INSOLVENCY ACCOUNTS [1] Introduction [2] Procedure [3] Some Important Provisions of Law (i) Volunta Transfer (ii) Fraudulent Preference [4] Statement of Affairs : (A) Liabilities sig, (B) Assets Stde [5] Deficiency Account [6] Some Important Items [7] Mlustration, 18] Missing Information [9] Insolvency of Partnership Firm. Ml Exercises \_ ae LINTRODUCTION : When a person is unable to pay his debts in full, out of his available assets, he is treated as an insolvent in Accountancy. However, legally he will be treated as an insolvent when an adjudication order is made against hin by a competent court under the insolvency law. Insolvency laws are made to protect the unfortunate persons who are involved in financial difficulties, due to no fault of their own. In old days, an insolvent was treated as a criminal and was imprisoned and subjected to hard labour. Even his wife and childrea could be sold as slaves alongwith him. It was difficult for such persons 0 live honourably in the society. However, in course of time, it was realised that no useful purpose was served by imprisoning him, particularly whea insolvency was caused by misfortune and not by his misdeeds. Hence, the modern Insolvency Law was evolved. The object of this law is to protect the insolvent from undue harassment of his creditors and also to distribute his assets equitably among his creditors. Blackstone said, "Bankruptcy is a proceeding by which, when a debict cannot pay his debts or discharge his liabilities or the Persons to whoa he owes money or has incurred liabilities cannot obtain satisfaction of the! claims, the state in certain circumstances take possession of his prope"Y by an officer appointed for the purpose and such property is realised 3° distributed in equal proportion among the persons to whom the debtor owe money or has incurred pecuniary liabilities." The two objects of insolvency law are : (1) to protect the debtor fio" undue harassment of his creditors, and (2) to secure an equitadlé distribution of his assets among his creditors. 2. [PROCEDURE : Either the debtor himself or his creditors can make a petition, subie*! {0 certain conditions, to the competent court to make an addin ort i.e, to declare the debtor insolvent. After an insolvency petition js presen" \ (72) tilt,INSOLVENCY ACCOUNTS B to the Court, the Court shall fix a date for hearing the petition. Notice of the same shall be given to all creditors and also to the debtor. After hearing both, the debtor and creditors and examining the debtor, the Court may pass an Order of Adjudication, declaring the debtor insolvent. The Court appoints a Receiver to take charge of the assets of the debtor, to realise them and distribute the same among the creditors. The insolvent is required to prepare statement of his financial position. The final stage of the insolvency proceeding is to obtain an order of discharge. When the assets of the insolvent are distributed among his creditors, the debtor has to make a petition to the Court for getting an order of discharge. In certain circumstances, the Court refuses to grant such an order. If an unconditional order of discharge is granted to the insolvent, he again becomes a free man and is not required to pay any unpaid amount of his past liabilities. A person, a partnership firm or a Hindu Undivided Family can be declared insolvent. A joint stock company cannot be declared insolvent but is taken into liquidation under Indian Companies Act, 2013. The Insolvency Law in India consists of two statutes viz. (1) The *Presidency Towns Insolvency Act, 1909 which applies to three Presidency Towns of Bombay, Calcutta and Madras, and (2) The Provincial Insolvency ‘Act, 1920 which applies to rest of India. Most of the provisions of the two Acts are similar except some differences in certain provisions only. It may be noted that 'Insolvency' and ‘Bankruptcy’ mean the same thing. The word ‘Insolvency’ is used in India and the word ‘Bankruptcy’ is prevalent in England. 43. |SOME IMPORTANT PROVISIONS OF LAW : : We give below the important provisions of Insolvency Law that may prove useful in solving accounting problems : (1) Voluntary Transfer : An insolvent may transfer his property to his wife and children or to some other relatives even before he is declared insolvent and may damage the interest of creditors. This is unjust to creditors and hence, the insolvency law makes such transfer void. The receiver will cancel such transfer and receive back the property so transferred for distribution among his creditors, According to Sec. 53 of Prov. Act, "Any transfer of property, Not being a transfer — (1) made before and in consideration of marriage, or (2) made in favour of a purchaser or encumbrancer in good faith and for valuable consideration, shall, if the transferor is’ adjudged insolvent on a petition presented within two years after the date of transfer, be voidable as against the receiver and may be annulled by the Court." 2017 does not inclu Ann Scanned by TapScannerSuch transfer without consideration is voidable against the Receiver, But the time limit is prescribed. The petition of insolvency must have been made within two years of such transfer and he must have been declareq insolvent on the basis of that petition. Suppose, a person has made a gift of his house worth Rs. 50,000 to his son on 1-7-2016 without consideration, A petition is made against him for insolvency on 1-5-2017 and is declared insolvent on 1-6-2017. Here, the petition is made within two years of the transfer. Hence, the Receiver is entitled to get this transfer cancelled and get the possession of the building. There are two exceptions mentioned in the Act, i.e. the following two transfers are not treated as voluntary transfer : (1) transfer made before and in consideration of marriage, or (2) transfer made in favour of a purchaser who takes it in good faith and for valuable consideration. (2) Fraudulent Preference : The object of insolvency law is to equitably distribute the assets of the insolvent among his creditors and to see that no creditor gets undue benefit at the cost of others. Therefore, any payment to or transfer of property in favour of any creditor at the cost of others, is void against the receiver. Sec. 54 provides as follows : “(1) Every transfer of property, (2) every Payment made, (3) every obligation incurred, and (4) every judicial Proceeding taken or suffered by any person, unable to pay his debts as they become due from his own money, in favour of any creditor, with a view to giving that creditor a preference over other creditors, shall, if such person is adjudged insolvent within three months after the date there of, be deemed fraudulent and void as against the Teceiver, and shall be annulled by the Court.” The receiver shall get such payments or Property back and distribute them among the creditors, The following conditions must be fulfilled for a transaction to be treated as fraudulent preference ; (i) The debtor must be unable to pay his debts as they become due from his own money on the date of the transaction, The transaction must be in favour of any creditor, Gii) The intention of the debtor must be to give that creditor # Preference over the other creditors. (iv) The debtor must be adjudged insolvent on within three months after the date of the transaction, On a petition presented Petition presenteder are less de his private liabilities, the deficien | | f the or the hi aor Dusiness assets. Assets of the firm are used first for paymen* © e firm. If there is a surplus, a part reas (OF private liabilities. i Partner can take his share of surpl 'S, _ STATEMENT OF paying his csenaanemnmaaneenenilns: Sips WAN iti ‘o the official receiver rs, he has to The insolvent has to prepare a statement of affairs and submit t within 30 days of the order of adjudication. Along with the statement of affai prepare a ‘Deficiency A/c’ also A statement of affairs shows the insolvent's financial position order of adjudication. It has to be prepared in the prescribed form which is as required by Presidency Towns Insolvency Act. as on the date of the given below Statement of Affairs he Presidency Towns Insolvency Act, 1909) (As required by In ise Gros Liabilitie " Expected | Book | Estimated Liabilities (as stated& estimated by Debtor) wank (as stated& estimated by Value to produce z Debtor) ZR ~~ [Property as per List 'E’ Creditors fully secured as per List 1) Cash at Bank B ) Cash in hand Estimated value of security ) Cash with Solicitors Surplus 4) Stock in Trade Less : Amount carried to List ‘C” ) Machinery Balance to contra creditors partly 4) Fixtures, Fittings, secured as per Utensils List‘ ) Fumiture Less Estimated value of Security hy) Life Policies Preferential creditors as per List i) Other property LZ ‘Sundry Debtors as per List Deducted per contra | "FP Good Doubtful Bad Estimated to produce Bills of Exchange as per List ¢ | Estimated to produce | Surplus per Contra, | Deduct Preferential Creditors per contra Deficiency as explained in Statement 'H! [ Fig. 2.1 Explanation of the Form : The two sides of the statement of affairs are headed as ‘Liabilities’ and ‘Assets’ like # Balance Sheet. Each side has two amount columns - 'Gross Liability’ and ‘Expected Rank’ on the liability side, and ‘Book Values’ and ‘Estimated to Produce’ on the asst! side, The material columns are only ‘Expected to Rank’ and ‘Estimated to Produce’. 'Boo* Values’ and ‘Gross Liability’ columns do not enter into calculations. ‘The form specifies eight lists (A to H) under which various items are grouped. Ea“ list is prepared separately and attached to the statement of affairs. All the lists except © and H give details about names, addresses, dates, amounts, securities, etc. Creditors[53] wes Fully secured (List B), partly secured (List C) and Insolvency Accounts classified into unsecured (List A) preferential creditors (List D) List A’: This list includes unsecured liabilities for goods, expenses, (other than preferential), Bank overdraft, bills payable, wife's loan and such contingent liabilities (e g. discounted bills, uncompleted contracts partly paid shares guarantee for others etc) a5 are expected to mature List B : Includes only fully secu; is adequate to cover up the debts. List C : It contains only partly secured creditors. List D : It contains preferential creditors viz., taxes, salaries, etc Only List A and C to the extent of uncovered balance appear in the ‘Expected to Rank’ column, since list B is not concerned due to complete coverage. List D is deducted on the asset side. Hence A & C form relevant part of the liabilities. List E : It contains free assets such as cash, stock, fixtures etc. List F : It contains sundry debtors or Book Debts. It is classified as ‘Good’, ‘Doubtful and ‘Bad 7 List G : It contains Bills receivable on hand List H : It is a deficiency which is explained separately. The realisable value of assets in the ‘Estimated to Produce’ column are then added up along with the surplus from secured creditors carried from List B and inserted below List G. Preferential debts are deducted from it and the gap between ‘Expected to Rani and Estimated to Produce’ reveals deficien %&_ DISTINCTION BETWEEN STATEMENT red creditors if the realisable worth of the securities Balance Sheet Statement of Aff 1. Assets are mentioned at book values. 1, Assets are ‘mentioned at book values as : well as at realisable values. “ 2. Liabilities are shown at book values. 2. Liabilities are shown at book values and at ‘Expected to Rank’ values. SSnnnnns 3. Shows excess of assels over outside|3. Shows excess of outside liabilities over liabilities as capital. “assets as deficiency. “4. Separates personal assets and liabilities|4. Integrates personal assets & business assets from business assets and liabilities. & liabilities in the case of an individual ‘5. It includes intangible assets, fictitious as|5, It excludes intangible assets if they are well as non-fictitious, fictitious, 6. Itexeludes contingent liabilities. 6. It includes contingent liabilities to the extent to which they are expected to rank 7. No lists for grouping of assets are given. Lists for various assets and liabilities are 8. Charged assets are not shown by way of 8. Char ed assets are shown by way of deduction of the very debts. ‘No division of liabilities is given. firms. iction from the very debts, of liabilities is given into different 10. It has a prescribed form and it is prepared ‘under oath, Sa SaEnaThis account shows how the deficiency as shown under List H under statement of Affairs has arisen. It explains the reasons of deficiency. This is prepared for the periog beginning from the date fixed by the court or official receiver to the date of adjudication On the left hand side of the account, items reducing deficiency are shown : 1. Capital (excess of assets over outside liabilities) 2. Increments to capital from business viz., profits, interest on capital etc 3. Contributions from personal property. 4. Realisable profits viz. from assets at higher realisable values and liabilities = lower expected values. On the right hand side, items contributing to deficiency are shown : Depletion of capital from trading losses. Bad Debts as per list F. Household Expensés. Speculation losses. Realisable losses. Loss from unprovided contingent liabilities likely to materialise. Private liabilities (In case of individuals only). Excess of right hand side total over left hand side total is the deficiency which must Noupoene agree with the amount disclosed by the Statement of Affairs. The account is prepared as follows : Deficiency Account (List H) z im: 1. Excess of assets over liabilities (ie. capital 1. Net losses arising out of business! as on the specified date or from the date of during the period under review. | Commencement of business). 2. Bad Debts as per List 'F’, 2. Net profits arising from business during. 3. Household Expenses other than) the period under review business expenses ive., drawings. 3. Interest on capital Other Losses : | 4. Income or profit from other sources e.g. Loss through betting or speculation Profit on realisation of assets or payment loss. | ofa liability Losses on realisation of assets and| Private asset brought into business, ete. payment of liabilities. 5. Deficiency as per Statement of Affairs Bills discounted likely tobe dishonoured. Payment of private or other liabi-lities not recorded in the books. | Fig. 2.2INSOLVENCY ACCOUNTS + Exception : The exception is provided in the Act, according to which. se rights of any person who has acquired a title through or under a creditor of the insolvent, in good faith and for valuable consideration. shall not se affected. (ie. it will not be treated as fraudulent preference) G_STATEMENT OF AFFAIRS : When @ person is declared insolvent, he is required to prepare a aatement showing his assets and liabilities. The assets are shown at their cealtsable values because the intention of preparing this statement is to the total amount available to creditors. The assets are shown on the ght hand side and the liabilities on the left hand side. The excess of abilities over assets is the deficiency. There will be three columns on each side of the Statement of Affairs dn the left hand side are shown the liabilities. The first column shows the yess liabilities. In the second column will be shown the details of the catilities. The third column is headed ‘Expected to Rank’ meaning thereby ‘e liabilities which may have to be paid in insolvency. The difference setween the first column and the third column is that in the first column the sxeal contingent liabilities are shown, whereas under the third column. only Se liabilities expected to rank are shown. Three columns are, likewise. sown on the right hand side for assets. The first column is meant for the ceticulars of the assets, the second column for the book values of the assets 124 the third column shows the estimated realisable values of these assets. In the form of Statement of Affairs the liabilities and assets are dassified into certain groups. (a) LIABILITIES SIDE : The liabilities are classified into four groups, viz. (1) Unsecured “redstors, (2) Fully Secured Creditors, (3) Partly Secured Creditors, and \4) Preferential Creditors. (1) Unsecured Creditors : i The creditors who do not have any security a; susecured creditors, ft is generally this type of creditors who do not get fet) amount of their dues in insolvency. The following are included in sexecured creditors : (1) Trade Creditors; (2) Bills Payable, (3) Bulls Feceivable discounted but likely to be dishonoured, (4) Creditors for weges, salaries, taxes el beyond their preferential limits, (3) Bank Overdraft (against personal security). ‘As the unsecured creditors do not have any security, they have to prove forthe full amount of their liabilities in insolvency A list 1s t0 be prepared ing the names and addresses of such creditors and the amount a ‘ach one of them. This list is'hnown as ‘List A’ The total amount of ay An shown in the outer column headed "Expected to Rank’ The ets st % the first item in the Statement of Affairs on the Jeg h 1S is shown, and sideB.S. SHAT PRAKASH Ay (2) Fully Secured Creditors + Those creditors are fully secured who hold as security some propery, belonging to the insolvent and the realisable value of the Property is equa to or is in excess of the amount of debt. e.g. There is a Viability of ban; overdraft of Rs, 20,000 against which the plant and machinery a, mortgaged, which are expected to realise Rs. 30,000. Hence, bank overdrat is fully secured, as the bank is in a position to recover its debt in fuy, If the bank itself realises the asset, it will hand over the surplus « Rs. 10,000 to the receiver. A list is prepared showing the names and addresses of each sug creditor, the amount of debt owed to cach of them, the particulars of th: security and the estimated realisable value of the security. The list is calle ‘List B'. The total amount of this list appears in the ‘gross liabilities’ colum, of the Statement of Affairs. As these creditors are able to recover the: dues in full, no amount is carried in the outer column headed ‘Expects, to Rank’, | (3) Partly Secured Creditors : These creditors hold securities which are not sufficient to cover th’ whole of the debts due from the insolvent. They are secured to the exter} of the realisable value of their security and unsecured for the balance. The) rank for dividend against the estate of the insolvent for such unsecure) balance. e.g. X has advanced Rs. 15,000 to the insolvent against a securit| worth Rs. 12,000 which is expected to realise Rs. 8,000. Thus X is a part! secured creditor as he is secured to the extent of Rs. 8,000 and is unsecure: to the extent of Rs. 7,000. } A list is prepared showing the names, addresses, amounts of debt) particulars of securities etc. which is called ‘List C'. The total of this list!) shown in the gross liabilities column of Statement of Affairs. The value ¢ security is deducted from the total amount of the debt and the unsecurt’ balance is carried in the ‘outer column headed ‘Expected to Rank’. (4) Preferential Creditors : There are certain creditors among unsecured creditors who have to paid in full, before anything is paid to other unsecured creditors accordik to Law. They are called Preferential Creditors. A list showin, the cule of such creditors is called ‘List D'. 8 the partic: Under Sec, 61 of Provincial Insolvency Act, the pref as follows Preferential debts ¥ In the distribution of the property of the insolvent, in priority to other debts : here shall be id () all debts due to the government or to any local auth 10] ih\ SOLVENCY ACCOUNTS :: (b) all salary or wages, not exceeding twenty rupees in all, of any > gerk, servant or labourer in respect of services rendered to the insolvent \quring four months before the date of the presentation of the petition. {These preferential debts are payable in full. If the property of the + jsolvent is not sufficient to meet them in full, they shall be paid in equal ‘proportion between themselves. It may be noted that receiver's remuneration and other liquidation expenses are to be paid in full before making payment to even preferential creditors. It is provided in the Act "Subject to the retention of such sums as may be necessary for the expenses of administration or otherwise, the debts specified sub-section (1) (i.e. preferential debts) shall be discharged forthwith..." The details about the preferential debts are given in a separate list which is called ‘List D'. In the Statement of Affairs the total amount of preferential debts would be shown in gross liabilities column and no amount will be carried in the outer column. This is because they do not rank as unsecured creditors and are to be paid in full. Hence, the amount is shown as a deduction from the assets side. Wife's Loan : If the wife of the insolvent has given loan out of the money given to her by her husband, she cannot claim anything in insolvency and as such, her loan will not be included in any type of qreditors. As the amount is not to be paid, it will appear on the left hand side of deficiency account. This is because it is a saving for the Receiver. However, if she has given loan out of her streedhan or from her separate estate, the amount will have to be paid and included in unsecured creditors and included in list A. The details of liabilities wi (1) Unsecured Creditors as per List A (2) Creditors Fully Secured as per List B (3) Creditors Partly Secured as per List C (4) Preferential Creditors as per List D. (or Creditor for wages, salaries, taxes etc. payable in full as per List D) (B) ASSETS SIDE = The details about the unencumbered assets belonging to the insolvent ‘ae shown under three headings on the assets side. All free assets, except, Book-Debis and Bills Receivable on hand, are shown under List B; Book Debts are shown under List F and Bills Receivable appear under List G. There are two columns for showing amounts on the assets side. The fi Column shows the book bee and the second column shows the Late Tealisable value of assets under the heading ‘ Ne 8 ‘Estimated to Produce’. I, thus, be shown under four heads, viz.' B.S. SHAH PRAKASii| (a) Property : Under List‘E are shown those assets which are no given as security for any debt of the insolvent. These are the asse, 3 ¢ for distribution among unsecured creditors of the insolvent, 7), ce between the book values and estimated realisable values il transferred to the right hand side of the Deficiency Account as a loss | lisation of assets, Generally, the assets shown under this list are Stock. in-trade, Plant and Machinery, Furniture and Fixture, Investments, Pateny, and Trade Marks ete. In case of a sole trader, his private free assets ay also shown under this list. In case of partnership firm, the surplus fron say partner's private assets is shown here. A statement showing detaik about the assets is prepared, which is known as 'List E’. | (®) Book Debts : The book debts or debtors are shown under Lis) FL List F is a statement showing the names, addresses, and occupation) of debtors, and the particulars of securities, if any, held against these debi. Tae book—debts are divided into three groups, viz good, doubtful ani bad. The smount of good debt is shown in the outer column heade! “estimated to produce.'.The doubtful and bad debts are shown in the inne! column of book values and the amount estimated to produce is shown it, the outer column. The amount not likely to be recovered i: debts on the right hand side of the Deficiency Account. (©) Bills Receivable : The bills receivable held by the insolvent whict| have not matured on this date are shown in List G. This list shows complet: details about these bills and the total of this list appears in the Statement of Affairs. The book values and the amount expected to realise from thes! bills are shown in the two columns of Statement of Affairs, the differenct being shown in the Deficiency Account. (4) Deficieacy : The difference between the liabilities expected to ran 2s unsecured debts and the amount available for such creditors (the fins! total on assets side of Statement of Affairs) is the ‘Deficiency’, A statemet which explains how this deficiency arose is known as ‘Deficiency Account or List H. The amount of deficiency is shown on th is shown as baé| le Assets si the Statement of Affairs. ets side of Thus, the total amounts of following four lists appear ‘ (1) Property as per List E ON assets side : (2) Book Debts as per, List F (3) Bills Receivable as per List G (4) Deficiency as per List H