Accountancy and Financial Management – IV-munotes

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1
Module I
1
INTRODUCTION TO COMPANY
ACCOUNTS - I
Unit structure
2.0 Objectives
2.1 Introduction
2.2 Formation of Company
2.3 Shares
2.4 Share Capital
2.5 Format of Balance Sheet
2.6 Issue of Shares
2.7 Issue of Shares on Preferential Basis
2.8 Employee Sto ck Option (ESO)
2.9 Sweat Equity Shares
2.10 Escrow Account
2.11 Issue of Shares at Par, At Premium and At Discount
2.12 Exercise
2.0 OBJECTIVES
After studying the unit students will be able to:
 Know the meaning, features and types of company
 Understand t he procedure of Formation of the company.
 Discuss about the meaning, types of shares.
 Know the meaning and classification of share capital.
 Explain the Balance sheet of the company
 Understand the meaning of forfeiture of shares
2.1 INTRODUCTION
 Meaning a nd Definition
Company is a type of commercial organisation, Lord Justice Hanay had
said company is an artificial person created by law having perpetual munotes.in

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2 succession and a common seal. It is owned by shareholders and managed
by directors.
Definition: Sec 2(2 0) of the Companies Act 2013 states that, “A company
means a company formed and registered under that Act or under any
previous Companies Act.”
 Features of Company:
From above meaning and definition we can identify following features of
the company:
i. Regis tered / Incorporation : The company need to be formed and
registered under the Companies Act, this process is known as
Incorporation of the company. Without such incorporation company
cannot come into existence.
ii. Artificial Person : The Company is considered as artificial person so it
has power to acquire, hold and sale all types of properties, it can enter
into legal agreements, it can file a case or case can be filed against the
company.
iii. Separate Legal Entity: A company is considered as separate legal entity
hence its existence is not affected due death, insolvency of its members
or transfer of shares by the members. A member of company is not liable
for act of the company and vice versa.
iv. Perpetual Succession: A company is created by following process of
law and it cease to exist only upon the process of law. It enjoys perpetual
(permanent) existence. Companies existence is independent of death,
insolvency or changes in membership of the company.
v. Common Seal: It is the most important property, common seal act as
signature of company and use to authenticate the documents. If the
common seal if affixed on any document by the authorised person it
becomes a legal document
 Types of Companies
There are various types of companies which are described in following
diagram.
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3 Companies are basically classified as Chartered Company, Statutory
Company and Registered Company.
1. Chartered Companies: These companies come into existence by
Royal Charter which is issued by Head of State. For eg. East India
Company.
2. Statutory Co mpanies: These are formed under special statute of the
parliament or the state legislature. These are public undertakings and form
with main objective to serve social need not earn profit. For eg. RBI, LIC,
SBI UTI etc.
3. Registered Companies: These are the companies which are
registered under Indian Companies Act 2013, or any other previous Indian
Companies Act. These companies are divided on the basis of Constitution
Control and Other Liability.
 On the basis of Constitution
a) Associate Company S2(6): A compa ny is said to be associate
company of other, if other company had control on 20% of total voting
power in the company or have control over business decisions of the
company under an agreement. However an Associate Company is not
subsidiary company.
b) Dormant Company S455: Where a company is formed for future
projects or to hold an asset or intellectual property and do not have
significant financial transactions for atleast 2 years may obtain status of
Dormant Company by applying to Registrar.
c) One Person Compa ny S2 (62): It is a new type of company
introduced in the Companies Act 2013. It can be formed with only one
member and have only one director. However the Act prescribed
maximum in respect of amount of Share Capital and Turnover if One
Person Company is e xceeding that limit it need to be converted into
Private or Public Company.
d) Private Company : I t is a types of company which is formed with
minimum two shareholders and two directors, Anot her crucial condition of
a private limited company is that it by its articles of association restricts
the right to transfer its shares & also prohibits any invitation to the public
to subscribe for any securities of the company. A private company is
exemp ted from various provisions of the Companies Act 2013 in
comparison with the public company.
e) Public Company S2 (71): A company which is not a Private
Company is a Public Company. A Public Company had minimum 7
members; there is no any restriction for minim um paid up capital for
Public Company. Its shares are freely transferable. It can also invite public
to subscribe its shares.
f) Small Company S2(85): Small company means a company other than
a public company and should fulfil the following criteria: munotes.in

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4 a. Paid-up share capital of which does not exceed 50 Lakh Rupees or
anything higher than that as may be prescribed will not be more than
five crore rupees, and;
b. Turnover of last profit and loss statement should not exceed 2 Crore
Rupees or such higher amount as may b e prescribed.
 On the basis of Liability:
a) Company Limited by Guarantee S2(21): Each member promises to
pay a fixed sum of money, specified in Memorandum of Association
in the event of liquidation or payment of debt. This promised amount
is called as guarant ee. If a company insert such clause in its
Memorandum the said company is Limited by Guarantee.
b) Limited Company: In these types of companies shareholders are
bound to pay a fixed amount per share i.e. face value of shares either at
the time of subscription or in instalments.
c) Unlimited Liability Company: If a company does not have any limit
for liability of its members then such company is called as unlimited
company. In this case members are liable to pay full amount of debt at
the time of winding up of the company.
 On the basis of Control
a) Foreign Company: It is a company which is incorporated outside
India and having its place of business in India has a place of business
in India whether by itself or through an agent, physically or through
electronic mo de; and conducts any business activity in India in any
other manner.
b) Government Company: It is the company whose minimum 51% paid
up capital is held by government, i.e. State or Central Government or
subsidiary of Government Company.
c) Holding Company: It is the company which has control over other
company. If any company held more than 51% of the share capital of
another company then it is called as holding company.
d) Subsidiary Company: It is the company which is controlled by
another company i.e. Holding Com pany.
 Other Companies:
a) Investment Company: It is the company whose main business is to
acquire shares, debentures, or other securities.
b) Non Trading Company: This is also called “association not for profit
or charitable companies” These companies are regis tered under special
license issued by government. The object of the company is to
promote arts, science, sports, education, research, social welfare,
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5 c) Producer Company: In generic terms, producer companies can be
said to be a way to improve th e standard of living of those involved in
the agricultural sector. Such companies are deemed to possess the
goodness of co -operatives and the dynamicity of companies. A
producer company is a company incorporated under Companies Act
2013 (formerly the Compa nies Act 1956) and shall carry on prescribed
activities as mentioned in Section 581B of Companies Act 1956, to
name few, Production, harvesting, procurement, grading, pooling,
handling, marketing, selling, export of primary produce of the
Members or import goods for their benefit. Processing including
preserving, drying, distilling, brewing, venting, canning and packaging
of produce of its members. Manufacture, sale or supply of machinery,
equipment or consumables mainly to its Members. Promoting mutual
assistance, financial services and welfare measures of producers or
their primary produce.
2.2 FORMATION OF COMPANY
Company is generally formed by the promoters. Promoter is a person who
conceives a business idea and to bring it into reality he take initiativ e to
Form and Register the company.
 Steps in formation
Following Steps are taken in respect of registration of company.
1. Name: The promoter may propose name of the company for
registration, they can propose up to six names. If name is available
further pr ocess is carried out.
2. Memorandum of Association and Articles of Association : Promoter
should prepare Memorandum of Association and Articles of
Association. Promoters should sign both and submit it to Registrar of
Companies.
3. Filling of Documents : Following documents need to be filled with
registrar for the purpose of registration
a) Memorandum of Association and Articles of Association
b) A declaration by advocate or practicing professional (CA, CS etc)
regarding compliance.
c) Affidavit from each subscriber from ea ch person named as first
director.
d) Address for correspondence till its registered office is not established
e) Details of each subscriber
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6 g) Required amount of registration fees and any other document if
required
4. Incorporation Certifica te: Once all these required documents are
received Registrar of the company will issue Incorporation Certificate
for the company.
2.3 SHARES
 Meaning & Definition:
Share is the smallest part of the share capital of the company. As per
section 2(84) of the Companies Act “A Share in the share capital of a
company and includes stock except where a distinction between stock and
share is expressed or implied.”
Shares are considered as movable property and can be transferred as per
procedure laid down in Articles of the company. Each and every share has
a predetermined value which is called as face value.
 Shareholder:
The owner of the shares is called as shareholder. Company issues a share
certificate to the holder having his name along with other details such as
no of shares and their distinct no. The share holders are co -owners of the
company he has right to attend meeting and to receive dividend. He has
right to receive back his capital at the time of winding up of the company.
 Stock:
Stock is a bundle of fu lly paid shares. A limited can company can convert
its fully paid shares into stock. Stock can be divided into any fractions and
subdivisions regards to the face value.
 Types of Shares
There are two types of shares, 1. Equity Shares, 2. Preference Shares
1. Equity Shares: Explanation to section 43 It is that part of share
capital which is not preference share capital.
Equity shares are of two types:
a) With voting rights: These are normal equity shares having equal
rights regards to voting at meeting, dividend an d same rights in each
and every aspect.
b) With differential voting rights: Company can issue equity shares
with differential rights as to dividend, voting rights etc. However such
must can be done subject to Rule 4 of Companies (Share Capital and
Debentures) Rules 2014.
2. Preference Shares: These are the shares having preferential rights in
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7 winding up of the company. Preference Shares will receive dividend
at fix rate before any dividend is pai d to equity shares and receive
back their capital before equity shares.
Types of Preference Shares:
a) Cumulative and Non -cumulative Preference Shares: If any year
company does not pay dividend Cumulative preference shares will
receive dividend for that year from the profits of following year.
However Non -cumulative preference shares do not enjoy such
benefits.
b) Participating and Non -participating Preference Shares:
Participating Preference Shares are entitled to participate in surplus
profits remaining after p ayment of dividend of both types of shares.
c) Convertible and Non -convertible Preference Shares: Convertible
Preference Shares can be converted into equity shares whereas non -
convertible preference shares are not converted into equity shares.
d) Redeemable and Non-redeemable Preference Shares: Redeemable
preference shares are redeemed (paid back) during life time of the
company whereas Non -redeemable Preference shares are not
redeemed during life time of the company they are redeemed at the
winding up of the com pany.
2.4 SHARE CAPITAL
Capital of the company is collected by issue of shares, there is no any limit
for maximum no of members / shareholders of the company and shares are
freely transferable so it’s impossible to have separate capital account for
each sh areholder. The company maintain a share capital account in its
books representing amount collected from all shareholders.
 Classification of Share Capital
1. Authorised Capital: Authorised Capital or Nominal Capital is capital
which is mentioned in memorandum and company cannot issue shares
exceeding this amount.
2. Issued Capital: It is the no shares issued by the company for
subscription. Company can issue full or part of its authorised capital.
3. Subscribed Capital: It is the part of issued capital, it refers to the no
of shares actually subscribed or taken u by general public.
4. Called up Capital: Called up capital is the amount of subscribed
capital which is actually called by the company. (demanded by the
company)
5. Paid up Capital: Paid up capital is the amount received against called
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8 6. Reserve Capital: It is the uncalled amount of share subscribed capital
which company will demand at the time of emergency or liquidation
of company.
 Dividend
Dividend is part of profit distributed among shareholders by the company.
Dividend can be classified as final dividend and Interim dividend. The
dividend can be paid as % of paid up capital or at a fixed amount per
share.
1. Final Dividend: Final dividend is proposed by directors and
declared at annual general meeting of the company. It should be noted that
proposed dividend will be considered as contingent liability and will not
be recorded in balance sheet. Once the dividend is declared it will be
considered as liability and should be paid off i n stipulated time.
2. Interim Dividend: Interim dividend is declared by board of
directors in between two annual general meetings. Any dividend declared
over and above the final dividend will be considered as Interim dividend.
2.5 FORMAT OF BALANCE SHEET
The company need to prepare its financial statements i.e. Profit & Loss
A/c and Balance Sheet in the format prescribed by Companies Act 2013.
Schedule 3 of Companies Act provide format for the financial statements.
Any requirement of Accounting Standard will o verride the requirements
of the schedule 3 of the Companies Act.
The balance sheet needs to be prepared in vertical format along with notes
to accounts.
Part I – Form of Balance Sheet
Name of the Company: - ______________________________
Balance Sheet as at :- ________________________________
(Rupees in _________)






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9 Particulars Note
No Figures as
at the end
of the
current
reporting
period Figures as at
the end of
the previous
reporting
period
EQUITY AND LIABILITIES
Shareholders Fund
Share Capital
Reserves Surplus
Money Received against Share
Warrants
Share Application Money Pending
Allotment
Non Current Liabilities
Long Term Borrowings
Differed Tax Liabilities (Net)
Other Long Term Liabilities
Long Term Pr ovisions
Current Liabilities
Short Term Borrowings
Trade Payable
Other Current Liabilities
Short Term Provisions
Total
ASSETS
Non-Current Assets
Fixed Assets
Tangible Assets
Intangible Assets
Capital work in Progress
Intangible Assets under
developments
Non-Current Liabilities
Differed Tax Assets (Net)
Long Term Loans and Advances munotes.in

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10 Other Long Term Assets
Current Assets
Current Investments
Inventories
Trade Receivables
Cash and Cash E quivalents
Short Term Loans and Advances
Other Current Assets
Total

The balance sheet of the company is presented along with relevant notes to
accounts providing detailed information regarding the particular item. The
notes accounts are pr esented as follows.
Notes to accounts Rs.
A.











B.









Share Capital
 Authorised shares (Par Value per Share : Rs…..)
 Issued, subscribed, called up & fully paid shares
 Subscribed but not fully paid shares
Less : Calls unpaid
– By Directors
– By Officers
– By Others
 Forfeited Shares
 Forfeited Shares reissued
 Reconciliati on of Shares Outstanding

Reserves and Surplus
a. Capital Reserves
b. Capital Redemption Reserve
c. Securities premium
d. Debenture Redemption Reserve
e. Revaluation Reserve
f. Share Options Outstanding Account
g. Other Reserves
h. General Reserves
i. Surplus
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11



C.













D.






E.





F.








G.



– Balance b/d
Add : Profit for Year
Less : Appropriations

Long Term Borrowings
a. Bonds / Debentures
b. Term Loans
i. Term Loans from Banks
ii. Term Loans from Other Parties
c. Deferred Payment Liabilities
d. Deposits
i. Public Deposits (GN)
ii. Inter -Corporate Deposits (GN)
e. Loans and Advances fr om Related Parties
f. Long Term Maturities of Finance Lease Obligations
g. Other Loans and Advances

Other Long Term Liabilities
a. Trade Payables
b. Other Payables
i. Trade Deposits (GN)
ii. Security Deposits (GN)

Long Term Provisions
a. Provision for Employee Benefits
b. Other s
– Provision for Warranties (GN)

Short Term Borrowings
a. Loans Repayable on Demand
i. From Banks
ii. From Other Parties
b. Loans and Advances from Related Parties
c. Deposits
d. Other Loans and Advances

Other Current Liabilities
a. Current Maturities of Long Term Debt
b. Current Maturities of Finance Lease Obligations
c. Interest Accrued but not Due on Borrowings
d. Interest Accrued and Due on Borrowings munotes.in

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12











H.




I.








J.










K.


e. Income Received in Advance
f. Unpaid Dividends
g. Application Money Refund and Interest Due
h. Unpaid Matured Deposits and Interest Accru ed
thereon
i. Unpaid Matured Debentures and Interest Accrued
thereon
j. Other Payables
– Calls -in-Advance (GN)
– Non -Trade Payables (GN)
– Taxes Payable (GN)

Short Term Provisions
a. Provisions for Employee Benefits
b. Others
–Provision for Tax (Net of tax payments) (FAQ)

Tangible Assets
a. Land
b. Buildings
c. Plant and Equipment
d. Furniture and Fixtures
e. Vehicles
f. Office Equipment
g. Others (specify nature)

Intangible Assets
a. Goodwill
b. Brands / Trademarks
c. Computer Software
d. Mastheads and Publishing Titles
e. Mining Rights
f. Copyrights, Patents, etc.
g. Recipes, Formulae, Models, Designs and Prototypes
h. Licenses and Franchise
i. Others (specify nature)

Non-Current Investments
a. Investments in Property
b. Investment in Equity Instruments
c. Investments in Preference Shares munotes.in

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13





L.









M.



N.








O.








P.

d. Investments in Government or Trust Securities
e. Investments in Debentures or Bonds
f. Investments in Mutual Funds
g. Investments in Partnership Firms
h. Other Non Current Investments

Long Term Loans and Advances
a. Capital Advances
b. Security Deposits
c. Loans and Advances to Related Parties
d. Other Loan s and Advances
– Advances Tax (Net of provision) (FAQ)
– CENVAT Credit Receivable (GN)
– VAT Credit Receivable (GN)
– Service Tax Credit Receivable (GN)

Other Non Current Assets
a. Long Term Trade Receivables
b. Others

Current Investments
a. Investments in Equity Instruments
b. Investments in Preference Shares
c. Investments in Government or Trust Securities
d. Investments in Debentures or Bonds
e. Investments in Mutual Funds
f. Investments in Partnership Firms
g. Other Investments

Inventories
a. Raw Materials
b. Work -in-progress
c. Finis hed Goods
d. Stock -in-Trade
e. Stores and Spares
f. Loose Tools
g. Others

Trade Receivables
a. Secured, Considered Good
b. Unsecured, Considered Good munotes.in

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14
2.6 ISSUE OF SHARES
Company issue shares for formation of its on capital. There are sev eral
modes for issue of shares such as public offer, private placement, right
issue etc. However regulations of Companies Act lay don guidelines in
respect of these modes. Depending upon type of company modes of issue
will be applicable for issue of shares .







Q.









R.





S. i. More than 6 months ii. Other
c. Doubtful
Less : Provision for Bad and Doubtful Debts

Cash and Cash Equivalents
a. Balances with Ban ks
b. Cheques, Drafts on Hand
c. Cash on Hand
d. Others (specify nature)
– Other Bank Balances
– Earmarked (Unpaid Dividend A/c)
– Margin Money Deposit
– Deposits Maturing After 12 Months

Short Term Loans and Advances
a. Loans and Advances to Related Parties
b. Other s
– Prepaid Expenses (GN)
– Tax Refund Receivable vide A.O. (FAQ)

Other Current Assets
 Non-Trade Receivables (GN)
 Unamortized Expenditure (GN)
 Unbilled Revenue (GN)
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15 Issue of Shares
1. Public Offer: In this case company offer shares to general public for
subscription it need to follow a prescribed procedure laid down by
companies act and rules in respect of the issue of shares. Public offers are
classified as fol lows.
a) Initial Public Offer (IPO): When company offer its shares to public
for subscription through prospectus for the first time it is called as
initial public offer. Generally such offer is made by unlisted
companies. This enables listing and trading of companies shares at
stock exchange.
b) Further Public Offer (FPO): When an existing listed company makes
a fresh issue of securities to the public through an offer document it is
called as Further Public Offer.
c) Offer for Sale of Securities (OFS): Offer for s ale of securities is
different from IPO and FPO. It is used to reduce promoters holding or
to provide exit route to venture capitalist. In this case shares offered to
public are shares held by promoters of the company. In this case
balance sheet of the com pany is not affected as new shares are not
issued .
2. Private Placement: In case of private placement company does not
offer its shares to general public instead it offers its shares to selected
group of persons. Such offer is made through issue of a priv ate
placement offer letter. However company need to satisfy various
conditions mentioned in section 42 of the Companies Act 2013.
3. Right Issue: Right Issue referrers to offer given by company to its
existing equity shares to subscribe for additional shar es. However such
offer will be given to the shareholder for limited no of shares in
proportion to shares already held by him. Section 62(1) (a) of the
Companies Act 2013 provide guidelines for right issue.
4. Bonus Shares: Bonus shares are free gift given by company to its
existing equity share holders. In this case company allot fully paid
shares to its existing equity share holders for free increasing their
shareholding and companies share capital. Company can issue bonus
shares by utilising its free rese rves, securities premium or capital
redemption reserve. Section 63 of the Companies Act provides
guidelines for issue of bonus shares.

2.7 ISSUE OF SHARES ON PREFERENTIAL BASIS

Section 62(1)(c) of the Companies Act and Rule 13 of Companies (Share
Capital and Debentures) Rule 2014 enable the company to issue shares on
preferential basis. However the company need to comply with section 42
of the Companies Act while issuing shares on preferential basis. Apart
from compliance of various provisions of Companie s Act, a special
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16 Meaning: “PREFERENTIAL ALLOTMENT” means an issue of shares
or other securities, by a Company to any select person or group of persons
on preferential basis and does not include shares or other securities offered
through a public issue, right issue, employee stock option scheme,
employee stock purchase scheme or an sweet equity issue or bonus issue
or depository receipts issued in a country outside India or foreign
securi ties.
Price: The price of shares or other securities to be issued on preferential
basis shall be determined on the basis of valuation report of a registered
valuer or Independent Valuer having 10 year of experience.
Consideration other than Cash: Company can issue shares on preferential
basis as consideration for other than cash. However valuation of such
consideration shall be done by registered valuer who need to submit a
valuation report to the company giving justification for the valuation.

2.8 EMPLO YEE STOCK OPTION (ESO)

Meaning
Section 2(37) of the Companies Act, 2013 Employees Stock Option means
the option given to the directors, officers, or employees of a company or
of its holding company or subsidiary company or companies, if any, which
gives s uch directors, officers nor employees the benefit or right to
purchase or to subscribe for the shares of the company at a future date at a
predetermined price.
Section 62(1)(b) of the Companies Act enable the company to offer shares
to its employees throug h Employee Stock Option. A special resolution is
required for such issue and company also need to comply with Rule 12 of
Companies (Share Capital and Debentures) rules 2014.

For this purpose employee means
1. A permanent employee of the company
2. A director of the company excluding independent director
3. A employee (1 or 2 mentioned above) in subsidiary company of Indian
Holding Company.
Employee does not include following
1. An employee who is promoter of the company or belonging to
promoter group
2. A director himse lf or through his relative hold directly or indirectly
more than 10% of share capital of the company.
Following are important point in respect of Employee Stock Option
1. Company can offer these shares at any price to its employees
2. There should be time gap o f atleast 1 year between granting of option
and vesting of option. munotes.in

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17 3. Option granted to employee is non transferable
4. The company need to maintain a separate register for Employee Stock
Option in prescribed form.
5. If company is listed on any recognised stock e xchange, then Employee
Stock Option Scheme shall be issued in accordance with the
regulations made by SEBI.

2.9 SWEAT EQUITY SHARES

 Meaning
According to Section 2(88) of the Companies Act 2013, SWEAT equity
shares means such equity shares issued by a co mpany to its directors, or
employees at a discount or for consideration other than cash, for providing
their knowhow or making available rights in the nature of intellectual
property or value additions, by whatever name called. It should be noted
that SWEA T Equity is different from Employee Stock Option Scheme and
Employee Stock Purchase Scheme.
 Conditions to be fulfilled by the company
Section 54 of the Companies Act prescribed conditions to be fulfilled by
the company for issue of SWEAT Equity Shares whic h are as follows
1. A special resolution is required for issue of SWEAT Equity Shares.
2. The resolution must specify no. of shares, market price, consideration
and details of directors or employees to whom such shares are issued.
3. The Company must have started i ts business for at least 1 year not less
than that.
4. If the equity shares of the company is listed on recognised stock
exchange issue of SWEAT Equity Shares will be done as per
guidelines issued by SEBI. If company is not listed it will be issued as
per Cha pter IV of the Companies Act 2013.

2.10 ESCROW ACCOUNT

 Meaning
Escrow means depositing funds with third party to be used latter on
compliance of certain conditions. Company use this system at the time of
IPO, it is used to put Share Application Money re ceived at the time of
receiving applications from public for an IPO.
Escrow account is the dedicated bank account, it is opened with Escrow
Collections Bank which is used for collection of application money at the
time of public offer. The company need to enter into escrow agreement.
Escrow Agreement is an agreement between issuer company, registrar of
issue, and escrow collection bank for collection of application money and
its refund whenever applicable. munotes.in

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18  Escrow Mechanism
1. Company open one or more escrow ac count with Escrow Collections
Bank for collection of application money. Application money
received from public along with applications is deposited in escrow
account. The company also open Public Issue Account and Refund
Account with Bankers of Issue.
2. The money received will be held by the Escrow Collection Bank on
behalf of issuing company till date of allotment.
3. On date of allotment money as per size and terms of issue will be
transferred from escrow account to Public Issue Account.
4. The balance left in escrow account will be transferred to refund
account. The amount will be refunded to all unsuccessful applicants,
and applicants who have paid excess application money after
adjusting for allotment money within 15 days from closing date of
issue. If it fai ls to repay on time, company need to pay 15% interest
on the amount to the applicants.

2.11 ISSUE OF SHARES AT PAR, AT PREMIUM AND
AT DISCOUNT

The company can issue shares at any price. It can issue shares at Par, at
Premium or at Discount.
a. At par: When shares are issued at its face value, they are said to be
issued at par.
b. At premium: When shares are issued at a price more than its face
value, they are said to be issued at premium.
c. At Discount: When shares are issued at price less than its face value,
they are said to be issued at discount.
 Oversubscription and Under subscription
Public Company issue shares to general public, for this purpose it invites
applications from interested investors by issuing prospectus. Interested
investors need to subscribe fo r the shares as per procedure described in
prospectus. Oversubscription or Under subscription relates to the response
received from general public for companies offer for issue of shares.
Under subscription:
It is the situation in which number of shares s ubscribed by public is less
than no of shares offered by company. In this case shares can be allotted
only when minimum subscription received. However applications are
received more than minimum subscription shares can be allotted.

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Introduction to Company
Accounts - I

19 Oversubscription:
When no of applications received are more than shares offered by
company then it is called as oversubscription. In case of oversubscription
shares can be allotted in following ways:
i. Partial Allotment: The directors may decide to fully accept some
applications and reject remaining excess applications.
ii. Pro-rata Allotment: Pro -rata allotment means proportionate
distribution of shares available for allotment among the applicants for
the shares.
iii. Combination: Company can combine both the above methods where
it rejec ts few applications and allots shares on prorate basis among
remaining applicants.
 Issue of Shares for Consideration Other than Cash
A company can issue shares for consideration other than cash. Such issue
can be at par, at premium or at discount. Followin g are some of the cases
in which company can issue shares for consideration other than cash.
Vendors: The vendors may be an individual, a firm or company whose
business is taken over by the company. The purchasing company may
issue its shares to vendors fr om whom their business is purchased.
Promoters: Shares may be issued to promoters of the company as
remuneration for the services rendered for the formation of the company.
Underwriters: Shares may be issued to underwriters in lieu of
underwriting commissi on payable to them.
Directors or Employees: A company can SWEAT Equity Shares to its
directors or employees as consideration other than cash for providing
know -how or making available rights in the nature of intellectual property
rights or value additions.
 Forfeiture and Re -Issue of Forfeited Shares
On issue of shares company can collect entire money at the time of
application or it can collect it in instalments, at the time of application,
allotment and balance in calls. If any shareholder fails to pay all otment or
call money, company can forfeit his shares, i.e. take back his shares
without paying any compensation.
Forfeiture of Shares
Forfeiture of shares can be referred as compulsory termination of
membership of shareholder by the company die to non -paym ent of
allotment or call money. In this case shareholder ceases to be member of
company and company take back its shares and confiscate any amount
paid by the shareholder against those shares. Company need to follow the munotes.in

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Accountancy and
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20 procedure laid down by Articles of A ssociation of the company to forfeit
the shares of any shareholder.
Re-Issue of Forfeited Shares
A company can re -issue the forfeited shares. Re -issue of shares though
called as re -issue it is ‘sale’ of shares not ‘issue’ of shares. Company need
to follow the procedure laid down in its Articles of Association in respect
of re -issue of shares. The company can re -issue the forfeited shares at par,
at premium or at discount; however re -issue of shares cannot have
allotment, calls etc.
2.12 EXERCISE
Descriptiv e Questions
1. What is mean by Company? Explain its features
2. Describe different type of companies.
3. Define Shares? Explain different types of Shares
4. Explain different types of Preference Shares
5. Explain Share Capital
6. Explain different modes for issue of shares.
7. Explain Equity & Liabilities of Balance Sheet as per Schedule -III of
Companies Act 2013.
8. Explain Forfeiture and re -issue of forfeited shares.
Short Notes
1. One Person Company
2. Private Company
3. Public Company
4. SWEAT Equity
5. ESCROW Account
6. Share
7. Bonus Shares
8. Righ t Shares
Objective Questions
1) Fill in Blanks.
1. A Public company may be formed by _______ or more persons.
2. One Person company may have _____ person as director.
3. ___________ Preference Shares are converted into equity shares.
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Introduction to Company
Accounts - I

21 5. Preference Shareholders are entitled to receive dividend at ______
rate.
6. Inventories appear under __________ in Balance Sheet.
7. Creditors are recorded under __________ in Balance Sheet.
8. Forfeiture of shares results in _________ termination of membership.
9. SWEAT Equity shares can be issued to directors & ______ of the
company.
10. A share denotes a _____ part of company’s share capital.
(seven, one, Redeemable, dividend, fixed, Current Assets, Trade Payable,
compulsory, empl oyees, smallest)
2. Match Pairs
Group A Group B
Authorised Capital Creditors of the company
One Person Company Receive dividend at fixed rate
Debenture holders Can be formed with only 1 member. Preference Shares Compulsory termination of
membership
Forfeiture of shares Minimum 7 members
Public Company Shares issued to vendor for
purchase of its business.
Shares issued for consideration
other than cash Memorandum of Association
(a – 7, b – 3, c – 1, d – 2, e – 4, f – 5, g – 6)
3. True or False
1. Only a natural person can form one person company.
2. A stock can be transferred in any fractions.
3. Right issue is made to existing shareholders only.
4. Forfeited shares cannot be reissued.
5. Company can issue bonus shares out of capital reserve.
6. Company has perpetual life.
7. ESCROW is a special bank account used specifically for public offer.
8. Offer for Sale of securities is not fresh issue of shares.
(True – 1, 2, 3, 6, 7, 8) (False – 4, 5)

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22 2
INTRODUCTION TO COMPANY
ACCOUNTS
ISSUE OF DEBENTURES
Unit Structure:
2.0 Objective
2.1 Introduction
2.2 Types of Debentures
2.3 Issue of debentures at Par, Premium and Discount
2.4 Issue of Debentures with consideration of Redemption
2.5 Issue of debentures for cash receivable in instalments or at a time
issue of debentures for consideration other than cash
2.6 Provisions of the Companies Act, 2013 regarding issue of
Debentures
2.7 Distinction between Share and Debenture
2.8 Model Journal Entri es on Issue of Debentures
2.9 Summary
2.10 Exercise

2.0 OBJECTIVE
After studying the unit students will be able to
 Understand the provisions regarding issue of debentures under the
Companies Act, 2013
 Explain the accounting treatment for the same.
2.1 INTRODUCTION
 Meaning:
Section 2(30) of the Companies Act, 2013 defines a as ‘Debenture’
includes debenture stock, bonds or any other securities of a company
evidencing a debt whether constituting a charge on the company’s assets
or not . In other words, a debenture is a borrowing or a loan. Schedule III
of the Companies Act, 2013 classifies debenture as a Long Term
Borrowing. Debentures are issued by the company only if it is authorised
by the Articles of Association of the Company. It is in the form of a
certificate issued under the common seal of the company and it creates or
acknowledges a debt. Debentures are normally secured against the assets munotes.in

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Introduction to Company
Accounts Issue of
Debentures
23 of the company and interest is payable on them which is calculated on the
nominal value of the debentures issu ed by the company. The debenture
certificate specifies the date of redemption of the debenture. The persons
to whom the debentures are allotted are known as debenture holders
 Features of Debentures:
a. It is a document which creates or acknowledges debt.
b. It is in the form of certificate issued by company under its common
seal.
c. The certificate will show rate of interest payable.
d. Normally debentures are secured against assets of the company.
2.2 TYPES OF DEBENTURES
Debentures are classified as follows:
1. Secured debentures and Unsecured debentures:
A. Secured debentures: The debentures which have a charge
(security) on the assets of the company are called secured
debentures. The charge may be fixed charge or floating charge.
The charge is on all assets of the compa ny in general.
i) Fixed Charge: In case of fixed charged the debentures are secured
on specific assets of the company like Land & Building, Plant &
machinery etc. The company cannot sell such assets until the
debenture holders are repaid. In this case the deb enture holder can
recover their dues out of the specific asset of the company which is
identified in mortgage deed.
ii) Floating Charge: In this case debenture holders do not have charge
on specific asset of the company. The charge may be on current
assets su ch as stock, debtors etc. of the company. It is very difficult
to pinpoint an asset as value of the current assets keeps changing.
Hence company can use these assets for normal business operations
however the floating charge become fixed in the event of de fault by
company in respect of interest or redemption of debentures.
B. Unsecured debentures are also known as ‘simple’ or ‘naked’
debentures. The debentures which do not have a charge (security)
on the assets of the company are called unsecured debentures. I n
the event of the winding up of company, such debentures are
treated as unsecured creditors.

2. Registered debentures and Bearer debentures:
A. Registered debenture must be compulsorily registered with the
company and the details of these debentures are record ed by the
company in the Register of Debenture holders which is kept by the
company.
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Accountancy and
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24 B. Bearer debentures are not registered with the company. They are
transferred by mere delivery.

3. Redeemable debentures and Irredeemable Debentures:
A. Redeemable debentures are redeemed after a specified period of
time in future. The date on which the debenture would be
redeemed is mentioned on the debenture certificate.

B. Irredeemable debentures are redeemed only when the company
is liquidated. They continue to remain in existe nce as long as the
company exists.
2.3 ISSUE OF DEBENTURES
 Issue of debentures at Par, Premium and Discount
A. Issue of debentures at Par : Debentures are said to be issued at par
when their issue price is equal to their nominal value. For example
debentures of nominal value of `100 is issued at ` 100.

B. Issue of debentures at Premium: Debentures are said to be
issued at a premium when their issue price is greater than their
nominal value. For example debentures of nominal value of `100is
issued at ` 101 or mo re. In this case `1 is the premium and would
be credited to securities premium account.

C. Issue of debentures at Discount: Debentures are said to be
issued at a discount when their issue price is less than their
nominal value. For example debentures of nom inal value of `100
is issued at `99 or less. In this case `1 is the discount and would be
debited to discount on issue of debentures account.
 Issue of Debentures with consideration of Redemption
Debentures may be issued with consideration of redemption.
Debentures can be redeemed (repaid) at par, premium or discount.
A. If debentures are redeemed at an amount equal to their face, they
are redeemable at par.

B. If debentures are redeemed at an amount greater than their face
value, they are said to be redeemable at a premium. Such premium
though payable on redemption, must be provided as a liability at
the time of issue itself. Such premium payable on redemption is a
capital loss for the company.

C. If debentures are redeemed at an amount less than their face valu e,
they are said to be redeemable at a discount. Such discount on
redemption is a capital profit for the company.
 Issue of debentures for cash receivable in instalments or at a time
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Introduction to Company
Accounts Issue of
Debentures
25 A. Debentures can be is sued for cash or for consideration other than
cash. In both these cases, debentures can be issued at par, premium
or at a discount. When debentures are issued for cash, the cash may
be received in instalments such as application, on allotment and
balance i n calls. The premium or discount, if any, is adjusted at the
time of allotment itself.

B. Debentures issued for consideration other than cash means that the
company issues debenture without receiving money for the
debentures issued.

Examples: Debentures i ssued to vendors for purchase of business,
debentures issued to suppliers for purchase of machinery.

C. Debentures can also be issued to the lender as a collateral security.
Collateral security means an additional or parallel security. Such
debentures are in the nature of contingent liability. The lender will
be the custodian of the debentures. There is no accounting entry
(journal entry) passed in the books of accounts of the company for
debentures issued as a collateral security, since there is no
immediate liability created by the company. Only a note in the
balance Sheet has to be given to that effect
2.4 PROVISIONS OF THE COMPANIES ACT, 2013
REGARDING ISSUE OF DEBENTURES
Section 71 of the Companies Act, 2013 provides the manner in
which debentures are to be issued by the Company. The features of the
provisions are:
1. A company cannot issue any debentures carrying voting rights.

2. A company may issue debentures with an option to convert such
debentures into shares, either wholly or partly at the time of
redemp tion. Such an issue must be approved by a special resolution at
a general meeting.

3. A company shall pay interest and redeem debentures as per the terms
and conditions of the issue.

4. Secured debentures shall be issued by a company as per the terms and
cond itions prescribed in Rule 18 of the Companies (Share Capital and
Debentures) Rules, 2014

5. The company shall create a Debenture Redemption Reserve account
(DRR A/c) out of company’s profits available for dividend and the
amount appropriated to DRR account s hall be utilised by the company
only for redemption of debentures.
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Accountancy and
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26 6. A debenture trustee shall ensure the protection of Debenture holders’
interest and redress their grievances as prescribed by the rules.

7. The debenture trustee can approach the Tribunal for an order, if the
assets of the company become insufficient or are likely to become
insufficient to discharge the principal amount as and when it becomes
due.

8. If the company fails to redeem the debentures on due date or it fails to
pay the interest on deb entures on due date, then the tribunal can direct,
by order, the company to redeem the debentures forth with on payment
of principal and interest due thereon.

9. If the company fails to comply the tribunal’s order, then every officer
of the company who is in default shall be punishable with
imprisonment upto three years or a fine of at least rupees two lakhs
which can be extended to Rupees five lakhs or with both.

10. The Central Government may prescribe procedure for securing the
issue of debentures, the form of trust deed and its inspection and to
obtain its copies, the amount of DRR to be created and such other
matters.

11. Rule 18 of the Companies (Share Capital and Debentures) Rules,
2014 provides that a company shall issue secured debentures on the
following terms and conditions:

i. Secured debentures can be issued provided its date of redemption
shall not exceed ten years from the date of it issue.

ii. The following classes of companies can issue secured debentures for
a period exceeding ten years but not exceedi ng thirty years

a) Companies who are engaged in setting up infrastructure
projects
b) Infrastructure Finance Companies
c) Infrastructure Debt Fund Non -Banking Financial Companies

iii. There shall be a creation of charge on the issue of such debentures.

iv. The company s hall appoint a debenture trustee before issue of
prospectus or offer letter for subscription of debentures.

v. The charge or mortgage shall be created in favour of the debenture
trustee on any specified movable or immovable property.



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Introduction to Company
Accounts Issue of
Debentures
27 2.5 DISTINCTION BETW EEN SHARE AND
DEBENTURE
Share Debenture
1. It is an owned capital. It is a borrowed capital.
2. A person who holds share is
known as shareholder. A person who holds debenture is
known as debenture holder
3. The shareholder is the owner of
the company. The debenture holder is the
creditor of the company.
4. Earnings on share are in the form
of dividend. Earnings on debentures are in
the form of interest.
5. The rate of dividend fluctuates in
case of equity shares The rate of interest is fixed.
6. Shares do not have any security.
They are unsecured. Debentures may have security.
They are secured.
7. Shareholders enjoy voting rights Debenture holders do not have
voting rights
8. Equity shares can never be
converted Debentures can be converted
9. Share Trust Deed is not required
to be executed. Debenture Trust Deed is
required to be executed.
10. Section 53 of the Companies Act
2013 prohibits issue of shares at a
discount. There are no restrictions in the
Companies Act on issue of
debenture at discou nt

2.6 MODEL JOURNAL ENTRIES ON ISSUE OF
DEBENTURES
Nature of Transaction Journal Entry Amount
1. When debentures are
issued at par and
redeemable at par Bank A/c Dr.
To Debentures A/c Amount Received
2. When debentures are
issued at a p remium and
redeemable at par Bank A/c Dr.
To Debentures A/c
To Securities Premium
A/c Amount Received
NV of Debentures
Amount of Premium
3. When debentures are
issued at a discount and
redeemable at par Bank A/c Dr.
Discount on issue of
Debentures A/c Dr.
To Debentures A/c Amount Received
Amount of discount
NV of Debentures munotes.in

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Accountancy and
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28 4. When debentures are
issued at par and
redeemable at premium Bank A/c Dr.
Loss on issue of
Debentures A/c Dr.
To Debentures A/c
To Premium o n
redemption of
debentures A/c Amount Received
Premium on
redemption
NV of Debentures
Premium on
redemption
5. When debentures are
issued at a discount and
redeemable at premium Bank A/c Dr.
Loss on issue of
Debentures A/c Dr.
To Debentures A/c
To Premium on
redemption of
debentures A/c Amount Received
Disc. allowed & POR
NV of Debentures
Premium on
redemption
6. When debentures are
issued at a premium and
redeemable at premium Bank A/c Dr.
Loss on issue of
Debentures A/c Dr.
To Debentures A/c
To Securities Premium
A/c
To Premium on
redemption of
debentures A/c Amount Received
Premium on
redemption
NV of Debentures
Amount of Premium
Premium on
redemption

NV = Nominal Value
POR = Premium on Redemption
2.7 ILLUSTRATION:
Ajay Lt d. issues 2,000 8% debentures of 100 each
You are asked to give journal entries on issue if:
a. the debentures are issued at par and redeemable at par
b. they are issued at a premium of 5% but redeemable at par
c. they are issued at a discount of 5% but redeemable at par
d. they are issued at par bu t redeemable at a premium of 10%
e. they are issued at a discount of 10% but redeemable at a premium of
5%
f. they are issued at a premium of 5% but redeemable at a premium of
10%


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Introduction to Company
Accounts Issue of
Debentures
29 Solution:
Working Note
On date of
Issue
` On date of
Redemption
`
a. NV 2,000 x of 100 (at par) 2,00,000 2,00,000
b. NV
+ Premium on issue 5% 2,00,000
+10,000 2,00,000
-
c. NV
- Discount on issue 5% 2,00,000
-10,000 2,00,000
-
d. NV
+ Premium on redemption 10% 2,00,000
- 2,00,000
+20,000
e. NV
- Discount on issue 5%
+ Premium on redemption 10% 2,00,000
-20,000
- 2,00,000
-
+10,000
f. NV
+ Premium on issue 5%
+ Premium on redemption 10% 2,00,000
+10,000
- 2,00,000
-
+20,000

Journal entries in the books of Ajay on Issue of Debentures
Nature of
Transaction Journal Entry Debit ` Credit `
a. When issue d at par
and redeemable at par Bank A/c Dr.
To Debentures A/c 2,00,000
2,00,000
b. When debentures are
issued at a premium
and redeemable at par Bank A/c Dr.
To Debentures A/c
To Securities Premium A/c 2,10,000
2,00,000
10,00 0
c. When debentures are
issued at a discount
and redeemable at par Bank A/c Dr.
Disc. on issue of Deb. A/c
Dr.
To Debentures A/c 1,90,000
10,000

2,00,000
d. When debentures are
issued at par and
redeemable at
premium Bank A/c Dr.
Loss on issue of Deb. A/c
Dr.
To Debentures A/c
To Prem. on redemption of
deb. A/c 2,00,000
20,000

2,00,000
20,000 munotes.in

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Accountancy and
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30 e. When debentures are
issued at a discount
and redeemable at
premium Bank A/c Dr.
Disc. on issue of Deb. A/c
Dr.
Loss on issue of Debentures
A/c Dr.
To Debentures A/c
To Prem on redemption of
deb. A/c 1,80,000
20,000
10,000


2,00,000
10,000
f. When debentures are
issued at a premium
and redeemable at
premium Bank A/c Dr.
Loss on issue of Debentures
A/c Dr.
To Debentures A/c
To Securities Premium A/c
To Prem. on redemption of
deb. A/c 2,10,000
20,000

2,00,000
10,000
20,000

2.9 SUMMARY:
1. Debenture is acknowledged as a debt
2. Debenture is a long term borrowing
3. It is given in the form of a certificate under the common seal of the
company
4. The terms of issue and redemption of debentures are mentioned in the
certificate
5. Debenture can be issued at par, premium or discount
6. Debentures can be issued for consideration other than cash.
7. Debenture can be offered as a c ollateral security
8. Debentures can be secured or unsecured.
9. Interest is payable on nominal value of debentures.
10. Debentures do not carry voting rights
2.10 EXERCISE:
1. Distinguish between a share and debenture?
2. Explain the different types of debentures?
3. What a re the provisions of the Companies Act regarding issue of
debentures?
4. Write Short Notes on:
i. Meaning and features of debentures.
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Introduction to Company
Accounts Issue of
Debentures
31 iii. Simple debentures
iv. Fixed charge and floating charge on debentures
v. Secured debentures and redeemable debenture s
vi. Issue of debentures
vii. Issue of debentures other than cash
viii. Issue of debentures as a collateral security
Objective types questions

A. State whether the following statements are True or False
i. Debenture is a short term borrowing
ii. Debenture holders are creditors o f the company
iii. Interest on debentures is calculated on the cost of the
debentures
iv. Debentures can be issued as a collateral security
v. Debentures can be issued for consideration other than cash
vi. Debentures cannot be issued at a discount
vii. A charge on all the asse ts of the company is a fixed charge
viii. Unsecured debentures are simple debentures
ix. Bearer debentures are registered with the company
x. A company cannot issue secured debentures
xi. Debentures carry voting rights.
Answers:
True : ii, iv, v, viii
False : i, iii, vi, v ii, ix, x, xi

B. Fill in the blanks choosing correct alternative
i. Debenture holders are the ________of the company
(Owners/Creditors)
ii. Naked debentures are also known as ______ debentures.
(Secured/Unsecured)
iii. Debenture is a _______________capital (Borrowed/Own ed)
iv. Interest is calculated on the __________ of the debentures (Nominal
Value/Cost Price)
v. A charge on specific assets of the company is a _______ charge.
(Fixed/Floating)
vi. Collateral security is a ___________ security (Lateral/Parallel)
vii. The rate of interest on debenture is_______ (Fixed/Fluctuating)
viii. The maximum tenure for debentures issued by Companies engaged
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Accountancy and
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32 ix. When debentures of the face value of `100 are issued at `105, the
issue is said to be at_ _____ (Discount/Premium)
x. Issue of debentures must be authorised by __________ of
Association (Memorandum/Articles)
Answers:
i. Creditors, ii. Unsecured, iii. Borrowed, iv. Nominal Value,
v. Fixed, vi. Parallel, vii. Fixed, viii 30 ix. Premium, x. Artic les

C. Match the Columns
Column A Column B
1. Debenture holders are a. Simple debentures
2. Unsecured Debentures b. Collateral Security
3. Bearer Debentures c. Charge on the assets of the
company
4. Secured Debentures d. Creditors of the company
5. Parallel Security e. Transfer by mere delivery

Answers:
1- d, 2-a, 3- e, 4-c, 5-b

Illustration
Varun Ltd. issues 1,000 7% debentures of `100 each
You are asked to give journal entries on issue if:
i. the debentures are issued at par and redeemable at par
ii. they are issued at a discount of 5% but redeemable at par
iii. they are issued at a premium of 5% but redeemable at par
iv. they are issued at a discount of 10% but redeemable at a premium of
5%
v. they are issued at par but redeemable at a premium of 10%
vi. they are iss ued at a premium of 5% but redeemable at a premium of
10%

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33 Module II
3
REDEMPTION OF PREFERENCE SHARES
Unit Structure
3.0 Objective
3.1 Introduction
3.2 Accounting Procedure
3.3 Questions
3.0 OBJECTIVE
After studying this unit students will be able to:
 Know the Concept of Redemption and purpose of issuingredeemable
Preference Shares.
 Understand various provision of the Companies Act
regardingredemption of Preference Shares.
 Know the sources of redemption including divisible profits
andproceeds of fresh issue of shares
 Understand the concept of Premium on Redemption &
CapitalRedemption Reserve.
 Know to prepare Capital Redemption Reserve Account and use.
 Know the Methods of redemption of Preference Shares
 Understand the Accounting procedure of redemption of Preference
Shares.
 Prepare the Balance Sheet (Schedule III) of the Company after
redemption of Preference Shares.
3.1 INTRODUCTION
As studied in the earlier chapter, a share is the part of the amount of the
capital of a company. The preference shares are the one’s which have a
fixed rate of dividend and enjoy preferential rights of repayment at the
time of winding up of the company.
55 of the Companies Act 2013 ha s laid down various provisions in respect
of the issue and redemption of the preference shares which has been
briefed as under :
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Accountancy and
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34 1) With the commencement of the Co. Act 2013 the Companies that are
limited by shares shall issue only redeemable preference s hares.
2) Such companies may issue redeemable preference shares for a period
of 20 years only.
3) However if the company is undertaking infrastructure projects then
such shares may be issued for a period exceeding 20 years subject to
certain laid down co nditions for issue as well as redemption.
4) The redemption of the preference shares may be carried out by either
i) Proceeds of fresh issue of shares
ii) Divisible profits of the company.
5) Only fully paid shares can be redeemed.
6) In case the redemption is out of profits, a sum equal to the nominal
value (NV) of the shares redeemed must be transferred to the Capital
Redemption Reserve (CRR)
7) The redemption may be carried out at par or premium. In case of the
premium on redemption, it may be provided out of the security
premium A/c. However as per S. 133, the companies that are required
to use divisible profits itself for providing the premium on
redemption of the preference shares.
8) The redemption require the consent of three fo urth of the preference
share holders.
9) Incase there are untraceable share holders or the company is unable
to redeem the preference shares or pay the dividends, then the
company upon the approval of the tribunal may issue further
redeemable preference s hares to a matching amount.
10) Also for the dissenting shareholders, such redeemable shares may be
issue. However such issue of shares under this section does not deem
an increase in the share capital of the company.
11) The balance generated through th e CRR may be after the redemption
used for the issuance of bonus shares.
3.2 ACCOUNTING PROCEDURE :
1) Making final calls incase the shares are partly paid.
Calls on Preference share A/c or
To Preference Capital A/c
2) Receiving money on the call
Bank A/c Dr
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35
3) Share forfeiture on non payment
i) Preference Capital A/c Dr.
To Share forfeiture A/c
(Reduction of the shares that are to be forfeited)
ii) Share forfeiture A/c Dr
To Capital Reserve
(Share f orfeiture balance transferred)
4) Create the claim of the Preference share holders.
Preference Capital A/c Dr.
Premium on Redemption A/c Dr.
To Preference Share holders A/c
(Premium on Redemption will appear only if the shares are redeemed
at a premium).
5) Sale of assets to fund redemption Bank A/c Dr.
Profit & Loss A/c Dr.
To Assets A/c
To Profit & Loss A/c
(Depending on the gain or loss an the sale value of the a sset, Profit and
Loss A/c will be either debited or credited)
6) Issue of shares
Bank A/c Dr.
To Equity Capital A/c
To Security premium A/c
(Where shares are issued at a premium)
7) Payment to preference share holders
Preference share Holders A/c Dr.
To Bank A/c
8) A mortising the premium on redumption
Profit and Loss A/c Dr.
To Premium on Redemption A/c
9) Creating the CRR
Profit and Loss A/c Dr.
General Reserve A/c Dr.
To CRR A/c
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36 10) Declaration of Bonus
Bonus to Equity share holder A/c Dr.
To Equity Capital A/c
11) Capitalising the reserves for Bonus
CRR A/c / Profit & Loss / General Reserves A/c Dr.
To Bonus to Equity share capital A/c
Study Note : (A) Bonus
For the purpose of calculation of bonus shares, the following steps are to
be followed.
1) Calculate the number of equity share = originally in the B/s + Fresh
issue made.
2) Look upon the ratio given Eg : 1 bonus for 5 shares held.
3) Calculate the bo nus : (for 20,000 equity shares)
Eg : Held Bonus
5 1
20,000 2
Bonus = 20,00015 40000 shares
Refer Q. No. - 4 & 5 in this chapter)
B) Divisible Profits :
The profits which can be distributed to the shareholders or may be used
for any business purpose by the company are called as divisible profits.
These include - Profit and Loss A/c, General Reserve, Investment
fluctuation Reserve, dividend Equalisation Reserve.
Also specifi cally created funds like sinking Fund, Workmen
Compensation Fund may be treated as divisible profits subject to the
deduction of the liability in respect of that particular fund.
II) Practical Questions :
Redemption fully out of new issue.
Q.1 Salman Ltd. has 50,000 8% Preference shares of `100 each fully paid.
On 31/12/18, the Company decided to redeem the preference shares at
10% premium. For funding the redemption the Company issued 5,00,000
equity shares of `10 each issued at `12 are. The is sue was fully subscribed
and the redemption was duly carried out Journalise the transactions in the
books of the Company.
Ans. Journal of Salman Ltd.
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37 1) 8% Preference Capital A/c Dr. 50,00,000
Premium on Redeem A/c Dr. 5,00,000
To Preference Shar e Holders A/c 55,00,000
(Being the claim of Preference Share holders created)
2) Bank A/c Dr. 60,00000
To Equity Capital A/c 50,00,000
To Security Premium A/c 10,00,000
(Being equity shares issued at a premium of `2/ share)
3) Profit and Loss A/c Dr 5,00,000
To premium on Redeem A/c 5,00,000
(Being premium on redeem W/off)
4) Preference share holders A/c Dr. 55,00,000
To Bank A/c 55,00,000
(Being the claim of the preference shares holders settled)
Redemption fully ou t of the profits
Q.2 The following balances are extracted from the books of Katrina Ltd. as
on 31/3/18
5,000 10% Preference Shares `100 each 5,00,000
General Reserve A/c 2,80,000
Profit & Loss A/c 3,00,000
The Company decided to redeem at far the preference shares fully out of
the available reserves on 1/4/18. Journalise the above transactions.
Ans. Journal of Katrina Ltd.
1) 10% Preference share capital A/c Dr. 5,00,000
To Preference share holder A/c 5,00,000
(Being the claim of the preference share holders created)
2) Profit and Loss A/c Dr 3,00,000
General Reserve A/c Dr. 2,00,000
To Capital Redeem Reserve A/c 5,00,000
(Being CRR created for the redemption of preference share capital)
3) Preference share holders A/c Dr. 5,00,000
To Bank A/c 5,00,000
(Being Preference share holders claim settled)
Redemption partly out of the fresh issue and partly out of profits.
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Accountancy and
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38 Q.3 Shahrukh Ltd. has 6000 9% Preference shares of `100 eac h
redeemable at 5% premium. To fund the redemption, the Co. issued
30,000 equity share of `10 each at 10% premium. The divisible
profits of the firm included.
General Reserve `2,00,000
Profit & Loss A/c `2,00,000
Journalise the transactions.
Ans. Journal of Sharukh Ltd.
1) 9% Preference Capital A/c Dr. 6,00,000
Premium on Redeem A/c Dr. 30,000
To Preference share holders A/c 6,30,000
(Being Preference share holders claim created)

2) Bank A/c Dr 3,30,000
To Equity Capital A/c 3,00,000
To Security Premium A/c 30,000
(Being equity shares issued at a premium)

3) Profit and Loss A/c Dr 2,00,000
General Reserve A/c Dr 1,00,000
To CRR A/c 3,00,000
(Being CRR created for redemption of Preference shares) (Balance
Amount)

4) General Reserves A/c Dr. 30,000
To Premium on Redeem 30,000
(Being premium on Redeem w/off)

5) Preference share holders A/c Dr. 6,30,000
To Bank A/c 6,30,000
(Being preference share holders claim settled)

Redemption then bon us - declaration

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39 Q.4 Ranveer Ltd.’s Balance sheet as on 31/12/2018 is as follows
10% Preference Capital 2,50,000 Bank 1,75,000
Equity capital 5,00,000 Investments 2,00,000
General Reserve 2,00,000 Stock 2,75,000
Profit & Loss A/c 4,00,000 Debtors 3,00,000
11% Debentures 2,00,000 Land & Building 4,00,000
Creditors 2,00,000 Equipments 4,00,000
17,50,000 17,50,000

On the above date, the Company decided to redeem the preference shares
at 10% premium. For this purpose, the Co. sold 50% of the investments at
20% Profit and issued 1200 equity share of `100 each at part. The issue
was fully subscribed and the redemption was carried out.
Post redemption the company insured bonus @ 1 share for 10 shares held
by the owners.
Journalise all the above transactions.
Ans. Journal of Ranveer Ltd.
1) 10% Preference Capital A/c Dr. 2,50,000
Premium on Redeem A/c Dr. 25,000
To preference share holder A/c 2,75,000
(Being the claim of preference share holders created)
2) Bank A/c Dr. 1,20,000
To Investment A/c 1,00,000
To Profit & Loss A/c 20,000
(Being investments sold at a gain, WN1)
3) Bank A/c Dr. 1,20,000
To Investment A/c 1,20,000
To Profit & Loss A/c 20,000
(Being equity share issued at par)
4) Profit and Loss A/c Dr. 1,30,000
To CRR A/c 1,30,000
(Being CRR created for redemption)
5) Profit and Loss A/c Dr. 25,000
To Premium on Redeem A/c 25,000
(Being premium on redeem w/off)
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Accountancy and
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40 6) Preference share holders A/c Dr. 2,75,000
To Bank A/c 2,75,000
(Being preference share holders paid)
7) CRR A/c Dr 51,200
Bonus to Equity share Holders 51,200
(Being bonus shares declared)
8) Bonus to Equity share holder A/c Dr. 51,200
To Equity Capital A/c 51,200
(Being bonus shares declared)
WN1 - Calculate of sale value of investments MC of investment =
2,00,000
Extent of investment sold = 50% = 1,00,000
Profit = 20% = 20,000 Sale value = 1,00,000 + 20,000 = 1,20,000
WN2 - Calculation of Bonus shares
Total no. of equity share = (before bonus)
Originally issued + Fresh issue
= 50,000 + 1200
= 51,200
Held Bonus
10 1
51200 ?
Bonus = 51200 110 5120 shares of `10 each
Redemption with untraceable preference shareholder s and Balance sheet.
(Comprehensive question)
5) Balance sheet of Adira Ltd. as on 31/3/18 is as follows :
9% Preference share of
`100 each 4,00,000 Fixed Assets 16,00,000
Equity share of `100
each 8,00,000 Investments (M.V. -
2,00,000) 1,60,000
Security Premium 24,000 Stock 2,80,000
General Reserve 2,40,000 Debtors 2,80,000
Profit & Loss A/c 1,04,000 Bank 80,000
Current Liabilities 8,32,000
24,00,000 24,00,000
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41 Adjustments :
1) The Company decided to redeem all the preference shares at 10%
premium.
2) The Company decided to use 2,00,000 from general reserve & 50,000
from Profit & Loss to fund the redemption. The balance was arranged
from the fresh issue of equity shares at 20% p remium.
3) The company has arranged for a temporary overdraft facility from the
bank in case of shortage of funds.
4) The redemption was carried out on 1/4/18 except for 2 shareholders
shares.
5) Post redemption, the company declared a bonus @ 1 share f or 25
shares held.
Journalise the above transaction in the books of Adira Ltd. and also
prepare a balance sheet.
WN1
Calculation of extent of issue of equity share
NV of pr eference share to be redeemed 4,00,000
Premium @ 10% 40,000
Redemption value 4,40,000
(-) Divisible Profits used (given)
General Reserve 2,00,000
Profit & Loss 50,000 (2,50,000)
(-) Premium W/off through Profit & Loss (40,000)
Extent of equity shares funding 1,50,000
NV of equity shares = `100 each
IP = 20% Premium = 100+ 20% = 120
No. of equity shares = 1,50,0001250120 shares
WN2
Actual Payment made to PSH
No. of preference shares = 4,00,000 / 100 = 4,000
Redeem value = 4,40,000 munotes.in

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42 Redeem value / share = 110
No. of share unpaid = 500
Amount unpaid = 500 x 110 = 55,000
 Amount paid = 4,40,000 - 55,000
= 3,85,000
WN3
Calculation of Bonus
Total no. of Equity shares = 8000 + 1250
= 9250
Bonus Held
1 25
2 9250
Bonus = 9250 137025shares x `100 each
Journal of Adira Ltd.
1) 9% preference Capital A/c Dr. 4,00,000
Premium on Redeem A/c Dr 40,000
To PSH A/c 4,40,000
(Being the claim of PSH created)
2) General Reserve A/c Dr. 2,00,000
Profit & Loss A/c Dr 50,000
To CR RA/C 2,50,000
(Being CRR created for redemption of preference share)
3) Profit and Loss A/c Dr. 40,000
To Premium on Redeem A/c 40,000
(Being the premium on redemption amountised through profit and loss
A/c)
4) Bank A/c Dr 1,50,000
To Equity Capit al A/c 1,25,000
To security premium A/c 25,000
(Being equity shares issued at a premium)
5) PSH A/c Dr. 4,40,000
To Bank A/c 85,000
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43
6) CRR A/c Dr. 37,000
To Bonus to ESH A/c 37,000
(Being bonus declared)
7) Bonus to ESH A/c Dr . 37,000
To Equity Capit al A/c 37,000
(Being bonus shares issued)
Balance sheet of Adira Ltd. as on 1/4/2018
Capital & Liabilities
1 Shareholders funds
a Share Capital 1 9,62,000
b Reserves & Su rplus 2 3,16,000
2 Non Current Liabilities Nil
3 Current Liabilities 3 10,42,000
Total 23,20,000
Assets
1 Non Current Assets 4 17,60,000
2 Current assets 5 5,60,000
Total 23,20,000
Note 1 : Share Capital
9620 Equity Share of `100 each 9,62,000
(Out of these 370 shares were issued as bonus shares so no consideration
has been received)
Note 2 : Reserves & Surplus
Security Premium 99,000
(24000 + 25000)
(RR (250 -37) 2,13,000
General Reserves (240 - 200) 40,000
Profit and Loss A/c (104 - 50 - 40) 14,000
3,16,000
Note 3 : Current Liabilities
Current Liabilities 8,32,000
UnclaimPSH balance 55,000
Bank O/D 1,55,000
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44 Note 4 : Non CA
Fixed Assets 16,00,000
Non Curren t Assets 1,60,000
(M.V. - 2,00,000) 17,60,000

Note 5 : CA
Stock 2,80,000
Debtors 2,80,000
5,60,000
WN4 : Calculation of Bank balance
Opening balance 80,000
+ Fresh issue 1,50,000
- Payment to PSH (3,85,000)
Bank O/D 1,55,000

3.3 QUESTIONS :
I) True or False.
1) Preference shareholders are also known ordinary shareholders.
2) Partly paid preference shares can not be redeemed
3) Redeemable preference shares can be issued only if authorized by the
Company’ s Articles of Association.
4) Dividends of a preference share are directly paid to the preference
shareholders every year.
5) Redemption of preference shares results in the resolution of the issued
capital always.
(Ans : True - 2, 3, False - 1, 4, 5)

II) Fill in the blanks.
1) Workmen Compensation Fund is a _______________ profit.
2) Capital Redemption Reserve may be used for issuing _________
shares.
3) Preference shareholders have ___________ rights of repayment at the
time of winding up.
4) A co mpany limited by shares can issue preference shares for
__________ years.
5) Bonus issue helps in ______________ the profits.
(1-divisible, 2 -bonus, 3 -preferential, 4 -20, 5 - capitalizing utilizing) munotes.in

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45 Questions for self Test
1) Ranbir Ltd. has 1,00,000 9% P reference shares of `10 each fully paid.
The company decided to redeem these preference shares at 10% premium.
The board of directors decided to redeem the shares on 31/3/18 by raising
funds through the issue of 10,000 equity share of `100 each at 20%
premium. The issue was fully subscribed and the redemption was carried
out. Journalise the above transactions in the books of Ranbir Ltd.
2) Sara Ltd. provided the following information
10% preference share of `100 each 8,00,000
Gener al Reserve 4,00,000
Profit & Loss A/c 5,00,000

The directors decided to redeem the preference shares at 10% premium by
using the profits. The company carried out the redemption as decided at
par. Journalise the above transactions in the books of the company.
3) Taimur Ltd. provides the following information to you
12% Preference share of `10 each 10,00,000
General Reserve 3,00,000
Profit & Loss A/c 4,00,000
The preference shares were due for redemption on 1/1/2019 at 10%
premium. For the redemption the company issued 70,000 equity share of
`10 each at par. The balance funds were utilized from the divisible profits.
Journalise the above transactions in the boo ks of the company.
4) Following is the Balance sheet of Rishi Ltd. as on 31/3/18
Equity share of `10
each 4,00,000 Fixed assets 6,00,000
9% Preference share of
`100 each 2,00,000 Bank 2,00,000
General Reserve 1,00,000 Other current assets 2,40,000
Profit & Loss A/c 1,00,000
Creditors 2,40,000
10,40,000 10,40,000

The Board of Directors decided to redeem the preference shares at 10%
premium. The Company issued 10,000 equity share of `10 each at 10%
premium. The balance was funded through the profits.
Post redemption the company declared a bonus of share for 5 shares held.
Journalise the above transactions and also prepare the Balance sheet. munotes.in

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Accountancy and
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46 5) The Balance sheet of Twinkle Ltd. as on 31/3/19 is as follows :
Equity share of `100 each 15,00,000
10% preference share of `100 each 6,00,000
Profit & Loss A/c 6,00,000
Current Liabilities 5,00,000
32,00,000
Fixed Assets 10,00,000
Investments 5,00,000
Bank 3,00,000
Other Current assets 14,00,000
32,00,000
On the 1st April the Company
1) Redeemed the preference shares at 20% premium
2) Realised 50% of the investments at 10% profits.
3) Issued 5,000 equity share of `100 each at 10% premium.
4) The Company redeemed the preference share except 10 preference
share holders holding 1000 shares who were untraceable.
5) The Company issued 1 bonus share for every 10 shares held.
Journalise the above transactions and prepare the Balance sheet.

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47
Module III
4
REDEMPTION OF DEBENTURES
Unit Structure:
I. Introduction
II. Provisions of Section 71 (1) and (4) of the Companies Act,
2013
Creation and investment of DRR including The Companies
(Share Capital and Debentures) Rules, 2014
III. Methods of writing off dis count/loss issue of debentures
IV. Terms of issue of debentures
V. Methods of redemption of debentures
VI. Summary
VII. Exercise
Unit II
Objective of the Unit:
The objective of the unit is to enable the students to understand the
accounting treating for regarding the rede mption of debentures in
accordance with the provisions the Companies Act, 2013
Unit III
Introduction:
Redemption of debentures means to repay the debenture holders the
amount paid by them to the company towards the debentures issued by the
company. It is repayment of the debenture liability to debenture holders.
In simple words, redemption of debentures implies repayment of
debenture capital.
The redemption of debentures depends upon the type of debentures issued
by the company and the terms of redemption. A company can issue two
type of debentures viz. Redeemable and Irredeemable. Redeemable
debentures are redeemable after a specific period, as per the terms and
conditions. Irredeemable debentures are paid at the time of winding up of
the company.
Unit IV
A. Provisions of Section 71 (1) and (4) of the Companies Act, 2013
Sec. 71(1) of the Companies Act 2013 provides that a company may issue
debentures with an option to convert such debentures into shares either
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48 Conv ersion of debentures must be approved by a special resolution passed
at a general meeting. A company may issue either fully convertible or
partly convertible debentures.
Rule 18(7) of the Companies (Share Capital and Debentures) Rules
2014provides that in case of partly convertible debentures, D.R.R. shall be
created in respect of Non -convertible portion of the debenture issue.
D.R.R. is not required in the case of fully convertible debentures.
Sec. 71(4) of the Companies Act,2013 together with The Companie s
(Share Capital and Debentures) Rules, 2014 requires a company to create
a Debenture Redemption Reserve A/c (DRR A/c) out of profits of the
company available for payment of dividend and the amount credited to
such account shall be used only for the redemp tion of Debentures.
B. The methods of writing off discount/loss on issue of debentures
When debentures are issued at a price less than their nominal/face value,
then the debentures are said to be issued at a discount .

If debentures are redeemed at a price g reater than their nominal/face value,
they are said to be redeemable at a premium. Such premium though
payable on redemption, must be provided as a liability at the time of issue
itself. Such premium payable on redemption is a capital loss for the
company.

There is no legal obligation to write off discount/loss on issue of
debentures. Since discount/loss on issue of debentures is a capital loss for
the company, it should be written off as early as possible. The
discount/loss on issue of debentures shown in the balance sheet until
written off. The amount of discount/loss written off is shown on debit side
of Profit and Loss Account under the head, ‘Other Expenses” and the
amount not written off is shown in the Balance Sheet under the head,
“Other Non -Current Assets”
The following are the two methods by which the amount of discount/loss
on issue of debentures can be written off:

1. Fixed Instalment Method
When debentures are redeemed in lump sum at the end of a certain period,
total discount/loss is spread equal ly over the period over which the
debentures will be redeemed. In this method, the amount of discount to be
written over every year is a fixed amount.
Discount/loss written off= Total Discount
No. of years
2. Fluctuating Instalment Method
When debentures ar e to be redeemed in instalments, the total amount of
discount/loss on issue of debentures should be written off in the ratio in
which the amount of debentures has been used each year. In this method,
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49 The discount /loss on issue of debentures being a capital loss can be written
off against capital profit / capital reserve. As per Section 52 of the
Companies Act 2013, securities premium can be used to write off discount
on issue of debentures.

Journal entry to write off Discount/Loss on issue of debentures:
Securities Premium A/cDr.
Profit and Loss/General Reserve A/cDr.
To Discount/Loss on issue of Debentures A/c
Illustration 1:
On 1st January, 2015, HK Ltd. issued 5,000 15% debentures of `100 each
at a discount of 10% redeemable at a premium of 10%.
Show Loss on Issue of Debentures A/c if:
1. Such debentures are redeemable after four years.
2. Such debentures are redeemable by equal annual drawings in 4
years.
HK Ltd. follows calendar year as its accounting year.
Solutio n:
1. Such debentures are redeemable after four years.
a. Total amount of discount = 10% of `10,00,000 = `1,00,000
b. Amount of premium on redemption = 10% of `10,00,000 = `1,00,000
Total Loss (a+b) = `2,00,000
Term of Debenture = 4 years
Amount of loss to be written off = `2,00,000 / 4 years = `50,000
In the books of HK Ltd.
Loss on Issue of Debentures A/c
Date Particulars ` Date Particulars `
1-1-2015 To 15% debentures
a/c 2,00,000 31-12-2015 By P&L a/c
By Balance c/d 50,000
1,50,000
Total 2,00,000 Total 2,00,000
1-1-2016 To Balance b/d 1,50,000 31-12-2016 By P&L a/c
By Balance c/d 50,000
1,00,000
Total 1,50,000 Total 1,50,000
1-1-2017 To Balance b/d 1,00,000 31-12-2017 By P&L a/c
By Balance c/d 50,000
50,000
Total 1,00,000 Total 1,00,000
1-1-2108 To Balance b/d 50,000 31-12-2018 By P&L a/c 50,000
Total 50,000 Total 50,000

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Accountancy and
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50 2. Such debentures are redeemable by equal annual drawings in 4 years.
FV of debentures redeemed each year `10,00,000 = `2,50,000
Discount/Loss to be written off each year
Year ended FV of debentures used Ratio Loss to be written off
31-12-2015
31-12-2016
31-12-2017
31-12-2018 `10,00,000
`7,50,000 (10,00,00 -2,50,000)
`5,00,000 (7,50,00 -2,50,000)
`2,50,000 (5,00,00 -2,50,000) 4
3
2
1 `2,00,000 x 4/10 = `80,000
`2,00,000 x 3 /10 = `60,000
`2,00,000 x 2/10 = `40,000
`2,00,000 x 1/10 = `20,000
Total 10 `2,00,000

In the books of HK Ltd.
Loss on Issue of Debentures A/c
Date Particulars ` Date Particulars `
1-1-2015 To 15%
debentures a/c 2,00,000 31-12-2015 By P&L a/c
By Balance c/d 80,000
1,20,000
Total 2,00,000 Total 2,00,000
1-1-2016 To Balance b/d 1,20,000 31-12-2016 By P&L a/c
By Balance c/d 60,000
60,000
Total 1,20,000 Total 1,20,000
1-1-2017 To Balance b/d 60,000 31-12-2017 By P&L a/c
By Balance c/d 40,000
20,000
Total 60,000 Total 60,000
1-1-2108 To Balance b/d 20,000 31-12-2018 By P&L a/c 20,000
Total 20,000 Total 20,000

Illustration 2:
On 1st April, 2015, R Ltd. issued 50,000, 7% debentures of `100 each at a
discount of 6% redeemable at par as follows:
Year End Face value of debentures to be redeemed
1
2
3
4 10%
20%
30%
40%

Calculate the amount of discount to be written off each year assuming that
the company close its accounts on 31st March each year.


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51 Solution:
Amount of discount = 6% of 50,000 debentures x `100 = `3,00,000
Discount to be written off each year
Year
ending
31-3 FV of debentures used ` Ratio Loss to be written off
2016
2017
2018
2019 `50,00,000
`45,00,000 (50,00,000 -10% of
50,00,000)
`35,00,000(45,00,000 -20% of
50,00,000 )
`20,00,000 (35,00,000 -30% of
50,00,000) 10
9

7

4 `3,00,000 x 10/30 = `1,00,000
`3,00,000 x 9/30 = `90,000

`3,00,000 x 7/30 = `70,000

`3,00,000 x 4/30 = `40,000
Total 30 `3,00,000

In the books of R Ltd.
Loss on Issue of Debentures A/c
Date Particulars ` Date Particulars `
1-1-
2015 To 7% debentures
a/c 3,00,000 31-12-
2015 By P&L a/c
By Balance c/d 1,00,000
2,00,000
Total 3,00,000 Total 3,00,000
1-1-
2016 To Balance b/d 2,00,000 31-12-
2016 By P&L a/c
By Balance c/d 90,000
1,10,000
Total 2,00,000 Total 2,00,000
1-1-
2017 To Balance b/d 1,10,000 31-12-
2017 By P&L a/c
By Balance c/d 70,000
40,000
Total 1,10,000 Total 1,10,000
1-1-
2108 To Balance b/d 40,000 31-12-
2018 By P&L a/c 40,000
Total 40,000 Total 40,000


C. Terms of issue o f debentures
There are no legal restrictions on the terms of issue of debentures. The
debentures can be issue at par, premium or discount.

This topic has been dealt in Introduction to Companies Account

D. Methods of redemption of debentures
The different me thods of redemption of debentures are:
1. By drawing lots in instalments: In this case debentures are redeemed
by annual or periodic drawings within a specific period.
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Accountancy and
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52 2. In lump sum: In this method debentures are redeemed in one lump
sum after a specific perio d of time from the date of issue.

3. By purchase of own debentures in the open market: In this case,
the company purchases its own debentures for immediate cancellation
or for investment.

4. By conversion: In this case debentures are redeemed by converting
them into equity shares or into preference shares or converting into a
new class of debentures.
SOURCES OF REDEMPTION
1. Redemption out of Capital
In this method, debentures are redeemed out of capital of the company.
The debenture holders are paid out of ca sh or bank account and not out of
profits, hence, it is termed as redemption out of capital. Since the
redemption is not out of profits, the entry regarding transfer of profits to
Debenture Redemption Reserve account is not passed. As a result, balance
of profits is not reduced by the amount utilised for redemption of
debenture. As per the SEBI Guidelines, redemption of debentures wholly
out of capital is not possible. Redemption out of capital is done when the
debentures are for a period of less than 18 mo nths or profits are not
enough for creation of Debentures Redemption Reserve.

The Government has put a restriction on this method by requiring every
company to create Debentures Redemption Reserve.
Illustration 3:
On 1st April, 2015, ITI Ltd. issued 8,000 6% debentures of `100 each at
10% discount, redeemable at a premium of 5% at the end of the 4th year.

Pass Journal entries. Ignore the treatment of loss on issue of debenture and
interest.

Solution:
Journal Entries in the books of ITI Ltd.

Date Partic ulars Debit ( `) Credit ( `)
1-4-2015 Bank A/c Dr.
Discount on issue of debentures
A/c Dr.
Loss on issue of debentures A/c Dr.
To 6% Debentures A/c
To Premium on redemption of
debentures A/c
(Being 8,000 6% debentures issued
at a 10% discount, redeemable at
5% premium) 7,20,000
80,000
40,000


8,00,000
40,000 munotes.in

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53 31-3-2019 6% Debentures A/c Dr.
Premium on redemption of
debentures A/c Dr.
To6% Debentureholders A/c
(Being amount due to
debentureholders on redemption) 8,00,000
40,000

8,40,000
31-3-2019 6% Debe ntureholders A/c Dr.
To Bank A/c
(Being debentureholders paid off) 8,40,000
8,40,000

2. Redemption out of Profits
In this method, debentures are redeemed out of profit earned. Profits are
utilised for redemption of debentures. The following are the two methods
by which debentures can be redeemed out of profits.
A. Creating Debenture Redemption Reserve &B. Creating Sinking Fund
A. Creating Debenture Redemption Reserve (DRR)
In this method, amount is appropriated from Profits and Loss
Appropriation Account and it is transferred to Debenture Redemption
Reserve Account before redemption. This reduces the profit available for
distribution as dividend.
As per Sec. 71(4) of the Companies Act,2013 a company shall create a
Debenture Redemption Reserve A/c out of pr ofits of the company
available for payment of dividend and the amount credited to such account
shall not be utilised except for the redemption of Debentures.
Rule 18(7) The Companies (Share Capital and Debentures) Rules, 2014
requires that an amount equal to atleast 25% of nominal value of
debentures must be transferred to DRR by the company before
commencement of redemption of debentures. The company can transfer at
its option, more than 25% to DRR account.
As per Rule 18(7) the following categories of com panies are exempted
from creating a DRR A/c:
1. All India Financial Institutes regulated by the RBI
2. Debentures placed publicly and privately by Banking Companies
3. Debentures placed privately by Non - banking and other Financial
institutions (NBFC)
4. Fully convert ible debentures

As per SEBI it is not mandatory to create DRR in case of:
1. Debentures maturing in 18 months or less
2. For Infrastructure Companies.
Further every company requiring to create DRR a/c, shall before 30th April
of each year deposit or invest atle ast 15% of the face value of debentures munotes.in

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Accountancy and
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54 maturing during the year ending on 31st March next, in any one or more of
the following:
1. In deposit with any scheduled bank free from charge or lien.
2. In unencumbered securities of the central or any of the state
gove rnment.
3. In unencumbered securities mentioned under section 20 (a) to (d) and
(ee) of the Indian Trust Act 1882
4. In unencumbered bonds issued by any other company which is notified
under section 20 (f) of the Indian Trust Act 1882
Illustration 4:
Zebra Ltd. issued on 1st April 2016, 10,000 8% debentures of `100 each
redeemable by draw of lots as under:
1. During the year ending on 31st March,2018 – 15%
2. During the year ending on 31st March, 2019 – 20%
3. During the year ending on 31st March, 2020 – 25%
4. During the ye ar ending on 31st March, 2021 – 15%
5. During the year ending on 31st March, 2022 – 25%

What is the minimum deposit or investment Zebra Ltd. should make as per
the Companies Act, 2013 before debentures are redeemed? Also state
when the investment should be m ade. State the minimum amount to be
transferred to Debenture Redemption Reserve A/c as per Companies Act,
2013
Solution:
Date of
Redemption Date of
Investments Nominal value
of debentures
maturing Minimum
depositor
investment Minimum
amount to
be
transferr ed
to DRR A/c
31st March, 2018 On or before
30th April, 2017 15% of
`10,00,000 =
`1,50,000 15% of
`1,50,000
=`22,500 25% of
`1,50,000
=`37,500
31st March, 2019 On or before
30th April, 2018 20% of
`10,00,000 =
`2,00,000 15% of
`2,00,000
=`30,000 25% of
`2,00,000
=`50,000
31st March, 2020 On or before
30th April, 2019 25% of
`10,00,000 =
`2,50,000 15% of
`2,50,000
=`37,500 25% of
`2,50,000
=`62,500
31st March, 2021 On or before
30th April, 2020 15% of
`10,00,000 =
`1,50,000 15% of
`1,50,000
=`22,500 25% of
`1,50,000
=`37,500
31st March, 2022 On or before
30th April, 2021 25% of
`10,00,000 =
`2,50,000 15% of
`2,50,000
=`37,500 25% of
`2,50,000
=`62,500
munotes.in

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Redemption of Debentures


55 Illustration 5:
Prakash Ltd. issued 4,000 8% debentures of `100 each on 1st April, 2015
at a discount of 10%, redeemable at a premium of 10% out of profits. Give
journal entries both at the time of issue and redemption of debentures if:
a) the debentures are redeemable in lump sum at the end of 4th year
from the date of issue and
b) the Company has decided to c reate a Debenture Redemption
Reserve, every year.
(Ignore the treatment of loss on issue of debenture and interest.
March 31stis the accounting year of Prakash Ltd)
Solution:

Journal Entries in the books of Prakash Ltd.

Date Particulars Debit ( `) Credit (`)
1-4-2015 Bank A/c Dr.
Discount on issue of debentures A/c
Dr.
Loss on issue of debentures A/c Dr.
To 8% Debentures A/c
To Premium on redemption of
debentures A/c
(Being 4,000 8% debentures issued at
a 10% discount, redeemable at 10%
premium) 3,60,000
40,000
40,000


4,00,000
40,000
31-3-2016 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of profits equal to
25% of the nominal value of
debentures issued) 1,00,000
1,00,000
31-3-2017 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of profits equal to
25% of the nominal value of
debentures issued) 1,00,000
1,00,000
31-3-2018 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of profits equal to
25% of the nominal value of
debentures issued) 1,00,000
1,00,000 munotes.in

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56 29-4-2018 Debenture Redemption Investment
A/c Dr.
To Bank A/c
(Being investment made @ 15% of
the nominal value of debentures to be
redeemed) 60,000
60,000
31-3-2019 Profit & Lo ss Appropriation A/c Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of profits equal to
25% of the nominal value of
debentures issued) 1,00,000
1,00,000
31-3-2019 Bank A/c Dr.
To Debenture Redemption
Investment A/c
(Being Investments encashed) 60,000
60,000
31-3-2019 8% Debentures A/c Dr.
Premium on redemption of
debentures A/c Dr.
To 8% Debentureholders A/c
(Being amount due to
debentureholders on redemption) 4,00,000
40,000

4,40,000
31-3-2019 8% Debentureholders A/c Dr.
To Bank A/c
(Being debentureholders paid off) 4,40,000
4,40,000
31-3-2019 Debenture Redemption Reserve A/c
Dr.
To General Reserve A/c
(Being transfer of balance in DRR a/c
to general reserve a/c on redemption
of debentures) 4,00,000
4,00,000

Illustration 6:
Kajal Ltd. h as 12,000, 9% debentures of `100 each due for redemption in
four equal instalments starting from 31st March, 2016. On that date the
Debenture Redemption Reserve Account has a balance of `70,000. Record
necessary journal entries in the books of the Company.








munotes.in

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Redemption of Debentures


57 Solution:

Journal Entries in the books of Kajal Ltd.

Date Particulars Debit ( `) Credit ( `)
30-4-2015 Debenture Redemption Investment A/c
Dr.
To Bank A/c
(Being investment made @ 15% of the
nominal value of debentures to be on
31st March 2016) 45,000
45,000
31-3-2016 Bank A/c Dr.
To Debenture Redemption Investment
A/c
(Being Investments encashed) 45,000
45,000
31-3-2016 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of profits to DRR A/c,
25% `3,00,00 0 = `75,000 – `70,000) 5,000
5,000
31-3-2016 9% Debentures A/c Dr.
To 9% Debenture holders A/c
(Being 1/4th amount due to debenture
holders on redemption) 300,000

3,00,000
31-3-2016 9% Debenture holders A/c Dr.
To Bank A/c
(Being 1/4thdebentureholders paid off) 3,00,000
3,00,000
30-4-2016 Debenture Redemption Investment A/c
Dr.
To Bank A/c
(Being investment made @ 15% of the
nominal value of debentures to be
redeemed on 31st March 2017)) 45,000
45,000
31-3-2017 Bank A/c Dr.
To Debenture Redemption Investment
A/c
(Being investments encashed) 45,000
45,000
31-3-2017 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of profits to DRR A/c
@ 25% of the nominal value of
debentures to be redeemed) 75,000
75,000 munotes.in

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Accountancy and
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58 31-3-2017 9% Debentures A/c Dr.
To 9% Debentureholders A/c
(Being 1/4th amount due to
debentureholders on redemption) 300,000

3,00,000
31-3-2017 9% Debentureholders A/c Dr.
To Bank A/c
(Being 1/4thdebentureholders paid off) 3,00,000
3,00,000
30-4-2017 Debenture Redemption Investment A/c
Dr.
To Bank A/c
(Being investment made @ 15% of the
nominal value of debentures to be on
31st March 2018) 45,000
45,000
31-3-2018 Bank A/c Dr.
To Debenture Redemption Investment
A/c (Being investments encashed) 45,000
45,000
31-3-2018 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of profits to DRR A/c
@ 25% of the nominal value of
debentures to be redeemed) 75,000
75,000
31-3-2018 9% Debentures A/c Dr.
To 9% Debentureholders A /c
(Being 1/4th amount due to
debentureholders on redemption) 300,000

3,00,000
31-3-2018 9% Debentureholders A/c Dr.
To Bank A/c
(Being 1/4thdebentureholders paid off) 3,00,000
3,00,000
30-4-2018 Debenture Redemption Investment A/c
Dr.
To Bank A/c
(Being investment made @ 15% of the
nominal value of debentures to be on
31st March 2019) 45,000
45,000
31-3-2019 Bank A/c Dr.
To Debenture Redemption Investment
A/c
(Being investments encashed) 45,000
45,000 munotes.in

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59
31-3-2019 Profit & Loss Appropriation A/c Dr .
To Debenture Redemption Reserve A/c
(Being transfer of profits to DRR A/c
@ 25% of the nominal value of
debentures to be redeemed) 75,000
75,000
31-3-2019 9% Debentures A/c Dr.
To 9% Debenture holders A/c
(Being 1/4th amount due to debenture
holders on redemption) 300,000

3,00,000
31-3-2019 9% Debenture holders A/c Dr.
To Bank A/c
(Being 1/4thdebentureholders paid off) 3,00,000
3,00,000
31-3-2019 Debenture Redemption Reserve A/c
Dr.
To General Reserve A/c
(Being transfer of balance in DRR a/c
to ge neral reserve a/c on redemption of
debentures) 3,00,000
3,00,000

Illustration 7:
Raman Ltd. issued 21,000, 7% debentures of `100 each on 1st October,
2011 redeemable in three equal annual instalments starting from 31st
March, 2015. The Board of director s decides to transfer to Debenture
Redemption Reserve A/c `50,000 and `4,00,000 on 31st March, 2012 and
2013 respectively and the balance required on 31st March, 2014. Ignore
payment of interest. Investments as required by law are made by the
Company in ba nk fixed deposits. Pass necessary journal entries.
Solution:

Journal Entries in the books of Raman Ltd .

Date Particulars Debit ( `) Credit ( `) 1-9-2011 Bank A/c Dr.
To 7% Debentures A/c
(Being 21,000 7% debentures issued at
par) 21,00,000

21,00,000
31-3-2012 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of profits to DRR A/c) 50,000
50,000
31-3-2013 Profit & Loss A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of profits to DRR A/c) 4,00,000
4,00,000 munotes.in

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Accountancy and
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60 31-3-2014 Profit & Loss Appropriation A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of balance required
profits to DRR A/c, 25% of `21,00,000
– `50,000 -`4,00,000) 75,000
75,000
30-4-2014 Debenture Redemption Investment A/c
Dr.
To B ank A/c
(Being investment made @ 15% of
`7,00,000 ) 1,05,000
1,05,000
31-3-2015 Bank A/c Dr.
To Debenture Redemption Investment
A/c
(Being Investments encashed) 1,05,000
1,05,000
31-3-2015 7% Debentures A/c Dr.
To 7% Debentureholders A/c
(Being 1st inst alment due to
debentureholders on redemption,
`21,00,000/3) 7,00,000

7,00,000
31-3-2015 7% Debentureholders A/c Dr.
To Bank A/c
(Being 1st instalment paid to
debentureholders) 7,00,000
7,00,000
30-4-2015 Debenture Redemption Investment A/c
Dr.
To Bank A/c
(Being investment made @ 15% of
`7,00,000 ) 1,05,000
1,05,000
31-3-2016 Bank A/c Dr.
To Debenture Redemption Investment
A/c
(Being Investments encashed) 1,05,000
1,05,000
31-3-2016 7% Debentures A/c Dr.
To 7% Debentureholders A/c
(Being 2nd instalm ent due to
debentureholders on redemption) 7,00,000

7,00,000
31-3-2016 7% Debentureholders A/c Dr.
To Bank A/c
(Being 2ndinstalment paid to
debentureholders) 7,00,000
7,00,000 munotes.in

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61
30-4-2016 Debenture Redemption Investment A/c
Dr.
To Bank A/c
(Being inve stment made @ 15% of
`7,00,000 ) 1,05,000
1,05,000
31-3-2017 Bank A/c Dr.
To Debenture Redemption Investment
A/c
(Being Investments encashed) 1,05,000
1,05,000
31-3-2017 7% Debentures A/c Dr.
To 7% Debentureholders A/c
(Being 1st instalment due to
deben tureholders on redemption) 7,00,000

7,00,000
31-3-2017 7% Debentureholders A/c Dr.
To Bank A/c
(Being 1st instalment paid to
debentureholders) 7,00,000
7,00,000
31-3-2017 Debenture Redemption Reserve A/c
Dr.
To General Reserve A/c
(Being trf. of balan ce in DRR a/c to
general reserve a/c on redemption of
debentures) 5,25,000
5,25,000

Illustration 8:
Apple Ltd. issued 9,000, 6% debentures of `100 each on 1st November,
2011 redeemable at a premium of 7% as under:
On 31st March, 2017 3,000 debentures
On 31st March, 2018 3,000 debentures
On 31st March, 2019 3,000 debentures

The Board of directors decides to transfer to the required amount to
Debenture Redemption Reserve A/c in four equal annual instalments
starting with 31st March, 2013. Ignore entr ies for payment of interest and
write off of loss on issue of debentures. Investments as required by law are
made by the Company in bank fixed deposits. Pass necessary journal
entries.







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62 Solution:
Journal Entries in the books of Apple Ltd.

Date Part iculars Debit ( `) Credit ( `)
1-11-2011 Bank A/c Dr.
Loss on issue of debentures A/c Dr.
To 6% Debentures A/c
To Premium on redemption of
debentures A/c
(Being 9,000 6% debentures issued
at a par, redeemable at 7%
premium) 9,00,000
63,000


9,00,000
63,00 0

31-3-2013 Profit & Loss Appropriation A/c
Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of 1st instalment of
profits to DRR A/c, 25% of
9,00,000 = 2,25,000/4) 56,250
56,250
31-3-2014 Profit & Loss Appropriation A/c
Dr.
To Debenture Redempti on Reserve
A/c
(Being transfer of 2nd instalment of
profits to DRR A/c) 56,250
56,250
31-3-2015 Profit & Loss Appropriation A/c
Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of 3rd instalment of
profits to DRR A/c) 56,250
56,250
31-3-2016 Profit & Loss Appropriation A/c
Dr.
To Debenture Redemption Reserve
A/c
(Being transfer of 4th instalment of
profits to DRR A/c) 56,250
56,250
30-4-2016 Debenture Redemption Investment
A/c Dr.
To Bank A/c
(Being investment made @ 15% of
`3,00,000 ) 45,000
45,000
31-3-2017 Bank A/c Dr.
To Debenture Redemption
Investment A/c 45,000
45,000 munotes.in

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Redemption of Debentures


63 (Being Investments encashed)
31-3-2017 6% Debentures A/c Dr.
Premium on redemption of
debentures A/c Dr.
To 6% Debentureholders A/c
(Being 1st instalment due to
debentureh olders on redemption) 3,00,000
21,000


3,21,000
31-3-2017 6% Debentureholders A/c Dr.
To Bank A/c
(Being 1st instalment paid to
debentureholders) 3,21,000
3,21,000
30-4-2017 Debenture Redemption Investment
A/c Dr.
To Bank A/c
(Being investment made @ 15% of
`3,00,000 ) 45,000
45,000
31-3-2018 Bank A/c Dr.
To Debenture Redemption
Investment A/c
(Being Investments encashed) 45,000
45,000
31-3-2018 6% Debentures A/c Dr.
Premium on redemption of
debentures A/c Dr.
To 6% Debentureholders A/c
(Being 2nd instalment due to
debentureholders on redemption) 3,00,000
21,000


3,21,000
31-3-2018 6% Debentureholders A/c Dr.
To Bank A/c
(Being 1st instalment paid to
debentureholders) 3,21,000
3,21,000
30-4-2018 Debenture Redemption Investment
A/c Dr.
To Bank A/ c
(Being investment made @ 15% of
`3,00,000 ) 45,000
45,000
31-3-2019 Bank A/c Dr.
To Debenture Redemption
Investment A/c
(Being Investments encashed) 45,000
45,000
31-3-2019 6% Debentures A/c Dr.
Premium on redemption of
debentures A/c Dr.
To 6% Debent ureholders A/c 3,00,000
21,000


3,21,000 munotes.in

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Accountancy and
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64 (Being 1st instalment due to
debentureholderson redemption)
31-3-2019 6% Debentureholders A/c Dr.
To Bank A/c
(Being 3rd instalment paid to
debentureholders) 3,21,000
3,21,000
31-3-2019 Debenture Redemption Res erve A/c
Dr.
To General Reserve A/c
(Being transfer of balance in DRR
a/c to general reserve a/c on
redemption of debentures) 2,25,000
2,25,000

Illustration 9:
Mala Ltd. has a balance of `25,00,000 in the Profit & Loss A/c. The
company decided to redeem fully out of profits `25,00,000 10%
debentures which were issued on 1st April, 2015. These debentures are
redeemable at a premium of 10% on 30th June, 2019. Interest is payable
annually on 31st December every year when the accounts are closed. The
company has a balance of `6,25,000 in DRR A/c. Journalise the
transaction during the year of redemption.

Solution:
Journal entries in the books of Mala Ltd.

30-4-
2019 Debenture Redemption Investment
A/c Dr.
To Bank A/c
(Being investment made @ 15% of
`25,00,00 0) 3,75,000
3,75,000
30-6-
2019 Bank A/c Dr.
To Debenture Redemption
Investment A/c
(Being investments encashed) 3,75,000
3,75,000
30-6-
2019 Debenture Interest A/c Dr.
To 10% Debentureholders A/c
(Being half year debenture interest
due, `25,00,000 x 10/ 100 x 6/12
months ) 1,25,000
1,25,000
30-6-
2019 10% Debentures A/c Dr.
Premium on redemption of
debentures A/c Dr.
To 10% Debentureholders A/c
(Being amount due to
debentureholders on redemption) 25,00,000
2,50,000


27,50,000 munotes.in

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65 30-6-
2019 10% Debenturehol ders A/c Dr.
To Bank A/c
(Being debentureholders paid along
with interest) 28,75,000
28,75,000
30-6-
2019 Debenture Redemption Reserve A/c
Dr.
To General Reserve A/c
(Being transfer of balance in DRR
a/c to general reserve a/c on
redemption of debentures) 6,25,000
6,25,000
30-6-
2019 Profit & Loss A/c Dr.
To Debenture Interest A/c
To Premium on redemption of
debentures A/c
(Being debenture interest &
premium on redemption of
debentures transferred to P&L A/c) 3,75,000
1,25,000
2,50,000

Note: premium on redemption of debentures is transferred to P&L A/c on
the assumption that it was not written off in the earlier year.
B. Creating Sinking Fund
This method is known as Sinking Fund (SF) Method / Debenture
Redemption Fund (DRF) Method. In this method a fixe d amount is kept
aside or appropriated out of profits every year and invested outside the
business by creating a sinking fund or debenture redemption fund. This
fixed amount is also known as Annual Instalment towards sinking fund.
Out of the fund the compa ny either purchases investments or takes an
insurance policy.
The sinking fund may be cumulative or non - cumulative. In case of
Cumulative SF, the income from the investment/policy is added back to
the fund and reinvested. In case on non -cumulative SF, the income from
investment/policy is credited to Sinking Fund account.
In the year of redemption, the investments are sold or the policy is
surrendered in order to obtain money required to pay off the debenture
holders. Any profit or loss on sale of investme nts is transferred to Sinking
Fund Account. After redemption of the debentures the balance if any in
the Sinking Fund Account is transferred to General Reserve Account.
The amount to be kept aside/appropriated depends on the rate of interest to
be received and the terms of redemption. There are mathematical tables
available for this purpose. These are called Annuity Tables. The annual
amount set aside or appropriation required is calculated as follows:
Amount to be kept aside/appropriated = Amount of redemp tion x factor in
annuity table munotes.in

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Accountancy and
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66 Model Journal Entries:
I. 1st Year Amount
1. For making yearly appropriations
Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
Annual Instalment 2. For making investment
Sinking Fund Investments A/c Dr.
To Bank A/c
Annual Instalment II. 2nd Year Onwards
1. For interest received in SF Investments
Bank A/c Dr.
To Sinking Fund A/c
Interest received
on Investments
2. For making yearly appropriations
Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
Annual Inst alment 3. For making investment
Sinking Fund Investments A/c Dr.
To Bank A/c Annual Instalment
+Interest
III. Year of Redemption
1. For interest received in Sinking Fund
Investments Bank A/c Dr.
To Sinking Fund A/c
Interest received
on Investments
2. For making yearly appropriations
Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
Annual Instalment No investments are made in the year of
redemption
3. When Sinking Fund Investments are sold
a. At par
Bank A/c Dr.
To Sinking Fund Investments A/c
Selling price of
Investments
b. At Profit
Bank A/c Dr.
To Sinking Fund Investments A/c
To Sinking Fund A/c
Selling price
Cost Price
Profit
c. At Loss
Bank A/c Dr.
Sinking Fund A/c Dr.
To Sinking Fund Investments A/c
Selling price
Loss
Cost Price
4. Sinkin g fund balance transferred to General
Reserve
Sinking Fund A/c Dr.
To General Reserve A/c
Balance in
Sinking Fund A/c munotes.in

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Redemption of Debentures


67 Illustration 10:
CIT Ltd. issued 1,100 6% debentures of `100 each at par on 1stApril, 2016
redeemable at par. The Company decided to se t aside every year a sum of
`34,893 to be invested @ 5% outside the business. The investments were
sold at `71,580 at the end of the third year and the debentures were
redeemed. Give journal entries. Also prepare Sinking Fund Account and
Sinking Fund Inves tments Account. Ignore interest on debentures.
Solution:
Journal Entries in the books of CIT Ltd.

Date Particulars Debit ( `) Credit ( `)
1-4-2016 Bank A/c Dr.
To 6% Debentures A/c
(Being 1,100 6% debentures `100
each issued at par, redeemable at par) 1,10,000
1,10,000
31-3-2017 Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
(Being amount appropriated out of
profits and transferred to SF A/c) 34,893
34,893
31-3-2017 Sinking Fund Investment A/c Dr.
To Bank A/c
(Being amount invested out of SF
A/c) 34,893
34,893
31-3-2018 Bank A/c Dr.
To Sinking Fund A/c
(Being interest received on SF
investments @ 5% on `34,893) 1,745
1,745
31-3-2018 Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
(Being amount appropriated out of
profits and transfe rred to SF A/c) 34,893
34,893
31-3-2018 Sinking Fund Investment A/c Dr.
To Bank A/c
(Being amount invested out of SF
A/c + interest) 36,638
36,638
31-3-2019 Bank A/c Dr.
To Sinking Fund A/c
(Being interest received on SF
investments @ 5% on `71,531 ) 3,577
3,577
31-3-2019 Profit & Loss Appropriation A/c Dr.
To Sinking Fund A/c
(Being amount appropriated out of 34,893
34,893 munotes.in

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Accountancy and
Financial Management IV
68 profits and transferred to SF A/c)
31-3-2019 Bank A/c Dr.
To Sinking Fund Investment A/c
To Sinking Fund A/c
(Being SF investme nts sold at a
profit) 71,580
71,531
49
31-3-2019 6% Debentures A/c Dr.
To 6% Debentureholders A/c
(Being amount due to
debentureholders on redemption) 1,10,000

1,10,000
31-3-2019 6% Debentureholders A/c Dr.
To Bank A/c
(Being 1/4thdebentureholders pai d
off) 1,10,000
1,10,000
31-3-2019 Sinking Fund A/c Dr.
To General Reserve A/c
(Being transfer of balance in SF a/c
to general reserve a/c on redemption
of debentures) 1,10,050
1,10,050

In the books of CIT Ltd.
Sinking Fund A/c
Date Particulars ` Date Particulars `
31-3-
2017 To Balance c/d 34,893 31-3-2017 By P&L
Appr. a/c 34,893
Total 34,893 Total 34,893
31-3-
2018 To Balance c/d 71,531 01-4-2017
31-3-2018
31-3-2018 By Balance
b/d
By Bank A/c
By P&L
Appr. a/c 34,893
1,745
34,893
Total 71,531 Total 71,531
31-3-
2019 To General
Reserve A/c 1,10,050 01-4-2018
31-3-2019
31-3-2019
31-3-2019 By Balance
b/d
By Bank A/c
By P&L
Appr. a/c
By Bank A/c 71,531
3,577
34,893
49
Total 1,10,050 Total 1,10,050
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Redemption of Debentures


69 Sinking Fund Investment A/c
Date Particulars ` Date Particulars `
31-3-
2017 To Bank A/c 34,893 31-3-
2017 By Balance
c/d 34,893
Total 34,893 Total 34,893
01-4-
2017
31-3-
2018 To Balance b/d
To Bank A/c 34,893
36,638 31-3-
2018 By Balance
c/d
71,531
Total 71,531 Total 71,531
01-4-
2018
31-3-
2019 To Balance b/d
To Sinking
Fund A/c
(Profit) 71,531
49 31-3-
2019 By Bank A/c 71,580

Total 71,580 Total 71,580

Illustration 11:
On 31st March, 2019 the following balance stood in the books of Jani Ltd.
8% Second Mortgage Debenture Stock ` 4,00,000
Incom e received on Sinking Fund
Investments
` 14,500
Discount on issue of Debentures ` 25,000
Sinking Fund ` 3,65,500
Sinking Fund Investments:
` 80,000, 6% SD Loans ` 76,000
` 90,000, 7% ND Bonds ` 1,00,000
` 70,000, 8% PD Loans ` 70,000
`1,80,000 8½% CD Securities ` 1,85,000

On the same day the investments were sold: the 5% SD Loans at 90; the
6% ND Bonds at par; the 7% PD at 115 and the 7½% CD at 120. On
1stApril, 2019 the debentures of `3,00,000 were redeemed at a premium of
2½%. On th e very same day, the 8% MD Loans of `1,00,000 were
purchased at a premium of 3%.

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Accountancy and
Financial Management IV
70 Annual contribution for redemption was `50,000. Ignore interest.
Prepare the following accounts:
i. Debenture Stock;
ii. Sinking Fund;
iii. Sinking Fund Investments
iv. General Reserve
Solu tion:
In the books of Jani Ltd.
8% Debentures Stock A/c
Particulars ` Particulars `
To Bank a/c
To Balance c/d 3,00,000
1,00,000 By Balance b/d 4,00,000

Total 4,00,000 Total 4,00,000

Sinking Fund A/c
Particulars ` Particulars `
To discount on issue o f
debentures a/c( `25,000x3/4)
To Premium on redemption of
debentures
To General Reserve a/c
To Balance c/d 18,750

7,500
3,00,000
1,31,250 By Balance
b/d
By Income on
SFI
By P&L Appr.
By SFI a/c 3,65,500
14,500
50,000
27,500
Total 4,57,500 Total 4,57,500

Sinking Fund Investments A/c
Particulars ` Particulars `
To Balance b/d
To Sinking Fund a/c (profit on
sale of invests)
To Bank a/c 4,31,000
27,500
1,03,000 By Bank a/c
(Sale of
Invests)
By Balance c/d 4,58,500

1,03,000
Total 5,61,500 Total 5,61,500

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Redemption of Debentures


71
General Reserve A/c
Particulars ` Particulars `
To Balance c/d 3,00,000 By Sinking
Fund a/c 3,00,000
Total 3,00,000 Total 3,00,000

Working Note:
1. Calculation of selling price & profit or loss on sale of investments

Investments Selling Price
(A) ` Cost
Price
(B) ` Profit/(Loss) (A-B) `
6% SD Loans 72,000
`80,000 x 90/100 76,000 (4000)
7% ND
Bonds
90,000
`90,000 at par 1,00,000 (10,000)
8% PD Loans 80,500
`70,000 x 115/100 70,000 10,500
8½% CD
Securities
2,16,000
`1,80,000 x 120/100 1,85,000 31,00 0
Total 4,58,500 4,31,000 27,500

2. Since only `3,00,000 nominal value of debentures are redeemed, only
proportionate amount of discount on issue of debentures is written off
and amount equal to nominal value of debentures redeemed is
transferred from sink ing fund account to general reserve account.

3. Redemption by Conversion
Redemption by conversion means redeeming the debentures by converting
them into new class of shares or even issuing new class of debentures. The
new shares or debentures issued by w ay of conversion may be issued at
par or at a premium after complying the relevant provisions of the
Companies Act. The conversion may be made at a discount on the market
price of shares or at premium on the face value of shares. Debenture
Redemption Reser ve is not to be created for redemption of fully
convertible debentures.
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Accountancy and
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72 Sec. 71(1) of the Companies Act 2013 provides that a company may issue
debentures with an option to convert such debentures into shares either
wholly or partly at the time of redempti on.
Conversion of debentures must be approved by a special resolution passed
at a general meeting. A company may issue either fully convertible or
partly convertible debentures.
Illustration 12:
Alpha Limited issued 5,000 8% debentures of `100 each redeema ble on
31st December, 2018 at a premium of 5%.
The Company offered three options to debenture holders as under:
i. 7% preference shares of `10 at `12
ii. 9% debentures of `100 at par
iii. Redemption in cash (assume redemption out of capital only)
The options were acce pted as under
i. Option by holders of 1500 Debentures
ii. Option by holders of 1500 Debentures
iii. Option by holders of 2000 Debentures
The redemption was carried over by the Company. Show the Journal
entries.
Solution:
Options i ii ii
NV of debentures
redeemed
(Options accepted x
`100)+ Premium on
redemption 5% `1,50,000
(1,500 x 100)
`7,500 `1,50,000
(1,500 x 100)
`7,500 `2,00,000
(2,000 x 100)
`10,000
Total amount due on
redemption `1,57,500 `1,57,500 `2,10,000
Number of Preference
shares & debentures
issued on conversion
= Total amount due/
Issue price 13,125 shares

1,57,500/12 1,575
debentures
1,57,500/100 Redemption in
cash
7% Pref.sh
capital 13,125 x `10
Securities Premium
13,125 x `2 `1,31,250
`26,250
9% Debentures at par
1,575 x `100 `1,57,500 munotes.in

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Redemption of Debentures


73 Journal Entries in the books of Alpha Ltd.

Sr. No. Particulars Debit ( `) Credit ( `)
1. 8% Debentures A/c Dr.
Premium on redemption of
debentures a/c Dr.
To 8% Debentureholders A/c
(Being amount due to
debentureholders on redemption
against option i) 1,50, 000
7,500

1,57,500
2. 8% Debentureholders A/c
To 7% Preference Share Capital
A/c, To Securities Premium A/c
(Being 1,500 8% debentures
converted into 13,125 7%
preference shares of `10 each
issued at premium of `2 per
share) 1,57,500
1,31,250
26,250
3. 8% Debentures A/c Dr.
Premium on redemption of
debentures a/c Dr.
To 8% Debentureholders A/c
(Being amount due to
debentureholders on redemption
against option ii) 1,50,000
7,500

1,57,500
4. 8% Debentureholders A/c
To 9% Debentures A/c
(Being 1,500 8% debentures
converted into 1,5759%
debentures of `100 each issued at
par) 1,57,500
1,57,500

5. 8% Debentures A/c Dr.
Premium on redemption of
debentures a/c Dr.
To 8% Debentureholders A/c
(Being amount due to
debentureholders on redemption
against opt ion iii) 2,00,000
10,000

2,10,000
6. 8% Debentureholders A/c
To Bank A/c
(Being 2,000 8% debentures paid
in cash) 2,10,000
2,10,000

7. Securities Premium A/c Dr.
To Premium on redemption of
debentures a/c (Being premium
on redemption of debentures
written off) 25,000
25,000 munotes.in

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Accountancy and
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74 Note: Premium on redemption of debentures is written off on the
assumption that it was not written off in the earlier year.
Illustration 13:
Tony Limited gave notice of its intention to redeem its 7% debentures
amounting to `4,00,000 of `100 each at `102 and offered the debenture
holders the following three options, to apply the redemption money to
subscribe for:
a) 5% cumulative preference shares of `20 each at `22.50 per share.
b) 7% debentures at `96 and
c) to have their holdings rede emed for cash
i.Debenture holders for `1,71,000 accepted the proposal (a)
ii.Debenture holders for `1,44,000 accepted the proposal (b)
iii.Remaining debenture holders accepted the proposal (c) (assume
redemption out of profits only)
Pass the necessary journal entri es to record the above transactions in the
books of the Company. Ignore entry pertaining to minimum required
investments.
Solution:
Options i ii ii
NV of debentures
redeemed
+ Premium on
redemption 2% `1,71,000
`3,420 `1,44,000
`2,880 *`85,000
`1,700
Total amount due on
redemption `1,74,420 `1,46,880 `86,700
Number of
Preference shares &
debentures issued on
conversion
= Total amount due/
Issue price 7,752 shares

1,74,420/22.5 1,530
debentures
1,46,880/96 Redemption in
cash
5% Pref.sh
capital7,752 x `20
Securities Premium
7,752 x `2.50 `1,55,040
`19,380
7% Debentures at
`96
1,530 x `100 `1,53,000
`4,00,000 – `1,71,000 – `1,44,000 = * `85,000


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Redemption of Debentures


75 Journal Entries in the books of Tony Ltd.

Sr. No. Particulars Debit ( `) Credit ( `)
1. 7% Debenture s A/c Dr.
Premium on redemption of
debentures a/c Dr.
To 7% Debentureholders A/c
(Being amount due to
debentureholders on redemption
against option i) 1,71,000
3,420

1,74,420
2. 8% Debentureholders A/c
To 5% cumulative preference
Share Capital a/c
To S ecurities Premium A/c
(Being 7% debentures of NV
`1,71,000 converted into
7,7525% cumulative preference
shares of `20 each issued at
premium of `2.50 per share) 1,74,420
1,55,040
19,380
3. 7% Debentures A/c Dr.
Premium on redemption of
debentures a/c Dr.
To 7% Debentureholders A/c
(Being amount due to
debentureholders on redemption
against option ii) 1,44,000
2,880

1,46,880
4. 7% Debentureholders A/c
Discount on issue of debentures
A/c Dr.
To 6% Debentures (New) A/c
(Being 7% debentures of NV
`1,44,00 0 converted into 1,530
new 6% debentures of `100 each
issued at `96 per debenture) 1,46,880
6,120

1,53,000

5. 7% Debentures A/c Dr.
Premium on redemption of
debentures a/c Dr.
To 7% Debentureholders A/c
(Being amount due to
debentureholders on redempti on
against option iii) 85,000
1,700

86,700 munotes.in

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Accountancy and
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76
6. 7% Debentureholders A/c
To Bank A/c
(Being balance 7% debentures
paid in cash) 86,700
86,700

7. Securities Premium A/c Dr.
To Premium on redemption of
debentures a/c (Being prem on
redemption of deb w ritten off) 8,000
8,000
8. Profit & Loss Appropriation A/c
Dr.
To Debenture Redemption
Reserve A/c
(Being transfer of profits equal to
25% of the nominal value of
debentures redeemed in cash,
25% of 85,000) 21,250
21,250
9. Debenture Redemption Reserve
A/c Dr.
To General Reserve A/c
(Being transfer of balance in
DRR a/c to general reserve a/c on
redemption of debentures in
cash) 21,250
21,250

Note: Premium on redemption of debentures is written off on the
assumption that it was not written off in the earlier year.
Unit V
Summary:
1. Repayment of the amount due to the Debenture holders on an agreed
date is called redemption of debentures.

2. Debenture can be redeemed at par, premium or discount

3. The redemption of debentures depend upon the type of debentur es
issued by the company and the terms of redemption.

4. Discount/loss on issue of debentures is a capital loss for the company
and it should be written off as early as possible

5. There are different methods of redemption of debentures

6. Debentures can be rede emed out of capital, profits and by conversion
by complying the provisions of Companies Act, 2013
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Redemption of Debentures


77 Unit VI
Exercise:
1. Explain the accounting treatment for write off of discount/loss on
issue of debentures?

2. Explain the methods of write off of discount/loss on issue of
debentures?

3. Explain the different methods of redemption of debentures?

4. What are the provisions of the Companies Act, 2013 regarding
redemption of debentures by creating Debenture Redemption
Reserve?

5. Write Short Notes on:
i. Sources of Redempti on of debentures
ii. Methods of Redemption of debentures
iii. Redemption by Conversion
iv. Debenture Redemption Reserve
v. Sinking Fund Method
vi. Redemption out of Capital
vii. Write off of discount/loss on issue of debentures
viii. Redemption out of profits

6. State whether the follow ing statements are True or False
I. Conversion of debentures must be approved by a special
resolution passed at a general meeting.
II. A company can issue only fully convertible debentures.
III. In case of partly convertible debentures, D.R.R. shall be
created in re spect of Non -convertible portion of the debenture
issue.
IV. D.R.R. is not required in the case of fully convertible
debentures
V. D.R.R. can be created out of non -divisible profits
VI. Discount/loss on issue of debentures is a capital loss for the
company.
VII. When debe ntures are redeemed out of capital, the entry
regarding transfer of profits to Debenture Redemption
Reserve account is not passed.
VIII. As per the SEBI Guidelines, redemption of debentures
wholly out of capital is not possible.
IX. As per SEBI it is not mandatory to create DRR in case of
debentures maturing in 18 months or less
X. As per SEBI it is mandatory to create DRR for Infrastructure
Companies.
XI. As per Rule 18(7), All India Financial Institutes regulated by
the RBI is exempted from creating a DRR A/c
XII. As per Rul e 18(7), banking companies are compulsorily
required to create DRR A/c, when redeeming debentures. munotes.in

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Accountancy and
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78 XIII. As per Companies Act, 2013, every company requiring to
create DRR a/c, is required to deposit or invest atleast 10% of
the face value of debentures being red eemed.
XIV. On redemption of debentures, the balance in sinking fund
account is transferred to P&L A/c.
XV. In case of redemption by conversion debentures can be
converted into equity shares only.

7. Fill in the blanks choosing correct alternative
i. Company requiring t o create DRR a/c, are required to deposit or
invest atleast ______ of the face value of debentures being
redeemed. (10%/15%)

ii. On redemption of debentures, the balance in DRR account is
transferred to ________account (P & L /General Reserve)

iii. As per SEBI i t is not mandatory to create DRR in case of
debentures maturing in ______18 months. (18/15)

iv. Discount/loss on issue of debentures is a ________loss for the
company. (Capital/Revenue)

v. Conversion of debentures must be approved by a
________resolution passed at a general meeting.
(Special/Ordinary)

vi. D.R.R. can be created out of ______profits. (Divisible/Non -
divisible)

8. Match the Columns

Column A Column B
1. Creation of DRR a. Capital Loss
2. Discountissue of
debenres b. Creation of DRR not
mandatory
3. Balance in Sink ing fund
A/c c. Requires special resolution
4. Conversion of debentures d. Transferred to general
reserve A/c
5. Infrastructure Companies e. From divisible profits

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Redemption of Debentures


79 9. Z Ltd. issued `10,00,000 7% debentures at 15% discount. Debentures are
to be redeemed in the following manner:
Year End 2 3 4 5
FV of
Debentures ( `) 1,00,000 2,00,000 3,00,000 4,00,000

Give discount on issue of debentures account for five years
10. Amar Ltd. issued 15,000, 9% debentures of `100 each on 1st
November, 2011 redeemable at a premium of 8% as under:
On 31st March, 2017 5,000 debentures
On 31st March, 2018 5,000 debentures
On 31st March, 2019 5,000 debentures

The Board of directors decides to transfer to the required amount to
Debenture Redemption Reserve A/c in four equal annual instalments
starting with 31st March, 2014. Ignore payment of interest. Investments as
required by law are made by the Company in bank fixed deposits. Pass
necessary journal entries.

11. On 1st April, 2016, King Ltd. issued ` 20,00,000 7% debentures of
`100 each at par redeemable at a premium of 5%. The terms of issue was
that 60% of the debentures are to be redeemed at the end of 2nd year and
the balance at the end of 3rd year. The Board of directors decides to
transfer to the minimum required amount to Debenture Redemption
Reserve A/c at the end of first year. Ignore entries pertaining to payment
of interest and loss on issue of debentures.
Pass necessary journal entries.

12. Rani Ltd. has a balance of `20,00,000 in the Profit & Loss A/c. The
company d ecided to redeem fully out of profits `20,00,000 10%
debentures which were issued on 1st April, 2015. These debentures are
redeemable at a premium of 5% on 30th June, 2019. Interest is payable
annually on 31st December every year when the accounts are clos ed. The
company has a balance of `5,00,000 in DRR A/c. Journalise the
transaction during the year of redemption.
13. On 1st January, 2014 Sagar Ltd. issued 60,000 10% redeemable
debentures of `100 each at 5% discount, redeemable at 10% premium on
31st Dec ember 2018. The amount is to be invested in 10% PR Bonds.
Amount of annual appropriation is fixed at `8,00,000. Pass necessary
Journal Entries and show Sinking Fund Account and Sinking Fund
Investments Account for first 5 years.
14. Idea Ltd. issued on 1st April, 2015, 4,000 7% redeemable debentures
of `100 each at par redeemable at a premium of 10% at the end of the 4th
years. The company decided to set up a sinking fund for the redemption of
debentures setting aside necessary amount every year and invest ing it in munotes.in

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Accountancy and
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80 investments carrying interest @ 12% p.a. The sinking fund factor for 4
years @ 12% was `0.20964. On 31st March, 2019, the sinking fund
investments were sold for `3,15,000.
You are required to show the necessary ledger accounts in the books of
Idea Ltd.
(Hint: Annual Appropriation = 4,40,000 x 0.20964 = `92,242)
15.Tetron Ltd gave notice of its intention to redeem its outstanding
`12,00,000 – 7% debentures at `103 and offered the holders the following
options: -
a) 10% Preference shares of `20 each a t `25
b) 9% debentures at `96 and
c) To have their holdings redeemed for cash
i. The holders of `3,60,000 debentures accepted the proposal (a)
ii. The holders of `4,80,000 debentures accepted the proposal (b)
iii. The remaining debenture holders accepted the proposal (c) (a ssume
redemption out of capital only)
Pass journal entries in the books of Tetron Ltd.
16. Adarsh Limited issued 10,000 6% debentures of `100 each redeemable
on 31st December, 2018 at a premium of 5%.
The Company offered three options to debenture holders as
under:
a. 7% preference shares of `10 at `12
b. 8% debentures of `100 at par
c. Redemption in cash (assume redemption out of profits only)
The options were accepted as under
a. Option by holders of 3,000 Debentures
b. Option by holders of 3,000 Debentures
c. Option by holde rs of 4,000 Debentures
The redemption was carried over by the Company. Show the Journal
entries ignoring entry for minimum required investments.
17. B Ltd gave notice of its intention to redeem its outstanding `4,00,000
– 8% debentures at `105 (nominal value `100) and offered the holders
the following options: -
a. 11% Preference shares of `40 each at `50 munotes.in

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Redemption of Debentures


81 b. 9% debentures at `100 (at par) and
c. To have their holdings redeemed for cash (assume redemption
out of profits only)
i. The holders of `1,40,000 debentures accepted t he proposal
(a)
ii. The holders of `1,60,000 debentures accepted the proposal
(b)
iii. The remaining debenture holders accepted the proposal (c)
Pass journal entries in the books of B Ltd.
Answers:
6. True :i, iii, iv, v, vii, viii, ix, xi
False : ii, vi, x, xii, x iii, xiv, xv
7. i.15%, ii.General Reserve, iii. 18, iv. Capital, v. Special,
vi. Divisible.
8. 1- e, 2-a, 3- d, 4-c, 5-b





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82 Module IV
5
PROFIT PRIOR TO INCORPORATION
Unit Structure
5.0 Objectives
5.1 Introduction
5.2 Computation of Profit Before Incorporation
5.3 Solved Problems
5.0 OBJECTIVES
After studying the unit, the students will be able to:
 Understanding the concept of Profit prior to incorporation
 Understanding the accounting treatment of Profit prior to and Post
incorporation.
 Understanding the basis of allocation of various items of Income and
Expenses in Pre and Post incorporation periods
 Calculating the Profit /Loss for pre and post incorporation periods
separately.
5.1 INTRODUCTION
Prior means before and post means after. Profit prior to incorporation
refers to the profit before incorporation. For computing the profit before
incorporation, the profit and loss account is to be prepared in a columnar
form to arrive at profit earned before and after incorporation separately.
Alternatively, a statement in columnar form showing the results in the pre/
post incorporation period may be prepared.
4.1.1 Concept -
The pr ofit earned before incorporation cannot be treated as a business
profit and hence is not available for distribution as dividend to the
shareholders .It is a capital profit and should be transferred to Capital
Reserve. The profit earned after incorporation is available for
appropriations.

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Profit Prior to Incorporation
83 4.1.2 Utilisation of Profit prior to incorporation -
1. For writing off fixed assets acquired
2. For writing off goodwill, if any
3. For paying interest to vendors, if any on the value of purchase
consideration
4. For writing off pre liminary expenses.
5.2 COMPUTATION OF PROFIT BEFORE
INCORPORATION
Step -1 Calculate the Time ratio and Sales ratio -
 Time ratio refers to the number of months in the accounting period
before incorporation and after incorporation.
 Sales ratio refers to the s ales in the pre incorporation and post
incorporation periods.
 For example - The accounting period is from 1 -4-2010 to 31 -3-2011(12
months) and the date of incorporation is 1 -7-2010 .In this case the
accounting period can be divided into two distinct period s- 1-4-2010 to
1-7-2010 (3 months before incorporation) and 1 -7-2010 to 31 -3-2011(9
months after incorporation) Time ratio is 3 months : 9 months or 1:3.
 Sales during the pre incorporation period is Rs. 150000 and the total
sales during the entire accounti ng year is Rs. 900000 This means that
the sales in the post incorporation period is 750000(900000 -150000).
Thus the sales ratio is 150000:750000 or 1:5.
Step -2 Prepare profit and loss account in a columnar format and
allocate the expenses profit and income s on a suitable basis
 If the gross profit is given in the problem, allocate the gross profit in the
sales ratio calculated in step 1.
 If the gross profit is not given, then find out the gross profit by
preparing trading account as is normally done in final accounts.
 The gross profit can also be worked out by using the formula Gross
profit =Sales - Cost of Goods Sold.
Step 3 - Allocate all items appearing on the debit side of Profit and loss
account and credit side of Profit and Loss a/c on suitable basis.
Generally the expenses are allocated in the following manner -
 All fixed expenses, period costs, administration expenses, general
expenses in time ratio.
 All selling and distribution expenses, variable expenses in sales ratio
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Accountancy and
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84 Step 4 - There are some items of e xpenditure and income which are
not to be allocated.
 They pertain wholly to the pre incorporation period - for example -
Partners salaries, interest on partners’ capitals.
 Similarly expenses like preliminary expenses, directors fees , interest
on debentures are to be shown in post incorporation only.
 Incomes like share transfer fees will appear on the credit side in the
post incorporation column only.
 However, if specific information is given about a particular item of
expense, it must be considered while allocating the expense. For
example - bad debts are generally allocated on sales ratio but if there is
an additional information about bad debts that bad debts relate to sales
effected in the pre -incorporation period, then in such case bad debts
should not be allocated on sales ratio but it should be shown only in
the pre - incorporation column on the debit side of profit and loss
account.
Profit and Loss account
For the year ended 31st March 2018
Dr. Cr
Particulars Basis Pre Post Particulars Basis Pre Post
To Salary Time xx xx By Gross
Profit Sales xx xx
To Rent Time xx xx By Share
transfer
fees Post - xx
To Discount Sales xx xx
To Directors
fees Post --- xx
To Partners
salary Pre xx ---
To
Advertisement Sales xx xx
To Commission Sales xx xx
To Capital
reserve xx
To net profit xx
Total xx xx Total xx xx
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Profit Prior to Incorporation
85 Alternatively the details of profit before and after incorporation may be
presented in a statement format as unde r -
Statement of Profit and loss account for the year ended 31st March 2018
Particulars Basis Pre-
incorporation Post
incorporation Incomes Gross Profit Sales
ratio xxxxx xxxxx
Less Expenses
Salaries Time
ratio xxxxx xxxxx
Advertisement Sales
Ratio xxxx xxxx
Directors fees Post ------- xxxx
Debenture Interest Post ------- xxxx
Capital Reserve (Balancing
figure) xxxxxxx
Profit and Loss account
(Balancing figure ) xxxxx
Total xxxxx xxxxx

Step -5 Balance the Profit and l oss account and find out profit/loss.
 Profit in the pre - incorporation period - is to be transferred to Capital
Reserve account.
 Loss in the pre - incorporation period - debited to Goodwill account.
 Profit in the post - incorporation period - Transferred to P rofit and loss
appropriation account.
Check your progress
Calculate time ratio and sales ratio from the following information -
The company was incorporated on 1st June 2015 for the purpose of
purchasing an established business as from 1st April 2015. The books of
account for the year ended 31st March 2016 showed the total sales for the
year as Rs 3,21,040 and sales from 1st April to 1st June as Rs 80,260. The
gross profit for the year was Rs 41,280
Calculation of TIME RATIO
Accounting period –
Date of incorporation -
Pre incorporation period — munotes.in

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Accountancy and
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86 Post incorporation period –
TIME RATIO -
Calculation of SALES RATIO
Total sales during the year –
Sales in the pre incorporation period –
Sales in the post incorporation period –
SALES RATIO
(Answer - TR-1:5, SR -1:3)
5.3 SOLVED PROBLEMS
Illustration 1
Calculate Time ratio and Sales Ratio from the following information -
A limited company was registered on 1st January 2016 to take over a
business as on 1st October 2015. The books of accounts are closed on 30th
September 2016. The certificate of commencement of business was
obtained on 1st February 2016. The turnover (sales) for the year ending
30th Sept 2016 was Rs 3,00,000 of which Rs 50,000 related to the period
from 1st Oct 2015 to 1st January 2016. (Answer: TR 1:3 SR 1:5 )
The Trading account showed a total gross profit of Rs 1,20,000 . How will
the gross profit be allocated?
Illustration 2 -
Calculate Time Ratio and Sales Ratio fr om the following information.
A limited company was incorporated on 1st July 20 17 to take over a
business as on 1st January 2017 and the company follows calendar year.
The books of accounts were closed on 31st December 2017 and the
monthly sales effected from 1st Jan to 31st December 2017 were as
follows -
January, February, March an d April - Rs 50,000 each month May, June
Rs 75,000 each month and Sales from July to December was uniform at
Rs 1,00,000 each month
Solution:
Time Ratio:
Accounting period – 1 January to 31st December 2017
Date of Incorporation 1st July 2017
Pre inco rporation period – 1st January to 30th June 2017 – 6 months
Post Incorporation - 1st July to 31st December 2017 – 6 months
Time Ratio 1:1
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Profit Prior to Incorporation
87 Sales Ratio
Sales in pre incorporation period January to June -
50,000+50,000+50,000+50,000+75,000+75,000 = 3,50, 000
Sales in the post incorporation period July to December -
1,00,000+1,00,000+1,00,000+1,00,000+1,00,000+1,00,000= 6,00,000
Sales Ratio – 3,50,000 : 6,00,000 or 7:12
Illustration 3
Big Co. Ltd took over the business of Small &Sons, a firm w.e.f. 1 -4-
2007. The company was registered on 1 -11-2007. Profit and loss account
for the year ended 31 -3-2008 was as under -
Particulars Amt(Rs.) Particulars Amt(Rs.)
To Salaries 2,40,000 By Gross profit b/d 12,60,000
To Rent and rates 1,80,000
To Printing and
statio nery 96,000
To Audit fees 30,000
To Sundry expenses 24,000
To Carriage outward 90,000
To Advertising 63,000
To Electricity charges 72,000
To Commission on
sales 1,08,000
To Debenture interest 28,000
To Depreciation 42,000
To Inte rest on purchase
consideration 27,000
To Net profit c/f 2,60,000
12,60,000 12,60,000

Additional information:
1. Sales for each of the months July, August, September, January,
February and March were twice the sales for each of the months April,
May, June, October, November and December. munotes.in

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Accountancy and
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88 2. Depreciation shown above includes depreciation on furniture worth
Rs. 2,40,000 @ 10% and on delivery van worth Rs.90,000 @ 20%.
Both these assets were taken over from Small and sons.
3. Big Co. Ltd. settled Purchase cons ideration on 1st January,2008
4. Audit fees are payable for the whole year.
Prepare Profit and Loss account for the year ended 31st March, 2008
showing profits for pre - incorporation and post incorporation periods
separately.
(University of Mumbai - October 20 09)
Solution: --
WN - Time ratio -
Pre- incorporation period - 1-4-2007 to 1 -11-2007( 7 months)
Post- incorporation period - 1-11-2007 to 31 -3-2008( 5 months)
Time ratio - 7:5
Sales ratio -
Let monthly sales be -1
Pre-incorporation period - 1+1+1+2+2+2+1=10
Post- incorporation period -1+1+2+2+2=8
Sales Ratio - 10:8 or 5:4
Interest on purchase consideration -
(payable for 9 months from April to December)
Pre-incorporation - 1-4-2007 to 1 -11-2007 (7 months)
Post- incorporation - 1-11-2007 to 31 -12-2007(2 months)
Specif ic ratio - 7:2
Depreciation on assets - Furniture - 240000x10%= 24,000
Delivery van - 90,000x 20%= 18,000

Total Depreciation (24,000+ 18,000) = 42,000 in Time Ratio 7:5

Profit and Loss account for the year ended 31st March, 20 08








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Profit Prior to Incorporation
89 Dr. Cr
Particulars Basis Pre Post Particulars Basis Pre Post
To Salaries Time 1,40,000 1,00,000 By Gross
profit Sales 7,00,000 5,60,000
To Rent and
taxes Time 1,05,000 75,000
To Printing
&Stationery Time 56,000 40,000
To Audit fees Time 17,500 12,500
To Sundry
expenses Time 14,000 10,000
To Carriage
outward Sales 50,000 40,000
To
Advertising Sales 35,000 28,000
To Electricity
charges Time 42,000 30,000
To
Commission
on sales Sales 60,000 48,000

To Debenture
interest Post ---------- 28,000
To
Depreciation Time 24,500 17,500
To Interest on
purchase
consideration 7:2 21,000 6,000
To Capital
Reserve ( bal
fig) 1,35,000 -----------
To Net Profit
( bal fig) ----------- 1,25,000
Total 7,00,000 5,60,000 Total 7,00,000 5,60,000

Note: Alternatively the depreciation on Delivery van may be allocated in
sales ratio also. The working note on depreciation will be as follows –
Depreciation on Furniture in Time ratio ( Rs 24,000 in Time ratio) and
Depreciation on delivery van in sales ratio ( Rs 18,000 in sales ratio).
In such case the answer will change and profit before incorporation would
be Rs 1,35,500 which will be transferred to capital reserve and the profit
after incorporation would be Rs 1,24,500


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Accountancy and
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90 Illustration 4
M/s Abani Offshore Ltd took over a running business with effect from 1st
April, 2018. The company was incorporated on 1st September, 2018. The
summarized Profit and Loss Account for the year ended 31st March,2019
is as under:
Particulars Rs. Particulars Rs.
To Printing and
Stationery
To Salaries
To Directors fees
To Selling expenses
To Debenture
Interest
To Auditors Fees
To Rent and taxes
To Office Expenses
To Bad Deb ts
To Preliminary
Expenses
To Net Profit

2,40,000

39,00,000
5,00,000
24,30,000

5,80,000

1,00,000
9,60,000

6,00,000

12,00,000

10,00,000
66,90,000
1,82,00,000
========== By Gross Profit
By Interest on
Fixed Deposit





1,70,00,000
12,00,000














1,82,00,000
==========
Additional Information:
1. It is ascertained that monthly sales from October 2018 to March 2019
was twice the average of the monthly turnover from April 2018 to
September 2018.
2. Out of bad debts Rs. 2,00,000 relate to debts crea ted prior to
incorporation. Remaining bad debts are out of sales affected
throughout the year.
3. Rent is doubled from 1st December, 2018.
4. Salaries include salary of three employees at equal monthly
remuneration. However one of them was appointed as manager f rom
1st January, 2019. His salary was doubled from that date.
5. Vendors were entitled to 40% of the profit earned in Pre -incorporation
period.
6. Interest on Fixed Deposit was received for the entire year.
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Profit Prior to Incorporation
91 Prepare the Statement of Profit and Loss in columnar f orm, showing
distinctly the allocation of profits between pre incorporation and post
incorporation periods, indicating the basis of allocation.
Solution:
Working Notes –
Time Ratio 5:7
Sales Ratio 5: 13
Basis for Allocating Rent 5:11
Salaries 15:24 or 5:8
Bad Debts Rs. 12,00,000
Rs 2,00,000 in pre incorporation (given)
Balance bad debts Rs 10,00,000 to be divided in Sales Ratio:
Pre incorporation: 2, 77,778
Post Incorporation: 7, 22,222
Total Pre Incorporation Bad Debts Amount:
2,00,0 00 + 2,77,778 = 477778
Post Incorporation Bad Debts=722222
Statement of Profit And Loss
For The Year Ended 31ST March 2019
Pre-
Incorporation Post-
Incorporation
INCOMES
Gross profit (SR) 47,22,222 122,77,778
Interest on FD (TR) + 5,00,000 + 7,00,000
Total Income (A) 52,22,222 129,77,778
EXPENSES
Printing and Stationery (TR) 1,00,000 1,40,000
Salaries (5:8) 15,00,000 24,00,000
Directors Fees
(Post) ------------- 5,00,000
Selling Expenses (SR) 6,75,000 17,55,000
Debenture Int erest (Post) -------------- 5,80,000
Auditors fees (TR) 41,667 58,333
Rent and Taxes (5:11) 3,00,000 6,60,000
Office Expenses (TR) 2,50,000 3,50,000 munotes.in

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Accountancy and
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92 Bad Debts (WN) 4,77,778 7,22,222
Preliminary expenses (Post) ------------ 10,00,000
Total expe nses (B) 33,44,445 81,65,555
Capital Reserve (A -B) (bal.fig) 18,77,777
Net Profit (A -B) (bal.fig) 48,12,223

Illustration 5:
Avenue Ltd was incorporated on 1st August, 2017 to acquire the business
of Shah and Bros from 1st April, 2017. The co mpany received the
certificate of commencement of business on 1st October, 2017.
The agreement also provided that vendors are entitled to 60% of Profits
(or Loss, if any) for the period upto 1st August, 2017.
The following Profit & Loss Account for the ye ar ended 31st March, 2018
is presented as under:
Particulars Rs. Particulars Rs.
To Office Salaries
To Bad Debts
To Depreciation
To Office rent
To Commission on
Sales
To Debenture
Interest
To Directors Fees
To Interest on
Purchase
Considerati on
To Net Profit 36,00,000
5,00,000
18,00,000
9,00,000
15,00,000

8,00,000

8,00,000

6,00,000

35,00,000
1,40,00,000 By Gross Profit
By Profit on
sale of
Investment
1,20,00,000
20,00,000











1,40,00,000

You obtained the following additional information :
(a) Monthly Sales for October, 2017 to March, 2018 is 150% of
monthly sales for April, 2017 to September, 2017.
(b) Office rent was increased from Rs. 50,000 per month to Rs.
1,00,000 per month effective from 1st October, 2017. munotes.in

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Profit Prior to Incorporation
93 (c) Investment was sold on 1st November, 2017.
(d) Bad debts were in respect of sales affected two years ago.
(e) Consideration to Vendors was paid on 1st October, 2017.
Prepare the Statement of Profit and Loss in columnar form, showing
distinctly the allocation of prof its between pre incorporation and post
incorporation periods, indicating the basis of allocation.
Working notes -
Time Ratio 1:2
Sales Ratio 4:11
Interest on Purchase Consideration 4: 2 or 2:1
Interest is paid for 6 months from April to September.
(April, May, June, July) 4 months pre incorporation period
While (August and September) 2 months post incorporation period.
Office rent Pre Post
50,000x4 months 2,00,000
50,000x2 months 1,00,000
1,00,000x6 months 6,00,000
Total office rent 2,00,000 7,00,000

Statement of Profit and Loss
For the year ended 31st March 2018
Pre-
Incorporation Post-
Incorporation
Incomes
Gross Profit (SR) 32,00,000 88,00,000
Profit on Investment (Post) -------------- +20,00,000
Total Income (A) 32,00,000 1,08,00,000
Expenses
Office Salaries(TR) 12,00,000 24,00,000
Bad Debts(Pre) 5,00,000 ----------
Depreciation (TR) 6,00,000 12,00,000
Office Rent(WN) 2,00,000 7,00,000
Commission on Sales (SR) 4,00,000 11,00,000
Debenture Interest(Post) ------------ 8,00,000 munotes.in

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Accountancy and
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94 Directors Fees( Post) ------------- 8,00,000
Interest on Purchase consideration
(2:1) 4,00,000 2,00,000
Total Expenses (B) 33,00,000 72,00,000
Loss(A -B)
Less Vendors share 60%
Loss transferred to Goodwill 1,00,000
(60,000)
40,000
Net Profit (A -B)
36,00,000

Illustration 6
Kalpana Limited was registered on 1st February 2013 to acquire the
business of M/s. XYZ as on 1st October 2012. The accounts of the
company for the period ended 30th September 2013 disclosed the
followin g facts:
1) The turnover for the whole period 1st October 2012 to 30th
September 2013 was Rs. 2,40,000 of which 40,000 related to the
period from 1st October 2012 to 1st February 2013
2) The trading account showed a gross profit of Rs. 96,000
3) The following items appeared in the Profit and Loss Account:
a. Directors Fees – Rs. 1,500
b. Auditors fees – Rs. 750
c. Rent, rates and Taxes – Rs. 4,800
d. Bad debts (of which Rs. 700 related to book debts created before 1st
February 2013) – Rs. 2000
e. Salaries – Rs. 12,000
f. Interest on Debentures – Rs. 6,000
g. Depreciation – Rs. 3,600
h. Preliminary expenses – Rs. 2,400
i. General Expenses – Rs. 1,800
j. Commission on sales – Rs. 3,600
k. Printing and Stationery – Rs. 2,400
l. Advertising – Rs. 4,200
m. Traveller’s salaries – Rs. 8,400
n. Interest to Vendor at 10% p.a. on Rs. 1,00,000 from 1st October
2012 to 31st May 2013 – Rs. 6,667

Prepare a statement showing profits earned by the company prior to
incorporation and after incorporation clearly indicating the basis of
allocation of expenses. Assume Audit fees is for the entire year.


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Profit Prior to Incorporation
95 Solution -
WN 1
Time ratio – 1:2
Sales Ratio 1: 5
Total Turnover for the accounting periods = Rs 2,40,000
Sales in the pre incorporation period (OCT - FEB) = Rs. 40,000
Therefore Sales in post incorporation period = Rs. 2, 00,000
Therefore SR 1: 5
WN2
Interest to Vendor
10% on 1,00,000 for 8 months – Rs 6666.66
Rounded off to Rs 6667
Out of which from 1st October 2012 to 1st February 2013 –
4 months will be pre incorporation.
From 1st Feb 2013 to 31st May 2013 -
4 months will be post incorporation.
Thus the amount will be allocated in the ratio 4: 4 or equally among the
pre and post incorporation periods.
Statement showing Profit and loss
For the year ended 30th September 2013.
Particulars Basis Pre-
Incorporation Post-
Incorporation
Debit Credit Debit Credit
Gross Profit –SR Turnover 16,000 80,000
Expenses
Directors fees Post 1,500
Auditors fees –TR 1:2 250 500
Rent , Rates 1:2 1600 3200
Bad Debts Given 700 1300
Salaries 1:2 4000 8000
Debenture Interest Post 6000
Depreciation 1:2 1200 2400
Preliminary expenses Post 2400
General expenses 1:2 600 1200 munotes.in

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Accountancy and
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96 Commission on sales 1:5 600 3000
Printing and Stationery 1:2 800 1600
Advertis ing 1:5 700 3500
Travellers Salary 1:5 1400 7000
Interest to vendor 4:4 3333 3334
Total of expenses 15183 44934
Capital Reserve (Bal.
fig) 817
Net Profit (Bal Fig) 35066
Total 16,000 16,000 80000 80,000

Illustration 7
Sunder am Brothers was taken over by Sunderam Ltd on 1st May 2017.
However the company was incorporated on 1st February 2018. The
following was the Profit and Loss a/c for the period from 1st May 2017 to
31st March 2018.
To Salaries 72,000 By Gross Profit 7,00,000
To Rent( Net) 39,000 By Discount 7,000
To Delivery van
expenses 14,000
To General Expenses 22,000
To Advertisement
expenses 3,50,000
To Bad debts written
off 14,000
To Debenture Interest 70,000
To Directors meeting
fees 10,000
To Preliminary
expenses 4,000
To Net profit c/d 1,12,000
Total 7,07,000 Total 7,07,000


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Profit Prior to Incorporation
97 You are informed that –
a) Salaries in pre - incorporation and post - incorporation period were Rs
6,000 p.m and Rs 9,000 p.m respectively.

b) Gross profit percentage is fixed. Average monthly turnover is nine
times in May, October and November 2017 as compared to average
monthly turnover of remaining months .

c) Audit fees Rs 4,400 is to be provided for the a bove period.

d) Rent on the debit side is after subtracting rent received at Rs 4,000
p.m from 1st December 2017.

You are requested to prepare Statement of Profit and Loss in columnar
form apportioning various incomes and expenses on suitable basis in the
pre and post incorporation period from 1st May 2017 to 31st March 2018.
(Mumbai University April 2010)
Solution:
Working notes1:
Pre incorporation period 1st May 2017 to 1 Feb 2018 = 9 months
post incorporation 1st Feb. 2018 to 31st Mar. 2018 = 2 months
Time ratio (TR ) 9:2 and
Sales ratio (SR) 33:2
WN-2 Salaries
Pre incorporation Rs 6,000x 9 months = 54,000
Post incorporation Rs 9,000x 2 months = 18,000
WN- 3 Rent received
Pre incorporation 4000 x 2 months = 8,000
Post incorporation 4,000 x 2 months= 8,000
WN-4 Rent paid
Pre incorporation 5,000x 9 months =45,000 post incorporation 5,000x 2
months =10,000
WN-4 Audit fees to be allocated in the Time ratio 9:2

In the books of Sunderam Ltd –
Profit and Loss a/c
For the period 1st May 2017 to 31st March 2018 Dr. Cr.
Particulars Pre Post Particulars Pre Post
To Salaries –
WN1 54,000 18,000 By Gross
Profit -SR 6,60,000 40,000
To Rent –WN 3 45,000 10,000 By Rent
received 8,000 8,000
To Delivery van
expenses –SR 13,200 800 By Discount –
SR 6,600 400
To General 18,000 4,000 By Net Loss 90,000 munotes.in

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Accountancy and
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98 Expenses –TR (Bal. Fig)
To Advertisement
expenses - SR 3,30,000 20,000
To Bad debts
written off – SR 13,200 800
To Debenture
Interest - Post 70,000
To Directors
meeting fees -
Post 10,000
To Preliminary
expenses –Post 4,000
To Audit - TR 3,600 800
To Capit al
Reserve
(Bal Fig) 1,97,600
6,74,600 1,38,400 6,74,600 1,38,400

Illustration 8
Abhishekh Ltd was incorporated on 1st August 2017 to take over a running
partnership business with effect from 1st April 2017. Following are the
details of Income and Expenses for the year ended 31st March 2018

Particulars Amt Rs Amt Rs
Gross Profit 19,20,000
Less Expenses
Directors Fees 98,000
Rent 1,71,000
Bad debts 24,000
Salaries 3,66,000
Interest on Debentures 45,000
Depreciation 1,32,000
Preliminary expenses written off 87,000
General Expenses 98,400
Commission on Sales 72,000
Printing and Stationery 1,86,000
Advertisement Expenses 2,41,000 munotes.in

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Profit Prior to Incorporation
99 Audit Fees 1,17,200
Carriage Outward 1,45,600
Electricity charges 88,800
Insurance Premium 48,000
Net Profit NIL
19,20,000 19,20,000

Additional information -
a) Rent is paid on the basis of floor space occupied .Floor space
occupied was doubled in the post incorporation period

b) Sales for each month of December 201 7 to March 2018 were double
the monthly sales of April 2017 to November 2017.

c) Audit fees is for entire year

d) Bad debts Rs 4,000 is in respect of sales effected two years ago.

e) Mr Anil was a working partner in the firm entitled to a remuneration
of Rs 24, 000 per month From 1st August 2017, he was made the
Managing Director of the company and was entitled to salary Rs
30,000 per month. The remaining salary is to two clerks employed
during the period from 1st July 2017 to 31November 2017.

Prepare a stateme nt showing profits in the pre and post incorporation
period separately.
Solution:
WN 1 -
Time ratio - TR 4: 8 or 1: 2
Sales Ratio - SR 4:12 or 1: 3
WN-2
Bad debts total 24,000 to be allocated as under
Pre Post
Given 4,000
Balance Rs. 20,000 in SR 5,000 15,000
TOTAL 9,000 15,000
WN-3
Rent to be allocated on the basis of floor space which was doubled in post
incorporation rat io is 1:4

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100 WN-4
Salary to Anil as partner
24,000 x 4 months= 96,000 in pre incorporation
Salary to Anil as Managing director –
30,000 x 8 months = 2,40,000 in post incorporation
Balance salary
3,66,000 – (96000+240000) = 30,000 to be paid to clerks from 1st July
2017 to 30th November in 1: 4 ratio
Statement Showing Pre and Post Incorporation Profit/ Loss
For The Year Ended 31st March 2018
Particulars Basis Pre Post
Gross Profit SR(1:3) 4,80,000 14,40,000
Less Expenses
Directors fees POST 98,000
Rent WN 2 ( 1:4 ) 34,200 1,36,800
Bad debts WN 1 9,000 15,000
Salary --- Anil WN 3 96,000 2,40,000
Clerks WN 3 ( 1:4 ) 6,000 24,000
Interest on Debentures POST 45,000
Depreciation TR (1:2) 44,000 88,000
Prelimin ary expenses
written off POST 87,000
General expenses TR(1:2) 32,800 65,600
Commission on sales SR 18,000 54,000
Printing and stationery TR 62,000 1,24,000
Advertising expenses SR 60,250 1,80,750
Auditors fees TR 39,066 78,134
Carriage outward SR 36,400 1,09,200
Electricity charges TR 29,600 59,200
Insurance premium TR 16,000 32,000
Total expenses 4,83,316 14,36,684
Loss transferred to
Goodwill (Bal. Fig) 3,316
Net Profit ( Bal. Fig) 3,316

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Profit Prior to Incorporation
101 5.4 EXERCISE
Practical Problems
1. A limited company was incorporated on 1st July 2018 to take over
business as a going concern as from 1stApril 2018. The profit and loss a/c
was drawn as on 31st December 2018. Calculate Time ratio.
(Answer: Time Ratio -3: 6 or 1:2)
2. A limited company was incorpo rated on 1st April 2018 to take over
business with effect from 1st January 2018.The company prepared its
Profit and Loss account for the year ended 31st March 2019.The company
was able to double the average monthly sales from 1st April 2018.
Calculate Time Ratio and Sales Ratio.
(Answer: Time Ratio 3: 12 or 1: 4 Sales Ratio 3: 24 or 1: 8)
3. A limited company took over the business of a partnership firm with
effect from 1st January 2018. The company was registered on 1st August,
2018. Details of Income and e xpenses for the year ended 31st December
2018 is as under –
Particulars Amt ( Rs) Amt ( Rs)
Gross Profit
Less Expenses
Salaries
Rates and Insurance
Printing and Stationery
Audit Fees
Directors Fees
Carriage Outward
Advertising
Electricity charge s
Commission on sales
Debenture Interest
Depreciation
Interest on Purchase consideration

7,20,000
5,40,000
2,88,000
90,000
72,000
2,70,000
1,89,000
2,16,000
3,24,000
84,000
1,26,000
81,000 37,80,000












30,00,000
NET PROFIT 7,80,000

Addit ional Information -
1) Sales for each of the months April, May, June, October, November and
December were twice the sales for each of the months January,
February, March, July, August and September.
2) The purchase consideration was settled on 1st November 2018.
3) Audit fees are payable for the entire year .Calculate the profits for Pre
and post incorporation periods separately.
(Answer – Time Ratio 7: 5 Sales Ratio 5:4) munotes.in

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102 (Hints - Rs 81,000 Interest on Purchase consideration to be allocated in 7:
3 Ratio . Amount in pre incorporation Rs 56,700 and in post incorporation
Rs 24,300 Final answer Profit prior to incorporation transferred to Capital
Reserve Rs 453300 and Profit post incorporation Rs 326700)
4. RJ Ltd was incorporated on 1st August 2017 to acquire b usiness as on
1st April 2017. The first accounts were closed on 31st March 20118.
The following items appeared in the Profit and Loss Account .
Profit and Loss A/c for the year ended 31st March 2018
Dr Cr
Particulars Amt
(Rs) Particulars
Amt(Rs)
To Directors Fees 49,000 By Gross Profit 9,60,000
To Rent 85,500
To Bad Debts 12,000
To Salaries 1,83,000
To Interest on
Debentures 24,000
To Depreciation 66,000
To Preliminary
expenses 42,000
To General Expenses 49,200
To Commission on
Sales 36,000
To Printing and
Stationery 93,000
To Advertising 1,20,000
To Audit Fees 58,600
To Carriage Outward 72,800
To Electricity charges 44,400
To Insurance Premium 24,000
Total 9,60,000 Total 9,60,000

Additional Information -
1) Rent is paid on the basis of floor space occupied. The floor space was
doubled in the post incorporation period.
2) Sales for each month of December 2017 to March 2018 were double
the monthly sales of April to November 2017.

3) Bad Debts Rs 2,000 were in respect of sales effected two years ago.
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Profit Prior to Incorporation
103 4) Mr Amit was working partner in the firm entitled to a remuneration @
Rs 12,000 p.m from 1st August 2017. He was Managing Director of a
company entitled to salary @Rs 15,000 p.m . The remaining salary is
to two clerks employed during the period 1st July to 30th November
2017.You are required to prepare Statement of Profit and Loss for the
year ended 31st March 2018 and show the Pre and post incorporation
profit or Loss .

(Answer: Time Ratio 1:2 Sales Ratio 1: 3 Pre incorporation loss Rs 1658
Post Incorporation Profit Rs 1658)
(Hints -
 Bad debts Rs 12,000 Rs 2000 old bad debts to be shown in pre
incorporation and balance (12000 -2000=10,000) to be allocated in the
sales ratio 1: 3 Allocation of Bad debts in -Pre incorporation period (
2000+ 2500) 4500 and Post incorporation 7500.

 Rent to be allocated in 4: 16 ratio

 Salaries a) Amit pre incorporation 12000x4 months =48,000 post
incorporation From August2017 t o March 2018 8 months @ 15,000
per month 15000x8= 1,20,000 Total Salary as per P&L a/c Rs
1,83,000 Total salary to Amit ( 48000+ 120000) 1,68,000 Therefore
balance amount to clerks for 5 months July to November is 183000 -
168000=15000

b) For clerks pre i ncorporation 1 month Rs 3000 and post incorporation
for 4 months August to November 2017 3000x4 =12,000)

Objective Questions
5. Match the Columns -

GROUP A GROUP B
1) Sales related expenses
2) Time related expenses
3) Share transfer fees
4) Debenture In terest
5) Partners Salaries
6) Pre- incorporation profit
7) Post incorporation profit a) Transferred to Profit and loss Appropriation account
b) Transferred to Capital Reserve
c) Shown in debit side pre incorporation
column only
d) Shown in debit side post incorp oration
column only
e) Shown in credit side pre incorporation
column only
f) Shown in credit side post
incorporation column only
g) Allocated in time ratio
h) Allocated in Sales ratio
(Answers 1 -h 2-g 3 -f 4-d 5 -c 6 -b 7 -a)


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Accountancy and
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104 GROUP A GROUP B
1) Gross Profit
2) Audit Fees
3) Profit prior to
incorporation
4) Profit post incorporation
5) Loss prior to
incorporation
6) Dividing point for pre and
post incorporation
7) Preliminary expenses a) is revenue profit
b) Transferred to Goodwill account
c) Date of incorporation
d) is no t available for dividend
e) Allocated in Sales Ratio
f) Allocated in Time ratio
g) Shown in pre incorporation only
h) Transferred to General Reserve
i) Shown in post incorporation
(Answers - 1— e 2 — f 3 — d 4 — a 5 — b 6 — c 7 — i)

6. State wheth er the following statements are True or False

1) The fixed expenses are normally to be allocated in Time ratio - True

2) The variable expenses are normally to be alloca ted in sales ratio -
True

3) Gross profit is to be allocated in Sales ratio - True

4) Directors fees are to be allocated equally in the Pre and Post
incorporation periods –False

5) The Profit before incorporation is to be transferred to General
Reserve – False

6) The Profit after corporation is a revenue Profit - True

7) While computing pre and post incorporation profits, Audit fees are
allocated on Time basis – True

8) Profit prior to incorporation is available for payment of dividend –
False

9) Loss prior to incorpo ration is debited to Goodwill account - True

10) Preliminary expenses should be debited to pre -incorporation period -
False

7. Multiple Choice Questions
1) While calculating profit prior to incorporation, the fixed expenses are
to be allocated _____
a) in Sales ratio b) in Time ratio
c) equally d) none of the above
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Profit Prior to Incorporation
105 2) While calculating profit prior to incorporation, the variable expenses
are to be allocated _____
a) in Sales ratio b) in Time ratio
c) equally d) none of the above

3) While calculating profit prior to incorporation, the Directors fees are to
be ______
a) allocated in sales ratio b) shown as pre incorporation expense
c) shown as post incorporation expenses d) ignored

4) While calculating profit prior to incorporatio n, the partners salaries
are to be _______
a) allocated in sales ratio b) shown as pre incorporation expense
c) shown as post incorporation expenses d) ignored

5) The profit prior to incorporation is transferred to _________
a) Capital Reserve b) Ge neral Reserve
c) Securities Premium d) Goodwill

6) The share transfer fees are _______
a) to be shown on the credit side of P&L A/c in the pre -
incorporation column
b) to be allocated equally
c) to be shown on the debit side of P&L A/c in the pre -
incorporation column
d) to be shown on the credit side of P&L A/c in the post -
incorporation column
(Answer: 1 - b, 2 - a, 3- c, 4- b, 5- a, 6- d.)
8. Short Numerical Objective Questions –
1) Kalpana Limited was registered on 1st February 2013 to acq uire the
business of M/s. XYZ as on 1st October 2012. The accounts of the
company for the period ended 30th September 2013 disclosed the
following facts:
a) The turnover for the whole period 1st October 2012 to 30th
September 2013 was Rs. 2,40,000 of which 40 ,000 related to the period
from 1st October 2012 to 1st February 2013
b) The Trading account showed a Gross profit of Rs. 96,000
Calculate Time Ratio and Sales Ratio. State how the Gross profit will be
allocated between the pre and post incorporation periods.
(Answer - Time ratio 4:8 or 1:2 Sales Ratio 1: 5 Gross profit Rs 96,000 to
be allocated in Sales Ratio Pre incorporation amount Rs 16,000 post
incorporation Rs 80,000)
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106 2) Friendship Ltd was incorporated on 1st April 2017 to take over
business of the partne rship firm with effect from 1st January 2017. The
company prepared its Profit and Loss a/c for the year ended 31st March
2018 . The company was able to double the average monthly sales from 1st
April 2017. Calculate Time ratio and Sales ratio
(Answer Time Ratio 3:12 or 1:4 Sales Ratio 3:24 or 1:8)
3) Indo-Japan Ltd was incorporated on 1st May 2018 to take over a
business as a going concern from 1st January of the same year. The total
turnover for the year ended 31st December was Rs 2,00,000 namely Rs
60,000 for the first period upto 1st May and Rs 1,40,000for the remaining
period. Calculate Time Ratio and Sales Ratio
(Answer Time ratio 4: 8 or 1:2 and Sales ratio 6:14 or 3: 7)

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