Financial Accounting II (B Com 2nd Sem)

Prepared By Shamnad Shahul Financial Accounting II (B.
Com 2nd Sem), MG University 1
Financial Accounting II
Module 1
Accounting for Hire Purchase – Meaning and features of Hire Purchase System – Hire Purchase Agreement – Hire
Purchase and Sale – Hire Purchase and Instalment – Interest Calculation – Recording transaction in the Books of both the
parties – Default and Repossession – Complete Repossession – Partial Repossession
Meaning of Hire Purchase System
Hire Purchase System is a system in which the hirer (hire purchaser) buys a good from the seller (hire vendor) but does
not make a full payment at one time. However, makes a lumpsum amount as a down payment and the remaining amount
will be paid in instalments by the hirer. It is somehow like an instalment system but, the major difference in instalment
system and hire purchase system is the time of transfer of ownership.
Features of Hire Purchase System/ Agreement
1. Possession only is transferred: The Hire Vendor transfers only the possession of the goods to the Hire
Purchaser immediately after the contract for hire purchase is made.
2. Periodical instalment: The goods should be delivered by the Hire Vendor on the condition that the Hire
Purchaser should pay, the agreed amount in periodical instalments.
3. Capital goods: Hire purchase system cannot be followed in consumable and perishable items which have
only short life.
4. Down payment: The Hire Purchaser generally makes a down payment (initial payment) on signing the
agreement and the balance of the amount along with interest is paid in instalments at regular intervals for a
specified period.
5. Hire charge: Each instalment including down-payment (if any) is treated as hire charges by the seller till the
last instalment is paid.
6. Option to purchase: The Hire Purchaser should be given power to exercise the option to purchase the hired
goods.
7. Title in the goods: The property in goods is to be passed to the Hire Purchaser on the payment of the last
instalment by exercising the option conferred upon him under the agreement.
8. Termination of agreement: The Hire Purchaser has the right to terminate the agreement at any time before
the property so passes.
9. Right to repossession: In case of default in respect of payment of even the last Instalment, the Hire Vendor
has the right to take the goods back without making any compensation.
Hire Purchase Agreement
Hire purchase agreements are used as an arrangement when purchasing expensive goods or services. The purchaser will
pay the initial instalment or down payment at the beginning, followed by additional payments in the future to pay off the
remaining balance of the good, plus interest. In some cases, when the good is paid off, the purchaser will still not secure
ownership rights. There may be a final, previously agreed-upon fee that must be paid before the title is transferred to the
buyer. Other similar financing programs include never-never and rent-to-own.
Hire purchase agreement contains the terms and conditions on which the purchaser and seller mutually agree to let the
goods on hire. This agreement contains the following clauses:
 Vendor or seller gives the possession of goods to the hirer or hire purchaser with the condition that ownership
will be transferred only when the hirer makes the payment of the last instalment.
 Hirer has an option to terminate the agreement anytime if he/she don’t want an asset or unable to pay the further
instalments. The instalments paid till that date will be considered as rent for using an asset, and with the
termination of the agreement, the hirer should return the asset to the vendor.
Prepared By Shamnad Shahul Financial Accounting II (B.Com 2nd Sem), MG University 2
Contents of Hire Purchase Agreement
According to the Hire Purchase Act, 1972 (Section 4), the following contents should be mandatorily mentioned in a hire
purchase agreement:
1. Description of goods.
2. Selling price of the goods sold.
3. Actual cash price of the goods sold.
4. Date and time of agreement initiation.
5. Amount and number of instalments to be paid by the hirer along with the rate of interest.
6. Last date till all instalments should be paid off.
7. The name of the person to whom the instalment is payable.
Benefits of Hire Purchase Agreements
The benefits of using hire purchase agreements stem mainly from the ability to purchase more expensive products than a
person or company could normally afford. The payments are spread out over time, making it less of a burden on the
purchaser and allowing them to acquire a more expensive asset. A person with a poor credit rating or maxed-out credit
can still use a hire purchase agreement because it is not considered an extension of credit.
Similarly, businesses with little or no working capital can take advantage of hire purchase agreements. The ownership of
the good is not acquired until all the payments are made, creating minimal risk for the seller as the good can be
repossessed at any time if the instalments are not made. The agreement is not an extension of credit, making the
payment plan an intriguing strategy for consumers to use.
The vendors benefit from hire purchase agreements alongside the buyer. Most of the benefit comes from the increased
demand for their product, given that more consumers can afford the expensive goods. Ultimately, hire contracts provide
the company with more revenue and a broader customer base. If the company is financing the product themselves, they
also reap the benefits of the buyer’s accrued interest, which they will receive in the later instalments.
Drawbacks of Hire Purchase Agreements
The hire purchase agreement comes with negatives on both the vendor and buyer sides. The buyer often overextends
himself in the attempt to purchase expensive goods outside of their budget and end up burdened by future payments.
Additionally, the interest payments can be quite costly, especially compared to outright purchasing the good at the start.
The interest rates also do not need to be explicitly stated, adding to the risk of taking on the hire contract.
On the vendors’ side, hire purchase agreements often lead to complicated organizational and administrative tasks,
ultimately creating more costs for the company.
Hire Purchase and Sale
Hire Purchase, as the name suggests, is the system of trade in which one party pays for the cost of the asset in a number
of instalments while making use of that asset. In this system, the ownership of the asset is transferred by the hire vendor
only on the full-fledged payment of the remaining balance. On the other hand, the sale represents the actual sale of
goods, in which the ownership and possession both are transferred to the customer, instantly by the seller.
Definition of Sale
In a contract of sale of goods, the seller transfers or agrees to transfer the property in goods to the buyer, for a definite
return i.e. price. It represents the usual deal between the parties, i.e. buyer and seller. The parties to the contract of sale
have the right to modify the provisions of law by explicit preconditions.
It is a form of contract that is formally governed by law. It can be absolute or conditional.

Types of Contracts of Sale
There are two types of the contract of sale: Sale and Agreement to Sell
 Sale: When in a contract of sale, there is an immediate transfer of property in the goods from the seller to the
buyer of goods, for a price, it is called a sale.
 Agreement to Sell: When in a contract of sale, the transfer of property in the goods from the seller to the buyer
will take place at a future specified date or subject to the fulfilment of some conditions, such a contract is called
as agreement to sell. It reflects the intention to transfer, the property in goods when the conditions are fulfilled.
Elements of Contract of Sale
 Parties: At least two parties must be present to constitute the sale, i.e. buyer and seller.
 Presence of Subject Matter: The presence of subject matter, i.e. goods is important in a contract of sale, which
must be a movable item.
 Price: The price of goods should be paid or promised to be paid monetarily and not in kind.
 Transfer of Property: There has to be a transfer of property in goods.
 Elements of Contract: All the essential elements of a contract must be there in a contract of sale.
Key Differences Between Sale and Hire Purchase
The difference between sale and hire purchase can be drawn clearly on the following grounds:
1. A contract of sale is one in which the customer buys or agrees to buy certain goods from a seller, at an agreed-
upon price. On the contrary, Hire Purchase refers to a system of buying the asset, wherein buyer acquires the
possession of the asset with down payment and completes the purchase by paying periodical instalments, and
the seller retains the ownership until the final instalment against the asset is paid.
2. The contract of sale is governed by the Sale of Goods Act, 1930, whereas the hire purchase contract is governed
by the Hire Purchase Act, 1972.
3. When a sale is made, the ownership of goods is transferred immediately to the buyer of the goods. On the
contrary, in case of hire purchase, the ownership of the asset is transferred to the hire purchaser, on the payment
of the last instalment.
4. In case of a sale, the buyer’s position is that of the owner. In contrast, the position of the hire purchaser is just
like a bailee in the contract of bailment, until he pays the final instalment due.
5. In the sale, the payment is made in lumpsum, i.e. one-shot payment either in cash or via cheque or via online
modes. As against, in hire purchase, payment is made in instalments.
6. In the sale, the consideration covers the price of the goods purchased. Conversely, in hire purchase, the
consideration includes the hire charges for the use of the asset, along with the price of the asset.
7. On the non-payment of the amount due, in case of a sale, the seller can only take legal action against the buyer
but cannot take back the goods. However, in hire purchase, the hire vendor can repossess the goods, when the
hire purchaser defaults in payment.
8. In case of sale of goods, the buyer cannot terminate the contract, and he/she is obligated to pay the price. On the
flip side, the hire purchaser can terminate the contract by returning the asset to the vendor and has no liability to
pay the instalments in full.
9. In the case of hire purchase, the hire vendor does not have to bear the risk of loss due to the insolvency of the
hire purchaser because the hire vendor can simply repossess the goods. As opposed, in case of a sale, the seller
of the goods has to bear the loss due to insolvency.
10. When it comes to repairing, the hire vendor has to bear the expenses of repair in case of hire purchase.
Contrastingly, in a sale contract, the buyer of the goods bears any expenses related to the repair of the goods,
once the goods are sold.
11. In case of a sale, the buyer becomes the ultimate owner of the goods, and so the buyer can transfer a good title
to the third party. On the other hand, in case of hire purchase, as only the possession of the asset changes and
not the ownership, the hire purchaser cannot transfer a good title to the third party.
Hire Purchase and Instalment
S. No Installment Sales Hire Purchase

The ownership of the asset is transferred at the time Ownership is transferred after the payment of last
1 of making down payment instalment
In installment sales, if the buyer makes default in In hire purchase, if the buyer makes default in making
making future payments, the seller cannot recover future payments, the seller can recover the asset sold
2 the asset sold because he is still the owner of the asset
The seller can only file a case against the buyer and There is no need to file a case as the asset is already
he will get only the outstanding amount the property of the seller. If the buyer defaults in the
payment, the seller coups the asset and all the
payments done by the buyer till now are charged as
3 hire
Default and Repossession in Hire Purchase
‘Default’ is the failure to act, appear or pay, i.e., failure to meet the obligation. Under a hire purchase agreement, the
hirer has an obligation to pay up to the last instalment so that the ownership of goods smoothly passes to him. If he fails
to meet this obligation, it will be treated as a default on his part.
Possession of goods means the physical holding of goods. You know that under the hire purchase agreement, the vendor
transfers the possession of goods. He does not transfer the ownership, and if the hirer fails to pay even the last
instalment, he has the legal right to recover the possession of the goods.
This act of recovery of possession is termed as ‘repossession’.
Rights of the Hire Vendor
A. Rights of hire vendor to terminate the hire purchase agreement
Where the hirer makes more than one default in payment of instalment as provided in the agreement, the hire vendor
(the owner) shall be entitled to terminate the agreement by giving the notice of termination in writing.
B. Rights of the hire vendor on termination:
Where a hire purchase agreement is terminated, the hire vendor (the owner) shall be entitled
I. to enter the premises of the hirer and seize the goods,

II. to retain the hire charges already paid and to recover the arrears of hire charges due, and
III. to claim damages for non-delivery of the goods.
Restrictions on the Owner
The above rights of the owner are, however, subject to the following restrictions:
A. Rights of the hirer in case of seizure of goods by the owner:
Where the owner seizes the goods lent under a hire purchase agreement, the hirer may recover from the owner the
amount, if any, by which the hire purchase price falls short of the aggregate of two amounts
i. the amounts paid in respect of the hire purchase price up to the date of seizure) and
ii. the value of the goods on the date of seizure.
B. Restrictions on owner’s right to repossess:

Where goods have been let under a hire purchase agreement, and the statutory amount of the hire purchase price has
been paid, the owner shall not enforce any right to recover possession of the goods from the hirer otherwise than by
‘verdict of any competent court.
Accounting Treatment of Default and Repossession
As per the hire purchase agreement, when the purchaser or hirer fails to pay his required instalments, and by that
agreement, the seller or owner gets the right to repossess the goods or assets for such default. Under such
circumstances, the seller may repossess the goods or assets entirely or partially. Their accounting treatments under
different situations are shown below.
Complete Repossession
In the books of the buyer
1. All the necessary entries are to be shown up to the date of default as usual.
2. Then Vendor’s A/c is to be closed by debiting his A/c and crediting the Asset A/c.
3. After that, if there is any balance in the Asset A/c, the Asset A/c is to be closed by transferring the balance to
Profit and Loss A/c.
In the books of the seller
1. All necessary entries are to be shown up to the date of default as usual.

2. Then Purchaser’s A/c is to be closed by debiting Goods Repossessed A/c and crediting Purchaser’s A/c.
3. After that, if any expenditure is incurred to repair the said asset/goods, the Goods Repossessed A/c is to be
debited.
4. Subsequently, when the repossessed goods are sold, Cash/Bank A/c will be debited, and Goods Repossessed
A/c will be credited. If there is any balance in the Goods Returned A/c, it is to be transferred to Profit and Loss
A/c.
Partial Repossession
In the books of buyer
1. All the necessary entries are to be shown up to the date of default as usual.
2. Then entry to be shown for the agreed value of the assets taken over by the seller by debiting Vendor’s A/c and
crediting Assets A/c.
3. The remaining asset left by the seller will continue as before and will show the closing balance (c/d) of the Asset
A/c. If there is any balance in the Asset A/c, it will represent profit/loss on repossession and is to be transferred
to Profit and Loss A/c.
In the books of the seller
1. All the necessary entries are to be shown up to the date of default as usual. Then Purchaser’s A/c is to be
credited, and Goods Returned A/c is to be debited for the assets taken over (as per the agreed value).
2. The Purchaser’s A/c will continue as per the new agreement.
3. After that, if any expenditure is incurred for repair of the said asset/goods, the Goods Repossessed A/c is to be
debited.
4. Subsequently, when the repossessed goods are sold, Cash/Bank A/c will be debited, and Goods
Repossessed/Returned A/c will be credited. If there is any balance in the Goods Repossessed/Returned A/c, it is
to be transferred to Profit and Loss A/c.
Module 2
Branch Accounts – Objectives – Features – Types – Accounting for Branches keeping full system of accounting – Debtors
System – Stock and Debtors System – Independent branches and Incorporation of Branch Accounts in the Books of H.O. –
Cash in Transit and Goods in Transit – Consolidated balance sheet. (Accounting for foreign branches excluded).
Branch Accounts
Departments
With the purpose of reaching maximum customers and thereby increasing the volume of sales, large business
organisations often divide their business into different units or divisions. In case the divisions are located under one roof
or in the same building they are called Departments.
Branches
With the purpose of reaching maximum customers and thereby increasing the volume of sales, large business
organisations often divide their business into different units or divisions. In case the divisions are located in different
places either in the same city or in different cities of one country or in different countries, they are called branches.
Head Office
The main establishment or entity that owns and controls the divisions is known as Head Office and its divisions within a
city, or country or outside the country are known as branches. Thus, branch is a sub division or extension of the head
office
Meaning of Branch Accounts
The accounts which are maintained to ascertain the profit or loss of each individual branch as well as of the business as
a whole are known as Branch Accounts.
Branch accounting is a bookkeeping system. It separates accounts into different branches, each of which is maintained
separately. This is a system that is typically found in corporations that are geographically dispersed, as well as chain
operators. It allows for greater transparency when it comes to transactions and calculating cash flow, as well as helping
accountants track the overall performance and financial position of each branch.
Branch accounts also refer to individually produced records. These records show the performance of the different
locations. These accounting records are maintained at the corporate headquarters. But in most cases, each branch
keeps its own books. They will then send them to their respective corporate headquarters at the end of each accounting
period, where they will be combined with reports from all other branches.
Objectives of Branch Accounts
The Branch Accounts are maintained to achieve the following objectives.
1. To know the profit or loss of each branch separately.

2. To ascertain the financial position of each branch on a particular date.
3. To know the cash and goods requirement of various branches
4. To decide whether a particular branch is to be expanded or closed down
5. To evaluate the progress and performance of each branch
6. To achieve proper control over each branch
7. To calculate commission payable to branch manager based on profits.
8. To meet the requirements of specific laws as all branches of a company must keep the accounts for audit
purposes
Types of Branches
1) Inland or Home Branches: Are located in the same country in which its head office functions. Inland branches are
further divided into:
a) Dependent Branches: Are the branches that do not maintain full system of accounting. Its accounts are
maintained by the head office. The head office prepares the accounts of dependent branches based on the
reports and returns received from them. Further, the business policies and administration are controlled by the
head office.
b) Independent Branches: Means a branch that maintains complete set of accounting books. Subject to the broad
policies framed by the Head Office, independent branches operate like autonomous business units and execute
all accounting functions.
2) Foreign Branches: Are generally operate like independent business units and record their transactions in the
currency of the country in which they operate. They are divided into:
a) Branches having Integral Foreign Operations (IFO)
b) Branches having Non-Integral Foreign Operations (NFO)
Dependent Branches
Dependent branches are those branches which are not keeping their own separate set of books of accounts. The relation
between head office and branch is just like agency, therefore, these are also known as agency branches.
The following are the salient features of such a branch:
i. These branches generally depend upon the head office for supply of goods. However, the branch may be allowed
to make purchases from the local parties.
ii. All expenses of the branch are directly paid by the head office.
iii. In order to meet the petty expenses of the branch, e.g., conveyance expenses, entertainment expenses etc., may
be provided with the petty cash from the head office.
iv. Normally branches receiving goods from head office selling for cash only but also selling on credit if it is
authorised by the head office.
v. Cash received from branch from its debtors or on account of cash sales is daily remitted to head office or
deposited into a bank account opened in the name of the head office.
vi. Such branches maintain certain memorandum records only such as cash book, debtors account and stock
registers.
Accounting of Dependent Branches
1. Debtors System: This system is suitable for small sized branches. It is a system of ascertaining the profit earned
by the head office at each branch by preparing a nominal account called Branch Account in the ledger of head
office to find out the profit earned at branch. There will be a branch account for all branches in the books of the
head office. This system is called debtors system because under this system, branch is assumed as a debtor of
the head office.
Memorandum Debtors Account: In order to prepare the Branch account under debtors’ system, opening balance
of debtors, closing balance of debtors and cash received from debtors are required. If any of this information is
missing, Memorandum Branch Account is prepared. The Memorandum Branch Account will help to ascertain the
amount due from debtors on account of credit sales (Closing debtors), opening debtors and cash received from
debtors.
2. Stock and Debtors System: When the branch operates on the big scale and the head office desires to exercise
better control on the working of the branch, Stock and Debtors System is preferred. Under this method instead of
branch account, the head office maintains a number of accounts to ascertain the profit earned at branch.
Branch Stock Account, goods sent to Branch Account, Branch Stock Reserve Account, Branch Adjustment
Account, Branch Debtors Account, Branch Expense Account, Branch Asset Account.
3. Final Account System: Under this system Profit or Loss of a branch is found out by the Head Office by preparing
Memorandum Branch Trading and Profit and Loss Account. While preparing this account, care should be taken
to see that opening stock, goods sent to branch less returns, and closing stock are all taken at cost price and not
at invoice price. It is similar to ordinary trading and profit and loss account.
4. Wholesale Branch System: Sometimes, head office opens its own retail branches and sells goods through them
in addition to selling goods through wholesalers. The head office invoices the goods to the wholesalers at
wholesale price while branches sell goods to the consumer at retail price. Since retail price is more than the
whole sale price, hence more profit is earned on sales through its own branch but the entire profit cannot be
treated as branch’s profit. However, the branch’s profit will be equal to the difference between wholesale price
and retail price and remaining profit,
Independent Branches
The branches that can keep their accounts themselves and sell goods that are sent by the head office, as well as those
purchased by themselves, are known as independent branches. When the size of the branches is very large their function
becomes complex. Independent Branch, like the Head Office, keeps all its records separately and independently on
Double Entry System. In such a situation it is desirable or practicable for each branch to establish its double-entry
bookkeeping system quite separate from those of head office under this system of branch accounting. These are the
branches which can sell the goods to the head office too. It is legally and organisationally a part of the enterprise of the
foreign headquarters and to its extent subject to the law of the foreign headquarters.
They can pay their own expenses and can deposit their collection in their own name in the bank. It prepares its own trial
balance and final accounts. These branches are those which make purchases from outside, get goods from Head Office,
supply goods to Head Office and fix the selling price by itself. It has to send only the trial balance and final accounts at
the end of the year. These branches record separately and independently all the transactions which are even recorded by
the head office. The profit and loss are found out by the branch and remitted to H.O. at the end of the year. Steps involved
in preparing accounts of independent branches: Reconciliation, Adjustment, and Incorporation.
Characteristics of an Independent Branch:
i. Such Branch gets goods from Head Office and from outside parties. It has its own Bank Account.
ii. It prepares its own Trial Balance, Trading and Profit, and Loss Account and Balance Sheet.
iii. There may be inter-branch transactions. That is, goods transferred by one Branch to another Branch of the same
Head Office.
iv. A combined Balance Sheet of branch and H.O is prepared by the branch.
Accounting of Independent Branches
1. Preparation of Head Office account in Branch Book and Branch Account in Head Office Book: Though the
branch is independent, the transactions between branches and the head office are to be recorded in the books
of accounts. For this, an independent branch prepares a personal account called Head Office Account which
reveals the amount due to or due from the Head Office. At the same time, the Head Office also prepares a
personal account called Branch Account which will disclose the amount due to or due from the Branch.
Transit Items: Refer to goods/cash sent by Head Office/ Branch but not received by Branch/Head Office before
the closing of the books of accounts.
Goods in Transit: Means goods sent by the Head Office to branch or Branch to the Head Office but not received
by the Branch or Head Office before the closing of books of accounts.
Cash in Transit: Means cash or cheque sent by the Head Office to branch or Branch to the Head Office but not
received by the Branch or Head Office before the closing of books of accounts.
2. Incorporation of Branch Trial Balance in the Head Office Books (Preparation of Consolidated Final
Accounts): Independent branches record all its transactions in their own books, extract their own Trial Balance
and prepare their own Trading and Profit and Loss Account and Balance Sheet. A copy of the Trial Balance so
extracted is sent to the Head Office and the Head Office will integrate the same in its books of accounts. After
this the Head Office prepares the Consolidated Profit and Loss Account and Balance Sheet for the business as a
whole. This process is called Incorporation of Branch Trial Balance. Normally any of the following methods are
adopted for the same:
Detailed Incorporation: Under this method, in order to prepare the Consolidated Balance Sheet, each item of
Branch Trading and Profit and Loss Account (all nominal accounts) and each item of assets and liabilities are
transferred to the Head Office book through Branch Account. As a result, the Branch Account in the Head Office
book and Head Office Account in the Branch Book will be closed.
Abridged Incorporation: Under this method, instead of transferring nominal accounts in the Trial Balance,
Branch Trading and Profit and Loss Account is prepared as a memorandum account and profit or loss as per the
Branch Trading and Profit and Loss Account is transferred to the Head Office Account.
Methods to Incorporate Branch Transactions
Independent branches have some unique transactions which must be accounted in a certain way. They include:
 Goods in transit
 Cash in transit
 Head office expenses chargeable to branch
 Depreciation on branch fixed assets
 Inter-branch Transactions
These transactions require adjustment entries to be done at the end of the accounting period. This is required because
the balances of the books of the HO and branch will not tally due to time slack involved in completing the transaction.
Goods in transit: When goods are sent by the HO to the branch, the HO debits the branch account immediately.
However, the branch credits the HO account only when the goods are received by it. While the goods are in transit, it
shows that it has moved out from the HO but not yet received by the branch. This is not a problem in the entire
accounting period because it balances not immediately but later on.
When it comes to the closing of the accounting year and the goods are not received then such goods are recorded as
goods in transit. There is a debit entry in the branch account of the HO books but no entry in the HO account of the
branch books. Therefore, the accounts will not tally and show a difference.
Cash in transit: To take care of the branch’s expenses, the HO has to transfer cash from time to time. Like goods, the
cash transfer entries are made in the books of both HO and branch. When cash is transferred from the HO to the branch,
the HO immediately debits the branch account and the branch account credits the HO account on receipt of the cash.
However, the transfer does not happen immediately and may take some time. It has to be adjusted when this transfer
happens during the closing of the accounting period. Therefore, there would be a debit in the books of head office but no
reciprocal entry in the books of the branch. Therefore, either the HO or the branch has to pass an adjustment entry to
tally the books.
Head office expenses chargeable to branch: The expenses of the independent branch are borne by the branch itself.
However, the HO may decide to allocate some of its expenses to the branch. For example, the time of the support staff at
the branch or any other expenses which the HO thinks incurs majorly for the branch.
Depreciation on branch fixed assets: The fixed assets accounts are all maintained at the HO accounts. Therefore, all
entries related to the assets are done in the books of the HO. For example, the HO purchases a fixed asset for a branch
and it debits the branch fixed assets account and credits the cash account.
There is no entry in the branch account unless payment for the asset is made by the branch. In case the branch makes a
payment, it claims a remittance for the payment and does not debit the fixed assets account in its books.
Thus, depreciation on such fixed assets has to be done by the branch in its books as the asset is used by the branch and
not by the HO. The normal entry for depreciation is done by debiting the depreciation account and crediting the fixed
asset account. But since there is no fixed asset, the entry passed for depreciation is not like the normal entry.
Inter-branch Transactions: It is not always that transactions happen between the HO and the branch only. When a
business has many branches, transactions may also happen between two or more branches. For example, branch A
wants goods from the HO but if the HO is located far away and branch B is nearby and has ample stock, then to save the
transportation cost, the HO would suggest branch B to supply goods to branch A.
In such a case, the branch which is transferring the goods will make an entry as though it is returning the goods to the HO
and the branch that is receiving the goods will make an entry as though it is receiving the goods from the HO.
consolidated balance sheet
A consolidated balance sheet is a financial statement that shows the financial position of a parent company and its
subsidiary companies. In simple words, a consolidated balance sheet is mere consolidation of financial details of all a
subsidiary including parent company and presenting as one balance sheet for the entire group.
A consolidated balance sheet is usually prepared by the business operating as a group of companies that have more
than one subsidiary and it portrays the combined details of assets and liabilities.
Module 3
Departmental Account – Meaning – Objectives – Advantages – Distinction between branch and department – Accounting
Procedure – Allocation of Expenses and Income – Inter Departmental Transfers – Provision for Unrealized Profits
DEPARTMENTAL ACCOUNTING
Departmental accounting is a system of accounting which maintains a separate book of account for every department or
branch of a business enterprise. It is one where accounts are prepared and maintained for different departments of an
organization on an individual basis for evaluating their results in a fair manner. These individual books of account are
then consolidated together with accounts of head office for preparation of financial statements of business.
Departmental accounting aims at recording all the expenses and revenues of each department in a separate book of
accounts. It enables in measuring the profitability of every branch and detect if any department is underperforming than
their capability.
Such accounting information system is suitable for organization operating in diversified range of activities. Departmental
accounting is an efficient tool for monitoring the expenses and performance of business where several products are
produced by different branches under same roof.
Departmentalization is very beneficial for large scale organization for managing their activities and attainment of desired
goals. Good departmentalization enables firms to easily identify their most crucial branches playing more important role
in achieving results. It enables in bringing all necessary adjustments from time to time in case of any variation by finding
out performance of each department. Departmental accounting is more favourable for this type of large-scale firms than
a single centralized accounting system. Single accounting system fails to properly account for divisional performance
and therefore comparison of results at department level can’t be made. Companies implementing departmental
accounting are easily able to categorize their departments into well performing, average performing and moderate
performing units. This type of accounting assist managers in formulating effective policies.
Objectives of Departmental Accounting
Main objectives of departmental accounting are as given below: –
 To evaluate each branch's performance, allowing for easier comparison of findings.

 To compare the department's performance to the prior period's results.
 To compute the gross profit of each department.
 To highlight the non-profitable departments.
 It aids in determining the department manager's commission when it is linked to the profit made by their
department.
 Each department's progress may be tracked to determine what measures should be taken.
 To assist the owner in developing the best insurance for the future.
 To aid management in selecting whether to eliminate or create a department.
 It can assist management in determining which departments should expand and which should close to
maximise overall business profitability.
 To offer complete information on the entire organisation.
 To aid management with cost-cutting measures.
 It also aids in allocating expenditures to various divisions, allowing for greater control of the company's costs.
 Controlling and monitoring numerous departments depending on the items they sell is considerably easier for a
corporation dealing with multiple products than controlling it as a single firm.
 Determines the financial situation of each department in the organisation.
 After learning the findings of each branch, develop appropriate plans and tactics.
 Taking necessary steps after assessing the performance of all divisions.
 Efficient cost management of all departments through efficient cost distribution to all departments.
 Encourages a solid competitive spirit among several branches, which leads to increased profitability
METHODS OF DEPARTMENTAL ACCOUNTING

There are two methods of keeping departmental accounts:
1. Accounts of all departments are kept in one book only
It is method under which every branch of an organization is regarded as separate unit and therefore individual book of
accounts are prepared and maintained for every unit. At the end, financial result of every department is calculated and
consolidated to find the overall performance and net result of whole organization.
This method of departmental accounting involves huge costs and is preferred only by large scale organizations or where
is required by the law. Companies involved in insurance business are the one which are compulsorily required to
implement this system of accounting.
2. Separate set of books are kept for each department

Under this technique of departmental accounting, accounts of all branches are maintained collectively in columnar form
by central accounts department. In this method for every department a departmental trading and profit and loss account
is opened in columnar way altogether. There is a separate column for “Total” for finding out the results of different
departments both on individual and collective basis. Balance sheet is however prepared in a combining form.
For incorporation of purchase and sale of goods, a subsidiary book of accounts is prepared with different columns for
different departments. Various subsidiary books prepared are Purchase book, Sales book, Purchase return and Sales
return book. Cash book with separate columns of cash purchase and cash sale is also maintained in case of large
volumes of purchase and sales done on cash basis.
Advantages of Departmental accounting
Most significant advantages of departmental accounting are described in points given below: –
1 Facilitates interdepartmental comparison: -Departmental accounting is one which enables managers in doing
a performance comparison of various departments of business. A separate book of accounts is prepared for
every unit which records revenue and expenses of these units on an individual basis. Profit is calculated and
compared with one another for determining their performance level.
2 Formulation of policies: - Formulation of proper plans and policies is an important role played by departmental
accounting. Managers get detailed information about every unit through the individual book of accounts. They
analyse these set of books for determining the efficiency level of various departments. Proper knowledge of
every business unit enables them to take proper actions for increasing profitability.
3 Assist in Expansion and Shut down decisions: - Departmental accounting plays an inefficient role in deciding
the expansion and shutting down of different departments of an organization. Managers through an individual set
of books are able to detect which units have a more important role in business operations and which one plays
the least role. They can easily decide on the basis of results that which units should be expanded further and
which one should be closed.
4 Reveal the success or failures of units: - This accounting determines the success rate and failure of every
department within the organization. Every expense and income of these departments are properly recorded for
calculating its real profitability. Amount of revenue generated by these units gives a clear idea about the one that
is successful in their role and one that fails to meet their goals.
5 Benefits to Auditors and Investors: - It supplies all revenant information in a correct manner about each unit of
business to auditors and investors. Auditors can easily access to the account of each individual unit for knowing
all expenses and revenues and thereby enables them in verifying the correctness of financial statements.
Investors can get a clear view of portability and overall value of an organization.
6 Determine manager’s commission: - Departmental accounting assist in the fair calculation of manager’s
commission working within different departments of the business. Commissions are paid to managers on the
basis of profit earned by their respective departments. Proper accounts that are maintained separately for every
unit yield right amount of their profit levels.
7 Promote competitive spirit: - It promotes a sense of completive spirit among all staff working within an
organization. All operations of each business unit are properly monitored under this system of accounting. Team
members are rewarded on the basis of performance of their departments which is revealed by the departmental
book of accounts. This motivates staff to work efficiently for improving the overall performance.
8 Enhance profitability: - Departmental accounting has an efficient role in increasing the profitability of the
business organization. This system of accounting closely monitors every aspect of cost and revenues of
organization related to various units for avoiding any errors and frauds. It ensures that all resources are
efficiently utilized with minimum wastage. These separate account books assist managers in determining
performance level from time to time and taking corrective actions which leads to raising the profit level.
Distinction between Branch and Department Accounting
BASIS OF
DEPARTMENTAL ACCOUNTING BRANCH ACCOUNTING
DIFFERENCE
Departments are attached with the Branches are separate from the main
LINKAGE
main organization under a single roof. organization.
Branches are the outcomes of the tough

Departments are the results of fast
RESULTS OF competition and expansion of the
human life.
business.
GEOGRAPGICAL Departments are not geographically

Branches are geographically separated.
LOCATION separated.
There is no classification of The branches may be dependent or

TYPES
departments. independent.
ALLOCATION OF Allocation of departmental common There is no need of allocation of branch

EXPENSES expenses is a tough job. expenses.
In departmental accounts, no To find out the net result of organization

RECONCILIATION reconciliation is required because there the reconciliation of different branch is
is no central account division. a main job.
Departmental trading with their head Branch trading is conducted in different

office is conducted under the same roof parts of the country under the head
TRADING
although each department deals with office dealing with usually the same line
separate line of activity. of activity.
The profitability position of department

The profitability of each branch is
PRFOITABILITY is seen within the larger picture of a
equally important and seen separately.
parent organizational profits.
METHODS OF There are only two methods: Separate There are various methods of
PREPARATION OF set of books are maintained Separate preparation of accounts like Stock and
ACCOUNTS set of books are not maintained. debtors’ system Debtors system Final
accounts system Wholesale price

system
The accounts maintained are; The accounts maintained are: Branch

ACCOUNTS Departmental trading and profit and stock account Branch adjustment
MAINTAINED loss account General profit and loss account Branch debtors account
account Branch expenses account
FUNCTIONAL Functional division is possible in case of

It is not possible in case of branch.
DIVISION departmental concerns.
The chief executive who is to keep a

Control is unpracticable in case of a far-
constant watch over the department
CONTROL off branch since it is not possible for the
supervisor closely and supervises
head office to keep instant watch.
effectively.
Departmental accounting presents the

RECONCILIATION OF Branch accounts present the trading
trading results of each individual
RESULTS results of each individual branches.
department.
Departmental accounting is practically Branch accounts are a condensation of

NATURE
a segment of accounts. accounts.
These are comparatively less costly as a Branch accounts are costly to maintain
EXPENSIVE small team of accountants can be as it involves a big team of accountants
appointed to maintain the accounts. to maintain accounts for each branch.
Module 4
Accounting for Dissolution of partnership firm – Dissolution of a firm – Settlement of Accounts on dissolution –
Insolvency of a partner – Application of decision of Garner Vs Murray Case – Settlement of Accounts when all partners
are insolvent – Piecemeal distribution – Highest Relative Capital Method – Maximum Possible Loss Method
Dissolution of Partnership Firm

Dissolution of Firm is entirely different from Dissolution of Partnership. Dissolution of Firm leads to complete closure of a
partnership business. In case of dissolution of partnership, the business may continue with a new agreement, but in
dissolution of firm, business will not continue.
Dissolution of Partnership
Any change in the relation between partners leads to dissolution of partnership. At the time of change in profit sharing
ratio between partners, admission, retirement, death etc. of partners cause change in the relationship between partners.
In all these cases dissolution of partnership takes place. At the time of dissolution of partnership, the business can
continue with a new agreement.
Situations (reasons) of Dissolution of Partnership
 Admission of a new partner

 Retirement/death of an existing partner
 Change in profit sharing ratio among partners
 Amalgamation of firms
In all the above cases the firm can continue its business with a new agreement, there is no need to close (Dissolution of
Firm) the firm.
Dissolution of a Firm
Dissolution of Firm means complete closure of the business. Dissolution of a firm also known as winding up of a firm,
results in termination of relationship between all partners and stoppage of business. At the time of dissolution of firms,
all assets of the firm are sold, cash realized and with that cash liabilities are to be paid off. If there is any cash, balance
left, it will be distributed among the partners as per their ratio.
Modes of Dissolution of a Firm
Dissolution of a firm takes place in the following ways:
 Dissolution by Agreement
 Compulsory Dissolution
 On the happening of certain contingencies
 Dissolution by notice
 Dissolution by court
1. Dissolution by agreement
A firm is dissolved
a. With the consent of all the partners

b. As per the terms of the partnership agreement
2. Compulsory Dissolution
A firm is dissolved compulsorily in the following cases:
a. When the business of the firm becomes illegal

b. When all the partners or all except one become insolvent
c. When all the partners or all except one decide to retire from the firm
d. When all the partners or all except one die
3. On the happening of certain contingencies
In the absence of an agreement to the contrary, a firm will be dissolved in the following cases:
a. If the constituted for a fixed period, by the expiry of that term

b. If constituted to carry out one or more ventures, by the completion thereof;
c. By the death of a partner
d. By the declaration of a partner as an insolvent
4. Dissolution by notice
In case of a partnership at will, the firm may be dissolved if any one of the partners gives a notice in writing to the other
partners, signifying his intention to dissolve the firm
5. Dissolution by court
At the suit of a partner, the court may order a partnership firm to be dissolved on any of the following ground:
a. When a partner becomes of unsound mind

b. When a partner becomes permanently incapable of performing his duties as a partner
c. When the partner transfers whole of his interest in the firm to a third party
d. When the business of the firm is can’t be carried on at a loss.
e. When the partner commits breach of agreement relating to the management of the firm
f. When, on any ground, the court regards dissolution to be just and equitable
Liability for Acts Done After Dissolution
When a firm is dissolved a public notice must be given of the dissolution. If it is not done, the partners continue to be
liable as such to third parties for any act done by any of them after the dissolution, and in such a case, the act of a
partner done after dissolution is deemed to be an act done before the dissolution.
Settlement of Accounts
Dissolution of Firm means complete closure of the business. So, on dissolution, the firm disposes off all its assets for set
off all its liabilities. The mode settling accounts will be mentioned in the partnership deed. But in the absence of an
agreement between the partners, the rules given in section 48,49 and 55 of the Indian Partnership Act,1932 will apply.
These rules are:
A. Treatment of losses
Losses including deficiencies of capital shall be paid first out of profit, next out of capital and lastly, if needed, by the
partners individually in their profit-sharing ratio
B. Application of Assets The assets of the firm including any amounts contributed by the partners to compensate
deficiencies of capital, must be applied in the following manner:
a. Paying the realization expenses
b. Paying the debts from third parties-creditors, loans, bills payable, bank overdraft, loan from partners’
relatives etc.
c. Repayment of loans from partners.
d. Repayment of capital contributed by partners.
e. Surplus, if any, is distributed by among the partners in their profit-sharing ratio.
Settlement of Private Debts and Firm’s Debt
Where private debts of the partner and firm’s debt co-exist, the following rules, as stated in Section 49 of the Act, shall
apply Settlement of private debts The personal debts and liabilities of individual partners should be paid first out of his
private property and surplus if any can be utilized for the payment of firm’s debts. On the other hand, firm’s debts are first
paid out of firm’s assets and the surplus if any would be distributed to partners. The partners can use this amount to pay
off their private debts.
The personal debts and liabilities of individual partners should be paid first out of his private property and surplus if any
can be utilized for the payment of firm’s debts. On the other hand, firm’s debts are first paid out of firm’s assets and the
surplus if any would be distributed to partners. The partners can use this amount to pay off their private debts.
Accounting Treatment
On dissolution of a firm, the firm ceases (stop) to conduct business and has to settle its accounts. So, at the time of
dissolution of a firm, books of accounts are to be closed, assets realized, liabilities are to be paid off and balance if any,
distributed among partners according to their ratio. In this process the following accounts are prepared:
 Realisation Account
 Partners’ Capital Account
 Bank/Cash Account
Realisation Account nominal account. It is prepared at the time of dissolution of a firm. Realisation account is
prepared to close the accounts of assets and liabilities and to find out profit or loss on realization of assets and
repayment of liabilities. All assets except cash, bank and fictitious assets are closed by transfer it to the debit side of the
realization account at its book values and all external liabilities are closed by transfer it to the credit side of the
realization account at its book value. Any provision relating to asset/liability must also be transferred to the realization
account. Amounts realized are credited and liabilities settled are debited to this account. Realisation expense is debited
to this account. At last, this account is closed by transferring the realization profit or loss to partner’s capital accounts.
Cash/Bank Account is opened to record all cash transactions. When the purpose is over the Cash Account shows a
balance, which is equal to the amounts due to partners.
Capital Accounts are opened to make all entries connected with the partners’ accounts. Current Accounts, if any, are
transferred to Capital Accounts. Finally, the Capital Accounts are closed by receiving or paying cash.
Insolvency of a Partner:
The Capital Account of a partner may show a debit balance because of excess drawals or losses on account of
realisation or some other reasons. Such a debit balance is called Capital Deficiency. If the Capital Account of a partner
shows a debit balance as a result of various entries passed on account of dissolution of the firm, it is expected that he
will pay the money from his estate. If this is done, the other partners will be able to get in full what is due to them. If the
partner is solvent, he will have to make good such capital deficiency by bringing cash. But if the partner is unable, he may
not be able to pay off even his own private liabilities. In some cases, after paying the private liabilities, a small sum which
is lesser than the amount due to the firm, may be given by the partner, whose capital account shows a debit balance.
When a partner is insolvent, then such a capital deficiency will be a loss to other solvent partners. For example, if there
are two partners in a firm and if one of them is insolvent, then the capital deficiency will be borne by the other partner,
who is solvent. But, when there are more than 2 partners, there arise problems as to the ratio in which the capital
deficiency be borne by the remaining partners.
In such a case, the deficiency shown by the insolvent partner’s capital account should be divided among the solvent
partners in the ratio which has already been agreed upon by them for the purpose. Prior to the decision in the leading
case of Garner vs. Murray, this loss was borne by the solvent partners in the profit-sharing ratio just like trading losses. No
distinction was observed between trading loss and capital loss. The rule was laid down by Justice Joyce, in November
1903, in Garner vs. Murray.
Garner vs. Murray Decision:
Garner, Murray and Wilkins were partners, in a firm, sharing profits and losses equally. Their capitals were not equal.
There was no partnership deed. The firm dissolved on 30th June 1900.
The position was as follows, after dissolution:
Mr. Wilkins became insolvent and could not pay anything against the capital deficiency. When the loss on realization is
distributed, Garner Capital account would be reduced of £2,288 (£ 2,500 – 212), Murray’s capital would be reduced to £
102 (314-212) and Wilkins’ capital deficiency would be increased to £ 474 (£ 263 + 211). Such a loss which is due to
capital deficiency, prior to Garner vs. Murray decision, was to be borne by the solvent partners in profit sharing ratio. But,
here, Murray had raised an objection and claimed that the loss is a capital loss and not a business loss. Therefore, such
loss due to capital deficiency of a partner to be borne in capital ratio and not in profit sharing ratio. Murray got the
decision in his favour. In Garner vs. Murray, a historic decision was given by Justice Joyce, upholding the contention of
Murray i.e. capital deficiency of insolvent partner is a capital loss and is to be shared by the solvent partners, in capital
ratio, just before dissolution.
Main Points of Garner vs. Murray Decision:
1. Loss due to insolvency is a capital loss.

2. Such loss, due to insolvency, is to be shared by solvent partners in their capital ratio just before dissolution.
3. All solvent partners should bring in their share or realization loss in cash.
4. If a partner’s capital account shows a debit balance, he need not share the capital loss of the insolvent partner.
Application of Garner vs. Murray Rule in India:
The rule of Garner vs. Murray is applicable in India only if:
a) There is no agreement to the contrary.’

b) The capitals of partners are not in profit sharing ratio.
c) There must be capital deficiency in a partner’s capital account.
If there is a provision in the partnership deed as to the ratio in which losses or gains including losses arising from capital
deficiency of a partner shall be borne, then the solvent partners will bear the insolvent partner’s deficiency in that ratio.
In the absence of any such agreement, the adjustments shall be made according to the decision in Garner vs. Murray
case. The amount left unsatisfied or unpaid by the insolvent partner has to be transferred to the capital accounts of the
other partners in the ratio of their capitals just before the dissolution. As regards the cash to be brought in by the solvent
partners, it is only a notional entry, actually no cash is brought. Is India specially, there does not seem to be any need for
the solvent partners bringing in cash equal to their share of the loss or realisation. But the main point decided in Garner
vs. Murray that the loss is to be borne by the solvent partners in the ratio of their capitals just before the commencement
of dissolution stands.
Piecemeal Distribution
In actual practice, the assets are not realized at once on a single day unless the business is sold to somebody. The
partners expect a good price for the assets and therefore, they gradually realize them depending on the market condition.
Thus, the whole process of realization takes some time, i.e., may be a few months, even a year, or even more. The
process followed to discharge the liabilities and claims of the partners as and when the assets are realized is called
piecemeal distribution of cash.
Gradual Realization and Distribution of Cash
In the process of realizing the assets and discharging liabilities, the assets are usually realized slowly, steadily and
gradually depending on the demand, the liabilities are discharged as and when the assets are realized. Therefore, this
process is also known as “gradual realization and distribution of cash”. It is also known as “interim distribution of cash”
because when the amount realized is not sufficient to discharge the liability fully, an interim payment is made to the
extent of cash available. For the balance, the liability holder should wait for another asset to be realized. Thus, the
liabilities are paid off as and when the assets are realized.
Methods of distributing cash in piecemeal
There are two methods for distribution of cash under Piecemeal distribution:
1. Proportionate Capital Method: If the capitals of the partners are in the ratio of their profit-sharing arrangement,
then each of them is paid out according to his capital ratio at each distribution. If the capitals of the partners are
not in the profit-sharing ratio, then the first cash available (after making payment of outside liabilities and loans
due to the partners) for distribution amongst the partners should be paid to those partners whose capitals are
more than their profit-sharing ratio so as to bring their capitals to their profit-sharing levels. After this, the cash
available is distributed amongst all partners according to their profit-sharing ratio. The unpaid balance of capital
accounts will represent loss on realisation and this loss will be exactly in their profit-sharing ratio.
2. Maximum Loss Method: An alternative method of piecemeal distribution amongst partner is to calculate the
maximum possible loss on every realisation after the outside liabilities and the partner’s loan has been paid. The
amount available for distribution amongst partners is compared with the total amount of capital payable to the
partners and the maximum loss is ascertained on the assumption that in future assets will not realise any
amount. The maximum possible loss so ascertained is deducted from the capital balances of the partners in
their profit and loss sharing ratio and the balance left in the capital account after deducting the maximum
possible loss will be the amount payable to the partner.
If a partner’s share of maximum possible loss is more than the amount standing to the credit of his capital
account, he should be treated as insolvent and his deficiency should be debited to the capital accounts of the
solvent partners in the proportion of their capitals which stood on the dissolution date as stated under the
Garner v/s. Murray Rule. The amount standing to the credit of the partners after debiting their share of maximum
loss and their share of insolvent partner’s deficiency will be equal to the cash available for the distribution
amongst the partners. This process of maximum possible loss is repeated on each realisation till all the assets
are disposed
Module 5
Accounting Standards – Importance – Accounting Standards Board – Applicability of Accounting Standards – Brief
learning of AS1, AS2, AS9, AS10 and AS19 (Theory Only)
Accounting Standards
Accounting standards refer to written policy documents that encompass preparation, presentation and disclosure of
accounting transactions in financial statements.
In India, accounting standards are issued by the Institute of Chartered Accountants of India (ICAI), a professional body of
accounting. These accounting standards provide a set of standard accounting policies, valuation norms and disclosure
requirements. This helps organisations in bringing uniformity in the preparation of financial statements, thereby
enhancing the reliability of statements for different users.
ICAI defines accounting standards as “written policy documents issued by expert accounting body or by government or
other regulatory body covering aspects of recognition, measurement, presentation and disclosure of accounting
transactions in the financial statements”.
Apart from improving the credibility of financial data, accounting standards facilitate the comparability of financial
statements both at intra and inter levels of an organisation. These comparisons are widely used by the users of
accounting information for assessing the performance of the organisation.
Accounting standards are consistent with the provisions of the law and are, thus, extremely useful to investors and other
external parties interested in assessing an organisation’s performance for the purpose of investment. The main aim of
accounting standards is to eliminate variations in accounting treatment to prepare financial statements.
Objectives of Accounting Standards
Following are some other important objectives of accounting standards.
Improves the Credibility and Reliability of Financial Statements: Accounting standards improves the reliability of
financial statements by providing a common framework of accounting.
Determines managerial accountability: It implies that the accounting standards determine the regulations and
corporate accountability, which helps to assess the managerial skills in maintaining and improving profitability,
liquidity and solvency.
Assists accountants and auditors: It refers to the instructions that the accounting professionals get through these
accounting standards, which help them to prepare and audit the financial statements appropriately. In case of financial
reporting issues, an accountant may refer to the published accounting standard to interpret on how to record the
transactions.
Enables ease of understanding: Accounting standards specify the processes and formats to be followed by
organisations in preparing and reporting their financial statements. users of financial statements depend on the
assumptions set forth by the accounting standards while interpreting the reported figures. Once users become
accustomed to these assumptions, they may use this knowledge to interpret the financial statements of different
organisations with ease.
Scope of Accounting Standards
In its Preface to the Statements of Accounting Standards, the ASB has outlined the scope of accounting standards.
These are as follows:
 Efforts will be made to issue Accounting Standards which are in conformity with the provisions of the applicable
laws, customs, usages and business environment in India. However, if a particular Accounting Standard is found
to be not in conformity with law, the provisions of the said law will prevail and the financial statements should be
prepared in conformity with such law.
 The Accounting Standards by their very nature cannot and do not override the local regulations which govern the
preparation and presentation of financial statements in the country. However, the ICAI will determine the extent
of disclosure to be made in financial statements and the auditor’s report thereon. Such disclosure may be by
way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the
nature of clarification and therefore need not be treated as adverse comments on the related financial
statements.
 The Accounting Standards are intended to apply only to items which are material. Any limitations with regard to
the applicability of a specific Accounting Standard will be made clear by the ICAI from time-to-time. The date on
which a particular standard will come into effect, as well as the class of enterprises to which it will apply, will
also be specified by the ICAI. However, no standard will have retroactive application, unless otherwise stated.
 The Institute will use its best endeavours to persuade the government, appropriate authorities, industrial and
business community to adopt the Accounting Standards in order to achieve uniformity in preparation and
presentation of financial statements.
 In formulation of Accounting Standards, the emphasis would be on laying down accounting principles and not
detailed rules for application and implementation thereof.
 The standards formulated by the ASB include paragraphs in bold italic type and plain type, which have equal
authority. Paragraphs in bold italic type indicate the main principles. An individual standard should be read in
the context of the objective stated in that standard and this preface.
 The ASB may consider any issue requiring interpretation on any Accounting Standard. Interpretations will be
issued under the authority of the council. The authority of interpretation is the same as that of Accounting
Standard to which it relates.
Benefits and Limitations
Accounting standards seek to describe the accounting principles, the valuation techniques and the methods of applying
the accounting principles in the preparation and presentation of financial statements so that they may give a true and fair
view. By setting the accounting standards the accountant has following benefits:
I. Standards reduce to a reasonable extent or eliminate altogether confusing variations in the accounting
treatments used to prepare financial statements.
II. There are certain areas where important information are not statutorily required to be disclosed. Standards
may call for disclosure beyond that required by law.
III. The application of accounting standards would, to a limited extent, facilitate comparison of financial
statements of companies situated in different parts of the world and also of different companies situated
in the same country. However, it should be noted in this respect that differences in the institutions,
traditions and legal systems from one country to another give rise to differences in accounting standards
adopted in different countries.
However, there are some limitations of setting of accounting standards:
I. Alternative solutions to certain accounting problems may each have arguments to recommend them.
Therefore, the choice between different alternative accounting treatments may become difficult.
II. There may be a trend towards rigidity and away from flexibility in applying the accounting standards.
III. Accounting standards cannot override the statute. The standards are required to be framed within the
ambit of prevailing statutes.
Accounting Standards in India
Realising that there was a need of accounting standards in India and keeping in view the international developments in
the field of accounting, the Council of the Institute of Chartered Accountings of India constituted the Accounting
Standards Board (ASB) in April, 1977. The Accounting Standards Board is performing the function of formulating the
accounting standards. While doing so, it takes into account the applicable laws, customs, usages and business
environment. It gives adequate representation to all the interested parties; the Board consists of representatives of
industries, Central Board of Direct Taxes and the Comptroller and Auditor General of India. To start with, ASB finalised the
procedure to be followed in the formulation of standards. The "Preface to the Standards of Accounting Standards” was
issued in January, 1979. The preface outlines scope and functions of ASB, the scope of accounting standards, the
procedure to be followed by ASB in formulating the standards and the phased manner in which the compliance with the
standards will be encouraged by the Institute.
In 1977, the ICAI formed the Accounting Standards Board (ASB) which is the apex body responsible for developing and
updating accounting standards in India.
These accounting standards are developed by considering various factors such as the applicable laws, customs and the
contemporary business environment of India. The standards formulated by the ASB are issued by the ICAI.
Following are the main functions of the ASB:
 To conceive of and suggest areas in which Accounting Standards need to be developed.

 To formulate Accounting Standards with a view to assisting the Council of the ICAI in evolving and establishing
Accounting Standards in India.
 To examine how far the relevant International Accounting Standard/International Financial Reporting Standard
can be adapted while formulating the Accounting Standard and to adapt the same.
 To review, at regular intervals, the Accounting Standards from the point of view of acceptance or changed
conditions, and, if necessary, revise the same.
 To provide, from time- to-time, interpretations and guidance on Accounting Standards.
 To carry out such other functions relating to Accounting Standards.
Following are the steps in the standard formulation process by ASB:
 Identification of broad areas for developing accounting standards

 Constitution of a study group to prepare an initial draft of the proposed accounting standards
 Consideration of the initial draft and revision (if any) based on careful discussions
 Circulation of the draft to different bodies such as council members of ICAI, Department of Company Affairs
(DCA), Securities and Exchange Board of India (SEBI), Comptroller and Auditor General of India (CAG), Central
Board of Direct Taxes (CBDT), and Standing Conference of Public Enterprises (SCOPE)
 Ascertainment of views of specified bodies on the draft
 Finalisation of the draft of the proposed standard inviting public comments
 Consideration of comments received on the draft and finalisation of the draft of accounting standards for
submission to the ICAI for approval
 Modification of the draft in case of any suggestions given (in consultation by the ASB) by the ICAI
 Issuance of the accounting standard by the ICAI
Applicability of Accounting Standards
For the purpose of compliance of the accounting Standards, the ICAI had earlier issued an announcement on ‘Criteria for
Classification of Entities and Applicability of Accounting Standards’. As per the announcement, entities were classified
into three levels. Level II entities and Level III entities as per the said Announcement were considered to be Small and
Medium Entities (SMEs).
However, when the accounting standards were notified by the Central Government in consultation with the National
Advisory Committee on Accounting Standards, the Central Government also issued the ‘Criteria for Classification of
Entities and Applicability of Accounting Standards’ for the companies. It is pertinent to note that the accounting
standards notified by the government were mandatory for the companies since it was notified in pursuant to sections
211(3C) of the Companies Act, 1956.
According to the ‘Criteria for Classification of Entities and Applicability of Accounting Standards’ as issued by the
Government, there are two levels, namely, Small and Medium- sized Companies (SMCs) as defined in the Companies
(Accounting Standards) Rules, 2006 and companies other than SMCs. Non-SMCs are required to comply with all the
Accounting Standards in their entirety, while certain exemptions/ relaxations have been given to SMCs.
Consequent to certain differences in the criteria for classification of the levels of entities as issued by the ICAI and as
notified by the Central Government for companies, the Accounting Standard Board of the ICAI decided to revise its
‘‘Criteria for Classification of Entities and Applicability of Accounting Standards’ and make the same applicable only to
non-corporate entities. Though the classification criteria and applicability of accounting standards has been largely
aligned with the criteria prescribed for corporate entities, it was decided to continue with the three levels of entities for
non-corporate entities vis-à-vis two levels prescribed for corporate entities as per the government notification.
‘Criteria for Classification of Entities and Applicability of Accounting Standards’ for corporate entities and non-corporate
entities have been explained in the coming paragraphs.
No relaxation was given to Level II and III enterprises in respect to recognition and measurement principles. Relaxations
were provided with regard to disclosure requirements .
Criteria for classification of non-corporate entities as decided by the Institute of Chartered Accountants of
India
Level I Entities
Non-corporate entities which fall in any one or more of the following categories, at the end of the relevant accounting
period, are classified as Level I entities:
I. Entities whose equity or debt securities are listed or are in the process of listing on any stock exchange, whether
in India or outside India.
II. Banks (including co-operative banks), financial institutions or entities carrying on insurance business.
III. All commercial, industrial and business reporting entities, whose turnover (excluding other income) exceeds
rupees fifty crore in the immediately preceding accounting year.
IV. All commercial, industrial and business reporting entities having borrowings (including public deposits) in
excess of rupees ten crore at any time during the immediately preceding accounting year.
V. Holding and subsidiary entities of any one of the above.
Level II Entities (SMEs)
Non-corporate entities which are not Level I entities but fall in any one or more of the following categories are classified
as Level II entities:
I. All commercial, industrial and business reporting entities, whose turnover (excluding other income) exceeds
rupees one crore but does not exceed rupees fifty crore in the immediately preceding accounting year.
II. All commercial, industrial and business reporting entities having borrowings (including public deposits) in
excess of rupees one crore but not in excess of rupees ten crore at any time during the immediately preceding
accounting year.
III. Holding and subsidiary entities of any one of the above.
Level III Entities (SMEs)
Non-corporate entities which are not covered under Level I and Level II are considered as Level III entities.
Additional requirements
1. An SME which does not disclose certain information pursuant to the exemptions or relaxations given to it should
disclose (by way of a note to its financial statements) the fact that it is an SME and has complied with the
Accounting Standards insofar as they are applicable to entities falling in Level II or Level III, as the case may be.
2. Where an entity, being covered in Level II or Level III, had qualified for any exemption or relaxation previously but
no longer qualifies for the relevant exemption or relaxation in the current accounting period, the relevant
standards or requirements become applicable from the current period and the figures for the corresponding
period of the previous accounting period need not be revised merely by reason of its having ceased to be covered
in Level II or Level III, as the case may be. The fact that the entity was covered in Level II or Level III, as the case
may be, in the previous period and it had availed of the exemptions or relaxations available to that Level of
entities should be disclosed in the notes to the financial statements.
3. Where an entity has been covered in Level I and subsequently, ceases to be so covered, the entity will not qualify
for exemption/relaxation available to Level II entities, until the entity ceases to be covered in Level I for two
consecutive years. Similar is the case in respect of an entity, which has been covered in Level I or Level II and
subsequently, gets covered under Level III.
4. If an entity covered in Level II or Level III opts not to avail of the exemptions or relaxations available to that Level
of entities in respect of any but not all of the Accounting Standards, it should disclose the Standard(s) in respect
of which it has availed the exemption or relaxation.
5. If an entity covered in Level II or Level III desires to disclose the information not required to be disclosed
pursuant to the exemptions or relaxations available to that Level of entities, it should disclose that information in
compliance with the relevant Accounting Standard.
6. An entity covered in Level II or Level III may opt for availing certain exemptions or relaxations from compliance
with the requirements prescribed in an Accounting Standard: Provided that such a partial exemption or
relaxation and disclosure should not be permitted to mislead any person or public.
7. In respect of Accounting Standard (AS) 15, Employee Benefits, exemptions/ relaxations are available to Level II
and Level III entities, under two sub-classifications, viz.,
a. entities whose average number of persons employed during the year is 50 or more, and
b. entities whose average number of persons employed during the year is less than 50. The requirements
stated in paragraphs (1) to (6) above, mutatis mutandis, apply to these sub-classifications.
Criteria for classification of Companies under the Companies (Accounting Standards) Rules, 2006:
Small and Medium-Sized Company (SMC) as defined in Clause 2(f) of the Companies (Accounting Standards) Rules,
2006:
“Small and Medium Sized Company” (SMC) means, a company-
I. whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether
in India or outside India;
II. which is not a bank, financial institution or an insurance company;
III. whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding
accounting year;
IV. which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the
immediately preceding accounting year; and
V. which is not a holding or subsidiary company of a company which is not a small and medium-sized company.
Explanation: For the purposes of clause (f), a company shall qualify as a Small and Medium Sized Company, if the
conditions mentioned therein are satisfied as at the end of the relevant accounting period.
Non-SMCs
Companies not falling within the definition of SMC are considered as non-SMCs. Instructions
General Instructions
SMCs shall follow the following instructions while complying with Accounting Standards under these Rules:
1. The SMC which does not disclose certain information pursuant to the exemptions or relaxations given to it shall
disclose (by way of a note to its financial statements) the fact that it is an SMC and has complied with the
Accounting Standards insofar as they are applicable to an SMC on the following lines: “The Company is a Small
and Medium Sized Company (SMC) as defined in the General Instructions in respect of Accounting Standards
notified under the Companies Act Accordingly, the Company has complied with the Accounting Standards as
applicable to a Small and Medium Sized Company.”
2. Where a company, being an SMC, has qualified for any exemption or relaxation previously but no longer qualifies
for the relevant exemption or relaxation in the current accounting period, the relevant standards or requirements
become applicable from the current period and the figures for the corresponding period of the previous
accounting period need not be revised merely by reason of its having ceased to be an SMC. The fact that the
company was an SMC in the previous period and it had availed of the exemptions or relaxations available to
SMCs shall be disclosed in the notes to the financial statements.
3. If an SMC opts not to avail of the exemptions or relaxations available to an SMC in respect of any but not all of the
Accounting Standards, it shall disclose the standard(s) in respect of which it has availed the exemption or
relaxation.
4. If an SMC desires to disclose the information not required to be disclosed pursuant to the exemptions or
relaxations available to the SMCs, it shall disclose that information in compliance with the relevant accounting
standard.
5. The SMC may opt for availing certain exemptions or relaxations from compliance with the requirements
prescribed in an Accounting Standard:
Provided that such a partial exemption or relaxation and disclosure shall not be permitted to mislead any person or
public.
Other Instructions
Rule 5 of the Companies (Accounting Standards) Rules, 2006, provides as below:
“5. An existing company, which was previously not a Small and Medium Sized Company (SMC) and subsequently
becomes an SMC, shall not be qualified for exemption or relaxation in respect of Accounting Standards available to an
SMC until the company remains an SMC for two consecutive accounting periods.”
AS 1 and AS 2
AS 1 and AS 2 deal with the disclosure of accounting policies and valuation of inventories, respectively. Let us discuss
them in detail.
AS 1: Disclosure of Accounting Policies
As per AS 1, an organisation is required to disclose all accounting policies that it has followed in the preparation and
presentation of financial statements. Adherence to AS 1 ensures that the financial statements of an organisation can be
compared with the financial statements of another organisation (inter-organisation comparisons).
Additionally, an organisation may also carry out intra-organisation comparisons from one time period to another. Also,
consistent and full disclosure of accounting policies ensures that financial statements represent a true and fair picture
of the cash flow and financial performance of an organisation.
The major areas with respect to which organisations must disclose their accounting policies include:
 Method of depreciation and amortisation

 Recognition of profit on long-term contracts
 Valuation of fixed assets
 Treatment of contingent liabilities
 Treatment of expenditure during construction
 Treatment of foreign currency conversion/translation
 Treatment of intangible assets
 Treatment of retirement benefits
 Valuation of inventories
 Valuation of investments
As per AS 1, organisations must disclose all significant accounting policies that they have used while preparing and
presenting financial statements by the way of a note. Although all material accounting policies must be disclosed by
organisations, there are certain basic assumptions that are used while preparing the financial statements for which
separate disclosure is not required.
These include assumptions of going concerned, consistency and accrual. However, if an organisation does not comply
with any of these assumptions, it needs to disclose the same.
AS 2: Valuation of Inventories (Revised)
In accordance with AS 2, organisations need to formulate a method for computing the cost of inventories and
determining the value of closing stock that must be shown in the balance sheet till the inventories are sold and
recognised as revenue. Certain cases where AS 2 is not applicable are:
 Work-in-progress inventory under a construction service contract (AS 7)

 Work-in-progress inventory in case of usual course of business for service providers such as ongoing
consultancy services, ongoing medical service, etc.
 Financial instruments that are held as stock-in-trade
 Producer’s inventories such as livestock, agricultural and forest products, mineral oils, ores and gases if they are
valued at net realisable value
For applicability of AS 2, it is necessary to note the following: Settings
 Inventories include finished goods

 Inventories include raw material and work-in-progress materials
 Inventories include stores, spares, raw material, consumables, etc.
 Inventories include goods purchased and goods offered for sale
 Inventories do not include machinery and plant
 Inventories do not include spare parts, servicing equipment and standby equipment
 Inventories include machinery spares which are not used in any particular item of fixed asset and can be used
generally for multiple fixed assets
AS 2 also states that inventories should be valued at the lower of cost and the net realisable value. For valuing the
inventory, the cost and the net realisable value of the inventory are compared and the lower value is selected.
AS 4 AND AS 5
AS 4 AND AS 5 deal with ‘contingencies and events occurring after the balance sheet date’ and ‘net profit or loss for the
period, prior period items and changes in accounting policies, respectively.
AS 4 Contingencies and Events Occurring after the Balance Sheet Date

AS 4 helps a business entity in the treatment of contingencies and events occurring in the balance sheet after the
balance sheet date. A contingency refers to a future condition or event which is possible, but it cannot be determined
with certainty. The contingency may result in profit or loss.
AS 4 is not applicable to the following:
 Life insurance and general insurance policy obligations

 Retirement benefit plan obligations
 Long-term lease contracts obligations
The contingencies related to conditions that exist at the balance sheet date are of two types:
 Contingent loss: Contingent losses are those which are either probable or reasonably possible or remote in
nature. For contingent losses, the organisation needs to make provisions and is charged to the Profit and Loss
Account.
 Contingent gain: Contingent gains are not recognised in financial statements since their recognition may result
in the recognition of revenue which may never be realised. However, when the realisation of a gain is virtually
certain, then such gain is not a contingency and accounting for the gain is appropriate.
Certain events usually take place in between the time when an accountant has prepared the financial statements of an
organisation and the time when the financial statements are approved by the competent authorities. These events are
called events occurring after the Balance Sheet date.
The events are usually of two types:
 Adjusting events: These events are related to circumstances and existed on the date of balance sheet. In this
case, the losses must be accounted for in the financial statements and the assets and liabilities must be
adjusted.
 Non-adjusting events: These events are related to circumstances and did not exist on the date of balance sheet.
In this case, the non-adjusting events must be disclosed by providing notes with financial statements, but no
adjustment needs to be made.
For AS 4, the disclosure requirements are:
 Disclose all contingencies and events which can materially change the financial position of the organisation
 Disclose in a note the nature and an estimate of financial effect of remote contingent losses
AS 5: Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
The objective of this Standard is to prescribe the classification and disclosure of certain items in the statement of profit
and loss so that all businesses prepare and present such a statement uniformly.
AS 5 specifically deals with four items, which are:
1. Net profit or loss for the period: The net profit or loss for the period comprises the following components, each
of which should be disclosed on the face of the statement of profit and loss:
a. Profit or loss from ordinary activities: These activities take place in the normal course of business; for
example, profit/ loss on sale of goods or services.
b. Profit or loss from extraordinary activities: These activities do not arise under the normal course of
business; therefore, these activities are not expected to recur frequently or regularly. For example, profit
on sale of non-current assets or loss due to theft.
2. Prior period items: These are income or expenses that arise in the current period as a result of errors or
omissions in the preparation of the financial statements of one or more prior periods.
3. Changes in accounting estimates: A business entity needs to make certain estimates while preparing financial
statements for any period; for example, estimate on the useful life of machinery.
These estimates need to be revised for various reasons such as change in circumstances, advent of new
technology or information and subsequent developments. The effect of such change in estimates is to be taken
into account while preparing financial statements.
4. Changes in accounting policies: Accounting policies comprise specific accounting principles and the methods
of applying those principles adopted by a business entity in the preparation and presentation of financial
statements.
AS 10
AS 10 (Revised) guides an organisation with respect to the accounting treatment for Property, Plant and Equipment
(PPE). This AS helps users of financial statements find out how their investments reflect in plant, property and
equipment of an organisation and what changes are made in their investments. There are four primary issues in
accounting for PPE as follows:
 Recognition of PPE assets

 Determination of carrying costs of PPE
 Computation of depreciation charge
 Recognition of impairment losses
AS 10 is applicable to tangible assets. The tangible assets are those that fulfil the following conditions:
 Held for use in production or for supply of goods and services

 Held for administrative purposes
 Not held for sale
 Used for at least 12 months
For example, land, building, plant and machinery, furniture, office equipment are types of PPE. AS 10 is not applicable to
the following:
 Biological assets such as forests, plantations and similar regenerative natural resources, and livestock except
bearer plants
 Wasting assets such as mineral rights, expenditure on the exploration for and extraction of minerals, oil, natural
gas and similar non-regenerative resources
 Expenditure on real estate development

Financial Accounting II (B Com 2nd Sem)

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Accounting II (B Com 2nd Sem)

Uploaded by

Copyright:

Available Formats

Prepared By Shamnad Shahul Financial Accounting II (B.

Com 2nd Sem), MG University 1

Meaning of Hire Purchase System

Features of Hire Purchase System/ Agreement

Hire Purchase Agreement

Contents of Hire Purchase Agreement

Benefits of Hire Purchase Agreements

Drawbacks of Hire Purchase Agreements

Hire Purchase and Sale

It is a form of contract that is formally governed by law. It can be absolute or conditional.

Types of Contracts of Sale

Elements of Contract of Sale

Key Differences Between Sale and Hire Purchase

Hire Purchase and Instalment

S. No Installment Sales Hire Purchase

Default and Repossession in Hire Purchase

This act of recovery of possession is termed as ‘repossession’.

Rights of the Hire Vendor

A. Rights of hire vendor to terminate the hire purchase agreement

B. Rights of the hire vendor on termination:

I. to enter the premises of the hirer and seize the goods,

Restrictions on the Owner

A. Rights of the hirer in case of seizure of goods by the owner:

B. Restrictions on owner’s right to repossess:

Accounting Treatment of Default and Repossession

In the books of the buyer

In the books of the seller

1. All necessary entries are to be shown up to the date of default as usual.

In the books of buyer

In the books of the seller

Meaning of Branch Accounts

Objectives of Branch Accounts

The Branch Accounts are maintained to achieve the following objectives.

1. To know the profit or loss of each branch separately.

The following are the salient features of such a branch:

Accounting of Dependent Branches

Characteristics of an Independent Branch:

Accounting of Independent Branches

Methods to Incorporate Branch Transactions

consolidated balance sheet

Objectives of Departmental Accounting

Main objectives of departmental accounting are as given below: –

 To evaluate each branch's performance, allowing for easier comparison of findings.

METHODS OF DEPARTMENTAL ACCOUNTING

1. Accounts of all departments are kept in one book only

2. Separate set of books are kept for each department

Advantages of Departmental accounting

Distinction between Branch and Department Accounting

Branches are the outcomes of the tough

GEOGRAPGICAL Departments are not geographically

There is no classification of The branches may be dependent or

ALLOCATION OF Allocation of departmental common There is no need of allocation of branch

In departmental accounts, no To find out the net result of organization

Departmental trading with their head Branch trading is conducted in different

The profitability position of department

accounts system Wholesale price

The accounts maintained are; The accounts maintained are: Branch

FUNCTIONAL Functional division is possible in case of

The chief executive who is to keep a

Departmental accounting presents the

Departmental accounting is practically Branch accounts are a condensation of

Dissolution of Partnership Firm

Situations (reasons) of Dissolution of Partnership

 Admission of a new partner