Accounting and Auditing Notes (UGC NET Unit 2)

An analysis of 227 previous year questions of Unit 2 across 24 exam cycles (prepared for this site; 222 are classified by topic, 5 sit in a mixed bucket) shows where the marks come from. Revise in this order.

How to use this unit

• Numerical topics repeat. About one in three questions needs a calculation. Practise the formulas in the quick revision table until each takes under a minute.
• Matching and sequence questions are common. Learn Ind AS numbers with subjects, the order of steps in processes, and who proposed which theory.
• Standards change. Ind AS 117 (insurance contracts) is notified; Ind AS 118 (presentation) is still a proposal; SQM 1 and SQM 2 are deferred. The section on recent developments lists the position as on 12 November 2026.

Accounting is the process of identifying, measuring, recording, classifying, summarising and communicating the financial information of an entity to its users. The rules that guide it are called principles, concepts, postulates, conventions or assumptions; in practice the words are used loosely.

Principles, postulates, concepts and conventions: how the words are used

• The basic ideas of accounting go by many names: concepts, postulates, propositions, basic assumptions, underlying principles, fundamentals, conventions, doctrines and rules. Each could be defined exactly, but general usage in the profession has given them loose and overlapping meanings.
• The same idea is called a concept by one writer and a convention by another. The idea behind conservatism, for example, is a modifying convention to one author, a principle to another and a doctrine to a third. This variety of terms confuses the learner, so the working distinctions below are used.
• Accounting principles are the rules that should be followed when making financial statements. They rest on the norms of GAAP, are man-made, and are accepted because they are believed to be useful.
• A principle is generally accepted according to how well it meets three criteria: relevance, objectivity and feasibility. It is relevant to the extent that it gives meaningful or useful information to those who need to know about a business.
• Accounting postulates are assumptions based on concepts or on historical information; they give clarity to the information recorded in financial statements.
• Accounting conventions are statements of practice or principles that companies follow over time, so that all companies record transactions in the same way. They are also called accounting concepts in loose usage, are in effect unwritten laws, and have grown through usage and custom over the years.

Generally Accepted Accounting Principles (GAAP)

GAAP are the rules, standards and practices accepted by the profession for preparing financial statements. In India the sources are the Companies Act, 2013, the Accounting Standards (AS) and Indian Accounting Standards (Ind AS) notified under it, guidance notes of the ICAI, SEBI rules for listed companies, and accepted practice. The older term for the framework before Ind AS is Indian GAAP (IGAAP).

Accounting concepts (postulates)

Concepts explained with examples

• Entity concept: a business is a separate identity from its owner, and accountants treat it as distinct. Business transactions go into the business books and personal affairs of the owner stay out; this separation began in the early days of double-entry bookkeeping. It applies to sole proprietorships and to corporate entities alike. Example: Mr X starts with ₹7,00,000, buys machinery for ₹5,00,000 and keeps the balance as cash, so the business owes ₹7,00,000 to Mr X (capital). If he withdraws ₹5,000 for personal expenses, this is charged to his capital account as drawings: capital ₹7,00,000 less drawings ₹5,000 = ₹6,95,000, against machinery ₹5,00,000 and cash ₹1,95,000.
• Money measurement concept: only transactions that can be measured in money are recorded, because money is the medium of exchange and the standard of economic value. Facts such as the production manager and chief internal auditor not being on speaking terms, staff dissatisfaction with working conditions, or a competitor taking over the best customer are not recorded, however important they are to the business.
• Periodicity (accounting period) concept: also called the concept of the definite accounting period. Going concern assumes an indefinite life, which makes it inconvenient to measure performance only at the end of the life, so a slice of the life is taken for measuring performance and financial position. A year is usual, but it can be 6, 9 or 15 months; in India the year normally runs from 1 April to 31 March of the next year. The concept helps in comparing the statements of different periods, gives uniform and consistent treatment in finding profit and assets, and matches periodic revenues with expenses to get correct results.
• Accrual concept: the effects of transactions and events are recorded and reported in the periods to which they relate. Accrual-basis statements tell users not only of past cash payments and receipts but also of obligations to pay cash in future and resources that represent cash to be received. Accrual means recognising revenue and cost as they are earned or incurred, not as cash is received or paid; it relates to the measurement of income and to the identification of assets and liabilities. Revenue less expenses equals profit.
• Revenue is the gross inflow of cash, receivables and other consideration arising in the ordinary course of business from the sale of goods, from rendering services, and from the use by others of the enterprise’s resources yielding interest, royalties and dividends. Example: Mr X invests ₹50,000, buys merchandise for ₹50,000 and sells it for ₹60,000; customers pay ₹50,000 in cash and promise the remaining ₹10,000. The revenue is ₹60,000, not the cash of ₹50,000.
• Matching concept: only expenses of the period should be set against the revenue of that period, and when revenue is recognised, the expenses related to earning it are recognised too. It rests on the accrual concept, so it needs adjustments for items such as prepaid and outstanding expenses and unearned income. Not every expense can be tied to particular revenue: selling expenses go with sales, but rent and salaries are time-bound and are recorded for the accounting period, so periodicity is followed while applying matching.
• Illustration (matching): Mr PK buys 10,000 garments at ₹100 and sells 8,000 at ₹150 in the year 1 January to 31 December 2019; he pays shop rent of ₹3,000 a month for 11 months, pays ₹8,00,000 to suppliers and receives ₹10,00,000 from customers. On the accrual and matching basis, revenue is 8,000 × 150 = ₹12,00,000; cost of goods sold is 8,000 × 100 = ₹8,00,000 (the unsold 2,000 pieces are closing stock); rent is for all 12 months, 12 × 3,000 = ₹36,000 (one month is outstanding); profit is 12,00,000 − 8,00,000 − 36,000 = ₹3,64,000, though cash received less cash paid looks different.
• Going concern concept: statements are normally prepared on the assumption that the enterprise will continue in operation for the foreseeable future, with neither the intention nor the need to liquidate or materially curtail the scale of operations. If such an intention or need exists, the statements may have to be prepared on a different basis, and that basis must be disclosed. Assets are therefore kept for generating future benefit, not for immediate sale, and a current change in asset value is ignored.
• Cost concept: assets are recorded at historical (acquisition) cost. Example: of ₹7,00,000 invested, a business pays ₹5,00,000 for a machine and ₹70,000 as transport and installation, so the machine appears at ₹5,70,000 and cash at ₹1,30,000 (total ₹7,00,000). Even if the machine would fetch more or less, the short-run rise or fall in value is ignored. Other bases of measurement are replacement cost, realisable value and present value, but accountants prefer historical cost for objectivity: replacement cost is hard to fix if the same model is not on the market; realisable value is only hypothetical until the asset is sold; present value is highly subjective because it depends on an uncertain future.
• Dual aspect concept is the core of double-entry bookkeeping: every transaction has two aspects. It may increase one asset and decrease another, increase an asset and increase a liability (or capital), decrease an asset and decrease a liability, increase one liability and decrease another, or decrease one asset and increase another; in every case the accounting equation stays in balance.

Accounting conventions

• Consistency: the same methods are followed from year to year so that results are comparable. A change needs a valid reason and disclosure.
• Full disclosure: all material facts must appear in the statements or notes.
• Materiality: only items large enough to influence decisions need separate treatment. A pencil bought for the office is expensed at once.
• Conservatism (prudence): anticipate no profit but provide for all possible losses. Stock is valued at cost or market value, whichever is lower. This is the ‘playing safe’ policy.

The concept of Realisation, Matching and Accrual work together: together they form the base of the accrual system of accounting.

Conventions explained further

• Consistency: the same principles are used year after year, so a meaningful conclusion can be drawn by comparing the statements of one enterprise over time. This works only if the policies and practices are uniform; if different methods are used in different years, the results are not comparable. Example: a business that values inventory by one method (say FIFO) must use that method for all items, so that book values are comparable from year to year.
• Full disclosure: all relevant information about the financial position and results must be fully disclosed. Full means nothing is omitted; fair means recorded transactions are accounted for so that the statements show the true results of the business; adequate means information that influences users’ decisions is disclosed in enough detail to make sense. The Companies Act prescribes a format for the balance sheet and statement of profit and loss that every company must follow, and SEBI makes complete disclosure compulsory for registered (listed) companies.
• Materiality: to keep statements meaningful, only material facts, that is, important and relevant information, are shown. Materiality depends on the nature of a fact and the amount involved; a material fact is one that will influence the decision of its user. Example: stationery bought but not fully used in the year is charged wholly to expense, and depreciation is not charged on small items such as books, though they are assets of the company and last more than a year.
• Conservatism (prudence): anticipate no profit but provide for all possible losses. Where an accountant has two alternatives, a larger or a smaller figure, the principle favours the lower asset value and the lower profit; the aim is to show the minimum profit and never overstate it. Profit is not recorded until realised, but an expected loss is provided for at once. Examples: closing stock at cost or market price whichever is lower, a provision for doubtful debts, a provision for discount on debtors, and writing off intangible assets such as goodwill. It is a useful guide in conditions of uncertainty and doubt.

Capital and revenue items

Deferred revenue expenditure is a revenue item whose benefit spreads over several years, such as heavy advertising for a new launch; it is written off over a few years. Under present standards most such items are now expensed.

Accounting cycle

The order is: transactions, journal, ledger, trial balance, adjusting entries, adjusted trial balance, financial statements, closing entries.

Under Section 4 of the Indian Partnership Act, 1932, partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. It is created by contract, not by status.

Meaning of partnership, essential elements and terms

• Section 4 of the Indian Partnership Act, 1932 defines partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Individually the persons are partners, collectively they are the firm, and the name under which the business is carried on is the firm name.
• Essential elements: (1) at least two persons who are competent to contract (natural or artificial persons); (2) an agreement between them, oral or written, express or implied; (3) the agreement is to share the profits of a business; and (4) the business is carried on by all or any of them acting for all.
• Minor as a partner (Section 30): a minor can be admitted to the benefits of the partnership with the consent of all partners, and the agreement is executed through his guardian. His rights: to share the profits, to share the property of the firm, to inspect the accounts and to take copies of them. He is not personally liable, but his share in the firm is liable for the firm’s debts.
• Types of partnership: partnership at will is formed for an indefinite period, has no fixed time, and can be dissolved by any partner giving notice to the others of his wish to quit; particular partnership is formed for a specific time or purpose and ends when the time is over or the purpose is achieved.
• Partner as agent of the firm (Section 18): every partner is an agent of the firm and of the other partners for the business of the firm, so any act done by a partner binds the firm and all partners. The firm is not bound if the partner had no authority and the third party knew it, or the third party did not know or believe him to be a partner.
• From the legal viewpoint, a partnership firm is not a separate legal entity from its partners, so if the firm cannot pay its liabilities, the private assets of the partners can be used to pay them.

Rules when the deed is silent (Section 13)

• Profits and losses are shared equally.
• No salary or commission is paid to a partner.
• Interest on capital is not allowed; interest on a partner’s loan is allowed at 6 per cent a year.
• Interest on drawings is not charged.
• Every partner may take part in management; the consent of all is needed to admit a new partner.

Types of partners

• Active (working) partner: contributes capital and takes an active part in management; bears unlimited liability; is known to outsiders; shares the profits; is a full-fledged partner.
• Sleeping (dormant) partner: contributes capital only and does not take part in management; liability is unlimited; not known to outsiders; may retire without giving any public notice.
• Secret partner: contributes capital, takes an active part in the business and shares profits and losses, with unlimited liability; but his connection with the firm is not known to the outside world.
• Limited partner: liability is limited to his share in the capital and profits of the firm; he does not take an active part in the business; the firm is not dissolved on his death, lunacy or bankruptcy; he is associated with his money and goodwill.
• Partner in profits only: shares only the profits of the firm and not the losses, but his liability to outsiders is unlimited.
• Nominal partner: lends his name and reputation for the firm’s benefit, represents himself (or knowingly allows himself to be represented) as a partner, neither contributes capital nor takes part in management, does not share profits or losses, yet is liable to outsiders for the firm’s debts.

Fixed and fluctuating capital

Profit and loss appropriation account

It shows how net profit is divided. Interest on capital, salary and commission are appropriations of profit (debited here) when the deed allows them. Interest on drawings is credited here.

Interest on capital is allowed only out of profit; if profit is insufficient, it is paid in the profit-sharing ratio unless the deed says otherwise.

Appropriation account: items and an illustration

• The Profit and Loss Appropriation Account continues from the Profit and Loss Account and shows how profit or loss is shared among the partners. Its items are partners’ salaries, interest on capital, interest on drawings and the share of the remaining profit.
• Charge against profit versus appropriation of profit: a charge is an expense deducted from revenue to find net profit or loss; it is shown in the Profit and Loss Account and is payable even if the firm earns no profit (rent paid to a partner, interest on a partner’s loan, commission to a manager). An appropriation is the distribution of net profit among partners under different heads as per the partnership deed; it is made in the Profit and Loss Appropriation Account after all charges, and only if there is profit (partner’s salary, interest on capital, transfer to general reserve).
• Illustration: net profit ₹20,000; add interest on drawings (Abrahams ₹2,000, Peterson ₹3,000) ₹5,000 = ₹25,000; less interest on capital (Abrahams ₹4,000, Peterson ₹2,000) ₹6,000; less Abrahams’ salary ₹9,000; the balance ₹10,000 is shared equally, ₹5,000 each.

Goodwill

Goodwill is the extra value a firm earns over a normal return, because of reputation, location or customer loyalty. It is an intangible asset but is not recorded unless it is bought. Classification: purchased goodwill (paid for) and inherent (self-generated) goodwill.

Adjustments to profit before averaging: remove abnormal gains and losses, add back non-trading losses, deduct non-trading gains, adjust for undervalued or overvalued stock, and charge a fair remuneration for the partner’s services.

Goodwill: meaning, factors and when it is valued

• Goodwill relates to the profits expected in future over and above the normal level of profits earned by undertakings of the same class. It is the firm’s anticipated super-normal earnings, the earnings above the normal rate of return earned by representative firms in the industry. It arises from successful operations and customer satisfaction, lets the firm earn more than others in the industry, and is an intangible but real asset, not a fictitious one.
• Factors that contribute to the value of goodwill: location of the business unit, reputation of the owners, monopolistic nature of the business, risk involved in the business, efficiency of management and quality of the goods sold.
• Goodwill needs to be valued whenever the relationship of partners changes and some partners sacrifice future profit while others gain; the sacrificing partners must be compensated by the gainers. The occasions are a change in the profit-sharing ratio, admission of a partner, retirement or death of a partner, sale of the business, and amalgamation of a firm with another firm.
• Reconstitution of a firm: any change in the existing agreement or relationship of partners reconstitutes the firm and changes the partnership agreement. It occurs on a change in the profit-sharing ratio, admission of a new partner, retirement of an existing partner, death of a partner, or amalgamation of two partnership firms.

Goodwill methods: numerical examples

• Average profit method: goodwill = average profit × number of years’ purchase. Example: average profit ₹50,000, 3 years’ purchase, goodwill = ₹50,000 × 3 = ₹1,50,000.
• Super profit method: normal profit = capital employed × normal rate of return; super profit = average profit − normal profit; goodwill = super profit × years’ purchase. Example: average profit ₹1,00,000, capital employed ₹5,00,000, normal rate 10%: normal profit ₹50,000, super profit ₹50,000, 3 years’ purchase, goodwill ₹1,50,000.
• Capitalisation method: capitalised value = average profit × 100 ÷ normal rate of return; goodwill = capitalised value − net assets (total assets − outside liabilities). Example: average profit ₹1,00,000, net assets ₹7,00,000, normal rate 10%: capitalised value ₹10,00,000, goodwill ₹3,00,000.

When a new partner joins, the old firm is treated as ended and a new one begins. The following adjustments are needed.

Why a partner is admitted and the key adjustments

• A new partner is admitted with the consent of all existing partners, for reasons such as more capital, influence or managerial skill. The partner who gains under the new ratio must compensate the partner who loses; a gaining partner may buy his share of profit from any one or two partners, as the case may be.
• Key adjustments: goodwill treatment, capital contribution of the new partner (as agreed), and revaluation of assets and liabilities through a Revaluation Account.
• Goodwill treatment: debit Goodwill Account and credit the old partners’ capital accounts in their old ratio. Example: goodwill ₹50,000 and old ratio 3:2 gives ₹30,000 and ₹20,000.
• New ratio = old ratio − sacrificing ratio. Sacrificing ratio = old share of profit − new share of profit, and it is the ratio in which the old partners agree to give up part of their profit to the incoming partner.

1. New profit-sharing ratio and sacrificing ratio

Worked example. A and B share profits 3:2. They admit C for 1/5 share, which C takes equally from A and B. Each gives up 1/10. A’s new share = 3/5 – 1/10 = 5/10; B’s new share = 2/5 – 1/10 = 3/10; C = 2/10. New ratio = 5:3:2. If C takes the share only from A, A’s new share = 3/5 – 1/5 = 2/5, B stays at 2/5 and C gets 1/5, so the new ratio is 2:2:1.

Three cases for the new profit-sharing ratio

• Case 1 (only the new partner’s share is given; how much each old partner gives up is not given): the old partners sacrifice in their old ratio. A and B share equally and admit C for 1/4: the remaining 3/4 is shared equally, so the new ratio is 3/8 : 3/8 : 1/4 = 3 : 3 : 2.
• Case 2 (the new partner acquires his share in a stated ratio): A and B share 3:2 and admit C for 1/5, acquired from A and B in the ratio 2:1. A sacrifices 1/5 × 2/3 = 2/15 and B sacrifices 1/5 × 1/3 = 1/15, so A’s new share = 3/5 − 2/15 = 7/15, B’s = 2/5 − 1/15 = 5/15 and C’s = 3/15. The new ratio is 7 : 5 : 3.
• Case 3 (old partners surrender a fraction of their own shares): A and B share 5:3. A surrenders 1/5 of his share and B surrenders 1/3 of his share to C. A’s sacrifice = 5/8 × 1/5 = 1/8; B’s sacrifice = 3/8 × 1/3 = 1/8; C gets 1/8 + 1/8 = 2/8. New shares: A = 5/8 − 1/8 = 4/8, B = 3/8 − 1/8 = 2/8, C = 2/8, so the ratio is 4 : 2 : 2 or 2 : 1 : 1.
• Illustration (equal partners): A, B and C share 5:3:2 and decide to become equal partners (1/3 each); goodwill is ₹4,50,000 and land and buildings are appreciated by ₹1,40,000, with no goodwill account in the books. A loses 5/10 − 1/3 = 5/30; B gains 1/3 − 3/10 = 1/30; C gains 1/3 − 2/10 = 4/30. A is credited with 5/30 of ₹4,50,000 = ₹75,000, B is debited ₹15,000 and C is debited ₹60,000. The revaluation profit of ₹1,40,000 goes to the old partners in the old ratio.

2. Goodwill adjustment

• Premium method: the new partner brings cash for goodwill; it is shared by the old partners in the sacrificing ratio.
• If the new partner cannot bring goodwill in cash: the new partner’s capital account is debited with his share of goodwill and the old partners’ capital accounts are credited in the sacrificing ratio.
• Hidden goodwill: if the new partner brings capital for his share, total capital of the firm is worked out, and the goodwill is found as the difference from the net assets.
• Self-generated goodwill is not recorded under accounting standards. In partnership problems, goodwill raised at admission is usually written off straight away among all partners in their new ratio, unless the question says to keep it.

Journal entries in the Revaluation Account

• Revaluation is needed at a change in the partnership so that partners’ capital accounts reflect the true net worth of the business, which depends on realistic values of assets.
• An increase in an asset is debited to the asset and credited to the Revaluation Account; a decrease is debited to the Revaluation Account and credited to the asset. Provision for depreciation no longer needed is debited and Revaluation is credited. A fresh or increased provision for bad debts is debited to Revaluation and credited to the provision, and a reduced provision is the reverse.
• Finally the Revaluation Account is closed to the partners’ capital accounts in the old profit-sharing ratio.

3. Revaluation of assets and liabilities

Assets and liabilities are revalued and the profit or loss goes to the Revaluation Account, shared by the old partners in the old ratio. A gain is credited to partners’ capital; a loss is debited.

4. Treatment of reserves

Accumulated profits, general reserve and the profit and loss balance belong to the old partners and are credited to them in the old ratio. The new partner has no claim on past profits and bears no past losses.

Reserves transfer when the ratio changes

• Reserves created out of profits, and the balance in the Profit and Loss Account at the time of admission, belong to the old partners and are transferred to their capital accounts in the old ratio; accumulated losses are transferred in the same way. The new partner has no share in accumulated profits.
• This transfer is made even when no new partner is admitted but the partners only change their profit-sharing ratio.

5. Adjustment of capitals

Capitals of old partners may be adjusted to the new profit ratio. Steps: find the new partner’s capital, work out the total capital of the firm, divide it in the new ratio to get each partner’s required capital, and compare it with the actual balance to find the cash to bring in or withdraw.

On retirement or death the firm continues but the old partnership is reconstituted. The outgoing partner (or the legal heirs) must be paid what is due.

Retirement: reasons, rule and key adjustments

• A partner may retire under Section 32(1) of the Partnership Act: with the consent of all the other partners, by an express agreement among the partners, or, in a partnership at will, by giving written notice of his intention to retire to all other partners. The business generally does not end when one partner retires; the others continue it. Reasons include old age or personal reasons.
• Key adjustments: settle the retiring partner’s dues (transfer his capital and goodwill to his account); revalue assets and liabilities through the Revaluation Account and share it among the partners; and adjust the profit-sharing ratio for the remaining partners.
• Settlement entry: debit the remaining (gaining) partners’ capital accounts and credit the retiring partner’s capital account, in the gaining ratio. Example: goodwill ₹30,000 and gaining ratio 3:2 gives ₹18,000 and ₹12,000. If the dues are kept as a loan, debit the retiring partner’s capital account and credit the Loan Account.

Gaining ratio

The gaining partners compensate the outgoing partner for goodwill. If goodwill is already in the books, it is first written off in the old ratio. If it is not, the retiring partner’s share of goodwill is raised and debited to the continuing partners in the gaining ratio.

Retirement: new ratio when the retiring partner’s share is taken over

• Case 1 (share taken in the existing ratio): Tanu, Manu and Rena share 4:3:2 (Manu 3/9, Rena 2/9, Tanu 4/9). Manu and Rena take Tanu’s 4/9 in the ratio 3:2. Manu gains 4/9 × 3/5 = 12/45 and Rena gains 4/9 × 2/5 = 8/45. Manu’s new share = 3/9 + 12/45 = 27/45; Rena’s = 2/9 + 8/45 = 18/45. The new ratio is 27 : 18 = 3 : 2, the same as their old ratio, and the gaining ratio is 12/45 : 8/45 = 3 : 2. Gain of a partner = new share − old share.
• Case 2 (share taken in a stated proportion): A, B and C share 3:2:1 and B retires; his share 2/6 is divided equally between A and C. A gains 1/2 × 2/6 = 1/6 and C gains 1/6. A’s new share = 3/6 + 1/6 = 4/6 and C’s = 1/6 + 1/6 = 2/6, so the new ratio is 2 : 1.

Steps on retirement

1. Calculate the new profit-sharing ratio and the gaining ratio.
2. Adjust goodwill (retiring partner’s share) through the gaining partners.
3. Revalue assets and liabilities (profit or loss shared by all partners in the old ratio, including the retiring partner).
4. Distribute reserves and undistributed profit in the old ratio.
5. Settle the amount due: lump sum in cash, or transfer to a loan account bearing interest (6 per cent unless agreed otherwise), or in instalments.

Death: accrued profit and settlement with heirs

• Key adjustments: calculate goodwill, accrued profit and interest on capital up to the date of death; revalue assets and liabilities; and settle with the legal heirs by transferring the deceased partner’s share to them.
• Accrued profit is worked out on a time or turnover basis. Example: the firm earned ₹1,20,000 in the last 12 months; the share for the first 6 months is ₹60,000 (before the partner’s share is applied).
• Goodwill: the deceased partner’s share is credited to him. Example: total goodwill ₹50,000 and his share 2/5 gives ₹20,000 due to his heirs.
• Final payment to heirs: debit the remaining partners (as gainers) and credit the executor or heirs of the deceased partner.

Death of a partner

The same steps follow, with additions: profit up to the date of death is estimated on the basis of the last year’s profit or sales (time basis or turnover basis), interest on capital and drawings up to the date of death is calculated, and the amount due is credited to the executor’s account.

A joint life policy is shown as an asset at its surrender value. On the death of a partner, the policy amount is received; any difference from the surrender value is a profit shared by all partners in the old ratio.

Dissolution of the firm means the firm itself comes to an end, its assets are sold and its liabilities paid, while dissolution of the partnership is only a change in the relationship among partners and the firm may continue.

Dissolution of partnership and dissolution of firm compared

• Dissolution of partnership changes the existing relationship among partners, but the firm may continue its business as before, with the same name if the partners decide. It occurs on a change in the profit-sharing ratio, admission of a partner, retirement, death or insolvency of a partner, and the like. The firm continues after the change with a new, reconstituted partnership. Example: A, B, C and D carry on business; A is declared insolvent by the court, so the partnership of A, B, C and D ends and a new partnership of B, C and D comes into existence (the reconstituted firm); the partnership is dissolved but the firm continues.
• Dissolution of the firm means the dissolution of the partnership between all the partners: the business is completely stopped, assets are realised, outside liabilities are paid off, partners’ claims are settled and the surplus is distributed among partners. When a firm is dissolved, it necessarily involves dissolution of the partnership, but dissolution of the partnership does not necessarily dissolve the firm.
• Ways a partnership may be dissolved: change in the profit-sharing ratio, admission of a new partner, retirement of a partner, death of a partner, insolvency of a partner, completion of the venture for which the partnership was formed, and expiry of the period if the partnership was for a fixed period.

Modes of dissolution

• By agreement, by notice (partnership at will), by compulsory events (insolvency of all partners, business becoming unlawful), on the happening of a contingency, and by order of the court (Section 44).

How a firm may be dissolved

• By agreement: a firm may be dissolved at any time with the consent of all partners, for example when it does not expect good prospects.
• Compulsory dissolution (Section 41): by operation of law when all partners, or all but one, become insolvent, or when the business becomes illegal or an event makes it unlawful to carry it on.
• On the happening of certain contingencies (Section 42): expiry of the term for which the firm was formed, completion of the venture for which it was constituted, death of a partner, or a partner being adjudicated insolvent (subject to a contract to the contrary).
• By notice (Section 43): where the partnership is at will, any partner may dissolve the firm by giving written notice to all the other partners of his intention to dissolve it.
• By the court (Section 44): the court may order dissolution on a partner’s suit where a partner has become of unsound mind, has become permanently incapable of performing his duties, is guilty of conduct likely to affect the business adversely, wilfully or persistently breaks the agreement so that others cannot reasonably carry on with him, has transferred his interest to a third party, where the business can only be carried on at a loss, or where it is just and equitable to dissolve the firm.
• Settling the accounts after dissolution: (1) sell the assets or convert them into cash (capital equipment, inventory, receivables); (2) pay off the liabilities, including loans, taxes and wages payable; (3) distribute the remaining assets among partners in the profit-sharing ratio, usually as specified in the partnership agreement.

Accounts on dissolution

Order of application of assets (Section 48)

1. Losses, including deficiency of capital, are paid first out of profits, then out of capital, and lastly by the partners individually in the profit-sharing ratio.
2. Assets are applied first to pay debts to outsiders.
3. Then, to pay each partner’s loan or advance.
4. Then, to pay partners’ capital contributions.
5. Any balance is divided among partners in the profit-sharing ratio.

Statutory provisions after dissolution

• Mode of formation (Section 6): a partnership may be formed by agreement or by implication from the conduct of the partners.
• Liability after dissolution (Section 45): partners remain liable to third parties for acts done on behalf of the firm until public notice of dissolution is given. Each partner remains responsible for his own debts, and partners are jointly responsible for winding up the affairs, that is, settling obligations, realising assets and distributing the balance as per the agreement.
• Right to have the business wound up (Section 46): after dissolution each partner can require the firm’s property to be applied in payment of the debts and liabilities, and the surplus to be distributed among partners (a right in the nature of an equitable lien on the firm property).
• Mode of settling accounts (Section 48): accounts are settled after any change in the partnership by considering all assets and liabilities, and the remaining amount is distributed among partners according to their respective shares.
• Other rights of partners after dissolution: return of the premium paid on premature dissolution (Section 51); rescission of the contract and claim for remedies if the partnership was entered into by fraud or misrepresentation (Section 52); the right to restrain others, including former partners, from using the firm name or property without consent (Section 53); and the right to carry on business and earn personal profit from the firm’s goodwill if he buys it at dissolution.
• Sale of goodwill (Section 55): where goodwill is sold after dissolution, its value is divided among partners as they share profits and losses. In settling accounts, goodwill is subject to contract between partners and counted with the other property of the firm. A seller may compete with the buyer but, unless agreed otherwise, may not use the firm name, represent himself as carrying on the firm’s business or solicit the old customers; the seller may also agree not to carry on a similar business within a specified period or local limits.

Insolvency of a partner: Garner v Murray rule

When a partner becomes insolvent and cannot make up the deficiency in his capital account, the loss is borne by the solvent partners. In the case of Garner v Murray (1904), it was held that the solvent partners bear the deficiency in the ratio of their last agreed (fixed) capitals, not in the profit-sharing ratio.

Points to remember. (1) Use the capital ratio based on capital balances before the dissolution, adjusted for earlier profits and losses. (2) Where all partners are insolvent, the firm’s creditors and partners’ private creditors are paid in the order of Section 49. (3) If the firm’s assets are less than liabilities to outsiders, the shortfall is a loss to the partners.

Amalgamation of partnership firms

• Amalgamation of partnership firms means the merger of two or more firms into one another so as to form a new partnership firm. It can take place by merging two or more sole proprietors into a new partnership; merging an existing firm with a sole proprietor to form a new firm; absorption of one firm by another firm; or merging two or more existing firms into a new firm.
• Objectives: to avoid cut-throat competition, to minimise common expenses, to gain the advantages of large-scale business, to strengthen the capital position, and to use the expertise of different people.
• Closing the books of the old firms: prepare the Revaluation Account; pass the entry for raising goodwill; transfer to partners’ capital accounts the assets and liabilities not taken over by the new firm; and debit the new firm’s account with the value of assets taken over and credit it with liabilities taken over (the difference is debited to the new firm’s account).
• Opening the books of the new firm: debit the assets taken over, credit the liabilities taken over, and credit or debit the partners’ capital accounts with the difference: Assets (taken over) A/c Dr, To Liabilities (taken over) A/c, To Partners’ Capital A/cs. It is advisable to pass separate entries for the assets, liabilities and capital balances taken over from each old firm, though a combined entry can be written.

Admission, retirement, death, dissolution and amalgamation compared

A company is an artificial legal person with a separate existence. Its capital is divided into shares. The authorised capital is the maximum the memorandum allows; issued capital is the part offered; subscribed capital is the part applied for and allotted; called-up capital is the amount demanded from shareholders; paid-up capital is the amount actually received.

Company, share and share capital: basic points

• A company is an association formed to do business with a distinct name and limited liability. It is a juristic (artificial) person with a separate legal entity distinct from its members, capable of its own rights and duties and endowed with perpetual succession. The Companies Act defines a company as one formed and registered under the Act or under any previous company law.
• A private limited company cannot issue shares to the public. A public limited company collects funds by issuing shares to the public: after incorporation it issues a prospectus inviting the public to subscribe, persons wishing to subscribe apply, and on receiving applications the directors allot shares and money is raised.
• A share is a single unit of ownership in a company. People who own shares are shareholders or stockholders; they receive income as dividends. Shares are traded through a stockbroker, who acts as middleman. Each share is a unit of ownership (for example, 1,000 shares out of 10,000 is a 10% stake); shareholders bear losses and share profits in proportion to their holding.
• The money a company needs to carry on business is its capital, called share capital in the case of a company. The capital clause of the Memorandum of Association states the amount of capital the company may raise in its lifetime; this authorised (nominal or registered) capital is divided into shares of a fixed amount, for example ₹10 each.
• Issued capital is the part of authorised capital actually offered to the public; the balance is unissued capital. Subscribed capital is the part of issued capital for which applications are received and shares allotted; a company cannot accept more than the issued amount, and if the issue is wholly subscribed, subscribed capital equals issued capital. Called-up capital is the part of the face value demanded from shareholders in instalments (application, allotment, first call, second call and so on); the part not yet called is uncalled capital. Paid-up capital is the part of called-up capital actually received. Example: if ₹5,00,000 is called up but ₹4,90,000 is received, paid-up capital is ₹4,90,000 and the unpaid ₹10,000 is calls in arrears; with no arrears, paid-up equals called-up capital.
• Ways of issuing shares: public issue (directly to the public), private placement (to select investors), rights issue (to existing shareholders) and bonus issue (free shares from reserves).

Kinds of shares

• Equity shares: voting rights, dividend after preference shares, residual claim.
• Preference shares: fixed dividend and priority in dividend and repayment. Cumulative, non-cumulative, participating, convertible and redeemable types exist. Under Section 43 of the Companies Act, 2013, preference shares carry no right to vote on ordinary matters.
• Bonus shares, rights shares, sweat equity shares (Section 54), shares with differential voting rights.

Procedure of a public issue

• Prospectus: the company issues a prospectus giving complete information about itself to prospective investors; the funds are then collected through applications.
• Receipt of applications: application forms are made available through brokers and banks, and applications are received through a scheduled bank for a minimum number of days from the opening of the subscription list.
• Allotment: after the subscription list closes, shares are allotted (older provisions: within 120 days of the prospectus) provided the minimum subscription, the amount the directors consider must be raised to meet the basic needs of the business, has been received. If it is not received, the company cannot allot and must refund the application money (older provisions: within 130 days of the prospectus). Under the present Companies Act, 2013 and SEBI rules, the minimum subscription for a public offer is 90 per cent and refunds must be made within the short period SEBI prescribes. After the formalities, allotment letters are sent to successful applicants and letters of regret with refund orders to the rest.
• Face value (par, nominal or denominational value) is the value printed on the share; shares can be issued for cash or for consideration other than cash.
• Issue for consideration other than cash: shares may be given to promoters for services at incorporation, or to vendors or creditors when the company lacks funds to buy fixed assets or pay creditors; any such allotment is an issue for consideration other than cash. Typical entry: Goodwill or Asset A/c Dr, To Share Capital A/c (and Securities Premium A/c if issued at a premium).

Issue at par, premium and discount

• At premium: the excess over face value is credited to Securities Premium Account (Section 52).
• At discount: a company cannot issue shares at a discount (Section 53), except sweat equity shares in specific cases.

Issue of shares: a worked illustration

• Illustration: a company issues 1,00,000 shares of ₹10 each on 1 April, payable ₹2 on application, ₹3 on allotment and ₹5 on call. Entries: (1) Bank A/c Dr ₹2,00,000, To Share Application A/c (money received); (2) Share Application A/c Dr ₹2,00,000, To Share Capital A/c (transferred on allotment); (3) Share Allotment A/c Dr ₹3,00,000, To Share Capital A/c (made due); (4) Bank A/c Dr ₹3,00,000, To Share Allotment A/c (received); (5) Share Call A/c Dr ₹5,00,000, To Share Capital A/c (made due); (6) Bank A/c Dr ₹5,00,000, To Share Call A/c (received).
• Issue at par means at face value; at premium means above face value; at discount below it. A company issues at a premium only when its financial position is sound. Premium is a capital gain, credited to Securities Premium Account and not to Share Capital; it may be collected with application, allotment or call money. The entry where premium is received on application: Share Application A/c Dr, To Share Capital A/c and To Securities Premium A/c; if collected with allotment or a call, the due entry credits Securities Premium along with Share Capital.
• Issue at discount (the old treatment, for example ₹100 shares issued at ₹90): the discount is adjusted against allotment money, with the entry Share Allotment A/c Dr and Discount on Issue of Shares A/c Dr, To Share Capital A/c. Under Section 53 of the Companies Act, 2013 such an issue is now prohibited, except sweat equity shares in specific cases.

Utilisation of securities premium (Section 52(2))

1. Issue of fully paid bonus shares to members.
2. Writing off preliminary expenses.
3. Writing off expenses, commission or discount on issue of shares or debentures.
4. Premium payable on redemption of preference shares or debentures.
5. Buy-back of shares or other securities (Section 68).

Accounting steps for a public issue

Under-subscription and over-subscription

• Under-subscription: shares are allotted to those who applied. At least 90 per cent of the issue must be subscribed in a public offer, otherwise the money is refunded (minimum subscription).
• Over-subscription: three options: reject some applications, allot pro rata, or a mix of both. The excess money on applications is adjusted against allotment or calls, and refunded if there is nothing due.

Rights issue and public issue

If a shareholder fails to pay a call, the board may forfeit the shares after notice, as the articles allow. The shares are cancelled and the amount already paid is kept by the company.

Forfeiture: procedure and worked entry

• If a shareholder fails to pay a call, the directors can forfeit the shares held by him, remove his name from the Register of Members and treat the amount already paid as forfeited to the company. Table F (and the articles) authorise forfeiture, but the procedure laid down must be strictly followed, including notice.
• On forfeiture, debit Share Capital Account with the amount called up (not the full nominal value unless the whole amount has been called), credit Share Forfeiture Account with the amount already received, and credit Calls in Arrears (or the call accounts) with the unpaid calls.
• Example: X holds 100 shares of ₹10, has paid application ₹2 and allotment ₹3 but fails to pay first call ₹2 and second and final call ₹3, and the shares are forfeited. Entry: Share Capital A/c (100 × ₹10) Dr ₹1,000; To Share Forfeiture A/c (100 × ₹5) ₹500; To Share First Call A/c (100 × ₹2) ₹200; To Share Second and Final Call A/c (100 × ₹3) ₹300.

Accounting on forfeiture

• Debit Share Capital with the called-up amount on those shares.
• Credit Share Forfeiture Account with the amount actually received.
• Credit Calls in Arrears with unpaid calls.
• If shares were issued at a premium and premium was not received, Securities Premium Account is also debited with the unpaid premium.

Reissue: meaning and partial reissue

• On forfeiture the membership of the original holder ends and the shares become the property of the company, which may sell (reissue) them, usually to recover the unpaid amount. Reissue may be at par, at a premium or at a discount.
• If all the forfeited shares are reissued, the Share Forfeiture Account ends with a zero balance after adjusting the discount allowed; any balance left is transferred to Capital Reserve.
• If only some are reissued, the forfeited amount on the shares not reissued stays in the Share Forfeiture Account. The amount to be adjusted on the shares reissued = (total forfeited amount ÷ total number of shares forfeited) × number of shares reissued.
• Example: 200 shares of ₹10 on which ₹600 was received are forfeited. The maximum discount on reissue is ₹600. If they are reissued at ₹9 per share as fully paid: Bank A/c Dr ₹1,800; Share Forfeiture A/c Dr ₹200; To Share Capital A/c ₹2,000.

Reissue of forfeited shares

Forfeited shares may be reissued at par, premium or discount. The loss on reissue is charged to the Share Forfeiture Account, but the discount cannot exceed the forfeiture credit on those shares.

Example. A Rs 10 share on which Rs 8 has been paid is forfeited. The forfeiture credit is Rs 8. The share can be reissued, as fully paid, for as little as Rs 2 (Rs 10 – Rs 8).

After all forfeited shares are reissued, the remaining balance of the Share Forfeiture Account is transferred to Capital Reserve. If only some are reissued, a proportionate part is transferred.

Redemption of preference shares (Section 55)

• Only fully paid preference shares can be redeemed.
• Redemption must be out of profits available for dividend or out of the proceeds of a fresh issue of shares made for this purpose.
• A company cannot issue irredeemable preference shares. The period cannot exceed 20 years; infrastructure projects can go up to 30 years, with a condition.
• If shares are redeemed out of profits, an amount equal to the nominal value redeemed is transferred to the Capital Redemption Reserve (CRR). CRR can be used only to issue fully paid bonus shares.
• Any premium on redemption is first met from the securities premium account, and then from profits.

Buy-back of shares (Sections 68 to 70)

Liquidation is the process by which a company’s assets are sold, creditors are paid and any surplus is distributed to members, after which the company is dissolved. For solvent and insolvent companies, the main law is now the Insolvency and Bankruptcy Code, 2016 (IBC); earlier winding up under the Companies Act, 1956 and 2013 handled most cases.

Modes

• Voluntary liquidation (Section 59 of the IBC): by a solvent company whose directors make a declaration of solvency; a liquidator is appointed and creditors holding two-thirds in value approve it.
• Liquidation after a failed resolution (Section 33 of the IBC): the NCLT orders liquidation when the resolution plan is not approved or the creditors resolve to liquidate.
• Winding up by the Tribunal under the Companies Act, 2013 (Sections 270 to 365) remains for grounds such as just and equitable winding up, acts against public order or fraud.

Order of distribution of proceeds (Section 53, IBC)

Items at the same level rank equally and share rateably if funds are short. The cost of the insolvency resolution process and the liquidation cost come first, ahead of all dues. Secured creditors can also choose to enforce their security outside the liquidation, in which case they stand outside this waterfall.

Liquidation accounts to prepare

Treatment of partly paid shares

In the liquidation of a company with partly paid equity shares, the liquidator may call up the unpaid amount from contributories if the funds are not enough. A call of equal amount per share is first made; if some contributories default, the loss falls on the others proportionately (the amount is called again on those who are solvent). Preference shareholders rank before equity shareholders in the return of capital.

Liquidator’s remuneration

It is usually a percentage on the assets realised (with a separate percentage on the amount distributed to the unsecured creditors and shareholders), after the Statement of Affairs is prepared. Check the rate in the question; do not assume.

When two or more companies combine, it is an amalgamation (a new company takes over all) or an absorption (an existing company takes over another). A purchase of controlling shares without taking over the business is an acquisition.

Why companies combine: amalgamation, absorption and reconstruction

• To enjoy economies of scale and reduce cut-throat competition, two or more joint stock companies may combine their undertakings into one, either by one company taking over the others (which are dissolved) or by a new company taking over all of them. This is done by amalgamation or absorption.
• Amalgamation: two or more companies go into liquidation and a new company is formed to take over their business. Example: A Ltd and B Ltd are wound up and a new company C Ltd takes over both. Absorption: no new company is formed; an existing company purchases another existing company, which goes into liquidation.
• Objectives of amalgamation: to eliminate competition among the combining companies; to have better control over the market and increase market share and area of operations; to eliminate cut-throat competition and rivalry; to enjoy economies of large-scale production; to use the services of professional experts; to increase the availability of funds for future investment; and to gain other advantages of combination.
• Reconstruction is entirely different: the aim is not to combine companies but to reorganise a company that has suffered heavy losses which are to be written off. In external reconstruction the existing company is wound up by selling its business to a newly formed company, usually owned by the same shareholders (old company X Ltd sells to X (New) Ltd). In internal reconstruction the company keeps its legal entity and is reorganised internally, by rearrangement and reduction of share capital: capital is reduced to its real worth and the amount is used to eliminate accumulated losses and fictitious assets and to write down overvalued assets.
• In short: amalgamation = two or more liquidations and one formation; absorption = one liquidation and no formation; external reconstruction = one liquidation and one formation.

Accounting standard and method

Forms and key elements of amalgamation

• As per the accounting standard there are two types of amalgamation: amalgamation in the nature of merger (satisfies all five conditions) and amalgamation in the nature of purchase (does not satisfy one or more of them). Forms of combination are also described as merger and acquisition.
• In an amalgamation the business of the selling (transferor) company is taken over, so the books of the selling company are closed and the books of the purchasing (transferee) company are opened.
• Pooling of interests method: the assets, liabilities and reserves of the transferor company are recorded by the transferee at their existing carrying amounts, after the adjustments required. If the two companies follow conflicting accounting policies, a uniform policy is adopted after the amalgamation, and the effect of any change is reported under AS 5 (net profit or loss for the period, prior period items and changes in accounting policy).
• Purchase method: the transferee incorporates the assets and liabilities of the transferor at their existing carrying amounts, or allocates the consideration to the individual assets and liabilities of the transferor on the basis of their fair values at the date of amalgamation.

Conditions for a merger (AS 14)

1. All assets and liabilities of the transferor become those of the transferee.
2. Shareholders holding at least 90 per cent of the face value of the transferor’s equity shares become shareholders of the transferee.
3. The consideration is discharged by issue of equity shares in the transferee (cash only for fractions).
4. The business is intended to be carried on after the amalgamation.
5. No adjustment is made to the book values of assets and liabilities, except to make accounting policies uniform.

An amalgamation that does not satisfy all these conditions is an amalgamation in the nature of purchase.

Purchase consideration

Purchase consideration: meaning and methods

• Purchase consideration is the amount payable by the transferee (purchasing) company to the selling company for taking over the business. It is the aggregate of the shares and other securities issued and the payment made in cash or other assets by the transferee to the shareholders of the transferor company.
• Lump sum method: the transferee agrees to pay a fixed sum; the amount of purchase consideration is simply stated.
• Net assets method: the net worth of the assets taken over is calculated: agreed value of assets taken over less agreed value of liabilities taken over.
• Payment (net payment) method: purchase consideration is the total of payments in shares, securities, cash and so on made by the transferee to the transferor’s shareholders; liabilities are not deducted, even if the purchasing company assumes them.
• Intrinsic value method: an extension of the net assets method; the purchase consideration is settled by exchanging shares of the transferee company for the transferor’s shares on the basis of intrinsic value, found by dividing the net assets available for equity shareholders by the number of equity shares. This value fixes the ratio of exchange of shares between the transferor and transferee companies.

Amalgamation Adjustment Account

In a merger, the transferor’s statutory reserves (such as a development allowance reserve) must be kept. To show them in the transferee’s books, an Amalgamation Adjustment Account is debited on the assets side. It is cleared when the reserve is no longer needed.

Entries in the books of the transferor (vendor company)

Open the Realisation Account; transfer assets and liabilities; credit it with the purchase consideration; settle the shareholders through the Equity Shareholders’ Account. A profit on realisation goes to the shareholders. Entries in the books of the transferee record assets and liabilities at book or fair value, the consideration, and goodwill or capital reserve.

Internal reconstruction reorganises the capital of the same company, usually to remove accumulated losses and overvalued assets, so that the company can resume paying dividends. External reconstruction is when a new company buys the business of the old one.

Capital reduction (Section 66)

• Requires an authority in the articles, a special resolution and the confirmation of the NCLT; creditors must be given a chance to object.
• It can be done by cancelling paid-up capital that is lost, by reducing liability on unpaid capital, or by paying off excess capital.
• A Capital Reduction Account is opened. Credits: sacrifice by shareholders, creditors, debenture holders. Debits: write-off of accumulated losses, goodwill, fictitious assets and over-valued fixed assets.
• A balance left in the account after the write-offs is transferred to Capital Reserve.

Schemes under Sections 230 to 232

A company may enter into a compromise, arrangement or merger with its creditors or members, approved by the NCLT. A fast-track merger under Section 233 is allowed between holding and wholly owned subsidiaries and between small companies, with no NCLT hearing.

Holding and subsidiary companies

• Holding company (Section 2(46)): a company with one or more subsidiary companies.
• Subsidiary (Section 2(87)): a company in which the holding company controls the composition of the board, or exercises or controls more than half of the total voting power. A subsidiary of a subsidiary is also a subsidiary.
• Associate (Section 2(6)): significant influence, presumed at 20 per cent or more voting power. Accounted for under Ind AS 28 by the equity method.
• Joint arrangements (Ind AS 111): joint operations and joint ventures.

Holding company: benefits, objectives and types

• A holding company is one with one or more subsidiary companies under its control (Section 2(46)); it is often formed to buy and own shares in other companies. Its benefits are more control over subsidiaries, retention of existing management and lower tax liability.
• A wholly owned subsidiary has 100 per cent of its shares and voting rights held by the holding company; a partly owned subsidiary has more than 50 per cent but less than 100 per cent held by it, and the remaining shareholders are minority shareholders who hold the minority interest. A group means a parent and all its subsidiaries.
• Objectives: to eliminate competition, to enjoy economies of large-scale production, and to secure an assured market for the company’s product.
• Types of holding company: a pure holding company only controls other companies and carries on no other business (formed solely to own shares); a mixed holding company controls other companies and also carries on its own business; an immediate holding company directly controls a subsidiary; an intermediate holding company is both a holding company of one entity and a subsidiary of another, and it may be exempt from publishing its own consolidated financial statements.
• Every company having a subsidiary must prepare consolidated financial statements in addition to its own.

Which standard

Under Ind AS 110, control means (1) power over the investee, (2) exposure or rights to variable returns, and (3) ability to use power to affect returns. A parent must prepare consolidated statements (Section 129(3) of the Companies Act) unless an exemption applies.

Rules for preparing the consolidated balance sheet

• A consolidated balance sheet is prepared by adding the items of the holding company and its subsidiaries line by line, with these exclusions: the holding company’s investment in the share capital of the subsidiary is eliminated; the share capital of the holding company and the subsidiary is never aggregated (only the holding company’s share capital is shown); a negative (debit) balance of profit and loss in the holding company is not added; revaluation of assets must be done before aggregation; and inter-company (mutual) transactions and balances are eliminated.
• Wholly owned subsidiary: assets and liabilities of both companies are added. Illustration: the consolidated statement shows share capital ₹20,00,000 and reserves ₹6,00,000 (total ₹26,00,000), trade payables ₹2,20,000 (holding ₹1,40,000 plus subsidiary ₹80,000) and total liabilities of ₹28,20,000, matched by assets of the same amount.
• Cost of control (goodwill) or capital reserve: ideally the holding company buys shares at par, but in practice it may pay more or less than face value. If it pays more than the face value of the shares (and pre-acquisition reserves), the excess is goodwill (cost of control); if it pays less, the difference is a capital reserve shown in the consolidated balance sheet.
• Partly owned subsidiary: the holding company does not own 100 per cent (for example 75 per cent, so outsiders own 25 per cent). The outsiders’ interest is the minority interest, shown as a separate item below share capital and reserves (older presentations show it on the liabilities side; under Ind AS it is non-controlling interest within equity). It is their claim on the net assets (assets less liabilities): their proportionate share in share capital, in reserves (both pre- and post-acquisition) and in the surplus in the profit and loss statement. The method of consolidation is otherwise the same: all the assets and liabilities of the holding and subsidiary companies are included.

Steps in consolidation

1. Find the holding percentage and the non-controlling (minority) interest (NCI).
2. Fix the date of acquisition and split profits into pre-acquisition (capital) and post-acquisition (revenue).
3. Calculate goodwill (cost of control) or capital reserve.
4. Calculate NCI = NCI share of share capital + share of pre- and post-acquisition reserves (after revaluation adjustments).
5. Calculate consolidated reserves = Holding company’s reserves + holding’s share of the subsidiary’s post-acquisition profits.
6. Eliminate inter-company transactions, balances and unrealised profit in stock.

Pre-acquisition profit is capital profit; it is used to find goodwill and is not part of consolidated reserves. Post-acquisition profit belongs partly to the holding company and partly to NCI. A dividend paid out of pre-acquisition profit is treated as a return of capital and reduces the cost of investment.

Mini-example. P buys 80 per cent of S for Rs 150 lakh when S has share capital Rs 100 lakh and reserves Rs 50 lakh. Holding company’s share = 80 per cent of 150 = Rs 120 lakh. Goodwill = 150 – 120 = Rs 30 lakh. NCI at acquisition = 20 per cent of 150 = Rs 30 lakh.

Terms in exam use

• Minority interest is the share of outsiders in the net assets of the subsidiary; the modern name is non-controlling interest.
• Consolidated balance sheet shows NCI separately in equity, not as a liability.

Material control keeps the cost of holding and ordering stock at the lowest point while avoiding stoppages. The two costs that pull in opposite directions are the ordering cost (falls as order size rises) and the carrying cost (rises as order size rises).

Economic Order Quantity (EOQ)

At the EOQ, total ordering cost equals total carrying cost and total inventory cost is the lowest. Example. Annual use 12,000 units, ordering cost Rs 150, carrying cost Rs 6 per unit. EOQ = square root of (2 x 12,000 x 150 / 6) = square root of 600,000 = about 775 units. If the question gives monthly consumption, convert it to annual first.

Stock levels

Inventory systems and issue pricing

• ABC analysis: A items are high value and few in number (tight control); C items are low value and many in number (loose control).
• FIFO, weighted average: accepted for inventory valuation under Ind AS 2. LIFO is not permitted under Ind AS 2.
• Inventory is valued at the lower of cost and net realisable value (Ind AS 2 and AS 2).

Marginal cost is the amount by which total cost changes when output changes by one unit; in practice it is the variable cost of a unit (direct material, direct labour, variable overhead). In marginal costing, fixed cost is treated as a period cost and written off in the period, and stock is valued at marginal cost.

Absorption vs marginal costing

Contribution

Reading the chart. Below the break-even point the firm makes a loss; above it, a profit. The angle of incidence is the angle at which the sales line cuts the total cost line; a large angle means high profitability. Margin of safety shows how far sales can fall before the firm makes a loss.

Example. Sales Rs 5,00,000; variable cost Rs 3,00,000; fixed cost Rs 1,00,000. Contribution = 2,00,000; P/V ratio = 40 per cent; break-even sales = 1,00,000 / 0.40 = Rs 2,50,000; margin of safety = 2,50,000 (50 per cent of sales); profit = 2,00,000 – 1,00,000 = Rs 1,00,000.

C/S ratio is another name for P/V ratio. Cash break-even point excludes non-cash fixed costs such as depreciation from the fixed cost. Assumptions of CVP: costs are separable into fixed and variable, selling price is constant, production equals sales, and there is a single product or a constant mix.

Methods to separate semi-variable cost

• High-low method, scatter graph, least squares (regression) and the engineering method. These are the methods of determining cost behaviour.

A standard cost is a predetermined cost for materials, labour and overhead based on a technical estimate for a set of working conditions. It is different from an estimated cost, which is a forecast of what the cost is likely to be (a prediction); a standard cost is what the cost should be (a target), and is used for control.

Steps in standard costing

1. Set the standards (material, labour, overhead) and the standard cost card.
2. Record the actual costs and output.
3. Compare actual with standard and find the variances.
4. Analyse the causes of the variances.
5. Report to management and take corrective action; revise standards when needed.

Types of standard

• Ideal standard (no waste or breakdown), normal standard (average of past and expected), basic standard (fixed for a long time), current standard (valid for a short period).

Material variances

Labour variances

Overhead variances

Sales variances

Sign rule. For costs, a variance is favourable (F) when actual cost is less than standard; for sales and profit it is favourable when actual is more. A negative answer under the formula ‘Standard minus Actual’ means adverse. Check: Price variance + Usage variance = Cost variance; Mix variance + Yield variance = Usage variance.

A budget is a financial or quantitative plan for a future period. Budgetary control is the process of planning, coordinating and controlling resources by setting budgets, comparing actual results with them and taking corrective action.

Objectives and importance

• Planning, co-ordination, communication, motivation, control and performance evaluation.

Types of budget

Key or limiting factor

The principal budget factor limits the activity of the firm (usually sales demand; sometimes raw material, labour or capital). The budget process starts with it, and the other budgets are drawn up around it.

Sequence in budget preparation

1. Fix the budget period and appoint the budget committee; issue the budget manual.
2. Identify the key factor and prepare the sales budget.
3. Prepare the production budget, then the material, labour and overhead budgets.
4. Prepare the cash budget, capital expenditure budget and others.
5. Combine into the master budget (budgeted profit and loss account and balance sheet).
6. Operate, measure actual performance, report variances and take action.

Zero-base budgeting steps: define decision units, prepare decision packages, rank them by benefit, and allocate resources in order of rank.

Process costing is used where production is continuous and the units are alike: chemicals, cement, textiles, paper, oil refining, food, soap and glass. Costs are collected process by process and averaged over the units produced.

Features

• Costs are accumulated for each process for a period.
• Output of one process becomes input of the next.
• Normal loss, abnormal loss and abnormal gain arise.
• By-products and joint products may appear.

Treatment of loss

Equivalent production

When work-in-progress exists, partly completed units are converted into equivalent completed units. Under the FIFO method, the opening work-in-progress is completed first; under the weighted average method, opening stock is merged with current output.

Order of steps in preparing a process account

1. Collect the input units and costs.
2. Account for normal loss, abnormal loss and gain.
3. Compute equivalent units.
4. Compute the cost per equivalent unit.
5. Value the finished output, work-in-progress and losses.
6. Prepare the process account and transfer to the next process.

Activity Based Costing assigns overhead to products in proportion to the activities that cause the cost, rather than spreading it over a single base such as direct labour hours. It was developed by Robin Cooper and Robert Kaplan in the 1980s.

Steps

1. Identify the main activities of the firm.
2. Group the costs of each activity into a cost pool.
3. Select a cost driver for each pool.
4. Compute the rate per unit of cost driver = Cost pool / Total driver volume.
5. Assign cost to products = Rate x Driver units used by the product.

Types of cost driver

• Unit level (machine hours), batch level (number of set-ups), product level (design changes), facility level (rent), also resource drivers and activity drivers.

Merits and limits

• More accurate product cost where overhead is high and the product mix is varied; helps in pricing, cost reduction and activity based management.
• Costly to set up; some cost drivers are hard to find; not needed when overhead is small.

Decisions look to the future. Only relevant costs matter: future costs that differ between alternatives. Sunk costs (already spent) and costs common to all alternatives are ignored; opportunity cost (value of the best alternative given up) is included.

Common decisions

Life cycle costing

Tracks all costs of a product from design to disposal: research and development, design, production, marketing, distribution, after-sales service and withdrawal. Most of the cost is committed (fixed in effect) during design, though little is actually spent then, so early cost planning gives the greatest saving. Stages: introduction, growth, maturity, decline.

Target costing

A market-led method that begins with the price the customer will pay.

The gap between the current cost and the target cost is closed by value engineering and design changes before production. Used widely in automobile and electronics firms; it originated in Japan.

Kaizen costing

Kaizen means continuous improvement. Kaizen costing aims to reduce cost steadily during production, in small steps from many sources and from workers, after the product is launched. It works with standard costing: the standards are reset downward each period.

Just-in-time (JIT)

JIT means materials arrive and products are made only when needed, so stock is held at near zero. It uses the pull system and kanban cards (from Toyota), small batches, close supplier ties and total quality control. Backflush costing works out cost after output is produced instead of tracking each step.

• Benefits: lower stock holding, less waste, shorter lead time, better quality.
• Needs reliable suppliers and steady demand; a break in supply stops the line.

A ratio shows the relationship between two figures. Ratio analysis turns the numbers of the financial statements into ratios to judge profitability, liquidity, solvency and efficiency. Ratios are compared across years (trend), with other firms (inter-firm) and with industry norms.

Liquidity ratios

Effect of equal change. If current assets and current liabilities are increased by the same amount, the current ratio moves towards 1: a ratio above 1 falls, a ratio below 1 rises. The quick ratio is a stricter test than the current ratio because it leaves out inventory.

Solvency and capital structure ratios

Activity (turnover) ratios

Profitability ratios

Du Pont analysis

Limitations

• Based on historical cost, affected by window dressing and accounting policy, no allowance for price level change, hard to compare firms of different size or industry, and ratios alone do not give causes.

A funds flow statement shows the sources from which funds were obtained and the applications (uses) to which they were put during a period. ‘Funds’ here usually means working capital (current assets less current liabilities). So it explains why working capital changed, and why profit did not turn into cash.

Meaning of fund, flow and the purpose of the statement

• A funds flow statement shows the sources from which funds are obtained and the uses to which they are put. It explains how the working capital position changes over a period, generally between two balance sheet dates, and reveals the funds generated internally, the funds raised from external sources and their various uses during the year. It also highlights changes in the financial structure, asset structure and liquidity position of a business.
• The word ‘fund’ is used in different senses (cash, capital fund, working capital); here fund means working capital, the difference between current assets and current liabilities, not cash. ‘Flow’ means change or movement: a flow of funds means an increase or decrease in working capital.
• Working capital changes only when one affected account is a current item (current assets or current liabilities) and the other is a non-current item (fixed assets, long-term liabilities, capital). A transaction between two current accounts, or between two non-current accounts, does not change working capital and so is not a flow of funds.
• Non-current accounts: equity share capital, general reserve, capital reserve, profit and loss account, debentures, long-term loans, provision for taxation (as treated in the note), goodwill, land, building, plant and machinery, furniture, long-term investments, preliminary expenses. Current accounts: creditors, bills payable, outstanding expenses, income tax due, dividend payable, short-term loans; stock, short-term investments, bills receivable, debtors, cash in hand and at bank, prepaid expenses.

Sources and applications

Sources and applications of funds in detail

• Funds are the part of current assets financed not by current liabilities but by long-term (non-current) sources. The statement gives two pieces of information: sources (where the funds came from, from owners and outsiders) and applications (where they were used).
• External sources: raising additional capital, increasing long-term borrowings, and sale of fixed assets and long-term investments. Internal source: funds from operations, the profit earned on sales over cost of goods sold.
• Applications: purchase of fixed assets and long-term investments; redemption of debentures and preference shares; repayment of long-term loans; payment of dividend and tax; meeting losses from operations (net loss); and financing the increase in working capital. Not all funds raised from long-term sources go into working capital; much of it may buy fixed assets, redeem securities, pay dividends or cover losses, and only the remainder finances the increase in working capital.

Funds from operations

Add back depreciation, goodwill written off, preliminary expenses written off, loss on sale of fixed assets and transfer to reserves. Deduct profit on sale of fixed assets and other non-operating gains. Do not treat changes in current assets and liabilities as sources or uses; they go into the Schedule of Changes in Working Capital.

The two parts of the statement

• Preparing the funds flow statement has two parts: (1) the schedule of changes in working capital and (2) the statement of sources and application of funds.
• The schedule is prepared only from current assets (cash in hand and at bank, marketable securities, bills receivable, sundry debtors, temporary investments, stock, prepaid expenses, accrued incomes) and current liabilities (sundry creditors, bank overdraft, bills payable, short-term advances, outstanding expenses, dividend payable, proposed dividend), with columns for previous year, current year, increase and decrease, ending in the net increase or decrease in working capital.
• The statement of sources and application analyses the causes of that net change. It uses the changes in fixed assets, long-term liabilities and capital, the only items left after the schedule. Sources are funds from operations, issue of shares, issue of debentures, raising long-term loans and sale of fixed assets; applications are loss from operations, redemption of debentures or preference shares, repayment of long-term loans, purchase of fixed assets, and payment of dividend and tax. The difference between total sources and total applications equals the net increase or decrease in working capital shown by the schedule.

Schedule of changes in working capital

• Increase in a current asset increases working capital; decrease reduces it.
• Increase in a current liability reduces working capital; decrease increases it.
• The net change in this schedule is the figure that balances the funds flow statement.

Funds flow vs cash flow

A cash flow statement reports the inflows and outflows of cash and cash equivalents during a period, classified into operating, investing and financing activities. Cash equivalents are short-term, highly liquid investments (generally maturity of three months or less from the date of acquisition). Ind AS 7 applies to companies following Ind AS; AS 3 applies to the others.

Why cash matters, features and key terms

• Cash plays a vital role in the economic life of a business: it is needed to pay salaries, wages, interest and dividends. A concern that earns profit but lacks enough cash to pay dividends gives a poor signal to shareholders and the public, so management of cash is essential, and the cash flow statement is one of the three most important financial statements.
• It shows the inflows and outflows of cash and cash equivalents over a period, giving information about historical changes by classifying all cash flows into operating, investing and financing activities; users give it great weight in judging liquidity, solvency and long-term outlook.
• The revised AS 3 made it mandatory for listed companies to present an annual cash flow statement along with the other financial statements.
• Features: it shows the movement of cash and explains the reasons for the change in cash position between two balance sheet dates; it does not match cost against revenue; it shows how the enterprise generates cash and cash equivalents and how it uses them.
• Cash fund (AS 3): cash in hand, demand deposits with banks and cash equivalents. Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and are subject to an insignificant risk of change in value (for example treasury bills, short-term deposits, marketable securities, and bank overdraft or cash credit repayable on demand in the older description). Long-term fixed deposits, and preference shares redeemable only later, are not cash equivalents.
• Operating activities are the principal revenue-producing activities of the enterprise (for a garment maker: buying raw materials, incurring manufacturing expenses, selling garments). Investing activities are the acquisition and disposal of long-term assets (land, buildings, machinery, furniture) and other investments not included in cash equivalents. Financing activities change the size and composition of owners’ capital (including preference share capital) and the borrowings of the enterprise.

Classification

Interest and dividend. Under AS 3, interest paid and dividend paid are financing, and interest and dividend received are investing, for non-financial enterprises. Ind AS 7 allows an entity to choose between operating and investing or financing, with consistent disclosure.

Typical inflows and outflows under each activity

• Operating inflows: cash from sale of goods and rendering of services; royalties, fees, commissions and other revenue. Operating outflows: payments to suppliers for goods and services; payments to and on behalf of employees; payments of insurance premiums and claims, annuities and other benefits (for an insurer); income tax paid. Non-operating flows such as taking a loan or issuing shares are usually non-recurring and are not operating.
• Investing inflows: sale of fixed assets including intangibles; repayment of advances or loans made to third parties; sale of shares, warrants or debt instruments of other enterprises; interest received on loans and advances; dividend received on investments; receipts from futures, forward, option and swap contracts (unless held for trading or classified as financing). Investing outflows: purchase of fixed assets, including intangibles and capitalised research and development; purchase of shares, warrants or debt instruments of other enterprises; advances and loans made to third parties (other than by a financial enterprise); payments for futures, forward, option and swap contracts.
• Financing inflows: proceeds from issue of shares (equity or preference) and from issue of debentures, loans, bonds and other short or long-term borrowings. Financing outflows: repayment of amounts borrowed, interest paid on debentures and long-term loans, and dividends paid on equity and preference capital.
• One transaction may fall into more than one classification: purchase of shares is an operating activity for a share broker but an investing activity for another enterprise.
• Classification examples: cash sale of goods, payment to suppliers of raw material, salaries and wages, and income tax are operating; cash paid to acquire fixed assets and income on investments are investing; proceeds of shares issued at a premium, payment of dividend, interest on loan capital and redemption of loans are financing.

Methods for operating activities

In the indirect method: add depreciation and amortisation, loss on sale of assets, interest expense; deduct gain on sale and interest income; then adjust for increase in debtors and stock (deduct), increase in creditors (add).

Structure of the statement and the working capital rules

• Basic structure: (A) cash flows from operating activities, (B) from investing activities and (C) from financing activities; their total is the net increase or decrease in cash, which is added to cash and cash equivalents at the beginning to get cash and cash equivalents at the end. Only the operating section differs between the direct and indirect methods; the investing and financing sections are the same. Most firms use the indirect method.
• Direct method: cash receipts from customers, less cash paid to suppliers and employees, gives cash generated from operations; less income tax paid gives cash flow before extraordinary items; plus or minus extraordinary items gives net cash from operating activities.
• Indirect method: start with net profit (or loss) and adjust it for accruals and non-cash items. Stage 1 finds operating profit before working capital changes: net profit before tax and extraordinary items, add non-cash and non-operating charges already debited (depreciation, amortisation of intangibles, goodwill and preliminary expenses written off, loss on sale of fixed assets or long-term investments, provision for tax, interest and dividend paid), and deduct non-cash and non-operating incomes already credited (profit on sale of fixed assets or investments, interest and dividend received). Stage 2 adjusts for working capital.
• Working capital rules: an increase in current assets blocks cash (deduct); a decrease in current assets releases cash (add); an increase in current liabilities saves cash (add); a decrease in current liabilities uses cash (deduct). So cash from operations = operating profit before working capital changes + decrease in current assets + increase in current liabilities − increase in current assets − decrease in current liabilities, then less income tax paid.
• Non-cash transactions: under AS 3, investing and financing transactions that do not use cash or cash equivalents are excluded from the statement; examples are acquiring machinery by issuing shares and the issue of bonus shares.

Items that are not cash flows

• Bonus shares, conversion of debentures into shares, purchase of an asset by issue of shares, and writing off of assets are non-cash transactions; they are disclosed separately, not included.
• Cash flows not from financing: proceeds of sale of fixed assets (investing) and interest income (investing).

Points to check in coaching-note answer keys

• A commonly circulated question gives sale of machinery ₹1,00,000, purchase of land ₹2,00,000 and dividend received ₹50,000 and asks for net cash flow from investing activities. The working 1,00,000 − 2,00,000 + 50,000 equals ₹(50,000); a key that marks ₹(1,50,000) as correct has an arithmetic slip, so answer ₹(50,000).
• Another circulated question asks how interest paid is classified under AS 3 and marks ‘operating or financing as per policy’. Strictly, AS 3 puts interest paid and dividend paid under financing activities for a non-financial enterprise, while Ind AS 7 lets the entity choose operating or financing and apply it consistently.

Human resource accounting (HRA) is the process of identifying, measuring and reporting the value of human resources and the cost of people to a firm. Employees are not shown as assets in the balance sheet under current standards, so HRA is a supplementary disclosure. The idea began with Rensis Likert (University of Michigan) and was developed in the 1960s by Brummet, Flamholtz and Pyle.

Valuation approaches

Merits and limits

• Helps in manpower planning, retention and decisions on training. It is not accepted by the standard setters because of difficulty in measurement and no ownership of employees.

Historical cost accounting overstates profit when prices rise: old costs are matched with new, higher revenue, and asset values in the balance sheet are out of date. Inflation accounting adjusts the accounts for changes in prices.

Two main approaches

Monetary and non-monetary items (CPP)

• Monetary items (cash, debtors, creditors, loans, debentures) are fixed in money terms and are not restated; holding them in a period of inflation gives a purchasing power gain (liabilities) or loss (assets).
• Non-monetary items (stock, plant, land, equity) are restated using the index.

CCA adjustments

• Depreciation adjustment (on current cost), cost of sales adjustment (COSA), monetary working capital adjustment (MWCA) and gearing adjustment.

In India, Ind AS 29 deals only with financial reporting in hyperinflationary economies; no general inflation accounting standard is in force for Indian companies.

Environmental accounting identifies, measures and reports the cost of environmental effects of business activity, such as pollution control, waste disposal, clean-up and the use of natural resources. It includes environmental management accounting (internal) and environmental financial accounting (external disclosure).

Main elements

• Environmental costs: prevention, appraisal, internal failure (waste treatment) and external failure (clean-up and fines).
• Natural resource accounting and full cost accounting (including costs passed on to society).
• Green accounting adjusts national income for the use of natural resources.

Reporting framework in India

• Business Responsibility and Sustainability Report (BRSR) is mandatory for the top 1,000 listed companies by market capitalisation under SEBI regulations; BRSR Core gives assurance on selected indicators.
• Globally, IFRS S1 and IFRS S2 (June 2023, ISSB) are the baseline for sustainability and climate disclosure. India has not adopted them; the ICMAI issued its own sustainability standards ISS 1 and ISS 2 in January 2026, in line with IFRS S1 and S2.
• Integrated reporting and the Triple Bottom Line (people, planet, profit) are related ideas.

Accounting standards are written rules that set how transactions and events are recognised, measured, presented and disclosed. In India the Accounting Standards Board (ASB) of the ICAI drafts them; the National Financial Reporting Authority (NFRA) recommends them to the Central Government; the Ministry of Corporate Affairs (MCA) notifies them under Section 133 of the Companies Act, 2013.

Two sets in force

Once a company adopts Ind AS, it cannot go back to AS. Banking companies, insurance companies and NBFCs follow separate roadmaps with their own thresholds (for NBFCs, net worth of Rs 500 crore or more is the main test).

IFRS convergence

• India follows convergence, not adoption: it keeps its own numbering, and keeps a few carve-outs (differences made for Indian conditions) such as on the fair value of the equity component of convertible instruments and on the treatment of foreign currency monetary items.
• Examples of change from IFRS: fair value treatment for investment property, Ind AS 115 recognises revenue under the five-step model; Ind AS 116 has a single lessee model.
• International bodies: IASB (IFRS), ISSB (IFRS S1 and S2 for sustainability), IFAC (ethics and auditing), IAASB (International Standards on Auditing).

Matching Ind AS numbers with their subjects is the single most repeated question in this unit. Learn this table.

Omitted standards: Ind AS 11 (construction contracts) and Ind AS 18 (revenue) are replaced by Ind AS 115; Ind AS 17 (leases) is replaced by Ind AS 116; Ind AS 104 is replaced by Ind AS 117. Ind AS 118 is not yet notified (see recent developments).

Old Accounting Standards: quick list

Ind AS 1: Presentation of financial statements

A complete set has a balance sheet, statement of profit and loss (with other comprehensive income), statement of changes in equity, cash flow statement and notes. Principles: fair presentation, going concern, accrual, materiality, offsetting only when allowed, consistency and comparative information. A company’s format is set by Schedule III (Division II for Ind AS).

Ind AS 2: Inventories

Inventory is valued at the lower of cost and net realisable value. Cost has purchase cost, conversion cost and other costs of bringing the item to its present location and condition. Excluded: abnormal wastage, storage costs (unless needed for production), administrative overheads and selling costs. FIFO or weighted average is allowed; LIFO is not.

Ind AS 8 and Ind AS 10

• Ind AS 8: a change in accounting policy and correction of a prior period error are applied retrospectively; a change in accounting estimate is applied prospectively.
• Ind AS 10: adjusting events give more evidence of conditions at the balance sheet date (a customer’s insolvency, a court decision on an existing case); non-adjusting events concern conditions arising later (a fire after the date, a major acquisition). Dividends declared after the period are not a liability at the balance sheet date.

Ind AS 12: Income taxes

Uses the balance sheet liability method. Deferred tax liability arises from taxable temporary differences; deferred tax asset arises from deductible temporary differences, carry-forward of losses and credits, if future taxable profit is probable. They are not discounted. They are ‘book entries’ (they do not involve cash at the time), and are shown net only when allowed.

Ind AS 16: Property, plant and equipment

Recognise when it is probable that future economic benefits will flow and cost can be measured reliably. Measure at cost; later use the cost model or the revaluation model. Depreciate over the useful life; each major component with a different life is depreciated separately.

Ind AS 36: Impairment of assets

Goodwill and intangible assets with an indefinite life are tested for impairment every year.

Ind AS 37: Provisions, contingent liabilities and contingent assets

Ind AS 103: Business combinations

Uses the acquisition method: identify the acquirer, find the acquisition date, recognise identifiable assets and liabilities at fair value, and recognise goodwill or a bargain purchase gain (in capital reserve). Combinations under common control are accounted by the pooling of interests method (Appendix C).

Ind AS 110 and Ind AS 115 and 116

• Ind AS 110: control model for consolidation (power, variable returns, link between them).
• Ind AS 115: five steps: identify the contract, identify the performance obligations, determine the transaction price, allocate the price, recognise revenue as each obligation is satisfied.
• Ind AS 116: lessee shows a right-of-use asset and lease liability for almost all leases; exemptions for short-term (12 months or less) and low-value leases. Lessor continues operating and finance lease classification.

AS 2: Valuation of inventories

Lower of cost and net realisable value. Costs include purchase, conversion and other costs. Excluded: abnormal waste, selling and administration costs, storage unless needed. Cost formulas: FIFO, weighted average; LIFO is not allowed.

AS 3: Cash flow statements

Required for companies whose equity or debt is listed or about to be listed, and for other companies that are in the high turnover or borrowing group. A small company, one-person company and dormant company are exempt (Companies (Accounting Standards) Rules).

AS 4: Events after the balance sheet date

Adjusting events (events that give further evidence of conditions at the date) change the figures; non-adjusting events are only disclosed. Proposed dividends are not liabilities at the date.

AS 9: Revenue recognition

Revenue from sale of goods is recognised when significant risks and rewards of ownership pass to the buyer and there is reasonable certainty of collection. Services are recognised by the proportionate completion method. Interest, royalty and dividends have their own rules (time basis; accrual; right to receive).

AS 19: Leases

A finance lease transfers substantially all risks and rewards; it is shown as an asset and a liability in the lessee’s books at the lower of fair value and present value of minimum lease payments. An operating lease payments are an expense on a straight-line basis. Lessor treats a finance lease as a receivable.

AS 22: Taxes on income

Deferred tax is recognised on timing differences; a deferred tax asset on unabsorbed depreciation or carried forward loss is recognised only if there is virtual certainty of future profit. Deferred tax is an item of book entry.

AS 26 and AS 29

• AS 26: an intangible asset is recognised if it is identifiable, controlled and gives probable future benefit; internally generated goodwill is not recognised. Amortised normally over a period not above 10 years.
• AS 29: like Ind AS 37; a provision is recognised only when there is a present obligation, the outflow is probable and a reliable estimate can be made.

Standards change; know the position on the date of your exam. This table is checked up to 12 November 2026.

The word audit comes from the Latin word audire, meaning ‘to hear’. Auditing is a systematic and independent examination of data, statements, records, operations and performance of an enterprise to see that they are in accordance with stated criteria, and to express an opinion on them.

Objectives

• Primary: to express an opinion on whether the financial statements give a true and fair view.
• Secondary: to detect and prevent errors and frauds, to check the accuracy of books, and to confirm legal compliance.

Types of audit

Auditor’s independence and ethics

• Auditor is an independent professional, not an employee. Fundamental principles (ICAI Code of Ethics): integrity, objectivity, professional competence and due care, confidentiality and professional behaviour.
• Audit evidence is the information the auditor uses; it must be sufficient and appropriate (SA 500).

True and fair view

There is no statutory definition. It means the financial statements are free from material misstatement and comply with the applicable framework (the Companies Act and the standards). Materiality and audit risk (inherent risk x control risk x detection risk) frame the work.

Standards on Auditing (SAs)

Issued by the Auditing and Assurance Standards Board (AASB) of the ICAI and made binding for company audits through Section 143(10) of the Companies Act, 2013, once notified by the Central Government on the NFRA’s recommendation. Important ones: SA 200 (overall objectives), SA 230 (documentation), SA 240 (fraud), SA 300 (planning), SA 315 (risk assessment), SA 320 (materiality), SA 500 (evidence), SA 520 (analytical procedures), SA 530 (sampling), SA 570 (going concern), SA 700 to 706 (audit reports).

Who can be an auditor (Section 141)

• A chartered accountant in practice (individual) or a firm of chartered accountants (including an LLP, if a majority of partners are practising CAs).
• Not qualified: a body corporate other than an LLP; an officer or employee of the company; a partner or employee of an officer or employee; a person indebted to the company for more than Rs 5 lakh, or who has given a guarantee or security for a third party’s debt of more than Rs 1 lakh; a person with a business relationship with the company; a person whose relative is a director or KMP; a person convicted of fraud (disqualified for 10 years); and a person who is already auditor of 20 companies (with exemptions for one-person, dormant and small companies, and some private companies).

Appointment (Section 139)

Rotation (Section 139(2))

For listed companies and specified classes of unlisted public and private companies: an individual auditor can serve one term of 5 years and a firm up to two terms of 5 years. A cooling-off period of 5 years follows. This is meant to keep auditors independent of management.

Removal and resignation (Section 140)

• Removal before the term ends: needs a special resolution at a general meeting and the prior approval of the Central Government (Form ADT-2); the auditor must be heard.
• Resignation: file Form ADT-3 with the company and the Registrar.
• Remuneration is fixed by the company in general meeting or as members decide (Section 142).

Powers and rights (Section 143(1))

• Right of access at all times to books, accounts and vouchers of the company.
• Right to ask for information and explanations from officers.
• Right to visit branches and to receive reports of branch auditors.
• Right to attend general meetings and be heard on matters concerning him; to receive notices of the meetings.
• Right to remuneration and to a lien on books given to him for non-payment of fees (as in common law).

Duties

• To report to members on the financial statements and state whether, in his opinion, they give a true and fair view; to enquire into the matters listed in Section 143(1), for example whether loans are properly secured and transactions are prejudicial.
• To state in his report the matters in Section 143(3): whether he got all information; proper books kept; branch audit report; agree with the books; compliance with accounting standards; going concern; directors disqualified; qualifications; internal financial controls (IFC) reporting; and pending litigation.
• To report on fraud: under Section 143(12), fraud of Rs 1 crore or more is reported to the Central Government within the time set; a fraud of less than Rs 1 crore is reported to the audit committee or the Board.
• To report on the matters in the Companies (Auditor’s Report) Order (CARO), 2020.
• To verify fixed assets: the auditor checks the records of fixed assets, their physical verification and title; he is not the valuer and need not value them unless asked.

Liabilities

• Civil: for negligence or misfeasance, to the company and to third parties, in damages (Section 147 covers fraud).
• Criminal: punishment for a wrong statement or omission, or for fraud: imprisonment up to 10 years and a fine of 1 to 3 times the amount involved (Section 447 read with Section 147).
• Disciplinary: by the ICAI (Chartered Accountants Act, 1949) and, for specified classes, by the NFRA.

Non-audit services (Section 144)

An auditor cannot provide services such as accounting and book-keeping, internal audit, actuarial, investment advisory, investment banking or management services to the company or its holding and subsidiary companies.

Stages

1. Engagement and planning (SA 210, SA 300): agree terms (engagement letter), understand the entity, set materiality and risk, plan the nature, timing and extent of work.
2. Audit programme: a detailed plan of the audit procedures to be done, by whom and when. Audit note-book and working papers record the work (SA 230).
3. Study of internal control: to decide the extent of testing.
4. Obtaining evidence by inspection, observation, enquiry, confirmation, recomputation, reperformance and analytical procedures.
5. Evaluation and reporting.

Internal control and internal check

• Internal control is the whole system of controls set up by management, financial and otherwise. Internal check is a part: it arranges the work so that one person’s work is checked by another. Internal audit is an independent appraisal of operations by staff or an outside firm.
• Under Section 143(3)(i), the auditor must report on whether the company has adequate internal financial controls over financial reporting (IFCoFR) and whether they operate effectively.

Test checking and sampling

Test checking is the audit of a sample of the transactions; sampling (SA 530) can be statistical or non-statistical, and the sample must represent the population. Audit trail: from 1 April 2023, companies using accounting software must use software with an audit trail (edit log) that cannot be switched off, and the auditor reports on it.

Vouching is the examination of documentary evidence (vouchers) that supports an entry in the books; it proves that the transaction is authorised, recorded in the right account and amount, and belongs to the entity. It is the backbone of the audit of the transactions.

Objectives

• To check that the entries are genuine, authorised, properly recorded and correctly classified (capital or revenue).

Vouchers for common items

Technique: check the date, amount, name, authorisation, stamp, and that the voucher is cancelled after the entry so that it cannot be used again. Vouching tests the correctness of the transactions; verification tests the existence and title of assets.

Verification is proving the existence, ownership (title), possession, absence of charge and proper valuation of assets and liabilities; valuation is determining their proper value. The auditor is not a valuer; he relies on expert’s reports (SA 620) for specialised items.

Verification of assets

Verification of liabilities

• Check loans (confirmation from lender), trade payables (suppliers’ statements), contingent liabilities, provisions, and unrecorded liabilities after the balance sheet date.

Valuation

• Inventory: lower of cost and NRV; investments: cost or fair value as per Ind AS 109; fixed assets: cost less depreciation; goodwill: only if purchased.

Audit of financial statements

The auditor carries out audit work to see whether the balance sheet, the statement of profit and loss, the cash flow statement and the statement of changes in equity give a true and fair view, and whether the Companies Act and standards are followed. The Board’s report (Section 134) and the auditor’s report (Section 143) are placed before members at the AGM.

Companies (Auditor’s Report) Order (CARO), 2020

• A statutory report on specific matters in 21 clauses (fixed assets, inventory, loans, investments, deposits, statutory dues, default in repayment, fraud, whistle-blower complaints, related party transactions, internal audit, cash losses, resignation of the previous auditor, CSR and others).
• Exempt: banking, insurance and Section 8 companies (with conditions), one-person and small companies, and private companies below the limits of paid-up capital and reserves Rs 1 crore, borrowings Rs 1 crore and revenue Rs 10 crore.

Content of the audit report (SA 700)

1. Title, addressee and opinion paragraph.
2. Basis for opinion.
3. Key audit matters (SA 701, for listed companies).
4. Going concern, other information, and responsibilities of management and the auditor.
5. Report on other legal and regulatory requirements (Section 143(3), CARO).
6. Signature, membership number, place and date.

Types of opinion (SA 705 and 706)

Emphasis of matter (SA 706) draws attention to a matter already properly disclosed; it does not modify the opinion. Other matter paragraph covers matters not presented in the statements.

Cost audit is the verification of cost records and cost accounts to see that they follow the cost accounting rules. In India it is governed by Section 148 of the Companies Act, 2013 and the Companies (Cost Records and Audit) Rules, 2014.

Cost records and cost audit are two tests

Procedure

1. The Board appoints a cost auditor (a cost accountant in practice, holding a certificate of practice from the ICMAI) on the recommendation of the audit committee; members ratify the remuneration.
2. The company files the appointment in Form CRA-2 within 30 days of the Board meeting.
3. The cost auditor submits the report (Form CRA-3) to the Board within 180 days of the close of the financial year.
4. The company files the report with the Central Government in Form CRA-4 within 30 days of receipt.

The MCA replaced the forms CRA-2 and CRA-4 through the Companies (Cost Records and Audit) Amendment Rules, 2025 (in force from 14 July 2025). The statutory auditor cannot be the cost auditor. Objectives of cost audit: to check the accuracy of cost accounts, detect wastage and inefficiency, help fix prices, and help control cost. Materials cost audit includes purchase, stores, issues, wastage and scrap.

Management audit

A management audit is a systematic review of the efficiency and effectiveness of management at all levels: its plans, policies, organisation and control. It has no statutory requirement and covers the performance, not the accounts. The term and idea were developed by Leslie R. Howard, among others. Its aim is to improve management and identify weaknesses.

Steps of a management audit (logical order)

1. Define the objectives and scope of the audit.
2. Collect facts about the policies, structure and plans.
3. Evaluate performance against the standards or benchmarks.
4. Analyse the causes of weakness and prepare recommendations.
5. Report to the top management and follow up on the action taken.

Management audit is not an extension of the statutory audit, is not done only by an accountant, and does not look for fraud as its main aim. It is a wider and forward-looking review.

Energy audit

An energy audit is a study of how energy is used in a plant or building, to find savings. It is under the Energy Conservation Act, 2001, administered by the Bureau of Energy Efficiency (BEE). Designated consumers (large energy users) must get energy audits done by accredited energy auditors and appoint energy managers. The Perform, Achieve and Trade (PAT) scheme gives energy savings certificates. The Energy Conservation (Amendment) Act, 2022 allows a carbon credit trading scheme.

• Types: preliminary (walk-through) and detailed audit. Objectives: reduce energy cost, improve efficiency, cut emissions, set targets and monitor consumption.

Environment audit

An environment audit checks whether an organisation follows environmental laws, policies and standards. In India, every industry that needs consent under the Water or Air Act must file an environmental statement (Form V) every year. Related: Environmental Impact Assessment (EIA), ISO 14001 (environmental management systems), Life Cycle Assessment, and green audit for campuses.

Systems audit (information systems audit)

A systems audit is an examination of the computer-based information system, its controls, security, data integrity and efficiency. It checks general controls (access, backup, development, change management) and application controls (input, processing, output). Tools: computer-assisted audit techniques (CAATs), test data, integrated test facility. Frameworks: COBIT and ISO 27001. In India the Information Technology Act, 2000 and the audit trail rules from April 2023 apply.

Safety audit

A safety audit is a systematic review of the workplace safety system: hazards, accident records, emergency plans and compliance. In India the law on factory safety is now the Occupational Safety, Health and Working Conditions Code, 2020, in force from 21 November 2025, which replaced the Factories Act, 1948 and 12 other Acts. Tools: hazard and operability study (HAZOP), fault tree analysis, safety checklists.

Related audits worth a line

• Forensic audit (fraud investigation for use in court), social audit (social impact), internal audit (Section 138 requires it for specified companies), secretarial audit (Section 204), tax audit (Section 63 of the Income-tax Act, 2025 replaced Section 44AB from 1 April 2026; business turnover above Rs 1 crore, or Rs 10 crore if cash transactions are 5 per cent or less; professionals above Rs 50 lakh gross receipts).

Key dates

1. Q1. The concept that treats the owner and the business as two separate persons is
   (a) Going concern (b) Business entity (c) Money measurement (d) Cost

   Answer: (b). Personal transactions of the owner are not recorded in the business books.

2. Q2. Which concept supports valuing a machine at cost less depreciation, not at its sale value?
   (a) Going concern (b) Realisation (c) Materiality (d) Consistency

   Answer: (a). The firm is assumed to continue, so assets are not valued at what they would fetch in a forced sale.

3. Q3. ‘Anticipate no profit but provide for all possible losses’ is the rule of
   (a) Consistency (b) Conservatism (c) Materiality (d) Full disclosure

   Answer: (b). It is the convention of prudence, also called the playing safe policy.

4. Q4. Wages paid for installing a new machine are
   (a) Revenue expenditure (b) Capital expenditure (c) Deferred revenue expenditure (d) Prior period item

   Answer: (b). Installation cost is part of the cost of the asset.

5. Q5. In the absence of a deed, interest on a partner’s loan is allowed at
   (a) 5 per cent (b) 6 per cent (c) 8 per cent (d) 12 per cent

   Answer: (b). Section 13 of the Indian Partnership Act, 1932.

6. Q6. A and B share profits 3:2. C is admitted for 1/5 share, taken equally from A and B. The new ratio is
   (a) 5:3:2 (b) 3:2:1 (c) 2:2:1 (d) 6:4:2

   Answer: (a). A = 3/5 – 1/10 = 5/10; B = 2/5 – 1/10 = 3/10; C = 2/10.

7. Q7. Sacrificing ratio is
   (a) New ratio – Old ratio (b) Old ratio – New ratio (c) Old ratio x New ratio (d) Equal for all partners

   Answer: (b). It is the share that old partners give up to the new partner.

8. Q8. Goodwill by the super profit method (3 years’ purchase) when average profit is Rs 1,40,000 and normal profit is Rs 1,00,000 is
   (a) Rs 1,20,000 (b) Rs 40,000 (c) Rs 4,20,000 (d) Rs 3,00,000

   Answer: (a). Super profit = 40,000; goodwill = 40,000 x 3 = 1,20,000.

9. Q9. Garner v Murray says the deficiency of an insolvent partner is borne by solvent partners in the ratio of their
   (a) Profit-sharing ratio (b) Last agreed fixed capitals (c) Current capital balances after losses (d) Equal shares

   Answer: (b). Rule of the 1904 case.

10. Q10. On dissolution, after outside liabilities, the next claim to be paid is
    (a) Partners’ capital (b) Partner’s loan (c) Partners’ profits (d) Reserves

    Answer: (b). Section 48: debts to outsiders, then partners’ loans, then capital.

1. Q1. A company cannot issue shares at a discount under
   (a) Section 52 (b) Section 53 (c) Section 55 (d) Section 62

   Answer: (b). Section 53 prohibits it, except sweat equity under Section 54.

2. Q2. Securities premium can NOT be used for
   (a) Issue of bonus shares (b) Writing off preliminary expenses (c) Payment of dividend (d) Premium on redemption of preference shares

   Answer: (c). Dividend is paid out of profits, not out of securities premium.

3. Q3. A Rs 10 share with Rs 8 paid is forfeited. The minimum price at which it can be reissued as fully paid is
   (a) Rs 10 (b) Rs 8 (c) Rs 2 (d) Nil

   Answer: (c). Discount cannot exceed the forfeiture credit of Rs 8; minimum = 10 – 8 = 2.

4. Q4. Capital Redemption Reserve is created when preference shares are redeemed out of
   (a) Fresh issue (b) Profits (c) Securities premium (d) Debentures

   Answer: (b). An amount equal to the nominal value redeemed from profits is transferred to CRR.

5. Q5. Maximum buy-back limit (equity) is
   (a) 10 per cent of paid-up equity (b) 15 per cent (c) 25 per cent (d) 50 per cent

   Answer: (c). 25 per cent of paid-up capital and free reserves, and of equity capital.

6. Q6. Which is NOT a method of calculating purchase consideration?
   (a) Lump sum method (b) Net payment method (c) Net asset method (d) Weighted average method

   Answer: (d). The recognised methods are lump sum, net payment, net assets and intrinsic value.

7. Q7. An amalgamation in the nature of merger needs at least ___ per cent of transferor’s equity shareholders to become shareholders of the transferee.
   (a) 51 (b) 75 (c) 90 (d) 100

   Answer: (c). AS 14 condition.

8. Q8. The highest priority in distribution under Section 53 of the IBC in liquidation goes to
   (a) Workmen’s dues (b) Unsecured creditors (c) Insolvency resolution and liquidation costs (d) Government dues

   Answer: (c). Costs come first.

9. Q9. Goodwill on consolidation arises when
   (a) Cost of investment is more than the parent’s share of net assets at acquisition (b) Cost is less than parent’s share (c) Subsidiary earns profit (d) NCI is positive

   Answer: (a). Excess of cost over share of net assets is goodwill; shortfall is capital reserve.

10. Q10. Under Ind AS 110, control requires
    (a) Only more than 50 per cent shares (b) Power, variable returns and ability to use power (c) Only board seats (d) Significant influence

    Answer: (b). Control is a three-part test.

1. Q1. Annual demand 4,800 units, ordering cost Rs 100, carrying cost Rs 6 per unit. EOQ is
   (a) 400 units (b) 283 units (c) 200 units (d) 566 units

   Answer: (a). Square root of (2 x 4,800 x 100 / 6) = square root of 160,000 = 400.

2. Q2. At EOQ, total ordering cost is
   (a) More than carrying cost (b) Equal to carrying cost (c) Less than carrying cost (d) Zero

   Answer: (b). The two are equal at the minimum total cost.

3. Q3. Reorder level equals
   (a) Maximum usage x Maximum lead time (b) Normal usage x Normal lead time (c) Minimum usage x Minimum lead time (d) Average usage x Emergency lead time

   Answer: (a). Standard definition.

4. Q4. Sales Rs 2,00,000, variable cost Rs 1,20,000. P/V ratio is
   (a) 40 per cent (b) 60 per cent (c) 66.7 per cent (d) 25 per cent

   Answer: (a). Contribution 80,000 / 2,00,000 = 40 per cent.

5. Q5. Fixed cost Rs 60,000, P/V ratio 30 per cent. Break-even sales is
   (a) Rs 1,80,000 (b) Rs 2,00,000 (c) Rs 2,50,000 (d) Rs 20,000

   Answer: (b). 60,000 / 0.30 = Rs 2,00,000.

6. Q6. Margin of safety is
   (a) Actual sales – Break-even sales (b) Break-even sales – Fixed cost (c) Contribution – Profit (d) Sales – Contribution

   Answer: (a). It is the sales above the break-even point.

7. Q7. Under marginal costing, fixed cost is
   (a) Included in stock (b) A period cost (c) Spread over products (d) Ignored

   Answer: (b). It is written off in the period it arises.

8. Q8. If production exceeds sales, profit under absorption costing compared with marginal costing is
   (a) Lower (b) Higher (c) Equal (d) Cannot say

   Answer: (b). Part of fixed cost is carried forward in closing stock.

9. Q9. Variable cost per unit Rs 12, P/V ratio 40 per cent. Selling price is
   (a) Rs 20 (b) Rs 30 (c) Rs 18 (d) Rs 24

   Answer: (a). Price = 12 / (1 – 0.40) = Rs 20.

10. Q10. Which method is used to separate semi-variable cost?
    (a) High-low method (b) Du Pont (c) ABC analysis (d) Rolling budget

    Answer: (a). High-low, scatter graph and least squares are the standard methods.

1. Q1. Standard quantity 100 kg at Rs 20; actual 110 kg at Rs 19. Material usage variance is
   (a) Rs 200 Adverse (b) Rs 200 Favourable (c) Rs 110 Favourable (d) Rs 90 Adverse

   Answer: (a). (100 – 110) x 20 = 200 adverse.

2. Q2. Same data. Material price variance is
   (a) Rs 110 Favourable (b) Rs 110 Adverse (c) Rs 100 Favourable (d) Rs 200 Adverse

   Answer: (a). (20 – 19) x 110 = 110 favourable.

3. Q3. Idle time variance is
   (a) Always adverse (b) Always favourable (c) Zero (d) Either

   Answer: (a). Idle time is a loss.

4. Q4. A standard cost differs from an estimated cost because it is
   (a) A forecast (b) A target of what cost should be (c) Always historical (d) Based on last year

   Answer: (b). Standards are targets used for control.

5. Q5. The budget that adjusts to the actual activity is
   (a) Fixed budget (b) Flexible budget (c) Master budget (d) Cash budget

   Answer: (b). It is recast for the level of activity.

6. Q6. The first step in budget preparation, after the committee is set up, is to find the
   (a) Cash position (b) Principal budget factor (c) Master budget (d) Capital budget

   Answer: (b). Key factor first.

7. Q7. Process costing is suitable for
   (a) Shipbuilding (b) Construction contracts (c) Cement manufacture (d) Job work

   Answer: (c). Continuous production of like units.

8. Q8. Abnormal loss in a process is valued at
   (a) Scrap value (b) Cost of good units (c) Zero (d) Market price

   Answer: (b). It is charged at the cost of normal units, with scrap credited.

9. Q9. Activity Based Costing assigns overhead using
   (a) Direct labour hours only (b) Cost drivers (c) Machine hours only (d) A flat percentage

   Answer: (b). Activities are the cause of cost; drivers measure them.

10. Q10. Target cost is
    (a) Cost + Profit (b) Target price – Target profit (c) Standard cost (d) Historical cost

    Answer: (b). Target costing starts with the market price.

1. Q1. Current assets Rs 4,00,000, current liabilities Rs 2,00,000, inventory Rs 1,00,000. Quick ratio is
   (a) 2:1 (b) 1.5:1 (c) 1:1 (d) 0.5:1

   Answer: (b). (4,00,000 – 1,00,000) / 2,00,000 = 1.5.

2. Q2. EBIT Rs 3,00,000, interest Rs 50,000. Interest coverage ratio is
   (a) 3 times (b) 6 times (c) 5 times (d) 0.17 times

   Answer: (b). 3,00,000 / 50,000 = 6.

3. Q3. If equal amounts are added to current assets and current liabilities and the current ratio was 2:1, the ratio will
   (a) Rise (b) Fall (c) Stay 2:1 (d) Become 1:1

   Answer: (b). The ratio moves towards 1.

4. Q4. Which is NOT a financing activity?
   (a) Issue of shares (b) Repayment of loan (c) Purchase of machinery (d) Payment of dividend

   Answer: (c). Purchase of machinery is investing.

5. Q5. Funds in a funds flow statement usually mean
   (a) Cash (b) Working capital (c) Net profit (d) Fixed assets

   Answer: (b). Change in working capital is explained.

6. Q6. Which is a source of funds?
   (a) Redemption of debentures (b) Sale of fixed assets (c) Purchase of investments (d) Payment of tax

   Answer: (b). Sale of fixed assets brings in funds.

7. Q7. Increase in a current liability causes working capital to
   (a) Increase (b) Decrease (c) Stay the same (d) Double

   Answer: (b). More liabilities reduce working capital.

8. Q8. In the indirect method of the cash flow statement, an increase in debtors is
   (a) Added (b) Deducted (c) Ignored (d) Shown as financing

   Answer: (b). It means cash is tied up in credit sales.

9. Q9. Bonus shares issued appear in the cash flow statement as
   (a) Financing inflow (b) Operating inflow (c) Not shown (non-cash) (d) Investing outflow

   Answer: (c). No cash is involved.

10. Q10. Operating ratio is
    (a) (COGS + Operating expenses) / Net sales x 100 (b) Net profit / Capital (c) Current assets / Liabilities (d) EBIT / Interest

    Answer: (a). Total operating cost as a percentage of sales.

1. Q1. Opportunity cost method of HR valuation was proposed by
   (a) Likert (b) Hekimian and Jones (c) Lev and Schwartz (d) Flamholtz

   Answer: (b). Competitive bidding for employees’ services.

2. Q2. Present value of future earnings model of HR was proposed by
   (a) Lev and Schwartz (b) Likert (c) Brummet (d) Sandilands

   Answer: (a). Discounts the future earnings of employees.

3. Q3. Replacement cost approach to HR valuation is associated with
   (a) Rensis Likert (b) Sweeney (c) Kaplan (d) Imai

   Answer: (a). Likert suggested valuing at the cost of replacement.

4. Q4. In CPP accounting, which item is restated using the price index?
   (a) Cash (b) Debtors (c) Plant and machinery (d) Loans

   Answer: (c). Non-monetary items are restated.

5. Q5. The Sandilands Committee recommended
   (a) CPP accounting (b) Current cost accounting (c) Historical cost (d) Zero-base budgeting

   Answer: (b). UK report of 1975.

6. Q6. Ind AS 2 deals with
   (a) Property, plant and equipment (b) Inventories (c) Cash flow (d) Leases

   Answer: (b). Inventories.

7. Q7. Ind AS 7 deals with
   (a) Cash flow statements (b) Segment reporting (c) Borrowing costs (d) EPS

   Answer: (a). Statement of cash flows.

8. Q8. Ind AS 21 deals with
   (a) Foreign exchange rates (b) Government grants (c) Related parties (d) Intangibles

   Answer: (a). The effects of changes in foreign exchange rates.

9. Q9. Ind AS 113 deals with
   (a) Fair value measurement (b) Revenue (c) Leases (d) Agriculture

   Answer: (a). Fair value measurement.

10. Q10. Ind AS 116 deals with
    (a) Revenue (b) Leases (c) Financial instruments (d) Consolidation

    Answer: (b). Leases.

1. Q1. Which Ind AS deals with consolidated financial statements?
   (a) Ind AS 29 (b) Ind AS 101 (c) Ind AS 110 (d) Ind AS 41

   Answer: (c). Control and consolidation.

2. Q2. Ind AS 115 uses a model of
   (a) Three steps (b) Five steps (c) Seven steps (d) Ten steps

   Answer: (b). Five steps.

3. Q3. Under Ind AS, inventory cost formula NOT permitted is
   (a) FIFO (b) Weighted average (c) LIFO (d) Specific identification

   Answer: (c). LIFO is not allowed.

4. Q4. A change in accounting estimate is applied
   (a) Retrospectively (b) Prospectively (c) Never (d) With restatement of earlier years

   Answer: (b). Ind AS 8.

5. Q5. An adjusting event after the reporting period is
   (a) Fire after the date (b) Insolvency of a debtor proved after the date (c) New acquisition (d) Share issue

   Answer: (b). It gives evidence of conditions at the date.

6. Q6. Recoverable amount in Ind AS 36 is the higher of
   (a) Cost and NRV (b) Fair value less costs of disposal and value in use (c) Book value and cost (d) Fair value and cost

   Answer: (b). Definition.

7. Q7. A present obligation with a probable outflow gives rise to
   (a) Contingent liability (b) Provision (c) Nothing (d) Contingent asset

   Answer: (b). Ind AS 37.

8. Q8. Ind AS 12 follows the
   (a) Income statement method (b) Balance sheet liability method (c) Cash method (d) Net method

   Answer: (b). Temporary differences are used.

9. Q9. Net worth threshold for mandatory Ind AS for unlisted companies is
   (a) Rs 100 crore (b) Rs 250 crore (c) Rs 500 crore (d) Rs 1,000 crore

   Answer: (b). Rs 250 crore or more.

10. Q10. Ind AS 118 is
    (a) In force (b) Notified, not yet in force (c) A proposed standard, not yet notified (as on 12 November 2026) (d) Withdrawn

    Answer: (c). Expected from 1 April 2027 after notification.

1. Q1. The word audit comes from the Latin word audire which means
   (a) To see (b) To hear (c) To write (d) To count

   Answer: (b). In old times accounts were read out and heard.

2. Q2. The first auditor of a company is appointed by the Board within
   (a) 15 days (b) 30 days (c) 60 days (d) 90 days

   Answer: (b). Section 139(6).

3. Q3. The term of an auditor appointed at an AGM is
   (a) 3 years (b) 5 years (c) 10 years (d) Annual

   Answer: (b). Five years, to the close of the sixth AGM.

4. Q4. Removal of an auditor before term needs a special resolution and
   (a) Court order (b) Prior approval of the Central Government (c) SEBI approval (d) NCLT order

   Answer: (b). Section 140.

5. Q5. An individual cannot be appointed auditor if he is already auditor of more than
   (a) 10 companies (b) 20 companies (c) 30 companies (d) 50 companies

   Answer: (b). Section 141(3)(g).

6. Q6. Which of these is NOT qualified to be a company auditor?
   (a) Chartered accountant in practice (b) Firm of chartered accountants (c) Body corporate (other than LLP) (d) LLP of chartered accountants

   Answer: (c). Section 141.

7. Q7. A fraud of Rs 1 crore or more is reported by the auditor to
   (a) Audit committee (b) Central Government (c) SEBI (d) ICAI

   Answer: (b). Section 143(12).

8. Q8. ‘Except for’ wording is used in a
   (a) Qualified opinion (b) Adverse opinion (c) Disclaimer (d) Unmodified opinion

   Answer: (a). SA 705.

9. Q9. An adverse opinion is given when misstatements are material and
   (a) Minor (b) Pervasive (c) Corrected (d) Disclosed

   Answer: (b). Material and pervasive.

10. Q10. CARO 2020 contains
    (a) 15 clauses (b) 21 clauses (c) 30 clauses (d) 10 clauses

    Answer: (b). 21 clauses.

1. Q1. Vouching is the examination of
   (a) Physical assets (b) Documentary evidence supporting entries (c) Directors (d) Stock count

   Answer: (b). It checks vouchers.

2. Q2. The best evidence for a cash sale is
   (a) Cash memo and counterfoil (b) Goods received note (c) Bank statement (d) Wages sheet

   Answer: (a). Cash memos are the primary voucher.

3. Q3. Verification of an asset proves existence, title and
   (a) Colour (b) Proper valuation (c) Age of the auditor (d) Number of owners

   Answer: (b). Existence, title, possession, no charge and valuation.

4. Q4. Cost records must be kept by specified companies with overall turnover of Rs
   (a) 10 crore or more (b) 35 crore or more (c) 50 crore or more (d) 100 crore or more

   Answer: (b). Rule 3.

5. Q5. The cost audit report (CRA-3) is submitted to the Board within ___ days of the year end.
   (a) 90 (b) 120 (c) 180 (d) 365

   Answer: (c). 180 days.

6. Q6. The cost auditor is appointed by the
   (a) Members (b) Board on the audit committee’s recommendation (c) NCLT (d) ICMAI

   Answer: (b). Section 148.

7. Q7. The Energy Conservation Act, 2001 is administered by
   (a) SEBI (b) Bureau of Energy Efficiency (c) CAG (d) RBI

   Answer: (b). BEE.

8. Q8. Which is NOT a step of management audit?
   (a) Fact finding (b) Evaluation (c) Vouching of each cash entry (d) Follow up

   Answer: (c). Vouching is financial audit.

9. Q9. Tax audit under Section 44AB for professionals applies above gross receipts of
   (a) Rs 10 lakh (b) Rs 25 lakh (c) Rs 50 lakh (d) Rs 1 crore

   Answer: (c). Rs 50 lakh; the same limit continues in Section 63 of the new Act.

10. Q10. The SQM 1 and SQM 2 standards of the ICAI are
    (a) In force from 1 April 2026 (b) Deferred; SQC 1 continues (c) Withdrawn (d) Applicable only to cost auditors

    Answer: (b). ICAI deferred them on 31 March 2026.