TM Account XII

Accountancy, Grade XII ...
Teaching Manual
Subject : Accountancy II Grade: XII
Full Marks: 100 Teaching Hours: 150
I. Introduction Accounting is a process designed to identify, measure, and communicate financial information about an organisation or other entity. It is both an art and a science of keeping record of financial transactions, presenting and analysing financial information of government and non-governmental enterprises. It is an essential component of commerce education. II. General Objectives General Objectives of this course are to: a. introduce to the students the concepts of accounting for companies, cost accounting, and auditing, and to develop the students' ability to prepare and analyse financial statements. b. provide them with fundamental knowledge of book-keeping and accounting required while pursuing higher education in commerce and management fields. III. Specific Objectives On completion of the course, the student shall be able to: a. develop strong foundation of knowledge and understanding required for advanced level education in management. b. be familiar with formation of companies, raising of capital by issuing share and debentures, and preparation of final accounts for companies. c. use worksheet for preparing the financial statements in the format prescribed by the Company Act 2053 BS. d. utilize and analyse accounting data for meaningful interpretation. e. understand the basic knowledge of cost accounting. IV. Course Scheme: Units 1 2 3 4 V. Chapters Accounting for Companies Final Accounts of a Company Financial Statement Analysis Cost Accounting Course Content Teaching Hours 35 30 35 50
Accountancy, Grade XII ...2
Chapter-1
COMPANY ACCOUNTS
A. Introduction The size and volume of business are increasing day by day. It has made more difficult for a sole trader or a partnership firm to run effectively because of lack of resources and technical know how. The Joint Stock Company provides ample opportunities for procuring funds from the public and helps in effective economics of large scale production. This unit is related with accounting procedure of such a company and provides the knowledge on the features of Joint Stock Company and the stages of formation of a company, including, the important documents such memorandum of association, Article of association and prospectus. It also includes the procedures to be followed for raising capital by a Joint Stock Company, from shares and debentures issues. B. Objectives
The objectives of this unit is to help the students to acquire knowledge of Joint Stock Company. After studying this unit students would be able to: (i) (ii) (iii) (iv) (v) (vi) (vii) C. Define company and write its features, Mention the type of Company, Write about memorandum of association, Article of association and prospectus of company, Mention the different type of capital of a company, Bring out clearly the entire range of capital of a company, Record transactions relating to the forfeiture and reissue of share, Prepare the opening balance sheet of a company.
Specification of Content Area of the Unit 1. 2. 3. 4. 5. 6. Company and its formation. Capital of a company. Method of raising capital. Issue of shares and accounting for share issue. Debentures. Balance sheet of a company.
This unit includes the following sub-units:
D. 1.1.
Description of Content Area of the Unit Company and its formation
1.1.1. Meaning and concept The meaning of Joint Stock Company should include the following points: It is an organization consisting of individuals, shareholders by virtue of a company. It is a certain of law and is sometimes called artificial person. The capital of the undertaking is contributed by large group of people called the shareholders. The legal personality and limited liability are the two fundamental features of a company.
1.1.2. Characteristics of the company The important characteristics of a company are as follows: 1. It is an association of different people for earning profit. 2. It is an artificial person created by law and can conduct a lawful business and enter into contracts in its own name. It can sue and be sued by other. 3. The existence of a company can be terminated by only by law. Its life does not depend on the life of its members. Its existence is not affected by the death, lunacy and bankruptcy of its shareholders. 4. The common seal of the company is the authorized signature of the company and is accepted by all. 5. The liability of every shareholder is limited by the nominal value of shares held by them. 6. The shares of a public limited company are freely transferable. 7. Actual owners of the Company are shareholders, but they have very limited role in the operating activities of business. They elect their representatives called directors, who manage the company's affairs on behalf of the shareholders. Thus the ownership and management of a company are separated. 8. A company can conduct only such business as stated in its memorandum of association. 9. The profits of a company are distributed in accordance with the legal provision. 10. Every company is required under the law to maintain proper books of accounts and it is compulsory to get its account audited.
1.1.3. Types of Company Company may be classified from different point of view: They are: 1.1.3.1. On the basis of incorporation 1.1.3.2. On the basis of liability 1.1.3.3. On the basis of ownership. 1.1.3.1. On the basis of incorporation On the basis of incorporation, Companies can be classified into 3 types. They are: (i) Chartered Company (ii) Statutory Company (iii) Registered Company (i) Charted Company: It refers to a kind of company which is established under the Royal Charter of order of the head of the state. Such type of companies came into existence in Great Britain in the early years. Those type of Joint Stock Company are not existed in Nepal. (ii) Statutory Company: A kind of company which is established under a special act of parliament is known as statutory company. Nepal Rastra Bank, Nepal Industrial Development Corporation are some examples of statutory companies in Nepal. The power, objects and activities of these companies are defined in the respective act itself. (iii) Registered Company: Companies established by registering under the provision of company act are known as Registered Companies. Registered Companies are also known as Limited Company. 1.1.3.2. On the basis of liability On the basis of the liability of members companies may further classified into three types. They are: (i) Unlimited company (ii) Company limited by shares (iii) Company limited by guarantee (i) Unlimited company: The liability of the shareholders are unlimited in this type of company. In the event of company being wond up, shareholders will be liable to pay the debt of the company from their personal estate. Such companies are rarely formed.
(ii)
Company limited by shares: In this case the liability of the members is limited only to the extent of the shares held by them. Most of the companies formed these days are of this type. Company limited by guarantee: In this case each member promises to pay a fixed sum of money in the event of liquidation of the company. This amount is called guarantee.
(iii)
1.1.3.3. On the basis of ownership From the point of view of ownership a limited company may further classified as private company and public company. (i) Private Limited Company A private limited company is one which by its articles: (a) (b) (c) restricts the right of their member to transfer their shares. limits the number of its members to fifty, and prohibits any invitation to the public to subscribe for any of its shares and debentures.
The word 'Private Ltd.' should be mentioned after the name of the company. Privileges of Private Ltd. Company The company act provides large numbers of privileges to Private Ltd. Companies. These are stated below: 1. A private limited company need not require to submit its prospectus with the company register. 2. It can commence its business immediately on incorporation. 3. It is not required to hold statutory meeting or file statutory reports with the registrar. 4. The managerial remuneration in case of public limited company is restricted to maximum of 11% of net profit. This restriction is not applicable to a private limited company. 5. It can begin allotment of shares even before raising the minimum subscription. 6. A company is free to allot new shares as there is no question of right issue. 7. Since there is no provision regarding the minimum number of members, even one member could form a Private Ltd. Company.
(ii) Public Limited Company A Public limited company is an association of persons having the ownership divided into different numbers of transferable shares. It is an artificial person can sue and be sued by all. It is represented by common seal. Nepal company act, 2053 has defined public company as a company which is not a private company. The member of a public company enjoy the following privileges. (a) (b) (c) Members can freely transfer their shares No limitation on the maximum number of its members, however the minimum number must be at last seven. Free to invite the general public to subscribe its shares and debentures.
Features of Public Limited Company A public limited company has the following features: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. The minimum number of members required to form a company is seven. There is no limit on maximum number of members. The minimum number of directors are three. There is no restriction on the transfer of shares. It can invite the public to purchase its shares and debentures. It must issue the prospectus. It can start its business only after obtaining certificate of commencement of business. It must add work 'Limited' in its name. It must hold a statutory meeting and file a company of it with the company registrar. There are number of legal restrictions on allotment of shares.
Advantages of Public Limited Company The company has the following advantages: 1. Members with limited incomes and savings also may contribute to accumulate the fund by subscribing the shares issued. 2. The liability of each member is limited to the extent of face value of shares held by them. They have no other obligation toward the company creditors. 3. As a company has a separate legal entity, death or insolvency of its members do not threaten its existence.
4. It can employ the qualified and highly efficient personals in the different field of management and it will help to increase efficiency in management through rationale decisions. 5. As there is no limit for number of shareholders, it is easier for companies to raise large amount of fund through the issue of shares. 6. The company is equally accountable to its owners, government and general public. As such it is compulsory to disclose its financial statement as required by law. 7. Shares of the company is freely transferable. It does not affect the company. 8. It can raise loan by issuing debentures. 9. The management in a public limited company follows a democratic norms by electing the directors. They are elected by the general body. 10. An intangible benefit of a limit company is that it gives permanence to a business. (iii) Government Companies
A government company is one in which not less than 51% of the share capital is held by the government. This type of company also has to comply the provision of the company act. 1.1.4. Formation of a Company The formation of a company involves the following stages: (i) Promotion: It involves the activities by which business enterprise is brought into existence. It includes generation of idea, detailed investigation selection and implementation of idea. Incorporation: It involves many legal formalities to bring the company into its existence. It includes approval of name, filing of related documents, registration and obtaining of certificate of commencement. Floatation: Floatation refers to the actual working of shares, issue of prospectus, inviting general public to subscribe to the share capital of the company.
(ii)
(iii)
1.1.4.1. Company Promoters: A person who plans the formation of a company and brings it into existence is known as Promoter. He may be an individual, a firm, a company or even the government. Promoters are those who originates a scheme for the formation of the company gets the memorandum and article prepared, executed and registered and finds the first directors, settles the term of the preliminary
contracts and prospectus (if any) and make arrangements for the advertising and circulating the prospects and placing the capital. 1.1.4.2. Importance Documents: Three important documents involve in the formation of a Company. They are: (i) Memorandum of association (ii) Article of association (iii) Prospectus (i) Memorandum of association
It is very important document. It contains the fundamental rules regarding the constitution and activities of a company. The objective and business of a company are guided by the provision contained in the document. It contains the following particulars: (a) (b) (c) (d) (e) (f) (g) (ii) Name of the company with 'public' or 'private Ltd.' at the end of name. Address of the registered office. Objectives of the company. Nature of liability of its members. Share capital and division there of into shares of fixed amount. The number of shares to be taken up by the promoters. Other necessary matters. Article of association
A document which contains rules regarding the internal management of the company is known as article of association. According to sec. 17 of company Act 2053 B.S., the following should be disclosed. (a) (b) (c) (d) (e) (f) (g) (h) (i) Directors and their tenure in the office. The number of qualifying shares to become a director. Number of directors and their tenure. Mode of calling the meeting and matters relating to the notice etc. Special rights and restriction of the preference shareholders. Managing director's duties, responsibilities and rights. Matters relating to director's fees, remuneration, allowances etc. Information as mentioned in the memorandum of association. Other important matters.
(iii)
Prospectus
A prospectus is an invitation to the general public to participate in the share capital or debenture of the company. The detail description of the company as well as its objectives should be included in prospectus. It should contain: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Objectives of the company along with other important information as stated the memorandum and article of association. Shares to be taken by the directors and director's salary, allowances remuneration etc. Cash paid or payable to the promoters for their services. Matters relating to bonus shares. Policy of reserving shares for the shareholders, employees or any other persons if any, should be disclosed. Introductory profiles of directors. It shares are to be issued at a premium, the reasons and rational of charging such premium. Matters relating to representation of the shareholders in the board of directors. Minimum number of shares to be taken up and money to be paid application for shares. The reason behind raising loan capital by issuing debentures and the mode payment for debentures i.e. in installment of lump sum and their number along with information regarding outstanding loans. The details about the properties purchased with the money raised by issuing shares or information regarding any arrangement to issue shares or debentures as payment for the purchase of property be given if such arrangement has been agreed upon. The name of the seller is also to be disclosed. Rate of brokerage on shares and debentures. Estimated expenditure to run the company and its anticipated earnings for at least three years hence. Estimated financial risk factors of the company. Company's financial policy and its net worth. Auditor's name and address and auditor's report, if any. Company's promoter of director's personal contribution, if, any, for the purchase or decision to purchase any property for the company. Also,
11.
12. 13. 14. 15. 16. 17.
information regarding promoter's or director's partnership in any other firm or their association with any other company, if any. 18. 19. 20. 21. 22. 23. 24. 25. 26. Date of notifying the allotment of shares. Details of preliminary expenses for a new company and latest balance sheet for an existing company. Brokerage payable to the trustee of a trust for dealing in company's securities. Company balance sheet, profit or loss statement, agreement covered by section 15 and subsection 2 of the act, time and place of inspecting them. Information about the understanding of shares or debentures and the understanding commission. Name and address of the firm dealing in company's securities (shares, debentures, bonds etc.) Name of shareholders holding more than 50% of the issued number of shares. Special rights and restrictions of the preference shareholders. Other essential matters.
1.2. Capital of Company Capital may be defined as a minimum amount of fund required to run the business. Capital of a company refers to the amount at which a company has been registered. The company raise the required amount of capital of capital by issuing shares which is known as share capital. The share capital of a company may be classified into following types: 1.2.1. Authorized or Registered or Nominal Capital The maximum amount of capital which the company is authorized to raise capital is known as authorized capital. It represent the amount of share capital mentioned in the memorandum of association at the time of company registration. 1.2.2. Issued Capital A part of authorized capital offered to public for subscription is called issued capital. 1.2.3. Subscribed Capital It represents the nominal value of the shares subscribed by the public subsequently allotted to them by the directors of the company.
1.2.4. Called up Capital It is that portion of subscribed capital which is actually called up by the company to pay the shares subscribed by them. 1.2.5. Paid up Capital The portion of a called up which actually is paid by the members is known as paid capital. The unpaid capital out of the called up capital is called calls-in-arrear. 1.2.6. Uncalled Capital The uncalled portion of subscribed capital is called 'Uncalled Capital' or 'Reserve Capital' and usually called at the time of winding up. 1.3. Methods of Raising Capital 1.3.1. Shares: Meaning and Types The capital of a company is divided into certain units of small denominations. Such unit is called a 'Share'. The common types of shares are ordinary shares and preference shares. 1.3.2. Equity Shares The shares which carry no preference right regarding the payment of dividend and in the repayment of capital are called equity shares. Equity share is also referred to as ordinary or common shares. The holders of these shares are entitled to receive what is left after the prior claims have been settled. However, if there is enough surplus after prior claim, they enjoy the high return. 1.3.3. Importance of Equity Shares (1) (2) (3) (4) (5) It is a permanent type of capital & provides the permanent funds of a company. It does not impose an obligation to pay a fixed dividend. It provides a sense of safety shield for the collection of loan capital. The shareholders of equity capital enjoy full voting power in management. The company is not required to mortgage or pledge its assets for issuing equity shares.
1.3.4. Preference Shares Shares having some shorts of preferential right over an above ordinary shares are called preference shares. Preference share capital provides two preferences namely. (i) (ii) Receipt of dividend and Return of capital in the case of liquidation of company.
1.3.5. Difference Between Equity Shares and Preferences Shares (i) (ii) (iii) (iv) (v) (vi) Preference dividends are paid prior to equity dividend whereas equity dividends are paid only after paying the preference share dividend. In case of winding up, preference shareholders get their capital back over equity shareholder whereas equity shareholders do not get this priority. The rate of preference share dividend is fixed while the rate of equity dividend may very over the years. Arrears of preference dividend may be accumulated but equity dividend is not accumulated. Preference share is convertible while ordinary share is not convertible. Preference share is redeemable during the life of the company whereas equity share is not redeemable during the life of the company. In some country buying back of own shares in the market to certain extent have been legalized.
(vii) Preference shareholders do not have any voting rights on general meeting but equity shareholders enjoy voting rights on such meeting. 1.3.6. Types of Preference Shares Preference shares may be of following types: (a) Cumulative Preference Shares: A cumulative preference share is that shares which carry the right to cumulate the unpaid dividend during any subsequent year when the available profits are sufficient. Non-cumulative Preference Shares: Unpaid dividends are not carried forward or not accumulate on non-cumulative preference shares. In a particular year if there is no profits available for dividend, the preference shareholders get no dividend during that year. Participating Preference Shares: The participating preference shareholders are entitled to receive from surplus profit remained after paying dividend to equity shareholders, in addition to the fixed rate of dividend. Non-participating Preference Shares: Those preference shares which do not carry the right of shares in excess profit is known as non-participating preference shares.
(b)
(c)
(d)
(e)
Redeemable Preference Shares: Those preference shares which are redeemed by the company after the expiry of fixed period in accordance to the provision of article known as redeemable preference shares. Non-redeemable Shares: These type of shares cannot be redeemed during the life of the company. Convertible Preference Shares: Those shares which can be converted into equity shares within a certain period is known as convertible preference shares. Non-convertible Preference Shares: Such shares have no option to convert their shares into equity shares.
(f) (g) (h)
1.4. Issue of Shares and Accounting for Share Issue A company can issue its shares in two ways: 1.4.1. For cash 1.4.2. For consideration other than cash. 1.4.1. Shares Issued for Cash The capital of a company is collected by issuing shares or debentures. The amount share is gradually collected in different installments. The following steps are to be take by a public company for the issue of shares: (a) (b) (c) (d) To issue prospectus To receive application To make allotment To make calls
(a) To issue prospectus: Besides the other information a prospectus disclose, the number, types and amount of shares issuing by the company for the general public also indicate the amount which is payable along with the application, allotment and calls. (b) To receive application: The general public interested is buying shares of a company have a apply with the requested application money and specified in the prospectus. The application money should not be more then 50% of the face value of the shares. The application money is deposited by the application in a scheduled bank. (c) To make allotment: After receiving the applications, they are considered in the meeting of the board of directors. The letters of allotment are issued to those applicants
(d) To make calls: After the shares have been allotted, the shareholders have to pay allotment money for their accepted number of shares. After collecting the application and allotment money, the balance amount is collected as and when it needs money. This is termed as the call money. The call money can be divided into first call, second call and so on. Illustration 1 A company issued a prospectus, inviting applications for 10,000 shares of Rs. 100 each, payable as follows: Rs. 10 on application Rs. 20 on allotment Rs. 30 on first call Rs. 40 on second call Application for all these shares were received. Give journal entries in the books of the company assuming that all sums due have been received. Solution Books of A Co. Ltd. Journal Date Bank A/C To share application A/C (For application money received for 10,000 shares @ Rs. 10 per share) Share application A/C To share capital (For application money transferred to share capital account) Share allotment A/C To share capital A/C (For the amount due on 10,000 shares @ Rs. 20 per share on allotment) Bank A/C To share allotment (For allotment money received in full) Dr. 2,00,000 2,00,000 Dr. 2,00,000 2,00,000 Dr. 1,00,000 1,00,000 Particulars Dr. L.F. Dr. (Rs) 1,00,000 1,00,000 Cr. (Rs.)
Share first call A/C To share capital A/C
Dr.
3,00,000 3,00,000
(For first call money due on 10000 shares @ Rs. 30 per share as decided by board of directors dated ) Bank A/C To share first call A/C (For first call money received in full) Share second & final call A/C To share capital A/C (For amount due on 100000 shares @ Rs. 40 per share on second and final call) Bank A/C To share second & final call A/C (For share second & final call money received in full) Dr. 4,00,000 4,00,000 Dr. 4,00,000 4,00,000 Dr. 3,00,000 3,00,000
1.4.2. Minimum Subscription The minimum amount to be raised by issue of share is denoted by minimum subscription. According to Nepal Company Act, 2053 B.S., section 26, the company should receive subscription for at least 50% of its issued capital as minimum subscription for making allotment of shares. The minimum subscription is required for: a. b. c. d. e. purchasing necessary assets of the company. paying the preliminary expenses and commission on sale of shares repayment of loan arranged for the above two purposes. working capital arrangement. For other expenses.
1.4.3. Over Subscription of Shares and their Accounting Treatment To receive applications for more shares than offered is said to be over subscribed. The company cannot allot more shares than offered for subscription. In the case of over subscription the company may exercise any of the following three possible alternatives or options.
(i) (ii) (iii)
The applications for excess share are rejected and full amount is made up to the number of shares offered. All the applicants are allotted on the basis of pro-rata or proportionately. Some applicants are accepted in full, some are rejected and some are allotted proportionately.
Illustration 2 A Ltd. Co. invited application for 1,000 equity shares of Rs. 100 each payable as under: On application Rs. 20 per share On allotment Rs. 30 per share On first call Rs. 30 per share On second and first call Rs. 20 per share The calls were not made. Application is received for 400 shares on 1st Baisakh and allotment was made on 1st Jestha. The directors decided on allot 1000 shares to selected applicants and the application for the remaining shares were rejected outright. Required: Journal entries in the looks of the company. Solution: In the books of A. Ltd. Journal Date 1st Baisakh Particulars Bank A/C Dr. To equity share application A/C (For application money received on 4000 shares @ Rs. 20 per share) Equity share application A/C Dr. To equity share capital A/C To bank A/C (for application money on 1000 shares were transferred to share capital and application money on 3000 shares to whom no shares were allotted are refunded) Equity share allotment A/C Dr. To equity share capital A/C (for allotment due on 1000 shares @ Rs. 30 each) L.F. Dr. (Rs) 80,000 80,000 Cr. (Rs.)
1st Jestha
80,000 20,000 60,000
1st Jestha
30,000 30,000
Illustration 3 A limited company invited applications for 1,00,000 equity shares of Rs. 20 payable as under: Rs. 5 per share on application Rs. 10 per share on allotment Rs. 5 per share on first and final call Applications were received for 3,00,000 equity shares and the directors decides to make a pro-rata allotment of the shares applied for by every applicant; to apply the application monies toward amount due on allotment; and to refund the amount remaining thereafter. Required: Journal entries in the company. Solution: In the books of a Ltd. Co. Journal Date Particulars Bank A/C Dr. To equity share application A/C (For cash received on application for 3,00,000 shares @ Rs. 5 each) Equity share application A/C Dr. To equity share capital A/C To equity share allotment A/C (for application money transferred to share allotment account) Equity share allotment A/C Dr. To equity share capital A/C (for allotment due on 100000 shares @ Rs. 10 per share) Equity share first call A/C Dr. To equity share capital A/C (for first call due on 100000 share@Rs. 5 per share as decided by board of directors dated) Bank A/C Dr. To equity share first and find call A/C (for first call money received on 100000 shares@ rs. 5 per share) L.F. Dr. (Rs) 15,00,000 15,00,000 Cr. (Rs.)
15,00,000 5,00,000 10,00,000
10,00,000 10,00,000
5,00,000 5,00,000
5,00,000 5,00,000
Illustration 4 On 1st Baisakh, the directors of Paragon Co.Ltd. issued for public subscription 50,000 equity shares of Rs. 100 each, payable as Rs. 20 per share on application; Rs. 30 per share on allotment; Rs. 30 per share on first call and balance on final call. Applications were received for 2,00,000 share sand the directors totally reject application for 1,00,000 shares, accepted in full application for 40,000 shares and make a pro-rata allotment of the remaining 10,000 shares. The balance of application monies is to be adjusted towards allotment and calls. All money due and received. Required: Journal entries in the books of the company. Solution In the Books of Paragon Co. Ltd. Journal Date Bank A/C To equity share application A/C (for application money received on 2,00,000 shares @ Rs. 20 per share) Equity share application A/C To equity share capital A/C To equity share allotment A/C To calls-in-advance A/C To bank A/C (for application money transferred to share capital and excess amount on share application to share allotment and calls in advance and balance refunded) Equity share allotment A/C To equity share capital A/C (for amount due on allotment of 50,000 share @ Rs. 30 per share) Bank A/C Dr. 12,00,000 Dr. 15,00,000 15,00,000 Dr. 40,00,000 10,00,000 3,00,000 5,00,000 22,00,000 Particulars Dr. L.F. Dr. (Rs) 40,00,000 40,00,000 Cr. (Rs.)
To equity share allotment A/C (Allotment money received on 40,000 share @ Rs. 30 per share) Equity share first call A/C To equity share capital A/C (for first call money due on 50,000 share @ Rs. 30 per share) Bank A/C Calls-in-advance A/C To equity share first call A/C (for money receiving on first call after adjusting money received in advance) Equity share final call A/C To equity share capital A/C (for final call made on 50,000 shares @ Rs. 20 per share) Dr. 10,00,000 Dr. Dr. 12,00,000 3,00,000 Dr. 15,00,000
12,00,000
15,00,000
15,00,000
10,00,000
Bank A/C Calls-in-advance A/C To equity share final call A/C (for money receiving on final call after adjusting money received in advance)
Dr. Dr.
8,00,000 2,00,000 10,00,000
Alt. Methods of Journal Date Bank A/C To equity share application A/C (being application money received on 2,00,000 shares @ Rs. 20 per share) Share application A/C To equity share capital A/C To equity share allotment A/C Dr. 40,000 10,00,000 3,00,000 Particulars Dr. L.F. Dr. (Rs) 40,00,000 40,00,000 Cr. (Rs.)
To first call A/C To final call A/C To bank A/C (for application money transferred to share capital and excess amount on application to share allotment, first call, final call, and balance refunded) Equity share allotment A/C To equity share capital A/C (for allotment due on 50,000 share @ Rs. 30 per share) Bank A/C To equity share allotment A/C (Allotment money received on 40,000 share @ Rs. 30 per share) Equity share first call A/C To equity share capital A/C (for first call money due on 50,000 shares @ Rs. 30 per share) Bank A/C To equity share first call A/C (for money receiving on first call after the adjusting money received in advance) Equity share final call A/C To equity share capital A/C (for final call made on 50,000 shares @ Rs. 20 per share) Bank A/C To equity share final call A/C (for money receiving on final call after adjusting money received in advance) Dr. 8,00,000 Dr. 10,00,000 Dr. 12,00,000 Dr. 15,00,000 Dr. 12,00,000 Dr. 15,00,000
3,00,000 2,00,000 22,00,000
15,00,000
12,00,000
15,00,000
12,00,000
10,00,000
8,00,000
Analytical Table No. on Shares 40,000 60,000 1,00,000 Total Application money received 8,00,000 12,00,000 20,00,000 40,00,000 Applied for application 8,00,000 2,00,000 1,00,000 Allotment 1st Call 2nd Call Refunded
3,00,000 3,00,000
3,00,000 3,00,000
2,00,000 2,00,000
2,00,000 2,00,000
1.4.4. Issue of shares at per If the shares are offered for subscription at its nominal value, that is known as 'shares issued at per'. The accounting treatment for shares issued at per will be the same as were discussed earlier. 1.4.5. Issue of shares at premium When shares are issued at the value of shares more than its face value, it is known as the issue of shares at premium. Premium may be collected by a company along with the application, allotment or even calls. However in general practice, company collects the premium along with allotment money. (i) Accounting entries when premium is received with allotment:(a) Share allotment A/C Dr. To share capital A/C To share premium A/C (for allotment made on . Shares at a premium of Rs. . Per share) (b) Bank A/C To share allotment A/C (for cash received on allotment) (ii) Dr.
When premium is received with call money (a) Share . Call A/C Dr. To share capital A/C To share premium A/C (for share call due on .. shares @ Rs. .. per share and the premium of Rs. Per share) (b) Bank A/C Dr. To share . A/C (for share call money received)
1.4.6. Issue of shares at a discount When a company issue its shares at a price less than its face value, that is called shares discount. Issue of shares at discount is prohibited by sec. 50 of company Act 2053 B.S. Discount on share is loss of capital nature. So it appears on the assets side of the balance sheet. It is gradually written off against Profit and loss account over a number of years. The accounting entries while issuing shares at a discount are: (a) For due on allotment: Share allotment A/C Dr. Discount on share issued A/V Dr. To share capital A/C (b) For allotment money receiving: Bank A/C Dr. To share allotment A/C Illustration 5 A limited company issued 10000 shares of Rs. 10 each at a premium of Rs. 2 each, payable Rs. 2 on application, Rs. 5 on allotment (including premium) and balance on first and final call, as and when required. All shares were taken up and money due were received. Solution: In the books of A Co. Ltd. Journal Particulars L.F. Bank A/C Dr. To share application A/C (for application received for 10,000 shares with Rs. 2 application money per share) Share application A/C Dr. To share capital A/C (for application money transferred to share capital account) Share allotment A/C Dr. To share capital A/C To share premium A/C (for amount due on allotment @ Rs. 3 per share, and rS. 2 per share on account of premium) Bank A/ C Dr. To share allotment A/C (for receipt of allotment money including premium on 10,000 shares)
Date
Dr. (Rs) 20,000
Cr. (Rs.) 20,000
20,000 20,000
50,000 30,000 20,000
50,000 50,000
Illustration 6 A company limited issued 10,000 shares of Rs. 100 each at Rs. 90 per share. The amount on the shares were payable as under: On application Rs. 50 On allotment Rs. 20 On final call Rs. 20 All shares were subscribed and money was duly received. Required: Journal entries is the books of the company. Solution: In the books of A Co. Ltd. Journal Date Particulars Bank A/C Dr. To share application A/C (for application received for 10,000 shares with Rs. 50 application money per share) Share application A/C Dr. To share capital A/C (for application money transferred to share capital account) Share allotment A/C Dr. To share capital A/C To share premium A/C (for allotment money due on 10,000 shares @ Rs. 20 per share, after adjustments of discount @ Rs. 10 per share) ) Bank A/ C Dr. Discount on issue of share A/C Dr. To share allotment A/C (for allotment money received on 10,000 shares @ Rs. 20 per share) Share first & final call A/C Dr. To share capital A/C (for final call due on 10,000 shares @ Rs. 20 per share) Bank A/C Dr. To share first & final call A/C (for final call money received on 10,000 shares @ Rs. 20 per share L.F. Dr. (Rs) 5,00,000 5,00,000 Cr. (Rs.)
5,00,000 5,00,000
3,00,000 3,00,000
2,00,000 1,00,000 3,00,000
2,00,000 2,00,000
2,00,000 2,00,000
1.4.8. Share underwriting and commission
An under-writer is a person or a financial institution who undertakes in consideration of commission, to take whole or a portion of the shares offered by a company to the public for subscription, if the public do not subscribe such shares. In such case the under writer will be paid their commission for underwriting of shares. The entry required for such issue is as follows: Underwriting commission A/C To share capital A/C Illustration 7 Dr.
A Ltd. Company issued 10,000 shares of Rs. 100 each as fully paid. The merchant Bank Ltd. Underwrites the shares of the company for a commission of 2%. Pass the necessary entry for the same. Solution: In the books of A Ltd. Journal Date Bank A/C To share capital A/C (for cash received on 10,000 shares @ Rs. 100 each as fully paid) Underwriting commission A/C To bank A/C (for underwriting commission paid @ 2%) Alt. entry for the above two entries: Bank A/C Underwriting commission To share capital A/C Dr. Dr. 9,80,000 20,000 10,00,000 Dr. 20,000 20,000 Particulars Dr. L.F. Dr. (Rs) 10,00,000 10,00,000 Cr. (Rs.)
1.4.9. Brokerage Share broker is an agent acting for the company in issuing of shares. Brokerage is the commission paid to brokers for completing and negotiation for issue of shares and debentures of a company. 1.4.10. Issue of shares to promoters For promoting a new company the promoters are sometime paid in shares for services rendered by them. In such, as cash is not received, an entry is passed by debiting the goodwill account in the following way: Goodwill A/C To share capital A/C (for shares issued as fully paid to promoters) 1.4.11. Calls in arrears The calls made by the company on its issued shares but not paid by shareholders is termed as 'Calls in arrears'. There are two methods to dealt with calls in arrears: (a) Without opening a separate account for calls in arrears. (b) With opening a separate account for calls in arrears Under the first method and amount received on calls will be debited and respective calls will be credited by the extent of amount of cash received. The calls in arrears account will not be opened. Under second method both bank and calls in arrear account will be debited and respective calls will be credited. The journal entries for both the alternative will be: (a) Without opening a separate account for calls in arrears. Share allotment / call A/C To share capital A/C Bank A/C To share allotment A/C Dr. Dr. Dr.
(b) With opening a separate account for calls in arrears Share allotment / call A/C Dr. To share capital A/C Bank A/C Dr. Calls in arrears A/C Dr. To share allotment / call / A/C Illustration 8 A limited Company issued 10,000 shares of Rs. 10 each payable as Rs. 2 on application, Rs. 3 on allotment and Rs. 2 on final call. The public applied for 8,000 shares; which were allotment. All the money due on hares were received except the final call on 500 shares. Required: Journal entries in the books of the company. Solution: In the book of A Co. Ltd. Journal Date Particulars Bank A/C Dr. To share capital A/C (for application money received on 8,000 shares @ Rs. 2 per share) Share application A/C Dr. To share capital A/C (for application money transferred to share capital account) Share allotment A/C Dr. To share capital A/C (for allotment money due on 8,000 shares @ Rs.3 per share) Bank A/C Dr. To share allotment A/C (for allotment money received on 8,000 shares @ Rs. 8 each) Share final call A/C To share capital A/C Dr. L.F. Dr. (Rs) 16,000 16,000 Cr. (Rs.)
16,000 16,000
24,000 24,000
24,000 24,000
40,000 24,000
(for final call due on 8,000 shares @ Rs.5 per share) Bank A/C Dr. To share final call A/C (for final call money received on 7,500 shares @ Rs. 5 per share) Alternative entry: Ban A/C Dr. Calls-in-arrear Dr. To share final call A/C (for final call money received on 7,500 shares @ Rs. 5 per share and balance transferred to calls-in-arrear) 1.4.12. Calls in advance The amount which has not been called up by the company but has been paid by shareholders advance is termed as 'calls in advance'. (a) for money received Bank A/C Dr. To calls in advance A/C (b) for adjustment of calls in advance Calls in advance A/C To share .. A/C Illustration 9 A company limited offered 1000 shares of Rs. 100 each to the public payable as under: Rs. 25 on application Rs. 25 on allotment Rs. 25 on first call Rs. 25 on final call All shares were applied for and allotted. A shareholder to whom 100 shares were allotted, paid the whole of the sum due to along with allotment. Assume all sums were received. Required: Journal entries in the books of the company 37,500 37,500
37,500 2,500 40,000
Solution: In the books of A Co. Ltd. Journal Date Bank A/C To share capital A/C (for application money received on 1,000 shares @ Rs. 25 each) Share application A/C To share capital A/C (for application money transferred to share capital account) Share allotment A/C To share capital A/C (for allotment money due on 1000 shares @ Rs. 25 each) Bank A/C To share allotment A/C To calls in advance A/C (Being money due on allotment money received on 10,000 shares and money for first call and final call received in advance on 100 shares) Share first call A/C To share capital A/C (for first call made on 1000 shares @ Rs. 25 each) Bank A/C Calls-in-advance To share final call A/C (for final call money received on 900 shares @ Rs. 25 per share and adjustment of callsin-advance received on 100 shares) Dr. Dr. 22,500 2,500 25,000 Dr. 25,000 25,000 Dr. 30,000 25,000 5,000 Dr. 25,000 25,000 Dr. 25,000 25,000 Particulars Dr. L.F. Dr. (Rs) 25,000 25,000 Cr. (Rs.)
1.4.13. Forfeiture of shares Forfeiture of shares means compulsory termination of membership. If a shareholder fails to pay the calls made on him, his shares may be forfeited. The following conditions must be fulfilled for the validity of forfeiture of shares: (i) (ii) (iii) (iv) Shares can be forfeited only against non-payment of calls due in respect of shares. Proper notice must be serve on defaulting members. The procedure given in the article of association must be followed. The board of directors must pass a resolution for a forfeiture of shares.
Accounting treatment of forfeiture of shares (a) Forfeiture of shares issued at par Share capital A/C To share forfeited A/C To calls unpaid A/C Or Share capital A/C To share forfeited A/C To calls-in-arrear A/C (b) Forfeiture of shares issued at premium Share capital A/C Share premium A/C To share forfeited A/C To calls unpaid A/C Note: Share premium account may not be debited if share premium amount was already received. (c) Forfeiture of shares issued at discount Share capital A/C To share forfeited A/C To discount on issued of shares A/C To calls unpaid A/C Dr. Dr. Dr. Dr. Dr. (No. of share forfeited called up per share) (Paid up amount on forfeited shares) (Unpaid amount on forfeited shares)
Illustration 10 Morang Metal Co. Ltd. of Biratnagar issued 10,000 equity shares of Rs. 100 each payable Rs. 30 on application, Rs. 20 on allotment, Rs. 40 on first call and Rs. 10 on final call. All money was duly received except from a shareholder, holding 1,000 shares on which application and allotment money were only received. His shares are forfeited. Required: Journal entry to record forfeiture: (i) if the shares are forfeited after the first call. (ii) if the shares are forfeited after the final call. Solution: (Q.i) In the books of Morang Metal Co. Ltd. Journal Date Share capital A/C To share forfeited A/C To share first call A/C (for forfeiture of 1,00 shares of Rs. 90 called up for non-payment of first call of Rs. 10 each by the decision of board of director dated ..) Particulars Dr. L.F. Dr. (Rs) 90,000 50,000 40.000 Cr. (Rs.)
Alternative entry: (illustration 10 Q.1.) Date Particulars Share capital A/C To share forfeited A/C To Calls-in-arrear A/C (Being the forfeiture of 1000 shares on which Rs. 90 was called up for non-payment of first call of Rs. 10 each; by the decision of board of directors dated) Dr. L.F. Dr. (Rs) 90,000 50,000 40.000 Cr. (Rs.)
(Q.II) Journal Date Particulars Share capital A/C Dr. To share forfeited A/C To share first call A/C To share final call A/C (Being for feature of 1000 shares of Rs. 100 called up on which Rs. 50000 have been forfeited and unpaid calls in respect of being eliminated) (Q.II) Alternative entry: Journal Date Particulars Share capital A/C Dr. To share forfeited A/C To Calls-in-arrear A/C (For forfeiture of 1000 shares of Rs. 100 each called up, for non-payment of first call and final call as decided by the board of directors dated .. ) L.F. Dr. (Rs) 1,00,000 Cr. (Rs.) 50,000 50,000 L.F. Dr. (Rs) 1,00,000 50,000 40,000 10,000 Cr. (Rs.)
Illustration 11 Mr. X, a shareholder of a company, failed to pay share final call of Rs. 20 on 5,000 shares issued to him at Rs. 120 (including share premium of Rs. 20). His shares were forfeited. Show the journal entry for forfeiture of shares.
Solution: Date Journal Particulars Share capital A/C Dr. To share forfeited A/C To share first call A/C (being 5000 shares forfeited on account of non-payment of share final call of Rs. 20 by the resolution of the board of directors dated .. ) L.F. Dr. (Rs) 50,00,000 Cr. (Rs.) 4,00,000 1,00,000
Problem 11.
A Ltd. Co. Issued 2,000 shares of Rs. 100 each at a premium of Rs. 50 to Mr. X which he paid Rs. 30 on application and failed to pay Rs. 80 (including premium on allotment), Rs. 20 on first call; and Rs. 20 on final call. His shares were forfeited. Required: Journal entry for the forfeiture of A Ltd. Co.
Date
Particulars Share capital A/C Share Premium A/C To share forfeited A/C To share allotment A/C To share first call A/C To share final call A/C (Being forfeiture of 2000 shares issued at premium due to unpaid from allotment) Dr. Dr.
L.F.
Dr. (Rs) 2,00,000 1,00,000
Cr. (Rs.)
60,000 1,60,000 40.000 40,000
Alternative entry: Date Particulars Share capital A/C Share Premium A/C To share forfeited A/C To calls in arrears A/C (Being the forfeiture of 2000 shares of Rs. 100 each, for allotment money, first call and the final call money, including premium of Rs. 50 each as decided by the board of directors dated.) Dr. Dr. L.F. Dr. (Rs) 2,00,000 1,00,000 60,000 1,60,000 40.000 40,000 Cr. (Rs.)
Problem 13 Chitwan Expo Co. Ltd. forfeited 200 shares of Rs. 100 each issued at a discount of Rs. 10 to Mr. Mahila on on which only Rs. 80 were called up so far. Mr. Mahila had to pay Rs. 20 on first call. Required: Journal for the forfeiture of shares. Journal in the books of Chitwan Co. Ltd. Particulars L.F. Dr. (Rs) Share capital A/C Dr. 16,000 To share forfeited A/C To discount on issued of shares A/C To share first call A/C (Being forfeiture of 200 shares issued at discount or Rs. 10 on which first call is not received)
Date
Cr. (Rs.) 10,000 2,000 4,000
1.4.14. Re-issue of shares The forfeited shares can be re-issued by the company. The re-issue could be done at par, at discount or at premium. Accounting treatment necessary for reissue of shares are given below: (a) Re-issue of shares at par: Bank A/C Dr. (Amount received) To share capital A/C (Amount treated as paid up capital) (b) Re-issue of shares at discount: Bank A/C Dr. Share forfeiture A/C Dr. To share capital A/C Re-issue of shares at par: Bank A/C To share capital A/C To share premium A/C
(Amount received) (Discount on reissued share) (Paid up capital amount)
(c)
Dr.
(Amount received) (Paid up capital amount)
(Amount received in excess of paid up capital)
(d)
Re-issue of shares originally at a discount Bank A/C Dr. (Amount received) Discount of shares A/C Dr. (Amount originally allowed as discount at the time of issue)
Share forfeiture A/C To share capital A/C 1.4.15. Capital reserve account
Dr.
(Amount allowed as discount only on reissue)
There may be some gain on forfeiture and re-issue of shares. Such a gain should be credited to capital reserve account. The difference between the account credited to forfeited share account at the time of forfeiture of shares and the amount debited to the account at the time of re-issue of shares is transferred to capital reserve account. The journal entry for transferring gain to capital reserve will be: Share forfeited A/C Dr. To capital reserve A/C Illustration 14 The directors Nepalgunj Eco. Co. Ltd. have forfeited 60 shares of Rs. 10 each, on which Rs. 6 have been paid. Of these, 50 shares were re-issued to Mr. B as fully paid up for Rs 7 per share. Rs. 8 had been called up at the time of forfeiture. Solution: Journal entries in the books of Nepalgunj Eco. Co. Ltd. Date Particulars Share capital A/C Dr. To share forfeited A/C To share first call A/C (Being 60 shares forfeited on which Rs. 8 each was called) Bank A/C Dr. Share forfeited A/C Dr. To share capital A/C (Being 50 shares re-issued as fully paid up shares) Share forfeited A/C Dr. To capital reserve A/C (Being proportionate amount from share forfeiture account transferred to capital reserve account) L.F. Dr. (Rs) 480 360 120 Cr. (Rs.)
350 150 500
150 150
Problem 15 A company issued 1000 shares of Rs. 10 each at a premium of Rs. 5 per share, payable as to Rs. 7 (including the premium) on application, Rs. 5 on allotment and the balance on call which was duly made. A shareholder, to whom 100 shares were allotted, failed to pay the allotment and call money, and his hsares were forfeited. The forfeited shares were subsequently re-issued as fully paid for Rs. 900. Required: Journal entries for recording forfeiture and re-issued of shares. Journal entries in the books A. Co. Ltd. Date Share capital A/C To share forfeited A/C To share allotment A/C To share call A/C (Being 100 shares forfeited for non-payment of allotment and call money) Bank A/C Share forfeited A/C To share capital A/C (Being re-issued as of 100 shares) Share forfeited A/C To capital reserve A/C (Being balance of net gain on re-issued transferred to capital reserve account) Dr. 100 100 Dr. Dr. 900 100 1000 Particulars Dr. L.F. Dr. (Rs) 1000 200 500 300 Cr. (Rs.)
Problem 16 A company issued 1000 shares of Rs. 10 each at a premium of Rs. 5 per share, payable as to Rs. 5 on application, Rs. 7 (including the premium) on allotment and the balance on call which was duly made. A shareholder, to whom 100 shares were allotted, failed to pay the allotment and call money, and his shares were forfeited. The forfeited shares were subsequently re-issued. Required: Journal entries for forfeiture and re-issued of shares if the forfeited shares were re-issued as fully paid for (i) Rs. 1200 and (ii) Rs. 800.
Solution: Journal Date Share capital A/C To share premium A/C To share forfeited A/C To share allotment A/C To final call A/C (Being 100 shares forfeited for non-payment of allotment, final call and premium) (i) Bank A/C To share capital A/C To share premium A/C (Being re-issued of 100 shares as fully paid of Rs. 10 per share) (ii) Bank A/C Share forfeited A/C To share capital A/C (being re-issue of 100 shares as fully paid of Rs. 10 per share) Share forfeited A/C To capital reserve A/C (For balance of gain on re-issued transferred to capital reserve account) It should be noted that forfeiture of shares of different categories would not be as simple as has been discussed so far. The category of the shares and non payment of amount should be rightly assessed for forfeiture of such shares. However the student must also be instructed that where the category has not been identified, the forfeiture would be of those shares on which the lowest amount have been received. Example A company limited issued 10,000 shares of Rs. 100 each at a par, payable as: On application Rs. 20 Dr. 300 300 Dr. Dr. 800 200 1000 Dr. 1200 1000 200 Particulars Dr. L.F. Dr. (Rs) 1000 500 500 700 300 Cr. (Rs.)
On allotment On first call On final call
Rs. 30 Rs. 20 Rs. 30
Application were received for 30,000 shares and the directors followed the following allotment polices: (a) Applicants for 2000 shares to receive in full. (b) Applicants for 12000 shares to receive 4000 shares. (c) Applicants for 16000 shares to receive 4000 shares. A holder of 400 shares failed to pay final call and his shares were forfeited. Analytical Table No. of Shares 2000 12000 16000 Application Received Rs. 40000 240000 320000 Share Capital Rs. 40000 80000 80000 Since in this case the lowest paid share category is 12000 applicants receiving only 4000 shares, the forfeiture share account will be credited by the sum as: Application 4000 shares @ Rs. 20 Allotment 4000 shares @ Rs. 30 First Call 4000 shares @ Rs. 10 Working Notes: 40,000 = Rs. 10 4,000 10x400 = Rs. 4,000 Illustration 17 A company issued 2,000 shares of Rs. 10 each, at a discount of 10%. The final call of Rs. 2 was not paid by A who held 200 shares and his shares were forfeited. Half of the forfeited shares were re-issued at Rs. 8. = Rs. 8000 = Rs. 12000 = Rs. 4000 Allotment 120000 120000 First Call 40000 80000 Second Call 40000 Refunded -
Total: = Rs. 24000
Required: Journal entries for forfeiture and re-issue of shares. Solution: Journal Date Particulars Share capital A/C To discount on shares A/C To share forfeited A/C To share final call A/C (Being 200 shares forfeited for non-payment of allotment final call) Bank A/C Discount on shares A/C Share forfeited A/C To share capital A/C (Being re-issue of 100 shares as fully paid of Rs. 10 per share) Share forfeited A/C To capital reserve A/C (Being gain on forfeiture and re-issued of shares transferred to capital reserve account) 1.4.16. Issue of shares for consideration other than cash Shares are generally issued for cash. But sometimes shares are also issued to vendor, company as against the assets purchased; and to the promoters and the underwriters the service rendered. The accounting entries required are: (a) On purchase of vender company assets: Assets A/C To vendor company A/C (b) Issue of share at par for payment of assets Vendor company A/C To share capital A/C Dr. Dr. Dr. 600 600 Dr. Dr. Dr. 800 100 100 1,000 Dr. L.F. Dr. (Rs) 2,000 200 1,400 400 Cr. (Rs.)
(c)
Issue of share at a premium for payment of assets Vendor company A/C To share capital A/C To share premium A/C Dr.
(d)
Issue of share at a discount for payment of assets Vendor company A/C Discount on share issued A/C To share capital A/C Dr.
Illustration 18 A limited company purchased the assets costing Rs. 4,00,000 from x Co. Ltd. The consideration being issue of shares of Rs. 100 each. Required: Journal entries if the shares are issued at: (i) par Solution Journal Date Assets A/C To X Co. Ltd. A/C (For assets purchased) (i) Shares issued at par: X Co. Ltd. A/C To share capital A/C (For issued of 4000 shares@Rs. 100 each for purchase of assets. (ii) Shares issued at 25% premium X Co. Ltd. A/C To share capital A/C To share premium A/C (Being issued of 3200 shares of Rs. 100 4,00,000 3,20,000 80,000 4,00,000 4,00,000 Particulars Dr. L.F. Dr. (Rs) 4,00,000 4,00,000 Cr. (Rs.) (ii) 25% premium (iii) 20% discount
each at a premium of 25%) (iii) Shares issued at discount X Co. Ltd. A/C Discount on share issued A/C To share capital A/C (For issued of 5000 shares of Rs. 100 each at a discount of 20%) Dr. 4,00,000 1,00,000 5,00,000
Working notes: (ii) Number of shares = 4,00,000 = 3200 shares 125 (iii) Number of shares = 4,00,000 = 5000 shares 80 Discount = (5000 x 100) x 20 = Rs. 1,00,000 100 1.4.17. Issue of shares for purchase of business Taking over of agreed assets and liabilities of a company by another company is referred as purchase of business. The agreed price to be paid by purchasing company to its vendor company is termed as purchase price. The purchasing price may be paid in cash or may be selected by issuing shares or it may partly be paid in shares and partly in cash. The amount of purchase consideration may be equal or less than or more than the net value of assets and liability purchased. The net value of assets remained after deducting liabilities is also known as net worth. These possibilities and their results are summarized below: Conditions Net worth = Purchase consideration Net worth is consideration greater than purchase Results No gain, No loss Gain Loss Produces Nothing Capital reserve Goodwill
Net worth is less than purchase consideration
The journal entries for the above three conditions are: (i) Net worth = Purchase consideration: Assets A/C To liabilities A/C Dr.
To vendor A/C (For taken over of assets and liabilities) Vendor Co. A/C To share capital A/C (For payment of agreed amount) (ii) Net worth is greater than purchase consideration Assets A/C Dr. To liabilities A/C To vendor A/C To capital Reserve A/C (For taken over of assets and liabilities) Vendor Co. A/C Dr. To share capital A/C (For payment of agreed amount) (iii) Net worth is less than purchase consideration Assets A/C Dr. Goodwill A/C Dr. To liabilities A/C (For taken over of assets and liabilities) Vendor Co. A/C Dr. To share capital A/C (For payment of agreed amount) Illustration 19 A Co. Ltd. registered with Rs. 5,00,000 in shares of Rs. 100 each acquired the following assets and liabilities of X Co. Ltd. Land and building Rs. 2,00,000 Plant & machinery Rs. 1,00,000 Debtors Rs. 50,000 Inventory Rs. 75,000 Cash at Bank Rs. 50,000 Bank overdraft Rs. 75,000 Accounts payable Rs. 1,25,000
The purchasing price agreed between A Co. Ltd. and X Co. Ltd. was discharged by issuing shares: Required: Journal entries in the books of A Co. Ltd. if the price was agreed at: (i) Rs. 2,75,000 (ii) Rs. 3,75,000 (iii) Rs. 2,25,000 Solution: Q. (I) In the books of A Co. Ltd. Journal Date Particulars Land and building A/C Plant & machinery A/C Debtors A/C Inventory A/C Cash at bank A/C To bank A/C To accounts payable A/C To X Co. Ltd. A/C (Being assets and liabilities taken over) X Co. Ltd. A/C To share capital A/C (Being 2750 shares issued @ Rs. 100 each for the payment of purchase price) Dr. 2,75,000 2,75,000 Dr. Dr. Dr. Dr. Dr. L.F. Dr. (Rs) 2,00,000 1,00,000 50,000 75,000 50,000 75,000 1,25,000 2,75,000 Cr. (Rs.)
Q. (ii) Journal Date Particulars Land and building A/C Plant & machinery A/C Dr. Dr. L.F. Dr. (Rs) 2,00,000 1,00,000 Cr. (Rs.)
Debtors A/C Dr. Inventory A/C Dr. Cash at bank A/C Dr. Goodwill A/C Dr. To bank overdraft A/C To accounts payable A/C To X Co. Ltd. A/C (Being assets and liabilities taken over) X Co. Ltd. A/C Dr. To share capital A/C (Being 3750 shares issued @ Rs. 100 each for the payment of purchase consideration) Q. (iii) Journal Date Particulars Land and building A/C Dr. Plant & machinery A/C Dr. Debtors A/C Dr. Inventory A/C Dr. Cash at bank A/C Dr. To bank overdraft A/C To accounts payable A/C To X Co. Ltd. A/C To capital reserve A/C (Being assets and liabilities taken over) X Co. Ltd. A/C Dr. To share capital A/C (Being 2250 shares of Rs. 100 each issued for discharge of purchase consideration) 1.5. Debentures L.F.
50,000 75,000 50,000 1,00,000 75,000 1,25,000 3,75,000 3,75,000 3,75,000
Dr. (Rs) 2,00,000 1,00,000 50,000 75,000 50,000
Cr. (Rs.)
75,000 1,25,000 2,25,000 50,000 2,25,000 2,25,000
1.5.1. Meaning Debenture is a borrowed capital. It is a certificate issued by a company acknowledgement debt of a specified amount of the person named in it. The interest
rate is prefixed and periodic payment of interest is to be paid on debentures. Besides, the principal amount is also refunded after a specified period. A person holding such a debenture is called debenture holders. They cannot participate in management of the company. Thus, it can be defined as 'a document which refers to an undertaking of the company in writing for acknowledging a debt and containing a contract for the payment of the principal sum at a specified date and for the payment of interest at a fixed rate'. 1.5.2. Features of debentures. The important features of debentures are: A document of certificate which acknowledges the debt of the company. Issues under the seal of the company. Payment period of principal and interest is prefixed. Rate of interest is also prefixed. A long term borrowing.
1.5.3. Importance of debentures Debentures are important to raise long term loan for: meeting expenditures on modernization of plant. Expansion and diversification of plant. Meeting long term requirement of working capital Setting up new projects.
1.5.4. Types of debentures Company can issue different types of debentures simultaneously or any one of these to raise loan. The various kinds of debentures are as follows: (i) (ii) Redeemable debentures: These debentures are repayable after a stipulated period as per the terms of their issue. Irredeemable debentures: These debentures are repayable only at the time of liquidation. It is also termed as perpetual debentures.
(iii)
Bearer debentures: In this type of debentures, the name and address of the holder is not registered with the company. It can be transferred to any body and interest is paid to the person who produces the interest coupon attaches to such debentures. Registered debentures: The debentures which are recorded and registered in the book of the company and are payable to the registered holders are called registered debentures. These types of debentures can be transferred only by adopting the procedure which laid down in the article of association. The interest is paid to the registered holder only. Naked or unsecured or simple debentures: These debentures are not secured by a charge on company's assets. Secured or mortgage debentures: Debentures which are secured by a charge on the assets of the company are called mortgage debentures. Convertible debentures: If the debentures holders are given an option to convert the holding of debentures into shares preference or equity after certain.
(iv)
(v) (vi) (vii)
(viii) Non convertible Debentures: those debentures which can not be converted into shares known as non-convertible debentures. (ix) Collateral Debenture: Debenture issued to bank and financial institution, are called collateral debentures. If the company fails to pay loan taken against his security ,lending institution can exercise their right as debenture holder. First Debentures: Debentures, having priority of repayment over other debentures are termed as first debentures. Second Debentures : these types of debenture are to be redeemed only after the repayment of the first debentures.
(x) (xi)
Students must be told that repayment of debentures of 1st and 2nd charges will only be applicable at the time of liquidation of a company. 1.5.5 Issue of debentures and accounting for debentures Debentures are issued at par or at premium or at discount. at also can be issued for consideration other than cash or as collateral security. 1.5.5.1 Issue of debentures for cash The following entries are passed for issue of debentures: (1) On receipt of application money Bank A/C Dr To debenture Application (2) On transfer of application of money to debenture Account
Debenture application A/C To Debentures A/C
Dr
(3) On refund of money to totally rejected application Debenture application A/C To Bank A/C (4) On transfer of surplus application money to allotment of partially rejected applications. Debenture application A/C Dr To Debentures allotment A/C (5) On making allotment money due Debenture allotment A/C Dr To Debentures A/C (6) On receipt of allotment money Bank A/C Dr To Debenture allotment A/C (7) On making first call money due Debenture first call A/C Dr To Debenture A/C (8) On receipt of the first call money Bank A/C Dr To Debenture first call A/C Illustration 20 A limited Co. issued 1,000; 10% debentures of Rs. 100 each payable Rs.40 On application .Rs.30 On allotment, Rs.15 on first call and balance on final call. All the money due was dally received. Required: Journal entries in the books of the company Solution: Journal in the books of Ltd. Date Bank A/C To Debenture Application (Being application money received on 1000 debentures @ Rs. 40 each) Debenture application A/C Dr 40,000 Particulars Dr L.F. Dr.(Rs) 40,000 40.000 Cr. (Rs.) Dr
To 10% Debenture A/C (Being allotment money transferred) Debenture allotment A/C To 10% Debentures A/C (Being allotment money due on debentures @Rs.30each) Bank A/C To debenture allotment A/C (Being allotment money received) Debenture first call A/C To 10% Debentures A/C (Being first call due on debentures @ Rs.15each) Bank A/C Todebenture first call A/C (Being first call money received) Debenture final call A/C To 10% Debentures A/C (Being final call due debentures @ Rs15each) Bank A/C To debenture final call A/C (Being final call money received) 1.5.6 Issue of debenture at a Premium on 1000 Dr 15,000 Dr 15,000 Dr 15,000 1000 Dr 15,000 1000 Dr 30,000 Dr 30,000
40.000
30.000
30.000
15,000
15,000
15,000
15,000
When the debenture are issued at a price higher than their face value that is called as "issued of debentures at premium. The debenture premium is a capital profit and it is shown separately as premium on debenture in the balance sheet on the liability side. Following entry is palled for debenture premium: Debenture allotment A/C Dr To Debenture A/C To Debenture premium A/C
Illustration 21 A company issued 2000, 10% debentures of Rs.100 each at Rs. 120 pauable as follows Rs.20 on application. Rs.50 on allotment (including premium) Rs.50 on first call All the debentures were applied for and allotted. All money due was received. Required: Journal entries in the books of the company Solution: Journal in the books of A Co. Date Particulars Bank A/C Dr To debenture application A/C (For application money received on 2000 debenture @Rs20 each) Debenture application A/C To 100% debenture A/C (For application money transferred) Debenture allotment A/C Dr To 10% debenture A/C (Being the allotment due on 2000 share including premium of Rs.20 each) Bank A/C To debenture allotment A/C (Being allotment money received) Dr 1,00,000 Dr L.F. Dr.(Rs) 40,000 Cr.(Rs) 40,000
40,000 40,000 60,000 40,000
1,00,000
1,00,000
Debenture first and final call A/C Dr To 10% debentures A/C (being first and final call due on 2000 shares @ Rs50 each) Bank A/C Dr To 10% debentures A/C (Beer cash received on first a final call) 1.5.7 Issue of debenture at a discount
1,00,000
1,00,000
1,00,000
1,00,000
When debenture are issued at a price less than their face value that is termed as issued of debenture at a discount. It is a capital loss and shown on the assets side of the balance sheet. It will be written off out of the debenture premium gradually to
the profit) and loss account as early as possible. The following entry is passed fir debenture issued at a discount: Debenture allotment A/C Dr Debenture discount A/C Dr To debenture A/C Illustration 22 A company Ltd. issued 2,000, 10% debenture of 100 each at a discount of 10% payable as; Rs.25 on application,Rs.50 on allotment and Rs.15 on final call. All money due was received. Required: journal entries in the books of the company for allotment due & collection Solution: Journal in the books of A co.Ltd. Date particulars Debenture allotment A/C Dr Dis. on debentures A/C Dr To 10 % debentures A/C (Being the allotment due on 2000 debentures issued at a discount of Rs. 10 each) Bank A/C Dr To debenture allotment A/C (Being allotment money received) 1.5.8 L.F. Dr.(Rs) 80,000 20,000 1,00,000 cr.(Rs)
1,00,000 1,00,000
Issue of debenture for consideration other the cash
Debenture may also be issued for the purchase of assets and issuing is termed as issue of debentures for consideration other than the cash. Debentures may be issued to the vendors at par, at premium and at a discount. The following Journal entries are passed regarding the issue debenture for the assets. (i) For the purchase of assets: Assets A/C To Vendor A/C (ii) For issuing debenture at par: Vendor A/C To Debenture A/C (iii) For debenture issued at discount: Vendor A/C Discount on issue Debenture A/C To Debenture A/C Dr Dr Dr Dr
(iv)
For debenture issued at premium: Vendor A/C To debenture A/C To premium on issue of debenture A/C Dr
Illustration 23 A company limited purchased a plant for Rs. 5,00,000 and issued Rs 100 debentures in consideration Required: Journal entries in the books of the company If debentures were issued: (a) at par (b) at 20% Discount (c) at 25% premium Solution: Journal in the books of A Co Ltd. Date Particulars Plant A/C Dr To Vendor A/C (Being plant purchased from Vendor Co.) (a) If debentures are issued at par: Vendor Co Ltd A/C Dr To Debenture A/C (Being 5000debenture issued for the payment of plant Purchased) (b) If debentures are issued at discount: Vendor Co Ltd A/C Dr Debenture discount A/C Dr To Debenture A/C (Being issue of 6250debenturesof Rs. 100each at a discount of 20% payment of plant purchased) (c) If debentures are issued at par: Vendor Co. Ltd.A/C Dr To Debenture premium A/C (Being issue of 4000 debentures of Rs. 100 each at a premium of Rs.25per debenture for the payment of plant purchased) L.F Dr.(Rs) 5,00,000 5,00,000 5,00,000 5,00,000 Cr.(Rs)
5,00,000 1,25,000
6,25,000
5,00,000 4,00,000 1,00,000
Working notes: (b) No of debentures= 500000=6250 80 (c) No. of debentures=500000=4000 125 The amount of debenture issued for the purchase of assets of a business may or may not be equal to the value of assets so purchased. The likely possibilities and their results for different conditions are given below: Condition 1. Net worth is equal to Debenture amount 2. Net worth is greater than the Debenture amount 3. Net worth is less than the Debenture amount Result No gain, no loss Gain Loss Product nothing Capital Reserve Goodwill
Illustration 24 A company tool over assets of Rs.5,00,000 and liabilities worth Rs.2,00,000 of V. Co. Ltd. The purchase price agreed between them discharged by issuing 10% debentures. Required: Journal entries in the books of A.Co., If the purchase price was agreed at: (a) Rs.3,00,000 (b) Rs.3,50,000 (c) Rs.2,75,000 Solution: In the books of A.Co. Journal Date Particulars (a) If purchase Consideration agreed at Rs. 3,00,000 Sundry assets A/C Dr To V.Co. Ltd A/C (Being assets and liabilities taken over) V.Co .Ltd .A/C To 10% debenture A/C Dr L.F. Dr.(Rs.) 5,00,00 Cr.(Rs.) 2,00,000 3,00,000
3,00,000
3,00,000
(Being debenture issued for discharge of purchase Consideration ) (b) If purchase Consideration was agreed at Rs.3,50,000 Sundry assets A/C Goodwill A/C To sundry liabilities A/C To V. Co Ltd. A/C (Being assets and liabilities taken over) Dr Dr 5,00,000 50,000 2,00,000 3,50,000
V.Co. Ltd A/C To 10 debenture A/C
Dr
3,50,000
3,50,000
(Being debenture issued for discharge if purchase Consideration) (c) If purchase Consideration was agreed at Rs.2,75,000 Sundry assets A/C To sundry liabilities A/C To V.Co. Ltd. A/C To Capital Reserve A/C (Being assets and liabilities taken over) V.Co. Ltd. A/C To 10% debenture A/C (Being debenture issued for discharge of purchase Consideration) Dr 2,75,000 2,75,000 Dr 5,00,000 2,00,000 2,75,000 25,000
1.5.9. Issue of Debentures as collateral Security When a company takes loan, it has to give some security. The debentures can be issued at a security if debentures is said to be collateral security against the loan the company fails to repay the loan and interest thereon, the lender will become a debenture holder . There are two method of treatment of debentures issued as collateral security.
Method 1.: No entry is made in the books. Only a mote is being recorded to the loan account in the ledger and the Balance sheet. Method 2.: The issue of debentures as collateral security is recorded in the journal and the entry will be as follows: For issuing debenture as collateral security : Debenture Suspense A/C Dr To Debenture A/C When the loan is paid off : Debenture A/C Dr To Debenture suspense A/C Debenture suspense account will be shown in the assets side and debenture account will be shown on the liability side of the Balance Sheet. A contra entry to represent both the liability and assets, having no net effects. Illustration 25 A limited company deposited 2000,8% debentures of Rs 75 each with the back as collateral security against a loan of Rs,100000. Required: Journal entries and its treatment in Balance Sheet. Solution: Journal Bank A/C To Bank Loan (For loan taken against collateral security of 2000,8%debentures of Rs.75 each) Balance Sheet on.. Liabilities Bank Loan (On collateral security of 2000,8% debentures of Rs. 75 each) Rs. 1,00,000 1,00,000 Assets Cash at Bank Rs. 1,00,000 1,00,000 Dr 1,00,000 1,00,000
Alt. Method: Bank .A/C To Bank Loan (For loan taken from Bank) Debenture Suspense A/C To 8% debenture A/C Dr 1,50,000 1,50,000 Dr 1,00,000 1,00,000
(For 2000,6% debenture of Rs. 75 each, deposited as collateral security against a bank loan Rs.1,00,000) Balance Sheet as on.. Liabilities Bank Loan 8% Debentures Rs. 1,00,000 1,50,000 2,50,000 Assets Cash at Bank Debenture Suspense A/C Rs. 1,00,000 1,50,000 2,50,000
1.5.10 interest on debentures The interest on debentures is calculated at a fixed rate on the face value of the debentures and is charged to profit and Loss Account, Whether or not the company earns profit. Accounting treatment for interest are: Accounting treatment for interest on debentures: (a) When debenture interest due for payment Interest on debenture A/C To Debenture holders A/C (b) When debenture interest paid Debenture holders A/C To Bank A/C (c) For classing of interest on debentures Profit and Loss A/C To interest on debenture A/C Illustration 26 A Company issued 5000, 10% debentures, Rs 100each on 1st Baisakh of the Year. The interest is to be paid half yearly in 30th Aswin and 31st Chaitra each year. Required: Journal entries for 1st Year. Dr Dr Dr
Solution:
Date 1-1 Bank A/C To 10% Debentures A/C (For 5000, 10% debentures issued at par) 30-6 Interest on debenture A/C To debenture holder A/C (For half yearly interest due on debentures) Debenture holder A/C To Bank A/C (Being interest paid) 3112 Interest in debenture A/C To debenture holder A/C (For half yearly interest due in debentures) Debenture holder A/C To Bank A/C (Being interest paid) Profit &Loss A/C To interest on debenture A/C (Being interest on debentures transferred to P/L A/C) Dr 50,000 50,000 Dr 25,000 25,000 Dr 25,000 25,000 25,000 Dr 25,000 Dr 25,000 25,000 Particulars Dr L.F. Dr.(Rs.) 5,00,000 Cr.(Rs.) 5,00,000
1.5.11 Redemption of debentures The repayment of debentures made by the company in accordance with the terms and condition of issue is termed as 'Redemption of Debentures'. The different possibilities and the required Journal entries at the time of issue and redemption are below:
Issued at Par Redeemable at Par Entries on issue Bank A/C To Debentures A/C Par Premium Bank A/C Loss on issue of Dr Dr Entries Redemption Debentures A/C To Bank A/C Debentures A/C Premium on Dr Dr
Accountancy, Grade XII ...56 Debenture A/C To Debenture A/C To Premium o Redemption A/C P/L A/C A/C Discount par Bank A/C Discount on issue of Debentures A/C To Debentures A/C Discount Premium Bank A/C Loss on issue of Debentures A/C To debentures A/C To Premium o Redemption A/C [Loss on issue = discount +Premium on redemption] Discount Discount Bank A/C Discount on Deb A/C To Debenture A/C Premium Par Bank A/C To Debenture A/C To Deb. Premium A/C Bank A/C Loss on issued A/C To Debenture A/C To Deb. Premium A/C Bank A/C To Debentures A/C To Deb. Premium A/C Dr Dr Dr Debentures A/C To Bank A/C To Discount on Redemption A/C Debenture A/C To Bank A/C Debentures A/C Dr To Bank A/C To Premium on Redemption A/C Debentures A/C To Bank A/C To Discount on Redemption A/C Dr Dr Dr Dr Dr Debentures A/C Premium on Redemption A/C To Bank A/C Dr Dr Dr Dr Debentures A/C To Bank A/C Dr Dr Dr Redemption A/C To Bank A/C Dr
To Loss on issue of Debenture
Premium
Premium
Dr Dr
Premium
Discount
Dr
Note: The discount on redemption should not be considered at the time of redemption since it is a future gain.
Illustration 27 The following transactions are provided: (i) (ii) (iii) (iv) (v) Issued 5000, 10% debentures of Rs. 100each, at par and redeemable at par value Issued 5000,10% debentures of Rs.100each, at a discount of 5% and redeemable at par value Issued 5000,10% debentures of Rs. 100each, at a Premium of 5% and redeemable at par value Issued 5000,10%debentures of Rs. 100each, at par and redeemable at 5% Premium Issued 5000,10% debentures of Rs.100each,at a iscount of 3% redeemable at 5% Premium
Required: Journal entries for the issue and redemption of debentures for the above cases. Also show the related item in the Balance Sheet in each case. Solution: (i) At the time of issue: Bank A/C Dr 5,00,000 To 10% Debentures A/C 5,00,000 (For 5000 debentures of Rs. 100 each issued at par) Balance Sheet as on Liabilities 10% Debentures of Rs.100each Rs. 5,00,000 Assets Cash at Bank Rs. 5,00,000
At the time of redemption: 10% Debenture A/C Dr 5,00,000 To Bank A/C 5,00,000 (For debentures redeemed at par value) (ii) At the time of issue: Bank A/C
Dr Dr
4,75,000 25,000 5,00,000
Discount on Debentures To 10% Debentures A/C
(For 5000,10% debentures issued at a discount of 5%)
Balance Sheet as on Liabilities 10% Debentures of Rs.100each At the time of redemption: 10% Debenture A/C Dr 5,00,000 To Bank A/C (For redemption of debentures at par value) (iii) At the time of issue: Bank A/C Dr 5,25,000 5,00,000 25,000 To 10% Debentures A/C To debenture Premium A/C (For 5000,10% debentures issued at a Premium) Balance Sheet as on Liabilities 10% Debentures of Rs.100each Debenture Premium At the time of redemption: 10% Debenture A/C To Bank A/c (For redemption of debentures at par value) (iv) At the time of issue: Bank A/c Loss on issue of debenture A/C To 10% Debentures A/C To Premium on redemption A/C Dr Dr 5,00,000 25,000 5,00,000 25,000 Dr 5,00,000 500,000 Rs. 5,00,000 25,000 Assets Cash at Bank Rs. 5,25,000 5,00,000 Rs. 5,00,000 Assets cash at Bank Discount on debentures Rs. 4,75,000 25,000
(For issue of debenture at par and redeemable at premium) Balance Sheet as on.. Liabilities 10% Debentures of Rs. 100each Premium on redemption of Debenture Rs. 5,00,000 25,000 Assets Cash at Bank Loss on issue of debentures Rs. 5,00,000 25,000
At the time of redemption: 10% Debenture A/C Premium on redemption A/C Dr To Bank A/C (For debentures redeemed at premium) (v) Dr 25,000 5,25,000 5,00,000
At the time of issue: Bank A/C Dr 4,85,000 Loss on issue of debenture A/C Dr 40,000 To 10% Debentures A/C 5,00,000 To Premium on redemption A/C 25,000 (For debentures issued at discount but redeemable at premium) Alt.entry: Bank A/C Dr 4,85,000 Debenture discount A/C Dr 15,000 Loss on issue of debenture A/C Dr 25,000 To Debentures A/C 5,00,000 To Debenture Premium A/C 25,000 Balance Sheet as on Liabilities Rs. Assets 10% Debentures of Rs.100each 5,00,000 Cash at Bank Premium on redemption of Debenture 25,000 Loss on issue of debentures At the time of redemption: 10% Debenture A/C Dr 5,00,000 Premium on redemption A/C Dr 25,000 To Bank A/C (For debentures redeemed at premium) 1.5.11 Redemption by Conversion
Rs. 4,85,000 40,000
Sometimes a company, instead of redeeming its debentures in cash, may offer the debenture holders fresh debentures or shares in exchange for the old one. The entry in case of conversion at par, discount and premium are given below: Redeemable at par: a For redemption due: Debenture A/C Dr
To Debenture Holders A/C b. For Conversion: Debenture Holders A/C To Equity share Capital A/C Or To New Debentures A/C Redeemable at a discount: a. For redemption due: Debenture A/C To Debenture Holders A/C To profit on redemption A/C b. For Conversion into shares at a discount Debenture Holders A/C Discount on issue of shares A/C To Share Capital A/C Redeemable at a Premium: a.For redemption due: Debentures/C Premium on redemption A/C Dr To Debenture Holders A/C Dr Dr Dr Dr Dr
b. For conversion into shares at premium: Debentures holders A/C Dr Discount on issue of Shares A/C Dr To share Capital A/C Redeemable at a Premium: a.For redemption due: Debentures A/C Premium on redemption A/C To Debenture Holders A/C Dr Dr
b. For conversion into shared at premium: Debenture Holders A/C To share Capital A/C To premium on issue of shares A/C Illustration 28 A company limited converted 540, 125 debentures of Rs. 100 each issued at 10% discount into 600 shares of Rs. 90 fully Paid up. Required : Journal entries in the books of the Company. Solution: In the books of A Co. Ltd. Journal Date Particulars 12% Debentures A/C To Debenture Holder's A/C (Being the Rs.54,000 Debentures redeemable at par transferred to debenture holder account for conversion) Debenture Holders A/C Discount on shares A/C To share Capital A/C (Being conversion of Rs. 54,000 debentures into 600 shares of Rs.100 at Rs.90,as fully paid up) 1.6 Opening Balance Sheet of a Company 60,000 Dr Dr 54,000 6,000 54,000 Dr L.F. Dr.(Rs.) 54,000 Cr.(Rs.) Dr
The opening balance sheet of a newly established company does not contains much items of assets and liabilities. It includes share capital, debentures, premium, discount on shares or debentures issued and so on. The specimen of an opening balance sheet of a newly established company is illustrated below:
Liabilities Authorized Capital: .Equity shares of Rs each.% preference shares of Rseach Issued Capital: .Equity shares of Rs..each ..% Preference shares of Rs..each subscribed Capital: equity shares of Rseach% Preference shares of Rs.each Called Up &Paid Up Capital Equity shares of Rs.each Less: Calls in arrears .% Preference shares of Rs.each Less: Calls in arrears Calls in advance Share premium Share Forfeiture Capital Reserve Secured Loan: .%Debentures
Rs. xxx xxx xxx xxx xxx xxx
Assets Fixed assets Goodwill Preliminary expenses Discount on issue of shares Current assets Cash at bank Cash in hand
Rs. xxx xxx xxx xxx xxx xxx xxx
xxx xxx xxx xxx xxx
xxx
xxx xxx
xxx xxx xxx xxx xxx xxx xxx xxx
Illustration 29 A limited Company was incorporated with an authorized capital of Rs. 10,00,000 divided into shares of Rs.100each. It offred to the public for subscription 6000 shares payable as follows: Rs. 30 per share on application Rs. 30 per share on allotment Rs. 40 per share on first and final call
The public subscribed 5000 shares only. All the money was duly received except the final call on 100 shares. Required : The Balance Solution: A Limited Company Balance Sheet as on Sheet of the Company
Liabilities Authorized Capital : 10,000 Shares of Rs. 100 each Issued Capital : 6,000 shares of Rs.100 each Subscribed Capital: 5,000 Shares of Rs. 100each
Rs. 10.00.000
Assets Cash at Bank
Rs. 4,96,000
6,00,000
5,00,00 Called pu Capital: 5,000 Shares of Rs. 100each 5,00,000 Less :Calls in arrear 4,000 4,96,000 4,96,000 4,96,000
Illustration 30 A Company was required with an authorized capital of Rs. 25,00,000 divided into 10,000 preference shares of Rs 100each and 1500 equity shares of Rs. 100each Out of these, 5000 and 10,000 equity shares were issued. These shares were payable as under: Preference share Equity share On application Rs.25 Rs.25 On allotment Rs.25 Rs.40 On First and final call Rs.50 Rs.35 All these shares were paid in full. Required: (i) Journal entries (ii) Cash Book (iii) Balance Sheet
Solution : Journal Date Particulars Preference share application A/C Dr To Preference share capital A/C (Being application money received on 5000 preference shares @ Rs. 25 Per share transferred to preference share capital) L.F Dr.(Rs) 1,25,000 Cr.(Rs.) 1,25,000
Equity share application A/C Dr To equity share capital A/C (Being equity share application money @ Rs.25 each," transferred " to share capital A/C) preference share allotment A/C Dr To preference share capital A/C ( Being the amount due on allotment of 5,000 preference share @ Rs.25each) Equity share allotment A/C Dr To equity share capital A/C (Being the amount due on allotment of 10,000 shares @ Rs.40 pre share) Preference share first &final call A/C Dr To Preference share capital A/C (Being the amount due on first call 5000 shares @ Rs.50each) Equity share first &final call A/C Dr To equity share capital A/C (Being the "nerent" due on first and final call on 10000 shares @ Rs.35 each) Cash Book Dr. Particular To Preference share application 5000 shares @ Rs.25 Rs. 1,25,000
2,50,000
2,50,000
1,25,000
1,25,000
4,00,000
4,00,000
2,50,000
2,50,000
3,50,000
3,50,000
Cr. Particulars By Balance c/d Rs. 15,00,000
To equity shate application A/C (10000 shares @ Rs.25) To pref. shares allotment A/C (5000 shares@ Rs25) To equity share
2,50,000 1,25,000 4,00,000 2,50,000 3,50,000 15,00,000 15,00,000
Balance sheet as on Liabilities Authorised capital: 10,000 preference shares of Rs.100 each Issued, subscribed and called up and paid up capital: 50,000 Preference share of Rs. 100 each 10000 equity shares of Rs 100 each Rs. Assets Cash at bank 10,00,000 15,00,000 25,00,000 5,00,000 10,00,000 15,00,000 Illustration 31 Kantipur Co. ltd. Issued 20,000 shares of RS. 10 each payable as Rs. 5 on application, Rs.6 on allotment and Rs. 2 on call which was duly made. The subscription were received from the public fot 30,000 shares and the allotment was made Pro-rata, the excess application money were retained towards the money due on allotment & call. Mr. A Who was allotted 4000 shares failed to pay the money due from him on allotment and call, but other shareholders paid the amount due from them. Required: Journal entries. Solution: Analytical Table No of shares issued Application money Transferred to capital Share allotment Calls 30,000 Rs.1,50,000 Rs.1,00,000 Rs.50,000 15,00,000 Rs. 15,00,000
Journal in the books of Kantipur Co. Ltd. Date Bank A/C To Share application A/C (Being application money received for 30000 Shares @ Rs. 5 each) Share application A/C To share capital A/C To share allotment A/C (Being application money for 20,000 Shares transferred to share capoital account & excess application transferred to share allotment Account) Share allotment A/C To Share capital A/C (Being amount due on allotment of 20,000 shares @ Rs. 3each) Bank A/C Dr. To share allotment A/C (Being amount received on allotment) Share final call A/C To share capital A/C (Being money due on final call) Dr. 9,800 9,800 Dr 60,000 60,000 Dr. 1,50,000 1,00,000 50,000 Particulars Dr. L.F. Dr. 1,50,000 Cr.(Rs.) 1,50,000
40,000
40,000
Bank A/C Dr. To Share final call A/C (Being amount received on final call)
39,200
39,200
Working notes: Application applied by Mr. A=30000 400=600 shares 2000 Amount paid on application by Mr. A=6005 = 3000 Amount required for application= 400 5 = 2000 Received as an advance on application = 1000 Amount received in advanced on application = 1200 Amount received in advanced on application = 1000 Amount arrear on allotment = 200
Illustration 32 A Company limited issued for public subscription 4,000 equity shares of Rs. 10each at a premium of Rs. 2 per share payable as under: On application Rs. 2 per share On allotment Rs.5 per share (including premium) On first call Rs. 2 per share On second call Rs. 3 per share Application were received for 6,000 shares. Allotment was made Pro-rate to the applicants of4,800 shares, the remaining applicants were refused. Money overpaid on application was applied towards sum due on allotment. Mr. A, to whom 160 shares were allotted failed to pay the allotment and Mr. X, to whom 200 shares were allotted, failed to pay the two calls. These shares were subsequently forfeited after the second call was made. Required: Journal entries Solution: Journal entries Date Particulars Bank A/C Dr To equity shares application A/C (Being money received on application ) Equity share application A/C Dr To equity share capital A/C To Bank A/C TO equity share allotment A/C (Being application money transferred to share capital and excess of application transferred to share capital and excess of application transferred to share allotment account and refunded rejected applications) Equity share allotment A/C Dr To share capital A/C To share premium A/C (Being allotment money due with premium) L.F. Dr. (Rs) 12,000 Cr.(Rs.) 12,000
12,000
8,000 2,400 1600
20,000
12,000 8,000
Bank A/C Dr To equity share allotment A/C (Being allotment money received ) Equity share first call A/C Dr To equity share capital A/C (Being first call money due) Bank A/C Dr TO equity share first call A/C (Being cash received on first call) Equity share second call A/C Dr To equity share capital A/C (Being second call money due) Bank A/C Dr To equity share second call A/C (Being second call money received) Equity share capital A/C Dr Share premium A/C Dr To share forfeited A/C To equity share allotment A/C To equity share first call A/C To equity share second call A/C (Being 360 shares forfeited due to unpaid of allotment, first call & second call)
17,664
17,664
8,000
8,000
7,280
7,280
12,000
12,000
10,920
10,920
3600 320
1,384 736 720 1,080
Working Notes: I. Application money transferred to allotment A/C = 800 2 = Rs.1600 II. Allotment due from Mr. A: Allotment money on his allotment shares = 160 = Rs. 800 Excess application money due to Pro-rate distribution = [(1604800)-160]2 4000 = Rs.64 Allotment due from Krishna = 800-64 = Rs.736
(iii) Allotment money received
= 20000-1600-736 =Rs.17,664 (iv) Amount of shares forfeited = (1922) + (2005) = Rs.1384 Teaching Hours The teaching hours allotted for the unit is 35 hours and it may be sub-divided in the following way. However, the teacher being the ultimate guide of the class may change them as per his convenient Topics No. of Lect. Hours. 1.1 Company & its formation 2 1.2 Capital of a company 2 1.3 Method of Raising Capital 1 1.4 Issue of shares and accounting for share 18 1.5 Debentures 10 1.6 Balance sheet of a company 2 .. TOTAL 35 Some Model Questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. What do you mean by joint stock Company? Write any two characteristics of a Company. Define shares and name the types of shares. What do you mean by Equity Shares. What is meant by Share Capital ? List out the classification of share capital. Difference between cumulative and non cumulative preference shares. How a company can issue its shares? What is Memorandum of association? Define calls in-arrear. What is call- in- advance? What is a 'Debenture'? What do you mean by Prorate allotment? What is meant by Debentures as collateral Security? What do you understand by redemption of debentures? What is over and under subscription? Define redeemable debenture. Write in brief about the forfeiture of shares. Can a company issue shares at a discount / Give a example. [3] [2] [2] [2] [2] [2] [2] [3] [2] [2] [2] [2] [2] [2] [2] [2] [2] [2] [1+1]
20. 21.
22.
23
24
25
26
27
28.
Differentiate between Issue and Subscribed Capital . [2] A holder of 500 equity share of Rs. 10 each Issue at a discount of Rs.2 pre share failed to pay final call of Rs. 3 The board of of directors decided to forfeit these shares and re-issue them at Rs.8 fully paid .Requires (a) Entry forfeiture [1] (B) Entry for re-issue [B] A Company forfeited 100 share of Rs. 100 each fully called up, held by Mr.X for non were reissued to Mr. B for Rs 80 per share as fully paid up. Require Journal entries for forfeiture & reissue A company issued 5000 shares of Rs. 100 for public subscription at a premium of Rs. 10 each Application were received for 10,000 shares and it was decided to make prorate allotment to all applicants. Amount payable on application was Rs. 50 (including Rs. 10 Premium) [1+2] A company limited issued 10,000 shares of Rs. 50 each to the public at a premium of Rs.10each, payable as follows: Rs. 20 on application Rs. 20 on allotment All the shares which were applied for were duly allotted Required journal entries in the books of the Company Lumbini Co Ltd Issued 1000shares of Rs. 100each at a discount of 10%. The amount was payable as Rs.40on application and balance on allotment. Application were received for all shares and they were duly allotted. All money were duly received. Required Journal entries. Janaki Tr adding Co.Ltd Forfeited 50 equity shares of Rs100 each issued at a premium of Rs.20 per share, for non repayment of allotment of Rs.50 per share (including Rs.20share premium),the firs call of Rs20 per share and final call of Rs30per share. Out of these share 40 equity shares were reissued at Rs.110 per share. Required: Journal entries for forfeiture and re-issued of share. Mr A applied for 2000 shares of Rs. 100 each at a premium of Rs 25 per share. But he was allotted only for 1000 shares. After having paid Rs. 30 per share on application, he did not pay the balance On allotment money due of Rs. 45 per share(including premium) On his subsequent failure to pay the first call of Rs 20 per share, his shares were forfeited. These shares were re-issued at the rate of Rs. 90 per share credited as fully paid. Required: Journal entries to record the forfeiture and reissue of shares Birat Co.Ltd purchased the business of Morang Co. Ltd. for Rs.1,44,000 payable in fully paid shares of Rs. 10each. Required: Journal entries in the books of Birat Co.Ltd.,if share are issue at; (a) a Premium of 20% (b) a discount of 10%
29
Parsa Technico Co. purchased a plant costing Rs.500000 from Bishal Machinery Co.Ltd. payments were made as to Rs. 200000 by a crossed cheque and remaining amount by equity share of face value of Rs.100each fully paid at an issue price of Rs150each. Required: journal entries. 30 A Co.Ltd. Issued 4000 shares of Rs100 each at par to purchase the following assets and liabilities Land and Building Rs 1,00,000 Plant and Machinery Rs 4,00,000 Inventory Rs 60,000 Account Receivable Rs 40,000 Account payable Rs 1,60,000 The Company was also subscribed for 6000 shares of Rs100each at par. These shares were fully paid. Required: Journal entries. 31 Kantipur company purchased assets of Rs6,00,000 and also took over the liabilities of Rs.75,000 The purchase price of Rs. 6,00,000 were paid by issuing of debentures of Rs100each. Required: Journal entries. 32 A Company offered 10,000, 10% debentures of Rs. 100 for public subscript making Rs.50payable with the application. Applications were received for 11,000 debentures. Application money on 500 debentures were applied for allotment and the application money on 500 debentures were refunded. 33 A Company issued 1,000,10% debentures of Rs100 at a discount of 10% The money payable were: Rs20 on application Rs20 on allotment (including discount) Rs.50 one year after. 2000 application were received, and the directors made the following allotment decision: (a) Applicants of 500 debentures were to received in full. (b) Applicants of 1000 debentures were to receive 500 debentures pro-rata (c) Applicants remaining debentures were to be refunded. Required: Journal entries for application and allotment made. 34 Dharan Expo. Ltd. Issued Rs 10,00,000,105 debentures at a discount of 6% repayable at a premium of 5% after 4 years. Required: (I) Journal entry at the time of issue (II) Journal entry at the time of redemption. 35 The following different transactions are provided: (i) A. Ltd issues 5000, 10% debentures of Rs.100 each at a discount of 5% redeemable at the end of 5years at a premium of 5%
(ii) B.Ltd. issued 5000, 10% debentures of Rs. 100each at par redeemable at the end of 5 years at a premium of 5% Required : Journal entries for the above transactions. 36. The following cases are given: (i) Issued Rs.20,000, 10% debentures at par, redeemable at par. (ii) Issued Rs. 20,000, 10% debentures at discount of 10% redeemable; e at par (iii) Issued Rs. 20,000,10% debentures at premium of 10%, redeemable at par. (iv) Issued Rs. 20,000, 10% debentures at par, redeemable at a premium of 10% . (v) Issued Rs. 20,000,10% debentures at discount of 10% redeemable at premium of 10% . Required: Journal entries for above different cases. 37. A Company Limited with authorized capital of 10000 equity shares of Rs.100each and 10,000,10% preference shares of Rs.100each offered to the public 10,000 equity shares at a premium of Rs. 10per share and 10,000, 10% preference shares. Applications were received for 9000 equity shares and 10000,10% preference shares. The shares were accordingly allotted and fully called up. One share holder failed to pay final call of Rs. 20per share, holding 500shares. Required: Opening Balance Sheet. I. Terms introduced in the units Chartered company, Statutory company , Registered company, unlimited company, Company limited by shares, Company limited by guarantee, private limited company, public Limited company , Government Companies, Company promoters: Memorandum of association, Article of association, prospectus, Authorized capital, Issued Capital, Subscribed Capital, Called Capital, paid up Capital, Reserve capital, Shares, Equity shares, preference shares, Cumulative preference shares, Non-Cumulative preference Shares, Participating preference shares, Redeemable preference shares, NonRedeemable preference shares, Convertible preference shares, Non convertible preference shares, Shares Application Share Allotment, Share Calls, Share Capital, Issued Of Shares at par, Issued of shares premium, Issued of Shares Discount, share Underwriting and Commission, Brokerage, Calls- in-arrear, calls-in-advance, Forfeiture of shares, Re-issued of shares, Capital Reserve Account, Debentures, Redeemable Debentures, secured Debentures, Convertible Debentures, Non Convertible Debentures, collateral Debentures, First Debentures, Second Debentures, Redemption Debentures.
Chapter-2
FINAL ACCOUNTS OF A COMPANY

INTRODUCTION: The Income Statement is a period-of-time report, which establishes the profitability of a business entity. The Balance Sheet is a stock report of resources on a given day but the Income statement is a flow report of resources during a period. The balance sheet is a representation of the financial position at a specified date that is why it is also called a Statement of Financial Position. It provides information about entitys economic resources and the claims against those resources by the creditors and owner(s). The economic resources reported on the balance sheet are called assets, and they include such items as cash, inventory of goods, land, buildings, and equipments. The claims against the assets are known as liabilities or equity depending upon who has provided the resources. When the outsiders provide the resources, it is known as liabilities and if the owners provide the resources, it is known as equity. Worksheet is a scratch pad tool for accountants outside the accounting system. It is not a formal step in accounting cycle; rather it is the rough work, hence the phrase scratch pad. The accountants work out the details of the end-of-period adjustments and get a preview of the Financial Statements using the Work Sheet. PREREQUISITE: The knowledge of all accounting concepts, conventions, principles affecting the accounting records and competence in passing journals, preparing ledgers and the ability of preparation of Trial Balance are essential to fully understand the unit. Ability to prepare the Trading Account, Profit and Loss Account, and Balance Sheet and knowledge of adjusted Trial Balance is needed. OBJECTIVES: The following are the learning objectives of the Unit: 1. Be able to prepare a simple worksheet. 2. Be able to prepare the Income Statement and a Balance Sheet as the Companies Act 2053 from a given unadjusted Trial Balance using a Work Sheet.
CONTENT AREAS OF THE UNIT: The following are the content areas of the Unit and their suggested teaching hours. The teaching hours allocated could vary depending upon a teachers style of teaching. Hence, they could be suitable modified but limiting the total hours to 4 hours:
SN
Content Areas of the Unit
Teaching Hours
1. 2. 3. 4. 5.
Concept and preparation of Income Statement and Balance Sheet as prescribed by the Company Act 2053 BS using a work sheet.
DESCRIPTION OF THE CONTENT: Concept and Preparation of Income Statement The income statement is the primary source of information for a company's current profit performance. Investors, lenders, analysts, and other financial statement readers use this and other information in predicting the amount, timing, and uncertainty of the firm's future income and cash flows. This predictive value of the income statement is one of the reasons it is so relevant. The income statement also plays an important role in providing feedback: how good were predictions of prior years' earnings? Another important use of the income statement is for performance evaluation. The primary financial statement for evaluating the performance of managers (both internally and external stakeholders) is the income statement. Of course, the income statement must be interpreted within the company's economic, industrial, and competitive environment. Nevertheless, profit is considered to be the main indicator of management's performance. Investors look at the return and risk their investment. The level of earnings is viewed as the return, while the volatility of earnings is viewed as one measure of risk. It is a major reason why management is so often concerned about maximizing and smoothing net income; managers hope that by maximizing net income, they can improve investors' perception of return, while by smoothing net income, they hope to lower investors' perception of risk.
INCOME STATEMENT AS PER COMPANIES ACT 2053 BS Although, there are several formats of Income Statement in use, but the official pronouncement for use in Nepal is the one issued for the benefit of companies registered under Company Act 2053 to accompany section 84 of Companys Act. The Nepal Gazette has circulated a format dated 1st Jestha 2058. According to which the Income Statement should be drawn in the format provided in Exhibit 2.1. Exhibit 2.1 The Income Statement (Company Act 2053) Name of the Company Income Statement for they year ending Description Current Yr. Rs. Previous Yr. Rs.
Sales Revenue Cost of Goods Sold Gross Profit Add: Other business Incomes Selling & distribution Expenses Administrative Expenses Operating Profit Less: Interest Expenses Depreciation Expenses Add: Income from Subsidary Other Investment Incomes Add/ Less: Income or Loss from sale of assets Less Loss from discontinued operations Add/ Extra-ordinary Income or Loss Income before Tax Less: Distributions of Net Income a. General Reserve b. Proposed Dividend: Preference Shares Ordinary Shares C. Other Reserves Net Income transferred to Balance Sheet
15
MAJOR COMPONENTS OF INCOME STATEMENT REVENUE Revenue is the increase in retained earnings because of sale of goods or services. It is also the amount of cash received or a promise by a customer for sale of goods or services. In all, it is the inflow of assets whether received in cash or creation of an obligation, the benefit of which is receivable in the future that ultimately increases the owners equity from the operating activities. In effect, revenue is anything of value generated through business operations. 1. Sales Revenue
This is the most common type of revenue reflecting the aggregate of the selling price of the goods sold during the year. Sales revenue is the amount earned in exchange of goods. For example, IBM sells computers and the sum total of the selling price of all the computers sold is sales revenue. The selling price of returned goods and reduction in selling price for damaged or defective merchandise, which is clubbed as sales returns and allowances, is adjusted from the gross sales revenue to calculate the net revenue. Apart from the adjustment regarding sales return and adjustment, sales revenue needs to be adjusted for the sales discounts depending upon the credit terms of the sale. The common terms of sale are: n/10, EOM; n/30; 2/10,n30 etc. OTHER BUSINESS INCOMES 2. Service Revenue This is the amount of revenue peculiar to companies providing services. The service providing companies earn fees in return for their services, like an auditing firm earns audit fees, computer consultants earn consultancy fees, law firms earn the legal fees, and leasers earn leasing fees. Some companies may even earn both revenues: sales revenue and service revenue. For example, IBM earns Sales Revenue by selling computers and it earns service revenues by providing consulting services on Information Technology. 3. Interest Revenue
Companies engaged in banking and financial institutions would earn interest revenue as their main business revenue but others also could earn interest revenue on investments earned temporary investments of excess cash not forming part of their business operations.
4.
Other Revenue
There are many more revenues, probably as many as the possible ways of making money, all having their own nomenclature. A college could call it revenue as tuition fees, a doctor as consultation fees, a cricketer as licensing fees, a chain store as franchising fees, and an author as royalty. What ever is the nomenclature used, ultimately it reflects the inflow of asset. COST OF GOODS SOLD Cost of goods sold is the major component of the income statements prepared by a trading and manufacturing concern. For the merchandising business, dealing in purchase and sale of goods, cost of goods sold is the sum of the purchase price and other costs associated for the goods, which have been sold during the accounting period. In other words, the amount of direct costs of the goods, which have been sold, is considered cost of goods sold. The cost of goods sold for a merchandising company is calculated using the following formulae:
Formula (a) : Cost of Goods Sold = Cost of Goods - Ending Inventory available for sale
Formula (b) :
Cost of Goods available = for sale
Beginning Inventory
+ Net Purchase
Formula (c) :
Net Purchase
Gross Purchases Purchase return Purchase Freight + (Invoice Price) and allowances Discounts Inward
For a manufacturing concern, the calculation of cost of goods sold is an elaborate matter requiring quite a lot of information and it is normally associated with cost accounting and management accounting texts, rather than the financial accounting text like this. GROSS PROFIT Gross Profit, often called gross margin, is the first important sub-total on the income statement. It is the difference between sales revenue, which represents the selling price of the goods sold, and the goods cost to the business.
The gross profit must be sufficient to provide the business with the resources necessary to pay for operating expenses, financial expenses, and income tax expense, and of course to provide returns for the capital employed (owners and creditors). The amount of gross profit is a function both of quantity of goods sold and of the selling price exceeding the cost of goods sold per unit. Therefore, gross profit can be increased either by selling a larger quantity of goods sold at the same price or by selling the same quantity of goods for a higher price.
OPERATING EXPENSES Operating expense are the period expenses incurred in discharging the most important activities of the business i.e. selling goods or providing service. Since period expenses are related to the period rather than product (like the cost of goods sold which is a product expense), they are listed separately in the Income Statement. In addition, they are shown separately from other finance expenses like interest and even depreciation is shown separately rather than clubbing altogether with the operating expenses (see Exhibit 8.3). The operating expenses in the same format are classified as: administrative and selling expenses.
Administrative expenses are the costs associated with managing and administering the firms entire range of activities. The administrative expenses are to be shown as Schedule 15 of the Annual Report according to the format mandated by Companies Act 2053. The Schedule 15 (Exhibit 8.4) lists the expenses considered as administrative expenses by the said Act.
Selling expenses are those, which are incurred to create and stimulate demand and secure orders. Their aim is to push and promote sales either in the existing markets or new markets. Distribution expenses are the costs, which begin with the packaging the goods produced available for despatch and actual distribution expenses. However, in most enterprises, because of overlapping nature of the two functions, these are grouped together and known as selling and distribution expenses. The common items falling under selling and distribution overheads are as shown in Exhibit 2.2.
EXHIBIT 2.2 THE ADMINISTRATIVE EXPENSES Schedule 15 : Administrative Expenses Current Rs. A B C D E F G H I J K L M N O P Q R S T U V W X Y Z AA Salary, Wages and other expenses on Employees Contribution to Provident Fund & Gratuity Fund Rent Repairs and Maintenance Electricity, Fuel and Water Travel Transportation Office operation expenses Audit Fees Legal Fees Meeting Allowances (Board Meeting) Tax and Rates Bank Charges Discount Allowed Meeting Expenses (Ordinary) Fees and Commission Insurance Premium Communication (Postage, Telephone, Telex) Miscellaneous & Printing Advertisement Training Donations & Ad Books and Preiodicals Uniform Expenses Entertainment and Promotion Expenses Furniture & Equipments not capitalised Sundry Expenses Total Previous Rs.
INCOME FROM OPERATIONS Income from operations is another important sub-total. It is the amount that remains after adjusting the administrative, selling and distribution expenses of a business and indicates the level of profit produced by the principal activities of the firm. Income from operations can be increased by enhancing the gross profit or by reducing the operating expenses. Income from Operations must be enough to pay firms remaining expenses. The common Selling and Distribution expenses are as shown in Exhibit 2.3 below: EXHIBIT 2.3 THE SELLING AND DISTRIBUTION EXPENSES Current Rs. A B C. D. E. F. G. H. I. J. K. Advertising Carriage and transport outward Carriage and transport outward Catalogues, price lists etc. Running costs of delivery vans. Legal costs in connection with salesmen's agreements, etc. Market research expenses Packing materials Rent, rates, and insurance of warehouses. Rent, rates, maintenance, and insurance of showrooms and sales office. Salaries, commission, and travelling expenses of salesmen and technical representatives and sales manager. Selling department salaries and stationery Telephones and postage connected with selling. Wages of packers, deliveries van drivers etc. Warehouses expenses Wastage of finished goods. Previous Rs.
Selling and Distribution Expenses
L. M. N. O. P.
DEPRECIATION All businesses own some non-trading fixed assets like land, building, machinery, etc that are generally used for facilitating trading activities. Some of these fixed assets are directly productive [machinery] as they produce the trading assets like goods whereas
others only assist in production or trading [land, building]. However, both of these kinds of assets increase the revenue earning capacity of the business since they are solely purchased for permanent use and not for resale. These assets are not durable infinitely and hence, after a certain period, depending upon the nature of the asset, are reduced to scrap. In other words, each year the intrinsic value of the asset declines. This reduction in the value of the asset each year is a loss or an inherent expense due to having the asset and must be accounted for in the firms books. This loss/expense is literally termed as depreciation. Provision against this loss of capital is an essential cost for the business during the effective commercial life of the asset. FINANCIAL EXPENSES Financial expenses are the interest expense and other period expenses related to funds borrowed by the firm. Debt like Notes Payable, Bank Loans, Mortgages, or Bonds Payable, has become one of the very important elements of financing for any modern business firms. Debt has become apparently main thrust of the modern financing technique as an inexpensive source of capital.
Depreciation and Financial expenses are material information, which show the provision against the loss of value of assets and the amount of loan burden taken by the firm that is why they are shown as separate items in the Income Statement. INCOME FROM SUBSIDIARY One company acquires all or a majority of the equity shares of another company. By virtue of its voting powers, the acquiring company becomes the parent or holding company and the acquired company becomes the subsidiary company. The holding company controls the affairs of the subsidiary, as it is a part of the combined business. The profit earned by the subsidiary company is shared between the minority shareholders and the holding company. The income received (as the dividend revenue) from the subsidiary of a company needs to be disclosed as a separate item in the Income Statement of the holding company. OTHER INVESTMENT INCOME These are the interest revenue and other revenues related to funds loaned or invested by the firm. Many firms derive substantial revenue from investments and from interest on credit sales to customers.
GAINS AND LOSSES These are amounts of money made or lost on activities outside the normal business of a company. For example, Pepsi Co sells Pepsi products and makes money, which is called revenue. However, when it makes money by selling old delivery van, the amount is called a gain, not revenue, because Pepsis main business is not selling delivery vans. At the same time, losses are money lost; for example, loss incurred on sale of old furniture. LOSS OR GAIN FROM DISCONTINUED OPERATIONS The term discontinued operations is used to express the operations of a major business segment that has been sold, abandoned, or disposed off. After such a decision is made, the results of the discontinued segment are reported separately in the Income Statement including the costs of disposing the segment. The disposal of the discontinued operation could result into a net gain or loss depending upon the costs associated with the disposal decision. For the purpose, Segment, is that portion of the business, which constitutes (a) separate major line of business or (b) separate class of customer qualify for treatment as discontinued operations. EXTRA-ORDINARY INCOME OR LOSS Another category of items that must be reported separately from income from operations is the extra-ordinary income or loss. For accounting purposes, extra-ordinary items are defined as events or transactions that are: (a) unusual in nature and (b) infrequent in occurrence. Unusual in Nature: The event or transaction should posses a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to the ordinary and central operation of the entity, taking into account the environment in which the entity operates. Infrequent in occurrence: The event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates For example, a company suffering a large uninsured loss from an earthquake would report the loss as an extra-ordinary item.
INCOME TAX Income Tax expense is the sum total of all the income tax consequences of all transactions undertaken by a company during a particular year. The income tax expense is recognised in the periods in which the taxable income is earned. The Taxable income is computed in conformity with income tax regulations and not based on generally accepted accounting principles. NET INCOME OR NET LOSS The resultant figure calculated by matching the revenue and the expenses can be positive or negative. The positive figure denotes a net income and negative figure denotes a net loss. The Accounting equation discussed earlier can be re-drafted as follows:
Event Assets =
Balance Sheet Liability + Equity
Income Statement + Net Income - Revenue - Expenses)
After completing one operating cycle, the equity of a business shall be increased by any profit made and shall be decreased with any loss made. ILLUSTRATION- 1 The following information is provided to you for the year ending 31st March 2001 for Amrit Company Ltd: Administrative Expenses Beginning Inventory Depreciation Expenses Ending Inventory Extra-ordinary Income Freight Inward Income from Subsidiary 12,000 4,000 4,500 5,000 45,000 4,000 10,000
Income Tax Interest Expenses Loss from Discontinued Operations Other Business Income Other Investment Income Proposed Dividend Purchase Returns Purchases Sales Return and Allowances Sales Revenue Selling and Distribution Expenses
14,600 2,500 6,000 4,000 5,000 7,300 1,000 36,000 2,000 80,000 6,000
Required Prepare a multiple-step Income Statement Solution:
Calculation of Cost of Goods Sold: Beginning Inventory Add: Net Purchases (36,000 - 1000) Freight Inward 4,000 35,000 4,000 43,000 Less: Ending Inventory 5,000 38,000
Description
Amrit Company Ltd. Income Statement for the year ending 3/31/2001 Schedule No.
Current Yr. Rs 78,000 38,000 40,000 4,000 6,000 12,000 26,000 2,500 4,5000 10,000 5,000 6,000 45,000 73,000 14,600 58,400
Previous Yr. Rs
Sales Revenue (Net of returns and allowances) Cost of Goods Sold Gross Profit Add: Other business Income Less: Operating Expenses: Selling & Distribution Expenses Administrative Expenses Operating Profit Less: Interest Expenses Depreciation Expenses Add: Income from Subsidiary Other Investment Incomes Add/Less: Income or Loss from sale of assets Less Loss from discontinued operations Add: Extra-ordinary, Income or Loss Income before Tax Less: Income Tax Income after Tax Concept and Preparation of Balance Sheet
The balance sheet is also known as a sheet of balances. All accounts showing a debit balance are shown as assets and all accounts showing a credit balances are revealed as either a liability or as equity. The balances are shown in such a way that they are two lists, one showing all the assets, and another showing all the liabilities and the equity. The lists could be arranged side by side; with the assets on one side, and liabilities and equity on the other, (see Exhibit 2.4) or sequentially; with assets above the liabilities and equity see Exhibit 2.5. The balance sheet is a measurement of assets, liabilities, and equity of a business entity on a given date, which means that the reported assets are owned or are in control of the entity on that particular date and the same case also is applicable with reported claims against those assets, i.e. all liabilities and equity are effective on that only. Considering the importance of the date, it must be included as part of the heading of the Balance Sheet.
EXHIBIT 2.4: THE BALANCE SHEET (SIDE BY SIDE HORIZONTAL) Balance Sheet as on June, 30, 2001 Liabilities Capital Stock (7,800 shares of Rs. 100) Retained Earnings Total Equity Liabilities 10% Debentures Outstanding Interest Accounts Payable Total Liabilities Total Liabilities & Equity Amount 780,000 118,000 898,000 600,000 30,000 203,000 833,000 1,731,000 Total Assets 1,731,000 Amount Assets Land and Building (Net) Plants & Machinery (Net) Furniture (Net) Accounts Receivables Closing Stock Cash & Bank Amount Amount 861,00 306,000 54,000 175,000 250,000 35,000
EXHIBIT 2.5: THE BALANCE SHEET (SEQUENTIAL - VERTICAL) Balance Sheet as on June 30, 2001 Particulars Assets Land and Building (Net) Plant & Machinery (Net) Furniture (Net) Accounts Receivables Closing Stock Cash & Bank Total Assets Equity Capital Stock (7,800 shares of Rs. 100) Retained Earnings Total Equity Liabilities 10% Debentures Outstanding Interest Accounts Payable Total Liabilities Total Liabilities & Equity Amount Amount 861,000 306,000 54,000 175,000 250,000 35,000 1,731,000
780,000 118,000 898,000 600,000 30,000 203,000 833,000 1,731,000
FORMAT OF A BALANCE SHEET There are several formats of a Balance Sheet but the official pronouncement for use in Nepal is the one issued for the benefit of companies registered under Company Act 2053. To accompany section 84 of Companys Act, The Nepal Gazette has circulated a format dated 1st Jestha 2058, according to which the balance sheet should be drawn as shown in the following illustration: ILLUSTRATIVE PROBLEM 2 The following balances are provided to you: July 2002 Rs 650,000 Share Capital 198,000 Reserve Fund and Retained Profit 200,000 Long Term Loans: Secured 50,000 Unsecured July 2003 Rs 650,000 215,000 150,000 130,000 500,000 250,000 350,000 150,000 50,000 80,000 120,000 15,000 100,000 1,380,000 In the Current year Rs 50,000 is to be paid out of the Secured Loans
550,000 Long-term Assets 250,000 Investments 280,000 Inventory 120,000 Trade and Receivables 25,000 Cash and Bank Prepaid Expenses, Advances, Loans & 75,000 Deposits 110,000 Trade and other payables 12,000 Short-term Loans 80,000 Provisions
Required The Balance Sheet. SOLUTION Gurung & Pun Co. Ltd. Balance Sheet as on 31 - Jul - 03
Description Capital and Liabilities Capital and Reserve Fund Share Capital Reserve Fund and Retained Profit Medium and Long-term Loan Secured Unsecured Grand Total Assets Long-term Assets Investments Current Assets Inventory Trade and Receivables Cash and Bank Prepaid Expenses, Advances, Loans & Deposits Total Less Current Liabilities and Provisions Current Liabilities Trade another payables Short-term Loans Long-term Loans payable in Current Year Provisions Total Net Current Assets Unamortized Expenses Grand Total Contingent Liabilities Main Accounting policies and notes Schedule No. 2003 Rs. 2002 Rs
1 2 3
650,000 215,000 100,000 130,000 1,095,000
650,000 198,000 200,000 50,000 10,098,000 550,000 250,000 280,000 120,000 25,000 75,000 500,000
4 5 6 7 8 9
500,000 250,000 350,000 150,000 50,000 80,000 630,000
10 120,000 15,000 50,000 100,000 285,000 345,000 12 1,095,000 13 14 1,098,000 110,000 12,000 80,000 202,000 298,000
11
Preparation of Income Statement and Balance Sheet using a Work Sheet Work sheet is a schedule of data showing the relationship among (1) adjusting entries, (2) adjusted trial balance, and (3) financial statements. It allows the accountants to assemble all the ledger account balances and adjustment information, all in one place. Work sheet is also known as Extended Trial Balance (ETB). This terminology is quite popular in the British accounting literature. FORMAT OF A WORK SHEET The following is the format of a Worksheet. PART 1 Trial Balance Dr Cr Part 2 Adjustme nts Dr Cr Part 3 Adjusted Trial Balance Dr Cr Part 4 Income Statement Dr Cr Part 5 Balance Sheet Dr Cr
Part 1: Part 2: Part 3: Part 4: Part 5:
It is the unadjusted Trial Balance part. It is adjusting entries part. Two extra columns are provided to write the reference numbers. It is the adjusted Trial Balance part. It is the Income Statement part, where items taken to the Income Statement are recorded. It contains the data for preparing the Balance Sheet.
THE PROCEDURE OF WORK SHEET The preparation of a work sheet involves four basic steps, which are as follows: STEP 1: ENTER THE LEDGER ACCOUNT BALANCES IN THE UNADJUSTED TRIAL BALANCE SECTION (PART 1) Enter all the ledger balances classified as Balance Sheet Items and Income Statement Items leaving few lines blank immediately below the last items listed from the unadjusted Trial Balance which are used to add more accounts created during adjusting process.
STEP 2: ENTER THE ADJUSTMENTS IN THE ADJUSTMENT COLUMNS (PART 2) The next step is to enter the adjustments in the Adjustment columns numbering each adjustment. Use the space on the left to add new accounts created by the adjusting process (Use different ink colour to differentiate the account heads in the Unadjusted Trial Balance and new accounts created). STEP 3: PREPARE THE ADJUSTED TRIAL BALANCE The original balances in the Unadjusted Trial Balance are adjusted for the debit and credit amounts in the adjustment column. Debit is added to a debit and credit is subtracted, and vice-versa. The Adjusted Trial Balance is totalled to check its agreement. STEP 4: TOTAL THE INCOME STATEMENT AND BALANCE SHEET The next step is to transfer the Income Statement and Balance Sheet items to their respective columns. After transferring the respective items, the Income Statement, and Balance Sheet columns are added. Unless there is a situation of no profit or no loss situation, the debit and credit total will not agree. However, each set of the columns should be out of balance with the same amount and that is the net income or net loss. The amount needs to be inserted in both the two sections to make the same total for respective sections. STEP 5: SHOW THE ADJUSTMENTS FROM THE AVAIBLE PROFIT The final step is to show the appropriations out of profit like creation of proposed dividend, transfer to reserves etc. (See Illustration 4) Illustrative Problem 3: The following unadjusted trial balance is provided to you: Account Heads Cash Accounts Receivable Supplies Prepaid Insurance Land Building Accumulated Depreciation Dr 25,000 7,000 2,000 3,000 51,500 40,000 2,000 Cr
Plant Accumulated Depreciation Notes Payable Accounts Payable Unearned Rent Share Capital Retained Earnings Dividends Service Revenue Advertising Wages Supplies Exp Depreciation Exp (Building) Depreciation Exp (Plant) Utility Expenses Insurance Exp Interest Exp
40,000 1,000 30,000 4,000 6,000 60,000 20,000 15,000 160,000 4,000 50,000 6,000 1,500 2,000 18,000 15,000 3,000 283,000 283,000
Adjustments: a. Service revenue earned but not yet billed Rs 1,000 b. Supplies consumed during the year Rs 500 c. Half of the un-earned rent is earned during the year d. One-third of un-expired Insurance has expired during the period e. Unpaid wages during the period is Rs 2000 f. Interest due is Rs 500 g. Income Tax is 30% of Net Income for the year Required: 1. 2. Work Sheet Income Statement
3.
Balance Sheet
Part 1 Trail Balance Dr. Cr. Part 2 Adjustments Dr Cr Part 3 Adjusted Trail Dr Cr Part 4 Income Statement Dr Cr Part 5 Balance Sheet Dr Cr 1 25,000 7,000 2,000 3,000 51,500 40,000 2,000 40,000 1,000 30,000 4,000 6,000 60,000 20,000 15,000 h 15000 h e f 15,000 2,000 500 15,000 2,000 500 2,000 500 c 3,000 40,000 1,000 30,000 4,000 3,000 60,000 5,000 a 1,000 b d 500 1000 25,000 8,000 1,500 2,000 51,500 40,000 2,000 40,000 2000 1,000 30,000 3,000 60,000 5,000 25,000 8,000 1,500 2,000 51,500 40,000 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 160,000 4,000 50,000 6,000 1,500 2,000 18,000 15,000 3,000 283,000 283,000 c 23,000 3,000 23,000 103,500 60,500 g 18,150 g 18,150 42,350 41,150 41,150 289,650 289,650 164,000 164,000 18,150 18,150 18,150 42,350 168,000 168,000 3,000 164,000 d f 1000 500 a b 2,000 500 a 1000 4,000 52,000 6,500 1,500 2,000 18,000 16,000 3,500 161,000 4,000 52,000 6,500 1,500 2,000 18,000 16,000 3,500 161,000 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Balance Sheet Cash A Receivable Supplies Prepaid Insurance Land Building Ac. DepreciationBldg Plant Ac. DepreciationPlant Notes Payable Acc Payable Unearned Rent Share Capital Retained Earnings Dividends Wages Payable Interest Payable INCOME STATEMENT Service Revenue Advertising Wages Supplies Expenses Dap Expenses (Blg) Dep. Expenses (Plant) Utility Expenses Insurance Expenses Interest Expenses
Rent Revenue Totals Net Income before Tax Income Tax Expense Income Tax Payable Net Income After Tax Totals
An additional entry for transfer of dividends to retained earnings is made as (h). Income Statement for the year ending ___________ Description Service Revenue Add: Rent revenue Less: Operating Expenses: Selling & distribution Expenses Administrative Expenses Operating Profit Less: Interest Expenses Depreciation Expenses Add: Income from Subsidiary Other Investment Incomes Add/Les Income or Loss sale of s: assets Less Loss from discontinued operations Add: Extra-ordinary Income or Loss Income before Tax Less: Income Tax Income after Tax Sched ule No. Current Yr. Rs. 161,000 3,000 164,000 4,000 15 92,500 67,500 3,500 3,500 Previous Yr. Rs.
60,500 18,150 42,350
Schedule 15 : Administrative Expenses Rs A B C D Wages Utility Expenses Supply Expenses Insurance Total 52,000 18,000 6,500 16,000 92,500
Balance Sheet BALANCE SHEET Description Schedule No. Capital and Liabilities Capital and Reserve Fund Share Capital Reserve Fund and Retained Profit Medium and Long-term Loan Secured Unsecured-Notes Payable Grand Total Assets Long-term Assets Investments Current Assets Inventory Trade and Receivables Cash and Bank Prepaid Expenses, Advances, Loans & Deposits Total Less: Current Liabilities and Provisions Current Liabilities Trade and other payables Unearned Revenues Long-term Loans payable in Current Year Provisions Total Net Current Assets Unamortized Expenses Grand Total Contingent Liabilities Main accounting polices and notes 2003 Rs. 2002 Rs.
1 2 3
60,000 47,350
30,000 137,350 4 5 6 7 8 9 1,500
1,500 8,000 25,000 2,000 36,500
10 6,500 3,000
11
18,150 27,650 8,850
12 137,350 13 14
Illustrative Problem 4: The following unadjusted trial balance is provided to you of ABC Co. as on 30th Chaitra 2063 Dr Cr Stock 1.1.2063 Purchase Fuel, Power Building Salaries Machinery Debtors Cash at Bank Wages Carriage Outward Investment Rent Stationery Goodwill Interest on Debenture 30,000 Sales 550,000 Share Capital 5,000 Creditors 200,000 Reserve Fund 10,000 P/L Appropriation A/c 200,000 6% Debentures 100,000 25,000 20,000 5,000 200,000 10,000 20,000 20,000 5,000 1,400,000 Additional information: a) b) c) d) e) f) g) h) i) Required: Stock on 30th Chaitra 2063 was of Rs 30,000 Depreciation on Building at 5% Depreciation on Machinery at 10% Provision for doubtful debts to be maintained at 5% on sundry debtors Outstanding Salary was Rs 2,000 Wages was prepaid of Rs 3,000 Directors decided to pay 10% dividend on paid up capital Transfer Rs 10,000 to Reserve fund out of profit. Debenture interest is due Work Sheet Income Statement Balance Sheet 1,400,000 800,000 450,000 10,000 20,000 20,000 100,000
Work Sheet For the Year Ended December 30 Chaitra 2063

Account Unadjusted Trial Balance Debit Building Machinery Debtors Cash at Bank Investment Goodwill Share Capital Creditors Reserve Fund 6% Debentures P/L Appropriation A/C Stock 1.1.2063 Purchase Fuel, Power Salaries Wages Carriage Outward Rent Stationary Interest on Debenture Sales Total Closing Stock Depreciation Exp-Building
Depreciation Exp.- Machinery
Adjustments Debit Credit b. 10,000 c. 20,000
Adjusted Trial Balance Debit 190,000 180,000 100,000 23,000 200,000 20,000 430,000 10,000 20,000 30,000 100,000 20,000 Credit
Income Statement Debit Credit
Balance Sheet Debit 190,000 180,000 100,000 23,000 200,000 20,000 430,000 10,000 20,000 100,000 20,000 Credit
Credit
200,000 200,000 100,000 23,000 200,000 20,000 430,000 10,000 20,000 100,000 20,000 30,000 330,000 3,000 10,000 20,000 3,000 10,000 20,000 3,000 800,000 1,400,000 1,400,000 a. 30,000 b. 10,000 c. 20,000 d. 3,000 e. 2,000
30,000 320,000 3,000 12,000 17,000
a. 30,000
320,000 3,000 12,000
f. 3,000
17,000 3,000 10,000 20,000 3,000 30,000 10,000 20,000 3,000 800,000
3,000 10,000 20,000 3,000 800,000 30,000 10,000 20,000 3,000
Bad Debt Expense Bad Debt Provision Outstanding Salary Prepaid Wages Debenture Interest Outstanding Interest Net Income Total P/L Appropriation A/C Proposed Dividend Reserve Fund Total
d. 3,000 e. 2,000 f. i. 3,000 1,000 i. 1,000 3,000 1,000
3,000 2,000 3,000 1,000 1,000 660,000 800,000
3,000 2,000
1,000 140,000 140,000 800,000 800,000 748,000 748,000 140,000 83,000 43,000 10,000
71,000 g. 43,000 h. 10,000
71,000 1,405,000 1,408,000 43,000 10,000 g. 43,000 43,000 h. 10,000 10,000
Please Note: 1. Whenever there are balances in the Profit and Loss Account, and Reserves, carry them directly to the Balance Sheet from the Work Sheet and make additions or deductions there. 2. The simpler method to handle closing stock of inventory is to adjust with the purchases and prepare a schedule of cost of goods sold while preparing the Income Statement. Income Statement for the year ending 12/30/2063 Description Sales Revenue Cost of Goods Sold Gross Profit Add: Other business Income Less: Operating Expenses: Selling & Distribution Expenses Administrative Expenses Operating Profit Less: Interest Expenses Depreciation Expenses Add: Income from Subsidiary Other Investment Incomes Add/Less: Income or Loss from sale of assets Less Loss from discontinued operations Add/Less: Extra-ordinary Income or Loss Income before Tax Less: Income Tax Income after Tax Less: Distributions of Net Income a. General Reserve b. Proposed Dividend: Preference Shares Ordinary Shares c. Other Reserves Net Income transferred to Balance Sheet Schedu le No. Current Yr. Rs. 800,000 572,000 228,000 Previous Yr. Rs
15
10,000 42,000 176,000 6,000 30,000
140,000 140,000 10,000
45,000 55,000 85,000
BALANCE SHEET Description Schedule No. Capital and Liabilities Capital and Reserve Fund Share Capital Reserve Fund and Retained Profit Medium and Long-term Loan Secured Unsecured-Notes Payable Grand Total Assets Long-term Assets Investments Current Assets Inventory Trade and Receivables Cash and Bank Prepaid Expenses, Advances, Loans & Deposits Total Less: Current Liabilities and Provisions Current Liabilities Trade and other payables Unearned Revenues Long-term Loans payable in Current Year Provisions Total Net Current Assets Unamortized Expenses Grand Total Contingent Liabilities Main accounting polices and notes
2063 Rs.
2062 Rs.
1 2 3
450,000 135,000 101,000 686,000
4 5 6 7 8 9
390,000 200,000 30,000 95,000 25,000 3,000 153,000
10 12,000
11
45,000 57,000 96,000
12 686,000 13 14
Illustration The trial balance of Ganapati Trading Co. Ltd. on Chaitra 30 is as follows: Particulars Opening Stock Purchases Furniture and Fixtures Rent Plant and Machinery Wages Interim Dividend Salaries Sundry Expenses Dividend for last year Debtors Chas and Bank Rs 90,000 3,90,000 34,000 8,000 1,58,000 60,000 2,000 19,000 14,000 18,000 1,25,000 97,000 10,15,000 Additional information: a. Make a provision for income tax Rs. 50,000 b. Depreciate plant by 10% c. Outstanding: Rent Rs. 2,000 and Salaries Rs. 1,000 d. The directors proposed a divident@15% per annum and provided the transfer to general reserve Rs. 3,000 Required: Work Sheet. 10,15,000 Sales Discount Profit and Loss Account Share Capital General Reserve Creditors Particulars Rs. 6,79,000 6,000 44,000 2,00,000 51,000 35,000
page 2
EVALUATION SCHEME: The competency achieved by a student in this Unit will be evaluated on the following basis: No. of Questions 1 2 Problem Solving type of questions based on preparation of an Income Statement and Balance Sheet in a Vertical format using a Work Sheet 20 Marks Type of Question Marks
2 Questions Problem The trial of a trader, at the end of Chaitra, 20xx was as under: Account Titles Dr. (Rs.) Capital Account Bank Loan Sundry Creditors Sales Purchase Return Provision for Doubtful Debts Discount & Commission Opening Stock 24,000 Plant & Machinery 70,000 Furniture 32,000 Sundry Debtors 64,000 Cash at Bank 36,000 Purchases 1,60,000 Wages & Other Direct Expenses 28,000 20,000 Office Salaries Bad Debts 1,000 General Expenses 2,000 Insurance Premium 2,000 Office Rent 16,000 4,55,000 Adjustments: (a) Plant & furniture are to be depreciated by 10% each. (b) Provision for doubtful debt is to be maintained at 5%. (c) Office salaries to be paid Rs. 5,000. (d) Closing stock was valued at Rs. 32,000. Required: (i) 10 column work sheet. (ii) Income statement. (iii) Balance Sheet.
Cr. (Rs.) 1,20,000 4,000 32,000 2,50,000 8,000 2,000 3,000
4,55,000
Problem Birat Shoe Repair shows the following account balance as December 31, 20x5: Account Titles Balance (Rs.) Cash 8,000 Supplies 1,000 Prepaid Insurance 1,800 Equipment 25,000 Accumulated Depreciation: Equipment 4,000 Accounts Payable 8,000 Capital 22,000 Drawing 2,000 Revenue from Service 65,000 Rent Paid 8,000 Salaries Paid 51,000 Utilities Expenses 2,200 Adjustments: (a) Supplies on hand Rs. 700. (b) Insurance expired Rs. 600. (c) Depreciation on equipment Rs. 2,000. (d) Salaries unpaid Rs. 2,000. Required: (i) Work sheet. (ii) Adjusting entries. (iii) Income Statement (iv) Balance Sheet. Problem The balance on the books of the Bright star Co. Ltd. after closing the Trading account as on 31st. Chaitra are as follows: Particulars Debit (Rs.) Credit (Rs.) Equity Share Capital 8,00,000 10% Preference Share Capital 4,00,000 4,00,000 Machinery and Plant 7,00,000 Land and Building Divided Equilisation Reserve 20,000 4,00,000 Investment in Shares Stock 1,40,000 Cash at Bank 1,20,000 Accounts Receivable 1,00,000 Profit and Loss Account 50,000 Accounts Payable 60,000 Establishment Expenses 30,000 Rent and Taxes 12,000 5,000 Audit Fees 24,000 Managing Director's Remuneration Director's Fees 12,000 Sundry Expenses 4,000
Dividend Received Miscellaneous Receipt Trading Accounts Balance Income Tax for Previous Year
15,600 5,600 6,08,800 12,000 19,59,000
19,59,000 Additional Information: (a) Depreciation is to be charged on the written down value of plant at 10% and land and building at 5%. (b) The directors propose to recommend a divided of 15% on equity shares. (c) Provision for taxation is to be made of 55%. (d) The Managing Director is entitled to pay Rs. 24,550 per annum as commission. (e) A sum of Rs. 30,000 is to be transferred to dividend equilisation reserve. Required: (i) Profit and Loss Account (ii) Profit and Loss Appropriation Account. (iii) balance Sheet. Problem Trial Balance Of Aarshiya & Co. For the year ended 31 Chaitra 2062 Amount Particulars 57,000 Sales 2,00,000 Subsidies Received 40,000 Provision for baddebts 18,000 General Reserve 25,000 P/L Appropriation A/C 15,000 Interest and Dividend 5,000 Share Capital 3,50,000 Advance Commission 75,000 Creditors 5,000 1,20,000 10,000 6,000 10,000 30,000 4,000 12,000 22,000 60,000 40,000 11,04,000
Dr. Particulars Cash in hand machineries Wages Rent Salaries Prepaid Insurance Baddebts Purchase Opening Stock Sales Return Leasehold Factory Loose Tools Legal Charge Trade Expenses Goodwill Repairs and Renewals Coal, Gas & Water Store Consumed Sundry Debtors Fixed Deposit
Cr. Amount 5,10,000 25,000 7,000 25,000 32,000 10,000 4,50,000 30,000 15,000
11,04,000
Problem The Trial Balance of A Company on 31st, Chairtra, Last year is as under: Debit Rs. Credit Beginning Stock 50,000 Share Capital, Purchases 6,60,000 Rs. 1000 each Building 3,00,000 Creditors Machinery 50,000 Profit and Loss Investment 2,00,000 Appropriation Account Carriage 30,000 Sales Salaries 50,000 1,00,000 Debtors 20,000 Cash at Bank Wages 40,000 15,00,000
Rs. 5,00,000 60,000 40,000 9,00,000
15,00,000
Additional information: (i) Provide depreciation on building at 10% and Machinery at 5%. (ii) Provision for doubtful debt is to be made at 5% on sundry debtors. (iii) Outstanding salaries Rs. 5,5000. (iv) Stock at end Rs. 60,00.0. (v) the directors proposed 10% dividend on share capital. Required: (a) Trading Account (b) Profit and Loss Account (c) Profit and Loss Appropriation Account. (d) Balance Sheet as on Chaitra 31st, last year. Problem: The Trial Balance of a company as on 31st Chaitra, last year is given below: Particulars Debit (Rs.) Credit (Rs.) Share Capital 3,00,000 Revenue 8,00,000 Bank Loan 2,50,000 Creditors 50,000 Cash in Hand 40,000 Debtors 60,000 Fixed Assets 7,00,000 Administrative Expenses 2,00,000 Salaries 2,50,000 Other Expenses 1,50,000 Total 14,00,000 14,00,000 Additional information: (i) Provide depreciation@ 10% p.a. on Fixed assets. (ii) Salaries payable Rs. 10,000. Required: (a) Journal entries for adjustment. (b) Work Sheet
Problem The following is the trial balance of ABC Co. on 30th Chaitra Particulars Stock Opening Purchases Interim Dividend Building Salaries Machinery Debtors Cash at Bank Wages Insurance Investment Rent Stationery Goodwill Interest on Debenture Dr. Rs. 30,000 6,50,000 5,000 2,00,000 10,000 2,00,000 1,00,000 25,000 20,000 5,000 2,00,000 10,000 20,000 20,000 5,000 15,00,000 Particulars Sales Share Capital Creditors General Reserve Profit and Loss Appropriation Account 5% Debentures Cr. Rs. 9,00,000 4,50,000 10,000 20,000 20,000 1,00,000
15,000,00
Additional information: (i) Stock on 30th Chaitra was of Rs. 30,000 (ii) Provide depreciation on building at 5% and machinery at 10% and provision for doubtful debts to be maintained at 5% on sundry debtors. (iii) Outstanding salary was Rs. 1,000 and insurance were prepaid of Rs. 3,000 (iv) The directors decided to pay 10% dividend on paid up capital and transfer Rs. 5,000 to the reserve found out of profit. Required: (i) Work Sheet (ii) Income Statement (iii) Balance Sheet. KEY TERMS USED IN THE UNIT: Accounting Period Assumption Administrative Expenses Cost of Goods Sold Depreciation Expense Extra-Ordinary Income or Loss Financial Expenses
Gain or Loss From Discontinued Operation Gross Profit Income from Operations Income from Subsidiary Income Statement Income Tax Interest Revenue Matching Principle Multiple Step Income Statement Net Income (Loss) Operating Expenses Revenue Revenue Principle Sales Revenue Selling & Distribution Expenses Service Revenue Single Step Income Statement Unearned Revenue
Chapter-3
FINANCIAL STATEMENT ANALYSIS

A. Introduction
Financial statement includes trading, Profit and Loss Account and Balance Sheet. These accounts and statement are prepared at the end of accounting period. These accounts and statement provide a summarized view of the operation of a firm. They contains only quantitative aspects of the transaction but not the qualitative. Those financial statements cannot judge the financial health, profitability performance and solvency position of the enterprise. Therefore the analysis of financial statement is required to fulfill these objectives. This unit is related with the analysis of financial statement. It includes the concept, importance and limitation of financial statement on one hand and on the other it also includes the Ratio Analysis & funds flow statement.
B.
Objective
The objective of the unit is to outline the rationale and nature of analysis of the financial statement. After completing the unit, the student would be able to: i) ii) iii) Understand the meaning, importance and limitation of financial statement Define and calculate importance ratios Prepare funds flow statement.
C.
Specification of Content Area of the unit This unit includes the following sub-units: 3.1 3.2 3.3 Financial statement Ratio Analysis Statement of changes in financial Position
D.
Description of Content Area of the unit
3.1 Financial statement

3.1.1 Concept The organized Summary of detailed information about financial position and the performance of the concern is known as Financial statement. The financial statements are prepared at the end of accounting period . The financial Statement includes profit and Loss Account or Income Statement and Balance Sheet . The Income statement may include Trading Account and Manufacturing Account. 3.1.2 Features of Financial Statement i) ii) iii) Financial Statement are historical in nature and relate to the past period. Financial Statement are expressed in financial of monetary terms. Financial Statement indicate the financial position of a business.
3.1.3 Contents of Financial Statement Financial Statement refers to two statements. Those are: i) ii) Income Statement Balance Sheet
The students are familiar with the contents and preparation of financial statement, which they have studied in Final Accounts of a company. Besides they also have the knowledge about the classification of Assets and Liabilities therefore these items are not explained here. 3.1.4 i) ii) iii) 3.1.5 Importance The valuable information for decision making are provided by Financial statement It also provide information relating to profitability and operating cost. The financial statement shows true, clear and fair picture of the organization.
Limitations Limitation of Financial statement are: Contain only quantitative but not the qualitative information. Includes valueless assets such as goodwill, preliminary expenses, patent, discount on issue of shares and debentures, etc.
Because of historical account it cannot represent the true position to date Management may be biased and feed manipulated information to prove its point of view. Can show the financial problems and operational inefficiency, but it cannot suggest definite remedies.
3.1.6
Concept of financial statement Analysis In order to make financial statement more meaningful, analysis of financial statement is made. A systematic process of analyzing and evaluating the relationship between the component parts of financial statement is known as financial statement Analysis. Analysis of financial statement is to classify the complex data in a convenient way and to present the information of financial statement in rational groups.
3.1.7
Patties interested in financial Statement Analysis Generally the following parties are interested in analysis of financial statement:
Users 1. Short-term creditors 2. Long term creditors 3. Present shareholders 4. Potential Shareholders 5. Management 6. Works
Purpose of Analysis To determine whether the amount owing to them will be paid when due. To determine whether their principal and the interest thereon will be paid when due. To decide whether they should buy, hold or sell the shares. To decide whether they should buy the shares. To evaluate the solvency, profitability & efficiency of the business enterprise. To evaluate their stability of employment & their remuneration which depends upon the earning capacity of the business. To determine the tax liability
7. Government 3.1.8
Objectives of Financial Statement Analysis Following are the main objectives of Financial Statement Analysis: i) ii) To know the profitability of the business To know the security & solvency of the business
iii) iv) v) vi) vii) 3.1.9
To know the trend of business, sales, purchases, profit and earning Capacity, etc To ascertain the financial strength and soundness of the business. To judge the efficiency of management. To compare financial & operating efficiency of different organizations. To help a great deal in forecasting for the future.
Limitation of Financial Statement Analysis The limitations are: i) Financial analysis is based on financial statement. Hence the limitation of financial statement such as influence of accounting concept, personal, Judgement disclosure of monetary facts, etc are also the limitation of financial statement analysis. Financial analysis fails to disclose current worth of the enterprise. Tools and technique of Financial Analysis Financial analysis are dine by using following techniques: a) Ratio Analysis b) Statement of change in financial position c) Cash flow analysis
ii) 3.1.10
3.2
3.2.1
Ratio Analysis
Concept
An arithmetical relationship between two accounting figures is known as Ratio. It is computed by dividing one item of relationship with the other. Ratio simply means one number expressed in terms of another. Ratio analysis is a technique of analysis and interpretation of financial statement . The evaluation of performances of an organization by creating the ratios from the different accounting figures consisting in Income statement and the Balance Sheet is Known as Ratio Analysis. Ratio analysis involves the following steps:
i) ii) iii)
iv)
Creating relationship between the relevant accounting figures of financial statement according to the objective of the analysis. Calculation of ratio of the data. Comparison of calculated ratios with: a) Ratio of the same concern (firm) over the periods in the past. b) The ratios developed from the projected financed statement. c) The ratios of other firms to which the firm belongs. d) The ratios of industry in average. Interpretation of Ratios.
3.2.2 Importance and advantages The following are the main advantages of Ratio Analysis" i) helps in communicating financial information in a meaningful manner and also incenses the value of financial statement: ii) useful for making decision on any financial activity iii) useful for simple assessment of liquidity, profitability, solvency and efficiency of the firm. iv) Helps management in evolving future 'market strategies'. v) Helps in co-ordination. 3.2.3 Limitation of Ratio Analysis The following are the some limitations of Ratio Analysis: i) It is a means not an end. ii) Incorrect data gives false ratios. iii) Without adjustment for price level changes, Ratio analysis may not be correct. iv) Ratio calculated from the past year data may not be helpful in forecasting. v) Ratio may not be comparable where different firms follow different account policies. vi) Ratios based on past financial statement are not an indications of future. 3.2.4 i) Calculation of Ratios Current Ratio: A relation between current assets and current liability is known as current Ratio. The formula for this Ratio is: Current assets Current ratio = ------------------Current liabilities
ii)
Quick ratio or Liquid or Acid-test ratio: The over all assets contained in current assets are not convertible into cash and cash equivalent in short period of time or in short notice. Therefore a relation of easily convertible current asset is developed to examine the urgency of liquidity, which is known as quick ratio. A relation between quick assets and current Liabilities is termed as quick Ratio. Quick assets is also termed as liquid assets and it includes all current assets other than stock and prepaid expenses. The formula for this ratio is: Quick assets Quick ratio = -------------------Current liabilities
Illustration: The following current assets and current liabilities are given to you: Current Liabilities: Accounts Payable Rs. 1,00,000 Tax liabilities Outstanding wages Current assets: stock in hand Account Receivable Bills receivable Cash at bank Prepaid insurance Rs. 40,000 Rs. 20,000 Rs. 1,50,000 Rs. 80,000 Rs. 1,20,000 Rs.40,000 Rs.10,000
Calculate i. Current ratio ii. Quick ratio Solution: Current assets Current = ---------------Current liabilities Stock in hand + account receivable + bills receivable + cash at bank + prepaid Insurance = -------------------------------------------------------------------------------------accounts payable + tax liabilities+ outstanding wages
4,00,000 =------------1,60,000 = 2.5:1 Quick assets Quick ratio= -------------Current liabilities Account receivable + bills receivable + cash at bank = -----------------------------------------------------------account payable +tax liabilities + outstanding wages 2,40,000 ----------1,60,000
= 1.5:1 Thought the interpretation of the result in a topic, is out of the syllabus, but the teacher should provide (through) some light about the desirability of the different ratios in order to enlighten the knowledge of the student. For example: A minimum of 2.1 in course of current ratio and 1.1 in course of quick ratio are desirable for the sound financial health of a firm. iii) Debt- equity Ratio: The relationship between borrowed fund and owner's equity is Debt-equity Ratio. It is calculated as follows: Long term debt Debt-equity Ratio = --------------------Shareholders equity Alt. Formula: Total debt Debt-equity = ---------------Shareholders equity [Total Debt = Long term liabilities+ current liabilities]
iv)
Debt to total capital ratio: It is a relationship between long term debt and the total capital. Total capital includes owner's equity as well as borrowed capital. It is calculated in following way" Long term debt Debt to total capital ratio = ___________ Total capital
Or,
total debt -----------------------total capital + currant liabilities total debt -----------------total net Tangible assets
Or,
Illustration: Following is the Balance sheet of ABC Ltd. As on 31st , December, 1998: Liabilities Equity share capital Reserve for contingencies 10% debentures Outstand interest on debentures general reserve account payable bills payable 1,50,000 1,50,000 7,500 1,50,000 1,00,000 42,500 9,00,000 9,00,000 Rs. 3,00,000 Assets Fixed assets Current Rs. 6,00,000 3,00,000
Required. i. Debt-equity ratio ii. Debt to total capital ratio Solution: i) Long term loan Debt- equity ratio = ----------------------Shareholder's equity
= Reverse
10% debenture ------------------------Equity share capital + Reserve + Reserve for contingencies + Gen.
1,50,000 = ----------6,00,000 = 0.25 or 25 Long term debt ii) Debt to total capital ratio = --------------------Total capital 10% debenture = ---------------------------------------Shareholder's equity + long term debt 1,50,000 = ------------7,50,000 = 0.20 or 20% [Outstanding interest on debenture is not a long term liability] v) Inventory turnover ratio or stock turnover ratio: It is computed by dividing the cost of goods sold by the average inventory for the period. It is calculated as follows:
Cost of goods sold Inventory turnover ratio = ----------------------------Average inventory Cost of goods sold = net sales gross profit Or = Opening stock + Purchases closing stock direct expenses (wages, carriage, etc.) opening stock + closing stock Average inventory = --------------------------------------2 Net Sales = Sales- Return inward
Alternatively , if gross profit and opening stock are not known , it is calculated in following way. Sales Inventory turnover = --------------------Closing inventory vi) Debtors turnover or Receivable turnover : It indicate the velocity of debt collection of a firm. It is computed as follows: Credit sale Debtors turnover = -----------------Average debtors Opening debtors + closing debtors Average debtors = ---------------------------------------------2 It the information about opening and closing balance of debtor and credit sale is not available, it can be calculated in following way: Debtors turnover Total sales = -----------------Debtors
vii)
Average collection period: It represents the average numbers of days for collecting from debtors. It is also turned as debt collection period. The formula for finding out average collection period are: a) By using Debtors Turnover Radio Days in year Average collection period = ---------------------Debtors turnover b) Without using Debit Turnover Ratio: Debtor x Days in year Average collection period = --------------------Sales c) By using sales per day: Debtors Average collection period = -----------------Sales per day Net credit sales Sales per day = --------------------Days in year The answer in all above cases would be in the form of number of days.
viii)
Fixed assets Turnover Ratio: A relationship between sales and fixed assets is know as fixed assets turnover ratio. It shows the efficiency of utilizing fixed assets. It is calculated as follows.
Sales Fixed assets Turnover = ------------Net fixed assets ix) Total Assets Turnover Ratio: This ratios establishes a relationship between net sales and total assets. The total assets includes current assets, fixed assets and intangible assets But it should not included fictitious assets. Those assets which have no physical existence is know as intangible assets: goodwill, copyright, patents, etc. are the example of fictitious assets. Fictitious assets refers to deferred expenditures and debit balance of profit and Loss Account. The formula for computing Total Assets Turnover is: Sales Total Assets Turnover ratio = -----------------Total Assets Capital Employed turnover Ratio : this ratio indicates the relationship between sales and capital employed. It is a measure of efficiency of the capital employed in the business. The following formula is used for calculation of this ratio: Sales Capital Employed Turnover = -----------------------Capital employed Capital employed or Total Capital = Shareholder's equity + Long term liabilities xi) Gross profit Margin: this ratio expresses the relationship between gross profit margin and sales It is an indication of general profitability of the concern. It is calculated as under. Gross profit Gross profit Ratio = -----------------Sales Net profit Margin : The overall profitability of the firm is measured by Net profit Margin. It is a relationship between Net profit & sales. The formula calculating Net Profit Margin is: Net Profit Net profit Ratio = ------------Sales
x)
xii)
xiii)
Return on assets: The profitability is measured in terns of the relationship between net profit and assets in the ratio: The alternative formula for calculating this ratio are:
Net profit after tax Return on assets = ----------------Total assets Net profit after tax preference dividend Return on assets = -------------------------------------------------Total assets Net Profit after tax + Interest Return on assets = -----------------------------Total assets Net profit after tax preference dividend Return on assets = --------------------------------------------------Total tangible assets xiv) Return on Shareholder's equity : This ratio measures a relationship between Net profit after tax and shareholder's fund. Shareholder' fund includes equity share capital preference share capital, reserve and surplus, reserve reserve fund , general reserve capital reserve, share premium retained earning. The fictitious assets should be deducted from total shareholder's equity for finding out the ratio. Thus, Net profit after tax Return in Shareholder's equity = -----------------------------Shareholder's equity xv) Earning per share: The earning of a company at per share basis is determined by earning per share. The formula for calculating this ratio is:
Net profit after tax pref. Dividend Earning per share = -------------------------------No. of equity shares xvi) Dividend per share: The entire amount of earning may or may not be distributed by a company. This ratio measure the dividend distributed among the equity shareholders on a per share basis. Formula for this: Earning paid Dividend per share = -----------------No. of equity shares
Illustration 1 Following is the Balance Sheet of A Co. Ltd. As at, Chaitra, Last Year:
Liabilities Share capital 12% Debentures Sundry creditors Bank overdraft Bills payable Reserve and Surplus
Rs. 2,00,000 80,000 60,000 10,000 10,000 40,000 4,00,000
Assets Plant & Machinery Furniture & fixture Investment Inventory Sundry debtors Cash & Bank Balance
Rs. 1,80,000 40,000 80,000 32,000 60,000 8,000 4,00,000
Required: i) ii) iii) iv) Current Ratio Quick Ratio Debt-equity Ratio Debt to total capital Ratio
Solution: i) Current assets Current Ratio = --------------------Current liabilities Inventory + sundry debtors + cash & bank balance = ----------------------------------------------------------sundry creditors + bank overdraft +bills payable 32,000 +60,000 +8,000 = ---------------------------60,000+10,000+10,000 1,00,000 = ----------80,000 = 1.25:1
Quick assets ii) Quick Ratio = ---------------Current liabilities Sundry debtors + cash & bank balance = ---------------------------------------------Sundry creditors +bank overdraft + bills payable 68,000 = --------80,000 =0.85:1 Long term debt iii) Debt-equity Ratio = ----------------------Shareholder's equity 12% Debenture = -------------------------------------------Share capital + reserve and surplus 80,000 = ----------2,00,000 +40.000 =0.3333 or 33.33% Long term debt Debt to total capital Ratio = ---------------------Total capital 12% Debenture = -------------------------------------------------------------Share capital +12% Debenture +Reserve & Surplus 80,000 = --------------------------2,00,000+80,000+40,000 80,000 = -------------3,20,000 =0.25 or 25% Illustration 2 The following are the summarized profit and Loss Account of a company for the year ended 31st Dec., last year and a balance sheet of the company as on that date:
iv)
Particulars To opening stock To purchase To carriage inward To gross profit To office expenses To selling expenses To financial expenses To loss on sale of assets To Net profit
Rs. 29,850 1,63,575 4,275 1,02,000 -----------2,99,700 ========= 45,000 9,000 4,500 1,200 45,000 1,04,700
Particulars By sales By closing stock
Rs. 2,55,000 44,700
------------By gross profit By interest 2,99,700 ======== 1,02,000 2,700
1,04,700
Balance Sheet Liabilities Share capital: 6,000 share of Rs. 10 each Reserve Profit and Loss A/C Debenture Bank overdraft Sundry creditor Outstanding expenses 60,000 27,000 8,000 10,000 9,000 24,000 6,000 1,44,000 Required: a) inventory turnover ratio b) debtor turnover ratio c) average collection period d) fixed assets turnover ratio e) capital employed turnover ratio Rs. Assets Land & Building Plant & Machinery Stock Debtors Bills receivable Cash & Bank Balance Preliminery expenses Goodwill Rs. 45,000 24,000 42,000 21,000 3,000 4,000 1,000 4,000 1,44,000
f)
total assets turnover ratio
g) gross profit margin h) net profit margin Solution: a) Cost of goods sold Inventory turnover ratio = -------------------Average inventory 1,53,000 = -----------32,275 =4.74 times Cost of goods sold = sales gross profit = 2,55,000 1,02,000 = 1,53,000 Opening stock + closing stock Average of goods sold = --------------------------------------2 29,850+44,700 = --------------------2 = Rs. 37,275] b) sales Debtors Turnover Ratio = ----------------Closing debtors 2,55,000 = ------------21,000 = 12.14 times c) Day in year = ---------------Debtors turnover ratio 365 = -------12.14 = 30.06 or 31 days
d) Net sales Fixed assets turnover ratio = -------------Net fixed assets 2,55,000 = ------------45,000+24,000 =3.7 times e) Sales Capital employed turnover = -------------------------Capital employ 2,55,000 = -----------1,05,000 = 2.43 times Capital employed = ( current assets current liabilities ) + Non current assets = ( 70,000 -39,000)+74,000 = Rs.1,05,000 or, Capital employed = Shareholders equity +ling term liabilities =60,000+27,000+8,000+10,000] = Rs.1,05,000 or, Capital employed = Total assets current liabilities = 1,44,000-39,000 =Rs. 1,05,000 Sales f) Total assets turnover ratio = -------------------Total assets 2,55,000 = -------------1,44,000-1,000-4,000 2,55,000 = -----------1,39,00 = 1.83 times Gross profit = --------------Sales
g) Gross profit Margin
1,02,000 = ---------2,55,000 = 0.4 or 40% h) Net Profit Net Profit margin = ------------Sales 45,000 = ----------2,55,000 = 0.1765 or 17.65 % Illustration 3 From the following information calculate return on assets and return on shareholder's equity: Equity share capital Preference share capital Reserve & Surplus Preliminary expenses Net profit after tax Fixed assets Current assets Investment Solution: Net profit after tax Return on assets = -----------------Total assets Net Profit after tax = -------------------------------------------------Fixed assets +current assets +investment 1,80,000 = ----------------2,00,000+40,000+3,00,000 1,80,000 = --------------5,40,000 Rs. 2.00,000 Rs. 2,00,000 Rs.6,00,000 Rs.1,00,000 Rs.1,80,000 Rs.2,00,000 Rs. 40,000 Rs.3,00,000
= 0.3333 or 33.33% Return on Shareholder's equity = Net profit after tax --------------------------Shareholder's equity
= Net Profit after tax ------------------------------------------------------------------------------equity share capital +pref. share capital + reserve & surpluspreliminary expenses = 1,80,000 ---------------------------2,00,000+2,00,000+6,00,000-1,00,000 = 1,80,000 ---------------9,00,000 =0.2 or 20% Illustration 4 The following information are provided: Equity shares of Rs. 100 each 12% Preference share of Rs. Rs. 1,00,000 Rs. 100,000
Net profit before interest and tax Rs. 6,00,000 Tax Rate 50% Dividend of 40% is declared on equity shares Required: i) j) Solution: Net profit after tax = 6,00,000- (50% of 6,00,000) = Rs. 3,00,000 = Net Profit after tax pref. Divident No . of equity shares = 3,00,000-12,000 1,000 Earning per share Dividend per share
= 2,88,000 1,000 = Rs. 2,88. Dividend per share = Earning paid No . of equity shares = 40% of 1,00,000 1,000 = 40,000 1,000 = Rs.40
Illustration 5 If current ratio is 5 times and current liabilities are Rs. 40, 000. Calculate current assets. Solution: We have , current ratio = Current assets Current liabilities Or, 5 =Current assets 40,000 Current Assets = 5 x 40,000 =Rs. 2,00,000] Illustration 6 If current liabilities are 60,000, current ratio 4.5 times and liquid ratio 2.5 times, calculate assets, liquid assets and stock in-hand. Solution: Liquid Ratio= Liquid assets Current liabilities Or, 2.5 = Liquid assets 60,000 Liquid assets = 2.5 X 60,000 = Rs. 1,50,000 Again, current ratio = current assets Current liabilities Or, 4.5 = current assets 60,000
Current assets = 4.5 X 60,000 = Rs.2,70,000 Stock-in-hand= current assets- Liquid assets = 2,70,000-1,50,000 = Rs.1,20,000 Illustration 7 From the following information determine the average inventory : Stock turnover ratio = 10 times Total sales = Ts. 4,00,000 Gross profit = 25% on sales If the closing stock is more by Rs. 4,000 than the opening stock, determine the opening stock and closing stock. Solution: Stock turnover ratio = cost of goods sold Average stock Or, 10 = 3,00,000 Average stock : . Average stock = 3,00,000 10 = Rs. 30,000 Cost of goods sold = sales- gross profit = 4,00,000-1,00,000 =3,00,000 [ Gross profit = 4,00,000X 25 100 = 1,00,000] Average stock = opening stock + closing stock 2 Or, 30,000 = x + (x+ 4000) 2 Or, 60,000 = 2x+ 4000) Or, 2x = 60000-4000 x = 56000 2 =2800 Hence, opening stock = Rs. 28000 and Closing stock = Rs. 28000 +4000 = Rs. 32,000
3.3
Statement of Changes in Financial Position
3.3.1 Concept The balance sheet of a business shows the financial position at a given point of time. In the sane way income statement represent the summary of revenue and expenses during the accounting period. Although, income statement shows the operational activities of a firm but the balance sheet shows the position of assets and liabilities at the certain data only. Therefore these statement are called as static statement which fail to explain the changes between the accountancy periods. Management planning, evaluation of past performance and business potentials need analyses of these statements, and the statement prepared to analyze these statement is known as fund flow statement. It explains the causes of changes in the assets and liabilities from the end of one point of time ( previous year) to the end of another period of time ( current year). It is a comparative study of two balance sheets, one prepared at the closing data of last year and another prepared at the end of current financial year. Fund flow statement explains about the movement of funds. From where the funds have been obtained and where they have been utilized can be easily known with the help of funds flow statement . The tern " funds" have a variety of meaning. In its narrowest sense the term fund means cash only and in the wider sense it means all resources. The third and general use of the term ' fund ' Is the amount of working capital . However for the purpose of finds flow analysis, the term 'Fund' means 'net working capital'. The funds required for the day to day operation of a business is known as working capital. It Is a short term investment . On the basis of net concept, we can define working capital as a difference between current assets and current liabilities . i.e. Working capital = current assets current liabilities. The term 'flow' means change or movement. Flow may be inflow (sources of funds) or outflow (uses of funds). Thus funds flow statement is a statement that shows changes in
working capital in two periods Balance Sheet . The sources and application of funds are as follows: Sources of funds: i) ii) iii) iv) v) vi) vii) viii) Issue of shares: Issue of debenture Sale of fixed assets Sale of investment Dividend received Increased in ling term liabilities Funds from operation Decreased in working capital etc.
Uses of funds: i) ii) iii) iv) v) vi) vii) Redemption of redeemable preference shares Redemption of debentures Repayment of long term liabilities Purchased of fixed assets Purchased of ling term investment Dividend paid & tax paid Increased in working capital etc.
3.3.2 Importance The importance of funds flow statement are as under: i) ii) iii) i) ii) iii) iv) v) To know the source from where the funds were obtained and where the resources have been utilized. To know the way the increase or decrease in working capital has taken place. Helps the management for arranging working capital. Helps as a tool of planning and budgeting . To know where did profit go. To know the efficiency of manager involved in fiscal administration. To know about the solvency of the business. To help management for correct allocation of resources and dividend policy.
3.3.3 Preparation of funds flow statement The preparation of funds flow statement involves the following steps: Step 1 : To prepare a schedule of changes in working capital for determining whether the net working capital has increased or decreased in the period. Step 2 : To prepare the necessary ledgers for non current account. Step 3 : To determine funds from operation or operating profit by preparing adjusted profit and loss account . Step 4 : To prepare funds flow statement for determining sources and uses of funds. Step 1 : Schedule of changes in working capital Working capital here refers to net. The excess of current assets over current liabilities in known as working capital. It can be shown by the following equation: Working capital = current assets- current liabilities Thus, the schedule of changes in working capital includes current assets and current liabilities only. The general rules preparing the schedules are: 1. 2. 3. 4. An increase in current assets increases the working capital. A decrease in current asset decreases the working capital. An increase in current liability decreases working capital. A decrease in current liability increases working capital.
The general format of working capital statement is: Schedule of changes in working capital Previous year Current Assets: Cash in hand Cash at bank Bills Receivable Sundry Debtors Marketable Securities Inventory Prepaid expenses Accrued income Total current Assets (CA) Current Liabilities: Bills payable Sundry creditors Current year Effect in working capital Increase Decrease
Outstanding expenses
Bank overdraft Cash credit Dividend payable Prevision for Bad debts Received in advance Total current liabilities ( CL) Working capital ( CA-CL) Increased or decreased in working capital Total Step 2: To find out funds from operation The profit and loss account ascertain the amount of net profit of the business. The amount of net profit is mot the amount of funds available or provided by the business. Therefore, it cannot by treated as funds from operation. The net profit is affected by some non- trading items, which do not effect the working capital. The amount of net profit is the result of profit after taking into account of many non- trading transaction which do not effect working capital. The examples are Amortization of fictitious and intangible assets such as goodwill, preliminary expenses and discount on issue of shares, depreciation, loss on sale of fixed assets, dividend received, refund of tax, etc. To determining the treatment for the different items in calculation of funds from operation, the following chart could be useful: Net Profit Add 1. Depreciation expenses 2. Writing off or amortization of goodwill, patents, trademarks. 3. Amortization of discount on issue of shares. 4. Provision for taxation, dividend etc. 5. Loss on sale of fixed assets 6. Extra ordinary non-recurring losses etc. 7. Premium paid on retirement of preference share and long term liabilities. 8. Other provision and appropriation of profit - except provision for doubtful debts & inventory Result = Funds from operation. Less 1. Decrease in tax liabilities 2. Refund of tax 3. Profit on sale of fixed assets 4. Amortization of share premium and debenture premium, etc. 5. Extra ordinary profit 6. Transfer from provision and reserve to meet normal expenses & losses-expenses written off out of the reserve.
The statement may be prepared in two ways. The first method is by preparing a profit and loss adjustment account and next is by preparing a statement. While preparing profit and loss adjustment account, the ass amount shown on about chart will be on debit side and deduct amount o credit side. The balancing figure will be the amount available or funds from operation. In course of statement, the starting point will net profit. The different items shown on about chart will be added into Net profit and shown on right hand side will be deducted. The result will be funds from operation. Step 3 : To prepare funds statement or sources and application of fund Sources Decreased in working capital Funds from operation Issued of shares (and premium) Issued of debentures (and premium) Increased in ling term liabilities Sale of fixed assets Sale of investment Dividend received Rs. Uses Increased in working capital Operating loss Redemption of shares Redemption of debentures Repayment of long term liabilities (And premium if any) Purchase of fixed assets Purchased of long term investment Dividend paid Rs.
Where possible students must be taught to make difference between shares issued in cash and for consideration other than cash. Shares issues for consideration other than cash does not involve fund item. Therefore they may be ignored white preparing the statement if resources and application of funds. Thus they can be taught to make difference between shares issued for cash & for other than cash wherever is possible to do so. Illustration 1: The following is the summarized Balance Sheet of A Co. Ltd. As on 31st, Chaitra Liabilities Share capital Profit & loss A/C Last yr. 1,00,000 1,60,000 This yr. 1,00,000 2,00,000 Assets Cash Marketable Last yr. 40,000 60,000 This yr. 20,000 40,000
10% debenture Outstanding expenses Bills payable Creditors Provision for Depreciation
40,000 20,000 40,000 40,000 80,000 4,80,000
1,00,000 10,000 10,000 50,000 1,10,000 5,80,000
securities Stock Debtors premises
1,20,000 60,000 2,00,000
1,60,000 80,000 2,80,000
4,80,000
5,80,000
Required: i. Schedule of changes in working capital ii. Adjusted profit and loss account iii. Funds flow statement Solution: (i) Schedule of changes in working capital Current assets: Cash Marketable securities Stock Debtors i. Total current assts Current liabilities: Outstanding expenses Bills payable Creditors ii. Total current liabilities Working capital (i.) (ii.) Increased in working capital 2,30,000 ii) Dr. Particulars To depreciation To balance c/d 2,30,000 1,00,000 Cr. Rs. 1,60,000 80,000 2,30,000 Last Yr. 40,000 60,000 1,20,000 60,000 2,80,000 20,000 40,00 40,000 1,00,000 1,80,000 50,000 This Yr. 20,000 40,000 1,60,000 80,000 3,00,000 10,000 10,000 50,000 70,000 2,30,000 50,000 Increase Decrease 20,000 20,000 40,000 20,000
10,000 30,000
10,000
Adjusted Profit & Loss Account Rs. 30,000 2,00,000 2,30,000 particulars By balance b/d By funds from operation
iii) Sources Funds from operation Issued of debenture
Funds flow statement Rs. 70,000 60,000 Uses Increased in working capital Premises purchased Rs. 50,000 80,000
1,30,000
1,30,000
Illustration 2. The following details are provided: i. Net profit for the year Rs. 60,000 ii. Gain on sale of building Rs. 10, 000 iii. Goodwill appears in the books Rs. 20,000 out of that 10% has been written off during the year. iv. Old machinery worth at Rs. 10,000 has been sold during the year for Rs. 8,000. v. Rs. 5,000 have been transferred to general reserve fund. vi. Depreciation has been provided during the year of RS. 6,000 Required: calculate funds from operation . Solution: Adjusted profit & Loss A/c Particulars To net profit To goodwill To loss in sale of machinery To general reserve To depreciation Rs. 60,000 2,000 2,000 5,000 6,000 Particulars By gain on sale of building By funds from operation Rs. 10,000 65,000
75,000
75,000
Illustration 3 The following details are provided: i) Increased in working capital Rs. 16,000 ii) net profit Rs. 43,000 (before writing off goodwill)
iii) Depreciation Provided in fixed assets Rs. 7,000 iv) Dividend paid Rs. 14,000 v) Rs. 20,000 cash was received on account of issue of shares. vi) Goodwill if Rs. 20,000 was written off out of profits vii) Machinery was purchased for Rs. 40,000 Required: Funds flow statement. Solution: Funds flow statement Sources Funds from operation Issued of shares Rs. 50,000 20,000 70,000 Uses Increased in working capital Dividend paid Machine purchased Rs. 16,000 14,000 40,000 70,000
Notes: funds from operation = Net profit + Depreciation = 43,000+7,000 =Rs. 50,000 Illustration: 4 The comparative Balance Sheets of A Co. Ltd for the year ended 31st , chaitra are as follows: Liabilities Share capital Reserve & Surplus Current Liabilities 10% debenture Last year 2,10,000 2,27,400 1,67,100 2,70,000 This year 4,20,000 3,01,500 2,04,000 2,25,000 Assets Fixed assets, net Investment Current assets Last year 2,40,000 84,000 5,50,500 This year 5,40,000 1,20,000 4,90,500
8,74,500
11,50,500
8,74,500
11,50,50 0
The income statement for the year ended 31st .Chaitra, this year is as follows: Rs.
Sales Less: cost of goods sold Gross profit Les: operating expenses ( including depreciation of Rs. 42,000) Less : Interest expenses Profit before taxes Less: Tax Net profit after tax
10,20,000 5,76,000 4,44,000 2,34,000 2,10,000 18,000 1,92,000 87,000 1,92,000 87,900 1,04,100
The dividend distributed to shareholders in the year was Rs. 30,000 and purchesed of fixed assets Rs:3,42,000. Required: i) ii) iii) i) Particulars Current Assets Current liabilities Working capital Decreased in working capital 3,83,400 Statement of changes on working capital. Computation of funds from operation. Funds flow statement Statement of Changes in working capital Last yr. 5,50,5000 1,67,100 3,83,400 This yr. 4,90,500 2,04,000 2,86,500 96,900 3,83,400 96,900 96,900 Increase 96,900 Decrease 60,000 36,900
Solution:
Dr. Particulars to Net profit To Depreciation
Adjusted profit & Loss A/c Rs. 1,04,100 42,000 1,46,100 1,46,100 Particulars By funds from opration Rs. 1,46,100
Cr.
Funds flow Statement Sources Decreased in working capital Operating profit Issued of shares Rs. 96,900 1,46,100 2,10,000 Uses Plant & Machinery purchased Divided Redemption of debentures Investment 4,53,000 4,53,000 Rs. 3,42,000 30,000 45,000 36,000
Illustration 5 The summarized balance sheets of Koshi Pvt. Ltd. For two years are as follows: Liabilities Share capital General reserve Profit & Loss A/c Creditors Provision for tax Mortgage loan 10,49,000 1st year 4,50,000 3,00,000 56,000 1,68,000 75,000 2nd year 4,50,000 3,10,000 68,000 1,34,000 10,000 2,70,000 12,42,000 10,49,000 12,42,000 Assets Fixed assets Investment Stock Debtors Bank 1st year 4,00,000 50,000 2,40,000 2,10,000 1,49,000 2nd year 3,20,000 60,000 2,10,000 4,55,000 1,97,000
i)
Investment costing Rs, 8,000 were sold during the second year for Rs. 8,500 and purchased for Rs. 18,000. ii) Provision for tax made during the year was of Rs. 9,000 and Tax Paid Rs. 74,000. iii) During the year , part of the fixed assets costing Rs. 10,000 were sold for Rs. 12,000 and the profit was included in profit and loss account. The depreciation for the year was Rs. 70,000 iv) Dividend paid during the year amount to Rs. 40,000 Required: i) Schedule of changes in working capital ii) Adjusted profit and Loss Account iii) Funds flow statement
Solution: Schedule of changes in working capital Particulars Current Assets: Stock Debtors Bank Total current Assets Current Liabilities: Creditors Working capital Increased in working capital 7,28,000 7,28,000 3,27,000 3,27,000 1st ` 2,40,000 2,10,000 1,49,000 5,99,000 2nd 2,10000 4,55,000 1,97,000 8,62,000 Increase 2,45,000 48,000 Decrease 30,000 2,97,000
1,68,000 4,31,000 2,97,000
1,34,000 7,28,000 34,000
Profit & Loss A/c To Provision for tax To Depreciation To dividend-used To General Reserve To Balance c/d 9,000 70,000 40,000 10,000 68,000 1,97,000 1,97,000 By Balance b/d By gain on sale of investment By gain in sale of fixed assets By funds from operation 56,000 500 2,000 1,38,500
Funds Flow Statement Sources Sale of Fixed assets Operating Profit Mortgage Loan Sale of investment Rs. 12,000 1,38,000 2,70,000 8,500 4,29,000 . Uses Increased in working Capital Investment Tax paid Dividend Rs. 2,97,000 18,000 74,000 40,000 4,29,000
3.4 Cash Flow Statement

INTRODUCTION: The Statement of Cash Flows is the third financial statement required for full disclosure. The Cash Flow statement shows the inflows and outflows of Cash over a period of time, usually one year. The time period will coincide with the Income Statement. In fact, account balances are not used in the Cash Flow statement. The accounts are analyzed to determine the Sources (inflows) and Uses (outflows) of cash over a period of time. PREREQUISITE: The knowledge of all accounting concepts, conventions, principles affecting the accounting records and competence in passing journals, preparing ledgers and the ability to analyse the Income Statement, Balance Sheet and other information associated with final accounts are essential to fully understand the unit. OBJECTIVES: The following are the learning objectives of the Unit: 1. Be able to explain the meaning of cash flow statement 2. Be able to appreciate the purposes and importance of cash flow statement 3. Be acquainted with the three activities effecting the cash flows and be able to compute the cash flows relating to financing and investing activities 4. Be able to explain the two methods of calculating cash flows from operating activities - direct and indirect method 5. Be able to compute of cash flows from operating activities using the direct method and indirect method 6. Be able to prepare a cash flow statement from simple and direct adjustments CONTENT AREAS OF THE UNIT The following are the content areas of the Unit and their suggested teaching hours. The teaching hours allocated could vary depending upon a teachers style of teaching. Hence, they could be suitable modified but limiting the total hours to 35 hours:
SN
Content Areas of the Unit
Teaching Hours
6. 7. 8.
4. 5. 6. The preparation of cash flow statement with simple and direct adjustments. 10 35 Hours
DESCRIPTION OF THE CONTENT: Meaning of Cash Flow Statement: Income statement measures only flows (based on accrual accounting) restricted to transactions that relate to rendering of goods or services to customers. The Balance Sheet, on the other hand, is merely a static statement of assets and liabilities as on a particular day. It does not provide information on those major financial transactions, which have a bearing on cash. One has to draw inferences from the Balance Sheet and Income Statement about major cash transactions. Thus, a cash flow statement is the missing link between the conventionally prepared Income Statement and the Balance Sheet. Cash is King- is a familiar quote applicable to all, especially, so for a business because cash is all-important to businesses. Without cash employees cannot be paid, suppliers cannot be paid, and the business will ultimately crumble. Cash is, thus, the king of business, and a Cash Flow Statement tells us how much cash is or will be available within the business or how much cash will be needed to keep the business running. It provides a summary of cash inflows and outflows from the three main business activities: operating, investing, and financing. Purpose and Importance of Cash Flow Statement: The primary purpose of the Cash Flow Statement is to report the changes in cash over a period and explain these changes i.e. how cash was generated and used throughout the accounting period. The secondary purpose is to provide information about the three business activities: operating, investing, and financing activities, and their impact on the business cash.
The Statement is important because: Market Values of the company's debt and securities are dependent on investor's estimates of the Company's cash flows. A company's liquidity depends on the relationship between cash inflows and outflows. The liquidity has great bearing on the risk of investing in a company. The pattern of a company's inflows and outflows of cash identifies management's financial and spending patterns.
Three activities effecting cash flows 1. The operating activities section shows the cash effects of revenue and expense transactions which are normally part of Income Statement. Operating activities are in fact related to acquiring and selling products and services reported on a cash basis. It is rather like an income statement, prepared on a cash basis reporting the cash effects of items that enter into the determination of net income and usually relating to an increase or decrease in a current asset or liability.
Operating Activities Cash Inflows 1 Cash Receipts from sale of goods or services 2 3 4 5 6 7 8 Sale of Trading Securities not considered as cash equivalents Refund of Tax Interest received on cash equivalents Proceeds from settlement of litigations Insurance claims against loss of inventory Interest Received Dividend Received 1 2 3 4 5 6 7 Cash Outflows Payment for purchase of inventory Payment to Employees Payment to Government Payment for Interest on Loans Payment to other suppliers and for expenses Purchase of Trading Securities not considered as cash equivalents Dividend Paid
2.
Investing activities include transactions involving long-lived assets, as well as lending of funds and the acquisition or sale of securities. It involves cash inflows
and outflows from: 1) acquiring and selling productive assets such as Plant, Equipment, and equipments; 2) acquiring and selling investment securities; 3) lending money and collection on those loans; and 4) dividend and interest received from investments and loans given.
Investing Activities 1 2 3 4 5 Cash Inflows Collection of Loan (Principal Amount) Sales of Long-term Assets Sale of Investments (non-trading securities) Proceeds from discounting of Notes Receivable Sale of business segments 1 2 3 Cash Outflows Loans provided Purchase of long-term assets Payments to acquire investments in debts and equity securities (non-trading)
Illustration 1 The following information is extracted from the records of Artificial Studio, New Road:
Beginning cash balance: Ending cash balance: Cash payments for supplies Cash paid for rent Cash paid for salaries Cash received from customers Cash paid for interest Cash paid for dividends Cash received from a loan Issuance of stock Cash paid for studio equipment Required:
15,375 40,069 10,400 1,200 3,750 17,868 150 200 10,000 25,000 12,874
Prepare the investing section of the statement of cash flows for February.
Answer: Artificial Studio Statement of Cash Flows For Month Ended February 28, 2007 Cash flows from investing activities: Purchase of studio equipment Net cash used for investing activities (12,874) (12,874)
FINANCING ACTIVITIES The financing activities are those directed at managing the finance for the business involving borrowings from creditor or repaying creditors as well as transactions with the companys owners. These activities include the issue of shares and various forms of debt and their repurchase or repayment, along with the payment of dividends to stockholders.
Financing Activities Cash Inflows 1 2 Capital Contribution by Owners or Issue of Shares Issue of Debt instruments and Loans taken 1 2 3 Cash Outflows Cash Payments of Dividends or Drawings made by owners Payments to purchase treasury stock Repayment of Loan (Principal Amount)
ALTERNATIVE VIEWS: 1. IAS 7 allows Dividend Paid to be treated as Operating as well as Financing Activity. However, FASB (USA) or AS 3 (India) considers it as financing Activity. (In Nepal Financing Activity or Operating NAS 03) 2. Accounting Standard of India (AS 3) considers Interest Paid as Financing Activity but IAS 7 and FASB consider it as Operating Activity (In Nepal Operating Activity or Financing Activity NAS 03 ) 3. IAS 7 (revised) considers interest and dividend received as part of Investing Activities. FASB considers them as Operating Activities (In Nepal could be treated as Operating or Investing Activity)
4. However, majority prefer to consider Dividend Paid as financing activity. Interest Paid, Interest Received and Dividend Received as Operating Activity. Illustration 2 The following information is extracted from the records of Artificial Studio, New Road: Beginning cash balance: Ending cash balance: Cash payments for supplies Cash paid for rent Cash paid for salaries Cash received from customers Cash paid for interest Cash paid for dividends Cash received from a loan Issuance of stock Cash paid for studio equipment Required: Prepare the financing section of the statement of cash flows for February. Answer: Artificial Studio Statement of Cash Flows For Month Ended February 28, 2007 Cash flows from financing activities: Issuance of stock Loan proceeds Cash paid for dividends Net cash from financing activities 25,000 10,000 200 35,200 15,375 40,069 10,400 1,200 3,750 17,868 150 200 10,000 25,000 12,874
Computation of Cash flow from operating activities There are two approaches of reporting cash from operating activities - the direct approach and the indirect approach. Although, the standard setters have preferred the direct method of presenting cash flow from operating activities, the indirect method is more popular amongst the companies.
INDIRECT METHOD The Indirect method adjusts net income for the period to cash flows from operating activities by removing the effects of changes in income-related accounts that did not involve cash and cash equivalents during the period. The calculation of cash from operations begins with net income, and then items like depreciation, amortisation, provisions, loss on sale etc are added and items like gain on sale of assets, extra-ordinary gains, dividend received, interest received etc are deducted to calculate the cash flows before working capital changes. To this amount, the changes in working capital are adjusted to calculate cash from operating activities. The remainder of the statement of cash flows, cash flows from investing and financing activities, is the same, regardless of which method was used to arrive at cash flow from operating activities. The following exhibit shows Operating Section of the cash flow statement using the indirect method for International Gems Pvt Ltd:
International Gems Pvt. Ltd. Cash Flow Statement

for the year ending Description A. Cash Flows from Operating Activities Net Profit after Tax Add: Depreciation Amortisation Loss on Sale of Plant Less: Add: Gain on Sale of Investments Increase in Current Liabilities Decrease in Current Assets Less: Decrease in Current Liabilities Increase in Current Assets Cash flows from Operating Activities (90,000) (59,000) 1,28,000 1,43,000 (9,000) 235,000 25,000 15,000 5,000 (3,000) 125,000 15,000 12,000 3/31/2001 2001 Rs. 2000 Rs. Note No.
International Gems Pvt Ltd Cash Flow Statement

for the year ending Description A. Cash Flows from Operating Activities Net Profit after Tax Add: Depreciation Amortisation Loss on Sale of Plant Less: Gain on Sale of Investments Interest Received Dividend Received Add: Increase in Current Liabilities Decrease in Current Assets Less: Decrease in Current Liabilities Increase in Current Assets Cash flows from Operating Activities 3/31/2001 Note No. 2001 Rs 235,000 25,000 15,000 5,000 (3,000) (15,000) (18,000) 2000 Rs 125,000 15,000 12,000
(12,000) (16,000)
(90,000) (59,000) 95,000
(9,000) 115,000
ILLUSTRATION 3 The following information is extracted from Artificial Studio:
Beginning cash balance: Ending cash balance: Net change in accounts receivable Net change in inventory Net change in accounts payable Depreciation expense Net income Cash paid for dividends Cash received from a loan Purchase of treasury of stock Cash received from sale of studio equipment
21,470 63,735 1,800 (2,675) (890) 8,000 23,450 625 9,000 3,780 6,235
Required: Prepare the operating section of the statement of cash flows for February using the indirect method. Solution: Artificial Studio Statement of Cash Flows For Month Ended February 28, 2007
Cash flows from operating activities: Net income Net increase in accounts receivable Depreciation expense Net change in inventory Net change in accounts payable Net cash from operations 23,450 (1,800) 8,000 2,675 (890) 31,435
DIRECT METHOD Under the Direct method, the following major sources of operating cash flows must be calculated independently and reported separately: 2 3 4 5 6 1. Cash collected from customers for sale of goods or services Cash Payment for purchases of goods Cash Payment for expenses and employees Cash Payment for Interest Cash Payment for Taxes Collection from customers - this is the amount of cash collected from customers for sales or service during a period. a. Calculations would be: Net Sales + decrease in gross accounts receivable - increase in gross accounts receivable
- bad debts - increase in provision for bad debts + decrease in provision for bad debts = Collection from customers 2. Payment to suppliers - this is the amount of cash expended on goods and services from outsiders. a. Calculations would be: Cost of Goods Sold + miscellaneous expenses + increase in inventory (or - decrease) + decrease in accounts payable (or increase) = Payment to suppliers 3. Payment to employees - this is the amount of cash paid to employees for salaries and wages. a. Calculations would be: Salaries and Wages Expenses + decrease in salaries/ wages payable OR - increase in salaries/ wages payable = Payment to Employees 4 Payment to government for taxes- this is the amount of cash paid during the year for income tax. a. Calculations would be: income tax expense + decrease in taxes payable OR - increase in taxes payable = Payment to Government for Taxes 5. Interest payment or receipts. This is the cash paid or received during the year for interest . a. Calculations would be: Interest Income + decrease in interest receivable (- increase) OR - increase in interest payable (+ decrease) = Interest Received
6.
Dividend received. This is the cash received during the year for dividend on stocks held by the business. a. Calculations would be: Dividend Income + decrease in dividend receivable OR - increase in dividend receivable = Dividend Received
The following exhibit shows the cash flow statement prepared under direct approach:
International Gems Pvt. Ltd. Cash Flow Statement for the year ending 3/31/2001
Description A. Cash Flows from Operating Activities Cash Collected from Sales Cash Payment for Purchases Cash Payment to Employees and for Expenses Cash Payment for interest Cash Payment for Tax Interest Received Dividend Received Net Cash Flows from Operating Activities B. Cash Flows from Investing Activities Sale of Plant Purchases of Land Sale of Investments Loan to Subsidiary Net Cash Flows from Investing Activities C. Cash Flows from Financing Activities Issue of Shares Loans Repaid 50,000 (40,000) 12,000 (80,000) 57,000 (150,000) 125,000 (150,000) 1 2 3 4 5 500,000 (250,000) (120,000) (20,000) (15,000) 15,000 18,000 128,000 400,000 (180,000) (80,000) (15,000) (10,000) 12,000 16,000 143,000 Note No. 2001 Rs. 2000 Rs.
Loans Taken Dividend Paid Net Cash Flows from Financing Activities Net Change in Cash and Cash Equivalent Opening Cash and Cash Equivalent Closing Cash and Cash Equivalent (25,000) (15,000) 170,000 10,000 180,000
100,000 (30,000) 70,000 63,000 57,000 120,000
It can be noticed from above that the direct approach examines each and every item on the income statement and calculates how much cash it either generated or used. Illustration 4 The following information is extracted from the books of Artificial Studio of New Road: Beginning cash balance: Ending cash balance: Cash payments for supplies Cash paid for rent Cash paid for salaries Cash received from customers Cash paid for interest Cash paid for dividends Cash received from a loan Issuance of stock Cash paid for studio equipment 15,375 40,069 10,400 1,200 3,750 17,868 150 200 10,000 25,000 12,874
Required: Prepare the operating section of the statement of cash flows for February using the direct method. Solution: Artificial Studio Statement of Cash Flows For Month Ended February 28, 2007 Cash flows from operating activities: Cash received from customers 17,868
Cash received from interest Cash paid for supplies Cash paid for rent Cash paid for salaries Net cash from operations
368 (10,400) (1,200) (3,750) 2,368
Illustration 5 Three Stars Club reported the following items on its Year 2 and Year 3 balance sheet: Year 3 Year 2 Accounts Receivable 40,000 30,000 Supplies Inventory 15,000 12,000 Prepaid Rent 6,000 5,000 Salaries Payable 17,000 11,500 Utilities Payable 1,500 1,000 Supplies Payable 4,500 5,500 Interest Payable 8,500 7,000 The following information is from the income statement for Year 3: Service Revenue 60,000 Rent Expense 12,000 Salaries Expense 52,500 Utilities Expense 16,000 Supplies Expense 32,500 Interest Expense 21,000 Required: 1. How much cash did Three Star Club collect from customers in Year 3? 2. How much cash did Three Star Club pay for supplies during Year 3? 3. How much cash did Three Star Club pay for salaries during Year 3? 4. How much cash did Three Star Club pay for utilities expense in Year 3? 5. How much cash did Three Star Club pay for rent during Year 3? 6. How much cash did Three Star Club pay for interest during Year 3?
Solution: 1. 2. 160,000 sales 10,000 increase in A/R = 150,000 32,500 + supplies expense 3,000 + 1,000 supplies supplies inv. increase pay. Decrease = 36,500
3. 4. 5. 6.
52,500 salaries expense 5,500 increase in salaries payable = 47,000 16,000 utilities expense 500 increase in utilities payable = 15,500 12,000 rent expense + 1,000 increase in prepaid rent = 13,000 21,000 interest expense 1,500 increase in interest payable = 19,500
PREPARATION OF CASH FLOW STATEMENT In the preceding section, we have learned to analyse the Income Statement, the changes in the Balance Sheet and any additional information provided. All these should now culminate into the preparation of a Cash Flow Statement, which in fact is just the assembling of information into a statement. ILLUSTRATION 6 The following information is extracted from the books of Himali Tea Co: Beginning cash balance: Ending cash balance: Cash payments for supplies Cash paid for rent Cash paid for salaries Cash received from customers Cash paid for interest Cash paid for dividends Cash received from a loan Issuance of stock Cash paid for drying equipment 15,375 40,069 10,400 1,200 3,750 17,868 150 200 10,000 25,000 12,874
Required: Prepare the statement of cash flows for February using the direct method. Answer: Himali Tea Co. Statement of Cash Flows For Month Ended February 28, 2007 Cash flows from operating activities: Cash received from customers 17,868 Cash paid for supplies (10,400) Cash paid for rent (1,200) Cash paid for salaries (3,750) Cash paid for interest (150) Net cash from operations Cash flows from investing activities: Purchase of drying equipment (12,874) Net cash used for investing activities Cash flows from financing activities: Issuance of stock 25,000 Loan proceeds 10,000 Cash paid for dividends 200 Net cash from financing activities Net increase in cash:
2,368
(12,874)
35,200 24,694
ILLUSTRATION 7 The following financial statements are extracted from the books of Hand & Mouth Co: June 30, 2006 June 30, 2007 Comparative Balance Sheet Assets Cash Prepayments Accounts Receivable Inventory Land and Building Plant and Machinery Accumulated Depreciation, P & M Totals Liabilities and Stockholders Equity Accounts Payable 20,000 14,000 200 25,000 30,000 166,000 20,000 (6,000) 235,200 200 100 34,000 36,000 176,000 20,000 (12,000) 254,300
Bank Overdraft Loan from ABC Capital Totals Income Statement
30,000 63,200 122,000 235,200
32,000 20,000 188,300 254,300
For Year Ended June 30, 2007 Sales Cost of Goods Sold Gross Profit Expenses: Depreciation Expense Salaries Advertisement Interest Expenses Total Expenses Net Profit 6,000 16,000 4,000 5,000 31,000 79,000
250,000 140,000 110,000
Required Cash flow Statement using the direct method of showing Cash from Operating Activities Cash from Operating Activities using Indirect method Additional Information: 1. No extra capital was contributed but drawings were made. 2. Drawings by the owner was Rs 12, 700 3. Purchase of Building Rs. 10,000 4. Borrowed as overdraft Rs 2,000 5. Loan to ABC paid Rs 43,200 Solution Working Notes: 1. Sales Less Increase in Receivables Collection from Sales 2. Cost of Goods Sold Add Decrease in Payables
250,000 9,000 241,000 140,000 6,000
Add 3. Less
Increase in Inventory Cash Paid to Suppliers Operating Expenses (16,000 + 4,000) Decrease in Prepaid Expenses Cash Paid for Operating Expenses 5,000 Nil
Hand and Mouth Cash Flow Statement for the year ending 31/6/2001 Description A. Cash Flows from Operating Activities Cash Collected from Sales Cash Payment for Purchases Cash Payment to Employees and for Expenses Cash Payment for Interest Cash Payment for Tax Net Cash Flows from Operating Activities B. Cash Flows from Investing Activities Purchase of Land & Building (176000-166000) Net Cash Flows from Investing Activities C. Cash Flows from Financing Activities Bank Overdraft Loan to ABC repaid Drawings Net Cash Flows from Financing Activities Net change in Cash and Cash Equivalent Opening Cash and Cash Equivalent Closing Cash and Cash Equivalent 6 Note No. 1 2 3 4 5
6,000 152,000 20,000 100 19,900
4. Cash Paid for Interest 5. Cash Paid for Taxes
Amount Rs 241,000 (152,000) (19,900) (5,000) 64,100 (10,000) (10,000) 2,000 (43,200) (12,700) (53,900) 200 200
Cash from Operating Activities using Indirect Method Net Income Add: Add: Less: Depreciation Expenses Decrease in Prepaid Expenses Increase in Receivables Increase in Inventory Decrease in Payables Cash from Operating Activities Illustration 8: The following data relates to Tankanath & Co for 2006 and the preceding year ended December 31, 2005: Year 2006 Cash Accounts receivable (net) Inventories Equipment Accumulated depreciation 100,000 78,000 101,500 410,000 (150,000) 539,500 ======== Year 2005 78,000 85,000 90,000 370,000 (158,000) 465,000 ======== 100 9,000 6,000 6,000 (20,900) 64,100 79,000 6,000 85,000
Accounts payable (merchandise creditors) Cash dividends payable Common stock, Rs 10 par Share Premium Retained earnings
58,500 5,000 200,000 62,000 214,000 539,500 ========
55,000 4,000 170,000 60,000 176,000 465,000 ========
Additional Information: 1. Equipment costing Rs. 125,000 was purchased for cash. 2. Another equipment costing 85,000 with accumulated depreciation of 65,000 was sold for 15,000. 3. The common stock was issued for cash 4. The only entries in the retained earnings account were net income of 51,000 and cash dividends declared of 13,000. Required: Prepare a statement of cash flows. Use the indirect method of reporting cash flows from operating activities. SOLUTION: Tankanath & Co Statement of Cash Flows For Year Ended December 31, 2006 Cash flows from operating activities: Net income, per income statement Add: Depreciation Decrease in accounts receivable Increase in accounts payable Loss on sale of equipment Deduct: Increase in inventories Net cash flow from operating activities 57,000 7,000 3,500 5,000 72,500 123,500 11,500 112,000 51,000
Cash flows from investing activities: Cash from sale of equipment Less: Cash paid for purchase of equipment Net cash flow used for investing activities Cash flows from financing activities: Cash received from sale of common stock (including premium) 32,000 15,000 125,000 (110,000)
Less: Cash paid for dividends Net cash flow provided by financing activities Increase in cash Cash at the beginning of the year Cash at the end of the year
12,000* 20,000 22,000 78,000 100,000 ========
* 13,000 + 4,000 - 5,000 = 12,000
Illustration 9 The comparative balance sheet of Padam Company, for 2006 and the preceding year ended December 31, 2005, appears below in condensed form: Year 2006 Cash Accounts receivable (net) Inventories Investments Equipment Accumulated depreciation-equipment 53,000 37,000 108,500 ..... 573,200 (142,000) 629,700 ======== Accounts payable Bonds payable, due 2010 Common stock, Rs. 10 par Share Premium Retained earnings 62,500 ..... 325,000 80,000 162,200 629,700 ======== The income statement for the current year is as follows: Year 2005 50,000 48,000 100,000 70,000 450,000 (176,000) 542,000 ======== 43,800 100,000 285,000 55,000 58,200 542,000 ========
Sales Cost of merchandise sold Gross profit Operating expenses: Depreciation expense Other operating expenses Income from operations Other income: Gain on sale of investment Other expense: Interest expense Income before income tax Income tax Net income 6,000 4,000 26,000 68,000
625,700 340,000 285,700
94,000 191,700
(2,000) 189,700 60,700 129,000 ========
Additional data for the current year are as follows: (a) Fully depreciated equipment costing 60,000 was scrapped, no salvage, and another equipment was purchased for 183,200. (b) Bonds payable for 100,000 were retired by payment at their face amount. (c) 5,000 shares of common stock were issued at 13 for cash. (d) Cash dividends declared and paid, 25,000. Required: Prepare a statement of cash flows, using the indirect method of reporting cash flows from operating activities. Padam Company Statement of Cash Flows For the Year Ended December 31, 2006 Cash flows from operating activities: Net income, per income statement Add: Depreciation 26,000 129,000
Decrease in accts. rec. Increase in accts. pay. Deduct: Increase in inventories Gain on sale of investments Net cash flow from operating activities Cash flows from investing activities: Cash from sale of investments Less: Cash paid for purchase of equipment Net cash flow used for investing activities Cash flows from financing activities: Cash from sale of common stock Less: Cash paid to retire bonds payable Cash paid for dividends Net cash flow used for financing activities Increase in cash Cash at the beginning of the year Cash at the end of the year
11,000 18,700 8,500 4,000 12,500 172,200 74,000 183,200 (109,200) 55,700 184,700
65,000 100,000 25,000 125,000 (60,000) 3,000 50,000 53,000 ======
EVALUATION SCHEME: The competency achieved by a student in this Unit will be evaluated on the following basis: No. of Questions 1 Type of Question Theory Question with exact requirement or an answer consisting of 3 to 5 effective sentences based on Financial Statement Analysis Theory Question with exact requirement or an answer consisting of 5 to 7 effective sentences based on ratio analysis, funds flow and cash flow statement Marks 2 Marks
3 Marks
3 4
Problem Solving type of questions based on calculation and simple interpretation of ratios. Problem Solving type of questions based on preparation of funds flow statement, calculation of funds from operations, and cash from operations. Problem Solving type of questions based on preparation of Cash Flow Statement/ Funds Flow Statement
6 Marks 4 Marks
5 5 Questions
10 Marks 25 Marks
Some Model Questions 1. Some do you mean by financial statement? [2Marks] 2. Write any two features of financial statement. [2Marks] 3. Write any three objectives of financial statement. [3Marks] 4. Are there any limitation of financial statement? Mention than [5Marks] 5. Give any three limitation of financial statement. [3Marks] 6. Named the parties who are interested in the financial statement. [2Marks] 7. What is ratio ? Define ratio analysis. [1+2] 8. What are the limitation of Ratio Analysis? [5] 9. What does the Debt-equity Ratio indicate? [2] 10. What does the Net profit Ratio show ? Give suitable example with imaginary figures. [1+2] 11. Define the Term 'fund' & 'Glow' in respect of funds flow statement? [1.5+1.5] 12. State any there importance of funds flow Statement. [3] 13. What do you mean by mean by funds from operation? [2] 14. Describe the method of calculating funds from operation. [3] 15. List out major source of funds. [3] 16. The Balance sheet of a company as on 31st Chaitra, Last year is given below: Liabilities Capital Debentures Bills payable Outstanding expenses Bank overdraft Rs. 50,000 50,000 20,000 10,000 20,000 1,50,000 Requited: Current Ratio & quick ratio Assets Inventory Debtors Cash & bank balance Marketable securities Fixed assets Rs. 35,000 25,000 20,000 20,000 50,000 1,50,000
17. The following information is given about a company: Stock Rs. 25,00 Bills payable Debtors Rs. 20,000 Bank overdraft Bills receivable Rs.5,000 sales Prepaid Rs. 2,000 gross profit Cash in hand Rs. 15,000 net profit Creditors Rs.30,000 Required: i) Current Ratio ii) Quick Ratio iii) Gross profit Ratio iv) Net profit Ratio 18. Following data are given: Closing Stock Opening Stock Stock Turnover Ratio Selling Price Required i. Current Assets ii. Current Ratio
Rs. 20,000 Rs.2,000 Rs. 3,50,000 Rs.25.000 Rs. 15,000
Rs.2,00,000 Rs.1,20,000 10 times 20% above sales
20. The Balance Sheet of A Co. Ltd. As on 31st Chaitra are as follows:
Liabilities Share Capital 12% Debentures General Reserve Profit & Loss A/C Share Premium 10% Public Deposit Sundry Creditors Bills Payable Bank overdraft Outstanding Last year 3,75,000 1,75,000 75,000 1,25,000 12,500 2,00,000 20,000 15,000 25,000 750 This year 4,75,000 1,25,000 50,000 1,75,000 20,000 3,00,000 25,000 10,000 30,000 250 Assets Goodwill Land and Building Plant & Machinery Furniture's Investment Stock Debtors Bills Receivable Accrued income Prepaid expenses Cash & Bank Balance Last year 2,500 3,75,000 2,00,000 12,500 11,25,000 1,50,000 50,000 20,000 2,500 85,750 10,23,250 This year 1,250 5,50,000 2,50,000 11,250 1,00,000 1,87,500 42,500 22,500 1,500 500 43,250 12,10,250
Required: i. Schedule for changes in working capital ii. Adjusted profit & Loss Account iii. Funds Flow Statement 21. The following are the summaries Balance Sheet of a company as on 31st Chaitra.
Liabilities Equity Share capital Profit & Loss A/C Bank Loan Sundry Creditors Accumulated Depreciation for plane Provision for Tax Proposed Dividends 1st year` 2,00,000 1,25,000 80,000 60,000 40,000 20,000 20,000 5,45,000 2nd year 3,00,000 1,75,000 40,000 67,500 60,000 27,500 30,000 7,00,000 Assets Premises Plat & Machinery Stock Sundry Debtors Cash 1st year 1,50,000 2,30,000 90,000 50,000 25,000 _________ 5,45,000 2nd year 2,00,000 3,15,000 1,00,000 77,500 7,500 7,00,000
A piece of machinery costing Rs. 30,000 was sold for Rs. 2, 000. The book value of the cachine was of Rs. 3,000. Required: i. Statement of changes in working capital. ii. Adjusted profit & Loss Account. iii. Funds Flow Statement. The following schedule shows in condensed form the Balance Sheets of A company limited. In addition to the Balance Sheets, other information concerning the transactions available are as under: i. 10% dividend was paid in cash. ii. New machinery for Rs. 15,000 was purchased, but old machinery costing Rs. 6,000 was sold for Rs. 2,000. Accumulated depreciation was Rs. 2,000. iii. Short term investment worth Ts. 36,000 were sold for Rs. 38,000. Balance Sheet
Liabilities Current liabilities 10% Debentures Depreciation for funds Reserves Profit & Loss A/C Capital 1-1-55 58,000 45,000 20,000 30,000 8,000 1,15,000 2,76,000 31-12-55 54,000 35,000 22,000 30,000 11,500 1,15,000 2,67,500 Assets Current Assets Land & Building Machinery 1-1-55 1,75,000 75,000 26,000 31-1255 1,57,500 75,000 35,000
22.
2,76,000
2,67,500
Required : i. Schedule of changes in working capital. ii. Adjusted profit & Loss A/C iii. Funds flow Statement 23. The non-current assents and equities of a company limited, at the beginning and at the end of the year are given: Editing Beginning Plant, net and depreciation 28,000 13,000 Investment 58,000 26,000 10% Debentures 1,40,000 50,000 Share Capital 80,000 80,000 Retained Earning 82,000 47,000 You are unable to obtain complete balance sheet data or an income statement of the year, but you have obtained the following information: i. Dividends of Ts. 7,000 was paid. ii. A gain on the sale of equipment of Rs. 2,600 has been included in net income. The gross plant assets increased by Ts. 18,000 even though equipment costing Rs. 5,000 with a net book value of Rs. 3,800 was sold. Required : A statement of source and use of funds. 24. following are the abstract of the balance sheet items of ABC Co. Ltd. Liabilities Share Capital Profit & Loss A/C Creditors Mortgage Last yr. 1,60,000 29,000 18,000 This yr. 1,70,000 49,000 10,000 10,000 2,39,000 Assets Fixed Assets Stock Debtors Cash in hand Last yr. 1,48,000 18,000 33,000 8,000 2,07,000 This yr. 1,30,000 39,000 50,000 20,000 2,39,000
2,07,000
Required : i. Schedule of changes in working capital. ii. Funds Flow Statement 25. The following information are provided: i. Net profit for the year Rs. 60,000. ii. Gain as sale of building Rs. 10,000. iii. Goodwill appears in the books Rs. 20,000 out of that 10% has been written off during the year.
iv. Old machinery with Rs. 10,000 has been sold during the year for Rs. 8,000. v. Rs. 5000 have been transferred to General Reserve fund. vi. Depreciation has been provided during the year Rs. 6,000. Required : Adjusted profit & Loss Account. 26. The Balance Sheets of a Company as on Chaitra 31st, are as follows: Liabilities Year 1 Year 2 Assets Year 1 Share Capital 5,00,000 6,00,000 Fixed Assets 6,00,000 Share Premium 50,000 60,000 Inventories 50,000 Retained Earning 1,00,000 1,50,000 Accounts 1,50,000 50,000 Receivable 10% Debentures 1,00,000 1,00,000 Bills Payable 50,000 40,000 Cash at Bank Accounts Payable 1,00,000 1,50,000 9,00,000 10,50,000 9,00,000 Additional information: (i) Sales for year 2 Rs. 6,00,000. (ii) Cost of goods sold Rs. 3,50,000. (iii) Operating expenses Rs. 1,00,000. (iv) Fixed assets costing Rs. 20,000, sold for Rs. 30,000. (v) Fixed Assets purchased for Rs. 3,00,000. (vi) Dividend distributed Rs. 20,000. (vii) Debentures is redeemed with Rs. 10,000 premium. Required: Cash Flow Statement using direct method
Year 2 8,00,000 1,00,000 1,00,000 50,000 10,50,000
27. The closing assets and liabilities extracted from the balance sheets of a company are as under: Year I Year II Share Capital 1,00,000 2,00,000 Share premium 10,000 20,000 Accounts payable 40,000 70,000 Bills payable 30,000 20,000 Investments 30,000 20,000 Accounts receivable 50,000 40,000 Inventories 30,000 50,000 Cash at bank 30,000 50,000 Additional information: (a) Sales for the year II was Rs. 3,00,000 and cost of sale was Rs. 2,00,000. (b) Operating cost for the Year II was Rs. 50,000 which includes depreciation Rs. 30,000 and interest Rs. 5,000. (c) Debentures of Rs. 50,000 has been redeemed at a premium of 10%.
The sale and purchase of plant in year II was Rs. 25,000 and Rs. 1,00,000 respectively. (e) Divided paid Rs. 20,000. Required: Cash flow statement showing cash from operating, investing and financing activities. 28. The following are the Balance Sheets and the Profit & Loss Account of a company:
Liabilities Share Capital Share Premium 10% Debentures Accounts Payable Bills Payable Retained Earning Year I 3,60,000 36,000 1,80,000 1,44,000 1,08,000 2,52,000 10,80,000 Year II 7,20,000 72,000 2,52,000 72,000 3,24,000 14,40,000 Assets Plant and Machinery Investment Accounts Receivable Inventory Cash at Bank Year I 5,76,000 1,08,000 1,80,000 1,08,000 1,08,000 10,80,000 Year II 7,20,000 2,16,000 1,44,000 1,80,000 1,80,000 14,40,000
(d)
Less:
Income Statement for the Year II Sales Revenue Cost of Sales Gross Profit Operating & Other Cost: Operating Cost (including debenture interest) Depreciation Debenture Premium on Redemption Loss on Sale of Plant (depreciated value Rs. 1,08,000) Total Operating Cost Net Income Before Tax
10,80,000 7,20,000 3,60,000
Less:
72,000 1,08,000
18,000
2,16,000 1,44,000
Additional information: (a) Plant purchased during the year Rs. 3,60,000 (b) Divided paid Rs. 72,000. Required: (i) Cash from operating activities by using direct and indirect method. (ii) Cash from investing activities. (iii) Cash from financing activities. (iv) Changes in cash position.
KEY TERMS INTRODUCED IN THE CHAPTER: Financial Statement, Income Statement, Current Ratio, Quick Ratio, Quick Ratio, Inventory Turnover Ratio, Debtors Turnover , Average Debtors, Average collection period, Average Stock, Fixed assets turnover, Total asset Turnover Ratio, capital Employed Turnover, Debit-equity ratio, Debt on shareholders equity, Earning per share, Dividend per share, Dividend per share, Working Capital, funds, funds from operation, current assets, Current liabilities, Non-current assets & liabilities, operation and Non operating items, Sources of funds, Uses of funds Accrual basis of accounting Cash & equivalents Cash basis of accounting Cash flow from operations Cash from financing Cash from investing Cash inflows Cash outflows Direct method Financing activities Indirect method Investing activities Operating activities Statement of cash flows
Chapter - 4
COST ACCOUNTING
A. Introduction
This unit gives an overview of (and introduction to) cost Accounting, in five sub- units. The first sub-unit deals with conceptual knowledge of cost accounting and different method of costing with classification of costs. The second sub-unit deals with controlling and procedures of accounting for materials & stores. Preparation of stores Ledgers, Stores Routing and computation of different stock levels are included in this unit. The third sub-unit deals with controlling and procedures of accounting for lab ours. The fourth sub-unit deals with accounting for overhead . The last sub-unit is related with unit or output costing. It includes the reparation of Manufacturing Account, Cost sheet and Tender sheet.
B.
Objective
The main objective of the unit is to help the students to acquire the knowledge of cost accounting. After studying this unit, the student will be able to: (i) (ii) (iii) (iv) (v) (vi) (vii) define the cost Account and write objectives, importance advantages, features and limitations of cost accounting. classify costs in the basis of capture, function, variability and controllability. understand the purchasing, storing and issuing procedures. Prepare stores ledger by applying LIFO, FIFO and average method and calculate different stock levels. understand the method or procedure which are necessary for controlling and accounting for labour cost. Define overhead and understand the concept of allocation and apportionment of overhead calculate the cost of production and unit cost showing elements of cost through cost sheet prepare Tender sheet and Manufacturing Account.
C.
Specifications of content Areas of the unit
This unit includes the following sub-units: 4.1 Cost accounting 4.2 Accounting for materials 4.3 Accounting for labours 4.4 Accounting for overhead 4.5 Unit or output costing D. Description of content Areas of the unit 4.1 Cost Accounting 4.1.1 Objectives of financial Accounting The main objectives of financial Accounting are: i) To maintain records of financial transactions according to specified rules. ii) To ascertain profit or loss made by the business at the end of each accounting period. iii) To depict financial position of an enterprise by preparing a Balance sheet. iv) To provide information to different users, such as owners, management , creditors, government, employees, bank and so on. v) To help in determining the tax amount for a financial period. 4.1.2 Limitations of financial Accounting The financial account suffers from the following limitations: i) ii) iii) iv) v) vi) vii) viii) ix) x) It provides only past or historical data It reveals only overall result of the business. It is static in nature. It fails to take into account the impact of price level changes. It fails to exercise control over resources. If fails to provide adequate data for management in carrying out its functions. It does not provide a basis for cost comparison. If fail to provide adequate data for price fixation. It does not make use of control techniques It does not provide cost of various unit or department which are necessary for control and performance evaluation.
4.1.3 Concept of cost Accounting Cost accounting is practice and process of cost which determines the profitability of a business concern by controlling the cost with the application of cost accounting principles, process and rules. It is an art as well as since, and is a prime part of accounting system which records systematically the cost involved in raw materials and lab our used in the process of reduction and at the same time determines the total cost and unit cost of product . It is the process of accumulating, classifying, analyzing cost and presenting them in logical manner for management control and decision making. 4.1.4 Objective of cost accounting The main objectives of cost accounting are i) To ascertaining cost of production ii) To determine the selling price of a product iii) To help to analyses cost iv) To control cost v) To minimize or reduce cost vi) To assist he management vii) To assist in preparation of final account 4.1.5 advantage of cost accounting the cost accounting overcomes the limitations of financial accounting. The following are the advantages of cost accounting. i) The profitable and unprofitable activates of a business can be easily disclosed by the use of cost accounting. ii) Cost may be controlled effectively from cost accounting. iii) Cost accounting helps by providing information for decision making in the business. iv) It helps to fix the selling price at an acceptable rate. v) It plays a vary important role in the inventory control. vi) It provides detail information which are indispensable for formulating the future policies . vii) It helps to prepare a cost reduction plan and provides a guide line for how to achieve it. viii) It helps to identify the reasons of idle capacity. ix) With the introduction of cost accounting, accuracy of financial accounting can be checked indirectly.
4.1.6
Importance of Cost Accounting
Cost accounting has many importunes , specially the following parties are benefited from it: i) ii) iii) iv) v) 1) Management or Manufacturers Investors General consumer of society Employees Government
Importance to management of manufacture
Management or manufacturer is highly benefited with the introduction of cost accounting. It helps to: i) ii) iii) iv) v) vi) 2) ascertain selling price of the product form business policies analyses and classify costs control for the better utilization of resources submit tender and quotation make decision regarding different problem Important to investors
Cost accounting provides a guide line to investors to take correct decision regarding whether to invest or not in specific industry. It provides necessary information regarding cost, price, profitability, financial strength and credit worthiness of the business. 3. Important to consumers
The ultimate aim of costing is to minimize cost of production. Reduction in cost is usually passed onto the consumers in the form lower price. 4. Importance to employees
Cost accounting helps to fix the wages of workers. Efficient workers are rewarded for their efficiency. It helps to induce incentive wage plans in the business. 5. Important to Government
Cost accounting facilitates the government in assessment of excise duty, income tax and formulation of policies regarding industry, export and import.
4.1.7 i)
Features of cost accounting It is a basis for accumulating cost. It is the method of accumulating of manufacturing costs. Costs accumulation may be done by individual jobs or by manufacturing departments of processes. Cost accounting system is complementary to financial account. It gives cost date regarding stock, work -in -progress and finished goods which are necessary for repairing financial statement. It is a basis for ascertainment of product cost. It estimates costs which are desirable in addition to the actual or historical costs. Actual cost incurred for period is used to computer product cost. The cost accounting system is simple and practical. It is flexible in nature. Expansion or contraction or contraction may be possible accounting to changed conditions and circumstances. Difference between cost accounting and financial accounting.
The following are the features of a cost accounting system:
ii)
iii)
iv) v)
4.1.8
The followings are some of the most important differences between financial accounting and cost accounting: 1. 2. 3. Purpose: the purpose of financial accounting is reporting whereas the purpose of cost accounting is for external reporting. Statutory requirement: financial account is compulsory by law but cost account is kept to meet the requirement of management and it is optional. Duration if reporting : Financial account covers the transactions of whole form for a definite period but cost accounting furnishes cost data at frequent interval. Some reports are prepared daily, some are weekly and some monthly. Efficiency: the information provided by financial accounts is not sufficient to evaluate the efficiency of departments and business , whereas cost accounting helps in evaluating the efficiency of the departments and entire organization. Cost Control: Financial account lays importance to recording aspect instead of control. But cost accounting provides importance to control of cost with recording. Basic: financial account is historical in nature while cost account is historical and futuristic as well. Stock valuation: The stock is valued by financial account at cost or market privet whichever is less. But the stock is always valued of cost price by cost account.
4.
5.
6. 7.
8.
Dealings: financial account deals with actual facets and figures and external transactions, whereas, cost accounting deals with internal transactions and also partly with estimates. Dependability: the financial account is quite independent of cost accounting while cost accounting is depend up on financial accounting for basic data. Analysis of Profit: financial accounting discloses profit for the entire business as a whole, whereas, cost accounts shows the profitability of otherwise of each products, process or operation so as to reveal the area of profitability. Pricing: financial accounting fails to guide the formulation of pricing policy. But cost accounting provides adequate data for formulating pricing policy. Usefulness: financial accounting is suitable to all types of business. Whereas cost accounting is useful specially to production and service industries. Methods and techniques of cost accounting
9. 10.
11. 12.
4.1.9
4.1.9.1 Method of cost accounting The concept and rules relating to determine the cost of a product or service is called cost accounting methods or costing. There are different methods of costing: i. Job order costing ii. Unit costing iii. Process costing iv. Operating costing v. Contract costing vi. Batch costing vii. Multiple costing I. Job order costing:
Job order costing is used in an organization where goods are produced according to specification or the order of the customers. In this method of costing goods are not produced at the producers will. Therefore, there is no similarity in production process. Each job involves different operation. The object of job costing is to ascertain the cost of each job separately.
II.
Unit Costing
It is a method of costing by production, unit where manufacturing is continuous and units produced are identical in nature. This method is also called single or output costing. By preparing a COST SHEET, the cost per unit is arrived at by dividing the total cost by the number of units produced. III. Process costing
It applies to industries where production is carried on through different stages of processes before coming a finished product . it is a method of costing where cost is ascertained at the stage of every process and also after completion of production process. IV. Operating Costing
Operating costing is used by the organization which renders services like transport, electricity, hostels, canteens, etc. although they do not produce manufactured goods like manufacturing company, but do need to cost their unit of output i e. service as in the case of manufacturing industries. V. Contract Costing
Organization engaged in construction work or contract generally adopt this method of costing . for each individual contract, separate accounts have to be kept. Basically this type of costing is similar to job costing, but differs on length of time. VI. Batch costing
This method is used to determine the cost of group of identical of similar product called batch. It is an extension of job order costing where a firm receives number of orders for special nature and similar types of goods. In the method, a batch of similar products is treated as a job and the cost are accumulated in respect of a batch. VII. Multiple costing
The application of two or more than two costing method for determination of cost of final product is known as multiple costing. This method is adopted in a manufacturing concerns where a variety of pars are produced separately and later on they are assembled into a final product. It is also known as composite costing.
4.1.10.2 Techniques of cost accounting Some of the important techniques of cost accounting are as follow: i) ii) iii) iv) v) vi) Historical Costing Standard Costing Marginal or variable costing Absorption or full costing Uniform costing Direct Costing
i. Historical Costing or traditional costing Historical costing is a technique of costing under which costs are deter minded after they have been incurred. ii. Standard costing The costs are determined in advance of production, which is known as standard cost. The standard cost are compared with the actual cost. The difference between the actual cost and standard cost is termed as variance. The variances are recorded and causes there of are investigated and remedial steps are taken. This system enables for control of cost and also in measuring the efficiency of operation. iii. Marginal or variable costing
Under this technique, a distinction is made between variable cost and fixed cost . Only variable costs are charged to cost of production. Fixed costs are not treated as product cost . iv. Absorption or full costing:
Costing which absorbs both fixed as well as variable cost to determine the cost of production is called as Absorption costing. v. Uniform costing It is mot a distinctive form of costing, but is and attempt by several undertakings and organization of similar nature to use uniform costing principles and or practices for example Hotel industries, Banking Business etc.
vi.
Direct costing:
Costing system that absorbs only the direct expenses and excludes all indirect expenses in the calculation of total cost of production of total cost of production is called is direct costing. 4.1.11 Brief introduction of cost Cost represents a sacrifice, a foregoing or a release of something for obtaining something. It is the amount of expenditure, actual (incurred) or notional ( attributable), relating to a specific thing or activity. The specific thing or activity may be a produce, job, service, process or any other activity. A cost is composed of four elements: i) ii) iii) iv) i). Material Labour Expenses Overhead Material: all types of goods used in the process of production are called material and the expenses incurred for material is termed as material cost. It also include all those cost associated with the purchase of material and its storing an handling costs. The example of which are excise duty, custom duty, dock charges, inspection cost, etc. Material costs are of two types. A. B. (a) Direct Material cost Indirect Material cost
Direct Material cost: Those material cost which can be directly identified with each unit of finished product, is known as direct material. Direct material generally become a part of the finished product. Indirect Material cost: Those material which necessary for production but cannot be traced as a part of the product produced is known as indirect material . costs of these materials cannot be directly identified whit a particular unit of product. Lab our: cost paid for the work made by a person is known as labour cost . wages, salaries, commission, bonus, etc. are included in labour cost. There are two classes of lab our involve into production of goods. They are: (a) Direct Labour (b) Indirect Labour
(b)
(ii)
(a)
Direct Lab our : The wages paid to the workers directly engaged in manufacturing process a goods in knows as direct lab our cost. Such wage can be conveniently identified with a particular, job or process. Indirect Labour: Labour whose wage cannot be allocated, but that can be apportioned to a product is known as indirect lab our cost . Indirect labour be directly identified with a particular job or cost unit. Expenses: all other cost other than materials an lab our costs are termed as expenses for simplicity, Royalty, Hire charge, rent, cost of training of new employees, etc. are the example of expenses. These types of expenses may be sub-divided into two heads. (a) (b) Direct Expenses Indirect Expenses
(b)
(iii)
(a)
Direct Expenses: Expenses other than direct material and direct lab our, which can be conveniently identified with an unit of output in known as direct expenses. Direct expenses are also known as chargeable expenses, prime cost , process expenses or productive expenses. Cost of hiring special plant, cost of designing or pattern of building, royalty, excise duty, cost of rectifying defective work, etc. are the examples of direct expenses. Indirect Expenses: expenses other than indirect material and indirect lab our are indirect expenses. These expenses cannot be identified or traced out for a particular job or product. Rent of building, insurance premium, depreciation, repairs and maintenance, welfare and medical expenses, etc. are the examples of indirect expenses. Overheads:- The aggregate of indirect of indirect material cost, indirect lab our and indirect expenses is knows as overheads. Indirect cost refers to cost which cannot be allocated but which should be apportioned or absorbed by cost centers or cost unit overheads. Overheads cost are also knows as 'burden'. Overheads may be sub-divided into the following groups. a) b) c) d) Production overhead Administrative Overhead Selling Overhead Distribution overhead
(b)
(iv)
(a)
Production overhead or works overhead or factory overhead or manufacture overhead: it represents all those costs other than direct material, direct lab our and direct expenses , which are incurred in the manufacturing process. They are: 1. 2. 3. 4. 5. Indirect materials in work Indirect wages to workshop employees Factory expenses like rent, rates, taxes, insurance, repairs etc. Depreciation on plant, machinery and maintenance of factory building Welfare and medical expenses of factory employees.
(b)
Administrative overhead or office overhead: The represent cost associated with the office and administration. It consists of all expense incurred in formulating the policies, directing. The organization and controlling he operation of and undertakings. Examples ate: 1. 2. 3. 4. Office expenses including rent, taxes, lighting, printing, stationery, insurance, postage, telegram telephone, etc. Salaries of office staff, accountant ,directors. Legal expenses, audit fees, etc. Depreciation on office building and other assets used in the office.
(c)
Selling overhead: cost incurred in selling and distribution of product is termed as selling overhead. Sales department expenses, sales department salary, advertisement, expenses of sales promotion, gifts, samples, expenses on market research, etc. are the example of selling overhead. Distribution overhead: These are the expenses concerned with the delivery and dispatch of finished goods to customers. Cost of packing cases, upkeep of delivery vans, warehouse rent, warehouse insurance, loading expenses, carriage outward, etc. are the example of distribution overhead.
(d)
(Notes: Selling overhead and distribution overhead can be combined together and which may be termed as selling and distribution overhead) 4.1.12 Classification of costs Costs have been classified in different ways in accordance with their common characteristics. The following are the important ways of classification: i) ii) On the basic of element of costs. According to functions
iii) iv) i)
According to variability According to controllability
on the basic of element : Under this basic costs can be classified into: a) b) c) Material cost Lab our cost Expenses
The meaning of these termed have been already discussed in sub-unit 4.1.11. These classification can be shown as follows: (ii) on the basic of functions:
Element of cost
Material
Lab our
Expenses
Direct
Indirect
Direct
Indirect
Direct
Indirect
according to function classification cost may be sub- divided into four parts. These are: a) production cost b) Administration cost c) Selling cost d) Distribution cost (a) (b) Production cost: Those costs incurred in fabrication and assembling of units of output is knows as production cost. Administrative cost: as has been defined by the terminology, the sum of those cost of general management and secretarial accounting and administrative services are called administrative costs. These cannot be directly related to the production, marketing, research or development functions of the enter prince. Selling cost: This has been defined as cost of securing and execution of orders. Distribution cost: distributions cost refers to those costs which are incurred to promote sale and also to facilitate the movement of goods into the hands of purchases.
(c) (d)
(iii)
On the basis of Variability: Costs can also be classified according to variability or behavior of cost . they are: (a) (b) (c) Fixed cost Variable cost Semi- variable cost
(a)
Fixed cost: fixed costs are those cost which will remain constant for all or different level of output costs which tend to remain constant tat the different level of output are called fixed cost . some important features of fixed cost. (i) The amount of fixed cost remain constant for varying level of output. (ii) Fixed cost per unit will decrease with increased output and vice- versa (iii) Fixed cost is controllable by the top level (iv) Some fixed costs ate controllable at the supervisory level and most are not controllable by the departmental supervisors.
(b)
Variable cost: cost that charges directly and proportionately with the change in level of output , therefore it tends to vary with the volume costs are: (i) Only total cost varies in direct proportion to volume of output or sales (ii) The variable cost per unit of product remains constant (iii) The cost incurred for any product of departments may be identified easily (iv) Control over variable cost lies in the hands of departmental heads.
Important features of variable costs are:
(c)
Semi-variable cost: A cost containing both fixed as well as variable element is knows as semi variable cost. The variable portion of semi-variable cost is affected by fluctuation in volume of output or turn over. Like variable cost the portion increases or decreases proportionately with the increases or decrease of volume of output, but the fixed portion of the semi-variable cost remains constant for all level of activities. Therefore a semi-variable cost increases with the increase in level of output, but the will not be proportionate as in the case of variable cost. On the basic of controllability: on the cost is classified into two types. Those are: a) controllable cost b) non-controllable cost
(iv)
a) b)
Controllable cost: cost which is influence by the action of management is controllable cost. Practically all variable costs are controllable. Non-controllable cost: cost which cannot be controlled bu management action is called uncontrollable cost. All fixed costs are non-controllable cost. E.g. depreciation of plant and machinery, rent of building. Accounting for materials Meaning of materials
4.2 4.2.1
Commodities which are used in the production of finished product are called materials. It includes all raw materials and supplies such as lubricants, fuel and loose, tools, etc. therefore, materials and stores are used interchangeably sometimes. Sometimes materials are also denoted by the term 'inventory' inventory includes all raw materials , semi-finished goods and finished goods. Materials are two types-Direct materials and indirect materials. 4.2.2 Martial control The term material control means a systematic control over purchasing, storing and consumption of material, so as to maintain a regular and timely supply of materials, at the same tine avoiding over stoking. It covers following three stages: 1. Purchases of materials 2. Storing of materials 3. Issue of materials 1.2.3 Need for Material control Material Control is require for following reasons. i) ii) iii) iv) v) To ensure the availability of material To ensure optimum investment in materials To ensure minimum wastage To provide information about the availability of material To ensure reasonable price.
4.2.4
Objective of Material Control The basic objective of material control are to manage regular supply of material for uninterrupted production and sales function and to minimize the investment of resources in material and investment.
Some basic objective or function may be sub-divided as: i) To make available of all typed of materials and stores of right quality without any interruption. ii) To purchases materials of required quality iii) To purchase materials at reasonably low cost or at maximum economy iv) Investment in material should not tie up huge amount of capital. There should mot be overstocking . v) To avoid abnormal wastage, leakage, etc., of the materials, storekeepers must be trained to minimize the loss of stores. vi) To avoid obsolescence of materials by adopting better method of issue of materials. vii) To provide the management with information of raw materials cost, availability etc, viii) To ensure proper storage and utilization of materials. ix) To avoid overstocking of materials to minimize investment in material. 1.2.4 Essentials of Material Control
The following are the general requirement of material control: i) There should be proper coordination between sales, production, purchasing, receiving, inspection, storage departments. ii) There should be a system of centralized purchasing. iii) All item in stores should be codified, classified and standardized. iv) Standard form should be used for issuing, transferring, returning, etc. v) Material storage should be planned to avoid losses from damage, theft, evaporations, pilferage, deterioration etc. vi) Proper store control should be used. vii) Stock at different levels should be fixed to ensure that there is no shortage and overstocking of materials. viii) Re-ordering quantity should be fixed to reduce the ordering cost and carrying cost. ix) Issue of material should be on the basis of requisition. x) Requisition and stock must be priced on a suitable basis in order to ensure reliable costs. xi) Information about material purchased, issued, obsolete, soiled, defective, etc., should be made continuously available to management.
4.2.6
Advantage of Material control A good system of material control have the following advantages: 1. Eliminates wastage in use of materials 2. Minimizes loss on account of theft, loss, fraud, etc, 3. availability of the right quality of materials in time. 4. Avoids over stocking. 5. Economic buying is possible. 6. possible to have quick & interruption in production due to materials. 7. Reviewing and revising of product design and savings in materials.
Store Routing Store routing refers to he procedures relating to material or material scheduling . it includes: 1. Purchase procedures. 2. Inspection and Receiving of materials. 3. Store keeping procedures. 4. Issuing procedures Procedures relating to materials can be depicted in following chart: Purchase Requisition Purchase department
4.2.7
Suppliers
Placing Orders
Inviting quotation & Tender
Goods received Note
Inspection
STORES 1. Receiving 2. Storing 3. Issuing Account Department
Invoice & Payment 4.2.8 Purchasing
Purchasing is the most important function of material management. The objective of purchasing is to procure right material:
a) b) c) d) e) f) g) h)
at right rice of right quality on right contractual terms on right time from right source to delivery on right place by right mode of transportation on right quantity
Efficient purchasing avoid late delivery and production delay. 1. Purchase control
An effective material control requires a good amount of attention ti the purchasing procedures of materials. Purchase control avoids purchasing of unnecessary materials, unnecessary quantity of materials and purchase at unreasonable price. Purchase control is an in built system of managing the purchasing function of and organization. It generally stats with initiation of purchase requisition and ends with receipt o materials by store and payment of bills. Purchase control aims to achieve the following: i) ii) iii) iv) v) vi) To ensure uninterrupted flow o materials. To ensure that capital is not blocked in surplus and obsolete stock To make the purchase at the most economical prices. To purchase the right quality of materials. To ensure timely delivery of the purchased items. To maintain alternate sources of supply if a particular supplier fails to supply the materials.
4.2.8.2 Centralized Purchasing The purchase of materials under on purchase department is referred by centralized purchasing. A centralized purchasing is advantageous in the following respects: 1. The company can employ specialized and experienced purchase executives who can study the trends of the markets and secure & purchase on most favorable terms. Bulk purchase can be made at a cheaper rate and at a good trade discount. Excessive purchases, overlapping or duplication in purchase is avoided. Quality of the materials can be maintained through the specified knowledge of personnel.
2. 3. 4.
5. 6. 7. 8. 9.
Better layout o stores is possible. It is possible to reduce investment in stock. Records relating to material and stores can be kept in one central place. Transport cost can be minimized. It is possible to minimize cost in clerical work, lab our time and efforts.
There are certain demerits of centralized purchasing. They are: 1. It involves high initial cost. 2. There may be delayed in getting materials from the central stores. 3. Emergency purchase cannot be made under this system. 4. There is possible to issue material of wrong quality. 5. Unnecessary material may be purchased by the purchasing department. 4.2.8.3 Purchase procedure The purchasing procedures vary from one business to another, but all of them follow a general pattern in the purchases and receipt of materials. The main steps involved in the purchase procedure can be depicted in the following chart:
1.
PURCHASINGPROCEDURES
1. Receiving Parching requisition (a) Supplier's search (b) Request for teachers. ( c) Receipt of Quotation (a) Supplier's selection (b) Purchase Orders. ( c)Receipt of goods
2. Inviting Quotation
3. Placing Orders
4. Receiving & Inspecting materials
Receiving Purchase Requisition. A purchase requisition is a formal request made to the purchase manager to arrange for the purchase of materials described in the purchase requisition. Purchase requisition is made by the storekeeper or a responsible clerk. Sometimes, it is also initiated by other departments. The form of purchase requisition, generally used, is as follows:
ABC Co. Ltd.

purchase Requisition No Department .. Date by which materials are required .. Purpose for which materials are required ..
Serial No
Stock No.
Description
Quantity
Remarks
Requested by For use in purchase department
Approved by.
Quotation invited on From : 1.. 2.. 3 Order laced if any . Purchase officer ........
Purchase requisition is prepared in triplicate so that: i) ii) iii) 2. The first copy is sent to purchase department The second copy is sent to the production department from where the stores requisition has been received. The third copy is retained in the department, which initiates the purchase requisition. Inviting Quotation
After receiving purchase requisition, the purchase department will invite quotations. Generally the purchase department maintains a roster of possible supplier of different material. Sometimes a public notice is given in the news paper by inviting tender for the supply of materials where roster of probable supplier are either not available or would like to explore the source of supplier at the cheaper price. Purchase department issues tender form in following format to supplier:
A B C Co. Ltd Request for quotation This is not an order. No Date: To, .. . Dear sir, We are interested in purchasing the following materials , please quote us your terms, conditions and delivery date. S.No Description of Materials Quantity Quantity required Date of delivery Price remarks
Yours faithfully, For A BC Co. Ltd A comparative statement of all quotation received is prepared o select the supplier. The specimen of comparative statement of quotation is given below: A B C Co. Ltd Comparative statement of Tender No Name of material.. S.N. Name dealer of Price Quantity Date:-.. Terms of delivery Others terms remarks
Prepared by
3.
Placing orders
After selecting the supplier, the purchase department proceeds to place the order for the materials. The purchase order will be issued to the supplier, whose quotation is the lowest as revealed by the comparative statement. A purchase order is a contractual document which authorizes the supplier to supply the material. Once the purchase order is issued to a supplier, it is obligatory on the part of purchase manager to take delivery of materials and arrange for the payment of in, generally the following factors maybe considered in selecting a supplier for placing an order: 1. Reasonableness of rates. 2. Quality of supplies . 3. Timely delivery of goods. 4. Mode of delivery and transportation charge. 5. Reliability of supplier. 6. Terms of payment and discount offered. 7. 8. The financial standing and reputation of the supplier. Courtesy and prompt attention in attending order.
A specimen of the purchase order is given below:
A B C Co. Ltd Purchase Order Supplier .. No .. Date:-.. Please supply the following subject to the terms and condition mentioned herewith. S.N. Description Qty. Price Amount
Please quote purchase order number on all advice notes and invoices. Place of delivery. Chief buyer.. Date of delivery.. Terms and condition:. .. ..
Purchase orders are prepared generally in five copies sent to concerned departments: a) b) c) d) e) 4. First copy goes to supplier. The second copy is retained in purchase department . The third copy goes to account department along with the receipt note and the invoice for payment . The fourth copy to the department which initiated the purchase requisition . The fourth copy to material receiving department.
Receiving and inspecting materials When the materials order are delivered by the supplier the material received are inspected by the inspector or inspection clerk to ensure the necessary quality of material supplied and their agreement with the inspection specifications. Following form is used for preparing inspection report.
A B C Co. Ltd Material Inspection Report No Goods received note no.. Date. Supplier's name . Purchase order No. ........ Purchase order date. . S.N. Description Code no Quantity Received Special remarks. Accepted Rejected Reasons rejection
Inspector
Generally, four copies of material inspection report are prepared and sent to concerned departments: a) Purchase departments b) Receipt Departments c) Stores department d) Inspection department Along with the inspection report, materials will be received by procurement department or by stores. The receiving department will prepare the goods received note on receiving of materials .the goods received note is prepared in following format:
A B C Co. Ltd Goods Received Note Supplier .. Purchase order No .. No Date:-
S.N.
Description
Code no
Quantity
Amount
Remarks
Received by................................. Stoke keeper................................ store ledger posted by.............................. 1st copy: stores department 2nd copy: Account department 3rd copy: Receiving departments
Inspected by......................
4.2.9. Store keeping Store keeping is concerned with the physical storage of materials. it is essentially a service function. it should aim at providing this service efficiently and effectively at a minimum cost. The essentials of good stoke- keeping are outlined below: a) Allot a proper place for every item of store b) Keep every item of store in the allotted place. c) Maintain proper records of stores and keep them up-to-date. d) Issuing materials promptly to various departments. e) Storing materials in an orderly fashion. f) Protecting materials against damage and pilferage. g) Issuing oldest material first. h) Classify and codify the materials for easy identification. i) Adequate space must be provided in between racks and bins for easy movement of stores assistance. j) Undertaking continuous verification of materials. 4.2.10 Types of Stores Following are the three types of stores: a) Centralised stores b) Decerntralised stores c) Central stores with sub-stores.
a) Centralised stores: If materials are received by and issued from one store department, that is known as centralised stores. under this system, there will be only one store for entire department o an enterprises. there are advantages of centralised system. Advantages: (i) Economy in cost. (ii) Better supervision of stores and control are possible. (iii) Better layout of stores and control are possible. (iv) Less space is required as stores are kept in minimum. (v) Minimum investment in stores is possible. (vi) Better forecasting of requirements of material is possible. (vii) Economy in staff and stationery. (viii) A high specialized purchases can be appointed for securing maximum advantage in purchasing. (ix) Constant and easy stock-taking is possible. (x) Better safety and security of stock. Disadvantages: Following are the disadvantages of centralized stores: i. Cost of materials handling may increase. ii. Delay is generally found. iii. Overcrowding of materials will affect storing & control. iv. Breakdown of transport will adversely affect production. v. The risk of loss by fire is greater. (b) Decentralised Stores: This is a system where each department has its own store. The purchasing and handling of materials are undertaken by the buyer of each department. Advantages: i. Economy in material handling cost. ii. Delay in material issue will be eliminated iii. Storing and control will be easy. iv. Production will not be affected due to transport interruption. v. Risk of loss by fire will be minimum. Disadvantages i. Multiple stores increase cost ii. Lacks efficient store control iii. Increases stores spaces and staff.
iv. Stock taking and checking takes time v. Increases investment in stores. (c) Central store with sub stores This system is followed in order to minimize material handling expenses. Under this system a sub-store is located near the production department. Such system is also known as impress system of store control. The advantages of this system of this system are as follows. Advantages: i. It minimize the demerits of centralized store ii. It relieves the burden of central stores from sundry issue. iii. Multiple sub-stores allow room for improved store management. iv. It facilitates easier location of discrepancies in stores. v. It avoids delay in issuing materials. Disadvantages: i. It makes store control complex. ii. More store space along with more staff will increase cost. iii. Stock taking will be time consuming. 4.2.11 Location of stores Physical arrangement of storage space and facilities so as to provide for most efficient receipt, storage issue of materials are referred by location of stores. Stores should be located centrally for facilitating prompt receipt and issue of material. A planned location of store will facilitate easy movement of materials handling. The location of store is affected by number of factors, which are as follows: i. Nature of material ii. Distance of stores and user's department iii. Quantity to store iv. Available space for store. v. Safety requirement Following points should be kept in view in determining the location of store. a. Store should be near to transportation facility. b. Store should be easily accessible to all user departments. c. Store should be centrally located to reduce internal transport cost. 4.2.12 storekeeper The store is headed by a competed authority known as storekeeper is responsible for store control. A good storekeeper must possess the following requisites. a. He must be hard working b. He must be honest
He must have knowledge of accounts. He must possess leadership abilities so as to command his subordinates to carry out storekeeping functions efficiently. e. He must have enough academic qualification depending upon the type of industry. The main functions of storekeeper are: i) ii) iii) iv) To prevent production stoppage due to shortage of materials To supply material required by the production department. To provide safety to materials in store. To supply materials on the basis of daily authorized requisition slip.
c. d.
4.2.12.1 Duties of Storekeeper a) To prepare and issue purchase requisition note for materials which have reached to re-order level. b) To received purchased materials from receiving department. c) To enter the particulars of materials in the bin card. d) To store materials in their appropriate place for easy identification. e) To issue the materials to production department on the basis of "material requisition note" f) To take back the surplus materials returned by production department. g) To undertake stock verifications of materials. h) To report on scrap, waste, surplus, obsolete materials to management for taking necessary action. i) To equip the storeroom with material handling equipment for easy and economical handling. j) To prevent unauthorized persons from entering into the storeroom. 4.2.12.2 Responsibilities of Storekeeper a. The storekeeper is responsible for the material which he receives. Therefore at the time of receiving of materials in to the storeroom he must verify the quantity, quality and the specification of materials. b. He is responsible for the timely issue of material. So, the storekeeper has to classify and codify the materials and store then at appropriate place. c. Ht is responsible for shortage of materials on account of theft, damage and spoilage. d. It is the responsibility of the storekeeper to work in close co-ordination for the smooth functioning of the factory. e. He is responsible for the negligence of his as well as his subordinates duties.
4.2.13 Classification and codification of Materials The process of grouping of each material either on the basis of their nature or on the basis of their usage is known as classification. The procedure for assigning symbols for each items in accordance with a proper arrangement is known as codification. There are four methods of codifications. They are: a) b) c) d) Alphabetical Alphabets are used fir codification, in this method. Numerical In this method, each item is allotted a numerical. Mnemonical Abbreviations are used in this method e.g. P.m. for production material. Alphabetic & numeric method : A combination of Alphabetical & numerical methods also may be used for coding .
4.2.14 Recording of materials received Two records are generally maintained in stores. They are: i) Bin card. ii) Store ledgers i) Bin cards : A pace or cupboard where materials have been kept is denoted by bin and the card issued to identify and record the materials at the bin known as bin card. The physical movement of each material in store is shown by bin card. It show the quantity of materials received , issued and an balance at any time . to each bin a card is attached for identify and showing the stock position and that card is termed as bin card. A specimen of bin card is given below: BIN CARD Discretion Minimum Level store ledger No . Maximum level Bin No Code No.. Re-order level Re-order quantity
Date
Received Ref. No. Quantity
Issued Ref .No. Quantity
balance Quantity Check Date Initials
ii)
Store Ledger
A store ledger is a record of stock both in quantity and value. It shows receipt, issues and balance of materials both in quantities as well as in values. It is maintained in stores accounting section and is outside the control of storekeeper. The pro-forma of stores ledger is given below: STORE LEDGER Material Code No.. Location Bin No. Date G.R.No Receipts Qty Rate Amt. Qty Maximum level Minimum level Re-order level.. Re-order Quantity Issues Rate Amt. Qty. Balance Rate Amt.
G.R. No:- Goods Received note number S.R.No:- stores requisition number A store ledger can differs form a bin card in the following respect: 1. 2. 3. 4. Bin card is maintained by the respect by the storekeeper while stores ledger is maintained by costing departments. Bin card is a record o quantities only whereas stores ledger is a record of quantities and values. Entries are posted individually in bin card whereas these are posted periodically in stores ledgers. In bin card posting is generally made before the transaction take place. But it is done after the transaction in stores ledger.
5. 6.
A bin card cannot show inter-departmental transaction. But it is shown by the store ledger. A bin card cannot supply inventory value for the preparation on finical account whereas a stores ledger can easily supply the inventory value.
4.2.15 Perpetual Inventory system It is a stoke control system. It is method of recording store balances after every receipt and issue under this system two bin cards are maintained one in the store and the other at the control department to show continuous movement of stores to the control. The main objective of this system is to make available details about the quantity and value of stock at all times. A perpetual inventory system is usually supported by a programmer of continuous stock taking . under this system a number of items are physically verified daily with reference to bib card balance. A physical verification programmer is drawn to cover each item by rotation. The success of the perpetual inventory system depends upon the following: 1 2 3 4 5 6 Maintenance and up-to-date writing up of bin cards and stores ledger. reconciling the quantity balances shown by bin cards and stores ledger. Checking the physical balance of number of items every day systematically and by rotation. Explaining promptly the cause of discrepancies between physical balance and book figures. Making corrective entries where called for after noting the discrepancies. Removing the cause of discrepancies.
4.2.16 Material Issue Procedure Material issue is Carrie out by the storekeeper. the materials should be issued at the right time, in right quantity and of right quality. for these purpose every organization must develop a issue procedure. all issues should be recorded in the Bin card by the storekeeper and in the stores ledger by cost department. For the authorization of material issues, material requisition note is prepared. Whenever, materials are required from the store the foreman or departmental head imitates a material requisition note. It is a formal request to issue the material. It contains
information about the description, code, quantity of material and job or work order for which it is needed. Generally a material requisition note is prepared in triplicate. One copy is meant for further reference and the other two copies are sent to the stores. The storekeeper, at the time of issue, posts the requisition in the bin cards, sends the first copy to the store accounting section and the other copy is kept by him, for his own record.
Store/Material Requisition Note Job process no................. Department/Shop................................... No.................................. Date:-..............................
To, The storekeeper Please issue the material stated herein Description Code no. Quantity For cost office Rate Value Remarks
Bin No.............................. Stores ledger folio No...................... Stores ledger folio No....................... Issued by........................ Received by................. Priced by.......................... Authorized by .................
4.2.17 Pricing of Material Issue There are number of methods which may be employed for pricing of material issues, however only the following methods are prescribed in the syllabus 1. First in first out (FIFO) method. 2. Last in Last out (LIFO) method. 3. Simple average method. 1. First in First out (FIFO) method.
This method takes into account of the price of materials at which they are bought for the purpose of valuing them at the time of issue. Stock are priced out at the old stock price and the price of new will be charged afterward. It must be noted here this is a method of valuing or forcing of material used for production to facilities the output costing and it has no relation with physical movement of material in stores. The important effects of using FIFO method are: a) Materials are priced at the actual cost. b) The current cost of production includes the oldest price of materials. c) Closing stock is valued at the latest price paid. Advantages 1. This method is easy to understand and simple to operate. 2. Closing stock reflects the current market price 3. Materials are issued at actual cost. As a result unrealized profit or loss will not arise from the operation if this method. 4. If purchases are few and if the prices of materials remain stable he method will be simple to operate. 5. This method recovers the cost of material and cost of production includes real cost of material. Disadvantages: 1. Issue price do not reflect current market price nor so does cost of production. 2. When prices fluctuate, calculation becomes complicated. 3. Two similar jobs cannot be compared as different rates of materials are used to execute the jobs. 4. The calculation is complicated under FIFO and there is chance of clerical errors. 5. Materials returned to stores are treated as new purchases for the purpose of next issue.
Illustration 1 The purchased and issued of material during the month were as follows: Magh 1 Opening stock 1,000 units @ Rs 4 each 3 purchased 800 units @ Rs. 4.20 each 5 Issued 1200 units 12 purchased 16,00 units @ Rs. 4.20 each 17 Issued 1500 units 20 purchased 900 units @ Rs. 5 each issued are to be priced on the principle of first in first out. Required : stores ledger account.
Solution: Stores ledger account (FIFO)

Date Magh1 3 5 12 17 20 Particulars Units Balance b/d Goods received note no Requisition slip no Goods received note no Requisition slip no Goods received note no 800 1600 900 Receipts Rate 4.20 4.20 5 Rs. 3360 6720 4500 Units 1000 20 1500 Issues Rate 4 4.20 4.20 Rs. 4000 840 6300 Units 1000 1000 800 600 600 1600 700 700 900 Balance Rate 4 4 4.20 4.20 4.20 4.20 4.20 4.20 5 Rs. 0000 4000 3360 2520 2520 6720 2980 2940 4500
Value of closing stock 700 units @ Rs. 4.20 = Rs. 2940 900 units @ Rs. 5 = Rs. 4500 2. Last in First out Method
This method is exactly the opposite of FIFO method. The assumption of this method is that the materials last purchased are issued first. The issues are priced at the unit cost of the latest lot or the most recent purchases. As such the balance on hand is priced at the cost of the earliest purchases. Three pointes should be noted regarding this method.
a) Material issues are priced at actual cost. b) Charge to production for material cost is at the latest price paid. c) Closing stock valuation is at the oldest prices paid and is completely out of line with the current prices. Advantages: a) This method is easy to understand and simple to operate. b) This method, like FIFO does not result in any unrealistic profit or loss. c) Issue prices reflect current market rates which is more realistic. d) It is most suitable when prices are rising. Disadvantages: a) Tow similar jobs cannot be compared because of charging of different rates of materials to different jobs. b) The closing stock is valued at the oldest price and does not represent the current economic values. c) This system is not accepted by income tax authorities. d) It involves considerable clerical work Illustration 2 The purchases of a company were made during the month as follows: 10.1.2056 12.1.2056 25.1.2056 15.1.2056 12.1.2056 28.1.2056 60 units @ Rs. 10 per unit 90 units @ Rs. 12 per unit 30 units @ Rs. 15 per unit 40 units 40 units 40 units
Issued of the month were as follows.
required: stores ledger for the month of Baisakh on the assumption that materials were issued on last in first out principle.
Solution: Stores ledger account (LIFO)
Date
Particulars Units
2056-110 1-12 1-15 1-22 1-25
Goods received note no.... Goods received note no.... Requisition slip no Requisition slip no Goods received note no....
60 90 30
Receipts Rat Rs. e 10 600 12 15 1080 450
Unit s 40 40 -
Issues Rat Rs. e 12 12 480 480 -
Units 60 60 90 60 50 60 10 60 10 30 60
Balance Rate Rs. 10 10 12 10 12 10 12 10 12 15 10 600 600 1800 600 600 600 120 600 120 450 600
1-28
Requisition slip no
30 10
15 10
450 120
Material returned to vendor These materials returned should be accounted for at the same rate at which they were originally purchased. Transfer of material from one job to another Entries for transfer of materials from one job to another will be passed on the basis of material transfer notes debiting the job, receiving the materials and crediting the job giving the materials at originally issued price. Discrepancies in Physical Stock The discrepancies should be adjusted in store ledger and in card and pricing of such discrepancies should be made on the basis of system of pricing followed: Illustration 4 The following is an extract or receipt and issue of material during Magh 2055 Date Magh 3 4 5 6 Receipt 1500 units@ Rs. 21 each 1000 units@Rs.22 each Issue 1800 units 720 units Returns -
7 8
30 units to vendor purchased on 6th Magh. 9 Received back 40 units @ Rs 21 each 10 5000 units 11 500 units @ Rs 25 each 400 units 13 90 units On 15th Magh, when the stock is verified, it is found that actual stock is more by 20 units. The opening inventory at the beginning of Magh was 2000 units @ Rs 20 each. Required: stores ledger under FIFO method. Solutions: Stores Ledger under (FIFO) method
Date Particulars Unite Magh 1 3 4 5 6 7 8 9 10 11 12 13 15 Balance b/d Requisition slip no.. Goods receipt note no Requisition slip no.. Goods receipt note no Requisition slip no.. Returned Goods receipt note no Requisition slip no.. Goods receipt note no Requisition slip no.. Requisition slip no.. Debit note no.. 1500 1000 40 500 20 Receipt Rate 21 22 21 25 25 Rs. 31500 22000 840 12500 500 Unit e 180 0 200 520 980 420 30 40 460 90 310 90 Issue Rat e 20 20 21 21 22 22 21 22 22 25 25 Rs. 3600 4000 10290 20580 9240 660 840 10120 1980 7750 2250 Balance Unit Rat Rs. e e 2000 20 40000 200 200 1500 980 980 1000 580 550 40 550 90 90 500 190 100 120 20 20 21 21 21 22 22 22 21 22 22 22 25 25 25 25 4000 4000 31500 20580 20580 22000 12760 12100 840 12100 1980 1980 12500 1980 2500 3000
1400 units -
Value of closing stock = 120 units @ Rs. 20 each = Rs. 3000
Illustration 5 The following are the details of receipts and issues of material in a factory during Magh. Magh1 opening balance 500 kgs at Rs. 30 per kg 3 Issue 250 kgs 13 received from vendor 200 kgs at Rs.28 per kg 14 refund of surlus from a work order 15 kgs at Rs. 25 prr kg 16 Issue of 180 kg 20 Received from vendor 240 kgs at Rs. 26 per kgs 24 Issue 305 kgs 27 Refund of suplus from a work order 12 kgs(issue on 16th Magh) Issue are to be priced on the basis of LIFO. The store verifier of the factory mortified than on 15th Magh he had found a shortage of 10 kgs. Required: store ledger account. Solution: Stores Ledger under (LIFO) method
Date Magh 1 3 13 14 Particulars Unite Balance b/d Requisition slip no.. Goods receipt note no Goods returned note no 200 15 Receipt Rate 28 25 Rs. 5600 5600 Unite 250 Issue Rate Rs. 30 7500 Unite 500 250 250 200 250 200 15 250 200 5 250 25 250 25 240 210 Balance Rate Rs. 30 1500 30 7500 30 7500 28 5600 30 7500 28 5600 25 375 30 7500 28 5600 25 375 30 7500 28 700 30 7500 28 700 26 6240 30 6300
15
Credit note no..(shortage)
10
25
250
16 20
Requisition slip no.. Goods receipt note no
240
26
6240
5 175 -
25 28 -
125 4900 -
24
Requisition slip no..
240 25 40 -
26 28 30 -
6240 700 1200 -
27
Goods Receipt note no
12
28
336
210 12
30 6300 28 360
Closing stock: 210 units @ Rs. 30 each = Rs. 6300 12 units @ Rs.28 each = Rs. 336 Illustration 6 X Ltd. Has purchased and issued the materials in the following order: Baisakh 1 4 6 10 15 20 23 Purchased 300 units@Rs.3 per unit Purchased 600 units @ Rs.4 per unit Issued 500 units Purchased 700 units @Rs.4 per unit Issued 800 units Purchased 300 units @ Rs.5 per units Issued 100 units
Ascertain the quantity of closing stock as on 31st Baisakh and state what will be its valu (in each case), if issues are made under the following methods.
a. b.
First in First out Last in Last out
Solution: Closing stock of the materials in units: Total purchased Total issued Closing stock = 19000 units = 14000 units = 500 units
a) Valuation of closing stock under LIFO 200 units @ Rs. 4 300 units @ Rs. 5 Total 500 units 300 units @ Rs. 3 200 units @ Rs. 5 Total 500 units = = = = = = Rs. 800 Rs.1500 Rs.1900 Rs.900 Rs.1000
b) Valuation of closing stock under FIFO
Rs.2300
Working notes: Baisakh 6 issued 500 units @ Rs. 4 each 15 issued 800 units@ Rs. 4 each 23 Issued 100 units @ Rs.5 each 31 balance 500 units 200 units out of purchased on 20th Baisakh 300 units out of purchased on 1st Baisakh 4.2.18 Stock Level The systematic control concerned with procuring, storing and use of materials so as to minimize wastage and losses and at the same time avoiding excess investment in a materials are referred by material control. For effective and efficient control of inventory, the following techniques are employed: 1. Fixation of stock levels: a) b) c) d) e) 2. 3. 4. Minimum stock level Maximum stock level Re-order level Average stock level Danger level
Determination of re-order quantity or economic order quantity Abc analysis Perpetual inventory system
4.2.18.1 Computation of Different stock level Any firm has to maintain stocks at an optimum level. It should be more or less than optimum level. Carrying too much or too stock is disadvantageous for a firm. If stock is more than required, the firm will incur heavy carrying, the firm will have to face frequent stock-out condition and inure heavy ordering cost. Hence, for effective control so materials the different stock levels have to be determined: The various stock levels are as following: a) Re-ordering level
This is the level on reaching of which a fresh order is prepared and paced with the supplier. Re-order level depends upon the lead time, rate of consumption and sometimes Minimum level. The re-order level is generally calculated by one of the following formulas.
Re-order level (Point)
= lead time* daily consumption Or Re- order Level (Point) =Maximum consumption* Maximum lead time Or Re- order Level (Point) =Maximum level+(Lead time*Daily consumption b) Minimum level
It is that level below which stock should not normally be allowed to fall. This is the minimum amount of inventory which a firm must held in all time. In the determination of minimum level, following are taken into consideration: i) re-order level ii) Average (Normal) Consumption iii) Average (Normal) lead time or re-order period Minimum level is determined by following formula: Minimum stock level= re-order-(Normal Consumption* Normal re-order period) c) Maximum Stock Level
It is the level beyond which storage of raw materials are not allowed to go. This maximum amount of inventory which may be held at any time. In the determination of maximum level, following factors are considered. i) ii) Re-order level Minimum consumption
iii) Minimum re-order period or lead time iv) Re-order quantity Maximum level is computed as: Maximum level = Reorder level + Re-order quantity- (Minimum consumption*Minimum reorder period) d) Average Stock Level
The average stock level held by the firm is known as average stock level. The average stock level is generally calculated by one of the following formula: Average stock level= Maximum Level+ Minimum Level 2 or Average stock level= Minimum Level + of re-order quantity
Illustration 7 The following are the information extracted from a store ledger Annual consumption Safety stock Lead time = 6000 units (360 days) = 30 days consumption = 12 days
Required : Re-order Level. Solution: Re-Order Level = Safety stock +(Lead time* Daily consumption) = {6000 * 30} + = {12 * 6000} 360 = 500 + 200 = 700 units Illustration 8 Calculate re-ordering point from the following information: re-order period consumption Solution: re-order point (point) = Maximum consumption* Maximum re-order period = 300*6 = 18000 units Illustration 9 Calculate the firm's re-order point from the following information's: Annual consumption = 120000 units Lead time Days in year Solution: Re-order point = Lead time* Daily consumption = 6 * 1200000 360 = 2000 units = 6 days = 360 days = 4-6 days = 200-300 units 360
illustration 10 The particulars o material for the last twelve months were as follows: Maximum usage in a month Minimum usage in a month Re-ordering quantity Required: i) Re-ordering level ii) Minimum Level iii) Maximum Level iv) Average stock level Solution: i) Re-ordering Level = Maximum consumption* Maximum Re-order Period =600*6 =3600 units ii) Minimum Level = Re-order Level ( Normal consumption*Normal re-order period) = 3600-(500*4) = 1600 units iii) Maximum Level = Re-order level + re-order quantity-(Minimum consumption* Minimum reorder period) =3600+ 1500- (400*2) = 4300 units iv) Average stock level = Minimum level + of Re-order quantity = 1600 + 1500 2 = 2350 units Illustration 11 The following information is available: Re-order period Re-order quantity Maximum Level Required: Re-ordering level 10 to 14 days 1800 units 3600 units Daily consumption (Minimum) 100 units 600 Nos. 400 Nos. 1500 Nos.
Time lag in procurement of materials 2 months to 6 months
Solution: Maximum level = reordering level+ Re-order quantity-(Minimum consumption*Minimum Re-order period) Or, 3600 = Re-ordering level + 1800-(100*10) = Re-ordering level +800 therefore, R.O.L. = 3600-800 = 2800 units 4.2.18.2 Economic Order Quantity or Re-order Quantity The optimum quantity for which an order should be placed at one point of tie is known as economic order quantity. It minimizes the combined annual cost of placing and order and holding stock. It is also termed as re-order quantity. Economic order quantity is that size of the order which gives maximum economy in purchasing of any material and ultimately contributes towards maintaining the material at the optimum level and at a minimum cost. The quantity of materials to be ordered at a time is affected by two conflicting costs, termed as "ordering" and "carrying cost". The cost of placing an order with the supplier is termed as ordering cost. Clerical and administrative cost of purchasing, accounting and receiving of goods, transporting cost etc. are included in ordering cost .the cost of holding the stock in store is known as carrying cost. It includes the following: i) Interest on capital invested in stock ii) Storage charges which includes rent, lighting, heating , etc. iii) Store staffing, equipment, maintenance & running cost. iv) Material handling cost v) Stock taking, store recording cost vi) Insurance & security vii) Deterioration an obsolescence viii) Pilferage, evaporation & vermin damage EOQ Formula: EOQ =
2 AO C
Where, A= Annual requirement O= ordering cost per order C= Carrying cost per unit per year
Illustration 12 The following information is available: Annual Requirement Carrying cost per unit Ordering cost per order Cost per unit = 6000 units = Re. 1 = Rs. 30 = Rs. 20
Required: a) Economic order quantity c) Number of EOQ orders. Solution : a) A, Annual Requirement B, Carrying cost per unit C, Ordering cost per order We have, EOQ = = 6000 units = Re.1 = Rs. 30
2 AO C 2 * 6000 * 30 1
= 36000 = 600 units b) No. of EOQ orders = 60000 = 10 times 600 Total cost at E O Q is calculated as follows. Total cost = A 0 + QC Q 2 Where, A = Annual Requirement Q= Quality to be ordered 0= ordering cost per order C= carrying cost per unit Alt. Method: Total cost = AOC Illustration 13 The annual demand for a product is 6400 units. The unit cost is Rs. 6 and inventory carrying cost is 25 % per annum. If the cost of one procurement is Rs. 75, determine.
a) b) c) Solution: a)
Economic order quantity No of orders per years Total cost of economic order quantity
Economic order quantity =
2 AO C
2 * 6400 * 75 1.50
= 960000 1.50 = 640000 = 800 units Where, A, Annual Requirement = 6400 units O , Ordering cost per order= Rs. 75 C, Carrying cost per unit = 6* 25 100 = Rs. 1.50 b) No of E O Q orders per years = 6400 800 = 8 times. c) Total cost of E O Q = A 0 + Q C = Q 2 = 6400 * 75 + 800-1.50 800 2 = 600+600 = Rs. 1200 Alt. Method: Total cost of E O Q =
2 AOC
=
2 * 6400 * 75 *1.50
= Rs. 1200 Illustration 14 The following E O Q formula is given to you: EOQ=
2 AO C
OR, Required :
400 =
2 * A * 200 50
orders
i) Number of units required for the year ii) Number of E O Q iii) Total cost of E O Q
Solution: i) we have, 400= 2*A*200 50 squaring both sides, 16000= 8A A = 160000 8 Hence, units required for the year= 20000 units ii) Number of E O Q orders = 20000 400 = 50 times. iii) Total cost of E O Q = A O + Q C Q = 20000 * 200 + 400 = 10000 + = Rs. 20000 10000 2 400 * 50 2
4.3
Accounting for Labours
4.3.1 Meaning of Labour cost The various types of expenses incurred on workers include in lab our cost. In a simple world the payments made to the force for utilization of their service in production work are known as labor cost. It includes various types of expenses incurred on workers. Basically it includes: a. Monetary Benefits: Basis Wages Dearness, allowance, Employer's contribution to provided fund
b.
Fringes Benefits:
Production bonus, Pension & Gratuity, Holiday Pay Subsides housing, Subsided food, Subsided education to the children of workers, Medical facilities Holiday homes, Recreational facilities.
4.3.2 Types of labour cost Lab our cost can be classified into following two types. a. Direct Labour Cost b. Indirect lab our cost a) Direct Labour cost: The wages paid to the workers who are directly engaged manufacturing of goods is known as direct labour cost . such wage can be conveniently identified with a particular product job or process. b) Indirect Labour cost: Labour whose wage can not be allocated but which can be apportioned to a product is known as indirect labour cost. Indirect labour cannot be directly identified with a particular job a cost unit. 4.3.3 Lab our cost control: 4.3.4 A control exercised over labour cost by roper employment and there afterwards efficient utilization of labour force is known as labour cost \control. For most favorable cost control & to have a good effect from the functional point of view, following departments are involved in an organization. i) ii) iii) iv) v) vi) i) The personnel department the engineering department The rate or time & motion study department The time keeping department Cost accountancy department The payroll department Personnel Department:
it is a service department . this is department is concerned with the recruitment & selection of employees. The main functions of the department are:
a) b) c) d)
Recruitment, selection & training Placement, fixation of wages, promotion, transfer & discharge. Maintaining service & leave records of employed Preparation & submission of various reports to concerned authorities.
This departments maintains two important documents. They are: a) b) Labour placement repulsion Employee history card
A labour placement requisition is prepared by various departments, which are in need of employees. On receipt of the labour placement requisition, the personal department takes initiative to appoint the applicants. Tests, interviews etc. are administrated & If satisfied appointment orders are issued. co[y of appoint letter is given to requisitioned & payroll departments. Labor placement requisition Performa is given below. Lab our Placement requisition Department.. Requisition No Date:- Please arrange for workers mentioned below with effect from Category Specification of Job Description Remarks
No. of employee require
Requisitioned By.
Approved by..
Employee history card is maintained to keep the record of every employee. It contains the details such as name, address, departments where he works, name of the former employers date of appointment, rate of pay etc. the Performa of the employee's history card given is self explanatory: Employee's history card (persona record card)
Clock No.. Name Address Permanent/ temporary Education.. Date of birth. Marital Status No. of Children. Ht.weight.. General physique.. Employment record Date Department Grade Remarks
Department Category Grade... Starting Day Previous employee. ... Reasons for leaving the job... . . Training Progress Date Particulars Reasons for change (Promotion increment) Remark s
Employment Record Date Department Grade Remarks
Training progress Date Particulars
Reasons for change(Promoti on Increment)
Remarks
ii)
Engineering Department
The engineering department maintains control over working condition & production methods for each job & department o process. The functions of engineering department will be : a) b) c) d) e) f) g) h) iii) To determine & provide for good working conditions. To determine production method for each job To prepare design for each job To conduct time & motion study To determine the rate o pay To conduct research & development work To make job analysis & job studies To reduce lab our turnover rate Time & Motion Study
Time & motion study is based on scientific management. Under scientific management standard lack of an y worker is determined through the careful study, the standard is the quantity of work done by an average worker, under standardized condition. Time & motion study department carefully determine a standard task for every worker by conduction method motion & time study. Motion study aims to eliminate the unnecessary work & movement & to ascertain the easiest & best method of performing a job. Motion study is the study o movements o workers in performing on operation for the propose of eliminating unnecessary motions. The object of motion study is to improve the system of working by economizing effort & reducing fatigue. This study is the art of observing & recording the time required to do each detailed element of an operation. It facilitates in fixing a standard time for a job. iv) Time Keeping department
Time recording serves two purpose, viz. time keeping & time booking. Time keeping refers to recording of incoming & outgoing time of employees in factory. Time booking refers to recording the time of employees spent on various jobs. a. b. To calculate the wages payable to the employees. To calculate the normal working hours & over time working hours of the employees.
c. d. e. f. g. v)
The meet statutory requirements. To calculate labour cost of an operation or job. To apportion overhead if they are based on number of workers or wages. To provide a basis for preparing statistical record which help in controlling labour cost. Ti introduce incentive among workers i.e. Regularity & punctuality. Cost Account Department
This department is concerned with proper recording control of labour costs. This department accumulates & classifies all cost date of which labour in one important element. The cost accreting department is also responsible for presenting clear & well- designed reports on labors. Such report includes normal & abnormal idle time, department labour cost, variances from budgeted costs etc. the main functions of the department are: a. b. c. To accumulate & classify labour cost according to job process & production orders. To prepare different reports showing direct labour cost, indirect labour cost, overtime & labour cost variances. To highlights the areas where managerial action can help to reduce the labour cost. Payroll Department
vii)
The payroll department is concerned with calculation disbursement of wages to employees. It performs the following functions. a) b) c) d) e) f) To maintain a record of job classification, department & wage rate for each employees. To verify & to summarize the time of each worker as shown on the daily time cars. To prepare the payroll & compute the wages earned by each employee. To compute the payroll deductions. To maintain a permanent payroll record of each employees. To disburse wage payments.
The main function of payroll department is to prepare or wage sheet. The wage sheet contains detailed information of the gross and net income of each worker. The format of the payroll is shown below:
PAY ROLL OR WAGES SHEET Department...

Workers Number Workers Name Reg. Over Rs. Time Rs. Rate Hour Earning Gro ss I. Other Rs.
For the months..

Deductions
Bonus Other Wages PF ESI Rs. Allow ance Rs. Rs.
Total Rs.
Wages Payable Rs.
Rs Tax
Remark s
Prepared by. Checked by
Payment made by.
4.3.4 System of wage payment The wage system should be planned with great care. The most suitable wage system helps to increase efficiency of the worker on one had & on the other it brings satisfaction to the workers. An ideal system of wage payment should have the following characteristic: 1. It should be easily understood by workers.
2. It must ensure satisfaction to both the employees & employer. 3. The system should provide sufficient incentives to workers to work hard & with great care. 4. It should guarantee a minimum wage at satisfactory level. 5. It must be accepted by trade union. 6. It should have flexibility.
7. It should reduce labor turnover. 8. It should be economical to operate. 9. It should reduce absenteeism & late attendance. 10. It should be consistent with government policy. 11. It must increase the moral of the employees. 12. It should encourage productivity. 4.3.5 Methods of remuneration Basically there are two principal system of wages payment: i) Times rate system ii) Piece rate system iii) Times rate system Under this system wages are paid on the basis of time spent in a job by the workers with out considering the output. The unit of time may be an hour, a day , a week, or a month. The payment is made on the basis of attendance. The payment is calculated as follows. Earning= working period * Rate per period. (Period may be an hour or a day or week or a month) The time rate method is suitable in the following cases: i) ii) iii) iv) v) vi) vii) Where the production cant measured in terms of unit. Where quality of the output is of utmost importance & a considerable degree & skill is needed. Where output is beyond the control of workers & is regulated by the speed of a machine. Where work is being done on a small scale so that close supervision possible. Where the worker is a learner or apprentice. Where the different process are involved for the production. Where indirect is employed.
Advantages: The advantage of this methods are: i) ii) iii) iv) Simplicity- easy to understand. Stability in wages. Sense of security to workers. Quality production
v) vi)
Unity in labour. Economical to operate- less clerk work.
Disadvantages: The main disadvantages are: i) ii) iii) iv) v) vi) II) No distinction can be made between efficient & inefficient workers. No inducement for hard work. Efficient workers to lengthen the work period. Discontentment among efficient & quick workers. Equality in wages to all, will depress the superior worker. Labour cost cannot be estimated in advance. Price Rate System (Payment by result)
Under this system a worker is paid on the basis of the quantity of work done without any consideration to the taken by him to perform the work. This method offers a direct financial inventive to the workers who can earn more wages by producing more number of articles. The payment is calculated as under: Total wages= total output in units * Rate permit This method is applicable where: i) ii) iii) iv) v) vi) Production is standardized Quantity has predominance over quality Work is of a repetitive nature Strict supervision is not possible. The output of workers can be measured Single process is evolved.
Advantages: i) ii) iii) iv) v) Workers can have the option of increasing their earnings by producing more. The system induces workers to adopt better and efficient methods of production to increase output. Because of high production, overhead per unit is also reduced. Because supervision is not necessary the workers are themselves interested in maximizing their earning through the maximization of output. This system recognizes the merit & efficiency of the workers.
vi) vii) viii) ix)
The total earning of the worker cab be easily ascertained. The method is simple to understand & easy to operate. Labour cost per unit is easily is known in advance & as a result it simplifies costing. Tools & machinery are handle are handle with care.
Disadvantages: The disadvantages of payment by results system are: i) Workers are always in hurry as result accident may occur. ii) Quality of the product may suffer as workers are interested in quantity & as a result overhead cost increases. iii) Inefficient workers will be thrown out. iv) Health of workers suffers because of high speed work. v) In order to maxims production, it is possible that machines are use recklessly. vi) Breakdown of machine or power failure may disappoint the workers. vii) When there is less demand, over production may arise. viii) Fixation of a satisfactory piece of rate is a difficult task. ix) It is possible that materials may be wasted or spoiled as the workers are only anxious about more production. Difference between time rate & piece rate. System of wage payment. Time Rate System i) ii) iii) iv) v) vi) vii) Wages is based on the time worked. Wages are not linked with the efficiency of the workers. Supervision for quality work is not needed. There is less chance of wastage of material & machinery. Cost of production can be not be minimized. Cost of production will not provide benefit to fix wage rate. Easy to fix wage rate. vii) viii) i) ii) iii) iv) v) vi) Piece Rate System Wages is based on unit produced. Wages are directly linked with the efficiency of the workers. Supervision is required for quality work. There is a high chance of wastage of materials & machinery. Cost of minimized. production can be
Excess production will provide benefits both to worker & management. It is not easy to fix wage rate. Self control over idle time.
viii) Excessive idle time.
4.3.6 Internal Control of Wage Payment The chances of fraud & manipulation are more in connection with payment of wages than with any other transaction. So the strict control must be exercised at the time of payment of ways. For avoiding frauds & manipulation proper systematic & strict procedure should be adopted. The procedure should be designed in such a way that it should be difficult to comet fraud without collusion of two or more person. The following types of frauds are commonly seen. 1. 2. 3. 4. 5. 6. 7. 8. 9. Inclusion of dummy or ghost workers in the payroll. Manipulating the hours worked in job cards. Recording bogus over time. Using wrong rate of pay in the pay roll. Manipulating wages calculations. Making pigment to wrong person. Making a worker resent who where actually absent. Omission to make authorized deductions. Making payment to worker twice.
The following steps should be taken to avoid or minimize frauds.
1. 2. 3. 4. 5. 6. 7.
The wages of workers should be paid in the presence of supervisor or departments head so that the worker can be identified. Each worker should be provided with an identity card with out photograph attached to identity the workers along with necessary information. To avoid bogus house entries in the payroll should be verifying with time keeping and booking records. The pay roll should be certified as to its correctness by the Person who prepared it & counter signed by the works manager to ensure the correct rate of wages. To avoid the combined & effective effort to fraud, the cashier should not be associated with payroll section. Pay pocket must be prepared for each worker his name clock no. & not amount written clearly on them. The term of remuneration & bonus scheme should be clearly defined.
8. 9. 10. 11.
Suitable internal check system must be introduced in the payroll section. wage packets are to be given only to the persons concerned or to properly authorized persons, if any worker is sick or unable to present himself. Undisputed amount in pay packets is to be entered in the unpaid wage account book & may be disabuse through the main cash office. Outstation workers are to be paid by the head office.
Illustration 1 The following information is provided: Working hour per day = 8 hours Hourly wage rate = Rs. 20 per hour Working days per month = 25 days. Required: Total wages for the month by using time wage system. Solution: Total wages = Time worked x Rate = 25 days x 8 hours x Rs. 20 = Rs. 4,000 Illustration 2 The following is one week's record, worked by a worker, who is engaging in a factory: Sunday Monday Tuesday 10Hours 8 Hours 9 Hours Wednesday Tursday Friday 12 Hours 11 Hours 6 Hours
The working hour per day is 8 hours and standard wage rate is Rs. 20 per hour. Overtime wage rate is Rs. 15 per hour, which is 75% of the standard rate. Required: Total wages eamed by the worker for one week. Solution: Normal hours Overtime Wages eamed = 8+8+8+8+8+6 = 46 hours. = 2+1+4+3 = 10 hours = (46 x 20) + (10x15) = Rs. 1070
4.4 Accounting for Overheads

4.4.1 Concept of overhead The total cost is broadly divided into direct cost & indirect cost. The total of all direct cost is termed as prime cost & the total of all indirect cost is overhead. The aggregate of indirect material cost, indirect labour cost & indirect expenses is known as overhead. Overhead costs are expenses which cannot be identified with a particular product, job, process or work order & hence cannot be allocated overhead do not relate to any one specific cost centre. Overhead is also knows as 'on cost', Burden, indirect expenses, supplementary costs, non production cost, loading, etc. 4.4.2 Classification of overhead Overhead cost may be classified according to : a) b) c) d) a) i) ii) iii) i) Nature Function Variability Controllability Classification according to nature of element According to nature, overhead can be classified Indirect material Indirect labour Indirect expenses Indirect material : This is part of material cost which cannot be allocated to a particular job or production, some example are : sewing thread in dress making, nails in furniture making, fuel, consumable, stores, cotton waste etc. Indirect Labour: This includes such wages which can be allocated but can only be apportioned to cost centers of cost units, non- productive labour can be termed as indirect labour. The wages of storekeepers, time keepers, factory clerks, superintendents, mangers etc. are the example of non- productive labour. Indirect expenses: Expenses which are not related directly to the production process are considered as direct expenses. The common examples are: rent, rates, insurance municipal taxes lighting and heating telephone etc. Classification according to function: The main group of over heads on the basis of this classification are:
ii)
iii)
i)
i) ii) iii) iv) i)
Production overhead Administrative overhead Selling overhead Distribution over head Production overhead: Production overheads are also called manufacturing overhead or works overhead or factory overhead. The indirect expenditures included in connection with production operation will come under production overhead. It includes all such expenses included by the factory from the receipt of material unit production is completed. It includes following expenses: a) b) c) d) e) f) g) Factory rent, rates, lighting & heating Factory power, fuel & insurance Factory salaries, indirect wages & pension. Factory stationery & printing. Canteen, medical, education & entertainment facilities to the factory workers. Repairs & maintenance of plant & machinery and factory building. Deprecation, insurance etc of the factory building, plant, machine, tools & equipment.
ii)
Administrative overhead: These represents costs associated with the office maintenance & administration. The heading includes all expenditures incurred in formulating the plans, directing the organization & controlling the operation. A few examples are gives below. a) b) c) d) e) Office rates, rent. Lighting, heating & cleaning expenses. Depreciation , insurance & repairs of office. Legal & financial expenses, bank charge & audit fees. Office stationery, printing, postage, telephone & telegram, fax etc. Salary of administrative directors, manager & staff.
iii)
Selling overhead: this expenditures incurred in promoting sales & retaining customers, following expenses comes under this overhead. a) b) c) Printing & stationary for selling, mailing literature catalogues, price lists, samples, free gifts, displays & exhibition materials. Salaries & commission of salesmen, sales representative, sales manager & selling department staff salaries. Advertisement expenses, bad debts, collection charges, rent & rates of showrooms, cash discount, after sales service expenses, brokerage, expenses in making quotation etc.
iv) Distribution overhead: Expenses incurred after completion production in the factory till they are reached to he final destination or customers. The term distribution over head includes following expenses. a) b) c) Packing cases, oil, grease, spare, parts used for upkeep of delivery vans. Wages of packers, van driver& dispatch clerks etc Carriage & freight outwards, rent, rates & insurance of warehouse, depreciation & maintenance of transport vans running expenses of delivery vehicles.
c)
Classification According to variability (Behavior)
This classification is based on behavior of cost. Different overhead costs. Behave in different ways when volume of production increases of decreases. Based on this behavior, the overhead may be classified into. a) b) c) i) Fixed overhead Variable overhead Semi variable overhead
Fixed overhead: Those overhead tend to remain fixed by variation in volume of output is knows as fixed overhead. Overhead cost remains constant in total but varies in cost per unit. The cost per unit increases by decreasing the output & vice versa. Example of fixed cost are depreciation, rent, salaries, legal expenses etc. Variable overhead: This is the cost which in total tends to vary in direction proportion to changes in the volume of output. Total variable costs will tend to vary directly with volume, while unit variable cost will remain constant at all levels. The examples of variable costs are : indirect material, indirect lab our, power & fuel, spoilage stores handling, overtime etc. Semi variable overhead: These costs are partly fixed & partly variable. Those expenses which neither remain fixed nor they vary directly with the output are called semi- variable overhead. This types of overhead varies with a change in the volume of output but in proportion of the output change. Repairs & maintenance, depreciation of plant machinery, telephone, electricity , insurance, salary to supervisor's etc are the examples of semi- variable overhead Classification according to controllability According to controllability, overhead can be divided into two types:
ii)
iii)
d)
i) ii) i)
Controllable Uncontrollable
Controllable overhead: Those overhead which can be controlled by executive action at the point of their incurrence is knows as controllable overhead. Mostly the variable overhead comes under controllable overhead. Indirect, materials, indirect lab ours, idle time, wastage etc are the example of controllable overhead. Uncontrollable overhead: which are not controllable are not controllable by executive e action is known as uncontrollable overhead. All fixes cost are uncontrollable overhead cost
ii)
4.2.14 Allocation of overhead Allocation consists of tracing out and assigning the amount of overhead cost to a particular department or cost center, certain items of overhead cost can be directly identified with a particular department or cost center as having been incurred for that cost center. Allotment of such cost to departments or cost centers is known as allocation. For example the salary paid to a foremen of a particular production department can be directly identified with that department and therefore it will be directly charged to that department. An items of overhead cannot be allocated to a department till the following two condition are satisfied. a) the concerned department should have caused the overhead to be increased. b) Extra amount incurred in a cost centre must be knows. 4.2.15 purpose & importunate of allocation 1. 2. 3. 4. 5. 6. 7. 8. 9. To provide information for economic decision. to motivate managers & employees. To justify costs & computer bonus payable one the basis of saving in cost. To measure income & assets for reporting to external parties. To evaluate profitability of a product line in multi-product business. To fix the accountability To allocate cost per usage. To promote more effective resource usage To foster cost awareness.
4.4.5 Apportionment of overhead Apportionment refers to the distribution of overhead costs among various departments or cost centers certain overhead cost cannot be directly charged to department or cost centers. Such costs are common to number of cost centers and do not originate from any specific department. Distribution of such overhead costs to various departments is known as apportionment. For example the factory manager's salary has to be distributed on an equitable basis among various departments. Apportionment of overhead are made on the basis of: i) ii) iii) iv) Benefits or service received Capacity to bear the cost. Efficiency achieved Analysis & research
4.4.6 Distinction between Allocation & Apportionment The main difference between allocation & apportionment of overhead are as follows:. 1. 2. 3. 4. Allocation deals with whole items of cost, apportionment deals with proportions o items of cost. Allocation is a direct process but apportionment is an indirect method for which equitable bases are to b be selected. Allocation ends with a cost center, but the process of apportionment is carried further down. Allocation refers to distribution of overhead expenses on department basis, while apportionment means the method of distribution of the overhead of one department of other d department. Allocation is much wider & accurate than apportionment.
5.
4.4.7 Absorption of overhead After the apportionment o overhead, the next step is to spread factory overhead to different products or jobs produced . this is termed as overhead absorption in cost accounting . there are various methods of absorption. Among them two methods are prescribed by syllabus. Those are: a) Labor hour rate method b) Machine hour rate method
a)
Labour Hour rate Method : Under this method, labour hours are taken as the base for absorption of overhead. The actual or predetermined rate is calculated by dividing the overhead of a department for a particular period by the total number of direct labour hour of that department for the same period. Thus: Total labour hours
Direct labour Hour rate = Total Overhead b) Machine Hour rate method
This method is quite similar to direct labout hour rate, but instead of using a labour hour as the denomimator , the machine hour are used. This method is used in those organizations where the process of manufacture are carried out by machines & there is very little manual labour. The formula for determining overhead rate is as follows. Overhead rate= Amount of overhead Machine Hours
4.5
Unit or Output costing
4.5 .1 Concept This method is applied in such undertaking which produces one produce or only a few grades of similar articles. The ascertainment of cost of producing one unit of output is referred as unit costing. It is also termed as output costing of single output costing. By preparing a cost sheet, the cost per unit is arrived at by dividing the total cost by the total number of unit produced . This method is suitable to industries producing pencils, cigarettes, dairy products, brick works, steel works etc. A cost sheet is a statement of various costs involved in the production & sales of manufactured product. 4.5.2 Importance of unit costing : Unit costing is important because of the following reasons : 1. 2. 3. 4. 5. It shows the total cost and cost per unit of product produces during the given period, It helps the manufacturers to control the cost of production. It helps the management in fixing up the selling price of their products. It acts as a guide to the manufactures and helps them in formulating a defang and profitable production policy. It helps the management in comparative study of the various elements of cost with the past result and standard cost.
6. 7.
It helps to minimum the cost of production whine there is competition. It helps the businessmen to submit quotation for supply of goods against tender.
4.5.3 Limitations 1. 2. 3. It is not useful to those industries where the production is not uniform and not a continuous affair and the unit of production are not identical. It can not be used by those industries which are engaged in providing of serves. The confidentiality of cost data cannot be maintained as every component of cost has to be sown on the cost sheet.
4.5.4 Component of cost sheet The statement cost according to element wise so known as cost sheet . It is a statement showing the details of total cost of a job, operation of order. It brings out the composition of total cost in a logical order, under classification and sub-divisions. The total cost of every cost unit is analysed into : i. ii. iii. iv. i ii iii. Prime cost Factory cost Office and administrative cost Cost of sales
Prime cost : the aggregate of direct materials cost, direct labour and direct expenses is known as prime cost Factory cost : prime cost plus works or factory expenses in known as factory cost or manufacturing cost or work cost. Office and administrative cost : work cost plus office and administrative overhead is calls cost of production of gross cost of office & administrative cost or office cost. Cost of sales : cost of production polus selling and distribution overhead is known as cost of sales. Selling price : it is the price which includes cost of sales plus profit or muinus loss og any.
Iv v
Chart showing classification of expenses is given below :
1. Direct material + direct labour + direct expenses = prime cost 2. Prime cost + factory overhead = work cost 3. Work cost + office overhead = cost of production 4. Cost of production+ selling and distribution overhead = cost of sales 5. Cost of sales+ profit=selling price 4.5.5 Preparation of cost sheet The specimen of a cost sheet is given below : Statement of cost and profit (cost sheet) Unit produced.. Particulars Opening stock of raw materials Add : purchases Carriage in ward Octrio and customs duty Less: Closing stock of raw materials Cost of direct materials consumed Direct or productive wages Direct (or chargeable) expenses Add: work or factory overhead: Indirect wages Leave wages Overtime wages Fuel and power Factory rent and taxes Insurance Factory lighting Supervision Works stationery Canteen and welfare expenses Repairs Works salaries Depreciation plant & machinery Works stationery Canteen and welfare expenses Repairs Works salaries Total Cost Cost per
Depreciation plant & machinery Work expenses Gas and water Drawing office salaries Depreciation of plant & machinery Technical director's fees Laboratory expenses Works telephone expenses Internal transport expenses Add: Opening stock of work-in progress Less: Opening stock of work-in progress Work cost Add: office and administrative overheads: Office salaries Director's fees Office rent and rates Office stationery and printing Sundry office expenses Depreciation of office furniture Subscription to trade journals Office lighting Establishment charges Directors traveling expenses Postage Legal charges Audit fees Depreciation and repair of office equipment Cost of production Add: Opening stock of finished goods Less: closing stock of finished goods Cost of goods sold Add: selling and distribution overheads: Advertising Show-room expenses xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx
xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx
Bad debts Salesmen's salaries and expenses Packing expenses Carriage outward Commission of sales agents Country house salaries Cost of catalogues Expenses of delivery vans Collection charges Traveling expenses Cost of tenders Warehouse expenses Cost of mailing literature Sales manager's salaries Insurance of showroom Sales director's fees Sales office expenses Rent or sales office Depreciation of delivery vans Expenses of sales branch establishments Total cost (or cost of sales) Profit (or loss) Sales 4.5.6 Calculation of Profit
xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx xxxx
For determination of selling price the profit should be determined first. The profit percentage may be given on cost price of selling price. If the percentage is based on cost price, the following formulae could be used for determining profit and selling price: Profit = Total Cost
gain percent 100
Selling price = total cost +profit If the profit percentage is based on selling price, the following formulae could be used for determining profit and selling price: Profit = Total Cost
gain percent 100 - gain percent
Selling price = total cost profit.
4.5.7 Tender or quotation It is also a kind of cost sheet. Frequently a manufacturer of capital goods, consumers durable goods etc., is required to quote the price at which he can supply a particular article. The price, at which the supplier offers his goods for sale, is known as tender or quotation. The tender is made on the basis of recent cost sheet by making necessary adjustments in the relevant costs. To prepare a tender the following details are carefully analyzed: 1. cost of materials 2. cost of direct labour and chargeable expenses 3. cost of works overhead 4. cost of office overhead 5. cost of selling overhead 6. estimated profit Overheads are estimated on the basis of past experience and current trends and then absorbed on a suitable basis. Generally, percentage is established between following expenses and expenses for a tender is determined on the same basis: 1. percentage of factory overhead on: a) direct wages =
factory overhead 100 direct labour factory overhead b) prime cost = 100 prime cost
Percentage of office overhead on work cost = Percentage of selling and distribution on:
2. 3.
factory overhead 100 Work cost
selling & distribution cost 100 work cost selling & distribution b) cost of production = 100 cost of production
a) work cost = Illustration 17 The following details are available from the books of a manufacturing company:
Stock of raw material Stock of raw material Purchase of raw material Direct wages Works salaries
1-1-20X1 21-12-20X1
Rs. 40,000 30,000 1,70,000 2,50,000 50,000
Factory rent and taxes Indirect wages Motive power Indirect materials Works lightning and heating Works repairs Factory insurance Direct expenses Works stationery Plant and works depreciation Oiling and cleaning Gas and water Workman's compensation Administrative expenses chargeable to works Office salaries and wages Office rent and taxes Printing and stationery Office repairs Office lighting and insurance Telephone charges Director's fees-proportionate chargeable to Administration Legal expenses Audit fees Postage and telegrams Advertising Printing & stationery for sales Traveller's salaries Traveller's commission Showroom expenses Bad debts Postage and sundries for sale Carriage out ward Delivery vans: Running expenses Depreciation Showroom insurance Director's fees-chargeable to sales Total sales Required: cost sheet showing:
10,000 9,000 7.000 2,000 2,400 3,000 2,400 15,000 400 2,700 700 1,200 2,200 4,000 12,000 1,800 1,300 420 600 850 3,000 1,500 2,000 650 17,000 3,500 5,000 7,400 2,300 1,400 1,600 2,800 1,000 2,000 880 2,000 7,00,000
i. ii. iii. iv. v.
prime cost work cost cost of production cost of sales profit
Solution: Cost sheet Particulars Opening stock of Raw materials Add: purchase of taw materials Rs. 40,000 1,70,000 2,10,000 Less: closing raw materials Raw material consumed Direct wages Direct expenses (i) Prime cost Factory overheads: Salaries Factory rent and taxes Indirect wages Motive power Indirect materials Works lightning and heating Works repairs Factory insurance Works stationery Depreciation on plants Oiling and cleaning 50,000 10,000 9,000 7,000 2,000 2,400 3,000 2,400 400 2,700 700 30,000 1,80,000 2,50,000 15,000 4,45,000 Rs.
Gas and water Workmen's compensation Administrative expenses (ii) Work cost Administrative & Office overhead: Office salaries & wages Office rent & taxes Printing and stationery Office repairs Office lighting and insurance Telephone charges Director's fees Legal expenses Audit fees Postage & telegrams (iii) cost of production selling & distribution overhead: advertising printing & stationery traveller's salaries traveller's commission Showroom expenses Bad debts Postage and sundries carriage out ward Running expenses: D.V. Depreciation _ Del. Vans Showroom insurance Director's fees (iv) cost of sales (v) profit
1,200 2,200 4,000 97,000 5,42,000
12,000 1,800 1,300 420 600 850 3,000 1,500 2,000 650 24,120 5,66,120
17,000 3,500 5,000 7,400 2,300 1,400 1,600 2,800 1,000 2,000 880 2,000
46,880 6,13,000 87,000 7,00,00
Illustration 18 A manufacturing company submits the following information on 31st Chaitra 2055. Rs. st Stock of hand-Baishakh 1 Raw materials 25,000 Finished goods 17,300 Work-in-progress 8,200 Sock on hand Chaitra 31st Raw materials 26,200 Finished goods 15,700 Work-in progress 9,100 Purchase of raw materials 21,900 Carriage on purchases 1,100 Sale of finished goods 72,300 Direct wages 17,200 Non-productive wages 800 Direct expenses 1,200 Factory overhead 8,300 Administrative wages 3,200 Selling & distribution overhead 4,200 Required: Cost Sheet Solution: Cost sheet for the year ended 31st Chaitra, 2055 Particulars Opening stock of Raw materials Add: purchases Less: closing stock Raw material consumed Carriage on purchases Direct wages Direct expenses Prime cost Factory overhead Add: work-in progress (1-1-55) 8,300 8,200 16,500 Rs. 25,000 21,900 46,900 26,200 20,700 1,100 17,200 1,200 40,200 Rs.
Less: work-in-progress (31-12-55) Work cost Office on cost: Non-productive wages Administrative overheads Cost of production Add: opening stock of finished goods Less: closing stock of finished goods Cost of goods sold selling & distribution Cost of sales Add: profit Sales Notes: Profit = 72,300 - 57,400 (Sales-Cost on sales) = Rs. 14,900 Illustration 19 From the following particulars, prepare a cost sheet showing: a) i. The cost of material consumed ii. Prime cost iii. Production cost iv. Total cost v. Profit b) percentage of i. production overhead to direct wages ii. General overhead to production cost iii. profit on sales 1-1-98 (Rs.) Raw materials 30,850 Work-in-progress 60,850 Raw material purchases Direct wages Production overhead General overhead Sales for the year
9,100
7,400 47,600
800 3,200
4,000 51,600 17,300 68,900 15,700 53,200 4,200 57,400 14,900 72,300
31-12-98(Rs.) 37,700 67,750 1,43,250 1,78,500 1,42,800 1,12,700 7,04,375
Solution Cost sheet for the year ending 31-12-98 Particulars Opening value of Raw materials Add: purchases Less: closing value of raw materials (i) cost of material consumed Direct wages (ii) Prime cost Production overhead Add: work-in-progress (31-12-98) Less: work-in progress (31-12-98) 1,42,800 60,850 2,06,650 67,750 1,35,900 (iii) Production cost General overhead (iv) Total cost (v) Profit Sales (b) i. Percentage of production overhead to direct wages = 4,50,800 1,12,700 5,63,500 1,40,875 7,04,375 Rs. 30,850 1,43,250 1,74,100 37,700 1,36,400 1,78,500 3,14,500 Rs.
1,35,900 100 1,78,500

= 76.13%
ii. percentage of general overhead to production cost =
1,12,700 100 4,50,800

= 25%
iii. percentage of Profit on sales
Profit 100 Sales 1,40,875 = 100 7,04,375
= 20%
Illustration 20 The following information are provided: Prime cost Work overhead Administrative overhead Selling overhead Gain on sale Required: cost sheet showing total sales Solution: Cost Sheet Rs. Prime cost Work overheads (20% on 50,000) Work cost Administrative overhead (15% in 60,000) Cost of production Selling overhead (10% on 69,000) Cost of sales Add: profit 75,900 Total Sales 50,000 10,000 60,000 9,000 69,000 6,900 75,900 Rs. 50,000 20% on prime cost 15% on work cost 10% on cost of production 20%
20 80
18,975 94,875
Illustration 21 A factory supplies to you the following information in respect of the year 2 X 1: Rs. Cost of material 4,00,000 Direct wages 3,00,000 Factory overhead 1,50,000 Administrative overhead 2,12,500 Selling and distribution overhead 1,06,250 Profit 2,92,187.5 A work order has been accepted and the following expenses have been incurred: Material 16000 Labour 12000
For the tender pricing assume, factory expenses will increase by 20% and administrative overhead will decrease by 10%. The selling and distribution expenses will also go up to by 10%. The tender should realize the same percentage of profit on selling price as was in the year 20 X 1. Absorb factory overhead on the basis of labour and all other overhead on the basis of factory cost. Required: (i) Cost sheet for the year 20 X 1 (ii) Tender Solution: (i) Cost sheet for the year 20 X 1 Rs. Material Direct Wages Prime Cost Factory overhead Work cost Administrative overhead Cost of production Selling and distribution overhead Cost of sales Profit Total sales Working notes: a) percentage of factory overhead on wages = 4,00,000 3,00,000 7,00,000 1,50,000 8,50,000 2,12,000 10,62,500 1,06,250 11,68,750 2,92,187.5 14,60,937.5
1,50,000 100 3,00,000 2,12,500 100 8,50,000
= 50% b) percentage of administrative overhead on work cost =
= 25% c) d) percentage of selling and distribution overhead on work cost gain % on scale = =
1,06,250 100 8,50,000
2,92,187.5 100 14,60,937.5
= 10% (ii) Tender for the works order
Particulars Materials Labour Prime Cost Factory Overhead (50% of 12000) Add: 20% increased Work Cost Administrative overhead (25% of 35,200) Less: 10% decrease Cost of production Selling & distribution overheads (12.5 on 35,200) Add: 10% on 4,400 Cost of Sales
Rs. 16,000 12,000
Rs.
28,000 6,000 1,200
7,200 35,200
8800 880
7,920 43,120
4,400 440
4,840 47,960 11,990
Add: profit
20 47,960 80
Selling Price
59,950
4.5.8 Manufacturing Account It is prepared by an enterprise engaged in manufacturing activities. A manufacturing account ascertains cost of goods manufactured. Sometimes, it is prepared with the object of ascertaining profit also. It is prepared in "T" form. 4.5.8.1 Features of Manufacturing account i. manufacturing account is debited with all expenses that are incurred in manufacturing of goods. ii. Instead of showing figures of opening stock, purchased and closing stock separately, the material consumed is calculated and shown on debit side. iii. Beginning balance of work-in-progress is debited and closing is credited. iv. The amount of scrap sold is credited to the manufacturing account. v. The balance of manufacturing account is the cost of goods manufactured or profit on manufacturing depends on the type of manufacturing account prepared.
4.5.8.2 Preparation of Manufacturing Account Manufacturing account may be prepared with two purposes. Those are i. for finding out cost of manufacturing ii. for finding out the manufacturing profit. For these purposes, the separate accounts are prepared and the specimen of these accounts are given below: Format of Manufacturing Account Showing cost of production
Particulars To opening stock of raw materials Add: purchases of raw materials Add: carriage on purchases Less: closing stock of raw material Cost of material consumed To opening stock of work in progress To productive wages To factory expenses Rent & rates Lightening & heating Motive power Coal & coke Factory insurance Non-productive wages Repairs to plant Repairs to factory building Dep. of plant Dep. of factory building To fuel and power To stores consumed To royalties Rs. By stock at end of work-in progress By sale of scrap By cost of Production
Dr.
Cr.
Rs.
Dr.
Format of Manufacturing Account Showing manufacturing profit

Particulars Rs. By closing progress By sale of scrap work-in
Cr.
Rs.
To opening stock of raw materials Add: purchases of raw materials Add: carriage on purchases
Less: closing stock of raw material Cost of material consumed
To opening work in progress To productive wages To factory expenses Rent & rates Lightening & heating Motive power Coal & coke Factory insurance Non-productive wages Repairs to plant Repairs to factory building To fuel and power To stores consumed To royalties To profit on manufacturing
Illustration 22 The following details have obtained from the records of a manufacturing company: Opening value: Rs. Closing Rs. Raw materials 1,50,000 Raw materials 1,83,000 Work-in-progress 56,000 Work-in-progress 70,000 Direct wages 1,05,000 indirect wages 5,500 Purchases of raw materials 1,32,000 factory rent, rates & power 30,000 Depreciation on plant 7,000 expenses on purchases 3,000 advertising 7,000 Carriage outward 5,000 office rent & taxes 5,000 Salesman's salaries 13,000
Required: Manufacturing Account the cost of manufacturing Solution: Dr. Showing manufacturing profit Cr.
Particulars To opening stock of raw materials Add: purchases Add: expenses on purchases
Rs. 1,50,000 1,32,000 3,000 2,85,000
Particulars
Rs.
By closing work-in- 70,000 progress

By cost manufacturing of
2,35,500
Less: closing stock of materials
1,83,000 1,02,000
To direct wages To opening work in progress To indirect wages To factory rent, rates, & power To depreciation on plant
1,05,000 56,000 5,500 30,000 7,000 3,05,500 3,05,500
Illustration 23 From the following, prepare a manufacturing Account showing the Manufacturing profit: Rs. Rs. Opening stock: Raw materials Finished goods 25,000 20,000 Factory insurance Sale of scrap Printing & stationery Closing stock: Raw Materials Finished goods Raw material purchased Chargeable expenses Power Bad debts Commission to salesman Current trade price Wages paid to workers Factory rent & tax Factory heating & lighting Experimental expenses Office salaries 5,000 1,000 5,000 5,000 5,00,000 1,00,000 25,000 10,000 2,500 20,000
20,000 25,000 2,50,000 10,000 12,000 5,000
Solution Dr. Manufacturing profit Cr.
Particulars To opening stock of raw materials Add: material purchased Less: closing materials stock of
Rs. 25,000 2,50,000 raw 2,75,000 20,000 2,55,000
Particulars By sale of scrap By current price
Rs. 1,000
trade 5,00,000
To chargeable expenses To wages To power To factory insurance To factory rent & tax To factory heating & lighting To experiment exp. To manufacturing profit
10,000 1,00,000 12,000 5,000 25,000 10,000 2,500 81,500 5,01,000 5,01,000
Some model questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. State three objectives of cost accounting. Write in brief any two limitations of financial accounting. Define cost accounting in your own language. Briefly write the importance of cost accounting to management or manufacturer. List the method of costing. What do you mean by process costing. Differentiate between absorption & marginal costing. Differentiate between direct & indirect expenses. What is an overhead cost? What are the costs classified on the basis of variability? Write their meanings in short. What is material control?
12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40.
Why is material control is needed. Write any four objectives of material control. Draw a diagram showing material routing process. Give the specimen of purchase requisition Differentiate between centralised and decentralised stores. Write the advantages of centralised stores. What is bin card? What is a classification & codification of materials. Write short notes on FIFO & LIFO. Write a short note on perpetual inventory system. Write in short any four advantages of FIFO. In an about three to five sentences write the meaning of simple average method of issuing materials with valuation. What do you understand by Re-order level? How do you calculate it. What do you understand by economic order quantity? Give its formula. Mention three differences between time rate and piece rate. Write any six advantages of piece rate system of wage payment. Write mature of fraud generally found in wage payment. Mention any six steps to be taken for minimise the fraud in wage payment. What do you understand by overhead cost? Mention the classes of overhead. Classify overhead cost according to control. What do you understand by machine hour rate? What is an allocation of overhead? Differentiate between allocation and appointment of overhead. How direct labour hour rate is determined? What do you understand by unit costing? What is prime cost? Give the items of expenses under it. What is manufacturing Account? The following is an extract of the record of receipt and issue of material during Baisakh last year: Baisakh 1 Baisakh 5 Baisakh 10 opening inventory purchased issued 2000 units @ Rs.5 4000 units @ Rs. 5.25 4000 units
Baisakh 15 Baisakh 16 Baisakh 20
purchased Issued Returned to stores (Out of Baisakh 16 issue)
8000 units @ Rs. 5.50 4000 units 200 units
Required: Stores ledgers under FIFO method. 41. The material purchase and issue on different dates on a particular month is as follows: Baisakh 1 Baisakh 4 Baisakh 6 Baisakh 10 Baisakh 11 Baisakh 25 42. purchase purchase issued surplus returned to stores stock verified and shortage quantity purchased Required: stores ledger account under LIFO method. From the following receipts and issues of material, prepare stores ledger under simple average price method: Date Receipts Rate/Unit Issue Baisakh 1 200 units Rs. 2 Baisakh 10 300 units Rs. 2.40 Baisakh 18 250 units Baisakh 22 250 units Rs. 2.60 Baisakh 30 200 units 10 kgs. 1000 kgs @ Rs. 15 per kg. 5000 kgs at Rs. 16 per kg. 2000 kgs at R%s. 15 kg 3000 kgs. 300 kgs.
43.
Material consumption details are given below: Re-order level 24,000 units Re-order period 4 to 8 months Consumption per month 1600 units to 3000 units Required: (i) Minimum level (ii) Maximum level 44. The following are the extracted from a store ledge: (i) Days in year 360 days. (ii) Annual consumption 36,000 units (iii) Safety stock 30 days consumption (iv) Normal lead time 12 days.
Required: i. Safety stock ii. Re-order level
45.
The following information are available: Re-order period Daily consumption Re-order quantity Re-ordering level 10 to 14 days 100 to 200 units 1800 units 2800 units
Required: Maximum level 46. According to marketing division of a firm, the expected sales are 50,000 units in the coming year. On a average, each other would cost the firm Rs. 15 the price paid for the material is Rs. 30 per unit. Estimated average inventory carrying cost are 20% of the value of inventory? Required: Economic order quantity 47. Following are the information provided to you: (a) The carrying cost per unit of inventory Rs. 5 (b) Ordering cost per order Rs. 20 (c) The number of units required for the year 20,000 (d) The purchase price per unit is Rs. 200 Required: (i) Economic order quantity (ii) Total number of orders in a year. (iii) Total cost of economic order quantity. On 1st Baisakh, 100 kgs. of materials were in stores which was valued at Rs. 20 per kg. On 3rd Baisakh, 150 kgs of materials were receive at Rs. 25 per kg. On 5th Baisakh, 125 kgs of materials were issued. Required: The price of the issued and closing stock, if material is priced according to (i) FIFO and (ii) LIFO method 48. 49. The following information is available in respect of a material: Maximum stock level 25,000 units Consumption per month 1600 to 3,000 units Re-order period 4 to 8 months
Required: (i) Re-order level (ii) Re-order quantity
50.
The following economic quantity model is given:
EOQ =
2 Annual requirement + ordering cost per Carrying cost perunit

2 2000 200 C
or, 400 =
Required: (i) Carrying cost per unit (ii) Total cost of EOQ
The following figures relates to a manufacturing company, whose accounting year closed on 31st Chaitra. Baisakh 1st Chaitra 30th Cost of raw material Rs. 30,000 Rs. 25,000 Work in progress Rs. 12,000 Rs. 15,000 Finished goods Rs. 60,000 Rs. 25,000 Purchase of raw material Rs. 4,50,000 Wages paid Rs. 2,30,000 Factory overhead Rs. 92,000 Administrative overheads Rs. 30,000 Selling and distribution overhead Rs. 20,000 Sales Rs. 9,00,000 Required: Cost sheet showing: a. Material consumed b. Prime cost c. Factory cost d. Cost of goods sold e. Net profit 56. The following figures are extracted from the books of a certain company: Direct material Rs.12,00,00 Direct labour Rs. 2,50,000 Depreciation of factory building Rs. 7,500 Branch office expenses Rs. 20,000 Depreciation of office building Rs. 4,000 Salary: Sales manager Rs. 12,500 Factory Chief engineer Rs. 12,500 Office executives and others Rs, 1,25,000
55.
Finished goods warehouse expenses Electricity (including Rs. 2000 for administrative office) Advertisement Factory expenses Sales promotion Office administrative expenses Expenses for participating in industrial exhibition Sales Required: Cost sheet showing 1. Prime cost 2. Factory cost 3. Cost of production 4. Cost of sales 5. Profit earned 57.
Rs, 10,000 Rs. 20,000 Rs. 10,000 Rs. 2,70,000 Rs. 2,500 Rs. 25,000 Rs. 5,000 Rs. 21,00,000
A manufacturing concern present you the cost sheet as follows: COST SHEET Particulars Rs. 2,91,200 1,98,800 Prime cost 4,90,000 43,736 5,33,736 5,33,73.6 5,87,109.6 12,890.4 6,00,000 20,000 Cost of goods sold Selling on cost Cost of sales Profit Sales 5,80,000 29,000 6,09,000 1,21,800 7,30,800
Materials Direct wages Works overhead Work cost Office and general expenses Total cost Add: Opening stock Less: Closing stock
The company received a bid for supplying the product, which requires materials Rs. 2,00,000 and wages Rs. 1,00,000. The company is also estimated that the factory overhead will bear the same relation to direct wages as in the presented cost sheet. It is also estimated that the percentage office expenses and selling on cost on work cost and cost of goods sold respective will be the same as in presented cost sheet. The company would like to maintain same percentage of profit. Required: A tender sheet showing: 1. Prime cost 2. Work cost 3. Cost of production 4. Cost of tender 5. Profit on tender 58. A company manufactured and sold 1,000 radios during a year. The summarised trading and profit and loss account for the year are: Particulars To materials To direct wages To work on cost To gross profit Rs. 80,000 1,20,000 50,000 1,50,000 4,00,000 To salaries To rent and rates To selling expenses To general expenses To net profit 60,00,000 10,000 30,000 20,000 30,000 1,50,000 Estimation for the next year are: 1. Output and sales will be 1,200 radios. 2. Price of materials will raise by 20% and wages rate by 5% 3. works on cost will raise in proportion to the combined cost of material and wages. 4. A profit of 10% on the selling price is expected 5. Selling cost per unit and others will remain unchanged Required: A tender sheet showing: 1. Prime Cost By gross profit 1,50,000 Particulars By sales Rs. 4,00,000
4,00,000
1,50,000
2. Work cost 3. Office cost 4. Cost of sales 5. Profit on tender 6. Total sales 59. A manufacturer finds that it cost him Rs, 3,60,030 to manufacture 200n units of article on which he sold for Rs. 2,000 each. The cost is made up of: Materials Direct wages Factory overhead Office overhead (a) (b) (c) Rs. 1,41,000 Rs. 1,62,000 Rs. 24,300 Rs. 32,730
For the next year he estimates that: Each unit of article will require material of Rs. 600 and labour Rs. 800 The factory overhead will bear the same relation to wage as in the previous. The office overhead percentage on factory cost will be the same as in the past.
Required: A statement showing the profit he would make per unit, if he reduces the price of article by Rs. 100. 60. The cost information of manufacturing company for producing a product is given below: Rs. 50,000 Rs. 14,720 Rs. 16,440 Rs. 52,500 Rs. 31,500 Rs. 18,000 Rs. 43,800 Rs. 1,660 Rs.6,320 Rs. 34,300 Rs. 16,680 Rs. 8,420 Finished goods Work-in-progress Closing stock raw materials Finished goods Work-in-progress Purchase of Raw materials Indirect wages Office expenses Direct wages Factory expenses Selling expenses
Opening Stock: Raw materials
Required: Manufacturing account showing cost of production.
H.
Terms introduced in the units
Costing, Job order costing, Unit costing, Process costing, Operating costing, Contract costing, Batch costing, Multiple costing, Historical costing, Standard costing, Marginal or variable costing, Absorption or full costing, Uniform costing, Direct costing, Direct material, Indirect material, Direct labour, Indirect labour, Direct expenses, Indirect expenses, Overhead, Production overhead, Administrative overhead, Selling overhead, Distribution, Distribution overhead, Element of cost, Fixed cost, Variable cost, Semivariable cost, controllable cost, Non-controllable cost, Material control, Purchase of material, Storing of material, Issue of material, Stores Routing, Purchase control, Centralise purchasing, Purchase, Procedure, Purchase Requisition, Quotation, Purchase order, Material inspection report, Store keeping, Centralized stores, Decentralize stores, Central stores with sub stores, store keeper, codification of materials, Bin card, Stores ledgers, perpetual inventory system, Material requisition note, first in first out, last in first out, simple average, stock level, recorder level, maximum level, minimum level, average stock level, economic order quantity, monetory benefit, Fring benefit, Personal Department, Cost accounting Department, Payroll Department, Labour placement, Requisition, Employee's history card, Time rate system, piece rate system, internal control of wage payment, allocation of overhead, appointment of overhead, absorption or overhead, labour hour rate method, machine hour rate method, cost sheet, prime cost, work cost, cost of production, cost of sales, selling price, work-in-process, finished goods, tender or quotation, manufacturing account.
Reconciliation of Cost And Financial Accounts

1. Meaning and Concept Cost accounting and financial accounting are two different accounting systems. The cost accounting is prepared by cost accounting department whereas financial accounting is prepared by financial accounting department. The objective of cost accounting is to record, classify, control and analyse of the cost. But the objective of financial account is to record the financial transactions and report the financial position of the business. Both accounting reports the profit or loss in their own way. The amount of profit or loss obtained from both accounts are often found to be different. The difference is not because of errors in system but due to difference in procedures and principle followed by these accounts. Hence, it becomes necessary to reconcile the profit between these two accounts. The statement which is prepared for reconciling the profit between cost and financial account is known as Reconciliation Statement. 2. Reasons for differences in Profit or Loss The main reasons for differences in profit or loss between cost and financial accounts are as follows: 1. Items shown only in Financial Accounts. 2. Items shown only in Cost Accounts. 3. Over absorption and under absorption of overhead. 4. Difference in stock valuation. 5. Difference in methods of charging depreciation. Items shown only in financial account There are certain items which are shown only in financial account but not in cost account. Due to those items, the profit or loss reported by one set of account may not agree with the profit or loss reported by another set of account. Incomes and expenses included by financial account but excluded by cost account are given below: (a) Expenses or losses shown in only financial account. (i) Interest on debentures, loan, mortgage loan and bank loan. (ii) Discount on issued debentures and shares. (iii) Loss on sale of fixed assets. (iv) Loss on investment. (v) Interest on capital. (vi) Expenses for issuing of shares or debentures. (vii) Penalties and fine. (viii) Damage payable etc.
The expenses and losses mentioned above are not included in the cost account. They are recorded only in financial account. Because of these items, the profit shown by financial account will be les than the profit shown by cost account. (b) Income or gain shown by financial account only: (i) Gain on sale of fixed assets. (ii) Collection of dividend. (iii) Gain on investment. (iv) Interest received from bank. (v) Rent receivable. (vi) Transfer fees from shares and debentures. (vii) Discount or commission received. The above mentioned income or gain items are credited only in the profit and account in financial account. Due to these items, the profit shown by financial account will be more than the profit reported by cost account.
3.
The following proforma can be followed while reconciling the profit:

Rs. Profit as per Cost Account Add: Income Recorded in Financial Account but not in Cost Account Expenditure Charged in Cost Account but not in Financial Account Excess Income shown in Financial Account Over Corresponding Income in Cost Account Excess Expenditure shown in Cost Account Over Corresponding Items in Financial Account Over-absorption of Overhead in Cost Account Under Valuation of Closing Stock in Cost Account Over-valuation of opening stock in Cost Account Depreciation Over Charged by Cost A/C Less: Expenses shown in Financial Account but not in Cost Account Income Shown in Cost Account but not in Financial Account Excess Income shown in Cost Account Over Corresponding items in Financial Account Excess Expenditure shown in Financial Account Over Corresponding Items in Coast Account Under Absorption of Overhead in Cost Account Over Valuation of Closing Stock in Cost Account Under Valuation of Opening Stock in Cost Account Depreciation Under Charged by Cost Account Profit as per Financial Account xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xx xxx xxx xxx xxx Rs. xxx
Illustration 1 The net profit of a company showed by the cost account for the year was Rs. 80,000.00 while the net profit shown by financial accounts amounted to Rs. 68,000. On reconciling the figures, the following difference are brought to light. (i) Selling overheads over-absorbed in cost Rs. 2,000 and factory overhead under-absorbed in cost Rs. 1,000 (ii) Loss due to obsolescence charge in financial records, Rs. 2,000 (iii) Depreciation charged in financial accounts Rs. 5,000 and recorded in costs Rs. 7,000 (iv) Interest on investment not included in costs Rs. 5,000 (v) Income tax paid Rs. 15,000 (vi) Bank interest and transfer fees received Rs. 500 (vii) Stores adjustment (credited in financial records) Rs. 300 (viii) Loss due to depreciation in stock values charged in financial books Rs. 3,800 Prepare a reconciliation statement to reconcile the cost and financial records. Solution Reconciliation Statement Particulars Net Profit as per Cost Account Add: Selling Overhead Over-absorbed Depreciation Overcharged in Cost Account Interest on Investment Bank Interest and Transfer Fees Received Stores Adjustment, Credit in Financial Account Less: Factory overhead Under-absorbed Loss due to Obsolescence Income-Tax Paid Loss due to Depreciation in Stock Profit as per Financial Account Rs. 2,000 2,000 5,000 500 300 1,000 2,000 15,000 3,800 Rs. 80,000
9,800 89,800
21,800 68,000
Illustration 2 From the following figures prepare a reconciliation statement and find out profit as per cost account: Net Profit as per Financial Account Rs. 1,20,000 Works Overhead Under Recovered in Costing 3,000 Administrative Overhead Recovered in Excess 2,000
Depreciation Charged in Financial Account Depreciation Recovered in Costing Interest Received but not Included in Costing Obsolescence Loss Charged in Financial Account Income-tax Provided in Financial Account Ban-interest Credit in Financial Books Depreciation of Stock Charged in Financial Account Solution: Reconciliation Statement Particulars Net Profit as per Financial Account Add: Works Overhead Under-recovered Obsolescence Loss not Charged in Cost Account Income-tax Provided in Finance Account Depreciation in Stock Value Less: Depreciation Overcharged in Cost Account Over-absorption of Adm. Overhead Interest Received but not included in Cost Account Bank Interest Credited in Financial Account Profit as per Cost Account
11,000 12,000 8,000 6,000 30,000 1,000 6,000
Rs. 3,000 6,000 30,000 6,000
Rs. 1,20,000
45,000 1,65,000
1,000 2,000 8,000 1,000
12,000 1,53,000
PROBLEM 1 Prepare a reconciliation statement to reconcile the cost and financial records from the following information: (i) Selling Overhead over Absorbed in Cost Rs. 1,000 and Factory Overheads under Observed in Costs Rs. 2,000. (ii) Depreciation Charged in Financial Account Rs. 6,000 and Recorded in Cost Rs. 7,000. (iii) Interest on Investment not Included in Costs Rs. 4,000. (iv) Loss due to Obsolescence Charged in Financial Records Rs. 3,000. (v) Income Tax Paid Rs. 20,000. (vi) Bank Interest and Transfer Fees Received Rs. 400. (vii) Loss due to Depreciation in Stock Value Charged in Financial Books Rs. 4,000. (viii) The Profit shown by Financial Account for the Year Ended in Rs. 60,000.
PROBLEM 2 The net profit of a company for the year was Rs. 60,000 as shown by the Cost Account. On an examination of financial account and cost account, the following facts were disclosed: (i) Selling Overhead Over-absorbed in Cost Account Rs. 1,000. (ii) Factory Overhead under Absorbed in Cost Account Rs. 2,000. (iii) Depreciation charged in Financial Account Rs. 6,000 and Recovered in Cost Account Rs. 7,000. (iv) Interest on Investment not included in Cost Account Rs. 4,000. (v) Income Tax Paid Rs. 20,000. (vi) Loss in Stock shown only in Financial Account Rs. 3,000. Required: Reconciliation statement between financial and cost account. PROBLEM 3 The net loss as per cost account is Rs. 4,22,000. On reconciliation the following details are ascertained: Factory Overhead under Recovered in Costing Rs. 3,04,000 Administrative Overhead over Absorbed in Costing 2,30,000 Direct Material Over Charged in Costing 30,000 Dividend Received not Included in Costing 50,000 Over Valuation of Closing Stock in Costing 94,000 Bank Interest Collected in Financial Account 10,000 Interest Charged in Financial Account 20,000 Preliminary Expenses Written-off 10,000 Provision for Doubtful Debt made 5,000 Required: Reconciliation Statement.

TM Account XII

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TM Account XII

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Accountancy, Grade XII ...

Full Marks: 100 Teaching Hours: 150

Accountancy, Grade XII ...2

This unit includes the following sub-units:

Accountancy, Grade XII ...3

Description of Content Area of the Unit Company and its formation

Accountancy, Grade XII ...4

Accountancy, Grade XII ...5

Accountancy, Grade XII ...6

Accountancy, Grade XII ...7

Accountancy, Grade XII ...8

Accountancy, Grade XII ...9

12. 13. 14. 15. 16. 17.

Accountancy, Grade XII ...10

Accountancy, Grade XII ...11

Accountancy, Grade XII ...12

Accountancy, Grade XII ...13

(f) (g) (h)

Accountancy, Grade XII ...14

Accountancy, Grade XII ...15

Share first call A/C To share capital A/C

Accountancy, Grade XII ...16

(i) (ii) (iii)

80,000 20,000 60,000

Accountancy, Grade XII ...17

15,00,000 5,00,000 10,00,000

Accountancy, Grade XII ...18

Accountancy, Grade XII ...19

8,00,000 2,00,000 10,00,000

Accountancy, Grade XII ...20

3,00,000 2,00,000 22,00,000

Accountancy, Grade XII ...21

Accountancy, Grade XII ...22

Dr. (Rs) 20,000

Cr. (Rs.) 20,000

50,000 30,000 20,000

Accountancy, Grade XII ...23

2,00,000 1,00,000 3,00,000

Accountancy, Grade XII ...24

1.4.8. Share underwriting and commission

Accountancy, Grade XII ...25

Accountancy, Grade XII ...26

Accountancy, Grade XII ...27

37,500 2,500 40,000

Accountancy, Grade XII ...28

Accountancy, Grade XII ...29

Accountancy, Grade XII ...30

Accountancy, Grade XII ...31

Accountancy, Grade XII ...32

Dr. (Rs) 2,00,000 1,00,000

60,000 1,60,000 40.000 40,000

Accountancy, Grade XII ...33

Cr. (Rs.) 10,000 2,000 4,000

(Amount received) (Discount on reissued share) (Paid up capital amount)

(Amount received) (Paid up capital amount)

(Amount received in excess of paid up capital)

Accountancy, Grade XII ...34

(Amount allowed as discount only on reissue)

350 150 500

Accountancy, Grade XII ...35

Accountancy, Grade XII ...36

Accountancy, Grade XII ...37

On allotment On first call On final call

Rs. 30 Rs. 20 Rs. 30