
To Drawer / X A/c

10. Retirement of a Bill

Aspect Explanation Accounting Treatment

1. Retirement When the drawee pays the bill before its In the Books of Drawee (Y):
of a Bill due date, it is called retirement of the bill. Bills Payable A/c Dr
This occurs with mutual understanding To Cash / Bank A/c
between the drawer and drawee. In the Books of Drawer (X):
Cash / Bank A/c Dr
To Bills Receivables A/c
2. Rebate on Interest payable for the unexpired period In the Books of Drawee (Y):
Bill of the bill (i.e., between the payment date Rebate Received A/c Dr
and maturity date) is called rebate on the To Cash / Bank A/c
bill. This rebate is income for the drawee In the Books of Drawer (X):
and an expense for the payee. Rebate Allowed A/c Dr
To Interest A/c

Page | 44
11. Accommodation Bill

Content
1. Definition
Accommodation Bills are bills drawn and accepted without any consideration. These are
often drawn between two or more persons who are not in a debtor-creditor relationship.
2. Purpose
The primary purpose of these bills is to help the parties involved in raising funds through
bill discounting. After the bill is accepted, it is discounted, and the proceeds are shared by
the parties in an agreed-upon proportion.
3. Relationship
No actual goods or services are exchanged between the parties. The bill is created purely
for the purpose of securing financing.
4. Also Known As
Accommodation Bills are also referred to as Kite Bills.
5. Process
➢ Two or more parties (not in a debtor-creditor relationship) agree to draw bills on each
other.
➢ They aim to discount the bills after acceptance.
➢ The proceeds from discounting the bill are shared according to the agreed proportion.
➢ The parties involved provide money for honouring the bill at maturity.

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3. CONSIGNMENT
1. Consignment

Basics - Consignment
1. Concept and Introduction
➢ Business organisations often aim to expand operations by adopting different marketing
and distribution strategies.
➢ One common method is appointing selling agents, formally called entering into a
consignment agreement.
2. Definition
➢ Consignment is a transaction where one entity (the consignor) sends goods to another
entity (the consignee) for sale on its behalf, with a predetermined commission.
➢ It is an agency relationship, not a sale between consignor and consignee.
➢ The ownership of goods remains with the consignor until the consignee sells them to a
third-party buyer.
3. Parties Involved
Aspect Consignor Consignee
Meaning The party who sends goods on The party who receives goods and
consignment sells them on behalf of consignor
Status Principal in the Principal–Agent Agent who sells for the principal
relationship
Ownership Retains ownership until goods are sold Does not own the goods
Function Sends goods to consignee for sale Sells goods, collects proceeds,
earns commission
Business May be a manufacturer or wholesaler Retailer or sales agent
Type
Entitlement Entitled to receive sale proceeds Entitled to receive commission and
after deducting commission/expenses reimbursements
4. Documents Related to Consignment Transactions
Document Issued Issued Purpose & Key Features
By To
Proforma Consignor Consignee ➢ Sent along with goods - Contains details like:
Invoice Quantity
Cost/Invoice Price
Expenses incurred
Minimum selling price
➢ Used as proof of dispatch
➢ Format similar to an invoice, but not a sale
invoice

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Account Sales Consignee Consignor ➢ Sent after goods are sold Contains:
Quantity sold
Sale price
Expenses incurred
Commission charged
Net amount due to consignor
➢ Acts as a report of sale performance
5. Revenue Recognition
Revenue for the consignor is recognized once the goods are sold by the consignee.

Proforma
XYZ Cloth Merchant
Proforma Invoice
Goods sent on Consignment to:
Kamal Garments
80A, Nehru Road,
Guwahati – 781005. Date: March 17, 2023
Particulars (Rs.) (Rs.)
1,200 T-Shirts @ Rs. 1,000 each 12,00,000
500 Formal Shirts @ Rs. 800 each 4,00,000
Charges: (Rs.) 16,00,000
Packing 25,000
Carriage 42,000
Insurance 13,000 80,000
Goods despatched vide A.W.B. No. 85138 dated 17.3.2023 Total 16,80,000
E.&O.E. For XYZ Cloth Merchant
Ahmedabad Suresh Barua
Partner

Proforma:
Account Sales for Wrist Watches & Wall Clocks sold by Prime Watch Dealers
on behalf of GMT Watch Makers
Particulars (Rs.) (Rs.)
Gross Sale Proceeds:
1,050 wrist watches @ Rs. 2,400 each 25,20,000
180 wall clocks @ Rs. 600 each 1,08,000 26,28,000
Less: Charges:
Unloading & Carriage to godown 4,500
Godown rent & insurance 96,000
Selling expenses 12,500

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Commission @ 5% on Rs. 26,28,000 1,36,800 2,49,800
Net Sale Proceeds 23,78,200
Less: Advance (by Bank Draft No. …. dated ….) 10,00,000
13,78,200
Less: Amount remitted (by Bank Draft No. …. dated ….) 10,00,000
Balance Due 3,78,200
E.&O.E. For Prime Watch Dealers
New Delhi …………………..
(Signature)

2. Consignment Sales Vs Regular Sales

Point Consignment Sales Normal Sales

Nature A method of business expansion A firm’s primary business activity
Usage Entered into by some specific entities Entered into by all commercial
organisations
Parties Involved Consignor and Consignee Seller and Buyer
Relationship Principal–Agent relationship Debtor–Creditor relationship
Ownership & Risk Remain with Consignor until goods are Transfer to Buyer immediately
sold upon sale
Expenses Borne by Consignor, including those Borne by Seller until transfer of
incurred by consignee ownership
Pricing Goods sent at Cost or Invoice Price Goods sold at Selling Price (above
cost)
Document Issued Proforma Invoice issued by Consignor Sales Invoice issued by Seller
Return of Goods Consignee can return unsold goods Buyer generally cannot return,
unless agreed

3. Consignment Related Transactions

1. Goods Sent on Consignment

➢ Consignor sends goods to Consignee for sale.
➢ Ownership, risk, and title remain with Consignor.
➢ Consignee doesn't pass any journal entry.
➢ Consignor adjusts Purchases A/c or Trading A/c.
➢ Goods can be recorded at:
• Cost Price (CP), or
• Invoice Price (IP) = CP + Load (Profit Margin %)
2. Advance by Consignee to Consignor
➢ Consignee may give advance to consignor Via Bank Draft or Bills of Exchange.
➢ Later adjusted against final sale settlement.
➢ Security Deposit / Caution Money:

Page | 48
• Sometimes demanded as per agreement.
• Proportion relating to unsold stock is retained & carried forward to the next period.
3. Expenses on Consignment
a. The expenses in relation to the consignment business may be incurred either by the
consignor or by the consignee.
b. Expenses By Consignor
Nature:
• Incurred to send goods to the consignee.
• Always Non-recurring in nature.
Examples:
❖ Carriage & Freight to consignee
❖ Packing Charges
❖ Loading Charges
❖ Export Duty
❖ Transit Insurance
Included in Valuation of:
❖ Unsold Consignment Stock
❖ Abnormal Loss
❖ Goods-in-Transit
c. Expenses by Consignee
Nature:
Incurred by the consignee for storage, handling, or selling of goods after receipt.
Recovery:
a. Not reimbursed directly by the consignor.
b. Adjusted against sale proceeds in the Account Sales sent to consignor.
Valuation Impact:
Only non-recurring expenses are considered for:
• Unsold Consignment Stock
• Abnormal Loss (at consignee’s premises)
4. Consignment Sale
a. Nature:
• Goods are sold by the consignee on behalf of the consignor under a consignment
contract.
• The revenue belongs to the consignor, not the consignee.
b. Mode of Sale: Cash basis, or Credit basis
c. Accounting Treatment:
• Cash Sales: Recorded in both consignor’s and consignee’s books.
• Credit Sales:
✓ If Del-Credere Commission is paid → Recorded by consignee (as they bear bad
debt risk).
✓ If not paid → Not recorded by consignee; only consignor records it.

Page | 49
d. Collection & Remittance:
• Consignee collects the sale proceeds.
• Remits the net amount to the consignor after deducting:
Consignee’s expenses
Commission
Any advance already paid (if applicable)

4. Commission

Meaning
➢ Commission is the reward given to the consignee for acting as an agent of the consignor.
➢ It is not paid in cash, but deducted by consignee from sale proceeds in the Account Sales.
Types of Commission
1. Ordinary Commission
For performing normal consignment activities (selling on behalf of consignor).
Basis of Calculation: % on Gross Sales
2. Del-credere Commission
For bearing bad debt risk on credit sales and responsibility of collection.
Basis of Calculation: % on Gross Sales unless otherwise agreed upon
3. Over-riding Commission
Extra incentive for:
• Selling above fixed price, or
• Exceeding sales targets. Also called Special Commission.
• Basis of Calculation: Calculated on the excess amount achieved over target / fixed price.

5. Loss of Goods in Consignment Business

1. Loss of Goods Sent on Consignment

Goods sent on consignment may get lost due to various reasons, categorized into Normal
Loss and Abnormal Loss.
2. Normal Loss
➢ Occurs due to inherent nature of goods.
Examples: Evaporation, spillage, drying, leakage.
➢ Unavoidable and expected.
➢ Not recorded separately.
➢ Loss is absorbed in the cost of remaining goods (increases per unit cost).
3. Abnormal Loss
➢ Occurs due to avoidable or accidental events.
Examples: Theft, fire, accident, natural calamities.
➢ Recorded separately in books.
➢ Not part of normal cost of goods sold.
4. Stage-wise Treatment of Abnormal Loss

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(a) Abnormal Loss during Transit
• Occurs while goods move from consignor to consignee.
• Valuation includes:
❖ Cost of goods
❖ Consignor’s expenses only (e.g., freight, insurance).
❖ Ignore consignee’s expenses.
(b) Abnormal Loss at Consignee’s Premises
• Occurs after goods are received by consignee.
• Valuation includes:
❖ Cost of goods
❖ Consignor’s expenses
❖ Consignee’s non-recurring expenses

6. Valuation of Unsold Stock with Consignee

Content
1. Meaning
➢ Goods not sold by consignee at the end of accounting period are called Consignment Stock.
➢ Ownership remains with the consignor, though physically lying with the consignee.
2. Purpose
➢ To ensure accurate profit/loss determination for the consignment transaction.
➢ Must be included in closing stock of the consignor.
3. Valuation Basis
Method of Recording Valuation Approach
Goods Sent
At Cost Stock valued at Cost of goods + Consignor’s expenses + non-recurring
expenses incurred by consignee
At Invoice Price (IP) Stock valued at Invoice Price +Consignor’s + Consignee’s non-recurring
expenses − Load (excess over cost) needs to be removed
Note: As per AS-2, unsold stock is to be valued at ‘Cost’ or ‘Net Realisable Value (NRV)’, whichever
is lower. When the NRV of the unsold stock fall below its cost, in that case the consignment
statement is to be valued at the lower NRV.

7. Valuation of Goods-in-Transit

Content
1. Meaning
Goods that have been dispatched by the consignor but have not yet reached the consignee’s
premises at the end of the accounting period.
2. Ownership
Remains with the consignor until the goods are delivered to the consignee.
3. Need for Valuation

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Such goods must be shown as an asset in the consignor’s books for proper presentation in financial
statements.
4. Valuation Method
Valued at:
Cost of goods
Plus: Expenses incurred by the consignor (e.g., freight, packing, loading, transit insurance)
No expenses incurred by the consignee should be added to the value of goods-in-transit.

8. Accounting for Consignment Transactions

A. Books of the Consignor

1. Consignment Account
➢ A profit determining account.
➢ All expenses and losses are debited, and revenues are credited.
➢ The resulting profit or loss is transferred to the Profit and Loss A/c.
2. Goods Sent on Consignment Account
➢ Records the value of goods sent on consignment.
➢ Also includes returns from consignee, if any.
3. Consignee’s Account
➢ A personal account that records all transactions with the consignee (e.g., advances,
expenses, sales).
➢ Shows the amount receivable from the consignee at period-end.
4. Consignment Stock Account
Reflects the value of unsold stock lying with the consignee at the close of the accounting
period.
5. Consignment Debtors Account
➢ Opened only when credit sales are made by consignee and del-credere commission is not
paid.
➢ Records credit sales, collections, bad debts, discounts allowed, etc.

B. Books of the Consignee

1. Consignor Account
➢ Records all transactions with the consignor relating to consignment.
➢ The closing balance indicates the amount due to the consignor.
2. Commission Account
Separate accounts are maintained for:
• Ordinary Commission
• Del-Credere Commission
• Over-riding / Special Commission
3. Consignment Debtors Account
➢ Maintained when del-credere commission is payable by the consignor.

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➢ Records credit sales, collections, bad debts, and discounts allowed.

4. Consignment Inwards Account

➢ Usually, no entry is made for receipt of goods.
➢ However, a special account may be opened to track movement of goods received.

9. Journal Entries

Transaction Books of Consignor Books of Consignee

Opening Stock on Consignment At Cost: No entry
Consignment A/c Dr.
To Consignment Stock A/c
At IP:
Consignment A/c Dr.
To Consignment Stock A/c
Cancellation of load on Opening Stock Reserve A/c Dr. No entry
Stock To Consignment A/c
Goods Sent on Consignment At Cost: No entry
Consignment A/c Dr.
To Goods Sent on Consignment A/c
At IP:
Consignment A/c Dr.
To Goods Sent on Consignment A/c
[Note: Load to be cancelled]
Cancellation of load on goods Goods Sent on Consignment A/c Dr. No entry
sent To Consignment A/c
Advance received from Bank A/c / Bills Receivable A/c Dr. Consignor A/c Dr.
consignee by consignor To Consignee A/c To Bank A/c / Bills Payable
A/c
Discounting of Bills Receivable Bank A/c Dr. No entry
by consignor Discount on Bill A/c Dr.
To Bills Receivable A/c
Expenses incurred by consignor Consignment A/c Dr. No entry
To Cash/ Bank A/c
Goods-in-Transit At Cost: No entry
Goods-in-Transit A/c Dr.
To Consignment A/c
At IP:
Goods-in-Transit A/c Dr.
To Consignment A/c
[Note: Load to be cancelled]
Cancellation of load on Goods- Consignment A/c Dr. No entry
in-Transit To Goods-in-Transit A/c
Expenses paid by consignee Consignment A/c Dr. Consignor A/c Dr.

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To Consignee A/c To Bank / Cash A/c
Sale of goods by consignee (For Consignee A/c Dr. Bank A/c Dr.
cash) To Consignment A/c To Consignor A/c
Sale of goods by consignee (For Del-credere commission provided: Consignment Debtors A/c Dr.
credit) Consignee A/c Dr. To Consignor A/c
To Consignment A/c
Del-credere commission not provided: No entry
Consignment Debtors A/c Dr.
To Consignment A/c
Commission payable by Consignment A/c Consignor A/c Dr.
consignor to consignee To Consignee A/c To Commission A/c
Amount received from No entry Bank A/c Dr.
Consignment Debtors (Del- To Consignment Debtors A/c
credere commission provided)
Amount received from Consignee A/c Dr. Bank A/c Dr.
Consignment Debtors (Del- Bank A/c Dr. To Consignor A/c
credere commission not [if directly collected by consignor]
provided) To Consignment Debtors A/c
Bad Debt in connection to No entry Bad Debt A/c Dr.
consignment business (Del- To Consignment Debtors A/c
credere commission provided) Commission A/c Dr.
To Bad Debt A/c
Bad Debt in connection to Consignment A/c Dr. No entry
consignment business (Del- To Consignment Debtors A/c
credere commission not
provided)
Goods returned by consignee Goods Sent on Consignment A/c Dr. No entry
(At Cost) To Consignment A/c
Goods returned by consignee Goods Sent on Consignment A/c Dr. No entry
(At IP) To Consignment A/c
Abnormal Loss of goods (in Abnormal Loss A/c Dr. No entry
Transit / Consignee’s premises To Consignment A/c
- At Cost)
Abnormal Loss of goods (in Abnormal Loss A/c Dr. No entry
Transit / Consignee’s premises To Consignment A/c
- At IP) [Note: Load to be cancelled]
Cancellation of loading of Consignment A/c Dr. No entry
abnormal goods (At IP) To Abnormal Loss A/c
Insurance claim received / Bank A/c (Amount received) Dr. Bank A/c Dr.
admitted against Abnormal Insurance Claim A/c Dr. To Consignor A/c
Loss (Amount admitted but not realised) [Amount received from
Consignee A/c Dr. Insurance Co. on behalf of the
(Amount received by consignee) consignor]
P/L A/c (Net Loss) Dr.

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To Abnormal Loss A/c
Closing Stock on Consignment Consignment Stock A/c Dr. No entry
(At Cost) To Consignment A/c
Closing Stock on Consignment Consignment Stock A/c Dr. No entry
(At IP) To Consignment A/c
Cancellation of loading on goods Consignment A/c Dr. No entry
sent (If goods sent at IP) To Stock Reserve A/c
Closing of Goods Sent on Goods Sent on Consignment A/c Dr. No entry
Consignment A/c To Purchases / Trading A/c
Profit/Loss on Consignment In case of Profit: No entry
Consignment A/c Dr.
To P/L A/c
In case of Loss: P/L A/c Dr. No entry
To Consignment A/c
Final Remittance received by Bank A/c / Bills Receivable A/c Dr. To Consignor A/c Dr.
consignor from consignee Consignee A/c To Bank A/c / Bills Payable
A/c

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4. JOINT VENTURE
1. Joint Venture

Content
1. Definition
A Joint Venture is a short-term business undertaking by two or more persons who share
the profits and losses in an agreed ratio.
2. Nature of organisation
It is a temporary business organization, not intended for long-term operations.
3. Purpose
Formed to execute specific projects involving high risk, large investment, or multi-skill
requirements.
4. Need for Collaboration
When an individual lacks resources or expertise, others may combine their strengths.
5. Temporary Partnership
This collaboration creates a temporary partnership, specifically for a defined objective.
6. Formal Agreement
A written Memorandum of Undertaking (MOU) is signed outlining terms and conditions.

Parties in a Joint Venture

Content
1. Co-venturers / Joint Venturers
The parties involved in a joint venture are called Co-venturers or Joint Venturers.
2. Relation to Partnership
➢ It is similar to a partnership, except that it is temporary and ends after the venture is
completed.
➢ Generally, a firm name is not used since the venture is short-term in nature.
➢ It is a temporary partnership, formed with or without a firm name.
3. Profit Sharing
In the absence of an agreement, profits and losses are shared equally among all co-venturers

Difference Between Joint Venture and Partnership

Aspect Joint Venture Partnership
1. Firm’s Name No firm name required. Firm name is used.
2. Participants Participants are called co-venturers. Participants are called partners.
3. Duration Temporary, formed for a specific Long-term, formed for various
job/project. projects or ongoing business.
4. Governance No specific legal enactment, treated Governed by the Partnership Act,
as a partnership. 1932.

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5. Number of No limit to the number of co- Limited to 10 in banking and 20 in
Participants venturers. other businesses.
6. Liability Limited to the project or task. Unlimited liability, which may extend
to personal assets.

Difference Between Joint Venture and Consignment

Aspect Joint Venture Consignment

1. Relationship Co-venturers are owners of the Consignor and consignee have a
joint venture. principal-agent relationship.
2. Sharing of Profits Co-venturers share profits Consignee receives commission,
according to an agreed ratio. not a share of profits.
3. Ownership of Goods Co-venturers are co-owners of Ownership remains with the
the goods or project. consignor.
4. Contribution of Funds All co-venturers contribute Only the consignor invests;
funds in agreed proportions. consignee only handles goods.
5. Continuity of Business No continuity after the project Consignment is typically a
is completed. continuous process.

2. Accounting of Joint Venture

content
There are different methods of recording joint venture transactions. They can be broadly
classified into two following methods:
I. When Separate Set of Books are Maintained
II. When Separate Set of Books are Not Maintained

Method I: When Separate Set of Books are Maintained for the Joint Venture
Content
➢ As the business duration is short, the books of accounts are not very comprehensive.
➢ The basic purpose is to ascertain the profit or loss on account of the joint venture.
➢ Generally, under this approach, the following accounts are maintained:
a) Joint Venture Account
b) Joint Bank Account
c) Co-venturers’ Accounts
a) Joint Venture Account
➢ Records all expenses (paid personally or through joint bank), regardless of capital or
revenue nature – on debit side.
➢ Records all sales (to outsiders or co-venturers) – on credit side.
➢ Used to find profit or loss of the venture.
b) Joint Bank Account
➢ Acts as the cash book of the venture.
➢ Debit side: Initial contributions by co-venturers, sales proceeds.

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➢ Credit side: Expenses, settlement to co-venturers.
➢ Final balance is used to settle claims of co-venturers.
c) Co-venturer’s Account
➢ Records transactions related to individual co-venturers.
➢ Similar to capital accounts in partnership.
➢ Shows amount due to/from each co-venturer.
➢ Settled through the Joint Bank Account.

Journal Entries
Transaction Journal Entry
1. Contribution made by Co-Venturers Joint Bank A/c Dr.
To Co-Venturer A/c
2. Expenses paid through Joint Bank Account Joint Venture A/c Dr.
To Joint Bank A/c
3. Expenses paid or goods supplied by Co-Venturer Joint Venture A/c Dr.
To Co-Venturer A/c
4. Sale proceeds or collections Joint Bank A/c Dr.
To Joint Venture A/c
5. Collections received by Co-Venturer Co-Venturer A/c Dr.
To Joint Venture A/c
6. Assets taken over by Co-Venturer Co-Venturer A/c Dr.
To Joint Venture A/c
7. Liabilities taken over by Co-Venturer Joint Venture A/c Dr.
To Co-Venturer A/c
8. Profit on Joint Venture Joint Venture A/c Dr.
To Co-Venturer A/c
9. Loss on Joint Venture Co-Venturer A/c Dr.
To Joint Venture A/c
10. Final settlement made to Co-Venturer Co-Venturer A/c Dr.
To Joint Bank A/c

Method II: When Separate Set of Books Are Not Maintained

Content
1 Used when the venture is very short-term and no separate books are maintained jointly.
2 Co-venturers do not maintain separate books for the joint venture.
3 No joint bank account is opened.
4 No cash contribution is made by co-venturers.
5 Goods are supplied from own stock.
6 Expenses are incurred and settled individually by co-venturers.
7 Accounts Maintained by Each Co-Venturer:

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• Joint Venture Account: To record all joint venture transactions.
• Other Co-venturer’s Account: To record transactions related to the other co-
venturer.
8 Each co-venturer calculates profit or loss independently in their own books.
9 This method is suitable when:
• The business is small, and
• Co-venturers operate from different locations.

When each co-venturer keeps record of all transactions

Content
1 Each co-venturer prepares:
• Joint Venture Account (to record all venture-related transactions)
• Other Co-venturer’s Account (to record the transactions with the other party)
2 Profit or loss is calculated separately by each co-venturer in their own books.
3 Each co-venturer records all transactions both those done by self and on behalf of/by the
other co-venturer.
In Books of Co-Venturer A In Books of Co-Venturer B
When goods are supplied and expenses paid by A
Joint Venture A/c Dr. Joint Venture A/c Dr.
To Purchases A/c To A’s A/c
To Cash/Bank A/c
When goods are supplied by B and expenses paid by B
Joint Venture A/c Dr. Joint Venture A/c Dr.
To B’s A/c To Purchases A/c
To Cash/Bank A/c
When advance is given by A to B or bill accepted by A
B’s A/c Dr. Cash/Bank A/c Dr.
To Cash/Bank A/c B/R A/c Dr.
To B/P A/c To A’s A/c
When sale proceeds are received by A
Cash/Bank A/c Dr. A’s A/c Dr.
To Joint Venture A/c To Joint Venture A/c
When sale proceeds are received by B
B’s A/c Dr. Cash/Bank A/c Dr.
To Joint Venture A/c To Joint Venture A/c
For unsold goods taken over by A
Goods A/c Dr. A’s A/c Dr.
To Joint Venture A/c To Joint Venture A/c
For unsold goods taken over by B
B’s A/c Dr. Goods A/c Dr.

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To Joint Venture A/c To Joint Venture A/c
For profit on joint venture business
Joint Venture A/c Dr. Joint Venture A/c Dr.
To B’s A/c To A’s A/c
To P&L A/c To P&L A/c
For loss on joint venture business
B’s A/c Dr. A’s A/c Dr.
P&L A/c Dr. P & L A/c Dr.
To Joint Venture A/c To Joint Venture A/c
After closure the business of joint venture, the co-venturer who has received surplus cash will
remit it to the other co-venturer

Memorandum Method for Joint Venture Accounting

Content
➢ Each co-venturer maintains only own transactions in a personal account called:
"Joint Venture with Co-venturer A/c" (like a personal venture ledger)
➢ A Memorandum Joint Venture A/c is prepared separately (not part of double-entry).
➢ It records transactions of both co-venturers, shown separately under each name.
➢ It is used to ascertain total profit or loss of the venture.
➢ Each co-venturer sends a periodic statement of joint venture transactions to the other.
➢ On receiving the statement, both prepare the Memorandum Joint Venture A/c.
➢ This account is not a double-entry account.
➢ It is a memorandum statement prepared for profit/loss calculation only.

Accounting Entries
Transaction In the Books of Co-Venturer
Amount received from co-venturer Cash/Bank/B/R A/c Dr.
in cash / cheque or B/R To Joint Venture with Co-Venture’s A/c
Discounting of Bills Receivable Bank A/c Dr.
Joint Venture with Co-venturer .... A/c (Discount) Dr.
To B/R A/c
Purchase of goods Joint Venture with Co-venturer .... A/c Dr.
To Cash/Bank A/c
To JV Creditors A/c
Making payment to creditors JV Creditors A/c Dr.
(including discount received) To Cash/Bank/B/P A/c
To Joint Venture with Co-venturer .... A/c (Discount
received)
Goods supplied by co-venturer Joint Venture with Co-venturer .... A/c Dr.
from own stock To Purchases A/c/Goods Sent to JV A/c

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Payment of expenses Joint Venture with Co-venturer .... A/c Dr.
To Cash/Bank A/c
Sale of goods Cash/Bank/JV Debtors A/c Dr.
To Joint Venture with Co-venturer .... A/c
Collection from customer Cash/Bank A/c Dr.
(including bad debts and discount Joint Venture with Co-venturer .... A/c Dr.
allowed) (Amount of bad debts and discount allowed)
To JV Debtors A/c
Taking away of unsold goods Goods Sent to JV A/c Dr.
To Joint Venture with Co-venturer .... A/c
Co-venturer entitled to commission Joint Venture with Co-venturer .... A/c Dr.
/ salary etc. To Commission/Salary A/c
Share of profit on joint venture Joint Venture with Co-venturer .... A/c Dr.
To Profit & Loss A/c
Share of loss on joint venture Profit & Loss A/c Dr.
To Joint Venture with Co-venturer .... A/c
Settlement of balance of JV In case of debit balance:
Cash/Bank A/c Dr.
To Joint Venture with Co-venturer .... A/c
In case of credit balance:
Joint Venture with Co-venturer .... A/c Dr.
To Cash/Bank A/c
Note:
The following transactions are not recorded in the books of either co-venturer:
● Transactions effected by other co-venturer; and
● Transactions not involving cash receipt or cash payment

3. Conversion of Consignment into Joint Venture

Content
1. Accounting Until Conversion:
Till the date of conversion, normal consignment accounting is followed in the books of both
Consignor and Consignee.
2. Treatment of Unsold Stock
On the date of conversion, the unsold stock on consignment is transferred to the Joint
Venture Account.
3. After Conversion
From the date of conversion onwards, all transactions are accounted using the joint venture
accounting principles.

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4. Joint Ventures Running for More than One Accounting Period

Content
1. Special Issue – Closing Stock:
When a joint venture continues beyond one accounting period, valuation of closing stock
becomes necessary.
2. Stock Valuation Basis:
Closing stock is valued at:
Cost + Proportionate Non-recurring Expenses (e.g., freight, customs, insurance, etc.)
3. Treatment in Memorandum Joint Venture A/c:
• End of Year 1: Stock is shown on the credit side
• Start of Year 2: Same stock is shown on the debit side
4. Treatment of Other Accounts:
All other accounts (like Joint Venture with Co-venturer A/c) are prepared in the usual
manner.
5. Interim Settlement Option:
If co-venturers want to settle accounts at the end of the year:
• They record their share in closing stock in their respective ‘Joint Venture with Co-
venturer A/c’.
• The share in stock is shown on the debit side of that account and carried forward.

Page | 62
5. PREPARATION OF FINAL ACCOUNTS OF
COMMERCIAL ORGANISATIONS
1. Objective of accounting

Content
1. Objective of Accounting
➢ Besides record-keeping, a key objective of accounting is:
• Determination of operating results &
• Disclosure of financial position.
➢ In commercial organisations:
Operating result = Profit earned or Loss suffered during a specific period
➢ This is done through preparation of Financial Statements
2. Components of Financial Statements
a. Income Statement
b. Balance Sheet
c. Cash Flow Statement (excluded from this chapter)

2. Income Statement

Content
1. Meaning
➢ ‘Income Statements’ is a generic term.
➢ Refers to components of Financial Statements used for: Determination of operating
result i.e. Ascertainment of profit or loss
➢ Income Statements include:
Trading Account
Profit & Loss Account (P/L A/c)
Profit & Loss Appropriation Account (in case of partnership only)
Form of Organisation Components of Income Statement
Proprietary Organisation Trading A/c, Profit & Loss A/c
Partnership Organisation Trading A/c, Profit & Loss A/c, Profit & Loss Appropriation
A/c

3. Trading Account

Content
1. Objective: Determine Gross Profit / Gross Loss.
2. Based on:
• Matching of Sales and COGS.
• Considers direct incomes and direct expenses only.
• It is a Nominal Account, closed by transferring the balance to P/L A/c.

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3. Items in the Trading Account (Debit Side)
a. Opening Stock: Finished goods from the Trial Balance.
b. Purchases:
Cash + Credit Purchases.
Less:
• Purchase Returns
• Goods withdrawn by proprietor
• Free samples distributed
c. Other Direct Expenses
Costs from purchase till making goods saleable.
E.g.: Freight Inward, Octroi, Wages, etc.
d. Gross Loss: If Dr. side > Cr. side, Gross Loss is transferred to P/L A/c.
4. Items in the Credit Side of Trading Account
a. Sales Revenue:
From regular business activities.
Less: Sales Returns
As per Accrual Concept, sales are recorded when earned.
b. Closing Stocks/Inventories:
Only finished goods.
Valued at Cost or NRV, whichever is lower (as per Conservatism).
c. Gross Profit: If Cr. side > Dr. side, Gross Profit is transferred to P/L A/c.
Trading Account for the year ended
Particulars Amount Particulars Amount
To Opening Stock By Sales
To Purchases Less: Sales Returns
Less: Purchase Returns By Closing Stock
To Wages By Profit and Loss A/c
(Gross Loss transferred)
To Other Direct Expenses
To Profit and Loss A/c
(Gross Profit transferred)

4. Profit & Loss Account

Content
1. objective
The second income statement, prepared after determining Gross Profit or Gross Loss. It
determines the Net Profit or Net Loss for the accounting period.
Debit Side of Profit & Loss A/c
2. Cost of Sales
Refers to the cost of goods sold, which could be manufactured or directly related to goods.
3. Other Expenses

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Expenses not directly related to the main business activity, including:
➢ Administrative Expenses (e.g., office staff salary, salesmen commission, insurance,
audit fees)
➢ Selling & Distribution Expenses (e.g., advertising, bad debts, free samples)
➢ Items like loss on sale of fixed assets, interest, and provisions.
4. Abnormal Losses
Losses that are unusual or unexpected, such as stock destroyed by fire or goods lost in
transit.
Credit Side of Profit & Loss A/c
5. Revenue Incomes
Incomes from ordinary business activities, such as commission received, discount received,
etc.
6. Other Incomes
Incomes unrelated to the main business activity, including items like interest received and
dividends received.
7. Transfer of Result to Balance Sheet
The Net Profit or Net Loss is transferred to the balance sheet as an addition or reduction
in owners' equity. In a company, the profit figure is shown separately.
Profit & Loss Account for the year ended
Particulars Particulars
To Trading A/c By Trading A/c
(Gross Loss transferred) (Gross Profit transferred)
To Administrative Expenses By Other Income
To Office Salaries By Interest Received
To Communication By Commission Received
To Travel & Conveyance By Profit on Sale of Assets
To Office Rent By Rent Received
To Advertising By Capital A/c
To Audit Fees (Net Loss Transferred)
To Insurance
To Repairs & Maintenance
To Selling & Distribution Expenses
To Bad Debts
To Salesmen Commission
To Interest on Loans
To Depreciation and Amortization
To Financial Expenses
To Bank Charges
To Loss on Sale of Assets
To Capital A/c
(Net Profit Transferred)

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5. Profit & Loss Appropriation Account

Content
1. Profit & Loss Appropriation Account
Shows how the net profit is appropriated (distributed) among the partners in a partnership
business.
2. Applicability
Not required for sole proprietorship businesses.
3. Uses of Net Profit
The net profit can be used for:
✓ Distributing dividends
✓ Creating reserves, etc.
4. Purpose of P/L Appropriation A/c
It is used to show the distribution adjustments of profits. Profit appropriation does not
mean an expense.
5. Effect on Owner's Equity
After making the distribution entries, the remaining surplus is added to the owner’s equity.
Profit and Loss Appropriation Account for the year ended
Particulars Particulars
To Proposed Dividend By P/L A/c
To Reserves (Transfer) (Net Profit Transferred)
To Capital A/c

6. Manufacturing Account

Content
1. Manufacturing Account
➢ Prepared by businesses that manufacture goods to show the cost of goods
manufactured.
➢ It is an extension of the Trading Account.
2. Purpose
To determine the cost of producing goods and then transferring this cost to the Trading
Account.
Manufacturing Account for the year ended
Particulars Particulars
To Opening Stock of Raw Materials By Closing Stock of Raw Materials
and WIP and WIP
To Purchase of Raw Materials By Cost of Goods Manufactured
Less: Purchase Returns transferred to Trading Account
To Wages
To Other Direct Expenses

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1. Trading Account
Prepared after the Manufacturing Account to show Gross Profit or Gross Loss.
2. Purpose
To match the cost of goods manufactured with the sales revenue to calculate Gross Profit.
Trading Account for the year ended
Particulars Particulars
To Opening Stock of Finished By Sales
Goods Less: Sales Returns
To Cost of Goods Manufactured
(Transferred from Manufacturing
Account)
By Profit and Loss A/c (Gross By Closing Stock of Finished
Profit transferred) Goods
By Profit and Loss A/c
To Profit and Loss A/c (Gross
Loss transferred)

7. Balance Sheet

Content
1. Balance Sheet
A financial statement showing the financial position of an organization at a specific date.
It includes assets and liabilities at a particular point in time.
2. Types of Balance Sheet Formats
➢ Horizontal Format: Liabilities on the left, assets on the right (traditional format).
➢ Vertical Format: Liabilities and assets appear in a top-down order.
3. Marshalling of Items
The order in which items appear in the Balance Sheet. It can follow:
✓ Rigidity Order (Assets listed from most permanent to current, and liabilities from long-
term to short-term).
✓ Liquidity Preference Order (Reverse ordering, current assets and short-term liabilities
appear first).
4. Preparation of Final Accounts
Final accounts are prepared from the ledger balances and include:
✓ Income Statements (e.g., Trading Account, Profit & Loss Account).
✓ Balance Sheet. Adjustments may be made for accounting principles or errors.
5. Important Adjustments
Adjustments/rectifications may include:
✓ Closing stock, Outstanding expenses, Prepaid expenses, Accrued income, Income
received in advance
✓ Goods sold on approval basis, Goods withdrawn by proprietor, Depreciation, Bad debts,
Provision for doubtful debts, etc.

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6. Sequence of Preparing Financial Statements
➢ Trading Account is prepared to determine Gross Profit or Gross Loss.
➢ Profit & Loss Account is prepared next to determine Net Profit or Net Loss.
➢ The Balance Sheet is prepared to reflect the final financial position.
7. Transfer of Balances
✓ Gross Profit/Gross Loss from the Trading Account is transferred to Profit & Loss
Account.
✓ Net Profit/Net Loss from the Profit & Loss Account is transferred to the Capital
Account.
✓ For partnerships, Profit & Loss Appropriation Account is also prepared.
Balance sheet as at
Liabilities Amount Assets Amount
Capital: PPE:
Opening capital XXXX Land
Less:Drawings (XXXX) Building
Add/Less: Plant and Machinery
C.y Netprofit/Loss XXXX Vehicles
XXXX Computer systems
Office equipment
Long term Liabilities: Intangible Assets
Long term Loans from banks or financial Current Assets:
Institutions Stocks
Sundry debtors less provisions
Current Liabilities: Bills receivables
Short-term borrowings Cash in hand
Sundry creditors Cash at bank
Bills payable Advances to suppliers
Advances from customers Prepaid expenses
Outstanding expenses Income receivable
Income received in advance
Total Total

8. Important Adjustments:

Closing Inventory and its valuation:

a) Usually there is no account to show the value of goods lying in the godown at the end of
the year. However, to correctly ascertain the gross profit, the closing Inventories must
be properly taken and valued.
b) If closing stock given as adjustment to trial balance then the entry is
Closing Inventory Account Dr.
To Trading Account
The closing inventory is also shown in balance sheet on Assets side.

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c) If Closing Stock appears in the Trial balance means it was already adjusted with purchases.
Now the purchases given in trial balance are Adjusted purchases. Then the closing
inventory is not entered in the trading account, it is shown only in the balance sheet.
d) The valuation principle for inventory is cost or net realisable value whichever is lower.

1. Outstanding expenses or Accrued expenses:

➢ If outstanding expenses given as adjustment, then it is added to relevant expense in
P&l and outstanding expense is shown under Liabilities side.
➢ If outstanding expenses given under Trial balance, then it is shown under Liabilities
side only.
2. Prepaid expenses:
➢ If Prepaid expenses given as adjustment, then it is reduced from relevant expense in
P&l and Prepaid expense is shown under Assets side.
➢ If Prepaid expense given under Trial balance, then it is shown under Assets side only.
3. Accrued income:
➢ If Accrued income given as adjustment, then it is added to relevant income in P & L
and Accrued income is shown under Assets side.
➢ If Accrued income given under Trial balance, then it is shown under Assets side only.
Income received in advance:
➢ If Income received in advance is given as adjustment, then it is reduced from relevant
income in P & L and Income received in advance is shown under Liabilities side.
➢ If Income received in advance given under Trial balance, then it is shown under
Liabilities side only.
4. Goods sold on approval basis:
➢ If approval received before the end of financial year or reasonable time period
expired, it is treated as sales and added to current year revenue.
➢ If approval not yet received before the end of financial year and reasonable time not
yet expired, then it is treated as stock lying with customer and will show along with
closing stock in Trading A/c.
5. Goods distributed as free samples: It is reduced from purchases in Trading A/c and shown
as expense in P&L.
6. Goods withdrawn by proprietor: It is reduced from purchases in Trading A/c and shown
as reduction from capital in Balance sheet.
7. Abnormal loss of stock: It is initially shown under credit side in Trading A/c to match with
purchased goods. Later, based on amount of recovery from Insurance company balance
amount debited under P&L as loss from abnormal loss.
8. Bad debts, Provision for doubtful debts, Provision for discount on debtors: Previously
discussed under Introduction to FA chapter.

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6. PREPARATION OF FINAL ACCOUNTS OF
NOT-FOR-PROFIT ORGANISATIONS
1. Non-profit Organisations

Content
1. Meaning of NPO
➢ Organisations formed primarily to offer services to society rather than to earn profit.
➢ Their main objective is to operate for adding value to different sections of the society
and the funds are utilized maximum for the benefits of the society.
➢ Examples include educational institutions, charitable trusts, social clubs, religious
institutions, etc.
2. Features of Non-profit Organisations
The salient features of such non-trading entities are:
➢ This organization is governed by elected body or trustee board.
➢ Its operation is not driven by any profit motive unlike trading concerns.
➢ Main purpose of the organization is to provide social service.
➢ Main source of their income comes from donation and membership subscription.
➢ The funds are utilized maximum for the benefits of the society.
➢ The membership process for this concern is non-transferable.
➢ The method of accounting that is followed here is entity concept.
3. Financial Statements of Non-profit Organisations
The different components of the financial statements of non-profit organisations are:
➢ Receipts & Payments Account;
➢ Income & Expenditure Account; &
➢ Balance Sheet

2. Preparation of Receipts and Payments Account

Concept
1. Type of Account
➢ This is the summarized form of the cash book of a non-profit organisation.
➢ Entries are made on cash basis and
➢ Items pertaining to previous year or current year or subsequent years are also
recorded.
2. Nature of the Account
➢ It is a real account
➢ Records only actual cash/bank transactions.
3. Account Structure & Contents
➢ The account begins with the opening balance of cash and bank and ends with the
closing balance of cash and bank.

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➢ It is a memorandum account in which the receipts are shown on left side and payments
are shown on the right side.
➢ Capital as well as revenue items are entered in the Receipts and Payments Account.
➢ No provisions are recorded in this account.
Proforma of Receipts and Payments Account
Receipts (Rs.) Payments (Rs.)
Starts with opening balance
All receipts (capital & revenue) All payments (capital & revenue)
May relate to previous, current, or May relate to previous, current, or
subsequent periods subsequent periods
Ends with closing balance

3. Preparation of Income and Expenditure Account

Content
1. Type of Account
It is the income statement of a non-profit organisation, similar to the Profit & Loss Account
of profit-oriented entities.
2. Nature of the Account
It is a nominal account – only revenue items are recorded (no capital items).
3. Basis of Accounting
Prepared on the accrual basis – incomes and expenses are recorded when they are earned
or incurred, not when cash is received or paid.
4. Period Coverage
Only items pertaining to the current accounting period are included.
5. Account Structure
Revenue Incomes → shown on the credit side.
Revenue Expenditures → shown on the debit side.
6. Result/Balancing Figure
If incomes > expenditures, the result is Surplus.
If expenditures > incomes, the result is Deficit.
Proforma of Income and Expenditure Account:
Dr. Expenses (Rs.) Cr. Income (Rs.)
Only revenue expenses Only revenue receipts
Only related to the current period Only related to the current
period
Shows either Surplus or Deficit

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4. Preparation of Balance Sheet

Content
1. Date of Preparation
It is prepared as on the last day of the accounting period.
2. Contents
Shows the organisation’s Assets and Liabilities, similar to any other entity.
3. Basis
Prepared based on the Accounting Equation: Assets = Liabilities + Capital Fund
4. Capital Representation
There is no Capital Account. Instead, a Capital Fund (also called General Fund) is shown under
liabilities.
5. Surplus/Deficit Adjustment
The Surplus or Deficit from the Income & Expenditure Account is added to or deducted
from the Capital Fund at year-end.
6. Structure
➢ Assets include Fixed Assets, Investments, Cash/Bank, Receivables, etc.
➢ Liabilities include Outstanding Expenses, Subscriptions Received in Advance, Loans, etc.
➢ Capital Fund appears on the liabilities side, representing accumulated surplus.

5. Difference between Receipts and Payments Account and Income and Expenditure Account

Receipts & Payments Account Income & Expenditure Account

1. It is a summarized Cash Book 1. It closely resembles the Profit & Loss
Account of a trading concern.
2. Receipts are debited and Payments are 2. Incomes are credited and Expenditures are
credited. debited.
3. Transactions are recorded on a Cash basis. 3. Transactions are recorded on an Accrual
basis.
4. Amounts related to previous or future 4. Transactions are recorded on accrual basis.
periods may remain included. Outstanding All amounts not related to the current
amounts for the current year are excluded. period are excluded. Outstanding amounts
of the current period are added.
5. It records both Capital and Revenue 5. It records only Revenue transactions.
transactions.
6. It serves the purpose of a Real Account. 6. It serves the purpose of a Nominal Account.
7. It starts with the opening Cash and Bank 7. It does not record such balances; rather, its
balances and ends with the closing Cash and final balance shows a surplus or deficit for
Bank balances. the period.
8. It does not record notional losses or non- 8. It considers all such expenses (e.g., bad
cash expenses like bad debts, depreciation, debts, depreciation, etc.) for matching
etc. against revenues.

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9. Its closing balance is carried forward to the 9. Its closing balance is transferred to Capital
same account of the next accounting period. Fund, General Fund, or Accumulated Fund in
the same period’s Balance Sheet.
10. It helps to prepare an Income & Expenditure 10. It helps to prepare a Balance Sheet.
Account.

6. Accounting Treatment of Various Inflows in Non-Profit Organisations

Content
1. Entrance Fees
➢ Received at the time of admission of a new member; generally one-time and non-
recurring.
➢ Can be capitalised (treated as capital receipt) or treated as revenue, based on the
institution’s policy.
➢ If admissions are regular, it may be treated as a revenue receipt.
2. Donations
➢ Donations may be used to meet capital or revenue expenses.
➢ Specific Purpose Donations: Credited to a separate fund; amounts are spent for the
intended purpose only.
➢ Such funds may be invested, and the income earned is also credited to the same fund.
➢ General/Small Donations (not earmarked): Treated as revenue receipts and credited to
the Income & Expenditure A/c.
3. Legacy
➢ Many times trusts are formed in the memory of certain persons by their will.
➢ In such case after the demise of the person, the funds pass on to the institution.
➢ Such legacies are of course one-time and therefore should be taken to the capital fund.
4. Endowments
➢ Sometimes, donations are also in the form of endowments to be used as per instructions
of the donor.
➢ These are to be treated as capital receipts.
5. Life Membership Fees
➢ These could be taken as capital receipts and every year a charge is debited.
➢ In other words, when received, it could be treated as deferred receipt in the balance
sheet and every year a specific amount is credited to Income & Expenditure A/c.
6. Subscriptions
➢ These are annual receipts and therefore taken as revenue receipts.
➢ These must be recognised as revenue on the accrual concept

7. Fund Asset Accounting and its peculiarities

Content
i. Capital Fund
➢ Also called General Fund or Accumulated Fund.

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➢ It represents the capital of the non-profit, calculated as assets - liabilities.
➢ Surplus or deficit is added/deducted, and capitalized income (like donations) may also
be added.
ii. Special Fund
➢ Created from special donations, subscriptions, or part of surplus (e.g., Building Fund).
➢ Used for specific expenses or asset acquisition.
➢ If any income is derived out of investments made against this fund or if any profit or
loss occurs due to sale of such investments, such income or profit or loss is transferred
to this fund.
➢ If the Special Fund is used to meet an expense, the following entry is passed:
Special Fund A/c Dr.
To Bank A/c (amt. of expense)
If any balance there after utilization, it will be transferred to Capital Fund.
Special Fund A/c Dr.
To Capital Fund A/c (Balance of Special Fund)
➢ If the Special Fund is used to purchase an asset
Asset A/c Dr.
To Bank A/c (Cost of the asset)
Special Fund A/c Dr.
To Capital Fund A/c (Special Fund closed)
iii. Donations
a. Donations for a specific purpose are credited to the relevant Special Fund (e.g., Building
Fund).
b. Follow by-laws for other donations.
c. Non-recurring donations go to Capital Fund, recurring ones to Income & Expenditure
Account.
Donations paid by the organization are debited to Income & Expenditure Account.
iv. Legacy received
➢ It is to be directly added with Capital Fund after deduction of tax, (if any).
➢ It is a kind of donation received according to the will made by a deceased person.
v. Entrance Fees or Admission Fees
➢ The rules or by-laws of the concern should be followed.
➢ If there is no such rule, Admission or Entrance Fees paid once by members for acquiring
membership should be added with Capital Fund.
➢ If such fees are of small amounts covering the expenses of admission only, the fees
may be credited to Income & Expenditure Account.
vi. Subscriptions
➢ Annual subscriptions are credited to Income & Expenditure Account on accrual basis.
➢ Life membership subscription is usually credited to a separate account shown as a
liability.

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➢ Annual Subscription apportioned out of that is credited to Income & Expenditure
Account and deducted from the liability. Thus, the balance is carried forward till the
contribution by a member is fully exhausted.
➢ If any member dies before hand, the balance of his life Membership contribution is
transferred to Capital Fund or General Fund.

8. Restaurant Trading and Bar Trading

Content
1. Restaurant/Bar Trading
Some clubs have Restaurant and Bar facilities for members and outsiders. Under the
circumstances, Restaurant Trading or Bar Trading Account is opened to ascertain the
Restaurant or Bar profit, it is just like Trading Account which is opened in case of a trading
concern.
2. Profit Transfer
The Restaurant or Bar profit so ascertained from Restaurant Trading or Bar Trading is
transferred to the Income and Expenditure Account as we generally transfer the Gross
Profit from Trading Account to Profit and Loss Account in case of Trading concern.

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7. PREPARATION OF FINAL ACCOUNTS FROM
INCOMPLETE RECORDS
1. Single Entry System

Content
1. Introduction
➢ Transactions occur in every business organisation.
➢ Primary function of accounting is to record these transactions.
➢ Transactions should be recorded in a systematic and scientific manner, as per the Double
Entry System.
➢ However, some entities do not follow the double entry system.
➢ Such entities are generally small-time traders e.g., grocery stores, kirana shops, etc.
➢ They maintain records in a casual and sketchy manner.
➢ This leads to incomplete recording of transactions.
➢ This incomplete method is referred to as the Single-Entry System of account keeping.
2. Meaning of Single-Entry System
➢ Does not follow double entry principles.
➢ Some transactions:
▪ Fully recorded
▪ Partially recorded
▪ Not recorded at all
➢ Term ‘Single Entry’ = Misnomer
➢ Better term: ‘Incomplete Records’
3. Features of Single-Entry System
➢ Unscientific method of recording.
➢ Mix of: No entry, Single entry, and Double entry
➢ Used by: Small businesses, semi-skilled service providers, workers, etc.
➢ No uniformity in recording.
➢ Only Cash A/c and Personal A/cs are usually maintained.
➢ Original vouchers kept for reference; Relevant accounts not prepared
4. Limitations / Defects of Single-Entry System
➢ Trial Balance not possible – No double entry → no arithmetical accuracy.
➢ Profit/Loss only estimated – No Nominal A/cs maintained.
➢ Balance Sheet can't be prepared – Real A/cs not available.
➢ Errors & Frauds not traceable – Lack of checks.
➢ Improper valuation – Assets & liabilities not correctly shown.
➢ Not reliable for external users – e.g., Banks can’t assess creditworthiness.
➢ Business & personal transactions may get mixed up.

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2. Difference Between Single Entry System and Double Entry System

Aspect Single Entry System Double Entry System

1. Approach Casual and unscientific recording of Scientific and systematic method
transactions. of recording transactions.
2. Recording Only one aspect (debit or credit) of a Both debit and credit aspects of
Transactions transaction is recorded, or sometimes every transaction are recorded.
both aspects are recorded
incompletely.
3. Subsidiary No subsidiary books (except cash book). Subsidiary books such as sales,
Books purchases, etc., are maintained.
4. Ledger Ledger contains only cash and personal Ledger contains personal, real, and
accounts. nominal accounts.
5. Trial Balance Cannot be prepared. Can prepare a trial balance to
verify accuracy.
6. Financial Only a rough profit or loss estimate is Trading, Profit & Loss Accounts,
Statements made, and a Statement of Affairs is and Balance Sheet are prepared.
prepared, resembling a balance sheet.
7. Fraud Greater likelihood of fraud or Less likelihood of fraud, due to the
Detection misappropriation. checks and balances in the system.
8. Usage Followed by small businesses, sole Followed by most businesses,
traders, professionals, and including large corporations, to
partnerships who can't afford formal ensure accuracy and reliability of
books of accounts. financial records.

3. Accounting from Incomplete Records & Preparation of Final Accounts

Content
1. Entities not following double entry have no uniformity in recording.
2. Transactions recorded as per personal needs; no proper books maintained.
3. TB & FSs can’t be prepared directly.
4. Still, such entities want to know: Operating results (Profit/Loss) & Financial position
(Assets/Liabilities)
5. But partial/incomplete records don’t give accurate info.

Methods to prepare Final Accounts from Incomplete Records

a. Balance Sheet Approach (Net Worth Approach / Comparison Approach)
b. Conversion Approach

Page | 77
4. Approach 1: Balance Sheet / Net Worth / Comparison Approach

Content
1. How it Operates?
➢ Profit/Loss = Change in Net Worth over two periods.
➢ Capital (Net Worth) at two dates is compared.
➢ Statement of Affairs is prepared to find capital on both dates.
➢ Difference in capital = Operating Result (after adjustments).
2. Statements Prepared Under Balance Sheet Approach
a. Statement of Affairs
b. Statement of Profit & Loss
c. Final Statement of Affairs
3. Statement of affairs:
It is a statement of financial position that is prepared with the balances of various assets
and liabilities to ascertain the capital/ net worth at the beginning and end of the accounting
period.
4. Statement of profit & loss:
➢ This statement is prepared for determination of the profit/ loss) of the entity.
➢ Firstly, the trading profit/loss is determined by comparing the capital / net worth as
at the beginning and end of the accounting period.
➢ Thereafter, effect is to be given for the necessary adjustments for determination of
the net profit/ loss for the accounting period.
Particulars (Rs.) (Rs.)
Capital (at the end) xx
Less: Capital (at the beginning) xx xx
Add: Drawings xx
xx
Less: Further Capital Introduced (if any) xx
Profit/Loss xx
Less: Adjustments, if any say, Bad debts,
Depreciation etc. xx
Net Profit/Loss for the Period xx
Less: Appropriation Items:
(i) Interest on Partner’s Capital xx
(ii) Partners’ Salaries etc. xx xx
Divisible Profit xx
5. Final statement of affairs:
➢ This statement is to be prepared at the end of the accounting period with the closing
balances of the assets and liabilities after providing for the necessary adjustments viz.
Depreciation, provision for bad & doubtful debts etc.
➢ It is also known as the revised statement of affairs.

Page | 78
Difference between ‘Statement of Affairs’ & ‘Balance Sheet’
Aspect Statement of Affairs Balance Sheet
1. Preparation Prepared by entities following the Prepared by entities following the
Method single-entry system. double entry system.
2. Purpose Determines Capital or Net Worth at Discloses the financial position of
two different points in time. the entity.
3. Reliability Reflects an estimated financial Reflects the true financial position.
position.
4. Reliability of The information is comparatively The information is more reliable due
Information less reliable. to the double-entry system.
5. Capital Account The capital balance is calculated as The capital balance is available from
Balance the excess of assets over liabilities. regular accounting records.
6. Format No statutory format is specified. The Balance Sheet format is
specified under various statutes,
e.g., Companies Act, Banking
Regulations Act.
Statement of Profit & Loss and Profit & Loss Account
Aspect Statement of Profit & Loss Profit & Loss Account
Preparation Prepared by entities following the Prepared by entities following the
Method single-entry system. double entry system.
Profit/Loss Profit or loss is determined by Profit or loss is determined by
Determination comparing capital/net worth at two matching expenses and losses against
points in time. incomes and gains.
Reliability of Reflects the estimated profit or loss Reflects the true profit or loss of an
Profit/Loss of an entity. entity.
Disclosure of Not all items of expenses, losses, All items of expenses, losses,
Items incomes, and gains are properly incomes, and gains are properly
disclosed. disclosed.
Reliability of The information is comparatively less The information is reliable, as it
Information reliable. follows the double-entry system.

5. Approach 2: Conversion Method

Content
1. Key Points:
➢ Used when only some transactions are recorded (incomplete data).
➢ Direct preparation of financial statements is not possible (no full ledger balances).
➢ Available data is converted into double entry form and then to draw up the Profit and
Loss Account and the Balance Sheet, instead of determining the amount of profit/loss
by preparing the statement of affairs.
➢ Prepare accounts like: Debtors A/c Creditors A/c Cash Book Asset A/cs, etc.

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➢ Missing info (e.g., Credit Sales, Cash Paid) is calculated using balancing figures.
➢ No fixed steps – depends on available data in each case.
➢ Called Conversion Approach as single entry data is converted to double entry.
2.
General
Techniques

Fresh Derivation of
Investment by Information
proprietors/ Techniques from Cash
partners of obtaining Book

complete accounting
information

Distinction
Analysis of
between
Sales Ledger
Business
Expenses and and Purchase
Ledger
Drawings

3. From exam point of view

In the examination they would be given:
a. Opening and closing assets and liabilities
b. Cash transactions
c. Other information
From this we have to prepare
a. Trading Account
b. Profit and loss account
c. Balance Sheet
How to proceed?
STEP I:
Prepare format of
1. Trading Account for the year
2. Profit and loss account for the year
3. Balance Sheet at the end of the year
And various other accounts as working notes as follows
1. Opening Balance Sheet
2. Cash Book (with two separated Cash and Bank column if possible)
3. Total Debtors Account
4. Bills Receivable Account (if required)
5. Total creditors Account
6. Bills payable Account (if required)
7. Any particular fixed asset (if required)

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8. Any other account as required
STEP II
a. Do the posting of opening balances in the opening balance sheet and as opening balance
in concerned account.
b. Do the posting of all the transactions on the basis of double entry.
c. Take in to account all the information given.
d. Close all the accounts one by one logically, finding out missing figures and posting them
to second account concerned. e.g. you can find cash collected from debtors from cash
account, then post it to debtors account and find closing debtors etc.
e. Complete the trading account, profit and Loss account and then balance sheet.

Incomplete Completion
Preparation Preparation
books of of double Accounting
of Trial of Financial
entry in all process
accounts Balance statements
transactions

4. Some Important Points

➢ Single entry problem is just like su do ku, one must be able to find out missing figures
logically and sequentially.
➢ The main items are:
a. Rent of premises commonly used for residential as well as business purposes.
b. Common electricity and telephone bills.
c. Life insurance premiums of proprietor/partners paid from business cash.
d. Household expenses met from business cash.
e. Private loan paid to friends and relatives out of business cash.
f. Personal gifts made to any friends and relatives out of business cash.
g. Goods or services taken from the business for personal consumption.
h. Cash withdrawals to meet family expenses.
i. Amount collected from debtors directly used for meeting personal expenses.
So, it is necessary to scan the summary of cash transactions, business resources and
their utilization to assess the nature of drawings and its amount.
➢ Fresh Investment by proprietors / partners
a. Money collected and put in the business on maturity of Life Insurance Policy of the
proprietors.
b. Interest and dividend of personal investment of the proprietors collected and put
in the business.
c. Income from non-business property collected and put in the business.
d. Payments made to creditors out of personal cash.

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8. PARTNERSHIP ACCOUNTING
1. Admission of Partner

Partnership Definition
➢ The term ‘partnership’ refers to ‘the relation between two or more persons who have agreed
to share the profits of a business carried on by all or any of them acting for all.’
➢ The persons who have entered into partnership agreement with each other are referred to as
Partners, and they are collectively referred to as the Partnership Firm.

Admission of New Partner

➢ To meet the need for additional capital, technical expertise, or better managerial efficiency,
a partnership firm may admit a new partner with the consent of all existing partners.
➢ A new partner can be admitted only with the consent of all existing partners, unless agreed
otherwise.
➢ Admission of a new partner is a form of partnership reconstruction, as it ends the existing
partnership and creates a new one.

Accounting Adjustments on Admission

1. Computation of New Profit-Sharing Ratio
2. Revaluation of Assets and Liabilities
3. Memorandum Revaluation of Asset and liabilities (to bring the asset and liabilities to the
book value)
4. Distribution of Reserves, Accumulated Profits and Losses
5. Adjustment for Goodwill
6. Adjustments regarding Capital Contribution of new partner and the Capitals of the
existing partners
7. Adjustment for Life Policy

1. New Profit-Sharing Ratio

➢ The new profit-sharing ratio is computed based on how the existing partners will sacrifice
their share of profit for the new partner. This is known as the Sacrificing Ratio.
➢ Sacrificing Ratio = (Old Ratio – New Ratio).
➢ New ratio may be mutually agreed upon or unchanged.

2. Revaluation of Assets and Liabilities

➢ At the time of admission (or any reconstruction), assets and liabilities are revalued to reflect
their fair values and to uncover any hidden profits or losses.

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➢ Profit arises from an increase in asset values or decrease in liabilities, while loss results from
a decrease in assets or increase in liabilities.
Journal Entries
Revaluation Event Journal Entry
Assets Upward Revaluation of Asset Asset A/c Dr.
To Revaluation A/c
Downward Revaluation of Asset Revaluation A/c Dr.
To Asset A/c
Recording of Unrecorded Asset Asset A/c Dr.
To Revaluation A/c
Liabilities Upward Revaluation of Liability Revaluation A/c Dr.
To Liability A/c
Downward Revaluation of Liability Liability A/c Dr.
To Revaluation A/c
Recording of Unrecorded Liability Revaluation A/c Dr.
To Liability A/c
Revaluation Revaluation Expenses Paid by the Firm Revaluation A/c Dr.
Expenses To Bank A/c
Revaluation Expenses Paid by a Partner Revaluation A/c Dr.
To Partner’s Capital A/c

3. Memorandum Revaluation Account

Content
❖ When a firm chooses not to alter the Balance Sheet values of assets and liabilities, a
Memorandum Revaluation Account is prepared.
❖ The steps involved are:
a. Record increase/decrease in asset and liability values.
b. Share resulting profit/loss among old partners in old ratio.
c. Reverse the changes made to assets and liabilities.
d. Calculate profit/loss after reversal.
e. Share this among all partners (including the new partner) in new ratio.
Proforma: Memorandum Revaluation Account
Particulars Amount Particulars Amount
(₹) (₹)
To Assets (Decrease) x By Assets (Increase) x
To Liabilities A/c (Increase) x By Liabilities A/c (Decrease) x
To Partners’ Capital A/c (Share of x By Partners’ Capital A/c (Share of x
Revaluation Profit) Revaluation Loss)
(Old partners in old profit-sharing (Old partners in their old profit-
ratio) sharing ratio)

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To Reversal of Items b/d x By Reversal of Items b/d x
To Partners’ Capital A/c x By Partners’ Capital A/c x
(Revaluation Profit amount, all (Revaluation loss amount, all
partners in new profit-sharing partners in their new profit-sharing
ratio) ratio)
Total xxx Total xxx

4. Distribution of Reserves/Profits/Losses
Content
These are undistributed profits or losses from previous periods.
• Reserves/Accumulated Profits are credited to old partners' capital accounts in the old ratio.
• Accumulated Losses are debited to old partners' capital accounts in the old ratio.
Journal Entries
Type Fluctuating Capital Method Fixed Capital Method
Reserves / Reserves A/c Dr. Reserves A/c Dr.
Accumulated Profits Profit and Loss A/c Dr. Profit and Loss A/c Dr.
To Partners’ Capital A/c To Partners’ Current A/c
(Among old partners in the old (Among old partners in the old
profit-sharing ratio) profit-sharing ratio)
Accumulated Loss Partners’ Capital A/c Dr. Partners’ Current A/c Dr.
To Profit and Loss A/c To Profit and Loss A/c
(Among old partners in the old (Among old partners in the old
profit-sharing ratio) profit-sharing ratio)

5. Adjustment for Goodwill

Introduction
➢ Goodwill exists due to efforts of old partners.
➢ It enables the firm to earn super-normal profits.
➢ A new partner benefits from these profits upon joining.
➢ Therefore, the new partner must bring in an extra amount besides capital.
➢ This extra amount is called Premium for Goodwill.
Accounting of Goodwill
❖ AS-26 provides clear guidance on recognition and treatment of goodwill.
❖ It applies to all intangible assets, including goodwill—whether tangible or intangible, assets
must meet recognition criteria.
❖ Asset recognition criteria:
• Expected future economic benefits
• Reliable measurement of cost
❖ Internally generated goodwill usually fails these criteria, especially reliable measurement.
❖ Therefore, goodwill is generally not shown in the books as an asset.

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❖ Since goodwill cannot be shown in the books of Account, the treatment will be as below under
different situations through new partner’s capital/current Account.
Scenario Journal Entry
When Premium for Goodwill is Bank/Cash/Other Mode A/c Dr.
Paid by New Partner To Old Partners’ Capital / Current A/c (in sacrificing ratio)
When New Partner Does Not New Partner’s Capital/Current A/c Dr.
Pay Premium for Goodwill To Old Partners’ Capital / Current A/c (in sacrificing ratio)
When New Partner Pays Partly New Partner’s Capital/Current A/c Dr. (to the extent not
for Goodwill paid)
Bank/Cash/Other Mode A/c Dr.
To Old Partners’ Capital / Current A/c (in sacrificing ratio)
Goodwill Already Shown in the ❖ Goodwill may be already shown in the balance sheet before
Balance Sheet admission.
❖ It is not disturbed because its nature (purchased or self-
generated) is not known.
❖ New partner will not bring premium for such goodwill.
❖ Old partners are assumed to have already received its
benefit.
❖ If the question asks to write off goodwill, do so among old
partners in old ratio.
Old Partners’ Capital A/c Dr.
To Goodwill A/c
(in old profit-sharing ratio)
Valuation of Inherent or Non-Purchased Goodwill

1. Average Profits Method

Value of Goodwill = Agreed Number of Years (Purchase) × Average Maintainable Profits
Average Maintainable/Profit:
Average Annual Profits 00
[Simple average or may be weighted average considering the trend of profits]
Less: Exceptional/Casual Income 00
Add: Abnormal Loss 00
00
Add: Capital Expenditure wrongly charged against profits 00
00
Less: Provision for Taxation 00
Adjusted Maintainable Profits 000
(“Adjustments for undercharged or overcharged Depreciation or under or over
valuation of stocks to be made, if required)
➢ Fluctuating Profits → Use Simple Average
➢ Increasing Trend in Profits → Use Weighted Average

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➢ Consistently Decreasing Profits → Consider Lowest Profit (after adjustments)
➢ Exceptional income/expense (one-time, non-recurring) should not distort regular profit trends.
Adjust these items only in that particular year.
➢ Later Years Often Get Higher Weight in Weighted Average
2. Super Profits Method
Super Profit = Future maintainable profits – Normal Return on Capital Employed
Goodwill = Super Profit × No. of years of purchase
Steps (a) Calculation of Capital employed OR Average Capital Employed
Sundry Assets 00
Excluding:
Goodwill But including Goodwill at Cost Paid for
Non-trading assets &
Fictitious Assets
Less:
Current Liabilities & Provisions -00
Contingent & Probable Liabilities -00
(Trading) Capital Employed 00
Less:
½ of Current years trading profits after taxation (if the profits remain -00
undistributed)
Average Capital Employed 000
Step (b) Average Annual Adjusted Profits (Maintainable)
Step (c) Calculate Normal Return on Capital Employed or Average Capital Employed
Step(d) Deduct Normal Return (c) from Average Maintainable Profits (b).
The difference is called Annual Super Profit
Step (e) Goodwill = Annual Super Profit × No. of Years for which the Super Profit can be
maintained.
3. Capitalization of Profits Methods
A. Profits
Under the method follow these steps –
a. Calculate Annual Maintainable Profit as shown above.
b. Calculate normal Capital Employed capitalizing the above profit by applying the normal rate
of return.
Normal Capital Employed = Maintainable Profit / Normal Rate of Return × 100
c. Calculate actual Capital Employed
d. Goodwill = Normal Capital Employed – Actual capital Employed.
B. Super Profits
a. Calculate Super profit as said under Method 2.
b. Goodwill = Super Profit / Normal Rate of Return × 100
4. Annuity Method

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➢ It is a derivative of super profit concept.
➢ If super profit is expected to be earned uniformly over a number of years, Goodwill is
computed with the help of Annuity Table.
➢ Calculate Super Profit as discussed before
➢ Goodwill = Annual Super Profit x Present Value of Annuity of Rs.1.

6. Adjustments regarding Capital Contribution of new partner and the Capitals of the
existing partners
Concept
➢ New partner brings capital as cash or other assets, as mutually agreed.
➢ Revaluation profit/loss, reserves, and goodwill adjustments are made in books.
➢ After adjustments, capital account balances are finalized.
➢ These adjusted capitals are shown in the post-admission Balance Sheet.
➢ Partners may decide to maintain capital balances in a fixed ratio.

7. Adjustment for Life Policy

Content
➢ JLIP covers lives of all partners.
➢ Premium is paid by the firm.
➢ On admission of a new partner, use the Surrender Value of the policy for accounting.
➢ Maturity Value is not considered at this stage.

2. Retirement of Partner

Content
1. Retirement of Partner
➢ A partner may retire from the firm for various reasons.
➢ Retirement usually happens with the consent of all partners or through proper notice.
➢ As per Section 32 of the Indian Partnership Act, 1932, a partner can retire:
✅ With consent of all partners, or
✅ As per an express agreement, or
✅ By written notice in case of a Partnership at Will.
2. Reconstitution of Firm
Like admission, retirement of a partner is another mode of reconstitution of partnership
firm.

Adjustments After Retirement

Content
❖ After retirement of a partner, the other partners may continue the business.
❖ For paying off the retiring partner(s), some specific adjustments are required to be done in
the books of the firm.

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1. Calculate new profit-sharing ratio and gaining ratio.
2. Distribute reserves and accumulated profits/losses.
3. Revalue assets and liabilities.
4. Adjust goodwill of the firm.
5. Adjust Joint Life Policy (JLP), if applicable.
6. Settle final amount payable to the retiring partner.
7. Adjust capital accounts of continuing partners.

1. New Profit-Sharing Ratio

❖ On retirement, the retiring partner’s share is taken over by continuing partners.
❖ The New Profit-Sharing Ratio is the ratio in which the remaining partners will share future
profits.
❖ The Gaining Ratio is the ratio in which they acquire the retiring partner’s share.
❖ Gaining Ratio = New Ratio – Old Ratio (for each continuing partner).

2. Distribute reserves and accumulated profits/losses

Reserves or profits are shared among all partners (including the retiring one) in their old profit-
sharing ratio.

3. Revaluation of Assets & Liabilities

❖ The logic for revaluation of Assets and liabilities at the time of retirement of a partner is
same as that at the time of admission of a new partner.
❖ In case of retirement, the revaluation profit or loss is distributed among all the partners in
the Old Profit-Sharing Ratio.

4. Adjustment for Goodwill

Content
❖ Goodwill was created by all partners, including the retiring one.
❖ So, continuing partners must compensate the retiring partner for their share of goodwill.
❖ Compensation is made in the Gaining Ratio.
❖ Gaining Ratio = New Ratio – Old Ratio (for continuing partners).
Accounting Entry
Gaining Partners' Capital A/c Dr. (in gaining ratio)
To Outgoing Partner’s A/c (with retiring partner’s share of goodwill)

5. Adjustment for Joint Life Policy (JLP)

❖ JLP covers the lives of all partners; premium is paid by the firm.
❖ On reconstitution (Admission, Retirement, Change in Ratio), Surrender Value is considered
for accounting.
❖ The Surrender Value can be:

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a. Adjusted through partners’ capital accounts, or
b. Shown as an asset in the books.
❖ Maturity Value is not relevant for such accounting adjustments.

6. Settlement of Final Balance of Retiring Partner

1. Final Amount Due

Calculated after all adjustments (goodwill, revaluation, reserves, JLP, etc.).
2. Mode of Settlement
As per Partnership Deed, or
If deed is silent, then mutual agreement among partners.
3. Payment Methods
Immediate Payment: Full amount paid in cash/bank.
Deferred Payment: If not enough funds, pay in instalments via a Loan Account opened in
the name of the retiring partner.
4. Legal Right – Section 37 of Indian Partnership Act, 1932
The retiring partner is entitled to the higher of the following two:
a. Share in Profits: Calculated from retirement date till final payment, based on adjusted
capital ratio.
b. Interest @ 6% p.a.: On amount due from the date of retirement till actual settlement.

Retirement-cum-Admission
1. Retirement-cum-Admission
This occurs when an existing partner retires and another partner joins the firm at the same
time.
2. Accounting Principles
The accounting principles for both admission and retirement are followed.
3. Combined Effect
The combined effect is managed by incorporating two sets of transactions simultaneously.
4. No Separate Treatment
No separate treatment is needed; the same principles for admission and retirement are
applied.

3. Death of Partner

Death of Partner – Reconstitution of Partnership

➢ If a continuing partner dies, then it leads to reconstitution of partnership firm.

Adjustments After Death

Content
➢ In the event of death of a partner, the other partners may decide to continue the business.

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➢ Certain adjustments to be made in the books of accounts of the existing partnership firm
which are as follows
1. Calculation of new profit-sharing ratio and gaining ratio,
2. Distribution of reserves and accumulated profits and losses,
3. Revaluation of assets and liabilities,
4. Adjustment for goodwill,
5. Adjustment for Joint Life Policy (JLP),
6. Adjustment for interim period’s profit/loss,
7. Settlement of final balance of the deceased partner to his Executor.

1. New Profit-Sharing Ratio

1. When a partner dies, remaining partners continue the firm.
2. They decide a new way of sharing profits – called New Profit-Sharing Ratio.
3. The share of the deceased partner is taken over by the remaining partners.
4. The Gaining Ratio = New Share – Old Share (of continuing partners).
5. Gaining Ratio is used to compensate the deceased partner’s share of goodwill.

2. Distribution of Reserves & Profits

➢ The balance of reserves or undistributed profit (as represented by balance of Profit & Loss
Account) are distributed among all the partners (including the Executor of deceased partner)
in their old profit-sharing ratio in the event of death of a partner.

3. Revaluation of Assets & Liabilities

1. The logic for revaluation of Assets and liabilities at the time of death of a partner is same
as that at the time of admission of a new partner.
2. In case of death, the revaluation profit or loss is distributed among all the partners
(including the Executor of the deceased partner) in the Old Profit-Sharing Ratio.

4. Adjustment for Goodwill

1. The goodwill of the firm, created by all partners (including the deceased), needs to be
adjusted.
2. The continuing partners compensate the deceased partner’s share in the Gaining Ratio.

5. Adjustment for Joint Life Policy (JLP)

1. Accounting treatment of JLP depends on firm’s policy: Treated either as Asset or Expense.
2. On death of a partner, only the Maturity Value is relevant.
3. Surrender Value is ignored in such cases (unlike in admission/retirement).
4. Maturity amount received is credited to all partners in their profit-sharing ratio.

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6. Adjustment for Interim Period’s Profit or Loss
1. Death is unplanned, so profit/loss from start of year till date of death is estimated.
2. The deceased partner’s share in that period’s profit/loss is to be credited/debited to their
capital account.
3. P&L Suspense A/c is temporarily opened for such adjustments.
4. Two methods of estimation:
• Time Basis: Use average profit of past years → apportioned up to death.
• Sales Basis: Apply last year’s profit % on sales → to current period’s sales up to death.

7. Settlement of Final Balance of Deceased Partner (to Executor)

1. The amount due to the deceased partner’s representative (Executor) is settled:
➢ Lump Sum Payment: If the firm has enough funds, the amount is transferred to the
executor’s account and settled immediately.
Entry: Executor A/c Dr.
To Bank A/c
➢ Instalment Payment/Loan:
❖ Transfer due amount to Loan A/c in executor’s name.
❖ Pay in installments with agreed interest.
❖ Acts like a loan from executor to the firm.

4. Treatment of Joint Life Policy

Joint Life Policy (JLP)

1. Purpose of JLP
A Joint Life Policy (JLP) is taken by the firm to cover the lives of its partners, to provide
funds in case of the death of a partner. The premium is paid by the firm.
2. Types of JLP
✓ Individual Life Insurance Policy: Covers individual partners.
✓ Joint Life Insurance Policy: Covers all partners under a single policy.
3. Maturity Value
The amount receivable on the death of a partner or when the policy expires.
4. Surrender Value
If the policy is surrendered before maturity, the firm receives the surrender value which
gradually increases over time and is considered the fair value for accounting.

Methods of Accounting JLP

1. Methods of Accounting JLP
Two main methods for accounting for JLP:
Method A: JLP is not treated as an asset in the books of the firm
Method B: JLP is treated as an asset in the books of the firm
Method A: JLP is not treated as an asset in the books of the firm

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Content
1. Premium paid is treated as an expense not as an asset.
2. The surrender value does not appear in the books.
Accounting Entries
1. On payment of insurance premium on JLP:
JLP Premium A/c Dr.
To Bank A/c
P/L A/c Dr.
To JLP Premium A/c
2. On Change of Constitution: (i.e. Admission, Retirement, Change in profit sharing ratio etc.)
The surrender value of the JLP is accounted for in any one of the following two ways:
Raising and Writing-off JLP Account:
Raising of JLP A/c: JLP A/c Dr.
To Existing Partners’ Capital A/c (in old p.s.r.)
Writing-off JLP A/c: Continuing Partners’ Capital A/c Dr.
To JLP A/c (in new p.s.r.)
Adjusting Capital Accounts: Gaining Partners’ Capital A/c Dr.
To Sacrificing Partners’ Capital A/c
On Death of a Partner:
On maturity of the JLP JLP Receivable A/c Dr.
To Existing Partners’ Capital A/c (in old p.s.r.)
On receipt of maturity value Bank A/c Dr.
To JLP Receivable A/c

Method B: JLP is treated as an asset in the books of the firm

Content
1. Premium paid is treated as investment (asset) not expense.
2. JLP shown in Balance Sheet at its surrender value.
3. Surrender value is usually less than total premiums paid.
4. So, the difference between:
Total premiums paid
And current surrender value Is written off (debited to P&L or partners' capital).
5. For the purpose of ensuring that the JLP A/c is reflected at its surrender value, there are
two recognised methods of accounting.
Approach 1: Surrender Value Method
Approach 2: Joint Life Policy Reserve Method

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Approach 1: Surrender Value Method
Accounting Entries
1. One Account maintained – Joint Life Policy A/c (JLP A/c).
For Premium paid every year:
JLP A/c
To Bank A/c
2. For ensuring that this JLP A/c is maintained at its ‘surrender value’
P/L A/c (the excess of premium paid over the increase in surrender value)
To JLP A/c

Approach 2: JLP Reserve Method

Accounting Entries
1. Two accounts are maintained: JLP A/c and JLP Reserve A/c.
2. Premium is recorded as an investment in the JLP A/c
JLP A/c
To Bank A/c Dr
3. The insurance premium paid on the joint life policy is considered as an ‘appropriation of
profit’.
P/L Appropriation A/c Dr.
To JLP Reserve A/c
4. For ensuring that JLP A/c and JLP Reserve A/c are maintained at its ‘surrender value’
JLP Reserve A/c Dr.
To JLP A/c (the excess of premium paid over the increase in surrender value)
Note: Both the JLP A/c and JLP Reserve A/c appear in the Balance Sheet of the firm in the
Asset-side and Liabilities side respectively.

On change in constitution of firm (i.e. Admission, Retirement, Change in profit sharing ratio)
➢ Surrender Value Method: JLP is considered as an asset and shown at the surrender value. As
such no further accounting treatment is required.
➢ JLP Reserve Method: Both JLP A/c and JLP Reserve A/c appear at surrender value in the
Balance Sheet.
Accounting Entries
Situation Transaction under Surrender Transaction under JLP Reserve
Value Method Method
1. If the partners Write-back JLP Reserve A/c and N/A
decide not to maintain distribute among existing
JLP Reserve A/c partners in old P.S.R.
JLP Reserve A/c Dr.
To Existing Partners’ Capital A/c
(in old P.S.R.)

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2. If the partners Adjustment through Capital A/c Adjustment through Capital A/c
decide to maintain JLP for gaining and sacrificing for gaining and sacrificing
Reserve A/c partners’ share. partners’ share.
Gaining Partners’ Capital A/c Dr. Gaining Partners’ Capital A/c Dr.
To Sacrificing Partners’ To Sacrificing Partners’
Capital A/c Capital A/c

On the event of death of a partner

The JLP matures, and the maturity value of the policy is received by the firm. Thereafter it gets
distributed among all the existing partners in their old p.s.r.
Accounting Entries
1. On Death of a JLP Receivable A/c Dr. JLP Receivable A/c Dr.
Partner (Maturity To JLP A/c To JLP A/c
of JLP) (with maturity value) (with maturity value)
2. On receipt of Bank A/c Dr. Bank A/c Dr.
maturity value To JLP Receivable A/c To JLP Receivable A/c
3. Closing of JLP N/A JLP Reserve A/c Dr.
Reserve A/c To JLP A/c
(with last recorded surrender
value)
4. Closing of JLP JLP A/c Dr. JLP A/c Dr.
A/c To All Partners’ Capital A/c To All Partners’ Capital A/c
(with difference between last (with difference between current
recorded surrender value and year premium paid, if any, and
maturity value in old P.S.R.) maturity value in old P.S.R.)

5. Dissolution of Partnership Firms including Piecemeal Distribution

Dissolution of Firm and Settlement of Accounts on Dissolution

Basics
1. A partnership is dissolved when:
Mutual Consent: All partners agree or follow a contract. [Section 40]
2. Notice: A written notice by any partner if the partnership is at will. [Section 43]
3. Happening of Certain Events: [Section 42]
a. Expiry of a fixed-term partnership
b. Completion of the partnership’s defined adventure
c. Death of a partner
d. Partner’s adjudication as insolvent
4. Compulsory Dissolution: [Section 41]
a. All partners or all but one are adjudged insolvent
b. The partnership becomes unlawful to carry on
5. Dissolution by Court: [Section 44] Court can dissolve the firm for reasons such as:

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a. Insanity of a partner
b. Permanent incapability of a partner to perform duties
c. Misconduct of a partner affecting the business
d. Breach of agreement by a partner
e. Transfer of share to a third party or charging the share
f. Court deems the business can’t be carried on without loss
g. Other reasons that make dissolution just and equitable
6. Settlement of Accounts on Dissolution
After dissolution, accounts must be settled based on:
Losses
Losses are paid in this order:
a. Profits first,
b. Capital next,
c. Individual partners if necessary, in profit-sharing ratio. [Section 48(1)]
7. Assets
Assets of the firm are distributed in this order:
a. Pay debts to third parties
b. Pay advances due to each partner (separate from capital)
c. Pay capital due to each partner
d. Any residue is divided among partners in profit-sharing ratio. [Section 48(2)]
A. Realization of Assets and Payment of Liabilities

Item/Purpose Journal Entry Special Points to Note

1. Transfer of Book Realization A/c Dr. Cash or Bank A/c are not credited
Values of Assets To Sundry Assets (Book unless the firm is sold as a going
Value) concern.
Realization A/c Dr. Debit balance of Capital A/c or P/L
To Debtors A/c A/c are not transferred to
Realization A/c.
Provision for Bad Debts A/c Dr. If there's a Provision for Bad
To Realization A/c Debts, debit Realization A/c and
credit Debtors A/c with the gross
figure, then adjust Provision
accordingly.
2. Realization/Sale of Cash/Bank A/c (Amount Realized) If assets are taken over by a
Assets Dr. partner, the entry will be Partners'
Partners Cap. A/c Dr. (agreed Capital A/c Dr. (agreed value) To
value at which a partner takes Realization A/c.
over an asset/assets)
To Realization A/c

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3. Shares Received as In exchange of the firm’s assets. a) Alternatively – this entry may
Purchase Shares A/c Dr. be passed (combining 4,5 & 6)
Consideration To Realization A/c Liability A/c Dr.
(Agreed Value) To Bank A/c (actual amt. paid)
4. Closing the External External Liabilities A/c Dr. OR,
Liabilities (creditors, outstanding expenses, To Partners Cap. A/c (agreed
Bank Loan etc) value)
To Realization A/c (Book To Realization A/c (Discount, if
Value) any received on
5. External Liabilities Realization A/c Dr. payment/discharge)
Paid Off To Cash/Bank A/c b) Where assets and liabilities are
(Actual Amount Paid) taken over by another business
6. External Liabilities Realization A/c Dr. on making some lump sum
Taken Over by a To Particular Partner's payment, separate entries for
Partner Capital A/c (Agreed Value) realization of assets and /
7. Unrecorded Asset Cash/Bank A/c Dr. payment of liabilities need not
Sold or Taken Over Partners Cap. A/c Dr. be made.
by a Partner To Realization A/c
8. Unrecorded Liability Realization A/c Dr. -
Paid To Cash/Bank A/c
(Actual Amount Paid)
9. Shares Received and Cash/Bank A/c Dr. Profit/loss on sale is transferred
Sold or Transferred Or to Realization A/c.
to partners Partners Cap. A/c Dr. [excluding
insolvent partner]
To Shares A/c
10. Payment of Realization A/c Dr. If a partner bears expenses
Expenses of To Cash/Bank A/c personally, no entry is required.
Realization (If Paid by the Firm)
Realization A/c Dr.
To Partner's Capital A/c
(If Paid by a Partner)
11. Balance of Realization A/c Dr. -
Realization Account To Partners' Capital A/c
(Profit/Loss) (Profit shared in Profit Sharing
Ratio)
Partners' Capital A/c Dr.
To Realization A/c
(Loss shared in Profit Sharing
Ratio)

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[B] Settlement of Partners Dues – through Capital Accounts

Item/Purpose Journal Entry Special Points to Note

1. Prepare Capital By Balance b/d (Cr. Balance) Capital accounts are updated
Accounts (Before To Balance b/d (Dr. Balance) before dissolution as per the
dissolution) balances in the Balance Sheet.
2. Transfer of Current Partner’s Current A/c Dr. Transfer of credit balance in
A/c (If any) To Partner’s Capital A/c current account to capital account.
(Credit Balance)
Or Partner’s Capital A/c Dr. Transfer of debit balance in capital
To Partner’s Current A/c account to current account.
(Debit Balance)
3. Transfer Profit & Loss (Cr.) A/c Dr. Undistributed profits and reserves
Undistributed Profit, To Partner’s Capital A/c like Joint Life Policy Reserve,
Reserves, etc. (Profit Sharing Ratio) Contingency Reserve, etc., are
Or Any Reserve A/c Dr. transferred to capital accounts.
To Partner’s Capital A/c
(Profit Sharing Ratio)
4. Transfer Partners’ Capital A/c Dr. Undistributed losses and
Undistributed Loss, To Profit & Loss (Dr.) A/c unrealizable assets (e.g.,
Fictitious / Or Partners’ Capital A/c Dr. Advertisement Suspense A/c) are
Unrealizable Assets To Fictitious Assets A/c transferred to capital accounts in
(Profit Sharing Ratio) profit-sharing ratio.
5. Repayment of Loan Partner’s Loan A/c Dr. Loan repayment takes priority over
Taken from Any To Cash/Bank A/c capital repayment. Loans from
Partner partners are settled first as per
Section 48.
6. Loan Given to Any Cash/Bank A/c Dr. If loan is given to a partner, the
Partner To Partner’s Loan A/c loan account is debited and cash is
credited.
Or Partner's Capital A/c Dr. Alternatively, adjust capital
To Partner’s Loan A/c account against the loan.
7. Debit Balance in Cash/Bank A/c Dr. If a partner has a debit balance in
Partner’s Capital A/c To Particular Partner’s their capital account, cash is
Capital A/c brought in to cover the shortfall.
If the deficient partner is
insolvent, special treatment is
applied as per insolvency laws.
8. Payment of Credit Particular Partner’s Capital A/c Credit balance in capital accounts is
Balance (After Final Dr. paid off in cash after final
Balancing) To Cash/Bank A/c adjustments.

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Liabilities of Retiring/Deceased Partners
1. Debts Due on the Date of Retirement/Death
The retiring partner and the estate of the deceased partner are liable for all debts of the
firm on the date of their retirement or death.
They are liable to the extent of their share in the firm.
2. Debts Incurred After Retirement
If the retiring partner did not publish a notice of retirement, they remain liable for debts
incurred after retirement.
3. Deceased/ Insolvent Partner’s Liability
The estate of a deceased or bankrupt partner will not be liable for debts contracted by
the firm after the death or bankruptcy.

Applicability of Section 37 of the Partnership Act (Unsettled Dues)

Content
1. Introduction
In case of retirement, the retiring partner or in case of death, the executor of the
deceased partner, if the dues are not settled, then such retired partner or the executor
is entitled to the following:
Maximum of:
a. Interest @ 6% per annum on the unsettled amount.
b. Share of profit earned on the unsettled capital.
2. Conditions:
a. The surviving partners/continuing partners continue to carry on the business of the
firm.
b. The business is carried on without any final settlement of accounts between the
continuing partners and the outgoing partners or his estate.
c. There is no contract to the contrary of the options contained in Section 37 i.e. share
in the profits or interest @ 6% p.a. on the unsettled capital.
3. Example (Unsettled Capital)
Unsettled capital of C 52,000 (Date of retirement: 30.09.22, financial year 2022-2023).
Net Profit earned by the firm after C’s retirement 25,000.
Capitals of A: 57,000 and B: 76,000
C is entitled to the maximum of the following:
(i) Interest on unsettled capital = 52,000 × 6% × 6 months = 1,560
(ii) Profit earned out of unsettled capital = Profit × Retired or Deceased Partner’s
unsettled Dues/ Total Capital of the firm (including the amount due to the retired or
deceased partner) = (25,000 × 52,000)/(52,000 + 57,000 + 76,000) = 7,027.

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Insolvency of a Partner (Garner vs. Murray Case)
Loss Due to Insolvency
1. If a partner becomes insolvent and cannot pay their debit balance in the capital account,
the loss is shared by solvent partners.
2. Prior to the decision in the leading case of Garner vs. Murray this loss was borne by the
solvent partners in the profit-sharing ratio just like ordinary losses.
Garner vs. Murray Case (Decision)
1. The loss arising due to the insolvency of a partner must be distinguished from an ordinary
loss (including realization loss).
2. Unless otherwise agreed, the decision in Garner vs. Murray requires
(i) That the solvent partners should bring in cash equal to their respective shares of the
loss on realization;
(ii) That the solvent partners should bear the loss arising due to the insolvency of a partner
in the ratio of their Last Agreed Capitals.
3. Last Agreed Capital Meaning:
➢ Fixed Capital System: Use capital balances from the last balance sheet.
➢ Fluctuating Capital System: Adjust capital for:
• Reserves
• Undistributed profits/losses
• Drawings, interest, errors
• But exclude realization profit/loss
4. If a partner has a nil or negative capital balance, they contribute nothing to the loss.
Criticism of Garner vs. Murray
5. ✓ If a solvent partner has a debit balance, they should not bear the deficiency of the
insolvent partner.
✓ The principle does not apply if there are only two partners.
✓ A solvent partner with more private assets but less capital may bear less deficiency,
which may seem unfair.

Insolvency of All Partners

Content
➢ Since all partners are insolvent, creditors cannot expect to be paid in full. In such a case
Sundry Creditors should not be transferred to Realization Account.
➢ Cash in hand together with the amount realized on sale of assets and surplus from private
estate of partners, if any, less expenses will be applied in making payment to the creditors.
➢ The balance of Creditors Account represents the deficiency to be borne by them which to be
transferred to a Deficiency Account.
➢ The balance of Capital Accounts should also to be transferred to the Deficiency Account to
close the books.

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➢ Alternatively, the deficiency to be borne by the Creditors may be directly adjusted in between
Creditors Account and Capital Accounts.
Accounting Entries
Item/Purpose Journal Entry
i. Paying off the creditors Creditors A/c Dr. (Total Creditors)
To Bank A/c (Amount paid)
To Deficiency A/c (Amount unpaid)
ii. Transferring deficiency Deficiency A/c Dr.
To Partners' Capital A/c
Alternative treatment (adjusting deficiency Creditors A/c Dr.
directly between creditors and capital accounts) To Partners’ Capital A/c
(Adjustment of deficiency directly)

Return of Premium on Dissolution Before Expiry of Term

1. Conditions for Refund
1. A partner was admitted for a fixed term period.
2. The partner paid a premium for goodwill at the time of admission.
3. The partnership firm dissolves before the expiry of the fixed term.
2. Exceptions (No Claim)
The partner is not entitled to a refund if:
1. The firm is dissolved due to the death of a partner.
2. The dissolution is due to the misconduct of the partner claiming a refund.
3. The dissolution is in pursuance of an agreement containing no provision for the return
of the premium or any part of it.
3. Amount of Refund
The amount of refund is determined based on:
1. The terms upon which the partner was admitted.
2. The length of the period agreed upon and the period that has already expired.
4. Liability of Other Partners
The refund payable will be borne by the other partners in their profit-sharing ratio.

Piecemeal Distribution of Assets

Content
1. Meaning
➢ on the dissolution of a partnership, assets are sometimes realized gradually over a
period of time.
➢ In such cases, payments may be made to parties in a fixed order as assets are gradually
realised, without waiting for all assets to be sold.
2. Order of Payment
a. Realisation expenses

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b. For provision for expenses that are to be made
c. Preferential creditors (say, Income Tax or any payment made to the Government)
d. Secured creditors – upto the amount realized from the disposal of assets by which
they are secured and for the balance, if any, to be paid to unsecured creditors
e. Unsecured creditors – in proportion to the amount of debts, if more than one creditor
f. Partners’ loan – if there is more than one partner – in that case, in proportion to the
amount of loan
g. Partners’ capital – the order of payment may be made by any one of the following two
methods:
I. Surplus Capital Method/ Proportionate Capital Method/ Highest Relative
Capital Method
II. Maximum Possible Loss Method

I. Surplus Capital Method / Proportionate Capital Method / Highest Relative Capital Method
1. Objective
To compare the actual capital of partners at the time of dissolution with their
proportionate capital (based on the minimum capital per unit of profit).
2. Calculation of Surplus Capital
Surplus capital is determined by comparing the actual capital of each partner with their
proportionate capital.
a. Adjusted Capital: Adjust partners’ capital accounts with undistributed profits, losses,
drawings, and reserves.
b. Base Capital: Divide the adjusted capital by the unit of the profit share (for example,
5:3:2 ratio).
c. Proportionate Capital: Multiply the base capital by the unit of the profit share (e.g.,
base capital of ₹20,000, multiply by 5, 3, and 2).
d. Surplus Capital: Subtract proportionate capital from adjusted capital to calculate
surplus capital. Continue the process until an absolute surplus is reached.
3. Payment of Surplus Capital
Surplus capital is paid first to the partners.
4. Distribution of Remaining Capital
Any remaining balance is distributed among the partners in the profit-sharing ratio.
5. Final Balance Settlement
After the surplus capital is paid, the final balances reflect each partner’s share of
realization profit/loss, so no further settlement is needed at that point.

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Maximum Possible Loss Method
Content
1. Alternative method for distributing capital among partners. The calculation depends on the
maximum possible loss that could be faced.
2. Steps
a) Prepare a statement showing distribution of cash
b) Pay off the external Liabilities
c) After all the payment is made for the external liabilities, the partners will be paid off.
Total Due of Partners xxx
Less: Net/Balance of Realisation (x)
Maximum Loss xxx
d) The maximum loss shall be shared amongst the partners in their profit-sharing ratio,
as if, there will be no further realisation.
e) If any of the partner capitals, after step (4) is negative, that partner shall be treated
like an insolvent partner.
f) The deficiency of the insolvent partner as per step (5) shall be shared by the other
solvent partners (i.e. those partners who has positive capital balances) in their capital
contribution ratio as per Garner vs. Murray Rule.
g) Repeat the steps (3) to (6) till final realisation.

6. Amalgamation of Partnership Firms

Step Action
Step 1 Prepare the Balance Sheet on the date of dissolution.
Step 2 Open a Realisation Account and transfer all assets and liabilities at their book values.
Step 3 Transfer all undistributed reserves, profits, or losses to the partners’ capital accounts.
Step 4 Calculate Purchase Consideration based on the agreed terms between the parties.
Agreed value of assets taken over xxxx
Less: Agreed value of liabilities assumed xxxx
Purchase consideration xxxx
Step 5 Credit the Realisation Account with the amount of purchase consideration.
Step 6 Record unrecorded assets or liabilities if any exist.
Step 7 Transfer the profit or loss on realisation (balancing figure) to the capital account of
the proprietor.
Step 8 Close the accounts of the sole proprietorship business.

Accounting Entries for Amalgamation of Sole Proprietors into a New Partnership Firm
Step/Purpose Journal Entry
1. Transfer of Sundry Assets to Realisation Account Realisation A/c Dr.
To Sundry Assets A/c
[Individually]

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2. Transfer of Sundry Liabilities to Realisation Account Liabilities A/c Dr.
To Realisation A/c
[Individually]
3. Amount of Purchase Consideration New Firm A/c Dr.
To Realisation A/c
4. Assets Taken Over by the Proprietor Capital A/c Dr.
To Realisation A/c
5. Realisation of Assets Not Taken Over by the New Firm Bank A/c Dr.
To Realisation A/c
6. Recording of Unrecorded Assets Assets A/c Dr.
To Capital A/c
7. Realisation of Unrecorded Assets Bank A/c Dr.
To Assets A/c
8. Payment of Liabilities Not Taken Over Realisation A/c Dr.
To Bank A/c
9. Recording of Unrecorded Liabilities Capital A/c Dr.
To Liabilities A/c
10. Payment of Unrecorded Liabilities Liabilities A/c Dr.
To Bank A/c
11. Liabilities Taken Over by the Proprietor Realisation A/c Dr.
To Capital A/c
12. Realisation Expenses Realisation A/c Dr.
To Bank A/c
13. Profit on Realisation Realisation A/c Dr.
To Capital A/c
14. Loss on Realisation Capital A/c Dr.
To Realisation A/c
15. Transfer of Accumulated Profits/Reserves Reserves A/c Dr.
Profit and Loss A/c Dr.
To Capital A/c
16. Transfer of Accumulated Losses Capital A/c Dr.
To Profit and Loss A/c
17. Settlement of Purchase Consideration by the New Firm Capital in New Firm A/c Dr.
To New Firm A/c
18. Final Adjustment Capital A/c Dr.
To Capital in New Firm A/c
To Bank A/c

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Accounting Entries in the Books of the New Firm
Situation Journal Entry

1. Net Acquired Assets Equal to Assets A/c Dr. [Acquired value]

Purchase Consideration To Liabilities A/c [Assumed value]
To Partners' Capital A/c [Purchase consideration]
2. Net Acquired Assets Greater Assets A/c Dr. [Acquired value]
Than Purchase Consideration To Liabilities A/c [Assumed value]
To Partners' Capital A/c [Purchase consideration]
To Capital Reserve A/c [Purchase consideration - Net
assets]
3. Net Acquired Assets Less Assets A/c Dr. [Acquired value]
Than Purchase Consideration Goodwill A/c Dr. [Purchase consideration - Net assets]
To Liabilities A/c [Assumed value]
To Partners' Capital A/c [Purchase consideration]

7. Conversion of Partnership Firm into a Company and Sale of Partnership Firm to a Company

Accounting Treatment in the Books of the Selling Partnership Firm

Step/Purpose Journal Entry
1. Transfer of Assets to Realisation Realisation A/c Dr. [Individually]
Account To Sundry Assets A/c
2. Transfer of Liabilities to Realisation Liabilities A/c Dr. [Individually]
Account To Realisation A/c
3. Purchase Consideration Due Purchasing Co. A/c Dr.
To Realisation A/c
4. Assets Taken Over by the Proprietor Capital A/c Dr.
To Realisation A/c
5. Realisation of Assets Not Taken Over Bank A/c Dr.
by the Company To Realisation A/c
6. Recording of Unrecorded Assets Assets A/c Dr.
To Capital A/c
7. Realisation of Unrecorded Assets Bank A/c Dr.
To Assets A/c
8. Payment of Liabilities Not Taken Over Realisation A/c Dr.
To Bank A/c
9. Recording of Unrecorded Liabilities Capital A/c Dr.
To Liabilities A/c
10. Payment of Unrecorded Liabilities Liabilities A/c Dr.
To Bank A/c
11. Liabilities Taken Over by the Realisation A/c Dr.
Proprietor To Capital A/c

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12. Realisation Expenses Realisation A/c Dr.
To Bank A/c
13. Profit on Realisation Realisation A/c Dr.
To Capital A/c
14. Loss on Realisation Capital A/c Dr.
To Realisation A/c
15. Transfer of Undrawn Profits/Reserves Reserves A/c Dr.
Profit and Loss A/c Dr.
To Capital A/c
16. Transfer of Accumulated Losses Capital A/c Dr.
To Profit and Loss A/c
17. Transfer of Partners’ Current Partners’ Current A/cs Dr.
Accounts (Credit Balances) To Partners’ Capital A/cs
18. Settlement of Purchase Consideration Shares in Purchasing Co. Dr.
by the Company Debentures in Purchasing Co. Dr. Cash A/c Dr.
To Purchasing Co. A/c
19. Final Adjustment Partners’ Capital A/cs Dr.
To Shares in Purchasing Co. A/c
To Debenture in Purchasing Co. A/c To Cash A/c

Accounting Entries in the Books of the Purchasing Company

Situation Journal Entry
1. 1. Assets and Liabilities Taken Over
i. When Net Assets Taken Over is Less Assets A/c Dr. (Agreed Value)
Than Purchase Consideration Goodwill A/c Dr. (Balancing Figure)
To Liabilities A/c (Agreed Value)
To Firm A/c (Purchase Consideration)
ii. When Net Assets Taken Over is More Assets A/c Dr. (Agreed Value)
Than Purchase Consideration To Liabilities A/c (Agreed Value)
To Firm A/c (Purchase Consideration)
To Capital Reserve A/c (Balancing Figure)

2. Discharge of Purchase Consideration Firm A/c Dr. (Purchase Consideration)

To Share Capital A/c (Face value of shares
issued)
To Securities Premium A/c (if any)
To Debentures A/c
To Bank A/c

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8. Accounting of Limited Liability Partnership

Limited Liability Partnership (LLP)

1. Definition
A Limited Liability Partnership (LLP) is a hybrid business form combining the features of
a partnership and a company, with limited liability for partners.
2. Governing Act
Governed by the Limited Liability Partnership Act, 2008 (effective from April 1, 2009).
3. Liability of Partners
Partners' liability is limited to their capital contribution, similar to a company. Personal
assets of partners are not liable for the firm's debts.
4. Applicability of Indian Partnership Act
Indian Partnership Act, 1932 does not apply to LLPs.

Nature of Limited Liability Partnership (LLP)

1. Legal Entity
An LLP is a body corporate, meaning it is a separate legal entity from its partners.
2. Existence
A change in partners does not affect the existence, rights, or liabilities of the LLP.

Features of LLP
1. Formation
Formed and incorporated under the LLP Act, 2008.
2. Minimum Partners
A minimum of two partners is required to form an LLP.
3. Designated Partners
At least two designated partners are required, and at least one must be a resident of India.
4. Name of LLP
The name of the LLP must include the words "Limited Liability Partnership" or the acronym
"LLP".

Books of Accounts of LLP

1. Books of Accounts Maintenance
LLPs must maintain proper books of accounts either on a cash or accrual basis.
2. Accrual Basis and Double Entry
Accounts should be kept under double-entry system to reflect financial transactions.
3. Required Books
Books should disclose:
1. Receipts and Expenditures of the LLP.
2. Assets and Liabilities of the LLP.

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3. Statements of goods purchased, inventories, work-in-progress, finished goods, and
cost of goods sold.
4. Period for Preserving Accounts
Books must be preserved for 8 years from the date they were made.

Statement of Account and Solvency

1. Filing with Registrar
LLPs must file a Statement of Account and Solvency every year within six months of the
end of the financial year.
2. Forms to Be Filed
The Statement of Account and Solvency must be filed in Form 8 within 30 days after six
months from the end of the financial year.
3. Required Documents
1. Statement of Assets and Liabilities
2. Statement of Income and Expenditure
4. Signature
The statement must be signed by designated partners of the LLP.
5. Inspection
Filed statements are available for inspection by any person, with applicable fees.
Statement of Assets and Liabilities

Particulars Figures as at the end of Figures as at the end of

the current reporting the previous reporting
period (in ₹) period (in ₹)
(I) CONTRIBUTION AND
LIABILITIES
(1) Partner’s funds
Contribution received
Reserves and surplus (including
surplus being the profit/loss made
during year)
(2) Liabilities
Secured loans
Unsecured loans
Short-term borrowings
Creditors/Trade payables
Advance from customers
Amount of other liabilities
Other liabilities (to specify)
Provisions
For taxation

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For contingencies
For insurance
Other provisions (if any)
Total
(II) ASSETS
Gross Fixed assets (including
intangible assets)
Less: Depreciation and amortization
Net fixed assets
Investments
Loans and advances
Inventories
Debtors/trade receivables
Cash and cash equivalents
Amount of other assets
Other assets (to specify)
Total
Disclosure of Contingent Liabilities
Contingent Liabilities
(a) Whether there are any contingent liabilities to report? Yes/No
(b) Contingent Liabilities

(b) (c) (d)

S. No. Description of contingent liability Amount
Income Statement Format

Particulars Figures for the period Figures for the period

(Current reporting period) (Previous reporting period)
From (DD/MM/YYYY) To From (DD/MM/YYYY) To
(DD/MM/YYYY (in Rs.) (DD/MM/YYYY (in Rs.)
Income
Gross Turnover r
Less: Excise duty or service
tax
Net Turnover Details
(I) Domestic turnover
(a) Sale of goods
manufactured
(b) Sale of goods traded

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(c) Sale or supply of
services
(II) Export turnover
(a) Sale of goods
manufactured
(b) Sale of goods traded
(c) Sale or supply of
services
Other income
Increase/ (decrease) in stocks
including for raw materials,
work in progress and finished
goods
Total Income
Expenses
Raw material consumed
Purchases made for re-sale
Consumption of stores and
spare parts
Power and fuel
Personnel Expenses
Administrative expenses
Payment to auditors
Selling expenses
Insurance expenses
Depreciation and amortization
Interest
Other expenses
Total expenditure
Net Profit or Net Loss
(before taxes)
Provision for Tax
Profit after Tax
Profit transferred to
Partners’ account
Profit transferred to
Reserves and Surplus

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Penalties and Compliance Requirements for LLPs
Provision Explanation Penalties
1. Failure to Maintain LLPs must maintain books of accounts ✓ Fine: ₹25,000 to ₹5,00,000
Books of Accounts and prepare Statement of Account for the LLP.
and Solvency as per Section 34. ✓ Fine: ₹10,000 to ₹1,00,000
for each designated
partner.
2. Annual Return Every LLP must file an Annual Return ✓ Fine: ₹25,000 to ₹5,00,000
Filing with the Registrar within 60 days of for the LLP.
the closure of the financial year. ✓ Fine: ₹10,000 to ₹1,00,000
for each designated
partner.
3. False Statements If any statement in the annual return ✓ Imprisonment: Up to 2
in Annual Return is false (knowing it to be false) or years.
omits material facts, it will be ✓ Fine: ₹1,00,000 to
penalized. ₹5,00,000.
4. Audit of Books of LLPs are required to have an audit of ✓ Auditor: Must be a
Accounts their accounts according to Chartered Accountant in
prescribed rules. practice.
5. Appointment of A qualified auditor must be appointed ✓ Non-compliance can result in
Auditor for each financial year to audit the penalties under the relevant
LLP’s accounts. provisions.

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9. LEASE ACCOUNTING (AS – 19)
1. What is a Lease

Lease An agreement where the Lessor (legal owner) conveys to the Lessee (user) the right
to use an asset in exchange for lease rent (payment) for an agreed period of time.
A lease includes hire agreements where the hirer has the option to acquire ownership
upon meeting agreed conditions.

2. Applicability of AS 19

The standard applies to all leases other than

a. Natural Resources
Leases for exploration or use of natural resources such as oil, gas, timber, metals, and
other minerals.
b. Licensing Agreements
Covers motion picture films, video recordings, plays, manuscripts, patents, and
copyrights.
c. Land Use Leases
Agreements specifically for using land.

3. Definitions

1. Non-Cancellable Lease
A non-cancellable lease is a lease that is cancellable only:
a. upon the occurrence of some remote contingency; or
b. with the permission of the lessor; or
c. if the lessee enters into a new lease for the same or an equivalent asset with the
same lessor; or
d. upon payment by the lessee of an additional amount such that, at inception,
continuation of the lease is reasonably certain.
2. Lease Term
The lease term is the non-cancellable period for which the lessee has agreed to take
on lease the asset together with any further periods for which the lessee has the
option to continue the lease of the asset, with or without further payment, which
option at the inception of the lease it is reasonably certain that the lessee will
exercise.
3. Inception of Lease
The inception of the lease is the earlier of the date of the lease agreement and the
date of a commitment by the parties to the principal provisions of the lease.
4. MLP
Minimum lease payments are the payments over the lease term that the lessee is, or
can be required, to make excluding contingent rent, costs for services and taxes to be
paid by and reimbursed to the lessor, together with:

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a. In the case of the lessee, any residual value guaranteed by or on behalf of the
lessee; or
b. In the case of the lessor, any residual value guaranteed to the lessor:
i. by or on behalf of the lessee; or
ii. by an independent third party financially capable of meeting this guarantee.
If the lessee has an option to purchase the asset at a price that is expected to be
significantly lower than the fair value when the option becomes exercisable, and it is
reasonably certain to be exercised at the inception of the lease, the minimum lease
payments include:
✓ The payments due over the lease term, plus
✓ The payment required to exercise the purchase option.
5. Economic Life
The total usable period of an asset across multiple users.
6. Useful Life
The depreciable life of an asset used by the lessee. (Always shorter than economic
life).
7. Residual Value
Residual value of a leased asset is the estimated fair value of the asset at the end of
the lease term.
8. : Guaranteed residual value is:
Guaranteed residual value is:
a. in the case of the lessee, that part of the residual value which is guaranteed by
the lessee or by a party on behalf of the lessee and
b. in the case of the lessor, that part of the residual value which is guaranteed by or
on behalf of the lessee, or by an independent third party who is financially capable
of discharging the obligations under the guarantee.
9. Unguaranteed residual value
Unguaranteed residual value of a leased asset is the amount by which the residual value
of the asset exceeds its guaranteed residual value.
10. Gross investment
Gross investment in the lease is the aggregate of the minimum leas payments under a
finance lease from the standpoint of the lessor and any unguaranteed residual value
accruing to the lessor.
11. Unearned finance income
Unearned finance income is the difference between:
a. the gross investment in the lease; and
b. the present value of
i. the minimum lease payments under a finance lease from the standpoint of the
lessor; and
ii. any unguaranteed residual value accruing to the lessor,
at the interest rate implicit in the lease.

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12. Net investment
Net investment in the lease is the gross investment in the lease less unearned finance
income.
13. Interest rate implicit in the lease
The interest rate implicit in the lease is the discount rate that, at the inception of the
lease, causes the aggregate present value of
a. the minimum lease payments under a finance lease from the standpoint of the
lessor; and
b. any unguaranteed residual value accruing to the lessor, to be equal to the fair value of
the leased asset.
14. Lessee’s incremental borrowing rate of interest
The lessee’s incremental borrowing rate of interest is the rate of interest the lessee
would have to pay on a similar lease or, if that is not determinable, the rate that, at
the inception of the lease, the lessee would incur to borrow over a similar term, and
with a similar security, the funds necessary to purchase the asset.
15. Contingent rent
Contingent rent is that portion of the lease payments that is not fixed in amount but
is based on a factor other than just the passage of time (e.g., percentage of sales,
amount of usage, price indices, market rates of interest).

4. Types of Leases

Lease Type Definition

Finance Lease A lease where substantially all risks and rewards of ownership are
transferred.
Operating Lease A lease where ownership risks and rewards are NOT transferred.
Classification Basis Determined by the substance of the transaction, not just legal form.

Transfers the risk and reward

Finance
Typically, a loan arrangement
Type of Lease
Does not transfer the risk and reward
Operating
Typically, a rental arrangement

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5. Indicators of Finance Lease

AS 19 has given a total of 8 parameters to decide whether it is a finance lease or not.

These 8 conditions can be divided into following categories:

5 Parameters -
Any 1 condition is met – It will be
Deterministic in
classified as finance lease.
nature
8 Parameters
Even if all the conditions are met
3 Parameters -
– It does not necessarily imply
Suggestive in nature
that it is a finance lease.

Finance Lease Classification: Deterministic & Suggestive Conditions

1. Deterministic Conditions (Normally Lead to Finance Lease Classification)
a. The lease transfers ownership of the asset to the lessee by the end of the lease term;
b. The lessee has the option to purchase the asset at a price which is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable such
that, at the inception of the lease, it is reasonably certain that the option will be
exercised;
Example
Mr. A has taken a car on lease for 5 years from XYZ. After 5 years of lease term Mr.
A has the option to purchase this car for Rs.20,000, whereas it is assumed the car
market value at the end of 5th year would be Rs.2,00,000. Considering the option to
buy it at bargain price, it is reasonably certain that Mr. A would exercise that option.
c. The lease term is for the major part of the economic life of the asset even if title is
not transferred;
Example
XYZ has taken a property on lease for 32 years from ABC, expected economic life of
the property is 40 years. Since XYZ is going to use the asset over major part of its
economic life (80% in this case), it will meet the condition to be treated as finance
lease.
d. At the inception of the lease, present value of the minimum lease payments amounts to
at least substantially all of the fair value of the leased asset; and
e. The leased asset is of a specialized nature such that only the lessee can use it without
major modifications being made.
Example
PQR, a hospital ordered 10 ambulances, specially designed as per the requirement of
PQR. These ambulances are taken on lease and it cannot be used by anyone else without
major modifications. This would meet the condition of finance lease

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2. Suggestive Conditions (Additional Indicators for Finance Lease Classification)
a. If the lessee can cancel the lease and the lessor’s losses associated with the
cancellation are borne by the lessee;
b. If the lessee benefits from fluctuations in the asset’s residual value (e.g., receiving
rent rebates based on disposal value).
c. If the lessee continues the lease for a secondary period at a rent substantially lower
than the market rate.

3. Key Notes on Lease Classification

a. Lease classification is determined at inception.
b. If terms change (except renewals), a new lease classification applies.
c. Changes in Estimates or Circumstances
Changes in economic life, residual value, or lessee default do not lead to reclassification.

6. Accounting for Finance Leases (Books of Lessee)

1. Initial Recognition (At Inception of Lease)

Accounting Entry Debit Credit
Recognition of Asset & Liability Leased Asset Lessor
1. Measurement Basis
Lease recorded at lower of:
✓ Fair Value of the asset
✓ Present Value of MLP (Discounted at interest rate implicit in the lease or, if
unavailable, lessee’s incremental borrowing rate).
2. Subsequent Accounting Treatment
a. Lease Payments
Apportioned between:
➢ Finance Charge (Interest Expense)
➢ Reduction of Lease Liability.
b. Finance Charges
Allocated across periods to maintain a constant interest rate on the outstanding
liability.
c. Depreciation
➢ Finance lease results in depreciation expense for the asset.
➢ Depreciation policy must align with AS 10.
3. Depreciation Criteria
a. Lessee Retains Asset
Depreciated over its useful life.
b. Asset is Returned to Lessor
Depreciated over lease term or useful life, whichever is shorter.

4. Initial Direct Costs

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a. Costs Related to Lease Negotiation
Included in asset cost as part of lease recognition.
5. Interest Rate Implicit in Lease (Computation)
a. Implicit Interest Rate
The discount rate that equates: Present Value of Minimum Lease Payments (MLP) +
Unguaranteed Residual Value (UGRV) = Fair Value of the Leased Asset.

Example 1
Annual lease rents = Rs.50,000 at the end of each year.
Lease period = 5 years;
Guaranteed residual value = Rs.25,000
Unguaranteed residual value (UGR) = Rs.15,000
Fair Value at the inception (beginning) of lease = Rs.2,00,000
Interest rate implicit on lease is computed below:
Interest rate implicit on lease is a discounting rate at which present value of minimum lease
payments and unguaranteed residual value is Rs.2 lakhs.
PV of minimum lease payments and unguaranteed residual value at guessed rate 10%
Year MLP + UGR DF (10%) PV
Rs. Rs.
1 50,000 0.909 45,450
2 50,000 0.826 41,300
3 50,000 0.751 37,550
4 50,000 0.683 34,150
5 50,000 0.621 31,050
5 25,000 0.621 15,525
5 15,000 0.621 9,315
2,14,340
PV of minimum lease payments and unguaranteed residual value at guessed rate 14%
Year MLP + UGR DF (10%) PV
Rs. Rs.
1 50,000 0.877 43,850
2 50,000 0.769 38,450
3 50,000 0.675 33,750
4 50,000 0.592 29,600
5 50,000 0.519 25,950
5 25,000 0.519 12,975
5 15,000 0.519 7,785
1,92,360

Interest rate implicit on lease is computed below by interpolation:

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14% - 10%
Interest rate implicit on lease =10% + x (2,14,340 - 2,00,000) = 12.6%
2,14,340 - 1,92,360
Example 2
Annual lease rents = Rs.50,000 at the end of each year.
Lease period = 5 years;
Guaranteed residual value = Rs.25,000
Unguaranteed residual value (UGR) = Rs.15,000
Fair Value at the inception (beginning) of lease = Rs.2,00,000
Interest rate implicit on lease is = 12.6%
Present value of minimum lease payment is computed below:
Year MLP DF (12.6%) PV
Rs. Rs.
1 50,000 0.890 44,500
2 50,000 0.790 39,500
3 50,000 0.700 35,000
4 50,000 0.622 31,100
5 50,000 0.552 27,600
5 25,000 0.552 13,800
1,91,500
Present value of minimum lease payment = Rs.1,91,500
Fair value of leased asset = Rs.2,00,000
The accounting entry at the inception of lease to record the asset taken on finance lease in
books of lessee is suggested below:
Rs. Rs.
Asset A/c Dr. 1,91,500
To Lessor (Lease Liability) A/c 1,91,500
(Being recognition of finance lease as asset and liability)
Example 3
Using data for example 2 and assuming zero residual value, allocation of finance charge over
lease period is shown below:
Year Minimum Lease Finance Charge Principal Principal due
Payments Rs. (12.6%) Rs. Rs. Rs.
0 -- -- -- 1,91,500
1 50,000 24,129 25,871 1,65,629
2 50,000 20,869 29,131 1,36,498
3 50,000 17,199 32,801 1,03,697
4 50,000 13,066 36,934 66,763
5 75,000 8,237 66,763
2,75,000 83,500 1,91,500
Accounting entries in year 1 to recognise the finance charge in books of lessee are suggested
below:

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Rs. Rs.
Finance Charge A/c Dr. 24,129
To Lessor 24,129
(Being finance charge due for the year)
Lessor Dr. 50,000
To Bank A/c 50,000
(Being payment of lease rent for the year)
P & L A/c Dr. 24,129
To Finance Charge A/c 24,129
(Being recognition of finance charge as expense for the year)

7. Disclosures made by the Lessee

Lessee’s Disclosure Requirements for Finance Leases

a. Finance lease assets should be separately disclosed from owned assets.
b. For each asset class, disclose the net carrying amount at the balance sheet date.
c. Show a reconciliation between total MLP and their present value, including a breakdown
for:
✓ Not later than one year
✓ Later than one year and not later than five years
✓ Later than five years.
d. Disclose contingent rents recognized as expense in the Profit & Loss Statement.
e. Disclose total future minimum sublease payments under non-cancellable subleases at
the balance sheet date.
f. Provide key details of the lessee’s leasing arrangements, including:
✓ Basis of contingent rent payments
✓ Renewal, purchase options, and escalation clauses
✓ Lease restrictions (e.g., dividends, additional debt, further leasing).

8. Accounting for Finance Leases (Books of Lessor)

1. Initial Recognition (At Lease Inception)

Accounting Entry Debit Credit
Purchase of Asset by Lessor Asset (Fair Value) Bank (Fair Value)
Recognition of Lease Receivable Lease Receivable (at NI) Asset (at NI)
2. Recognition of Finance Income
a. Unearned Finance Income (UFI)
Recognized systematically over the lease term.
b. Income Allocation Method
Ensures a constant periodic return on the net investment.
c. Interest Rate Basis
Based on Interest Rate Implicit in Lease or Commercial Interest Rate.

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3. Initial Direct Costs
a. Definition
Includes commissions, legal fees, and other costs incurred to arrange the lease.
b. Accounting Treatment
✓ Recognized immediately in Profit & Loss, or
✓ Allocated over lease term against finance income.
4. Review of Unguaranteed Residual Value (UGRV)
a. Regular Review
Lessor must regularly review UGRV.
b. Reduction in UGRV
Revise income allocation over remaining lease term; previously accrued income is
adjusted immediately.
c. Increase in UGRV
Upward adjustments are NOT allowed.
5. Manufacturer or Dealer Lessor
a. Sales Recognition
Recognized in Profit & Loss as per normal sales policy.
b. Low Interest Rate Quotes
If an artificially low interest rate is used, profit should be restricted to a commercial
rate.
c. Initial Direct Costs
Recognized as an expense in Profit & Loss at lease inception.

9. Disclosures

Lessor’s Disclosure Requirements for Finance Leases

a. Show a reconciliation between total Gross Investment (GI) and Present Value (PV) of
Minimum Lease Payments (MLP) receivable, with a breakdown for:
✓ Not later than one year
✓ Later than one year and not later than five years
✓ Later than five years.
b. Disclose the total unearned finance income (interest income not yet recognized).
c. Report the unguaranteed residual value (UGRV) that benefits the lessor.
d. Disclose the accumulated provision for uncollectible MLP receivables.
e. Report contingent rents recognized as income in the Profit & Loss Statement.
f. Provide a general description of the lessor’s significant lease agreements.
g. Disclose the accounting policy for initial direct costs (whether expensed immediately
or allocated over lease term).
h. Report Gross Investment Less Unearned Income for new leases added, after deducting
cancelled leases.

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10. Accounting For Operating Leases (Lessee Books)

Accounting Treatment in the Books of Lessee

a. Recognition of Lease Payments
Lease payments are recognized as an expense in the Profit & Loss Statement on a
straight-line basis over the lease term, unless another method better reflects the
benefit pattern.
b. Requirement under AS 19
To ensure a better revenue-cost match, AS 19 mandates that operating lease payments
be recognized on a straight-line basis, unless another method better represents the
benefit pattern.

Example
Suppose outputs from a machine taken on a 3 year operating lease are estimated as 10,000
units in year 1; 20,000 units in year 2 and 50,000 units in year 3. The agreed annual lease
payments are Rs.25,000, Rs.45,000 and Rs.50,000 respectively.
The total lease payment Rs.1,20,000 in this example should be recognised in proportion of
output as Rs.15,000 in year 1, Rs.30,000 in year 2 and Rs.75,000 in year 3. The difference
between lease rent due and lease rent recognised can be debited / credited to Lease
Equalisation A/c.
The accounting entries for year 1 in books of lessee are suggested below:
Rs. Rs.
Lease Rent A/c Dr. 15,000
Lease Equalization A/c Dr. 10,000
To Lessor 25,000
(Being lease rent for the year due)
Lessor Dr. 25,000
To Bank A/c 25,000
(Being payment of lease rent for the year)
P & L A/c Dr. 15,000
To Lease Rent A/c 15,000
(Being recognition of lease rent as expense for the year)
Since total lease rent due and recognised must be same, the Lease Equalisation A/c will close
in the terminal year. Till then, the balance of Lease Equalisation A/c can be shown in the
balance sheet under "Current Assets" or Current Liabilities" depending on the nature of
balance.

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11. Disclosures made by Lessee

Disclosures for Operating Leases

a. Disclose payments due in:
✓ Not later than one year
✓ Later than one year and not later than five years
✓ Later than five years
b. Disclose total sublease payments expected to be received at balance sheet date.
c. Report lease payments recognized, with separate amounts for minimum lease payments
and contingent rents.
d. Report sublease payments received (or receivable).
e. Disclose key lease terms, including:
✓ Basis of contingent rent payments
✓ Renewal, purchase options, and escalation clauses
✓ Restrictions on dividends, debt, further leasing

12. Accounting for operating leases (Lessor books)

Accounting Treatment in the Books of Lessor

a. Recognition of Asset
Asset given on lease remains in the books of the lessor as Property, Plant & Equipment
(PPE).
b. Lease Income Recognition
Recognized in Profit & Loss Statement on a straight-line basis (SLM) unless another
method better reflects the time pattern of benefit.
c. Depreciation
Charged as per AS 10, following the lessor’s normal depreciation policy.
d. Impairment Losses
Assessed and accounted for as per AS 28.
Accounting Treatment in the Books of Lessee vs. Lessor
Particulars Books of Lessor Books of Lessee
Asset Recognition Appears in books as PPE Not recognized as an asset
Depreciation Charged Not applicable
Impairment Applicable Not applicable
Lease Rent Treatment Income recognized on SLM Expense recognized on SLM

Example:
Suppose outputs from a machine of economic life of 6 years are estimated as 10,000 units in
year 1, 20,000 units in year 2 and 30,000 units in year 3, 40,000 units in year 4, 20,000 units
in year 5 and 5,000 units in year 6. The machine was given on 3-year operating lease by a
dealer of the machine for equal annual lease rentals to yield 20% profit margin on cost
Rs.5,00,000. Straight-line depreciation in proportion of output is considered appropriate.

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Output during lease period
Total lease rent = 120% of Rs.5 lakhs x
Total output
60,000 units
= Rs.6 lakhs x = Rs.2.88 lakhs
1,25,000 units
Annual lease rent = Rs.2,88,000 / 3 = Rs.96,000
Total lease rent should be recognised as income in proportion of output during lease period,
i.e. in the proportion of 10: 20 : 30. Hence income recognised in years 1, 2 and 3 are Rs.48,000,
Rs.96,000 and Rs.1,44,000 respectively.
Since depreciation in proportion of output is considered appropriate, the depreciable amount
Rs.5 lakh should be allocated over useful life 6 years in proportion of output, i.e. in proportion
of 10: 20 : 30 : 40 : 20 : 5. Depreciation for year 1 is Rs.40,000.
The accounting entries for year 1 in books of lessor:
Rs. Rs.
Machine given on Operating Lease Dr. 5,00,000
To Purchase 5,00,000
(Being machine given on operating lease brought into books)
Lessee Dr. 96,000
To Lease Equalization A/c 48,000
To Lease Rent (Being lease rent for the year due) 48,000
Bank Dr. 96,000
To Lessee 96,000
(Being receipt of lease rent for the year)
Lease Rent Dr. 48,000
To P & L A/c 48,000
(Being recognition of lease rent as income for the year)
Depreciation Dr. 40,000
To Machine given on Operating Lease 40,000
(Being depreciation for the year)
P & L A/c Dr. 40,000
To Depreciation 40,000
(Being depreciation for the year transferred to P & L A/c)
Since total lease rent due and recognised must be same, the Lease Equalisation A/c will close in
the terminal year. Till then, the balance of Lease Equalisation A/c can be shown in the balance
sheet under "Current Assets" or Current Liabilities" depending on the nature of balance.

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13. Disclosures by Lessors for Operating Leases (As per AS 19)

a. For each class of assets, disclose:

✓ Gross carrying amount
✓ Accumulated depreciation
✓ Accumulated impairment losses
i. Depreciation in P&L
Depreciation expense recognized during the period.
ii. Impairment Losses in P&L
Impairment losses recognized during the period.
iii. Reversal of Impairment Losses in P&L
Impairment losses reversed during the period.
b. Disclose lease amounts for:
✓ Not later than one year
✓ Later than one year and not later than five years
✓ Later than five years
c. Report contingent rent recognized as income in the Profit & Loss Statement.
d. Provide a general description of the lessor’s significant lease agreements.
e. Disclose accounting policy for initial direct costs (whether expensed immediately or
allocated over lease term).

14. Sale and Leaseback

Accounting of Sale and Leaseback

a. A property owner sells an asset and leases it back from the buyer.
b. The seller (lessee) receives cash upfront while retaining the asset’s use.
c. Lease payments and sale price are negotiated together.
d. Accounting Treatment Depends on whether the lease is a Finance Lease or an Operating
Lease.
I. Where sale and leaseback results in finance lease
The excess or deficiency of sales proceeds over the carrying amount should be
deferred and amortised over the lease term in proportion to the depreciation of the
leased asset.
II. Where sale and leaseback results in operating lease
Case 1: Sale price = Fair Value
Profit or loss should be recognised immediately.
Case 2: Sale Price < Fair Value
Profit and loss should be recognised immediately. However, if the loss is compensated
by future lease payments at below market price, it should be deferred and amortised
in proportion to the lease payments over the period for which the asset is expected to
be used.

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Case 3: Sale Price > Fair Value
The excess over fair value should be deferred and amortised over the period for which
the asset is expected to be used.
Sale and Leaseback Accounting Summary
Sale Price at Fair Carrying Amount = Carrying Amount < Fair Carrying Amount >
Value Fair Value Value Fair Value
Profit No profit Recognize profit Not applicable
immediately
Loss No loss Not applicable Recognize loss
immediately

Sale Price below Fair Value Carrying Amount Carrying Amount Carrying Amount >
= Fair Value < Fair Value Fair Value
Profit No profit Recognize profit No profit (Asset
immediately written down to fair
value)
Loss (Not Compensated by Recognize loss Recognize loss Write down asset to
Below-Market Lease immediately immediately fair value
Payments)
Loss (Compensated by Below Defer & amortize Defer & amortize Write down asset to
- Market Lease Payments) loss loss fair value

Sale Price Carrying Amount = Carrying Amount < Fair Carrying Amount > Fair
above Fair Fair Value Value Value
Value
Profit Defer & amortize Recognize difference Defer & amortize profit
profit between carrying amount (Profit = Sale Price - Fair
& fair value immediately Value, since asset is
+ Defer & amortize written down to fair value)
excess over fair value
Loss No loss recognized No loss recognized Write down asset to fair
value + Defer & amortize
difference between sale
price & fair value

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10. BRANCH (INCLUDING FOREIGN
BRANCHES) ACCOUNTS
1. Introduction

1. Branch
An establishment that operates at a different location from the Head Office, carrying
out the same or similar activities.
2. Head Office Requirement
A branch cannot exist without a Head Office, which is the principal place of business.
3. Difference Between Branch & Department
a. Branch
Operates at a different location from the Head Office but performs the same or
similar activities.
b. Department
A division within the same location handling different activities in a large
organization.

2. Classification of Branches from Accounting Point of View

1. Inland Branches
Branches which are situated within the territories of a country. Inland branches are
also known as home branches. They are further classified into
a. Independent Branches
Maintain their own independent accounting records.
b. Dependent Branches
All accounting records are maintained at the Head Office.
2. Foreign Branches
Foreign branches are the branches which are situated outside the country.

3. Dependent Branches

1. Dependent Branch
A branch fully controlled by the Head Office (H.O.), including business policies,
administration, and accounts.
2. Accounting
All transactions related to the branch are recorded in the H.O. books, and the H.O.
determines the branch’s profit or loss.
3. Branches maintain memorandum records like: -
➢ Stock Register
➢ Debtors Ledger
➢ Petty Cash Book
➢ Customers' Ledger

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4. Types of Dependent Branches
a. Order-Booking Branch
Takes customer orders, but H.O. fulfils them.
b. Sales Branch
Sells goods supplied by the H.O. and H.O. manages collections.
c. Retail Branch
Directly sells goods to customers, supplied by the H.O.

4. Methods of Charging Goods to Branches

1. At Cost
Goods are sent to the branch at their actual cost price.
2. At Selling Price
Goods are invoiced at pre-determined selling prices.
3. At Wholesale Price
Goods are invoiced at the wholesale price, which is lower than the final selling price.
Used primarily for retail branches.

5. Accounting for Dependent Branches

Methods of Branch Accounting

1. If goods are sent at cost or at selling price
➢ Debtors Method
➢ Stock & Debtors Method
➢ Final Accounts Method
If goods send at whole sale price
➢ Wholesale Branch Method

A. Debtors Method

1. Suitable for Small Branches

➢ This method is used for small-sized branches.
➢ where the H.O. maintains a separate Branch Account. To determine the profit or
loss of each branch.
2. Nature of Branch Account
The Branch Account is a nominal account, recording all transactions related to the
branch.

Transaction Journal Entry (In H.O. Books)

1. Opening Balances of Branch Assets Branch A/c Dr.
To Branch Opening Stock A/c
To Branch Petty Cash A/c
To Other Assets at Branch A/c
2. Opening Balances of Branch Liabilities Branch Liabilities A/c Dr.

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To Branch A/c
3. Goods Sent to Branch Branch A/c Dr.
To Goods Sent to Branch A/c
4. Cash/Draft Sent to Branch for Branch A/c Dr.
Expenses To Cash or Bank A/c
5. Goods Returned by Branch to H.O. Goods Sent to Branch A/c Dr.
To Branch A/c
6. Remittance from Branch (Cash Cash or Bank A/c Dr.
Received from Branch) To Branch A/c
7. Goods Sold by Branch (Intimated to No Journal Entry
H.O.)
8. Transfer of 'Goods Sent to Branch' to Goods Sent to Branch A/c Dr.
Trading/Purchases Account To Branch Trading (or Purchases) A/c
9. Closing Balances of Branch Assets Branch Stock A/c Dr.
Branch Petty Cash A/c Dr.
Branch Assets A/c (after depreciation) Dr.
To Branch A/c
10. Closing Liabilities of Branch Branch A/c Dr.
To Branch Creditors A/c
To Branch Outstanding Expenses A/c
11. Transfer of Branch Profit/Loss to H.O. (A) For Profit:
Branch A/c Dr.
To Profit & Loss A/c
(B) For Loss:
Profit & Loss A/c Dr.
To Branch A/c
Proforma Branch Account
Particulars Amount Particulars Amount
To Balance b/d By Balance b/d
(Assets in the beginning): (Liabilities in the beginning)
Stock Creditors,
Petty Cash Outstanding Expenses
Debtors By Bank A/c
Furniture (Remittances from the Branch)
Prepaid Expenses By Cash Sales
To Goods sent to Branch A/c By Cash received from debtors
To Cash or Bank A/c (For By Goods sent to Branch A/c
Expenses) (Goods returned by branch)
Salaries By Balance c/d
Rent (Assets at the end)
Wages etc.

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To Balance of Branch Liability (if Stock
any) Balancing Petty Cash
To P & L A/c (if Profit) figure Sundry Debtors
Prepaid Expenses
Furniture Balancing
By P & L (if Loss) figure

Accounting for Goods Sent to Branch at Invoice Price

Procedure The accounting process is the same as when goods are sent at cost,
except for adjustments related to goods.
Need for ➢ To accurately determine branch profit or loss, loading’ adjustments
Adjustments must be made.
➢ Loading refers to the difference between Invoice Price and Cost
Price of goods.
Adjustment Entries in H.O. Books (When Goods Sent at Invoice Price)
Transaction Journal Entry
Goods Sent to Branch at Invoice Price Branch A/c Dr.
To Goods Sent to Branch A/c
Adjustment for ‘Loading’ Goods Sent to Branch A/c Dr.
(Invoice Price - Cost Price) To Branch A/c
Goods Returned to H.O. at Invoice Price Goods Sent to Branch A/c Dr.
To Branch A/c
Adjustment for ‘Loading’ on Goods Returned Branch A/c Dr.
To Goods Sent to Branch A/c
Adjustment for ‘Loading’ in Opening Stock Stock Reserve A/c Dr.
To Branch A/c
Closing Stock at Invoice Price Branch Stock A/c Dr.
To Branch A/c
Adjustment for ‘Loading’ in Closing Stock Branch A/c Dr.
To Stock Reserve A/c

B. Stock and Debtors Method

When Goods Are Sent at Cost

➢ This method is used to exercise detailed control over branch operations.
➢ The Head Office (H.O.) maintains separate accounts for different aspects of branch
activities.
➢ Accounts Maintained by Head Office & Their Purpose

Account Purpose
1. Branch Stock Account Ascertainment of shortage or surplus

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(or Branch Trading Account)
2. Branch Debtors Account Ascertainment of closing balance of debtors
3. Branch Expenses Account Ascertainment of total expenses incurred
4. Goods sent to Branch Account Ascertainment of cost of goods sent to branch
5. Branch Cash / Bank Account Know about cash flow at branch
6. Branch Fixed Asset Account Control over branch Fixed Assets
7. Branch Profit and Loss Account Calculation of net profit or loss
Journal Entries in HO books
Transaction Account debited Account credited
a. Cost of goods sent to the Branch Branch Stock A/c Goods sent to Branch
A/c
b. Remittances for expenses Branch Cash A/c Cash A/c
c. Any asset (e.g. furniture) provided Branch Asset Asset A/c
by H.O. (Furniture) A/c
d. Cost of goods returned by the Goods sent to Branch Branch Stock A/c
branch A/c
e. Cash Sales at the Branch Branch Cash A/c Branch Stock A/c
f. Credit Sales at the Branch Branch Debtors A/c Branch Stock A/c
g. Return of goods by debtors to the Branch Stock A/c Branch Debtors A/c
Branch
h. Cash paid by debtors Branch Cash A/c Branch Debtors A/c
i. Discount & allowance to debtors, Branch Expenses A/c Branch Debtors A/c
bad debts
j. Remittances to H.O. Cash A/c Branch Cash A/c
k. Branch Expenses directly paid by Branch Expenses A/c Cash A/c
H.O.
l. Expenses met by Branch Branch Expenses A/c Branch Cash A/c
Final Adjustments in Stock and Debtors Method
Transaction Journal Entry Explanation
Closing Stock Branch Stock A/c Cr. (at Closing stock is credited to
cost) Branch Stock A/c and
carried forward as opening
stock for the next period.
Effect of Branch Stock A/c ✓ Credit balance → Gross The final balance in the
Balance Profit Branch Stock Account helps
✓ Debit balance → Loss determine gross profit or
loss.
Transfer of Branch Stock Branch Stock A/c Dr. Any remaining balance in
A/c Balance to Branch P&L To Branch Profit & Loss A/c Branch Stock A/c is
A/c

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transferred to Branch P&L
A/c.
Transfer of Branch Branch Profit & Loss A/c Dr. All branch expenses are
Expenses to Branch P&L A/c To Branch Expenses A/c transferred to Branch P&L
A/c to determine net profit
or loss.
Transfer of Branch P&L A/c Head Office P&L A/c Dr. The final net profit/loss of
Balance to H.O. P&L A/c To Branch P&L A/c the branch is transferred to
the H.O. Profit & Loss A/c.
Transfer of Goods Sent to Goods Sent to Branch A/c Dr. The credit balance in Goods
Branch A/c to H.O. To H.O. Purchase A/c / Sent to Branch A/c is
Purchase/Trading A/c Trading A/c transferred to H.O.
Trading/Purchase A/c for
final accounting.

When Goods Are Sent at Invoice Price

➢ When goods are invoiced at selling price, an additional account called the Branch
Adjustment Account is maintained.
➢ This helps adjust the loading (difference between Invoice Price and Cost Price) to reflect
actual profit or loss.
Journal Entries
Transaction Accounts debited Accounts credited
a. Sale price of the Branch Stock A/c (at i. Goods sent to Branches
goods sent from H.O. selling price) A/c with cost of the
to the Branch goods sent.
ii. Branch Adjustment A/c
(with the loading i.e.,
Difference between the
selling and cost price).
b. Return of goods By i. Goods sent to Branch A/c Branch Stock A/c
the Branch to H.O. (with the cost of goods
returned).
ii. Branch Adjustment A/c
(with the loading)
c. Cash sales at the Branch Cash/Bank A/c Branch Stock A/c
Branch
d. Credit Sales at the Branch Debtors A/c Branch Stock A/c
Branch
e. Goods returned to Branch Stock A/c Branch Debtors A/c
Branch by customer (at selling price)
f. Goods lost in Transit i. Goods Lost in Transit A/c Branch Stock A/c

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or stolen or Goods Stolen A/c (with
cost of the goods)
ii. Branch Adjustment A/c
(with the loading)
Adjustments for Goods Sent at Invoice Price
Transaction Journal Entry Purpose
Goods Sent to Branch Branch A/c Dr. Records goods sent to branch
at Invoice Price To Goods Sent to Branch A/c at invoice (selling) price.
Adjustment for Goods Sent to Branch A/c Dr. Records excess price
‘Loading’ on Goods To Branch Adjustment A/c (loading) to ensure profit is
Sent not overstated.
Goods Returned to Goods Sent to Branch A/c Dr. Adjusts for goods returned
H.O. at Invoice Price To Branch A/c to H.O. at invoice price.
Adjustment for Branch Adjustment A/c Dr. Reverses excess price
‘Loading’ on Goods To Goods Sent to Branch A/c (loading) on returned goods.
Returned
Adjustment for Stock Reserve A/c Dr. Removes loading from opening
‘Loading’ on Opening To Branch Adjustment A/c stock to reflect actual cost.
Stock
Closing Stock at Branch Stock A/c Dr. Records closing stock at
Invoice Price To Branch A/c invoice price.
Adjustment for Branch Adjustment A/c Dr. Removes loading from closing
‘Loading’ on Closing To Stock Reserve A/c stock to reflect cost price.
Stock

Adjustments for Stock Discrepancies

Stock Loss (Due to Pilferage, Fire, or Dr. Goods Lost A/c (for cost value)
Other Reasons) Dr. Branch Adjustment A/c (for profit margin
included in invoice price)
Cr. Branch Stock A/c
Stock Surplus (Excess Stock Found Dr. Branch Stock A/c
During Physical Verification) Cr. Branch Adjustment A/c (for markup
amount)
Stock Lost Due to Theft Dr. Loss by Theft A/c (instead of Goods Lost
(Misappropriation of Sale Proceeds) A/c)
Dr. Branch Adjustment A/c (for profit margin)
Cr. Branch Stock A/c
Example (Stock Loss of Rs.100 with 25% Profit Margin)
Account Dr. (Rs.) Cr. (Rs.)
Goods Lost A/c 80 -

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Branch Adjustment A/c 20 -
To Branch Stock A/c - 100

Elimination of Unrealized Profit in Closing Stock

To ensure the Branch Stock Account reflects stock at cost price, the profit margin (markup)
needs to be removed.
Adjustment Journal Entry
Removing Profit Element in Dr. Branch Adjustment A/c
Closing Stock Cr. Stock Reserve A/c (for markup amount)
Alternative Method Dr. Branch Adjustment A/c
(Direct Adjustment) Cr. Branch Stock A/c
Impact on Balance Sheet The credit balance in Stock Reserve A/c is deducted from
closing stock value, ensuring stock is shown at cost.

C. Branch Trading and Profit and Loss Account (Final Accounts Method)
1. Profit & Loss Calculation
The Branch Trading and Profit & Loss Account is prepared to determine branch profit
or loss using standard accounting principles.
2. Basis for Calculation
The Trading & P&L Account is based on:
✓ Cost of opening and closing stock
✓ Cost of goods supplied to branch
✓ Goods transferred to and from the branch
3. Nature of Branch Trading & P&L Account
It is a memorandum account; it does not follow the double-entry system but is used for
tracking branch profitability.
4. Adjustments for Invoice Price
If figures are at loaded price (invoice price), they must be converted to cost price by
removing the loading (markup).
5. Branch Account Classification
Unlike the Branch Trading & P&L Account, the Branch Account is a personal account,
tracking amounts owed to or by the branch instead of being a nominal account.

D. Wholesale Branch Method (Goods Invoiced at Wholesale Price to Retail Branches)

1. Goods Supplied at Wholesale Price
The H.O supplies goods to its retail branches at wholesale price, which includes cost +
wholesale profit.
2. Branch Profit Calculation
Profit = Sale Proceeds at Shop - Wholesale Price of Goods Sold.
3. Manufacturer’s Assumption
It is assumed that the manufacturer could always sell at wholesale price,

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Manufacturer's Profit = Wholesale Price - Cost.
4. Why Use This Method?
Many businesses invoice goods at wholesale price to branches and determine branch
profit or loss based on retail sales.
Entries in Branch Stock/Trading Account
Debits (Dr.) Credits (Cr.)
Opening Stock at Wholesale Price Sales at Shop
Price of Goods Sent to Branch at Closing Stock at Wholesale Price
Wholesale Price
Goods Lost (Accident, Theft, etc.) at Wholesale Price

Result:
After these adjustments, the Branch Stock or Trading Account reveals the gross profit or
loss, which is transferred to the Branch Profit & Loss Account.
Entries in Branch Profit & Loss Account
Debits (Dr.) Credits (Cr.)
Shop Expenses Gross Profit (Transferred from Branch Trading A/c)
Wholesale Price of Goods Lost
Result: The final balance in Branch P&L A/c shows the net profit or loss at the branch.

6. Accounting for Independent Branches

Independent Branch Accounting System

1. Independent Branches
When a business is large, branches maintain complete records of their transactions and
operate independently.
2. Accounting System
Each independent branch maintains its own books of accounts and prepares a trial
balance separately.
3. Head Office Control
The Head Office (H.O.) maintains one ledger account per branch, recording all
transactions between H.O. and the branch.
Salient Features of Independent Branch Accounting
1. Double-Entry System
The branch maintains its own books under the double-entry system for accurate
financial tracking.
2. Head Office & Branch Accounts
✓ The Branch opens a Head Office Account to record transactions with H.O.
✓ The H.O. maintains a Branch Account to track transactions with the branch.
3. Independent Financial Statements

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The branch prepares its Trial Balance, Trading, and Profit & Loss Account at the end
of the period and sends them to the H.O.
4. Reconciliation Between H.O. & Branch
The Head Office reconciles its Branch Account with the Head Office Account in the
branch books.
5. Journal Entries in H.O. Books
After receiving the Branch Trial Balance, the H.O. records journal entries to
incorporate branch financials into its books.
The Head Office Account in branch books and Branch Account in head office books is maintained
respectively.
Transactions Head office books Branch books
i. Dispatch of goods to Branch A/c Dr. Goods received from Dr.
branch by H.O. To Good sent to H.O. A/c
Branch A/c To Head Office A/c
ii. When goods are Goods sent to Branch Dr. Head Office A/c Dr.
returned by the A/c To Goods received
Branch to H.O. To Branch A/c from H.O. A/c
iii. Branch Expenses are No Entry Expenses A/c Dr.
paid by the Branch To Bank or Cash A/c
iv. Branch Expenses paid Branch A/c Dr. Expenses A/c Dr.
by H.O. To Bank or cash To Head Office A/c
v. Outside purchases No Entry Purchases A/c Dr.
made by the Branch To Bank (or)
Creditors A/c
vi. Sales effected by the No Entry Cash or Debtors A/c Dr.
Branch To Sales
vii. Collection from Cash or Bank A/c Dr. Head office A/c Dr.
Debtors of the Branch To Branch A/c To Sundry Debtors
recd. by H.O. A/c
viii. Payment by H.O. for Branch A/c To Bank Dr. Purchases (or) Sundry Dr.
purchase made by Creditors A/c
Branch To Head Office
ix. Purchase of Asset No Entry Sundry Assets Dr.
by Branch To Bank (or)
Liability
x. Asset purchased by Branch Asset A/c Dr. Head office Dr.
the Branch but Asset To Branch A/c To Bank (or)
A/c retained at H.O. Liability
books
xi. Depreciation on (x) Branch A/c Dr. Depreciation A/c Dr.
above To Branch Asset To Head Office A/c

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xii. Remittance of funds Branch A/c Dr. Bank A/c Dr.
by H.O. to Branch To Bank To Head Office
xiii. Remittance of funds Reverse entry of (xii) Reverse entry of (xii)
by Branch to H.O. above i.e. above
xiv. Transfer of goods (Recipient) Branch A/c Supplying Branch Dr.
from one Branch to To Supplying Branch Dr. H.O. A/c
another branch A/c To Goods sent to
H.O. A/c
Recipient Branch Dr.
Goods Received from
H.O. A/c
To Head Office A/c

Adjustment and Reconciliation of Branch and Head Office Accounts

1. Need for Reconciliation
If the Branch Account (in H.O. books) and Head Office Account (in Branch books) do not
tally, they must be reconciled before finalizing accounts.
2. Example – Goods in Transit
If the H.O. sent goods worth Rs. 50,000 but the branch received only Rs. 40,000, the
branch should record Rs. 10,000 as Goods in Transit.
3. Journal Entry in Branch Books
Dr. Goods in Transit A/c – Rs. 10,000
Cr. Head Office A/c – Rs. 10,000
4. Journal Entry in Head Office Books
No entry, as the event has already been recorded in full.
Reasons for Disagreement Between Branch and Head Office Accounts
1. Goods Sent by H.O. but Not Received by Branch
The goods are in transit or lost; the branch will record them once received.
2. Goods Returned by Branch but Not Received by H.O.
The returned goods might still be in transit or lost; the H.O. records them only upon
receipt.
3. Money Transfer in Transit
If funds are sent but not yet received, they remain unrecorded until reflected in the
recipient’s books.
4. Income or Expenses Directly Handled by H.O. or Branch
If one entity directly handles an income/expense on behalf of the other, it may not be
recorded until the adjustment is made.

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Important Points in Branch and Head Office Accounting
1. Reconciliation of Branch & Head Office Accounts
1. Balance Agreement
The Head Office A/c in Branch Books and Branch A/c in Head Office Books should
match after adjustments.
2. Adjustments
Adjustments are only made when a transaction is missing in either books, not where it
has already been recorded.
2. Inter-Branch Transactions
✓ Inter-branch transactions are routed through the Head Office to ensure smooth
consolidation, especially when multiple branches exist.
✓ Example: If Kolkata Branch spends Rs. 1,000 on advertisement for Delhi Branch, the
entries will be:
Books Journal Entry
Kolkata Branch Dr. Head Office A/c – Rs. 1,000
Cr. Cash A/c – Rs. 1,000
Delhi Branch Dr. Advertisement A/c – Rs. 1,000
Cr. Head Office A/c – Rs. 1,000
Head Office Dr. Delhi Branch A/c – Rs. 1,000
Cr. Kolkata Branch A/c – Rs. 1,000
3. Fixed Assets Accounting in Branch Books
✓ If the H.O. maintains fixed asset accounts, depreciation is charged by H.O. to the branch
at year-end.
Books Journal Entry
Head Office Dr. Branch A/c
Cr. Branch Fixed Asset A/c
Branch Dr. Depreciation A/c
Cr. Head Office A/c
4. Head Office Expenses Charged to Branch
✓ H.O. allocates expenses to branches for administrative support.
✓ The H.O. debits the Branch A/c and credits the respective expense account.
✓ The Branch debits its expense account and credits Head Office A/c.
Books Journal Entry
Head Office Dr. Branch A/c
Cr. Salaries / General Expenses A/c
Branch Dr. Expense A/c
Cr. Head Office A/c
5. Incorporation of Branch Accounts into Head Office Books
The method that will be adopted for incorporating the trading result of the branch with that
of the head office would depend on whether it is desired to prepare

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a. Standalone P&L & Balance Sheet for each Branch, or
b. Consolidated statement of Branch & H.O.
Method I: Separate P&L & Balance Sheet for each Branch
➢ Amount of P&L is shown by Branch & is transfer to H.O. in Branch books & converse entry
is passed in H.O. Books as:
Branch A/c Dr.
To Profit & Loss A/c
➢ In such a case, not only P&L but also separate Balance Sheet for Branch & H.O. is to be
prepared.
➢ The Branch Balance Sheet would show the amount advanced by H.O. to it as "Capital." In
H.O. Books such amount would be shown as "Advance to Branch"
Method II: Prepare a consolidated Profit & Loss Account and Balance Sheet
• The individual balances of all revenue accounts (such as sales and income) are transferred
to the Head Office Account in the branch books. The opposite entries are made in the
Head Office books.
• This process reflects the transfer of the branch’s net profit or loss.
• If a consolidated balance sheet for the Head Office and branch is required, the balances
of the branch’s assets and liabilities need to be transferred to the Head Office books.
The adjusting entries that would be passed in this respect in the books of branch are
shown below:
Head Office Account Dr.
To Asset (individual) Account
(Individual) Liability Account Dr.
To Head Office Account
Converse entries are passed in the head office books.
• It is obvious that after the above-mentioned entries have been passed, the Branch
Account in the Head Office books and Head Office Account in the branch books will be
closed, and it will be necessary to restart them at the beginning of next year.
• In consequence, at the beginning of the following year, the under-mentioned entry is
recorded by the branch:
Asset Account (In Detail) Dr.
To Liability Accounts (In Detail)
To H.O. Account (The difference between assets and liabilities)

7. Foreign Branches

Accounting for Foreign Branches

➢ Foreign branches maintain independent records in local currency, but for consolidation
into Indian accounts, their balances must be converted to Indian Rupees.
➢ This conversion is influenced by exchange rate fluctuations.

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Classification of Foreign Branches (As per AS 11)
1. Integral Foreign Operation (IFO)
A foreign branch that is an extension of the reporting enterprise’s business. It
operates as if it were part of the main entity.
Example: A branch that sells imported goods from the Indian enterprise and remits
proceeds back.
2. Non-Integral Foreign Operation (NFO)
A foreign operation that functions independently, managing its own cash, expenses,
income, and financing in local currency.
Example: A production unit that operates using local resources, separate from the
parent company.

Indicators of a Non-Integral Foreign Operation (NFO)

Indicator Description
Control by Reporting Controlled by the reporting enterprise but operates
Enterprise independently without significant reliance on it.
Transactions with Limited transactions with the reporting enterprise, indicating
Reporting Enterprise operational independence.
Financing Primarily self-financed through its operations or local borrowings,
with no dependency on the reporting enterprise for funds.
Sales Currency Predominantly conducts sales in currencies other than the
reporting currency.
Expense Payments Expenses are mainly paid in the local currency rather than the
reporting currency.
Cash Flow Independence Cash flows of the foreign operation are separate from the
reporting enterprise’s cash flows.
Pricing and Exchange Sales prices are unaffected by daily exchange rate fluctuations
Rate Impact of the reporting currency.
Active Sales Market Has an active local market for its products, supporting its
independent operation.
Note: These indicators help classify a foreign operation as NFO but are not conclusive factors.
Each case must be analyzed individually.
Foreign Currency Translation Techniques
Items Integral Foreign Operation Non-Integral Foreign
(IFO) Operation (NFO)
Monetary Items (Cash, Closing rate Closing rate
Debtors, Creditors, Loans,
etc.)
Non-Monetary Items (Fixed Rate on purchase date Closing rate
Assets, Inventory, etc.)

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Inventory Generally, closing rate (or Closing rate
purchase rate if available)
Profit & Loss Items (Revenue Average rate (or transaction Average rate (or transaction
& Expenses) date rate if available) date rate if available)
Exchange Difference Charge to P&L Account Accumulated in Foreign
Currency Translation Reserve

Change in Classification of Foreign Operations

1. Change from Integral to Non-Integral
Exchange gain or loss from the date of reclassification should be transferred to FCTR
a/c.
2. Change from Non-Integral to Integral
➢ Exchange gain or loss from the date of reclassification should be transferred to P&L
a/c and
➢ Balance in FCTR A/c will continue in bs till the date of sale of foreign operation.
➢ If investment in non-IFO’s is sold in part then FCTR a/c is also proportionately
transferred to P&L a/c.

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11. DEPARTMENTAL ACCOUNTS
1. Introduction to Departmental Accounts

Need for Departmental Accounting in Multi-Activity Organisations

Content
1. Purpose
Used by large organizations with diverse products/services.
2. Goals
➢ Efficient management
➢ Effective operations
➢ Better control
3. Function
Each department works as a separate unit for accounting and performance evaluation.
Industry Examples of Departments
Bank Forex, Underwriting, Credit Cards
Hospital Rooms, Medical Store, Cafeteria
Hotel Rooms, Restaurants, Confectionery, Gym & Spa
Departmental Store Stationery, Electronics, Grocery
Two-Wheelers Motorcycles, Scooters
Automobile Hatchback, Sedan, SUV, EVs

Responsibility Accounting
1. Definition
For better performance and control, responsibility and authority are decentralized to each
department.
2. In-Charge
A manager or supervisor is assigned to each department to whom the targets and budgets
are provided for carrying out the operations.
3. Cost Centre
Although all departments are “Cost Centres”, all may not be “Revenue Centres”. At the end
of certain period, the performance of the Department/Centre is assessed and suitable
measures are taken for betterment.

Department vs. Branch

Point of Department Branch
Difference
1. Concept A segment/unit of the business A geographically separate part of the
business
2. Purpose Better control, operations, and Increase market reach and boost
management sales revenue

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3. Location Located within the same premises Located in different cities / regions /
countries
4. Interrelation A department cannot have its own A branch may contain several
branch departments

2. Concept of Departmental Accounting

Meaning
1. Traditional accounting shows overall profit/loss of the entity.
2. It does not show performance of each department.
3. For managerial control and decision-making, individual department results are needed.
4. Departmental Accounting is the branch of accounting that focuses on financial performance
of each department.
5. It is used in large organisations with multiple departments.

Features of Departmental Accounting

1. Transactions are recorded department-wise in the books of accounts.
2. Expenses and incomes are recognised separately for each department.
3. It is an application of Responsibility Accounting.
4. Each department acts as a Responsibility Centre.
5. Both internal and external transactions are recorded.
6. Provides useful information to internal stakeholders (like management).
7. Involves preparation of Departmental Trading & Profit and Loss Account.

Objectives of Departmental Accounting

1. To get an analytical view of the affairs of each department.
2. To find out the true operating result (profit/loss) and efficiency of each department.
3. To compare financial performance between different departments.
4. To provide data for managerial decisions and policy formulation.

3. Methods of Maintaining Departmental Accounts

Content
Two methods are used to record department-wise expenses and incomes
1. Maintenance of Same Set of Books (Also called Columnar / Tabular Method)
➢ A single set of books is maintained for all departments.
➢ Records are kept in a tabular or columnar format.
➢ Accounts are maintained by a centralized accounting department.
➢ It is less expensive and widely used.
2. Maintenance of Separate Set of Books (Also called Unitary Method)
➢ Each department maintains separate books of accounts.
➢ Figures for expenses and incomes are recorded independently.

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➢ Suitable for large organisations.
➢ This method is costly but gives better control and independence.

4. Components of Departmental Final Accounts

Content
1. Departmental Trading Account
➢ Prepared in columnar format (each column = one department).
➢ Shows Gross Profit / Gross Loss of each department.
➢ Direct expenses are debited.
➢ Direct incomes are credited.
2. Departmental Profit & Loss Account
➢ Columnar format (one column per department).
➢ Shows Net Profit / Net Loss of each department.
➢ Indirect expenses are debited (allocated between departments).
➢ Indirect incomes are credited (allocated), after including Gross Profit / Loss.
3. General Profit & Loss Account
➢ Shows Overall Net Profit / Net Loss of the entity.
➢ Used for common indirect incomes/expenses that cannot be allocated to departments.
➢ Prepared in normal format (no departmental columns).
➢ Includes Departmental Net Profit / Net Loss.

Format: Departmental Trading & Profit & Loss Account (Columnar Format)
Particulars Dept. Dept. Particulars Dept. Dept.
I II I II
To Opening Stock xx xx By Sales xx xx
To Purchases xx xx By Transfers xx xx
To Wages xx xx By Closing Stock xx xx
To Other Direct Expenses xx xx
To Transfer xx xx
To Gross Profit c/d xxx xxx
xxx xxx xxx xxx
To Rent, Salaries, Depreciation, xx xx By Gross Profit b/d xx xx
Other Indirect Expenses
To General P&L A/c (Dept. Net xxx xxx By Indirect Income xx xx
Profit transferred)
xxx xxx xxx xxx

General Profit & Loss Account for the year ended

Particulars ₹ Particulars ₹
To General Expenses xx By Departmental P&L A/c (Net Profit) xx

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To Stock Reserve (Provision on stock) xx
To Capital A/c (Net Profit Transferred) xx
Total xxx Total xxx

5. Steps for Preparation

Step 1: Departmental Gross Profit/Loss

Item Treatment
Direct Allocable Direct Expenses Debit to Dept. Trading A/c
Direct Expenses that cannot be directly Apportioned on suitable basis & Debited to Dept.
allocated Trading A/c
Direct Allocable Direct Incomes Credited to Dept. Trading A/c
Inter-departmental Transfers Dr. Receiving Dept, Cr. Sending Dept
After determining Departmental Gross Profit/Loss, it is transferred to Departmental Profit &
Loss A/c.
Step 2: Departmental Net Profit/Loss
Item Treatment
Direct Allocable Indirect Expenses Debit to Dept. P&L A/c
Indirect Expenses that cannot be Apportioned & Debited to Dept. P&L A/c
directly allocated
Directly Allocable Indirect Incomes Credited to Dept. P&L A/c
Indirect Incomes that cannot be Apportioned & Credited to Dept. P&L A/c
directly allocated
After determining Departmental Net Profit/Loss, it is transferred to General Profit & Loss A/c.
Step 3: General Profit/Loss
Item Treatment
Indirect Expenses that could not be Debit to General P&L A/c
allocated to departments
Indirect Incomes that could not be Credit to General P&L A/c
allocated to departments
Provision for Unrealised Profit (if any) ➢ Unrealised Profit on Closing Stock → Debit
➢ Unrealised Profit on Opening Stock → Credit
By, Balancing General Profit & Loss A/c, Consolidated or Overall Net Profit / Loss is ascertained.

6. Treatment of Specific Transactions in Departmental Accounting

Items of Income
Type Treatment Example Basis of
Apportionment
1. Directly Allocable Credited to the specific Sales of Dept A, Direct Allocation
Income department Service income from
Dept B

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2. Common Income Apportioned over all Discount Received, Discount Received:
(among concerned departments Sales Commission Net Purchases =
departments) Purchases - Returns
Outward
Sales Commission:
Net Sales = Sales -
Returns Inward
3. Other Indirect Credited to General P&L Dividend Received, Not Apportioned
Incomes which are A/c (Not departmental) Interest on Deposits,
of financial in Profit on sale of
nature assets

Items of Expenses
Type Treatment Example Basis of
Apportionment
1. Directly Allocable Debited to the Dept A Wages, Dept B Raw Direct
Expenses specific Materials Allocation
department
2. Common Expenses Apportioned over Rent, Power, Carriage See basis below
(among departments) all concerned Inwards
departments
3. Other indirect Debited to General General charges, Sundry Not
expenses which are of P&L A/c (Not charges, MD’s Apportioned
general nature as well departmental) Remuneration,
as expenses which are Miscellaneous expenses,
of financial in nature Bank Charges, Interest on
loan/debentures

Common Expense – Basis of Apportionment

Expense Item Basis
Commission to Purchase Manager, Carriage Inwards Purchases
Selling Expenses, Salesman Commission, Bad Debts, Discount Allowed Sales
Depreciation, Insurance, R&M Value of Fixed Assets
Rent, Rates, Insurance (building), Heating Floor Area Occupied
Power HP × Hours Worked

Inter-Departmental Transfer
Concept
Goods/services transferred from one department to another:
➢ Transferor Department: Treats as Sales

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➢ Transferee Department: Treats as Purchases

Valuation Methods of Inter-Departmental Transfers

Method Transfer Value Used By Treatment of Purpose
Unrealised Profit
in Closing Stock
At Cost Cost to Any department ❌ Not required No internal profit
Transferor booking; purely cost
Department pass-through
At Cost plus Cost + Pre- Intermediate ✅ Required Reflects internal
Profit determined Goods/Service performance and
Margin Departments ensures profit
recognition
At Normal Prevailing Marketable ✅ Required Reflects external
Selling Price Market Price Goods/Service market comparability;
Departments profit booking is maxed

Provision for Unrealised Profit

1. Concept
Profit included in goods transferred between departments (at cost + profit/selling price),
but not yet sold externally by transferee dept.
2. Reason for Adjustment
To comply with the prudence concept – profits not yet realized from external parties should
not be recognized at the entity level.
3. Impact
Overstates entity's profit if not adjusted.
4. Where applicable?
On closing stock of Transferee Dept, if it includes inter-departmental transfers at price >
cost. Applies to all predecessor departments, not just immediate one.

Steps to Calculate Provision for Unrealised Profit

Step Description
Step 1 Identify value of transferred stock included in closing inventory of Transferee Dept.
Step 2 Ascertain Gross Profit Rate (GP%) of Transferor Department.
Step 3 Apply the GP rate:
Provision = Value of Transferred Stock × GP% (of Transferor Dept.)

Accounting of Transfer-Entries
1. On Transfer of Goods/Services:
Transferee Department A/c Dr.

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To Transferor Department A/c
Explanation: This entry records the transfer of goods or services from the transferor
department to the transferee department.
2. Creation of Provision for Unrealized Profit on Closing Stock:
General Profit & Loss A/c Dr.
To Provision for Unrealised Profit A/c
Explanation: This entry is made to create a provision for any unrealized profit on the
closing stock, reflecting the internal transfer.
3. On Opening Stock (in the subsequent period):
Provision for Unrealised Profit A/c Dr.
To General Profit & Loss A/c
Explanation: In the subsequent period, the provision for unrealized profit on the opening
stock is reversed and adjusted in the general profit and loss account.

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12. INSURANCE CLAIM FOR LOSS OF STOCK
AND LOSS OF PROFIT
1. Insurance Claim for Loss of Stock

Accidental Loss & Insurance Coverage

1. Accidental Loss
➢ Accidents may occur during operations at business premises (e.g., factory, godown,
shop).
➢ Such accidents can damage assets, mainly:
• Fixed Assets: buildings, machineries, furniture, etc.
• Stock: raw materials, WIP, finished goods, etc.
2. Need for Funds
To replenish the damaged/mutilated assets, immediate funds are required.
3. Insurance Coverage
➢ To cover such risks, the business takes an insurance policy.
➢ Insurance premium is paid yearly, quarterly, or as per agreement.
4. Loss Assessment
➢ On occurrence of loss, the business must:
• Compute the amount of loss, and
• File a claim with the insurance company.
➢ The insurer appoints a loss assessor to:
• Verify the cause and
• Assess the extent of loss.
➢ Based on the assessor’s report, the insurance claim is settled—either fully or partly.

Loss of Stock

1. Common Accident
Among accidental losses, loss by fire is the most common.
2. Covered by Policy
Businesses usually take a fire insurance policy to cover:
(i) Loss of Stock
(ii) Loss of Profits
3. Significance
➢ Stock forms a major part of working capital, especially in trading concerns.
➢ Any loss of stock can adversely affect the solvency of the business.
➢ Hence, it is essential to adequately insure stock against such risks.

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Steps in Determination of Insurance Claim
Step 1 Value of Stock on the date of fire
➢ If stock records and physical stock are destroyed, it becomes difficult to determine
the stock lost.
➢ Since the accident occurs suddenly, the up-to-date stock value is often not available.
➢ In such cases, the stock value is estimated using available data by preparing a
Memorandum Trading Account.
➢ A Memorandum Trading Account is:
• A statement, not a ledger account
• Prepared in the format of a Trading Account
➢ It is prepared for the period:
• From the beginning of the accounting year
• To the date of accident
Memorandum Trading A/c for the period April 1 of year of accident – Date of accident
Particulars Amount Particulars Amount
(Rs.) (Rs.)
To Opening Stock *** By Sales ***
To Purchases *** By Closing Stock (Balancing Figure) ***
To Gross Profit (Sales × GP Rate) ***
Note”
➢ The GP Rate may be:
• Known to the entity, or
• Estimated based on previous year’s data
➢ Usually, the Trading Account of the preceding accounting year is prepared to ascertain the GP
Rate.
➢ Adjustments may be required in past/current data for:
• Slow-moving or obsolete items
• Abnormal/defective goods
• Free samples distributed
• Goods withdrawn by proprietor
• Over/under valuation of stock
• Omissions in stock recording
Step 2 Salvaged Stock
Salvaged Stock refers to the portion of stock saved from the accident.
Step 3 Value of Stock Lost
= Value of Stock on the date of fire – Salvaged Stock
Step 4 Calculation of Insurance Claim
➢ To determine amount of insurance claim we need to see whether insurance is Full or over
insurance or under insurance.

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➢ Policy Value ≥ Value of Stock (Full/over Insurance): Full claim allowed. Average Clause
not applicable.
Insurance claim = total value of stock lost
➢ Policy Value < Value of Stock (Under Insurance): Average Clause applies.
Insurance Claim = Value of stock Lost × Policy Value / Value of Stock on accident date

Special Situations in Stock Valuation & Insurance Claims

Situation
1. Goods-in-Transit / Sent to Branch or Consignee
➢ Cost of such goods is not part of current stock.
➢ It should be:
• Deducted from Purchases,
or
• Credited separately in Trading A/c or Memorandum Trading A/c.
2. Goods Sold but Not Yet Delivered
➢ These goods are not yet out of stock.
➢ Hence, their sale value must be deducted from Sales in Trading A/c or Memorandum
Trading A/c.
3. Goods Sent on Approval Basis
➢ These goods are not yet confirmed as sales.
➢ Adjustments required:
• Cost to be deducted from Purchases
• Sale Value to be deducted from Sales
4. Change in Price Level
If Prices have changed during the period:
➢ Adjustments are needed to nullify the effect.
➢ Use consistent stock pricing method (e.g., FIFO, LIFO) for proper GP rate application.
5. Under-Valued / Over-Valued Stock
➢ Incorrect stock valuation affects GP rate.
• If under-valued:
Add the under-valued amount back to stock to get actual cost.
• If over-valued:
Deduct the excess amount to arrive at cost.
➢ While computing Gross Claim, consider only the unsold portion of such stock.
6. Abnormal/ Defective/ Usual Selling line Items
➢ Items that do not fetch the usual Gross Profit rate are considered abnormal or
defective items.
➢ Treatment in Memorandum Trading Account:
a. Opening Stock:
• Deduct unwritten-off value of such items from Opening Stock.

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b. Purchases:
• Deduct the cost of such items (if purchased during the current period) from
Purchases.
c. Sales:
• Deduct the actual selling price of such abnormal items (if sold) from Sales.
d. Closing Stock (on date of fire):
• If any such items remain unsold, their agreed value is added to the estimated
value of normal stock.
Additional Note:
➢ Similar adjustments may be made in the Trading Account of the previous year, if such
items existed.
➢ Alternatively, a Columnar Trading Account may be prepared:
• One column for normal items
• Another column for abnormal/defective items

2. Insurance Claim for Loss of Profit

Loss of Profit / Consequential Loss Policy

1. Purpose
➢ When fire occurs, there is:
• Direct loss of stock or other assets, and
• Consequential loss due to business disruption.
➢ After the fire, the business may:
• Be disorganized or
• Temporarily shut down operations.
➢ During this period, standing expenses continue, such as:
• Rent
• Salaries
• Other fixed overheads
➢ The business also suffers loss of profit it would have earned in the normal course.
Such losses can be covered through a: "Loss of Profit" or "Consequential Loss" Policy
➢ This is a separate insurance policy taken in addition to fire insurance.
➢ Claim under this policy is admitted only if the fire insurance claim is also accepted.
2. Coverage
The Loss of Profit Policy normally covers the following items:
a. Loss of net profit
b. Standing charges
c. Any increased cost of working

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Key Terms
1. Indemnity Period
The period beginning with the occurrence of the damage and ending not later than twelve
months. Thus, it is a period during which business is disturbed due to fire and it is not
greater than 12 months.
2. Standard Turnover
The turnover of the period in corresponding previous year from the year in which damage
occurred, that corresponds with the Indemnity Period after adjustment of trend in
turnover.
3. Annual Turnover
The turnover during the twelve months immediately preceding to the date of damage.
4. Adjusted Annual Turnover
Annual Turnover adjusted with (+/-) Trend
5. Standing Charges
➢ Unavoidable fixed expenses which have to be paid even if there is reduction in sale.
➢ Interest on Debentures, Mortgage Loans and Bank Overdrafts, Rent, Rates and Taxes
(other than taxes which form part of net profit) Salaries of Permanent Staff and
Wages to Skilled Employees, Boarding and Lodging of resident Directors and/or
Manager, Directors’ Fees, Unspecified Standing Charges.
6. Trend
It is an indication of Sales pattern of an organization over a specific time period. It will
help in estimation of future expected sales.

Steps to Calculate Net Claim

Step Calculation
Step 1 Determine Gross Profit Rate
GP Rate = GP / Sales × 100
If Net Profit exists:
GP = Net Profit + Insured Standing Charges
If Net Loss exists:
GP = Insured Standing Charges – (Net Loss × Insured Standing Charges / All Standing
Charges)
Step 2 Calculation of Short Sales
Particulars Amount
Standard turnover XXXX
+/-Increase/decrease in trend XXXX
Adjusted standard turnover XXXX
- Actual turnover XXXX
Short Sales XXXX

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Step 3 Calculation of GP on Short Sales
GP on Short Sales = Short Sales × GP Rate
Step 4 Calculation of Claim for additional working expenses
Least of the following:
a. Actual additional expenses
b. Additional Sales × GP rate
c. Actual expenses × (Net Profit + Insured Standing Charges) / (Net Profit + All
Standing Charges)
Step 5 Calculation of G.P on Adjusted Annual Turnover (G.P on AAT)
Particulars Amount
Annual turnover XXXX
+/- Increase/decrease in trend XXXX
Adjusted annual turnover XXXX
G.P ON AAT= AAT X G.P %
Step 6 Calculation of Gross Claim
Particulars Amount
G.P on short sales as per step 3 XXXX
+ Claim on increased cost of working XXXX
- Savings in Insured standing charges (XXXX)
Gross claim XXXX
Step 7 Calculation of Net Claim
✓ If Average Clause applies (Insurable Value > Policy Value):
Net Claim = (Policy Value / Insurable Value) × Gross Claim
✓ If Average Clause does not apply:
Net Claim = Gross Claim

Important Notes
➢ If additional Sales due to additional expenses is not given, assume that entire sale has been
attained due to additional expenses.
➢ All standing charges = insured standing charges + uninsured standing charges.
➢ In absence of specific information assume that all standing charges are insured.
➢ If sales for past years is given we need to determine the trend of sales.

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13. HIRE PURCHASE AND INSTALLMENT SALE
TRANSACTIONS
1. Hire Purchase

Meaning
1. Agreement between Hire Vendor and Hire Purchaser.
2. Possession is given to the purchaser at the start.
3. Ownership remains with the vendor until full instalment payment.
4. Payment is made in instalments over time.
5. If any instalment is unpaid (even the last), vendor can repossess goods.
6. Amounts already paid are treated as hire charges - no refund on repossession.

Special Features of Hire Purchase agreement

1. Possession:
Transferred to hire purchaser at the time of agreement.
2. Instalments:
Payment made in periodic instalments.
3. Down Payment:
Initial amount paid at the time of agreement.
4. Instalment Components:
Each instalment includes interest and principal.
5. Ownership:
Passes only after payment of final instalment and exercising purchase option.
6. Repossession Right:
On default (even last instalment), vendor can repossess goods without refund.

Key terms
1. Hire Vendor: The seller who delivers goods and possession under the agreement.
2. Hire Purchaser: The buyer who receives goods and uses them while paying in instalments.
3. Cash Price: Price payable for immediate outright purchase in cash.
4. Down Payment: Initial amount paid by the purchaser at the time of agreement.
5. Hire Purchase Instalment: Periodic payment including principal + interest on unpaid
balance.
6. Hire Purchase Price: Total amount payable (i.e., Cash Price + Interest) to gain ownership.

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2. Hire Purchase vs Installment Sale

Particulars Hire Purchase Installment Sale

1. Ownership Ownership transfers only after the last Ownership passes immediately at
installment is paid. the time of sale.
2. Default in Seller can repossess the goods; paid Seller cannot repossess; can only
Payment installments are treated as hire sue for non-payment of price.
charges.
3. Right of Sale / Hirer cannot sell or transfer; legal Buyer has full right to sell or
Transfer status is that of a bailee. transfer the goods.
4. Loss or Damage Seller bears loss if the hirer has taken Buyer bears the loss once goods
to Goods reasonable care. are sold.

3. Different Situations – Calculation of Interest & Cash Price

Situation Given Missing Approach / Method

Situation – I Rate of Interest, Nothing Use the interest rate to compute
Total Cash Price, interest component in each installment.
Installments Subtract from installment to find
principal.
Situation – II Rate of Interest, Cash Price Use reverse calculation by subtracting
Installments interest from installments over time.
Apply the interest rate on outstanding
balance to compute interest portion.
Situation – III Installments only Cash Price, Rate Treat this as a simple allocation problem:
of Interest divide installments equally assuming no
interest (implied 0% rate).
Used when no data on interest is given.
Situation – IV Rate of Interest, Cash Price Use annuity table to find the Present
Installments, Value of installments at the given
Reference to interest rate and duration. This Present
Annuity Table Value = Total Cash Price. Then solve as in
Situation I.

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4. Accounting Treatment in the Books of the Hire-Purchaser

Methods

Cash Price Method Interest Suspense Method

At the time of transfer At later years, as and when

Full cash price of asset of possession of asset, interest becomes due,
is debited to Asset total interest unaccrued interest account is debited
Account and credited to is transferred to and interest suspense
Hire Vendor Account interest suspense account is credited
account.

Cash Price Method Interest Suspense Method

1. On Purchase of Asset 1. On Purchase of Asset
Hire Purchase Asset A/c Dr. Hire Purchase Asset A/c Dr. (cash price)
To Hire Vendor A/c (for Cash Price) Interest Suspense A/c Dr. (Total Interest)
To Hire Vendor A/c (for HP Price incl.
interest)
2. On Down Payment 2. On Down Payment
Hire Vendor A/c Dr. Hire Vendor A/c Dr.
To Bank A/c To Bank A/c
3. On Interest Due (each year) 3. On Interest Due (each year)
Interest A/c Dr. Interest A/c Dr.
To Hire Vendor A/c To Interest Suspense A/c
4. On Installment Paid 4. On Installment Paid
Hire Vendor A/c Dr. Hire Vendor A/c Dr.
To Bank A/c To Bank A/c
5. Year-End Transfers to P&L 5. Year-End Transfers to P&L
P&L A/c Dr. P&L A/c Dr.
To Interest A/c To Interest A/c
To Depreciation A/c To Depreciation A/c

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5. Accounting Treatment in the Books of the Hire-Vendor

Methods of recording hire purchase transactions

Sales Method Interest Suspense Method (hire purchaser is

debited with full cash price and interest
(hire purchase sale is treated as a credit sale). included in the selling price)

Sales Method
Transaction Entry
1. When goods are sold and delivered Hire Purchaser A/c Dr. [Full cash price]
under hire purchase To Hire Purchase Sales A/c
2. When the down payment is received Bank A/c Dr. [Down payment]
To Hire Purchaser A/c
3. When an instalment becomes due Hire Purchaser A/c Dr. [Amount of instalment]
To Interest A/c
4. When the amount of instalment is Bank A/c Dr. [Amount of instalment]
received To Hire Purchaser A/c
5. For closing interest Account Interest A/c Dr.
To Profit & Loss A/c
6. For closing Hire Purchase Sales Hire Purchase Sales A/c Dr
Account To Trading Account
Interest Suspense Method
Transaction Entry
1. When goods are sold and delivered Hire Purchaser A/c Dr. [Full cash price + Total Interest]
under hire purchase To Hire Purchase Sales A/c [Full cash Price]
To Interest Suspense A/c [Total Interest]
2. When the down payment is Bank A/c Dr. [Down payment]
received To Hire Purchaser A/c
3. For Interest of the relevant Interest Suspense A/c Dr
accounting Period Interest A/c
4. For closing interest Account Interest A/c Dr.
To Profit & Loss A/c
5. For closing Hire Purchase Sales Hire Purchase Sales A/c Dr
Account To Trading Account

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Disclosure in Balance Sheet
Balance Sheet of Hire Purchaser Balance Sheet of Hire Vendor
Liabilities (Rs.) Assets (Rs.) Liabilities (Rs.) Assets (Rs.)
Balance in Hire xxxx Fixed Assets: Current
Vendor’s Account Assets:
(outstanding Balance)
Asset (at full xxx Hire Purchase xxx
cash price) Debtors
Less: xxx
Depreciation till
date
xxx xxx

6. Default & Repossession

Repossession
Meaning
➢ In a hire purchase agreement, the hire purchaser has to pay up to the last instalment to obtain
the ownership of goods.
➢ If the hire purchaser fails to pay any one or more of the instalments, the hire vendor has the
right to take the asset back in its actual form without any refund of the earlier payments to
the hire purchaser.
➢ This act of recovery of possession of the asset is termed as repossession.

Types of Repossession

Repossession

Complete Repossession Partial Repossession

(Hire vendor repossesses all (Hire vendor repossesses part of the
the goods.) goods and balance of goods remains with
the purchaser. )

Complete or Full Repossession

Journal Entries
Books of Hire Purchaser Books of Hire Vendor
1. Closing Hire Vendor’s A/c 1. On Repossession of goods

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Hire Vendor A/c Dr. Goods Repossessed A/c Dr.
To Asset A/c P/L A/c Dr.
Note: This entry is passed with the amount due to To Hire Purchaser’s A/c
the hire-vendor. Note: This entry is passed with the revalued
amount of goods repossessed.
2. Closing Asset A/c 3. For amount spent on reconditioning of
i. If Book Value > Amount Due to Hire Vendor Goods Repossessed
Profit & Loss A/c Dr. Goods Repossessed A/c Dr.
To Asset A/c To Cash A/c/Bank A/c
ii. If Amount Due > Book Value 4. For sale of Goods Repossessed
Asset A/c Dr. Cash A/c/Bank A/c /Debtors A/c Dr.
To Profit & Loss A/c To Goods Repossessed A/c
5. For loss on sale of Goods Repossessed
Profit & Loss A/c Dr.
To Goods Repossessed A/c
Note: In case of profit, a reverse entry will
be passed

Partial Repossession
Journal Entries
Books of Hire Purchaser Books of Hire Vendor
1. For transfer of the agreed value of Goods 1. On Repossession of Goods at agreed
Repossessed value H.P. Goods Repossessed A/c Dr.
Hire Vendor’s A/c Dr. To Hire Purchaser’s A/c
To Asset A/c
2. For Transfer of Loss on default 2,3,4—Same entries as in case of complete
Profit & Loss A/c Dr. repossession
To Asset A/c
Note: In case of profit on default, the reverse
entry will be passed

Practical Steps under Partial Repossession

Step1: Calculate Book value of Goods Repossessed
A. Cost xxxx
B. Less: Depreciation upto date of repossession (xxxx)
C. Book value of Goods Repossessed xxxx
Step 2: Calculate Agreed Value of Goods Repossessed
Step 3: Loss on default = Book Value – Agreed Value

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14. INTRODUCTION TO ACCOUNTING
STANDARDS
1. Overview of Accounting Framework
1. Introduction
Accountancy is the art of recording, classifying, and summarizing financial information
using creative skills. However, complete freedom can lead to non-uniformity and
manipulation. Hence, there's a need for a standard accounting framework.
2. Need for GAAP
To ensure that financial transactions are recorded uniformly and financial statements are
comparable, the concept of Generally Accepted Accounting Principles (GAAP) emerged.

2. Generally Accepted Accounting Principles (GAAP)

1. Definition
GAAP is a collection of commonly followed accounting rules and standards used for
recording and reporting transactions.
2. Purpose
Provides financial information to stakeholders for decision-making via financial statements.
3. Components
Includes accounting standards, principles, and procedures.
4. Nature
It is a framework for more detailed rules and industry-specific practices.

3. Accounting Standards (AS)

1. Definition
Written policy documents covering recognition, measurement, treatment, presentation,
and disclosure of transactions.
2. Issuing Authority
Issued by professional accounting bodies, government, or regulators.
3. Purpose
Standardise treatment of business transactions and ensure proper disclosure in financial
statements.
4. India-specific
➢ For non-corporate entities: Standards issued by ASB of ICAI
➢ For corporate entities: Standards notified by MCA through Companies (Accounting
Standards) Rules

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4. Convergence to Indian Accounting Standards (Ind AS)
1. Convergence
The process of harmonising accounting standards globally to create a single set of high-
quality standards.
2. IFRS
Set of global standards developed by IASB.
3. Objective
Create common high-quality standards to ensure:
➢ Comparability
➢ Lower cost of capital
➢ Mobility of professionals
4. Types
➢ International-level convergence: Between IASB and National Standard-Setters (NSS)
➢ National-level convergence: Local GAAP aligned with IFRS
5. India’s Role
ICAI works with IASB to converge Indian GAAP with IFRS.
6. Ind AS vs. IFRS
➢ Convergence ≠ Adoption
➢ Convergence means aligning standards, not full adoption.
7. Notification
MCA notified Companies (Ind AS) Rules, 2015 for phased implementation from 2016-17
onwards.

5. Ind AS Applicability Timeline

A. Companies (Other than Banks, NBFCs, and Insurance Companies)
Phase Effective Applicable To
From
st
Voluntary Adoption 1 April 2015 All companies (with comparatives)
Phase-I 1st April 2016 ➢ Listed or listing in process (India/abroad) with net
(Mandatory) worth ≥ ₹500 Cr
➢ Unlisted companies with net worth ≥ ₹500 Cr
➢ Their holding, subsidiary, JV, and associate companies
st
Phase-II 1 April 2017 ➢ Remaining listed/listing in process companies not in
(Mandatory) Phase-I
➢ Unlisted companies with net worth ≥ ₹250 Cr but < ₹500
Cr
➢ Their holding, subsidiary, JV, and associate companies
Important Notes - ➢ Companies listed on SME exchange
▪ Not required to follow Ind AS
➢ Once adopted (voluntarily or mandatorily)
▪ Irrevocable

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➢ Criteria met in a year
▪ Apply Ind AS from next year with comparatives
➢ Applicable on both standalone & consolidated financials
B. NBFCs, Banks, and Insurers
Phase Effective Applicable To Key Notes
From
1. NBFCs Phase-I 1st April ➢ Listed/Unlisted NBFCs ➢ For large NBFCs
2018 with net worth ≥ ₹500 Cr
➢ Their holding, subsidiary,
JV, associate, excluding
those under corporate
roadmap
Phase- 1st April ➢ Listed/Listing NBFCs ➢ For medium NBFCs
II 2019 with net worth < ₹500 Cr
➢ Unlisted NBFCs with net
worth ≥ ₹250 Cr but <
₹500 Cr
➢ Their holding, subsidiary,
JV, associate, excluding
those under corporate
roadmap
Notes — ➢ Ind AS to be applied to ➢ No voluntary
standalone & adoption if < ₹250
consolidated statements Cr
➢ NBFCs with net worth <
₹250 Cr
▪ Cannot adopt
voluntarily
2. Scheduled — Initially from All (excluding Regional Rural ➢ Implementation
Commercial 1st April Banks) deferred until
Banks 2018 further notice
3. Insurance FY 2018-19 All insurance companies Mandated under
Companies (with FY Section 34, Insurance
/ Insurers 2017-18 Act, 1938 by IRDA
comparatives) based on MCA roadmap

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15. AS – 1: DISCLOSURE OF ACCOUNTING
POLICIES
1. Objective/Need

1. Objective
Prescribes the principles for selecting and disclosing significant accounting policies in
financial statements there by
✓ Enhances understanding of financial statements.
✓ Facilitates comparison between different enterprises for the same period.
2. Need for Disclosure of Accounting Policies
➢ Diversity in Accounting Policies are unavoidable due to:
a. Limited coverage of standards – AS do not cover all areas, allowing enterprises
to adopt reasonable policies where no standard exists.
b. Diverse business situations – A single set of policies cannot apply to all
enterprises at all times.
➢ AS allow multiple policies, even in covered areas.
➢ Different policies lead to different financial results, even for the same
transactions.
➢ Comparability suffers due to variations in policies.
➢ Compliance with standards alone is not enough; disclosure is necessary.
➢ AS-1 requires disclosure of significant accounting policies used.
➢ Users can understand differences and adjust their analysis accordingly.
3. Changes in Accounting Policies
This also mandates disclosing changes in accounting policies to facilitate period-to-
period comparison.
4. AS 1 is applicable to all enterprises.

2. Fundamental Accounting Assumptions

Fundamental Accounting Assumptions

Going concern Consistency Accural

Fundamental Accounting Assumptions

If followed If not followed

Not required to be disclosed Disclosure required in financial

statements

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Principle
1. Going Concern
✓ FSs are prepared on the assumption that an enterprise will continue its operations
in the foreseeable future.
✓ No intention or need to materially curtail the scale operations.
✓ Recognizes the need to:
a. Retain profits to replace used assets.
b. Provide for adequate provision for liabilities.
2. Consistency
✓ Same accounting policies should be used for similar transactions across all periods.
✓ Improves comparability over time.
✓ Changes in accounting policies are allowed if:
a. Required by law (statute).
b. Mandated by an accounting standard.
c. Leads to better financial statement presentation.
3. Accrual Basis of Accounting
➢ Transactions are recorded when they occur, irrespective of cash flow.
➢ Provides a better revenue-cost matching, ensuring accurate performance
measurement.
➢ More logical than cash basis but risks recognizing income before actual receipt.
➢ Can overstate profits, leading to capital erosion if dividends are paid on unrealized
income.
➢ Despite risks, accrual basis is widely used due to its logical approach.
➢ Revenue is recognized only when realization is reasonably certain.
➢ Mandated for companies under Section 128 of the Companies Act, 2013.

3. Accounting Policies

1. Accounting Policies
➢ Specific accounting principles and methods used by the enterprise in preparing and
presenting financial statements.
➢ Accountants choose from various options for recording and disclosing items in books
of accounts. This list is not exhaustive i.e. endless. Example
Items to be disclosed Method of disclosure or valuation
Inventories FIFO, Weighted Average etc.
PPE Historical cost, market value, revaluation method etc
➢ Policies cover valuation of assets/liabilities, revenue recognition, and expected
losses etc.,
➢ Policies impact financial results, making comparison between financial statements
difficult

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4. Selection of Accounting Policy

Major Considerations for Selecting Accounting Policies

I. Prudence
✓ Profits should not be anticipated, but potential losses must be accounted for.
✓ Requires provisions for all known liabilities and losses, even if amounts are
uncertain.
✓ Ensures:
➢ No overstatement of profits
➢ No understatement of losses
➢ No overstatement of assets
➢ No understatement of liabilities
Example 1
Inventory Valuation: At lower of cost or net realizable value (NRV).
✓ If NRV > Cost, ignore future profit.
✓ If NRV < Cost, recognize potential loss immediately.
A company facing a damage lawsuit should recognize a provision only if the probability
of losing is higher than winning.
Scenario 1: NRV is ₹15 per unit
Purchase Cost: 500 units × ₹10 = ₹5,000
Sold: 400 units × ₹15 = ₹6,000
Unsold Stock (100 units): Valued at ₹10 per unit (cost, since NRV is higher).
Profit Calculation: (400×15) −(500×10−100×10) =6,000−4,000=₹2,000
Future profit (₹500) is ignored, as it is not yet realized.
Scenario 2: NRV is ₹8 per unit
Unsold Stock (100 units): Valued at ₹8 per unit (NRV, since it is lower than cost).
Profit Calculation: (400×15) −(500×10−100×8) =6,000−4,200=₹1,800
Possible loss (₹200) is recognized immediately, following conservatism.
Example 2
Exercise of prudence does not permit creation of hidden reserve by understating
profits and assets or by overstating liabilities and losses. Suppose a company is facing
a damage suit. No provision for damages should be recognised by a charge against
profit, unless the probability of losing the suit is more than the probability of not
losing it.
II. Substance Over Form
Transactions should be recorded based on their true economic impact, not just their
legal form.
Example: A company sells an asset to a bank and immediately leases it back. Legally, it
appears as a sale, but economically, the company still controls the asset. So, instead
of recording it as a sale, it should be treated as a finance lease in the books.
III. Materiality

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✓ Financial statements must disclose all material items that could influence user
decisions.
✓ Materiality is not always based on size but based on nature of items for example,
a small fraud could indicate major internal control weaknesses.
Materiality Limits (as per Schedule III of the Companies Act, 2013)
a) Any income/expenditure item exceeding 1% of revenue from operations or
₹1,00,000, whichever is higher, must be disclosed.
b) Shareholding disclosure: Companies must disclose in Notes to Accounts the shares
held by shareholders owning more than 5% of the company's shares.

5. Manner of Disclosure

1. ✓ All significant accounting policies used in preparing and presenting financial

statements must be disclosed.
✓ The disclosure should form part of the financial statements.
✓ All policies should be disclosed in one place for clarity.
✓ Disclosure is not a remedy for wrong accounting.

6. Disclosure of Changes in Accounting Policies

Change in Accounting Policy

Material in current period Not material in current period but

ascertainable in later periods

Amount Amount not

ascertained ascertained
Fact of such change in later period
to be disclosed in current period.
Fact to be
Amount to be
disclosed
disclosed

Example of Disclosure
A company switches from FIFO to weighted average method for inventory valuation, reducing
profit and inventory value by Rs. 20,000.
Disclosure: "The company changed its policy to the weighted average method, which better
reflects consumption. This change reduced profit and inventory value by Rs. 20,000."

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16. AS – 10: PROPERTY, PLANT AND
EQUIPMENT
1. Definition Of PPE

use in production or supply of goods or services

,or
Condition 1:
For Rental to others,or
Held for
PPE are
For Administrative purposes
Tangible items
Condition 2 :
Used during more than one period
Expected to be

1. Administrative Purposes
includes all business purposes can be used for:
✓ Selling and distribution
✓ Finance and accounting
✓ Personnel and other functions of an enterprise.
2. If spare parts or standby equipment meet the definition of PPE, apply AS 10.

2. Objective

1. Objective
To prescribe the accounting treatment for PPE.
2. Principal Issues
The main issues in accounting for PPE are:
➢ Recognition of assets
➢ Carrying amounts determination
➢ Depreciation charges and impairment losses to be recognised.

3. Scope of the Standard

1. Application of the Standard

This Standard applies to PPE accounting unless another Standard requires a different
treatment.
2. Example
AS 19 assesses leased PPE based on risk transfer, while depreciation follows PPE
accounting standards.

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AS 10
Not Applicable to

Wasting Assets including Mineral rights ,

Biological Assets (other than bearer Expenditure on the exploration for and
plants) related to agricultural activity extraction of minerals ,oil,natural gas and
similar non - regenerative resources

Note: AS 10 applies to Bearer Plants but it does not apply to the produce on Bearer Plants.

4. Other Definitions

1. Biological Asset:

Living AS 10 does not apply if

Animal definition of PPE not met
Biological Asset
As 10 applices to Bearer
Plant
plants

2. Bearer Plant: Is a plant that (satisfies all 3 conditions):

Is used in the production or supply •Of Agricultural procedure

•For more than a period of

Is expected to bear produce
12 months

Has a remote likelihood of being •Except for incidental scrap

sold as Agricultural produce sales

Note: When bearer plants are no longer used to bear produce, they might be cut down and
sold as scrap.
For example - use as firewood. Such incidental scrap sales would not prevent the plant from
satisfying the definition of a Bearer Plant.

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What are not "Bearer plants"

Plants cultivated Plants cultivated to produce when

to be harvested there is more than a remote
Annual Crops
as Agricultural likelihood that the entity will also
produce harvest and sell the plant as
agricultural produce , other than as
incidental scrap sales

Trees grown for Maize and

use as lumber Trees which are Wheat
cultivated both for their
fruit and their lumber

5. Recognition criteria for PPE

➢ Probable future economic benefits will flow to the enterprise from the asset.
➢ The cost of the asset must be measurable reliably.
Note:
✓ Small items like moulds, tools, and dies can be grouped, applying recognition criteria to the
total.
✓ If the cost is immaterial, an enterprise may expense it instead of capitalizing as PPE.

6. Measurement of PPE

At Recognition Cost Model

Measurement
Cost Model
After Recognition
Revaluation Model

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7. Initial Recognition

An item of PPE that qualifies for recognition as an asset should be measured at its cost.
Cost of an item of PPE comprises:

Cost of an Item of PPE

Includes Excludes

Any Directly Decommissioning, 1. Costs of opening a new

Purchase
Attributable Restoration and facility or business (Such as,
Price
Costs similar Liabilities Inauguration costs)
2. Costs of introducing a new
product or service (including
costs of advertising and
promotional activities)
3. Costs of conducting business
in a new location or with a new
class of customer (including
costs of staff training)
4. Administration and other
general overhead costs

A. Purchase Price
➢ Includes import duties and non-refundable purchase taxes.
➢ Trade discounts and rebates must be deducted.
B. Directly Attributable Costs
Costs directly related to bringing the asset to the location and condition necessary for
it to operate as intended by management. Recognition stops once the item is ready for
use.
Costs Not Included
a. Costs incurred before the asset is fully operational or running at full capacity.
b. Initial operating losses.
c. Relocation or reorganization costs of operations.
Examples of Directly Attributable Costs
a. Employee benefits (as per AS 15) directly linked to the construction or acquisition.
b. Site preparation costs.
c. Delivery and handling costs.
d. Installation and assembly costs.
e. Testing costs (after deducting proceeds from selling items produced during
testing).
f. Professional fees.

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Examples of Costs Not Included
a. Opening costs (e.g., inauguration cost).
b. Costs for introducing new products/services (e.g., advertising).
c. Costs for conducting business in a new location or with new customers (e.g., staff
training).
d. Administration and general overhead co
Example:
Income from incidental operations, like using a site as a car park before construction, is
recognized in the Statement of Profit and Loss, as it is not necessary to prepare the asset for
its intended use.

Income earned during development of PPE

Directly Attributable Incomes (e.g. sale of Not directly attriubtable to the asset
scrap material on demolition in case of (e.g. car parking rental income)
redevelopment

Recognize as income
Adjust from the cost in the Statement of
of PPE Profit and Loss

C. Decommissioning, Restoration, and Similar Liabilities

Initial estimate of costs related to dismantling, removing the item, and restoring the
site referred to as decommissioning, restoration, and similar liabilities.
Exception
Costs for dismantling and site restoration, when related to inventory production, are
accounted for under AS 2 – Valuation of Inventories instead of capitalizing as PPE.
Note: These obligations are recognized and measured in accordance with AS 29.

8. Cost of a Self-Constructed Asset

1. Self-constructed Asset Cost

The cost of a self-constructed asset is determined using the same principles as for an
acquired asset.
2. Special Points
➢ Internal profits are eliminated in calculating the cost.
➢ The cost of abnormal amounts of wasted material, labour, or other resources is not
included in the cost of the asset.
➢ Borrowing costs should be included in PPE, following AS 16
3. Bearer Plants
Bearer plants are treated the same way as self-constructed items of PPE.

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Summary: Initial Recognition (COST)

Purchase Self-constructed

Material xxx
Purchase Price xxx
+ Labour xxx
+ non-creditable taxes xxx
+ Fixed/Variable Prod. Overheads xxx
- Trade discount xxx
+ Directly attributabel Exp/Income xxx
+ Directly attributable Expense/Income xxx
+ Initial Estimate of Restoration etc. xxx
+ Initial Estimate of Restoration etc. xxx
+ Borrowing Cost (if qualifying asset) xxx
COST OF ASSET xxx
COST OF ASSET xxx

9. PPE Acquired in Exchange of Assets

Acquisition of Assets for non-cash/partly cash partly non-cash consideration

Transaction has Transaction has no

Commercial Substance Commercial Substance

Cost of such PPE is measured at Fair Value A transaction lacks commercial

(FV) of the assets given up unless the FV of substance if the position of the
the asset received is more reliable. company (in terms of cash flows
or enterprise-specific values)
If information about reliability is not before and after the exchange
available, the following order of preference transaction reamin the same.
for recording PPE can be followed:
1. Measure at FV of asset given up.
2. Measure at FV of assets received (if FV of
asset given up is not available). In such cases, the
3. WDV of assets given up (ONLY if Points 1 assets acquired will be
and 2 are not available, which is a very measured at the WDV
remote possibility). of the assets given up.

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Commercial Substance in Exchange Transaction
An exchange transaction has commercial substance if:
a. Cash Flow Configuration
The configuration (risk, timing, and amount) of the cash flows of the asset received
differs from the configuration of the cash flows of the asset transferred.
b. Enterprise-Specific Value
The enterprise-specific value of the portion of the operations of the enterprise
affected by the transaction changes as a result of the exchange.

10. Determination of Cost in Special Cases

A. Deferred Payment Beyond Normal Credit Terms

Recognition of Interest
Total payment minus cash price equivalent is recognised as interest expense over the
period of credit, unless the interest is capitalised in accordance with AS 16.
B. PPE Purchased for a Consolidated Price
When several items of PPE are purchased for a consolidated price, the consideration is
apportioned to the items based on their respective fair values at the acquisition date.
C. PPE Held Under Finance Lease
The cost of an item of PPE held by a lessee under a finance lease is determined in
accordance with AS 19.
D. Government Grant Related to PPE
The carrying amount of PPE may be reduced by government grants in accordance with
AS 12.

11. Treatment of Subsequent Costs

Subsequent Expenditure

Major replacements / major

Regular / day-to-day Repairs Expenses which increase life
inspection / major overhaul
& Maintenance or efficiency of the asset
beyond the originally
assessed life or efficiency

Capitalized as under:

Expensed to P/L WDV of Asset xxx

+ Cost of New Part xxx
Capitalized - WDV of Old Part xxx
Revised WDV xxx

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12. Measurement After Recognition

1. Choice of Model
An enterprise should choose either the Cost model or the Revaluation model as its
accounting policy and apply it to an entire class of PPE.
2. Class of PPE
A class of PPE is a grouping of assets of similar nature and use in the operations of the
enterprise.
Examples:
➢ Land
➢ Land and Buildings
➢ Machinery
➢ Ships
➢ Aircraft
➢ Motor Vehicles
➢ Furniture and Fixtures
➢ Office Equipment
➢ Bearer plants
3. Cost Model
After recognition, an item of PPE should be carried at:
Cost
(-)
Accumulated Depreciation
(-)
Accumulated Impairment Losses.
4. Revaluation Model
After recognition, an item of PPE whose fair value can be measured reliably should be
carried at:
Carrying Value =
Fair value at the revaluation date
-
Subsequent Accumulated Depreciation
–
Subsequent Accumulated Impairment Losses.

Revaluation for Entire Class of PPE

If one item of PPE in a class is revalued, the entire class must be revalued.

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Frequency of Revaluations

Frequency of Revaluations (Sufficient Regularity)

Items of PPE experience significant and Items of PPE experience significant

volatile changes in Fair value changes in Fair value

Annual revaluation Revalue the item only every 3 or 5 years

1. Fair Value Determination

Fair value is usually determined through market-based evidence by a professional
appraiser. If there is no market-based evidence, fair value is estimated using:
➢ Income Approach (Discounted Cash Flow projections)
➢ Depreciated Replacement Cost Approach.
2. Accounting Treatment of Revaluations
When revalued, the carrying amount of the asset is adjusted to the revalued amount.
Technique 1: Adjust Gross Carrying Amount
PPE is revalued to Rs.1,500 consisting of Rs.2,500 Gross cost and Rs.1,000 Depreciation
based on observable market data.
Details of the PPE before and after revaluation are as follows:
Particulars Cost/ Revalued Accumulated Net
Cost depreciation book
value
PPE before revaluation (assumed) 1,000 400 600
Fair Value 1,500
Revaluation Gain
Gain allocated proportionately to 900
cost and depreciation 1,500 600 900
(900 x1,000/600) (900 x 400/600)
PPE after revaluation 2,500 1,000 1,500
The increase on revaluation is Rs.900 (i.e., Rs.1,500 – Rs.600).
The following journal entry will be passed:
PPE Dr. 1,500
To Accumulated Depreciation 600
To Gain on Revaluation* 900
Technique 2: Eliminate Accumulated Depreciation
Accumulated depreciation is eliminated against the gross carrying amount.
Details of the PPE before and after revaluation are as follows:

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Particulars Cost / Accumulated Net book
Revalued depreciation value
Cost
PPE before revaluation (assumed) 1,000 400 600
PPE after revaluation 1,500 1,500
Revaluation gain 500 400
The increase on revaluation is Rs.900 (i.e., Rs.500 + Rs.400).
The following journal entries will be passed:
Accumulated Depreciation Dr. 400
To PPE 400
(Accumulated depreciation eliminate against gross carrying amount of asset)
Therefore, carrying amount of asset is reduced to = 1,000 – 400 = 600
PPE Dr. 900
To Gain on Revaluation* 900
* Gain on Revaluation 1,500 – 600 = 900 recognized entirely in PPE

Revaluation – Increase or Decrease:

Revaluation

Increase Decrease

Credited directly to Exception: Charged to the Exception:

owners' interests under When it is subsequently statement of When it is subsequently
the heading of increased (intially profit and loss Decreased (initially
Revaluation surplus Decreased ) increased )

Decrease should be debited

directly to owners’ interests
Recognised in the statement of profit and loss
under the heading of
to the extent that it reverses a revaluation
Revaluation surplus to the
decrease of the same asset previously
extent of any credit balance
recognised in the statement of profit and loss
existing in the Revaluation
surplus in respect of that
asset

1. Revaluation Surplus Transfer

The revaluation surplus in owners' interests for an item of PPE can be transferred to
Revenue Reserves when the asset is derecognized (retired or disposed).
2. Case I: Whole Surplus Transfer
The whole surplus is transferred to Revenue Reserves when the asset is:
➢ Retired, or

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➢ Disposed of.
3. Case II: Partial Surplus Transfer
Some of the surplus may be transferred as the asset is used by the enterprise. The
amount transferred is the difference between:
➢ Depreciation (based on revalued carrying amount)
➢ Depreciation (based on original cost).
Note
Transfers from revaluation surplus to revenue reserves are not made through the
Statement of Profit and Loss.

13. Depreciation of PPE

1. Depreciation
Systematic allocation of the depreciable amount of an asset over its useful life.
2. Depreciable Asset
Depreciable amount = Cost of asset – Residual value
3. Residual Value
The estimated amount an entity would obtain from disposing of the asset, after
deducting the estimated disposal costs.
4. Useful Life
The period over which an asset is expected to be used by the entity or the number of
production units expected to be obtained.
5. Commencement of Depreciation
Depreciation begins when the asset is available for use, i.e., when it is in the location
and condition needed for operation.
6. Cessation of Depreciation
Depreciation stops at the earlier of:
✓ The asset is classified as held for sale
✓ The asset is derecognized.

14. Depreciation Method

1. Depreciation Method
The method used should reflect the pattern in which the asset's future economic
benefits are consumed by the entity.
2. Types of Depreciation Methods
➢ Straight Line Method (SLM): Constant charge over the useful life if residual value
remains unchanged.
➢ Reducing Balance Method (WDV): Decreasing charge over the useful life.
➢ Units of Production Method: Charge based on expected use or output.
3. Review of Depreciation Method
The depreciation method is reviewed at least at each financial year-end.
4. Change in Depreciation Method

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A change in depreciation method is treated as a change in accounting estimate as per
AS 5 (Prospective accounting).
5. Revenue-based Depreciation
A depreciation method based on revenue generated by an activity involving the use of
an asset is not appropriate because inflation can affect revenue but not asset
consumption.

15. Retirements

1. Retired PPE Held for Disposal

Items of PPE retired from active use and held for disposal should be stated at the lower
of:
✓ Carrying Amount
✓ Net Realisable Value
2. Write-down
Any write-down (reduction in value) should be recognized immediately in the Statement
of Profit and Loss.

16. De-Recognition

1. Derecognition of PPE
The carrying amount of an item of PPE should be derecognised when:
➢ On disposal
By sale
By entering into a finance lease
By donation
➢ When no future economic benefits are expected from its use or disposal.
2. Gain or Loss from Derecognition
Gain or loss should be included in the Statement of Profit and Loss when the item is
derecognised.
Gain or Loss = Net disposal proceeds - Carrying amount of the item.
Comparison of Ind AS 16 and AS 10

Aspect Ind AS 16 AS 10
1. Scope Does not exclude real estate Excludes real estate developers
developers from the scope. from the scope.
2. Recognition of Fixed Specific recognition criteria for No specific recognition criteria
Assets fixed assets. for fixed assets.
3. Components Components approach is No requirement for components
Approach mandatory for asset recognition approach.
and depreciation.
4. Model Selection Requires an organization to Recognizes the revaluation of
choose between Cost Model or fixed assets but doesn’t

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Revaluation Model for specifically require choosing a
measurement. model.
5. Change in A change in depreciation method No specific guidance provided
Depreciation is considered as a change in for change in depreciation
Method accounting estimate. method.
6. Jointly Owned Does not deal with jointly owned Provides guidance for fixed
Assets assets. assets owned jointly.
7. Assets Held for Does not deal with assets held Deals with assets held for sale
Sale for sale. or those retired from active
use.
8. Self-Generated Additional costs in the No specific guidance provided.
Asset Construction construction of self-generated
Costs assets should not be capitalized.
9. Revaluation Surplus Revaluation surplus may be Provides recycling to the income
transferred to retained earnings statement in the ratio of
on derecognition of the asset. additional depreciation.
10. Gain on Gain on derecognition should be No specific guidance provided
Derecognition considered as revenue. for gain on derecognition.
11. Non-Monetary PPE acquired in exchange of a PPE acquired in exchange is
Exchange non-monetary asset should be recorded at the net book value
recognized at fair value. of the asset given up.

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17. AS - 11: THE EFFECTS OF CHANGES IN
FOREIGN EXCHANGE RATES
1. Objective

➢ A business can deal with foreign exchange in two ways.

a. It may have transactions in a foreign currency.
b. It may have operations in a foreign country.
➢ All foreign currency transactions & financial statements of foreign operations must be
converted into the business’s reporting currency.
➢ The principal issues here addressed by this AS are
✓ to decide which exchange rate to use &
✓ how to recognise in the FS’s the financial effect of changes in exchange rates.

2. Scope

1. Application of the Standard

This standard should be applied:
a) In accounting for transactions in foreign currencies.
b) In translating the financial statements of foreign operations.
c) In accounting for foreign currency transactions related to forward exchange
contracts.
2. Exclusions from the Standard
This standard does not:
a. Specify the currency in which an enterprise presents its financial statements.
✓ Usually, the currency of the country where the company is based is used.
✓ a different currency is used, the reason must be disclosed.
✓ Indian companies are required to present financial statements in INR.
✓ If an Indian company is a subsidiary of a U.S. company, it may report in USD U.S.
Dollars with a disclosed reason.
b. Showing cash flows from foreign currency transactions in the cash flow statement.
c. Exchange differences on foreign currency borrowings to the extent that they are
regarded as an adjustment to interest costs.
d. Restatement of an enterprise’s financial statements from its reporting currency
into another currency just for user convenience.

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3. Accounting of FCT

FCT

2.VALUATION ON
1.INITIAL BS DATE / 3.CONTINGENT 4.EXCHANGE
RECOGNITION SUBSEQUENT LIABILITIES DIFFERENCES
MEASUREMENT

1. A foreign currency transaction

is a transaction which is denominated in or requires settlement in a foreign currency,
including transactions arising when an enterprise either
a. Involves buying or selling goods or services priced in a foreign currency.
b. Involves borrowing or lending funds in a foreign currency.
c. Involves entering into a forward exchange contract.
d. Acquiring or disposing of assets or incurring liabilities in a foreign currency.
2. Initial Recognition
FCTs are initially recognized by applying:
➢ Exchange rate on the date of the transaction.
➢ Alternatively, the average rate of a week or month can be used if there is no
significant fluctuation in the exchange rate.
3. Valuation on BS/Subsequent Measurement
For valuation on the balance sheet date, items arising from FCT are classified into:
a. Monetary items
b. Non-monetary items
Monetary Items
Monetary items include:
➢ Money held
➢ Assets and liabilities to be received or paid in fixed or determinable amounts of
money.
For example, cash, receivables and payables.
Non-Monetary Items
Non-monetary items are assets and liabilities other than monetary items.
For example, fixed assets, advances for purchase of goods / fixed assets, inventories
and investments in equity shares.

MONETARY ITEMS CLOSING RATE

ASSETS/LIABILIT CARRIED AT ACTUAL RATE(NO

IES NON HISTORICAL COST REMEASUREMENT)
MONETARY
ITEMS CARRIED AT
CLOSING RATE
FMV/NRV

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4. If the closing rate is unrealistic or remittance restrictions exist, the monetary item
should be reported at the amount likely to be realized or required to settle at the
balance sheet date.
5. Contingent Liabilities
Contingent liabilities are reported at the exchange rate on the balance sheet date.
6. Exchange Differences
Exchange differences are transferred to the Profit & Loss Account.

4. Special Option Available to Companies-Amendment to Para 46A

1. Irrevocable Option
➢ Paragraph 46A of AS 11, introduced in December 2011, allows enterprises to follow
this treatment for periods starting April 1, 2011, onwards.
➢ Once exercised, the option is irrevocable and must be applied consistently to all
such items.
2. Long-Term Foreign Currency Monetary Items
An asset or liability is designated as a long-term foreign currency monetary item if it
has a term of 12 months or more from the date of origination.
3. ADD/DEDUCT FROM COST OF
THE ASSET AND
RELATED TO ACQUISITION
DEPRECIATED OVER THE
OF A DEPRECIABLE ASSET
BALANCE LIFE OF THE
ASSET
EXCHANGE
DIFFERENCE ON LTFCMI
TRANSFER TO FCMITD A/C
AND AMORTISE OVER THE
OTHERS
BALANCE PERIOD OF SUCH
LONG TERM ITEM.

The debit or credit balance in FCMITDA shown under the head ‘Reserves and Surplus’
as a separate line item.

5. Foreign Operations

1. Foreign Operations
➢ Foreign operation is a subsidiary, associate, joint venture or branch of the reporting
enterprise, the activities of which are based or conducted in a country other than
the country of the reporting enterprise.
➢ These are classified as either integral foreign operations (IFO’s) or non-integral
foreign operations (Non-IFO’s).
2. Integral Foreign Operations (IFO’s)
➢ IFO is an operation whose activities are an essential part of the reporting
enterprise's activities.
➢ An IFO operates as an extension of the reporting enterprise.
3. Non-Integral Foreign Operations (Non-IFO’s)
A non-integral foreign operation (Non-IFO) is not an integral part of the reporting
enterprise.

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4. Indications of Non-IFO
The following indicate a foreign operation is a Non-IFO:
➢ It operates independently from the main enterprise.
➢ Transactions with the main enterprise are minimal.
➢ It is self-financed or uses local borrowings.
➢ Costs (labour, materials) are paid in local currency.
➢ Sales are mainly in other currencies, not the reporting currency.
➢ The main enterprise’s cash flows are not affected by daily activities of foreign
operation.
➢ Prices depend on local factors, not exchange rates.
➢ It has a strong local market, even if it exports.

6. Translation of Fs’s of IFO’s

1. Translation of Financial Statements of Integral Foreign Operation (IFO)

IFO

MONETARY
NON MONETARY P&L ITEMS
ITEMS CONTINGENT
ITEMS
LIABILITIES

CLOSING RATE
CARRIED AT CARRIED AT RATE ON DATE OF
COST FMV
TRANSACTION CLOSING RATE
OR

ORIGINAL AVERAGE RATE

CLOSING RATE
RATE

2. Exchange Differences
Any exchange differences arising from translating the financial statements of IFO are
transferred to the P&L account.

7. Translation of Fs’s of NON-IFO’S

NON - IFO

MONETARY &
P&L ITEMS CONTINGENT
NON MONETARY
RATE LIABILITIES
ITEMS

RATE ON THE DATE OF

CLOSING RATE TRANSACTION OR CLOSING RATE
AVERAGE RATE

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1. Exchange Difference on Conversion
Exchange differences arising from the conversion of financial statements should be
transferred to the FCTR.
2. FCTR in Reserves & Surplus
The FCTR account should be shown under reserves & surplus until the sale of the foreign
operation.

8. Re-classification of Foreign operations

Integral to Non-Integral:
Exchange gain/loss after reclassification goes to FCTR.
Non-Integral to Integral:
➢ Exchange gain/loss after reclassification goes to Profit & Loss (P&L) account.
➢ Existing FCTR balance stays in the Balance Sheet until the foreign operation is sold.
➢ Partial Sale of Non-IFO
A proportionate amount from FCTR is transferred to P&L.

9. Forward Exchange Contracts

1. Forward Exchange Contracts

A forward exchange contract is a contract where one party agrees to buy from or sell
to the other party an asset (in this case, foreign currency) at a future date for an
agreed price.
2. FC Types
FC is entered into for:
a. Managing or minimizing foreign exchange fluctuation risks (Hedging).
b. Trading or speculation purposes.
3. FC for Hedging
➢ Premium or discount at the inception FEC should be amortized over the contract
period.
➢ Exchange differences are recognized in the P&L account.
➢ Profit or loss from cancellation or renewal of FEC is recognized in the P&L account.
4. FC for Trading or Speculation
➢ The premium or discount on the FEC is ignored and not recognized separately.
➢ At each balance sheet date, the contract value is marked to its current market
value, and the gain or loss on the contract is recognized.
➢ Gain/Loss on reporting date = foreign currency amount × (forward rate at reporting
date for remaining maturity less contracted forward rate)

10. Disclosure

1. Disclosure of Exchange Differences

An enterprise should disclose:
➢ Disclose exchange differences included in net profit or loss.

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➢ Show net exchange differences in the Foreign Currency Translation Reserve (FCTR)
with a reconciliation of opening and closing balances.
2. Reason for Using a Different Reporting Currency
If the reporting currency differs from the country’s currency, disclose the reason.
If the reporting currency changes, disclose the reason for the change.
3. Change in Classification of Foreign Operation:
a) The nature of the change.
b) The reason for the change.
c) The impact of the change on shareholders' funds.
d) Effect on net profit/loss in prior periods if applied earlier.

Comparative Provisions Between AS 11 and Ind AS 21

Aspect Ind AS 21 AS 11
1. Forward Exchange Not covered by Ind AS 21. Included within the scope of AS
Contracts 11.
2. Accounting for Based on the functional Based on integral and non-
Foreign Operations currency approach. integral approach.
3. Exchange No specific guidance provided. Option to recognize exchange
Difference difference arising on the
Recognition on Long- translation of certain long-term
Term Monetary monetary items over the period.
Items
4. Presentation The presentation currency could No such specification provided.
Currency be different from the local
currency.

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18. AS - 12: ACCOUNTING FOR GOVERNMENT
GRANT
1. Objective/scope

1. Objective
This standard deals with accounting for government grants. GG can be in the form of
subsidies, cash incentives, duty drawbacks, etc.
2. Scope of the Standard
➢ Does not address/deals with
a. accounting for government grants in financial statements reflecting the effects
of changing prices or similar supplementary information.
b. government assistance other than government grants.
c. government participation in the ownership of the enterprise.
➢ Proper accounting is required when a government grant is received.
➢ FS should indicate how much the enterprise has benefited from the grant during
the reporting period.
➢ Clear reporting helps in comparing financial statements across different periods and
with other enterprises.

2. Definitions

1. Government
Government refers to government, government agencies and similar bodies whether
local, national or international.
2. Government Grants
Government grants are assistance provided by the government, in cash or kind, to an
enterprise for past or future compliance with certain conditions.
➢ They exclude those forms of government assistance which cannot reasonably have
a value placed upon them &
➢ transactions with government which cannot be distinguished from the normal
trading transactions of the enterprise.

3. Accounting treatment of Government Grants

1. Two broad approaches may be followed for the accounting treatment of government
grants:
2. Capital Approach
The ‘capital approach’, under which a grant is treated as part of shareholders’ funds,
and, suitable for grants similar to promoters' contributions.
3. Income Approach
The grant is recognized as income over one or more periods, typically used for other
types of grants.

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Choice of Approach
The choice of approach depends on the nature of the grant.

4. Recognition of Government Grants

1. Grant Recognition Conditions

A government grant is not recognised until there is reasonable assurance that:
➢ the enterprise will comply with the conditions attaching to it &
➢ the grant will be received.
Receipt of a grant is not of itself conclusive evidence that the conditions attaching to
the grant have been or will be fulfilled.
Example
X Ltd applies for a grant from the local authority for a social cause. To receive the
grant, X Ltd must meet certain conditions. There is reasonable assurance that the grant
will be received on time. However, there is a possibility that X Ltd may not fulfill all the
conditions. In such a case, X Ltd should not recognize the grant until it is reasonably
assured that all conditions will be met.

5. Non-Monetary Government Grants

1. Government Grants in Non-Monetary Assets (e.g., land or other resources)

non-monetary assets given
➢ at concessional rates - recorded at their acquisition cost.
➢ At free of cost - recorded at a nominal value.
Example
X Convent applies for a land grant to the State authority for building a school. The
market value of the land is Rs. 20 crores, but the authority provides it at a nominal cost
of Rs. 50 lakhs. X Convent should recognize the land at its acquisition cost of Rs. 50
lakhs.

6. Presentation of Grants Related to Specific Fixed Assets

1. Grants Related to Specific Fixed Assets

These grants are given to enterprises to purchase, construct, or acquire fixed assets.
Example
The Central Government aims to boost employment in rural and backward areas by
providing grants to eligible entities. F Ltd applies for such a grant, which requires the
company to construct a factory and employ at least 500 workers for the next five years.
The estimated cost of construction is ₹50 crore, while the grant amount is ₹30 crore.
F Ltd can recognize the grant in its books only if there is reasonable assurance that it
will meet the condition of employing 500 workers for the required period.
2. Methods of Accounting for Grants
Two methods for presenting grants related to specific fixed assets in the financial
statements:
Method I: Deduction method

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➢ The grant is deducted from the gross value of the asset and balance asset value is
depreciated over the remaining useful life of the asset.
➢ If the grant equals the entire cost of the asset, show the asset in the balance sheet
at a nominal value.
Method II: Income Method
➢ For depreciable assets, treat the grant as deferred income, which is recognised in
the profit and loss statement on a systematic and rational basis over the useful life
of the asset.
➢ For non-depreciable assets, credit the grant to capital reserve.
➢ If a non-depreciable asset grant requires fulfilling obligations, the grant is credited
to income over the same period as the cost of fulfilling the obligations.

7. Presentation of Grants Related to Revenue

1. ➢ These are the grants given to meet any specific expenditure (e.g salary, R&D etc)
or as reimbursement to the previously incurred expenditure.
➢ These grants can be shown either as other income separately or deducted from the
related expenses in the P&L account.
➢ If the grant is given as a reimbursement of previously incurred expenditure
transfer it to capital reserve a/c.

8. Presentation of Grants of the Nature of Promoters’ Contribution

1. ➢ Where the government grants are of the nature of promoters’ contribution, i.e.,
they are given with reference to the total investment in an undertaking or by way
of contribution towards its total capital outlay (for example, central investment
subsidy scheme) and
➢ no repayment is ordinarily expected in respect thereof,
➢ the grants are treated as capital reserve which can be neither distributed as
dividend nor considered as deferred income.

9. Refund of Government Grants

1. Refundable Government Grants

Treated as extraordinary items (AS 5).
1. For grants related to revenue:
➢ Refunds are first applied against any unamortised deferred credit.
➢ If refundable amount exceeds deferred credit, it is charged directly to profit
and loss.
2. For grants related to a specific fixed asset:
➢ Refund is applied by increasing the asset’s book value or reducing deferred
income.
➢ If book value is increased, depreciation is adjusted over the remaining useful
life of the asset.
3. For promoters’ contribution grants, if refundable:

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➢ The refundable amount is deducted from the capital reserve.

10. Disclosure

➢ The accounting policy adopted for government grants should be disclosed, including
methods of presentation in the financial statements.
➢ Disclose the nature and extent of government grants recognised in the financial
statements, including non-monetary assets given at a concessional rate or free of cost.

Comparative Provisions under Ind AS 20 and AS 12

Aspect Ind AS 20 AS 12
1. Disclosure Requires disclosure in financial No specific guidance on other
Requirement statements about other forms forms of government
of government assistance assistance.
received.
2. Capital Contribution Capital contribution grants are Capital contribution grants are
Grants not recognized. specifically recognized.
3. Recognition of Prohibits recognition of grants Grants for non-depreciable
Grants in directly in shareholders' funds. assets are shown as capital
Shareholders' Funds reserve under shareholders'
funds.
4. Recognition of Non- Non-monetary grants are Non-monetary grants are
Monetary Grants recognized at fair value. recognized at acquisition cost
or nominal value.
5. Deduction of Grant No option to deduct the grant Optional to deduct the amount
from Asset Book from the book value of the asset. of grant from the book value of
Value the asset.

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19. AS - 16: BORROWING COSTS
1. Objective & Scope

1. Objective
This AS provides accounting for borrowing costs.
2. Scope
The Standard does not deal with the actual or imputed cost of owners’ equity, including
preference share capital not classified as a liability.
Clarification Chart:
Particulars Remarks – Is the fund covered
by AS 16?
Equity share capital No
Retained earnings No
Preference Share Capital classified as a liability Yes
Preference Share Capital classified as equity No

2. Definitions

Borrowing costs are interest and other costs incurred by an enterprise in connection with the
borrowing of funds. Borrowing cost may include

Borrowing Cost

Exchange
Finance
Interest & Amortisation Amortisation Differences to the
charges for
Commitment of Discount/ of ancillary extent they are
assets
charges on Premium on costs relating regarded as
acquired on
Borrowings Borrowings to Borrowings adjustment to
Finance Lease
interest cost

1. Qualifying Asset
An asset that takes a substantial period of time to be ready for its intended use or
sale
Examples of Qualifying Assets
➢ Manufacturing plants, power generation facilities, and investment properties.
➢ Inventories that require substantial time to bring them to a saleable condition
Non-qualifying assets include:
➢ Investments.
➢ Inventories produced quickly in large quantities.
➢ Assets that are ready for use or sale when acquired.
2. Substantial Period of Time
➢ Substantial period of time depends on facts and circumstances of each case.
➢ Ordinarily, 12 months is considered substantial, unless a shorter or longer period
can be justified.

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➢ a rebuttable presumption of a period of twelve months is considered “substantial”
period of time.
➢ The estimated period should consider the time needed for an asset to be
technologically and commercially ready for use or sale.
3. Clarification Chart:
Particulars Remarks – Is the fund covered
by AS 16?
PPE (Property, plant and equipment) Yes
Intangible assets Yes
Investment Properties Yes
(Building meant for capital appreciation and
earning rental income)
Inventory Yes – If they require a
substantial period of time to
bring them to a saleable
condition.
Investments (Financial assets) No

3. Exchange Differences on Foreign Currency Borrowings

Particulars Accounting Treatment

Exchange Gain Credited to P&L
Exchange Loss Lower of the following treated as borrowing cost:
1. Actual exchange loss
2. Difference between interest on local and foreign currency
borrowings
Excess Exchange Charged to P&L
Loss
Understand this concept with example:
Loan Details
XYZ Ltd. took a loan of USD 10,000 on April 1, 20X1, at an interest rate of 5% p.a., payable
annually.
Exchange Rates
On April 1, 20X1, the exchange rate was Rs. 45/USD.
On March 31, 20X2, the exchange rate was Rs. 48/USD.
Local Currency Interest Rate
The corresponding local currency loan interest rate was 11% p.a. as of April 1, 20X1.
Computation for Borrowing Costs (AS 16)
i. Interest for the Period
USD 10,000 x 5% x Rs. 48/USD = Rs. 24,000
ii. Increase in Liability for Principal
USD 10,000 x (48-45) = Rs. 30,000

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iii. Interest if Loan was in Local Currency
USD 10,000 x 45 x 11% = Rs. 49,500
iv. Difference in Interest (Local vs. Foreign Loan)
Rs. 49,500 - Rs. 24,000 = Rs. 25,500
Final Calculation of Borrowing Costs
Out of Rs. 30,000 increases in liability, only Rs. 25,500 is considered as borrowing costs.
Total borrowing cost = Rs. 24,000 (interest on foreign currency loan) + Rs. 25,500 (exchange
difference).
Rs. 49,500 is considered as borrowing cost as per AS 16, and Rs. 4,500 is exchange difference
under AS 11.
Alternative Scenario (13% Interest on Local Loan)
If the interest rate on the local currency loan is 13% instead of 11%, the entire exchange
difference of Rs. 30,000 will be considered as borrowing costs.
Total borrowing cost = Rs. 24,000 + Rs. 30,000 = Rs. 54,000 under AS 16.
No exchange difference is recorded under AS 11.

4. Borrowing Costs Eligible for Capitalisation

Borrowing costs

Directly related to
acquisition
construction
production of

Qualifying Assets Assets other than Qualifying assests

Capitalized Revenue Expenditure

5. Commencement of Capitalization

1. Conditions for Capitalisation

Capitalisation of borrowing costs should begin when all the following conditions are met:
a. Expenditures for the asset are incurred.
b. Borrowing costs (loan taken) are incurred.
c. Activities necessary to prepare the asset for its intended use or sale are in
progress.

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2. Expenditures on a Qualifying Asset
Expenditures include:
➢ Cash payments, transfers of other assets, and assumption of interest-bearing
liabilities.
➢ Expenditures are reduced by progress payments received and grants related to the
asset.
3. Activities to Prepare Asset for Use/Sale
➢ Activities to prepare an asset for intended use or sale include more than just
physical construction.
➢ They also cover technical and administrative work before construction begins.
➢ Excludes periods when the asset is held without any development or production
activity.
➢ Example:
• Borrowing costs incurred during land development → Capitalized.
• Borrowing costs incurred while holding land without development → Not
capitalized.
4. Example of Borrowing Cost Capitalisation
X Ltd. is starting a construction project, financed by borrowing. The key dates are:
i. 15th May, 20X1: Loan interest related to the project starts incurring.
ii. 2nd June, 20X1: Technical site planning begins.
iii. 19th June, 20X1: Expenditure on the project starts incurring.
iv. 18th July, 20X1: Construction work begins.
Commencement Date for Capitalisation
The three conditions are:
a. Borrowing cost incurred: 15th May, 20X1
b. Expenditure incurred: 19th June, 20X1
c. Activities necessary to prepare the asset: 2nd June, 20X1
The commencement date for capitalisation of borrowing cost is the date when all three
conditions are met: 19th June, 20X1.

6. Suspension of Capitalization

1. Suspension of Capitalisation
➢ Capitalization of borrowing costs is suspended during extended periods when active
development is interrupted.
➢ Costs incurred during such interruptions are considered holding costs and do not
qualify for capitalization.
➢ Exceptions (Capitalization continues):
• When technical or administrative work is ongoing.
• When the delay is a normal or necessary part of development (e.g., inventories
maturing, seasonal delays like high water levels affecting bridge construction).
2. Example 1 (Suspension of Development)

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Construction suspended from October 20X1 to January 20X2 due to heavy equipment
being moved to another site.
In this case, capitalisation of borrowing costs must be suspended since the active
development was interrupted.
Example 2 (Temporary Delay)
Temporary delay of 20 days during the completion of construction due to technical
reasons.
Capitalisation of borrowing costs shall continue during this temporary delay.

7. Cessation of Capitalization

1. Cease Capitalisation of Borrowing Costs

Capitalisation of borrowing costs should cease when substantially all activities
necessary to prepare the qualifying asset for its intended use or sale are complete.
Note: Even if some routine administrative work is pending in respect of an asset like
decoration of the property still it is treated as substantially completed.
2. Construction in Parts (Usable Separately)
If an asset is completed in parts and each part is capable of being used while
construction continues on other parts, capitalisation ceases once substantially all
activities are completed for that part.
Example 1 (Business Park)
A business park with several buildings, each usable individually, is a qualifying asset.
Capitalisation ceases when each part is ready for use.
3. Construction in Parts (Not Usable Separately)
If part of the asset cannot be used separately (e.g., industrial plant), capitalisation
continues until the entire asset is complete.
Example 2 (Industrial Plant)
For an industrial plant (e.g., a steel mill) involving several processes carried out in
sequence, capitalisation only stops when the entire plant is complete.

Capitalization of Borrowing Cost

Commencement Suspension Cessation

Expenditure Borrowing during

Activities to when
for costs are extended
prepare the substantial
qualifying being periods in
qualifying ly all the
asset is incurred which active
asset is in activities
being development is
progress. are
incurred. interrupted. complete͘

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8. Amount of capitalization

1. Conditions for Capitalisation

Borrowing costs are capitalised when both conditions are met:
1. It is probable that the borrowing costs will result in future economic benefits to the
entity.
2. The borrowing costs can be measured reliably.
2. Other Borrowing Costs
Other borrowing costs are recognised as an expense in the period in which they are
incurred.
3. Classification of Borrowings
Borrowings are classified as:
1. Specific borrowings: Amount borrowed specifically for the acquisition or construction
of a qualifying asset.
2. General borrowings: All other borrowings that are not specific, which can be used for
any purpose.
4. Calculation of specific Borrowing Costs
Actual borrowing costs incurred during the period
Less
Investment income on temporary investments made using those borrowings.
5. Capitalisation of General Borrowing Costs
When general borrowings are used for a qualifying asset (QA), the entity must determine
the borrowing costs eligible for capitalisation by applying the capitalisation rate.
Compute Capitalisation Rate
Capitalisation rate =
Borrowing cost on general borrowings ÷ weighted average of general borrowings
outstanding during the period × 100
Amount eligible for capitalisation =
Expenditure on QA × Capitalisation rate
6. Maximum Capitalisation
The amount of borrowing costs capitalised during a period must not exceed the actual
borrowing costs incurred during that period.
7. Total Borrowing Costs to Capitalise on QA
Total borrowing costs capitalised on QA = Specific borrowing costs + General borrowing
costs

9. Excess of the Carrying Amount Over Recoverable Amount

1. After capitalization of borrowing cost

➢ If the carrying amount or expected cost of a qualifying asset exceeds its
recoverable amount or net realizable value, it must be written down or written off
as per relevant accounting standards.

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➢ In some cases, this write-down or write-off can be reversed if allowed by those
accounting standards.

10. Disclosure

a. Amount of borrowing costs capitalised during the period

b. accounting policy adopted for borrowing costs.

Comparative Provisions: Ind AS 23 vs AS 16

Aspect Ind AS 23 AS 16
1. Qualifying Biological assets will never be Biological assets may be included as
Assets included as qualifying assets. qualifying assets.
2. Definition of No specific definition provided; it is Specific definition and explanation
Substantial a matter of judgement. on the substantial period of time is
Period of provided.
Time
3. Inventories as Inventories produced in large Inventories can be considered as
Qualifying quantities should not be considered qualifying assets if they meet the
Assets as qualifying assets. condition of substantial period.
4. Disclosure of Interest expense, whether Disclosure is required only if
Interest capitalised or not, should be capitalisation of borrowing costs
Expense disclosed separately during the has occurred during the period.
period.
5. Borrowing Hyper-inflationary situations No specific guidance on
Costs in addressed. Increases in interest hyperinflation and its impact on
Hyper- costs due to hyperinflation must be interest costs.
inflation written off in the income
statement.
6. Capitalisation Weighted average capitalisation No specific guidance on
Rate rate on borrowings should be capitalisation rate disclosure.
Disclosure disclosed in Notes to accounts.
7. Consolidated In consolidated financial No specific guidance on
Financial statements, the weighted average capitalisation rate for consolidated
Statements capitalisation rate on borrowings of statements.
the holding and subsidiaries should
be considered.

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20. AS – 22: ACCOUNTING FOR TAXES ON
INCOME
1. Objective

1. This standard prescribes the accounting treatment for taxes on income.

2. Matching Concept
In accordance with the matching concept, taxes on income are accrued in the same
period as the revenue and expenses to which they relate.
3. Taxable income may be significantly different from the accounting income.

2. Scope

1. This Standard applies to accounting for taxes on income.

2. Covers determining tax expense for an accounting period and its disclosure in financial
statements.
3. Taxes on income includes all domestic & foreign taxes based on taxable income.

3. Key Terms

1. AI (Accounting Income)
Net profit or loss before tax.
2. TI (Taxable Income)
Income computed under tax laws, on which tax is payable.
3. Tax Expense
Current Tax + Deferred Tax.
4. CT (Current Tax)
Tax payable on taxable income for the period.
5. DT (Deferred Tax)
Tax effect of timing differences.
6. Timing Differences
Differences between taxable & accounting income that originate in one period and
reverse in future periods.
Example
Machinery purchased for scientific research – fully deductible for tax in Year 1, but
depreciated over years in accounting books. Creates a temporary difference, leading to
a deferred tax asset or liability.
7. Permanent Differences
Differences that originate in one period and do not reverse later.
Example
Fine for late tax payment – considered an expense in profit & loss, but not allowed for
tax computation. Since it never reverses, it is a permanent difference.

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4. Recognition

1. Tax on Income as an Expense

Tax on income is considered as an expense for the period, (current tax and deferred
tax), should be included in the determination of the net profit or loss for the period.
2. Tax Effects of Timing Differences
Shown in Statement of Profit & Loss as tax expenses & as DTA or DTL in the Balance
Sheet.
3. Recognition of Deferred Tax Assets (DTA)
DTA should be recognised and carried forward only to the extent that there is a
reasonable certainty that sufficient future taxable income will be available against
which such deferred tax assets can be realised.
4. DTA for Unabsorbed Depreciation or Losses
If an enterprise has unabsorbed depreciation or carry-forward losses, DTA can be
recognized only when there is virtual certainty, backed by convincing evidence, that
sufficient future taxable income will be available to utilize these assets.
5. Criteria for Certainty in Recognizing Deferred Tax Assets
a. This reasonable level of certainty would normally be achieved by
➢ Examining the past record of the enterprise and
➢ by making realistic estimates of profits for the future.
b. Virtual certainty cannot be based only on performance forecasts.
➢ It must be backed by strong evidence, such as:
• A binding export order that ensures profits.
• A contract where cancellation leads to heavy penalties for the defaulting
party

5. Measurement

1. Current Tax
Measured at the amount expected to be paid to tax authorities using applicable tax
rates & laws.
2. Deferred Tax Assets & Liabilities
Measured using tax rates & laws that are enacted or substantively enacted by the
balance sheet date.
3. Discounting of Deferred Tax
Deferred tax assets & liabilities should not be discounted to their present value.

6. Re-Assessment of Unrecognised Deferred Tax Assets

Reassessment of Deferred Tax Assets (DTA)

At each balance sheet date Unrecognized DTAs are reassessed.
Future taxable income is reasonably or Recognize previously unrecognized DTAs.
virtually certain

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7. Review of Previously Recognised Deferred Tax Assets

1. Review of Recognized DTA

Carrying value of recognized DTAs must be reviewed at each balance sheet date.
2. Insufficient Future Taxable Income
If future taxable income is unlikely, the DTA must be written down.
3. Improved Future Taxable Income
If taxable income becomes reasonably or virtually certain, the write-down can be
reversed.

8. Presentation and Disclosure – Offsetting Assets and Liabilities

Offsetting Tax Assets & Liabilities

1. Current Tax Assets & Liabilities
Offsetting allowed if:
a. Legally enforceable right to set off exists.
b. Intent to settle on a net basis.
2. Deferred Tax Assets & Liabilities
Offsetting allowed if:
a. Legally enforceable right to set off exists.
b. Both relate to taxes levied by the same taxation laws.

9. Special Cases

Tax Holiday (Sections 10A, 10B, 80IA)

Timing differences originate & reverse within No Deferred Tax is created.
tax holiday period
Timing differences originate in tax holiday Deferred Tax is created.
period but reverse after it
Reversal Order Timing differences originating first are
considered to reverse first.

Accounting for Taxes under Section 115JB (MAT)

1. Tax paid under Section 115JB
Considered as current tax for the period.
2. Deferred Tax Measurement
DTAs & DTLs for timing differences during tax payment under 115JB must be measured
using regular tax rates, not 115JB rates.
3. Reversal of Timing Differences
If timing differences of current period are expected to reverse in a period where tax
under 115JB may apply, regular tax rates must be used for measuring DTAs & DTLs.

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Comparative Provisions between AS 22 and Ind AS 12

Aspect Ind AS 12 AS 22
(Income Taxes) (Accounting for Taxes on
Income)
1. Approach Based on Balance Sheet approach. Based on Income Statement
approach.
2. Recognition Recognizes the difference between Recognizes the difference
Basis carrying amounts of assets and between taxable income and
liabilities and their tax base. accounting income.
3. Types of Applies to Timing Differences and Applies to Taxable Temporary
Differences Permanent Differences. Differences and Deductible
Temporary Differences. Does not
address Permanent Differences.
4. Recognition of Recognizes deductible temporary Deferred tax assets are
Deferred Tax differences to the extent that recognized only when there is
future periods are likely to provide reasonable certainty of its
taxable earnings. realization.
5. Concept of No concept of virtual certainty. Deferred tax assets related to
Virtual unabsorbed depreciation or carry
Certainty forward losses are recognized
only if there is virtual certainty
backed by convincing evidence.
6. Tax Recognition Current and deferred tax are No specific guidance on this.
in Income recognized in the income statement,
Statement except for tax arising from
transactions in Other
Comprehensive Income or directly
in equity.
7. Revaluation of Disparity between carrying amount No specific guidance on this.
Assets of a revalued asset and its tax base
is addressed.
8. Minimum No specific guidance on Minimum Specific guidance on Minimum
Alternate Tax Alternate Tax under Section 115JB. Alternate Tax under Section
(MAT) 115JB.
9. Tax Holiday & No specific guidance on deferred Specific guidance on deferred
Capital Gains tax for tax holiday situations and tax for tax holiday situations and
capital gain cases. capital gain cases.

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