Category: Commerce Notes PPT

One significant aspect that is responsible for the development of humans is knowledge. Knowledge in the form of education, learning, and training can be achieved and shared from various means like books, music, tutorials, etc. 

The term human capital refers to the economic value of a person’s skills and experience. It is said to include qualities like health and education.

Human capital is an intangible asset of a company that is not listed on the balance sheet. As all employers are not equal, companies can invest a sufficient amount to upgrade their skills leading to profits. They can invest in their training, education, and other relevant skills.

Human capital has a relationship with profitability, productivity and economic growth. Similar to other assets, it can depreciate due to unemployment if individuals won’t adopt new technologies. 

It is quite evident that trades and businesses pioneered by skilled professionals will yield more productivity than initiated by an unskilled person. Consequently, the income made by a learned person is much more than by an untrained individual. All these earnings contribute to a nation’s economy and define the human capital formation of a country.

Sources of Human Capital Formation

One of the most important investments during Human Capital Formation is made in education. Many factors affect human capital formation. Underneath are the factors affecting the human capital formation: 

1. Expenditure on Education

By nourishing and enhancing the education system, a state’s workforce can be upgraded and improved. That is the reason why guardians and the government spend a vast amount behind education. Here are few purposes why the administration of a state or a country and parents invest so much on academics:

• To enhance and develop their income in the upcoming times.

• Strengthen human resources and improve their technical abilities. That, in turn, will help in enhancing the productivity of work and finally result in the expansion of the economy.

• Educating individuals help in controlling the population hike of a country. If the birth rate decreases, sufficient resources can be provided to each studying individual.

• By obtaining education and knowledge, one can further share it with other people. It is a social advantage.

By this, it is understandable that the role of education in human capital formation is a major one.

2. Training

A lot of organisations and companies present on-job training to enhance their employee productivity. This requires a massive amount of money and companies spend extensively in providing on-job training. Some examples are training under-skilled personnel, off-campus training programmes, in-house training and development, etc.

3. Investment in The Health sector

The very next source of capital formation is the medical and health care. For correct diagnosis and speedy recovery, people will always prefer going to the best healthcare units. Thus, it is necessary to build medical centres with all the required equipment and services to provide effective treatment. Some investments in health can be supplying drinking water that is safe and providing curative medicines, etc.

4. Expenditure on Information

Details and statistics related to healthcare and education can be acquired by providing money. Like, for example, facts and figures associated with remuneration and salary are produced for numerous markets.

5. Migration

To get better remuneration and salary, people migrate to other nations. Moreover, some people also look for better opportunities to build their career. Eventually, they shift from their native place to some other place. Rural-urban migration is one primary reason behind unemployment in India. Doctors, engineers and other qualified people migrate to different countries when they receive better opportunities. Shifting from one place to another includes travelling costs, living costs in the new location, etc. The hike in the pay scale in the migrated area is higher than the cost of shifting. Henceforth, expenditure on account of migration also acts as a source of human capital formation.

6. Investment in Information

Information associated with health and education can be achieved by spending money. For instance, data with respect to salaries are prepared for different markets. 

Now, that human capital examples are discussed, various hazards affect its formation as well. Below are some of the problems:

Problems of Human Capital Formation

An increase in population in developing nations can influence human capital formation. It reduces the per capita accessibility of the available resources. A massive headcount requires additional investments.

Human skill development involves a prolonged duration process. Enhancing and upgrading skills need more time. Hence, the activity process slows down considerably.

Gender and regional disparity also hamper the development levels

On-job training related to the working of advanced tools and equipment is not provided to the workers in the agricultural field.

A large percentage of the Indian population falls under the poverty line. So, those people cannot even afford primary education and health services.

To learn more about what is human capital formation and other topics related to the +2 commerce stream, you can attend ’s online classes and study materials.

Brain Drain refers to the migration of individuals from one place to another. It may happen from rural to urban areas or from one country to another. People migrate in search of better job opportunities, healthcare facilities, high salaries, etc. This can adversely affect the economic development of the nation. There can be loss of tax revenue, loss of capable future entrepreneurs, loss of innovative ideas, shortage of important and skilled workers, loss of country’s investment in health and education services. And most importantly, it can instigate a desire in other people to leave their home country.

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Trading activity on the financial market forefront is widely seen as a reflection of the health of the world’s economies. People are quite inquisitive about trade, or about trading successes or failures. Generally, it is common to come across the word trade in conjunction with other words such as free trade, which was in the news in 2016 when Britain decided to vote itself out from the EU.

Trading activities are very much of a need to boost the nation’s economy overall. In our next section, we will know about Incidental Trading Activity which is also relevant for our study. 

Incidental Trading Activity

This Incidental Trading activity is also known as incidentals, these are the gratuities and the fees or costs which are incurred in addition to the main item, service or event paid for during the trading pursuits.

Trading pursuits like a hospital or a chemist shop or even a beauty parlour or canteen, all these places can also in use to furnish certain provisions to the members or public. In this scenario, the trading A/c has to be drawn to determine the outcome of this incidental pursuit. The profit from these trading pursuits is solicited to accomplish the primary objectives which satisfy the cause for which the establishment was set up, then it is being transferred to the Income and Expenditure A/c. 

In Relation to the Above, the following are the Details:

• The trading A/c has to be outlined to ascertain either profit or the loss due to incidental commercial pursuit. All these costs and revenues in a straight way and principally are associated with such pursuits, are documented in the trading A/c. After this, the Balance of the trading A/c is being transferred to the Income and Expenditure A/c

• Income and Expenditure A/c documents, also the trading profit (or loss), all other incomes and expenses are not documented in the Trading A/c. Surfeit or deficit is disclosed by the Income and Expenditure A/c as is being transferred to the capital or general fund.

What do You Need to Know about Trade?

Generally, we wonder what is meant by trade, what exactly and how much do we need to know about the term is the point of discussion here. 

Trade is the transfer of goods or services from one person or one organization to another person or organization. Trades are possible often in exchange for money. A network that importantly facilitates trade is called a market.

We all have read about the ‘Barter Trading System’ which was actually the first form of trading things without the use of money, this involved the direct exchange of goods and services for yet other goods and services. 

Today, the traders usually negotiate through a medium of exchange, ‘money’. The invention of money, paper money, credit, and non-physical money massively simplified the procedure of trade.

Bilateral trade is one where two traders trade among themselves. While trade between more than two traders is known as multilateral trade. Trade has expanded internationally as well. International trade relationships have helped to develop the global economy, but the introduction of lower tariffs to promote free trade has at times been disadvantageous to markets for local products in developing countries.

What Are Incidental Expenses (IE)?

Incidental expenses, shortly known as incidentals, are the gratuities and other minor fees or costs that are incurred in addition to the main service, item, or event that is paid for during business activities.

Incidental expenses are ancillary to the costs of transportation, meals, and lodging. These are common when an employee travels for business purpose. An employee who takes a taxi from the airport to a hotel will face expenses for taxis and hotels and, if it is locally customary, he will incur incidental expenses of tips to the taxi driver and the hotel staff. 

Company Procedures for Incidentals

Incidental expenses are to be defined, as business or personal, and limited to the quantity, quality, or dollar amount. Company procedures for the reimbursement may require incidental expenses to be paid by the employees out of pocket or by a company credit card or petty cash.

These procedures are to facilitate the tracking of incidental expenses for accounting and tax purposes. Employees are required to keep detailed records of all the purchases. Employees should summarize these records in an expense report backed by the actual receipts evidencing payment and submit them to the company. Incidental expenses paid by the employees’ personal funds are to be reimbursed by stand-alone checks so that this is clear that the payments are reimbursements and not the income to the employees.

Goodwill is an asset that is impalpable, and it is associated with the procurement of a company by another. To be more specific, goodwill is a portion of the purchase price that is usually higher than the total sum of the net fair for all the assets purchased. A company’s goodwill is based on the brand name, proprietary technology, good customer base, customer relationship, and employee relationship. A detailed study can be achieved from the Indian partnership act-goodwill of a firm.

 

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The long-term asset of goodwill is categorized as an important part of the growth of business reputation. The amount of goodwill is the cost to purchase that is subtracted from the fair market value. Hence, this intangible asset can be identified based on the obtained liabilities from the purchase. Goodwill of the firm can be adjusted to a smaller amount due to an impairment of the company that has been procured. It is usually shown on the balance sheet of the company. Most of the private companies want to amortize goodwill over 10 years and thus, reduce the complexity and cost involved in the process.

 

How to Calculate Goodwill When Selling a Business?

The process of goodwill partnership is calculated based on a fairly straightforward principle. However, sometimes it can be pretty complex in practice. If you want to determine the goodwill of the firm in a simple formula, consider taking the company’s purchase price and then subtract it from the net fair market value. The formula stands:

 

Goodwill = P – (A – L).

 

P – Purchase price

 

A – Asset value of the fair market

 

L – Liabilities value of the fair market

 

What are the Features of Goodwill?

If you want to know what is goodwill in partnership, consider the following key features.

• Goodwill is the overall position and reputation in the market a firm has, especially when it comes to monetary terms.

• Goodwill showcases the capacity of an enterprise in terms of earning profits.

• Goodwill cannot be seen, but certainly can be felt. 

• Goodwill in business has no connection with the contribution of capital for establishing a reputation in the market.

• The value of a company’s goodwill may change in the long run.

• The value is prone to fluctuation due to factors contributed to the business environment.

 

What is Goodwill in a Partnership? 

The value of goodwill in partnership arises when there is an acquisition. It occurs when an acquirer purchases a target company. The amount that is paid by the acquirer to the target company is the value of the goodwill, the target company has. The sum is based on the target company’s net assets based on the fair value market. When the acquiring company pays less than the sum shown on the target’s book, the acquirer achieves negative goodwill. This indicates that the acquirer has purchased the company on a distress sale over a bargain. 

 

Understanding the goodwill of a partnership is crucial if you are looking for – how to calculate goodwill when selling a business? Goodwill is recorded in the company’s balance sheet long-term asset account. Under the terms of GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards), companies need to evaluate goodwill’s value based on the financial statements for at least once in a year. This is a good practice to keep track of the impairments.

 

Factors that Contribute to Goodwill of a Company

Goodwill incorporation is not an easy task for a firm. It cannot be ensured in a single day. With continued great efforts, it takes years to maintain proper goodwill. The factors that contribute to the goodwill of the firm are as follows.

• Customer service

• The quality offered through products and services

• Efficiency in management

• The Reputation of the promoters or founders

• Goodwill in business through locational advantage

• Monopolistic nature

• Fair competition

• Consistency

• Market share

• Coverage or reach

• Advertising and marketing strategy

• Customer satisfaction

• Possession of trademark and distinctive patent

 

Goodwill Partnership with customers also means a lot when it comes to business reputation. When the customers stay loyal to the firm and keep visiting regularly, it can be said that the company has the potential of earning surplus profits.

Indian businesses are well known for their successful partnership, so to monitor and govern such partnerships The Indian Partnership Act was established on the 1st October 1932.

This partnership act provides an agreement between two or more persons who agree to do the business as one and share the profits between themselves. A partnership is classified into various types and it depends on the state and the business location. Here are some of the most common types of partnerships in a business.

Goodwill

When a company is purchased by another company, then it is called goodwill. It is an intangible asset. In particular, In a situation where the purchase price is greater than the sum of the fair value of all solid assets and purchase of intangible assets, by acquisition and the liabilities assumed in the process.

Types of Goodwill

There are two different types of goodwill, they are

• Purchased goodwill.

• Inherent goodwill.

Purchased Goodwill

Purchased goodwill is the difference of the purchase value of a business as an ongoing concern and the sum of its fixed assets less the sum of its liabilities, each item of them is to be separately identified and valued.

Inherent Goodwill

It is the value of an enterprise higher than the fair value of its separable net assets. It is also known as internally generated goodwill, and it emerges for a fixed time, due to the good fame of a business. It can also be called self-generated or non-purchased goodwill.

Calculation of Goodwill

When an entire business is acquired by another company, goodwill comes into play. The amount of goodwill is defined as the cost to purchase the business minus the fair market value of the tangible assets, the identified intangible assets, and the liabilities on purchase.

The calculation of goodwill is as follows,

Goodwill = P−(A+L)

where,

P = Purchase cost of the company

A = Fair market value of assets

L = Fair market value of liabilities

For example, If you sell a remarkable product or consistently provide outstanding service, then there is a higher possibility for an increase in goodwill.

Interest on capital is the fixed return amount that the business owner is eligible to receive from their investment. It is the interest on share capital paid to the investor for the amount they agree to start their business. The partner is eligible to receive the interest for the amount exceeding the total amount employed by them. It generally occurs in partnership business. However, the company does not pay interest on capital in cash but increases the partner’s capital. Interest on capital is deducted from the profit and loss statement of the business and is recorded as an expense on the debit side and added to the partner’s capital account.

What is Interest on Capital?

Interest on capital is the interest allowed on capital allocated by the partners. Generally, if the partner’s capital is unequal to the profit-sharing ratio, then the partners may agree to allow interest on capital. It will compensate the partners who have invested a high amount towards the capital. The rate of interest on capital is generally agreed upon by the partners of the business firm and is always mentioned in the partnership deed. It is permitted only when the business earns a profit and it is provided before the division of profits among the partners. No interest is permitted on the capitals of partners if it is not specifically mentioned in the partnership deed.

When the business firm faces loss, the interest on capital will not be provided. If there is insufficient profit, that is, the net profit is less than the amount of interest on capital, interest on capital will not be given, but the profit among the partners of the business firm will be distributed in their capital ratio.

What is the Journal Entry for Interest on Capital?

For Providing Interest On Capital

For closing Interest on Capital Account

Interest on  Capital Example

Rahul is the business owner of the firm ABC solution. He has contributed ₹ 20,00,000 to the business with 10% interest provided to Rahul at the end of the year.

Solution: 

Here, interest on capital is calculated as

Interest on capital Formula: Amount Invested * Rate of Interest * 12

Therefore, IOC = 20,0000 * 10100 * 12

= 20,000

The journal entry for the same will be:

Interest on Capital A/C 10,000

To Rahul’s Capital A/C  10,000

What Does Capital Interest Mean?

A capital interest is a hypothetical interest that a shareholder receives if the company was to be liquidated and the partnership was dissolved. A capital interest is a financial interest for a company. A capital interest holder shares both the profits and losses of the partnership. A capital interest is often determined by:

The capital interest rate is defined as the one percent over the AA Bond rate. This is calculated with the amount which is being reported to the financial press during the initial purchase.

What is Interest in Borrowed Capital?

Interest on capital that is borrowed is deductible, only if the conditions given below are satisfied —

• The assessee must have borrowed the money.

• The borrowed money is used for business purposes.

• The interest is paid or payable on the amount that is borrowed.

Interest in respect of the capital that is borrowed for business or profession is a type of permissible deduction. Interest in your capital is not deductible. In other words, it means that interest will be paid to another person. Interest paid by one unit of the assessee to another unit is not allowed to be deducted.

The following propositions should also be considered:

1. The deduction of interest on capital that is borrowed cannot be ignored only because the borrowed capital obtains nontaxable income.

2. The assured interest paid to shareholders of the company on paid-up capital is not deductible.

3. Interest that is paid to wife and daughters on money given to them on the partition, is deductible.

4. As per the provision of section 40 (b) i.e.@ 12% per annum simple interest, Interest paid by a firm to partners is deductible. However, the interest that is authorized to be paid by an association of persons to its members is not deductible.

Interest on Borrowed Capital for Acquiring Capital Interest

Interest liability refers to the period initiating from the date on which capital is borrowed by an existing concern for the purchase of an asset till the date. When such an asset is first put to use, it should be capitalized and it cannot be declared as deduction according to section 36. Only interest on capital that is borrowed to purchase a capital asset for business use concerning the period after the asset is put to use, is withdrawn every year according to section 36.

What is Capitalized Interest?

Capitalized interest is the financing cost used to finance the construction of a long-term asset that an entity builds for itself. The capitalization of interest is needed under the accrual basis of accounting and increases the total amount of fixed assets that are shown on the balance sheet. An example of such a situation is when an enterprise constructs its corporate headquarters, by using a construction loan to do so.

Accounting Equation on Capitalized Interest

The capitalized interest is included in the cost of the long-term asset so that the interest is not identified as an interest expense in the current period. Rather, it is represented as a fixed asset and is included in the depreciation cost of the long-term asset. Hence, it first appears in the balance sheet and is charged to expense over the useful life of the asset. Therefore, the expenditure appears as depreciation expense on the income statement, rather than interest expense.

Established in the year 2013 Indian companies act states that “It will govern all the companies and will provide guidelines for them which they are bound to adhere to.” A company is an association of people who come across voluntarily to each other and contribute money to satisfy a common purpose. 

The capital of the company is established by the contribution of money by people and its members. So the capital of a company is known as “share capital” and the contributors are known as “shareholders”. 

A company is an association of persons who contribute money voluntarily for a common purpose. The contribution of money by them forms the capital of the company. The persons who contribute are the members of the company. This contributed money is known as share capital of the company and the contributors are its shareholders. This is governed by the Indian Companies Act.

Accounting is the system of recording financial transactions in the form of financial statements. The different types of company accounts are (1) asset, (2) liability (3) equity, (4) revenue, and (5) expense.  Each of these account types has sub-accounts to record the details of transactions.

What are Shares?

Share can be defined as a share in the share capital of the company which includes stocks. According to section 2(84), the company act 2013, a share capital can be divided into several units of smaller denominations. These units are called shares.

Types of Share Capital:

Share capital can be classified into two types:

• Equity share capital

• Preference share capital

1. Equity share capital:

Equity shares have the maximum risk and reward both in a business in case the company has involved itself with high profits then they are more likely to receive a high payment from high dividends and increment in reputation in the market.

In any case, if the company is subjected to a loss then there is a huge risk of either losing a part of the shares or losing the whole of the shares, equity shares are not at all preferential.

2. Preference share capital:

As per the Indian companies act established in 2013 under section 43(b), preference share capital consists of preference shares. These are some preferential rights that are subjected to preference shares and they can be stated as described below:

• In order to receive a dividend: a particular amount of payment is first done to a person who is holding preference shares at a fixed rate or amount by the company and the equity shareholders are paid after the payment is done for preference shareholders.

• Repayment of capital: Before paying the equity shareholders the preferential shareholders receive the whole repayment during the winding uptime.

Company accounts have a totally different format which is quite different from sole proprietorship or partnership. It facilitates different ownership structures like shares and debentures. A specific law is also subjected to a definite format for the final accounts of the company.

Now that we have an idea of company accounts, let’s try to understand the calls in arrears meaning.

Call in Arrear

A company issues its shares in the market and the public purchases its shares. The company may either call the whole amount or partially by way of ‘calls’. The company calls for money from shareholders when needed within a certain period. If the shareholder is not able to pay the call amount due on an allotment or on any calls according to the terms before or on the specific date fixed for payment, such amount is taken as ‘call in arrears’.

Calls in Arrears in Balance Sheet

Once the company confirms the allotment of shares to a person, it becomes a valid contract and he becomes the shareholder. He is liable to pay the entire amount of shares. In case if the shareholder is not able to pay the call amount due on the allotment, the unpaid amount becomes a call-in-arrears. Such an amount of calls in arrears is shown in the liability side of the balance sheet by deducting from the called up capital. In case if the shares are forfeited, then it is deducted from the forfeited account.

Calls in Advance in Balance Sheet

The company, according to terms on issue of shares, may call for partial payment instead of lump-sum by way of calls. If the company accepts the amount against the calls, which are not made yet, the amount received in advance is called ‘calls-in-advance’.  In the balance sheet, the call-in-advance is shown in the subhead other current liability under the Current Liabilities.

Calls in Arrears Journal Entry

When the shareholders make default in payment, the amount due is stated as Calls in Arrears. This amount is shown in the journal by opening a separate account called the Calls in Arrears Account and all such calls in arrears are charged an interest of 5% p.a. until the amount is repaid. Finally, the total (call in arrears entry) is shown in the balance sheet as a deduction from the Called up Capital.

Calls in Advance Journal Entry

A company, well authorized by the Articles can accept calls in advance from its shareholders but in the journal entry, the amount of call in advance cannot be credited to the capital amount.

Calls in Arrears Example

When financing is demanded from shareholders on calls, the respective accounts are debited. There are certain situations in which some shareholders cannot pay their dues on the allotment and/or on calls within the stipulated time. The amount which is not paid by defaulter shareholders is termed as calls in arrears and it shows a debit balance. The opening of ‘calls in arrears account’ supports in preparing the balance sheet since it is deducted from called up capital.

An example:

XXX Ltd made its first call @ of Rs. 3 on 10,000 shares. Mr A has not paid on the first call on his 200 shares. However, he paid this default amount after one month.

Preference shares are shares that represent part of capital issued by a company. The shares thus issued usually carries a definite rate of dividend, which generally is lower than that, is declared on ordinary shares. 

Further, the holders of such shares are having a right to receive part of the company’s profit before the payment to ordinary shareholders. If the company fails, preference shareholders have a right to get back the capital repaid.

    

Redemption of Preference Shares Solved Problems

Under Section 55 of Companies Act 2013, a company can issue preference shares liable to be redeemed at the end of twenty years. A company cannot issue an irredeemable preference share as per the Act.  Preference shares are redeemable and the company has to redeem out of profits it earned or out of the proceeds of fresh issue of shares made for such redemption.

Issue and Redemption of Preference Shares 

The issue of shares for raising capital for a company is of two types. One is equity share capital and the other is preference share capital. The Article of Association of a company empowers the board to issue preference shares, setting certain terms and conditions. The maximum period for which the company can issue the preference should not exceed twenty years. That is such shares must be redeemed within that period. 

The holders of the preference share have a preferential right overpayment of dividends and also for repayment of share capital in the event of failure or winding up of the company. A company can issue only redeemable preference shares. It is also mandatory for a company to issue such shares redeemable within twenty years.

The redemption of preference shares implies the repayment to the shareholders either at a fixed date or within a time frame. Preference shares can be redeemed only if it is fully paid-up. The shares are redeemed out of the profits that are available for distribution to its shareholders or from the fresh proceeds issued for funding the redemption of preference shares.  

Accounting for Preference Shares

In a financial statement of a company, redeemable preference shares are reported as a liability. The dividend paid on such shares is recorded as an expense in the income statement. In the case of irredeemable preference shares, the company does not have to retrieve and they are like ordinary shares. 

So, they are recorded as part of the equity in the financial statement. Any return paid on such shares is treated as a distribution of profits and reported in the statement of changes in equity.

Preference Shares Formula

The formula for calculating Preference Share capital is as follows:

Accounting Treatment of Redeemable Preference Shares

While redeeming the preference shares from the company’s profits, an amount that is equal to the face value of them is transferred to the capital redemption reserve. In order to immobilize profit from being used for any other purpose, the said procedure is necessary.

Redemption of Preference Shares Journal Entries

Only fully paid preference shares can be redeemed. On redemption, we repay the amount to the shareholders.

At the time of maturity of the preference shares, the journal entry passed is as under:

Both the Redeemable preference share capital account with the face value and the premium on redemption account is reduced by debiting the same.  Such debited amounts are to be credited to Preference shareholders Account or Preference Share Redemption Account.  

The main reason for crediting Preference Shareholders Account is to get sufficient time for arranging cash from different sources.