Category: Commerce Notes PPT

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.

Industrialization and technology have brought many discoveries, inventions and ultimately a bigger and better lifestyle. People are constantly surrounded by a very happening world and the drastic change is going through. Humans are evolving and so is society and its perception. However, it is quite mandatory to commemorate and keep certain duties and responsibilities that people have towards those who/which helped in living on this planet. A collectivistic approach and group acts can cultivate comparatively more results. 

With the change in the business scenario, businesses are more inclined towards serving society. They understand the role of society in their business, without society, their business would have landed nowhere. Hence, nowadays we see big business houses perform societal duties. A large amount of their profits is diverted to the needs of society.

Also, various kinds of servings can be done in the interest of society. Here, we point out the kinds in our discussion with a deeper analysis of the social responsibility performed by the business sectors.

 

What is Social Responsibility of Business?

Social responsibility in the business is also known as corporate social responsibility abbreviated as CSR, which pertains to people and the organizations behaving and ethically conducting business with crucial sensitivity towards the society’s – social, cultural, economic, and environmental issues. Performing social responsibility helps individuals, organizations, and governments to have a positive impact on development, business, and society. 

To initiate a smart business decision, the companies are required to earn the belief of the society by serving them rather than only counting the short-term dollars or rupees. Decision-makers should consider the future impact of today’s choices on the societal people, on the community at large, and customers and their cultural opinions. 

Social Responsibility helps the business by:

• Providing a cultural view of the company and understanding of quality

• Generating new career paths for quality professionals who are experts in Social Responsibility related decisions.

• Providing methods to enhance the efforts of SR professionals’

• Growing the community of SR practitioners

All this will help to communicate the value of SR

Social responsibility of business means the obligations or duties of the management of a business enterprise to protect the interests of society at large. According to the concept of social responsibility, the objective of managers for taking business decisions is not only to maximize the profits or shareholders’ wealth but also to serve the societal interest and protect the interests of workers, consumers and the community as a whole.

Types of Social Responsibility

There are various types of social responsibilities that can be served by the corporates: 

This is the most common form of corporate social responsibility many companies focus on this type of CSR efforts which focuses on reducing their hazardous impact on the environment. After harmful effects on the environment were once ejected in the environment as an unavoidable cost of doing business, pollution and excessive consumption of resources now threaten social and political concern on a global level. For this reason, environmental CSR is now prioritising the impact that their business has on the environment. 

Companies, when engaged in environment-friendly practices can bring about a massive change in their surroundings and within themselves. Corporations, enormous industries, many uncountable numbers of small scale production communities and a lot of other people are contributing directly or indirectly towards the deterioration of the only planet that we got. The rapid rate of natural resource consumption and ascension of environmental pollution will only invite disastrous conclusions. Therefore Business companies can show their CSR towards the environment by raising awareness programs, initiating eco-friendly changes within the circles, conducting recycling programs, collaborating with local as well as national environmental protection based institutions. 

Ethical corporate social responsibility programmes ensure that all the stakeholders in a business will receive fair treatment, from employees to customers. Ethical responsibilities are self-enforced initiatives that a company puts in place because they believe it is the morally correct thing to do rather than out of any obligation. Businesses consider how stakeholders will be affected by their activity and work to have the most positive impact.  While the economic and legal responsibilities are the primary concerns of a company, after addressing the fundamental requirements of businesses, they can then focus on their ethical responsibilities. Ethical CSR is intended to enforce fair treatment for all employees, including paying higher wages, offering jobs to the individuals equally based on required criteria.    

Philanthropic social responsibilities extend further than simply operating as ethical in making society better. This corporate social responsibility is moreover associated with donating money to charities, with many businesses supporting the particular charities that are related to their business in some way. Not only charity donations but other common philanthropic responsibilities include investing in the community or participating in local projects. The main intention is to support a community in a wholesome manner. 

Just like ethical responsibility emerges from the sense of right, wrong and moral integrity, philanthropic responsibility should be kept alive by putting out individual emotions together. Since business isn’t mostly a one-man army field, the steps taken by all the people of a company or many such companies can easily make an impact on the lives of people who we may even never see. 

Economic responsibility is ensuring an economic advantage both to the region from where the purchase arrived and to the region where it is destined to be marketed. The responsibilities are the basic social responsibilities of the business. Economic Responsibility is viewed by some economists as the legitimate social responsibility of business. Living up to the economic responsibilities requires managers to maximize profits wherever and whenever it is possible. The essential responsibility of business is to be assumed to provide goods and services to society at a reasonable cost. In performing that economic responsibility, the company also emerges as socially responsible by providing jobs for its workforce.

Suppose if a company is raising the cost of a day-to-day product like detergent or vegetables, and starts selling it to people at a higher price, they are showing their lack of economic responsibility. 

The business itself is an economic exercise. It aims at making money and earning profit. Do cut off the size of economic responsibility of business organizations with just provision of goods to people at a reasonable price. Business heads, through business processes, can show responsibility towards their employees too. Increment in salary, scale revision, provision, the adequate and deserving wage for each worker and to different sectors within the organization can induce a sense of happiness and in-turn make them responsible to keep up with the expectations of their senior employees. 

Apart from all these, another type of responsibility that business societies should ponder upon in future is Individual responsibility. Though all the types are interconnected in some way or the other, the integral value crafted by individual responsibility is much higher than anything. Business requires many people on board to run it. Naturally, it follows group-favourable approaches and decisions for the fulfilment of thoughts to actions. But it is also important to have an individualistic view when it comes to considerations and help. A business institution can grow individualistically responsible if the members can give care, respect and reflections to desired individuals. 

This includes regular surveys and meetings conducted to check on the mental health of employees, administering different tests that come in alignment with the company mission and work, among employees to motivate them to learn more and to recognize where a persons’ true passion lies. Also collect information about their family and financial background after which, collective decisions and ideas can be made to uplift at least one persons’ family who needs it the most. 

It is not easy to streamline such needs on an individual basis and gather things in one place. But it is also not impossible to do so. 

Section 23 of The Indian Contract Act states that for a contract to be valid, there must be the legality of object and consideration. The object is the purpose for which the parties enter into a contract. The fulfillment of the object leads to the transfer of the consideration agreed from one party to the other. Let’s look into the parameters under the legal object contract law that define what is a lawful object and consideration.

Lawful Object and Lawful Consideration

The legality of the object in contract law stipulates that the consideration and the object of a contract are considered legal except when:

• They are specifically forbidden by law.

• They are fraudulent in nature.

• The nature of the object and the consideration is such that it defeats the purpose of the law.

• They involve injury or harm to a person(s) or property.

• Are considered immoral by the court of law.

• Are against public policy.

Forbidden by the Law

An object and/or a consideration prohibited by law are not considered legal and render a contract void. Unlawful consideration of the object means unlawful acts that are punishable by the law. The acts disallowed by the appropriate authority by means of their rules and regulations are also considered for determining the legality. However, if these rules and regulations are not in tandem with the law, they are not applicable.

Forbidden by law provision renders a contract void but all void contracts may not be illegal.

Fraudulent in Nature

The object and the consideration of the contract must not be fraudulent as then, the contract will become void.

Example- A enters into a contract with B where he agrees to pay B if he embezzles money from C. This is considered a fraudulent object and the contract is not valid.

Defeats the Purpose of the Law

If the purpose of entering into the contract is to go against any provisions of law, the contract will be deemed void. The contract is void if:

• The object of the contract is to perform an illegal act.

• The object of the contract is explicitly or in an implied manner prohibited by law.

• The completion of the contract is impossible without going against the provisions of the law.

Example – A enters into a contract with B whereby B promises to not pursue legal proceedings against A if A commits a robbery in B’s house. This contract is against the provisions of the IPC law.

Involves Injury or Harm to Another Person or Property

The object of the contract must not cause any destruction to property or cause injury to another person.

Examples:

A enters into a contract with B whereby he agrees to pay a sum of money to B if he destroys a city landmark. This contract does not have a lawful consideration and lawful object and it is not deemed legal.

Immoral as Per Law

If the object and/or consideration of the contract are considered immoral, the contract will not be deemed void. Immoral acts are against the reasonable and acceptable general behavior or personal conduct accepted by society.

Example – A lends money to B on the condition that B will divorce C, and later get married to A. If B does not divorce C, then A cannot pursue legal proceedings against B to recover the money. The basic premise of this contract is immoral so it will be deemed void.

Against the Public Policy

A lawful object in business law means that it should not be against public policy. The purpose of public policy is not to curtail any individual’s rights but to maintain and protect the general welfare of the community. Let’s see what kind of contracts are considered to be against the public policy:

• Entering into an agreement with a party that belongs to a country with which India does not have peaceful relations, makes the agreement void. 

• Restraining from prosecution: A contract that prohibits a person from pursuing legal recourse is considered void. 

• Maintenance and Champerty: In a maintenance agreement, a person promises to maintain a lawsuit in which he has no vested interest. Champerty is when a person agrees to assist another party in litigation in return for a portion of the damages or proceeds received.

• An agreement to indulge in trafficking in public offices.

• Agreements to create monopolies.

• An agreement to brokerage marriage as a reward.

• An agreement to induce judiciary or state officials to act in a corrupt manner and interferes with legal proceedings.

Solved Questions on the Legality of the Object in Business Law

Q1. L lends some money to P to help him buy some goods from X who belongs to a country with which India is at war. Can L recover his money from P?

Ans. Any agreement for the purchase of goods between P and X will be considered void since entering into trade with the enemy is against public policy. Any agreement between L and P will also be void since it is collateral to the main agreement. So L cannot recover his money from P. However, If L did not know the reasons for P borrowing the money, he can enforce the contract for recovering money.

Q2. Is an agreement between a husband and wife to stay separately after marriage considered valid?

Ans. The agreement will be considered void since it is against the provisions of Hindu Law. The nature of the contract between the husband and wife is against the spirit of the Hindu marriage act and hence considered void.

Section 23 of the Indian Contract Act

Section 23 of the Indian Contract Act, 1872 (“the Act”), clarifies three matters, for example, the consideration of an agreement, the purpose of the contract, and the actual agreement. Article 23 imposes restrictions on individual freedoms by entering into agreements and places the rights of such persons in the higher concepts of public policy and the other provisions mentioned under it. Article 23 repeats its appearance in Section 264.

The Word “Object” used in Section 23 

The word “object” used in Section 23 indicates and implies “purpose” and does not mean significance in the same sense as “consideration”. Therefore, unless the consideration of the agreement may be legal and valid, that will not prevent the contract from being invalid if the purpose of the agreement is invalid. Section 23 limits the courts as the section may be guided by thought or motive, for the purpose of exchange or transaction is basically not for reasons leading to equality. Although the consideration is provided under Section 2 (d) [1] of the Act, no official definition of the word ‘object’ exists. An “object” can better be understood as the “purpose” or “design” of a contract. Thus, when a loan is taken under a contract for the purpose of marriage, in that case, the marriage is the purpose of the contract.

 

Lawful Object and Lawful Consideration- Section 23 Order

The purpose or consideration of an agreement is absolutely valid unless it falls into any of the categories provided below-

•  It is forbidden by the Law

• A consideration or object violation of the provision of Law

• Deceptive thoughts or something

• A consideration or object includes an injury to a person or property

• The court considers it immoral

• The consideration or intent is contrary to public policy

• Trading with enemy

 

It is forbidden by the Law

If the purpose of the contract or the consideration of the contract is legally prohibited, then there is no legal consideration or objection. Then they become naturally illegitimate. Therefore such an agreement will no longer apply. Illegal consideration of an object includes actions that are directly punishable by law. This includes those who have legitimate authority over the existence of laws and regulations. But if the rules made by such authorities do not comply with the law it will not work.

Let’s see an example. A licensed Department of Forestry for cutting local grass. Departmental officials told him he could not pass such an interest on to anyone else. But the Forest Law does not have that law. So A sold his interest in B and the contract was held legally.

A Consideration or Object Violation of the Provision of Law

This means that if the contractor tries to defeat the purpose of the law. If the courts find that the real purpose of the parties to the agreement is to circumvent the provisions of the law, they will set aside the stated contract. Give an example A and B enter into an agreement, where A is a debtor, B will not agree to a limit. This, however, is done to defeat the purpose of the Restrictions Act, so the courts may decide the contract as null and void because of something illegal.

Deceptive Thoughts or Something

A legitimate consideration or object can never be deceptive. Agreements entered into that contain the presumption of illicit fraud or material misconduct. Suppose that A decides to sell goods to B and smuggles them out of the country. This is falsework as it is useless. Now B cannot reimburse under the law if A does not fulfill his promise. 

A Consideration or Object includes an Injury to a Person or Property

In this case, the word injury refers to acts of violence, harassment, coercion, assault, etc. An assault agreement, for example, falls under this section. Thus, when X borrowed Rupees 1000 from Y and made a bond promising to work for Y without pay for two years and in the event of any failure allowed to pay high interest on the principal amount, the contract was held in vain. as it involved the injury of someone in the contract. 

The Court considers it Immoral

The term “immorality” is often translated in conjunction with the norms and definitions of the Courts. The Supreme Court has given a limited definition of the word “immorality” and has interpreted it as a strong reference to “forms of sexual immorality”. Thus, betting agreements cannot be considered immoral. Explaining the scope of the Gherulal Parakh v Mahadeodas, the Supreme Court cited certain agreements in which the consideration or object was immoral: the promise of marriage for consideration, a contract for the sale of goods for the prostitute to continue her work, a contract. facilitating divorce, future settlement agreement, etc. A good example of an agreement that facilitates divorce is when a person, X, gives Y to Y with the promise that Y will divorce Z, and later marry X. Here if Y does not separate from Z, A cannot continue legal action against him. Y refund. The very nature of this contract is immoral and will therefore be regarded as null and void.

 

The Consideration or Intent is Contrary to Public Policy

The word ‘enforce’ is broad in scope and is governed by precursors. In the case of Ratanchand Hirachand v Askar Nawaz Jung, the Court defined the definition of “public policy” as the development of the public good on the one hand and the prevention of public evil on the other. When the marriage was dissolved on the condition that the wife would not claim maintenance or maintenance money but later the wife applied for maintenance, the Court held that the terms of the divorce would not prevent the court from granting maintenance as this right was part of it. of a larger “right to life” and would be against public policy to seize it. Thus, anything that harms the public interest or the welfare of the community falls under this category. However, it is not possible to provide a complete list of assumptions against public policy. It varies from time to time. 

Trading with Enemy

An agreement with an unknown enemy during the war without an Indian government license is invalid because it violates civil policy. The proclamation of war brings a ban on trade relations and contacts with the citizens of the enemy country. The very nature of the war is the crippling trade of the enemy world.

Conclusion

The importance of legitimacy and consideration in making an agreement work can not be underestimated. If the object and consideration are illegal, the agreement becomes void. As knowledgeable citizens, we must understand that until further notice unless our agreement falls under the provisions of Sections 10, 23, and 24 of the Indian Contract Act, 1872, our efforts to enforce our rights under this agreement in a court of law will be in vain. This is because such a covenant would not be sacred in the eyes of the law. Therefore, when entering into agreements we must be very careful to ensure that they are not just “agreements”, but rather meet the requirements of the law so that in the event of a collision, we will not be without legal action.

Liquid funds help a business in meeting its short-term expenses commitments. Liquidity can be defined as an organization’s ability to meet an expense or settle a liability towards its stakeholders, as and when it becomes due. It is a parameter that gives a picture of the solvency of the firm.

To measure the liquidity, we need to calculate the liquidity ratios. These ratios give a short-term answer as the creditors are interested in the current liquidity position of the entity. If the organization is not in a position to meet its short-term commitments, it has an adverse effect on its credit rating and credibility. If the organization is not able to honor its financial commitments, it can result in its bankruptcy or closure. The liquidity of the organization must neither be insufficient nor should it be excessive.  

Types of Liquidity Ratio 

• Current Ratio

• Quick Ratio or Acid test Ratio

• Cash Ratio or Absolute Liquidity Ratio

• Net Working Capital Ratio

Let’s look at these ratios in detail.

Current Ratio

One of the most common ratios for measuring the short-term liquidity of the firm is the current ratio. This ratio is also called the working capital ratio. It measures whether the current assets of the firm are enough to pay the current liabilities or debts of the firm. This ratio keeps a margin of safety for any potential losses that might occur during the realization of the current assets. It can be calculated as the ratio between the Current Assets and Current Liabilities.

The ideal current ratio is 2:1 but it also depends on the characteristics of the current assets and current liabilities along with the nature of the business of the firm. Let’s see the heads that are included under current assets and current liabilities.

Current Assets 

• Stock

• Sundry Debtors

• Cash/ Bank Balances

• Bills receivable

• Accruals

• Short term loans given

• Short term Securities

Current Liabilities

• Creditors

• Outstanding Expenses

• Short Term Loans taken

• Bank Overdrafts

• Provision for Taxation

• Proposed Dividend

Current Ratio Formula

Current Ratio = Current Assets / Current Liabilities

Where,

• Current Assets = Sundry Debtors + Inventories + Cash-at-Bank + Cash-in-hand + Receivables + Loans and Advances + Advance Tax + Disposable Investments

• Current Liabilities = Creditors + Short-term Loans + Bank Overdraft + Cash Credit + Outstanding expenses + Dividend payable + Provision for Taxation 

Quick Ratio

Quick Ratio is also known as Acid-test Ratio. It is a measure of the liquidity calculated on the basis of the relationship between Quick Assets and Current Liabilities. It is used to calculate if the readily convertible quick funds are enough to pay the current debts. The ideal Quick Ratio or Acid-test Ratio is 1:1. 

Acid-Test Ratio Formula or Quick Ratio Formula

Quick Ratio= Quick Assets / Current Liabilities

Where,

Quick Assets = Current Assets – Inventories – Prepaid Expenses

Cash Ratio or Absolute Liquidity Ratio

The cash ratio is used to measure the absolute liquidity of the firm. It calculates whether a firm can use only its cash balances, bank balances, and marketable securities to pay its current debts. Inventory and Debtors are not included while calculating this ratio because there is no guarantee of their realization. 

Cash Ratio= Cash and Bank Balances + Marketable Securities + Current Investments / Current Liabilities

It is a measure of the cash flow and this ratio should be positive. This ratio is very important for the bankers as it helps them gauge if there is a financial crisis in the firm.

Net Working Capital Ratio= Current Assets – Current Liabilities (exclude short-term bank borrowing)

Solvency Ratios vs. Liquidity Ratios

Solvency ratios, in contrast to liquidity ratios, assess a company’s capacity to satisfy all of its financial obligations, including long-term debts. Liquidity focuses on current or short-term financial accounts, whereas solvency refers to a company’s overall capacity to satisfy debt commitments and maintain its operations.

To be solvent, a business must have more total assets than total liabilities; to be liquid, it must have more current assets than current liabilities. Liquidity ratios provide an early assessment of a company’s solvency, despite the fact that solvency is not directly related to liquidity.

Divide a company’s net income and depreciation by its short- and long-term obligations to get the solvency ratio. This determines if a company’s net income is sufficient to cover all of its liabilities. A corporation with a greater solvency ratio is generally thought to be a better investment.

Solved Example on Liquidity Ratios

1. Calculate the different liquidity ratios from the following particulars

1. Current Ratio= Current Assets/ Current Liabilities

Current Assets = Sundry Debtors + Inventories + Cash-in-hand + Bills Receivable

Current Liabilities = Creditors + Bank Overdraft

Current Assets= 300,000 + 150,000+ 50,000+ 30,000= 530,000

Current Liabilities = 350,000+ 30,000= 380,000

Current Ratio= 530,000 / 400,000= 1.3 :1

2. Quick Ratio or Acid Test Ratio= Quick Assets / Current Liabilities

Quick Assets = Current Assets – Inventories

Quick Assets= 530,000 – 150,000= 380,000

Quick Ratio or Acid Test Ratio= 380,000 / 380,000 = 1:1

3. Cash Ratio = Cash Balance / Current Liabilities

Cash Ratio = 50,000 / 380,000= 0.13:1

4. Net Working Capital Ratio = Current Assets – Current Liabilities (exclude short-term bank borrowing)

Net Working Capital Ratio = 530,000- 350,000= 180,000