SELF LEARNING MATERIAL

B.Com. – FINANCIAL ACCOUNTING

COURSE : B.Com - 103

B.Com. (1st Semester)

Directorate of Distance Education

DIBRUGARH UNIVERSITY
DIBRUGARH - 786 004
BLOCK-1: FINANCIAL ACCOUNTING
Unit 1: Financial Statements for Profit Organisation

Unit 2: Accounting of Not for Profit Organisation

Unit 3: Accounts of Incomplete Records: Single Entry System

BLOCK-2: HIRE PURCHASE SYSTEM AND INSTALLMENT

ACCOUNTS
Unit 1: Hire Purchase and Installment Account

Unit 2: Accounting Entries in the Books of Hire Purchaser and Hire

Vendor

BLOCK- 3: PARTNERSHIP ACCOUNTS

Units 1: Dissolution of Partnership Firms

Unit 2: Insolvency of Partners

Unit 3: Sale of a Firm to a Company: Purchase Considerations and

Accounting Entries

BLOCK- 4: Royalty Accounts

Unit 1: Royalties Accounts

Unit 2: Branch Accounts

Unit 3: Departmental Accounts

BLOCK- 5: INTRODUCTION TO GOVERNMENTACCOUNTING

Unit 1: Government Accounting- Basic Understanding

Unit 2: System of Financial Administration in India

BLOCK- 1: FINANCIAL ACCOUNTING

Introduction

There are three units in this block. Unit 1 focuses on preparation of financial
statements for profit organisations.

Likewise, Unit 2 gives emphasis on accounting of not- for- profit organisations.

Related concepts of not for profit organisations have been detailed out with
accounting problems.
Unit 3 concentrates on accounts from incomplete records popularly known as
single entry system.

While going through the units you will get Self Assessment Questions. At the
end of every unit, suggested readings are also given. So, you can refer to these
books in case you require deeper and better understanding of related concepts.

Unit 1: Preparation of Financial Statements for Profit Organisations

Structure

1.0 Objectives
1.1 Introduction
1.2 Preparation of Final accounts
1.2.1 Trading Account
1.2.2 Profit and Loss Account
1.2.3 Balance Sheet
1.2.4 Preparation of Final Accounts with Adjustments
1.3 Let’s Sum Up
 1.4 Key Words
1.5 SAQs
1.6 Hints/ Answers of SAQs
1.7 Suggested Readings
1.8 Model Question

1.0 Objectives:

After going through this unit, you will be able to:

• Prepare Trading and Profit and Loss Account
• Prepare Balance Sheet
• Prepare both Trading and Profit and Loss Account and Balance Sheet with
adjustments.

1.1 Introduction
Financial Accounting is that field of accounting which is concerned with the
classifying, summarizing, analyzing and reporting of financial transactions
pertaining to an entity. Accounting is a process of using financial information so
as to show the financial position and financial result of an entity at the end of the
financial period. For determining the profit and loss position Trading and Profit
& Loss Account is prepared. Likewise, for determining the assets, liabilities and
capital position, Balance Sheet is prepared.

The entire idea of financial accounting is illustrated with the help of a diagram
below:
 Financial Accounting
↓

Using financial information to determine

↙ ↘

Financial position Financial result

↓ ↓

Balance sheet Profit and Loss Account

1.2 Preparation of final accounts

Arithmetical accuracy of maintaining books of accounts can be determined by

preparing a Trial Balance with the balances of various ledger accounts at
periodical interval. The accounts showing debit balance and accounts showing
credit balance are grouped separately and put in one statement. In the credit side
(column) of trial balance, items related to both revenue and capital receipts are
shown. Contrary to that all the revenue and capital payments are shown in the
debit side of trial balance. In other words, the ledger accounts showing credit
balance are shown in the credit column and the accounts showing debit balance
are shown in the debit column of the Trial Balance. Actually, the Trial Balance is
not a formal part of financial accounitng.
All the revenue receipts and payments of the trial balance are shown/ transferred
in the Trading and Profit & Loss Account and all the capital receipts and
payments of Trial Balance are shown in the Balance Sheet relating to a particular
accounting year.
Trading Account includes all the direct income and expenditure. Direct income
and expenditure are those which are directly related to production for a
manufacturing concern or related to purchase for a trading concern. Likewise,
Profit and Loss Account includes all the indirect incomes and expenditure which
are neither directly related to production nor with purchase rather these are related
to administration and selling and distribution.
 1.2.1Trading Account

This account is prepared to know the trading results or gross margin on trading
of the business i.e., how much gross profit or loss the business has earned from
buying and selling during a particular period. The excess of sales over the cost of
goods sold is gross profit. For the purpose of calculating cost of goods sold, we
have to take into consideration of opening stock, purchases, direct expenses on
purchasing or manufacturing the goods and closing stock. The balance of this
account represents gross profit or loss and is transferred to the profit and loss
account. The pro-forma of a trading account is given as follows:

Trading Account
For the year ending 31st March, 2018
Dr. Cr.
Particulars Amount Particulars Amount
(Rs) (Rs)

Sales
Opening stock Less: Sales return
Purchases Closing stock
Less: Purchase return ● Profit and Loss Account
Direct expenses: (Gross loss c/d)
Carriage inward and
freight
Wages
Fuel and power
Manufacturing expenses
Motive power
Octroi duty
Custom duty
Consumable stores
Foreman/ works
manager’s remuneration
Royalty on manufactured
goods
● Profit and Loss Account
(Gross profit c/d)
●Balancing figure will either be gross profit or gross loss.

Detailed study of the items posted to the debit side of Trading Account:
1. Opening stock: It means goods lying unsold with the firm at the
beginning of the accounting year. Opening stock consists of raw
materials, work in progress and finished goods.
2. Purchases: it includes both cash and credit purchases of goods
which are for resale. Purchase returns and discount on purchase,
if any should be deducted from purchases in the inner column and
only net purchases are shown in the outer column. The worth
noting points in this respect are:
a) Goods purchased but in transit will not affect the trading
account. It is better to debit the goods in transit account and
credit suppliers account as a liability in the balance sheet.
b) Goods purchased for personal use of proprietor out of
business funds should be first recorded as ordinary purchases
debiting purchase account and crediting suppliers/cash
account. Then it should be recorded as goods withdrawn by
the proprietor for personal use and entry for that will be: Debit
Drawing a/c and Credit Purchase a/c.
c) Invoice of goods purchased are received in advance before
actual receipt of such goods. For such goods, neither purchase
a/c be debited nor goods will be included in closing stock.
d) Purchase made under future transactions and goods received
on consignment or on behalf of third party should not be
included in purchase.
e) Purchase of any fixed assets for business use such as furniture,
machinery, etc should be kept separate.
f) Adjusted purchases: some organizations for comparison
purpose prefer to adjust the opening and closing stock through
Purchase Account. Entries for this will be as under:

For adjustment of opening stock

Purchase A/c - Dr
To Opening Stock A/c
 For adjustment of closing stock
Closing stock A/c - Dr
To Purchases A/c

Due to these adjustments there will be no opening stock in the

trial balance. Adjusted purchase a/c is shown on the debit side
of Trading Account and closing stock (having debit balance)
appears as an asset in the Balance sheet.

3. Direct expenses: These include all the expenses which have been
incurred before the goods become ready for sale and are shown
on the debit side of Trading Account. The examples of direct
expenses are:
a) Wages: Amount paid to workers for their services related to
factory or may be purchase.
b) Octroi Duty: It denotes tariff paid in order to bring the goods
into municipal limit.
c) Carriage on Purchase: Transportation cost incurred to bring
the goods into factory/place of business is called as carriage
inward/carriage on purchase.
d) Motive Power, Coal, Gas and Fuel: These are direct
expenditure to run the machines and other equipments and are
shown to the debit side of Trading Account.
e) Import duty and dock charges: In case goods are imported
from abroad, custom duty, dock charges etc. need to be paid.
As these relate to goods purchased, they are shown on the
debit side of Trading Account.
f) Manufacturing expenses: All expenses incurred in
manufacturing the goods in the factory such as factory rent,
factory insurance, depreciation on factory machinery, factory
lighting, etc are debited to Trading Account.
g) Consumable stores: These are incurred to keep the machine
in right condition and include engine oil, soft soap, cotton
waste, oil, grease and waste consumed in a factory.

Let us have some illustrations to understand the points better:

Illustration 1.1 Following is the Trial Balance of a sole proprietorship concern.
Prepare Trading Account for the year ending 31st March, 2019.

Items Debit Balance (Rs.) Credit Balance

(Rs.)

Opening Stock
Purchase 10,000
Wages 1, 00,000
Factory Lighting 5,000
Octroi Duty 5,000
Carriage on Purchase 2,000
Sales 1,000 1, 50,000

1,50,000
1,50,000

# Note: Here in this sum, it is asked to prepare only Trading account . So all the
items mentioned are related to production process.

Solution
 Trading and Profit & Loss Account
For the year ended on 31st March, 2019

Dr Cr

Particulars Rs.
Particulars Rs.

By Sales 1,50,000
To Opening Stock 10,000

To Purchases 1,00,000

To Wages 5,000

To Factory Lighting 5,000

To Octroi Duty 2,000

To Carriage on Purchase 1,000

To Profit and Loss Account 27,000

(Gross Profit c/d)
1,50,000
1,50,000

By Trading Account 27,000

(Gross Profit b/d)
1.2.2 Profit and Loss Account
This account is prepared to calculate the net profit of the
business. There are certain items of incomes and expenses of
the business which must be taken into consideration for
calculating net profit of the business. These are of indirect
nature i.e., considering the whole business and relating to
various activities which are done by the business for the
purpose of making the goods available to the consumers.
Indirect expenses may be selling and distribution expenses,
management expenses, financial expenses, extra ordinary
losses and expenses in maintaining the assets or expenses on
assets to keep it in working condition. This account is
prepared by putting the nominal account balances which are
either indirect income (credited to profit and Loss Account)
or indirect expenses (debited to profit and Loss Account) and
its final balance (Net profit/Loss) is transferred to capital
account. Since the owners are taking the risk of business they
have their right to get the entire profit or loss to their favour
as such the final affect is to given to the capital account of the
owner. Net Profit will increase the balance in capital and Net
Loss will reduce the balance in capital. The specimen of the
Profit and Loss account is given as under:
Profit and Loss Account
For the year ending 31st March, 2019
Dr. Cr.
Particulars Amount Particulars Amount
(Rs) (Rs)

By Trading Account
To Trading Account (Gross
(Gross profit b/d)
Loss b/d)
By Interest received
To selling and distribution
By Discount received
expenses:
By Commission received
Advertisement
By Rent from tenants
Traveler’s salaries,
By Income from
expenses and commission
investments
Bad debts
By Apprenticeship
Go down rent
premium
Export expenses By Interest on debenture
Carriage outwards By Income from other
Bank charges sources
Agent’s commission By Miscellaneous
Upkeep of motor lorries revenue receipts
To Management expenses: ●By Capital Account
Rent, rates and taxes ( Net Loss
Heating and lighting Transferred to capital a/c)
Office salaries
Printing and stationery
Telephone charges
Legal charges
Audit fee
Insurance
General expenses
To Depreciation and
Maintenance:
Depreciation on fixed assets
Repairs and maintenance
To Financial expenses:
Discount allowed
Interest on capital
Interest on loan
Discount on bills
To Extra ordinary expenses:
Cash defalcation
●To Capital Account
(Net Profit
Transferred to capital a/c)

● Balancing figure will be either net profit or net loss.

Important points to be kept in mind at the time of preparation
of the Profit and Loss Account are shown as below:
a) Salaries: These include salaries paid to office, go down
and warehouse staff , marketing personnel should be
shown on the debit side of profit and loss account.
b) Rent, rates and taxes: These include offices and
warehouse rent, municipal rates and taxes.
c) Interest: Interest paid on loans, overdrafts and bills
overdue is an expense and is taken to the debit of the
 Profit and Loss Account. Interest received on loans and
advanced by the firm on deposits and on securities is a
gain/income and is shown on the credit side of profit and
loss account. Interest on capital should be shown
separately on the debit side and interest on drawings on
the credit side of profit and loss account.
d) Commission: Commission received for doing the work
for other firms may be credited to profit and loss account
as a gain and commission payable to the agents employed
to sell the firm’s goods is debited as an expense.
e) Repairs: Repairs and small renewals or replacement
relating to the plant and machinery, fixture, fittings,
utensils, etc. are generally included under this heading
and such expenditure are debited to profit and loss
account.
f) Depreciation: It is an expense due to wear and tear, lapse
of time and exhaustion of assets used in business. This is
loss sustained by fixed assets and should be charged to
the debit of profit and loss account.
g) Stable expenses: These are incurred for the fodder of the
horse and wages paid to persons looking after the stable.
h) Trade expenses: These are expenses of a varied nature for
which it is not worthy to open separate accounts. These
are amalgamated under trade or general or sundry or
petty expenses.
i) Samples: Samples of the goods manufactured by the
business concerns are often distributed free of charge to
push up sales. Being indirect expense (sales promotion)
these are debited to profit and loss account.
j) Advertisement: All sums spent on advertising is charged
to profit and loss account.
k) Apprentice premium: This is the amount charged from a
person to whom training is given by the business. It is a
gain and should be credited to profit and loss account.
l) Abnormal losses: Some abnormal losses like loss on sale
of fixed assets, cash defalcations, stock destroyed by fire
 not covered by insurance, etc should be debited to profit
and loss account.

Expenses not be shown in profit and loss account

a) Domestic and household expenses

b) Income tax
c) Life insurance premium

1.2.3 Balance Sheet

A Balance Sheet can be simply described as a statement of assets
and liabilities on a specific date. A Balance Sheet has two sides. In
the left hand side liabilities and capital are shown; whereas in the
right hand side, assets are shown. Liabilities are the claims against
the assets. Liabilities are divided into: (a) Fixed liability or non-
current liabilities under which capital, long term liabilities will
come & (b) Current liability which includes all the short term
liabilities like creditors (to whom money is due to pay), outstanding
expenses, short term loan etc.
Assets denote the resources acquired by business from the funds
made available either by owners of the business or other financiered.
Assets are categorized as: (a) Fixed/ Non-Current assets include all
the assets which are bought for use for a long period not for resale,
e.g., buildings, machinery, etc. (b) Current assets include short term
assets , e.g., closing stock, debtors (from whom money is due to
receive), cash, etc.(c) Intangible assets are those assets which cannot
be touched or seen physically, e.g., goodwill, patents, etc. (d)
Fictitious assets are those assets which cannot be represented using
any tangible possession or property, e.g., preliminary expenses,
some other deferred revenue expenses yet to be written off.
In other words all the capital receipts of the firm are liabilities;
whereas all the capital expenditures are assets.

Illustration 1.2 Prepare Trading and Profit & Loss Account for the
year ended 31st March, 2019 and Balance Sheet as on 31st March,
2019.
 Trial Balance
st
as on 31 March, 2019
Debit (Rs.) Credit (Rs.)
Land & Building 5, 00,000
Machinery 1, 00,000
Capital 10, 00,000
Sales 6, 00,000
Creditors 10,000
Opening Stock 10,000
Purchases 3, 57,000
Wages 15,000
Salary 25,000
Printing & Stationery 2,000
Freight 1,000
Cash at Bank 2, 32,000
Interest 2,000
Investments 1, 50,000
Goodwill 1, 00,000
Furniture 1, 00,000
Debtor 20,000
-------------- --------------
16,12,000 16,12,000
-------------- -------------

Solution to illustration 1.2

Trading and Profit & Loss account

For the year ending 31st March, 2019

Dr. Cr.

Particulars Rs. Particulars Rs.

To Opening Stock 10,000 By Sales 6,00,000

To Purchase 3,57,000
To Freight 1,000

To Wages 15,000
To Profit and Loss Account 2,17,000
(Gross Profit c/d)
6,00,000 6,00,000
By Trading Account 2,17,000
To Salary (Gross Profit b/d)
25,000
To Printing & Stationery By Interest
2,000 2,000
To Capital Account (Net
Profit transferred) 1,92,000

2,19,000 2,19,000

Balance Sheet as on 31st March, 2019

Liabilities Rs. Assets Rs.

Capital 10,00,000 Goodwill 1,00,000

Add: Net profit 1,92,000 11,92,000 Land & Building 5,00,000
Creditors 10,000 Machinery 1,00,000

Furniture 1,00,000
Investment 1,50,000

Debtors 20,000

Cash at Bank 2,32,000

12,02,000 12,02,000
 Things to learn from the illustration:

In this problem we have recorded all the revenue income and

expenditure either in the Trading account or in the Profit and Loss
Account. Capital receipts and payments which are referred to as
liabilities and assets respectively have been shifted to Balance
Sheet. The net profit coming out of the Profit & Loss Account is
added with the capital. Capital is the contribution of the owner in
the business. And one more thing that is prominent in Balance
Sheet is both the sides must tally.

1.2.2 Preparation of Final Accounts with Adjustments

While preparing trading and profit and loss account one point that
must be kept in mind is that expenses and incomes for the full
trading period are to be taken into consideration. This means that if
an expense has been incurred but not paid during that period, a
liability for the unpaid amount should be created before the
accounts can be said to show the true profit or loss. All expenses
and incomes should properly be adjusted through adjustment
journal entries. These journal entries are passed at the end of the
accounting period are called adjusting entries. Some of the most
commonly used adjustments are:

a) Closing stock b) outstanding expenses and income c) prepaid

income and expenditure d) depreciation e) bad debts and
provision for doubtful debts f) interest on capital and drawings

The illustration 1.3 will give us idea about how adjustments are actually
passed in Trading and Profit and Loss Account and Balance Sheet.

Illustration 1.3 Prepare Trading and Profit & Loss Account

for the year ended 31st March, 2019 and Balance Sheet as on
31st March, 2019.
Trial Balance
As on 31st March, 2019
Debit (Rs.) Credit (Rs.)
Land and Property 5, 00,000
Machinery 1, 00,000
Capital 10, 00,000
Sales 6, 00,000
Creditors 10,000
Opening Stock 10,000
Purchases 3, 57,000
Wages 15,000
Salary 25,000
Printing & Stationery 2,000
Carriage inward 1,000
Cash at Bank 2, 32,000
Interest 2,000
Investments 1, 50,000
Patents 1, 00,000
Furniture 1, 00,000
Debtor 20,000
------------ --------------
16,12,000 16,12,000
-------------- ---------------

Adjustments:
1. Closing stock Rs. 30,000
2. Appreciate land and property @10% p.a.
3. Depreciate machinery @10% p.a. & furniture @5% p.a.
4. Write off bad debt Rs. 1000 and create a provision for
doubtful debts Rs. 1,500.
5. Outstanding wages Rs. 200.
6. Advance interest received Rs. 100.
7. Prepaid salary Rs. 1,000

Solution to illustration 1.3

Trading and Profit & Loss account

For the year ending 31st March, 2019
Dr. Cr.

Particulars Rs. Particulars Rs.

To Opening Stock 10,000 By Sales 6,00,000

To Purchase 3,57,000

To Carriage inwards 1,000

To Wages 15,000 By Closing Stock 30,000

Add: Outstanding 200 15,200

To Profit and Loss Account 2,46,800

(Gross Profit c/d)
6,30,000 6,30,000
By Trading Account 2,46,800
To Salary 25,000 (Gross Profit b/d)
24,000
Less: Prepaid 1,000 By Interest 2,000
2,000 1,900
To Printing & Stationery Less: Prepaid 100
50,000
To New Bad debts 1,000 By Appreciation in Land
2,500 & Property
Add: New Provision 1,500
To Depreciation on

Machinery 10,000
15,000
Furniture 5,000
To Capital Account (Net
Profit transferred) 2,55,200

2,98,000 2,98,700

Balance Sheet as on 31st March, 2019

Liabilities Rs. Assets Rs.

Capital 10,00,000 Patents 1,00,000

Add: Net profit 2,55,200 12,55,200 Land & Building

5,00,000
Creditors 10,000 5,50,000
Add: Appreciation
Outstanding wages 200 50,000
Prepaid/advance interest 100 Machinery 1,00,000 90,000
Less: Depreciation
10,000
95,000
Furniture 1,00,000
1,50,000
Less: Depreciation 5,000
1,000
Investments
30,000
Prepaid salary
Closing Stock

Debtors 20,000

Less: Bad debt 1,000

17,500
19000
2,32,000
Less: Provision 1,500
12,65,500 12,65,500
Cash at Bank

Things to learn from the illustration:

• In this problem, we have seen that all the adjustments are shown
twice. Value of land and property got appreciated. Appreciation in
the value of an asset has been shown as an income. So, the
appreciated amount is added to its original cost and the same amount
is also credited to Profit and Loss account as an income. But contrary
 to that, value of machinery and furniture got depreciated.
Depreciation is a loss. So the amount of depreciation is debited to
Profit and loss account.
• Advance interest received is a liability so as the outstanding wages.
But prepaid salary is an asset. We must remember, all the prepaid
expenses are current assets and all the outstanding expenses are
current liabilities. Likewise, all the outstanding incomes are current
assets and all the advance incomes are current liabilities.
• Debtor is an entity to whom the business has lent its money or given
its assets/ goods on credit. So, debtor is a current asset. Debtors
which cannot be recovered or become irrecoverable are called bad
debts. As because bad debt is loss on debtors so it is deducted from
debtors. As we know as per the convention of conservatism, we
have to anticipate all the future losses. So provision for doubtful has
also been deducted from the debtor.

1.3 Let Us Sum It Up

So, in this unit we have seen how to prepare the financial statement
of a for profit organisation. Basically, we have considered sole
proprietorship entity into consideration for preparing financial
statements and we have seen that they prepare two statements: 1)
Trading and Profit & Loss Account and 2) Balance Sheet.
Trading and Profit & Loss Account includes all direct and indirect
income and expenditure for a particular year which depicts the profit
and loss position of the business. Likewise, Balance Sheet shows
capital as well as assets and liabilities position of the business
depicting the financial position on the last day of the financial year.

1.4 Keywords
Trading and Profit & Loss Account, Balance Sheet, Income,
Expenditure, Assets, Liabilities, Capital
1.5 SAQs
Choose the correct alternative:
1. Which of the following is not an item under Balance Sheet:
a) Furniture b) Cash in hand c) Discount allowed d) Debtors

2. Which of the following is an item under Trading A/C?

 a) Commission to salesman, b) Office expenses, c) Factory lighting,
d) Interest on investment

3.Depreciation is charged on:

a) Fixed assets b) Current asset

1.6 Answers of SAQs

1. c 2. c 3. a

1.7 Suggested Readings

Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors

Pvt Ltd, New Delhi,

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

1.8 Model Question

1. Prepare Trading and Profit & Loss Account for the year
ended on 31st March, 2019 and Balance Sheet as on 31st
March, 2019.
Trial Balance
as on 31st March, 2019
Debit (Rs.) Credit (Rs.)
Land 15, 00,000
Plant & Machinery 10, 00,000
Capital 20, 00,000
Sales 25, 30,000
Creditors 40,000
Opening Stock 40,000
Purchases 13, 57,000
Wages 15,000
Salary 55,000
Petty expenses 2,000
Carriage outward 1,000
Cash 2, 32,000
Commission 18,000
Furniture 30,000
Investments 1, 20,000
Goodwill 1, 00,000
Equipments 1, 00,000
Debtor 20,000
Carriage inward 10,000
Trade expenses 10,000
Discount received 4,000
----------------- ------------
45,92,000 45,92,000

Adjustments:
1) Closing stock Rs. 25,000
2) Appreciate land by 6% p.a.
3) Depreciate machinery @4% p.a., equipment @ 2% &
furniture @3 % p.a.
4) Write off bad debt @3% p.a. Provision for doubtful debt
@4% p.a .
5) Outstanding salary Rs. 1800.
6) Advance commission received Rs. 1000.

2. Prepare Trading and Profit & Loss Account for the year
ended on 31st March, 2019 and Balance Sheet as on 31st
March, 2019.
Trial Balance
For the year ending 31st March, 2019
Debit (Rs.) Credit (Rs.)
Building 20, 00,000
Machinery 5, 00,000
Capital 19, 00,000
Sales 25, 10,000
Creditors 50,000
Opening Stock 40,000
Purchases 13, 57,000
Wages 15,000
Salary 25,000
Factory manager’s salary 12,000
Carriage outward 1,000
Bank 2, 32,000
Commission 10,000
Manufacturing expenses 10,000
Investments 1, 42,000
Equipments 1, 00,000
Debtor 20,000
Carriage inward 10,000
Sundry expenses 10,000
Interest received 4,000
----------------- ------------
44, 74,000 44, 74,000

Adjustments:
a) Closing stock Rs. 60,000
b) Depreciate building and machinery at 2%, equipment at
3% p.a.
c) Factory manager’s salary outstanding Rs. 1,000.
d) Write off provision for doubtful debts Rs. 500.
 Unit 2: Accounting of Not for Profit Organization

Structure

2 2.1 Objectives
2.2 Introduction
2.3 Receipts and Payment Account
2.4 Income and Expenditure Account
2.5 Differences Between Income and Expenditure Account and
Receipts and Payments Account
2.6 Treatment of Some Important Items
2.7 Let’s Sum Up
2.8 Key Words
2.9 SAQs
2.10 Hints/ Answers of SAQs
2.11 Suggested Readings
2.12 Model Question
2.0 Objectives
After going through this unit, you will be able to:
• Understand the concept of not for profit organization
• Know the different set of accounts prepared by these organizations
• Differentiate between receipts and payment account and income and
expenditure account
• Prepare both receipts and payment account and income and
expenditure account.

2.1 Introduction
There are some institutions whose main objective is not to earn profit
but to render valuable services to its members and to the society, e.g.,
clubs, schools, colleges, universities, trade unions, NGOs, etc.
In order to find out their operating financial results and financial
position, they prepare the following statements for the purpose of
financial reporting:
a) Receipts and Payments Account
b) Income and Expenditure Account
c) Balance Sheet

Let us now discuss in detail about all these three statements prepared by non
trading concern:

2.2 Receipts and Payments Account

It is an account which summarizes all the cash receipts and cash
payments of the organization. It is the summary/substitute of cash book
prepared by trading organizations. It is a real account. All the cash
receipts are debited and all the cash payments are credited to the
account. For example, cash received from sale of goods is taken as
receipt and is debited. Contrary to this, cash paid on purchasing
materials are credited because it is a payment. One thing should be
noted that credit transactions or non cash items are not recorded in
Receipts and Payments Accounts. As a result, items like credit purchase
or credit sales can’t be recorded.
2.3 Income and Expenditure Account
Income and Expenditure Account is a nominal account. It is prepared
by non-profit organization in lieu of Trading and Profit and Loss
Account. Debit all losses or expenses and credit all incomes or gains is
followed while preparing this account. Incomes are shown on the credit
side and expenses on the debit side. There is no opening balance but
closing balance will show either surplus i.e., excess of income over
expenditure or deficit i.e., excess of expenditure over income. Only
income and expenses which are revenue in nature are taken into
consideration in Income and Expenditure Account i.e., capital items are
totally excluded. Moreover, income and expenditure of current year are
taken into consideration so any arrear, outstanding, advance relating to
period other than the current year are excluded while preparing this
account. This account is prepared on accrual basis of accounting and
thus all adjustments relating to prepaid or outstanding expenses and
incomes related to current year, provision for depreciation or doubtful
debts etc are to include in the income and expenditure account. Only
nominal accounts are taken into consideration for the preparation of
Income and Expenditure Account.

Let us now discuss the differences between Receipts and Payments

Account and Income and Expenditure Account:

2.4 Differences Between Receipts and Payments Account and Income

and Expenditure Account

Basis of difference Receipts and Payments Income and

A/C Expenditure A/C

1. Type of It is a real account. It is a nominal account.

account

2. In lieu of It is prepared in lieu of It is prepared in lieu of

cash book. Trading and Profit and
Loss account.

3. Basis of It is prepared on cash It is prepared on accrual

accounting basis of accounting. basis of accounting.
 4. Period All the receipts and Only current period
payments whether income and expenditure
relating to current period, are taken into
succeeding or preceding consideration.
periods are taken into
consideration.
5. Capital and Both capital and revenue Only revenue items are
revenue items are taken into considered.
items consideration.
6. Necessity for As it includes revenue It includes only revenue
preparation and capital items, items, so for recording
of Balance preparation of balance the capital items there
Sheet Sheet is ignored. might be a necessity to
prepare Balance Sheet.

Let us now discuss some important concepts having relation with

maintaining financial records and for financial reporting to be made by
a non trading concern. In this regard we will also discuss about their
accounting treatment.
2.5 Treatment of some important items
• Legacy: It is the amount which a non trading concern may
receive as per the will of a deceased person. It will be shown to
the debit side of the receipts and payments account. It should be
capitalized being an item of non recurring nature and should be
shown on the liabilities side of the balance sheet.
• Donation: It is the amount which is given to non trading concern
by the members of the society. It is put on the receipts side of
receipts and payments account. Donation may be general
donation or may be a specific donation. If the amount is small
and not for a specific purpose then it is credited to income and
expenditure account as a revenue income. But if the amount is
huge and received for a specific purpose then it is capitalized and
shown as a liability in the balance sheet. All the specific
donations are treated capital receipts and are shown as liability.
• Sale of an asset: It is shown as a receipt in the receipts and
payments account. To show this item in the income and
 expenditure account some adjustments are required. The
difference between book value and sale proceeds of the asset is
required to be shown in the income and expenditure account. If
sale value is more than book value, it is profit and taken as
income to the credit side of the income and expenditure account.
On the other hand, if sale value is less than the book value it
indicates a loss on sale so to be treated to the debit side of the
income and expenditure account.
• Sale of newspaper or obsolete items: It is treated as receipt
under receipts and payments account and since it is an income
revenue in nature so credited to the income and expenditure
account.
• Entrance fee: This fee is generally paid by members normally
once in life time. Since it is a receipt for such an institution it is
shown to the debit side of the receipt and payment account. As a
result, it is considered as a capital receipt in general or it may be
partially treated as capital receipt as per the policy of the concern.
If the entire amount of entrance fees is treated as capital receipt
then it is shown to the liabilities side of the balance sheet. But
when it is treated partially as capital and revenue receipt then the
revenue part of such income is required to be shown as a revenue
income to the credit side of the income and expenditure account.
• Subscription: It is taken as receipt to the receipt and payment
account and it is credited to the income and expenditure account
as a revenue income. Only the subscription relating to the current
year is required to be shown as revenue income on accrual basis.
• Life membership fee: It is a one time fees to be paid by those
who want to become life member of the institution. A life
member need not pay annual membership fees. It is treated as a
capital receipt and shown in the receipt and payment account.
Since it is a capital receipt not to show in the income and
expenditure account. But required to be shown as a liability in
the liability side of the balance sheet. When life membership fees
is treated one part as capital and another part as revenue income
then the revenue income part is to be shown as income to the
credit side of the income and expenditure account. Under
receipts and payments account, it is taken as receipt.
 • Honorarium: any amount paid to a person (who is not an
employee of the organization) for rendering his or her services to
the concern is called as honorarium. It is a revenue payment and
thus is shown on the payments side of Receipts and Payments
Account. In the Income and Expenditure Account, it is shown on
the expenditure side.
• Endowment fund: It is a specific fund created out of
contribution as a permanent means of support for any person or
institution. Any contribution received for the endowment is to be
treated in the fund account and any payment made out of such
fund is required to be charged to that fund account only. It is a
capital receipt and is shown on the liabilities side of the Balance
sheet. Any amount received during the year is to be shown to the
receipt side of Receipts and Payments Account

Let us consider some illustrations for better understanding the procedure of

preparing receipt and payment account and an income and expenditure
account:

Illustration 2.1 From the following information, prepare, Receipts and Payments
Account for the year 2019:

Rs.

Cash at Bank on 1.1.2019 10,000

Furniture purchased 6,000

Subscription received from members 10,000

Entry fee received 5,000

Donation received 50,000

Books purchased for library 6,000

Miscellaneous expenses incurred 5,000

Subscription receivable 2,000

Solution to illustration 2.1 :

 Receipts and Payments Account for the year 2019

Dr Cr

Receipts Rs. Payments Rs.

To Balance b/d 10,000 By Furniture 6,000

To Subscription 10,000 By Books 6,000

To Entry fee 5,000 By Misc. Exp 5,000

To Donation 50,000 By Balance c/d 58,000

75,000 75,000

Things we learnt from the illustration:

We have seen all the cash receipts have been debited and all cash payments
have been credited in the receipt and payment account. After adjusting receipts
and payments, we have found closing cash balance in the credit side at the end of
the accounting year and which will be the opening balance of cash in the next
year. The item subscription receivable will not appear in the receipt and payment
account as cash/bank has not received during the year. This account is prepared
on cash basis only.

Illustration 2.2 From the following information, prepare, Receipts and Payments
Account for the year 2019:

Rs.

Cash at Bank on 1.1.2019 25,000

Sports materials purchased 10,000

Subscription received from members 10,000

Entrance fee received 5,000

Honorarium paid to coach 5,000

Donation for renovation of playground 50,000

Maintenance of Playground 6,000

Miscellaneous expenses incurred 5,000

Salary payable to staff 4,000

Solution to illustration 2.2 :

Receipts and Payments Account for the year 2019

Dr Cr

Receipts Rs. Payments Rs.

To Balance b/d 25,000 By Sports materials 10,000

To Subscription 10,000 By Maintenance of playground 6,000

To Entrance fee 5,000 By Honorarium 5,000

To Donation for renovation 50,000 By Misc. Expenses 5,000

of playground
By Balance c/d 64,000

90,000 90,000

Things we have learned from the illustration:

Similar to the earlier problem, here also all the cash receipts have been debited
and all cash payments have been credited to the receipt and payment account.
After adjusting receipts and payments, we have found closing cash balance in the
credit side which will be the opening balance of cash for the next year. Salary
payable to staff will not appear in the receipt and payment account as it has not
affected in the cash position of the entity.

Illustration 2.3 From the following information prepare Income and Expenditure
Account for the year ended on 31st December, 2019 and Balance Sheet as on 31st
December, 2019.
 Particulars Rs. Particulars Rs.

Books for library 15,000 Donation for building 40,000

Maintenance of library 16,000 Entrance fee 5,000

Salary to librarian 10,000 Interest on bank deposit 6,000

Purchase of furniture 24,000 Sale of newspaper 4,000

Sundry expenses 10,000 Life membership fee 10,000

Salary to staff 5,000 Capital fund at the beginning 35,000
of the year
Cash 20,000

Solution to 2.3 Income and Expenditure Account

For the year ending 31st December, 2019

Dr. Cr.

Expenditure Rs. Income Rs.

To Maintenance of library 16,000 By Interest on bank deposit 6,000

To Salary to librarian 10,000 By Sale of newspaper 4,000

To Sundry expenses 10,000 By Deficit 31,000

To Salary to staff 5,000 (Excess of expenditure over

income)
41,000 36,000

Balance Sheet as on 31st December, 2019

Liabilities Rs. Assets Rs.

Capital fund 35,000 Books for library 15,000

Less: Deficit 31,000 4,000 Furniture 24,000

Donation for building 40,000 Cash 20,000

Entrance fee 5,000

Life membership fee 10,000 59,000

59,000

Things to be taken care of:

• All the revenue items are shown in Income and Expenditure A/C and
all the capital items are put in the Balance Sheet.
• The Income and Expenditure shows deficit so it is deducted from
capital fund.

2.6 Let Us Sum Up

Not for profit organizations, e.g., clubs, schools, colleges, etc. in order
to find out their financial position, they prepare:
d) Receipts and Payments Account
e) Income and Expenditure Account
f) Balance Sheet
1.3 SAQs
Choose the correct alternative

1. Receipts and Payment Account is a:

a) Real A/c b) Personal A/c c) Nominal A/c d) Valuation A/c

2. Income and expenditure account includes:

a) Only capital items b) only revenue items c) both revenue and

capital items d) None of the above

2.8 Answers of SAQs

 1. a 2. b

2.9 Suggested Readings

Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and

Distributors Pvt Ltd, New Delhi,

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

2.10 Model Questions

1. Write down the differences between Receipts and Payments Account and
Income and Expenditure Account.

2. Write down the treatments of following items:

a) Legacy b) Life membership fee c) Entrance fee

2. From the following information, prepare Receipts and Payments Account for
the year 2019:

Rs.

Cash at Bank on 1.1.2019 28,000

Billiard table purchased 10,000

Subscription received from members 10,000

Entrance fee received 7,000

Honorarium paid to coach 15,000

General donation 70,000

Newspaper and magazines purchased 6,000

Unit 3: Accounts of Incomplete Records: Single Entry System

Structure

3.0 Objectives
3.1 Introduction
3.2 Single Entry System
3.2.1 Salient features of single entry system
3.2.2 Advantages of single entry system
3.2.3 Disadvantage of single entry system
3.2.4 Difference between single entry and double entry system
3.3 Profit Determination under Single Entry System
3.4 Let Us Sum It Up
3.5 Key Words
3.6 SAQs
3.7 Hints/ Answers of SAQs
3.8 Suggested Readings
3.9 Model Question

3.0 Objectives

After going through this unit, you will be able to:

• Interpret accounting for incomplete records.
• Understand the salient features of single entry system.
• Distinguish between single entry and double entry system.
• Ascertain profits/loss from single entry records.

3.1 Introduction

In the previous unit, we have understood the accounting of not for profit
organization. Prior to that, we learnt how to prepare the final accounts of
profit making entity. In this unit, we will learn about the accounting
records kept under single entry system or incomplete records.

Basically in double entry system, all the transactions are recorded

recognizing their two fold aspects i.e., against every debit there is equal
and corresponding credit. But in single entry system the two fold affects
of all the transactions are not taken into consideration. Under this system,
 with respect to some transactions both the aspects debit and credit are
taken into consideration; while with respect some transactions only one
aspect is recorded and with respect to some transactions no records are
maintained. Therefore, it is called a system of double entry, single entry
and no entry. As such, we cannot say that it is a system; rather it is a style
of maintaining accounting data in an incomplete form.

Under this system, no records are maintained with respect to certain

transactions like bad debt, depreciation etc. With respect to cash
transactions only the cash aspect is recorded like cash purchase of assets,
cash sales etc. Transactions which are credit in nature like credit sales of
goods, credit purchase of goods both the aspects are recorded. Only the
personal accounts are maintained in its full form and content but so far the
nominal and real accounts are concerned no records are made available
under the incomplete system of accounting.

3.2 Single Entry System

In this section, you will learn the fundamentals of single entry system.

Firstly, let us have a discussion on salient features of single entry system:

3.2.1 Salient features of single entry system

The salient features of single entry system are as follows:

a) Maintain personal accounts: usually under this system, personal

accounts are maintained while real and nominal accounts are avoided.
b) Maintain cash book: Under this system, cash book is maintained, which
unusually takes into account both personal transactions and business
transactions.
c) Dependence on original voucher/evidences: In order to collect the
necessary information one has to depend on original voucher, e.g., the
figure of credit purchase may not be readily available. It is required to
calculate on the basis of original invoices received from suppliers along
with other details available in regard to transactions with the suppliers like
returns, discount etc.
d) No uniformity: The system may differ from organizations to
organizations depending upon their individual requirement.
e) Suitability: This system is suitable or normally practiced by small,
proprietary concerns or sometime may be suitable to small partnership
concerns. Limited companies cannot adopt this system due to legal
requirements relating to maintenance of account.

Let us now discuss on the advantages and disadvantages of single entry

system:

3.2.2 Advantages of single entry system

a) Simple and easy method of recording transaction:
Single entry system does not need any special accounting
knowledge or expertise to record financial transaction of
the business. It can be maintained easily by the business
owner no need to appoint any expert person to do
accounting work.
b) Economical: It is less costly system of recording business
transactions compared to double entry system. It is
economical because of limited number of transactions and
limited numbers of books (only personal account and cash
account) are maintained.
c) Suitable for small business concerns: Double entry
system is very expensive and time consuming because
books of accounts are to maintain in a formal way in quite
a good number of books of accounts. So, small firms with
limited financial transactions prefer single entry system.
d) Time saving: Single entry system is less time consuming because of
limited number of books and limited type of transactions are recorded.

3.2.3 Disadvantages of single entry system

The system suffers from certain demerits. Some of those are as follows:
a) Arithmetical accuracy cannot be checked: Under double entry
system, Trial Balance is prepared to check arithmetical accuracy of
books of accounts. Single entry system itself is an incomplete record
so it is not possible to prepare trial balance.
b) True profits cannot be ascertained: In the absence of complete
information for sales, purchases and other expenses, it is not possible
to draw a conclusion on the actual operating result of such concern.
 c) Financial position of the business cannot be judged: In the absence
of sufficient figures of profit and adequate information about assets and
liabilities of the business, the Balance Sheet cannot reflect true
financial position of the business.
d) Difficulty in planning and decision making: Since the system doesn’t
provide accurate details on financial position of the business, it is
difficult to take any managerial decision and to make plans for future.

Let us now discuss on the differences between double entry system and
single entry system of book keeping:

3.2.3 Difference between double entry and single entry system

The following are the differences between double entry and single
entry system:
a) Single entry method of maintaining accounts is an incomplete
record of the financial transactions whereas double entry system of
accounting is a complete record of financial transactions.
b) In single entry system, only personal accounts are maintained
whereas in double entry system in addition to personal account, real
and nominal accounts are also maintained.
c) Books maintained by single entry system are not reliable whereas
books maintained under double entry system are systematic so
reliable.
d) Arithmetical accuracy of recording the transactions cannot be
checked under single entry system whereas under double entry
system, arithmetical accuracy of the accounting records can be
checked by preparing trial balance.

3.3 Profit Determination under Single Entry System

Now let us discuss how the profit determination under single entry system:

The profit or loss in case of single entry system can be computed under
two different methods:
a) Net worth method or capital comparison method; and
 b) Conversion method

Net worth method/ capital comparison method

According to this method, the profit or loss made by business is computed by

comparing the net worth of the business on two different dates. Firstly, Statement
of Affairs on two different dates is prepared. Thereafter, to determine the
profit/loss position a Statement of Profit/Loss is prepared.

Statement of affairs is a statement showing assets, liabilities and capital of the

entity based on records available maintained on the basis of single entry system.
Small traders and their firms do not maintain their books of accounts as per double
entry system. As such, the number of financial transactions recorded by these
firms is limited. However, at the end of the financial year, these firms also want
to know the position of the business. For this purpose, statement of affairs is
prepared at the beginning and at the end of the period to determine the overall
change in the capital during the financial year. To prepare this statement we have
to refer some documents available related with purchase of assets and due
consideration may be given for depreciation and any addition made to that asset
during the current year. Since they maintain records of credit transactions so it is
possible to ascertain anything due and receivable from creditors and debtors
respectively this can be put in the statement of affairs. After putting the assets and
liabilities the capital figure is calculated as a balancing figure of the statement.

As we have learnt the theoretical aspects of single entry system, now let us solve
some illustrations to understand the concept better:

Illustration 3.1: Mr. Arun keeps his books under single entry system. His
position of assets and liabilities on 1st January, 2019 was:

Cash at bank Rs. 5,000; Cash in hand Rs. 1,000; Stock Rs. 7,000; Sundry debtors
Rs. 8,400; Plant & Machinery Rs. 6,500; Bills Receivable Rs. 2,600; Creditors
Rs. 2,500; Bills Payable Rs.4,000.

On December 31, 20019, his position was as follows:

 Cash at bank Rs. 4,300; Cash in hand Rs. 1,700; Stock Rs. 9,000; Sundry debtors
Rs. 6,000; Plant & Machinery Rs. 6,500; Bills Receivable Rs. 3,200; Creditors
Rs. 1,600; Bills Payable Rs.3,200. During the year, Mr. Arun introduced further
capital of Rs. 2,000 and his drawings were Rs. 800 per month.

Depreciate plant & machinery @ 5% p.a. and create a provision for doubtful debts
@5% p.a.

From the above information, prepare a statement showing profit or loss made by
Mr. Arun for the year ended on 31st December, 2019.

Solution to Illustration 3.1:

Statement of Affairs of Arun As on 1.1. 2019

Liabilities Rs. Assets Rs.

Capital 24,000 Cash at bank 5,000

(Balancing figure) Cash in hand 1,000

Creditors 2,500 Bills Receivable 2,600

Bills Payable 4,000 Sundry Debtors 8,400

Stock 7,000
Plant & machinery 6,500

30,500 30,500

Statement of Affairs of Arun As on 31.12.2019

 Liabilities Rs. Assets Rs.

Capital 25,275 Cash at bank 4,300

(Balancing figure) Cash in hand 1,700

Bills Payable 3,200 Bills Receivable 3,200

Creditors 1,600 Debtors 6,000

Less: Provision 300 5,700

Stock 9,000

Plant & Machinery 6,500 6,175

Less: Depreciation 325 30,075

30,075

Statement of Profit of Arun For the year ending 31.12.2019

Particulars Rs.

Capital as on 31.12.2019 25,275

Add: Drawings made during 2019 (Rs. 800× 12) 9,600

---------------------
-34,875
2,000
Less: Fresh capital introduced
---------------------
Adjusted capital as on 31.12.2019 -32,875
Less: Capital as on 1.1.2019 24,000
----------------
8,875
Profit made during 2019

Things to learn from the illustration:

● We know the accounting equation is [Assets - Liabilities=Capital]. So
additional capital introduced is deducted from closing capital.

● Drawings represent the amount taken by the owner of the business for his
personal use in anticipation of profit. The amount of drawing is added with the
capital at the end.

• Since the closing adjusted capital is greater than the opening capital, the
entity could earn profit during the year.

Conversion method

Conversion method means converting the accounts from single to double entry.
If it is desired to change the system of accounting from single entry to double
entry on a given date, the following procedure should be adopted:

●Preparation of statement of affairs: The statement of affairs should be prepared

on the date on which the shifting from single entry to double entry is to be made.

●Prepare cash and bank summary: It should be seen that cash and bank balances
shown in the statement of affairs must reconcile with the cash and bank balance
as shown by the cash book. Moreover, bank balance as shown by the bank column
of the cash book and the pass book are to reconcile if there is any discrepancy is
noticed.

●Prepare total debtors and total creditors account: Similarly, the amount of
debtors and creditors shown in the statement of affairs should agree with the total
of debit and credit balance extracted from the individual accounts of debtors and
creditors.

●For bringing into books the various assets and liabilities appearing in the
statement of affairs, an opening journal entry should be made as follows:

Various Assets A/c –Dr

To Various Liabilities A/c

To Capital A/c (balancing figure)

(Being balances of assets and liabilities brought forward from statement of

affairs)
Thereafter, the books can be opened under the double entry. In future, all
transactions should be recorded according to the double entry system by
maintaining the subsidiary books and then posting the transactions into the ledger
accounts in the ledger book.

Now let us solve one numerical problem to have better understanding:

Illustration 3.2 Ranjit commenced business as a cloth merchant on 1.1.2018 with

a capital of Rs. 10,000. On the same date, he purchased furniture by paying cash
Rs. 3,000. From the following particulars obtained from his books kept under
single entry, you are asked to prepare a Trading and Profit & Loss Account for
the year ended on 31st December, 2018 and a Balance Sheet as on the same date.

Particulars Rs.

Sales (inclusive of cash Rs. 7,000) 17,000

Purchases (inclusive of cash Rs. 4,000) 15,000

Ranjit’s drawings 1,200

Salaries to staff 2,000

Bad debts written off 500

Business expenses 700

Ranjit took cloth worth Rs. 500 from the shop for his personal use and paid Rs.
200 to his daughter, but omitted to record these transactions in his books. On 31 st
December, 2018, his sundry debtors were Rs. 5,200 and sundry creditors Rs.
3,600. Stock in hand on 31st December, 2018 was Rs. 6,500.

Solution to Illustration 3.2:

Trading and Profit & Loss Account of Ranjit

For the year ended on 31st December, 2018

Dr. Cr.

Particulars Rs. Particulars Rs.

To Purchases 15,000 By Sales 17,000

Less: Drawings 500 14,500 By Closing Stock 6,500

Gross Profit c/d 9,000

23,500 23,500
To Salaries 2,000 By Gross Profit b/d 9,000
To Bad debts 500
To Business expenses 700
To Net Profit 5,800

9,000 9,000

Balance Sheet of Ranjit As on 31.12.2018

Liabilities Rs. Assets Rs.

Capital 10,000 Cash Balance 2,800

Less: Drawings 1,900 Sundry Debtors 5,200

8,100 Closing Stock 6,500

Add: Net Profit 5,800 13,900 Furniture 3,000

Sundry Creditors 3,600

17,500 17,500

*Drawings= Rs. 1,200+ Rs. 500+ Rs.200= Rs. 1,900

Working Notes:

1)
 Receipts and Payments Account
For the year ending 31.12.2018
Receipts Rs. Payments Rs.
To Capital A/C 10,000 By Furniture 3,000
To Cash Sales 7,000 By Cash Purchase 4,000
To Sundry Debtors 4,300 By Drawings (1200+200) 1,400
(Working Note 2) By Salaries 2,000
By Business Expenses 700
By Sundry Creditors 7,400
(Working Note 2)
By Balance c/d 2,800
21,300 21,300

2)
Sundry Debtors Account
Dr. Cr.
Particulars Rs. Particulars Rs.
To credit Sales 10,000 By Cash (Balancing 4,300
figure)
By Bad Debts 500
By Balance c/d 5,200
10,000 10,000

3) Sundry Creditors Account

Dr. Cr.

Particulars Rs. Particulars Rs.

To Cash (Balancing 7,400 By Credit Purchases 11,000

figure)
To Balance c/d

3,600

11,000 11,000

Things to learn from this illustration:

• The money given by Ranjit to his daughter and cloth taken by him from his
business is taken as his drawings. The value of cloth taken has been
deducted from purchase.
• Figures of cash, debtors and creditors were not directly given. So with the
help of preparing concerned accounts in the working notes, we have found
the missing figures and by incorporating the figures in the Profit & Loss
A/C we have tried to showcase the profit and loss position of the business.
• Unlike net worth method, by following conversion method, we have
calculated gross profit, net profit and also found the operating expenses of
the business.

3.4 Let Us Sum It Up

The term “single entry” is vaguely used to define the method of
maintaining accounts which does not exactly follow the principles of
double entry system. It does not mean (as the name goes) that there is
one entry for each transaction i.e., only one account is given debit or
credit for each transaction. But it simply means that principles of
double entry system are not followed under single system. Under this
system, only personal accounts are considered for the purpose of
generating accounting records whereas real and nominal accounts are
ignored under this system.
The profit or loss in case of single entry system can be computed with
the help of:
c) Net worth method or capital comparison method
d) Conversion method

3.5 Key Words

 Single entry system, Double entry system, Net worth method, Conversion
method.

3.6 SAQs

1. Single entry system takes into consideration:

a) Only personal account b) Only nominal account c) Only real account d)

All the accounts

2. Statement of Affairs is prepared under:

a) Conversion method b) Net worth method

3.7 Answers of SAQs

1. (a) 2. (b)

3.8 Suggested Readings

Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors

Pvt Ltd, New Delhi,

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

3.9 Model Question:

Debasish started business on 1.1.2018 with a capital of Rs. 12,000. On the same
date, he purchased machinery by paying cash Rs. 3,000. From the following
particulars obtained from his books kept under single entry, you are asked to
prepare a Trading and Profit & Loss Account for the year ended on 31 st
December, 2018 and a Balance Sheet as on the same date.

Particulars Rs.

Sales (inclusive of cash Rs. 3,000) 14,000

Purchases (inclusive of cash Rs. 2,000) 13,000

Debasish’s drawings 1,200

 Salaries to staff 1,500

Bad debts written off 300

Business expenses 700

Debasish spent Rs.500 for his personal use, but omitted to record these
transactions in his books. On 31st December, 2018, his sundry debtors were Rs.
5,000 and sundry creditors Rs. 3,600. Stock in hand on 31 st December, 2018 was
Rs. 6,100.

BLOCK-2: HIRE PURCHASE SYSTEM AND INSTALLMENT

ACCOUNTS

Introduction

There are two units in this block. Unit 1 focuses on basic concepts of hire
purchase and installment purchase.

Likewise, Unit 2 deals with accounting entries in the books of hire purchaser and
hire vendor.

Unit 1: Hire Purchase and Installment Account

Structure

1.0 Objectives

1.1 Introduction
1.2 Hire Purchase System
1.3 Installment Purchase System
1.4 Differences between Hire Purchase and Installment Purchase
1.5 Let’s Sum Up
1.6 Key Words
1.7 SAQs
1.8 Hints/ Answers of SAQs
1.9 Suggested Readings
1.10 Model Question

1.0 Objectives

After going through this unit, you will be able to:

• Understand the concept of hire purchase system.
• Understand the concept of installment purchase system.
• Distinguish between hire purchase and installment purchase system.

1.1 Introduction
This unit focuses on basic understanding of the concepts like hire purchase
and installment purchase system. Hire purchase contract is a contract
between two parties where one party agrees to buy the asset by not paying
the total cost of the asset in full to the seller at a time but he agrees to pay
the amount on installment basis over a certain period allowed by seller.
The ownership of the asset is retained by the seller till the last installment
is paid by the buyer.
Unlike the hire purchase system, where ownership of the asset is retained
by the seller till the last installment is paid by the buyer; In case of
installment purchase, ownership of the asset is transferred to the buyer
straightway after the agreement.

1.2. Hire Purchase System

A hire purchase is a contract where goods are purchased or sold with the
stipulations that:
a) The delivery of goods is given by the owner of the goods to the hire
purchaser;
b) The payment of the price for the goods to be made in installments;
c) Ownership of the goods passes to the hire purchaser only on payment of
all the installments;
 d) In the event of hire purchaser’s failure to pay any installment, the hire
vendor is entitled to seize the goods and adjust the money paid by the
hire purchaser against the hire charges for the use of the goods.

In hire purchase contract, there are two parties, i.e., hire vendor means
the seller and hire vendee means the buyer. The initial amount paid
against the asset by the buyer is termed as initial payment or down
payment. Thereafter, installments which are also called as hire charges
are paid regularly and preferably along with interest.
For example: a television costing Rs. 15,000 is purchased by A from B
under hire purchase contract. A agrees to pay Rs.5, 000 as the initial
payment called down payment. He agrees to pay the remaining amount
in 3 equal monthly installments plus interest of 5% p.a. So, after paying
off all the installments only A can become the owner of the television
though he can use the television after taking delivery of the same.

1.3 . Installment Purchase System

This system is also termed as deferred installment system. In this system,
there is an outright sale of goods with the buyer having the facility to pay
the purchase price in certain number of agreed installments. Thus, the
installment price includes both the cash price as well as the interest for
delayed payment. The possession and legal ownership of the goods passes
to the buyer immediately on its delivery.
The following are the essential characteristics of this system:
a) The buyer gets immediate possession and ownership of the goods;
b) The payment of price has to be made by the buyer in agreed
installments;
c) In the event of default by the buyer in payment of any installment, the
seller can file a suit against the buyer for recovery of unpaid price and
damages.
1.4 Differences between the Hire Purchase System and Installment
Purchase System
The following are the differences between the two systems:

From Legal View point:

a) Transfer of ownership: In case of hire purchase system, the
ownership in goods sold passes to the buyer only on payment of the
 last installment. But in case of installment purchase system,
ownership to the buyer is transferred at the time of sale of goods.
b) Recovery of goods: In case of hire purchase system, if the buyer
fails to pay the last installment, the seller can repossess the goods
from the buyer. But in installment purchase system, the seller cannot
repossess the goods. He can only sue for recovery of price and
damages.
c) Forfeiture of installments paid: In case of hire purchase system, in
the event of buyer’s default in payment, the seller can forfeit all the
money paid by the buyer so far, while in case of installment purchase,
the money paid by buyer will be taken as part payment made towards
the selling price and the seller can only sue for the balance amount.

From Accounting Viewpoint:

a) Computation of loss of seizure of goods by the vendor: In case

of hire purchase, in the event of seizure of goods by the vendor,
due to buyer’s default the loss on seizure of goods has to be
computed. However, in installment purchase, the vendor cannot
seize the goods and henceforth the need for computation of loss
on seizure does not arise.

1.5 Let’s Sum Up

• Hire purchase contract is a contract between two parties where one
party agrees to buy the asset by not paying the total cost of the asset
fully to the seller at a time but he agrees to pay the amount on
installment basis for a certain period allowed by seller. The ownership
of the asset is retained by the seller till the last installment is paid by the
buyer.
• But in installment purchase, the ownership of the asset is
transferred straightway after the sales.
1.6 Key Words
Cash Price: It refers to the price at which goods are sold under the
contract of sale.
Down Payment/ Cash Down: It refers to the initial amount which is
required to be paid by the hire purchaser to the hire vendor against the
cash price of the asset.
 Hire Vendor: Hire vendor is a person who delivers the goods to the hire
purchaser with the intention to sell the goods under hire purchase
agreement.

1.7 SAQs
1. Hire Vendor under hire purchase contract is?
a) Buyer of asset b) Seller of asset
2. In hire purchase system, who retains the right of ownership till last
installment paid?
a) Vendor b) Vendee
3. In installment system, ownership right is transferred to vendee
immediately after sales.
a) True b) False

1.8 Hints/ Answers of SAQs

1. B 2. A 3. A

1.9 Suggested Readings

Harrison Walter T., et al (2009), “Financial Accounting”, 8th Edition, Prentice

Hall

Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors

Pvt Ltd, New Delhi,

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2 nd Revised Edition,
Kalyani Publisher

1.10 Model Questions

1. What is Hire Purchase Contract? Discuss essential characteristics of
Hire Purchase System.
2. What is Installment Purchase Contract? Discuss essential
characteristics of Installment Purchase Contract.

3. Differentiate between Hire Purchase and Installment Purchase

Contract.
Unit 2: Accounting Entries in Hire Purchase System

Structure

2.0 Objectives
2.1 Introduction
2.2 Accounting Entries in the books of Hire Purchaser
2.3 Accounting Entries in the books of Hire Vendor
2.4 Let’s Sum Up
2.5 Key Words
2.6 SAQs
2.7 Hints/ Answers of SAQs
2.8 Suggested Readings
2.9 Model Question

2.0 Objectives

After going through this unit, you will be able to:

• Deal with accounting entries in the books of hire vendor.
• Deal with accounting entries in the books of hire vendee.

2.1 Introduction
The previous unit focuses on basic understanding of the concepts like hire
purchase and installment purchase system. In this unit, we will try to
understand how accounting records are maintained for transactions taking
place relating to hire purchase system.
Now, let us discuss and understand the accounting entries of hire
purchase in the books of both vendor and vendee:

2.2 Accounting Entries in the books of Hire Purchaser/ Hire Vendee

There are two methods for making accounting entries of the hire purchase
transactions in the books of hire purchaser:
a) When asset is recorded at full cash price
b) When asset is recorded at the cash price actually paid.

a) When asset is recorded at full cash price

Here the common notion is that as the hire purchaser has agreed to buy
asset so he is considered as the owner of the asset. The following
journal entries are recorded in the books of hire purchaser:
i. On the purchase of the asset
Asset A/C -Dr
To Hire vendor A/C
(With full cash price of the asset)

ii. On making cash down payment

Hire vendor - Dr
To Cash/ Bank A/C
(With actual cash down payment)

iii. For interest due

Interest A/C – Dr
To Hire vendor A/C
(Interest is calculated on the outstanding amount when
installment becomes due)

iv. On payment of hire purchase installments

Hire vendor A/C – Dr
To Cash/ Bank
(With amount of installment paid)

v. For depreciation of the asset

Depreciation A/C –Dr
To Asset A/C
(At the end of the accounting period)

vi. For transferring of depreciation and interest

Profit and Loss A/c - Dr
To Depreciation A/c
To Interest A/c
(Being depreciation transferred to P/L a/c)
b) When asset is recorded at the cash price actually paid.

Here, it is assumed that the hire purchaser has not become an owner of
the asset till he pays the final installment. The following journal entries
are recorded:
I. On cash down payment
Asset A/C - Dr
To Cash/ Bank A/C
(With the amount of cash down payment)

II. On hire purchase installment becoming due

Asset A/C - Dr
Interest A/C -Dr
To Hire vendor A/C
(Asset account is debited with the amount of cash price included in each
installment. The interest on outstanding cash price is debited to the
interest account)

III. On making payment of installment

Hire vendor A/C –Dr
To Cash/ Bank A/C
(With the amount of installment paid)

IV. For depreciation of the asset

Depreciation A/C –Dr
To Asset A/C
(Depreciation is charged on full cash price of the asset)

V. For transferring of depreciation and interest

Profit and Loss A/c -Dr
To Depreciation A/c
To Interest A/c
(Being depreciation and interest transferred to profit and
loss account)
2.3 Accounting Entries in the books of Hire Vendor

The following entries are passed in the books of hire vendor:

1) On sale of goods under hire purchase:
Hire Purchaser A/C - Dr
To Hire Sales A/C
(With full cash price)

2) On receiving cash down payment

Cash/ Bank A/C -Dr
To Hire Purchaser A/C
(With the amount of cash down payment)

3) For interest due

Hire Purchaser A/C – Dr
To Interest A/C
(Interest is calculated when installment becomes due)

4) On getting payment of installment

Cash/ Bank A/C -Dr
To Hire Purchaser A/C
(With the amount of installment received)

5) For transferring of interest

Profit & Loss A/c – Dr
To Interest A/c
(Being interest transferred to Profit and Loss A/c)

Let us solve a practical problem to understand it better:

Illustration 2.1: The following are the particulars relating to hire

purchase:
Purchaser: Ram & Co. Seller: Shyam & Co. Asset: Machine
Date of Purchase: 1.1.2015
Cash Price: Rs. 12,894
Payments: Rs. 2,000 on signing of agreement and balance in three
equal installments of Rs. 4,000 due on 31st December each year.
Rate of interest is 5 %p.a.
Depreciation is 20% p.a. at written down value method.
Make journal entries and prepare necessary ledger accounts in the
books of hire purchaser.

Solution to illustration 2.1

Working notes:
1.1.2015 Cash Price = Rs. 12,894
1.1.2015 Less: Down Payment = Rs. 2,000
Rs. 10,894
31.12. 2015 Add: Interest Rs. 545
Rs. 11,439
31.12.2015 Less: Installment Rs. 4,000
1.1.2016 Balance Rs. 7,439
31.12.2016 Add: Interest Rs. 372
Rs 7,811
31.12.2016 Installment Rs. 4,000
1.1.2017 Balance Rs. 3,811
31.12.2017 Add: Interest Rs. 189
Rs. 4,000
31.12.2017 Installment Rs. 4,000
1.1.2018 Balance Nil

Note: [So, we can see that the payment of installment is completed

within three years of its purchase]

Calculation of depreciation
1.1.2015 Cost = Rs.12894
31.12.2015 Depreciation = Rs. 2578
1.1.2016 Book value Rs. 10,316
31.12.2016 Depreciation Rs. 2,063
1.1.2017 Book value Rs. 8,053
1.1.2017 Depreciation Rs. 1,611
1.1.2018 Book value Rs. 6,442
 Journal Entries in the books of Ram & Co.
Dr Cr

Date Particulars L/F Amount Amount

(Rs) (Rs)

1.1.2015 Machinery A/c - Dr 12,894

To Shyam & Co. A/c 12,894

(Being purchase of machinery on

hire purchase)

Shyam & Co. A/c – Dr 2,000

31.12.2015 2,000
To Cash A/c

(Being down payment made)

31.12.2015 Interest A/c – Dr 545

To Shyam & Co. A/c 545

(Being interest credited to

vendor)
4,000
Shyam & Co. A/c – Dr
31.12.2015 4,000
To Cash A/c

(Being installment paid)

31.12.2015 Depreciation A/c - Dr 2,579
2,579
To Machinery A/c

(Being depreciation charged on

machinery)
 Profit and Loss A/c – Dr 3,124
31.12.2015
To Interest A/c
545
To Depreciation A/c 2,579

(Being balance of interest and

depreciation transferred to Profit
and loss account)

Interest A/c – Dr 372

31.12.2016 372
To Shyam & Co. A/c

(Being interest credited to

vendor)

Shyam & Co. A/c – Dr

31.12.2016 4,000
To Cash A/c 4,000

(Being installment paid)

Depreciation A/c - Dr
2,063
To Machinery A/c 2,063
(Being depreciation charged on
31.12.2016
machinery)

31.12.2016 Profit and Loss A/c – Dr 2,435

To Interest A/c 372

To Depreciation A/c 2,063

(Being balance of interest and

depreciation transferred to Profit
and loss account)
 31.12.2017 Interest A/c – Dr 189

To Shyam & Co. A/c 189

(Being interest credited to

vendor)

31.12.2017 Shyam & Co. A/c – Dr 4,000

To Cash A/c 4,000

(Being installment paid)

31.12.2017 Depreciation A/c - Dr 1,650

To Machinery A/c 1,650

(Being depreciation charged on

machinery)

31.12.2017 Profit and Loss A/c – Dr 1,839

To Interest A/c 189

To Depreciation A/c 1,650

(Being balance of interest and

depreciation transferred to Profit
and loss account)

In the books of Ram & Co.

Machinery A/c

Dr. Cr
Date Particulars J/ Amoun Date Particulars J Amount
F t (Rs) / (Rs)
F
1.1.15 To Shyam & Co 12,894 31.12.15 By Depreciation 2,579
A/c
31.12.15 By Balance c/d 10,315
12,894 12,894
1.1.16 To Balance b/d 10,315 31.12.16 By Depreciation 2,063
A/c
By Balance c/d 8,252
10,315 10,315
1.1.17 To Balance b/d 8,252 31.12.17 By Depreciation 1,650
A/c
By Balance c/d
6,602
8,252 8,252

1.1.18 To Balance b/d 6,602

In the books of Ram & Co.

Depreciation A/c
Dr. Cr

Date Particulars J/ Amount Date Particulars J Amount

F (Rs) / (Rs)
F
31.12.15 To Machinery A/c 2,579 31.12.15 By P/L A/c 2,579

2,579 2,579

31.12.16 To Machinery A/c 2,063 31.12.16 By P/L A/c 2,063

2,063 2,063
31.12.17 To Machinery A/c 1,650 31.12.17 By P/L A/c 1,650

1,650 1,650

In the books of Ram & Co.

Shyam & Co. A/c

Dr. Cr

Date Particulars J/ Amount Date Particulars J Amount

F (Rs) / (Rs)
F
1.1.15 To cash A/c 2,000 1.1.15 By Machinery 12,894
31.12.15 To Cash A/c 4,000 A/c
31.12.15 To Balance c/d 7,439 31.12.15 By Interest A/c 545
13,439 13,439
31.12.16 To Cash A/c 4,000 31.12.16 By Balance b/d 7,439
31.12.16 To Balance c/d 3,811 31.12.16 By Interest A/c 372
7,811 7,811
4,000 31.12.17 By Balance b/d 3,811
31.12.17 To Cash A/c By Interest 189
4,000 4,000

In the books of Ram & Co.

Interest A/c
Dr. Cr

Date Particulars J/ Amount Date Particulars J Amount

F (Rs) / (Rs)
F
31.12.15 To Shyam & Co. 545 31.12.15 By P/L A/c 545
A/c
545 545
31.12.16 372 31.12.16 By P/L A/c 372
 To Shyam & Co.
A/c 372 372
189
31.12.17 31.12.17 By P/L A/c 189
To Shyam & Co. 189 189
A/c

2.10 Let’s Sum Up

There are two methods for making accounting entries of the hire
purchase transactions in the books of hire purchaser:
a) When asset is recorded at full cash price;
b) When asset is recorded at the cash price actually paid

The hire vendor takes the sale of goods on hire purchase as ordinary sale.

2.11 Key Words

Hire Purchaser, Hire Vendor, Installment, Cash Down, Cash Price
2.12 SAQs
1. Depreciation is charged by hire vendor:
a) Yes b) No
2.13 Hints/ Answers of SAQs
1. B)

2.14 Suggested Readings

Harrison Walter T., et al (2009), “Financial Accounting”, 8th Edition, Prentice

Hall

Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors

Pvt Ltd, New Delhi,

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2nd Revised Edition,
Kalyani Publisher

2.9 Model Question

1. The following are the particulars relating to hire purchase:

Purchaser: Hari & Co. Seller: Varun & Co. Asset: Air
Conditioner
Date of Purchase: 1.1.2016
Cash Price: Rs. 25,000
Payments: Rs. 10,000 on signing of agreement and balance in three
equal installments of Rs. 5,000 due on 31st December each year.
Depreciation is 10% p.a. at written down value method.
Make journal entries and prepare necessary ledger accounts in the
books of hire purchaser.

2. The following are the particulars relating to hire purchase:

Purchaser: Krishna & Co. Seller: Harish & Co. Asset:
Refrigerator
Date of Purchase: 1.1.2016
Cash Price: Rs. 15,000
Payments: Rs. 3,000 on signing of agreement and balance in three
equal installments of Rs. 4,000 plus interest due on 31st December
each year.
Interest charged: 5 % p.a.
Depreciation is 10% p.a. at written down value method.
Make journal entries and prepare necessary ledger accounts in the
books of hire purchaser.

BLOCK- 3: PARTNERSHIP ACCOUNTS

Introduction

There are two units in this block. Unit 1 deals with admission, retirement and
death of partners.
Unit 2 deals with dissolution of firm and insolvency of partners.

While going through the units you will get Self Assessment Questions. At the end
of every unit, suggested readings are given. So, you can refer to these books in
case you require deeper and better understanding of related concepts.

Unit 1: Problems Relating to Admission, Retirement of Partners

Structure
1.0 Objectives
1.1Introduction
1.2Treatment related to Admission of New Partners
1.3Treatment Related to Retirement of Existing Partners
1.4Treatment Related to Death of Existing Partners
1.5 Let’s Sum Up
1.6 Key Words
1.7 SAQs
1.9Hints/ Answers of SAQs
1.8 Suggested Readings
1.9 Model Question

1.0 Objectives

After going through this unit, you will be able to:

• Understand the accounting entries to be given on admission of a new

partner.
 • Understand the accounting entries to be given on retirement of an existing
partner.
• Understand the accounting entries to be given on death of an existing
partner.

1.1 Introduction
The Indian Partnership Act, 1932, defines “Partnership is the relation between
persons who have agreed to share the profits of a business carried on by all or
any of them acting for all.”
The document which contains the terms and conditions regarding the conduct
of partnership business, is called as Partnership Deed.
The following are the important clauses that are to be incorporated in a
partnership deed:
1. The name of the firm.
2. The nature of the business which the firm is supposed to do.
3. The amount of capital and in what way this capital will be contributed
by each partner.
4. The proportion in which the partner will share profit and losses.
5. The amount of drawings which a partner can draw from the firm.
6. Whether interest on capital and interest on drawings will be allowed? If
so, then what will be the rate of interest on capital and interest on
drawings?
7. What will be the authority of each partner? Will some restrictions be
imposed on the duties of the partners?
8. What will be the duration of the firm? Whether the firm will be
dissolved at will or will continue for a fixed period or till the happening
of a particular event or on the completion of a particular venture?
9. How the amount of the goodwill of the firm will be ascertained at the
time of change in profit sharing ratio, admission, retirement or death of
a partner?
10.Will some salary or remuneration or commission be allowed to any of
the partners?
11. How the annual accounts of the firm will be prepared? Will the
accounts be audited by an independent Chartered Accountant? How the
auditor will be appointed?
 12.In case of retirement or death of a partner, how the amount required to
be paid to the partner or his legal representative will be ascertained? If
the partners have taken joint life policy or individual policies, the
premium of which is being charged to the Profit and Loss Account and
on the death of a partner, how the amount received from the insurance
company and their surrender value will be distributed among the
partners.
13.If a partner has given any amount of the loan besides his capital, will
interest be allowed to him? If so, what will be the rate?
14.In case a partner becomes insolvent, how the accounts of the firm will
be settled? Will the rule Garner vs Murray be applicable in this case?
15.The circumstances in which the firm will be dissolved and the manner
in which the accounts will be settled in case of dissolution of a firm.
16.In case some dispute arises among the partners, how will it be settled?
Will it be referred to some arbitrator?
17.Any other clause on which the partners may agree at the time of
settlement.
The following rules are applicable in the absence of a partnership deed:
1. The profits or losses of the firm will be shared equally by the
partners.
2. Interest on capital will not be allowed to any partner. If agreed the
interest will be allowed only out of profits of the firm. Similarly, no
interest will be charged on drawings of the partners unless agreed
upon.
3. If any partner has given a loan to the firm besides his share of capital,
he will be allowed 6% interest on such loan.
4. No salary or remuneration will be allowed to any of the partners.
5. Every partner can take part in the management of the partnership
business.
6. No person can be admitted without the consent of all the existing
partners.
7. The partnership books are to be kept at the place of the partnership
business and every partner must have access to and inspect and copy
any of them.

1.2 Treatment Related to Admission of A New Partner

 Whenever a partner is admitted into partnership firm, the new partner
contributes capital into the business; so he acquires two rights.

Rights of a new partner

↙ ↘
Right to share
In the assets
Right to share in the
of partnership
Profits of the
partnership

The following are the main points which usually require attention at the time of
admission of a partner:

• Calculation of new profit sharing ratio

• Revaluation of assets and liabilities
• Treatment of goodwill
• Adjustment of undistributed profits and losses
• Adjustment of capitals in order to bring these in proportion to profit
sharing ratio or as agreed upon.
All these are discussed in details.
1.2.1 Calculation of new profit sharing ratio

The calculation of new profit sharing ratio depends on the agreement between
the old partners and the new partner but the following cases may arise while
calculating the profit sharing ratio.

1) If the new partner’s share is given and nothing else is mentioned in the
question, then it is presumed that the remaining partners will share the
rest of the profits in the old ratio.
For example, A and B are partners sharing profits and losses in
proportion of 2:1. They admit a new partner C whom they give 1/6th
share in profits. The new profit sharing ratio will be:
Suppose the total share is 1
The new partner C takes 1/6 of 1
Share of profit left for other partners = 1-1/6= 5/6
 A’s new share= 5/6×2/3= 10/18
B’s new share= 5/6×1/3= 5/18
So, New profit sharing ratio of A:B:C= 10 : 5 : 3
18 18 18

= 10 : 5: 3

2) The new partner, in some cases, purchases his share of profit from the
existing partners in a particular ratio. New profit sharing ratio of the
existing partners is calculated by deducting the proportion given to the
new partner from the shares of existing partners.
For example, A & B are partners sharing profits and losses in the
proportion of 7:5. They agree to admit C into partnership who is to get
1/6th share in profits. He acquires this share as 1/24 from A and 1/8
from B. New profit sharing ratio will be calculated as:

The new partner C acquires 1/6th share in profits.

He takes 1/24 from A; 1/8 from B
A’s new share = 7/12- 1/24= 13/24
B’s new share = 5/12- 1/8 = 7/24
So, A, B, C’s new share of profit = 13/24: 7/24: 1/6 (or we can say
4/24) = 13: 7: 4

Sacrificing Ratio
When a new partner is admitted, the existing partner/s sacrifices a
fraction of his share in favor of the new partner. It is calculated as:

Sacrificing Ratio = Old Ratio – New Ratio

Say for instance, two partners i.e., A and B shared profits 4/7th and
3/7th respectively. So their old ratio was 4:3 respectively. When a
new partner is admitted, their new ratio becomes 2:2:3. In this case the
sacrifice ratio of the existing partners will be:
A’s sacrifice = 4/7- 2/7= 2/7
B’s sacrifice = 3/7 – 2/7= 1/7
So, sacrificing ratio = 2:1

1.2.2 Revaluation of Assets and Liabilities

It is in the interest of all partners the revaluation of assets and liabilities is done
at the time of admission of a partner. When a new partner is admitted into the
business, it is natural that he should not be benefitted from any appreciation in
the value of assets which has taken place nor he should suffer because of any
depreciation in the value of assets. Same is the case with liabilities. Therefore,
assets and liabilities are revalued at the time of admission of a partner. The
changes in the value of assets and liabilities are recorded in revaluation account
(also known as profit and loss adjustment account); whatever profit or loss
arises from such revaluation is to be credited or debited to the existing partners’
capital accounts in their old profit sharing ratio. The following journal entries
are passed in the books of the firm when values are to be altered in the books:

1) For any increase in the value of an asset

Asset A/c - Dr
To Revaluation A/c

2) For any decrease in the value of an asset

Revaluation A/c -Dr
To Asset A/c

3) For any increase in the value of liabilities

Revaluation A/c -Dr
To Liabilities A/c

4) For any decrease in the value of liabilities

Liabilities A/c - Dr
To Revaluation A/c

5) For profit on revaluation

Revaluation A/c -Dr
To Old Partners’ Capital A/c

6) For any loss on revaluation

Old Partners’ Capital A/c -Dr
To Revaluation A/c
An illustration on revaluation of assets and liabilities is given so that you can
understand the treatment very easily.

Illustration 1.1 A and B are partners sharing profits in equal proportion. The
following is Balance Sheet of the firm as on 31st December, 2018

Liabilities Rs. Assets Rs.

A’s capital 50,000 Cash 10,000

B’s capital 50,000 Bank 10,000
1,00,000 Debtors 10,000
Creditors 40,000 Furniture 10,000
Building 1,00,000
1,40,000 1,40,000

Before C joins the firm as partner, it was found that value of

furniture and building was raised to Rs 11,000 and Rs. 1, 10,000
respectively. Value of creditors was devalued at Rs. 35,000.
Pass journal entries related to revaluation.

Solution to Illustration 1.1

Journal Entries

Date Particulars L/F Amount Amount

(Rs.) (Rs.)

Furniture A/C - Dr 1,000

Building A/c - Dr 10,000
To Revaluation A/C 11,000
(Being value of assets
increased)

Creditor A/C – Dr 5,000

To Revaluation A/c 5,000
(Being value of creditor
decreased)
Revaluation A/c – Dr 16,000
To A’s capital A/c 8,000
To B’s capital A/c 8,000
 (Being profit on
revaluation distributed
between partners)
Things that we learnt from illustration:

Increase in value of assets is a gain on revaluation so as decrease in the value of

liabilities is also a gain. So, the total profit on revaluation arrived at Rs. 16,000
which is distributed between two old partners in their old profit sharing ratio.
Since there is no mention about the profit sharing ratio it implies that the
partners share profit/losses equally.

1.2.3 Treatment of goodwill

When a new partner admits into partnership, he is likely to contribute certain

amount as goodwill amount along with capital. Goodwill is the value of the
reputation of a firm in respect of profits expected in future over and above the
normal rate of profits. The existing partners with their endeavor made the
partnership firm successful and they expect to get more profits than normal which
is otherwise called as goodwill. But when a new partner admits into partnership,
the existing partners sacrifice their profit sharing ratio. So when the new partner
enters into partnership firm, he agrees to pay the premium for goodwill along with
capital.

1.2.4 Methods of valuation of goodwill

1) Average Profit Method for valuing goodwill

Under this method, average profit of past few years is multiplied by number of
years in which the anticipated profit is available. The formula for average profit
method is:

Goodwill under Average Profit Method= Total profits ×No. of years of purchase

No. of years
= Average profit × No. of years of purchase
2) Super Profit Method for valuing goodwill
The super profit is the amount of excess profit earned by an entity over and above
the normal rate of return earned by an entity of similar kind and nature or the
normal market rate of return can also be considered as normal rate of profit.
Therefore, the supper profit= Actual profit of the entity-Normal profit on the
investment. To get the value of goodwill under this method, the super profit is
multiplied by certain years of purchase. The formula for super profit is:

Super Profit = Actual Profit- Normal Profit

And, Normal Profit= Investment × Normal Rate of Profit.

Goodwill under Super profit Method=Super profit x certain years of purchase

3. Capitalization Method

Under this method, the average profits are capitalized taking into consideration
the general expected rate of return in the same industry. The value of goodwill
under the capitalization method is:

Goodwill under Capitalization Method= (Actual Profits× Capitalized Rate) – Net

Assets

Need for valuing goodwill

1) When profit sharing ratio is changed
2) When a new partner is admitted
3) When a partner dies or retires
4) Who two or more firms are amalgamated
5) When a firm’s business is dissolved or sold to a company.

1.2.5 Journal Entries Related to Goodwill on the Admission of New Partner

under different situations:

1) When the amount of goodwill is paid privately.

[No journal entry is passed.]

2) When the goodwill is received in cash and retained in the business:

Cash A/c -Dr

To Premium for goodwill A/c
 (Being cash brought in credited to new partners capital account)

Premium for goodwill A/c –Dr

To Old Partners’ Capital A/c (in sacrificing ratio)

Alternatively, by combining both these entries, the entry will be:

Cash A/c - Dr.
To Old Partners’ Capital A/Cs (in sacrificing ratio)

3) When the amount of goodwill is received in cash and withdrawn by old

partners:

Cash A/c -Dr

To Premium for goodwill A/c
(Being cash brought in credited to new partners capital account)

Premium for goodwill A/c –Dr

To Old Partners’ Capital A/c (in sacrificing ratio)

Alternatively, by combining both the entries, we can pass the

entry:

Cash A/c – Dr
To Old Partners’ Capital A/Cs (in sacrificing ratio)

For withdrawal of the amount of goodwill by the existing

partners, the entry will be:

Old Partners’ Capital A/c – Dr (in sacrificing ratio)

To Cash A/c

4) When goodwill is raised at full value:

Goodwill A/c - Dr (in old profit sharing ratio)
To Old Partners’ Capital A/c

5) When the goodwill is already appearing in the books:

 a) In case goodwill is overstated in the books, then goodwill is to be
written back by debiting the old partners’ capital accounts in the old
profit sharing ratio and goodwill account is credited.
b) In case goodwill is understated in the books, then by crediting the old
partners’ capital accounts in the old profit sharing ratio and goodwill
account is debited.

6) Sometimes new partner is unable to bring cash equal to his share and
goodwill is also appearing in the Balance Sheet. In this case, first of all
write off the amount of goodwill shown in the books debiting the old
partners’ capital account. The cash brought by new partner for goodwill
may be credited to his capital account. Then raise the goodwill account
with full value on the basis of new partner by giving corresponding credit
to the capital accounts of the old partners in the old profit sharing ratio.
This amount of goodwill will be written off in the new profit sharing ratio
by giving corresponding debit to the capital accounts of all partners in their
new profit sharing ratio. Journal entries are as under:

Old Partners’ Capital A/c -Dr

To Goodwill A/c
(Being goodwill written off from the books)

Cash A/c - Dr
To New Partner’s Capital A/c
(Being cash brought in by new partner out of his share of goodwill)

Goodwill A/c - Dr
To Old Partners’ Capital A/c
(Being raise of goodwill with full value)

All Partners’ Capital A/c -Dr (in new profit sharing ratio)
To Goodwill A/c
(Being goodwill written off in new profit sharing ratio)

7) When goodwill is hidden:

In case goodwill is not clearly mentioned then amount is calculated using
any of the methods of goodwill valuation. Journal entries will be similar.

An illustration will make you understand how to make journal entries on

account of goodwill.

Illustration 1.2 Give journal entries to record the following arrangements

in the books of the firm.

a) A & B are partners sharing profits in the ratio of 3:2. C is admitted

paying of Rs. 2000 as premium for goodwill for 1/4th share of the
profits; shares of A & B remaining as before. No goodwill account
appears in the books.
b) A &B are partners sharing profits in the ratio of 3:2. Goodwill appears
in the books at Rs. 3000. C is admitted into partnership on payment of
Rs. 2000 for 1/4th share as premium for goodwill. A & B between
themselves sharing future profits and losses equally.
c) A, B & C are partners sharing profits in the ratio of 3:1:1. The goodwill
does not appear in the books but it is worth Rs. 3000. The partners will
share profits in future equally.

Solution to illustration 1.2

Journal Entries
Date Particulars L Amount Amount
/ (Rs.) (Rs.)
F
a) Cash A/c - Dr 2,000
To Premium for goodwill A/c 1,200
(Being the amount of goodwill 800
brought in by new partner)
Premium for goodwill A/c –Dr
2,000
To A’s Capital A/c
1,200
To B’s Capital A/c
800
(Being amount of goodwill
distributed between the existing
partners in the sacrificing ratio)
 b) A’s Capital A/c - Dr
B’s Capital A/c -Dr 1,800
To Goodwill A/c 1,200
(Being existing goodwill written 3,000
off)

Cash A/c - Dr
To A’s Capital A/c 2,000
To B’s Capital A/c 1,800
(Being the amount of goodwill 200
credited to old partners in
sacrificing ratio)

c) Goodwill A/c -Dr

To A’s Capital A/c 3,000
To B’s Capital A/c 1,800
C’s Capital A/c 600
(Being the goodwill raised in the 600
books and credited to capital
accounts in old profit sharing
ratio)

A’s Capital A/c - Dr

B’s Capital A/c - Dr 1,000
C’s Capital A/c - Dr 1,000
To Goodwill A/c 1,000
(Being goodwill written off in 3,000
their new profit sharing ratio )

Things that we learnt from illustration 1.2

Sacrificing ratio is the difference between new ratio and old ratio
and we have seen goodwill is distributed between old partners in the
sacrificing ratio.

1.2.6 Adjustment of Undistributed Profits and Losses

If some undistributed profits appear in the name of general reserve or profit and
loss account (credit balance), these should be divided among old partners in the
old profit sharing ratio by passing following journal entry:
 General Reserve or Profit & Loss A/c - Dr
To Old Partners’ Capital A/c

Similarly, if profit and loss account (debit balance) is appearing on the assets side
of balance sheet, it should be closed by transferring the same to old partners’
capital accounts in their old profit sharing ratio by passing following journal
entries:

Old Partners’ Capital A/c -Dr

To Profit & Loss A/c

1.3 Accounting Treatment Related to Retirement of Existing Partners

The only difference between admission and retirement of a partner is that in case
of the former, the new partner joins the firm whereas in case of retirement, a
partner leaves the firm because of certain reasons as old age, ill health, etc.

The main points which require attention in case of retirement of a partner are:

a) Treatment of goodwill
b) Revaluation of assets and liabilities
c) Calculation of gaining ratio
d) Treatment of undistributed profits or losses
e) Calculation of total amount due to the retiring partner
f) Adjustment of capitals after retirement in order to be proportionate to the
new profit sharing ratio
g) Settlement of total amount due to the retiring partner

These above points are discussed in details.

1.3.1 Treatment of goodwill
We have learnt the treatment of goodwill when a new partner is
admitted. The following cases are adopted for goodwill when a partner
retires:
1) When the goodwill is raised in the firm’s books at full value:
Goodwill A/c -Dr
To All Partners’ Capital A/c
 2) When the goodwill is raised in the books but is written off:
a) For raising of goodwill
Goodwill A/c - Dr
To all Partners’ Capital A/c

b) For writing off the goodwill

Remaining Partners’ Capital A/c - Dr (in new profit sharing ratio)

To Goodwill A/c
3) When the goodwill account is raised only for the share of the
retiring partner in the books and then written off in the gaining
ratio:
a) When goodwill is raised
Goodwill A/c -Dr
To Retiring Partners’ Capital A/c
b) When goodwill is written off:
Remaining Partners’ Capital A/c - Dr (in gaining ratio)
To Goodwill A/c

1.3.2 Revaluation of Assets and Liabilities

Revaluation of assets and liabilities is done on the same basis as it is done in case
of admission of a partner. The only difference is that profit or loss on revaluation
is to be divided among all the partners including the retiring partners in the profit
sharing ratio in case of retirement of a partner.

1.3.3 Calculation of Gaining Ratio

This ratio is calculated when a partner retires from the firm. If new ratio of the
continuing partners is not given in the question, it is presumed that the remaining
partners will continue to share in the old ratio existed between them prior to
retirement of a partner, i.e., they gain in the old ratio. If the new profit sharing
ratio of the partners is given in the question, the gaining ratio can be calculated
by deducting the old ratio from the new ones. This ratio is very important as it
helps to determine the amount of compensation to be paid by each of the
remaining partners in the firm to the retiring partners.

1.3.4 Treatment of Undistributed Profits or Losses

General reserve or credit balance of profit and loss account is to be distributed by
crediting all partners’ capital accounts in their profit sharing ratio and will not be
shown on the liabilities side of the Balance Sheet. Alternatively, only retiring
partners’ share of these items may be credited to his capital account and residual
amount of such accounts may be shown on the liabilities side of the Balance Sheet
after retirement. Reverse treatment will be given if there is debit balance of profit
and loss account on the assets side of the Balance Sheet.

1.3.5 Calculation of Total Amount Due to a Retiring Partner

The total amount due to a retiring partner may include: 1) Capital on the date of
last Balance Sheet; 2) Interest or salary if any payable to him; 3) Share of profit
or loss to the date of retirement. 4) Share in the goodwill of the firm 5) Share in
the general reserve or profit and loss account appearing in the Balance Sheet and
6) Share of profit/loss on revaluation of assets and liabilities. Total amount
calculated may be transferred to the retiring partners’ loan account to be paid over
certain number of installments or it may be paid immediately. The entry will be:

Retiring Partners’ Capital A/c – Dr

To Retiring Partners’ Loan A/c
or To Cash/ Bank A/c (if paid immediately)

1.3.6 Adjustment of Capitals after Retirement in order to make the partners’

capital Proportionate the Profit Sharing Ratio
Sometimes after the retirement of a partner, the continuing partners decide to have
a certain sum as to be the capital of the firm and that too should be in their new
profit sharing ratio. From the total amount of the capital, the capital required by
each partner is calculated with reference to his profit sharing ratio and compared
with the existing balance in the capital account after making all adjustments. If
the balance of capital of any partner shown surplus than what it should have, the
amount will be withdrawn by the partner concerned and if the balance is less than
the required amount of his share of capital, he will have to bring the difference of
amount in cash in firm’s books.

1.3.7 Settlement of the Total Amount Due to the Retiring Partner

Retiring partner may demand immediate payment of the balance due to him at the
time of retirement but the financial resources of the firm may not permit the firm
to pay entire amount due to the retiring partner in one installment. In that situation
an agreed amount may be paid immediately and rest may be treated as retiring
partner’s loan to the firm carrying a certain rate of interest. Partners’ loan account
will be continuously shown on the liabilities side of the Balance Sheet till all the
outstanding amount of loan is paid by the firm to the retiring partner.

1.4Treatment Related to Death of Existing Partners

The problems which arise in case of death of a partner are similar to those of a
retiring partner except that the death of a partner may occur at any time whereas
the retirement of a partner may be planned, i.e., partner is allowed to retire on the
last date of the accounting period. On death of the partner the firm become liable
to pay entire amount standing to his favour to the legal heir of the deceased. Such
amount payable on death may be the aggregate of many things as stated below.
The deceased partner’s capital account is credited with the balance of capital at
the beginning of the year, interest on capital, share of profit on revaluation of
assets and liabilities, share of undistributed profits, share of profit to the date of
death, his share of goodwill and the amount which is received from Life Insurance
Corporation of India (or surrender value in case of individual policies). The
deceased partner’s capital account is debited with drawings to the date of death,
interest on drawing and anything recoverable from the deceased partner and the
final balance in his capital account is transferred to the executor’s account of the
deceased partner.
Moreover, u/s 37 of the Partnership Act, the executors of the deceased partner
would be entitled at their discretion either interest at 6% p.a. on the amount due
from the date of death to the date of actual payment or to that portion of the profit
that is earned by the firm with the amount due to the deceased partner. Most of
the points have already been discussed in the retirement of a partner but the
following two points require special attention:
a) Calculation of deceased partner’s share of profit
b) Treatment of life insurance policy
These have been discussed in details:

a) Calculation of Deceased Partner’s Share of Profit

The deceased partner’s share of profit is to be determined either on the
basis of time or turnover.
1) On the basis of time: In this case, it is assumed that profit during
the previous year has been earned uniformly in all months during
 the year, provided previous year is taken as base for calculation of
profit. Sometimes average profits of the past three or four years are
taken as base rather than the previous year. Whatever base may be
taken, it is to be multiplied by the period for which the deceased
partner remained in the firm and also by his profit sharing ratio at
the time of his death. An illustration is shown in this respect.
Illustration 1.3 A, B and C are partners in a firm sharing profits
and losses in the ratio of 3:2:1. B dies on 14 th March, 2020. The
average profit of the last three calendar years is Rs. 30,000.
Calculate B’s share of profit on the basis of time. The firm is
following the English calendar year.

Solution to Illustration 1.3

Average yearly profit = Rs. 30,000

Profit for 73 days (January 1 to March 14, 2020) = Rs. 30,000×73 = Rs. 6,000
365
So, B’s share = 2/6 × Rs. 6,000= Rs. 2,000

2) On the basis of turnover: In this method, the average past profit is

divided into two portions, i.e., before the death and after the death
on the basis of ratio of turnover to the date of death to average
turnover and deceased partner’s share is calculated and credited to
his capital account. Again an illustration is shown to make the
point understandable.
Illustration 1.4 A, B and C are partners in a firm sharing profits
and losses in the ratio of 3:2:1. B dies on 14th March, 2020.
Turnover from 1st January to 14th March, 2020 is Rs. 42,000.
Average turnover of the last three years is Rs. 60,000 and profit is
Rs. 30,000. Calculate B’s share of profit on the basis of turnover.
The firm is following the English calendar year.

Solution to Illustration 1.4

Average turnover = Rs 60,000
Sales to the date of death = Rs 42,000
Profit to the date of death = Rs 42,000×30,000
60,000
 = Rs 21,000
B’s share of profit = 1/3 × Rs 21,000 = Rs 7,000

b) Treatment of Joint Life Policy

There are three methods of dealing with joint life policy:
1) When the premiums are written off to profit and loss account
2 When insurance premium is paid

Insurance Premium A/c - Dr

To Bank A/c

3 When charged to profit and loss account

Profit and Loss A/c - Dr
To Insurance Premium A/c

4 When the amount is received on the death of a partner

Bank A/c - Dr
To Joint Life Policy A/c
5 When the amount received is distributed among partners in their profit
sharing ratio

Joint Life Policy A/c -Dr

To Partners’ Capital A/c

2) When premiums are to be written off through joint life policy reserve
account.
6 When premium is paid

Joint Life Policy A/c - Dr

To Bank A/c

7 When a reserve equal to premium paid is created out of profit and loss

Profit and Loss A/c - Dr

To Joint Life Policy Reserve A/c
8 When excess of joint policy over surrender value is written off to joint life
policy reserve account

Joint Life Policy Reserve A/c - Dr

To Joint Life Policy A/c

9 When the amount of joint policy is received

Bank A/c -Dr

To Joint Life Policy A/c

10 When the balance of joint policy reserve account is transferred to joint policy
account

Joint Policy Reserve A/c - Dr

To Joint Policy A/c
11 When balance of joint policy is distributed among the partners

Joint Life Policy A/c -Dr

To Partners’ Capital A/c

3) When surrender value is to be treated as an asset

Under this case, the amount of premium paid is debited to Joint Life
Policy Account which is reduced to its surrender value by
appropriate debit to the profit and loss account. The balance in joint
life policy will be shown as an asset in the Balance Sheet. The
amount received on the death of a partner on account of joint life
policy from the insurance company is credited to joint life policy
account and the balance standing in joint life policy account after the
receipt of the amount of the policy is closed by transferring it to
Capital Accounts of all partners in their profit sharing ratio. The
journal entry for closing the balance of joint life policy account is:

Joint Life Policy A/c - Dr

To Partners’ Capital A/c

1.5 Let Us Sum It Up

Whenever in a partnership firm, a new partner enters or an existing partner dies
or retires, then it brings changes in profit sharing ratio. Alongside that certain
other ratios do emerge like sacrificing ratio in case of admission of a partner or
gaining ratio in case of retirement. These are the important critical areas which
need to be taken care of in dealing with the accounting treatment for change in
the partnership for various reasons.

1.6 Keywords
Profit sharing ratio, gaining ratio, sacrificing ratio, goodwill

1.7 SAQ
1. A & B are partners sharing profits and losses in the proportion of 7:5.
They agree to admit C into partnership who is to get 1/6th share in profits.
He acquires this share as 1/24 from A and 1/8 from B. Calculate new
profit sharing ratio.
2. When value of asset increases, revaluation account is credited and asset is
debited.
A. True B. False

1.8 Answer of SAQ

1) 13:7:4 2) True
1.9 Suggested Readings

Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2 nd Revised Edition,
Kalyani Publisher

1.10 Model Questions

Pass journal entries of the following:

a) A & B are partners sharing profits in the ratio of 3:2. C is admitted

paying of Rs. 2000 for 1/4th share of the profits; shares of A & B
remaining as before. No goodwill account appears in the books.
b) A &B are partners sharing profits in the ratio of 3:2. Goodwill appears
in the books at Rs. 3000. C is admitted into partnership on payment of
 Rs. 2000 as premium for goodwill for 1/4th share. A & B between
themselves sharing future profits and losses equally.
c) A, B & C are partners sharing profits in the ratio of 3:1:1. The goodwill
does not appear in the books but it is worth Rs. 3000. The partners will
share profits in future equally.

Unit 1: Dissolution of Partnership and Insolvency of Partners

Structure
1.0 Objectives
1.1Introduction
1.2Dissolution of Partnership
1.2.1 Modes of Dissolution of Firm

1.2.2 Entries on Dissolution

1.3Insolvency of Partners
1.5 Let’s Sum Up
1.9 Key Words
1.10 SAQs
1.9Hints/ Answers of SAQs
1.11 Suggested Readings
1.9 Model Question

1.0 Objectives
In this unit we will be able to:
➢ Understand the dissolution partnership and its accounting treatment.
➢ Understand the insolvency of partners and its accounting treatment.

1.1Introduction
In the previous unit, we have learned about accounting treatment in case of
admission, retirement and death of partners. In this unit, concepts on dissolution
of partnership and insolvency of partners have been discussed.

1.2 Dissolution of Partnership

The Indian Partnership Act, 1932 recognizes the difference between the
‘dissolution of partnership and dissolution of partnership firm’. The
definitions of the two terms are as follows:
Under section 39 of the Indian Partnership Act, 1932, “The dissolution of
partnership between all the partners of a firm is called the dissolution of the
firm.” Thus the dissolution of a firm is the complete breakdown of a
partnership and partners do not continue the firm. On the other hand,
dissolution of the partnership means a reconstitution of the firm due to the
retirement of a partner or the insolvency of a partner or the death of a partner
and the remaining partners provide for the continuation of the firm in
pursuance of an express or implied agreement to that effect. On dissolution
of a firm, the firm’s assets are realized and liabilities are discharged because
the firm is to be closed, whereas on dissolution of a partnership, the share of
the outgoing partner is ascertained and the firm is not closed.

1.3.1 Modes of Dissolution of Firm

Section 40 to 44 of the Indian Partnership Act, 1932 deal with the various
ways in which a firm may be dissolved. A firm may be dissolved in any of
the following ways:
Dissolution by agreement: A firm is dissolved when all the partners agree that
it should be dissolved. A partnership firm is the creation of an agreement of
an understanding; similarly a firm can be dissolved by an agreement.
Dissolution on the happening of contingency: A firm is dissolved in any of
the following ways unless there is a contract between the partners to the
contract-
a) By the expiry of the term or duration of the firm
b) On the completion of the adventure for which the firm was constituted.
c) On the death of a partner
d) By adjudicating a partner as insolvent.

Dissolution by notice of partnership at will: When the partnership is at will,

the firm may be dissolved at any time by any partner giving notice in writing
to all the other partners of his intention to dissolve the firm.
 Compulsory dissolution or dissolution by the operation of law: A firm is
compulsorily dissolved in any of the following situations:

a) When all the partners except one become insolvent

b) When all the partners become insolvent
c) When the business becomes illegal
d) Where the number of partners exceed twenty in case of ordinary business
or ten in case of banking business.

Dissolution by the court: at the suit of a partner, a court may order dissolution
of a firm in any of the following ways:

a) When a partner becomes of unsound mind

b) When a partner suffers from permanent incapacity and becomes incapable
of performing his duties as a partner.
c) When a partner is guilty of misconduct affecting the business of the firm
d) When the business of the firm cannot be carried on except at a loss.

1.2.2 Entries on Dissolution

A firm is totally closed down on its dissolution, so books of accounts should also
be closed. The following journal entries are to be passed on dissolution of firm:

1. For closing assets accounts

Realization A/c - Dr
To Assets A/c (Individually)
(Being transfer of assets at book value to the realization account)

2. For closing the provision of assets

Provision for Doubtful Debts A/c - Dr
Provision for Discount A/c - Dr
Provision for Depreciation A/c - Dr
Joint Life Policy Reserve A/c - Dr
Contingency Reserve A/c -Dr
Investment Fluctuation Fund/Reserve A/c -Dr
To Realization A/c
(Being transfer of various provisions to the realization account)
 3. For closing debit balance of profit and loss account representing
accumulated losses:
Partners’ Current Accounts (if capitals are fixed) - Dr
Or, Partners’ Capital Accounts (if capitals are fluctuating) –Dr
To Profit & Loss Account
(Being transfer of accumulated losses)

4. For closing liabilities accounts:

Sundry Creditors A/c -Dr
Bills Payable A/c - Dr
Loan A/c - Dr
Bank Overdraft A/c - Dr
Outstanding Expenses A/c - Dr
To Realization A/c
(Being transfer of liabilities to third parties)

5. For closing reserve fund and credit balance of profit and loss
account:
Reserve fund A/c –Dr
P&L A/c - Dr
To Partners’ Capital A/c
(Being transfer of reserve fund and profit and loss a/c to partners’
capital accounts in their profit sharing ratio)

6. For realization assets:

Assets may either be sold for cash or may be taken over by any of
the partners or may be taken over by any creditor in full or part of
payment of the amount due to them. If assets are sold for cash, the
entry is:
Cash A/c -Dr
To Realization A/c
(Being assets are sold for cash)

If assets are taken over by any partner:

Partner’s Capital A/c -Dr
 To Realization A/c
(Being assets taken over by partners)

7. For payment of liabilities

Realization A/c – Dr
To Cash A/c
(Being payment of liabilities to third parties)

8. For expenses of realization:

Realization A/c –Dr
To Cash A/c
(Being expenses incurred in connection with the dissolution of
firm)

9. For closing realization account:

Realization A/c –Dr
To Partner’s Capital A/c
(Being profit on realization of assets and liabilities are transferred
to partners capital account)
This entry will be reverse if there is any loss on realization occurs

10.Payment of partner’s loan:

Partner’s Loan A/c – Dr
To Cash A/c
(Being the payment of partner’s loan)

11.Closing of current accounts:

If current accounts show credit balance:
Partners’ Current Accounts –Dr
To Partners’ Capital Accounts
(Being transfer of credit balances of current accounts)

If current accounts show debit balance:

Partners’ Capital Accounts –Dr

To Partners’ Current Accounts
(Being transfer of debit balances of current accounts)
 12.For closing capital accounts:
If capital account of any partner shows debit balance:
Cash A/c –Dr
Partner’s Capital A/c
(Being amount due from the partner received)

If capital account of any partner shows credit balance:

Partner’s Capital A/c –Dr
To Cash A/c
(Being amount due to the partners paid)

1.3 Insolvency of a Partner- Garner vs. Murray

If a partner’s capital account shows a debit balance on dissolution of the
firm, he is to pay the debit balance to the firm to settle the account. But if
such partner is insolvent i.e., unable to satisfy his debt to the firm, then his
deficiency which he is not able to bring will be borne by the solvent
partners in accordance with the decision in Garner vs. Murray. In this case,
it was ruled out that in the absence of any agreement to the contrary, the
deficiency of the insolvent partner’s capital account must be borne by other
solvent partners in proportion to their capital which stood before
dissolution of the firm. The effect of this ruling is to make a distinction
between an ordinary loss due to trading or realization of assets and loss on
account of insolvency of a partner.
Another ruling in Garner vs. Murray case is that the solvent partners should
bring in cash equal to their share of loss on realization.

1.3.1 Gradual Realization of Assets and Piecemeal Distribution

In case of dissolution of partnership, it is assumed that all assets are
realized immediately on the date of dissolution and accounts of all the
creditors and partners are settled on the same date. But this
assumption is unrealistic because normally the process of realizing
the assets takes a long time and cash can be distributed as and when
it is realized. In such case, when there is a gradual realization of
assets, it is necessary to avoid the unpleasant consequences of a
partner’s account being overdrawn to distribute cash against
obligations. On a gradual realization of assets, the cash realized is
 distributed in the following order to avoid any excess payment to any
partner:
1. The debts of the firm to third parties must be paid out in full prior
to any partner being paid any amount in respect of his loan and
capital; secured creditors should get preference over unsecured
creditors. But their preference is subject to the realization of asset
kept with them as security otherwise they are to be treated like
unsecured creditors. Expenses of realization are to get preference
over unsecured creditors.
2. After the creditors have been paid off, the amount due to a partner
as loan should be paid. When the loans are due to more than one
partner, the cash available should be paid proportionately.
3. After the payment of outside liabilities and loans due to partners,
the capitals of the partners are paid.

There are two methods of piecemeal distribution of cash among

partners:
1. Proportionate capital method
2. Maximum loss method
➢SOME EXPLANATION OF THESE TWO
METHODS HAVE NOT MADE BY THE
AUTHOR ALTHOUGH IT WAS
SUGGESTED EARLIER BY THE EDITOR.
➢IT IS FURTHER OBSERVED THAT THE
AUTHOR HAS IGNORED LOT MANY
THINGS IDENTIFIED BY THE EDITOR.

1.4 Let Us Sum It Up

There are various ways of dissolution like dissolution by
agreement, dissolution by court, etc. Dissolution may happen due
to retirement, death or insolvency of partners.
1.5 Keywords:
Dissolution, Insolvency
1.6 SAQs
1. Which of the following is not a way of dissolution of a firm?
a) Dissolution by agreement b) Dissolution on happening of
contingency c) Dissolution by operation of law d) Dissolution by
order
2. Realization account is a:
a) Personal account b) Real account c) Nominal account

3. On dissolution of a firm, the firm’s assets are realized and liabilities

are discharged because the firm is to be closed.
a) True b) False

1.7 Answer to SAQs

1. D 2. C 3. A

1.8 Suggested Readings

Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2 nd Revised Edition,
Kalyani Publisher

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

1.9 Model Question

1. What do you mean by dissolution of a firm? Give entries needed to
close the books of the firm upon dissolution.
2. What is Realization Account? How is it different from Revaluation
Account?

BLOCK 4- ROYALTY ACCOUNTS

Introduction
 In this block there are three units. Unit 1 concentrates on Royalty
Accounts. Unit 2 concentrates on Branch Accounts while Unit 3
concentrates on Departmental Accounts.

Unit 1: Royalty Accounts

Structure
1.0 Objectives
1.1Introduction
1.2 Basic Concepts
1.3 Difference between Rent and Royalty

1.4 Accounting Entries of Royalty accounts

1.5 Let’s Sum Up

1.6 Key Words
1.7 SAQs
1.8 Hints/ Answers of SAQs

1.9 Suggested Readings

1.10 Model Question

1.0 Objectives

In this unit we will be able to:

• Understand various aspects of royalty accounts.

• Understand the accounting treatment of royalty accounts.

1.1 Introduction
Royalty is a periodical payment made based on output or sale for the use of
certain asset or right on certain assets like mine, copyright or patent to its
owner. In lease contract, royalty is a common terminology. It is termed as
the amount paid by the lessee (user of lease asset) for using the property of
lessor (owner of lease asset). Likewise, royalty is also paid by the publisher
to the author of the book.

1.2 Basic concepts relating to royalty

There are various terminologies which royalty accounts are associated with.
We will discuss one by one in details:
a) Minimum Rent/ Dead Rent
Royalty agreements are usually associated with a clause that the lessor or
landlord must receive a minimum amount irrespective of the production
or sales made by using the lease asset during a particular period. Such
minimum amount is known as minimum rent or dead rent or fixed rent.
The fixation of such rent is in the interest of landlord because it
guarantees him the receipt of the minimum amount in case of low output
or sales. Further, it gives incentive to the lessee to increase the production
or sales in the initial period of lease agreement .
For example, M/S Kalyani Publishers printed a book on Advanced
Accountancy at a minimum rent of Rs. 20,000 p.a. royalty being payable
@ Rs. 7.50 per copy sold and the number of copies sold in the first year is
2,000 and in the second year is 4,000. In this case M/S Kalyani Publishers
will have to pay Rs. 20,000 to the authors as minimum rent even though
royalty works out to be Rs. 15,000 for 2,000 copies @ Rs. 7.50 per copy
sold. In the second year Rs. 30,000 as royalty for 4,000 copies @ Rs. 7.50
per copy sold will be paid to the authors even though the minimum rent is
Rs. 20,000.

b) Short working
The excess of minimum rent over actual royalty calculated on the basis of
output or sales is termed as short working. In the example previous
example, there was a short working of Rs. 5,000 i.e., (Rs. 20,000- Rs.
15,000). There was no short working in the second year.

c) Ground/ Surface Rent

It is the fixed yearly or half yearly rent payable by the lessee to the
landlord in addition to the minimum rent.

d) Recouping short workings

 It means the recovery of short workings of the previous years out of
surplus royalty of subsequent years. The following conditions can be
there for the recouping of short workings:
• The short workings are always recouped when there is surplus i.e.,
excess of royalty over minimum rent
• The recouping of short working is to be done within the agreed
period as given in the agreement.
• If short workings could not be recouped within the agreed period,
it will be transferred to Profit and Loss Account.

e) Nazrana or Lease Premium

In some cases, the lessee may agree to pay lump sum to the lessor in
addition to royalty. This extra payment in addition to royalty is known
as lease premium.
Royalty is a different concept from conventional rent paid to the
landlord. Some of the points related to their differences are mentioned
below:

1.3Distinction between Rent and Royalty

Basis of difference Rent Royalty

It is the consideration It is the consideration

1. Nature of payable for the use of only payable for the use of
assets tangible assets as building, special right for both
machinery, etc. tangible and
intangible assets.
2. Basis of It is mostly payable on the It is paid on the basis
payable basis of time as weekly, of production, yield or
monthly or yearly. sale.

3. Fixed or The amount of rent is The amount of royalty

variable generally fixed with regard to is variable and is
time. calculated in
accordance with
production or sales.
 There is no concept of It generally contains a
minimum rent. clause in the
4. Minimum agreement to pay
rent minimum rent.

The parties are known as Parties are known as

tenant and landlord lessee/ patent holder/
publisher/ lessor/
5. Parties author, etc.

1.4Accounting Entries in Royalty Accounts

Accounting entries in the books the lessee

When royalties are less than the minimum rent and the short workings are
recoverable in subsequent years when royalties exceed the minimum rent:

If minimum rent account is not opened:

a) Royalties Payable A/c -Dr. (with actual amount of royalties earned)

Short workings Allowable A/c - Dr (Actual Rent- Minimum Rent)
To Landlord (with the minimum rent)

b) Landlord A/c -Dr

To Bank A/c

c) Profit & Loss or Production A/c -Dr

To Royalties Payable A/c (actual amount of royalties transferred)

The debit balance of the short workings account will be carried forward
and shown as an asset in the Balance Sheet till it is recoupable.

If minimum rent account is opened in the books:

a) Minimum Rent A/c - Dr
To Landlord A/c

b) Royalties Payable A/c - Dr

Minimum Rent A/c

c) Landlord A/c - Dr
To Bank A/c

d) Profit & Loss A/c or Production A/c -Dr

To Royalties Payable A/c

The only difference between two methods is that entry a) in the first method
requires two entries a) and b) in the second method, other entries being
same.

2) When royalties exceed the minimum rent and short workings are
recouped:
a) Royalties Payable A/c - Dr
To Landlord A/c

b) Landlord A/c -Dr

To Short workings Allowable A/c

c) Profit & Loss A/c or Production A/c – Dr

Royalties A/c

Now look at the journal entries passed in the books of landlord.

Accounting Entries in the Books of Lessor/ Landlord

In the books of the lessor receiving the royalties, the treatment will be the
reverse of what we have done so far. The following entries will be recorded:
1) When the royalties received are less than the minimum rent and short
workings are recoverable out of future years, the following entries are
made:
a) Lessee’s A/c -Dr (with minimum rent)
To Royalties Recoverable A/c (with actual royalties)
To Royalties or Short workings Suspense A/c (with the difference)

b) Bank A/c - Dr (with actual amount received)

To Lessee’s A/c

c) Royalties Receivable A/c - Dr (with amount of royalties earned)

To Profit and Loss A/c

The credit balance of Royalties or Short Workings Suspense Account

will be carried forward and shown as a liability in the Balance Sheet
till it is recoupable.

2) When the royalties earned exceed the minimum rent and short workings
are recovered, the entries are as follows:
a) Lessee’s A/c -Dr (with the amount of royalties earned)
To Royalties Receivable A/c

b) Royalties A/c -Dr (with the amount of short workings recovered)

To Lessee’s A/c

c) Bank A/c -Dr (with the amount due received)

Lessee’s A/c

d) Royalties Receivable A/c –Dr

To Profit and Loss A/c

If any balance of Royalties or Short workings Suspense Account will

no longer recoverable, it should be transferred to Profit and Loss
Account. The entry will be:

Royalties/ Short workings Suspense A/c -Dr

To Profit and Loss A/c
 1.5 Lets Sum It Up

Royalty is periodical payment based on output or sale for the use of a

certain asset or right like mine, copyright or patent to its owner. It is
termed as the amount paid by the lessee (user of lease asset) for using the
property of lessor (owner of lease asset). The concepts like minimum
rent, short workings, lease premium etc. are important terms used in
royalty accounts. The accounting treatment of both lessor and lessee are
recorded.

1.6 Key words:

Royalties, Lessor, Lessee, Minimum Rent, Short workings

1.7 SAQs
1. The minimum amount paid to the landlord by the lessee is:
a) Ground rent c) short workings c) Minimum rent

2. Royalty is payable on both tangible and intangible assets.

a) True b) False

3. The additional payment in addition to royalty by the lessee is:

a) Short workings b) Lease premium c) Rent

1.8 Answers of SAQs

1. C 2. A 3. B

1.9 Suggested Readings:

Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2nd Revised
Edition, Kalyani Publisher

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11 th

Edition, Vikas Publishing House New Delhi
 1.10 Model Question
1. Explain the terms:
a) Royalty b) Minimum Rent c) Right of Recoupment d)
Ground Rent

2. Write down the accounting entries of royalty in the books of both

lessor and lessee.

UNIT 2 BRANCH ACCOUNTS

Structure
2.0 Objectives
2.1 Introduction
2.2 Need for Branch Accounting
2.3 Types of Branches
2.4 Accounting for Dependent Branches
2.5 Debtors System
2.5.1 Cost Price Method
2.5.2 Invoice Price Method
2.6 Final Accounts System
2.7 Stock and Debtors System
2.8 Let Us Sum Up
2.9 Key Words
2.10 SAQs
2.11 Answers to SAQs
2.12 Suggested Readings
2.13 Model Questions

2.0 OBJECTIVES
After studying this unit you should be able to:
• Describe the need for branch accounting
• Explain the different types of branches from accounting point of view
• Describe three systems of maintaining branch accounts for a dependent
branch
• Understand the accounting treatment applicable under all the methods of
branch accounts.
2.1 INTRODUCTION
A business may be split up into a number of divisions. The divisions are known
as departments if located under the same roof and branches if located at different
places of the same town, country or world. For example, Cottage Emporium has
various divisions like garments, furniture, gift items, jewellery, etc. They are
located in the same building and so are called departments. Snowhite has its
showrooms in Connaught Place, Nehru Place, Karol Bagh, South Extension and
Kemlanagar. These are all branches of Snowhitc. Similarly, Bata has its branches
all over the country and Leventies all over the world. Each branch is treated as a
separate profit centre and hence the profit or loss is to be worked out separately
for each branch, Moreover, the firm has to keep strict control over various
activities of each branch and ensure its smooth functioning. The accountants,
therefore, have developed some specialized accounting methods for the recording
of transactions at branch level and for incorporating the net effect of all branch
transactions in a firm's books.
From accounting point of view, the branches are divided into three categories:
(i) Dependent branches (ii) Independent branches, and (iii) foreign branches. In
this unit you will learn how the accounts of dependent branches are maintained
and how their profit or loss is worked out.

1.2 NEED FOR BRANCH ACCOUNTING

As stated earlier each branch is treated as a separate profit centre. Hence it should
record various transactions in such a manner that its profit or, loss can be worked
out and incorporated in the firm's overall results at the end of the accounting year.
Moreover, the branches conduct all activities under the direction and control of
the head office which may need a variety of information from time to time about
the functioning of each branch. This becomes possible only if the branches keep
proper books of account. Thus, the main reasons of keeping branch accounts can
be summarized as follows:

i) To find out the profit or loss of each branch for the accounting period

ii) To ascertain the financial position of each branch at the end of the accounting
year

iii) To incorporate the net effect of branch transactions and their assets and
liabilities in a firm's final accounts

iv) To estimate requirements of cash and stock for each branch

v) To evaluate the progress and performance of each branch

vi) To calculate the commission for payment to the managers, if based on profit
of branch

vii) To assess the prospects for expansion of business in each branch

viii) To meet audit requirements.

1.3 TYPES OF BRANCHES

From accounting point of view the branches can be divided into the following
Categories:

1) Branches not keeping full system of accounting;

2) Branches keeping full system of accounting;
3) Foreign branches,

Let us have an idea about their main characteristics.

Branches not Keeping Full System of Accounting: The branches not keeping full
system of accounting are also called dependent branches. The main features of
such branches are:
i) They sell only those goods which are received from the head office and are not
usually allowed to make purchases in the open market except with the permission
of the head office.

ii) Goods are supplied by the head office to such branches either at cost price or
at invoice price.

iii) All major expenses of the branch are paid by the head office. The branch
manager is allowed to incur only petty expenses like cartage, postage, etc. out
of the petty cash provided to him for which he is required to maintain a simple
petty cash book.

iv) The amount received from cash sales and debtors is either remitted to the head
office daily or deposited in the- account of head office in some local bank

v) The branch manager is normally expected to sell the goods for cash, but he
may be authorized to sell goods on credit in certain cases.

vi) Such branches do not keep complete account books. They simply maintain
reward of sales and prepare debtors accounts, if necessary. They are also required
to maintain a stock register and furnish weekly or monthly statements giving
complete information about stock position and movement of goods to the head
office. This enables the head office to keep proper control over stock at branches.
Branches Keeping Full System of Accounting:
Branches keeping full system of accounting are called independent branches.
They are allowed to purchase goods from the market and also supply to the head
office, if necessary. They can incur expenses from the cash realized and operate
the bank account in their own names. Thus, they operate as independent units for
all practical; their only link with the head office is that they are worried by the
head office and whatever profit they earn or loss they incur ultimately belongs to
the head office. Such branches keep a complete set of books on the double entry
system and prepare their own Trial Balance, Trading and Profit & Loss Account
and Balance Sheet. Such branches open Head Office Account in their books and
record all transactions between the branch and the head office in this account.
Foreign Branches: When a branch is located in a foreign country, it is called
foreign branch. Such branches will keep their books of account in foreign
currency. The distinctive feature of foreign branches is that financial information
received from them will be in foreign currency which has to be converted into the
currency of the country of the head office before it can be incorporated in the
head office books. For example, if an Indian company has a branch in Nairobi,
the branch Trial Balance will be in Kenyan shillings. The Trial Balance must be
converted into rupees before it can be incorporated in head office books. For all
practical purposes, however, foreign branches are treated as independent
branches.

1.4 ACCOUNTING FOR DEPENDENT BRANCHES

You know that the dependent branches do not keep a complete set of books.
Most of their transactions are recorded at the head office level. The accounting
system adopted by head office for a branch depends up on the size of a branch
and the degree of control to be exercised by the head office. The following are
the various methods by which the head office usually keeps branch accounts in
its books:

a) Debtors System: This system is adopted generally for those branches

which are fairly small in size. Under this system, the head office
simply opens a Branch Account for each branch in which it records all
transactions relating to the branch. The Branch Account is prepared in
such a manner that it also helps in ascertaining the branch profit or
loss.
b) Final Account System: Under this system, the head office prepares a
Trading and Profit and Loss Account in order to find out profit or loss
of each branch and a Branch Account to find out the amount due to, or
due from, that branch, In this case the Branch Account simply acts as
a personal account.
iii) Stock and Debtors System: Under this system, the head office does not
open any Branch Account. For each branch, it prepares a Branch Stock
Account, a Branch Expenses Account, a Branch Adjustment Account and
Goods sent to Branch Account in order to find out the profit or loss of each
branch. As stated earlier, under debtors system, the head office simply opens a
Branch Account for each branch in which it records all transactions relating to
the branch. The Branch Account also helps in ascertaining the profit or loss of
the branch. Goods may be invoiced to a branch at cost or at selling price (also
called invoice price).
Accordingly, there are two methods of preparing the Branch Account:
a) Cost Price Method and (b) Invoice Price Method. Let us now study the
preparation of Branch Account under both of these methods.

1.5.1 Cost Price Method

When goods are invoiced at cost, the following journal entries are passed in the
books of the head office to record various transactions relating to the branch.
1) For goods sent to branch
Branch A/c Dr.
To Goods Sent to Branch A/c
(Being goods sent to branch)

2) For return of goods to head office

Goods Sent to Branch A/c -Dr
To Branch A/c
(Being goods returned by the branch)

3) For amount sent to branch for expenses

Branch A/c - Dr.
To Bank A/c
(Being cheque sent to branch for expenses)

4) For amount received from branch

Bank A/c - Dr.

To Branch A/c
(Being cash or cheque received from branch)

5) For closing goods sent to branch account

Goods Sent to Branch A/c -Dr.
To Purchase/ Trading A/c
(Being balance transferred to Trading Account)

6) For closing balances of assets at the branch:

Branch Assets A/c -Dr. (Individually)
To Branch A/c
(Being closing balances of assets brought into account)

7) For closing balances of liabilities at the branch:

Branch A/c -Dr

To Branch Liabilities A/c (Individually)
(Being closing balances of liabilities
brought into account)

8) For transferring profit or loss to the General Profit and Loss Account
i) If profit:
Branch A/c - Dr.
To General Profit and Loss A/c
(Being branch profit transferred to
General P & L A/c)

ii) If loss

General Profit and Loss A/c - Dr

To Branch A/c
(Being branch loss transferred to
General P & L A/c)

The closing balances of branch assets and liabilities are shown in the Balance
Sheet of the head office. At the beginning of the next year, the entire numbers 6
and 7 are reversed so as to show opening balances in the Branch Account.

Let us now have some illustration to understand this method further.

Illustration 1
From the following particulars relating to Delhi Branch for the year ending
December 31, 2000 prepare Branch Account in the books of head office.
Rs.
Stock at Branch on 1-1-2000 15,000

Debtors at Branch on 1-1-2000 30,000

Petty Cash at Branch 1-1-200 300

Goods sent to Branch 2, 52, 000

Cash sales 60,000

Received from Debtors 2, 10,000

Credit Sales 2, 28,000

Cheque sent to Branch for:

Salaries 9,000

Rent and Taxes 1,500

Petty Cash 1,100

Goods returned by the branch 2,000

Stock at Branch on 31-12-2000 25,000

Petty cash at Branch on 31-12-2000 200

Debtors at Branch on 31-12-2000 48,000

Solution

Head Office Ledger

Delhi Branch Account

Dr. Cr.
 Rs. Rs.

To Balance b/d By Cash

Branch stock 15,000 Cash Sales 60,000
Branch debtors 30,000 Received from debtors 2,10,000
Branch petty cash 300
By Goods sent to Branch A/c 2,000
To Goods sent to Branch 2,52,000
A/c By Balance c/d
Brach stock 25,000
To Bank A/c Branch Debtors 48,000
Salaries 9,000 Branch Petty Cash 200
Rent and Taxes 1,500 11,600
Petty Cash 1,100

36,300
To Profit (transferred to
General P/L A/c) 3,45,200 3,45,200

1.5.2 Invoice Price Method

As in the case of consignment the goods may be invoiced to branches at a price
higher than the cost (termed as invoice price). This is done primarily to have in
effective control over stock with branches and keep the margin of profit secret
from the branch manager. In such a situation, all entries relating to goods are
made in the Branch Account at invoice price and necessary adjustments for
loading (difference between Invoice Price. and Cost Price) are recorded at the
end by passing the following additional journal entries:

1) For adjustment of loading in opening stock at branch

Stock Reserve A/c Dr.

To Branch A/c

2) For adjustment of loading in goods sent to branch less returns

Branch A/C Dr.

To Goods Sent to Branch A/c

3) For adjustment of loading in closing stock at branch

Branch A/c Dr.

To Stock Reserve A/c

Let us solve a sum to understand this method better and see how Branch Account
is prepared when goods are invoiced at a price higher than cost.

Illustration 2:

The Vaikuntha Gas Co., Varanasi has a sales branch at Ghaziabad and invoiced
goods to the branch at cost price plus 33.33%. It is arranged that all cash received
by the branch is to be paid daily to the Head Office Account with the Banaras
State Bank Ltd. and the necessary advice sent to the Head Office. From the
following particulars, prepare Branch Account and Goods sent to Branch Account
in the Head Office ledger showing the actual profit or loss of the branch for the
year ending - December 31, 2000.

Rs.
Stock on 1-1-2000 12,000
(At invoice price)
Goods sent to Branch 96,000
(At invoice price)
Debtors on 1-1- 2000 1,500
Cash sent to Head Office 77,100
Sales 77,100
Rent, Rates and Taxes 3,200
Salaries 4,800
Debtors on 31-12-2000 1,600
Goods returned to Head Office 16,000
(At invoice price)
Shortage of stock 200
(At invoice price)

Solution
Ghaziabad Branch Account
Dr. Cr
Rs Rs
To Balance b/d By Cash Received 77,100
Branch Stock 12,000
Branch Debtors 1,500 By Goods returned by 16,000
Branch A/c
To Goods sent to Branch 96,000
A/c By Stock Reserve A/c 3,000
To Bank A/c (Loading in opening
Rent, Rates and Taxes 3,200 stock) 20,000
Salaries and Wages 4,800 By Goods sent to Branch
A/c (Loading in goods
To Stock Reserve A/c 3,700 sent less returns)
(Loading in closing.
Stock) By Balance c/d 14,800
11,300 Branch Stock 1,600
To Profit (transferred to Branch Debtors
General P & L A/c) 1,32,500 1,32,500

Goods Sent to Branch Account

Dr. Cr
Rs Rs
To Ghaziabad Branch A/c 1,600 By Ghaziabad Branch
A/c 96,000
To Ghaziabad Branch A/c 20,000
(Loading on Rs. 80,000)
To Trading A/c 60,000
(Transfer)
96,000 96,000

Notes:
► Branch stock at the end has not given. It can be worked out by preparing
Memorandum Branch Stock Account as follows:
► Loading is 25% of invoice price

Memorandum Branch Stock Account

Dr. Cr
Rs Rs
To Balance b/d 12,000 By Goods returned to Head 16,000
To Goods received from Office
Head Office 96,000 By Sales 77,000
To Goods returned by By Shortage of Stock 200
Customers - By Balance c/d 14,800

1,08,000 1,08,000
►It should be noted that all figures in Memorandum Branch Stock Account
have been recorded at the invoice price.

1.6 FINAL ACCOUNTS SYSTEM

The profit or loss of a dependent branch can also be worked out by preparing a
Memorandum Branch Trading and Profit & Loss Account. This account is
prepared on the basis of cost of goods sent to the branch (not the invoice price).
Apart from the Branch Trading and Profit & Loss Account, the Head Office
also maintains the Branch Account. But, under this system, the Branch Account
is in the nature of a personal account which shows only the mutual transactions
between the head office and the branch, the balance of Branch Account,
therefore, represents the net assets of the branch.

1.7 STOCK AND DEBTORS SYSTEM

Under Stock and Debtors System, the head office does not open a Branch
Account in its books. It maintains a few control accounts for recording the
various branch transactions. These accounts usually are: (i) Branch Stock
Account, (ii) Branch Debtors Account, (iii) Branch Expenses Account, (iv)
Branch Cash Account, (v) Goods sent to Branch Account, and (vi) Branch
Fixed Assets Account. At the end of the accounting year, it prepares the Branch
Adjustment Account and the Branch Profit & toss Account. This system is used
only when goods are invoiced at selling price which the branch is not allowed to
vary.
Let us now study the working of each account opened by the head office when
such a system is followed:

Branch Stock Account: This is the most important account which helps the
head office in controlling the branch stock. It shows all branch transactions
relating to goods. The goods sent to branches and the sales returns are shown on
its debit side, and the sales (both cash and credit) and the goods returned to head
office on the credit side. All these items are recorded at the invoice price.
Hence, if the figure of any of these items is given at cost, the same should be
converted into invoice price before recording it in the Branch Stock Account.
The balance of this account would show the unsold goods (stock) lying with the
branch. If it is found that the actual stock with the branch is less than the
balance shown by the Branch Stock Account, it means that there is a 'shortage'
in the stock with the branch. Similarly, if the actual stock with the branch is
more than the balance shown by the Branch Stock Account, it would reflect
'surplus'. Both situations warrant investigation. But, so far as their recording
goes, the shortage will be shown on the credit side of the Branch Stock Account
and if there is surplus, the same will be recorded on its debit side. Then, the
balance of the Branch Stock Account will be the exact amount of actual stock
with the branch. In other words, while preparing the Branch Stock Account, you
will show the actual stock with branch as the balance in this account, and then if
the totals of both sides do not tally, you will show the difference as shortage or
surplus as the case may be.

Branch Debtors Account: This account shows all transactions relating to

branch debtors. The credit sales are shown on its debit side, and cash received
from debtors, sales returns, bad debts, discount allowed, etc. on the credit side.
The balance of this account represents the closing debtors of the branch.

Branch Expenses Account: This account shows all expenses incurred by the
branch. In addition, the items like bad debts, discount allowed, and depreciation
on branch fixed assets, etc. are also debited to this account. This account is
closed by transfer to the Branch Adjustment Account.

Branch Cash Account: This account shows all cash transactions of the branch
where the branch is not required to remit all collection of cash immediately to
the head office but use it for branch expenses and remit the balance to the head
office from time to time. This account helps the head office to keep control over
branch cash. Normally, the dependent branch is not allowed the freedom to
retain cash collections. Hence, this account need not be maintained.

Branch Fixed Assets Account: The head office maintains separate account for
each type of branch asset such as furniture, equipment, building, etc. These
accounts are prepared in the usual manner. The depreciation on branch fixed
assets is, however, debited to Branch Expenses Account and credited to the
respective account.

Goods Sent to Branch Account: This account is prepared in the same manner
as in case of branches to which the goods are sent at the invoice price (Sub-
section 1.5.2).Branch Adjustment Account: This account is like a Trading
Account of the branch. It is prepared to ascertain the gross profit or gross loss
made at the branch by recording the loading (difference between invoice price
and cost price) on various items. The loading on branch closing stock and
shortage is shown on its debit side while-the loading on branch opening stock,
goods sent to branch (less returns) and surplus on the credit side. The balance of
this account reflects the gross profit or gross loss which is transferred to Branch
Profit & Loss Account.

Branch Profit and Loss Account: This account is prepared to ascertain the net
profit or net loss made at the branch. As stated earlier, the gross profit or gross
loss ascertained by the Branch Adjustment Account is transferred to this
account. It is debited with branch expenses as per the Branch Expenses Account
and the loss on account of shortage being the cost of such shortage. In case the
Branch Stock Account reveals some surplus, the amount equal to the cost of
such surplus will be shown on the credit side of the Branch Profit & Loss
Account. The balance of the Branch Profit& Loss Account represents the net
profit or net loss made at the branch which is transferred to the General Profit &
Loss Account.
Now let us discuss the journal entries that are passed in the head office books
for opening the above accounts relating to the various branch transactions:

1) When goods are sent to the branch (at invoice price):

Branch Stock A/c -Dr.

Goods Sent to Branch A/c

2) When goods are returned by the branch to the H.O. (at invoice price):

Goods Sent to Branch A/c -Dr.

To Branch Stock A/c

3) When sales are made by the branches:

i) For Cash Sales

Cash A/c - Dr.

To Branch Stock A/c

ii) For Credit Sales

Branch Debtors A/c -Dr.

To Branch Stock A/c

4) When cash is received from debtors

Cash A/c -Dr.

To Branch Debtors A/c

5) For sales returns

Branch Stock A/c -Dr.

To Branch Debtors A/c

6) For discount allowed and bad debts, etc.

Branch Expenses A/c -Dr.
To Branch Debtors A/c
7) For shortage of stock

Branch Adjustment A/c -Dr.

(with amount of loading)
Branch Profit & Loss A/c -Dr.
(with cost of shortage)
To Branch Stock A/c
*For surplus at branch, the reverse entry will be passed.

8) For Branch expenses paid in Cash

Branch Expenses A/c -Dr.
To Cash A/c

9) For closing branch expenses account

Branch Profit & Loss A/c Dr.
To Branch Expenses A/c

10) For adjustment of loading on the opening stock

Stock Reserve A/c Dr.

To Branch Adjustment A/c

11) For adjustment of loading on the closing stock

Branch Adjustment A/c Dr.

To Stock Reserve A/c ,

12) For adjustment of loading of net goods sent to branch

Goods Sent to Branch Alc Dr.
To Branch Adjustment Alc

13) For transfer of gross profit

Branch Adjustment A/ c -Dr.
To Branch Profit & Loss A/ c

14) For transfer of net profit to General Profit & Loss Account

Branch Adjustment A/c Dr.

To General Profit & Loss A/c

*The entry will be reversed if there is net loss.

15) For closing the Goods Sent to Branch Account.
Goods Sent to Branch A/c Dr.
To Trading A/c

1.8 Let Us Sum It Up

From accounting viewpoint, each branch is recorded as a separate profit

centre. Hence, accounting for branch transactions are designed in such a
way that profit or loss made at each branch can be correctly worked out
and proper control can be exercised over their financial activities. For this
purpose, branches are divided into three categories: a) branches not
keeping full system of accounting (dependent branches); b) branches
keeping full system of accounting (independent branches); c) foreign
branches.

Where branches do not keep full system of accounting, the head office has
to maintain proper record of branch transactions. Three methods can be
followed for this viz, a) Debtors system b) Final account system c) Stock
and debtor system.

Debtor system is adopted for small branches which rarely act as sales
depots. Under the final account system of branch accounts, the head office
prepares a Memorandum Profit and Loss Account for each branch from
the data provided by the branch and ascertains its profit and loss for an
accounting year. Stock and debtors system are followed where goods are
invoiced at selling price.

2.9 Keywords
Branch account, branch adjustment account, debtors system, final
account system and stock & debtors system.

2.10 SAQs
Fill in the blanks
1. The closing balance of Branch Account under the final
account system represents ___________ at the branch.
2. Branch Expenses Account under the stock and debtors system
is closed by transfer to___________ Account.
 3. The branch expenses paid by head office are ___________ to
the Branch Account.
4. The balance in Goods Sent to Branch Account is transferred
to ____________ Account.

2.11 Answers to SAQ

1. Net assets 2. Brach Adjustment 3.Debited 4. Trading

2.12 Suggested Readings

Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2 nd Revised Edition,
Kalyani Publisher

Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition,

Vikas Publishing House New Delhi

2.13 Model Questions

1. Explain how Branch Stock Account helps in keeping
dependent branch describe how profit is ascertained under
each system?
2. What are the objectives of keeping branch accounts?
3. Write a note on:
a) Stock system b) Final account system c) stock and debtor
system.
4. What do you understand by the term ‘Branch Adjustment
Account’? Explain clearly.
5. The Prajapati Traders, Lucknow has a sales branch at Agra
and invoiced goods to the branch at cost price plus 33.33%. It
is arranged that all cash received by the branch is to be paid
daily to the Head Office Account with the Lucknow State
Bank Ltd. and the necessary advice sent to the Head Office.
From the following particulars, prepare Branch Account and
Goods sent to Branch Account in the Head Office ledger
showing the actual profit or loss of the branch for the year
ending - December 31, 2002.
Rs.
 Stock on 1-1-2002 14,000
(At invoice price)
Goods sent to Branch 98,000
(At invoice price)
Debtors on 1-1- 2002 1,700
Cash sent to Head Office 81,300
Sales 81,300
Rent, Rates and Taxes 4,200
Salaries 4,900
Debtors on 31-12-2002 1,750
Goods returned to Head Office 16,800
(At invoice price)
Shortage of stock 600
(At invoice price)

6. From the following particulars relating to Kolkata Branch for

the year ending December 31, 2010 prepare Branch Account
in the books of head office.

Rs.
Stock at Branch on 1-1-2010 19,000

Debtors at Branch on 1-1-2010 39,000

Petty Cash at Branch 1-1-2010 900

Goods sent to Branch 2, 72, 200

Cash sales 90,000

Received from Debtors 2, 60,300

Credit Sales 2, 57,200

Cheque sent to Branch for:

Salaries 13,000

Rent and Taxes 5,500

Petty Cash 4,200

Goods returned by the branch 4,200

Stock at Branch on 31-12-2000 27,700

Petty cash at Branch on 31-12-2000 800

Debtors at Branch on 31-12-2000 56,500

UNIT 2 DEPARTMENTAL ACCOUNTS
Structure
3.0 Objectives
3.1 Introduction
3.2 Need for Departmental Accounts
3.3 Advantages of Departmental Accounts
3.4 Methods of Departmental Accounts
3.5 Let Us Sum Up
3.6 Key Words
3.7 SAQs
3.8 Answers to SAQs
3.9 Suggested Readings
3.10 Model Questions

3.0 OBJECTIVES
After studying this unit you should be able to:
• Describe the need for branch accounting.
• Explain the different methods of departmental accounts.
• Understand the differences between departmental accounts and branch
accounts.

a. INTRODUCTION
When a business sells different types of goods or carries on several
activities under one room, it is generally split up into a number of
departments. This is generally done for smooth and efficient
running of the business. A department is generally a physical part
of the rest of the business. When a business is divided into several
departments, internal information about operating results of each
department is required. This enables the management to take
decisions relating to pricing, enclosures, etc. after taking into
consideration of the different rates of growth, profitability and
degree of risk of different departments.

b. NEEDS FOR DEPARTMENTAL ACCOUNTS

When all the divisions of a business are located under one roof and
it is desired to ascertain the profit or loss of each department or class
 of goods separately, then departmental accounts are prepared. The
main objectives of preparing such accounts are:
a) To have comparison of the results of a particular department
with previous year and also with other departments of the same
organization.
b) To help the owner in formulating policy to expand the business
on proper lines so as to optimize the profits of the concern.
c) To allow departmental managers’ commission on the basis of
profits of their departments.
d) To generate information which may be helpful for planning,
control, evaluation of performance of each department and for
taking various managerial decisions.

c. ADVANTAGES OF DEPARTMENTAL ACCOUNTS

The major advantages of departmental accounts are:
a) The trading results of each department may help to evaluate the
performance of each department. The sales of that department
which gives maximum profit may be pushed up by special
efforts.
b) The profitability of each department may help the management
for taking decision whether to drop a department or add a new
one.
c) The growth potentials of a department can be evaluated by
having comparison with other departments.
d) The users of accounting information can be provided more
detailed information like shareholders, investors, creditors, etc.
e) It helps the management to determine the justification of proper
use of capital invested in each department.
f) The information provided by departmental accounts may be
helpful to the management for future reference and control.

d. METHODS OF DEPARTMENTAL ACCOUNTS

There are two methods of keeping Departmental Accounts:
a) Separate Set of Books for each department
b) Accounting in Columnar Books form
Separate Set of Books for each Department
Under this method of accounting, each department is treated as a separate unit
and separate set of books are maintained for each unit. Financial results of each
unit are combined at the end of accounting year to know the overall result of the
store.
Due to high cost, this method of accounting is followed only by very big business
houses or where to do so is compulsory as per the law. Insurance business is one
of the best examples, where to follow this system is compulsory.
Accounting in Columnar Books Form
Small trading unit generally uses this system of accounting, where accounts of
all departments are maintained together by central accounts department in the
columnar books form. Under this method, sale, purchase, stock, expenses, etc.
are maintained in a columnar form.
It is necessary that to prepare a departmental Trading and Profit and Loss
Account, preparation of subsidiary books of accounts having different columns
for the different department is required. Purchase Book, Purchase Return Book,
Sale Book, Sales return books etc. are the examples of the subsidiary books.
Specimen of a Sale Book is given below −
Sales Book

Dat Particula L.F Departme Departme Departme Departme

e rs . nt A nt B nt C nt D

A Trading account in columnar form is prepared to know the department wise

gross profit of the concern.
Function wise classification may also be done in a business unit like Production
department, Finance department, Purchase department, Sale department, etc.
Allocation of Department Expenses
• Some expenses, which are specially incurred for a particular department,
may be charged directly to the respective department. For example, hiring
charges of the transport for delivery of goods to customer may be charged
to the selling and distribution department.
• Some of the expenses may be allocated according to their uses. For
example, electricity expenses may be divided according to the sub meter
of each department.
Following are the examples of some expenses, which are not directly related to
any particular department may be divide as −
• Cartage Freight Inward Account: Above mentioned expenses may be
divided according to purchase of each department.
 • Depreciation: Depreciation may be divided according to the value of
assets employed in each department.
• Repairs and Renewal Charges: Repair and renewal of the assets may be
divided according to the value of the assets used by each department.
• Managerial Salary: Managerial salary should be divided according to the
time spent by the manager in each department.
• Building Repair, Rents & Taxes, Building Insurance, etc.: All the
expenses related to the building should be divided according to the floor
space occupied by each department.
• Selling and Distribution Expenses: All the expenses relating to selling
and distribution expenses should be divided according to the sales of each
department, such as freight outward, travelling expenses of sales
personals, salary and commission paid to salesmen, after sales services
expenses, discount and bad debts, etc.
• Insurance of Plant & Machinery: The value of such Plant & Machinery
in each department is the basis of the insurance.
• Employee/worker Insurance: Charges of a group insurance should be
divided according to the direct wage expenses of each department.
• Power & Fuel: Power & fuel will be allocated according to the working
hours and power of the machine (i.e. Hours worked x Horse power).
Inter-Department Transfer
An inter-department analysis sheet is prepared at a regular interval such as
weekly or monthly basis to record all the inter-departmental transfers of goods
and services. It is necessary, as each department is working as a separate profit
center. Transfer of the prices of such transactions can be cost base, market price,
or duel basis.
Following Journal entry will pass at the end of that period (weekly or monthly)
−
Journal Entry

Receiving Department A/c Dr

To Supplying Department A/c
Inter-Department Transfer Price
There are three types of transfer prices −
• Cost based transfer price: Where the transfer price is based on standard,
actual, or total cost, or marginal cost is called cost based transfer price.
 • Market based transfer price: Where the goods are transferred at selling
price from one department to another is known as market based price.
Therefore, unrealized profit on the goods sold is debited from the selling
department in the form of a stock reserve for both the opening and the
closing stock.
• Dual pricing system: Under this system, the goods are transferred on the
selling price by the transferor department and booked at the cost price by
the transferee department.

Let us do a practical to understand the treatment of departmental accounts.

Illustration 1
Prepare a Departmental Trading and Profit and Loss Account & General Profit
and Loss Account for the year ended 31-12-2014 of M/s Andhra & Company
where department A sells goods to department B on Normal selling price.

Particulars Dept. A Dept. B

Opening stock 175,000 -

Purchases 4,025,000 350,000

Inter Transfer of Goods - 1,225,000

Wages 175,000 280,000

Electricity Expenses 17,500 245,000

Closing Stock (at cost) 875,000 315,000

Sales 4,025,000 2,625,000

Office Expenses 35,000 28,000

Combined Expenses for both Department

Salaries (2:1 Ratio) 472,500

Printing and Stationery Expenses (3:1 Ratio) 157,500

Advertisement Expenses ( Sale Ratio) 1,400,000

Depreciation (1:3 Ratio) 21,000

Solution to Illustration 3.1

M/s Andhra & Company
Departmental Trading and Profit and Loss Account
For the year ended 31-12-2014

Particulars Dept. A Dept. B Particular Dept. A Dept. B

s

To Opening 175,000 -- By Sales 4,025,00 2,625,00

Stock 0 0
4,025,00 350,000 By
To Purchases 0 Transfer 1,225,00 -
1,225,00
to B 0
To Transfer 0 315,000
from A By 875,000
280,000
175,000 Closing
To Wages
1,085,00 Stock
1,750,00
To Gross 0
0
Profit c/d

Total 6,125,000 2,940,000 Total 6,125,000 2,940,000

To Electricity 17,500 245,000 By Gross 1,750,00 1,085,00

Expenses Profit b/d 0 0
35,000 28,000
To Office
315,000 157,500
Expenses
To Salaries 118,125 39,375
(2:1 ratio)
To Printing &
847,368 552,632
Stationery
(3:1 Ratio)
To
5,250 15,750
Advertisemen
t Exp. 411,757 46,743
( Sales Ratio
40.25 :26.25)
To
Depreciation
(1:3 Ratio)
To Net Profit

Total 1,750,000 1,085,000 Total 1,750,000 1,085,000

General Profit and Loss Account
For the year ended 31-12-2014

Particulars Dept. A Particulars Dept. B

To Stock reserve 81,667 By Departmental Net

(Dept. B) Profit b/d
To Net Profit c/d Dept. A Rs. 411,757
376,833
Dept. B Rs. 46,743
4,58,500

4,58,500
4,585,00

Things to be learnt:
➢ All the items taken are considered from departmental aspects.
➢ Profits are calculated on departmental basis.
 e. Let Us Sum Up
When all the divisions of a business are located under one roof and
it is desired to ascertain the profit or loss of each department or class
of goods separately, then departmental accounts are prepared. There
are two methods of keeping Departmental Accounts:
c) Separate Set of Books for each department
d) Accounting in Columnar Books form

3.6 Key Words: Departmental accounts, Inter-Department Transfer, Cost based

transfer price, Market based transfer price, Columnar subsidiary books.

a. SAQs
Fill in the blank
1. There are two methods of keeping Departmental Accounts namely Separate
Set of Books for each department and ______________________________.
2. Where the transfer price is based on standard, actual, or total cost, or marginal
cost is called ___________________________________.
3. Under ______________________ system, the goods are transferred on the
selling price by the transferor department and booked at the cost price by the
transferee department.

f. Answers to SAQs
1. Accounting in Columnar Books form 2. Cost based transfer price
3. Dual pricing

b. Suggested Readings
Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2nd Revised
Edition, Kalyani Publisher
Maheswari S. N., Sharad (2013) “An Introduction to Accountancy” 11th
Edition, Vikas Publishing House New Delhi

c. Model Questions
1. What is Departmental Accounts? Describe their need and
advantages.
2. Explain the basis of allocation of expenses over various
departments of a departmental organization.
BLOCK- 5: INTRODUCTION TO GOVERNMENTACCOUNTING

Introduction

In this block there are two units. Unit 1 concentrates on government accounting-
basic understanding whereas Unit 2 concentrates on system of financial
administration in India.

Unit 1 Government Accounting- Basic Understanding

Structure
1.0Objectives
1.1 Introduction
1.2 Accounting for Government Grants
1.3 Difference between Government Accounting and Commercial
Accounting
1.4 General Principles of Government Accounting
1.5 Classification of Government Accounts
1.6 Form of Government Accounts
1.7 Let Us Sum Up
1.8 Key Words
1.9 SAQs
1. 10 Answers to SAQs
1.11 Suggested Readings
1.12 Model Question

1.0Objectives
After going through the unit, you will be able to:
• Evaluate accounting for government grants
• Distinguish between government accounting and commercial accounting
• Interpret general principles of government accounting
• Classify government accounts
• Analyze different forms of government accounts
1.1 Introduction
Government accounting refers to all the financial documents and records of
public institutions that relate to the collection of taxpayers’ money and the
analysis, control of expenditure, administration of trust funds, management
of government stores and all the financial responsibilities and duties of the
relevant organs.
Government accounting system is the way of accountability through which
the established institutions of the public render stewardship on the revenue
of the nation and how it has been disbursed.
Government accounting incorporates the process of recording, analyzing,
classifying, summarizing, communicating and interpreting financial
information about government in aggregate and in details recording all
transactions involving the receipt, transfer and disposition of public funds
and property.
In this unit we will study about government accounting with regards to
government grants, classification of government accounts and interpret the
general principles of government accounting.
1.2 Accounting for Government Grants
Government accounting is an important concept as it gives us the idea about
how much of tax and non tax revenue has been generated by government
and also highlights the areas in which disbursement of public money has
been taken place.
Objectives of Government Accounting
The various objectives of government accounting can be summarized as
follows:
1. Providing information about revenue: Government accounting aims to
provide information about the revenues of the government during the
year. The government revenues can be classified into two categories: a)
tax revenue and b) non tax revenue
2. Providing information about expenditure: Government accounting
aims to provide information about the expenditure on different items.
This is necessary because Parliament or State Legislature, as the case
may be, would like to know whether the amounts spent the government
on different activities are within the limits sanctioned by it or not.
3. Providing information about loans and deposits: Government
accounting provides information about loans and deposits which the
government has to pay to its creditors and also debts due by others to the
government.
4. Information about cash availability: Government accounting provides
information on availability of cash in present situation.

1.3 Difference between Government Accounting and Commercial

Accounting
The differences between the two can be summarized as follows:
1) System of accounting: The accounts of a commercial concern are usually
kept on accrual system and according to the double entry system of book
keeping. In case of a manufacturing concern, appropriate cost records are
also maintained to ascertain the cost of production of each product so that
its selling price may appropriately be fixed. The overall objectives of
maintain accounts of a commercial concern is to prepare the Profit and
Loss Account and Balance Sheet so as to show the financial position and
profitability of the business for a given period.
On the contrary, government accounts are mostly kept on
cash basis. And most importantly, there is no scope for profit and loss in
government accounting. Instead, it focuses on the areas in which government can
collect funds and disburse the funds.
2) Final Accounts: In case of government accounts two statements are
mostly prepared. These are: Government Account & Statement of
Balancing Account.
In commercial organizations, they prepare Trading and Profit and
Loss Account and Balance Sheet.

3) Classification of Accounts: in case of commercial undertakings, all

transactions are broadly classified into three categories- Real, Nominal
and Personal Accounts.
In government accounting, there involves broadly three accounts: a)
Consolidated Fund b) Public Account and c) Contingency Fund.
Even the Consolidated Fund has three divisions: a) Revenue and
Expenditure Heads b) Capital Receipts and Disbursement Heads and c)
Public Debt and Loans and Advances.
4) Independence of Accounts and Audit Function: In case of
commercial accounting, audit function is independent of the accounts
function; while in case of government accounting, in most cases, the
function both of maintenance of accounts and their audit are handled by
the Indian Audit and Accounts Department.

1.4 General Principles of Government Accounting

1. Charges or expenditure on a new project like constructions, new
equipment, plant & machinery installation, maintenance, improvement,
and service should be allocated to the capital account as per the rule made
by competent authority.
2 Working charges of the project should be allocated to the revenue account.
3 In case of renewal and replacement and cost of the genuine replacement
should be charged to capital account.
4 In case of damage due to extraordinary calamities, charged should be debited
from the capital account or revenue account or from both. However, it will
be determined by the government according to the case and circumstances.
5 Capital receipts during the new project should be credited to the capital
account to reduce the capital expenditure of the project.
Comptroller and Auditor General of India
Comptroller and Audit General (CAG) is an independent Constitutional body.
Special status has been given to safeguard his independence and enable him to
discharge his duty without fear or favor.
As per the Article 148 of the Constitution of India, the comptroller and Auditor-
General will be appointed by the President of India. The provision of removal of
CAG is the same as of the judges of the Supreme Court. He can be removed only
on the basis of proven misbehavior or incapacity.
As per the Article 150 of the Constitution of India — the accounts of the Union
and of the States shall be kept in such form as the President may prescribed, on
the advice of the Comptroller & Auditor General.
Article 151 of the Constitution provides that the audit reports of the Comptroller
& Auditor General relating to the accounts of the Union shall be submitted to
the President, who shall cause them to be laid before each House of Parliament.

5.1 Classification of Government Accounts

Government of India has following three types of Funds for marinating the
records of all sorts of financial transactions −

• Consolidated Funds of India

• Contingency Funds of India
• Public Account
Let’s discuss each of them succinctly −
Consolidated Funds of India
As per the Clause 1 of the Article 266 of the Indian Constitution −
“All revenues received by the Government by way of taxes like Income Tax,
Central Excise, Customs and other receipts flowing to the Government in
connection with the conduct of Government business i.e. Non-Tax Revenues are
credited into the Consolidated Fund constituted. Similarly, all loans raised by the
Government by issue of Public notifications, treasury bills (internal debt) and
loans obtained from foreign governments and international institutions (external
debt) are credited into this fund. All expenditure of the government is incurred
from this fund and no amount can be withdrawn from the Fund without
authorization from the Parliament.”
Contingency Funds of India
As per the Article 267 of the Indian Constitution −
“The Contingency Fund of India records the transactions connected with
Contingency Fund set by the Government of India. The corpus of this fund is Rs.
50 crores. Advances from the fund are made for the purposes of meeting
unforeseen expenditure which are resumed to the Fund to the full extent as soon
as Parliament authorizes additional expenditure. Thus, this fund acts more or less
like an imprest account of Government of India and is held on behalf of President
by the Secretary to the Government of India, Ministry of Finance, and
Department of Economic Affairs.”
Public Account
The Public Account is constituted under Clause 2 of Article 267 of the Indian
Constitution, which says −
“The transactions relate to debt other than those included in the Consolidated
Fund of India. The transactions under Debt, Deposits and Advances in this part
are those in respect of which Government incurs a liability to repay the money
received or has a claim to recover the amounts paid. Transactions relating to
Remittance and Suspense shall embrace all adjusting heads. The initial debits or
credits to these heads will be cleared eventually by corresponding receipts or
payments. The receipts under Public Account do not constitute normal receipts
of Government. Parliamentary authorization for payments from the Public
Account is therefore not required.”
Similarly, all 29 states of India have the same structure as described above.
General Structure of Government Accounts
The general structure of the government accounts is illustrated below −
5.2 Form of Government Accounts
Treasury and other government departments, initially compile their receipt
and payment accounts on monthly basis for central government and state
government separately and then send to respective Accountant General of
India.
Collection of revenue and disbursement are directly made by Railway,
Defense, Post & Telegraphs, Forest, and public departments and lump sum
payments are made by treasury through the departmental officers. Detail of
accounts on monthly basis is maintained by the departmental Accounts
officers.
Monthly accounts submitted by the treasury and account officer are compiled
by the Accountant General, for the central government as a whole and for
each state separately. The compiled report shows progressive figure of each
month from 1st April to 31st March of every year. Complied accounts along
with appropriation accounts are submitted by Comptroller and Auditor
General of India to the President of India, to the Governor of each state, or to
the Administrator of the Union Territory accordingly.
1.7 Let Us Sum Up
Government accounting refers to all the financial documents and records of
public institutions that relate to the collection of taxpayers’ money and the
analysis, control of expenditure, administration of trust funds, management
of government stores and all the financial responsibilities and duties of the
relevant organs.
Government accounting is different from commercial accounting in respect
of preparation of final accounts and system of accounts. Government
accounts are mostly cash based accounts where commercial accounts are
accrual based. Likewise, double entry system is followed in commercial
accounting but same kind of accounting is not practiced under government
accounting.
The primary classification of government accounts are: consolidated fund,
public account and contingency fund.

1.8 Key Words: consolidated fund, public account and contingency fund.
1.9 SAQs
1. Government accounting advocates for preparation of Profit and Loss
Account. (True or False)
2. There are three classifications of government accounts: Consolidated Fund,
Public Account and ____________________________. (Fill in the blank)
3. All loans raised by the Government by issue of Treasury bill, loans will come
under __________________________. (Fill in the blank)

1.10 Answers to SAQs

1. False 2. Contingency Fund 3. Consolidated Fund

1.11 Suggested Readings

Sahaf, M. A. (2009) “Management Accounting: Principles and Practice”,
Second Edition, Vikash Publishing House, New Delhi
Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors
Pvt Ltd, New Delhi,

1.12 Model Questions

 1. What is Government Accounting? Discuss how is it different from
Commercial Accounting?
2. Discuss the classification of Government Accounts.

Unit 1 System of Financial Administration in India

Structure
1.0Objectives
1.1 Introduction
1.2 System of financial administration in India
1.3 Classification of expenditure in Government Accounts
1.4 Important Terms
1.5 Let Us Sum Up
1.6 Key Words
1.7 SAQs
1. 8 Answers to SAQs
1.9 Suggested Readings
1.10 Model Questions

1.0Objectives
After going through this unit, you will be able to :
• Understand the system of financial administration in India.
• Familiarize with various terminologies related to government accounts.

1.1 Introduction
In the last unit, we have learnt about government accounting and essence of
maintaining government accounts. We have also learnt about various
classifications of government accounts. Here in this unit, we will focus on
system of financial administration in India.
1.2 System of Financial Administration in India
The system of financial administration in India can be summarized as:
1. Maintenance of Funds/ Accounts: Under the present financial set up,
the Central Government and each State Government have to maintain the
following funds/ accounts:
 a) Consolidated Fund: This fund is credited with all the revenues
received by the central or state government, as the case may be. It is
charged with all expenditure as authorized by the appropriate
legislative authority.
b) Public Account: this account is credited with all receipts accrued
received by the state or central government from debt, deposits and
remittances. Disbursements are made out of this fund in accordance
with the rules.
c) Contingency Fund: this fund is at the disposal of the Governor of the
State/ President of India, to enable them to make advances for
meeting unforeseen expenditure pending authorization of such
expenditure by the Parliament or the State Legislature, as the case
may be. Such fund is financed by such sums as the case may be
determined by the appropriate legislature.
2. Presentation of Budget: Budget is the most important element as it is
the forecast of government’s probable receipts and disbursements.
According to Article 122 of the Constitution, the President of India has
to see that a Statement of Estimated Receipts and Expenditure for every
financial year is presented before the Parliament by the Government.
Such annual financial statement is also known as Government Budget.
At present, the financial year is from 1st April to 31st March.
Regarding expenditure, the budget needs to show separately the
following:
• The sums required to meet expenditure charged upon the
Consolidated Fund
• The sums required to meet other expenditure proposed to be made
from the Consolidated Fund.
It may be noted that the expenditure ‘charged upon’ does not
require the Vote of Approval of the Parliament. Of course, the
parliament may discuss such expenditure but it has no right to
reduce it. Some of the examples of ‘charged upon’ expenditure are
the emoluments and expenditure relating to the office of the
President/ Governor, salaries and allowances of Vice President,
Speaker of the Lok Sabha, Deputy Speaker of Lok Sabha/
Legislative Assembly, Judges of Supreme Court and High Courts,
etc. The expenditure, other than ‘charged upon’ expenditure are
 called as ‘demand for grants’. ‘Demand for grants’ of the central
government is submitted to Lok Sabha.
3. Appropriation Act: As soon as the Lok Sabha votes demand for grant
proposed in the budget, an Appropriation Bill is introduced in the Lok
Sabha. Such bill is introduced to provide for appropriations out of
Consolidated Fund for the following reasons:
• Meeting the demands for grant
• The expenditure charged upon the Consolidated Fund of India.

It may be noted that no amendment can be proposed in either

House of Parliament i.e Rajya Sabha and Lok Sabha which can
have any effect on varying the amount of purpose of demand for
grants or charged expenditure. The passing of Appropriation Act is
necessary because without it no expenditure can be incurred out of
Consolidated Fund.
4. Communication of Grants to Appropriate Ministries: The grants as
appropriated are communicated to appropriate ministries. This is an
indication to the concerned authorities that they should incur expenditure
within limits allocated to them. The Finance Minister in consultation
with CAG (Comptroller and Auditor General of India makes appropriate
rules both for receipts and expenditure which ministries and authorities
must obey.

1.3 Classification of expenditure in Government Accounts

Each Government whether Union or State keep three distinct funds or
accounts:
a) Consolidated Fund
b) Public Account
c) Contingency Funds
In the Consolidated Fund, there are three divisions:
1. Revenue receipt head comprise the following:
➢ Tax revenue
➢ Non tax revenue
➢ Grants in aid and contribution.
The expenditure heads comprise of:
➢ General Service e.g., fiscal services, interest payment and
servicing of debt, administrative services, defence services, etc.
 ➢ Social Service e.g., education, sports, arts and culture, health
and family welfare, information and broadcasting, etc.
➢ Economic Service e.g., agriculture and allied services, energy,
transport, communication, etc.
➢ Grants in aid and contribution.
2. Capital Division: this division consists of capital receipts and capital
disbursements. Here the capital expenditure includes expenditure of
considerable magnitude incurred with the object of increasing tangible
assets or reducing recurring liabilities e.g., capital outlay on large project or
major portion of payments in the form of commutation and pensions.
3. Public Debt, Loans and Advances Division: This division consists of loans
raised by the government whether temporary or permanent and also loans
and advances made by the government together with the repayment of the
former and recovery of the later. Under each of these heads, expenditure is
further classified as “voted” and “charged”.
b) Public Account
The Public Account is meant for receiving all other
public money received by or on behalf of the government,
which does not come under Consolidated Fund. It has two
divisions:
➢ Debt and Deposit Division: This division deals
with the receipts and payments other than those
falling under the “debt heads” of the Consolidated
Fund in respect of which the government incurs
liability to repay the money e.g., earnest money,
deposits of contractors, court deposits, etc or as a
claim to recover the amounts paid e.g., advances of
pay and travelling allowances to government
servants on transfers.
➢ Remittance Division: This division deals with
merely adjusting heads e.g., cash remittances from
one treasury to another, transfer between different
accounting circles, etc.
The classification of government expenditure is
done in a manner that it has a close reference to
department in which expenditure occurs rather than
its objective. The President or the Governor has the
 power to issue general or special orders as to the
head of the account, under which a particular
transaction or a class of transaction is included.
This is done by the President or Governor in
consultation with Comptroller and Auditor General
of India.

1.4 Important Terms

➢ Public Accounts Committee: It is appointed by the Parliament to
securitize the appropriation of accounts of Union Government and the
report of the Comptroller and Auditor General of India. Examination
by the PAC is similar to post-mortem of the reports. Members of the
PAC are appointed from the Opposition Parties of the Parliament.
Member of the ruling party cannot be part of this committee, as this
committee is working as a watchdog to look after the affairs of ruling
party.
➢ Vote on Account: In addition to the prescribed procedure regarding
provisions of funds to meet the expenditure and liabilities of the
government for the entire financial year, the Constitution also
provides for the grant of funds and advances by the Legislature for a
part of the financial year before completion of the said procedure.
Such grants are called as “Votes on Account”.
➢ Supplementary Grant: In case the amount authorized by the
Parliament or State Legislature for a particular service for the current
financial year is not found to be sufficient for the purposes of that
year or where a need arises during the current financial year or
supplementary or additional expenditure, for some new service not
contemplated earlier, the statement showing the estimated amount of
expenditure is presented to both the Houses of the Parliament. Such
estimates are called supplementary or additional demands for grant.

➢ Appropriation Act − After the approval of the budget proposal in the

Parliament or Legislature, an Appropriation Bill has to be introduced,
when this Bill is passed, it becomes Appropriation Act. Now, money
can be withdrawn from the Consolidated Fund of India or the
concerned State to meet the grants.
 ➢ Treasuries − Treasuries are the units of fiscal system in India. Every
Indian States and Union Territory is divided into different districts’
headquarters and every district headquarters has one or more than one
treasury. Treasuries are conducted by the State Bank of India as an
agent of the Reserve Bank of India. Central Government and State
Government keep their separate accounts and differences of Central
and State Govt. are adjusted by the Reserve Bank of India.
1.5 Let Us Sum Up
Government follows some procedure for the smooth conduct of financial
administration of a country or state like maintaining funds, presenting
budget, Appropriating Acts, etc.
1.6 Key Words: Vote on Accounts, Demand for Grants, Public Accounts
Committee, Comptroller and Auditor General of India.
1.7 SAQs
1. The passing of Appropriation Act is necessary because without it no
expenditure can be incurred out of Consolidated Fund. (True/ False)
2. Public Accounts Committee is appointed by the Comptroller and Auditor
General of India.
1. 8 Answers to SAQs
1. True 2. False
1.9 Suggested Readings
Sahaf, M. A. (2009) “Management Accounting: Principles and Practice”,
Second Edition, Vikash Publishing House, New Delhi
Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors
Pvt Ltd, New Delhi,

1.10 Model Questions

1. Discuss the system of financial administration in India.

2. Describe the classification of expenditure in government accounts.