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JAIIB - Accounting & Finance for Bankers MOD-D – Final Accounts of Banks & Companies

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  1. JAIIB - Accounting & Finance for BankersMOD-D – Final Accounts of Banks & Companies Prof. RAVISHANKAR ULLAL CFO TODAYS WRITING PRODUCTS

  2. FINAL ACCOUNTS The most important objective of accounting is to ascertain • the profit or loss made by the concern • Financial position of the concern The final product of accounting process iS • final accounts • The objectives of accounting can be achieved by preparing the final accounts, which comprise of: • Profit & Loss Account & Balance Sheet

  3. FINAL ACCOUNTS • Summary of those accounts which affect the profit and loss of a business concern is called • Income Statement • The income statement has normally Income statement comprises of Trading and Profit & Loss Account. They have two parts-the first part is called Trading account which reveals gross profit or gross loss, and the second part is called Profit & Loss account to show net profit or net loss.

  4. FINAL ACCOUNTS • In a trading concern direct expenses include: • all expenses in bringing the goods to the godown of the firm and in making them ready for sale, like freight paid on purchases, cartage, octroi, custom duty, carriage inward, etc. • all expenses for sale and distribution of goods.

  5. FINAL ACCOUNTS • In a manufacturing concern direct expenses include: • all expenses incurred for production of goods (like wages, power and fuel, Factory lighting,, factory rent and rates) and all expenses incurred in bringing the goods to the godown of the firm and in making them ready for sale, like freight paid on purchases, cartage, octroi, custom duty, carriage inward, etc.

  6. FINAL ACCOUNTS • Administrative and office expenses include: • Office salaries • Establishment expenses • Office rent & taxes • Printing & Stationnery • Postage & Telephone expenses • Electricity charges • Entertainment expenses • Conveyance expenses • Legal expenses & Audit fee

  7. FINAL ACCOUNTS • : Selling & Distibution expenses include: • Advertising • Commission • Discount • Packing expenses • Carriage outward • Freight on sales • Export duties • Insurance • Bad debts

  8. FINAL ACCOUNTS • Fixed assets are those which are acquired for • continuous use • not for sale • may be tangible • may be intangible

  9. FINAL ACCOUNTS • Current assets are those which are: • kept temporarily for resale • for converting into cash • they are cash or cash equivalent • are to be realized within a period of one year • are to be realized during the normal operating cycle

  10. FINAL ACCOUNTS • Owners fund includes: • Capital less drawings of the owner • Undistributed profits • Reserves • Assets minus liabilities

  11. FINAL ACCOUNTS • : Closing consolidated journal entries are normally passed for • Transfer of all manufacturing and purchase expense to the debit side of trading a/c • Transfer of Purchases and Sales return to the debit side of Trading a/c • Transfer of Sales and Purchases return to the credit side of Trading a/c • Transfer of closing stock to the credit of trading account by an adjustment entry

  12. FINAL ACCOUNTS • Transfer of Gross profit to the credit side of Profit & Loss a/c • Transfer of Gross loss to the debit side of Profit & Loss a/c • Transfer of all administrative, selling and financial expenses to the debit of P & L A/c • Transfer of all operational and non-operational incomes to the credit of P & L A/c • Transfer of Net proft to the credit of Capital a/c • Transfer of net loss to the debit of Capital a/c

  13. FINAL ACCOUNTS • Some common adjustments are: • Closing Stock • Expenses due but not paid (Outstanding expenses) • Expenses paid in advance (Prepaid expenses) • Incomes due but not received (Accrued incomes) • Incomes not due but received (Unearned incomes) • Depreciation on assets • Interest on Capital

  14. FINAL ACCOUNTS • Interest on Drawings • Interest on Loan • Bad debts to be written off • Provision for bad debts • Provision for discount on Debtors • Provision for discount on creditors • Losses on account of accidents • Commission payable on profit • Goods used by the proprietor Goods distributed as Free Samples

  15. Fundamentals of Partnership Accounts • The important features of partnership are • It is a relationship between persons • There should be minimum two persons to form a partnership • It is the result of an agreement • The partnership agreement may be written or oral • The agreement is to share the profits of the business. • There must be a lawful business • The business must be carried on by any one of them acting for all or by more than one, or by all of the partners

  16. Fundamentals of Partnership Accounts • Following details should be incorporated in the Partnership deed as different clauses: • Name and business of the partnership firm • Commencement and duration of the business • Amount of capital to be contributed by each of the partner • Rate of interest to be allowed/charged to each of partner on his • Capital • His loan to the firm • His drawings • Profit sharing ratio for disposal of profits • Amount to be allowed as drawings and the timings of such drawings • Whether any partner will be allowed a salary

  17. Fundamentals of Partnership Accounts • Any variations in the mutual rights and duties of partners • Method by which goodwill is to be calculated on the admission, retirement or death of a partner • Procedure by which a partner may be admitted or retired, and the method of payment of dues • Basis of the determination of the executors if any one of them is deceased and the method of payment • Treatment of losses arising out of the insolvency of a partner. Whether Garner vs. Murray rule will be applicable to them or not. • Procedure to be followed for settlement of disputes among partners • Preparation of accounts and their audit.

  18. Fundamentals of Partnership Accounts • Goodwill is normally due to: • Favourable Location • Nature of business • Licences and quotas with the business • Possibility of competition • Better customer service • Efficient advertisement • Possession of patent rights and trade marks • Efficiency and Personal skill/ reputation of the management • Better products

  19. Fundamentals of Partnership Accounts • It’s reputation, super profit earning capacity of a firm • Necessity • change in profit sharing ratio • Admission, retirement, death • Sale of business • Methods: • Average profit • Super profit • capitalization of profit

  20. Fundamentals of Partnership Accounts Average profit(AP) Super profi(SP) Capitalization of profit AP x Multiplier SP x multiplier SP = AP less NP NP=normal profit (Capitalised value) less Actual Multiplier is given Multiplier is given CAPITAL

  21. Fundamentals of Partnership Accounts • Goodwill on capitalization basis can be calculated by the following steps: • Determine the normal rate of return. • Find the average profits of the firm • Find out the total capital employed by the same firm • Find the normal value of business by dividing Average profits into normal rate of return. • Take the difference of normal value of business and the capital employed • This will be the value of goodwill of the firm

  22. Fundamentals of Partnership Accounts • Super profit can be calculated by the following steps: • Identify the total capital employed by the Partnership firm • Identify the average profit earned by the partnership firmbased on past few years figures • Determine the normal rate of teturn prevailing in the industry or locality for the similar firms • Apply normal rate of return on capital employed to arrive at normal profit • Deduct normal profit from the average profit of the firm. If the average profit of the firm is more than the normal profit, there exists super profit

  23. Fundamentals of Partnership Accounts • The following adjustments are made in the accounts of a partnership when a new partner is admitted • Changes in profit sharing proportions • Valuation of goodwill • Distribution of accumulated profits and reserves by existing partners • Re-valuation of assets and liabilities • Re-structuring of capitals • Preparation of a new balance sheet

  24. Fundamentals of Partnership Accounts • When a new partner takes admission, he acquires the ownership rights of the assets and also makes himself responsible for the firms liabilities. It, therefore, becomes necessary to scrutinize the balance sheet carefully so that new partner should not get any benefit from the appreciation in the value of assets or reduction in the value of liabilities, nor he should suffer because of any decrease in the value of assets or increase of liabilities. Therefore, on the date of admission, the assets and liabilities of the firm are revalued and its profit or loss is transferred to the old partners capital accounts in their old profit sharing ratio

  25. Fundamentals of Partnership Accounts • When the capital of the new partner is fixed on the basis of the combined capital of old partners, it requires following steps: • 1. Post all entries relating to old partners capital accounts and arrive at the closing balances • 2. The combined capital represents the capital for the share held by old partners i.e. One minus proportion of new partner. • 3. Based on the balance of old partners capital and their share, calculate the capital for full one share of profits. • 4. On this basis calculate the share of new partner.

  26. Fundamentals of Partnership Accounts • When the capital of the old partners is fixed on the basis of capital brought in by the new partner, it requires following steps: • 1. Post all entries relating to all partners capital accounts and arrive at the closing balances. • 2. Based on the balance of new partners capital and his share, calculate the capital for full one share of profits. • 3. Calculate the balances that each old partner should hold keeping in view the total amount of capital multiplied with his proportion. • The capital accounts of old partners may show debit or credit balances. If debit balance, it shows the amount to be brought in by that partner. If it shows credit balance, the excess amount may either be paid back to him or may be transferred to his current account.

  27. Fundamentals of Partnership Accounts • Let us say A and B are partners sharing profits equally. They take C as partner with equal share. The position will be as under: • Partners Old Ratio New Ratio Loss(Sacrifice)/ • Gain • A 1/2 1/3 –1/6 • B 1/2 1/3 –1/6 • C Nil 1/3 +1/3 • Sacrificing Ratio = Old ratio  (–)  New ratio

  28. Fundamentals of Partnership Accounts • Let us suppose A, B, and C are partners sharing profits and losses in the ratio of 5 : 3 : 2. A retires and B and C agree to continue at the ratio of 3: 2. In this case, the position will be as follows: • Old Ratio New Ratio Net Gain/Loss • A 5/10 Nil — • B 3/10 3/5 + 3/10 (3/5 – 3/10) • C 2/10 2/5 + 2/10 (2/5 – 2/10) • Gain ratio will be 3 : 2. • (b) Let us now suppose B and C change their ratio to 5 : 3; then the position will be as follows: • Old Ratio New Ratio Net Gain/Loss • A 5/10 — (–) 5/10 i.e 1/2 • B 3/10 5/8 + 13/40 (5/8 – 3/10) • C 2/10 3/8 +  7/40 (3/8 – 2/10) • Gain ratio will be 13/40 : 7/40 i.e. 13 : 7.

  29. Fundamentals of Partnership Accounts • When a memorandum revaluation account is prepared, firstly the effect of changes in the value of assets and liabilities is transferred to the old partners capital accounts in their old ratio. Simultaneously, the entries are reversed and the balance is transferred to all the partners , including the new,in their new profit sharing ratio. This nullifies the effect of changes in the value of assets and liabilities of the firm and the capitals of the partners are adjusted.

  30. Fundamentals of Partnership Accounts • On the death of a partner the executors or representatives of the deceased partner are entitled to the following benefits: • The amount standing to the credit of deceased partners’ capital a/c • His share in the goodwill of the firm • His share of profits earned from the beginning of the year to the date of death • His share of profits on revaluation of assets and liabilities. His share of the loss, if any, shall be deducted • His share of undistributed profit or reserves • Interest on capital, salary or commission, etc. if provided in partnership deed. • His share of the proceeds of the joint life policy.

  31. Fundamentals of Partnership Accounts • If the death takes place in the middle of accounting period, the deceased partner is entitled to his share in profit or loss upto the date of his death. The amount can be determined by • (i)preparing final accounts up to the date of death, or • (ii) an estimated share in profit or loss is determined on the basis of • (a) Preceding year • (b) on the basis of sales up to the date of death and calculating profit on the basis of • the percentage of profit earned in the previous year • (c) on the basis of the time • (d) on the basis of the average of the two

  32. COMPANY Accounts • Features of a Joint Stock Company • 1. Incorporated association: • A company is a registered body of individuals. According to the Companies Act, 1956, it is compulsory to register a joint stock company. • 2. Artificial person: • It is an artificial person created by law. It is different from its members It can enter into contracts, purchase and sell the properties, can sue and be sued upon. Even a member can enter into contract with the company. • 3. Perpetual succession: • A company has a perpetual succession. Death, or insolvency of any shareholder does not affect existence of the company. • 4. Common seal: • As the company is an artificial person created by law, it cannot sign its name. So it has a common seal on which the company’s name is engraved. The common seal is treated as company’s signature and is affixed in all important documents and contracts as per the resolutions passed by the Board. • 5. Limited liability: • The liability of the members of the joint stock company is limited to the face value of shares held by them. Companies (Amendment) Bill 2003 states that if a company, private or public, fails to enhance its minimum paid up capital ( i.e. One Lakh rupees or Five Lakh rupees, as the case may be) each director or manager or shareholder will have unlimited liability.

  33. COMPANY Accounts • 6. Separation of management from ownership: • Even though the shareholders are true owners, they do not participate in the management of the company. They elect their representatives known as Board of Directors. • 7. Transferability of shares: • The shares of a company are freely transferable subject to restrictions placed on transfer of private limited company’s shares. • 8. Separate legal status: • A company has an independent legal status and as such, the shareholders or the owners are not liable for the acts of the company. • 9. Large membership: • A company is owned by a large number of members. In the case of private limited company the minimum number of members is 2 and the maximum is 50. In the case of public limited company, the minimum number of members is 7 and there is no maximum limit on the number of members.

  34. COMPANY Accounts • The Liabilities of a company are arranged in the following order • Share Capital • Reserves and Surplus • Secured Loans • Unsecured loans • Current Liabilities & Provisions • Current Liabilities • Provisions • Other Provisions

  35. : Sweat shares means • Equity shares issued by the company to employees or directors • at a discount, or • for consideration other than cash • -for providing know how • -making available right in the nature of intellectual property rights • -value additions • shares should be of the same class which have already been issued • it should be authorized by members by passing resolution in the General meeting • it should be issued in accordance with the regulations made by the SEBI

  36. Under Employees Stock Option Scheme, the company grants option to an employee • to apply for shares at a pre-determined price • the right to be exercised during a specified period • listed companies have to follow SEBI guidelines for ESOS

  37. COMPANY Accounts • The Assets side of the balance sheet shows the following sequence: • Fixed Assets • Investments • Current assets, Loans and Advances • Current Assets • Loans & Advances • Miscellaneous Expenditure • Profit & Loss account (Debit balance, if any)

  38. COMPANY Accounts • With regard to Share Capital, the company should specifically state: • Details of Authorised, Issued, Subscribed, Called up and Paid up capitals • Details of number of shares and face value of each share • Amount called up on each share • Classes of shares-Preference or Equity with or without voting rights • Shares allotted as fully paid for consideration other than cash • Shares issued as bonus shares and source

  39. COMPANY Accounts • RESERVES AND SURPLUS • Capital Reserve • Capital redemption Reserve • Share Premium Account • Other reserves • Less: Debit balance in P & L A/c, if any • Surplus (Balance in the P & L appropriation A/c) • Proposed additions to reserves • Sinking funds

  40. COMPANY Accounts • SECURED LOANS • Debentures • Loans and advances from banks • Loans and advances from Subsidiaries • Other Loans and advances

  41. COMPANY Accounts • UNSECURED LOANS • Fixed deposits • Loans and advances from subsidiaries • Short term loans & Advances • from Banks • From Others • 4. Other loans and advances • (a.)from Banks • (b) From Others

  42. COMPANY Accounts • CURRENT LIABILITIES & PROVISIONS • (A) Current Liabilities • Acceptances • Sundry Creditors • Subsidiary companies • Advance payment and unexpired discounts • Unclaimed dividends • Other liabilities (if any) • Interest accrued but not due on loans

  43. COMPANY Accounts • FIXED ASSETS • Goodwill • Land • Buildings • Leaseholds • Railway sidings • Plant & Machinery • Furniture & fittings • Development of property • Patents, trade marks & designs • Live stock • Vehicles, etc.

  44. COMPANY Accounts • The fixed assets must be • Classified and distinguished • The following details are required to be shown separately: • original cost, • additions during the year, • deductions there from during the year, • Total depreciation written off or provided up to the end of the year

  45. COMPANY Accounts • INVESTMENTS • Investments in Government or trust securities • Investment in shares, Debentures or bonds • Investment in immovable properties • Investment in the capital of partnership firms • Balance of un-utilised monies raised by issues

  46. COMPANY Accounts • : The followings must be clearly stated with regard to Investments: • Nature of Investments • Mode of valuation (Cost or market value) • Classification of Investments

  47. COMPANY Accounts • CURRENT ASSETS LOANS & ADVANCES • Current Assets • Interest accrued on investments • Stores and spare parts • Loose tools • Stock in trade • Sundry Debtors • Cash in hand • Bank balances • With scheduled banks • With others

  48. COMPANY Accounts • : In respect of Sundry Debtors following details are to be shown: • Debts considered good and in respect of which the company is fully secured • Debts considered good for which the company holds no security other than personal security of debtors • Debts considered doubtful or bad

  49. COMPANY Accounts • Loans & Advances • Advances and loans • Bills of Exchange • Advances receivable in cash or kind or for value to be received • Balances on current accounts • Balances with Customs, Port trust, etc. (where payable on demand)

  50. COMPANY Accounts • Miscellaneous expenditure is shown in the following sequence on the assets side of the balance sheet: • Preliminary expenses • Expenses including commission or brokerage on underwriting or subscription of shares or debentures • Discount allowed on issue of shares or debentures • Interest paid out of capital during construction • Development expenditure not adjusted • Other items