SIR Shubham Jagdish's Accounts Theory Booklet

Prepared by Shubham Jagdish 8112601234/ 8299364494
Important Viva Questions

-What is PL appropriation account
-What is PL adjustment account
-What are the journal entries for
°Interest on capital
°Interest on drawing
°Salary
°Commission
°Rent
°Interest on loan
°Reserves
°Managers commission
-Ratio formulas
-What is comparative and common size statement
-What are different types of analysis
-Income statement format
-Balance sheet format
-Formula of comparative and common size statement
-Deviations of income statement
°C o r f o = opening inventory + purchases + direct expense - closing inventory
°GP= Rfo-corfo
-Property plant and equipment

-Debentures current maturities come in short term borrowings
-Propose dividend
-Account standard 4 mentions that prepaid dividend written under contingent liabilities
-Section 52 security premium written off

CHAPTER AT A GLANCE Fundamental
Definition of Partnership
Section 4 of the Indian Partnership Act, 1932 defines Partnership to be,
“The relationship between two or more persons who have agreed to share the profits of business carried on by
all or any of them acting for all.’’
Features/Characteristics of Partnership
(i) Two or More Persons: At least two persons to form a partnership are necessary. Maximum number of
Partners cannot be more than 50 (Fifty). The limit is prescribed in the Companies Act, 2013 (Section 464,
Read with rules).
(ii) Agreement
(a) There should be an agreement between/among the partners to carry on business.
(b) Agreement may be oral or written.
(iii) Profit Sharing
(a) The partners should agree to share profits and losses of the business.
(b) In case, profit-sharing ratio is not agreed, profits (and losses) are shared equally, as is provided in the
Partnership Act, 1932.
(iv) Lawful Business: The business for which partnership is entered into should be lawful.
(v) Business Carried on by all or any of them Acting for all: Partners are agents of other partners as well as
principal to other partners.
Is it mandatory to have a Partnership Deed?
Though it is not mandatory, but it is better to have a Partnership Deed. It is so because in case any dispute
arises among the partners, the dispute shall be settled based on the Partnership Deed.
Rules Applicable in the Absence of Partnership Deed
In case partners do not have a Partnership Deed or Agreement, the provisions of the Indian Partnership Act,
1932 apply.
Treatments in absence of Partnership Deed are as follows:
(i) Profits and losses are to be shared equally among the partners.
(ii) Interest is not charged by the firm on Drawings by partners.
(iii) Interest on Capital is not allowed by the firm to partners.
(iv) Partners are not entitled for Salary and commission.
(v) Interest on loan by the firm to the partner is not charged.
(vi) Interest on loan by a partner to the firm is allowed @ 6% p.a.
(vii) New partner cannot be admitted without consent of all the partners.

Partnership firms prepare every year their financial statements, i.e., Trading Account, Profit & Loss Account,
Profit & Loss Appropriation Account and Balance Sheet.
Trading Account determines Gross Profit or Gross Loss. Opening Stock, Purchases (Net) and Direct Expenses
are transferred to the debit while Revenue and Closing Stock are transferred to the credit of Trading Account.
Difference between the totals of two sides is either Gross Profit (if total of credit side is more) and Gross Loss
(if total of debit side is more). Gross Profit is transferred to the credit side of Profit & Loss Account and Gross
Loss is transferred to the debit side of Profit & Loss Account.
Profit & Loss Account is prepared to determine Net Profit or Net Loss. Expenses incurred whether paid or not
are transferred to the debit while indirect incomes are transferred to the credit of Profit & Loss Account.
Amounts payable to the partners which are charge against profit are also transferred to the debit and interest
from partners on loan given by the firm are also transferred to the credit of Profit & Loss Account. Difference
between the totals of two sides is either net profit (if total of credit side is more) and net loss (if total of debit
side is more), which is transferred to Profit & Loss Appropriation Account.
Profit & Loss Appropriation Account is prepared to show the way distributable profit has been distributed.
Profit & Loss Appropriation Account is credited with interest charged on drawings (if any) by partners and
debited with remuneration (Salary and Commission) to partners, interest on capitals (if any), transfer to
reserves and distribution of Divisible Profit. Appropriation of Divisible Profit is to Partners’ Capital/Current
Account as per the terms of Partnership Deed or Agreement. If Partnership Deed or Agreement does not exist,
it is appropriated as per the provisions of Partnership Act, 1932.
Format of Profit & Loss Account of a Partnership Firm (after expenses and incomes but before debit of
payables to partners as a charge)
Dr. PROFIT & LOSS ACCOUNT Cr.
Particulars Amount Particulars Amount
` `
To Loss (given in the question) … By Profit (given in the question) …
To Interest on Loan by Partner … By Interest on loan to Partner …
To Rent to Partners … By Loss transferred to Capital Accounts …
of Partners
To Manager’s Remuneration …
(Salary/Commission)
To Interest on Capital (If it is a charge) …
To Net Profit (Balancing figure) …
… …
Important Journal Entries

Interest on Capital:
(i) Interest on Capital A/c
...Dr.
To Partner’s Capital/Current A/c a.)
(Interest allowed on capitals @ ... % p.a.)

(ii) Closing Entry of Interest on Capital A/c:
Profit & Loss Appropriation A/c ...Dr.
To Interest on Capital A/c
(Interest transferred to Profit & Loss Appropriation A/c)
(ii) Closing Entry for Interest on Drawings A/c:

Interest on Drawings A/c ...Dr.
To Profit & Loss Appropriation A/c
(Interest on Drawings transferred to Profit & Loss Appropriation A/c)
For Salary or Commission Payable to Partner:
(i) Salary/Commission A/c ...Dr.
To Partner’s Capital/Current A/c
(Salary/commission credited to Partner’s Capital Account)
(ii) Closing Entry for Salary/Commission:

To Salary/Commission A/c
(Salary/Commission transferred to Profit & Loss Appropriation A/c)
For Transferring Profit to Reserve:
To Reserve A/c
(Profit transferred to Reserve)
For Transferring Balance of Profit & Loss Appropriation Account:
To Partners’ Capital/Current A/cs
(Profit/credit balance of Profit & Loss Appropriation Account
transferred to Partners’ Capita/Current Accounts)
Partners’ Capital/Current A/cs ...Dr.

(Loss/debit balance of Profit & Loss Appropriation Account
transferred to Partners’ Capital/Current Accounts)
S.No Basis of Difference Drawing against Capital Drawing against Profit
1. Accounting Treatment Debited to Capital Account Debited to Drawings Account
2. Reduction of Capital Reduces Capital Does not reduce Capital till the time of
preparing final accounts.
3. Considered for Interest on Not considered for calculation Considered for calculation of interest on

Drawings of interest on drawings drawings
4. Considered for Interest on Considered for calculation of Not considered for calculation of interest
Capital interest on Capital on capital
Calculation of Interest on Drawing:
I. Product Method:
(i) Simple Method
(ii) Product Method
II. Average Period Method:
Interest on Drawing = Total Drawing
Average Period =
Case 1: Fixed Drawings in the beginning of every Month: Average Period = (Months left after First
Drawing + Months left after Last Drawing)/2 = 6.5 months.
Case 2: Fixed Drawings at end of every Month: Average Period = 5.5 months.
Case 3: Fixed Drawings in the Middle of every Month: Average Period = 6 months.
Case 4: Fixed Drawings in the Beginning of every Quarter: Average Period = 7.5 months.
Case 5: Fixed Drawings in the Middle of every Quarter: Average Period = 6 months.
Case 6: Fixed Drawings at the end of every quarter: Average Period = 4.5 months.
Case 7: Fixed Drawings during the 6 months: Average Period (if drawings in the beginning of each month)
= 3.5 months.
Average Period (if drawings in the middle of each month) = 3 months.
Average Period (if drawings at the end of each month) = 2.5 months.
Case 8: Date of drawing not given: Average Period = 6 months.
Methods of Preparation of Partners’ Capital Accounts
Partners’ Capital Accounts are prepared either by Fixed Capital Accounts Method (Under this Partners’ Capital
Accounts and Partners’ Current Accounts are prepared) or by Fluctuating Capital Accounts Method (Under this
only one Capital Account of each partner is prepared).
Important Note: In the absence of any instruction or information, the Partners’ Capital Accounts should be
prepared under Fluctuating Capital Accounts Method.
Fixed Capital Method

Dr. PARTNER’S CAPITAL ACCOUNTS Cr.
Particulars X(`) Y(`) Z (`) Particulars X(`) Y(`) Z(`)
To Cash/Bank A/c ()Withdrawal … … … By Balance b/d (Opening Balance) … … …
of Capital)
To Balance c/d (Closing Balance) … … … By Cash/Bank A/c … … …
(Additional Capital introduced
by Partner)
… … … … … …

To Balance b/d (in Case of Debit … … … By Balance b/d (in Case of Credit … … …
Balacnce Balance)
To Drawing (Except Capital) … … … By Interest on Capital … … …
To Interest on Drawings … … … By Salary … … …
To Profit & Loss Appropriation … … … By Commission … … …
A/c (Share in loss)
By Profit & Loss Appropriation … … …
A/c (Share in Profits.)
… … … … …
Fluctuating Capital Method

To Cash/Bank A/c (Withdrawal … … … By Balance b/d (Opening Balance) … … …
of capital)
To Drawings A/c … … … By Cash/Bank A/c (Additional … … …
Capital)
To Interest on Drawings … … … By Salary … … …
To Profit & Loss Appropriation … … … By Commission … … …
A/c (Share in loss)
To Balance c/d (Closing Balance) … … … By Profit & Loss Appropriation … … …
A/c (if Profit)
… … … … …
Fixed Capital Accounts vs. Fluctuating Capital Account

S.No Basis Fixed Capital Account Fluctuating Capital Account
1. Change in Capital Balances of Capital Accounts Balances of the Capital Accounts are not
usually remain fixed during fixed. It changes in every accounting
the life of the firm except in period.
case of addition or
withdrawal of capital.
2. Accounts Maintained Two accounts are maintained Only one account, i.e., Capital Account
for each partner: is maintained for each partner.
(i) Capital Account, and
(ii) Current Account.
3. Debit/Credit Balance Partners’ Capital accounts will Partners’ Capital Accounts may show
show either credit or nil debit or credit or nil balance.
balance.
Interest on Partner’s Loan/Loan by Partner
Important Journal Entries:
Interest on Partner’s Loan A/c ...Dr.
To Partner’s Loan A/c
(Interest allowed on loan by partner)
Profit & Loss A/c ...Dr.
To Interest on Partner’s Loan A/c
(Interest on loan transferred to Profit & Loss Account)
Important Points to Remember regarding Loan by Partner to Firm:
(i) Partner is entitled to receive interest on loan given by him to the firm at an agreed rate of interest.
(ii) If the agreement does not exist for rate of interest, interest on loan is allowed @ 6% per annum as is
provided in the Indian Partnership Act, 1932.
(iii) Interest on partner’s loan is a charge against profit and hence interest is allowed irrespective of the firm
earning profit or not.
Interest on Loan by the Firm to a Partner
Important Journal Entries:
Partner‘s Capital/Current A/c ...Dr.
To Interest on Loan to Partner A/c
(Interest charged on loan)
Interest on Loan to Partner A/c ...Dr.
To Profit & Loss A/c
(Interest transferred to Profit & Loss Account)
Important Points to Remember regarding Loan by Firm to Partner:

(i) The firm may charge interest on the loan issued by Firm to Partner. It is a gain (profit) for the firm and is
transferred in the credit side of Profit & Loss Account.
(ii) If there is no information, interest on loan by firm to partner is not charged.
Rent Paid or Payable to a Partner
Rent A/c ...Dr.
To Cash/Bank A/c
[When Rent is Paid]
To Rent Payable A/c
[When Rent is Payable]
(Rent paid/payable to Partner)
Profit & Loss A/c ...Dr.
To Rent A/c
(Rent Account transferred to Profit & Loss Account)
Manager’s/Partner’s Commission
IMPORTANT POINT TO REMEMBER REGARDING MANAGER’S/ PARTNER’S COMMISSION.
(i) If only rate is given and nothing is mentioned then it is assumed to be before charging the commission:
Manager/Partner’s Commission = Profit × Rate/100.
(ii) If rate is given and it is mentioned that it is after charging the commission:
Manager/Partner’s commission = Profit × Rate/(100 + Rate).
Past Adjustments after Closing the Books of Account
Past Adjustments means adjustment made in the Current Year:
(i) To rectify the errors and omissions committed in the past;
(ii) Without amending the financial Statements of that year.
Adjustment in Partners’ Capital Accounts is made either
(i) by passing an adjustment Journal entry; or
(ii) by passing adjustment entries by debiting/crediting Profit & Loss Adjustment Account.
Guarantee of Profits
POINTS TO REMEMBER
In case where a partner is given a guarantee of minimum amount of profit as his share in profits of a business
by all partners in an agreed ratio OR by any one of the partners, then, in such a case,
Deficiency will be borne by the partners even if their profits become negative after deduction of deficiency amount.
Deficiency will be borne even if there is a net loss.

CHAPTER 2 GOODWILL

CHAPTER 2 GOODWILL
CHAPTER AT A GLANCE
Meaning of Goodwill
Goodwill means the reputation earned by the business over the period through right pricing, quality of
products, customer handling and management efficiency.
Goodwill places the firm in better position to earn higher profits in comparison to normal profits earned by its
competitors.
Nature of Goodwill
Goodwill is an intangible asset since it does not have physical existence and thus, cannot be seen or touched.
Classification of Goodwill
Purchased Goodwill: Purchased goodwill is excess of purchase consideration over its net assets. It is
recognized as Intangible Asset in Balance sheet in accordance with Accounting Standard 26, Intangible Assets.
Self-generated Goodwill: Self-generated goodwill is an internally generated goodwill and is not recognized in
the books of accounts since consideration is not paid and received by independent persons at arm’s length.
Need for Valuation of Goodwill: Need for valuation of Goodwill arises:
1. On change in profit sharing ratio among the existing partners.
2. On admission of a new partner or retirement/death of a partner.
3. On amalgamation with another firm.
4. On dissolution of a firm.
Methods of Valuation of Goodwill
Average Profit Method Super Profit Method Capitalization Method
Simple Average Weighted Average Capitalization of Average Capitalization

Method Method Profit Method of Super Profit Method
Simple Average Profit x Weighted Average Profit x Capitalized Value of Business Super Profit
No. of Years' Purchase No. of Years' Purchase Net Assets X
100/NRR
Super Profit x
No. of Years' Purchase
1. Average Profit Method
(i) Simple Average Profit Method
Goodwill = Average Adjusted Profit x Number of Years' Purchase
(ii) Weighted Average Profit Method
Goodwill = Weighted Average Profit* x Number of Years' Purchase
*Sum of Weighted Profits/Sum of Weights

CHAPTER 2 GOODWILL
2. Super Profit Method:

Super profit is the profit earned by the business that is in excess of the normal profits. Goodwill is
determined by multiplying super profits by the numbers of years' purchase.
Goodwill = Super profit x No. of years' purchase
Super Profit Actual Average Profit - Normal Profit
Normal Profit = Capital Employed x Normal Rate of Return/100
Capital employed can be calculated from two approaches:
(a) Assets Side Approach
Capital Employed = All assets (except Goodwill, Non-trade Investments and Fictitious Assets) - Outside
Liabilities (Both Long-term and Short-term Liabilities)
(b) Liabilities Side Approach
Capital Employed = Capital + Reserves - Goodwill - Fictitious Assets - Non-Trade Investments
Note: Unless Investments are specified to be trade investments, they are taken as Non-Trade Investments.
3. Capitalization Method: Under the method, goodwill can be calculated by two Methods:
Capitalization of Average Profit: Under this method, first average profit is calculated, and the average profit
is multiplied by 100 and divided by normal rate of return to arrive at capitalized value of business.
Capitalized Value of Business = Average Profit x 100/Normal Rate of Return
Then, Net Assets as on the date of valuation of goodwill are determined.
Net Assets = All assets (except Goodwill, Non-trade Investments and Fictitious Assets) - Outside Liabilities
Value of Goodwill = Capitalized Value of Business - Net Assets
Capitalization of Super Profit: Under this method goodwill is calculated by capitalizing super profit at the
normal rate of return.
Goodwill = Super Profit × 100/Normal Rate of Return
Super Profit = Actual Average Profit - Normal Profi

CHAPTER 3 CHANGE IN PSR 1
CHAPTER AT A GLANCE
Reconstitution of firm
When existing partners decide to share their profits and losses in a ratio that is different from the earlier profit-
sharing ratio, it is termed as Change in Profit-sharing Ratio. It is one of the modes of reconstitution of
partnership.
Stating it differently, any change in existing agreement of partnership is reconstitution of the firm.
Reconstitution of firm happens in the following situations:
1. Change in profit-sharing ratio among existing partners;
2. Admission of partner(s);
3. Retirement of partner;
4. Death of partner;
5. Amalgamation of two or more partnership firms.
Change in Profit-Sharing Ratio leads to dissolution of existing partnership and not of the firm. This is because
the existing agreement between partners ends and a new agreement becomes effective.
Issues need to be addressed on Change in Profit-sharing Ratio
1. Determining Sacrificing and Gaining Ratios.
2. Valuation of Goodwill and compensate the Sacrificing Partner(s).
3. Accounting of Reserves, Accumulated Profits and Losses.
4. Revaluation of Assets and Reassessment of Liabilities.
Determination of Sacrificing and Gaining Ratio
Sacrificing Ratio is the ratio in which one or more partners of the firm sacrifice their profit share(s) in favor of
one or more partners of the firm.
Sacrificed Profit Share = Old Profit Share – New Profit Share
Gaining Ratio is the ratio in which one or more partners gain profit share(s) as a result of sacrificed profit
share(s) by one or more partners of the firm.
Gained Profit Share = New Profit Share – Old Profit Share
Adjustment of Goodwill
Gaining Partners’ Capital/Current* A/cs …Dr.
[In Gaining Ratio]
To Sacrificing Partners’ Capital/Current* A/cs
[In Sacrificing Ratio]
(Adjustment made for goodwill on change in Profit-sharing Ratio)
*When Capital Accounts are maintained following Fixed Capital Accounts Method.
Goodwill existing in the Books of Account
If goodwill exists in the Balance Sheet at the time of change in profit-sharing ratio among existing partners, it is
written off among all the partners in their old profit-sharing ratio. The Journal entry is:

All Partners’ Capital/Current* A/cs ...Dr.

To Goodwill A/c
(Goodwill existing in books written off in old profit-sharing ratio)
Accounting treatment of Reserves and Accumulated Profits/Losses
Reserve (Sometimes written as Fund) or the balance of Profit & Loss Account existing in the Balance Sheet at
the time of change in profit-sharing ratio is transferred to all Partners’ Capital Accounts (in case of fluctuating
capitals) or Partners’ Current Accounts (in case of fixed capitals) in their old profit-sharing ratio. The Journal
entry is:
Profit & Loss A/c …Dr.
General Reserve A/c …Dr.
Workmen Compensation Reserve A/c …Dr.
(Excess of Reserve over Liability)
Investment Fluctuation Reserve A/c …Dr.
(Excess of Reserve over difference between
Book Value and Market Value)
To All Partners’ Capital/Current* A/cs
(Reserves, accumulated profits and losses distributed among partners in their old profit-sharing ratio)
Debit balance of Profit & Loss Account and Deferred Revenue Expenditure (For example, Advertisement
Suspense Account) shown in the Assets side of Balance Sheet, are transferred to debit side of all Partners’
Capital Accounts (in case of fluctuating capitals) or Partners’ Current Accounts (in case of fixed capitals) in
their old profit-sharing ratio. The entry passed will be:
All Partners’ Capital/Current* A/cs …Dr.
To Deferred Revenue Expenditure A/c
(Debit balance of Profit & Loss A/c and Deferred Revenue Expenditure A/c transferred
to capital/current accounts of all partners in their old profit-sharing ratio)
Treatment of Workmen Compensation Reserve

(A) When claim against Workmen Compensation Reserve does not Exist
In this situation amount of Workmen Compensation Reserve being a reserve against which liability does
not exist is in the nature of free reserve. It is therefore, transferred to all Partners’ Capital Accounts(in case
of fluctuating capitals) or Partners’ Current Accounts (in case of fixed capitals) in their old profit-sharing
ratio.
(B) When claim against Workmen Compensation Reserve Exists
Situation Accounting Treatment
(a) Claim is equal to the amount of Reserve The amount of reserve is transferred to Workmen
Compensation Claim Account. The amount in
excess of reserve is debited to Revaluation
Account. The net balance of Revaluation Account
(Profit or Loss) is transferred to the
Capital/Current Accounts among all partners in
their old profit-sharing ratio.

(b) Claim is less than the amount of Reserve After transferring the amount of reserve to the
extent of claim to Workmen Compensation Claim
Account, excess reserve is transferred to all
Partners’ Capital/ Current Accounts in their old
Profit-sharing Ratio.
(c) Claim is more than the amount of Reserve The amount of reserve is transferred to Workmen
Compensation Claim Account. The amount in
excess of reserve is debited to Revaluation
Account. The net balance of Revaluation Account
(Profit or Loss) is transferred to the
Capital/Current Accounts among all partners in
Treatment of Investment Fluctuation Reserve

(A) When Market Value of Investment is equal to its Book Value
In this case, Investment Fluctuation Reserve is in the nature of free reserve, it is distributed among all
partners in their old profit-sharing ratio. It is so because, it was set aside from profits before the change in
profit-sharing ratio.
(B) When Market Value of investment is higher than its Book Value
The amount of Reserve is distributed among all partners in their old profit-sharing ratio and also increase
in the value of Investment is accounted as gain (profit) in Revaluation Account, net balance of which is
distributed among all partners in their old profit-sharing ratio.
(C) When Market Value of Investments is lower than Book Value
Situation How Dealt
(a) Fall in Value of Investments is equal The amount of reserve is adjusted against the fall in
to Investment Fluctuation Reserve value of investment
.
(b) Fall in Value of Investment is less Investment Fluctuation Reserve to the extent of fall in
than Investment Fluctuation Reserve value is adjusted and balance is appropriated among
all partners in their old ratio.
(c) Fall in Value of Investments is more Investments Fluctuation Reserve is adjusted against
than Investment Fluctuation Reserve the fall in value of investments and excess of fall in
value of investments is debited to Revaluation Account,
which is distributed among all partners in old profit-
sharing ratio.
Accounting Treatment of Reserves, Accumulated Profits and Losses when Net Effect is recorded without
affecting the existing values
If the partners decide to record the net effect of Reserves, Accumulated Profits and Losses without affecting the
original values, a single Adjustment Entry is passed for the net effect of the amounts to be adjusted. First step is
determining the net effect of reserves, accumulated profits and losses.
Steps for calculation of amount to be credited or debited to Partners’ Capital or Current Accounts:
I. Calculate the Net Effect of Reserves, Accumulated Profits and Losses:
Accumulated Profits [e.g., Profit & Loss A/c(Cr.)]

Reserves (e.g., General Reserve) ...

Less: Accumulated Losses [e.g., Profit & Loss A/c (Dr.)]
(...)
Deferred Revenue Expenditure (e.g., Advertisement Suspense)
(...)
Net Effect of Reserves, Accumulated Profits and Losses ...
II. Calculate Sacrificed/(Gained) Profit Share of each Partner
III. Calculate share of Gaining Partners and Sacrificing Partners in the Net
Effect of Reserves, Accumulated Profits and Losses:
For Gaining Partner = Gained Profit Share × Net Effect
For Sacrificing Partner = Sacrificed Profit Share × Net Effect
IV. Pass single adjustment entry by adjusting Partners’ Capital/Current A/cs.
Case 1: When the balance is Net Accumulated Profit

Gaining Partners’ Capital/Current* A/cs ...Dr.
Case 2: When the balance is Net Accumulated Loss

Sacrificing Partners’ Capital/Current* A/cs ...Dr.
To Gaining Partners’ Capital/Current* A/cs
REVALUATION OF ASSETS AND REASSESSMENT OF LIABILITIES
(A) When Assets and Liabilities are shown at their Revised Values in Balance Sheet
Dr. REVALUATION ACCOUNT Cr.
Particular ` Particular `
To Assets A/c (Decrease in value of assets) By Asset A/c (Increase in value of assets)
To Liabilities A/c (Increase in value of By Liabilities A/c (Decrease in value of
liabilities) liabilities)
To Unrecorded Liabilities A/c By Unrecorded Assets A/c
To Partner’s Capital A/c (Remuneration) By Loss on Revaluation transferred to all

Partners’ Capital/Current* A/cs (old
ratio)
To Cash/Bank A/c (Expenses on

revaluation)
To Profit on Revaluation transferred to all
Partners’ Capital/Current* A/cs (old ratio)

Important Journal entries in relation to Revaluation:

For Decrease in the value of assets:
Revaluation A/c …Dr.
To Assets A/c
(Decrease in the value of assets recorded)
For increase in the value of assets:
Assets A/c …Dr.
To Revaluation A/c
(Increase in the value of assets recorded)
For increase in the value of liabilities:
Revaluation A/c …Dr.
To Liabilities A/c
(Increase in the value of liabilities recorded)
For decrease in the value of liabilities:
Liabilities A/c …Dr.
To Revaluation A/c
(Decrease in the value of liabilities recorded)
For recording Unrecorded Liabilities:
Revaluation A/c ...Dr.
To Unrecorded Liabilities A/c
(Unrecorded liabilities accounted for)
For recording Unrecorded Assets:
Unrecorded Assets A/c ...Dr.
To Revaluation A/c
(Being unrecorded assets accounted for)
For profit on Revaluation:
To All Partners’ Capital/Current* A/cs
(Profit on revaluation transferred to all Partners’ Capital/Current Accounts in old profit-sharing
ratio)
For loss on Revaluation:
To Revaluation A/c
(Loss transferred to old Partners’ Capital/Current Accounts in old profit-sharing ratio)
(B) When Assets and Liabilities are not shown at their Revised Values
Accounting Treatment of Revaluation of assets and reassessment of liabilities when Net Effect is
recorded without affecting the existing values
If the partners decide to record the gain (profit) or loss on revaluation of assets and reassessment of
liabilities is adjusted through Partners’ Capital Accounts by passing an adjustment entry by
debiting/crediting the Capital (or Current) Accounts of gaining partners and crediting/debiting the
sacrificing partners. The single Adjustment Entry passed is as follows:
Case 1: For Gain (Profit) on Revaluation

Case 2: For Loss on Revaluation

Sacrificing Partners’ Capital/Current* A/cs
To Gaining Partners’ Capital/Current* A/cs
I. Calculate Net Effect of Revaluation:
Decrease in liabilities …
Increase in Assets …
(…)
Less: Decrease in Assets
(…)
Increase in Liabilities
…
Net Effect of Revaluation
II. Calculate sacrificed/gained share of each partner
III. Calculate proportional amount of net effect on revaluation:
For Gaining Partner = Gained Profit Share × Net Effect of Revaluation
For Sacrificing Partner = Sacrificed Profit Share × Net Effect of Revaluation
IV. Pass single adjustment entry by adjusting Partners’ Capital/Current A/cs

CHAPTER 4 ADMISSION

CHAPTER 4 ADMISSION
CHAPTER AT A GLANCE
Admission of a Partner is reconstitution of the firm as on admission of a partner old partnership comes
to an end and new partnership comes into force.
On admission of a new partner, new Partnership Deed or Agreement is prepared among the existing partners
and the new partner. By virtue of this old Partnership Deed existing agreement among the partners is replaced
with the new deed or agreement among all the partners. Hence, admission of a partner is reconstitution of the
firm.
Sacrificing and Gaining Ratio, New Profit-sharing Ratio
Sacrifice by a Partner = Old Profit Share – New Profit Share
Gain of a Partner = New Profit Share –Old Profit Share
Profit share of a partner after sacrificing profit share:
New Profit Share = Old Profit Share – Sacrifice of a Partner
In case, existing partner has gained:
New Profit share = Old Profit Share + Gain of a Parnter

CHAPTER 4 ADMISSION
Accounting treatment Of Goodwill

(i) When Premium for Goodwill is paid privately: No entry will be passed in the firm’s books of
accounts because the new partner is paying the amount of goodwill directly to the sacrificing
partners, directly without involving the firm.
(ii) When new partner brings his share of goodwill in cash:
Case 1: When the amount of goodwill brought in by Case 2: When goodwill brought in by new
new partner is retained in the business partner is withdrawn by the sacrificing
partners
Cash/Bank A/c ...Dr.
To Premium for Goodwill A/c Cash/Bank A/c ...Dr.
To Premium for Goodwill A/c
(Amount brought as Goodwill by new partner)
(Amount of Goodwill brought by new partner)
Premium for Goodwill A/c ...Dr. Premium for Goodwill A/c ...Dr.
To Sacrificing Partners’ Capital/Current A/cs To Sacrificing Partners' Capital/Current A/cs
(Amount of Goodwill distributed among old (Amount of Goodwill distributed among old
partners in their sacrificing ratio) partners in their sacrificing ratio)
Sacrificing Partners’ Capital/Current A/cs ...Dr
To Cash/Bank A/c
(Amount of goodwill withdrawn)
(iii) When new partner does not bring his share of goodwill in cash:
Goodwill not brought by new partner is debited to his Capital or Current Account (depending on the
question) and credited to the Sacrificing Partners’ Capital Accounts in their Sacrificing Ratio. The reason
being that Sacrificing Partners are entitled to Premium for Goodwill for the profit share sacrificed by them.
New partner’s Capital Account or Current Account is debited as the amount is payable by him. The Journal
entry is:
New Partner’s Capital/Current A/c …Dr.
To Sacrificing Partner’s Capital/Current A/c
(Premium for Goodwill credited to sacrificing partners in their sacrificing ratio)
(iv) When new partner brings part of premium of goodwill in cash:
Bank A/c …Dr.
[For the amount brought]
New Partner’s Capital/Current A/c …Dr.
[For share of Goodwill not brought]
(Goodwill brought by new partner and Goodwill not brought credited to Sacrificing Partners)
(v) Goodwill brought in kind:

Assets A/c ...Dr.
(Assets brought by the incoming partner)
Premium for Goodwill A/c ...Dr.
To Sacrificing Partner’s Capital/Current A/c

CHAPTER 4 ADMISSION
(Goodwill credited in sacrificing ratio)
Goodwill existing in the books of account

If goodwill exists in the Balance sheet at the time of admission of a new Partner, it is written off
among old partners in their old profit-sharing ratio. The Journal entry would be:
Old Partners' Capital/Current A/cs ...Dr.
To Goodwill A/c
(Goodwill existing in books written off in old profit-sharing ratio)
Hidden Goodwill
Hidden or inferred goodwill = Excess of total capital of the new firm on the basis of capital
contributed by the new partner over existing capital (after all adjustments) of new firm by adding
all partners’ capital (including new one).
Accounting treatment of Reserves and Accumulated Profits/Losses

Reserves and/or balance of Profit & Loss Account appearing in the Balance Sheet at the time of admission of a
partner is transferred to old Partners’ Capital Accounts (in case of fluctuating capitals) or Partners’ Current
Accounts (in case of fixed capitals) in their old profit-sharing ratio because reserves were set aside out of
profits in the past which otherwise, would have been distributed among old partners in their old-profit sharing
ratio. Accumulated profits/losses are undistributed profits/losses. The Journal entry is.
Profit & Loss A/c …Dr.
General Reserve A/c …Dr.
Workmen Compensation Reserve A/c …Dr.
(Excess of Reserve over Liability)
Investment Fluctuation Reserve A/c ...Dr.
(Excess of Reserve over difference between
Book Value and Market Value)
To Old Partners’ Capital/Current* A/cs
(Reserves, accumulated profits and losses distributed among old partners in their old profit-sharing ratio)

CHAPTER 4 ADMISSION
Debit balance of Profit & Loss Account (Accumulated Losses) and Deferred Revenue
Expenditure (For example, Advertisement Suspense Account) appearing in the Assets side of
Balance sheet, is transferred to the debit of old Partners’ Capital Accounts (in case of
Fluctuating Capitals) or Partners’ Current Accounts (in case of Fixed Capitals) in their old
profit-sharing ratio. The entry passed is:
Old Partners’ Capital / Current* A/cs ...Dr.
To Deferred Revenue Expenditure A/c
(Debit balance of Profit & Loss A/c and Deferred Revenue Expenditure A/c transferred to
capital/current accounts of old partners in old profit-sharing ratio)
Treatment of Workmen Compensation Reserve

A. When claim against Workmen Compensation Reserve does not Exist
In this situation, amount of Workmen Compensation Reserve is transferred to old Partners’ Capital Accounts
(in case of fluctuating capitals) or Partners’ Current Accounts (in case of fixed capitals) in their old profit-
sharing ratio as there is no claim against the reserve and they are in the nature of free reserve.
B. When claim against Workmen Compensation Reserve Exists

(a) Claim amount is equal to the amount of Amount of Workmen Compensation Reserve is
Reserve transferred to Workmen Compensation Claim Account
(b) Claim amount is less than the amount of After transferring the amount of reserve to the extent
Reserve of claim to Workmen Compensation Claim Account,
excess reserve is transferred to old Partners’ Capital/
Current Accounts in their old Profit-sharing Ratio
(c) Claim amount is more than the amount of The amount of reserve is transferred to Workmen
Reserve Compensation Claim Account. The amount in excess of
reserve is debited to Revaluation Account and credited
to Workmen Compensation Claim Account. The
resultant loss is distributed among old partners in
Treatment of Investment Fluctuation Reserve

A. When Market Value of Investment is equal to its Book Value
It is distributed among old partners in their old profit-sharing ratio.
B. When Market Value of investment is higher than its Book Value
The amount of reserve is distributed among old partners in their old profit-sharing ratio and also increase
in the value of Investment is accounted as gain (profit) and credited in Revaluation Account and debited to

CHAPTER 4 ADMISSION
Investment Account. The net result of Revaluation Account is credited/debited to old Partners’ Capital
Accounts in their old profit-sharing ratio.
C. When Market Value of investment and its Book Value differ:

(a) Fall in Value of Investments is equal to The amount of reserve is credited to Investment
Investment Fluctuation Reserve Account
(b) Fall in Value of Investment is less than Investment Fluctuation Reserve to the extent of fall in
Investment Fluctuation Reserve value is credited to Investment Account and balance is
credited to old Partners’ Capital Accounts in their old
profit-sharing ratio
(c) Fall in Value of Investments is more than Investments Fluctuation Reserve is credited to
Investment Fluctuation Reserve Investment Account and excess of fall in value of
investments is debited to Revaluation Account. The net
balance of Revaluation Account is credited to old
Partners’ Capital Accounts in their old profit-sharing
ratio.
Accounting Treatment of Reserves, Accumulated Profits and Losses when

Net Effect is recorded without affecting the existing values
When Partners decide to record the net effect of Reserves, Accumulated Profits and Losses without affecting
the original values, a single Adjustment Entry is passed as follows:
Case 1: When the balance is Profit Case 2: When the balance is Loss
Gaining Partners’ Capital/Current* A/cs Sacrificing Partners’ Capital/Current* A/cs ...Dr.
…Dr. To Gaining Partners’ Capital/Current* A/cs
To Sacrificing Partners' Capital/Current* A/cs
(i) Calculate the Net Effect of Reserves, Accumulated Profits and Losses:
Accumulated Profits [e.g. Profit & Loss A/c (Cr.)] xxx
Reserves (e.g. General Reserve) xxx
Less: Accumulated Losses [e.g. Profit & Loss A/c (Dr.)]
(xxx)
Deferred Revenue Expenditure (e.g. Advertisement Suspense) (xxx)
Net Effect of Reserves, Accumulated Profits and Losses xxx
(ii) Calculate Sacrificed/(Gained) Profit Share of each Partner
(iii) Calculate share of Gaining Partners and Sacrificing Partners in the Net Effect of Reserves, Accumulated
Profits and Losses:

CHAPTER 4 ADMISSION
(iv) Pass single adjustment entry by adjusting Partners’ Capital/Current A/cs.

REVALUATION OF ASSETS AND REASSESSMENT OF LIABILITIES
A. When Assets and Liabilities are shown at their Revised Values in Balance Sheet
Particulars ` Particulars `
To Assets A/c … By Asset A/c …
(Decrease in Value of assets) (Increase in value of asset)
To Liabilities A/c … By Liabilities A/c …
(Increase in Value of liabilities) (Decrease in value of
liabilities)
To Unrecorded Liabilities A/c … By Unrecorded Assets A/c …
To Partner’s Capital A/c … By Loss on Revaluation …
(Remuneration) transferred to Old
Partners’ Capital/Current
To Cash/Bank A/c … A/cs (old Ratio)
(Expense on revaluation)
To Profit on Revaluation transferred to …
Old Partners’ Capital/Current A/cs
(Old Ratio)
… …
Important Journal entries in relation to Revaluation:
For Decrease in the value of assets:

To Assets A/c
(Decrease in the value of assets recorded)
For increase in the value of assets:
Assets A/c ...Dr
To Revaluation A/c
(Increase in the value of assets recorded)
For increase in the value of liabilities:
To Liabilities A/c
(Increase in the value of liabilities recorded)
For decrease in the value of liabilities:
Liabilities A/c ...Dr.
To Revaluation A/c
(Decrease in the value of liabilities recorded)
For recording Unrecorded Liabilities:
To Unrecorded Liabilities A/c

CHAPTER 4 ADMISSION
(Unrecorded liabilities accounted for)

For recording Unrecorded Assets:
Unrecorded Assets A/c ...Dr.
To Revaluation A/c
(Unrecorded assets accounted for)
For gain (profit) on Revaluation:
To Old Partners’ Capital/Current* A/cs
(Gain (Profit) on revaluation transferred to old Partners’
Capital/Current Accounts in old profit-sharing ratio)
For loss on Revaluation:
Old Partners’ Capital/Current* A/cs ...Dr.
To Revaluation A/c
(Loss transferred to Old Partners’ Capital/Current Accounts in old
profit-sharing ratio)
B. When Assets and Liabilities are not shown at their Revised Values
Accounting Treatment of Revaluation of assets and reassessment of liabilities when Net Effect is recorded
without affecting the existing values
When partners decide to record the gain (profit) or loss on revaluation of assets and reassessment of
liabilities is adjusted through Partners’ Capital Accounts by passing an adjustment entry by
debiting/crediting the Capital (or Current) Accounts of gaining partners and crediting/debiting the
sacrificing partners. The single Adjustment Entry passed is as follows:
Case 1: For Gain (Profit)on Revaluation Case 2: For Loss on Revaluation
Gaining Partners’ Capital/Current* A/cs Sacrificing Partners’ Capital/Current* A/cs ...Dr.
…Dr. To Gaining Partners’ Capital/Current* A/cs
To Sacrificing Partners' Capital/Current* A/cs
(i) Calculate Net Effect of Revaluation:
Decrease in Liabilities xxx
Increase in Assets xxx
Less: Decrease in Assets (xxx)
Increase in Liabilities (xxx)
Net Effect of Revaluation xxx
(ii) Calculate sacrificed/gained share of each partner
(iii) Calculate proportion amount of net effect on revaluation:
(iv) Pass single adjustment entry by adjusting Partners’ Capital/Current A/cs.
ADJUSTMENT OF CAPITAL

CHAPTER 4 ADMISSION
A. Adjustment of the old Partners’ Capital Accounts on the basis of the New Partner’s Capital
Following Steps are taken:
(i) Compute Total Capital of the firm on the basis of Capital of New Partner.
(ii) Determine Capital (i.e., Proportionate) of each partner in reconstituted firm.
(iii) Ascertain Present Capital (after all adjustments) of old partners.
(iv) Determine Surplus or Deficit Capital by comparing Present Capital and Proportionate Capital.
(v) Pass Journal entries for adjusting Surplus or Deficit Capital.
B. Calculating the Capital of the new partner on the basis of Capitals of the old partners
(i) Ascertain Capitals of old partners after all adjustments.
(ii) Determine sum of Adjusted Capital of old Partners.
(iii) Determine Total Capital of New Firm by multiplying Total adjusted capital of old partners with
Reciprocal of combined new share of old partners.
(iv) Determine Capital of New Partner in proportion to Capital of New Firm.
C. When new partner brings capital on the basis of Combined Capital of the old partners
(i) Ascertain Capitals of old partners after all adjustments.
(ii) Determine total of Adjusted Capital of old Partners.
(iii) Determine Capital of New Partner in proportion to Total adjusted capital.

CHAPTER 5 RETIREMENT 1
CHAPTER AT A GLANCE
RETIREMENT OF A PARTNER
1. Retirement of a partner is reconstitution of partnership because new Partnership Deed is entered into
among the continuing partners and as a result old Partnership Deed comes to an end.
2. A partner may retire,
• If there is an agreement; or
• If agreement does not exist, but all the partners agree to his retirement.
ADJUSTMENTS REQUIRED ON RETIREMENT OF A PARTNER
1. Calculation of New Profit-Sharing Ratio and Gaining Ratio of the continuing partners.
2. Treatment of Goodwill.
3. Revaluation of Assets and Reassessment of liabilities.
4. Accounting treatment of Reserves, accumulated profits and losses.
5. Determination of amount due to the retiring partner. It is either paid in cash or is transferred to his Loan
Account.
6. Adjustment of Capitals.
1. CALCULATION OF NEW PROFIT-SHARING RATIO AND GAINING RATIO
Case 1 Case 2
When one partner retires and the new profit-sharing ratio When the remaining partners take profit share of
among the remaining partners is not given: the retiring partner in an agreed ratio:
It is assumed that the remaining or continuing partners In such a case, profit share taken by each partner is
will continue to share profits and losses in their old profit- added to his existing profit share and new profit-
sharing ratio. sharing ratio is determined.
For example: For example:
A, B and C are partners sharing profits and losses in the A, B and C were sharing profits and losses in the
ratio of 3 : 2 : 1. ratio of 3 : 2 : 1. B retired. His profit share is taken
by A and C in the ratio of 2 : 1. New profit-sharing
New profit-sharing ratio when
ratio will be:
A retires, B and C will share profits in the ratio of 2 : 1;
B’s Share of profit 2/6th
B retires, A and C will share profits in the ratio of 3 : 1;
Profit share taken by A from B’s profit share =
C retires, A and B will share profits in the ratio of 3 : 2. 2/6 × 2/3 = 4/18
A’s new share = Old Profit Share + Gain =
3/6 + 4/18 = 13/18
Profit share taken by C from B’s profit share =
2/6 × 1/3 = 2/18
C’s new share = Old Profit Share + Gain =
1/6 + 2/18 = 5/18

Thus, New profit-sharing ratio between A and C is

13 : 5.
GAINING RATIO
Case 1 Case 2
If new profit-sharing ratio of remaining partners is not If new profit-sharing ratio of remaining
given in the question: partners is given in the question:
It will be assumed that the remaining partners Gain of each continuing partner is
continue to share profits in their old profit-sharing calculated by deducting his old profit
ratio, thus, gaining ratio would be equal to their old share from his new profit share, i.e.,
Gain of a Partner = New Profit Share – Old
Profit Share.
IMPORTANT NOTES:
1. Unless agreed otherwise, New Profit-sharing Ratio among remaining or continuing partners is same as t
heir old Profit-sharing Ratio.
2. Unless agreed otherwise, Gaining Ratio of remaining or continuing partners is same as their old profit-
sharing ratio.
2. TREATMENT OF GOODWILL
Goodwill existing in the books of account is written off among all the partners (including retiring partner) in
their old profit-sharing ratio because Goodwill is valued afresh at the time of retirement.
The retiring partner gets his share of goodwill at the time of retirement because the goodwill earned by the
firm is the result of the efforts of all the existing partners in past and future profits will be earned on basis of
present goodwill.
Retiring Partner’s share of Goodwill = Value of Firm’s Goodwill × Profit share of the Retiring Partner
Retiring Partner’s share of Goodwill = Value of Firm’s Goodwill × Profit share of the Retiring Partner
When goodwill does not exist in When goodwill exists in the Hidden Goodwill
the Books books
Gaining Partners’ Capital/Current* All partners’ Capital/Current* Sometimes, amount due to retiring
A/cs ...Dr. A/c’s ...Dr. partner is settled by paying a lump sum
amount which is in excess of the
To Retiring Partner’s (old Ratio)
amount payable (after alladjustments
Capital/Current* A/c To Goodwill A/c (Existing goodwill except goodwill) to him.
(Adjustment made for goodwill on written off)
Retiring partner’s share of Goodwill =
retirement) Gaining Partners’ Capital/Current* Amount agreed to be paid in settlement
A/cs ...Dr. – Retiring Partner’s Capital (after all
To Retiring Partner’s adjustments).
Capital/Current* A/c
(Adjustment made for Valued

goodwill on retirement)
*In case Partners’ Capital Accounts are maintained following Fixed Capital Accounts Method.
3. REVALUATION OF ASSETS AND REASSESSMENT OF LIABILITIES
(a) When Assets and Liabilities are shown at their Revised Values in Balance Sheet

Particulars `` Particulars ``
To Asset A/c (Decrease) ... By Asset A/c (Increase) ...
To Liabilities A/c (Increase) ... By Liabilities A/c (Decrease) ...
To Profit on Revaluation transferred to all ... By Loss on Revaluation transferred to all Partners’ ...
Partners’ Capital A/cs (Old Ratio)* (Bal. Fig.)
Capital A/cs (Old Ratio)* (Bal. Fig.)
… …
*Either will appear.
(b) When Assets and Liabilities are not shown at their Revised Values
The effect of Revaluation of Assets and Reassessment of Liabilities will be given by passing an Adjustment
Entry, which is:
In case of Gain on Revaluation In case of Loss on Revaluation

Gaining Partners’ Capital/Current A/cs Dr. Retiring Partner’s Capital/Current A/c Dr.
To Retiring Partner’s Capital/Current A/c To Gaining Partners’ Capital/Current A/cs
(i) Calculate Net Effect of Revaluation: `
Increase in the value of Assets ...
Decrease in amount of Liabilities ...
Less: Decrease in value of Assets (...)
Less: Increase in amount of Liabilities (...)
Net Effect of Revaluation ...
(ii) Calculate sacrificed/gained share of each partner
(iii) Calculate proportionate amount of net effect on revaluation:
(iv) Pass single adjustment entry by adjusting partners' Capital/Current A/cs.

4. RESERVES. ACCUMULATED PROFITS AND LOSSES

(a) When they are not shown in Balance Sheet of Reconstituted Firm
For distributing Reserves and Accumulated Profits:
General Reserves A/c ..Dr.
Profit & Loss A/c (Credit Balance) ...Dr.
[Excess of reserve over difference between
Book Value and Market Value]
Workmen Compensation Reserve A/c ...Dr.
[Excess of Reserve over liability]
To All Partners’ Capital/Current* A/cs [Old Ratio]
For distributing accumulated losses:
[Old ratio]
To Profit & Loss A/c (Debit Balance)
*In case of Fixed Capitals
(b) When they are continued to be shown in Balance Sheet of Reconstituted Firm
The effect of Reserves, Accumulated Profits and Losses will be given by passing an Adjustment Entry, which is:
In case Net Balance is Positive Balance In case Net Balance is Negative Balance
Gaining Partners’ Capital/Current A/cs ...Dr. Retiring Partner’s Capital/Current A/c ...Dr.
To Retiring Partner’s Capital/Current A/c To Gaining Partners’ Capital/Current A/cs
(i) Calculate the Net Effect of Reserves, Accumulated Profits and Losses:
Accumulated Profits [e.g. Profit & Loss A/c(Cr.)] ...
Reserves (e.g. General Reserve) ...
Less: Accumulated Losses [e.g. Profit & Loss A/c(Dr.)] (...)
Deferred Revenue Expenditure(e.g. Advertisement Suspense) (...)
Net Effect of Reserves, Accumulated Profits and Losses ...
(ii) Calculate Sacrificed/(Gained) Profit Share of each Partner
(iii) Calculate share of Gaining Partners and Sacrificing Partners in the Net
Effect of Reserves, Accumulated Profits and Losses:
(iv Pass single adjustment entry by adjusting Partners’ Capital/Current A/cs.
5. AMOUNT DUE TO RETIRING PARTNER

When the amount due to retiring partner is ascertained after all adjustments, it is either paid or
transferred to his Loan Account.
(i) If the amount is paid in cash or by cheque:
Retiring Partner’s Capital A/c ...Dr.
To Cash/Bank
(ii) If the amount is not paid in cash, the amount due to him is transferred to his Loan Account:
Retiring Partner’s Capital A/c ...Dr.
To Retiring Partner’s Loan A/c
Notes:
1. When Partners’ Capital Accounts are maintained following Fixed Capital Accounts Method, transactions
other than transactions of withdrawal or introduction of capital are recorded in the Current Account of
each partner. In this case, balance in Retiring Partner’s Current Account is transferred to his Capital
Account. Thereafter, the amount due to retiring partner is either paid or transferred to his Loan Account.
Alternatively, balance of Current Account is transferred to his Capital Account and adjustments are passed
through Capital Accounts.
2. If nothing is mentioned in the question about the payment of the amount due to retiring partner, it is
transferred to his Loan Account.
6. ADJUSTMENT OF CAPITAL
(a) When Capital of the New Firm is Given
Steps involved in adjusting capitals of partners are as follows:
1. Ascertain Adjusted Capital (after all adjustments) of continuing partners.
2. Calculate Proportionate Capital of continuing partners on the basis of total capital of the new firm
and new profit-sharing ratio.
3. Determine Surplus Capital or Deficit Capital by comparing Present Adjusted Capital and
Proportionate Capital.
4. Adjust Surplus Capital or Deficit Capital either in cash or through respective partner’s Current
Account.
(b) When Total Capital of Remaining Partners is to be in their New Profit-sharing Ratio
1. Compute Adjusted Capitals (after all adjustments) of continuing partners.
2. Ascertain total capital of New firm as sum of adjusted capitals of continuing partners.
3. Calculate new capitals of continuing partners by dividing total capital of new firm in their new
4. Find Surplus Capital or Deficit Capital of each continuing partner by comparing his new capital
with adjusted capital.
5. Pass necessary Journal entry for adjusting the Surplus Capital/Deficit Capital.
(c) When Total Capital of New Firm is equal to Total Capital before Retirement of a Partner


1. Compute New Profit-sharing Ratio.
2. Determine adjusted capitals of continuing partners.
3. Calculate new capital of each continuing partner by multiplying total capital of all partners before
adjustment with his new profit share.
5. Pass necessary Journal entry for adjusting the Surplus Capital/Deficit Capital.
(d) When the Retiring Partner is to be paid from amount brought by the continuing partners in a
manner to make their capitals proportionate to their New Profit-sharing Ratio
1. Ascertain adjusted capitals (after adjustments) of continuing partners.
2. Compute total capital of new firm as sum of adjusted capitals of continuing partners and shortage
of amount to be brought in by continuing partners to pay the retiring partner.
3. Calculate new capital of each continuing partner by dividing total capital of new firm in their new
5. Pass necessary Journal entry for adjusting the Surplus Capital/Deficit Capital either in Cash or
through Current Account.
(e) When the Retiring Partner is to be paid from amount brought by the continuing partners in a
manner to make their capitals proportionate to their New Profit-sharing Ratio and leave an
agreed Cash Balance
1. Determine adjusted capitals (after adjustments) of continuing partners.
2. Compute total capital of new firm as:
Adjusted capitals of continuing partners + Shortage of amount to be brought in by continuing
partners to pay the retiring partner (i.e., Amount payable to retiring partner less existing cash
balance) + Minimum Cash Balance Required.
3. Calculate new capital of each continuing partner by dividing total capital of new firm in their new
5. Pass necessary Journal entry for adjusting the Surplus Capital/Deficit Capital either in Cash or
through Current Account.
7. RETIREMENT OF PARTNER IN-BETWEEN THE YEAR
Normally retirement date of a partner is planned, i.e., a partner may retire on the first day of the accounting
year. However, there may be a situation where a partner decides to retire from the partnership on a date in-
between the accounting year.
In such a situation the retiring partner is entitled to get his share of profit or loss (from the beginning of the
year till the date of his retirement), which may be:

(a) Estimated Profit based on Last Year’s Profit or Average Profit of Past Years’ Profits
The share of profit thus can be calculated on the following two bases under two situations:
1. When profit-sharing ratio of the remaining partners doesn't change; and
2. When Profit-sharing Ratio of the remaining partners change.
1. When Profit-sharing ratio of the Remaining Partners Doesn't Change
On Time Basis On Sales Basis

Retiring Partner's Share of Profit = Profit of Previous Retiring Partner’s Share of Profit = Last Year's
Year × No. of Months he stays/12 × Retiring Partner's Profit/Last Year’s Sale × Sales till Date of Death ×
Share of Profit Retiring Partner's Profit Share
In case of Profit: In case of Profit:
Profit & Loss Suspense A/c …Dr. Profit & Loss Suspense A/c …Dr.
To Retiring Partner's Capital/Current A/c To Retiring Partner's Capital/Current
A/c
In case of Loss:
In case of Loss:
Retiring Partner's Capital/Current A/c …Dr.
Retiring Partner's Capital/Current A/c
To Profit & Loss Suspense A/c …Dr.
To Profit & Loss Suspense A/c
Notes:
• If there is a debit balance in Profit & Loss Suspense Account, it is shown in the assets side of the
Balance Sheet of the Reconstituted firm. Whereas, its credit balance is shown in the Liabilities side of
the Balance Sheet of Reconstituted firm.
• ater on, at the end of the accounting year, balance of Profit & Loss Suspense Account is transferred to
Profit & Loss Appropriation Account by passing the following entry:
In case of Debit balance in Profit & Loss Suspense A/c:
In case of Credit balance in Profit & Loss Suspense A/c:
Profit & Loss Suspense A/c ...Dr.
2. When Profit-sharing Ratio of the remaining partners change

On Time Basis On Sales Basis

Retiring Partner's Share of Profit = Profit of Previous Retiring Partner’s Share of Profit = Last Year's
Year × No. of Months he stays/12 × Retiring Partner's Profit/Last Year’s Sale × Sales till Date of Death ×
Share of Profit Retiring Partner's Profit Share
Profit & Loss Suspense A/c Profit & Loss Suspense A/c …Dr
…Dr.
To Retiring Partner's Capital/Current A/c
To Retiring Partner's Capital/Current A/c
Gaining Partner's Capital/Current A/cs Gaining Partner's Capital/Current A/cs …Dr
(Gaining Ratio) …Dr. (Gaining Ratio)
To Profit & Loss Suspense A/c To Profit & Loss Suspense A/c
Alternatively, Alternatively,
Gaining Partners' Capital/Current A/cs Gaining Partners' Capital/Current A/cs …Dr

…Dr.
(Gaining Ratio)
(Gaining Ratio) .
To Retiring Partner’s Capital/Current A/c
To Retiring Partner’s Capital/Current A/c
(Transfer of profit till the date of retirement in
(Transfer of profit till the date of retirement in case of case of change
change
in profit-sharing ratio)
in profit-sharing ratio)
When Retiring partner’s share is loss, the reverse of above entries are passed.
(b) Determined by Preparing Financial Statements till the Date of Retirement
Preparation of financial statements up to the date of retirement means profit or loss for the period is
determined and not estimated. The profit or loss is determined by preparing Profit & Loss Account
and Profit or Loss is appropriated or distributed by preparing Profit & Loss Appropriation Account
among all partners in their profit-sharing ratio.

CHAPTER 6 DEATH

CHAPTER 6 DEATH
CHAPTER AT A GLANCE
DEATH OF A PARTNER
1. Partnership comes to an end on the death of a partner but the firm may continue its business with
remaining partners.
2. Accounting treatment on death of a partner is same as that on the Retirement of a Partner.
3. On Death of a partner, the amount payable to him is paid to his legal representative (Executor).
CALCULATION OF TOTAL AMOUNT DUE TO THE REPRESENTATIVES OF THE DECEASED PARTNER
The legal heirs or executors of the deceased partner are entitled to the following:
Amount Credited to his Capital Account
1. The amount standing in the credit of Capital A/c and Current A/c if Capital accounts are maintained
following Fixed Capital Accounts Method (Note).
2. His share in the goodwill of the firm.
3. Interest on Capital up to the date of death, if provided to be allowed in the Partnership Deed.
4. His share of profit on Revaluation of Assets and Reassessment of Liabilities.
5. His share of the undistributed/accumulated Profits and Reserves.
6. His share of profit earned from the beginning of the financial year up to the date of his death.
Amount Debited to his Capital Account
1. His Drawings.
2. Interest on Drawings, if provided to be charged in the Partnership Deed.
3. His share of Loss on Revaluation of Assets and Reassessment of Liabilities.
4. His share of undistributed/accumulated losses such as Debit balance of Profit & Loss Account.
5. His share of the Goodwill that exists in the books.
6. His share of loss, if any, incurred from the beginning of the year up to the date of his death.
7. Advance or loan taken by him from the firm, if any, along with interest thereon.
Note: When Partners’ Capital Accounts are maintained following Fixed Capital Accounts Method, transactions other
than transactions of withdrawal or introduction of capital are recorded in the Current Account of each partner.
Therefore, at the time of death of a partner, all adjustment entries are passed through his Current Account. Thereafter,
his Current Account balance is transferred to his Capital Account.
Date Particular L.F. Debit(`) Credit(`)

Deceased Partner’s Capital A/c …Dr. …
To Deceased Partner’s Executor’s A/c …
Following are the adjustments to be made in case of death of a Partner and the remaining partners continue
the firm.

CHAPTER 6 DEATH
1. CALCULATION OF NEW PROFIT-SHARING RATIO AND GAINING RATIO

New Profit-sharing Ratio
Case 1:When one partner dies and the new profit-sharing ratio among the remaining partners is not given.
It is assumed that the remaining partners will continue to share profits and losses in their old
For example:
A, B and C are partners sharing profits and losses in the ratio of 3 : 2 : 1. Calculate the new ratio
when
A dies, the new ratio between B and C is 2 : 1; when
B dies, the new ratio between A and C is 3 : 1; and when
C dies, the new ratio between A and B is 3 : 2.
Case 2: When the remaining partners take the profit share of the deceased partner in an agreed ratio.
In such case, profit share taken by each partner is added to his existing profit share and new
profit-sharing ratio is determined:
For example:
A, B and C are sharing profits and losses in the ratio of 3 : 2 : 1. B died. His profit share is taken by
A and C in the ratio of 2 : 1. Calculate the new ratio.
B’s Share of profit 2/6th
Profit share taken by A from B’s Share = 2/6 × 2/3 = 4/18
A’s new share = old share + gain = 3/6 + 4/18 = 13/18
Profit share taken by C from B’s share = 2/6 × 1/3 = 2/18
C’s new share = old share + gain = 1/6 + 2/18 = 5/18
Thus, New profit-sharing ratio between A and C is 13 : 5.
Gaining Ratio
Case 1: If new profit-sharing ratio of remaining partners is not given.
Under such situation, it is assumed that the remaining partners continue to share profits in the
old ratio, thus, gaining ratio would be same as their old ratio.
Case 2: If new profit-sharing ratio of remaining partners is given in the question.
Gain of each continuing partner is calculated by deducting his old profit share from his new profit
share, i.e., Gain of a Partner = New Profit Share – Old Profit Share.
IMPORTANT NOTES
1. Unless agreed otherwise, New Profit-sharing Ratio among remaining or continuing partners is same as
their old Profit-sharing Ratio.
2. Unless agreed otherwise, Gaining Ratio of remaining or continuing partners is same as their old profit-
sharing ratio.

CHAPTER 6 DEATH
2. TREATMENT OF GOODWILL
The deceased partner is entitled to be compensated for his share of goodwill at the time of death because
goodwill earned by the firm is the result of the efforts of all the existing partners in past and future profits
will be earned on basis of the present goodwill.
Gaining partners compensate the sacrificing (Deceased) partner in their Gaining Ratio.
Deceased Partner’s share of Goodwill = Value of Firm’s Goodwill × Profit share of deceased partner
Case 1: When goodwill does not exist in the Books
To Deceased Partner’s Capital/Current* A/c
(Adjustment made for goodwill on death)
Existing Goodwill, if any is written off by debiting all partners (including deceased partner) in their Old
Profit-sharing Ratio.
Case 2: When goodwill exists in the books
(Old Profit-sharing Ratio)
To Goodwill A/c
(Existing goodwill written off)
To Deceased Partner’s Capital/Current* A/c
(Adjustment made for valued goodwill on death of a partner)
Case 3: Hidden Goodwill
Sometimes, deceased partner’s account is settled by paying a lump sum amount which is in excess of
amount payable or due to him. The difference between amount paid and amount due is hidden goodwill.
Deceased partner’s share of goodwill = Amount agreed to be paid in full settlement – Deceased Partner’s
Capital after all adjustments.
*In case, Partners’ Capital Accounts are maintained following Fixed Capital Accounts Method.
3. REVALUATION OF ASSETS AND REASSESSMENT OF LIABILITIES

(A) When Assets and Liabilities are shown at their Revised Values in the Balance Sheet
It is prepared in the same manner as is in the case of Retirement of a partner

CHAPTER 6 DEATH

Particular Amount Particulars Amount
To Assets A/c (Decrease) By Assets A/c (Increase)

To Liabilities A/c (Increase) By Liabilities A/c (Decrease)
To Profit on Revaluation transferred to By Loss on Revaluation transferred to all
all Partners’ Capital A/cs (old ratio)* Partner’s Capital A/cs (old ratio)*
Balancing Figure Balancing Figure
*Either of the two will appear
(B) When Assets and Liabilities are not shown at their Revised Values
It is prepared in the same manner as is in the case of Retirement of a partner.
The effect of revaluation of Assets and Reassessment of liabilities will be given by passing an Adjustment
Entry, which is:
In case of Gain on Revaluation

Gaining Partners’ Capital/Current A/cs ...Dr.
To Deceased Partners’ Capital/Current A/cs
In case of Loss on Revaluation

Deceased Partners’ Capital/Current A/cs ...Dr.
To Gaining Partners’ Capital/Current A/cs
Note: In the above situation the profit or loss on revaluation is adjusted in the gaining ratio among the
continuing partners.
I. Calculate Net Effect of Revaluation:
Decrease in Liabilities …
Increase in Assets …
Less: Decrease in Assets (…)
Increase in Liabilities (…)
Net Effect of Revaluation …
II. Calculate sacrificed/gained share of each partner
III. Calculate proportionate amount of net effect on revaluation:
For Gaining Partner = Gained profit share × Net Effect of Revaluation
For Sacrificing Partner = Sacrificed profit share × Net Effect of Revaluation
IV. Pass single adjustment entry by adjusting Partners’ Capital/Current Accounts
4. RESERVES, ACCUMULATED PROFITS AND LOSSES

CHAPTER 6 DEATH
(A)When they are not to be shown in Balance Sheet of the Reconstituted Firm at Revised Values
Reserves and Accumulated Profits are transferred to the credit of Partners’ Capital Accounts
(including Deceased Partner) in their old profit-sharing ratio. While Accumulated losses are
transferred to the Debit.
For distributing Reserves and Accumulated Profits:
General Reserve A/c ...Dr.
Profit & Loss A/c (Credit Balance) ...Dr.
[Excess of reserve over difference between Book Value and Market Value]
Workmen Compensation Reserve A/c ...Dr.
[Excess of reserve over liability]
To All Partners’ Capital/Current* A/cs [Old Ratio]
For Distributing Accumulated Losses:
All Partners’ Capital/Current* A/cs ...Dr. [Old Ratio]
To Profit & Loss A/c (Debit Balance)
*In case of Fixed Capitals
(B) When they are to be shown in Balance Sheet of Reconstituted Firm at Old Values
The net effect of Reserves, Accumulated Profits and Losses are adjusted by passing an Adjustment
Entry by debiting/crediting continuing Partners’ Capital Accounts and crediting/debiting Deceased
Partner’s Capital Account.
In case of difference being Positive Balance:
To Deceased Partner’s Capital/Current A/c
In case of difference being Negative Balance:
Deceased Partner’s Capital/Current A/c ...Dr.
To Gaining Partners’ Capital/Current A/cs
I. Calculate the Net Effect of Reserves, Accumulated Profits and Losses:
Accumulated Profits [e.g., Profit & Loss A/c (Cr.)] …
Reserves (e.g., General Reserve) …
Less: Accumulated Losses [e.g., Profit & Loss A/c (Dr.)] (…)
Deferred Revenue Expenditure (e.g., Advertisement Suspense) (…)
Net Effect of Reserves, Accumulated Profits and Losses …
II. Calculate Sacrificed/(Gained) Profit Share of each Partner
III. Calculate share of Gaining Partners and Sacrificing Partners in the Net Effect of Reserves,
Accumulated Profits and Losses:
For Gaining Partner = Gained profit share × Net effect

CHAPTER 6 DEATH
For Sacrificing Partner = Sacrificed profit share × Net effect

IV. Pass single adjustment entry by adjusting Partners’ Capital/Current A/cs
5. SHARE OF PROFIT OR LOSS IN THE YEAR OF DEATH

The executor of deceased partner is entitled to the share of profit earned by the firm from the beginning of
the year till the date of death. Deceased Partner’s share of profit is credited and loss is debited to his
Capital Account. The share of profit is accounted on the following two bases:
(i) When profit-sharing ratio of the remaining partners doesn’t change;
(ii)When profit-sharing ratio of the remaining partner’s changes.
(i) When Profit-sharing Ratio of Continuing Partners Doesn’t Change
On Time Basis
Deceased Partner’s Share of Profit = Profit of Previous Year × No. of Months he lived/12
Accounting Entries:
In case of Profit:
In case of Loss:
On Sales Basis
Deceased Partner’s Share of Profit = Last Year’s Profit/Last year’s Sale × Sales till date of death
Accounting Entries:
In case of Profit:
In case of Loss:
Notes:
1. If there is a debit balance in Profit & Loss Suspense Account, it is shown in the assets side of the Balance Sheet
Prepared by Reconstituted
of the Shubham Jagdish 8112601234/
firm. Whereas, its credit balance is shown in the Liabilities side of8299364494
the Balance Sheet of
CHAPTER 6 DEATH
(ii) When Profit-sharing Ratio of Continuing Partners Changes

On Time Basis
Deceased partner’s share of profit = Profit of previous year × No of months he lived/12.
Gaining Partner's Capital/Current A/cs ...Dr.
[Gaining Ratio]
Alternatively, Gaining Partners’ Capital/Current A/cs ...Dr.
[Gaining Ratio]
(Transfer of profit till the date of death in case of change in profit-sharing ratio)
On Sales Basis
Deceased Partner’s Share of Profit = Last year’s profit/last year’s sale × Sales till date of death.
[Gaining Ratio]
Alternatively, Gaining Partners’ Capital/Current A/cs ...Dr.
[Gaining Ratio]
(Transfer of profit till the date of death in case of change in profit-sharing ratio)
When Deceased partner’s share is loss, the reverse of above entries is passed.
Note: Deceased partner may also be entitled for other appropriations like interest on capital, salary,
commission, etc. They are also adjusted in the same manner. Estimated profit is adjusted either
through Profit & Loss Suspense Account (When Profit-sharing Ratio of continuing partners does not
change) or through Gaining Partners’ Capital Accounts (When Profit-sharing Ratio of continuing
partner’s changes) in their gaining ratio.
WHEN PROFIT-SHARING RATIO OF CONTINUING PARTNERS DOES NOT CHANGE

(Transfer of interest on capital, salary or commission till the date of death in case of profit-sharing ratio of
continuing partners does not change)

CHAPTER 6 DEATH
WHEN PROFIT-SHARING RATIO OF CONTINUING PARTNERS CHANGES

(Gaining Ratio)
(Transfer of interest on capital, salary or commission till the date of death in case of change in profit-sharing
ratio)
Note: If interest on deceased partner’s drawings is charged, the reverse of above entry is passed as per the
situation.
Transfer of Deceased Partner’s Capital Account to his Executor’s Account: When the amount due to
deceased partner is ascertained after all adjustments, the total amount due is transferred to Deceased Partner’s
Executor’s Account and settlement is made through Executor’s A/c as per the agreement.

CHAPTER 7 DISSOLUTION
CHAPTER AT A GLANCE
Dissolution of Partnership: It means termination of old partnership agreement and reconstitution of the firm
due to Change in profit-sharing ratio, Admission, Retirement and Death of partner. It may or may not result
into the closure.
Dissolution of Partnership Firm: It means closure of the firm and end of business relationship among
all the partners.
MODES OF DISSOLUTION
Dissolution of Partnership Dissolution of Partnership Firm
In case of, Without intervention of the Court:
 Change in profit-sharing ratio among the existing • By Mutual Agreement
partners • Compulsory Dissolution
 Admission of a partner • On the Happening of an Event (Insolvency of a
 Retirement of a partner partner, Death of a partner, fulfilment of the object
 Death of a partner for which firm was formed, expiry of the period for
 Insolvency of a partner which firm was formed)
 •Expiry of period of partnership • By Notice

By Order of the Court:
• When a partner has become a person of unsound
mind
• When a partner has become permanently
incapable of performing his duties as partner
• When a partner is guilty of misconduct that may
harm the partnership
• When a partner willfully or persistently commits
breach of partnership agreement
• Court finds dissolution of the firm justified
• • The business cannot be carried on except at a
loss
SETTLEMENT OF ACCOUNTS ON DISSOLUTION OF THE FIRM

Generally, two issues have to be resolved at the time of dissolution:
1. Settlement of Accounts (Section 48)
• Section 48 of the Indian Partnership Act, 1932 deals with settlement of accounts whereby-
• Treatment of losses-Loss (including deficiencies of capital) is paid first out of profit, then out of capital
and lastly (if necessary) by partners individually in their profit-sharing ratio.

• Application of Assets-Assets of the firm (including amount contributed by the partners to make up
deficiencies of capital) shall be applied in following order: -
(a) In paying firm's debts to third parties.
(b) Out of remaining amount, the loan advances by partners will be paid.
(c) Thereafter, the balance of partners' Capital Accounts will be returned.
(d) If still amount remains, it will be distributed among partners in their profit-sharing ratio.
2. Payment of Firm's Debts and Private Debts (Section 49)
• Debts which the firm owes to outsiders are known as Firm's Debts, whereas the debts which a partner
owes in his personal capacity are known as Private Debts.
• Firm's property is applied for payment of firm's debts.
• Private property of each partner is applied towards the payment of his private debts and surplus, if any, is
applied towards payment of firm's debts.
ACCOUNTING ON DISSOLUTION OF PARTNERSHIP FIRM
Dissolution process starts by preparing the following accounts in the firm's book:
1. Realization Account,
2. Loan by Partner Account,
3. Loan by Firm to Partner Account,
4. Partners' Capital Accounts, and
5. Bank or Cash Account.
1. REALISATION ACCOUNT
• Realization Account is opened for disposal of all assets of the firm and settling all liabilities.
• It is a Nominal Account and the object of such an account is to determine profit or loss on realization of assets
and payment of liabilities.
Dr. REALISATION ACCOUNT Cr.
Particulars ₹ Particulars ₹
To Sundry Assets A/c --- By Sundry Liabilities A/c ---
(Except Cash and Bank balance, (Except Partners' Loan) (Note 2)
Fictitious By Bank/Cash A/c (Assets Realized)
---
Assets, Loan to Partner and Debit By Partner's Capital A/c (Assets Taken)
balance of Capital A/c) (Note 1) --- By Partners' Capital A/cs (Loss on ---
To Bank/Cash A/c (Liabilities Paid) --- Realization) * ---
To Bank/Cash A/c (Note 3) (Realization
Expense) ---
To Partner's Capital A/c
(Realization Expenses if paid by --
Partner) --- ----
To Partners' Capital A/cs (Gain on
Realisation)*
*Either of the two will appear.

Important Notes (Points to Remember)

1. While transferring Assets following points should be remembered:
(a) All Asset Accounts except Fictitious assets, i.e., accumulated losses like Debit Balance of Profit & Loss
Account and Deferred Revenue Expenditure like Advertisement Suspense Account, etc., are transferred
to Realization Account.
(b)If there exists a provision against any asset, i.e., provision for doubtful debts, the assets should be
transferred to the Realization Account at its gross figure and such Provision Account should be
transferred to the Credit side of Realization Account.
(c) Loan to Partner is retained in a separate account and is received.
(d) If Question is silent about the realization of an asset, it is assumed that the all tangible asset WILL
BE realized at book value. (intangible assets will not be realized at all )
2. While transferring Liabilities following points should be remembered:
(a) Only those liabilities which are related to the outside parties are transferred such as Creditors, Bills
Payable, Bank Overdraft, Provident Fund, Outstanding Expenses, Partner's Wife's Loan, etc.
(b) Partner's Loan Account is not transferred to Realization Account.
(c) Undistributed profits such as General Reserve, Reserve Fund, Credit balance of Profit & Loss Account are
also not transferred to Realization Account.
(d) Bank overdraft being outside liabilities is transferred to Realization Account.
(e) Even if the question is silent about the payment of a liability, it is paid in full.
REALISATION EXPENSES
Borne by Firm and Paid by Firm: Borne by Firm and paid by Partner:
Realisation A/c Realisation A/c ...Dr.
...Dr. To Partner's Capital A/c
To Cash/Bank A/c
Borne by Partner and Borne by Partner and Firm paying a fixed amount to partner and
paid by Partner: paid by Firm: partner has to bear the expenses:
No Entry Needs to be Partner's Capital A/c Realisation A/c ...Dr.
Passed ...Dr. To Partner's Capital A/c
To Cash/Bank A/c
Note: There may be a case where realization expenses are to be borne by a Partner (say, Ajay) but paid by
another Partner (say, Vijay). The entry if passed in this case is as follows:
Ajay's Capital A/c ...Dr.
To Vijay's Capital A/c
2. LOAN BY PARTNER TO FIRM ACCOUNT
If partner has given loan to the firm, his loan will be paid after payments of all outside liabilities. Therefore,
'Loan by Partner' is not transferred to the Realization Account and his Loan Account is kept separate and paid
after payment of outside liabilities but before repayment of capitals. The entry passed is:
`Loan by Partner A/c ...Dr.
To Cash/Bank A/c
3. LOAN BY FIRM TO PARTNER ACCOUNT
If the firm has given loan to partner, it is an asset of the firm and this amount should be utilized to make
payment of outside liabilities of the firm. Hence, it is not debited to his Capital Account but instead is received
from him. The entry passed is:
To Loan to Partner A/c
4. PARTNER'S CAPITAL ACCOUNT
After the transfer of Gain (Profit) or Loss on realization, undistributed profits, reserves, etc., to the Partners'
Capital Accounts, the balance of Partners' Capital Accounts are settled by passing the followings entries:
To Partner's Capital A/c
(Deficit in capital brought by partner)
Partner's Capital A/c ...Dr.
To Cash/Bank A/c
(Amount paid to partner)
Dr. PARTNERS' CAPITAL ACCOUNTS Cr.
Particulars A (₹) B(₹) Particulars A (₹) B(₹)
To Balance b/d* --- --- By Balance b/d* --- ---
To Realization A/c --- --- By Realization A/c (Liabilities taken --- ---
(Assets taken over by Partner) by Partner)
To Realization A/c* (Loss on By Realization A/c* (Gain on
Realization) --- --- Realization) --- ---
To Cash/Bank A/c (Realization By Reserve A/c
Expenses to be Borne by Partner By Undistributed Profit A/c
--- --- --- ---
paid from Firm's Account) By Realization A/c
To Cash/Bank A/c* (Final Payment) (Realization Expenses paid on --- ---
behalf of Firm) --- ---
By Cash/Bank A/c* (Deficit brought
--- ---
in)
--- ---

5. BANK or CASH ACCOUNT

Dr. BANK/CASH ACCOUNT Cr.
To Balance b/d --- By Realization A/c (Liabilities paid off) ---
To Realization A/c (Asset Sold) --- By Realization A/c (Realization Expenses) ---
To Loan to Partner A/c --- By Loan by Partner A/c ---
To Partner's Capital A/c (Amount brought by --- By Partners' Capital A/cs (Amount paid to ---
Partners) Partners)
Note: If both cash and bank accounts are given in the question either of the accounts can be prepared by
closing one account after transferring its balance to other account.

CHAPTER 8 SHARES

CHAPTER 8 SHARES
CHAPTER AT A GLANCE
Meaning of a Company
A Company is:
 An artificial person separates from its members (owners/shareholders).
 which does not have physical existence.
 formed and registered under the Companies Act, 2013 or any of the earlier Companies Acts.
Features or Characteristics of a Company
 Artificial Person: A company is an artificial person having its own existence and can enter a contract,
carry business in its name and sue or be sued for its debts and actions.
• Separate Legal Existence: A company is separate from its owners/members/shareholders.
• Perpetual Succession: A company has a perpetual existence. Change in shareholders does not affect its
existence. It can only be wound up.
• Transferability of shares: Shares of a company are freely transferable, in the case of Listed Companies
while in other companies shares transfer is restricted.
• Limited Liability: Liability of its shareholders is limited to the nominal or face value of the shares held
by them.
• Management: A company is managed by its Directors, thus management and ownership are separate.
• Common Seal: A company may or may not have a common seal.
Kinds of Companies
• One Person Company: One Person Company means a company which has only one natural person as
member. One-person company should have at least 2 Directors but cannot exceed 15 Directors.
• Public Company: A Public Company is a company which is not a Private Company. It should have at
least 7 members and a minimum of 3 Directors but not more than 15 Directors.
A Public Company may be Listed or an Unlisted Public Company.
• Private Company: A Private Company is a company that is not public company. It can have a maximum
of 200 members and should have at least 2 Directors and a maximum of 15. The shares of a Private
Company are not freely transferable.
Types of Companies based on Liability
• Limited Liability Company: Liability of its members is limited by the amount unpaid on shares held
by them.
• Unlimited Liability Company: In this type of company, the liability of members is unlimited.
• Company limited by Guarantee: The liability of members is limited to amount guaranteed by them in
the event of the company being wound up.
Stages for Incorporation of a Company
Promotion Registration/Incorporation Subscription to Capital
Commencement of Business
MEANING OF SHARE CAPITAL
Share Capital is the amount subscribed by the members in the company. There are two types of shares:
(a) Equity Shares: An equity share is a share which is not a preference share. These shares do not carry any
preferential right of dividend or repayment of capital. These shares are the most common and carry highest
risk and reward.

CHAPTER 8 SHARES
(b) Preference Shares: Preference shares are those shares which carry preferential right to receive dividend
compared to equity shareholders and carry the right to receive repayment of capital in case of winding up
of the company. Different types of Preference Shares are:
• Cumulative Preference Shares/Non-Cumulative Preference Shares
• Participating/Non-Participating Preference Shares
• Convertible/Non-Convertible Preference Shares
• Redeemable/Irredeemable Preference Shares
Classification of Share Capital
• Authorized/Nominal/Registered Capital: It is the maximum amount that a company can raise as
capital and is stated in the Memorandum of Association of the Company.
• Issued Capital: It is that part of the Authorized Capital which the company has issued for subscription
and includes shares issued for consideration other than cash, etc.
• Subscribed Capital: It is that part of the Issued Capital which has been subscribed. Subscribed Capital
may further be classified into Subscribed and fully paid-up and Subscribed but not fully paid-up.
• Paid-up Capital: It is that part of subscribed capital, which is paid-up by the shareholders.
Reserve Capital and Capital Reserve

Reserve Capital is that part of the subscribed share Capital Reserve is a reserve created out of capital
capital which the company resolves to call only at the profits but cannot be used for payment of dividend.
time of winding up of the company.
Issue of Shares for Cash
A company may issue shares for cash in either:
• Lump sum amount along with Application, or
• In instalments with money to be paid on application, allotment and on calls.
As per Companies Act, minimum application money should be 5% of the face value of the share or as
prescribed
by SEBI. SEBI prescribes that application money cannot be less than 25% of the issue price.
Shares may be issued at par or at Premium.
• Issue of Shares at Par: Shares are said to be issued at par when issue price is same as face value or nominal
value of a share. For example, if share is of 10 and is issued at 10, it is said that the share is issued at par.
• Issue of Shares at Premium: Shares issued at a price more than the face value or nominal value of a share, it
is said that shares are issued at a premium. For example, if a share of the face value of 10 is issued at 20, 10
will be the premium on each share. The premium on issue of share is a capital profit and it is credited to a
separate account called "Securities Premium Account".
Journal entries for Securities Premium
Generally, the question specifies when securities premium is receivable. However, in absence of any
information, it is assumed that premium will be collected along with allotment money.
Journal entries passed under different situations are as follows:
If the amount of premium is received along with application money:

CHAPTER 8 SHARES
Particulars Amount
Bank A/c ...Dr. Total application money received including securities
To Shares Application A/c premium
(Amount received on application)

Shares Application A/c Total application money
To Shares Capital A/c With amount paid towards share capital
To Securities Premium A/c Amount of premium received along with application
(Shares allotted and Application money transferred) money
If the amount of premium is received along with allotment/Calls money:

Particulars Amount
For Allotment being due Total money due on allotment/Call with the amount
Share Allotment A/c/Share Call A/C …Dr paid towards share capital.
To Share Capital A/c Amount of premium received along with application

money
To Securities Premium A/c
(Amount due on allotment along with Securities
Premium)
Bank A/c …Dr Total allotment money received including premium

To Shares Allotment A/c / Share Call A/c
(Amount received on allotment)
Utilization of Securities Premium

As per Section 52(2) of the Companies Act, 2013, Securities Premium or Securities Premium Reserve can be
used for the following purposes:
• Issuing fully paid bonus shares;
• Writing off preliminary expenses;
• Writing off the expenses, commission paid or discount allowed on issue of securities or debentures;
• Providing for the premium payable on redemption of preference shares or debentures;
• Purchasing/buy-back of own shares.
Issue of Shares for Consideration Other than Cash
A company may issue shares for consideration other than for cash. For example, in lieu of payment against
purchase of assets, business, etc. In this case, there are two different transactions, i.e., purchase of business/
assets and payment through issue of shares. The Journal entries passed are:

CHAPTER 8 SHARES
On Purchase of Assets:
Sundry Asset A/c …Dr
To Vendor's A/c
(Amount due to vendor on purchase of assets)
On Purchase of Business:
Sundry Assets A/c …Dr
Goodwill A/c* …Dr
To Vendor's A/C
To Sundry Liabilities A/c
To Capital Reserve A/c*
(Amount due on acquisition of business)
On Issue of Shares:
Vendor's A/c
To Securities Premium A/c (in case shares are issued at premium)
To Share Capital A/c
(Shares issued to vendor)
Issue of Shares to Promoters:
A company may issue shares to Promoters for the services rendered by them or the expenses incurred by them.
For this purpose, following entry will be passed:
Incorporation Expenses/Preliminary Expenses A/c …Dr
To Promoters' A/c
(Amount due to promoters) Promoters' A/c
Promoters' A/c …Dr
(Shares issued to promoters on premium)
Issue of Shares to Underwriters:
Underwriting is a contract under which the underwriter undertakes to subscribe the shares which remain
unsubscribed by the public. Underwriter agrees to subscribe for the remaining shares, for a commission. The
Journal entries passed are:
Underwriting Commission, A/c …Dr
To Underwriters' A/c (Underwriting commission due)
Underwriters' A/c …Dr
(number of shares of__each, issued to underwriter)
Oversubscription of Shares

CHAPTER 8 SHARES
Oversubscription is when shares applied are more than the shares offered by the company in the public offer.
In such a case, a company may allot shares in one or combinations of the following:
(i) Reject excess applications; and
(ii) Pro rata allotment.
Points to Remember in Oversubscription

1. Application money left after adjustment against Allotment Money is refunded to the applicants.
2. Excess Application Money is adjusted against Call or Calls only if the question so specifies. It is carried forward
as Calls in Advance.
Undersubscription of Shares:
When the number of shares applied for is less than the number of shares offered for issue, it is known as Under
Subscription. This is subject to the qualification, that minimum subscription, i.e., 90% of the issue has at least
been received.
SEBI prescribes that at least 90 per cent of the issue of shares should be subscribed before shares can be
allotted.
Calls-in-Arrears:
When a shareholder does not pay allotment money or call money within time specified, it is known as Calls-in-
Arrears. Two alternative accounting methods of treatment of Calls-in-Arrears are:
(i) Not opening Calls-in-Arrears Account: In this method, the allotment or call account will show a debit
balance representing the amount due but not received. This account will be settled on receipt of money or
forfeiture of shares.
(ii) Opening Calls-in-Arrears Account: In this method, a Calls-in-Arrears Account is opened when allotment
or call(s) money is not received from the shareholder and the amount not received on allotment or call(s)
are transferred to Calls-in-Arrears. On receipt of money, the Calls-in-Arrears Account is credited.

CHAPTER 8 SHARES
Interest on Calls-in-Arrears
In case of Calls-in-Arrears, if the Articles of Association of a company is silent, then Table F of the companies
Act, 2013 shall apply and interest @ 10% p.a. may be charged on Calls-in-Arrears.
Calls-in-Advance:
In case a shareholder pays part or in the whole, any sum of money which is not yet due to be paid, then the
amount received is credited to Calls-in-Advance Account.
Calls-in-Advance is shown under main head 'Current Liabilities' and sub-head 'Other Current Liabilities'.
Interest on Calls-in-Advance:
In case Articles of Association of the company do not specify the rate of interest, Table F of Companies Act 2013
will apply and interest @ 12% p.a. will be paid.
Forfeiture of Shares:
In case a shareholder fails to pay the amount due on allotment or call(s), the company may forfeit or cancel the
shares held by him. It is called Forfeiture of Shares. However, a company can forfeit shares if the Articles of
Association of the company permits.
IMPORTANT POINTS ABOUT FORFEITURE OF SHARES
1. On forfeiture, Share Capital Account is debited by the amount called-up till the date of forfeiture. 2. Amount
not received (say, on allotment or calls), if not transferred to Calls-in-Arrears Account, are credited to
Allotment Money Account or Calls Account, as the case is.
3. Amount not received and transferred to Calls-in-Arrears Account, at the time of forfeiture, Calls-in- arrears
Account is credited.
4. Forfeited shares may be issued by the company at par, premium or discount. However, discount cannot
exceed the amount forfeited on each such share.
5. Forfeited shares reissued at a discount, the amount of discount is debited to Forfeited Shares Account. 6.
Gain, if any, on reissue of forfeited shares is transferred to Capital Reserve Account.
Journal Entries
(A) When Calls-in-Arrears Account is not Opened:
Share Capital A/c ...Dr.
Securities Premium A/c (if premium due but is not received) ...Dr.
To Shares Allotment A/c (if allotment money is unpaid)
To Shares Call (s) A/c (if call (s) money is unpaid)
To Forfeited shares A/c
(Shares forfeited for non-payment)
(B) When Calls-in-Arrears Account is Opened:
Share Capital A/C …Dr
Securities Premium A/c (if premium due but is not received) …Dr
To Calls-in-Arrears A/c
To Forfeited shares A/c
(Shares forfeited for non-payment)
Re-issue of Forfeited Shares:
A company may re-issue the forfeited shares at par, premium or at discount. However, discount cannot be
more than the amount previously received on forfeited shares. The entries are:

CHAPTER 8 SHARES
Bank A/c
To Shares Capital A/c ...Dr.
To Securities Premium A/c (if shares are reissued at premium, i.e., at more than its nominal (face) value)
(Forfeited shares re-issued)
Bank A/c
…Dr
Forfeited Shares A/c …Dr
(Forfeited shares issued at discount)
Forfeited Shares A/c …Dr
To Capital Reserve A/c
(Gain on reissued shares transferred to Capital Reserve A/c)

CHAPTER 9 ROD
CHAPTER AT A GLANCE
Redemption of Debentures means discharging the liability for debentures issued by a company by making
payment to debenture holders or by conversion into shares or new debentures.
As a result of debentures redeemed by payment in cash or by conversion into shares, liability for debentures
ends to the extent of debentures redeemed. As far as conversion of debentures into new debentures is
concerned, liability against converted debentures comes to an end but liability towards new debentures comes
into existence.
Debentures are redeemed either
(i) on the due date; or
(ii) earlier;
as per the terms of issue of debentures.
At the time of redemption of debentures, following three points should be kept in mind:
1. Time of Redemption of Debentures
• Redemption on Due Date.
• Redemption before the due date, if terms of issue permit.
2. Amount of Redemption of Debentures
• Nominal (face) value, if redeemed at par.
• Nominal (face) value plus premium payable, if redeemed at premium.
• Amount Paid for purchase, if purchased from open market.
3. Sources of Redemption of Debentures
• Out of Capital: Without transfer of amount to DRR.
• Out of Profits: Transfer amount equal to Value of Debentures, i.e., 100% of value to DRR.
• Out of Profits and Capital: Transfer a part of value of Outstanding Debentures, i.e., less than 100% of
the value to DRR.
DEBENTURES REDEMPTION RESERVE (DRR)
Debentures Redemption Reserve (DRR) is a reserve set aside out of Profits available for payment of dividend
for the purpose of redemption of debentures.
Rule 18(7)(b) of the Companies (Share Capital and Debentures) Rules, 2014 prescribes as follows:
Amount shall be transferred to DRR, out of profits of the company that are available for payment of dividend.
Dividend can be paid by a company from:
General Reserve;
Dividend Equalization Reserve; and
Surplus, i.e., Balance in Statement of Profit & Loss.
Thus, amount can be set aside to DRR out of the above Reserves and Surplus. The entry passed is:
General Reserve A/c
...Dr.
Dividend Equalization Reserve A/c
...Dr.
Surplus, i.e., Balance in Statement of Profit & Loss A/c ...Dr.
To Debentures Redemption Reserve A/c

CHAPTER 9 ROD
KEY POINTS RELATED TO DRR

• Only Unlisted Companies (Other than NBFCs and/or HFCs) are required to transfer amount to DRR which
shall not be less than 10% of the value of Outstanding Debentures, i.e., nominal (face) value of the
outstanding debentures.
• Amount can be set aside to DRR, out of profits available for payment as dividend, at any time before the
redemption of debentures.
• Amount may be transferred to DRR in lump sum or in parts but before the redemption of debentures.
• If Debentures are redeemed out of profit alone, amount equal to 100% of the value of Outstanding
Debentures should be transferred to DRR.
• In case Debentures are fully convertible into shares or new debentures, amount is not transferred to DRR.
• In case Debentures are partly convertible, amount is transferred to DRR on Non-convertible part of the
debentures.
TRANSFER OF DRR TO GENERAL RESERVE
Rule 18(7)(b) of the Companies (Share Capital and Debentures) Rules, 2014 prescribes that adequate amount,
i.e.,
Minimum amount - 10% of Outstanding Debentures;
Maximum amount - 100% of Outstanding Debentures;
should be the balance in DRR Account.
Therefore, a company has the option to transfer amount of DRR to General Reserve either:
(i) proportionate amount after every redemption; or
(ii) total amount after redemption of all the debentures.
The accounting entry passed is:
Debentures Redemption Reserve A/c ...Dr.
To General Reserve A/c
DISCLOSURE OF DRR IN COMPANY'S BALANCE SHEET

Debentures Redemption Reserve is shown in the Equity and Liabilities part of the Balance Sheet under the
main head 'Shareholders' Funds' and sub-head 'Reserves and Surplus'.
DEBENTURES REDEMPTION INVESTMENT (DRI)
Rule 18(7)(b) of the Companies (Share Capital and Debentures) Rules, 2014 prescribes that companies that are
to redeem debentures, except the companies exempted from Debentures Redemption Investment, shall
"Invest an amount not less than 15 per cent of the nominal (face) value of the debentures to be redeemed
by 31st March of the next year in specified securities on or before 30th April of the current year."
It further prescribes that the amount remaining invested or deposited, as the case may be, shall not at any time
fall below 15 per cent of the amount of the debentures maturing during the year ending on 31st March of that
year.
Accounting Entries
On Investment or Deposit being made in Specified Securities:
Debentures Redemption Investment A/c To Bank A/c ...Dr.
On Realizing Debentures Redemption Investment (DRI):
Bank A/c
...Dr.
To Debentures Redemption Investment A/c

CHAPTER 9 ROD
Debentures Redemption Investment (DRI) Provisions at a Glance

S.No. Debentures Issued by Whether
Investment to be
made in DRI or
Not
1. All India Financial Institutions (AIFIS) regulated by RBI No
2. Banking Companies (for both Public Issue and Private Placement) No
3. Other Financial Institutions (Fls) with the meaning of Section 2(72) of the No
Companies Act, 2013
4. Listed Companies (Other than AIFIs and Banking Companies) (for both Public
Issue and Private Placement of Debentures)
(a) NBFCs, registered with RBI under Section 45-IA of the RBI Act, 1934; Yes
(b) HFCs, registered with National Housing Bank; Yes

(c) Other Listed Companies. Yes
5. Unlisted Companies (Other than AIFIs and Banking Companies) (for Privately
Placed Debentures)
(a) NBFCs, registered with RBI under Section 45-IA of the RBI Act, 1934; No
(b) HFCs, registered with National Housing Bank; No
6. Other Unlisted Companies (Other than NBFCs and HFCs) Yes
KEY POINTS RELATED TO DRI

• The term "On or before 30th April" means that a company redeeming the debentures may invest in the
specified securities on 30th April of the current year or any time before that date. Thus, investment can be
made in DRI in the earlier year or years.
• The amount invested or deposited in specified securities shall not be used for any purpose other than for
redemption of debentures.
• In case of redemption of debentures in annual instalments by draw of lots, total investment in DRI made for
the redemption of the instalment of debentures is not realized at the end of the year but is realized/further
purchased to the extent to maintain 15% of the nominal (face) value of the debentures to be redeemed in
the next instalment.
• In case of redemption in equal annual instalments, DRI for the first instalment remains invested till the last
instalment.
ACCOUNTING ENTRIES
(i) On transferring amount to General Reserve A/c ...Dr.
Debentures Redemption Reserve Dividend Equalization Reserve A/c ...Dr.
Surplus, i.e., Balance in Statement of Profit & Loss A/c ...Dr.
To Debentures Redemption Reserve A/c
(ii) On Investment or Deposit Debentures Redemption Investment A/c ...Dr.
in Specified Securities To Bank A/c
(iii) For Interest Received on Bank A/c ...Dr.
Investment To Interest Earned A/c

CHAPTER 9 ROD
(iv) On Realizing Investment or Bank A/c

Deposit in Specified Securities
...Dr.
To Debenture Redemption Investment A/c
(v) On amount being due to ...% Debentures A/c
Debenture holders on
Redemption ...Dr.
Premium on Redemption of Debentures A/c*
...Dr.
To Debenture holders' A/c
*When Debentures are redeemed at premium.
(vi) On payment to Debenture Debenture holders' A/c
holders ...Dr.
To Bank A/c
(vii) On Transfer of amount from DRR Debentures Redemption Reserve A/c
to ...Dr.
General Reserve To General Reserve A/c
METHODS OF REDEMPTION OF DEBENTURES
1. Redemption of Debentures in Lump Sum on Maturity

When all the debentures are redeemed together on the redemption date specified in the terms of issue, i.e.,
on their maturity. The debentures may be redeemed at par or at premium.
A. For the Amount Due to Debenture holders on Redemption:
...% Debentures A/c
...Dr.
Premium on Redemption of Debentures A/c* ...Dr.
To Debenture holders' A/c
B. For Payment to Debenture holders:

CHAPTER 9 ROD
Debenture holders' A/c

...Dr.
To Bank A/c
*When Debentures are redeemed at premium.
2. Redemption of Debentures by Draw of Lots in Instalments on Maturity
As per the terms of issue, company may redeem its debentures at par or at premium by payment each year,
the debentures being selected by draw.
Amount is set aside to DRR before the redemption of debentures and also investment is made in DRI as per
the provisions of Companies Act, 2013.
DRR is transferred to General Reserve in proportion to the debentures redeemed. It is so because part of
the Specific Reserve (i.e., DRR) becomes Free Reserve (i.e., General Reserve) to the extent of amount
proportionate to debentures redeemed.
In case of redemption of debentures in annual instalments by draw of lots, the total DRI for the redemption
of the instalment of debentures is not realized at the end of the year but is realized/further purchased to
the extent to maintain 15% of the face value of the debentures to be redeemed in the next instalment.
In case of redemption in equal annual instalments, DRI made for the first instalment remains invested till
the last instalment.

CHAPTER 10 FINANCIAL STATEMENT

CHAPTER AT A GLANCE
Meaning of Financial Statement
Financial statements are a summary of accounting data (transactions) prepared on the basis of accounting
principles and practices, and accounting standards. Section 129 of the Companies Act, 2013 requires that a
company should prepare its financial statements at the end of every accounting period as per Schedule III of
the Companies Act, 2013. Financial Statements include:
(i) Balance Sheet, i.e., Statement of Financial Position;
(ii) Statement of Profit & Loss, i.e., Income Statement;
(iii) Notes to Accounts;
(iv) Cash Flow Statement.
Nature of Financial Statements
(i) Based on recorded facts: Financial Statement is a summary of recorded transactions which are entered
in the accounting data based on evidence or supporting document/information.
(ii) Accounting Concepts and Conventions: Financial Statements are prepared by following accounting
concepts and conventions. The three fundamental accounting concepts are Going Concern Concept,
Consistency Concept and Accrual Concept. These fundamental accounting concepts are presumed to have
been followed unless stated otherwise in the financial statements.
(iii) Accounting Standards: Accounting Standards prescribed by Companies Act, 2013 are mandatory in nature
and must be followed by the companies in preparing their financial statements.
(iv) Accounting Policies: Accounting policies affect treatment of certain items. For example, method of
depreciation or valuation of inventory.
(v) Estimates: Financial Statements have transactions or events based on estimates made by the management.
Examples where estimates are made are: life of an asset to provide depreciation, provision for doubtful
debts and provision for retirement benefits of employees, etc.
Contents of Annual Report
A set of Annual Report of a company has:
(i) Board of Directors Report as per Section 134 of Companies Act, 2013, Directors' Responsibility
Statement, Report on Corporate Governance and Management Discussion and Analysis.
(ii) Auditor's Report issued by the Statutory Auditor.
(iii) Financial Statements including Balance Sheet, Statement of Profit & Loss, Notes to Accounts and Cash Flow
Statement.
Financial Statements
Balance Sheet: Balance Sheet shows the financial position of a company showing balances of Assets, Equity
(Shareholder's funds) and Liabilities at a specific point of time. Balance Sheet is prepared by companies in the
format prescribed in Part I of Schedule III of the Companies Act, 2013.

Format of Balance Sheet

Name of the Company
BALANCE SHEET as at .. (Rs. In…)
Particular Note Figures as the end of Figures as the end
No. Current Reporting of Previous
Period Reporting Period
(1) (2) (4)
(3)
I. EQUITY AND LIABILITIES
1. Shareholders’ Funds
(a) Share Capital … …
(b) Reserve and Surplus … …
(C) Money Received against Share Warrants … …
2. Share Application Money Pending Allotment … …
3. Non-Current Liabilities
(a) Long-term Borrowings … …
(b) Deferred Tax Liabilities (Net) … …
(c) Other Long-term Liabilities … …
(d) Long-term Provisions … …
4. Current Liabilities
(a) Short-term Borrowing … …
(b) Trade Payables … …
(c) Other Current Liabilities … …
(d) Short-term Provisions … …
Total … …
II. ASSETS
1. Non-Current Assets
(a) Property, Plant and Equipment and Intangible
Assets … …
(i) Property, Plant and Equipment … …
(ii) Intangible Assets … …
(iii)Capital Work-in-Progress … …
(iv) Intangible Assets under Development … …
(b) Current Investment … …
(c) Deferred Tax Assets (Net) … …
(d) Long-term Loan and Advances … …
(e) Other Non-current Assets
2. Current Assets … …
(a) Current Investments … …
(b) Inventories … …
(c) Trade Receivables … …
(d) Cash and Cash Equivalents … …
(e) Short-term Loan and Advances … …
(f) Other Current Assets.
Total … …

Statement of Profit & Loss

Statement of Profit & Loss is a statement that shows the profit earned or loss incurred during the accounting
period.
Format of Statement of Profit & Loss
Name of the Company
STATEMENT OF PROFIT & LOSS for the year ended …
Particulars Note Figures for the Figures for the
No. Current Reporting Previous Reporting
period Period
I. Revenue from Operations … …
II. Other Income … …
III. Total Revenue (I +II) … …
IV. Expenses:
Cost of Material Consumed … …
Purchases of Stock-in-Trade … …
Changes in Inventories of Finished Goods, Work-in- … …
Progress and
Stock-in-Trade … …
Employee Benefit Expenses … …
Finance Costs … …
Depreciation and Amortization Expenses … …
Other Expenses … …
Total Expenses … …
V. Profit before Tax (III-IV) … …
VI. Less:Tax … …
VII. Profit or Loss for the Period (V-VI) … …
Revenue from Operations: Revenue earned by the company in its normal course of business are shown as
revenue from operations. Examples are: Net Sales (Sales less Sales Return) earnings from rendering of services,
etc.
Other Income: Earnings which are not revenue from operations are shown as Other Income. Examples are
interest/dividend from investments, Excess provision written back, etc.
Cost of Materials Consumed: It is used by manufacturing enterprises and is the amount of material consumed
in the manufacturing process.
Purchase of Stock-in-Trade: The term is used for the goods purchased for resale. For example, a trading
enterprise purchases finished goods for resale. The purchase of finished goods are shown under this entry.
Changes in Inventories of Finished Goods, Work-in-Progress and Stock-in-Trade: It is the difference
between the closing stock of finished goods, WIP and Stock-in-Trade.

Employee Benefits: The expenses paid or payable in future (including provision for Employee Benefits) is
shown under this entry. Examples are Salaries, Contribution to Provident Fund, Provision for Retirement
Benefits, etc. Finance Cost: Finance Costs means expenses incurred in relation to borrowings by the company.
It will include interest on Bank Loan, Debentures, Discount or Loss on Issue of Debentures (if written off from
Statement of Profit & Loss, etc.
Depreciation and Amortization: Depreciation is allocating of cost of property, plant and equipment (fixed
assets) over its estimated useful life in a systematic manner. Thus, the term Depreciation is associated with
tangible fixed assets.
Amortization is allocating cost of intangible assets (Goodwill, Patents, Trade Marks, etc.) over their estimated
useful life. Thus, the term Amortization is associated with Intangible Assets.
Other Expenses: The entry "Other Expenses" is a residuary entry. All expenses that are not covered by the
entries (heads) of expense are shown in this head of expense. Examples are Electricity Expenses, Courier
Expenses, Audit Fee, etc.
Difference between Total Revenue and Total Expenses is Profit before Tax on which tax is computed. The
balance is Profit after Tax.
Proposed Dividend: Proposed (Final) Dividend for a year is not a liability till it has been declared (approved)
by the shareholders. Thus, proposed dividend is not shown as Short-term Provision in the current year's
Balance Sheet of a company but is disclosed in the Notes to Accounts as Contingent Liabilities.
Liability Vs. Provision: Liability is when the amount of liability is determined whereas Provision is when the
liability is known but the amount of expense or liability is estimated.
Provision Vs. Reserve: Provision is a charge on profit whereas Reserve is an appropriation of profit.
Operating Cycle: It is the time between the acquisition of an asset for its processing and its subsequent
realization in Cash and Cash Equivalents.
FINANCIAL STATEMENT ANALYSIS
Meaning of Financial Statement Analysis
Analysis of Financial Statements is a study of relationships among items in the financial statements i.e., Balance
Sheet, Statement of Profit & Loss and Cash Flow Statement. Financial Statement Analysis is undertaken by
creditors, investors and other users of financial statements to assess the credit worthiness, financial
soundness, safety of investments and earning potential of the company.
Tools or Techniques of Financial Statement Analysis
Some of the commonly used tools or techniques for financial statement analysis are:
Comparative Statements (Horizontal Analysis)
As the name suggests, 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. This analysis can be intra-
firm (for different years) or inter-firm (with another firm of similar nature and size).
Common-size Statements (Vertical Analysis)
In common-size financial statement analysis, individual items are converted into percentage taking a common
base, i.e., Total Assets or Total of Equities and Liabilities in case of Balance Sheet or Revenue from Operations
in case of Statement of Profit & Loss.

Ratio Analysis
Ratio is an arithmetical expression of relationship between two related or inter-dependent components of
financial statements for an accounting period.
Cash Flow Statement
Cash Flow Statement shows inflow and outflow of Cash and Cash Equivalents for the accounting period,
classified into Operating Activities, Investing Activities and Financing Activities.
Objectives of Financial Statement Analysis
1. Evaluating performance of the company
2. Assessing Managerial Efficiency
3. Assessing Short-term and Long-term Solvency of the Enterprise
4. Forecasting and budget preparation
5. Evaluating performance in comparison to similar enterprises
Parties interested in Financial Statement Analysis
1. Management: To evaluate performance and take decisions.
2. Shareholders/Investors: Understand profitability and growth prospects for potential appreciation of
their investment.
3. Lenders: To know Long-term and Short-term Solvency of the enterprise and whether enterprise will
be able to service its debt.
4. Government: To know whether proper and due taxes have been paid on time.
5. Suppliers/Creditors: To know the Short-term Solvency of the enterprise.
6. Employees/Workers: To know how a company is performing, its solvency and sustainability.
Limitations of Financial Statement Analysis
1. Historical Analysis: Financial Statement Analysis is prepared on past data or past numbers. Thus, it is
historical analysis.
2. Different Accounting Practices: It is important for inter-firm comparison; the accounting practices
should be same. Hence, such comparison does not yield desired result, if accounting policies differ.
3. Window Dressing: In case the financial statements are window dressed, the analysis will give false
information.
4. Qualitative information is ignored: Financial Statement Analysis ignores qualitative information which
is equally significant.
5. Inherent limitations of financial statements: Some of the inherent limitations of financial statements
such as price level changes are ignored, bias, historical cost, etc. also affect analysis as the basis of analysis
are the financial statements.

TOOLS OF FINANCIAL STATEMENT ANALYSIS -

COMPARATIVE STATEMENTS AND COMMON-SIZE STATEMENTS
TOOLS OR TECHNIQUES OF FINANCIAL ANALYSIS

Financial Statements have absolute figures which do not show the earning capacity, liquidity and financial
soundness of the enterprises. They need to be analyzed and presented in simple and understandable form.
The tools used for Financial Statement Analysis are:
1. Comparative Statements
2. Common-Size Statements
3. Ratio Analysis
4. Cash Flow Statement
1. COMPARATIVE STATEMENTS
1. Comparative Financial Statement is a tool of financial analysis that shows change in each entry (item)
of the financial statement in both absolute amount and percentage terms, taking the amounts for the
preceding accounting period as base.
2. It is a Dynamic or Horizontal Analysis which is also a Time Series Analysis.
Objectives of Comparative Statements
1. To know the nature of changes influencing financial position.
2. To forecast and plan.
3. To know the movements of key financial statistics.
4. To compare the firm's performance with the average performance of the industry.
5. To know the weaknesses and soundness about liquidity, profitability and solvency of the enterprise.
Comparative Financial Statements
1. Comparative Balance Sheet (Position Statement).
2. Comparative Statement of Profit & Loss (Income Statement).

Format of Comparative Balance Sheet

COMPARATIVE BALANCE SHEET as at 31st March, Previous Year and Current Year
Particulars Not Previo Curre Absolute Change Absolute Change
e us nt (Increase/Decrea (Increase/Decrea
No. Year Year sed) sed)
Rs. Rs. Rs. %
(1) (A) (B) (C=B-A) (D=C/A x 100)
(2) (3) (4) (5) (6)
1. EQUITY AND LIABILITY
1. Shareholders, Fund
(a) Share Capital … … … …
(i) Equity Share Capital … … … …
(ii) Preference Share Capital … … … …
(b) Reserve and Surplus … … … …
2. Non-Current Liabilities
(a) Long-term Borrowings … … … …
(b) Long-term Provisions … … … …
(a) Short-term Borrowing … … … …
(b) Trade Payables … … … …
(c) Other Current Liabilities … … … …
(d) Short-term Provisions … … … …
Total … … … …
II. ASSETS
(a) Property, Plant and Equipment (Fixed
Assets)
(i) Property, Plant and Equipment … … … …
(ii) Intangible Assets … … … …
(b) Non-Current Investments … … … …
(c) Long-term Loan and Advances … … … …
2. Current Assets
(a) Current Investment … … … …
(b) Inventories … … … …
(c) Trade Receivables …. … … …
(d) Cash and Cash Equivalents … … … …
(e) Short-term Loan and Advances … … … …
(f) Other Current Assets … … … …
Total … … … …
Note: If current year's value has decreased, show the Absolute change and Percentage change in brackets to
reflect negative item.

Format of Comparative Statement of Profit & Loss

COMPARATIVE STATEMENT OF PROFIT & LOSS
for the years ended 31st March, Previous Year and Current Year
Particulars Note Absolute Amounts Percentage of Revenue
No from Operations(Net
Sales)
(2) Figures for the Figures for the Previous Current
Previous Year Current Year Year Year
(1) (Rs.) (Rs.) % %
(3) (4) (5) (6)
I. Revenue from Operations (Net Sales) … … 100 100
II. Other Income … … … …
III. Total Revenue (I+II) … … …
IV. Expenses
(a) Cost of Materials Consumed … … … …
(b) Purchases of Stock-in-Trade … … … …
(c) Changes in Inventories of Finished
Goods Work-in-Progress and Stock- … … …. …
in-Trade
(d) Cost of Materials Consumed … … … …
(e) Finance Costs … … … …
(f) Depreciation and Amortization … … … …
Express
(g) Other Expenses … … … …
Total Expenses … … … …
V. Profit before Tax (III-IV) … … … …
VI Less: Income Tax … … … …
VII Profit after Tax (V-IV) … … … …
.
Note: If current year's value has decreased, show the Absolute change and Percentage change in brackets to
show negative item.
2. COMMON-SIZE STATEMENTS
1. These are the statements prepared to compare components of financial statements (Balance Sheet
and Statement of Profit & Loss) of two years by converting them into percentages taking a common
base.
2. It is also a Static or Vertical Analysis which is carried out at one particular point of time, generally
when the accounts are closed.
Objectives of Common Size Statements
1. To present the change in various entries (items) to a common base.
2. To develop an insight in the structure of Financial Statements.

3. To compare the enterprises that differ substantially in size.

COMMON-SIZE FINANCIAL STATEMENTS
1. Common-size Balance Sheet (Position Statement); and
2. Common-size Statement of Profit & Loss (Income Statement).
Format of Common-size Balance Sheet
COMMON-SIZE BALANCE SHEET
as at 31st March, Previous Year and Current Year.
Particulars Note Absolute Amounts Percentage of Balance
No Sheet Total
Figures as at Figures as at Previous Current
the end of the end of Year Year
Previous Year Current Year % %
(Rs.) (Rs.)
(1) (2) (3) (4) (5) (6)
I. EQUITY AND LIABILITIES
1. Shareholders’ Funds
(a) Share Capital
. (i) Equity Share Capital … … … …
(ii) Preference Share Capital … … … …
(b) Reserve and Surplus … … … …
2 Non-Current Liabilities
(a) Long-term Borrowing … … … …
(b) Long-term Provisions … … … …
(a) Short-term Borrowings … … … …
(b) Trade Payable … … … …
(c) Other Current Liabilities … … … …
(d) Short-term Provisions … … … …
Total … … 100 100
II ASSETS
(a) Property, Plant and Equipment and
Intangible Assets:
(i) Property, Plant and Equipment … … … …
(ii) Intangible Assets … … … …
(b) Non-Current Investments … … … …
(c) Long-term Loans and Advances … … … …
2. Current Assets
(a) Current Investments … … … …

(b) Inventories … … … …
(c) Trade Receivables … … … …
(d) Cash and Cash Equivalents … … … …
(e) Short-term Loan and Advances … … … …
(f) Other Current Assets … … … …
Total … … 100 100
Notes:
1. It does not include line items of Balance Sheet, accounting treatment of which are not evaluated.
2. Taking total amount of Balance Sheet as base to calculate the percentage.
Format of Common-size Statement of Profit & Loss

COMMON-SIZE STATEMENT OF PROFIT & LOSS
for the years ended 31st March, Previous Year and Current Year
Particulars Note Absolute Amounts Percentage of Revenue
No from Operations(Net
Sales)
(2) Figures for the Figures for the Previous Current
Previous Year Current Year Year Year
(1) (Rs.) (Rs.) % %
(3) (4) (5) (6)
I. Revenue from Operations (Net Sales) … … 100 100
II. Other Income … … … …
III. Total Revenue (I+II) … … …
IV. Expenses
(a) Cost of Materials Consumed … … … …
(b) Purchases of Stock-in-Trade … … … …
(c) Changes in Inventories of Finished
Goods Work-in-Progress and Stock- … … …. …
in-Trade
(d) Employee Benefit Expenses … … … …
(e) Finance Costs … … … …
(f) Depreciation and Amortization … … … …
Expenses
(g) Other Expenses … … … …
Total Expenses … … … …
V. Profit before Tax (III-IV) … … … …
VI Less: Income Tax … … … …
VII Profit after Tax (V-IV) … … … …
Note: Taking amount of Revenue from operations as base to calculate percentage.

3. RATIO ANALYSIS
It is tool of financial statements analysis wherein financial data is analyzed using
(a) Liquidity Ratios
(b)Solvency Rations
(c) Activity Rations
(d)Profitability Ratios
4. CASH FLOW STATEMENT
It is a tool of financial statements analysis wherein Cash Flow for the accounting period is determined
under three activities, i.e., Operating, Investing and Financing Activities.

CHAPTER 11 ACCOUNTING RATIO

CHAPTER AT A GLANCE
Ratio Analysis
Ratio Analysis is a technique of analyzing Financial Statements with the help of 'accounting ratios'. Accounting
Ratio is an expression of relationship between accounting variables in Balance Sheet and Statement of Profit &
Loss. Forms of Expression of Ratios:
1. Pure: Expressed in ratio. For example, Current Ratio or Liquid Ratio.
2. Percentage: Expressed in percentage. For example, Net Profit Ratio.
3. Times: Expressed in number of times. For example, Trade Receivables Turnover Ratio.
4. Number of Days: Expressed in number of days. For example, days in Average Collection Period or Average
Payment Period.
Objectives/Benefits of Ratio Analysis:
 To make better understanding of accounting information.
 To determine the financial health (i.e., short-term solvency or Liquidity and long-term solvency or
Solvency) of the business.
 To determine operational performance (profitability, turnover ratios).
 To perform inter-firm or intra-firm comparison.
 To perform forecasting on the basis of past trend of ratios.
 To identify the areas in the business not performing well.
Types of Accounting Ratios:
1. Liquidity Ratios: These ratios show the ability of the company to meet its short-term liabilities.
Important Liquidity Ratios are:
(i) Current Ratio = Currents Assets Expressed as Pure Ratio
Current Liabilities
(ii) Quick Ratio = Liquid Assets Expressed as Pure Ratio
Current Liabilities
• Liquid Assets = Current Assets - Inventories - Prepaid Expenses - Advance Tax
2. Solvency Ratios: Solvency Ratios are calculated to assess the ability of the company to meet its long-
term liabilities. Important Solvency Ratios are:
(i) Debt to Equity Ratio = Debt or Long-Term Debts Expressed as Pure Ratio
Equity
(ii) Total Assets to Debt Ratio = Total Assets Expressed as Pure Ratio
Debt
(iii) Proprietary Ratio = Equity or Shareholders' Funds Expressed as Pure Ratio

Total Assets

• Debts = Long-term Borrowings + Long-term Provisions

• Equity (Shareholders' Funds) = Share Capital + Reserves and Surplus
or
Non-Current Assets (Intangible Assets + Tangible Assets + Non-Current (Trade) Investments + Long-term
Loans and advances) + Working Capital - Non-Current Liabilities (Long-term Borrowings + Long-term
Provisions)
(iv) Debt to Capital Employed Ratio = Debt (Long-term) Expressed as Pure Ratio
Capital Employed
• Capital Employed Shareholders' Funds + Long-term Borrowings + Long-term Provisions
(v) Total Assets to Debt Ratio = Total Assets Expressed as Pure Ratio
Debts (Long-term)
• Total Assets or Net Assets may be taken to calculate the ratio.
(vi) Interest Coverage Ratio = Profit Before Interest and Tax Expressed as Pure Ratio
Interest on Long-term Debts
3. Turnover/Activity Ratios: These ratios show how efficiently the company is using its resources. Important
ratios include:
(i) Inventory Turnover Ratio = Cost of Revenue from Operations Expressed in Times
Average Inventory
• Cost of Revenue from Operations = Revenue from Operations - Gross Profit

If Revenue from Operations is given instead of Cost of Revenue from Operations, Revenue from Operations
is used to calculate the ratio.
• Average Inventory = (Opening Inventory + Closing Inventory)/2
(ii) Trade Receivables Turnover Ratio = Credit Revenue from Operations Expressed in Times
Average Trade Receivables
• Credit Revenue from Operations = Total Sales - Cash Sales - Sales Return
• Average Trade Receivables = (Opening Receivables + Closing Receivables)/2
• Trade Receivables = Debtors + Bills Receivables
Average Collection Period = Number of Days or Months Expressed in Days/Months
Trade Receivables Turnover Ratio
(iii) Trade Payables Turnover Ratio = Net Credit Purchases Expressed in Times
Average Trade Payables

• Net Credit Purchases Total Purchases - Cash Purchases - Purchases Return

• Average Trade Payables = (Opening Payables + Closing Payables)/2
• Trade Payables = Creditors + Bills Payables
Average Payment Period = Number of Days or Months Expressed in Days or Months

Trade Payables Turnover Ratio
(iv) Working Capital Turnover Ratio = Revenue from Operations Expressed in Times
Working Capital
• Working Capital = Current Assets - Current Liabilities
• Important Note: When there is no information about Revenue from Operations is given, the ratio may be
calculated based on Cost of Revenue from Operations.
(v) Fixed Assets Turnover Ratio = Revenue from Operations Expressed in Times
Net Fixed (Operating) Assets
• Net Fixed (Operating) Assets = Total Fixed Assets (Cost) - Accumulated Depreciation - Capital Advances -
Non-trade Investment - Capital Work-in-Progress
(vi) Current Assets Turnover Ratio = Revenue from Operations Expressed in Times
Current Assets
• Current Assets include Trade Receivables less Provision for Doubtful Debts
(vii) Net Assets Turnover Ratio = Revenue from Operations Expressed in Times
Net Assets or Capital Employed
• Net Assets or Capital Employed = Total Assets - Current Liabilities
4. Profitability Ratios: These ratios measure the profitability of the company. Important Profitability
Ratios include:
(i) Gross Profit Ratio = Gross Profit x 100 Expressed in Percentage (%)
Revenue from Operations
• Gross Profit = Revenue from Operations - Cost of Revenue from Operations
• Cost of Revenue from Operations = Opening Inventories (Excluding Spare Parts and loose tools) + Net
Purchases + Direct Expenses - Closing Inventories (excluding Spare part and loose tools)
or
Cost of Materials Consumed (including Direct expenses) + Purchases of Stock in Trade + Change in Inventories
of WIP and Finished Goods and Stock in Trade

or
Revenue from Operations - Gross Profit
(ii) Net Profit Ratio = Net Profit after Tax x 100 Expressed in Percentage (%)
• Net Profit Gross Profit + Other Incomes - Indirect expenses - Tax
(iii) Operating Ratio = Operating Cost x 100 Expressed in Percentage (%)

• Revenue from Operations = Sales - Sales Returns
• Operating Cost = Cost of Revenue from Operations + Operating Expenses
• Cost of Revenue from Operations = Opening Inventory (Excluding Spare Parts and Loose Tools) + Net
Purchase + Direct Expenses - Closing Inventory (excluding Spare Parts and Loose Tools)
or
Cost of Material Consumed (including Direct Expenses) + Purchases of Stock in Trade + Change in Inventories
of Finished Goods, WIP and Stock-in-Trade
or
• Operating Expenses = Employees Benefit Expenses + Depreciation and Amortization Expenses + Other
Expenses (Other than Non-Operating Expenses)
or
Office Expenses + Administrative Expenses + Selling & Distribution Expenses + Employees Benefit Expenses +
Depreciation and Amortization Expenses
(iv) Operating Profit Ratio = Operating Profit x 100 Expressed in Percentage (%)
• Revenue from Operations = Sales - Sales Returns
• Operating Profit = Revenue from Operations - Operating Cost
• Operating Cost = Cost of Revenue from Operations + Operating Expenses
• Cost of Revenue from Operations = Opening Inventory (Excluding Spare Parts and Loose Tools) + Net
Purchase + Direct Expenses - Closing Inventory (excluding Spare Parts and Loose Tools)
or
Cost of Material Consumed (including Direct Expenses) + Purchases of Stock in Trade + Change in Inventories
of Finished Goods, WIP and Stock-in-Trade
or
• Operating Expenses = Employees Benefit Expenses + Depreciation and Amortization Expenses + Other
Expenses (Other than Non-Operating Expenses)
or

Office Expenses + Administrative Expenses + Selling & Available Distribution Expenses + Employees
Benefit Expenses + Depreciation and Amortization Expenses
(v) Earning Per Share (EPS) = Profit Available for Equity Shareholders
Number Per Share
(vi) Price Earning (P/E) Ratio = Market Price of a Share
Earnings Per Share

CHAPTER 12 Cash Flow Statement

CHAPTER AT A GLANCE
CASH FLOW STATEMENT
The Institute of Chartered Accountants of India (ICAI) has issued Accounting Standards AS-3 (revised) for
preparing Cash Flow Statement.
Cash Flow Statement is a statement that shows cash flows, i.e., inflow and outflow of cash and cash
equivalents during the accounting period under three different activities which are Operating,
Investing and Financing.
A Cash Flow Statement is a
1. summary;
2. showing inflows and outflows of cash and cash equivalents;
3. during a particular period; and
4. from Operating, Investing and Financing Activities.
OBJECTIVES
1. To ascertain sources/inflow (Receipts) and application/outflow (payments) of cash and cash equivalent
from different activities of the enterprise.
2. To ascertain net change in cash and cash equivalents.
3. To study reason for change in cash and cash equivalents between two consecutive Balance Sheets. 4. To
ascertain liquidity and solvency of the enterprise.
Importance/Uses of Cash Flow Statement Limitations of Cash Flow Statement
1. Useful for short-term financial planning 1. Possibility of window dressing
2. Useful for preparing Cash Budget 2. Ignores non cash transactions
3. Useful for Comparison and Analysis of cash budget 3. Historical in nature
4. Useful to study the trend of cash receipts and 4. Does not show true picture of liquidity
payments
5. Useful for managerial decisions
6. Useful for dividend decisions
PREPARATION OF CASH FLOW STATEMENT
To prepare the Cash Flow Statement, following terms need to be understood:
1. CASH & CASH EQUIVALENTS
Cash means cash on hand, cash at bank and demand deposits with banks.
Cash Equivalent means short term, highly liquid investments that are readily convertible into known amount of
cash and which are subject to an insignificant risk of change in value. For example: current investments,
marketable securities, cheques and drafts on hand.
Note: A short-term Investment qualifies as Cash Equivalent only when:
(i) It has a short maturity period of, say, 3 months or less from the date of acquisition i.e., purchase; and
(ii) It is subject to an insignificant risk of change in value.

2. CLASSIFICATION OF FIRM'S ACTIVITIES: To understand the CASH FLOW STATEMENT presentation as per AS-
3 (Revised), it is required to classify the activities of a business or firm into three categories.
Activities
Operating Activities Investing Activates Financing Activities
They are the Principal Revenue They include the purchase and They are the activities which
Producing Activities and those sale of long term assets not change the composition of
Activities which are not held for resale and investments Owners Capital (including
Investing or Financing not included in cash Preference Share Capital) and
Activities. equivalents. size of Borrowings.
3. FORMAT OF CASH FLOW STATEMENT

A CASH FLOW STATEMENT may be prepared either by direct or indirect method. CASH FLOW STATEMENT
under direct method is not under purview of existing syllabus. Under indirect method, format is as follows:
ABC Ltd.
FORMAT OF CASH FLOW STATEMENT (INDIRECT METHOD)
for the year ended...
[As per Accounting Standard-3 (Revised)]
Particulars Rs.
I. Cash Flow from Operating Activities
(A) Net Profit before Tax and Extraordinary Items (as per Working Note)
Adjustment for Non-cash and Non-Operating Items
(B) Add: Items to be Added
- Depreciation
- Goodwill, Patents and Trademarks Amortized
- Interest on Bank Overdraft/Cash Credit
- Interest on Borrowings (Short-term and Long-term) and Debentures
- Writing off Underwriting Commission/Share Issue Expenses
- Loss on Sale of Fixed Assets
- Increase in Provision for Doubtful Debts*
(C) Less: Items to be Deducted
- Interest Income
- Dividend Income
- Rental Income
- Gain (Profit) on Sale of Fixed Assets
- Decrease in Provision for Doubtful Debts*
(D) Operating Profit Before Working Capital Changes (A + B-C)
(E) Add: Decrease in Current Assets and

Increase in Current Liabilities

- Decrease in Inventories (Stock)
- Decrease in Trade Receivables (Debtors and Bills Receivable)
- Decrease in Accrued Incomes
- Decrease in Prepaid Expenses
- Increase in Trade Payables (Creditors and Bills Payable)
- Increase in Outstanding Expenses
- Increase in Advance Incomes
(F) Less: Increase in Current Assets and
Decrease in Current Liabilities
- Increase in Inventories (Stock)
- Increase in Trade Receivables (Debtors and Bills Receivable)
- Increase in Accrued Incomes
- Increase in Prepaid Expenses
- Decrease in Trade Payables (Creditors and Bills Payable)
- Decrease in Outstanding Expenses
- Decrease in Advance Incomes
(G) Cash Generated from Operations (D + E-F)
(H) Less: Income Tax Paid (Net of Tax Refund)
(I) Cash Flow before Extraordinary Items
- Extraordinary Items (+/-)
(J) Cash Flow from (or Used in) Operating Activities
II. Cash Flow from Investing Activities
- Proceeds from Sale of Fixed Assets
- Proceeds from Sale of Investments (Other than Current Investments (to
be included in Cash and Cash Equivalents) and Marketable Securities)
- Proceeds from Sale of Intangible Assets
- Interest and Dividend received (For Non-Financial Companies only)
- Rent Received
- Payment for Purchase of Fixed Assets
- Payment for Purchase of Investments (Other than Marketable Securities)
- Payment for Purchase of Intangible Assets like Goodwill
- Extraordinary Items (e.g., Insurance Claim on Machinery against Fire)
(+/-) Cash Flow from (or Used in) Investing Activities
III. Cash Flow from Financing Activities
- Proceeds from Issue of Shares and Debentures

- Proceeds from Other Long-term Borrowings

- Increase/Decrease in Bank Overdraft and Cash Credit
- Payment of Final Dividend (on both Equity and Preference Share Capital)
- Payment of Interim Dividend
- Payment of Interest on Debentures and Loans (Short-term and Long-
term)
- Repayment of Loans
- Redemption of Debentures/Preference Shares
- Payment of Share Issue Expenses or Underwriting Commission
- Payment for Buy-back of Shares as Extraordinary Activity Cash Flow
from (or Used in) Financing Activities
IV. Net Increase/Decrease in Cash and Cash Equivalents (I + II + III)
V. Add: Cash and Cash Equivalents in the beginning of the year –
- Cash on Hand
- Cash at Bank
- Short-term Deposits
- Current Investments
- Marketable Securities
VI. Cash and Cash Equivalents at the end of the year
- Cash on Hand
- Cash at Bank
- Short-term Deposits
- Current Investments
- Marketable Securities
*Alternatively, increase/decrease in Provision for Doubtful Debts may be treated under increase/decrease in
Current Liabilities. In this situation, increase/decrease in Provision for Doubtful Debts is adjusted after Operating
Profit before Working Capital Changes.
Working Note: Net Profit before Tax and Extraordinary Items: Rs.
Net Profit as per Statement of Profit & Loss or Difference between Closing Balance and ...
Opening Balance of Surplus, i.e., Balance in Statement of Profit & Loss
Add: Transfer to Reserves ...
Dividend Payable (Proposed Dividend of previous year) paid during the year ...
Interim Dividend paid during the year
Provision for Tax for the current year

Extraordinary Items, if any, debited to the Statement of Profit & Loss

Less: Extraordinary Items, if any, credited to the Statement of Profit & Loss
Refund of Tax credited to the Statement of Profit & Loss
Net Profit before Tax and Extraordinary Items
Working of 'Net Profit before Tax and Extraordinary Items' may be shown within the Cash Flow Statement.
IMPORTANT NOTES
1. Current Investments to be taken as Marketable Securities unless otherwise specified.
2. Bank Overdraft and Cash Credit are shown or classified under Financing Activities.
IMPORTANT ADJUSTMENTS
1. Fixed Asset Account (Ascertaining missing figures by preparing Fixed Asset Account): Fixed Asset
Account is maintained by any of the following two Methods:
Methods of Maintaining
Fixed Asset Account
Written Down Value Method Historical or Original Cost Method

Only one account is prepared Two accounts are prepared
(Fixed Asset Account) - Fixed Asset Account
- Accumulated Depreciation or
Provision for Depreciation Account
WRITTEN DOWN VALUE METHOD

Dr. FIXED ASSET ACCOUNT
Particulars Amount (Rs) Particulars Amount (Rs)
To Balance b/d By Bank A/c
To Profit on Sale of Fixed Asset A/c (Sale of Asset)-Investing
(Statement of Profit & Loss)* Activity
By Depreciation A/c
To Bank A/c (Current Year's Depreciation)
(B/F Purchase of Asset)- By Loss on Sale of Fixed Asset
Investing Activity A/c
(Statement of Profit & Loss)*
By Balance c/d*
*Loss/Gain on Sale of Fixed Asset being Non-operating expense/income is adjusted (i.e., added or subtracted)
while computing Cash Flow from Operating Activities.
HISTORICAL OR ORIGINAL COST METHOD

Dr. FIXED ASSET ACCOUNT


To Balance b/d … By Bank A/c …
To Profit on Sale of Fixed Asset A/c … (Sale of Asset)-Investing …
(Statement of Profit & Loss)* Activity
To Bank A/c … By Accumulated Depreciation …
(B/F Purchase of Asset)- A/c …
Investing Activity … (Accumulated Depreciation …
on Fixed Assets sold)
By Loss on Sale of Fixed Asset …
A/c
(Statement of Profit & Loss)*
By Balance c/d
Dr. ACCUMULATED DEPRECIATION ACCOUNT Cr.

To Fixed Asset A/c … By Balance b/d …
(Transfer of depreciation till date … By Depreciation A/c …
on sold fixed asset) … (Operating Activity) (B/F …
To Balance c/d … Current Year's Depreciation) …
*Loss/Gain on Sale Fixed Asset Being Non-operating expense/income is adjusted (i.e., added or subtracted) while
computing Cash Flow from Operating Activities.
Amount realized on sale of fixed assets is shown as inflow in Investing Activities.
2. Provision for Tax:
Case 1: If there is no information about Provision for Tax in Balance Sheet but in additional information
provision for tax made or tax paid is given, then:
(i) While computing Net Profit before Tax, Provision for Tax Made or Tax Paid is added back.
(ii) While computing Cash Flow from Operating Activities, Tax paid is deducted (Refer format above).
Case 2: If in Balance sheet opening and closing balances of provision for tax are given but no additional
information is given, then:
(i) Provision for Tax of current year (closing balance) would be taken as provision made and previous year
(opening balance) as tax paid.
Case 3: If opening and closing balances of provision for tax along with additional information are given,
then:
(i) Refer to Provision for Tax Account below
Dr. PROVISION FOR TAX ACCOUNT Cr.
To Bank A/c (Paid)-Operating … By Balance b/d …
Activity … By Statement of Profit & Loss- …
To Balance c/d Provision made*
*Provision for Tax made is added to Net Profit after Tax as per Statement of Profit & Loss while computing Net
Profit before Tax and Extraordinary Items.
3. Proposed or Final Dividend: The effect of Proposed Dividend on Cash Flow Statement is as follows: Current
Year

There will be no effect of Current Year's Proposed Dividend on Cash Flow Statement because it will be declared
at Annual General Meeting of shareholders held after the end of financial year, i.e., in the next financial year.
Previous Year
It is added back to Net Profit before Tax and Extraordinary Items as it is a financing activity.
It will be shown as outflow of cash under Financing Activities assuming it has been declared (approved) at the
Annual General Meeting of Shareholders in the Current Year.
4. Extraordinary Items: These are abnormal gains or losses that are not generated from the ordinary business
operations of an enterprise. Cash flow relating to extraordinary items such as preliminary expenses, claim
received from insurance company, winning of a lottery or a lawsuit Damages, etc., shown separately as arising
from Operating, Investing or Financing Activities.
Points to Remember: It is important to differentiate the business activities as Operating Activity, Investing
Activity and Financing Activity. Operating Activity depends upon the nature of business. Whereas investing and
Financing Activities remain same for all nature of business.
For example:
1. For Financing Companies like banks, Investment Companies and Mutual Funds giving and taking loans,
purchase and sale of securities (on own behalf), interest received, dividend received, interest paid are
operating activities whereas for Non-Financing Companies like trading companies, manufacturing
companies and other business establishments consider them as investing activities (interest and dividend
received) or financing activities (interest and dividend paid).
2. For Insurance Company receipt of premium and payment of claims shall be classified as Operating
Activities.
3. For Real Estate Enterprises: Purchase and sale of land and rent received shall be classified as Operating
Activities.


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Prepared by Shubham Jagdish 8112601234/ 8299364494

Important Viva Questions

-Property plant and equipment

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Important Journal Entries

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(ii) Closing Entry for Interest on Drawings A/c:

(ii) Closing Entry for Salary/Commission:

Partners’ Capital/Current A/cs ...Dr.

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Interest on Drawing = Total Drawing

Fixed Capital Method

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Dr. PARTNER’S CAPITAL ACCOUNTS Cr.

Fluctuating Capital Method

Fixed Capital Accounts vs. Fluctuating Capital Account

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Methods of Valuation of Goodwill

Average Profit Method Super Profit Method Capitalization Method

Simple Average Weighted Average Capitalization of Average Capitalization

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2. Super Profit Method:

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All Partners’ Capital/Current* A/cs ...Dr.

Treatment of Workmen Compensation Reserve

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Treatment of Investment Fluctuation Reserve

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Reserves (e.g., General Reserve) ...

Case 1: When the balance is Net Accumulated Profit

Case 2: When the balance is Net Accumulated Loss

To Unrecorded Liabilities A/c By Unrecorded Assets A/c

To Partner’s Capital A/c (Remuneration) By Loss on Revaluation transferred to all

To Cash/Bank A/c (Expenses on

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Important Journal entries in relation to Revaluation:

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Case 2: For Loss on Revaluation

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Sacrificing and Gaining Ratio, New Profit-sharing Ratio

Sacrifice by a Partner = Old Profit Share – New Profit Share

Gain of a Partner = New Profit Share –Old Profit Share

Profit share of a partner after sacrificing profit share:

New Profit Share = Old Profit Share – Sacrifice of a Partner

In case, existing partner has gained:

New Profit share = Old Profit Share + Gain of a Parnter

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Accounting treatment Of Goodwill

(v) Goodwill brought in kind:

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(Goodwill credited in sacrificing ratio)

Goodwill existing in the books of account

Accounting treatment of Reserves and Accumulated Profits/Losses

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