Accounting for Partnership — Basic Concepts
Key Points to Remember
- →Partnership: two or more persons carrying on business together for profit. Governed by Partnership Act, 1932.
- →Partnership Deed: written agreement. If absent, Partnership Act applies — no salary/commission to partners, profit shared equally, 6% interest on capital to all, no interest on drawings.
- →Capital Accounts: Fixed capital method (separate current accounts) vs Fluctuating capital method (one account for all).
- →Profit and Loss Appropriation Account: distribution of profits. Debits: interest on capital, partners' salary, commission. Credits: net profit transferred from P&L.
- →Guarantee of profit: one partner guarantees minimum profit to another. Deficiency met by guaranteeing partner.
- →Interest on drawings: charged on drawings at given rate for proportional months.
Exam Tips
Most asked: preparation of Profit & Loss Appropriation Account with all items.
Fixed vs fluctuating capital: In fixed — current account fluctuates; in fluctuating — only one account per partner.
When no deed: equal profit sharing, no salary, no commission, 6% p.a. interest on capital, no interest on drawings.
Reconstitution of Partnership — Admission of a Partner
Key Points to Remember
- →New partner brings: capital + premium for goodwill. Existing partners sacrifice in agreed ratio.
- →New profit sharing ratio = Old ratio adjusted for new partner's share.
- →Sacrificing ratio = Old ratio − New ratio.
- →Goodwill treatment on admission: new partner brings cash for goodwill → credited to old partners in sacrificing ratio.
- →Revaluation of assets and liabilities: Revaluation Account (real/nominal account). Profits credited to old partners in old ratio; losses debited similarly.
- →Accumulated reserves: transferred to old partners' capital accounts in old ratio before reconstitution.
- →Hidden goodwill: calculated when goodwill not stated — use net worth method.
Exam Tips
Most asked: preparation of Revaluation Account, Partners' Capital Accounts, and Balance Sheet on admission.
Goodwill brought in cash: Debit Bank, Credit Goodwill — then Debit Goodwill, Credit Old Partners' Capital (in sacrificing ratio). Or: directly credit old partners.
Calculate new ratio carefully: new partner's share + remaining old partners' share = 1.
Reconstitution — Retirement and Death of a Partner
Key Points to Remember
- →On retirement: retiring partner's share is acquired by remaining partners. Gaining ratio = New ratio − Old ratio.
- →Goodwill: retiring partner's share of goodwill credited to his account. Remaining partners bear in gaining ratio.
- →Revaluation on retirement: same as admission — Revaluation Account prepared.
- →Joint Life Policy (JLP): insurance policy on lives of all partners. On death/retirement, surrender value distributed.
- →Retiring partner's loan account: if not paid immediately, amount transferred to loan a/c — interest at agreed rate.
- →On death: same as retirement. Executor's account opened for amount due to deceased partner.
- →Executor's account: includes capital + share of profits/losses to date of death + goodwill + revaluation gain − drawings.
Exam Tips
Gaining ratio = New ratio − Old ratio (for remaining partners after retirement).
Sacrificing ratio (admission) vs Gaining ratio (retirement) — don't confuse.
Death: profit calculated for period from last account date to date of death using time ratio or sales ratio.
Dissolution of Partnership Firm
Key Points to Remember
- →Dissolution: firm ceases to exist. Assets realised, liabilities paid, balance to partners.
- →Realisation Account: all assets and external liabilities transferred. Assets sold → realisation credited. Liabilities paid → realisation debited.
- →Settlement sequence: external liabilities → partner's loan → partner's capital.
- →Garner vs Murray rule (India: not strictly applicable in CBSE): insolvency of a partner — loss borne by solvent partners in capital ratio.
- →Piecemeal distribution: assets realised gradually. Partners paid in sequence.
- →Fictitious assets (preliminary expenses, discount on issue of shares): have no realisable value — written off to Realisation Account.
Exam Tips
Most asked: preparation of Realisation Account, Partners' Capital Accounts, and Cash/Bank Account.
Order of Realisation Account entries: 1. Transfer all assets (debit side), 2. Transfer all external liabilities (credit side), 3. Realisation proceeds, 4. Realisation costs, 5. Settlement of liabilities.
Partner's loan is not an external liability — paid after external creditors but before capital.
Issue and Forfeiture of Shares
Key Points to Remember
- →Share capital: Authorised → Issued → Subscribed → Called-up → Paid-up.
- →Types of shares: Equity (Ordinary) and Preference (get dividend first, repaid first).
- →Issue at Par, Premium (Sec. 52 — Securities Premium Reserve account), Discount (not allowed under Companies Act 2013 generally).
- →Calls in advance (Sec. 50): interest paid by company. Calls in arrears (Sec. 49): interest charged to shareholder.
- →Forfeiture: shares cancelled for non-payment of calls. Journal entries: Debit Share Capital, Credit Calls in Arrears, Credit Forfeited Shares Account.
- →Reissue of forfeited shares: must not be issued below original issue price. Surplus → Capital Reserve.
- →Minimum subscription: 90% of issue must be subscribed before allotment.
Exam Tips
Most asked: journal entries for issue, forfeiture, and reissue of shares.
Securities Premium: must be used for specific purposes only — issue of bonus shares, writing off preliminary expenses, buy-back premium.
Forfeiture calculation: total called up − paid = forfeited. Reissue: loss on reissue ≤ forfeited amount per share.
Issue of Debentures
Key Points to Remember
- →Debenture: debt instrument — company borrows from public. Debenture holders are creditors (not owners).
- →Types: Secured (charge on assets), Unsecured; Redeemable, Irredeemable; Convertible, Non-convertible; Registered, Bearer.
- →Issue of debentures: at par, at premium, at discount. Issue for consideration other than cash (purchase of assets).
- →Debenture redemption: at par, at premium (loss on redemption → Finance Cost). DRR (Debenture Redemption Reserve) required.
- →Methods of redemption: payment in lump sum, by purchase in open market, conversion to shares.
- →Collateral security: secondary security for a loan — debentures issued as collateral, not counted as regular issue.
Exam Tips
Most asked: journal entries for debenture issue, redemption at premium.
Debentures issued at discount: debit 'Discount on Issue of Debentures' — written off over life of debentures.
Loss on redemption at premium: Debit P&L (Finance Cost), Credit Premium on Redemption.
Financial Statements of a Company
Key Points to Remember
- →Companies Act 2013: Schedule III — format of Balance Sheet and Statement of Profit & Loss.
- →Balance Sheet: Equity & Liabilities (Shareholders' Funds, Non-current Liabilities, Current Liabilities) and Assets (Non-current, Current).
- →Statement of Profit & Loss: Revenue from Operations, Other Income, Expenses (Cost of Materials Consumed, Employee Benefits, Depreciation, Finance Costs, Other Expenses), Tax, PAT.
- →Notes to Accounts: detailed breakdown — mandatory for many items (share capital, reserves, tangible assets).
- →Shareholders' Funds = Share Capital + Reserves & Surplus.
- →Working capital = Current Assets − Current Liabilities.
- →Contingent liabilities: not recorded in accounts — shown as footnote (e.g. pending lawsuits, guarantees given).
Exam Tips
Most asked: preparation of Statement of Profit & Loss and Balance Sheet from given trial balance.
Memorise the format of Schedule III Balance Sheet — Equity & Liabilities side + Assets side.
Current vs Non-current: current = within 12 months. Non-current = beyond 12 months.
Analysis of Financial Statements
Key Points to Remember
- →Objectives of financial analysis: assess profitability, solvency, efficiency, and liquidity.
- →Tools: Comparative statements, Common-size statements, Ratio analysis, Cash flow analysis.
- →Comparative statements: two years side by side with absolute and percentage change.
- →Common-size statements: each item as % of Revenue (P&L) or Total Assets (Balance Sheet). Allows inter-firm comparison.
- →Limitations of financial analysis: historical data, ignores qualitative factors, window dressing possible, different accounting policies.
Exam Tips
Common-size P&L: all items as % of Revenue from Operations. Common-size Balance Sheet: all items as % of Total Assets.
Comparative statements: absolute change = Current year − Previous year. % change = (Absolute change / Previous year) × 100.
These are frequently paired with ratio analysis questions in the exam.
Accounting Ratios
Key Points to Remember
- →Liquidity: Current Ratio = Current Assets / Current Liabilities (ideal 2:1); Quick Ratio = Quick Assets / Current Liabilities (ideal 1:1). Quick Assets = CA − Inventory − Prepaid.
- →Solvency: Debt-Equity Ratio = Long-term Debt / Shareholders' Funds; Proprietary Ratio = Shareholders' Funds / Total Assets; Total Assets to Debt = Total Assets / Long-term Debt.
- →Activity (Turnover): Inventory Turnover = COGS / Avg Inventory; Trade Receivables Turnover = Net Credit Revenue / Avg Trade Receivables; Trade Payables Turnover = Net Credit Purchases / Avg Trade Payables; Working Capital Turnover = Revenue / Working Capital.
- →Profitability: Gross Profit Ratio = (GP / Revenue) × 100; Net Profit Ratio = (NP / Revenue) × 100; Operating Ratio = (COGS + Operating Expenses) / Revenue × 100; ROCE = (EBIT / Capital Employed) × 100.
- →Capital Employed = Total Assets − Current Liabilities = Non-current Assets + Working Capital.
Exam Tips
Most asked: calculation of all ratios from given data + interpretation (high/low is good/bad for each).
Quick assets: do NOT include inventory, prepaid expenses, or advance tax.
COGS = Opening Inventory + Purchases − Closing Inventory. Or = Revenue − Gross Profit.
High current ratio: good (liquidity) but too high means idle current assets. Low: risk of default.
Cash Flow Statement
Key Points to Remember
- →Cash Flow Statement: As 3 (Accounting Standard 3). Shows sources and uses of cash during an accounting period.
- →Three activities: Operating (core business), Investing (purchase/sale of long-term assets), Financing (borrowing/repayment/dividends).
- →Indirect method for Operating Activities: Start with Net Profit before tax → Add non-cash expenses (depreciation, provisions) → Adjust working capital changes → Deduct tax paid.
- →Investing: purchase of fixed assets, purchase of investments, proceeds from sale of assets/investments, interest received, dividend received.
- →Financing: proceeds from issue of shares/debentures, repayment of loans, interest paid, dividends paid.
- →Cash equivalents: short-term, highly liquid investments convertible to cash within 3 months (treasury bills, commercial paper).
Exam Tips
Most asked: preparation of Cash Flow Statement (indirect method) from given Balance Sheet and additional information.
Indirect method starting point: Net Profit BEFORE tax and extraordinary items.
Increase in current asset = Use of cash (deduct). Decrease in current asset = Source of cash (add). Opposite for current liabilities.
Interest received and dividends received by non-financial companies = Investing activities. Dividends paid = Financing activities.