Financial Accounting – II CBCAT5T07

Syllabus topics (RTMNU)

• Meaning
• Need for Valuation of Shares
• Factors affecting the Value of shares
• Methods of valuation of Shares
• Net Assets Method/Intrinsic Value Method
• Yield Method
• Fair value method, based on the Indian Company Act, 2013

Meaning of Valuation of Shares

Definition: Valuation of shares means finding the fair money value of one share of a company on a given date, using accepted methods based on its assets, profits and dividends.

The market price of a listed share is fixed by buyers and sellers on the stock exchange (NSE/BSE). But shares of private companies and unlisted companies have no market price, so their value must be calculated. Even for listed shares, valuation is needed when the market price is not a true picture.

Need for Valuation of Shares

Valuation is needed in these situations:

1. Amalgamation and absorption: to fix how many shares of the new company are given for old shares.
2. Purchase of a block of shares: when a buyer wants to take control of a company.
3. Unlisted shares: private company shares have no stock-exchange price.
4. Taxation: for gift, wealth or capital gains purposes, the fair market value is needed.
5. Loans against shares: banks lend against shares as security.
6. Conversion of shares: e.g. conversion of preference shares into equity shares.
7. Compensation: when a company is taken over by the Government (nationalisation).
8. Dissenting shareholders: those who do not agree to a scheme of merger are paid the fair value of their shares.
9. ESOPs and buy-back: issue of shares to employees or buy-back needs a fair price.

Factors Affecting the Value of Shares

1. Net worth of the company: more net assets per share means higher value.
2. Earning capacity: regular and growing profits raise the value.
3. Rate of dividend: a steady, high dividend attracts investors.
4. Dividend policy and reserves: big reserves mean safety and future bonus shares.
5. Demand and supply of the shares in the market.
6. Goodwill and management: good name and good management raise value.
7. Nature of business and economic conditions: growing industries (IT, pharma) get higher value.
8. Government policy: taxes, licensing and controls affect value.
9. Size of holding: a controlling block of shares is worth more per share than a few shares.

Methods of Valuation of Shares

There are three main methods:

• Net Assets Method (Intrinsic Value / Asset Backing / Break-up Value Method)
• Yield Method (Market Value / Income Method)
• Fair Value Method (Dual Method) — average of the above two

1. Net Assets Method / Intrinsic Value Method

Meaning: The value of a share is found by dividing the net assets available for equity shareholders by the number of equity shares. It shows what each share would get if the company were closed (wound up).

Steps:

1. Take all assets at their revalued (realisable) figures, including goodwill and non-trade investments.
2. Do not include fictitious assets (preliminary expenses, discount on issue of shares, debit balance of P&L).
3. Deduct all outside liabilities: creditors, bills payable, debentures, loans, provisions, outstanding expenses, proposed tax.
4. Deduct preference share capital (and arrears of preference dividend, if payable).
5. The balance is net assets for equity shareholders.
6. Divide by the number of equity shares.

Merits: simple; useful in winding up and amalgamation; based on the Balance Sheet. Demerits: ignores earning power; revaluation of assets is a matter of opinion; not suitable for a running (going) concern.

Illustration 1 (Net Assets Method): The Balance Sheet of Vidarbha Traders Ltd as on 31 March 2026 is as follows:

Revalued figures: Goodwill ₹1,50,000; Land & Building ₹8,00,000; Plant ₹3,50,000; a 5% provision for doubtful debts is needed on debtors. Find the intrinsic value of an equity share.

Solution: Statement of net assets available for equity shareholders

Intrinsic value per share = ₹12,90,000 ÷ 10,000 = ₹129. (Preliminary expenses ₹20,000 are fictitious and are ignored.)

2. Yield Method

Meaning: The value of a share is based on the return (dividend or profit) the investor expects, compared with the normal rate of return in that industry. It is best for valuing a small number of shares, because a small investor is interested in dividends, not in assets.

Profit available for equity dividend = Average future maintainable profit − tax − transfer to reserves − preference dividend.

Illustration 2 (Yield Method): Paid-up capital of Satpuda Ltd: 1,00,000 equity shares of ₹10 each (₹10,00,000) and 10% preference shares ₹5,00,000. Average profit before tax ₹4,00,000; tax rate 25%; 20% of profit after tax is transferred to General Reserve every year. The normal rate of return in the industry is 10%. Find the value of an equity share.

Expected rate of dividend = 1,90,000 ÷ 10,00,000 × 100 = 19%.
Value per share = 19 ÷ 10 × ₹10 = ₹19.

3. Fair Value Method (based on the Companies Act, 2013 practice)

Meaning: Fair value is the simple average of the intrinsic value and the yield value. It gives weight both to the assets (safety) and to the earnings (return) of the company. It is commonly used for share exchange in amalgamation and for unlisted shares.

Illustration 3: If the intrinsic value of a share is ₹129 and its yield value is ₹111, the fair value = (129 + 111) ÷ 2 = ₹120.

Companies Act, 2013 link: Under Section 247 of the Companies Act, 2013, when a valuation of shares, property, net worth or assets is required under the Act, it must be done by a Registered Valuer. Accounting standards (Ind AS 113, Fair Value Measurement) define fair value as the price received to sell an asset in an orderly market transaction.

Likely exam questions

1. (Long, 8/16 marks) What is valuation of shares? Explain the need for valuation of shares and the factors affecting the value of shares.
2. (Long, 8/16 marks) From the following Balance Sheet of Vidarbha Traders Ltd, find the intrinsic value of an equity share: Equity capital 10,000 shares of ₹100 = ₹10,00,000; 8% Preference capital ₹2,00,000; General Reserve ₹80,000; P&L A/c ₹40,000; 10% Debentures ₹2,00,000; Creditors ₹1,50,000; Goodwill ₹1,00,000 (revalued ₹1,50,000); Land & Building ₹6,00,000 (revalued ₹8,00,000); Plant ₹4,00,000 (revalued ₹3,50,000); Stock ₹2,50,000; Debtors ₹2,00,000 (5% provision needed); Cash ₹1,00,000; Preliminary expenses ₹20,000.
3. (Short, 4 marks) Explain the Yield Method of valuation of shares.
4. (Short, 4 marks) What is fair value of a share? How is it calculated?
5. (Short, 4 marks) Intrinsic value ₹150 and yield value ₹130 of a share. Calculate its fair value.

Syllabus topics (RTMNU)

• Accounting to Double Accounting System – Meaning
• Main Features of Double Accounting System
• Objective of Double Accounting System
• Difference between Double Accounting System and Single Accounting System
• Demerits of Double Accounting System
• Preparation of Final Accounts

Public Utility Companies and the Double Account System

Public utility companies supply essential services to the public, such as electricity, gas, water supply, railways and tramways. Examples in India: Mahavitaran (MSEDCL), Tata Power, Mahanagar Gas, Indraprastha Gas, city water-supply undertakings. They need huge fixed capital (power plants, pipelines, cables) and are usually run under a licence from the Government.

Double Account System — Definition: The Double Account System is a method of presenting the final accounts of public utility undertakings in which the Balance Sheet is split into two parts: (1) a Capital Account showing capital raised and spent on fixed assets, and (2) a General Balance Sheet showing the remaining assets and liabilities.

Main Features of the Double Account System

1. Two-part Balance Sheet: Receipts and Expenditure on Capital Account + General Balance Sheet.
2. Fixed assets at original cost: fixed assets are shown at cost year after year; depreciation is not deducted from them.
3. Depreciation fund: depreciation is charged to Revenue Account and credited to a Depreciation Fund shown on the liabilities side of the General Balance Sheet.
4. Revenue Account: takes the place of the Trading and Profit & Loss Account.
5. Net Revenue Account: takes the place of the Profit & Loss Appropriation Account; interest on debentures and loans, and dividends, are shown here.
6. Capital receipts shown in full: shares and debentures are shown at their full nominal value; premium or discount on issue is kept separate.
7. Three columns in the Capital Account: up to the beginning of the year, during the year, and total to date.

Objectives of the Double Account System

• To show clearly how much fixed capital was raised and how it was spent on fixed assets.
• To satisfy the Government and the public, because these companies use public money and supply essential services.
• To show whether capital raised was enough for fixed assets, or whether working capital was used for them.
• To help Government regulators fix the rates (tariffs) charged to consumers, often on the basis of return on capital employed.
• To show the true revenue profit for the year after keeping fixed capital separate.

Final Accounts under the Double Account System

The final accounts consist of four statements:

1. Revenue Account — all revenue incomes and expenses of the year (like Trading and P&L A/c). Balance = net revenue.
2. Net Revenue Account — starts with net revenue; interest on debentures/loans, dividends and transfers to reserves are debited. Balance carried to General Balance Sheet.
3. Receipts and Expenditure on Capital Account — capital raised (shares, debentures, long-term loans) on the receipts side and amounts spent on fixed assets on the expenditure side, each in three columns. The balance (receipts over expenditure) is carried to the General Balance Sheet.
4. General Balance Sheet — shows the balance of capital account, current assets, current liabilities, depreciation fund, reserves and the balance of Net Revenue Account.

Illustration 1 (Capital Account): Nagpur Electric Supply Co. Ltd had, up to 31 March 2025: equity share capital ₹20,00,000, debentures ₹8,00,000; spent on land ₹6,00,000, buildings ₹8,00,000, machinery ₹9,00,000 and mains & cables ₹3,00,000. During 2025-26 it issued further shares of ₹5,00,000 and debentures of ₹2,00,000, and spent ₹1,00,000 on land, ₹2,00,000 on buildings, ₹3,50,000 on machinery and ₹50,000 on mains. Prepare the Receipts and Expenditure on Capital Account.

Receipts and Expenditure on Capital Account for the year ended 31 March 2026

Illustration 2 (Revenue and Net Revenue Accounts): For 2025-26: fuel ₹4,00,000; wages at generating station ₹1,50,000; repairs ₹50,000; distribution expenses ₹1,00,000; rent, rates & taxes ₹40,000; management expenses ₹1,20,000; depreciation ₹1,40,000; sale of electricity ₹13,50,000; meter rent ₹30,000; other income ₹20,000. Net Revenue A/c balance brought forward ₹1,00,000; interest on 8% debentures of ₹10,00,000; interim dividend paid ₹1,50,000.

Revenue Account for the year ended 31 March 2026

Net Revenue Account for the year ended 31 March 2026

Replacement of an Asset (often asked)

When an old asset is replaced by a better one, the cost is split: the cost of replacing the old asset at current price is revenue expenditure; the extra cost (improvement) is capital expenditure.

Double Account System vs Single Account System

Demerits of the Double Account System

1. Fixed assets are always shown at cost, so the Balance Sheet does not show their true present value.
2. Depreciation fund may not be invested outside, so it may not be available in cash when assets must be replaced.
3. It is more complicated than the ordinary system and harder for a common reader to understand.
4. Revaluation of assets is not possible, so price rises are not reflected.
5. Since the Companies Act requires Schedule III format for most companies, the system is now mainly of academic and regulatory interest.

Likely exam questions

1. (Long, 8/16 marks) What is the Double Account System? Explain its features and objectives. Distinguish between the Double Account System and the Single Account System.
2. (Long, 8/16 marks) From the following, prepare the Revenue Account and Net Revenue Account of an electricity company for the year ended 31 March 2026: Fuel ₹4,00,000; Wages ₹1,50,000; Repairs ₹50,000; Distribution expenses ₹1,00,000; Rent, rates & taxes ₹40,000; Management expenses ₹1,20,000; Depreciation ₹1,40,000; Sale of electricity ₹13,50,000; Meter rent ₹30,000; Other income ₹20,000; Net Revenue balance b/f ₹1,00,000; Interest on 8% debentures of ₹10,00,000; Interim dividend ₹1,50,000.
3. (Short, 4 marks) State any four demerits of the Double Account System.
4. (Short, 4 marks) What is the Receipts and Expenditure on Capital Account?
5. (Short, 4 marks) Explain the treatment of replacement of an asset under the Double Account System.

Syllabus topics (RTMNU)

• Introduction
• Types of General Insurance
• Important Terms – Reserve for unexpired Risk
• Reinsurance Claims
• Reinsurance Premium
• Commission
• Bonus in Reduction of Premium
• Preparation of final accounts as per the IRDA Regulation Act, 2002

Introduction

General insurance means all insurance other than life insurance — it protects property and liability against loss from fire, theft, accident, flood, transit risk, illness etc. Contracts are usually for one year, and they are contracts of indemnity (the insurer pays only the actual loss). Examples of general insurers in India: New India Assurance, United India Insurance, ICICI Lombard, Bajaj Allianz General. They are regulated by the Insurance Regulatory and Development Authority of India (IRDAI) under the Insurance Act, 1938 and the IRDA Act, 1999.

Their final accounts are prepared as per the IRDA (Preparation of Financial Statements and Auditor's Report of Insurance Companies) Regulations, 2002. Schedule B of these regulations applies to general insurers.

Types of General Insurance

1. Fire insurance: covers loss to buildings, stock and machinery from fire, lightning, explosion, riots etc.
2. Marine insurance: covers ships (hull) and goods in transit (cargo) by sea, air, rail or road.
3. Motor insurance: covers vehicles; third-party cover is compulsory under the Motor Vehicles Act, 1988.
4. Health insurance: covers hospital and medical expenses (e.g. mediclaim, Ayushman Bharat PM-JAY).
5. Miscellaneous insurance: burglary, personal accident, crop insurance (PMFBY), travel, fidelity guarantee, liability, engineering insurance.

Important Terms

1. Reserve for Unexpired Risk (Unearned premium reserve): Policies are issued throughout the year, but the accounts close on 31 March. So part of the premium received relates to the risk of the next year. This part is kept as a reserve and carried forward. Traditionally (textbook rule from the Insurance Act, 1938) the reserve is 50% of net premium for fire and miscellaneous business and 100% of net premium for marine hull business. An additional reserve may also be kept. (IRDAI rules now allow the more exact 1/365 method — check latest; in the exam, use the percentage given in the question.)

2. Reinsurance: When an insurer takes a big risk, it passes a part of the risk to another insurer (e.g. GIC Re). This is reinsurance ceded. Taking a risk from another insurer is reinsurance accepted.

3. Reinsurance Claims: When a loss occurs, the insurer pays the full claim to the policyholder and recovers the reinsurer's share. Claims recovered on reinsurance ceded are deducted from claims; claims paid on reinsurance accepted are added.

4. Reinsurance Premium: Premium paid to the reinsurer for reinsurance ceded is deducted from premium; premium received on reinsurance accepted is added.

5. Commission: Paid to agents and brokers for getting business. Commission on reinsurance accepted is added and commission received on reinsurance ceded is deducted to get net commission (Schedule 3).

6. Bonus in Reduction of Premium: A benefit allowed to a policyholder (for example a No Claim Bonus in motor insurance) by reducing the premium payable. In accounts, the premium is credited in full and the bonus in reduction of premium is shown as a charge (or the premium is shown net of it) — profit is the same either way. Follow the treatment the question indicates.

Final Accounts as per IRDA Regulations, 2002

Schedule B prescribes these forms for general insurers:

1. Form B-RA — Revenue Account: prepared separately for Fire, Marine and Miscellaneous business. Shows premium earned (Schedule 1), profit/loss on sale of investments, interest and dividends, on the income side; claims incurred (Schedule 2), commission (Schedule 3) and operating expenses (Schedule 4) on the expense side. Balance = operating profit/loss.
2. Form B-PL — Profit and Loss Account: operating profit/loss of each class, income from investments of shareholders' funds, other income, provisions, tax, and appropriations (dividends, transfer to reserves).
3. Form B-BS — Balance Sheet: sources of funds (share capital, reserves, borrowings) and application of funds (investments, loans, fixed assets, current assets less current liabilities and provisions).
4. Schedules 1 to 15 give the details (1 Premium, 2 Claims, 3 Commission, 4 Operating expenses, 5 Share capital, … 8 Investments, … 13 Current liabilities, 14 Provisions).

Illustration 1 (Net premium and net claims): Shield General Insurance Co. Ltd (Fire) for 2025-26: premium received ₹10,00,000; outstanding premium 31.3.2026 ₹50,000 and 1.4.2025 ₹40,000; reinsurance premium accepted ₹20,000; reinsurance premium ceded ₹1,00,000. Claims paid ₹4,50,000; claims outstanding 31.3.2026 ₹80,000 and 1.4.2025 ₹60,000; claims paid on reinsurance accepted ₹20,000; claims recovered on reinsurance ceded ₹30,000. Find net premium and net claims incurred.

Illustration 2 (Revenue Account, Form B-RA): Fire business for 2025-26: premium less reinsurance ₹10,00,000; claims paid less reinsurance ₹5,50,000; claims outstanding 1.4.2025 ₹40,000 and 31.3.2026 ₹60,000; commission ₹1,00,000; expenses of management ₹2,10,000; interest and dividends ₹40,000. On 1.4.2025: reserve for unexpired risk ₹4,20,000 and additional reserve ₹30,000. Keep the reserve for unexpired risk at 50% of net premium and raise the additional reserve to ₹50,000.

Working notes: Closing reserve = 50% × 10,00,000 = ₹5,00,000. Premium earned = 10,00,000 + (4,20,000 + 30,000) − (5,00,000 + 50,000) = ₹9,00,000. Claims incurred = 5,50,000 + 60,000 − 40,000 = ₹5,70,000.

Form B-RA: Revenue Account (Fire) for the year ended 31 March 2026

Likely exam questions

1. (Long, 8/16 marks) Explain the following terms: (a) Reserve for unexpired risk (b) Reinsurance (c) Reinsurance claims (d) Commission. Also state the forms of final accounts of a general insurance company under the IRDA Regulations, 2002.
2. (Long, 8/16 marks) From the following, prepare the Fire Revenue Account (Form B-RA) for the year ended 31 March 2026: Premium less reinsurance ₹10,00,000; Claims paid less reinsurance ₹5,50,000; Claims outstanding 1.4.2025 ₹40,000 and 31.3.2026 ₹60,000; Commission ₹1,00,000; Expenses of management ₹2,10,000; Interest and dividends ₹40,000; Reserve for unexpired risk 1.4.2025 ₹4,20,000; Additional reserve 1.4.2025 ₹30,000. Keep reserve for unexpired risk at 50% of net premium and raise the additional reserve to ₹50,000.
3. (Short, 4 marks) What are the types of general insurance?
4. (Short, 4 marks) What is reserve for unexpired risk?
5. (Short, 4 marks) Claims paid ₹4,50,000; outstanding claims at end ₹80,000 and at beginning ₹60,000; recovered on reinsurance ceded ₹30,000. Calculate net claims incurred.

Syllabus topics (RTMNU)

• Meaning of Profit Prior to Incorporation
• Methods of ascertaining the Pre-incorporation and Post-incorporation Profit
• Statement of Profit & Loss as per the Indian Company Act, 2013

Meaning of Profit Prior to Incorporation

Sometimes a company is formed to take over a running business (for example, a partnership or proprietary firm) from a date earlier than the date of its incorporation. The profit earned from the date of purchase of business up to the date of incorporation is called profit prior to incorporation (pre-incorporation profit).

Definition: Profit prior to incorporation is the profit earned by a business between the date from which the company acquires it and the date on which the company is incorporated (gets its Certificate of Incorporation).

The company did not exist in this period, so it could not earn this profit. Therefore pre-incorporation profit is a capital profit. It is transferred to Capital Reserve and cannot be distributed as dividend. It may be used to write off goodwill, preliminary expenses or to issue bonus shares. A pre-incorporation loss is a capital loss; it is debited to Goodwill A/c (treated as goodwill) or shown under Other non-current assets/written off against capital reserve.

Profit earned after incorporation is post-incorporation profit. It is a revenue profit, available for dividend, and is shown in the Statement of Profit and Loss.

Methods of Ascertaining Pre- and Post-incorporation Profit

Method 1 — Closing the books on the date of incorporation: stock is taken and separate final accounts are prepared on the date of incorporation. Accurate but costly and time-consuming.

Method 2 — Apportionment (Time ratio and Sales ratio) — most used: one Statement of Profit and Loss is prepared for the whole year and each item is divided between the two periods on a suitable basis.

Steps in the Apportionment Method

1. Time ratio: ratio of the months before incorporation to the months after incorporation.
2. Sales ratio: ratio of sales made before incorporation to sales after it.
3. Divide gross profit in the sales ratio.
4. Divide each expense in the proper ratio (see table) or charge it wholly to one period.
5. Prepare a statement with columns: Particulars | Basis | Pre-incorporation ₹ | Post-incorporation ₹.
6. Pre-incorporation profit → Capital Reserve; post-incorporation profit → Statement of Profit and Loss.

Basis of Apportionment

Illustration 1: Shri Ganesh Ltd was incorporated on 1 July 2025 to take over a running business from 1 April 2025. Accounts are closed on 31 March 2026. Total sales ₹24,00,000, of which sales from 1 April to 30 June 2025 were ₹4,00,000. Gross profit ₹6,00,000. Expenses: salaries ₹1,20,000; rent ₹60,000; selling expenses ₹48,000; bad debts ₹12,000; directors' fees ₹30,000; preliminary expenses written off ₹20,000; debenture interest ₹18,000; depreciation ₹24,000. Find pre- and post-incorporation profit.

Working notes: Time ratio = 3 months : 9 months = 1 : 3. Sales ratio = 4,00,000 : 20,00,000 = 1 : 5.

Check: Total profit = 6,00,000 − 3,32,000 = ₹2,68,000 = 39,000 + 2,29,000. ✔

Illustration 2 (uneven sales): Wainganga Ltd took over a business from 1 April 2025 and was incorporated on 1 August 2025. Total sales for the year ended 31 March 2026 were ₹18,00,000. The average monthly sales in the first four months were half of the average monthly sales of the remaining eight months. Gross profit ₹4,50,000; salaries ₹72,000; advertising ₹36,000; directors' remuneration ₹24,000; office rent ₹30,000.

Working notes: Let monthly sales after incorporation = x. Then 4 × x/2 + 8x = 10x = ₹18,00,000, so x = ₹1,80,000. Pre sales = 4 × 90,000 = ₹3,60,000; post sales = 8 × 1,80,000 = ₹14,40,000. Sales ratio = 1 : 4. Time ratio = 4 : 8 = 1 : 2.

Check: 4,50,000 − 1,62,000 = ₹2,88,000 = 48,800 + 2,39,200. ✔

Statement of Profit and Loss as per the Companies Act, 2013

Under Section 129 and Schedule III (Division I) of the Companies Act, 2013, the company prepares its Statement of Profit and Loss in vertical form: Revenue from operations, Other income, Total income; Expenses (cost of materials, purchases, changes in inventories, employee benefit expense, finance costs, depreciation, other expenses); Profit before tax; Tax expense; Profit for the period.

• Only the post-incorporation profit is the profit of the company shown under "Reserves and Surplus — Surplus in Statement of Profit and Loss".
• The pre-incorporation profit is shown under "Reserves and Surplus — Capital Reserve" in the Balance Sheet.
• A pre-incorporation loss may be added to Goodwill (or treated as a capital loss).

Likely exam questions

1. (Long, 8/16 marks) What is profit prior to incorporation? How is it treated in accounts? Explain the bases of apportionment of expenses between pre- and post-incorporation periods.
2. (Long, 8/16 marks) A company was incorporated on 1 July 2025 to take over a business from 1 April 2025. Accounts are closed on 31 March 2026. Sales ₹24,00,000 (₹4,00,000 up to 30 June 2025); Gross profit ₹6,00,000; Salaries ₹1,20,000; Rent ₹60,000; Selling expenses ₹48,000; Bad debts ₹12,000; Directors' fees ₹30,000; Preliminary expenses written off ₹20,000; Debenture interest ₹18,000; Depreciation ₹24,000. Ascertain pre- and post-incorporation profit.
3. (Short, 4 marks) Distinguish between time ratio and sales ratio.
4. (Short, 4 marks) How is pre-incorporation profit treated in the books of a company?
5. (Short, 4 marks) A business was taken over from 1 April and the company was incorporated on 1 August. Accounts close on 31 March. Calculate the time ratio.