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Semester 2: CORE – III: FINANCIAL ACCOUNTING II
Hire Purchase and Instalment System: Hire Purchase System Accounting Treatment, Calculation of Interest, Default and Repossession, Hire Purchase Trading Account, Instalment System, Calculation of Profit
Hire Purchase and Instalment System
Overview of Hire Purchase System
The hire purchase system is a financial arrangement where a buyer acquires an asset by making an initial down payment followed by periodic payments. Ownership of the asset is transferred to the buyer after the final payment is made. It is commonly used for high-value items such as vehicles and machinery.
Accounting Treatment for Hire Purchase
In accounting for hire purchase, the asset is recorded at its full cost in the buyer's books. The liability to pay is recorded as a hire purchase liability. Each installment consists of principal and interest, and interest expense is recognized over the term of the agreement.
Calculation of Interest in Hire Purchase
Interest in a hire purchase agreement is typically calculated on the reducing balance of the outstanding principal. This means as the principal is paid down, the interest charged on the remaining balance decreases. The total interest can be calculated using the formula: Total Interest = (Total Payments) - (Principal Amount) for the entire tenure.
Default and Repossession
In case of default, the seller retains the right to repossess the asset. The terms of default and repossession are generally specified in the hire purchase agreement, which often allows the seller to reclaim the asset after a certain number of missed payments.
Hire Purchase Trading Account
A hire purchase trading account reflects the income and expenses related to hire purchase transactions. It includes sales, cost of goods sold, total interest charged, and any associated expenses. The profit can be determined by deducting total expenses from total income.
Instalment System Overview
The instalment system allows buyers to purchase goods and pay for them in installments over a specified period. Unlike hire purchase, ownership of the asset typically transfers immediately, which is a significant distinction in its accounting treatment.
Calculation of Profit in Instalment System
Profit in an instalment system can be calculated by comparing the total selling price with the cost of the goods sold. The profit margin is determined by subtracting the total cost from the total revenue generated from the sales.
Branch and Departmental Accounts: Branch – Dependent Branches: Accounting Aspects, Debtors system, Stock and Debtors system, Distinction between Wholesale Profit and Retail Profit, Independent Branches (Foreign Branches excluded), Departmental Accounts: Basis of Allocation of Expenses, Inter- Departmental Transfer at Cost or Selling Price
Branch and Departmental Accounts
Dependent branches are branches that do not maintain their own accounting records. Instead, all transactions are recorded in the books of the head office.
All financial transactions are reflected in the head office accounts, and periodic financial statements may be prepared to assess branch performance.
Debtors are managed by the head office, which maintains the record of credit sales and collections.
Stock is generally held at the branch but accounted for in the head office records.
Wholesale profit is the profit made from selling goods in bulk to retailers, typically at a low markup.
Retail profit is generated from selling goods directly to consumers at a higher markup, accounting for higher overhead costs.
Independent branches maintain their own accounting records and prepare their own financial statements.
Independent branches other than foreign branches maintain records in local currency and can practice their accounting systems while aligning with the head office.
Expenses are allocated based on specific metrics like sales, square footage occupied, or direct costs attributable to each department.
When goods are transferred at cost, it reflects the original cost incurred by the transferring department.
When goods are transferred at original selling price, it reflects the markup over cost, ensuring profit margin is considered.
Partnership Accounts - I: Admission of a Partner, Treatment of Goodwill, Calculation of Hidden Goodwill, Retirement of a Partner, Death of a Partner
Partnership Accounts
Admission of a Partner
The process of introducing a new partner into an existing partnership involves adjustments to the profit-sharing ratio, capital accounts, and treatment of goodwill. The existing partners must agree on the terms of the new partnership including the percentage of ownership for the new partner.
Treatment of Goodwill
Goodwill represents the intangible value of a firm. Upon admission of a new partner, goodwill can be valued and recognized in the books. This can be done in two ways: through capitalization of super profits or the average profit method. Goodwill is typically shared among existing partners based on their profit-sharing ratio.
Calculation of Hidden Goodwill
Hidden Goodwill refers to unrecognized goodwill that may exist if profits are understated. This calculation is essential when valuing a partnership for an incoming partner. It involves comparing the total value of the partnership against the net asset value to determine if additional goodwill exists.
Retirement of a Partner
The retirement of a partner requires adjustments to the capital accounts and profit-sharing ratio among remaining partners. It is important to ascertain the retiring partner's share of goodwill and the settlement of their account, which may involve cash payments or the transfer of assets.
Death of a Partner
In the event of a partner's death, the partnership must be dissolved unless the partnership agreement specifies otherwise. The deceased partner's estate is entitled to their share of the partnership's assets, which may include goodwill. The remaining partners will need to adjust the partnership structure and potentially bring in a new partner.
Partnership Accounts - II: Dissolution of Partnership, Methods, Settlement of Accounts Regarding Losses and Assets, Realization account, Treatment of Goodwill, Preparation of Balance Sheet, Insolvency of Partners, Application of Garner Vs Murray Theory, Accounting Treatment, Piecemeal Distribution, Surplus Capital Method, Maximum Loss Method
Partnership Accounts - II: Dissolution of Partnership
Dissolution of Partnership
Dissolution of partnership refers to the process of ending the partnership agreement and involves the cessation of business activity. This can be triggered by various factors such as mutual consent, expiration of the term, or legal issues.
Methods of Dissolution
There are several methods for dissolving a partnership, including voluntary dissolution, compulsory dissolution by law, and dissolution due to certain events or conditions stipulated in the partnership agreement.
Settlement of Accounts Regarding Losses and Assets
Upon dissolution, partners must settle their accounts, which includes determining profit or loss and how to divide the assets among them. Liabilities need to be settled before distributing residual assets.
Realization Account
Realization account is prepared to determine the profit or loss during the dissolution of the partnership. It accounts for the sale of assets and settlement of liabilities.
Treatment of Goodwill
Goodwill is treated based on the agreement among partners. It may be valued and settled among partners, often influencing the distribution of profits or losses.
Preparation of Balance Sheet
A balance sheet is prepared at the time of dissolution to ascertain the financial position of the partnership. It reflects assets, liabilities, and capital balances before final settlement.
Insolvency of Partners
In cases where one or more partners are insolvent, it impacts the distribution of assets. The solvent partners must cover the losses incurred by the insolvent partners.
Application of Garner Vs Murray Theory
This legal case provides guidelines on how profits and losses are shared among partners when one partner is insolvent. It dictates that the capital of each partner should bear losses in a specific order.
Accounting Treatment
The accounting treatment for dissolution includes preparing realization accounts, determining the final settlements, and recording any gains or losses from the liquidation process.
Piecemeal Distribution
Piecemeal distribution occurs when the assets are sold slowly over time and proceeds are distributed gradually to the partners based on agreed terms.
Surplus Capital Method
Under the surplus capital method, the capital contributions of partners are first settled, and any remaining assets are distributed according to the profit-sharing ratio.
Maximum Loss Method
This method involves distributing assets to cover maximum losses first before any surplus is shared among partners, ensuring that the most significant liabilities are prioritized.
Accounting Standards for financial reporting (Theory only): Objectives and Uses of Financial Statements for Users, Role of Accounting Standards, Development of Accounting Standards in India, Role of IFRS, IFRS Adoption vs Convergence Implementation Plan in India, Ind AS Introduction, Difference between Ind AS and IFRS
Accounting Standards for financial reporting (Theory only)
Financial statements provide information about the financial position, performance, and cash flows of an entity.
Users of financial statements include investors, creditors, regulators, and management, each using the information for different decision-making purposes.
Objectives include providing reliable financial information for assessing the entity's ability to generate future cash flows and the risks associated with its operations.
Accounting standards establish consistent financial reporting practices.
They enhance transparency, comparability, and reliability of financial statements for users.
Standards help mitigate the risk of misrepresentation and enhance investor confidence.
The development began with the Institute of Chartered Accountants of India (ICAI) issuing the first set of accounting standards in 1977.
The process of standard-setting involves consultation with various stakeholders including industry practitioners, regulators, and users.
Adoption of International Financial Reporting Standards (IFRS) is an ongoing process in India.
IFRS provides a globally accepted framework for financial reporting.
They aim for consistency in financial statements across different countries, facilitating international investment.
IFRS enhances transparency and comparability among global enterprises.
Adoption refers to the outright implementation of IFRS, while convergence seeks to align Indian standards with IFRS.
India has predominantly followed a convergence approach through the introduction of Indian Accounting Standards (Ind AS).
The transition aims to simplify accounting practices while aligning with global reporting standards.
Ind AS is a set of accounting standards notified by the Ministry of Corporate Affairs in India.
It is largely aligned with IFRS, tailored to address the needs of the Indian economy.
The implementation began in phases, impacting listed companies and large unlisted companies.
While Ind AS is based on IFRS, there are differences in certain areas due to legal, economic, and cultural contexts in India.
Examples of differences include revenue recognition, financial instruments, and accounting for leases.
Understanding these differences is crucial for companies operating both in India and internationally.
