Incorporation Entries in the Books of Purchasing Company

When a purchasing company acquires the assets and liabilities of a partnership firm or another company, incorporation entries are made in the books of the purchasing company. These entries serve to record the assets and liabilities taken over from the vendor (the selling company or firm) and to reflect the purchase consideration (which may be paid in cash, shares, debentures, or a combination thereof).

Steps Involved in Incorporation Entries:

  • Recording the Assets and Liabilities Taken Over:

The purchasing company needs to record all the assets (such as property, plant, equipment, inventory, receivables) and liabilities (like loans, payables, provisions) that it has taken over. These are recorded at their respective agreed values, which may be based on the purchase agreement or a valuation report.

  • Recording Purchase Consideration:

The purchase consideration, which is the total amount payable to the selling company (or its partners), is recorded as a liability in the purchasing company’s books. This consideration may be paid in cash, shares, debentures, or a combination of these.

  • Settling the Purchase Consideration:

Once the purchase consideration is settled (whether in cash, shares, or debentures), appropriate journal entries are passed.

Incorporation Entries – Journal Entries

The journal entries made by the purchasing company during the incorporation process can be summarized in the table below:

Date Particulars Debit (₹) Credit (₹) Narration
1 Assets A/c Dr. ₹XX
To Vendor’s Realization A/c ₹XX (Being assets taken over from the vendor at agreed values)
2 Vendor’s Realization A/c Dr. ₹XX
To Liabilities A/c ₹XX (Being liabilities of the vendor taken over)
3 Purchase Consideration A/c Dr. ₹XX
To Vendor’s Realization A/c ₹XX (Being purchase consideration payable to the vendor)
4 Purchase Consideration A/c Dr. ₹XX
To Cash/Bank A/c ₹XX (Being part of purchase consideration paid in cash)
5 Purchase Consideration A/c Dr. ₹XX
To Shares in Purchasing Company A/c ₹XX (Being purchase consideration settled through shares issued)
6 Purchase Consideration A/c Dr. ₹XX
To Debentures in Purchasing Company A/c ₹XX (Being purchase consideration settled through debentures issued)
7 Vendor’s Realization A/c Dr. ₹XX
To Capital A/c ₹XX (Being final settlement of purchase consideration with the vendor)

Explanation of Journal Entries:

  • Recording Assets Taken Over:

When assets are transferred from the vendor to the purchasing company, the assets are recorded in the purchasing company’s books at their agreed values. This is done by debiting the respective asset accounts and crediting the vendor’s realization account.

  • Recording Liabilities Taken Over:

Similarly, liabilities of the vendor (such as loans, creditors, provisions) are transferred to the purchasing company. These are debited to the vendor’s realization account and credited to the respective liability accounts.

  • Purchase Consideration Payable:

The total amount of purchase consideration payable to the vendor is recorded in the purchasing company’s books as a liability. This is done by debiting the purchase consideration account and crediting the vendor’s realization account.

  • Payment of Purchase Consideration in Cash:

When part of the purchase consideration is paid in cash, the bank account is debited and the purchase consideration account is credited.

  • Payment of Purchase Consideration through Shares:

If part of the purchase consideration is settled through the issuance of shares, the respective share capital account is credited.

  • Payment of Purchase Consideration through Debentures:

Similarly, if debentures are issued to settle the purchase consideration, the debenture account is credited.

  • Final Settlement with Vendor:

After all assets and liabilities are transferred, the purchase consideration is fully paid. The vendor’s realization account is closed by transferring the balance to the capital account.

Mode of Discharge of Purchase Consideration

When a business entity, such as a partnership firm, is converted into a limited company, the new company is required to settle or “discharge” the purchase consideration agreed upon. The discharge of purchase consideration refers to the method by which the purchasing company pays the agreed amount to the seller (partners of the firm). This discharge can be done in various modes, including cash, shares, or debentures.

The modes of discharge are broadly categorized as follows:

1. Discharge through Cash Payment

In this method, the purchasing company pays the entire or part of the purchase consideration in cash to the selling partners. This mode is simple and involves direct cash transactions.

Features

  • Suitable for quick settlements.
  • Immediate liquidity is provided to the selling partners.
  • Often used when the purchasing company has sufficient cash reserves.

Example

If the purchase consideration is ₹10,00,000 and the company pays ₹6,00,000 in cash, the balance can be settled using other modes.

2. Discharge through Equity Shares

The purchasing company can issue equity shares to the partners of the selling firm as part or full payment of the purchase consideration. Equity shares represent ownership in the company, providing partners with voting rights and dividends.

Features

  • Allows the selling partners to become shareholders in the new company.
  • Helps the purchasing company retain cash.
  • Suitable when the firm being acquired has long-term strategic importance.

Example

If the purchase consideration is ₹10,00,000, the company may issue 10,000 equity shares at a face value of ₹100 each to the selling partners, thereby discharging the entire amount through equity shares.

3. Discharge through Preference Shares

In some cases, the purchasing company may issue preference shares instead of equity shares. Preference shares offer a fixed rate of dividend but usually do not carry voting rights.

Features

  • Preference shares provide a fixed return to the selling partners.
  • Preferred when the selling partners are more interested in stable income than ownership control.
  • Helps in maintaining control with the existing shareholders of the purchasing company.

Example

If the purchase consideration is ₹10,00,000, the company may issue 1,000 preference shares at ₹1,000 each with a dividend rate of 8% to the partners.

4. Discharge through Debentures

The purchasing company may issue debentures to the selling partners. Debentures are debt instruments that provide a fixed interest rate and are redeemable after a specified period.

Features

  • Ensures a regular interest income to the selling partners.
  • Does not dilute ownership control of the purchasing company.
  • Suitable when the purchasing company prefers to treat the settlement as a debt obligation rather than ownership transfer.

Example

If the purchase consideration is ₹10,00,000, the company may issue 1,000 debentures at ₹1,000 each, carrying a fixed interest rate of 10%.

5. Combination of Cash and Securities

Often, the purchasing company may use a combination of cash, equity shares, preference shares, and/or debentures to discharge the purchase consideration. This method provides flexibility to both parties and allows for better negotiation terms.

Example

Suppose the purchase consideration is ₹20,00,000. The discharge may be structured as follows:

  • Cash payment: ₹5,00,000
  • Equity shares: ₹10,00,000 (10,000 shares at ₹100 each)
  • Debentures: ₹5,00,000 (500 debentures at ₹1,000 each with 9% interest)

This combination ensures liquidity (through cash), ownership interest (through equity shares), and fixed income (through debentures) for the selling partners.

6. Discharge through Business Assets

In some cases, the purchasing company may transfer specific business assets, such as property, plant, or machinery, to the selling partners in lieu of cash or securities. This method is less common but may be used in special circumstances.

Features

  • Suitable when the selling partners are interested in specific assets rather than monetary payment.
  • Helps the purchasing company reduce excess or non-essential assets.
  • May involve complex valuation and legal formalities.

Comparison of Different Modes

Mode Description Advantages Disadvantages
Cash Payment Full/partial settlement in cash Quick settlement, easy to understand Requires large cash reserves
Equity Shares Issue of ownership shares Provides ownership interest to sellers Dilutes control of existing shareholders
Preference Shares Issue of fixed dividend shares Fixed income for sellers, no dilution No voting rights for sellers
Debentures Issue of interest-bearing debt instruments Fixed income, no dilution Increases debt burden of purchasing company
Combination Mixture of cash, shares, and/or debentures Flexible, suits both parties May involve complex structuring
Business Assets Transfer of specific assets Reduces excess assets Involves complex valuation

Methods of Calculation of Purchase Consideration: Lump Sum Method, Net Assets Method, Net Payment Method

When a business, such as a partnership firm, is converted into a company or taken over by another entity, the purchase consideration refers to the amount payable by the purchasing company to the selling entity (partners of the firm) in exchange for the business’s assets and liabilities.

Lump Sum Method

Under the Lump Sum Method, a fixed amount is mutually agreed upon by both parties (the seller and the buyer) as the total purchase consideration. This method is straightforward and does not involve detailed valuation of individual assets and liabilities.

Features

  • No need to compute individual asset or liability values.
  • The agreed lump sum amount is considered as the purchase consideration.
  • This method is generally used when the parties want a quick transaction without detailed valuation.

Example

A partnership firm agrees to sell its business to a company for a lump sum of ₹15,00,000. This amount is the purchase consideration, and no further valuation of assets and liabilities is necessary.

Net Assets Method

In the Net Assets Method, the purchase consideration is calculated as the difference between the total assets taken over by the company and the total liabilities assumed by the company. This method involves valuing each asset and liability at its fair value.

Formula

Purchase Consideration = Total Assets Taken Over − Total Liabilities Assumed

Steps

  1. List all assets being transferred to the purchasing company.
  2. Assign fair values to each asset (considering appreciation or depreciation).
  3. List all liabilities being transferred.
  4. Deduct the total liabilities from the total value of assets to arrive at the purchase consideration.

Example

  • Assets taken over by the company:
    • Fixed Assets: ₹20,00,000
    • Inventory: ₹5,00,000
    • Debtors: ₹4,00,000
  • Liabilities taken over by the company:
    • Creditors: ₹6,00,000
    • Loan: ₹3,00,000

Purchase Consideration = (20,00,000 + 5,00,000 + 4,00,000) − (6,00,000 + 3,00,000) = 29,00,000 − 9,00,000 = ₹20,00,000

In this case, the purchase consideration is ₹20,00,000.

Net Payment Method

Under the Net Payment Method, the purchase consideration is determined as the total amount payable by the company to the selling entity. This includes payments made in cash, shares, or other securities.

Steps

  1. Determine the mode of payment (cash, equity shares, preference shares, debentures, etc.).
  2. Calculate the total value of payments to be made by the purchasing company.
  3. Add up the values of all forms of payment to arrive at the purchase consideration.

Example

A company agrees to take over a partnership firm and makes the following payments:

  • Cash payment: ₹10,00,000
  • Issue of equity shares (1,000 shares at ₹100 each): ₹1,00,000
  • Issue of preference shares (500 shares at ₹200 each): ₹1,00,000

Purchase Consideration = 10,00,000 + 1,00,000 + 1,00,000 = ₹12,00,000

Thus, the total purchase consideration payable by the company is ₹12,00,000.

Comparison of Methods

Method Basis Formula/Approach Use Case
Lump Sum Method Agreed fixed amount Agreed lump sum When quick valuation and agreement is needed
Net Assets Method Fair valuation of assets and liabilities Assets – Liabilities When accurate valuation of assets/liabilities is required
Net Payment Method Total payment by the company Sum of cash + shares + securities issued When purchase consideration involves multiple modes of payment

Partnership firm to Limited Company Conversion, Introduction, Objectives, Purchase Consideration

Conversion of a partnership firm into a limited company is a strategic decision taken by partners to achieve growth, financial stability, and limited liability. A partnership firm is characterized by personal liability of partners and limited capital, whereas a limited company enjoys perpetual existence, better access to funding, and the benefit of limited liability for its shareholders. This process involves transferring the assets and liabilities of the partnership firm to a newly formed or existing company in exchange for shares and/or other considerations.

Introduction

A partnership firm is governed by the Indian Partnership Act, 1932, and is suitable for small to medium-scale businesses. However, as businesses expand, they may need more capital, better organizational structure, and reduced risk exposure. Converting a partnership into a limited company helps the business in addressing these needs.

A limited company, formed under the Companies Act, 2013, provides partners (who become shareholders) with limited liability, better access to institutional finance, and improved business credibility. The conversion process ensures continuity of business operations and ownership while adhering to legal compliance.

Objectives of Conversion:

The main objectives behind converting a partnership firm into a limited company include:

  • Limited Liability:

In a partnership firm, the partners’ personal assets are at risk in case of business losses. By converting into a limited company, shareholders’ liability is restricted to the unpaid amount on shares held by them.

  • Perpetual Succession:

A partnership firm dissolves on the retirement, insolvency, or death of a partner. A limited company, on the other hand, continues to exist irrespective of changes in ownership or management.

  • Access to Capital:

A limited company can raise funds by issuing shares to the public, private investors, or financial institutions, thus ensuring better capital availability for expansion and growth.

  • Transferability of Shares:

Sares of a limited company can be easily transferred, ensuring flexibility in ownership changes.

  • Brand Image and Credibility:

Limited companies are perceived as more credible and stable in the market, making it easier to attract clients, investors, and business partners.

  • Tax Benefits:

Under the tax laws in India, companies often have more favorable tax treatment compared to partnership firms. Additionally, tax benefits such as carry forward of losses and depreciation may be availed.

  • Better Governance:

A company operates under a well-defined regulatory framework as per the Companies Act, ensuring transparency, accountability, and improved decision-making.

Purchase Consideration:

Purchase consideration refers to the amount that the limited company agrees to pay to the partnership firm in exchange for transferring its assets and liabilities. This is an important aspect of the conversion process, as it determines the value at which the partnership business is taken over by the company.

Methods of Calculating Purchase Consideration

  • Net Asset Method:

Under this method, the purchase consideration is determined by calculating the net assets of the partnership firm. The net assets are the difference between total assets and total liabilities.
Formula:

Purchase Consideration = Total Assets − Total Liabilities

  • Net Payment Method:

In this method, the purchase consideration is determined based on the total amount payable by the company to the partners of the firm. This includes payment in the form of shares, debentures, or cash.

  • Intrinsic Value Method:

This method considers the intrinsic or fair value of the firm’s assets and liabilities rather than their book value. This approach is often used when assets have appreciated in value over time.

Steps in Determining Purchase Consideration

  • Valuation of Assets:

The company evaluates the assets of the partnership firm, including fixed assets, current assets, and intangible assets like goodwill.

  • Valuation of Liabilities:

All external liabilities such as creditors, loans, and outstanding expenses are considered. Internal liabilities, like partners’ capital and reserves, are excluded.

  • Calculation of Net Assets:

The difference between the total value of assets and liabilities gives the net assets, which form the basis for determining the purchase consideration.

  • Issuance of Shares:

The company may issue shares to partners in exchange for their respective share of capital in the partnership firm. The shares issued can be in the form of equity or preference shares.

Example of Purchase Consideration

A partnership firm, ABC & Co., has decided to convert into a limited company, ABC Ltd. The firm has the following assets and liabilities:

  • Assets:
    • Fixed Assets: ₹10,00,000
    • Current Assets: ₹5,00,000
  • Liabilities:
    • Creditors: ₹3,00,000
    • Loan: ₹2,00,000

Step 1: Calculate Net Assets

Net Assets = Total Assets − Total Liabilities

 

Step 2: Determine the Purchase Consideration

Assuming that the company agrees to issue shares worth ₹10,00,000 to the partners in proportion to their capital contributions, the purchase consideration will be ₹10,00,000.

Step 3: Distribution of Shares

If the partners’ capital contributions in the firm were as follows:

  • Partner A: ₹6,00,000
  • Partner B: ₹4,00,000

The company will issue shares worth ₹6,00,000 to Partner A and ₹4,00,000 to Partner B.

Accounting Treatment in the Books of the Company

The limited company records the purchase consideration and the acquisition of assets and liabilities through journal entries.

Date Particulars Debit (₹) Credit (₹)
1 Fixed Assets A/c Dr. 10,00,000
Current Assets A/c Dr. 5,00,000
To Creditors A/c 3,00,000
To Loan A/c 2,00,000
To Purchase Consideration A/c 10,00,000
2 Purchase Consideration A/c Dr. 10,00,000
To Equity Share Capital A/c 10,00,000

When Separate set of Books are not Maintained (Co-venturer keeps Records of Own Transactions, Memorandum Joint Venture A/c Method)

In many joint ventures, particularly small-scale or short-term ventures, separate books of accounts may not be maintained. Instead, each co-venturer records only their own transactions. At the end of the venture, they prepare a Memorandum Joint Venture Account to determine the profit or loss. This method is simpler and less formal, making it suitable for ventures with minimal transactions.

Features of the Memorandum Joint Venture Account Method:

  • Individual Recording:

Each co-venturer records only their own transactions (e.g., personal contributions, expenses incurred, and revenue collected).

  • No Joint Bank Account:

Transactions are carried out through the personal bank accounts of the co-venturers. No joint bank account is opened.

  • Memorandum Joint Venture Account:

At the end of the venture, the co-venturers combine their individual records and prepare a Memorandum Joint Venture Account to ascertain the overall profit or loss.

  • Profit Sharing:

The profit or loss determined through the Memorandum Joint Venture Account is shared among the co-venturers according to their agreed ratio.

Steps in Recording Transactions:

  1. Recording by Each Co-venturer:
    Each co-venturer records only those transactions that they personally handle:

    • Contributions made by them.
    • Expenses incurred by them.
    • Revenue collected by them.
  2. Preparation of Memorandum Joint Venture Account:
    At the conclusion of the venture, both co-venturers share their transaction details and prepare a combined Memorandum Joint Venture Account. This account is not part of the double-entry system but is used only to determine profit or loss.
  3. Profit Distribution:

The profit or loss is distributed in the agreed ratio, and necessary adjustments are made in the personal accounts of the co-venturers.

Example

X and Y enter into a joint venture to sell furniture. They agree to share profits and losses equally. The following transactions take place:

  1. X’s Transactions:
    • X purchases furniture for ₹60,000.
    • X pays ₹10,000 for transportation.
    • X sells goods for ₹1,00,000.
  2. Y’s Transactions:
    • Y incurs ₹5,000 as advertising expenses.
    • Y sells goods for ₹40,000.

Preparation of Memorandum Joint Venture Account:

Particulars Amount (₹)
Debits
Furniture Purchased by X 60,000
Transportation Paid by X 10,000
Advertising Paid by Y 5,000
Total Expenses 75,000
Credits
Sales by X 1,00,000
Sales by Y 40,000
Total Revenue 1,40,000
Profit (Revenue – Expenses) 65,000

Profit to be shared equally:

  • X’s share = ₹65,000 ÷ 2 = ₹32,500
  • Y’s share = ₹65,000 ÷ 2 = ₹32,500

Entries in Personal Accounts

  1. X’s Personal Account
    Since X has already recorded revenue of ₹1,00,000 and expenses of ₹70,000 (₹60,000 + ₹10,000), his net result before profit-sharing is a surplus of ₹30,000. After adding his share of profit (₹32,500), X’s final balance is:
    ₹62,500 (Credit balance)
  2. Y’s Personal Account
    Since Y has recorded revenue of ₹40,000 and expenses of ₹5,000, his net result before profit-sharing is a surplus of ₹35,000. After adding his share of profit (₹32,500), Y’s final balance is:
    ₹67,500 (Credit balance)

Final Settlement

At the conclusion of the venture, the co-venturers settle their balances. If either co-venturer has withdrawn funds in excess of their share of profits or has outstanding liabilities, those amounts are adjusted before final distribution.

Summary

  • The Memorandum Joint Venture Account Method is a simplified approach for recording joint venture transactions when separate books are not maintained.
  • Each co-venturer records only their personal transactions, and a combined account is prepared at the end to ascertain the overall profit or loss.
  • This method avoids the complexity of maintaining separate books, making it ideal for small or temporary ventures.
  • The method relies on trust and transparency between the co-venturers, as they must share accurate records to determine the final result.

Advantages

  • Simple and Cost-Effective:

No need to maintain a separate set of books or open a joint bank account.

  • Time-Saving:

Each co-venturer records only their transactions, reducing accounting workload.

  • Transparency:

Since the profit or loss is shared at the end based on actual transactions, the method ensures fair distribution.

Disadvantages

  • Risk of Errors:

As each co-venturer records only their own transactions, there is a risk of incomplete or incorrect recording.

  • Dependence on Honesty:

This method requires mutual trust between the co-venturers, as errors or omissions can lead to disputes.

  • Limited Control:

Without a joint bank account and central record-keeping, it can be challenging to monitor the overall financial status of the venture during its operation.

Recording of Joint Venture Transactions (Both Journal and Ledger)

Joint Venture is a business arrangement where two or more parties collaborate for a specific business project, sharing profits and losses in a pre-determined ratio. Recording joint venture transactions involves accurate bookkeeping to reflect the financial dealings of the joint venture. The accounting process can vary based on whether a separate set of books is maintained or if each co-venturer records transactions individually.

This explanation focuses on both journal entries and ledger postings, along with a detailed example.

Methods of Maintaining Joint Venture Accounts

  1. When Separate Books Are Maintained
    A separate set of books is maintained for the venture, which includes:

    • Joint Bank Account: All cash transactions are recorded here.
    • Joint Venture Account: Tracks expenses, revenues, and the resulting profit or loss.
    • Co-Venturers’ Accounts: Individual accounts for each co-venturer, recording their contributions and share of profit or loss.
  2. When No Separate Books Are Maintained
    Each co-venturer records only their share of transactions in their books.

Journal Entries for Joint Venture

Common Journal Entries

S. No. Transaction Journal Entry
1 When cash is contributed by co-venturers Joint Bank Account Dr. To Co-Venturer’s Account
2 When expenses are incurred Joint Venture Account Dr. To Joint Bank Account
3 When revenue is earned Joint Bank Account Dr. To Joint Venture Account
4 When profit is distributed Joint Venture Account Dr. To Co-Venturers’ Accounts
5 When co-venturers withdraw cash Co-Venturer’s Account Dr. To Joint Bank Account

Example

A and B enter into a joint venture to undertake a construction project. They agree to share profits and losses equally. Below are the transactions during the venture:

  1. Initial Contribution:
    • A contributes ₹1,00,000, and B contributes ₹1,00,000.
  2. Expenses:
    • Materials purchased for ₹1,20,000.
    • Wages paid for ₹40,000.
  3. Revenue:
    • Revenue from the project amounts to ₹2,50,000.
  4. Profit Sharing:
    • The profit is to be shared equally.
  5. Withdrawals:
    • A withdraws ₹50,000, and B withdraws ₹50,000.

Solution

Step 1: Calculate the profit.

Revenue = ₹2,50,000

Expenses = ₹1,20,000 (materials) + ₹40,000 (wages) = ₹1,60,000

Profit = ₹2,50,000 – ₹1,60,000 = ₹90,000

Each co-venturer’s share of profit = ₹90,000 ÷ 2 = ₹45,000

Journal Entries

Date Particulars Debit (₹) Credit (₹)
Jan 1 Joint Bank Account Dr. 2,00,000
To A’s Account 1,00,000
To B’s Account 1,00,000
Jan 5 Joint Venture Account Dr. 1,20,000
To Joint Bank Account 1,20,000
Jan 10 Joint Venture Account Dr. 40,000
To Joint Bank Account 40,000
Jan 15 Joint Bank Account Dr. 2,50,000
To Joint Venture Account 2,50,000
Jan 31 Joint Venture Account Dr. 90,000
To A’s Account 45,000
To B’s Account 45,000
Feb 5 A’s Account Dr. 50,000
To Joint Bank Account 50,000
Feb 10 B’s Account Dr. 50,000
To Joint Bank Account 50,000

Ledger Accounts

1. Joint Bank Account

Date Particulars Debit () Credit () Balance (₹)
Jan 1 A’s Contribution 1,00,000 1,00,000
B’s Contribution 1,00,000 2,00,000
Jan 5 Materials Purchased 1,20,000 80,000
Jan 10 Wages Paid 40,000 40,000
Jan 15 Revenue 2,50,000 2,90,000
Feb 5 A’s Withdrawal 50,000 2,40,000
Feb 10 B’s Withdrawal 50,000 1,90,000

2. Joint Venture Account

Date Particulars Debit (₹) Credit (₹) Balance (₹)
Jan 5 Materials Purchased 1,20,000 1,20,000
Jan 10 Wages Paid 40,000 1,60,000
Jan 15 Revenue 2,50,000 90,000 (Profit)

3. A’s Account

Date Particulars Debit (₹) Credit (₹) Balance (₹)
Jan 1 Contribution 1,00,000 1,00,000
Jan 31 Share of Profit 45,000 1,45,000
Feb 5 Withdrawal 50,000 95,000

Revised Statement of Affairs

Revised Statement of Affairs is a comprehensive financial statement used to ascertain the financial position of a business, particularly during insolvency or bankruptcy proceedings. Unlike a basic statement of affairs that is used for determining the capital by listing assets and liabilities, the revised statement provides a more detailed and realistic picture by valuing assets based on their realizable value rather than book value. It also categorizes liabilities according to their priority in repayment. This type of statement is primarily prepared when a business is undergoing liquidation, or when stakeholders require an accurate assessment of the company’s solvency status.

Purpose of Revised Statement of Affairs

The main purposes of preparing a revised statement of affairs include:

  • Assessing Solvency:

It helps determine whether the company’s assets are sufficient to cover its liabilities.

  • Providing Realizable Values:

Unlike the basic statement of affairs, the revised version provides the actual or estimated amounts that can be obtained from the sale of assets.

  • Prioritizing Liabilities:

It classifies liabilities into secured, unsecured, preferential, and contingent, ensuring proper order of repayment in case of liquidation.

  • Reporting to Stakeholders:

It offers creditors, shareholders, and other stakeholders a clear understanding of the company’s financial health.

Components of Revised Statement of Affairs

A typical revised statement of affairs includes the following sections:

  1. Assets (Listed by Realizable Value):
    Assets are listed with their estimated realizable values, which are the amounts expected to be obtained upon their sale. These assets can be categorized as:

    • Fixed Assets: Land, buildings, plant, machinery, etc.
    • Current Assets: Inventory, debtors, cash, etc.
    • Other Assets: Investments, intangible assets, etc.
  2. Liabilities (Listed by Priority):
    Liabilities are categorized and listed in the order of priority in which they need to be paid. These categories include:

    • Secured Liabilities: Loans or borrowings backed by specific assets (e.g., mortgage).
    • Preferential Liabilities: Liabilities that are legally required to be paid before other debts, such as unpaid wages and taxes.
    • Unsecured Liabilities: Creditors who do not have any security against the loan.
    • Contingent Liabilities: Potential liabilities that may or may not materialize, depending on future events.
  3. Capital:
    This represents the equity or ownership interest in the business after deducting liabilities from assets.

Steps to Prepare a Revised Statement of Affairs

  • List Assets with Realizable Values:

All assets should be listed with their realizable values. This requires assessing the market conditions and estimating what the business can reasonably expect from selling the assets.

  • Classify Liabilities:

Classify liabilities based on their nature and priority. Ensure that secured liabilities are listed first, followed by preferential, unsecured, and contingent liabilities.

  • Calculate Deficiency or Surplus:

The difference between total assets and total liabilities indicates whether the company has a surplus or a deficiency. A deficiency occurs when liabilities exceed assets, while a surplus indicates that assets are greater than liabilities.

Example of Revised Statement of Affairs:

Let’s take an example where a company, ABC Ltd., is undergoing liquidation. The details of its assets and liabilities are as follows:

Assets

Particulars Book Value (₹) Realizable Value (₹)
Land & Building 50,00,000 45,00,000
Plant & Machinery 20,00,000 18,00,000
Inventory 10,00,000 8,00,000
Debtors 5,00,000 4,50,000
Cash 2,00,000 2,00,000
Total Assets 87,00,000 77,50,000

Liabilities

Particulars Amount (₹)
Secured Loans (Mortgage) 30,00,000
Preferential Creditors 5,00,000
Unsecured Creditors 40,00,000
Contingent Liabilities 3,00,000
Total Liabilities 78,00,000

Analysis

  1. Total Realizable Value of Assets: ₹77,50,000
  2. Total Liabilities: ₹78,00,000
  3. Deficiency:

    Since total liabilities exceed total realizable assets by ₹50,000, the company has a deficiency of ₹50,000.

Interpretation of the Revised Statement of Affairs:

  • Secured Creditors:

The secured creditors will be paid first using the realizable value of the mortgaged assets. If the realizable value is insufficient, the remaining balance becomes part of unsecured liabilities.

  • Preferential Creditors:

After paying the secured creditors, the next priority is given to preferential creditors, such as unpaid wages and government dues.

  • Unsecured Creditors:

Once secured and preferential liabilities are settled, the remaining amount is used to pay unsecured creditors.

  • Deficiency to Owners:

If liabilities still exceed assets after settling all creditors, the remaining deficiency is borne by the owners or shareholders, reducing their equity to zero.

Opening and Closing Statement of Affairs

Statement of Affairs is a financial statement that lists the assets and liabilities of a business to determine its net worth at a specific point in time. It is used when proper double-entry bookkeeping records are not maintained, especially by small businesses and sole traders. The difference between total assets and total liabilities represents the capital or net worth of the business.

Two statements are prepared:

  1. Opening Statement of Affairs: To find the capital at the beginning of the period.
  2. Closing Statement of Affairs: To find the capital at the end of the period.

Purpose of Opening and Closing Statement of Affairs

  • Opening Statement of Affairs:

This statement helps determine the initial capital or net worth of the business at the start of the accounting period. It forms the basis for comparing financial performance at the end of the period.

  • Closing Statement of Affairs:

The closing statement shows the financial position of the business at the end of the period. Comparing the opening and closing capital after considering drawings and additional capital helps ascertain profit or loss.

Steps to Prepare Statement of Affairs

  • List the Assets:

Include all assets such as cash, debtors, inventory, furniture, equipment, and any other resources owned by the business.

  • List the Liabilities:

Include all liabilities such as creditors, loans, and outstanding expenses.

  • Calculate Capital:

The difference between total assets and total liabilities is the capital or net worth of the business.

Capital = Total Assets − Total Liabilities

Example

Let’s take an example of a sole trader, Mr. Y, who started his business on January 1, 2024. His financial details on January 1, 2024 and December 31, 2024 are as follows:

Details on January 1, 2024 (Opening Statement of Affairs)

Particulars Amount ()
Cash 20,000
Debtors 50,000
Inventory 30,000
Furniture 40,000
Creditors 25,000
Loan 10,000

Details on December 31, 2024 (Closing Statement of Affairs)

Particulars Amount ()
Cash 15,000
Debtors 60,000
Inventory 35,000
Furniture 38,000
Creditors 20,000
Loan 5,000

Step 1: Prepare Opening Statement of Affairs

Particulars Amount (₹)
Assets:
Cash 20,000
Debtors 50,000
Inventory 30,000
Furniture 40,000
Total Assets 1,40,000
Liabilities:
Creditors 25,000
Loan 10,000
Total Liabilities 35,000
Opening Capital 1,05,000

Step 2: Prepare Closing Statement of Affairs

Particulars Amount (₹)
Assets:
Cash 15,000
Debtors 60,000
Inventory 35,000
Furniture 38,000
Total Assets 1,48,000
Liabilities:
Creditors 20,000
Loan 5,000
Total Liabilities 25,000
Closing Capital 1,23,000

Step 3: Calculate Profit or Loss

To determine profit or loss, the closing capital is adjusted by adding drawings and subtracting additional capital introduced during the year. In this case, assume Mr. Y withdrew ₹15,000 as drawings and introduced additional capital of ₹8,000 during the year.

Adjusted Closing Capital = Closing Capital + Drawings − Additional Capital = 1,23,000 + 15,000 − 8,000 = 1,30,000

Profit or Loss is calculated as:

Profit or Loss = Adjusted Closing Capital − Opening Capital = 1,30,000 − 1,05,000 = 25,000 (Profit)

Summary of Statements

Particulars Amount ()
Opening Capital 1,05,000
Closing Capital 1,23,000
Drawings 15,000
Additional Capital Introduced 8,000
Adjusted Closing Capital 1,30,000
Profit for the Year 25,000

Ascertainment of Profits or Loss of a Sole Trader Using Statement of Affairs Method

The Statement of Affairs Method is a technique used to ascertain the profit or loss of a sole trader who does not maintain proper double-entry accounting records. This method is often employed when only incomplete records are available. The profit or loss is determined by comparing the net worth of the business at two different points in time, after considering any additional capital introduced or drawings made by the proprietor during the period.

Steps in Statement of Affairs Method

  1. Prepare Opening Statement of Affairs:
    This statement lists all the assets and liabilities at the beginning of the period. The difference between total assets and total liabilities is the opening capital.
  2. Prepare Closing Statement of Affairs:
    Similar to the opening statement, this lists all assets and liabilities at the end of the period. The difference here gives the closing capital.
  3. Calculate Adjusted Closing Capital:
    The closing capital is adjusted by adding drawings and subtracting additional capital introduced during the period to find the adjusted closing capital.
  4. Ascertain Profit or Loss:
    • If the adjusted closing capital is greater than the opening capital, it indicates a profit.
    • If the adjusted closing capital is less than the opening capital, it indicates a loss.

The formula can be expressed as:

Profit or Loss = Adjusted Closing Capital − Opening Capital

Example

Mr. X is a sole trader. His business assets and liabilities as of January 1, 2024, and December 31, 2024, are as follows:

Particulars Jan 1, 2024 Dec 31, 2024
Cash ₹10,000 ₹15,000
Debtors ₹50,000 ₹60,000
Inventory ₹40,000 ₹45,000
Furniture ₹30,000 ₹28,000
Creditors ₹20,000 ₹25,000
Bank Loan ₹10,000 ₹5,000

During the year, Mr. X withdrew ₹20,000 for personal use and introduced additional capital of ₹10,000.

Step 1: Calculate Opening Capital

Opening Capital = Total Assets − Total Liabilities

Opening Assets (Jan 1, 2024) = Cash + Debtors + Inventory + Furniture = ₹10,000 + ₹50,000 + ₹40,000 + ₹30,000 = ₹1,30,000

Opening Liabilities (Jan 1, 2024) = Creditors + Bank Loan = ₹20,000 + ₹10,000 = ₹30,000

Opening Capital = ₹1,30,000 – ₹30,000 = ₹1,00,000

Step 2: Calculate Closing Capital

Closing Assets (Dec 31, 2024) = Cash + Debtors + Inventory + Furniture = ₹15,000 + ₹60,000 + ₹45,000 + ₹28,000 = ₹1,48,000

Closing Liabilities (Dec 31, 2024) = Creditors + Bank Loan = ₹25,000 + ₹5,000 = ₹30,000

Closing Capital = ₹1,48,000 – ₹30,000 = ₹1,18,000

Step 3: Adjust the Closing Capital

Adjusted Closing Capital = Closing Capital + Drawings – Additional Capital = ₹1,18,000 + ₹20,000 – ₹10,000 = ₹1,28,000

Step 4: Ascertain Profit or Loss

Profit or Loss = Adjusted Closing Capital – Opening Capital = ₹1,28,000 – ₹1,00,000 = ₹28,000 (Profit)

Summary Table

Particulars Amount ()
Opening Capital 1,00,000
Closing Capital 1,18,000
Drawings 20,000
Additional Capital Introduced 10,000
Adjusted Closing Capital 1,28,000
Profit for the Year 28,000

Advanced Financial Accounting Bangalore North University B.Com SEP 2024-25 2nd Semester Notes

Unit 1
Single Entry System, Meaning, Features VIEW
Ascertainment of Profits or Loss of a Sole Trader Using Statement of Affairs Method VIEW
Opening and Closing Statement of Affairs VIEW
Statement of Profit or Loss VIEW
Revised Statement of Affairs VIEW
Unit 2
Joint Venture Introduction, Meaning and Objectives VIEW
Distinction between Joint Venture and Partnership VIEW
Recording of Joint Venture Transactions (Both Journal and Ledger) VIEW
When Separate Set of Books are Maintained VIEW
When Separate set of Books are not Maintained (Co-Venturer keeps Records of own Transactions – Memorandum Joint Venture A/c Method) VIEW
Unit 3
Consignment Introduction VIEW
Consignor VIEW
Consignee VIEW
Distinction between Joint Venture and Consignment VIEW
Goods Invoiced at Cost Price VIEW
Goods Invoiced at Selling Price VIEW
Normal Loss and Abnormal Loss VIEW
Valuation of Stock VIEW
Stock Reserve VIEW
Journal Entries and Ledger Accounts in the books of Consignor and Consignee VIEW
Unit 4
Partnership firm to Limited Company Conversion: Introduction, Objectives, Purchase Consideration VIEW
Methods of Calculation of Purchase Consideration: Lump Sum Method, Net Assets Method, Net Payment Method VIEW
Mode of Discharge of Purchase Consideration VIEW
Ledger Accounts in the Books of Vendor VIEW
Incorporation Entries in the Books of Purchasing Company VIEW
Preparation of Balance Sheet in Vertical form VIEW
Unit 5
Royalty, Introduction, Meaning and Definition VIEW
Technical Terms: Royalty, Royalty Agreement, Landlord, Minimum Rent, Short Workings VIEW
Recoupment of Short Working under Restrictive (Fixed Period) and Non-restrictive (Floating Period) VIEW
Recoupment within the Life of the Lease VIEW
Accounting Treatment for Strike and Stoppage of Work VIEW
Accounting Treatment in the books of Lessee VIEW
Accounting Treatment in the books of Lessor VIEW
Journal Entries and Ledger Accounts with Minimum Rent Account VIEW
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