CHAPTER

Accounting for Partnership

1 Firms--Fundamentals
LEARNING OBJECTIVES
The study of this Chapter would enable students to
understand:
Meaning and Definition of Partnership 1.1
Essential Features or Characteristics of Partnership
1.2
Rights of Partners
1.2
Partnership Deed: Meaning, Clauses and Importance 1.3
Provisions of the Partnership Act, 1932 Affecting Accounting Treatment in the
Absence of Partnership Deed
1.4
Interest on Loan by the Partner to the Firm and by the Firm to the
Partner 1.6
Distribution of Profit among Partners: Profit &Loss Appropriation Account 1.11
Special Aspects of Partnership Accounts: 1.23
" Partners' Capital Accounts under Fixed and Fluctuating
Methods
Salary or Commission to Partners " Interest on Partners' Capitals Interest on Partners' Drawings
Adjustments for Incorrect Appropriations of Profits in the Past (Past Adjustments)
Guarantee of Profit

MEANING AND DEFINITION OF PARTNERSHIP

Partnership is defined by Indian Partnership Act, 1932, Section 4, as follows:
"Partnership is the relation between persons who have agreed to share the profits of a business carried
on by allor any of them acting for all."
Apartnership, thus, is a business relationship between/among two ormore persons who share
profits and losses of the business, that may be carried on by all or any of them acting for all.
Partners, Firm and Firm Name: The persons who have entered into a partnership with one
another are individually called partners and collectively a firm. The name under which the
business is carried is called firm name.
Nature of Partnership
Partnership, from the legal viewpoint, is not a separate legal entity from its partners since firm's
debts are payable from personal assets of the partners, if the firm is unable to repay its liabilities.
However, partnership firm and partners are twO separate entities from accounting viewpoint
because transactions are recorded in the books of account of the firm from the view point of the firm.
Partnership may be governed by Oral Agreement, i.e., terms of Partnership are agreed upon
orallyor it may be governed by a written Agreement, i.e., terms of Partnership are written
in an agreement called Partnership Deed. down
 ESSENTIAL FEATURES OR CHARACTERISTICSOF PARTNERSHIP
The essential characteristics of partnership are:
1. Two or More Persons: There must be at least two persons to torm a partnership and
all such persons must be competent to contract. According to Indian Contract Act, 1872
every person except the following is competent to contract:
(a) Persons of unsound mind, and
(b) Persons disqualified by any law.
Minor as a Partner: Aminor though not competent to contract, can be a partner in the
firm but only in profits of the irm and not in losses. A minor partner should accept
or refuse the partnership in the firm within 6 months on becoming major, i.e., attaining
18 years of age. If he/she does not so decide, he/she becomes liable for all the actions
since he/she became partner.
Maximumn Number of Partners: The Partnership Act, 1932 does not prescribe the
maximum number of partners in afirm. However, the Companies Act, 2013 (Section 464)
empowers the Central Government to prescribe number of partners in a firm subject to
maximum of 100 partners. The Central Government has prescribed maximum number of
partners in a firm to be 50 vide Rule 10 of the Companies (Miscellaneous) Rules, 2014.
As a result, a partnership firm cannot have more than 50 partners.
2. Agreement: Partnership comes into existence by an agreement, either written or oral. It is
the basis of relationship among partners, which may be for a particular venture, for aperiod
or at will. The written agreement among the partners is known as Partnership Deed.
3. Business: A partrnership is established for a business.
4. Profit Sharing: The agreement between/among the partners should be to share profits
and losses of the business.
5. Business can be Carried on by All or Any of the Partners Acting for All: Business of
the partnership may be carried on by all the partners or by any of them acting for all the
partners. In other words, partners are agents of other partners as well as the principals.
As an agent, he represents other partners and thereby, binds them through his acts.
As a principal, he is bound by the act of other partners.

RIGHTS OF PARTNERS
1. Every partner has the right to participate in the management of the business.
2. Every partner has the right to be consulted about the business matters.
3. Every partner has the right to inspect the books of account and have a copy of it.
4. Every partner has the right to share profits and losses in the agreed ratio. In case
profit-sharing ratio is not agreed, profits and losses are shared equally as is provided
the Partnership Act, 1932.
5. If apartner has advanced loan, he has the right to receive interest thereon at an agreed
rate of interest. In case the rate of interest is not agreed, interest is paid at the la
provided in the Indian Partnership Act, 1932, which is 6% p.a.
 Apartner has the right to take decisions in the interest of the business.
7 A partner has the right not to allow the admission of a new partrner.
&After giving notice, a partner has the right to retire from the firm.

PARTNERSHIP DEED
Agreement either oral or written, is the basis of partnership. It is always better to have written
agreement to avoid any dispute. This written document, known as Partnership Deed details
the terms and conditions of partnership. It is a legal document signed by all the partners and
normally has clauses on the following:
(i) Description of the Partners: Names, description and addresses of the partners.
(ii) Descriptionof the Firm: Name and address of the firm.
(ii) Principal Place of Business: Address of the principal place of business.
(iv) Nature of Business: Nature of business that the firm shall carry on.
(v) Commencement of Partnership: Date of commencement of partnership.
(vi) Capital Contribution: The amount of capital to be contributed by each partnmer,
whether the Capital Accounts shall be fixed or fluctuating.
(vii) Interest on Capital: Rate of interest, if allowed, on capital.
(vii) Interest on Drawings: Rate of interest, if to be charged, on drawings.
(ix) Profit-sharing Ratio: Ratio in which profits or losses are to be shared by the partners.
(x) Interest on Loan: Rate of interest on loan by a partner to the firm and interest on
loan to a partner by the firm.
(xi) Remuneration to Partners: Amount of salary, commission, etc., if agreed, to be paid.
(xii) Valuation of Goodwill: Method by which goodwill of the firm will be valued at
the time of reconstitution of the firm, i.e., change in profit-sharing ratio, admission,
retirement or death of a partner.
valued at the
(xiii) Valuation of Assets: The manner in which assets of the firm shall be
time of its reconstitution.
(xiv) Settlement of Account: The manner in which accounts of partner(s) shall be paid in
case of his (their ) retirement or death or at the time of dissolution of the firm.
(xv) AccountingPeriod: The date on which accounts shallbe closed every year. Normally,
accounts are closed on 31st March every year because every entity must submit the
return of income for its income for the period or year ended on 31st March every year.
(xvi) Rights and Duties of Partners: The rights and duties of partners are defined.
(xvii) Duration of Partnership: The period of partnership, i.e., whether it is for a specified
period or for aventure or at will.
(xviii) Bank Account Operation: How shall the Bank Account be operated? Whether it shall
be operated by any of the partners or jointly.
(xix) Death of a Partner: Whether the firm willcontinue on the death of a partner.
(xx) Settlement of Disputes:Disputes, if any, among the partners-howthey shall be settled.
Asample Partnership Deed is given in QR Code.
Importance of Partnership Deed
Partnership Deed is an inmportant legal document whichdefines relationship between/among
the partners. It is important to have written Partnership Deed so that disputes do not arise. In
case, thev stillarise they can be resolved on the basis of Partnership Deed.
It is useful because:
1. It governs the rights, duties and liabilities of each partner.
the basis of
2. Disputes arising, if any, between/among the partners are resolved on
Partnership Deed.
3. If the Partnership Deed does not exist or where it exists but does not have a term on a particular
matter, provisions of the Partnership Act, 1932 apply. For example, if the Partnership Deed
does not allow salary to partners, salary will not be paid to partners because the Partnership
Act, 1932 does not allow salary to partners. Another example, if a partner has given loan to
loan by
the partrner and the Partnership Deed is silent on allowance of interest, interest on
partner is payable @6% p.a. as is provided in the Partnership Act, 1932.
ProvisionsAffecting Accounting Treatment in the Absence of Partnership Deed
In the absence of a Partnership Deed or where it does not have a clause in respect of the following
matters, the provisions of the Indian Partnership Act, 1932 apply:
Matters Provisions of the Indian Partnership Act, 1932
1. Interest on Advance/Loan by a Partner Interest on loan by partner is paid (allowed) @6% p.a.
Interest on loan by partner is a charge against proñt It means interest is paid
whether the frm earns profit or incurs loss.
2. Sharing of Profits/Losses Profits/Losses are shared equally by the partners.
3. Interest on Capital Interest on capital is not paid (allowed) to partners.
4. interest on Drawings Interest on drawings is not charged from partners.
5. Remuneration to Partners Remuneration (salary, commission, etc.) is notpaid (allowed) to any partner.
6. Admission of Partner New partner cannot be admitted unless allthe partners agree to it.
Important Provisions of the Indian Partnership Act, 1932
(i)| If all the partners agree, a minor may be admitted for the benefit of Sec. 30]
partnership.
Sec. 31|
(ü)|A person mnay be admitted as a partner either with the consent of all the
existing partners or in accordance with an agreement among the partners.
32|
(iii)| Apartner may retire from the firm either with the consent of all the other Sec.
partners or in accordance with an agreemnent among the partners.
(iv) Registration of the firnm under the Partnership Act, 1932 is optional and| [Sec. o|
not compulsory.
Deed, a firm (Sec. 9)
(v)|Unless otherwise agreed by the partners in the Partnership
is dissol ved on the death of a partner.
to include or change any of the clauses of the
The partners may change the P'artnership Deed
Partnership Deed as and when considered appropriate by them.
Liabilities of Partners
Subject to agreement among the partners,
without the consent of other
1. If apartner carries on a business in competition with the firm
partners and earns profit from it, the profit earned from such business shall be paid to the
firm. However, losses incurred, if any, are borne by him alone.
2. If apartner earns profit for himself from any transaction of the firm or from the use of
firm's property or business connection, the profit so earned shall be paid to the firm.
For example, a partner gets commission from the seller of goods on goods purchased by
the firm, the commission so earned shall be paid to the firm.
Difference between Charge against Profit and Appropriation of Profit
Basis Charge against Profit Appropriation ofProfit
1. Nature It is an expense hence deducted from revenue to It means distribution of net profit for the year
determine net profit or net loss for the year. among partners under different heads as per the
Partnership Deed.
2. Recording It is transferred to the debit (debited) of Profit &Loss |It is transferred to the debit (debited) of
Profit &
Account. Loss Appropriation Account.
3. Priority It isallowed before Appropriation of Profit.
It is appropriated after accounting of allcharges.
4. Examples Rent paid to a partner, interest on loan by partner, Salary to partners, interest on capital, transfer of
etc.
profit to General Reserve, etc.
Features of Profit &Loss Appropriation Account
1. It is an extension of the Profit & Loss Account.
2. It is prepared for the year.
3. It is prepared by the partnership firms.
4. It shows the appropriation of net profit or loss for the accounting period.
5. Entries in this account are passed giving effect to the Partnership Deed.
Difference between Profit &Loss Account and Profit &Loss Appropriation Account
Basis Profit &Loss Account Profit &Loss Appropriation Account
1. When Prepared It is prepared after Trading Account. It starts It is prepared after Profit &Loss Account. It
with Gross Profit (in the credit side) or Grossstarts with Net Profit (in the credit side) or Net
Loss (in the debit side) as per the Trading Loss (in the debit side) as per the Profit &Loss
Account for the year. Account for the year.
2. Objective It is prepared to determine net profit earned or It is prepared to show appropriation of net
net loss incurred during the accounting year. profit, ie., distribution of Net Profit or Net Loss
for the year among the partners.
3. Nature of Items It is debited with the expenses (charge againstIt is debited for appropriation of profit such as
profit) and credited with the income, to salary/remuneration/commission to partners,
determine net profit or loss for the accounting interest on capital and transfer to reserve, etc.
period. It is credited with interest on drawings,etc.
4. Partnership DeedPreparation of thisaccount is not guided by the Preparation of this account is guided by the
or Agreement Partnership Deed or Agreement. Partnership Deed or Agreement.
5. Matching While preparing this account, Matching Principle While preparing this account, Matching Principle
Principle (i.e., expense is matched against revenue) is is not followed being not applicable.
followed.
Let us understand complete set of final accounts of a partnership firm with the help of
illustration for better understanding of Profit &Loss Appropriation Account.
Difference between Fixed Capital Account and Fluctuating Capital Account
Besis Fixed Capital Account Fluctuating Capital Account
1. No. of Accounts Two acCounts are maintained for each One account (ie., Capital Account) is maintained
Maintained partner, i.e., Fixed Capital Account and for each partner.
Current Account.
2. Frequency of Change Balance in Fixed Capital Account does Balance changes with every transaction of
with the firm.
change except when further capital is the partner
introduced or capital is withdrawn.
3. Transferring the Transactions relating to Capitals are transferred All transactions whether for capital, drawings.
Transactions to Fixed Capital Accounts and transactions interest on drawings, interest on capital,
for drawings, interest on drawings, interest salary, commission, share of profit or loss are
on capital, salary,commission, share of profit transferred to Capital Account.
or loss are transferred to Current Account.
4. Balance Capital Account has credit balance. Fluctuating Capital ACcount may have credit
or debit balance.

Difference between Capital Account and Current Account

Basis Capital Account Current Account

1. Need Capital Account is maintained in all the cases, Current Account is maintained when
whether following Fixed Capital Accounts. Fixed Capital Accounts method is followed.
Method or Fluctuating Capital Accounts Method.
2. Balance of AcCount Capital Account will have acredit balance whenBalance of aCurrent Account may have a
Fixed Capital Accounts Method is followed. In credit or debit balance.
Fluctuating Capital Accounts Method, it may
have either credit or debit balance.
3. Nature In case of fixed capital, Capital Account balance Balance of Current Account does not
generally remains unchanged from yeartoyear. change when capital is introduced or
Itchanges when further capital is introduced withdrawn by apartner.
or capital is withdrawn by apartner.
4. Transactions
Capital AcCount records the amount invested by Current AcCount records the
à partner in the firm. transactions
such as drawings, interest on capital, interest
on drawings, salary, commission, profit or
loss, etc.
Difference between Drawings against Capitaland Drawings against Profit
Basis
Drawings against Capital Drawings against Profit
1. Where Debited It is debited to Capital Account. It is debited to Drawings Account.
2. Part It is against capital. It is against expected profit for the year.
3. Effect It reduces capital immediately onwithdrawal. It reduces capital when final accounts are
prepared and Drawings is transferred to the
debitof Partner's Capital Account.
Interest on Drawings It is not considered for calculating interest It is considered for calculating interest
on drawings. on drawings.
5. Interest on Capital It is considered for calculating interest on It is not considered for calculating interest
capital. on capital.
ainst eynected nroft for the vear if the Partnershin Deed
CHAPTER
Goodwill: Nature and Valuation
2
LEARNING OBJECTIVES
IThestudy of this Chapter would enable students to understand:
Meaning of Goodwill 2.1
2.1
Characteristics or Features of Goodwill
2.2
Nature of Goodwill and Need for Valuing Goodwill
Factors Affecting Value of Goodwill 2.2
2.3
Types of Goodwill: Purchased Goodwill and Self-generated Goodwill
2.5
Methods of Valuation of Goodwill
(a) Average Profit Method
" Simple Average Profit Method
Weighted Average Profit Method
(b) Super Profit Method
(c) Capitalisation Method
" Capitalisation of Average Profit
" Capitalisation of Super Profit
2.20
Difference between Average Profit and Super Profit

MEANING OF GOODWILL
advantage to earn higher
Goodwill is an asset (Intangible) which places an enterprise at an
than normal profits.
Goodwillis the present value of expectedfuture profit that is expected to be in excess of normal
return on investment or for the excess price paid for a business over the book value or
assets, i.e., Assets - Liabilities.
over the computed or agreed value of net
connections or other advantages
"Goodwill maybe said to be that element arising from the reputation,
than the returns normally to be expected
possessed by a business which enables it to earn greater profits business." - Spicer and Pegler
in the
capital represented by the net tangible assets employed
CHARACTERISTICS OR FEATURES OF GOODWILL
The characteristics or features of goodwill are:
physical existence, but has a value.
1. It is an intangible asset, i.e., it does not have
enterprise.
2. Itdoes not have an existence separate from that of an
3. It helps in earning higher than normal profits.
4. It attracts customers to come frequently.
locational advantages, favourable
5. It comes into existence due to various factors such as
contracts, brands, trademarks, patents, market reputation, customer base, etc.
 the valuer.
6. Value of goodwillis subjective as it depends on the assessment of
7. In the context of partnership, it is the value of share of profit sacrificed by the
sacrificing partner.
TANGIBLE ASSETS, INTANGIBLE ASSETS AND FICTITIOUS ASSETS
Tangible Assets: Tangible assets are the assets which have physical existence, ie, they can be seen and
|Examples are land, building, plant and machinery, stock, debtors, etc. touched
|Intangible Assets: Intangible Assets are the assets which do not have physical existence, i.e, they cannet t
seen and touched. Examples are goodwill, patents, trademarks, etc.
|AS-26, Intangible Assets issued by ICAl has defined intangible asset as follows:
An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the productioe
or supply of goods or services, for rental to others, or for
administrative purposes."
Fictitious Assets: Fictitious assets neither have physical existence nor realisable value. They are
are charged as expense in the year they relate to (Prepaid Expenses) or written off in expenses which
are shown in the assets side of more than one year. They
the Balance Sheet till they are written off.

NATURE OF GOODWILL
It is an
intangible asset having value. It is amortised over its estimated useful life.
Standard-26 (AS-26), Intangible Assets prescribes that goodwill is not to be Accounting
books of accountunless consideration has recognised in the
at an arm's length. Therefore,
exchanged hands between knowledgeable persons
self-generated goodwill is not recognised in the booksof account
whereas purchased goodwill is recognised.
its value is subjective and is agreed Self-generated Goodwill is not recognised because
purchased goodwillis recognised beingbetween/among interested parties. On the other hand,
evidenced by payment
parties at arm's length. between/among independent
NEED FOR VALUINGGOODWILL
Goodwill is valued, when
1. profit-sharing ratio changes;
2. a partner is admitted;
3. a partner retires or dies;
4. the firm is sold;
5. two or more firms
6. the firm is amalgamate;
converted into a company.
FACTORS AFFECTING VALUE OF GOODWILL
Goodwill is affected by the factors which increase the
1. Efficient Management: If the earning capacity of the firm. These are:
the firm will earn higher profits asmanagement
is experienced, capable and
compared to other firms. competent,
2. Favourable Location: If the
business is located at a
customer walk-in and, therefore, increased sale andfavourable place, resulting in increased
increased profit.
 Favourable Contracts: If afirm has long-term contracts for sale and purchase of goods at
3.
(avourable prices, this will also affect profits and goodwill of the firm.
Longer Establishment of Business: Business established since
long is likely to have
will
4. extensive
(broader) customer base resulting in higher sale and profit. As a result, it
have higher value of goodwill.
Advantage of( Patents: Normally, patents are necessary forthe manufacture or production
5. articles. Afirm which possesses the necessary patents will have a better
of certain types of
value for its goodwill.
Access to Supplies: When supplies of materials are difficult to get, there will be a high
value of goodwillfor a firm which has good arrangements for getting regular supplies.
7 Ouality: If a firm is known for quality of its products, sale is likely to be higher and value
of its goodwill, therefore, will be high.
is
s Market Situation: If a firm is in a business wherein demand for the products dealt in
higher than the supply, it will lead to lower capital requirement and higher profit. It will,
thus, increase the value of its goodwill.
than
o Risks Associated with Business: If the risks associated to the business are lesser
normal, business will have higher value for goodwill
in
10. Nature of Business: If the business of a firm is of the nature where the products dealt
are in high demand although not short in supply, the profit will be higher. It will, thus,
increase the value of its goodwill.
11. Past Performances: The firms earning higher profits year after year, will have better value
similar
for goodwill as compared to firms earning lesser profits or incurring losses with
amount of capital employed.
12. Other Factors: (a) After sale services, (b) Good customer relations, and (c) Good labour
relations, etc.

TYPES OF GOODWILL

Goodwill is of two types:

1. Purchased Goodwill; and
2. Self-generated Goodwillor Non-purchased Goodwill.
1. Purchased Goodwill: Purchased Good will is that goodwill for which the firm has paid
consideration in cash or kind. For example, when a business is purchased and purchase
consideration is more than the value of net assets (i.e, Assets - Liabilities), the difference
amount is the value of purchased goodwill.
For example, AB Consultants purchases Mahagun Business for a net consideration of
10,00,000. Assets acquired were valued at 20,00,000 and liabilities taken over were of
?12,00,000.7 2,00,000 paid in excess of net assets, i.e., 8,00,000 (R 20,00,000 - 12,00,000)
is towards goodwill. It is purchased goodwill.
AS-26, Intangible Assets prescribes hat purchased goodvill nmay be recognised in the books of
Qccount and written off at the earliest but within the estimated useful life, which normally should
not exceed 10 years.
Features of Purchased Goodwill:
i) It normally arises on purchase of a business.
(ii)) Since consideration is paid for it, it may be recognised in the books of account.
(111) If it is recognised, it is shown in the Balance Sheet as an asset.
(iv) Value of goodwill depends on expected profits.
(v) Value of Goodwillis asubjective assessment but it is ascertained when both purchaser
and seller agree for consideration for goodwill.
(vi) It is amortised at the earliest but not later than its estimated useful life.
CHAPTER
Admission of a Partner
4
LEARNING OBJECTIVES
The study of this Chapter would enable students to understand:
Admission of a Partner 4.1
Effects of Admission of a Partner 4.2

Meaning and Calculation of New Profit-sharing Ratio 4.2

Meaning and Calculation of Sacrificing Ratio 4.10

Valuation and Accounting of Goodwill as per Accounting Standard-26 4.15

Revaluation of Assets and Reassessment of Liabilities:

4.33
Preparation of Revaluation Account
4.43
Adjustment of Deferred Revenue Expenditure
4.43
Accounting of Reserves, Accumulated (Undistributed) Profits and Losses
4.62
Adjustment of Capital

ADMISSION OF A PARTNER

Admission of apartner is reconstitution of the firm because with the admission of a partner,
existing partnership deed or agreement ends and new agreement among all the partners
the new
(including incoming or new partner) comes into force. Capital contribution by
partner, his share in profits and other conditions are agreed upon.
According to Section 31 of the Indian Partnership Act, 1932, a person can be admitted as
a partner:
i) if it is so agreed in the Partnership Deed, or
(ii) in the absence of the agreement, if all the partners agree to admit the partner.
After admission, the new partner gets following two rights:
1. Right to share future profits of the firm, and
2. Right to share assets of the firm.
At the same time, he becomes liable for liability of the business incurred after admission
and any loss incurred by the firm.
New or incoming partner receives share in future profits equal to the sacrifice of profit share
or sharesby existing partner or partners of the firm. New or incoming partner compensates
all those partners whosacrifice their profit shares in his or her favour. The amount new
partner pays for their sacrifice is called Goodwill or Premium for Goodwill
Besides goodwillor premium for goodwill, new or incoming partner brings capital to get
right in the assets of the firm.
 EFFECTS OF ADMISSION OF A PARTNER
The effects of admission of apartner are:
Old partnership comes to an end and new partnership comes into existence. However
1.
the firm continues.
entitled to share future profits of the firm and the
2. New or incoming partner becomes
combined share of the old partners gets reduced.
amount of capital in the firm.
3. New or incoming partner contributes an agreed
incoming partner acquires right in the assets and also becomes liable for the
4. New or
liabilities of the firm.
loSses.
5. Adjustment is made for reserves, accumulated profits and
change is adjusted in Existing
6. Assets are revalued and liabilities are reassessed. The net
fluctuating) or Current Accounts
or Old Partners' Capital Accounts (if capitals are
(if capitals are fixed) in their old profit-sharing ratio.
for their sacrificed profit
7. Goodwill of the firm is valued and is paid to sacrificing partners
shares by the gaining partners.

ADJUSTMENTS REQUIRED ON ADMISSION OF A PARTNER

The adjustments required on admission of a partner are:

Sacrificing Ratio.
1. Change in Profit-sharing Ratio: Determining New Profit-sharing Ratio and
2. Valuation and Accounting of Goodwill.
liabilities.
3. Adjustment of gain (profit)/loss from revaluation of assets and reassessment of
4. Adjustment of Deferred Revenue Expenditure (Advertisement Suspernse).
5. Adjustment of reserves, accumulated (undistributed) profits and losses.
6. Adjustment of capital on the basis of new profit-sharing ratio (if so agreed).
Let us discuss each of these adjustments in detail.
 Hidden or Inferred GoodwilI
Sometimes, value of goodwill of the firm is not given, it has to be inferred on the basis
of net worth (capital) of the firm. For example, A and B whose capitals in the firm are
? 50,000 and 1,00,000respectively share profits equally. They admit Cintothe partnership
and he brings 60,000 as capital for 1/4th share of profits. In this case, total capital of the
new firm should be 60,000 x 4, i.e., ? 2,40,000. But the total capital of all three partners is
only 2,10,000 (i.e., 50,000 +7 1,00,000 + 60,000).
Therefore, hidden goodwill is 30,000 (ie., 2,40,000 2,10,000) and C's Share of
Goodwill comes to 7,500 (i.e., ? 30,000 x 1/4). C's Share of Goodwill will be shared by
Aand B in their sacrificing ratio, in this case equally.
In case of ad1ission of anew partner, 'Hidden Goodwill' is the excess of total capital of the firm
calculated on the basis of new parter's capital over the adjusted capitals of the existing partners
and capital of incoming partner.
The change in value of assets and liabilities is adjusted through an account titled
Revaluation Account or Profit & Loss Adjustment Account. Increase in value of assets,
recording of unrecorded assets and decrease in amount of liabilities are credited to
Revaluation Account, they being gain (profit), On the other hand, decrease in value
of assets, increase in amount of liabilities and recording of unrecorded
liabilities are
debited to the account, they being loss. The difference between two sides (credit and
debit) of Revaluation Account is either gain (profit) if credit side total is bigger than
the total of debit side or loss if debit side total is bigger than the total of credit side.
Gain (lrofit)/Loss of Revaluation ACCount is transferred to Old Partners' Capital Accounts
in their old profit-sharing ratio.
Preparation of Revaluation Account
Accounting entries passed on revaluation of assets and reassessment of liabilities are:
() For an increase in value of assets Assets A/c (Individually) ..Dr.
To Revaluation A/c or Profit &Loss Adjustment A/c
(ü) For adecrease in value of assets Revaluation A/cor Profit &Loss Adjustment A/c ...Dr.
To Assets A/c (Individually)
(ii) For an increase in amount of liabilities Revaluation A/c or Profit &Loss Adjustment A/c ...Dr.
To Liabilities A/c (Individually)
(iv) For adecrease in amount of liabilities Liabilities A/c (Individually) ...Dr.
To Revaluation A/c or Profit &Loss Adjustment A/c
For accounting Unrecorded Assets Unrecorded Assets A/c (Individually) .Dr.
To Revaluation A/c or Profit &Loss Adjustment A/c
(vi) For accountingUnrecorded Liabilities Revaluation A/c or Profit &Loss Adjustment A/c ..Dr.
To Unrecorded Liabilities A/c (ndividually)
CHAPTER
Retirement of a Partner
5
LEARNING OBJECTIVES
The study of this Chapter would enable students to understand:
5.1
Meaning of Retirement of a Partner
5.2
New Profit-Sharing Ratio of the Remaining or Continuing Partners after Retirement of a Partner
5.5
Gaining Ratio of the Remaining or Continuing Partners
5.9
Difference between Sacrificing Ratio and Gaining Ratio
Valuation and Accounting of Goodwill on Retirement of a Partner 5.9
> Revaluation of Assets and Reassessment of Liabilities on Retirement of a Partner 5.16
Adjustment of Reserves, Accumulated (Undistributed) Profits and Losses on Retirement of aPartner 5.20

Determination of Amount Due to Retiring Partner 5.24

Methods of Payment of Amount Due to Retiring Partner 5.25

Adjustment of Capitals of the Remaining or Continuing Partners in

New Profit-Sharing Ratio 5.38
5.54
Retirement of Partner during the year

RETIREMENT OF A PARTNER

Meaning
Retirement of apartner means reconstitution of the firm under which old partnership agreement
comes to an end and new partnership agreement between/among the remaining or continuing
partners, Comes into existence. The firm, however, continues.
Apartner may retire from the firm:
(1) if there is an agreement to that effect; or
(i) ifall the partners agree to retirement of apartner, in the absence of Partnership Deed or
Agreement; or
(üi) ifthe Partnership is at Will, by giving a notice (written) to the remaining partners of his
decision to retire.
In short, retirement ofa partner means a partner ceasing to be a partner in the firm and the
firm is reconstituted.
Liability of a Retiring Partner
Liability for the Acts before Retirement
Aretiring partner remains liable for all the acts of the firm up to the date of his retirement.
However, a retiring partner may be discharged from his liability by an agreement between
himself, third party and the continuing partners. [Section 32(2)]
Liability for the Acts after Retirement
Aretiring partner also continues to be liable to third parties for the acts of the firm even
after
hisretirement until apublicnotice of his retirement is given. [Section 32(3)|
Rights of a Retiring Partner
1. To get his share in the goodwillof the firm.
2. To receive his capital along with share in accumulated profits and other claims.
Adjustments Required on Retirement of a Partner
Following matters are considered and resolved on retirement of a partner:
1. Determining New Profit-sharing Ratio and Gaining Ratio, ie, change in profit-sharing
ratio.
2. Valuation and Accounting of Goodwill.
3. Revaluation of Assets and Reassessment of Liabilities.
4. Reserves and Undistributed Profits (Accumulated Profits)/Losses.
5. Determination of amount due to Retiring Partner.
6. Payment tothe Retiring Partner.
7. Adjustment of Capitals (if so agreed by the remaining or continuing partners).
pifference between Sacrificing Ratio and Gaining Ratio
Basis Sacrificing Ratio Gaining Ratio
1. Meaning It is the ratio in which the old partners have It is the ratio in which the remaining partners
sacrificed their profit shares infavour of the take the outgoing (retired or deceased)
newor incoming partner. partner's share.
2. Objective It is calculated to determine the amount of It is calculated to determine the amount
compensation to be paid by the incoming of compensation to be paid by each of the
partnertothesacrificing partners as premium gaining partner to the outgoing partner as
for goodwill or goodwill. premium for goodwillor goodwill.
3. When to Calculate It is calculated at the time of admission of It is calculated at the time of retirenment or
a new partner and on change in the profit- death of a partner and on change in the
sharing ratio. profit-sharing ratio.
4. Method of Sacrificing Ratio = Old Profit-sharing Ratio Gaining Ratio = New Profit-sharing Ratio
Calculation - New Profit-sharing Ratio. -Old Profit-sharing Ratio
 8. RETIREMENT OF PARTNERDURING THEYEAR
Normally retirement date of partner is planned, i.e, a partner may retire on the first day of the
accounting year. But there may be a situation where a partner may retire from the partnership
adate in-between the accounting year. Insuch a situation, the retiring partner is entitled to
his share of profit or loss from the beginning of the accounting year up to the date of retirement
besides his share in reserves, revaluation profitor loss and goodwill, etc.
 shareof profit or loss may
be:
His
estimated
(a)est
based on last year's profit or average of past years' profits, or
(b)
determineddby preparing the financial statements up to the date of retirement.
WhenProfit or Loss is estimated based on Last Year's profit or Average of Past Years' Profits
(a)
loss from the
Profitor beginning of the accounting period up to the date of retirement may be
estimated| byapplying any of the following two methods:

() Profit or
loss for the period may be estimated based on last year's profit or on average
profit of past few years.
Examples:
1 Amrit with profit share of 3/10 retired from the firm on 30th June, 2024. It was agreed
that profit share of the retiring partner willbe estimated based on net profit of the last
accounting year. Net profit for the last year was ? 2,40,000. Amrie's share of profit for
the period 1st April, 2024 to 30th June, 2024 will be? 18,000, calculated as follows:
3 3
72,40,000x x -718, 000.
12 10

2. Bharat with profit share of 1/2 retired from the firm on 30th September, 2024. It was
agreed that profit/oss share of the retiring partner will be estimated based on average
net profit/loss of last three years. Net profits/losses for the last three years were
T240,000 (Loss); 2,20,000 (Loss) and 2,80,000. Bharae's share of loss for the period
lst April, 2024 to 30th September, 2024 willbe 15,000,calculated as follows:
(2,40,000)+(72,20,000) + 2,80, 000
Average Profit = 3
-(T60, 000)
Estimated loss for the period 1st April, 2024 to 30th September, 2024 will be
60,000)/2 =( 30,000)
Profit/(Loss) share of Bharat =( 30,000)x-15,000).
2
(i) Percentage of profit earned in the past year may be applied to the sale of the current
period, i.e., from the beginning of the accounting year up to the date of retirement to
estimate the profit or loss.
Example:
Sharad with profit share of 4/10 retired from the firm on 31st July, 2024. In terms of the
Partnership Deed, profit share of the retiring partner was to be estimated applying the last
year's net profit rate on the sale from the beginning of the accounting vear till the date of
retirement. In the year ended 31st March, 2024, net profit on the sale ot ? 20,00,000 was
2,00,000.Sale from 1st April,2024 up to31st July, 2024 was 15,00, 000. Profit share of
Sharad will be 60,000, calculated as follows:
Last Years rate of net protit= ?2,00,000 -x 100 =10%
? 20,00,000

Estimated profit from 1st April, 2024 to 31st July, 2024 * 15,00,000 × 10%,- *,50,000,
Profit share of Sharad = , 50,000 x- - 60,000.
10
Accounting of Profit Share of Retiring Partner
In the event of a partner retiring from the partnership, there can be any of the following two situations:
(a) Remaining (e, Continuing) partners continue to share profits in their old profit-sharine
ratio, or
(b) The profit-sharing ratio between/among the remaining (i.e,, continuing) partners changes,
Accounting of profit share of the retiring partner differs under the two situations as follows:
(a) When Remaining (i.e., Continuing) partners continue to share profits in their old proft.
sharing ratio
Profit share of the Retiring Partner is debited to Profit &Loss Suspense Account and credited to
Retiring Partner's Capital Account. At the end of the accounting period, Profit &Loss Suspense
Account is transferred to Profit & LOss Appropriation Account. In the event of loss, reverse
Journal entry is passed. The Journal entries passed are:
Situation (a): Situation (b):
When Retiring Partner's Share is Profit When Retiring Partner's Share is Loss
Profit &Loss Suspense A/c ..Dr. Retiring Partner's Capital A/c ..Dr.
To Retiring Partner's Capital A/c To Profit & Loss Suspense A/c
The balance of Profit &Loss Suspense Account is The balance of Profit &Loss Suspense Account is
shown in Assets side of the Balance Sheet and is shown in Liabilties side of the Balance Sheet and is
transferred to the debit of Profit &Loss Appropriation transferred to the credit of Profit &Loss Appropriation
Account at the end of the year. Account at the end of the year.

(b) When the profit-sharing ratio between/among the remaining (i.e. continuing) partners changes
Profit share of the Retiring Partner is debited to Gaining Partners' Capital Accounts in their
Gaining Ratioand credited to Retiring Partner's Capital Account. In the event of loss, reverse
Journal entry is passed.
Gaining ratio is calculated to compensate the Retiring Partner by paying goodwill for his
sacrifice of profit share. Thus, Gaining Ratio need not be calculated since it is already calculated
to pay goodwill.
The Journal entries passed are:
Situation (a): Situation (b):
When Retiring Partner's Share is Profit When Retiring Partner's Share is Loss
Profit &Loss Suspense A/c ..Dr.
To Retiring Partner's Capital A/c
Retiring Partner's Capital A/c ...Dr.
To Profit &Loss Suspense A/C
Gaining Partners' Capital A/cs ...Dr. Profit &Loss Suspense A/c .Dr.
To Profit &Loss Suspense A/c
To Gaining Partners' Capital A/cs
(Balance of Profit &Loss Suspense Account transferred (Balance of Profit &Loss Suspense Account transferred
to gaining partners in their gaining ratio)
to gainingpartners in their gaining ratio)
Alternatively, following Journal entry may be passed at Alternatively, following Journal entry may be passedat
the time of retirement of a partner: the time ofretirement ofapartner:
Gaining Partners' Capital A/cs ...Dr. Retiring Partner's Capital A/c ..Dr.
To RetiringPartner's Capital Ac To Gaining Partners' Capital Acs
(Share of retiring partner's appropriations transferred (Share of retiring partner's appropriations transferred
to gaining partners in their gaining ratio) to gainingpartners in their gaining ratio).
CHAPTER
Death of a Partner
6
LEARNING OBJECTIVES
The study of this Chapter would enable students tounderstand:
6.1
>Concept of Accounting on Death of a Partner
Change in the Profit-sharing Ratio: NewProfit-sharing Ratio and Gaining Ratio of the Remaining
6.2
or Continuing Partners after Death of a Partner
6.2
º Accounting of Goodwillon Death of a Partner
6.3
> Revaluation of Assets and Reassessment of Liabilities
Adjustment of Reserves, Accumulated (Undistributed) Profits and LoSses 6.5
6.5
Share of Profit or Loss of Deceased Partner in the year of Death
6.12
Computation of Amount Due to Deceased Partner
6.13
Payment of Amount due to Legal Heirs or Executors of the Deceased Partner
6.13
Preparation of Deceased Partner's Capital Account and Executor's Account

ACCOUNTING ON DEATH OF A PARTNER

and retirement of a
Partnership Agreemernt, like change in profit-sharing ratio, admissionAgreement comes into
partner, comes to an end on death of a partner and new Partnership take share
effect. However, the firm maycontinue its business with the remaining partners who
them.
of the deceased partner in their old profit-sharing ratioor in the ratio as is agreed by
partnerdies, the
In case, Partnership Deed does not provide for continuation of the firm, and a42).
firm is dissolved, as is provided in the Indian Partnership Act, 1932 (Section
retirement of a
Ihe accounting process on death ofa partner is same as that in the case of
partner. The differences between the two situations are:
planned, whereasdeath
() Retirement of apartner is voluntary in nature and thus, it can be
of a partnercannot be planned.
a partner,
() Payment of due amount is made to the retiring partner in case of retirement of Partner's
whereas due amount is paid to the legal heirs or the Executor of the Deceased
will in case of death of a partner.
hajustments that are made at the time of death of a partner:
I. Determining changed Profit-sharing Ratio;
2. Accounting for Goodwill;
O. Adjustment for Revaluation of Assets and Reassessment of Liabilities;
* Adjustment for Reserves, ACcumulated (Undistributed) Profits and LOsses;
d. Determining deceased partner's share of profit or loss up to the date of death;
6. Determining amount due to Deceased Partner;
7. P'ayment to the Deceased Partner's Legal Heirs or Executors of his estate; and
6. Adjustment of Capitals of the Continuing Partners (if agreed).
on Retirement of a Partner
The above said issues have been discussed in detail in the chapter
and, therefore, are discussed briefly in this chapter.
RATIO:
1.DETERMINING CHANGEDPROFIT-SHARING
RATIO
NEW PROFIT-SHARING RATIO AND GAINING
continuing
As aresult of death of a partner, profit-sharing ratio among the remaining or
remaining or
partners willchange. After the death of a partner, new profit-sharing ratio of the
Continuing partners and their gaining ratioare determined.
New profit-sharing ratio is calculated by adding the Existing (Old) Profit Share and acquired
Profit Share of the deceased partner, i.e.,
Partner
New Profit Share = Existing (0ld) Profit Share + Profit Share taken of Deceased
Unless agreed otherwise, deceased partner's profit share is taken by the continuing partners in
their old profit-sharing ratio. It means that profit-sharing ratio among the continuing partners
willremain same as it was before the death of a partner.
It isalso possible that new profit-sharing ratio is given.In that case gaining ratio is determined
bydeducting old profit share from the new profit share, ie.,
GainingRatio: Gain of a Partner =New Profit Share - OldProfit Share
The topic has been discussed on Pages 5.2 to 5.8 of Chapter Retirement ofa Partner.

2.ACCOUNTING OF GOODWILL
The deceased partner is entitled to his share of goodwill because goodwill was earned by
the firm when he was a partner. As in the case of Retirement of a Partner, Gaining Partners
compensate the deceased (sacrificing) partner by paying goodwill in their gaining ratio. Value
of goodwill is determined as per the terms of the Partnership Deed.
Valuation of Goodwill is discussed in Chapter 2, Goodwill.
Deceased Partner's Share of Goodwill=Value of Firm's Goodwill ×Profit Share of Deceased Partner
Goodwill, if existing in the books, is written off by debiting all Partners' (including Deceased
Partner) Capital Accounts. Thereafter, Deceased Partner's Capital Account is credited with his/
her share in Goodwill as valued on the date of death. Journal entry passed is:
Gaining Partners' Capital A/cs ..Dr. (InGaining Ratio)
To Deceased Partner's Capital A/c (With share of goodwil)
(Adjustment made for goodwill at the time of death of a partner)
It is tobe kept in mind that AS-26, Intangible Assets prescribes that self-generated Goodwill is
not recognised in the books of account. Hence, itis adjusted through Capital/Current Accounts
of the Gaining Partners.
The topic of acounting trentment of Godwill is discussed on Pages 5.9to 5.16of Chapter Retirement
of a Partner.
 ARESERVES, ACCUMULATED (UNDISTRIBUTED) PROFITS AND LOSSES
Reserves, accumulated (undistributed) profits and losses and fictitious assets (Deferred
Revenue Expenditure) are credited or debited to the Capital or Current Accounts of all the
partners(inchuding deceased partner) in their profit-sharing ratio.
decide to continue showing the balances in these accounts in the Balance
The partners may
is credited or
Sheet of the new firm. In this situation, Deceased Partner's Capital Account
Jalhited with his share in net effect of reserves, accumulated profits and losses and Gaining
Partners' Capital Accounts are debited or credited in their Gaining Ratio.
The topic is discussed on Pages 5.20 to 5.24 of Chapter Retirement ofa Partner.

5. SHARE OF PROFIT OR LOSS IN THE YEAR OF DEATH

Deceased partner is entitled to his/her share in profit from the beginning of the accounting
vear up to the date of his death. Similarly, he/she bears loss, if any incurred by the firm during
this period.
Deceased partner's profit share for the period is taken by the remaining partners either in
their profit-sharing ratio or as is agreed by the partners. In the absence of information it
is assumed that deceased partner's profit share is taken by the remaining partners in their
profit-sharing ratio.
The Journal entries passed under the two situations are different and are as follows:
(i) If profit-sharing ratio of the remaining or continuing partners does not change:
(a) When Deceased Partner's Share is Profit:
Profit &Loss Suspense A/c ...Dr.
To Deceased Partner's Capital A/c
The balance of Profit & Loss Suspense Account is shown in the assets side of the Balance
Sheet and is transferred to the debit of Profit &Loss Appropriation Account at the end of
the year on preparation of final accounts.
(b) When Deceased Partner's Share is Loss:
Deceased Partner's Capital A/c ..Dr.

To Profit &Loss Suspense A/c

The balance of Profit &Loss Suspense Account is shown in the liabilities side of the
Balance Sheet and is transferred to the credit of Profit &Loss Appropriation Account at the
end of the year.
) If profit-sharing ratio of the remaining or continuing partners changes:
(a) When Deceased Partner's Share is Profit:
Profit &Loss Suspense A/c ...Dr.

To Deceased Partner's Capital A/c

 Later, the balance of Proit &Loss Suspense Account is transferred to the gaining partners
intheir gaining ratio. The Journalentry passed is:
Gaining Partners' Capital A/cs ..Dr. [In Gaining Ratio]
To Profit &Loss Suspense A/c
Alternatively, follooing Journal entry may be passed at the time of death ofa partner:
Gaining Partners' Capital A/cs ...Dr. [In Gaining Ratio]
To Deceased Partner's Capital A/c
(b) When Deceased Partner's Share is Loss:
Deceased Partner's Capital A/c ...Dr.

To Profit &Loss Suspense A/c

Later, the balance of Profit &Loss Suspense Account is transferred to the gaining partners
in their gaining ratio. The Journal entry passed is:
Profit &Loss Suspense A/c ..Dr.
To Gaining Partners' Capital A/cs [In Gaining Ratio]

Alternatively, following Journalentry may be passed at the time of death of apartner:

Deceased Partner's Capital A/c ..Dr.

To Gaining Partners' Capital A/cs [In Gaining Ratio]

Determining Share of Profit or Loss of Deceased Partner

Deceased Partner'sshare of profit or loss from the beginning of the financial year up to the
date of death can be either

(a) determined; or
(b) estimnated.
(a) When Share of Profit or Loss is determined
Profit or Loss for the period is determined by preparing financial statements, ie., Profit &Loss
Account for the period from the beginning of the year up to the date of death and Balance
Sheet as on the date of death.

Financial Statements are prepared in the same manner as the accounts are prepared at the
year end. As a result, profit of the firm and the profit shareof all the partners, including
deceased partner for the period are determined. Net Profit, as per the Proit &Loss Account is
transferred to Profit &Loss Appropriation Account. Profit is appropriated to partners as per
the Partnership Deed. The Journal entry for the appropriation of profit is:
Profit &Loss Appropriation A/c ...Dr.
To Partners' Capital A/cs
(Profit share of partners including Deceased Partner transferred
totheir capitalaccounts in their profit-sharing ratio)
Section 37 of the Indian Partnership Act, 1932
As per Section 37 of the Indian Partnership Act, 1932, if full or part amount of outgoing partner
is unpaid:
(a) he will be entitled to interest or share in profits. If it is mutually agreed amongpartners
that interest or share in profit will not be paid, no amount shall be payable.
(b) if the partners do not have agreement as to payment of interest or profit share to the
outgoing partner (deceased partner in this case), the executor hasa choice to get either of
the following till final settlement:
(i) Interest @ 6% p.a. on the balance amount.
(ii) Share in the profit earned proportionate to his amount outstanding to total capital.
Share in Profit =
Outstanding Amount of Outgoing Partner Profit from the date of death
of a partner till the date of
Capital of all Partners+ Balance of Outgoing Partner next Balance Sheet
CHAPTER
Dissolution of aPartnership Firm
7
LEARNING OBJECTIVES
The study of this Chapter would enable students to understand: 7.1
Meaning of Dissolution of Partnership Firm
7.1
Modes of Dissolution of a Firm
7.2
Difference between Dissolution of Firm and Dissolution of Partnership
7.2
Settlement of Accounts
7.4
Difference between Firm's Debts and Personal Debts
7.4
g on Dissolution of Partnership Firm
7.25
between Revaluation Account and Realisation Account

MEANING OF DISSOLUTION OF PARTNERSHIP FIRM

i.e., dissolved.
Dissolution of firm means business of the firm is closed and the firm is wound up,
It differs from dissolution of
As a result, economic relationship among the partners ends. continues.
partnership which means reconstitution of partnership but the firm
firn means
According to Section 39 of the Indian Partnership Act, 1932, "Dissolution of the
dissolution of partnership among allthe partners in the firm."
loan by partner or
Indissolution of firm, assetsof the firm are realised and outside liabilities and
their Capital Accounts
partners are paid. Balance, if any, is paid to the partners in settlement of
outside liabilities, it is
(including loan to partner or partners). If there is shortfall in meeting
met by the partners from their personal assets.
MODES OF DISSOLUTION OF A FIRM

The modes by which afirm may be dissolved are:

for its dissolution.
1. By Mutual Agreement: Afirm may be dissolved when all the partners agree
2. Compulsory Dissolution: Afirm may becompulsorily dissolved:insolvent.
(a) when all the partners or all the partners except one become
(b) when business of the firm becomes unlawful.
3. By Notice: In case Partnership is at Will, the firm may be dissolved by any partner giving
(Section 43]
notice in writing to all the other partners of his intention to dissolve the firnm.
the
4. On Happening of anEvent: A firm may be dissolved in any of the following events, if
Partnership Deed so provides:
(a) on expiry of the term for which the firm was constituted.
(b) on completion of the venture.
(c) on death of a partner, if the Partnership Deed does not provide for continuation of the firm.
(d) on adjudication of a partner as insolvent.
 5. Dissolution by Court: Court may pass order for the dissolution of the firm when:
(a) apartner becomes aperson of unsound mind;
(b) apartner becomes permanently incapable of performing his duties as apartner;
(c) apartner is found guilty of misconduct, which is likely to adversely affect the business
of the firm;
(d) partnership agreement is breached persistently by a partner or partners;
(e) court finds dissolution of the firm justified;
(f) the business of the firm cannot be carried on except at a loss.
Difference between Dissolution ofFirm and Dissolution of Partnership
Basis Dissolution of Firm Dissolution of Partnership
1. Meaning It means closure of the firm and end ofIt means changeinbusiness relationship among
business relationship armong all the partners. the partners. The firm continues its busines.
2. Court's Intervention It can be either voluntarily by the partners It is always voluntary.
or compulsorily by order of court.
3. Business Continuation Business of the firm comes to an end. Business of the firm continues.
4. Closure of Books of Books of account of the firm are closed. Books of account of the firm need not be closed.
Account
5. Assets and Liabilities Assets of the firm are realised and liabilities Assets of the firm are revalued and liabilities
are settled. The balance amount, if any, is are reassessed. The gain (profit) or loSs due to
distributed among all the partners. it, is distributed among the partners in their old
profit-sharing ratio.
6. Economic RelationshipEconomic relationship between/among theEconomic relationship between/among the
partners ends. partners changes.
7. Effect Dissolution of firm also means dissolution Dissolution of partnership does not mean
of partnership. dissolutionof the firm.

SETTLEMENT OF ACCOUNTS

Generally, two issues are to be resolved at the timeof dissolution of a firm. These are:
1. Settlement of ACcounts, and
2. Paymernt of Firm's Debts and Personal Debts.
1. Settlement of Accounts [Section 48]I
Section 48 of the Indian Partnership Act, 1932 deals with the settlement of accounts when the
firm is dissolved. It is discussed below:
Treatment of Losses: Loss, including deficiencies of capital, is paid first out of profit, then out
of capitaland lastly, if necessary, by the partners individually in the ratio in which they share
profits. [Section 4S(a)]
Application of Assets:Assets of the firm, including amount contributed by the partners to meet
deficiencies of capital, are applied in the following orde:
(a) In paying firm's debts to the third parties, ie., outside parties;
(b) In paying to each partner rateably what is due to him on account of loans or advances;
() In paying to each partner rateably what is due tohim on accountof capital;and
(d) The residue, if any, is distributed among the partners in their profit-sharing ratio.
[Section 48(b)]
pifference between Revaluation Account and Realisation Account
Realisation Account
Basis Revaluation Account
and
1. Meaning It shows the effect of revaluation of assets t shows the realisation of assets
and reassessment of liabilities. settlement of liabilities.

2. Objective It isprepared to make adjustments in the It is prepared to determine net gain

value of assets and amount of liabilities. (profit)/loss on realisation of assets and
settlement of liabilities.

3. Time It is prepared at the time of admission or It is prepared at the time of dissolution

retirement or death of a partner. of the firm.

4. Contents In this account, only changes in the values In this account, all assets and liabilities
of assets and liabilities are shown. are shown.

5. Effectof entries on accounts Asa result of entriespassed in this account, Asa result of entries passed in this account,
relating to assets and the accounts of assets and liabilitiesthe accounts of assets and liabilities
liabilities revalued, are not closed. are closed.

6. Frequency of Preparation This account may be prepared anumber This account is prepared only once during
of Account of times during the life of a firm. the life of a firm.
 and "A ontinues
Insolvency Itnormally asenttty,Definitions theMeaning Aand Concept of >Meaning > > The
Lompany members company Concept
Concept Accounting
Procedure
Concept Accounting
Undersubscription Accounting
Shares
Oversubscriptionof Preference
SharesDifference
between
of Types Difference
Incorporation Companies
ofa Characteristics
CategoriesDifference
Companies
Types
of ofMeaningand study
mpany a Companies
on
1.e., or of
CHAPTER
means even an MEANING of of
Private of Kinds ofamong between this
or orhas (or EmployeesSweatPreferential and of of of Share
al." is artificial
an shareholders.
a
death
if
a share
a Act. joint a Accounting Shares
Calls-in-Arrears Issue or Chapter
8
tificial company Placement
Equity ClassesCapital
member(s) of It of Company One Partnership
capitalperson stock is AND Stock Allotment lssued Shares Person would
member a a of
person, legal of Shares
incorporated company)
CHARACTERISTICS Option of
Forfeiture for for (Features)enable
Accounting
divided
separate and Shares
Equityand Company,
becomes person
SharesConsideration
Cash and
created does Calls-in-Advance OBJECTIVES
LEARNING
Plan Company students
at
into not is (ESOP) and Par Private of
under not from an
entityby insolvent Reissue and Company a
law affect units association having Other (Joint to
this its at Company understand:
having members Shares
continuity called of
than Premium Stock
Act or physical (FEATURES) Forfeited
dies. Cash and Company)
-Section or
parate shares, of
any
(shareholders). persons Public for
previous of existence Shares
2(20) the the Company
formed OF Share
company, owners
Companyof and COMPANY A
with the
Companies a of has and
erpetual Law." i.e., which registered a
rof.
ney the separate legal Capital
cession Act, company are
known under 8.103 8.103 8.103 8.103 8.63 8.58 8.49 8.43 8.30 8.19 8.9 8.7 8.7 8.5 8.5 8.4 8.3 8.2 8.1
2013
Characteristics (Features) of a Company
i) Incorporation: Acompany is an artificial person created by the process of lavw, ie, the
Companies Act.
(i) Separate Legal Entity: Acompany is an artificial person having a legal entity separate
from its shareholders.
(iii) ArtificialPerson: In the eyes of law, it is an artificial person. It can own property, enter
actions.
into contract, conduct business, sue or be sued for its debts and
i.e., its existence is not
(TV) Perpetual Existence: A company has a perpetual succession, shareholders. Life of a
affected by the death, lunacy or bankruptcy of its members or
law.
Company comes to an end, only by winding up through the process of
(face) value of
(v) Limited Liability: Liability of its mnembers is limited to the nominal winding up
shares subscribed by them or amount guaranteed to be paid at the time of
in the case of companies limited by guarantee.
However, in case of companies incorporated with unlimited liabilities, liability of
members is unlimited.
(vi) Transferability of Shares: Shares of a company are freely transferable in the case of
companies listed on aStock Exchange. In the case of unlisted companies and private
companies, it is regulated by Articles of Association of the company.
(viü) Management and Ownership: Acompany is not managed by allthe members but by their
elected representatives called LDirectors. Thus, management and ownership are separate.
(viii) Common Seal: A company may or may not have a common seal. If it has acommon
seal, it is affixed to all the important documentsof the company.
Difference between Partnership and Company (Joint Stock Company)
Basis Partnership Company (Uoint Stock Company)
1. Mode of Formation It is set up by an agreement among the It is set up by registration under the
partners. Registration is not compulsoryunder Companies Act, 2013 or under any previous
the Indian Partnership Act, 1932. Companies Acts.
2. Regulatory Act The Indian Partnership Act, 1932 applies. The Companies Act, 2013 applies.
3. No. of Members Minimum number of partners is 2 and Inthe case of publiccompany, minimum number
maximum 50 as per Section 464 of the of members is 7without any maximum limit.
Companies Act, 2013 and Rule 10of CompaniesA private company has at least 2members but
(Miscellaneous) Rules, 2014. not more than 200 excluding its present or past
employee members.
One Person Company has only one member.
4. Liability Liability of thepartners is unlimited, joint and| Liability of the members is limited to the
several. amount of shares held by them or amount
guaranteed to be paid on winding up in case
of Companies Limited by guarante.
In the case of companies with unlimited
liability, liabilities of members is unlimited.
5. Distribution of Profits are distributed as per the terms of the The Board of Directors decides dividend to be
Profts Partnership Deed or equaly if Partnership paid. Interim Dividendis declared by the Board
Deed does not exist. of Directors while Proposed (final) Dividend is
declared (approved) by the shareholders.
 6. Management Business may be managed by all the partnersBusiness is managed by thedirectors who are
or any of them acting for all. elected by the shareholders.
, Transfer of SharesApartnercàn trànster his profit share to other Except in case of unlisted and private
person as is provided in the Partnership Deed companies,transfer of shares is not restricted.
or with the consent of all the partners.
8. Business Apartnership can carry onany business, if allA companycan carry on only that business
the partners agree. which is permitted by the Objects Clause of
its Memorandum of Association.
9. Winding up A partnership may be wound up by an Acompany can be wound up only by the
agreement or by an order of the court. process prescribed in the Companies Act, 2013.
10. Stabilityof the It is affected by death, retirement or insolvency Shareholder's death, insolvency or transfer of
Business of partners. shares do not affect continuity of the company.

TYPES OF COMPANIES

Companies are of following three types:

(i) One Person Company (OPC);
(ii) Private Company; and
(iüi) Public Company.
One Person Company (OPC)
One Person Company (OPC) is a company which has only one natural person as a member or
shareholder.
Section 2(62) of the Companies Act, 2013 defines One Person Company as One Person Company
means a Company which has only one person as member".
Rule 3of the Comparies (Incorporation) Rules, 2014 relating to One Person Company prescribes that:
One Person
(a) Onlya natural person being an Indian Citizen and resident in Indiacan form
Company or can be a nominee for the sole member of One Person Company.
one such
(b) One person can form only one One Person Company' or become nominee of only
company.
(c) It canrnot be formed for charitable purposes.
investments in
(a) Itcannot carry out Non-Banking Financial Investment activities including
Securities of any body corporate.
(e) Its Paid-up Share Capital is not more than? 50lakh.
2 Crore.
() lts average annual turnover of three years should not exceed
A One Person Company can have at least 1 director but not more than
15 directors.
lhe name of One Person Company ends with OPC.
Private Company
Alrivate Company is one which has a minimum paid-up share capital as may be prescribed
and which by its Articles of Association:
(a) restricts the right to transfer its shares, if any.
dated
*Thecompanies are not required to have minimum paid-up capital at present vide notification
29th May, 2015.
 (b) limits the number of its members excludng its present or past employee members to 200
Where shares are held by two or more persorns jointly they shall be treated as asingle memkL
(c) prohibits any invitation topublic to subscribe for any securities of the company.
(Section 2(68)of the Companies Act, 20131
A private company should have at least 2 directors but not more than 15 directore
The name of a Private Company ends with the words, Private Limited'.
Public Company
APublic Company is acompany which:
(a) is not aprivate company;
(b) has a minimum paid-up capital as may be prescribed*; and
(c) is a Private Company, being a subsidiary of a company which is not a Private Company.
|Section 2(71) of the Companies Act, 2013]
Apublic company must have at least 7 members. There is no restriction on the maxinmum
number of members.
A public limited company should have at least 3 directors but not more than 15 directors.
The name of a Public Company ends with the word Limited'.
A
public company is further categorised into (i) Listed Company, and (i) Unlisted Company.
Apublic company can raise its capital by issue of shares to public for subscription. Shares
on issue topublic are listed on Stock Exchange and the company is categorised as Listed
Company. Securities listed on Stock Exchange can be sold or purchased without restriction.
 derenceamong One Person Company, Private Company and Public Company
Difference
Bass One Person Company Prlvate Company Public Company
Numberof Minimum and maximum Minimum number of members Minimum nunber of members is 7and
Members number of members (share- is 2 and the maximum 200, there is no limit as to the
holders) is1(one). maximum
excluding its present or past number of members.
employee members.
2. Transferof Not Applicable. Articles of Association of Transfer of shares of listed companies
Shares the company restricts the are without restriction.
transfer of shares. However, shares of unlisted companies
are restricted by the Articles of Association
of the company.
3. Prospectus Not Applicable. Prospectus is not issued. Prospectus is issued to invite public to
subscribe for shares.
Statement in Lieu of Prospectus is filed
with the Registrar of Companies, if shares
are issued on private placement.
4 SubscriptionShares cannot be offered to Shares cannot be offered to Shares can be offered to public for
of Shares public for subscription. public for subscription. subscription.
5. Articles of Special Articles of Association Special Articles of Association Table F given in the Companies Act,
Association are necessary. are necessary. 2013 may be adopted. Alternatively, it
can have its own Artides of Association
having cdauses different from those given
in Table F of the Companies Act, 2013,
which willoverride TableF.
6. Number of Itmust have at least 1Director | Itmusthave at least 2 Directors It must have at least 3 Directors but not
Directors but not more than 15. but not more than 15. more than 15.
7. Allotment Not Applicable. Shares may be allotted as Listed Companies: Shares can be allotted
of Shares the Directors decide. only if Minimum Subscription has been
received.
SEBI* prescribes that acompany should
receive at least 90% of issue before
allotment of shares.
Unlisted Companies: Shares can be
allotted as the Directors decide.
The Companies Act, 2013 [Section 39(1)
prescribes that the company may
decide minimumsubscription.
8. Public
It cannot invite and acceptIt cannot invite and accept It can invite and accept deposits from
Deposits deposits frompublic. deposits from public. public.
9. Name
The word'OPC'is used as part The words Private Limited The word limited is used as part of the
of the name. are used as part of the name. name.
DL l means Securities and Exchange Board of India.
 1.Promotion
incorporation. A person or a group of persons agree to start
It is the irst stage of the company's These persons are known as Promoters.
business in the form of acompany.
2.Incorporationor Registrationof a Company procedure prescribed in the Companies Act, 2013
following the
Acompany isincorporated name of the proposed company approved from the Registrar
The promoters after getting the of Association (In the Memorandum of
Association.
of Companies submit Memorandum the stated numnber of shares once the company
subscribe
the promoters also undertake to consent of first directors to act as directors
and a
Articles of Association,
is incorporated), Act have been complied with.
declaration that the requirements of the Companies
Registrar of Companies, thereafter, issues Certificate of lncorporation. The Company,
The
thereafter, comes into existence.
Commencement of Business
3. Capital Subscription and declaration is to
company has to obtain 'Commencement of Business' certificate for which
A
has to submit a declaration tothe effect
filed within 180 days of its incorporation. A company
has paid the amount for the shares
that every subscriber to the Memorandum of Association
undertaken by him/her to subscribe.
Prospectus
conditions of the issue
Apublic company issues a document called 'Prospectus' in which terms and
used.
are stated along with the purpose for which the proceeds of the issue of securities shall be
"Prospectus" means any document described or issued as a prospectus and includes a red
herring prospectus or shelf prospectus or any notice, circular, advertisenment or other document
inviting offers from the public for the subscription or purchase of any securities of a body
corporate. [Section 2(70) of the Companies Act, 2013]
Minimum Subscription (Section 39(1) ofthe Companies Act, 2013]
and Provisionsof SEBI (Securities and Exchange Board of India)
As per Section 39(1)of the Companies Act, 2013, Minimum Subscription is the amount the
company states in the prospectus which must be subscribed and the amount payable on
application for the amount stated as minimum subscription have been paid to and received
by the company by cheque or other instrument.
SEBI(Securities and Exchange Board of India),the regulatory authority for listedcompanies,
prescribes that a company must receive minimum subscription of 90 per cent of the shares issued
for subscription before it allots the shares.
Thus, in the case of public issue of shares, at least 90% of the sum payable on application
or minimum subscription stated in the prospectus, whichever is higher, should be received by
the company before the shares can be allotted.
In case, minimum subscription is not received within the specified period, application money
has to be refunded within fifteen days from the closure of the issue.
Preliminary Expenses
Preliminary Expenses are the expenses incurred for incorporating the company, such as
registration fee, legal expenses, preparation of project report, public issue expenses,
etc., or if anew project is started. These expenses are written of from Securities Premium
and/or from Staterment of Profit & Loss (in that order) in the year they are incurred.
Non-cumulative Preference Shares
Non-cumulative Preference Shares do not carry the right to receive arrears of dividend. In the
for the yea
above example, Preference Shareholders shallbe entitled to receive dividend only
Shareholders.
ended 31st March, 2024, i.e., 70,000 before dividend is paid to Equity
On the basis of Participation in Surplus Profit
Preference Shares
Preference Shares may be Participating Preference Shares or Non-participating
Participating Preference Shares
after dividend has been paid to
The Articles of Association of a company may provide that
have a rightto participate in
the Equity Shareholders, holders of Preference Shares will also Preference
called Participating
the remaining profit. The Preference Shares having this right are
Shares.
Non-participating Preference Shares
Preference Shares which do not have the right to participate in the profit remaining after Equity
Shareholders have been paid dividend are Non-participating Preference Shares.
On the basis of Convertibility
Preference Shares.
Preference Shares may be Convertible Preferernce Shares or Non-convertible
Convertible Preference Shares
Convertible Preference Shares carry a right to be converted into Equity Shares.
Non-convertible Preference Shares
Non-convertible Preference Shares do not carry a right to be converted into Equity Shares.
On the basis of Redemption
Preference Shares may be Redeemable Preference Shares or Irredeemable Preference Shares.

Redeemable Preference Shares

Redeemable Preference Shares are redeemed by the company at the time specified (not
exceeding 20 years from the date of issue) for their repayment or earlier. The repayment of
amount is termed as Redemption.

Irredeemable Preference Shares

Irredeemable Preference Shares are those the amount of which can be returned by the company
to the holders of such shares when the company is wound up.
The Companies Act, 2013 does not permit issue of Irredeemable Preference Shares.
2. Equity Shares [Section 43(1) of the Companies Act, 2013]
Equity Shares are those shares which are not Preference Shares.
Equity Shares are.the most commonly issued class of shares and have the maximum ´risks
and rewards' of the business: the risks being losing part or all of the value of shares if the
business incurs losses; the rewards being payment of higher dividends and appreciation
in the market value.
 orence between
Difference Preference Shares and Equity Shares
Basis Preference Shares Equity Shares
1. Right to Dividend Dividend paid on Preference Shares if it is Dividend may or may not be paid on
is
paid on Equity Shares. Equity
Shares if it is paid on Preference Shares.
2. Rate of Dividend Rate of Dividend is fixed,
Rate of dividend is proposed by the Board of
Directors every year and declared byshareholders.
Interim dividend (declared within the financial
year) is declared by the Board of Directors.
2 Arrears of Dividend If Preference Shares are Cumulative
Preference Dividend is declared every year. In case,
Shares, arrear of dividend is paid before ividend is not declared for the year, it is not
dividend is paid on Equity Shares. accumulated to be paid in the coming years.
4. Convertibility Preference Shares may be converted to Equity Equity Shares are not convertible.
Shares, if the terms of issue so provide.
5. Redemption Preference Shares are redeemed on the due date. Acompany may buy-back its Equity Shares.
6. Voting Rights Preference shareholders have voting rights Equity shareholders have voting rights in all
only in special circumstances. the circumstances.
7. Repayment of On winding up, Preference Share Capital is On winding up, Equity Share Capital is repaid
Capital repaid before the Equity Share Capital is paid. after the Preference Share Capital is paid.
8. Right to Participate Preference shareholders do not have a right to
Equity shareholders have a right to participate
in Management participate the management of the company. in the management of the company.
in
Difference between Authorised or Nominal Capital and lssued Capital
Basis Authorised or Nominal Capital Issued Capital
1. Meaning It is the amount stated in the MemorandumIt is the nominal value of that pat of
of Association which a company can issue as Authorised Share Capital which is issued
share capital of the company. for subscription.
2. Disclosure in The amount is stated in Memorandum of It is not stated in the Memorandum of
Memorandum of Association. Association.
Association
3. Whether one can It is equal to or more than the Issued Share It is equal to or less than the Authorised
exceed the other Capital. Share Capital.
Diference between Reserve Capital and Capital Reserve
Basis Reserve Capital Capital Reserve
1. Meaning It is that part of the uncalled capital which is It is that part of the reserves which is not free
called in the event of company's winding up. for distribution as dividend.
2. Creation It is an uncalled capital. It is a reserve set aside out of capital profits.
3, Optional/Mandatory It is not mandatory to have reserve capital. It is appropriate to transfer capital profits to
capital reserve.
4. Resolution Specialresolution is required for reserve capital. No resolution isrequired for capital reserve.
5. Writing off It cannot be used to write off capital losses. It can be used towrite off capital losses.
Capital Losses
6. Disclosure It is not disclosed, i.e., shown in the company's It is disclosed, iie., shown in the Note to
Balance Sheet. Accounts on Shareholders' Funds under the
head'Reserves and Surplus.
 Utilisation of Securities Premium
Section 52(2) of the Companies Act, 2013 restricts the use of the amounts received as premium on securities
for the following purposes:
() Issuing fully paid bonus shares to the members;
(i) Writing off preliminary expenses of the company:
{ii) Writing off the expenses of, or the commission paid or discount allowed on any issue of securities or
debentures of the company;
(iv) Providing for the premium payable on the redemption of any redeemable Preference Shares or of any
debentures of the company;
(v) in purchasing its own shares or other securities under Section 68.
Difference between Oversubscription and Undersubscription of Shares
Basis Oversubscription of Shares Undersubscription of Shares
1. Shares Applied Number of shares applied is more than the | Number of shares applied is less than the
shares offered for subscription. shares offered for subscription.
2. Acceptance Allapplications are not accepted. Some are Allthe applications for shares are accepted
rejected. Alternatively, shares are allotted on and allotment is made to all the applicants.
pro rata basis.
3. Refund Excess application money is refunded or As all the applications are accepted, there is
adjusted towards allotment and calls. no excess application money to be refunded.
4. Minimum A
company does not face issue of Minimum A company may face the problem of
Subscription Subscription! 'Minimum Subscription.
Interest on Calls-in-Arrears
The company if authorised by its Articles of Association may charge interest at the
specified
rate on Calls-in-Arrears from the due date to the date of payment. In case, the Articles of
Association of the Comparny is silent or it does not have clause to this effect, Table F of the
Companies Act, 2013 applies which provides for interest on Calls-in-Arrears @10% p.a. However,
the company has the right to waive the interest on Calls-in-Arrears.
Interest on Calls-in-Arrears is not in syllabus.
Interest on Calls-in-Advance
Calls-in-Advance is paid if the Articles of Association so provides. But if the
Interest on effect, provisions of Table F
to this
Articles of Association is silent or it does not have clause
pay interest on Calls-in-Advance
of the Companies Act, 2013 apply and the company is liable to
@12% p.4.
Interest on Calls-in-Advance and Calls-in-Arrears is not in syllabus.
referential Allotment
Dooferential Allotment means allotment of shares at apredetermined price to the
ho are interested in taking shares in the company such as identified people
promoters, venture
institutions, buyers of company's products or its suppliers. The company capitalists, financial
is required to pass
snecial resolution in the meeting of shareholders before proceeding with
preferential allotmernt.
Concept of Private Placement of Shares
According to Section 42 of the Companies Act, 2013, Private placement means any
offer ot
serurities or invitation to subscribe securities to a select group of persons by a
company (other
than by way ot public ofter) through issue of private placement offer letter arnd which satisfies
the conditions specified in this section. Stating it differently, securities offered to the
selective
group of persons is known as the Private Placement of shares.
Accounting Entries
Accounting entries for private placement of shares are passed as in the case of issue of shares
for cash to public. These entries have been discussed earlier in the chapter.

Concept of Sweat Equity

The term Sweat Equity Shares' is defined in the Companies Act, 2013 (Section 2(88)] as
"Sweat Equity Shares means such equity shares as are issued by a company to its directors or employees
at adiscount or for consideration other than cash, for providing their knozv-how or making available
rights in the nature of intellectual property rights or alue additions, by whatever name called."
Thus, Sweat Equity Shares can be issued in lieu of know-how or intellectual property right
Or value additions which may be called by any name. Further these shares may be issued at a
discount for cash or for consideration other than cash. Sweat Equity Shares are allowed to be
ISsued at discount by Section 54 of the Companies Act, 2013. However, acompany may issue
these shares at par or at premium,as it decides.
Ine term "Sweat Equity Shares" is a wider term than Employees Stock Option Plan (ESOP)
SInce ESOPs are restricted to be issued to employees and employee directors whereas Sweat
tquity Shares may be issued to directors who are not employees of the company.
Concept of Employees Stock Option Plan (ESOP)
mployees Stock Option Plan (ESOP) means option granted by the company to its employees
and employee directors to subscribe the shares at a price that is lower than the market price,
l.e., fair value. It is an option or aright granted by the company but it is not an obligation on
the employee to subscribe it. The employees may or may not exercise the option.
Employees Stock Option Plan is acategory of Sweat Equity. Sweat Equity is a wider term than ESoN
and includes issue of shares to promoters as remuneration for
incorporating the companyo
for their other services.

Acompany may issue stock (shares) options fulfilling the following conditions:
(a) these shares are of the same class of shares already issued;
(b) it is authorised by a special resolution passed by the company;
(c) the resolution specifies the number of shares, the current market price, consideration, ifany. and
the class or classes of directors or employees to whom such equity shares are to be issued:
(d) not less than one year has, at the date of issue, elapsed since the date on which the company
1

had commenced business; and

1
(e) these shares are issued in accordance with SEBI regulations, if the shares are listed.
17
 CHAPTER
Issue of Debentures
9
LEARNING OBJECTIVES
The study of this Chapter would enable students to understand: 9.1
Meaning and Characteristics or Features of Debenture 9.2
Meaning of Bond
9.2
Difference between Debenture and Share
9.2
Difference between Debentureholder and Shareholder
9.3
Types of Debentures
9.6
> Issue of Debentures for Cash at Par, at Premium and at Discount
9.19
> Issue of Debentures for Consideration other than Cash 9.29
Issue of Debentures as Collateral Security
9.50
AccountingTreatment of Interest on Debentures
9.53
Writing off Discount or Loss on Issue of Debentures

MEANING ANDCHARACTERISTICS OR FEATURES OF DEBENTURE

Debenture is a written instrument or document issued by the company acknowledging the
borrowing, i.e., debt. The terms of repayment of principal and payment of interest at a specified
rate are stated in the document.
"Debenture includes debenture stock, bonds and any other instrument of the companyevidencing a debt,
whether constituting a charge on the assets of the company or not."
-Section 2(30)of the Companies Act, 2013

"A debenture is a document given by a company as evidence of a debt to the holder usually
arising out
of aloan and most commonly secured by a charge." -Topham
debentures are issued
Thus, debenture is borrowing of the company and the persons to whom
are called Debentureholders.
Characteristics or Features of Debenture
1. Debenture is a written document or certificate acknowledging debt by the company.
k. Mode and period of repayment of principal and interest is specified.'Debentures' with the
J. Rate of interest on the debenture is specified. It is a practice to prefix
title of the debentures will be
Tate ofinterest. For example, if the rate of interest is 7%, the
"7% Debentures'.
4. It is borrowing of the company.
D. It is normally secured by way of charge on the assets of the company.
b. Interest on Deberntures is a charge against profit.
Bond
Bond, like debenture, is an acknowledgement of debt issued by the company and. signed by:
authorised Signatory. The expression "Bond' is synonymous with debt instrument
rate of interest is not stated rather the amount payable on maturity is stated.
wherof e the
are Deep Discount Bond and Zero-Coupon Bond.
Examples bonds
Any Other Instrument
Anyother instrument will include any kind of security (document) evidencing borrowine th.
a company may issue. For example, Public Deposit, it being an instrument of the Company, is
also a debenture. In other words, the term 'Any Other Instrument is a wide term that inchud
every instrument issued by the company that evidences debt.
Difference between Debenture and Share
Debenture Share
Basis
Debenture is borrowing of the company. Share is capital of the company. Hence a
1. Ownership shareholder is the owner.
Therefore, adebentureholder is a lender.
2. Return
Debentureholder gets interest at the stated| Ashareholder gets dividend on his investment
rate whether the company earns profit or not.

3. Repayment Debentures are issued for aspecifhed period. Normally, the amount of share is not repaid
Hence, the amount of debentures is repaid on duringthe lifetime of the company. However.
the due date. preference shares have a limited life and are
redeemed on due date.

4. Issue at Discount Debentures can be issued at discount. Shares cannot be isSued at disCOunt except
where they are issued as Sweat Equity shares.
5. Security Debentures may or may not be secured by a Shares are not secured.
charge on the assets of the company.
Debentures can be converted into shares. Shares (except Convertible Preference Shares)
6. Convertibility cannot be converted into any other security.
Debentureholders do not have voting right. Shareholders (Equity)have aright to attend and
7. Voting Right
vote in the general metings.
8. Risk
Debentureholders are relatively safe. Secured Shareholders are at agreater risk. They caneven
Debentures are almost risk free. lose the amount invested in shares.

9. Priority as to In case of winding-up of the company, payment In case of winding-upof the company, payment
Repayment of of debentures is made before the payment of of share capital is made after repayment o
share capital. debentures.
Principal
Difference between Debentureholder and Shareholder
Basis Debentureholder Shareholder
Shareholder is the owner of the company.
1. Status Debentureholder is the lender of the company.
2. Return Adebentureholder gets interest on his investment at the Ashareholder gets dividend.
specifhed rate whether the company earns profit or not.
3. Control Adebentureholder does not have right to participate Ashareholder has a right to particip3te
by attending
and
in the management of the company by voting or management of the company
otherwise. voting in the General Meeting.

4. Risk
Debentureholders are relatively safe. Secured Shareholders are at agreater risk. They an
debentureholders are almost free from risk. lose the amount ivested in shares.
(i1) Unregstered or Bearer Debentures: Unregisteredlor Bearer debentures are the
are not registered in the records of the companyinthe name of the holder. These debentures that
are transferable by mere delivery. Interest is paid tothe person who produces
attached to the debenture.
debCoupons
entures
4. Convertible and Non-convertible Debentures
(i) Convertible Debentures: Convertible Debentures are the debentures that are
into shares. If a part of the debenture amount is convertible into Equity Shares, they convertible
known as Partly Convertible Debentures. If full amount of debentures is convertible in
Equity Shares, they are krown as Fully Convertible Debentures.
(ii) Non-convertible Debentures:Non-convertible Debentures are the debentures that are moL
convertible into shares.
Debentures Trust Deed
Company issuing debentures to public is required to appoint trustees and execute aTrust Deed
It is the responsibility of the trustees to protect the interest of the debentureholders throueh
the powers granted by the Trust Deed.
Disclosure of Debentures in the Balance Sheet
Debentures are borrowings of acompany, ie, aliability. Hence, they are shown in the Equity
and Liabilities part of the Balance Sheet.
Debentures may be issued for long-term or short-term period. Thus, they are shown as either
Long-term Borowings under the head Non-current Liabilities or Short-term Borrowings under the hend
Curent Liabilities, which depends on the tenure of the debentures from the date of their issue.
In the absence of information, debentures are assumed to be Long-term Borrowings.

NON-CURRENT LIABILITIES AND CURRENT LIABILITIES

Scheduleilof the Companies Act, 2013 prescribes that liabilities are to be shown as Non-current Liabilites
and Current lLiabilities on the basis of its maturity period. To recapitulate, liabilities that are due for payment
after 12 months or after the period of Operating Cycle from the date of Balance Sheet are shown as
Non-current Liabilities and the remaining Liabilities as Current Liabilities.
Debentures--When Long-term Borrowings (Non-Current Liability)
Debentures are classified, ie., shown in the Balance Sheet under the main head 'No1-current
Liabilities' and sub-head 'Long-term Borrowings', when they are redeemable after 12 months
or after the period of Operating Cycle from the reporting date, ie, the date of Balance
Sheet, whichever is later. Whether debentures are to be shown as Long-term Borrowings or
Short-term Borrowings, it is determined on the date of issue of debentures.
For example, Nirula's Ltd. has 10,000;9% Debentures of ?100 each redeemable on 31st March, 2023.
The period of Operating Cycle is 24 months. In the Balance Sheet as at 31st March, 202+
such debentures will be shown as Long-term Borrowings under the head Non-current
Liabilities because they are redeemable after 31st March, 2025 (i.e., 12 months after the Cycle
date
of Balance Sheet) and also after 31st March, 2026, i.e., after the period of Operating
(i.e., 24 months after the date of Balance Sheet).
 Applications Supported by Blocked Amount (ASBA)
ASBA is a system for applying shares or securities whereby the appBicant authorises his or her bank to block
the amount payable as application money, i.e., place a lien up tothe amount payable as Application Money
on the number of Shares or securities applied.
securities to
on snares or securities being allotted. the bank willtrancfer the amount due on allotted shares Qr
the company and remove lien on the balance amount.
The effect of ASBA is as follows:
I. The bank account of the applicant is debited by thebank after the shares or securities have been allotted to
him. As a result, the Account holder will get interest on the blocked amount till the time shares or securities are
allotted. Application money on allotted shares is remitted to the company. Thereafter,the account holder
Wii get interest onthe reduced amount, ie.. blocked amount less amount remitted to the cOmpany.

2. As far as the company is concerned, the company willreceive Application Money on the shares or securities
allotted. lt means the company will not have excess Application Money. The company will demand the
aliotment money and First Call, etc. as per the terms of issue.
Let us take an example to understand it better.
Feviquick Ltd. issued 10,000,89% Debentures of 100 each, payable 50 on application and balance amount
on allotment. Rakesh applied 500; 8% Debentures of ? 100 each through ASBA and authorised the bank to
block 25,000 (500 x 50). Bank at this stage, will place lien on 25,000 in the account of Rakesh and not
debit (withdraw) the amount from his acCount.Subsequently, Rakesh was allotted 250, 8% Debentures, Bank
willtransfer 12,500 (250 x R50) to the account of the company by debiting the account of Rakesh by the
amount and remove lien on the balance of 12,500.
Exampie 1.
Blue Star Ltd. invited applications for 10,000, 7% Debentures of ?100 each payable on application through ASBA.
Itreceived applications for 15,000, 7% Debentures. It allotted the debentures to all the applicants on pro ratabasi.
Pass the necessary Journal entries in the books of Blue Star Ltd.

Solution: JOURNAL
Date Particulars LF. Dr. ()
Bank A/c .Dr. 10,00,000
To Debentures Application and Allotment A/c 10,00,000

(Application Money received on 10,000, 7% Debentures @ 100 each)

Debentures Application and Allotment A/c ..Dr. 10,00,000
To 7% Debentures A/c 10,00,000
(10,000; 79% Debentures allotted)

Example 2..
Red Star Ltd. invited applications for 10,000, 7% Debentures of 100 each application, 25on
payable 740 on Itreceived
allotment and balance on First and Final Cal. Applications were required to be made usingJASBA facility.I
applications for 16,000, 7% Debentures. It allotted the debentures to allthe applicants on pro rato vosia
Pass the necessary Journal entries in the books of Red Star Ltd.
 VARIOUSCASES OF ISSUE OF DEBENTURES FROM THE POINT OF VIEW OF REDEMPTION
Debentures issued at par, at premium or at discount may be redeemable either at par or at
premium. If the debentures are redeemable at premium, premium payable on redemption of
debentures is provided in the books of account at the time of allotment of debentures following
the Prudence Concept of accounting.
The term Redeemable at Par mearns debentures are redeemable at their nominal (face) value.
For example, a debenture has a nominal (face) value of ? 100 and is redeemable at ? 100, it is
redemption at par.
The termn Redeemable at Premium means debentures are redeemable at a value that is higher than
their nominal (face) value. For example, a debenture has anominal (face) value of 100 and is
redeemable at ? 110, it is redemption at premium.
Diference between Premium on Issue of Debentures and
Premium on Redemption of Debentures
Basis Premium on Issue of Debentures Premiumn on Redenmption of Debentures
1. Capital Profit/Loss Itis a capitalreceipt andis used forthe purposes Itis acapital loss.
specified in Section 52(2) of the Companies
Act, 2013.
2. Nature It isa reserve. It is a liability.
3. Flow of Cash It involves inflow of cash. It involves outflow of cash on redemption.
4. How shown in The Balance is shown in the Equity and| It is shown in the Equity and Liabilities part of
Balance Sheet Liabilities part of the Balance Sheet under the Balance Sheet under the main head
main head Shareholders'Funds andsub-head Non-current Liabilities' and sub-head 'Other
Reserves and Surplus. Long-term Liabilities.

There are six cases of issue and their redemption as follows:

Case Conditions of issue Conditionsof Redemption
1. Issued at par Redeemable at par
2. Issued at discount Redeemable at par
3. Issued at premium Redeemable at par
4. Redeemable at premium
Issued at par
5. Issued at discount Redeemable at premium
6.
Issued at premium Redeemable at premium
 CHAPTER

Financial Statement Analysis

LEARNING OBJECTIVES
The study of this Chapter would enable students to
e Meaning of Financial Statement Analysis understand:
2.1
e Tools or Techniques of Financial Statement
Analysis 2.2
" Types of Financial Statement Analysis 2.3
Distinction between Horizontal Analysis and Vertical Analysis 2.3
Process of Financial Statement Analysis 2.4
" Objectives and Significance of Financial Statement Analysis 2.5
Uses of Financial Statement Analysis 2.6
e Parties Interested in Financial Statement Analysis 2.6
Limitations of Financial Statement Analysis 2.8

MEANING OF FINANCIAL STATEMENT ANALYSIS

Analysis of Financial Statements is a systematic process of analysing the financial information in
the financial statements to understand and take economic decisions.
Analysis of Financial Statements is a study of relationships among various financial values
in the financial statements, i.e., Balance Sheet, Statement of Profit & Loss and Cash Flow
Statement. The data given in the financial statements is divided or broken into simple
and valuable' elements and relationships are established between the interdependent or
related elements of the same statement or different financial statements. This process of
division, establishing relationships and interpretation thereof to understand. the working
and financial position of a business is known as Analysis of Financial Statements.
"Financial Statement Analysis is largely a study of relationships among the various financial
factors in a business, as disclosed by a single set of statements, and a study of trends of these
factors, as shown in a series of statements." -Myer
"The analysis and interpretation offinancial statements are an attempt to determine the significance
and meaning of financial statement data so that the forecast may be made of the prospects for future
earnings, ability to pay interest and debt maturities (both current and long-terim) and profitability
and sound dividend policy." -Kennedy and Muller
The term 'Financial Analysis' includes both 'Analysis' and 'Interpretation'. 'Analysis' is
Concerned with simplification of financial data given in the financialstatements by proper
Classification. 'Interpretation' is concerned with explaining the meaning and significance
of the financial data. These two terms are complementary to each other, i.e., analysis is
not of much use without interpretation of analysis.
Financial Statement Analysis provides information about the Liquidity, Long-term Solvency,
Operating Efficiency and Profitability of the business.
Fnancial Statement Analysis is undertaken by creditors, investors and other users of financial
Statements to assess credit worthiness, financial soundness and earning potential of the business.
 TOOLSOR TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS
Analvsis of FinancialStatements involves analysis and interpretation of Financial Statemente
For this, a number of tools or techniques have been developed by financial
Commonly used tools for Financial Statement Analysis are: experts.
Comparative Statements
Comparative Statements or Comparative Financial Statements mean a comparative study of
individual items or components of financial statements, i.e., Balarnce Sheet and
of Profit & Loss of two or more years of the enterprise itselt.
Statement
In Comparative Statements, amounts of two or more years are placed side by side along
with change in amounts in absolute and percentage terms to facilitate comparison. Both
Statementof Profit and Loss and Balance Sheet are prepared in the form of Comparative
Statements or Comparative Financial Statements.
This technique of financial analysis is also known as Horizontal Analysis. This technique
is used for intra-firm analysis (ie., comparison of actual values of one period with those
of another period for the same firm) as well as for inter-firm analysis (i.e., comparison of
actual values of one firm with another firm of similar nature and size).
Common-size Statements
Common-size Statements or Common-size Financial Statements mean statements in which
individual items of financial statements of two or more years are placed
thereafter converted into percentages taking a common base. side by side and
Assets or Total of Equity and Liabilities, in the case of Common base taken is Total
from Operations, in the case of Common-size Balance Sheet and Revenue
Common-size Statement of Profit & Loss.
In Common-size Balance Sheet, the Total Assets or Total of Equity and
100 and all amounts are expressed as liabilities is taken as
percentage of total. Similarly, in
i.e., Net Sales is taken Common-size
of Profit & Loss, Revenue from Statement
of incomes and expenses are Operations, as 100 and all amounts
expressed as a percentage of
Net Sales. This technique of
financial analysis is also knownRevenue
as
from Operations, 1.e,
Vertical Analysis.
Ratio Analysis
Ratio is an arithmetical expression of
components of financial statements of anrelationship between two related or interdependent
with the help of accounting ratios is accounting period. An analysis of financial statemens
tool or technique for analysing termed as Ratio Analysis. Ratio
&Loss. It helps in financial statements, i.e., Balance SheetAnalysis is an importa
and Statement of Prous
Cash Flow Statement
assessing the profitability, solvency,
liquidity and efficiency of an enterP
Cash Flow Statement is a
statement showing flow of Cash and Cash
accountingItperiod, classified Equivalents during
Activities. shows the sourcesunder Operating Activities, Investing Activities and Financ'
which it is utilised (used). It also from which cash is received (generated) and the purpoSes
shows the changes in cash
In addition of the
above tools, position from one period to anou
Funds Flow
also tools of Financial
been discussed. Statement Analysis. Since Statement and Trend Percentages
they are not in Syllabus, they have
TYPESOF FINANCIAL STATEMENT ANALYSIS
Financial Statement Analysis can be classified into four categories:
External Analysis
External Analysis is conducted by those who do not have access to the detailed records
of an enterprise and, therefore, have to depend on published accounts, i.e., Statement of
Profit & L0ss, Balance Sheet, Directors' and Auditor's Reports. Such type of analysis is
made by investors, lenders, creditors, government agencies and research scholars.
Internal Analysis
Internal Analysis is conducted by the management to know the financial position and
operational efficiency of the organisation. The important feature of such analysis is that
the management has access to all information of the enterprise and, therefore, the analysis
is more detailed, extensive and accurate.
External Analysis is carriedout by outsiderssuchas creditors, lenders,bankers, debentureholders and government
agencies. Internal Analysis is meant for management.

Horizontal (or Dynamic) Analysis

This analysis is made to review and analyse financial statements for a number of years.
It is a Time Series Analysis. It shows comparison offinancial data for several years against
a chosen base year. It is useful for trend analysis and long-term planning. Comparative
Statements or Comparative Financial Statements are examples of horizontal analysis.
Vertical (or Static) Analysis
This analysis is made to review and analyse the financial statements of one year only. It is
a Cross-sectional Analysis. Ratio Analysis of the financial statement relating to a particular
accounting year is an example of this type of analysis. Such an analysis is useful in comparing
the performance of several companies of the same type or divisions or departments in
one enterprise.
Horizontal or Dynamic Analysis is atime series analysis. Vertical or Static Analysis is carried out at one
particular point of time, generally when the accounts are closed. si2 is
Distinction between Horizontal Analysis and Vertical Analysis
Basis Horizontal Analysis Vertical Analysis
1. Period It requires financial statements of two or It requires financial statement of one period.
more accounting periods.
2. Components It deals with same items of different periods. It deals with different items of same period.
or Items
3. Information It provides information in absolute andIt provides information in percentage terms.
percentage terms.
4. Usefulness It is generally used for Time Series Analysis.| Itisgenerally used for Cross-sectional Analysis.
S. Comparison It is a part of comparison. It is a step towards comparison.
Analysis
Comparative financial data are then analysed with reference to financial characteristics
like profitability, solvency and liquidity.
Interpretation
The concludingpart of financial statement analysis is interpretation of financial information
generated in the process of financial statement analysis. The interpretation should be
precise and directed towards indicating the movement of various financial characteristics.

OBJECTIVES AND SIGNIFICANCE OF FINANCIAL STATEMENT ANALYSIS

Financial statements are used by various interested groups for various purposes. Financial
analysis serves the following purposes and brings out the significance of such analysis:
Assessing the Earning Capacity or Profitability
On the basis of financial analysis, the earning capacity Or profitability of an enterprise
can be assessed. In addition, the earning capacity of the enterprise, in coming years, may
also be forecast. All the external users of financial statements, especially investors and
potential investors, are interested in earning capacity and forecast.
Assessingthe Managerial Efficiency
The financial statement analysis helps to identify the areas where the managers have been
efficient and the areas where they have been inefficient. For example, by using accounting
ratios, it is possible to analyse relative proportion of production, administrative and
marketing expernses. Any favourable or unfavourable variation can be identified and reasons
thereof can be ascertained to pinpoint managerial efficiency or inefficiency.
Assessing theShort-term and Long-term Solvency of the Enterprise
Long-term and short-term solvency of an enterprise can be assessed on the basis of financial
statement analysis. Creditors or suppliers are interested to know the short-term solvency
or liquidity of the enterprise, i.e., its ability to meet short-term liabilities. Debentureholders
and lenders are interested to know the long-term and short-term solvency of the enterprise
to assess the ability of the company to repay the principal amount and interest thereon.
Inter-firm Comparison
Inter-firm comparison becomes easy with the help of financial analysis. It helps an enterprise
n assessing its own performance as well as that of others, if mergers and acquisitions
are to be considered.

Forecasting and Preparing Budgets

Fast financial statement analysis helps in assessing developments in future, especially in
e next year. For example, given a certain investment, it may be possible to forecast the
ext year's profit on the basis of earning capacity shown in the past. An analysis thus
helps in forecasting and preparing the budgets.
 Explainable and Understandable
Financial analysis helps the users of the financial statements to understand the complicated
charte
matter in a simpliied manner. Financial data can be made more comprehensive by
understood.
graphs and diagrams, which can be easily explained and
USES OF FINANCIAL STATEMENT ANALYSIS
On the basis of financial analysis we can take a variety of decisions in various areas such
as securities analysis, credit analysis, debt analysis, dividend decision and general busines
analysis. These are discussed below:
Securities Analysis
It is aprocess by which the investor comes to know whether the firm is fulfilling his
expectations with regard to payment of dividend, capital appreciation and security of
money. Such analysis is done by a securities analyst who is interested in cash-generating
ability, dividend payout policy and the behaviour of share prices.
Credit Analysis
Such analysis is useful when a firm offers credit to a new customner or a dealer. The
manager of the firm would like to know whether to allow or extend credit to them or
not. Such analysis is also useful for a bank before granting loan.
Debt Analysis
Such analysis is done by the fim to know its borrowing capacity.
Dividend Decision
Financial analysis helps the firm in deciding about the rate of dividend. The
would have to decide about how much portion of the management
much to retain. Such decisions indicate the
earnings to distribute and how
profitability of the firm and hence, to some
extent affect the behaviour of share prices.
General Business Analysis
Financial analysis can be used to identify the key profit drivers and
to assess the profit potential of the firm. It helps in business risks in order
future growth scenarios for the firm.
PARTIES INTERESTED IN FINANCIAL
STATEMENT ANALYSIS
The parties interested in the analysis of
financial statements are:
Management
Financial analysis helps the management to ascertain segment-wise
efficiency of the business. Besides, it helps them in overall ås well as
self-evaluation. decision-making, controlling a
 Employees and Trade Unions
Employees are interested in better emoluments, bonus, better working conditions and
securityoftheir jobs. So, they are always interested in profitability, operating sustainability
and financial strength of the business. Trade Unions are also interested in financial analysis
because the degree of profitability helps them in negotiating and entering into revised
wage agreements with the employers.
Shareholders or OWners or lnvestors
Ownersinvest their savings in the enterprise. Therefore, they are interested in profitability
and safety of theit investments. They would like to know whether the business is profitable,
has growtn potental and its progress is on expected lines. Growth potential of business
helps in appreciation of their investment.
Potential Investors
They are interested to know the present profitability (i.e, earning) and financial position as well
as future prospects to determine whether they should invest in aparticular company or not.
Suppliers or Creditors
They are interested to know the short-term solvency position of airm, ie, the ability to
meet its short-term liabilities. Short-term solvency of a irm can be determined with the
help of fnancial statemént analysis. On the basis of analysis, they decide whether they
should allow or extend credit to the enterprise or not.
Bankers and Lenders
Bankers and Lenders are interested in servicing of the loans granted to an enterprise, i.e.,
regular payment of interest and repayment of principal amount on due dates. In other
words, they are interested in long-term and short-term solvency of a firm, ie, ablityto
pay interest on loans and debts and its repayment.
Researchers

Researchers may like to analyse profitability, growth, financial position and future prospects
of abusiness or industry. They may be interested in analysing the data of different aspects
of a business like purchases, sales, operating cost, particular type of expenditure, etc.
Regulatory Authorities
They (such as SEBI, Registrar of Companies (ROC), Tax Authorities, etc.) would like to
know that the financial statements are prepared in conformity with the specifed laws and
rules and safeguard the interest of allthe concerned agencies.
lax authorities are interested in ensuring proper assessment of tax liabilities of the enterprise
as per the laws in force from time to time.
Customers
Customers have an interest in information about the continuance of an enterprise, especially
when they have a long-term involvement with, or are dependent on the enterprise.
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS
The limitations of financial statement analysis are:
Historical Analysis
Financial statement analysis is a historical analysis. It analyses what has happened till
date. It does not reflect the future. Persons like shareholders, investors, etc., are mor
interested in knowing the likely position in future.
Ignores Price Level Changes
Price level changes and purchasing power of money are inversely related. A change in
the price level makes analysis of financial statements of different accounting years invalid
because accounting records ignore change in value of money.
Ignores the Qualitative Aspect
Since the financial statements are confined to monetary matters alone, the qualitative
aspects like quality of management, quality of staff, public relations are ignored while
carrying out the analysis of financial statements.
Suffers from the Limitations of Financial Statements
Analysis of financial statements is based on the information given in the
financial statements. Hence, this analysis suffers from all such limitations from which
the inancial statements suffer. Therefore, unless the basic data given in the financial
statements is reliable, the conclusions derived on the basis of the analysis of this data
cannot be reliable.

Not Free from Personal Bias

In many situations, the accountant has to make a choice out of alternatives available, e.g.,
choice in the method of inventory valuation, choice in the method of depreciation (straight
line or written down value), etc. Since the subjectivity is inherent in personal judgment;
the financial statements are, therefore, not free from bias.

Variation in Accounting Practices

For inter-firm comparison, it is necessary that accounting practices followed by the firms
do not vary significantly. As there may be variations in accounting practices followe
by different firms, a meaningful comparison of their financial statements is not
possible.
Window Dressing
Window dressing refers to the presentation of a better financial position than what
actually is by manipulating the books of account. On account of such a situation, financial
analysis may give false information to the users.
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OBJECTIVES OF FINANCIAL STATEMENTS
The Objectives of Financial Statements are:
1. To provide financial data on economic resources and obligations of an enterprise.
2. To show implications of operating profit on the financial position of an enterprise.
3. To provide information about cash flow to investors and creditors for assessing, comparing
and evaluating, potential cash flow in terms of amount.
4. To provide sufficient and reliable information to various parties interested in
financial statements.
5. To present a true and fair view of the business.
6. To assess effectiveness of management towards utilisation of resources of business.
7. To provide information about activities of business affecting the society.
8. To disclose accounting policies followed in the accounting process for the better
understanding of financial statement.
 OR
PARTIES INTERESTED IN FINANCIAL STATEMENTS
USERS OF FINANCIAL STATEMENTS
Users and (2) External Users
Users of Financial Statements may be categorised into (1) nternal
1. Internal Users
(i) Management
investment but also to increase
Management has the responsibility tonot only safeguard the
profit. The management
its value by managing the business efficiently and maximisinginformed decisions such as
makes extensive use of accounting information to arrive at projects, etc.
determination of selling price, cost controls and reduction, investment into new
2. External Users
(ii) Shareholders
In
Shareholders contribute capital in the business and thus are always exposed to risk.
profitability, financial
view of the risk involved, they are always interested in knowing the
strength and cash position of the company.
iii) Employees
Employees are entitled to bonus at the end of the year besides the salary and wages taken
every month. Bonus is linked to the profit earned by an enterprise. Thus, the employees
are much interested in financial statements.
(iv) Banks and Financial Institutions
Banks and Financial Institutions provide loans to the businesses, It is natural that the
Banks and Financial Institutions will watch the performance of the business to know
whether it is making progress as projected to ensure the safety and recovery of the loa
position
advanced. Cash Flow Statement and Segment Reports enable them to assess cash
and whether the business segments are making progress as planned and projected.
(v) Investors and Potential Investors
affairs.
Investment involves risk and the investors donot have direct control over businessquestions
afta
Therefore, they rely on the available accounting information and seek answersto
investment?
such as: What is the earning capacity of the enterprise and how safe is their
(vi) Creditors
Creditors are the parties who supply goods or services on credit. Before granting credit,
creditors satisfy themselves about the creditworthiness of the business. The financial
statements help them immensely in making such an assessment.
(oii) Government and its Authorities
The government makes use of financial statements to compile national
and other information. The information so available enables it to take income accounts
policy decisions.
Financial Statements provide input for taxation and other economic policies of the
government
(vii) Securities and Exchange Board of India (SEBI)
SEBI and other agencies like to study the financial
is within its limit ánd the interest of the statements to see whether a company
investors is well protected.
LIMITATIONS OF FINANCIAL STATEMENTS
() Historical Records
Financial Statements are based on past or historical data while parties, (e.g., shareholders,
Investors, etc.,) are more interested in knowing the present position and future prospects
of the concern.

(i) Affected by Estimates

Financial Statements are the outcome of accounting concepts and conventions combined
with estimates. Stock valuation, provision for depreciation, etc., are based on estimates.
Therefore, financial statements are not free from bias.
(ii) Different Accounting Practices
The Financial Statements can be drawn up on the basis of different accounting practices.
For example, depreciation can be provided either on straight-line basis or on written-down
value basis. Profit earned or loss incurred will be different when different practices are followed.
(iv) Qualitative Elements are Ignored
elements
Financial statements provide only financial information and do not show qualitative
relations, etc., because
such as quality of management, working conditions of workers, public
they cannot be mneasured in money terms.
(o) Price Level Changes are lgnored
Statements, therefore, ignore the
Different assets are shown at historical cost. Financial
Hence, financial statements do not
price level changes or present value of the assets.
reflect current market position.
(vi) Cannot Meet the Purpose of all Parties
of parties interested in the Financial Statements is large and their interests
Ihe number parties.
Vary. Financial Statements, therefore, cannot meet the purpose of all interested
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CHAPTER
alysis

5
Intra-firm Comparison
Comparative Statement of the firm's financial statements of two or more years prepared, is known
as Intra-frm Comparison. It is comparison of values of one period with those of another period for the
same firm.

Inter-firm Comparison
Comparative Statement of the firm's financial statements prepared taking items of the financial statements
of the firm and comparing them with that of another firm or with industry data or with the budget is known
as Inter-firm Comparison.
Objectives of Comparative Statement of Profit &Loss (Income Statement)
The objectives of Comparative Income Statement are:
1. To analyse each item of Revenue and Expense of two or more
years.
2. Toanalyse increase or decrease in each item of Revenue and Expense in terms of
rupees
as well as percentage and thus, determine the trend of each item.
3. It comnpares data of more than one year. Hence, it shows the overall trend of
profit.
4. To analyse and determine the reasons for change in
financial performance.
Objectives of Common-size Statement of Proft&Loss (lncome Statement)
1. To analyse change in individual items of Income Statement.
2.. To study the trend in different items of Incomes and Expenses.
3. To assess the efficiency.