SUBJECT NAME: Corporate Accounting I

CHAPTER NAME: Issue of Equity Shares & Underwriting of Shares

UNIT I
ISSUE OF EQUITY SHARES
Introduction:
Sole proprietorship is the most common type of business when the size of business is small. Partnership
became popular as the size increased. As firms became very big requiring more amount of capital and
involving more risks, it leads to the formation of companies.
A company is an association of persons who contribute money or money’s worth to a common stock
(capital), for carrying on business for the purposes of profit, the capital is divided into shares, which are held by
member (shareholders) in any proportion and are transferable. It is a legal person and in law exists like an
individual, but with no physical existence.

Q: What do you mean by company? Define company.

Meaning:
A company is a voluntary association of persons formed for some common purpose. It is an artificial
being, invisible, intangible and existing only in contemplation of law. In a legal sense, it is separate and distinct
from its shareholders. The owners of a company are called shareholders and their liabilities are limited only to
the face value of their shares.
Definitions:
Sec.3(1)(i) of the Indian Companies Act, 1956 defines a company as, “a company formed are registered
under the companies Act”.
According to Justice care, “a corporation is a legal person just as much as an individual, but with no
physical existence”.
Lord Justice Lindley defined a company as “an association of many person who contribute money or
money’s worth to a common stock and employ it in some common trade or business (i.e., for a common
purpose) and who share the profit or loss arising there from”.

Q: What do you mean by shares? Mention the different kinds of shares?

Shares – Meaning:
The capital of the company can be divided into different units with definite value called shares. A share
is one of the units into which the total capital of the company is divided. Sec 2(46) of the companies act defines
a share, “as a share is the share capital of a company and includes stock”.
Kinds of shares:
 Preference shares:
These are the shares which enjoy preferential rights as to the payment of dividend at a fixed rate during
the life of the company and as to the return of capital on winding up of the company.
 Equity shares:
Equity shares are those shares which do not carry any preferential right in respect of payment of
dividend and repayment of capital. According to sec 85 of Companies Act, 1956, “An equity shares is a
share which is not a preference shares”. These are shares having no special rights. The holders of equity
shares participate in the profits available after all preferential rights have been fully satisfied. They are not
entitled to any fixed rate of dividend.

Q: What do you mean stock?

Stock - Meaning:
As per sec 94(1) of the companies Act, 1956, when all the shares of the company have been fully paid
up, they may be converted into stock if so authorized by the articles of association. It is another type of unit of
capital of a company. Conversion of shares into stock is made because it is a convenient method of denoting
the capital of a company. Share capital of the company cannot be offered directly in the form of stock.

Q: Distinguish between stock and shares.

Difference between shares and stocks:
 Stocks are fully paid up where as shares may be fully paid up or partly paid up.
 Shares may be issued when a company is incorporated but stock cannot be issued under such circumstances.
Only fully paid shares can be converted into stock

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 Stock is convenient method of transferring because it can be issued or transferred in fractional parts whereas
shares cannot be divided below the face value of each shares.
 Stocks are not numbered whereas shares are serially numbered.
 Shares are of equal nominal value but stocks may be divided into unequal amounts.
 Shares are always registered and not transferable by mere delivery but stock may be registered or
unregistered stock can be mere delivery.

Q: Explain the various kinds or types of share capital.

Kinds or Types of share capital:
 Authorized capital (or) Nominal capital:
It is the maximum amount of capital that can be raised by a company by the issue of shares. This
amount is also mentioned in the capital clause of the memorandum of association of the company. This
capital is also called “Registered capital” (or) “Nominal capital”.
 Issued capital:
Issued capital is that part of the authorized capital which is offered for subscription to the public. The
part of authorized capital not offered for subscription to the public is known as un issued capital
 Subscribed capital:
It is that part of issued capital which represents the face value of shares subscribed by the public. This
also includes the face value of shares issued by the company for consideration other than cash.
 Called up capital:
It is that portion of the subscribed capital which the directors have to called up in order to carry on the
business of the company.
 Paid up capital:
That portion of the called up capital of a company which is actually paid by the shareholders is known
as the paid up capital. The paid up capital may be less than the called up capital due to the non payment of
allotment or call money by some of the shareholders.
 Reserve capital:
It is that part of uncalled which has been reserved by the company to be called only in the event of its
winding up. It is kept to instill confidence in the creditors of the company.

Q: Write short notes on issue of equity shares at par, at premium and at discount.
Issue of equity shares:

The following should be observed in connection with the issue of shares.

 No allotment shall be made of any share of a company offered to the public for subscriptions unless the
minimum subscription stated in the prospectus has been received.
 The amount payable on application on each share shall not be less than 5% of the nominal amount of the
shares.
 All money received from applicants shall be deposited in a scheduled bank
 Shares may be issued for cash or for consideration other than cash.
 The company cannot allot more number of shares than those specified in the prospectus.

Share may be issued at a price which is termed as (i) at par, (ii) at a premium (or) (iii) at discount.
 Issue of share at par:
If a company issues its shares at the original value it is called issue of shares at par. For example an
Rs.100 equity shares issued at a price of Rs.100.
 Issue of shares at premium:
If a company issues shares at a price greater than its face value. This is called issue of shares at a
premium. Generally the premium amount will be collected at the time of allotment. Sometimes it may be
collected even at the time of share application. It is a capital profit for company and the amount so earned
has to be credited to a separated account called security premium account.
 Issue of shares of discount:
If a company may issue shares at a price less than the face value. This is called issue of shares at a
discount. The total amount of discount should be debited to discount on issue of shares account. This item
will appear in the assets side of the balance sheet and it is to be written off over a period of time.

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Q: What are the conditions be satisfied for issuing shares at discount?
Conditions for issue of shares at a discount:
According to sec 79 of the companies Act, 1956 allows a company to issue shares at a discount subject
to the following conditions.

 The issue of shares at a discount must be authorized by an ordinary resolution passed by the company is
general meeting and sanctioned by the company law board.
 The resolution specifies the maximum rate at which shares are to be issued. The rate of discount must not
exceed 10% of the nominal value. However, the rate of discount can be more than 10% of the nominal
value of shares if the government is convinced that a higher rate is necessary.
 At least one year must have elapsed (passed) since the company was entitled to commence business.
 The shares are of a class which, have already been issued.
 The shares are issued within 2 months of the date on which the issue is sanctioned by the company law
board or within such extended time as the board may allow.

Q: What is over subscription and under subscription?

Over subscription – Meaning:
When shares are issued by well managed and financially strong companies to the public, they often
receive more number of applications than that they offer through prospectus and intend to allot. This is known
as over subscription. In such case, it becomes necessary to refuse allotment to some applicants.

Under subscription – Meaning:

Sometimes the shares offered to the public for subscription will not be fully subscribed to. This is
known as under subscription. If the company has received the minimum subscription it can proceed with the
allotment formalities. Unlike over subscription, under subscription does not require any special accounting
treatment.

Q: What is full allotment, selective partial allotment and pro-rata allotment?

(1) Full allotment:
The board of directors may make full allotment to the required number of applicants and reject the other
applications. The application money of the allotted application is to be transferred to share capital account and
the application money of the rejected applicants has to be refunded in full.

(2) Selective partial allotment:

Share may be partially allotted to different categories of applicants in different ratio. For example, those
who have applied for 200 shares or less may get 50% of the shares they applied for and those who have applied
for more than 200 shares may get 25% of the shares they applied for.
(3) Pro-rata allotment:
Shares may be allotted proportionate to the applications. It may be possible to reject some applications on
the basis of some criterion and for the balance application, proportionate allotment may be made

Q: What is calls-in-arrears and calls-in-advance?

Calls-in-arrears:
It often happens that some shareholders fails to pay the allotment money or call money due by them to
the company. The total of such unpaid amount is known as calls-in-arrears. The debit balance in allotment or
call account indicates the amount of calls-in-arrears and is often transferred to calls-in-arrears account. Though
it is an outstanding asset, it is not shown on the assets side of the balance sheet instead it is shown as a
deduction from the called up capital on the liability side of the balance sheet.
Journal entry:
Particular Debit Credit
Calls-in-arrears A/c Dr. XXX
To Share allotment A/c XXX
To Share first call A/c XXX
To Share second & final call A/c XXX

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Calls-in-advance:
Some of the shareholders may pay the balance amount on their shares along with allotment money or
call money though not demanded by the company. Such amounts received in advance by the company from its
shareholder are known as call-in-advance. This amount is to be credited to call-in-advance account. Call-in-
advance is shown as a separate item on the liability side of balance sheet under the heading ‘Share capital’, but
it is not added to the amount of paid up capital. Call-in-advance is not entitled to any divided declared by the
company as it does not form part of the share capital.
Journal entry:
Particular Debit Credit
For calls in advance:
Bank A/c Dr. XXX
To Calls in advance A/c XXX
The amount of calls-in-advance adjusted:
Calls in advance A/c Dr. XXX
To Share call A/c XXX

Q: What is forfeiture of shares? What are the conditions for forfeiture of shares?
Forfeiture of shares – Meaning:
Forfeiture of shares means cancellation of shares. If a shareholder fails to pay the allotment or call
money when demanded, the directors have the power of forfeiting the shares issued to the shareholder. When
shares are forfeited the shareholders name is removed from the register of members and the amount already
paid by him on the shares becomes the property of the company.
Conditions for forfeiture of shares:
 Shares can be forfeited only for non-payment of allotment or call money.
 Shares can be forfeited only if the articles of association authorizes the directors to do so.
 The directors have to give 14 days notice to the shareholder in his registered address, calling upon him to
pay the amount due from him together with interest at prescribed rate before a certain date.
 The notice must clearly state that the shares will be forfeited if no payment is made within the stiputlated
date.
 The directors should pass a resolution approving forfeiture. After forfeiture the matter should be
communicated to the shareholder.

Q: Explain the accounting treatment of forfeiture of shares.

Accounting treatment:
Since a company can issue shares either at par or at a premium or at a discount, it is sure that share
forfeited by the company may belong to any of the above three categories. Accounting treatment in the above
three cases has been explained below:

 Forfeiture of shares issued at par:

When the shares issued at par are forfeited, the balance in share forfeited account should be shown on
the liability side of the balance sheet by adding it to the share capital, until the forfeited shares are reissued.

Journal entry:
Particular Debit Credit
Share capital A/c Dr. XXX
To Share allotment A/c (amount due) XXX
To Share call A/c (amount due) XXX
To Forfeited share A/c (amount received) XXX

 Forfeiture of shares issued at a premium:

Sometime shares issued at a premium to shareholder have to be cancelled for non-payment of allotment
or call money. In such a case, if share premium has been received by the company, it should remain in
securities premium account. The securities premium account should not be debited at the time of forfeiture.
But if the premium has been credited to premium account, but the premium has not been received, the
premium account should be debited with the amount not received as and when shares are forfeited.

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Journal entries:
Particular Debit Credit
When the premium has been credited, but the amount has not been received:
Share capital A/c Dr. (called up amount) XXX
Securities Premium A/c Dr. (unpaid amount) XXX
To Share allotment A/c XXX
To Share call A/c XXX
To forfeited shares A/c XXX
When the premium has been received but forfeiture is due non payment of
subsequent calls:
Share capital A/c Dr. XXX
To Share call A/c XXX
To forfeited shares A/c XXX
 Forfeiture of shares originally issued at a discount:
When shares forfeited were originally issued at a discount the discount applicable to forfeited shares
must be cancelled on forfeiture of such shares. It means discount on issue of share account must be credited
with the proportionate amount of discount. The balance on discount on issue of share account (after
forfeiture) relates to the remaining shares forming part of shares capital account.
Journal entry
Particular Debit Credit
Share capital A/c Dr. XXX
To Discount on issue of Share A/c XXX
To Share allotment A/c XXX
To Share call A/c XXX
To forfeited share A/c XXX

Q: What is surrender of shares?

Surrender of shares – Meaning:
When a shareholder is not able to pay future calls on shares, he may voluntarily return his shares to the
company such voluntary return of shares by the shareholder to the company is called surrender of shares. When
shares are surrendered by a member, he ceases to be a member. Such surrendered shares can be reissued by a
company.

Q: What is right issue?

Right issue - Meaning:
Subsequent issues of shares by an existing company to existing shareholders are known as right issues.
Sec 81 of the companies Act, 1956 provides: where at any time after the expiry of two years from the formation
of a company or the expiry of one year from the first allotment of shares in the company, which ever is earlier,
if the board of director decide to increase the subscribed capital of the company by the allotment of further
shares.

Q: What is meant by reissue of forfeited shares?

Reissue of forfeited shares:
The forfeited shares may be reissued by a company to any person who is prepared to pay the amount
unpaid by the previous shareholders. The company can reissue such forfeited share at a discount. But the
discount allowed on reissue shall not exceed the amount originally paid on such shares by the original holders.

 When all forfeited shares are reissued (complete reissue):

After forfeiting the shares, the company may choose to reissue these shares to any person. After reissue
of all forfeited shares, if there is no balance in shares forfeited account, then there will be no capital profit.
But when there is profit on the reissue of forfeited shares such profit should be treated as capital profit and
will be transferred to capital reserve account.

 When all forfeited shares are not reissued (partial reissue):

After forfeiture, only a past of such shares is issued, it is desirable to spread the amount of share
forfeited account on all such forfeited shares and of the amounting relating to that part of forfeited shares
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 which has been reissued, discount on reissue of shares should be deducted from such amount and the
balance is transferred to capital reserve. The amount relating to that past of shares forfeited account which
has not been reissued should be shown on the liabilities side of balance sheet as share forfeited account.
Specimen journal entries for issue of shares at par, at premium or at discount:
Particular Dr. Cr. Particulars Dr. Cr.
For receiving share application money: Issue of share at premium:
Bank A/c Dr. Share allotment A/c Dr. XXX
To Share application A/c XXX To Share capital A/c XXX
XXX To Share premium A/c XXX
At the time of share allotment: Issue of shares at discount:
Share application A/c Dr. XXX Share allotment A/c Dr. XXX
To Share capital A/c XXX Discount on share A/c Dr. XXX
To Share capital A/c XXX
For return of rejected application money: When cash received for
Share application A/c Dr. allotment:
To Bank A/c XXX Bank A/c Dr. XXX
XXX To Share allotment A/c XXX

For transfer of excess application money to For first & final call amount
allotment: receivable:
Share application A/c Dr. XXX Share first & final call A/c
To Share allotment A/c XXX Dr. XXX
To Calls in advance XXX To share capital A/c XXX
For allotment money receivable: When cash is received for
Issue of share at par: first & final call:
Share allotment A/c Dr. Bank A/c Dr. XXX
To Share capital A/c XXX To Share First & Final
XXX Call A/c XXX
Issue of shares:
Issue of shares for immediate full consideration: (for cash consideration)
PROBLEM: 1
B Co., Ltd., issued 50,000 equity shares of Rs.10 each to the public on condition the full amount of shares will
be pid in a lumpsum. All these shares were taken up and paid by the public. Pass Journal entries in the books
of company when (a) Shares are issued at par; (b) Shares are issued at a premium of 10% and (c) Shares are
issued at a discount of 10%

PROBLEM: 2
Journalize the following transactions:
 A Ltd., issued 25,000 shares of Rs.10 each for cash. The whole amount is duly received.
 B Ltd., issued 7,500 shares of Rs.10 each for cash at a premium of Rs.2 each. The whole amount is duly
received.
 C Ltd., issued 1,50,000 shares of Rs.10 each for cash at a discount of 10 per cent. The whole amount is
duly received.
 ABC Ltd., issued 20,000 shares of Rs.10 each to a promoter, for service rendered.

Issue for consideration other than cash:

PROBLEM: 3
Ram Ltd., purchased assets of Rs.8,00,000 from Anil Bros. It issued equity shares of Rs.100 each fully paid up
in satisfaction of their claim. Make journal entries to record these transactions.

Issue for both cash and non cash:

PROBLEM: 4
A & Co., purchased Land & Buildings costing Rs.20,00,000 and in payment allotted 20,000 equity shares of
Rs.100 each as fully paid. Further the company issued 40,000 equity shares to the public. The shares were
payable as follows: On application Rs.20; On allotment Rs.40; On call Rs.40. The public applied for all the
shares which were allotted. All moneys were received. Give journal entries of the company.
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Issue of shares at par:
PROBLEM: 5
The authorized capital of A Ltd., Co., is Rs.2,00,000 divided into 20,000 equity shares of Rs.10 each. Out of
these 15,000 shares, have been issued to the public, payable as follows:
Rs.2 on application,
Rs.4 on allotment,
Rs.2 on first call and
Rs.2 on final call.
Pass necessary journal entries. All the amounts have been duly received.

PROBLEM: 6
Preeti Ltd. Invited applications for 5,000 shares of Rs.10 each payable as follows:
Rs.3 on Application,
Rs.2 on Allotment,
Rs.2 on First call and
Rs.3 on Final call
All these shares were subscribed and paid for. Pass journal entries.

Issue of shares at premium:

PROBLEM: 7
A limited company issued 1,00,000 equity shares of Rs.10 each at a premium of Rs.2 per share payable as
follows:
On application Rs.2
On allotment Rs.5 (including premium)
On first call Rs.3
On final call Rs.2
All the shares offered were subscribed by the public and cash duly received. Make the necessary journal and
cash book entries.

PROBLEM: 8
Sugumar ltd. Issued 60,000 shares of Rs.10 each payable at a premium of Rs.2 per share as below:
Rs.4 on Application,
Rs.5 on Allotment, (including premium)
Rs.3 on First call and Final call
Applications were received for 78,000 shares and directors made allotment in full to the applicants demanding
10 or more shares and returned money in full to the applicants’ 18,000 shares. All money was duly received
pass journal entries.

Issue of shares at a discount:

PROBLEM: 9
Sardar Ltd., issued 45,000 shares of Rs.10 each, at a discount of Rs.1 per share.
On application Rs.3
On allotment Rs.4 (with adjustment of discount)
On first call Rs.1
On final call Rs.1
Applications were received for 50,000 shares and the excess money was adjusted towards allotment. All the
share money was collected. Write journal entries and prepare a balance sheet.

PROBLEM: 10
Star Ltd., issued 35,000 equity shares of Rs.10 each at a discount of Rs.1 per share payable as follows:
On application Rs.2
On allotment Rs.2 (with adjustment of discount)
On final call Rs.5
Application were received for 40,000 shares. Excess application money was refunded. All the shares were
called and paid up. Write journal entries in the books of the company.

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Calls-in arrears:
PROBLEM: 11
Kevin Ltd., invited application for 25,000 shares of Rs.10 each payable:
Rs.2.50 on Application,
Rs.3 on Allotment, (including premium)
Rs.2 on First call and
Rs.2.50 on Second call
The public applied for 22,000 shares, which were allotted, the allotment-taking place on 1st April 2018. All
money due on allotment was received. Calls were duly made but a shareholder holding 500 shares failed to pay
the calls. Make journal entries.

Calls in advance:
PROBLEM: 12
Mari Ltd., issued 1,000 shares of Rs.100 each to the public at discount of Rs.5 payable as under:
Rs.20 on Application,
Rs.25 on Allotment, (with discount adjustment)
Rs.20 on First call and
Rs.30 on Final call
All the shares were applied for and allotted. Shanmugam, to whom 100 shares were allotted, paid the final call
amount due along with first call. All money was received. Pass journal entries.

Forfeiture & reissue:

PROBLEM: 13
A company forfeited 10 shares of Rs.10 each issued at a premium of 10% for nonpayment of the final call of
Rs.3 per share. Out of these, 7 shares were reissued at Rs.8 per share as fully paid up. Give entries for
forfeiture and reissue.

PROBLEM: 14
A company issued shares of Rs.10 each at 10% premium payable Rs.2 on application; Rs.3 on allotment
including premium; Rs.3 on first call and Rs.3 on final call. ‘A’ who was holding 50 shares failed to pay his
allotment and first call and his shares were forfeited. ‘B’ who was holding 30 shares did not pay his first call
and his shares were also forfeited. Give journal entries for forfeiture shares.

Forfeiture & Reissue of shares, without pro-rata allotment

PROBLEM: 15
Ram & Co., issued 12,000 equity shares of Rs.10 each at a premium of Rs.2 per share payable as follows:
On application Rs.2; On allotment Rs.5 (including premium); On final call Rs.5
Applications were received for 20,000 shares. 5,000 applications were rejected and application money
refunded. Allotment was made pro-rata to the applicants of 15,000 shares and money overpaid on application
was applied towards amount due on allotment.
Mr. K to whom 1,200 shares were allotted failed to pay the final call money. His shares were forfeited. Give
entries in the books of the company and prepare the balance sheet.

Forfeiture & Reissue of shares, with pro-rata allotment

PROBLEM: 16
Arul Ltd., invited applications for 20,000 equity shares of Rs.100 each at a premium of Rs.10 per share.
Payment was to be made as follows:
Rs.20 on Application,
Rs.40 on Allotment, (including premium)
Rs.30 on First call and
Rs.20 on Final call
Application totaled for 26,000 shares. Applications for 4,000 shares were rejected and allotment of shares was
made proportionately to the remaining applicants. The directors made both the calls and all the moneys
received except the final call on 600 shares, which were forfeited after the required notices were served. Later
400 of the forfeited shares were reissued as fully paid @ Rs.85 per share. Journalize the transactions and
prepare the balance sheet.

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PROBLEM: 17
X Ltd., issued for public subscription 20,000 share of Rs.10 each at a premium of Rs.2 per share payable as
under:
Rs.2 on Application; Rs.5 on Allotment (including premium)
Rs.2 on First call; Rs.3 on Final call
Applications for 30,000 shares were received. Allotment was made pro-rata to the applicants for 24,000 shares,
the remaining applications being rejected. Money over paid was used towards allotment. ‘Y’ to whom 800
shares were allotted failed to pay the allotment money, first and second calls and ‘Z’ to whom 1,000 shares
were allotted failed to pay the last two calls. These shares were subsequently forfeited after the second call was
made. All these forfeited shares were subsequently forfeited after the second call was made. All these forfeited
shares were reissued to ‘W’ as fully paid at Rs.8 per share. Give journal entries to record the above
transactions.
Underwriting of Shares
Q: Define underwriting. What do you mean by underwriting of shares?
Underwriting – Meaning & definition
According to the institute of company secretaries of India “Underwriting may be defined as a contract
entered into by the company with persons or institutions, called underwriters, who undertake to take up the
whole or a portion of such of the offered shares (or) debentures as may not be subscribed for by the public, in
consideration of remuneration called underwriting commission”.
As indicated by the above definition:
 Underwriting is an undertaking or guarantee, legally enforceable.
 It is between a company and underwriters who may be individuals or institutions.
 The underwriters undertake to take up shares or debentures which may not be subscribed for by the public.
 The underwriters may agree to take up a portion or whole issue made for public subscription.
 The consideration for the underwriting is ‘underwriting commission’.

Q: Who is underwriters and brokers?

Underwriters: An underwriter guarantees subscription for a company’s shares and debentures he has personal
responsibility and potential liability. He takes financial risks.
Brokers: A broker agrees to procure subscription for the shares or debentures of a company without any
commitment or responsibility or risk. A broker places a company’s securities with his contracts and brings the
potential customers and the company together. Brokers are eligible for remuneration from the company called
brokerage.

Q: What is underwriting commission?

Underwriting commission

The commission is the consideration for service rendered by the underwriters. It is paid for the risk
taken by them in placing of the shares before public. Underwriting commission is paid at specified rates, as per
the agreement, subject to limits fixed by the Companies Act. The commission is payable whether an
underwriter was called upon to take any shares or debentures or not. It is usually paid as a percentage on the
total issue price of the shares or debentures underwritten.
Q: What are the provisions of the companies act regarding the same?
Provisions

Provision of companies’ act of payment of the underwriting commission:

Sec. 76 of the companies’ act lays down the following relating to payment of the commission.
 Payment of the commission has to be authorized by the articles of association of the company.
 The commission should not exceed 5% of the issue price of shares or the rate authorized by the articles,
whichever is less. In case of debentures, the commission should not exceed 2.5% of the issue price or the
rate authorized by the articles, whichever is less.
 The amount or rate of commission agreed to be paid should be disclosed in the prospectus.
 The commission is payable on shares or debentures offered to the general public only. No commission is
payable on shares taken by the promoters group, employee, and directors their friends and business
associates.

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The following rates for payment of underwriting commission are in force with which SEBI also concurs and
allows commission on shares at a maximum of 2.5% only.
Particulars On amount developing On amount subscribed
on the underwriters by the public
(A) Equity shares 2.5% 2.5%
(B) Preference shares / convertible and
non-convertible debentures:
(i) For amounts up to Rs.5 Lakhs 2.5% 1.5%
(ii) For amounts in excess of Rs.5 lakhs 2% 1%

Meaning of Marked and Unmarked Application

Q: What is marked application and unmarked application?
Marked application:
These are the duly filled up application received by a company from the public, bearing the ‘stamp’ or
‘marking’ of a particular underwriter. They were originally issued to the public by the underwriter or his agent.
The marked applications are deemed to be received through the underwriters’ even if they are directly
submitted by the applicant to the company.

Unmarked application:
These are the duly filled up application received by the company from the public without bearing any
‘stamp’ or ‘marking’. They were originally issued by the company to the public directly. They are usually
termed as ‘direct applications’.
Types of underwriting – Complete, Partial and Firm Underwriting applications
Q: Explain the various types of underwriting. How to determining the liability of the underwriter?
Types of underwriting:
Underwriting agreements can be broadly divided into two types:
 Pure underwriting:
Open underwriting is an arrangement under which an underwriter or underwriters agree to take up
the shares or debenture of a company only when the whole or a part of the issue of shares or debenture of
the company underwritten by him or them is not fully subscribed for by the public. In the case of open
underwriting, the liability of the underwriter or underwriters is conditional i.e., his or their liability arises
only when them is not subscribed for in fully by the public.
Pure underwriting can again be subdivided into two types:
❑ Complete underwriting:
Complete underwriting is an arrangement under which the whole of the issue of shares or debenture
of a company is underwritten by the underwriters. The whole of the issue of shares or debenture of the
company may be underwritten either by a single underwriter or by two (or) more underwriters.
▪ When an entire issue is fully underwritten by a single underwriter:
If the issue is fully subscribed by the public, the underwriter is free from any liability. He gets
his commission without taking any shares or debentures. If the issue is not fully subscribed, the
underwriter has to take all the shares or debentures which are not applied for the public. Then he has to
pay for such shares or debentures, after adjusting the commission due to him.
▪ When an entire issue is fully underwritten by two or more underwriters:
If the issue is fully subscribed by the public, the underwriters are completely free from any
liability. They receive commission on the portion of the issue each of them has underwritten. If the
issue is not fully subscribed by the public, the underwriters have to take the balance of shares or
debentures. Liability of each underwriter is determined as follows:
Particulars No. of shares
Gross liability of each underwriter as per agreed ratio XXX
Less: Marked applications XXX
Balance left XXX
Less: Unmarked applications in the ratio of gross liability XXX
Net liability XXX
Transfer: Any surplus of one underwriter to other (in their gross liability ratio)
XXX
Net liability XXX
12
❑ Partial underwriting:
Partial underwriting is an arrangement under which only a part of the issue of shares or debentures
of a company is underwritten by the underwriters. The part of the issue of shares or debentures of the
company may be underwritten either by a single underwriter or by two or more underwriters.
▪ When a part of the issue is underwritten by only one underwriter:
Particulars No. of shares
Total issue XXX
Less: The portion of the issue for which the company is responsible XXX
Gross liability of the underwriter XXX
Less: Marked applications XXX
Balance left XXX
Less: Surplus unmarked applications (if any) XXX
Net liability of the underwriter XXX
▪ When a part of issue is underwritten by two or more underwriters:
Particulars No. of shares
Gross liability XXX XXX
Less: Marked applications XXX XXX
Balance left XXX XXX
Less: Surplus unmarked applications in gross liability ratio XXX XXX
Balance left XXX XXX
Less: Surplus of one underwriter to other (in their gross liability ratio) XXX XXX
Net liability of underwriters XXX XXX
 Firm underwriting:
The underwriter must subscribe for the shares or debentures underwritten ‘firm’. When there is over
subscription also, underwriter gets priority over the general public for shares or debentures underwritten
‘firm’.
❑ When application for firm underwriting are treated like marked form:
Particulars No. of shares
Gross liability XXX XXX
Less: Firm underwriting XXX XXX
XXX XXX
Less: Marked applications XXX XXX
XXX XXX
Less: Unmarked application in gross liability ratio XXX XXX
XXX XXX
Less: Surplus of underwriter to the other in gross liability ratio XXX XXX
Net liability XXX XXX
Add: Firm underwriting XXX XXX
Total liability XXX XXX

❑ When application for firm underwriting are treated like unmarked forms:
Particulars No. of shares
Gross liability XXX XXX
Less: Marked applications XXX XXX
XXX XXX
Less: Unmarked application in gross liability ratio XXX XXX
XXX XXX
Less: Surplus of underwriter to the other in gross liability ratio XXX XXX
Net liability XXX XXX
Add: Firm underwriting XXX XXX
Total liability XXX XXX

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Underwriting of shares – Complete underwriting:
PROBLEM: 1 (When the entire issue is underwritten by one underwriter)
GL Ltd., issued 1,000 equity shares of Rs.100 each and 1,000 6% debentures of Rs.100 each. The debentures
were issued at a discount of 6%. The whole of the issue was underwritten by W Co., for a commission of 4%
on the issue price of share and 2% on the issue price of debentures. The public applied for 900 shares and 800
debentures. There were immediately paid for. The underwriters fulfilled their obligations.

PROBLEM: 2 (When the whole issue is underwritten by two or more underwriters)

Sahul Ltd., issued 5,000 12% preference shares of Rs.10 each. The issue was underwritten as follows: Anand
30%; Malan 30% ; Elango 20%. Application for 4,000 shares were received by the company in all. Determine
the liability of the respective underwriters.

PROBLEM: 3
Balu Ltd., issued 1,50,000 Equity shares. The whole of the issue was underwritten as follows: X – 50%; Y –
25%; Z – 25%. Applications for the 1,20,000 shares were received in all, out of which applications for 30,000
shares had the stamp of X, those for 15,000 shares that of Y and those for 30,000 share that of Z. The
remaining applications for 45,000 shares did not bear any stamp. Determine the liability of the underwriters.

PROBLEM: 4
ABC Ltd., incorporated on 1st January 1985, issued prospectus inviting applications for 6,00,000 equity shares
of Rs.10 each.
The whole issue was fully underwritten by A, B, C and D as follows:
A – 2,00,000 shares; B – 1,50,000 shares; C – 1,50,000 shares; D – 1,00,000 shares.
Applications were received for 6,50,000 shares of which marked applications were as follows:
A – 2,50,000 shares; B – 1,70,000 shares; C – 1,40,000 shares; D – 40,000 shares.
Find out the liabilities of individual underwriters.

PROBLEM: 5
Tamil Nadu Co., Ltd., was formed with a capital of Rs.10,00,000 in Rs.10 per shares, the whole amount being
issued to the public. The underwriting of these shares was done as follows:
A – 35,000 shares; B – 30,000 shares; C – 20,000 shares; D – 10,000 shares; E – 3,000 shares; F – 2,000 shares.
All the marked application forms were to go in relief of the underwriters whose name they bore. The
applications markets by the underwriters were:
A – 10,000 shares; B – 22,500 shares; C – 20,000 shares; D – 7,500 shares; E – 5,000 shares; F – Nil.
Applications for 20,000 shares were received on forms not marked. Draw up a statement showing the number
of shares each underwriter had to take up.

Partial underwriting
PROBLEM: 6 (When a part of the issue is underwritten by one underwriter)
Mari Ltd., issued 1,00,000 equity shares of which only 60% was underwritten by Gandhi. Applications for
90,000 shares were received in all out of which application for 52,000 were marked. Determine the liability of
Gandhi.

PROBLEM: 7
X Company Ltd., issued 60,000 shares of Rs.10 each at a premium of 10% and 3,000 6% debentures of Rs.100
each at a discount of 5%. 75% of the issue is underwritten by M/s. Keval Singh & Co., at the maximum rate of
commission allowed by law, on the issue price. Applications were received for 50,000 equity shares and 2,000
debentures which were accepted and payment for these was received in full. Journalize the above transactions
and show the entries in the balance sheet assuming that the amount due from the underwriter has been received.

PROBLEM: 8 (When a part of issue is underwritten by two or more underwriter)

Neeraj Ltd., issued 10,000 shares of Rs.100 each at premium of 10%. These shares were underwritten by
Joseph and Jaleel to the extent of 5,000 shares and 3,000 shares respectively. The total applications received by
the company were 8,000 of which the marked applications were: Joseph – 1,200 shares; Jaleel – 300 shares.
You are required to determine the liability of the underwriters.

14
PROBLEM: 9
A Company issued 40,000 shares of Rs.100 each for public subscription. The issue was underwritten as
follows: P – 25%; Q – 30% and R – 25%
The company received a total number of 28,000 applications of which marked applications were as follows:
P – 8,000 shares; Q – 6,000 shares and R – 8,000 shares.
Determine the liability of each of the underwriters.

Firm underwriting – Only one underwriter:

PROBLEM: 10
PQR Ltd. issued 25,000 shares of Rs.100 each. The whole issue was underwritten by D. In addition, there is a
firm underwriting of 3,000 shares by D. Applications for 17,000 shares were received by the company in all.
Calculate the liability of D.

PROBLEM: 11 (two or more underwriting the full issue)

T.T. Ltd., issued 50,000 equity shares of Rs.10 each at par. The entire issue was underwritten as follows:
A – 30,000 shares (firm underwriting 4,000); B – 15,000 shares (firm underwriting 5,000); C – 5,000 shares
(firm underwriting 1,000);
The total applications including firm underwriting were for 40,000 shares. The marked applications were as
follows: A – 10,000 shares; B – 7,000 shares; C – 3,000 shares.
The underwriting contract provides the credit for unmarked applications are given to the underwriters in
proportion to the shares underwritten. Determine the liability of each underwriter and amount of commission
payable to them assuming the rate to be 2% on issue price.

PROBLEM: 12
‘A’ Co. Ltd., has an authorized capital of Rs.50,00,000 divided into 1,00,000 equity shares of Rs.50 each. The
company issued for subscription 50,000 shares at a premium of Rs.10 each. The entire issue was underwritten
as follows: Calculate the liability of each underwriter.
X – 30,000 shares (firm underwriting 5,000); B – 15,000 shares (firm underwriting 2,000); C – 5,000 shares
(firm underwriting 1,000).
Out of the total issue 45,000 shares including firm underwriting were subscribed. The following were the
marked forms: X – 16,000 shares; Y – 10,000 shares; Z – 4,000 shares.

15
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SUBJECT NAME: Corporate Accounting I

CHAPTER NAME: Redemption of Shares, Issue and redemption of debentures

UNIT II
Redemption of Shares, Issue and redemption of debentures
Q: What is preference share? Explain the various kinds or types of preference.
Preference shares - Meaning:
There are the shares which enjoy preferential rights as to the payment of dividend at a fixed rate during
the life of the company and as to the return of capital on winding up of the company.

Various kinds or types of preference share:

 Cumulative preference share:
Cumulative preference share are those shares which carry the right to cumulative dividends. That
means, if the company fails to pay the dividend in a particular year, due to insufficiency of profits, such
dividend is payable even out of future profits. In other words, dividend on these shares accumulates till it is
paid off in full; such shares are therefore called cumulative preference shares.
 Non-cumulative preference shares:
This is the preference shares which doe not carry the right to receive arrears of dividend. If the
company fails to declare dividend in a particular year that need not be paid out of future profits. If no
dividend is paid in any particular year, it lapses.
 Participating preference shares:
This type of shares which have right to participate in the surplus profits of the company after paying
the equity shareholder, in addition to the fixed rate of their dividend, are called participating preference
shares.
 Non participating preference shares:
Preference shares which have no right to participate on the surplus profits of the company are called
non participating preference shares.
 Redeemable preference shares:
There are shares which a company may issue on the stipulation that they may be repaid either after a
fixed period or even earlier at the companies’ option. The repayment of these shares is called redemption
and is governed by sec.80 of the companies Act, 1956. In India companies can now issue only this category
of preference shares.
 Irredeemable preference shares: These are shares which are redeemed only on winding up of the
company.
 Convertible preference shares: These are the shares which enjoy the right to get converted into equity
shares at a later date.
 Non convertible preference shares: Preference shares which are not convertible into equity shares are
called non convertible preference shares
 Guaranteed preference shares:
Dividend at fixed rates is guaranteed to such shareholders irrespective of the fact whether the company
has earned any profit or not. Such guarantee is not given by the company itself but by some third party like
a bank, an individual or an institution.

Q: Explain the advantages & disadvantages of preference shares.

Advantages of preference shares:
 Appeal to cautious investors:
Preference shares greatly appeal to those investors who look for reasonable safety of their capital as
also a fixed but regular return on it.
 No liability to pay regular dividends:
Even a company with irregular or uncertain earnings may go in to raise capital through the issue of
preference shares. There is no legal compulsion to pay yearly dividend on preference shares.
16
 No interference in management and control:
Normally, preference share do not carry any voting rights. The means that if the company raises its
capital mostly through the issue of preference shares, it can enable a small number of equity shareholders to
retail exclusive control over the company.
 Trading on equity made possible:
Preference share makes it possible for the company to trade on equity. The rate of dividend on such
share is fixed with the result that as the companies earning rise, its equity shareholder will have an
increasingly larger slice of the profits to distribute among themselves.
 Preference share made to order:
Seeing the mood of investors at a particular point of time, different kinds of preference share may be
issued to suit their tastes.
 No charges on a set:
Issue of preference share does not require the company to create any mortgage on its assets. Thus,
the company can keep its fixed assets free to use them for raising loans in future.

Disadvantages of preference shares:

 Fixed liability:
Dividend as preference share has to be paid at a fixed rate and before it is paid on the equity
shareholder. In case the companies’ earnings are not enough, preference shares may claim a lion’s shares of
its profits.
 Limited appeal:
Preference share have no appeal for those who enjoy taking risks. Such persons go in for equity
share but preference shares are also no much liked by the more cautious and orthodox investors. This is for
the simple reason that return on such shares may be irregular, even at times uncertain. Therefore cautious
and orthodox investors prefer debenture and government securities.
 Absence of voting rights:
Limited return on preference share makes them unattractive. But what makes them still more
unpopular is the fact that these shares carry no voting rights.
 When low return becomes too low:
Fixed return in preference share may seem good when the companies’ earnings are not large enough.
But when the company starts earning huge profit and its equity share holders are paid increasing returns on
their capital, the limitation of preference share become obvious.
 Fear of being shown the door:
Holders of redeemable preference shares have to face yet another unpleasant prospect. The
company raises capital from them when it is badly in need of funds.

Q: What do you mean by redemption of preference shares? Explain the various provisions regarding
redemption of preference shares.
Redemption of preference shares – Meaning:
The companies Act permits a company limited by shares to issue redeemable preference share provided
its articles of association permit such issue. However redemption of such shares involves reduction of capital.
It is obvious that the company is buying its own shares and refunding the money to the shareholders.
Legal provisions:
Sec.80 of the companies Act permits a company to redeem its preference share subject to certain
safeguards to its creditors.
 The shares shall be redeemable only if they are fully paid up. If the shares to be redeemed are partly paid
up, they should be made fully paid up before they are redeemed.
 The shares shall be redeemable either out of profits of the company which would otherwise available for
dividends or out of the proceeds of a fresh issue of shares made for the purpose of redemption. Profit
available for the purchase purpose include credit balance in profit & loss A/c, General reserve, Reserve
fund, Dividend equalization fund etc.
Note: Shares cannot be redeemed out of the proceeds of a fresh issue of debentures or any sale proceeds of
any property.
 Capital profits such a share forfeiture account, development rebate account, capital redemption reserve
account, share premium account, profit to incorporation, capital reserve etc., are not available for dividend
and hence not applied for repayment of preference share capital.

17
 Premium, if any, payable on redemption should be provided for out of profit of the company or out of the
share premium of the company.
 Where redemption is made out of profits, a sum equivalent to the amount paid on redemption should be
transferred to a reserve called capital redemption reserve.
 The capital redemption reserve account can be used for issuing fully paid bonus shares to the shareholders.

Q: What are capital profit & revenue profit? (or) What are the items will appear in capital & revenue
profit?
Items appear in capital profit & revenue profit:
Revenue profit Capital profit
General reserve Capital reserve
Dividend equalization reserve Capital redemption reserve
Reserve fund Development rebate reserve
Profit on sale of investment & fixed asset Depreciation reserve
Workmen’s accident fund Profit prior to incorporation
Workmen’s compensation fund Forfeited shares account
Insurance fund Profit on sale of fixed assets
Debenture redemption fund Securities premium account
Debenture redemption account
Profit and loss account

Specimen journal entries for redemption of preference shares:

Particulars Debit credit

1. If the shares to be redeemed are to be made fully paid up:
Preference share final call A/c Dr. XXX
To Preference share capital A/c XXX
Bank A/c Dr. XXX
To Preference share final call A/c XXX
2. When equity shares are issued for the purpose of redemption (at par, at premium
& at discount:
Bank A/c Dr. XXX
Discount on issue of shares A/c Dr. XXX
To Equity share capital A/c XXX
To Securities premium A/c XXX
3. When accumulated profits are utilized for the purpose:
Profit & loss A/c (or) General reserve A/c Dr. XXX
To Capital Redemption Reserve A/c XXX
4. To provide for premium on redemption:
Security premium A/c Dr. (or) XXX
Profit & loss A/c Dr. (or) XXX
General reserve A/c Dr. XXX
To Premium on redemption A/c XXX
5. If liquid assets are not available, either current assets may be sold (or) bank
overdraft may be arranged. The entry is :
Bank A/c Dr. XXX
Profit & Loss A/c Dr. (loss) XXX
To Current assets A/c XXX
To Profit & loss A/c (profit) XXX
6. For the total amount payable:
Redeemable preference share capital A/c Dr. XXX
Premium on redemption A/c Dr. XXX
To Redeemable preference shareholder A/c XXX
7. On payment of amount due:
Redeemable preference shareholder A/c Dr. XXX
To Bank A/c XXX
18
 8. For declaration of bonus:
Capital redemption reserve A/c Dr. XXX
General reserve A/c Dr. XXX
Profit & loss A/c Dr. XXX
To Bonus to shareholder A/c XXX
9. For issue of bonus shares:
Bonus to shareholders A/c Dr. XXX
To Equity share capital A/c XXX
Capital redemption reserve:
PROBLEM: 1
Redemption of 20,000 preference shares of Rs.100 each was carried out by utilization of reserves and by issue
of 8,000 equity shares of Rs.100 each at Rs.125. How much should be credited to capital redemption reserve
account?
PROBLEM: 2
Lakshmi Company Ltd., had decided to issue 2,000 equity shares of Rs.100 each at par and utilize the proceeds
to redeem 20,000 6% preference shares of Rs.10 each at a premium of 10%. The new issue was fully
subscribed and paid up. The redemption was completed as per schedule. Give journal entries.
PROBLEM: 3
‘Y’ Company Ltd., decides to redeem 50,000 11% preference shares of Rs.10 each at premium of 10%. For the
purpose of redemption, the company decides to issue 25,000 equity shares of Rs.10 each at a premium of 15%.
The balance in profit & loss account is Rs.14,50,000. Assume that the above decisions were implemented.
Give journal entries.
Redemption of preference shares:
PROBLEM: 4
The following balances appear in the ledger of a company as on 30.6.1995:
Share capital:
Equity shares (fully paid up) 6,00,000
Redeemable preference shares (fully paid up) 3,00,000
General reserve 2,00,000
Profit & loss A/c (Cr. Balance) 1,25,000
Securities premium account 50,000
The company decided to redeem the preference shares at a premium of 10% out of its general reserve and
undistributed profits. Give journal relating to redemption of the preference shares.
PROBLEM: 5
The following extract from the balance sheet of Vijay Ltd., as on 31st December 1997 is given to you and you
are asked to give journal entries.
Share capital:
2,00,000 equity shares of Rs.10 each 20,00,000
2,00,000 6% Redeemable preference shares of Rs.10 each 20,00,000
Capital reserve 10,00,000
General reserve 6,00,000
Profit & Loss account 17,00,000
PROBLEM: 6
The following is the balance sheet of Raman company Ltd., as on 31-12-96:
Liabilities Rs. Assets Rs.
Share capital: Fixed assets 3,10,000
1,000 6% Redeemable Pref. shares of Cash at bank 1,40,000
Rs.100 each fully paid 1,00,000
20,000 equity share of Rs.10 each 2,00,000
Profit & loss A/c 1,20,000
Sundry creditors 30,000
4,50,000 4,50,000
The company resolved to redeem its preference shares at a premium of 2% out of profits. Give the necessary
journal entries.
19
Redemption of preference shares with new issue of equity shares:
PROBLEM: 7
Sam Ltd., had as part of the share capital 20,000 preference shares of Rs.100 each fully paid up. When the
shares became due for redemption, the company had Rs.12,00,000 in its Reserve fund. The company issued
necessary equity share of Rs.25 each specially for the purpose of redemption and carried out the redemption.
Make necessary journal entries to record the above transactions.
Redemption at a premium, partly out of profit and partly out of fresh issue:
PROBLEM: 8
A Company has 8,000 redeemable preference shares of Rs.100 each fully paid. The company decides to
redeem the shares on September 30, 1997 at a premium of 7%. The company has sufficient profits but in order
to augment liquid funds the following issues are made:
 1,000 equity shares of Rs.100 each at a premium of 10%
 1,000 5% debentures of Rs.100 each.
The issue was fully subscribed and all the amounts were received. The redemption was duly carried out. Give
journal entries to record the above.
PROBLEM: 9
XYZ Ltd., had to redeem the 5,000 6% redeemable preference shares of Rs.100 each at a premium of 4% on
December 31, 1990. The company made the following issues in the later half of December.
 2,000 equity shares of Rs.100 each @ Rs.130 per share.
 6% debentures of Rs.2,00,000 at a discount of 5%. The whole issue was subscribed and all the cash
against them was received. The company carried out the redemption satisfying the legal requirements.
Expenses in this respect came to Rs.5,000.
Show the journal entries covering the issue of shares and debentures and the redemption of preference shares.
PROBLEM: 10
Sri Ram Ltd., had the following balance sheet as on 1.4.1990:
Liabilities Rs. Assets Rs.
10,000 6% preference share of Rs.10 each 1,00,000 Buildings 2,00,000
30,000 equity share of Rs.10 each 3,00,000 Plant 2,00,000
General reserve 1,00,000 Stock 1,00,000
P & L A/c 80,000 Debtors 1,00,000
Creditors 1,20,000 Cash at bank 1,00,000
7,00,000 7,00,000
The company decided to redeem its preference shares at 10% premium. For this purpose, it issued new 5,000
equity shares of Rs.10 each at 10% premium. Show necessary journal entries and balance sheet.
PROBLEM: 11
The following is the summarized balance sheet of a company.
Liabilities Rs. Assets Rs.
Share capital: Sundry assets 8,10,000
1,000, 10% Red. Pref. shares of Rs.100 each 1,00,000 Cash at bank 90,000
50,000 equity shares of Rs.10 each fully paid 5,00,000
General reserve 1,00,000
Capital reserve 50,000
Creditors 1,50,000
9,00,000 9,00,000
For the purpose of redemption of preference shares, the company made a fresh issue of 4,500 equity shares of
Rs.10 each, at a premium of 10%. The preference shares were redeemed at a premium of 10%. Show journal
entries and prepare the balance sheet after redemption.
PROBLEM: 12
The balance sheet of ABC & Co., Ltd., on 31-12-1990 stood as follows:
Liabilities Rs. Assets Rs.
Equity shares of Rs.100 each 5,00,000 Fixed assets 8,00,000
9% redeemable pref. shares of Rs.100 each 3,00,000 Investments 1,00,000
Securities premium 50,000 Bank balance 2,00,000
20
 Capital reserve 1,00,000 Other current assets 5,00,000
P & L A/c 2,00,000
10% Debentures 3,00,000
Creditors 1,50,000
16,00,000 16,00,000
Both the redeemable preference shares and debentures were due for redemption on 1-1-91. The company
arranged for the following:
 It issued 2,000 equity shares of Rs.100 at a premium of 10%.
 It sold the investments for Rs.90,000.
 It arranged a bank overdraft to the extent necessary.
The redemptions were carried out. Give entries for redemption of preference shares and debentures and balance
sheet after redemption.

Minimum fresh issue of shares:

PROBLEM: 13
The following is the summarized balance sheet of a company.
Liabilities Rs. Assets Rs.
Share capital: Assets 25,60,000
6,000, 8% Red. Pref. shares of Rs.100 each fully paid 6,00,000 Cash at bank 2,85,000
3,000, 9% Red. Pref. shares of Rs.100 each fully paid,
Rs.75 paid up 2,25,000
1,50,000 equity shares of Rs.10 each, fully paid 15,00,000
Capital reserve 1,00,000
Share premium 60,000
Current liabilities 3,60,000
28,45,000 28,45,000
It was decided to redeem both the classes of preference shares at a premium of 5%. The company issued equity
shares of Rs.10 each at a premium of 10% as were necessary to provide cash for redemption. The issue was
fully subscribed and all the money was received. You are required to give journal entries and prepare balance
sheet.

Issue of bonus shares out of capital redemption reserve:

PROBLEM: 14
The balance sheet of Suraj as on 31-12-1997 was as under:
Liabilities Rs. Assets Rs.
5,000, 6% Red. Pref. shares of Rs.10 each fully paid 50,000 Fixed assets 1,00,000
6,000 equity shares of Rs.10 each fully paid 60,000 Investments 20,000
Securities premium 20,000 Cash at bank 18,000
General reserve 40,000 Other current assets 62,000
Profit & loss A/c 5,000
Sundry creditors 25,000
2,00,000 2,00,000
st
The company passed the following resolution on 1 January 1998.
 To redeem the entire preference share capital at a premium of 10%.
 To issue 2,000 equity shares of Rs.10 each at a premium of Rs.2 per share, this has been fully subscribed.
 To sell the investment at Rs.15,000.
 To issue bonus shares as fully paid in the ratio of 2:1 to the existing shareholders including the fresh issue.
Draft the journal entries and prepare the balance sheet as on 1st January 1998.

PROBLEM: 15
The balance sheet of M/s. Ajanta Ltd., as at 31-12-1992 was as under.

Liabilities Rs. Assets Rs.

10,000 6% Red. Pref. shares of Rs.10 each 1,00,000 Land & building 2,50,000
50,000 equity shares of Rs.10 each 5,00,000 Plant & machinery 1,50,000
General reserve 1,10,000 Stock 3,00,000
21
 P & L A/c 2,00,000 Debtors 1,60,000
15% Debentures 50,000 Bank 2,40,000
Sundry creditors 1,40,000
11,00,000 11,00,000
The directors decide to
 Redeem preference shares at a premium of 5%
 Redeem debentures at a premium of 10%.
 Make a bonus issue to the equity shareholders of one Rs.10 equity share for every five Rs.10 shares held
in order to capitalize a part of the undistributed profit.
The appropriate resolution having been passed, the above transactions were completed. You are required to
show – (i) Journal entries and (ii) Balance sheet after redemption.

Untraceable shareholders:
PROBLEM: 16
The following is the balance sheet of Manish Ltd., as on 31-12-1996.
Liabilities Rs. Assets Rs.
16,000 6% Redeemable Pref. shares of Rs.10 each 1,60,000 Fixed assets 5,20,000
39,000 Equity shares of Rs.10 each fully paid 3,90,000 Current assets 3,22,000
Profit & Loss A/c 2,00,000
Sundry Creditors 92,000
8,42,000 8,42,000
The preference shares were redeemed on 1-1-1997 at a premium of Rs.2 per share, the whereabouts of the
holders of 1,200 such shares not being known. At the same time, a bonus issue of equity shares was made at par
one share being. Draw up the journal entries to record the above transactions and show the balance sheet after
redemption.

Redemption by conversion:
PROBLEM: 17
What entries can be made for the following redemptions made by the company?
 In 1996 X Ltd., redeemed Rs.3,50,000 preference shares by converting them into equity share of Rs.10 each
issued at 25% premium.
 In 1997 X Ltd., redeemed Rs.3,32,500 preference shares by converting them into equity shares issued at 5%
discount.
 In 1998 X Ltd., redeemed 10,000 preference shares of Rs.10 each at a premium of Rs.1.25 per share by
converting into equity shares of Rs.10 each issued at discount of 10%

Issue and Redemption of Debentures

Issue of debentures
Q: What do you mean debenture? Define debenture. Explain the features of debenture. (2/5/10 Marks)
Meaning
The word debenture is derived from ‘debera’ a Latin word which means to owe a debt. It is only a
written document issued by a company as an evidence of its debt.
Definition
The companies Act defines debenture as, “Debenture includes debenture stock, bonds or any other
securities of a company, whether constituting a charge on the assets of the company or not”.
It may also defines as, “An instrument in writing acknowledging a debt ;under the seal of the company,
usually secured by a fixed or floating charge on the assets of the company, bearing a fixed rate of interest and,
repayable during the existence of the company”.
Features
Features of issue of debenture:
Finance raised by the issue of debentures has the following special features.
 Debenture constitutes the loan capital of the company.
 Debenture holders are the creditors of the company.
 Interest on debentures is paid at a fixed rate and on a periodical basis, i.e., six month, yearly etc.,
 If redeemable, debenture capital has to be refunded after a prescribed period.
 Debentures carry no voting rights except under special circumstances.
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 For any default in the matter of payment of interest or repayment of capital, debenture holders, can take
legal action against the company.
 In case the company has created any mortgage or charge on its assets to secure the issue of debenture, the
debenture holder have the rights to claim the payment of their dues from out of these assets.
 If it is in their interest to do so, debenture holders can even apply for winding up of the company.

Kinds
Q: What are the different kinds (or) Types (or) Classification of debenture? (10 Marks)
Kinds (or) Types (or) Classification of issue of debentures:
Debenture are classified on the basis of
 On the basis of transferability: Debentures may be bearer or registered debenture from this point of view:
❑ Registered debentures: Registered debentures are made out in the name of a particular person who are
registered as debenture holders, with their full details, in the books of the company. The payment of
interest and repayment of capital transferable in the same way as shares.
❑ Bearer debentures: Bearer debentures are freely transferable without endorsement and they are just
like bearer cheque or government currency notes. They are treated as negotiable instruments and
transferable by mere delivery. The principal amount and investment when due are payable to the holder
of these debenture.
 On the basis of security:
❑ Secured (or) Mortgage debentures: These are debenture which are secured by a fixed or floating
charge on the assets of the company. Repayment of principal and interest on such debenture is secured.
When specific assets are named as security it becomes a fixed charge.
❑ Simple (or) unsecured debentures: These debentures carry no security with regard to repayment of
principal and interest. They are also called “naked debentures”. The general solvency of the company is
the only security for these debentures. On winding up of the company, the holders of these debentures
will be treated like other unsecured creditors.
 On the basis of permanence (Redeemability):
❑ Redeemable debenture: Debentures, the principal amount of which is repayable after a specified
period of time are called redeemable debentures.
❑ Irredeemable debentures: Debentures which are not repayable during the life time of the company are
called irredeemable debentures. They are also called perpetual debenture.
 On the basis of convertibility:
❑ Convertible debentures: A convertible debenture can be converted into shares of the same company at
the option of the holders convertible debentures may be fully convertible (or) partly convertible.
❑ Non-convertible debentures: Debentures which are not convertible into shares of a company are called
non-convertible debentures.
 On the basis of priority:
❑ First mortgage debentures: These debentures are payable first out of the property charged.
❑ Second mortgage debentures: These debentures are payable after satisfying the first mortgaged
debentures.
Consideration for issue of debentures
Q: What is issue of debentures? What are the considerations for the issue of debenture? What is
collateral security? (2/5/10 Marks)
Issue of debentures:
Debentures may be issued at par, at a premium or at a discount. They may be issued for cash or for
consideration other than cash (purchase of assets). It may also be issued to creditors as collateral security. The
amount of debenture may be collected in lump-sum or installments.
The entire of issue of debentures are made on the same pattern as for the issue of shares. The following
are the entries to be given in the books of company, when debentures are issued at par, at premium or at a
discount and the amount collected in lump sum.
Consideration for the issue of debenture:
 Issue of debentures at par: When debentures are issued at par the company has to collect the face value of
debentures.
 Issue of debenture at a premium: Debentures are rarely issued at a premium. The debenture which are
issued at a premium are issued at a higher price than their nominal value i.e., if a debentures with a nominal
value of Rs.100 issued at a premium of 10% the company receives Rs.110. There is no restriction in

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 companies Act 1956 regarding the utilization of debenture premium. It can be used to write off: (a)
Discount on issue of shares (or) debentures; (b) Premium on redemption of shares (or) debentures; (c)
capital losses and (d) Intangible assets such as goodwill etc., any balance left in the debenture premium
account should be transferred to capital reserve account.
 Issue of debentures at a discount: When debentures are issued at a price less than their face value, it is
said that they are issued at a discount. The companies Act does not prescribed any maximum limit for
discount on debentures when debentures are issued at a discount, the amount of the discount is debited to a
separate account called “Discount on issue of debenture account”. Usually discount on issue of debenture is
adjusted with debentures allotment account.
 Issue of debenture for consideration other than cash: Sometime a company may issue debenture against
certain assets purchased. In such cases debenture are issued to vendor (sellers).
Collateral security
 Collateral security: Company may issue debentures as collateral security against loans taken from banks or
other financial institutions (or) Debentures may be issued as secondary security or subsidiary security in
addition to the main security for a bank loan (or) mortgage loan. Such an issue is termed as “Issue of
debentures as collateral security”.
Debenture issued as collateral security can be treated in either of the following ways:
❑ First method: Under this method, no entries are made in the companies books and only a note giving
details of debenture offered as securities is appended to the loan account in the ledger on the liability
side of the balance sheet details of debenture offered as a security is given as a note below the item
‘loan’.
❑ Second method: Under this method, the company passes the following journal entry at the time of
issuing debenture as collateral security.

Particulars Debit Credit

All the time of issuing the debenture:
Debenture suspense A/c Dr. XXX
To __ % Debenture A/c XXX
When the loan is repaid and the debenture are returned by
the lender, the following entry is passed:
__ % Debenture A/c Dr. XXX
To Debenture Suspense A/c XXX

Specimen journal entries:

Issue of debenture for cash

Particulars Debit Credit
If full amount received in one lump sum:
Bank A/c Dr XXX
To _ % Debentures A/c XXX
If cash is receivable in two or more stages:
Bank A/c Dr. XXX
To Debenture application A/c XXX
Debentures application A/c Dr. XXX
To __ % Debentures A/c XXX
Debenture application A/c Dr. XXX
To Bank A/c XXX
To Debentures allotment A/c XXX
Debentures allotment A/c Dr. XXX
To __ % Debentures A/c XXX
Bank A/c Dr. XXX
To Debentures allotment A/c XXX
Debenture call A/c Dr. XXX
To __ % Debentures A/c XXX
Bank A/c Dr. XXX
To Debenture call A/c XXX
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 Issue of debentures for debentures for consideration other than cash:
Particulars Debit Credit
When assets are acquired:
Sundry assets A/c Dr. XXX
To Vendors A/c XXX
When assets & liabilities are acquired:
Sundry assets A/c Dr. XXX
Goodwill A/c Dr. XXX
To Sundry liabilities A/c XXX
To Vendor A/c XXX
When debentures are issued to the vendor:
Vendors A/c Dr. XXX
To __ % Debentures A/c XXX
Advantages and disadvantages
Q: What are the advantages and disadvantages of debentures? (10 Marks)
Advantages of debentures:
 Good number of willing buyers: Debentures can be issued to raise large sums of capital from those
investors who regard a fixed and regular income and safety of capital as the main test of a good investment.
The number of such cautions and risk-fearing investors being quite large, selling of debentures does not
pose much of a problem.
 Not affected by company’s fortunes: Debenture holders are paid interest at a fixed rate and at periodical
intervals. Be this profit or loss, the company has to find funds to pay interest to its debenture holders on the
due date. Debenture holders thus enjoy complete security against any financial setbacks suffered by the
company.
 Repayment is secure: Mostly, debentures carry a charge (mortgage on the assets of the company). In case
of default by the company, the debenture holder can recover their dues from the proceeds of such mortgaged
assets.
 Reliable source of long term financial: A company can issue long-term debenture, with maturity dates
falling in the distant future. Thus, between the raising of the debenture capital and its repayment, the
company has enough time to make the most profitable use of the funds at its disposal.
 Benefits of redemption: Generally, debentures are made redeemable after a specified period. This works
to the companies advantages in two ways. First, as a source of finance, the company can draw a debenture
whenever it needs funds to meet its short term or long term requirement. Secondly, the funds raised by the
issue of debentures can be easily repaid when the company does not need them any more.
 Trading on the equity made possible: Rising of funds by the issue of debenture enables the company to
trade on the equity. Interest on debenture is paid at a fixed rate. But once it has been paid the entire
remaining profits will become available for distribution as dividend among equity shareholders.
 Negligible cost: Raising funds by the issue of debenture is less costly. An important reason for this is that
debenture are generally regarded as safe investment and it is, therefore, not very difficult to sell them.
 Tax relief: While determining the tax liability of a company under the income tax law, interest paid on
debenture is allowed as a deduction.
 No window-dressing necessary: While issuing debenture the company does not need to make any tall
claims about its future performance. Those investing in debenture know well that whether the company
makes profit (or) loss, they need have no fear about the payment of interest or repayment of capital.
Disadvantages of debentures:
 Stable earning a must: Only companies with reasonably adequate and regular earnings can raise funds by
the issue of debentures. Because debenture creates a fixed liability in respect of payment of interest as also
because these have to be redeemed after a time, stability of earnings is a must.
 Mortgage of fixed assets: Debentures are preferred solely for the reason of safety of capital. But what is it
that leads investors to regard them as a safe investment? It is because in the matter of repayment of capital.
Debentures enjoy priority over all classes of shares.
 Too much of debenture finance counter-productive: Debenture finance is cited as a factor that enables
the company to trade on the equity. But too much of such finance may have an altogether opposite effect.

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 Burdensome in times of depression: From the point of view of trading on the equity book time is an ideal
time for raising by the issue of debenture with the growth in its earning, the company will have no difficulty
in paying interest on debenture and in providing for their repayment.
 Loss of prestige: A company which is known for depending too heavily on debenture finance may have
difficult in selling debenture particularly those belonging to the subsequent issues. May be, it will have to
offer a higher rate of interest or other out of turn benefits to attracts investors into buying its debenture.
 Absence of voting rights: Debenture holders are not entitled to attend the meeting of shareholders or to
vote there in. in some special circumstances, when their own interests are substantially involved, they may
be given the right to not only attend such meetings but also vote on resolutions affecting them.

Redemption of Debentures
Q: What do you mean by redemption of debentures? (2 Marks)
Meaning
Redemption of debenture is the process of extinguishing or discharging the liability on account of
debenture in accordance with the terms of redemption stated in the debenture trust deed. Discharge of
debenture liability is usually by paying cash to the debenture holders. But this can take other forms such as
conversion or rollover. In the case of conversion debenture or converted into preference share or equity shares,
Rollover refers to the issue of new debenture in exchange for the old ones.

Q: What are the important aspects are to be considered in relation to redemption of debentures? (5
Marks)
Important aspects are to be considered in relation to redemption of debentures:
 Time of redemption: Generally debentures are redeemed at the expiry of their period by making the
payment of the amount promised for. But sometime company may reserve the rights in the articles of
association to redeem the debenture even before the date of redemption either by installments or by
purchasing them in the open market. Payment of debenture by installment is noting but redemption of
debenture by drawing a lot. Sometimes a company does not want to serve a notice to the debenture holder
and wants redeem the debenture before the date of redemption. This is possible by purchasing out own
debenture in the open market. Thus debentures can be redeemed either at the expiry of the period of
debenture or before the expiry of the period by drawing a lot or by purchasing in the open market before the
expiry of the period of debenture.
 Amount payable on redemption: The amount to be paid on redemption of debenture depends on the
circumstances of each case. If the debentures are redeemed on expiry of the period or only during a lot
these amount to be paid can be either at premium or at par as promised by the company. If the debentures
are redeemed by purchasing them in the open market, then the amount to be paid depends on the market
quotation, i.e., either at par (or) at premium. Generally, the companies purchase their own debenture from
the market when the debentures are quoted below face value to take the advantages of depressed prices.
 Sources of funds: The major sources where from the debenture can be redeemed may be (i) out of profit,
(ii) out of capital, (iii) out of provisions made for redemption and (iv) Converting them in to shares or new
debentures.

Conditions of redemption of debentures

Q: What are the different conditions of issue and redemption of debentures? (5 Marks)
Different conditions of issue and redemption of debentures:
 Debentures issued at par and redeem at par
 Debentures issued at discount and redeem at par
 Debentures issued at premium and redeem at par
 Debentures issued at par but redeemable at premium
 Debentures issued at discount but redeemable at premium
 Debentures issued at premium but redeemable at premium

Various methods of debentures

Q: Explain the different methods of debentures. (10 Marks)
Methods of redemption of debentures:
Methods of redemption may be broadly divided into two categories.

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 Redemption of debentures

Redemption without provision Redemption out of provision

Redemption Redemption Redemption Insurance Sinking fund

on specified in installment by policy method method
due date conversion

Drawing Conversion Conversion

Redemption by lot before date of on the date of
out of profit redemption redemption

Open market
buying Redemption on Redemption at
Redemption specified date company’s option
out of capital

 Redemption without provision: The debenture trust deed or the debenture issue terms. May not provide
for creating a sinking fund for redemption of the debenture. The board of director also may not think it
necessary to create such a fund. In such cases, redemption of debenture is carried out without any provision
for such redemption.
❑ Redemption on specified due date: On specified due date, debentures are repaid as per the terms of the
issue at par or at premium.
▪ Redemption out of profit: When debentures are redeemed out of profit, profits of the company are
utilized for the purpose of redemption with holding the same for dividend. In such a case the following
journal entries will be passed.
Particulars Debit Credit
For repayment of debentures:
__ % Debentures A/c Dr. XXX
To Bank A/c XXX
For transfer of profits:
P & L Appropriation A/c Dr. XXX
To Debenture Redemption Reserve A/c XXX
For closing debentures Redemption Reserve, when all the debenture are
redeemed: XXX
Debenture Redemption reserve A/c Dr. XXX
To General Reserve A/c
▪ Redemption out of capital: If debenture are redeemed out of capital no amount of divisible profit is
kept aside for redeeming debenture profit are not utilized for redemption of debenture and may go to the
shareholders by way of dividend. Redemption out of capital reduces the liquid resources available to
the company. Therefore, a company may adopt this method only when it has sufficient surplus funds.
Particulars Debit Credit
Debentures A/c Dr. XXX
To Bank A/c XXX
❑ Redemption in installments: When debentures are issued, the terms of issue may provide for the
repayment of the debts. The following different method can be adopted for redemption in installments.
▪ Drawing by lot: A company may agree to repay every year a predetermined amount of debenture by
conducting a lot, using the distinctive numbers of the debentures. The debentures whose number are
taken out in the lot will have to be repaid by the company by giving the particular debenture holder

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 intimation about the repayment. The redemption may be at par at premium, as per the term of the
debentures issue agreement.
Particulars Debit Credit
For debentures repayable:
Debenture A/c Dr. XXX
Premium on redemption A/c Dr. XXX
To Debenture holder A/c XXX
For payment of cash:
Debenture holders A/c Dr. XXX
To Bank A/c XXX
If redemption is out of profit:
P & L Appropriation A/c Dr. XXX
To Debenture Redemption Reserve A/c XXX

▪ Open market buying: If a company is authorized by the terms of issue it can purchase its own
debenture from the open market. Debenture thus purchased can either be cancelled or treated as
investments by the company. This method of redemption of debenture is usually adopted when the
market price of debenture falls below the normal value.
❑ Redemption by conversion: Redemption of debenture by conversion is possible when the debenture
were originally issued as ‘convertible debentures’. They may be partly convertible debenture or fully
convertible debentures.
▪ Conversion on the date of redemption: Sometime the debenture holders of a company are given the
option to convert their debenture into the shares or new debenture within a stipulated period. Such
option is exercised by the debenture holders only when they are very sure about the progress of the
company. The new shares or debentures can be issued either at par (or) at a premium (or) at a discount.
The following entry will be made:
Particulars Debit Credit
__ % Debenture A/c Dr. XXX
Premium on redemption of debenture A/c Dr. XXX
To Debenture holder A/c XXX
For conversion into shares: XXX
Denture holders A/c Dr. XXX
To Share Capital A/c XXX
To Security Premium A/c

▪ Conversion on the before redemption due date: Sometimes, option may be given to the debenture
holders to convert their debenture into shares earlier than the due date for redemption. In such cases
there is no problem if the debenture were originally issued at par or premium.

 Redemption of debenture out of provision: Redemption of debenture is a very important obligation of a

company. If a specified future date is fixed for redemption of debenture, it is essential to see that sufficient
cash is available on that date for such redemption. In the normal course, liquid cash may not be available
for the redemption. ‘Making provision’ in the best way to ensure that necessary cash is available on the
date of redemption.
Sinking fund and insurance policy
❑ Sinking fund method: The sinking fund is defined as “a fund created for redemption of a liability or
replacement of an asset”. Since redemption of debenture is a known liability for the company a sinking
fund can be created out of profits every year. After creating a sinking fund, it is usually invested in
government or outside securities. For sinking fund investments, the company will get annual interest
and it should be reinvested. On the date of redemption of debentures payments are made out of sale
proceeds of sinking fund investments. It is also called “Debenture redemption fund”

Particulars Debit Credit

At the end of the first year, for making annual transfer to sinking fund:
P & L Appropriation A/c Dr. XXX
To Sinking fund A/c XXX
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 For making investment:
Sinking fund investment A/c Dr. XXX
To Bank A/c XXX
For receiving interest to sinking fund A/c:
Bank A/c Dr. XXX
To Interest on Sinking fund investment XXX
For transferring interest to sinking fund A/c:
Interest on sinking fund investment A/c Dr. XXX
To sinking fund A/c XXX
For annual transfer to sinking fund:
P & L Appropriation A/c Dr XXX
To sinking fund A/c XXX
For making investment, including the interest received:
Sinking fund investment A/c Dr. XXX
To Bank A/c XXX
For sale of investment:
Bank A/c Dr. XXX
Sinking fund A/c Dr. XXX
To Sinking fund investment A/c XXX
For redemption of debentures:
__ % Debenture A/c Dr. XXX
To Bank A/c XXX
For closing the Sinking fund:
Sinking fund A/c Dr. XXX
To General reserve A/c XXX
❑ Insurance policy method: Under this method a fixed amount of premium is paid every year to an
insurance company. At the end of a specified period, the insurance companies pay the amount for
redemption of debentures. Under this method, the amount of annual allocation is used for paying the
premium on insurance policy.
Particulars Debit Credit
For the amount of premium paid:
Debenture redemption policy A/c Dr. XXX
To Bank A/c XXX
At the end of the accounting year:
P & L Appropriation A/c Dr. XXX
To Debenture redemption Policy A/c XXX
In the last year, on realizing the policy:
Bank A/c Dr. XXX
To Debenture redemption policy A/c XXX
For any profit on realization of policy.
Debenture redemption policy A/c Dr. XXX
To Debenture redemption Fund A/c XXX
For redemption of the debentures:
Debentures A/c Dr. XXX
To Bank A/c XXX
For closing the debenture redemption fund:
Debenture redemption fund A/c Dr. XXX
To General Reserve XXX

Ex-interest and Cum-interest

Q: What do you mean Ex-interest and Cum-interest? (5 Marks)
Cum-interest and ex-interest - Meaning:
When a company buys and sells its own debentures in the open market, the prices quoted may include or
exclude interest accrued till than date on the debenture. If the quoted price includes interest on the debenture
from the previous interest date till the date of sales, the price is known as ‘cum-interest’. If the price quoted
does not include the interest from the previous interest date till the date of sale the price is known as ‘ex-interest
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price’. When purchase and sale transaction of own debenture are recorded in books, the nature of quotation
given whether the price quoted is ‘cum-interest’ or ‘ex-interest’ should be carefully observed.
When own debentures are purchased in the market and immediately cancelled:
Particulars Debit Credit
__ % Debentures A/c Dr. XXX
Debentures interest A/c Dr. XXX
To Bank A/c XXX
To Profit on cancellation A/c XXX
When own debentures are purchased in the market and retained as investment:
Particulars Debit Credit
When own debenture are purchased:
Own debentures A/c Dr. XXX
Debentures interest A/c Dr. XXX
To Bank A/c XXX
On the date of interest payment:
Debenture interest A/c Dr. XXX
To Interest on own debentures A/c XXX
To Bank A/c XXX
When own debentures are resold:
Bank A/c Dr. XXX
To Own debentures A/c XXX
To Interest on own debentures A/c XXX
When own debentures are cancelled:
Particulars Debit Credit
__ % Debenture A/c Dr. XXX
To own debenture A/c XXX
To Profit on cancellation of debenture A/c XXX

Different between shares and debentures

Shares Debentures
Amount collected through shares constitute capital of Amount collected through debentures constitute
the company “borrowed fund of the company”
A shareholder is a member of the company A debentures holder is only a creditors
A shareholder gets a shares in the profits called A debentures holder receives interest at a fixed rate.
divided
A shareholder is entitled to vote at meeting A debentures holder is not entitled to vote
In the even of winding up of the company the In the event of winding up of the company the
shareholders gets their dues after paying all the debenture holder are paid first.
liabilities of the company
Dividend on equity share is paid at a variable rate, Debenture interest is paid at a predetermined fixed
which is vastly affected by the profit of the company rate. It is paid whether there is any profit (or) not.
Dividend are appropriation of profits and there are not Interest on debentures are the charges against profit
deductible in determining taxable profit of the and they are deductible as an expenses in determining
company taxable profit of the company.
There are only two kinds of shares equity shares and These are different kinds of debentures such as
preference shares secured, unsecured redeemable, irredeemable etc.,
In the balance sheet shares are shown under share In the company balance sheet debenture shown under
capital secured loans.
Shares cannot be converted into debenture in any Debenture can be converted into share as per the terms
circumstances of issues of debentures.

PROBLEM: 1
Pass necessary journal entries in the following cases, when debenture issue price is Rs.1,00,000.
 Issued at par and redeemable at par.
 Issued at a discount of 10% and redeemable at par.
 Issued at premium of 5% and redeemable at par.
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 Issue of debenture at par and redeemable at premium 10%.
 Issue of debentures at a 5% discount and redeemable at a premium 10%.

PROBLEM: 2
You are required to set out the journal entries relating to the issue of the following debentures in the books of X
Ltd.,
 8% 120 Rs.1,000 debentures are issued at 5% discount and are repayable at par.
 Another 7% 150 Rs.1,000 debentures are issued at 5% discount and repayable at 10% premium.
 Further 80, 9% Rs.1,000 are issued at 5% premium.
 In addition another 400, 8% Rs.100 debentures are issued as collateral securities against a loan of
Rs.40,000.

PROBLEM: 3
Excel Ltd., made the following issues of debentures on 1-4-1997:
 200 10% debentures of Rs.100 each to settle a creditor who supplied a machine on credit some time ago at a
price of Rs.18,000.
 300 10% debentures of Rs.100 each for cash at a discount of 5%.
 1,000 10% debentures of Rs.100 each to the bankers as collateral security for a loan of Rs.80,000.
All the above issues are redeemable at par. Pass journal entries to record the above in the books of the company
and show how these items are to be shown when the company’s balance sheet is prepared.

PROBLEM: 4
Give journal entries in the books of ‘A’ Co. Ltd., if
 It purchased assets of Rs.5,00,000 and agreed to pay the price by issuing 9% debentures of Rs.100 each at
premium of 25%.
 It purchased assets of Rs.3,00,000 and acquired liabilities of Rs.30,000. It issued 8% debentures of Rs.100
each at a discount of 10% to satisfy the net purchase price.
 It purchased assets and liabilities of a firm for Rs.4,00,000. The assets acquired were valued at Rs.6,00,000
and the liabilities taken over were Rs.2,40,000. The purchased price is to be satisfied by issue of 10%
debentures of Rs.100 each at par.

PROBLEM: 5 (For consideration other than cash)

A company purchased Building of the book value of Rs.1,98,000 from another firm. It was agreed that the
purchase consideration be paid by issuing 10%debentures of Rs.100 each. Give journal entries if the debentures
have been issued: (i) at par; (ii) at discount of 10%; and (iii) at a premium of 10%.

PROBLEM: 6 (Writing off discount on issue of debentures)

On 1-1-2000, Exe Ltd., issued Rs.1,10,000, 9%debentures at a discount of 5% repayable as follows: On 31-12-
2000 – Rs.20,000; On 31-12-2001 – Rs.40,000; On 31-12-2002 – Rs.50,000. Calculate the amount of discount
to be written off in each of the three years.

PROBLEM: 7
Jones Co. Ltd., issued 2,000 8% debentures of Rs.100 each at a discount of 6%. The debentures are repayable
by annual drawings at the end of each year, from the first year onwards at the rate of Rs.40,000 per year. You
are required to ascertain the discount amount to be written off each year under (a) Fluctuating installment
method (b) Fixed installment method.

PROBLEM: 8 (Redemption in installment)

Rashid Ltd., has Rs.10,00,000 8% debentures outstanding on 1-1-96. The company has been redeeming every
year on January 1st Rs.1,00,000 debentures by drawings by lot, at par. Give necessary journal entries: (a) If the
redemption is out of profits; (b) If the redemption is out of capital.

PROBLEM: 9 (Redemption out of profit)

G Ltd., issued 2,000 12% Debentures of Rs.100 each on 1-1-98 at a discount of 10%, redeemable at premium of
15% in equal annual drawings in 4 years out of profits. Give journal entries both at the time of issue and
redemption of debentures. (Ignore the treatment of loss on issue of debentures and interest.

31
PROBLEM: 10 (Redemption out of capital)
A company on 31st December, 1994 redeemed Rs.10,000 6% debentures out of capital by drawing a lot.
Similarly, the company on 31st December. 1995 redeemed Rs.15,000 6% debentures out of profit by drawing a
lot. You are required to pass journal entries in the books of a company.

PROBLEM: 11 (Redemption by conversion)

Eastern Plastics Ltd., issued fully convertible 10%debentures of Rs.100 each for Rs.10,00,000. The following
were the terms of issue:
 Date of issue January 1, 1993
 60% of the debentures issued will be converted into equity shares of Rs.10 each at a premium of 20% on
31-12-95.
 Balance of 40% of the debentures will be converted into equity shares of Rs.10 each at a premium of Rs.6
per share on 31-12-1996.
Pass journal entries in the books of the company for conversion of the debentures.

PROBLEM: 12 (Open market buying method)

Krishna Ltd., which had Rs.50,00,000 10% debentures outstanding, made the following purchases in the open
market for immediate cancellation:
 1-4-1997 1,000 debentures of Rs.100 each at Rs.99
 1-9-1997 2,000 debenture of Rs.100 each at Rs.97
You are required to give the journal entries for purchase and cancellation of the debentures. (a) If the above
purchase rates is ‘Ex-interest’ (b) If the above purchase rates are ‘Cum-interest’. Assume that interest is
payable every year on 30th June and 31st December.
PROBLEM: 13
On 1st January, XYZ Ltd., has Rs.1,00,000 10% debentures. In accordance with the power under the deed, the
directors have the powers to acquire the debentures in the open market for immediate cancellation. The
following purchases, of own debentures were made by the company:
 March 1, Rs.20,000 debentures at Rs.98 cum-interest
 August 1, Rs.40,000 debentures at Rs.99 ex-interest
Debenture interest is payable half-yearly on 30th June and 31st December every year. Show journal entries for
purchase and cancellation of the debentures.
PROBLEM: 14
On 1st January, X Ltd., has Rs.1,00,000 6% debentures. In accordance with the power under the deed, the
directors have the powers to acquire the debentures in the open market for immediate cancellation. The
following purchases, of own debentures were made by the company:
 March 1, Rs.20,000 debentures at Rs.98 cum-interest
 August 1, Rs.40,000 debentures at Rs.100.25 cum-interest
 December 15, Rs.10,000 at Rs.98.5 ex-interest
Debenture interest is payable half-yearly on 30th June and 31st December every year. Show journal entries for
purchase and cancellation of the debentures.
PROBLEM: 15 (Sinking fund method)
On 1st January 1986 XYZ Ltd., issued 4,000, 12% debentures of Rs.100 each repayable at the end of four years
at a premium of 5%. It has been decided to institute a sinking fund for the purpose, the investments being
expected to realize 4% net. Sinking fund table shows that 0.235490 amounts to Rs.1 at 4% in four years.
Investments were made in multiples of hundred only.
On 31st December 1989 the bank balance was Rs.1,18,000 and investments realized Rs.3,13,600. The
debentures were paid off. Give the appropriate ledger accounts.
PROBLEM: 16 (Insurance policy method)
Zee Co., Ltd., issued 1,000 12% Debentures of Rs.100 each at par on 1-4-1998, repayable at par after 3 years on
31-3-2001. The directors decided to take out an insurance policy to provide necessary cash for the redemption
of the debentures. The annual premium of the policy, payable on 1st April every year was Rs.31,410. You are
required to show the journal entries in the books of the company relating to the issue and redemption of
debentures.

32
 PSG COLLEGE OF ARTS & SCIENCE
An Autonomous College – Affiliated to Bharathiar University
Accredited with ‘A++’ Grade by NAAC (4th Cycle)
College with Potential for Excellence(Status Awarded by the UGC)
Star College Status Awarded by DBT-MST, An ISO 9001-2015 Certified Institution
Coimbatore – 641014.

SUBJECT NAME: Corporate Accounting I

CHAPTER NAME: Final Accounts & Profit Prior to Incorporation
UNIT III
Final Accounts
Introduction
There is no statutory obligation upon sole proprietorship or partnership firms to prepare final accounts,
but companies have a statutory obligation to prepare final accounts as required by Section 128 of the
Companies Act, 2013. The general principles of preparing the final accounts of joint stock companies are the
same as in the case of the sole proprietorship or partnership firms. But, in addition to these principles, a joint
stock company must conform to certain legal provisions as given in the Companies Act, 2013 in respect of
forms and contents of the final accounts. It may be remembered that the provisions of the Companies Act, 2013
relating to forms and contents of the final accounts do not apply to insurance, banking and electricity companies
which are governed by special Acts relating to such companies.

A. BOOKS OF ACCOUNTS TO BE MAINTAINED BY A COMPANY

Section 128 of the Companies Act, 2013 requires that every company shall prepare and keep at its
registered office books of accounts and other relevant books and papers and financial statements for every
financial year which give a true and fair view of the state of affairs of the company, including that of its branch
office or offices, if any, and explain the transactions effected both at the registered office and its branches and
such books will be kept on accrual basis and according to the double entry system of accounting.
All or any of the books of account aforesaid and other relevant papers may be kept at such other place in
India as the Board of Directors may decide and where such a decision is taken, the company shall, within seven
days thereof, file with the Registrar a notice in writing giving full address of that other place.
The company may keep such books of account or other relevant papers in electronic mode in such
manner as may be prescribed.
The books of account and other books and papers maintained by the company within India shall be open
for inspection at the registered office of the company or at such other place in India by any director during
business hours and in the case of financial information, if any, maintained outside the country, copies of such
financial information shall be maintained and produced for inspection by any director subject to such conditions
as may be prescribed. The officers and other employees of the company shall give to the person making such
inspection all assistance in connection with the inspection which the company may reasonably be expected to
give.
The books of account of every company relating to a period of not less than eight financial years
immediately preceding a financial year, or where the company had been in existence for a period less than eight
years, in respect of all the preceding years together with the vouchers relevant to any entry in such books of
account shall be kept in good order.
Section 129 of the Companies Act, 2013 requires that the financial statements anal give a true and fair
view of the state of affairs of the company or companies, comply with the accounting standards under Section
133 and shall be in the form or forms as may be provided for different class or classes of companies in Schedule
I11.
At every annual general meeting of a company, the Board of Directors of the company shall lay before
such meeting financial statements for the financial year.
Where a company has one or more subsidiaries, it shall in addition to ita financial statementa, prepare a
consolidated financial statements of the company and of all the subsidiaries in the same form and manner as
that of its own which shall also be laid before the annual general meeting of the company along with the laying
of its financial statements.
If a company contravenes the provisions of Section 129 of the Companies Act, 2013, the managing
director, the whole-time director in charge of finance, the chief Financial Officer or any other person charged
by the Board with the duty of complying with the requirements of this Section and in the absence of any of the
officers mentioned above, all the directors shall be punishable with imprisonment for a term, which may extend

33
to one year or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh
rupees, or with both.
It is further stated that the books of accounts should be maintained on accrual basis and according to the
double entry system of accounting to ensure that these represent true and fair view of the affairs of the company
or branch office, as the case may be
The Act requires that proper stock records should form a necessary part of proper books of accounts and
also that the books of accounts and the relevant vouchers must be preserved for a minimum period of eight
years in good order.

Statutory Books
Following statutory books are required to be maintained by a company to comply with the various
provisions given in the Companies Act, 2013
1. Register of charges (Section 85)
2. Register of members (Section 88)
3. Index of members (Section 88)
4. Register of debenture holders with index (Section 88)
5. Copies of annual returns (Section 94)
6. Minute books--to record the proceeding of the general meetings and of the meetings of the board and its
committees (Section 118)
7. Register of contracts with companies and firms in which directors are interested (Section 189)
8. Register of directors, managing director, manager and secretary (Section 170)
9. Register of directors' shareholdings (Section 170)
10. Register of investments in shares and debentures of bodies corporate
11. Register of loans made to other companies under the same management
12. Directors' attendance book
Constitution of National Financial Reporting Authority
Section 139 of the Companies Act, 2013 provides as follows:
(1) The Central Government may, by notification, constitute a National Financial Reporting Authority to
provide for matters relating to accounting and auditing standards under this Act.
(2) Notwithstanding anything contained in any other law for the time being in force the National
Financial Reporting Authority shall-
a) make recommendations to the Central Government on the formulation and laying down of accounting
and auditing policies and standards for adoption by companies or their auditors, as the case may be;
b) Monitor and enforce the compliance with accounting standards and auditing standards in such manner as
may be prescribed;
c) oversee the quality of service of the professions associated with ensuring compliance with such
standards, and suggest measures required for improvement in quality of service and such other related
matters as may be prescribed;
d) perform such other functions; and clauses (a), (b), and (c) as may be prescribed,
(3) The National Financial Reporting Authority shall consist of a chairperson who shall be a person of
eminence and having expertise in accountancy, auditing, finance or law De to n pointed by the Central
Government and such other members not exceeding fifteen consisting of part-time and full-time members as
may be prescribed.
Compliance with the Accounting Standards
According to Section 129 of the Companies Act, 2013, the financial statements shall give a true and fair
view of the state of affairs of the company or companies, comply with the accounting standards and shall be in
the form or forms as may be provided for different class or classes of companies in Schedule III. It is further
provided that items contained in such financial statements shall be in accordance with the accounting standards.
As per Section 133 of the Companies Act, 2013, the Accounting Standards recommended by the Institute of
Chartered Accountants of India and prescribed by the Central Government in consultation with National
Financial Reporting Authority are mandatory and applicable to all companies while preparing Statement of
Profit and Loss and Balance Sheet Section 129(5) prescribes that: Where Statement of Profit and Loss and the
Balance Sheet of a company do not comply with the accounting standards, such a company shall disclose in its
Statement of Profit and Loss and Balance Sheet (a) the deviation from the accounting standards; (b) the reasons
for such deviation and (c) the financial effect, if any, arising due to such deviation.

34
 B. FORMATS OF FINANCIAL STATEMENTS
Form and Contents of Profit and Loss Account
Sub-section (2) of Section 129 of the Companies Act, 2013 requires that "every Profit and Loss Account
of a company shall give true and fair view of the profit or loss of the company for the financial year and comply
with the requirements of Part II of Schedule III so far as they are applicable thereto.
Provided that nothing contained in this sub-section shall apply to any insurance or banking company, or
any company engaged in the generation or supply of electricity or to any other class of company for which a
form of profit and loss account has been specified in or under the Act governing such class of company."
It is also given in sub-section (6) of Section 129 that the Central Government may exempt any class of
companies from compliance with any of the requirements in Schedule III if, in its opinion, it is necessary to
grant exemption in the public interest. Any such exemption may be granted either unconditionally or subject to
such conditions as may be specified in the notification.

Form and Contents of Balance Sheet

Section 129 of the Companies Act, 2013 requires that at every annual general meeting of the
shareholders, the Board of Directors of the Company shall lay before the company a Balance Sheet as at the end
of each trading period. Every Balance Sheet of a company shall be prepared in the form given in Part I of the
Schedule III of the Companies Act, 2013, or as near thereto as circumstances admit, or in such other form as
may be approved by the Central Government either generally or in a particular case. It further states that in
preparing the Balance Sheet due regard shall be had, as far as may be, to the general instructions for preparation
of the Balance Sheet. The objective of prescribing the form for the Balance Sheet in Schedule Ill is to make sure
that Balance Sheet exhibits a true and fair view of the state of affairs of the company. There should be no room
for window dressing, showing a better position than what actually is, and secret reserves showing a worse
picture than what actually is.
The Companies Act, 2013 replaced the existing Schedule VI by a revised Schedule III wherein several
changes in the presentation and disclosures requirements have been made. The most important change is that
the financial statements will be presented in the vertical formats. There is no option to use horizontal forms in
the presentation of financial statements and the financial statements are to be prepared in the prescribed vertical
formats of Schedule III. Only broad and significant items are to be shown on the face of the Balance Sheet and
Statement of Profit and Loss. Detailed information of broad and significant item is to be given in Notes to
Accounts accompanying the financial statements. Broad and eration ant items to be shown on the face of the
financial statements will be decided taking into consideration the concept o materiality and presentation of true
and fair view of the financial statements.

"SCHEDULE III”
(See section 129)
GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET AND STATEMENT OF
PROFIT AND LOSS OF A COMPANY IN ADDITION TO THE NOTES INCORPORATED ABOVE
THE HEADING OF BALANCE SHEET UNDER
General Instructions
1. Where compliance with the requirements of the Act including Accounting Standards as applicable to the
companies require any change in treatment or disclosure including addition, amendment, substitution or
deletion in the head/sub-head or any changes inter se, in the financial statements or statements forming part
thereof, the same shall be made and the requirements of this Schedule shall stand modified accordingly.
2. The disclosure requirements specified in this Schedule are in addition to and not in substitution of the
disclosure requirements specified in the Accounting Standards prescribed under the Companies Act,
2013. Additional disclosures specified in the Accounting Standards shall be made in the notes to accounts or by
way of additional statement unless required to be disclosed on the face of the Financial Statements. Similarly,
all other disclosures as required by the Companies Act shall be made in the notes to accounts in addition to the
requirements set out in this Schedule.
3. Notes to accounts shall contain information in addition to that presented in the Financial Statements and shall
provide where required (a) narrative descriptions or disaggregation’s of items recognized in those statements
and (b) information about items that do not qualify for recognition in those statements.
Each item on the face of the Balance Sheet and Statement of Profit and Loss shall be cross-referenced to any
related information in the notes to accounts. In preparing the Financial Statements including the notes to

35
accounts, a balance shall be maintained between providing excessive detail that may not assist users of financial
statements and not providing important information as a result of too much aggregation.
4. Depending upon the turnover of the company, the figures appearing in the Financial Statements may be
rounded off as below:
Turnover Rounding off
(i) less than one hundred crore rupees To the nearest hundreds, thousands, lakhs or millions,
or decimals thereof.
(ii) one hundred crore rupees or more To the nearest, lakhs, millions or crores, or decimals
thereof.
Once a unit of measurement is used, it should be used uniformly in the Financial Statements.
5. Except in the cast of the first Financial Statements laid before the Company (after its incorporation) the
corresponding amounts (comparatives) for the immediately preceding reporting period for all items shown in
the Financial Statements including notes shall also be given.
6. For the purpose of this Schedule, the terms used herein shall be as per the applicable Accounting Standards.

NOTE: This part of Schedule sets out the minimum requirements for disclosure on the face of the Balance
Sheet, and the Statement of Profit and Loss (hereinafter referred to as "Financial Statements" for the purpose of
this Schedule) and Notes. Line items, sub-line items and sub-totals shall be presented as an addition or
substitution on the face of the Financial Statements when such presentation is relevant to an understanding of
the company's financial position or performance or to cater to industry/sector-specific disclosure requirements
or when required for compliance with the amendments to the Companies Act or under the Accounting
Standards.

PART I – Form of BALANCE SHEET

Name of the Company____________
Balance sheet as at ______________ (Rupees in ________)

Particulars Note Figures as at the Figure as at the end

No. end of current of the previous
reporting period reporting period
1 2 3 4
I. EQUITY AND LIABILITIES
(1) Shareholders' funds
(a) Share capital
(b) Reserves and surplus
(c) Money received against share
warrants
(2) Share application money pending
allotment
(3) Non-current liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (Net)
(c) Other Long-term liabilities
(d) Long-term provisions
(4) Current liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
TOTAL
IL. ASSETS
Non-current assets
(1) (a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
36
 (iv) Intangible assets under
development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets
(2) Current assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
TOTAL
See accompanying notes to the financial statements

PART II – Form of STTEMENT OF PROFIT AND LOSS

Name of the Company____________
Profit and loss statement for the year ended ______________ (Rupees in ________)

Particulars Note Figures as at the Figure as at the end

No. end of current of the previous
reporting period reporting period
I. Revenue from operations
II. Other income
III. Total Revenue (I + II)
IV. Expenses:
Cost of materials consumed
Purchases of Stock-in-Trade
Changes in inventories of finished goods
work-in-progress and Stock-in-Trade
Employee benefits expense
Finance costs
Depreciation and amortization expense
Other expenses
Total expenses
V. Profit before exceptional and extraordinary
items and tax (III-IV)
VI. Exceptional items
VII. Profit before extraordinary items and tax (V
-VI)
VIII. Extraordinary Items
IX. Profit before tax (VII-VIII)
X. Tax expense:
(1) Current tax
(2) Deferred tax
XI. Profit (Loss) for the period from continuing
operations (VII-VIII)
XII. Profit/(loss) from discontinuing operations
XIII Tax expense of discontinuing operations
XIV Profit/(loss) from Discontinuing operations
(after tax) (XIl - XIII)
XV Profit (Loss) for the period (XI + XIV)
XVI Earnings per equity share:
(1) Basic
(2) Diluted

37
 C. DIVISIBLE PROFITS
The term "Divisible Profit" is a very complicated term because all profits are not divisible profits. Only
those profits are divisible profits which are legally available for dividend to shareholders. Dividends cannot be
declared except out of profits, i.e., excess of income over expenditure; ordinarily capital profits are not available
for distribution amongst shareholders because such profits are not trading profits. Thus, profits arising from
revaluation or sale of fixed assets or redemption of fixed liabilities should not be available for distribution as
dividend amongst shareholders. The principles of determination of the divisible profits are governed by Section
123 of the Companies Act, 2013 which is reproduced below:
"(1) No dividend shall be declared or paid by a company for any financial year except out of the profit
of the company for that year arrived at after providing for depreciation in accordance with the provision of sub-
Section (2) or out of the profits of the company for any previous financial year or years arrived at after
providing for depreciation in accordance with those provisions and remaining undistributed or out of both or out
of moneys provided by the Central Government or a State Government for the payment of dividend in
pursuance of a guarantee given by the Government:
Provided that a company may, before the declaration of any dividend in any financial year, transfer such
percentage of its profits for that financial year as it may consider appropriate to the reserves of the company.
No dividend shall be declared or paid by a company from its reserves other than free reserves.
It is further provided that where owing to inadequacy or absence of profits in any financial year, any
company proposes to declare dividend out of the accumulated profits earned by it in previous years and
transferred by the company to reserves, such declaration of dividend shall not be made except in accordance
with such rules as may be prescribed in that behalf.
(2) For the purposes of sub-section (1), depreciation shall be provided in a accordance with the
provisions of schedule II.
(3) The board of Directors may declare interim dividend during any financial year out of the surplus and
out of profits of the financial year in which such interim dividend is sought to be declared.
Provided that in case the company has incurred lows during the current financial year up to the end of
the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not
be declared at a rate higher than the average dividends declared by the company during the immediately
preceding three financial years,
(4) The amount of dividend, including interim dividend, shall be deposited in a scheduled bank in a
separate account within five days from the date of declaration of such dividend.
(5) No dividend shall be paid by a company in respect of any share therein except to the registered
shareholder of such share or to his order or to his banker and shall not be payable except in cash.
Provided that nothing in this sub-section shall be deemed to prohibit the capitalization of profits or
reserves of a company for the purpose of issuing fully paid-up bonus shares or paying up any amount for the
time unpaid on any shares held by the members of the company.

From the above provisions it is clear that dividends cannot be declared unless:
(1) depreciation has been provided for in respect of the current financial year for which
dividend is to be declared;
(2) arrears of depreciation in respect of previous years have been deducted from the profits; and
(3) losses incurred by the company in the previous years.
It is not compulsory for a company to provide for depreciation on fixed assets. But it makes
compulsory for the provision of the depreciation if dividend is to be declared. Depreciation on circulating
assets is compulsory. How is it provided? It is provided by valuing circulating assets at cost or market
price, whichever in lower. If depreciation on fixed assets is not provided for, the fact and the amount
involved has to be disclosed by way of a note.
Sometimes in an examination problem, rates for calculating the amount of depreciation on
various fixed assets along with the maximum amount of depreciation permissible as per Income-tax rules
may be given. In such a case, Profit and Loss Account is debited with the amount of depreciation
calculated according to the rates given and the same amount of depreciation is deducted from fixed assets
in the Balance Sheet too. But the maximum limit of depreciation prescribed by the Income-tax rules is
taken into consideration for calculating provision for taxation and managerial remuneration, i.e., the
excess amount of depreciation charged according to the rates given over the maximum limit as per
income-tax rules is added to the profits as disclosed by the Statement of Profit and Lows and on this
adjusted profit, the provision for taxation and the managerial remuneration is calculated.

38
Dividends
Shareholder expect some return for the money invested by them in the company. They get the return on
their investment in the form of dividends given to them from time to time. Thus, dividends are the profits of the
company distributed amongst the shareholders. The company may declare dividends in general meeting, but no
dividend shall exceed the amount recommended by the Board of Directors. Thus, shareholders in annual
general meeting can only reduce the amount of dividends but cannot increase the amount of dividends
recommended by the Board of Directors. It is no because directors are familiar with the financial affairs of the
company and as such are considered as the experts to decide the amount to be distributed as dividend among
shareholders. The directors may not recommend dividend even if there are profit if they think that distribution
of dividend will impair the financial position of the company.

Dividends are usually paid in proportion to the amount paid on shares in the absence of any
Indication to the contrary in the Articles of Association.

Sources of Declaring Dividend

As per Section 123 of the Companies Act, 2013 dividend may be declared out of the following
three sources:
1. Out of Current Profits. Dividend may be declared out of the profits of the company for the current
year after providing depreciation.
2. Out of Past Reserves. Dividend may be declared out of the profits of the company for any previous
financial year or years arrived at after providing for depreciation in accordance with the provisions of
the Companies Act, 2013 and remaining undistributed.
3. Out of Money Provided by the Government. A company can also declare dividend out of the moneys
provided by the Central Government or a State Government for payment of such dividend in
pursuance of guarantee given by the Government.

Types of Dividend
Dividends may be of the following two types
1. Interim Dividend. 2. Final Dividend.
1. Interim Dividend:
This dividend is declared between two annual general meetings. Subject to the provisions of Section 123
of the Companies Act, 2013 as per regulation 81 of Table F, the Board may from time to time pay to the
shareholders such interim dividends as appear to it to be justified keeping in view the profits of the company.
The articles of association may allow for the payment of such a dividend if Table F has been adopted by a
company. The payment of such a dividend is declared by the directors, so there is no necessity of calling a
meeting of the shareholders to sanction the payment of such a dividend as it is in case of a final dividend. But
the directors are to be very careful while declaring interim dividend. They are to keep in mind the future
prospects of the profits and are to declare interim dividend only if they feel that profits will be maintained for
the remaining part of the year. If it is discovered at the end of the year that the profit disclosed by the Statement
of Profit and Loss is not sufficient to cover the amount paid as interim dividend, the directors will have to make
good the amount of such dividends as dividends can be paid legally out of profits and not out of capital.
Interim dividend like final dividend is an appropriation of profits and has to be shown as a deduction
from Surplus (i.e. Balance of Statement of Profit and Loss) under the head of "Reserves and Surplus" in the
Balance Sheet. The Board of Directors may declare interim dividend and the amount of dividend including
interim dividend shall be deposited in a separate bank account within five days from the date of declaration of
such dividend. The amount of dividend including interim dividend so deposited shall be used for the payment of
dividend. As per Section 2(35) of the Companies Act, 2013, dividend includes any interim dividend.
2. Final Dividend:
It is a dividend which is declared at the annual general meeting of the shareholders and is declared by
the shareholders only on the recommendation of the directors. The dividend proposed by the directors is
provided for in the final accounts of the company and is paid only after it has been passed at the annual general
meeting of the shareholders.
Distinction Between Interim Dividend and Final Dividend
Interim dividend is the dividend which is paid in anticipation of profits. It is dividend paid by the
directors any time between the two annual general meetings of the company, that is, on the basis of less than a
full year's results. Final dividend is recommended by the directors and declared by the shareholders in the

39
Annual General Meeting whereas interim dividend can be declared by the directors and does not require the
approval of the shareholders.
The payment of interim dividend depends much more upon estimates and opinions than the declaration
of a final dividend which is made upon the information contained in the Final Accounts.
Final dividend is declared and paid once in a year whereas interim dividend can be declared and paid
for more than one time in a year.
For declaration and payment of interim dividend, the directors need to satisfy that there are adequate
distributable profits and payment of interim dividend would not result in payment of dividend out d
capital.
Dividends on Preference Shares. Preference shareholders enjoy a preferential right in respect of
dividends as compared to the equity shareholders and are paid a fixed rate of dividend. But the right of dividend
is subject to the availability of profits and recommendation of the directors. The holders of non-cumulative
preference shares cannot claim dividend in subsequent years if there are inadequate profits in any year, but the
holders of cumulative preference shares can claim the unpaid dividend in any year during the subsequent year
or years when there are sufficient profits. Arrears of dividends on cumulative preference shares are shown as a
contingent liability outside the Balance Sheet because the payment of arrears of dividends depends upon the
future profits of the company which are uncertain.
Scrip Dividend. Previously some companies used to distribute dividend in the form of shares of other
companies which may have been held by them as investments. Such type of dividend given in the form of
shares was known as scrip dividend. But now-a-days such type of dividend is not allowed because according to
Section 123 of the Companies Act, 2013 no dividend shall be payable except in cash.
Separate Bank Account for the Payment of Dividends. Usually a company opens a separate bank
account for the payment of dividends. From the general bank account an amount equal to the net amount
payable to the shareholders as dividends is transferred to the Dividend Banking Account. Such an account is
debited when dividends are paid. Section 124 of the Companies Act, 2013 lays down that if a company is
unable to make the payment of the dividend or post the dividend warrant within 30 days of the declaration of
the dividend, it must open a special account entitled "Unpaid Dividend Account of...... (Name of the company"
in a scheduled bank and deposit therein the amount of the dividend as yet unpaid. The special account must be
opened within 7 days after the 30th day of the declaration of the dividend. On the expiry of the 7th day after the
30th day, the company will be liable to pay interest to the shareholders @ 12% p.a. on the amount that has not
been deposited in the special bank account. After the transfer of the amount of the unpaid dividend to the
special bank account, the dividends concerned will be paid out of this special account. If any dividend is not
claimed for a period of 3 years, the balance in the special bank account must be transferred by the company to
the general revenue account of the Central Government. After such transfer, the claim for the unpaid dividend
by the shareholders can be lodged with the Central Government. Thus, unclaimed dividend cannot be forfeited
by the company but has to be deposited with the Central Government.
Corporate Dividend Tax. As per the Finance Act, 1997 dividends paid or declared were subject to
corporate dividend tax @ 10% with effect from 1st June, 1997. Such corporate dividend tax is deducted from
Surplus sub-head in the Balance Sheet and it is also shown under the heading 'Short-term Provisions' as a
current liability till it is paid. But as per recent Finance Act, 2019-20, corporate dividend tax is not required
to be provided. Hence, Provision for corporate dividend tax is not required now-a-days.

Capital Profits.
Capital profits are not earned during the normal course of the business and arise in the following special
circumstances:
(a) Excess of sale proceeds over the cost of the fixed assets.
(b) Profit on sale of the undertaking or part of it.
(c) Profits on purchase of business, such profit arises when the value of assets taken over minus the liabilities
taken over is more than the amount paid for the purchase of the business.
(d) Profit on revaluation of fixed assets and liabilities.
(e) Profit prior to incorporation.
(f) Premium received on issue of shares or debentures.
(g) Balance left in Forfeited Shares Account after the reissue of forfeited shares.
(h) Profit made on redemption of debentures.
(i) Profit set aside for redemption of preference shares.

40
 Generally capital profits are not available for the distribution of dividend. Such profits can be utilised
for writing off capital losses and fictitious assets like preliminary expenses, goodwill, discount or commission
on issue of shares or debentures etc. or for issuing bonus shares.
Capital profits can be distributed as dividend only if (a) the Articles of a Company permit; (6) they are
realised in cash; (c) surplus remains after a revaluation of all assets ; and (d) capital losses have been written
off. It may be noted that premium on issue of shares, profit on reissue of forfeited shares and profits transferred
to Capital Redemption Reserve Account consequent upon the redemption of preference shares out of profits
cannot be distributed as dividend under the Companies Act.
Profits of Subsidiary Companies. Profits of subsidiary companies are not to be included in divisible
profits of the holding company. Only share of dividend declared by the subsidiary company belonging to the
holding company should be treated as divisible profit. Dividend received out of profits existing on the date of
acquiring shares of the subsidiary company must be treated as a capital receipt and is not to be included in
divisible profits of the holding company.

Provision for Taxation

A company is liable to pay income-tax or tax on profits under the Income-tax Act, 1961 and such tax is
treated as a charge against the profits of the accounting year, although the profits are assessed and actual
liability for tax is determined in the following year. Moreover, the assessable profits (taxable profits) are seldom
the same as accounting profits. As such it is not possible to determine the actual amount of tax payable at the
time the final accounts are prepared. Therefore, liability for tax is estimated and provided for while preparing
the final accounts. Such provision is is a charge against profit profit and loss statement and credited to provision
for taxation account.

While making the estimate of provision for taxation, due consideration should be given to the following points:
(i) Whether the net profit has been determined after deducting depreciation according to Income-tax
Act and managerial remuneration.
(ii) Whether income-tax has been computed at the rates prescribed.
(iii) Whether profit sur-tax is payable or not.
(iv) Whether capital gains tax is payable or not.
(v) Whether penalty is payable under any tax laws. (vi) Whether rebates are available for double taxation.
(vi) Whether investment allowance, extra shift allowance, etc., if any, have been duly deducted or not
in estimating the tax liability.
(viii) Whether adjustment has made for the last year's actual tax liability or not.

D. MANAGERIAL REMUNERATION
The Companies Act lays down restrictions on the remuneration to be paid to directors, manager, and managing
director. Under Section 197 of the Companies Act, the total remuneration payable by a public company to
directors, manager and managing director in any financial year should not exceed 11% of the net profits of the
company for that financial year computed in the manner laid down in Sections 198 of the Companies Act, 2013.
For the purpose of Section 198 and other related Sections, however, remuneration shall include:
(a) any expenditure incurred by the company in providing any rent-free accommodation, or any other benefits
or amenity in respect of accommodation free of charge, to any of the managerial personnel;
(b) any expenditure incurred by the company in providing any other benefit or amenity free of charge or at
concessional rate to them:
(c) any expenditure incurred by the company in respect of any obligation or service which but for such
expenditure by the company would have been incurred by any of the managerial personnel; and
(d) any expenditure incurred by the company to effect any insurance on the life of, or to provide any pension,
annuity, or gratuity for any of the managerial personnel, or his spouse or child.
It shall, however, exclude any fee payable to the directors for attending the meeting of the Board or a
committee thereof.

Remuneration in Case of Nil or Inadequate Profits

Notwithstanding anything contained in this Part, where in any financial year during the currency of tenure of
the managerial person, a company has no profits or its profits are inadequate, it may pay remuneration to a
managerial person by way of salary, dearness allowance, perquisites and any other allowances as per Part II of
Schedule V as given below:

41
 Where the effective capital of Company is Yearly remuneration payable shall not
exceed (Rupees)
(i) Negative or less than rupees 5 crores 30 lakhs
(ii) 5 crores and above but less than rupees 100 crores 42 lakhs
(iii) 100 crores and above but less than rupees 250 crores 60 lakhs
(iv) rupees 250 crores and above 60 lakhs plus 0.01% of the effective capital
in excess of Rs.250 crores

Provided that the above limits shall be doubled if the resolution passed by the shareholders is a s resolution.
For a period less than one year the limits shall be prorated.
Provided that the ceiling limits specified under this sub-paragraph shall apply, if:
a) payment of remuneration is approved by a resolution passed by the Remuneration Committee
b) the company has not made any default in repayment of any of its debts (including deposits) or
debentures or interest payable thereon for a continuous period of thirty days preceding financial year
before the date of appointment of such managerial person;
c) a special resolution has been passed at the general meeting of the company for payment of
remuneration for a period not exceeding three years;
d) a statement along with a notice calling the general meeting referred to in clause (iii) is given
shareholders containing the following information, namely

I. General Information
1. Nature of industry
2. Date or expected date of commencement of commercial production
3. In case of new companies, expected date of commencement of activities as per project approve
financial institutions appearing in the prospectus
4. Financial performance based on given indicators
5. Export performance and net foreign exchange collaborations
6. Foreign investments or collaborators, if any.

II. Information about the Appointee

1. Background details
2. Past remuneration
3. Recognition or awards
4. Job profile and his suitability
5. Remuneration proposed
6. Comparative remuneration profile with respect to industry, size of the company, profile of the
position and person (in case of expatriates the relevant details would be w.r.t. the country of his origin)
7. Pecuniary relationship directly or indirectly with the company, or relationship with the managerial
personnel, if any.

III. Other Information

1. Reasons of loss or inadequate profits
2. Steps taken or proposed to be taken for improvement
3. Expected increase in productivity and profits in measurable terms.

IV. Disclosures
1. The shareholders of the company shall be informed of the remuneration package of the mar
person.
2. Following disclosures shall be mentioned in the Board of director's report under the I
"Corporate Governance", if any, attached to the annual report:
(i) All elements of remuneration package such as salary, benefits, bonuses, stock pension etc. of all the
directors;
(ii) Details of fixed component and performance linked incentives along with the performance criteria;
(iii) Service contracts, notice period, severance fees;
(iv) Stock option details, if any, and whether the same has been issued at a discount as
the period over which accrued and over which exercisable.
42
Remuneration to Directors.
According to Section 197, a whole-time director or managing director may be paid remuneration by
monthly payment or by a percentage of profit or by both methods, but except with the approval of the Central
Government, such remuneration should not exceed 5 per cent for any one such director; when there is more
than one such director, 10 per cent for all of them put together.
In case of part-time directors, total remuneration, except with the approval of the Central Government,
cannot exceed 1 per cent of the net profits of the company if the company has a managing or whole-time
director, or a manager and 3 per cent of the net profits if the company has not a managing or whole time
director or a manager. If any director draws or receives remuneration in excess of the amount mentions above,
he shall refund such sums to the company. The company has no power to waive the recovery of any such
refundable sum, except with the approval of the Central Government.
It is further laid down that remuneration to a director will include any remuneration paid to him for
services rendered by him in any capacity except when the services are of a professional nature and in the
opinion of the Central Government he is a professionally qualified person.
It may be noted that the Companies Act, 2013 prescribes the maximum limit of overall managerial
remuneration and of remuneration payable to various managerial personnel. But a company is free to fix up the
managerial remuneration at a rate within those prescribed limits. The company is also empowered to calculate
the managerial remuneration either on the net profits of the company before charging such commission or on
the net profits of the company after charging such commission. If nothing is given in the question as to whether
the managerial remuneration is to be calculated on the net profits of the company before charging such
remuneration or after charging such remuneration, it is to be assumed that the remuneration is to be calculated
on the net profits before charging such remuneration.

CHART SHOWING OVERALL PICTURE OF MANAGERIAL REMUNERATION

Different categories of managerial personnel entitled to remuneration Maximum percentage of net profit
1. Total managerial remuneration to all directors, director(s) or 11% and if there are no profits or
manager and/or whole-time director(s) inadequate profits Rs.30 lakhs to
Rs.60 lakhs per year per person
depending on the effective capital
of the company
2. All directors when there is no manager or managing director or 3%
whole-time director
3. All directors when there is a manager or managing director or 1%
whole-time director
4. Whole-time director (when there is one such director) 5%
5. Managing director (when there is one such director) 5%
6. Managing director and whole-time directors taken together or when 10%
number of whole-time directors or managing directors is two or more
than two.
7. Manager (there is no provision of having more than one manager). 5%

Methods of calculating net profit for the purposes of calculating the managerial remuneration
There are two methods of calculating the net profit for the purpose of calculating the managerial
remunerations: (1) Gross Profit Approach; (2) Net Profit Approach.

(1) Gross Profit Approach:

Under this approach gross profit is taken as the starting point. Income to be taken in Statement of Profit
& Loss are added. Expenses allowable are to be deducted. This will be more clear from the following format:
Particulars Rs.
Gross Profit (Sales - Cost of Goods Sold) XXX
Add: Income to be taken into account XXX
Bounties and subsidies received from Government XXX
Capital Profit on the Sale of Fixed Asset (Sale Proceeds - Original Cost) XXX
Less: Expenses Allowable
(i) Salaries & Wages XXX
(ii) Rent, Rates & Taxes XXX
43
 (iii) Repairs and Renewals XXX
(iv) Misc. Expenses XXX
(v) Workmen Legal Compensation (not Voluntary Compensation) XXX
(vi) Interest on Bank Loan XXX
(vii) Interest on Debentures XXX
(viii) Directors' Fees XXX
(ix) Donations as per the Act XXX
(x) Depreciation to the extent specified under Schedule II of the Companies Act, 2013 XXX
Net Profit for the purpose of calculating commission XXX

(2) Net Profit Approach:

Under this approach, profit (as calculated as per Statement of Profit & Loss) is taken as the starting
point. All items not to be deducted (i.e. not allowable) from computing profit for the purpose of commission are
added. Items allowable are deducted for the purpose of calculating commission. It will be non-clear from the
following format.
Particulars Rs.
Net Profit as per Statement of Profit & Loss XXX
Add: Items not allowable:
Managing Director's Remuneration XXX
Scientific Research Expenditure XXX
Provision for Doubtful Debts XXX
Tax Provision XXX
Preliminary Expenses XXX
Depreciation (Already taken in Statement of P/L - Depreciation Allowable as
per Section 123 of the Companies Act) XXX
Loss on the Sale of Investment XXX
Proposed Dividend XXX
Ex-Gratia Payment to Employees XXX
Manager's Salary XXX
Commission to Manager (on Account) XXX
Capital Expenditure XXX XXX
XXX
Less: Items Allowable
Bonus (Liability as per Payment of Bonus Act--Bonus already debited to XXX
Statement of P & L)
Capital Profit on Sale of Fixed Asset (in excess of original cost) (Sale Price i.e. XXX
Book Value + Profit - Original Cost)
Profit on Sale of Investment (Capital Profit) XXX XXX
Profit for the Purpose of Managerial Commission XXX

Final account of companies:

Calculation of Managerial remuneration
PROBLEM: 1
From the following information provided by MNC Ltd., for the year ended 31st March, 2021, calculate the
overall (maximum) managerial remuneration:
Particulars Rs. Particulars Rs.
To Salaries and Wages 65,000 By Gross Profit 16,70,000
To Repairs 30,000 By Profit on Sale of Plant (Cost 1,70,000
To Depreciation (including Rs.3,00,000; Written down value
Development Rebate Rs.15,000) 1,10,000 Rs.1,50,000 Amount realised on Sale
To General Expenses 25,000 Rs.3,20,000)
To Loss on Sale of Investment 20,000 By Subsidy from Government 40,000
To Scientific Research (new Laboratory
setup) 1,03,000
To Donation to Charitable Institutions 35,000
To Interest on Debentures 35,000
44
To Debenture Trustees Remuneration 15,000
To Directors' Fees 12,000
To Income Tax 5,10,000
To Proposed Dividend 5,10,000
To Balance c/d 4,10,000
18,80,000 18,80,000

PROBLEM: 2
Calculate the managerial remuneration from the following particulars of Ankit and Company Ltd., due to
managing director of the company at the rate of 5% of the profits. Also determine the excess remuneration paid,
if any:
Particulars Rs.
Net Profit 2,00,000
Net profit is calculated after considering the following:
(i) Depreciation 40,000
(ii) Tax provision 3,20,000
(iii) Directors' fees 8,000
(iv) Bonus 15,0200
(v) Profit on sale of fixed assets (original cost Rs.20,000 written down value Rs.11,000). 15,500
(vi) Provision for doubtful debts 9,000
(vii) Scientific research expenditure (for setting up new machinery) 20,000
(viii) Managing director's remuneration paid 30,000
Other information:
(a) Depreciation allowable according to the Companies Act, 2013 35,000
(b) Bonus liability as per Payment of Bonus Act, 1965 18,000

PROBLEM: 3
Pagadiwala Containers Ltd., having three whole-time directors, on its board, the others being part-time
directors, earned profits during the year ended 31st March, 2021 to the tune of Rs.2,50,000 after taking into
consideration the following:
Particulars Rs.
Depreciation of fixed assets (Depreciation admissible 47,800
as per income tax rules Rs.32,800)
Provision for income-tax 1,22,500
Capital expenditure included in general expenses
charged to profit and loss account 12,500
Calculate the maximum remuneration payable to the whole-time directors assuming that the remuneration
payable to the whole-time directors is to be calculated on net profits remaining after payment of commission to
part-time directors and the commission to part-time directors is to be calculated on net profits remaining after
payment of remuneration to whole-time directors.

PROBLEM: 4
From the following information of Swatantra Ltd., for the year ended 31st March, 2021, calculate the
commission payable to the Managing Director and other Directors of the company whose commission was
fixed @5% and 2% respectively on the profit of the company before charging their commission.
Salaries and wages 20,00,000 Gross Profit 51,00,000
Rent, Rates and Taxes 4,50,000 Bounties and Subsidies received from 1,00,000
Repairs and Renewals 60,000 Govt.
Miscellaneous Expenses 1,40,000 Profit on Sale of Fixed Assets 80,000
Workmen Compensation including Premium on Issue of Shares 20,000
Rs.10,000 legal compensation 25,000 Profit on Sale of forfeited Shares 10,000
Interest on Bank Overdraft 40,000
Interest on Debentures 50,000
Directors’ Fees 18,000
Donation 35,000
Depreciation on Fixed Assets 1,00,000
45
Loss on Sale of Investment 25,000
Reserve for Redemption of Redeemable
Preference Shares 1,50,000
Development Rebate Reserve 1,00,000
Provision for Taxation 10,00,000
Balance c/d 11,17,000
53,10,000 53,10,000
Notes:
S. No. Particulars Rs.
1 Original cost of the fixed assets sold 1,90,000
Written down value of the fixed assets sold 1,40,000
Sales proceeds of the fixed assets 2,20,000
2 Donation allowable under the Income Tax Act 25,000
3 Depreciation allowable for income tax purposes 80,000
PROBLEM: 5
Determine the maximum remuneration payable to the part-time directors and manager of B Ltd., (a
manufacturing company) under the Companies Act, 2013 from the following particulars:
Before charging any such remuneration, Statement of Profit and Loss showed a credit balance of Rs.23,10,000
for the year ended 31st March, 2021 after taking into account the following matters:
Particulars Rs.
Capital expenditure 5,25,000
Subsidy received from Government 4,20,000
Special depreciation 70,000
Multiple shift allowance 1,05,000
Bonus to foreign technicians 3,15,000
Provision for taxation 28,00,000
Compensation paid to injured workman 70,000
Ex-gratia to an employee 35,000
Loss on sale of fixed assets 70,000
Profit on sale of investment 2,10,000
Company is providing depreciation as per Section 123 of the Companies Act, 2013.
PROBLEM: 6
Prepare the Balance Sheet as at 31.3.2021 from the particulars furnished by M/s Pran Ltd., as per Schedule III
of the Companies Act:
Particulars Rs. Particulars Rs.
Share capital 7,50,000 Capital Redemption Reserve 20,000
Calls in arrear 5,000 Investment in 6% GP Notes (Tax Free) 3,00,000
Land 2,20,000 Surplus account 65,000
Building 2,00,000 Cash in hand 25,000
General reserve 50,000 Debtors 10,000
Loan from IDBI 1,00,000 Stock 1,00,000
Sundry creditors 1,50,000 Goodwill 25,000

PROBLEM: 7
Rising Engineers Ltd., have authorized capital of Rs.50 lakhs, divided into 5,00,000 equity shares of Rs.10
each. Their books show the following balances as on 31st March, 2021:
Particulars Rs. Particulars Rs.
Stock as on 1.4.2020 6,65,000 Bank Current A/c 20,000
Discount & Rebates 30,000 Cash in hand 8,000
Carriage Inwards 57,500 Debenture Interest (for ½ year to 30.09.2020) 10,000
Patterns 3,75,000 Interest – Bank 91,000
Rates, Taxes and Insurance 55,000 Calls in arrears 10,000
Furniture & Fixtures 1,50,000 Equity Share Capital (2,00,000 shares of Rs.10 each) 20,00,000
Materials Purchased 12,32,500 4% Debentures (repayable after 10 years) 5,00,000
Wages 13,05,000 Bank overdraft 7,57,000
46
 Coal & Coke 63,000 Sundry Creditors (for goods) 2,40,500
Freehold land 12,50,000 Sales 36,17,000
Plant and Machinery 7,50,000 Rent (Cr.) 30,000
Engineering Tools 1,50,000 Transfer Fees 6,500
Goodwill 3,75,000 Surplus A/c (Cr.) 67,000
Sundry debtors 2,66,000
Bills Receivable 1,34,500
Advertisement 15,000
Commission & Brokerage 67,500
Business Expenses 61,000
Repairs 46,500
Bad Debts 25,500
The stock (valued at cost or market value whichever is lower) as on 31st March, 2021 was Rs.7,08,000.
Outstanding liability for wages Rs.25,000 and business expenses Rs.25,000.
Dividend declared @10% on paid up capital. To charge depreciation: Plant & Machinery @5%, Engineering
tools @20%; Patterns @ 10%; and furniture & fixture @ 10%.
Provide 2% on debtors as doubtful debts after writing off Rs.21,500 as bad debts and create debenture
redemption reserve Rs.10,000. Provide Rs.2,40,000 for income-tax.
You are required to prepare (i) Statement of Profit and Loss for the year ended 31st March, 2021; and (ii)
Balance Sheet as on that date; in accordance with Companies Act, 2013 giving as much information as
necessary, Ignore previous year’s figures. [Net Profit Rs.1,85,610; B/S Total Rs.40,40,110]

PROBLEM: 8
Moon and Star Co., Ltd., is a company with an authorized capital of Rs.5,00,000 dividend into 5,000 equity
share of Rs.100 each on 31.12.2020 of which 2,500 shares were fully called up. The following are the balances
extracted from the ledger as on 31.12.2020.
Trail Balance of Moon & Star Co., Ltd.,
Debit Rs. Credit Rs.
Opening stock 50,000 Sales 3,25,000
Purchases 2,00,000 Discount received 3,150
Wages 70,000 Profit & loss A/c 6,220
Discount allowed 4,200 Creditors 35,200
Insurance (up to 31.3.2021) 6,720 Reserves 25,000
Salaries 18,500 Loan from managing directors 15,700
Rent 6,000 Share capital 2,00,000
General expenses 8,950
Printing 2,400
Advertisements 3,800
Bonus 10,500
Debtors 38,700
Plant 1,80,500
Furniture 17,100
Bank 34,700
Bad debts 3,200
Calls-in-arrears 5,000
6,60,270 6,60,270
You are required to prepare Statement of Profit & Loss for the year ended 31.12.2020 and a balance sheet as on
that date. The following further information is given:
(a) Closing stock was valued at Rs.1,91,500.
(b) Depreciation on Plant at 15% and on furniture at 10% should be provided.
(c) A tax provision of Rs.8,000 is considered necessary.
(d) The directors declared an interim dividend on 15.8.2020 for 6 months ending June 31, 2020 @ 6%.
(e) Provide for corporate dividend tax @ 17%.

47
PROBLEM: 9
A Ltd., registered with an authorized capital of Rs.6,00,000 in equity shares of Rs.10 each. The following is its
Trial Balance on 31st March 2020.
Trail Balance of A Ltd.,
Particulars Debit Credit
Goodwill 25,000 -
Cash 750 -
Bank 39,900 -
Purchases 1,85,000 -
Preliminary expenses 5,000 -
Share capital - 4,00,000
12% debentures - 3,00,000
P & L A/c (Cr.) - 26,250
Calls-in-arrears 7,500 -
Premises 3,00,000 -
Plant & Machinery 3,30,000 -
Interim dividend 39,250 -
Sales - 4,15,000
Stock (1.4.2019) 75,000 -
Furniture & fixtures 7,200 -
Sundry Debtors 87,000 -
Wages 84,865 -
General expenses 6,835 -
Freight and carriage 13,115 -
Salaries 14,500 -
Directors’ fees 5,725 -
Bad debts 2,110 -
Debenture interest paid 18,000 -
Bills payable - 37,000
Sundry creditors - 40,000
General reserve - 25,000
Provision for bad debts - 3,500
12,46,750 12,46,750
Prepare statement of Profit & Loss and Balance Sheet in proper form after making the following
adjustments:
(a) Depreciate plant and machinery by 15%.
(b) Writ off preliminary expenses.
(c) Provide for 6 months interest on debentures.
(d) Leave bad and doubtful debts provision at 5% on sundry debtors.
(e) Provide for income tax at 50%.
(f) Stock on 31.3.2020 was Rs.95,000.
(g) Provide for corporate dividend tax @ 17%.

48
 Profit Prior to Incorporation
Q: What do you mean by profit prior to incorporation?
Meaning
A Company legally comes in to existence only from the date of getting the certificate of incorporation
from the registrar of joint stock companies. Incorporation certificate is the birth certificate of the company. In
order to get an incorporation certificate, a company has to fulfill certain legal formalities, fulfillment of
formalities take three or four moths. During this period of three or four months, the business will earn some
profit. The amount of profit, which is earned by a company from the date of its acquisition to the date of
incorporation, is known as “Profits prior to incorporation”.

Methods of ascertaining profit or loss prior to incorporation

Q: Describe the methods of ascertaining ‘Profit prior to incorporation’.
There are three possible methods of ascertaining profit or loss prior to incorporation:
 Preparation of trading & profit and loss A/c for the period up to the date of incorporation: A trial
balance has to be prepared as on the date of incorporation of the company by balancing the books of
accounts of the business. The closing stock on that date has to be valued. Trading and profit & loss account
has to be prepared in the normal way. Profit or loss prior to incorporation can be ascertained accurately in
this method. At the end of the accounting year, profit or loss of the post incorporation period may be found.
 Preparation of trading and profit & loss A/c for the whole accounting period and apportionment of
the resulting profit or loss between pre and post incorporation periods: Under this method, trial balance
is prepared and trading and profit and loss account are prepared at the end of the accounting period. Then, a
separate note is prepared, in the form of a statement showing pre & post incorporation profit by
apportioning the various expenses between the respective periods.
 Preparation of common trading account and the profit and loss account in ‘columnar form’: Under
this method, trading account is prepared at the end of the accounting year from the trial balance in the usual
manner. Unless otherwise mentioned, the date of incorporation does not affect the computation of gross
profit. The profit and loss account is prepared in columnar form, with separate column for pre & post
incorporation periods. All expenses and the gross profit are divided the two periods in an appropriate
manner.

Q: What are the steps for calculating profit prior to incorporation?

Steps involved in ascertaining pre & post incorporation profit:
 Trading account has to be prepared for the accounting period and gross profit has to be found.
 After a careful scrutiny of the sales, expenses etc., sales ratio and time ratio have to be computed and a list
of expenses which can be allocated to specific periods should be drawn up.
 If a statement is preferable for ascertaining pre incorporation profit, normal profit & loss account can be
prepared otherwise, columns for basis of apportionment, total, pre incorporation and post incorporation
should be provided on both the sides of the profit and loss A/c. The gross profit and the expenses can be
recorded, dividing them or showing them appropriately.
 In the profit and loss appropriation account the amount of pre incorporation profit should be transferred to
capital reserve. If there is loss in pre incorporation period it is carried down from profit & loss account to
appropriation account debit side.
Basic apportionment of expenses & incomes
Q: How do you apportion various expenses and incomes between pre & post incorporation periods?
The various expenses which are shown in profit and loss A/c should be divided between pre and post
incorporation periods on some logical and appropriate basis. The following are the bases for such
apportionment.
 Time ratio: This is the ratio of months or days before and after incorporation during the accounting period.
All expenses of a company which can be linked or related to ‘time’ must be divided between pre and post
incorporation periods in time ratio. Example are salaries, rent, stationery etc.,
 Weighted or adjusted time ratio: If any changes were made in the number of employees, or office
accommodation, etc., weightage must be given to the changes in arriving at the time ratio. Such a ratio is
called weighted time ratio.
 Sales ratio: This is the ratio of sales or turnover of the company before and after incorporation. Sales ratio
is the logical basis to divide the gross profit earned by the company similarly; all expenses related to sales
are also to be apportioned in sales ratio. Example: advertisement, salesmen’s commission etc.

49
 Weighted sales ratio: If sales were not uniform throughout the accounting period, weightage must be given
to the trends observed in the sales. Sales ratio adjusted for the change in trend is called weighted sales ratio.
 Allocation of expenses: Specific expenses which can be identified with either period have to be fully
allocated to that period. All company related expenses like debenture interest, directors remuneration etc.,
have no connection with the pre incorporation period.
 Actual expenditure: If specific details are available about any particular item of expenses as to how much
was spent in the pre & post incorporation periods, the actual amount should be charged to the respective
periods.

Profit prior to incorporation:

PROBLEM: 1
Kalpana Ltd., was incorporated on 1-4-1992 to take over the business of Natu Brothers from 1-1-92. From the
following information, calculate sales ratio and gross profit:

 Sales during the period January – December 1992 amounted to Rs.72,000. The trend of the sales was as
under
❑ January and February – half the average sales in each month
❑ May, June and July – average sales in each month
❑ October – average sales
❑ November and December – half the average sales in each month.
 Cost of goods sold Rs.18,000.

PROBLEM: 2
S & R Co., Ltd., was incorporated on 1st July 1992 to purchase the business of Nish Bros as on 1-4-1992.
Certificate of commencement of business was received on 1-8-1992. The accounts for the year ended 31-3-
1993 disclosed net profit of Rs.80,000 after charging the following:
 Director’s salary Rs.10,000
 Salary Rs.20,000 (4 employees in pre incorporation period and 6 employees in post incorporation
period)
 Wages Rs.10,200 (5 workers at Rs.80 p.m. in pre acquisition period and 10 workers at Rs.100 p.m. in
post acquisition period)
 The sales were Rs.3,00,000 of which Rs.75,000 were in pre incorporation period.
Calculate the profit of pre and post incorporation periods. How will you treat pre incorporation profit?

PROBLEM: 3
A company was incorporated on 1st May 1984 to take over a business as a going concern from 1st January of the
same year. The turnover for the year ended 31st December was Rs.2,00,000, namely Rs.60,000 for the first
period up to 1st May and Rs.1,40,000 for the following period. From the profit and loss account given below
for the year ended 31st December 1984, you are required to ascertain profits prior to incorporation.
Profit & loss Account for the year ended 31-12-84
To Rent & rates 3,240 By Gross profit 70,000
To Insurance 720
To Lighting 2,040
To Salaries 7,800
To Director’s fees 2,000
To Sales discount 5,000
To Sales commission 10,00
To General expenses 2,400
To Carriage outwards 3,000
To Bank charges 420
To Repairs 1,380
To Bad debts 600
To Loan interest 1,200
To Net profit 30,200
70,000 70,000

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PROBLEM: 4
From the following particulars, ascertain profit prior to and after incorporation.
 Time ratio – 3:5
 Sales ratio – 4:6
 Gross profit – Rs.10,00,000
 Expenses debited to profit and loss account were:
Salaries 96,000 Preliminary expenses 70,000
General expenses 12,000 Rent and rates 15,000
Discount on sales 40,000 Printing and stationary 65,000
Advertisement 50,000
 Income credited to profit and loss account were:
Rent received 18,000 Interest received 50,000

PROBLEM: 5
X Company purchased a business on 1-4-1993. The company obtained certificate of incorporation on 31-7-
1993. From the following particulars for the year ending 31-3-94, ascertain profit prior to incorporation and
divisible profits.
 Total sales up to 31-3-1994 to Rs.10,00,000; Sales from 1-4-1993 to 31-7-1993 Rs.2,50,000.
 Gross profit for the year Rs.2,12,000.
 Expenses debited to profit and loss account were as under:

Rent 6,000 Directors’ fees 2,600

Insurance 1,500 Preliminary expenses 7,200
Salaries 27,000 Interest paid to vender up to 1st Sep. 93 5,000
Selling expenses 9,000 Interest on debentures 4,000
Advertisement 8,000 Printing & stationery 4,200
Audit fees 1,200 Depreciation on machinery 30,000
Bad debts (Rs.850 related to pre incorporation) 2,400 Commission on sales 12,600
General expenses 4,800

PROBLEM: 6
A public limited company was formed to take over a running business with effect from 1-4-2006. The
company was incorporated on 1-8-2006 and the certificate of commencement of business was received on 1-10-
2006. The following is the profit and loss account for the period 1-4-2006 to 31-3-2007:
Particulars Rs. Particulars Rs.
To Salaries 12,000 By Gross profit b/d 80,000
To Printing & stationery 1,200
To Advertisement 4,200
To Traveling expenses 4,000
To Trade expenses 9,450
To Rent 6,600
To Electricity charges 1,050
To Directors’ fees 2,800
To Bad debts 800
To Commission to selling agents 4,000
To Audit fees 1,500
To Debenture interest 750
To Interest paid to vendors 1,050
To Selling expenses 6,300
To Depreciation 2,400
To Net Profit 21,900
80,000 80,000
Additional information:
 Total sales for the year amounted to Rs.4,80,000. This was even up to the date of certificate of
commencement, where after they recorded an increase of 2/3rd during the rest of the year.
 Rent was paid @ Rs.500 per month up to September 2006 and thereafter it was increased by Rs.200 p.m.
51
 Traveling expenses include Rs.1,200 towards sales promotion.
 Depreciation included Rs.150 for assets acquired in the post incorporation period.
 Purchase consideration was discharged by the company on 30th August 2006 by issuing equity shares of
Rs.10 each.

PROBLEM: 7
The following trial balance was extracted from the books of Heera Pvt., Ltd., formed by Mr. Chand of
Faizlabad on 1st April, 1989 but was incorporated on 1st July 1989. No entries relating to the transfer of the
business were entered in the books, which was carried on until 31st March 1990.
Trial balance as on 31st March 1990
Stock (1-4-1989) 42,940 Sales 2,79,300
Purchases 1,96,780 Capital A/c of Chand (1-4-89) 2,00,000
Carriage outwards 1,650 Current liabilities 31,660
Travelers’ commission 6,150
Office salaries 16,640
Rent & taxes 1,640
Office expenses 2,400
Directors’ salary 15,000
Fixed assets 1,25,000
Current assets (other than stock) 1,01,200
Preliminary expenses 1,560
5,10,960 5,10,960
 Stock on 31 march, 1990 amounted to Rs.35,420
st

 Purchase consideration Rs.2,50,000 to be paid by the issue of 25,000 equity shares of Rs.10 each.
 Gross profit percentage is fixed, turnover is double in April, November and December
 Preliminary expenses are to be written off.
 Carriage outward and travelers’ commission vary in direct proportion to sales.
Prepare trading and profit and loss account for the year ended 31st March 1990 appropriating between the pre
and post incorporation periods and a balance sheet as on 31st March 1990.

52
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SUBJECT NAME: Corporate Accounting I

CHAPTER NAME: Valuation of Goodwill & Shares and Liquidation of Companies

UNIT IV
Valuation of goodwill
Q: What is goodwill? Define goodwill. What is the need for valuation of goodwill?
Meaning & definition
Goodwill is simple words, means the ‘good name’ or the ‘reputation’ of the business which attracts
more customers and therefore, helps in earning more profit in future. It is an intangible real assets and not a
fictitious one. “It is perhaps the most intangible of intangibles”
Goodwill is a valuable assets it the concern is profitable, on the other hand, it is value less if the concern
is an losing one. Therefore, it can be stated that goodwill represents the value of the reputation of a firm.
However, some of the definitions are discussed here under.
In the words of Spicer and Pegler, “Goodwill may be said to be that element arising from the reputation,
connection, or other advantages possessed by a business which enables it to earn greater profits than the return
normally to be expected on the capital represented by the net tangible assets employed in the business”.
According to Braden & Allyn, “Goodwill is an intangible asset compounded from a variety of
successful business ingredients – component and energetic management, customer acceptance, a favorable
location, a quality and profitable product, efficient production methods, an outstanding reputation, plus the
expectation that these ingredients, will continue to produce an above normal rate of return for an indefinite
period of time”.
According to Hendrickson, “If the expected future earnings are less than a satisfactory return, the
capitalization of this deficiency is sometime thought of a negative goodwill.
Methods of valuation of goodwill
Q: Explain the various methods of valuation of goodwill.

Methods of valuation of goodwill

Simple profit method Super profit method

Purchase of part profit Capitalization of

method (or) Average average profit method
profit method

Purchase of super Sliding-scale valuation Annuity of super Capitalization of super

profit method of super profit method profit method profit method

Average Profit, Super Profit, Annuity and Capitalization method

 Simple profit method: The goodwill can be expressed in terms of a number of years of average profit.
Here there are two important methods in the computation.
❑ Average profit method: Under this method, goodwill is calculated as under
▪ The profit for an agreed number of years proceeding the valuation year is taken.
▪ Find the simple average / weighted average of the profit taken.

53
 ▪ Now, this average profit is multiplied by the number of years of purchase. Thus, the method of valuing
goodwill is
Goodwill = Average profit X Number of years of purchase

❑ Capitalization of average profit method: Here, the following steps are to be followed:
▪ Ascertain the average profit, as above.
▪ Capitalize this average profit at the normal rate of return resultant is net worth.
▪ Find the value of net tangible assets of the business
▪ Deduction of (iii) from (ii) gives the value of goodwill.

Goodwill = Capitalized net worth – Net tangible assets

Capitalized net worth = Average profit X Normal rate of return

 Super profit method: Super profit is the difference between expected future profit and normal profit.
Expected profit is average profit of the business adjusted for future changes. Normal profit is average
capital employed multiplied by normal rate of return. The normal rate is the profit earned by similar firms
in the industry. Average capital employed is net assets minus 50% of current year profit. Here super profit
is computed.

Super profit = Average profit – normal profit

Normal profit = Capital employed X Normal rate of return

Normal rate of return: It is the rate of earning which the investors in general expects on his / her
investments in a particular types of industry. It varies depending upon some general factors like bank rate,
political stability etc.

Average capital employed: (Assets side approach)

Particulars Rs. Rs.
Assets at market value:
Fixed assets less depreciation XXX
Current assets (other than goodwill, non trading assets, etc.,) XXX
Less: External liabilities (at revised value, if any) XXX
Creditors XXX
Bills payable XXX
Debtors XXX
Taxes XXX
Outstanding bills etc., XXX XXX
Capital employed at the end of the year XXX
Less: Half the profit earned during the year XXX
Average capital employed for the year XXX
Average capital employed: (liabilities side approach)
Particulars Rs. Rs.
Equity share capital XXX
Preference share capital XXX
Reserve XXX
Profit & loss A/c XXX
Profit on revaluation of assets and liabilities XXX XXX
XXX
Less: Goodwill (book value) XXX
Losses and past expenses not yet written off XXX
Loss on revaluation XXX XXX
Capital employed at the end XXX
Less: ½ of current year profit XXX
Average capital employed XXX

54
There are four methods available for the valuation of goodwill based on super profit method:
❑ Purchase of super profit method:
Goodwill = Super profit X Number of year of purchase
❑ Sliding scale valuation of super profit method: This method is a variation of the first method. It is based
on the logic that the greater the amount of super profit, the more difficult it would be to maintain. Generally
higher profit will naturally attract competition and soon the firm’s ability to make super profit is curtailed.
❑ Annuity of super profit method: Under this method, goodwill is calculated by multiplying super profit
and annuity table value. Usually reference to the annuity table will give the present value of annuity for the
given number of years and at the given rate of interest.
Goodwill = Super profit X Annuity table value
❑ Capitalization of super profit method: Under this method, the super profit when capitalized at the normal
rate of return will give the value of goodwill.
Super profit
Goodwill = X 100
Normal rate of return
Needs of valuation of goodwill
Valuation of goodwill becomes necessary in the following circumstances.
 In case of a partnership, when there is an admission, retirement, death or amalgamation or a change in the
profit sharing ratio then valuation becomes necessary.
 In case of a company, when two or more companies amalgamate, or one company absorb another company,
or one company wants to acquire controlling interest in another company, or when the government takes
over the business, valuation becomes necessary.
 In case of a sole trader concern, at the time of selling the business, to decide purchase consideration,
valuation becomes necessary.
 In case of individuals, for purposes of estate duty, death duty etc., on the death of a person, valuation is
necessary.
Factors determining and affecting the valuation of goodwill
Q: What are the factors determining the value of goodwill?
Factors determining the value of goodwill:
 Location factors: If the business is situated in a familiar place it also influences the earning capacity of the
business and it naturally enhances its goodwill.
 Time factor: Since the business in an order, well established, it enjoys better goodwill than a new business.
 Nature of business: The nature of goods dealt with, the risks attached, the competition involved, and
certain special privileges enjoyed by the firm such an special licenses, franchise etc., determine the value of
goodwill.
 Efficiency of management: The management of the business is well efficiency and having well planned
production, distribution and highly successful marketing of a business leads to better profits and earn a
higher value of goodwill.
 Other factors: The other factors such as government policies, political stability, economic conditions, trade
cycles, money market conditions etc., are also influencing the value of goodwill of the business.
Q: Explain the various factors affecting value of goodwill.
Factor affecting value of goodwill:
 Profitability:
The profitability here refers to the profits which the firm is expected to earn in future. The buyer of
business always interested in knowing whether the business will maintain its profit in the future also. If the
advantage is not likely to come to the buyer, the buyer will not be ready to pay anything for goodwill.
Therefore, when evaluating the amount of goodwill, the buyer always keeps the future in mind and goodwill
is the assurance of the future maintainable profits.
 Normal rate of return:
It refers to the rate of earnings which investors in general expect on their investment in a particular
type of industry. It varies depending upon general factors like the bank rate, general economic conditions,
political stability etc., and specific factors like period of investments, risk attached to the investment etc. It
consists of three components: (i) Return of Zero risk level; (ii) Premium for business risk and (iii) Premium
for financial risk.
 Capital employed:

55
 At the time of calculating the goodwill of a firm, it is very important to ascertain the value of capital
employed, since the profit of a firm can be justified in terms of capital employed only. Capital employed is
now recognized to mean fixed assets plus net working capital.

Valuation of goodwill:
PROBLEM: 1 (Average profit or purchase of average profit)
Net profit for the six years on 31st December was as follows:
Year Rs. Year Rs. Year Rs.
1992 15,000 1994 25,000 1996 27,000
1993 20,000 1995 15,000 1997 43,000
Goodwill should be calculated on the basis of five years purchase of average net profits of the preceding six
years.

PROBLEM: 2
From the following calculate the value of goodwill on the basis of 5 years purchase of average profits of the
preceding 7 years.
Year Rs. Year Rs. Year Rs. Year Rs.
1991 85,000 1993 Loss: 50,000 1995 1,00,000 1997 80,000
1992 Loss 60,000 1994 1,10,000 1996 90,000

PROBLEM: 3
The following particulars are available in respect of business carried on by Mrs. Nandhini.
 Profits earned 1991 – 60,000; 1992 – 48,000; 1993 – 57,000.
 Profit of 1992 is reduced by Rs.5,000 due to stock destroyed by fire and profits of 1991 included a non-
recurring income of Rs.3,000.
 Profits of 1993 include Rs.2,000 income on investment.
 The stock is not insured and it is thought prudent to insure the stock in future. The insurance premium is
estimated to Rs.1,500 per annum.
 Fair remuneration to the proprietor is Rs.15,000 per annum.
You are required to compute the value of goodwill on the basis of 2 years purchase of average profit of the last
3 years.

PROBLEM: 4
The following particulars are available in respect of the business carried on by Bal Thakrey Ltd.
 Profit earned: 1996 – Rs.50,000; 1997 – Rs.48,000; and Rs.52,000.
 Profit of 1997 is reduced by Rs.5,000 due to stock destroyed by fire and profit of 1996 included a non-
recurring income of Rs.3,000.
 Profit of 1998 include Rs.2,000 income on investment.
 The stock is not insured and it is thought prudent to insure the stock in future.
 The insurance premium is estimated at Rs.500 p.a.
 Fair remuneration to the proprietor (not taken in the calculation of profits) is Rs.10,000 p.a.
You are required to calculate the value of goodwill on the basis of 2 years purchase of average profits of the last
three years.

Weighted average profit method:

PROBLEM: 5
Mr. X Proposed to purchase the business from Mr. Lal. Goodwill for this purpose is agreed to be valued at 5
years purchase of the average of the past six years. The weights and profit are as follows:
Year Weights Profit Year Weights Profit Year Weights Profits
1991 1 1,00,000 1993 3 75,000 1995 5 1,10,000
1992 2 2,50,000 1994 4 1,25,000 1996 6 90,000

Capitalization of average profit method:

PROBLEM: 6
 Average profit Rs.2,50,000 per year
 Return on investment 10%
56
 Net assets Rs.20,00,000
 Expenses not to be incurred in future – Rent Rs.15,000;
 Directors fees Rs.20,000
Calculate the value of goodwill under capitalization of average profit method.
Super profit method:
PROBLEM: 7
A partnership firm earned net profits during the last three years are as follows: 1986 – Rs.17,000; 1987 –
Rs.20,000; 1999 – Rs.23,000. The capital investment in the firm throughout the above mentioned period has
been Rs.80,000. Having regard to the risk involved, 15% is considered to be a fair return on the capital.
Calculate the value of goodwill on the basis of 2 years’ purchase of average super profits earned during the
above mentioned three years.

PROBLEM: 8
From the following information calculate the value of goodwill on the basis of three years purchase of the super
profit:
 Average capital employed in the business Rs.7,00,000.
 Net trading profit of the firm for the past three years Rs.1,07,600; Rs.90,700 and Rs.1,12,500.
 Rate of interest expected from capital having regard to the risk involved 12%.
 Fair remuneration to the partner for their services Rs.12,000 per annum.
 Sundry assets of the firm – Rs.7,54,762.
 Sundry liabilities of the firm – Rs.31,329.

PROBLEM: 9
From the following particulars relating to the business of Mr. Rahul, compute the value of goodwill on the basis
of 3 years purchase of super profits taking average of last four years:
Capital invested – Rs.1,20,000; Market rate of return on investment – 12%;
Rate of risk return on capital invested – 3%;
Managerial remuneration of the proprietor, if employed elsewhere Rs.30,000 p.a. trading results:
1995 (profit) – 60,000; 1996 (profit) – 72,000; 1997 (loss) – 8,000; 1998 (profit) – 88,000

PROBLEM: 10
The balance sheet of a partnership firm is as follows:
Liabilities Rs. Assets Rs.
Capital: X 1,20,000 Goodwill 68,000
Y 1,20,000 Buildings 1,46,000
Sundry creditors 1,20,000 Stock 90,000
Bills payable 40,000 Debtors 58,000
Cash and bank 38,000
4,00,000 4,00,000
J.J. Co., Ltd., is to be formed to take over this firm. For this purpose, assets are revalued as under: Stock –
Rs.94,000; Debtors – Rs.40,000; Buildings – Rs.1,28,000.
Profit of the firm of the past five years before charging anything in respect of the partners were Rs.40,000;
Rs.60,000; Rs.72,000; Rs.64,000; Rs.74,000. Included in these profits were non-recurring items averaging
Rs.3,000, but from the nature of the business casual non-recurring items were found to arise every year and the
promoters agreed that Rs.2,400 should be allowed as profit from this source. Similar businesses paid a dividend
of 8% per annum on their equity shares and the partners who would be the directors of the company were to be
paid remuneration X – Rs.18,000 and Y – Rs.12,000 p.a. Calculate goodwill on five years purchase of super
profits.

PROBLEM: 11 (Capitalization of super profit method)

Find out goodwill by capitalizing super profit:
 Normal rate of return 12%
 Profits for the last four years are: Rs.30,000; Rs.40,000; Rs.50,000 and Rs.45,000.
 Non-recurring income of Rs.3,000 is included in the above mentioned profit of Rs.30,000
 Average capital employed is Rs.3,00,000.

57
PROBLEM: 12
The following information is given:
 Capital employed – Rs.3,00,000; Normal rate of profit 10%.
 Net profit for five years: 1991 – Rs.28,800; 1992 – Rs.30,800; 1993 – Rs.33,800; 1994 – Rs.34,800 and
1995 – Rs.35,800. The profits included non-recurring profits on an average basis of Rs.2,000 out of which
it was deemed that even non-recurring profits had a tendency of appearing at the rate of Rs.1,400 p.a.
 Normal rate of profit 10%
You are required to calculate the value of goodwill as per capitalization of super profit method.

PROBLEM: 13 (Annuity method)

The net profits of a company after providing for taxation, for the past five years are Rs.40,000; Rs.42,000;
Rs.45,000; Rs.46,000 and Rs.47,000. The capital employed in the business is Rs.4,00,000 on which a
reasonable rate of return of 10% is expected. It is expected that the company will be able to maintain its super
profits for the next five years. Calculate the value of goodwill of the business on the basis of an annuity of
super profits, taking the present value of annuity of one rupee for 5 years @ 10% interest as Rs.3.78.

PROBLEM: 14
From the following particulars, find out the value of goodwill as per annuity method:
 Capital employed: Rs.3,00,000;
 Normal rate of return: 10%
 Present value of Rs.1 for 5 years at 10% at 3.78.
 Normal profit for 5 years: 1st year – Rs.30,000; 2nd year – Rs.32,000; 3rd year – Rs.34,000; 4th year –
Rs.36,000; 5th year – Rs.38,000.
 Non-recurring income – Rs.1,600; Non-recurring expenses – Rs.1,000.

PROBLEM: 15
Ascertain the value of goodwill of Imran Co. Ltd., carrying on business from the following:
Liabilities Rs. Assets Rs.
2,500 shares of Rs.100 each fully paid 25,00,000 Goodwill at cost 2,50,000
Bank overdraft 4,80,000 Land & Building at cost 11,00,000
Sundry creditors 8,05,000 Plant & machinery at cost less depreciation 10,00,000
Provision for taxation 4,25,000 Stock in trade 15,00,000
Profit & Loss Appropriation A/c 6,00,000 Book debts less provision for bad debts 9,60,000
48,10,000 48,10,000
The company started operations in 1989 with a paid up capital as afforested of Rs.25,00,000. Profit earned
before providing for taxation have been as follows: (year ended 30th June) 1990 – Rs.6,00,000; 1991 –
Rs.7,50,000; 1992 – Rs.8,50,000; 1993 – Rs.9,50,000; 1994 – Rs.8,50,000. Income tax @50% has been
payable on these profits. Dividend have been distributed form the profits of the first three years @10% and
from those of the next two years @15% of the paid up capital.

58
 Valuation of shares
Q: What do you mean by valuation of shares? Need for valuation of shares?
Meaning
The valuation of shares by the company becomes necessary where there is no market price of the shares,
as in the case of a private limited company or a proprietorship company as the shares of such companies are not
quoted in the market or where, for certain reasons, the market price does not reflect the true value of the shares.
In addition, the need for the valuation of shares of a company arises in the following circumstances also:
 For formulating amalgamation or absorption schemes.
 For purchase or sale of controlling shares.
 For reconstruction schemes.
 For estate duty purposes.
 For pledging shares as a security against loan.
 When shares are acquired by the government.

Needs for valuation of shares

 When shares of unquoted private companies should be purchased or sold.
 When amalgamation or absorption of companies takes place.
 When controlling no. of shares are purchased by the company in another.
 For settlement of shareholders in reconstruction in schemes.
 For assessment of estate duty, wealth tax, gift tax etc.
 For sanctioning loan by financial institution on the security of shares.

Methods of valuation of shares

Net assets, Yield and Fair value methods
Q: Explain the various methods of valuation of shares? What is fair value?
Usually value of preference share depends on their rate of dividend. But equity share are valued in
different ways. There are three methods of valuation of shares.
 Net assets method (or) intrinsic value method: The assets of the company of market value are added up.
The liabilities including debenture and preference shares are reduced. The balance is net assets. It is
divided by the number of shares to find the value of each share. This method ignores the earning capacity
of a business and is considered as suitable only for sale of business.
Formula:
Net assets = Total assets (realisable value) - Outside liability
Net assets
Value per equity share =
Number of equity shares

 Yield method (or) Market value method: Small investors are generally interested in the income they earn
from the company and hence the price they will be prepared to pay will depend upon the yield or the size of
the dividends that can be expected.
Formula:
Calculation the expected rate of earnings :
Expected profit
Expected rate = X 100
Equity capital
Note: Expected profit is the profit after deducting taxes payable, transfer to any reserve, transfer to various
funds such as debenture redemption fund etc., and the preference dividend payable.
Expected rate
Yield value = X Paid up value per share
Normal rate
If the dividend per share is known, the rate of dividend will be calculated as follows:
Dividend per share
Rate of dividend = X 100
Paid up value per share

 Dual method (or) Fair value method: Under this method, the valuation depends upon the comparison of
the company’s earning capacity and the normal rate of return on capital employed. Fair value is the average
of net assets value per share and yield value per share. This is a compromise method to bridge the gap
between the values shown by both the methods.
59
 Formula:
Intrinsic value + Yield value
Fair value per share =
2
The fair value method takes the average of the values obtained in net assets basis and earnings basis; it
makes an attempt to minimize the demerits of both net assets and earnings basis methods.

Factor affecting valuation of shares

Q: What are the factors affecting the value of shares?
The value of shares of a company is greatly affected by the economic, political and social factors, some
of which are noted below:
 The economic condition of the company;
 The nature of company’s business;
 Other political and economic factors.
 The demand and supply of shares.
 Proportion of liabilities and capital.
 Rate of proposed dividend and past profits of the company;
 Yield of other related shares of the stock exchange etc.

Valuation of shares:
PROBLEM: 1 (Net assets method (or) intrinsic value method)
The following is the summarized balance sheet of X Company as at December 31, 1995:
Liabilities Rs. Assets Rs.
10,000 5% Pref. Shares of Rs.10 each fully paid 10,00,000 Fixed assets 38,00,000
2,00,000 Equity shares Rs.10 each fully paid 20,00,000 Investments 10,25,000
General reserve 15,00,000 Stock 5,72,000
Profit and loss A/c 12,00,000 Sundry debtors 12,78,000
6% Debentures 8,00,000 Cash and bank balance 2,25,000
Sundry creditors 2,75,000
Liabilities for expenses 1,25,000
69,00,000 69,00,000
For purpose of valuation of shares, fixed assets are to be depreciated by 10% and investments are to revalued at
Rs.10,80,000. Debtors will realize Rs.12,14,100. Interest on debentures is accrued due for 9 months and
preference dividend for 1995 is also due: neither of these has been provided for in the balance sheet. Calculate
the value of each equity share.

PROBLEM: 2
Crystal Ltd., started its business on 1st April 1996. On 31st March 1999, its balance sheet in a summarized from
was as follows:
Liabilities Rs. Assets Rs.
15,000 10% Pref. shares of Rs.100 each, fully paid 15,00,000 Fixed assets 45,00,000
4,50,000 equity shares of Rs.10 each fully paid 45,00,000 Current assets 60,00,000
Capital reserve 37,500 Preliminary expenses 75,000
Profit & loss A/c 8,25,000
13% debentures 7,50,000
Sundry creditors 27,00,000
Provision for income tax 2,62,500
1,05,75,000 1,05,75,000
The company is yet to declare its maiden dividend on 31-3-1999. The fixed assets are revalued at
Rs.48,00,000. Calculate the value of the two classes of shares.

PROBLEM: 3
The following is the balance sheet of ‘S’ company limited as on 31st December 1998.
Liabilities Rs. Assets Rs.
3,000 equity shares of Rs.100 each 3,00,000 Cash in hand 2,000
1,500 8% preference shares of Rs.100 each 1,50,000 Cash at bank 20,000
General reserve 40,000 Sundry debtors 80,000
60
 Profit & loss A/c 10,000 Stock-in-trade 1,40,000
Bank loan 50,000 Land & buildings 2,05,000
Sundry creditors 15,000 Furniture 30,000
Goodwill 70,000
Discount on shares 18,000
5,65,000 5,65,000
The value of assets is assessed as follows:
 Value of stock-in-trade, land and buildings and goodwill is estimated at Rs.1,20,000; Rs.2,50,000 and
Rs.80,000 respectively. Furniture to be depreciated at 10%
 Debtors are expected to realize 80% of book value. Find out the value of equity shares.

PROBLEM: 4
The summarized Balance sheet of BK Ltd., as at 31st March 1997, is as follows:
Liabilities Rs. Assets Rs.
30,000 Equity shares of Rs.10 each fully paid 3,00,000 Goodwill 70,000
10,000 Equity share of Rs.10 each Rs.8 paid up 80,000 Fixed assets 4,50,000
Reserves 1,80,000 Current assets 2,20,000
11% Debentures 1,00,000 Preliminary expenses 10,000
Current liabilities 90,000
7,50,000 7,50,000
The goodwill is independently valued at Rs.50,000 and fixed assets at Rs.4,20,000 there was a contingent
liability of Rs.20,000 which has become payable. Determine the value of both the categories of shares under the
Net assets method.

PROBLEM: 5 (Net assets or intrinsic value method (with goodwill valuation))

From the following information, find out the value of each share:
Liabilities Rs. Assets Rs.
20,000 equity shares of Rs.10 each 2,00,000 Goodwill 1,90,000
Reserves 2,50,000 Investment 3,00,000
Profit & loss A/c 30,000 Current assets 50,000
Unsecured loans 80,000 Loans & advances 30,000
Current liabilities 20,000 Miscellaneous expenditure 10,000
5,80,000 5,80,000
For the purpose of valuation of shares goodwill shall be taken at two years purchase of the average profit of the
last five years. The profits for the last five years are – Rs.60,000; Rs.70,000; Rs.40,000; Rs.50,000 and
Rs.50,000.

Valuation under net asserts method with claims of participating preference shares on surplus assets:
PROBLEM: 6
From the following details, calculate the value of each equity share and preference share:

Liabilities Rs. Assets Rs.

80,000 equity shares of Rs.10 each 8,00,000 Land & building at cost 3,00,000
4,000 7% preference shares of Rs.100 4,00,000 Plant & Machinery at cost 5,00,000
General reserve 1,00,000 Stock at market value 5,00,000
Profit & loss A/c 80,000 Book debts 2,40,000
Workmen’s savings A/c 40,000 Cash at bank 1,50,000
Provident fund 50,000 Prepaid expenses 30,000
Depreciation fund 1,60,000
Creditors 90,000
17,20,000 17,20,000
Additional information:
 Goodwill is valued at Rs.1,60,000
 Depreciation fund is excess to the extent of Rs.60,000.
 Debtors of Rs.20,000 are likely to prove bad.

61
 There is a dispute liability of Rs.30,000 (not provided in the accounts) out of which Rs.20,000 is likely to
materialize.
 On liquidation preference shareholders have a right to participate in surplus.

PROBLEM: 7
From the following information, calculate the value per equity share:
1,000, 9% Preference shares of Rs.100 each 1,00,000
1,00,000 Equity shares of Rs.5 each, Rs.2 per share paid up 2,00,000
Expected profit per year before tax 1,09,000
Rate of tax 50%
Normal rate of return 15%
Transfer to general reserve 20% of Net profits.

PROBLEM: 8
Mr. Share Wallah holds 12,000 equity share in Bharath Ltd., the nominal and paid up capital of which consists
of:
 40,000 equity shares of Rs.1 each.
 10,000 preference shares of Rs.1 each, rate of dividend 12%.
 Preference shares do not further participate in profits.
 Usual transfer to reserve 10% of the profits.
It is ascertained that: (a) Normal annual profit is Rs.12,000; (b) Normal rate of return 15%. Mr. Share Wallah
requests you to value his holdings based upon the above figures.

PROBLEM: 9
S. Vinoth holds 5,000 equity shares in Hindustan Ltd. The paid up capital of which is 30,000 shares (equity) of
Re.1 each. It is ascertained that
 The normal annual net profit of such company is Rs.5,000, and transfer to reserve is 20%.
 The normal return for the type of business carried out by the company is 8%.
Mr. S. Vinoth requires you to value his shareholdings based upon the above figures.

PROBLEM: 10
The following is the summarized balance sheet of ABC Ltd., as at 31st December 1998.
Liabilities Rs. Assets Rs.
1,00,000 equity shares of Rs.10 each 10,00,000 Plant & machinery 4,80,000
Share premium 2,00,000 Furniture 2,00,000
General reserve 4,78,800 Stock 12,40,000
Profit & loss A/c 3,15,200 Debtors 4,12,000
Sundry creditors 8,18,800 Cash at bank 8,74,800
Provision for taxation 3,74,000
32,06,800 32,06,800
The company transfer 20% of its profit (after tax to general reserve. Net profits before taxation of the last three
years have been as follows: 1996 – Rs.6,70,000; 1997 – Rs.7,32,000; and 1998 – Rs.7,88,000. Machinery is
valued at Rs.6,40,000. Average yield in this type of business is 20%. The rate of tax is 50%. Find out the
value of each equity share on the basis of (a) net assets method (b) yield method and (c) Fair value.

62
 Liquidation of Companies
Q: What is liquidation? What are the various modes of winding up of a company?
Meaning of liquidation
The setting up or closure of a company is done through a legal process under the purview of law. In
other words a company comes into being through a legal process and also comes to an end by law.
“Liquidation is the legal procedure by which the company comes to an end”.

Features of liquidation
➢ A company, it necessary, can be liquidated. In most cores when company attains the position of insolvency,
the liquidation proceedings are applied to it.
➢ But it is not meant that only insolvent company can be liquidated. Sometime, even a solvent company can
be liquidated in course of time.
➢ When liquidation takes place, assets of the company are realized; capital is collected and out of the proceeds
claims of creditors are settled. If there is surplus left, it is returned to the share holders of the company
according to their rights.

Modes of winding up
Sec. 425(1) of the companies Act provides that a company can be liquidated in any of the following
three ways.
➢ Compulsory winding up:
This is also called winding up by the court. This can happen when –
o The company passes a special resolution (or)
o Defaults in delivering the statutory report to the registrar (or) in failing to conduct the statutory meeting
(or) Doesn’t commerce business with a year from the date of incorporation (or) it suspends business for
a year (or)
o The company members fall below seven, in case of public company, whereas in case of private
company it is two (or)
o It is unable to pay its debt (or)
o In the eyes of law, it is just and equitable to be wound up.

➢ Voluntary winding up:

o Members voluntary winding up: Member’s voluntary winding up takes place when a declaration of
the company’s solvency; verified by an affidavit, is made by its directors. In member’s voluntary
winding up the relevant control in the proceeding of the winding up is that of the member (while in
creditor’s it is vice versa).
o Creditors’ voluntary winding up: When the declaration of solvency is not made and delivered to the
registrar it is presumed that the company is insolvent and the winding up is called a creditors’
voluntary winding up. In creditor’s voluntary winding up, creditors have the dominating control over
the proceedings.
o Winding up subject to supervision of court: This mode of winding up is comparatively rare. It is a
voluntary winding up under the supervision of court. The liquidator can continue to exercise his
powers subject to any restrictions or conditions laid down by the court. This type of winding up is
made to safeguard the interest of the creditors and contributories or member of the company.
Q: Explain the order in which payment should be made by liquidator?
Order of payment
The amount realized from the assets not specifically pledged and the amount contributed by the
contributories must be distributed by the liquidator in the following order:
➢ Secured creditors
➢ Cost of liquidation: (a) Legal charges, (b) Liquidator’s remuneration, (c) Cost of winding up
➢ Preferential creditors
➢ Debenture holders having floating charges on assets;
➢ Unsecured creditors
➢ Preference share holders
➢ Equity share holders

63
Q: Who are secured and preferential creditors?
Secured creditors
A secured creditor is one who holds some security for a debt due to him from the company such as a
pledge, mortgage, charge or lien. In liquidation proceedings of an insolvent company a secured creditors has
three rights, namely:
➢ He may rely on the security and ignore the liquidation altogether, or
➢ He may value his security and prove for the balance of his debt, or
➢ He may give up his security and prove for the whole amount of his debt.
Secured creditors may be fully secured (or) partly secured. If they are fully secured, the value of security
offered to them would be more than the amount due, but in case of partly secured creditors, the value of security
would be less then the amount due to them. In such a case, the partly secured creditors are secured to the extent
of the value of security offered to them. For the remaining balance due to them, they will be treated as
unsecured creditors.
Preferential creditors
The amount to preferential creditors is paid before the payment is made to unsecured creditors. It must be
remembered that preferential creditors are in the nature of unsecured creditors who have priority of claims over
other unsecured creditors not because of any security held by them but because of section 530 of the companies
Act.
➢ All revenues, taxes, cesses and rates whether payable to the Government or to a local authority, due and
payable by the company with in 12 months before the date of commencement of winding up.
➢ All the wages or salaries of any employees in respect of services rendered to the company and due for a
period not exceeding 4 months with in next 12 months before the relevant date, and any compensation
payable to any workmen under any of the provisions of chapter VA of the Industrial Dispute Act, 1947
provide the amount payable to any one claimant will not exceed Rs.1000.
➢ All accrued holiday remuneration becoming payable to an employee on account of the termination of his
employment before or on account of winding.
➢ All sum due as compensation under Workmen’s Compensation Act, 1923 unless the winding up is for
reconstruction or amalgamation.
➢ All sum due to an employee from the provident fund, pension fund, and gratuity or any other fund
maintained for the welfare of the employees.
➢ The expenses of any investigation held in pursuance of Sec.235 or Sec.237 in so far as they are payable by
the company.
Q: Who is liquidator? What is liquidator’s final statement of accounts? Write short notes on liquidators’
remuneration.
Meaning of liquidator
The job of realizing various assets and paying various liabilities in a systematic manner is generally
performed by a person called a liquidator. The appointment of a liquidator depends upon the mode of
liquidation.
Liquidator’s remuneration
A liquidator normally gets the remuneration in the form of commission, which is based as a percentage
on assets realized and on payments made to unsecured creditors. In calculating his remuneration, the following
points may be noted:
➢ Commission on assets given as securities to secured creditors: The liquidator get commission in the
surplus from such assets left after making the payment of secured creditors because he makes on effort of
realizing the surplus of such assets from secured creditors. However if he sells the assets himself, he gets
commission on the total proceeds of such assets.
➢ Cash and bank balance: If the liquidator is to get a commission on assets realized, he also gets a
commission on cash and bank balance unless otherwise stated.
➢ Unsecured creditors: If the liquidator is to get a commission on amount paid to unsecured creditors, will
also includes preferential creditors for the purpose of calculation of remuneration unless otherwise stated.
➢ I Case:
If the amount available is sufficient to make the full payment of the unsecured creditors then the
commission in such case is calculated as follows:
Amount due to unsecured creditors X Percentage of commission on creditors
Liquidator s remuneration =
100

64
 II Case:
If the amount available is not sufficient to make the full payment of unsecured creditors, the commission is
calculated as below.
Amount available for unsecured creditors X Percentage of commission
Liquidator s remuneration = X Percentage of commission
100

Liquidator’s final statement of accounts

As we know, the main job of the liquidator is to collect the assets of the company and realize them and
distribute the money realized among right claim amounts. For this purpose he maintains a cash book and
submits relevant report to the court in case of compulsory winding up and to the company in case of voluntary
winding up. The account prepared by the liquidator regarding winding up is known as liquidator’s final
statement of accounts.

The following shall occur on the debit side of the liquidator’s final statement of accounts:
➢ Amount realized on sale of assets
➢ Amount received from delinquent directors and other officers of the company.
➢ Contribution made by the contributories.

On the credit side of the account, he records the payments made in the following order:
➢ Payment of secured creditors and dues to workmen up to their claim or up to the amount of securities held
by secured creditors as per Sec.529.
➢ Cost of winding up (i.e., legal charges)
➢ Liquidator’s remuneration.
➢ Payment of creditors (e.g., debenture) having a floating charges on the assets of the company. Interest on
debenture should be paid up to the date of actual payment to the debenture holders and not only up to the
date of liquidation provided is the company solvent.
➢ Workmen’s dues and claims of secured creditors as mentioned in Sec.529A.
➢ Payment of preferential creditors.
➢ Payment of unsecured creditors. This may also include liability in respect of dividend declared but not paid
but the payment of dividend due will be paid only after the amount due to outsiders is paid.
➢ Amount paid to preferential shareholders.
➢ Amount paid to equity shareholders.

LIQUIDITION
PROBLEM: 1 (Liquidator’s remuneration)
Ascertain the remuneration payable to Liquidator from the data given below:
Secured creditors Rs.50,000 (Securities realized: Rs.60,000)
Assets realized Rs.80,000
Liquidator’s remuneration 3% on the amount realized

PROBLEM: 2
Find out the remuneration payable to liquidator with the help of the following information:
Preferential creditors Rs.1,400
Unsecured creditors Rs.81,000
Amount available for unsecured creditors
after paying preferential creditors, before
paying liquidator’s remuneration Rs.74,154
Liquidator’s remuneration 2% on amount distributed to unsecured creditors

PROBLEM: 3
The liquidators of SR & Co., Ltd., is entitled to get a remuneration of 3% on the amount realized from the
assets and 2% on the amount distributed to the unsecured creditors. From the following particulars calculate the
remuneration payable.

Cash realized from assets 3,00,000

Preferential creditors 10,000
Amount due to unsecured creditors 3,00,000
65
Liquidator’s final statement:
PROBLEM: 4
The following particulars related to a company which went into voluntary liquidation. Prepare liquidators final
statement of account. At that time allow 2% remuneration to liquidator on the amount realized and 3% on the
amount distributed to unsecured creditors.
Unsecured creditors 2,80,000 Assets realized: Cash in hand 21,500
Preferential creditors 20,000 Land & building 1,30,000
Debentures 1,90,000 Plant & machinery 1,80,000
Share capital 2,00,000 Furniture 20,000

PROBLEM: 5
A Ltd., went into liquidation with the following liabilities:
Secured creditors (securities realized Rs.25,000) Rs.20,000
Preferential creditors 600
Unsecured creditors Rs.30,500
Liquidation expenses are Rs.252. Liquidator is entitled to a remuneration of 3% on the amounts realized
(including securities with creditors) and 1½% on the amount distributed to unsecured creditors. The various
assets realized Rs.26,000 (excluding securities in the hands of secured creditors). Prepare the liquidator’s final
statement of account.
PROBLEM: 6
The Ultra Optimist Ltd., went into liquidation. Its assets realized Rs.3,50,000 excluding amount realized by
sale of securities held by the secured creditors. The following was the position:
Share capital: 1,000 shares of Rs.100 each
Secured creditors (securities realized Rs.40,000) 35,000
Preferential creditors 6,000
Unsecured creditors 1,40,000
Debentures having a floating charge on the assets of the company 2,50,000
Liquidation expenses 5,000
Liquidator’s remuneration 7,500
Prepare the liquidator’s final statement of account.
PROBLEM: 7
The following particulars are related to a company which has gone into liquidation. You are required to prepare
liquidator’s final statement of account allowing for his remuneration at 2% on the amounts realized on assets
and 2% on the amounts distributed to unsecured creditors other than preferential creditors.
Preferential creditors 2,24,000 The assets realized: Cash in hand 20,000
Unsecured creditors 70,000 Land & buildings 1,30,000
Debenture 75,000 Plant & machinery 1,10,500
Fixtures and fittings 7,500
The liquidation expenses amounted to Rs.2,000. A call of Rs.2 per share on the partly paid 10,000 equity shares
was made and duly paid except in case of one shareholder owning 500 shares.
PROBLEM: 8
X Ltd., went into liquidation on 31.3.1989 when the following balance sheet was prepared:
Liabilities Rs. Assets Rs.
Share capital: 19,500 equity shares of Rs.10 each 1,95,000 Goodwill 50,000
Sundry Creditors: Building 48,000
Partly secured creditors (secured on building) 55,310 Machinery 65,500
Unsecured creditors 99,790 Stock 56,800
Preferential creditors 24,200 Sundry debtors 64,820
Bank overdraft (unsecured) 12,000 Cash 2,500
Profit & loss A/c 98,680
3,86,300 3,86,300
Assets realized as follows:
Building – Rs.35,000; Machinery – Rs.51,000; Stock – Rs.39,000; Sundry debtors – Rs.58,500; Cash –
Rs.2,500. The expenses on liquidation amounted Rs.1,000.
66
The liquidator’s remuneration was agreed at 2.5% on the amount realized (including cash) and 2% on the
amount paid to unsecured creditors. You are required to prepare the liquidators final statement of account.
PROBLEM: 9
K Ltd., went into voluntary liquidation on 30.10.1991. The below given is its balance sheet on that date:
Liabilities Rs. Assets Rs.
2,000 equity shares of Rs.100 each 2,00,000 Land & buildings 1,40,000
6% Debentures 1,00,000 Machinery 60,000
Mortgage loan (secured on machinery) 50,000 Stock 1,22,500
Sundry creditors 1,50,000 Debtors 1,10,000
Cash 2,500
P & L A/c 65,000
5,00,000 5,00,000
➢ Sundry creditors include Rs.6,000 payable as preferential creditors. Liquidation expenses amounted to
Rs.1,800.
➢ Assets realized as follows: Land & buildings Rs.60,000; Machinery Rs.63,500; Stock Rs.90,000; Debtors
40% of book value.
➢ Liquidator’s remuneration: 3% on assets realized including cash and 2% on the amount paid to unsecured
creditors including preferential creditors.
➢ Debenture holders were repaid on 31.12.91 along with two months interest.
Prepare liquidator’s final statement of account.
PROBLEM: 10
Kannan Ltd., was liquidated on 31-12-96.
Liabilities Rs. Assets Rs.
Share capital 1,00,000 Land & buildings 60,000
8% debentures 1,00,000 Plant & machinery 60,000
Mortgage loan (secured on land& building) 50,000 Stock 60,000
Sundry creditors 80,000 Cash in hand 5,000
Debtors 70,000
Profit & loss A/c 75,000
3,30,000 3,30,000
Adjustments:
➢ Land & building Rs.55,000; Stock Rs.20,000; Plant & machinery Rs.25,000
➢ Half of the debtors were bad and the balance realized 60% of book value.
➢ Liquidator was entitled to a commission of 3% on amount realized other than cash and 2% of the amount
paid to unsecured creditors. Preferential creditors amounted to Rs.10,000 (included in sundry creditors)
➢ Liquidation expenses amounted to Rs.970. Prepare liquidator’s final statement of accounts.

PROBLEM: 11
The Fast Foods Ltd., went into voluntary liquidation on 31st December 2004. The balance in its books on that
date was:
Liabilities Rs. Assets Rs.
5,000 6% Pref. Shares of Rs.100 each 5,00,000 Land & buildings 2,50,000
2,500 Equity shares of Rs.100 each, Rs.75 paid 1,87,500 Plant & machinery 6,25,000
7,500 Equity shares of Rs.100 each, Rs.60 paid 4,50,000 Patents 1,00,000
5% Mortgage debentures 2,50,000 Stock 1,37,500
Interest outstanding 12,500 Debtors 2,75,000
Creditors 3,62,500 Cash at bank 75,000
P & L A/c 3,00,000
17,62,500 17,62,500
The liquidator is entitled to a commission of 3% on all assets realized except cash and 2% on amounts
distributed among unsecured creditors other than preferential creditors. Creditors include preferential creditors
Rs.37,500 and a loan for Rs.1,25,000 secured by a mortgage on Land & buildings. The preference dividends
were in arrears for two years. The assets realized as follows: Land & buildings Rs.3,00,000; Plant & machinery
Rs.5,00,000; Patents Rs.75,000; Stock Rs.1,50,000; Debtors Rs.2,00,000. The expenses of liquidation
amounted to Rs.27,250. Prepare the liquidator’s final statement of account.

67
 PSG COLLEGE OF ARTS & SCIENCE
An Autonomous College – Affiliated to Bharathiar University
Accredited with ‘A++’ Grade by NAAC (4th Cycle)
College with Potential for Excellence(Status Awarded by the UGC)
Star College Status Awarded by DBT-MST, An ISO 9001-2015 Certified Institution
Coimbatore – 641014.

SUBJECT NAME: Corporate Accounting I

CHAPTER NAME: ACCOUNTS OF ELECTRICITY COMPANIES

UNIT V
ACCOUNTS OF ELECTRICITY COMPANIES
Introduction:
Public utility undertakings supplying or operating Electricity, Gas, Water, Power, Railways, Tramways,
etc., which operate under special acts of Parliament enjoy monopolistic rights in their business of rendering service
to the community. These undertakings require huge amount of fixed or long term capital to be invested on fixed or
permanent assets. they raise most part of their fixed capital from the public by the issue of shares and debenture.
so, they are bound to give information to the public as to what amount of fixed capital has been raised by them
from the public and how much of it has been invested on fixed assets. To provide such information to the public,
the public utility undertakings split their balance sheet into two parts viz., (i) Receipts and Expenditure on capital
account disclosing the amount of fixed capital raised from the public and the manner in which the fixed capital has
been invested on fixed assets, and (ii)the general balance sheet disclosing the other liabilities and assets.
The system of presenting balance sheet in two parts is called the 'Double Account System'. In other words,
It is alternative system of presenting final accounts. It was originally adopted in England, when the public utility
concerns were owned by incorporated companies. Today, it has lost its importance.

Special features of Double Account System:

The following are the special features of the double account system:
➢ It is not a system of maintaining accounts, but only a system of presenting the final accounts.
➢ It is generally adopted by public utility concerns formed under special acts of parliament.
➢ As indicated earlier, under this system, the balance sheet is bifurcated into two parts viz., (i) Receipts and
Expenditure on capital A/c and (ii) General Balance sheet.
➢ The main purpose of this system is not to reveal the financial position of the public utility concern as on the last
date of the accounting year but to reveal the amount of fixed capital raised from the public and the manner in
which the fixed capital has been utilized in the acquisition of fixed assets.
➢ Under this system, the account prepared for disclosing the expenses and incomes of a public utility concern is
known as 'Revenue A/c' and not profit & loss account.
➢ The account prepared, under this system, for disclosing the appropriations of Profits is known as 'Net Revenue
A/c' and not profit & loss appropriation A/c.
➢ Under this system, interest on debentures and loans is shown on the debit side of Net Revenue Account as an
appropriation. Similarly, interest received / receivable is also shown on the credit side of Net Revenue account.
➢ Under the system, the fixed assets are shown in the 'Capital Account' at cost, but not at depreciated value. The
depreciation on fixed assets is usually, debited to revenue account and credited to depreciation reserve or fund
account which appears in the general balance sheet.
➢ Discount and Premium on issue of shares and debentures are permanently retained as capital items. The
discount on issue of shares and debentures is not shown separately in the capital account. Instead, it is
deducted from the proceeds of issue of shares and debentures and only the net proceeds after such deduction is
shown in the capital account.
➢ Loans and debentures are treated as capital and shown in the capital account.
➢ General Reserve, investment fluctuation reserve and other reserves are shown in the general balance sheet on
the liabilities side.
➢ Renewals are provided out of current revenue.

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Double Account system Vs. Double Entry system:
The double account system is entirely different from double entry system. The double entry system is a
system of maintaining records in the books of account, whereas the double account system is a system of
presenting the final accounts of public utility concerns. however, both the systems go together. Usually, the final
accounts of the public utility concerns, which are presented under the double account system, are maintained on the
double entry system.
Double Account system Vs. Single Account System:
The single account system is nothing but preparation of a single balance sheet disclosing the financial
position of a business concern on a particular date. This system differs from double account system in many
respects. The main difference between these two are summarized as follows:
S.NO SINGLE ACCOUNT SYSTEM DOUBLE ACCOUNT SYSTEM
1 It is usually maintained by non-public It is generally maintained in public utility
utility undertakings undertakings.
2 The financial affairs of a concern are The financial affairs of a concern are shown
shown through a single balance sheet. through two statements viz., (i) Capital A/c
and (ii) General balance sheet
3 The main object of preparing the balance The main object of preparing two separate
sheet is to show the financial position of statements is to show how the capital is
the concern raised and how it is invested in fixed assets.
4 A 'Profit & Loss A/c' is prepared to A 'Revenue A/c' is prepared to ascertain the
calculate the profit earned during the current year's profit.
year.
5 A 'Profit & Loss Appropriation A/c is A 'Net Revenue A/c' is prepared to disclose
prepared to indicate the various the appropriations of profits.
appropriation of profits.
6 Interest paid / Payable and interest Interest paid / payable and interest received
received / accrued are shown in the Profit / accrued are shown in the Net Revenue
& Loss account. A/c.
7 Under this system, fixed assets are shown Under this system, fixed assets are shown at
at depreciated value. original cost in capital account and
depreciation fund is shown on the liabilities
side of general balance sheet.
8 Discount on issue of share and debentures Discount on issue of shares and debentures
is shown separately in the Balance sheet is subtracted from the share or debenture
under the head 'Miscellaneous expenses capital in the capital A/c.
and losses'.
9 When a old fixed asset is replaced by new When an old fixed asset is replaced by a
fixed asset, the old fixed asset is new fixed asset, the original cost of the old
completely written off in the books. asset continues to appear in the books, even
after replacement.
Advantages of Double account system:
The important advantages of double account system are as follows:
➢ The presentation of accounts in the prescribed form enables the state to ensure that the undertaking is
rendering efficient service at reasonable cost.
➢ The capital account readily discloses the sources of funds and the manner in which they are utilized,
thereby enabling an outsider to know whether the concern is over-capitalized or under-capitalized.
➢ As depreciation fund is compulsory under double account system, it helps the undertaking to replace any
fixed asset without any depletion of the cash resources of the company.
➢ The segregation of income statement into 'Revenue A/c' and ' Net Revenue A/c' enables the ascertainment
of 'pure' operating results of the concern.
➢ The publication of accounts in prescribed form enables the undertakings to compile many statistical returns
reflecting the services rendered to the public.
69
Disadvantages of Double Account System:
The Chief limitations of double account system are as follows:
➢ The Revenue Account fails to exhibit the true and fair view of the result of the business as interest paid or
received is not shown in the revenue account.
➢ The balance sheet also fails to exhibit the true and fair view of the position of the company on a particular
date as the assets are shown in the capital account at cost price and depreciation is credited to the
deprecation fund which appears as a liability in the general balance sheet.
➢ Moreover, some of the assets of short duration are taken to the capital account and are continued to be
shown at cost price even after they have been reduced to scrap value.
➢ Calculations regarding how much to be charged to 'revenue account' towards replacement of assets, is
confusing and not easily understandable.
➢ The system cannot be understood by the general public easily.

Final Accounts under Double Account Systems:

From the above discussion, it is clear that the final accounts prepared under the double account system consist of:

(1) A Revenue A/c:

It is in the nature of Profit & Loss Account. All the expenses are shown on the debit side of this account
and all the incomes are shown on the credit side of this account.
Revenue A/c. for the year ended.......
Particulars Rs. Particulars Rs.
To Staff salaries XXX By Income (except interest
To Rent, rates & taxes XXX earned and Government subsidy) XXX
To Printing & stationery XXX By Net Revenue A/c. (Loss - if
To postage & telegrams XXX any, transferred) (Bal. fig.) XXX
To Repairs & Renewals XXX
To Depreciation on Fixed assets XXX
To Discount allowed XXX
To Miscellaneous expenses XXX
To Net Revenue A/c (Bal. Fig.) XXX
XXX XXX
(2) Net Revenue Account:
It is similar to the ordinary Profit & Loss Appropriation Account. This accounts starts with the balance of
the net revenue account brought forward from the last year.
Net Revenue A/c. for the year ended.......
Particulars Rs. Particulars Rs.
To Balance B/d (if any) XXX By Balance B/d (Balance from last year)
To Revenue A/c (Loss of current year By Revenue A/c (Profit of current year XXX
transferred from Revenue A/c) XXX transferred from Revenue A/c)
To Interest on debentures XXX By Government subsidy XXX
To Interest on Loans XXX By Interest earned XXX
To Interest on Security deposits XXX By Transfer from Reserve XXX
To Contingency Reserve XXX By General Balance sheet (Loss - if any,
To Dividend Control Reserve XXX transferred to general balance sheet - Bal. fig) XXX
To General Balance Sheet (Bal. fig.) XXX
XXX XXX

(3) Capital Account (or) Receipts and Expenditure on Capital Account:

This account is mainly prepared to show as to how much fixed or long term capital has been raised by a
public utility concern and how it has been utilized. The account is usually prepared in a three columnar form on
either side. On the left side is recorded the Capital expenditure and on the right side Capital Receipts.

70
 Receipts and Expenditure on Capita A/c for the year ending.......
Expenditure Upto the During Total Receipts Upto the During Total
end of the year end of the year
previous Rs. previous Rs.
To Preliminary expenses XXX XXX XXX By Equity Shares XXX XXX XXX
To Land XXX XXX XXX By Pref. Shares XXX XXX XXX
To Building XXX XXX XXX By Debentures XXX XXX XXX
To Plant XXX XXX XXX By Loans XXX XXX XXX
By Calls-in-arrears XXX XXX XXX
Total Expenditure XXX XXX XXX Total Receipts XXX XXX XXX
To Balance transferred to XXX
General Balance sheet
XXX XXX XXX XXX XXX XXX

(4) General Balance sheet:

In the general balance sheet the balance of the capital account, the current assets and liabilities are recorded.
General Balance sheet
Liabilities Rs. Assets Rs.
Capital A/c. (Bal. B/f. from Capital A/c.) XXX Stores XXX
Sundry creditors for capital A/c XXX Sundry debtors XXX
Sundry Creditors on Open A/c XXX Cash at bank XXX
Net Revenue A/c (Bal. B/f. from Net Revenue A/c.) XXX Cash in hand XXX
Reserve fund XXX Securities XXX
Depreciation fund XXX Special items XXX
Sinking fund XXX Other assets XXX
Investment fluctuation fund XXX
Other liabilities` XXX
XXX XXX

FINAL ACCOUNTS OF ELECTRICITY SUPPLY COMPANIES

Electricity supply being a public utility service, the business is controlled by the government. These
undertakings are governed by the Indian Electricity Act 1910 and the Electricity (Supply) Act 1948. The published
accounts of electricity companies are to be prepared in accordance with the Provisions of Companies Act 1956 to
ensure greater transparency and maximum disclosure. The electricity companies are required to present their final
accounts according to the Double account system. The preparation final accounts involves preparation of 'Revenue
A/c', 'Net Revenue A/c', ' Capital A/c' and 'General Balance Sheet'. However, the Revenue account of electricity
companies is different from the generalized Revenue Account given earlier.
The specimen form of Revenue Account of Electricity companies is as follows:
Revenue A/c. for the year ended.......
Particulars Rs. Particulars Rs.
A. Generation: By Sale of energy for lighting XXX
To Fuel XXX By Sale of energy for power XXX
To Oil, Wastage, Water etc. XXX By Sale of energy under special contracts XXX
To Salary of engineers XXX By Public lighting XXX
To Wages and gratuities XXX By Rent receivable XXX
To Repairs & Maintenance XXX By Transfer fees XXX
B. Distribution: By Other items XXX
To Salary of engineers XXX By Miscellaneous receipts XXX
To Wages & gratuities XXX By Sale of Ashes XXX
To Repairs & Maintenance XXX By Reconnection and disconnection fees XXX
C. Public lamps:
To Attendance & repairs XXX
71
 To Repairs XXX
D. Rent, Rates & Taxes:
To Rent payable XXX
To Rates & Taxes XXX
E. Management Expenses:
To Directors remuneration XXX
To General establishment XXX
To Auditors of the company XXX
F. Law charges:
To Law charges XXX
G. Depreciation:
To Lease XXX
To Building XXX
To Plant & Equipment XXX
H. Special charges:
To Bad debts XXX
To Net Revenue A/c. (Bal. fig. transferred) XXX
XXX XXX

PROBLEM: 1
From the following details relating to an electricity undertaking, you are required to draw up the Capital Account
and General Balance Sheet as at 31st March, 2021, under the Double Account System.
Authorized capital: 8,000 shares of Rs.100 each
Issued Capital: 4,000 shares of Rs.100 each fully paid (out of which 500 share were issued during the year)
13% Debentures Rs.2,00,000; Trade Creditors Rs.50,000, Reserve fund Rs.1,00,000; Trade Debtors Rs.90,000 and
Cash at Bank Rs.50,000. Reserve fund Investment (cost) Rs.1,00,000; Market Value Rs.1,10,000; Stock
Rs.60,000.
Fixed asses - spent up to 31.3.2020; Machinery Rs.3,00,000; Building Rs.2,00,000; Additions during the year
Machinery Rs.60,000; Building Rs.10,000. Depreciation Fund: Machinery Rs.70,000; Building Rs.10,000. Profit
& Loss Account Rs.40,000

PROBLEM: 2
From the following particulars draw up (1) Capital Account and (2) General Balance Sheet as on 31 st March, 2021
on Double Account System.
Authorized Capital Rs.30,00,000; Subscribed Capital Rs.26,00,000; 11% Debentures Rs.4,00,000; Trade Creditors
Rs.1,60,000; Reserves Rs.1,50,000; Trade Debtors Rs.3,80,000; Cash in hand and at Bank Rs.3,50,000;
Investments Rs.1,50,000; Stock Rs.2,40,000.
Expenditure to 31st March, 2020:
Land Rs.1,20,000; Shafting etc., Rs.13,50,000; Machinery Rs.4,00,000; Buildings Rs.1,30,000.
The expenditure during the year ended 31.3.2020 was Rs.2,50,000; Rs.2,50,000 and Rs.1,00,000 respectively on
the last three items and a renewal fund of Rs.2,50,000 had been created. The balancing item of Rs.1,60,000 may be
taken as profit of the company.

PROBLEM: 3
Following are the balances of the Central Railway for the year ended 31st March, 2021. Make out in the prescribed
form (i) Revenue Account, (ii) Net Revenue Account, and (iii) General Balance Sheet:
Particulars Rs. Particulars Rs.
Interest on debenture Stock 14,500 Expended upon:
Rent paid on leased lines, guarantees, etc. 26,000 Locomotive Power 7,92,000
Balance to credit to net revenue A/c on Maintenance of ways stations 4,10,000
1.4.2020 32,000 Carriage and wagon repairs 98,000
General Interest A/c, Credit Balance 500 Traffic expenses 2,00,000
72
Capital A/c, balance on 31.3.2021 4,75,000 Shipping expenses 90,000
Cash in hand and at bank 1,10,000 General charges 1,50,000
General stores - Stock in hand 82,000 Docks and harbour expenses and repairs 40,000
Sundry debtors 25,000 Rates and taxes 75,000
Traffic A/c due to the company 1,08,000 Law charges 10,000
Amounts due from other companies 55,000 Preliminary expenses (not to be
Amounts due from post office 30,000 capitalised) 16,000
Amount due to clearing house 18,000 Compensation 2,000
Sundry creditors and suspense A/c 1,00,000 Government duty 4,000
Unpaid dividend and interest 25,000 Received from: Passengers 13,80,000
Debt due to other companies 30,000 Merchandise 5,00,000
Fire insurance fund 1,20,000 Docks and harbour 1,40,000
Reserve fund 2,00,000 Shipping 50,000
Employees’ savings Bank deposits 32,000 Parcels 80,000
Rents 30,000
Mails 75,000

PROBLEM: 4 (Disposal of profit)

Compute reasonable return from the following information given below:

Particulars Rs.
Capital base 34,00,000
Loan from Electricity board 30,00,000
Development reserve 10,00,000
10% Debentures 8,00,000
Reserve Fund Investment (6%) 60,00,000
Assume the bank rate to be 8%
PROBLEM: 5
Compute reasonable return from the following information given below:

Particulars Rs.
Capital base 15,39,000
Loan from Electricity board 11,40,000
Development reserve 2,85,000
12% Debentures 5,70,000
Reserve Fund Investment (4%) 14,25,000
Assume the bank rate to be 5%
PROBLEM: 6
City Electricity Ltd., earned a profit of Rs.4,22,500 during the year ended 31st March 2004 after debenture interest
@ 7½ % on Rs.1,25,000. With the help of the figures given below, show the disposal of profit.

Particulars Rs.
Original cost of fixed assets 50,00,000
Formational and other expenses 2,50,000
Monthly average of current assets (net) 12,50,000
Reserve fund (represented by 4% Govt. Securities) 5,00,000
Contingencies Reserve fund investments 1,25,000
Loan from electricity board 7,50,000
Total depreciation written off to date 10,00,000
Tariff and dividend control reserve 25,000
Security deposits received from customers 1,00,000
Assume bank rate to be 6%
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PROBLEM: 7
Following information is extracted from the accounting records of ECT Electricity Supply Ltd.,for the financial
year ended 31st March, 2021:

Particulars Rs. In Crores

Share capital 60
Fixed assets (tangible) at cost 116
Accumulated depreciation 40
Intangible assets 6
Investments:
Depreciation Reserve Fund 40
Contingencies Reserve 4
Loan from State Electricity Board 10
12% Debentures 20
Tariff and dividend Control Reserve 6
Net Profit after Tax 12.2
Customers’ Security Deposits 6
Monthly average of Current Assets 7
The monthly average of current assets includes Rs.1,00,00,000 (one crore) due from customers. Investment yield
10% return p.a. The applicable bank rate is 9% p.a. You are required to determine: (I) The Capital base; (ii) The
reasonable return; (iii) The disposal of Profit.

PROBLEM: 8
Following balances have been extracted at the end of the year from the books of an electricity company:

Particulars Rs.
Share Capital 2,00,00,000
Fixed Assets 5,00,00,000
Depreciation reserve on fixed assets 60,00,000
Reserve fund (Invested in 8% Govt. Securities (at Par) 1,20,00,000
Contingency reserve invested in 7% State loan amount 24,00,000
Consumers’ Contribution towards fixed assets 4,00,000
Consumers’ deposit 80,00,000
Tariffs and dividends control reserve 20,00,000
Development reserve 16,00,000
12% Debentures 40,00,000
Loan from State Electricity Board 50,00,000
Intangible Assets 16,00,000
Current Assets (monthly average) 30,00,000

The company earned a profit of Rs.56,00,000 (after tax) for the year. Show how profits have to be dealt with by
the company assuming the bank rate was 10%. All working should form part of your answers.

PROBLEM: 9 (Replacement of an Asset)

Ratnakar Electricity Supply Co., Ltd., (which adopts the Double Account System) rebuilt and re-equipped a power
station and the connecting lines during the year 2021. For the purpose they purchased materials of Rs.10,85,000
and used store worth Rs.4,90,000 from their existing stock. The cost of labour came to Rs.5,22,000. The estimated
supervisory overheads attributed to this project were Rs.13,000. The station was erected in 1993 at a cost of
Rs.5,00,000 and the index of costs in the line stood in 2021 @ 385, taking 2000 as the base year. Discarded
materials from the old station fetched Rs.12,000. Show journal entries to record the entries relating the new
station.

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PROBLEM: 10
The Indian Gas Company rebuilt their works with double the capacity at a cost of Rs.8,00,000. The cost of the part
of old work was Rs.3,50,000. In working the new works old material of Rs.15,000 was reused and material worth
Rs.25,000 was sold away. The costs of labour and materials are 50% higher now than when the old works were
built. Your are required to make necessary calculations and give journal entries.

PROBLEM: 11 (Final Account)

The following are the balances on 31.03.2004 in the books of the Ernakulam Power and Light Company Ltd.,
Particulars (Dr.) Rs. (Cr.) Rs.
Land on 31.03.03 60,000 --
Land expended during 2003-04 2,000 --
Machinery on 31.3.03 2,40,000 --
Machinery expended during 2003-04 2,000 --
Mains including cost of laying 80,000 --
Mains expended during 2003-04 20,400 --
Equity shares -- 2,19,600
Debentures -- 80,000
Sundry creditors -- 400
Depreciation fund A/c -- 1,00,000
Sundry debtors for current supplied 16,000 --
Other debtors 200 --
Cash 2,000 --
Cost of generation of electricity 14,000 --
Cost of distribution of electricity 2,000 --
Rent rates and taxes 2,000 --
Management expenses 4,800 --
Depreciation 8,000 --
Sales of current -- 52,000
Rent of meters -- 2,000
Interest on debentures 4,000 --
Interim dividend 8,000 --
Net Revenue A/c balance on 31.03.03 -- 11,400
4,65,400 4,65,400
From the above Trial Balance, Prepare Revenue A/c, Net Revenue A/c, Capital A/c and Balance sheet.

75
 HUMAN RESOURCE ACCOUNTING (HRA)
Need for HRA
It is a known fact that success of an organization depends on the quality, caliber and character of the people
working in it. Employees are, thus the greatest assets of an organization and the success or failure depends on the
skill and the performance of the employees. In spite of the vast physical resources and the latest technology, an
organization finds itself in the midst of financial crisis if it does not have the right people to manage and conduct its
affairs. Thus, human resource is a very valuable asset without which an organization cannot progress in all
directions. In a business enterprise, a well organized and loyal work force may be much more asset than a stock of
merchandise. But it is unfortunate that accountants, till now, could not evolve a generally accepted system to value
and record this important asset, i.e., the human resources.

Reasons for Human Resource Accounting:

The analysis of earlier studies reveals the following declarations:
S. No. Internal Reasons Internal and External Reasons External Reasons
1 To improve human To overcome problems arising To overcome the
resource management from the valuation of intangible difficulties in providing
assets. sufficient information to
investors in traditional
balance sheets.
2 To focus on employees as To redistribute social To profile the enterprise
assets responsibilities between the and improve its image.
public and the private sectors.
3 To retain qualified work -- To attract future
force. employees
Human Resource Accounting is receiving so much attention in recent years because of the following
two reasons:
(i) Development in modern organisation theory have made it apparent that there is a genuine need for
reliable and complete information which can be used improving and evaluating the management of
human resources.
(ii) The traditional framework of accounting is in the process of being expanded to include a much broader
set of measurement than was thought possible or desirable in the past.

Development of HRA:
The concept of recognizing human being as an asset is an old one. The Indian history has evidences for this
as Emperor Akbar gave importance to the nine jewels (Courtiers). The names of freedom fighters like Shri Moti
Lal Nehru, Mahatma Gandhi, Sardar Vallabh Bhai Patel, Pandit Jawahar Lal Nehru, Subash Chander Bose etc.
cannot be forgotten in the history of freedom movement of India. But no one made efforts to assign any monetary
value to such individuals in the Balance Sheet of the nation.
William Petty (in 1991) made the first attempt to value the human beings in monetary terms. He was
of the opinion that labour was the father of wealth and it must be taken into consideration while making an estimate
of wealth. Efforts were further made by William Far (1853) and Earnest Engel (1883) in this connection.
The real work was started by behavioural scientists from 1960 onward. The notable experts were Shultz
SinGo,. William Prlo (1967), Flam Holtz (1971, 1972, 1975), Morese (1975), Jaggi and Lax 01914), Rennet
Sinclare (1978), N. Dasgupta (1978) and Dr. Rao (1983), etc. who developed appropriate methodology and
procedures for finding out the cost and value of the people to the organisation.

Meaning (or Concept) of Human Resource Accounting

Human Resource Accounting (HRA) is a new branch of accounting. It is based on the traditional
concept that all expenditure on human capital formation is treated as a charge against the revenue of the
period as it does not create any physical asset. But now a days this concept has changed and the cost
incurred on any asset (as human resources) should be capitalised as it yields benefits measurable in
monetary terms.
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 Human resource accounting means accounting for people as the organisational resources, It is the
measurement of the cost and value of people to organisations. It involves measuring costs incurred by
private firm and public sectors to recruit, select, hire, train and develop employees and judge their economic
value to the organisation.

Few important definitions of HRA are given below:

“Human resource accounting is the process of identifying and measuring data about human resources and
communicating this information to interested parties."
- American Accounting Society Committee on HRA
“Human resource accounting is the measurement and quantification of human organisational inputs such as
recruiting, training, experience and communication".
- Stephen Knauf
“Human resource accounting is an attempt to identity and report investments made in human resources of an
organisation that are presently not accounted for in conventional accounting practice. Basically, it is an information
system that tells the management what changes over time are occurring to the human resources of the business."
- Woodruff
"Human resource accounting is accounting for people as an organisation resource. It involves measuring the costs
incurred by business firms and other organisations to recruit, select, hire, train and develop human assets. It also
includes measuring the economic value of people to organisations."
- Flamholtz
Human Resources Accounting (HRA) is an attempt to identify, quantify and report investment made in
human resources of an organisation. Leading public sector units like OIL, BHEL, NTPC and SAIL etc. have started
reporting human resources in their annual reports as additional information. Although human being are considered
as the prime mover for achieving productivity, and are placed above technology, equipment and money, the
conventional accounting practice does not assign significance to the human resource. Human resources are not thus
recognised as 'assets' in the Balance Sheet. While investments in human resources are not considered as assets and
not amortised over the economic service life, the result is that the income and expenditure statement comprising
current revenue and expenditure gives a distorted picture of the real affairs of the organisation.
H.R.A is the art of valuing, recording and presenting systematically the work of human resources in the
books of accounts of an organisation. Thus, it is primarily an information system which informs the management
about the changes that are taking place in the human resources of an organisation.

Objectives of Human Resource Accounting

Following are the main objectives of an HRA system:
1. To furnish cost value information for making management decisions about acquiring, allocating, developing and
maintaining human resources in order to attain cost effective organisation objectives.
2. To allow management personnel to monitor effectively the use of human resources.
3. To provide a determination of asset control ie., whether human assets are conserved, depleted or
appreciated.
4 To aid in the development of management principles by classifying the financial consequences of
various practices.
5. To recognise the nature of all resources used or cultivated by a firm and improvement of the management of
human resources so that the quality and quantity of goods and services increased.
6. To facilitate the effective and efficient management of human resources.
7. To evaluate the return on investment in human resources.

From Internal and/or External point of view, the objectives of HIRA may be stated as under:
Internal Internal and External External
To improve human resource To indicate human resources as an 1.To provide information to
management: assets in order: investors and potential investors
(i)m identifyi9ng the range of skills, (i) To attract and support investment about the capabilities of the
competencies and expertise in the organisation. organisation.
77
available within the organisation. (ii) To convince investors and other 2. to present an image of the
(ii) Identifying the most appropriate staff of the value of human company as capable and competent:
persons for particular tasks. resources. (i) To attract targeted and new
(iii) Assisting in putting together (iii) to provide information customers and clients; (to attract
teams of staff for particular projects. indicating: new business.
(iv) Revealing gaps in skills and (a) The link between human 3. to keep up with competitors.
competence in the organisation. resource interventions and
(v) Clarifying roles in the financial results.
organisation, including roles as (b) The returns on investments
‘knowledge brokers. in training and
(vi) Assisting in planning for career development.
progression, succession, training or (iv) To present an image of the
development and knowledge company that will attract new staff
management. and increase the retention of existing
staff.

From the above it is clear that HRA is basically adopted to treat human resources as assets, to generate human data
about human resources, to assign value to human resources and to present human assets in the balance sheet.
From the above, it is clear that there are three important aspects of HRA as given below:
1. Valuation of human resources.
2. Recording the valuation in the books of accounts.
3. Disclosure of the information in the financial statements of the business.

VALUATION OF HUMAN RESOURCES

The important approaches for valuation of human resources are given below:
1. Historical Cost Approach:
This approach was first developed by William C Pyle (and assisted by R. Lee Brummet and Eric G.
Flamholtz) and R.G. Bary Corporation, a leisure footwear manufacturer based in Columbia, Ohio (USA) in
1967. In this approach, actual cost incurred on recruiting, hiring, training and developing the human resources of
the organisation are capitalised and amortised over the expected useful life of the human resources. Thus, a proper
recording of the expenditure made on hiring, selecting, training and developing the employees is maintained and a
proportion of it is written off to the income of the next few years during which human resources will provide
service. If the human assets are liquidated prematurely, the whole of the amount not written off is charged to the
income of the year in which such liquidation takes place. If the useful life is recognised to be longer than originally
expected, revisions are effected in the amortisation schedule. The historical cost of human resources is very much
similar to the book value of the other physical assets. When an employee is recruited by a firm, he is employed
with the obvious expectation that the returns from him will far exceed the cost involved in selecting, developing
and training in the same manner as the value of fixed assets is increased by making additions in them. Such
additional costs incurred in training and developing are also capitalised and are mortised over the remaining life.
The unexpired value is investment in human assets.
This method is simple to understand and easy to work out. It meets the traditional accounting concept of matching
cost with revenue. It can provide a basis of evaluating a company's return on its investments in human resources.
But it suffers from the following limitations:
(i) It takes into account a part of the employees acquisition costs and thus ignores the aggregate value of their
potential services.
(ii) It is difficult to estimate the number of years over which the capitalised expenditure is to be
amortised.
(iii) It is difficult to determine the rate of amortisation. Should it be increasing, constant or a
decreasing one?
(iv) The economic value of human resources increases over time as the people gain experience. But in this
approach, the capital cost decreases through amortisation. How to reconcile the above difference?

78
2. Replacement Cost Approach:
This approach first suggested by Rensis Likert, was developed by Eric G. Flamboltz on the basis of concept
of replacement cost. Human resources of an organisation are to be valued on the assumption that new similar
organisation has to be created from scratch and what would "be the cost to the hirts of the sisting resources are
required to be replaced with other persons of equivalent talents and experience. It takes into consideration all costs
involved in recruiting, hiring, training and developing the replacement to he present level of proficiency and
familiarity with the organisation.
This approach is more realistic as it incorporates the current value of company's human resources in its
financial statements prepared at the end of the year. It is more representative and logical. But it suffers from the
following limitations:
a) This method is at variance with the conventional accounting practice of valuing assets.
b) There may be no similar replacement for a similar certain existing asset. It is really difficult to find identical
replacement of the existing human resource in actual practice.
c) The determination of a replacement value is affected by the subjective considerations to a marked
extent and, therefore, the value is likely to differ from man to man.

3. Opportunity Cost:
This method was first advocated by He Kiman and Jones for a company with several divisional heads
bidding for the services of various people they need among themselves and then include the bid price in the
investment cost. Opportunity cost is the value of an asset when there is an alternative use of it. There is no
opportunity cost for those employees that are not scarce and also those at the top will not be available for auction.
As such, only scarce people should comprise the value of human resources.
This method can work for some of the people at shop floor and middle order management. Moreover, the
authors of this approach believe that a bidding process such as this is a promising approach towards more optional
allocation of personnel and a quantitative base for planning, evaluating and developing human assets of the firm.
But this approach suffers from the following limitations:
a) It has specifically excluded from its perview the employees who are not scarce or are not being bid by the other
departments. This is likely to result in lowering the morale and productivity of the employees who are not
covered by the competitive process.
b) The total valuation of human resources on the competitive bid price may be misleading and inaccurate. It may
be due to the reason that a person may be an expert for one department and not so for the other department. He
may be valuable person for the department in which he is working and thus, commands a high value but may
have a lower price in the bid by the other department.
c) Under this method, valuation on the basis of the opportunity cost is restricted to alternative use within the
organisation. In real life such alternative use may not be identifiable on account of the constraints in an
organisational environment.

4. Standard Cost Approach:

This approach envisages establishment of a standard cost per grade of employee updated every year.
Replacement costs can be used to develop standard costs of recruitment, training and developing individuals. Such
standards can be used to compare results with those planned. Variances produced should be analysed and would
form a useful basis for control. But under this approach determination of the standard cost for each grade of
employee is a ticklish process.

5. Present Value Approach:

Under this approach, the value of human resources of an organisation is determined according to their
present value to the organisation. A number of valuation models have been developed to determine the
present value.
I. Present Value of Future Earnings Model.
This model has been developed by Brauch Lev and Abe Schwartz in 1971. They are of the opinion that
determination of the total value of a firm's labour force is a straight forward extension of the measurement
procedure of an individual value to the organisation. They have divided the whole labour force into certain

79
homogeneous group such as unskilled, semi-skilled, technical staff, managerial staff etc. and in accordance with
different classes and age groups. Average earnings stream for different classes and age groups are prepared for
each group separately and the present value for the human capital is calculated. The aggregate present value of
different groups represents the capitalised future earnings of the firm as a whole. They have advocated the use of
cost of capital rate for the purpose of capitalizing the present value of the future earning of the employees.
According to them, the value of human capital represented by a person of ager is the present value of his remaining
future earnings from his employment. They have given the following formula for calculating the value of an
individual:
𝑡
𝐼 (𝑡)
𝑉𝑟 = ∑
(1 + 𝑟)𝑡−𝑟
𝑡=𝑟

Where:
Vr = the value of an individual r years old
I(t) = the individual's annual earnings upto the retirement
T = retirement age
R = a discount rate

However, the model suffers from the following limitations:

a) A person's value to an organisation is not determined entirely by the person's inherent qualities, traits and skills
but also by the organisational role in which the individual is placed. Moreover, the
individual's skill and knowledge are not valuable to an organisation in an abstract form. They are valuable sir
when such qualities serve as a means to achieve the organisational goals.
b) The model ignores the possibility and probability of an individual leaving the organisation for reasons other
than death or retirement. People may leave the organisations for a variety of reasons.
c) The assumption of the model that people will not make role changes during their career with the organisation,
also seems to be unrealistic. Employees are quite often transferred to other departments within the organisation.
Their role also changes when they are transferred on promotion.
d) It fails to correctly evaluate the team work involved. Team work is something more than the sum of the values
of individuals. The valuation does not reflect the contribution of the team as a whole.
e) (v)This model ignores security, bargaining capacity, skill and experience etc. which may affect the payment of
higher or lower salaries. Again salaries paid to the employees may not reflect the real worth of the employees
to the organisations.

II. Rewards Valuation Model:

This model has been suggested by Flamholtz. It identifies the major variables that determine an individual's value
to an organisation, i.e., his expected realisable value. The expected realisable value of an individual is the present
worth of future services expected to be provided during the period is expected to remain in the organisation. The
model is based on the presumption that a person's value to an organisation depends upon the positions to be
occupied by him in the organisation. The movement of people from one organisational role to another is a
stochastic process with rewards. As people move and occupy different organisational roles, they render services
(i.e., rewards) to the organisation.

However, the roles they will occupy in future will have to be determined probabilistically for each individual. The
model suggests a five steps approach for assessing the value of an individual to the organisation:
a) Forecasting the period a person will remain in the organisation i.e, his expected service life.
b) Identifying the services states, i.e., the roles that he might occupy including, of course, the time at which he will
leave organisation.
c) Estimating the value derived by the organisation when a person occupies a particular position for a specified
time period.
d) Estimation of the probability of occupying each possible mutually exclusive state at specified future times.
e) Discounting the value at a predetermined rate to get the present value of human resources.

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This model is certainly an improvement over the Lev and Schwartz model. But this model when examined on
operational capacity falls short of a practical value in as much as that probabilities will have to be determined for
each individual occupying various service states, and these probabilities will have to be determined for all
employees for n periods on an individual basis. Further, it will be tremendously expensive way to predict career
movements or exit probabilities on an individual basis. Moreover, data developed on this basis will involve large
variance which will reduce usefulness of the model.

III. Net Benefit Model:

Morse (1973) suggested this approach. Under it the value of human resources is equivalent to the present value of
the not benefits derived by the enterprise from the service of its employees. Following steps are involved under this
approach:
a) The gross value of the services to be rendered in future by the employees in their individual and collective
capacity
b) The value of direct and indirect future payments to the employees is determined.
c) The excess of the value of future human resources (as per (a) above) over the value of future payments (as per
(b) above) is ascertained. This represents the net benefit to the enterprise because of human resources.
d) By applying a predetermined discount rate (usually the cost of capital) to the net benefit, the
present value is determined. This amount represents the value of human resources to the enterprise.

IV. Certainty Equivalent Net Benefit Model:

This approach has been suggested by Pekin Ogan (1976) is, in fact, an extension of net benefit approach of Morse.
Under it, the value of human resources is determined by taking into consideration the certainty with which the net
benefits in future will accrue to the enterprise. The method involves the following steps:
a) Net benefit from each employee. (as determined under the previous approach)
b) Certainty factor at which the benefits will be available in future.
c) The certainty equivalent benefits will be calculated by multiplying the certainty factor with the net benefits
from all employees. This will be the value of human resources of the enterprise.

V. Aggregate Payment Approach:

This approach has been suggested by Prof. S.K. Chakraborty (1976) the first Indian to suggest a model on
human resources of an enterprise. In his model, he has valued the human resources in aggregate and not on an
individual basis. However, managerial and non-managerial manpower can be evaluated separately. The value of
HR on a group basis can be found out by multiplying the average salary of the group with the average tenure of
employment in that group. The average annual salary payments for next few years could be found out by salary
structure and promotion schemes of the organisation.
He has further suggested that the recruitment, hiring, selection, development and training cost of each
employee can be recorded separately. These could be treated as deferred revenue expenditure to be written off over
the expected average stay of the employee in the organisation. The deferred portion should be shown in the
position statement of the organisation. If there is a permanent exist on account of death, retrenchment etc. then the
balance on deferred revenue expenditure for that year attributable to that person should be written off against the
income in the year of exist itself.
The discount rate for the purpose of ascertaining the present value of estimated payments in the future
should be taken as the expected average after tax return on capital employed over the average tenure period. He
suggests the adoption of such a long-term rate to avoid fluctuations in human asset valuation from year to year
simply due to changing rates of return. For in a year of low rate of return, the valuation will have an upward bias,
and conversely in a year of high return.
Regarding disclosure of accounting information relating to human resources he suggested that it was most
appropriate to include human assets under the head investments in the position statement of an organisation
prepared at the year end. He has not favored its inclusion under the head Fixed Assets' as it would cause problems
of depreciation, capital gains or losses upon exit etc. He is also in favor of including them in 'Current Assets' on the
ground that this will not be in conformity with the general meaning of the term.

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VI. Total Cost Concept. Prof. N. Dasgupta (1978) suggested this approach:
The various approaches (discussed in the previous pages) take into account only those persons who are
employed and ignore those who are unemployed. According to him both employed and unemployed persons
should be brought in its purview for determination of the value of human resources of the nation. Thus, for the
preparation of the balance sheet of the nation, the system should be such so that it fits and shows the human
resources not only a firm but also of the whole nation.
According to him, the total cost incurred by an individual, the state and the organisation to bring that
individual upto the present position should be taken as the value of a person on the day when he starts serving the
organisation or becomes fit for appropriate employment. It will include not only all expenses incurred by the
individual for his education and training but also by the organisation on recruitment, training, familiarizing and
development human beings employed in the organisation. The valuation can be done groupwise, if the number of
employees is large. The value thus, determined should be further adjusted at the end of each year by organisation
on the basis of his age, seniority, status, performance, experience, leadership, managerial capabilities etc. The
psychologists and other concerned experts will be helpful for such measurement. The revised value would be the
value of the employee at the end of the year.
Theoretically this model may be sound but its practical application may be difficult as it will involve a
number of factors which may not be capable of being expressed precisely and objectively in monetary terms.
Human resources valued according to this model should be shown both on the assets and liabilities sides of
the balance sheet. On the assets side it should be shown after the fixed assets as Human Assets classified into two
parts: (i) value of individual (i) value of firm's investment. On the liabilities side, it should be shown after the
capital as Human Assets by the amount at which it has been shown on the assets side against the value of
individuals.

VII. Input/Output Control Mechanism:

This approach was suggested by Dr. Rao in 1983. Under this approach, a system of human resource
accounting was developed and illustrated its application in a transport equipment manufacturing concern. He has
designed the system based on Input/Output Control Mechanism. The output variables of the system are described
to be the indicators of human resource development and utilization. The human resource investments are measured
through human resource investments, a distinction is made between human resource current costs and human
resource investments. All the human resource costs, whose benefits are expected to affect in future periods are
treated as investments. Then the annual human resource investments are adjusted to the tune of changes due to
intake or separation or natural deterioration. The intake of people results in the addition of human resource
investments while separation necessitates writing off, of human resource investments. The human resource
deterioration is measured and adjusted with the help of amortisation rates in each year.

Recording and Disclosure in Financial Statements:

The various models dealing with the mode of valuation of human resources as an asset have been explained
in the previous pages of this chapter. In India Human Resource Accounting has not been included so far as a
system. Indian Companies Act, does not provide any scope for furnishing any significant information about human
resources in financial statement. Beyond it, there is no rigid instruction on behalf of the Companies Act, to attach
information about the value of human resources and the results of their performance during the accounting year in
notes and schedules. In India, a growing trend towards the measurement and reporting of human assets, particularly
in the public sector, is noticeable during the past few years. There are about twelve companies in India which have
adopted the concept of human resource accounting so far. The data of only four companies is compatible for
comparison. The companies are:
1) Bharat Heavy Electrical Limited (BHEL), which is the first Indian company to publish human resource
accounts from 1974-75 onwards and is one of the FORTUNE 500 companies listed outside U.S.A.
2) Steel Authority of India Ltd. (SAIL), which is a holding company consisting of five integrated steel plants
and two alloy steel units in the public sector.
3) Minerals and Metals Trading Corporation (MMTC), which is the biggest trading organisation in India.
4) Southern Petrochemical Industries Corporation Ltd. (SPIC), which is one of the biggested diversified
organisations in the Joint Sector, producing fertilisers, chemical, electronic etc.

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 Most of the Indian enterprises observed Lev and Schwartz model in the sense that they have computed the
present value of future direct and indirect payment to their employees as the basic frame work of human resource
valuation. MMTC has considered twelve per cent, SPIC has considered the rate of return which is used for
evaluating the company's capital expenditure proposals while SAIL has applied fourteen per cent to arrive at the
present value of human capital. BHEL also reported human resource value with similar model using twelve per
cent discount factor on the future earnings of its employees. The human accounting information is mostly given in
the form of supplementary information attached to the financial statements in annual reports, which are primarily
meant for external reporting.

Benefits of Human Resource Accounting:

The concept of human resource accounting cover the people who constitute a valuable resource of an
enterprise and information on the investment and value of such resources is useful for internal and external
decision-making. Such accounting is of permanent importance to the nation and also to individual organisations.
Following are the main benefits of Human Resource Accounting:
1. Helpful in Proper Interpretation of Return on Capital Employed:
The human resource accounting will disclose the value of human resources. This will help in proper
interpretation of return on capital employed. Such information will give long-term perspective of the business
performance which could be more reliable than the return on capital employed based on net profit only.
2. Improves Managerial Decision-making:
The maintenance of detailed records relating to internal human resources (i.e. employees), will improve
managerial decision-making specially in situations like direct recruitment versus promotion, transfer versus
retention, retrenchment or relieving versus retention, utility of cost reduction programme in view of its possible
impact on human relations and impact of budgetary control on human relations and organisational behaviour and
decision on relocating plants, closing down existing units, developing overseas subsidiaries etc. Thus, the use of
HRA will definitely improve the quality of management.
3. Serves Social Purpose:
It will serve social purpose by identification of human resource as a valuable asset which will help in
prevention of misuse and under use due to thoughtless or rather reckless transfers, demotions, layoffs and day to
day maltreatment by supervisors and other superiors in the administrative hierarchy; efficient allocation of
resources in the economy; effecting economy and efficiency in the use of human resources and proper
understanding of the evil effects of avoidable labour unrest/disputes on the quality of the internal human resources.
4. Increase in Productivity:
It will have the way for increasing productivity of the human resources because, the fact that a monetary
value is attached to human resources, and that human talent, devotion and skill are considered as valuable assets
and allotted a place in the financial statements of the organisation, would boost the morale, loyalty and initiative of
the employees, creating in their mind a sense of belonging towards the organisation and would act as a great
incentive, giving rise to increased productivity.
5. Invaluable Contribution to Humanity:
HRA will be an invaluable contribution for accounting to humanity and it will lead to improve human
efficiency while preserving human dignity and honour. For this, a basic change in individual behaviour, attitude
and thinking is required. HRA will help in realising the value of human resources and, thus, will influence the
individual behaviour, attitude and thinking in the desired direction.
6. Essential where the Human Element is the Prime Factor:
HRA is absolutely essential in such organisations where human element is the prime factor, e.g., a
professional accounting firm, a drama company, a solicitor and attorney firm, an educational institution etc.
7. Helps in Investment Decisions:
The value of a firm's human resources is helpful in potential investors and other users in making long-term
investment decisions.
8. Completes MIS:
Human resource data would create a more complete management information system as it can provide
information of vital importance for both short-term and long-term decision-making as well as performance
measurement. 'It will provide adequate basis for decision on allocation of resources e.g, budgeting, capital

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expenditure decisions and better measurement of resources of an organisation. Performance measurement helps in
assessing the strengths and shortcomings of an organisation and helps in making better promotion policies.
9. For Successful Operation of an Organisation:
The success of an organisation very much depends on the buildup of quality work force at all levels. The
success stories of BHEL, ITC, Hindustan Lever, Larsen & Toubro and several other enterprises are largely due to
the emphasis on human resource development. If this vital asset is not shown in the balance sheet, to that extent the
public and investors are handicapped.
10. Proper Manpower Planning:
Human resource accounting provides scope for planning and decision making in relation to proper
manpower planning. Also, such accounting can bring out the effect of various new rules, procedures and incentives
relating to work force, and in turn, can act as an eye opener for modifications of existing statutes and laws.

Problems and Limitations of HRA

No doubt HRA can provide valuable information both for management and outsiders, yet its development
and application in different industries and organisations has not been very encouraging. This accounting concept is
not popular like social accounting because it may not result in providing immediate and tangible benefits and on
account of the fact of lack of consensus among at rest in providing immediate about the basis of measurement of
the value of human resources. The reluctance on the part of the organisation to introduce the HRA system can be
attributed to the following:
1) There are no specific and clear-cut guidelines for finding cost and 'value of human resources of an organisation.
The existing valuation system suffers from many drawbacks.
2) The life of human resources is uncertain and, therefore, valuing them under uncertainty seems unrealistic.
3) There is a possibility that HRA may lead to dehumanising and manipulations in employees. For example, a
person having a low value may feel discouraged and thus, in itself, may affect his competency in
4) The much-needed empirical evidence is yet to be found to support the hypothesis that HRA, as a managerial
tool, facilitates better and effective management of human resources.
5) Human resources, unlike physical assets, are not capable of being owned, retained and utilised at the pleasure
of the organisation. Hence, treating them as 'asset' in the strict sense of the term, could not be appropriate.
6) There is a constant fear of opposition from the trade unions. Placing the value on employees would prompt
them to seek rewards and compensation based on such valuation.
7) In what form and manner, should their value be included in the financial statements? Is another question on
which there is no consensus in the accounting profession.
8) If a valuation has to be placed on human resources, how should it be amortised? Should the rate of amortisation
be decreasing, constant or increasing? Should it be the same or different for different categories of personnel?
9) Tax laws do not recognise human beings as assets. So human resource accounting has been reduced to a merely
theoretical concept.
10) Accountants have been severely criticised by the Behavioral Scientists for their failure to value human resource
as this has come out as a handicap for effective management
Inspite of the above problems and limitations, human resource accounting is a must to improve human
resource management to overcome problems arising from valuation of intangible assets and to overcome the
difficulties in providing sufficient information to investors in traditional Balance Sheets.

Position of HRA in India

Human resources in any organisation are invaluable but their value cannot be measured accurately. Of
course, in recent years, the Indian Corporate Sector has shown growing interest in accounting for human resources.
In the directors' report, acknowledgement of services rendered by the employees at various levels is an indication
in this regard. It is interesting to note that despite the constraints and challenges, a few lading public sector
undertakings and also a few private sector companies have taken the lead in Introducing human resources
accounting in a formal manner in their balance sheets. Human assets reporting in India usually includes a profile of
human assets, the compensation pattern, training and development, human asset productivity, human asset value
and the total wealth of the organisation.

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 However, the measurement bases used in accounting for human resources differ widely. Several models for
valuation of human resources and accounting have been developed by various experts such as Lev and Schwartz,
Jaggi and Lau. Some companies have adopted these models after modification to suit Indian conditions. Of late,
certain research studies on the human resources valuation practices in India have also been conducted, which also
show a growing interest in the development of the dimension of accounting.
The absence of general acceptance of the measurement criteria for valuation of human resources
would prove to be an impediment towards its wider adoption. However, as more experience is gathered in
the use of various models, it is expected that in the years to come corporate reporting practices will ascribe
greater importance to this emerging dimension of accounting. Much will, therefore, depend upon the
application and usefulness of human resource accounting efforts made by managers, accountants and
academicians. Much will also depend on their willingness to experiment and innovate, keeping the doors and
windows open to let free air from a far blow in.
The concept of human resource accounting is still at the experimental and developmental stage; very few
firms in developed nations have introduced in their respective organisations. HRA is still new and much additional
research will be necessary before it can be applied universally. This is because of the fact that there is no
universally accepted method of human asset valuation. So there is an urgent need for evolving a method which
could be universally acceptable. This is all the more important for optimum allocation of scarce resources in India
and elsewhere.
Moreover, if the historical efforts of different persons are supported by a coordinated effort of the
International Accounting Standard Committees and other professional bodies, for development and preparation of
standard guidelines, format and procedures of Human Assets Accounting, it will be of immense help to the
corporate world in valuing and reporting their human assets.

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