Paper XV Corporate Accounting: Kannur University School of Distance Education

KANNUR UNIVERSITY

SCHOOL OF
DISTANCE EDUCATION

II. M.Com
Paper XV
Corporate Accounting

Lessons Prepared by :
Chapters : 1,2,4 and 5

1) Ms. T. K. Jeeshma
P.G. Dept. of Commerce
S.N. College, Kannur-7
2) Chapter : 3
Prof . Jinachandran N.
P.G. Dept. of Commerce
S.N. College, Kannur -7
All rights reserved. No part of this book may be reproduced or transmitted in any form, by any means
(Electronic, Photocopying, Recording or otherwise) without prior written permission from the Kannur University.
Copy right Director, SDE 2007
SYLLABUS
PAPER XV CORPORATE ACCOUNTING
1. Amalgamation, Absorption and External Reconstruction of Companies - Inter-company owings inter-company holdings - internal reconstructions - scheme of capital reductions - steps for reconstructions
2. Liquidation of companies - meaning - methods of winding up - preparation of statement of affairsdeficiency/surplus account - liquidators final statement of accounts-receivers statement of accounts
3. Insurance claims - computation of fire claims-loss of profits - loss of stock - consequential loss
policy
4. Analysis and interpretation of financial statements - nature - characteristics - types of statements interpretation of statements - tools and techniques of analysis - common-size statements - comparative statements-trend analysis - common-size balance sheet and income statement.
5. Double account system-meaning-double account system Vs double entry system - main features of
double account system - advantages and disadvantages-accounts for electricity companies - legal
provisions - reasonable returns - clear profits - disposal of surplus - final accounts.
Books recommended :
1. S.N. Maheswari
: Corporate Accounting
2. S.P. Jain & K.L. Narang
: Advanced Accounting
3. Arulanandam & Raman
4. K. Br. Paul
: Accounting
5. B.S. Raman
6. R.L. Gupta
: Principles of Accounting
7. M.C.K Nambiar
: Advanced Accounts
CONTENT
Page No.
1. Amalgamation
5-37
2. Liquidation of Companies
38-51
3. Insurance Claims
52-59
4. Analysis and Interpretation of Financial Statements
50-97
5. Double Account System
98-110
UNIT - 1
AMALGAMATION; ABSORPTION AND

RECONSTRUCTION
OBJECTIVES
The objectives of this lesson are to:
Explain the meaning of Amalgamation, Absorption and Reconstruction
Discuss the methods of Accounting for Amalgamation and Reconstruction
STRUCTURE
1. 00
Meaning of Amalgamation, Absorption and Reconstruction
1. 01
1.02
1.03
1.04
1.05
1.06
1.07
1.08
Types of Amalgamation
Purchase consideration
Method of Accounting for Amalgamations
Journal entries to close the books of transferor company
Journal entries in the books of transferee company
Illustration
Alteration of share capital and Internal reconstruction
Illustration
Assignments
Amalgamation, Absorption and Reconstruction

1.00
MEANING
Amalgamation is a form of combination. It is brought about by blending of two or more undertakings

carrying on the same type of business or engaged in the same line of business activity. When two or more
existing companies merge themselves into a newly formed company, they lose their independent legal status.
Thus two liquidations and a formation characterise amalgamation.
Amalgamation may also be brought about by the transfer of one or more undertakings to an existing undertaking so as to result in merger of the undertakings. This form of combination is generally known as absorption.
However, the accounting standard (AS-14) of the Institute of Chartered Accountants of India does not distinguish between amalgamation and absorption.
Reconstruction is a process by which the affairs of a company are reorganised by revaluation of assets,
reassessment of liabilities and by writing off the losses already suffered by reducing the paid up value of shares
and / or varying the rights attached to different classes of shares. The object of reconstruction is usually to
reorganise capital or to compound with creditors or to effect economies. Such a process is called Internal
Reconstruction which is carried out without liquidating the company and forming a new one. However, there
may be external reconstruction. Wherever an undertaking is being carried on by a company and is in substance
transferred, not to an outsider, but to another company consisting substantially of the same share holders with a
view to its being continued by the transferee company, there is external reconstruction. Such external reconstruction is essentially covered under the category amalgamation in the nature of merger in AS-14
1-1 Types of Amalgamation

The Companies Act, 1956 has not specifically defined the term Amalgamation. However, from several
legal decisions, the definition of Amalgamation may be inferred. The Institute of Chartered Accountants of India
has introduced Accounting Standard -14 (AS-14) on Accounting for Amalgamations. The standard recognises
two types of Amalgamation. They are:
(a) Amalgamation in the nature of merger and
(b) Amalgamation in the nature of purchase.
Amalgamation in the nature of merger is an Amalgamation which satisfies all the following conditions.
(i) All the assets and liabilities of the transferor company become, after Amalgamation, the assets and
liabilities of the transferee company.
(ii) Share holders holding not less than 90% of the face value of the equity shares of the transferor company
(other than the equity shares already held therein, immediately before the amalgamation, by the transferee
company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue
of the amalgamation.
(iii) The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity share holders of the transferee company is discharged by the transferee
company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect
of any fractional shares.
(iv) The buisiness of the transferor company is intended to be carried on, after amalgamation, by the transferee company.
(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor
company when they are incorporated in the financial statements of the transferee company except to ensure
uniformity of accounting policies.
If any one or more of the above conditions are not satisfied in an amalgamation, such amalgamation is called
amalgamation in the nature of purchase. For example, if the business of the transferor company is not intended
to be carried on by the transferee company after amalgamation, there is amalgamation in the nature of purchase.
1-2 Purchase consideration

The consideration or the price payable by the transferee company to the transferor company for taking over
the business of the latter, is known as a purchase consideration. Para 3 (g) of AS-14 defines the term Purchase
consideration as the aggregate of the shares and other securities issued and the payment made in the form of
cash or other assets by the transferee company to the shareholders of the transferor company. Therefore,
purchase consideration does not include the sum which the transferee company will directly pay to the creditors
of the transferor company.
Net Assets method

Net asset means excess of assets over liabilities taken over, if purchase consideration is to be as ascertained
under the net assets method, it is necessary to determine the fair value of assets and liabilities. Thus purchase
consideration is arrived at by adding the fair value of the assets taken over and deducting therefrom the total fair
value of liabilities taken over. While adding up the fair value of assets taken over, it is necessary to include cash
and bank balances also, if the transferee company takes over all the assets of the transferor company. However
fictitious assets in the nature of preliminary expenses, brokerage and underwriting commission, profit and loss
account and similar items shown under the head Miscellaneous Expenditure should not be included amongst
the assets taken over.
Net payment method

Under this method, the amount of purchase consideration is determined on the basis of the aggregate of the
shares and other securities issued and the payment made in the form of cash or other assets to the shareholders
of the transferor company. The aggregate should not, therefore, include any payment made to debenture
holders or other outside liabilities of the transferor company. The same is true of realisation or liquidation expenses paid by the transferee company. In the case of payment to debenture holders and other outside liabilities,
the presumption is that they will be taken over by the transferee company and then paid out.
Inter-company transactions
In the context of amalgamation, whether in the nature of merger or purchase, we usually come across
certain inter-company transactions which might have created debtor- creditor relationship between the transferor and transferee companies even before any scheme of amalgamation.
If, at the time of amalgamation, it is found that the transferor company owes money to the transferee
company, or vice versa, debtors and creditors or bills receivable and bills payable accounts of the respective
companies include amounts owing by one to the other such inter-company indebtedness is known as inter company owings.
Account treatment
1) In the books of transferor company :- inter-company transactions do not require any special accounting
treatment in the books of the transferor company. Even if such transactions resulting in inter-company owings
are found in the books of the transferor company, a Realisation Account is opened and any owing to or owing
from the transferee company is transferred to this account as if the transferee company has taken over these
items.
2) In the books of transferee company :Even in the books of transferee company the usual entries for taking over assets and liabilities of the
transferor company and payment of purchase consideration are passed in spite of the existence of inter-company owings. However, the following adjusting entries are also passed.
For cancelling Debtors and creditors
Transferee companys creditors A/c
To Transferor companys
Dr
Debtors A/c
Transferor companys creditors A/c
Dr.
To Transferee Companys Debtors A/c
Adjustment of value of Stock

Inter-Company owings arise usually from purchase and sale of goods; it is likely, therefore, that at the time
of the sale of business, the debtor company also has goods in stock which it purchased from the creditor
company. The Cost of the debtor company will include the profit made by the creditor company. After the
takeover of the business, it is essential that such a profit is eliminated. The entry for this will be made by the
purchasing company. If it is vendor company which has such goods in stock at the time of passing the acquisition
entries, the value of the stock should be reduced to its cost to the company which is acquiring the business;
automatically goodwill or capital reserves as the case may be, will be adjusted. But if the original sale was made
by the vendor company and the stock is with the company acquiring the business the latter company will have to
debit Goodwill or (or Capital Reserve) and credit stock with the amount of the profit included in the stock
Methods of accounting for amalgamation

There are two main methods of accounting for amalgamation
a) The pooling of interest method and
b) The purchase method
The First Method is used in case of amalgamation in the nature of merger and the second method is used in
case of amalgamation in the nature of purchase.
Under pooling of interest method, the assets, liabilities and reserves of the transferor company will be taken
over by transferee company at existing carrying amounts unless any adjustment is required due to different
accounting policies followed by these companies. As a result, the difference between the amount recorded as
share capital issued (plus any additional consideration in the form of cash or other assets) and the amount of
share capital of transferor company should be adjusted in reserves
Under purchase method, the assets and liabilities of the transferor company should be incorporated at their
existing carrying amounts or the purchase consideration should be allocated to individual identifiable assets and
liabilities on the basis of their fair values at the date of amalgamation. But no reserves other than statutory
reserves of the transferor company should be incorporated in the financial statements of transferee company.
Statutory reserves of the transferor company should be incorporated in the balance sheet of transferee company
by way of the following journal entry :
Amalgamation adjustment A/c.
Dr.
To statutory Reserves A/c.
When the above statutory reserves will no longer be required to be maintained by transferee company, such
reserves will be eliminated by reversing the above entry.
In purchase method, any excess of the amount of purchase consideration over the value of the net assets of
the transferor company acquired by the transferee company, should be recognised as goodwill in the financial
statement of the transferee company. Any shortfall should be shown as capital reserves.
1-4
Journal entries in the books of transferor company
1) For transfer of assets taken over

Realisation A/c
Dr
To Each asset A/c
(with book value)
_________________________________________________________________________________
2) For transfer of liabilities taken over
Each liability A/c
Dr.
(with book value)
To Realisation A/c
_________________________________________________________________________________
3) For purchase consideration due
Transferee company A/c
Dr
(with the amount agreed upon)
To Realisation A/c
_________________________________________________________________________________
4.) For expenses of realisation
Realisation A/c
To Bank A/c
(When paid for by the transferor company)
Dr.
(with the amount paid)
No entry
(when paid for by the transferee company)
Alternatively :
If liquidation expense are met by the purchasing company or to be reimbursed by purchase consideration
already paid
a) for payment of expenses:
Purchasing company A/c
Dr.
To Bank A/c
b) For getting the expense reimbursed
Bank A/c
Dr.
To purchasing Company A/c

_________________________________________________________________________________
5) For adjustment of premium
Realisation A/c
Dr.
To pref. Shareholders A/c
(With the premium)
___________________________________________________________________________________
6) For sale of assets not taken over
Bank A/c
Dr
(with total)
To Each asset A/c
(with Book value)
To Realisation A/c
(with profit on Sale)
__________________________________________________________________________________
7) For receipt of purchase consideration
Shares in Transferee company A/c
Dr.
Debentures in Transferee Company A/c Dr.
Bank A/c
Dr
To Transferee Company A/c
_________________________________________________________________________________
8) For liabilities not taken over
Each liability A/c
Dr.
(book value)
To Bank A/c
_________________________________________________________________________________
9) a) For profit on realisation
Realisation A/c
Dr
To Equity Share holders A/c
b) For loss on realisation
10
Equity shareholders A/c

To Realisation A/c
Dr.
_________________________________________________________________________________
10. For payment of preference share capital
a) Pref. Share capital A/c
Dr.
(With book value)
To pref. Share holders A/c

b) Pref. Shareholders A/c
Dr.
To Bank A/c
11. For Transfer of capital and retained earnings
Equity share capital A/c
Dr.
General Reserves
Dr.
Profit and loss A/c
Dr.
Capital Reserve A/c
Dr.
To Equity share holders A/c

_________________________________________________________________________________
12. For Transfer of accumulated losses and fictitious assets
Equity shareholder A/c
Dr.
To profit and loss A/c

To preliminary Expenses A/c
To underwriting commission A/c
To Discount on issue of shares A/c
To Advertising suspense A/c
____________________________________________________________________________________
13. For payment to equity share holders :
Equity share holders A/c
Dr.
To shares in Transferee company A/c

To Debentures in Transferee company A/c
To Bank A/c
The important ledger accounts to be opened in the books of the transferor company are Realisation A/c,
Transferee company A/c, Equity Share capital A/c, Preference share capital A/c, Equity share in Transferee
company A/c, pref. Shares in Transferee company A/c, Debentures in Transferee company A/c and any other
asset or liability account not taken over by the transferee company.
11
1.5 Journal entries in the books of Transferee company

I. Pooling of interests method
According to para 31 of the Standard (AS-14), when an amalgamation is considered to be an amalgamation in the nature of merger, it should be accounted for under the pooling of interests method. Under this method
of accounting, the following journal entries become necessary.
Journal entries
1. For purchase consideration due :
Business purchase A/c
Dr.
To liquidator of Transferor Co.

___________________________________________________________________________________
2. For taking over assets and liabilities :
Each Asset A/c
Dr.
To Each liability A/c

To Each provision A/c
To Profit & loss A/c
(With book value)
To Reserve
To Business purchase A/c
________________________________________________________________________________________
3. For payment of purchase consideration
Liquidator of Transferor Company A/c
Dr.
(With purchase consideration)
To Share capital A/c

To share premium A/c
To Bank A/c
_________________________________________________________________________________________________
4.For realisation expense borne :
a)
Liquidation expenses A/c
Dr.
To bank A/c
b)
Profit and loss A/c
Dr.
To liquidation expenses A/c

___________________________________________________________________________________________
5. For formation expenses :
Preliminary Expenses A/c
Dr.
To Bank A/c
12
II Purchase Method
According to para 32 of the Standard (AS-14), when an amalgamation is considered to be an amalgamation in the nature of purchase, it should be accounted for under the purchase method. Accordingly the
following entries should be passed in the books of transferee under this method.
Journal Entries
1. For purchase consideration due :
Dr.
To liquidator of transferor Co.

_______________________________________________________________________________________________
2. For assets and liabilities taken over
Each Asset A/c
Dr.
To Each liability A/c
(With fair value)

(The difference in the total of debit and credit will be transferred to Goodwill or Capital Reserves)
_______________________________________________________________________________________________
3. For discharge of purchase consideration
Liquidator of transferor Comp. A/c
Dr.
To share capital A/c
To Share premium A/c
To Debentures A/c
To Bank A/c
___________________________________________________________________________________________
4.For Realisation expenses borne
Goodwill A/c
Dr.
(With the expenses)
To Bank A/c
__________________________________________________________________________________
5. Preliminary expense
Preliminary expense A/c
Dr.
To Bank A/c
_____________________________________________________________________________________________
1-6
Illustration -I (Amalgamation in the nature of merger)
The Pig Iron Company Ltd. agrees to absorb the business of the Iron Ore company Ltd. and to take
over the assets and liabilities at their balance sheet values, in exchange for which it is to issue 12 shares of
Rs. 10 each for every share of Rs 100 each in the Iron Ore Company Ltd. The expense of absorption Rs.
10,000 will be paid by the Pig Iron Company Ltd. On the date of absorption, ie, 31st March 2003, the balance
sheets of the two companies were as under:
13
The Iron Ore Company Ltd.

Liabilities
Rs.
Assets
Rs.
5000 Equity shares of

Rs 100 each
5,00,000
Land and Buildings
3,00,000
2,00,000
General Reserve
35,000
Machinery and plant
Bills payable
35,000
Sundry Debtors
less provision
55,000
5,000
50,000
Creditors
40,000
Stock
25,000
Bank
35,000
6,10,000
6,10,000
The pig Iron Company Ltd.

Liabilities
Rs.
1,00,000 Equity Shares
Assets
10,00,000
of Rs 10 each
General Reserve
80,000
Creditors
1,00,000
Rs.
Land and Buildings
5,00,000
Machinery and Plant
3,00,000
Goodwill
1,00,000
Stock
60,000
Debtors
1,20,000
Bank
1,00,000
11,80,000
11,80,000
You are required to :a) pass the necessary journal entries in the books of Pig Iron Company Ltd.
b) Prepare the balance sheet of Pig Iron Company Ltd. after the amalgamation in the nature of merger.
Solution
5000 x 12 = 60000 shares x Rs 10
= 6,00,000
14
Pig Iron Co. Ltd.

Journal Entries
Date
Particulars
LF
Dr.
Debit
Credit
Rs
Rs.
6,00,000
To Liquidator of Iron Ore Co. Ltd.
6,00,000
(Being the purchase consideration due)

General Reserve A/c
Dr.
65,000
Land & Buildings A/c
Dr.
3,00,000
Machinery & Plant A/c
Dr
2,00,000
Debtors A/c
Dr.
55,000
Stock A/c
Dr.
25,000
Bank A/c
Dr.
35,000
To Bills Payable
35,000
To creditors
40,000
To Provision for doubtful debts
5,000
6,00,000
(Being the assets and liabilities taken over

from Iron Ore Co. Ltd)
Liquidator of Iron Ore Co. Ltd
Dr.
6,00,000
To Equity share capital A/c
6,00,000
(Being allotment of shares in Settlement

of purchase consideration)
Liquidation Expense A/c
Dr.
10,000
To Bank A/c
10,000
(Being the entry for payment of liquidation

expenses Iron Ore. Co. Ltd.)
General Reserves A/c
Dr.
To Liquidation Expenses A/c
10,000
10,000
(Being the entry for transfer of liquidation

Expenses to reserve)
15
BALANCE SHEET OF PIG IRON Co. As at 1-4-2003

Rs
Rs
SHARE CAPITAL
FIXED ASSETS
Issued and subscribed 16,000
Goodwill
1,00,000
Land & Buildings
8,00,000
(of these 60,000
Machinery & Plant
5,00,000
equity shares were issued for
CURRENT ASSETS
consideration other than cash)
Stocks
equity shares of Rs. 10 each
16,00,000
Debtors
85,000
1,75,000
Less provision
5,000
1,70,000
RESERVES & SURPLUS

General Reserve
5,000
Bank
1,25,000
CURRENT LIABILITIES
Creditors
1,40,000
Bills Payable
35,000
17,80,000
17,80,000
Note: The contents of para 35 of the standard (AS-14) are given effect to in the case of the pooling of
interest method applicable to an amalgamation in the nature of a merger as under
Rs
6,00,000
less: Equity share capital of

Iron Ore Co. Ltd.
5,00,000
1,00,000
less: General Reserves of Iron

Ore Co. Ltd.
35,000
Balance in debt
65,000
General Reserve of Pig Iron Co. Ltd
80,000
less debit balance as above
65,000
To be shown in the Balance sheet after

amalgamation
15,000
16
Since liquidation expenses of Rs. 10,000 paid by the transferee company are to be charged to profit and loss
account, the same are set off against the balance of reserve in the absence of profit and loss account.
Illustration 2 (Amalgamation in the nature of purchase)
The X Co. Ltd. and Y Co. Ltd. carry on business of a similar nature and it is agreed that they should
amalgamate. A new company XY Ltd. is to be formed to which the assets and liabilities of the existing companies with certain exceptions, are to be transferred. On 31st March, 2003, the balance sheet of the two companies were as under:X Co. Ltd. Y Co. Ltd
Rs.
X Co. Ltd. Y Co. Ltd
Rs.
Rs.
Issued capital
Land & buildings
15,000 shares of
Rs 10 each
1,50,000
8,000 shares of Rs 10 each
80,000
General Reserve
80,000
Profit and loss A/c
20,000
5% Debentures
Creditors
20,000
Rs.
1,05,000
60,000
Plant & Machinery
25,000
15,000
Motor Vehicles
10,000
Stock
60,000
78,000
Debtors
82,000
21,000
Cash
43,000
18,000
3,25,000
1,92,000
60,000
75,000
32,000
3,25,000
1,92,000
The assets and liabilities are to be taken over at book values with the following exceptions:
a) Goodwill of X Co. and Y Co. to be valued at Rs. 80,000 and Rs 30,000 respectively
b) Motor Vehicles of X Co. are to be valued at Rs. 30,000
c) Debentures of Y Co. are to be discharged by the issue of 5% Debentures of X Y Co. at a premium
of 4%
d) Debtors and cash of Y Co. are to be retained by the liquidator, and creditors are to be paid out of the
proceeds thereof.
Compute the basis on which shares in X Y Co. will be issued to shareholders in the existing companies.
Pass journal entries in the books of X Co. Ltd, Y Co. Ltd. XY Co. Ltd and draw up the balance sheet of XY Co.
Ltd. as at Ist April 2003.
17
Solution
Assets taken over :
X Co. Ltd.
Land and Buildings
Plant & Machinery
Motor Vehicles
Stock
Debtors
Y Co. Ltd.
Rs
1,05,000
25,000
30,000
60,000
82,000
Rs.
60,000
15,000
-------78,000
--------
43,000
--------
Cash
__________________________________________________________________________________
3,45,000
1,53,000
--------
62,400
Less liabilities :
5% Debentures
__________________________________________________________________________________
3,45,000
90,600
75,000
--------
Creditors
__________________________________________________________________________________
Net tangible assets
2,70,000
90,600
80,000
30,000
Add: Goodwill
__________________________________________________________________________________
Net assets or Purchase consideration
Mode of discharge:
a) In shares of XY Co. Ltd
35,000 equity shares of
Rs. 10 each (assuming face value
of shares is Rs. 10)
3,50,000
1,20,600
3,50,000
12000 Equity shares of Rs 10 each
1,20,000
b) Cash to avoid fraction
600
__________________________________________________________________________________
3,50,000
1,20,600
____________________________________________
___________________________________
___
Although purchase consideration consists of only equity shares and cash to avoid fraction, the amalgamation is in the nature of purchase since all the five conditions laid down in para 29 of Standard (AS-14) are not
satisfied. For instance, all the assets and liabilities of the transferor company are not taken over. Further, assets
are not transfered to the transferee company at their carrying amounts.
18
In the book of X Co. Ltd.

Journal Entries
Date
Particulars
LF
Debit
Rs
Realisation A/c
Dr.
To Land and Buildings
To Plant & Machinery
To Motor Vehicles
To Stock
To Debtors
To Cash
(Being the transfer of assets taken over
by the transferee company)
Creditors A/c
To Realisation A/c
(Being the transfer of creditors to
Realisation A/c)
Dr
XY Co, Ltd
To Realisation A/c
Dr.
Credit
Rs.
3,25,000
1,05,000
25,000
10,000
60,000
82,000
43,000
75,000
75,000
3,50,000
3,50,000
(Being the purchase consideration due)

Equity shares in X Y Co. Ltd
To X Y Co Ltd
(Being the receipt of Purchase
Consideration)
Dr.
3,50,000
3,50,000
Realisation A/c
Dr.
To Equity shareholders A/c
(Being the profit on realisation transferred
to shareholders account)
1,00,000
Share Capital A/c

Dr.
General Reserve
Dr.
Profit and loss A/c
Dr.
(Being the transfer of amounts due to equity
shareholders A/c)
1,50,000
80,000
20,000

Dr.
To Equity shares in X Y Co. Ltd.
(Being the payment to equity share holders)
3,50,000
19
1,00,000
2,50,000
3,50,000
Date
Particulars
In the Books of Y Co, Ltd.

LF
Debit
Credit
Rs
Realisation A/c
Dr.
Rs.
1,53,000
To Land and Buildings
60,000
To Plant & Machinery
15,000
To Stock
78,000
(Being the transferor of assets taken over

by the transferee company)
5% Debentures A/c
Dr
60,000
To Realisation A/c
60,000
(Being the transfer of debentures)

XY Co. Ltd.
Dr.
1,20,600
To Realisation A/c
1,20,600
(Being the Purchase consideration due)

Equity shares in XY Co.
Dr.
1,20,000
Cash A/c
Dr.
600
To XY Co. Ltd.
1,20,600
(Being receipt of Purchase consideration)

Creditors A/c
Dr.
32,000
To Bank A/c
32,000
(Being the entry for paying off Creditors)

Realisation A/c
Dr.
27,600
To shareholders A/c
27,600
(Being the entry for profit on realisation)

Dr.
80,000
Profit and loss A/c
Dr.
20,000
1,00,000
(Being the transfer of share capital and net

profit to shareholders A/c)
Dr.
To Equity shares in XY Co.
1,27,600
1,20,000
To Cash
7,600
(Being the payment to equity share holders)
20
Date
Particulars
In the Books of XY Co. Ltd

Journal Entries
LF
Debit
Rs
Business Purchase A/c
Dr.
Credit
Rs.
4,70,600
To Liquidator of X Co. Ltd
3,50,000
To Liquidator of Y Co. Ltd.
1,20,600
(Being the entry for acquiring the business

of X Co.and Y Co.
Land and Building A/c
Dr.
1,65,000
Plant and Machinery A/c
Dr.
40,000
Motor Vehicles A/c
Dr.
30,000
Stock A/c
Dr.
1,38,000
Debtors A/c
Dr.
82,000
Cash A/c
Dr.
43,000
Goodwill A/c
Dr.
1,10,000
To 5% debentures in Y Co
62,400
To Creditors A/c
75,000
4,70,600
(Being the assets and liabilities taken over)

Liquidator of X Co. Ltd.
Dr.
3,50,000
Liquidator of Y Co. Ltd
Dr.
1,20,600
4,70,000
To Bank A/c
600
(Being the payment of purchase

consideration)
5% Debentures Y Co. A/c
Dr.
To 5% Debentures A/c
62,400
62,400
(Being the entry for discharging the old

debentures of Y Co. at a premium 4%)
21
BALANCE SHEET OF X Y Co. Ltd. (After Absorption) as at 1-4-2003

Liabilities
Rs.
Assets
Rs.
FIXED ASSETS
SHARE CAPITAL
Issued and Subscribed :
Goodwill
1,10,000
47000 equity shares
Land and Buildings
1,65,000
of Rs 10 each
Plant and Machinery
40,000
(Issued to vendors
Motor vehicles
30,000
for consideration other than cash)
Current Assets :
RESERVES & SURPLUS
Stock
secured loan:
Debtors
82,000
cash
42,400
5% Debentures
4,70,000
62,400
1,38,000
Current liabilities:
creditors
75,000
6,07,400
6,07,400
Note: As per AS-14 excess of purchase consideration over the value of net assets of the transferor company should be treated as Goodwill in the transferee companys Financial Statements. Similarly, if the amount of
Consideration is less that the value of net assets, the difference should be treated as capital reserve (Para 37)
INTER-COMPANY HOLDINGS
With reference to inter-company holdings, there may be three situations
(i) Shares held by the transferee company in the transferor company.
(ii) Shares held by the transferor company in the transferee company
(iii) Share held by both the companies in each other
(i) Shares held by the transferee company in the transferor company :The transferee company being a shareholder of the transferor company has a right to proportionate net
assets of the transferor company. Therefore, the absorbing company (Transferee company) buys only the net
assets belonging to outside shareholders. Usually, the absorbing company issues its own shares and debentures
in payment of the purchase consideration. This it does only in respect of amount due to outsiders. For the amount
due to itself it cannot receive its own shares.
Accounting treatment will be as under :
In the books of transferor company :
22
Purchase consideration is calculated for the entire undertaking either by the net assets or net payment
method as the case may be. The transferee company is debited with the full price, but credited with only what
is received in respect of outsiders. This leaves a debit balance representing the amount still receivable from the
purchasing company towards purchase Price. Likewise, in the shareholders account, since only outside shareholders are paid, there will be a credit balance representing the amount payable to the purchasing company as a
shareholders of the transferor (Vendor) company. The amount in question is neither paid by the transferee
company as the buyer of the business nor received by it as a shareholder. These two accounts will be closed by
means of the following set of entry.
Shareholders A/c
Dr.
To Transferee company A/c

In the books of transferee company:
In the books of purchasing company, the first two entries are passed as usual. However, when the question
of settling the amount due to the liquidator arises, payment is shown only in respect of what is due to outsider
and for the balance the shares in the transferor company are surrendered by crediting the investment account.
The journal entry is as follows:
Liquidator of transferor Co. A/c Dr.
(with full purchase price)
To share capital/Debenture/bank
(Amount payable to outsiders)
To Shares in the transferor Co.
(amount due to transferee (purchasing) company)
Any difference in the Shares in the vendor company account will be transferred to Goodwill or capital
reserve, as the case may be.
(ii) Shares held by the transferor company in the transferee company
In this case when the assets of the transferor company are acquired by the transferee company the
latter company cannot purchase its own shares.
If net payment method of purchase consideration is adopted, deduct the number of shares already held by
the transferor company from the shares agreed to be issued. Thus the shares held by the transferor company
before its absorption continue to be with them and are treated as part payment of purchase consideration. The
investment of the transferor company in share of the transferor company is not taken over by the transferee
company. Therefore investment in the shares (of the transferee company) should not be transferred to realisation
account.
Sometimes the issue price of the shares now received and the price at which the previous investment has
been acquired may differ. In such a case the investment in the transferee company already made must be
revalued by adopting the latest price and any profit and loss on such revaluation must be transferred to shareholders
account.
If the purchase consideration is calculated under the net assets method, the assets in the form of investment
in shares of the purchasing company are not taken into consideration.
(iii) Shares held by both the companies in each other
23
This is the case of cross holdings. Accounting treatment is explained as under:

a) Net payment method. Under this method, purchase price is calculated as follows:
(1) Calculate the number of shares to be issued to outside shareholders in the absorbed company.
(2) Calculate the number of shares due to transferee company as shareholders in the transferor company.
These however will not be issued. The value of these shares would be set off against shareholders
account.
(3) Add the shares calculated under (1) and (2) to get the total number of shares
(4) From the total under (3) deduct the number of shares already held by the absorbed company.
(5) Multiply the number of shares arrived at under (4) with the issue price and the resultant figure is
purchase consideration.
Illustration-3
The Balance sheets of Z Ltd. and A Ltd. as on March 31, 2000 are given below :
Z Ltd.
A Ltd.
Z Ltd.
A Ltd.
Rs.
Rs.
Rs.
Rs.
Equity share capital

Rs. 10 each
Reserves and surplus
2,00,000
4,00,000
Sundry Assets
3,10,000
6,00,000
40,000
1,00,000
Loan to A Ltd
30,000
--------
9% Debentures
(Rs. 100 each)
Investments
1,00,000
--------
Loan from Z Ltd.
--------
30,000
Sundry creditors
50,000
70,000
3,90,000
6,00,000
5000 shares of A Ltd
50,000
3,90,000
6,00,000
A Ltd. proposes to takeover Z Ltd. on the following terms :

1)
A Ltd. will issue a sufficient number of its shares @ Rs. 11 each and pay Re. 0.50 cash per share helo
by members of Z Ltd.
2)
9% debentures of Z Ltd are to be paid at 8% premium by issue of a sufficient number of 10%

debentures of A Ltd. @ Rs. 90.
Assumining that the take over has been complete, show journal entries and ledger accounts in the books of
the companies and draft the Balance sheet in the books of A Ltd. (ACS inter)
Solution:
24
Calculation of purchase consideration

Total number of shares in Z Ltd. is 20,000 shares and so the number of shares to be issued by
A Ltd. to Z Ltd.
20,000
less shares of A Ltd. already held in Z Ltd.

The new shares to be issued
5000
15,000
Amount
Form
Rs.
Value of 15,000 shares @ Rs 11 each
1,65,000
shares
cash @ Re. 0.50 per share on

20,000 shares
10,000
cash
9 % Debentures 1,00,000
Add. 8% premium 8000
1,08,000
10% Debentures
of A Ltd.
2,83,000
(1,08,000 x 100)
90
Face value = 1200
Z Ltd.
JOURNAL
L/F
Realisation A/c
Dr.
To sundry Assets
To Loan to A Ltd.
(Being the assets transferred)
_____________________________________________
Sundry creditors
Dr.
To realisation A/c
Dr.
Cr.
Rs
Rs.
3,40,000
3,10,000
30,000
50,000
50,000
(Being the creditors transferred)

_____________________________________________
A. Ltd A/c
2,83,000
To Realisation A/c
2,83,000
(Being the purchase consideration received)
25
Shares in A Ltd.
Dr.
1,65,000
Cash A/c
Dr.
10,000
10 % Debentures in A Ltd
Dr.
1,08,000
To A. Ltd
2,83,000
(Being the purchase consideration received)

_____________________________________________
9% Debentures A/c Dr.
1,00,000
Realisation A/c Dr.
800
To Debenture holders A/c
1,08,000
(Being the amount due to debenture holders with a

premium of 8%)
_____________________________________________
Debenture holders A/c
Dr.
1,08,000
To 10% Debentures in A Ltd
1,08,000
(Being the debentures settled)

_____________________________________________
Investment A/c
Dr.
5,000
To realisation A/c
5,000
(Being the profit on revaluation @ Re. 1 on the 5,000

shares in A Ltd. held)
_____________________________________________
Share capital A/c
Dr.
2,00,000
Reserves and surplus A/c
Dr.
40,000
To Shareholders A/c
2,40,000
(Being the share capital and reserves transferred)

_____________________________________________
Shareholders A/c
To realisation A/c
(Being the loss on realisation transferred)
Dr.
10,000
10,000
_____________________________________________
Shareholders A/c
Dr.
To shares in A Ltd. (165000x55000)
To cash A/c
(Being the final settlement made by the allotment
of shares of A Ltd. together with the shares already
held and cash)
26
2,30,000
2,20,000
10,000
Realisation Account
Rs.
To sundry assets
,, Loans to A Ltd.
,, Debenture holders A/c
Rs.
3,10,000
By Sundry creditors
30,000
50,000
,, A Ltd. (Purchase consideration)
2,83,000
,, Investment A/c (profit on revaluation)
8,000
(Premium)
5,000
,, share holders A/c (LOSS)
10,000
3,48,000
3,48,000
ShareholdersAccount
Rs.
To Realisation (loss)
To shares in A Ltd.
To Cash
Rs.
10,000
By Share capital
2,20,000
2,00,000
By Reserves and surplus
40,000
10,000
2,40,000
2,40,000
A Ltd.
JOURNAL
L/F
Business Purchase A/c
Dr.
To Liquidators of Z Ltd.
(Being the purchase consideration payable)
_____________________________________________
Sundry assets
Dr.
Loan to A Ltd
To Sundry creditors
To Capital Reserve A/c
(Being the assets and liabilities taken over)
27
Dr.
Cr.
Rs
Rs.
2,83,000
2,83,000
3,10,000
30,000
50,000
2,83,000
7,000
Liquidators of A Ltd.
Discount on Debentures A/c
Dr.
Dr.
2,83,000
12,000
To Equity Share capital A/c
1,50,000
To share premium A/c
15,000
To 10% debentures
1,20,000
To cash A/c
10,000
(Being the settlement of the purchase

consideration due)
_____________________________________________
Loan from Z Ltd.
Dr.
30,000
To Loan to A Ltd.
30,000
(Being the inter-company loan cancelled)
Balance sheet of A Ltd. as on April 1, 2000

Liabilities
Rs
Assets
Rs
Share capital :
55,000 shares of
Sundry Assets
Rs 10 each
5,50,000
Reserves and surplus
1,00,000
Share premium
15,000
Capital reserve
7,000
10% Debentures
1,20,000
Sundry creditors
1,20,000
Discount on debentures
9,12,000
9,00,000
12,000
9,12,000
Alteration of share capital and Internal Reconstruction

According to section 94 of the Companies Act, a limited company can, if authorised by its Articles of
Association alter the capital clause of its Memorandum of Association in any of the following ways.
(a) Increase its share capital by issue of new shares
(b) Consolidation of shares :- Consolidate its existing shares of smaller amounts into shares of larger
amounts. For example, the existing 10,000 shares of Rs 10 each may be consolidated into 1000 shares
of Rs. 100 Each. The journal entry will be :
Share capital A/c (Rs 10 each) Dr. 1,00,000
To Share capital A/c (Rs100 each) 1,00,000
28
c)
Subdivision :- Subdivide its share capital of larger amount into shares of smaller amounts.
The entry will be :

Share capital A/c (Rs. 100 each)
Dr.
1,00,000
To share capital Account (Rs. 10 each)

d)
1,00,000
Conversion : Convert its fully paid shares into stock or reconvert its stock into fully paid shares.
Journal entry is :
Equity Share capital A/c
Dr
Equity capital stock A/c
To Equity capital stock A/c
or
Dr.
To Equity share capital A/c.
Internal Reconstruction or capital Reduction

Internal Reconstruction means the reduction of capital to cancel any paid up share capital which is lost or
unrepresented by available assets. This is generally resorted to write off past accumulated losses of the company.
The internal reconstruction and reduction of capital mean the same.
Reduction of capital is unlawful, except when sanctioned by the court because conservation of capital is one
of the main principles of the company law. The issued share capital of a company represents the security on
which the creditors rely. Companies usually, do not call the full value of shares at one time. The uncalled capital
acts as a future security for the companies creditors. Therefore, any reduction of capital reduces the security of
the creditors. Keeping this in view all safeguards have been provided for in the Companies Act to conserve the
capital of a company. However, in genuine cases, a company is permitted to reduce its share capital by section
100 in any of the following ways:
(a) Extinguish or reduce the liability
Where the shares of a company are partly paid-up, the company may extinguish or reduce the liability on its
shares. To that extent, the shareholders gain since they need not pay up the balance of uncalled share amount.
In this case, the total paid-up capital of the company remains the same although the partly paid-up shares
become fully paid-up.
The entry in the books of the company will be:
Equity share capital A/c (old)
Dr
To Equity share capital A/c (New)

( In both the cases the paid-up amount is the same)
Example :
X Ltd. having 10,000 equity shares of Rs 10 each, Rs. 7 paid up decides to cancel the liability of members to
the extent of Rs 3 per share and make shares of Rs 7 each fully paid. The entry is :
Equity share capital A/c (Rs 10)
Dr. 70,000
To Equity share capital A/c (Rs 7)

(Being the entry for converting partly paid up shares
of Rs. 10 each into fully paid-up shares of Rs. 8 each
by extinguishing liability of uncalled capital)
29
70,000
b) Refund or return of excess capital

When a company finds that it has a surplus capital, it may decide to reduce it by returning the surplus
part of capital to its members. Journal entries are as follows :
(i)
Equity share capital A/c (old)
Dr
To Equity share capital A/c (New)

To Equity share holders A/c (Amount to be returned)
(ii)
Dr
To bank A/c
(On payment of money)
Example:
A Ltd with a share capital of 1,00,000 Equity shares of Rs 10 each fully paid decides to repay
members Rs. 2 per share thus making each share of Rs 8 fully paid.
The entry is:
Equity share capital A/c (Rs. 10)
Dr
10,00,000
To Equity share capital A/c (Rs 8)
8,00,000
To Equity share holders A/c (Rs. 2)
2,00,000
(Being the entry for reducing the face value

of each equity share of Rs. 10 each, to
Rs 8 each and refund of capital to share holders)
Dr.
2,00,000
To bank A/c
2,00,000
(Being the entry for payment to shareholders)

c) Reduction of paid-up capital
When a company suffers losses continuously either due to bad investment policy or due to some other
reasons, it is often seen that the asset side of its balance sheet shows accumulated losses, and deferred expenses
like discount on issue of shares and debentures, preliminary expenses etc. In such companies any amount
appearing under heading goodwill is nothing but an example of an accumulated loss. In essence, capital of the
company, suffering losses continuously for a long period is not represented by the assets. The capital reduction
programme is a remedy under such circumstances. The according entry in this case would be:
Dr.
To capital Reduction A/c

(Being the entry for capital reduction)
Capital Reduction Account is a temporary account opened for carrying out the internal reconstruction and
will be closed when the scheme is carried out.
In case the face value of the equity / preference shares is changed with a view to reducing the paid-up value
of share capital, it becomes necessary to close the old share capital and open the new share capital account and
30
the difference between the two accounts should be credited Capital Reduction Account.
The entry would be:
Equity/preference share capital A/c (old)Dr.
To Equity/preference share capital A/c (New)
(Being the entry for reducing the face value of shares and crediting
the amount of reduction to Capital Reduction Account)
In case the debenture holders and creditors agree to forgo a portion of the amount due to them, the entry
would be:
Debentures A/c
Dr.
Interest on Debentures A/c
Dr.
Creditors A/c
Dr.
To Capital Reduction A/c

(Being the entry for debenture holders
and creditors forgoing a portion of amount due to them)
Now, the losses can be written off with the help of Capital Reduction Account. The entry would be :
Capital Reduction Account
Dr.

To Preliminary expenses
To Discount on issue of shares
To Deferred revenue expenses
To Plant and Machinery
To Furniture and Fittings
To Goodwill
(Being the entry for fictitious assets and writing down other assets)
The balance, if any remaining in the Capital Reduction Account after writing off losses, will be transferred
to Capital Reserve Account. The journal entry is :
Capital Reduction A/c
Dr.
To capital Reserve.
31
Illustration:
The following was the Balance sheet of Universal Auto Ltd. as at 31st March 2000
Rs.
Rs.
Authorised Share Capital

10,00,000
Goodwill
1,00,000
Fixed Assets
3,80,000
Issued, subscribed and paid-up
Cash
1000 9% of cumulative pref.
Profit and Loss A/c
shares of Rs. 100 each
1,00,000
3000 equity shares of Rs 100 each
3,00,000
13.5 % Debentures
1,00,000
9,000
61,000
credits (including Rs. 10,000

holding lien on some assets)
50,000
5,50,000
5,50,000
The Company decided on a scheme for reduction of capital which was duly authorised. The scheme provided as follows:
1) Two equity shares of Rs 100 each, Rs. 50 paid up per share to be issued for each preference share.
2) Each existing equity shares is to be reduced to Rs 50 paid up, the face value remaining the same at
Rs 100
3) 1,000 Equity shares were taken up by the Directors and paid for by them for the extent of Rs. 50
each.
4) Arrears of preference divided for the last four years to be cancelled.
5) Debenture holders to receive 800 Equity shares of Rs 100 credited as fully paid up.
6) Unsecured creditors to be paid immediately to the extent of 10% of their claims and they accepting a
remission of 20% of their claims.
7) The amount available as a result of the scheme to be used to write off a debit balance in the profit and
loss Account, to write down Fixed Assets by Rs. 10,000 and to adjust goodwill.
You are required to give journal entries to record the above and give the balance sheet after the reconstruction effected (I.C.W.A-Final)
32
Solution
UNIVERSAL AUTO Ltd.
JOURNAL ENTRIES
Particulars
Debit
Rs
Rs.
9% cum preference share capital A/c

Dr.
(Being two Equity shares of Rs. 100 each Rs 50 paid
up per share issued for each preference share)
1,00,000

Dr.
(Being the reduction of equity shares of Rs. 100 each
into shares of 50 each)
1,50,000
Bank A/c
Dr.
(Being 1000 Equity shares taken up by the Directors
and paid for by them to the extent of Rs. 50 each)
50,000
13.5% Debentures A/c

Dr.
(Being 800 Equity shares of Rs. 100 each credited
as fully paid-up issued to debenture holders
1,00,000
Sundry creditors A/c

Dr.
To Bank
To Capital Reduction A/c
(Being unsecured creditors paid to the extent of 10%
of their claims and they accepting a remission of 20%
of their claims)
12,000
Capital Realisation A/c

To fixed Assets A/c
To Goodwill
(Being the past losses eliminated Goodwill
written off and other assets reduced
Dr.
Capital Reduction A/c

Dr.
To Capital Reserve A/c
(Being the balance in capital Reduction Account
Transferred to capital Reserve A/c)
33
Credit
1,00,000
1,50,000
50,000
80,000
20,000
4000
8000
1,71,000
1,61,000
10,000
7,000
7,000
UNIVERSAL AUTO LTD.

BALANCE SHEET as at 31st March 2000
(After reduction)
Liabilities
Rs.
Assets
Authorised Share Capital

Fixed Assets
10,00,000
Cash/Bank
Rs.
3,70,000
55,000
Issued and subscribed: 6000 Equity

shares of Rs 100 each Rs 50
per share paid up
3,000,00
80,000
fully paid up
Reserves as surplus :
Capital Reserve
7,000
Current liabilities:
Sundry creditors including
Rs. 10,000
holding lien on some assets
38,000
4,25,000
4,25,000
Assignment
1. Differentiate between (i) pooling of interests method and (ii) the purchase method of recording
transactions relating to amalgamation.
2. Explain the terms amalgamation, absorption and reconstruction.
3. Explain reduction of share capital
4. Explain the factors you would take into account for suggesting a suitable scheme of reconstruction.
34
5. Following are the Balance sheet of X Ltd. and Y Ltd. as on 31st March 1995
Balance Sheet as on 31st March 1995
Liabilities

Rs.000
Rs.000
50,00
30,000
Assets

Rs.000
Rs.000
Land and Building
25,00
15,50
Plant and Machinery
32,50
17,00
Furniture & Fittings
5,75
3,50
7,00
5,00
12,50
9,50
Equity Share Capital

(Rs. 10 each)
14% Preference share
capital (Rs. 100 each)
22,00
1,700
General Reserve
5,00
2,50
Investments
Export profit reserve
3,00
2,00
Stock
1.00
Debtors
9,00
10,30
Cash and Bank
7,25
5,20
99,00
66,00
Investment Allowance
Reserve:
Profit and loss A/c
7,50
5,00
(Rs 100 each)
5,00
3,50
Trade creditors
4,50
3,50
Other current liabilities
2,00
1,50
99,00
66,00
13% Debentures
X Ltd. takes over Y LTd. on Ist April, 1995. X. Ltd. discharges the purchase consideration as below:
(i) Issued 3,50,000 equity shares of Rs 10 each at par to the equity shareholders of Y Ltd.
(ii) Issued 15% preference shares of Rs. 100 each to discharge the preference shareholders of Y Ltd. at
10% premium :
The debentures of Y Ltd. will be converted into equivalent number of debentures of X Ltd. The Statutory
reserves of Y Ltd. are to be maintained for 2 more years. Show the balance sheet of X Ltd. after amalgamation
on the assumption that:
(a)
The amalgamation is in the nature of merger.
35
(b)
The amalgamation is in the nature of purchase.
6. The following are the summerised Balance sheet of A. Ltd. and B. Ltd. as on 31st march 1997
A Ltd.
Liabilities
Rs.
Assets
Rs.
40,000 equity shares of Rs 100 each
40,00,000
Fixed Assets
30,00,000
General reserve
30,00,000
Investments
5,00,000
Current liabilities
30,00,000
Current assets
1,00,00,000
65,00,000
1,00,00,000
B Ltd.
Liabilities
Rs.
Share capital
20,000 equity shares of Rs 50 each
Assets
Goodwill
10,00,000
General Reserve
5,00,000
Current liablities
1,00,000
Provision for tax
1,00,000
Proposed dividend
1,00,000
Fixed assets
Current asstes
18,00,000
Rs.
50,000
3,50,000
14,00,000
18,00,000
B Ltd. is to be absorbed by A Ltd. on the following terms :

(i) B Ltd. declares a dividend of 10% before absorption for the payment of which it is to retain sufficient
amount of cash
2) The net worth of B Ltd. is valued at Rs 14,50,000
3) The purchase consideration is satisfied by the issue of fully paid up shares of 100 each in A Ltd.
Following further information is also to be taken into consideration.
a) A Ltd. holds 5000 shares of B Ltd. at a cost of Rs. 3,00,000
b) The stocks of B Ltd. include items valued at Rs. 1,00,000 purchased from A Ltd. (cost to A Ltd. Rs
75,000)
c) The creditors of B Ltd. include Rs 50,000 due to A Ltd.
36
Show ledger accounts in the books of B Ltd. to give effect to the above and balance sheet of A Ltd. after
completion of the absorption
7) Paradise Limited which had experienced training difficulties, decided to organise its finances on March
31, 2000 a final trial balance extracted from books of the company showed the following position.
Dr.
Rs
Share capital, Authorised and issued :

1500 6% cumulative preference shares of
Rs. 100 each
Capital reserve
Profit and loss Account
Preliminary expenses
Goodwill at cost
Trade creditors
Debtors
Bank overdraft
leasehold Property, at cost
leasehold Property, provision for depreciation
Plant and Machinery at cost
Plant and Machinery, Provision for Depreciation
Stock in trade
Cr.
Rs
1,50,000
2,00,000
36,000
1,10,375
7250
50,000
42,500
30,200
51,000
80,000
30,000
2,10,000
57,500
79175
5,67,000
5,67,000
The approval of the court was obtained for the following scheme for reduction of capital:
a) The preference shares to be reduced to Rs 75 per share
b) The Equity shares to be reduced to Rs 12.50 per share
c) One Rs 12.50 Equity share to be issued for each Rs 100 of Gross Preference dividend arrears; the
preference dividend has not been paid for three years.
d) The balance in capital Reserve Account to be utilised
e) Plant and Machinery to be written down to Rs. 75,000
f) The profit and loss account balance and all intangible assets to be written off.
At the same time as the resolution to reduce capital was passed, another resolution was approved
resorting the total Authorised capital to Rs. 3,50,000 consisting of 1500 6% cumulative preference
shares of Rs 75 each and the balance in Equity shares of 12.50 each. As soon as the above resolution
has been passed, 5000 Equity shares were issued at part for cash, payable in full upon application. The
same were fully subscribed and paid.
You are required:
(i) To show the journal entries necessary to record the above transactions in the companys books and
(ii) To prepare the balance sheet of the company, after completion of the scheme.
37
UNIT - 2
LIQUIDATION OF COMPANIES
OBJECTIVES
By the end of this unit, you should be able to:
Understand the meaning and legal aspects of liquidation of companies
Learn the preparation of statement of Affairs, Deficiency/Surplus Account and Liquidators

Final statement of Accounts
STRUCTURE
2. 01
Meaning of liquidation.
2. 02
Modes of winding up or liquidation.
2. 03
Order of payments.
2. 04
Statement of affairs.
2. 05
Deficiency /Surplus Account.
2. 06
Liquidators Final Statement of Accounts.
2. 07
Liquidators Remuneration.
2. 08
Assignments.
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2.01 Meaning of liquidation

Liquidation is a legal procedure by which the corporate life of a company is brought to an end. Any
company, when found necessary can be liquidated. It is not necessary that only insolvent companies should be
liquidated. Sometimes, even solvent companies are liquidated. When liquidation takes place, assets of the
company are realised , capital is collected and out of the proceeds, claims of creditors are settled. If any
surplus is left, it is returned to the shareholders of the company according to their rights. The job of realising
various assets and paying various liabilities in a systematic way is performed by a person called the Liquidator.
2.02
Modes of winding up or liquidation.
Section 425(1) of the Companies Act provides that a company can be liquidated in any of the following
three ways:
1. Compulsory winding up or winding up by the court,
2. Voluntary winding up
a) Members voluntary winding up
b) Creditors voluntary winding up.
3. Winding up under the supervision of the Court.
Compulsory Winding up.

A court may order the winding up of a company on anyone or more of the following grounds.
a) If the company has passed a special resolution to the effect that the company be wound up by the
court,
b) If default is made in filing statutory reports or in holding statutory meetings,
c) If the company does not commence business within a year from its incorporation or suspends its
business for a whole year,
d) If the number of members is reduced in the case of a public company below seven and in the case of
private company below two,
e) If the company is unable to pay its debts, and
f) If the court is of the opinion that it is just and equitable that the company be wound up.
Voluntary Winding up.

Voluntary winding up may be either members voluntary winding up or creditors voluntary winding up.
When a companys solvency is declared by the directors in voluntary winding up, it is called Members Voluntary
Winding up. When a companys solvency is not declared by the directors in voluntary winding up it is called
Creditors Voluntary Winding up.
Winding up under supervision of the court.

This is voluntary winding up with the supervision of court. The object of a supervision order is to ensure
the protection of interests of all persons concerned - the company, the contributories and the creditors.
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Contributory
According to Sec.428 of the Companies Act, a contributory is every person liable to contribute to the
assests of a company in the event of its being wound up, and includes the holder of any shares which are fully
paid up and also any person alleged to be a contributory. A contributory can be either a present member or a
past member. A present member is that member whose name is included in the register of members when the
company is wound up. On the other hand, past members are those members who ceased to be shareholders
within one year of the winding up of the company and can be called upon to pay if the present contributories are
not able to pay the liabilities of the company. A contributory is not entitled to claim the set off in respect of any
amount due to him for dividend or any other sum. This means that a contributory must first pay the amount
demanded of him and then demand the amount due to him.
2.03
Order of payments.
The proceeds of assets not specifically pledged with any creditor and the surplus of assets specifically
pledged, if any, is available for distribution in the following order.
a) legal charges
b) liquidators remuneration
c) cost and expense of winding up
d) preferential creditors
e) creditors secured by floating charge and
f) unsecured creditors.
If still some surplus is left, it is distributed among contributories as follows:
i) Preference shareholders: Preference shareholders are entitled to the return of capital in priority to
any return of capital to equity shareholders.
ii) Equity shareholders: Any amount left after paying to preference shareholders will go to equity
shareholders. If any surplus is still left, it again goes to equity shareholders unless it is specifically mentioned
that preference share capital is a participating share capital. If preference shares are participating, then they
have the right to share the surplus left after paying equity capital.
Preference dividend: The position of preference dividend is as under:
a) If preference dividend has been declared but not paid, then they are paid as debt.
b) If preference dividend is in arrear for one or more years and it has not been declared, then the
position would be as follows:
arrears of preference dividend will be paid only when preference share capital and then equity share
capital are returned in full and surplus is left.
Preferential payments:
The amount of preferential creditors is paid out of the proceeds of assets not specifically pledged left
after retaining the amount necessary for cost and expense of winding up but before making any payment to any
other unsecured creditors. Sec. 530 of the Companies Act states the following as preferential creditors:
a) All revenues, taxes, cesses and rates due from the company to Central or State Governments or to
40
Local authority at the relevant date and having become due and payable within the 12 months next before that
date;
b) All wages or salaries of any employee inrespect of services rendered to the company and due for a
period not exceeding 4 months within the 12 months before the relevant date and any compensation
payable to any workman under any of the provisions of Charter V-A of the Industrial Disputes Act,1947,
provided the amount payable to any one claimant does not exceed Rs.1,000/-;
c) All accrued holiday remuneration becoming payable to any employee or in case of his death, to any
other person in his right, on the termination of his employment before, or by the affect of the winding
up order or resolution;
where a person advances money for the payment of employees wages or salary and holiday remuneration
stated above under (b) and (c) he will be treated as a preferential creditor.
d) Unless the company is being wound up voluntarily for reconstruction or amalgamation with another
company, all amounts due, in respect of contributions payable during the 12 months next before the
relevant date, by the company as the employer of any persons under Employees State Insurance Act,
1948;
e) All sums due as Compensation under the Workmens Compensation Act, 1923, in respect of death or
disablement of any employee of the company;
f)
All sums due to an employee from a Provident Fund, Pension Fund, or any other Fund for the welfare
of the employee maintained by the Company; and
g) The expenses of any investigation held under Sec.235 or 237 in so far as they are payable by the
company.
Interest on liabilities:
The date upto which interest on loan, debentures etc., is payable depends on the fact whether the
company is solvent or insolvent. In the case of solvent companies interest on loan, debentures etc.is payable upto
the date of payment and in case of insolvent companies the interest is payable upto the date of winding up. A
company is said to be solvent if the assets realised are sufficient to pay all creditors of the company in full and
some surplus is available for returning the capital. If not, the company is said to to be insolvent.
2. 04 Statement of affairs.
When a company is wound up under the order of the court or whcn the official liquidator has been
appointed by the court as provisional liquidator, the officers and directors of the company must submit within 21
days of the courts order a statement called statement of affairs.
FORM OF STATEMENT OF AFFAIRS
Statement as to the affairs of ............ Ltd. on the ........... day of ........... being the date of the winding
up order (or order appointing Provisional liquidator or the date directed by the official liquidator as the case may
be ) showing assets at estimated realisable values and liabilities expected to rank.
41
Assets not specifically pledged (As per list A )
Estimated
realisable Value
Rs.
Balance at Bank
Cash in hand
Marketable Securities
Bills receivable
Trade debtors
Loans and advances
Unpaid calls
Stock in trade
Work in progress
Freehold property, land and buildings
Lease hold property
Plant & Machinery
Furniture fittings, utensils etc.
Investment other than marketable securities
Livestock
Other property, etc.
Assets Specifically pledged (as per list B)]
(a)
Assets
(b)
(c)
(d)
Estimated
Due to
Deficiency ranking Surplus carried
realisable values Secured as unsecured
to Last colum
creditors
Rs.
Rs.
Rs.
Rs.
Estimated surplus from assets specifically pledged

Estimated total assets available for preferencial creditors, debenture holders
secured by a floating charge and unsecured cretitors
Summary of Gross Assets
Gross realisable value of assets
Specifically pledged
Rs............
Other assets
Rs...........
Gross assets
...............
Liabilities
Gross Liabilities
Rs............
( To be deducted from surplus or added to
deficiency as the case may be )
secured creditors (as per list B ) to the extent to which
42
Rs.
Rs.
their claims are settled (item a or b

whichever is less)
(Insert in Gross Liabilities column only)
Preferential creditors (as per list C)
Estimated balance of assets available for debenture holders
Secured by a floating charge and unsecured creditors
Debenture holders Secured by a floating charge (as per list D)
Estimated Surplus/deficiency as regards debenture holders
Unsecured creditors (as per list E)
Estimated Surplus/Deficiency as regards unsecured creditors
(Being the difference between Gross assets and Gross liabilities)
Issued and called up capital
( ......... preference shares of ........... each Rs.........called up (as per List F)
........... equity shares of ......... each Rs.............called up ( as per list G )
Deficiency or surplus as regards contributories ( as per list H )
Procedure of preparation of statement of affairs.
1. Write down the assets which are not specifically pledged at their realisable values. This includes the
calls in arrears but does not include uncalled capital.
2. Add to those assets the surplus, if any existing from those creditors who have been secured on assets
specifically pledged.
3. From the total, first deduct preferencial creditors, then creditors having a floating charge and then
unsecured creditors.
4. After having deducted the unsecured creditors, deduct from the remaining Surplus (or add to the
deficiency) the amount of Share capital.
5. The balance left will be the Surplus or deficiency.
2. 05 Deficiency/Surplus Account.
The deficiency or Surplus as the case may be stated in the statement of affairs is to be proved separately by preparing another statement called the Deficiency/Surplus Account. The items contributing to deficiency are listed first followed by items reducing deficiency. The difference between totals is the deficiency or
surplus and must tally with the figures given in the statement of affairs.
List H. Deficiency or Surplus Account.
1.
2.
3.
4.
5.
Items contributing to deficiency or reducing surplus.

Excess (if any) of capital and liabilities over assets
Net dividends and bonuses declared during the period.
Net trading losses
Losses other than trading losses
Estimated losses, not written off or for which provision has been made
in the books during the same period
43
6. Other items contributing to deficiency or reducing surplus.

Items reducing deficiency or contributing to surplus.
7. Excess of assets over capital and liabilities
8. Net trading profits.
9. Profits or income other than trading profits during the same period
10. Other items reducing deficiency or contributing to surplus.
Deficiency/Surplus as shown by the statement of affairs
Illustration - 1
Shri A.B. Govind is appointed liquidator of a company in voluntary liquidation on 01/07/2002 and the
following balances are extracted from the books on that date.
Rs.
Rs.
16000 shares of Rs.5/-each
80,000
Machinery
30,000
Reserve for bad debts
10,000
Leasehold properties
40,000
Debentures
50,000
Stock in Trade
Bank overdraft
18,000
Book debts
60,000
Liability for purchases
20,000
Investments
6,000
Calls in arrears
5,000
Cash in hand
1,000
Profit and Loss Account

1,78,000
1,000
35,000
1,78,000
You are required to prepare

(1) Statement of Affairs as regards creditors and contributories, and
(2) Deficiency or Surplus Account.
The Machinery is valued at Rs.60,000; the lease hold properties at Rs.73,000; investments at Rs.4,000;
Stock in trade at Rs.2,000; bad debts are Rs. 2000; doubtful debts are Rs.4,000, estimated to realise Rs.2,000.
The bank overdraft is secured by deposit of title deeds of lease hold properties. Preferencial creditors for taxes
and wages Rs.1,000. Telephone rent owing is Rs.80.
44
Solution :
STATEMENT OF AFFAIRS OF SHRI A.B. GOVIND AS ON 1st JULY 2002
Assets
Estimated
Releasable Value
Rs.
Assets not speficifically pledged ( as per List A )

Cash in hand
1,000
Book debts
56,000
Calls in arrears
5,000
Investments
4,000
Stock
2,000
Machinery
60,000
1,28,000
Assets specifically pledged ( as per list B )
Lease hold property
Estimated
Due to
Deficiency
Surplus
Realisable
Secured
ranking as
carried to
value
creditors
unsecured
last column
Rs.
Rs.
Rs.
Rs.
73,000
____
18,000
____
__
_______
55,000
______
Estimated surplus from assets specifically pledged
55,000
Estimated total assets available for preferential creditors, debenture holders secured
by floating charge and unsecured creditors.
1,83,000
Summary of Gross Assets
Rs.
Gross realisable value of assets specifically pledged
73,000
Other assets
1,28,000
Gross Assets
2,01,000
45
Gross Liabilities
Rs.
Liabilities
Rs.
( To be deducted from surplus or added to deficiency as the

case may be )
18,000.
Secured creditors ( as per List B ) to the extent to which claims

are estimated to be covered by assets specifically pledged.
1,000.
Preferential creditors (as per List C )
1,000
Estimated balance of assets available for debenture holders

secured by floating charge and unsecured creditors
50,000
1,82,000
Debenture holders secured by a floating charge ( as per list D)

Estimated surplus as regards debenture holders
1,32,000
Unsecured creditors (as per list E )
Rs.
Liabilities for purchases
20,000
20,080
Telephone Rent outstanding
89,080
Estimated surplus as regards creditors
50,000
80
20,080
1,11,920
Issued and called up capital (as per list G. )
80,000
Estimated surplus as regards contributories (as per list H)
31,920
List H.
SURPLUS ACCOUNT
Items reducing surplus:

Excess of Capital and Liabilities over assets,
i.e. Profit and Losses Account
35,000
Estimated losses now written off for which provision has been
made for the purpose of preparing the statement:
Rs.
Investments (Rs.6000 - 4000)
2,000
Preferential creditors for taxes and wages
1,000
Telephone rent outstanding
80
3,080
38,080
Items contributing to surplus:

Machinery (Rs.60,000-30,000)
30,000
Lease hold properties (Rs.73,000-40,000)
33,000
Stock
(Rs.2000-1000)
1,000
Debtors provision for Bad debts Rs.10,000

Less Bad debts
Doubtful debts
Rs.2,000
2,000
4,000
Surplus as shown by the statement of Affairs
46
6,000
70,000
31,920
2. 06 Liquidators Final Statement of Account.

The main function of the liquidator is to realise the assets of the company under liquidation, and settle the
accounts of every creditor proving his claim against the company. It is, therefore, necessary for him, in every
mode of winding up, to maintain proper records of receipts and payments and submit a summary of the same to
the Court and to the company depending upon the mode of winding up. When the affairs of the company under
liquidaion are fully wound up, he has to prepare a final statement of account showing the amount realised and
then utilisation of the same for disbursement amongst the claimants.
Liquidators final statement of account takes the form of cash account, where on the left handside
records various receipts and the right hand side the payments. The various receipts shown on the left hand side
are:
i)
Realisation of assets,
ii) Surplus of securities,

iii) Payments by contributories,
iv) Receipts from delinquent directors and other officers of the company,
v) Any other receipts.
On the right hand side of the account are recorded the various payments made in the following order:
i)
Secured creditors,
ii) Legal charges,

iii) liquidators remuneration,
iv) costs of liquidation such as auctioneers charges, cost of notice in Gazette and newspapers, establishment and other expenses of liquidation.
v) Preferential creditors,
vi) Debentures with a floating charge,
vii) Unsecured creditors,
viii) Preference shareholders, and
ix) Equity shareholders.
2-07
Liquidators Remuneration.
The liquidator normally gets his remuneration in the form of commission which is usually based on the
value of assets realised and the payments made to creditors. While calculating the liquidators remuneration the
following points are to be borne in mind:
1.
He gets the commission, at the agreed percentage on all assets ( not specifically pledged ) realised by him.
If the payment to the secured creditors is made by him by way of selling the assets specifically pledged,
then he is entitled to the commission for the proceeds so realised by him. However, he is not entitled for the
commission if the assets given as securities are realised by the secured creditors themselves.
2.
Cash and Bank balances:- Unless otherwise stated, he is not entitled for the commission on such balances.
47
3.
When the liquidators commission is based on the amount paid to unsecured creditors, preferential creditors
are also taken into consideration because they are also unsecured creditors.
4. If the amount available is sufficient to make the full payment of unsecured creditors, the commission is
calculated as follows:
Liquidators remuneration : Amount due to unsecured creditors X % of commission
100
If the amount available is not adequate to make the full payment to the unsecured creditors, the commission
is calculated as follows:
Liquidators remuneration = Amount available for unsecured creditors X % of commission
100 x % of commission.
Illustration - 2
Given below is the position as on August 1st, 2002 of Ganges Silk Mills Ltd. on which date it goes into
liquidation.
1.
Share capital:
(a) 10,000 preference shares of Rs.10 each fully paid
(b) 5,000 Equity shares of Rs.10 each fully called
less calls-in arrears on 1000 shares at Re.1. per share
(c) 10,000 Equity shares of Rs.10. each at Rs.5. per share paid
(d) 20,000 Equity shares of Rs.10. each at Rs.3. per share paid
Rs.
1,00,000
Rs.50,000
1000
2.
Secured loan from bank (against pledge of stock of raw material)
3.
Unsecured dues :
Preference
49,000
50,000
60,000
38,000
Rs. 1,200
Others
1,01,800
Total
1,03,000
Rs.4,00,000
4.
Cash at Bank
5,000
5.
Stock of raw material
6.
Other stocks
1,50,000
7.
Other assets
1,45,000
8.
Profit and loss account ( debit balance )
50,000
50,000
4,00,000
Realisations were :
(a) Stock of raw material realised by bank Rs.30,000; (b) other stocks Rs.80,000; (c) Remaining assets
Rs.20,000.
The liquidator is entitled to the fixed remuneration of Rs.1,000. plus 3% of the gross amount realised by
him. Other costs and charges amounted to Rs.11,000. Equity share capital carry the same rights regardless of
the amount paid as far as capital repayment is concerned. Show the liquidators final statement of account.
48
Solution :
Liquidators Final Statement of Account.
Receipts
Rs.
Payments.
Other stock
80,000
Legal charges
Remaining assets
20,000
Remuneration of liquidators
Cash at bank
5,000
Rs.
Nil
4,000
Cost and expense of
Calls on shares
winding up
20,000 shares @Rs.5. per share (8-3) 1,00,000
11,000
Preferential creditors
1,200
Calls on shares
10,000 shares @Rs.3. per share (8-5) 30,000
Creditors secured by floating charge
Nil
Unsecured creditors 1,01,800 +

8,000
Preference Share holders
1,09,800
1,00,000
Equity Share holders

4,000 shares @ 2 - 4,000 X 2 = 8000.
1,000 shares @ 1 - 1,000 X 1 = 1000.
2,35,000
2,35,000
Working Note:a)
Liquidators remuneration.
b)
9,000
1,000 + 3% of 1,00,000.
Rs.4,000/-
2,26,000
1,05,000
_______
1,21,000
Calculation of loss per equity share

Calculation of deficiency.
Payment
(-)
Receipts
Add paid up equity Capital

49,000
50,000
60,000
Deficiency
1,59,000
2,80,000
Deficiency per equity share
=
=
49
2,80,000
35,000
Rs.8/- per share
Assignments:
1.
What is statement of Affairs? How is it prepared?
2.
Who are preferential creditors under Company Law?
3.
How is liquidators remuneration calculated?
4.
Give a proforma of liquidators final statement of account with imaginary figures.
5.
What are preferential creditors? State the various types of preferential creditors in the event of the
companys winding up.
List the preferential creditors who have to be paid off in priority over other creditors in the event of a
companys winding up.
1.
On January 31st, 2002, a compulsory order for winding up was made against X Co. Ltd. The following
particulars being disclosed.

Book Value
Estimated to
Produce
Rs.
Cash in hand
Rs.
100
100
4,000
3,600
Land and buildings
60,000
48,000
Furniture & fixtures
20,000
20,000
Unsecured creditors
20,000
Debtors
Debentures:
Secured on land and buildings
42,000
Secured on floating charge
10,000
Preferential creditors
6,000
Share Capital (3200 shares of Rs.100. each )
3,20,000
Estimated liability for bills discounted was Rs.6,000. Estimated to rank at Rs.6,000. Other contingent
liabilities were Rs.12,000. Estimated to rank at Rs.12,000.
The company was formed on January 1st, 1998 and has made losses of Rs.3,13,900
Prepare the statement of Affairs and the Deficiency Account.
2.
A company went into voluntary liquidation on 31/12/2002. Its position as on that date was as follows:
1000 preference shares of Rs.100. each, fully paid
2000 equity shares of Rs.100. each, fully paid
2000 equity shares of Rs.100 each, Rs.75. paid up.
Unsecured creditors
Rs.1,90,000.
50
Assets realised
Rs.3,20,000.
Liquidation expenses
Rs. 12,000.
Liquidators remuneration
5% on the amounts realised, and
3% on the amount distributed to unsecured creditors.
The liquidators made a call of Rs.25/- on the partly paid equity shares which was duly paid. Prepare
liquidators final statement of account.
3.
Balance sheet of Sona Ltd. as on 31st December, 2002 is as follows:

SONA LTD.
BALANCE SHEET AS ON 31ST DECEMBER 2002
Liabilities
Rs.
Assets
Paid up capital:
1000, 6% Preference shares of
Rs.100. each
1,00,000
2,00,000
3000, equity shares of Rs.100 each

Rs.50. paid
Land and Buildings
2,00,000
Plant and Machinery
2,20,000
Current Assets:
2000, equity shares of Rs.100 each

Fully paid
Rs.
Stock
1,00,000
Debtors
1,00,000
Cash at Bank
1,50,000
30,000
Miscellaneous expenditure:
Profit & loss A/c
1,00,000
Secured Loan:
6% debentures (floating charge on
all assets )
1,00,000
Others ( Mortgage on land & buildings) 1,00,000

Current liabilities :
Sundry creditors
90,000
Income-tax
10,000
7,50,000
7,50,000
The company went into liquidation on January 1,2003. The preference dividends were in arrears for 3
years and payable on liquidation.
The assets realised as follows: Land and Building Rs.2,40,000; plant and machinery Rs.1,80,000; Stock
Rs.70,000; Debtors Rs.60,000.
The expenditure of liquidation amounts to Rs.8000. The liquidator is entitled to a commission of 2% on all
assets realised and 3% on amounts distributed to unsecured creditors.
All payments were made on June 30, 2003. Prepare Liquidators final Statement of Account.
51
Unit III
INSURANCE CLAIMS OR FIRE CLAIMS
Fire insurance claim can be studied under two parts, 1) Loss of asset (a) loss of stock (b) loss of fixed
assets like building, machinery, furniture etc. 2) Loss of profit.
1.
Claims for Loss of Assets:When a fire occurs, it destroys all assets such as building, machinery, furniture, stock etc. The books of
account maintain accounts of all the assets except (usually) stock in trade. Claims in respect of building,
machinery, furniture etc, can be made on the book value of these assets. But difficulty arises in connection with
the loss of stock for which no account appears in the books. The value of stock in hand on the date of fire,
therefore, has to be estimated to make a claim against the Insurance company. For this purpose, a Memorandum Trading Account has to be prepared as shown below:
Memorandum Trading A/c

To
Opening Stock
--
By sales
--
Purchases
--
Closing stock
--
wages
--
carriage inwards
--
Gross profit (certain

percentage on sales )
(Balancing fig.)
--
Adjustments
Gross profit ratio is determined on the basis of the previous years trading results. Some times stock
might have been valued below cost or above cost. In such a situation, trading account will have to be prepared
with full cost of opening and closing stocks. The opening stock of current year should also be adjusted while
preparing the Memorandum Trading a/c for ascertaining the value of stock destroyed.
Loss of stock is calculated as follows.
Value of stock on the date of fire
---
Less value of salvaged (saved) stock
---
Loss of Stock
---
52
Illustration I
A fire occurred on 21st April 2004 in the premises of Appolo Ltd. and stock in trade was destroyed. The
following are the information.
Opening stock on 01-01-2004
Rs.11,000
Purchases upto 21-04-2004
Rs.45,000
Sales upto 21-04-2004
Rs.60,000
The stock in hand was always valued at cost price or market price whichever was lower. However, the
closing stock as at 31st Dec. 2003 was valued at market price which was 10% above cost. The percentage of
profit usually obtained in the business was 15%. The salvage realised only Rs.400. Compute fire claims.
Solution.
Memorandum Trading A/c 01-01-04 to 21-04-04
To op. stock (last year closing
By Sales
stock at cost price 11,000 X 100 )

110
To Purchases
10,000
60,000
By closing stock
(balancing figure )
4,000
45,000
To G.P (15% on sales )
9,000
64,000
64,000
Statement of fire claim

Value of closing stock
4,000
Less Stock salvaged
400
Rs.3,600
II
A fire occurred in the godown of a company on 20th March 2002. All stocks were destroyed except to
the extent of Rs.13,000. From the following figures ascertain the claim amount in respect of loss of stock by
fire.
Stock on 01-01-2001
Rs.40,000
Purchases less returns during 2001
Rs.1,40,000
Sales
Rs.2,00,000
Stock on 31-12-2001
Rs. 24,000
Purchases during 2002 upto the date of fire
Rs.1,46,000
Sales
Rs.1,60,000
Stocks were always valued at 80% of cost.

Solution.
The rates of gross profit to sales is not given; to find it out it is necessary to prepare Trading A/c for
2001.
53
Trading A/c for 2001

To Op. Stock
(40,000 X 100 )
80
50,000
To Purchases
By sales
1,40,000
2,00,000
closing stock
24,000 X 100
80
To G.P
30,000
40,000
2,30,000
2,30,000
Note: Both opening stock and closing stock are valued at 80% of cost. So it is necessary to bring them to the
level of actual cost.
G.P.Ratio
40,000 X 100
2,00,000
= 20%
Memorandum Trading A/c

To stock
30,000
Purchases
By sales
1,46,000
G.P (20% of sales )
Clo. stock
32,000
(Balancing figure)
2,08,000
Amount of claim:
1,60,000
48,000
2,08,000
Rs.
Closing stock
48,000
Less salvage
13,000
35,000
Gross Profit Ratio: G.P is the key factor while calculating stock destroyed by fire. G.P. is always
calculated on the basis of sales. If gross profit ratio is not given, it can be computed as
G.P. Ratio =
G.P X 100
sales
Average Clause.
In general insurance policies, there is a clause as average clause. If the stock is under insured and if
there is average clause in the insurance policy, the amount of claim for the loss of stock will be that proportion of
the sum insured bears to the actual value of the insured stock. For eg., if stock worth Rs.60,000 is insured for
Rs.40,000 and the loss of stock amounts to Rs.30,000, the amount of claim for the loss of stock will be
Claim
=
Actual loss X Amount of Policy
Value of stock on the date of fire
54
30,000 X 40,000
60,000
= Rs.20,000.
Illustration 2.
A fire occurred in the premises of a merchant on 18 September, 2003 and a considerable part of the
stock was destroyed. The merchant has taken out a fire insurance policy of Rs.21,000 covering his stock in
trade and the policy was subject to average clause.
The books disclosed that on 1st April, 2003 the stock was valued at Rs.66,500. The purchase to the date
of fire amounted to Rs.1,85,000 and the sales to Rs.2,82,500. Goods costing Rs.500 was taken for personal use
and goods sold for Rs.2,500 were returned to the merchant. On investigation, it is found that during the past 5
years the average gross profit on cost was 25%. The value of the stock saved was Rs.7,000/Prepare a statement showing the amount the merchant should claim from the insurance company in
respect of stock destroyed by fire.
Solution
The rate of gross profit on cost is 25%
The rate of gross profit on sales is 25%
Memorandum Trading A/c for the period upto 18, September, 2003
To opening stock
To purchases
66,500
By sales
1,85,000
Less goods for own use 500

To G.P (20% on 2,80,000)
Less returns
2,82,500
2,500
1,84,500
By Stock on date of fire
56,000
( Balancing figure )
3,07,000
2,80,000
27,000
3,07,000
Claims to be made :Stock on date of fire
27,000
Less salvage
7,000
20,000
Since there is average clause, the claim to be made is

Rs.27,000 stock is insured for
20,000 stock.
Rs.21,000
Claim =
21,000 X 20,000
27,000
Rs.15,556
Consequential loss or loss of profit.

An ordinary fire insurance policy covers the loss of stock on properties destroyed by fire, but it does not
cover loss of profit due to stoppage of production or sale on account of fire. So, a new type of insurance known
55
as loss of profits insurance or consequential loss insurance has come into vogue. This policy covers the
following losses due to fire.
1.
Loss of profits due to stoppage of business or reduced turnover.
2.
Loss of standing charges (ie. fixed charges ) due to their non-recovery or less recovery, because of no
production or less production as a result of fire. Examples for standing charges are salaries, rent, rates,
taxes, lighting, dpn. telephone charges etc.
3.
Loss due to increased working expenses during indemnity period ie., additional expenses during
dislocation period. eg: renting a new business place.
Explanation of Certain terms.
1). Indemnity period.
Indemnity period is the period covered by the consequential loss policy. For example, if A Ltd.
takes a loss of profit policy on 1-1-2004 for a year and if the fire broke out on 1-12-2004, then Indemnity period
runs from 1-12-2004 to 30, November, 2005.
2). Standing or fixed charges or constant expenses. It refers to those fixed expenses which are incurred irrespective of reduction in business during dislocation period.
Eg:
1)
Wages and salaries of permanent staff
2)
Rent, rates, taxes etc.
3)
Interest on loan, bank overdraft etc.
4)
Depreciation on fixed assets.
The standing charges which are insured are called insured standing charges.
3). Increased cost of working:
These are additional expenses incurred by the insured in order to carry on the business during
the
indemnity period.
4).Saving in expenses:
These are the expenses which are usually incurred by a business but are avoided during dislocation
period.
5). Rate of gross profit:
The term gross profit is not used in the sense as it has been understood commonly. It has different
meaning and is calculated as follows:
Net profit + Insured standing charges
G.P =
X 100
Turn over ( Previous year )
6).Short sales:
It is calculated by comparing the sales made during the period of business dislocation caused by fire to
the sales of the year preceding the period of fire.
7).Standard Turnover:
Refers to the sales during that period in the preceding financial year which corresponds to the period of
dislocation. Suppose the period of claim is 3 months ie., from 1-4-2004 to 30-06-2004.
56
Standard sales is the sales during 3 months from 1-4-2004 to 30-6-2004.
Computation of claim for loss of profit:

I. Calculation of the loss of profit during dislocation period. In order to calculate loss of profit following steps are
required.
a)
Determination of period of claim.

Period of claim is the period covered by the policy. (Period of indemnity or period of disloca
tion whichever is less).
b)
Ascertain short sales or loss of turnover.

Short sales
c)
Standard sales - sales during dislocation period.
Calculation of G.P. Ratio.

G.P. Ratio
Net Profit + Insured Standing Charges X 100

Last year sales
d)
Calculate loss of profit during dislocation period.

Loss of profit
Short sales X Gross profit ratio.
II. Computation of claim for increased Cost of working.

a)
If only a part of fixed charges are insured, then increased cost of working is proportionately
reduced as follows:
Increased cost of working
X Net profit + Insured standing charges

N.P.
+ all standing charges
Compare this with G.P on turnover saved. Only less is allowed.

b)
Calculate G.P. on turnover saved.

=
G.P X turnover saved.
Turnover is saved by incurring additional cost of working. But insurance company will pay only less by comparing these two ie., (1) increased cost of working (2) G.P. on turnover saved.
III.
Deduct the amount of expenses saved.

Gross claim for loss of profit
loss of profit on short sales + Increased working

expenses
expenses saved.
Gross claim is subject to average clause.

When average clause is applied, the amount of claim
=
Gross claim X
Amount of Policy
G.P. on sales of preceding 12 months of fire.
The result is the amount of claim.
57
Illustration 3.
ABB Ltd. has a Loss of Profit insurance policy of Rs.21,00,000. The period of indemnity is 3 months.
A fire occurred on 31-03-2003. The following information is available.
Sales for the year ended 31-3-2002
Rs.70,00,000
Sales for the period from 1st April 2002 to 30th June 2003
80,00,000
18,00,000
1,20,000
Standing charges for 2002
16,00,000
Profit for 2002
5,00,000
Savings in standing charges because of fire
50,000
Additional expenses to reduce loss of turnover
1,00,000
Assuming that no adjustment is to be made for the upward trend in the turnover, compute the claim to
be made on the insurance company.
Solution
Loss of profit during dislocation period
Short sales
Short sales X G.P. ratio
Standard sales - sales during dislocation period.
18,00,000 - 1,20,000
Short sales
16,80,000
G.P
Net Profit + Insured standing charges X 100

Last year sales
5,00,000 + 16,00,000 X 100

70,00,000
Loss of profit
= 30%
Short sales X G.P. Ratio
16,80,000 X 30
100
Rs.5,04,000
After calculating loss of profit during dislocation period, calculate claim for increase in cost of working.
Increase in cost of working
1 lakh.
Compare this with G.P. on turn over saved, less is allowed by insurance company.
If all standing charges are not insured, only proportionate amount of increase in cost of
working will be allowed and it is calculated
=
N.P + insured standing charges X increase in cost of working

N.P + all standing charges
In this problem it is assumed that all standing charges are insured ie., 1,00,000
58
G.P. on turnover saved
Turnover saved X G.P. Ratio
1,20,000 X 30
100
{ assume that sales during dislocation period is the turnover saved }.

=
Gross claim
1,20,000 X 30
100
Rs.36,000.
loss of profit + increased cost of working - standing charges saved.

=
5,04,000 + 36,000 - 50,000
Rs.4,90,000
In order to apply average clause, first find out whether there is under insurance. It can be calculated by
taking the sales of 12 months preceding the date of fire X G.P
=
80,00,000 X 30/100 = Rs.24,00,000
But sum insured is Rs.21 lakh. So there is under insurance

Actual claim
4,90,000 X 21,00,000
24,00,000
Rs.4,28,750.
59
UNIT IV
ANALYSIS AND INTERPRETATION OF

FINANCIAL STATEMENTS
OBJECTIVES
After studying this unit, you should be able to understand:
the Meaning of financial analysis and interpretation
the Tools of financial analysis
the Techniques of application of tools and making its interpretation
STRUCTURE
4. 01
Meaning of financial statements
4-02
Nature of financial statements
4-03
Analysis of financial statements
4-04
Analysis and interpretation
4-05
Types of financial analysis
4-06
Tools or Techniques of analysis
60
4-01 MEANING OF FINANCIAL STATEMENTS

Financial Statements are the end products of financial accounting. They are statements containing financial
information of a business enterprise. Financial Statements may be defined as statements containing summaries
of detailed information about the financial position and performance of an enterprise.
Traditionally financial statements comprised two statements ie, Income Statement also known as Profit and
Loss Account and the Position Statements, also known as the Balance Sheet. In recent years however, the term
financial statements is given a broad connotation to include besides the income and position statements, cash
flow statement, fund flow statement, Statement of retained earnings, schedules, Annexure and Explanatory
Notes.
4-02 NATURE OF FINANCIAL STATEMENTS

Financial statements report financial information to those who are external to business as well as those
interested in the accounting information relating to the business. The information conveyed is about the result of
business operations as also a true and fair view of the affairs of the business. These statements are prepared as
per the legal requirements. But yet, they exhibit the following characteristics.
Factual financial information : Financial statements present the net effect of the actual business transactions. Financial statements reflect only the recorded facts. They do not reveal the financial position of the
concern in terms of current economic conditions.
Influence of conventions: In the preparation of financial statements, certain Generally Accepted Accounting Principles, concepts and conventions are followed. For example, according to the convention of Conservatism profit should not be anticipated although loss may be anticipated and provided for. As a consequence of
applying this convention, the profit and loss account shows a position which is not really the position of the
concern, ie, much better than that reflected by the account.
Accountants discretion : Financial statements are affected by the accountants discretion or personal
judgement in the treatment of some items for purposes of preparing financial statements, for example, the
method of stock valuation, method of depreciation etc. depend on the personal judgement of the accountant.
4-03 ANALYSIS OF FINANCIAL STATEMENT
Financial analysis is the process of evaluation of relationship between component parts of financial statements to obtain a better understanding of the firms position and performance. It is the process of identifying the
strengths and weaknesses of the company with the help of accounting information provided by the profit and
61
loss account and Balance sheet. Financial analysis mainly measures the liquidity, solvency and profitability of
business concern.
4-04 ANALYSIS AND INTERPRETATION

The term interpretation means explaining the meaning and significance of the data so arranged.
Analysis and Interpretation are closely related. Interpretation is not possible without analysis and without
interpretation analysis has no value. So first the data in the financial statements are to be analysed. From
analysis of data, draw conclusion which mean interpretation. Interpretation is thus drawing of inference and
stating what the figures in the financial statement really mean. The most important objective of the analysis and
interpretation of financial statements is to understand the significance and meaning of financial statements data
to know the strength and weakness of a business undertaking, so that forecast may be made of the future
prospects of that business undertaking.
4-05 TYPES OF FINANCIAL ANALYSIS

The classification of financial analysis can be made either on the basis of materials used or according to the
modus operandi of the analysis
TYPES OF FINANCIAL ANALYSIS
on the basis of materials used
on the basis of
or information used
modus operandi
External analysis
Internal Analysis
Horizontal analysis
Vertical analysis
A. On the basis of material used or information used financial analysis can be of two types :
a) External analysis
This type of analysis is done by those who are outsiders to the business. The outsiders are creditors,
investors, Government etc. This people mainly depend upon the published financial statements.
b) Internal Analysis
This analysis is done by those who have access to the books of accounts and other informations relating to
the business concern. This Analysis is done for managerial purpose. This is conducted by executives or employees of the firm.
62
B. On the basis of modus operandi, financial analysis can be of two types.

a) Horizontal analysis
This method of analysis is also known as Dynamic Analysis, as it analyses changes in the related
items in the financial statements of two or more accounting periods or two or more business concerns. Horizontal analysis portrays figures for a number of years and changes in these figures from the figures of a particular
year chosen as the standard or the base year. For example, study of profitability trend for a period of 5 to 10
years. In these current year figures are compared with standard or base year and shown as percentage.
b) Vertical Analysis
This type of analysis aims at making a static analysis of financial statements for one year only. In this type
each figure, representing a particular item is compared with the total of a single financial statement. For example, comparison of current Assets and current liabilities for one point of time or one accounting period.
4-06 TOOLS OR TECHNIQUES OF ANALYSIS

1. Comparative Financial Statements
2. Common-size statements
3. Trend analysis
4. Ratio analysis
5. Fund flow statement
6. Cash flow statement
1) Comparative Financial Statements
One of the techniques of financial statements analysis is the preparation of comparative financial statements
of the same concern for two accounting periods or for two or more concerns for a particular period. In this
statement figures of two or more years are placed side by side to facilitate comparison.
a)
Comparative Income Statement
The income statement discloses Net profit or Net loss resulting from the operations of business. A comparative income statement will show the absolute figures for two or more periods, the absolute change from one
period to another and if desired the change in terms of percentages. Since the figures for two or more periods
are shown side by side, the reader can quickly ascertain whether, sales have increased or decreased, whether
cost of sales has increased or decreased etc. This statement helps in deriving meaningful conclusions.
b) Comparative Balance Sheet
Comparative Balance sheet as on two or more different dates can be used for comparing assets and
liabilities and finding out any increase or decrease in those items. This facilitates comparison of figures of two or
more periods and provide necessary information which may be useful in forming an opinion regarding the
63
financial condition as well as progressive outlook of the concern.

Illustration-I: From the following Profit and Loss Account and Balance Sheet of X Ltd. you are required to
prepare a Comparative Income Statement and a Comparative Balance Sheet.
PROFIT AND LOSS ACCOUNT

for the year ended 31st December
(Rupees in Lakhs)
To cost of goods sold
2002
2003
2002
2003
Rs.
Rs.
Rs.
Rs.
600
750
To Administration expenses
20
20
To Selling expenses
30
40
150
190
800
1000
To Net profit
By Sales
800
1,000
800
1000
BALANCE SHEET
as at 31 st December
(Rupees in Lakhs)
Liabilities
2002
2003
Rs.
Rs.
Assets
2002
2003
Rs.
Rs.
Equity capital
400
400
Land and Building
400
370
6% pref. capital
300
300
Plant and Machinery
400
410
Reserves
200
245
Stock
200
300
8% Debentures
100
150
Debtors
200
300
50
75
Cash
100
140
250
350
1300
1520
1300
1520
Bills Payable
Sundry creditors
64
Solution :
X Ltd.
COMPARATIVE INCOME STATEMENT

For the years ended 31-3-02 and 31-3-2003
Particulars
2002
2003
(Rupees in lakhs)
Absolute increase or Percentage increase

Decrease in 2003
or decrease in 2003
Net Sales
800
1000
+200
+25
Cost of goods sold
600
750
+150
+25
Gross profit (A)
200
250
+50
+25
Administration expenses
20
20
------
------
Selling expenses
30
40
+10
+33.33
Total (B)
50
60
+10
+20
150
190
+40
+26.67
less operating expenses :
Operating profit (A) - (B)
X Ltd.
COMPARATIVE BALANCE SHEET as at 31st Dec. 2002 and 2003

(Rupees in lakhs)
2002
2003
Absolute increase or Percentage increase

Decrease in 2003
or decrease in 2003
Cash
100
140
+40
+40
Debtors
200
300
+100
+50
Stock
200
300
+100
+50
Total Current Assets
500
740
240
48
Land and Building
400
370
-30
-7.5%
Plant and Machinery
400
410
+10
+2.5%
Total of fixed Assets
800
780
-20
-2.5%
1300
1520
+220
ASSETS:
Current Assets :
Fixed Assets:
Total Assets
65
+17%
LIABILITIES:
Current Laibilities:
Bills payable
50
75
+25
+50%
Sundry creditors
250
350
+100
+40%
Total of Current liabilities
300
425
+125
+41.67 %
8% Debentures
100
150
+50
Total liabilities
400
575
+175
+43.75%
6% Preference capital
300
300
-----
-----
Equity capital
400
400
-----
-----
Reserves
200
245
+45
+22.5%
Total Shareholders Funds
900
945
+45
+5%
1,300
1,520
+220
+17%
Long-term liabilities:
+50%
Capital and Retained Earnings :
Total Capital & liabilities
2. Common - Size Statements

Common-size financial statements are those in which figures reported are converted into percentages to
some common base. According to Kohler, they are accounting statements expressed in percentage of some
base, rather than rupees. The base selected may be sales which is an item of the income statement and the
same is assumed to be equal to 100. Similarly, capital or total assets of the position statement may be the base
converted to 100, and all other items in the financial statements are expressed as a percent of sales, capital or
total assets as the case may be. Since the bases selected represent 100 percent in the financial statements, there
is a common basis for analysis and the statements are known as 100 percent statement or common-size statements.
Illustration 2
On the basis of data given in Illustration 1 prepare a common-size income statement and common size
Balance sheet of X Ltd. for the years ended 31st march 2002 and 2003.
66
X Ltd.
COMMON-SIZE INCOME STATEMENT
for the years ended 31st March 2002 and 2003
(Figures in percentage)
Particulars
2002
2003
Net Sales
100
100
less cost of goods sold
75
75
Gross profit
25
25
Operating expenses:Administration expenses
2.50
Selling expenses
3.75
Total operating expenses
6.25
18.75
19
Operating Profit
Interpretation
Here each expense is shown as a percentage of net sales. The sales figure is assumed to be 100% and all
figures are shown as a percentage of net sales. The statement shows that though in absolute terms, the cost of
goods sold has gone up, the percentage of its cost to sales remains consistent at 75 %. Therefore Gross profit
continues at 25% of sales. Similarly, in absolute terms the amount of administration expenses remains the same
but as percentage to sales, it has come down by 5%. Selling expenses have increased by 25%. This all leads to
Net Profit by 25% (ie. from 18.75 % to 19%)
X Ltd.
COMMON-SIZE BALANCE SHEET
as at 31st Dec. 2002, 2003
Assets
2002
2003
100
100
7.70
9.21
Debtors
15.38
19.74
Stock
15.38
19.74
Total Current Assets
38.46
48.69
Current Assets:
Cash
67
Fixed Assets:
Land and Building
30.77
24.34
Plant and Machinery
30.77
26.97
61.54
51.31
Total fixed assets

Total Assets
Liabilities and Capital
100
100
2002
2003
100
100
Current Laibilities
Bills Payable
3.84
4.93
19.23
23.02
23.07
27.95
7.70
9.87
6% preference share capital
23.08
19.74
30.77
26.32
Reserves
15.38
16.12
Total Shareholders fund
76.93
72.05
Sundry creditors
Long term liabilities

8% Debentures
Capital and Reserves
Total liabilities and capital
100
100
Interpretation
Each asset is shown as a percentage of total asset and each liability and capital as a percentage
of total liability and capital. The percentage of current assets to total assets was 38.46 in 2002. It has gone up
to 48.69 in 2003. Similarly, percentage of current liabilities to total liabilities has gone up from 23.07 in 2002 to
27.95 in 2003. Thus proportion of current assets has increased by a higher percentage (about 10) as compared
to increase in the proportion of current liabilities (about 5) This has improved the working capital position of the
company. The proportion of shareholders fund in the total liabilities has come down from 69.23% to 62.18 %
while debentures has gone up from 7.70 % to 9.87 %
3) Trend Analysis
Both the comparative and common size statements suffer from a major limitation ie. absence of a
68
basic standard or a reference level to indicate whether the proportion of an item is normal or abnormal. This
limitation is overcome in the case of the trend analysis.
Trend analysis is an important tool of financial analysis. Under this method, a particular year, usually the first
year, is taken as the base year and the figures of the succeeding years for every item in the financial statements
are expressed as percentage of the same item. In other words, under this method, a representative year is
selected as the base and the values of items in the base year are assumed to be 100. Later, the relationship of
each item to the same item in the base year is expressed as a percentage. Thus when an item is expressed as
100, all other values expressed in terms of the base year will reflect a tendency in relation to 100. This tendency
expressed numerically is known as the Index number. The trend percentage of each item is compared with its
percentage of the preceding year for getting an idea of the progress of the concern.
Illustration 3- From the following information extracted from the Balance sheet of a company for five
previous financial periods, calculate the trend percentages taking 1998 as the base year.
in Rs 000
1998
1999
2000
2001
2002
Current Assets:
Cash
80
100
120
200
110
Bank
100
130
150
100
120
Debtors
150
200
300
500
800
stock
300
400
600
900
1000
500
500
600
600
600
1000
1000
1200
1200
1200
2130
2330
2970
3500
3830
Fixed assets:
Building
Plant and Machinery
Solution:
TREND PERCENTAGES
(Rs. in 000)
Trend percentages
1998
1999
2000
2001
2002
1998
1999
2000
2001
2002
Cash
80
100
120
200
110
100
125
150
250
137.50
Bank
100
130
150
100
120
100
130
150
100
120.00
Debtors
150
200
300
500
800
100
133
200
333
53.00
Stock
300
400
600
900
1000
100
133
200
300
333.00
Current Assets:
69
Fixed Assets:
Building
500
500
600
600
600
100
100
120
120
120.00
Plant
1000
1000
1200
1200
1200
100
100
120
120
120.00
Total
2130
2330
2970
3500
3830
100
109
139
164
180.00
4. Ratio Analysis
The ratio analysis is one of the most useful and common methods of analysing fianancial statements. As
compared to other tools of financial analysis, the ratio analysis provides very useful conclusions about various
aspects of the working like financial position, solvency, liquidity and profitability of an enterprise. Ratio analysis
as a tool for the interpretation of fianancial statements is also significant because ratios help the analyst to have
a deep peep into the data given in the statements. Figures in their absolute forms shown in financial statements
are neither significant nor able to be compared. In fact, they are basically dump. Ratios provide the power to
speak.
A ratio is a mathematical relationship between two related items expressed in quantitative form. When this
definition of ratio is explained with reference to the items shown in financial statements, then it is called accounting ratio. So Accounting ratios are relationships, expressed in quantitative terms, between figures which
have a cause and effect relationship or which are connected with each other in some manner or the other.
Accounting ratios can be expressed in various forms
i) As pure ratio, for eg: ratio of current assets to current liabilities 2:1
ii) As rate, for example, stock turn over 4 times a year
iii) As percentage, for example Gross profit to sales 25%
Steps involved in ratio analysis

1. Selection of relevant data from the financial statements depending upon the objectives of the analysis
2. Calculation of appropriate ratios
3. Comparison of calculated ratios with those of previous years or similar ratios of other concerns in the
same industry.
4. Interpretation of this ratios
Uses or
1.
2.
3.
4.
5.
advantages of Ratio Analysis.

Facilitates analysis of financial statements
Ratio analysis facilitates intra-firm and interfirm comparison
It reveals operational efficiency.
Planning device
Ratios may be used as instrument of management control.
70
6. Ratio analysis communicate the financial strength or weakness of a firm.

In a more easy and understandable manner.
Llimitations of Ratio Analysis.
1. May get false results, if based on incorrect accounting data
2. The technique is quantitative in nature; it ignores the qualitative factors.
3. Problem of window dressing
4. Price level changes make the ratio analysis difficult
5. Lack of adequate standard
6. No idea of probable happenings in future
7. Divergent methods of computing ratios
Classification of Accounting Ratios
(A) Classification according to accounting statement
(1) Balance sheet ratios
(2) Profit and loss account ratios
(B) Classification according to importance
(1) Primary ratios
(2) Secondary ratios
(C) Classification according to nature or purpose
1) Liquid Ratios, 2) Leverage Ratios, 3) Activity Ratios, 4) Profitability Ratios
(1) Liquidity Ratios: These ratios measure the capacity of a firm to meet its short-term liabilities out of the
short term resources
a) Current ratio :- This is the ratio of current assets to current liabilities. It shows the relationship between total
current assets and total current liabilities.
Current Ratio =
Current assets
Current liabilities
Current assets of a business consist of those assets that can be converted into cash in the ordinary course of
business, and within a short period of time. These include cash, bank, marketable securities, stocks, sundry
debtors bills receivables and pre-payments. Similarly current liabilities include trade creditors, bills payable, bank
overdraft, provision for taxation, outstanding liabilities etc.
Current ratio is a test of short-term solvency of the firm. The higher the current ratio, the greater the firms
ability to meet short term debts. Conventionally, a current ratio of 2:1 is considered satisfactory.
b) Liquid ratio or Quick Ratio
It is a measure of the immediate debt paying capacity of a firm. It shows the relationship between Quick
assets and Quick liabilities or current liabilities. Quick assets comprise all current assets with the exception of
inventories and pre-payments. Liquid liabilities are current liabilities minus bank overdraft. This ratio is also
known as Acid Test Ratio. It is computed as follows:
Liquid Ratio =
Liquid assets
Liquid liabilities
or
Liquid assets
Current liabilities
71
2) Leverage Ratios: These are also called capital structure ratios. This ratios analyse long term solvency or
financial position of a firm. Ratios to test long term solvency are as follows:
(a) Debt - Equity Ratio:- This ratio is also known as the external-internal equity ratio as it relates external
equity to internal equity. It shows the proportion of funds provided by the owners as against outsiders. It is
computed as follows.
Debt - equtiy ratio =
Total outside liabilities or long -term debt

shareholders funds
Shareholders equity
A high debt-equity ratio indicates that outsiders have contributed more funds than the owners and hence,
they have a larger claim on the firms assets. A low ratio, on the other hand, signifies that outsiders claim on the
firms assets is less.
b) Proprietary Ratio:
This ratio is also known as the ratio of networth to total assets. This ratio establishes the relationship between
proprietors fund and total assets. Proprietors funds comprise equity and preference share capital as well as
reserves and surplus. Assets comprise both fixed and current assets, excluding fictitious assets. Intangible
assets may be included provided they have realisable value. It is computed as follows:
Proprietary Ratio
Shareholders funds
Total assets
A high proprietary ratio indicates a relatively favourable position to the creditors at the time of liquidation. A
low ratio indicates a higher risk and danger to creditors.
c) Ratio of Fixed Assets to proprietors funds :
It states the relationship between fixed assets and
shareholders funds. It shows what portion of proprietors funds have been invested in fixed assets. A very high
ratio of fixed assets indicates that a considerable part of proprietors funds is locked up in fixed assets. This ratio
is computed as follows :
Fixed assets to proprietors funds =
Fixed assets
shareholders funds
d) Capital Gearing ratio :

This is one of the important ratio used to analyse the capital structure of a company. The capital gearing ratio
is computed as follows.
Capital Gearing ratio = Fixed income bearing funds
Equity shareholders fund
72
Fixed income bearing funds include preference share capital, debenture and long term loans. A company
would be highly geared, if the proportion of preference share capital and debenture is high ie. equity capital is
less and a company is said to be low geared, if the proportion of preference capital and debenture is low ie.
equity capital is high.
e) Coverage ratios :
Financial Coverage ratios calculated in flow terms, are known as coverage ratios which assess
the degree of risk associated with lending. The following are the coverage ratios.
(i) Interest coverage ratio :
This ratio relates the fixed interest charges to the operating profit or the earnings before interest and tax
(EBIT) it is computed as follows:
Interest coverage Ratio =
Earnings Before Interest and Tax (EBIT)

Interest
A high interest coverage ratio indicates that the concern has the ability to pay fixed charges. A very low ratio
indicates inefficient business operations and excessive use of borrowed funds.
(ii) Preference Dividend coverage Ratio
This ratio measures the ability of a concern to pay the fixed dividend on preference shares after payment of
tax.
Preference coverage Ratio = Earnings after taxes
Preference Dividend
3. Activity Ratios
These are also known as turnover ratios. These ratios indicate how effectively the resources are being
utilised by a firm. These ratios reflected the efficiency of a firm in the asset management. They express the
relationship between sales and the different types of assets, showing the speed with which these assets generate
sales. Important activity ratios are enumerated below.
a)
Current assets turnover
Sales
Current assetes
b)
Fixed assets turnover ratio
Sales
Fixed assets
c)
Total assets turnover ratio
Sales
Total assets
d)
Inventory turnover ratio
Sales
Average inventory
e)
Debtors turnover ratio
Sales
Average debtors
73
4. Profitability Ratios
The success of any business depends upon its profitability ie. its ability to earn profits. Profitability is also a
measure of business or operational efficiency. These ratios are calculated by relating the profits either to sales
or to investment or to the equity shares. Important ratios are listed below:
A. Profitability related to sales.
a) Gross profit ratio =
Gross profit
sales
b) Net profit ratio
Net profit (earnings after tax)

Sales
c) Operating profit ratio
EBIT (Earining Before Interest and Tax)

Sales
d) Administrative expenses ratio = Administrative exp.

Sales
e) Selling expenses ratio
Selling expenses
Sales
f) Operating expenses ratio
administrative exp. +selling exp.

Sales
g) Operating ratio
Cost of goods sold + operating exp.

Sales
B. Profitability related to investment

a) Return on assets
Earnings after tax

Total assets
b) Return on capital employed =
EBIT
Total capital employed
c) Return on equity
EAT
Shareholders equity
C. Profitability related to equity shares

a) Earnings per share (EPS)
= Net profit available to equity share holders
Number of equity shares
b) Earnings yield =
EPS
Market price per share
c) Dividend yield =
DPS ( Dividend per share)

74
d)
Dividend payout ratio
DPS
EPS
e)
Price earnings ratio
(P/E ratio)
EPS
D. Overall profitability (Earning power)

Return on Investment (ROI) =
EAT
Sales
sales
Total assets
or
EAT
Total assets
The overall profitability is measured by the return on investments which is the product of net profit ratio and
investment turnover.
Thus Ratio analysis is a method of interpreting the financial statement of a company. A single ratio by itself
is not of much use. A comprehensive evaluation of the financial performance of a company emerges only from
a study of all the important ratios.
Illustration:The summarised Balance Sheet of Goods Value Traders Ltd. for the year ended 31-3-03 is given below:
(Rs. in Lakhs)
Rs.
Equity Share capital
(fully paid up)
Rs.
fixed Assets (at cost)
140
Less: Depreciation
210
25
Reserves and Surplus;
45
185
Profit and Loss Account
20
Current Assets:
.Provision for taxation
10
Stock
25
Sundry Creditors
40
Debtors
30
Cash
15
70
255
255
The following further particulars are also given for the year:
Sales
120
Earnings before interest and tax (EBIT)
30
Net profit after tax (PAT)
20
Calculate the following for the company and explain the significance of each in one or two sentences.
i) Current ratio, (ii) Liquidity ratio, (iii) Profitability ratio, (iv) Profitability on funds employed (v) Debtors Turnover.
75
(vi) Stock turnover (vii) average collection period and (viii) return on equity ( I.C.W.A Inter; June 1998.
Adapted)
(i)
Current Assets
Current Ratio
Current Liabilities
70 = 1 40 : 1
50
Current ratio indicates short-term solvency of a concern, i.e., whether the concern is capable of meeting its
immediate commitments out of its current assets, The standard being 2:1, the concern is not up to the standard.
(Provision for tax is treated as a current liability.)
ii)
Liquidity Ratio
Liquid Assets
Current Liabilities
45 = 09:1
50
The liquid ratio tells us whether the position of a concern is liquid enough to meet its current liabilities, ie ,
whether the current assets can be converted into ready cash for meeting the claims of creditors. The standard
ratio being 1 : 1, the concerns liquidity position also is not up to the standard .
EBIT
iii)
Profitability Ratio (on funds employed =
Capital employed
x 100
30
x 100 = 14.63 %
205
iv)
Profitability Ratio
EBIT
x 100
Sales
30 x 100 = 25%
120
While the profitability ratio on funds employed measures the return on investment, the latter shows the
margin of profit on sales.
v)
Debtors Turnover Ratio =
Sales
Average Debtors
120
= 4 times
30
According to this ratio, debtors are converted to cash four times during the period of operating cycle.
vi)
Stock Turnover Ratio
=
Cost of goods sold
Sales
OR
Average stock
Average stock
120
= 4.8 times
25
This ratio indicates that stock is turned over as sales 4.8 times.
76
vii)
Average collection period
Average Debtors + Average B/R

Credit Sales
30
120
viii)
Return on Equity
x 360 days = 90 days
PAT
Equity
20
x 100 =9.76 %
205
This ratio indicates the percentage of profit earned by the equity shareholders on their funds.
Illustration -6
Using the following data, complete the balance sheet of X Limited as at 31-3-2000
a)
Gross profit 25 % of sales
b)
Gross proft = Rs 1,20,000
c)
Shareholders equity Rs. 20,000
d)
Credit sales to total sales 80%
e)
Total turnover to total assets = 4 times
f)
Cost of sales to inventory = 10 times
g)
Average collection period = 5 days. Assume 365 days in a year.
h)
Long-term debt = ?
i)
Current ratio = 1.5
j)
Sundry creditors = Rs. 60,000
BALANCE SHEET OF X LIMITED as at 31-3-2000

Liabilities
Rs
Assets
Sundry Crditors
Cash
Long-term. Debt
Sundry Debtors
Share Capital
Inventory
Rs.
Fixed Assets
(CA Inter Nov. 2000)
77
Solution:
Gross Profit Ratio
25
25 Sales
Sales
Gross Profit x 100

Sales
1,20,000 x 100
Sales
= Rs. 1,20,00,000
= Rs. 4,80,000
Sales-Gross profit
= Cost of goods sold
4,80,000- 1,20,000
= Rs. 3,60,000
Current Ratio
Current Assets
Current Liabilities
Current Assets
1.5
Current Assets
60,000
60,000x1.5 = Rs. 90,000
Cost of sales to inventory 10 times.

Cost of sales
10
Inventory
10
10 Inventory
3,60,000
Inventory
Rs. 36,000
Average Collection Period
Debtors
x No. days in year
Credit sales
5 days
Debtors
3,60,000
inventory
3,84,000
x 365 days
365 Debtors
19,20,000
Debtors
Rs. 5,260
(Credit sales is 80% of total sales
4,80,000 x 80
100
Total Turnover-to total assets
4 times.
Total turnover
Total assets
4 Total assets
4,80,000
78
= Rs. 3,84,000 )
Total assets
Rs. 1,20,000
Current Assets
Rs. 90,000
Inventory
Rs. 36,000
Debtors
5,260
41,260
Cash
48,740
Total Assets
Rs. 1,20,000
Current Assets
90,000
Fixed Assets
Rs. 30,000
BALANCE SHEET OF X LIMITED as at 31-3-2000

Rs.
Rs.
Creditors
60,000
Cash
48,740
Long-term debt (balancing figure)
40,000
Debtors
Share capital
20,000
Inventory
36,000
Fixed Assets
30,000
5,260
1,20,000
1,20,000
Illustration -7 : From the following information relating to a company, prepare a statement of Proprietors
Funds :
i)
Current ratio
ii)
Liquid ratio
1.5
iii)
Fixed Assets / Proprietary Funds
3/4
iv)
Working capital
v)
Reserves and Surplus
50,000
vi)
Bank overdraft
10,000
Rs. 75,000
There were no long- term loans or fictitious assets
(CA Inter, Revision Test Nov. 1997
Solution:
Current Ratio
Current Assets
Current Liabilities
Current Assets
Current Liabilities
Current Assets
2 Current Liabilities
Working capital
Current Assets - Current Liabilities
75,000
2 Current Liabilities - Current Liabilities
Current Liabilities
Rs. 75,000
79
Since current assets are equal to 2 current liabilities, and current liabilities being Rs. 75,000 current assets
should be 75,000 x 2 = Rs. 1,50,000
Liquid Ratio
Current Assets - Stock

Current Liabilities
1.5
1,50,000-stock
75,000
1,50,000-Stock
1,12,500
Stock
1,50,000-1,12,500=Rs.37,500
Proprietary Funds+Current Liabilities =
Fixed Assets + Current Assets
Fixed Assets are 3/4 of Proprietary Funds. If proprietary funds were x:

x + 75,000
3/4x + 1,50,000
x-3/4x
1,50,000 - 75,000
1/4x
75,000
Rs. 3,00,000 and fixed assets are 3/4 of

Rs 3,00,000=Rs2,25,000
Proprietary funds include share capital and retained earnings. Accordingly, Rs. 3,00,000-Reserves and Surplus
of Rs. 50,000 = Rs. 2,50,000 is share capital.
STATEMENT OF PROPRIETORS FUNDS
Rs.
Rs.
Sources :
Share capital
Reserve and Surplus
2,50,000
50,000
3,00,000
Application:
Fixed Assets
Current Assets:
Stock
Liquid Assets
2,25,000
Rs.
37,500
1,12,500
1,50,000
Current Liabilities:
Bank overdraft
Others
10,000
65,000
75,000
Working capital being excess of current assets

over current liabilites
75,000
3,00,000
80
Illustration 8
From the following details find out - (a) Sales (b) Sundry Debtors (c) closing stock (d) Sundry creditors.
Debtors velocity
3 months
Stock velocity
8 months
Creditors velocity
2 months
Gross profit ratio -
25%
Gross profit for the year ended 31st Dec. 1998 amounts to Rs. 4,00,000. Closing stock of the year is
Rs. 10,000 above the operating stock. Bill receivable amounts to Rs. 25,000 and Bills payable to Rs. 10,000
Solution
1) Sales :-
G/P ratio
25%
G/P
4,00,000
... Sales
4,00,000 x 100 = Rs. 16,00,000

25
Debtors velocity
3 months
Debtors velocity
Drs + B/R
x l2
Credit Sales
3 months
Drs + B/R
16,00,000
Sundry Debtors
3)
x 12
Drs x 12
16,00,000 x 3
(Drs + B/R)
1,60,000 x 3
12
Rs. 4,00,000
Drs
4,00,000 - 25,000
Rs. 3, 75,000
Stock Velocity
8 months
Stock velocity
Average Stock x 12
Cost of sales
Average stock x 12
Cost of sales x 8
Cost of sales
Rs. 12,00,000
Rs. 8,00,000
Closing stocks
16,00,000-4,00,000
... Average stock x12
12,000,00 x8
Average stock
12,00,000 x 8
12
Total of opening stock + closing stock =

=
8,00,000 x 2
Rs. 16,00,000
81
As closing stock is more by 10,000

Opening stock
... Closing stock

d)
16,00,000 - 10,000
2
Rs. 7,95,000
7,95,000 + 10,000
Total Crs + B/P
Rs.8,05,000
Sundry creditors
Creditors Velocity
x12 =
2 months
Credit purchases
Purchases
Closing stock + cost of goods sold - opening stock
8,05,000 +12,00,000 - 7,95,000
Purchases
Rs. 12,10,000
Creditors Velocity
Crs + B/P
x 12
12,10,000
(Crs + B/P) +2
12,10,000 x 2
12
Crs + BP
2,01,667
Crs.
2,01,666 -B/P
2,01,667-10,000
Rs. 1,91,667
Crs.
Illustration 9
From the following information, prepare a Balance sheet. Show the workings.
1. Working Capital
2.
3.
4.
5.
6.
7.
Reserves & Surplus

Bank overdraft
Current Ratio
Liquid ratio
Fixed Assets to proprietors funds
Current Ratio
Working Capital
Working Capital
W.C
.75
Rs. 75,000
1,00,000
60,000
1.75
1.15
0.75
Nil
1.75:1
C.A - C.L
1.75 - 1
.75
75,000
=
=
=
=
=
=
=
82
... Current Assets (1.75)
75,000 x 1.75
.75
Rs. 1,75,000
Current Liabilities (1)
Rs. 1,00,000
Liquid Ratio
75,000 x 1
.75
Liquid Assets
Current Liabilities
or
L.A
L.L
liquid liability
=
=
1,00,000-Bank overdraft
1,00,000 - 60,000
=
1.15:1
=
=
40,000
40,000 x 1.15
...
...
Liquid Ratio
Liquid Liabilities (1)
Liquid Assets
Stock in trade
Fixed assets to proprietors funds
Share capital
Rs. 46,000
1
Current Assets - Liquid Assets
1,75,000 - 46,000
=
Rs. 1,29,000
=
=
F.A
=
.75
P.F
This means that .25 or 25 % Proprietors fund is invested in working capital
... .25
=
75,000
.. . Fixed Assets (.75)
=
75,000 x75
=
.25
Proprietors fund
40,000
Rs. 2,25,000
75,000 x 100 or Fixed assets + working capital

.25
=
=
=
2,25,000 + 75,000
Rs. 3,00,000
Proprietors fund - Reserves & Surplus
=
=
3,00,000 - 1,00,000
Rs. 2,00,000
83
Balance Sheet
Liabilities
Rs.
Assets
Share capital
2,00,000
Fixed Assets
Reserve & Surplus
1,00,000
Current Assets
Current Liabilities
Rs.
2,25,000
Stock
Sundry Creditors
40,000
Bank overdraft
60,000
1,29,000
Liquid Assets
46,000
4,00,000
4,00,000
Illustration 10
With the following ratios and further information given below, prepare a trading Account, Profit and loss
account and a Balance sheet.
1.
Gross profit ratio
25 %
6. Fixed Assets / Capital
2.
Net Profti Sales
20%
7. Fixed Assets/Total
3.
Stock Turnover
10
4.
Net profit / Capital
/5
8. Fixed Assets
= 5
7
= 10,00,000
5.
Capital to total liabilities
9. Closing stock
= 1,00,000
Fixed Assets / Capital
Fixed Assets
10,00,000
5
4
10,00,000
Capital
5
4
10,00,000 x 4
5 x Capital
Capital
10,00,000 x 4
5
Capital
Rs. 8,00,000
Current Assets
Solution
1.
Fixed Assets
Capital
/4
84
= 5
4
2.
Capital to Total Liabilities

Capital
8,00,000 x2
Rs. 16,00,000
1
5
Total Liabilities
8,00,000
Total Liabilities
Total Liabilities x 1
3.
Net Profit to capital

N/P
Capital
4.
5.
= 1/5 ie
N/P
8,00,000
/5
ie N/P x 5
8,00,000
NP
8,00,000 = 1,60,000
5
Net profit is 20 % on sales

20%
1,60,000
Sales (100%)
1,60,000 x 100
20
Rs. 8,00,000
8,00,000
Stock Turnover ratio

S.T ration
=
=
10
Cost of sales
= 10
Average stock
Cost of sales
=
=
=
Sales - G/P
8,00,000 - 2,00,000
Rs. 6,00,000
=
=
=
10
6,00,000
6,00,000
10
=
=
=
=
=
6,00,000
60,000 x 2
1,20,000
1,00,000
20,000
G/P is 25 % on sales
G/P
6.
6,00,000
A Stock
A.S. x 10
A.S
Average stock
So Total Stock (opening + Closing)
Closing stock
Opening Stock
85
x 25
100
Rs. 2,00,000
Rs 60,000
F.A
C.A
/7
ie. F.A x 7
C.A x 5
1,00,000 x 7
C.A. x 5
C.A
=
=
=
Current Assets
Less stock
Other Current Assets
=
=
=
=
C.A x 5
1,00,000 x 7
1,00,000 x 7
5
Rs. 14,00,000
14,00,000
1,00,000
13,00,000
Fixed Assets to total current Assets

=
5
7
Trading and profit and Loss Account

To Opening Stock
,, Purchases
(Bal. fig.)
,,
G/P
,, Expenses
,, N/P
20,000
6,80,000
By sales
,, closing stock
2,00,000
9,00,000
40,000
1,60,000
2,00,000
8,00,000
1,00,000
9,00,000
By G/P
2,00,000
2,00,000
Balance sheet
Capital
Opening 6,40,000
Add N/P 1,60,000
Liabilities
8,00,000
16,00,000
Fixed Assets
Closing Stock
Other Current Assets
24,00,000
Illustration 11
From the following figures and ratios, draw out Balance sheet and Trading and P&L a/c
Share capital
Rs.
1,80,000
Working capital
63,000
Bank overdraft
10,000
86
10,00,000
1,00,000
13,00,000
24,00,000
There is no fixed assets. In current assets there is no asset other than stock, debtors and cash. Closing stock
is 20 % higher than the opening stock.
Current ratio
=
2.5
Net Profit ratio
=
10%
Proprietary ratio
=
0.7
(to average capital employed)
Stock velocity
=
4
Quick ratio
=
1.5
G/P Ratio
=
20% to sales
Debtors velocity
=
36.5 year
Solution
Current ratio
2.5-1
1.5
Current Assets (2.5)
=
2.5:1
= 63,000
= 63,000
Quick ratio
Current liabilities (1)
Bank overdraft
63,000 x 2.5
1.5
= Rs. 1,05,000
=
=
=
= 63,000 x 1
1.5
= Rs. 42,000
Closing stock
= C.A - L.A
= 1,05,000 - 48,000
= Rs. 57,000
Closing stock is 20% higher than opening stock
So opening stock
= 57,000 x 100
120
= Rs. 47,500
Average stock
= 57,000 + 47,500
2
= Rs. 52,250
Stock velocity
= Cost of Sales
=
Average stock
Quick liabilities (1) =

Quick assets (1.5) =
Current liabilities
Cost of sales
G/P on sales
(ie. 1/4 on cost)
Cost of sales
G/P (1/4)
Sales
1.5:1
42,000
10,000
=
=
=
=
Average stock x 4
52.250 x 4
Rs. 2,09,000
20%
= Rs. 2,09,000
52,250
= Rs. 2,61,250
87
= Rs. 48,000
32,000
32,000 x 1.5
1
Debtors velocity
= 36.5 year
Drs
=
x 365
Cr. sales
= 36.5
Drs
x 365
= 36.5
2,61, 250
Drs
= 2,61,250 x 36.5
365
Drs
= Rs. 26,125
Proprietary Ratio
=
0.7
It means 70 % of proprietary fund represents Fixed Assets and 30 % is invested in working capital
30% = 63,000
F.A (70%)
= 63,000 x 70
=
Rs. 1,47,000
30
Working capital 30 %
So proprietary fund
= 63,000
=
1,47,000 +
63,000
Rs. 2,10,000
Net profit
Let net profit be x
x
x
x
= 10% of (opening Capital + Closing Capital)

2
= 10% of (Closing capital -x + closing Capital)
2
= 1 (2,10,000 - x + 2,10,000)
20
20x
20 x
20x + x
21 x
x
=
=
=
=
=
1 (4,20,000 - x)
20
1 (4,20,000 - x)
4,20,000 - x
4,20,000
4,20,000
4,20,000
21
=
88
Rs. 20,000
Trading and Profit and loss A/c

To Opening stock
,, Purchases (Bal. fig)
47,500
2,18,500
G/P. c/d
,, G/P c/d
,, Expenses (Bal. fig)
,, N/P
52,250
3,18,250
32,250
20,000
By sales
,, Closing stock
2,61,250
57,000
By Gross Profit b/d
3,18,250
52,250
52,250
52,250
Balance Sheet
Share Capital
Reserve & Surplus
P & L a/c
Bank overdraft
Creditors
1,80,000
10,000
20,000
10,000
32,000
fixed Assets
Current assets---Closing stock
Debtors
Cash (Bal. fig)
2,52,000
1,47,000
57,000
26,125
21,875
2,52,000
Illustration 12
From the following information, make out a statement of proprietors funds with as many details as possible.
Current ratio=2.5; liquid ratio = 1.5 propietary ratio (fixed assets / proprietary fund = 0.75 Working capital
Rs. 1,20,000; Reserves and surplus Rs. 80,000 and Bank overdraft Rs. 20,000.
Solution
Working Capital
1.5
Current Assets (2.5)
=
=
=
=
Current liabilities
Bank overdraft
Creditors & Others
Proprietary fund
2.5 - 1 = 1.5
1,20,000
1,20,000 x 2.5
1.5
Rs. 2,00,000
1,20,000 x 1
1.5
Rs. 80,000
=
=
=
20,000
60,000
75 % in Fixed Assets
89
So 25 % is working capital
25%
=
...Proprietary fund
=
Capital
Capital
Fixed Assets 75%
Liquid ratio
Liquid Assets
Liquid liabilities
Liquid Assets
60,000
=
=
=
=
=
Rs. 4,80,000
Proprietors fund - reserves
4,80,000 - 80,000
4,00,000
4,00,000 x 75
= Rs. 3,60,000
100
1.5
1.5
1
Liquid Assets
=
=
=
Stock
Rs. 1,20,000
Rs. 1,20,000 x 100
25
1.5
1
60,000 x 1.5
Rs. 90,000
2,00,000 - 90,000
(C.A - L.A)
= 1,10,000
Statement of Proprietors funds

Capital employed :Equity Capital
4,00,000
Reserves & Surplus
80,000
4,80,000
Employment of Capital :Fixed Assets
3,60,000
Current Assets ------Stock
1,10,000
Liquid Assets
90,000
2,00,000
Less current liabilities :Bank overdraft

Creditors
20,000
60,000
80,000
1,20,000
4,80,000
90
Illustration 13
From the following details, draw up a Balance sheet in summary form.
Stock velocity
6;
Capital Turnover ratio
Fixed Assets Turnover
4;
G/P ratio
20%
Debt collection period
2 months;
creditors payment period 73 days`
The gross profit was Rs. 60,000. Closing stock was Rs. 5000 in excess of the opening stock.
Solution
1.
Gross profit ratio
20%
... Sales
G/P
Sales
60,000 x 100
Sales
60,00,000
20
Rs. 3,00,000
=
2.
Stock velocity
Average stock
=
=
Opening stock
... Closing stock

3. Capital Turnover
2
Capital x 2
Capital
x 100
Cost of goods sold

Average stock
3,00,000 - 60,000
Average stock
2,40,000
6
Rs. 40,000
=6
Total stock - 5000 = 40,000 x 2 - 5000

2
2
Rs. 37,500
Rs. 42,500
Sales
Capital
3,00,000
Capital
3,00,000
3,00,000
2
=
=
(37,500 + 5000)
=2
= Rs. 1,50,000
91
4.

ratio
4
F.A
5.
Debtors
=
=
=
3,00,000
F.A
Rs. 75,000
Debtors
Net sales
Drs
3,00,000
x 12 =2
x 12
Rs. 50,000
Opening stock + Purchases - Closing Stock

Purchases
7.
=
=
6.
Sales
=4
Fixed Assets
Credit payment period
Creditors
= Cost of goods sold
2,40,000 - 37,500 + 42,500
Rs. 2,45,000
Crs
x 365 = 73
Purchases
73 = Creditors x 365
2,45,000
Rs. 49,000
Balance Sheet
Rs.
Capital
Sundry creditors
Rs.
1,50,000
49,000
1,99,000
92
Fixed Assets
75,000
Stock
42,500
Sundry debtors
50,000
Cash (Bal. fig)
31,500
1,99,00
Illustration 14
From the following information, prepare a Balance sheet.
1. Current ratio
= 1.75
6. Reserves & Surplus to capital = 0.2
2. Liquid ratio
= 1.25
7. Turnover to fixed assets
= 1.2
= 9
8. Capital gearing ratio
= 0.6
4. Gross profit ratio
= 25%
9. Fixed Assets to net worth
= 1.25
5. Debt collection period
= 11/2 months 10.Sales for the year
3. Stock Turnover ratio

(Cost sales/closing stock)
Solution
1. Cost of sales
= Sales - Gross profit

= 12,00,000 - (12,00,000 x 25 )
100
= 12,00,000 - 3,00,000
= Rs. 9,00,000
2. Stock turnover ratio
Cost of sales
Average stock
9,00,000
stock
Rs. 1,00,000
11/2 months
= Drs x 12
12,00,000
1 1/ 2
Drs
= 12,00,000 x 3
2
Drs x 12
Drs
= 18,00,000
12
Rs. 1,50,000
Stock
9,00,000
9
3. Debtors
Current Assets
Current Assets
Drs x 12
Net sales
Current ratio
Stock ratio
x stock
= 1.75 x 1,00,000 = Rs. 3,50,000

0.5
93
= Rs. 12,00,000
(Stock Ratio
= Current ratio - Liquid ratio)

= 1.75 - 1.25
Calculation of liquid assets
0.50
= Current Assets - stock

= Rs. 3,50,000 - Rs. 1,00,000
Rs. 2,50,000
Calculation of cash
cash
= Liquid Assets - debtors

= Rs. 2,50,000 - Rs. 1,50,000
= Rs. 1,00,000
Fixed Assets
Fixed Assets
Cost of sales
= 9,00,000
1.2
= Rs. 7,50,000
Current Liabilities
Current ratio
Current Assets
Current Liabilities
Current Assets
Current ratio
or
Current Liabilities
= 3,50,000
1.75
= Rs. 2,00,000
Share capital
Share capital
= Net worth - Reserve & Surplus

= 6,00,000 - 1,00,000
= Rs. 5,00,000

= Share capital x Gearing ratio

= 5,00,000 x 0.6
= Rs. 3,00,000
Notes
Calculation of Net worth
Net worth
Fixed Assets
Fixed assets to Networth
94
= 7,50,000
1.25
= Rs. 6,00,000
Calculate of Reserves & Surplus
Reserves
= Networth + Ratio of Reserves and surplus to capital

Total Ratio
= 6,00,000 x 0.2
1.2
= Rs. 1,00,000
Calculation of Total ratio

Share holders worth
= Capital + Reserves
Let capital be 1, then share holders worth 1.2 ie (1 + 0.2) Thus total ratio = 1.2
Balance sheet
Liabilities
Rs.
Assets
Rs.
Share capital
5,00,000
Fixed Assets
7,50,000
Reserves & Surplus
1,00,000
Stock
1,00,000
Long term Liabilities
3,00,000
Debtors
1,50,000
Current liabilities
2,00,000
Cash
1,00,000
11,00,000
11,00,000
95
5. Fund Flow analysis

Fund flow analysis has become an important tool available to financial analysts for their work. The Balance
Sheet of a business reveals its financial status at a particular point of time. Both the B/S and Income Statement
do not explain the changes in the firms financial position during a particular period of time. They do not indicate
the causes of changes or the movement of funds between two periods.
Fund flow analysis reveals the changes in working capital position. It tells about the source from which the
working capital was obtained. Thus it explains how working capital is raised and used during an accounting
period.
Under funds flow analysis, we prepare two statements- (i) Statement of changes in the working capital (ii)
Fund flow statement
Statement of changes in working capital is prepared with the help of current assets and current liabilities.
This statement shows changes in current assets and current liabilities. The purpose of this statement is to find
out the net changes in working capital.
Fund flow statement shows the sources and application of funds. It is prepared with the help of non current
assets and non current liabilities. It is a statement showing the changes in financial position between two balance
sheet dates. It shows the sources from which funds have been derived and the uses to which the funds were put.
6) Cash flow analysis

Income Statement and B/S are normally based on the accrual method of accounting instead of actual cash
receipt basis. They do no reveal the actual cash flow position of a firm. In order to determine the actual cash
flow position the income statement and B/S should be translated into a statement called cash flow statement. It
is an important tool of cash planning and control. A cash flow statement is a statement depicting change in cash
position from one period to another. The cash flow statement summarises the reasons for increase or decrease
in the amount of cash between two balance sheet dates.
Assignments
1.
What do you understand by analysis and Interpretation of Financial Statements ?
2.
What are the different types of financial analysis ?
3.
Give an analytical note on common-size statements and state the procedure of computing them.
4.
What is trend analysis ?
5.
Write short notes on common - size statement.
6.
Explain the significance of accounting ratios in financial statement analysis.
96
1.
The balance sheet of X Ltd. for the year 2000 and 2001 are given below :
BALANCE SHEET
Liabilities
31-12-2000
31-12-2001
6,00,000
12,00,000
5,00,000
9,00,000
Assets
31-12-2000
31-12-2001
15,00,000
28,00,000
5,00,000
8,00,000
10,00,000
20,00,000
Fixed Assets:
10% Preference
share capital
Gross block
Less depreciation
Reserve Fund
4,00,000
5,00,000
Net block
Profit & Loss account
2,00,000
3,00,000
Investments
4,00,000
5,00,000
Long term Loans
2,00,000
5,00,000
Inventories
4,50,000
6,50,000
Creditors
1,00,000
3,00,000
Debtors
1,00,000
4,00,000
50,000
1,50,000
Cash
_________
_________
_________
_________
20,00,000
37,00,000
20,00,000
37,00,000
Your are required to comment on the financial position of the business with the help of comparative Balance
Sheet technique.
2. Following are the ratios relating to the trading activities of National traders Ltd:
Debtors s Velocity
3 months
Stock Velocity
8 months
Creditors Velocity
2 months
Gross Profit Ratio
25%
Gross profit for the year ended 31st December, 2001 amounts to Rs. 4,00,000. Closing stock for the year is
Rs. 10,000 above the opening stock. Bills Receivable amounts to Rs. 25,000 and Bills Payable amounts to
Rs. 10,000. Find out:
i) Sales, ii) Sundry Debtors, iii) Closing Stock, and iv) Sundry Creditors.
(C.A. Inter, May 2000)
Books Recommended for further reference

S.P IYENGAR
Advanced Accounting, Volume -II
Dr. B.S. RAMAN
Advanced Accountancy
Dr. S.N. MAHESWARI
Management Accounting and Financial Control
S.P. JAIN &
Advanced Accountancy
Dr. M.A. ARULANANDAM &
K.L. NARANG
97
UNIT - 5
DOUBLE ACCOUNT SYSTEM
OBJECTIVES
To understand the meaning and features of Double Account System.

To understand the distinctions between Double Account System and Double Entry System.
To learn the technique of preparing Revenue A/c, Net Revenue A/c, Capital A/c and General
Balance Sheet
To learn the determination of reasonable return, clear profit, surplus and Disposal.
To learn the preparation of final accounts of electricity companies.
STRUCTURE
5. 01
Meaning of Double Account System.
5. 02
Features of double account system.

Double entry system and double account system.
Advantages of Double Account System.
Disadvantages of double account system.
Accounts of Electricity companies.
Replacement of asset.
Assignments.
5. 03
5. 04
5. 05
5. 06
5. 07
5.08
98
DOUBLE ACCOUNT SYSTEM

5. 01
Meaning:
The Double Account System is a system of presenting annual financial statements originally adopted in
England by Public Utility Organisations such as Railways, Electricity, Water and gas undertaking etc. These
public utilities enjoy monopolistic rights in their business of rendering service to community. These undertakings
are formed under Special Acts of Parliament and function subject to the restrictions imposed on them by the
relevant Acts and are required to prepare and present their annual accounts in the forms prescribed.
Public utility concerns are required to invest huge amount in fixed assets. A large part of the capital is
raised from the public and hence the undertaking has a moral responsibility to give full information to the public
as to the sources from which the fixed capital was raised and how the amount was utilised in the acquisition of
fixed assets. This is done by splitting the balance sheet into two parts, viz, Receipts and Expenditure on Capital
Account (Capital account ) and General Balance sheet. It is on account of this doubling of Balance Sheet, the
system has come to be called Double Account System.
5. 02
Features:
The main features of double account system are as follows:

1.
The concerns which adopt this system of presenting their final accounts require a large amount of fixed
capital.
2.
This is a special form of final accounts in greater detail accompanied by a number of statistical statements.
3.
Another special feature of this system is that the Balance sheet is prepared and presented in two parts, i.e.,
Capital Account and General Balance Sheet. The Capital Account shows Capital receipts on the credit side
and capital expenditure on the debit side.
4.
Since public utility concerns are not expected to aim at profit, they do not prepare Profit and Loss Account.
Instead, they prepare a Revenue Account which takes the place of a profit and loss account. Similarly, the
Profit and Loss Appropriation Account is replaced by net Revenue A/C.
5.
Depreciation is not shown as a deduction from fixed assets. Thus fixed assets are shown at original cost
plus additions during the year and depreciation is provided by creating reserves or fund which is shown on
the liability side of the General Balance sheet.
6.
Loans and debentures are treated as capital and shown in the capital account.
7.
Interest on debentures and loans are shown in the Net Revenue Account as an appropriation of profit.
8.
Discount and premium on issue of shares and debentures are permanently retained as capital items.
5. 03 Double Entry System and Double Account System.

The method of recording transactions systematically in the formal books of account, by recognising the
double aspect of each transaction, is known as the double entry system. Double account system is merely a
method of presentation of annual accounts. But this does not mean that double account system is fundamentally
different from double entry system. In fact, even under double account system, transactions are recorded on the
99
basis of double entry and the trial balance is extracted to test whether the total debits of accounts in the ledger
are equal to the total credits. Up to the preparation of Trial balance there is no difference between the double
entry and double account systems. The difference arises only in the preparation of the Revenue Accounts and
Balance Sheet.
5. 04 Advantages of double account system.
The main advantages of double account system are as follows:
1. Public utility concerns which adopt the double account system enjoy monopolistic rights granted by the
State. The prescribed form of presentation of accounts enables the state to ensure that the concern
renders the most efficient service at reasonable cost.
2. Depreciation fund is compulsorily created and invested in securities. This helps in the replacement of
assets without affecting cash resources of the undertaking.
3. Double account system presents clear cut statement as to Capital raised and its utilisation in the
acquisition of permanent assets.
4. Capital account helps in comparing receipts and expenditure of fixed nature which is not possible in
the case of ordinary Balance sheet. The balance of capital account is useful for making future plans
of capital nature.
5. Revenue Account is concerned purely with the operating activities of the undertaking. All items
which are extraneous to the actual working of the concern are taken to the Net Revenue Account.
5. 05 Disadvantages of Double Account System.
The main disadvantages or criticisms against Double Account System are as follows:
1. All assets are shown in the capital account at cost and hence the balance sheet does not reveal the true
position.
2. When an asset is replaced, it is not always possible to calculate the amount to be charged to revenue.
3. Capital Account includes assets having very short life. Such assets appear in the account even after
they are reduced to scrap value.
4. The Revenue Account is not able to disclose a fair and true view of the trading results since it does not
include interest paid or received. As renewals are usually charged to revenue, profits of any year are
not always correctly stated.
5. It is difficult to make a proper distinction between capital and revenue.
6. The general public cannot easily understand the accounts and the accompanying statements.
5. 06
Accounts for Electricity Companies.
Legal provisions relating to Electricity companies.

The electricity supply being a public utility service, the business is controlled by the Government. Electricity
undertakings are governed by the Indian Electricity Act, 1910 and the Electricity (Supply ) Act, 1948. These
concerns prepare and present their annual accounts in accordance with the form laid down by Schedule VI of
100
the Companies Act. However, Rule 26 of the Indian Electricity Rules, 1956 makes the following provisions in
accordance with Sec. 11 of the Indian Electricity Act, 1910 for final accounts of Electricity (Supply) Companies.
(1) Every electricity company shall prepare its accounts to 31st March and shall render them to the State
Government within six months from such date.
(2) The accounts shall be made in the prescribed forms as set in Annexure V to the Indian Electricity
Rules, 1956.
Besides, the provisions regulating annual accounts, the following provisions should also be noted:
Depreciation.
Under the Amended Electricity (Supply) Act, 1978, which came into force from 1st April 1979, depreciation
can be charged only on the straight line method. The central Government has been empowered to prescribe, by
notification, the life of various assets. Further, no depreciation can be written off when an asset has been written
down to 10% of its original cost. Again, no depreciation is to be written off when asset goes out of use due to
obsolescene, inadequacy, superfluity or any other reason. Any debit balance remaining on such an asset account
is to be charged to Contingencies Reserve. In case of profit or loss on the discarded asset, the same should also
be charged to this account.
Reasonable Return.
The law seeks to prevent an electricity undertaking from earning exorbitant profit. For this purpose, the concept
of reasonable return has been introduced. The reasonable return comprises:
(a) an yield at the standard rate, which is the Reserve Bank Rate plus 2% on the Capital base;
(b) income from investment except investments made against Contingencies Reserve;
(c) an amount equal to 1/2% on loans advanced by the Electricity Board
(d) an amount equal to 1/2 % on the balance of Development Reserve and
(e) an amount equal to 1/2 % on Debentures.
Capital base means:
(a) the original cost of fixed assets available for use and necessary for the purpose of the undertaking less,
contribution, if any, made by consumers for construction of service lines;
(b) the cost of intangible assets;
(c) the original cost of work-in-progress;
(d) the amount of investments compulsorily made against Contingencies Reserve; and
(e) monthly average of current assets.
From the total of above items, deduct
(i) the amounts written off or set aside on account of depreciation of fixed assets and amounts written
off in respect of intangible assets;
(ii) loans advanced by the State Electricity Board;
(iii) debentures issued;
(iv) security deposits of consumers;
(v) amount to the credit of Tariff and Dividends Control Reserve,
(vi) amount set apart for Development Reserve; and
101
(vii) amount carried forward in the accounts of the license for distribution to consumers.
The resulting figure is the Capital base.
Clear Profits.
Clear Profits means the difference between the total income and the total expenditure plus specific
appropriations such as Development Reserve, Contingency Reserve, Reserve and appropriations permitted by
the concerned state governments etc. The calculation of Clear profits will be done in the following manner:
Statement of Clear Profit

Expenditure
Rs.
Income
Rs.
1. Cost of generation and purchase of energy
....
2. Cost of distribution and sale of energy
....
3. Rent rates and taxes.
....
2. Rental of meters, etc. lamps.
....
4. Interest on loans.
....
3. Sales and repair of lamps
....
5. Interest on Security deposits.
....
4. Rent.
....
6. Bad debts.
....
5. Transfer fees.
....
7. Audit fees.
....
6. Interest from investments fixed and
....
8. Management expenses.
....
9. Depreciation.
....
1. Receipts from sale of energy .

Less discount
all deposits and bank balances

7. Other taxable receipts.
....
.....
....
10. Other admissible expenses for

tax purposes
....
11. Contributions to P.F., Gratuity etc.
....
12. Bonus to employees.
....
Special appropriations:
....
1. Past losses.
....
2. Income Tax.
....
3. Amounts written off from intangibles
.....
4. Transfer to contingencies reserve
....
5. Arrears of depreciation.
....
6. Transfer to development reserve.
....
......
Balance b/d
....
7. Other special appropriations permitted

by the State Government
....
Balance being Clear Profit
....
.....
.......
102
Disposal of Surplus.
Surplus is the excess of Clear profit over reasonable return. If the clear profits exceed the reasonable
return, the surplus has to be disposed in the following manner:
(1) One-third of the surplus, not exceeding 5% of the reasonable return, will be at the disposal of the
undertaking;
(2) of the balance of excess, one-half will be transferred to Tariff and Dividends Control Reserve; and
(3) the balance will be distributed among consumers by way of reduction of rates or by way of specific
rebate.
Illustration. I
The following are the balances extracted from the books of Tata Electric Company Limited for the
year 31st December, 2002.
31-12-2001.
Rs.
50,000
Capital (3,000 shares of Rs.100 each, Rs.80. paid up-)
30,000
Land
20,000
Building
11,000
Plant and machinery
6,000
Dr.
Cr.
Rs.
Rs.
2,40,000.
1,00,000
60,000
1,11,000
Transformers
16,000
Debentures
1,50,000
Reserve Fund
17,000
Depreciation Fund
10,000
Premium on shares
7,000
Mains
80,000
Furniture
20,000
Coal and Fuel
19,000
Stores on Land
7,000
Wages
63,000
5,000
Directors fees
6,000
Law charges
2,000
Sales of current
87,800
Rent of meters
50,000
Sundry creditors
22,000
Net Revenue Account
16,000
Sundry debtors
40,000
103
Cash at Bank
47,000
Dividend paid for 2001
5,000
Transfer fees
200
Interest on Debentures
19,000
6,00,000
6,00,000
Other informations:
Depreciation to be provided on opening balances on Building 10%, plant and machinery 5%, Transformers
8%, and Furniture 1%.
you are required to prepare:
a) Revenue Account, b) Net Revenue Account, c) Capital Account, and d) Balance sheet.
Solution:
Tata Electric Company Limited
REVENUE ACCOUNT for the year ended 31st DEC. 2002
Dr.
Rs.
Cr.
Rs.
To Coal and Fuel
19,000
By sales of current
87,800
To wages
63,000
By rent of meters
50,000
To Directors fee
6,000
By Transfer fees
200
To Law charges
2,000
ToDepreciation
Building @10%
6,000
Plant and Machinery @5%
5,550
Transformers @ 8%
1,280
Furniture @ 1%
200
To Balance carried to
Net Revenue Account
34,970
1,38,000
Dr.
1,38,000
Cr.
NET REVENUE ACCOUNT for the year ending 31st December, 2002
Rs.
To Interest on Debentures
To Dividend paid
To Balance carried to Balance sheet
Rs.
19,000
By Balance b/d
16,000
5,000
By Revenue A/c
34,970
26,970
50,970
50,970
104
Dr.
Cr.
TATA ELECTRIC COMPANY LIMITED

RECEIPTS AND EXPENDITURE ON CAPITAL ACCOUNT for the year ended 31st December,2002
Expenditure
Expenditure Expenditure
Upto 31st during the
Dec.2001
year
Rs.
Rs.
Total
Rs.
105
To Land
30,000
70,000
1,00,000
Building
Plant and Machinery
20,000
40,000
60,000
11,000
1,00,000
1,11,000
6,000
10,000
16,000
80,000
80,000
20,000
20,000
5,000
5,000
1,72,000
2,20,000
3,92,000
Transformers
Mains
Furniture
Balance on Capital A/c
Receipts
By Capital
Debentures
Premium on shares
Receipts
Upto 31st
Dec.2001
Rs.
50,000
1,50,000
Receipts
during the
year
Rs.
Total
Rs
1,90,000 2,40,000
-
1,50,000
7,000
7,000
2,07,000
1,90,000
3,97,000
5000
1,72,000
2,20,000
3,97,000
GENERAL BALANCE SHEET

as on 31st DECEMBER 2002
Rs.
Receipts on Capital A/c
Rs.
3,97,000
Expenditure on Capital A/c
3,92,000
Reserve Fund
17,000
Stores in hand
7,000
Depreciation Fund
23,030
Sundry Debtors
40,000
Sundry creditors
22,000
Cash at Bank
47,000
Net Revenue A/c
26,970
4,86,000
4,86,000
Illustration - 2.
The following balances have been extracted from the books of Kanpur Electricity Company at the end
of 2001.
Rs.
Share Capital
10,00,000
Reserve fund ( invested in 41/2 %Government Securities at par )
5,00,000
Contingencies Reserve ( Invested in 5% state loan )
1,00,000
Loan from State Electricity Board
6,00,000
8% Debentures
2,00,000
Development reserve
1,00,000
Fixed assets
20,00,000
Depreciation Reserve on fixed assets
5,00,000
Consumers deposits
5,50,000
Amounts contributed by consumer for fixed assets
10,000
Intangible assets
50,000
Tariffs and dividends control reserve
50,000
Current assets ( Monthly average )
2,00,000
The Company earns a profit of Rs.70,000 (after tax ) in 2001. Show how the profit is to be dealt
with by the company, assuming the Reserve Bank Rate is 9 %.
Solution.
Kanpur Electricity Company Limited

STATEMENT SHOWING DISPOSAL OF PROFIT for the year ended 31-03-2001
CAPITAL BASE:
Fixed assets
20,00,000
Less: Depreciation reserve
5,00,000
15,00,000
106
Add:
Intangible assets
50,000
Current assets
2,00,000
Contingent reserve
1,00,000
Total
18,50,000
Less:
Loan from State Electricity Board
6,00,000
Debentures
2,00,000
Development Reserve
1,00,000
Consumers Deposits
5,50,000
Amounts contributed by consumers for

fixed assets
10,000
50,000
Tariff and dividend Control reserve
15,10,000
Capital Base
3,40,000
Reasonable Return:
a)
Yield at Standard rate

(9% Bank rate plus 2%) 11% on 3,40,000
b)
41/2% on Reserve fund investment

( 5,00,000 X 4.5% )
c)
22,500
1/2% on loan from Electricity Board

( 6,00,000 X 0.5% )
d)
3,000
1/2% on Development Reserve

(1,00,000 X .5% )
e)
37,400
500
1/2% on debentures
( 2,00,000 X 0.5% )
1,000
Reasonable return
Surplus earned
64,400
Clear Profit - reasonable return.
75,000 - 64,400
10,600
Disposal of Surplus:
a)
To be retained by the Company
Reasonable return + 1/3 of the surplus not

exceeding 5% of reasonable return
64,400 + 5% of 64,400
Rs.67,620.
107
b)
To be transferred to Tariffs
and Dividends Control Reserve
c)
One half of the balance
1/2 of (10,600 - 3,220 )
Rs. 3,690
The balance ie. Rs. 3690
To be distributed among
consumers by way of reduction
of rates or otherwise
5. 07 Replacement of an Asset.
The distinction between capital and revenue expenditure is important in the Double Account System,
when entries are made for replacement of an asset. In the Single Account System, the amount standing in the
book against an asset is written off when the asset is replaced by another and the cost of new asset is capitalised. But the treatment is different under Double Account System. In this system, the original cost of the old
asset to be replaced is not touched at all and continues to appear in the books even after its replacement. The
estimated cost of the replacement of old asset ( in the original form ) is calculated. Out of the estimated cost, the
sale proceeds of old materials or the value of materials re-used in reconstruction is deducted. The amount left
is charged to the Revenue Account. The difference between the total cost of the work and the estimated
replacement cost ( without reducing it by the amount of materials used or sold ) of the old asset is capitalised.
The accounting entry will be:
a)
For the amount spent on new works:

New works A/c Dr.
(With the amount to be capitalised)
Replacement A/c Dr.
( With the estimated cost of replacement )
To Bank A/c
b)
For the sale of Old materials

Bank A/c..
Dr
To replacement A/c
c)
For the value of old materials re-used in the construction.

New works A/c ...
Dr.
To Replacement A/c.
d)
The balance in the Replacement Account represents a charge to revenue.

Revenue A/c...
Dr.
To Replacement A/c
108
5. 08 Assignments.
1.
Discuss the special features of double account system.
2.
Distinguish between double entry system and double account system.
3.
What are the advantages of double account system ?
4.
Discuss the limitations of double account system.
5.
How is reasonable return computed under the Electricity (Supply ) Act, 1948 ?
Problem - 1
From the following Trial Balance of Moon Light Company and other information, prepare:
(1) Revenue a/c (ii) Net Revenue a/c (iii) Capital A/c and (iv) General Balance sheet.
TRIAL BALANCE as on 31st December, 2002.
Dr.
Cr.
Rs.
Rs.
Share Capital
1,20,000
Debentures
75,000
Depreciation fund
5,000
Freehold land
46,500
Buildings
25,000
Machinery
50,000
Mains
40,000
Transformers
10,000
Meters
7,500
Electrical Instruments
2,000
General stores
11,750
Office Furniture
1,250
Coal and Fuel etc.
9,500
Salaries
15,750
Wages
20,000
Office expenses
4,500
Sale by meters
43,750
Sales by contracts
25,000
Meter rent
1,500
109
Creditors
5,000
Debtors
15,000
Cash in hand
16,500
2,72,250
i.
2,72,250
Additions made during the year were:

Share capital
20,000
Buildings
5,000
Machinery
20,000
Mains
15,000
Transformers
5,000
Meters
5,000
Electrical Instruments
500
General Stores
3750
ii.
Provide interest on Debentures @6%
iii.
Provide depreciation on:

Building 21/2%, Machinery 71/2%, Mains 5%, Transformers 10%, and Meters 15% on opening
balances.
Books for further reference:

1.
ADVANCED ACCOUNTANCY
- R.L. GUPTA & M. RADHASWAMY

2.
ADVANCED ACCOUNTANCY.
Corporate Accounting ( Part 2 )
- M.A. ARULANANDAM
B.S. RAMAN
3.
ADVANCED ACCOUNTING - Volume II

- S.P. IYENGAR
110

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KANNUR UNIVERSITY

Chapters : 1,2,4 and 5

Copy right Director, SDE 2007

PAPER XV CORPORATE ACCOUNTING

2. S.P. Jain & K.L. Narang

3. Arulanandam & Raman

4. Analysis and Interpretation of Financial Statements

5. Double Account System

AMALGAMATION; ABSORPTION AND

Explain the meaning of Amalgamation, Absorption and Reconstruction

Discuss the methods of Accounting for Amalgamation and Reconstruction

Meaning of Amalgamation, Absorption and Reconstruction

Amalgamation, Absorption and Reconstruction

Amalgamation is a form of combination. It is brought about by blending of two or more undertakings

1-1 Types of Amalgamation

1-2 Purchase consideration

Net Assets method

Net payment method

Transferor companys creditors A/c

To Transferee Companys Debtors A/c

Adjustment of value of Stock

Methods of accounting for amalgamation

Journal entries in the books of transferor company

1) For transfer of assets taken over

To Each asset A/c

(with book value)

(with book value)

(with the amount agreed upon)

(with the amount paid)

To purchasing Company A/c

To pref. Shareholders A/c

(With the premium)

To Each asset A/c

(with Book value)

(with profit on Sale)

Equity shareholders A/c

(With book value)

To pref. Share holders A/c

Profit and loss A/c

Capital Reserve A/c

To Equity share holders A/c

To profit and loss A/c

To shares in Transferee company A/c

1.5 Journal entries in the books of Transferee company

To liquidator of Transferor Co.

To Each liability A/c

(With book value)

(With purchase consideration)

To Share capital A/c

Liquidation expenses A/c

Profit and loss A/c

To liquidation expenses A/c

To liquidator of transferor Co.

To Each liability A/c

(With fair value)

To Business purchase A/c

Illustration -I (Amalgamation in the nature of merger)

The Iron Ore Company Ltd.