Syllabus
FIRST
SEMESTER
102:
FINANCIAL ACCOUNTING I
Total
Marks: 80
UNIT-I:
Accounting Principles and Accounting Standards: 20
Accounting
Information and their qualitative features; Generally Accepted Accounting
Principles (GAAP), their application in preparation and presentation of financial
statements; Accounting Standards- meaning, need, and advantages; Accounting
standards setting procedure in India.
UNIT-II:
Sectional and Self Balancing Ledger System: 20
Sectional
and self balancing ledger system – features and advantages; Accounting
treatment of Rectification of errors under sectional and self balancing ledger
system.
UNIT-III:
Hire Purchase and Installment Purchase System: 20
Meaning,
features, advantages, disadvantages of hire purchase and installment purchase
system; Rights of hire purchaser & seller; accounting treatment, different
methods of calculation of interest; accounting treatment on default by the hire
purchaser.
UNIT-IV:
Royalty Accounts:
20
Definition
of royalty; minimum rent; short workings and its accounting treatment;
Accounting for royalty transactions; Impact of strikes and lockouts; Accounting
for sub-lease.
SUGGESTED BOOKS
1. Financial
Accounting- Ashish Bhattacharya, Prentice Hall.
2. Financial
Accounting, S.N. Maheshwari, Vikash Publishing.
3. Financial
Accounting, B.B. Dam, H.C. Gautam,, and other, Capital Publishing.
4. Financial
Accounting, K.R. Das, K.M. Sinha, Lawyers Book Stall.
5. Advanced
Accounts, M.C. Shukla, T.S. Grewal, S.C. Gupta, S. Chand & Co.
6. Accountancy,
R.L. Gupta, M. Radhaswamy, Sultan Chand & Sons.
7. Bittiya Hisab
Vidya, Oriental Book Co.
8. Financial
Accounting –A dynamic Approach –B.K. Banerjee –Prentice Hall of India Private
Limited, New
Delhi.
9. Fundamentals
of Accounting –T.P. Ghosh –Sultan Chand & Sons.
10.
Financial Accounting –M. Hanif, A. Mukherjee, Tata McGraw Hill.
Unit-I:
Accounting
Principles, Concepts & Conventions and Accounting Standard.
Accounting Information:
Accounting information means the
data provided in the Financial Statements and reports. Financial Statement
includes: (i) Trading Account (ii) Profit and Loss Account, (iii) Balance
Sheet, (iv) Cash Flow Statement and (v) Fund Flow Statement. Reports include
Directors’ Report and Auditor’s Report (in case of a limited Co. )
These statements and reports are published in the form of Annual Reports of
Companies.
The basic statements provide
information on five elements. These five elements are (a) Assets, (b)
Liabilities, (c) Equities (Capital & Reserves), (d) Incomes and gains and
(e) Expenses and losses. Basically, the accounting information is used for
decision-making purpose by its users. Information regarding to these elements
of Financial Statements is called Accounting Information. As a basis for forming rational and judicious
decision, theses accounting information should possess a minimum level of
quality.
Uses of Accounting Information/ Financial Statements:
The accounting information is used for decision-making
purpose by the users. The users of accounting information have their own
interest in the financial statement. These users are as follows:
1. Management: Management people includes-
Directors, Officials, Managers, Departmental Heads & Supervisors. They are
responsible for using resources & managing the affairs of an entity to
achieve the definite goals & objectives. Accounting provides a timely &
useful information to the management for their decision making purpose. Thus
management is one of the important users of the accounting information and a major
function of accounting is to provide useful information to the management.
2.Existing & Potential Investors: Existing and
potential investors are interested in accounting information to determine
regularities of receiving income on investments, safety of their investment.
For this purpose they seek several information from financial statement such as
amount of equity investment, long term debt, net profit, preference dividend,
interest on debentures etc.
3.Creditors: Creditors and suppliers of raw
materials used accounting information to ascertain the short-term liquidity,
long-term liquidity or solvency position, the ability of the entity to repay
the amount in schedule time and the earning capacity.
4.Employees: Employees are interested in financial
information in order to assess the stability of their employment to lodge their
claim for hike in wages, shares in profit, bonus etc.
5.Customers:- Customers used financial accounting
information to save guard their interest in regard to quality of products,
price charged and to uphold the customer movement.
6.Tax Authorities: Tax Authorities require the
financial information to ascertain the tax liability of a company.
7.Government & Regulatory Agencies:- Government
is interested to assess. Levy and collection of Sales Tax, Excise Duties,
Custom Duties, Income Tax etc.
[Other Regulatory Agencies
interested in financial accounting information are Department of Company
Affairs (DCA), Stock Exchange Authorities, Securities & Exchange Board of
India (SEBI), Reserve Bank of India (RBI), Institute of Chartered Accountants
of India (ICAI), Institute of Company Secretary of India (ICSI), Institute of
Cost and Work Accountants Of India (ICWAI) etc.]
8.Trade Union and Chamber of Commerce: These bodies
make use of financial statement to frame various types of demands to be placed
before the concerned authorities and also to formulate business policy, trade
pattern, strategy of the enterprise etc.
9.Researchers: Researchers scholars make use of
financial statement for making analysis and interpretations of data to derive
new findings.
10.Broker and Advisors: Stock brokers and invest
advisor have indirect interest in financial performance and prospects of a
company as they advice investors and creditors.
Quality of Accounting Information:
The
qualitative aspect of accounting information of financial statement has
received considerable amount of importance from various users. This is because
the quality of a decision is depended upon qualitative features of information.
Hence, Accounting Bodies of the world has been given emphasis on improvement of
the quality of accounting information.
The
Accounting Principle Board of AICPA, USA , has underlined seven
qualitative objectives of financial statement. These are:-
1.
Relevance,
2.
Understandability.
3.
Verifiability,
4.
Neutrality,
5.
Timeliness,
6.
Comparability, and
7.
Completeness.
In India ,
the ICAI has outlined four qualitative aspects of financial statement. These
are:
(i)
Understandability.
(ii)
Relevance,
(iii)
Reliability, and
(iv)
Comparability,
(i) Understandability:
An essential quality of the information provided in the financial statement is
that it is readily understandable by user. For this purpose users are assumed
to have a reasonable knowledge of business and economic activities and
accounting and a willingness to study the information with reasonable
diligence.
(ii) Relevance:
The accounting information must be relevant for decision making by its users.
Information has the quality of relevance when it influences the economic
decision of the users by helping them to evaluate past, present or future event
or confirming or correcting their past evaluation.
(iii) Reliability:
To be useful, information must be reliable. Information has the quality of the
reliability when it is free from material error and bias and can be depended
upon by users to represent faithfully. Information may be relevant but
unreliable in nature may be potentially misleading and so it becomes useless.
(iv) Comparability:
User must be able to compare the financial statement of an enterprise through
time to time to identify trends in its financial positions and performance.
Users must be able to compare the financial statement of different enterprises
in order to evaluate their relative financial position, performance and changes
in financial position.
When accounts are prepared and
presented in the form of financial statement.
Any information contained therein should be conformed of the
above qualities.
GAAP: Generally Accepted Accounting Principles.
‘GAAP’
means Generally Accepted Accounting Principles. They refer to accounting
principles generally approved by accounting professions. General acceptability
of accounting principles is not decided by formal vote of accountants but it
depends on the general acceptance of the principles by the accounting professions.
GAAP
guide the Accounting profession in the choice of accounting techniques and in
the preparation of financial statements in such way, which is considered to be
a good accounting practice. They are not immutable laws like physical sciences.
They are subject to changes according to the changing economics circumstances.
In India , organizations like Accounting Standard
Board (ASB), Institute of Chartered Accountants of India, Department of Company
Affairs, Securities and Exchange Board of India, Institute of Cost
Structure of GAAP:
The
structure of GAAP refers to the forms of elements of GAAP. Traditionally, these
are known by various names, viz., assumptions, principles, concepts,
conventions, etc.
These has
been modified into the following four broad heads:
(i)
Assumptions: Assumptions are traditions
and customs developed over a period of time and well accepted by the accounting
profession. Basic accounting assumptions provide a foundation for recording the
transactions and preparing the financial statements there from. The following
five assumptions are considered as basic assumptions of accounting. These are:
(1)
Accounting Entity,
(2)
Accrual,
(3)
Going Concern,
(4)
Money Measurement; and
(5)
Accounting Period.
(ii) Principles:
Basic accounting principles are the general decision rules, which govern the
development of accounting techniques. They work as complimentary to basic
assumptions. These are:
(1)
Dual Aspect,
(2)
Revenue Recognition,
(3)
Cost,
(4)
Matching,
(5)
Full Disclosure; and
(6)
Objectivity.
(iii) Modified
Principles: Generally, The financial statements are prepared keeping in
view the basic principles and assumptions of accounting. However, difficulties
are faced in the application of accounting principles in certain situations,
which called for the modified application of the principles and assumptions of
accounting. These are:
(1)
Materiality,
(2)
Conservatism (Prudence),
(3)
Cost-Benefit,
(4)
Timeliness,
(5)
Consistency,
(6)
Substance over Legal Form; and
(7)
Industry Practice.
(iv) Accounting
Standards: Accounting Standards are the established and accepted models,
which aim at providing excellent, adequate and unbiased treatment of accounting
information and reporting the same in the financial statement to facilitate
their users in forming rational and judicious decision.
Accounting
Standards:
Standards
are established and accepted model. Accounting standards may be defined as
written statements, issued from time to time by institutions of accounting
professionals, specifying uniform rules or practices for drawing the financial
statements.
Eric
L. Kohler defines accounting standards as, “a code of conduct imposed on
accountants by custom, law or profession.
History of accounting standards:
Over
a period of time a number of Generally Accepted Accounting Principles (GAAP) in
the form of concepts and conventions have been developed and accepted to bring
comparability and uniformity in the financial statements of various business
enterprises. But the difficulty is that GAAP also allow a large number of
alternative treatments (policies & practices) for the same item. As a
result, the financial statements become inconsistent and incomparable. Hence
there is an urgent need to harmonize and standardized the diverse accounting
policies and practices followed by the business enterprises. Accounting
standards must be developed for the developing of accounting as a business
language.
An
International Congress of Accountants was organized in Sydney, Australia in
1972 to ensure expected level of uniformity in accounting practices. Keeping
this in view the International
Accounting Standard Committee (IASC) was setup on June 29,
1973 with a Head Quarter at Landon. This was the result of an agreement of
Sixteen Accounting Bodies from Nine Nations viz. Australia ,
Canada , France , Germany ,
Japan , Mexico , Netherlands ,
United Kingdom and USA .
At present there are 118 member bodies in IASC from 85 countries of the world.
Accounting Standard Committee
in India
The
ICAI along with the ICWAI become an associate member of IASC in April 1974.
They ensure the task of setting, issuing and forcing the implementation of
Accounting Standard in India .
With this view and recognizing the needs to harmonize the diverse accounting
practices prevalent in India
and also to integrate them with the International Accounting Practices, the
Accounting Standard Board (ASB) was constituted in 21 April 1977 by the ICAI.
In
India
till June 2003, 28 Accounting Standard has been issued and several other matter
be brought within the ambit in future.
First ten Accounting Standards
issued by ICAI:
AS-1 Disclosure
of Accounting Policies on
1.4.1991
AS-2 Valuation
of Inventories (Revised) on
1.4.1999
AS-3 Cash Flow Statement (Revised) on
1.4.1997
AS-4 Contingencies
& Event Occurring after the Balance Sheet on
1.4.1995
AS-5 Net
Profit or Loss for the Period on
1.4.1996
AS-6 Depreciation Accounting (Revised) on
1.4.1995
AS-7 Accounting
for Construction Contracts on
1.4.1991
AS-7 (Revised) Construction Contracts on
1.4.2003
AS-8 Accounting for Research & Development on 1.4.1991
AS-9 Revenue
Recognition on
1.4.1991
AS-10 Accounting for Fixed Assets on
1.4.1991.
Differences Between Accounting
Principles and Standards:
Accounting Standards are generally
based on Accounting Principles. However there are some differences between
these two:
1. Principles
are fundamental or basic rules governing the accounting system, while on the
other hand standard are professional opinions and guidelines of a professional
institute like ICAI.
2. Accounting
Principles are generally agreed rules of law adopted by the accountants. It
does not bear any professional institution, while standards are guiding rules
prescribed by professional institution.
3. Accounting
Principles are generally difficult to be implemented without legal support.
Accounting Standards are enforceable either by professional institute or by any
government or regulatory agencies.
4. Accounting
Principles are not mandatory, where Standards are mandatory by the enforcing
agencies of Accounting Standards.
5. Accounting
Principles provide a large number of alternative treatments to a given
accounting item like Revenue, Cost, Assets and Liabilities, where as an
Accounting Standards try to reduce the alternatives and reduces the flexibility
of opinion.
Objectives of Accounting Standards/International
Accounting Standards:
The reasons behind the formulation
of Accounting Standards are as follows:
a. To
harmonized different accounting policies and practices in use in a company.
b.
To reduce the accounting alternatives in the
preparation of financial statements within the bounds of nationality.
c.
To ensure comparability of financial statements
of different enterprises with a view to provide meaningful information to
various users of financial statements.
d.
To ensure uniformity of accounting policies and
practices among the nation across the globe.
e. To
harmonized the diverse accounting policies and practices in use in a country
and to formulate its own accounting standards and to integrate them to the
extent possible.
Needs of Accounting Standards:
The needs for Accounting Standard
(AS) arises out of the following considerations:
1. Restricting
freedom and alternatives: Complete freedom cannot be granted to prepare the
financial statements. A mandatory reporting framework should be needed
regarding what to report and how to report.
2. Enforcement
of Uniformity: The same accounting principle should be followed by all the
enterprises in a similar circumstances this is necessary to enforce uniformity
of adoption of the Generally Accepted Accounting Principles (GAAP). As a result
the financial statement will be more acceptable to its ultimate users.
3. Ensuring
reliability of information: Enforcement of uniformity in reporting
practices would make the financial statement reliable to its users. Without
reliability of the information a meaningful economic decision cannot be taken.
4. Comparability:
Comparability of financial information can be ensured through the adoption of a
uniform accounting principle and practice. The value of information would be
enhanced, if these can be compared from period to period and also from entity
to entity.
5. Harmonization:
Harmonization of accounting principles and practices has become a top most
priority in offshore trading, in global financial and capital market operation.
The diverse accounting policies and practices in use in a country should
integrate to the extent possible to formulate its own accounting standards.
Conceptual
Framework of Accounting:
‘Conceptual
Framework’ means a constitution which guides the preparation and presentation
of financial statements. It works as the basis for the preparation of accounts.
In India
the Institute of Chartered Accountants of India (ICAI) has issued its
‘Conceptual Framework for the preparation and presentation of financial
statements.’ In the year 2000. It does not define any Accounting Standard and
it does not override any specific Accounting Standard. The Framework is
concerned with general purpose financial statements.
Examine the correctness of the
following statements:
1. “Anticipated incomes and
expenses should not be accounted for in the books of accounts”.(GU 2004)
Answer: The above statement
is partially correct, because according to convention of conservatism, all
unfavourable events should be recognized at the earliest. The basic rule of
conservatism is that, ”Recognized all possible losses and anticipated no gain”.
It is due to policy of playing safe in a world of uncertainties. Therefore
anticipated expenses should be recorded or accounted as provision but
anticipated incomes should not be accounted.
2. “Companies registered under
the Companies Act 1956 should not comply with the Accounting Standards issued
by the Institute of Chartered Accountants of India
Answer: The Companies Act
1956 was amended in the year 1999 to support the Accounting Standards in true
sense. The Amended Act came into force w.e.f. 31st Oct. 1998 , which has made the
compliance of the Accounting Standards mandatory. Three new Sub-section 3A, 3B
and 3C have been added to Section 211. Therefore, the above statement is not
correct.(GU 2004)
3. “Accounting for hire
purchase transactions are based on the accounting concept, ’Substance Over
Legal Form.”(GU 2005)
Answer: According to Modified
Principles of Substance Over Legal Form, the transactions and events recorded
in the books of accounts and presented in the financial statements governed by
the, ‘Substance of such transactions and not by legality of such transaction’
in case of hire purchase transactions. In such a case, legally hire purchaser
does not become the owner of the asset till the payment of last installment; he
is allowed to record the asset as full cash price in the books of accounts even
on the date of acquisition. Since, for all practical purpose he uses the asset
as if he is the owner. So, above transaction is wrong.
4. “Revenue Principle states
that income should be recognized in the period in which the money is received.”
(GU 2005)
Answer: According to Revenue
Principle, revenue is recognized when title of the goods passes from seller to
buyer or when service is performed to the customer legally. However, in some
cases income (revenue) may be measured objectively before actual sales. As for
example in case of gold which has specified market value, revenue is recognized
in the accounting period when agreement take place not in the period when it’s
sales take place. Similarly, in the case of hire purchase transaction, revenue
is recognized by the seller on the payment of the last installment.
Therefore,
the above statement is partially correct.
5. “Timeliness is the basic
assumption of accounting.”
Answer: Basis assumptions
accounting are Accounting Entity, Accrual, Going Concern, Money Measurement and
Accounting Period. Timeliness belongs to Modified Accounting Principle.
Therefore,
above statement is a false statement.
6. “Going Concern Assumption
state that assets are valued at realizable price currently going in the market.”
Answer: According to Going Concern
Assumption the business entity will continue to exist indefinitely. Therefore,
fixed assets will be shown at cost price less annual depreciation and market
price/ realizable value will not be considered for valuing fixed assets, as
they are not for resale.
Hence.
Above statement is not correct.
Provisions of Accounting
Standards (AS) of India
1.Disclosure of Accounting
Policies: The As-1, Disclosure of Accounting Policies, has been drafted
more or less the same manner as that the International Accounting Standard,
IAS-1; Disclosure of Accounting Policies. The provision regards disclosure of
Accounting policies are given below:-
(i)
The standard deals with disclosure of
significant accounting policies followed in preparation of financial statement
(or annual report)
(ii)
The accounting policies so disclosure would form
a part of financial statement.
(iii)
Any change in accounting policies which has a
material effect either in the current year or in the subsequent year are to be
disclosed.
(iv)
It is also the Fundamental Accounting Assumption
viz. Going Concern, Consistency and accrual.
2. Revenue Recognition:
The standard (AS-9) deals with the basis for recognition of revenue arising
from ordinary activity of an enterprise in the Profit& Loss Account. It
excludes arising from Construction Contracts, Hire Purchase. Lease Agreement,
Government Grant and Insurance Contract.
The standard prescribes two
conditions for Revenue Recognition of sale.
(i)
The seller of goods has transferred the property
in goods to the buyer along with significant risks and rewards of the ownership
and seller has no effective control over goods transferred.
(ii)
No significant uncertainty exists regarding the
amount of the consideration that will be derived from the sale.
3. Valuation Inventories:
of The revised AS-2, Valuation of Inventories came into effect from1st April
1999 and is mandatory in nature.
The standard excludes that the
following items:
(i)
Work-in-progress arising under Construction
Contracts, including direct related Service Contract.
(ii)
Work-in-progress arising in the ordinary course
of business of Service Providers.
(iii)
Shares, debentures & other financial
instruments held as stock-in-trade.
(iv)
Producers’ inventories of livestock, agriculture
and forest products, minerals oils, ores and gases.
The standard
includes:
(i)
Inventories held for sale in the ordinary course
of business;
(ii)
Inventories in the process of production of such
sale; or
(iii)
Inventories in the form of materials or
suppliers to be consumed in production process or in the rendering of services.
Valuation: Inventories
should be valued at lower of cost and net realizable value.
Cost of inventories: The
cost of inventories should be comprises all cost and purchase including duties
and taxes thereon and excluding trade discount, rebate, duty drawback.
Cost formula: The cost
should be assigned by using First-in-First-out (FIFO) or Weighted Average Cost
formula.
4.Depreciation Accounting:
Accounting Standard-6, Depreciation Accounting was issued in 1985, and inserted
in the Companies Act 1988 (Amended). Depreciation accounting is applicable to
all assets expect the followings:
(i)
Forest, Plantation
and similar regenerating natural resources,
(ii)
Wasting assets such minerals, natural gas, oils
etc.,
(iii)
Expenditure on Research & Development
(R&D),
(iv)
Goodwill,
(v)
Livestock,
(vi)
Land.
Depreciation accounting is
applicable to following assets:
(i)
Which are expected to be used more than on
accounting period,
(ii)
Which have a limited useful life, and
(iii)
Which are held by an enterprise for use in the
production or supply of goods and services and not for the purpose of resale.
Progress in India
The
legal and authoritative support has recently been given to the Accounting
Standards in India .
This support to the accounting standards given by three agencies:
(a)
The Institutes of Chartered Accountants of India
(ICAI),
(b)
The Central Government: (i) Income Tax Act,
& (ii) Companies Act.,
(c)
The SEBI.
The
manner of exercising authority for enforcement and compliance by the above
agencies is discussed below:
(a) The
Institutes of Chartered Accountants of India
(b) The
Central Government:
(i)
Income Tax Act: the Central Government,
under Section 145(2) of the Income Tax Act, is authorized to notify, from time
to time, the accounting standards to be followed by any class of assessment or
any class of income. Till now two standard have been issued under the Income Tax
Act. They are: (1) Disclosure of Accounting Policies, & (2) Disclosure of
the Prior Period and Extra-ordinary Items and Changes in Accounting Policies.
(ii)
Companies Act: The real legislative
support to the accounting standards in true sense has been completed only in
the year 1999, when the Companies Act 1956 was amended. The amended Act came
into force w.e.f. 31-10-1998 ,
which has made the compliance of accounting standards mandatory. Three new
Sub-section 3A, 3B and 3C have been added to Section 211.
Another amendment in Companies Act was made in 2000, which has made
the Directors of a company responsible to make a disclosure on compliance of
accounting standards. For this purpose the Companies (Amendment) Act, 2000 has
made a provision under Section217 (2AA) (i) for ‘Directors Responsibility
Statement’.
(c) The SEBI:
The enforcement of accounting standards has further been strengthened by the
initiatives of the Securities and Exchange Board of India. The SEBI has formed
a committee under the Chairmanship of Y. H. Malegam, the former President of
ICAI to ensure the implementation of accounting standards. It is expected that
this initiative of SEBI will ensure greater co-ordination between the standard
setting process and the standard implementation process. It will invariably
ensure greater corporate transparency.
XXXXXX
Unit: II
Sectional and Self-Balancing Ledger System:
Sub-Division of Ledger:
In a large business enterprise
both the number of transactions and the number of accounts are too large to be
accommodated in one single ledger. Moreover, it becomes inconvenient on the
part of ledger clerks to do the work of posting in one ledger simultaneously.
Therefore, it is felt necessary to divide the ledger book into different
sections, viz.-
1. Debtors
Ledger or Sales Ledger or Sold Ledger,
2. Creditors
Ledger or Purchases Ledger or Bought Ledger,
3. General
Ledger or Nominal Ledger or Impersonal Ledger or Main Ledger.
1.
Debtors Ledger or Sales Ledger or Sold
Ledger: In this ledger, the accounts of all debtors for
goods are maintained. Posting is made from Sales Book, Return Inward
Book, Cash Book, Bills Receivable Book and Journal Proper.
2.
Creditors Ledger or Purchases Ledger or
Bought Ledger: In this ledger, the account of all creditors for
goods is maintained. Posting is made from Purchases Book, Return
Outward Book, Cash Book, Bills Payable Book and Journal Proper.
3.
General Ledger or Nominal Ledger or
Impersonal Ledger or Main Ledger: This ledger contains all accounts
other than the accounts of Debtors and Creditors for goods. Posting is made
from all the Books.
Sectional
Ledger Balancing System
Sectional
Ledger Balancing System is a system under which only one section of the ledgers
i.e. General Ledger is ‘Self-balanced’. Two Control Accounts namely Total Debtors
Account and Total Creditors Account are opened in the General Ledger to make it
self balanced. The Trial Balance is prepared only for the General Ledger.
Features of Sectional Balancing System:
Sectional Balancing Ledger System has the following features:
1.
Subdivision of Ledger:
Under this system, the ledger is divided into three sections, viz.,- Debtors’
Ledger, Creditors’ Ledger & General Ledger.
2.
Self-Balancing of one Ledger:
Under this system one section of the ledger i.e. General Ledger is self-balanced.
3.
Preparation of Control Accounts:
Two Control Account, viz., Total Debtors Account and Total Creditors Account
are prepared in General Ledger.
4.
Preparation of Trial Balance:
A Trial Balance of the whole business can be prepared from the balances of the
accounts including the Control Account maintained in the General Ledger.
Advantages of Sectional Ledger Balancing System:
1.
Division of work: Under the system
ledger is divided into three sections and more than one ledger keeper can be
employed, which facilitates the division of work.
2.
Internal Check: The two control
Accounts are kept under the control of responsible official and the ledger
clerks are not allowed to have access the these accounts, these can act as a
valuable part of internal check system.
3.
Ascertainment of balances of Debtors and
Creditors: The preparation of Total Debtors and Creditors
Accounts in General Ledger facilitates the ascertainment of balances of Debtors
and Creditors before the end of the specified period.
4.
Location of errors: Under this
system, errors can be located without much effort and time.
5.
Reduction in Auditors’ work:
As the Debtors and Creditors Ledgers are automatically check, it reduces the
volume of work of an auditor.
Defects of Sectional Ledger Balancing System:
Following are the defects of sectional balancing
ledger:
1.
Self-balancing of one ledger:
Under this system only General Ledger is self-balanced. Debtors and Creditors
Ledger are not self-balance. Hence, errors cannot be located in two ledgers.
2.
Arithmetical accuracy of one ledger only:
The system is limited to self-balancing of General Ledger only. Hence,
arithmetical accuracy does not proof in the case of Debtors and Creditors
Ledger.
3.
Non-adherence to Double Entry:
Sectional balancing does not adhere to Double Entry System of accounting, as no
journal entry is required to be passed.
4.
Limited application of internal check:
Internal check system is limited in one section of ledger i.e. General Ledger.
Treatments of Adverse or
Contra Balance in Debtors’ Ledger and Creditors’ Ledger under sectional
Balancing System:
Normally, customers’ accounts in
Debtors Ledger have debit balances because the customers are like to pay to the
business. However, sometimes, some customers’ accounts may show credit balances
due to excess amount received from customers, goods return by the customers
after full payments made etc.
Similarly, suppliers’ accounts in
Creditors Ledger have credit balances because the suppliers are like to receive
from the business. However, sometimes, some suppliers’ accounts may show debit
balances due to excess payments made to suppliers, goods return to suppliers
after full payments.
Such balances are called adverse/ contra
balances because they show the reverse of the normal balances.
Where the ledgers are kept under
Sectional Balancing System, the adverse balances are dealt with as under:
(i)
In Case of Adverse Opening Balance:
Where the opening balance of some of the Debtors’ Accounts shows credit
balance, the total of such credit balances are shown on the credit side of the
Total Debtors’ Account as ‘By Balance b/d’.
Where the
opening balance of some Creditors’ Account Shows debit balance, the total of
such debit balances are shown on the debit side of the Total Creditors Accounts
as ‘To Balance b/d’.
(ii)
In case of Adverse Closing Balance:
Where the closing balance of some of the Debtors’ Account shows credit balance,
the total of such credit balances are shown on the debit side of the Total
Debtors’ Account at the end of the period as ‘To Balance c/d’.
Where the closing balance of
some of the Creditors’ Account shows debit
balance, the total of such
balances are shown on the credit side of the Total Creditors’ Account at the
end of the period as ‘By Balance c/d’.
Specimen Copy of
In General
Ledger
Total Debtors
Account
Dr.
Cr.
|
Dt.
|
Particulars
|
Amt.
|
Dt.
|
Particulars
|
Amt.
|
|
|
To Balance b/d
(Opening
Debit Balance)
To Sales A/c
(Credit
sales from Sales Book)
To Bills Receivable A/c
(B/R
Dishonoured from Journal Proper)
To Interest A/c
(Charged,
from Journal Proper)
To Expenses A/c
(Charged,
from Journal Proper)
To Cash A/c
(Refund,
from Cash Book)
To Bank A/c
(Cheque
Dishonoured, from Cash Book)
To Balance c/d
(Closing
Credit Balance, if any)
|
|
|
By Balance b/d
(Opening
Credit Balance, if any)
By Cash A/c
(Received,
from Cash Book)
By Bank A/c
(Received
cheque, from Cash Book)
By Discount Allowed A/c
(From
Cash Book)
By Return Inward A/c
(From
Return Inward Book)
By Bills Received A/c
(Received,
from B/R Book)
By Bad Debts A/c
(From
Journal Proper)
By Allowances A/c
(From
Journal Proper)
By Transfer
(From
Journal Proper)
By Balance c/d
(Closing
Debit Balance)
|
|
Specimen Copy of
In General
Ledger
Total Creditors
Account
Dr.
Cr.
|
Dt.
|
Particulars
|
Amt.
|
Dt.
|
Particulars
|
Amt.
|
|
|
To Balance b/d
(Opening
Debit Balance, if any)
To Cash A/c
(Paid,
from Cash Book)
To Bank A/c
(Issued
cheque, from Cash Book)
To Discount Received A/c
(From
Cash Book)
To Return Outward A/c
(From
Return Outward Book)
To Bills Payable A/c
(Accepted,
from B/P Book)
To Allowances A/c
(From
Journal Proper)
To Transfer
(From
Journal Proper)
To Balance c/d
(Closing
Credit Balance)
|
|
|
By Balance b/d
(Opening
Credit Balance)
By Purchases A/c
(Credit
purchase from Purchases Book)
By Bills Payable A/c
(B/P
Dishonoured from Journal Proper)
By Interest A/c
(Charged,
from Journal Proper)
By Expenses A/c
(Charged,
from Journal Proper)
By Cash A/c
(Refund,
from Cash Book)
By Bank A/c
(Cheque
Dishonoured, from Cash Book)
By Balance c/d
(Closing
Debit Balance, if any)
|
|
Note: Bad
Debts Recovered, Reserve or Provision for Doubtful Debt, Reserve for Discount
on Debtors and Provision for Discount on Creditors have no affect on the Total
Debtors Account as well as on the Total Creditors Account hence they will be
excluded.
Self-
Balancing Ledger System
Self-balancing Ledger System is a
system of maintaining ledgers in such a way that an independent Trial Balance
can be prepared from each ledger without the help of other ledgers.
Under this system, an Account
called ”Adjustment A/c” is opened in the backside of each ledger for the
purpose of completing double entry of each of the transaction relating to each
ledger itself.
The following adjustment accounts
are required to be opened in the ledgers:--
Name of the ledger Name of the Adjustment Account
(A) General Ledger (i) Debtors’ Ledger
Adjustment Account.
(ii)
Creditors’ Ledger Adjustment Account.
(B) Debtors’ Ledger (i) General Ledger
Adjustment Account.
(C) Creditors’ Ledger (i) General Ledger
Adjustment Account.
Procedures of self-balancing of the Debtors Ledger:
For the
purpose of self-balancing of Debtors Ledger, the following two Adjustment or
Control Accounts are opened:
1.
General Ledger Adjustment Account in Debtors
Ledger,
2.
Debtors Ledger Adjustment Account in General Ledger.
To self-balancing of Debtors Ledger, the following Journal
Entries will be passed:
(i) For Credit Sales, Bills Receivable Dishonoured, Cash
Refund, Cheque Dishonoured, Interest & Expenses Charged:-
Debtors’ Ledger Adjustment A/C Dr .
(In
General Ledger)
To General Ledger Adjustment A/C
(In Debtors’ Ledger)
(ii) For Cash received from Debtors, Cheque received,
Returns Inward, Discount Allowed, Bills Receivable received, Bad Debts,
Allowances, and Transfer etc.
(In Debtors’ Ledger)
To Debtors’ Ledger Adjustment A/C
(In General Ledger)
Entries
passed to the debit side of the General Ledger Adjustment Account are the
reverse entries of the transactions that have already been credited in the
Personal Accounts in the Debtors Ledger.
Similarly,
the entries passed to the credit side of the General Ledger Adjustment Account
are nothing but the reverse entries of the transactions that have already been
debited in the various Personal Accounts in the Debtors Ledger.
Thus, the
Double Entry of the transaction is completed and the total of the balances of
the Debtors Accounts will show a debit balance while the General Ledger
Adjustment Account will show equal amount of credit balance.
Debtors
Ledger Adjustment Account in General Ledger is the reverse photocopy of the
General Ledger Adjustment Account in Debtors Ledger.
Now,
an individual Trail Balance can be prepared from the Debtors Ledger.
Procedures of self-balancing of the Creditors
Ledger:
For the
purpose of self-balancing of Creditors Ledger, the following two Adjustment or
Control Accounts are opened:
3.
General Ledger Adjustment Account in Creditors
Ledger,
4.
Creditors Ledger Adjustment Account in General
Ledger.
To self-balancing of Creditors Ledger, the following Journal
Entries will be passed:
(i) For Credit Purchases, Bills Payable Dishonoured,
Cheque Dishonoured, Cash Refund by Creditors, B/R Endorsed Dishonoured,
Interest & Expenses Charged etc.
(In Creditors’ Ledger)
To Creditors’ Ledger Adjustment
A/C
(In General Ledger)
(ii) For Cash paid, Cheque issued, Returns Outward,
Discount Received, Bills accepted, Allowances, and Transfer etc.
Creditors’ Ledger Adjustment A/C Dr .
(In
General Ledger)
To General Ledger Adjustment A/C
(In Creditors’ Ledger)
Entries
passed to the credit side of the General Ledger Adjustment Account are the
reverse entries of the transactions that have already been debited in the
Personal Accounts in the Creditors Ledger.
Similarly,
the entries passed to the debit side of the General Ledger Adjustment Account
are nothing but the reverse entries of the transactions that have already been
credited in the various Personal Accounts in Creditors Ledger.
Thus, the
Double Entry of the transaction is completed and the total of the balances of
the Creditors Accounts will show a credit balance while the General Ledger
Adjustment Account will show equal amount of debit balance.
Creditors
Ledger Adjustment Account in General Ledger is the reverse photocopy of the
General Ledger Adjustment Account in Creditors Ledger.
Now,
an individual Trail Balance can be prepared from the Creditors Ledger.
Procedures of self-balancing of the General Ledger:
In order
to make the General Ledger self balanced, the following Adjustment or Control
Accounts are opened in the General Ledger:
1.
Debtors Ledger Adjustment Account,
2.
Creditors Ledger Adjustment Account.
For the purpose
of self-balancing of General Ledger, no further Journal Entries are required.
General Ledger contains all accounts of individual Assets, Liabilities,
Incomes, Expenses etc. expect individual Debtors Creditors Account. The
accounts of Total Debtors and Total Creditors will be incorporated in ‘Debtors
Ledger Adjustment Account’ and ‘Creditors Ledger Adjustment Account’.
Now,
a Trial Balance can be prepared from the General Ledger.
Essential features of Self Balancing Ledger System:
The essential features of self-balancing system are as
under:
1.
Self-Balancing of each Ledger:
Under this system each ledger is made self-balance. Which means that an
independent trail balance can be prepared for each ledger.
2.
Opening of Adjustment Account:
Each ledger contains an Adjustment Account for the completing of double entry
of the transaction relating to that ledger.
3.
Contra Entries between two Adjustment
Account: Journal entries for contra entries are required to be passed
between two Adjustment Accounts maintain in two different ledger.
4.
Separately designed Subsidiary Books:
Subsidiary Books are made in such a manner that they readily show the total of
transaction to be posted in the Adjustment Account in the various ledger at the
end of the period say weekly, monthly, according to self-balancing system.
Additional columns are to be maintained for that purpose.
5.
Periodical posting: Contra entries
are made and posted at the time of balancing and not daily.
Objectives of Self-Balancing Ledger System:
The following are the objectives of self-balancing ledger
system:
1.
Location of error: The primary
objectives of self-balancing system are the location of book-keeping and
arithmetical error and reduction of time and labour in detecting such error.
2.
Internal Check: As the correctness
of the posting in various ledgers can be verified independently by other
person, the object of enforcing a system of internal check is achieved.
3.
Effective Supervision: The Chief
accountant can enforce effective supervision on account-keeping staffs by means
of Control/Adjustment Account in General ledger.
4.
Preparation of Internal Account:
Internal system can be prepared for managerial purpose because the accounts are
kept up to date under this system.
5.
Timely Preparation of Trial Balance:
A trial balance can be prepared from the Control/ Adjustment Account without
waiting for rectification any error in any ledger.
Advantages of Self-Balancing Ledger System:
Following are advantages of Self-Balancing Ledger System:
1.
Provides arithmetical accuracy of ledger:
It provides a proof of the total arithmetical accuracy of the book-keeping
entries in any ledger.
2.
Provides internal check: It
provides a sound system of internal check because some responsible official can
verify the work of a ledger keeper through Control Accounts.
3.
Early preparation of final account: The
Trail Balance can be easily prepared without waiting for individual Debtor and
Creditor’s balance. Quick preparation of Trail Balance results in early and
timely preparation of Final Accounts.
4.
Fixation of responsibility: As
each ledger is maintained by different set of persons, it is possible to fix
the responsibility in case of some error found in a particular ledger.
5.
Reduction of Auditor’s work: It
reduces the work of the auditors because this system acts automatic control of
the ledgers.
Distinction between Sectional Ledger System and
Self-Balancing System:
|
Points
|
Sectional
Ledger Balancing System
|
Self-Balancing
System
|
|
1.Nature of work
|
It involves checking
of a section of a group of ledgers.
|
It involves checking
of each ledger.
|
|
2. Scope of work
|
It makes part of the
ledgers self-balance.
|
It can make each
ledger self-balance.
|
|
3.Objectives
|
The objective is the
location of errors of a section of ledger.
|
The objective is the
location of errors of each ledger.
|
|
4. Application of
Double Entry System
|
Double Entry System
can be completed only in respect of General Ledger.
|
Double Entry System
is completed in General Ledger and other ledgers too.
|
|
5. Preparation of
Trail balance
|
It is possible to
prepared Trail Balance of the General Ledger only.
|
It is possible to
prepared Trail Balance of other ledgers along with General Ledger.
|
Transfer from one ledger to another:
Some
times goods may be purchase from a person on credit and again goods may be sold
to that person on credit. In such a situation, the person may be a debtor as
well as a creditor. As a debtor his personal account will be appeared in the
Debtors’ Ledger and as a creditor his personal account will also be appeared in
the Creditors’ Ledger. Settlement of such person’s account will be either paid
or received. The same cannot be a debtor and a creditor of firm at the same
time. So, his smaller account/amount must be transferred to the greater
account/amount. For that purpose Transfer Entry is required to be passed to
avoid omission of effect.
In the
case of Self-Balancing Ledger System, multiple ledgers are maintained where
ledgers are sub-divided into Debtors Ledger, Creditors Ledger and General
Ledger. The account of such person will
appear in the Debtors Ledger and Creditors Ledger for goods sold on credit and
purchased on credit respectively. At the time of final settlement, following
three entries have to be passed:
1.
Transfer Entry:
(Creditors’ Ledger)
To
Mr. X A/c Smaller
amt.
(Debtors’
Ledger)
2.
Self-Balancing Entry:
(i) Creditors’ Ledger Adjustment A/c Dr . do
(General
Ledger)
To
General Ledger Adjustment A/c do
(Creditors’
Ledger)
(ii) General Ledger Adjustment A/c Dr . do
(Debtors’
Ledger)
To
Debtors’ Ledger Adjustment A/c do
(General
Ledger)
Rectification of Error Under Self-Balancing System:
In course of accounting work
there may be some errors, which may cause disagreement of the Trial Balance. It
should be kept in mind that if the error is caused due to the wrong totaling of
some subsidiary books, the error would also be reflected in the Adjustment
Accounts kept under Self-Balancing system.
Since, the self balancing entries
are passed on the basis of total of subsidiary books such as Sales Book,
Purchases Book, Returns Books etc., if the error relates to the wrong casting
of any of the subsidiary books, then such errors would also affect the
correctness of the Adjustment Accounts opened for maintaining under
Self-Balancing system.
When an error affects a
subsidiary books, total of the subsidiary books become wrong and as a result
the corresponding Adjustment Accounts are also affected. If the error does not
affect the total of a subsidiary book, it does not affect the Adjustment Accounts.
It should be kept in mind,
that an error affecting the total of a subsidiary book, an additional
Self-Balancing Rectification Entry is required to be passed. No Self-Balancing
Rectification Entry is required it does not affect the total of any subsidiary
books.
Rectification entries for sales books is undercast:
When the
sales book is undercast the Sales A/c (in the General Ledger) will affected,
but not the Individuals Accounts (in the Debtors Ledger). Because the posting
in the individuals Debtors A/c in the Debtors Ledger has been correctly made.
Where the
ledgers are maintained under Self Balancing System, the undercasting of the
Sales Day Book also affect the:
1. Debtors
Ledger Adjustment Account in General Ledger; and
2. General
Ledger Adjustment Account in Debtors Ledger.
The following rectification
entries will have to be passed:
(i)
For Book Keeping Rectification Entry:
Suspense A/c Dr.
To Sales A/c
(ii)
For Self Balancing Rectification Entry:
Debtors Ledger Adjustment A/c Dr .
(in
General Ledger)
To
General Ledger Adjustment A/c
(in
Debtors Ledger)
Treatments of adverse balances under Self-Balancing
Ledger System:
Where the ledger are kept under
Self balancing system, the adverse balances are dealt with as under:
(i) In case of Adverse Opening
Balance: Where the opening balance of some of the Debtors’ account
show credit balance, the total of such credit balances are shown as below:
(a)
Credit side of the ‘Debtors Ledger Adjustment
Account’ in the General Ledger as ‘By Balance b/d’.
(b)
Debit side of the ‘General Ledger Adjustment
Account’ in the Debtors Ledger as ‘To Balance b/d’.
Where the opening balance of some
of the Creditors’ account show credit balance, the total of such debit
balances are shown as below:
(a)
Debit side of the ‘Creditors Ledger Adjustment
Account’ in the General Ledger as ‘To Balance b/d’.
(b)
Credit side of the ‘General Ledger Adjustment
Account’ in the Creditors Ledger as ‘By Balance b/d’.
(ii) In case of Adverse
Closing Balance: Where the closing balance of some of the Debtors’
account show credit balance at the end of the period, the total of such
credit balances are shown as below:
(a)
Debit side of the ‘Debtors Ledger Adjustment
Account’ in the General Ledger as ‘To Balance c/d’.
(b)
Credit side of the ‘General Ledger Adjustment Account’
in the Debtors Ledger as ‘By Balance c/d’.
Where the closing balance of some
of the Creditors’ account show credit balance at the end of the period,
the total of such debit balances are shown as below:
(c)
Credit side of the ‘Creditors Ledger Adjustment
Account’ in the General Ledger as ‘By Balance c/d’.
(d)
Debit side of the ‘General Ledger Adjustment
Account’ in the Creditors Ledger as ‘To Balance c/d’.
If the closing balances of
debtors and creditors are not given in the question, then such balance will
have to be ascertained after entering the closing or debit balances.
State whether the following statement are true or
false:
1. “Under casting of Sales Day Book affect both
General Ledger and Debtors Ledger under Self –balancing ledger system.”
Answer: The Ledgers are maintained under Self-balancing
System, the undercasting of Sales Day Book affects the General Ledger and
Debtors Ledger, because the total of the Sales Day Book represent the total
credit sales for the period in both the ledgers.
So, the
above statement is correct one.
2. “ Self-balancing can be introduce even in a small
business where there is only one ledger.”
Answer: Self-balancing system can be introduced even in a
small business where the ledgers are sub-divided, viz. Debtors Ledger,
Creditors Ledger and General Ledger. Sub-division of ledger is based on size
and nature of the business. But it is not possible to introduce this system
where there is only one ledger.
Therefore,
the above statement is not correct.
3.” In case of transfer from one ledger to another,
three entries will have to be made in case of Self-balancing System.”
Answer: In the case of transfer from one ledger to another
ledger where an account of a person appears in debtors’ ledger as well as in
creditors’ ledger, three entries will have to be made in the case of
Self-balancing System. These are as follows:
(iii)
Simple Transfer Entry,
(iv)
Self-balancing Transfer Entry in Debtors Ledger.
(v)
Self-balancing Transfer Entry in Creditors
Ledger.
4.” Where multiple ledgers are kept, Provision for
Doubtful Debts is opened in the Debtors Ledger.”
Answer: The above statement is a totally wrong statement,
because Provision for Doubtful Debts does not have the effect increasing or
decreasing the balance of Debtors Account. So, this item is not considered in
Debtors Ledger the case of multiple ledger system.
Question: What are the Total Debtors and Total
Creditors Account opened in General Ledger? How and why they opened in that
ledger?
Answer:
Total
Debtors and Total Creditors Account in the General Ledger:
Where the
multiple ledgers are kept, the General Ledger contains double aspect of the
transactions relating to cash transaction only. The double aspect of all
transaction relating to credit purchases and credit sales of goods are not
completed in the General Ledger itself, Because one aspect either debit or
credit is recorded in the General Ledger and other aspect of the same
transaction is recorded either in the Debtors Ledger or in the Creditors
Ledger.
When
goods are sold on credit the accounts of the individual debtors are posted in
the Debtors Ledger and the sales account is credited in the General Ledger.
Now, if a trail balance is prepared from the General Ledger, the trail balance
will not agree. The aspect relating to debtor’s personal account is missing
from the General Ledger.
In order
to enable the preparation of Trail Balance from the General Ledger, two Control
Account viz. Total Debtors and Total Creditors Accounts are required to be
prepared in the General Ledger to complete the double aspect of the credit
transaction.
The Total
Debtors Account and Total Creditors Account are prepared from the subsidiary
books at periodical intervals. Total
Debtors Account in the General Ledger is debited with amount of credit sales,
bills receivable from debtors dishonoured, interest, expenses charges etc. and
credited with the amount receive from customers, discount allowed, returns
inward, bills receivable during the year, bad debts, allowances, transfer etc.
Total
Creditors Account in the General Ledger is debited with total amount paid to
suppliers, discount received from them, bills payable accepted, returns
outward, allowances, transfer etc. and credited with total credit purchases
during the year, bills payable dishonoured, interest & expenses charged by
the suppliers etc.
Question: How does the Sectional balancing helps in
internal check system.
Ans: The two Control Accounts viz. Total Debtors and Total
Creditors Account are maintained in General Ledger. These two-control accounts
are kept under the control of some responsible official and the ledger clerks
are not allowed to have access these accounts.
Therefore, it will act as a
valuable part of internal check system.
XXXXXXX
Unit-III
Hire Purchase and Instalment Purchase System
Meaning of Hire Purchase:
Hire
purchase system is a system under which the buyer agrees to pay the price of
the goods bought in periodical instalments viz. yearly, half-yearly, quarterly,
monthly; to acquire the immediate possession for use. But the ownership of such
goods passes to the buyers only on the payment of last instalment.
In hire
purchase system, there are two parties viz. the seller, is known as Hire Vendor
and buyer, is known as Hire purchaser or Hirer. The periodical instalments are
treated as rent.
According
to J. Stephenseon, “The hire purchase is a form of trade in which credit is
granted to the buyer on the security of a lien on the goods.”
Special features
of hire-purchase system:
1.
Agreement: It is as agreement to
sell goods but not a contract of sale. The sale takes place in future on the
fulfillment of certain conditions.
2.
Possession of the goods: The hire
purchase agreement gives the buyer the right to get immediate possession of the
goods for use only.
3.
Ownership: The right of ownership
of the goods remains with the seller till the last instalment is paid.
4.
Down payment: On agreement and
delivery of the goods generally some amount of payment is made by the buyer to
the seller, which is called ‘Down
Payment or Cash Down’. It does not include any interest.
5.
Mode of payment: The payments made
by periodical instalments viz. monthly, quarterly, half yearly, yearly etc. and
each instalment includes interest and capital value of the goods.
6.
Hire charger: Each and every
instalment including interest is considered as a ‘Hire charge or rent’ till the
payment of the last instalment.
7.
Right of repossession: If the
buyer makes a default in respect of payment of any instalment, the seller has
the right to repossess the goods and also forfeits the amount already paid by
the buyer as instalment.
Unit-VI
Royalty Account
Meaning of Royalty:
Royalty
is a periodical payment based on output or sale for the use of a certain right
of asset like mine, copyright or patent. It is usually calculated at a given
rate either based on unit produced or sold or at a certain percentage on the
sale proceeds.
Actual
Royalty = No. of unit produced/sold X Rate
of royalty.
The
person who makes the payment to the owner of the asset in exchange for the
right to use his asset is known as Lessee/ Publisher/Licensee etc. And
the owner of the asset to whom the payments made is known as Lessor/Landlord/Author/Patent
etc.
Accounting
Treatment of Royalty (When there is no minimum rent)
In the
books of Lessee:
(i) When
Royalty occurred:
Royalty
A/c Dr.
To
Landlord A/c
(ii) When
amount is paid:
Landlord
A/c Dr.
To
Bank A/c
(iii)
When Royalty A/c is transferred:
Trading/Production/
Profit & Loss A/c Dr.
To
Royalty A/c
Note:
If the payment of Royalty based on number of unit produced or output, then
Royalty A/c is transferred to Trading or Production A/c and when it is based on
number of unit sold or turnover, the it is transferred to Profit or Loss A/c.
But,
in the case of a limited company royalty based on production is also
transferred to Profit & Loss A/c, because under Schedule-VI, Part-II,
Section 211 (2) of the Companies Act 1956, only Profit & Loss A/c is
prepared by a limited company.
In the
books of Lessor:
(i) When
Royalty occurred:
Lessee
A/c Dr.
To
Royalty A/c
(ii) When
amount is received:
Bank
A/c Dr.
To
Lessee A/c
(iii)
When Royalty A/c is transferred:
Royalty
A/c Dr.
To
Profit & Loss A/c
Minimum Rent/Dead Rent/Fixed Rent/Certain Rent:
The
minimum amount which is payable periodically by the lessee to the lessor is
known as minimum rent or dead rent. Usually, the agreement of the royalty
contains a clause for the payment of a fixed minimum amount to the lessor every
year as royalty irrespective of the benefit to be taken by the lessee. Where
the agreement provide for payment of minimum rent, the lessee will be paid
either minimum rent or actual royalty for the benefit taken, which ever is
higher.
The
object of fixing the minimum or dead rent is that the lessor may not get less
than a certain amount per year even there is no output or very small output.
Shortworking:
When the
Minimum Rent exceeds the Actual Royalty, the difference is known as
Shortworking. The question of Shortworking arises only when the Lease Agreement
provide for the payment of minimum rent.
Shortworking = Minimum Rent
- Actual Royalty.
Shortworkings are two types:
3. Shortworkings
Irrecoverable (Fixed), &
4. Shortworkings
Recoverable (Floating).
1. Shortworkings Irrecoverable (Fixed):
Where there is no stipulation/condition in the agreement for the recovery of
Shortworkings by the lessee out of excess working/ surplus royalty (Excess workings = AR- MR) in subsequent
years, where actual royalties exceed the minimum rent, such Shortworkings are
called Shortworkings Irrecoverable.
They are
debited to an account called ‘Shortworkings Irrecoverable’ and which is
transferred to the Profit & Loss Account at the end of the year.
Accounting
Treatment:
In the
books of Lessee:
(i) When
Shortworking occurred:
To
Landlord A/c
(ii) When
transferred:
Profit
& Loss A/c Dr.
To
Shortworking A/c
In the
books of Lessor:
(i) When
Shortworking occurred:
Lessee
A/c Dr.
To
Royalty Suspense A/c
(ii) When
transferred:
Royalty
Suspense A/c Dr.
To
Profit & Loss A/c
2. Shortworkings Recoverable(Floating):
Where there is stipulation/condition in the agreement for the recovery of
Shortworkings by the lessee out of excess working/ surplus royalty (Excess workings = AR- MR) in subsequent
years, where actual royalties exceed the minimum rent, such Shortworkings are
called Shortworkings Recoverable. The agreement usually mentions some conditions
for recoupment of the Shortworkings:
(i)
The Shortworkings are always recouped when there
is excess working/ surplus royalty.
Accounting
Treatment: When Shortworking is
recovered:
In the books of Lessee:
Landlord
A/c Dr.
To
Shortworking A/c
In the books of lessor:
Royalty
Suspense A/c Dr.
To
Lessee A/c
(ii)
The recoupment of Shortworking is to be done
within the agreed period as given in the agreement and to be carried forward to
subsequent years.
Accounting Treatment:
When Shortworking is carry forwarded, no journal is required to pass in Lessee
and Lessor books.
(iii)
If the Shortworkings could not recouped within
the agreed period; it will be lapsed and transferred to the Profit & Loss
Account.
Accounting Treatment: When Shortworking is lapsed:
In the books of Lessee:
Profit
& Loss A/c Dr.
To
Shortworking A/c
In the books of Lessor:
Royalty
Suspense A/c Dr.
To
Profit & Loss A/c
Strikes and
Loch-out:
In the
event of a strike or lockout, the minimum rent can be reduced proportionately
only when there is an agreement to that effect between the parties; otherwise
as per Section 56 of the Contract Act 1872, the strikes and lockouts will not
be an excuse for reduction of the minimum rent.
Since,
lease is a result of agreement between the two parties, i.e., lessor and
lessee, everything will be settled in terms of the lease agreement. Usually, a
lease agreement contains a clause to the effect that in the event of strikes or
lockouts during the working of a lease, if the Minimum Rent could not be
raised, it is dealt with following manners:
(i)
Actual royalty earned considered as
Minimum Rent: In the event of a strike or lockout in a particular year,
if the Minimum Rent could not be raised, the actual royalty earned will
discharge all rental obligation i.e. it will be taken to be the Minimum Rent of
the year.
(ii)
Reduction of Minimum Rent: In the
event of strike or lockout in a particular year, if the Minimum Rent could not
be raised, the Minimum Rent will be reduced proportionately having regard to
the length or stoppage.
(iii)
Reduction of Shortworking proportionately:
In the event of a strike or lockout in a particular year, if the Minimum Rent
could not be raised Shortworking may be reduced proportionately having regard
to the period of stoppage of work. In this case the difference between the
Minimum Rent and the Actual Royalty will be calculated for the actual working
period and it will be treated as the total Shortworking of that year. Then the
Minimum Rent (MR=AR+SW) will be proportionately reduced having regard to the
period of stoppage of work.
Royalty Suspense Account:
Generally, in the case of any
Shortworking arises the in the books of Lessor, an account called ‘Royalty/
Shortworking Suspense Account’ is opened. When the lessee has the right to
recoup the Shortworking out of excess working/surplus royalty in subsequent
years, where actual royalties exceed the minimum rent, then this will be
adjusted against the Royalty Suspense Account. The balance of Royalty Suspense
Account, if any, will be transferred to Profit & loss Account of the year in
which the right of recoupment of the lessee expired.
Distinction
between Royalty and Rent:
|
Point
|
Royalty
|
Rent
|
|
1.
Basis of calculation
|
It
is calculated on the basis of unit of production or on the basis of certain
percentage of sale proceeds
|
It
is calculated on the basis of time for which the asset is used.
|
|
2.
Type of cost
|
It
is a unit cost.
|
It
is a time cost.
|
|
3.
Nature of the amount
|
The
amount of royalty is variable depending on the value of production or sale,
except minimum rent.
|
The
amount of rent is fixed.
|
|
4.Shortworking
|
Shortworking
may be raised if actual royalty is less than minimum rent, which can be
adjusted in future from excess working.
|
There
is no scope for Shortworking.
|
|
5.
Act
|
Patent
and Copy Right Act are applicable in the case of royalty
|
Rent
Control Act is applicable.
|
State
whether the statements are ‘true’ or ‘false’:
1.
“The object of dead rent is that the Landlord should not get more than a
certain amount per year.”
Ans:
The above statement is a wrong statement. The object of fixing the minimum rent
is that Landlord should not get less than a certain amount per year even when
there is no output or a very small output. The Landlord will get the minimum
rent and actual royalty, whichever is higher.
2.
“ Shortworking is the loss of the lessee not in the year of their
occurrence, but in the year they lapse.”
Ans:
The above statement is partially correct, because in the case of Shortworking
without the option of recoupment in the future, such type of Shortworking lapse
and transferred to the Profit & Loss A/c in the year in which they
occurred. But Shortworking with the option of recoupment will be lapse and
transferred to Profit & loss Account of the year in which the right of
recoupment of the Shortworking expired.
3.“Royalty
is a real account”.
Ans:
Royalty is not a real account. It is a
nominal account. Royalty received by the landlord is an income and royalty paid
by the lessee is an expenses.
Importance
of Minimum Rent:
Minimum Rent is the amount, which
has to be paid by the lessee irrespective of the actual benefit taken from the
lease property. The important of minimum rent or dead rent is that it helps the
landlord to get certain regular income from the property. Generally, royalty is
calculated at a given rate either based on unit produced or sold or at a
certain percentage on the sale proceeds. Therefore, the amount of royalty
depends on the production or sales, if there is no production or no sales, no
royalty will be received by the landlord. But when the minimum rent or dead
rent is mentioned in the agreement, the landlord will get either minimum rent
or the actual royalty, whichever is higher.
Therefore, the minimum rent is the
guaranteed amount of income to the landlord and on the other hand it compel the
lessee to work on the right at lease to cover the minimum rent.
Accounting
Treatment of Royalty:
Accounting treatments of royalty in
the books of Lessee and Lessor, are based on four different situations:
Situation- (I): Minimum Rent is not provided in the
agreement.
Situation- (II): Shortworkings are not recoverable
and Minimum Rent Account is not
opened.
Situation- (III): Shortworkings are recoverable and
Minimum Rent Account is not
opened.
Situation- (IV): Shortworkings are recoverable and
Minimum Rent Account is opened.
