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By going through these CBSE Class 12 Accountancy Notes Chapter 6 Accounting for Share Capital, students can recall all the concepts quickly.

Accounting for Share Capital Notes Class 12 Accountancy Chapter 6

With the expansion in the scale of operations, non-corporate forms of organizations, for example, sole proprietorship, partnership firms found themselves unequal to the tasks of meeting all the capital requirements of the present-day large-scale business operations. Thus, a relatively new form of the business organization came into vogue and this is called a Company.

Company:
A Company may be defined as an artificial person created by law, having a corporate and legal personality distinct and separate from its members, perpetual succession, and a common seal.

The word Company implies a group of people who voluntarily agree to form a company.
In the eyes of law ‘Company’ is termed as ‘Company’ which is formed and registered under any of the previous laws before the Indian Company Act 1956 or under this act.

“Company is an artificial person created by law having a separate legal entity with a perpetual succession and a common seal.” -L.H. Haney

“A corporation is an artificial being, invisible, intangible and existing only in the contemplation of law.” -Justice Marshall

“it is an association of persons who contribute money or money’s worth to a common stock and employ it for some common purpose.” -Justice Lindley

Features of a Company:

1. It is a voluntary association of persons for profit.
2. It is a separate legal entity i.e. Its legal existence is different from that of its member.
3. The members have limited liability.
4. It has perpetual succession.
5. It has a common seal which signifies the sign of company.
6. The shares of a public limited company can be freely transferable.
7. It can enter into contracts and can enforce contractual rights against others. Similarly, the company can be sued by others if there is a breach of contract by the company.

Kinds of a Company:

Companies Limited by Shares: In this case, the liability of the members is limited to the extent of the nominal value of shares held by them.

Companies Limited by Guarantee: In this case, the liability of its members is limited to the extent of the guarantee given by them in the event of the company being wound up.

Unlimited Companies: When there is no limit on the liability of its members, such Companies are called unlimited companies.

Public Company: A Public Company means a company that is not a Private Company.

Private Company: A Private Company is one which by its Articles of Association:

1. Restricts the right to transfer its shares;
2. Limits the number of its members to fifty;
3. Prohibits any invitation to the public to subscribe for any shares in or debentures of the company.

Share Capital of a Company:
Every company should have capital in order to finance its activities. The company raises this capital by issue of share because it does not have capital of its own being an artificial person. Thus, the total capital of the company is divided into shares, therefore, it is called share capital.

Categories of Share Capital:
1. Authorised Capital: An Authorised Capital refers to that amount that is stated in the Memorandum of Association as the share capital of the company. It is the maximum amount with which the company is registered and which it is authorized to raise from the public by the issue of shares. The amount is also called the registered or nominal capital.

2. Issued Capital: It is the portion of authorized capital that is offered to the public for subscription and the remaining portion not yet offered to the public for subscription is called the unissued capital.

3. Subscribed Capital: It is that part of the issued capital which has been actually subscribed by the public. When the shares offered for public subscription were subscribed fully by the public, in such a case the issued capital and subscribed capital would be the same.

4. Called-up Capital: It is that part of the subscribed share capital which the company actually demands from the share-holders. The company may decide to call the entire amount or part of the face value of the shares.

5. Paid-up Capital: It means the total amount paid up or credited as paid upon the subscribed capital. Some of the shareholders may fail to pay the amount due from them on account of a call which is termed as ”call-in-arrears” or “unpaid capital”.

6. Uncalled Capital: That portion of the subscribed capital that has not been called up is called uncalled capital. The company may collect this amount at any time when it needs further funds.

7. Reserve Capital: Sometimes a company, by means of a special resolution, decides that a certain portion of its uncalled capital shall not be called up during its existence and it would be available in the event of winding up of the company. Such a portion of uncalled capital is termed as ‘reserve capital’.

Share Capital in the Balance Sheet of Company:
According to Schedule VI of the Companies Act, 1956 the information regarding Share Capital is to be shown in the following manner

Sunrise Company Ltd.
Balance Sheet as at…………

Shares of a Company:
The capital of a company is divided into a number of equal units. Each unit is called a share. The Companies Act 1956, defines a share as “a share in the share capital of the company. The person who contributes money through shares is called Shareholders.”

The company issues a certificate to every shareholder stating the number of shares he holds. The certificate is called a Share Certificate.

Classes of Shares:
According to the Indian Companies Act, 1956 a company can issue two types of shares:

1. Preference Share
2. Equity Share (formerly known as ordinary share)

1. Preference Share: According to Section 85 of the Companies Act, 1956 a preference share is one, which fulfills the following conditions:
(a) That it carries a preferential right to the dividend to be paid either as a fixed amount or an amount calculated by a fixed rate which may be either free of or subject to income tax; and
(b) That with respect to the capital it carries or will carry, on .the winding-up of the company, the right to the repayment of capital before anything is paid to equity shareholders.

2. Equity Share: According to Section 85 of the Companies Act, 1956, an equity share is a share that is not a preference share.
This share does not carry any preferential right or in other words, equity share is one that is entitled to dividend and repayment of capital after the claims of preference share are satisfied.

According to Section 86 (a), equity share capital may be:

1. With voting right or
2. With differential rights as to voting, dividend, or otherwise in accordance with such rules and subject to such condition as may be prescribed.

Issue of Share:
The shares of a company can be issued in two ways:

1. for cash
2. for consideration other than cash.

Issue of Share for cash
Steps for the issue of share for cash:
1. Issue of Prospectus: The company first issues the prospectus to the public. It contains complete information about the company and the manner in which share capital is to be collected from the prospective investors.

2. Receipt of Application: When a prospectus is issued to the public, prospective investors intending to subscribe to the share capital of the company would make an application along with the application money and deposit the same with schedule bank as specified in the prospectus.

3. Receipt of Minimum Subscription: The company has to get a minimum subscription. It is to be noted that the minimum subscription of the capital cannot be less than 90% of the issued amount according to SEBI (Disclosure and Investor Protection) Guidelines, 2000 [6.3.8.1 and 6.3.8.2]. If this condition is not satisfied, the company shall forthwith refund the entire subscription amount received.

If a delay occurs beyond 8 days from the date of closure o! subscription list, the company shall be liable to pay the amount with interest at the rate of 15% [Section 73 (2)]. Within 120 days from the date of the issue of the prospectus, if the company fails to receive the same within the said period, the company cannot proceed with the allotment of shares, and the application may be returned within 130 days of the date of issue of prospectus.

Allotment of Shares:
When a minimum subscription has been received, the company may proceed with the allotment of shares. When allotment is made, it results in a valid contract between the company and the applicants who now became the shareholders of the company.

Accounting Treatment of Issue of Shares
Issue of Shares at Par:
When shares are issued for an amount equal to the face value of a share, they are said to be issued at par.

The issue price of a share may be payable either in lump sum along with the application or in installments.

The amount of application money is fixed by the directors but, according to legal provisions, it can in no case be less than 5% of the face value of shares.

Accounting Treatment:
When Share Application money received along with the application:
BankA/c Dr.
To Share Application A/c [Total Amount received on, application]
(Amount received on the application for -Share Rs. -Per Share)

1. Transfer of Application money

[Application money on-Share allotted /transferred to Share Cap.]

2. Money refunded on rejected application

(Application money returned on rejected applications for-share)

3. Amount Due on Allotment

4. Adjustment of Excess Application money

(Application Amount on -Shares @ Rs. -per shares adjusted to the amount due on allotment.)

5.Receipt of Allotment Account
Bank A/c Dr.
To Share Allotment A/c
(Allotment money received on -Share @ Rs.-Per share)

Combined Account:
Sometimes a combined account for share application and share allotment is kept in the books of a company under the name Share Application and Allotment Account.
1. For Receipt of Application and Allotment
Bank A/c Dr.
To Share Application and Attotment A/c [Total Amount Received on Application]
(Money received on applications for shares @ Rs.-per share)

2. Transfer of Application money and Allotment Amount Due
Share App. and Allotment A/c Dr.
To Share Capital [No. of share Allotted × (Application money per share + Allotment Amount per share)]
(Transfer of application money to share capital for the amount due on allotment of shares @ Rs. – per share)

3. Money Refunded on Rejected Applications
Share App. and Allotment A/c Dr.
To Bank A/c [No. of share Rejected × App. money per share]
(Application money returned on the rejected application for….share)

4. Receipt of Balance Allotment money
Bank A/c Dr.
To Share Application and Allotment A/c
(Balance of Allotment money received)

Calls on Share: Two points are important regarding the Calls on shares.

1. The call amount should not exceed 25% of the face value of shares.
2. There must be an internal dynamics of keeping at least some months between the making of two calls unless otherwise provided by the Articles of Association of the company.

Accounting Treatment:
1. Call Amount Due

(Call money due on – Shares @ Rs. – per share)

2. Receipt of Call Amount
Bank A/c Dr.
To Share Call A/c
(Call money received)

Note: The name of the call viz. First, the second and final call is added between the words ‘share’ and ‘call’ in the entry depending upon the identity of the call made.

Calls-in-Arrears: When any shareholder fails to pay the amount due on allotment or on any of the calls, such amount is known as ‘Calls- in-Arrears / Unpaid Calls’.

Call in Arrears amount shows the debit balance and the same is shown as a deduction from the paid-up capital on the liabilities side of the Balance sheet.

Accounting Treatment:
Calls-in-Arrears A/c Dr.
To Share Allotment A/c To Share Call/Calls A/c
(Calls in Arrears brought into account)

The Articles of Association of a company usually empower the directors to charge interest at a stipulated rate on calls in arrears. In case the Articles are silent in this regard, the rule contained in Table A shall be applicable, which states that the interest at a rate not exceeding 5% p.a. shall have to be paid on all unpaid amounts on shares for the period intervening between the day fixed for payment and the time of actual payment thereon. On receipt of the call amount together with interest.

Bank A/c Dr.
To Calls-in-Arrears A/c
To Interest A/c

Calls-in- Advance:
Sometimes some shareholders pay a part or whole of the amount on the calls not yet made. Such amount received in advance from the shareholders is known as “Calls in Advance”. It may also happen in the case of partial allotment of shares when the full amount of application money paid is not adjusted to the allotment. The amount received will be adjusted towards the payment of calls as and when it becomes due.

Accounting Treatment:
A separate call in advance A/c is opened for its accounting treatment and the following entry will pass:
Bank A/c Dr.
To Call-in-Advance A/c
(Amount received on Call-in-Advance)

When call becomes actually due requiring adjustment of
Call- in-Advance’A/c:
Calls-in-Advance A/c Dr.
To Particular Call A/c [Call Amount due]
(Calls-in-advance adjusted with the call money due)

The credit balance of Calls-in-Advance A/c is shown separately on the liabilities side of the balance sheet under the heading ‘Share Capital’ but is not added to the amount of Paid Up Capital.

As calls in advance are a liability to the company and it is under an obligation if provided by the Articles of Association, to pay interest on such amount. In case, the articles are silent then Table ‘A’ shall be applicable, according to which interest @ 6% p.a. may be paid.

1. Interest due
Interest on Calls-in-Advance A/c Dr.
To Sundry Shareholder’s A/c [Amount of Interest due for payment]
(Interest due on Calls-in-Advance)

2. Payment of Interest
Sundry Shareholder’s A/c Dr.
To Bank A/c [Amount of Interest paid]
(Interest paid on Calls-in-Advance)

Oversubscription:
When Shares are issued to the public for subscription through the prospectus by well-managed and financially strong companies, it may happen that applications for more shares are received than the number of shares offered to the public, such a situation is said to be a case of oversubscription.

Alternative:

1. They can accept some applications in full and totally reject the others.
2. They can make a pro-rata distribution.
3. They can adopt a combination of the above two alternatives.

Accounting Treatment:
1. If the excess applicants are totally refused for allotment, the application money received on these shares’s refunded.

(Transfer of money on the application for Share allotted and money refunded on the application for Share rejected)

2. If the applicants are made partial allotment (or pro-rata allotment):
The directors can as well opt to make a proportionate distribution of shares available for allotment among the applicants of shares. The proportion is determined by the ratio which the number of shares to be allotted to bear to the number of shares applied for. This is called ‘pro-rata allotment.

Generally, excess application money received on these shares is adjusted towards the amount due on allotment or call.

(Transfer of application money to share capital and excess application money credited to share allotment.)

(Amount due on the Attotment of – Share @ Rs. – Per Share)

(Allotment money received after adjusting the amount already received as excess application money)

3. This is a combination of two alternatives described above as thus:
(a) Application for some shares are rejected outright, and
(b) pro-rata allotment is made to the applicants of a remaining number of shares.

Thus, money on the rejected applications is refunded and excess application money due to pro-rata distribution is adjusted towards the amount due on the allotment of shares allotted.

(Transfer of application money to share capital, excess application amount credited to share allotment and money refunded on rejected application)

(Amount due on the Allotment of — Share @ Rs. — Per Share)

(Allotment money received after adjusting the amount already received as excess application money)

Under Subscription:
In case applications for a lesser number of Shares have been received than that for which they have been invited by the company, it is called Under Subscription of shares. When an issue of shares is undersubscribed, the company can proceed with the allotment of shares, provided a minimum subscription is raised.

Issue of Shares at a Premium [Sec 781 When shares are issued at an amount more than the face value of a share, they are said to be issued at a premium. The difference between the issue price and the face value of the Share is called the premium.

Note: According to the Companies (Amendment) Act, 1999, the term, ‘Securities Premium’ is required to be used in place of ‘Share Premium’.

Under Section 78 of the Companies Act 1956, the amount o share premium may be used only for the following purposes:

1. In writing off the preliminary expenses of the company.
2. For writing off the expenses, commission, or discount allowed on the issue of shares or debentures of the company.
3. For issuing fully paid bonus shares to the shareholders of the company.
4. For providing for the premium payable on redemption of redeemable preference shares or debenture of the company.

When Shares are issued at a premium, the journal entries are as follows:
(a) Premium Amount called with Application money

(Money received on the application for— Shares @ Rs. — per share including premium)

(Transfer of application money to share capital and premium accounts)

(b) Premium Amount called with Allotment money

(Amount due on allotment of shares @ Rs. – per share including premium)
(ii) Bank A/c Dr.
To Share Allotment A/c
(Allotment money received including premium)

Issue of Shares at a Discount:
When a share is issued at a price that is less than its face value, it is said that it has been issued at a discount.

Normally, a company cannot issue its share at a discount. Share can be issued at a discount only when the following conditions gives in Section 79 of the Companies Act, 1956 are satisfied.
1. At least one year must have elapsed since the company became entitled to commence business. It means that a new company cannot issue shares at a discount at the very beginning.

2. The company has already issued such types of the share;

3. An ordinary resolution to issue the shares at a discount has been passed by the company in the General Meeting of shareholders and sanction of the Company Law Board has been obtained.

4. The resolution must specify the maximum rate of discount at which the share is to be issued but the rate of discount must not exceed 10% of the face value of the share, for more than this limit sanction of the Company Law Board is necessary.

5. The issue must be made within two months from the date of receiving the sanction of the Company Law Board. Generally, the amount of discount is recorded at the time of allotment. Therefore the following entry should be passed on attornment.
Share Allotment A/c Dr.
Share Discount A/c Dr.
To Share Capital A/c
(For the amount due on the allotment, excluding discount)

‘Discount on the Issue of Shares Account’, showing a debit balance, denotes a loss to the company, which is in the nature of capital loss. Therefore, the account is presented on the assets side of the company’s balance sheet under ‘Miscellaneous Expenditure’. It is written off by being charged straight-way to the Securities Premium A/c if any, and in its absence, by being gradually charged to the Profit and Loss A/c over a period of years.

Issue of Shares for Consideration other than cash:
If a company purchases some assets from vendors, in exchange it can issue fully paid shares to them whereby the latter agrees to accepts it. Thus, no cash is received for the issue of shares. These shares can also be issued either at par, at a premium, or at a discount. The number of shares to be issued will depend on the price at which shares are issued and the amount payable to the vendor. To find out the number of shares to be issued to the vendor will be calculated as follows:
No. of Shares to be issued = \(\frac{\text { Amount Payable }}{\text { Issue Price }}\)
(a) On purchase of assets:
Assets A/c Dr.
To Vendor’s A/c
(Assets Purchased)

(b) Shares can be issued to vendors in any manner out of the following:
1. At Par:
Vendor’s A/c Dr.
To Share Capital A/c

2. At Premium:
Vendor’s A/c Dr.
To Share Capital A/c
To Securities Premium A/c

3. At discount:
Vendor’s A/c Share Discount A/c
To Share Capital A/c

Forfeiture of Shares:
If a shareholder fails to pay allotment money or call money on his share as called upon by the company, his shares may be forfeited by giving due notice and following the procedure specified in the Articles of Association in this behalf. This is known as forfeiture of shares.

To forfeit a share means to cancel the allotment to the defaulting shareholders and to treat the amount already received thereon as forfeited to the company.

Accounting Treatment:
1. Forfeiture of Shares issued at par

Note: In case’Calls-in-Arrears’ A /c is maintained by a company, ‘Call-in-Arrears’ A/c would be credited in the above instead of ‘Share Allotment’ and/or ‘Share Call or Calls’ A/c.

The balance on the Share Forfeited A/c is shown in addition to the total paid capital of the company under the heading ‘Share Capital’ on the liabilities side of the Balance Sheet till the forfeited shares are reissued.

2. Forfeiture of Shares issued at a Premium:
(a) If Premium has not been paid by the Shareholders:
Share Capital A/c Dr. (Amount Called up Premium)
Securities Premium A/c Dr. (Premium amount)

To Share Allotment A/c (Amount unpaid)
To Share Call/Calls A/c (Amount unpaid)
To Share Forfeiture A/c (Amount paid)
(For Share forfeited)

(b) If Premium has been paid by the shareholder:
Share Capital A/c Dr. (Amount Called up Premium)

To Share Allotment A/c Dr. (Premium amount)
To Share Call/Calls A/c (Amount unpaid)
To Share Forfeiture A/c (Amount paid)
(For Share forfeited)

3. Forfeiture of Shares issued at a discount:
Share Capital A/c Dr. (Amount Calledup + Discount)

To Discount on Issue of Share A/c (Discount on forfeited share)
To Share Allotment A/c (Amount unpaid)
To Share Call/Calls A/c (Amount unpaid)
To Share Forfeiture A/c (Amount paid)
(Forfeiture of Shares and discount on issue adjusted)

Re-Tissue of Forfeited Share:
The director of a company has the authority to re-issue the shares once forfeited. These forfeited shares are reissued at par, at a premium, or at a discount, the amount of the discount does not exceed the amount paid on such shares by the original shareholder but in case of shares originally issued at discount, the maximum permissible discount will be the amount paid on such shares by the original shareholder plus the amount of original discount.

Accounting Treatment:
1. For Forfeited Shares reissued at Par:
Bank A/c Dr.
To Share Capital A/c

2. For Forfeited Shares reissued at Premium:
Bank A/c Dr.
To Share Capital A/c
To Securities Premium A/c

3. For Forfeited Shares reissued at Discount:
Bank A/c Dr.
Share Forfeiture A/c Dr. (Discount Allowed)
To Share Capital A/c

Transfer:
When all forfeited shares have been reissued, the credit balance left on the Share Forfeiture A/c is transferred ta> Capital Reserve A/c
Share Forfeiture A/c Dr.
To Capital Reserve A/c

Buy-Back of Shares:
A company may buy its own shares from the market. This is called ‘buyback of shares’. Section 77 A of the Companies Act, 1956 provides such a facility to the companies and can buy its own shares from either of the following:

1. Existing equity shareholders on a proportionate basis
2. Open Market
3. Odd lot shareholders
4. Employees of the company.

Buyback of its own shares may be made out of:

1. Free reserve of the company e.g. general reserve, reserve fund, Cr. balance of Profit & Loss A/c.
2. From the proceeds of all earlier issues.
3. From Securities Premium A/c.

Section 77 A of the Companies Act has laid down the following procedures for buy-back of share:

1. Its Articles of Association authorize it to do so.
2. A special resolution must be passed in the companies annual general body meeting.
3. The buyback should not exceed 25% of the total paid-up capital and free reserve of the company.
4. The debt-equity ratio should not be more than a ratio of 2: 1 after the buy-back.
5. All the company’s shares are fully paid up.
6. The buy-back of the shares should be completed within 12 months from the date passing the special resolution.
7. The company should file a solvency declaration with the Registrar and SEBI which must be signed by at least two directors of the company.

By going through these CBSE Class 12 Accountancy Notes Chapter 5 Dissolution of a Partnership Firm, students can recall all the concepts quickly.

Dissolution of a Partnership Firm Notes Class 12 Accountancy Chapter 5

The word Dissolution implies “the undoing or breaking of a bond tie”. In other words, dissolution implies that the existing state of arrangement is done away with. In terms of the partnership, dissolution means discontinuance of relationships amongst the partners.

But the dissolution of partnership and dissolution of a partnership firm are two different terms. As we know that the reconstitution of a partnership firm takes place on account of admission, retirement, or death of a partner. Here, the existing partnership is dissolved, but the firm may continue under the same name if the partners so decide. It means that it results in the dissolution of a partnership but not that of the firm.

The dissolution of a partnership does not lead to the dissolution of the firm since the two situations are different. In case of dissolution of the partnership, the firm continues, only the partnership relation is reconstituted, but in case of dissolution of the firm, not only partnership is dissolved but the firm also loses its existence, implying thereby that the firm ceases to operate as a partnership firm.

Dissolution of a Partnership:
If dissolution involves only the reconstitution of the firm and the business in partnership is continued in the same name after the dissolution of the partnership agreement, it is known as the ‘Dissolution of the Partnership’. It involves a change in the relationship between partners without affecting the continuity of business. Here, the firm is reconstituted without the dissolution of the Finn.

A partnership is dissolved by change of mutual contract in the following cases:

1. Change in the existing profit sharing ratio among partners.
2. Admission of a new partner.
3. Retirement of a partner.
4. Death of a partner (Section 42).
5. Insolvency of a partner.
6. Completion of the venture if the partnership is formed for that,
7. Expiry of the period of the partnership, if the partnership is for a specific period.
8. The merger of one partnership firm into another.

Dissolution of a Firm:
According to Section 39 of the Indian Partnership Act, 1932 dissolution of a partnership between all the partners of a firm is called the ‘dissolution of the firm’.

It refers to the winding up of the business in partnership. It involves a complete breakdown of relations among all the partners and is the dissolution of a partnership between all the partners of a firm. Here, in this situation, business is to be discontinued, it requires the realization of assets and settlement of liabilities.

Dissolution of a firm takes place in the following cases:
Dissolution by Agreement

1. All the partners give consent to it; or
2. As per the terms of the partnership agreement.

Compulsory Dissolution:

1. Where all the partners or all expect one partner, become insolvent or insane rendering them incompetent to sign a contract; or
2. When the business of the firm becomes illegal; or
3. When some event has taken place which makes it unlawful for the partner to catty on the business of the firm in partnership.

On the Happening of Certain Contingencies

Subject to contract between the partners, a firm is dissolved:

1. if constituted for a fixed term, by the expiry of that term; or
2. if constituted to carry out one or more ventures, by the completion thereof; or
3. where all the partners except one decided to retire from the firm; or
4. where all the partners or all except one partner dies; or
5. by the adjudication of a partner as an insolvent.

Dissolution by Notice:
In case of partnership at will, the firm may be dissolved if any of the partners give notice in writing to the other partners signifying his intention of seeking dissolution of the firm.

Dissolution by Court (Under Section 44):
At the suit of a partner, the court may order for dissolution of partnership firm on any of the following grounds:

1. If a partner becomes insane; or
2. When a partner becomes permanently incapable of performing his duties as a partner; or
3. When a partner is guilty of misconduct that is likely to adversely affect the business of the firm; or
4. When a partner deliberately and consistently commits a breach of agreements relating to the management of the firm; or
5. When the partner transfer whole of his interest in the firm to a third party; or
6. When the business of the firm cannot be carried on, except at a loss; or
7. When the court, on any ground, regards dissolution to be just and equitable.

Difference between Dissolution of Partnership and Dissolution of Firm:


Settlement of Accounts
In case of dissolution of a firm, the firm ceases to conduct business and has to settle its accounts. For this purpose, it disposes of all its assets for satisfying all the claims against it. Section 48 of the Partnership Act provides the following rules for the settlement of accounts between the partners:
(a) Treatment of Losses
Losses, including deficiencies of capital, shall be paid:

1. first out of profits,
2. next out of the capital of partners, and
3. lastly, if necessary, by the partners individually in their profits sharing ratio.

(b) Application of Assets
The assets of the firm, including any sum contributed by the partners to make up deficiencies’ of Capital, shall be applied in the following manner and order:

1. In paying the debts of the firm to the third parties;
2. In paying each partner proportionately what is due to him/ her from the firm for advances as distinguished from capital (i.e. partner’s loan);
3. In paying to each partner proportionately what is due to him on account of capital; and
4. The residue, if any, shall be divided among the partners in their profit-sharing ratio.

Thus, assets realized along with a contribution from the partner if required, are applied as follows:

1. To pay outside liabilities. Debts with fixed charges are paid first, followed by debts with floating charges and then unsecured debts. Such as creditors, loans, bank overdraft, bills payable, etc.
2. To pay loans and advances made by the partners to the firm (in case the balance amount is not adequate enough to pay off such loans and advances, they are to be paid proportionately).
3. To settle capital accounts of the partners.

Private Debts and Firm’s Debts:
Where both the debts of the firm and private debts of a partner co-exist, the following rules, as stated in Section 49 of the Indian Partnership Act, 1932, shall apply:
(a) The property of the firm shall be applied first in the payment of debts of the firm and then the surplus if any shall be divided among the partners as per their claims, which can be utilized for payment of their private liabilities.

(b) The private property of any partner shall be applied first in payment of his private debts and the surplus, in any, may be utilized for payment of the firm’s debts, in case the firm’s liabilities exceed the firm’s assets. In nutshell, private property shall be first used to settle private debts and business property shall be first used to settle business debts, and the surplus if any, can be transferred.

Accounting Treatment:
Dissolution of the firm involves the realization of assets and settlement of liabilities and capital accounts. For this purpose, the following accounts are opened in the firm’s books:

1. Realization Account.
2. Partner’s Loan Account
3. Partner’s Capital Account
4. Bank or Cash Account

1. Realization Account:
A realization Account is opened on the dissolution of a firm. It is a nominal account. It shows the net result of realization of assets and settlement of liabilities.

For this purpose, the balances of assets and liabilities appearing in the ledger books are transferred to the realization account. It also records realized value of recorded as well as unrecorded assets. Similarly, payment for liabilities and unrecords liabilities are also recorded in the realization account.

It also recorded the realization expenses. The balance in this account is termed as profit or loss on realization which is transferred to partner’s, capital accounts in their profit sharing ratio. As the dissolution of a firm involves winding up of partnership business and requires final closure of books, the following steps are followed to record dissolution of the partnership firm:

→ Journal Entries:
1. For transfer of Assets
Realization A/c Dr.
To Sundry Assets (Individually) A/c [With a book value of individual asset]

All assets transferred to the realization account at their book value and its corresponding provisions or reserve appearing on the balance sheet are also transferred to the credit side of the realization account. Balance of cash, bank, and fictitious assets are not transferred to realization account.

2. For transfer of liabilities
Book value of all outside liabilities recorded in the books is transferred to realization account along with provisions against various assets.

Liabilities A/c (Individually) Dr.
To Realisation A/c [With a book value of Liabilities]

Note:
Partner’s capital account, accumulated profits, general reserves, reserve fund, partner’s loan are not transferred to realization account.

3. For Sale of Assets (recorded or unrecorded)
Bank/Cash A/c Dr.
To Realisation A/c [With the amount actually realized]

4. For an asset taken over by a partner
Partner’s Capital A/c Dr.
To Realisation A/c [ With the agreed take over the price of the assets]

5. For payment of liabilities
Realization A/c Dr.
To Bank/Cash A/c [With the amount actually paid]

6. For a liability which a partner takes responsibility to discharge
Realization A/c Dr.
To Partner’s Capital A/c [With the agreed value of liability taken over]

7. For transfer of assets to settle liabilities
If assets are transferred to settle the liability account (full and final settlement), then no separate journal entry is passed to record settlement of liability by transfer of assets. But if there is a difference, then we have to pass entry.

For example: If the creditor accepts an asset only as part of the payment of his dues, the entry will be made for cash payment. Creditors to whom Rs. 4,000 was due accepts typewriter worth Rs. 3,000 and Rs. 1,000 paid in cash, the following entry shall be made for the payment of Rs. 1,000 only.

If a creditor accepts an asset whose value is more than the amount due to him, he will pay cash to the firm for the difference for which the entry will be:
Bank A/c Dr.
To Realisation A/c

8. For payment of realization expenses;
(a) Expenses paid by the firm:
Realization A/c Dr.
To Bank/Cash A/c

(b) Expenses paid by a partner on behalf of the firm:
Realization A/c Dr.
To Pa liner’s Capital A/c

(c) When a partner has agreed to undertake the dissolution work for an agreed remuneration bear the realization expenses:
1. If payment of realization expenses is made by the firm:
Partner’s Capital A/c Dr.
To Bank/Cash A/c

2. If the partner himself pays the realization expenses:
[No Entry]

3. For agreed remuneration to such partner:
Realization A/c Dr.
To Partner’s Capital A/c

9. For the realization of any unrecorded assets including goodwill
Bank/Cash A/c Dr.
To Realisation A/c

10. For settlement of any unrecorded liability
Realization A/c Dr.
To Bank A/c

11. For transfer of profit and loss on realization
(a) In case of profit
Realization A/c Dr.
To Partner’s Capital A/c (Individually)

(b) In case of loss
Partner’s Capital A/c (Individually) Dr.
To Realisation A/c

Important:

1. If nothing is mentioned regarding the sale value of intangible assets like goodwill, prepaid expenses, patents, etc., it is assumed that these are valueless.
2. If nothing is mentioned regarding the sale value of tangible assets in the question, it is assumed that these are realized at their book value shown in the Balance Sheet.

→ Accounting Treatment of Reserve and Provisions:
1. If there exists a special reserve against any assets, it should be transferred to the credit side of the Realisation Account.
Provision for Depreciation A/c Dr.
Provision for Bad and Doubtful Debts Dr.
Investment Fluctuation Fund A/c Dr.
Life Policy Fund A/c Dr.
To Realisation A/c

→ These are not to be paid.
(a) Undistributed profits
General Reserve A/c Dr.
Reserve Fund A/c Dr.
Profit and Loss A/c (Credit Balance) Dr.
Workmen Compensation Fund A/c Dr.
To Partner’s Capital A/c (Individually)

(b) Undistributed losses
Partner’s Capital A/c (Individually) Dr.
To Profit and Loss A/c (Debit Balance)
To Advertisement Expenses A/c

2. Partner’s Loan Account:
When all the outside liabilities are paid in full, afterward this loan will be paid.
Partner’s Loan A/c Dr.
To Bank/Cash A/c

3. Partner’s Capital Accounts: After all the adjustments.
(a) If capital account showed debit balance:
Bank/Cash A/c Dr.
To Partner’s Capital A/c (Individually)
(For deficit amount of capital brought in cash by the partner)

(b) If capital account showed credit balance:
Partner’s Capital A/c Dr.
To Bank/Cash A/c (For final payment made to a partner)

4. Bank/Cash Account:
On the debit side of this account, entries as opening balance, sale of assets, and cash brought in by partners are shown and on the credit side, entries as cash payment for liabilities, expenses, and amount paid to partners are shown. If all the entries are correctly recorded, this account balances, and hence all accounts are closed.

Format of Realisation Account
Answer:

By going through these CBSE Class 12 Accountancy Notes Chapter 3 Reconstitution of Partnership Firm: Admission of a Partner, students can recall all the concepts quickly.

Reconstitution of Partnership Firm: Admission of a Partner Notes Class 12 Accountancy Chapter 3

As we know that Partnership is an agreement between the partners or members of the firm for sharing profits and losses of the business carried on by all or any of them acting for all. Any change in this agreement amounts to the reconstitution of the partnership firm.

A change in the agreement brings to an end the existing agreement and a new agreement comes into existence. This new agreement changes the relationship among the members or partners of the partnership firm. Hence, whenever there is a change in the partnership agreement, the firm continues but it amounts to the reconstitution of the partnership firm.

Modes of Reconstitution of the Partnership Firm:
Reconstitution of partnership firm usually takes place in any of the following situations:

1. At the time of admission of a new partner;
2. Change in the profit-sharing ratio of existing partners;
3.  At the time of retirement of an existing partner;
4. At the time of death of a partner;
5. The amalgamation of two partnership firms.

Admission of a New Partner:
When a business enterprise requires additional capital or managerial help or both for the growth and expansion of the business it may admit a new partner to supplement its existing resources. So, admission of a new partner is required for the following reasons:

1. Requirement of more capital for the expansion of the business.
2. Need of a competent and experienced person for the efficient running of the business.
3. To increase the goodwill of the business by taking a reputed and renowned person into the partnership.
4. To encourage a capable employee by taking him into the partnership.

According to Sec. 31, Indian Partnership Act, 1932, a new partner can be admitted into the firm only with the consent of all the existing partners unless otherwise agreed upon. Admission of a new partner means reconstitution of the firm. It is so because the existing agreement comes to an end and a new agreement comes into effect.

A newly admitted partner acquire s two main rights in the firm:

1. Right to share m the assets of the partnership firm, and
2. Right to share in the profits of the partnership firm.

Section 31, Indian Partnership Act, 1932, further specifies that the new partner is not liable for any debts incurred by the firm before he became a partner. New partner, however, will become liable if:

1. the reconstituted firm assumes the liabilities to pay the debt; and
2. the creditors have agreed to accept the reconstituted firm as their debtors and discharge the old firm from liability.

A new partner brings an agreed amount of capital either in cash or in-kind and he also contributes some additional amount known as premium or goodwill. This is done primarily to compensate the existing partners for the loss of their share in the profits of the firms.

Adjustment at the Time of Admission of a New Partner:

1. New profit sharing ratio;
2. Sacrificing ratio;
3. Valuation and adjustment of goodwill;
4. Revaluation of assets and liabilities;
5. Distribution of accumulated profits or losses or reserves; and
6. Adjustment of partners capitals.

New Profit Sharing Ratio:
The ratio in which all partners including new partner share the future profits is called the new profit sharing ratio. In other words, on the admission of a new partner, the old partners sacrifice a share of their profits in favour of the new partner. On admission of a new partner, the profit-sharing ratio among the old partners will change keeping in view their respective contribution to the profit-sharing ratio of the incoming partner. Hence, there is a need to ascertain the new profit sharing ratio among all the partners.

The new partner may acquire his share from the old partners in any of the following situations:
1. If only the ratio of the new partner is given, then in the absence of any other agreement or information, it is assumed that the old partners will continue to share the remaining profits in the old ratio.
Example: X, Y.and Z are partners sharing profits in the ratio 3:2:1 respectively. A is admitted in the firm as a new partner with \(\frac{1}{6}\)th share. Find the new profit sharing ratio.
Answer:
Let total profit = 1
A’s share = \(\frac{1}{6}\)th
Remaining Profit = 1 – \(\frac{1}{6}\) = \(\frac{5}{6}\)
Old partners share this remaining profit in the old profit sharing

= \(\frac{15: 10: 5: 6}{36}\)
= 15: 10: 5: 6

2. If the new partner acquires his share of profit from the old partners equally. In that case, the new profit sharing ratio of the old partner will be calculated by deducting the sacrifice made by them from their existing share of profit.

Example: Varun and Daksh are partners sharing profits and losses in the ratio 5:3. They admit Dhruv as a partner for \(\frac{1}{4}\)th share, which he acquires equally from Varun and Daksh. Calculate the new profit sharing ratio.
Answer:
Dhruv1s share = \(\frac{1}{4}\)
Share acquired by Dhruv from Varun = \(\frac{1}{4} \times \frac{1}{2}=\frac{1}{8}\)
Share acquired by Dhruv from Daksh = \(\frac{1}{4} \times \frac{1}{2}=\frac{1}{8}\)

3. In the new partner acquire his share of profit from the old partners in a particular ratio. In that case, the new profit sharing ratio of the old partners will be calculated by deducting the sacrifice made by them from their existing share of profit.

Example: Noni and Pony are partners, sharing profits in the ratio of 7:5. They admit Tony as new partner for \(\frac{1}{6}\)th share which he takes \(\frac{1}{24}\)th from Noni and \(\frac{1}{8}\)th from Pony. Calculate the new profit sharing ratio.
Answer:

4. If the old partners surrender a particular fraction of their share in favour of the new partner. In that case, the new partner’s share is calculated by adding the surrendered portion of the share by the old partners. Old partners’ share is calculated by deducting the surrendered portion from their old ratio.

Example: Anu and Priti are partners in firm sharing profits in the ratio of 5:3. Anu surrenders \(\frac{1}{20}\)th of her share and Priti surrenders \(\frac{1}{24}\)th of her share in favour of Kapil, a new partner. Calculate the new profit sharing ratio.
Answer:
Anu’s share = \(\frac{5}{8}\)

5. If the new partner acquires his share of profit from only one partner. In that case, the new profit sharing ratio of the old partner will be calculated by deducting the sacrifice made by one partner from his existing ratio.

Example: Akshay and Anshul are partners in a firm sharing profits in a 4: 1 ratio. They admitted Shikha as a new partner for \(\frac{1}{4}\) share in the profits, which she acquired wholly from Akshay. Calculate the new profit sharing ratio.
Answer:
Akhay’s share = \(\frac{4}{5}\)

Sacrificing Ratio:
The ratio in which the old partners have agreed to sacrifice their shares in profit in favour of a new partner is called the sacrificing ratio. This ratio is calculated by taking out the difference between the old profit sharing ratio and the new profit sharing ratio.

Sacrificing Ratio = Old Ratio – New Ratio

Goodwill:
Goodwill is the value of the reputation of a firm in respect of the profits expected in future over and above the normal profits earned by other similar firms belonging to the same industry. In other words, a well-established business develops an advantage of good name, reputation and wide business connections. This helps the business to earn more profits as compared to newly set-up business. This advantage in monetary terms called ‘Goodwill’. It arises only if a firm is able to earn higher profits than normal.

“Goodwill is nothing more than the probability that old customers will resort to the old place.” – Lord Eldon

“The term goodwill is generally used to denote the benefit arising from connections and reputation.” -Lord Lindley

“Goodwill is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connections of a business. It is the attractive force that brings in customers. It is one thing which distinguishes an old-established business from a new business at its first start.” -Lord Macnaghten

“Goodwill may be said to be that element arising from the reputation, connections or other advantages possessed by a business which enable it to earn greater profits than the return normally to be expected on the capital represented by the net tangible assets employed in the business.” – Spicer and Pegler

“When a man pays for goodwill, he pays for something which places him in the position of being able to earn more than he would be able to do by his own unaided efforts.” -Dicksee

Thus, goodwill can be defined as “the present value of a firm’s anticipated excess earnings “or as” the capitalised value attached to the differential profits capacity of a business.”

Characteristics of Goodwill:

1. Goodwill is an intangible asset but not a fictitious asset;
2. It is a valuable asset. Its value is dependent on the subjective judgement of the valuer.
3. It helps in earning higher profits than normal.
4. It is very difficult to place an exact value on goodwill. It is fluctuating from time to time due to changing circumstances of the business.
5. Goodwill is an attractive force that brings in customers to the old place of business.
6. Goodwill comes into existence due to various factors.

Factors Affecting the Value of Goodwill:
1. Nature of business: Company produces high value-added products or having stable demand in the market. Such a company will have more goodwill and is able to earn more profits.

2. Location: If a business is located in a favourable place, it will attract more customers and therefore will have more goodwill.

3. Efficient Management: Efficient Management brings high productivity and cost efficiency to the business which enables it to earn higher profits and thus more goodwill.

4. Market Situation: A firm under monopoly or limited competition enjoys high profits which leads to a higher value of goodwill.

5. Special Advantages: A firm enjoys a higher value of goodwill if it has special advantages like import licences, low rate and assured supply of power, long-term contracts for sale and for purchase, patents, trademarks etc.

6. Quality of Products: If the quality of products of the firm is good and regular, then it has more goodwill.

Need for Valuation of Goodwill:

1. At the time of sale of a business;
2. Change in the profit-sharing ratio amongst the existing partners;
3. Admission of a new partner.
4. Retirement of a partner;
5. Death of a partner;
6. Dissolution of a firm;
7. The amalgamation of the partnership firm.

Methods of Valuation of Goodwill:
Goodwill is an intangible asset, so it is very difficult to calculate its exact value. There are various methods for the valuation of goodwill in the partnership, but the value of goodwill may differ in different methods. The method by which the value of goodwill is to be calculated may be specifically decided among all the partners.

The methods followed for valuing goodwill are:

1. Average Profit Method
2. Super Profit Method
3. Capitalisation Method.

1. Average Profit Method:
Goodwill is calculated on the basis of the number of past years profits. In this method, the goodwill is valued at an agreed number of ‘years’ purchase of the average profits of the past few years.

Steps:

1. Find the total profit of the past given years.
2. Add ail Abnormal Losses like loss from fire or theft etc. and any Normal Income if not added before to the total profit of past given year.
3. Then, subtract, Abnormal Income (income from speculation or lottery etc.), Normal Expenses (if not deducted), Income from investment (if not related to general activities of business) and remuneration of the proprietor (if not given), if any, from the total profit of past given years.
4. After this, calculate the actual average profit by dividing the total profit by a number of years.
5. Then multiply Average Profit by the numbers of year purchases to find out the value of goodwill.

In other words:

Actual Average Profit = \(\frac{\text { Total Profit }}{\text { No. of Years }}\)

Goodwill = Actual Average Profit × No. of Years Purchased
→ Weighted Average Profit Method
Sometimes, if there exists an increasing or decreasing trend, it is considered to be better to give a higher weightage to the profits to the recent years than those of the earlier years. This method is an extension of the average profit method.

Steps:

1. Multiply each year’s profit to the weights assigned to each year respectively.
2. Find the total of the product.
3. Divide this product by total weights for ascertaining average profits.
4. Average profits then multiplied with No. of years purchased to find the value of Goodwill.

2. Super Profit Method:
Under this method, goodwill is valued on the basis of excess profits earned by a firm in comparison to average profits earned by other firms. When a similar type of firm gets a return as a certain percentage of the capital employed, it is called ‘normal return’. The excess of actual profit over the normal profit is called ‘Super Profits’. To find out the value of goodwill, Super profit is multiplied by the agreed number of year’s purchase.

Steps:

1. Calculate Actual Average Profit i.e. \(\left[\frac{\text { Total Profit }}{\text { No. of Years }}\right]\)
2. Calculate Normal Profit i.e.
   = \(\text { Capital Employed } \times \frac{\text { NormalRate of Return }}{100}\)
   [Capital Employed = Total Assets – Outside Liabilities]
3. Find Out Super Profits
   Super Profits = Actual Average Profit – Normal Profit
4. Calculate the Value of Goodwill
   = Super profit × No. of years purchased

3. Capitalisation Methods:
(a) by capitalizing the average profits
(b) by capitalizing the super profits.

(a) Capitalisation of Actual Average Profit Method:
Steps:

1. Calculate actual average profit: \(\left[\frac{\text { Total Profit }}{\text { No. of Years }}\right]\)
2. Capitalize the average profit on the basis of the normal rate of return:
   The capitalised value of actual average profit
   = Actual Average Profit × \(\frac{100}{\text { Normal Rate of Return }}\)
3. Find out the actual capital employed:
   Actual Capital Employed = Total Assets at their current value other than [Goodwill, Fictitious assets and non-trade investments] – Outside Liabilities.
4. Compute the value of Goodwill:
   Goodwill = Capitalised value of actual average profit – Actual Capital Employed.

(b) Capitalisation of Super Profit Method:
Steps:

1. Calculate Actual Capital Employed [same as above].
2. Calculate Super Profit [same as under Super Profit Method].
3. Multiply the Super Profit by the required rate of return multiplier:
   Goodwill = Super Profit × \(\frac{100}{\text { Normal Rate of Return }}\)

Treatment of Goodwill:
To compensate old partners for the loss (sacrifice) of their share in profits, the incoming partner, who acquire his share of profit from the old partners brings in some additional amount termed as a share of goodwill.
Goodwill, at the time of admission, can be treated in two ways:

1. Premium Method
2. Revaluation Method.

1. Premium Method:
The premium method is followed when the incoming partner pays his share of goodwill in cash. From the accounting point of view, the following are the different situations related to the treatment of goodwill:

(a) Goodwill (Premium) paid privately (directly to old partners)
[No entry is required]

(b) Goodwill (Premium) brought in cash through the firm
1. Cash A/c or Bank A/c Dr.
To Goodwill A/c
(For the amount of Goodwill brought by new partner)

2. Goodwill A/c Dr.
To Old Partner’s Capital A/c
(For the amount of Goodwill distributed among the old partners in their sacrificing ratio)

Alternatively:
1. Cash A/c or Bank A/c Dr.
To New Partner’s Capital A/c (For the amount of Goodwill brought b> a new partner)

2. New Partner’s Capital A/c Dr.
To Old Partner’s Capital A/c’s (For the amount of Goodwill distributed among the old partners in their sacrificing ratio)

3. If old partners withdrew goodwill (in full or in part) (if any)
Old Partner’s Capital A/c’s Dr.
To Cash A/c or Bank A/c
(For the amount of goodwill withdrawn by the old partners)

When goodwill already exists in books:
If the goodwill already exists in the books of firms and the incoming partner brings his share of goodwill in cash, then the goodwill appearing in the books will have to be written off.

Old Partner’s Capital A/c’s Dr.
To Goodwill A/c
(For Goodwill written-off in old ratio)

After the admission of the partner, all partners may decide to maintain the Goodwill Account in the books of accounts.
Goodwill A/c Dr.
To All Partner’s Capital A/c’s (For Goodwill raised in the new firm after admission of a new partner in new profit sharing ratio)

2. Revaluation Method:
If the incoming partner does not bring in his share of goodwill in cash, then this method is followed. In this case, the goodwill account is raised in the books of accounts. When goodwill account is to be raised in the books there are two possibilities:
(a) No goodwill appears in books at the time of admission.
(b) Goodwill already exists in books at the time of admission,

(a) No goodwill appears in the books:
Goodwill A/c Dr.
To Old Partner’s Capital A/c’s (For Goodwill raised at full value in the old ratio)
If the incoming partner brings in a part of his share of goodwill. In that case, after distributing the amount brought in for goodwill among the old partners in their sacrificing ratio, the goodwill account is raised in the books of accounts based on the portion of premium not brought by the incoming partner.
Example: X and Y are partners sharing profits in the ratio of 3: 2.

They admit Z as a new partner. \(\frac{1}{4}\)th share. The sacrificing ratio of X and Y is 2: 1. Z brings Rs. 12,000 as goodwill out of his share of Rs. 18,000. No goodwill account appears in the books of the firm.
Answer: Journal

(b) When goodwill already exists in the books
1. When the value of goodwill appearing in books is equal to the agreed value:
[No Entry is Required]

2. If the value of goodwill appearing in the books is less than the agreed value:
Goodwill A/c Dr.
To Old Partner’s Capital A/c’s (For Goodwill is raised to its agreed value)

3. If the value of goodwill appearing in the books is more than the agreed value:
Old Partner’s Capital A/c’s Dr.
To Goodwill A/c
(For Goodwill brought down to its agreed value)

→ If partners, after raising Goodwill in the books and making necessary adjustments decide that the goodwill should not appear in the firm’s balance sheet, then it has to be written off.
All Partners’ Capital A/c’s Dr.
To Goodwill A/c (For Goodwill written off)

→ Sometimes, the partners may decide not to show goodwill account anywhere in books.
New Partner’s Capital A/c Dr.
To Old Partner’s Capital A/c (For adjustment for New Partner’s Share of Goodwill)

Hidden or Inferred Goodwill:
1. To find out the total capital of the firm by new partner’s capital and his share of profit.
Example: New partner’s capital for \(\frac{1}{4}\)th share is Rs. 80,000, the entire capital of the new firm will be
80,000 × \(\frac{4}{1}\) = Rs. 3,20,000

2. To ascertain the existing total capital of the firm: We will have to ascertain the existing total capital of the new firm by adding the capital (of all partners, including new partner’s capital after adjustments, if any excluding goodwill)
→ If assets and liabilities are given:
Capital = Assets (at revalued figures) – Liabilities (at revalued figures)

3. Goodwill = Capital from (1) – Capital from (2)
Generally, this method is used, when the incoming partner does not bring his share of goodwill in cash. Here, we find out the total goodwill of the firm. After that, we can find out the new partner’s share of goodwill and treat accordingly.

Adjustment for Accumulated (Undistributed) Profits and Losses:
1. For Undistributed Profits, Reserves etc.
(For distribution of accumulated profits and reserves to old partners in old profit sharing ratio)
General Reserves A/c Dr.
Reserve fund A/c Dr.
Profit and Loss A/c Dr.
Workmen’s Compensation Fund A/c Dr.
To Old Partner’s Capital A/c’s
(For distribution of accumulated profits and reserves to old partners in old profit sharing ratio)

2. For Undistributed Losses:
Old Partner’s Capital A/c’s Dr.
To Profit and Loss A/c
(For distribution of accumulated losses to old partners in old profit sharing ratio)

Revaluation of Assets and Reassessment of Liabilities: Revaluation of Assets and Reassessment of Liabilities is done with the help of ‘Revaluation Account’ or ‘Profit and Loss Adjustment Account’.

The journal entries recorded for revaluation of assets and reassessment of liabilities are following:
1. For increase in the value of an Assets
Assets A/c Dr.
To Revaluation A/c (Gain)

2. For decrease in the value of an Assets
Revaluation A/c Dr.
To Assets A/c (Loss)

3. For appreciation in the amount of Liability
Revaluation A/c Dr.
To Liability A/c (Loss)

4. For reduction in the amount of a Liability
Liability A/c Dr.
To Revaluation A/c (Gain)

5. For recording an unrecorded Assets
Unrecorded Assets A/c Dr.
To Revaluation A/c (Gain)

6. For recording an unrecorded Liability
Revaluation A/c Dr.
To Unrecorded Liability A/c (Loss)

7. For the sale of unrecorded Assets
Cash A/c or Bank A/c Dr.
To Revaluation A/c (Gain)

8. For payment of unrecorded Liability
Revaluation A/c Dr.
To Cash A/c or Bank A/c (Loss)

9. For transfer of gain on Revaluation if the credit balance
Revaluation A/c Dr.
To Old Partner’s Capital A/c’s (Old Ratio)

10. For transfer of loss on Revaluation if debit balance
Old Partner’s Capital A/c’s Dr.
To Revaluation A/c (Old Ratio)

Adjustment of Capitals:
1. When the new partner brings in proportionate capital OR On the basis of the old partner’s capital.
(a) Calculate the adjusted capital of old partners (after all adjustments)

(b) Total capital of the firm
= Combined Adjusted Capital × Reciprocal proportion of the share of old partners

(c) New Partner’s Capital
= Total Capital × Proportion of share of a new partner.

2. On the basis of the new partner’s capital:
(a) Total Capital of the firm = New Partner’s Capital × Reciprocal proportion of his share.
(b) Distribute Total Capital in New Profit Sharing Ratio.
(c) Calculate adjusted capital of old partners.
(d) Calculate the difference between New Capital and Adjusted Capital.

1. If the debit side of the Capital Account is bigger then it means he has excess capital
   Partner’s ( capital Accounts Dr.
   To Cash A /c or Bank A/c or Current A/c
2. If the credit side is bigger then it means that he has short capital
   Cash A/c or Bank A/c or Current A/c Dr.
   To Partner’s Capital A/cs

Change in Profit Sharing Ratio among the Existing Partners:
Sometimes the existing partners of the firm may decide to change their profit sharing ratio. In such a case, some partner will gain in future profits and some will lose. Here the gaining partners should compensate the losing partners unless otherwise agreed upon. In such a situation, first of all, the loss and gain in the value of goodwill (if any) will have to adjust.
1. Goodwill A/c Dr.
To Partner’s Capital A/c’s (For raising the amount of Goodwill in old ratio)

2. Partner’s Capital A/c’s Dr.
To Goodwill A/c
(For writing off the amount of Goodwill in New Profit sharing ratio)

Alternatively:
Gaining Partner’s Capital A/c’s Dr.
To Losing Partner’s Capital A/c’s (For adjustment due to change in profit sharing ratio)

By going through these CBSE Class 12 Accountancy Notes Chapter 2 Accounting for Partnership: Basic Concepts, students can recall all the concepts quickly.

Accounting for Partnership: Basic Concepts Notes Class 12 Accountancy Chapter 2

Due to the limitation of sole-tradership regarding limited capital, limited managerial abilities, the low scale of business, involves more risk due to unlimited liability, tie need of partnership arises. A partnership is a relation of mutual trust and faith. There are certain peculiarities in ” the accounts of partnership firm than those are prepared in the sole tradership firm. The main peculiarities regarding the accounting of partnership firms are maintenance of the capital accounts of partners, distribution of profits to the partners, etc.

Meaning of Partnership:
The partnership is an agreement written/oral between two or more persons who have agreed to do some lawful business and to share profit ! or loss arising from the business.

According to the Indian Partnership Act, 1932, Section 4
“Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.”

In partnership, two or more persons join hands to set up a business and share its profit and losses.

Persons who have entered into a partnership with one another are called individually partners and collectively ‘a firm’, and the name under which their business is carried on is called the ‘firm name’. A partnership firm is not a separate legal entity apart from the partners constituting it.

There must be a minimum of two persons to form a partnership firm, according to the Indian Partnership Act, 1932, but it does not specify the maximum number of partners. In this issue Section 11 of the Companies Act, 1956 limits the number of partners to 10 for a partnership carrying on banking business and 20 for a partnership carrying on any other type of business.

Features of Partnership
1. Two or More Persons: There must be a minimum of two persons to form a partnership firm, according to the Indian Partnership Act, 1932, but it does not specify the maximum number of partners. In this issue Section 11 of the Indian Companies Act, 1956 limits the number of partners to 10 (ten) for a partnership carrying on banking business and 20 (twenty) for a partnership carrying on any other type of business.

2. Agreement: Partnership comes into existence on account of an agreement among the partners, and not from status or operations of law. The agreement becomes the basis of the relationship between the partners. It may be written or oral. It may be for a fixed period or for a particular venture or at will.

3. Business: A partnership can be formed for the purpose of carrying on some lawful business with the intention of earning profits. Mere co-ownership of a property does not amount to a partnership.

4. Mutual Agency: The partnership business may be carried on by all the partners or any of them acting for all. This statement means that every partner is entitled to participate in the conduct of the affairs of its business and there exists a relationship of mutual agency between all the partners.

Partners are agents as well as principals for all other partners. Each partner can bind other partners by his acts and also is bound by the acts of other partners with regard to the business of the firm. Relationship of the mutual agency is so important feature of partnership that one can say that there would be no partnership if this feature is absent,

5. Sharing of Profit: The agreement between the partners must be to share the profits (or losses). Though the definition of partnership, according to Partnership Act, describes the partnership as the relationship between people who agree to share the profits of a business, the sharing of loss is implied. If some persons join hands for the purpose of some charitable activity, it will not be termed as a partnership.

6. Liability of Partnership: The liability of partnership is unlimited. Each partner is liable jointly with all the other partners and also individually to the third party for all the acts of the firm done while he is a partner.

Partnership Deed:
A partnership is formed by an agreement, it is essential that there must be some terms and conditions agreed upon by all the partners. These terms and conditions or Agreements may be written or oral. Though the Partnership Act does not expressly require that there should be an agreement in writing. But in order to avoid all misunderstandings and disputes, it is always the best course to have a written agreement duly signed and registered under the Act.

A document in writing which contains the terms of agreement for the partnership is called ‘Partnership Deed’. This document contains the details about all the aspects affecting the relationship between the partners including the objectives of the business, the contribution of capital by each partner, ratio in which the profit and losses will be shared by the partners, and entitlement of partners to interest on capital, interest on the loan, etc. The clauses of the partnership deed can be altered with the consent of all the partners.

Contents of Partnership Deed:

1. Names and Addresses of the firm and its main business.
2. Names and Addresses of all partners.
3. Amount of capital contributed or to be contributed by each partner.
4. The accounting period of the firm.
5. Date of commencement of partnership firm.
6. Rules regarding operations of a bank account.
7. Profit and loss sharing ratio.
8. Duration of partnership, if any.
9. Rate of interest on capital, loan, drawings, etc.
10. Salaries, commissions, etc., if payable to any partner(s).
11. The rights, duties, and liabilities of each partner.
12. Mode of auditor’s appointment, if any.
13. Rules to be followed in case of admission, retirement, death of a partner.
14. Rules to be followed in case of insolvency of one or more partners.
15. Settlement of accounts on the dissolution of the firm.
16. Rules for the settlement of disputes among the partners.
17. Safe custody of the books of accounts and other documents of the firm.
18. Any other matter relating to the conduct of business.

Provisions Relevant for (Affecting) Accounting of Partnership:
Normally, the partnership deed covers all matters relating to the mutual relationship of partners amongst themselves. But if the partnership silent on certain matters, or in the absence of any deed, the provisions of the Indian Partnership Act, 1932 shall apply.

The important provisions affecting partnership accounts are:

1. Profit-Sharing Ratio: In absence of deed or agreement, according to the act, the profit-sharing ratio is equal i.e. the profit and loss of the firm are to be shared equally by the partners, irrespective of their capital contribution in the firm.
2. Interest on Capital: No interest on capital shall be allowed to the partners. In case the deed provides for payment of interest on capital but does not specify the rate, the interest will be paid at the rate of 6% p.a., only from the profits of the firm. It is not payable if the firm incurs losses during the period.
3. Interest on Drawings: No interest is to be charged on drawings.
4. Interest on Loan, Advances: If any partner, apart from his capital, provides a loan to the firm, he is entitled to get interested at the rate of 6% per annum. Such interest shall be paid even if there a losses to the firm.
5. Remuneration to Partners: No partner is entitled to any salary or commission for participating in the business of the firm.

Apart from the above, the Indian Partnership Act specifies that subject to a contract between the partners:

• If a partner derives any profit for himself/herself from any transaction of the firm or from the use of the property or business connection of the firm or the firm name, he/ she shall account for the profit and pay it to the firm
• If a partner carries on any business of the same nature as and competing with that of the firm, he/she shall account for and pay to the firm, all profit made by him/her in that business.

Maintenance of Capital Accounts of Partners:
There are two methods by which the capital accounts of partners are maintained. They are the following:
(a) Fixed Capital Method
(b) Fluctuating Capital Method

(a) Fixed Capital Method: Under the fixed capital method, the capitals of the partner shall remain fixed or unaltered unless some additional capital is introduced or some amount of capital is withdrawn with the consent of all the partners.

In this method, two accounts for each partner are to be maintained:

1. Capital Account
2. Current Account.

1. Capital Account: This account is credited with the amount of capital introduced by the partner. This account will continue to show the same balance from year to year unless some amount of capital is introduced or withdrawn. This account always appears on the liabilities side in the balance sheet.

2. Current Account: All entries relating to drawings, interest on capital, interest on drawings, salary or commission, the share of profit or loss, etc. are made in this account. This account is debited with drawings, interest on drawings, the share of loss, etc. and credited with the interest on capital, salary, commission, the share of profit, etc. The balance of this account will fluctuate from year to year. If it has a credit balance then it will appear on the liabilities side of the Balance Sheet and if it has a debit balance then it will appear on the assets side of the Balance Sheet.

The format of the Capital Account and Current account are as follows:


(b) Fluctuating Capital Method: Under this method, only one account i.e. Capital Account is maintained for each partner. All the entries relating to the interest on capital, salary, commission to partners, the share of profit and loss, drawings, interest on drawings, etc. are directly recorded in the capital accounts of the partners. The balance of this account fluctuates from year to year. The format of Fluctuating Capital Account is as follows:

Partner’s Capital Account

Difference between Fixed and Fluctuating Capital Accounts


Profit and Loss Appropriation Account:
In partnership, net profit after adjustment of partner’s interest on capital, salary, and commission to partner’s, interest on drawings, etc. is distributed among the partners in the agreed profit sharing ratio. For this purpose, a separate account is prepared called Profit and Loss Appropriation Account.

It is merely an extension of the Profit and Loss Account. All adjustments in respect of partner’s commission and salary, interest on capital and on drawings, etc. are made through this account. It starts with the net profit/net loss as per the Profit and Loss Account is transferred to this account.

Journal Entries relating to Profit and Loss Appropriation Account:
1. Transfer of Net Profit/Net Loss as per Profit and Loss Account to Profit and Loss Appropriation Account:
(a) If Profit:
Profit and Loss A/c Dr.
To Profit and Loss App. A/c

(b) If Loss:
Profit and Loss App. A/c Dr.
To Profit and Loss A/c

2. Interest on Capital:
(a) For crediting interest on capital to partner’s Capital/Current
Account:
Interest on Capital A/c Dr.
To Partner’s Capital A/c or Current A/c (Individually)

(b) For transferring interest on Capital to Profit and Loss Appropriation A/c:
Profit and Loss App. A/c Dr
To Interest on Capital A/c OR

Only one entry may be passed in place of the above two entries:
Profit and Loss Appropriation A/c Dr.
To Partner’s Capital/Current A/c (Individually)

3. Interest on Drawings:
(a) For charging interest on drawings to partner’s Capital/ Current A/c:
Partners Capital/Current A/c (Individually) Dr.
To Interest on Drawings A/c

(b) For transferring interest on drawings to Profit and Loss Appropriation Account:
Interest on Drawings A/c Dr.
To Profit and Loss Appropriation A/c OR

Only one entry may be passed in place of the above two entries:
Partner’s Capital/Current A/c (Individually) Dr.
To Profit and Loss Appropriation A/c

4. Salary to Partner(s):
(a) For crediting partner’s salary’ to partner’s Capital/Current A/c:
Salary to Partner A/c Dr.
To Partner’s Capital /Current A/c (Individually)

(b) For transferring partner’s salary to Profit and Loss Appropriation A/c:
Profit and Loss Appropriation A/c Dr.
To Salary to Partner A/c OR

Only one entry may be passed in place of the above two entries:
Profit and Loss Appropriation A/c Dr.
To Partner’s Capital/Current A/c (Individually)

5. Commission to Partner(s):
(a) For crediting partner’s commission to partner’s Capital/ Current A/c:
Commission to Partner A/c Dr.
To Partner’s Capital/Current A/c (Individually)

(b) For transferring partner’s commission to Profit and Loss Appropriation A/c:
Profit and Loss Appropriation A/c Dr.
To Commission to Partner A/c OR

Only one entry may be passed in place of the above two entries:
Profit and Loss Appropriation A/c Dr.
To Partner’s Capital/Current A/c (Individually)

6. Share of Profit/Loss after adjustments:
(a) If Profit
Profit and Loss Appropriation A/c Dr.
To partner’s Capital/Current A/c (Individually)
OR
(b) If Loss:
Partner’s Capital/Current A/c (Individually) Dr. To Profit and Loss Appropriation A/c
Format of Profit and Loss Appropriation Account is given below:
Profit and Loss Appropriation Account

Interest on Capital:
Interest on Capital is generally provided for in two situations:

1. When the partners contribute unequal amounts of capital but share profits equally.
2. When the capital contribution is the same but profit sharing is unequal.
   Interest on Capital = Amount of Capital × \(\frac{\text { Rate }}{100}\) × Time

When there are both addition and withdrawal of capital by the partners during the financial year, the interest on capital can be calculated as:
1. On the opening balance of Capital A/c, interest is calculated for the whole year.
If the closing balance of the Capital A/c is given then we have to find the opening balance of Capital A/c:
Closing Capital + Drawings during the year + Interest on Drawing – Share of Profits – Salary to Partner – Commission
to Partner – Additional Capital = Opening Capital

2. On the additional capital brought in by any partner during the year, interest is calculated from the date of introduction of additional capital to the last day of the financial year

3. On the amount of capital withdrawn (other than usual drawings) during the year interest for the period from the date of withdrawal to the last day of the financial year is calculated and deducted from the total of the interest calculated under points (1) and (2) above.
Or
Drawing has been made then the amount deducted from the capital and interest is calculated on the balance amount.

The interest on capital is allowed only when there is profit during the financial year. No interest will be allowed on capital if the firm has incurred a net loss during the year. If the profit of the firm is less than the amount due to the partners as interest on capital, the payment of interest will be restricted to the number of profits. In other words, profit will be distributed in the ratio of interest on capital of each partner.

Interest on Drawings:
Drawings is the amount withdrawn, in cash or in-kind, for personal use by the partner(s). Interest on drawings is calculated with reference to the date of withdrawal.

The calculation of interest on drawings under different situations is shown as under:
(a) When Fixed Amount is Withdrawn Every Month/Quarter:
If the equal amount is withdrawn at equal intervals of times, interest on the drawing can be calculated by Monthly/Quarterly Drawing Methods. While calculating the time period, attention must be paid to whether the fixed amount was withdrawn on the first day (beginning) of the month, at the last day (end) of the month, middle of the month, at the beginning of the Quarter or at the end of Quarter. Depending upon the time period the interest on drawings can be calculated as follows:

When drawings are made:
1. At the beginning of each month of the financial year:
Interest on Drawings = Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{6^{1 / 2}}{12}\)
Here, time period is 6\(\frac{1}{2}\) months.

2. At the middle of each month of the financial year
Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{6}{12}\)
Here, time period is 6 months.

3. At the and of each month of the financial year:
Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{5^{1 / 2}}{12}\)
Here, time period is 5\(\frac{1}{2}\) months.

4. At the beginning of the eaclr quarter of the financial year:
Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{7^{1 / 2}}{12}\)
Here, time period is 7\(\frac{1}{2}\) months.

5. At the end of each quarter of the financial year:
Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{4^{1 / 2}}{12}\)
Here, time period is 4\(\frac{1}{2}\) months.

(b) When Varying Amounts are Withdrawn at Different Intervals: When the partners withdraw different amounts of money at different time intervals, the interest is calculated using the production method. In this method, each amount of drawing is multiplied by the number of days/months (from the date of drawings to the last date of the financial year) to find out the product and then all the products are totaled. Here, the total product and interest for 1 month at the given rate are calculated.

Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{1}{12}\)
or
\(\frac{1}{365}\)

(c) When Dates of Withdrawal are Not Specified: When the total amount withdrawn is given but the dates of withdrawals are not specified, then it is assumed that the amount was withdrawn evenly throughout the year. Here, the time period is taken 6 months.
Interest on Drawings = Total Drawings × \(\frac{\text { Rate }}{100} \times \frac{6}{12}\)

Guarantee of Profit to a Partner:
Sometimes a partner may be guaranteed a minimum amount of profit by one or some or by all the partners in the existing profit sharing ratio or some other agreed ratio. The minimum guaranteed amount shall be paid to a partner when his share of profit as per the profit-sharing ratio is less than the guaranteed amount.

The following steps may be followed in this case:

1. Calculate the share of profit of the partner who has been guaranteed a minimum amount of profit as per profit sharing ratio. If this amount is more than or equal to the amount guaranteed, no adjustment is required.
2. If the share of profit of that partner is less than the guaranteed amount, then we have to find out the difference between the guaranteed amount and the share of profit of that partner.
3. Then, we add this difference to the share of the profit of the partner and deduct the difference from the share of profit of other partners or partner who has guaranteed the amount in the agreed ratio.

Past Adjustments:
Sometimes, after making of final accounts and the distribution of profits among the partners, a few omissions or errors in the recording of transactions or the preparation of summary statements are found. These errors or omissions need adjustments for correction of their impact.

This error or omissions may relate to:

1. Interest on capital may have omitted or have been wrongly treated.
2. Interest in drawings may have been omitted.
3. Salary or commission payable has been omitted in the capital account of the partner.
4. The profit-sharing ratio has been changed from the past.
5. Interest in the partner’s loan has been omitted.

Instead of altering old accounts, necessary adjustments can be made either by:
(a) through ‘Profit and Loss Adjustment Account’
Or
(b) directly in the capital account of the concerned partners.

(a) Profit and Loss Adjustment Account:
1. For omission of Interest on Capital, Salaries to partner(s), Commission to partner, etc.
Profit and Loss Adjustment Account Dr.
To Partner’s Capital/Current A/c (Individually)

2. For omission of Interest on drawings etc
Partner’s Capital/Current A/c Dr.
To Profit and Loss Adjustment Account

3. Calculate the difference or balance of the Profit and Loss Adjustment Account and transfer it to the Capital/Current Accounts of partners in the profit-sharing ratio.
(a) If Profit (Credit balance):
Profit and Loss Adjustment A/c Dr.
To Partner’s Capital/Current A/c (Individually)
OR

(b) If Loss (Debit balance):
Partner’s Capital/Current A/c (Individually) Dr.
To Profit and Loss Adjustment A/c (b) Adjustment through a single entry or directly in the capital account of the concerned partner(s):

In this case, the following steps should be taken:

1. Calculate amount which should have been credited to each partner’s Capital/Current Account by way of (Interest on Capital + Salaries to Partner(s) + Commission to Partner(s) – Interest on Drawings etc.)
2. Distribute the amount calculated in step (1) in the current profit sharing ratio.
3. Calculate the difference between the above two steps for each partner (1) – (2)
   (-) Excess or (+) Short

Pass the following Journal entry:
Excess having Partner’s Capital A/c Dr.
To Short Partner’s Capital A/c

By going through these CBSE Class 12 Accountancy Notes Chapter 1 Accounting for Not for Profit Organisation, students can recall all the concepts quickly.

Accounting for Not for Profit Organisation Notes Class 12 Accountancy Chapter 1

There are certain institution or organization which are set-up not to earn a profit, but for providing service to its members and the public in general. The main aim of this institution or organization is rendering service to its members and the public, but not the profit as in the case of business. Such organization includes schools, hospitals, clubs, charitable institutions, religious organizations, trade unions, welfare societies, consumer-cooperatives, literary societies, etc.

These organizations or institutions are managed by a group of people known as trustees who are fully accountable to their members and the society for the utilization of funds and the objectives of the organization. So, they have to maintain proper accounts and financial statements in the form of the Receipt and Payment Account, Income and Expenditure Account, and the Balance Sheet. This financial statement helps them to keep track of their income and expenditure as well as fulfill the legal requirements for maintaining records.

Meaning of Not-For-Profit Organisation:
All trading and business organizations are profit organizations since their main objective is to earn profit. Not-For-Profit Organisations are those organizations whose main aim/objective is to rendering service to their members or the society at large and not the earning of profits.

These organizations refer to the organizations that are set up for the welfare of the society, as charitable institutions, which run without a profit motive. Their main aim is to provide services to its members or the society at large. The funds, raised by such organizations are represented as capital funds or general funds. The main source; of their income usually are subscriptions from their members, donations, grants, income from investment, etc.

These organization keeps the accounting records to meet the statutory requirements and controlling utilization of their funds. They usually prepare them at the end of the financial year to ascertain their income and expenditure and the financial position of the organization and submit them to the statutory authority i.e. Registrar of Societies.

Characteristics of Not-For-Profit Organisation:
1. Service Motive: The main motive of these organizations is service motive. They provide service either free of cost or at a nominal cost and not to earn profit. These are formed for rendering service to a specific group or society at large such as education, health care, recreation, sports, and so on without any consideration of caste, creed, and color.

2. Organisation: Not-For-Profit Organisations are organized as charitable trusts or societies. The subscribers to such trust or societies are called its members.

3. Management: The affairs of Not-For-Profit Organisations are normally managed by a managing committee or executive committee. These committees are elected by their members or subscribers.

4. Source of Income: The main source of income of these organizations are:

1. Subscriptions from members
2. Life-membership fees
3. Endowment fund
4. Donations
5. Legacies
6. Grant-in-aid
7. Income from investments etc.

5. Capital Fund or General Fund: The funds raised by Not-For-Profit Organisations through various sources are credited to capital funds or general funds.

6. Surplus Added to Capital Fund: The surplus generated in the form of excess income over expenditure is simply added to the capital fund or general fund. It is not distributed amongst the members as in trading or business organization.

7. Goodwill: The Not-For-Profit Organisation earn their reputation or goodwill on the basis of their contribution to the welfare of the society rather than on the customers’ satisfaction or owner’s satisfaction.

8. Accounting Records: The accounting records of these organizations are totally different from the trading or business organization. They are not prepared financial statements like Trading Account and Profit and Loss Account, instead, they prepare Receipts and Payment Account and Income and Expenditure Account. The preparation of the Balance Sheet is the same in both organizations.

9. Statutory Requirement: The accounting information provided by such organizations is meant for the present and potential contributors to meet the statutory requirements.

Accounting Records of Not-For-Profit Organisations:
As we know that Not-For-Profit Organisations are not engaged in any trading or business activity normally. Their main source of income is subscriptions/donations, financial assistance or grant from the government, etc. Most of their transactions are in form of cash or through the bank. These organizations are required by law to keep proper accounting records and keep proper control over the utilization of their funds.

For maintaining accounting records these organizations usually keep a cash book to record all receipts and payments and maintain ledger accounts of all income, expenses, assets, and liabilities. In addition, they maintain a stock register to keep records of all fixed assets and consumables.

In place of the capital account, they maintain a capital fund or general fund that goes on increases due to surpluses, life membership fees, donations, legacies, etc. received from year to year.

Final Accounts or Financial Statements of Not-For-Profit Organisations:
As they are non-profit making entities, so they are not required to make Trading and Profit and Loss Account but instead of these accounts to know whether the income during the year was enough to meet the expenses or not they prepare:

1. Receipts and Payment Account,
2. Income and Expenditure Account, and
3. Balance Sheet.

For the preparation of these financial statements, the general principles of accounting are fully applicable. The statements provide the necessary financial information to members, donors, and to the Registrar of Societies.

Along with all these, Not-For-Profit organizations also prepare a trial balance for checking the accuracy of ledger accounts. The trial balance also facilitates the preparation of an accurate Receipt and Payment Account as well as the Income and Expenditure Account and the Balance Sheet.

Receipts and Payment Account:
A Receipts and Payments Account is a summary of cash A transactions. It is prepared at the end of the accounting period from the cash receipts journal and cash payment journals.

“Receipts and Payment Account is nothing more than a summary of the cash book (Cash and Bank transactions) over a certain period, analyzed and classified under the suitable heading. It is the form of account most commonly adopted by the treasurers of societies, clubs, associations, etc. When preparing the results of the year’s working.” – William Pickles

In ‘other words, the Receipt and Payment Account simply is a summary of cash and bank transactions under various heads. On the debit side, it begins with an opening balance of cash and bank and records all the items of receipts irrespective of whether they are of capital or revenue nature or whether they pertain to the current or past or future accounting periods.

The payments are recorded on the credit side without making any distinction between items of revenue and capital nature and whether they belong to the current or past or future accounting period(s). It may be noted that this account does not show any non-cash item like depreciation.

At the end of the period, this account is balanced to ascertain the balance of cash in hand or cash at the bank. The annual totals of various items of receipts and payments are found from their respective accounts in the ledger or from the cash book and are then entered in the Receipts and Payment Account.

Salient Features of Receipts and Payment Account:
1. Real Account: It is a real account, so the rule of a real account i.e. ‘Debit what comes in and credit what goes out, is followed. Thus receipts are recorded on the Debit side and the payments are recorded on the Credit side.

2. Summary of the Cash Book: It is a summary of the cash book. Its form is similar to cash book (without discount and bank column) with debit and credit sides.

3. Shows amount irrespective of period: It shows the total amount of all receipts and payments irrespective of the period to which they pertain.

4. No distinction between nature (Capital or Revenue nature): It includes all receipts and payments whether they are of capital nature or of revenue nature.

5. No distinction between the mode of the transaction (Cash or Bank): No distinction is made in receipts/payments made in cash or through the bank. With the exception of the opening and closing balances, the total amount of each receipt and payment is shown in this account.

6. Do not show non-cash items: Non-cash items like depreciation, outstanding expenses, accrued income, etc. are not shown in this account.

7. Opening and closing balances: The opening and closing balance in its respective mean cash in hand or cash at a bank in the j beginning and at the end. The balance of receipts and payment account must be debit being cash in hand or cash at the bank unless there is a bank overdraft.

8. Does not reflect net income or net loss: Thir account does not tell us whether the current income exceeds the current expenditure or vice versa or in other words, it does not give any information of net 1 income or a net loss.

Steps in the prepare ion of Receipt and Payment Account:
1. Put the opening balance of cash in hand and cash at the bank at the beginning on the Receipt side. If there is a bank overdraft at the beginning, but the same in the Payment side of the account.

2. Enter the total amounts of all receipts (either cash or cheque) in the Receipt side (Dr. side) irrespective of their nature, (whether capital or revenue) and whether they pertain to past, present, and future periods.

3. Enter the total amounts of all payments (either cash or cheque) in the Payment side (Cr. side) irrespective of their nature (whether capital or revenue) and whether they pertain to past, present, and future periods.

4. Do not enter the non-cash item like depreciation, outstanding expenses, accrued income, etc.

5. Find out the difference between the total debit side and the total credit side of the tired account and enter the same on the credit side as the closing balance of cash or bank balances.

But, if the total of credit side is more than of debit side, show the difference on the debit as bank overdraft and close the account.

Examples of Important Receipts and Payments Items:

Format of Receipts and Payments A/c:


There will be either of the two amounts i.e. cash at a bank or bank overdraft, not both.

Limitations of Receipts and Payments Account:

1. It does not show expenses and incomes on an accrual basis.
2. It does not show whether the organization is able to meet its day-to-day expenses out of its income.

Income and Expenditure Account:
It is a nominal account of the Not-For-Profit Organisation equivalent to the profit and loss account of the trading concerns. The terms profit is substituted by the words excess of income over expenditure (surplus) and the loss is expressed as an excess of expenditure over income (deficit).

It reveals the surplus or deficit arising out of the organization’s activities during an accounting period. This account is prepared on an accrual basis and includes only items of revenue nature. All the revenue items relating to the current period are shown in this account, the expenses and losses on the expenditure side (debit side), and incomes and gains on the income side (credit side) of the account. It shows the net operating result in the form of surplus or deficit, which is transferred to the capital fund shown in the balance sheet.

Salient Features of Income and Expenditure Account:
1. Nominal Account: It is a nominal account, therefore the rule of nominal account i.e. “Debit all expenses and losses and credit all incomes and gains” is followed.

2. Ignore Items of Capital Nature: In this account, only items of revenue nature are to be considered and all the items of capital nature should be ignored.

3. Prepare from Receipt and Payment Account: It is generally
prepared from a given Receipts and Payments Account and other information after making necessary adjustments.

4. No Opening and Closing Balances: In this account, no opening and closing balances of cash and bank are recorded.

5. Same as Profit and Loss Account: This account is prepared in the same manner in which a Profit and Loss Account is prepared, considering, all adjustments relating to the current year.

6. Exclude Past and Future Items: It excludes all the items of j income and expenditure which do not pertain to the current period.

7. End-balance of this Account: The end balance of the Income and Expenditure Account, which may be either ‘excess of income over expenditures’ or ‘excess of expenditure over income’ would be added to or deducted from, as the case may be, tire capital fund, on the liabilities side of the Balance Sheet.

Steps in the Preparation of Income Expenditure Account:

1. From the Receipts and Payments, the Account excludes the opening and closing balance of cash and bank as they are not an income.
2. Exclude the items of capital nature as these are to be shown in the balance sheet.
3. Take out the revenue receipts only for the current year to be shown on the income side of the Income and Expenditure Account. These are adjusted by excluded the amounts relating to the preceding and the succeeding periods and including the amounts relating to the current year not yet received.
4. Take out the revenue payments only for the current year to be shown on the expenditure side of the Income and Expenditure Account. These are adjusted by excluded the amounts relating to the preceding and the succeeding periods and including the amounts relating to the current year not yet paid,
5. Make the adjustments of non-cash items like:
   (a) Depreciation on fixed assets.
   (b) Provision for doubtful debts, if required.
   (c) Profit or Loss on sale of fixed assets etc.

For determining the surplus/deficit for the current year.

So, we can also prepare the Income and Expenditure Account with the help of the following methods after considering Receipt and Payment Account and information given:

Income and Expenditure Account for the year ended.

Format of Income and Expenditure Account Income and Expenditure Account for the year” ended.


The distinction between Income and Expenditure Account and Receipt and Payment Account


Balance Sheet:
Not-For-Profit organizations prepare a Balance Sheet at the end of an accounting period to ascertain the financial position of the organization. The preparation of their Balance Sheet is the same as that of the business or trading entities. It is prepared in the usual way showing assets on the ‘right-hand side’ and the liabilities on the ‘left-hand side. However, the term capital is not to be found.

Instead, there will be a capital fund or a general fund, or an accumulated fund, and the surplus or deficit as per Income and Expenditure Account shall be added to or deducted from this fund. Some capitalized items like legacies, entrance fees, and life membership fees directly (added) in the capital fund.

Sometimes it becomes necessary to prepare a Balance Sheet at the beginning of the year in order to find out the opening balance of the capital/general fund.

Steps in the Preparation of Balance Sheet:
1. Find out the Capital fund as per the Opening Balance Sheet and add surplus from the Income and Expenditure Account. Then, add capitalized items like legacies, entrance fees, and life membership fees, etc. received during the year.

2. Put all the fixed assets (from the opening balance sheet) with additions (from Receipts and Payments Account) after charging depreciation (as per Income and Expenditure Account), on the assets side of the balance sheet.

3. Compare items on the receipts side of the Receipts and Payments Account with the income side of the Income and Expenditure Account to find out the amounts of:
(a) Subscription due but not yet received,
(b) Income received in advance,
(c) Sale of fixed assets made during the year,
(d) Items to be capitalized etc.

4. Compare items on the payment side of the Receipts and Payments Account with the expenditure side of the Income and Expenditure Account to find out the amount of:
(a) Outstanding Expenses,
(b) Prepaid Expenses,
(c) Purchases of a fixed asset during the year,
(d) Depreciation on fixed assets,
(e) Stock of consumable items like stationery in hand,
(f) Closing balance of cash in hand and cash at bank etc.

Format of Balance Sheet:
Balance Sheet of……………………
as on…………………….

Some Important items relating to Not-For-Profit Organisations:
1. Subscription: It is the amount paid by the members of the organization periodically so that their membership is not canceled. This is the main source of income of Not-For-Profit Organisations.

Treatment:

1. The total amount of subscriptions received during the accounting period is shown on the receipt side (Dr. side) of the Receipt and Payment Account.
2. Subscription related to the current period shown in the income side (Cr. side) of Income and Expenditure Account. The amount of subscription to be shown in the Income and Expenditure Account is calculated as follows :
   Table Showing Calculation of Subscriptions
   
   or
   Subscription Account
   
3. Subscription Outstanding at the end of the year is shown on the assets side of the Balance Sheet and subscription received in advance in the current year for the next year is shown on ‘ the liabilities side of the Balance Sheet.

2. Donations: It is a type of gift in cash or in property received from some person, firm, or company. The donation can be for specific purposes or for general purposes. Both the donation received appears on the receipts side of the Receipts and Payments Account.
1. Specific Donations: If the amount received as the donation is for a specific purpose such as a donation for extension of the existing building, donation for the library, for construction of new computer laboratory, etc., it is capitalized and is shown in the liabilities side of Balance Sheet.

2. General Donations: Such donations are to be utilized to promote the general purpose of the organization. It is of two types:
(a) General Donation of Big Amount: It is shown on the liability side of the Balance Sheet because it is non-recurring in nature as the donations of huge amounts cannot be expected every year.
(b) General Donation of Small Amount: These are treated as revenue receipts as it is a regular source of income hence, it is taken to the income side of the Income and Expenditure Account of the current year.

3. Legacies: It is in the nature of a gift, received in cash or in the property as per the will of a deceased person. It is not treated as an income because it is not of recurring nature. Such receipts come very rarely and therefore it is of a capital nature and is shown on the liabilities side of the Balance §heet. It appears on the receipt side of the Receipts and Payments Account and is directly added to Capital Fund in the Balance Sheet. However, legacies of the small amount may be treated as income and show on the income side of the Income and Expenditure Account.

4. Life Membership Fees: In order to become a member of an organization for the whole of the life, some members pay the fee in lump sum i.e. once in their lifetime. It is a receipt of non-recurring nature since the members will not be required to pay the fees regularly. It is shown on the receipt side of the Receipt and Payment Account and added to the Capital Fund in the Balance Sheet. It should not be credited to the Income and Expenditure Account.

5. Entrance Fees: The entrance fee also known as the Admission Fee is paid only once the member at the time of becoming a member.
1. In the case of organizations like clubs and some charitable institutions, where the membership is limited and the amount of Entrance Fees is quite large. It is treated as a non-¬recurring item and added directly to Capital Fund in the Balance Sheet and also shows in the receipt side of the Receipt and Payment Account.

2. For some organizations like educational institutions the entrance fee is a regular income and the amount is quite small. So it is treated as the recurring item and shown in the income side of the Income and Expenditure Account. It is also shown on the receipt side by the Receipt and Payment Account.

From the examination point of view, if there is no specific instruction about Entrance Fees, it should be treated as Capital Receipt and directly added to Capital Fund in the Balance Sheet.

6. Sale of Old Assets: Receipt from the sale of the old asset appears in the receipt side of Receipt and Payment Account. Only the profit or loss on the sale of a fixed asset is credited or debited, as the case may be, to the Income and Expenditure Account. In the Balance Sheet, the book value of the asset sold should be deducted from the relevant asset.

7. Sale of Periodicals: Receipts from the sale of periodicals shown in the receipt side of Receipt and Payment Account. It is an item of recurring nature and shown in the income side of the Income and Expenditure Account.

8. Sale of Sports Materials: The sale of sports materials like old bats, old nets, etc. is a regular feature with any sports club. It is treated as revenue income on the assumption that their book value is zero. It is therefore shown in the income side of the Income and Expenditure Account. It is also shown on the receipt side of the Receipt and Payment Account.

9. Payment of Honorarium: It is the payment made to a person for his specific services rendered by him, not as a regular employee. This is an item of expense and is shown in the ‘debit or expenditure side’ of the Income and Expenditure Account.

10. Endowment Fund: “It is a fund arising from a bequest or gift, the income of which is devoted for a specific purpose. – Eric L. Kohler

Thus, Endowment Fund is a capital receipt and is shown on the liabilities side of the Balance Sheet.

11. Government Grant: Some organizations like schools, colleges, public hospitals, etc. depend upon Government grants for their activities.

It is shown on the receipt side of the Receipt and Payment Account:

1. The tie maintenance grant is a recurring grant. It is treated as a revenue receipt and shown on the income side of the Income and Expenditure Account.
2. Grants such as building grants are treated as capital receipts and transferred to the building fund account.
   Cash subsidy: Some Not-For-Profit Organisations receive cash subsidies from the Government or Government agencies. This subsidy is also treated as revenue income for the year in which it is received.

12. Special Funds: Not-For-Profit Organisation creates some special funds for a specific purpose such as ‘prize funds’, ‘match fund’ and ‘sports fund’ etc. The number of such hands is invested in securities and the income earned on such investment is added to the respective fund, not credited to the Income and Expenditure Account. Similarly, the expenses incurred on such a specific purpose are also deducted from the fund.

13. Stationery (or some consumable items): Expenses incurred on Stationery (or some consumable items) are charged to the Income and Expenditure Account.

If the opening or closing stock of stationery is given, then the amount of stationery consumed during the year will be shown in the Income and Expenditure Account and the closing stock in the Balance Sheet.

The calculation for Expenses for the Current Year

Total Amount Paid shown in Payment side of Receipt and Payment Account. Outstanding expenses at the end of the current year shown in the Liabilities side of the Balance Sheet and prepaid at the end shown in the Assets side of the Balance Sheet.

The calculation for Income for the Current Year

Total Amount Received shown in Receipt side of Receipt and Payment Account. Accrued income at the end of the current year shown in assets side of Balance Sheet and Income received in advance at the end of the current year shown in the liabilities side of Balance Sheet