CONVERSION METHOD 

The Net Worth Method explained in the preceding pages does not provide a clear picture of the operational results of a business. It does not give information about sales, purchases, gross profit, operating expenses etc. of the business. As a result, a meaningful analysis of the financial statements cannot be done nor effective steps can be taken to improve the financial position of the business. It will, therefore, be better to collect all, such information ffom the books of accounts, and other sources which are necessary for preparing Trial Balance of the business. This is done by preparing a Total Debtors Account, aTotal Creditors Account, a Bills Receivable Account and a Bills Payable Account and Receipts and Payments Account etc., on the basis of double entry. Accounts relating to different expenses, incomes, fixed assets and fixed liabilities and outstandings are also prepared with the help of Receipts & Payments Accounts and additional information available. Thus, the closing balances of different accounts are found out and a Trial Balance prepared. Final accounts can then be prepared in the usual way. Such a method of collection information as per the requirements of the double entry system of book keeping, is termed as Conversion Method.

Classification of Expenditure:

Expenditure can be classified into three categories:

1. Capital Expenditure. It means an expenditure which has been incurred for the purpose of obtaining a long-term advantage for the business. Such expenditure is either incurred for acquisition of an asset (tangible or intangible) which can later be sold and converted into cash or which result in increasing the earning capacity of the business or which affords some other advantage to the business. In ether words, such an expenditure does not grow out or pertain to the running of the business proper.

Following are some of the examples of Capital expenditure:

(i) Expenditure incurred in increasing the quality of fixed assets, e.g., purchase Of additional furniture, plant, building for permanent use in the business.

(ii) Expenditure incurred in increasing the quantity of a fixed asset, e.g., expenditure incurred for increasing the useful tile or capacity or efficiency of a fixed asset. 

According to AS 10 Goodwill should be recorded in the books only when some consideration in money or money’s worth has been paid for it. In other words no goodwill account should be raised in case of internally generated goodwill.

When the new partner brings a portion of the required amount of goodwill.  In such a case, the amount brought in by the new partner should be shared by the old partners in the sacrificing ratio nd the portion of amount of goodwill not brought in by the new partner thould be adjusted through the capital accounts of partners by debiting new partner’s capital account with the amount and crediting the old partners’ capital accounts in their sacrificing ratio.

Where the new partner privately pays the amount of goodwill to old partners: In this case, no entry should be passed in the books of the firm. The amount to be paid to each partner should be calculated as per the profit-sacrificing ratio.

Important Points Regarding Manufacturing Account

1. Stocks. In case of a manufacturer, there can be stocks of three types:

 Stock of raw materials. It includes stock of raw materials or finished components which might have been purchased by the manufactrn-er for using them in the products manufactured by him but still lying unsold.

Stock of work-in-process. This is also tenned as stock of work-in-progress. It includes goods in semi-finished form.

Stock of finished goods. It includes stock of those goods which have been completely processed and are lying unsold at the end of a period with the manufacturer. It also includes stock of those finished goods which might have been purchased by a manufacturer-cum-trader from outside parties, but still lying unsold with him at the end of the accounting period.

2. Raw materials consumed. It is customary to show in the Manufacturing Account, the value of raw materials consumed for manufacturng goods during a particular period.

3.Carriage inwards, etc. The expenses incurred for bringing the raw materials to the factory or the octroi or customs duty paid by the manufacturer on the raw materials purchased or imported by him will also be charged to Manufacturing Account.

4.Cost of production. The Manufacturing Account gives the cost of manufacturing the goods during a particular period. This is comuted by deducting from the total of the dedit side of the Manufacturing Account, the total of the various items appearing on the credit side of the Manufacturing Account as shown in the proforma of the Manufacturing Account given earlier in the chapter.

5. Sale of scrap. In manufacturing operations, certain scrap is unavoidable, it may or may not have any sales value. In order to calculate the true cost of manufacturing the goods, it is necessary that the money realised on account of sale of scrap (or realisable value of the scrap in case it has not been sold) should be considered. The amount of scrap is, therefore, credited to the Manufacturing Account.

PARTNERSHIP DEED

Partnership is created by an agreement. It is not necessary that the agreement should be in writing. It may be oral but to avoid future disputes it is always better to have it in writing. The document in writing containing the important terms of partnership as agreed by the partners between themselves is called the Deed of Partnership. It should be properly drafted and stamped according to the provisidns of The Stamp Act.

Contents of the deed.

The deed usually contains the Following information:

1. Name of the firm.

2. Names of partners.

3. Nature and place of the business of the finn.

4. Date of commencement of partnership.

5. Duration of the firm.

6. Capital employed or to be employed by different partners.

7. Rules regarding operation of bank accounts.

8. Ratios in which profits and losses are to be shared.

9. How the business is to be managed?

10. Rules to be followed in case of admission, retirement, expulsion etc., of a partner.

11. Salaries etc., if payable to partners.

CLASSIFICATION OF INCOME

(i) Capital Income. The term ‘Capital Income’ means an income which does not grow out of or pertain to the running of the business proper. It is synonymous to the turn ‘Capital Gain’. For example, if a building costing Rs 10,000 purchased by a business for its use is sold for Rs 15,000, Ps 5,000 will be taken as a capital profit.

However, it should be noted that only the profit realised over and above the cost of the fixed-asset shouki be taken as a capital frofit. The profit realised over and above book value of the asset till it does not exceed the original cost of the asset should be taken as a revenue profit though it does not strictly arise out of and in the course of regular business transactions. This is because, the depreciation against the fixed asset has already been charged to the Profit & Loss Account of the earlier years and any profit which is now made on the sale of a fixed asset (not exceeding the original cost of the fixed asset) is simply recovery of excess provision for depreciation made in the earlier years. This is also provided by the Income Tax Rules. For example, if a plant originally purchased for Rs 10,000 standing in the books at Rs 6,000 (on account of charging depreciation) is sold for P.s 12,000, there is a profit of Rs 6,000 on the sale of this plant Out of this profit, Rs 2,000 (i.e., the amount over and above cost of the asset) should be taken as a capital profit while the balance of Ps 4,000 should he taken as a revenue profit. Capital profit is transferred to the Capital Reserve and is shown in the Balance Sheet on the liabilities side while revenue profit is credited 10 the Profit & Loss Account.

Revenue Income. Revenue Income means an income which arises out of and in the course of the regular business transactions of a concern. For example, in the course of rnnning business, the profit is made on sale, of goods, income is received from letting out the business property, dividends are received on business investments etc. All such incomes are revenue incomes. It should be noted that the terms “Revenue profit’ and Revenue Income’ synonymous.