Category: Accounting

Accounting Problems 

The accounting problems in the event of retirement of a partner can be put as follows:

(i) Adjustment for Goodwill,

(ii) Revaluation of assets  and liabilities.

(iii) Adjustment regarding Reserves and other undistributed profits.

(iv) Adjustments regarding profit sharing ratios.

(v) Payment to the retiring partner.

1. Goodwill. The retiring partner will be entitled to his share of goodwill in the (inn. The problem of goodwill can be dealt in the following two different ways:

(a) Where goodwill account is already appearing in the books:

In such a case if goodwill is properly valued, no further adjustment will be needed. The amount has already been credited to all the partners including the retiring partner.

(b) Where goodwill account is not appearing in lire book. 

Steps for preparing statement of affairs. The following steps may be taken for preparing the Statement of Affairs.

(i) In most cases in single entry system, a cash book is maintained. In case, this has been done, the cash and the bank balances can be taken from the cash book. In the absence of a proper cash book, cash balance may have to be found out by preparing a receipts and payments account on the basis of information collected from the proprietor of the business and the statement of accounts which might have been received or sent by the proprietor from/to his debtors and creditors. Information regarding other business expenses can be collected from the salaries register of his employees, petty cash book if any maintained by him, etc., and the actual cash balance available with the business. The balance at the bank can be verified from the bank pass book or Statement of Account from the Bank.

(ii) A list of sundry debtors and creditors should be prepared. This may not be difficult because in mostcases, a record of personal accounts is maintained under the single entry system.

(iii) The value of the fixed assets like building, plant, furniture. etc., should be ascertained from vouchers or other documents available with the business. A reasonable charge for depreciation should also be made and the assets should be shown in the Statement of Affairs after charging depreciation.

(iv) A physical verification of the stock should be taken and the value of the stock in hand should be ascertaIned on the basis of the different invoices received from suppliers from time to time in respect of the goods purchased.

(v) The amount of outstanding expenses and the accrued income should also be determined. Last year’s figures about these items may be of considerable help in this respect.

(iv) The excess of assets over liabilities should be found out and this will denote the net worth or the capital of the business on the date on which the Statement of Affairs has been prepared.

Pricing of Goods Sent on Consigmnent 

Goods can be consigned to the consigneç either (1) at cost or (ii) at invoice price.

At cost. In case of this method the goods are charged to the consignment at cost price to the consignor. The proforma invoice is also prepared at this price. For example if the goods costing Rs 10,000 are purchased by A and 80 per cent of such goods are sent by him on consignment to Bombay, proforma invoice will show the value of goods as Rs 8,000 and the Consignment to Bombay account will also be charged with this price. The consignee may be given the direction regarding the price at which he should sell the goods (see illustration 1.2.).

At invoice price, In case of this method the goods are charged to the,consignment at a price higher than cost The proforma invoice also shows the value of goods at such higher price. The excess of invoice price over the actual cost, represents the profit which the consignor intends to make on the goods consigned. For example, if in the above case the goods are consigned at a profit of 25 per cent on cost (or 20 per cent on invoice price), the consignment account will be charged with Rs 10,000 (i.e., Ps 8,000 + Rs 2,000) for the value of goods sent on consignment However, in order to find out the profit, at the end of the accounting period, the consignment account will be given credit with the excess price so charged. In this case, the credit to the consignment account will be of Rs 2,000. Thus, in fact, consignment account has been charged only with the cost (i.e., Ps 10,000— Ps 2,000) of the goods sent on consignment as has been done in the first case. Suitable adjustment for profit clement included in the stock with the consignee has also to be made

The system suffers from several disadvantages:

(i) Arithmetical accuracy cannot be checked. In case of Double Entry System

Book-keeping Trial Balance is prepared to check the arithmetical accuracy of the books of accounts. This is possible because every transaction is recorded at two places. In case of Single Entry System, this is not done. Hence, Trial Balance cannot be prepared and the

-arithmetical accuracy of the books of accounts cannot be checked. This increases the possibility of more frauds and misappropriations as compared to the Double Entry System of Book-keeping.

(ii) True profits cannot be known. In the absence of complete information for sales, purchases and other expenses, it is notpossible to draw the Profit and Loss Account. Hence, the true profit or loss made or suffered by the business cannot be known.

(iii) Financial position of the business cannot be judged. In the absence of true figure of profit and correct information about the assets and liabilities of the busiiless, the Balance Sheet cannot be drawn up to give a correct picture of the financial position of the business on a particular date.

(iv) Makes planning and decision-making difficult. The system does not provide accurate figures about the performance of the business and its financial position. For example, separate figure of gross profit, net profit and sales are not available. Thus, the ratio of gross profit to sales or net profit to sales cannot be found out. Similarly in the absence of any information about the cost of goods sold, the proportion of differeut elements of cost of sales cannot be found out. In the absence of such information, it becomes difficult for the proprietor of the business to know the reasons of his improving or deteriorating profitability and financial position. Thus, he is not in a position to compare, plan and take sound decision for the prosperity of the business. Moreover, it may be difficult for him to find the real value of his business in the event of his deciding to sell the business.

When assets and liabilities have to appear in the books at the revised values.

In such a case a Profit and Loss Adjustment Account or Revaluation Account is opened in the books. The following entries are to be passed.

(i) For increase in the value of an asset or decrease in the value of a liability: 

Asset/Liability A/c  Dr.

To P. & L. AdjustnientA/c

(ii) For decrease in the value of an asset or increase in the value of a liability. 

P. & L. Adjustment A/c Dr.

To Asset/Liability A/c

(iii) The profit on revaluation will be transferred to old partners’ capital accounts in the old profit sharing ratio. 

P. & L. Adjustment A/c  Dr.

To Old Partners Capital A/cs. (Individually)

In the event of loss, the entry will be reversed.

When assets and liabilities have to appear at old values in the books 

A Memorandum Profit and Loss Adjustment Account will be opened in the books. The increase in the value of assets or decrease in the value of liabilities will be credited to this account. The decrease in the value of assets or increase in the value of liabilities will be debited to this account. However only two entries will be passed:

(i) For credited in the profit on revaluation to old partners’ accounts: 

Memorandum P. & L. Adjustment A/c Dr.

To Old Partners’ Capital Accounts (in old ratio)

In case of loss the entry will be reversed.

(ii) For writing off the profit on revaluation to all partners’ capital accounts (including the new partner): 

Partners’ Capital Accounts (in the new ratio) Dr.

To Memorandum P& L. Adjustments A/c

In case of loss the entry will be reversed.

AS 10 : Accountiug for Fixed Assets and Goodwill: It has already been stated while discussing treatment of goodwill in the preceding chapter, that goodwill account should be raised in the books only when it is paid for and not self-generated by the firm. Hence, the following treatment for goodwill should be preferred in case of retirement, death, change in profit sharing ratio or amalgamation of firms.

(i) Goodwill on Retirement: Death of a Partner: In the case of retirement of a partner, the continuing partners will gain in tenns of profit sharing ratio. Hence, the continuing partners have to share the burden ofthe share of goodwill of the retiring partner in their gaining ratio. In this case the retiring partner’s capital account should be credited with his share of goodwill and the continuing partners’ capital accounts should be debited with the amount in their gaining ratio. Alternatively, the total value ofhe goodwill may be raised by debiting the goodwill account and crediting all the partners’ capital account in the old profits sharing ratio. The goodwill may then be written off debiting the capital accounts of the remaining partners in the new ratio and crediting the goodwill account.

VALUATION OF UNSOLD STOCK

Where all the goods have not been sold, it becomes necessary to value the unsold goods.

Such goods are similar to closing stock in case of a Trading Account This stock should be valued at a price which will include:

(i) proportionate cost price and

(ii) proportionate direct expenses, i.e., proportionate expenses incurred both by the consignor and the consignee till the goods reach the godown of the consignee.

It should be noted that direct expenses will include all expenses incurred by the consignor while only such expenses of the consignee which are incurred by him till goods reach his godown. Examples of such expenses are: carriage charges, freight, octroi, import duty etc., paid by the consignee. Expenses like godown rent, selling expenses, insurance of the godown etc. paid by the consignee, should be excluded.

Moreover, the fundamental principle of accounting regarding valuation of stock should also be taken into consideration i.e., stock should be valued at cost or market price whichever is less. Cost price stands for cost + proportionate direct expenses.

Thtorlal Note. In case in an examination question, the details regarding expenses incurred by the consignee have not been given (e.g. the question states “expenses incurred by the consignee are Rs 2,000” or “the consignee paid Rs .2,000 as cartage, godown rent, insurance etc.”), the student are advised to consider only proportionate expenses incurred by the Consignor, while valuing the unsold stock).

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.