Accounting for Special Transactions CBCAT3T04

Syllabus topics (RTMNU)

• Meaning of Hire Purchase Accounts
• Features
• Merits and Demerits of Hire Purchase System
• Distinguish between Hire Purchase and Instalment System
• Numerical on Hire Purchase System (Excluding Repossession of Assets)

Meaning of Hire Purchase Accounts

Definition: Hire purchase is an agreement in which goods are delivered to the buyer at once, the buyer pays the price in instalments, and ownership passes to the buyer only when the last instalment is paid.

Till the last instalment, the buyer is only a hirer (user) of the goods. Each instalment is treated as hire charges. If the buyer stops paying, the seller can take back the goods and keep the instalments already received.

• Hire vendor: the seller who gives goods on hire purchase.
• Hire purchaser: the buyer who uses the goods and pays instalments.
• Cash price: the price if the goods were bought for ready cash.
• Hire purchase price: cash price + total interest (all instalments including down payment).
• Down payment: the amount paid at the time of signing the agreement.
• Instalment: each periodic payment; it contains part of cash price + interest.

Example: a farmer in Wardha buys a tractor worth ₹6,00,000 by paying ₹1,00,000 now and the rest in monthly instalments with interest. He uses the tractor from day one but becomes owner only after the last instalment.

Features of Hire Purchase System

1. Possession at once: the buyer gets the goods immediately.
2. Ownership later: ownership passes only after the last instalment.
3. Payment in instalments: price is paid in parts, usually with a down payment.
4. Instalments as hire charges: till the final payment, instalments are rent for using the goods.
5. Right to repossess: on default, the vendor can take back the goods.
6. Right to return: the hirer can return the goods before full payment and is not liable for future instalments.
7. Interest included: each instalment includes interest on the unpaid cash price.
8. Written agreement: terms are fixed in a written HP agreement.

Merits and Demerits of Hire Purchase System

Merits (advantages):

1. Buyers with small savings can use costly assets (vehicles, machines, TV, fridge).
2. Payment comes from the income earned by using the asset.
3. Sellers get higher sales and interest income.
4. Seller's risk is low, because ownership stays with him till the end.
5. Small industries can modernise without a big loan.
6. The hirer can claim depreciation on the asset.

Demerits (disadvantages):

1. HP price is higher than cash price because of interest.
2. Buyer may lose the asset and all instalments paid if he defaults.
3. Encourages people to buy things they cannot afford.
4. Seller needs large working capital as money comes slowly.
5. Collection of instalments needs follow-up and costs money.
6. Goods may be damaged by the hirer before repossession.

Distinguish between Hire Purchase and Instalment System

Instalment system: an agreement of sale in which ownership passes to the buyer at once, but the price is paid in instalments.

Numerical on Hire Purchase System (Excluding Repossession of Assets)

Accounting in the books of the hire purchaser (full cash price / asset accrual method):

1. On purchase: Asset A/c Dr, To Hire Vendor A/c (with cash price).
2. Down payment: Hire Vendor A/c Dr, To Bank A/c.
3. Interest due: Interest A/c Dr, To Hire Vendor A/c.
4. Instalment paid: Hire Vendor A/c Dr, To Bank A/c.
5. Depreciation: Depreciation A/c Dr, To Asset A/c.
6. Closing: P&L A/c Dr, To Interest A/c and To Depreciation A/c.

Books of the hire vendor: Hire Purchaser A/c Dr, To HP Sales A/c (cash price); Bank A/c Dr, To Hire Purchaser A/c (down payment and instalments); Hire Purchaser A/c Dr, To Interest A/c (interest); Interest A/c Dr, To P&L A/c.

Illustration 1: On 1 April 2023, Shree Traders, Nagpur bought a machine on hire purchase from Kirloskar Ltd. Cash price ₹1,00,000. Down payment ₹25,000; balance to be paid in three annual instalments of ₹30,000, ₹30,000 and ₹30,525 on 31 March each year. Interest 10% p.a. Depreciation 10% p.a. on written down value. Prepare the interest table and journal entries for year 1 in the buyer's books.

Solution — Working note: Calculation of interest

Journal of Shree Traders (Year 1)

Hire Vendor (Kirloskar Ltd) Account — Year 1 (2023-24)

Working: Depreciation table

Check: total interest ₹15,525 = HP price ₹1,15,525 (25,000 + 30,000 + 30,000 + 30,525) − cash price ₹1,00,000.

Illustration 2 (cash price not given): Ramesh bought a tractor from Mahindra Dealers on 1 April 2023 on hire purchase. He paid ₹10,000 down and three annual instalments of ₹39,000, ₹36,000 and ₹33,000. Interest is 10% p.a. Find the cash price and pass entries for year 1 in the vendor's books.

Solution: When the rate is 10%, interest included in an amount = Amount × 10/110. Start from the last instalment and work backwards.

Cash price = Down payment ₹10,000 + ₹90,000 = ₹1,00,000. Total interest = ₹9,000 + ₹6,000 + ₹3,000 = ₹18,000 (HP price ₹1,18,000 − cash price ₹1,00,000).

Journal of Mahindra Dealers (Year 1)

Likely exam questions

1. (Long, 8/16 marks) What is hire purchase system? Explain its features, merits and demerits. Distinguish between hire purchase system and instalment system.
2. (Long, 8/16 marks) On 1 April 2023, Anand Transport bought a truck on hire purchase from a finance company. Cash price ₹4,00,000; down payment ₹1,00,000; the balance is paid in three annual instalments on 31 March: ₹1,20,000, ₹1,20,000 and ₹1,22,100. Interest is 10% p.a. Depreciation is 20% p.a. on written down value. Prepare the interest table, the Truck Account and the Hire Vendor's Account in the books of Anand Transport for three years.
3. (Short, 4 marks) Define hire purchase. Explain the terms cash price, hire purchase price and down payment.
4. (Short, 4 marks) Give any four differences between hire purchase system and instalment system.
5. (Short, 4 marks) A machine was bought on hire purchase for a cash price of ₹60,000 with a down payment of ₹15,000. Interest is 12% p.a. on the outstanding cash price. Calculate the interest included in the first annual instalment of ₹20,000 and the balance due after it.

Syllabus topics (RTMNU)

• Meaning
• Needs
• Advantages
• Formalities in consignment
• Difference between Consignment and Sale
• Proforma invoice
• Account sales
• Accounting Procedure of consignment
• Valuation of consignment stock
• Normal & Abnormal Loss

Meaning of Consignment

Definition: Consignment is an arrangement in which a trader (consignor) sends goods to an agent (consignee) at another place, to be sold on behalf of and at the risk of the consignor, for a commission.

• Consignor: owner who sends the goods (principal).
• Consignee: agent who receives and sells the goods.
• Commission: reward of the consignee, a % of sales.
• Del credere commission: extra commission paid when the consignee takes the risk of bad debts on credit sales.

Example: Usha Fans of Nagpur sends 100 fans to Patil & Sons, Pune. Patil & Sons sells them in Pune and gets 5% commission. The fans remain the property of Usha Fans till sold.

Needs and Advantages of Consignment

1. Market expansion: the consignor reaches distant markets without opening a branch.
2. Local knowledge: the consignee knows local buyers, prices and tastes.
3. Less investment: no need for own shop, staff or godown at the other place.
4. No risk for consignee: he does not buy goods, so he needs little capital.
5. Better price: goods are sold at the best local price.
6. Useful for new products and exports: testing a new market becomes easy.

Formalities in Consignment

1. Consignor sends goods with a proforma invoice.
2. Consignor pays expenses like packing, freight and insurance up to the consignee's place.
3. Consignee may send an advance (cash or bill of exchange) as security.
4. Consignee receives goods, pays unloading, carriage, godown rent and selling expenses.
5. Consignee sells goods and periodically sends an account sales.
6. Consignee remits the balance after deducting expenses, commission and advance.

Difference between Consignment and Sale

Proforma Invoice and Account Sales

Proforma invoice: a statement sent by the consignor with the goods, giving quantity, quality and price of goods. It is not a bill (the consignee does not owe that amount); it only informs the consignee and guides him about the minimum selling price.

Account sales: a periodic statement sent by the consignee to the consignor showing goods sold, sale price, expenses paid, commission deducted, advance sent and the balance due or remitted.

Accounting Procedure of Consignment

In the consignor's books, a Consignment Account (a nominal account showing profit or loss on each consignment) and a Consignee's Personal Account are opened.

In the consignee's books only the consignor's personal account is opened (the goods are not his).

Valuation of Consignment Stock

Unsold stock is valued at cost or net realisable value, whichever is lower. Cost = cost price of goods + proportionate non-recurring expenses (freight, insurance, carriage, octroi, unloading — expenses incurred to bring goods to the consignee's godown).

Recurring expenses (godown rent, selling expenses, salesman salary, advertisement, commission) are not added to stock.

Normal and Abnormal Loss

Normal loss: unavoidable loss due to the nature of goods (evaporation, drying, breakage in handling). It is not shown separately; its cost is spread over the good units. Example: 1,000 kg sent at ₹45 (₹45,000) + freight ₹9,000 = ₹54,000; normal loss 100 kg. Cost per kg = 54,000 ÷ 900 = ₹60. If 100 kg is unsold, stock = 100 × 60 = ₹6,000.

Abnormal loss: avoidable loss due to accident, fire, theft or flood. Its value (cost + proportionate non-recurring expenses up to the point of loss) is credited to Consignment A/c and debited to Abnormal Loss A/c. Insurance claim is credited to Abnormal Loss A/c and the balance goes to P&L A/c.

Illustration 1: Usha Fans, Nagpur sent 100 fans costing ₹2,000 each to Patil & Sons, Pune, and paid freight ₹6,000. Patil & Sons paid carriage ₹2,000, godown rent ₹1,500 and selling expenses ₹1,000. They sold 80 fans at ₹3,000 each. Commission 5% on sales. The balance was remitted by bank transfer. Show journal entries and ledger accounts in the consignor's books.

Working: Closing stock (20 fans) = 20 × ₹2,000 = ₹40,000 + (₹6,000 + ₹2,000) × 20/100 = ₹1,600 → ₹41,600. Commission = 5% × ₹2,40,000 = ₹12,000. Godown rent and selling expenses are recurring, so not added.

Consignment to Pune Account (Books of Usha Fans, Nagpur)

Patil & Sons (Consignee) Account

Illustration 2 (abnormal loss): Gandhi Soaps, Nagpur consigned 500 cartons costing ₹400 each to an agent in Indore and paid freight and insurance ₹10,000. In transit 50 cartons were destroyed by accident; the insurance company paid ₹15,000. The agent received 450 cartons, paid carriage ₹4,500 and selling expenses ₹3,000, and sold 400 cartons at ₹600 each. Commission 5% on sales. Prepare Consignment Account and Abnormal Loss Account.

Working notes: (1) Abnormal loss = 50 × (₹400 + 10,000/500 = ₹20) = 50 × ₹420 = ₹21,000. (2) Closing stock of 50 cartons: cost per carton at Indore = ₹420 + 4,500/450 = ₹430; stock = 50 × ₹430 = ₹21,500. (3) Commission = 5% × ₹2,40,000 = ₹12,000. (4) Agent remits ₹2,40,000 − 4,500 − 3,000 − 12,000 = ₹2,20,500.

Consignment to Indore Account (Books of Gandhi Soaps, Nagpur)

Abnormal Loss Account

Likely exam questions

1. (Long, 8/16 marks) What is consignment? Explain its advantages and formalities. Distinguish between consignment and sale.
2. (Long, 8/16 marks) Kamal Traders, Nagpur sent 200 mixers costing ₹1,500 each to Joshi Agencies, Aurangabad, and paid freight ₹8,000. Joshi Agencies paid unloading ₹2,000, godown rent ₹1,200 and advertisement ₹800. They sold 150 mixers at ₹2,200 each. Commission is 5% on sales plus 2% del credere commission. Show the Consignment Account and Joshi Agencies' Account in the books of Kamal Traders, and value the closing stock.
3. (Short, 4 marks) Explain proforma invoice and account sales.
4. (Short, 4 marks) What are normal loss and abnormal loss in consignment? How are they treated in accounts?
5. (Short, 4 marks) 500 kg of oil costing ₹100 per kg was consigned; consignor's freight ₹5,000; normal loss 50 kg in transit; 300 kg sold. Calculate the value of closing stock.

Syllabus topics (RTMNU)

• Meaning of Branch
• Objective of Branch Accounting
• Type of Branches
• Maintenance of Accounting Records
• Transactions relating to Branch
• Accounting procedure of Branch

Meaning of Branch

Definition: A branch is a unit or shop of a business located away from the head office, which sells the goods or services of the same business under the control of the head office.

Examples: Bata showrooms in many cities, branches of Big Bazaar style retail chains, a Nagpur cloth merchant opening a shop in Amravati. The main office is called the Head Office (H.O.).

Objectives of Branch Accounting

1. Find profit or loss of each branch separately.
2. Control stock, cash and debtors at the branch.
3. Compare performance of different branches.
4. Decide expansion or closure of a branch.
5. Fix responsibility of the branch manager and detect losses or fraud.
6. Prepare consolidated accounts of the whole business.

Types of Branches

1. Dependent branch: does not keep a full set of books. Goods are supplied by H.O., expenses are paid by H.O., and all cash is sent to H.O. Accounts are kept by H.O. Example: a small showroom of a shoe company.
2. Independent branch: keeps its own complete books, buys goods from outside also, and sends a trial balance to H.O. Example: a large regional branch of a trading company.
3. Foreign branch: located outside India (excluded from our syllabus).

Maintenance of Accounting Records

For a dependent branch, H.O. can use any of these systems:

1. Debtors system: one Branch Account is opened in H.O. books. It works like a nominal account and shows branch profit. Suitable for small branches.
2. Stock and Debtors system: separate Branch Stock A/c, Branch Debtors A/c, Branch Expenses A/c, Branch Adjustment A/c and Branch P&L A/c are kept. Gives better control over stock.
3. Final accounts system: a Branch Trading and P&L Account is prepared like a separate business.

For an independent branch, the branch keeps full books; H.O. keeps a Branch A/c (personal account) and the branch keeps a Head Office A/c. Both should show the same balance (reconciled at year-end).

Transactions relating to Branch

• Goods sent by H.O. to branch (at cost or at invoice price).
• Goods returned by branch to H.O.
• Cash sent by H.O. for branch expenses (rent, salary, petty cash).
• Cash sales and credit sales at branch.
• Cash collected from branch debtors and remitted to H.O.
• Discount allowed, bad debts and sales returns at branch.
• Assets at branch: stock, debtors, petty cash, furniture.

Accounting Procedure of Branch (Debtors System)

Debit side of Branch A/c: opening assets (stock, debtors, petty cash), goods sent to branch, cash sent for expenses, closing liabilities.

Credit side: opening liabilities, remittances received from branch (cash sales + cash from debtors), goods returned by branch, closing assets. The balance is profit (if credit side is more) or loss.

Invoice price method: when goods are sent at a price above cost, the extra amount (loading) must be removed: (1) Goods Sent to Branch A/c Dr, To Branch A/c (loading on goods sent); (2) Stock Reserve A/c Dr, To Branch A/c (loading on opening stock); (3) Branch A/c Dr, To Stock Reserve A/c (loading on closing stock).

Illustration 1 (goods at cost): Nagpur H.O. has a branch at Amravati. For 2023-24: opening stock ₹20,000, debtors ₹15,000, petty cash ₹500; goods sent ₹1,20,000; cash sent by H.O. for rent ₹6,000, salaries ₹12,000 and petty cash ₹2,000; cash sales ₹80,000; credit sales ₹90,000; cash collected from debtors ₹85,000 (all cash remitted to H.O.); petty expenses ₹2,200; closing stock ₹25,000, debtors ₹20,000, petty cash ₹300. Prepare Branch Account.

Amravati Branch Account (Books of Head Office, Nagpur) for 2023-24

Verification: Sales ₹1,70,000 − Cost of goods sold (20,000 + 1,20,000 − 25,000 = ₹1,15,000) = Gross profit ₹55,000; less expenses (6,000 + 12,000 + 2,200 = ₹20,200) = Net profit ₹34,800. Closing debtors check: 15,000 + 90,000 − 85,000 = ₹20,000.

Illustration 2 (invoice price): Akola branch receives goods at cost plus 25%. For 2023-24: opening stock (invoice price) ₹25,000; opening debtors ₹10,000; goods sent (invoice price) ₹1,50,000; cash sales ₹1,00,000; credit sales ₹60,000; cash from debtors ₹55,000; branch expenses paid by H.O. ₹15,000; closing stock (invoice price) ₹15,000; closing debtors ₹15,000. Pass adjustment entries and prepare Branch Account.

Working: Loading = 1/5 of invoice price. On goods sent 1,50,000 × 1/5 = ₹30,000; on opening stock 25,000 × 1/5 = ₹5,000; on closing stock 15,000 × 1/5 = ₹3,000.

Akola Branch Account (goods invoiced at cost + 25%) for 2023-24

Verification: Sales ₹1,60,000; cost of sales = 1,60,000 × 100/125 = ₹1,28,000; gross profit ₹32,000 − expenses ₹15,000 = ₹17,000.

Likely exam questions

1. (Long, 8/16 marks) What is a branch? Explain the objectives of branch accounting and the types of branches. How are accounting records of a dependent branch maintained?
2. (Long, 8/16 marks) Nagpur Head Office sends goods to its Chandrapur branch at cost plus 25%. From the following, prepare Chandrapur Branch Account in H.O. books for 2023-24 under the debtors system: Opening stock (invoice price) ₹50,000; opening debtors ₹20,000; goods sent (invoice price) ₹2,00,000; cash sales ₹1,20,000; credit sales ₹1,00,000; cash received from debtors ₹90,000; expenses paid by H.O. ₹25,000; closing stock (invoice price) ₹30,000; closing debtors ₹30,000.
3. (Short, 4 marks) Distinguish between dependent branch and independent branch.
4. (Short, 4 marks) State the objectives of branch accounting.
5. (Short, 4 marks) Goods costing ₹80,000 were sent to a branch at cost plus 33⅓%. Calculate the invoice price and the loading, and pass the entry to remove the loading.

Syllabus topics (RTMNU)

• Meaning
• Characteristics and features of goodwill
• Type of goodwill
• Need for valuation of goodwill
• Factors influencing valuation of goodwill
• Methods of valuation of goodwill
• Valuation of goodwill as per – Average Profit Method
• Weighted Average Profit Method
• Super Profit Method
• Capitalization Method

Meaning of Goodwill

Definition: Goodwill is the value of the reputation and business connections of a firm, which helps it to earn more profit than a normal firm in the same industry.

It is the extra value a buyer is ready to pay over the net assets of a business. Example: a famous sweet shop in Nagpur with loyal customers earns more than a new shop with the same capital; the extra earning power is its goodwill.

Characteristics and Features of Goodwill

1. Intangible asset: it cannot be seen or touched, but it has value.
2. Not a fictitious asset: it has real value and can be sold with the business.
3. Cannot be sold alone: it is sold only with the whole business.
4. Linked with super profit: goodwill exists only if the firm earns more than normal profit.
5. Value changes: it rises or falls with the firm's performance.
6. Hard to value exactly: its value is an estimate based on future profits.
7. Built over time: it comes from good service, quality, location and management.

Types of Goodwill

1. Purchased goodwill: paid for when a business is bought (price paid over net assets). It is recorded in books.
2. Self-generated (inherent) goodwill: built by the firm over years. As per accounting standards (AS 26 / Ind AS 38) it is not recorded in the books.

Goodwill is also described by its source: cat goodwill (customers loyal to the place), dog goodwill (customers loyal to the owner personally), and rat goodwill (customers who move away easily).

Need for Valuation of Goodwill

• Change in profit-sharing ratio among partners.
• Admission of a new partner.
• Retirement or death of a partner.
• Sale of the business or amalgamation of firms.
• Conversion of a firm into a company.
• Purchase of shares where valuation of the company is needed.

Factors influencing Valuation of Goodwill

1. Profitability: higher and steady profits mean higher goodwill.
2. Location: a shop on a busy market road has more goodwill.
3. Quality of products and services.
4. Efficient management and skilled staff.
5. Competition: less competition, more goodwill.
6. Special rights: monopoly, patents, trademarks, licences.
7. Age and reputation of the business.
8. Risk in the business: higher risk lowers goodwill.
9. Normal rate of return in the industry.

Methods of Valuation of Goodwill

Normal profit = Capital employed × Normal rate of return ÷ 100. Capital employed = Total assets (excluding goodwill and non-trading investments) − Outside liabilities.

Adjustments to past profits: remove abnormal gains (profit on sale of assets, one-time income) and add back abnormal losses (loss by fire or flood); deduct a fair remuneration to partners if not already charged.

Valuation of Goodwill: Average Profit Method

Illustration 1: Profits of M/s Deshmukh & Co.: 2020-21 ₹42,000; 2021-22 ₹38,000 (after an abnormal loss of ₹7,000 due to flood); 2022-23 ₹55,000 (including profit of ₹5,000 on sale of old machinery); 2023-24 ₹60,000. Goodwill is valued at 2 years' purchase of average profit.

Average profit = 1,97,000 ÷ 4 = ₹49,250. Goodwill = 49,250 × 2 = ₹98,500.

Valuation of Goodwill: Weighted Average Profit Method

Illustration 2: Profits: 2021-22 ₹30,000; 2022-23 ₹42,000; 2023-24 ₹48,000. Weights 1, 2, 3 respectively. Goodwill = 3 years' purchase of weighted average profit.

Weighted average profit = 2,58,000 ÷ 6 = ₹43,000. Goodwill = 43,000 × 3 = ₹1,29,000.

Valuation of Goodwill: Super Profit Method and Capitalization Method

Illustration 3: A firm has total assets of ₹6,50,000 (excluding goodwill) and outside liabilities of ₹1,50,000. Its average profit is ₹80,000. Normal rate of return in the industry is 10%. Calculate goodwill by (a) 4 years' purchase of super profit, (b) capitalisation of super profit, (c) capitalisation of average profit.

Solution:

1. Capital employed = 6,50,000 − 1,50,000 = ₹5,00,000.
2. Normal profit = 5,00,000 × 10/100 = ₹50,000.
3. Super profit = 80,000 − 50,000 = ₹30,000.
4. (a) Goodwill = 30,000 × 4 = ₹1,20,000.
5. (b) Goodwill = 30,000 × 100/10 = ₹3,00,000.
6. (c) Capitalised value of business = 80,000 × 100/10 = ₹8,00,000; Goodwill = 8,00,000 − 5,00,000 = ₹3,00,000.

Likely exam questions

1. (Long, 8/16 marks) What is goodwill? Explain its characteristics, types and the factors influencing its valuation.
2. (Long, 8/16 marks) The capital employed in a business is ₹8,00,000 and the normal rate of return is 12%. Profits for the last four years were ₹1,10,000, ₹1,25,000, ₹1,05,000 (after an abnormal loss of ₹15,000) and ₹1,40,000. Calculate goodwill by (a) 3 years' purchase of average profit, (b) 4 years' purchase of super profit, and (c) capitalisation of super profit.
3. (Short, 4 marks) State the need for valuation of goodwill.
4. (Short, 4 marks) Distinguish between purchased goodwill and self-generated goodwill.
5. (Short, 4 marks) Profits of a firm for three years are ₹50,000, ₹60,000 and ₹70,000. Calculate goodwill at 2 years' purchase of weighted average profit, giving weights 1, 2 and 3.