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MCA-14-Financial Accounting:

I. Financial Statements

Financial Statements- meaning-Usefulness-Trading Account – Manufacturing Account-Profit and Loss A/c- Balance Sheet- Distinction between Fixed Assets and Current

Assets-Tangible Assets and Intangible Assets- Distinction between Trading and Profitand Loss Account and a Balance Sheet-Distinction between a Trial Balance and a

Balance Sheeet

Introduction:

Financial statements give detailed information about the firm. Financial

statements are organized summaries of detailed information and are thus a form of

analysis. The type of statement, the accountants prepares, the way they arrange items onthese statements, and their standard of disclosure are all influenced by a desire to provide

information in a convenient form.

A financial statement is an organized collection of data according to logical and

consistent accounting procedures. Its purpose is to convey financial information to

concerned party. It may show the financial position of the business as on a particular dayas in the case of balance sheet or disclose a series of activities during a given period, as in

case of income statement or profit and loss account. The focus of financial analysis is on

key figures contained in the financial statement. Financial statements are indicators of

two significant factors, namely:a) Profitability

b) Financial soundness

Meaning of Final accounts of company :

Section 209 of the Companies Act requires every company to maintain properBooks of accounts and section 210 has made it mandatory on the company to lay

before its shareholders, at every annual general meeting, a balance sheet and profit and

Loss account. Therefore every company is under legal obligation to present its

accounts in the prescribed manner.

The final accounts of a joint stock company refer to profit and loss account(Income Statement) and Balance Sheet (Position statement) prepared at the end of

every year. Though the Act mentions only profit and loss account and Balance sheet, in

practice Profit and Loss account is divided into Trading account, Profit and Loss

account and profit and Loss Appropriation account. Trading account shows the resultof trading by disclosing Gross Profit/Loss and Profit and Loss account shows the Net

Profit/loss of the business.


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Trading and Profit and Loss Account

The Trading and Profit and Loss Account shows operating expenses and other

expenses incurred by the company during the accounting period.It contains items as

detailed below.

Format of Trading and Profit and Loss account:

Trading and Profit and Loss Account for the year ended....

Dr TRADING ACCOUNT Cr

---------------------------------------------------------------------------------------------------------

PARTICULARS Rs PARTICULARS Rs

To Opening stock xxxx By Sales xxxx

To Purchases xxxx xxxx less: sales returns xxx xxxx

Less purchase returns xxx xxxx By Closing Stock xxxTo Direct/Mfg.expenses

Wages xxxx By Gross loss c/d xxxx

Fuel and power xxxx

Coal,gas and water xxxx

Freight xxxx

Import duty xxxx

Excise duty xxxx

Octroi xxxx

Royalty paid xxxx

Other direct expenses xxxx

To Gross profit c/d xxxx .......

PROFIT AND LOSS ACCOUNT

PARTICULARS Rs PARTICULARS Rs

To gross loss b/d xxxx By gross profit b/d xxxx

To Office/Admn. expenses By interest received xxxx

Salaries xxxx By discount received xxxx

Rent,rates and taxes xxxx By commission received xxxx

Printing &Stationery xxxx By rent received xxxx


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Postage & telegrams xxxx By dividend received xxxx

Insurance xxxx By transfer fees xxxx

Legal charges xxxx By Miscellaneous incomes xxxx

Telephone charges xxxx By Net loss transferred to

Audit fees xxxx P&L Appn.account xxxx

Bank Charges xxxx

General expenses xxxx

Director’s fees xxxx

Miscellaneous exps. xxxx

To Selling &Distribution Expenses

Advertising xxxx

Travelling expenses xxxx

Commission paid xxxx

Discount allowed xxxx

Carriage/freight outwards xxxx

Bad debts etc.

To financial expenses:

Interest on loan xxxx

Interest on debentures xxxx

To provision for:

Bad & doubtful debts xxxx

Depreciation xxxx

Repairs & maintenance xxxx

Managerial remuneration xxxx

To any other expenses xxxx

To Net profit transferred

To P&L Appropriation a/c xxxx

---------------------------------------------------------------------------------------------------------- xxxx xxxx

Profit and Loss Appropriation Account


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The Profit and Loss Appropriation account is prepared in order to show how the

profits of the company are appropriated or allocated for various purposes such as

payment of dividend, transfer to vaious reserves etc.

Format of Profit and Loss Appropriation account

Name of the company.......

Dr Profit and Loss appropriation account for the year ended.... Cr

---------------------------------------------------------------------------------------------------------

Particulars Rs Particulars Rs

To Balance b/d xxxx By balance b/d xxxx

(losses b/d from previous year) (profit b/d from previous year)

To Net loss transferred By net profit transferred

from P&L a/c of current year xxxx from P&L a/c of current year xxxx

To transfer to funds xxxx By transfer from any fund xxxx(Reserve fund, Sinking fund By balance carried to

Dividend Equalization Fund etc.) to assets side of the Balance sheet xxxx

To Dividend paid xxxx

To Interim dividend xxxx

To Proposed dividend xxxx

To Balance carried to liabilities

side of the balance sheet xxxx

---------------------------------------------------------------------------------------------------------

xxxx xxxx

Differences between Profit and Loss account and Profit and Loss Appropriation

account

1. Profit and loss account is prepared for recording expenses, losses, and gains of

the current uear, whereas profit and loss appropriation acount is prepared for recording

the appropriation of profit i.e how the profits are utilized for various purposes such as

payment of dividend, etc.

2. Profit and Loss account is always prepared whereas the profit and lossappropriation account is prepared only when there is appropriation of profits.

3. The balance of profit and loss accounti.e net profit or loss is transfered toprofit and loss appropriation account. On the other hand the balance of Profit and Loss

Appropriation account is carried forward from year to year.

4. Profit and loss accunt discloses the net profit or net loss before appropriation

whereas the closing balance of profit and loss appropriation account represents net


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profit or net loss after

appropriation.

Balance sheet

Section 211 provides that the balance Sheet shall give a true and fair value of thestate of affairs of the company as at the end of the financial year and shall be in the

prescribed form set out in part I of schedule VI. The balance Sheet is prepared in orderto indicate the financial position of the company as on the last date of the trading

period.

The Balance sheet of a company can be drawn either in horizontal form or in

vertical form. In the horizontal form of presentation assets are shown on the right hand

side and liabilities are shown on the left hand side. In the vertical form, the liabilitiesare shown under the “Sources of funds” and assets are shown under the heading

“Application of funds” given below are the two forms of Balance Sheet:

Horizontal form:

Name of the company

Balance Sheet as at....

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Liabilities Rs Assets Rs

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1. Share capital 1. Fixed Assets

Authorized: Shares of Rs... each a) Goodwill .....

Issued: Shares of Rs...each b) Land .....

Subscribed: Shares of Rs...each c) Building .....

Called up: Shares of Rs...each d) Leaseholds .....

Rs....called up ..... e) Railway Sidings .....

Less calls unpaid ..... f) Plant and Machinery .....

..... g) Furniture and fittings .....

Add: Forfeited Shares ..... h) Development of property .....

Paid up capital ..... i) Patents, Trade marks & designs .....

2. Reserves and Surplus j) Live stock .....

1) Capital Reserve ..... k) Vehicles .....

2) Capital Redemption Reserve .....

3) Securities premium a/c ..... 2. Investments:

4) Other Reserves ...... 1) In Government Securities

Less Debit balance in 2) In Shares, Debentures,


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P& L Account, if any ..... 3) In immovable Properties

5) P & L Appropriation a/c ..... 3) Current Assets, Loans

6) Proposed Addition to reserve & Advances

7) Sinking Funds A) Current Assets

3. Secured Loans: 1) Interst accured on investments .....

1) Debentures ..... 2) Stores and Spare parts .....

2) Loans and advances 3) Loose Tools .....

from Banks ..... 4) Stock in Trade..... .....

3) Loans and Advances 5) work in progress .....

from subsidiaries ..... 6) Sundry Debtors .....

4) Other Loans and Advances ..... 7) Cash Balance on hand .....

4. Unsecured loans 8) Bank Balance .....

1) Fixed Deposits ..... B) Loans and Advances

2) Loans and Advances 9) Loans and Advances

3) Short-term loans & Advances: to subsidiaries

a) From Bank ..... 10) Bills of exchange ie.,Bills

b) From Others.... Receivable

..... 11) Prepaid expenses .....

5. Current Liabilites 4. Miscellaneous Expenditure

and Provisions 1) Preliminary expenses ....

(A) Current Liabilites 2) Expenses including commission

1) Acceptances (B/P) ..... or brokerage on underwriting of

2) Sundry Creditors ..... Shares or Debentures

3) Outstanding expenses .....

4) Income recieved in advance ..... 3) Discount allowed on

5) Unclaimed Dividends ..... issue of shares

6) Other Liabilities ..... or debentures

(B) Provisions 4) Development expenditure

7) Provision for Taxation ..... not adjusted

8) Proposed dividends ..... 5) Other sums

9) Provision for Contingencies ..... 5. Profit & Loss Account

10) Provision for Insurance, Debit balance of profit

Pension and Similar Staff and loss accounts


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Benefit Scheme ..... which could not be deducted

11) Other Provision ..... from free reserves, if any .....

Total ..... Total.....---------------------------------------------------------------------------------------------------------

Vertical form of Balance Sheet:

Balance sheet as on..........

---------------------------------------------------------------------------------------------------------

Schedule No. Figures as ath the Figures as at the

End of the current end of the previous

Financial Year Financial year

---------------------------------------------------------------------------------------------------------

Rs. Rs.

I Sources of Funds

1. Shareholders Funds

a) Capital

b) Reserves and Surplus

2. Loans Funds:

a) Secured Loans

b) Unsecured Loans

Total

II Application of Funds:

1. Fixed Asets:

a) Gross Block

b) Less Depreciation

c) Capital Work-in-progress

2. Investments

3. Current Assets,

Loans and Advances:

a) Inventories

b) Sundry Debtors

c) Cash and Bank balances

e) Loans and Advances

Less: Current Liabilities and Provisions

a) Liabilities


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b) Provisions

Net Current Assets

4. a) Miscellaneous expenditure

(to the extent not written off or adjusted)

b) Profit and Loss account

(Debit Balance)

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Total

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Details under each of the above items are to be given by way of a separate

schedule. The schedule incorporates all the information required.

TRIAL BALANCE:Trial Balance is a statement showing Debit and Credit Balances of Accounts

obtained after balancing them. It contains two separate sides called debit side and creditside. The totals of both debit side and credit side of the trial balance should be equal

keeping in conformity with the basic rule of double entry book keeping that every debit

should have a corresponding credit. There are mainly two methods of preparing the trialbalancenamely; The Balances method and the totals method. Under the Balances

method only balances obtained by balancing various accounts will be listed. Under the

totals method, the totals of accounts are listed. A third method of showing both totals

and balances is also used rarely.

Differences between Trial Balance and Balance sheet:

.1. A trial Balance shows balances of all the accounts maintained where as a

balance sheet shows the balances of Assets and Liabilities only.

2. A trial balance may be prepared in any format as long as debit and credit

balances are shown. It is not a statutory document. Balance sheet has to be prepared

keeping in mind the provisions of companies act.

3. A trial Balance has debit and credit columns where as a Balance sheet has

Liabilities and Assets columns.

4. A trial Balance shows only balances of various accounts, whereas a Balance

sheet shows financial position of a company as at the end of an accounting period.

Important points to be considered while preparing the final accounts of

companies

Treatment of some items while preparing final accounts:


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1.Outstanding or Accrued Expenses: Expenses which have been incurred

during the year, the benefit out of which has been derived during the year, but thepayment in respect of which the payment has not been made is called accrued expense.

It is shown on the debit side of the profit and loss account. It will also be shown in the

Balance sheet on the liability side.

2.Accrued or outstanding income: These are incomes or benefits which havebeen earned but not yet received in cash during the year. It will be shown on the creditside of the Profit and Loss account and it also appears on the Asset side of the Balance

sheet.

3.Prepaid or unexpired expenses: In some cases the benefits of payment made

during the previous year will be available in the next year also. It is shown in the

balance sheet as an asset. It is shown as a deduction from the account concerned on

the debit side of the profit and loss account.

4.Capital and Revenue expenditure: Of the total expenditure incurred by acompany during a year, two types are there, viz.Capital Expenditure and Revenue

Expenditure. Revenue expenditure are shown in the Profit and loss account. Thebenefit derived from revenue expense are having benefits during a short period. Thecapital expenses are shown in the balance sheet and the benefits derived from capital

expenditure are long range. Viewed from this angle, the profit and loss account is

called Revenue Account.

5.. Calls in arrears:

Calls-in-arrears represent the amount not paid by the shareholders on the calls

made by the company. This items usually appears on the debit side of the trial balance

and in the balance sheet it should be shown by the way of deduction from called-up-

capital.

6. Calls in advance:

Calls in advance represent the amount received from the shareholders before

calls are made by the company. It is shown separately as an item under the heading

‘share capital’. It should not be added to called up or paid up capital.

7. Forfeited shares:

It represents shares forfeited by the company for the non payment of allotmentmoney or/and call money.It is shown on the liabilities side of the balance sheet by way

of addition to the paid up capital.

8. Preliminary expenses:

They represents expenses incurred in the formation of a company. They areentered on the assets side of the balance sheet under the heading ‘Miscellaneous

expenditure’ However,

preliminary expenses written off should be debited to profit and loss account.

9. Dividend:

Dividend refers to that portion of profits of a company distributed among the

shareholders. If it appears in the trial balance (debit balance) it should be shown on the


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debit side of the profit and loss appropriation account. On the other hand, if it appears

in the adjustment, first it should be shown on the debit side of the profit and lossappropriation account and secondly it should be shown as a liability under the heading

‘provisions’ in the balance sheet.

10. Interim dividend:

It is the dividend declared by the directors of company in the middle of the year

in anticipation for the profits of the current year. It should be shown on the debit side

of the profit and loss

appropriation account.

11. Final dividend:

It is the dividend recommended by the directors and approved in the annual

general meeting by the shareholders. When the final dividend is declared, the interim

dividend already declared and paid should not be adjusted against the final dividend,

unless otherwise instructed. Final dividend appearing in the adjustments should be firstentered on the debit side of the profit and loss

appropriations account and secondly it should be recorded as a liability in the balance

sheet under the head “Provisions”.

13. Proposed dividend:

it is dividend proposed by the directors and it is usually given in the adjustment.

Therefore it should be recorded on the debit side of profit and loss appropriation

account and also shown as a liability in the balance sheet under the heading

“provisions”. Further when dividend is to be

calculated as a percentage on share capital, it should be calculated only on paid up

capital (i.e, called up capital less calls in arrears)14. Unclaimed dividend:

It represents dividend not collected by the shareholders from the company.

Therefore it is a

liability and shown under the heading “current liabilities” in the balance sheet.

15. Dividend received:

It represents income of the company on investments made by it in the shares of

other

companies. It appears as a credit balance in the trial balance and hence recorded on the

credit side of the profit and loss account.

Illustration -1

From the following information of Ajantha limited, prepare Trading and profit

and loss account for the year ended 31-12-2005

Opening stock 16,000

Purchases 28,600


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Sales 50,900

Purchases returns 600

Sales returns 900

Wages 2,400

Salaries 2,800

Directors Fees 2,000

Gas and water 1,100

Carriage inwards 1,600

Trade expenses 2,000

Rent, rates and insurance 1,100

Discount allowed 400

Discount received 200

Bad debts 1,200

Audit fees 1,400

Interim dividend 2,800

Preliminary expenses written off 400

Profit and Loss appropriation a/c (cr) 3,000

Adjustments:

Closing stock 16,000

Transfer to general reserve 2,200

Depreciation on machinery 1,300

Solution -

Trading and profit and loss Account for the year ended 31-12-2005

Dr. Cr.

---------------------------------------------------------------------------------------------------------


To opening stock 16,000 By Sales 50,900

To Purchases 28,600 Less sales returns 900 50,000

To Carriage inwards 1,600

To Wages 2,400

To Gas and water 1,100

To Gross profit c/d 16,900

---------------------------------------------------------------------------------------------------------


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66,000 66,000

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To Salaries 2,800 By Gross profit b/d 16,900

To Trade expenses (Gen expenses) 2,000 By Discount received 200

To Rent, rates and insurance 1,100

To Directors Fees 2,000

To Audit Fees 1,400

To Prel.expenses written off 400

To Discount allowed 400

To Bad debts 1,200

To Depreciation on machinery 1,300

To Net profit transferred

to profit and loss

appropriation a/c 4,500

---------------------------------------------------------------------------------------------------------

17,100 17,100

---------------------------------------------------------------------------------------------------------

Dr. Profit and Loss Appropriation account for the year 31-12-2005 Cr.


To Interim dividend 2,800 By bal c/d (last year’s bal) 3,000

To Transfer to Gen. reserve 2,200 By current year’s profit b/d 4,500

To Balance carried to

Balance sheet 2,500

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7,500 7,500

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Illustration - 3

From the following balances of the Bahubali Trading company Ltd., for the year ended

31-12-2005, prepare profit and Loss appropriation Account and Balance sheet aftertransferring Rs. 20,000 to reserve fund, Rs. 10,000 to Dividend Equalization Fund and

Rs. 6,000 to Insurance Fund from the current year’s profit.

Rs.

Share Capital 20,000


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Reserve Fund 34,000

Dividend Equalization Fund 16,000

Insurance Fund 8,000

Land & Buildings 1,00,000

Profit & Loss Appropriation A/c (Cr) 14,000

Profit & Loss Account (Current year Net profit) 42,000

Machinery 12,000

Interim dividend paid 12,000

Stock 48,000

Debtors 50,000

Creditors 20,000

Cash 30,000

Security premium A/c 2,000

Forfeited Shares A/c 4,000

Calls in Arrears 20,000

Solution - 3

Bahubali Trading Co., Ltd.,

Profit and Loss Appropriation A/c for the year ended 31-12-2005

Dr. Cr.

---------------------------------------------------------------------------------------------------------


To Interim Dividend 12,000 by Balance B/d 14,000

To Transfer to reserve fund 20,000 By Current years Net profit 42,000

To Transfer to Dividend

Equalization fund 10,000

To Transfer to Insurance fund 6,000


Balance sheet 8,000

---------------------------------------------------------------------------------------------------------

56,000 56,000


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Bahubali Trading Co., Ltd.,

Balance sheet as on 31-12-2005


---------------------------------------------------------------------------------------------------------

1. Share Capital 1. Fixed Assets

Authorised capital 2,00,000 Land & Buildings 1,00,000

Issued & Subscribed 2,00,000 Machinery 80,000

Called up 2,00,000 2. Investments------------------------

Less calls in arrears 20,000 3. Current assets and--------------------

1,80,000 Loans and Advances--------------------

-

Add forfeited Shares 4,000 A. Current Assets

Paid up capital 1,84,000 Stock 48,000

2.Reserve & Surplus: Debtors 50,000

Reserve Fund 34,000 Cash 30,000

Add Addition 20,000 54,000 B. Loans & Advances

-

Dividend 4. Miscellaneous Expenditure---------

Equalisation Fund 16,000

Add Additions 10,000 26,000Insurance Fund 8,000

Add. Additions 6,000 14,000

Security premium 2,000

Profit & Loss Appropriation A/c 8,000

3. Secured Loans -

4. Unsecured Loans -

5. Current Liabilities & Provisions:

A. Current Liabilities Creditors 20,000

B. Provisions

---------------------------------------------------------------------------------------------------------

3,08,000 3,08,000

---------------------------------------------------------------------------------------------------------

--


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3,95,000 3,95,000

---------------------------------------------------------------------------------------------------

Adjustments:

a) Write off Rs. 2,000 from preliminary expenses

b) Transfer Rs. 10,000 to reserve fund

c) Stock on 31-12-2004 Rs. 65,000

d) Provide for dividend on share capital at 10%

e) Debentures interest is outstanding for one year

Solution -4

Cheman Company Ltd.,

Dr. Trading and Profit and Loss Account for the year ended 31-12-2004 Cr.

---------------------------------------------------------------------------------------------------------


To Opening stock 30,000 By Sales 1,10,000

To Purchases 60,000 Less sales returns 2,000 1,08,000

Less Purchase returns 1,000 59,000 By Closing stock 65,000

To Carriage inwards 2,500

To Wages 21,000

To Gross profit c/d 60,500

---------------------------------------------------------------------------------------------------------

1,73,000 1,73,000

To Salaries 8,500 By Gross profit b/d 60,500

To Rent & rates 1,800

To Advertising 2,500

To Insurance 1,300

To Discount 2,000To Preliminary exp.written off 2,000

To Interest due on Debentures 2,000

[4,000x5/100]

To Net profit transferred to profit

and loss appropriation a/c 40,400


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60,500 60,500

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Dr. Profit and Loss appropriation A/c for the year 31-12-2004 Cr.

---------------------------------------------------------------------------------------------------------


---------------------------------------------------------------------------------------------------------

To Transfer to Reserve fund 10,000 By BalanceB/d 14,000

(Last year’s profit)

To Proposed dividend 20,000 By Current year’s Net profit 40,400

[2,00,000x10/100]


Balance sheet 24,400

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54,400 54,400

Balance Sheet as on 31-12-2004

------------------------------------------------------------------------------------------------


------------------------------------------------------------------------------------------------

1. Share Capital 1. Fixed Assets

Authorised capital 2,50,000 Land & Buildings 1,30,000

2,500 share of Rs. 100 each Machinery 15,000

Issued & Subscribed 2,500 Furniture 4,000

shares of Rs. 100 each 2. Investments 60,000

Called up and paid up 2,50,000 3. Current Assets &

2500 shares of Rs.100 Loans and Advances

each, 80 called up and paid up A. Current Assets

Stock 65,000

Debtors 42,000

2,00,000 B. Loans and Advances


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Bills Receivable 6,400

2. Reserves & Surplus:

Reserve Fund 10,000 4. Miscellaneous Expenditure

Add. Additions 10,000 20,000 Preliminary Exps. 6,000

Profit and Loss Less written off 2,000 4,000

Appropriation A/c 24,400

3. Secured Loans

5% Debentures 40,000

Add interest due 2,000 42,000

4. Unsecured Loans

5. Current Liabilities and

Provisions

A. Current Liabilities

Creditors 15,000

Bills payable 5,000

B. Provision: Proposed Dividend 20,000

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3,26,400 3,26,400

---------------------------------------------------------------------------------------------------------

--

****************


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2. Consignment Accounts

CONSIGNMENT

Consignment: Sometimes businessmen appoint their agents at distant place to sell

their products or goods with a view to increase the sales and earn larger profits. Goodsare sent to these agents who sell them on commission on account and risk of the

principal. The Word “consignment” is derived from these types of principal agent

relationships and implies sending of goods to another person without transferring theownership to that other person. In such a case, if the goods do not fetch the required

price or are destroyed, the loss will be borne by the person who sends them.

In consignment business, generally there are two parties-the consignor and theconsignee. The person who sends the goods to the agent for sale is called the consignor.

The person to whom the goods are sent for sale is called the consignee. The consignee

sells the goods and remits the proceeds to the consignor after deducting his expenses.

Consignment Terminology

1. Consignment A/c. : A consignment account is separately prepared which is

debited with the cost of goods supplied and expenses incurred both by the consignor andthe consignee. It is credited by the sales proceeds and the stock of unsold gods.

Consignment account reveals profit or less on consignment which is transferred to profit

and loss A/c. Goods sent to an agent for the purpose of sale cannot be treated as sales.The transfer of such goods is credited to Goods sent on Consignment A/c and debited toConsignment A/c.

2. Account Sales. This is a statement of account prepared and sent by the agent tothe principal. After a certain period of time, the agency (consignee) prepares the account

sales which show the quantity and description of goods sold, sales proceeds realized, the

expenses incurred by consignee, his commission and the balance amount payable by himto the principal. The account sales is rent to the consignor, who makes entries in

Consignment A/c and consignee’s A/c and ascertains the amount of profit or loss on

consignment. (A specimen of Account sales is given below.)

Account Sales of 200 Transistor received from and sold on behalf

And at the risk of M/s Shri Sounds, Bangalore.

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Date Particulars Amount Total

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1976 150 Transistors Sold @ Rs.150 each 22,500

Sept.30 50 Transistors Sold @ Rs.180 each 9,000 31,500

Less: Expenses Incurred:

Cartage and Freight 250

Insurance 150

Godown rent 100

Commission @ 10% of sales 3,150

3,650

Less Bill accepted by us 27,850

Bank Draft enclosed 10,000

17,850

---------------------------------------------------------------------------------------------------------

E.& O.E. For Shri Sounds

Ramesh, Partner

3. Consignee’s Commission. Commission is the remuneration paid to the

consignee by the cosignor is consideration of the services provided by him in selling thegoods consigned. This is given over and above the amount of expenses incurred by

consignee on sale of goods. Commission is paid at an agreed percentage over the sales

proceeds. It thus depends on the amount of sales done by the consignee.

4. Del Credere Commission. Sometimes the consignor expects that the consignee

should himself recover all the debts and bear the loss, on account of bad debts, if any. In

order to compensate him from this type of loss, some extra commission is paid to him.

This extra commission is called Del Credere commission and is calculated on the totalamount of sales unless there is a special agreement that it is to be paid only on the amount

of credit sales. Payment of this commission imposes extra liability on the consignor and

induces him to deal in a prudent and cautions manner became otherwise loss on accountof bad debts will be borne by him.

5. Proforma Invoice. As already stated, goods sent on consignment cannot be

treated as sale therefore invoice can’t be prepared in respect of such goods. Therefore,the consignor sends a proforma invoice (invoice for form’s sake to the consignee so as toinform him about the cost of goods supplied, expenses incurred and a minimum sale price

to be charged by him on sales. A proforma invoice also includes information about the

quantity and description of goods, the number and weight, mark, packing of thecontainers of goods and so on.


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A proforma invoice may reflect (i) actual cost and expenses incurred by the

consignee or it may be prepared at (ii) inflated price of goods so that consignee may notknow the actual cost of the goods. The main object for which inflated proforma invoice

is prepared is to ensure a minimum margin of profit over the cost of goods supplied to the

consignee.

6. The Consignee. The consignee does not become the owner of goods on

receiving the consignment. H remains as an agent of the consignor. The law of agency

applies between consignor-consignee relationships. The consignee is to sell the goodsconsigned to him. If he has incurred some expenses, such as advertisement, insurance,godown rent, salesmen’s salaries etc., he can recover them from the amount of sales

proceeds received by him. We can also charge his commission, including del Credere

commission out of the sales proceeds. He is not liable to make payment to the consignoruntil the goods are sold. When goods are sold out or after a certain period of time, he

sends an account sales to the consignor giving details of the goods sold, his expenses and

commission and the balance payable by him to the consignor.

Difference between a Consignment and a Sale:

1. In a sale, the relationship between the parties is that of a buyer and seller

whereas in a consignment, the relationship is that of an agent and principal.

2. Where a sale is complete, the buyer becomes the debtor of the seller but in aconsignment, the consignee does not become debtor of the consignor on receipt of the

consignment.

3. In case of a sale, the legal ownership and title of goods sold of transferred to thebuyer whereas in a consignment, the legal ownership and title over goods remains with

the consignor.

4. Goods can’t be returned after the sale is complete. But in the case of

consignment, the consignee can return the unsold goods to the consignor.

5. In case of a sale, expenses incurred by the buyer on goods after sale are to be

borne by the buyer himself. But in a consignment, consignee can recover the amount of

expenses incurred by them on the goods consigned.

6. If goods are destroyed after sale, buyer only will suffer the Loss, because hebecomes the owner of goods, after sale. But in case of consignment, risk attached to the

goods is borne by the consignor and not the consignee.

ACCOUNTING TREATMENT

Accounting Treatment. Journal entries in the books of the consignor and the

consignee relating to the transactions of consignment will be made in the mannerdiscussed below:


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1. When goods are sent to the consignee. As consignment of goods can’t be

treated as sales of goods, sales account will not be credited in the books of the consignor.In its place, an account entitled goods sent on consignment account will be credited.

The following entry will be recorded:

Consignor’s Books Consignee’s Books

Consignment Account Dr. No Entry

To Goods sent on Consignment Account

The entry in consignor’s books will be made with the cost of the goods consigned.

If consignments have been sent to more than one consignees, the consignment accountsmay be distinguished by adding the names of the place or the consignees along with the

Consignment A/s, (for example Consignment to Bombay A/c, Consignment to Ramesh

A/c etc.) It may be noted that no entry will be passed by the consignee.

2. Consignor’s Expenses. All expenses incurred by the consignor on consignment

of goods to the consignee are debited to the consignment account and are thus added to

cost of goods consigned. The following entry will be recorded in this connection.



To Cash Account

It may be noted that no entry will be recorded in the books of the consignee in this

respect.

3. Advance Remittance by Consignee. Usually the consignee remits a certain sumof money either by way of cash, bank draft or accepting a bill of exchange as a security

against the goods received by him on consignment. The amount of advance can’t be

treated as sales proceeds and therefore should not be credited to the consignment account.The following journal entries will be recorded in this connection:


Cash Account Dr. Consignor Dr.

or Bank Account Dr. To Cash Account or

or Bills Receivable Account Dr. To Bank Account orTo Consignee To Bills Payable

4. On discounting the bill, If consignor gets the bill receivable discounted from his

bankers, the following entry will be recorded in his books:

Consignor’s Books Consignee’s Books Bank Account Dr. No Entry

Discount Account Dr.

To Bills Receivable Account

The amount of discounts is not debited to Consignment Account.

5. Consignee’s Expenses. Sometimes the consignee also has to incur some

expenses either on the upkeep and maintenance of the goods in safe condition or on their

sale. These expenses may be freight, cartage, godown rent, advertisement, insurance


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charges etc. All such expenses are to be borne by the consignor. The following entries

will be recorded in the books in this connection:


Consignment Account Dr. Consignor Dr.

To Consignee’s A/c To Cash Account

6. Goods sold by Consignee: When the goods are sold out or after a certain period

of time, the consignee will send an account sales to the consignor, intimating him the

total sales and the amount of his expenses and commission, with the amount of totalGross sales, the following entries will be recorded in books of the consignor and the

consignee:


Consignee’s A/c Dr. (i) For Cash Sales:

To Consignment Account Cash or Bank Account Dr.

To Consignor’s A/c(ii) For Credit Sale:

Consignment Debtors

Account Dr.

To Consignor’s A/c

(iii) When Cash received from

Debtors:

Cash or Bank Account Dr.

To Consignment Debtors

Account7. Consignee’s Commission: The consignee is entitled to commission at an agreed

rate on the gross sales proceeds. The Commission is paid in consideration of the servicesprovided by him in selling the goods. Commission paid to consignee is debited to

consignment account in consignor’s books. To the consignee, the amount of commission

is an item of income therefore commission account is credited for it. The followingentries are recorded:


Consignment Account Dr. Consignor A/c Dr.

To Consignee’s A/c (commission) To Commission Account

8. Goods returned by Consignee: Sometimes defective or obsolete goods arereturned by the consignee to the consignor. When such goods are received book the

consignor records this transaction by making the following journal entry:


Goods sent on Consignment Account Dr.


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To Consignment A/c No Entry

It may be noted that no entry will be recorded in the books of the consignee forthis transaction as he is not required to maintain accounts for goods received on

consignment.

9. Bad Debts: When Del Credere commission is paid. Del Credere commission

is paid to the consignee, if he undertakes to bear the bad debits himself. In case, some

debits are not recorded from consignment debtors, the following entries will be recorded

in the books:


No Entry Bad Debts Account Dr.

To Consignment

Debtors Account

10. Remittance by Consignee in settlement of account. Out of the sales proceeds

collected by the consignee, the following items are deducted: expenses incurred byconsignee, his commission (ordinary and del Credere) and the advance remittance madeby him. The balance made by him. The balance amount will have to be remitted by the

consignee to the consignor in settlement of the account. The following entries, in this

connection, will be recorded:


Cash or Bank Account Dr. Consignor A/c Dr.

To Consignee’s A/c To Cash or Bank Account

11. Unsold stock with the Consignee. It at the end of the accounting period, some

goods remain unsold with the Consignee, the value of such goods be ascertained. Thevalue is ascertained should be shown in the asset side of the consignor’s balance sheet.

Valuation of stock. The unsold stock with the consignee is to be valued like

ordinary stock. The method of valuation of unsold stock is cost or market pricewhichever is lower. Cost price of the unsold stock must included proportionate expenses

incurred by the consignor as well as the consignee relation to the goods sent on

consignment. But consignee’s commission selling expenses, salesmen’s salaries,advertisement etc. Should be included in such expenses. It may be expressed in simple

terms like this: “All expenses which of incurred up to the point of time; the goods are

received into the godown after consignee should be included in valuation of stock. But

expenses incurred after the goods have been put into consignee’s godown should not beincluded in the cost of unsold stock because such expenses usually do not increase the

value of the goods.”

The following expenses, which are of non-recurring nature, should be

proportionately added to the value of the unsold stock:

Carriage,

Freight,


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Custom Duty,

Loading and unloading charges,Insurance,

Dock Charges,

Import duty,

Normal loss etc,The Following expenses, which are of recurring nature, should not be included in

the value of the unsold stock:

Advertisement,

Godown Rent,

Godown Insurance,

Selling expenses,

Travelling expenses of Salesmen,

Free Samples,

Abnormal loss etc.

The following entry is passed to record the value of unsold stocks:


Consignment Stock Account Dr.

To Consignment Account No Entry.

12. Normal loss of goods.: In consignment business, Normal loss of goods is that

part of loss which is unavoidable. Normal loss occurs because of some inherent, natural

or unavoidable reasons. Examples of normal loss are: loss of coal in loading andunloading, loss of spirit or petrol due to evaporation, loss of timber in cutting it into

pieces and so on. Suppose 100 tons of atta at the rate of Rs. 80 per ton was consigned to

the consignee who received 95 tons of coal and the remaining 5 tons of atta was wastedin loading and unloading. It can legitimately be said that the cost of 95 tons of atta is Rs.

7600 (95 Tons X Rs.80 per ton). Loss of normal type should be apportioned on the

amount of unsold stock in the proportion of the above example,if 10 tons of atta was leftunsold with the consignee, it will be valued like this:

7600 X 10= Rs.800.

95

In the case of normal loss of goods, no entry is to be passed in the books of theconsignor as well as the consignee.

13. Abnormal loss of goods. Abnormal loss is that loss which could have been

avoided. It occurs because of negligence, carelessness, theft, mischief fraud ofemployees or inefficiency. Examples of abnormal loss are destruction of goods by fire

theft, breakage, leakage, loss of goods because of mishandling etc. Loss of this nature is

to be treated separately. It is not to be apportioned on the amount of unsold stock. The

cost of goods lost because of abnormal or avoidable reasons is ascertained din the samemanner as cost of unsold stocks is ascertained. This value is debited to abnormal loss

account and credited to consignment Account. The following entry is passed to record

abnormal loss of goods:


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Abnormal Loss Account Dr. No EntryTo Consignment Account

It is to be noted here that abnormal loss account is finally closed by debiting the

balance of this account to the profit and loss account after giving credit for any amountreceived from the insurance company.

14. Profit or Loss on Consignment. The balance of the consignment account in

the books of the consignor will now show the amount of profit or loss on consignment.

The following journal entries are recorded in the connection:


(i) In case there is profit


To Profit & Loss Account

(ii) In case there is loss:Profit and Loss Account Dr. No Entry

To Consignment A/c

After making this entry, the consignment account will be closed.

17. Closing Entry for Goods sent on Consignment Account. When the goodshave been sold out by the consignee, they can be treated as sales and may be credited

either to Purchases account or trading account at the end of the period. The entry to close

goods sent on consignment account is given below:


Goods Sent on Consignment account Dr. No EntryTo Trading Account

Consignment Account

A Consignment account is prepared by the consignor of goods to the consignee, All

transactions such as cost of goods supplied, expense incurred by consignor or consignee,

consignee’s commission, sales, unsold stock, profit or loss on consignment are to berecorded through this account. This account presents a summary of the transactions that

have taken place between the consignor and the consignee. The consignment account

reveals profit or loss on consignment and is thus a mini trading and profit and lossesaccount Consignment account is a nominal account. Therefore the following items are

debited to this account:

1) Cost of goods sent on Consignment

2) Expenses incurred by the consignor

3) Expenses incurred by the consignee


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4) Consignee’s commission.

5) Bad debts when Del Credere commission is not paid.

6) Profit on consignment.

The following items are credited to the consignment account:

1. Sales proceeds.

2. Returns of goods by consignee.

3. Abnormal loss of goods.

4. Unsold Stock with the consignee.

5. Loss on consignment (if any).

Performa of a consignment account is given below:

Consignment Account

Consignment to ………………….Account

-----------------------------------------------------------------------------------------------------------

Date Particular Amount Date Particulars Amount

Rs. Rs.

To Goods sent on Consignment A/c” By Consignee(Sales Proceeds)”

!! Cash (Expenses Incurred by consignor)” !! Goods sent on Consignment

!! Consignee (consignee’s Expenses)” (Returns of goods by consignee)”

!! Consignee (Commission)” !! Abnormal Loss A/c”

!! Consignee (Bad Debts)” Profit & !! Consignment Stock A/c

(unsold

Loss A/c ( Profit on consignment stock) (By Profit & Loss A/c)

transferred to Profit & Loss A/c) (Loss on consignment, if any,

transferred to Profit & Loss

A/c)

----------------------------------------------------------------------------------------------------------------------

METHODS OF ACCOUNTING

There are three different method of preparing accounts relating the consignment ofgoods.

These are:

1. Cost Price Method


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2. Invoice Price Method

3. Memorandum Columns Method

1. Cost Price Method: Under this Method entries relating to consignment in thebooks of consignor or passed with the actual cost of goods and amount spent or expenses

incurred by him. The journal entries already mentioned in a previous question will bepassed in the books of consigner under this method.

2. Invoice Price Method (When consigned goods are invoiced at higher than

actual cost price). Sometimes the consigner sends a Performa invoice to the consignee.

In a Performa invoice goods are generally priced at higher than actual cost say cost plus

20 percent. This may be done with any of the following objective.

1. Not to disclose actual cost of goods to the consignee

2. Suggesting the consignee a minimum cost price which already includes some

profit margin.

3. To ensure minimum amount of profit and consignment.

4. To Provide for all the expenses and consignee’s commission in the invoice price.

5. To discourage consignee from starting competing business.

If the goods are invoiced at cost plus 10per cent and the cost of goods is Rs. 20,000,

these will be invoiced at Rs.22,000 in the Performa invoice. A difference of Rs. 2,000will then arise in the books of accounts. In order to nullify the effect of such difference,

some entries are passed by the consignor in his books of accounts.

1. Recording Performa Invoice Price. Referring to above example when goods

are invoiced at higher then cost price, the following entry will be recorded by theconsignor on consignment of goods:

Consignment A/c Dr. Rs.22, 000

To Goods sent on Consignment 22,000

2. Recording the difference of invoice & cost price. In order to nullify thedifference of Rs.2,000 between invoice and cost price, the following entry is recorded by

the consignor in his books of accounts:

Goods sent on Consignment A/c Dr.Rs.2, 000

To Consignment A/c 2,000

The effect of this entry is to show the actual cost of goods consigned in the

consignment account so that profit or loss on consignment can be properly calculatedly.

This entry is in one sense an adjusting entry which adjusts both the consignment accountand the goods sent on consignment account. Goods sent on consignment account are to

be transferred to the trading account at the end of the year. Therefore unless this account

is adjusted, trading account will not show correct figures of profit or loss.


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3. Unsold Stock. The unsold amount of stock in the hands of the consignee is to be

valued at invoice price plus the proportionate share of expenses includable in the value ofgoods. For example, if in the above example, 25% goods are buying unsold and

proportionate expenses on these 25% goods are Rs. 300, the amount of unsold stock will

be calculated as under:

Invoice price of goods Rs.22, 000

Value of 25% goods Rs. 5,500

Add Proportionate expenses Rs. 300

Value of unsold stock Rs. 5,200

The following entry will be passed to record this value of unsold stock:

Consignment stock A/c Dr. .5,200

To Consignment A/c . 5200

4. Recording the difference of invoice and cost price of unsold stock. The value

of closing stock must be ascertained by the consignor at cost or Market value whichever

is lower, But the value of closing stock, recorded above does not conform to thisprinciple. In the above example, the cost of 25% unsold stock is Rs. 5,000 (25% of

Rs.20,000) but the invoice price of 25% unsold stock is Rs. 5,500 (25% of Rs.22,000),

the difference of Rs.500 in the valuation of closing stock has got to be adjusted bypassing the following entry:

Consignment stock A/c Dr. Rs.500

To Consignment Stock Suspense A/c Rs.500

This entry will be adjusting the excess of invoice price over cost price of unsold

stock. Consignment stock suspense is deducted from consignment stock account toascertain the cost of unsold stock with the consignee.

It is important to note here that there is no difference in the entries to be passed in

the books of the consignee.

5. Memorandum Columns Method: It is a combined method recording

transactions at both the invoice and the cost price. For this purpose, separate columns are

provided for Invoice prices and cost price in the following accounts:

1. Consignment A/c

2. Goods sent on consignment A/c

3. Consignment stock A/c

Columns relating to invoice price are called memorandum columns. They are notto taken into consideration while preparing the final accounts but are useful to compare

profit on consignment on the basis of Invoice and cost price. A proforma of consignment

account with memorandum columns is given below:


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Consignment Account

------------------------------------------------------------------------------------------------------------ Date Particulars Invoice Actual Date Particulars Invoice Actual

Price Price Price Price

--------------------------------------------------------------------------------------------------------

Illustration:

(i) The firm of Delta & Co., Of Delhi consigned to Premier & Co. of Rangoon 50

cases of Piece goods valued at Rs. 350 each.

(ii) The consignors paid freight and insurance thereon Rs. 1800,

(iii) They received as an advance from Premier & Co Rs. 8000.

(iv) Received an Account Sales from Premier & Co. giving particulars as under:

Gross proceeds Rs. 28000, expenses of Warehousing, Carriage, Dock Dues, etc,

Incurred by them amounted to Rs. 900. and their commission to Rs. 1000.

(v) Received a Bank Demand Draft of the balance due by them on the consignment.

From the above particular, prepare the necessary Ledger Accounts in the books of

the Consignors and those of the Consignees.

Solution

In the Books of Delta&Co.,

Consignment Account

--------------------------------------------------------------------------------------------------------

Rs. Rs.

To Goods sent on consignment a/c 17,500 By Premier & Co. 28,000

To Cash A/c (Freight and Insurance) 1,800

To Premier & Co. (Exp.) 900

To Premier & Co. (Com.) 1,000

To Profit and loss A/c 6,800

--------------------------------------------------------------------------------------------------------

28,000 28,000

Premier & Co’s Account

Rs. Rs.


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To Consignment A/c 28,000 By Cash (Advance) 8,000

By Consignment a/c (Exp) 900

By Consignment a/c (Com.) 1,000

By Bank A/c. 18,000

28,000 28,000

In the Books of Premier & Co,

Delta & Co’s Account

--------------------------------------------------------------------------------------------------------

Rs. Rs.

To Cash (Advance) 8,000 By Cash (Sales) A/c 28,000

To Cash (Expenses) 900

To Commission 1,000

To Bank 18,100

28,000 28,000

3. Accounting for Partnership Accounts

Fundamentals

Partnership. Partnership is the relation which subsists between persons carrying onbusiness in common with a view of profit. The Indian Partnership Act 1932 vide its

section 4 defines the term Partnership as under. “Partnership is the relation between

persons who have agreed to share the profits of a business carried on by all or any ofthem acting for all”.

According to this definition the essential features of partnership form of business

organisation are :

1. Two or more persons. None can be a partner with himself. There must be at

least two or more persons to form a partnership. The term person does not include firmsand joint stock companies and as such only partners on firms or members of joint stock

companies can enter into a Partnership agreement provided the number of partnersremains within statutory limit. The maximum number is ten in case of banking firms and

twenty in all other business.

2. Agreement. Partnership arises out of an agreement only. It does not arise out of

status or by operation of law. There must be an agreement among the partners of the firm.


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3. Business. Partners must carry some lawful business and not for any other

purpose. Business includes any trade, occupation and profession.

4. Profit Motive and Sharing of Profits. Partners must enter into partnership

agreement with a motive to earn and distribute among themselves profits of a business in

an agreed ratio. Clubs, building societies or any other associations, religious or charitableare not partnerships as there is no motive to earn profit. Agreement to share profit inplies

agreement to share losses also.

5. Application of law of Agency. According to the definition, partnership business

may be carried on by all or any of them acting for all. This implies that partnership isbased on law of agency. Each partner acts as an agent as well as principal of other

partners. Thus every partner can bind other partners and the firm by his own acts and be

bound by the acts of the other partners. This means that a partner has implied authority tobind other partners for the acts done by him in the course of the business.

Legal points affecting Partnership:

1. Members. The maximum number of partners in a partnership is limited to 10 in

the case of banking business and 20 in the case of other business. A minor can’t becomefull fledged member of a partnership but a female can be. A minor however can be

admitted to the benefits of partnership with the consent of other partners.

2. Liability. In partnership, liability of partners is unlimited.

3. Admission. No new partner can be introduced in the partnership save with the

unanimous consent of all partners.

4. Death of a partner. Death of a partner will bring about the dissoulution of the

partnership unless the partnership agreement provides otherwise.

5. Dissolution. In case of partnership at will, Partnership may be dissolved at the

desire of any partner ant at any time by giving a notice in writing to other partners.

6. Registration. Registration of the partnership is not compulsory but the law hasindirectly made registration compulsory because an unregistered firm suffers from many

disabilities

like :-

(a) A partner of an unregistered firm cannot file a suit against the firm or any

partner thereof for the purpose of enforcing a right arising from contact or right conferredby the Partnership Act.

(b) No suit can be filed on behalf of an unregistered firm against any third party forthe purpose of enforcing a right arising from a contract.

(c) An unregistered firm cannot claim a set off in a suit against the firm by a third

party to enforce a right arising from a contract (where the claim of set off is above Rs.

100).


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7. The rights and liabilities of the partners are governed by the Indian Partners Act,

1932.

8. Firm and firm name. Persons who have entered into partnership with one

another are called individually partners and collectively a firm and the name under which

the business is carried on is called the firm name.

Legal point affecting Partnership Accounts.

1. Partners are entitled to share profits equally, and must likewise bear losses

equally irrespective of the amount of their respective capital accounts unless agreedotherwise.

2. Partners are not entitled to Interest on capital, salaries or remuneration, unless

otherwise agreed.

3. Partners who advance loan to the partnership firm over and above the amount ofcapital contributed by them are entitled to charge interest thereon, at the rate of 6 percent

per year, unless otherwise agreed.

4. No interest is charged to the partners in respect of their drawings, unlessotherwise agreed.

5. Generally, an outgoing partner is entitled to have his proper share of the netassets (i.e.,) asset less liabilities), including goodwill, as they exist at the date of his

retirement, quite apart from their book values.

6. A partner is entitled to be indemnified for expenses properly incurred by him onbehalf of the partnership firm.

Partnership Deed

According to the definition of partnership under the Indian Partnership Act, there

must be an agreement between the partners of a partnership firm. The agreement may beexpress or implied. It may be a written or oral agreement. In most of the cases, these

agreements are drawn up in writing. These written agreements are called by variousnames such as partnership deed, partnership agreement, constitution of partnership or

Articles of partnership etc. The exact terms of the partnership deed (or agreement) will

depend upon circumstances but, generally partnership deeds contain the following points:

1. The name of the firm and business to be carried on under that name.

2. Address (s) of business place (s)

3. Nature and scope of the Business.

4. Commencement and duration of partnership.


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5. The capital and the contribution made by each partner.6. Provision for further

capital and loans by partners to the firm.

7. Partner’s Drawings.

8. Interest on capital, loans, drawings and current account.

9. Salaries, commission and remuneration to partners.

10. Profit )or loss) sharing ratio of partners.

11. The keeping of proper books of accounts, inspection and audit, Bank

Accounts and its operation

12. The accounting period and the date on which final accounts are to be

prepared.

13. Rights, power and duties of partners.

14. Whether, and in what circumstances, notice of retirement or dissolution canbe given by a partner.

15. Provision that death or retirement of a partner will not bring about dissolution

of partnership.

16. Valuation of goodwill on retirement, death dissolution etc.

17. The method of valuation of assets (and liabilities) on retirement or death ofany partner.

18. Provision for expulsion of a partner.

19. Provision regarding the allocation of business activities to be performed by

individual partners.

20. The arbitration clause for the settlement of disputes.

It may be noted that the exact terms of the partnership deed will a depend upon thecircumstances of each case.

The Rights of partners in a partnership firm are as follows :

1. Every partner is entitled to take active part in the management of the business.

2. Every partner has an inherent right to be consulted in all matters affecting thepartnership.

3. Every partner has a right to have access to the accounts of the firm and he can

have a copy of the books of the firm.

4. Every partner is entitled to share profits equally with other partners unless

otherwise agreed.

5. If a partner contributes in excess of the amount he is supposed to subscribe, he is

entitled to receive an interest on that amount @ 6% per annum out of profits of the firm.

6. Every partner has a right to use for the dissolution of the firm.


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7. Every partner has a right to be indemnified by the firm in respect of payments

made and liabilities incurred by him (a) in the conduct of the business and (b) in doingsuch act in an emergency for the purpose of protecting the firm from loss, as would be

done by a person of ordinary prudence in his own case, under similar circumstances.

8. Every partner has a right to retire :

(a) with the consent of all the partners, of

(b) in accordance with an express agreement by the partners, or

(c) where the partnership is at will, by giving a notice in writing to all partners of

his intention to retire.

9. Every partner has a right not to be expelled from the partnership.

Obligations :

The following are the main obligations of the partners :

1. Every partner is bound to act honestly, faithfully and diligently for the greatestcommon advantage of the firm’s business.

2. Every partner is bound to render true, proper and correct accounts of partnership

and allow other partners to inspect and copy them.

3. If due to negligence or fraud of a partner, the firm suffers losses, the partnerresponsible for such acts shall make good the loss.

4. Every partner is bound to use the property of the business for the purpose of thebusiness only.

5. Every partner must share losses equally, unless agreed otherwise.

6. Every partner is under an obligation to account for private profits made by him

from any use of partnership property, name of business connection.

7. Every partner is bound not to carry on competing business to the firm, during hisstay in the partnership firm.

8. Every partner must act within the scope of his authority and where he exceeds,

he must compensate other partners for any loss unless such act is ratified.

9. Every partner is liable severally and jointly with all other partners, for all acts ofthe firm done while he is a partner.

Kinds of Partners :

Partners can be divided into the following categories :


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1. General Partners. All partners, if there is no specific agreement otherwise, are

basically general partners and their liability is unlimited.

2. Active Partners. Those partners who take active part in the management of the

business are known as active partners.

3. Sleeping Partners. Partners who though subscribe their share of capital but donot take active part in the management of the business are called as sleeping partners.

4. Secret Partners. Certain persons, though become partners, want to remain

behind the screen. Such partners are called Secret Partners. The liability of such partners

is unlimited.

5. Nominal Partners. Sometimes persons of credit or importance lend their name

to the firm but neither they invest nor share the profits. But such partners can’t escape

liability towards third person.

6. Partners by Estoppel. Some persons, though not partners, mislead other personsby saying that they are partners in a certain firm. Such persons are known as partners by

estoppel. They are liable to third parties for their acts done in inducement of the

statements given by such person.

7.Sub-Partner. Where a partner agrees to share his profits derived from a firm with

a third person that third person is known as a sub-partner. He is not connected with the

firm is any way and has no right or obligations towards the firm.

Goodwill

The Goodwill of a business is the advantage which a person gets by continuing tocarry on, and being entitled to represent to the outside world that he is carrying on a

business, which has been carried on for some time in the past.

Goodwill is a thing very easy to describe, very difficult to define. (It is the benefit

and advantage of the good name. reputation and connection of a business). It is theattractive force which brings in customers to the business. It is the one thing which

distinguishes an old established business from a new business at the first start. Goodwill

is composed of a variety of elements. It differs in its composition in different trades andin different business in the same trade.

We may describe Goodwill as an intangible asset arising out of super profit earning

capacity of a concern. The existence of Goodwill of a firm distinguishes the same fromothers. If a firm being situated in a comparable position with others and doing the samenature of trade earns extra profit, then there is some factor favorable in the firm for

bringing more and more customers to that particular firm. In economic sense, marginal

firms have no goodwill but super marginal (above marginal) firms enjoy goodwill uptothe value they are away from marginal firm.


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But Goodwill, in the sense of attracting customers, has little significance unless it is

valuable in the sense of having a saleable value.

The Goodwill possessed by a firm may be due to the following elements of the

business :

1. Favorable Location of the Business premises.

2. Quality of firm’s products or services.

3. Personal reputation of the partners.

4. The possession of efficient and contented employees.

5. The possession of well known Trade Marks, patents etc.

6. The possession of favorable contracts or monopoly

7. The continuity of advertisement.

8. Flexibility and development of business with charging conditions.

9. Freedom from legislative restrictions.

Although a firm may possess goodwill, it is not always necessary to raise agoodwill account in the books of accounts except to the extent that cash or other assets of

the firm have been used to pay for it. Because if payment is made for goodwill but is notrecorded in the books, the capital accounts of the partners of the firm are understated to

the extent of the value of goodwill account is opened, it is not always adjusted to give

effect to every fluctuation in its value.

Valuation of Goodwill

There are various methods of valuation of goodwill much as

1. Average Profit Basis. In this case the profits of the past few years are averaged

and adjusted (multiplied) for any charge that is expected to occur in the near future. Theaverage is multiplied (adjusted) by a certain number. This is expressed, for example as 3years of five years profits, suppose the profits for last 5 years are 10,000, 15,000, 20,000,

25,000,30,000 Goodwill will amount to

10,000 + 15,000 + 20,000 + 25,000 + 30,000

-----------------------------------------------------

5

If there was a loss in the 2nd year of Rs. 15,000 then Goodwill would have beenRs. 42,000

2. Super Profit Basis. The super profits of a business are the profits which can beexpected in the future over and above those necessary to pay a fair return upon thecapital invested in the business, having regard to the risk involved in that particular

business and a fair remuneration for the services of the partners who work thereon.

Super Profits-Net Profits-(Normal rate of Int. on Cap.

+ Reasonable Salary to Partners)


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Super profits multiplied by the number of years purchase agreed upon gives

goodwill.thus

Goodwill = Super Profits x No. of years purchase.

Illustration

Suppose Annual profits expected is Rs. 10,000 Profits 10,000

Average Capital employed Rs. 50,000 Interest 5,000

Expected Interest rate on Cap. 10% -Remuneration 2,500

______

Remuneration to Purchase Rs. 2,500 Super Profits 2,500

Goodwill = 2,500 X ‘x’ No. of years purchase.

3. Capitalisation Method.

According to this method, the value of the business as a running concern isascertained, and from the figure arrived at the value of the tangible assets is deducted, the

difference being taken to represent Goodwill.

The value of the business may be found out by the formula.

Profit

-----------------------------------

Reasonable Return on Cap.

and goodwill may be calculated by deducting the capital employed from the figure

of the value of the business. In the above example.

Estimated annual Profit Rs. 10,000Less Partner’s remuneration Rs. 2,500

__________

Available for Interest on Capital employed Rs. 7,500

7,500Value of Business = ------- X100=75,000

10%

Goodwill = 75,000-50,000 (Cap. employed)=Rs. 25,000

Adjustment in Goodwill Account :

Whenever there is a change in the constitution of the firm or the business, value of

the business fluctuates and Goodwill account needs some adjustment. In each of the

following cases, a change in the profit sharing ratio takes place, and therefore, unless aGoodwill account already stands in the books at its correct value, some adjustment must

be made.

1. Upon the Admission of a partner.

2. On the death or retirement of a partner.


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3. Upon an agreement between partners to change the profit sharing ratio between

themselves.

Distinction between Partnership & Co., The following are the main points of distinction between a partnership firm and a

joint stock company :

1. Registration. A company comes into existence only after registration under the

companies Act. In case of partnership registration is not compulsory.

2. Legal Status. A company is a legal person and regarded by law as a single

person. A partnership is a collection of individuals.

3. Minimum number of members. The minimum number required to form acompany is two in case of private limited companies and seven in case of public limited

companies. The minimum number of persons required to form partnership is two.

4. Liability of members. The liability of the members of a company is limitedwhere as the liability of the partners for the debts of a firm is unlimited. Partners are also

personally liable for the debts of a firm.

5. Transferbility. A shareholder can transfer his share without the consent of othershare-holders. In case of partnership, a partner cannot transfer his share without the

consent of other partners.

6. Maximum number of members. A public company may have any number of

members. In case of a private company the maximum number cannot be more than 50. In

a trading partnership the maximum number of members is twenty, in a bankingpartnership ten.

7. Contractual capacity. The shareholders of the company can enter into contractwith the company and can be an employee of the company. Partners can contract with

other partners but not with the firm.

8. Duration of existence. The death or retirement or a partner dissolves the

partnership. But a company having legal existence can continue, inspite of death or

retirement of a member. It has thus perpetual succession.

9. Statutory obligations. A company is required to comply with various statutory

obligations regarding management, e.g. filing of balance sheet, maintaining of prescribed

registers etc. In case of partnership there are no such statutory obligations.

10. Authority of members, (a) In case of companies, management vest in the

hands on a few directors, elected from amongst the share holders. A share holder as such

cannot participate in the management. All the partners are entitled to share in the

management of the firm.


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11. Each partner is prima face the agent of the other partners and can bind

hem for the acts done in the course of the partnership business. Shareholders in thecompany are not the agents of one another.

Capital Accounts

Capital Accounts. The amount of contribution by each partner in the partnershipfirm is called his capital and is credited to his Capital Account Capital accounts of thepartners may be either fixed or fluctuating.

Fixed Capital Accounts. If the capital accounts of partners are to remain intact(expect under exceptional circumstances mentioned in the partnership agreement during

the continuance of the partnership, the capital accounts will be called as fixed capital

accounts, In the case of fixed capital accounts, no adjustments are made in the capital

account and the balance on each such account will remain at the same figure year afteryear, representing the amount of capital briginally contributed. Where fixed capital

accounts are maintained, capital and share of profits etc., are to be recorded in an account

called as current account is shown quite separately in the Balance Sheet. If the currentaccount shows a credit balance, it represents the surplus of profits and salaries etc., over

drawings and on the other hand, if it shows a debit balance it represents account being

overdrawn and the debit balance will be shown on the asset side of the Balance Sheet.This if capitals of partners are to be kept fixed, the following two accounts will be opened

for each partner.

1. Capital Account.

2. Current Account.

Fluctuating Capital Accounts. When the partners agree upon the employment of

capital account only, for each partner, it will contain all transactions relating to the

amount of capital contributed, drawings, interest on capital and drawings, salary,commission or remuneration and the share of profit or loss etc. It is, therefore, that the

balance of this account will fluctuate from year to year the account is called as fluctuatingcapital account. In the case of fluctuating capital accounts, current accounts are not

maintained.

:

Interest on Capital

(i) Interest on Capital. According to the provisions of the Act, no partner is

entitled to Interest on capital unless otherwise agreed. If Interest is agreed to be payable,

it is payable only out of profits of the business, when allowed, Interest account is debitedand partner’s capital accounts are credited Subsequently the amount of interest is debited

to the profit and loss account of the firm.

Generally interest on capital is provided in the following cases :

(i) When capitals are unequal but profit sharing ratios are equal.

(ii) When capitals are unequal and profit sharing ratios are also unequal.


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Interest on capital in the above instances reduces the inequalities in the distribution

of profits amount the partners. The following journal entries are recorded for interest oncapital.

1. When interest is allowed.

Interest Account Dr.

To Capital Account

2. When interest account is closed at the end of the year.

Profit and loss Account Dr.

To Interest Account.

(ii) Interest on Drawngs. Just like interest is allowed on capitals, partners may

decide to charge interest on drawings also. Interest charged on drawings in an item ofincome and is credited to the profit and loss account. The amount of interest thus adds to

the profits of the business which is further distributed among the partners. The following

entries are passed for interest on drawings.

(i) When interest is charged on drawings

Capital Account Dr.

To Interest Account

(ii) Closing entry for Interest account.

Interest Account. Dr.

To Profit and loss Account

Calculation of Interest on Drawings

It may be noted that the interest on drawings is charged for the time period which

lapses between the date of withdrawal and the end of accounting year. Problem arises

when many withdrawals have been made on different dates during the year. The intereston drawing in such caes may be calculated after calculating an average date for all the

withdrawals. The following illustration will calrify the point :

Illustration :

A, a partner has withdrawn the following sums of money :

Rs.

On 1st March 1976 500

On 1st April 1976 400

On 1st uly 1976 600

On 1st November 1976 300

Calculate interest @ 6 per cent per annum if the accounts are closed on 31stDecember every year.


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Solution

Interest

Rs. Rs.

On 500 for 10 months 25



On 300 for 2 months 1.50_______

Total Interest 62.50

_______

Alternatively. Interest can be calculated in the following manner :

Amount Months Product

Rs. Rs.500 10 5,000

400 9 3,600

600 6 3,600

300 2 600

_______

1,800 12,800

_______

Interst on Rs. 12,800 for one month @ 6% p.a. is Rs. 62.50

(iii) Salary to Partner. Sometimes, a partner who devotes more time and efforts

towards the business of the firms than the other partners is allowed a certain amount of

salary or commission for services rendered by him. This amount is adjusted to the profitand loss account and is credited to the capital account of the Active partner (to whom

salary or commission is payable). The following entry is passed in the books of accounts.

Profit and loss Account Dr.

To Capital Account (Concerned)

Profit or loss arrived at after making the adjustments relating to interest on capitalsor drawings, salaries or commission etc, is distributed among the partners in their profit

sharing ratio. The following entry is recorded for the distribution of profits :

Profit and loss Account

To all Partners Capital Accounts Dr.(in their profit sharing ratio)

A reverse entry will be passed in case of loss in business.


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(iv) Adjustments of closed Partnership Accounts. After the preparation of final

accounts for a certain period, if it is discovered that some errors or omissions werecommitted in the accounts, the closed partnership accounts will have to be readjusted.

The errors or omissions may relate to the following.

1. Charging a very high (or low) rate of interest on capitals or drawings.

2. Distributing profits or loss in a ratio different than that agreed upon.

3. Wrong payment of salary to any partner.

4. Not debiting the capital account in respect of drawings and so on.

Adjustment entries required to correct any such error or omission will have to bemade in the usual manner.

4. Accounting for Partnership Accounts

ADMISSION OF A PARTNER

Goodwill on Admission of a new Partner :

Goodwill is the attractive force that brings in customers. It is the benefit of a goodname, reputation and connection of a business. It is one thing that distinguishes an old

established business with a new bussiness at its first start. It is the benefit that attaches to

the ownership of a successful business. It is therefore but natural to think that the ownersof a successful business will nto like it to be shared by any one else. It is therefore that

whenever a new person is admitted to the partnership, he is charged some amount of

premium over and above his share of capital for the participation in the profits and the

reputation established by the hard work, character, industry, enterprise and businesscapacity of the old partners. This amount of premium is called the price of Goodwill.

Goodwill is dealt with on the admission of a new partner as follows :

(A) Premium Method :

This method is used when the new partner brings in the amount of Goodwill as

cash. Under this method, the receipt of Goodwill is dealt with in the following ways :

1. As a Private Transaction. When the amount of Goodwill is received by old

partners privately and outside the business in cash. In such a case, no entry will be madein the books of the firm.

2. As a firm’s Transaction ; The cash being Immediately withdrawn In such a

case the receipt of Goodwill money is recorded in the books of the firm and transferredto the capital accounts of the old partners in their Profit Sacrifions also. The amount thus

transferred is immediately withdrawn by the old partners.

The following entries are recorded in firm’s books in the above case.

(i) For the amount of Goodwill received in cash.


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Cash Account Dr.

To New Partner’s Capital Account

Note. The above entry is made with the amount of Capital plus Goodwill brought in

by the new partner. For example if X brings in Rs. 10,000 as capital and Rs. 2,500 as

Goodwill, the above entry will be made with Rs. 12,500).

(ii) For the distribution of goodwill among old partners.

New Partners’ Capital, Account Dr.To Old Partner’s Capital Account

Note. The above entry is made with the amount of Goodwill only brought in by

new partner. The amount of Goodwill is to be shared by old partners in their profitsacrificing ratio).

(iii) For the amount of Goodwill withdrawn by old partners :

Old Partner’s Capital Accounts Dr.

To Cash Account

It is emphasised here again that the amount of Goodwill is to be distributed among

the old partners in their Profit sacrificing ratio and not in their Pro

fa mca notes

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