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Advanced Bank Management

In the courseware on Advanced Bank Management, under Module D (Credit Management), the types of
borrowers are mentioned in Unit 26. Candidates need to have a broader understanding of the types of
borrowers who may be availing credit facilities from banks.While the details regarding companies are covered
in the courseware on Accounting & Finance for Bankers (JAIIB), the salient features of Partnership accounts
and Joint Ventures are given below. Salient features of Consignment Accounts, Leasing and Single Entry
System are also mentioned.

PARTNERSHIP ACCOUNTS

INTRODUCTIONTOPARTNERSHIP

Section4oftheIndianPartnershipAct, 1932definespartnership as Therelation between personswho


haveagreedtosharetheprofitsofabusinesscarriedonbyalloranyoneofthem actingforall.
Accordingtotheabovedefinition,themainfeaturesofpartnershipareasunder:
(i) Itistherelationshipbetweenpersons,whichmeansthatthereshouldbeatleasttwopersonsto
formapartnership.
(ii) Apartnershipistheresultof anagreement,whichmaybewritten,ororal.
(iii) Theagreement is tosharetheprofitsofthebusiness.This meansthatprofitshavetobeshared by
allthoughlossmaybebornebyonlyonepartner,afewpartnersorallthepartners.
(iv) Thebusiness mustbecarriedbyoneormorethanoneorall,onbehalfofall. Thismeansthatone
partnercanacton behalfoftheotherpartners.Thisisknownastheprincipleofagency.

Whenallthesefourcharacteristicsarefulfilled,therelationshipbetweenthepersonsisknownasthePartner
ship.Personswhohaveenteredintopartnershipwithoneanotherareindividuallycalledpartnersandcoll
ectively afirm.Thenameunderwhichthebusiness iscarriedonis calledthefirm
nameanditconstitutesaseparateentityforitsactivities/operationsandsubsequentaccountingtreatment
thereof.
AccordingtotheIndianPartnershipAct,thereisnomaximum limitofpartnersinthepartnership,but
accordingtothe CompaniesAct2013;themaximumnumberofpartnersistenincaseofbanking
businessand hundredin caseofotherbusinessoperations.TheCompanies(Amendment)Bill2003
permitstheformationofpartnershipconsistingofprofessionalsuptofifty partners. Anassociationof
personsofmorethanthesaidlimitisanillegalassociation.
Thedocument,whichcontainsthepartnershipagreement,isknownasPartnershipDeed.Legally,it
isnotcompulsoryforanypartnershipfirmtohaveawrittenpartnershipdeedbutitis alwaysadvisable
tohaveawrittenpartnership deedto be referredtoinfutureintheeventofany disputesbetween
partners.Sometimes,evenifthereisapartnershipdeed,itmaybesilentoncertainpoints.Insuch
cases,therelevantprovisionsofthePartnershipActwillapply.
Someoftheimportantclausesofapartnershipdeed(particularlythoseaffectingaccountsandconsequent
accountingtreatment)areasfollows:
1. Nameofthefirm andthepartnershipbusiness.
2. Commencementanddurationofbusiness.
3. Amountofcapitaltobecontributed byeachpartner.
4. Rateofinteresttobeallowedtoeachpartneronhiscapitalandonhisloantothefirm.
5. Disposalofprofits,particularlytheratioinwhichprofitsorlossesistobeshared.
6. Amounttobeallowedtoeachpartnerasdrawingsandthetimingsofsuchdrawingsandinterest
chargeable,ifany.
7. Whetherapartnerwillbeallowedtodrawasalary.
8. Anyvariationsinthemutualrightsanddutiesofpartners.
9. Methodbywhichthegoodwillistobecalculatedontheadmission,retirementordeathofa partner.
10. Procedurebywhichapartnermayretireandthemethodofpaymentofhisdues.
11. Basisofdeterminationoftheexecutorsofadeceasedpartnerandthemethodofpayment.
12. Treatmentoflossesarisingoutoftheinsolvencyofapartner.
13. Proceduretobefollowedforsettlementofdisputesamongpartners.
14. Preparationofaccountsandtheiraudit.
Intheabsenceofanypartnershipdeedorwhereadeedissilentinrespectoftheabove-mentioned
points,thefollowingrulesofthePartnershipActwillhavetobeobserved:
1. Thepartnersareentitledtoshareprofitsorlossesequally.
2. Thepartners arenotentitledtoanyintereston capitalnor anyinterest istobechargedby thefirm
ondrawings.
3. Thepartnersareentitledtointerestat6percentperannum onloansgivenbythem tothefirm.
4. Thepartnersarenotentitledtoanysalary,remunerationorcommissionforanyextraworkdone.

DISTINCTIONBETWEEN PARTNERSHIPAND OTHERFORMSOFBUSINESS

ThedistinctionbetweenpartnershipaccountsandotherformsofbusinessisdepictedintheTable below:
Pointsof Proprietary Partnership Companyandother
Distinction formswhich areseparate
legalentitles(Artificial
Judicialpersons)
LegalStatus Individual,i.e.one Partnersandpartnership Theyareseparate
singleperson. firmisoneentity.All legalentities.
partnersarejointlyand
severallyliableforacts
ofthefirm.
Ownership Ownedbyasingle Ownedjointlybyall MembersoftheCompany,
person. thepartners. i.e.Shareholdersarethe
owners.
ShareofProfit Entire profits Allthepartners Members, i.e.shareholders
belongto the sharetheprofitsin enjoy theprofitintheform
proprietor. someagreedproportion. ofdividends.
Managementof Business inmost Businessmayberunby BoardofDirectorswho
Business casesisrunby oneorsomeorallthe areprofessionalsandmay
singleperson. partnersactingforall. alsobeshareholders
managesbusiness.
Proprietorship andpartnershiparetwoformsofbusinessorganisationinwhich thereisnotmuch
differencebetweentheaccountsthereof.However,insteadofonecapitalaccountinaproprietaryconcern,
therewillbe asmany capitalaccountsasthere arepartnersin apartnershipfirm.Moreover,thereare
certaintransactionsapplicableonlytoapartnershipfirmsuchas interestoncapitalanddrawings ofthe
partners,salaryandcommissionandinterestonloanpayabletoapartner. Alltheseitemsareshown separatelyin
theprofitandlossappropriationaccountandprofitsandlossesaredistributedamongthe partnersintheir
respectiveprofit sharingratioaftersuchadjustmentsasstatedabove.Partnerscapital accountsareseparately
shownontheliabilitiessideofthebalancesheet(assuming creditbalancesin
theaccountsinnormalcircumstances).
Sometimes,anewpartnerisadmittedtothefirmor anoldpartnerretiresorisexpelledordies. Insuch events,
specialadjustmentsarerequiredtobemade(explained indetaillater).Fordissolutionofafirm
also,specialaccounting procedureforrealisingthefirmsassets,settling theliabilitiesandpartners
duesisrequiredtobeadopted.

PARTNERSCAPITALANDLOANACCOUNTS

A.MethodsofMaintainingCapitalAccounts
ThePartnerscapitalaccountsmay bemaintained bytwomethods,viz.,FixedCapitalMethodand
FluctuatingCapitalMethod.Generally,thepartnership deedmentions themethodofmaintainingcapital
accounts.Ifaparticularmethodisstatedinthepartnershipdeedthenthefirm hastomaintainthe
capitalaccountsonlyby thatmethod.However, ifthereisno mentionaboutthemethodofmaintaining
capitalaccountsin thepartnershipdeed,thecapitalaccountsaremaintained aspertheFluctuating
CapitalMethod.
(a)Fixed CapitalMethod
Underthismethod,foreachpartnertwo accountsaremaintained.Oneiscalledthepartnerscapital accountand
theotheriscalledpartnerscurrentaccount.Partnerscapitalaccountis creditedwiththe
amountofcapitalcontributedbythepartner. Alltheadjustmentsregardinginterestoncapital,interest
ondrawingsandshareinprofitorlossarerecordedinthecurrentaccount.
(b)Fluctuating CapitalMethod
Underthismethod,allthetransactionsrelating toapartnerareenteredin onlyonecapitalaccount maintained
forhim.No currentaccountisopened asintheFixed CapitalMethod.Capitalaccountis
credited,notonlywiththeamountcontributed by him/herascapital,butothertransactions,suchas
interestoncapital,drawingsandshareofprofits,arealsorecordedinthesamecapitalaccount.

B.PartnersLoanAccounts
Loans givenbythepartners, exclusiveandindependentofcontributionsbyway ofcapital, arerecorded
inseparateaccountscalledPartnersLoan Accounts,keepingtheCapitalAccountsundisturbed.

C.InterestonCapital,DrawingsandLoansfromPartners
Ifthereisanagreementtoallowintereston capital,loan anddrawings,interestiscalculatedata rate
specifiedinthe agreement.Intheabsenceof anysuchprovisionintheagreement,no interestwillbe
allowed/chargedonthecapitalanddrawingsandinterestattherateof6percentperannum willbe
allowedonthepartnersloans tothefirm.Itmay furtherbenoted that,intheabsenceofanyagreement
tothecontrary,interesttopartners, onthecapitalaccount,willbepaidonlyifthereisaprofit. However,
interestonaloan,givenbythepartners, hastobeallowed, irrespectiveofthefact thatthereisnoprofit.
GOODWILLANDMETHODOFITSVALUATION

Goodwillisthevalueofan established businessoverand abovethevalue represented by itstangible


assets.Itisthereputationthatthefirmhasbuiltupinthecourseofitsbusiness.Itisalsothevalueattached
tothesuperprofitearningcapacityofabusinessarisingfromitswideconnectionsandlongstanding in
thebusiness.Goodwill isthevalueofthegoodnameofafirm, whichattracts morecustomers and helps
itearnmoreprofits.Itisan intangiblefixed assetbuiltupslowlybytheownersofthebusinessovera period
oftimeandisveryoftenrecordedin thebooks ofaccount. Unlikeafictitious asset,whichhasno
realisablevalue,Goodwillhasarealisablevalueandcanbeboughtandsoldinthemarket.
Necessity:Thenecessityforvaluationofgoodwillinafirm arisesinthefollowingcases:
1.Changeinprofitsharingratio.
2.Admissionofanewpartner.
3.Retirement,expulsionordeathofapartner
4.Saleofbusiness
Therearemainlythreemethodsofvaluationofgoodwill,viz.
(i)AverageProfitMethod
(ii)SuperProfitMethod
(iii)CapitalisationofProfitMethod
(i)AverageProfitMethod
Inthismethod,goodwillisvaluedonthe basisoftheaverageprofitsofpastfewyears(normally
abnormalincreaseordecreasein profitisleftout).Averageprofit(simpleorweighted), so arrivedat,is
multiplied by an agreed multiplierfactor(called numberofyearspurchase)and the amountso arrived
istakenastheamountofgoodwill.

(ii)SuperProfitMethod
Underthismethod,goodwilliscalculatedon thebasisofthenumberofyearspurchaseofSuper
Profits.SuperProfitisthedifferencebetweenthe ActualProfitandthenormalexpectedprofitinthe trade.
Superprofitismultipliedbyacertainmultiplier,asinthesimpleaveragemethod.
(iii)CapitalisationofProfitMethod
Underthismethod,valueofgoodwillisarrivedataftercapitalisingthenormalprofitatagivenreasonable
ornormalrateof return.Profit,when dividedbythenormal rateof return,gives theamount,which should
havebeeninvestedinthebusiness ofthefirmintheformofcapital.This valueiscomparedwith
thenetassetsofthefirm. Thevalueofgoodwillistheexcess ofcapitalisedvalueoverthenetassetsof thefirm.

ADMISSIONOFAPARTNER

Anewpartnermaybe admittedintoanexistingpartnership forthepurposeofsecuringadditional


capitaloradditionalskillor foranyotherpurpose. Whenanewpartneris admittedinanexisting firm,
thenewpartnerwillgetcertainbenefitssuchas:
Shareintheassetsandliabilitiesofthefirm.
Shareintheprofit/lossofthefirm.
Shareinthegoodwillenjoyedbythefirm.
Alltheseadvantagesarederived bythenewpartnerattheinitialsacrificeoftheold partners.Thus,at
thetimeofadmissionofanewpartner,thefollowingstepsarerequiredto betakenbythefirm:
1.Revaluationof assetsandliabilities
2.Treatmentofgoodwill
3.Decisionregardingamountofcapitaltobebroughtinbythenewpartner
4.Adjustmentregardingaccumulatedlossesandreserves
5.Capitalaccountsofthepartner.

1. RevaluationofAssetsandLiabilities
Anewpartner,admittedintoapartnership, gets ashareintheprofitsaswellastheassetsofthebusiness.
Onthedateof admissionofthenewpartner, therealvalueofassetsofthefirmmaybemoreorlessthan
thevalueappearingin thebooksofaccount. Thisincreaseordecreasein valuebelongsentirely to the old
partnersandhence,hastobeadjustedbeforetheadmissionofthenewpartner.Similarly,the
liabilitiesexistingonthedateofadmissionofthenewpartnermayalsoneedrevision.
Whentheassetvalueincreases,thereis aprofitandwhenitgoes down,thereis aloss.Whenliabilities
increase,thereisalossandwhenliabilitiesdecrease,thereisaprofit.Thisincreaseordecreasein
assetsandliabilitiesisadjustedtotheaccountsoftheoldpartnersthroughanaccountcalledthe
RevaluationAccountor ProfitandlossAdjustmentAccount.Theentriesrecordedinthisaccount
areontheprinciplethatwhenthereis aloss,debitprofitandloss adjustmentaccountandwhenthereis
again,creditprofitandlossadjustmentaccount. Thedifferencein thetwosidesofthisaccountwill
showeitherprofitorloss,whichistransferred to theaccountsoftheold partnersin oldprofitsharing ratio.

2.TreatmentofGoodwill
A. Admission of a Partner
When a new partner is admitted to partnership, adjustments of goodwill is necessary because goodwill has
been built up by the old partners over a period of years for which they have worked hard and they would not
like to just pass on a part of it to the new partner. The new partner also gets a share in profits of the firm from
the date of his admission, which is sacrificed by the existing partners. The existing partners would not like to
just pass on this benefit to the new partner without a consideration.

B.RetirementorDeathofaPartner
Onretirementordeathofanypartner,theportionofgoodwillofthefirm belongingtotheretiring
partnerorthepartnerwho died,hastobepaidbythecontinuing/survivingpartners,totheretiring
partnerortheheirsofthedeceasedpartner,asthecasemaybe. Asthecontinuing/survivingpartners
gainintermsofincreaseinshareofprofitsduetodeath/retirementofapartner,they bearthisamount
ofgoodwillpaid,inthegainratio.

3. CapitaltobebroughtinbyaNewPartner
Thenewpartnerbringsincapital,inaddition to goodwill,to getashareinthefirmsassets,liabilities andprofits.
It can be in the form of cash or assets.
4.AdjustmentRegardingAccumulatedLossesand Reserves
Normally,theprofitsofthepartnershiparedividedbetweenthepartnersattheendofeachyear.In
case,apartoftheprofitsiskeptin reserve,totakeadvantageofitin badtimes,then theoldpartners would
notlikethenewly admitted partnerto sharethebenefitofthisreserveorundistributedprofits. Therefore,thesaid
amountisdividedbythe oldpartnersamongstthemselvesinthe oldprofitsharing ratio.
Sometimes,lossesof theearlieryearsarecarriedbythepartnershipundertheheadprofit andloss account.
Theyalsobelongentirelytotheold partnersandthenewpartnerwould definitely notbearthis loss.

5.AdjustmentofCapitalAccountsofPartners
Sometimes, it maybedecidedthataftertheadmissionofanewpartner,theold partnerscapitals should
alsobeadjustedaccordingtothenewprofitsharingratio. This isbecauseold partnerscapitalbalances
mayhavechangedconsiderablyduetorevaluationofassetsandliabilities,transferofreserves,adjustment
ofgoodwill,etc.Forthispurpose,generally,thenewpartnerscapitalandhisshareofprofitaretaken
asthebasisforcalculationandtheoldpartnerscapitalsareascertainedaccordingtothefuture profit sharing
ratio.Theamountsso arrivedatarecompared with thecapitalsstanding tothecreditoftheir
capitalaccounts.Excessmaybepaidoffbythefirmtotheoldpartnersanddeficiency,ifany,maybe
requiredtobemadeupbythembybringinginadditionalcash.

RETIREMENTANDDEATHOFAPARTNER

A. Retirement ofaPartner
Retirementofapartnermeansthatthepartnerbreaksoffhis/herrelationswithallotherpartnersand
withdrawshimself/herselffromthefirm.
ReasonsofRetirement
(a)Duetooldage
(b)Retiringpartnermaynothavefaithinthefutureprospectsofthefirmorinotherpartners
(c)Differenceofopinionwithotherpartners
(d)Retiringpartnermaymigrateorshiftfrom theplaceofbusiness
(e)Voluntarilydecidestoretire
(f)Aspertermsofpartnershipdeed.
AccordingtoSection32oftheIndianPartnershipAct,1932,apartnermayretire:
(a)withtheconsentofallthepartners,
(b)inaccordancewiththetermsofthepartnershipagreement,or
(c)bygivinganoticetoallthepartnersofhisintentiontoretire,whenthepartnershipisAtWill.
Incaseofretirement,aretiringpartnerisinterestedincollecting his shareinthevarious activitiesofthe
businessofwhichhewasapartownertillthedateofhisretirement.

B.DeathofaPartner
Inretirement,apartnerbreaksoffhis/herrelation withthefirmvoluntarily,i.e.onhisown.Deathofa
partnerautomaticallyterminatessuchrelationship. Unlikeretirement,whichisonaspecificconvenient
datemutually agreedupon withotherpartners,death ofapartnercan occuratanytimeduringthe
accountingyear.
C. NewProfitSharingRatioofContinuingPartners
Afterretirementordeathofaparticularpartner,thecontinuingpartnersmayagreetosharetheprofits
inthesameold ratio orinanewagreedratio. Theratioinwhichthe continuing partnersgainorbenefit
fromtheshareoftheretiringordeadpartneriscalledtheGainingratio.Gainingratioisequaltothe
newratiominustheoldratio.

D.JointLifePolicy
Inorderto provideforthe cashincontingencylikethedeathofapartner, etc.,afirmmay decidetotake
ajointlifepolicyonthelivesofpartnerssothattheproceeds receivedfromtheinsurancecompanymay
beutilisedtomakepaymentsoftheduesofadeceasedpartnerandthefirm issavedfromfinancial hardship.

SLEEPINGPARTNERANDQUASIPARTNER

SleepingPartner
Inapartnership, very often, somepartnersagreetoworkwhileothers areinterestedinmerelyinvesting
thecapitalandgetting ashareofprofits.Suchpartnersarenormallynotinterestedintheday-to-day
workingofthepartnershipandarecalledsleepingpartners. Theotherpartnerswhoworkforthebusiness
ofthefirmarecalledworkingpartners oractivepartners.However,itmustbenotedthat lawmakesno
differencebetweenasleepingpartnerandaworking partnerandthesleepingpartnerwillbeequally
responsibletothethirdpartiesforallactsoromissionsofaworkingpartner.

QuasiorNominalPartner
Sometimes,someprominentpersonslendtheirnamestoafirminordertoallowthefirm toenjoytheir
goodwillinfurtherance ofitsbusiness.Likewise,insomecases,apersonsnamemaybe usedbythe
partnershipfirmshowinghim/hertobeapartner,whereasthepersonis,infact,notapartnerinthe
firm.Insuchcases,althoughnorelationshipofpartnershipexists,thelawstopsapersonfromdisclaiming
his/herstatusaspartnervis--vis third parties,ifhe/shekeepsquiet, inspiteofbeingfullyawareofthe fact
thathis/hernameisutilisedaspartner. Suchaquasi-partnershipprotects thethirdpartieswhomay makeanon-
partnerliableinthesecircumstances.
Joint Ventures

INTRODUCTION

Whereabusinessmanfindsitdifficultto undertakeanybusinessworkoraventure alone,he/she may


associatewith otherbusinessman/ businesswoman. Such anassociationofpersonsisforashortperiodor
foraparticular
ventureandisknownasJointVenture.Itisregardedasatemporarypartnershipwithoutafirmname
anditceaseswith thecompletion ofthetaskundertaken.Persons,whohavecometogether,arecalled co-
venturersandnotpartners.Theco-venturersenterintoacontractwith each other,deciding about
theircapitalcontributionandshareofprofit.In theabsenceofany agreement,profitand lossesare
sharedequallybytheco-venturers.

DEFINITION

Adictionaryforaccountants,byEricL.Kohler,definesjointventureasunder:
Acommercialundertakingbytwoormorepersons,differingfrom apartnershipinthatrelateto disposition
ofasinglelotofgoodsorthecompletion ofasingleproject.Itsduration islimitedtothe
periodinwhichgoodsaresoldortheprojectiscarriedon.

FEATURES
Theessentialfeaturesofajointventureagreementare: (1)
Itisanagreementbetweentwoormorepersons. (2)
Theagreementismadetocarryonaspecificjob.
(3) Theagreementisoverassoonastheventureiscompleted.
(4) Itisatemporarypartnershipwithoutanyfirmsname.

DISTINCTIONBETWEENJOINTVENTUREANDPARTNERSHIP

(1) Apartnershiphasafirm namewhileajointventuredoesnotpossesssuchacommonname. (2)


Apartnershipisacontinuingbusinesswhereasajointventureispurelytemporaryinnature.
(3) Thepersonswhoenterintojointventurearecalledco-venturerswhileincaseofapartnership,
suchpersonsarecalledpartners.
(4) Partnershavejointandseveralliabilitieswhileinajointventureitdependsonthemodeof contract.
(5) Separatesetofbooksis maintainedincaseofapartnershipfirmwhereas thesameis notamust in
caseofajointventure.
(6) Inapartnershipfirm, accrualbasis ofaccounting isfollowed whereasin ajointventurecashbasis
ofaccountingisusuallyfollowed.
(7) Inapartnership,profitorlossisascertainedattheendoftheyearwhereasinajointventureitis
ascertainedoncompletionofeachventure.
DISTINCTIONBETWEENJOINTVENTUREANDCONSIGNMENT

(1) Inajointventure,theventurerscontributecapitaland sharetheprofitorlossesaccording toan


agreedratio,whereas,inaconsignment,theconsigneedoesnotcontributeanycapitalandheis
notentitledtotheprofitorlossbuthegetsacommissionatanagreedrate.
(2) Inajointventure,eachco-venturercan takepartinthemanagementoftheventure,whereasin
consignment,neithertheconsignornortheconsigneecantakepartintheothersbusiness.
(3) AjointventureisgovernedbythePartnership Actandbythetermsofcontractbetweentheco-
venturersbutaconsignment is governedbythelaw relatingtoAgencyandtheterms ofcontract
betweenpartiestothecontract.
(4) Ajointventuremayberegarded as atemporarypartnershipwhereasconsignment isnotsimilarto
jointventuresincetherelationshipbetween consignorandconsigneeisthatofthePrincipaland
Agent

Consignment Account

MEANING

Aconsignment isthedispatchofgoodsbyitsownertohisagentforthepurposeofselling. Theformer


iscalledthePrincipalorConsignor andthelatteriscalledAgent orConsignee.Thegoodsso
dispatchedorsentbytheconsignorisregardedasConsignmentOutwardin thebooksofconsignor,
whereasthegoodssoreceived bytheconsigneeistreatedasConsignmentInwardinhisbooks.

DIFFERENCEBETWEENCONSIGNMENTANDSALE

Thefollowingpointsmaybenoted.
(a) AccordingtoSaleofGoods Act,wherethepropertyinthegoodsistransferredfromthesellerto
thebuyer,thecontractiscalledasale.Butin consignment,theownershipofthegoodsisnot
transferredtotheconsignee.
(b) Inactualsale,thepurchasercandisposeoffthegoodsaccordingtohisownchoiceanddesire
sinceheistheownerofsuchgoods.Butin aconsignment,theconsigneecannotdososinceheis
nottheownerofthegoodsandatthesametime,heisbound tosell thesameprescribed bythe consignor.
(c) Incaseofsale,riskistransferredfrom thesellertothebuyerassoonasthetransactiontakes
place.Therefore, anyloss,ifincurred,istobebornebythepurchaser. Butincaseofconsignment,
lossistobebornebytheconsignorandnotbytheconsigneesinceheisonlytheagent.
(d) Inacontractofsale,thepurchasercannotreturnthegoodsto theseller,butin consignment,the
consigneecandosoifhethinksthatthegoodsarenotmarketable.

PROFORMAINVOICE

Itisaninvoicesentby consignortothe consigneestating fulldetailsofthegoodsconsigned,suchas


quantity,grade,value,etc.Sincetransferofgoodsto consigneeisnotasale,theinvoiceiscalledPro
formaInvoice.
ACCOUNTSALE

Consignor, whois amanufacturerorwholesaler, sendstheconsignmenttohisagent,consignee,for sellingthegoodson


hisbehalfatthebestavailableprice.The consignor,reimbursesalllegitimate expensesincurredby theconsigneeforselling
thesegoods.Suchexpensesincluderentalofshop, salary and commission to salesmen,etc. Theconsigneeisgiven afixed
rateofcommissionoverand abovethereimbursementofexpenses. The consigneeisrequiredto submit tothe consignorastatement,
showingdetailsofgoodssold,expensesincurred,commissionduetohimandhowthebalancepayable
toconsignorissettled.ThisstatementiscalledAccountSale

VALUATIONOFCLOSINGSTOCK

Unsold stockofgoodswiththeconsigneemustbevaluedproperly.Thestockisvaluedatcostplusthe
proportionateexpensesincurredbytheconsignorandtheconsignee.Incaseoftheconsignor,allexpenses
incurredforsendinggoodsto theconsignee areto beconsidered.Butin caseofconsignee,only non-
recurringordirectexpenses,incurredbyhim aretakenintoaccount.

CONSIGNINGGOODSATAHIGHERPRICE

Whenthe consignorthinksthat the consigneeshouldhaveno knowledgeofthecostofgoods consigned,


hepreparesaproformainvoiceatahigherprice.Anotherobjectofpreparingtheproformainvoiceat
ahigherpriceistokeeptheconsigneeinthedarkabouttheactualamountofprofitearned. Theexcess
amount,overthecostprice,iscalledLoading. WhengoodsareconsignedattheInvoicePrice (Loaded Price),the
consignmentaccountisdebitedwiththeloadedpriceand immediatelytheexcess
overthecostiscreditedtoconsignmentaccount sothattheelementoftheunrealized profitisremoved.
Similarly,whilevaluingclosingstocks,goodsarevaluedfirstattheinvoicepriceandtheexcessincluded
inthestocksistransferredtoconsignmentstockrevenuebydebitingconsignmentaccount.

COMMISSIONPAYABLETOCONSIGNEE
Overandabovethereimbursementofexpensesincurred bytheconsignee,heispaidacommissionat
afixedrateonthesalesbyhim.Commissionpayabletotheconsigneeisoftwotypes,i.e.
(1) Ordinaryand
(2) DelCredere.
Ordinarycommissionis paidatafixed rateonallsales madebyhim,cashaswellascredit. Collection
charges,lossduetobaddebtsmustbebornebytheconsignor.
DelCredere commissionisanextracommission,overandabovethenormal,paidtothe consigneefor selling
goodson credit.Underthesecircumstances,alllossesdueto bad debts,collectionchargesand
discountmustbebornebytheconsignee.Thisiscalculatedontotalsales.

NORMALLOSS

Ifsomelossisunavoidable(e.g,leakage)itwouldbespreadovertheentireconsignmentwhilevaluing stock.
Thetotalcostplusexpenses incurred shouldbedividedbythequantityavailableafterthenormal
losstoascertainthecostperunit.
ABNORMALLOSS

Ifanyaccidentalorunnecessarylossoccursthensuchlossisascertainedandtransferredtotheprofit
andlossaccount.

LEASING

Definition
Leasingcanbedescribedas a contractbetweentwoparties,wherebytheownerofan assettransfershis
rightofusetosomeotherpartyonpaymentofafixedperiodicalrent.

Essentialfeaturesof aleasecontract
There aretwo partiesto aleasetransaction,theowneroftheassetknownasthelessorandtheuserof theassetas
thelessee. Byvirtueoftheleaseagreement, thelesseegetstherightofuninterrupteduseof
theassetprovidedhemakes thepaymentofleaserentals regularly. Duringtheentireperiod ofcurrency
ofthecontract,theownership oftheassetremainswiththelessoronly.Thecontractisusuallyfora
specificperiod,normallyfiveyearsandontheexpiryofthesame,itcanberenewedorterminatedor theassetcan
bepurchasedbythelesseedependinguponthetermsofthecontract.
Advantages
Leasing,asameansoforganisingindustrialproductioncapacity,hasbecomeverypopularinIndiain
thelastfewyears.Theleasingisbeneficialbothtothelessoraswellasthelessee.

Advantages toLessor
1. Expansionofbusiness:Manufacturersofplantandmachinerywithhighpricesmayfinditdifficult
toexpand theirsalesiftheyinsistonsellingtheirproductsonanoutrightownershipbasis. Owing
torecession in theeconomy,thegrowth ofcapitalgoodsindustry isaffected toaconsiderable extent.In
thissituation,leasingisincreasinglyusedtorevivethedemand forcapitalgoods.The
manufacturersofthecapitalgoodshavebenefitedimmenselybyadoptingleasingarrangements.
2. Tooloftaxplanning:Ifamanufactureroradealersellscapitalgoods,itincreaseshis profitsand
asaresult,hewill paymoreincometax.Largerthesales,higheristheprofitand consequently higherthe
taxliability.Insteadof sellingthecapitalgoods,ifthe manufacturerordealerleases them
out,theleaserentbecomesreceivableoveralongperiod.Thus,withthehelpofleasing,
manufactureroradealerorlessorreduceshistaxliability.Inthisway,leasingcanbeusedas
atax-planningtool.

Advantages toLessee
1. Reductionin capital investment:Instead ofpurchasingthecapitalgoods, ifthesamearetaken on lease,
themanufacturercanreducethecapital investment in theproject. Entrepreneurs withlower
financialcapacitycanstartaventurewithout investing hugefunds. Leasingalsosaves theinterest
burdenonfundswhichthelesseewouldhavepaidontheborrowedfundforpurchasingthe assets.
2. Eliminationofriskofobsolescence:Withfastdevelopingtechnology,theownerofanassethas to
beartherisk ofhisassetbecoming obsoleteoroutdated.Sincethelesseeisnot theownerofthe
asset,hedoesnothavetobearthisrisk.Iftheleaseperiodisshort, onexpiryoftheleaseperiod,
thelesseecantakeonleaseanothercapitalassethavingthemostadvancedtechnology.
3. Increaseinborrowingcapacity:Ifthecapitalgoodsarepurchasedwithborrowedfunds,the
asset,aswellastheborrowed funds,appearin thebalancesheet;thisreducesfurtherborrowing
capacityofthebusinessalthough leasingofcapitalassetsinvolves substantialpaymentsovera
longperiod.Infuture,suchliabilityneednotbeshowninthebalancesheet.From thepointof
viewofthelendersofthelong-term loans,theborrowersborrowingcapacityincreaseswithno
pastborrowings.Thus,thelesseecanborrowmorefundsfrom thefinancialinstitutionswithout
muchdifficulty.
4. Reduction intaxliability:Leaserentpayablebythelesseeistreatedasrevenueexpenditurein his hand
which isfully debited to profitand lossaccountbeforecalculatingthetaxableprofitofthe
lessee.Thiswillreducehistaxliability.
5. Applicationofcertainlaws:TheprovisionsoftheMonopoliesandRestrictiveTradePractices
Actcan beavoidedbykeepingthecapitalinvestmentatalowerlevel.
6. Interferenceoffinancial institutions:Leasingreducesthedependenceonthefinancialinstitutions
andbanksforborrowinghugesumsforlong-termormedium term.Thus,thelesseecanavoid
interferenceoftheseinstitutionsintheday-to-daymanagementofhisorganisation.
Limitations
1. Leaserentmaybequiteburdensometothelesseeasithastocoverthecostofdepreciation,cost
offinanceandadministrativeexpensesofthelessor.
2. Whenthelessorhasacquiredtheleasedassetsbyborrowingfundsagainstthehypothecationof
theleasedassets,any defaultonthepartofthelessormayadversely affecttheoperationsofthe lessee.
3. Leasingonlyshiftstheneedforborrowingfrom thelesseetothelessor.Thus,forthebanksand
thefinancialinstitutions,thedemandforthefinanceremainsthesame.
4. Leasedassetsarenoteligibleforcapital subsidiesavailableforprojectsinbackwardareas.
5. Generally, leaserentalstructuresdonotprovideforamoratoriumperiod asavailableinrespectof finance
frombanks/financialinstitutions.Thus,leasingisconsideredunattractiveforprojects
withalonggestationperiod.
6. Thedisadvantagetothelesseeincasesoffinancialleaseis thatheis notentitledto theprotection
ofwarrantiesfromthesupplieroftheequipmentsasthesamearepurchasedbylessor.Hehasto
payleaserentalsinspiteofloss,destructionordefectsintheleasedassets.
TypesofLeases
Leaseismainlyoffourtypes:
1. FinanceorCapitallease
2. Operatinglease
3. Servicelease
4. Leveragedlease
1. FinanceorCapitalLease
Thisis themostpopulartypeoflease. It isfairlylong-termin nature. Generally,the entire economiclife
oftheasset isagreed tobetransferred foruseby thelessee,thoughtheownership remainswiththe
lessor.Lesseeagreestopaythefixed instalments(leaserentals)which,intotal,exceedthecostof
equipment.Normally,suchacontractisnon-cancellableinnature duringtheprimaryperiod.Lessee
bearstheriskofobsolescence andunderutilisation,ifany.Theleaseisgenerallyspreadintotwo periods:
(a) PrimaryPeriod:Normally,forequipment,theperiodisfiveyears.Thelessorrecoversthecostof
theassetandinterestthereonduringthisperiod.
(b) SecondaryPeriod:Itstartsaftertheprimaryperiodisover.Theleaseiscontinuedonavery nominalrental.

2.OperatingLease
OperatingleaseisaleasewhichisnotFinanceoraCapitallease.Itdoes nottransfer anyofthe rewards
andrisks ofownership oftheleased propertyto thelessee. Thecontract is,usually, cancellable andoflower
maturity periodthan inthe caseoffinanciallease.Normally,theperiodofleaseismuch lesscomparedto
theeconomiclifeoftheasset.Leasing oftelephones,vehicles,computers,etc.,are someofthe examples
ofoperatinglease. Theleaseperiodis normallyforashortperiodandmaystretch from adaytoaboutthreeyears.

3.ServiceLease
Itisaleaseagreementeffectedbymanufacturersordealersofcapitalgoods(likemachinery)orconsumer
durables(likeAir-conditioners,etc.)inwhichthey deal.Serviceleasecoversthecostofmaintenance
andservicingtheassetsforashortperiod. Theleasepaymentcoverscostofservicingandnotthe
capitaloutlay.Sometimes,thelesseemaybegivenanoptiontoretaintheassetontheexpiryofthe leaseperiod.

4.LeveragedLease
Inthistypeoflease,therearethreepartiestothelease agreement.Inadditionto thelessorandthe lessee, thethird
partyisthefinancierto lessor. Hence,theleaseisalsoknown as aThirdPartyLease. Underthislease,thethird
party provides thefinanceto thelessor.Leasinghasnowadaysbecomea specialised serviceindustry.Many
leasingcompanieshavebeen formedto purchaseassetsand give themonleasetothelessees.
Theleasingcompaniesgiveplantandmachinery,factorybuildings,worth croreofrupees,
onlease.Inordertoleasesuchassetsinvolvinghugecapitaloutlays, evenleasing
companieshavetoborrowhugefunds. Whenabusinessusesborrowedfunds,havinglow costs,to maximiseits
profits,itissaidinthefinancialmanagement that thebusinesshas usedfinancialleverage.
Sincetheleasingcompanies(i.e.thelessors)useborrowedfundstofinancetheirleasingactivities,
suchleaseisknownasLeveragedLease.

HIREPURCHASEANDINSTALMENTSALE

Meaning
Inahirepurchaseandininstalmentsale, abuyerpurchasesgoodsbutpays thepriceofthegoods notin
onelumpsum butinvariousinstalments.Thebuyertakespossessionofthegoodsandenjoysthemas
ifheisthesoleownerofthegoods,although,thepriceforthegoodsisnotfullypaid.
Thepersonwhopurchasesgoods onhirepurchasebasis iscalledhirer;whiletheselleriscalledhire
purchaseseller, hirepurchasevendororowner.Thehirepurchaseagreementmustbeinwriting.It
includesthedescriptionofthegoods,cashprice,interesttobecharged,numberofinstalmentsandso
on.Thehirepurchasepriceconsistsoftwoelements:
(1) Cashpriceand
(2) Interestfordelayedpayments.
Normally,acertainamountispaidimmediatelyatthetimeofsigningtheagreement.Thisiscalled
Downpayment.

DistinctionBetweenHirePurchaseandInstalmentSale

HirePurchase InstalmentSale

1. Ownership
Theagreementmentionsthedateon Ownershippassestothebuyer assoonasthe
whichownershipinthegoodspasses transactionofinstalmentsaleiscompleted.
tothebuyer.Usually,itpassesonpayment
ofthelastinstalment.

2. Defaultinpaymentofinstalment
Incaseofadefault,thesellercantake Thesellercannottakebackthegoods.Hecansue
backthepossessionofthegoodsand thebuyerfornon-paymentofinstalment.
heisnotboundtoreturntheamount
alreadyreceived.

3. Buyersrighttoterminatecontract
Thebuyer hasanoptiontoterminatethe Thebuyer hasnorighttoterminatethecontract.
contractandreturnthegoods.

4. Buyersrighttodisposeofgoods
Hecannotdisposeofthegoodsas Since thebuyeristhesoleownerofthegoods,he
ownershiphasnotpassedontohim. candisposeofthesegoodsin anymannerhelikes.

5. LossofGoods
Lossofgoodshastobebornebytheseller Asheisthesoleowner,anylossofgoodshastobe
providedthebuyer hastakenreasonable bornebyhim.
careofthegoods.
ACCOUNTINGFROM INCOMPLETERECORDS (SINGLEENTRYSYSTEM)

SingleEntrySystemmaybedefinedasanysystem whichisnotexactlythedoubleentrysystem.In
otherwords,Singleentrysystemmayconsistof:
(i) Doubleentryinrespectofcertaintransactionssuchascashreceivedfromdebtors,cashpaidto
creditors,etc.
(ii) Singleentryinrespectofcertaintransactions suchascashpurchases,cashsales,expensesmade,
fixedassetspurchased,etc.
(iii) Noentryinrespectofcertainsuchasdepreciation,baddebts,etc.
Thus, abusiness issaidtobeusingsingleentrysystemifit is notfollowingcompletelytheprinciplesof
doubleentrysystemofbookkeeping.Kohlerdefinesthesingleentrysystem as,Asystemofbook- keeping
in which,asarule,onlyrecordsofcashandofpersonalaccountsaremaintained,itisalways
incompletedoubleentry,varyingwiththecircumstances.

SALIENTFEATURES

Thesalientfeaturesofthesingleentrysystem are asfollows:


(i)Maintenanceofpersonal accounts
Usuallyunderthissystempersonalaccountsaremaintainedwhilerealandnominalaccountsareavoided.
Onaccountofthisreasonsomeaccountantsdefineitasasystem whereonlypersonalaccountsare
maintained.
(ii)Maintenanceofcashbook
Acashbookismaintained,whichusuallymixesupboththepersonaltransactionsandthebusiness
transactions.
(iii)Dependenceonoriginalvouchers
Inorderto collectthenecessaryinformationonehastodependonoriginalvouchers.Forexample,the
figureofcreditpurchasesmay notbereadily available;itmay havetobefound outon thebasisofthe
original invoicesreceived fromthesuppliers.Similarly, thetotalfigureofsales attheendofaparticular
period may havetobefound outon thebasisoftheinvoiceswhichhavebeenissuedby thebusiness
fromtimetotime.
(iv)Nouniformity
Thesystemmaydifferfromfirmtofirmaspertheirindividualrequirementsandconveniences.
(v)Suitability
Thesystem issuitableincaseofsmallproprietaryorpartnershipconcerns.Limitedcompaniescannot
adoptthissystemonaccountoflegalrequirements.

LIMITATIONS

Thesystemsuffersfromthefollowinglimitations:

(i)Arithmeticalaccuracycannotbechecked
Incaseofdoubleentrysystem ofbookkeeping,Trialbalanceispreparedtocheckthearithmetical
accuracyofthebooksofaccounts. Thisispossiblebecauseeverytransactionisrecorded attwoplaces.
Incaseofthesingleentry system,thisisnotdone.Hence,trialbalancecannotbeprepared andthe
arithmeticalaccuracyofthebooksofaccountscannotbechecked.Thisincreasesthepossibilityof
morefraudsandmisappropriations,ascomparedtothedoubleentrysystemofbookkeeping.
(ii)Trueprofitscannotbeknown
Intheabsenceofcompleteinformationforsales,purchasesandotherexpenses,itisnotpossibleto
drawtheprofitandlossaccount.Hence,thetrueprofitorloss,madeorsufferedby thebusiness,
cannotbeknown.
(iii)Financialpositionofthebusinesscannotbejudged
Intheabsenceofatruefigureofprofitand correctinformation aboutthe assetsand liabilitiesofthe
business,thebalancesheetcannotbedrawnup togiveacorrectpictureofthefinancialposition ofthe
businessonaparticulardate.
(iv) Makesplanninganddecision-makingdifficult
Thesystem doesnotprovideaccuratefiguresabouttheperformanceofthebusinessanditsfinancial
position.Forexample,separate figuresofgrossprofit,netprofitandsalesarenotavailable.Thus,the ratio
ofgrossprofitto salesornetprofitto salescannotbefound out.Similarlyin theabsenceofany
informationaboutthecostofgoodssold,theproportion ofdifferentelementsofcostofsalescannotbe found
out.In theabsenceofsuch information,itbecomesdifficultfortheproprietorofthebusinessto
knowthereasonsofhisimprovingordeterioratingprofitabilityandfinancialposition.Thus,heisnot
inaposition to compare,plan and takesound decisionfortheprosperityofthebusiness.Moreover,it
maybedifficultforhim tofindtherealvalueofhisbusinessintheeventofhisdecidingtosellthe business.

COMPUTATIONOFPROFITSUNDERSINGLEENTRYSYSTEM

Theprofitorlossincaseofbusinessmaintainingaccountsaccordingtosingleentrysystemcanbe
computedbytwomethods:
(i) NetWorthmethod,and
(ii) Conversionmethod.
NetWorthMethod
Accordingtothismethod,theprofitorlossmadebythebusinessiscomputedbycomparingthenet
worth(orcapital)ofthebusinessontwodifferentdates.
Followingadjustmentsarerequiredfordeterminationoftheprofitincaseofthismethod:
(i) Adjustmentfordrawings:Theproprietormaywithdrawmoneyfromthebusiness forhis personal
use.Intheabsenceofanysuchwithdrawal,thecapitalattheendofaccountingperiodwould
havebeenmorebytheamountofmoney withdrawnby him. Thus,theamountofdrawings should
beaddedbackto thecapitalatthe endoftheaccountingperiodto find outhistrueprofitforthat period.
Adjustmentforcapitalintroduced:Theproprietormayintroduce furthercapitalinthebusiness
duringthecourseoftheaccountingyear. Thiswillincreasethecapitaloftheproprietorattheend
oftheaccounting year.Itis, therefore,necessarytoreducetheamountofcapital,by theamountof
capital introducedby theproprietorduringtheyear, inordertoascertaintheprofitearnedbyhim
duringthecourseoftheaccountingyear.

ConversionMethod
TheNetWorth method,explainedabove,doesnotprovideaclearpictureoftheoperational
resultsofabusiness.Itdoesnotgiveinformationaboutsales,purchases,grossprofit, operatingexpenses,
etc.ofthebusiness.Asaresult,neitherameaningfulanalysisofthefinancialstatementscanbedone
norcaneffectivestepsbetakentoimprovethefinancialpositionof thebusiness.Itwill,therefore,be
bettertocollectallsuchinformationfrom thebooksof accounts,andothersources,whichisnecessary
forpreparingaTrial Balanceofthebusiness. This is donebypreparingatotaldebtors account,atotal
creditorsaccount,abillsreceivableaccountand abillspayableaccountandreceiptsandpayments
accountsetc.on thebasisofdoubleentry. Accountsrelatingto differentexpenses,incomes,fixed
assetsandfixed liabilities,andoutstanding,are alsoprepared with thehelp ofreceiptsandpayments
accountsandadditionalinformationavailable. Thus,theclosingbalances ofdifferentaccountsare found
outand atrialbalanceprepared.Finalaccountscan thenbeprepared intheusualway.Such a
methodofcollectinginformationaspertherequirementsofthedoubleentrysystemofbookkeepingis
termedastheConversionMethod.
Inpractice,usually,an abridgedconversionmethod isfollowed.Underthismethod,nominalaccounts
arenotopenedintheledger,norisatrialbalance prepared.Onlysuchinformationiscollectedwhich
isrequiredforpreparingthetradingandprofitandlossaccount,andbalancesheetofthebusiness.

PREPARATIONOFSTATEMENT OFAFFAIRSUNDERSINGLEENTRYSYSTEM
Statementofaffairs is astatementgivingtheassetsandliabilities ofthebusiness onaparticulardate.It is
virtuallytheBalanceSheetofthebusiness.However, thetermBalance Sheet isusedforthestatement
ofassetsandliabilitiesinthedoubleentrysystem ofbookkeepingwherebalancesaretakenfrom the
ledger.In caseofsingleentrysystem,alltheassetsand liabilities,whichappearinthestatementof
affairs,arenotnecessarilytakenfrom theledgeraccounts,onaccountofincompleterecordingofthe
transactions.Moreover,thetermBalanceSheet is usedforstatementwhichshows thecorrectfinancial
positionofthebusiness.Incaseofthesingleentrysystem, itmaynotbepossibleto prepareastatement
whichshowsthecorrectfinancialpositionofthebusiness,sincetheinformationfromdifferentsources,
whichmayincludenotonlythebooksofaccounts,butothersources,whichmaynotbehundredper
centreliable.Forexample,estimateaboutdrawingsmayhavetobemadeonthebasisoftheestimated
livingexpensesof theproprietorofthebusinessandalsootherestimatedpaymentswhichmighthave
beenpaidonhisbehalf.
StepsforpreparingStatementofAffairs
The following steps may be taken for preparing the statement of affairs:

(i) Inmostcasesinsingleentrysystem,acash bookismaintained.In case,thishasbeendone,the


cashandthebankbalancescanbetakenfromthecashbook.Intheabsenceofapropercash book,
cashbalancemay havetobefound outbypreparingareceipts and payments accountonthe
basisofinformation,collectedfromtheproprietorofthebusiness,andthestatementofaccounts,
whichmighthavebeenreceivedorsent bytheproprietorfrom/to hisdebtorsandcreditors.
Informationregardingotherbusinessexpensescanbecollectedfrom thesalariesregisterofhis
employees,petty cash book,ifany,maintained byhim,etc.and the actualcash balanceavailable
withthebusiness.Thebalanceatthebankcanbeverifiedfromthebankpassbookorstatement
ofaccountfromthebank.
(ii) A listofsundrydebtorsandcreditorsshouldbeprepared.Thismaynotbedifficultbecausein
mostcases,arecordofpersonalaccountsismaintainedunderthesingleentrysystem.
(iii) Thevalueofthefixedassetslikebuilding,plant,furniture,etc.shouldbeascertainedfromvouchers
orotherdocumentsavailablewiththebusiness.Areasonablechargefordepreciationshouldalso
bemadeandtheassetsshould beshowninthestatementofaffairsafterchargingdepreciation.
(iv) Aphysicalverificationofthestockshouldbetakenandthevalueofthestockshouldbeascertained
onthebasisofthedifferentinvoicesreceivedfrom suppliersfrom timetotime,inrespectofthe
goodspurchased.
(v) Theamountofoutstandingexpensesandtheaccruedincomeshouldalsobedetermined.Last
yearsfiguresabouttheseitemsmaybeofconsiderablehelpinthisrespect.
(vi) The excessofassetsoverliabilitiesshouldbefound outandthiswilldenotethenetworth orthe
capitalofthebusinessonthedateonwhichtheStatementofAffairshasbeenprepared.