ACCOUNTANCY

Capital and Revenue

Classification of Income:
1. Capital Income- Non recurring incomes are capital income e.g. Profit on sale of fixed assets.
2. Revenue Income- Recurring incomes are revenue income e.g. Interest received.

Classification of expenditure:
1. Capital Expenditure- Capital Expenditure consists of expenditure, the benefits of which is
not fully consumed in one accounting period but spreads over several periods. It is, therefore,
of non-recurring nature e.g. Freehold Property.
2. Revenue Expenditure- Revenue expenditure consists of expenditure incurred in one
accounting period and the full benefit of which is also consumed in the same period.
Therefore, it is normally of recurring nature. Such an expenditure does not increase the
earning capacity of the business nor does it bring into existence an assets of an enduring
nature e.g. Depreciation.
3. Capitalised Expenditure- All expenditure which is primarily of revenue nature, but incurred
for the purpose of acquiring any asset or adding to its value is termed as capitalised
expenditure e.g. Carriage paid on any plant & machinery.
4. Deferred Revenue Expenditure- Expenditure of a revenue nature, the benefit of which
extends beyond the accounting period in which it is incurred is generally written off over a
number of years during which it is expected to benefit the business. The unwritten portion of
such expenditure which is carried forward to the subsequent years is referred to as deferred
revenue expenditure and is shown in the asset side of the balance sheet e.g. Research &
Development Expenditure.

Classification of Receipts:
1. Capital Receipts- Capital receipts comprise contribution by proprietors or partners towards
capital of their business, or in the case of a company subscription towards share capital or
debenture, any loan, sale proceeds of fixed assets. Thus capital receipts, other than sale
proceeds of fixed assets, create a liability either to outsiders or to the proprietors.
2. Revenue Receipts- Revenue receipts comprise sale proceeds of merchandise, interest on
investment, rent of property, commission earned, discount received etc. Thus, revenue
receipts include all the recurring incomes that a business gets in normal course of its function.

Depreciation, Provisions and Reserves

Concept of depreciation: “Depreciation may be defined as the permanent and continuing

diminution in the quality, quantity or value of an asset.”-William Pickles

Causes of depreciation:
1. Wear & Tear
2. Efflux of time
3. Physical Consumption
4. Obsolesce

Depletion: This method is specially suited to mines, oil wells, quarries, sandpits and similar
assets of a wasting character. Under this method, the cost of the assets is divided by the total
workable deposits of the mine etc. In this way, rate of depreciation per unit of output is ascertained.
Depreciation in any particular year is charged on the basis of the output of that year.

Amortization: Intangible assets, such as goodwill, trademarks and patients are written off over a
number of accounting periods covering their estimated useful lives. This periodic write-off is called
amortisation which is similar to depreciation of tangible assets.

Methods of recording depreciation:

1. Straight line or fixed instalment method

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 2. Diminishing balance or reducing instalment method
3. Sum of the years’ digits method
4. Annuity method
5. Depreciation Fund or sinking fund method
6. Insurance policy method
7. Machine hour rate method
8. Revaluation method
9. Depletion or output method

Methods of providing depreciation:

1. Straight line or fixed instalment method
Annual Depreciation= (Cost of the assets less Estimated break-up value) divided by number of
years of expected use.

2. Diminishing balance or reducing instalment method

Annual Depreciation= 1 minus nth root of (Residual value divided by cost). Where ‘n’
represents the life of the assets.

3. Sum of the years’ digits method

Annual Depreciation= (Remaining expectation of life divided by sum of annual expectations)
into Cost of the assets.

4. Annuity method
Annual Depreciation= Calculated using Annuity Table

5. Depreciation Fund or sinking fund method

Equal amount (calculated as straight line or fixed instalment method) of depreciation charged
to P&L A/c and credited to a depreciation/sinking fund account.

6. Insurance policy method

An endowment policy is taken on the life of the assets so that, at the end of its estimated life
the insurance company will pay a fixed sum of money with the help of which a new assets can
be purchased. Here Annual Depreciation= Annual insurance premium.

7. Machine hour rate method

Annual Depreciation= Number of hours the assets has been used during the year into (Cost of
the assets less Estimated break-up value) divided by estimated total number of hours of the
assets working life.

8. Revaluation method
Annual Depreciation= (Cost of the assets add addition value thereof, if any) less devalued
value of the assets at the end of the year.

9. Depletion or output method

Annual Depreciation= Annual output into (Cost of the assets divided by the total workable
deposits of the mine etc.)

Partnership Accounts
General Accounts:
1. Profit & Loss Appropriation A/c
2. Capital A/c of partners
The capital accounts of the partners may as per agreement, be fixed or fluctuating
• When capitals are fixed two account is to be prepared
a) Capital A/c [record the capital contributed by the partner];
b) Current A/c [record the partners drawings, interest chargeable on drawings, interest on
capital, share of profit/loss, partnership salary, interest on loan, goods withdrawal by the
partner for personal use]

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Goodwill- Goodwill is the value of reputation, connection or other advantages possessed by a
business with the help of which it can earn super profits. Goodwill is a real asset, because its
existence can be felt through superior earning capacity, but it is intangible, because it has no physical
existence.

In partnership the question of goodwill is required to be considered in the following

circumstances:
• Change in the profit sharing ratio of partners;
• Admission of a new partner;
• Retirement or death of a partner; and
• Dissolution or sale of the partnership business.

Methods of valuation of Goodwill:

• Average Profits Method- Goodwill = Average annual profits for a specified past number of
years into Agreed Number (say 1, 2, 3.....)
• Super Profits Method- Super profit=Average Net Profit less Reasonable managerial
remuneration less Reasonable return
Goodwill = Super Profit into Agreed number (say 1, 2, 3.....)
• Capitalisation of Future Profits Method- Goodwill = Capitalised value of expected future profit
less Net tangible assets.

Joint Life Policy- With a view to obtain the necessary funds to pay out a deceased partner’s share of
the capital, accrued profits and Goodwill, partners often to take up a joint survivorship policy, so that
the firm’s cash resources may not be crippled in case of the death of any one of them.

Change in Profit Sharing Raito- In case of change in capital contribution or in active participation in
management it occurs. One or more of the partners may acquire extra share at the cost of one or
more of the other partners. To maintain the equity between the partners adjustments are to be made
on the same line as in case of admission of a partner for over/under-valuation of assets and liabilities,
goodwill, life insurance policy, accumulated profits and losses etc.

Admission of a Partner- When a new person is admitted as partner, adjustments may be required in
respect of any or all of the following items:
• Revaluation of assets and liabilities.
• Goodwill.
• Life Insurance Policy.
• Accumulated profits and losses.
• Capital contribution.

Retirement of a Partner- The problems to dealt with on retirement of a partner are mainly similar to
those arising on the admission of a partner. The main difference between admission and retirement
is on the question of payment of the dues to the retiring partner. Settlement is made by way of
payment or transfer to his loan account

Death of a Partner- Death of a partner dissolves the partnership and the rights of the representatives
of the deceased partner would depend on the provisions of the Partnership Deed. Usually the
surviving partners carry the business, purchasing the share of the deceased partner after determining
the amount due to him and then treating it a loan to the firm. There are no special problems in death
except that death may occur at any time of the year and this would mean that the executors of the
deceased partner would be entitled to his share of profits arising after the last closing up to the date of
death. The partnership deed usually states how this share is to be determined. In absence of any
agreement or decision by arbitration, accounts will have to be prepared as on the date of death and
the profit or loss ascertained.

Amalgamation of Partnership Firms- When two or more firms are carrying on business of a similar
nature, it would be natural if they amalgamate their business to avoid competition. It is usual to
revalue all assets and liabilities so that true capital brought into a new firm by each of the partners is
ascertained. Therefore-

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 a. Each firm should prepare a Revaluation Account relating to its own assets and liabilities and
transfer the balance to the partner’s capital account in the profit sharing ratio.
b. Entries for raising Goodwill should be passed.
c. Assets and liabilities not taken over by the new firm should be transferred to the capital
account of the partners in the ratio of capitals.
d. The new firm should be debited with the difference between the value of assets and liabilities
taken over by it; the assets should be credited and liabilities debited.
e. Partners’ Capital Accounts should be transferred to the new firms account.

Partnership Dissolution
English Case of Garner vs. Murray- In this case it is ruled out that in the absence of any agreement
to the contrary the following method followed:
1. All the partners who are solvent should bring cash equal to their share of the loss on
realisation.
2. The loss arising as a result of insolvency of a partner should be borne by the solvent partners
in the ratio of their last agreed capitals. In case of fixed capital system, capitals as per last
balance sheet represent last agreed capitals. In case of fluctuating capital system, however,
all necessary adjustments in respect of reserves, un-appropriated profits or losses(but not
realisation profit or loss), drawing account, undisclosed liabilities and assets etc., must be
made to get last agreed capitals. A partner has nil or negative balance in his capital account
before dissolution does not contribute anything to the loss arising as a result of insolvency of
a partner.

The most vigorous criticism of the above decision of Garner vs. Murray are:
1. So long the solvent partners’ capital accounts show sufficient credit balances so as to cover
the realisation loss and also the deficiency of the insolvent partners, it is superfluous to bring
cash equal to their share of realisation loss. In actual practice, therefore, no cash contribution
is usually made in respect of realisation loss, but merely it is brought into account by notional
adjustments.
2. In case of fluctuating capitals, if any solvent partner withdraws capital immediately before
dissolution so as to make his capital balance either nil or negative, sharing of the deficiency of
the insolvent partner in the capital ratio shall not only be unjustified but also absurd.
Gradual Realization of Assets and piecemeal Distribution- In this method assets are realised
gradually over a period of time. In such a case it may be agreed that different parties are to be paid in
order of preference as and when assets are realised without unnecessarily waiting for the final
realisation of all the assets.
The order of payment:
1. Secured creditor is to be paid off in priority to unsecured creditors upto the amount realised
from the disposal of the assets by which his claim is secured and for the balance of his claim
if any, he will stand on the same footing with the unsecured creditors.
2. Unsecured creditors in proportion to their individual claims;
3. Loans from partners are to be paid proportionately.
4. Partners Capital

Partners’ capitals are paid in two different methods:

1. Surplus Capital Method- Under this method partners having surplus capital over those of
others are first paid off.
2. Maximum loss method- Under this method after each realisation the remaining unrealised
assets will be assumed to be worthless and hence their book value will be distributed
amongst the partners in their profit sharing ratio.

Dissolution of partnership Firm- Dissolution of partnership takes place on:

• The expiry of the term of duration;
• The completion of the adventure;
• The death of a partner;
• The insolvency of a partner; and
• The retirement of a partner
In all the cases mentioned above the remaining partner may continue the firm in pursuance of an
express or implied contract to that effect. If they do not continue the dissolution of the firm takes

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place automatically. But in the following cases in addition to the dissolution of partnership there is
also dissolution of the firm:-
1. Where the partners agree that the firm should be dissolved;
2. Where all the partners except one are insolvent;
3. Where the business becomes illegal;
4. In case of partnership at will, where any partner gives notice of dissolution; and
5. Where the court orders dissolution.
These circumstances in which the Court will order dissolution are the following:
a. Where a partners becomes of unsound mind;
b. Where a partners suffers from permanent incapacity;
c. Where a partners is guilty of misconduct affecting the business;
d. Where there is a persistent disregard of partnership agreement by a partner;
e. Where a partner transfers his interest or share to a third person;
f. Where a business cannot be carried on except at a loss; and
g. Where dissolution appears to the court to be just and equitable.

Modes of dissolution of a firm:

1. Losses including deficiencies of capital shall be paid first out of profits, next out of capital,
and lastly, if necessary, by the partners individually in the proportions in which they were
entitled to share profits.
2. The assets of the firm including any sums contributed by the partners to make up
deficiencies of capital shall be applied in the following order:
a. In paying the debt of the firm to third parties;
b. In paying to each partner rateably what is due to him from the firm for advances as
distinguished from capital;
c. In paying to each partner rateably what is due to him on account of capital; and
d. The residue, if any, shall be divided among the partners in the proportions in which
they were entitled to share profits.

Insolvency of Partners- If at the time of dissolution, a partner owes a sum of money to the firm, he
has to pay the firm. But if he is insolvent, he will not be able to do so, at least not fully. The sum
which is irrecoverable from the insolvent partner is, therefore, a loss. The question arises whether
this loss is like ordinary loss. Before the decision in Garner vs. Murray was made, such a loss was
treated as ordinary loss.

Company accounts
Various kinds of shares:
1. Preference Share
• Cumulative Preference Share
• Non-cumulative Preference Share
• Redeemable Preference Share
• Irredeemable Preference Share
• Participating Preference Share
• Non-Participating Preference Share

2. Equity Share

Issue of Share:
1. Application- A form of application, similar to the one, as indicated on the opposite page, is
usually attached to the prospectus. The application letter s together with the deposits are
sent by the applicants direct to the company’s bankers, as desired in the application form.
2. Allotment- After the minimum subscription is reached; the Board of Directors would proceed
to allotment. The allotment of shares must always be made by Directors by means of a
resolution at a meeting of the Board, and full particulars of such resolution must be entered in
the Directors’ Minute Book. It is usual for the Directors to initial the application and Allotment
Book each time the Allotment is made. The Secretary is then instructed to write Letters of
Allotment to whom shares have been allotted. In case of capitals over-subscribed and some
applications have been refused, or the applications of some shareholders have not been
accepted for one reason or the other, the moneys deposited with such applications will have
to be returned together with a Letter of Regret. When any applicant has been allotted a less

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 number of shares than he has applied for, the excess of his deposit on application will be
applied towards the allotment money due from him.
3. Call (one or more)- Usually, the prospectus mentions the dates on which further Calls will be
made on the shareholders for their instalments. In the absence of such arrangement, the
Board of Directors have an absolute discretion as to when to make a call. A resolution of the
Board is necessary for this purpose, and a proper record is made thereof in the Directors’
Minute Book. Then the Secretary sends out Notice of Call to all the members requesting
them to pay up the required amount.

Forfeiture of Share- If a member fails to pay any call, or instalment of a call, on the day appointed for
payment thereof, the Board may, at any time thereafter during such time as any part of the call or
instalment remains unpaid serve a notice on him requiring payment of so much of the call or
instalment as is unpaid, together with any interest which may have accrued. If the requirement of any
such notice as aforesaid is not complied with, any share in respect of which the notice has been given
may, at any time thereafter, before the payment required by the notice has been made, be forfeited by
a resolution of the Board to that effect.

Re-issue of forfeited shares- A forfeited share may be sold or otherwise disposed of on such terms
and in such manner as the Board thinks fit. This reissue is made even at a discount, provided such
discount does not exceed the amount already received on the same shares.
Company Accounts
Issue of Debentures- Debentures are issued in the same manner as shares. That is to say, a
prospectus will be issued and applications for debentures invited. Along with applications a small
deposit (Application money) will be asked for and the balance of the amount is usually payable on
allotment although there is nothing to stop a company from either asking for the whole of the amount
along with the application or gathering the amount in instalments. The total allotment of debentures
must not exceed the amount for which the prospectus is issued.

Treatment of cost of issue of debenture- The whole of the cost of issue of debenture should be
spread equally over the number of years for which the debentures are to run and a proportionate
amount charged off to Profit and Loss account each year. The balance not written off will, in the
meantime, appear on the assets side of the Balance Sheet as ‘Cost of Issue of Debentures Account
(Balance not written off)’.

Issue of bonus shares- Sometimes the company may not be in a position to pay cash dividends in
spite of adequate profits because of the adverse effect on the working capital of the company.
Moreover, all prudent companies build up reserves for purposes of expansion and for building up
financial strength. Later, however, to satisfy shareholders and to portray a realistic relationship
between capital and profits earned, the company may issue shares, without payment being required
to the existing equity shareholders. Such shares are known as bonus shares.

Redemption of Debentures- Unless they are irredeemable, debentures are redeemed according to
the terms of the issue. Redemption may be effected on the following ways:
1. By payment to the holders, either at per or at a premium, at the expiry of a specified perid
2. By payment year after year of a portion of the total debentures by means of drawings,
3. By conversion of debentures into shares or new debentures
4. By purchase of own debentures in the open market.

Redemption of Preference shares- Conditions:

1. The shares to be redeemed must be fully paid up.
2. The redemption should be made either a) out of profits of the company available for
distribution as dividend or b) out of the proceeds if a fresh issue of shares made for the
purpose
3. Any premium payable on redemption must be provided out of the profits of the company or
out of the company’s share premium account.
4. Where the shares are redeemed out of profits, an amount equal to the nominal value of the
shares redeemed must be transferred from the divisible profits to Capital Redemption
Reserve Account. This account cannot be reduced except in accordance with the law relating
to the reduction of share capital. It can, however, be used for issuing unissued shares of the
company to be issued to member as fully paid bonus shares.

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 Company Merger and Reconstruction

Amalgamation by Merger- Where two or more companies carrying on business of a like naure
combine together and form a new company. The companies forming part of such a combine all go
into liquidation, and sell their business to a new company, which is formed solely to take over the
assets and assume the liabilities of the companies going into liquidation. No return of capital
involved, as the shareholders are usually given fully paid shares in the new company in proportion to
their holdings in the old company.

Amalgamation by purchase- Where an existing company buys over or absorbs another smaller
company doing similar business for a consideration as may be agreed upon with the vendor
company. The company bought over goes into liquidation, and the absorbing company purchases the
business from the liquidator. The creditors of the absorbed company may either be paid off or the
purchasing company may take over the liabilities. The shareholders in the absorbed company may
be given shares or cash in return for their holdings.

External Reconstruction – Formation of a new company by liquidating the old company is termed as
external reconstruction

Internal Reconstruction- It includes i) Reorganisation of share capital i.e. alteration in capital

structure with or without variation of the respective rights of the various classes of shareholders and ii)
Reduction of Share Capital

Holding companies

Holding Companies are those that are able to nominate the majority of the directors of some
other companies; such other companies are known as subsidiary companies. The holding company
usually holds the majority of the paid up equity capital. A company may itself be a holding company
and at the same time be subsidiary of another company. A company may be formed and then it may
proceed to float the other company inviting others to join but holding the majority of shares in these
companies. Such a holding company is known as ‘parent’ company. When existing companies ,
wishing to avoid competition, float a company which then proceeds to acquire the majority if shares in
the existing companies, the name given to the holding company is ’offspring’ company.

Preparation of Consolidated Balance Sheet of Holding Company- Consolidated balance sheet is

the balance sheet of the holding company and its subsidiary company or companies taken together.
Such a balance sheet ignores separate entities of the companies within the group and shows the
position if the group as a whole. The object of preparing a consolidated balance sheet is to provide
the shareholders of a holding company with a composite picture which reflects the state of affairs of
the holding company in details.

According to the Schedule VI to the Companies Act, 1956, the following items relating to the
subsidiary companies are required to be shown in distinct details in the Balance Sheet of the holding
company:
1. Investment in shares, debentures or bonds of subsidiary companies.
2. Trading debts due from a subsidiary company which is under the same management as the
holding company.
3. Loans and advances to subsidiary companies. If a subsidiary company is under the same
management as the holding company the amount of loans and advances due from it must be
given separately.
4. Secured loans from subsidiary companies, stating the nature of security given.
5. Unsecured loans from subsidiary companies.
6. Current liabilities due to subsidiary companies.

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 Departmental and Branch Accounts

A business may be and generally is split into so many parts or divisions. If the various parts
are located under the same roof, they are known as departments.

Accounting- To obtain the results of each department separately, a separate set of books for each
department may be opened. Usually, the day books and nominal account in the ledger are ruled with
analysis column for each department so that departmental figures necessary for preparing
departmental final account can be easily obtained.

Apportionment of Common Expenses-

1. Expenses incurred for the direct benefit of a particular department are allocated to the
department concerned e.g. Departmental Salaries.
2. Expenses incurred for the benefit of more than one department which is capable of precise
apportionment, are distributed over the department concerned on some equitable basis e.g.
Rent.
3. Expenses incurred for the benefit of more than one department which are not capable of
accurate measurement, are distributed on some arbitrary basis e.g. Managers salary.
Examples of few basis of apportionment:
a. Sales(turnover) of each department;
b. Purchase of each department;
c. Floor space of each department;
d. Asset values of each department;
e. Wages of each department;
f. Number of workers of each department.
Inter-departmental transaction- When such transfers are made at prices above cost, they are
regarded as sales and are treated as such by the transferring department. But when the transfers are
made at cost prices, they are separately recorded and at balancing time the trading account if the
receiving department is debited and the trading account of the issuing department is credited. In the
former case, a reserve should be created in respect of the unrealised profit in unsold closing stock by
debiting the profit and loss account of issuing department.

If the various parts are located in different places of the same town or in different towns they
are known as branches.

Classification of Branches:
1. Inland Branch;
2. Foreign Branch.
Inland branches are of two types:
1. Not maintaining a complete set of Double Entry Books;
a. Goods invoiced to branch at cost;
b. Goods invoiced to branch at selling price; and
c. Goods invoiced to branch at cost plus a certain percentage.
2. Maintaining a complete set of Double Entry Books.

A- Goods invoiced to branch at cost

Accounts at Branch:
a. Stock Register;
b. Sales Ledger;
c. Petty Cash Book; and
d. Cash Book.

Head office account:

a. Synthetic Method- Under this method it is assumed that the branch has a separate entity
apart from the head office and, on this method, a branch account is opened separately for
each branch in the books of head office. This account is debited with the value of benefits
and cash given to the branch and correspondingly credited with the value and benefits and
cash received from the branch.

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 b. Analytical(Stock and Debtors) Method- Under this method, instead of only one branch
account, several accounts relating to the transactions of a branch are maintained in the books
of head office viz.,
• Branch Stock Account;
• Branch Debtors Account;
• Branch Expenses Account; and
• Branch Profit and Loss Account.

B- Goods invoiced to branch at selling price or at cost plus a certain percentage:

Branch accounting procedure is same. Head office accounting procedures are as follows:
Synthetic Method- As the good are supplied to the branch at loaded price, opening stock, goods
sent to branch, goods returned by branch and closing stock will be recorded in the branch
account at this price. Hence, in order to ascertain true profit or loss at branch it will be necessary
to eliminate the loads and bring down these items to cost level.
Analytical (Stock and Debtors) Method-
1. Branch Adjustment Account System- All adjustment entries relating to loads are
recorded in Branch Stock Adjustment Account balance of this account will be transferred
to branch profit and loss account. Any difference in branch stock account will be
transferred to Stock discrepancy account. The stock discrepancy account will be closed
by transferring the load to branch stock adjustment account and the balance to branch
profit and loss account.
2. Double Column System- In this system Branch stock account is prepared with two
columns, one to show stock and goods sent at loaded price and other at cost price.

Hire Purchase and Instalment Payment Systems

Hire Purchase Systems- Where a buyer undertakes to pay the price of the goods bought, by
instalments (which include interest) to acquire the possession immediately, but the title passes to the
buyer only on the payment of the last instalment.

Instalment Payment Systems- A system of sale under which the payment for the goods together
with interest on the price is made by periodical instalments, but the buyer acquires the title in the
goods and the possession thereof as soon as the transaction is completed.

Depreciation- In both systems the depreciation provided may either be shown by way of deduction
from the value of asset acquired or it may be shown on the liability side of the balance sheet.

Valuation of Goodwill and Shares

In joint stock companies the question of goodwill is required to be considered in the following
circumstances:
• When a company has previously written off goodwill and wants to write it back in order to
wipe off or reduce the debit balance in the Profit and Loss Account.
• When the business of the company is to be sold to another company or when the company is
to be amalgamated with another company.
• When stock exchange quotations not being available, shares have to be valued for taxation
purpose- estate duty, gift tax, etc.
• When such a large block of shares as to enable the holder to exercise control over the
company concerned has to be bought or sold.

Methods of valuation of Goodwill: Discussed in Partnership Account.

The necessity for the valuation of shares of a company may arise in following circumstances:
• When a block of shares is to be purchased not so much as to acquire the controlling interest;
• When a block of shares are purchased so as to acquire controlling interest on amalgamation
or merger of companies;

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 • When a shareholder dies, for the purpose of assessing estate duty; or when some shares age
given as a gift, for the purpose of assessing gift tax;
• When shares are purchased by employees of company to be retained only during the tenure
of service;
• When the interests of the shareholders who do not give consent to the scheme of
reconstruction are purchased;
• When a company is nationalised and the shareholders are compensated by the government;
• When shares are to be taken as a security against loan;
• When a class of shares is converted into another class;
• When partners in a firm jointly hold some shares of a company, for ascertaining the amount to
be distributed amongst the partners on dissolution, valuation of the shares become
necessary.

Methods of valuation of Equity Shares:

1. Intrinsic Value (Asset Backing or Balance Sheet) Method- Value of shares = Net Worth
divided by Number of shares

2. Yield (Earning Capacity) Method-

i) On the basis of expected return on capital employed- Rate of Return on capital divided by
Normal rate of return into Paid up value per share. Where rate of return = Profit earned
divided by Capital employed into 100 and Profit earned means profit before deducting
debenture interest and preference dividends but after charging income tax.
ii) On the basis of expected future dividends-

• The expected profit available for equity dividends is calculated by deducting from
estimated future maintainable profits, income tax, preference dividend and
transfer to reserves.
• Expected rates of dividend = Expected profit available for equity dividend divided
by Paid up Capital into 100.
• Value of each equity shares = Expected rate of dividend divided by Normal rate
of return into Paid up value per share.

Methods of valuation of Preference Shares:

1) If a liquidation is anticipated, intrinsic value method applied- Value of share = Normal value of
each Pref. Share plus (Surplus assets attributable to Pref. Shareholders divided by No of Pref.
Shares);
2) In all other cases Pref. Shares will be valued on the basis of dividends- Value of share = (Rate of
Pref. Dividends divided by Normal yield on Pref. Shares) into Paid up value of each Pref. Share

Insurance Claim

Procedure for estimating the loss of stock-

1. Calculation of Gross Profit ratio on sales.
2. Preparation of Memorandum Trading Account as on the date of hazard to calculate estimated
value of stock on the date of hazard.
3. Valuation of goods salvaged and deducts it from estimated value of stock.

Average Clause- In case of a fire insurance policy containing an ‘average clause’, the insurer is liable
to pay only that proportion of the total loss which the sum insured bears to the value of the property.

Consequential Loss or Loss of Profits – The loss of profit can be insured against under a loss of
profit or consequential loss policy. A loss of profits policy insures loss of net profit, the standing
charges and any increase in the working cost which is consequential.

Terms Used:
1. Standing Charges- Standing charges refer to those fixed expenses which are to be incurred
irrespective of the reduction in turnover. While taking out a loss of profits policy the standing

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 charges mentioned in the policy are the insured standing charges, and those not mentioned in
the policy ant insured standing charges.
2. Gross Profit- It is the net profit plus insured standing charges. In case of net loss the amount
under this heading would be the insured standing charges less such portion of net trading
loss as the amount of the insured standing charges bears to the whole of the standing
charges of the business.
3. Rate of Gross Profit- It is the percentage of gross profit to the turnover during the financial
year immediately preceding the date of hazard.
4. Turnover- It is the amount payable to the insured in respect of the sale of goods and
services.
5. Annual Turnover- It is the value of sales and services during the twelve months immediately
preceding the date of the hazard subject to adjustment for any change in the volume of sales.
6. Standard Turnover- It is the turnover during the period in the twelve months immediately
preceding the date of the hazard which corresponds with the indemnity period. Like annual
turnover this is also subject to adjustment for any change in the volume of sales.
7. Average- All forms of profit insurance are subject to average. If the turnover increases, the
amount of policy should also be increased, otherwise it will amount to under-insurance.
Under-insurance may also occur if all the standing charges are not covered by the policy.
8. Period of Indemnity- It is actually the period from the date of hazard up to the date the
organisation begins normal functioning, subject to the number of days or months mentioned in
the policy as the period of indemnity.

Calculation of Claims under a Loss of Profits Policy-

• Short sale is to be ascertained.
• Calculate Gross profit on short sales.
• Ascertain the increase in the cost of working incurred.
• Working must be reduced proportionately if all the standing charges are not insured.
• Claim = (Net Profit plus Insured standing charges) divided by (Net Profit plus All standing
charges) into Increased cost of workings.

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