Tag: Advanced Financial Accounting B.com Notes

This method is also called, Proportional Capitalization Method, Gradual Capitalization Method or Actual Cash Price Paid Method. As the name itself indicates, this method assumes that the asset accrues to the hirer gradually to the extent of payment made towards the cash price of the asset acquired on hire purchase basis. Therefore, in the books of the hirer or hire purchaser, Asset Account is debited to the extent of only the instalment amount paid towards the cash price of the asset. In other words, Asset Account is debited with the instalment towards cash price of the asset every time instalment is paid. The salient features of this method are as follows.

(1) As both the amount due and the interest due thereon (i.e., on the amount due) are zero at the time of signing the hire purchase agreement (i.e., at the time of delivery of the asset), down payment, if any, made is only towards the cash price of the asset (but not towards interest also). Therefore, the amount of down payment is debited to Asset A/c crediting Cash or Bank A/c.

(2) Each instalment payable is towards both the cash price of the asset (called, instalment cash price) and the interest accrued on the amount outstanding (from the date of immediately preceding instalment paid and the date of the current instalment payment). When the instalment is due for payment, a portion of instalment towards cash price is debited to Assets A/c and the remaining portion pertaining to interest is debited to Interest A/c crediting Hire Seller’s A/c. When the payment is made, Hire Seller’s A/c is debited and Cash or Bank A/c is credited.

(3) Since the hire purchaser starts using the asset acquired under hire purchase system, the asset is subject to wear and tear. Hence, depreciation is provided in the books of the hirer, usually, at the end of each accounting year. Therefore, Depreciation A/c is debited and Asset A/c is credited.

(4) As both the amounts of interest paid (as a part of instalment amount) and depreciation charged constitute the expenses (i.e., items of Nominal Accounts), both are transferred to Profit and Loss A/c at the end of each accounting year by debiting Profit and Loss A/c (for the aggregate of interest and depreciation) crediting Interest A/c (for the amount of interest) and Depreciation A/c (for the amount of depreciation).

With this introduction about the nature of Asset Accrual Method, the journal entries for different hire purchase transactions in the books of hire purchaser are presented below.

Hire Vendor

The hire vendor delivers the goods or asset to the hire purchaser at the time of agreement i.e., after singing agreement.

Hire Purchaser

The hire purchaser has the right to use the goods delivered to him by the hire vendor under hire purchase system.

Down Payment

Down Payment is the amount paid by the hirer to the hire vendor at the time of signing the agreement or at the time of taking delivery of the goods by the hirer from hire vendor.

The total sum payable by the hirer under a hire purchase agreement by way of a deposit or initial payment (called, down payment) and subsequent periodical instalments. Usually, the purchase price under hire purchase system (called, hire purchase price) is higher than the purchase price if the same goods had been purchased on cash basis (called, cash price).

That means, Hire Purchase Price > Cash (Purchase) Price. Hire purchase price is also called, net hire purchase price. If the hire purchase price includes the charges for (a) delivery expenses

(b) Registration fee

(c) Insurance premium, etc., they should be subtracted to arrive at the net hire purchase price.

Principal Component, Interest Component

As the hire purchase price comprises both cash price and interest, the amount of each instalment includes a part towards cash price (i.e., principal amount) and another part towards interest for a particular period (on the outstanding balance).

In the event of strike or lock-out, if the Minimum Rent is not raised, the amount of Minimum Rent depends on the clause of the agreement between the two parties, i.e., Lessor and Lessee.

However, it may be treated in two following ways, viz., the clause may contain like the following:

(1) During strike or lock-out, the actual royalty earned will discharge all rental obligations (if actual royalty is less than Minimum Rent).

(2) During strike or lock-out, the Minimum Rent will be reduced proportionately having regard to the length of stoppage.

(1) Where Actual Royalty earned will discharge all rental obligations:

Under the circumstances, during the period of Strike or Lock-out, there will neither be short-working nor will there be any recoupment. For example, the contract stipulates that the Minimum Rent is Rs. 12,000 per year. But, during the period of strike, actual royalty earned Rs. 8,000. Hence, landlord will get only Rs. 8,000. As such, there will not be any short-working of Rs. 4,000 (Rs. 12,000 – Rs. 8,000) which may be considered in other years.

(2) Where Minimum Rent is reduced proportionately:

Under the circumstances, the amount of Minimum rent will be reduced proportionately having regard to the length of stoppage. For example, the Minimum Rent is. 12,000 per year. Strike period is 3 months, as such, the amount of Minimum Rent will be Rs. 9,000 (i.e., Rs. 12,000 × 9/12).

As such, if actual royalty earned is less than Rs. 9,000 there will be short-working and, similarly, if actual royalties are more than Rs. 9,000, the excess portion may be recouped (of course, if there is any short-working balance).

The following example will help to understand the principle clearly:

Ex1 :

In case of strikes, recoupment of short-working etc.:

P Ltd. took a mine on lease from Landlord at a given rate of royalty with a Minimum Rent of Rs. 12,000 per year. Each year’s excess of Minimum Rent over royalties is recoverable out of the royalties for the next two years. In the event of Strike, the Minimum Rent was to be reduced proportionately, having regard to the length of the stoppage. But in the case of Lock Out, it was provided that the actual royalties earned for the year would discharge the full rental obligation for that year.

The results of the workings were

Workings:

1. In case of Strike, the Minimum Rent should be reduced proportionately i.e., Rs. 12,000 x Rs. 9,000.

Minimum Rent for the 4th year will be Rs. 9,000 and, as actual royalty is Rs. 10,000, so Rs. 1,000 is recouped.

2. In case of lockout the actual royalties will discharge all rental obligation i.e., landlord will get only Rs. 8,000 for the 5th year although the Minimum Rent is Rs. 12,000.
3. Since in the first year the actual royalty is ‘Nil’ the entire amount is treated as short-working.

Independent Branches

Independent 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 Thus an independent Branch enjoys a good amount of freedom like an American Son.

Characteristics of an Independent Branch:

1. Independent Branch keeps a complete set of books. Such Branch gets goods from Head Office and from outside parties. It has its own Bank Account. Thus, the Branch keeps frill system of accounting.
2. It prepares its own Trial Balance, Trading and Profit and Loss Account and Balance Sheet. Copies of these statements are sent to Head Office for incorporating in the Head Office Books.
3. The books contain an Account called “Head Office Account” or “Head Office Current Account” which is credited with everything received from the Head Office and debited with everything sent to Head Office. That is, all transactions relating to Head Office are recorded in this Account. The Head Office Current Account is thus a Proprietorship Account (i.e. Capital Account).

In-spite of the independent status, the Branch cannot function without resources, and the resources, specially at the initial stage, are provided by the Head Office. Thus, the investments made by the Head Office seen from the Head Office Account are a personal Account in nature.

Similarly, the Head Office in its books opens an Account “Branch Current” Account, which is also a running account between the Branch and the Head Office and incorporates all the transactions between Branch and the Head Office.

A special feature is that the Head Office Current Account in the books of Branch and Branch Current Account in the books of Head Office are maintained on a reciprocal basis.

The balance of these Accounts on any date will be equal to the difference between the assets and liabilities at the Branch on that date. The Branch Current Account in the Head Office books and Head Office Current Account in the Branch books show the same but opposite balance on a particular date.

4. There may be inter-branch transactions. That is, goods transferred by one Branch to another Branch of the same Head Office. Such entries have been explained later.
5. On receipt of the accounts and statements by the Head Office, the Head Office reconciles the balances, which is shown in Head Office Account in the Branch books with the Branch Account in Head Office books. Differences are reconciled. This is dealt with separately.

Accounting entries, in the book of Branch, for normal Transactions
1	Purchases made at branch	Purchase Account   To cash/Creditors Account	Dr.
2	Sales affected at Branch	Cash/Creditors Account   To Sales Account	Dr.
3	Payment of expenses at Branch	Expanses Account    To cash Account	Dr.
4	Any income received at Branch	Cash/Bank Account    To concerned income Account	Dr.

1. For goods supplied by head office to branch:

Branch book:

Goods supplied by head office A/C………Dr.

To Head office A/C

(Being receipt of goods)

Head office book:

Branch A/C…………..Dr.

To goods supplied to branch A/C

(Being goods sent to branch)

2. For cash remitted by head office to branch:

Branch book:

Cash A/C…………..Dr.

To head office A/C

( Being cash received)

Head office book:

Branch A/C ……………..Dr.

To cash A/C

(Being cash sent to branch)

3. For goods returned by branch:

Branch book:

Head office A/C…………Dr.

To goods supplied to head office A/C

(Being goods return to head office)

Head office book:

Goods supplied from branch A/C…………Dr.

To Branch A/C

(Being goods returned from branch)

4. For cash remitted by branch to head office:

Branch book:

Head office A/C………….Dr.

To cash

(Being cash sent to head office)

Head office book:

Cash A/C……………..Dr.

To Branch A/C

(Being cash received from branch)

5. For assets purchased by branch on behalf of head office:

Branch book:

Head office A/C ………………Dr.

To cash A/C

(Being purchase of assets)

Head office book:

Branch assets A/C………….Dr.

To branch A/C

(Being assets purchased by branch)

6. For depreciation charged:

Branch book:

Depreciation A/C ……………Dr.

To Head office A/C

(Being depreciation on branch fixed assets)

Head Office book:

Branch A/C……………….Dr.

To branch assets A/C

(Being depreciation of branch fixed assets)

7. For expenses incurred by head office

Branch book

Expenses A/C…………..Dr.

To head office A/C

(Being expenses incurred by head office)

Head office book:

Branch A/C………………….Dr.

To profit and loss A/C

(Being expenses incurred for branch)

Foreign Branches

Foreign branches are independent branches which are operating in foreign countries.

Accounting in respect of Foreign Branches:

Accounting in respect of foreign branches is done in the books of the branch as well as in the books of the Head Office.

Accounting at Branch:

As the foreign branch is an independent branch, it keeps a complete set of books on the double entry system, prepares all the necessary accounts including the account of the Head Office, prepares its own trial balance, Trading and Profit and Loss Account and Balance Sheet. In short, the accounting procedure adopted at a foreign branch is exactly the same as that adopted at an independent domestic branch.

Accounting at the Head Office:

The trial balance received by the Head Office from the foreign branch is in foreign currency. Therefore, before incorporating the items in the trial balance of the foreign branch, the Head Office is required to convert the various items in the trial balance into the currency of the Head Office. Thereafter, it has to incorporate the items in the Converted Branch Trial Balance in its books, prepare the Branch Trading and Profit and Loss account and Balance Sheet and Branch Account.

Rates at which the items in the trial balance of a foreign branch should be converted:

It is true that the items in the trial balance of a foreign branch should be converted into the currency of the Head Office. But the question is at what rates the various items in the trial balance of a foreign branch should be converted. The following points should be borne in mind while converting the items in the Trial Balance of a foreign branch:

1. If the rate of exchange is not subject to wide and frequent fluctuations, all the items in the trial balance (other than remittances and Head Office Account) can be converted at a fixed rate of exchange.
2. If the rate of exchange is subject to wide and frequent fluctuations, then, different rates should be adopted for different items. They are:
3. Opening stock should be converted at the opening rate of exchange (i.e, the rate of exchange prevailing at the beginning of the accounting year).
4. Closing stock should be converted at the closing rate of exchange (i.e., the rate of exchange prevailing on the last day of the accounting year).
5. All the other revenue items (i.e., expenses and incomes, except depreciation on fixed assets and reserve for bad debts, should be converted at the average rate for the year. (In this context, it may be noted that according to the recommendation of the Institute of Chartered Accountants, in the year in which the local currency is devalued, the revenue items should be converted at the closing rate, and not at the average rate.)

Depreciation on fixed assets should be converted at the same rate at which the converted fixed asset is converted

1. Fixed assets should be taken at the same figure at which they (i.e., branch fixed asset) appear in the books of Head Office.

If that figure is not given, the fixed assets should be converted at the rate of exchange prevailing on the date on which the fixed assets were acquired. If that rate is not given, then, the fixed assets should be converted at the opening rate of exchange.

If additions to fixed assets are made on various dates, average date of exchange for the period should be adopted.

1. Fixed liabilities should be converted at the rate of exchange prevailing on the date on which they were contracted. If that rate is not given, then, they should be converted at the opening rate of exchange.
2. All current assets and current liabilities should be converted at the closing rate of exchange.
3. Remittances appearing in the branch trial balance are converted at the actual rates at which they were effected. If they are not given, they should be converted, i.e., taken, at the same figure at which they appear in the Head Office books.
4. Head Office account is converted, i.e., taken at the same figure at which Branch Account appears in the Head Office books,
5. Goods received from Head Office should be converted, i.e., taken, at the same figure at which goods sent to branch appear in the head office books. If that figure is not given, then, the goods received from Head Office should be converted at the average rate of exchange, as it is a revenue item.

However, it should be noted that the converted Trial Balance, generally, does not tally. This is because the different items in the branch trial balance are converted at different rates. The difference in tial balance is taken as Difference in Exchange and is entered in the Profit and Loss Account, either on the debit side or on the credit side.depending upon its nature, if the difference is small. On the other hand, if the difference is fairly large, it is taken as Exchange Fluctuations Account or Exchange Suspense Account and is shown in the Balance Sheet either as an asset or as a liability, depending upon the nature, and is carried forward to be set off against future differences.

After having converted the Branch Trial Balance into head office currency, the Head Office will incorporte the items in the branch trial balance in its books and prepare the Branch Trading and Profit and Loss Account and Balance Sheet and the Combined Trading and Profit and Loss Account and the Balance Sheet, as required.

It is the primary aim of all business enterprises to increase their volume of sales. For this purpose, many firms open their shops in different parts of the locality/country. (The parent establishment is known as ‘Head Office’ and its offshoots are termed as ‘Branch’.)

Besides, if branches are opened, particularly in developed regions, both the local consumers and the firms are benefited.

Practically, it is an extension of an existing firm. It should be remembered that a branch has its separate existence but does not possess any separate legal entity. That is why, it is said that it is nearly an extension and a profit centre of an existing firm. Needless to say that all activities of the branches are controlled by the Head Office.

According to Sec. 2 (a) of the Companies Act, 1958, a branch (office) is defined as:

(a) Any establishment described as a branch by the Company, or,

(b) Any establishment carrying on either the same or substantially the same activity as that carried on by the head office of the company, or

(c) Any establishment engaged in any production, processing or manufacture, but does not include any establishment specified in any order made by the Central Govt., u/s-8.

As the foreign branch is an independent branch, it keeps a complete set of books on the double entry system, prepares all the necessary accounts including the account of the Head Office, prepares its own trial balance, Trading and Profit and Loss Account and Balance Sheet. In short, the accounting procedure adopted at a foreign branch is exactly the same as that adopted at an independent domestic branch.

Accounting at the Head Office:

The trial balance received by the Head Office from the foreign branch is in foreign currency. Therefore, before incorporating the items in the trial balance of the foreign branch, the Head Office is required to convert the various items in the trial balance into the currency of the Head Office. Thereafter, it has to incorporate the items in the Converted Branch Trial Balance in its books, prepare the Branch Trading and Profit and Loss account and Balance Sheet and Branch Account.

Atif & Co. of Delhi consigned 100 units of goods, costing $100 per unit, to their agent Gupta & Co. in Mumbai at a proforma invoice of 20% on cost. Atif & Co. paid the following expenses:

• Loading charges: $100
• Freight: $200
• Insurance: $300

Gupta & Co. took delivery of goods and, on the same day, they sent a bank draft of $5,000 to Atif & Co. as advance against consignment.

Gupta & Co. forwarded an account sales revealing that 75 units were sold @ $140 per unit. Their expenses in respect of the consignment were as follows:

• Unloading charges: $75
• Carriage: $25
• Godown rent: $60

Gupta & Co. was allowed a commission of 10% on gross sale proceeds.

Required: Prepare journal eateries and draw up consignment account in the books of Atif & Co.

Solution

• Journal entries in the books of Atif & Co:

• Consignment to Mumbai account

Notice that the loading on goods sent on consignment has been credited and the loading on closing stock has been been debited to the Consignment to Mumbai Account. This action removes the excess price that was added to the original cost of goods and is necessary to calculate the correct profit on consignment.

Working note 1: Calculation of stock on consignment:

Working note 2: Calculation of excess price or loading on goods sent:

The goods were consigned at cost plus 20%. The cost of 100 units @ $100 is $10,000 and the excess price or loading can be computed as follows:

= ($12,000/120) × 20
= $2,000

or

100 units × $20
= $2,000

Working note 3: Calculation of excess price or loading on closing stock:

= (1,800/120) × 20
= $300

Or

15 units × $20
= $300

Wholesale Branch System

Under this system, the goods are invoiced at the wholesale price to a retail branch. Opening stock and closing stock of branch will be shown at the wholesale price and unrealized profits in closing stock will be debited as stock reserve to profit and loss account of head office. Similarly, the stock reserve of opening stock will be credited to profit and loss account of head office.

There are many producers, now-a-days, who have their own retail shop (Branch). It deals in both retail and wholesale transactions. The profit rates earned by Branches differ between the retail sale and wholesale. Here, it is necessary to account the additional profit made by a Branch through retail trading over the wholesale trading. Wholesale price is always less than retail price.

For instance, the cost of a product is Rs 100, the wholesale price is Rs 140 and the retail price is Rs 160. If the Branch sells the product, the profit will be Rs 60; but the real profit earned by the Branch is Rs 20 (Rs 160 – 140), which is the contribution of Branch. The profit of Rs 40 (Rs 140 – Rs 100) would have been made by the Head Office by selling on wholesale basis to others.

Under this situation, to find out the real profit earned by a Branch, the Head Office charges the Branch with wholesale price. This facili­tates the Head Office to know the retail profit earned by a Branch. In other words, the difference between the wholesale price and selling price is the pure profit on retailing.

The Head Office sends the goods to Branch at wholesale price and in case all the goods have been sold, there is no problem. If not, the unsold goods lying with the Branch will be at invoice price and in such case adjustment for the unrealized profit of the Head Office Trading Account must be made through Branch Stock Reserve Account in order to find out true profit of the concern as a whole.

Ascertain the profit that you consider as having been earned by the Delhi Branch of Jaipur Industries Ltd. from the following:

(a) For Branch Trading:

(i) Branch Trading account is debited with the opening Stock at invoice price (i.e., wholesale price) and is credited with the Closing Stock at invoice price (i.e., wholesale price).

(ii) Branch Trading Account is debited with the goods sent to Branch at invoice price (i.e., wholesale price) and is credited with the retail price of goods sold.

(b) For Head Office Trading:

The Head Office Trading Account will be debited with opening stock, purchase of goods and the same is credited with Goods sent to Branch at invoice price, direct sales (at wholesale price) and along with the Closing Stock (at Cost).

If there is any closing stock in the hand of Branch, a Stock Reserve Account is to be opened by debiting Profit & Loss Account and crediting Stock Reserve Account. In the case of opening stock, the entry will be reversed.

At Cost Price/Invoice Price Basis (i.e.):

Where Branch Trading and Profit and Loss Account are Opened:

Branch Trading and Profit and Loss Account method is an alternative approach for ascertaining Branch Gross Profit and Net Profit. Branch Trading Account is debited by crediting Opening Stock; Goods sent to Branch etc. and is credited by debiting sales and closing stock.

The difference between the two sides represents Gross Profit or Gross Loss which will ultimately be transferred to Branch Profit and Loss Account Similarly, Branch Profit and Loss Account is debited by crediting all branch expenses account and is credited by debiting all branch incomes account, i.e., the principles of closing entries are to be followed.

The difference between the two sides of Branch P & L A/C represents Net Profit or Net Loss which will be transferred to General Profit and Loss Account.