Tag: Double Entry

Impairment

In accounting, the decrease in the net asset value of an asset due to the carrying amount of the asset exceeding the recoverable amount thereof. The effect of impairment constitutes the decrease in asset values per the Statement of Financial Position and a corresponding amount recognised through profit or loss in respect of the impairment loss.

Impairment describes a permanent reduction in the value of a company’s asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company’s balance sheet.

Impairment is commonly used to describe a drastic reduction in the recoverable amount of a fixed asset. Impairment may occur when there is a change in legal or economic circumstances surrounding a company or a casualty loss from unforeseen devastation.

Factors could lead to the value of the asset declining:

Change in legal climate: It’s also possible that a lawsuit, court case, or some other change to the general business/legal climate could cause a reduction in value of the asset. For example, if a worker gets injured while using your equipment and sues your company, you may not be able to use the asset until the legal situation is resolved.

Market downturn: If the market takes a dip, then the fair market value of an asset may end up being less than its book value. For example, if the real estate market experiences a downturn, then any land or property that you’re holding as an asset could decline in value.

Escalating costs: You may experience a situation where the running costs to maintain an asset are more than you were expecting when you made the initial investment, or the running costs have simply escalated over time, leading to a reduction in overall value.

Impairment vs. Depreciation and Amortization

Impairment of assets may sound similar to the accounting processes of depreciation and amortization (a reduction in the value of an asset over the course of its useful life). While there are some relatively clear similarities between the two concepts, there’s one key distinction: impairment denotes a sudden, irreversible drop in value, whereas depreciation/amortisation reduces the value of the asset over its entire lifetime. So, whereas impairment accounts for unusual drops in an asset’s value, depreciation and amortisation is generally used for standard wear and tear.

Fixed assets, such as machinery and equipment, depreciate in value over time. The amount of depreciation taken each accounting period is based on a predetermined schedule using either straight line or one of multiple accelerated depreciation methods. Depreciation schedules allow for a set distribution of the reduction of an asset’s value over its entire lifetime. Unlike impairment, which accounts for an unusual and drastic drop in the fair value of an asset, depreciation is used to account for typical wear and tear on fixed assets over time.

Asset Retirement Obligation

An Asset Retirement Obligation (ARO) is a legal obligation associated with the retirement of a tangible long-lived asset in which the timing or method of settlement may be conditional on a future event, the occurrence of which may not be within the control of the entity burdened by the obligation. In the United States, ARO accounting is specified by Statement of Financial Accounting Standards (SFAS, or FAS) 143, which is Topic 410-20 in the Accounting Standards Codification published by the Financial Accounting Standards Board. Entities covered by International Financial Reporting Standards (IFRS) apply a standard called IAS 37 to AROs, where the AROs are called “provisions”. ARO accounting is particularly significant for remediation work needed to restore a property, such as decontaminating a nuclear power plant site, removing underground fuel storage tanks, cleanup around an oil well, or removal of improvements to a site. It does not apply to unplanned cleanup costs, such as costs incurred as a result of an accident.

Firms must recognize the ARO liability in the period in which it was incurred, such as at the time of acquisition or construction. The liability equals the present value of the expected cost of retirement/remediation. An asset equal to the initial liability is added to the balance sheet, and depreciated over the life of the asset. The result is an increase in both assets and liabilities, while the total expected cost is recognized over time, with the accrual steadily increasing on a compounded basis.

An asset retirement obligation (ARO) is a legal obligation that is associated with the retirement of a tangible, long-term asset. It is generally applicable when a company is responsible for removing equipment or cleaning up hazardous materials at some agreed-upon future date.

The purpose of asset retirement obligations is to act as a fair value of a legal obligation that a company undertook when it installed infrastructure assets that must be dismantled in the future (along with remediation efforts to restore their original state). The fair value of the ARO must be recognized immediately, so the present financial position of the company is not distorted; however, it must be done reliably.

AROs ensure that known future problems are planned for and resolved. In the real world, they are utilized mainly by companies that typically use infrastructure in their operations. A good example is oil and gas companies.

Calculating AROs

When a company installs a long-term asset with future intentions of removing it, it incurs an ARO. To recognize the obligation’s fair value, CPAs use a variety of methods; however, the most common is to use the expected present value technique. To use the expected present value  technique, you will need the following:

• Discount Rate

Acquire a credit-adjusted, risk-free rate to discount the cash flows to their present value. The credit rating of a business may affect the discount rate.

• Probability Distribution

When calculating the expected values, we need to know the probability of certain events occurring. For example, if there are only two possible outcomes, then you can assume that each outcome comes with a 50% probability of happening. It is recommended you use the probability distribution method unless other information must be considered.

To calculate the expected present value of an ARO, companies should observe the following iterative steps:

• Estimate the timing and cash flows of retirement activities.
• Calculate the credit-adjusted risk-free rate.
• Note any increase in the carrying amount of the ARO liability as an accretion expense by multiplying the beginning liability by the credit-adjusted risk-free rate for when the liability was first measured.
• Note whether liability revisions are trending upward, then discount them at the current credit-adjusted risk-free rate.
• Note whether liability revisions are trending downward, then discount the reduction at the rate used for the initial recognition of the related liability year.

IFRS 15 specifies how and when an IFRS reporter will recognise revenue as well as requiring such entities to provide users of financial statements with more informative, relevant disclosures. The standard provides a single, principles based five-step model to be applied to all contracts with customers.

IFRS 15 was issued in May 2014 and applies to an annual reporting period beginning on or after 1 January 2018. On 12 April 2016, clarifying amendments were issued that have the same effective date as the standard itself.

Contracts with customers will be presented in an entity’s statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s payment.

A contract liability is presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity performing by transferring the related good or service to the customer.

Where the entity has performed by transferring a good or service to the customer and the customer has not yet paid the related consideration, a contract asset or a receivable is presented in the statement of financial position, depending on the nature of the entity’s right to consideration. A contract asset is recognised when the entity’s right to consideration is conditional on something other than the passage of time, for example future performance of the entity. A receivable is recognised when the entity’s right to consideration is unconditional except for the passage of time.

Contract assets and receivables shall be accounted for in accordance with IFRS. Any impairment relating to contracts with customers should be measured, presented and disclosed in accordance with IFRS 9. Any difference between the initial recognition of a receivable and the corresponding amount of revenue recognised should also be presented as an expense, for example, an impairment loss.

Disclosures

The disclosure objective stated in IFRS 15 is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Therefore, an entity should disclose qualitative and quantitative information about all of the following:

• Its contracts with customers;
• The significant judgments, and changes in the judgments, made in applying the guidance to those contracts;
• Any assets recognised from the costs to obtain or fulfil a contract with a customer.

Entities will need to consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the requirements. An entity should aggregate or disaggregate disclosures to ensure that useful information is not obscured.

In order to achieve the disclosure objective stated above, the Standard introduces a number of new disclosure requirements.

Recoupment of Short workings refers to the process by which a tenant can recover the difference between the minimum rent (dead rent) and the actual royalty payment when production or output falls short. There are two primary methods for recouping short workings: the Fixed Method and the Floating Method. Each method has its unique characteristics, applications, and implications for both the landlord and the tenant.

Fixed Method

Fixed Method of recoupment involves a straightforward approach to recovering short workings. Under this method, the tenant is allowed to offset the short workings against future royalty payments based on a fixed formula. Here’s how it works:

When the actual royalty earned in a given period is less than the minimum rent due, the short workings are calculated as follows:

Short Workings = Minimum Rent − Actual Royalty Earned

For example, if the minimum rent is ₹100,000, and the actual royalty earned during the period is ₹70,000, the short workings would amount to ₹30,000.

Recoupment Process:

In subsequent periods, the tenant can recoup the short workings amount by reducing their royalty payments. The amount recouped each period is fixed and agreed upon in advance, meaning that the tenant can offset a specific portion of the short workings against their future royalty liabilities.

If, in the next period, the tenant earns ₹120,000 in royalty, they would pay only ₹90,000 (₹120,000 – ₹30,000) after recouping the short workings.

Advantages

• Predictability:

The fixed amount allows both parties to predict future cash flows, making it easier for the tenant to manage cash flow and budgeting.

• Simplicity:

The fixed method is straightforward to implement, requiring less complex calculations compared to other methods.

Disadvantages

• Limited Flexibility:

This method can be restrictive for tenants with fluctuating output levels. If a tenant experiences significantly higher production levels in subsequent periods, they may prefer a more flexible recoupment approach.

• Potential for Underpayment:

If the fixed recoupment is too conservative, the landlord may receive less than expected in royalties if production is consistently high.

Floating Method

Floating Method of recoupment offers more flexibility in recovering short workings by allowing the tenant to adjust the amount of short workings to be recouped based on actual production levels in future periods. This method takes a more dynamic approach compared to the fixed method.

Similar to the fixed method, short workings are calculated in the same manner. However, under the floating method, the tenant can recoup short workings based on a percentage of the output or sales in future periods. The tenant may adjust the recoupment amount depending on their actual performance.

For example, if a tenant has short workings of ₹30,000 and the actual royalty earned in the next period is ₹150,000, the tenant might decide to recoup a percentage of that amount instead of a fixed sum.

Recoupment Process:

The tenant can recoup a variable amount of short workings in future periods based on their revenue. This flexibility allows them to manage their cash flow according to their production capabilities. If the tenant earns ₹150,000 in royalties, they might recoup 50% of their short workings, amounting to ₹15,000, leaving them to pay ₹135,000.

Advantages:

• Flexibility:

The floating method allows tenants to adjust the recoupment based on their financial performance, accommodating fluctuations in production or sales.

• Maximized Payments:

Tenants can maximize their payments in high-production periods while still recovering short workings, ensuring that the landlord receives appropriate compensation based on actual usage.

Disadvantages:

• Complexity:

The floating method requires more detailed tracking and calculations, which may lead to increased administrative costs for both parties.

• Uncertainty for Landlords:

Landlords may face uncertainty regarding their cash flow, as recoupment amounts can vary significantly based on tenant performance.

Royalty accounts refer to the financial records and statements that track royalty payments made by a licensee to a licensor for the use of intellectual property or natural resources. They ensure accurate accounting of revenues, expenses, and obligations.

1. Landlord (Lessor)

Landlord, also known as the lessor, is the owner of the property, asset, or natural resource being leased. In royalty agreements, the landlord grants the tenant the right to extract resources (such as minerals or oil) or use intellectual property in exchange for royalty payments. The landlord benefits by receiving periodic payments based on the usage or output from the leased property or asset.

2. Tenant (Lessee)

Tenant, also referred to as the lessee, is the party that obtains the right to use the landlord’s property, resource, or asset by making royalty payments. The tenant may be a company or an individual that uses the property or asset for activities like mining, production, or intellectual property usage. The tenant’s obligation is to pay royalties to the landlord based on an agreed formula, typically related to production or revenue.

3. Output

Output refers to the total quantity of production or extraction that occurs from the resource or asset being leased. For example, in a mining operation, the output could refer to the quantity of minerals extracted from the mine. The royalty payments made by the tenant to the landlord are often calculated as a percentage of this output, or based on the revenue generated from the sale of the output.

4. Minimum Rent (Dead Rent)

Minimum Rent, also known as Dead Rent, is the minimum amount of royalty the tenant must pay to the landlord, regardless of the level of production or output. Even if the output is low or zero, the tenant is obligated to pay this minimum amount. The purpose of dead rent is to ensure that the landlord receives a guaranteed payment, even during periods of low production. In years of high output, royalties are calculated based on production, but if production falls short, the tenant still pays the minimum rent.

5. Short Workings

Short Workings occur when the actual royalty based on output is less than the minimum rent (dead rent) payable by the tenant. In such cases, the tenant is still required to pay the minimum rent, but the difference between the minimum rent and the actual royalty is referred to as short workings. Short workings can sometimes be recovered or adjusted in future periods if production increases.

6. Recoupment of Short Workings

 Recoupment of Short Workings is a provision in royalty agreements that allows the tenant to recover or adjust the short workings against future royalty payments when output levels increase. If the actual royalty in subsequent periods exceeds the minimum rent, the tenant can offset the previous short workings by paying the lower royalty amount until the short workings are fully recouped. There is usually a time limit within which short workings can be recouped, beyond which they are considered irrecoverable.

Example:

Suppose the minimum rent is set at ₹100,000 per year, and the actual royalty based on output in a particular year is ₹80,000. The short workings will be ₹20,000 (₹100,000 – ₹80,000). If in the following year the royalty exceeds the minimum rent, say it is ₹120,000, the tenant can recoup the ₹20,000 short workings from the previous year and pay only ₹100,000.

Cost Price Method

The consignor wants to know two things which are:

(1) To ascertain profit or loss when goods on consignment sold by the consignee.

(2) To know the settlement of account by the consignee i. e. to know the amount due by or due to consignee.

The consignment account is opened by the consignor to know profit or loss on each consign­ment. Each consignment is distinguished from the other by naming it in respect to place, examples, Consignment to Madras, Consignment to Bombay etc.

If there are a number of consignments in one place, then the name of the consignee is added to the consignment account, for example: Consign­ment to Ramu Account, Consignment to Krishna Account etc. For that, he opens a Consignment Account for each consignment.

It is revenue (Nominal) Account. It is a special Trading and Profit and Loss Account. Consignee Account is prepared to know the amount due by or due to the Con­signee. It is a personal account.

Journal Entries:

Following are the set of journal entries in the books of Consignor:

(1) When the Goods are Sent on Consignment:

Consignment Account Dr

  To Goods Sent on Consignment A/c

(Being the cost of goods sent on Consignment)

(2) When Expenses are Incurred by the Consignor:

Consignment Account Dr.

  To Bank/Cash Account

(Being the expenses incurred on Consignment)

(3) When Advance is Received from Consignee:

Cash/Bank/Bill Receivable Account Dr.

  To Consignee Account

(Being the amount of advance received from Consignee)

(4) When the Bill is Discounted by the Consignor with his Banker:

Bank Account Dr.

Discount Account Dr.

  To Bills Receivable A/c

(Being the Bill is discounted)

Note: The Discount on Bills can be transferred to Profit and Loss Account or to the Consignment Account. Since it is a cost of raising finance, it can be transferred to Profit and Loss Account.

After the Consignee sends the Account Sales:

(5) When the Gross Sales Proceeds are Reported by the Consignee:

Consignee Account Dr.

  To Consignment Account

(Being the gross sales proceeds reported by the Consignee)

(6) For Expenses Incurred by the Consignee:

Consignment Account Dr.

  To Consignee Account

(Being the expenses incurred by the Consignee)

(7) For Commission Payable to the Consignee:

Consignment Account Dr.

  To Consignee Account

(Being the Commission due to Consignee)

(8) For Unsold Stock Remaining with the Consignee:

Consignment Stock Account Dr.

  To Consignee Account

(Being the value of unsold stock)

(9) For Transferring the Profit or Loss to Profit and Loss:

For Profit:

Consignment Account Dr.

  To Profit and Loss Account

(Being the profit transferred to Profit & Loss Account)

For Loss:

Profit and Loss Account Dr.

  To Consignment Account

(Being the loss on consignment transferred to Profit & Loss A/c)

(10) For Settlement of Account by the Consignee:

Generally, the balance amount is settled by the Consignee when he sends the Account Sales:

Bank/Cash/Bill Receivable Account Dr.

  To Consignee Account

(Being the amount due from Consignee is received)

(11) When Goods Sent on Consignment Account is Closed:

Goods sent on Consignment Account Dr.

  To Trading/Purchase Account

(Being the amount of goods sent on Consignment)

Note: If it is a manufacturing concern, then the Goods sent on Consignment account is closed by transfer­ring it to Trading Account. If it is a trading concern, then it is closed by transferring it to Purchase Account.

Invoice Price Method

The preparation of journal entries and ledger accounts under invoice price method is much similar to the cost price method, except for some adjusting entries that are required to remove excess price on goods and bringing their value down to the cost. The removal of excess price or loading is essential to know the actual profit earned by the consignment.

The journal entries that are made in the books of consignor under cost price method have been given here. In this article, we will discuss only those entries that are required to eliminate the impact of excess price or loading.

The Consignor, instead of sending the goods on consignment at cost price, may send it at a price higher than the cost price. This price is known as Invoice Price or Selling Price. The difference between the cost price and the invoice price of goods is known as loading or the higher price over the cost. This is done with a view to keep the profits on consignment secret.

As such, consignee could not know the actual profit made on consignment. Hence the consignor sends the Proforma invoice at a higher price than the cost price. When the consignor records the transaction in his book at invoice price, some additional entries have to be passed in order to eliminate the excess price and to arrive at the correct profit or loss on consignment.

Items on Which Excess Price is to be Calculated:

Excess Price or Loading is to be calculated on the following items:

1. Consignment stock at the beginning
2. Goods sent on consignment
3. Goods returned by the consignee
4. Consignment stock at the end of the period

(a) To Remove the Excess Price in the Opening Stock:

Consignment Stock Reserve A/c Dr.

  To Consignment Account

(Being the excess value of opening stock is brought down to cost price)

(b) To Remove the Excess Price in the Goods Sent on Consignment:

Goods sent on Consignment Account Dr.

  To Consignment Account

(Being the difference between the invoice price and cost price is adjusted)

(c) To Remove the Excess Price in Goods Return:

Consignment Account Dr.

  To Goods sent on Consignment A/c

(Being to bring down the value of goods to cost price)

(d) To Remove the Excess Price in Closing Stock:

Consignment Account Dr.

  To Consignment Stock Reserve A/c

(Being the excess value of stock is adjusted)

But these adjustments are not needed in consignee’s book. Invoice price does not affect the consignee. When the stock is shown in the Balance Sheet, in Consignor’s Book, the Consignment Stock Reserve is deducted.

Entries

1. Journal entry for adjusting the value of opening stock

Stock reserve [Dr]

Consignment [Cr]

2. Journal entry for adjusting the value of goods sent on consignment:

Goods sent on consignment [Dr]

Consignment [Cr]

3. Journal entry for adjusting the value of abnormal loss:

Consignment [Dr]

Abnormal loss [Cr]

4. Journal entry for adjusting the value of stock on consignment:

Consignment [Dr]

Stock reserve [Cr]

When balance sheet is prepared at the end of accounting period, the balance of the stock reserve account is shown as deduction from the value of stock on consignment.

Section 2 (4) of the sale of Goods Act defines a Document of title to goods as “A document used in the ordinary course of business as a proof of possession or control of goods authorizing or purporting to authorize either by endorsement or delivery, the possessor of the documents to transfer or to receive the goods thereby represented.”

Essential requirements of a Document of Title to Goods:

• The mere possession of the document creates a right by law or trade or usage, to possess the goods represented by the Document.
• Goods represented by documents are transferrable by endorsement and/or delivery of the document. The transferee can take the delivery of the goods in his own right.
• Bill of Lading, Dock-warrant, Warehouse-keeper certificate, Railway receipt and delivery orders, etc. can be said as the documents of title to goods.

Risk in Advance against Document of Title to goods:

1. Possibility of Fraud Dishonesty:

• It may happen that the documents may be forged one or the quantity written within the documents may be fraudulently altered.
• The shipping and railway authorities too do not testify such documents; they only testify the number of bags or packages received for the purpose of transportation.

2. Not Negotiable Document:

• These documents are not negotiable instruments like cheque, bill of exchange and promissory note.
• Here banker cannot have better title, if the documents are forged or stolen one.

3. Forgery of Endorsement:

• “Forgery conveys no title”, therefore, in case of forged endorsement banker cannot assert his right of ownership.

4. Right of stoppage in transit is with the unpaid seller:

• If the buyer becomes insolvent before the goods are delivered to him, the unpaid seller can stop the goods in transit.

Precautions to be taken by the banker at the time of Advancing against the documents of title to goods:

1. Integrity of the customer: In order to avoid risk of fraud the banker should take into account the character, capacity and capital of the customer. Banker should only accept the documents as security from honest, reliable and trustworthy customers.
2. Certificate of Packing: Banker should always ask for the certificate to ascertain the content of the packages or bags.
3. Supervise the Packing: the banker should depute a representative to supervise the packing.
4. No Onerous Condition: If the document of the title to goods contains any onerous remark, it make it unfit to be a security. The banker should avoid to advance against such documents.
5. Endorsement in Blank: The banker should get the document endorsed in blank, or the liability to pat the freights will be on the part of banker and not of the customers.
6. Insurance against Risk: The goods must be insured against the risks like Fire and theft for its full value. The banker should ask for the insurance policy before granting advances against such documents.
7. Special care in realizing the goods: It is advisable on the part of the banker, not to part with the security before repayment of advances.
8. Other Precautions:

• Proper examination to ensure the originality and recent origin of the document.
• Insurer must be a reliable person or firm for the goods in the document.
• To obtain a general stamped letter for the purpose of Hypothecation.

Documents of Title to Goods

1. Bill of Lading:

• Meaning: “A document issued by the shipping company acknowledging the receipt of goods to be transported to a specified port. It also contains the conditions for such transportation of goods and full description of the goods, i.e., their markings and contents as declared by the consignor.”
• Contents/Items in Bill of Lading:

1. Names of Consignor and consignee
2. Names of the ports of departure and destination
3. Name of Vessel
4. Date of departure and arrival
5. List of goods being transferred
6. Number of packages and kind of packaging
7. Marks and numbers on packages.
8. Weight of the goods
9. Freight and amount
10. Description of goods

2. Warehouse keeper’s certificate (wharfinger’s Certificate or warehouse Certificate:

“Warehouse receipt means an acknowledgement in writing or in electronic form issued by the warehouse keeper or by his duly authorized representative.” • Warehouse means a store where goods are accepted temporarily for safe keeping. On the receipt of the goods a warehouse keeper gives a certificate known as warehouse keeper’s certificate.

• Under the Bombay Warehouse Act 1959, the warehouse receipt shall be transferable by endorsement.

3. Dock- warrant:

“A Dock- Warrant is the document issued by a dock company in exchange of goods received.”

Key points of Dock-warrant;

1. The document possesses title to goods and the person named in can obtain the possession of the goods stored at the dock.
2. It is not a receipt, but it is a warranty only.
3. It can be transferred by endorsement and delivery.

Precautions in the case of Dock-Warrant:

1. Before advancing against the dock-warrant, the banker must be satisfied with the integrity and the financial condition of the customer.
2. It is to be verified that the dock company is having the authority of lien on goods or not.
3. To prevent the unauthorized dealing of the goods, the banker should get himself registered as owner of the goods.

4. Railway Receipt:

It is a document issued by the Railway authority acknowledging the receipt of the goods for the purpose of transportation to a space specified therein.

It cannot be transferred by endorsement and delivery.

Precautions to be taken by the banker in case of Railway Receipt:

1. Documentary bill of well–established parties only should be accepted/discounted.
2. To examine the authenticity of the railway receipt, banker should examine it carefully.
3. The railway receipt should be endorsed in favour of bank. (bank should be made consignee by endorsement)
4. There should not be any alteration in the receipt other than the competent authority.
5. The goods must be covered by the insurance against fire, theft and damage in transit.
6. The banker should accept only ‘Freight Paid’ railway receipt, as banker would ot be paying any freight due.
7. To ensure the validity and the availability of the goods the date of the receipt should be checked carefully.
8. Advance should not be granted in case if the receipt contains the information regarding the damaged goods or defective packing.
9. Delivery Order:

• Delivery order is an order issued by the owner of the goods to the warehouse keeper to deliver the goods to a particular person.
• According to the Uniform Commercial Code, “A delivery order refers to an order given by an owner of a goods to a person in possession of the warehouse keeper directing that person to deliver the goods to a person named in the order.”
• it is the document issued by the transporter or the carrier of the goods directly if they have their own office at the destination. The holder of the delivery order must either take delivery of the goods or obtain a receipt or warrant from warehouse keeper or get his title of goods registered in the books of the warehouse keeper.

Under invoice price method, the goods are consigned to the consignee at a price which is higher than their original cost. The proforma invoice is prepared by adding a certain percentage of the cost price or the sales price to the original cost of the goods.

The invoice price method is adopted to achieve one or more of the following purposes:

• Sending goods to consignee not at original cost but at a higher price helps keep the consignment profit secrete.
• Its incentives consignee to realize the best possible price on sale of goods.
• It makes consignee charge uniform price to all the customers.

Items on Which Excess Price is to be Calculated:

Excess Price or Loading is to be calculated on the following items:

1. Consignment stock at the beginning
2. Goods sent on consignment
3. Goods returned by the consignee
4. Consignment stock at the end of the period

(a) To Remove the Excess Price in the Opening Stock:

Consignment Stock Reserve A/c Dr.

  To Consignment Account

(Being the excess value of opening stock is brought down to cost price)

(b) To Remove the Excess Price in the Goods Sent on Consignment:

Goods sent on Consignment Account Dr.

  To Consignment Account

(Being the difference between the invoice price and cost price is adjusted)

(c) To Remove the Excess Price in Goods Return:

Consignment Account Dr.

  To Goods sent on Consignment A/c

(Being to bring down the value of goods to cost price)

(d) To Remove the Excess Price in Closing Stock:

Consignment Account Dr.

  To Consignment Stock Reserve A/c

(Being the excess value of stock is adjusted)

But these adjustments are not needed in consignee’s book. Invoice price does not affect the consignee. When the stock is shown in the Balance Sheet, in Consignor’s Book, the Consignment Stock Reserve is deducted.

Journal entries under invoice price method

The preparation of journal entries and ledger accounts under invoice price method is much similar to the cost price method, except for some adjusting entries that are required to remove excess price on goods and bringing their value down to the cost. The removal of excess price or loading is essential to know the actual profit earned by the consignment.

The journal entries that are made in the books of consignor under cost price method have been given here. In this article, we will discuss only those entries that are required to eliminate the impact of excess price or loading.

1. Journal entry for adjusting the value of opening stock

Stock reserve [Dr]

Consignment [Cr]

2. Journal entry for adjusting the value of goods sent on consignment:

Goods sent on consignment [Dr]

Consignment [Cr]

3. Journal entry for adjusting the value of abnormal loss:

Consignment [Dr]

Abnormal loss [Cr]

4. Journal entry for adjusting the value of stock on consignment:

Consignment [Dr]

Stock reserve [Cr]

When balance sheet is prepared at the end of accounting period, the balance of the stock reserve account is shown as deduction from the value of stock on consignment.

In accounting, Ledgers are the backbone of financial recording. A ledger is a book or record that contains all accounts related to assets, liabilities, income, and expenses. In TallyPrime, ledgers are created under predefined Groups that classify them into categories such as Assets, Liabilities, Direct Expenses, Indirect Income, etc. Groups act like a classification framework, while ledgers record specific transactions under those categories. For example, “Cash” is a ledger under the “Cash-in-Hand” group, and “Salaries” is a ledger under the “Indirect Expenses” group. Together, groups and ledgers form the foundation of a company’s accounting system.

Process of Ledger Creation in TallyPrime:

Step 1. Accessing Ledger Creation in TallyPrime

The process of creating a ledger begins from the Gateway of Tally. After launching TallyPrime and selecting the desired company, navigate to Create → Ledger. This menu allows users to define a new ledger for accounting purposes. TallyPrime provides a simplified interface where all essential details such as ledger name, group classification, and balances are entered. Accessing the ledger creation option is the very first step, as it ensures that all transactions can be systematically recorded under the correct head, forming the backbone of financial reporting and analysis.

Step 2. Entering Ledger Name

Once inside the ledger creation screen, the first important field is the Ledger Name. This should be meaningful, clear, and directly related to the account it represents. For example, names such as “Cash,” “HDFC Bank,” “Sales,” or “Salary Expense” can be used. A proper naming convention avoids confusion while recording entries and generating reports. Businesses may adopt consistent prefixes or suffixes to distinguish between different accounts. For instance, “Sales – Domestic” and “Sales – Export” make identification easier. A clear ledger name ensures proper categorization and easier recognition during day-to-day accounting operations.

Step 3. Selecting the Appropriate Group

The next critical step is to assign the ledger to a suitable Group. In TallyPrime, groups are categories such as Assets, Liabilities, Income, and Expenses. For example, “Cash” falls under the group Cash-in-Hand, “Rent” under Indirect Expenses, and “HDFC Bank” under Bank Accounts. Selecting the right group ensures the ledger contributes accurately to financial statements like the Balance Sheet and Profit & Loss Account. Misclassification here can distort reports, making decision-making difficult. Thus, groups serve as the foundation, ensuring that every ledger aligns correctly with the company’s financial framework.

Step 4. Providing Opening Balances

TallyPrime allows users to enter an Opening Balance while creating a ledger, which is essential when starting accounts for a new financial year or migrating from manual records. For example, if a company has ₹50,000 in cash on hand, this amount should be recorded as the opening balance in the “Cash” ledger. Similarly, outstanding creditors or debtors are entered with their balances. Opening balances provide a starting point for accounting records, ensuring continuity and accuracy in financial tracking. Without them, current transactions cannot reflect the true financial position of the business.

Step 5. Saving and Reviewing the Ledger

After filling in details such as name, group, and opening balance, the final step is to Save the ledger. Once saved, it becomes available for use in vouchers and transactions. However, before saving, it is advisable to review all details to ensure accuracy. Errors like misgrouping or incorrect balances can affect the entire accounting cycle. TallyPrime also allows editing of ledgers later, but careful entry at the start reduces mistakes. Reviewing helps maintain consistency and prevents the need for frequent corrections, which could otherwise disrupt financial statements and reports.

Step 6. Using the Created Ledger in Transactions

Once the ledger is created, it becomes functional within TallyPrime. Users can immediately use it while recording Vouchers, such as Sales, Purchases, Payments, and Receipts. For instance, the “Cash” ledger can be used in a payment voucher, while “Rent Expense” can be applied to a journal entry. The system automatically updates balances, ensuring real-time accuracy of books. This integration of ledgers into transaction processing makes TallyPrime a powerful accounting tool. By correctly setting up ledgers at the start, businesses ensure seamless operations and accurate financial analysis throughout the accounting period.

Process of Group Creation in TallyPrime:

Step 1. Accessing the Group Creation Option

The first step in group creation is to access the Group Creation screen from the Gateway of Tally. After selecting the active company, navigate to Create → Group. This option allows users to define new groups, which serve as categories for classifying ledgers. Groups are the foundation of TallyPrime’s accounting structure, ensuring proper segregation of accounts under Assets, Liabilities, Income, and Expenses. Accessing this option ensures that before creating ledgers, businesses can establish a strong categorization system to maintain clarity in financial reporting and smooth voucher entries.

Step 2. Naming the Group

Once inside the group creation screen, the first detail to be entered is the Group Name. This name should be clear and descriptive, as it helps in identifying the purpose of the group. For instance, groups can be created as “Sundry Debtors,” “Sundry Creditors,” “Fixed Assets,” or “Direct Expenses.” A logical naming convention avoids confusion and makes future ledger creation more streamlined. Choosing a precise name for the group is important because it directly impacts how ledgers and accounts are classified, making financial analysis easier and more systematic.

Step 3. Selecting Primary or Sub-Group

The next step is to specify whether the new group is a Primary Group or a Sub-Group. A primary group stands independently, such as “Assets” or “Liabilities,” while a sub-group is created under an existing group. For example, “Office Equipment” can be a sub-group under “Fixed Assets.” This classification is crucial for hierarchical arrangement in financial statements. Choosing the right level ensures that related ledgers are properly aligned in reports, providing clarity. Sub-groups enhance flexibility by breaking down broad categories into smaller, more detailed classifications for accurate reporting.

Step 4. Specifying Nature of Group

TallyPrime requires specifying the Nature of Group, such as whether it relates to Assets, Liabilities, Income, or Expenses. This step ensures that the group is reflected appropriately in the Balance Sheet or Profit & Loss Account. For instance, a group like “Direct Expenses” impacts the profit calculation, while “Loans” affect liabilities. By specifying the nature of the group, businesses maintain consistency in financial reporting. This step eliminates misclassification, which can otherwise distort the financial position. Proper categorization ensures smooth accounting operations and accurate representation of the company’s accounts.

Step 5. Setting Group Behaviors

After selecting the group nature, users can define Behavioral Settings for the group, such as whether it should calculate balances as debit or credit, or allow net debit/credit balances. For example, income groups usually have credit balances, while expense groups carry debit balances. These configurations help TallyPrime automatically manage postings and reports without manual intervention. Businesses can also decide if the group should be used in specific statements or excluded. Setting these behaviors reduces accounting errors and ensures smooth functioning, as the software follows predefined rules for the group.

Step 6. Saving and Utilizing the Group

The final step is to Save the group after reviewing all details. Once saved, the group becomes available for creating ledgers under it. For example, if a group “Bank Accounts” is created, ledgers such as “HDFC Bank” or “SBI Bank” can be added under it. The group thus acts as a parent category, simplifying the classification of ledgers. Groups ensure that all transactions fall under well-defined heads, making Balance Sheet and Profit & Loss reporting accurate. Proper group creation also helps during audits and decision-making, improving overall efficiency.

Importance of Ledger and Group Creation

• Systematic Recording – Ledgers classify and store transactions systematically.

• Financial Reporting – Groups allow TallyPrime to generate Balance Sheets, P&L A/c, and Trial Balance automatically.

• Error Prevention – Correct classification prevents mismatches in financial statements.

• Business Analysis – Helps management analyze income, expenses, assets, and liabilities in detail.

• Automation – Once groups and ledgers are created correctly, entries and reports flow automatically.

Key differences between Basic Ledger & Group Creation