कें द्रीय दिद्यालय संर् ठि , िई दिल्ली

वशक्षा मंत्रालय,भारत सरकार के अधीन स्वायत्य वनकाय

LAST MINUTE REVISION

कक्षा: बारहवीं / Class : 12th
ववषय : लेखाशास्त्र
Subject : Accountancy
सत्र : 2024-25

प्र रे णा स्त्रोत
डॉ .आर .सेंद िल कु मार कु मार,उपाय क्तु
के .दि.सं. क्षेत्र ीय कायााल य , भोपाल

मार्ािर्ाक
श्री दितेन्िर दसंह राित
प्राचाराया , कें द्रीय दिद्यालय क्र.3 , भोपाल

दिमााण सहयोर्
1. डॉ. दितेंद्र िीदक्षत, स्नातकोत्तर वशक्षक (वाविज्य) , के.वव. क्र. 3 , भोपाल
2. श्री र्र्ीकांत दसंघ ल, स्नातकोत्तर वशक्षक (वाविज्य) , के.वव. क्र. 1 , भोपाल
3. श्री स ुभ ाष चारंद्र , स्नातकोत्तर वशक्षक (वाविज्य) , के.वव. क्र. 2 , सी.पी.ई. इटारसी
 PART -A
Name of Unit : Accounting for Partnership Firms
Fundamentals of Partnership- Chapter 1
"Partnership is the relations between two or more persons who have agreed to share the profits of a business carried
on by all or any one of them acting for all.

Features of Partnership:

Two or more persons: There must be at least two persons to form a valid partnership.
1. Agreement: Partnership comes into existence by an agreement (either written or oral among the partners.
2. Existence of business and profit motive: A partnership can be formed for the purpose of carrying on legal
business with the intention of earning profits.
3. Sharing of Profits: An agreement between the partners must be aimed at sharing the profits.
4. Business carried on by all or any of them acting for all: It means that each partner can participate in the
conduct of business and each partner is bound by the acts of other partners in respect to the business of the firm .
5. Relationship of Principal and Agent : Each partner is an agent ad well as a partner of the firm.
Partnership Deed: Since partnership is the outcome of an agreement, it is essential that there must be some
terms and conditions agreed upon by all the partners. Such terms and conditions may be either written or oral. The
law does not make it compulsory to have a written agreement. However, in order to avoid all misunderstandings
and disputes, it is always the best course to have a written agreement duly signed and registered under the Act.

It is always best course to have a written partnership deed duly signed by all the partners
and registered under the Act.
Rules applicable in the absence of partnership deed:
Sharing profit / Losses Profit/Losses are shares equally by the partners
Interest on Capital No interest on capital will be allowed.
Interest on Drawings No interest on drawings will be charged.
Interest on advance/loan by partner 6% p.a. allowed
Remuneration to Partners Not allowed
A Profit and Loss Appropriation: Account is prepared to show the distribution of profits among partners as per
the provision of Partnership Deed (or as per the provision of Indian Partnership Act, 1932 in the absence of
Partnership Deed). It is an extension of profit and Loss Account. It is nominal account. It records entries for
interest on capital, Interest on Drawings, Salary to the partner, and division of profits among the partners.

The journal Entries regarding Profit and Loss Appropriation Account are as follows :

1.For transfer of balance of Profit and Loss Account:

Profit and Loss A/c Dr.
To Profit and Loss Appropriation A/c

2.For Interest on Capital/salary/commission:

Interest on Capital/salary/commission A/c Dr

To Partner’s Capital/ Current A/cs
3. For transferring IOC/salary/comm. To P& L App.

Profit and Loss Appropriation A/c Dr

To IOC/Salary/Comm A/c
Methods of calculating interest on drawings:

1) When unequal amounts are withdrawn at different dates, there are two methods for calculating interest on drawings:

a) Simple Method: Under this method, calculation of interest on drawings is done for the period, the amount has been
utilized.

Interest on Drawings = Drawings amount Rate/100 x No. of Months/12

b) Product method: When unequal amounts are withdrawn at unequal interval of time, product method is also used for
calculating interest on drawings.Under this method, first we calculate the period of each drawing. After that each
drawing is multiplied with the period to get the product.
Interest on drawings= Total of Products Rate/100×1/12
2) When equal amounts are withdrawn at regular/equal interval of time, interest on drawing can be calculated on
the total of the amount drawn, for the average of the period applicable to the first and last instalment.
Interest on Drawings =Total amount of drawings Rate/100 ×Average Period/12
Average Period = (No. of months left after first drawings+ No. of months left after last drawings)/2
Monthly drawings:
A) When equal amounts are withdrawn in the beginning of every month throughout the year:
Average period (12+1)/2=6.5 months
Interest on Drawings= Total of drawings x Rate/100 x 6.5/12
B) When equal amounts are withdrawn at the end of every month throughout the year:
Average period = (11+0)/2 = 5.5 months
Interest on Drawings= Total of drawings x Rate/100 x 5.5/12
C) When equal amounts are withdrawn in the middle of every month throughout the year:
Average period = (11.5+0.5)/2 = 6 months
Interest on Drawings = Total of drawings Rate/100 × 6/12
D) When equal amounts are withdrawn in the beginning of every month for 9 months:
Average period = (9+1)/2=5 months
Interest on Drawings = Total of drawings Rate/100×5/12
Quarterly Drawings:
A) When equal amounts are withdrawn in the beginning of each quarter throughout the year:
Average period (12+3)/2=7.5 months

Past Adjustment
Sometimes after the final accounts have been prepared and the Partners Capital Accounts are closed, it is found that
certain items have been omitted by mistake or have been wrongly treated.
Such omissions/mistakes usually related to the:
➤ Interest on Capital
➤ Interest on drawings
➤ Salary/Commission to partners
➤ Wrong profit distribution
Where errors have been discovered after closing the accounts, then instead of altering the closed accounts, an
adjustment entry for such errors or omissions is made in the beginning of the next year. For this purpose, Partner's
Capital Account will be debited with the amount, if it has been over credited and other Partner's Capital Accounts
will be credited with the amount, if it has been over debited.
GOODWILL: NATURE AND VALUATION
Goodwill is also one of the special aspects of partnership accounts which requires adjustment (also valuation if not
specified) at the time of reconstitution of a firm viz., a change in the profit-sharing ratio, the admission of a partner
or the retirement or death of a partner.
Meaning of goodwill:
Goodwill can be defined as "the present value of a firm's anticipated excess earnings or as "the capitalised value
attached to the differential profit capacity of a business. Thus, goodwill exists only when the firm earns super profits.
Any firm that earns normal profits or is incurring losses has no goodwill.
Factors affecting the value of goodwill:
The main factors affecting the value of goodwill are as follows:
1. Nature of business: A firm that produces high value added products or having a stable demand is able to earn
more profits and therefore has more goodwill.
2. Location: If the business is centrally located or is at a place having heavy customer traffic, the goodwill tends to be
high.
3. Efficiency of management: A well-managed concern usually enjoys the advantage of high productivity and cost
efficiency. This leads to higher profits and so the value of goodwill will also be high.
4. Market situation: The monopoly condition or limited competition enables the concern to earn high profits which
leads to higher value of goodwill.
Normally, the need for valuation of goodwill arises at the time of sale of a business. But in the context of a
partnership firm, it may also arise in the following circumstances:
1. Change in the profit-sharing ratio amongst the existing partners;
2. Admission of new partner;
3. Retirement of a partner;
4. Death of a partner and
5. Dissolution of a firm involving sale of business as a going concern.
6. Amalgamation of partnership firms
Methods of valuation of goodwill:
Since goodwill is an intangible asset it is very difficult to accurately calculate its value. Various methods have been
advocated for the valuation of goodwill of a partnership firm. Goodwill calculated by one method may differ from
the goodwill calculated by another method. Hence, the method by which goodwill is to be calculated, may be
specifically decided between the existing partners and the Incoming partner.
The Important methods of valuation of goodwill are as follows:
1. Average Profits Method
2. Super Profits Method
3. Capitalisation Method
Average profits method:
Under this method, the goodwill is valued at agreed number of years' purchase of the average profits of the past few
years. It is based on the assumption that a new business will not be able to earn any profits during the first few years
of its operations. Hence, the person who purchases a running business must pay in the form of goodwill a sum which
is equal to the profits he is likely to receive for the first few years.
Super Profits Method
The superiority and excellence of the firm lies in earning profit more than the normal profit earned by the other
firms. The excess profit is the super profit and the super profit may be assumed to be goodwill or it may be certain
number of times of Super Profit. We may use the following methods based on Super Profit for the calculation of
goodwill.
Goodwill -Super profit X No of years purchase
Super profit =Actual Profit Earned - Normal Profit
Normal Profit = Capital employed & Normal rate of return/100

Capitalisation Method. According to this method, goodwill is the amount of capital saved. Every business has to
invest capital to commence and operate its business activities, and earns profit with the efficient utilisation of
capital. If the firm earns more profit by investing lesser amount of capital as compared to other firms, who have
been earning the same amount of profit with more amount of capital, the capital saved will be assumed to be
goodwill.
Please Remember
Goodwill capital normally required - capital actually employed
According to this method goodwill can be calculated in two ways:
a) By Capitalisation of average profit
b) By Capitalisation of super profit
(a) Capitalisation of Average Profit: - According to this method goodwill is assumed to be excess of the capitalised
value of average profit over the actual capital employed. In other words, actual capital employed, i.e., net assets is
deducted from the capitalised value of average profit.
Calculation of capitalised value. We may use the following formula for its calculation:

Capitalized value of the average profits= Average profits x 100/NRR

 Reconstitution of Partnership (Chapter-2)
Meaning of Reconstruction:

Any change in agreement of partnership or profit sharing ratio is called reconstitution of partnership firm. In
following circumstances a partnership firm may be reconstituted:

1. Change in Profit Sharing Ratio

2. Admission of a partner
3. Retirement/Death of a partner,
4. Dissolution of Partnership firm
CHANGE IN PROFIT SHARING RATIO AMONG THE EXISTING PARTNERS
Meaning : A Change in profit sharing ratio means one or more partners acquires interest from another partner or
partners. Here it share of profit of one or more partners increases then share of one or more partner decreases to
same extent.
When all the partners of a firm agree to change their profit sharing ratio: The ratio may be changed
New profit sharing ratio: The ratio in which the partners are to share the profits in future on reconstitution is known
as new profit sharing ratio.
Gaining Ratio: It is the ratio in which the profit sharing ratio of gaining partners increases. It is calculated by taking
difference between New profit sharing ratio and old profit sharing ratio. (G=N-O) GNO
Sacrificing Ratio : It is the ratio in which the profit sharing ratio of sacrificing partners decreases. it is calculated by
taking difference between old profit sharing ratio and new profit sharing ratio. (S=O-N) SON
Note : If old ratio-new ratio is positive it means sacrifice and if it is negative it means gain.
Accounting Treatment of Goodwill IN CASE OF CHANGE IN PSR:
In case of change in profit sharing ratio, the gaining partner must components the sacrificing partner by paying the
proportionate amount of goodwill.
Note :
Increase in the value of an Asset and decrease in the value of a liability result in profit.
Assets A/c Dr.
Liabilities A/c Dr
To Revaluation A/c
Decrease in the value of any asset and increase in the value of a liability gives loss.
Revaluation A/c Dr
To Assets A/c
To Liabilities A/c
For increase in the value of liabilities:
Revaluation A/c Dr.
To Liabilities A/c
(Increase in value of Liability)
For decrease in the value of Liabilities:
Liabilities A/c Dr.
To Revaluation A/c
(Decrease in the value of Liabilities)
When Revaluation account shows profit
Revaluation A/c Dr.
To Partner's Capital A/c
(Profit credited to Partner's Capital A/c in old ratio)
In case of Revaluation Loss
Partnees Capital AlcisDr.
To Revaluation Alc
(Loss debited to Partner's Capital A/cs in old ratio)
 ADMISSION OF A PARTNER
Sometimes, a new partner is admitted in a running business. The new partner is needed:
(i) When there is requirement of more capital for the business expansion;
(ii) When there is a need for competent and experienced person for efficient running of the business;
(iii) When the firm wants to increase reputation of the business by taking a reputed and renowned person as a
partner.
According to Section 31 (1) of the Indian Partnership Act 1932:
"Subject to contract between the partners and to the provisions of section 30, no person shall be introduced as a
partner into a firm without the consent of all the existing partners."
In Simple Words
A person can be admitted as a new partner:
* As agreed in Partnership Deed: New partner can be admitted in the manner agreed upon by the partners in their
contract of partnership. For example, partners may agree in the contract that new partner can be admitted with
the majority of votes.
* In case of Minor (Section 30): A minor may not be a partner in a firm, but, with the consent of all the partners,
he/she may be admitted to the benefits of partnership.
* In the absence of Contract: If all the existing partners agree to admit the partner, i.e. with consent of all existing
partners, a person can be admitted as a new partner.
With the admission of a new partner, the partnership firm is reconstituted and the existing agreement or
Partnership Deed comes to an end. A new agreement among all the partners (including the new partner) is entered
into to carry on the business as partnership firm. The liabilities of the new partner padinarily commence from the
date when he/she is admitted as a partner (unless he/she agrees to be liable for obligations incurred by the firm
prior to the date). In simple words, new partner is not liable for any act of the firm done before he/she became a
partner. • A newly admitted partner acquires two main rights in the firm:

(1) Right to share in the future profits of the firm; and

(ii) Right to have a share in the assets of the firm.
In order to exercise these rights, the partner generally brings:
An agreed amount of Capital (to share in the assets of the firm); and
* Premium for Goodwill (to compensate other partner/s who sacrificed their profit share in his or her favour).
Effects of Admission of a Partner:

The effects of admission of a new partner are:

1. New Agreement: The old agreement comes to an end and a new Partnership Deed is entered into among all the
partners to carry on the business as partnership firm.
2. Change in Profit-sharing Ratio: The new partner is entitled to share future profits of the firm, which is
contributed by the old partner/s. As a result, combined profit share of old partners gets reduced.
3. Capital Contribution: The incoming partner contributes an agreed amount of capital in the firm.
4. Assets and Liabilities: The new partner acquires right in the assets and also becomes liable for the liabilities of
the firm. The net change in value of assets and liabilities is adjusted in capital/ current accounts of old partners.
5. Share in Reserves and Accumulated Profits/Losses: The adjustment is made for reserves and accumulated
profits/losses when the new partner is admitted.
6. Valuation of Goodwill: The incoming partner compensates the sacrificing partner/s who sacrificed their profit
share in his or her favour.
Adjustments Needed on Admission of a Partner:

The various matters that need adjustment at the time of admission of a partner are:
1. Determination of New Profit-Sharing Ratio and Sacrificing Ratio.
2. Accounting Treatment of Goodwill.
3. Revaluation of Assets and Reassessment of Liabilities.
4. Accounting Treatment of Reserves and Accumulated Profits/Losses.
5. Accounting Treatment of Deferred Revenue Expenditure
6. Capital Adjustment (if agreed between the partners).
 Let us now discuss each of these adjustments in detail.

DETERMINATION OF NEW PROFIT-SHARING RATIO AND SACRIFICING RATIO

When a new partner is admitted into partnership, he acquires his share in profits from the old partners. Share of
new partner is decided mutually among the old partners and the new partner.
It means, that the old partner/s sacrifice part of their share of profits in favour of the new partner. It requires
calculation of "Sacrificing Ratio" of old partners and "New Profit-Sharing Ratio" of all the partners including the
new partner.
New Profit-Sharing Ratio is the ratio in which all the partners (including new partner) will share the future profits
and losses.
Sacrificing Ratio is the ratio in which the old or existing partners sacrifice their share of profit in favour of the new
partner.

Difference between Sacrificing Ratio and New Profit-Sharing Ratio

Basis Sacrificing Ratio New Profit-Sharing Ratio

. Meaning It is the ratio in which the old or existing It is the ratio in which all the partners (including
partners sacrifice their share of profit in new partner) will share the future profits and
favour of the new partner. losses.

Related It is related to the old partners only. It is related to all the partners, including the
Partners new partner.
Requirement It is required to determine the amount of It is required for the purpose of distributing the
compensation to be paid by the incoming future profits of the firm among all the
partner to the sacrificing partners as partners.
premium for goodwill.
Calculation Sacrificing Ratio = Old Ratio - New Ratio New Profit-Sharing Ratio=Old Ratio Sacrificing
Ratio

Let us now discuss the various cases in which the new partner may acquire share in profits from the new partners.

Case 1: When share of New Partner is mentioned and sacrifice made by old partners is not given

In such a situation, it is assumed that the new partner has acquired his share from old partners in their old profit-
sharing ratio, i.e. old partners have sacrificed in the old ratio. As a result, old partners continue to share profits and
losses in the old ratio.
To calculate the new profit-sharing ratio:
New Partner's share is deducted from 1; and
* Balance profit share is divided among old partners in their old ratio.
ACCOUNTING TREATMENT OF GOODWILL

As discussed before, Goodwill is an intangible asset, which enables a firm to earn profits in excess normal profit,
earned by other firms in the same business. Goodwill arises due to efforts and hass of work done by the existing
partners in the past.
At the time of admission new partner acquires share in future profits from the existing partners. So the new
partner compensates the sacrificing partners by paying them an amount, termed as Goodwill or Premium for
Goodwill.
As discussed before, according to AS 26: Intangible Assets: "Internally generated goodwill is not ncognised as an
asset because it is not an identifiable resource controlled by the entity that can be measured reliably at cost".
So, at the time of admission of a new partner, value of goodwill is determined so that the new or incoming partner
can compensate the sacrificing partner(s).
Goodwill, in general, is recorded in the books only when some consideration in money or money's worth has been
paid for it.
So, the goodwill brought in by the new partner is adjusted through concerned partners' capital (or current)
accounts
The methods of valuation of Goodwill have already been discussed in the chapter 'Goodwill: Nature and Valuation
There may be different situations for the accounting treatment of goodwill (or preferably "Premium for Goodwill")
at the time of admission of a new partner:
1. When the new partner pays his share of Goodwill (Premium for Goodwill) Privately.
2. When the new partner pays his share of Goodwill (Premium for Goodwill) in cash or by cheque.
3. When the new partner pays his share of Goodwill (Premium for Goodwill) in kind.
4. When the new partner brings only a part of his share of goodwill (Premium for Goodwill).
5. When the new partner does not bring his share of goodwill (Premium for Goodwill).
Let us now discuss each of the situations in detail.
1. When the new partner pays his share of Goodwill (Premium for Goodwill) Privately

When the new partner pays his share of goodwill privately (outside the business) to the sacrificing partner(s), then
the same is not recorded and, hence, NO JOURNAL ENTRY is passed in the books of the firm because no
compensation is paid through the firm.
Note: If an old partner gifts his or her share of profit in favour of new partner, then the new partner will not pay
any premium for goodwill to that partner for such gift in profit share as gifts are free from consideration.
Question. (When Premium for Goodwill is paid privately) Isha and Anju are partners in a firm sharing profits and
losses in the ratio of 5:3. They admit Shruti as a partner for 1/4th share. Shruti paid 50,000 privately to Isha and
Anju as her share of goodwill. Pass the necessary Journal Entries on Shruti's admission.
Solution:
No Journal Entry will be passed in the books as Shruti has paid her share of goodwill to Isha and Anju privately
(outside the business).

2. When the new partner pays his share of Goodwill (Premium for Goodwill) in cash or by cheque:
If the new partner brings cash or by cheque for his share of goodwill, then such amount is shared by the sacrificing
partners in their sacrificing ratio. For this, the amount of goodwill is credited to capital (or current) accounts of
sacrificing partners in their sacrificing ratio.
The following entries are passed for this purpose:

Transaction Journal Entry

Cash/Bank A/c (with share of goodwill) Dr

(i) For Premium for Goodwill brought in To Premium for Goodwill A/c
cash or by cheque by the new partner. (Being premium for goodwill brought in cash or by cheque)
(ii) For capital brought in cash or by Cash/Bank A/c (with amount of capital brought in) Dr
cheque by the new partner. To New Partner's Capital A/c
(iii) For sharing of premium for goodwill Premium for Goodwill A/c Dr.
by the sacrificing partner(s). To Sacrificing Partners' Capital" (or Current**) A/cs
(Being premium for goodwill credited to sacrificing partners in
their sacrificing ratio)
iv) For withdrawal (if any) of amount of Sacrificing Partners' Capital" (or Current**) A/cs Dr.
goodwill by the sacrificing partner(s). To Cash/Bank A/c (with amount of goodwill withdrawn)
(Being premium for goodwill withdrawn by the sacrificing
partners
Treatment of Existing Goodwill:
If at the time of admission of a new partner, goodwill appears in the books, then it is purchased goodwill. Such
goodwill is written off among the existing old partners in their old profit-sharing ratio. The following entry is
passed:
Old Partners Capital/Current A/cs Dr
To Goodwill A/c (Being existing goodwill written off among the old partners in their old ratio)
Internally Generated Goodwill is Never Recorded in the Books

It must be noted that Goodwill is valued at the time of admission of a new partner to compensate the sacrificing
partners. It means, such goodwill is Internally Generated Goodwill.
 As per AS 26: Intangible Assets: "Internally generated goodwill is not recognised as an asset because it is not an
identifiable resource controlled by the entity that can be measured reliably at cost".
So, such Goodwill can never be recorded in the books of the firm. Its value is adjusted through the Partners' Capital
(or Current) Accounts.
When the new partner pays his share of Goodwill (Premium for Goodwill) in Kind
The new partner may also bring his share of Premium for Goodwill in the form of assets. In such a case
Debit the value of Assets (at the agreed values) brought in by the new partner;
Credit Premium for Goodwill for his share of goodwill; and
Credit New Partner's Capital Account for his capital.
Thereafter, Premium for Goodwill is transferred to the capital accounts of the sacrificing partners in their sacrificing
ratio.
The following entries are passed for this purpose:
Transaction Journal Entry
(i) For Premium for Goodwill and Assets A/c (Individually)
Capital brought in kind by the new To New Partner's Capital A/c (with share of Capital)
partner. To Premium for Goodwill A/c
(with share of Goodwill (Being capital and premium for goodwill brought)
(ii) For sharing of premium for Premium for Goodwill A/c Dr
goodwill by the sacrificing To Sacrificing Partners' Capital" (or Current**) A/cs
partner(s). (Being premium for goodwill credited to sacrificing partners in their
sacrificing ratio)
(iii) For withdrawal (if any) of Sacrificing Partners' Capital" (or Current**) A/cs Dr
amount of goodwill by the To Cash/ Bank A/cs
sacrificing partner(s).

4. When the new partner brings only a PART of his share of Goodwill

Sometimes, the new partner is not in a position to bring his full share of goodwill and brings only a part of it in
cash. In such a case, "Premium for Goodwill" Account is credited for the amount of premium brought in by the new
partner.
To transfer the amount of goodwill to sacrificing partners:
*Current Account of New Partner is debited with the unpaid share of premium; and
*Premium for Goodwill' account is debited for the amount of premium paid by the New Partner.
*"Capital Accounts' of sacrificing partners is credited for their share of goodwill.

The following Journal Entries are passed:

Transaction Journal Entry

For Premium for Goodwill and Capital Cash/Bank A/c Dr (with amount of capital and goodwill brought in)
brought in by the new partner To New Partner's Capital A/c (with share of capital)
To Premium for Goodwill A/c (with share of goodwill brought in)
(Being capital and premium for goodwill brought in cash)
For sharing of premium for goodwill by Premium for Goodwill A/c (with share of goodwill brought in) Dr
the sacrificing partner(s New Partner's Current A/c (with unpaid share of goodwill) Dr
To Sacrificing Partners Capital A/c (Being premium for goodwill
credited to sacrificing partners in their sacrificing ratio)

Important Points about Accounting Treatment of Goodwill

(1) At the time of admission, new partner acquires share in future profits from the existing partners. So, such new
partner should compensate the sacrificing partners by paying them Premium for Goodwill'. If any old partner also
gains at the time of admission, then such old partner should also compensate the sacrificing partners.
(ii) Unless otherwise stated, the Partners' Capitals are assumed to be fluctuating. So, Goodwill is adjusted through
the Capital Accounts of the partners.
(iii) However, in case of Fixed Capitals, Goodwill is adjusted through the Current Accounts of the partners.
(iv) Treatment of Existing Goodwill: When Goodwill appears in the books of the firm at the time of admission of a
new partner, then such goodwill has to be written off among the old partners in the old ratio.
(v) As per AS 26, Internally Generated Goodwill is not recognised as an asset because it is not an identifiable
resource controlled by the entity that can be measured reliably at cost. So, goodwill cannot be recorded in the
books of the firm as no consideration in money or money's worth has been paid for it.
Hidden or Inferred Goodwill
Sometimes, the value of goodwill on the admission of a new partner is not explicitly given. It has to be inferred or
determined on the basis of net worth or total capital of the firm.
Calculation of Hidden Goodwill:

(a) Net Worth (including goodwill) on the basis of capital brought in by New Partner ……..
(New Partner's Capital x Reciprocal of his Share)
(b) Net Worth (excluding goodwill) of the Reconstituted firm ………..
(**Adjusted Capital of Old Partners + New Partner's Capital)

(c) Value of Goodwill ((a)-(b))

Adjusted Capital of Old Partners

Capitals of old partners can also be calculated as: Sundry Assets - Outside Liabilities.
Capital of Old Partners + Reserves + Accumulated Profits - Losses Revaluation Profit-Revaluation Loss-Existing
Goodwill to be written off
Proforma of Revaluation Account:
Dr Revaluation Account Cr

Particulars Amount (Rs) Particulars Amount (Rs)

To Assets A/c (Individually) By Assets A/c (Individually)
[Decrease in value of Assets) (Increase in value of Assets)
To Liabilities A/c (Individually) By Liabilities A/c
(Increase in value of Liabilities) (Individually) (Decrease in
value of Liabilities)
To Unrecorded Liabilities A/c By Unrecorded Assets A/c
To Partners' Capital A/c By Loss on Revaluation
(Remuneration) transferred to Partners'
Capital (or Current) A/cs
To Cash/Bank A/c (Expenses)
To Gain (Profit) on
Revaluation transferred to
Partners' Capital (or Current)
A/cs*
------------------- --------------------

Accounting Treatment of Deferred Revenue Expenditure:

It is a revenue expenditure which is incurred during an accounting period but its benefit is likely to be derived over
a number of years. For example, Advertisement Suspense Account.

Such expenditure is transferred to the Profit and Loss Account proportionately every year over the period during
which it is supposed to yield benefit. Although the unabsorbed or unwritten deferred part of expenditure appears
on the assets side of the Balance Sheet, but it is a Fictitious Asset and not really an asset to the business.

At the time of admission of new partner, such expenditure is written off by transferring it to the debit of Old
Partners' Capital (or Current) Accounts in their old profit-sharing ratio.
The Journal Entry passed is:

Partners' Capital (or Current) A/cs

To Deferred Revenue Expenditure A/c (say, Advertisement Suspense A/c)
 ACCOUNTING TREATMENT OF RESERVES AND ACCUMULATED PROFITS/LOSSES

At the time of admission of a new partner, if there is a balance in "Reserves and Accumulated Profits Losses"
appearing in the Balance Sheet, then they are distributed among the old partners in their old ratio, ie. they are
transferred to Old Partners' Capital Accounts (or Current Accounts) in their old profit-sharing ratio.
Transfer of Free Reserves:
If the partners decide to use the free reserves (like General Reserve), fully or partly, to meet an expected claim or
loss, then such free reserves can be used in the manner as agreed by the partners For example, at the time of
admission of a new partner, partners may decide to transfer a part of (or entire) General Reserve to Workmen
Compensation Reserve (to meet expected claim on account of workmen compensation) and balance General
Reserve (if any) is distributed among the old partners in their old ratio.
Why are they transferred to Old Partners and not to the New Partner?
New partner is not entitled to any share of such reserves or profits/losses because these are the
accumulated profits/losses of past years, which have been earned by the old partners. So, the new partner should
not be put to any advantage or disadvantage. As a result, they are transferred to Old Partners' Capital (or Current)
Accounts in their old ratio.
Workmen Compensation Reserve (WCR)

Workmen Compensation Reserve is a reserve created out of firm's profit to meet the liability Workmen
Compensation to workers), if any, that may arise in future. At the time of admission of a partner it is treated as
under:

1. Nothing is mentioned or No liability is expected to arise: In such a case, entire amount of Workmen
Compensation Reserve is transferred to Old Partners' Capital (or Current) Account in their old profit-sharing ratio.

Workmen Compensation Reserve A/c

To Old Partners' Capital (or Current) A/cs (In Old Ratio) (Being workmen compensation reserve transferred to capital
(or current) accounts of old partners in their old ratio)

2. When there is a liability for Workmen Compensation: In such a case, treatment of Workmen Compensation
Reserve (WCR) depends on the amount of liability. There can be three possible cases:

(i) If expected liability is less than Workmen Compensation Reserve: WCR to the extent of liability is used to make
provision for such liability and balance is distributed among the old partners in the old ratio.
Workmen Compensation Reserve A/c
To Workmen Compensation Claim A/c
To Old Partners' Capital (or Current) A/cs (In Old Ratio)
(Being surplus of workmen compensation reserve transferred to capital (or current) accounts of old partners in
their old ratio)
(ii) If expected liability is equal to Workmen Compensation Reserve: Entire WCR is used to make provision for such
liability and nothing is left for distribution among the old partners.
Workmen Compensation Reserve A/c
To Workmen Compensation Claim A/c (Being provision made for Workmen Compensation Claim)
(iii) If expected liability is more than Workmen Compensation Reserve:
* Entire WCR is used to make provision for such liability; and

* Shortage is met out of Revaluation Account; and

* Loss on such revaluation is transferred to Old Partners' Capital (or Current) Account in their old ratio.
(i) Workmen Compensation Reserve A/c
Revaluation A/c
To Workmen Compensation Claim A/c
(Being provision made for Workmen Compensation Claim and shortfall charged to Revaluation Account)
(ii) Old Partners' Capital (or Current) A/cs (In Old Ratio)
Investment Fluctuation Reserve (IFR)
Investment Fluctuation Reserve is a reserve created out of profits to adjust the difference between the book value
and market value of investments. At the time of admission of a partner, it is treated as:
 1. Nothing is mentioned or No change in book value of investments: In such a case, entire amount of Investment
Fluctuation Reserve is transferred to Old Partners' Capital (or Current) Account in their old profit-sharing ratio.
Investment Fluctuation Reserve A/c Dr
To Old Partners' Capital (or Current) A/cs (In Old Ratio)
(Being investment fluctuation reserve transferred to capital (or current)
accounts of old partners in their old ratio)
CAPITAL ADJUSTMENT:
At the time of admission of a partner, it may be agreed between the partners that the capitals of the partners may
be adjusted as per agreement. The adjustment may take any of the following forms:
Case 1: Determination of Capital of New Partner on the basis of Old Partners' Capital.
Case 2: Adjustment of Old Partners' Capital on the basis of New Partner's Capital.
Case 3: Total Capital of Reconstituted Firm is given which is to be adjusted in New Ratio.
Let us discuss them one by one.
Case 1: Determination of Capital of New Partner on the basis of Old Partners' Capital
Sometimes, at the time of admission, the capital of the new partner is not given and the incoming partner is
expected to bring capital on the basis of capitals of old partners. There can be two situations:
Case 1A: When the New Partner is required to bring Proportionate Capital (In this case, "Total Capital of Firm" is
calculated on the basis of total adjusted capital of old partners)
Case 1B: When the New Partner has to bring capital on the basis of combined capitals of old partners (In this case,
"Total Adjusted Capital of Old Partners" is calculated)
Case 1A: When the New Partner is required to bring Proportionate Capital
If the partner has to bring "Proportionate Capital", then the following steps are taken:
Step 1. Calculate Total Adjusted Capital of old partners, i.e., after making adjustments for goodwill, reserves,
accumulated profits/losses and profit & loss on revaluation, etc.
Step 2. Calculate "Total Capital" of New Firm as: Total Adjusted Capital of Old Partners x Reciprocal of Total New
Share of Old Partners
Step 3. Calculate capital of the new partner as: Total Capital (as per Step 2) x Share of New Partner
Example. A and B are partners in a firm sharing profits and losses in the ratio of 2:1. The capitals of A and B after all
adjustments are 60,000 and 35,000 respectively. They admit C as a partner who is to contribute proportionate
capital to acquire a 1/6th share of total capital. Calculate capital to be brought by C.
Solution:
Step 1. Calculate total adjusted capital of A and B = 60,000+₹35,000 = 95,000
Step 2. Calculate "Total Capital" of New Firm as:
Total adjusted capital x Reciprocal of share of A and B**95,000x%=₹1,14,000.
Step 3. Calculate capital of the new partner as:
Total Capital x Share of New Partner = 1,14,000 x 1/6= 19,000.
Calculation of Reciprocal of share of A and B**: Let the total share of the firm = 1; C's Share =1/6 ; Remaining Share
of A and B = 1-1/6=5/6; Reciprocal of share of A and B = 6/5
Proportionate Capital and Capitals of Old Partners in New Ratio
There can be one more situation of Capital Adjustment in which new partner is required to bring Proportionate
Capital and the existing Total Capital of the Old Partners is to be in the New Ratio.
In such a case, the following steps may be followed:
1. Calculate New Profit-Sharing Ratio.
2. Calculate Total Adjusted Capital of old partners.
3. Calculate "Total Capital" of New Firm as:
Total Adjusted Capital of Old Partners × Reciprocal of Total New Share of Old Partners.
4. Calculate Capital of New Partner as: Total Capital × Share of New Partner.
5. Calculate New Capital of each Old Partner: Total Capital × New Share of Old Partner.
6. Calculate Surplus or Deficit in capitals of old partners as:
* Surplus arise when Present Adjusted Capital > New Capital. In such a case, old partner withdraws surplus in cash
or transfer it to Current A/c.
Deficit arise when Present Adjusted Capital <New Capital. In such a case, old partner brings deficit in cash or adjust
it through Current A/c.
 Case 1B: When the New Partner has to bring Capital on the basis of"Combined Capitals of Old Partners"
If the partner has to bring capital on the basis of combined capitals of old partners, then the following steps are
taken:

Step 1. Calculate "Total Adjusted Capital" of old partners, i.e., after making adjustments for goodwill, reserves,
accumulated profits/losses & profit & loss on revaluation, etc.
Step 2. Calculate capital of the new partner as:
Total Adjusted Capital (as per Step 1) x Share of New Partner
Example. A and B are partners in a firm sharing profits and losses in the ratio of 3:2. The capitals of A and B after all
adjustments are 70,000 and 40,000 respectively. They admit C as a partner who is to contribute 1/5th of the
combined adjusted capitals of A and B. Calculate capital to be brought by C.
Solution:
Step 1. Calculate total adjusted capital of A and B =Rs 70,000+ Rs 40,000= Rs 1,10,000
Step 2. Calculate capital of the new partner as:
Total adjusted Capital x share of New Partner= Rs 110000x 1/5= Rs 2200
Case 2: Adjustment of Old Partners' Capital on the basis of New Partner's Capital
If capital of the new partner is given, then the same is used as a base for calculating the new capitals of the old
partners. In such a situation, the following steps are taken:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate "Total Capital of the Firm" on the basis of capital of new partner as:
New Partner's Capital x Reciprocal of share of new partner
Step 3. Determine new capital of old partners, i.e. divide total capital in their new profit-sharing ratio.
New Capital of Old Partner = Total Capital of the Firm × New share of Old Partner
Step 4. Calculate present adjusted capital of the old partners, i.e., after making adjustments for goodwill, reserves,
accumulated profits/losses and profit and loss on revaluation, etc.
Step 5. Calculate surplus or deficit by comparing the new capital (determined in Step 3) and present adjusted
capital (determined in Step 4).
Surplus Present Adjusted Capital > New Capital
Deficit Present Adjusted Capital < New Capital
Step 6. Pass necessary Journal Entry for adjusting the above surplus/deficit.
(i) In case of Surplus, i.e. if Present Adjusted Capital is more than the New Capital:
Concerned Partner's Capital A/c Dr.
To Cash/Bank A/c (If amount brought)
To Concerned Partner's Current A/c (If amount not brought)

(ii) In case of Deficit, i.e. if Present Adjusted Capital is less than the New Capital:
Cash/Bank A/c Dr. (If amount withdrawn)
Concerned Partner's Current A/c Dr. [If amount is not withdrawn)
To Concerned Partner's Capital A/c
Case 3: Total Capital of Reconstituted Firm is given which is to be adjusted in New Ratio
If total capital of the new firm is already given, then the same is divided among all the partners (including the new
partner) in the new profit-sharing ratio. In such a situation, the following steps are taken:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Determine New Capital of all partners, i.e. divide Total Capital in their new profit-sharing ratio.
New Capital Total Capital of the Firm × New share of Partners
Step 3. Calculate Present Adjusted Capital of the old partners, i.e., after making adjustments for goodwill, reserves,
accumulated profits/losses and profit and loss on revaluation, etc.

Step 4. Calculate surplus or deficit (in case of old partners) by comparing the New Capital (determined in Step 2)
and Present Adjusted Capital (determined in Step 3).
Step 5. Pass necessary Journal Entry for adjusting the above surplus/deficit.
(i) In case of Surplus, i.e. if Present Adjusted Capital is more than the New Capital:
Concerned Partner's Capital A/c Dr.
To Cash/Bank A/c (If amount brought)
To Concerned Partner's Current A/c (If amount not brought)
 (ii) In case of Deficit, ie. if Present Adjusted Capital is less than the New Capital:
Cash/Bank A/c Dr. (If amount withdrawn)
Concerned Partner's Current A/c Dr. (If amount not withdrawn)
To Concerned Partner's Capital A/c

RETIREMENT OF A PARTNER
When a partner decides to discontinue from a partnership firm, it is termed as retirement of a partner.
firirement, the existing partnership comes to an end and a new partnership agreement is prepared between and
remaining partners on the basis of which the new firm operates. Thus, the partnership firm is reconstituted with
different terms and conditions. The partner leaving the firmis known as retiring partner or outgoing partner. A
partner may retire from the firm:

(i) If there is an agreement to that effect between the partners; or

(ii) If there is no agreement, then with the consent of all other partners (whether express or implied consent); or
(iii) In case of 'Partnership at Wil…
Rights of a Retiring Partner:
1. The retiring partner has a right to get his share of goodwill in the firm.
2. The retiring partner is also entitled to get his capital along with share in reserves and acumaling profits or losses
and other claims.
Adjustments Required on Retirement of a Partner:
The various matters that need adjustment at the time of retirement of a partner are:
1. Determination of New Profit-Sharing Ratio and Gaining Ratio.
2. Accounting Treatment of Goodwill.
3. Accounting Treatment of Reserves and Accumulated Profits/Losses.
4. Revaluation of Assets and Reassessment of Liabilities.
5. Settlement of Amount Due to the Retiring Partner.
6. Capital Adjustment (if agreed between the partners).

DETERMINATION OF NEW PROFIT-SHARING RATIO (NPSR) AND GAINING RATIO

On the retirement of a partner, his/her share is taken over by the remaining partners. However, the profit-sharing
ratio among the remaining partners may or may not change. It necessitates the calculation of new profit-sharing
ratio of the remaining partners and the gaining ratio.
New Profit-Sharing Ratio
New Profit-Sharing Ratio on retirement of a partner is the ratio in which the remaining partners decide to share the
future profits and losses.
On the retirement of a partner, there is a need to determine the new ratio when:
(i) New profit-sharing ratio is not given; and
(ii) The remaining partners purchase or acquire the share of retiring partner in a ratio which is different from their
present profit-sharing ratio.
New Profit-Sharing Ratio = Old Share + Share acquired from retiring partner
Gaining Ratio
Gaining Ratio is the ratio in which the remaining partners acquire the share of the retiring partner.
Gaining Ratio = New Ratio - Old Ratio
Unless specified to the contrary, the remaining partners gain in their old ratio and hence the gaining ratio is same
as old ratio.
Let us now discuss the various cases in which the remaining partners may acquire the share of the retiring partner.
Case 1: When a partner retires and the new profit-sharing ratio among the remaining partners is not given. OR
When there is no agreement or when no information is given about new ratio or/and gaining ratio.
When nothing specific is stated about the new profit-sharing ratio, then the continuing partner will share the
future profits in their old ratio, i.e. New Ratio = Old Ratio
Case 2: When the remaining partners purchase or acquire the share of retiring partner in a specified ratio
If the remaining partners purchase the share of retiring partner in some specified proportions, then share
purchased by the remaining partners is added to their old share to calculate the new ratio.
New Profit-Sharing Ratio = Old Share + Share acquired from retiring partner
When the entire share of retiring partner is taken by only one partner.
Sometimes the entire share of the retiring partner may be taken up by only one of the remaining partners. In such
a case, the share of only gaining partner changes, while the share of other partners remain unchanged.
ACCOUNTING TREATMENT OF GOODWILL
At the time of retirement, the remaining partners gain share of profit of the retiring partner. So, the gaining
partners should compensate the retiring partner in the form of Goodwill. Retiring partner is entitled for his share of
goodwill as goodwill was earned by the firm when he was a partner. It necessitates the valuation of goodwill at the
time of retirement of a partner. Goodwill is valued as agreed among the partners in the Partnership Deed or
agreed otherwise. The methods of valuation of Goodwill have already been discussed in the chapter 'Goodwill:
Nature and Valuation'.

Retiring Partner's Share of Goodwill = Value of Firm's Goodwill x Profit Share of Retiring Partner

As discussed in the previous chapters, according to AS 26: Intangible Assets: "Internally generated goodwill is not
recognised as an asset because it is not an identifiable resource controlled by the entity that can be measured
reliably at cost".
It must be noted that in case of admission/retirement/death of a partner or in case of change in profit-
sharing ratio among the partners, goodwill is not recorded in the books as no consideration in money or money's
worth has been paid for it. Value of goodwill is adjusted through concerned Partners' Capital (or Current) Accounts
The accounting treatment needed to treat goodwill is outlined in the following steps:
Step 1. Write off the existing book value of goodwill (if any):
If at the time of retirement of a partner, goodwill appears in the books, then it is purchased goodwill. Such goodwill
is written off among all the partners (including the retiring partner) in their old ratio.
The Journal Entry passed is:
Partners' Capital (or Current) A/cs Dr.
To Goodwill A/c (existing book value of goodwill)
[In old ratio)
(Being existing goodwill written off among all the partners in their old ratio)
Step 2. Give credit to the Retiring Partner for his share of goodwill.
The Retiring Partner is credited and the Gaining Partners' Capital or Current Accounts is debited in the gaining
ratio. In this case, the following entry is passed:

Gaining Partners' Capital (or Current) A/cs Dr.

To Retiring Partner's Capital/Current A/c (with share of Goodwill)

(Being retiring partner credited with his share of goodwill and gaining Partners' Capital/Current Accounts debited in
their gaining ratio)

Hidden Goodwill
Sometimes, the firm agrees to settle the retiring partner's account by payment in lump sum amount. If such
amount is in excess of his capital (after making all adjustments of reserves, accumulated profits/losses and
revaluation profit/loss) then the excess amount is treated as his share of goodwill For example, if retiring partner's
capital (after all adjustments of reserves, accumulated profits/losses and revaluation profit/loss) is ₹2,50,000 and
the firm has agreed to pay him ₹3,25,000, then the excess amount of ₹75,000 (=3,25,000-2,50,000) will be his
share of goodwill. This will be recorded by debiting the continuing partners' capital accounts in gaining ratio and
crediting retiring partner's capital account.
Accounting Entries to Record Revaluation of Assets and Reassessment of Liabilities

Sr No Transations . Journal Entry

1 For Increase in the value of an asset Asset A/c (Individually) Dr

To Revaluation A/c
(Revised Value-Book Value)
2 For Decrease in the value of an asset Revaluation A/c Dr.
To Asset A/c (Individually)
(Revised Value-Book Value)
 3 For Increase in the amount of a liability Revaluation A/c Dr
To Liability A/c (Individually)
4 For Decrease in the amount of a liability Liability A/c (Individually) Dr
To Revaluation A/c
(Book Value - Revised Value)
5 For Recording an unrecorded asset Unrecorded Asset A/c Dr.
To Revaluation A/c
6 For Recording an unrecorded liability Revaluation A/c Dr.
To Unrecorded Liability A/c
7 For Transfer of Balance in Revaluation Account: (a) When Credit side exceeds Debit side
(Gain)
Revaluation A/c Dr.
To All Partners' Capital A/cs
[In Old Ratio)
(b) When Debit side exceeds Credit side (Loss)
All Partners' Capital A/cs Dr.
To Revaluation A/c
(In Old Ratio)

SETTLEMENT OF AMOUNT DUE TO THE RETIRING PARTNER:

The amount due to the retiring partner is determined in the following manner:
Calculation of Amount Due to the Retiring Partner
Opening Balance of Capital Account of Retiring Partner (before Adjustments)
Add:
(i) Credit Balance of Current Account
(ii) Share in the Revaluation Profit
(i) Share of Reserves and Accumulated Profits
(iv) Share of Goodwill of the firm (to be contributed by gaining partners in gaining ratio)
(v) Share of Profit till the date of retirement
(vi) Salary and/or interest on capital till the date of retirement
Less
: (i) Debit Balance of Current Account
(ii) Drawings and interest on drawings till the date of retirement
(ili) Advance or loan taken by Retiring Partner from the firm, if any
(iv) Share of Accumulated Losses
(v) Share in the Revaluation Loss
Amount Due to the Retiring Partner
If the question is silent on the settlement of claim of the retiring partner, then the amount due in him is transferred
to 'Retiring Partner's Loan Account'. The Journal Entry passed is:
Retiring Partner's Capital A/c Dr.
To Retiring Partner's Loan A/c
(Being amount due to the retiring partner transferred to his loan account)
Retiring Partner's Loan Account is shown as a liability in the Balance Sheet of the reconstituted firm
Methods of Payment of Amount Due to the Retiring Partner
The amount is paid to the retiring partner as per terms of the Partnership Deed or as agreed to by the remaining
partners and the retiring partner. The amount due may be paid as:
1. Lump Sum Payment: When the amount due is fully paid in one instalment, then the following
Journal Entry is passed:
Retiring Partner's Capital A/c Dr.
To Bank A/c
(Being amount due to the retiring partner paid)

However, if Retiring Partner's Capital Account after all the adjustments shows 'Debit Balance', then the amount is
receivable from the retiring partner. In such a case, following Journal Entry is passed:
Bank A/c Dr
To Retiring Partner's Capital A/c (Being amount received from the retiring partner)
2. Payment in Instalments: When the amount due to the retiring partner is payable in instalments then Balance in
Retiring Partner's Capital Account is transferred to 'Retiring Partner's Loan Account and interest @ 6% p.a. is paid on
such loan (unless agreed otherwise). The Loun Account is shown as a liability in the Balance Sheet of redors agreed
the, till it is paid off Interest Payable (if any) is credited to the Retiring Partner's Loan Account and the amount of
instalment (principal amount + interest) paid is debited to Loan Account.

Settlement of Loan Account of the Retiring Partner

At the time of retirement of a partner, it may be agreed among the partners that the amount due to the retiring
partner will be paid in instalments. In such a case, interest will be credited to the Retiring Partner's Loan Account
on the basis of amount outstanding and the amount paid will be debited to the Loan Account.

There may be different situations in which Retiring Partner's Loan Account can be settled:
Case 1. When annual instalments are payable at the year end.
Case 2. When amount is to be paid in semi-annual instalments.
Case 3. When payment date of annual instalments is different from the accounting period followed by the firm.
Case 4. When annual instalments of fixed amount are payable in the initial years and the balance amount
(including interest) is paid in the last year.
Let us understand the different situations in which Retiring Partner's Loan Account can be settled.
CAPITAL ADJUSTMENT
At the time of retirement, the remaining partners may decide that their capitals after retirement of a partner be
adjusted. The adjustment may take any of the following forms:

Case 1. When Existing Total Capital of Remaining Partners is to be in New Ratio.

Case 2. When Total Capital of the New Firm is Given.
Case 3. When Total Capital of New Firm = Total Capital before Retirement of a Partner.
Case 4. When the Retiring Partner is to be paid through cash brought in by the Remaining Partners in a manner to
make their Capitals Proportionate to New Ratio.
Case 5. When the Retiring Partner is to be paid through cash brought in by the Remaining Partmen in a manner to
make their Capitals Proportionate to New Ratio and also leave a desired Cash Balance.
Let us discuss them one by one.
Case 1: When Existing Total Capital of Remaining Partners is to be in New Ratio.
When the existing total capital of the remaining partners is to be divided in their new ratio, then following steps
are taken:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate adjusted capital of each of the remaining partners, i.e., after making adjustments for goodwill,
reserves, accumulated profits/losses and profit or loss on revaluation, etc.
Step 3. Calculate Total Adjusted Capital of New Firm, i.e. calculate aggregate adjusted capital of remaining
partners.
Step 4. Divide total adjusted capital in their new profit-sharing ratio, i.e. calculate New Capital of each remaining
partner as: Total Adjusted Capital New Share.
Step 5. Calculate Surplus or Deficit by comparing New Capital (determined in Step 4) and Adjusted Capital
(determined in Step 2).
Surplus = Adjusted Capital > New Capital
(Withdraw surplus in cash or transfer it to Current A/c)
(Bring deficit in cash or adjust it through Current A/c)
Deficit = Adjusted Capital < New Capital
Case 2: When Total Capital of the New Firm is Given.
When total capital of the new firm is given, then following steps are taken:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate adjusted capital of each of the remaining partners, i.e., after making adjustments for goodwill,
reserves, accumulated profits/losses and profit or loss on revaluation, etc.
Step 3. Calculate New Capital of each remaining partner as:
Total Capital (as given in the question) x New Share
 Step 4. Calculate Surplus or Deficit by comparing New Capital (determined in Step 3) and Adjusted Capital
(determined in Step 2).
Surplus = Adjusted Capital > New Capital
Deficit = Adjusted Capital < New Capital
(Withdraw surplus in cash or transfer it to Current A/c)
(Bring deficit in cash or adjust it through Current A/c)
Case 3: When Total Capital of New Firm = Total Capital before Retirement of a Partner
When total capital of the new firm is to be same as the total capital before retirement, then following steps are
taken:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate adjusted capital of each of the remaining partners, i.e., after making adjustments for goodwill,
reserves, accumulated profits/losses and profit or loss on revaluation, etc.
Step 3. Calculate New Capital of each remaining partner as:
Total Capital (i.e. sum of old capitals of all partners including retiring partner before adjustments) × New Share
Step 4. Calculate Surplus or Deficit by comparing New Capital (determined in Step 3) and Adjusted Capital
(determined in Step 2).
Surplus Adjusted Capital > New Capital
Deficit Adjusted Capital < New Capital
[Withdraw surplus in cash or transfer it to Current A/c)
(Bring deficit in cash or adjust it through Current A/c)
Case 4: When the Retiring Partner is to be paid through cash brought in by the Remaining Partners in a manner to
make their Capitals Proportionate to New Ratio
Following steps are taken in this case:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate adjusted capital of each of the remaining partners, i.e., after making adjustments for goodwill,
reserves, accumulated profits/losses and profit or loss on revaluation, etc.
Step 3. Calculate Total Capital of the New firm as:
Total of Adjusted Capitals of Remaining Partners + Shortage of cash to be brought in by remaining partners to pay
the retiring partner
Step 4. Calculate New Capital of each remaining partner as:
Total Capital (as per Step 3) x New Share.
Seep 5. Calculate Surplus or Deficit by comparing New Capital (determined in Step 4) and Adjusted
Capital (determined in Step 2). Surplus = Adjusted Capital > New Capital
Deficit = Adjusted Capital < New Capital
(Withdraw surplus in cash or fransfer it to Current A/c)
(Bring deficit in cash or adjust it through Current A/c)
Case 5: When the Retiring Partner is to be paid through cash brought in by the remaining Partners in a manner to
make their Capitals Proportionate to New Ratio and also leave a desired Cash Balance
This case requires the following steps:
Step 1. Calculate New Profit-Sharing Ratio.
Step 2. Calculate Adjusted Capital of each of the remaining partners, i.e., after making adjustments for goodwill,
reserves, accumulated profits/losses and profit or loss on revaluation, etc.
Step 3. Calculate Total Capital of the New firm as:
Total of Adjusted Capitals of Remaining Partners + Shortage of cash to be brought in by remaining partners to pay
the retiring partner + Desired Cash Balance - Existing Cash Balance.
Step 4. Calculate New Capital of each remaining partner as:
Total Capital (as per Step 3) x New Share.
Step 5. Calculate Surplus or Deficit by comparing New Capital (determined in Step 4) and Adjusted Capital
(determined in Step 2).
Surplus Adjusted Capital > New Capital
Deficit Adjusted Capital < New Capital
[Withdraw surplus in cash or transfer it to Current A/c)
(Bring deficit in cash or adjust it through Current A/c)
 Death of a Partner
INTRODUCTION

On the death of a partner, the existing partnership comes to an end. However, the partnership firm may continue
its business with the remaining partners, if they decide to do so. For this, the remaining partners need to enter into
a fresh agreement and the partnership firm is reconstituted with different terms and conditions.
Accounting Treatment:
The accounting treatment at the time of death of a partner is much similar to the accounting treatment in case of
retirement of a partner. The legal heirs or representatives or executor of the deceased partner are entitled to All
the Rights which a retiring partner has at the time of retirement of a partner.
The basic DIFFERENCES between "Retirement of a Partner" and "Death of a Partner" are:
(i) Retirement may be planned but not Death: A partner may plan his date of retirement as retirement is voluntary,
whereas, death of a partner may occur at any time of the year.
(ii) Payment of Amount Due: In case of retirement, the amount due is paid to the retiring partner, whereas, in case
of death, it is paid to the legal heirs or executor of the deceased partner.
(iii) Share of Profit: In case of retirement, there is no problem in calculating share of profit of retiring partner upto
the date of his retirement as retirement is generally planned at the end of the accounting period, when profit is
automatically known.
However, death can take place at any time of the year and there is a problem in calculating the amount of profit
upto the date of death.

Adjustments Required on Death of a Partner

The various matters that need adjustment at the time of death of a partner are:
1. Determination of New Profit-Sharing Ratio and Gaining Ratio.
2. Accounting Treatment of Goodwill.
3. Accounting Treatment of Reserves and Accumulated Profits/Losses.
4. Revaluation of Assets and Reassessment of Liabilities.
5. Deceased Partner's Share of Profit or Loss upto the date of death.
6. Determination of Amount Due to the Deceased Partner.
7. Payment of due amount to Legal Heirs or Executors of Deceased Partner.
8. Capital Adjustment of the Continuing Partners (if agreed between the partners).
6.2 DETERMINATION OF NEW PROFIT-SHARING RATIO (NPSR) AND GAINING RATIO

On the death of a partner, share of deceased partner is taken over by the remaining partners. So, there is a need to
calculate new profit-sharing ratio of the remaining partners and the gaining ratio.

New Profit-Sharing Ratio:

New Profit-Sharing Ratio on death of a partner is the ratio in which the remaining partners decide to share the
future profits and losses.
New Profit-Sharing Ratio = Old Share + Share acquired from Deceased Partner
Unless specified to the contrary, share of the deceased partner is acquired by the remaining partners in their old
ratio. In such a case, profit-sharing ratio between the continuing partners will remain same as it was before the
death of the partner.
However, if the remaining partners purchase or acquire the share of deceased partner in a ratio which is different
from their present profit-sharing ratio, then there is a need to calculate gaining ratio.

Gaining Ratio
Gaining Ratio is the ratio in which the remaining partners acquire the share of the deceased partner.
Gaining Ratio = New Ratio - Old Ratio

* Unless specified to the contrary, the remaining partners gain in their old ratio and hence the gaining ratio is same
as old ratio.
This concept of New Profit-Sharing Ratio (NPSR) and Gaining Ratio has already been discussed in 'Chapter
 6.3 ACCOUNTING TREATMENT OF GOODWILL

On the death of a partner, the remaining partners gain share of profit of the deceased partner. So, the gaining
partners should compensate the deceased partner in the form of Goodwill as goodwill was earned by the firm
when he was a partner. It necessitates the valuation of goodwill at the time of death of a partner. Goodwill is
valued as agreed among the partners in the Partnership Deed or agreed otherwise.

Deceased Partner's Share of Goodwill = Value of Firm's Goodwill x Profit Share of Deceased Partner
As discussed in the previous chapters, according to AS 26: Intangible Assets: "Internally generated goodwill is not
recognised as an asset because it is not an identifiable resource controlled by the entity that can be measured
reliably at cost". So, goodwill is adjusted through Capital/Current Accounts of the Gaining Partners.
If goodwill appears in the books, then it is written off among all the partners (including the deceased partner) in
their old ratio. The Journal Entry passed is:

Partners Capital (or Current) A/cs Dr.

To Goodwill A/c (Existing book value of goodwill)
(Being existing goodwill written off among all the partners in old ratio at the time of death of a partner)

Thereafter, capital account of deceased partner is credited with his share in Goodwill and Gaining Partners' Capital
Accounts is debited. The Journal Entry passed is:

Gaining Partners' Capital (or Current) A/cs Dr.

To Deceased Partner's Capital (or Current) A/c (with share of goodwill)
(Being adjustment made for goodwill at the time of death of a partner (in gaining ratio) )

If on the death of a partner, any existing partner (other than the deceased partner) also sacrifices his share, then
the Journal Entry given above is reformulated as under.

Gaining Partners' Capital (or Current) A/cs To Deceased Partner's Capital (or Current) A/c To Sacrificing Partners'
Capital (or Current) A/cs (Being share of goodwill of the deceased partner and sacrificing partner credited and
gaining Partners' Capital/Current Accounts debited in their gaining ratio)

{Firm's Goodwill x Share Sacrificed) Dr. (in Gaining Ratio) (with share of Goodwill)

6.6 DECEASED PARTNER'S SHARE OF PROFIT OR LOSS UPTO THE DATE OF DEATH
As death can take place at any time of the year, the executors of the deceased partner are entitled to the
share of profits earned or loss suffered by the firm from the beginning of the accounting year till the date of death.
Share in profit or loss is calculated as per the provisions of the Partnership Deed. However, if deed is silent, then in
the manner agreed by the partners. The profit or loss so calculated is adjusted for the period up to the date of
death and then deceased partner's share is determined.
Author's Note: Unless specified to the contrary, share of profit of the deceased partner is acquired by the
remaining partners in their old ratio.
Calculation of Deceased Partner's Share of Profit or Loss
As discussed in 'Chapter 5: Retirement of a Partner' under the heading 'Retirement of a Partner during the Year',
the deceased partner's share of profit or loss can be calculated as:
(i) On the basis of Last Year's Profit or Loss: The proportionate profit or loss upto the date of death is calculated and
then the deceased partner's share is determined.
(ii) On the basis of Average Profits of few previous years: The share of profit of the deceased partner is calculated
on the basis of average profit of past few years, as agreed by the partners.
(iii) On the basis of Turnover or Sales: The percentage of profit earned in the previous year (based on sales and
profit earned in the previous accounting year) is applied to the sales up to the date of death.

Example: Komal, Parinita and Yashita were partners in a firm sharing profits and losses in the ratio of 2:2:1. Komal
died on 31st August, 2023. Calculate Komal's share of profit till her death in each of the following individual cases,
if share of profit of Komal is to be based on:
(i) Last year's profit and profit of 2022-23 was 60,000.
(ii) Average of last 3 years profits and profits for 2020-21, 2021-22 and 2022-23 were 75,000, 85,000 and 1,10,000
respectively.
(iii) Sales or Turnover and sales for the year 2022-23 amounted to 5,00,000 and profit earned in the same period
was 1,00,000 respectively. Sales up to 31st August, 2023 amounted to ₹ 1,80,000.
(i) Total Profit for last accounting year =₹ 60,000
Period (1st April, 2023 to 31st August, 2023) = 5 Months
Profit for 5 Months (taking profits of 2022-23 as base) = 60,000 × 5/12 = 25,000
Komal's share of estimated Profit = 25000 * 2/5 =₹ 10,000

(ii)Average Profits ={( 75000 + 85000 + 1 ,10,000)/3=₹ 90,000

Estimated Profit till date of death = 90000 *5/12)= ₹ 37,500
Komal's share of estimated Profit (= 37 ,500*2/5)= ₹15,000
(ii) Percentage of Profit to Sales (for the year 2022-23) = Profit /Sales * 100 = (100000)/(5,00,000) * 100 = 20%
Estimated Profit till the date of death =1, 80000 * 20 %= ₹ 36,000
(iii) Komal's share of Estimated Profit = 36000 * 2/5=₹14,400

DETERMINATION OF AMOUNT DUE TO THE DECEASED PARTNER

The amount due to the legal heirs or representatives or executors of the deceased partner is determined in the
following manner:
Calculation of Amount Due
Amount standing to credit of Deceased Partner's Capital Account and Current Account
Add:
(i) Share in the gain (profit) on revaluation of assets and reassessment of liabilities
(ii) Share of Reserves and Accumulated Profits
(iii) Share of Goodwill of the firm (to be contributed by gaining partners in gaining ratio)
(iv) Share of Profit from the beginning of accounting year till the date of death
(v) Interest on Capital upto the date of his death (if allowed by Partnership Deed)
(vi) Salary or Commission upto the date of his death (if allowed by Partnership Deed)
(vii) Loan or advance by him to the firm (along with interest, if any)
Less:
(i) Share in loss on revaluation of assets and reassessment of liabilities
(ii) Share of Accumulated Losses
(iii) Share of Loss from the beginning of accounting year till the date of death
(iv) Drawings upto the date of his death
(v) Interest on drawings upto the date of his death (if agreed in Partnership Deed)
(vi) Advance or loan taken by him from the firm (along with interest, if any)
Amount Due to Legal Representatives of Deceased Partner

Dissolution of a Partnership Firm

MEANING OF DISSOLUTION OF A PARTNERSHIP FIRM

When the business of the firm is closed down and the firm comes to an end, it is termed as Dissolution of
Partnership Firm. The economic relationship among the partners ends. On the dissolution of firm, the assets of the
firm are sold and liabilities are paid off and the balance, if any, is paid to the partners in settlement of their
accounts.

According to Section 39 of the Indian Partnership Act, 1932, "Dissolution of the firm means dissol…
Difference between Dissolution of Partnership and Dissolution of Firm

Basis Dissolution of Firm Dissolution of Partnership

1. Meaning When the business of the firm is closed When there is change in business
down and the firm comes to an end, it is relationship between the partners
termed as dissolution of firm. and firm continues its business, it is
 termed as Dissolution of
partnership.
2. Court's A firm can be dissolved by the court's Court does not intervene because
Intervention order. partnership is dissolved by mutual
agreement.
3. Economic The economic relationship between the The economic relationship between
relationship partners comes to an end. the partners continues though in a
changed form.
4. Continuation of Business of the firm comes to an end. Business of the firm continues
business
MODES OF DISSOLUTION OF A FIRM

A firm may be dissolved in any of the following ways:

1. By Mutual Agreement (Section 40): A firm may be dissolved when all the partners agree for its dissolution.
2. Compulsory Dissolution (Section 41): A firm may be compulsorily dissolved:
(a) When all the partners or all the partners except one become insolvent.
(b) When business of the firm becomes unlawful.
3. On Happening of an Event (Section 42): A firm may be dissolved in any of the following events.
if the Partnership Deed so provides:
(a) On the expiry of the term for which the firm was formed.
(b) On the completion of the venture(s) for which the firm was formed.
(c) On the death of a partner, if the Partnership Deed does not provide for continuation of firm
(d) On the adjudication of a partner as insolvent.
4. By Notice (Section 43): In case of "Partnership at Will", the firm may be dissolved when any one 5. of the partners
gives a notice in writing to other partners of his intention to dissolve the firm.
By Order of Court (Section 44): The court may pass an order for the Dissolution of the firm:
(a) When a partner has become of unsound mind.
(b) When a partner has become permanently incapable of performing his duties as partner. (c) When a partner is
found guilty of misconduct, which is likely to adversely affect the carrying on of the business.
Section 48 of the Indian Partnership Act, 1932 deals with the settlement of accounts at the time of dissolution of
firm. It is discussed below:

1. Treatment of Losses (Section 48 (a)): The amount of loss including deficiencies of capital will be paid first out of
profits, then out of capital and lastly by the partners individually in their profit-sharing ratio.
2. Application of Assets (Section 48 (b)): The amount realised from sale of assets (including amount contributed by
the partners to make up the deficiency of his capital) is applied in the following order:
(a) First of all, debts due to the third parties will be paid, i.e. external liabilities are paid.
(b) Out of the remaining amount, the loans or advances by partners is p…
(c) With the amount left thereafter, the balance of Partners' Capital Accounts is returned.
(d) If some amount still remains, it will be distributed among the partners in their profit-sharing ratio.

Payment of Firm's Debts and Private Debts (Section 49)

Pirm's debt means the debt owed by the firm to outsiders, whereas Private Debts means the debt owed by
Fipartner in his personal capacity to outsiders. The provisions applicable in case of firm's debts and private debts
are as under:

1. Firm's Debts: The property of the firm is applied first towards payment t of firm's debts. If any surplus is left,
then it is distributed to the partners in their profit-sharing ratio.
2. Private Debts: Private property of each partner is applied first towards the payment of his private debts and
surplus, if any, is applied towards payment of firm's debts.
ACCOUNTING PROCEDURE ON DISSOLUTION OF FIRM

As stated earlier, when a firm is dissolved, assets are realised (including loan to partners), external liabilities and
loan by partners are paid and balance, if any, is distributed among the partners in their profit-sharing ratio.
 However, in case of deficiency, shortfall is met by the partners. It means, the books of the firm are closed on
dissolution. This process of dissolution is completed by opening the following accounts in the firm's books:
1. Realisation Account
2. Loan by Partner Account
3. Loan to Partner Account
4. Partners' Capital Accounts
5. Bank or Cash Account
1. Realisation Account
'Realisation Account' is opened for disposing of all the assets of the firm and making payment to all the debts of the
third parties.
Objective: Its objective is to find out gain (profit) or loss on realisation of assets and payment of liabilities.
Transfer of Balance: Gain (profit) or loss on realisation is transferred to Partners' Capital Accounts in their profit-
sharing ratio.
Preparation of Realisation Account
To prepare the "Realisation Account", following steps are taken:
Step 1. Transfer All Assets: All assets of the firm (except Bank/Cash balance, Fictitious Assets) are
transferred at book values to the "Debit Side" of the account. "Loan to a Partner' is transferred to a separate
account and the amount is received/settled from such partner.
Step 2. Transfer All Liabilities: All external liabilities are transferred to the "Credit Side" of the account. "Loan by
Partner's' is transferred to a separate account and the amount is paid/settled
Step 3. Credit with Amount of Assets Realised: Amount realised on sale of assets (including unrecorded assets and
assets taken over by partner against capital) is credited to the Account
Step 4. Debit for Settlement of External Liabilities: Amount paid to settle the liabilities (including unrecorded
liabilities and liabilities assumed by a partner) is debited to the Account.
Step 5. Debit for Realisation Expenses: Amount paid on expenses incurred on dissolution are also debited to the
Account.
Step 6. Transfer the Balance: The balance in the account is either gain (profit) if total of credit side is greater and
loss, if total of debit side is greater, which is transferred to Partners' Capital Accounts in their profit-sharing ratio.

Let us now discuss the accounting entries for the six steps discussed above.
Step 1: For Closing the Assets Accounts (Transfer All Assets)
All assets of the firm, including goodwill (except Bank/Cash Balance) are transferred to the Realisation Account at
their book values. Since assets have debit balance, they will be closed by crediting them. The accounting entry is:
Realisation A/c
To Sundry Assets A/c (Individually)
(Being asset accounts closed by transferring to Realisation Account at book values)
Always Remember: This entry will close accounts of all the assets in the books of accounts.

Important Points while transferring Assets to Realisation Account

(i) Treatment of Fictitious Assets: Only those assets which can be converted into cash are transferred to this
account. Fictitious assets such as accumulated losses like debit balance of Profit and Loss A/c and Deferred
Revenue Expenditure like Advertisement Expenses A/c etc., are not transferred to Realisation A/c. Such accounts
are transferred to the Partners' Capital Accounts in Profit-Sharing Ratio. The accounting entry passed is:
Partners Capital A/cs Dr.
To Profit and Loss A/c
To Deferred Revenue Expenditure (like Advertisement Suspense Alc)
(i) Treatment of Provision Against an Asset: If there exists a provision against any asset, such as 'Provision for Bad
Debts' or 'Investments Fluctuation Reserve' etc., then the asset is transferred at its gross figure and the provision is
transferred to the Credit side of Realisation A/c. For example, if total Debtors are ₹ 70,000 and Provision for Bad
Debts is ₹3,000, then Debtors of 70,000 will be debited to Realisation A/c and Provision for Bad Debts of 3,000 will
be credited to Realisation A/c. The accounting entry passed is:
Realisation A/c Dr. 70,000
To Debtors A/c 70,000
Provision for Bad Debts A/c Dr. 3,000
To Realisation A/c 3,000
 Author's Note: Investment Fluctuation reserve is never transferred to the Capital Accounts of the Partners in case
of Dissolution of the Firm.

(iii) Treatment of Cash and Bank Accounts: They are not transferred to Realisation Account as they are already in
the liquid form.

(iv) Treatment of Loan to a Partner. The balance appearing in the Loan to a Partner Account is transferred to a
separate account and the amount is received from such partner. It is not transferred to the Realisation Account.

Cash/Bank A/c Dr.

To Loan to Partner A/c
(v) Transfer of Current Account (Dr. Balance): When partners also have Current Accounts along with their Capital
Accounts (ie. in case of Fixed Capital Account Method), then the debit balance of Partner's Current Account (if any)
is closed by transferring it to the concerned Partner's Capital Account. The entry passed is:
Partner's Capital A/c
To Partner's Current A/c

Step 2: For Closing the Liabilities Accounts (Transfer All Liabilities)

All the external liabilities (i.e. liabilities relating to third parties or outsiders) are transferred to the Realisation
Account. Since liabilities have credit balance, they will be closed by debiting them. The entry is:

Sundry Liabilities A/c (Individually)

To Realisation A/c (Being liabilities transferred to Realisation A/c)

Always Remember: This entry will close accounts of all the liabilities in the books of accounts.

Important Points while transferring Liabilities to Realisation Account

(i) Transfer Only External Liabilities: Only those liabilities which relate to third parties are transferred to Realisation
A/c such as, Creditors, Bills Payable, Partner's Wife Loan, Bank Loan, Provident Fund, Outstanding Expenses, etc.
(ii) Do Not Transfer Loan by Partner Account: Loan by Partner is not transferred to the Realisation Account. Loan by
Partner Account is prepared and paid off separately as it is paid after payment of external liabilities but before
payment of capitals.
(iii) Do Not Transfer Liabilities due to Partners: Liabilities due to the partners (i.e. Capital and Current Accounts of
Partners) are also not External liabilities and are not transferred to Realisation Account.
(iv) Transfer of Current Account (Cr. Balance): The credit balance of Partner's Current Account (if any) is closed by
transferring it to concerned Partner's Capital Account. The entry passed is:

Partner's Current A/c Dr.

To Partner's Capital A/c

Do Not Transfer Reserves and Accumulated Profits: Reserves like General Reserve, Reserve Fund and Accumulated
Profits such as credit balance of Profit and Loss A/c are also not transferred to Realisation A/c. They are transferred
to Partners' Capital Accounts in their profit-sharing ratio. Following Entry is passed:

General Reserve/Other Reserve A/c Dr.

Profit and Loss A/c Dr.
Workmen Compensation Reserve A/c Dr.
To Partners Capital A/cs
(Being balance in reserves or/and accumulated profits transferred to capital accounts of partners)

Workmen Compensation Reserve

As stated in the earlier chapters, Workmen Compensation Reserve is a provision created out of firm's profit to
meet the liability towards workmen (workers), if any, that may arise in future. At the time of dissolution, it is
treated as under:
1. Nothing is mentioned or No liability is expected to arise: In such a case, the entire amount of Workmen
Compensation Reserve is transferred to Partners' Capital Accounts in their profit-
sharing ratio. 2. When there is a liability for Workmen's Compensation: In such a case, treatment of Workmen
Compensation Reserve depends on the amount of liability. There can be two possible cases:
(i) If liability Workmen Compensation Reserve: Workmen Compensation Reserve to the extent of liability is
transferred to the credit side of Realisation Account and balance of Workmen Compensation Reserve is transferred
to Partners Capital Accounts in their profit-sharing ratio. The amount of liability is paid in full and is shown on the
debit side of Realisation Account.
(ii) If liability Workmen Compensation Reserve: Entire Workmen Compensation Reserve is transferred to the
credit side of Realisation Account. The amount of liability is paid in full and is shown on the debit side of Realisation
Account.

Illustration 1. Jayant and Anuj were partners sharing profits and losses in the ratio of 3:2. Show how will you treat
the following items at the time of dissolution of a firm:
(i) Workmen compensation reserve stood at in this respect. 10,000 in Balance Sheet and there was no liability
(ii) Workmen compensation reserve stood at 12,000 & liability for it was ascertained at ₹7,000.
(iii) Workmen compensation reserve stood at at 15,000. 12,000 and liability in respect of it was ascertained
(iv) Workmen compensation reserve stood at 12,000 and liability in respect of it was also ascertained at 12,000.
(v) There was no workmen compensation reserve and firm had to pay 3,000 as compensation to the workers.
Treatment of Unrecorded Assets and Liabilities
There may be some assets in the business, which do not appear in the Balance Sheet. For example, a machinery
has been written off completely in the past, but physically it still exists.

Similarly, there may be some liabilities, which do not appear in the books, but are still payable. For example, if a bill
receivable under discount is dishonoured, then such unrecorded liability has to be met by the firm.
These unrecorded assets and liabilities are not transferred to Realisation A/c as they do not appear in the Balance
Sheet. The accounting procedure followed for their treatment is outlined as under:
1. When an unrecorded asset is sold, then amount realised from its sale is debited to Cash/Bank Account and
Realisation Account is credited (being in the nature of gain).
2. When an unrecorded asset is taken over by a partner, then concerned Partner's Capital Account is debited and
Realisation Account is credited.
3. When an unrecorded liability is paid, then Realisation Account is debited (being in the nature of loss) and
amount paid is credited to Cash/Bank Account.
4. When an unrecorded liability is taken over by a partner, then Realisation Account is debited and concerned
Partner's Capital Account is credited.
5. However, if unrecorded asset is given to discharge a recorded or unrecorded liability, then NO ENTRY is passed.

Transfer of an Asset to Settle Liability**

Fan asset is given away to settle a liability (say, creditor) in part or full payment of his dues, then the agreed
amount of the asset is deducted from the claim of creditor and the balance is paid to him. Entry is passed for the
amount paid to the creditor, but no entry is passed for the transfer of asset. Let us understand this with the help of
an example:
Suppose, there is an amount due to a creditor for 20,000 and he agrees to take furniture in full settlement of his
dues. In such a case, No Entry will be made for such transfer of asset to settle the liability even if book value of
furniture is less than, equal to or more than 20,000. However, if the creditor is paid cash of ₹4,000 in addition to
the furniture, then following entry is passed on payment:

Realisation A/c Dr. 4,000

To Cash/Bank A/c 4,000

Step 4: For Settlement of Liabilities (Whether Recorded or Unrecorded)

When liabilities are settled, then following entries are passed:

 1. When Liabilities are paid.

Realisation A/c Dr
To Cash (or Bank) A/c (With amount paid)
(Being liabilities paid in cash)

2. When a partner agrees to settle a liability.

Realisation A/c Dr
To Concemed Partner's Capital A/c (With agreed price) (Being liability paid by the partner)

Important Points: Realisation of Assets and Settlement of Liabilities

(i) If the realised value of tangible assets is not given, then it should be considered as realised at book value itself.
Tangible Assets refer to those assets which have physical existence. For example, Plant and Machinery, Land and
Building, Furniture, etc.
(ii) If the realised value of intangible assets is not given, then it should be considered as nil (zero value).
Intangible Assets are those assets which do not have a physical existence. For example, Goodwill, Patents,
Trademarks, etc.
(iii) If question is silent about settlement of any liability, then it is assumed that book value of the liability is paid.
Treatment of Goodwill
If Goodwill appears in the Balance Sheet, then it is Purchased Goodwill and it is treated like any other asset and is
transferred to the Realisation Account. Let us discuss the accounting treatment of Goodwill in the following two
situations:
(a) When Goodwill appears in the Balance Sheet:
Transaction Journal Entry
1. On transfer to Realisation Account Realisation A/c Dr
To Goodwill A/c
2. When amount of Goodwill is realised in cash Cash (or Bank) A/c Dr
To Realisation A/c
3. When a partner agrees to pay for Goodwill Concemed Partner's Capital A/c (With agreed price) Dr
To Realisation A/c

(b) When Goodwill does not appear in the Balance Sheet:

Transaction Journal Entry

1. On transfer to Realisation Account No Entry is passed

2. When amount of Goodwill is realised in cash Cash (or Bank) A/c Dr

To Realisation A/c
3. When a partner agrees to pay for Goodwill Concemed Partner's Capital A/c (With agreed price) Dr
To Realisation A/c

Always Remember: As Goodwill is an intangible asset, if its realised value is not given, then it is considered as
NIL
Step 5: Realisation Expenses

Realisation or Dissolution expenses are the expenses incurred to wind up the business of the firm.
Realisation expenses are firm's expenses. So, if nothing is mentioned about the treatment of realisation expenses,
it is assumed that realisation expenses are borne and paid by the firm.
Sometimes, a partner may also agree to bear the realisation expenses.
At times, a partner may also be allowed a commission so that he bears realisation expenses. So, it is very important
to see who is paying the expenses and who is bearing the burden of the expenses.
Note: As per CBSE guidelines, if realisation expenses are borne by a partner, then clear indication should be
given regarding the payment thereof.
There may be various situation relating to Realisation Expenses which are as under:
Transaction Journal Entry

1. When realisation expenses are paid by firm Realisation A/c Dr

To Cash Or Bank A/c
2. When realisation expenses are borne by firm and paid Realisation A/c Dr
by a partner To Partner's Capital A/c
3. When realisation expenses are bome by a partner Concemed Partner's Capital A/c (With agreed price) Dr
and paid by firm. To Cash A/c

4. When realisation expenses are borne and paid by No Entry is passed

the same partner.

5. When the firm has agreed to pay fixed amount Realisation A/c Dr
(commission, salary or remuneration) to the partner To Partner's Capital A/c
towards realisation expenses and the partner has to
bear the expenses.

6. When realisation expenses are to be borne by one X Capital A/c Dr

partner (say, X) and paid by other partner (say, Y). To Partner’s Capital A/c

2. Loan by Partner Account

If a partner has given any loan to the firm, then such loan will be paid off after all the outside liabilities are paid in
full, but before payment of capital to the partners. Therefore, Loan by Partner is not transferred to the Realisation
A/c and his loan account is prepared separately.

The Journal Entry is:

Loan by Partner A/c
To Cash/Bank A/c
(Being loan by partner paid off)

Important Points about Treatment of Loan by Partner

1. If capital account of a partner shows a debit balance (after all adjustments) and the partner has also advanced a
loan to the firm, then the loan amount, to the extent of debit balance is transferred to his Capital Account and the
balance, if any, in his Loan Account is paid separately in priority to…
[07:10, 12/15/2024] Subhash Chander: Either of the two will appear.

Alternate Way:

For better understanding, the format of Realisation Account can also be presented as:

FORMAT OF REALISATION ACCOUNT

Particulars Amount Particulars Amount
To Sundry Assets A/c By Sundry Liabilities A/c
(Excluding Cash/Bank Balance, (Excluding Cr. Balance of Profit &
Fictitious Assets. Dr. Balance of Loss Avc Reserves, Cr. Balance of
Profit and Loss Aic Dr. Balance of Partners
Partners Capital/Current A/cs, Capital/Current A/cs, Loan from
Loans to Partners) Partner)
To Cash/Bank A/c By Provision on Assets A/c
(Amount paid for Discharging (Such as Provision for Depreciation,
Recorded/Unrecorded Liabilities) Provision for Doubtful Debts,
Investment Fluctuation Fund)
 To Cash/Bank A/c By Partners' Capital A/cs" (For
(Expenses on Realisation or transferring Loss on Realisation)
Dissolution) (Amount received on realisation of
Recorded/Unrecorded Assets)
To Partner's Capital Alc By Partner's Capital A/c
[Unrecorded/Recorded Liability
taken over by a partner or Recorded/Unrecorded asset taken
Commission/ over by a Partner)
Remuneration/Expenses Payable
to him
To Partners Capital A/cs** By Partners' Capital A/cs" (For
[For transferring Gain (Profit) on transferring Loss on Realisation)
Realisation)
----------------- -----------------

Name of Unit : Company Accounts

Accounting for Share Capital

Meaning of company: A company form of organization is the third stage in the evolution of forms of
organization. Itscapital is contributed by a large number of personscalled shareholders who are the real
owners of thecompany.

Definition – “Company means a company incorporated under this Act or any previous company - Section
2(20) of the Companies Act, 2013

Share Capital - Schedule III of the Companies Act, 2013 classified Share Capital as:

1.Authorized / Nominal/ Registered Share Capital: - It is the amount of share capital that a company is
authorized to raise as per its Memorandum of Association during its span of life.

2.Issued Share Capital: - It is that part of the authorized share capital which is actually offered to the public
for subscription.

3.Subscribed Share Capital: It is that part of issued share capital which has been subscribed by the
applicants. It should not be less that 90% of the issued capital (Minimum Subscription).

a.Subscribed and Fully Paid: - When entire nominal value of a share is called by the company and also paid
up by the share holder, it is said to be Subscribed and fully paid.

b.Subscribed but Not Fully Paid: - Shares are said to be Subscribed but not
fully paid-up under the following two situations:
i. When company has called up the full amount but some shareholders have not paid the full amount or
ii.When company has not called up the full amount.
4.Called-up Capital: - It means the amount that the shareholders have been called upon by the company to
pay on the shares subscribed by them.

5.Paidup Capital: - It is the amount of money actually paid by the subscribers.

6.Reserve Capital: - It is the part of the uncalled capital which has been

reserved by the company to be called in the event of winding up (sec.418).

DISCLOSURE OF SHARE CAPITAL IN BALANCE SHEET
Name of the Company ............................
Balance Sheet (An Extract) as on...............................
Particulars Note Figures at the end Figures at the end
No of current of previous
of reporting period of reporting period
1 2 3 4
I. Equity and Liabilities
1. Share holders’ funds
(a) Share Capital 1 XXX XXX

Asperschedule IIIdisclosurerequirementspertainingtoShareCapitalare tobeprovided innotes to

accounts
Notes to accounts:
Particulars Amount(₹) Amount(₹)
(a) Share Capital
Authorised Capital XXX
(................... Shares of ₹ ......... each)
Issued Capital XXX
(................... Shares of ₹ ......... each)
Subscribed Capital
Subscribed and fully paid up
(................... Shares of ₹ ......... each) XXX
Subscribed but not fully paid up
(.............. Shares of ₹ ....... Each, ₹...... called up) XXX
Less: Calls in arrears (if any) (XXX)
XXX
Add: Shares forfeited A/c XXX XXX
(Exam Tip : Generally one question of 3/4 marks is asked for disclosure of share capital in Balance sheet
and one MCQ for identifying kind of share capital.)

Kinds of Shares
(1) Preference Shares: - According to Section 43 of The Companies Act, 2013, a preference share is one,
which fulfils the following conditions:
(a) It has preferential right to dividend to be paid.
(b) On the winding up of the company, it has preferential right to the repayment of capital before
anything is paid to equity shareholders.
(2) Equity Shares:- According to Section 43 of The Companies Act, 2013, an equity share is a share which is
not a preference share.
(Exam Tip : Generally one question of 3 marks is asked for issue of shares for a consideration other than
cash .)

SWEAT EQUITY SHARES: - A company may issue sweat equity shares as per Section 54 of Companies Act,
2013. Sweat equity shares means equity shares issued by the company to its employees or directors at a
discount or for consideration other than cash for providing know-how or making available intellectual
property rights.
ISSUE OF SHARES FOR CONSIDERATION OTHER THAN CASH

On purchase of Asset:
Sundry Assets (with agreed value assets taken over)
To Vendors A/c (with agreed value of Purchase Consideration)
On purchase of entire business
Sundry Assets Dr. (with agreed value assets taken over)
Goodwill A/c Dr. (with the excess of P.C. over of net assets)
To Sundry Liabilities (with agreed value liabilities taken over)
To Vendors A/c(with agreed value of Purchase Consideration)
To Capital Reserves A/c (with the excess of value of net Assets over P.C.)

ON ISSUE OF SHARES TO VENDORS

If the Shares are issued at PAR
Vendor A/c Dr.
To Share Capital A/c

If the Shares are issued at PREMIUM

Vendor A/C Dr.
To Share Capital A/C
To Securities Premium Reserve A/c

If the Shares are issued at DISCOUNT

Vendor A/C Dr.
Discount on issue of shares A/C Dr.
To Share Capital A/C
(Exam Tip : Number of shares issued = Net Amount payable / Issue price of share )

ISSUE OF SHARES FOR CASH

Shares to general public may be issued at PAR or PREMIUM and either for lump sum or for instalments.
JOURNAL ENTRIES FOR ISSUE OF SHARES TO PUBLIC:
Particulars L.F. Amount Amount
(₹) (₹)
Bank A/C Dr.
To Share Application A/C
Being the application money received for...shares @ ₹...per share

Share Application A/c Dr.

To Share Capital A/c
To Securities Premium Reserve A/c (If there is Premium on
Application)
To Bank A/c (If applications are rejected)
To Share Allotment A/c (If application money is adjusted in allotment)
To Calls-in-advance A/c (If application money is adjusted in Calls)
Being the transfer of share application money towards
share capital account )
If the share are allotted at par
Share Allotment A/c Dr.
To Share Capital A/c
(Being the allotment money due on … shares @ ₹… per share)
If the share are allotted at a premium
Share Allotment A/c Dr.
To Share Capital A/c
To Securities premium A/c
(Being the allotment money due on …. shares @ ₹… per share including
premium of ₹ .. per share)
Bank A/c Dr.
Calls in arrear A/c (if unpaid) Dr.
To Share Allotment A/c
(Being the receipt of allotment money)
Share First Call A/c Dr.
To Share Capital A/c
(Being the first call money due on…shares @ ₹… per share)
Bank A/c Dr.
Calls in arrear A/c (if unpaid) Dr
To Share first call A/c
(Being the receipt of first call money)
Share Final Call A/c Dr.
To Share Capital A/C
(Being the final call money due on…shares @ ₹…per share)
Bank A/c Dr.
Calls in arrear A/c (if unpaid) Dr
To Share Final Call A/c
(Being the receipt of final call money)

USE OF SECURITIES PREMIUM RESERVE:

Under Section 52(2) of the Companies Act, 2013, the amount of securities premium reserve may be used
only for the following purposes:

1. To write-off preliminary expenses of the company

2. To write-off the expenses of, commission or discount allowed on issue of shares or
debentures of company
3. To issue fully paid bonus shares to the shareholders of the company
4. To pay premium on the redemption of preference shares or debentures of the company
5. To buy back of its own shares and other securities as per Section 68.
UNDER SUBSCRIPTION: - Sometimes, number of shares applied for by the public is less than the number of
shares offered by the company. Such an issue is said to be under –subscribed.

OVER SUBSCRIPTION: - Shares are said to be over-subscribed when the number of shares applied for is
more than the number of shares offered to the public for subscription.
PRO-RATA BASIS ALLOTMENT: The excess application money received is normally adjusted towards the
amount due on allotment. In case of over subscription, the Board of Directors can issue the shares in any of
the following four alternatives.
1. Rejecting the applications for excess number of shares
2. Allotting the shares on pro-rata basis on all the applications received
3. Rejecting some applications completely and allotting to the remaining application on a pro-rata basis
4. Rejecting some applications, allotting the number of shares asked for by some applicants and allotting
the remaining shares to the remaining applications on a pro-rata basis.

CALLS-IN-ARREARS: - It is often happens that some shareholders fail to pay the

amount of allotment or call when it becomes due. This is known as calls in arrears.

There are two methods to deal with calls in arrears.

1. Without opening calls in arrear account: - Under this method, there is no need to open calls-in-
arrear account.
 2. By opening Calls-in-arrears account: - Under his method, ‘Calls in Arrears A/c’ is opened and this
account is debited when some amount of allotment or calls is not received.

CALLS IN ADVANCE:- A shareholder sometimes pay a part, or whole, of the amount

not yet called upon his shares. The amount received as calls in advance, credited to a newly opened
account “Calls in advance A/c”.
(Exam Tip : Calls in arrear account is debited at the stage on which it is unpaid with bank entry

Calls in advance is credited at the stage at which it is received with bank entry however it is to
adjusted/debited at the stage for which it is received.)

FORFEITURE OF SHARES
If any shareholder fails to pay amount due on allotment or on any call within the specified period, the
Directors may cancel his shares. This is called Forfeiture of Shares.

Forfeiture of shares which were issued at par

OR
Forfeiture of shares which were issued at a premium and the premium on shares ALREADY RECEIVED

Share Capital A/C Dr. (No. of shares forfeited X amount called up per share
EXCLUDING PREMIUM)
To Shares forfeited A/C (Cash received on forfeited shares)
To Share Allotment (due on allotment)
To Share First call A/C (due on First call)
To Share Second Call A/C (due on Second Call)
To Share Final Call A/C (due on Final Call)
OR
Share Capital A/C Dr. (No. of shares forfeited X amount called up per share
EXCLUDING PREMIUM)
To Shares forfeited A/C (Cash received on forfeited shares)
To Calls in arrears (If Calls in arrear account is maintained)

Forfeiture of shares which were ISSUED AT A PREMIUM and the premium on shares
NOT RECEIVED

Share Capital A/C Dr. (No. of shares forfeited X amount called up per share
excluding premium)
Securities Premium A/C Dr. (No. of shares forfeited X Premium on each share)
To Shares forfeited A/C (Cash received on forfeited shares)
To Share Allotment (due on allotment)
To Share First call A/C (due on First call)
To Share Second Call A/C (due on Second Call)
To Share Final Call A/C (due on Final Call)
OR

Share Capital A/C Dr. (No. of shares forfeited X amount called up per share
excluding premium)
Securities Premium A/C Dr. (No. of shares forfeited X Premium on each share)
To Shares forfeited A/C (Cash received on forfeited shares)
To Calls in arrears (If Calls in arrear account is maintained)
 REISSUE OF FORFEITED OF SHARES

IF THE SHARES ARE RE-ISSUED AT PAR

Bank A/C Dr. (Amount received)
To Share Capital A/C (With the amount called-up per re-issued share)

IF THE SHARES ARE RE-ISSUED AT PREMIUM

Bank A/C Dr. (Amount received)
To Share Capital A/C (With the amount called-up per re-issued share)
ToSecurities Premium Reserve A/C (Premium Amount)
IF THE SHARES ARE RE-ISSUED AT Discount
Bank A/C Dr. (Amount received)
Shares forfeitedA/c Dr.( Discount allowed at the time of re-issue)
To Share Capital A/c (With the amount called-up per re-issued share)
Note : Discount on re-issue cannot be more than the amount forfeited

TRANSFER OF PROFIT ON RE-ISSUE OF FORFEITED SHARES to Capital Reserve:

Shares forfeited A/c Dr.

To Capital Reserve A/c
Formula to calculate amount to be transferred to CR

= (Total amount forfeitedX Shares re-issued / Total Shares Forfeited) – Discount allowed on re-issue

ACCOUNTING FOR DEBENTURES

Definition: A debenture is a written acknowledgment of debt by a company under its seal, promising to
repay the borrowed amount with interest.

Features:

A debenture is a debt instrument.

It can be secured or unsecured.
Interest is payable at a fixed rate.
Types of Debentures:

Secured vs. Unsecured

Redeemable vs. Irredeemable
Convertible vs. Non-convertible
DEBENTURES CAN BE ISSUED IN FOLLOWING WAYS:

(a) for cash

(b) for consideration other than cash
(c) as collateral security
ISSUE OF DEBENTURES FOR CASH
On receipt of application money –
(1) Bank A/c..............Dr. (Apl amt X Debs applied)
To Debenture Application & Allotment A/c
For transferring money to debentures account
(2) Debenture Application & Allotment A/c Dr. (Apl amt X Debs applied)
Loss on issue of debentures A/c Dr( If issued at discount)
To % Debentures A/c (Apl amt X Debs issued)
To Bank A/c (Apl amt X excess Debs applied)
To Securities premium a/c (If deb. Are issued at premium)

ISSUE OF DEBENTURES FOR CONSIDERATION OTHER THAN CASH

When Debentures are issued for purchased of asset/ business.
(A) When Debentures are issued for purchases Asset :
(i) AT PAR
Sundry Asset A/c ..................Dr. (value of Asset)
To Vendor (Purchases Consideration)

Vendor .................................Dr. (Purchases Consideration)

To Debenture A/c (No. of Debs X Face Value of Deb)
(ii) AT PREMIUM
Sundry Assets A/c.................. Dr. (value of Asset)
To Vendor (Purchases Consideration)

Vendor................................... Dr. (Purchases Consideration)

To Debenture A/c (No. of Debs X Face Value of Deb)
To Security Premium Reserve A/c (No. Of Debs X Premium amount)
(iii) AT DISCOUNT
Sundry Assets A/c.................. Dr. (value of Asset)
To Vendor (Purchases Consideration)

Vendor................................... Dr. (Purchases Consideration)

To Debenture A/c (No. of Debs X Face Value of Deb)
 To Security Premium Reserve A/c (No. Of Debs X Premium amount)

(B) When Business is Purchased:

a. When Purchase consideration equal to Net assets
Sundry Asset A/c......................Dr (value of Assets)
To Liabilities A/c (value of liabilities)
To Vendor A/c (Purchases consideration)
b. When Purchase Consideration is less than Net Value of Asset
Sundry Asset A/c......................Dr (value of Assets)
To Liabilities A/c (value of liabilities)
To Capital Reserve (Balance fig.)
To Vendor A/c (Purchases consideration)
c. When Purchase Consideration is more than Net Value of Asset
Sundry Asset A/c......................Dr (value of Assets)
Goodwill A/c ...........................Dr (Balance fig.)
To Liabilities A/c (value of liabilities)
To Vendor A/c (Purchases consideration)

Examination Tip : This concept is same as for issue of shares for a consideration other than cash. One question
from this concept is being asked in board exams either from shares or debentures.
ISSUE OF DEBENTURE AS COLLATERAL SECURITY
- Collateral security - security provided to lender (either Bank or Financial Institutions) in addition to
the Primary security.
- It is Secondary security.
- Such an issue of debentures is known as ‘issue of debentures as collateral security’.
- Lenders have a right over such debentures only when company fails to pay the loan amount and
the principal security falls short.
- In case the need to exercise the right does not arise - debentures are returned back to the
company.
- No interest is paid by company on such debentures.
Accounting for issue of debentures as collateral security
First method:
- No Journal entry in the books of accounts of the company for issue of debentures as collateral
security.
- A note of this fact is given in this case, specifying – “Secured by issue of Rs………… , ….% Debentures
as Collateral Security”.
- The above note is stated in the Notes to Accounts, under the heading of Long Term Borrowings
with the name of the Debentures.
Second method:
Journal Entry is made in the books of the company.
Debentures Suspense A/c............Dr. as no amount is received by company)
To % Debentures A/c
Journal Entries

Date Particulars LF AMT (Dr) Amt(Cr)

Bank A/C Dr
To Bank Loan A/C
(For raising Bank loan)
Debenture Suspense A/C Dr
To % Debentures A/c
(For issue of debentures as collateral security)
Notes to account :
Particulars
Non current Liabilities
Long Term Borrowings
(a) Bank Loan ------
(b) % Debentures ------
Less Debenture Suspense (----)

ISSUE OF DEBENTURES FROM POINT OF VIEW OF REDEMPTION

Conditions of issue and conditions of redemptions:

(A) Issued at Par, redeemable at Par
(i) Bank A/c.................. Dr.
To Deb. Application A/c (App. Money received)

(ii) Deb. Application A/c Dr. (App. Money received)

To % Debenture A/c (No. of Debs X Face value of deb)

(B) Issued at Premium, redeemable at Par

(i) Bank A/c .................. Dr.
To Deb. Application A/c (App. Money received)

(ii) Deb. Application A/c Dr. (App. Money received)

To % Debenture A/c (No. of Debs X Face value of deb)
To Securities Premium Reserve (No of Debs X Premium amt)

(C) Issued at Discount, redeemable at Par

(i) Bank A/c .................. Dr.
To Deb. Application A/c (App. Money received)

(ii) Deb. Application A/c Dr. (App. Money received)

Discount on issue of Debs A/c Dr. (No of Debs X Discount amt)
To % Debenture A/c (No. of Debs X Face value of deb)

(D) Issued at Par, redeemable at Premium

(i) Bank A/c .................. Dr.
To Deb. Application A/c (App. Money received)

(ii) Deb. Application A/c Dr. (App. Money received)

Loss on issue of Debs A/c Dr. (Premium on redemption amt)
To % Debenture A/c (No. of Debs X Face value of deb)
To Premium on Redemption A/c (Premium on redemption amt)

(E) Issued at Discount, redeemable at Premium

(i) Bank A/c .................. Dr.
To Deb. Application A/c (App. Money received)

(ii) Deb. Application A/c Dr. (App. Money received)

Loss on issue of Debs A/c Dr. (Premium on redemption amt)
Discount on issue of Debs A/c. Dr. (Discount on deb amt)
To % Debenture A/c (No. of Debs X Face value of deb)
To Premium on Redemption A/c (Premium on redemption amt)
*(in place of Loss on Issue of Debs A/c and Discount on issue of Debs A/c – LOSS ON ISSUE OF DEBS
A/c can be used alone (with aggregate of Discount and Premium on redemption)
 (F) Issued at Premium, redeemable at Premium
(i) Bank A/c .................. Dr.
To Deb. Application A/c (App. Money received)

(ii) Deb. Application A/c Dr. (App. Money received)

Loss on issue of Debs A/c Dr. (Premium on redemption amt)
To % Debenture A/c (No. Of Debs X Face value of deb)
To Premium on Redemption A/c (Premium on redemption amt)
To Securities Premium Reserve A/c (Premium on issue)
Examination tip :
1. There is only one case where there will be loss due to redemption i.e. when debentures are issued
at premium. Hence premium payable at the time of redemption needs to be adjusted at the time of
issue itself. This amount will be debited as ‘loss on issue of debentures’ and credited as ‘Premium
on redemption of debentures’.
2. Discount, Securities Premium, premium at redemption all will be calculated on face value of
debenture.
3. Observe the question carefully , sometime instead of number of debenturestotal face value of
debentures is given like Rs60000, 11% debentures of Rs100 each.
INTEREST ON DEBENTURES
- calculated at a fixed rate on Debenture’s face value.
- usually payable half yearly, or even yearly.
- is paid by the company even in the case of loss (as it is a charge on profit).
When interest is due and Tax is ignored
Debentures Interest A/c Dr. (Gross Interest)
To Debentures holder A/c (Net Interest)
To Income Tax Payable A/c (Income Tax Deducted)
When Interest is paid
Debentureholder A/c Dr. (With Interest)
To Bank A/c
On Transfer of Interest on Debenture to statement of profit and Loss A/c (Tax deducted at source)
Statement of P/L Dr.
To Debenture Interest A/c (Amount of Interest)

WRITING OFF DISCOUNT OR LOSS ON ISSUE OF DEBENTURES

- Discount or Loss on issue of debentures is a capital loss for a company
- is written off in the year it is incurred, i.e, in the year the debentures are allotted from-
a) Securities premium reserve , if it has a balance; OR
b) Statement of profit and loss
Journal entry is
Securities Premium Reserve A/c Dr
Statement of Profit & Loss A/c Dr
To Discount or loss on issue of debentures A/c
(Being the discount or loss on issue of debenture written off)
 PART-B
CHAPTER-8
ANALYSIS OF FINANCIAL STATEMENTS

Meaning of Financial Statements

Financial statements are the basic and formal annual reports through which the corporate management
communicates financial information to its owners and various other external parties which include investors,
tax authorities, government, employees, etc.
Nature of Financial Statements:
1. Recorded Facts
2. Accounting Conventions
3. Postulates
4. Personal Judgments
Uses and Importance of Financial Statements:
1. Report on stewardship function
2. Basis for fiscal policies
3. Basis for granting of credit
4. Basis for prospective investors
5. Guide to the value of the investment already made
6. Aids trade associations in helping their members
7. Helps stock exchanges
Meaning of Financial Statements
Financial statements are the basic and formal annual reports through which the corporate management
communicates financial in forma on to its owners and various other external par es which include investors,
tax authorizes, government, employees, etc.
Nature of Financial Statements:
1. Recorded Facts
2. Accounting Conventions
3. Postulates
4. Personal Judgments
Uses and Importance of Financial Statements:
1. Report on stewardship function
2. Basis for fiscal policies
3. Basis for gran ng of credit
4. Basis for prospective investors
5. Guide to the value of the investment already made
6. Aids trade associations in helping their members
7. Helps stock exchanges
Format of Balance Sheet (in accordance with the manner prescribed in the revised Schedule III to the
Companies Act, 2013-Part I):
NOTE PREVIOUS CURRENT
PARTICULARS No. YEAR YEAR
I. EQUITY AND LIABILITIES XXX XXX
1) Shareholder’s Funds
(a) Share Capital XXX XXX
(b) Reserves and Surplus XXX XXX
(c) Money received against share warrants XXX XXX
2) Share Application money pending
allotment XXX XXX
3) Non-current Liabilities
(a) Long term borrowings XXX XXX
 (b) Deferred tax liabilities (net) XXX XXX
(c) Other long term liabilities XXX XXX
(d) Long term provisions XXX XXX
4) Current Liabilities XXX XXX
(a) Short-term borrowings XXX XXX
(b) Trade payables XXX XXX
(c) Other current liabilities XXX XXX
(d) Short-term provisions XXX XXX
TOTAL XXX XXX
II. ASSETS
1) Non-Current Assets
(a)Property plant ,Equipment& Intangible
assets Property ,plant &Equipments-
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
XXX XXX
(iv) Intangible assets under development
(b) Non-current investments XXX XXX
(c) Deferred tax assets (net) XXX XXX
(d) Long-term loans and advances XXX XXX
(e) Other non-current assets XXX XXX
2) Current Assets XXX XXX
(a) Current investments XXX XXX
(b) Inventories XXX XXX
(c) Trade receivables XXX XXX
(d) Cash and cash equivalents XXX XXX
(e) Short term loans and advances XXX XXX
(f) Other current assets XXX XXX
TOTAL

FORMAT OF STATEMENT OF PROFIT AND LOSS (in accordance with the manner prescribed in the revised
Schedule III to the Companies Act, 2013-Part II):
FORMAT OF STATEMENT OF PROFIT AND LOSS
for the year ended 31 march......
NOTE PREVIOUS
CURRENT YEAR
PARTICULARS No. YEAR
1. Revenue from operation XXX XXX
2.(ADD) Other income XXX XXX
3. Total income (1+2) XXX XXX
4. (LESS) Expenses
Cost of material consumed (XXX) (XXX)
Purchase of stock in trade (XXX) (XXX)
Change in inventories of finished goods (XXX) (XXX)
Work in progress and stock in trade (XXX) (XXX)
Employee benefit expenses (XXX) (XXX)
Finance cost (XXX) (XXX)
 Depreciation and amortization expenses (XXX) (XXX)
Other expenses (XXX) (XXX)
5. Total expenses (XXX) (XXX)
6. Profit before tax (3-5) XXX XXX
7. (LESS) Tax (XXX) (XXX)
8. Profit after tax (6-7) XXX XXX

BALANCE SHEET OF COMPANY

MAIN HEADS SUB HEADS ITEMS INCLUDED
I. EQUITY AND
LIABILITIES
1.SHAREHOLDER'S FUND SHARE CAPITAL AUTHORISED CAPITAL
ISSUED CAPITAL
SUBSCRIBED CAPITAL
CALL IN AREARS
SHARE FOR FEITURE A/C
RESERVE AND SUPLUS CAPITAL RESERVES
GENERAL RESERVES
CAPITAL REDUMTION RESERVES
SECURITIES PRIMIUM RESERVES
DEBENTURES REDUMPTION RESERVES
SHARE OPTION OUTSTANDING A/C
OTHER RESERVES
SURPLUS i.e, BALANCE IN STATEMENT OF PROFIT AND LOSS
THIS ARE FINANCIAL INSTRUMENT WHICH GIVES RIGHT TO ACQIURE
MONEY RECEIVED AGAINST SHARE WARRANT EQUALITY SHARE AT A SPECIFIED DATE AND AT A SPECIFIED RATE
2.SHARE APPLICATION IT MEANS AMOUNT REQUIRED BY THE COMPANY TOWARD SHARE
MONEY APPLICATION AND AGAINST WITH THE COMPANY WILL CAN NOT ALLOT SHARES
PENDING ALLOTMENT
3.NON CURRENT LONG TERM BORROWINGS DEBENTURE
LIABILITIES BONDS
PUBLIC DEPOSITE
OTHER LONG TERM LOANS (More Than12 MONTHS/1YEARS)
DEFERED TAX LIABILITIES ACCOUNTING INCOME - TAXABLE INCOME
OTHER LONG TERM LIABILITIES PREMIUM ON REDUMPTION OF (REPAYMENT) DEBENTURE
PREMIUM ON REDUMPTION OF PREFERENCE SHARE
LONG TERM PROVISION PROVISION FOR GRATUITY
PROVISION FOR GRATUITY
PROVISION FOR PROVIDENT FUND
4.CURRENT LIABILITIES SHORT TERM BORROWING BANK OVERDRAFT
CASH CREDIT
LOAN REPAYABLE ON DEMAND
TRADE PAYABLES CREDITORS
BILL PAYABLES
OTHER CURRENT LIABILITIES OUTSTANDING INTEREST
OUTSTANDING EXPENSES
UNPAID DIVIDENDS
CALLS IN ADVANCE
OUTPUT SGST,CGST,IGST
SHORT TERM PROVISION PROVISION FOR TAX
PROVISION FOR DOUBTFULL DEBTS AND DEPRECIATION
PROVISION FOR EMPLOYEES BENEFITS

II. ASSESTS Property, Plant ,Equipments& TANGIBLE ASSETS

INTANGIBLE ASSETS
1.NON CURRENT ASSETS Intangible assets GOODWILL
TRADE MARK
COPYRIGHT
CAPITAL WORK IN PROGESS
INTANGIBLE ASSETS UNDER DEVELOPMENT
NON CURRENT INVESTMENTS INVESTMENT IN EQUITY, PREFERENCE SHARE OF OTHER COMPANY
INVESTMENT IN GOVERNMENT BONDS AND SECURITIES
MUTTUAL FUNDS (MORE THAN 12 MONTHS)
DEFFERED TAX ASSETS TAXABLE INCOME -ACCOUNTING INCOME
LONG TERM LOANS AND ADVANCES CAPITAL ADVANCES
SECURITY DEPOSITE FOR ELECTRICITY,TELEPHONE
OTHER NON CURRENT ASSETS PREPAID EXPENSES
 ACCRUED INCOME
2.CURRRENT ASSETS CURRENT INVESTMENTS INVESTMENT FOR LESS THAN 12 MONTHS
INVENTORIES RAW MATERIAL
WORK IN PROGRESS
STOCK OF FINISHED GOOD
STOCK IN TRADE
STORES AND SPARES
LOSS TOOLS
TRADE RECEIVABLES DEBTORS
BILLS RECEIVEABLES
CASH AND CASH EQUILANTS CASH AT BANK
CASH IN HAND
MARGIN MONEY
CHEQUE AND DRAFT IN HAND
SHORT TERM LOANS AND ADVANCES ADVANCES TO EMPLOYEES
OTHER CRRRENT ASSETS PREPAID EXPENSESS
ADVANCE TAXES
DIVIDENDS RECEIVABLES
ACCRUED INTEREST

Meaning of Analysis of Financial Statements:

The process of critical evaluation of the financial information contained in the financial statements in order
to understand and make decisions regarding the operations of the firm is called „Financial Statement
Analysis‟.
Significance/Importance of Analysis of Financial Statements:

(a) Finance manager

(b) Top management
(c) Trade payables
(d) Lenders
(e) Investors
(f) Labour unions
(g) Others
Objectives of Analysis of Financial Statements:

• to assess the current profitability and operational efficiency of the firm as a whole as well as its
different departments so as to judge the financial health of the firm.
• to ascertain the relative importance of different components of the financial position of the firm.
• to identify the reasons for change in the profitability/financial position of the firm.
• to judge the ability of the firm to repay its debt and assessing the short-term as well as the long-term
liquidity position of the firm.

Limitations of Financial Statement Analysis:

1. Financial analysis does not consider price level changes.

2. Financial analysis may be misleading without the knowledge of the changes in accounting procedure
followed by a firm.
3. Financial analysis is just a study of reports of the company.
4. Monetary information alone is considered in financial analysis while non-monetary aspects are ignored.
5. The financial statements are prepared on the basis of accounting concept, as such, it does not reflect the
current position.
Tools of Analysis of Financial Statements:
1. Comparative Statements: These are the statements showing the profitability (statement of profit and loss)
and financial position(balance sheet) of a firm for different periods of time in a comparative form to give an
idea about the position of two or more periods. This analysis is also known as ‘horizontal analysis’.
2. Common Size Statements: These are the statements which indicate the relationship of different items of a
financial statement with a common item by expressing each item as a percentage of that common item.
Common size statements are useful, both, in intra-firm comparisons over different years and also in making
inter-firm comparisons for the same year or for several years. This analysis is also known as ‘Vertical
analysis’.
3. Trend Analysis: It is a technique of studying the operational results and financial position over a series of
years. Using the previous years‟ data of a business enterprise, trend analysis can be done to observe the
percentage changes over time in the selected data.
4. Ratio Analysis: It describes the significant relationship which exists between various items of a balance
sheet and a statement of profit and loss of a firm. As a technique of financial analysis, accounting ratios
measure the comparative significance of the individual items of the income and position statements. It is
possible to assess the profitability, solvency and efficiency of an enterprise through the technique of ratio
analysis.
5. Cash Flow Analysis: It refers to the analysis of actual movement of cash into and out of an organisation.
The flow of cash into the business is called as cash inflow or positive cash flow and the flow of cash out of
the firm is called as cash outflow or a negative cash flow. The difference between the inflow and outflow of
cash is the net cash flow.

Comparative Statement:
These statements refer to the statement of profit and loss and the balance sheet prepared by providing
columns for the figures for both the current year as well as for the previous year and for the changes during
the year, both in absolute and relative terms.
 The figures in the comparative statements can be used for identifying the direction of changes and
also the trends in different indicators of performance of an organisation.
The following steps may be followed to prepare the comparative statements:
Step 1: List out absolute figures in rupees relating to two points of time (as shown in columns 2 and 3).
Step 2: Find out change in absolute figures by subtracting the first year (Col.2) from the second year (Col.3)
and indicate the change as increase (+) or decrease (–) and put it in column 4.
Step 3: Preferably, also calculate the percentage change as follows and put it in column 5.
Absolute Increase or Decrease (Col.4)/ First year absolute figure (Col.2) × 100
Comparative Balance Sheet as at 31st March, 20.....
Particulars Previous Current Absolute Percentage
Year Year Increase (+) Increase (+) or
or Decrease Decrease (–)
(–)
1 2 3 4 5(%)
I. EQUITY AND LIABILITIES
1) Shareholder’s Funds
(a) Share Capital
(b) Reserves and Surplus
(c) Money received against share
warrants
2) Share Application money pending
allotment
3) Non-current Liabilities
(a) Long term borrowings
(b) Deferred tax liabilities (net)
(c) Other long term liabilities
(d) Long term provisions
4) Current Liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
Total
II. ASSETS
1) Non-Current Assets
(a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets
2) Current Assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short term loans and advances
(f) Other current assets
Total

Comparative Statement of Profit and Loss for the year ended ______________
Particulars First Second Absolute Percentage
Year Year Increase (+) Increase (+) or
or Decrease Decrease (–)
(–)
1 2 3 4 5(%)
I Revenue from operations
II Other income
III Total Revenue (I+II)
IV Expenses:
Cost of materials consumed
Purchases of stock-in-trade
Changes in inventories of finished goods
Work-in-progress and stock-in-trade
Employee benefits expense
Finance costs
Depreciation and amortisation expense
Other expenses
Total expenses
V Profit before tax(III-IV)
VI Tax
VII Profit after tax(V-VI)

Common Size Statement:

Common Size Statement, also known as component percentage statement, is a financial tool for studying
the key changes and trends in the financial position and operational result of a company.
Here, each item in the statement is stated as a percentage of the aggregate, or revenue from operations of
which that item is a part. For example, a common size balance sheet shows the percentage of each asset to
the total assets, and that of each liability to the total liabilities. Similarly, in the common size statement of
profit and loss, the items of expenditure are shown as a percentage of the revenue from operations.
 Inter-firm comparison or comparison of the company‟s position with the related industry as a whole
is possible with the help of common size statement analysis.
The following procedure may be adopted for preparing the common size statements.
1. List out absolute figures in rupees at two points of time, say year 1, and year 2 (Column 2 &4 ).
2. Choose a common base (as 100). For example, revenue from operations may be taken as base (100) in
case of statement of profit and loss and total assets or total liabilities (100) in case of balance sheet.
3. For all items of Col. 2 and 3 work out the percentage of that total. Column 4 and 5 shows these
percentages.
Particulars First Year Second Year Percentage of Percentage of
Year 1 Year 2
1 2 3 4 5
% %

Common Size Balance Sheet as at 31st March, 20.....

Particulars Previous Current Percentage Percentage of
Year Year of Year 1 Year 2
1 2 3 4(%) 5(%)
I. EQUITY AND LIABILITIES
1) Shareholder’s Funds
(a) Share Capital
(b) Reserves and Surplus
(c) Money received against share
warrants
2) Share Application money pending
allotment
3) Non-current Liabilities
(a) Long term borrowings
(b) Deferred tax liabilities (net)
(c) Other long term liabilities
(d) Long term provisions
4) Current Liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
Total
II. ASSETS
1) Non-Current Assets
(a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets
2) Current Assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short term loans and advances
(f) Other current assets
Total
Common Size Statement of Profit and Loss for the year ended _____________
Particulars Previous Current Percentage Percentage of
Year Year of Year 1 Year 2
1 2 3 4(%) 5(%)
I Revenue from operations
II Other income
III Total Revenue (I+II)
IV Expenses:
Cost of materials consumed
Purchases of stock-in-trade
Changes in inventories of finished goods
Work-in-progress and stock-in-trade
Employee benefits expense
Finance costs
Depreciation and amortisation expense
Other expenses
Total expenses
V Profit before tax(III-IV)
VI Tax
VII Profit after tax(V-VI)

PREVIOUS YEARS’ CBSE QUESTIONS

Q.1 Under which major headings and subheadings will the following items be presented in the Balance
Sheet of a company as per Schedule III, Part I of the Companies Act, 2013?
(i) Calls in arrears (ii) Calls in advance (iii) Loose tools and Spare Parts
(iv) Drafts / Cheques in hand (v) Unpaid/ Unclaimed Dividend (vi) Capital Reserve
Q.2 Under which major headings and subheadings will the following items be presented in the Balance
Sheet of a company as per Schedule III, Part I of the Companies Act, 2013?
(i) Prepaid Rent (ii) Mortgage Loan (iii) Computer Software
(iv) Public Deposits (v) Income received in advance (vi) Patents
Q.3 Explain briefly any three objectives of „Analysis of Financial Statements‟.
(Hint: To assess the current Profitability and Operational efficiency, To ascertain the relative
importance of different components of the financial position, To identify the reasons for change in the
profitability/financial position or To judge the ability of the firm to repay its debt)
Q.4 Prepare a Comparative &Common-Size Statement of Profit and Loss of „Shyam Ltd.‟ from the
following information:
Particulars Note 2022 – 23 2021 − 22
No. (Rs.) (Rs.)
1.Revenue from operations 20,00,000 10,00,000
2. Purchase of Stock in Trade 7,70,000 4,20,000
3. Changes in Inventories 1,20,000 80,000
4. Other expenses 52,000 30,000
5. Other incomes 60,000 50,000
Tax Rate 50%
(Hint: 2022-23- 100%, 3%, 103%, 38.5%, 6%, 2.6%, 47.1%, 55.9%, 27.95%, 27.95%
2021-22- 100%, 5%, 105%, 42%, 8%, 3%, 53%, 52%, 26%, 26%)
CHAPTER-9
ACCOUNTING RATIOS
MEANING: Accounting ratios represent relationship between two accounting numbers.
OBJECTIVES OF RATIO ANALYSIS
● To simplify the accounting information
● To determine the liquidity (short term and long-term financial obligations)
● To assess the operational efficiency of the business
 ● To analyse the profitability of the business
● To help in comparative analysis (inter firm and intra firm comparisons)
ADVANTAGES OF RATIO ANALYSIS
● Useful tool for analysis of financial statements
● Simplifies accounting data.
● Useful for forecasting
● Useful in inter firm and intra firm comparison.
● Useful in locating the weak areas.
● Useful in assessing the operational efficiency of business.
TYPES OF RATIO ANALYSIS
1. LIQUIDITY RATIO
2. SOLVENCY RATIO
3. ACTIVITY (OR TURNOVER) RATIO
4. PROFITABILITY RATIOS

1. LIQUIDITY RATIOS
Liquidity ratios are calculated to measure the short-term solvency of the business.
TYPES:
1. Current ratio: Current ratio is the proportion of current assets to current liabilities.
Ideal ratio is 2:1.
Current Ratio =
Current assets include current investments, inventories, trade receivables (debtors and bills receivables less
provision), cash and cash equivalents (cash in hand, cash at bank, cheques/drafts), short-term loans and
advances and other current assets such as prepaid expenses, advance tax and accrued income, etc.
Current liabilities include short-term borrowings (bank overdraft), trade payables (creditors and bills
payables), other current liabilities (outstanding expenses, calls in advance, received in advance) and short-
term provisions.
Significance: A very high current ratio implies heavy investment and A low ratio endangers
2. LIQUID RATIO/QUICK RATIO/ACID TEST RATIO: This ratio establishes relationship between
liquid assets and current liabilities. Ideal ratio is 1:1
Quick Ratio =
Quick Assets = Current Assets – (Prepaid expenses + Closing Stock)
Significance:
A low ratio will be very risky, and a high ratio suggests unnecessarily deployment of resources in otherwise
less profitable short-term investments.
FORMULAES:
● Current assets = Total assets – fixed assets – noncurrent investment
● Current liabilities = Total debts – long term debts
● Liquid assets = Current assets – inventory-prepaid expenses
● Working capital = Current assets – current liabilities
● Current liabilities = Trade payables + other current liabilities
● Current liabilities = Total assets – capital employed
● Current assets = Capital employed + current liabilities – fixed assets

2. SOLVENCY RATIOS:
Solvency ratios are calculated to determine the ability of the business to service its debt.
TYPES:
1. Debt-Equity Ratio: Debt-Equity Ratio measures the relationship between long-term debt and
equity. Ideal ratio is 2:1.
Debt-Equity Ratio =
Significance:
● A high debt to equity means that the firm is depending more on borrowings as to shareholders
funds. So, lenders are at higher risks and have lower safety.
● A low ratio means that the firm is depending more on shareholders‟ funds than borrowings. So,
lenders are at a lower risk and have higher safety. A low ratio reflects more security.

2. Proprietary Ratio: Proprietary ratio expresses relationship of proprietor‟s (shareholders) funds to

net assets.
Proprietary ratio =
Significance:
● A high ratio means adequate safety for unsecured lenders and creditors.
● A low ratio indicates greater risk to unsecured lenders and creditors and the firm getting benefit of
trading on equity.

3. Total Assets to Debt Ratio: This ratio measures the extent of the coverage of long-term debts by
assets.
Total Assets to Debt Ratio =
Significance: The higher ratio indicates that assets have been mainly financed by owner‟s funds and the
long-term is adequately covered by assets.
Capital employed = Total Assets – Current Liabilities
4. Interest Coverage Ratio: It is a ratio which deals with the servicing of interest on loan.
Interest Coverage Ratio =
FORMULAES:
● Net Profit before charging interest and Tax = Profit after interest and Tax + Tax + Interest
● Fixed interest charges = Interest on Debentures and Long-Term Loans.
Significance: A higher ratio ensures safety of interest on debts.
5. Debt to Capital Employed Ratio: The Debt to capital employed ratio refers to the ratio of long-
term debt to the total of external and internal funds (capital employed or net assets).

Debt to Capital Employed Ratio = Long-term debts

Capital employed (Net Assets)
Significance: Like debt-equity ratio, it shows proportion of long-term debts in capital employed. Low
ratio provides security to lenders and high ratio helps management in trading on equity.

FORMULAES:
● Capital employed = Shareholders‟ funds + Long-term debts (or Non-current liabilities)
● Capital employed ( Net assets ) = Total assets – Current liabilities
Or = Non-current assets + Net working capital
● Debt to Capital Employed Ratio can also be computed in relation to total assets
● Total debts = Long-term debts + Current liabilities
● Total assets = Non-current assets + Current assets
(Or shareholders‟ funds + long-term debts + current liabilities).

3. ACTIVITY (OR TURNOVER) RATIO:

These ratios indicate the speed at which, activities of the business are being performed.
1. Inventory Turnover Ratio: It determines the number of times inventory is converted in to revenue
from operations.
 Inventory Turnover Ratio =

FORMULAES:
● Cost of revenue from operations: = Revenue from operations – Gross profit (Or)
● RevenueA from operations + gross loss (Or)
● Opening inventory + net purchases + direct expenses – closing inventory
● Average inventory = opening inventory + closing inventory
2
Significance: Lower ratio is danger and higher ratio is good.

2. Trade Receivables Turnover Ratio:It expresses the relationship between credit revenue from
operations and trade receivable. Higher turnover means speedy collection from trade receivable.
Trade Receivables Turnover Ratio =
FORMULAES:
● CREDIT REVENUE FROM OPERATIOINS: = CREDIT SALES – SALES RETURN
(OR)
● REVENUE FROM OPEATIONS –CASH REVENUE FROM OPERATIONS
● AVERAGE TRADE RECEIVABLES: OPENING DRS + b/R + CLOSING DRS+
B/R
2
● DEBT COLLECTION PERIOD: 365 (IN DAYS)
TRADE RECEIVABLES TURNOVER RATIO (OR)
12 (IN MONTHS)

TRADE RECEIVABLES TURNOVER RATIO

Significance: A high ratio is better since it shows that debts are collected more promptly. A lower ratio
shows inefficiency in collection or increased period and more investment in debtors than required.

3. Trade Payable Turnover Ratio: Trade Payables turnover ratio indicates the pattern of payment of
trade payable.
Trade Payable Turnover Ratio =
Significance: Lower ratio means credit allowed by the supplier is for a long period.
FORMULAES:
AVERAGE TRADE PAYABLES: OPENING CRS + B/P + CLOSING CRS + B/P
2
AVERAGE PAYMENT PERIOD: AVERAGE TRADE PAYABLES x No: Of months / days
Net credit purchases
(Or)Months or days in a year
Trade payables turnover ratio
4. Working capital Turnover Ratio:It shows the relationship between working capital and revenue
from operations. It shows the no. of times a unit of rupee invested in working capital produces Sales.

Working Capital Turnover Ratio =

Significance: A high ratio shows efficient use of working capital. A low ratio shows inefficient use of
working capital.
FORMULAES:
● working capital = current assets – current liabilities

5. Net Assets Turnover Ratio (or Capital Employed Turnover Ratio) :It reflects relationship
between net revenue from operations and net assets (capital employed) in the business. Higher
turnover means better activity and profitability.
Net Assets Turnover Ratio (or Capital Employed Turnover) =
FORMULAES:
● Net Assets / Net Capital Employed = Shareholders Fund + Long Term Debt
● Net Fixed Assets + Net Working Capital
Significance: High turnover of net assets (or capital employed) is a good sign and implies efficient
utilization of resources resulting in higher liquidity and profitability in the business.

6. Fixed Assets Turnover Ratio: It reflects relationship between net revenue from operations and net
fixed assets of the business. Higher turnover means better activity and profitability.

Fixed Assets Turnover ratio =Net Revenue from Operations

Net Fixed Assets
Significance: High turnover of fixed assets is a good sign and implies efficient utilisation of resources
resulting in higher liquidity and profitability in the business.
4. PROFITABILITY RATIOS:
“Profitability” refers to financial performance of the business.

1. Gross Profit Ratio:Gross profit ratio as a percentage of revenue from operations is computed to find
out gross margin. Higher gross profit ratio is always a good sign.
Gross Profit Ratio =
FORMULAES:
● Gross Profit = Revenue from operations – Cost of Revenue from operations)
● Cost of Revenue from Operation = Revenue from Operations–Gross Profit
● Opening Inventory + Net Purchases + Direct Expenses (Assume to be given)
– Closing Inventories
● Cost of materials consumed + purchase of stock- in-trade + change in
● Inventory (Finished Goods; Work in Progress & Stock-in-trade) + Direct Expenses

Significance: Higher gross profit ratio is always a good sign.

2. Operating Ratio: Operating ratio establishes the relationship between operating cost (cost of
revenue from operations + operating expenses) and revenue from operation

Operating Ratio =
● Cost of Revenue from Operations = Cost of Materials Consumed + Purchases of Stock-in- trade
+ Change in Inventories of Finished Goods, Work-in-progress and Stock in-trade + Direct
Expenses Or
● Revenue from Operations – Gross Profit.
● Operating Expenses = Employees Benefits Expenses + Other Expenses (Other than non-
operating expenses) + Depreciation and Amortization Expenses Or
● Office expenses, administrative expenses, selling and distribution expenses, employees benefit
expenses, depreciation and amortization expenses.
● Operating Cost = Cost of Materials Consumed + Purchases of Stock-in-trade + Change in
Inventories of Finished Goods, Work-in-progress and Stock-in-trade + Employees Benefits
Expenses + Other Expenses (Other than non-operating expenses)
Significance: Lower operating ratio is better because it leaves higher profit margin to meet non-
operating expenses, to pay dividend etc. A rise in the operating ratio indicates decline in efficiency.

3. Operating Profit Ratio: Operating profit ratio measures the relationship between operating profit
and revenue from operations.
 Operating Profit Ratio = 100 – Operating Ratio

Operating Profit Ratio = 100

FORMULAES:
● Operating Profit = Gross profit + Other Operating Income - Other Operating Expenses Or
● Net Profit (before tax) + non- Operating Expenses/Losses - Non - Operating Incomes Or
● Revenue from Operations - Operating Cost
Significance: Lower operating ratio is a very healthy sign.

4. Net Profit Ratio: Net profit ratio establishes the relationship between net profit and revenue from
operations.

Net Profit Ratio =

● Net Profit = Revenue from operations - Cost from Revenue from Operations - Operating
Expenses - Non- operating Expenses + Non-operating Income – Tax
Generally, Net Profit refers to Profit after Tax (PAT).
Significance: Higher the ratio, better the business.

5. Return on Capital Employed or Investment (ROCE or ROI): ROI shows the relationship of
profit (profit before interest and tax) with capital employed. This ratio assesses overall performance
of the enterprise.

Return on Capital Employed =

FORMULAES:
● Capital employed = Shareholders‟ funds + Long-term debts (or Non-current liabilities)
● Capital employed ( Net assets ) = Total assets – Current liabilities
Or = Non-current assets + Net working capital
● Debt to Capital Employed Ratio can also be computed in relation to total assets
● Total debts = Long-term debts + Current liabilities
● Total assets = Non-current assets + Current assets
(Or shareholders‟ funds + long-term debts + current liabilities).
Significance: It measures return on capital employed in the business.
Previous years’ CBSE questions:
MCQ:
1. Determine stock turnover ratio if, Opening stock is Rs 31,000, closing stock is Rs 29,000, Sales is Rs
3, 20,000 and Gross profit ratio is 25% on sales.
a. 31 times
b. 11 times
c. 8 times
d. 32 times

1. Working Capital Rs. 36,000; Current Ratio 2.8:1; Inventory Rs. 16,000. CalculateCurrent Assets,
Current Liabilities and Quick Ratio.
2. Current Assets of a company are Rs. 15, 00,000. Its current ratio 2.5 and liquid RatioIs 0.85.
Calculate Current liabilities, Liquid Assets and Inventory.
3. The Quick ratio of M Ltd. Is 1:1. State with reason which of the followingTransactions would (i)
increase; (ii) decrease or (iii) not change the ratio:
1. Included in the trade payable was a Bill payable of Rs. 3,000 which was met onMaturity.
2. Debentures of Rs. 50,000 were converted into Equity Shares.
4. Calculate Interest Coverage Ratio from the following information:
Net Profit (after taxes) = Rs. 1, 00,000
 Fixed interest charges on long term borrowing = Rs. 20,000
Rate of Income Tax 50%
5. From the following information calculate interest coverage ratio:
Rs.10, 000 equity shares to Rs. 10 each 1, 00,000
8% Preference Shares 70,000
10% Debentures 50,000
Long term Loans from Banks 50,000
Interest on longs term loans from bank 5,000
Profit after tax 75,000
Tax 9,000
6. For the following information compute Debt-Equity Ratio :
Long term borrowing Rs. 8, 00,000
Long term provisions Rs. 4, 00,000
Current Liabilities Rs. 2, 00,000
Non-Current Assets Rs.14, 40,000
Current Assets Rs.3, 60,000
7. Calculate the following ratio on the basis of following information:
(i) Gross Profit Ratio (ii) Working Capital Turnover ratio (iii) Acid Test Ratio (iv) Inventory Turnover Ratio
(v) Fixed Assets Turnover Ratio
Gross Profit Rs. 50,000, Revenue from Operations Rs. 1,00,000, Inventory Rs. 15,000, Trade Receivables
Rs. 27,500, Cash and Cash Equivalents Rs. 17,500, Current Liablilites Rs. 40,000, Land & Building Rs.
50,000, Plant & Machinery Rs. 30,000, Furniture Rs. 20,000
(Hint: (i) 50% (ii) 5:1 (iii) 1.1:1 (iv) 3.33 Times (v) 1:1
8. Rehan Ltd. has shown the following details about the financial year 2022-23:
Trade Receivable turnover ratio 3 times; Cost of Revenue from Operations Rs. 4,80,000; Gross profit
ratio 20%; Closing trade receivables were Rs. 50,000 more than opening trade receivables; cash
revenue from operations being 33 1/3 % of credit revenue from operations.
Based on the above information, answer the following:
(i) Value of Revenue from operations:
(a) Rs.6,00,000 (b) Rs.5,40,000(c) Rs.5,60,000 (d) None of the above
(ii) Value of Credit Revenue from operations:
(a) Rs.6,00,000 (b) Rs.4,50,000(c) Rs.5,00,000 (d) None of the above
(iii) Value of Opening Trade Receivables:
(a) Rs. 1,25,000(b) Rs. 1,50,000(c) Rs. 1,75,000 (d) None of the above
(iv) Value of Closing Trade Receivables:
(a) Rs. 1,25,000(b) Rs. 1,50,000(c) Rs. 1,75,000 (d) None of the above
Answer: (i) (a) Rs.6,00,000 (ii) (b) Rs.4,50,000 (iii) (a) Rs. 1,25,000 (iv) (c) Rs.1,75,000
 CHAPTER-10
CASH FLOW STATEMENTS

Meaning: Cash Flow Statement It is a statement that shows flow of cash and cash equivalents during the
period under report. The statement shows net increase or decrease of cash and cash equivalents under each
activity separately- operating, investing and financing as well as collectively.

Objectives of CFS:
 To ascertain the sources (receipts) of cash and cash equivalents under operating, investing and
financing activities by the enterprise.
 To ascertain applications (payments) of cash and cash equivalents under operating, investing and
financing activities by the enterprise.
 To ascertain net change in cash and cash equivalents being the difference between sources and
applications under the three between the dates of two balance sheets.

Steps in the preparation of CFS:

a) Ascertain cash flows from operating activities
b) Ascertain cash flows from investing activities
c) Ascertain cash flows from financing activities
d) Steps I, II AND III are added and the resultant figure is net increase or decrease in
cash and cash equivalents.
e) Cash and cash equivalents of the beginning are added to the cash flow arrived under
step IV.
f) In the last we get cash and cash equivalents at the end.

Terms used in Cash Flow Statement

Definition of Key Terms used in Cash Flow Statement:

CASH AND CASH EQUIVALENTS:
Cash: It includes Cash in hand and demand deposits with banks.
Cash Equivalents: It includes highly liquid short-term investments that are readily convertible into
cash and that are subject to an insignificant risk of change in value. It includes treasury bills,
commercial papers, current investments and preference shares if these are redeemable within 3
months from the date of purchase and if they do not have any significant risk of change in its value.
D ISCLOSURE IN CASH FLOW STATEMENT:
Cash and Cash Equivalent is calculated as: Rs
Cash in Hand …
Add: Cash at Bank …
Add: Cheques and Drafts on Hand …
Add: Short-term Investments (Marketable Securities) …
Add: Short-term Deposits in Banks …
Cash and Cash Equivalents …

Classification of Cash Flows as per Accounting Standard-3 (Revised): This standard on Cash
Flow Statement requires that all the inflows and outflows of the cash and cash equivalent during a
particular period should be classified under 3 different heads as per the nature of transactions. These 3
heads are explained as follows:
(a) Operating Activities: These are the principal revenue generating activities of an entity. It
includes all non-investing and non-financing activities. In a cash flow statement, net effect of all the
inflows and outflows from operating activities is shown as Cash Flow from (or used in) Operating
Activities.
Following is the list of operating activities for:
Financial Companies: It includes all transactions related to:
(a) Purchase of securities;
(b) Sale of securities;
(c) Interest on loans granted;
(d) Interest on loans taken;
(e) Dividends on securities;
(f) Salaries, bonus and other employee benefits paid to employees;
(g) Income tax paid and income tax refund received (unless such amounts are identified with investing
or financing activities).
Non-Financial Companies: It includes all transactions related to:
(a) Purchase of goods and/or availing of services;
(b) Sale of goods and/or rendering of services;
(c) Amounts received from trade receivables;
(d) Amounts paid to trade payables;
(e) Royalties, fees and commission, etc.;
(f) wages, salaries and other employee benefits paid to the workers and employees;
(g) payment of claims and receipt of premium (in case of Insurance Companies)
(h) Income tax paid and income tax refund received (unless such amounts are identified with investing
or financing activities).
Investing Activities: These include all activities related to the acquisition and disposal of Long-term
Assets and other investments which are not classified as cash equivalents. Following is the list of
investing activities:
(a)Purchase of fixed assets;
(b) Sale or disposal of fixed assets;
(c)Purchase of securities (in case of non-financial companies);
(d) Sale of securities (in case of non-financial companies);
(e)Loans and advances made to third parties (otherthanthosemadebyafinancial enterprise)
(f) Repaymentsreceivedfromloansandadvancesmadetothirdparties(otherthan those made by a financial
enterprise)

Financing Activities: These are those activities that change the size and composition of the owner‟s
capital (i.e., Equity and Preference Share Capital in case of a company) and borrowings of the
enterprise.
Following is the list of financing activities:
(a)Issue of shares or other similar instruments;
(b) Issue of debentures, loans, bonds, and other short-term borrowings;
(c)Changes in bank overdraft and cash credit;
(d) buy-back of equity shares;
(e)Repayment of borrowings including redemption of debentures;
(f) Dividends on both equity and preference shares;
(g) Interest on debentures and loans (both short and long-term loans).

Transactions not regarded as Cash Flow: These are the transactions that are mere movements in
between the items of Cash and Cash Equivalents. This includes cash deposited in bank, cash
withdrawn from the bank and purchase or sale of marketable securities.
Non- cash transactions: These are the transactions in which the in flow or out flow of Cash or Cash
Equivalent does not take place. Therefore, these non-cash transactions are not considered while
preparing the Cash Flow Statements. These transactions include depreciation, amortisation, issue of
bonus, etc.

TYPES OF BUSINESSES AND IMPACT ON C ASH FLOW:

Financial Enterprise: An enterprise that basically deals in lending (advancing loans) and borrowingof
funds (accepting deposits),such as Banks.
Non-Financial Enterprise: An enterprise that basically deals in areas other than finance (purchase
of raw material and sale of goods).
For an activity to be classified as „Operating‟ or „not‟ focus, Nature of Business is guiding factor,
i.e. Core Business Activity of the business.

Classification of Lending and Borrowing Functions

Functions Advancing Loans Accepting deposit from public
Business Activity Interest Dividend received Interest Dividend Paid
received paid
Trading or Non- Investing Investing Activity Financing Financing Activity
Financial Enterprise Activity Activity
Financial enterprise Operating Operating activity Operating Financing Activity
activity activity Paid on capital
raised from external
sources
CASH FLOW STATEMENT(ACCOUNTING SATANDARD-3)FOR THE YEAR ENDED
Particulars Amount
A. Cash flow from operating
activities Surplus i.e. balance in
statement of P/L (current year) XXX
(-) Surplus i.e. balance in statement of P/L (previous year) (XXX)
Net profit / loss after tax and extraordinary item XXX
(+) Apropriation
i. Proposed dividend (previous year) XXX
ii. Interim dividend XXX
iii. Provision for tax XXX
iv. Transfer to general reserve XXX XXX
(+) Extraordinary items
i. Loss due to earthquake XXX
ii. Loss of stock due to fire XXX XXX
(-) Extraordinary items
i. Insurance claim received (XXX)
ii. Compensation of loss due to earthquake (XXX)
iii. Refund of tax (XXX)
Net profit before tax and extraordinary item XXX
(+) Non cash and non-operating expenses
i. Depreciation on tangible fixed assets XXX
ii. Amortisation of intangible assets XXX
iii. Loss on sale of fixed assets XXX
iv. Interest on debenture / long term borrowings XXX
v. Premium on redemption of debentures / preference XXX
share
vi. Preliminary expenses written off XXX XXX
(-) Non-operating income
i. Interest received on investment (XXX)
ii. Rent received (XXX)
iii. Profit on sale of fixed assets (XXX)
iv. Dividend received on investments (XXX) (XXX)
Operating profit before changes in working capital XXX
(+) Increase in current liabilities / Decrease in current
assets
i. Trade payable ( creditors and bills payable) XXX
ii. Outstanding expenses XXX
iii. Outstanding interest XXX
iv. Advance received XXX
v. Inventory XXX
vi. Trade receivables ( debtors and bills receivables) XXX
vii. Prepaid expenses XXX
viii. Accured income XXX XXX
(-) decrease in current liabilities / Increase in current assets
i. Trade payables (XXX)
ii. Outstanding expenses (XXX)
iii. Inventory (XXX)
iv. Trade receivables (XXX)
v. Prepaid expenses (XXX)
vi. Accrued income (XXX) (XXX)
(+) Refund on tax XXX

(+) Extraordinary item XXX

i. Insurance claim received XXX
ii. Compensation for earthquake received XXX XXX
(-) Extraordinary items
i. Loss due to fire (XXX)
ii. Loss due to earthquake (XXX)
(-) Tax paid (XXX)
Net cash inflow / used from the operating activities XXX
B. Cash flow from investing activities
(Add)
i. Sale of fixed assets XXX
ii. Sale of non-current investments XXX
iii. Long term loans and advances (decrease) XXX
iv. Short term loans and advances XXX
v. Rent received XXX
vi. Dividend received XXX
vii. Interest received XXX XXX
(Less)
i. Purchase of fixed assets (tangible) (XXX)
ii. Purchase of fixed assets (intangible) (XXX)
iii. Purchase of non-current investments (XXX)
iv. Long term loans and advances (increase) (XXX)
v. Short term loans and advances (increase) (XXX) (XXX)
Net cash inflow / used from investing activities XXX
 C. Cash flow from financing activities
(Add)
i. Issue of preference share capital / equity share capital XXX
ii. Issue of debentures XXX
iii. Securities premium reserve XXX
iv. Long term borrowings and loans raised XXX
v. Short term borrowings raised (bank overdraft and cash XXX XXX
credit)
(Less)
i. Redemption of preference share (decrease) (XXX)
ii. Redemption of debentures (decrease) (XXX)
iii. Payment of long term loans and borrowings (XXX)
iv. Payment of short term borrowings (decrease) (XXX)
v. Interest on debentures paid (XXX)
vi. Interest on long term borrowings and loans (XXX)
vii. Proposed dividend paid (previous year) (XXX)
viii. Interim dividend paid (current year) (XXX)
ix. Premium on redemption of debentures and preference (XXX) (XXX)
shares
Net cash inflow / used from financing activities XXX

D. Cash and cash equivalants (Increase / Decrease) XXX

E. Cash and cash equivalents (Previous year) XXX
F. Cash and cash equivalents (Current year) XXX

DR PROVISION FOR TAXATION A/C CR

PARTICULARS AMOUNT PARTICULARS AMOUNT (RS)

(RS)
TO BANK (TAX PAID ) BY BALANCE B/D
TO BALANCE C/D BY P & L A/C
( PROVISION DURING THE
YEAR)

PROVISION FOR DEPRECIATION A/C

DR. CR
PARTICULARS AMOUNT (RS) PARTICULARS AMOUNT (RS)
TO FIXED ASSETS A/C BY BALANCE B/D
(DEP. ON ASSETS BY P & L A/C
SOLD) ( PROVISION DURING THE
TO BALANCE C/D YEAR)

FIXED ASSETS A/C

DR. CR
PARTICULARS AMOUNT PARTICULARS AMOUNT
(RS) (RS)
TO BALANCE B /D A/C BY BANK A/C ( ASSETS SOLD )
(BALANCE OF PREVIOUS BY P & L A/C
 YEAR) ( LOSS ON SALE OF ASSETS)
TO P & L A/C By Depreciation A/c
( PROFIT ON SALE OF (Dep. on assets Sold)
ASSETS ) By Balance c/d (Balance of Current
TO BANK A/C (PURCHASE Year)
PRICE)
CASH FLOW STATEMENT PRACTICEQUESTIONS
QN QUESTIONS M
1 Which of the following will result in flow of cash? 1
(a) Cash withdrawn from the bank ₹50,000
(b) ₹2,00,000, 9% debentures issued to vendors of machinery
(c) ₹30,000 received from debtors
(d) Cheques of ₹ 20.000 deposited in the bank
Ans (c) ₹30,000 received from debtors
2 Calculate Cash Flow from Investing Activities from the following particulars: 3
st st
Particulars 1 April,2021 31 March,2022
Plant and Machinery (Written Down Value) ₹ 7,20,000 ₹ 8,60,000
Information:
(i) Depreciation charged during the year ₹ 85,000.
(ii) Plant and Machinery having a written down value of ₹ 1, 10,000 was sold for
₹ 1, 25,000.
Ans.2 Cash Flow From Investing Activities
Particulars Detail amount ₹ Net amount ₹
Proceeds from Sale of Plant & Machinery 1,25,000
Payment of Purchase of Plant & (3,35,000)
Machinery
Net Cash used in Investing Activities (2,10,000) (2,10,000)

WORKING NOTE:
PLANT AND MACHINERY ACCOUNT
Particulars Amount Particulars Amount ₹
₹
To Balance b/d 7,20,000 By Bank A/c (Sale of Plant 1,25,000
and Machinery)
To Gain on Sale of Plant & 15,000 By depreciation A/c 85,000
Machinery A/c
To Bank A/c (Balancing Figure) 3,35,000 By Balance c/d 8,60,000
10,70,00 10,70,000
0
3 Rayan Ltd. Provides the following information. Determine Cash Flow from Financing 3
Activities:
Particulars 31st March, 2023(₹) 31st March, 2022 (₹)
Equity Share Capital 15,00,000 10,00,000
10% Debentures ----------- 1,00,000
8% Debentures 2,00,000 ---------------
Additional Information:
(i) Interest paid on Debentures ₹ 10,000.
(ii) Dividend paid ₹ 50,000.
 (iii) During the year 2022-23, Rayan Ltd. Issued bonus shares in the ratio of 2:1.

Ans.3 CASH FLOW FROM FINANCING ACTIVITIES

Particulars Detail amount (₹) Net amount (₹)
Proceeds from the issue of 8% Debentures 2,00,000
Redemption of 10% Debentures (1.00.000)
Interest paid on Debentures (10,000)
Dividend paid (50,000)
Cash Flow from Financing Activities 40,000 40,000
Notes:
1. Bonus shares are not shown in Cash Flow Statement because cash in not
transacted.
2. In the absence of information, it is assumed that 10% Debentures have been
redeemed and new 8% Debentures have been issued on 31st March, 2023.
4 From the following information, calculate Net Profit before Tax and Extraordinary 4
Items:
Particulars Amount
(₹)
Surplus, i.e., Balance in Statement of Profit and Loss (Opening) 50,000
Surplus, i.e., Balance in Statement of Profit and Loss (Closing) 1,18,000
Dividend paid ( Proposed dividend for the previous year) 36,000
Interim Dividend paid during the year 45,000
Transfer to Reserve 50,000
Provision for Tax made during the current year 75,000
Refund of Tax 1,500
Loss of Inventory due to Fire 1,00,000
Insurance Claim Received for above Loss 50,000
Ans.4 Calculation of Net Profit Before Tax and Extraordinary Items
Particulars Detail
amount (₹)
Net profit as per Surplus i.e., Balance in Statement of Profit and Loss (₹
1,18,000- ₹ 50,000) 68,000
Add:
Dividend paid during the year 36,000
Interim Dividend paid during the year 45,000
Transfer to Reserve 50,000
Provision for Tax during the current year 75,000
2,74,000
Less: Refund of Tax 1,500
2,72,500
Add: Extraordinary item debited as Expense ( Loss of Inventory due to
fire) 1,00,000
3,72,500
Less: Extraordinary item credited as income(i.e., insurance claim
received) 50,000
Net Profit before Tax and Extraordinary Items 3,22,500
5 From the following particulars, calculate cash flows from financing activities: 4
Particulars 31.03.2023 (₹) 31.03.2022 (₹)
Equity Share Capital 8,00,000 6,00,000
12% Preference Share Capital -------- 2,00,000
14% Debentures 1,00,000 --------------
Additional Information:
(i) Equity Shares were issued at a premium of 15%.
(ii) 12% Preference Shares were redeemed at a premium of 5%.
(iii) 14% Debentures were issued at a discount of 1%.
(iv) Dividend paid on old Preference Shares ₹ 24,000.
(v) Interest paid on debentures ₹ 14,000.
(vi) Underwriting commission of Equity Shares ₹ 10,000.
(vii) Proposed Dividend on Equity Shares for the year ended 31.03.2023 ₹ 1,
20,000.
(viii) Proposed Dividend on Equity Shares for the year ended 31.03.2022 ₹
90,000.
Ans.5 Cash Flow From Financing Activities
Particulars Detail Net
amount amount
(₹) (₹)
Proceeds form issue of Equity Share Capital (₹ 2,00,00 +
Securities Premium ₹ 30,000 – Underwriting Commission ₹
10,000) 2,20,000
Redemption of Preference Shares (₹ 2,00,000 + Premium on
Redemption ₹ 10,000) (2,10,00
0)
Proceeds from issue of Debentures ( ₹ 1,00,000 - ₹ 1,000) 99,000
st
Proposed Dividend on Equity Shares for the year ended 31
March, 2022) (90,000)
Dividend paid on Preference Shares (24,000)
Interest paid on Debentures (14,000)
Net cash used in Financing Activities (19,000) (19,000)
Notes:
(i) Proposed Dividend for Previous Year i.e., for the year ended 31st march,
2022 is declared (approved) in the year ended 31st March, 2023. Hence it
will be added back to Net Profit to determine net profit before tax. It will
also be shown under financing activities as Outflow of Cash.
(ii) Proposed Dividend for Current year i.e., for the year ended 31st March, 2023
will be declared (approved) in the next financial year. Hence, it will have no
effect on Cash Flow Statement.
6 From the following extracts taken from the Balance Sheets of M/s Agrawal Ltd., on 31st 4
March, and the additional information provided, ou are required to calculate:
(i) Cash Flows from Operating Activities.
(ii) Cash Flows from Financing Activities.
Equity and Liabilities 31.03.2021 (₹) 31.03.2022 (₹)
Equity Share Capital 20,00,000 30,00,000
10% Preference Share Capital 2,00,000 1,00,000
Securities Premium A/c ------------ 95,000
Profit and Loss Balance 4,00,000 8,00,000
10% Debentures 10,00,000 10,00,000
Additional Information:
(i) Fresh Equity shares were issued on 31st March, 2022 at a premium of 10%.
(ii) Interim Dividend was paid on equity shares @8%.
(iii) Preference shares were redeemed on 31st March, 2022 at premium of 5%.
 Premium on redemption was charged against premium received on issue of
fresh equity shares.

Ans.6 (i) Cash Flows From Operating Activities

Particulars Detail Net
amount (₹) amount (₹)
Net Profit before Tax (Note 1) 5,80,000
Adjustments for non-cash and non-operating items:
Add: Interest on Debentures 1,00,000
Net Cash Flow from Operating Activities 6,80,000 6,80,000
Note: (1)
Calculation of Net Profit before Tax: Amount (₹)
Profit and Loss Balance on 31st March, 2022 8,00,000
Less: Profit and Loss Balance on 31st March,2021 4,00,000
Net Profit after tax & extraordinary Items 4,00,000
Add: Dividend on Preference shares (10% on ₹ 2,00,000) 20,000
Dividend on Equity Shares (8% on ₹ 20,00,000) 1,60,000
Net Profit before tax 5,80,000

(ii) Cash Flows From Financing Activities

Particulars Detail Net
amount (₹) amount (₹)
Proceeds form Issue of Equity Shares
(₹10,00,000 + Securities Premium₹ 1,00,000) 11,00,000
Cash paid for Redemption of Preference Shares
(₹ 1,00,000 + Premium ₹ 5,000) (1,05,000)
Dividend paid on Preference Shares (20,000)
Dividend paid on Equity Shares (1,60,000)
Interest on Debentures (1,00,000)
Net Cash Flows from Financing Activities 7,15,000 7,15,000
Note: Dividend on Preference Shares is paid before payment of Dividend on Equity
Shares. The company has paid interim dividend on equity shares. Hence, it must have
paid dividend on preference shares.
7 From the following information of Nova Ltd., calculate the Cash Flow from Investing 4
Activities:
Particulars 31st Mach, 31st March,
2023 (₹) 2022 (₹)
Machinery ( At cost) 5,00,000 3,00,000
Accumulated Depreciation on Machinery 1,00,000 80,000
Goodwill 1,50,000 1,00,000
Land 70,000 1,00,000
Additional Information:
During the year, a machine costing ₹ 50,000, on which the accumulated depreciation
was ₹ 35,000, was sold for ₹ 12,000.
Ans.7 Calculation of Cash Flow from Investing Activities
Particulars Detail Net
amount amount
(₹) (₹)
Purchase of Machinery (WN) (2,50,000)
 Purchase of Goodwill (59,000)
Sale of Machinery 12,000
Sale of Land 30,000
Cash used in Investing Activities (2,67,000) (2,67,000)
Working Note:
Machinery Account
Particular‟s Amount Particular‟s Amount
(₹) (₹)
To Balance b/d 3,00,000 By Bank A/c (Sales) 12,000
To Bank A/c (Balancing 2,50,000 By Accumulated Depreciation A/c 35,000
figure
By Statement of Profit & Loss 3,000
(Loss on Sale)
By Balance c/d 5,00,000
5,50,000 5,50,000

Accumulated Depreciation Account

Particular‟s Amount Particular‟s Amount
(₹) (₹)
To Machinery A/c (Transfer 35,000 By Balance b/d 80,000
Accumulated Dep. On Machinery sold)
To Balance c/d 1,00,000 By Depreciation A/c
( For the Year) 55,000
Balancing figure
1,35,000 1,35,000