EPFO (Accountancy)

Introduction of Accountancy
Topics covered:
- Definition and basics of accountancy
- Concepts of accountancy

Definition of Accounting
• American Accounting Association (AAA) defined accounting as ‘the process of
identifying, measuring, and communicating economic information to permit
informed judgments and decisions by users of information’.
• Identification: Seeing whether any event/transaction has economic value
• Measurement: Estimating/quantifying the value of the transaction
• Communication: Putting the transaction in Books of Accounts

Uses of Accounting Information

• Accounting information can be used for:
• Economic decision making
• Providing information to different users such as shareholders, tax authorities
etc.
• Disclosing details of assets and valuation
• Users of accounting information
• Internal users: Employees and management
• External users: government/tax agencies, investors, bank lenders

Types of Accounting
1. Financial Accounting
• Used for calculating Profit and Loss of a business
• Closing balances at end of financial years
• Conveying financial information (debt-equity ratio, tax liability)
2. Cost Accounting
• Used in understanding and analyzing expenditure data (purchase price, rent etc)
• Helps in setting prices of goods that a business is selling (to ensure profitability)
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3. Management Accounting
• Looks at processes and outcomes holistically, not just in financial measures
• ESG Accounting
• Leads to better policy decisions (through customer feedback, employee
evaluation etc)

Mandatory Features of Accounting Books

1. Reliability: Accounting books should supply accurate and verifiable information.
2. Relevance: Accounting books should record all material transactions. Irrelevant details
should not be recorded.
3. Understandability: Accounting books should present information in a meaningful
way. It should not be confusing.
4. Comparability: Multiple accounting books across different years for the same
company, across different departments for a company, and across different companies
in the same industry.

Accounting Standards
• Generally Accepted Accounting Principles (GAAP)
• Set of rules for accounting.
• Started in USA. India’s GAAP laid down by ICAI.
• For example: Recording historical cost of assets is to be recorded
• International Financial Reporting Standards (IFRS)
• Set of principles for accounting. Can be applied according to every country’s
individual circumstances
• Now accepted across 167 jurisdictions
• For example: Fair market value should be represented in accounts.
• India’s NFRA
• National Financial Reporting Authority created under Companies Act 2013 to
lay down the formats for accounting.
• Replaces ICAI’s mandate.

Double Entry Bookkeeping

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• Bookkeeping is the act of record-keeping for financial information

• Based on the principle that every monetary transaction has dual effect
• Helps ensure accuracy of financial information and seamless flow of data
• Originated with Middle East traders. Luco di Borgo of Italy gave it modern form.
• Double entry bookkeeping is the modern form of record-keeping where every
transaction has two entries- one on the debit side and the other on the credit side.
• Debit and credit literally mean “left” and “right” respectively.

Basic Accounting Concepts

These concepts are applied when we prepare books of accounts. These are standard
assumptions that help maintain consistency across different books of accounts.
1. Business entity;
2. Money measurement;
3. Going concern;
4. Accounting period;
5. Cost
6. Dual aspect concept (or Duality);
7. Matching;
8. Full disclosure;
9. Consistency;
10. Conservatism (Prudence);
11. Revenue recognition (Realisation);
12. Materiality

1) Business entity concept

• It assumes that, for accounting purposes, the business enterprise and its owners are two
separate independent entities.
• For example, when the owner invests money in the business, it is recorded as liability
of the business to the owner.
• Books are prepared for the business entity, and the capital invested by the shareholders
is recorded as a liability of the business that is to be paid back.
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2) Money measurement
• It states that only those transactions and happenings in an organisation which can be
expressed in terms of money are to be recorded in the book of accounts.
• Transactions which can’t be expressed in monetary units are not recorded
• For example appointment of manager, new competitor entering in the market and rift
between production and marketing departments, capability of its human resources are
not recorded
3) Going Concern Concept
• It assumes that a business firm would continue to carry out its operations indefinitely,
i.e. for a fairly long period of time and would not be liquidated in the foreseeable future
• This allows closing accounts as well as opening accounts to be prepared at the end of
every financial year and beginning of the next financial year, respectively
4) Accounting Period Concept:
• In this, balance sheet and profit and loss account should be prepared at regular intervals.
• Life of an enterprise is broken into smaller accounting periods (normally 1 year) so that
its performance is measured at specified period.
• Can also be half-yearly or quarterly statements.
5) Cost Concept:
• It states that all assets are recorded in the book of accounts at their purchase price, which
includes cost of acquisition, transportation, installation and making the asset ready to
use. (eg. wages for installation of machinery will be recorded in cost of machinery)
• Market price at different dates is not recorded
• Depreciation of value or appreciation in value are recorded separately as new
transactions (to be discussed later)
• General rule is to only record cost price
6) Dual Aspect Concept:
• Dual aspect is the foundation or basic principle of double-entry bookkeeping.
• It assumes that every transaction has a dual effect i.e. it affects two accounts in their
respective opposite sides. Therefore, the transaction should be recorded at two places.
It means, both the aspects of the transaction must be recorded in the books of accounts.
• For example, goods purchased for cash has two aspects which are
• (i) Giving of cash
• (ii) Receiving of goods.
• These two aspects are to be recorded.
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• The duality principle is commonly expressed in terms of fundamental Accounting

Equation, which is as follows:
• Assets = Liabilities + Capital
• In other words, the equation states that the assets of a business are always equal to the
claims of owners and the outsiders. The claims also called equity of owners is
termed as Capital (owners’ equity) and that of outsiders, as Liabilities (creditor’s
equity).
• The two-fold effect of each transaction affects in such a manner that the equality of
both sides of equation is maintained.

7) Realisation (Revenue Recognition) Concept:

• Revenue from any business transaction should be included in the accounting records
only when it is realised. Revenue is said to have been realised when cash has been
received or right to receive cash on the sale of goods or services or both has been
created.
• Revenue is realized at the time when goods have been sold or service has been rendered
(when the obligation to receive the amount has been established).
• One should record revenue when it has been earned and not when the payment is
collected. This helps in ensuring details of one accounting period are maintained within
that period itself.
• For example, if A sells 100 barrels of oil to B on 10 March 2023, to be paid on 10 April
2023, then revenue is realized on 10th March, whereas the debt will become realizable
on 10th April.
• This is also the principle behind accrual basis of accounting (which requires debt to
recognised when it is accrued, not when it is paid off).

8) Matching Concept
• It states that expenses incurred in an accounting period should be matched with
revenues during that period. It implies that all revenues earned during an accounting
year, whether received/not received during that year and all cost incurred, whether
paid/not paid during the year should be taken into account while ascertaining profit or
loss for that year.
• It is a corollary of Accounting Period Concept and Duality Concept

9) Full Disclosure Concept (an accounting convention)

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• All material and relevant facts concerning financial performance of an enterprise must
be fully and completely disclosed in the financial statements.
• Full disclosure means that there should be full, fair and adequate disclosure of
accounting information.
• These are interchangeably called conventions or concepts.

10) Consistency Concept (an accounting convention)

• It means that same accounting principles should be used for preparing financial
statements year after year.
• This makes Books of Accounts comparable over time.
• Types of consistency:
• Vertical consistency- price of one asset within the organisation should be same
across different books of accounts (Cash Book, Journal etc)
• Horizontal consistency- same accounting books should be maintained over
multiple years
• Dimension consistency- similar trading organisations should have similar
accounts
11) Materiality concept (an accounting convention)
• only material fact i.e., important and relevant information should be supplied to the
users of accounting information.
• The materiality of a fact depends on its nature and the amount involved. Any fact would
be considered as material if it is reasonably believed that its knowledge would influence
the decision of informed user of financial statements.
• For example, money spent on food for employees can be recorded. It is not relevant
normally what food was eaten. (Not necessary to record how many pakoda, chai etc)

12) Conservatism (Prudence)

• It is based on the principle that “Anticipate no profit, but provide for all possible
losses”.
• It requires that profits should not to be recorded until realised but all losses, even those
which may have a remote possibility, are to be provided for in the books of account.
• This requires making Provisions for Losses
• For example, banks make provisions for Non-Performing Assets (NPAs). They don’t
account for early payment of loan. Business entities also make Provision for Doubtful
Debts.
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Topics covered:

- Types of cost and Accounting Bases (Cash basis and Accrual basis)
- Rules of Debit and Credit
- Modern Approach and Traditional Approach of Accounting

Types of Cost

• Original cost: The cost of an item at the time of purchase or creation. The original
cost includes all costs associated with the purchase of an asset and putting it to use,
including commissions, transportation, appraisals, and installation.

This is a concept of accountancy.

• Opportunity cost: It is the profit lost when one alternative is selected over another.
For example, investing in textile stocks instead of dairy stocks has an opportunity
cost.

This is a concept of economics

• Replacement cost: It is the price that an entity would pay to replace an existing
asset at current market prices with a similar asset.

This is a concept used in insurance and banking/investments decisions

• Cash cost: It is the recognition of expenses as they are paid in cash. This does not
account for the discounts received or deferred payment plans.

This is also a concept of accountancy, but it is not recorded in Accrual Basis.

Basis of Accounting

Two ways of recording transactions in books of accounts are possible:

1) Cash Basis- In this, accounting entries are recorded only when cash is received or
paid.

2) Accrual basis- Revenues and costs are recognised in the period in which they occur
rather when they are paid.

• Revenue and expense are taken into consideration for the purpose of income
determination on the basis of accounting period to which they relate

• Companies Act 1956 recognizes accrual basis of accounting

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Account Format

• In its simplest form, an account looks like the English Language Letter ‘T’.

• This account can be for any purpose (eg. Machinery, Goods, Debtors etc.)

• All transactions pertaining to one account should be mentioned together. For example,

Accounting Approaches

1. Modern Approach: Accounts are based on which side of the balance sheet they appear
(American method)

2. Traditional Approach: Accounts are based on their permanent or temporary nature.

I. Modern Approach of Accounting

All accounts are divided into five categories for the purpose of recording of the business
transactions:

1. Assets (eg. Machinery, Land, Building, Debtors, Cash)

2. Liability (eg. Loan, creditors, bank overdraft)
3. Capital
4. Expenses/Losses (Salaries, Rent, Advertisement Expenses)
5. Revenues/Gains (Sales, Interest received, Windfall gains)

For recording changes in Assets/Expenses/Losses

• Increase in Asset is debited,

decrease in Asset is credited.

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• Increase in Expenses/Losses is debited

decrease in Expenses/ Losses is credited

(Note: payments such as wages are ordinarily expenses, but for installation expenses,
they are included in asset cost. For example, wages on installation of Machinery or
Furniture)

For recording changes in Liabilities and Capital, Revenue/Gains

• Increase in Liabilities is credited and decrease in Liabilities is debited.

• Increase in Capital is credited and decrease in Capital is debited.

• Increase in revenue/gains is credited and decrease in revenue/gain is debited.

II. Traditional Approach of Accounting

All accounts are divided into 3 categories- personal, real and nominal

● Personal Account

These accounts have items which have legal personality (humans, companies,
organisations)

• Natural Persons (Mr. XYZ, Ms. Suman)

• Artificial Persons (ABC Charitable Trust, DAV Trading Co.)

• Representative Persons (Pre-paid Expenses, Outstanding Rent, Brokerage)

● Real Account

Real Account has items only on the assets side.

• Tangible Real (Machinery, Plant, Goods)

• Intangible Real (Goodwill, Patent)

● Nominal Account

These accounts are not carried on to the balance sheet. They are closed at the end of
every year and carried on to the Income Statement (Profit and Loss Account)

• Incomes/Gains (eg. Sales)

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• Expenses/Losses (eg. Rent, Salary)

Accounting rules for Traditional Approach

1. Personal Account

1) Natural Persons (Mr. XYZ, Ms. Suman)

2) Artificial Persons (ABC Charitable Trust, DAV Trading Co.)

3) Representative Persons (Pre-paid Expenses, Outstanding Rent, Brokerage)

Rule: Debit the receiver and Credit the giver.

Note: If a prefix/suffix (ex; outstanding, prepaid) is added to a nominal account, it

becomes personal account. For example, Wages A/c is nominal account but
outstanding wages a/c is representative personal account.

2. Real Account

a. Tangible Real (Machinery, Plant, Furniture)

b. Intangible Real (Goodwill, Patent)

These accounts are not closed at the end of the year. They are carried forward to the
Balance Sheet and continue.

Rule: Debit What Comes In, Credit What Goes Out.

3. Nominal Account

a. Incomes/Gains (eg. Sales)

b. Expenses/Losses (eg. Rent)

c. Branch

These are temporary accounts and thus we need to transfer their balances to Trading and
Profit and Loss A/c at the end of the accounting year.

Rule: Debit all expenses/losses, Credit all incomes/gains.

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EPFO Test 04 (2023) Model Answer

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Topics covered-

● Types of books of accounts

● Trial Balance and its role

Types of Books of Accounts

• Voucher: A Voucher is documentary evidence in support of a transaction. Cash

and non-cash vouchers both.

• Journal: A book of accounts in which all day-to-day business transactions are

recorded in a chronological order

• Ledger: Principal book of accounting system. It contains different accounts where

transactions relating to that account are recorded

• Bank Reconciliation Statement: A statement prepared to reconcile the difference

between the balances as per the bank column of the cash book and pass book on
any given date.

• Trial balance: A trial balance is a statement showing the balances, or total of debits
and credits, of all the accounts in the ledger with the aim to verify accuracy of the
ledger accounts. It shows the final position of all accounts and helps in preparing
the final statements. It is a statement containing the various ledger balances of an
entity on a particular date.

• Balance Sheet: Balance of assets and liabilities of a firm on any date.

Special Journals:

• Cash Book: A book in which all transactions relating to cash receipts and cash
payments are recorded.

• Purchase Journal/Purchase book: This book records only Credit purchase of

goods in which the firm deals.

• Sales Journal/sales Book: All credit sales of merchandise are recorded in the sales
journal.

• Purchases Return Book: A book in which return of merchandise purchased is

recorded.
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• Sales Return Book: A special book in which returns of merchandise sold on credit
are recorded.

• Journal Proper: A book maintained to record transactions, which do not find place
in special journals. (also called Journal Residual)

Sample Accounts

1. Journal
- Date (chronological)
- Details of each and every transaction
- Following rules of debit and credit

Example:

2. Ledger
- Multiple accounts are maintained together here

Example:
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3. Cash Book
- All cash transactions only
- It can be single column (which records all cash and bank transactions together)
or double column (which records cash and bank balances separately)

Example (Single Column Cash Book):

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Example (Double Column Cash Book):

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4. Balance Sheet
- Does not have debit and credit side, but rather assets and liabilities
- Always matches due to the accounting equation (Assets= Liabilities+Capital)

Example:

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Trial Balance

• Made from ledger balances of various accounts.

• Usually prepared at end of year. However, it can be at any date.

Example:

• Functions of Trial Balance

a. To Ascertain the Arithmetical Accuracy of Ledger Accounts

b. To Help in Locating Errors

c. To Help in the Preparation of the Financial Statements

• Types of Errors

1. Errors of Omission
- Missing one item in accounts
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- Eg. Salary might be debited to cash account, but the same may
not be noted in the cash book.
2. Errors of Commission
- Double-counting of transactions may happen at times
- Eg. Salary might be debited to Cash A/c as well as Bank A/c
simultaneously
3. Errors of Principle
- Mistake of debit/credit side
- Eg. Prepaid Rent might be noted on the credit side accidentally
(mistaking it for Outstanding Rent)

• Compensating Errors in Trial Balance

• If all entries are correct in all accounts of the firm, then the Trial Balance
should match

• However, just because Trial Balance matches does not mean that there are
no further errors.

• Compensating errors occur when equal amounts on both sides of the Trial
Balance get interchanged by accident

• For example, Furniture worth Rs 28,000 is noted on Credit Side; while

Creditors worth Rs 15,000 and Profits worth Rs 13,000 are noted on the
Debit Side.

• The Trial Balance will match, but the Financial Statements will still be
wrong.

• To solve any unresolvable error immediately, a Suspense Account is created.

This Suspense Account is resolved in due time. It is carried onto the Balance Sheet for
the immediate term if necessary.
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Financial Statements-1 (Income Statements)

Topics covered:
- Basics of financial statements
- Capital and revenue items, expenditure and receipts
- Income statements- Profit & Loss Account, Trading Account

What are Financial Statements?

● Financial statements are the statements that are prepared at the end of the
accounting period, which is generally one year.
● Financial statements convey financial information as a compilation of revenue items
and capital items
● These financial statements include
○ Income statement (Trading Account and Profit & Loss Account)
○ Position statement i.e., Balance Sheet

Capital and Revenue Items

All transactions have to be treated as either capital or revenue items
- The revenue items form part of the trading and profit and loss account
- the capital items help in the preparation of a balance sheet.

1. Capital items: Those transactions which affect the long-term non-cash assets or
liabilities in the balance sheet of the business are called capital items. These
transactions help in the long term profitability of the business.
a. Capital receipts (Sale of land- decrease in non-cash assets)
b. Capital expenditure (Purchase of machinery/furniture- increase in non-cash
assets)
2. Revenue items: Those transactions that are routine in nature and expected to
happen in the normal course of business
a. Revenue receipts (Sales of goods)
b. Revenue expenditure (Wages, rent)

Expenditure
Expenditure can be of two types- capital and revenue

Capital expenditure Revenue expenditure

increases earning capacity of business incurred to maintain the earning capacity

incurred to acquire fixed assets for incurred on day-to-day conduct

operation of business

Capital expenditure is non-recurring by Revenue expenditure is generally recurring

nature. expenditure
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Capital expenditure benefits more than one revenue expenditure normally benefits one
accounting year accounting year

Capital expenditure (subject to depreciation) revenue expenditure (subject to adjustment

is recorded in balance sheet for outstanding and prepaid amount) is
transferred to trading and profit and loss
account

Receipts
The similar treatment is given to the receipts of the business.
1. Capital Receipts
- If the receipts imply an obligation to return the money, these are capital receipts.
- The example can be an additional capital brought in by the owner or a loan taken
from the bank.
- Both receipts are leading to obligations, the first to the owner (called equity) and the
other to the outsiders (called liabilities).
- Another example on a capital receipt can be the sale of a fixed asset like old
machinery or furniture.

However, if a receipt does not incur an obligation to return the money or is not in
the form of a sale of fixed asset, it is termed as revenue receipt.

Income Statements

I. Trading Account
- Discusses position of inventory (stocks and supplies)
- Helps in calculating profit margins as well as Gross Profit
- Important for cost accounting purposes also
II. Profit and Loss Account
- Discusses overall financial position of the company
- Helps in calculating net profit
- Important for making other financial decisions about operating costs
- For example, expenses on salaries, advertisement, rent

Glossary of terms for Trading Account

1. Cost of goods sold

= Opening stock + Net purchases + All direct expenses Closing stock

2. Gross Profit
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= Net sales Cost of goods sold

3. Gross loss
= Cost of goods sold Net sales

4. Opening stock refers to the value of goods lying unsold at the beginning of the
accounting year. It is shown on debit side of Trading Account.

5. Closing Stock is the value of goods lying unsold at the end of the accounting year. It
is shown on credit side of Trading Account.

6. Direct expenses are the expenses that can be attributed directly to the purchase of
goods or goods manufactured.

Trading Account

- Debit side: Opening stock, net purchases and direct expenses and other particulars
listed above.
- Credit side: net sales and closing stock and other particulars listed above.

Glossary of terms for Profit and Loss Account

1. Gross Profit = Sales ––(Purchases + Direct Expenses)

2. Net Profit = Gross Profit + other incomes Indirect expenses.

Important Notes:
- All the items of revenue income and expenses whether cash or non cash are
consider in this account
- Only revenue income and expenses related to the current year are debited or
credited to this account.
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In P&L Account, the following are not shown:

● Drawings: Drawings are not expenses of firm so not show in this account. Drawings
are reduced from the owner’s capital (in the balance sheet)
● Income tax: In case of sole proprietor it is his personal expenses so debited from
capital account.

Deferred Revenue Expenditure

● Deferred Revenue Expenditure is that expenditure which is revenue in nature
● However, it has long term effects and large transaction value
● Thus, its cost should be distributed over many years
● For example:
○ Huge expenditure on advertisement campaign
○ Preliminary expenses for companies
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Financial Statements-2

Topics covered
- Balance Sheet (position statement)
- Concepts of stock and flow
- Types of Assets and Liabilities
- Branch Accounting

Balance Sheet (Position Statement)

● It is prepared to ascertain the financial position of a firm on a particular date.
● Depicts the liabilities and assets of firm
● Based on accounting equation (Asset= Total liabilities + Capital)
● Balance sheet is a statement and not an account (no debit and credit side)
● It is prepared from the closing balances of all personal and real accounts
(hence it is called the “balance” sheet)
● Balance Sheet is a “stock statement” unlike Profit and Loss Account which is
a “flow statement

Key Concepts: Stock and Flow

Stock Flow

Stock is basically the accumulated or Flow implies the movement of the

available quantity of any commodity at a commodity, from the source to
particular moment. destination, over a period.

Static (No time dimension) Dynamic (There is a time dimension)

Quantity measured at a particular point in Quantity measured in a particular period of

time. time.

- Both stock and flow influence each other

- Balance Sheet can only be prepared after Profit and Loss Account
- This is because the Profit and Loss Account ultimately shows the entire
change in the position of company from one year to another year
- The Profit and Loss Account explains the difference between two Balance
Sheets, and how that change was achieved.

Components of Balance Sheet: Assets and Liabilities

- Assets are the things owned by a business (such as cash, inventory, building,
goodwill, etc)
- Liabilities are the claims on the assets of the business (eg. whether the
assets were purchased through loan, or through owner’s self-financed capital, etc)
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I.Types of Assets
A. Fixed/ Long term Assets
Assets that are purchased for permanent i.e., long term use and these help
the business to earn revenue
Example: Land & Building, Plant & Machinery, Motor Vehicle, etc
B. Current Assets
Assets which are acquired by the business either for resale or for converting
them into cash. These are normally realised within a period of one year.
Example: cash in hand, cash at bank, bill receivable, debtors, stock, prepaid
expenses, advances, inventory, Bill/trade receivable etc.
C. Liquid Assets
Assets which are either in cash or can be easily converted into cash.
Example: cash, stock, marketable securities (such as mutual funds or shares)
etc.
D. Wasting Assets
Assets which exhaust or reduce in value by their use.
Example: Mines, quarries
E. Fictitious Assets
These are not the real assets. These are the items of such expenses and
losses which have not been written off in full.
Example: preliminary expenses, under writing commission, etc

II.Types of Liabilities
A. Long term Liabilities
Liabilities which are not payable during the current accounting year.
Generally, the funds raised through such means are used for purchase of
fixed assets.
Example: loan on mortgage, loan from financial institutions.
B. Current Liabilities
Liabilities which are payable during the current year.
Example: Bank overdraft, trade creditors, bill/trade payable, outstanding
expenses, advance taken etc.
C. Provisions
It is the amount that is generally put aside from the profit in order to meet a
probable future expense or a reduction in the asset value although the exact
amount is unknown.
D. Contingent Liabilities
- Some events are uncertain, which can become a liability for
the business later on.
- However, at present there is no liability.
- Thus, they are not recorded in Books of Accounts or Financial
Statements.They are disclosed in Notes to Accounts
- For some foreseeable contingencies, Reserves might be
created
For example, litigation against the business firm can lead to potential fine
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Branch Accounting
- Many businesses have multiple branches ( eg. Big Bazaar)
- Debtors System and Stock and Debtors System are two methods used in
branch accounting to keep track of transactions and balances between a head office
and its branch offices.

Debtors System Stock and Debtors System

The branch keeps its own accounts The branch keeps track of both its inventory
receivable ledger and sends a periodic and accounts receivable,
statement to the head office. and sends regular reports to the head office
about both.

The head office then records the The head office then records these
transactions in its own accounts and transactions in its own accounts and
includes the balance of the branch in its includes the balance of the branch in both
overall accounts receivable balance. the inventory an accounts receivable
balances.

Branch Account is a personal account Branch Accounts are nominal accounts

(Branch Expenses A/c, Branch Stock A/c
etc)

Debtors System is simpler and may be Stock and Debtors System provides more
more suitable for smaller branches with comprehensive information about the
fewer transactions. branch's financial position

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Depreciation, Provision and Reserves

Topics covered
- Depreciation and amortisation, and their accounting treatment
- Different kinds of provisions
- Different kinds of reserves

DEPRECIATION AND AMORTISATION

Depreciation
● Depreciation is the decline in the value of an asset on account of wear and tear or
passage of time.
○ For example, car outside a showroom loses value every year
○ Machinery’s wear and tear over the years
● Depreciation is decline in the book value of fixed assets. It is charged on the original
cost.
● Depreciation is charged on all fixed assets except land. Land faces appreciation over
time, not depreciation. However, a building might face depreciation.
● It is a non cash expense. It does not involve any cash outflow. It is the process of
writing off the capital expenditure already incurred.
● Depreciation is revenue expenditure.

Amortisation
- Amortisation refers to writing off the cost of intangible assets which have utility for a
specified period of time.
- Amortisation is for intangible assets (like patents, goodwill etc) just the same way
depreciation is for tangible assets (like furniture, machinery etc)
- Examples of intangible assets:
1. Patents
2. Assigned copyright
3. Trademarks (except well known marks)
4. Franchises
5. Goodwill

Calculating Depreciation
● Depreciation is the gradual writing down of value of any asset.
● Depreciable cost of an asset = Asset cost net residual value.
● Net residual value is the estimated net realisable value (or sale value) of the asset at
the end of its useful life.
● There are two methods of calculating depreciation
○ Straight Line Method
○ Written Down Value Method

I. Straight Line Method

○ Also called Fixed Instalment Method
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○ This method is based on the assumption of equal usage of the asset over its
entire useful life.
○ According to this method, a fixed and an equal amount is charged as
depreciation in every accounting period during the lifetime of an asset.
○ Annual Depreciation = (cost of asset- net realisable value)/ lifetime of asset
○ For eg. Cost of machinery is Rs. 1 lakh, and lifetime is 10 years after which it
will be obsolete. The annual depreciation will be Rs. 10,000/-each year.

II. Written Down Value Method

○ It is also known as ‘reducing balance method’
○ Under this method, depreciation is charged on the book value
○ of the asset
○ This method involves the application of a pre determined proportion/
percentage of the book value of the asset at the beginning of every
accounting period, so as to calculate the amount of depreciation
○ The amount of depreciation reduces year after year
○ For eg. Cost of machinery is Rs. 1 lakh.The annual depreciation will be
@10% p.a.
1. In the first year, Rs. 10,000/- will be charged as depreciation.
2. In the second year, it will be Rs 9000/-
3. In third year, Rs 8100/- and so on

Treatment of Depreciation
● Prescribed by Accounting Standard 6
○ AS 6 provides guidelines for the calculation and disclosure of depreciation,
including the various methods of depreciation that can be used.
○ AS 6 requires companies to apply the method of depreciation that best
reflects the pattern of consumption of the asset's future economic benefits.
● In India, both the Straight Line Method and the Written Down Value Method of
depreciation are used, but the Written Down Value (WDV) Method is the more
commonly used method of depreciation.
○ The WDV method of depreciation is preferred in India because it allows
companies to claim higher depreciation in the initial years of an asset's useful
life when the asset is likely to be most productive, and lower depreciation in
the later years when the asset is less productive.
○ This allows better profitability on the balance sheets of companies.
● The Income Tax Act also prescribes rules for the calculation of depreciation for tax
purposes.
○ Under the Income Tax Act, companies are required to use the Written Down
Value Method of depreciation for most assets
○ Straight Line Method is used for certain specified assets, such as buildings.
● Schedule II of Companies Act 2013 provides for various rates of depreciation for
many assets.

Asset Disposal Account

● When an asset is sold, a new account, namely, Asset Disposal a/c is created.
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● This is a temporary account (nominal account) just to make the adjustments for the
disposal of the asset.
● A disposal account is a gain or loss account that appears in the income statement,
and in which is recorded the difference between the disposal proceeds and the net
value of asset.
Sample:

PROVISIONS AND RESERVES

Provision
● It is the amount that is generally put aside from the profit in order to meet a probable
future expense or a reduction in the asset value although the exact amount is
unknown.
● There are certain expenses/losses which are related to the current accounting period
but amount of which is not known with certainty because they are not yet incurred.
● Provisions are made for revenue expenses that may be incurred in the course of
business
● Examples of provisions are:
○ Provision for depreciation;
○ Provision for bad and doubtful debts;
○ Provision for taxation;
○ Provision for discount on debtors;
○ Provision for repairs and renewals.

● Accounting Treatment of Provisions

In the balance sheet, the amount of provision may be shown in two ways
1. By way of deduction from the concerned asset on the assets side.
Eg. provision for depreciation as a deduction from the concerned fixed assets
2. On the liabilities side of the balance sheet along with current liabilities
Eg. Provision for Taxes and Provision for repairs and renewals.

Reserves
● A part of the profit may be set aside and retained in the business to provide for
certain future needs like growth and expansion or to meet future contingencies.
● Examples of reserves are:
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○ General reserve;
○ Workmen compensation fund;
○ Investment Fluctuation Fund;
○ Capital reserve;
○ Dividend equalisation reserve;
○ Reserve for Redemption of Debenture etc
● Reserves are normally kept either for business expansion, or for meeting capital
losses or payment of dividend. Unlike Provisions which are kept for revenue
expenses, reserves are for contingencies and capital expenditures normally.
● It is possible to have both capital and revenue reserve.

Secret Reserve
● Secret reserve is a reserve which does not appear in the balance sheet. It may also
help to reduce the disclosed profits and also the tax liability.
● It can be created by
○ Charging higher depreciation,
○ Undervaluation of inventories/stock,
○ making excessive provision for doubtful debts,
○ showing contingent liabilities as actual liabilities.
● It is not ethical for a company to maintain a secret reserve. It is against the values of
transparency and full disclosure.
Capital Reserve and Revenue Reserve

Capital Reserve Revenue Reserve

A capital reserve is created to finance long Revenue reserve is created to meet

term projects for a business unforeseen events in a business
organisation

To meet the mandatory purpose of meeting To be used as reinvestment for company

the accounting principles (eg. Capital
Reserve)

Cannot be distributed as dividend Can be used for dividend payout

Capital reserve is created by the sale of Revenue reserve is created from retained
fixed assets earnings

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Not-for-Profit Organisations

Definition
● Not-for-Profit Organisations are entities that work for the welfare of the society or only
its own members
● Its sole aim is to provide service either free of cost or at nominal cost, and not to earn
profit.
● Under the Companies Act 2013, these companies are registered as “not for profit
entities” under Section 8 of the Act. Thus, they are also sometimes called “Section 8
Companies”
● They can also be registered under the Trusts Act, or the Societies Act.
● For eg. Educational Trusts, Tata Trusts etc

Sources of Income
The main sources of income of such organisations are:
1. Subscription fee from members
2. Donations (general and for specific purposes)
3. Legacies (general and for specific purposes)
4. Grant in aid from the government
5. Income from investments

Difference in Accounting
There are some small differences in accounting process for NPOs
1. Receipts and Payments Account:
○ A Receipts and Payments Account is prepared at end of the accounting year.
○ This records all transactions which happened in the year, on a cash basis
2. Income and Expenditure Account:
○ Instead of “Profit and Loss Account”, they maintain a “Income and
Expenditure Account”
○ This is because these entities do not make any profits or losses
3. Balance Sheet:
○ The balance sheet of NPOs have some differences from balance sheets of
business organisations. Made on the same principles.
○ However, there is no “capital” account

I. Receipts and Payments Account

○ Summary of cash transactions based on the cash book.
○ Cash book is prepared on daily basis
○ Receipts & Payment account is prepared at the end of accounting year
○ It serves the purpose of trial balance and becomes the basis of preparing
financial statements i.e., Income and Expenditure Account and Balance sheet
for the organisation.
○ All cash receipts and payments are recorded in this account whether these
belong to current year or next year or previous year.
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○ All receipts and payments are recorded in this account whether these are of
revenue nature or capital nature.
○ All receipts are recorded on its debit side while all payments are shown on the
credit side.
○ Honorarium
■ This is an amount paid to persons who are not the employees of the
organisation but take part in the management of the organisation.
■ Remuneration paid to them is called honorarium.
■ Recorded on the “payment” side of Receipts and Payments Account
○ Sample:

II. Income and Expenditure Account

○ It is the summary of incomes and expenditures of the organisation of a
particular year and is prepared at the end of the year.
○ This account is similar to the Profit and Loss Account of the Business
Organisations, but for Non Trading Concerns
○ It is a nominal account
○ In this account revenue expenditure and revenue income of the year for which
Income and Expenditure A/c is prepared are taken.
○ Only transactions of revenue nature not capital are recorded
○ Only of that year not of previous or next year
○ Sample:
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III. Balance Sheet for NPOs

○ Every NPO prepares Balance Sheet at the end of the year. It also has the
asset side and the liability side.
○ However, there are a few differences such as absence of share/owner’s
capital
○ There are few different items also
■ Donations
■ Legacies
■ Life Membership Fees

1) Donations
○ It is a sort of gift in cash or property received from some person or
organisation.
○ It appears on the receipts side of the Receipts and Payments Account.
○ Donations can be general or for a specific purpose
i) Specific Donations:
● Donation received is to be utilised to achieve specified
purpose.
● Such donation is to be capitalised and shown on the liabilities
side of the Balance Sheet.
● Eg. Employee Welfare Fund
ii) General Donations:
● Such donations are to be utilised to promote the general
purpose of the organisation.
● These are treated as revenue receipts as it is a regular source
of income hence, it is taken to the income side of the Income
and Expenditure Account of the current year
● Eg. General Fund
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2) Legacies
○ It is the amount received by organisations as per the will of a deceased
person
○ A legacy may or may not specify the use of the amount.
○ Accounting treatment is similar to donations
○ Specific Legacies (use of which is specified are specific legacy) and is
shown in the balance sheet as liability.
○ General Legacies: If the use is not specified, it is considered as revenue
nature and credited ( income side) to income and expenditure account

3) Life Membership Fees

○ Life Membership Fees is not recurring in nature and received once for a
whole life from a member.
Thus, Life Membership Fees are capital receipts, so these are added to the Capital Fund on
the Liabilities side of the Balance Sheet.

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Accounting for Partnerships

Topics covered
- Nature of partnerships
- Accounting for partnerships
- Dissolution of partnership firms

Definition of Partnership
According to the Indian Partnership, Act 1932: “Partnership is the relation between persons
who have agreed to share profits of a business carried on by all or any of them acting for all”.

Key Words
1. Relation between persons: not companies or states
2. Agreement: It is only a contractual relationship. Unlike HUF (by birth) or company
(by law)
3. Sharing of profits: sharing of losses is not necessary, only agreement to share
profits is necessary.
4. Business: cannot be for charity, research etc. It has to be a business.
5. Participation by all or any of them acting for all. Partners are jointly and severally
(individually) liable for the acts of any partner done in the course of partnership
business.

Types of Partnership
1. Partnership at Will
- Partnership for profit, with/without an agreement
2. Partnership for Fixed Term
- Partnership comes to an end at the expiry of given term
- Must have a written partnership agreement (partnership deed)
3. Limited/Particular Partnership
- Partnership scope is limited to one narrow domain as specified in the
partnership deed
4. General Partnership- Partnership for all ventures undertaken by the parties together

Types of Partners
1. Active partner
- Partner who participates in the business management
2. Dormant/sleeping partner
- Partner who does not participate in business management
- Might contribute capital or provide resources
3. Nominal partner
- Partner only in name
- Nominal partners may provide repute to the partnership by his/her
association. May also provide network contacts.
- Nominal partner is also liable the same way as any other partner.
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4. Partner by estoppel/holding out

- Person who represents himself/herself to be a partner of a firm, even if he/she
does not share profits or contribute capital
- Partner by estoppel is still liable to third parties in the same manner
5. Partner in profits
- Does not share losses
- Possible in a registered partnership deed. Not possible if deed is not
registered.
6. Minor partner
- Minor can only be a partner in profits
- Cannot be asked to bear any loss.
- Minor can ratify his/her acts when they attain age of majority.

Partnership Deed
● The written form of the agreement is the basis of a document of partnership.
● It contains terms and conditions regarding the conduct of business, rights, duties &
obligations of partners.
● Also for the procedure of admission, retirement and death of partner.

Absence of Partnership Deed

While registration of Partnership Deed is not mandatory, there are repercussions to non-
registration. Provisions of the Partnership Act becomes applicable
1. Distribution of Profit: Partners are entitled to share profits equally.
2. Interest on Capital: Interest on capital is not allowed.
3. Interest on Drawings: No interest on drawing of the partners is to be charged.
4. Interest on partner’s loan: A Partner is allowed interest @ 6% per annum on the
amount of loan given to the firm by him/her.
5. Salary and commission to partner: A partner is not entitled to any salary or
commission or any other remuneration for managing the business.
6. No private profit: If a partner derives any profit for him/herself from any transaction
of the firm or from the use of the property or business connection of the firm or the
firm name, he/she shall account for the profit and pay it to the firm.
7. No competing business: If a partner carries on any business of the same nature as
and competing with that of the firm, he/she shall account for and pay to the firm, all
profit made by him/her in that business

Accounting for Partners’ Capital

Maintenance of Capital Accounts of Partners
All transactions relating to partners of the firm are recorded in the books of the firm
through their capital accounts.
1) Fixed Capital account 2 accounts are maintained
a) Capital account
b) Current account.
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In fixed a/c method, generally initial capital contributions by partners are

credited to partners’ capital accounts and all subsequent transactions &
events are dealt with through current accounts.

2) Fluctuating Capital account

- No current account is maintained.
- All such transactions & events are passed through capital accounts

Profit and Loss Appropriation Account

● It is merely an extension of the Profit and Loss Account of the firm.
● The profit of the firm has to be distributed amongst the partners in their respective
profit sharing ratio.
● But before its distribution it needs to be adjusted.
● All Adjustments are made in this account.
○ partner’s salary,
○ partner’s commission,
○ interest on capital,
○ interest on drawings etc.

Admission of Partner
A person can be admitted into partnership only with the consent of all the existing partners
unless otherwise agreed upon.

On the admission of a new partner, the following adjustments become necessary:

1. Adjustment in profit sharing ratio
2. Adjustment of Goodwill
3. Adjustment for revaluation of assets and reassessment of liabilities
4. Distribution of accumulated profits and reserves
5. Adjustment of partners’ capitals

Sacrificing Ratio:
The ratio in which the old partners agree to sacrifice their share of profit in favour of
the incoming partner is called sacrificing ratio.
Sacrificing Ratio = Existing Ratio - New Ratio

Retirement of Partner
A partner retires either:
1. with the consent of all
2. as per terms of the agreement;
3. at his or her own will (however, without other partners’ consent there can be financial
repercussions)
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The terms and conditions of retirement of a partner are normally provided in the partnership
deed. If not, they are agreed upon by the partners at the time of retirement.

Gaining Ratio:
Opposite of sacrificing ratio
Gain in profit sharing ratio upon the retirement of partner
Gaining Ratio= New Ratio - Old Ratio
If partner dies, share is transferred to legal representatives or Executioners
Goodwill
● It is the value of the reputation of a firm in respect of the profits expected in future
over and above the normal profits.
● It is intangible asset. It is shown on the balance sheet when it is monetarily
measured.
● It is calculated in money terms when a business is acquired by another, or when a
partner is admitted to a firm
● It can be calculated by valuation or it can be subjectively estimated based on
agreement.
● Calculation
1. Average Profit Method
Goodwill = Average Profit × Number of years purchased

2. Super Profit Method

Normal profit = Capital employed × normal rate of return/100
Super Profit = Average Profit - Normal Profit
Goodwill = Super Profit × No of years’ purchase

3. Capitalisation Method
a) Capitalisation of Average profit:
Capital employed = Total assets outsider liabilities
Capitalised value of profit = Average Profit × 100/ Normal rate of profit
Goodwill = Capitalised value of profits Capital employed

b) Capitalisation of Super profit:

Goodwill = Super profit × 100/normal rate of profit

● Both methods of capitalisation will lead to the same result.

Dissolution of Partnership
The dissolution of partnership is a reconstitution of partnership, which may take place by:
(1) Change in existing profit sharing ratio among partners;
(2) Admission of a new partner
(3) Retirement of a partner
(4) Death of a partner
(5) Insolvency of a partner
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Note: Dissolution of partnership is different from dissolution of partnership firm. Dissolution

of partnership means reconstitution of the partnership agreement. Dissolution of firm means
end of the business.The term “dissolution” is commonly used for end of the business only.

Dissolution of Firm
End of the partnership business due to:
1. Dissolution by agreement
2. Dissolution by law
3. Dissolution by court
4. Dissolution by time (fixed term partnership)
5. Dissolution by notice

Accounting Treatment of Dissolution

I. Treatment of Losses: Losses, including deficiencies of capital, shall be paid:

1. first out of profits,
2. next out of capital of partners,
3. lastly, if necessary, by the partners individually in their profit sharing ratio.

II. Application of Assets: The assets of the firm, including any sum contributed by the
partners to make up deficiencies of capital, shall be applied in the following manner
and order:
1. In paying the debts of the firm to the third parties;
2. In paying each partner proportionately what is due to him/her from the firm for
advances as distinguished from capital (i.e. partner’ loan);
3. In paying to each partner proportionately what is due to him on account of
capital
4. the residue, if any, shall be divided among the partners in their profit sharing
ratio.
III. Realisation Account:
- It is prepared to record the transactions relating to sale and realisation of
assets and settlement of creditors.
- The balance in this account is termed as profit or loss on realisation which is
transferred to partners’ capital accounts in the profit sharing ratio

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Accounting for Companies

Definition of “company”
● A company is an artificial legal entity which allows a formal organisation for a
voluntary association of people to carry on commercial activities.
● According to Section 2 (20) of the Company Act 2013 "Company means a company
incorporated under this Act or any previous Company Law."

Features of a Company
1. Artificial legal person: A company is an artificial person as it is created by law. It
has almost all the rights and powers of a natural person. It can enter into contract. It
can sue in its own name and can be sued.
2. Separate legal entity: The existence of the company is distinct from that of its
management as well as its shareholders
3. Perpetual existence: A company has an independent and separate existence
distinct from its shareholders.
4. Incorporated body: A company must be registered under Companies Act. By virtue
of this, it is vested with corporate personality. It has an identity of its own.
5. Representative Management: The number of shareholders is so large and
scattered that they cannot manage the affairs of the company collectively. Therefore,
they elect some persons among themselves to manage and administer the company.
These elected representatives of shareholders are individually called the ‘directors’ of
the company and collectively the Board of Directors.

Procedure for establishing a company

1. Need for directors: minimum 2 for private company, minimum 7 for public company.
Maximum 200 directors in a private company, no limit in a public company.
2. Preliminary expenses: Expenses in incorporation such as hiring of CA, bankers,
obtaining DIN and paying incorporation fees etc. These preliminary expenses are a
deferred revenue expenditure for the company.
3. Memorandum of Association: The MOA should provide for the authorised capital,
the types of shares that a company can issue, the main objectives of the company,
etc.
4. Application to Registrar of Companies: The ROC must verify whether all the
documents and procedures are in compliance with the law. The Ministry of Corporate
Affairs provides e-registration of companies too.
5. Incorporation: A Certificate of Incorporation is granted by the ROC once all
procedures have been vetted and approved. The Certificate of Incorporation is the
birth certificate of the company. After this, the company comes into existence as a
separate legal entity.
6. Articles of Association: The shareholders must approve of the Articles of
Association which provide for the general decision-making and powers of different
directors etc. The AoA is the bye-laws of the company.
7. Issue of shares: Share capital can now be issued to fresh shareholders outside the
promoter group as well. The company can commence operations.
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Memorandum of Association
● It is the charter document of company. Has to be filed at the time of incorporation
● It lays down the foundational principles and objectives of a company.
● There are 6 main clauses of MOA:
1. Name Clause
2. Objects Clause
3. Capital Clause
4. Domicile Clause
5. Liability Clause
6. Subscription Clause
● The MOA cannot be amended retrospectively. Acts in violation of the MOA are void
ab initio (illegal from the beginning)

Articles of Association
● These are rules and regulations of the company’s governance
● Provides how Annual General Meetings (AGM) and other meetings will be conducted
● Acts outside the AoA can be ratified by special resolution at AGM.

Types of Companies
1. Private company: can only sell its shares to individual/institutional investors and not
to public.
2. Public company: Can sell shares to any member of the public. No maximum limit on
shareholders.
3. Government company: 50%+ shareholding is with the government
4. Foreign company: Company registered outside India.
5. Holding/Subsidiary company: Holding company owns another company, whereas
a subsidiary company is one which is owned by another company.
6. Listed/unlisted company: listed companies have their shares traded on a stock
exchange, while unlisted companies do not have this facility.
7. One Person Company: no minimum requirement of 2 directors. One director for the
company may still have limited liability. Established to allow Ease of doing Business.

Shareholders as Owners
A company is an independent legal entity whose capital is shared by multiple owners. These
owners own “shares” in the capital of a company.
1. Divisibility of shares: The capital of the company is divided into shares. A share is
an indivisible unit of capital.
2. Transferability of shares: The shares of the company are easily transferable. The
shares can be bought and sold in the stock market for public companies. A private
company can allow its shareholders to privately sell shares to third parties.
3. Limited Liability: The liability of the shareholders of a company is limited to the
extent of face value of shares held by them. No shareholder can be called upon to
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pay more than the face value of the shares held by them. At the most the
shareholders may be asked to pay the unpaid value of shares.

Types of shares
Share capital can be “equity” or “preference”
I. Equity shares:
○ Gives one part in the right of ownership of the company. Each equity share
provides one vote in management.
○ Entitled to dividend out of profits (after preference dividend is paid).
○ Rate of dividend is not fixed
○ Last in series of liquidation
•
II. Preference shares:
○ Preference at time of redemption as well as dividends.
○ Get fixed percentage of dividend at times
○ Voting only in special circumstances
○ Second last in series of liquidation (just before equity shareholders)

Types of Preference Shares

1. Cumulative preference share: if dividend is not paid in any one year, it will
accumulate over the next few years.
2. Non cumulative preference share: if dividend is not paid in any one year, it will not
accumulate.
3. Participating preference share: Preference shareholders can also vote in decision-
making of company
4. Non participating preference share: Preference shareholders cannot vote in
decision-making of company
5. Redeemable preference share: Preference shares shall be paid back to the
shareholders within a few years (defined)
6. Non redeemable preference share: Preference shares shall not be paid back
during lifetime of the company
7. Convertible preference share: Preference shares shall/may be converted into
equity shares upon the happening of some events
8. Non convertible preference share: Preference shares cannot be converted into
equity shares.

Note: Generally, Preference Shares are non cumulative, non participating, non convertible,
and redeemable in nature.

Capital
The capital means the assets and cash in a business invested by owners

Types of Capital
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1. Nominal/Authorised/Registered capital - It refers to the maximum amount of share

capital which a company is authorised to issue as per its Memorandum of
Association.
[Authorised Capital = Issued Capital + Unissued Capital]
2. Issued capital: Issued capital is that part of the authorised capital which the
company offers to public that may include vendors, for subscription or purchase. A
company may issue its entire authorised capital or may issue it in parts from time to
time as per the needs of the company.
3. Subscribed capital: It is that part of issued capital which is taken up or subscribed
by those who are offered for subscription. Company may receive applications for
a. equal to (full subscription),
b. more than (over subscription) or
c. less than (under subscription) shares issued.
The portion of nominal value of the issued share capital which is actually paid (or
subscribed) by the shareholders forms part of the subscribed capital.
4. Called up capital: It is that part of the issued/subscribed capital which is called up by
company to pay on the allotted shares and is to be paid by the shareholders.
[Called up capital = Paid up capital + Call-in-arrears (unpaid capital) – Calls in advance.]
5. Uncalled capital: It is that portion of the issued/subscribed capital that is not called
up by the company on the shares allotted.
6. Paid up capital: It is the portion of called up capital which is paid by the
shareholders, to calculate the paid-up capital, the amount of instalments in arrears is
deducted from the called-up capital.
7. Unpaid capital: That part of the called-up capital which is called but is not paid by
the shareholders is called unpaid capital. i.e., calls-in-arrears.
8. Reserve capital: Company may keep some part of its share capital uncalled and
kept in reserve to be called only in case of need at the time of its winding up. For this,
a special resolution will have to be passed by the company. Thus, it is that portion of
the uncalled capital which a company has decided to call only in case of liquidation of
the company.

Issue of shares
Shares can be issued at different prices
1. Issue of shares at par: only share application money and share allotment money
collected. Eg Share of value Rs 10 is issued for Rs 10 only.
2. Issue of shares at premium: Shares are sold at a premium because of the good
performance of the company. A “securities premium reserve” is also created.
Eg. Share of face value Rs 10 is issued at Rs 1000/share.
3. Issue of shares at discount: only allowed in case of sweat equity shares (to
employees)

Forfeiture of Shares
● If a shareholder fails to pay the due amount of allotment or any call on shares issued
by the company, the Board of directors may decide to cancel his/her membership of
the company.
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● With the cancellation, the defaulting shareholder also loses the amount paid by
him/her on such shares.
● The result of forfeiture of shares is:
1) Cancellation of membership of the shareholder.
2) Reduction of issued share Capital of the company.
● Interest can be charged on late payment of share capital
● Reissue of Forfeited Shares
○ Reissue of shares means sale of shares which were issued earlier but had
been forfeited for non payment of called up amount.
○ The balance amount of share forfeited account is capital gain of the company
and is transferred to Capital Reserve A/c

Debentures
● Debt instruments which can be traded in the markets (eg. corporate bonds)
● Provides alternate source of financing for companies outside of bank loans
● Also issued as Zero Coupon Bonds
● Interest is payable before any dividend
● Can be issued for
○ Collateral security
○ Cash
○ Other consideration
● Premium on debentures also credited to Securities Premium Reserve.
● Types of Debentures
○ Redeemable/ Non-redeemable
○ Secured/ unsecured
○ Convertible/ non-convertible

Note: Format for Financial Statement of Companies is given in Schedule-III of Companies

Act, 2013

Joint Venture
● Temporary partnership who have agreed to jointly carry out a venture. The business
relationship between co venturers comes to an end as soon as the venture is
completed.
● JV are quite common in construction business, consignment, sale & purchase
property, underwriting of shares & debentures, etc.
● No specific firm name is used for JV business
● Terms and Conditions of JV
○ Co venturers share profit & loss in agreed ratio.
○ In absence of any agreement, profit & loss are to be shared equally.
○ Co venturers are free to continue with their own business unless agreed
otherwise.

Accounting for Joint Ventures:

Accounts of JV can be kept in any one of the following 4 ways:
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1. In books of one co-venturer

2. In books of all co-venturers
3. Memorandum JV account: In this method, each co venturer will record only those
transactions relating to joint venture which are directly concerned with him/her. Such
account will not disclose profit or loss. Thus, additional account called Memorandum
JV A/c will be prepared.
4. Separate set of books: Joint Venture A/c, Joint Bank A/c, Personal account of each
co venturer are prepared in this method.

Consignment
● A consignment is a contract where the principal sells goods through an agent.
● Principal (Consignor): Party which sends the goods.
● Agent (Consignee): Party to whom goods are sent.
● Consignee receives a commission calculated on basis of gross sale. It is calculated
on total sales, not mere on credit sales until & unless agreed
● Generally, consignee is not responsible for any bad debt that may arise. If
consignee is to be made responsible for bad debts, he is to be paid a commission
called del-credere commission .

Accounting for Consignment

● Consignment cost
In case of Consignment, cost means not only the cost of goods but also all expenses
incurred till the goods reach premises of the consignee.

● Valuation of Inventories
The principle is that inventories should be valued at cost or net realizable value
whichever is lower.

● Normal Loss
Unavoidable Loss. It would be spread over entire consignment while valuing
inventories. No entry is recorded for normal loss & same is considered as expense
which is considered for valuation of inventory.

● Abnormal Loss
Any accidental or unnecessary loss. Amount of such loss should be credited to
Consignment account and debited to Profit & Loss account.
If any amount is received from insurers, then debit to P&L a/c will not include that
amount. Such an amount is debited to Bank account.

● Consignee returns
Consigned goods returned by consignee to consignor are valued at price at which it
was consigned to consignee. Expenses incurred by consignee to send those goods
back to consignor (i.e., secondary freight) are not taken into consideration while
valuing
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Accounting Ratios
Topics covered:
1. Liquidity Ratio
2. Turnover Ratio
3. Profitability Ratio
4. Leverage Ratio

Accounting Ratios
● Ratios based on different elements of financial statements (different components of
Trading Account, P&L Account, Balance Sheet)
● Used to determine the financial performance of a business
● Helps in comparison with industry standards
● Useful for investment decisions as well as for banks to judge solvency

Types of Accounting Ratios

1. Liquidity Ratio:
● Used to measure the the short-term sustainability of the business
● Ratios like current ratio and quick ratio determine how well a business can
survive the next few months
2. Activity/Turnover Ratio:
● Determines the efficiency of a business
● The better it uses its inventory, working capital etc, the better its productivity
3. Profitability Ratio:
● Determines the ultimate profitability at present
● Communicates the margin of profit per unit sales
4. Leverage Ratio:
● Determines long-term solvency of the business

Liquidity Ratios
Used to measure the firm’s capacity to meet short term liabilities
I. Current Ratio
● Current Ratio= Current Assets/Current Liabilities
II. Quick Ratio
● Also called Acid test ratio or Liquid ratio
● Quick ratio= Liquid or quick assets/Current liabilities
● liquid assets = current assets ––(stock + prepaid expenses)
III. Absolute Cash Ratio
● Amount of liquid cash or cash equivalents with the business
● Absolute cash ratio = (Cash+ Bank Balance + Marketable securities) /
Current liabilities
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Turnover Ratios
They measure the efficiency of business operations for any concern•
I. Stock Turnover Ratio
● It measures the efficiency with which the stock is managed.
● Stock turnover ratio= cost of goods/average stock or inventory
● Average stock = (opening stock + closing stock)/2

II. Debtors Turnover Ratio

● It is calculated to indicate the efficiency of the company to collect its debts.
● Debtors’ turnover ratio = Net credit sales/Average account receivables

III. Creditors Turnover Ratio

● Creditors turnover ratio indicates the efficiency with which suppliers are paid.
● Creditors turnover ratio = Net credit purchases/Average trade creditors

IV. Working Capital Turnover Ratio

● Working capital turnover ratio indicates the speed at which the working capital
is utilised for business operations
● Working capital turnover ratio=Total Sales/Working Capital
● Working capital=current assets current liabilities

Profitability Ratio
I. Gross Profit Ratio
● Gross Profit Ratio = (Gross Profit/Net sales)x100
● Net sales = Total sales ––(sales returns + excise)
● Gross profit = Net sales- Cost of goods sold
● COGS includes
○ Purchases (less purchases returns)
○ Wages on production
○ Electricity charges for machinery for production

II. Operating Ratio

● Operating profit is an indicator of operational efficiencies.

● Operating profit ratio = (Operating profit/Net sales) × 100

● Operating Profit = Gross Profit ––(Administration expenses + selling
expenses)
○ Rent and insurance,
○ variable expenses, such as shipping and freight, payroll and utilities
○ amortization and depreciation of assets.

III. Net Profit Ratio

● Net profit ratio = (Net Profit/Net Sales)x100
● Net Profit= Gross Profit Indirect Expenses + Other incomes
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● Other Indirect expenses

○ Interest on Loan
○ Legal charges
● Other incomes
○ Interest received from investments
○ Special discount received
○ Rent waiver

IV. Return on Investment Ratio

● ROI = (net profit before interest, tax and dividend/capital employed) x100

1. Capital employed = Equity share capital + preference share capital +

Reserve and surplus + long term liabilities fictitious assets - Non
trading investment

2. Capital employed = (Fixed asset - depreciation) + (Current Asset -

Current liabilities)

3. Capital employed = (Fixed Assets- Depreciation) + (Working capital)

● Also called Return on Capital Employed (ROCE)

Leverage Ratio
● Leverage or capital structure ratios are calculated to test the long term financial
position of a firm.
● Capital gearing ratio = (Equity share capital + reserve and surplus) / (Preference
share capital + Long term bearing fixed interest)
● Capital Adequacy Ratio is also a popular leverage ratio for banks (not in syllabus)

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