Tag: Financial Statements

When a partnership firm is converted into a limited company, the firm transfers its assets and liabilities to the purchasing company. The vendor, i.e., the partnership firm, prepares certain ledger accounts to record the closure of its books.

1. Realization Account: To record the sale of assets and liabilities.
2. Purchasing Company Account: To record the purchase consideration receivable from the purchasing company.
3. Partners’ Capital Account: To account for partners’ balances after transferring assets and liabilities.
4. Bank Account: To record cash received and payments made during the process.

Steps in Preparing Ledger Accounts:

• Realization Account

All assets except cash and fictitious assets (e.g., goodwill) are transferred to the realization account. Liabilities are also transferred here. The account is closed by transferring the net profit or loss to the partners’ capital accounts.

• Purchasing Company Account

This account records the purchase consideration due from the purchasing company and its subsequent receipt in cash, shares, or debentures.

• Partners’ Capital Account

The net profit or loss from the realization account is transferred here, along with any settlement made in cash or through shares and debentures.

• Bank Account

Any cash received as part of the purchase consideration or payments made for expenses is recorded here.

Journal Entries:

Explanation of Journal Entries:

• Transfer of Assets:

All assets (except cash) are transferred to the realization account at their book value.

• Transfer of Liabilities:

All external liabilities are transferred to the realization account.

• Purchase Consideration Receivable:

The purchase consideration receivable from the purchasing company is recorded by debiting the purchasing company account and crediting the realization account.

• Receipt of Cash:

When cash is received from the purchasing company, it is debited to the bank account, and the purchasing company account is credited.

• Receipt of Shares and Debentures:

If part of the purchase consideration is received in the form of shares and debentures, these accounts are debited, and the purchasing company account is credited.

• Realization Expenses:

Any realization expenses paid by the firm are recorded by debiting the realization account and crediting the bank account.

• Profit or Loss on Realization:

The profit or loss on realization is transferred to the partners’ capital accounts in their profit-sharing ratio.

• Settlement of Partners’ Accounts:

The partners’ capital accounts are settled by transferring the balance to the bank account, shares, or debentures, depending on the mode of settlement.

Invoice

An invoice is a record of a sale or shipment made by a vendor to a customer that typically lists the customer’s name, items sold or shipped, sales price, and terms of the sale. In other words, it’s an itemized statement the reports the details of a sale for the buyer and seller’s records.

An invoice is a document created by the seller as evidence of a sales transaction between a buyer and the seller. It is often prepared in case of a credit sale. Nowadays invoices are prepared with the help of ERPs i.e. in a digital format yet they can also be prepared on paper.

It is a non-negotiable commercial document and normally contains details such as:

• Date of transaction
• Unique Identification Number
• Details of Buyer
• Quantity Sold
• Price Per Item
• Short Description of Items Sold
• Amount
• Taxes
• Terms of Payment
• Signature of the Authorized Party

Debit Note

A debit note’ or debit memorandum (memo) is a commercial document issued by a buyer to a seller as a means of formally requesting a credit note. Debit note acts as the Source document to the Purchase returns journal. In other words, it is an evidence for the occurrence of a reduction in expenses. The seller might also issue a debit note instead of an invoice in order to adjust upwards the amount of an invoice already issued (as if the invoice is recorded in wrong value). Debit notes are generally used in business-to-business transactions. Such transactions often involve an extension of credit, meaning that a vendor would send a shipment of goods to a company before the goods have been paid for. Although real goods are changing hands, until an actual invoice is issued, real money is not. Rather, debits and credits are being logged in an accounting system to keep track of inventories shipped and payments

When a price is included on a debit note, it is the price which the customer was actually charged for those goods.

When a seller receives goods returned by the buyer which were once sold on credit the seller also expects some form of confirmation from the buyer (on paper) related to the details of returned items. A debit note is a document sent by a buyer to the seller to confirm the details of goods returned (return outwards) and create an obligation for the seller to cancel the related dues.

It reduces the amount due to be paid back to the seller if the amount due is nil then it allows further purchases on behalf of that. The intent is to notify the seller that they’ve been debited against the goods returned.

A debit note is issued for the value of the goods returned. In some cases, sellers may send debit notes only to be treated as an invoice.

Few Characteristics of a Debit Note

1. It is sent to inform about the debit made on the account of the seller along with the reasons.
2. The purchase returns book is updated on its basis. (In case of return of goods)
3. Usual reasons range from incomplete goods received, damaged/inaccurate goods received, etc.
4. It is prepared like a regular invoice and shows a positive amount.

Credit Note

When a customer returns goods purchased on credit, he/she also expects some form of confirmation from the seller along with the cancellation of related dues. A credit note is a document sent by a seller to the buyer as a notification to acknowledge that the goods have been registered as (return inwards) and a credit has been provided to them for the eligible amount.

It reduces the amount due to be paid by the customer, if the amount due is nil then it allows further purchases in lieu of the credit note itself.

A credit note is issued for the value of goods returned by the customer, it may be less than or equal to the total amount of the order.

It can also be a document from a bank to a depositor to indicate the depositor’s balance is being in event other than a deposit, such as the collection by the bank of the depositor’s note receivable.

A credit notes or credit memo is a commercial document issued by a seller to a buyer. Credit notes act as a source document for the sales return journal. In other words, the credit note is evidence of the reduction in sales. A credit memo, a contraction of the term “credit memorandum”, is evidence of a reduction in the amount that a buyer owes a seller under the terms of an earlier invoice.

Stock

In accounting there are two common uses of the term stock. One meaning of stock refers to the goods on hand which is to be sold to customers. In that situation, stock means inventory.

Stock is a security that represents a fraction of the ownership of the issuing corporation. It is issued to investors in the form of stock certificates.

The term stock is also used to mean the ownership shares of a corporation. For example, an owner of a corporation will have a stock certificate which provides evidence of his or her ownership of a corporation’s common stock or preferred stock. The owner of the corporation’s common or preferred stock is known as a stockholder.

Acquisition and Sale of Stock

Stocks may be acquired or sold on a stock exchange or via a private sale. A sale on a stock exchange is a relatively simple transaction, but can only be accomplished if the issuer has registered the shares, has been accepted by the applicable stock exchange, and is current in its filings with the Securities and Exchange Commission.

Common Stock

Common stock is the baseline form of stock, and includes the right to vote on certain corporate decisions, such as the election of a board of directors. In the event of a corporate liquidation, the common stockholders are paid their share of any remaining assets after all creditor claims have been fulfilled. If a company declares bankruptcy, this usually means that the holdings of all investors are either severely reduced or completely eliminated.

Preferred Stock

A company may issue either common stock or preferred stock. Preferred stock has special rights, which can vary by class of preferred stock. These rights typically include a fixed dividend amount, and may also include special voting rights.

Par Value

A share may have a face value, which is known as its par value. The par value is usually quite small, with $0.01 per share being a common amount. If a share has no face value, then it is said to be no-par stock.

Stock as Inventory

An alternative definition of stock is the finished goods inventory that a company has on hand and available for sale.

Work-in-progress

Work in progress (WIP) refers to partially-completed goods that are still in the production process. These items may currently be undergoing transformation in the production process, or they may be waiting in queue in front of a production workstation. Work in progress items do not include raw materials or finished goods. Work in progress is usually comprised of the full amount of raw materials required for a product, since that is added at the beginning of production, plus the cost of additional processing as each unit progresses through the various manufacturing steps.

Work in progress is typically measured at the end of an accounting period, in order to assign a valuation to the amount of inventory that is on the production floor. WIP is one of the three types of inventory, of which the others are raw materials and finished goods. Work in progress may be reported on the balance sheet as a separate line item, but is usually so small in comparison to the other types of inventory that it is aggregated with the other inventory types into a single inventory line item.

It is extremely difficult to assign an accurate cost to a WIP item, since there may be many WIP items in various stages of completion as of period-end. To make the accounting process easier, some companies complete all WIP items and transfer them into finished goods inventory prior to closing the books, so that there is no WIP to account for. An alternative is to assign a standard percentage of completion to all WIP items, on the theory that an average level of completion will be approximately correct when averaged over a large number of units.

Work in Progress or WIP, as the name suggests are the goods that are not complete and are at some stage of production. The item is inclusive of entire raw materials that go into the production. It also includes the cost of processing. Cost of processing is significant because each semi-finish product moves through the various manufacturing steps.

A firm accounts for the work in progress towards the end of the accounting period. The accounting of WIP helps a company to determine the value of inventory that is in the production process.

It is possible to estimate the amount of ending work in progress, though the result can be inaccurate, due to variations caused by actual scrap levels, rework, and spoilage. The calculation of ending work in progress is:

Ending work in progress = Beginning WIP + Manufacturing costs – Cost of goods manufactured

Goods on consignment are sent by the consignor or the principle to the consignee or agent. The consignor is the owner of the goods and not the consignee though the possession is transferred. However, after the goods are sold the buyer becomes the owner of the goods. Here, we will discuss the accounting entries in the books of the consignee.

Parties in Consignment Account

There are two parties in a consignment.

• The person sending the goods is the consignor.
• The person receiving the goods is the consignee.

Accounting Entries in books of Consignee

There are no entries passed in the books of the consignee for the consignment of goods sent by the consignee and also for any expenses incurred by the consignor. However, the advance paid to the consignor, sales made, expenses incurred on the consignment and commission earned needs to be recorded.

A consignee is often allowed del-credere commission in addition to the usual ordinary commission. In the case where he is allowed del-credere commission, bad debts are borne by him and not the consignor.

The goods sent by the consignor to consignee is sold on behalf of the consignor. therefore, the consignor would like to know the profit earned or loss suffered from each different consignment. Before we discuss the entries in the books of the consignor, it is helpful to understand the nature of the following two accounts:

• Consignment account
• Consignee account

Consignment Account:

Consignment account is by nature a profit and loss account. One separate account is devoted to each different consignment with the heading “Consignment to………account”. Actually the consignment account is a particular trading and profit and loss account. All expenses specially related to the consignment must be debited to the concerned consignment account whether incurred by the consignor or by the consignee and all revenues and closing stock should be credited to this account. The difference between the two sides of this account will show the result of the particular consignment.

Consignee Account:

This is a personal account. It should be noted that the consignee is not the buyer. His personal account, therefore, is not debited when goods are sent to him. In cases where it is customary for the consignee to send some money as an advance against the consignment the payment is merely and advance (by way of security) and not a part of payment. Hence the advance received from the consignee should be posted to the credit side of the consignee’s personal account. In case part of the stock is still lying unsold the proportionate amount of advance should be carried down as credit balance in consignee’s personal account. In case where consignor draws a bill on consignee the bill is known as a documentary bill.

Journal Entries in the books of Consignee

Journal Entries in the Books of Consignor:

What is a Sale?

Sale refers to the complete transfer of ownership of goods from a seller (vendor) to a buyer. The seller relinquishes all rights to the goods in exchange for payment, and the buyer assumes ownership and the associated risks. Once the transaction is completed, the seller no longer has any control or responsibility over the goods, and the buyer has full rights to use, resell, or modify them as they wish.

In accounting terms, a sale is recognized when the following conditions are met:

• There is a transfer of control over the goods to the buyer.
• The seller has a reasonable expectation of receiving payment.
• The buyer has the risks and rewards of ownership.

Sales are recorded as revenue on the seller’s income statement, and the cost of the goods sold (COGS) is recorded as an expense.

What is Consignment?

Consignment is a business arrangement in which goods are sent by a consignor (owner) to a consignee (agent) who will sell the goods on behalf of the consignor. In a consignment transaction, ownership of the goods remains with the consignor until the goods are sold to a third-party customer. The consignee acts as an intermediary, holding and selling the goods, but does not take ownership of them. The consignee earns a commission for their role in selling the goods.

Key characteristics of consignment transactions include:

• The consignor retains ownership of the goods until they are sold.
• The consignee does not own the goods but is responsible for selling them.
• The consignee earns a commission for their services, but they bear no inventory risk.
• The consignor records sales revenue only when the goods are sold by the consignee.

In this arrangement, the consignor records the goods as inventory until they are sold, and the consignee records no inventory on their books. The consignee only records commissions earned from the sales.

Key Differences Between Consignment and Sales:

Example of Consignment vs. Sales

To better illustrate the differences between consignment and sales, let’s consider an example:

• Consignment Example:

A clothing manufacturer (consignor) sends 100 dresses to a boutique (consignee) to sell on consignment. The boutique does not pay for the dresses upfront but agrees to display and sell them. For each dress sold, the boutique will retain a 10% commission. If the boutique sells 60 dresses at $100 each, the boutique will retain $600 in commission (10% of $6,000), and the manufacturer will receive $5,400. The boutique returns the remaining 40 unsold dresses to the manufacturer.

• Sales Example:

The same clothing manufacturer sells 100 dresses directly to a retail store for $8,000. The retail store takes ownership of the dresses upon purchase, records them as inventory, and assumes all responsibility for selling them. The manufacturer recognizes $8,000 in revenue at the time of the sale. If the retail store is unable to sell the dresses, the manufacturer is not obligated to take them back unless specified in a return agreement.

Advantages of Consignment Over Sales:

• Risk Mitigation for the Consignee:

Since the consignee does not purchase the goods upfront, they face minimal financial risk. If the goods do not sell, they can return them to the consignor without bearing the cost.

• Market Expansion for the Consignor:

The consignor can reach a wider market by distributing goods to multiple consignees without having to sell them directly. This allows for broader distribution and increased exposure.

• No Upfront Payment:

Consignees can sell goods without paying for them upfront, which can be beneficial for businesses with limited capital. This arrangement enables them to offer a larger inventory without the need for immediate financial outlay.

• Flexible Return Policies:

Goods that do not sell can be returned to the consignor, reducing the financial burden on the consignee.

Disadvantages of Consignment Compared to Sales:

• Delayed Revenue Recognition:

In a consignment arrangement, the consignor must wait until the goods are sold by the consignee before recognizing revenue. This can delay cash flow and financial reporting.

• Inventory Risk for Consignor:

The consignor bears the risk of unsold goods. If the consignee is unable to sell the products, the consignor must retrieve them, which may involve additional costs.

• Lower Control for Consignor:

The consignor has limited control over how the consignee markets or displays the goods. Poor marketing or positioning may lead to slower sales, affecting revenue.

• Reduced Profit Margin for Consignor:

The consignor must pay a commission to the consignee, which reduces the net profit on each sale.

The consignee receives the goods from the Consignor. It is an inward consignment to the Con­signee. An inward consignment is the receipt of goods by the Consignee from the Consignor for the purpose of sale on commission basis. Consignee is not the owner of the goods.

Journal Entries:

Following are the set of journal entries recorded in the books of the Consignee:

(1) When the Goods is Received:

No entry

The Consignee is not the owner of the goods. He does not purchase the goods. Hence he does not include this in his book. The receipt of the goods is recorded in a Memorandum Book – Consignment Inward Book.

(2) When Expenses are Incurred by the Consignee:

Consignor Account Dr.

  To Bank Account

(Being expenses paid on consignment)

(3) Advance Remitted to Consignor by Cash/Cheque/Bills Payable:

Consignor Account Dr.

  To Cash/Bank/Bills Payable A/c

(Being advance paid to Consignor)

(4) When Consignee Sold the Goods:

(a) For cash sales:

Bank Account Dr.

  To Consignor Account

(Being the cash sales of consignment)

(b) For credit sale:

Consignment Debtors Account Dr.

  To Consignor Account

(Being the credit sales of consignment)

(5) When the Commission is Due:

Consignor Accounts Dr.

  To Commission Account

(Being commission earned on sale of consignment)

(6) When the Consignee Collected the Debt from Consignment Debtors:

Bank Account Dr.

  To Consignment Debtors A/c

(Being the Collection of consignment debts)

(7) For Bad Debts if Any:

(a) If Del Credere Commission is not paid:

Consignor Account Dr.

  To Consignment Debtors A/c

(Being bad debt incurred on sales)

(b) If Del Credere Commission is paid:

Bad Debts Account Dr.

  To Consignment Debtors A/c

(Being bad debts incurred on consignment sales)

Note: Bad debts from Consignment debtors are transferred to Del Credere Commission Account and the balance of Del Credere Commission Account along with Commission account is transferred to his Profit and Loss Account.

(c) Bad debts is transferred to his Profit & Loss Account:

Del Credere Commission Account Dr.

  To Bad Debts Account

(Being bad debts transferred to Del Credere Commission Account)

(8) Closing of Del Credere Commission and Commission Account:

Commission Account Dr.

Del Credere Commission Account Dr.

  To Profit and Loss Account

(Being Commission account and balance of Del Credere account is closed by transferring to Profit and Loss Account)

(9) Settlement of Account with Consignor:

Consignor Account Dr.

  To Cash/Bank/Bill Payable A/c

(Being the amount due to Consignor is settled)

Consignment account is prepared to ascertain the profit earned or loss incurred by the consignor on a specific consignment. This account can be viewed as a combined trading and profit and loss account prepared specifically for consignment business.

The nature of the consignment account is nominal which means it is drawn up to show the results of the consignment business for a specific period.

If consignor sends goods to more than one consignee working in different cities or areas, a separate consignment account is required for each consignment so that the profit or loss for each consignment can be determined separately. If consignor maintains more than one consignment accounts, he can distinguish them from each other by adding to the account title the name of the consignee or the name of the city or area to which the particular consignment belongs. For example, Consignment to David, Consignment to John, Consignment to Ottawa and consignment to New York etc.

Debit and credit entries in a consignment account

The entries in the consignment account are made on the basis of consignor’s own record as well as account sales sent by the consignee. The debit and credit entries are made as follows:

Debit entries

The common entries that appear on the debit side of a consignment account are listed below:

• Opening stock of goods
• Total cost of goods sent on consignment
• All the expenses incurred by consignor such as loading, freight, insurance etc.
• All the expenses paid by consignee such as unloading, freight, godwon rent, warehousing and storage, marketing expenses, packaging and selling expense etc.
• Bad debts regarding consignment sales.
• Consignee’s ordinary and del credere commission at agreed rate on sale proceeds.

Credit entries

The usual items that appear on the credit side of a consignment account are listed below:

• Gross sale proceeds
• Closing stock of goods
• Abnormal loss of goods
• Stock in transit

The balance of consignment account represents a profit or a loss on consignment and is transferred to “Profit and Loss on Consignment Account”. The consignment account is thus closed.

The Profit and Loss on Consignment Account is also a nominal account. If there are more than one consignment, the balances of all consignment accounts are transferred to this account.

The profit and loss on consignment account is closed at the end of the year by transferring its balance to the General Profit and Loss Account.

Proforma Invoice

A proforma invoice (also written as pro forma invoice) is one of the documents used in consignment business which contains information regarding the description of goods sent on consignment and the price at which those goods can be sold by the consignee. This document is prepared by consignor and sent to the consignee along with the goods.

The proforma invoice and invoice are not the same and should not be confused with each other. An invoice is sent by a seller to the buyer to provide him the details of goods sold or services provided to him, price of those goods or services and the agreed terms of payment. It indicates seller’s demand for payment after a sale has taken place. A proforma invoice, on the other hand, is not a demand for payment rather it is a memorandum invoice which tells what the actual invoice would be.

Where goods are consigned abroad, the proforma invoice plays an important role in custom clearance. The custom officer uses the information from proforma invoice in conjunction with the general physical examination of the goods to determine the total value of goods and the amount of imposable duty. Many international traders use consignment model of business and attach proforma invoices to their across-the-border shipments.

Invoice Price

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.

Account Sales

Account sales is a statement specifying the price at which the goods are sold, the commission earned by the consignee, the expenses incurred by the consignee on behalf of the consignment and the net balance for which the consignee is liable. It is prepared by the consignee and does not have a fixed or specified format.

Non-recurring Expenses

Non-recurring expenses are incurred for bringing the goods from the place of the consignor to the place of the consignee. Hence, all the expenses incurred till the goods reach the godown of the consignee are non-recurring expenses. These expenses are incurred only once on a particular con­signment. It will increase the value of goods. These expenses are paid by the consignor or by the consignee on behalf of the consignor.

The abovementioned expenses do not occur again like the recurring expenses. These expenses are met on the whole consignment. These expenses are added to the cost of the consignment so as to arrive at the cost price of goods at the point of sale. Again these are taken into consideration when the value of closing stock and abnormal losses are calculated.

Recurring Expenses

These expenses are incurred after the goods have been received at consignee’s godown. These expenses are incurred quite often and of recurring in nature. These expenses occur regularly at fixed intervals. Generally these expenses are incurred after the goods have reached the place of business by consignee. They are met by the consignor or consignee. These expenses do not increase the value of goods.

Ordinary Commission

The ordinary commission is the fees payable by the consignor to the consignee for the sale of goods when there is no guarantee for the collection of money from the consumer. The percent (%) of the commission is lower in such a case.

Overriding Commission

Overriding commission is a type of commission which a consignor grants to the consignee who achieves a specific sales target or whose total sales revenue exceeds a specified amount. It encourages consignee to realize the best possible price for goods sold. Sometime it is given to consignee as an incentive for putting his efforts to introduce, promote and create market for a new product in certain areas.

Overriding commission is an extra commission which is awarded to the consignee in addition to his ordinary or regular commission.

Del Credere Commission

Del Credre Commission is the additional amount which the consignor pays to the consignee for taking the responsibility of collection of debt from the customers.

When the customers make default in payment, consignee charges the amount of loss of bad debts in his books. We calculate this commission on Total sales.

Normal Loss

• It occurs due to the nature of goods shipped like leakage, evaporation, perishable goods etc.
• We add the normal loss to the cost of goods and thus, it also impacts the gross profit.
• Normal loss is not covered by insurance companies.
• It is certain but it varies from time to time.

Abnormal Loss

• Abnormal loss occurs due to unforeseen circumstances like an accident, natural calamity, fire damage etc.
• The abnormal loss does not impact the gross profit of the entity.
• Generally, insurance covers an abnormal loss.
• The abnormal loss is not certain due to unforeseen circumstances and situations.