Dep and Inventory

B.COM. (Hons.
) Semester-I
FINANCIAL ACCOUNTING
CORE COURSE - I
Reference Material
UNIT - (II-IV)
SCHOOL OF OPEN LEARNING

University of Delhi
Department of Commerce
Graduate Course
Core Course - 1
FINANCIAL ACCOUNTING
Contents:
Unit II
Lesson 1: Accounting for Depreciation
Lesson 2: Inventory Valuation
Unit III
Lesson 1: Hire Purchase Accounts
Lesson 2: Branch Accounts
Unit IV
Lesson 1: Dissolution of Partnership Firms
SCHOOL OF OPEN LEARNING

University of Delhi
5, Cavalry Lane, Delhi – 110007
UNIT-II
LESSON 1
Fixed assets are acquired by a business house for use for a long period of time. The cost of a fixed
asset has to be written off over its useful life. The amount that is written off every year in this manner
is called depreciation. We may define depreciation as a fall in the value of an asset, due to wear and
tear, due to actual use and effiux of time. Mere passage of time also causes a fall in the value of an
asset even if it is not used. It is so because new improved machines are constantly introduced in the
market making old machines outdated. Value of an asset may also fall due to obsolescence (i.e., due
to a new invention or a permanent change in the demend), accident or a fall in the market price of the
asset; such a fall is not reffered to as depreciation although it is also a loss and is written off. Save a
very few assets like land, goodwill and old famous paintings, all assets depreciate. While preparing a
balance sheet, current assets have to be shown at cost price or market price whichever is less; and the
question of depreciation does not arise. But all fixed assets are shown in the balance sheet at cost
minus depreciation thereon.
Provision for depreciation is essential to ascertain the true profit earned or true loss incurred by a
business house during a year and to show a correct financial position in the balance sheet at the end of
the year. Depreciation is very much an expense of the business. The difference between other expenses
and depreciation is that whereas payment has to be made for other expenses every year, no cash
payment is made for depreciation every year; the impact of this expenses is felt only when after a
number of years, an assets has to be replaced. Replacement of an asset makes one realise that the
amount originally spent on the asset has been used.
While calculating depreciation, there are certain basic factors which have to be taken into
consideration. These factors are as follows
(i) Cost of the asset : Depreciation has to be calculated on the basis of the cost of the asset to be
depreciated. The cost includes the price paid for the asset, the amount spent on its acquisition,
freight, octroi, carriage and installation of the asset.
(ii) Useful life of the asset :- Another factor that affects the amount of depreciation is the useful
life of the asset. A machinery may be capable of running for 15 years but if the firm is
expected to replace it after 10 years due to obsolescence the estimated useful life of the
machine will be considered to be 10 years for the purpose of calculating depreciation.
(iii) Scrap Value : The scrap value of the asset at the end of the useful life of the asset as
described in (ii) above also affects the amount of depreciation. The scrap value at the end of
the useful life has to be estimated when the asset is purchased. The estimated scrap value is
deducted from the cost of the asset as described in (i) above to provide the basis for calculating
depreciation. If in a question, the scrap value of the asset is not given, it should be assumed
that it is nil. So much depreciation has to be provided as will reduce the value of the asset to
its scrap value at the end of its estimated life.
2
There are different methods of providing depreciation which may be described as follows:-
(i) Straight Line Method : It is called Fixed Percentage on Original Cost Method or Fixed
Installment Method. Under this method, a suitable percentage of original cost is written
off the asset annually. Thus, if an asset costs Rs. 11,000/- in all and 10% per annum
depreciation is considered proper, depreciation amounting to Rs. 1,100 will be provided
every year if scrap value of the asset at the end of its estimate life of 10 years is
considered to be nil. To ascertain annual depreciation, the following formula may be
remembered :
However, if the asset exists in the business only for a part of the year, depreciation should be
provided only for that part of the year for which the asset remained in the business. For example, if
an asset is acquired on 1st September, 1987 and the annual depreciation of the asset works out to
be Rs. 8,000/-, then if final accounts are prepared on 31st December, 1987 depreciation for three
months only amounting to Rs. 2,000/- will be provided. Similarly in the part of the year in which
the asset is disposed of, if the asset is discarded after having been used for the accounting year,
depreciation will be provided for that part of year for which asset has been used. The profit or loss
on the disposal of the asset will be calculated after taking into account depreciation for the part of
the year also.
The Straight Line Method spreads depreciation evenly over the estimated life of the asset. But
there is one defect. As the years pass, the amount spent by way of repairs may go on increasing
whereas the amount of depreciation remains the same. It means that the Profit and Loss Account of
the later years will get a larger debit in respect of the same asset. To remove this defect, an estimate
should be made of the amount which will be spent by way of repairs during the estimated life of the
asset; then every year provision for repairs should be made at the average, actual repairs being debited
against this provision.
Entries: In order to provide depreciation, the following journal entry may be passed
Depreciation Account Dr.
To Asset
Depreciation Account is transferred to Profit and Loss Account by means of the following entry
Profit and Loss Account Dr.

To Depreciation Account
The balance in the account of the Asset is reduced and the Asset appears in Balance sheet at the
reduced figure.
Alternatively, the amount of the Asset may be made to show the cost of the asset year after year
and the depreciation provided may be accomulated in a separate account entitted ’Provision for
Depreciation Account". Every year, the following entry will be passed with the amount of depreciation:-
3
To Provision for Depreciation Account
Depreciation Account is transferred to Profit and Loss Account as in the first case, so that the
Profit and Loss Account is not affected by this change. Provision for Depreciation Account will
show a credit balance and may be shown on liabilities side of the balance sheet but for better presentation
it should be shown as a deduction from the cost of the asset concerned on the asset side of the balance
sheet. However, when the asset is discarded, the Provision for Depreciation Account will be closed
by the transfer to the Asset account concerned.
Now, study the following illustrations:-
On 1st April, 1993 a company purchased a Plant for Rs. 80,000/- spending Rs. 600 on carriage
and Rs. 1,700/- on installation of the Plant. The scrap value of the asset at the end of the estimated life
of the plant was estimated at Rs. 6,000/- The estimated life of the asset is 10 years. Plant is to be
depreciated on straight line method.
Show Plant Account and Depreciation Account for the years ending 31st December, 1993 and
31st December, 1994.
Calculation of annuar depreciation on straight line method:

Total cost of the plant: Rs. 82,300
—
Annual depreciation:
In 1993, the plant has been used only for 9 months. Hence, depreciation for 1993 will be
Rs. or Rs. 5,722.50 p.

Dr. Plant Account Cr.
1993 Rs. P. 1993 Rs. P.
April 1 To Bank 80,000.00 Dec. 31 By Depreciation 5,722.50
April 1 To Bank (Expenses) 2,300.00 ,, ,, By Balance c/d 76,577.50
82,300.00 82,300.00
1994 1994
Jan 1 To Balance b/d 76,577.50 Dec. 31 By Depreciation 7,630.00
Dec. 31 By Balance c/d 68,947.50
76,577.50 76,577.50
1995
Jan 1 To Balance b/d 68,947.50
Dr. Depreciation Account Cr.
1993 Rs. P. 1993 Rs. P.
Dec. 31 To Plant 5,722.50 Dec. 31 By P & L A/c transfer 5,722.50
1994 1994
Dec. 31 To Plant 7,630.00 Dec. 31 By P & L A/c transfer 7,630.00
4
On the Ist January, 1986 Blue Star Co. installed a plant at a total cost of Rs. 61,000 and
decided to depreciate it on straight line method @ 10% per annum. On 31st March, 1993 the
company decided to replace the old plant by a new one purchased for Rs. 89,000. A part of the
plant valued at Rs. 1,500 was found fit to be used in the new plant. The remaining part of the old
plant was sold as scrap for Rs. 400. The company decided to depreciate the new plant @ 12%
per annum on straight line method.
Show important ledger accounts for the year ended 31st December, 1993.
Balance as on 1st January, 1993 : Rs. —
(i.e., Cost-depreciation from 1986 to 93) : Rs. 61,000—48,800

: Rs. 12,200
Dr. Plant (Old) Account Cr.
1993 Rs. 1993 Rs.

Jan. 1 To balance b/f 12,200 March 31 By Depreciation (for 3 months) 1,525
March 31 By Plant (New) Account 1,500
March 31 By Cash-Sale of scrap 400
March 31 By Profit and Loss A/c 8,775
12.200 transfer of loss 12,200
Dr. Plant (New) Account Cr.
March 31 To Bank 89,000 Dec. 31 By Depreciation

(for 9 months) 8,145
March 31 To Plant (old) A/c 1,500 Dec. 31 By Balance c/d 82,355
90,500 90,500
1994
Jan. l To balance b/d 82,355
1993 Rs. 1993 Rs.

March 31 To Plant (Old) A/c 1,525 Dec. 31 By Profit & Loss A/c
transfer 9,670
Dec. 31 To Plant (New) A/c 8,145
9,670 9,670
5
Instead of opening a new Plant Account, the amount of the new plant may be debited to the Old
Plant Account, continuing the same account. In this case, there will be only one Plant Account which
will appear as follows:
1993 Rs. 1993 Rs.

Jan. l To balance b/fd 12,200 Mar. 31 By Depreciation A/c 1,525
Mar. 31 To Bank 89,000 By Cash-sale of scrap 400
,, ,, By Profit and Loss A/c
transfer of Loss 8,775
Dec. 31 By Depreciation 8,145
,, ,, By Balance c/d 82,355
1,01,200 1,01,200
1994
Jan. l To Balance b/d 82,355
Depreciation Account will appear as follows:-
1993 Rs. 1993 Rs.

Mar. 31 To Plant 1,525 Dec. 31 To Profit & Loss
Account transfer 9,670
Mar. 31 To Plant 8,145
9,670 9,670
(ii) Diminishing Balance Method : It is also called Reducing Instalment Method because under
this method, the amount of depreciation year after year goes on decreasing. Under this method, to
calculate the amount of depreciation for a particular year, a fixed percentage is applied, to the value at
which the asset stands in the books of account at the beginning of the year (after adjusting it for the
value of disposal, if any, of a part of asset). In the case of a new asset or additions, the rate is applied
to the cost of the asset newly acquired and the amount of depreciaton, must be calculated only for that
part of the year for which the newly acquired asset has been used. Under this method also, cost
includes money spent on carriage, installation etc. The entries for depreciation are the same as are
required under Straight Line Method-only the amount differ.
In one respect, Diminishing Balance Method is better than Straight Line Method. Under
Diminishing Balance Method, the total of depreciation and repairs expenses tends to be the same for
different years because the fall in the amount of depreciation is offset by an increase in repairs expenses
in later years of the life of the asset. Consequently no Provision for Repairs Accounts has to be
maintained when this method of providing depreciatin is used. This method also recognises the fact
that as soon as is put to use, its value for resale purposes falls heavily. Under this method the depreciation
is the heaviest in the first year. It goes on decreasing as the years pass and is the minimum in the last
year.
6
On Ist January, 1992 a firm installed a Machinery at a total cost of Rs. 10,000. It was decided to
depreciate the Machinery @ 10% per annum on diminishing balance method.
Show Machinery Account for the first years of its life, assuming that the firm closes its accounts
every year on 31st December.
Dr. Machinery Account Cr.
1992 Rs. 1992 Rs.

Jan. 1 To Bank 10,000 Dec. 31 By Depreciation 1,000
Dec. 31 By Balance c/d 9,000
10,000 10,000
1993 1993
Jan. 1 To Balance b/d 9,000 Dec. 31 By Depreciatorn 900
9,000 9,000
1994 1994
Jan. 1 To Balance b/d 8,100 Dec. 31 By Depreciation 810
8,100 8,100
1995
Jan. 1 To Balance b/d 7,290
J. Foster Ltd., a company with a turnover of Rs. 6,00,000 per year, acquired a machine on
1st January 1992 for Rs. 1,60.000. It was company’s policy to depreciate machinery on straight
line basis at 20% per year. During 1994 a modification was made to the machine to improve its
technical reliability at a cost of Rs. 16,000 which it was cosidered would extend the useful life of
the machine by 2 years. At the same time an important component of the machine was replaced
at a cost of Rs. 10,000, because of excessive wear and tear. Routine maintenance during the year
cost Rs. 5,000.
(i) Show the Asset Account, the Provision for Deprication Account and the charge to
Profit and Loss Account in respect of the machine for the year ended 31 December,
1994.
(ii) Once an assets such as a machine is installed what features should be considered when
deciding whether to capitalise or treat an expense subsequent expenditure relating to that
asset.
7
Dr. Machine Account Cr.
1994 Rs. Rs.

Jan. 1 To Balance b/d 1,60,000 Dec. 31 By Balance c/d 1,86,000
Jan. 1 To Bank (Cost of
Modification) 16,000
Jan. 1. To Bank
(Replacement) 10,000
1,86,000 1,86,000
1995
Jan. 1 To Balance b/d 1,86,000
Provision for Depreciation A/c
1994 Rs. 1994 Rs.

Dec. 31 To Balance c/d 88,400 Jan. 1 By Balance b/d 64,000
Dec. 31 By Profit & Loss
Account 24,400
88,400 88,400
1995
Jan. 1 By Balance b/d 88,400
Profit and Loss Account (Skeleton) for the year ending on 31 December 1995
Dr. Cr.
To Depreciation of Machine 24,400

To Maintenance 5,000
Working Notes:
(a) The component replaced has been capitalised because it would extend the life of the machine
and so is the cost of modification.
(b) The depreciation charge for 1995 has been calculated as under:
Written down value at 1st January 1994 (1,60,000-64,000)
Rs.
= 94,000
Add. Modification 16,000
Cost of component replaced 10.000
1,22,000
Expected life of machine is 5 years. Depreciation charge therefore is 20% of Rs. 1,22,000
= 24,400
8
(ii) Once an asset such as machine has been installed the following features are taken into account
to decide whether subsequent expenditure is to be capitalised or treated as an expense:
(i) Is the life of an asset expended?
(ii) Is the efficiency of an asset subsequently improved?
(iii) Is the additional expenditure subsequential?
(iv) Is it possible that the additional expenditure will recover?
Sometimes a firm wishes to shift over from straight line method to diminishing balance
method or vice versa with retrospective effect. In such a case, the balance according to the
desired method should be found out. The balance should be compared with the actual balance.
If the actual balance is less than the desired balance, the following entry should be passed with
the difference:
Asset (by name) Dr.
To Profit and Loss Adjustment A/c
If the actual balance is more than the desired balance, the above mentioned entry will be reversed
to bring down the balance of the asset to the desired amount.
On 1st July, 1991 a company installed a plant at a cost of Rs. 1,00,000. The company depreciated
the asset @ 10% per annum on straight line method. But on 1st january, 1994 it decided to provide
depreciation on the plant @ 13% per annum on diminishing balance method with retropsective effect
from the date of purchase.
Show Plant Account for the year ended 31st December, 1994.
Depreciation for 2½ years on straight line method.
Book value on 1st January, 1994. = Rs. 1,00,000-25,000 = Rs. 75,000

Calculation of desired balance on the basis of diminishing balance method of depreciation.
Rs. P.
Cost 1,00,000.00
Depreciation @ 13% for 6 months. 6,500.00
Balance as on 1.1.1992 93,500.00
Depreciation for 1992 13% on Rs. 93,500 12,155.03
Balance as on 1.1.1993 81,345.00
Depreciation for 1993 @ 13% on Rs. 81,345 10,574.45
70,770.55
9
Adjustment needed = Rs. 75,000 — Rs. 70,770.55P. = Rs. 4,229.45 P.

Rs. P. Rs. P.
1.1.1994 To balance b/d 75,000.00 1.1.1994 By Profit & Loss
Adjustment A/c 4229.45
(iii) Annuity Method : This method is based on the contention that amount of depreciation that
should be provided on an asset is not only the cost of the asset but also the interest at a certain
rate on the diminishing balance of the asset in various years. Thus, the method takes into
account the interest lost on the amount that emains invested in the asset.
Under this method, interst is calculated at a fixed rate in the book value of the asset and the
amount is debited to the asset concerned and credited to Interest Account. The amount to be
written off as depreciation remains the same year after year and it is calculated with the help of
the Annuity Tables. For an extract from the Annuity Tables, please consult your text book. The
Annuity Table indicates the sum which can be paid annually for a certain number of years if
there is Re. 1 in the beginning an if it earns interest at a given rate. The Table also indicates the
amount to be written off annually to reduce an asset valued at Re. 1 in the beginning to zero in a
specified period of time, assuming that the diminishing balances earn interest at a given rate
every year.
Suppose an asset costing Rs. 10,000 is to be written off in 10 years and inerest to be provided @
5% p.a. on diminishing balance of the asset, Rs. 1,295.05 p. will have to be written off every year. A
reference to the Annuity reveals that Re. 0.129505 should be written off to fulfill the above mentioned
conditions if the cost of the asset Re. 1. By multiplying Re. 0.129505 by 10,000 we get the amount of
depreciation that will have to be provided if the cost of the asset is Rs. 10,000.
This method is very suitable to write off lease accounts.
On 1st January, 1990 a lease was purchased for five years for Rs. 20,000. It was proposed to
depreciate the lease by the annuity method charging interest @ 5% per annum.
Annuity Table shows that to depreciate Re. 1 by annuity method over 5 years, charging 5%
interest, one must write off a sum of Re. 0.230975.
Show Lease Account and the relevant entries in Profit and Loss Account for the entire period of lease.
Amount of depreciation : Rs; 20,000 × 0.230975 = Rs. 4,619.50 P.

Dr. Lease Account Cr.
1990 Rs. P. 1990 Rs. P.
Jan. 1 To Bank 20,000.00 Dec. 31 By Depreciation 4,619.50
Dec. 31 To Interest (on
Rs. 20,000 @ 5%) 1,000.00 ,, ,, By Balance c/d 16,380.50
21,000.00 21,000.00
10
Dr. Cr.
1991 Rs. P. 1991 Rs. P.
Jan. 1 To Balance b/d 16,380.50 Dec. 31 By Depreciation 4,619.50
To Interest (on Rs.
16,380.50) @ 5% 819.02 ,, ,, By Balance c/d 12,580.02
17,199.52 17,199.52
1992 1992
Dec. 31 To Interest (on
Rs. 12,580.02 629.00 ,, ,, By Balance c/d 8,589.52
@ 50%
13,209.02 13,209.02
1993 1993
Dec. 31 To Interest 429.48 ,, ,, By Balance c/d 4,399.50
9,019.00 9,019.00
1994 1994
Dec. 31 To Interest 220.00
4,619.50 4,619.50
Dr. Profit and Loss Account Cr.

1990 Rs. P. 1990 Rs. P.
Dec. 31 To Depreciation 4,619.50 Dec. 31 By Interest 1,000.00
1991 1991
Dec. 31 To Depreciation 4,619.50 Dec. 31 By Interest 819.02
1992 1992
1993 1993
1994 1994
(iv) Depreciation Fund Metho]d : This method enables the firm to find ready cash to replace
an asset on the expiry of the useful life of the asset. An amount equal to the amount of
depreciation is invested in readily saleable securities every year. Interest received on
investments made in the previous years is also invested. At the time of replacement of the
assets, the entire investment made on this account sold out; thus cash received facilitates the
replacement of the asset without giving a set back to working capital of the concern.
Under this method, in order to ascertain the amount of depreciation, reference has to be made to
Sinking Fund Table. This Table shows how much is to be invested every year together with interest
earned so that at the end of the specified period of time, one may get Re. 1. For example, you will find
in the Table that in order to get Re. 1, at the end of 10 years one must invest Re. 0.079505 at the end
of every year (in addition to interest earned) if interest on investment is earned @ 5% per annum. If
cost of an asset is Re. 1, Re. 0.079505 also be annual depreciation if the asset’s estimated life is 10
years and investment are to fetch interest @ 5% per annum.
11
Journal Entries : Under this method, the scheme of entries is as follows:
Depreciation Account Dr. With the amount of depreciation

To Depreciation Fund Account calculated with the help of S.F. Table
(For providing depreciation)
Depreciation Fund Investment Account Dr.
To Bank
(For Investment made)
(For transfer of Depreciation Account to Profit and
Loss Account)
Investments made may not exactly be equal to the amount of depreciaton. It may be made to the
nearest rupee or the nearest multiple of the market value of securities in which the investment is made.
For example, the amount of depreciation may be Rs. 900.50 P. but if the money is to be invested in
securities which are available at Rs. 102 per unit, Rs. 918 will be invested to buy 9 units. It should
also be noted that the interest is received on the basis of the value and not cost price of the securities
purchased.
Bank Dr.
To Interest on Depreciation Fund Account
(For Interest received on Depreciation Fund
Investment)
Interest on Depreciation Fund Investment
Account Dr.
To Depreciation Fund Account
(For transfer of Interest on Depreciation Fund
Investment Account to Depreciation Fund Account)
(For the Annual Instalment of depreciation)
To Bank
(For the Investment of the amount of depreciation and
the interest on depreciation fund
investment made already)
12
(For the transfer of Depreciation Account to Profit and
Loss Account)
In every subsequent year (except the year in which the asset is disposed off), the above mentioned
entries will be repeated. Of course, the amount of interest received will go on increasing. Consequently,
the entries for receipt of interest, the transfer of interest to Depreciation Fund and the making fresh
investment will be with large amounts with the passage of time.
Asset Account will continue to show the cost price of the asset. Depreciation will go on
accumulating in Depreciation Fund Account which will show increasing credit balances. Investments
will continue to swell with the result that Depreciation Fund Investment will show increasing debit
balances. In the balance sheet the balance of Depreciation Fund should be shown by way of a deduction
from the Asset Account on the assets-side of the balance sheet. Depreciation Fund Investment Account
will also appear on the assets-side of the balance sheet.
Bank
To Interest on depreciation Fund
Investment Account
(For the amount of interest received)
Interest on Depreciation Fund Investment Account
(Transfer of Interest on D.F.I. Account to Depreciation Fund) Dr.
(For the annual installment of Depreciation)
Bank Dr.
To Depreciation Fund Investment Account
(For the sale proceeds of the total investment made in all the earlier year)
Either
(For transfer of profit on the sale of investment)
Or
To Depreciation Fund Investment Account
(For transfer of loss on the sale of investment)
Depreciation Fund Account Dr.
To Asset Account
(For transfer of Asset Account to Depreciation Fund Account)
13
Either
Depreciation Fund Account Dr.
To Profit and Loss Account
Or
(For transfer of Depreciation Fund
Account of Profit and Loss Account)
(For transfer of Depreciation Account to Profit and Loss Account)
A Machinery is purchased by Moonlight Ltd., on the 1st July, 1990 for Rs. 50,000. The machinery
is to be replaced at the end of 5 years for which purposed a sinking fund is established. It is expected
that securities will earn 5 percent interest. Sinking Fund tables show that Rs. .180975 invested each
year will produce Re. 1 at the end of 5 years at 5 percent. The Company closes its accounts on 30th
June every year.
At the end of the period the securities are realised for Rs. 39,000. New machinery is installed on
1st July, 1995 at a cost of Rs. 70,000. Show the necessary ledger accounts for all the years.
Dr. Depreciation Fund Account Cr.

1991 Rs. 1991 Rs.
June 30 To Balance c/d 9,048.75 June 30 By Depreciation Account 9,048.75
9,048.75 9,048.75
1992 1991
June 30 To Balance c/d 18,549.94 July 1 By Balance b/d 9,048.75
1992
June 30 By Interest on D.F.
Investment Account 452.44
,, ,, By Depreciation 9,048.75
Account
18,549.94 18,549.94
1993 1992
1993
Investment Account 927.50
,, ,, By Depreciation
Account 9,048.75
28,526.19 28,526.19
14
1994 1993
1994
Investment Account 1,426.31
By Depreciation
Account 9,048.75
39,001.25 39,001.25
1995 1994
June 30 To Machinery July 1 By Balance b/d 39,001.25
Account (Transfer) 50,000.00
1995
June 30 By Invest on D.F.
Investment Account 1,950.00
,, ,, To D.F. Investment 1.25 ,, ,, By Depreciation
Account 9,048.75
,, ,, By P & L Account transfer 1.25
50,001.25 50,001.25
1991 Rs. 1991 Rs.

June 30 To Bank 9,048.75 June 30 By Balance c/d 9,048.75
1991 1992
July 1 To Balance b/d 9,048.75 June 30 By Balance c/d 18,549.94
1992
June 30 To Bank 9,501.19
18,549.94 18,549.94
1993 1993
1993
28,526.19 28,526.19
1993 1994
1994
39,001.25 39,001.25
1994 1995
July 1 To Balance b/d 39,001.25 June 30 By Bank 39,000.00
By Depreciation
Fund Account 1.25
39,001.25 39,001.25
15
Machinery Account
1990 Rs. 1991 Rs.
July 1 To Bank 50,000.00 June 30 By Balance c/d 50,000.00
1991 1992
1992 1993
1993 1994
1994 1995
Dr. New Machinery Account Cr.

1995
July 1 To Bank 70,000.00

1991 1994
June 30 To Depredation June 30 By Profit & Loss
Fund Account 9,048.75 Account 9,048.75
1992 1992
June 30 To Depreciation June 30 By Profit & Loss
1993 . 1993
1994 1994
1995 1995
Dr. Interest on D.F. Investment Account Cr.

1992 1992
June 30 To Depreciation June 30 By Bank
Fund Account 452.44 452.44
1993 1993
Fund Account 927.50 927.50
1994 1994
Fund Account 1,426.31 1,426.31
1995 1995
Fund Account 1,950.00 1,950.00
16
(v) Insurance Policy Method : This method is similar to Depreciation Fund Method and enables
the firm to get the ready cash to replace the asset. Still, following are the points of difference
between the two methods:
(a) Under the Depreciation Fund Method, investment is made in securities, whereas under the
Insurance Policy Method, an insurance policy is taken and amount is invested in the policy
by paying premium.
(b) Under the Depreciation Fund Method, investment is made at the end of every year but under
the Insurance Policy Method, the premium is paid in the beginning of every year.
(c) Amount of depreciation and interest received determine the amount to be invested in the
case of Depreciation Fund Method. But under Insurance Policy Method, the premium required
to be paid is also considered to be amount of depreciation to be provided.
(d) Depreciation Fund Investment Account may reveal even a loss on disposal of investments
but Depreciation Insurance Policy Account will always reveal a profit because the amount
of the policy is always higher than the total premium paid on the policy. Under this method,
every year two entries are made:
Depreciation Insurance Policy Account Dr.

To Bank
(For the amount of the premium paid)
At the end of the year

To Depreciation Reserve Account
(The amount of premium paid during the year
credited to Depreciation Reserve)
At the end of the last year, policy will mature. For receipt of amount of policy, the following entry
will be passed:
Bank Dr.
To Depreciation Insurance policy account
(Amount received on maturity of policy)
In addition to the two usual entries mentioned above, the following additional entries will be
passed:
Bank Dr.
To Depreciation Insurance Policy Account
(For amount of the policy received from the insurance
company on the maturity of the policy)
17
Depreciation Insurance Policy Account Dr.
(For transfer of profit on the policy from Depreciation Policy
Account to Depreciation Reserve Account)
Depreciation Reserve Account Dr.
To Asset Account
(Transfer of Asset Account to Depreciation Reserve)
Depreciaton Reserve Account Dr.
Transfer of credit balance in Depreciation Reserve to
Profit and Loss Account)
Alternatively, under this method, Depreciation Account may also be opened. In that case, every
year the following entries will be passed:
Derpeciation Insurance Policy Account Dr.
To Bank
(For Premium)
(For depreciation provided)
(For transfer)
On 1st January, 1992 Mehar Co. Ltd. purchased a lease for four years for Rs. 42,000 and decided
to provide for its replacement by means of an insurance policy for Rs. 42,000. The insurance company
charged an annual of Rs. 8,500.
Show important ledger accounts.
Dr. Lease Account Cr.

1992 Rs. 1992 Rs.
Jan. 1 To Bank 42,000 Dec. 31 By Balance c/d 42,000
1993 1993
1994 1994
1995 1995
Jan. 1 To Bank 42,000 Dec. 31 By Depreciation 42,000
Reserve transfer
18
Dr. Depreciation Reserve Account Cr.
1992 Rs. 1992 Rs.

Dec. 31 To Balance b/d 8,500 Dec. 31 By Profit & Loss
Account 8,500
1993 1993
Dec. 31 To Balance b/d 17,000 Jan 1. By Balance b/d 8,500
Account 8,500
17,000 17,000
1994 1994
Dec. 31 ByProfit & Loss
Account 8,500
25,500 25,500
1995 1995
Account 8,500
By Depreciation
Insurance Policy A/c 8,000
42,000 42,000
Dr. Depreciation Insurance Policy Account Dr.
1992 Rs. 1992 Rs.

Jan. 1 To Bank-Premium 8,500 Dec. 31 By Balance c/d 8,500
1993 1993
Jan. 1 To Balance b/d 8,500 Dec. 31 By Balance c/d 17,000
Jan. 1 To Bank 8,500
17,000 17,000
1994 1994
Jan. 1 To Balance b/d 17,000 Dec. 31 By Balance c/d 25,500
Jan. 1 To Bank 8,500
25,000 25,500
1995 1995
Jan. 1 To Balance b/d 25,500 Dec. 31 By Bank 42,000
Jan. 1 To Back 8,500
To Depreciation
Reserve-Transfer
of profit 8,000
42,000 42,000
(vi) Depletion Method : This method is used to depreciate assets like mines and quarries where
on estimate of total quantity of output is available. Depreciation is calculated usually per
tone of output. For example if a mine is purchased for Rs. 1,00,000 and it is estimated that
19
the total quantity of mineral in the mine is 50,000 tonnes, the depreciation per tonne of
output will be Rs. 2. If the output in the first year is 8,400 tonnes, the depreciation to be
written off in the first year will be Rs. 16,800. In the second year the output may be 9,100
tonnes. Depreciation @ Rs. 2 per tonne will amount to Rs. 28,200.
(vii) Machine Hour Rate Method : This method is similar to Depletion Method but it is applied
to machines. The life of the machine is estimated in terms of hours it will run and then cost of
machine per running hour is calculated. An accurate record is kept regarding the number of
hours the machine is run and depreciation is calculated by multiplying the machine rate by
the number of hours the machine has run during the year. Suppose a machine costing Rs.
1,20,000 is estimated to run 40,000 hours during its useful life. Machine hours rate is Rs. 3.
If in a particular year the machine has run for 2,480 hours, depreciation will amount to Rs.
2,480 × 3 = Rs. 7,440.
(viii) Revaluation Method : This method is used in case of assets where there are a large number
of individual items. Live stock tools are examples of such an asset. In such cases, it is very
difficult to maintain an account of each single item and calculate depreciation thereon. Hence
the stock of such an asset is evaluated and an appropriate amount is provided in the books of
accounts by way of depreciation to bring down the book value of the asset. Suppose a firm
had in the beginning of a year tool of the value of Rs. 2,350. During the year it purchased
new tools costing Rs. 450, thus making a total of Rs. 2,800. If at the end of the year, the
loose tools are found to be worth Rs. 2,300 the depreciation for the year will be Rs. 2,800 —
Rs. 2300 = 500
Depreciation of Various Assets : Different methods are appropriate for differnt assets. To
depreciate Freehold Buildings, Plant and Machinery, straight line method with a provisior for repairs
or diminising balance method without a provision for repairs or depreciation fund method or depreciation
insurance policy should be employed. To depreciate leasehold and land and buildings, straight line
method to write off the asset together with its cost of dilapidation (if any) within the life of the asset is
the best. Annuity Method is also very appropriate for all leases. Loose tools and livestock should be
depreciated by means of revaluation method. For mines, oil wells and quarries, depletion is the best.
Plants and trade marks should be written off on straight line method within their commercial life or
legal life whichever is shorter. No depreciation arises in case of goodwill unless the firm’s profits start
decreasing. But it is better to write off the amount over a number of years on straight line method. No
depreciation arises in case of freehold land.
The following are the salient features of the Revised Accounting Standard on Depreciation
Accounting issued by the Institute of Chartered Accountants of India in September, 1994.1
1. The standard applies to all depreciable assets except the following items to which special
considerations apply :
(a) forests, plantations and similar regenerative natural resources;
(b) wasting assets including expenditure on the exploration for the extraction of minerals
oils, natural gas and similar non-regenerative resources;
(c) expenditure on research and development;
(d) goodwill;
20
(e) livestock;
(f) land unless it has a limited useful life for the enterprise.
2. The depreciable amount of a depreciable asset should be allocated on a systematic basis to
each accounting period during the useful life of the asset.
3. The depreciation method selected should be applied consistently from period to period. A
change from one method of providing depreciation to another should be made only if the
adoption of the new method is required by statute or for compliance with an accounting
standard or if it is considered that the change would result in a more appropriate preparation
or presentation of the financial statements of the enterprise. When such a change in the
method of depreciation is made, depreciation should be recalculated in accordance with the
new method from the date of the asset coming into use. The deficiency or surplus arising
from retrospective recomputation of depreciation in accordance with the new method should
be adjusted in the accounts in the year in which the method of depreciation is changed. In
case the change in the method result in deficiency in depreciation in respect of past years, the
deficiency should be charged in the statement of profit and loss. In case the change in the
method result in surplus, the surplus should be credited to the statement of profit and loss.
Such a change should be treated as a change in accounting policy and its effect should be
quantified and disclosed.
4. The useful life of a depreciable asset should be estimated after considering the following
factors :
(i) expected physical wear and tear;
(ii) obsolescence;
(iii) legal or other limits on the use of the asset.
5. The useful lives of major depreciable assets or classes of depreciable assets may be reviewed
periodically. Where there is a revision of the estimated useful life of an asset, the unamortised
depreciable amount should be charged over the revised remaining useful life.
6. Any addition or extension which becomes an integral part of the existing asset should be
depreciated over the remaining useful life of that asset. The depreciation on such addition or
extension may also be provided at the rate applied to the existing asset. Where an addition or
extension retains a separate identity and is capable of being used after the existing asset is
disposed of, depreciation should be provided independently on the basis of an estimate of its
own useful life.
7. Where the historical cost of a depreciable asset has undergone a change due to increase or
decrease in long-term liability on account of exchange fluctuations, price adjustments, changes
in duties or similar factors, the depreciation on the revised unamortised depreciable amount
should be provided prospectively over the residual useful life of the asset.
8. Where the depreciable assets are revalued, the provision for depreciation should be
based on the revalued amount and on the estimate of the remaining useful lives of such
assets. In case the revaluation has a material effect on the amount of depreciation, the
same should be disclosed separately in the year in which revaluation is carried out.
9. If any depreciable asset is disposed of, discarded, demolished or destroyed, the net surplus
or deficiency, if material, should be disposed separately.
21
10. The following information should be disclosed in the financial statements:
(i) the historical cost or other amount substituted for historical cost of each class of
depreciable assets;
(ii) total depreciation for the period for each class of assets; and
(iii) the related accumulated depreciation.
11. The following information should also be disclosed in the financial statements along with
the disclosure of other accounting policies:
(i) depreciation methods used; and
(ii) depreciation rates or the useful lives of the assets, if they are different from the principal
rates specified in the statute governing the enterprise.
1. What is depreciation? Why is it provided?

2. What are the factors which require consideration while ascertaining the amount of depreciation
to be provided on a certain asset ?
3. Distinguish between straight line method and diminishing balance method. What are their
relative advantage ?
4. What is annuity method of providing depreciation ? For which assets is it specially suitable
?
5. What is the special significance of sinking fund method of depreciation ?
6. Distinguish between sinking fund method and depreciation insurance policy method of
depreciation ?
7. For which assets is depletion method of depreciation used ?
8. What is machine hour rate? How is it calculated ?
9. What is revaluation method of providing depreciation? For which asset is it recommended ?
LESSON 2
INVENTORY VALUATION
Inventory is an important element of assets of an enterprise. In some enterprises, inventory constitute

the bulk of working capital. In view of this inventory of this inventory valuation and inventory control assume
a pivotal position for many concerns. However, inventory valuation is outside the purview of the present chapter.
According to IAS-2* and AS-2*inventories are tangible property held
(a) For sale in the ordinary course of business;
(b) in the process of production for such sale or
(c) to be consumed in the production of goods or services for sale,
We can rename the aboive three components of inventory as-
(a) Finished Goods,
(b) Work in process; or
(c) raw materials and components.
Objecctives of Inventory Valurtion

W hat aaare the objecttivs of inveentory valuation?The two objectives to be achieved by proper valuation
of inventoties are-
( I) Determinationof Income - We know that opening and closing stock affect the quantum of
Gross Profit (and hence net profit) of any concern. Any improper valuation of closing stock(i.e.
inventory) will lead to over and under statement of Gross profits of not only this year but also
next year(as closing stock of this year becomes the opening stock of next year).
(2) Determination of Financial position-Inventory appears as current asset in the balance sheet.
Any improper valuation will lead to distortion in the balance sheet also.
Besides these, inventory is use for computing various ratios which are u sed by proper valuation cannt
be over-emphasised.
Methods of taking Inventories

There are two methods of taking inventories
(1) Periodic Inventory Method,
(2) Perpetual Inventory Method,
Peridic Inventory Method-It requires periodic (annual) stock taking by actual aounting weighting or
measuring at each accounting date. This quantitative units are converted into financial unis by applying appopriate
pricing method (discussed shortly inthis chapter). The cost of sales of the period is obtained as follows-
Cost of sales = op. inventory + current purchase - closing inventory.
*IAS= International Accounting Standards Committee's IAS-2

AS= Accounting Standards Boards AS-2
23
However, it will not be out of place to state here the effect of any abnormal loss should done away with.
Perpetual Inventory Method-This method provides a running record of inventory hand Records oif
inventory can be compared by physical stock taking to find out are discrepancy of the two. Inventory control is
possible only through continuous stock taking.
Methods of Valuation of Inventories

basically there are theree methods of caluation of inventory-
1. Cost Price
(a) Historical Cost
(i) FIFO
(ii) LIFO
(iii) HIFO
(iv) Specific identification price
(v) Base Stock price
(vi) Simple average method
(vii) Weighted Average Method
(b) Current replacement price
(c) Standard Cost
2. Sale price
(i) Discounted future cash receipts
(ii) Net Realisable value
(iii) Current selling price
3. Lower of cost or sale price

(i) Aggregation total Inventory Method
(ii) Group Mehtod
(iii) Item by item method
Historical ost means the cost of acquisition on cost of production. Cost of acquisition includes not only
the price paid but also includes cost of transportation, insurance in transit, duties paid and other direct expenses.
It further includes indirect cost (like depreciation, rent) aand normal wastage of material and labour. This method
is very objective and personal bias is absent under this method. The man drawback of this method is that it does
not demarcate a line between operational gains and holding gains. This becomes very pronounced in a rapid
inflationary conditions (Holding gains are those gains which arise outof holding the inventory) e.g. an item
purchased two years back at Rs. 15,000 may be purchased at Rs. 20,000 now. If this can be sold at Rs. 30,000
now, the holding profits will be Rs. 20,000 - 15,000 = Rs. 5,000 and operating profts will be Rs. 30,000 -
Rs.20,000 = Rs. 10,000.
(i) FIFO (First in first out method): This method presumes that materials which are received first are
issued first. Issues of materials are pried in order of their purchase. The ending inventory consists of
most recently purchased goods. The closing stock is valued at latest purchase price.
24
Theoreticallly , it is presumed that inventory received first, will be issued first, but in practice this
may not be so. But from the pricing of issue of materials, point of view , this rule is folllwed.
The main defect of this method is that on a rising market, it reports larger earnings. Thiis inventory
gains arising out of holding inventory cannot be separated from the operating.
(ii) LIFo (last in first out) This method is the reverse of FIFO method. This method is based on the
assumption that the materials received last is issued first. Thus oldest acquisitions are from part of
closing stcok. This mwthod excludes the holding profits. But comparisons between similar jobs will
be difficult.
(iii) HIFO (highest in first out)- This method is based on the assumption that highest priced materials are
issued first. It results in closing inventory being kept at the lowest possible price. It leads to certaion
of secret reserves in times of rising prices.
Illustration
From the following find out FIFO and LIFO inventory values under-
1. Perpetual inventory Mehtod
2. Periodic Inventory Method
Rs.
Jan. 1 O.B. 100 Units @ 7 700,00
Jan. 15 Issue 80 units
Jan. 25 Purchases 120 units @ 9 1080.00
Feb 20 Issue 129 units
April 10 Purchases 160 units @ 8 1280.00
May 20 Issue 100 units
Oct 15 Purchases 80 units @ 10 800.00
Dec. 31 Inventory (Closing) 160 units Total 3860.00
Solution
FIFO
Perpetual Periodic
Rs. Rs.
80 units @Rs. 7 = 560 100 units @Rs.7 = 700
20units @Rs. 7 = 140 120 units @Rs.9 =1080
100 units @Rs.9 =900 80 units @Rs. 8 = 640
20 units @Rs.9 =180 Cost of Issue 2440
80 units @Rs. 8 =640 Inventory value =Rs. 3860- 2440 =Rs.1440
Cost of Issue 2420 = 1,440
Inventroy value = 3860-2440
25
LIFO
Perpetual Periodic
80 units @Rs. 7 = 560 80 units @Rs. 10 = 800
120 units @Rs.9 = 1080 160 units @Rs. 8 = 1280
100 units @Rs. 8 = 800 60 units @Rs.9 = 540
Cost of issue 2440 Cost of issue 2620
Inventoy value = Rs. 3860 - 2420 Inventory value =
=Rs. 1440 Rs. 3860-2620 =Rs.1240
(iv) Specific Identification price - This method is used where materials are purchased specially for a
particular order or job. Its application is confined to high cost items like cars computers, videos,
antiques etvc. The question of precise determination of costs may again arise in case of joint costs
like transportation.
(v) Base Stock price-This method is based widely accepted view that a minimum quantity of inventory
must be held at all items in order to carry on the business. This minimum quantity is costed at the
earliest acquisition price. Quantity over and above the base stock evaluated by some other method
say FIFO or LIFO.
(vi) Simple Average Mthod-is average is average of prices without any regard to quantities purchased.
Here, the issue price is calculated as-
Total of different prices

Issue Pr i. ce=----------
Number of Puuchases
The simple average gives equal importance to large and small purchases.
(vii) Weighted Average-Weighted average price is calculated by dividing the total cost of materila in
stock by total quantity of material in hand. Thus weighted average discriminates between small and
large quantity purchases.
(b) Current replacement price-This means the price at which the stock could have acquired at
the date of its issue. Under this method, all the inventories are valued at replacement price.
The historical cost does enable distinction between operational gains and holdig gains. So it
is suggested that taking of replacement costs in place of historical cost is better. This method
suffers one serious drawback. The closing stock, when valued on this basis, will be including
unrealised gains.
(c) Standard Cost - Under this method, the standard price of each material is fixed and all issues
are made out the standard price. The fixation of standard cost depends on a number of factors
like-quantity of material to be purchased which results in bulk discount, market conditions
regarding prices etc. This method is easy to operate. It can warn management about the
efficiency or otherwise of the ourchase department. The fixation of standard cost is subjective
and hence it is its greatest shortcoming.
26
Sale Price
(i) Disconted furture cas receipts- This method is used where goods are produced under long-term
contrcts. In such cases, the timing of receipts are known. They can be discounted at a suitable
interest rate arrived at their present value. Such a discounted value can be taken as value of inventory.
(ii) Net Realisable value-As per IAS-2, net realisable value is the selling price in the ordinary course of
business. From this selling price, cost of completion and cost incurred for making sale is deducted,
it should be noted here that temporary fluctuations in prices should be ignored. Where there are firm
sale contracts, the net realisable value should be taken into account. Any inventory in excess of sale
contracts should be valued on the basis of arket prices.
(iii) Current Selling Price - This method is followed in those cases where there are a government controlled
market. It is because of this the sugar industry in India has shifted over to the caluation of stock on
the current selling price basis. The closing inventory of sugar is split into two parts- levy sugar and
non-levy sugar. The levy sugar is vlaued at levy price and non levy sugar is valued at current selling
price.
3 Lower of Cost or Sale price - Having determined the cost (whatever method is used), such cost
should be reduced to selling price: This is done because of the principle of conservatism. By this principle,
likely profits are to be ignored and likely losses are to be taken into account. Now which market price is to be
considered? Is it not realisable value or replacement cost?
Net realisable value may mean-
(i) The selling price less estimated costs of completion and disposal. This is ceiling of this value.
(ii) Net realisable value as reduced by gross proft, marging. This provides the floor of this value.
The AICPA has suggested for the application of the rule' lower of cash or market value* the following
(a) The ceiling figure to be taken when the replacement cost is more that ceiling.
(b) The floor figure is to be taken when replacement cost is less than the floor.
(c) The replacement cost when it lies between the floor and ceilding
Application of principle of cost or market value can be applied in any one of the following three ways
(1) Aggregate or Total Inventory Method-Under this method total cost and total of net realisable
value is compared and lower of the two is considered for valuation.
(2) Group Method-Under this method, various types of inventories are grouped together on the
bases of theor sismilarities. After this, lower of cost or net realisable price principle is applied
for each category (not of individual item in the category.
(3) Item by Item Method - The cost and net realisable prices are compared by each item and lower
of the two is used for valuation of inventory.
According to AS-2 comparison of the historical cost with net realisable value van be made separately
for each item of inventory, or for groups of similar items. However comparison of the net realisable value of
all dissimilar items ion a class of business, or all inventories of an enterprises on an overall bais, with the
aggregate of the cost of all those items is not advisable because it amounts to setting off loss against unrealised
profi.
27
Illustration
Bed Sheet
Carpets Qty. Cost Mkt. Qty. Cash <kt.
Rs. Rs. Rs. Rs. Rs.
Coarse 50 60 50 100 20 18
Fine 100 100 125 200 30 28
How will value the inventory at lower of cost of market under-
(a) Total Inventory Method
(b) Group Method
(c) Item by Item Method
Solution
(a) Total Inventory Method
Price X Qty.
Qty. Cost Market Cost Market
Rs. Rs. Rs. Rs
Carpets
Coarse 50 60 50 3,000 2,500
Fine 100 100 125 10,000 12,500
Bed-Sheets
Coarse 100 20 18 2,000 1,800
Fine 200 30 28 6,000 5,600
21,000 22,400
Value of inventory = Rs. 21,000
(b) Group Method
Qty. Cost Market Price X Qty Lower of
Cost Market cost or market
Rs. Rs. Rs. Rs. Rs.
Carpets
Coarse 50 60 50 3,000 2,500
Fine 100 100 125 10,000 12,500
13,000 15,000 13,000
28
Bed Sheets
Coarse 100 20 18 2,000 1,800
Fine 200 30 28 6,000 5,600 7,400
8,000 7,400 20,400
Value of inventory = Rs. 20,400
(c) Item by Item Method
Quty. Cost Market Price X Qty. Lower of
Cost Market Cost or market
Carpets
Coarse 50 60 50 3000 2,500 2,500
Fine 100 100 125 10,000 12,500 10,000
Bed Sheets
Coarse 100 20 18 2,000 1,800 1,800
Fine 200 30 28 6,000 5,600 5,600
19,900
Value of Inventory = Rs. 19,900
Ilustration
Mr. Vijay is financial year ends the following 30 June 1994 when it is ascertained at Rs 7,425 you find
that
(i) Sales are entered in the sales book on the day as despatched and returns inwards in return inward
both to have the goods are received back.
(ii) Purchases are entered in the Purchase Day Book as the invoice are received.
(iii) Sales between 30 June and 8 July 1994 as per sales Day Book and Cash Book are Rs 8,600.
(iv) Purchases between 30 June and 8 July as per purchase day book are Rs 660 but these goods amounting
Rs 60 are not received until after stock was taken.
(v) Goods involved during June (before 30 June) but not received until after 30 June amounted to Rs
500 of which Rs 350 worth are received between 30 June to 8 July 1994.
(vi) Rate of Gross profit is 33 1/3 %on cost
29
Solution:
Calculation of Stock A on 30 June, 1994 Rs. Rs.
Stock as on 8 July 1994 7,425
Add: Cost of goods sold 8,600
Less Proft 25% 2,150 6,450
Less: Purchases enterd 660 13,875
Less Received after 8 July 60 600
13,275
Add: Purchases invoiced before 30 June 1994 received
Upto 8 July (500-350) Stock on 30 June 1994 150
13,425
IAS -2 INTERNATIONAL ACCOUNTING STANDARD
Valuation and Presentation of Inventories in the context of the Historical Cost System
Introduction
1. This Statement deals with the valuation and presentatioon of inventories* in financial statements in
the context of the historical cost system, which is the most widely adopted basis on which financial
statements are presented.
2. The Committee is aware of other systems that ate proposed or used in financial istatements, includiog
systems that ate based on replcement costs or other curretn values. Inventroy valuation and
presentatioion in the context of those other systems ar ebeyond the scope of this statement.
International Accounting Standard 1. Disclosure of Accounting policies, requires that the system
adopted must be clearly stated.
3. The Stat em en does not deal with inventories accumulated under loang-term construction contracts
and with in ventory treatment of byproducts.
4. The following terms are used in this atatement with the meanings specified:
Inventories are tangle property (a) held for sale in the ordinary course of busines, (b) in the process of
production for such sale or (c) to be consumed in the production of goods on services for sale.
Historical cost of inventories is the aggregae of costs of purchase, cost of conversion and other costs
incurred in brigning the inventories to their present location nd condition.
Cost of purchase comprise the purchase price including import duties and other purchase taxes, transport
and handling cost, and any other directly attributable costs of acquisition leess trade discounts, rebates, and
subsidies
Costs of voncersion are those costs in addition to the costs of purchases, that relate to bringing the
inventories to their present location and condition.
30
Net realisabe value is the estimated selling price of the assets of many enterprise. The valuation and
presentation of inventories therefore have a significant effect in determining and presenting the financial position
and results of operations of those enterprise.
Determination of Historical Cost

6. In determining historical costs as defined in paragraph 4, defferent interpretations arises in practice
as regards production overhead, other overheads,, and the cost formula to be used.
7. production overhead is comparised of costs incurred for production other than direct materials, and
labour, Examples are indiect materials, and Iabout depreciation and maintenance of factory buildings
and equipment, and the cost of factory management and administration.
8. Production overhead requires analysis to determine the portion related to bringing the inventories to
their present location and condition and thus to be included in the cost s of conversion when
determining the historical cost of inventories.
9. Both fixed and varibal production overheads incurred during production are usually allocated to
costs of conversion. That practivce is based on the view that they are both incurred in putting
inventories in their presetn location and condition. Fixed production overhead is sometimes excluded
in whole or in part from costs of conversion on the ground that it is not condidered to relate directly
to putting inventories in their present location and condition.
10. In a period of low production or if there is idle plant, it is customary to restrict the allocation of fixed
prodduuction overhead to the costs of conversion by relating it yo yr capacity of the production
facilities and not ot the actual level of the output. Capacity of the production facitlities is variously
interpreted, for example, as the normal production expected to be achieved over a number of periods
or seasons or as the maximum production that as a practical matter can be achieved. The interpretation
is determined in a advance and appliedconsistently, and is not modified for temporary conditions.
11. Similarly, exceptional amounts of waste-material, lobour, or bother expenses-which do not relate to
bringing the inventories to theior presetn location and condition are excluded from converstion cost.
Other Overheads
12. Overheads other thatn profudtion overhead are somtime incurred bringing inventories to their presetn
location and condition, for example expenditues incurred designing products for specific customers.
On the other hand, selling expenses, general administration overheads, research and development
costs, and interest are usually considered not to relate to putting the inventories in their present
location and condition.
Cost Formula Used

13. Several different formulae with widely different effects are in current use for the purpose of assigning
costs, including the following:
(a) First-in,first-out (FIFO)
(b) Weighted average cost
(c) Last-in, First-out (LIFO)
(d) Base stock
(e) Specific indentification
(f) Next-in first out (NIFO)
(g) Latest purchase price.
31
14. The FIFO, weighted average cost, LIFO, base stock, and specific identification formulae use costs
that have been incurred by the enterprise at one time or another. The NIFO and atest pruchase price
methods use costs that have not all been incurred and are therefore not based on historical cost.
15. Specific identification is formula that attributes specific costs to identified items inventory. This is
an apporopriate treatment for goods that have been bought or manufacturedand are segregated for a
specific project, if it is used, however, in respect of items of inventory which are ordinary
interchangeable, the section of items could be made in such a wasy as to obtain predetermine effects
on profits
Valuation of Inventories Below Historical Cost

16. The historical cost of inventories may not be realisable if their selling prices have declined, it they
are damaged, or if they have become wholly or partially obsolete. The practice of writing inventories
down below historical cost to net realisable value accords with the view that the view that current
assets should not be carried in excess of amountsse exected to be realised,. Declins in value are
computed separately for individual items, grouls of similar items, an entire clas of inventopry (for
example, finished goods), or items relating to a class of business, or they are cemputed onan overall
basiss o for all the inventories of the enterprise. The practice of writing inventories down based on
a class of inventory, on a class of business, or on an overall basis results in offsetting lossed incurred
against unrealised agains.
17. In some countires, writedowns are made which are not based on the practices described in paragraph
16. For example, writedowns below historical cost are arrived at by applying an arbitrary percentage
to the amounts otherwise computed or by undiscclosed reductions that result in secret reserves;
these produce inappropriate effects on financial statements.
18. The sub-classification of inventories in financial statements readers of the amounts held in different
categories and the extent of the changes from period to period. Common sub-classifications are
materials work in progress, finished goods, merchandise, and produuction supplies.
19. "inventories" in balance sheets usually consist of items included in the definition of inventories in
paragraph 4. Other items are sometimes shown under the heading "Inventories", for example, non
production supplies and research and development supplies.
INTERNATIONAL ACCOUNTS STANDARD -2
Valuation and Presentation of Inventories in the Context

of the Historical Cost System
International Accounting Standard-2 comprises paragraphs 20-36 of this Statement
of this Statement and of the preface to Statements
of International Accounting Standards.
20. Inventories should be valued at the lower of historical cost and net realisable value.
Ascertainment of Historical Cost

21. The historical cost of manufactured inventories should include a systematic allocation of those
production overhead costs that relate to putting the inventories in their present location and condition.
Allocation of fixed production overhead to the costs of conversion should be based on the capacity
of the facitlity. If fixed production overhead has been entirely or substantially excluded from the
32
valuation of inventories on the ground that it does nt directly relate to putting the inventories in their
present location and condition, that fact should be disclosed.
22. overheads other than production overhead should be included as part of inventory cost only to the
extent that they clearly relate to putting the inventories in their present location and condition.
23. Exceptional amounts of wasted material, labour, or other expenses shopuld not be included as part
of inventory cost.
24. Except as set out in paragraph 25 and 26, the historical cost of inventories should be accounted for
using the FIFO formula or a weighted average cost formula.
25. Inventories of items that are not ordinaryily interchangeable or goods mnufactured and segrefated
for specific projects should be accounted for, by using specific, identification of their individual
costs
26. The LFIO or base stock formulas may be used provided that there is disclosur of the difference
between the amount of the inventories as shown in the balance sheet and either (a) lower of the
amount arrived at in accordance with paragraph 25 and net realisable value or (b) the lower of
current cost at the balance sheet date and net realisable value.
27. Techniques such as the standard cost method of valuing products or the retai method of valuing
merchandise may be used for convenience, if they approximate consistently the results that would
be obtained in accordance with paragraph 20.
Ascertainment of Net Realisable Value

28. Estimates of net realisable value should be based not on temporary fluctuations of price or cost but
on the most reliable evidence available at the time the estimates are made as to what the inventories
are expected to realise.
29. Inventories should be written down to net realisable value item by iem or by groups of similar items,
whichever method is used hsould be consistently applied.
30. The net realisable value of the quantity of inventory held to satisfy firm sales contracts should be
based on the contract price. If the sales contracts are for less than the inventory quantities held, net
realisable value for the excess should be based on general market prices*
31. Normal quantities of materials and other supplies held for incorporation in the poduction of goods
should be written down below historical cost, if the finished products in which they will be incorporate
are expected to be realised at or above hisorical cost. Nevetheless, a decline in the price of materials
amy indicate that the histocial cost of finished products to be produced will exceed net realisable
value in which event a writedown of the materials inventories should be made: in this event,
replacement cost may be the best avauikable mesure of the net realisable value of thos materials.
Presentation in the Financial Statements

32. The profit and loss of the priod should be charged with the amount of inventories sold or used
(unless allocated to other asset accounts) and with the amount of any write down in the period to net
realisable value.
33. Inventories should be sub-classified in balance sheets or in notes to the financial statements in a
manner which is approprioare to the business and so as to indicate the amounts held in each of the
main categories.
34. The accounting policies adopted for the purpose fo valuation of inventories, including the cost
formula used, should be diclosed, A change in an accounting policy related to inventories that has a
33
material effect in the current period or may have a material effect in subsequent periods should be
disciosed together tith the reasons.The effect or the change should, if material, be cdisclosed and
quantified. (See International Accounting Standard -1 Disclosure of Accounting Polocies).
35. If items are shown under the caption "inventories" Other than those comprehended by the definition
in paragraph, 4 their nature, amounts and basis of valuation should be disclosed.
Effective Date
36. This international Accounting Standard becomes operative for financial statements covering periods
beginning on or after January 1,1976.
ACCOUNTING STANDARD: 2 (AS: 2)

VALUATION OF INVENTORIES
The following are the specific requirements of Accounting Standard: 2, issued by the Institute of Chartered
Accountants of India regarding valuation of inventories.
(i) Inventories should be valued at lower of historical cost and net realisable value except in the following
circumstances.
(a) Inventory of consumable stores and maintenance supplies should ordinarily be valued at cost.
In appropriate circumstances, however, they may be valued at below cost.
(b) Inventory of by-products should be valued at lower of cost and net realisable value. Where cost
of the by-product cannot be separately determined, it should be valued at net realisable value.
(c) Inventory of reusable waste should be valued at raw material cost less reprocessing cost where
facilities for reprocessing exist.
(d) Inventory of non-reusable waste or inventory of reusable waste for which facilities for
reprocessing do not exist should be valued at net realisable value.
(ii) For the purpose of comparing historical cost with net realisable value each item in the inventory
may be dealt with separately, or similar items may be dealt with as a group.
(iii) The historical cost of inventories should normally be determined by using 'FIFO' "Average Cost" or
"LIFO" methods.
(iv) the 'specific identification' method may be used for inventories of items that are not ordinarily
interchangeable, or for goods manufactured and earmarked for a specific purpose.
(v) The 'adjusted selling price' may be used in retail business or in businesses when the inventory
comprises items the individual costs of which are not readily ascertainable.
(vi) The 'standard cost' method of valuing inventories may be used if the results approximate consistently
the result that would be obtained in accordance with paragraph (iii).
(vii) The 'base stock' method may be used in exceptional circumstances only.
(viii) The historical cost of manufactured inventories may be arrived at on the basis of either direct costing
or absorption costing. Where absorption costing has been used, the allocation of fixed costs to
inventories should be based on the normal level of production.
(ix) Overheads other than production overheads should be included as part of the inventory cost only to
the extent that they clearly relate to putting the inventories in their present location and condition.
34
(x) The accounting policy adopted for valuation of inventories, including the cost formulae used should
be disclosed in the financial statements. Where the base stock method is used, the difference between
the value at which it is carried and the value by applying the method at which stock in excess of the
base stock is valued should be disclosed.
(xi) Consistency is generally accepted as a fundamental accounting assumption/Therefore, any change
in the accounting policy relating to inventories (including the basis of comparison of historical cost
with net realisable value and the cost formulae used) which has a material effect in the current
period or which is reasonably expected to have a material effect in later periods should be disclosed.
In the case of a change in accounting policy which has a material effect in the current period, the
change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable,
wholly or in part, the fact should be indicated.
UNIT-III
LESSON 1
36
not supposed to refund any of the amounts already received by him on repossession of goods for
non payment of any of the instalments by the hire-purchaser. Alternatively, under certain conditions
the hire purchaser may be allowed to retain a certain part of the property, or the hire vendor may
make an allowance for the property returned
(f) Instalments to be treated as hire : As said above every instalment (except the last on e) is treated as
hire for the use of goods as against the purchase price thereof. But with the payment of the last
instalment, every prior instalment is retrospectively treated as a payment for the price of the goods
so delivered.
(g) Liability for the outstanding instalments : The hire-purchaser, under a hire purchase agreement, is
liable for the outstanding (due but unpaid) instalments even after the seller decides to repossess the
goods for non-payment of the instalment by the hire-purchaser.
(h) Liability for future or undue liability : The hire-purchaser is not required to pay the future or undue
instalments once the goods are repossessed by the hire-vendor.
(i) Undertaking by the hire purchaser : The hire-purchaser cannot sell, destroy, damage, exchange or
pledge the goods until the final payment he frequently has to undertake to keep the goods in sound
repair and good condition until the last payment is made. Whereas the hire purchaser has the option
to buy, the hire-vendor is bound to sell.
Difference between hire-Purchase and Credit Sales

Hire-purchase transactions must be distinguished clearly from credit sales, in which the absolute
ownership is immediately transferred to the purchaser, and in which , on default by the purchaser, the seller
cannot repossess the goods, but can only sue for the unpaid instalments. But in case of hire purchase the hire
vendor has the right to repossess the goods so delivered if the hire purchaser makes default in making payment
of any instalment.
Difference between hire-Purchase and instalment System

The students should very carefully note the distinction between hire-purchase contracts and instalment
contracts. More so because in both the cases, the goods are sold on credit and payment is received in instalments.
The fundamental distinction between the two is that under a hire-purchase agreement the property in the goods
does not pass to the hire-purchaser until he has paid the last instalment, or exercised the option to purchase, as
the case may be. Till then the property in the goods remains with the hire-vendor, although they are in the
possession of the hire-purchaser. The hire-vendor may repossess the goods, if the hire-purchaser fails to pay an
instalment without in any way compensating the hire purchaser for the amount already paid by him. But in the
case of an instalment agreement, the property in the goods passes to the purchaser immediately on delivery. In
the event of default by the purchaser, the seller's only remedy is to use for the unpaid instalments, he cannot
repossess the goods.
Before we pass on to actual accounting entries let us discuss the problems that one is likely to face
while solving the hire purchase question. These are:-
1. Calculation of interest where cash price, interest rates and insalment are given.
As stated above ordinarily the instalment includes the amount of interest Interests being a nominal
account, its amount should be separated from the cost of the asset. It is very easy to do so once we know and
understand that total Hire-Purchase Price = Cash Price of the goods plus Total Interest. Thus Total Interest=
Hire Purchase Price Less Cash Price of the goods. But it is not enough to find out total Interest as it is or the total
period over which instalments as spread over. To be just and equitable what is required is not the calculation of
total interest, but the periodical interest so that the Profit and Loss Account of the year to which interest belongs
37
can be debited. This can be done by preparing a Memorandum Account of either the Hire-vendor or that of the
Hire-Purchaser. It is prepared in the usual manner.
Example 1
On April 1,1991 Reclamation Limited took delivery of a truck from Temple Truck Dealers on hire
purchase. Payment to be made by three equal instalments of Rs. 3,000 each on March 31, 1993 and 1994. The
Cash value of the truck was Rs. 8,170, the Vendors charging interest at 5% per annum on yearly balance.
Reclamation Limited took delivery of a truck from Temple Truck Dealers on hire purchase, Payment to be made
by three equal instalments of Rs. 3,000 each on March 31, 1992, 1992 and 1994. The Cash value of the truck
was Rs. 8,170, the vendors charging interest at 5% per annum on yearly balance. Reclamation Limited provide
25% depreciation on diminishing balance method. Calculate yearly interest to be charged to Profit and Loss
Account.
MEMORANDUM HIRE-VENDOR'S ACCOUNT

Date Particular Amount Date Particulars Amount
Rs. p Rs. P.
1992 To bank 3,000.00 1992 By Bank 8,170.00
Dec. 31 To Balance c/d 5,578.50 Jan. 1 By Interest 408.50
8,578.50 8,578.50
1993 To Bank 3,000.00 1993 By Balance b/d 5,578.50
Dec. 31 To Balance c/d 2,857.43 Jan. 1 By Interest 278.93
5,857.43 5,857.43
1994 1994 By balance b/d 2,857.43
Dec. 31 To Bank 3,000.00 Jan. 1 By Interest 142.47
Dec. 31 (Balance fig.)
3,000.00 3,000.00
Working Notes:
(i) Interest on the last payment is taken at the differential figure of Rs. 142.57 (viz. Ri 3,0000.00-Rs.
2857-43) although the computed figure is Rs. 142.87. The difference i ignored for the sake of round
of the instalments.
(ii) Interest at 5% per annum is calculated on the reducing balance of amount outstanding.
2. Calculation of interest where rate of interest is not given
Mathematically speaking total interest should be allocated between the years instalment in proportion
of outstanding cash price (or principal) But it is very complicated. Therefore, it i usually appointed in the
proportion of outstanding instalment or hire-purchase price with the hel of a table. For practical purposes it is
fairly precise and simple basis of apportionment.
Example 2:
Assuming the facts as given in example 1, except that the rate of interest is not giver calculate the
amount of interest that should be charged to each year's Profit and Loss Account.
38
Solution:
Total Interest = Total Hire Purchase Priced-Total Cash Price
or Rs. 9,000- Rs. 8,170 = Rs.830
This amount of Rs. 830 will be apportioned in the ratio of 3:2:1 as follows :
Instalment Amount outstanding Ratio Interest
1. 9,000 3 3/6 x 830 = Rs. 415
2. 6,000 2 2/6 x 830 = Rs. 277
3. 3,000 1 1/6 x 830 = Rs. 138
If we look at these figures and the compared figure; (as example 1 we find a difference between the
two. This is unavoidable in the second case the figures were estimates only which may or may not reasonable
with exactly calculated figures. These difference are, therefore, to be ignored.
3. Calculation of Cash Price where rate of interest and instalments are given
Sometimes the hire-pucehase problem may omit cash price. Gash price as we know is required for
preparing the asset account in the books of the hire-purchase. The way to proceed is take up the last instalment
first (or to start in ascending order) and to deduct interest from it. The amount of interest can be found out as
follows :-
Rate of Interest
Amount due at the end of the year x 100 + Rate of Int.
Suppose Prem owes Narain Rs. 100 on its January, 1992, the rate of interest being 6% then Prem will
have to pay Rs. 105 on 31st December, 1993. Out of the amount of Rs. 106, 6/ 100 of the amount due the end is
interest. We can find out the amount due at the beginning of the year by deducting the amount of interest for the
year calculated as above. This will also be the amount due at the end of last but one year after paying that year's
instalment. The total of these two will give amount due at the end of the last but one year before paying the
instalment. The amount due at the beginning of that and other previous years then can be found out by applying
a similar procedure. It can also be done with the help of a table.
Assuming the same facts as in Example I except that no cash price is given, find out the Cash Price.
Solutions:
Instal Amount due at Amount of Total amount due Interest Principal or
ments the end of the instalment at the end of the year @ 5/105 amount due
year (after paying paid (before paying in the beginning
instalment instalment) of the year.
Rs. P. Rs. P. Rs. P. Rs. P. Rs. P.
3. Nil 3,000.00 3,000.00 143 2,857.00

2. 2,857.00 3,000.00 5,857.00 279 5,578.00
1. 5,578.00 3,000.00 8,578.00 408 8,170.00
Thus Cash Prices = Rs. 8,170 + Cash Down, if any,

39
NOTE: Cash down means the amount paid at the time of signing the agreement, Since there is no time gap
between the signing of the agreement and the cash down payment, no interest occurs and entire
amount goes to increase the overall cash price.
Accounting Treatment
If strict regard is had to legal nature of the contract, the goods should be treated as continuing to belong
to the hire-vendor until all the payments have been paid, and until that time the hire purchaser should treat the
instalments paid as payment for hire or for the option to purchase, except that the portion of each payment
representing interest, should be written off to Profit and LossAccount in the period to which it relates From the
point of view of the hire-vendor, it might be considered that no profit on the transaction has been earned until all
the instalments have been paid. Alternatively credit should be taken in cash accounting period for the profit
included in the instalments that have been paid.Alternatively, credit should be taken in cash accounting period
for the profit included in the instalments that have been received. The instalments not yet due are, in such a case,
treated as stock in trade, valued at proportionate cost.
Since the intention of both the parties is to buy and sell, records of such transactions are made in the
books of both the parties. It can, therefore, readily be received that no rigid rule of accounting can be laid down
owing to the large number of varying circumstances in different business.
Accounting Entries
Set out below are various methods, any of which can be adopted to fit the circumstances (having regard
to the type and value of the goods, and the length of the period of purchase etc.) of the case.
Hire-vendor's Books
The following entries are passed by the hire-vendor :
1. On sale of goods on Hire-Purchase basis
Hire Purchaser's Ale ... Dr. With the Cash price of goods
To Sale
2. On receiving the amount of Cash Down
Bank Account ... Dr. With the amount of Cash down.
To Hire-Purchaser's Ale
3. On Interest becoming due on I Instalment
Hire-Purchaser's Ale ... Dr With the amount of interest.
To Interest Account
4. On receiving the amount of instalment
Bank Account ... Dr. With the amount of instalment.
To Hire Purchaser's Ale
5. For Transferring the Interest to P&LA/c
Interest Ale ... Dr.
To Profit & Loss Ale
Entries 3,4, and 5 will be repeated in subsequent year also :
40
Example 4:
Assuming all facts as given in Example 1, pass the necessary journal entries and prepare Ledger Account
in the books of Hire-vendor.
TEMPLE TRUCK DEALERS

Journal Entries
Date Particulars L.F. Dr. Amount Cr. Amount
Rs. P. Rs. p
1991
April, 1 Reclamation Ltd Dr. 8,170.00
To Sales Ale 8,170.00
Delivery truck sold on hire-purchase recorded
at cash sales price
1992
March., 31 Reclamation Ltd. Dr. 408.50
To interest Ale 408.50
Interest@ 5% on Rs. 8,170 made due.
March, 31 Bank Ale Dr. 3,000.00
To Reclamation Ltd 3,000.00
Receipt of first instalment
1993
March, 31 Reclamation Ltd Dr. 278.93
To Interest Ale 278.93
Interest@ 5% on Rs. 5,578.50 made due
March, 31 Bank Ale Dr. 3,000.00
To Reclamation Ltd 3,000.00
Receipt of second instalment
1994
March, 31 Reclamation Ltd. Dr 142.57
To Interest Ale 142.57
Interest@ 5% on Rs. 2,857.43 made due
March, 31 Bank Ale Dr 3,000.00
To Reclamation Ltd. 3,000.00
Receipt of third and last instalment.
41
LEDGER ACCOUNTS
Reclamation Ltd.
Date Particulars Amount Date Particulars Amount

Rs. P. Rs. P.
1991 1992
April, 1 To SaleA/c 8,170.00 March, 31 By Bank 3,000.00
1992
March, 31 To Interest Ale 408.50 March, 31 By Balance c/d 5,578.00
8,578.50 8,578.00
1992 1993
April, 1 To Balance b/d 5,678.50 March, 31 By Bank 3,000.00
1993
March, 31 To Interest Ale 278.93 " By Balance c/d 2,857.43
5,857.43 5,857.43
1994 1994
April, 1 To Balance b/d 2,857.43 March, 31 By Bank 3,000.00
1984
March, 31 To Interest Ale 142.47
3,000.00 3,000.00
INTEREST ACCOUNT

Rs. P. Rs. P.
1993 To Profit & Loss 1992 By Reclamation Ltd. 408.50
March, 31 Account-Transfer 408.50 March, 31
408.50 408.50
1993 To Profit & Loss 1993 By Reclamation Ltd. 278.93
March, 31 Account-Transfer 278.93 March, 31
1994 To Profit & Loss 1994 By Reclamation Ltd.
March, 31 Account-Transfer 142.57 March, 31 142.57
SALES ACCOUNT
1992 To Trading Ale 1991 By Reclamation Ltd.
March, 31 Transfer 8,170.00 April, 1 8,170.00
42
Hire-Purchase's Books
The following are the principal methods of recording hire purchase transactions in the books of the
hire-purchaser :
The full cash price is debited to the Assets Account and the same figure is credited to Hire vendor's
Account. Interest is credited to his account periodically and all the cash payments's are debited.
Since the hire purchaser uses the entire asset from the very beginning, depreciation is charged on the
full cash price (with due regard to residual value and method applied as against the instalment paid. The required
journal entries are :
1. For acquiring the assets under hire-purchase agreement
Asset Account Dr. With the full price of the Asset.
To Hire Vendor
2. For making payment of cash down
Interest Ale Dr. Worth the amount of cash down.
Hire-vendor
3. For making the interest due
Interest Ale Dr. With the amount of interest.
To Hire-vendor
4. For making payment of instalment
Hire vendor Dr. With the amount of instalme
To Bank Account
5. For providing Depreciation
Depreciation Ale Dr. With the amount of depreciat
To Assets Account
Profit & Loss Ale Dr.
To Interest Ale
To Close Interest and Depreciation Ale
To Depreciation Ale
(B) The second method is based on the facts that the property or ownership does not vest in the purchaser
untill all the instalments are paid by him. The required journal entries under this method are :-
1. Assets Ale Dr. With down payment of any becoming due
To Hire Vender Ale
2. Hire Vender Ale Dr.
To Bank Down payment made
3. Asset Ale Dr. Cash price of instalment, Interest on Instalment
Interest Ale Dr.
To Hire Vender Ale
43
4. Hire Vender Dr. H.P. Instalment paid

To Bank
5. Depreciation Ale Dr.
To Assets Depreciation charged
Note : Depreciation is always charged on the total cash price of the aaset and note on the debit bvalance
shown by the asset account.
6. Profit & Loss Ale Dr. Interest & Depreciation a/cs. closed by trans
To Interest Ale ferring to p & L Ale
To Depreciation Ale
Entries 3, 4, 5, 6, will be repeated for subsequent instalment in the future years.
Example 5
Assuming the same facts as given in example number 1 pass the required journal entries in the books of
Reclamation Ltd. and prepare Ledger Accounts therein.
Solution:
RECLAMATION LTD.
(Journal Entries)
Rs. P. Rs. p
1991
April, 1 Truck Ale Dr. 8,170 00
To Temple Truck Dealer 8,170 00
Purchase of one truck on hire-purchase Basis
1992
March, 31 Interest Ale Dr. 408 50
To Temple Truck Dealers 408 50
Interest @ 5% on Rs. 8,170 made due.
March, 331 Temple Truck Dr. 3,000 00

To Bank Account 3,000 00
Payment of first instalment
March, 31 Deprecitaion Ale Dr. 2,042 50
To Truck Ale 2,042 50
Depreciation 25% on Rs. 8,170.
44

Rs. P. Rs. p
March, 31 Profit & Loss Ale Dr. 2,451 00
To Interest Ale 408 50
To Depreciation Ale 2,042 50
Transfer entry.
March, 31 Temple Truck Dealers Dr. 3,000 00

To Bank 3,000 00
Payment of second instalments.
March, 31 To Depreciation Ale Dr. 1,531 87

To Truck Ale 1531 87
Depreciation @ 25% on Rs. 6,127,50
March, 31 Profit & Loss Ale Dr. 1,810 80

Transfer entry.
1994
March, 31 Interest Ale Dr. 142 57
To Temple Truck Dealers 142 57
Interest @ 5% on Rs. 2,857.43 made due.
March, 31 Temple Truck Dealers Dr. 3,000 00

To Bank 3,000 00
Payment of third and last instalment.
March, 31 Depreciation Ale Dr. 1,148 91

To Truck Ale 1,148 91
Depreciation @ 25% on Rs. 4,595.63
March, 31 Profit 7 Loss Ale Dr. 1,291 48

Transfer entry
45
LEDGER ACCOUNT
Truck Account
Date Particulars L. F. Amount Date Particulars L.F Amount

Rs. P. Rs. P.
1991 1992
April, 1 To Temple Truck March, 31 By Depreciation 2,042.50
Dealers 8,170.00 1993 By Balance c/d 6,127.50
8,170.00 8,170.00
1992
April, 1 To Balance b/d 6,127.50 March,. 31 By Depreciation 1,531.87
" By Balance c/d 4,595.63
6,127.50 6,127.50
1993 1994
April, 1 To Balance b/d 4,595.63 March, 31 By Depreciation 1,148.91
" By Balance c/d 3,446.72
4,595.63 4,595.63
1994
April, 1 To Balance b/d 3,446.72
Temple Truck Delaer

Rs. P. Rs. P.
1992 1991
March, 31 To bank 3,000.00 April, 1 By Truck Ale 8,170.00
1992 1985
To Balance c/d 5,578.50 March, 31 By interest Ale 408.00
8,578.50 8,578.50
1992 1992
March, 31 To Bank 3,000.00 April 1 By Balance b/d 5,578.50
1994 1993
To Balance c/d 2,857.43 March, 31 By interest Ale 278.93
5,857.43 5,857.00
1994
March, 31 To bank 3,000.00 April, 1 By Balance b/d 2,857.43
1994
March, 31 By Interest Ale 142.57
3,000.00 (Bal. Fig.) 3,000.00
46
INTEREST ACCOUNTS

Rs. P. Rs. P.
1992 To Temple Truck 1992
March, 31 Dealers March, 31 By Profit & Loss
408.50 Ale Transfer 408.50
March, 31 Dealers March, 31 By Profit 7 Loss
279.93 Account -transfer 278.93
March, 31 Dealer 142.57 March, 31 By Profit & Loss 142.57
Account-Transfer
DEPRECIATION ACCOPUNT
Date Particulars L.F. Amount Date Particulars L.F Amount

Rs. P. Rs P.
1992 1992
March, 31 To Truck Ale 2,042.50 March, 31 By Profit & Loss 2,042.50
Account - transfer
1993 1993
March, 31 To Truck Ale 1,531.87 March, 31 By Profit & Loss Ale 1,531.87
1994 -Ttransfer
1994
March, 31 To Truck Ale 1,148.91 March, 31 By Profit & LossA/c 1,148.91
-Transfer
Default and Repossession

As stated above where the hire-purchaser makes a default in making the payment of any instalment, the
hire-vendor has a right to repossess the goods sold on hire-purchase basis without in any way compensating the
buyer for the instalments already paid by him. The instalments already paid by the hire-purchaser are treated as
hire for the use of the commodity till the date of the repossession. The Hire-vendor in such a case has also the
right to recover from the hire purchaser the instalments becoming due upto the date of repossession. The right of
the hire-vendor arises due to the fact that in hire-purchase agreements the property in the goods sold on hire
purchase basis does not pass to the buyer unless and until the buyer makes payment of all the instalments. In
practice, however, the hire-vendor exercises this right discriminatingly because indiscriminate repossessions
47
may adversely affect his business. Accordingly, he taken eitheir complete or partial repossession depending
upon the circumstance of each case, let us now discuss each of these in some detail.
Complete repossession
Possession is said so be complete where the hire-vendor repossess, on default by the buyer, the entire
goods sold on hire-purchase basis.
The accounting treatment in case of repossession of goods in the books of the hire-purchaser and hire
vendor will be as follows:
Book of Hire-Purchaser
(a) Where first method of passing the journal entries is followed. In this case, the buyer debits the asset
account and credits the hire-vendor's account with the full cash price of the asset at the time of purchasing the
asset on hire-purchase basis, it means he opens an asset account and a hire-vendor's account in his books. So
when the asset is repossessed by the vendor, he has to close both these accounts. This he can do by first debiting
the hire-vendor's account by cash paid, if any, and then by transferring the balance in the hire-vendor's account
to the asset account. Balance, if any, left in the asset account being in the naturle of profit or loss on repossession
by the hire-vendor shall be transferred by him to the profit and loss account.
1. Pass as usual all entries except the entry for payment upto the date of repossession.
2. Far making payment, if any hire-vendor
Hire-Vendor Dr. With the amoung, if any, paid to the hire-vendor.
To Cash/Bank Account
3. For Clossing tyhe Hire-Vendor's Account

Hire-Vendor's Account Dr. With the balance in Hire-Vendor's Account
To Asset Account
4. For Loss on repossession

Profit and Loss Account Dr. With the balance in Asset
To Asset Account Account
In case of Profit, entry number 4 will be reversed.
(b) Where second method of passing the journal entries is followed: In this case the hire-purchaser uses
"Asset Actual Method" recording the hire-purchase transactions in his books. Under this method he capitalises
equivalent to the cash price of the instalment as and when paid. Accrodingly, he opens the Hire-vendor's account
and immediately closes it down after making the entry for payment of instalment etc. therein. He, however,
maintains an asset account at the amount paid less depreciation, if any, figure
(i) All entreis except the entry for payment will be passed as usual upto the date of repossession.
48
(ii) For closing the Asset Account

Profit and Loss Account Dr. With the balance in Asset Account
To Asset Account
Hire-Vendor's Books
The hire-vendor, on repossession, will pass the following journal entries in his books:
(1) All entries, except the entry for payment will be passed as usual upto the date of repossession
(2) For receiving the payment, if any, from the hire-purchaser
Cash or bank Account Dr. With the amount, if any, received
To Hire-Purchase's Account
(3) Closing the hire purchaser's Account
Goods Repossessed Account Dr. With the estimated value of goods repossessed
To Hire-Purchaser's Account
It be noted here that the goods repossessed account is debited and hire-purchaser's account is credited
with the present 9estirnated0 value of goods and not with the amount due for which such goods are repossessed.
The balance, if any, in the hire-purchaser's account is then transferred to Profit and loss Account.
(4) For Profit on Repossession
Hire-purchaser's Account Dr. With the credit balance in hire-purchaser's
To Profit and loss Account Account
(5) For Loss on Repossession
Profit and Loss Account Dr. With the debit balance in Hire -Purchaser's
To Hire-purchaser's Account Account
(6) For expenses incurred in renovating the repossessed goods
Goods Repossessed Account Dr. With the amount of expenses
To Cash/bank Account
(7) For the sale of repossessed goods
Cash/bank Account Dr. With the amount of sale proceeds.
To Repossessed Goods Account
(8) Profit on sale of repossessed goods
Repossessed goods Account Dr. With the amount of profit
Note: In Case of Loss, this entry will be reversed.

49
Example
On January 1, 1993 Ideal Engineers sell on hire-purchase system a machine to Trichur Laboratories for
Rs. 35,500, payable Rs. 8,000 on singing the contract and the balance in 5 annual equal instalments, commencing
from the end of 1993. The cash sale price of the machine is Rs. 28,850 and the rate of interest charged is 10%
per annum.
After paying cash down and the first year-end instalment, the hire-purchaser fails to pay the next
instalment, whereupon the hire-vendor takes back the machine on which 15% depreciation 9on written down
valueO has been charged by the former. T he cost of recapture amounts to Rs. 300 and the machine is assessed
at Rs. 19,400.
The machine is subsequently sold for Rs. 22,000 after incurring Rs. 1,500 in renovating the same.
Show the important ledger accounts in the books of both the parties.
Books of Trichur Laboratories

Ideal Engineers
Rs. P. Rs. P.
1993 1993
Jan. 1 To Bank Account 8,000 Jan., 1 By Machine Ale 28,850
Dec., 1 To Bank Account 5,500 Dec., 1 By Interest Ale 2,085
To Balance cld 17,435
30,935 30,935
1994 1994
Dec., 31 To Machine Ale 19,178 Jan., 1 By Balance bid 17,435
(Balancingfigure) Dec., 31 By Interest Ale 1,743
19,178 19,178
Machine Account
Rs. Rs
1993 1993
Jan. 1 To Ideal Engineers 28,850 Dec., 1 By Depreciation Account 4,327
By Balance bid 24,523
28,850 28,850
1994 1994
Jan., 1 To Balance bid 24,523 Dec. 31 By Depreciation Account 3,678
By Idea Engineers 19,178
ByP&LAte. 1,667
24,523 24,523
50
Note : Total loss suffered by Trichur Laboratories is equal to Rs. 3,410, i.e., Rs. 1,743 on account of
interest for the second year and Rs. 1,667 on account of seizure of assets by the hire-vendor.
Books of Ideal Engineers

Trichur laboratories
Rs. Rs.
1993 1993
Jan., 1 To Sales Accounts 28,850 Jan., 1 By Bank Account 8,000
Dec., 31 To interest Account 2,085 Dec., 31 By Bank Account 5,500
By Balance c/d 17,435
30,935 30,935
1994 1994
Jan., 1 To Cash Balance b/c 17,435 Dec., 31 By Goods Reposse
Dec., 31 To Interest Account 1,743 ssed Account 19,400
To Bank Account 300 By profit & Loss Account-loss 78
(Reposession Expenses)
19,478 19,478
Goods Repossessed Account

Rs. Rs
1994 1994
Dec., 31 To Trichur laboratories 19,400 Dec., 31 By Bank-Sale Proceeds 22,000
To Bank Account-
Renovation Expenses 1,500
To Profit & Loss Ale profit 1,100
22,000 22,000
Second Method
Books of Trichur laboratories
Ideal Engineers
Rs. Rs.
1993 1993
Jan., 1 To bank Account 8,000 Jan., 1 By Machine Account 8,000
Dec., 31 To bank Account 5,500 Dec., 31 By Machine Account 3,415
13,500 13,500
51
Machine Account
Rs. Rs.
1993 1993
Jan., 1 To Ideal Engineers 8,000 Dec., 31 By Depreciation Account 4,327
Dec., 31 To Ideal Engineers 3,415 By Balance c/d 7,088
11,415 11,415
1994 1994
Jan., 1 To Balance b/d; 7,088 Dec., 31 By Depreciation Account 3,678
By Profit and Loss Account-
Total Loss 3,410
7,088 7,088
Partial Repossession
The hire-vendor, may not be harsh enough to take possession of the entire asset. He may adopt a
considerate view and permit the hire-purchaser to retain a portion of the asset or a few pieces (where more than
one pieces are delivered on hire-purchase basis). In such a case, the price for the seized items is settled between
the two parties and their relation in respect of the retained items becomes that of an ordinary debtor and a
creditor, sincle the hire-purchase contract terminates by commission of default.
Account Treatment
The accountng, Treatment is substantially the same as explained under 'complete
repossession'>However, personal and assets accounts carry balances. The asset account should show the book
value of the asset still in hand.
Example
X purchased seven trucks on hire-purchase on 1st July, 1993. The cash purchase price of each truck
was Rs. 50,000. He was to pay 20% of the cash purchased price at the time of delivery and the balance in five
half yearly instalments starting from 3st December, 1993 with interest at 5% per annum.
On X's failure to pay the instalment due on 30th June, 1994 it was agreed that X would return 3 trurks
to the vendor and remaining 4 would be retained by him. The returning price of 3 trucks was Rs. 40,000.
Purchaser charges depreciation @ 20% per annum.
Vendor after spending Rs. 1,000 on repairs, sold away all the three trucks for Rs. 40,000.
Show Truck Account and Vendor's Account in the books of X and X's Account and Goods Returned
Account in the books of the vendor, assuming that their books are closed in June every year.
52
In the Book's of 'X'

Rs. Rs.
1993 1993
July., 1 To Bank Account 70,000 July, 1 By Truck Account 3,50,000
Dec., 31 To Bank Account 63,000 Dec., 31 By Interest Account 7,000
1994 1994
June, 30 To Truck Account 40,000 June, 30 By Interest Account 5,600
To Balance c/d 1,89,100
3,62,600 3,62,600
1994
July 1 By Balance b/d 1,89,100
Truck Account
Rs. Rs.
1993 1994
July, 1 To Hire-Vendor's Account June, 30 By Depreciation 70,000
3,50,000 By Hire-Vedndor's Account 40,500
By Profit & Loss Account 79,500
By Balance c/d 1,60,000
3,50,000 3,50,000
In the Books of Hire-Vendor X's Account

Rs. Rs.
1993 1993
July, 1 To Sale Account 350,000 July, 1 By Bank Account 70,000
Dec., 31 To Intyerest Account 7,000 Dec., 31 By Bank Account 63,000
1994 1994
June, 30 To Interest Account 5,600 June, 30 By Goods Returned Account 40,500
Balance c/d 1,9,100
3,62,600 3,62,600
53
Goods Returned (Repossessed) Account

Rs. Rs.
1993
June, 30 To X's Account 40,000 June, 30 By Bank Account Sale Proceeds 40,000
Bank Account By Profit and Loss Account Loss 1,500
Repairs Expenses 1,000 (Balancing Figure)
41,500 41,500
Working Notes
(1) Calculation of interest Rs.
Cash Purchased price 9 Rs. 50,000 x 7) 3,50,000
Less Payment on Delivery 70,000
(20% of Rs. 3,50,000) 2,80,000
Rs.
Interest @ 5% on Rs. 2,80,000 for 6 months 7,000
Less Amount of first instalment (Rs. 2,80,000) 56,000
2,24,000
Rs.
Interest @ 5% on Rs. 2,24,000 for 6 months 5,600
(2) Calculation of Depreciation

Total Cash Purchase Price for 7 Trucks 3,50,000
Less Depreciation @ 20% written Down Value 70,000
2,80,000
(3) Calculation of loss on repossession
Written Down Value of 3 Trucks (Rs. 2,80,000 x 3/7) 1,20,000
Less Agreed Value of 3 Trucks siezed 40,500
Loss on Repossession 79,500
Try yourself
P. purchased 4 cars of Rs 14,000 - each on hire purchase system. The Hire-Purchase Price for all the
four cars was Rs. 60,000/- to be paid Rs. 15,000/- each down and three instalments of Rs. 15,000/- each at the
end of each year. Interest is charged @ 5% pa. buyer depreciates car at 10% pa. on straight time method.
After having paid down payment and first instalment, the buyer could not pay the second instalment
and the seller took possession of 3 cars at an agreed value to be calculated after depreciating the cars at 20% p.a.
on written down value method. One car was left with the buyer.
54
The seller, after spending Rs. 12,000/- to repairs, sold away all the three cars for Rs. 35,000-. Open
ledger accounts in the books of both the parties.
Answer: (1) Loss to the buyer on default Rs. 6,720/-
(2) Balance due to the seller Rs. 2,573/-
(3) Profit on sale of repossessed car to the seller Rs. 6,920/-.
Hire-Purchase Trading Account
The system of keeping of hire-purchase transactuion as outlined above is suitable only where the
number of such transactions is small and price of the commodity sold is high. But where the businessman
sells goods of small value e.g., radio, cycle, fans, transistors etc. on hire-purchase system very frequently, it
may become incovenient for him to prepare separate account for each customer, in the way we have discussed
above. Moreover, it is neither desirable nor economical, though technically possible to ascertain the amount
of profit earned or loss incurred on each individual transaction. He can ascertain the profit or loss made
during a particular period by preparing a Hire-Purchase Trading Account. This method is also known as
Goods out or Stock Method.
The underlying feature of this method is to treat all the goods out on hire as a stock. The hire-vendor
prepares only one account i.e. Hire-purchase Trading Account and posts therein all the hire-sales, realisations,
repossessions, etc. no individual account of any hire customer is recorded on double entry. The details (as to the
date of contract, description of article, cost price, hire sale price, number of instalments, amount and due date of
each instalment, realisations, outstanding balance, etc.) of each hire-customer are, however, maintained in a
register etc. as memoranda.
(1) For opening balance of stock on the hire and instalments due but not received.
Hire-Purchase Trading Account Dr. With the opening balance
To Stock in Hire (Hire-Purchase Price)
" Instalment due
and unpaid - account
(2) For Goods sold on Hire-Purchase

Hire-Purchase Trading Account Dr. With the invoice price of goods sold on
To Goods sold on hire-purchase
Hire-Purchase
(3) For receipt of instalments

Cash/Bank Account Dr. With the amount of Cash Received.
To Hire Purchase Trading Account
(4) For repossession of goods

Goods Repossessed Account Dr. With the estimated value goods repossessed.
To Hire-Purchase Trading Account
55
(5) For instalments due but not received

Instalments Due and unpaid Account Dr. With the closing balance of instalments due.
(6) For goods/stock lying with customers in respect of which instalments are not due.
Stock out on Hire Dr. With the closing balance of Hire-Purchase
To Hire-Purchase Trading Account Price and cost
(7) For removing the loading (excess of Hire-Purchase price over cost price) for the opening stock
Stock Reserve Account Dr. With the difference between Hire-Purchase
To Hire-Purchase Trading Account Price and cost.
(8) For removing the loading from closing stock

Hire-Purchase Trading Account Dr. With the difference between Hire-Purchase
To Stock Reserve Account Price and cost.
(9) For removing the loading from Goods sold on Hire Purchase
Goods sold on Hire-Purchase Account Dr. With the difference between Hire-Purchase
To Hire-Purchase Trading Account Price and cost.
(10) For Profit

Hire-Purchase Trading Account Dr. With the the amount of Profit.
To General Profit and Loss Account
(11) For Loss

Profit and Loss Account Dr. With the amount of Loss.
The students should note that in questions of this type the examiners generally do not give the figure of
Instalment Due and unpoaid. They are, therefore, advised to see before solving a question of this type as to
whether the amount of instalments Due and unpaid is given in the quest' or not. If it is not given in the question
itself, then it is to be calculated from the information given. The formula formula for calculating the amount of
Instalment Due and unpaid is as folows
Instalmen6s Due and Unpaid= Hire Purchase Stock lying with the customers in the beginning+Goods
sold on Hire Purchase+Cash Received-Goods Repossessed (amount for which such goods were repossessed)
Hire-Purchaser Stock lying with the customers at th eend of the year.
Example
From the following details set out the Hire Purchase Trading Account in the books of a trader who sells
a number of articles of comparatively small value daily on the hire-purchase system, showing his profit on this
department of the business for the year ended 31st December, 1994.
56
1994 Rs.
January, 1 Stock in Customer's hands at selling price 1,620
Dec., 31 Sale of hire purchase goods
During the year at selling price 6,534
Cash received from hire-purchase at Selling Price 2,100
Stock in customers hadn at Selling Price 5,674
Hire-Purchase Trading Account

for the year ending 31st December, 1994
Rs. Rs.
To Stock out on Hire Acount 1,620 By Cash 2,100
To Goods sold on Hire -Purhase Acount 6,534 " Instalments Due and Unpaid 380
To Stok Reserve Acount 2,128 " Stock Reserve Account 608
To General Profit and Loss Aount -Profit 930 " Goods sent on Hire Purhase Acount (loading) 2,450
" Stok out on Hire Acount 5,674
11,212 11,212
Other Ledger aounts can be prepared as follows:
Stok Out on Hire Acount

Rs. Rs.
1994 1994
Jan., 1 To Balancce bid 1,620 Jan., 1 By Hire Purhase Trading Account
-Transfer 1,620
1994 1994
Dec., 31 To Hire-Purhase Trading 5,674 Dec., 31 By Balance bid 5,674
Acount - Transfer
1995
Jan., 1 To Balance bid 5,674
Goods sold on hire Purchase Account

Rs. Rs.
1994 1994
Dec., 31 To Hire-Purchase Dec., 31 By Hire-Purhase Trading Account 6,534
Trading Account-Loading 2,450
" Purhase Aount -Transfer 4,084
6,534 6,534
57
Stok Reserve Aount

Rs. Rs.
1994 To Hire Purhase 1994 By Balance b/d
Dec., Trading Account Jan., 1 608
-Transfer 608
1994 1994
Dec., 31 To balance c/d 2,128 Dec., 31 By Hire-Purhase Trading Acount
-Transfer 2,128
1995
Jan., 1 By Balance b/d 2,128
Instalments Due
Rs. Rs.
1994 1994
Dec., 31 To Hire-Purhase Trading Dec., 31 By Balance c/d 380
Acount -Transfer 380
General Profit and Loss Acount (lnusive) for the

year ending 31st Deem,ber, 1994
Rs. Rs.
By Hire-Purhase
Trading Acount -Profit 930
Illustration :
Fantastic Horne Ltd. Cornrnenced Business on 1st January, 1991. The business is to sell Radio
Recorders and Televisions both in hire -purhase and Cash basis. The information almost the terms in given
below:-
Radio Recorder Television set
Cost Price 6,000 18,000
Sale Prie (Cash) 7,800 19,500
Down payment for H.P. 600 3,000
Monthly instalments for H. P. 360 660
No. of instalments 20 25
The company purhased goods costing Rs 24,00,000 in all and made ash sales totalling Rs. 15,00,000.
Stock on hand was valued at Rs. 3,90,000 Hire Purhase transations were as follows:
58
Number Instalments Instalments-due

Sold Collected (customer's Paying)
Radio Reorders 30 300 15
Television sets 25 250 10
4 Radio Recorders and 3 Television sets on which only 10 monthly instalments were collected were
repossessed and were valued at Rs 45,000 This is not inluded in the stock mentioned above.
Prepare Hire Purhase Trading Account to show the profit or loss made by the hire vendor company.
Solution:
Hire Purhase Trading Account
Rs. Rs.
To Goods Sold on H.P. (1) 7,21,500 By Cash 3,66,000
To Stock reserve on By Goods repossessed 45,000
instalments not due (4) 36,600 By Instalments due 12,000
By Goods sold an H.P. Loading 91,500
Profit and Loss Aount (Profit) 55,800 By Instalments not yet
due-stock with customers c/d (3) 29,9,400
813,900 813,900
Working Notes:
1. Cost Price:
Radio Records (30 x 6,000) 1,80,000 30 X 7,800 2,34,000
Television sets (25 x 18000) 4,50,000 25 X 19,500 4,87,500
6,30,000 72,1500
Loading (Margin) = 7,21,500- 6,30,000 = Rs. 91,500
2. Cash Colleted: Radio Reorders Television sets
Rs. Rs
Down Payment 30 x 600 18,000 25 X 3000 75,000
Instalments 300 x 360 1,08,000 250 X 660 1,65,000
1,26,000 2,40,000
Total 1,26,000 + 240,000 = 3,66,000
3. Instalments not due:
(i.e. Stock with customers)
Radio Recorders:
Total Instalments on 26 sets = 26 x 20 520
Less: Instalments colleted and due (315 - 40) 275
Not yet due 245
59
Amount 245 x 360 = Rs. 88,200

Television Sets
Total Instalments on 22 sets 22 x 25 550
Less: Collected and due (260-30) 230

Not yet due 320
Amount 320 x 660 = Rs. 2,11,200 + 88,200 = 2,99,400
4. Stock Resource
Radio Recorders Television Sets
Total Amount due H.P.P. 7,800 19,500
Cost 6,000 18 ,000
1,800 17,500
1•800 = 1•500
Reserve Required = X 88 200 x1500
7,800 19,500
= 2,0354 (app.) 16,246 (app.)
Total Rs. 20,354 + 16246 = Rs. 36,600
Stock and Debtors System

Stock and Debtors system is only a varient of Hire-Purcchase TradingAcount. This is preferred by the
management owing to the revelation of detailed information like the aggregate amount of instalments beoming
due (from hire-purhase ustomers, etc).
Under this ystem we prepare (i) Hire-Purhase StockAount (ii) Hire-Purhase DebtorsAcount, (iii) Hire
Purchase Adjustment, (iv) Stock Account, and (v) Shop Stock Acccount.
It should be noted at the very outset that Hire-Purhase Stocck Acount, Hire-Purhase Debtors Acount
and Shop Stock Acount are real accounts and this being so, these will (if the firm is not a new firm) have a
opening balance. This opening balance will be a debit opening balance. Moreover, since the Hire-Purhase stock
Account has an opening balance, the Stock ReserveAcount will also have an opening balance. But it will have
a credit opening balane-a balance opposite to that of opening stock balance.
So the students, while solving questions acccording to this method, should first write the opening
balance in these four accounts.
Acounting Treatment
The Journal entries required to be passed under this system are as follows.
(1) For goods sold on Hire-purhase
(a) Hire-Purhase Stock Hire-Purhase Prie of goods
Acount Dr. sold on Hire-Purhase.
To Hire-Purhase Hire-Purhase Price-CCost
Adjustment Account Price (Leading).
" Shop Stock Account Cost of goods sold on Hire-Purhase
60
(b) Hire-Purhase Debtors Hire-Purhase Prie of goods

Account Dr. sold on Hire-Purhase.
To Hire-Purhase Stock Aount
(c) Shop Stock Acount Dr. Estimated Value of goods repossessed.

Hire-purhase Adjustment Acount Dr. Loss on repossession.
To Hire-Purcchase Debtors Amount due for which goods are repossessed.
( 4) Put down the losing balance on the credit side of Hire-Purhase Stock Acount, Hire-Purhase Debtors
Aount and Shop Stock Account on the debit side of Stok Reserve Account.
(5) From removing loading from the Opening Stocck

Stock Reserve Acount Dr. With the amount of loading.
To Hire-Purhase Adjustment Account
(6) For removing the loading from the losing Stok

Hire-Purhase Adjustment Acount Dr. With the amount of loading.
To Stock Reserve Acount
The Hire-Purhase Adjustment acount will now reveal profit or loss. It will reval profit if its redit side
total is greater than its debit side total, and loss if its debit side total is greater than it's credit side
total.
(6) For Profit

Hire-Purchase Adjustment Acount Dr. With the Amount of profit.
To General Profit and Loss Acount
(8) For Loss

General Profit and Loss Account Dr. With the Amount of Loss.
To Hire-Purhase Adjusltment Aount
Example
J Ram & Co. have a Hire-Purhase Department. Goods are sold on hire-purchase at cost plus 50%. From
the following particulars find out the profit made by the hire-purhase department:
1994 Rs.
Jan., 1 Stock out with Hire-Purchase
Customers at selling price 9,000
Stock at Shop at cost 18,000
Instalment Due 5,000
Dec., 31 Cash received from customers 60,000
Goods Repossessed (instalments due Rs. 2.000) as value 500
61
Instalment due, customers paying 9,000

Stock at shop (exluding repossessed goods) 20,000
Goods Purchased during the year 60,000
Hire-Purhase Stocck Acount

Rs. Rs.
1994 1994
Jan., 1 To Balance bid 9,000 Dec., By Hire-Purhase Debtors
Dec., 31 To Shop Stocck -Account - Goods sold on Hire Purchase 66,000
Transfer 58,000
To Hire-Purhase Adjustment By Balance c Id 30,000
Aount Loading 29,000
96,000 96,000
1995
Jan,. 1 By Balance bid 30,000
Hire-Purhase Debtors Account

Rs. Rs.
1994 1994
Dec., 31 To Balance bid 5,000 Dec., 31 By Banks 60,000
" Hire-Purchase Stock Account " Shop Stock Account 500
-Transfer (Baianing Figure) 66,000 " Hire-Purchase Adjustment
Aount (Loss) 1,500
" Balance c Id 9,000
71,000 71,000
1995
Shop Stock Account

Rs. Rs.
1994 1994
Jan., 1 To Balance bid 18,000 Dec., 31 By Hire Purchase Adjustment
Dec., 31 " Purchases 60,000 Account-Transfer 58,000
" Hire-Purchase - Debtors Balance cld (Rs, 20,000+Rs. 500 20,500
Account Goods Repossessed 500 Goods Respossessed)
78,500 78,500
1995
62
Hire Purchase Adjustment Account

Rs. Rs.
1994 1995
Dec., 31 To Hire-Purchase Debtors Dec., 31 By Hire-Purchase Stock
Account Loss on Account-Loading 3,000
Respossession 1,500
" Hire-Purchase Stock By Hire-Purchase Stock
Account Loading 10,000 Account Loading in
To General Profit and Goods sold on Hire-Purchase 29,000
Loss Account -Profit 20,500
32,500 32,000
Stock Reserve Account

Rs. Rs.
1994 1994
Jan.,l To Hire-Purchase Adjustment Jan., 1 By Balance b/d 3,000
Account-Transfer 3,000
1994 1994
Dec., 31 To Balance b/d 10,000 Dec., 31 By Hire Purchase Adjustment 10,000
Account-Transfer
1995
Jan., 1 By Balance b/d 10,000
Illustration:
Tee Vee house sold a Colour TV set to RITU on hire purchase system on 1.1.1993 for Rs. 9,200. RITU
paid Rs. 2,000 on the same date to receive the delivery of TV Set and agreed to pay the balance in 12 equal
monthly instalment, each installment becoming due on the last day ofeach months.
Ritu paid six instalments in time but failed to pay the other instalments In September 1993 (before the
monthly instalment had became due) the seller repossessed the TV Set. The repossessed set was valued at Rs.
3,500.
Show the ledger accounts (on the basis of Stock and Debtors system) in the books ofT.V. House.
Solution:
Total instalment 12 (From 1 Jan., to 31st December)
Less: Instalment Paid 6 (From 1 Jan., to 30 June)
Instalment due and not due 6
Ritu have paid instalments for the months ofJuly and August. Hence the number ofinstalments due is
2 (two) So the number ofinstalment not due must be 4 (four)
63
Instalments due means Hire Purchase Debtors (600 x 2)

Instalments must due means Hire Purchase Stock Account (600 x 4)
The basic entry on default and consequent repossession will be
Goods Repossessed Account Rs 3,600 (With the amount of instalments not paid) To Hire Purchase
Debtors Account, 1,200 (With the instalments due) To Hire Purchase Stock Account 2,000 (With the instalments
not due)
Since the goods repossessed have been revalued at Rs, 3,500, the following entry in also required).
Hire Purchase Adjustment Account Dr 100
To Goods Repossessed Account 100
Hire Purchase Stock Account

Rs. Rs.
To Goods sold on H.P (on H.P. Paid) 9,200 By Goods Repossessed Account 2,400
By Hire Purchase 6,800
9,200 9,200
Hire Purchase Debtors Account

Rs. Rs.
To Hire Purchase Stock Account 6,800 By Cash (Drown Payment+ 6 Instalments) 5,600
By Goods Repossessed 1,200
6,800 6,800
Goods Repossed Account

Rs. Rs.
To Hire Purchase Stcok Account 2,400 By Hire Purchase Adjustment Account 100
To Hire Purchase To Paid Cid 3,500
Debtors Account 1,200
3,600 3,600
64
LEASE
Introduction
A lease is a contract between two parties called the lessor and the lessee whereby the lessor conveys to
the lessee in return for rent the right to use an asset for an agreed period of time. The ownership of the asset
continues to rest with the lessor whereas the lessee enjoys the right of the use of the asset in consideration of the
rent paid to the lessor. The provisions of the Indian Contract Act, 1872 apply to lease contracts and the relationship
between the lessor and the lessee is that of a bailor and a bailee.
The meaning of the following terms used in connection with leases should be noted:
Inception of the lease : The earlier of the date of the lease agreement and the date of a commitment by
the parties to the principal provisions of the lease.
Lease Term: The non-cancellable period for which the lesseee has agreed to take on lease the asset
together with any further periods for which the lessee has the option to continue the lease of the asset, with or
without further payment, which option at the inception of the lease it is reasonably certain that the lessee will
exercise.
Minimum Lease Payments : The payments over the lease term that the lessee is, or can be required, to
make excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together
with:
(a) in the case of the lease, any residual value guaranteed by or on behalf of the lessee; or
(b) in the case of the lessor, any residual value guaranteed to the lessor:
(i) by or on behalf of the lessor; or
(ii) by an independent third party financially capable of meeting this guarantee.
However, if the lessee has an option to purchase the asset at a price which is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable that, at the inception of the lease, is reasonably
certain to be exercised, the minimum lease payments emprise minimum payment payable over the lease term
and the payment required to exercise this purchase option.
Contingent Rent: That portion of the lease payments that is not fixed in amount but is based on factor
other than just the passage of time (e.g., percentage of sales, amount of usage, price indices, market rate of
interest).
Economic Life : Either
(a) the period oyer which an asset is expected to be economically unable by one or more users; or
(b) the number of production or similar units expected to be obtained from the asset by one or
more users.
Useful Life : Either
(a) the period over which the leased asset is expected to be used by the lessee; or
(b) the number of production or similar units expected to be obtained from the use of the asset by
the lessee.
Residual Value : The estimated fair value of the asset at the end of the lease term.
Guaranteed Residual Value : In the case of the lessee, that part of the residual value which is guaranteed
by the lessee or by a party on behalf of the lessee (the amount of the guarantee being the maximum amount that
could, in any event, become payable); and in the case of the lessor, that part of the residual value which is
65
guaranteed by or on behalfofthe lessee, or by an independent third party who is financially capable ofdischarging
the obligations under the guarantee.
Unguaranteed Residual Value : The amount by which the residual value of the asset exceeds its
guaranteed residual value.
Gross Investment in the Lease : The aggregate of the minimum lease payments under a finance lease
from the standpoint of the lessor and any unguaranteed residual value accruing to the lessor.
Unearned Finance Income: The difference between (a) the gross investment in the lease, and (b) the
present value of (i) the minimum lease payments under a finance lease from the standpoint of the lessor, and
(ii) any unguaranteed residual value accruing to the lessor, at the interest rate implicit in the lease.
Net Investment in the Lease : The gross investment in the lease less unearned finance income.
Interest Rate Implicit in the Lease : The discount rate that, at the inception of the lease, cause the
aggregate present value of
(a) the minimum lease payments under a finance lease from the standpoint of the lessor; and
(b) any unguaranteed residual value accruing to the lessor, to be equal to the fair value of the
leased asset.
Types of Lease
Broadly speaking, there are the following two types of lease:-
(i) Financial Lease. It is a lease under which the present value of the minimum lease payments at the
inception of the lease exceeds or is equal to substantially the whole of the fair value of the leased
asset. In this type of lease, the asset is irrevocably leased out by the lessor to the lessee for nearly the
entire useful life of the asset. During the lease term, the lessor is able to recover his capital outlay
plus a return on his investment in the asset. Actually, the lessor plays the role of the financier of the
asset. After the lease agreement has been entered into, the lessor has not to bother himself about the
proper maintenance of the asset with the result that in a financial lease the maintenance of the asset
is made the responsibility of the lessee. A financial lease is also known as a Capital Lease.
(ii) Operating Lease. A lease other than a finance lease is an operating lease. In it, the period ofcontract
between the lessor and lessee is less than the full expected useful life of the asset. The lease contract
contains a clause by which the lessee is entitled to terminate the contract by giving due notice
thereof to the lessor. Thus, it is a cancellable lease.
In this type oflease, the primary lease period is mostly inadequate for the lessee to recover his investment
in the asset to the full extent. Also, as the lessee enjoys the right of cancellation, the lessor runs the risk of
obsolescence of the asset. Being interested in the proper maintenance of the asset, the lessor bears the expenses
of the maintenance of the leased asset in this type of lease.
It is notable that even a non-concealable lease is also cancellable but only in the following circumstances:
(a) upon the occurrence of some remote contingency,
(b) with the permission of the lessor,
(c) if the lessee enters into a new lease for the same or any equivalent asset with the same lessor, or
(d) upon payment by the lessee of an additional amount such that, at inception, continuation of the lease
is reasonably certain.
66
Leveraged Lease. A finance lease or an operating lease becomes a leveraged lease if in the lease
contract, apart from a lessor and a lessee there is a long-term lender also. In a leveraged lease, the lessor
finances only a small part of the investment involved in the lease and the major portion of the finance is provided
by the long-term lender. This type of lease is used by the lessor when such a huge capital outlay is required for
acquiring the asset that the lessor finds it necessary to use the services of a long-term lender.
Distinction between Finance Lease and Operating Lease. The following are the point of distinction
between a finance lease and an operating lease
(i) In a finance lease, the lease period covers nearly the entire useful life of the asset whereas in an
operating lease, the lease period is much shorter than the useful life of the asset.
(ii) A finance lease is non-revocable while an operating lease is revocable.
(iii) In a finance lease, the cost of maintenance is borne by the lessee. On the other hand in an operating
lease, the maintenance is the responsibility of the lessor.
(iv) In a finance lease, the lessee runs the risk of obsolescence of the asset; in an operating lease, the
lessor bears this risk.
(v) In a finance lease, the total lease rentals not only cover the cost of the asset but also include a margin
of profit for the lessor. Under an operating lease, the lessee is not given such an option.
Advantages and Disadvantages of Leasing. In recent years, leasing has become very popular. It is
because it is an excellent source of finance available to the industrialists. It provides hundred per cent finance
keeping the debt-equity ratio of the lease unaltered and thus not affecting the capacity of the lessee to raise
further capital for other purposes. The fact that the lessee is not the owner of the asset he uses is a big boon to
M.R.T.P. companies and the small-scale industrial units as it enables them to avoid statutory restrictions in the
path of further growth. In the case of an operating lease, the risk of obsolescence and the major expenses of
maintenance of the asset are also borne by the lessor which facilitates the job of the lessee.
Leasing has a few disadvantages also. The lessee cannot avail himself of certain tax benefits and
benefits like backward area incentives and the state subsidy in respect of the asset used by him on the basis of a
lease. In case of a non-cancellable lease, the lessee runs the irks of technological obsolescence of the asset.
Leasing is not a suitable method of finance of assets to be used in a project in which cash inflow will start after
a fairly long period of time. In the case of those assets also whose value is likely to appreciate over long period
of time, purchase of the asset is better than taking it on lease.
The contents of the following Accounting Standard 19 (AS 19) on Leases should be studied carefully to
understand the different points to be kept in mind while keeping a record of the transactions relating to a lease
in the books of lessor and the lessee.
LESSON 2
BRANCH ACCOUNTS
Branch and Department

Generally a business is split into many parts for the purpse to capture the market at different places or
to have better management. If the different parts, usually, selling the same products or rendering the same
services, are located at different places in the same town or in different towns, they are know as branches and
when the various parts are located under the same roof, they are known as departments. A firm which has
branches naturally wants to know the profit earned and loss suffered at each branch,, the systemn of accounting
will naturally depended on the type of branch. Branches may be divded as under:-
(a) Branches which receive goods only from head office, selling goods only for cash, remitting all cash
received to the head office, expenses being met out of remittance from the head office.
(b) Branches similar to the above except that goods are sold for cash and credit.
(c) Branches similar to above (b) with the difference that head office invocies goods to the branch at
selling price or at a price which is high er than Cost price and the office passes entries with the
invoice price.
(d) Branches making their own purchases and manufacturing goods and functioning more or less cases
as an autonomous units.
(e) Foreign branches, i.e. branches located in a foreign country. We will not study the accounting for
such branches it is not in the syhalbs.
Usually, account for the first three types branches are kept by the head office, The fourth and fifth type
of branches generally maintain an independent st of books of accounts.
The simplest case of branch is one where branch receives ggoods only from H,.o., sells goods only for
cash depositing the same with the bank in the name of H.O., and H.O., itself pays all branches' expenses and
record goods sent to branch at cost.
H.O. maintains a Branch Account to ascertain profits and loss made at the branch. Here 'Branch Account'
is in the nature of Trading and Profit and Loss Account. Al;l investment in the form of goods and expenses
incurred in respect of branch are recorded on the debit side of the 'Branch Account' - Whereas sale proceeds,
closing stock and other items of income are recorded on the credit side of this account, if credits exceed debits,
it means a profit at the branch which is transferred to profit & Loss Account where as id debit exceeds credits,
it means a loss at branch which, like the profit a branch, is transferred to Profit & Loss Account. The entries to
be made in the Head office books are :-
(a) When goods are sent to Branch
*Branch Account Dr.
To Goods sent to Branch Account
(For Cost Price of goods sent to Branch)
* If the branch returns some goods to H.O., a reverse entry will be passed with the Cost price of Goods returned.
68
(b) When branch expenses are met

Branch Account Dr.
(For payment for branch expenses)
(c) When sale proceeds deposited by Branch with the bank in the name of Head Office:-
Bank Account Dr.
To Branch Account
(For sale proceeds deposited with the Bank)
(d) When at the end of the year some goods are lying with the Branch unsold.
Branch Stock Account Dr.
To Branch Account
(For cost Price of goods lying at the branch at the end of the year)
(e) When Branch Account reveals a profit

** Branch Account Dr.
To Profit asnd Loss Account
(For transfer of branch profit from Branch Account to profit & Loss Account)
(f) Branch Stock account will appear in the Balance Sheet of Head Office. In the beginning of the next
year, this account is transferred t Branch Account by means of the following en try:-
Branch Account Dr.
To Branch Stock Account
(For Cost of Branch Stock as at the beginning of the year)
(g) Goods sent to Branch Account must be transferred at the end of the year to Purchase Account in
case of trading concern and to Trading Account in the case of manufacturing concern. The entry will
be:-
Goods Sent to Branch Account Dr.
To Purchase Account/Trading Account
(Transfer of Balance in Goods sent to Branch Account to Purchaseffrading Account)
(h) If the branch sells goods on credit also, a few additional entries will have to be made. For cash
received from branch debtors during the year, following entry will be passed:-
Bank Account Dr.
To Branch Account
(For cash received from Branch debtors)
** If Branch Account reveals a loss, a reverse entry will be passed with the amount of loss.
69
(i) At the end of the year, the following entry will be passed with the total amount due from the Branch
Account debtors as at the date:-
Branch Debtors Account Dr.
To Branch Account
(For closng branch debtors)
Branch Debtors will apear in the Balance Sheet of the H.O. and will be transferred to Branch Account
in the beginning of the next account period.
Note:- Sometime H.O. may send sme cash to the branch to meet opetty cash expenses at the branch. At the
end of the year, some cash may be lying with the branch. The amount should be treated in the same
way as stock at branch is treated.
Illustration 1
From the following particulars relating to Bangaslore Branch for the ending 31st December, 1994
prepare the accounts in the head office books:-
Rs.
Stock at Branch on 1st January, 1994 17,800
Branch Debtors on 1st January, 1994 9,400
Petty Cash at Branch on 1st January 1994 40
Goods sent to Branch during the year 56,800
Cash Sales during the year 31,600
Credit Sales during the year 80,800
Cash received from the debtors 75,800
Cash sent to Branch for expenses :-
Rent 4,000
Salaries 12,000
Petty Cash 2,000
Stock at Branch on 31st December 1994 10,800
Petty Cash at Branch on 31st December, 1994 60
Goods returned by the Branch 1,600

70
Solution:
Bangalore Branch Account

Dr. Cr.
Rs. Rs.
1994 1994
Jan., 1 To Balance b/d Jan.I By Cash
Stock 17,800 to Cash Sales 31,600
Debtros 9,400 Dec.,31 Received from
Petty Cash 40 27,240 Debtors 75,800 1,07,400
Jan.I to Goods sent to Brach
Dec.,31 To Goods sent to Account 1,600
Branch Account 56,800 Branch Stock Ale 10,800
" " To Cash for Expenses: Branch Debtors Ale
Rent 4,000 Petty Cash at Branch 14,400
Salary 12,000 Account 60
Petty 2,000 18,000
To Profit transferred to
Profit & Loss Account 32,220
1,34,260 1,34,260
Memorandum Branch Debtors Account

Dr. Cr.
To Balance b/d 9,400 By Cash 75,800
To Credit Sales 80,800 By Balance c/d 14,400
90,200 90,200
Godds sent to Branch Account

Rs. Rs.
1994 1994
Jan.I to To Bangalore Branch 1,600 Jan. 1 to By Bangalore Branch 56,800
Dec. 31 Ale returns Dec. 31 Account
Dec.31 To Purchase Account Transfer 55,200
56,800 56,800
71
Branch Stock Account

Rs. Rs.
1994 1994
Jan.I To Balance b/d 17,800 Jan.I To Transfer to Bangalore Branch Ale 17,800
Dec.31 To Banglore Branch Ale 10,800 Dec. 31 By balance c/d 10,800
28,600 28,600
1995
Jan.I To Balance b/d 10,800
Branch Debtors Account

Rs. Rs.
1994 1994
Jan. 1 To Balance b/d 9,400 Jan.I To Transfer to Bangalore Ale 9,400
Dec. 31 To Bang lore Branch Ale 14,400 Dec. 31 By Balance c/d 14,400
1995 To Balance b/d 14,400
Jan.I 23,800 23,800
Petty Cash at Branch Account

Rs. Rs.
1994 1994
Jan.I To Balance b/d 40 Jan.I By Bangalore Branch Ale 40
Dec. To Balngalore Branch Ale 60 Dec.31 By Balance b/d 60
100 100
1995
Jan.I To Balance b/d 60
Note: No entry is made for credit sales at branch in the H.O. books. The cash received from the debtors
will be remitted to the H.O. along with Cash received for Cash Sales. The H.O. makes no entry for
cash received by it. It will debit cash, credit branch. By the same token, the H.O. makes no entry for
discounts allowed, bad debt written off or returns by the Branch debtors. It the branch has received
to bill of exchange, it will be sent to the H.O.
The entry then will be to debit Bills Receivable Account and Credit Branch Account.
lype (c)
In this case, goods are invoiced to the Branch at selling price. In order to ascertain the profit, a justment
entries will have to be made for the difference between the invoice value of goods sent in branch and their cost.
Similarly stock at branch will be valued at invocie value but, again suitable adjustment will be necessary to
ensure that stock does not appear in the Balance Sheet at more than the cost.
72
The entries in respect of goods sent to Branch and Stock will be as follows:-
(a) When goods are sent to branch Branch Account Dr.

(For invoice price of the goods sent to branch)
(b) For stock lyiog at branch at the end of the Trading period
Stock at Branch Account Dr.
To Branch Account
(For invoice price of the goods lying at the branch athe end of the year)
(c) For adjustment in the Value of goods sent

Goods sent to Branch Account Dr.
To Branch Account
(For loading invoice price of goods sent to branch)
If some goods have been returned by the branch to Head Office the above mentioned entyr will be
passed only for the loading in invoice price f goods Sent to branch less invocie price of the goods
returned by branch.
4. For adjustment in the value of Closing Stock

Branch Account Dr.
To Stock Reserve Account
(Loading in the amount of closing stock at branch
credited to Branch Stock Reserve Account and debited to Branch Ale)
In the begining of the next year, Branch Stock Reserve Account will be transferred to Branch Account
by means of the following entry:
Branch Stock Reserve Account Dr.
To Branch Account
(Transfer of Branch Stock Reserve Account to Branch Account)
Illustration 2
Mohan Stores of Delhi has a branch at kanpur, goods are sent by the head office at invoice price which
is at a profit of 20% on invoice price. All expenses of the branch are paid by the head office. From the following
particulars prepare branch account in the Head Office books:-
73
Rs.
Opneing balance
Stock at invoice price 22,000
Debtors 3,400
Petty Cash 200
Goods sent to branch at invocice price 40,000
Expenses paid by H.O.
Rent 1,200
Wages 400
Sales and other expenses 1,800 3,400
Remittances made to Head Office
Cash Sales 5,300
Cash collected from Debtors 42,000 47,300
Goods returned by branch at invocie price 800
Balance at the end:
Stock at Invoice price 26,000
Debtors at the end 4,000
Petty Cash 250
Solution:
Branch Account
Dr. Cr.
To Opening balances: By Stock reserve (loading) of
Stock 22,000 stock in the beginning 4,400
Debtors 3,400 By Goods sent to branch (loading) 8,000
Petty Cash 200 25,600 By Cash Sales 5,300
To Good sent to branch Account 40,000 ByCash Collected from Customers 42,000 47,300
To Bank
Rent 1,200 By Goods returned to H.O. 800
Wages 400 By Balance:
Salary & other Expenses 1,800 3,400 Stock 26,000
To Stock reserve (loading) on Debtors 4,000
Closing Stock 5,200 Petty Cash 250 30,250
To Goods returned (loading) 160
To Net Profit 16,390
90,750 90,750
74
Illusration:
Naresh Stores Ltd. operate a retail branch at Madras All purchases are made by the Head Office in
Calcutta, goods being charged out to the branch at selling price which is cost plus 50%. All cash received by the
branch in remitted to Calcutta. Branch expenses are paid out of an imprest account which is reimbursed by
Calcutta monthly Branch helps a sales ledger and subsidiary books but other wise all branch transactions are
recorded in the books of the Calcutta Office. On April 1,1990 Stock in trade at Madras, at selling price, amounted
to Rs. 2,76,900 and debtors to Rs. 54,800.
During 1990-91 the following transactions took be place at the branch.
Rs.
Goods received from Calcutta at selling price 9,37,200
Cash Sales 5,21,000
Credit Sales les returns 4,23,700
Goods returned to Calcutta at selling price 14,400
Agreed Allownces to customers off selling price
(already taken into account while involing) 8,200
Cash receiving from debtors 3,98,600
Discount allowed to debtors 97,000
Bad debts written off 4,800
Expenses 1,43,800
On 31 March, 1991 Stock in trade at Madras was found to amount to Rs 2,45,100
You are required to (a) write up the Branch Stock Account, and (b) prepare the Trading and Profit and
Loss Account at the Branch for the year 1990-91
Solution :
Madras Branch Stock Account

Rs. Rs.
To Balance b/d 2,76,900 By Sales- Cash 5,21,000
To Goods sent to Credit 4,23,700 9,44,700
Branch Account 9,37,200 By Allowance to Customers 8,200
By Goods Sent & Branches 14,400
By Shortages (Balancing figure) 1,700
By Balances c/d 2,45,100
12,14,100 12,14,100
75
Branch & Trading and Profit & Loss Account

Rs. Rs.
To Opening Stock (Cost) 1,84,600 By Sales:
(2,76,900-92,300) Cash 5,21,000
To Goods Sent to Branch (Cost) Credit 4,23,700 9,44,700
(9,37,200 - 14,400 - 3,07,600) 6,15,200 By Closing Stock
Gross Profit 3,08,300 (2,45,700-81,700) 1,63,400
11,98,100 11,08,100
To Discount 9,700 By Gross Profit 3,08,300
To Bad debts 4,800
To Expenses 1,43,800
To Nel Profit 1,50,000
3,08,300 30,800
Stock and Debtors System

Account of balance of type (c) can also be prepared in another manner known as the Stock and
Debtors system a Branch Stock Account is mantained whose balance at any time shows the selling price of
goods lying at the branch, a Branch Debtors Account is maintained whose balance at any time reveals the
amount recoverable by the branch from its debtor at that particular time a Branch Expenses Account to show
total expenses incurred in connection with the branch by the branch and H.O. a Branch Adjustment Account
to reveal gross profit or gross loss at the branch and a Branch Profit and Loss Account to reveal net profit, or
net loss made at the branch. Sometimes Branch Profit and Loss Ale merged into Branch Adjustment Account
which is then made to reveal net profit or net loss instead of gross profit or gross loss. Under the method the
entires are made as follows:
1. Where goods are sent to a Branch

(For invoice price of goods sent to Branch Account)
Note : The above entry is reversed if goods are returned by branch t Head Office.
2. When expenses are incurred for the Branch

Branch Expenses Account Dr.
(For payment made by H.O. for tranch expenses)
76
3. When sales are made at the branch

(a) Cash/Bank Account Dr.
(For cash sales made at the branch)
(b) Branch Debtors Account Dr.

(For credit sales made at the branch)
4. When Cash is received n account of

Branch Debtors Cash/Bank Account Dr.
To Branch Debtors Account
(For cash received from branch debtors)
5. When goods are returned by the Branch Debtors to Branch

(For goods returned by Debtors to Branch)
6. When any allowance is made to branch debtors, say discount.

Branch Expenses Account Dr.
7. When there is any leakage, loss or wastage at the Branch

Branch Stock Adjustment Account Dr. (with loading)
Branch Profit and Loss Account Dr. (with Cost price)
To Branch Stock Account (With invoice price)
Note : To above entry is reversed if there is surplus in any stock. For the excess of selling price over
charged on goods sent ot branch;
8. Goods sent to Branch Account Dr.

To Branch Stock Adjustment Account
9. For the Adjustment of the invoice price of the closing stock.

Branch Adjustment Account Dr. With the difference in the invoice
To Stock Reserve Account price of the stock and the Cost
value of stock.
(The Stock Reserve Account, will be carried to the
next accouting year and then transferred to the creidt
Branch Adjustment Account)
77
10. For transfer of Branch Expenses Account to Branch Profit & Loss Account
Branch Profit & Loss Account Dr.
To Branch Expenses Account
11. For transfer of Gross profit revealed by branch adjustment account to Branch profit & Loss Account
Branch Adjustment Account Dr.
To Branch Proft & Loss Account
The aboive entry will be reversed if there is a Gross loss.
12. For transfer of Net Proft revealed by Branch proft & Loss Account to General proft & Loss Account
Branch profit & Loss Account Dr.
To (General) profit & Loss Account
The entry will be reversed in case of Net Loss.
13. For transfer of balance in Goods sent to Branch Account to Trading Account or Purchase Account
Goods sent to Branch Account Dr.
To Trading Account/Purchases Accounts
Illustration 3
Oils Ltd. opened a branch at kanpur in 1993. Goods are invoced to the branch at cost plus 25%. The
following figures are given to you for 1993 and 1994 ascertain the profit or Loss made in two years by stock and
debtors system:
Rs. Rs.
To Goods sent to Branch (Inv. Value) 1,40,400 2,65,200
Sales -Cash 50,000 80,000
Credit 70,000 1,60,000
Cash received from Debtors 62,400 1,51,400
Discount allowed to Customers 1,600 2,600
Goods returned by customers 2,000 1,500
Cash remitted to Branch for:
Rent 1,200 1,500
Salaries 6,000 8,000
Sundry Expenses 960 1,000
Stock at Branch as on 31st December 47,800
78
Solution:

Rs. Rs.
1993 1993
To Goods sent to Jan,l By Cash Sales (2) 50,000
Jan.I Branch Account (1) 1,40,400
Dec., 31 To Branch Debtors Ale Dec. 31 By Branch Debtors Ale
Returns 2,000 Credit Sales (3) 70,000
By BalanceC/d 22,400
1,42,400 1,42,400
1994
Goods sent to Branch Account

Rs. Rs.
1993 1993
Dec.31 Branch Adjustment Ale (8 28,080 Jan.I to By Branch Stock Ale (1) 1,40,400
To Purchase Account (11) 1,12,320 Dec.31
1,40,400 1,40,400
Branch Debtors Account

Rs. Rs.
1993 1993
Jan.I To Branch Stock Ale 70,000 Jan. I By Cash (4) 62,400
To Credit Sales (3) to
Dec. 31 Dec., 31 By Branch Stock Ale Returns (5) 2,000
" By Branch Exp. Ale Discount (7) 1,600
70,000 70,000
1994
Jan. 1 To Balance b/d 4,000
79
Branch Expenses Account

Rs. Rs.
1993 1993
Jan. 1 To Cash-Rent (6) 1,200 Dec.31 By Branch Adjustment
Salaries 6,000 Ale Transfered (10) 9,760
S. Exp. 960
To Branch Debtors Ale
Dec. 31 Discount (7) 1,600
9,760 9,760
Branch Adjustment Account

Rs. Rs.
1993 1993
Dec.31 To Stock Reserve Ale Dec.31 By Goods sent to Branch Ale 28,080
20% as Rs, 22400 (9) 4,480
To Branch Exp. Ale 9,760
General profit & Loss Ale
transfer 13,840
28,080 28,080
Stock Reserve Account

Rs. Rs.
1993 1993
Dec. 31 To Balance c/d 4,480 Dec.31 By Branch Adjustment Ale (4) 4,480
1994
Jan. 1 By Balance b/d
4,480 4,480
Note : Figure in Brackers show the setps and entries to be completed.

80

Rs. Rs.
1993 1993
Jan.I To Balance b/d 22,400 Jan. 1 By Cash Sales 80,000
" To Goods sent to to
to Branches Ale 2,65,200 Dec. 31 By Branches Deb. Ale
Dec. 31 To Branch Debtors Credit Sales 1,60,000
Ale Returns 1,500 Dec. 31 By Branch Adj . Ale - Wastage* 1,300
2,89,100 2,89,100
1994
Goods sent to Branch Account

Rs. Rs.
1993 1993
Dec. 31 To Branch Adj. Ale 53,040 Jan 1 to By Branch Stock Ale 2,65,200
" " To Purchases Ale 2,12,160 Dec. 31
2,65,200 2,65,200
Branch Debtor Account

Rs. Rs.
1993 1993
Jan.I To Balance b/d 4,000 Jan.I By Cash 1,51,400
Dec.31
Jan.I to To Branch Stock Ale By Branch Stock Ale
Dec. 31 Credit sales 1,60,000 Returns 1,500
By Branch Exp. Ale Discount 2,600
1,64,000 1,64,000
1994
* The wastage is found as a balancing figure after putting the figure of closing stock on the credit side.
81
Branch Expenses Account

Rs. Rs.
1993 1993
Jan. 1 To Cash-Rent 1,500 Dec.31 By Branch Adj. Ale
Salaries 8,000 Transfer 13,100
Sun Exp. 1,000 1994
Dec. 31 To Branch Debtors Ale Jan.I
Discount 2,600
13,100 13,100
Stock Reseve Accounts

Rs. Rs.
1993 1993
Dec.31 To Branch Adj. Ale Jan.I By Balance b/d 4,480
Transfer 4,480 Dec.31 By Branch Adj. c/d
Dec. 31 To Balance c/d 9,560 (reseve required closingstock) 9,560
14,040 14,040
1994
Jan., 1 By balance b/d 9,560
Branch Adjustment Account

Rs. Rs.
1993 1993
Dec., 31 To Branch Adj., Ale Dec., 31 By Stock Reserve Ale transfer 4,480
Reserve required
on closing stock 9,560
To Branch Stock Ale By Goods sent to
Wastage 1,300 Branch Ale 53,040
To Branch Exp. Ale 13,100
To profit & loss Ale
(transfer of Net Profit) 33,560
57,520 57,520
82
Distinction between whole-sale and retail profit at branch

Sometimes, the manufacturers of goods sell there goods on retail basis also. In such cases they supply
the goods to these retail branches at a price at which it is supplied to the wholesalers theus keeping them at par
with the wholesalers. Since goods are sold by branches at retail price which is more than wholesale price,
therefore, the difference between their sale price and wholesae price only will be taken to be profit earned by the
branch. For example the cost of an article may be Rs. 100, the wholesales price is Rs. 130 If the articles are sent
to branch and sold there, the proft revealed according to the above method will be Rs. 30 (retail Price minus the
cost.) It is apparent, however, that by selling goods throguh branch Profit is only Rs. 10 Rs. 20 could have been
earned by selling the goods on whole-sale basis to others. For knowing the true profit at retail branches, the
practice adopted sometimes is to charge the branch with wholesale price and then to ascertain the profit. The
Head Office Trading Account will then be credited with goods sent to branches at wholesale price and not at
cost.
It must be remembered however, that the stock at the end of the year at the branch will be valued at
wholesale price. Therefor, the Head Office must create a proper reseve by debtiting its own profit & Loss
account in order to show the branch stock at cost in the Balance Sheet.
Illustration 4
A Ltd. has a retail branch at Nagpur and goods are sold to customers at cost plus 100%. The wholesale
price is cost plus 80 %. Goods are invoiced to Nagpur at wholesale price. From the following particulars find
out the profit made atHead office and Nagpur for the year 1993-9
H.O. Nagpur
Stock on July 1,1993 25,000
Purchases 1,50,000
Goods sent to Branch (Invoice Price) 54,000
Sales 1,53,000 50,000
Stock on 30th, June 60,000 1,000
Sales atH.O. are made only on whole-sale basius and that at Branch only to customers. Stock at branch
is valued at Invoice Price.
Trading Account for 1993-94

Particulars H.O. Nagpur Particulars H.O. Nagpur
Rs. Rs. Rs. Rs.
To Opening Stock 25,000 - By Sales 1,53,000 50,000
To Purchases 1,50,000 -
To Goods received By Goods sent to

fromH.O. 54,000 Branch 54,000 -
To profit & Loss Ale By Closing Stock 60,000 9,000

Gross profit 92,000 5,000
2,67,000 59,000 2,67,000 59,000
83
Profit & Loss Account 1993-94

Particulars H.O. Nagpur Particulars H.O. Nagpur
Rs. Rs. Rs. Rs.
To Stock Reserve against for By Gross profit 92,000 5,000
160
Branch Stock Ne (80,000x -
200
) 4,000
To Net Profit (Subject to exp.) 88,000 5,000

92,000 5,000 92,000 5,000
Had the solution been attempted on the usual lines it would have been as follows:-
Trading and Profit & Loss Account for 1993-94

Particulars Head Office Nagpur Particulars Head Office Nagpur
Rs. Rs. Rs. Rs.
To Opening Stock 25,000 By Sales 1,53,000 50,000
To Purchase 150,000 By goods Sent to
To goods setn to (at cost)- 30,000
100
Branch at cost 54,000 x - By Closing Stock
180
(at cost) 60,000 5,000
30,000
68,000 25,000
243,000 55,000 243,000 55,000
Illustration:
A head office sends goods to its Branch at 20% less than its lisepitce. Goods are sold to customers at
cost plus 100% from the following particulars ascertain the profit made at the head office and the branch in case
of branch on the wholesale basis.
Head Office Branch
Rs. Rs.
Opening show of cost
(at invocie price in case of Branch) 40,000 32,000
Purchases 200,000
Goods Sent ot Branch(at invoice price ) 96,000
Sales 1,70,000 80,000
Expenses 14,000 8,000
84
Solution
H.O Branch By Sales No. Branch
Rs. Rs. Rs. Rs.
To Opening stock 40,000 32,000 By goods sent to 170,000 80,000
To Purchases 2,00,000 Branch Ale 96,000
To Goods From. H.O 96,000 By closing Stock
To Gross Profit c/d 1,21,000 16,000 95,000 64,000
3,61,000 144,000 3,61,000 1,44,000
To Expenses 14,000 8,000 By Gross Profet b/d 1,21,000 16,000
To Stock Reserve By Stock Reserve against
against Brncb stock 24,000 branch opening stick
60 60
64' ooox 32' ooox
160 160
To Net Profit 95,000 8,000 12,000

1,33,00 16,000 133,000 16,000
Calculation of closing stock

Head office Branch
Rs. Rs.
Opening stock 40,000 32,000 (at invoice price)
Purchases 2,00,000
Goodds from (HO) 96,000 (at invoice price)
2,40,000 1,28,000
100
Less cost of goods sent to Barnch ( 96,000 x 160) 60,000
lOO
Less cost of sales to Outisders (1' 7 0' 000 X 85,000
200)
160
For Branch (80,000 x-
200) 64,000
95,000 64,000
85
Independent Branch
So far we have studied branches which did not keep books of account. Now we s shall deal with
branches keeping their own accooounts.
The Heaaad Office will open its own books an account called "Branch account to shich goods or cash
sent will be debited. When cash is recieved from the branch , thebranch account will be credited. This account
is maintained more or less /like personal accounts so that any expenses incurred on behalf of the branch will
also be debited the account. The balance of this account shows hw much money the branch owes to Head
Office.
Similarly the branch will have "Head Office Account" in its books "goods" or Cash recieved from
Head office be credited and goods and cash sent to Head Office debited.
The balance in the account is usually credit and indicates the amount owed by branch to the Head
Office.
The balance in the branch account (Head Office books ) should agree with the balance in the Head
Office account ((branch books). But due to goods or cash in transit this may, not be so. ITgpods are sent by the
Head Officce it will pass an entry immediately but the branch will record the receipt of goods only on their
receipt. There will surely be some cash to Head Office, it will record it immediately but the Head Office will
wait till actual receipt. On the daate of closing of accooounts, ggoods or cash in transit, the Head Office will
have to pass the folloowing entry:
Goods in Transit Dr.
To Branch Account
Similarly, for cash sent by the branch but still in transit the branch will pass the entry;
Cash in Transit Account Dr.
To Head Office Account
Both Goods and Cash in transit are assets and should be shown in the balance sheet:
Note: If in examination problems, there is a difference in the balance shown by th Head Offece and Branch
Accounts; the difference should be assumed to be due to either gods in transit or cash-intransit.
Suppose in the Head Office hoods, branch account shows debit balance to Rs. 26,000/- and in the
branch books. Head Office account shows a credit balance of Rs. 21,000/ - worth of goods or cash
is in transit.
Now we shall take up certain other are peculiar to an independent nranch. Account of fixed assets at the
Branch are usually maintained in Head Office books and not in branch books even if the asset is originally paid
by the branch.
When such an assset is acquired and branch pays for it, the branch passes the following entry:
Head Office Account Dr.
The Head Office will pass the following entry on receipt of advice from Branch:
Branch Fixed Asset (by name) Dr.
To Branch Account
86
If Head Office pay s for it, it wiill debit Branch Fixed Asseett Accoount and will credit cash. Branch
passses no entry. Regarding depppreciation there is no peculiarity if the accounts of fixed assets are maintained
in the branch books. But if accounts of such asssets are maintained in Heaad Office books, the entry in respect
of depreciation will be:
Branch Account Dr.
To Branch Fixed Assets Account
In the branch books the entry will be:

Head Officce always does some work on behalf of the branch and thus Head Office Charges a reasonable
amount from the branch. For that the Branch passes the following entry:
Head Office Expenses Account Dr.
Head Office will pass the following entry:

Branch Account Dr.
To Salaries Account (Or Profit & Loss Account)
There may be inter branch transactions. Suppose A Branch sends goods to B branch, the various entries
to be passed are as follows:
In A's books:
Head Office Account Dr.
In B 's books :
Goodds received from Head Office Account Dr.
The Head Office will, of course, keep accounts of all the branches and will also record inter branch
transactions.
If, therefore , goods are supplied by A Branch to B Braanch the Head Office will Pass the following
entry :
A Branch Account Dr.
To B Branch Account
87
Illustration 5
Nagrik Cloth Ltd., had a branch at Rohtak. Preliminary account prepared by Rohtak Branch for 1994
showed a profit of Rs. 11,400 without considering the following:
Cash remitted to the Head Office not yet received 3,600
Goods sent by the H.O. not yet received at Rohtak 4,400
H.O. expenses charged to Branch 3,200
Depreciation on Branch assets (account kept in H.O. Books 900
Record the above in the books of both the Head Office and Branch.Also state how much profit has the
branch made.
Solution:
Books of Head office

Date Particulars L.F. Dr. Cr.
1994
Goods in transitAccount Dr. 4,400
To Rohtak Branch Account 4,400
(Being goods sent to Rohtak Branch not received there)
Rohtak Branch Account Dr. 3,200
To Salaries Account (or P&LA/c) 3,200
(being H.O. expenses to be received from the branch)
Rothak Branch Account Dr. 900
To Branch AssetsAccount 900
Depreciation on branch assets (account kept in
H.O. Books charged to Branch Ale)
Cash in Transit Account Dr. 3,600
To Head Office Account 3,600
(Cash sent to HO not yet received there)
Head Office Expenses Account Dr. 3,200
To Head Office Account 3,200
(Expenses Charged by Head Office)
Depreciation Account Dr. 900
To Head Office Account 900
(Depreciation in respect of branch
assets account in Head Office)
88
After making the above entries the profit at the branch will be reduced to Rs. 7,300 i.e. Rs, 11,400
being H.O. expenses depreciation.
Illustration 6
A&Co. Ltd, having their H.O. at Delhi with branches at Lucknow and Allahabad close their annual
account on 31st December, when the following transactions have taken place:
(a) Remittances of Rs. 4,500 mady by Lucknow bmch to its H.O. on 30th December, received by the
H.O. on 5th January.
(b) Goods valuing Rs. 2,200 despatched by the Allahabad on 27th December, under instructions from
the H.O. and received by the Lucknow on 30th December.
(c) Depreciation amounting to Rs, 1,100 on Lucknow branch fixed assets when accounts of such assets
are maintained at the H.O.
(d) Goods worth Rs. 9,000 despatched by the H.O. to Allahabad branch on 30th December received by
that branch on 7th January.
Show these entries in the books of the (i) H.O. and (ii) Lucknow branch as at the close of the year.
Solution:
H.O. JOURNAL
( a) No Entry Rs. Rs.
*(b) Lucknow Branch Ale Dr. 2,200

To Allahabad Branch Ale 2,200
(Goods sent by Allahabad Branch to Lucknow
Branch as per our instalment)
( c) Lucknow Branch Ale Dr. 1,100
To Lucknow Assets Ale 1,100
(Dep, on assets as Lucknow Branch)
(d ) Goods-in-Transit Ale) Dr. 9,000
To Allahabad Branch Ale 9,000
(Goods sent by us not yet received by Allahabad Branch)
* Strictly entry (b) is not required as the question requires entries only at the close of the year.
89
Lucknow Branch Journal

Rs. Rs.
(a) Cash-in-transit Ne Dr. 4,500
To Head Office Ne 4,500
(Entry for remittances still on transit) 2,200
(b) Goods from H.O. Ne Dr.

To Head Office Ne 2,200
(Goods received from Allahabad oon Head Office instructions)
(c) Depreciation Ne Dr. 1,100

To Head Office 1,100
(depreciation on assets)
Incorporation of branch trial balance in Head Office books

On the receipt of trial balance from the branhc, the H.O. will take steps to incorporate bracu figures
with its own figures with a view to present a common trading and profit and loss account and Blance sheets.
This process is known as Incorporation'. Before starting to pass entries, the Trading and Profit & Loss Account
of the branch will have to be prepared and after that the combined blance sheet of the branch and the Head
Office. There are two methods for doing this:
Under first method, the Trading and Profit and Loss Account of the Branch is prepared in the regular
way in the books of the Head Office. The entries to be passed are as follows:
1. Branch Trading Account Dr.

To Branch Account
(With the items of opening stock, purchases and other items
appearing on the debit side of Trading Account of the branch
but excluding gross pofit).
2. Branch Account Dr.
To Branch Trading Account
(With Sales; Closing Stock and other items appearing on
credit side of Trading Account of the branch but excluding loss).
2. Branch Trading Account Dr.
To Branch Profit and Loss Account
(For Gross profit revealed by Trading Account).
90
Note: If there is a gross loss, the entry will be reversed:

4. Branch Profit & Loss Account Dr.
To Branch Account
(Fro amounts appearing on the debit side a Profit & Loss
account of the branch but excluding net Profit and Gross Loss)
5. Branch Account Dr.
To Branch Profit & Loss Account
(With items appearing on the credit side of P&L A.c of
Branch but excluding gross profit and net loss).
6. Branch Profit and Loss Account Dr.
To Profit & Loss Account
(With net profit revealed by Profit & Loss Account of the Branch).
The above entry will be reversed if there is a net loss:
It should be noed that Branch Trading Account and Branch Profit and Loss Account will setoff.
It is desired to close the books of the branch completely and to record branch asets and liabilities in the
Head office books for the purpose of reparing common Blance Sheet, the folowing two further entries should be
poassed:
Branch Assets (individually)
To Branch Account
(Incorporation of branch assets as shown in the balance sheet at the branch)
Branch Account Dr.
To Branch Liabilities (individually)
(Incorporation of branch liabilities so outsiders shown in the Blance Sheet of the branch).
Illustration 6
You ar required to prepare the Trading and Profit & Loss Account and consolidated balance sheet of
Eve Ltd., inCalcutta and its branch atDelhi. Give Journal entries incorporation ofDelhi branch accounts in the
Head Office and show the branch account in Head Office book after incorporating these in the assets and
liabilities.
The trial balance as on 31stDecember, 1993 are as under.
H.O.Dr. BranchDr. H.O.Cr. BranchCr.

Manufacturing expenses 30,000 10,000
Salaries 30,000 10,000
Wages 1,00,000 40,000
Cash in Hand 10,000 2,000
Purchases 1,50,000 8,000
91
Capital 2,00,000
Goods received from H.O. 15,000
Rent 8,000 4,000
General expenses 20,000 5,000
Salaes - 4,50,000 1,50,000
Gooods sent to Branch 15,000
Purchase returns 5,000 1,000
Opening Stock 50,000 30,000
Discount earned 2,000 1,000
Machinery H.O. 1,50,000
Machinery, branch 50,000
Furniture H.O. 7,000
Furniture,Branch 3,000
Debtores 40,000 15,000
Creditors 30,000 5,000
H.O. Accounts 45,000
Branch Accounts 54,000
Total 7,02,000 2,11,000 7,02,000 1,11,000
Closing stock H.O. was Rs. 40,000 and at branch Rs. 30,000. Depreciation is to be chargeal or machinery
@ 20% and fueniture@ 15%. Rent outstanding is Rs. 500 (for branch).
Solution:
H.O..Books
Journal
Rs. Rs.
1993 Delhi Branch Account Dr. 10,450 10,000
Dec. 31 To Branch machinery account
To Branch furniture account 450
(Being the depereciation on branch fixed assets charged to branch)
Branch trading account Dr. 1,75,000
To Delhi Branch account 1,75,000
(Cueing the total of the following items in branch deebited to
branch trading account)
92
Stock 30,000
Purchases 80,000
Wages 40,000
Manufacturing Expenses 10,000
Goods reed from H.O. 15,000
Total 1,75,000
Delhi Branch Accounts Dr. 1,81,000
To Delhi trading acount 1,81,000
(Being the total of the following items at branches credited to
branch trading account)
Sales 1,50,000
Purcchases return 1,000
Branch stock 30,000
Rs. 1,81,000
Delhi Trading account Dr. 6,000
To Delhi Profit & Loss account 6,000
(Being the transfer of gross profit)
Delhi profit & Loss account Dr. 29,950
To Delhi branch account 29,950
(The total of the following expenses at branch debited to
branch profit and loss account)
Rent(including o/s) 4,500
Salaries 10,000
General expenses 5,000
Depreciation 10,450
Rs. 29,950
Delhi Branch account Dr. 1,000
To Delhi profit & Loss account 1,000
(Being the discount earned at Delhi credited to branch profit & loss a/c)
General profit & loss account Dr. 22,950
To Branch profit & loss account 22,950
(being the loss at Delhi transferred to Profit and loss account of the H.0.)
Brach debtors account Dr. 15,000
Branch cash account Dr. 2,000
93
Branch stock account Dr. 30,000

To Delhi Branch account 47,000
(being the transfer of various assetsa to branch to H.O. books)
Delhi Branch account Dr. 5,500
To Branch creditors account 5,000
To Branch expenseso/s account 500
(Being the transfer of liabilitites at branch to H.O. books)
Delhi Branch Account

1993 Rs. 1978 Rs.
Dec.31 To Balance b/d 54,000 Dec.31 By Delhi Trading Ale
To Branch assets depre -opening stock
ciation 10,450 purchases etc. 1,75,000
To Delhi trading account 1,81,000 By Delhi P&L Ale
sales and stock expenses, 29,950
To Delhi Profit & loss Sundry assets 47,000
account -discount 1,000
To S. Liabilities 5,500
2,51,950 2,51,950
Trading and profit and Loss Account of Eve Ltd.

Fr the year ended 31st December, 1993
H.O. Delhi H.O. Delhi
Rs. Rs. Rs. Rs.
To Opening Stock 50,000 30,000 BY Goods sent to branch 15,000 -
To Purchases less returns 1,45,000 79,000 By Sales 4,50,000 1, 50,000
To Goods receivedfrom H.O. - 15,000 By Closing Stock 40,000 30,000
To Wages 1,00,000 40,000
To Manufacturing ex. 30,000 10,000
To Gross profit carried down 1,80,000 6,000
5,05,000 1,80,000 5,05,000 1,80,000
To Rent (paid and o/c) 8,000 4,500 By Cross Profit b/d 1,80,000 6,000
To Salaries 30,000 10,000 By Discount 2,000 1,000
To General expenses 20,000 5,000 By Net Loss 22,950
To Depreciation:
Machinery 20% 30,000 10,000
FURNITURE 15% 1,050 450
TO NET PROFIT 92,950 -
1,82,000 29,950 1,82,000 29,950
94
(b) lighting and heating expenses are distributed on the basis off units of power consumed by each
department, and so on,
(iii) Common expenses whose benefit are not capable of accurate measurement are dealt with as follows:
(a) Selling expenses, e.g, discounts, bad debts, selling Commission, etc., are apprtioned on the
basis of sales or Cost of production plus Administrative expenses.
Balance Sheet of Eve Ltd.
At a 31st December, 1993
Rs. Rs.
H.O.profit 92,950 Machinery H.O. 1,50,000

Less profit & Loss at branch (Loss) 22,950 70,000 Branch 50,000
Sundry Creditors
H.O. 30,000 35,000 Less Dep. 40,000 1,60,000
Branch 5,000 Furniture
Rent outstanding at branch 500 H.O. 7,000
Branch 3,000
Less Dep. 1,500 8,500

Current Assets
Stock Head Office 40,000
Branch 30,000 70,000
Debtors
H.O. 40,000
Branch 15,000 55,000
Cash in hand
H.O. 10,000
Branch 2,000 12,000
3 05 500
of the profit made or loss suffered at the branch may be passed:

Brach Account Dr.
To H.o. Profit & Loss Account.
For loss the above entry is reversed.
UNIT-IV
DISSOLUTION OF PARTNERSHIP FIRMS
Dissolution
According to Section 39 of Partnership Act of 1922 "the dissolution of partnerships between all the
partners of a firm is called dissolution of the firm" .. In the case of dissolution of a firm, an and is put to he
business of the firm, assets are raised, the liabilities are paid of, and accounts of a the partners are settled.
Dissolution of a firm differs from dissolution of a partnership. When a partnership is formed for a
specified terms or venture; it is dissolved on expiry of h term or completion of the venture. Similarly, death,
retirement or insolvency of a partner results in the dissolution of the partnership, but the remaining partners may
continue to run the business in pursuance to an express or implied contract to that effect. If they do not do so, the
firm automatically stands dissolved. The dissolution of a partnership need not necessary lead to dissolution of
the firm but dissolution of a firm necessarily involves dissolution of partnership also. Dissolution of the firm in
addition to the dissolution of partnership takes place when;
(i) he partners agree that the firm be dissolved (Sec. 40);
(ii) all the partners or a the partners except one becomes insolvent (Sec, 41);
(ii) the business of the firm is declared illegal (Sec. 41);
(iv) in cas of partnership at will, a partner gives notice of his intention of dissolve the firm (Se, 42); and
(v) the court orders dissolution of the firm under any one of the following circumstance (Se. 44):
(a) Where a partner becomes of unsound mind;
(b) Where a partner is permanently incapable of performing his duties as a partner;
(c) Where a partner is guilty of misconduct affecting the business:
(d) Where a partner wilfully or persistently commits breach of partnership agreement:
(e) Where a partner transfer his entire interests to a third party;
(f) Where the business cannot the carried on except at a loss; and
(g) On any just and equitable ground.
Settlement of Accounts
According to Section 48 of the Partnership Act, he accounts; unless otherwise agreed upon, are settled
in the following manner:
(a) losses including deficiencies of capita, shall be paid first out of profits, next out of capita and
lastly, if necessary, by the partners individually in the proportions in which they are entitled to
share profits.
(b) The assets of the firm, including any sums contributed by the partners to make up deficiencies of
capital, shall be applied in the following manner and order:
(i) in paying the debts of the firm to third parties;
96
(ii) in paying to each partner rateably what is due to him from the firm for advances as distinguished
from capita;
(iii) in paying to each partner rateably what is due to him an acccunt of capital; an
(iv) the residue, i any, shall b divided among the partners in proportions in which thy are nit to
share profits.
Thus on dissolution of a firm, sa prods of the assets of the assets (including that of Goodwill) and any
sums contributed by h partners to make up deficiencies of capital must b applied:
1. In paying debts due of third parties (including debts d of partners' spouses);
2. Remainder, in paying partners' advances (loans) mad by hem over and above their capital
contributions. If the balance is not sufficient to pay h advances fully, ratable payment should b
made. In cases a partner has a debit balance in his capital account, sufficient amount should be
transferred to his capita account from his advance account to make up the debit balance before
allowing it of rank for payment among with advances from other partners.
3. The residue remaining still b used in paying of partners the sums due to them on account of
capitals. To arrive at the sums due to partners on capita accounts, the residue si remaining should
b compared with the total of he capitals (after adjustment of accumulated profits and losses) of a
he partners.The difference between the two should be transferred to heir capita accounts in heir
profit sharing ratio.
Firm's Debts and Private Debts

Where there are join debts from the firm, and also separate debts due from any partners in his individual
capacity, the legal position as to settlement of such debts is as follows:
(a) Debts ofthe firm should b paid first our ofhe property ofhe firm, and ifthere is any surplus, then he
share of each partner should be applied in payment ofseparate debts.
(b) Private property ofa partner must be applied in payment ofhis private debt, and the surplus, if any,
in payment of debts of h firm.
Accounting Treatment on Dissolution

On dissolution he boos of accounts of h firm will have to b finally closed. The procedure is of open
Realisation Accounts and take the following steps;
1. To Close Asset Accounts : Transfer a the assets except ash, Bank and fictitious assets like debit
balance ofP & Ale, Advertisement, etc.) at book values to newly opened Realisation Account. The entry will be:
Realisation Ale Dr.
To Various Assets Accounts
(Transfer Book debts at gross value, i.e. wihou deducting provision or Bad and Doubtful Debts, fthere
is cash in hand on the date of dissolution, transfer i of Bank Ac. reat Goodwill like any other Assets).
2. To Close liability Accounts : Transfer a he liabilities due to third parties of Realisation Account
(liabilities due to partners should not be so transferred) at book values. The entry will be :
Sundry liability Ale Dr.
To Realisation Ale
97
3. To Close Fictitious Assets Accounts: Transfer a the liabilities Assets A/s to partner capital or
current Ale
The entry Will be
Partners' Capital A/cs Dr.
To Realisation Ale
To Advertisement etc.
4. To Close Provision or Reserve : (created against an asset): Transfer provision or ReserveAccounts to
Realisation Ale. The entry will be:
Provision Ale Dr.
To Realization Ale
5. To Realise Assets :
(1) When hey are sod in he marker, the entry i b
Bank Ale Dr.
To Realization Ale
(2) When taken over by on or more partners
Partners's Capitals or (Current Ale) Dr.
To Realisations Ale
(3) When taken over by a creditors on full or payments-No entry will be passes (see point 'c' below)
6. To pay off liabilities due to third parties
(a) When paid in cash, the entry will be
Realisations Ale Dr.
To Bank Ale
(b) When partner agrees to discharge a liability
Realisation Ale Dr.
To Partner's Capita Ale
(c) When a liability is discharged by transferring an asset (other than cash an Bank at book value or
revised, he entry is made by net amount arrived at after deducting he amount of the asset so Transferred from the
gross amount of liability to be paid, The entry will be :
To Bank Ale
Net amount = Gross Amount of liability -Asset transferred
7. Net deal with the expenses on dissolution
(1) When he expenses are to be born by h firm the entry will be
To Bank Ale
(2) When the expense to b paid at a fixed rat to one of the partners who has contracted to bear a the
98
expenses of dissolution, no entry for actual expenses incurred will be made. However, the entry for the amount
paid at fixed rate to he partner will b :
To Partners' Capital Ale
or Current Ale
Alternatively, the actual expanses paid by a partner may be treated as drawings an in addition to entry
made above or more entry is passed. The entry will be:
Partners Capita or current Ale Dr.
To Bank Ale
(3) When expenses are borne by one of the partners in his personal capacity, no entry will be passed.
8. To Close Accumulated Profits and Reserve Ne (not being Reserves of Provisions against assets) :
Transfer accumulated profits and reserves to the capita or currentA/cs. of the partners. The entry will be :
Reserve Ale Dr.
To Partners' capital or currentA/cs
9. To deal with unrecorded dissolution
(1) When he unrecorded assets is realised in cash, the entry will be:
BankA/c Dr.
To Realisations Ale
(2) when the unrecorded asset is taken over by one of the partners, he entry will be :
Partners Capital or Current Ale Dr.
To Realisations Ale
There will be no transfer entry for such assets' A/s as they do no appear in the books
10. To Discharge Unrecorded liabilities
(1) When paid in cash, the entry will be:
Realisation Ale Dr.
To Bank Ale
(2) When taken over by one of he partners, he entry will be :
To Partner's capital or Current Ale
11. To Close Realisation Ale
RealisationA/ will disclose their profit or loss on dissolution. The profit or loss is shared by the partners
in their profit sharing ratio by transfer to their capital or urrent A/cs. The entry will be : In the case of profits
Realisation Ale Dr.
To Partners Capital or Current Ale
In the case of loss
Partners', Capital Ale or Current Ale Dr.
99
To Realisation Ale
12. To pay off advances due to partners
On making paymnet to partners for advance due to them, the entry will be:
Partners Advances (loans) Ale Dr.
To Bank.Ale
(When a partner has a debit balance in his apital Ale, the loan amount equal to the debit balance will be
transferred to the Capital Ale of the partner and only the balance will be transferred to the apital Ale of the
partner and only the balance will be paid).
13. To Close Partners' Current A/cs
Partners, Ccurrent Al balances (Dr. or Cr.) should be transferred to their respective CapitalA/cs prior to
final distribution of cash amongst the partners.
If Current A/cs show credit balane, the entry will be .
Partners' Current A/cs Dr.
To Partners' Capital Ale
If current A/cs show debit balances, the entry will be :
Partners' Capital A/cs Dr.
To Partners Current A/cs
14. To Close the Capital A/cs of the Partners
In the end any credit balance standing in the capital A/cs is paid, the entry for it will be:
Partners Capital A/cs Dr.
To Bank.Ale
If the capital acccount of a partner shows a Debit balance in the end, he will be required to bring in cash
to make up the debit balance. The entry will be
Bank Ale Dr.
To Partners Capital Ale
Illustration
P.Q. and R sharing profit and losses in the ratio of their capitals agreed upon dissolution of their firm on
31st December, 1994. On that date their Balance Sheet was as under:
Liabilities Rs. Assets Rs.
Capital A/cs Building. 56,000
Rs. Rs.
P-50,000 Plant & Machinery 25,000
Q-40,000 Less Prov. for Depreciation 5,000
R-10,000 1,00,000 20,000
Reserve Fund 10,000 Furniture 6,000
100
P's Loan 10,000 Investment 10,000

Mrs. P's Loan 5,000 Less Fluctuation Fund 500 9,500
Joint Life Policy Fund 15,000
Current A/cs Rs. Motor Vehicle 20,000
P-6,000 Joint Life Policy 15,000
R-4,000 10,000 Debtors 10,000
Sundry Creditors 15,500 Less Provision 1,000 15,000
Less provision 500 Stock at Invoice Price Rs. 20,000
For Discounts 15,000 Less Unrealised profit 5,000 15,000
Bills Payable 11,000
Outstanding Expenses 1,000 Unexpired Insurancce 100
Bills Receivanle 5,000
Q'sCurrent Ale 5,000
Cash in band 1,000
Ccash at Bank 9,400
1,77,000 1,77,000
Following further information is given :

1. Life Policy was surrendered for Rs. 13,000
2. Debtors raised 14,000 (including Rs, 1,000 in respect of debt written off as bad earlier).
3. P took over half of Mrs. Fs Loan and for the balance Mrs. P acccepted furniture,
4. Rebate of Rs. 200 was received on retiring all the bill payable immediately.
5. There was an unrecorded Liability of Rs 500
6. Stock-in-Trade which included an obsolete and valueless item of Rs. 1,000 was taken over by P & Q
equally at 20% discount.
7. A machine, completely written off from the books and which was estimated to realise Rs. 3,000 was
taken over by Q.
8. Goodwill realised Rs. 4,000, Building Rs. 60,000, Plant and Machinery Rs. 15,000, and investments
Rs. 8,500.
9. Realisation expenses amounted to Rs. 1,000. Half of the expenses were borne by P.
10. The partners presented the Motor Car of the firm to the manager of the dissolved firm in recognition
of his services.
Pass the entires neccessary to close the books, assuming that each partner finally settled his Ale with
the firm.
101
Solution
Journal
1994 Rs. Rs.
Dec. 31 Realisation Ale Dr. 1,73,100
To Building Ale 56,000
To Paint & Machinery Ale 25,000
To Furniture Ale 6,000
To Investments Ale 10,000
To Motor Vehicle Ale 20,000
To Joint Life Policy Ale 15,000
To Bectors Ale 16,000
To Stock Ale 20,000
To Unexpired Insurance Ale 100
To Bills Received Ale
(Being transfer of various assets to
Realisation Ale at book values)
Sundry Creditors Ale Dr. 15,500

Bills payable Ale Dr. 11,000
Mrs. P's Loan Ale Dr. 5,000
Outstanding Expenses Ale Dr. 1,000
To Realisation Ale 37,500
(Being various liabilities transferred to Realisation Ale) 15,000
1994
Dec. 31 Joint Life Policy Fund Dr.
Provision for Depreciation Dr. 5,000
Provision for Bad and Doubtful Debts Dr. 1,000
Provision for stock Dr. 5,000
Investment Fluctuation Fund Dr. 500
(Being various provision transferred to Realisation Ale) 500
Realisation Ale Dr.
To Reserve for Discount on Crs. 500
(Being Reserve for discount transferred to Realisation Ale
102
Bank Dr. 1,19,500

To Realisation Ale 1,19,500
(Being the amount realised cfrom sale of assets.)
Building .... 60,000
Plant
Machinery .... 15,000
Debtors .... 14,000
Goodwill .... 4,000
Investments .... 8,500
Bills
Receivable .... 5,000
Joint Life
Policy .... 13,000
1,19,500
Realisation Ale Dr. 27,300

To Bank 27,300
(Being the payment of various liabilities)
Bills Payable 10,800
(Rs. 11,000-200 Rebate,
Creditors 15,000
Outstanding Expenses 1,000
Unrecorded Liability 500
27,300
Realisation Ale Dr. 2,500
To P's Current Ale 2,500
(Being half of Mrs. P's loan taken over by P.)
P's Current Ale Dr. 6,000
Q's Current Ale Dr. 6,000
(being stock taken over by P and Q)
(being machine taker over by Q)
103
P's Current Ale Dr. 10,000

R's Current Ale Dr. 2,000
(Being Motor Car presented to manager
Loss before in profit sharing ratio.)
Realisation Ale Dr. 500
To Bank 500
(Being realisation expenses paid Rs, 1,000 - 500 borne by P)
" Realisation Ale Dr. 9,600
To Q's Current Ale 3,840
To R's Current Ale 960
(being profit on realisation transferred to partners Current A/cs)
" Bank Dr. 1,000
To Cash 1,000
(Being the amount of cash in hand transferred to Bank)
P's Loan Dr. 10,000
To Bank 10,000
(Being P's loan paid off)
" Reserved Fund Dr. 10,000
To R's Current Ale 1,000
(Being transfer of Reserve Fund to the Current A/cs
of the partners in their profits sharing ratio)
" P's Current Ale Dr. 2,300
R's Current Ale Dr. 3,960
To P's Capital Ale 2,300
To R's Capital Ale 3,960
(Being transfer of credit balances in P and
R's Current A/cs to their Capital A/cs)
" Q's Capital Ale Dr. 14,160
(Being transfer of.Q's Current A/cDebit balance to this Capital Ale)
104
P's Capital Ne Dr. 52,300

Q's Capital Ne Dr. 25,840
R's Capital Ne Dr. 13,960
To Bank 92,100
Note 8 : No entry for furniture takern over by Mrs P in satisfaction of balance of her loan [half having been
takern over by Mr.P] will be passed. Here furniture realised only an amount equal to the amount of
loan satisfied by its transfer.
2. In case where Current Ncs of the partners are not in use, their Capital Ncs should be debited or
credited.
Ledger Accounts
Realisation Account
Dr. Cr.
1994 Rs. Rs.
Dec.31 To Sundry Assets By Sundry Liabilities:
Building 56,000 Creditors 15,500
Plant & Machinery 25,000 Mrs. P's loan 5,000
Furniture 6,000 Bills Payable 11,000
Investments 10,000 Outstanding
Motor Vehicle 20,000 Expenses 1,000 32,500
Joint Life Policy 15,000 By Provisions :
Debtors 16,000 Joint Life Policy Fund 15,000
Stock (LP.) 20,000 Provision for
Unexperied Insurance 100 Deprn. 5,000
Bills Receivable 5,000 1,73,100 Provision for Debtors 1,000
To Reserve for
,, Discunts Crs. 500 Provision for Stock 5,000
To P's Current Ne 2,500 Inv. Fluctuation Fund 500 26,500
(Half of Mrs. P's Loan) By Bank:
,,
To Bank: Building 60,000
Bills Payable 10,800 Plant & Machinery 15,000
Creditors 15,000 Debtors 14,000
Outstanding Expenses 1,000 Bills Receivables 5,000
Unrecorded Liability 500 27,300 Investments 8,500
105
Joint Life Policy 13,000

To Bank (Realistation expenses) 500 Goodwill 4,000 1,19,500
" To Profit trans ferred to: By P's Current Ale
Stock 6,000
Car 10,000 16,000
P's Current Ale 4,800 By Q's Current Ale
Q's Current Ale 3,840 Stock 6,000
R's Current Ale 960 9,600 Machinery 3,000
Car 8,000 17,000
By R's Current Ale
Car 2,000
2,13,500 2,13,500
Bank Ale
Dr. Cr.
1994 Rs. 1994 Rs.
Dec. To Balance b/d 9,400 Dec. By Realisation Ale
31 To Cash (Balance in 31 Bills Payable 10,800
hand/transferred) 1,000 Creditors 15,00
Outstanding
Expenses 1,000
To Realisation Ale Unrecorded Lib. 500 27,300
Building 60,000 By Realisation Ale
Plant & Machinery 15,000 (Realisation Exp.) 500
Debtors 14,000 By P's Loan 10,000
Bills Receicable 5,000 By Capital A/cs
Investments 8,500 P's 52,300
Joint Life Policy 13,000 Q's 25,840
Goodwill 4,0001 1,19,500 R's 13,960 92,100
1,29,900 1,29,900
106
Current Accounts
Dr. Cr.
1994 p Q R 1994 p Q R
Rs. Rs. Rs. Rs. Rs. Rs.
Dec. To Balance b/d 5,000 Dec., By Balance b/d 6,000 4,000
To Realsisa tion Ale 6,000 6,000 By Reserve Fund 5,000 4,000 1,000
(Stock)
To Realisation Ale 3,000 By Realisation Ale. 2,500 - -
(Machinery) (Mrs. P's)
To Realisation Ale 10,000 8,000 2,000 LoanBy Realisation Ale 4,800 3,840 960
(Car) (Profit)
To Capital A/cs 2,300 - 3,960 By Capital A/cs - 14,160 -
18,300 22,000 5,960 18,300 22,000 5,960
Capital Accounts
p Q R p Q R
1994 1994
Dec. Dec.
31 To Current Ale - 14,160 - 31 By balance b/d 50,000 40,000 10,000
To Bank 52,300 25,840 13,960 By Current Ale 2,300 - 3,960
52,300 40,000 13,960 52,300 40,000 13,960
Alternative Method:
Under this method, the treatment differs from the one already discussed only in respect of the following:
1. Assets and liabilities (including provisions) are not transferred to Realisation Ale. Worthless Assets,
however, are transferred to Realisation Ale. at book accounts
2. Provisions are transferred to the resoectice asset or liability accounts.
3. On realisation of an asset, the sale proceeds are credited to the asset account. The balance remaining
in the account, being profit or loss, is then transferred to Realisation Ale. In case a partner takes over
an asset, the asset account is credited with the value at which the asset is taken over and capital Ale.
or Current Ale. of the partner is debitede.
4. On payment of liabilities, the liability account is debited and cash account credited.
Any balance remaining in the liability account is then transferred to Realisation Ale.
Under this method, in the solution to the previons illustration problem. Realisation Ale. and other
relevant accounts would have appeared as under:
107
Realisation Ale
Dr. Cr.
1994 Rs. 1994 Rs.
Dec. 1 To Plant & Machinery 5,000 Dec.31. By Building 4,000
" To Furniture 3,500 " By Joint Life Policy 13,000
" To Investments 1,000 " By Bills Payable (Rebates) 200
" To Stock 3,000 " By Bank:
" To Debtors 2,000 Bad Debts
" To Unexpired Insurance 100 Recovered 1,000
" To Bank Goodwill 4,000 5,000
Unrecorded Liability 500 By Q's Current Ale
Realisation Exp. 500 1,000 (Machinery)
To Profit
Transfered to
P's Current Ale 4,800
Q's Current Ale 3,840
R's Current Ale 960 9,600
25,200 25,200
Bank Ale.
Dr. Cr.
1994 Rs. 1994 Rs.
Dec. 31 To Balance b/d 9,400 Dec. By Bills Payable 10,800
" To Cash 1,000 " By Sundry Creditors 15,000.
" To Building 60,000 " By Outstanding Exp. 1,000
" To Plant & Machinery 15,000 " By Realisation Ale
" To Debtors 13,000 " Unrecorded
" To Bills Receivable 5,000 Liability 500
" To Investments 8,500 " Realisation Exp. 500 1,000
" To Joint Life Policy 13,000 " By P's Loan Ale 10,000
" To Realisation Ale " By Capital A/cs.
Bad Debts p 52,300

Recovered 1,000 Q 25,840
Goodwill 4,000 5,000 R 13,960 92,100
1,29,900 1,29,900
108
Current A/cs.
1994 p Q R 1994 p Q R
Dec., 31 To Balance b/d - 5,000 - Dec. By Balance b/d 6,000 - 4,000
" To Stock 6,000 6,000 " By Reserve Fund 5,000 4,000 1,000
" To Motor Vehicle 10,000 8,000 2,000 " By Mrs. P's Loan 2,500 - -
" To Realisation Ale - 3,000 - " By Realisation Ale 4,800 3,840 960
(Match)
" To CapitalA/c 2,300 - 3,960 " By Capital Ale - 14,160 -
18,300 22,000 5,960 18,300 22,000 5,960
The Capital A/cs, will be ahown as in the previous solution.
Building Ale.
Dr. Cr.
1994 To Balance b/d 56,000 1994 By BankA/c 60,000
Dec. 31 To Realisation Ale 4,000
60,000 60,000
Plant and Machinery Ale

1994 1994
Dec. 31 To Balance b/d 25,000 Dec. 31 By Provision for Depreciation 5,00,
By Bank 15,000
By Realisation Ale 5,000
25,000 25,000
Furniture Ale
1994 1994
Dec. 31 To Balance b/d 6,000 Dec. 31 By Mrs. P's Loan 2,500
By Realisation Ale. 3,500
6,000 6,000
Investment Ale
1994 1994
Dec. 31 To Balance b/d 10,000 Dec. 31 By investment Fluctuation Fund Ale 500
By Bank 8,500
10,000 10,000
109
Motor Vehicle Ale

Dr. Cr.
1994 1994
Dec. 31 To Balance 20,000 1994 By P's Current Ale 10,000
By Q's Current Ale 8,000
By R's Current Ale 2,000
20,000 20,000
Joint Life Policy Ale

1994 1994
Dec. 31 To Balance bid 15,000 Dec. By Joint Life Policy Fund 15,000
To Realisation Ale 13,000 By Bank 13,000
28,000 28,000
Debtors Ale
1994 1994
Dec.I By Balance bid 16,000 Dec. 31 By provision for Debtors 1,000
By Bank 13,000
16,000 16,000
Stock Ale
1994 1994
Dec. To Balance bid 20,000 Dec 31 By Provisions for Unrealised profits 5,000
By P's Current Ale 6,000
By Q's Current Ale 6,000
By R's Current Ale 3,000
20,000 20,000
Bills Receivable Ale

1994 1994
Dec. 31 To Balance bid 5,000 Dec 31 By Bank 5,000
5,000 5,000
Mr, P's Loan Ale

1994 To P's Current Ale 2,500 Dec. 31 By Balance bid 5,000
To Furniture Ale 2,500
5,000 5,000
110
Sundry Creditors Ale

1994 To P's Current Ne 500 Dec. 31 By Balance b/d 15,500
To Bank 15,000
15,500 15,500
Bills Payable Ale

1994 To bank 10,800 1994 By Balance 11,000
Dec. 31 To Realisation Ne 200
11,000 11,000
Outstanding Expenses Ale

1994 Rs. 1994 Rs.
Dec.31 To Bank 1,000 Dec. 31 By Balance b/d 1,000
1,000 1,000
Dissolution before expiry of a fixed term

A partner who on his admission, happens to-pay a premium (goodwill) to the existing partners under a
stipulation that the firm will not be dissolved before the expiry of a fixed ter, will be entitled to a refund of such
an amount of the premium so paid as is reasonable having regard to the terms upon which admission was made
and to the length of perod agreed upon and that already expired, if the firm is dissolved before the expiry of such
a term. However, no claim in this respect will arise if:-
1. the firm is dissolved due to the death of partner:
2. the dissolution is mainly due to the partner's own misconduct:
3. the dissolution is in pursuance of an agreement containing to propvision for the return of the premium
or any part of it.
Any amount that becomes due to such a partner will be borne by the other partners in their profit
sharing ratio. Suppose X,Y, take Z as a new partner on the condition that Z pays Rs. 20,000 for goodwill and it
is agreed that the partnership would be for 10 years. But if the firm is dissolved after 6 years only without there
being any misconduct on the part of the new partner, death of any partner or without an agreement entered into
not providing for return of goodwill so paid, he will be entitled to a refund of Rs. 8,000
SALE TO A COMAPNY
Often, a partnership firm converts itself into a joint stock limited company or sells its business to an
existing one. Broadly, the procedure already discussed above will be followed for closing the books of the firm.
Realisation Account will be opened ans assets transferred to it, so also liabilities (but not if liabilities are not
assumed by the company). Whatever the company pays as purchase consideration will be credited to the
Realisation Account. If expenses are incurred by the company, no further treatment is necessary beyond
transferring them to the credit of Realisation Account; but id creditors are to be paid by the firm, the actual
amount paid to them will be debited to liability account concerned; the difference betweeen the book figure and
the amount actually paid will be transferred to the realisation Account. The profit or loss on realisation will be
transferred to the capital accounts in the profit-sharing ratio. Besides the above, the main points to be noted are
the following:
111
(a) Usually, the company takes over all the assets including cash. Therefore, cash should also be
transferred to Realisation Account. If however, the company does not take over cash, it will not be transferred.
(b) Usually, the company will discharge the amount due from it in the form of cash, debentures and
shares. Separate accounts will, of course, be opened for debentures and share received, partners will divide the
debentures and shares among themselves, in the absence of an express agreement, in the ratio of their final
claims, that is to say, in the ratio of capitals standing after the loss or profit on realisation and other reserves and
profits have been transferred. Further, since no fraction of a share or debenture can be allotted, the nearest
whole number of shares or debentures should be given to a partner, the necessary adjustment being made in
cash, if there is an agreement of divide the shares or debenturs in a particular manner, the agreement should be
followed.
Notes : (])Some authorities recommend that shares in joint stock companies should be divided among
partners in the profit-sharing ratio. This will enable partners to enjoy any future profit -sharing ratio. This will
enable partners to enjoy any future profit or loss on shares in the profit-sharing ratio. However, it seems that in
the absence of an agreement, the Partnership Act does not permit this method of distribution. Profits and loss
after dissolution have no bearing on partnership accountts. Shares cannot be treated differnently from other
assets, say stock and furniture, it would of course, be better if the Partnership Deed contains a clause regarding
this matter.
(2) If there is some valueless asset in the bools of the firm and if this has to be divided among the
partners, it should be divided in the profit-sharing ratio so that any ultimate profit or loss may correspond to the
ratio in which profits are shared.
Illustration A.B. and C carry on business in partnership sharing profits and losses in the proportions of
1/2,3/8. and 1/8, respectively. On 31st March, 1991, they agreed to sell their business ot a limited company.
Their position on that date was as follows.
Rs. Rs.
A's Capital 40,000 Freehold property 48,000
B's Capital 30,000 Machinery 42,000
C's Capital 26,000 Book Debts 15,000
Loan on Mortage 16,000 Stock 23,000
Sundry Creditors 18,000 Cash 2,000
1,30,000 1,30,000
The company took the following assets at the valuation shown below:-
Rs. Freehold property 61,000
Machinery 31,800
Book Debtors 14,000
Stock 22,000
Goodwill 10,000
The company also agreed to pay the creditors which was agreed at Rs.17,700. The company paid
Rs. 67,000 in fully paid shares of Rs. 10 each and the balance in cash. The expenses to Rs. 1,500.
Prepare Ledger Accounts in the books of the firm.
112
Solution:
Realisation Account
Dr. Cr.
1991 Rs. Rs. 1 1991 Rs. Rs.
Mar. 31 To Sundry Assets: Mar 31 By Loan on Mortgage 16,000
Freehold property 48,000 By Sundry Creditors 18,000
Machinery 42,000 By Ltd. Company's Ale-
Book Debts 15,000 F. Property 61,000
Stock 23,000 1,28,000 Machinery 31,800
To Cash-expenses 1,500 Book Debts 14,000
To Cash-Loan paid 16,000 Stock 22,000
To profit transferred to: Good will 10,000
A's Capital, 1/2 4,800 1,38,800
B's Capital, 3/8 3,600 Less Creditors 17,700 1,21,100
C's Capital, 1/8 1,200 9,600
1,55,100 1,55,100
Limited Company's Account

1991 Rs. 1991 Rs.
Mar. 31 To Realisation Ale By Shares in Ltd. 67,000
purchase consideration 1,21,100 By Cash 54,100
1,21,100 1,21,100
Cash Account
1991 Rs. 1991 Rs.
Mar. 31 To Balance b/d 2,000 Mar.31 By Realisation Ale
To Ltd. Company 54,100 Expenses 1,500
Loan 16,000
By Capital Accounts:
A 16,380
B 12,280
C 9,940 38,600
56,100 56,100
113
Shares in Ltd. Co.

1991 Rs. 1991 Rs.
Mar. 31 To Ltd. Company 67,000 Mar31 By A's Capital Ne 28,420
By B's Capital Ne 21,320
By C's Capital Ne 17,360
67,000 67,000
Capital Accounts
A B C A B C
To Shares in ... Ltd. Co. 28,420 21,320 17,360 By Balance b/d 40,000 30,000 26,000
To Cash (balance) 16,380 12,280 9,940 By Realisation
Ne Profit 4,800 3,600 1,200
44,800 33,600 27,200 44,800 33,600 27,200
Note. Total number of shares received from the limited company is 6,700. These have been divided
among A ,B, and C in the ratio of 448,336 and 272 or 28,21 respectively, namely, in the ratio of the amount
finally due to them. Hence
6,700
A gets �x28 or 2,842 shares of Rs. 28, 420:
6,700
B gets �x21 or 2,132 shares of Rs. 21,320 : and
6,700
C gets �x17 or 1,726 shares of Rs. 17,260
Insolvency of a Partner
If on dissolution, the capital account of a partner shows debit balance after his share of profit or loss has
been adjusted therein, he becomes debtor to the firm to that extent and will have to bring insufficient amount to
make up the debit balance in his capital account. If however, the partner is insolvent, the amount due will either
not be realised al all or at any rate will not be paid in full. In such a case, the deficiency this arising will have to
be borne be solvent partners, before the decision in Gamer v Murray's case was delivered, such as loss was
treated as an ordinary loss and was borne by the solvent partners in their profit sharing ratio. But the decision in
the above mentioned case has changed the positon.
Decision in Garner v Murray

If a patner is unable to repay the debt due to the firm on dissolution, it was decided that:
1. First the loss on realisation should be transferred to the Capital accounts of all partners (including
the insolvent partner) in their profit sharing ratio. Then, the solvent partners having credit balance in
their Capital accounts should contribute cash equal to their share of loss on realisation. A solvent
114
Partner with a debit balance in his capital account will only be required to make the debit balance in
the end.
2. Deficiency arising due to insolvency of a partner must be borne by solvent partners in proportion to
their Capitals (here solvent partner means a partner who is solvent and has a credit balnce in his
Capital account just prior to dissolution). Thus the decision makes a distinction i.e. between a loss
occasioned by the default of partner, and an ordinary trading loss.
3. The Capitals in proportion to which the deficiency will have to be borne by the solvent partners
should be the Capital standing at the date on which, the partners determined upon dissolution and
prior to making of any adjustment arising from the realisation of assets. As the Capitals can be fixed
or fluctating for determining the relevant ratio, the real capitals will be ascertained as under:
1. Where the Capitals are fluctuating the Capital amounts are determined after adjusting all the
reserves and accumulated profits, all drawings, interest on capital, interest on drawings to the
date of dissolution but before adjusting loss on realisation.
2. Where the capitals are fixedd, the Capital amounts which the partners had last agreed to be
fixed. (All adjustments for reserves and accumulated profits etc., are through current Ale).
To sum up, when a partner is insolvent and there is deficiency in his capital account, the procedure to
settle the accounts will be.
1. Ascertain at the date of dissolution the solvent partners' adjusted capitals, if fluctutaing, otherwise
their fixed capitals.
2. Prepare realisation Ale as usual and transfer the loss on realisation to the capital accounts of all the
partners in their profit sharing ratio.
3. Credit, if anything is received from the estate of the insolvent partner, to his capital account.
4. Credit the solvent partners for cash brought in by them equal to their share of loss on realisation. (In
practice, only entries are made and no cash is brought actually, such normal adjustment is sufficient).
5. Determine the ultimate deficency of insolvent partner after making all the asjustments including
receipts from his estate, if any.
6. Transfer this deficiency to the capital accounts of solvent partners in the ratio of thir capitals as
determined (1) above.
7. The solvent partners will then draw out cash according to their claims.
Equity
According to the decision in Garner v. Murray case, only those solvent partners, whose capital accounts
show credit balance on the date on which they determine upon dissolution, are required to bear the loss arising
on account of insolvency of a partner. A partner with no capital or with his capital account showing a debit
balance, however a solvent and affluent he may be, is not called upon to bear any share in insolvent partner's
capital deficeny as the same has to be borne by solvent partners in proportion of their capitals. Such a partner is
only called upon to bring in the amount, if any, standing to the debit of his own capital account. Again as solvent
partners alone are made to bear the deficiency, so the partner or partners having the large balance irrespective of
their affluence will have to bear large proportion of the deficiency.
Application in India
The decision in Garner v. Murrary may appear to be contrary to the provisions of Partnership Act.
Section 48 (B) (III) clearly provides that the residue remaining still after payingoff outside liabilities and advances
by partners, shall be applied in paying to each partner rateably what is due to him (after adjustment of loss on
115
realisation) on account of capital. Where ther is dificiency in the capital account of an insolvent partner, even
after making ratable payment, the capital account of sol vent partners will not be closed, and on the other hand,
the insolvent partner's Capital account balance (Def.) will remain unadjusted. A strict interpretation of Sec. (h)
(III) suggest s that the unsatisfied credit balances in the capital accounts of the solvent partners should be
adjusted against the deficiency in the insolvent partners' capital account. Thus, the solvent partners are made to
bear the deficiency equal to the unsatisfied balances rernianing in their capitl accounts after rateable distribution
of the residue. However, in view of there being no judicial ruing of the point as to how the deficiency shoul be
borne by solvent partners, it would not be entirely improper to apply the decision of Garner v. Murray. Therefore,
when working out problems involving application of the dicision on one should indicate whether or not the
rules has been applied.
Illustration
A,B,C, and had been carrying on business in partnership sharing profits and losses in the ratio of
3:2:1:1. They decided to dissolve the partnership on the basis of the following Balance Sheet as on
31st Dec. 1994.
Capital Ale Land and Building 30,000
A 25,000 Furniture 10,000
B 15,000 40,000 Stock 25,000
Debtors 10,000
A's Loan 10,000 Bank 1,500
General Reserve 14,000 Cash in hand 500
Capital Reserve 3,500 Capital A/cs:
Mortgage Loan 10,000 C 3,500
Sundry Creditors 6,000 D 3,000 6,500
83,500 83,500
1. The assets were realised as under:

Rs.
Land & Building 22,500
Furniture 4,000
Stock 15,000
Debtors 6,000
2. Dissolution expenses amounted to Rs. 1000/-
3. Further liability of Rs. 6,500 had to be met.
4. C became insolvent and Rs. 1,300 was realised from his private estate.
Prepare necessary accounts to close the books of the firm. Apply the decision in Gamer v. Murray's
case.
116
Solution:
Realisation Ale
Dr. Cr.
1994 To Sundry Assets 1994 By Sundry Liabilit
Dec. 31 Building 30,000 Dec.31 Mortgage Loan 10,000
Furniture 10,000 S. Creditors 6,000 16,000
Stock 25,000 ByBank
Debtors 10,000 75,000 Building 22,500
Furniture 4,000
To Bank (Real.exp.) 1,000 Stock 15,000
To Bank Debtors 6,000 47,500
Mortgage Loan 10,000 By Loss Transferred to
S. Creditors 6,000 A 15,000
Further Liability 6,500 22,500 B 10,000
C 5,000
D 5,000 35,000
98,500 98,500
Bank.Ale
Dr Cr.
1994 Rs. 1994 Rs.
Dec.31 To Banalnce b/d 1,500 Dec.31 By Realisation:
To Cash 500 Mortgage Loan 10,000
To S. Assets S. Creditors 6,000
Building 22,500 Further liability 6,5,00 22,500
Furniture 4,000 By Realisation Exp. 1,000
Stock 15,000 By A's Loan Ale 10,000
Debtors 6,000 47,500
To Capital A/cs By Capital A/cs
A 15,000 A 29,900
B 10,000 B 18,400 48,300
C 6,000
D 1,300 32,300
81,800 81,800
117
Capital Accounts
A B C D A B C D
1994 Rs. Rs. Rs. Rs. 1994 Rs. Rs. Rs. Rs.
Dec. To Balance 3,500 3,000 Dec. By Balance 25,000 15,000 - -
31 bid 31 bid
To Loss By Gen. 6,000 4,000 2,000 2,000
on Real 15,000 10,000 5,000 5,000 Reserve
To C's By Res. 1,500 1,000 500 500
Capital By Bank
Ale 2,600 1,600 - - (Loss on 15,000 10,000 - -
To Bank 29,900 18,400 - - Reals)

By Bank - - 6,000 1,300
By A's
By Capital Ale - - 2,600
By B's
Capital Ale - - - 1,600
47,500 30,000 8,500 8,000 47,500 30,000 8,500 8,000
Note: Where the capitals are fixed, Reserves and other accumulated profits, if any, and loss on realisation
is transferred to partners' Current Accounts ion their profit sharing ratio. Cash brought in by solvent partners is
credited to their Current Accounts. The insolvent partners' current account is then transferred to his capital Ale.
After crediting any amount realised from the estate of the insolvent partner, the dificiency is determined and
transferred to the capital A/cs of solvent partner in the ratio of their fixed capitals. The current A/cs of solvent
partner in the ratio of their fixed capitals. The current A.cs of solvent partners are transferred to their capital
accounts to determine amounts finally due to them,
When All the partners are insolvent

If all the partners become insolvent, the balance of cash on the date of dissolution, sales proceeds of the
assets together with whatever is received from the private estate of the partners will not be sufficient to discharge
the claims of third parties in full after meeting realisation expenses. Partners' advances, if any, will also not be
PAID. Such advances should be transferred to the capital A/cs of thr partners concerned. In such a case, the
dissolution accounts may be prepared in any of the following two methods.
First Method
Under this method the dissolution accounts are prepared in the usual manner. All the assets (except
cash & Bank) and outside liabilities are transferred to Realsisation Ale Available amount of cash (cash balance
on the date of dissolution plus sale proceeds of assets plus cash received fom the private estates of insolvent
partners, if any, minus dissolution expenses) is paid to the creditors which will not be in full discharge in their
claims. The saving (balance remaining unpaid to creditors) will automatically be adjusted in Realisation Ale.
Profit or loss on realisation is distributed amongst the partners in their profit sharing ratio by transfer to their
118
capital accounts. If there is a debit balance in the capital account of any partner, it is transferred to the capital
accounts of the partners showing credit balance at this stage in the ratio of their capitals.
Second Method
Under this method all the asset accounts (except cash and banks) are transferred to Realisation Ale by the
liability A.c are not so transferred. Dissolution expenses are debited to Realisation Ale. The profit or loss on
realisation is transferred to the capital accounts of partner in their profit ratio. Availabel cash (balance on the date
of dissolution plus sale proceeds assets minus dissolution expenses) is utilised in making rateable payment to the
creditors. The balance in the creditors' accounts remaining unpaid is transferred to Deficiency Ale to which the
balances of partners' capital accounts are also transferred to finally close the books of accounts of the firm.
Illustration
The Balance Sheet of X,Yand Z who were sharping profits and losses in the ratio of 3:1:1, stood as
follows on 31st December, 1994 i.e., the date of dissolution:
Sundry Creditors 90,000 Cash in hand 2,000
Bank Overdraft 1,25,000 Bills Receivable 8,000
X's Capital Ale 30,000 Debtors 50,000
Z's Capital Ale 20,000 Stock 80,000
Plant 60,000
Goodwill 20,000
Y's Capital Ale 45,000
2,65,000 2,65,000
The Assets realised Rs. 1,59,500. Realisation expenses amounted to Rs. 4,000. Show the final adjustment
among the partners, assuming that they are all insolvent and Y's estate realised Rs. 5,000.
Solution:
(First method)
Realisation Ale
1994 1994 Rs.
Dec. To Sundry Assets Dec.
31 Bills receivable 8,000 31 By Sundry Liabilities:
Debtors 50,000 Bank Overdraft 1,25,000
Stock 80,000 S.Creditors 90,000 2,15,000
Plant 60,000 By Cash (Assets realised) 1,59,500
Goodwill 20,000 2,18,000 By Loss transferred to :
4,000 X's Capital Ale 6,000
To Cash (Realisation expenses) Y's Capital Ale 2,000
To Bank (Liabilities) 1,62,500 Z's Capital Ale 2,000 10,000
3,84,500 3,84,500
119
CashA/c
1994 Rs. 1994 Rs.
Dec. ToBalance 2,000 Dec. By Realisation Ne (Realisation Exp.) 4,000
To Realisation Ne By Realisation Ne (Liabilities) 1,62,500
(Sales proceeds of Assets) 1,59,500
To Y's Capital Ne
(Reed, from Y's estate) 5,000
1,66,500 1,66,500
Illustration
Red. Zed and Ted shared profits and losses in the ratio of 5: 3: 2 On 31st March, 1990, their balance
sheet was as follows: -
Trade Creditors 30,000 Sundry Assets 60,000
Bank Loan 10,000 Profit & Loss Account 40,000
Capitals:
Red 30,000
Zed 20,000
Ted 10,000 60,000
1,00,000 1,00,000
TheBank had a charge on all the assets; these realised Rs. 29,000 in all. Zed's private estate realised
Rs. 6,000 his private creditors were Rs. 5,000 Ted was unable to contribute anything. Red paid 1/3 of what was
finally due from him (taking the payment also into account) except on account of other partners. Prepare ledger
accounts, passing all matters relating to realisation of assets and payment of liabilities through the Realisation
Accounts.
Solution:
Realisation Account
Dr. Cr.
1990 Rs. 1990 Rs. Rs.
Mar. 31 To Sundru Assets transfer 60,000 Mar. 31 ByTrade Creditors 30,000
" ByBank Loan 10,000
" To Cash-Bank Loan 10,000 " ByBankNc 29,000
" To Cash-Trade Creditors 20,200 " By Loss transferred to:
Red's Capital Ne 10,600
Zed's Capital Ne 6,360
Ted's Capital Ne 4,240 21,200
90,200 90,200
120
Cash Book
1990 Rs. 1990 Rs.
Mar. 31 To Realisation Ne 29,000 Mar. 31 By Realisation Ne
" To Zed's Capital Ne 1,000 Bank Loan 10,000
To Red's Capital Ne 200 By Realisation Ne
Trade Creditors 20,200
30,200 30,200
Capital Accounts
Red Zed Ted Red Zed Ted
To Profit & Loss Ne 20,000 12,000 8,000 By Balance bid 30,000 20,000 10,000
To Realisation Ne Loss 10,600 6,360 4,240 By Cash 1,000
To Red's Capital Ne 400 By Cash 200
To Ted's Capital Ne 2,240 By Transfer to
Zed's Capital Ne 400 2,240
30,600 21,000 12,240 30,600 21,000 12,240
The amount brought in by Reds has been calculated as follows:-

Suppose, the amount brought in by Red is xi.e. 1/3 of amount due from Red. The amount then payable
to trade creditors will be Rs. 20,000 + x, Rs. 20,000 being available without the amount to be brought in by Red,
The loss on realisation will be : Rs. (60,000 + 10,000 + 20,000 + x - 69,000) or Rs. 21,000 + x.
Red's share will be Rs. 5/10 (21,000 + x) or Rs. 10,500 +l/2x, making the debit balance his capital
account to be Rs. 20,000 + 10,500 + x/2 - 30,000 or Rs. 500 + x/2.
Then 3x = 500 +x/2
6x = 1,000 +x
5x = 1,000
x = 200 Gradual Realisation of Assets and Piecemeal Distribution
GRADUAL REALISATION OF ASSETS AND PIECEMEAL DISTRIBUTION

It has been assumed in the working of all the illustrations so far in this chapter that all the assets are
realised on the date of the dissolution, and that 11 expenses and liabilities are paid on that date. This assumption
enables one to know immediately the profit or loss on realisation which can then be transferred to the capital
accounts; this determines the final amount due to the partners. In actual practice, this assumption is far from
valid. Assets are realised and cash collected gradually. Final results are not known till auite some time. In the
meantime, the cash collected is distributed among the carious paues. The student remembers that in case of
dissolution, first of all the outside creditors have to be paid, then if surplus remains, any loans givens by the
partners over and above their capitals are paid (rateably if the amount available is not sufficient) and last of all,
121
the partners' capitals are paid off. It is clear, therefore, that any cash in hand or cash clooected should be
distributed among creditors until all of them are paid off. One must remember to keep adequate funds for
liabilities that may arise in future, for instance, for bills discounted exected to be dishonoured. After this, the
cash available should be applied in returing partners' loans proportiontely if two or more than two partners have
advanced loans to the firm.
Proportionate Capital
The main question is how to distribute cash among partners for return of capital. One must remember
that the profit or loss on realisation of assets will not be known for some time and, therefore, this profit or loss
cannot be adjusted in the capital accounts immediately. And yet cash must be distributed in such a way that the
amounts finally left unpaid (i.e. the loss to be borne by the partners) are in the ratio in which profits and losses
are shared. The available cash cannot be distrubuted according to the profit-sharing ratio (unless the capitals are
themselves in the profit sharing ratio) because that will leave the balances unpaid out of proportion. The cash
available cabbot also be distributed in the ratio of capitals because, then the parttners will be forced to bear the
final loss in the ratio of capitals which may be different from the profit-sharing ratio. Suppose, after paying off
all the creditors, two further i nstalments are collected - one of Rs. 40,000 and the other of Rs. 20,000; suppose
further that there are two pattners (A andB) sharing profits in the ratio of 3:2 and having capitals - A, Rs. 70,000
andB, Rs, 30,000. If cash is distributed in the profit-sharing atio-the position will be as follows:
A B
Rs. Rs.
Amount due 70,000 30,000
First instalment of cash in the ratio of 3:2 24,000 16,000
Balance 46,000 14,000
Second instalment in the ratio of 3:2 12,000 8,000
Balance left unpaid or loss 34,000 6,000
This is obviously wrong because the loss is not in the ratio in which losses are to be borne by A andB.
It cash is distributed in the ratio of capitals, the position will be:
A B
Rs. Rs.
Amount due 70,000 30,000
Fist in stalment in the ratio of 7 : 3 28,000 12,000
Balance 42,000 18,000
Second instalment in the ratio of 7 : 3 14,000 6,000
Loss 28,000 12,000
This also is wrong, because the final loss is again not in the ratio in which lossess are to be borne by
A andB.
In this case, it is obvious that A's capital is more than his proportionate share. The profitsharing ratio is
3 : 2, Hence, ifB's capital ought to be Rs. 30,00x 3/2 or Rs. 45,000. The proper thing to do is to first of all bring
122
down A's capital to Rs. 45,000 by paying him enough cash. After that, the cash available will be distributed in
the profit-sharing ratio. It will now be worked out as follows :
A B
Rs. Rs.
Capital 70,00 30,000
First Instalment: Rs. 25,000 To A 25,000
Balance Due 45,000 30,000
Rs. 15,000 distributed between A
and B in the rato of 3 : 2 9,000 6,000
Balance due 36,000 24,000
Second instalment in the ratio of 3 : 2 12,000 8,000
Amount unpaid or loss 24,000 16,000
This must be correct, because the loss is being borne by the two partners in the profit-sharing ratio.
The rule to follow in piecemenal distribution is that the partners whose capital is more than proportionate
to other partners' capitals (considering the profit-sharing ratio) should first be refunded so much as to bring
their capitals to proportionate levels. After this, the cash available should be distributed among the partners in
the profit-sharing ratio. Each partner's position has to be compared with that of others.
Illustration
Following is the Balance Sheet of Mis. A, B and C who share profits and losses in the ratio of 2 : 2 :1.
Rs. Rs.
Sundry Creditors 15,000 Cash in hand 2,000
Capitals- Sundary Debtors 12,000
A 15,000 Stock 22,000
B 12,000 Furniture & Fixtures 10,000
C 4,000 31,000
46,000 46,000 46,000
The firm was dissolved and the assets were realised gradually; Rs. 1,000 were received once, Rs. 15,000
another time and Rs. 9,000 finally. Show how each instalment is to be distributed.
Solution:
The ratio is 2:2:1 among A, B and C. C's capital is Rs. 4,000, hence the proportionate capitals of A and
B are Rs. 8,000 each. This means C receives nothing until the capitals of A and B each are brought down to
Rs. 8,000. Now A and B being equal partners, their capitals ought to be equal. A's capital is Rs. 3,000 more than
B's and hence before B receives anything, A is paid Rs. 3,000. The following statement shows the distribution.
123
Distribution of Cash
Creditors Capitals
A B
cl
Rs. Rs. Rs. Rs.
Amount due 15,000 15,000 12,000 4,000
Cash in hand-paid to creditors 2,000
Balance due 13,000 15,000 12,000 4,000
First instalment:
Rs. 10,000 to creditors 10,000
Balance due 3,000 15,000 12,000 4,000
Second instalment:
Rs. 3,000 paid to creditors 3,000
Rs. 3,000 paid toA 3,000
Balance due 12,000 12,000 4,000
Rs. 4,000 paid each to A and B to bring down their
Capital to Rs. 8,000 4,000 4,000
Balance due 8,000 8,000 4,000
Rs. 1,000 distribted among all partners (ratio 2:2:1) 400 400 200
Balance due 7,600 7,600 3,800
Third instalment:
Rs. 9,000 distributed among the partners in profit-sharing ratio 3,600 3,600 1,800
Balance unpaid or Loss 4,000 4,000 2,000
Illutration:
X /and Z were in partnership with a capital of Rs. 30,000 originally contributed in the proportions of 1/
2, 1/3 and 1/6 respectively and shareing profits and losses in the same proportions. The partnership was dissolved
on March 31, the Balance Sheet on which date was as follows:
Capitals-X 20,000 Cash 4,000
y 10,000 Debtors 16,000
z 2,000 Stock 42,000
Loan-X 6,000
y 4,000
Creditors 20,000
62,000 62,000
124
It was agreed that the net realisations should be distributed in their due order at the end of each calendar
month. The realisations and expenses were:-
Debtors Stok Expenses
April 4,000 8,000 1,000
May 1,000 10,000 500
June 6,000 11,000 1,000
July 1,000 10,000 400
August 3,000 2,000 500 The stock having been completely disposed of, it was agreed that Z should
take over the remaining debts at Rs. 600. Show how the cash was distributed.
Solution:
The cash available each month is as follows:-
Debtors + Stock - Expenses = Cash

available
Rs. Rs. Rs. Rs.
April 4,000 8,000 1,000 11,000
May 1,000 10,000 500 10,500
June 6,000 11,000 1,000 16,000
July 1,000 10,000 400 10,600
August 3,000 2,000 500 4,500
At the end of August, the total amount to be distributed is Rs. 4,500 cash + Rs. 600 debtors, viz.,
Rs. 5,100.
Proportionate capitals :-
X y z
Profit-sharing ratio 3 2 1
Proportionate capitals Rs. Rs. Rs.
(taking Z's capital as the basis) 6,000 4,000 2,000
Excess capital 14,000 6,000
Proportionate capitals as between
X and Y with Y's capital as the basis 15,000 10,000
X's excess-actual over proportionate 5,000
125
Statement Showing Distribution of Cash

X's Y's X's Y's Z's
Creditors Loan Loan Capital Capital Capital
Amount due 20,000 6,000 4,000 20,000 10,000 2,000
Cash in hand-paid to Credition 4,000
Balance due 16,000 6,000 4,000 20,000 10,000 2.000
Aprl: Cash, Rs. 11,000 paid Creditors 11,000
Balance due 5,000 6,000 4,000 20,000 10,000 2,000
May: Cash, Rs. 10,500-
(a) Rs. 5,000 paid to Creditors 5,000
(b) Rs. 5,500 distributed amongX's
Loan and Y's Loan (ratio 6: 4) 3,300 2,200
Balances due 2,700 1,800 20,000 10,000 2,000
June: Cash Rs. 16,000-
(a) Rs 2,700 paid against X's Loan &
Rs. 1,800 against Y's Loan 2,700 1,800
(b) Rs. 5,000 paid against X's Capital to
bring it down to Rs. 15,000 5,000
(c) Balance Rs. 6,500 distributed between
X and Yin the ratio of 3: 2 3,900 2,600
11,100 7,400 2,000
Balance due
July: Cash, Rs. 10,600-
(a) Rs. 5,100 paid to X and Rs. 3,400 to
Y to bring their capital to Rs. 6,000
and Rs. 4,000 respectively) 5,100 3,400
(b) Balance Rs. 2,100 distributed between
all partners in profit-sharing ratio 1,050 700 350
Balance due 4,950 3,300 1,650
August: Cash and Debtors, Rs. 5,100 distributed
in profit sharing ratio 2,250 1,700 850*
Balance unpaid or Loss 2,400 1,600 800
* Rs._250 cash Rs. 600 Debtors

126
Alternative Mehtod-Maximum Loss Method. The other method to deal with the problem is to calculate
the maximum possible loss after outside creditors and partners* loans have been paid off. This loss is transferred
to the capitals and thus the amont payable to a partner would be known. If a partner's share of the loss is more
than the capital, he should be treated as "insolvent" and, in accordance with Garner vs. Murray, the loss should
be transferred to the othelr partners in the ratio of capitals just before dissolution. The amount to the credit of
partners will be equal exactly to the cash in hand and the cash will be distributed among the partners according
to the figures now resulting. Such calculation of maximum loss, whenever an instalment of cash is received,
will show how much is to be paid to various partners. Below is the statement of distribution of cash in illustration
according to this method :
Distribution of Cash
Creditors Capital Accounts
A B C
Rs. Rs. Rs. Rs.
Amounts due a 15,000 15,000 12,000 4,000
Cash in hand paid to Creditors b
---
2,000
--- --- ---
Balance C 13,000 15,000 12,000 4,000
First instalments :
Rs. 10,000 to Creditors d
---
10,000
--- --- ---
Balance due e 3,000 15,000 12,000 4,000
Second instalment : Cash Rs. 15,000
(Rs. 3,000 paid to creditors)
(Rs. 12,000 in hand) f
---
3,000
--- --- ---
Balances due g 15,000 12,000 4,000
Maximum Loss, (total of capitals minus Rs. 12,000
cash in hand) Rs. 19,000 allocated to
partners in the ratio of 2:2: 1 h ---
7,600 ---
7,600 ---
3,800
Amounts at credit 7,400 4,400 200
Cash (available), Rs. 12,000, paid j 7,400 4,400 200
Balances of capitals left unpaid (g-j) k 7,600 7,600 3,800
Third instalment, Rs. 9.000;
Maximum loss, Rs. 10.000 allocated L 4,000 4,000 2,000
Amounts at credit and hence cash paid m 3,600 3,600 1,800
Balances left unpaid or loss (k-m) n
---
4,000
---
4,000
---
2,000
Illustration:
Tom, Dick and Harry have capitals of Rs. 9,600, Rs. 6,000 and Rs. 8,400 and share profits and losses
as to one-half, one-third and one-sixth respectively. After paying creditors, the following sums become available
and it was agreed that they shall be distributed as and when determined :-
127
Rs.
January 1-Sale proceeds of Machinery 1,200
March 1-Realisation from Debtros 4,000
No further assets remain to be realised and Dick is insolvent. Show the sums to be paid ot the partners
out of the amounts available.
(C.A. Final)
Solution:
Tom Dick Harry
Rs. Rs. Rs.
Capitala:- a 9,600 6,000 8,400
Jan.1 Maximum possible loss, Rs. 22,800 (total
of capitals minus cash available) allocated
to partners in the ratio of 3:2:1 b 11,400 7,600 3,800
Amounts at credit C -1,800 -1,600 4,600
Tom's and Dick's losses transferred to Harry d +1,800 +1,600 -3400
Amount at credit and available cash paid e 1,200
balances in capital accounts (a-e) f 9,600 6,000 7,200
Mar.1 Maximum possible loss Rs. 18,800 i.e
Rs. (22,800-4,000) allocated to partners
in profit-sharing ratio g 9,400 6,267 3,133
Amounts at credit h 200 -267 4,067
Dick's loss transferred to Tom and Hurry
i.e. in the ratio of 96 : 84 -142 +267 -125
Amount at credit j 58 3,942
Balance in capital accounts left unpaid
and hence loss (f-i) k 9,542 6,000 3,258

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B.COM. (Hons.

SCHOOL OF OPEN LEARNING

SCHOOL OF OPEN LEARNING

Profit and Loss Account Dr.

Calculation of annuar depreciation on straight line method:

Rs. or Rs. 5,722.50 p.

Balance as on 1st January, 1993 : Rs. —

(i.e., Cost-depreciation from 1986 to 93) : Rs. 61,000—48,800

Dr. Plant (Old) Account Cr.

1993 Rs. 1993 Rs.

Dr. Plant (New) Account Cr.

March 31 To Bank 89,000 Dec. 31 By Depreciation

Dr. Depreciation Account Cr.

1993 Rs. 1993 Rs.

Dr. Plant Account Cr.

1993 Rs. 1993 Rs.

Depreciation Account will appear as follows:-

Dr. Depreciation Account Cr.

1993 Rs. 1993 Rs.

Dr. Machinery Account Cr.

1992 Rs. 1992 Rs.

Dr. Machine Account Cr.

1994 Rs. Rs.

Provision for Depreciation A/c

1994 Rs. 1994 Rs.

To Depreciation of Machine 24,400

Depreciation for 2½ years on straight line method.

Book value on 1st January, 1994. = Rs. 1,00,000-25,000 = Rs. 75,000

Dr. Plant Account Cr.

Amount of depreciation : Rs; 20,000 × 0.230975 = Rs. 4,619.50 P.

Dr. Profit and Loss Account Cr.

Depreciation Account Dr. With the amount of depreciation

Dr. Depreciation Fund Account Cr.

Dr. Depreciation Fund Account Cr.

1991 Rs. 1991 Rs.

Dr. New Machinery Account Cr.

Dr. Depreciation Account Cr.

Dr. Interest on D.F. Investment Account Cr.

Depreciation Insurance Policy Account Dr.

At the end of the year

Dr. Lease Account Cr.

1992 Rs. 1992 Rs.

Dr. Depreciation Insurance Policy Account Dr.

1992 Rs. 1992 Rs.

1. What is depreciation? Why is it provided?

Inventory is an important element of assets of an enterprise. In some enterprises, inventory constitute

Objecctives of Inventory Valurtion

Methods of taking Inventories

*IAS= International Accounting Standards Committee's IAS-2

Methods of Valuation of Inventories

3. Lower of cost or sale price

Total of different prices

IAS -2 INTERNATIONAL ACCOUNTING STANDARD

Determination of Historical Cost

Cost Formula Used

Valuation of Inventories Below Historical Cost

INTERNATIONAL ACCOUNTS STANDARD -2

Valuation and Presentation of Inventories in the Context

Ascertainment of Historical Cost

Ascertainment of Net Realisable Value

Presentation in the Financial Statements

ACCOUNTING STANDARD: 2 (AS: 2)

Difference between hire-Purchase and Credit Sales

Difference between hire-Purchase and instalment System