CBSE Notes

By going through these CBSE Class 12 Accountancy Notes Chapter 7 Issue and Redemption of Debentures, students can recall all the concepts quickly.

Issue and Redemption of Debentures Notes Class 12 Accountancy Chapter 7

In today’s growing business equity sources of financing only are not sufficient to meet the ever-growing needs of corporate expansion and growth. As a result, the companies turn to raise long-term funds by issuing debentures. Debt financing not only helps in reducing the cost of capital but also helps in designing the appropriate capital structure for the company.

Meaning of Debenture: The term, ‘debenture’ has been derived from the Latin word “debre” which means “to borrow”. Thus, it is a written document acknowledging a debt under the common seal of the company and containing a contract for the repayment of the principal sum at a specified date and for the payment of interest (usually half-yearly) at a fixed rate percent until the principal sum is repaid.

→ “Debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the company or not.”- Section 2(12) of the Companies Act, 1956

→ “A debenture is a document given by a company as evidence of a debt to the holder usually arising out of a loan and most commonly secured by a charge.”- Topham

→ “Debenture is a document under company’s seal which provides for the repayment of a principal sum and interest thereon at regular intervals which is usually secured, by a fixed or floating charge on the company’s property and which acknowledges loan of-a company.” – E. Thomas

→ “Debenture means a document which either creates a debt or acknowledges it and any document which fulfills either of these conditions.” -Chitty J.

Bond: Bond, like debenture, is an acknowledgment of debt issued under the seal of a company and signed by an authorized signatory.

Charge: It means securing the loan by encumbering a specific part of assets towards the loan. It means, if the company fails to meet its obligation, the lender can secure his payment from the assets mortgaged or in case of winding up of the company from the official liquidator.

The Companies Act, 1956) requires that all the charges be registered with the Registrar of Companies. Section 125 (4) of the Companies Act, 1956 requires that a charge when created on the following be got registered:

For the purpose of securing any issue of debentures.

• On uncalled share capital of the company.
• On calls made but not paid.
• On any book debts of the company.
• On any immovable property, wherever situated, or any interest therein.
• On a ship or any share in the ship.
• On goodwill, on a patent or a license under a patent, on a trademark or on the copyright or a license under copyright.

Difference Between Share and Debenture:


Types of Debentures:
1. Security point of view
(a) Secured/Mortgage Debentures: Secured Debentures are those which are secured either on a particular asset or on all the assets of the company in general.

(b) Unsecured/Naked Debentures: Unsecured Debentures do not have a specific charge on the assets of the company.

2. Tenure point of view:
(a) Redeemable Debentures: Redeemable debentures are those that will be repaid by the company at the end of a specified period during the existence of the company.
(b) Irredeemable Debentures: Irredeemable debentures are those that are not repayable during the lifetime of the company.

3. Mode of Redemption point of view:
(a) Convertible Debentures: Convertible debentures are those the holder of which is given an option of
exchanging the amount of their debenture for equity shares after a specified period.

These are of two types:

1. Fully Convertible Debentures (FCD) are those debentures where the whole amount is to be converted into equity shares.
2. Partly Convertible Debentures (PCD) are those debentures where only a part of the amount of debenture is convertible into equity shares.

(b) Non-Convertible Debentures: The debentures which cannot be converted into shares or in any other securities are called non-convertible debentures.

4. Coupon Rate point of view:
(a) Zero Coupon Rate Debenture: These debentures do not carry a specific rate of interest.
(b) Specific Coupon Rate Debenture: These debentures are issued with a specified rate of interest, which may either be fixed and floating.

5. Registration point of view:
(a) Registered Debentures: Registered debentures are those which are payable to the persons whose name appears in the Register of Debenture holders. These can be transferred only by executing a transfer deed.
(b) Bearer Debentures: Bearer debentures are those which are payable to the bearer thereof. These can be transferred merely by delivery. Interest is paid to the persons who produced the interest coupon attached to such debenture.

Issue of Debentures: Debentures can be issued at par, at a premium, or at a discount. They can also be issued for consideration other than cash or as Collateral Security. Accounting treatment regarding the issue of debenture is done in the same manner as in the case of the issue of share. The only difference is that ‘Debenture’ in place of ‘Share’ and ‘Debenture A/e’ in place of ‘Share Capital A/c’ is substituted.

Issue of Debentures at Par: Debentures are said to have been issued at par when the issue price is equal to their face value.
1. If the debenture amount is received in one installment (lump sum).


Similar entries like e, f may be made for the second call and final call.

Issue of Debentures at a Discount: When the debentures are issued at less than the face value, it is said to be issued at discount. Discount on issue of debenture is a capital loss and is shown on the assets side of the Balance Sheet under the head “Miscellaneous Expenditure” till it is written off.

Accounting Treatment:
On the issue of debentures at a discount
Debenture Allotment A/c Dr.
Discount of Issue of Debenture A/c Dr.
To Debenture A/c

Issue of Debentures at Premium: A debenture is said to have been issued at a premium when the price charged is more than the face value of debenture. Premium on Issue of Debenture represents a capital receipt and should be transferred to Securities Premium A/c. It can be used for writing off capital losses and fictitious assets. This account is shown on the liabilities side of the Balance Sheet under the head of ‘Reserves & Surplus’.

Accounting Treatment:
On Issue of Debenture at Premium
Debenture Allotment A/c Dr.
To Debenture A/c To Securities Premium A/c

Over Subscription: When the number of debentures applied for is more than the number of debentures offered to the public, the issue is said to be oversubscribed. The excess money received on oversubscription may be retained for adjustment towards allotment and respective calls when the amount is payable in Instalments or excess money will be refunded.

Issue of Debentures for Consideration Other than Cash: When the company purchases some assets (including services) and instead of making the payment to the supplier in the form of cash, issues its fully paid debentures, such issue of debentures is called the Issue of Debentures for Consideration Other than Cash. Such debentures can be issued at par, a premium, or at a discount.

If the purchase consideration is greater than the value of the net assets acquired (i.e., the difference between the agreed value of the assets taken over and the agreed value of liabilities taken over), the difference is treated as a capital loss which should be debited to Goodwill A/c.

Or
If the amount of the purchase consideration is lower than the value of the net assets acquired, the difference is treated as a capital profit which should be credited to Capital Reserve A/c.

(b) On the issue of Debentures
1. At par
Vendor’s A/c Dr.
To Debentures A/c

2. At Premium
Vendor’s A/c Dr.
To Debentures A/c To Securities Premium A/c

3. At a Discount Vendor’s A/c
Discount on Issue of Debentures A/c

To Debentures A/c
No. of Debentures issued = \(\)\(\)

Issue Price of a Debenture:
Issue of Debentures as Collateral Security: When a company takes a loan from a bank or any other party and gives some additional security in the shape of debentures, the debentures are said to be issued as collateral security. In such a case, the lender has the absolute right over the debentures unless and until the loan is repaid. On repayment of the loan, the lender is legally bond to release the debenture forthwith.

In case the loan is not repaid by the company on the due date, the lender has the right to retain these debentures and realize them. The holder of such debentures is entitled to interest only on the amount of loan, but not on the debentures.

Debentures issued as collateral security can be dealt with in two ways in the books.
1. No accounting entry is required to be shown in the books at the time of issue of such debentures, but a footnote to the fact that the loan has been secured by the issue of debentures is appended.

2. If it is desired that such an issue of debentures is to be recorded in the books, the following entries are recorded:
(a) On the issue of Debentures as Collateral Security
Debentures Suspense A/c Dr.
To Debentures A/c

(b) On repayment of the loan
Debentures A/c Dr.

To Debentures Suspense A/c The net effect of the above two entries is nil.
Issue of Debentures From Condition of Redemption Point of View: Redemption of debentures means discharge of liability on account of debentures by repayment made to the debenture holders. Depending upon the terms and conditions of issue and redemption of debentures, there may be the following six cases:

Accounting Treatment:
Case 1: Issue at Par and Redemption at Par

Case 2: Issue at Discount and Redemption at Par

Case 3: Issue at Premium and Redemption at Par.

Case 4: Issue at Par and Redemption at Premium

Case 5: Issue at Discount and Redemption at Premium

Case 6: Issued at Premium and Redemption at Premium

Interest on Debentures: Interest on debentures is a charge against the profits of the company and is payable irrespective of the fact whether there are profits or not. It is calculated on the face value of the debenture. According to Income-tax Act, 1961, the company must deduct income tax at the prescribed rate from the gross amount of interest payable on debenture before the annual amount is paid to debenture holders. Accounting Treatment:
1. For Interest due

2. For Payment of Interest
Debentureholder A/c Dr.
To Bank A/c

3. On Closing of Debenture Interest A/c
Profit and Loss A/c Dr.
To Debenture Interest A/c

4. For Payment of Income Tax to Government
Income Tax Payable A/c Dr.
To Bank A/c

Writing off Discount/Loss on Issue of Debentures: The discount/ loss on the issue of debentures is a capital loss and therefore must be written off during the lifetime of debentures. The discount/loss on the issue of debentures is shown under the head “Miscellaneous Expenditure” on the assets side of the Balance Sheet. Section 78 of the Companies Act, 1956 permits the utilization of Securities Premium for writing off the discount/loss on the issue of the debenture.

Entry is following:
Security Premium A/c Dr.
To Discount/Loss on
Issue of Debenture A/c

In case there are no capital profits or if the capital profits are not adequate, the amount of such discount/loss can be written off by utilizing the revenue profits.

There are two methods, which can be used to write off the Discount/Loss on the issue of debentures:
(a) Fixed Installment Method: When the debentures are redeemed at the end of a specified period, the total amount of discount should be written off in equal installments of a fixed amount over the period.

(b) Fluctuating Installment Method: When debentures are repaid by annual drawings or installments, the discount is written off in the ratio of debentures outstanding before redemption. The amount of discount, in this method, goes on reducing every year as a greater amount is used in the initial years than the later years. This method is also known as the Reducing Instalment Method.

Section-II
Redemption of Debentures: Redemption of debentures means repayment of the loan due on debentures to debenture holders. According to Section 117 C (3) of the Companies Act 1956, the debentures should be redeemed in accordance with the terms and conditions of their issue/ offer documents. The date, the terms, and the conditions are generally stated in the debenture certificate itself or in the trust deed.

On the due date or happening of the circumstances so specified, the company becomes liable to pay the principal amount to the debenture holder. A company may purchase its own debenture which then stands canceled.

In other words, the redemption of debentures means repayment of the number of debentures by the company. There are three aspects that a company should bear in mind regarding redemption namely the time of redemption, the amount to pay, and the sources from which redemption will have to be carried out.

Methods of the Redemption of Debentures: The various methods of redemption of debentures are as under:

1. Payment in Lump-Sum
2. Payment in Instalments
3. Purchase in Open Market
4. Conversion of existing Debenture into Shares or New Debentures.

1. Payment in Lump Sum: It means debentures can be redeemed by paying the debenture holders in one lump sum at the expiry of the agreed time or earlier at the option of the company. In this case, the time of repayment is known in advance and thus the company can plan its financial resources accordingly.

2. Payment in Instalments: It means the redemption is made in annual installments. The amount of installment is worked out by dividing the total amount of debentures by the number of years it is to last. The number of debentures to be redeemed each year are selected by lottery. Thus, it is also known as drawing by lottery or draw of lots.

3. Purchase in Open Market: A company, if authorized by its Articles of Association, can purchase its own debenture in the open market. Debentures so purchased may be canceled and it means the debentures have been paid.

4. Conversion of Existing Debentures into Shares or New Debentures: It means the debenture holder can exchange their debenture either for shares or new debentures of the company and the debentures which carry such right are called convertible debentures.

Sources of funds for Redemption of Debentures: The redemption of debentures can be done either out of capital or out of profits.

(a) Redemption of Debenture out of Capital: In this case, profits of the company are not utilized for the redemption of debentures, so the assets of the company are reduced by the amount paid. Normally the profits are transferred to Debenture Redemption Reserve for redemption. In case no profits have been transferred to Debenture Redemption Reserve and debentures are redeemed on the due date, it is regarded as redemption out of the capital. It is, however, presumed that the company has adequate funds to redeem the debentures.

Accounting Treatment:
(a) If debentures are to be redeemed at par
1. On debentures becoming due
Debentures A/c Dr.
To Debenture- holder A/c

2. On Redemption Debentureholder A/c Dr.
To Bank A/c

(b) If debentures are to be redeemed at a premium
1. On debentures becoming due
Debentures A/c Dr.
Premium on Redemption of
Debenture A/c Dr.
To Debentureholder A/c

2. On Redemption Debentureholder A/c Dr.
To Bank A/c

(b) Redemption of Debentures out of Profits: Redemption of debentures out of profits means the amount equal to that utilized for repayment to debenture holders is transferred from Profit and Loss Appropriation A/c to a newly opened A/c called ‘Debenture Redemption Reserve A/c’ (DRR). The portion of the profits set aside may either be retained in the business or maybe invested.

The Companies Act (Amendment), 2000 has introduced Section 117 C which provides as under:
(a) Where company-issued debentures after the commencement of this act, it shall create a DRR for the redemption of such debentures, to which adequate amount shall be credited, from out of its profits every year until such debentures are redeemed.

(b) The amount credited to the DRR shall not be utilized by the company except for the purpose of the redemption of debentures.

SEBI’s Guidelines: Securities and Exchange Board of India (SEBI) has provided some guidelines for the redemption of debentures. The focal points of these guidelines are:

1. Every company shall create a venture Redemption Reserve in case of issue of debenture redeemable after a period of more than 18 months from the date of issue.
2. The creation of Debenture Redemption Reserve is obligatory only for non-convertible debentures and a non-convertible portion of partly convertible debentures.
3. A company shall create a Debenture Redemption Reserve equivalent to at least 50% of the amount of debenture issue before starting the redemption of the debenture.
4. Withdrawal from Debenture Redemption Reserve is permissible only after 10% of the debenture liability has already been reduced by the company.

Exemption: SEBI guidelines would not apply under the following situations:
(a) Infrastructure company (a company wholly Engaged in the business of developing, maintaining, and operating infrastructure facilities.)
(b) A company issuing debentures with a maturity period of not more than 18 months.

Clarifications regarding Debenture Redemption Reserve:
The Department of Company Affairs, Government of India, vide their circular No. 9/2002, dates 18.04.2002 has issued the following clarifications regarding the creation of Debenture Redemption Reserve (DRR):
(a) No DRR is required for debentures issued by All India Financial Institutions, by RBI and, Banking Companies for both public as well as privately placed debentures.
(b) No DRR is required in case of privately placed debentures.
(c) Section 117c will apply to debentures issued and pending to be redeemed and, therefore, DRR will also be created for debentures issued prior to 13.12.2000 and pending redemption.
(d) Section 117c will apply to the non-convertible portion of debentures issued whether they are fully or partly paid.

Journal Entries:

1. Debenture A/c To Debentureholders A/c
2. Debenture holder A/c To Bank A/c
3. Profit and Loss Appropriation A/c To Debenture Redemption Reserve A/c

DRR A/c appears on the liability side of the Balance Sheet, under the head “Reserves and Surplus”. The balance in DRR A/c increases with each redemption. When all the debentures are redeemed, the DRR A/c is closed by transferring its balance to General Reserve A/c.

Redemption by Purchase in the Open Market: A company, if authorized by its Articles of Association, can redeem its own debenture by purchasing them in the open market.

If a company purchases its own debenture for the purpose of immediate cancellation, the purchase and cancellation of such debenture are called, redemption by purchase in the open market.

Advantages:

1. A company can redeem the debentures at its convenience whenever it has surplus funds.
2. A company can save money by purchasing its own debenture when they are available in the market at discount.

Accounting Treatment:
(In case of Profits)
(a) On purchase of own debentures for immediate cancellation.
Debenture A/c Dr.
To Bank A/c
To Profit on Cancellation of Debenture A/c

(b) On transfer of Profit on Redemption
Profit on Cancellation of Debenture A/c Dr.
To Capital Reserve A/c

(In case of Loss)
(a) On purchase of own debenture for immediate cancellation.
Debenture A/c Dr.
Loss on Cancellation
of Debenture A/c Dr.
To Bank A/c

(b) On transfer of Loss on Redemption
Profit and Loss A/c Dr.
To Loss on Cancellation of Debenture A/c

Redemption by Conversion: Sometimes, at the time of issue of debentures, a company gives the convertible debenture holders the privilege that they can get their debentures converted into shares or new debentures after the expiry of a specified period. Whenever debenture is redeemed by conversion, the debenture holders have to.; apply for the same. The new shares or debentures may be issued at par, discount, or a premium.

No DRR is required in case of convertible debentures because no funds are required for redemption.
If debentures to be converted were issued at discount, the issue price of the share must be equal to the amount actually received from debentures. If this rule is not followed, it would be a violation of section 79 of the Companies Act, 1956.

Accounting Treatment:
(i) For the amount due to debenture holders
(a) If Redemption at par
Debentures A/c Dr.
To Debentureholder A/c
Or
If Redemption at a premium
Debentures A/c Dr.
Securities Premium A/c Dr.
To Debentureholder A/c

(b) For discharging obligation by issuing shares or debentures
Debentureholder A/c Dr.
To Equity Share Capital
Or
To Debentures A/c (New)

If the new shares/debentures are issued at a premium, the Securities Premium A/c is credited or new shares/debentures are issued at a discount, the Discount on Issue of Shares/Debentures A/c is debited in the above-mentioned entry (b).

Sinking Fund Method: The amount required for the redemption of debentures is generally large and the date of redemption is known to the company. Thus, it is prudent for a company to make arrangements to ensure the availability of adequate funds for the redemption of debenture at the end of the stipulated period for which debentures are issued. Hence, it is better for the company to set aside every year a part of divisible profits and to invest the same outside the business in marketable securities.

This is done by creating a Sinking Fund. The company adopts the method of Debenture Redemption Sinking Fund. An appropriate amount calculated by referring to Sinking Fund Factors, depending upon the interest rate on investments and the number of years for which investments are made, is set aside.

Debenture Redemption Sinking Fund A/c will be created every year to provide means for the redemption of debentures. The company sets aside every year a certain sum of money out of its profits and invests the same along with the interest that may be earned on an investment. The investment is sold when debentures fall due for redemption. The amount available from the sale of investment is utilized for the redemption of debentures.

Accounting Treatment:
I. At the end of First Year
(a) For setting aside the amount out of Profit

(b) For Investing the amount set aside

II. At the end of the second year and subsequent years other than the last year.
(a) For Receiving the Interest on Investments made

(b) For the transfer of Interest on Deb. Red. Fund Investment to DRF A/c
The interest of Deb. Red
Fund Investment A/c Dr.
To Debenture Redemption Fund A/c

(c) For Setting aside the number of profits
Profit and Loss Dr. [With the amount
Appropriation A/c of Profit set aside]
To Debenture Redemption FundA/c

(d) For Investing the amount set aside along with interest • received.
Deb. Red. Fund Investment A/c Dr.
ToBank A/c

III. At the end of last year
(a) For Receiving the Interest on Investment made
Bank A/c Dr.
To Interest on Deb. Red. Fund Investment A/c

(b) For the transfer of Interest on Deb. Red. Fund Investment to DRF A/c
Interest in Deb. Red.
Fund Investment A/c Dr.
To Deb. Red. Fund A/c

(c) For setting aside the number of profits
Profit & Loss
Appropriation A/c Dr.
To Deb. Red. Fund A/c

(d) For Realising the Investment made
Bank A/c Dr. [With the sale
To Deb. Red. Fund proceeds]
Investment A / c

(e) For the transfer of profit/loss on realization of Deb. Red. Fund Investments

(f) For the amount due to debenture holders
Debenture A/c Dr.
To Debentureholders A/c

(g) For redemption
Debenture holders A/c
To Bank A/c

(h) For the transfer of the balance, if any, Discount on Issue of Debentures A/c/Loss on Issue of Debenture A/c
Deb. Red. Fund. A/c Dr.
To Discount on Issue of Debentures A/c,
To Loss on Issue of Debentures A/c

1. For the transfer of an amount from the Deb. Red. Fund A/c to General Reserve:
(a) If some of the Debentures are redeemed

(b) If all the Debentures are redeemed

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 4 Reconstitution of Partnership Firm: Retirement/Death of a Partner, students can recall all the concepts quickly.

Reconstitution of Partnership Firm: Retirement/Death of a Partner Notes Class 12 Accountancy Chapter 4

As we already knew that reconstitution of the partnership firm can also take place on the retirement of the partner or death of the partner. Here, the existing partnership deed comes to an end, and in its place, a new partnership deed comes into existence where remaining partners shall continue to do the business but on different terms and conditions. In both cases, i.e. on retirement or death of a partner, we are required to determine the sum due to the retiring partner or to the legal representatives of the deceased partner.

Retirement of a Partner:
A partner may retire from the partnership firm:

1. with the consent of all other partners;
   or
2. in case of retirement at will i.e. (partnership at will);
   or
3. by giving notice in writing to all other partners by the retiring partner.

On retirement, the old partnership comes to an end arid a new one between the remaining partner1 comes into existence. However the partnership firm as such continues.

Amount due to Retiring Partner:

1. Credit Balance of his Capital Account;
2. Credit Balance of his Current Account (if any);
3. His share of goodwill, accumulated profits, reserves etc.;
4. His share in the profit on revaluation of assets and liabilities;
5. His share of profit, interest on capital up to the date of retirement;
6. Any salary/commission due to him.

The following deductions (if any) made from his share:

1. Debit balance of the his-current account (if any);
2. His share of Goodwill to be written off, accumulated losses;
3. His share of loss on revaluation of assets and liabilities;
4. His share of loss, drawing and interest on drawings up to the date of retirement.

The various accounting aspects involved in retirement or death are as follows:

1. New profit sharing ratio
2. Gaining ratio
3. Goodwill Treatment
4. Accumulated profit and losses -Distribution
5. Profit and Loss till the date of retirement or death
6. Adjustment of Capital
7. Settlement of the amount due to retired /deceased partner.

New Profit Sharing Ratio:
The new profit sharing ratio is the ratio in which the remaining partners will share future profits after the retirement or death of any partners. In other words, the new profit sharing ratio of each remaining partner will be the sum total of his old share of profits in the firm and the portion of the retiring partner’s share of the profit acquired.

New Share of Partner = Old share + Acquired share from retiring/deceased partner.

(a) Nothing is mention about the new profit sharing ratio at the time of retirement:
If nothing is stated about the future ratio of the remaining partner, then their old ratio is considered as their new ratio. In other words, in the absence of any information regarding the profit-sharing ratio in which the remaining partner acquire the share of the retiring/deceased partner, then it is assumed that they will acquire it in the old profit sharing ratio and so the share the future profits in their old ratio.

For example, Kapil, Anu and Priti are partners in firm sharing profits and losses in the ratio 5: 3: 2. If Anu retires, then the new profit sharing ratio of Kapil and Priti will be 5: 2.

(b) Remaining partners acquire the share of retiring/deceased partner in the specified ratio:
If the remaining partners acquire the share of retiring/deceased partner in a specified ratio, other than their old ratio, then there is a need to compute a new profit sharing ratio among them. The new profit sharing ratio is equal to the sum total of their old ratio and the share acquired from the retiring/deceased partner.

For example, Kapil, Anu and Priti are partners in firm sharing profits and losses in the ratio 5: 3: 2. If Anu retires from the firm and her share was acquired by Kapil and Priti in the ratio 2: 1. In that case, the new share of profit will be calculated as follows:

New share of remaining partner = Old share + Acquired share from the outgoing partner.

(c) Remaining partners may agree on a particular new profit sharing ratio:
If the remaining partners decide a particular profit sharing ratio to share the future profits of the firm, in such a case the ratio so specified will be the new profit sharing ratio.

Gaining Ratio:
The ratio in which the continuing partners acquire the share of the retiring /deceased partner is called the gaining ratio.
(a) If nothing is mention in agreement:
If nothing is mention in the agreement about the gaining ratio, then it is assumed that the remaining partners acquire the share of the retiring/deceased partner in their old profit sharing ratio. In that case, the gaining ratio of the remaining partners will be the same as their old profit sharing ratio and there is no need to compute the gaining ratio.

(b) If a new profit sharing ratio is given:
If the new profit sharing ratio is given of the remaining partners then we have to compute the gaining ratio. In this case, the gaining ratio is calculated by deducting the old ratio from the new ratio.
Gaining ratio = New ratio – Old ratio

For example X, Y and Z are partners in a firm, sharing profits and losses in ratio 5:3:2. Y retires from the firm and X and Z decide to share future profits and losses in the ratio 7: 3. The gaining ratio will be calculated as follows:

Treatment of Goodwill:
The outgoing partner is entitled to his share of goodwill at the time of retirement/death because the goodwill has been earned by the firm with the efforts of all the existing partners. Therefore, goodwill is valued as per the agreement, at the time of retirement/death.

Due to the retirement/death of any partner, the continuing partners make again because the future profit will be shared only between the continuing partners. Therefore, the continuing partners should compensate the retiring/deceased partner for his share of goodwill in the gaining ratio.

The accounting treatment for goodwill depends upon whether the goodwill already appears in the books of the firm or not.

When Goodwill does not Appear in the Books:
When Goodwill does not appear in the books of the firm, there are four following ways to compensate the retiring partner for his share of goodwill:
(a) Goodwill is raised at its full value and retained in the books:
Goodwill A/c Dr.
To All Partner’s Capital AJc’s
(including retiring/deceased partner)
(For the goodwill raised at its full value and credited to capital A/c’s of a ’1 partners in their old profit sharing ratio)
The full value of goodwill will appear in the new balance sheet.

(b) Goodwill is raised at its full value and written off immediately:
If it is decided that the goodwill will not appear in the balance sheet of the reconstituted firm, then the following journal entries are required:
1. Goodwill A/c Dr.
To All Partner’s Capital A/c’s (For raising of Goodwill and credited to all partners capital A/c’s in their old profit sharing ratio)

2. Continuing Partner’s Capital A/c’s Dr.
To Goodwill A/c
(For written off goodwill between continuing partners in their new profit sharing ratio)

(c) Goodwill is raised to the extent of retired/deceased partner’s share and written off immediately:
1. Goodwill A/c Dr.
To Retiring/Deceased Partner’s Capital A/c (For the goodwill raised by share of outgoing partner)

2. Continuing Partner’s Capital AJc’s Dr.
To Goodwill A/c
(For the goodwill written off between the continuing partners in their gaining ratio)

(d) No Goodwill account is raised at all in the firm’s books:
If the outgoing partner’s share of goodwill is adjusted in the capital accounts of the continuing partners without opening a goodwill account, the following entry will be required:

Continuing Partner’s Capital A/c’s Dr.
To Outgoing Partner’s Capital A/c (For the share of outgoing partner in the goodwill adjusted through capital accounts in the gaining ratio)

The following example clears the above accounting treatment of Goodwill at the time of retirement/death:
Ram, Shyam and Mohan are partners in firm sharing profits and losses in the ratio of 5: 3: 2. Shyam retires. The goodwill of the firm is valued at Rs. 1,40,000 and the remaining partner’s Ram and Mohan continue to share profits in the ratio of 5:2. The following journal entries passed under various alternatives shall be as follows:

If goodwill is raised at full value and retained in books:

If goodwill is raised at full value and written off immediately:


If goodwill is raised to the extent of retiring partner’s share and written off immediately:

No goodwill account is raised at all in the firm’s books:

When Goodwill is already appearing in the books:
(a) If the value of goodwill appearing is equal to the current value of goodwill of the firm:
Normally, no adjustment is required if both the amounts are the same. Because goodwill stands credited in the accounts of all the partners including the retiring one.

(b) If the book value of goodwill is lower than its present value:
If the book value is less than the present value, the difference will be debited to the goodwill account and credited to the old partner’s capital accounts in their old profit sharing ratio.
Goodwill A/c Dr.
To All Partner’s Capital A/c’s (individually)
(For goodwill raised to its present value)

(c) If the book value of goodwill is more than the agreed or present value:
If the book value of goodwill is more than the present value, the difference will be debited to All partner’s capital accounts in their old profit sharing ratio and credited to the goodwill account.
All Partner’s Capital A/c’s (individually) Dr.
To Goodwill A/c
(For goodwill brought down to its present value)

Alternatively,
1. First, write off the existing goodwill that appears in the books:
All Partner’s Capital A/c’s (individually) Dr.
To Goodwill A/c
(For write off goodwill to all partners in old profit sharing ratio)

2. Adjust retiring partner’s share of goodwill through capital A/c’s
Remaining Partner’s Capital A/c’s Dr.
To Retiring/deceased Partner’s Capital A/c
(For goodwill share of retiring/deceased partner adjusted to remaining partner’s Capital A/c’s in their gaining ratio)

Hidden Goodwill:
If the firm has agreed to settle the retiring/deceased partner by paying him a lump sum, then the amount paid to him in excess of what is due to him based on the capital accounts balance after making all adjustments like accumulated profits and losses and revaluation profit or loss etc. shall be treated as his share of goodwill known as hidden goodwill.

Revaluation of Assets and Liabilities:
The retiring /deceased partner must be given a share of all profits that have arisen till his retirement/death and is made to bear his share of losses that have occurred till that period. This necessitates the revaluation of assets and liabilities. At the time of retirement/death of a partner, there may be some assets and liabilities which may not have been shown at their present values.

Not only that, there may be some unrecorded assets and liabilities which need to be brought into books. For this purpose, a revaluation account is opened, for the revaluation of assets and liabilities on the date of retirement/death of the partner. The journal entries to be passed for this purpose are as follows:

1. For increase in the value of assets:
Asset(s) AIc (individually) Dr.
To Revaluation A/c (For increase in the value of assets)

2. For decrease in the value of assets:
Revaluation A/c Dr.
To Assets A/c’s (individually)
(For decrease in the value of assets)

3. For increase in the number of liabilities:
Revaluation A/c Dr.
To Liabilities A/c’s (individually)
(for an increase in liabilities)

4. For decrease in the number of liabilities:
Liabilities A/c’s (individually) Dr.
To Revaluation A/c (For decrease in the liabilities)

5. For an unrecorded asset:
Assets A/c Dr.
To Revaluation A/c
(For unrecorded assets brought into books)

6. For an unrecorded liability:
Revaluation A/c Dr.
To Liability A/c
(For an unrecorded liability brought into books)

7. For the sale of an unrecorded asset:
Cash A/c Dr.
To Revaluation A/c (For the sale of unrecorded assets)

8. For payment of an unrecorded liability:
Revaluation A/c Dr.
To Cash A/c
(For the payment of an unrecorded*liability)

9. For-profit on revaluation:
Revaluation A/c Dr.
To All Partner’s Capital A/c’s (individually)
(For the distribution of profit on revaluation to all partners in their old profit sharing ratio)
Or

10. For Loss on revaluation:
All Partner’s Capital A/c’s (individually) Dr.
To Revaluation A/c
(For the distribution of losses on revaluation to all partners in their old profit sharing ratio)

Reserves and Accumulated Profits and Losses:
The retiring/deceased partner is also entitled to his/her share in the accumulated profits, general reserve, workmen compensation fund 1 etc. and is also liable to share the accumulated losses.

For this purpose the following journal entries are required:
1. For Transferring accumulated profits, General Reserves etc.
To All Partner’s Capital A/c’s (individually)
(For accumulated profits are transferred to all partner’s Capital A/c’s in their old profit sharing ratio)

2. For transfer of accumulated losses:
All Partner’s Capital A/c’s (individually) Dr.
To Profit and Loss A/c To Any Accumulated Loss A/c (For accumulated losses transferred to all partner’s Capital A/c’s in their old profit sharing ratio)

Settlement of Amount Due to Retiring Partner:
The retiring partner is entitled to the amount due to him. It is settled as per the terms of the partnership deed i.e. in lump sum immediately or in various instalments with or without interest as agreed or partly in cash immediately and partly in instalments.

In absence of any agreement, Section 37 of the Indian Partnership Act, 1932 is applicable, according to this, the retiring partner has an option to receive either interest 6% p.a. till the payment of his/her amount due or such share of profits which has been earned with his/her money i.e. based on the capital ratio. The necessary journal entries are as follows:
1. If payment (full) is made in cash:
Retiring Partner’s Capital A/c Dr.
To Cash/Bank A/c
(For the amount paid to retire partner)

2. If the amount due to retiring partner’s treated as loan:
Retiring Partner’s Capital A/c Dr.
To Retiring Partner’s Loan A/c (For the amount due to retiring partner transferred to his loan account)

3. When the amount due to retiring partner is partly paid in cash and the remaining amount treated as loan:
Retiring Partner’s Capital A/c Dr. (Total Amount Due)
To Cash/Bank A/c. (Amount paid)
To Retiring Partner’s Loaij A/c (Amount of loan) (For the amount due to retiring, partner; partly paid in cash and remaining transferred to his loan account)

4. When loan account is settled by paying in instalment includes principal and interest:
(a) For interest due on loan:
Interest on Loan A/c Dr.
To Retiring Partner’s Loan A/c
(For the interest due on the loan of retiring partner)

(b) For payment of instalment of the loan with interest:
Retiring Partner’s Loan A/c Dr.
To Cash/Bank A/c
(For the amount paid (Instalment + Interest) to retiring
partner)
These entries i.e. (a) and (b) repeated till the loan is paid off.

Adjustment of Partner’s Capital:
At the time of retirement or death of a partner, the remaining partners may decide to adjust their capital contribution in their new profit sharing ratio. The adjustment of the remaining partner’s capitals may involve any one of the following cases:
1. When the total capital of a new firm is specified.
Steps:
(a) Compute the new capitals of the remaining partners by dividing total capital in their new profit sharing ratio.

(b) Calculate the amount of adjusted old capital of the remaining partners after all adjustments regarding goodwill, accumulated profit and losses, profit or loss on revaluation etc.

(c) Find out the surplus or deficiency, as the case may be, in each
of the remaining partner’s capital account by comparing the new capital and the adjusted capital. ‘

(d) Adjust the surplus by paying cash to the concerned partner or by crediting his Current Account as agreed. Adjust the deficiency by asking the concerned partner to pay cash or by debiting his current account.

Journal Entries:
For excess capital withdrawn by the remaining partners:
Partner’s Capital A/c’s (individually) Dr.
To Cash/Bank A/c.

For the amount of capital to be brought in by the partners:
Cash/Bank A/c Dr.
To Partner’s Capital AJc’s (individually)
If the adjustment is made through the current account:

For excess capital:
Partner’s Capital A/c’s (individually) Dr.
To Partner’s Current A/c’s (individually)

For short capital:
Partner’s Current A/c’s /individually) Dr.
To Partner’s Capital A/c’s (individually)

2. When the total capital of the new firm is not specified:
Calculate the total capital of the new firm which will be equal to the aggregate of the adjusted old capitals of the continuing partners after all adjustments like goodwill, accumulated profits and losses, profit and losses on revaluation etc.
After calculating the total capital of the new firm, follow the same steps as discussed in case 1.

3. When the amount payable to retiring partner will be contributed by continuing partners in such a way that their capitals are adjusted proportionately to their new profit sharing ratio:

Calculate the total capital of the reconstituted firm by adding the adjusted old capitals of remaining partners and the cash to be brought in by continuing partners in order to make payment to the retiring/ deceased partner.
Then follow the same step we discussed in case 1.

Death of a Partner:
The accounting treatment in the event of the death of a partner is the same as that in the case of the retirement of a partner. Here, his claim is transferred to his executor’s account and settled in the same manner as that of the retired partner.

The only major difference between the retirement and death of a partner is that retirement normally takes place at the end of the accounting period whereas death may occur on any day. Therefore, in case of death, his claim shall also include his share of profit or loss, interest on capital, interest on drawings (if any), from the beginning of the year to the date of death.

Calculation of profit for the intervening period:
Share of profit of a deceased partner

Share of deceased partner = Profit of the firm till the date of death × Deceased partner share

Accounting Treatment of Outgoing Partner’s Share in Profit:
1. Through Profit and Loss Suspense Account
In case of Profit:
Profit and Loss Suspense A/c Dr.
To Deceased Partner’s Capital A/c (Share of profit for the intervening period)

In case of Loss:
Deceased Partner’s Capital A/c Dr.
To Profit and Loss Suspense A/c (Share of loss for the intervening period)

2. Through Capital Transfer In case of Profit:
Remaining Partner’s Capital A/c’s Dr.
To Deceased Partner’s Capital A/c In case of Loss:
Deceased Partner’s Capital A/c Dr.

To Remaining Partner’s Capital A/c’s The executors of deceased partner are entitled to the following:

1. The credit balance of deceased partner’s capital account;
2. His share of goodwill;
3. His share of profit till the date of death;
4. His share of profit on revaluation of assets and liabilities;
5. His share of accumulated profits and reserves;
6. His interest on capital if partnership deed provides till the date of death;
7. His share of Joint Life Policy (if any);
8. His salary and commission due (if any);

The following deduction has to made from above.

1. His drawings, interest in drawings till the date of death;
2. His share of loss till the date of death;
3. His share of loss on revaluation of assets and liabilities. ,
4. His share of the reduction in the value of goodwill (if any).

Payment to the executors:
1. When payment is made in full Executor’s A/c Dr.
To Bank A/c.

2. When payment is made in instalment The executor’s are entitled to interest when the payment is made in instalment. If the deed is silent about this, then 6% p.a. should be given as per Section 37 of the Indian Partnership Act, 1932.

When interest is due
Interest A/c Dr.
To Executor’s A/c

When instalment paid along with interest
Executor’s A/c Dr.
To Cash/Bank A/c

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)