AFM Unit II

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UNIT – 2 COMPANY ACCOUNTS

A company is an artificial person created by law having perpetual succession and a common
seal.
The distinctive features of the company form of organization are as follows:
1. Separate legal existence:
A company has a distinct legal entity independent of its members. It can own property, make
contracts and file suits in its own name. Shareholders are not the joint owners of the company's
property.
A shareholder cannot be held liable for the acts of the company. Similarly, members of the
company are not its agents.
There can be contracts between a company and its members. A creditor of the company is not a
creditor of its members.
The separate legal entity of a company was recognised in the famous case of Salomon, v.
Salomon and Co. Ltd. The facts of the case were as follows:
Salomon formed a company which acquired his own shoe business. He took all the shares except
six shares which he distributed among his wife, daughter and four sons.
Salomon also purchased some debentures of the company which gave him a charge over its
assets. At the time of winding up, the company's assets were not sufficient enough to pay its
debts.
The creditors of the company (other than Salomon) argued that their debts should be cleared
before paying Salomon for his debentures because Salomon and the company was one and the
same person.
The Court decided that after incorporation, Salomon and Co. had an identity separate from
Salomon even though he owned virtually all the shares in the company.

2. Perpetual succession:
Perpetual succession means continued existence. A company is a creation of the law and only the
law can bring an end to its existence. Its life does not depend on the life of its members.
The death, insolvency or lunacy of members does not affect the life of a company. It continues to
exits even if all its members die. Members may come and go but the company goes on until it is
wound up.
3. Limited liability:
As a company has a separate legal entity, its members cannot be held liable for the debts of the
company. The liability of every member is limited to the nominal value of the shares bought by
him or to the amount of guarantee given by him.
For instance, if a member has 50 shares of Rs. 10 each, his liability is limited to Rs 500. Even if
the assets of the company are insufficient to satisfy fully the claims of the creditors, no member
can be called to pay anything more than what is due from him.
However, if the members of the company so desire, they may form a company with unlimited
liability.
4. Transferability of shares:
The capital of a company is divided into parts. Each part is called a share. These shares are
generally transferable.
A shareholder is free to withdraw his membership from the company by transferring his shares.
However, in actual practice some restrictions are placed on the transfer of shares.
5. Common seal:
Being an artificial entity, a company cannot act and sign itself. Therefore, it acts through human
beings. All the acts of the company are authorised by its common seal.
The name of the company is engraved on its common seal. The common seal is affixed on all
important documents as a token of the Company's approval.
The common seal is the official signature of the company. Any document which does not bear
the common seal of the company is not binding on the company.
6. Separation of ownership and control:
Members have no right to participate directly in the day-to-day management of a company. They
elect their representatives, called directors, who manage the company's affairs on behalf of the
members.
Thus, the ownership of a company is distributed among the shareholders while management is
vested in the board of directors. The management of a company is delegated and centralised.
7. Voluntary association:
A joint stock company is a voluntary association of certain persons formed to carry out a
particular purpose in common. Members of a company can join it and leave it at their own free
will.
8. Artificial legal person:
A company is an artificial person created by law. It exists only in contemplation of law. It is
competent to enter into contracts and to own property in its own name. But it does not take birth
like a natural person and it has no physical body of a natural human being.
9. Corporate finance:
The share capital of a company is generally divided into a large number of shares of small value.
These shares are purchased by a large number of people from different walks of life.
10. Statutory regulation and control:
Government exercises control through company law over the management of joint stock
companies. A company is required to comply with several legal formalities and to file several
documents with the Registrar of Companies.

Documents Required For Incorporation


After obtaining Registrar’s approval for the company’s name, the promoters should prepare the
following documents, in the prescribed manner and form:
i. Memorandum of Association
ii. Articles of Association
iii. Prospectus /Statement in lieu of prospectus is not requires in case of a private company
iv. Copy of import agreements.
v. Statutory declaration in Form I
vi. Copy of Letter of Register indicating approval of name.
vii. Power of Attorney.
viii. Notice of situation of registered office (in Form 18) and particulars of Directors (in Form
32).
These two forms can be field either at the time of incorporation or within 30 days from the date
of incorporation.
 The documents should be duly executed signed and stamped from the date of approval of
name by the Registrar.
 It is to be ensured that subscribers to the Memorandum and Articles of Association of the
proposed company are same as the promoters whose names are appearing in the
application for availability of name. In the case of a change, the changed subscribers will
be asked to make a fresh application for availability of name. The ROC may allow the
same name, if available after six month from the date when the name was allowed to the
original promoter.

STATUTORY BOOKS:
Statutory Books are the official records kept by the company relating to all legal and statutory
matters. A company's statutory books are usually kept at the registered office of the company.
All the registered company must have the statutory books for the reference or during the time of
the inspection.
The word “statue” means law.
Statutory books are usually a bound book or ring binder contained in a boxed register, but with
the increased use of technology they can also exist in electronic format Only.Every Company is
required to keep the following statutory registers, and to provide access to them.
Most companies keep the statutory registers in a single bound book or loose-leaf binder, but they
may be kept in any form, such as a computer record.
IMPORTANCE OF STATUTORY BOOKS
As part of a company sale process, the buyer's solicitors will request the statutory books and, at
this stage, if they have not been properly kept they will require them to be reconstituted.
If there are any gaps that cannot be remedied the buyers may also require protection in the
purchase agreement whereby the seller will undertake to indemnify the buyer for any loss they
suffer as a result of the books not having been properly maintained.

CONTENTS OF STATUTORY BOOKS


 The register of shareholders.
 The register of company directors and secretaries.
 The register of company directors' interests.
 The register of charges.
 The register of interests in shares if the company is PLC.

CONTENT OF SHARE HOLDERS


 The shareholder’s name and address and the date on which the entry of the shareholder’s
name in the register is made.
 If the company has more than 50 shareholders, the company must include in the register
an up-to-date index of shareholders’ names.

 The index must be convenient to use and allow a shareholder’s entry in the register to be
readily found.

REGISTER OF COMPANY DIRECTORS AND SECRETARIES:


 The records that every registered company must maintain details of stock and other
securities issued by the company.
 There is no specific format for this register of company’s directors and secretaries.
PARTICULARS IN REGISTER OF COMPANY DIRECTORS AND SECRETARIES:
Register of directors and secretaries may contain the following items:
 Name of the director.
 Address.
 Designation.
 Date of appointment.
REGISTER OF COMPANY DIRECTOR’S INTEREST:
 A register of interests is maintained by the Company Secretary and will be reviewed
by the Board annually. It is the responsibility of Directors to update their entry when
necessary.
 There will also be an opportunity to declare interest at the start of meetings as they
may relate to particular business at hand.
REGISTER OF CHARGES:
 All companies must keep copies of all the documents that create a charge and are
required to be registered at Companies House.
 The following must be entered into it:
(a) all charges specifically affecting property of the company.
(b) All floating charges on the whole or part of the company’s property or undertaking.
The following charges must be registered
 A charge on land or any interest in land, charge for any rent or other periodical sum
issuing out of land.
 A charge created or evidenced by an instrument.
 A charge for the purposes of securing any issue of debentures.
 A charge on uncalled share capital of the company.
REGISTER OF INTERESTS IN SHARES:
 Employment by, or ownership or part-ownership of, businesses or consultancies.
 Directorships, including non-executive directorships of public or private companies.
 Significant (1%+) shareholdings in public and private companies.
 Membership of other bodies, whether public or private organisations, which may
impinge directly or indirectly on the business of the University.
Employee Stock Option Plan (ESOP)
Introduction:
There are three main forms of compensation that most corporations pay to
their employees. The primary type of compensation, of course, is cash, which comes in the form
of hourly wages, contract income, salaries, bonuses, matching retirement plan contributions,
and lifetime payouts from defined benefit plans.
The second method of compensation comes in the form of benefits, such as insurance (life,
health, dental, and disability), paid vacations and sick days, tuition and child care assistance, and
other miscellaneous perks, such as company cars and expense accounts.
But many employers also reward their workforce by allowing them to purchase shares of stock in
the company at a discount. Stock compensation comes in many forms, and is popular with both
employers and employees for many reasons. However, it does pose some potential drawbacks (to
which the former employees of Enron and World com can readily attest).
Eligibility of an employee:
An employee is eligible for ESOPs only after he/she completed 1000 hours within a year
of service. After completing 10 years of service in an organization or reaching the age of 55, an
employee should be given the opportunity to diversify his/her share upto 25% of the total.
Different terms used in an ESOP:
Grant date: The process of providing stock compensation usually begins by granting outright
shares of stock to employees or the right to purchase it. The employer issues an agreement giving
employees the option to purchase either a specific number or a dollar amount of shares according
to a set schedule or other conditions as set forth in the plan. The option to buy the stock becomes
active on a specific date known as the grant date.
Option Price: the price at which such shares in a scheme are offered. It is also known as the
strike price or grant price. Normally such price would be below the market value/fair value of the
shares on the date of grant.
Vesting: Vesting means the process by which the employee gets the right to apply for and be
issued shares of the company under the options granted to him. Till the vesting takes place, the
employee does not have a right to apply for the shares. Upon vesting, the employee gets an
unfettered right to apply for the issue of shares upon fulfillment of the conditions. In the event of
an employee resigning from the services of the company or his employment being terminated for
whatever reasons, all unvested options shall expire as on that date, but the employee would retain
all the vested options.
Vesting date: an ESOP would provide for a date on which an option is vested with the
employees and time frame over which the stock option would be vested with employees is called
vesting period.

Exercise period: the employees are given a time period, called exercise period, within which
they are required to exercise the option. The date on which employees exercise this option is
known as exercise date.
Two ways in which a company can set up an ESOP:
(a) Create a trust (Special Purpose Vehicle): depending on the number of options given to
the employees, the company will issue shares or options to the trust. The trust would need
fund to buy these shares. For this, the company can either give soft loans from its own
fund or the trust can raise loans through other sources to meet its financial requirement.
The company can act as guarantee to the lender of the trust. With the funds so raised, the
trust then acquires shares/options required. The trust repays its loans as and when the
employees purchase the options offered and when they exercise their options by paying
the exercise price.
(b) Give options directly to employees: the selection of the employees is based on
performance of the employee, indicated by annual performance appraisal, minimum
period of service, present and potential contribution of the employees, and such other
factors deemed to be relevant for the success of the company.
Different types of ESOPs:
Employee Stock Option Scheme(ESOS): under this scheme, the company grants an option
to its employees to acquire shares at a future date at predetermined price. Eligible employees
are free to acquire shares on vesting within the exercise period. Employees are free to dispose
of the shares subject to lock in period if any.
Employee Stock purchase plan(ESPP): This is generally used in listed companies, wherein
the employees are given right to acquire shares of the company immediately, not a future
date as in ESOS, at a price lower than the prevailing market price. Shares issued by listed
companies under ESPP will be subject to lock in period as a result the employee cannot sell
the shares and/or the employee has to continue with the employer for a certain number of
years.
Share Appreciation Rights(SAR)/ Phantom Rights: under this scheme, no shares are
offered or allotted to the employee. The employee is given the appreciation in the value of
money between the two specified dates as an incentive or performance of the company as a
whole, as reflected in its share value.
Rules and Regulations:
Companies Act: issue of stock options require approval of shareholders by way of a special
resolution. This is not applicable for private companies who can issue stock options without
share holder approval but approval by board of directors.
Income tax issues:
For employees: Till recently, the difference the cost of the share to the employees and market
value on the date on which an employee got the share would be taxed as pre requisite in addition
to capital gains tax payable by the employee on sale of those shares. However with the recent
announcement the pre requisite has been removed.
For the company: As per the SEBI, the company should have separate account for ESOP and
treat them same as the expense.
Advantages of ESOPs:
1. Takeover protection
2. Financing advantages
3. Deduction of dividends paid
4. Non recognition of capital gain
5. Deferral of taxation
6. Exemptions from the prohibited transaction rules
7. Marketability of stock
Takeover protection:
An ESOP can provide some protection against an unwelcome takeover attempt. This is
more likely to be an advantage for a publicly traded company, especially in the banking industry.
A take over offer often presents a conflict for the ESOP fiduciaries. They are typically top
managers of the target company, and they’ll have to resolve conflicts between their personal
interests as officers and employees of the company, their fiduciary responsibility to the ESOP
participants and beneficiaries.
Financing advantages:
When a corporation repays a conventional loan, the interest payments are deductible but
the principal payments aren’t. By contrast, when a corporation borrows money to buy stock for
an ESOP, both interest and principal payments are deductible, within limits, as contributions to a
qualified plan. This significantly reduces the corporation’s after tax costs.
Deduction for Dividends paid:
A c corporation can claim deductions for:
1. Dividends that are paid to an ESOP and are used to repay a securities acquisition loan.
2. Dividends that are paid directly to ESOP participants or their beneficiaries, or to an
ESOP, which distributes them to participants or beneficiaries within 90 days after the end
of plan year.
Non recognition of capital gain:
Taxation of gain on the shares sold to the ESOP is deferred by reinvesting the sales
proceeds in qualifying replacement property. Time limits do apply.
Deferral of taxation:
If corporation stock is held by an ESOP, then the ESOP’s proportionate share of the
corporate income isn’t currently taxed, within the corporation, to finance current operations and
future growth, or be paid to the ESOP.
Marketability of stock:
For a closely held corporation, the ESOP provides a market for shareholders who wish to
sell all or part of their stock. Because of the ESOP’s tax advantages, this can be preferable to a
stock redemption by the corporation.
Disadvantages of ESOPs:
1. Equity dilution
2. Valuation problems
3. Cost of operating the ESOP
4. Voting rights
5. Employer cash flow issues
6. Employee Risk

Equity Dilution: Adoption of an ESOP reduces the percentage ownership of at least some of
their shareholders.
Valuation problems: In any transaction with a disqualified person or party in interest, an ESOP
may not pay than adequate consideration, which is the fair market value of assest as determined
by the trustee or fiduciary, on a purchase of stock. An ESOP may not receive less than adequate
consideration on a sale of stock.
Cost of operating the stock:A valuation of corporate stock is required in connection with any
purchase or sale of stock. Generally the valuation must be updated at least annually. Adequate
appraisals can be costly.
Voting rights: The participants must be given the right to vote the employer securities allocated
to their accounts.
Employer cash flow issues: If the ESOP is leveraged, the ESOP debt may absorb much of the
corporation’s available credit. This can make it difficult for the corporation to borrow funds
needed for operations and growth. If the corporation becomes less profitable, it may be unable to
service the ESOP debt, despite the favourable tax treatment of ESOP loan repayments.A big
problem for most small ESOP employers is the repurchase obligation. As employees leave for
the company, or otherwise become entitled to ESOP distribution, they have the right to require
the employer to repurchase stock, which isn’t readily tradable, as its fair market value.
Employee risk:It may be necessary to reduce or eliminate contributions to other retirement plans
when an ESOP is adopted, to enable the employer to pay the cost of the ESOP. Employees may
not like the situation, particularly when other investments are doing well.
Buy back of securities.
Buy back of securities means repurchase by a company of its own shares or other specified
securities( employee’s stock option or other securities as may be notified by the central govt
from time to time) out of : (i) its free reserves (ii) the securities premium account (iii) the
proceeds of any shares or other specified securities, provided that no buy back of any kind shares
or other specified securities shall be made out of the proceeds of an earlier issue of the same kind
of shares or same kind of other specified securities.

Till oct 31 1998, Indian companies were not allowed to buy their own shares from the open
market. However the companies(Amendment) Act 1999, has introduced section 77A& 77B in
the companies Act 1956 permitting companies to buy back their securities from the open market
for cancellation. The buy back of securities would result in reduction of share capital. The
companies Act have introduced a lot of restrictions for capital reduction, as it would affect the
interest of creditors. Buy back of shares may be done at par or at premium or discount.

The company may resort to Buy back of its own securities due to the following important
reasons:

1. when the prevailing market rate of its own shares is much lower than its true value, Buy
back may improve the value of the company over all.
2. Buy back reduces the number of outstanding shares, which will improve the earnings per
share.
3. Buy back of shares enables a company to frustrate “ hostile take over bids”
4. Buy back of shares facilitates a company to restructure its capital by utilizing its cash
surplus. A company need not pay corporate dividend tax on buy back.

Conditions of Buy Back:

1. The Buy back should be authorized by the Articles of Association of the company. If
Articles is silent necessary amendments will have to be made.
2. A special resolution has to be passed in general body meeting of the company to
authorize the Buy back.
3. The Buy back should not exceed 25% of the paid up capital and free reserves of the
company concerned.
4. The ratio of the debt owed by the company is not more than twice the capital and its free
reserves after such Buy back.
5. All the shares or other specified securities should be fully paid up.
6. The Buy back of the shares or other specified securities listed in any recognized stock
exchange is in accordance with the regulations made by the SEBI in this behalf.
7. The Buy back in respect of share or other specified securities is in accordance with the
guide lines as may be specified.
8. Every Buy back should be completed with in 12 months from the date of passing the
special resolution.
9. The Buy back may be : (a). from the existing security holders on a proportionate basis or
(b) from the open market.(c) by purchasing the securities issued to the employees of the
company pursuant to a scheme of stock option or sweat equity.
10. where a company Buy back its own securities, it shall extinguish and physically destroy
the securities so bought back with in 7 days of the last date of completion of Buy back.
11. After the completion of the Buy back, a company can not issue the same kind of shares or
securities for a period of 24 months.
12. Loans from bank of financial institutions should not be used for the purpose of Buy back.
13. A company, which has failed to file annual returns and to prepare annual accounts or to
give correct accounts, is also not permitted to Buy back shares

PROFIT PRIOR TO INCORPORATION:

A running business may be acquired by another company. A public limited company has to get
certificate of Incorporation and Certificate of commencement of business. Only after getting the
certificate of Incorporation that the company comes into existence.. But it should be noted here
that a public limited company cannot commence its business till the certificate of
commencement of business is obtained. The new company is entitled to all profits earned after
the purchase or conversion of business till the date of incorporation. Such profit is referred to as
“Profit prior to Incorporation”.

Basis of Apportionment of Expenses:

1. Sales ratio: All expenses associated with sales are to be allocated in the ratio of the sales.
Gross profit is to be allocated on the basis of sales ratio.

Ex: Earnings outwards, Discount allowed, Commission to salesman, sales promotion expenses,
bad debts etc.

2. Weighted sales ratio: In case sales are not uniform throughout the accounting year,
weightage should be given to the trends observed in the sales. Adjustments have to be made
based on the charge in trend. The resultant is due to weighted sales ratio.

3. Time ratio: Time ratio is the ratio f period prior incorporation and post incorporation in an
accounting period. Ex: salaries, rent, interest, depreciation, bank charges,stationery postage, etc.

4. Weighted time ratio: In case of any changes made to the number of employees, weightage
should be given to such changes by arriving at the time ratio. Also, when some expenses are
incurred specifically pertaining to a part of the accounting period, separate ratio has to be
ascertained.

Various Items and Their Bases for apportionment are shown in the following:

Item Basis for Apportionment


1.Gross profit or loss Sales ratio/Weighted sales ratio
2.Variable expenses that vary in direct Sales ratio/Weighted sales ratio
proportion to sales
3.All fixed expenses Time ratio/weighted time ratio
4.Expenses specifically related to pre- Allocation to the pre-incorporation period only
incorporation period
5.All expenses specifically related to post- Allocation to the post-incorporation period only
Incorporation period
6. Actual expenses that are explicitly and Allocation to respective period only.
specifically related to pre or post
Incorporation period.

FINAL ACCOUNTS OF COMPANY


Trading account:
Trading Account is the first stage in the process of preparing final accounts. Trading
account shows the gross profit or gross loss during an accounting year. Its main
components are sales, services rendered in the credit side of such sales or services
rendered in the debit side.
Profit and loss account:
The next step after preparing the trading account is preparing the profit and loss account.
Profit and loss account is prepared to calculate the net profit or net loss of the business
for a given accounting period.
Gross profit:
Gross profit is a company's total revenue (equivalent to total sales) minus the cost of
goods sold. Gross profit is the profit a company makes after deducting the costs
associated with making and selling its products, or the costs associated with providing its
services.
Net profit:
This is the excess of revenue over expenditure during a particular accounting period
Definition of balance sheet:
Balance sheet is a statement of financial position of an enterprise as at a given date,
which exhibits it assets, liabilities, capital, reserves and other account balance at their
respective book values.
Asset:
An asset as something your company owns that can provide future economic benefits.
Cash, inventory, accounts receivable, land, buildings, equipment -- these are all assets.
Liabilities:
Liabilities are your company's obligations -- either money that must be paid or services
that must be performed. Eg. Capital, debenture, loan, bills payable, etc.
Current asset:
Current assets are balance sheet accounts that represent the value of all assets that can
reasonably expect to be converted into cash within one year. Eg. Cash, marketable
securities, short-term investments, accounts receivable, prepaid expenses, and inventory.
Current liability:
Current liabilities are a company's debts or obligations that are due within one year,
appearing on the company's balance sheet and include short term debt, accounts payable,
accrued liabilities and other debts. These are bills that are due to creditors and suppliers
within a short period of time.
Fixed asset:
Fixed Assets which are purchased for long-term use and are not likely to be converted
quickly into cash, such as land, buildings, and equipment.
Fixed Liability:
A fixed liability is are those long term liabilities, which a company has to pay after a time
period of at least one year. It simply means that these liabilities become due for a
business enterprise, after one year. Eg. Debenture, bonds, mortgages, and loans that are
payable over a term exceeding one year.
Tangible assets:
Tangible assets are those which can be physically seen, felt and touched. Eg. Plant,
machinery, building, etc.
Intangible assets:
Intangible assets are those which are not physically present but their presence can be felt.
E.g. Goodwill
Order of liquidity in writing Balance sheet:
Arrangement of assets and liabilities in the order of their “reliability” and priority or
preference of payment is called liquidity order
Order of permanency in writing Balance sheet:
The assets and liabilities are shown in the balance sheet o the basis of the length of time
they are likely to be with the business.
Income statements:
Income statements include trading account, profit and loss account and balance sheet.
Work in-progress
Work in-progress is the semi-finished output. It is converted into finished output during
current accounting period.
Fictitious asset
These are not real assets. Eg. Discount on issue of shares, debit balance in profit and loss
account, preliminary expenses.
Wasting assets:
These assets are called as depleting assets. Eg. Assets such as mines, timber forest and
quarries.
Contingent liabilities:
These liabilities will occur only if certain events happen. Eg. Bill discounted and
endorsed which may be dishonored, unpaid calls on investments

Q. Explain the importance of preparing Trading Account.

Meaning of Trading Account


Trading account is prepared with those expenses which are directly related to the manufacturing
activity. This account compares the cost of the goods sold with sales made during an accounting
period. The result shown by it is either Gross Profit or Gross Loss. It takes into account the stock
brought forward from the previous year, purchases of goods made during the accounting period,
all expenses incurred in bringing the goods to the factory and for converting it finished products.
This is compared with the sales generated during the said period and the stock at close Since in
the Trading account, only a part of the total expenses is compared with only a part of the total
income generated, the resultant figure is termed Gross Profit or Gross Loss, as the case may be.
It is very important to find out gross profit or loss for the business to know whether purchasing,
manufacturing and sales are sufficient for earning or not. The main objective or important of
trading account are as follows:
 Trading account helps to know gross profit or loss
 Trading account provides information about the direct expenses
 Trading account provides safety against possibilities of loss
 Trading account helps in comparison of closing stock with last year’s stock.
1) Cost of goods sold: This can be ascertained from Trading account by using the formula Cost
of goods sold = Opening stock + Purchases + Direct Expenses – Closingstock.
2) Gross Profit: It is the excess of net sales over the cost of goods sold.
4) Gross Loss: It is the excess of cost of goods sold over net sales.
5) Opening Stock: It is the stock in hand at the commencement of an accounting year. Closing
stock of the previous year becomes the opening stock of the current year.
6) Closing Stock: It is the stock in hand lying unsold at the end of an accounting year. This
becomes the opening stock of the next accounting period.
7) Purchases: When goods meant for re-sale are procured, it is called purchases.
8) Purchase Returns: When goods purchased are returned to its supplier, it is called purchase
return.
9) Sales: When goods meant for re-sale are sold, it is called sales.
10) Sales Returns: When sold goods are returned back from customer, it is called
Sales Returns.
11) Direct and Indirect Expenses: Expenses incurred in bringing the purchased raw materials
to the factory and converting them into finished products are called Direct
Expenses. Expenses incurred subsequent to this stage are called Indirect Expenses. These include
Office, administrative, selling and distribution expenses.
12) Outstanding Expenses: These are expenses which have become due but are yet to be paid.
13) Prepaid expenses / Expenses paid in advance: These refer to expenses paid before it
became due for payment.
14) Outstanding Income: These are income which have become due but is yet to be received.
15) Income received in advance: These refer to income received before it becamedue for
receipt.
16) Bad debts: It refers to that of the amount due from others which has becomedefinitely
irrecoverable. It is an actual loss to the business.
17) Provision for doubtful debts: This is that part of the amount due fromothers whose
recovery is doubtful. It is not an actual loss but an anticipated loss.Amount set aside to meet such
expected loss is known as Provision for BadDebts.
18) Provision for discount on debtors: Some of the debtors may make their paymentsproperly
as per their credit terms. Discount amount set aside in anticipation ofsuch prompt payments, is
called Provision of Discount on debtors.
19) Depreciation: It refers to the monetary value of the wear and tear resulting fromthe use of an
asset.
20) Net Profit: It is the excess of gross profit and non-operating incomes over theindirect and
non-operating expenses of the business.
21) Net Loss: If the indirect and non-operating expenses exceed the non-operating income and
gross profit, it is termed as net loss.

Explain the format for Trading Account.

FORMAT FOR TRADING ACCOUNT


Trading Account for the year ended ………..
Particulars Rs. Rs Particulars Rs Rs
To opening stock Xxx By sales Xxx
To purchases Xxx Less: sales returns xxx Xxx
Less: purchases returns Xxx Xxx By closing stock Xxx
To wages Xxx By gross loss xxx
Add: outstanding wages xxx Xxx
To Carriage inwards Xxx
To air,water,fuel,gas xxx
To factory lighting xxx
To freight xxx
Gross profit c/d xxx
From the above account we come to a conclusion that Gross profit = Net sales - cost of goods
sold
Cost of sales = opening stock + Net purchases + direct expenses – closing stock.
Q.Explain the format for profit and loss account.
Meaning and Methodology for preparing profit and Loss account

The main purpose of preparing this account is to know the net result of business carried out for a
particular period of time. That is to know exactly how much is profit earned or loss incurred.
Profit and Loss Account takes into consideration all those expenses and incomes which are
indirectly connected to carrying out business transactions. It takes into account all Indirect
Expenses, which includes office, administrative, selling and distribution expenses and non-
operating expenses. Also it includes non-operating incomes like commission received discount
received, dividend received interest received, rent received, etc., non operating expenses, and
losses are compared with non-operating incomes or gains made during an accounting period.
Thus, this account shows the net result of the entire business operation.
Format for Profit and loss Account

Profit and Loss Account for the year ended ………

Particulars Rs. Rs Particulars Rs Rs


To Gross Loss b/d By Gross profit b/d
To salary By commission received
Add: out standing By Discount received
To commission By interest (cr)
To Rent By Net Loss transferred to
To Insurance Capital Account
Less: Prepaid
To Depreciation
To interest on Capital
To Bad Debts
Add: New bad debt
To Provision for Doubtful Debt
Less: old provision
To Discount
To interest
To Net Profit transferred to
Capital Account

The following table gives the various adjustments which normally appear in final accounts
problems along with their respective adjustments entries. It also indicates how the adjustments be
dealt with in final accounts.
Adjustments Adjustment Trading A/c P&L A/C Balance Sheet
Entry
Closing Stock Closing stock a/c Shown on Shown on
Dr credit side ********* Asset side
To Trading A/c
Expenses out Particular It is added to the particular The outstanding
standing expense expense account shown on expense is shown
A/c ….Dr the debit side of Trading on
To outstanding A/c or Profit and Loss A/c, as the The liability side.
Expenses A/c case may be
Income outstanding Outstanding Added to particular income Outstanding
Income A/c… Dr account on the credit side of income is shown on
To Particular Trading A/c or Profit and the asset
Income A/c Loss A/c as the case may be side
Prepaid Prepaid expense Deducted from particular Shown on the asset
expenses/expense A/c…. Dr expense on the debit side of side
paid in To Particular Trading A/c and P&L A/c,
advance/unexpired expense A/c as the case may be
expense
Interest on Capital A/c…Dr Shown on Deducted from
drawings To Drawings A/c ************** the credit capital
side on the liability side
Income received Particular Income Deducted Shown on the
in advance A/c…..Dr ************* from the liability
To Income relevant side
received in income on
advance the credit side
Interest on capital Interest on capital Shown on Added to capital on
A/c ….Dr ************ the debit the liability side
To Capital A/c side
Depreciation on Depreciation A/c Depreciation Depreciation
Asset ….Dr *********** shown on deducted
To Asset A/c the debit from the gross
side value
of asset
Goods taken by Drawings Deducted Deducted from
the owner A/c Dr FromPurchases *********** capital
To Purchases A/c on the debit on the liability side
Goods distributed Advertisement Deducted Shown as
as free sample A/c….Dr From Purchases Advertisement **********
To Purchases A/c on the debit side on the debit
side
Further Bad debts Bad debts A/c Dr Bad debts Deducted from
incurred To Debtors A/c ********** shown on debtors on the asset
the debit side
side
Provision for bad P&LA/c…Dr PBD shown Deducted
debts [PBD] To PBD A/c ************ on the debit from
side Debtors on
the asset
side
Bad debts (a) Cash A/c…Dr Bad debts Added to cash
recovered To Bad Debts ********** recovered is balance on the
recovery A/c shown on Asset
(b)Bad debts credit side side
Recovery
A/c…Dr
To profit &loss
A/C
Provision for P&LA/c…..Dr Provision Deducted from
discount on Drs To Provision for ************ for discount Debtors on the
discount on debtors asset
shown on side
debit side

Explain the Balance Sheet format

Meaning and Format for Balance Sheet

Balance Sheet is a statement showing the list of assets and liabilities of a business as on a
particular period of time. It is prepared to know the financial position of a business unit. in a
balance sheet all the items of assets and liabilities are arranged according to the order of
liquidity. A Balance Sheet has two sides – Assets (right hand side) andLiabilities (left hand side).
Accounts which has debit balances are shown on the AssetSide and accounts which has credit
balances are shown on the Liabilities side.
BALANCE SHEET AS ON ………
LIABILITIES Rs Rs ASSETS Rs Rs
Bills Payable Cash in hand
Sundry Creditors Cash at bank
Outstanding expenses Sundry Debtors
Income received in advance Less: Bad debt
Bank overdraft Less: Provision for Bad debts
Loan from Bank Closing stock
Debenture Bills receivables
Capital Prepaid expenses
Add; Net profit Accrued income
Add: Interest on capital Short term investments
Less: Drawings Machinery
Less: Net loss Less: Depreciation
Less: interest on Drawings Building
Less: Depreciation
Furniture
Less: Depreciation
Goodwill

Items of Balance Sheet


1) Capital: It is the amount contributed by the owner of the business.
2) Liabilities: It is the amount which the business owes to outsiders.
3) Current Liabilities: Liabilities which become due for payment within a period ofone year are
called current liabilities.
4) Long – term liabilities: Liabilities whose due date for payment falls beyond oneyear are
termed are long-term liabilities.
5) Sundry Creditors: It is a collective name given to a group of outsiders to whomthe business
is obliged to pay.
6) Assets: They refer to rights or properties acquired by a business and the amountdue from
others.
7) Fixed Assets: Assets procured for permanent use in the business is termed fixedassets. By
using these assets, a firm earns its revenues. It includes land, building,plant and machinery, etc.
8) Intangible Fixed Assets: Assets which does not have physical appearance are called
intangible fixed assets. Examples are goodwill, patent, trademark, copyright, etc.
9) Current assets or Floating or Circulating assets: Assets which are meant for resale and
those which can change from one form to another within a year are Grouped as current assets.
10) Debtors: It is a collective name given to group of outsiders from whom the amounts are due
to the business.
Explain the functions and characteristics of Balance Sheet.
The function of a balance sheet is to inform the company owners, investors and creditors of the
assets, liabilities and owners’ equity at a specific point in time.
 A balance sheet exhibits the true financial position of a firm by showing the assets and
liabilities at a particular date to the owner as well as to the outsiders.
 It helps the investors to know the earning capacity of the firm and the dividend pay-out
ratio.
 It also provides valuable information about the existence of the firm after scrutinizing
some financial ratios to the creditors and investors by which they can take proper
decisions.
 It also highlights the financial strength of the firm to the creditors so that they can review
the repaying capacity after analyzing some ratios.
 A detailed financial position can be known if we analyze and securitise the assets and
liabilities at a particular date.
Characteristics of balance sheet:
a. A position statement: A Balance sheet is a position statement as it contains the assets,
liabilities and proprietor’s funds at a particular point of time stating the financial position
as a whole.
b. A periodical statement: Since it is prepared at the end of a particular period, the financial
position at a particular date, it is called a periodical statement. In short, it exhibits the
true and fair view of state of affairs of a firm at a particular point of time.
c. An unallocated cost statement: It is an unallocated cost statement in the sense that the
assets which appear in the assets side of the balance sheet are unallocated portion of
various costs which will be written off in future.\
d. A complementary statement: It is no doubt a complementary statement to income
statement and not a competing one.
e. An interim report: Balance sheet is an interim report as it is prepared for a particular
period only stating the financial position. But the business has its perpetual life. So one
year’s report may be considered an interim report.

Explain the Uses and importance of Balance sheet.

It is also called a statement of financial position, a balance sheet shows what your company owns
and what it owes through the date listed.
a. To determine if working capital is enough: The balance sheet is used to determine if the
business has enough working capital to sustain its operations. Working capital is the
difference of current assets less current liabilities. IT measure if the company still has
enough current resources after deducting its due loan or obligations. If the result of
computation is positive, that means the company is still doing okay. On the other hand, if
the computation becomes negative, that means the company is in trouble. There high risk
of bankruptcy or inability to continue operating.
b. To know the business net worth: Net worth is defined as the true value of an entity. IT
shows how rich or poor it is. It is computed by the difference of total assets less total
liabilities.
c. To see if the company can sustain future operations: By looking at the balance sheet, you
can determine if the company can sustain future operations. To do this, look at the value
of its noncurrent assets such as property, plant and equipment. IF the total is higher than
the current assets, it means the company has plans to sustain future operations. On the
other hand, if the amount is already lower than the current assets, it can be an indication
of inability to sustain future operations.
d. To identify if there possible issuance of dividend: Most business owners are interested to
know if when they will receive returns from their investment. Such returns can be in the
form of dividends. Dividends are issued if the company is profiting and has high amount
of retained earnings.
Explain the difference between a trial balance and a balance sheet.
TRIAL BALANCE BALANCE SHEET
1.It is prepared to verify the arithmetical It is prepared to disclose the true financial
accuracy of books of accounts position of the business
2. IT is prepared with balances of all the ledger IT is prepared with the balances of assets and
accounts. liabilities accounts.
3.It is not a part of final accounts It is an important part of final accounts
4.IT is prepared before the preparation of final It is prepared after the preparation of trading
accounts and profit and loss account
5. It may be prepared a number of time in an It is generally prepared once at the end of the
accounting year. accounting year.
6. Generally, it includes opening stock but not It always includes closing stock but not
closing stock. opening stock
7. There is no rule for arranging the ledger Assets and liabilities must be shown in it
balance in it. according to the rule of marshaling.
8.It is not required to be filed to anybody It must be filed with the registrar of companies
if the business is a company.
9. Auditor needs not to sign it. Auditor must sign it.

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