Financial Accounting - II - himpub.com

1 FinancialAccounting-II(AspertheRevisedSy llabus2016-17ofMumbaiUniversityforFirstY ear,BBI,SemesterII) ,MBA, ,UGCNET& ,Science&CommerceforBBI& ,Bhandup(W),Mumbai ,ChandrabhanSharma, , , ,SikkimManipalUniversity& ,MBA,BBI,BMS,BFM& , , ,MBA,NETHOD,AccountsatGurukulCollege,Gha tkopar& , ,MBA, , ,ShivajiShikshanSansthaCollege(Night), :2008 CERTIFIED AuthorsNopartofthispublicationmayberepro duced,storedinaretrievalsystem,ortransmi ttedinanyformorbyanymeans,electronic,mec hanical,photocopying, :2017 , Ramdoot PoojaApartments ,4-B,MurariLalStreet,AnsariRoad,DaryaGan j, :011-23270392,23278631;Fax:011-23256286 Nagpur:KundanlalChandakIndustrialEstate, GhatRoad, :0712-2738731,3296733;Telefax:0712-27212 16 ,2ndMainRoadSeshadripuram,BehindNataraja Theatre, :08041138821;Mobile:09379847017,09379847 005 ,Lingampally,BesidesRaghavendraSwamyMath am,Kachiguda, :040-27560041,27550139 , ,GroundFloor,SarangapaniStreet, , :09380460419 Pune:FirstFloor, Laksha Apartment, ,Mehunpura,Shaniwarpeth(NearPrabhatTheat re), :020-24496323,24496333;Mobile:0937057933 3 ,ShekhupuraColony, ,Aliganj, :0522-4012353;Mobile:09307501549 Ahmedabad:114, SHAIL ,1stFloor, , ,NavrangPura, :079-26560126;Mobile:09377088847 Ernakulam:39/176( ),1stFloor,KarikkamuriRoad,Ernakulam, :0484-2378012,2378016;Mobile:09387122121 Bhubaneswar:5 StationSquare,Bhubaneswar-751001(Odisha) .

2 Phone:0674-2532129;Mobile:09338746007 Kolkata:108/4,BeliaghataMainRoad,NearIDH ospital, , :033-32449649;Mobile:07439040301 DTPby:HansaBhoirPrintedat: , FinancialAccounting-II , ,theauthors, ,SuperProfitMethodCapitalizationMethod,A nnuityMethodValuationofSharesIntrinsicVa lueMethod, ,CompanyLaw/LegalProvisions(includingRel atedRestrictions,Power,TransfertoCapital RedemptionReserveAccountandProhibitions) ComplianceofConditionsincludingSources, CreationandUse, , :2 HoursMaximumMarks:75 (a)Sub-questionstobeasked(10)andtobeansw ered(any08)(b)Sub-questionstobeasked(10) andtobeanswered(any07)(*MultipleChoice/T rueorFalse/ (a)TheoryQuestion08(b) (05)Tobeanswered(03)Note:Theoryquestiono f15 Marksmaybedividedintotwosub-questionsof7 /8and10 136 Chapter pointofviewgoodwill,inthesenseofattracti ngcustom, ,therefore,goodwillmaybesaidtobethatelem entarisingfromthereputation,connection, ,regardmustbehadtothenatureofthebusiness ,therisksinvolved, ,interalia, ,thenatureofthefirm ,completeorpartialmonopoly, , ; ,stockexchangequotationsnotbeingavailabl e,shareshavetobevaluedfortaxationpurpose s,gifttax,etc.)

3 ; ,soastoenabletheholdertoexercisecontrolo verthecompanyconcerned,hastobeboughtorso ld; ,considerationofthefollowingfactorswillh aveabearing:(a)Natureoftheindustry,itshi storyandtheriskstowhichitissubjectto.(b) Prospectsoftheindustryinthefuture.(c)The company shistory itspastperformanceanditsrecordofpastprof itsanddividends.(d)Thebasisofvaluationof assetofthecompanyandtheirvalue.(e)Therat ioofliabilitiestocapital.(f)Thenatureofm anagementandthechanceforitscontinuation. (g)Capitalstructureorgearing.(h)Size,loc ationandreputationofthecompany sproducts.(i)Theincidenceoftaxation.(j)T henumberofshareholders.(k)Yieldonshareso fcompaniesengagedinthesameindustry,which arelistedintheStockExchanges.(l)Composit ionofpurchasersoftheproductsofthecompany .

4 (m) ,however,maybecomeimportant,whenlargeblo cksofsharesareinvolved.(n) :(i)Personalskillinmanagement(ii)Natureo fbusiness(iii)Favourablelocation(iv)Acce sstosupplies(v)Patentsandtrademarksprote ction(vi)Exceptionallyfavourablecontract s.(vii)Capitalrequirementsandarrangement ofcapital.(o)Estimationoftheprofitsexpec tedtobeearnedbythefirmandtheamountofcapi talemployedtoearnsuchprofits,aretobecomp utedcarefully.(p)Marketreputationwhichth ecompanyanditsmanagementenjoys.(q) ,thepurchasingcompanymaypaymorefortheacq uiredcompanythanthefairmarketvalueofitsn etidentifiableassets(tangibleassetsplusi dentifiableintangibles,netofanyliabiliti esassumedbythepurchaser). excessofacquisitioncostovernetassetsacqu ired , , ,afavourablereputationinthemarketplace,s uperiorproductionmethods, ,thesevaluesaredeterminedbyappraisal,but insomecases, ,eitherhigherorlower, ,givingCompanyY` `50,000accountsreceivablethatarebelieved tohavearealisablevalueof`60,000,andother identifiableassetsthatareestimatedtohave acurrentmarketvalueof` ``Totalpurchaseprice15,00,000 Less:Cashacquired50,000 Accountsreceivable60,000 Otheridentifiableassets(estimated)11,00, 000 Goodwill12,10,0002,90,000 Thisextraamountof`2,90,000paidoveranabov e,Networth`12,10,000isgoodwill, , , :(a)Simpleprofitmethodand(b)Superprofitm ethod.

5 (a)SimpleProfitMethod:Goodwillisgenerall yvaluedonthebasisofacertainnumberofyears , :TradingProfit/BusinessProfit/RecurringP rofit/NormalProfit(ofPastYear)Particular s1stYear2ndYear3rdYearNetProfitbeforeAdj ustmentandTaxxxxxxxLess:NonTradingIncome ( ,IncomefrominvestmentAsset)xxxxxxLess:No n-recurringIncome( ,profitonsaleofinvestment/Asset)xxxxxxAd d:Non-recurringLoss( ,Lossonsaleofinvestment/Asset)(xx)(xx)(x x)TradingProfitafterAdjustmentandbeforeT axxxxxxx4 ValuationofGoodwillandSharesCalculationo fAverageprofit:(a)SimpleAverageProfit=ye arspastofnumberTotal)yearspast(ofprofitT otal(b)WeightedAverageprofit:YearsTradin gProfit(a)Weight(b)Product(a b)2007xx1xx2008xx2xx2009xx3xx6xxxWeighte dAverageProfit=weightofTotalproductTotal Notes:Ifpastprofitsareinincreasingtrend, (FutureMaintainableProfit):(i)Allactuale xpensesandlossesnotlikelytooccurinthefut ureareaddedbacktoprofits.

6 (ii)Allactualexpensesandlossesnotlikelyt ooccurinthefutureareaddedbacktoprofits.( iii) `Simple/WeightedAverageProfitbeforeTaxxx Add:Expensesincurredinpastnottobeincurre dinfuture( ,Rentpaidinpastnotpayableinfuture)xxLess :Expensesnotincurredinpasttobeincurredin future( ,Rentnotpaidinpastpayableinfuture)(xx)Le ss:NotionalManagementRemunerationFutureM aintainableProfitbeforeTaxxxxxxLess:Tax( ifRateisnotgivenme50%)(xx)FutureMaintain ableProfitafterTaxxxxAfteradjustingprofi tinthelightoffuturepossibilities, purchaseoftheaverageprofitswhichcometo`5 0,000,thegoodwillwillbe`1,50,000, ,3 `50, , (AtAgreed/AdjustmentValue)(Except:Intang ible,Non-trading/FictitiousAssets)Planta ndMachineryxxLandandBuildingxxFurniturea ndFixturesxxStockxxCash/BankxxxxLess:Ext ernalLiability(AtAgreed/AdjustValue)(Exc ept.)

7 CapitalandReserveandsurplus)LoansxxDeben turesxxCreditorsxxxxxOutstandingExpenses , AverageCapitalEmployed=2 EmployedCapital ClosingEmployed Capital Opening =ClosingCapitalEmployed ofCurrentYears Profit+CurrentYears Dividend(b) ,thismethodofvaluinggoodwillwouldrequire thefollowinginformation:(i)Anormalrateof returnforrepresentativefirmsintheindustr y.(ii) ,bankrate,market,need, (NRR) +RateofReturnsorShareperPriceMarketShare perDividend ,2009:Liabilities`Assets``PreferenceShar eCapital5,00,000 FixedAssets:Cost50,00,000 EquityShareCapital20,00,000 Depreciation30,00,00020,00,000 ReservesandSurplus25,00,000 CapitalWork-inProgress40,00,000 Long-termLoans27,00,000 Investment10%5,00,000 CurrentLiabilitiesandProvisions15,00,000 CurrentAssets25,00,000 UnderwritingCommission2,00,00092,00,0009 2,00,000 Thecompanyearnedaprofitof`18,00.

8 Ifimmediatelyoperational, ,2010,twoadditionalWorksManagersarebeing appointedat`1,00, ,assumingthepresentreplacementcostoffixe dassetsis`1,00,00,000andtheannualrateofd epreciationis10% :Normalprofit:Supposeinvestorsaresatisfi edwitha180%return,intheaboveexample,then ormalprofitwillbe`11,34,000, ,18%of` ,fires,floodsandtheft,etc., ,appendedtotheaccountsorbyqualifications intheAuditor sReport,suchasprovisionfortaxationandgra tuities,baddebts,underprovisionoroverpro visionfordepreciation,inconsistencyinval uationofstock, , , ,therecordofpastearnings, , , , ,profitsmayrecordadistinctrisingorfallin gtrendfromyear;inthesecircumstances,asim pleaveragefailstoconsiderasignificantfac tor,namely, ,aweightedaveragegivingmoreweighttothere centyearsthantothepast, , , : , , time,abusiness,ifstartednowwillbeearning aboutthesameprofitsasanoldbusinessisearn ingnow, ,goodwillwillbe` , ,` ,inthiscase, , , , ` ` :=NRRP rofitSurper 1008 ValuationofGoodwillandSharesInaboveexamp le,Goodwillwillbe= =` ,MethodandFormulaforCalculationofGoodwil l(I)Goodwillbypurchaseofaverageprofitmet hod:Steps:(a)Findoutaveragetradingprofit .

9 (b)Findoutthenumberofyearpurchase(itwill alwaysbegiveninproblem).(c)Goodwill:Numb erofyearpurchase Averagetradingprofit.(II)Goodwillbypurch aseoffuturemaintainableprofitmethod:Step s:(a)Findoutfuturemaintainableprofit.(b) Numberofyearpurchase(giveninproblem).(c) Goodwill:Noofyearspurchase Futuremaintainableprofit.(III)Goodwillby capitalisationoffuturemaintainableprofit method:Steps:(a)Findoutfuturemaintainabl eprofit.(b) 100(c)Calculatecapitalemployed.(d)Goodwi ll= CapitalEmployed(IV)Goodwillbypurchaseofs uperprofitmethod:Steps:(a)Findoutaverage tradingprofit.(b)Findoutfuturemaintainab leprofit.(c)Findoutcapitalemployed.(d)Fi ndoutNormalRateofReturn(alwaysgiveninthe problemintermsof%).(e)Findoutnumberofyea rpurchase(givenintheproblem).(f)Findoutn ormalprofit:ValuationofGoodwillandShares 9 NormalProfit= Employed Capital (g)Findoutsuperprofit:SuperProfit=Future MaintainableProfit NormalProfit(h)Goodwill=Numberofyearpurc hase SuperProfit.

10 (V)Goodwillbycapitalisationsuperprofitme thod:Steps:(a) , , ,guesswork,intelligentorotherwise, , , ,enhancedearningpershare, ,EstateDuty,GiftTax, ,absorptions, , ,interalia, , ,viz.,(1)Openmarketprice,(2)Stockexchang equotation,(3)Netassetsbasis,(4)Earnings persharemethod,(5)Yieldorreturnmethod,(6 )Networthmethod,(7)Break-upvalue, ,RealValueMethod, , ,thesameistobeconsideredandintheabsenceo fsuchinformation, ,thefictitiousassetssuchaspreliminaryexp enses, ,ProfitandLossAccount,BalanceofDebenture RedemptionFund,DividendEqualisationReser ve,ContingencyReserve, ,2009, `Particulars`1000,8%PreferenceSharesof`1 00eachfullypaid1,00,000 BuildingsFurniture70,0003,0004,000 EquitySharesof`100fullypaid4,00,000 Stock(Marketvalue)4,50,000 Reserves1,50,000 Investmentatcost(facevalue4,00,000)