CU-MCOM-SEM-IV-Company Accounts & Audit

security that may be offered, such an issue of debentures is known as “Debentures Issued as Collateral Security.  A company may issue debentures on any specific condition as to its redemption such as: issued at par and redeemable at par, issued at discount redeemable at par, issued at premium redeemable at par, issued at par redeemable at premium, issued at discount, but redeemable at premium.  When a company issues debentures it undertakes to pay interest thereon at a fixed percentage. The payment of interest on the debt is obligatory on the part of the company issuing them irrespective of the fact whether the company earns profit or not and the interest payable on debentures is a charge against the profits of the company.  Discount on issue of debentures is a capital loss of the company and it is required to be shown on the assets side of the Balance Sheet under the heading “Other Current or Non-Current Asset” until it is written off.  When a company issues debenture at par or at a discount which are redeemable at a premium, the premium payable on redemption of the debentures is be treated as capital loss.  Redemption of debentures refers to the discharge of the liability in respect of the debentures issued by a company. Debentures can be redeemed at any time either at par or at a premium or at a discount.  Debentures may be redeemed by way of: annual drawings, payment in one lump sum at the expiry of a specified period or at the option of the company at a date within such specified period, purchase of debentures in the open market and conversion into shares.  Interest on debentures is generally paid half-yearly to the holders on certain specified dates. If the purchase price for the debentures includes interest for the expired period, the quotation is said to be “Cum-interest”, on the other hand, the purchase price for the debentures excludes the interest for the expired period, the quotation is said to be “Ex-interest”. 2.7 KEYWORDS  Secured and Unsecured:Secured debenture creates a charge on the assets of the company, thereby mortgaging the assets of the company. Unsecured debenture does not carry any charge or security on the assets of the company.  Registered and Bearer:A registered debenture is recorded in the register of debenture holders of the company. A regular instrument of transfer is required for their transfer. In contrast, the debenture which is transferable by mere delivery is called bearer debenture. 51 CU IDOL SELF LEARNING MATERIAL (SLM)

 Debentures at par:Debentures are said to be issued at par when the debenture holder is required to pay an amount equal to the nominal or face value of the debentures e.g., the issue of ` 1,000 debenture for ` 1,000.  Convertible debentures: A convertible debenture is a kind of long-term debt which can be transformed into stock after a specific period of time. A convertible debenture is usually an unsecured bond or a loan as in there is no primary collateral interlinked to the debt.  Non-convertibledebentures: Non-convertible debentures (NCD) are fixed-income instruments, usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. They offer relatively higher interest rates when compared to convertible debentures. 2.8 LEARNING ACTIVITY 1. Definition of Debentures ___________________________________________________________________________ _______________________________________________________________________ 2. What is redemption of debentures? ___________________________________________________________________________ _______________________________________________________________________ 2.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. In April 2009, a company issues 13% ` 20, 00,000 debentures at ` 96 but redeemable at `103. Redemption will be carried out by annual drawings of ` 4 lacs (face value) commencing at the end of March 2014. What do you recommend as the amount to be charged to the profit and loss account, apart from that of interest? 2. 40 lakhs 10% debentures are outstanding in the balance sheet of a company on 31st March, 2013. The company had not paid the six months interest after 30th June, 2013. State the amount of interest on debentures accrued and due as well as interest accrued but not due on 31st March, 2014 3. Calculate the amount of discount to be written off each year on the debentures of ` 60, 00,000 issued on 1.1.2014 at a discount of 5% repayable in annual drawings of ` 10, 00,000 each year. Accounting period ends on 31st December 4. 3A company issues 11% ` 10, 00,000 Debentures, repayable at the end of 10 years at a premium of 5%. It decides to establish a sinking fund to take care of the redemption. 52 CU IDOL SELF LEARNING MATERIAL (SLM)

Investments in readily marketable securities yield 6% per annum. Sinking Fund Table shows that ` 0.075868 annually is required to produce ` 1 at the end of 10 years @ 6%. What is the annual amount that has to be set aside and what account will be debited for credit to the Sinking Fund (Debenture Redemption Fund) A/c? If investments are made to the nearest ` 100, how much will be invested at the end of the 3rd year in the above case? 5. Wye Ltd. has 12% ` 10, 00,000 Debentures at issue. For the purpose of redemption, it maintains a Debenture Redemption Fund with an annual contribution of ` 90,000. On 1st April, 2013 the Fund stood at ` 4, 50,000 represented by 6% ` 5, 00,000 Government Loan. At what figure would the Debenture Redemption Fund stand at the end of March 2014? (b) In the above case, on 1st April, 2014, ` 1, 00,000 Government Loans was sold @ 93.50 and the proceeds were, utilized to purchase debentures for cancellation @ 85. What is the number of debentures, face value that has been cancelled? Long Questions 1. (A) Zed Ltd. shows in its balance sheet 9% ` 30, 00,000 Debentures; interest on these is payable on 31st March and 30th September. On 1st June, 2013 the company purchased as investment ` 50,000 of the debentures @ 89. What is the profit accruing to the company as a result? (b) Continuing the above, at what figure will the debentures appear in the balance sheet? 2. (a) Exe Ltd. purchased its own 12% Debentures (interest payable on 30th September and 31st March) as Sinking Fund Investment as shown below: (1) 1st August, 2013 ` 60,000 @ 94. (2) 31st December, 2012 ` 40,000 @ 95 cum-interests. The total amount of debentures outstanding on 1st April, 2013 was ` 10, 00,000. How much will be credited to the Sinking Fund in 2013-14 by way of interest resulting from the above two transactions? On 31st March, 2014 at what figure the investment in Own Debentures stand in the above case? 3. Ess Ltd. pays interest on its 12% Debentures on 30th September and 31st March. To redeem the debentures, it has maintained a sinking fund which stood on 31st December, 2013 at ` 2, 70,000 represented by 6% Government Loan of the nominal value of ` 3,00,000 (interest payable on the same dates as for debentures). 53 CU IDOL SELF LEARNING MATERIAL (SLM)

On 1st January, 2014, the company purchased ` 1, 00,000 of its debentures @ 96, raising the necessary funds by selling Government Loan @ 92.5 (to the nearest ` 100). What is the nominal value of the Govt. Loan sold and what is the profit/loss on the sale? (Hint: Every ` 100 of Debentures requires ` 99 i.e., ` 96 plus ` 3 for interest. Every ` 100 Of Government Loan will yield ` 94 i.e., the price stated plus ` 1.50 interest for 3 Months). 4. P. Ltd. issued ` 10, 00,000 13.5% Debentures at a discount of 5%; the debenture holders have an option of converting the amount into ` 10 equity shares at a premium of 10%. A debenture holder holding ` 40,000 debentures wish to exercise the option. How many shares will he get? 5. In 2010 Gee Ltd. issued 10% ` 20, 00,000 debentures at a discount of 10%; the debentures were redeemable in 2014. In 2014 the company gave the debenture holders the option of converting the debentures into equity shares at a premium of 25%. One debenture holder holding ` 1, 00,000 Debentures wants to exercise the option. What is the face value of the shares that he will get? B. Multiple Choice Questions 1. Debenture holders are a. Debtors of the Company b. Creditors of the Company c. External users d. Owners of the Company 2.Debentures indicate the a. Short-term Borrowings of a Company b. Directors’ shares in a company c. The Investment of Equity-Shareholders d. Long-term Borrowings of a Company 3.In debenture, interest payable is 54 a. Transferred to general reserve b. Transferred to falling fund investment account c. Charged against the firm’s profits CU IDOL SELF LEARNING MATERIAL (SLM)

d. Appropriation of the company’s profits 4. The owner of the debenture is qualified for a. Fixed-rate interest b. Company’s voting rights c. Firm’s Profits share d. Fixed dividend 5. When a company is liquidated, the debenture holders have a prior right for: a. principal amount b. interest c. both (a)and (b) d. none of these Answers 1-b,2-d, 3-c, 4-a, 5-c. 2.10 REFERENCES Reference books  M.C. Shukla, T.S. Grewal : & S.C. Gupta Advanced Accounts Vol. II; S. Chand & Company Ltd., 7361, Ram Nagar, New Delhi-110 055.  R.L. Gupta & :M. Radhaswamy Company Accounts; Sultan Chand & Sons,23, Daryaganj, New Delhi- 110 002.  S.P. Jain & K. L. Narang: Advanced Accountancy-Vol.II; Kalyani Publishers, 23, Daryaganj, New Delhi - 110 002.  S. N. Maheshwari &S.K. Maheshwari Advance Accounting Vol. II; Vikas Publishing House (Pvt.) Ltd., A-22, Sector 4, Noida – 201 301.  Ashok Sehgal & : Deepak Sehgal Textbook  Advanced Accounting Vol. 2; Taxmann’s,59/32, New Rohtak Road, New Delhi- 110 005. 55 CU IDOL SELF LEARNING MATERIAL (SLM)

 J. R. Monga : Fundamentals of Corporate Accounting; Mayoor Paperbacks, A-95, Sector 5, Noida-201 301.  Goel, Maheshwari Gupta : Corporate Accounting, International Publishers, Daryaganj New Delhi  Kamal Gupta, Ashok Arora : Fundamentals of Auditing: Tata McGraw Hill Education Limited  Kamal Gupta: Contemporary Auditing: Tata McGraw Hill Education Limited  International Financial Reporting Standards (IFRS) Taxmann Publication (P) Limited, 59/32, New Rohtak Road, New Delhi- 110 005  Dolphy D’Souza : Indian Accounting Standards & GAAPP; Snow White Publications Pvt. Ltd., Her Mahal, 532, Kalbadevi Road, Mumbai – 400 002.  N S Zad : Company Accounts and Auditing Practices : Taxmann Publications (P) Ltd., 59/32, Rohtak Road, New Delhi - 110005 Website  https://icmai.in/upload/Students/Syllabus2016/Inter/Paper-12_070219.pdf  https://www.mca.gov.in/MinistryV2/accounts+and+audit.html 56 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT – 3 : FINAL ACCOUNTS OF COMPANIES STRUCTURE 3.0 Learning Objectives 3.1 Introduction 3.2 Conceptual Framework 3.3 Preparation and Presentation of Financial Statements 3.4 Schedule VI 3.5 Interpretation and Scrutiny of Balance sheet 3.6 Treatment of Profit Prior to Incorporation 3.7 Preoperative and Preliminary Expenses 3.8 Preparation of Final Accounts under Company Law 3.9 Summary 3.10 Keywords 3.11 Learning Activity 3.12 Unit end Question 3.13 References 3.0 LEARNING OBJECTIVES The financial statements are the end products of accounting process. They are prepared following the consistent accounting concepts, principles, procedures and also the legal environment in which the business organizations operate. These statements are the outcome of the summarizing process of accounting and therefore, are the sources of information on the basis of which conclusions are drawn about the profitability and the financial position of a company. Hence, they need to be arranged in a proper form with suitable contents so that the shareholders and other users of financial statements can easily understand and use them in their economic decisions in a meaningful way. The objective of this lesson is to make the students understand the statutory provisions regarding preparation of final accounts of companies. After going through this lesson, the one should be able to – Familiarize and understand with the requirements of preparation of statement of Profit and Loss and Balance Sheet, appreciate the importance and modes of making different adjustments in the final account, apportion the profit of a company between pre-incorporation period and post incorporation period etc. 57 CU IDOL SELF LEARNING MATERIAL (SLM)

3.1 INTRODUCTION There is no legal obligation for sole proprietorship and partnership firm to prepare final accounts, but companies have statutory obligations to keep proper books of account and to prepare its final accounts every year in the manner as prescribed in the Companies Act. Chapter IX, sections 128 to 138 of the Companies Act, 2013 deals with the legal provisions relating to the Accounts of Companies. These sections including Schedule II and III were brought into force from 1st April 2014. The relevant rules pertaining to these provisions have also been notified. All these relevant provisions/schedules and rules will be applicable for the financial years commencing on or after 1st April 2014. It is clarified that in respect of financial years that commenced earlier than 1st April 2014, shall be governed by the relevant provisions/schedules and rules of the Companies Act, 1956. 3.2 CONCEPTUAL FRAMEWORK Conceptual Framework A conceptual framework can be defined as a system of ideas and objectives that lead to the creation of a consistent set of rules and standards. Specifically in accounting, the rule and standards set the nature, function and limits of financial accounting and financial statements. The main reasons for developing an agreed conceptual framework are that it provides:  a framework for setting accounting standards;  a basis for resolving accounting disputes;  Fundamental principles which then do not have to be repeated in accounting standards. History Prior to 1929, no group—public or private—was responsible for accounting standards. After the 1929 stock market crash, the Securities and Exchange Act of 1934 was passed. This resulted in the U.S. Securities and Exchange Commission (SEC) supervising public companies. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the U.S. The Financial Accounting Standards Board (FASB) is a private, not-for-profit organization whose mission is “to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.” Created in 1973, FASB replaced the Committee on Accounting Procedure (CAP) and the Accounting Principles Board (APB) of the American Institute of Certified Public Accountants (AICPA). 58 CU IDOL SELF LEARNING MATERIAL (SLM)

FASB’s Conceptual Framework, a project begun in 1973 to develop a sound theoretical basis for the development of accounting standards in the United States. From 1978 to 2010 the FASB released eight concept statements. 1. Objectives of financial reporting by business enterprises (sfac no. 1) 1978 2. Qualitative characteristics of accounting information (sfac no. 2)1980 3. Elements of financial statements of business enterprises (sfac no. 3)1980 4. Objectives of financial reporting by nonbusiness organizations (sfac no. 4) 1980 5. Recognition and measurement in financial statements of business enterprises (sfac no. 5)1984 6. Elements of financial statements; a replacement of fasb concepts statement n. 3, also incorporating an amendment of fasb concepts statement no. 2 (sfac n. 6) 1985 7. Using cash flow information and present value in accounting measurements (sfac no. 7) 2000 8. No. 8. Conceptual framework for financial reporting, a replacement of sfac no. 1 and no. 2 2010 Why is the Framework Necessary? With a sound conceptual framework in place the FASB is able to issue consistent and useful standards. In addition, without an existing set of standards, it isn’t possible to resolve any new problems that emerge. The framework also increases financial statement users’ understanding of and confidence in financial reporting and makes it easier to compare different companies’ financial statements. 3.3 PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS Section 129 of the Companies Act 2013 governs the preparation and presentation of financial statements of the company. (1) The financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under section 133 and shall be in the form or forms as may be provided for different class or classes of companies in Schedule III.  The items contained in such financial statements shall be in accordance with the accounting standards.  Nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity, or to any other class of company for which a form of financial statement has been specified in or under the Act governing such class of company.  the financial statements shall not be treated as not disclosing a true and fair view 59 CU IDOL SELF LEARNING MATERIAL (SLM)

of the state of affairs of the company, merely by reason of the fact that they do not disclose – a) in the case of an insurance company, any matters which are not required to be disclosed by the Insurance Act, 1938, or the Insurance Regulatory and Development Authority Act, 1999; b) in the case of a banking company, any matters which are not required to be disclosed by the Banking Regulation Act, 1949; c) in the case of a company engaged in the generation or supply of electricity, any matters which are not required to be disclosed by the Electricity Act, 2003; d) In the case of a company governed by any other law for the time being in force, any matters which are not required to be disclosed by that law. According to the rules for the purposes of sub-section (1) of section 129, the class of companies as may be notified by the Central Government from time to time, shall mandatorily file their financial statements in Extensible Business Reporting Language (XBRL) format and the Central Government may specify the manner of such filing under such notification for such class of companies. The term ‘Extensible Business Reporting Language’ means a standardized language for communication in electronic form to express report or file financial information by companies under this rule. (2) At every annual general meeting of a company, the Board of Directors of the company shall lay before such meeting financial statements for the financial year. (3) Where a company has one or more subsidiaries, it shall, in addition to financial statements provided under sub-section (2), prepare a consolidated financial statement of the company and of all the subsidiaries in the same form and manner as that of its own which shall also be laid before the annual general meeting of the company along with the laying of its financial statement under sub-section (2).  The company shall also attach along with its financial statement, a separate statement containing the salient features of the financial statement of its subsidiary or subsidiaries. According to the rules the statement containing the salient feature of the financial statement of a company’s subsidiary or subsidiaries, associate company and joint venture shall be in Form 9.1.  Further as per the rules the Consolidation of financial statements of the company shall be made in accordance with the Accounting Standards, subject however, to the requirement that if under such Accounting Standards, consolidation is not required for the reason that the company has its immediate parent outside India, then such companies will also be required to prepare Consolidated Financial Statements in the manner and format as specified under Schedule III to the Act. (4) The provisions of this Act applicable to the preparation, adoption and audit of the 60 CU IDOL SELF LEARNING MATERIAL (SLM)

financial statements of a holding company shall, mutatis mutandis, apply to the consolidated financial statements. (5) Without prejudice to sub-section (1), where the financial statements of a company do not comply with the accounting standards referred to in sub-section (1), the company shall disclose in its financial statements, the deviation from the accounting standards, the reasons for such deviation and the financial effects, if any, arising out of such deviation. (6) The Central Government may, on its own or on an application by a class or classes of companies, by notification, exempt any class or classes of companies from complying with any of the requirements of this section or the rules made thereunder, if it is considered necessary to grant such exemption in the public interest and any such exemption may be granted either unconditionally or subject to such conditions as may be specified in the notification. (7) If a company contravenes the provisions of this section, the managing director, the whole-time director in charge of finance, the Chief Financial Officer or any other person charged by the Board with the duty of complying with the requirements of this section and in the absence of any of the officers mentioned above, all the directors shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with both. Explanation. – For the purposes of this section, except where the context otherwise requires, any reference to the financial statement shall include any notes annexed to or forming part of such financial statement, giving information required to be given and allowed to be given in the form of such notes under this Act. 3.4 SCHEDULE VI Schedule VI to the Companies Act, 1956 deals with the form of Balance Sheet and Profit and Loss Account and classified disclosure to be made therein and it applies uniformly to all the companies registered under the Companies Act, 1956, for the preparation of financial statements of an accounting year. The original schedule VI, with minor amendments from time to time, has been in force for more than fifty years. To keep pace with the changes in the economic philosophy leading to privatization and globalization and consequent desired changes/reforms in the corporate financial reporting practices, the Ministry of Corporate Affairs, Government of India, has revised the above mentioned schedule and through its notification No. F. No. 2/6/2008—C.L-V has notified that the text of the Revised Schedule VI to the Companies Act, 1956 shall come into force for the Balance Sheet and Profit and Loss Account to be prepared for the financial year commencing on or after 01.04.2011. The primary focus of the revision has been to bring the disclosures in Financial Statements at par, or at least very close, to the international corporate reporting practices. 61 CU IDOL SELF LEARNING MATERIAL (SLM)

Salient features of Schedule VI include the following:  A vertical format for presentation of Balance Sheet with classification of Balance Sheet items into current and non-current categories.  A vertical format of Statement of Profit and Loss with classification of expenses based on nature.  Deletion of part IV of the original schedule requiring presentation of Balance Sheet abstract and general business profile.  The schedule VI has eliminated the concept of Schedules and such information is now to be furnished in terms of, ‘Notes to Accounts’.  While preparing the Balance-Sheet, ‘Cash and Cash Equivalents’ will be shown under, ‘Current Assets’, and include the following: 4 I. (a) Balance with banks (b) Cheques, drafts on hand. (c) Cash on hand (d) others (specify nature) II. Earmarked balances with banks (For example, for unpaid dividend) shall be separately stated (Not to be evaluated). III. Balances with banks held as margin money or security against the borrowings, guarantees, other commitments shall be disclosed separately (Not to be Evaluated). IV. Bank deposits with more than 12 months maturity (Not to be evaluated) 3.5 INTERPRETATION AND SCRUTINY OF BALANCE SHEET When it comes to understanding a business, there are few financial statements more important than the balance sheet. The balance sheet offers critical insight into the health of a business that can be used by:  Potential investors to decide whether to invest in a company  Business owners to craft more effective organizational strategy  Employees to adjust their processes to better reach shared organizational goals Whether you’re a business owner, employee, or investor, understanding how to read and understand the information in a balance sheet is an essential financial accounting skill to have. Here’s everything you need to know about understanding a balance sheet, including what it is, the information it contains, why it’s so important, and the underlying mechanics of how it works. What Is A Balance Sheet? A balance sheet is a financial document designed to communicate exactly how much a company or organization is worth—it’s so-called “book value.” The balance sheet achieves this by listing out and tallying up all of a company’s assets, liabilities, and owners’ equity as of a particular date, also known as the “reporting date.\" Typically, a balance sheet will be prepared and distributed on a quarterly or monthly basis, depending on the frequency of reporting as determined by law or company policy. The Purpose oftheBalance Sheet 62 CU IDOL SELF LEARNING MATERIAL (SLM)

A balance sheet provides a summary of a business at a given point in time. It’s a snapshot of a company’s financial position, as broken down into assets, liabilities, and equity. Balance sheets serve two very different purposes depending on the audience reviewing them. When a balance sheet is reviewed internally by a business leader, key stakeholder, or employee, it’s designed to give insight into whether a company is succeeding or failing. Based on this information, an internal audience can shift their policies and approach: doubling down on successes, correcting failures, and pivoting toward new opportunities. When a balance sheet is reviewed externally by someone interested in a company, it’s designed to give insight into what resources are available to a business and how they were financed. Based on this information, potential investors can decide whether it would be wise to invest in a company. Similarly, it’s possible to leverage the information in a balance sheet to calculate important metrics, such as liquidity, profitability, and debt-to-equity ratio. External auditors, on the other hand, might use a balance sheet to ensure a company is complying with any reporting laws it’s subject to. It’s important to remember that a balance sheet communicates information as of a specific date. By its very nature, a balance sheet is always based upon past data. While investors and stakeholders may use a balance sheet to predict future performance, past performance is no guarantee of future results. The Balance Sheet Equation The information found in a balance sheet will most often be organized according to the following equation: Assets = Liabilities + Owners’ Equity. While this equation is the most common formula for balance sheets, it isn’t the only way of organizing the information. Here are other equations you may encounter: Owners’ Equity = Assets - Liabilities Liabilities = Assets - Owners’ Equity A balance sheet should always balance. Assets must always equal liabilities plus owners’ equity. Owners’ equity must always equal assets minus liabilities. Liabilities must always equal assets minus owners’ equity. If a balance sheet doesn’t balance, it’s likely the document was prepared incorrectly. Typically, errors are due to incomplete or missing data, incorrectly entered transactions, errors in currency exchange rates or inventory levels, miscalculations of equity, or miscalculated depreciation or amortization. Here’s a closer look at what's typically included in each of those categories of value: assets, liabilities, and owners’ equity. 1. Assets 63 CU IDOL SELF LEARNING MATERIAL (SLM)

An asset is defined as anything that is owned by a company and holds inherent, quantifiable value. A business could, if necessary, convert an asset into cash through a process known as liquidation. Assets are typically tallied as positives (+) in a balance sheet and broken down into two further categories: current assets and noncurrent assets. Current assets typically include anything a company expects it will convert into cash within a year, such as:  Cash and cash equivalents  Prepaid expenses  Inventory  Marketable securities  Accounts receivable Noncurrent assets typically include long-term investments that aren’t expected to be converted into cash in the short term, such as:  Land  Patents  Trademarks  Brands  Goodwill  Intellectual property  Equipment used to produce goods or perform services Because companies invest in assets to fulfill their mission, you must develop an intuitive understanding of what they are. Without this knowledge, it can be challenging to understand the balance sheet and other financial documents that speak to a company’s health. Related: Financial Statement Analysis: The Basics for Non-Accountants 2. Liabilities A liability is the opposite of an asset. While an asset is something a company owns, a liability is something it owes. Liabilities are financial and legal obligations to pay an amount of money to a debtor, which is why they’re typically tallied as negatives (-) in a balance sheet. Just as assets are categorized as current or noncurrent, liabilities are categorized as current liabilities or noncurrent liabilities. Current liabilities typically refer to any liability due to the debtor within one year, which may include:  Payroll expenses  Rent payments  Utility payments  Debt financing 64 CU IDOL SELF LEARNING MATERIAL (SLM)

 Accounts payable  Other accrued expenses Noncurrent liabilities typically refer to any long-term obligations or debts which will not be due within one year, which might include:  Leases  Loans  Bonds payable  Provisions for pensions  Deferred tax liabilities Liabilities may also include an obligation to provide goods or services in the future. 3. Owners’ Equity Owners’ equity, also known as shareholders' equity, typically refers to anything that belongs to the owners of a business after any liabilities are accounted for. If you were to add up all of the resources a business owns (the assets) and subtract all of the claims from third parties (the liabilities), the residual leftover is the owners’ equity. Owners’ equity typically includes two key elements. The first is money, which is contributed to the business in the form of an investment in exchange for some degree of ownership (typically represented by shares). The second is earnings that the company generates over time and retains. A Balance Sheet Example By looking at the sample balance sheet below, you can extract vital information about the health of the company being reported on. 65 CU IDOL SELF LEARNING MATERIAL (SLM)

For example, this balance sheet tells you:  The reporting period ends November 30, 2018, and compares against a similar reporting period from the year prior  The company’s assets total $60,173, including $37,232 in current assets and $22,941 in noncurrent assets 66 CU IDOL SELF LEARNING MATERIAL (SLM)

 The company’s liabilities total $16,338, including $14,010 in current liabilities and $2,328 in noncurrent liabilities  The company retained $45,528 in earnings during the reporting period, slightly more than the same period a year prior 3.6 TREATMENT OF PROFIT PRIOR TO INCORPORATION Sometimes, a company is formed for purchasing certain running or going concern. A company comes into existence only after its registration i.e., its incorporation. A company can earn profits only after its incorporation, but not before its incorporation. In many cases, th6 date of acquisition of business may not coincide with the date of the incorporation. For instance, a company incorporated on 1st May 2004 may purchase a business from 1st January 2004, the date on which the financial year starts. Generally, the business of going concern is purchased on the basis of last Balance Sheet. It will be more convenient to both—the vendor and the vendee. In case if the business is purchased on a date other than the date of Balance Sheet, accounts of stocks, assets, liabilities etc. have to be taken and verified. The processes are tedious jobs. To avoid such a tedious job, the business may be acquired from the date the firm prepared its last final accounts. A private company can commence business soon after its incorporation, while a public company can commence business only after obtaining the certificate of commencement of business. That is, any profit made, in case of private company, before incorporation and in case of public company any profit made before the commencement of business, should be taken as a capital profit. However, it should be noted carefully that it is the date of incorporation and not the date of commencement of business which is taken into consideration for calculating profit or loss prior to incorporation. For instance, a company incorporated on 1.4.2004 agrees to take over a running business from 1.1.2004. It closes its accounts on 31st December. The company is entitled to not only the profit or loss from 1.1.2004 to 31.3.2004 but also the profit or loss from 1.4.2004 to 31.12.2004. The profit earned prior to incorporation i.e., 1.1.2004 to 31.3.2004 is known as PRE-INCORPORATION PROFIT, which cannot be taken as revenue profit, but is CAPITAL PROFIT. Such profit is to be transferred to CAPITAL RESERVE or may be used in writing down capital loss. When, there arises a loss in the pre-incorporation period, the loss should be debited to GOODWILL ACCOUNT. The profit earned during post period i.e., in the above example, from 1.4.2004 to 31.12.2004, is revenue profit and is available for dividend. Allocation of ‘Profit/Loss into Pre-and Post-Incorporation Period: As the profits earned prior to incorporation are not available for dividend, it is necessary to separate it from divisible profits. This is possible, when the profit and loss account is 67 CU IDOL SELF LEARNING MATERIAL (SLM)

prepared separately for the pre-incorporation period and post-incorporation period. And this is possible only by closing of the books and stock taking for the two periods. These involve tedious work. Therefore, the profit or loss is estimated by apportioning on some reasonable basis – time, turnover, equitable or actual. In practice, the same sets of books of accounts are maintained throughout the accounting year. A Profit and Loss Account is prepared at the end of the year and thereafter the profits or losses between the two periods are allocated: (i) From the date of purchase to the date of incorporation (Pre-incorporation period) and (ii) From the date of incorporation to the closing of the accounting year (post-incorporation period). Method of Accounting: Steps to find out the profit or loss before and after incorporation are as follows: 1. Prepare one trading account for the whole period. Do not consider the date of incorporation. Thus, one figure of gross profit for the entire period is arrived at. 2. The gross profit is apportioned between the two periods, prior to incorporation and post- incorporation, on the basis of sales in the two periods. 3. The various expenses, which are shown in the profit and Loss Account, should be divided between pre and post incorporation periods on some logical and appropriate basis. They are given below: 68 CU IDOL SELF LEARNING MATERIAL (SLM)

Sales Ratio: In simple problems, where the sales are evenly spread over the whole period, the sales are apportioned between pre- and post-incorporation periods in the proportion of their time periods. But in many cases, the sales are fluctuating from time to time. Therefore, the Sales Ratio is found out by considering pre and post-incorporation periods on the basis of their respective turnover. (Turnover-cum-time basis.) Treatment of Pre-Incorporation Results: Profit or loss from the date of purchase of business till the date of incorporation belongs to the company. Such profit should not be regarded as trading profit. The profit made before incorporation is not available for distribution as dividends to the shareholders of the purchasing company because it is treated as capital profit. The treatment of pre-incorporation results is given below: (A) Profit Prior to Incorporation: 1. The profit is in the nature of capital profit. 2. Capital profit should not be used for payment of dividend. 3. It can be used for writing down goodwill or capital losses. 4. The unutilised portion of the profit can be transferred to Capital reserve. (B) Loss Prior to Incorporation: 1. It can be treated as goodwill and added to goodwill account. 2. It can also be treated as deferred revenue expenditure and written off against profits, over a number of years. 3.7 PREOPERATIVE AND PRELIMINARY EXPENSES Preliminary Expenses:All expenses incurred before a company is formed i.e., cost incurredbefore the start of business operations is termed as preliminary expenses. They are a common example of fictitious assets and are written off every year from the profits earned by the business. Examples of such expenses suffered before the incorporation of business are;  Legal cost (Govt. & Court related fees)  Professional fees (Lawyers, Chartered Accountants, etc.)  Stamp duty  Printing fees Preoperative expenses are those expenses incurred by a company before commencement of commercial operations; or before starting to earn income. These are distinct frompreliminary 69 CU IDOL SELF LEARNING MATERIAL (SLM)

expenses or formation expenses. Any business before commencing its business incurs various expenditure, the most common ones being feasibility, marketing, brokerage for office/ work premise searching, rentals for place, salaries to staff, funding of the project etc. 3.8 PREPARATION OF FINAL ACCOUNTS UNDER COMPANY LAW Section 210 of the Companies Act governs the preparation of final account of a Company. The Board of Directors of a Company must, within 18 months from the date of incorporation, and subsequently once a year, lay take the company in general meeting the Balance Sheet of the Company and a Profit and Loss Account. In case of non-profit Companies, an Income and expenditure Account should be submitted. The period to which the account relates is called a Financial Year of the Company. It may be less or more of a calendar year but must not exceed 15 months. It may also be extended to 18 months provided the Register has granted special permission. The Profit and Loss Account or Income and Expenditure Account the relate, in the case of the first Annual General Meeting of the Company, in a period from the date of an incorporation to a day which shall not precede the day of the meeting by more than nine months. And in case of any subsequent Annual General Meeting, the period runs from the date of the previous accounts to a date not more than six months prior to the date of meeting. Section 211 prescribes the form of Balance Sheet and contents of Profit and Loss Account. Every Balance Sheet of Company shall give a true and fair view of the state of affairs of the Company as at the end of the financial year. It shall also be in the form set out in part 1 of Schedule VI, or in such other form as may be approved by the Central Government [211 (1)]. Provided that nothing contained in this sub-section shall apply to any Insurance or Banking Company or any Company engaged in the generation of supply of electricity or to any other class of Company for which a form of Balance Sheet been specified in or under the Act governing such class of Company. Every Profit and Loss Account of a Company shall give a true and, fair view of the profit and loss the Company for the financial year. It shall also comply with the requirements of part II of Schedule VI, so far as they are applicable thereto [Sec. 211 (2)]. This requirement does not apply to any Insurance or Banking Company or any Company engaged in the generation of supply of electricity, or any other class of company for which a form of Profit and Loss Account has been specified in or under the Act governing such class of Company. 70 CU IDOL SELF LEARNING MATERIAL (SLM)

Every Balance Sheet and every Profit and Loss Account of a Company shall be duly signed on behalf of the Board of Directors by the Manager or Secretary, if any, and by not less than two Directors of the Company. One of the Directors who sign shall be a Managing Director where there is one. The Balance Sheet and Profit and Loss Account must be approved by the Board before they are submitted to the auditors who must in turn attach their report thereto. The Profit and Loss Account shall be annexed to the Balance Sheet and the auditor’s report shall be attached thereto. If there is any separate, special supplementary report by the auditor, it shall also be attached to the Balance Sheet. If any person, being a Director of a Company, fails to take all reasonable step to company with the previsions, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with imprisonment for a term which may extend to six months, or with fine which may extend to Rs. 1,000 or with both. However, the punishment of imprisonment is given only when the offence is committed willfully. Profit and Loss Account: The Indian Companies Act is silent as to the form of Profit and Loss Account. But part II of Schedule VI contains a list of items of incomes and expenditure which should be included in the Profit and Loss Account. The profit and Loss Account of a Company should give a true and fair view of the profit or loss of the Company for the financial year. The first account covers the period since the incorporation of the Company, and subsequent accounts cover the period since the date of the preceding account. An Income and Expenditure Account takes the place of Profit and Loss Account in the case of a Company not trading for profit. Statutory Requirements: Profit and Loss Account shall be so made out as to clearly disclose the result of the working of the Company during the period covered by the account and shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring expenditure or expenditure of an exceptional nature. It shall set out the various items relating to the income and expenditure of the Company under the most convenient heads and in particular shall disclose the following information in respect of the accounting period. The Profit and Loss Account must be prepared with the directions given in part II Schedule VI of the Act. The important provisions are given below: 71 CU IDOL SELF LEARNING MATERIAL (SLM)

1. (a) The turnover, that is, the aggregate amount for which sales are affected by the Company, giving the number of sales in respect of each class of goods dealt with by the Company, and indicating the quantities of such sales for each class Separately. (b) Commission paid to sole selling agent within the meaning of section 294 of the Act (c) Commission paid to other selling agents. (d) Brokerage and discount on sales other than sales trade discount. 2. (a) In the case of manufacturing concerns, the purchase of raw material including consumption and the opening and closing stocks of the good produced indicating the quantity produced. (b) In the case of trading concerns the purchases made and the opening and the Closing stocks. (c) In the case of Companies rendering or supplying services, the gross income derived from service rendered or supplied. (d) In the case of Company which falls under more than one of the categories mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the requirements herein if the total amounts are shown in respect of the opening and closing stocks, purchases, sales up and the gross income from services rendered is shown (e) In the case of other Companies, the gross income derived under different heads. 3. In the case of all concerns having work-in-progress, the amounts for which (such works have been completed) at the commencement and at the end of the accounting period. 4. The amount provided for depreciation, renewals or diminution in value of fixed assets. If such provision is not made by means of a depreciation charge, the method adopted for making such provision. If not, provision is made for depreciation, the fact that no provision has been made shall be stated and the quantum of arrears of depreciation computed in accordance with Section 205 (2) of the Act shall be disclosed by way of a note. The amount of interest on the Company’s debentures and other fixed loans, that is to say loans for fixed periods stating separately the amount of interest if any, paid or payable to the Managing Director, and the Manager, if any. The amount of charge for Indian Income-tax and other Indian taxation on profit and distinguishing them. The amount reserved for: (a) Repayment of share capital and (b) Repayment of loans. 72 CU IDOL SELF LEARNING MATERIAL (SLM)

(a) The aggregate, if material, of any amounts set aside or proposed to be set aside to reserves but not including provisions made to meet any specific liability, contingency or commitment known to exist at the date of the Balance Sheet. (b) The aggregate, if material, of any amount withdraws from such reserves. (a) The aggregate, if material of the amounts set aside to provisions made for meeting specific liabilities, contingencies or commitments. c) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required. Expenditure incurred on each of the following items separately for each item: (a) Consumption of stores and spare parts. (b) Power and fuel. (c) Rent. (d) Repairs to Buildings. (e) Repairs to Machinery. (f) (i) Salaries, Wages and Bonus. (ii) Contribution to provident and other funds. (iii) Workmen and staff welfare expenses to the extent not adjusted from any previous provision or reserve. (g) Insurance (h) Rates and taxes including taxes on income. (i) Miscellaneous expenses. Provided that any item under which the expenses exceed 1% of the total revenue of the Com- pany or Rs. 5,000, whichever is higher, shall be shown as a separate and distinct item against an appropriate account head in the Profit and Loss Account and shall not be combined with any other items to be shown under Miscellaneous Expenses. (a) The amount of income from investments, distinguishing between trade Investments. (b) Other income by way of interest, specifying the nature of the income. (c) The amount of income tax deducted if the gross income is stated under subparagraphs (a) and (b) above. (a) Profit and losses on investments (showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm) to the extent not adjusted from any previous provision or reserve. 73 CU IDOL SELF LEARNING MATERIAL (SLM)

(b) Profit and losses in respect of transactions of a kind not usually undertaken by the Company or undertaken in circumstances of an exceptional or non-recurring if material in amount. (c) Miscellaneous income. (a) Dividends from Subsidiary Companies. (b) Provisions for losses of Subsidiary Companies. The aggregate amount of dividends paid and proposed, and stating whether such amounts are subject to deduction of income tax or not. Amount, if material, by which any items shown in the Profit and Loss Account is affected by any change in the basis of accounting. The Profit and Loss Account shall contain by way of a note detailed information showing separately the following payments provided or made during the financial year to the Directors (including Managing Directors) the Managing Agents, Secretaries and Treasurers or Manager, if any, by the Company. The subsidiaries the Company, the subsidiaries of the Company of any other person: Managerial remuneration under Section 198 of the Act paid or payable during the financial year. Expenses reimbursed to the Managing Agent under Section 345. Commission or other remuneration payable separately to a Managing Agent or his associate under Section 356,357 and 358. Commission received or receivable under Section 356 by the Managing Agent or his associate as selling agent of other concerns in respect of contracts entered into by such concerns with the Company. The money value of the contracts for the sale or purchase of goods and materials or supply of services, entered into by the Company with the Managing Agent or his associate under Section 360 during the financial year. Other allowances and commission including guarantee commission. Any other perquisites or benefits in cash or in kind stating the money value where practicable. Pensions, gratuities, payments from provident funds in excess of own subscription and interest thereon, compensation for loss of office, consideration in connection with retirement from office. The Profit and Loss Account shall contain or give by way of a note a statement showing the computation of net profits in accordance with Section 340 of the Act with the relevant details of the calculation of the commission’s payable by way of percentage of such profits to the directors including Managing Directors or Managers, if any. 74 CU IDOL SELF LEARNING MATERIAL (SLM)

The Profit and Loss Account also contains by way of note detailed information in regard to amounts paid to the auditors whether as fees, expenses or otherwise for services rendered as auditor and in any other capacity. Provision and reserves as per Company Act: Provision: Provision is a change against profits and finds its places on the debit side of Profit and Loss Account. The net profit is arrived at after taking into account all provisions. The provisions are in the nature of expense. Thus, Profit is subjected to further any adjustment that is in order to make it available for distribution of dividend to shareholders. It is popularly known as above line adjustments. Provisions that are generally charged to the debit side of Profit and Loss Account. Provision for Depreciation Provision for Reserve for Doubtful Debts on Debtors Provision for Managerial Remuneration payable Provisions for any expenses that may become payable Reserve: Reserve is an appropriation out of net profits (i.e., the Profits after adjustment of provision). The adjustments to reserve are made in Profit and Loss Appropriation Account. It is popularly known as below line adjustments. (Note: line denotes the stage at which the Net profit is arrived at) Reserves that are generally appropriated out of profits Reserve for Taxation i.e., provision for taxation though it is called a provision the meaning of provision is not applied to this and have to be treated as reserve. Moreover, tax can be provided only after all the expenses are provided for. Provision for Dividends as per law dividends can be paid out of profits. Profit means profit available after taking into all the statutory expenses and provision. This is applicable for interim dividend, final dividend and proposed dividend. Transfers to Reserves specifically like general reserve, sinking fund, and other specific reserves. The items usually appearing in the Profit and Loss Appropriation Account are as shown below: 75 CU IDOL SELF LEARNING MATERIAL (SLM)

76 CU IDOL SELF LEARNING MATERIAL (SLM)

77 CU IDOL SELF LEARNING MATERIAL (SLM)

78 CU IDOL SELF LEARNING MATERIAL (SLM)

Note: 1. Details under each of the above items shall be given in separate schedules. The schedules shall incorporate all the information required to be given under A. Horizontal form read with notes containing general instructions for preparation of Balance Sheet. 79 CU IDOL SELF LEARNING MATERIAL (SLM)

2. The schedules, referred to above, accounting policies and explanatory notes that may be attached shall form an integral pan of the Balance Sheet. 3. The figures in the Balance Sheet may be rounded off to the nearest ‘000’ or ’00’ as may be expressed in terms of decimals of thousands. 4. A foot note to the Balance Sheet may be added to show separately the contingent liabilities. (VIII) Special points to be remembered while preparing Balance Sheet: 1. Calls-in-arrears: It refers to the amount not paid by the shareholders on the calls made on them by the company. This item is usually given in the trial balance. It should be deducted from the called up the liabilities side of the Balance Sheet to find paid up capital. If the Trial balance shows only the paid-up capital and the call-in-arrears is given in the adjustment, the amount is first added to the paid-up capital to show the called-up capital and then deducted against so that the paid-up capital can be shown in the outer column. 2. Unclaimed dividend: It refers to the amount of dividend not collected by the shareholders from the company. This item is always shown on the credit side of Trial Balance. It is shown on the liabilities side of the Balance Sheet under the heading “Current Liabilities”. 3. Forfeited shares account: This item appears as a credit item in the Trial Balance and is shown on the liabilities side of the Balance sheet by adding it to the paid-up capital. 4. Securities premium account: This item is shown on the liabilities side of the Balance Sheet under the heading “Reserves and Surplus”. Illustration 1: A Ltd. was registered with an authorized capital of Rs. 6, 00,000 in equity shares of Rs. 10 each. The following is its Trial Balance on 31 March 2008. 80 CU IDOL SELF LEARNING MATERIAL (SLM)

Prepare Profit & Loss Account, Profit & Loss Appropriation A/c and Balance Sheet in proper form after making the following adjustments: (i) Depreciate plant and machinery by 15% (j) Write off Rs.500 from preliminary expenses (k) Provide for 6 months interest on debentures (l) Leave bad and doubtful debts provision at 5% on sundry debtors (m) Provide for income tax at 50% (n) Stock on 31.3.2008 was Rs. 95,000. 81 CU IDOL SELF LEARNING MATERIAL (SLM)

82 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration – 2: The Mafatlal manufacturing company Ltd. Chennai was registered with a nominal capital Rs. 12, 00,000 in equity shares of Rs.10 each. The following is the list of balances extracted from its books on 31s’ March 2008. 83 CU IDOL SELF LEARNING MATERIAL (SLM)

The following adjustments have to be made: (i) Stock on 31st March 2008 was valued at Rs. 1, 90,000 (ii) Write off Rs.2, 000 from preliminary expenses (iii) Provide for half year’s debenture interest (iv) The provision for doubtful debts on 31st March 2008 should be equal to 1% on sales (v) Directors’ fees are outstanding to the extent of Rs.550 and salaries Rs.1000 (vi) Depreciate Plant & Machinery by 5% premises by 2 % and write off Rs.2, 400 on furniture. (vii) Goods to the value of Rs.3, 000 were distributed as free samples during the year. But no entry in this respect had been made. You are required to prepare the Trading and Profit & Loss account and Profit & Loss Ap- propriation account for the year ended 31st March 2008 and the Balance Sheet as on the same date. Solution: 84 CU IDOL SELF LEARNING MATERIAL (SLM)

85 CU IDOL SELF LEARNING MATERIAL (SLM)

Note: Since interim dividend is for current year, dividend tax should also be provided in the current year. Surcharge on dividend tax is ignored since it changes from year to year. Illustration 3: The following information has been extracted from the books of account of Hema Ltd. As at 31st March 2009: - 86 CU IDOL SELF LEARNING MATERIAL (SLM)

The following additional information is provided to you: (i) The stock at 31st March 2009 (valued at the lower of cost or net realizable value) was estimated to be worth Rs. 1, 00,000. (ii) Fixtures, fittings, tools and equipment all related to administration. Depreciation is charged @20% per annum on cost. A full year’s depreciation is charged in the year of acquisition, but no depreciation is charged in the year of disposal. (iii) During the year to 31″ March, 2000, the company purchased Rs.60, 000 of equipment also sold some fittings (which had originally cost Rs.30, 000) for Rs. 5,000 and for which depreciation of Rs. 15,000 had been set aside. (iv) Make a provision for income – tax @40%. Factory closure cost is to be pressured as an allowable expenditure for income tax purposes. Assume depreciation for the year under the Income – tax Act comes to Rs. 84,000. (v) The company transfers Rs. 15000 to general reserve and purpose to pay a dividend @20%. A provision for corporate dividend tax @10% is also mode. Prepare Hema Ltd.’s profit and loss Account for the year ended 31st March, 2009 and a Bal- ance sheet as that date in accordance with the Companies Act, 1956 in the vertical form along with the Notes on Accounts containing only the significance accounting policies. Details of the schedulers are not required. Solution: 87 CU IDOL SELF LEARNING MATERIAL (SLM)

88 CU IDOL SELF LEARNING MATERIAL (SLM)

Notes of Accounts: Significant Accounting Policies: (i) Basis of preparation of financial statements: The financial statements have been prepared on the basis of historical cost concept in accordance with the generally accepted accounting principles and the provisions of the Companies Act, 1956. (ii) Valuation of Inventories: Inventories are valued at the lower of historical cost or the net realizable value. (iii) Valuation of Investments: Investments are valued at lower of cost or net realizable value. (iv) Depreciation: 89 CU IDOL SELF LEARNING MATERIAL (SLM)

Depreciation on fixed asserts is provided using the straight-line method, based on the period of five years. Depreciation on addition is provided for the full year but no depreciation is provided on the asserts sold in the year of their disposal. Working Notes: Alteration of Share Capital and Internal Reconstruction: According to sections94, 95 and 97 Of the Companies Act, a company can, if authorized by its articles, alter the capital clause of its Memorandum of Association in any of the following ways: (1) Increase its share capital by issue of news shares. (2) Consolidate the existing shares of smaller amounts into shares of larger amounts. For example, the existing 1, 00,000 shares Rs.1 each may be consolidated into 10,000 shares of Re. 10 each. The entry in the books of the company will be: 90 CU IDOL SELF LEARNING MATERIAL (SLM)

Thus, the total share capital remains the same, but the number of shares stands reduces and its face value is increased. (3) Subdivide the shares of larger amounts into shares of smaller amounts. The entry will be: (4) Reduction may take place in different forms: (a) Extinguishing or reducing the liability of any of the shares in respect of the unpaid amount. For example, the company has 10,000 shares of Rs. 10 each, Rs. 8 paid-up, and the company decides not to call the remaining Rs.2 per share. In such a case, the shareholders’ liability gets reduced and the partly paid – up (shares of Rs. 10 each, Rs8 paid – up) become shares of Rs.8 each fully paid – up, the total paid – up share capital remaining the same. The entry will be: (b) Paying beck, the already paid-up capital which is in excess of the needs of the company. For example, a company having 10,000 shares of Rs. 10 each, fully paid-up, decides to pay back Rs. 2 per share. The entry will be: (c) Writing off any paid-up, share capital which is lost or unrepresented by available assets. This is otherwise known as ‘Internal reconstruction’ (discussed in detail below). Reduction of capital by a company would be possible if it is authorized by Articles and by a special resolution and conformation of the Court (Section 100-105). The Court confirms re- education after consulting the creditors. The Court may be also ordering the company to add the words ‘and reduced’ to the name of the company for such period as it deems fit. Internal Reconstruction: When a company has been suffering losses continuously for any reason, its real capital is gradually lost and will not be represented by the available, tangible assets. Internal reconstruction refers to the reduction of capital to cancel any paid-up capital which is so lost or unrepresented by available assets. 91 CU IDOL SELF LEARNING MATERIAL (SLM)

This is generally resorted to, to write off the past accumulated losses and to make the Balance sheet show the true and fair value of the assets and capital. The capital written off is used to eliminate the losses accumulated and to bring down the assets to their true values. Consider the following Balance Sheet of X Company. In the example given above the paid – up capital of the company is Rs. 10,00,0 00 whereas the real worth of its assets is only Rs. ,00,000 and the remaining capital of Rs. 5,00,000 is already lost and, therefore, unrepresented by the available assets. The company, resorting to internal reconstruction, decides to write off the capital to the extent of Rs. 5, 00,000 which is already lost and eliminate the accumulated losses from the books. The entry will be: (1) For reducing the capital: Thus, the share of Rs. 10 each are now reduced to share of Rs. 5 each and the balance used for eliminating the losses. (2) For eliminating past losses, writing off fictitious assets and excess value of assets: (Profit and Loss A/c, Goodwill A/c, preliminary expenses, Plant and machinery, other assets) It is to be noted that the capital is not reduced just because we make an entry for it, but we make an entry to record the is already lost. After the above steps, the Balance Sheet will appear follows: 92 CU IDOL SELF LEARNING MATERIAL (SLM)

The Capital re-education Accounts is a temporary account opened for carrying out the internal reconstruction and will be closed when the scheme is carried out. If this account shows any balance after the scheme, it will be transferred to a Capital Reserve Account. The equity shareholders bear the losses and will be agreeing to a reduction of their capital for an internal reconstruction since the alternative would be to force the company into liquidation and in such an event their loss would be much heavier because the assets may be realized only at a loss on a forced sale. Further, after internal reconstruction, there is every possibility of a company making sufficient profits and in such a case it is only the ordinary shareholders who are going to be benefited. Hence, they generally prefer reduction of their capital to liquidation. If the losses accumulated are so heavy that the sacrifice made by ordinary shareholders alone would not be sufficient to wipe out the entire losses from the books, then the Preference Shareholders and Debenture holders and/or creditors would be involved in the scheme of reconstruction and their claims against the company would be reduced. For example, if 2,000, 6% preference shares of Rs. 100 each are converted into 2,000, 7% preference shares of Rs. 60 each, the entry will be In this case, the 6% preference shares are converted into 7% preference shares and shares of Rs. 100 each are reduced to shares of Rs. 60 each. Thus, there is a conversion and redaction. If the borrowed capital is reduced, the entry will be: If the scheme of reconstruction involves the sacrifice of debenture holders and other creditors also, it may be more appropriately known as a Reorganisation Scheme and the amount may be credited to a Reorganisation Account instead of to a capital Reduction Account. Illustration 1: 93 CU IDOL SELF LEARNING MATERIAL (SLM)

It was resolved that equity share capital of Rs.10 each be reduced to fully paid shares of Rs.6 each and 7% preference shares of Rs. 10 each reduced at 7 ½% fully paid preference shares of Rs.7 each. Number of shares in each case remained the same. It was further resolved the amount so available be used for writing off the debit balance of the Profit and Loss Account, and Goodwill Account and other fixed assets to the extent possible. There were arrears of reference dividends for the last three years and it was decided that they be cancelled. Draft the Journal entries and prepare the revised Balance Sheet. 94 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration 2: A valuation of machinery reveals that it is over-valued by Rs. 10,000. It is proposed to write down this asset to its true value, to eliminate the deficiency in the Profit and loss Account and to write off goodwill and preliminary expenses by adopting the following course: (1) Forfeit the shares on which call is outstanding. (2) Reduce the paid-up capital by Rs.3 per share; face value remaining the same. (3) Reissue the forfeited shares at Rs.5 per share. (4) Utilize the provision for taxes if necessary. All the above were duly put into action Pass necessary Journal entries and draw up the Balance sheet of the Company after carrying out the terms of the scheme. Solution: 95 CU IDOL SELF LEARNING MATERIAL (SLM)

96 CU IDOL SELF LEARNING MATERIAL (SLM)

Illustration 3: On January 1, 2008, the Balance Sheet of Wise men Ltd., was as follows: On January 1, 2008, a scheme to reduce the capital implemented the following: 97 (a) The ordinary shares were reduced to Rs.0.25 each. CU IDOL SELF LEARNING MATERIAL (SLM)

(b) The preference shares were reduced to Rs.3.75 each, and the rate of dividend on them to 5%. (c) The ‘A’ and ‘B’ debenture holders waived payment of Rs.42, 000 interests (which were included in ‘Creditors’ Rs.2, 00,000). (d) The Directors were to refund Rs.50, 000 fees they had received. (e) The ‘B’ debenture holders formed a new Company to take over the Calcutta Works for Rs.5, 00,000, and this price was satisfied on the same date, by the surrender of the ‘B’ debentures and the allotment of 50,000 fully paid shares of Rs.5 each in the new Company. The investments were valued at Rs.25, 000 Stock at Rs.50, 000, and the debtors at Rs.40, 000. There was no actual liability to workmen at Calcutta. The assets were to be written down accordingly; any fictitious assets were to be eliminated; only necessary reserves were to be retained and the balance available was to be written off the book value of the Bombay Works. Journalise these transactions and prepare the Balance Sheet after this scheme is carried out. Solution: 98 CU IDOL SELF LEARNING MATERIAL (SLM)

Solution: Illustration 3: 99 On January 1, 2008, the Balance Sheet of Wisemen Ltd. was as follows: CU IDOL SELF LEARNING MATERIAL (SLM)

On January 1, 2008, scheme to reduce the capital implemented the following: (a) The ordinary shares were reduced to Re. 0.25 each (b) The preference shares were reduced to Rs. 3.75 each, and the rate of dividend on them to 5%. (c) The ‘A’ and ‘B’ debenture holders waived payment of Rs. 42,000 interests (which was included in ‘Creditors’ Rs. 2, 00,000). (d) The Directors were to refund Rs. 50,000 fees they had received. (e) The ‘B’ debenture holders formed a new Company to take over the Calcutta Works for Rs. 5, 00,000, and this price was satisfied on the same date, by the surrender of the’ B’ debentures and the allotment of 50,000 fully paid shares of Rs. 5 each in the new Company. The investments were valued at Rs. 25,000. Stock at Rs. 50,000 and the debtors at Rs. 40, 00. There was not actual liability to workmen at Calcutta. The assets were to be written down accordingly; any fictitious assets were to be eliminated; only necessary reserves were to be retained and the balance available was to be written off the book value of the Bombay Works. Journalise these transactions and prepare the Balance Sheet after scheme is carried out. Solution: 100 CU IDOL SELF LEARNING MATERIAL (SLM)