Financial Accounting - 1 PDF

SYLLABUS
FINANCIAL ACCOUNTING – I
Course Code: 18BCM101 Semester I

Credits: 4 Total Hours: 60 Hours
Objective
The objective of this course is to acquaint students with the accounting concepts, tools and
techniques influencing business organizations
MODULE –I: 8 Hours

Introduction to Accounting and Overview of Accounting Standards in India
Introduction, Meaning, Definition, Objectives, Functions, Users of Accounting, various
Accounting terms, Rules and Accounting equations, (simple Problems),Simple Journal Entries,
Accounting Concepts and Conventions, Need for Accounting Standards, Accounting Standards
Board and its functions, Formulation of Accounting Standards-procedure, An Overview of Indian
Accounting Standards , List of International Accounting Standards
MODULE - II: Dissolution of Partnership 10 Hours

Modes of Dissolution, Settlement of Accounts, Difference between Dissolution of Partnership &
Dissolution of Firm, Accounting Treatment- Problems, Insolvency Loss, Garner v/s Murray –
Capital Ratio calculation, Insolvency of all Partners - Problems
MODULE – III: Conversion of Partnership 16 Hours

Introduction, Limited liability Partnership – Meaning, Need for conversion, Meaning of Purchase
Consideration, Mode of Discharge of Purchase Consideration, Method of calculation of Purchase
Consideration – (Net Payment Method, Net Asset Method, Lump sum Method) , Passing of Journal
Entries and Preparation of Ledger Accounts in the books of Vendor, Treatment of certain items –
Dissolution Expenses – Unrecorded Assets and Liabilities– Assets and Liabilities not taken over
by the Purchasing Company - Contingent liabilities – non assumption of trade liabilities , Passing
of Incorporation entries, Treatment of Security Premium, Fresh issue of shares and debentures to
meet working capital, Preparation of Balance Sheet
MODULE – IV: Hire-Purchase and Installment System 14 Hours

Introduction, Meaning, Hire Purchase Act 1972, Difference between Hire Purchase and
Installment Purchase system, Important Definitions – Hire Purchase Agreement- Hire Purchase
Price – Cash Price, Hire Purchase Charges, Net Hire Purchase Price –Net Cash Price , Calculation
of interest when both the cash price and the rate of interest are given
Calculation of interest when cash price is given but rate of interest is not given, Calculation of
interest when both the cash price and the rate of interest are not given, Calculation of cash price -
Annuity Method, Calculation of amount of installment, Journal entries and Ledger accounts in the
books of Hire Purchaser and Hire vendor under Asset Accrual method, Treatment of Interest
Suspense Account, Journal entries and Ledger account in the books of both parties.
MODULE –V : Royalties 12 Hours
Introduction, Meaning, Technical Terms – Royalty – Landlord – Tenant – Minimum Rent –Short
workings – Recoupment of Short working under Fixed Period & Floating Period, Recoupment
within the Life of a Lease, Treatment of Strike and Stoppage of work, Accounting Treatment – In
the books of Lessee (Tenant) – when royalty is less than Minimum Rent – When royalty is equal
to Minimum Rent, when royalty is more than minimum rent – When the right of recoupment is
lost, when Minimum Rent Account Method is followed , Preparation of ledger accounts – Royalty
Account, Landlord Account – Short workings Account - Minimum Rent Account when Minimum
Rent Account is followed.
BOOK FOR REFERENCE
1. Dr. S.N. Maheshwari, Financial Accounting - Vikas Publication House, (2011)

2. B.S. Raman, Financial Accounting – United Publishers, (2008)
3. Radhaswamy and R.L. Gupta, Advanced Accounting – Sultan Chand and Sons, (2011)
4. P.C. Tulsian, Introduction to Accounting - Pearson Editors, (2012)
5. Jain and Narang, Financial Accounting – Kalyani Publishers, (2012)
6. Grewal and Gupta, Advanced Accounting - Sultan Chand & Sons (2008)
7. Dr. S.M. Shukla and Dr. S.P. Gupta – S. Chand & Co. Ltd (2012)
MODULE I
INTRODUCTION TO ACCOUNTING AND
OVERVIEW OF ACCOUNTING STANDARDS IN INDIA
STRUCTURE
1.1 Introduction
1.2 Book keeping- meaning, definition, features and objectives
1.3 Accounting- meaning, definition, features, objectives, functions,
1.4 Distinction between Book keeping and Accounting,
1.5 Advantages & limitations of Accounting
1.6 Accountancy-meaning, objectives,
1.7 Distinction between accounting and accountancy
1.8 Users of accounting information
1.9 Basis of accounting
1.10 Branches of accounting
1.11 Various Accounting Terms
1.12 Rules and Accounting Equations
1.12.1 Accounting Rules (Rules of Debit and Credit)
1.12.2 Accounting Equation
1.12.3 Relationship between assets and liabilities and their impact on accounting equations
1.12.4 Steps in developing an Accounting Equation
1.13 Accounting cycle
1.14 Accounting Principles & Illustrations
1.15 Simple Journal Entries & Illustrations
1.16 Accounting concepts & Conventions
1.17 Accounting Standards
1.18 Accounting Standards Board
1.19 Formulation of Accounting Standards - procedure
1.20 An Overview of Indian Accounting Standards
1.21 List of International Accounting Standards (IAS)
1.22 Summary
1.23 Questions
1.24 Answers
Learning objectives:
 Understand the significance of accounting as a whole
 Show the difference between Financial accounting and Management accounting
 List and explain the objectives of Financial Accounting
 Understand the need for and the users of Financial Statements
1.1 INTRODUCTION
The success of a business entity depends on the combined effects of four factors – land, labour,
capital and management. The contribution of each factor has to be properly measured: only then
can the resultant performance of the entity be properly evaluated. Hence Accounting is the
language of business which is necessary for both business as well as non-business activities.
A business organization mainly aims at profitability. Profitability of the organization depends on,
the ability to utilize the resources available to the maximum extent possible. The profitability can
also be judged by the borrowing capacity of the organization. Thus, the need for accounting is very
essential, as it helps in maintaining and classifying day-to-day business transaction.
The day-to-day accounting transaction involved can be classified in to two main broad categories.
They are:
i) Transaction which bring revenue to the business. For example: Commission received, interest
received, discount from suppliers, Sale of fixed assets etc.
ii) The expenses incurred in maintaining day-to-day activities of the business. For example:
Payment for purchase of fixed assets etc.
It is very important for the organization to maintain transactions as it helps in:

i) Tracking what the business owns;
ii) Identifying the expenses which are incurred;
iii) Identifying what businesses owe to others;
iv) Tracking the profitability for the current year;
v) Knowing the actual financial position at the end of the year;
1.2 BOOK KEEPING- MEANING, DEFINITION, FEATURES AND OBJECTIVES
Meaning:
Book keeping is the process of recording business transactions.
Definition:
Book keeping is the science and art of correctly recording in the books of accounts all those
business transactions that result in the transfer of money or money’s worth.
– R.N. Carter
Book keeping may be defined as the science as well the art of recording business transaction under
appropriate accounts.
– J.R. Batliboi
Book keeping is the process of analyzing, classifying and recording transactions in accordance
with a pre-conceived plan.
- Kohler
According to the above definitions, book keeping is the process of recording financial transactions
in a business in terms of money. The method of recording these transactions confirms to a pre-
plan.
Features of book keeping

a) Book keeping is the process of recording business transactions.
b) These transactions are recorded in terms of their financial value.
c) It is a scientific and systematic recording.
d) The transactions are recorded in a set of well-organized books of accounts.
e) The method of recording is in accordance with certain time tested, universally accepted
principles.
f) The purpose of such recording is to present information about the transactions for future
requirements, such as calculation of profit and determination of financial position of the business.
Objectives of book keeping

a) To enable the calculation of the result of the business during an accounting year and also to
determine the financial position of the business.
b) To determine the results of the business during a financial year and also to determine the
financial position of the business.
c) To maintain an authentic record of all the business transactions.
d) To exercise control over the day – to – day transactions.
e) To produce a proper and authentic evidence at a court of law in case of a dispute.
f) To provide for an accurate income tax assessment for calculation of the amount of income tax
payable.
1.3 ACCOUNTING
Meaning:
If book keeping is the activity of recording financial transactions, accounting goes one step ahead
and does the activity of summarizing the transactions, calculating, analyzing the results and
communicating them to certain persons.
Definitions:
The art of recording, classifying and summarizing in a significant manner and in terms of money,
transactions and events which are, in a part at least of a financial character, and interpreting the
results thereof.
- The American Institute of Certified Public Accountants
Accounting is the process of identifying, measuring, recording and communicating economic

information to permit informed judgments and decisions by users of the information.
- The American Accounting Association
Accounting includes book keeping. However, it extends its scope to the activity of summarizing
of the business transactions, quantifying the results and communicating the results to several
parties.
Features of Accounting
1. Accounting involves identification and recording of business transactions.
2. Accounting classifies the transactions. Business transactions belong to several types, therefore
they are classified so that the transactions can be recorded in the appropriate accounts.
3. Accounting summarizes the transactions. This involves calculation of the result of the business
i.e., profit or loss. (Profit and Loss account is prepared for this purpose) and also determination of
the financial position of the business i.e., the position of assets and liabilities (a Balance sheet is
prepared for this purpose).
4. Accounting communicates the results to certain parties. There are several parties who are
involved in a business such as owners, creditors, suppliers; certain government authorities’ etc.
accounting communicates the results of the business to all these parties through reports, statements,
etc.
Objectives of Accounting or need for Accounting
The most important objective of accounting is to provide information to the interested users to
enable them to take business decisions.
The primary objectives of accounting are the following:

1. Systematic recording of transaction: Basic objective of accounting is to systematically record
the financial aspects of business transaction i.e., book-keeping which are later on classified and
summarized logically for the preparation of financial statements and for their analysis and
interpretation.
2. Ascertainment of results: Accounting is expected to ascertain and reveal the net results of the
operations of the business. While finalizing the accounts, objective approach is essential combined
with consistency and conservatism.
3. Ascertainment of financial position of the business: A true and fair view of financial position
should be presented. The properties and assets possessed by the business should be shown at
appropriate values as per the prevailing practices. To know what a businessman owes to the
outsiders (liability) and what he owns (assets) on a certain date, a financial statement known as
Balance Sheet is prepared.
The Balance sheet is a statement of assets and liabilities of the business at a particular point of
time and helps in ascertaining financial health of the business. The stake of creditors and owners
in the business should be clearly presented. All the material information must be clearly disclosed.
4. Providing information to the users for rational decision – making: Accounting
communicates the financial results of an enterprise and aims to meet the information needs to
various stakeholders by means of financial statements.
5. To know the solvency position: By preparing the Balance sheet, also gives the information
regarding the concern’s ability to meet its liabilities in the short run (liquidity position) as well as
long run (solvency position).
Functions of Accounting
a) The recording of business transactions which can be expressed in terms of money. It is done in
the account books – Journal or subsidiary books.
b) The classification of the recorded data. This is done by grouping of transactions of a similar
nature. It is done in the ledger.
c) Summarizing the information of the year at the end of that financial or accounting year. It is
given in the form of Balance Sheet and Profit and Loss Account.
d) Interpretation of the summarized data for forming judgments and for formulating future
policies.
Following are the other functions of accounting:

i) Accounting aims at protecting the property of a business from unjustified and unwanted use
and hence a suitable system should be designed.
ii) Accounting enables compliance with the legal requirements such as filing various statements
or returns for income tax, sales tax purpose, etc.
iii) Accounting communicates the results of business to the interested parties and shows the real
and true position of the business.
1.4 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING
Basis of Difference Book Keeping Accounting
Meaning Systematic recording of Includes summarizing and

business transactions. communicating the results in
addition to recording.
Sequence First Next
Nature of work Not much specialized, done by Specialized tasks, requires special
clerks. skills.
Nature of staff Clerks Qualified Accountants
Uniformity Principles are uniform Methods of communicating may

not be uniform.
Users of the Insiders of the business Insiders as well as outsiders.

information
1.5 ADVANTAGES & DISADVANTAGES OF ACCOUNTING
Advantages of Accounting:
a) Reveals the results of the business.
b) It helps in effective control over the business.
c) It provides an authentic evidence of all business transactions.
d) It makes possible for a business to maintain and prepare record of all transactions.
e) It helps a business to collect dues from the debtors and also pay to its creditors in time.
f) It provides information about the business to outsiders like creditors, banks, etc.
g) It enables evaluation and quantification of certain aspects of a business like goodwill, reserves,
etc.
Disadvantages of Accounting:
a) The system of accounting that we follow does not record the non-monetary transactions which
are important for the business.
b) The comparison of results of various years becomes difficult since the price level changes are
not brought into books (only cost levels are brought in).
c) A realistic system of accounting may not be followed.
d) Accountant may be biased towards using certain methods (such as, FIFO, LIFO, etc.) and
hence it might affect the Accounting statements.
e) The information provided by Accounting is of historical nature.
Steps in Accounting
From the above definition, the steps involved in the process of accounting can be explained in
detail. They are:
i)Recording: The first step in the process of accounting is recording. The recording of business
transactions must be done systematically. Every transaction recorded in a journal or a subsidiary
book. This is known as “Book of original entry”.
The small enterprises adapt to the “journal system” of recording various financial transactions
involved in the business. Large enterprises adapt to the “subsidiary book system”.
Journal: Journal is a book of primary entry or original entry. The ruling of the journal is such that
any business transaction can be analyzed under the heads of debit and credit. The debit and credit
forms the basis of journal. Any business transaction must be analyzed.
Subsidiary Books: When similar transactions are grouped at the first stage,i.e.,recording the
transactions into journals. Then, it is known as Special journal/ a subsidiary book. The subsidiary
books are backed by documentary evidence like invoices, purchase orders, debit and credit notes,
vouchers etc. The subsidiary books consists of purchase books, sales book, purchase returns book,
sales returns book, cash book etc.
ii) Classification: Classification refers to grouping of transactions into separate accounts called
ledgers. Each business transaction is segregated based on the expenses incurred or income earned,
liability towards outsiders or property to form identifiable groups. All the transactions are grouped
together in the person account of the company or organization.
iii)Summarizing: The grouped data collected in the ledger accounts are summarized in a much
simpler manner, so that it helps the users of the accounting information to easily understand the
actual financial position at the end of the financial year.
After recording and classifying the financial transactions involved in the business, at the end of
the year the ledger balances are closed and a trial balance is prepared. The trial balance is a
statement and not an account. It is a statement which shows the arithmetically accuracy of the
business transactions recorded in the ledgers.
The important characteristic feature of trial balance is that the total of the debit must be equal to
the total of the credit. In case, the trial balance does not tally, then the balance is transferred to
‘suspense account”. Sometimes, due to human error of the accountants the trial balance does not
tally.
The errors committed by the accountants are classified as:

1. Error of principle: These errors occur, when proper concepts and conventions of accounting
are not followed. For example:
a) Wrong allocation of expenditure between capital and revenue items.
b) Wrong posting of revenue items
c) Treating revenue expenditure as personal expenditure.
2. Error of omission: In these errors the transactions are either completely omitted while recording
or they are partially omitted.
3. Error of commission: In these, incorrect entries are made in the books of original entry or
ledger accounts, either wholly or partially. Example: Wrong entries in the books of original entry,
wrong calculations, posting, additions etc.
4. Error of duplication: These errors occur when the transactions have been recorded twice in the
books of original entry and in the ledger accounts.
5. Compensating errors: These errors counter balance other errors. They are also known as off-
setting errors
iv)The final step in the accounting process is the finalizing of accounts. This is done by preparing:
 Manufacturing or trading account
 Profit and Loss account
 Profit and Loss appropriation account
 Balance sheet
1.6 ACCOUNTANCY
Meaning:
Accountancy is a science by means of which all mercantile and financial transactions, whether in
money or money’s worth, including operations completed and engagements undertaken to be
fulfilled at once, or in future may be recorded.
Objectives:
i) Indicate the earning capacity and the financial position of the concerned business unit.
a) Record all transactions to ascertain correct results and financial position.
b) Assist management in decision making.
c) Depict the true position of the business.
d) Satisfy the Government and Income Tax authorities.
1.7 DISTINCTION BETWEEN ACCOUNTING AND ACCOUNTANCY& METHODS OF

ACCOUNTING
Basis of Difference Accounting Accountancy

Meaning Summarizing and Consists of rules, principles, etc., to
communicating the results of the be followed.
recorded transactions.
Focus Practical aspects. Regulation and guidance.
Nature An art A science
Methods of Accounting
i)Single Entry System
The term single entry is vaguely used to define this method of accounting. In a single entry system
the principles of double entry is not followed. In this context, single entry does not mean that there
is only one entry for each transaction. Under the single entry system, only the personal accounts
of the debtors, creditors and the cash book of the trader is maintained. Impersonal accounts such
as sales accounts, purchase accounts, assets accounts etc. are not maintained.
The absence of the two fold effect of each transaction makes it difficult to prepare the trial balance
of the trader and it fails to check clerical errors. These errors include omission errors, commission
errors, duplication errors, compensating errors etc. Since the sales and purchases accounts are not
maintained, this makes it difficult to profit and loss account. It is also very difficult to prepare the
balance sheet because of the absence of real and nominal accounts.
Thus from this we can conclude that single entry is not only incomplete, but also is not reliable.
ii)Double Entry System: A double entry system of accounting is a system where every transaction
entered in the book of original entry has both debit and credit aspects. The first aspect is receiving
aspect or incoming aspect and the other one is benefit giving aspect or outgoing aspect. The benefit
receiving aspect is said to be a debit and the benefit giving aspect is said to be a credit. For every
transaction, one account has to be credited and then simultaneously the corresponding account is
debited.
For Example: If furniture is purchased for cash. The first aspect is that, it is monetary in nature.
The second aspect is that Furniture is an asset whose benefit is received over the
years.Thus,furniture is an asset, thus it must be debited as the asset is coming into business and
cash is credited as the cash is going out of the business.
1.8 USERS OF ACCOUNTING INFORMATION
1.9 BASIS OF ACCOUNTING

The following are the two basis of accounting to record transactions –
i) Cash Basis: It is a method of recording transaction in which revenues, cost, assets and liabilities
are reflected in the accounts for the period in which actual cash receipts and actual cash payments
are made.
ii) Mercantile or accrual basis: It is a method of recording transactions in which revenue, cash,
assets and liabilities are reflected in the accounts for the period in which they accrue irrespective
of actual receipts or payments of cash.
1.10 BRANCHES OF ACCOUNTING
1.11 VARIOUS ACCOUNTING TERMS
In the subject of accounting the following are basic terms used. They are:
i) Capital: It represents owners’ funds invested in a business. It may be the original amount
invested by the owner or original contribution adjusted for profits and drawings. It is also known
as owners’ equity or net worth. Capital represents owners’ claim against the assets of the business.
It is equal to the total assets minus outside liabilities.
ii) Liability: It represents temporary interest of outside creditors in the assets of the business.
According to Finny and Miller, “Liabilities are debts; they are amounts owed to creditors; thus the
claims of those who are not owners are called liabilities”. In simple terms, debts repayable to
outsiders by the business are called liabilities.
iii) Assets: Assets are defined as ‘anything of value owned by a business’. According to Finny and
Miller, “Assets are future economic benefits, the rights which are owned or controlled by an
organization or individual.
iv) Revenue: It is defined as the inflow of assets which results in an increase in the owner’s equity.
It includes all incomes like sales receipts, commission received, brokerage received etc. However
receipts of capital nature like additional capital, sale of assets etc. are not a part of revenue.
v) Expenses: It is any amount spent in order to produce and sell the goods and services which
bring in the revenue. Expenses may be defined as the cost of the use of things or services for the
purpose of generating revenue. Expenses incurred can be in the classified into:
a) Capital Expense: A capital expense is an expense which generates revenue over several
accounting years. Capital expense includes acquisition of long term assets like machinery.
b) Revenue Expense: Revenue expense generates revenue in the current accounting year.
Revenue expenses include current expenses like salary, rent, lighting etc.
vi) Debtors: A person who receives a benefit without giving money or money’s worth
immediately but, liable to pay in future is a debtor. A debtor is a “trade debtor”, if he buys goods
on credit. Others are non-trade debtors.
vii) Creditors: A person who gives a benefit without receiving money or money’s worth
immediately, but liable to claim in future is a creditor. Creditor can be a “Trade Creditor”, if he
supplies goods on credit. Others are non-trade creditors.
viii) Tangible Assets: Assets which have a physical existence; i.e., they can be felt, seen or
touched, are termed as tangible assets. Examples: cash, machinery, buildings etc.
ix) Intangible Assets: Assets which have no physical existence i.e. They cannot be seen or felt or
touched, are termed as intangible assets. Examples: goodwill, patent rights, copyrights etc.
x) Fictitious Assets: Items shown along with other assets on the assets side of the balance sheet,
but actually representing unadjusted losses are termed as fictitious assets. Examples: Preliminary
expenses, profit and loss debit balance etc.
xi) Wasting Assets: Those assets which certainly lose value with usage are termed as wasting
assets. Example: Mines, forest etc. become waste once the mineral is fully extracted or the timber
is fully cut.
xii) Fixed Assets: Assets acquired for income generation, but not for resale are called fixed assets.
The benefit from them is derived for a longer period,i.e., more than one year. For Example: Plant
and Machinery, Land and Building etc.
xiii) Current or Floating assets: Those assets which are converted into cash in normal course of
business in less than one year are termed as current or floating assets.Example:Stock,debtors etc.
xiv) Purchases: Buying of goods with the intention of resale is called purchases. If cash is paid
immediately for the purchases, it is cash purchases. If the payment is postponed, it is credit
purchases.
xv) Sales: Selling of goods in the normal course of business is termed as sales. If the sale for
immediate cash payment, it is known as cash sales. If payment for sales is postponed, it is credit
sales.
xvi) Stock: The term stock refers to goods lying unsold on a particular date. The stock of goods at
the end of the accounting period is called closing stock and the stock of the goods at the beginning
of the year is known as opening stock.
xvii) Losses: ‘Loss’ really indicates something against which a firm receives no benefit. It may be
noted that expense may leads to revenue but losses do not. For Example: Loss due to fire, theft
and damages payable to others.
xviii) Drawings: Any amount of money or moneys’ worth withdrawn by the owners of the
business is known as drawings. It is usually subtracted from the capital and is shown in the
liabilities side of the balance sheet of a sole trader or a small business.
xix) Invoice: It is a statement prepared by a seller of goods, to be sent to the buyer. It shows details
of quantity, price, value etc., of the goods and any discount given, finally showing the net amount
payable by the buyer.
xx) Voucher: It is the written record and evidence of the transactions. So, documentary evidence
of any transaction is called a voucher. Vouchers are essential for the audit of accounts. Example:
Cheque book counterfoils, cash receipt invoices etc.
xxi)Goods: The term goods includes all merchandise, commodities etc. in which a trader deals in
the normal course of business. Thus, commodities bought for resale are treated as goods. For a
furniture dealer, furniture is goods, but, for other firms, furniture is an asset.
xxii)Current liability: Those liabilities which are payable within one year in the normal course of
a business are termed as current liabilities. Example: trade creditors, bills payable etc.
xxiii)Long term liabilities: Liabilities repayable beyond a period of 1 year are treated as long
term liabilities. For Example: Bank loans, mortgage loans etc.
xxiv)Solvent: A person who has assets with realizable values which exceed his liabilities is a
solvent.
xxv)Insolvent: A person whose liabilities are more than the realizable value of his assets is called
an insolvent.
1.12 RULES AND ACCOUNTING EQUATIONS:
Before understanding the rules and accounting equations, we need to understand the different types
of accounts.
Types of Accounts
Every financial transaction is recorded in the books of original entry and company must maintain
the following accounts. They are:
i) Accounts in the name of individuals, proprietors, suppliers, companies etc.
ii) Accounts in the name of assets purchased or sold, resalable goods,
iii) Accounts for every expense incurred or income earned.
These accounts to be maintained are grouped into the following .They are:
i) Personal accounts
ii) Impersonal accounts
i)Personal accounts- are those accounts which are maintained in the names of persons who are
involved in the dealings of the business.
ii)Impersonal accounts: are those accounts which are not personal accounts. They can be
categorized in to real accounts and nominal accounts.
a) Real Accounts: Real accounts are accounts maintained by the company which consists of the
assets of the business. In this case, the assets of the business can be either purchased for use or the
assets goods meant for use.
b) Nominal Accounts: Nominal accounts are accounts which relates to the items which relates to
the result of the activities of the business. In nominal accounts expenses and losses incurred or
incomes and gains earned are recorded. For Example: Rent account, Telephone charges account,
depreciation account, salary account, etc.
1.12.1Accounting Rules (Rules of Debit and Credit):

The following are the rules of debit and credit under the English system and American system:
1) Under the English system
a. Personal Account rule
“Debit the Receiver
Credit the Giver”
b. Real Account rule

“Debit what comes in
Credit what goes out”
c. Nominal Account rule

“Debit all expenses and loss
Credit all incomes and gains”
2) Under the American System

The following are the rules of accounting when the American system is followed:
a. Capital: If capital increases, it is credited, whereas, when it is reduced, it is debited.
“Debit Decrease in Capital
Credit Increase in Capital”
b. Outsider’s Liability: If the liabilities increase, external accounts are credited. On the other
hand, if the liabilities decrease, external liabilities will be debited.
“Debit decrease in Liability
Credit increase in Liability”
c. Revenue Income: The amount of revenue income leads to an increase in the Owners’ equity.
“Debit decrease in Incomes and Gains
Credit increase in Incomes and Gains”
d. Revenue Expenses: The amount of revenue expense leads to decrease in the owners’ equity.
“Debit increase in expenses and losses
Credit decrease in expenses and losses”
e. Assets: In case of an increase of assets of a company, assets will be debited. Whereas, in case
of decrease in the assets, it will be credited.
“Debit increase in an asset
Credit decrease in an asset”
1.12.2 Accounting Equation

The accounting equation illustrates the mechanism of accounting based on ‘dual aspect’ or ‘dual
concept’ of accounting. The dual aspect concept can be explained by the “accounting equation”:
Assets = Equities
The properties owned by the business are called ‘assets’. The rights to the properties are called
‘Equities’. The Equities may be classified based on its principles as:
i. Right to creditors – Equity of creditors represents the debts of the business and is called
‘liabilities’.
ii. The rights of the owners – Equity of owners is called ‘Capital’.
Under accounting equation mechanism, at any point of time the assets of any business enterprise
are equal in monetary terms to its equities both internal and external. Internal equities are the
amount contributed by proprietor as capital plus profit retained in the business. External equities
are liabilities which may be short-term or long-term liabilities. Thus,
Assets = Liabilities + Capital
Capital = Assets - Liabilities
1.12.3 Relationship between assets and liabilities and their impact on accounting equations:
1) In certain transactions, if the value of an asset decreases, the value of another asset increases.
For instance, if bonds or stock of a company are purchased for cash, bonds increases and the value
of cash goes down.
2) Certain transactions can lead to increase in one liability resulting from decrease of another
liability. For example, a company may decide to pay off creditors by borrowing loan.
3) Many times, an increase in the value of an asset will lead to a proportional increase in the
liabilities of the company. For example, when an organization acquires a land for its operations,
fixed assets of the company increases and in turn adds equity, which is a liability.
4) A company may also have circumstances where the value of an asset decreases with a
corresponding decrease in the liability. For example, when creditors are paid in cash, the creditors
value decreases with a decrease in the cash on the assets of the company.
1.12.4 Steps in developing an Accounting Equation:

Step 1: Ascertain the variables of an equation (i.e., Assets, Liabilities or Capital) affected
by a transaction.
Step 2: Find out the effect (i.e., increase or decrease) of a transaction on the variables of an
equation.
Step 3: Show the effect on appropriate side of an equation and ensure that the total of the
Assets side is equal to the total of the Liabilities side.
Effect of Transaction on Equation:

1. Increase in assets and increase in capital or liabilities
Examples: i. Purchase of goods on credit to Mr. A
ii. Loan borrowed from Bank
iii. Commencing business with Capital of Rs. 5,00,000
2. Increase in one asset and decrease in another asset

Examples: i. Purchase of goods for cash
ii.Interest paid in advance
iii. Cash received from debtors
3. Decrease in asset and decrease in liability

Examples: i. Paid cash to suppliers
ii. Repayment of loan by cash
4. Decrease in asset and decrease in Capital

Examples: i. Withdrawal of cash or goods for personal use
ii. Depreciation on fixed assets
iii. Salary paid to employees
5. Increase in liability and decrease in capital

Examples: i. Outstanding salary (Salary due but not paid)
ii. Interest on loan outstanding
1.13 ACCOUNTING CYCLE
Recording of
transaction in
journal or
subsidiary books
Preparation of Posting to various

final accounts ledger accounts
Preparation of
trial balance from
ledger accounts
1.14 ACCOUNTING PRINCIPLES

Accounting is an art of recording business transactions in the books of accounts, the basic aim of
which is to find out the profit or loss and financial position of the business.
To be generally acceptable it has to meet the following criteria–

a) Relevance: It should result in useful or meaningful information to the users.
b) Objectivity: It should be reliable and the results should be verifiable.
c) Feasibility: Can be implemented without undue complexity or cost.
Illustrations
1. Prepare accounting equation in the books of PQR Ltd.
a) Started business with cash Rs.1,00,000, assets Rs.3,00,000, liabilities Rs.1,00,000
b) Credited purchases of goods Rs.2,00,000
c) Cash sales of goods costing Rs, 85,000 at Rs.1,10,000
d) Credit sales of goods costing Rs. 45,000 at Rs.60,000
e) Defective goods returned to creditors Rs.7,000
f) Borrowed loan of Rs.30,000
g) Drawings of the proprietor Rs.10,000
h) Distributed goods costing Rs.5,000 as free samples
i) Sold goods for cash Rs.10,000 (Cost price Rs.12,000)
j) Cash received from debtors Rs.15,000
k) Damaged goods returned by debtors Rs.2,000
l) Cash paid to creditors Rs.20,000
Solution:
Accounting Equation
Transactions External
Total Assets= Capital +
Liabilities
1. Started business with cash 4,00,000 3,00,000 1,00,000

Rs.1,00,000, Rs.3,00,000, liabilities
Rs.1,00,000
2. Credited purchases of goods +2,00,000 - +2,00,000
Rs.2,00,000
New Equation 6,00,000 3,00,000 3,00,000
3. Cash sales of goods costing Rs.85,000 +1,10,000

at Rs.1,10,000
-85,000 +25,000 -
New Equation 6,25,000 3,25,000 3,00,000
4. Credit sales of goods costing +60,000

Rs.45,000 at Rs.60,000
-45,000 +15,000
New Equation 6,40,000 3,40,000 3,00,000
5. Defective goods returned to creditors -7,000 - -7,000

Rs.7,000
New Equation 6,33,000 3,40,000 2,93,000
6. Borrowed loan Rs.30,000 +30000 - +30,000
New Equation 6,63,000 3,40,000 3,23,000
7. Drawings of proprietor Rs.10,000 -10,000 -10,000 -
New Equation 6,53,000 3,30,000 3,23,000
8. Distributed goods costing Rs.5,000 as -5,000 -5,000 -

free samples
New Equation 6,48,000 3,25,000 3,23,000
9. Sold goods for cash Rs.10,000 (Cost +10,000

price Rs.12,000)
-12,000 -2,000 -
New Equation 6,46,000 3,23,000 3,23,000
10. Cash received from debtors Rs.15,000 +15,000

-15,000 - -
New Equation 6,46,000 3,23,000 3,23,000
11. Damaged goods returned by debtor +2,000 - -

Rs.2,000
-2,000
New Equation 6,46,000 3,23,000 3,23,000
12. Cash paid to creditors Rs.20,000 -20,000 - -20,000
New Equation 6,26,000 3,23,000 3,03,000
2. Prepare accounting equation in the books of A & Co.

1. Commenced business with capital of Rs.1,00,000
2. Bought goods on credit from Mr. X for Rs.80,000
3. Bought furniture for cash Rs.10,000
4. Sold goods for cash Rs.40,000
5. Paid Mr. X on account Rs.40,000
6. Paid shop rent Rs.10,000
7. Paid salaries to employees Rs.5,000
8. Sold goods on credit to Mr.C Rs.5,000
Solution:
Accounting Equation
Transactions
Assets Liabilities Capital
1. Commenced business 1,00,000 - 1,00,000
2. Bought goods on credit from Mr.X 80,000 80,000 -
New Equation 1,80,000 80,000 1,00,000
3. Bought furniture for cash Rs.10,000 +10,000
-10,000 - -
New Equation 1,80,000 80,000 1,00,000
4. Sold goods for cash Rs.40,000 +40,000 - -
-40,000
New Equation 1,80,000 80,000 1,00,000
5. Paid Mr. X on account Rs.40,000 -40,000 -40,000 -
New Equation 1,40,000 40,000 1,00,000
6. Paid shop rent Rs.10,000 -10,000 - -10,000
New Equation 1,30,000 40,000 90,000
7. Paid salaries to employees Rs.5,000 -5,000 - -5,000
New Equation 1,25,000 40,000 85,000
8. Sold goods on credit to Mr.C Rs.5,000 -5,000
+5,000 - -
New Equation 1,25,000 40,000 85,000
1.15 SIMPLE JOURNAL ENTRIES
The word journal is derived from the French word “Jour” meaning ‘day’. Journal therefore means
daily record business transactions. The ruling of the journal is such that any business transaction
can be analyzed under the heads of debit and credit.
The following is the proforma of a journal.

Date Particulars L.F Debit(Rs) Credit(Rs)
Transaction analysis for Journal entries:
Any business transaction must be analyzed through the following steps to write the correct journal
entry:
a) The accounts affected by the transaction have to be identified.
b) The identified accounts should be classified according the types of accounted which they come
under. The types of accounts are mainly personal, real or nominal accounted.
c) The accounts which are to be debited and credited should be deciding keeping the “Golden rules
of accounting” in mind.
Points to remember while preparing the journal:
i)Goods Accounts:The articles or products in which a firm deals are termed as “goods” for that
firm. Purchase A/c, Sales A/c, Purchase returns A/c and Sales returns A/c are all different types of
goods accounts by nature.
ii)Purchase Account:Purchase account is meant for purchase of goods only.It should not be used
for purchase of assets like machinery for purchase of stationery etc.
iii)Sales Account:Sales account is concerned with sale of goods only.It should not be used for sale
of assets.
iv) Owner’s transaction: When owner provides money to the business it is capital. Capital
account is credited. If owner withdraws money or anything else like goods, it is shown as drawings.
Drawings account is debited.
v) Payments for owner: Payments made on owner’s behalf for income tax, insurance
premium,purchase of assets for his personal use etc. should be treated as drawings.
vi) Abnormal losses of goods: Loss by fire, loss by theft or pilferage etc,goods should be treated
as abnormal losses and credited to trading account, after debiting the respective loss accounts.
vii) Goods utilized: Goods purchased for the purpose of sales may be used for other purposes. If
the owner takes goods, drawings account is debited and purchases account is credited; if goods are
distributed as ‘samples’, advertisement account is debited and purchases account is credited. If
goods are given as charity account (loss) is debited and purchases account is credited.
Illustrations
1. Journalise the following transactions:
a. Purchased goods for cash Rs.10,000/-
b. Purchased stationery for cash Rs.500/-
c. Purchased furniture for cash Rs.3,000/-
d. Sold goods for cash Rs.8,000/-
e. Sold goods to Jane for cash Rs.3,000/-
f. Sold goods to James on credit Rs.2,000/-
g. Paid rent to Krishnan, the landlord Rs.800/-
h. Paid salary of Rs.8,000/-.
i. Paid Lokesh, the manager his salary of Rs.3,000/-
j. Paid freight on the goods purchased Rs.300/-
k. Paid freight on machinery produced Rs.400/-
l. Paid wages Rs.500/-
m. Paid wages to erect a machine Rs.1,000/-
n. Received Rs.800 from Kamal
o. Received Rs.600 from Kamal as interest
p. Received Rs.7,000 from Kamal as loan @ 5% interest
Solution:
Date Particulars L.F Debit Credit
1. Purchases A/c Dr 10,000
To Cash A/c 10,000
(Being cash purchases of books)
2. Stationary A/c Dr 500
To Cash A/c 500
(Being purchase of stationary)
3. Furniture A/c Dr 3,000
To Cash A/c 3,000
(Being cash purchase of stationary)
4. Cash A/c Dr 8,000
To Sales A/c 8,000
(Being cash sales made)
5. Cash A/c Dr 3,000
To Sales A/c 3,000
(Being cash sales to Jane)
6. James A/c Dr 2,000
To Sales A/c 2,000
(Being good sold on credit)
7. Rent A/c Dr 800
To Cash A/c 800
(Being rent paid to Krishnan)
8. Salary A/c Dr 8,000
To Cash A/c 8,000
(Being salary paid in cash)
9. Salary A/c Dr 3,000
To Cash A/c 3,000
(Being manager’s salary paid in cash)
10. Freight A/c Dr 300
To Cash A/c 300
(Being freight paid for goods)
11. Machinery A/c Dr 400
To Cash A/c 400
(Being payment of freight on machinery)
12. Wages A/c Dr 500
To Cash A/c 500
(Being payment of wages)
13. Machinery A/c Dr 1,000
To Cash A/c 1,000
(Being wages paid to erect machine)
14. Cash A/c Dr 800
To Kamal’s A/c 800
(Being amount received from Kamal on
account)
15. Cash A/c Dr 600
To Interest A/c 600
(Being interest received from Kamal as interest)
16. Cash A/c Dr 7,000
To 5% loan A/c 7,000
(Being loan from Kamal for interest)
2. On 1st March 2014,the books of accounts of Mr.Raju disclosed the following position:
Cash in Hand Rs.20,000;Cash at Bank Rs.66,000;Stock of goods Rs.42,000;Machinery
Rs.1,00,000;FurnitureRs.15,000;Debtors:Mahesh brother Rs.15,000,Balu Brother: Rs.25,000;
Sundry Creditors: Jonny Brother:Rs.20,000;Loan Rs.50,000.
The transactions during the month:
Date
Particulars Amount(Rs)
March 2014
3 Purchased goods on credit from Sishya & co. 10,000
5 Sold goods for cash 5,000
Sold goods to Mahesh Brothers 10,000
6 Received from Mahesh Brothers in full statement of amount due 14,500
on March 1
7 Payment made to Jonny Brothers by cheque 9,800
Discount allowed 200
10 Sold old furniture for cash 500
12 Purchased goods for cash 1,200
13 Balu Brothers paid by cheque, cheque deposited in Bank 25,000
Repairs and Machinery paid 400
15 Purchased goods of Jonny Brothers 10,000
Freight paid on the goods from Johnny Brothers 100
18 Received cheque from Mahesh brothers, cheque deposited in 9,600
Bank
Discount allowed to them 400
19 Paid by cheque to Jonny Brothers 10,000
20 Bank intimated that the cheque of Mahesh brothers has been 6,000
returned unpaid
21 Cash Sales 7,000
22 Cash deposited in bank 1,000
23 Paid municipal taxes in cash 50
24 Old newspapers sold 1,000
25 Drew cash from bank for office use 2,000
Purchased furniture 8,200
Purchased adding machine and typewriter 500
(Payment in all cases made by cheque)
26 Received interest from bank 5,000
(Amount credited in Bank account)
27 Paid for advertisement 500
31 Paid rent by cheque 3,000
Paid salaries for the month 2,000
Drew out of bank for private use 200
Solution:
Journal entries in the books of Raju
Date Particulars L.F Debit Credit
2014
March 1 Cash A/c Dr 20,000
Bank A/c Dr 66,000
Stock A/c Dr 42,000
Machinery A/c Dr 1,00,000
Furniture A/c Dr 15,000
Mahesh Brothers A/c Dr 15,000
Balu Brothers A/c Dr 25,000
To Jonny Brothers A/c 20,000
To Loan A/c 50,000
To Capital A/c (Bal fig.) 2,13,000
(Being various assets and liabilities on 1st
March2014)
March 3 Purchases A/c Dr 10,000
To Sidhya and co.A/c 10,000
(Being goods purchased on order)
To Sales A/c 5,000
(Being goods sold for cash)
March 5 Mahesh BrothersA/c Dr 10,000
To Sales A/c 10,000
(Being goods sold on credit)
Discount allowed A/c Dr 500
To Mahesh Brothers 15,000
(Being cash received from Mahesh
Brothers & discount allowed to them)
March 7 Jonny Brothers A/c Dr 10,000
To Bank A/c 9,800
To Discount received A/c 200
(Being cheque issued to Johnny Brothers
& discount received from them)
March 10 Cash A/c Dr 500
To Furniture A/c 500
(Being old furniture sold for cash)
March 12 Purchase A/c Dr 1,200
To cash A/c 1,200
(Being goods purchased for cash)
March 13 Bank A/c Dr 25,000
To Balu Brothers A/c 25,000
(Being cheque received and deposited in
bank)
March 13 Repairs A/c Dr 400
To Cash A/c 400
(Being the amount paid for repairs to
machinery)
March 15 Purchases A/c Dr 10,000
To Jonny Brothers A/c 10,000
(Being goods bought on credit)
March 15 Freight A/c Dr 100
To Cash A/c 100
(Being the amount paid for freight on
goods bought from Jonny brothers)
Discount allowed Dr 400
(Being cheque received and deposited in
bank and discount allowed)
March 19 Jonny Brothers A/c Dr 10,000
To BankA/c 10,000
(Being the amount paid by cheque)
March 20 Mahesh Brothers A/c Dr 10,000
To Bank A/c 9,600
To Discount allowed A/c 400
(Being the cheque received from
Mahesh Brothers, dishonored and
discount allowed thereon cancelled)
To Sales A/c 6,000
(Being goods sold for cash )
To Cash A/c 7,000
(Being cash deposited into bank)
March 23 Municipal taxes A/c Dr 1,000
To Cash A/c 1,000
(Being the amount paid as tax)
To Sundry income A/c 50
(Being the income derived from sale of
newspaper)
To Bank A/c 1,000
(Being cash withdrawn from bank for
office use)
March 25 Furniture A/c Dr 2,000
Office Equipment A/c Dr 8,200
To Bank A/c 10,200
(Being assets purchased and paid by
cheque)
March 26 Bank A/c Dr 500
To Interest A/c 500
(Being interest credited in bank A/c)
March 27 Advertisement A/c Dr 5,000
To Cash A/c 5,000
(Being payment for advertisement)
March 31 Rent A/c Dr 500
To Bank A/c 500
(Being rent paid by cheque)
March 31 Salaries A/c Dr 3,000
To Cash A/c 3,000
(Being salaries paid)
March 31 Drawings A/c Dr 2,000
To Bank A/c 2,000
(Being amount drawn out of bank for
personal use)
Bad debts A/c Dr 4,000
(Being 60% of dues received from
Mahesh brother son their becoming
insolvent and Balance written off as bad
debts)
To Bad debts recovered A/c 200
(Being the sum previously written off
now recovered)
1.16 ACCOUNTING PRINCIPLES, CONCEPTS& CONVENTIONS
Accounting Principles:
The rules and guidelines that companies must follow when reporting financial data. The common
set of accounting principles is the generally accepted accounting principles (GAAP). To remain
listed on many major stock exchanges in the U.S., companies must file regular financial statements
reported according to GAAP. Accounting principles differ around the world, and countries usually
have their own, slightly different, versions of GAAP.
To be generally acceptable it has to meet the following criteria–

a) Relevance: It should result in useful or meaningful information to the users.
b) Objectivity: It should be reliable and the results should be verifiable.
c) Feasibility: Can be implemented without undue complexity or cost
Accounting Concepts:
1. Business Entity Concept: A business unit is separate and distinct from the persons who supply
funds to it in order to get a true position of the business.
2. Money Measurement Concept: Only those transactions which can be expressed in terms of
money are recorded in the books of accounts.
3. Accounting Period Concept: A life of business is divided into suitable accounting period. It is
made to ascertain the profit or loss of the business for a particular period (i.e., 31st March) and to
know the financial position of a business on a particular date.
4. Going Concern Concept: Refers to continuous existence of the business concern. The business
is carried on for a number of years in future.
5. Dual Aspect Concept: Every transaction involves two fold aspects –

a) Receiving aspect
b) Giving aspect
Thus every debit must have a corresponding credit.
A simple equation in this regard is –

Assets = Capital + Liabilities
Capital = Assets – Liabilities
6. Historical Record Concept: Only those transactions which have actually taken place must be
recorded.
7. Revenue Recognition Concept: It is mainly concerned with the revenue being recognized in
the income statement (Profit and Loss A/c) of a business. It is recognized in the period in which it
is earned irrespective of the fact whether it is received or not during the period.
8. Matching Concept: The expenses incurred in an accounting period should be matched with the
revenues recognized in that period. (Appropriate cost has to be matched with the appropriate
revenues for that accounting period).
9. Realisation Concept: A business has to record revenue or income, only after it has been
legitimately realized. Eg: If a business sells goods or services, the value is realized only when cash
is received or when the debtor agrees to pay (legal obligation) in future.
10. Objective Evidence Concept: All accounting transactions should be evidenced and supported
by documents such as invoices, receipts, vouchers, etc. These form the basis for making entries in
the books of accounts.
11. Cost Concept: An asset is recorded in the books at the price paid to acquire it and this is the
basis for all subsequent accounting for that asset.
12. Accrual Concept: While preparing Profit and Loss Account of a concern, all revenue items
relating to that period are taken into consideration irrespective of the fact that these items are paid
or payable.
13. Legal Aspect Concept: The accounting record should reflect the legal validity of the
transaction entered in the books. Eg: A concern should not say anybody as its debtors unless he is
legally bound to pay it.
Accounting Conventions:
1. Consistency convention: The accounting rules, practices and conventions followed should
remain the same every year and only then the results of different years can be compared. A change
can be done if it is really necessary by stating its effects clearly.
2. Full disclosure convention: The financial statements should act as a means of conveying and
not concealing. They must disclose all the relevant and reliable information. The disclosure should
be full, fair and adequate.
3. Conservatism convention: It is also known as the concept of prudence. It means that the
accountant should have a cautious approach. He should record lowest possible value for assets and
revenues and highest possible value for liabilities and expenses. Consequently, net assets are more
likely to be understated and income more likely to be overstated.
Eg: making provision for doubtful debts, creating provisions against fluctuations in prices of
investments, etc.
4. Materiality convention: It reveals that only important items should be recorded in the books.
1.17 ACCOUNTING STANDARDS
Meaning of Accounting Standards

“Accounting standards are the policy documents or written statements issued, from time to time,
by an apex expert accounting body in relation to various aspects of measurement, treatment and
disclosure of accounting transactions or events for ensuring uniformity in accounting practices and
reporting.”
These are gradually replacing the different national accounting standards. The rules to be followed
by accountants in order to maintain books of accounts which are comparable, understandable,
reliable and relevant as per the users internal or external.
Objectives of accounting standards

i. To provide information to the users of financial statements regarding the basis of
preparation of accounts and presentation of financial statements
ii. To harmonize the diverse accounting policies and practices which are used in the
preparation/presentation of accounts and statements?
iii. To make the financial statements more meaningful and make the people rely on them
iv. To guide the judgments of professional accountants in dealing with those items which are
to be followed consistently from year to year.
Need for Accounting Standards

Accounting is a language of business, which communicates the financial results, and performance
of an enterprise to various parties and users of financial statement. This language should be used
in such a way that everyone understands it in the same way and to make the financial statement
exhibit a true and fair view of the financial affairs of the enterprise.
The quick growth of international trade and internationalization of firms and the developments of
new communication technologies and the emergence of international competitive forces is
disturbing the financial environment to a greater extent.
Under such global business scenario, the people of the business community are in need of a
common accounting language that can be spoken by all people of the globe. A financial reporting
system of global standard is a pre-requirement for attracting foreign as well as present and
prospective investors at home and this can be achieved through harmonization of accounting
standards.
1.18ACCOUNTING STANDARDS BOARD
 The Institute of Chartered Accountants of India (ICAI), recognizing the necessity to match
the different accounting policies and practices used in India. For this purpose the Accounting
Standards Board (ASB) was constituted on 21st April 1977.
 The structure of the ASB is broad-based and ensures participation of all interested groups in
the standard-setting process.
The Institute of Chartered Accountants of India (ICAI), recognizing the need to harmonize the
diverse accounting policies and practices in use in India, constituted the Accounting Standards
Board (ASB) on 21st April 1977.
The composition of the ASB is fairly broad-based and ensures participation of all interest groups
in the standard-setting process. Apart from the elected members of the Council of the ICAI
nominated on the ASB, the following are represented on the ASB:
(i) Nominee of the Central Government representing the Department of Company Affairs on the
Council of the ICAI
(ii) Nominee of the Central Government representing the Office of the Comptroller and Auditor
General of India on the Council of the ICAI
(iii) Nominee of the Central Government representing the Central Board of Direct Taxes on the
Council of the ICAI
(iv) Representative of the Institute of Cost and Works Accountants of India
(v) Representative of the Institute of Company Secretaries of India
(vi) Representatives of Industry Associations (one from Associated Chambers of Commerce and
Industry (ASSOCHAM), one from Confederation of Indian Industry (CII) and one from Federation
of Indian Chambers of Commerce and Industry (FICCI)
(vii) Representative of Reserve Bank of India
(viii) Representative of Securities and Exchange Board of India
(ix) Representative of Controller General of Accounts

(x) Representative of Central Board of Excise and Customs
(xi) Representatives of Academic Institutions (on from Universities and one from Indian
Institutes of Management)
(xii) Representative of Financial Institutions
(xiii) Eminent professionals co-opted by the ICAI (they may be in practice or in industry,
government, education, etc.)
(xiv) Chairman of the Research Committee and the Chairman of the Expert Advisory Committee
of the ICAI, if they are not otherwise members of the Accounting Standards Board
(xv) Representative(s) of any other body, as considered appropriate by the ICAI
Functions
The Financial Accounting Standards Board is responsible for establishing, updating, clarifying,
and publishing. Both the principles and the specific practices that constitute acceptable private-
sector financial accounting. Individual businesses, accounting and industry associations and
government agencies, among other sources, request findings from the FASB on issues ranging
from the consolidation of subsidiaries to post-employment benefits.
The FASB operates through a process of research projects, discussion of memoranda, public
hearings, comment letters, and proposal drafts. The FASB’s ultimate findings on agenda items are
published as Statements of Financial Accounting Standards, which businesses are required to
adhere to. As of 1999, there were on record 134 such statements, some of which had been
subsequently amended or superseded.
An extensive research and technical staff, along with special task forces generally appointed by
the chair, assist the FASB in its standard-setting function. The Financial Accounting Standards
Advisory Council (FAS AC), a separate branch of the FAF, routinely advises the FASB on
fulfilling its complex mission, particularly in the setting of agenda priorities.
For public-sector accounting, the FASB and the FASAC are complemented within the FAF by the
Governmental Accounting Standards Board (GASB) and the Government Accounting Standards
Advisory Council (GASAC). Pronouncements by various government agencies (particularly the
SEC) and professional bodies (particularly the AICPA’s Accounting Standards Division) also
supplement the work of the Financial Accounting Standards Board.
1.19 FORMULATION OF ACCOUNTING STANDARDS-PROCEDURE
The procedure for setting standards for accounting, by its nature itself involves reaching an ideal
balance of the requirements of the financial information for various interested groups having a
stake in financial reporting. With a view to reach a consensus to the best extent possible as per the
requirements of the relevant interest-groups and thus bringing about a general acceptance of the
Accounting Standards among these groups, considerable amount of research, consultations and
discussions with the representatives of the important interest-groups at different stages of standard
formulation becomes important. The standard-setting procedure of the ASB is briefly outlined
below has been designed in such a way that it ensures such consultation and discussions:
The broad areas identified by the ASB for the purpose of formulation of accounting standards are
as follows:
• Constitution of a study groups by the ASB for the purpose of preparing the preliminary
drafts of the suggested Accounting Standards.
• A Consideration of the introductory draft prepared by the study group of the ASB and
reconsideration, of the draft if any on the basis of discussions at the ASB
• Circulation of the draft which has been revised among the Council members of the ICAI
and among the 12 specified outside bodies such as Standing Conference of Public
Enterprises (SCOPE), Indian Banks’ etc.
• Association from Confederation of Indian Industry (CII), SEBI and Comptroller and
Auditor General of India (C& AG) and from the Department of
• Company Affairs are important in order to enable them to make their comments.
• Meetings with the representatives of specified outside bodies in order to get their views on
the draft proposed by Accounting Standard.
• Finalizations of the Draft proposed by Accounting Standard on the basis of comments that
were received and discussions held with the representatives of specified outside bodies.
• Issuing the Exposure Draft and inviting public comments.
• Consideration of the feedback received on the Exposure Draft and finalizing the draft of
Accounting Standard by the ASB for the purpose of submission to the Council of the ICAI
for its Consideration and approval for the same.
• Consideration of the draft Accounting Standard by the Council of the Institute, and if it is
found necessary, modification of the draft is done in consultation with the ASB.
• The Accounting Standard that is finalized is issued under the authority of the Council.
1.20 OVERVIEW OF INDIAN ACCOUNTING STANDARDS
Following are the Indian Accounting Standards:

No. Name of the Accounting Standard Status
AS 1 Disclosure of the accounting policies Compulsory
AS 2 Valuation of inventories (revised)
AS 3 Cash Flow statements (revised)
AS 4 Contingencies & Events occurring after the (revised)
Balance Sheet Date
AS 5 Net Profit or Loss for the period, Prior period (revised)
items and Changes in Accounting policies
AS 6 Depreciation accounting (revised)
AS 7 Accounting for construction contracts (revised)
AS 9 Revenue recognition Mandatory
AS 10 Accounting for fixed assets These standards are
withdrawn either in full
or in parts of with the
issuance of AS 26
AS 11 The effects of changes in foreign exchange rates (revised)
AS 12 Accounting for government grants Mandatory
AS 13 Accounting for investments Mandatory
AS 14 Accounting for amalgamation Mandatory
AS 15 Accounting for retirement benefits in the Mandatory
financial statements of employers
AS 16 Borrowing costs Mandatory
AS 17 Segment reporting Mandatory
AS 18 Related party disclosures Mandatory
AS 19 Leases Mandatory
AS 20 Earnings per share Mandatory
AS 21 Consolidated Financial Statements Mandatory
AS 22 Accounting for taxes on income Mandatory
AS 23 Accounting for investments in associates in Mandatory
consolidated financial statements
AS 24 Discounting operations Mandatory
AS 25 Interim financial reporting Mandatory
AS 26 Intangible assets Mandatory
AS 27 Financial reporting of interests in joint ventures Mandatory
AS 28 Impairment of assets Mandatory
AS 29 Provisions, contingent Liabilities and contingent Mandatory
assets
AS 30 Financial instruments: Recognition and Mandatory w.e.f. 1-4-
measurement 2011
AS 31 Financial instruments: Presentations Mandatory w.e.f. 1-4-
2011
AS 32 Financial instruments: Disclosures Mandatory w.e.f. 1-4-
2011
1.21 LIST OF INTERNATIONAL ACCOUNTING STANDARDS (IAS)
No. Name of the IAS
IAS 1 Disclosure of accounting policies
IAS 2 Valuation and presentation of inventories
IAS 3 Consolidated financial statements
IAS 4 Depreciation accounting
IAS 5 Information to be disclosed in financial statements
IAS 6 Accounting response to changing prices

IAS 7 Statement of changes in financial position
IAS 8 Treatment in the Income statement of unusual items and prior

period
items, and changes in accounting policies and procedures
IAS 9 Accounting for research and development activities
IAS 10 Contingencies and events occurring after the balance sheet date
IAS 11 Accounting for construction contracts
IAS 12 Accounting for taxes on income
IAS 13 Presentation of current assets and current liabilities
IAS 14 Reporting of financial information by segments
IAS 15 Information reflecting the effect of changing prices
IAS 16 Accounting for property, plant and equipment
IAS 17 Accounting for lease
IAS 18 Revenue recognition
IAS 19 Accounting for retirement benefits in the financial statements

of Employers
IAS 20 Accounting for Government grants and disclosure of

Government assistance
IAS 21 Accounting for the effects of changes in foreign exchange rates
IAS 22 Accounting for business combinations
IAS 23 Capitalization of borrowing costs
IAS 24 Related party disclosures
IAS 25 Accounting for investments
IAS 26 Accounting and reporting of retirement benefit plans
IAS 27 Consolidated financial statements and accounting for

investment in subsidiaries
IAS 28 Accounting for Investments in associates
IAS 29 Financial reporting in hyper-inflationary economics
IAS 30 Disclosures in financial statements and accounting for

investments in Subsidiaries
IAS 31 Financial reporting of interests in joint ventures
IAS 32 Financial investments, disclosures and presentations
IAS 33 Earnings Per Share
IAS 34 Interim Financial Reporting
IAS 35 Discontinuing operations
IAS 36 Impairment of Assets
IAS 37 Provisions, contingent liabilities and contingent assets
IAS 38 Intangible Assets
IAS 39 Financial instruments, Recognition and measurement
IAS 40 Investment property
IAS 14 Agriculture
1.22SUMMARY
 Accounting is the process of identifying, measuring, recording and communicating economic

information to permit informed judgments and decisions by users of the information.
 Financial accounting is concerned with classifying, measuring and recording the transactions
of a business.
 Financial accounts are geared towards external users of accounting information. To answer
their needs, financial accountants draw up the profit and loss account, balance sheet and cash
flow statement of the company.
 Book keeping is the process of recording business transactions.
 In order to present the financial statement in a fair and consistent manner, Generally
Accepted Accounting Principles (GAAP) are adopted by the organizations.
 Accounting is based on the underlying assumptions such as Separate Entity, Going concern,
Money measurement, Periodicity concept, etc.
 The principles which are followed while preparing and presenting the data are Matching
concept, full disclosure, Revenue recognition, etc.
 The main users of financial statements are Investors, Creditors, Lenders, Government,
employees, Shareholders, etc. The statements must be prepared in a fair manner in order to
protect the interest of these stakeholders.
 The total assets of the business, equal to the sum of the assets contributed by investors and
the assets contributed by creditors, the relationship is referred to as the accounting equation.
Practically it can be shown as follows: Assets = Owner’s Equity + External Liabilities.
 Accounting standards provide rules and guidelines for observance in the work of preparation
of accounts and presentation of financial statements.
 The composition of the ASB is fairly broad-based and ensures participation of all interest-
groups in the standard-setting process.
 The sequence of activities beginning with the occurrence of a transaction till its inclusion in
the financial statements relating to the respective accounting period is known as the
accounting cycle.
 There are three golden rules of accounting. They are:
i) The personal account rule-Debit the receiver, credit the giver.
ii) The real account rule-Debit what comes in, credit what goes out.
iii) Nominal account rule-Debit all expenses and losses, credit all incomes and gains.
 The accounting concepts are the assumptions or postulates or ideas which are essential to the
practice of accounting and preparation of financial statements. The accounting concepts are
sub-divided according to their importance.
 Accounting conventions are the established traditions, customs, methods and practices which
usually act as guidelines for preparation and presentation of accounts. The conventions have
been accepted for their utility and importance in making financial statements more realistic,
reliable and useful to the end users.
 The accounting process involves four important steps. They are:
i) Recording, ii) Classifying, iii) Summarizing) Finalizing
1.23 QUESTIONS
Section A
1. Give the meaning of accounting.
2. Define ‘Accounting’.
3. What is Book Keeping?
4. State the functions of accounting.
5. What is meant by accounting convention?
6. What do you mean by Accounting Information?
7. Write different names of Accounting Concepts.
8. What are assets?
9. What is a liability?
10. Expand GAAP.
11. What are Accounting standards?
12. List any two Indian Accounting Standards.
13. What is ASB?
14. What is meant by accounting cycle?
15. List out the steps in accounting process.
16. What are the prominent methods of accounts?
17. What are the types of accounts in the Indian context?
18. List out the “Golden Rules of Accounting”.
19. State any two advantages of accounting?
20. State any two objectives of accounting?
21. List out the steps in accounting
Section B
1. Explain need for Accounting.
2. Explain the features of Accounting.
3. Distinguish between Book keeping and Accounting.
4. Write a note on accounting equations.
5. What are accounting standards? Discuss the main objectives of such standards.
Section C
1. What are the functions of Accounting? Discuss.
2. Explain users of accounting information.
3. What are the advantages and disadvantages of Accounting?
4. Explain Accounting principles.
5. What are accounting standards? List the accounting standards issued by Accounting Standards
Board in India.
6. Rewrite the accounting equation after each of the following transactions:
a. Started business with Cash Rs.3, 00,000/-, Stock Rs.2,00,000/-, Fixed assets Rs.2,00,000/-
Creditors Rs.1,50,000/-
b. Credit purchases of goods Rs.3,00,000/-
c. Cash purchases of goods Rs.90,000/-
d. Credit Sales Rs.20,000/-, Cost of goods Rs.16,000/-
e. Opened a bank account and deposited Rs.50,000/-
f. Gave advance salary Rs.10,000/-
g. Cash sales Rs.25,000/-, Cost of the goods Rs.25,000/-
h. Withdrawn cash from bank for office expenses Rs.10,000/-
i. Received an advance deposit from the cashier Rs.25,000/-
j. Withdrawn for personal expenses Cash Rs.5,000/-, Goods Rs.1,000/-
k. Paid two months’ rent in advance Rs.24,000/-
l. Received cash from debtors Rs.950/-, allowed discount Rs.50/-
m. Machinery depreciated by Rs.2,000/-
n. Paid creditors Rs.4,900/-, received discount Rs.100/-
o. Land value appreciated by Rs.6,000/-
7. Mr. Ram started a business under the name of Ram and Co. The details of the transactions of
his business are given below. Write accounting equation for the same.
a. Started business with Capital of Rs.1,00,000

b. Bought goods on Credit from Raju Rs.80,000
c. Bought furniture for cash Rs.10,000
d. Sold goods for cash Rs.40,000
e. Paid Raju on account Rs.40,000
f. Paid shop rent Rs.10,000
g. Paid salaries Rs.5,000
h. Sold goods on credit to Komal Rs.25,000
i. Withdraw cash for personal use Rs.10,000
j. Received commission Rs.5,000
8. Rewrite the accounting equation after each of the following transactions.
1. Commenced business with Cash Rs.1,20,000

2. Purchased assets for cash Rs.25,000
3. Sold assets of Rs.10,000 for Rs.12,000
4. Sold assets of Rs.5,000 for Rs.4,000
5. Goods destroyed by fire Rs.1,000
6. Withdrew cash for personal use Rs.5,000
7. Rent outstanding Rs.5,000
8. Insurance paid in advance Rs.400
9. Interest on loan allowed Rs.6,000
10. Depreciation on furniture Rs.2,500
9. . Journalize the following transactions in the books of Balu as:
a) Mr. Balu started business by investing cash Rs.50,000.He bought goods of Rs.4,000 and
Furniture of Rs.500.
b) Purchased building for Rs.10,000
c) Purchased goods for cash for Rs.3,000
d) Purchased goods on credit for Rs.2,500
e) Paid cartage Rs.20
10. Journalize the following transactions in the books of Mr.

2013 Particulars Amount
Dec 1 Mr. commenced business with a capital 1,00,000
3 Bought goods for cash 60,000
5 Deposited in IOB 40,000
6 Bought goods from Ravi 30,000
7 Bought furniture for cash 4,000
8 Sold goods to Nathan 40,000

9 Paid cash to Seenu 10,000
10 Nathan returned goods worth 2,000
11 Paid advertisement charges 4,000
12 Returned goods to Ravi 3,000
13 Withdrew cash from bank 10,000
15 Bought a bicycle for office use 3,000
16 Received commission 1,000
18 Drew cash for personal use 6,000
19 Electricity charges paid 600
KEPT FOR STUDENTS SELF STUDY

11. The following are the transactions of Shekhar and Co., for the month of July. Journalize the
following transactions:
2014 Particulars Amount
July 1 Capital paid into bank 10,000
Bought stationary cash 60
2 Bought goods for cash 4,200
3 Bought postage stamps 20
6 Bought office furniture from Babu Brothers 1,000
11 Sold goods to Mohan 2,000
12 Received cheque from Mohan 2,000
14 Paid Babu Brothers by cheque 1,000
16 Sold goods to Raj and co. 1,000
20 Bought goods from Swamy and Brothers 1,400

23 Bought goods for cash from Nathan Brothers & co 450
24 Sold goods to Mr.Prashanth 700
26 Raj and Co. paid on account 500
27 Paid Swamy and Brothers by cheque in full settlement 1,370
31 Paid Salaries 500
Rent is due to Sathya but not yet paid 200
12.. The following transactions belong to Mr. Kumar. Provide accounting equations for the same.
1. Started business with cash of Rs. 3,60,000
2. Rent paid in advance Rs. 8,000
3. Goods purchased for cash Rs . 1,00,000 and on credit Rs. 40,000
4. Sold goods worth Rs. 48,000 for cash of Rs. 80,000
5. Rent paid Rs. 20,000 and rent outstanding Rs. 4,000
6. Purchased motor cycle for personal use Rs. 1,60,000
7. Equipment purchased for cash of Rs. 10,000
8. Paid to creditors Rs. 12,00
9. Depreciation of Equipment Rs. 500
10. Business expenses Rs . 8,000
1.23 ANSWERS
Section A
1. Refer 1.3
2. Refer 1.3
3. Refer 1.2
4. Refer 1.3
5. Refer 1.16
6. Refer 1.8
7. Refer 1.16
8. Refer 1.11
9. Refer 1.11
10. Refer 1.22
11. Refer 1.17
12. Refer 1.20
13. Refer 1.18
14. Refer 1.13
15. Refer 1.5
16. Refer 1.7
17. Refer 1.12
18. Refer 1.12
19. Refer 1.5
20. Refer 1.3
21. Refer 1.5
Section B
1. Refer 1.3
2. Refer 1.3
3. Refer1.4
4. Refer 1.12.2
5. Refer 1.17
Section C
1. Refer 1.3
2. Refer 1.8
3. Refer 1.5
4. Refer 1.12
5. Refer 1.16 & 1.19
6. Final new equation: - Total Assets-10,22,050; Capital-5,52,050; Externalliability-4,70,000
7. Final new equation: - Total Assets-1,20,000; Capital-80,000; External liability-40,000
8. Final new equation: - Total Assets-1,12,500; Capital-1,06,000; External liability-6,500
12. Final new equation:- Total Assets-2,31,500; Capital-1,99,500; External liability-32,000
MODULE II
DISSOLUTION OF PARTNERSHIP
STRUCTURE
2.1 Introduction to the fundamentals partnership accounts
2.2 Partnership deed
2.3 Dissolution of a partnership firm
2.4 Modes of dissolution
2.5 Settlement of Account
2.6 Differences between dissolution of partnership and dissolution of firm
2.7 Procedure/ process of dissolution
2.8 Accounting procedure for dissolution
2.9 Journal entries in the books of the firm
2.10 Treatment of special items and Illustrations
2.11 Insolvency
2.12 Case of Garner vs. Murray
2.12.1 Applicability of Garner Vs Murray in India
2.12.2 Fixed and fluctuating capitals – Cases & Illustrations
2.13 Insolvency of all partners
2.13.1 Steps to be followed in preparing insolvency accounts
2.13.2 Determination of the insolvency of a partnership firm
2.14 Summary
2.15 Terminal questions
2.16 Terminal Answers
Learning Objectives:
 To recapitulate students with regard to the fundamentals of partnership.
 To understand the meaning, legal provisions relating to dissolution of a partnership firm and
the necessary accounts that should be prepared to close the books of the firm.
2.1 INTRODUCTION TO THE FUNDAMENTALS PARTNERSHIP ACCOUNTS
Partnership is a form of business organization like sole trading or a company. A partnership is

owned and managed by two or more persons who share its profit and generally its losses. The rules
and regulations regarding the starting of a partnership are governed under the Indian partnership
act 1932.
According to section 4 of Indian partnership act 1932, Partnership is defined as, “the relationship
between persons who have agreed to share profits of a business carried on by all or any of them
acting for all”.
A person making an agreement to carry on business for a common purpose is called as a partner
individually and collectively it is known as a firm, the name under which the business is carried is
carried on is called “Firm name”.
From the above definitions, the following features of a partnership firm can be identified. They
are:
i) Agreement: To start a partnership or a partnership firm, there must be a written agreement
between the two partners.
ii) Purpose of Business: The partnership is formed to carry out business lawfully. The business
must be carried on by all or by a representative of the partners.
iii) Sharing of profit: The main objective of the agreement between the two partners is to earn
profits and distribute them among its partners. Profit- sharing is a fundamental right every partner
enjoys. Sometimes according to the agreement the partners are required to share losses.
iv)Mutual and Implied Agency: Mutual and implied agency is the very essence of partnership.
Every partner is both a principal and agent to other partners
v) Minimum members: According to the Indian partnership act 1932, partnership is an

association of a minimum of two or more persons. In the case of starting the banking firm, then
the minimum members must not exceed ten and in case of other business firms it must not be more
than twenty.
2.2 PARTNERSHIP DEED
Partnership is formed from the agreement between two or persons to carry on a business jointly
for the common benefit of all. It is very essential that the partnership agreement must be in writing.
The document or the instrument, containing the agreement between the partners, is known as a
partnership deed.
The essential contents present in the partnership deed are as follows:

a) Name of the firm and nature of business.
b) Names and addresses of the partners.
c) Duration, if any of the partnership firm.
d) The total capital of the firm and the share of each partner.
e)The ratio of sharing profits and losses.
f) Whether the capital has to be fixed or floating.
g) Whether any interest is to be allowed on partner’s capital, and if so, at what rate.
h) Rate on interest on advances.
i)Whether any interest has to be charged on drawings. The rate of interest must also be specified.
j)The amount of salaries or some allowance, if any, payable to the partners.
k)The amount which each partner can withdraw for his private expenses.
l) The provision relating to maintaining proper accounting records.
m) The date on which the final accounts are to be prepared.
n) The conduct of the financial audit.
o)Admission of new partners and expulsion of existing ones.
p)The method of ascertaining the share of goodwill of a partner on his retirement or death.
q) Whether decision in case of Garner Vs Murray is applicable for insolvency of a partner.
Rules applicable in the absence of a partnership deed
The partnership deed forms the basis of starting a partnership firm. In the absence of partnership
deed the following rules are applicable. They are:
a) Profit sharing ratio: The profit sharing ratio plays an important role whiling allocating the
profit s to the partner. Thus, the profits and losses are to be apportion equally among the agreed
partners.
b) Interest paid on loan: Individual partner is entitled to pay interest on the amount of loan
granted by other partners. Then, the respective partner is entitled to interest on the same at 6% per
annum.
c) Interest on capital: No interest is to be allowed on capital. If under the agreement any interest
has to be paid, then such interest will be paid only when the firm earns profit. In the case of loss,
no interest on capital is allowed.
d) Partners’ salary: The partners are not entitled for any salary or other remuneration.
e) Interest on drawings: No interest is charged on drawings. The above points can be modified
whenever required.
2.3DISSOLUTION OF A PARTNERSHIP FIRM
Introduction
Partnership refers to the relationship between the partners and all the partners together are called
‘firm’. Dissolution means closing down of business and dissolution of partnership firm refers to
the termination of the relationship between the partners of the firm, which results in closing down
of the business of the firm. This module highlights the meaning of dissolution and the difference
between dissolution of partnership and partnership firm. The accounting treatment which involves
passing journal entries and preparation of ledger accounts is discussed in detail.
To understand the meaning, legal provisions relating to dissolution of a partnership firm and the
necessary accounts that should be prepared to close the books of the firm.
Meaning and definition of Dissolution in a Partnership Firm
Dissolution of a partnership firm means the dissolution of partnership between all the partners of
the firm (sec 39 of the Indian partnership act). In other words, dissolution of partnership firm
means the end of the partnership firm.
Definition:
Indian partnership act, 1932defines, dissolution of a firm as “the dissolution of partnership,

between all the partners of a firm. It means when all the partners in a firm or except one partner,
cut off their relationship with the firm, it is called dissolution of a firm.
On the other hand, dissolution of partnership is nothing but reconstitution of partnership on account
of change in the relationship among partner. It means when a partner is admitted, retired, dies or
becomes insolvent etc, then the firm carries business under a new constitution of partnership. In
case of dissolution of partnership, the firm will not be closed, but will continue to exist with new
deed, name and partners etc.
2.4 MODES OF DISSOLUTION
A partnership firm may be dissolved in any one of the following ways:

1. Dissolution by agreement:
A partnership firm can be dissolved at any time by mutual consent of all the partners.
2. Compulsory dissolution:
There are certain cases in which a firm becomes illegal and stands dissolved. The following are
such cases:
(i) If all the partners except one or all of them are declared insolvent.
(ii) When the number of partners exceed 20
(iii)When a citizen of an enemy country becomes a partner.
(iv) When the business of the firm is opposed to public interest.
3. Dissolution on happening of certain events:

A firm may also get dissolved in the following cases:
i) On the expiry of the period for which it was formed.
ii) On the death of a partner
iii) On the completion of the venture agreed upon
4. Dissolution by notice:
In case the partnership is at will, on any partner giving notice in writing to other partners with the
intention to dissolve the firm, it will be treated as dissolved from the date which is mentioned in
the notice.
5. Dissolution by court:
A court can order the dissolution of the partnership firm in the following cases:
i) When a partner transfers/sells his share to a third party without the consent of other partners.
ii) When a partner becomes of unsound mind.
iii) When a partner gets disabled permanently.
iv) When a partner is found guilty of misconduct.
v) When the firm cannot be carried on except with losses.
2.5 SETTLEMENT OF ACCOUNT
In the absence of any specific agreements between the partners of the firm as to the mode of
settlement of accounts after the dissolution of the partnership firm, the provisions of Sec. 48, 49
and 55 shall apply. These are as follows:
1. As regards losses.
Losses, including deficiencies of capital shall be paid first out of the profits. Next out of the capital,
and lastly, if necessary, by the partners individually in the proportions in which they are entitled
to share profits. (Sec 48(1)).
2. As regards assets.
The assets of the firm, including any sums contributed by the partners to make up the deficiencies
of capital, shall be applied in the following manner and order:
a) In paying the debts of the firm to third parties.
b) In paying each partner ratably what is due to him from the firm as advances
c) In paying to each partner ratably what is due to him on account of capital and
d) The residue, if any would be divided among the partners in the proportions in which they were
entitled to share profits (Sec. 48(2)).
The residue represents the total surplus realized by the firm and is a combination of trading
profits/losses and realization profit/losses. Realization profit/loss arises because of the realization
of assets and settlement of liabilities at the time of dissolution.
2.6 DIFFERENCES BETWEEN DISSOLUTION OF PARTNERSHIP AND

DISSOLUTION OF FIRM
Dissolution of partnership
Point of difference Dissolution of partnership firm
The nature Less comprehensive More comprehensive and
includes dissolution of
partnership.
The possibility of This can take place any number This can take place only once in
happening of times in the life time of the the life time of the firm.
firm.
The impact The firm continues even after The firm cannot continue after
this. this.
The treatment of The assets and liabilities are The assets are realized and
assets and liabilities merely revalued. liabilities are repaid.
The relationship The mutual relationship The mutual relationship
between/among the between/among partners may or between/among partners is
partners. may not affected. severed permanently.
The mutual impact This does not result in dissolution This does result in the
of the firm. dissolution of partnership also.
2.7 PROCEDURE/ PROCESS OF DISSOLUTION
The following steps are to be followed in settlement of dissolution of a firm

•Appointment of a person may be a partner or an outsider to take up the process of
dissolution who is known as liquidator or official assignee. He may be appointed by the
Step 1 partners or creditors or by the court.
•Realization of cash by selling all asset of the firm

Step 2
•Payment of external liabilities like creditors, bills payable, outsider’s loan, outstanding
Step 3 expenses etc.
•Repayment of partner’s loan, if any

Step 4
•Payment of partners claims

Step 5
•Distribution of surplus to partners if any

Step 6
2.8 ACCOUNTING PROCEDURE FOR DISSOLUTION
Step 1: Preparation of Realization a/c
Step 2: Preparation of Capital Accounts of the

Partners
Step 3: Preparation of Cash/Bank a/c
The above accounts are discussed as follows:

1. Realization account:
It is a nominal account opened to record both assets and external liabilities of the firm at their book
values and as well as realized values. Further it also helps to find out the profits or loss on
realization, which is transferred to partner’s capital account.
2. Capital accounts:
Partner’s capital account is to be prepared to know their claims against Firm and vice-versa. To
find out their claims, the capital balance, current account balance, reserve fund, undistributed
profits or losses, realization profit or loss, any other fund which there is no claim etc. are to be
transferred to their respective capital account. The deficit/debit balance should be made good by
the partner.
3. Cash account:
Finally we have to prepare cash or bank account to show the final settlement of partner’s claims
as well as all cash transactions resulting in closure of the firm’s business.
2.9 JOURNAL ENTRIES IN THE BOOKS OF THE FIRM
1. For closing asset accounts:

Realization A/c Dr. xx
To individual asset A/c xx
Note: a) Accumulated losses are transferred to partners’ capital accounts.

b) Cash and bank balances are not transferred unless the entire business is sold.
c) Debtors must be transferred at the gross value when a provision against debtors is given.
2. For closing liability accounts:

Individual liability A/c Dr. xx
To Realization A/c xx
Note: a) In the case of some liabilities, assets may be transferred in part settlement. In such cases
the liability account must be debited with the agreed value of asset transferred, and only the balance
of liability must be transferred to realization account.
b) Partners’ loan accounts which are also liabilities are usually not transferred to realization
account.
c) Provision against debtors must be transferred along with other liabilities.
3. For realization of assets

i) Through sale in the market
Bank A/c Dr. xx
ii) When taken over by partners at an agreed value

Capital A/c Dr. xx
iii) When taken over by creditors in part satisfaction of their claims

Liability A/c Dr. xx
4. For Paying off liabilities:

i) When paid out of amounts realized
To Bank A/c xx
ii) When a partner takes over the liability

To capital A/c xx
5. Expenses paid by firm on dissolution:

To Bank A/c xx
6. Expenses borne by partner but is entitled to a fixed remuneration:

To Capital A/c xx
Note: Actual expenses incurred are ignored.
7. For transferring reserves and credit balance in P/L A/c:

Reserve A/c Dr. xx
P/L A/c Dr. xx
To Capital A/c
8. For transferring debit balance in P/L A/c:

Capital A/c Dr. xx
To P/L A/c xx
9. For closing realization a/c

In case of profit:
To Capital A/c xx
In case of loss:
Capital A/c Dr. xx
To Realization a/c xx
10. For payment of loans due to partners:

Loans A/c Dr. xx
To Loan a/c xx
11.For closing capital accounts:

In case of credit balances;
Capital A/c Dr. xx
To Bank A/c xx
In case of debit balances:

Bank A/c Dr. xx
To Capital A/c xx
2.10 TREATMENT OF SPECIAL ITEMS AND ILLUSTRATIONS
Treatment of Goodwill
If it appears in the balance sheet, it is treated like any other asset and is closed by transferring it to
realization account at book value. If it does not appear, it is not to be calculated. If something is
realized towards goodwill then cash account (or partner’s capital account in case goodwill is
purchased by one of the partners) is debited and realization account is credited.
Illustration 1:
A, B and O are partners sharing profits and losses as to 2 : 2 : 1. The balance sheet on 31st
December, 1976 is as follows:
Liabilities Rs. Assets Rs.
Creditors 2,000 Cash 2,000
A 5,000 Sundry debtors 1,300
B 2,000 Less: Provision for 300
bad debts
C 1,000 8,000 1,000
Stock 2,000
Fixtures and other 5,000
assets
10,000 10,000
They decide to go out of business. The following are the amounts realized:
Rs.
Fixtures and other assets 4,500
Stock 2,260
Debtors 900
Creditors paid on complete discharge 1,900
Expenses on realization 60
Show the necessary accounts to close the books of the partnership firm.
Solution:
During dissolution of a partnership firm the following accounts are prepared to close all the
accounts of the firm – Realization A/c, partners’ capital A/c and cash A/c.
Note:
1. All assets except cash will have to be transferred to the debit side of realization A/c. Debtors
should be transferred at the gross value.
2. All the liabilities including provision for bad debts should be transferred to the credit side of
realization A/c.
3. The realization A/c is balanced by transferring the loss to the partners’ capital A/c in the profit
sharing ratio – 2:2:1.
Realization Account
Dr. Cr.
Particulars Rs. Particulars Rs.
To Sundry assets: By Creditors 2,000
Sundry debtors 1,300 By Provision for bad debts 300
Stock 2,000 By Cash:
Fixtures and other assets 5,000 Sundry debtors 900
Stock 2,260
Fixtures and other assets 4,500
To Cash: By Loss on realization:
Creditors 1900 A 120
Realisation expenses 60 B 120
C 60 300
10,260 10,260
A’s Capital Account

Dr. Cr.
To Realization A/c 120 By Balance b/d 5000
To Cash A/c 4,880
5000 5000
B’s Capital Account

Dr. Cr.
To Cash A/c 1,880
2000 2000
C’s Capital Account

Dr. Cr.
To Cash A/c 940
1000 1000
Cash Account
Dr. Cr.
To Balance b/d 2000 By Realization A/c
To Realization A/c Creditors 1,900
Sundry debtors 900 Realisation expenses 60
Stock 2260 By A’s account 4,880
Fixtures and other assets 4500 By B’s account 1,880
By C’s account 940
9,660 9,660
Accounting for unrecorded assets and liabilities

At the time of dissolution, there may be some assets not appearing in the books of accounts but
exist (the asset was probably written off earlier but does exist physically). There may be some
liabilities which are not recorded like a pending case that was decided or a contingent liability.
Both, unrecorded assets and liabilities are not transferred to the realization A/c as they do not
appear in the accounts.
Amount realized from the unrecorded asset should be recorded by the following entry:
Dr. xx
Cash / Partner’s capital A/c
If the asset is sold, cash a/c should be debited and if it is taken over by a partner, the capital a/c
should be debited.
For settling the amount due for the liability, the following entry should be passed:
To Cash / Partner’s capital A/c. xx

If amount is paid, cash A/c should be credited and if it is taken over by a partner, the capital A/c
should be credited.
Treatment of contingent liability:
As these liabilities have not been recorded in the books of the firm, and as such, have no book
value, there is no question of the transfer of these liabilities to realization account at their book
values. However, if these liabilities mature and become actual liabilities at the time of the
dissolution of the firm, these liabilities should be paid like any other liabilities and the actual
amount paid in respect of these liabilities should be brought into account in the realization account
by debiting realization account and crediting cash or bank account or partner’s capital account .
Illustration 2:
M, N and O showing profits and losses in the ratio of 3 : 2 : 1 agreed to dissolve their firm on 31-
12-1980. Their balance sheet on that date was as shown below:
Particulars Rs. Rs. Particulars Rs. Rs.
Creditors 18,500 Machinery 40,500
Mrs. M’s loan 10,000 Investments 20,830
Life policy fund 14,000 Stock 7,550
Investment 6,000 Joint-life policy 14,000

fluctuation fund
Capitals – Debtors 9,300
M 40,000 Less: Provision 600 8,700

for doubtful
debts
N 20,000 60,000 Bank 5,420
O’s Capital a/c 11,500

1,08,500 1,08,500
The life policy is surrendered for Rs. 12,000. M took over the investments at Rs. 17,500 and agreed
to discharge his wife’s loan. N took over all the stock at Rs. 7,000 and Debtors amounting to Rs.
5,000 at Rs. 4,000, remaining debtors realized 50% of their book value and machinery realized at
Rs. 53,800. Expenses of realization were Rs. 870.
An investment not received in the books worth Rs. 3,000 was taken over by one of the creditors at
the same value. Show the necessary ledger accounts to close the books of the firm.
Solution:
Realisation Account
Dr. Cr.
1980 Rs. 1980 Rs.
Dec, 31. To sundry
Dec. 31 By Sundries :
assets:
Provision for doubtful
Machinery 40,500 600
debts
Investments 20,830 Creditors 18,500
Stock 7,550 Mrs. M’s Loan 10,000
Joint-life policy 14,000 Life Policy fund 14,000
Investment fluctuation
Debtors 9,300 92,180 6,000 49,100
fund
To M’s Capital account
- Mrs. M’s Loan 10,000 By Bank account
To Bank – Payment of 15,500 Joint life policy 12,000
Creditors
To Bank – Realization 870 Debtors (50% of 4,300) 2,150
expenses
To Capital Accounts – Machinery 53,800 67,950
Profit on realization
M 13,500 M’s Capital a/c – 17,500
investments
N 9,000 N’s Capital account
O 4,500 27,000 Stock 7,000
Debtors 4,000 11,000
1,45,550 1,45,550
Capital Account
Dr Cr
M N O M N O
Rs. Rs. Rs. Rs. Rs. Rs.
To Balance b/d - - 11,500 By Balance b/d 40,000 20,000 -
To Realization 17,500 11,000 - By Realization 13,500 9,000 4,500

a/c- a/c-
Assets taken Profit
over
To Bank – final 46,000 18,000 - By Mrs. M’s 10,000 - -
settlement Loan
By Bank a/c – 7,000
Cash brought in
63,500 29,000 11,500 63,500 29,000 11,500
Bank Account
Dr Cr
To Balance b/d 5,420 By Realization a/c – 15,500
creditors paid
To Realization a/c- 67,950 By – do – expenses 870
Sale of assets
To O’s Capital a/c 7,000 By M’s Capital a/c final 46,000
payment
By N’s Capital a/c – final 18,000
payment
80,370 80,370
Illustration 3:
X, Y, and Z sharing profits in the ratio of 2: 2: 1 agreed upon dissolution of their partnership on
30th June, 1980 on which date their balance sheet was as under:
Liabilities Amount Assets Amount

Capital - X 40000 Fixed assets 50000
-Y 30000 Life policy(at surrender value) 10000
Reserve fund 10000 Debtors 10000
(-) provisions 500 9500
Joint life policy fund 10000 Stock at invoice price 10000
(-)price unloading 2000 8000
Creditors Capital Z 2000
19000 18500
(-) provision for discount 500
Salary outstanding 2000 Bank 23500
Investment fluctuating fund 500 Investments 8000
1,11,000 1,11,000
Investments were taken over by X at Rs.6,000; creditors of Rs.10,000 were taken over by Y who
has agreed to settle account with them at Rs.9,900. Remaining creditors were paid at Rs. 7,500.
Joint life policy was surrendered and fixed assets realized Rs.70,000. Stock and debtors was
written off as bad, now paid Rs.800 which is not included in Rs.9,500 above. There was one
unrecorded asset estimated at Rs.3,000. half of which was handed over to an unrecorded liability
of Rs.5,000 in settlement of claim of Rs.2,500 and remaining half was sold in the market which
realized Rs.1,300.
Y took over the responsibility of completing dissolution and he is granted salary of Rs.400 p.m.
actual realization expenses amounted to Rs.1,100. Dissolution was completed and final payments
were made on 31st October, 1980.
You are required to prepare ledger accounts in the books of the firm.
Solution:
Dr Realization A/c Cr
Particulars Amount Particulars Amount
To fixed assets a/c 50000 By creditors a/c 19000
To life policy a/c 10000 By salary outstanding 2000
To debtors a/c 10000 By joint life policy reserve a/c 10000
To stock at invoice price a/c 10000 By provision for debtors a/c 500
To investment a/c 8000 By provision for stock a/c 2000
To provision for discount on By investment fluctuation fund
creditors a/c 500 a/c 500
To Y a/c(creditors) 7500 By X a/c(investment) 6000
To bank a/c (unrecorded By bank a/c (joint life policy) 10000
creditors) 5000
(-) unrecorded assets 2500 2500
To Y a/c(realization expenses) 1600 By bank a/c(fixed assets) 70000
To bank a/c(salary O/s) 2000 By bank a/c(stock) 7000
To capital A/c: By bank a/c(debtors) 9000
X 10440 by bank a/c(bad debt recovered) 800
Y 10440 By bank a/c(unrecorded asset) 1300
Z 5220
138100 138100
Unrecorded asset valued at Rs.1,500 is given to settle half of an unrecorded liability (2,500).
Balance of unrecorded liability (2,500) has to be paid by cash.
Capital Account
Dr Cr
X Rs. Y Rs. Z Rs. X Rs. Y Rs. Z Rs.
To - - 2000 By 40000 30000 -
Balance Balance
b/d b/d
To 6000 - - By 4000 4000 2000
realization Reserve
A/c fund
To Bank - 1100 - By 10440 10440 5220
(expenses) Realization
a/c
To Bank 48440 54840 5220 By - 9900 -
Realization
a/c
(creditors)
By 1600
Realization
a/c
(expenses)
54440 55940 7220 54440 55940 7220
Bank Account
Dr Cr
To Balance b/d 23,500 By Realization a/c – creditors 7,500
To Realization a/c- 98,100 By Unrecorded (liability) 2,500
Sale of assets
By Salary outstanding 2,000
By Y (expenses) 1,100
By X 48,440
By Y 54,840
By Z 5,220
1,21,600 1,21,600
2.11 INSOLVENCY
A partner is declared insolvent when he is unable to pay the amount due from him to the firm. If
the Partnership Deed does not mention the basis on which the capital deficiency (referred to as
capital loss) is to be shared by the remaining partners, the decision given in Garner Vs Murray will
be applicable.
If a partner becomes insolvent the following are the consequences:

1. The partner adjudicated as insolvent ceases to be a partner.
2. He ceases to be a partner on the date on which the order of adjudication is made.
3. The firm is dissolved on the date of the order of adjudication, unless there is a contract to the
contrary.
4. The estate of the insolvent is not liable for any act of the firm after the date of the order of
adjudication, and
5. The firm cannot be held liable for any acts of the insolvent partner after the date of the order of
adjudication.
2.12 CASE OF GARNER VS. MURRAY
Garner, Murray and Wilkins were equal partners with unequal capitals. They went for dissolution
of their firm. They realized the firm’s assets and paid off all external liabilities along with Murray’s
loan. After this, it was insufficient to repay the capitals as Wilkins capital account showed a debit
balance and he had become insolvent. Then, a dispute arose between Garner Vs Murray regarding
sharing of Wilkins’s capital deficiency and they went to court.
After hearing the issue, the judgment was given by Justice Joyle in the year 1904, as under:
“The solvent partners are only liable to make good their share of deficiency and that the remaining
loss should be divided among them in proportion to their capitals.”
Thus, the Garner Vs Murray rule implies that:

a) The solvent partners should bring in cash towards their shares of realization loss.
b) The loss due to the insolvency of a partner should be shared by the solvent partners in their
agreed capital.
c) The loss arising out of capital deficiency is a capital loss.
d) If there is any other partner, whose capital account shows a debit balance, he need not share the
insolvent’s partner’s capital deficiency.
2.12.1 Applicability of Garner Vs Murray in India

This rule is applicable in indie, only under certain circumstances as given below:
a) There must be capital deficiency in the partner’s capital account.
b) The capital contribution should not be in profit sharing ratio.
c) If the partnership deed is silent towards the provisions as to how the capital deficiency of
insolvent partner is to be shared by solvent partners.
2.12.2 Fixed and fluctuating capitals:

i)Fixed capital:
In case the capitals of the partners are fixed, for the purpose of the decision in Garner Vs Murray
the term “capitals”, means only the opening capitals of the partners as given in the books.
ii)Fluctuating capitals:
If the capitals of the parkers are fluctuating, then, the term “capitals”, means capitals which result
after adjusting therein their drawings upto the date of dissolution, interest on capital, interest on
drawings, salary or any other remuneration due to any partner, reserve fund, other accumulated
reserves and profit and loss account balance given in the books.
Case 1: Fluctuating capital
Illustration 4:
A, B, C, and D were partners sharing profits in the ratio 3: 2: 3: 2. Their balance sheet on the date
of dissolution was as follows
Capital – A 10,000 Assets 17,000
Capital – B 5,000 C ‘s Capital 6,360
Reserve account 4,000 D ‘s Capital 1,640
Creditors 6,000
25,000 25,000
On the above date C becomes insolvent and was able to contribute only 50 paisa in the rupee.
Assets realized Rs.12,500. Realization expenses amount to Rs.400. Prepare the necessary ledger
accounts.
Solution:
Realization Account
Dr Cr
To Assets 17,000 By Creditors 6,000
To Bank 6,000 By Cash (assets) 12,500
(creditors)
To Bank 400 By A 1,470
(expenses)
By B 980
By C 1,470
By D 980 4,900
23,400 23,400
C’s Capital Account
Dr Cr
To Balance b/d 6,360 By Reserve 1,200
account
To Realization 1,470 By Cash 3,315
account (6360x0.5)
By A 2,184
By B 1,131 3,315
7,830 7,830
Note:
1. Loss on account of insolvency of C is not suffered by D although he is solvent. This is because
his capital has a debit balance (overdrawn).
2. Capital ratio is determined after transferring reserves 11,200:5,800.
A 3,315 x 112/170 = 2,184
B 3,315 x 58/170 = 1,131.
D’s Capital Account
Dr Cr
To Balance b/d 1,640 By Reserve account 800
To Realization account 980 By Bank 1,820
2,620 2,620
Dr A’s Capital Account Cr

To Realization account 1,470 By Balance b/d 10,000
To C 2,184 By Reserve account 1,200
To Bank 9,016 By bank (Real loss) 1,470
12,670 12,670

Dr Cr
To Realization account 980 By Balance b/d 5,000
To C 1,131 By Reserve account 800
To Bank 4,669 By bank (Real Loss) 980
6,780 6,780
Bank Account
Dr Cr
To Realization account 12,500 By Realization account -
To D’s Capital 1,820 By Creditors 6,000
To C’s Capital 3,315 By Expenses 400
To A capital 1,470 By A‘s Capital 9,016
To B capital 980 By B‘s Capital 4,669
20,085 20,085
Case 2. Fixed Capital
Illustration 5:
A, B and C are partners sharing profits in the ratio of 2:2:1. Their balance sheet on 31st December,
1980, the date of dissolution, was as follows:

Capital – A 7,000 Assets – Fixed 21,000
Capital – B 3,000 Current 2,000
Capital – C 1,000 Current account – C 3,000
Current accounts: A 2,000
Current accounts: B 1,000
Reserve account 2,000
Creditors 10,000
26,000 26,000
All assets, leaving Rs.500 of current assets C is declared insolvent. On the date of dissolution it
was found that a contingent liability in respect of a bill discounted Rs.800 has matured and the
firm recovered only Rs. 200 from the acceptor of the bill.
This amount is not included in Rs. 8,000 above. Realization expenses amounted to Rs.100.
Prepare ledger accounts.
Solution:
Realization Account
Dr Cr
To assets – Fixed 21,000 By Creditors 10,000
Current 1,500 By Cash (assets) 8,000
To Bank (creditors) 10,000 By Cash (from 200
the acceptor of
the bill)
To Bank (bills 800 By Capitals -
discounted)
To Bank (expenses) 100 A 6,080
B 6,080
C 3,040 15,200
33,400 33,400
C‘s Capital Account

Dr Cr
To Current account 5,640 By Balance b/d 1,000
By A 3,248
By B 1,392 4,640
5,640 5,640
Working Note:
A 4,640 x 7/10 = 3,248
B 4,640 x 3/10 = 1,392.
Dr C’s Current Account Cr

To Balance b/d 3,000 By Reserve account 400
To Realization account 3,040 By Capital 5,640
6,040 6,040
B’s Current Account

Dr Cr
To capital 408 By Bank 6,080
7,880 7,880

Dr Cr
To bank 3,408 By Balance b/d 3,000
By current a/c 408
3,408 3,408
A’s Current Account

Dr Cr
By bank 6,080
By capital 448
9,328 9,328
A’s Capital Account

Dr Cr
To Current account 448 By Balance b/d 7,000
To Bank 6,552
7,000 7,000
Bank Account
Dr Cr
To Balance b/d 500 By Realization a/c 10,000
To Realization account 8,200 By Creditors 800
To A 6,080 By Bill 100
To B 6,080 By Expenses 6,552
By A & B 3,408
20,680 20,860
Note: Loss arising due to insolvency has been distributed in the fixed capital ratio.
2.13 INSOLVENCY OF ALL PARTNERS
When all the partners become insolvent, the loss on account of insolvency of the partners will have
to be borne by the creditors. Only sundry assets are transferred to realization A/c. On realization
of assets, the realization account is credited. The amounts of external liabilities (creditors, bills
payable, overdraft etc.) are not transferred to realization a/c and their separate accounts are
prepared. Creditors are paid cash available, together with the amount received from the private
estate of the partners, if any, after meeting the expenses of realization. Profit on realization is
transferred to capital accounts. Balance remaining in the capital accounts and liabilities A/c is
transferred to “Deficiency A/c”. The deficiency A/c shall be automatically closed and the books
will thus be closed.
2.13.1 Steps to be followed in preparing insolvency accounts

1. Preparation of realization account in the usual manner, but unsecured liabilities should not be
transferred to this account.
2. Ascertain the loss on realization and transfer to capital accounts.
3. Debit cash or bank account and credit partner’s capital account if any amount is recovered from
their private estate.
4. Then, the cash available in the firm after deducting expenses, should be paid to unsecured
creditors account and the balance in the creditors account should be transferred to deficiency
account.
5. Close the capital accounts by transferring the balance including partner’s loan if any to
deficiency account.
6. Now the deficiency account will automatically tally.
2.13.2 Determination of the insolvency of a partnership firm

In the examination, one can determine whether a partnership firm is insolvent or by applying any
of the following tests:
1. If the problem specifically states that the firm is not able to pay off its liabilities in full, we can
conclude that the firm is insolvent.
2. If the problem stats that the partners of the firm are not able to bring in sufficient amount from
their private estates, we can conclude that the firm is insolvent.
3. If the cash available with the firm together with amount brought in by the parsers from their
private estates is not sufficient to pay off the liabilities of the firm in full, we can conclude that the
firm is insolvent.
4. If the problem instructs us to show the dividend, composition or part payment made to the
creditors, we can conclude that the firm is insolvent.
5. If the problem directs us to prepare the deficiency account, we can conclude that the firm is
insolvent.
Illustration 6:
A, B and C are equal partners whose balance sheet on December 31, 2001 is as follows:
Sundry Creditors 5,000 Cash in hand 50
A’s Loan 1,000 Stock 800
Capital Accounts: Sundry debtors 1,000
A 800 Plant and 2,000
Machinery
C 500 1,300 Furniture and 800
fittings
Land and 2,000
buildings
B’s capital 650
(overdrawn)
7,300 7,300
Due to lack of liquidity and weak financial position of the partners the firm is dissolved. A and C
are not able to contribute anything and sum of Rs. 200 is received from B. All of them are declared
insolvent. The assets are realized stock Rs. 500; plant and machinery Rs. 1,000; Furniture and
fittings Rs. 200; Land and buildings Rs. 800 and debtors Rs. 550 only. Realization expenses
amounted to Rs. 50.
You are required to close the firm’s books.
Solution:
Realization account
Dr Cr
To Sundry assets: By Cash:
Stock 800 Stock 500
Debtors 1,000 Plant and 1,000
Machinery
Plant and Machinery 2,000 Furniture and 200
fittings
Furniture and fittings 800 Land and 800
buildings
Land and buildings 2,000 6,600 Debtors 550 3,050
To Cash – expenses 50 By Loss
transferred to:
A 1,200
B 1,200
C 1,200 3,600
6,650 6,650
Sundry Creditors Account

Dr Cr
To Cash 3,250 By Balance b/d 5,000
To Deficiency (balance 1,750
transferred)
5,000 5,000
Cash Account
Dr Cr
To Balance b/d 50 By Realization a/c – 50
To Realization account 3,050 By Sundry Creditors 3,250
(available cash paid)
To B’s capital account 200
3,300 3,300
Capital Accounts
Dr Cr
A B C A B C
Rs. Rs. Rs. Rs. Rs. Rs.
To Balance - 650 - By Balance 800 - 500
b/d b/d
To Realization 1,200 1,200 1,200 By A’s Loan 1,000 -
A/c- loss
To Deficiency 600 - By Cash a/c - 200
A/c –
transferred
By Deficiency 1,650 700
a/c –
transferred
1,800 1,850 1,200 1,800 1,850 1,200
Deficiency Account
Dr Cr
To B’s capital account 1,650 By Sundry creditors 1,750
To C’s capital account 700 By A’s capital a/c 600
2,350 2,350
Illustration 7:
A,B, C and D were in partnership. Their position on 30.6.2007 was as follows. They shared profits
and losses in the ratio of 4:3:2:1.
Liabilities Amount Assets amount

Capitals: Sundry assets 32000
A 7000 Loss to date 15000
B 8000 Drawings
C 4000 B 4000
D 3000 D 1000
Creditors 30000
52000 52000
They decided to dissolve on this date. The sundry assets realized Rs.27000. And B are both
insolvent. B’s private assets are Rs.10000 and his private liabilities are Rs.7000. D’s private assets
are Rs.7000 and his private liabilities are Rs.1000
Show necessary ledger accounts assuming that B’s private estates realized only Rs.4000 and D’s
private estate realized Rs.5000
Solution:
Realization A/c
Dr CrCr
To sundry assets a/c 32000 By creditors a/c 30000
To cash a/c(creditors paid) 30000 By cash a/c(assets realized) 27000
By capital a/c:
A = (5000*4/10) 2000
B = (5000*3/10) 1500
C = (5000*2/10) 1000
D = (5000*1/10) 500
62000 62000
Partner’s capital accounts

Dr Cr
A B C D A B C D
To drawings - 4000 - 1000 By balance 7000 8000 4000 3000
a/c b/d
To realization 2000 1500 1000 500 By cash a/c - - 1000 500
a/c
To p & L A/c 6000 4500 3000 1500 By C & D 1000 2000 - -
capital a/c
To A &B - - 2000 1000 By cash a/c - - 1000 500
capital a/c
8000 10000 6000 4000 8000 10000 6000 4000
Dr Cash A/c Cr
Amount Amount
To realization a/c 27000 By realization a/c 30000
To C’s capital a/c(realization loss) 1000
To D’s Capital a/c(realization loss) 500
To C’s Capital a/c(deficit) 1000
To D’s capital a/c(deficit) 500
30000 30000
2.14 SUMMARY
 Dissolution of a firm takes place when all the partners terminate their relationship and close
the business of the firm. Accounts should be opened to close the various accounts in the books
of the partnership firm.
 Realization account, partners’ capital account and cash account are opened. All assets and
liabilities are transferred to the realization A/c, assets sold, liabilities paid and expenses paid
are also recorded. Additionally, assets and liabilities taken by partners are also recorded. The
realization A/c is balanced and the profit or loss on realization is transferred to the capital
accounts.
 Capital accounts of the partners are prepared and the balancing figure indicates cash brought
in or paid to the partner. Lastly, cash A/c is prepared. This account should balance which will
serve as a check to the correct preparation of accounts.
 In case of insolvency of partners in the absence of any specific agreement we have to follow
Garner Vs Murray rule.
 In that rule the solvent partners should bring in cash equal to their loss of realization.
 The deficiency of the insolvent partners should be borne by the remaining solvent
partners who are having credit balance in their capital accounts in the capital ratio
stood before the dissolution.
 If the capital is fixed, the capitals should be their opening capital.
 If the capital is fluctuating, the capital ratio should be after making all the adjustments
except realization profit or loss.
 Sometimes, all the partners except one become insolvent. In such case the debit
balance of the insolvent partners’’ capital accounts should be borne by the only solvent
partners.
 In case of insolvency of all the partners we have to prepare a additional accounts i.e.
deficiency account and liabilities account. In realization account we should not
transfer the liabilities. The deficiency account should tally.
 For unrecorded assets, it becomes firm’s asset, it will be recorded on the credit side of
realization account as “By cash/bank A/c”
 For unrecorded liabilities it should be treated as firm’s liability and hence, to be paid
by the firm. The entry for the same is
Realization a/c Dr. xx
To cash/bank/partner’s capital a/c xx
 A Comparison of the Revaluation and Realization account
Point of
Revaluation account Realization account
comparison
The nature Nominal account Nominal account
The content It contains the profits or losses on It contains the balance of all the
the revaluation of assets and assets and external liabilities
liabilities and also the sale values and the
amounts paid towards the
liabilities. It contains the
realization expenses.
Transfer of All partner’s capital account in All partners’ capital accounts in
balance their profit sharing ratio their profit sharing ratio.
Prepared at the Admission, retirement and death Dissolution of the partnership
time of a partner firm
2.15 QUESTIONS
Section A
1. Name the accounts that are prepared at the time of dissolution.
2. What is the journal entry for payment of realization expenses?
3. What is realization account?
4. What is meant by dissolution of a firm?
5. What is meant by dissolution of partnership firm?
6. State two reasons for dissolution.
7. How do you close the realization account?
8. How do you treat unrecorded asset on dissolution?
9. How do you treat unrecorded liability on dissolution?
10. Pass journal entry for assets taken over by a partner.
11. State the difference between realization and revaluation account
12. What do you mean by insolvency?
13. State the rule of Garner Vs Murray
14. How do you close the creditors account when all the partners are insolvent?
15. How do you treat contingent liability in case of dissolution?
16. How do you deal with goodwill in case of dissolution?
Section B
1. What are the circumstances under which a firm is dissolved?
2. List out the procedures in dissolution.
3. What are the differences between dissolution of the firm and partnership dissolution?
Section C
1.R, S& M are partners sharing profits and losses as 2:2:1. Their balance sheet on 30.6.07 was as
follows:
Creditors 4,000 Bank 5,000
R 10,000 Debtors 4,000
S 4,000 Stock 5,000
M 2,000 Fixtures 2,000
Reserve 5,000 Machinery 9,000
25,000 25,000
They decide to dissolve the business. The following are the amounts realized: machinery Rs.8,
500; fixtures Rs.1,500; stock Rs.7,000; & debtors. Rs.3,700.
Creditors allowed a discount of 2% and R agreed to bear all realization expenses. For this service
R is paid Rs.120. Actual expenses amounted to Rs.900. There was an unrecorded asset of Rs.500
which was taken over by S at Rs.400.
Pass journal entries to close the books of the firm.
2. X, Y & Z are sharing profits in the ratio of 3:2:1 decided to dissolve the firm on 31.12.97.
Their balance sheet was as under:

X 30,000 Premises 12,500
Y 10,000 Goodwill 20,000
Z 10,000 Machinery 30,520
Loan 11,500 Stock 7,550
Premises redemption fund 6,000 Investments 6,330
Life policy fund 12,000 JLP 12,000
Creditors 16,200 Debtors 5,800 5,300
-Reserve 500
Bank 1,500
95,700 95,700
The JLP is surrendered for Rs.10,000. Investments are taken over by Y for Rs.8,000. X agreed to
discharge the loan. The remaining assets are sold for Rs.86,700 and realization expenses amounted
to Rs.850.
Show the necessary ledger accounts.
3. A, B & C are partners in a firm sharing profits and losses in the proportion of 3:3:2. Their
balance sheet on 31.12.07 was as follows:
Creditors 47,500 Bank 55,000
Capital a/c Stock 69,000
A 75,000 Investments 6,000
B 75,000 Debtors 70,000
C 1,00,000 Buildings 1,25,000
Current a/c Goodwill 25,000
A 15,000
B 25,000
C 12,500
3,50,000 3,50,000
They decided to dissolve the firm on 1.1.08. The assets realized as follows:
Rs.
Buildings 90,000
Debtors 60,000
Investments 5,500
Stock 75,500
Goodwill Nil
Realization expenses amounted to Rs.2,000. Prepare necessary ledger accounts to close the books
of the firm.
4. D, E, F & G are partners sharing in the ratio of 4:3:2:1. Their statement was as follows:
D 90,000 Bank 4,500
E 60,000 Machinery 1,32,000
Creditors 1,20,000 Stock 60,000
Bank loan 60,000 Debtors 1,20,000
F 10,500
G 3,000
3,30,000 3,30,000
The firm is dissolved. All assets realized Rs.2,46,000. Creditors and loan were paid Rs.1,77,000
in full satisfaction. Dissolution expenses are Rs.1,800. G became insolvent and F paid only
Rs.9,000.
Prepare necessary accounts.
5. A, B & C are partners sharing in the ratio of 3:2:1. The firm is dissolved on 31.12.05 on which
date the balance sheet was as follows:
A 45,000 Plant 28,500
B 5,000 Stock 25,000
C 5,000 Debtors 25,000
A current a/c 750 Bank 1,500
Creditors 20,000 B current a/c 1,000
A loan 5,000 C current a/c 2,500
B/P 3,500 P/L a/c 750
84,250 84,250
Plant realized Rs.20,000; stock Rs.15,000; debtors Rs.21,000; goodwill was sold for Rs.300;
dissolution expenses amounted to Rs.600. C became insolvent and a dividend of 50 paise in a
rupee is received from his private estate. Prepare necessary accounts.
6. A & B are in equal partnership. Their balance sheet was as follows:

A 600 Plant 1,475
Creditors 3,900 Furniture 400
Debtors 500
Stock 625
Bank 300
B 1,200
4,500 4,500
The assets realized as follows:

Stock Rs.350; furniture Rs.200; debtors Rs.500; plant Rs.700. The cost of collecting and
distributing the estate amounted to Rs.150. A’s private estate is not sufficient even to pay his
private liabilities, whereas in B’s estate there was a surplus of Rs.50
Prepare necessary ledger accounts.
7. Amar, Prem and Saran were partners sharing profits and losses equally. On the dissolution of
their partnership, the balance sheet as stood as follows:

Amar’s capital 50,000 Cash at bank 48,000
Prem’s capital 30,000 Saran’s capital 8,000
Loss on realization 24,000
80,000 80,000
Saran became insolvent and was unable to contribute anything.

Show the necessary ledger accounts by applying the decision in Garner Vs Murray.
8. The partnership of A.B.C who are sharing profits and losses equally is dissolved on
31stDecember 2006. Their balance sheet after realization of assets and payment of liabilities is as
follows:

Capital accounts: Cash at bank 12,800
A 20,000 Realization losses 37,200
B 10,000
C 5,000
Reserve fund 12,000
Profit and loss account 3,000
50,000 50,000
C becomes insolvent and cannot contribute anything. Give the necessary ledger accounts: (a)
When capitals are fixed (b) When capitals are not fixed
9. .A, B, C and D are in partnership sharing profits and losses 1/3,1/4,1/4,1/6 respectively. Their
balance sheet as on 31.12.2006 was as follows:

Capitals: Goodwill 10,000
A 27,000 Machinery 25,000
B 1,980 Debtors 16,000
C 10,000 Cash 5,000
56,000 56,000
They decide to dissolve the partnership. The machinery realized Rs.10000; debtors Rs.7000 and
the goodwill did not fetch anything. The costs came to Rs.560. B and D have no other means and
were adjudicated insolvents.
Give the necessary ledger accounts and close the books of the firm.
KEPT FOR STUDENTS SELF STUDY

10. Q, S and O are in partnership sharing profits and losses in the ratio of 4:3:1. They decided to
dissolve partnership. During the dissolution, O is adjudicated insolvent and can pay only 50 paise
in the rupee. The original capital wereQRs.4000, S Rs.3000 and O Rs.1000 but by agreement
amongst the partners, the drawings had been merged in the capital accounts and balance at the date
of dissolution were as shown in the following balance sheet
Q, S, O balance sheet as at….

Capital Land and buildings 4000
Q 6000 Plant and machinery 2500
S 1500 Stock 800
Creditors 2500 Debtors 1400
Cash 300
O- Capital overdrawn 1000
10,000 10,000
The assets realized as follows:

Rs.
Land and buildings 3,000
Plant and machinery 2,000
Stock 900
Sundry debtors 1,350
5%discount is allowed by creditors and a contingent liability of Rs.165 matures.

The expenses of realization are Rs.110
11. The balance sheet of Ramesh, Suresh and Satish who were sharing profits and losses in 3:2:1.,
stood as follows

Bank overdraft 28,000 Cash in hand 500
Creditors 24,500 Bills receivable 2,000
Ramesh’s capital 7,500 Debtors 1,200
Satish’s capital 5,000 Stock 19,000
Machinery 16,000
Goodwill 5,000
Suresh’s capital 10,500
65,000 65,000
The assets realized Rs.39875. the expenses amounted to Rs.1000. The liabilities were paid 75 paisa
in rupee.
Prepare dissolution accounts, assuming that all the partners are insolvent.

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SYLLABUS

Course Code: 18BCM101 Semester I

MODULE –I: 8 Hours

MODULE - II: Dissolution of Partnership 10 Hours

MODULE – III: Conversion of Partnership 16 Hours

MODULE – IV: Hire-Purchase and Installment System 14 Hours

BOOK FOR REFERENCE

1. Dr. S.N. Maheshwari, Financial Accounting - Vikas Publication House, (2011)

It is very important for the organization to maintain transactions as it helps in:

1.2 BOOK KEEPING- MEANING, DEFINITION, FEATURES AND OBJECTIVES

Features of book keeping

Objectives of book keeping

Accounting is the process of identifying, measuring, recording and communicating economic

Objectives of Accounting or need for Accounting

The primary objectives of accounting are the following:

Following are the other functions of accounting:

1.4 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

Basis of Difference Book Keeping Accounting

Meaning Systematic recording of Includes summarizing and

Sequence First Next

Nature of staff Clerks Qualified Accountants

Uniformity Principles are uniform Methods of communicating may

Users of the Insiders of the business Insiders as well as outsiders.

1.5 ADVANTAGES & DISADVANTAGES OF ACCOUNTING

The errors committed by the accountants are classified as:

1.7 DISTINCTION BETWEEN ACCOUNTING AND ACCOUNTANCY& METHODS OF

Basis of Difference Accounting Accountancy

Focus Practical aspects. Regulation and guidance.

Nature An art A science

1.9 BASIS OF ACCOUNTING

1.11 VARIOUS ACCOUNTING TERMS

1.12 RULES AND ACCOUNTING EQUATIONS:

1.12.1Accounting Rules (Rules of Debit and Credit):

b. Real Account rule

c. Nominal Account rule

2) Under the American System

1.12.2 Accounting Equation

ii. The rights of the owners – Equity of owners is called ‘Capital’.

1.12.4 Steps in developing an Accounting Equation:

Effect of Transaction on Equation:

2. Increase in one asset and decrease in another asset

3. Decrease in asset and decrease in liability

4. Decrease in asset and decrease in Capital

5. Increase in liability and decrease in capital

Preparation of Posting to various

1.14 ACCOUNTING PRINCIPLES

To be generally acceptable it has to meet the following criteria–

1. Started business with cash 4,00,000 3,00,000 1,00,000

3. Cash sales of goods costing Rs.85,000 +1,10,000

New Equation 6,25,000 3,25,000 3,00,000

4. Credit sales of goods costing +60,000

New Equation 6,40,000 3,40,000 3,00,000

5. Defective goods returned to creditors -7,000 - -7,000

6. Borrowed loan Rs.30,000 +30000 - +30,000

New Equation 6,63,000 3,40,000 3,23,000

7. Drawings of proprietor Rs.10,000 -10,000 -10,000 -

New Equation 6,53,000 3,30,000 3,23,000

8. Distributed goods costing Rs.5,000 as -5,000 -5,000 -

9. Sold goods for cash Rs.10,000 (Cost +10,000

New Equation 6,46,000 3,23,000 3,23,000

10. Cash received from debtors Rs.15,000 +15,000

New Equation 6,46,000 3,23,000 3,23,000

11. Damaged goods returned by debtor +2,000 - -