Special type of Accounting (B.Com Hons) Notes || Unit 3 || Sem - 1 Delhi University

Unit-3 : Special types of Accounting (Sem-1) Notes Delhi University
Hire Purchase Accounting

1. Introduction to Hire Purchase Accounting

Hire purchase is a financial arrangement where a buyer acquires goods by paying an initial deposit and the remaining balance in installments. The key feature of this system is that ownership of the asset is transferred only after the final payment is made. Until then, the seller retains ownership, and the buyer has possession and usage rights.

1.1 Key Features of Hire Purchase System

  • Legal Ownership: The seller retains ownership until the full payment is made.
  • Down Payment: The buyer makes an initial deposit (down payment) at the time of purchase.
  • Installments: The remaining amount is paid over a period of time in fixed installments.
  • Interest Component: Each installment consists of a principal and interest component.
  • Default & Repossession: If the buyer defaults, the seller can repossess the goods either partially or fully.

2. Calculation of Interest in Hire Purchase Accounting

Interest is a crucial element in hire purchase transactions. It is calculated on the outstanding balance of the cash price over the period of the agreement. There are two methods for computing interest:

2.1 Flat Rate Method

  • Interest is calculated on the original cost of the asset for the entire duration of the hire purchase agreement.
  • Formula:
    \text{Total Interest} = \text{Cash Price} \times \text{Rate of Interest} \times \text{Time (Years)}
  Total Interest=Cash Price×Rate of Interest×Time (Years)
  • Each installment consists of an equal amount of interest.
  • This method is simple but does not reflect the declining principal balance.

2.2 Reducing Balance Method

  • Interest is charged on the outstanding balance of the cash price after each installment.
  • Formula:     Interest for the Period=Outstanding Balance×Rate of Interest
  • This method is widely used as it accurately reflects the interest burden over time.

Example: Interest Calculation

Assume a machine is purchased under a hire purchase agreement:

  • Cash Price: ₹1,00,000
  • Interest Rate: 10% p.a.
  • Installments: 4 years

Flat Rate Method:
Total Interest = ₹1,00,000 × 10% × 4 = ₹40,000
Total Payment = ₹1,00,000 + ₹40,000 = ₹1,40,000
Annual Installment = ₹1,40,000 ÷ 4 = ₹35,000

Reducing Balance Method:
Interest is calculated on the outstanding balance, and it decreases each year.

3. Accounting Treatment for Hire Purchase Transactions

Hire purchase transactions are recorded in the books of both the buyer and the seller.

3.1 Accounting in the Books of the Buyer

The buyer records the transaction in one of two ways:

  1. Asset Accrual Method (Hire Purchase System): The asset is recorded in full at the time of purchase, and liability is created for the unpaid amount.
  2. Expense Recognition Method (Revenue Method): Installments paid are treated as expenses instead of recording an asset.

Journal Entries:

  1. At the time of purchase:

    • Asset Account Dr. (Cash Price)
    • To Hire Vendor Account (Liability Created)

  2. At the time of installment payment:

    • Hire Vendor Account Dr. (Installment Amount)
    • To Bank Account (Cash Paid)

  3. At the time of interest adjustment:

    • Interest Expense Account Dr.
    • To Hire Vendor Account

  4. At the time of final payment:

    • Hire Vendor Account Dr. (Final Payment)
    • To Bank Account

3.2 Accounting in the Books of the Seller

The seller records hire purchase transactions using one of two approaches:

  1. Sales Method: Sales are recorded at the full price, and interest is recognized over time.
  2. Hire Purchase Stock & Debtors System: This system helps track goods sold on hire purchase.

Journal Entries:

  1. At the time of sale:

    • Hire Purchase Debtor Account Dr. (Total Hire Purchase Price)
    • To Sales Account (Cash Price)
    • To Interest Suspense Account (Total Interest)

  2. At the time of installment receipt:

    • Bank Account Dr.
    • To Hire Purchase Debtor Account

4. Repossession of Goods (Partial and Full Repossession)

If the buyer fails to pay installments, the seller has the right to repossess the goods. Repossession can be:

4.1 Partial Repossession

  • The seller takes back only a part of the goods sold under hire purchase.
  • Accounting Treatment:
    • Goods Repossessed Account is debited with the value of the repossessed goods.
    • Any difference in the asset’s book value and the repossessed value is recorded as profit or loss.

4.2 Full Repossession

  • The seller takes back the entire asset.
  • The buyer’s liability is canceled, and the repossessed goods are recorded at their fair value.
  • If the repossessed goods are sold later, any profit/loss is recorded in the books of the seller.

5. Profit Computation: Stock and Debtors System

This system is widely used in hire purchase transactions where multiple assets are sold on credit.

5.1 Key Accounts Maintained

  1. Hire Purchase Stock Account: Maintains details of goods sold on hire purchase at selling price.
  2. Hire Purchase Debtors Account: Tracks payments due from buyers.
  3. Hire Purchase Adjustment Account: Records profit or loss from hire purchase transactions.

5.2 Steps for Profit Computation

  1. At the time of Sale:

    • Debit Hire Purchase Debtors Account (Hire Purchase Price)
    • Credit Hire Purchase Stock Account (Selling Price)

  2. At the time of Installment Payment:

    • Debit Bank Account
    • Credit Hire Purchase Debtors Account

  3. At the end of the Accounting Period:

    • Compute closing balance of Hire Purchase Debtors
    • Adjust interest earned in the Hire Purchase Adjustment Account

  4. Profit Calculation:

    • Profit = Selling Price – Cost Price

6. Relevant Accounting Standards for Hire Purchase Accounting

6.1 AS 19: Leases

  • Governs accounting for lease transactions, which are similar to hire purchase.
  • Requires disclosure of future installment payments and interest costs.

6.2 AS 9: Revenue Recognition

  • Revenue from hire purchase sales is recognized when ownership transfers or substantial risks/rewards are passed.

6.3 IFRS 16: Leases (International Standards)

  • Recognizes lease/hire purchase liabilities in the balance sheet.
Accounting for Leases

1. Introduction to Leasing

Leasing is a contractual agreement where one party, the lessor (owner of the asset), grants the other party, the lessee (user of the asset), the right to use an asset for a specified period in exchange for periodic payments. Leases help businesses acquire expensive assets without making an outright purchase, allowing them to use the asset while spreading costs over time.

Key benefits of leasing include:

  • Lower capital outlay – No large upfront investment is required.
  • Flexibility – Businesses can use assets without committing to ownership.
  • Tax benefits – Lease payments are often tax-deductible.
  • Conservation of working capital – Companies can invest funds elsewhere instead of purchasing assets.

2. Classification of Leases

Leases are categorized based on the extent of risk and reward transfer from the lessor to the lessee. The major classifications are finance leases and operating leases.

2.1 Finance Lease (Capital Lease)

A finance lease is one where the lessee substantially assumes all risks and rewards of ownership of the asset, even if legal ownership remains with the lessor.

Key Characteristics of a Finance Lease:

  1. Transfer of ownership – The lease agreement may specify that ownership is transferred to the lessee at the end of the lease term.
  2. Bargain purchase option – The lessee may have an option to purchase the asset at a price significantly lower than its fair value.
  3. Lease term covers most of the asset’s useful life – If the lease period is 75% or more of the asset’s useful life, it is a finance lease.
  4. Present value of lease payments – If the present value of lease payments equals 90% or more of the asset’s fair value, it is classified as a finance lease.
  5. Specialized asset – If the asset is so specific that it has no alternative use except for the lessee, it is considered a finance lease.

Accounting Treatment for Finance Leases (Lessee’s Books):

  1. Initial Recognition
    • The asset is recorded as a right-of-use asset and a lease liability is created at the present value of lease payments.
    • The lease liability is split into principal and interest components.
  2. Depreciation
    • The leased asset is depreciated over its useful life or lease term, whichever is shorter.
  3. Lease Payments
    • Part of the payment reduces the liability, and part is recorded as an interest expense.

Accounting Treatment for Finance Leases (Lessor’s Books):

  1. Initial Recognition
    • The leased asset is derecognized from the lessor’s books, and a lease receivable is recorded.
  2. Income Recognition
    • Lease payments received are split into principal repayment and interest income.

2.2 Operating Lease

An operating lease is any lease that does not meet the criteria of a finance lease. The lessor retains the risks and rewards of ownership, and the lessee only pays for the right to use the asset.

Key Characteristics of an Operating Lease:

  1. No transfer of ownership at the end of the lease term.
  2. No bargain purchase option for the lessee.
  3. Short lease term compared to the asset’s useful life.
  4. Asset remains on the lessor’s balance sheet.

Accounting Treatment for Operating Leases (Lessee’s Books):

  1. Lease payments are recorded as an expense in the income statement on a straight-line basis.
  2. No asset or liability is recorded on the balance sheet.

Accounting Treatment for Operating Leases (Lessor’s Books):

  1. The asset remains on the lessor’s balance sheet.
  2. Lease payments received are recognized as rental income in the income statement.

3. Journal Entries for Leases

3.1 Finance Lease (Lessee’s Books)

At the beginning of the lease:

1. Recognizing the leased asset and lease liability:
        Right-of-Use Asset A/c  Dr.    ₹XXXX  
             To Lease Liability A/c        ₹XXXX  

2. Lease Payment (At Year-End)
        Lease Liability A/c     Dr.    ₹XXXX  
        Interest Expense A/c    Dr.    ₹XXXX  
               To Cash/Bank          ₹XXXX  

3. Depreciation on the leased asset
        Depreciation A/c        Dr.    ₹XXXX  
             To Accumulated Depreciation A/c  ₹XXXX 
 
3.2 Operating Lease (Lessee’s Books)
1. Lease payment recorded as an expense:
         Lease Rent Expense A/c  Dr.    ₹XXXX  
               To Cash/Bank A/c      ₹XXXX  

4. Practical Problems on Leases

Problem 1: Finance Lease Accounting

Scenario:
On April 1, 2024, XYZ Ltd. leases machinery from ABC Ltd. for 5 years with annual payments of ₹2,00,000. The implicit interest rate is 10%, and the fair value of the machine is ₹8,00,000. The lease contract states that ownership will transfer to the lessee at the end of the lease.

Solution:

  1. Classification of Lease:

    • The lease term is 5 years, and the asset's useful life is also 5 years, meaning the lessee will use the asset for its entire life.
    • The ownership transfers at the end of the lease.
    • Hence, this is a finance lease.

  2. Journal Entries (Lessee’s Books):
    April 1, 2024: Recognition of Right-of-Use Asset and Lease Liability

            Right-of-Use Asset A/c  Dr.    ₹8,00,000  
                  To Lease Liability A/c        ₹8,00,000  

April 1, 2024: First Lease Payment (Reduces Liability)

            Lease Liability A/c     Dr.    ₹2,00,000  
                  To Cash/Bank A/c      ₹2,00,000  

March 31, 2025: Interest Expense and Lease Liability Adjustment

Interest Expense A/c    Dr.    ₹60,000 (10% of ₹6,00,000)  
Lease Liability A/c     Dr.    ₹1,40,000  
  To Cash/Bank A/c      ₹2,00,000  


March 31, 2025: Depreciation on Right-of-Use Asset
 Depreciation A/c        Dr.    ₹1,60,000 (₹8,00,000 ÷ 5 years)  
     To Accumulated Depreciation A/c  ₹1,60,000  

Problem 2: Operating Lease Accounting

Scenario:
ABC Ltd. leases office space for 3 years, with an annual rental of ₹5,00,000.

Solution:
Lessee’s Journal Entry for Lease Payment:

Lease Rent Expense A/c  Dr.    ₹5,00,000  
  To Cash/Bank A/c      ₹5,00,000
Accounting for Branches :

1. Introduction to Branch Accounting

In a business structure where operations are spread across multiple locations, branch accounting is essential for tracking financial activities separately for each branch. This enables the head office (HO) to monitor the performance of each unit efficiently.

1.1 Meaning of Branch Accounting

Branch accounting is a system of maintaining accounts separately for different branches of an organization. It helps in determining the branch’s profitability and controlling operations.

1.2 Objectives of Branch Accounting

  • Performance Evaluation: To assess the profitability and efficiency of individual branches.
  • Control and Supervision: To ensure better control over the branch’s activities.
  • Legal Compliance: To maintain records in accordance with legal requirements.
  • Financial Reporting: To facilitate consolidated financial statements.

2. Classification of Branches

Branches can be categorized based on their level of independence in maintaining records and financial transactions.

2.1 Dependent Branches

Dependent branches do not maintain complete financial records. Instead, the HO records all transactions related to the branch. These branches typically send periodic reports to the HO.

Examples: Retail chains, departmental stores, and franchise stores.

2.2 Independent Branches

Independent branches maintain their own financial records and prepare financial statements. They operate autonomously and remit profits to the HO.

Examples: Large businesses with multiple locations, such as multinational corporations.

3. Accounting for Dependent Branches

For dependent branches, the HO maintains accounts using two primary systems:

3.1 Debtors System (Synthetic Method)

This is the simplest method used for small branches. Here, a single Branch Account is maintained at the HO, summarizing all transactions. It functions like a debtor's account where the branch is treated as a separate entity.

3.1.1 Features of the Debtors System:

  • Suitable for small branches.
  • The HO records all transactions.
  • The branch only maintains cash and stock records.
  • The closing balance of the Branch Account represents branch profit or loss.

3.1.2 Journal Entries under the Debtors System

  1. Goods Sent to Branch:

    • Debit: Branch Account
    • Credit: Goods Sent to Branch Account

  2. Cash Remitted by Branch to HO:

    • Debit: Cash/Bank
    • Credit: Branch Account

  3. Branch Expenses Paid by HO:

    • Debit: Branch Account
    • Credit: Cash/Bank

  4. Closing Stock at Branch:

    • Debit: Branch Stock Account
    • Credit: Branch Account

  5. Branch Profit Transferred to P&L Account:

    • Debit: Branch Account
    • Credit: Profit & Loss Account

3.2 Stock and Debtors System (Analytical Method)

This system is used for branches with more transactions, particularly those involving credit sales. It provides a more detailed view of the branch’s financial position by maintaining separate accounts.

3.2.1 Features of the Stock and Debtors System:

  • Provides a more detailed analysis of branch activities.
  • Suitable for branches dealing in credit sales.
  • Maintains multiple accounts for stock, debtors, and expenses.

3.2.2 Accounts Maintained Under the Stock and Debtors System:

  1. Branch Stock Account: Tracks stock sent to the branch and sales made.
  2. Branch Debtors Account: Records credit sales and collections.
  3. Branch Expenses Account: Maintains records of branch expenses.
  4. Branch Cash Account: Keeps track of cash sales and receipts.

3.2.3 Journal Entries under the Stock and Debtors System

  1. Goods Sent to Branch:

    • Debit: Branch Stock Account
    • Credit: Goods Sent to Branch Account

  2. Cash Sales at Branch:

    • Debit: Branch Cash Account
    • Credit: Branch Stock Account

  3. Credit Sales by Branch:

    • Debit: Branch Debtors Account
    • Credit: Branch Stock Account

  4. Cash Collected from Debtors:

    • Debit: Cash/Bank
    • Credit: Branch Debtors Account

  5. Expenses Incurred by Branch:

    • Debit: Branch Expenses Account
    • Credit: Cash/Bank

  6. Profit Transfer to HO’s Profit and Loss Account:

    • Debit: Branch Adjustment Account
    • Credit: Profit & Loss Account

4. Accounting for Independent Branches

Independent branches maintain their own books of accounts and prepare financial statements. However, periodic consolidation with the HO is required.

4.1 Features of Independent Branches:

  • Maintain their own financial records.
  • Prepare independent trial balance and financial statements.
  • Remit a portion of profits to the HO.

4.2 Methods of Accounting for Independent Branches:

4.2.1 Direct Method

The branch submits trial balances to the HO, which consolidates them into the final accounts.

4.2.2 Memorandum Trading and P&L Method

A separate Trading and Profit & Loss Account is prepared for the branch.

5. Key Differences Between Dependent and Independent Branches

FeatureDependent BranchIndependent Branch
AutonomyLimitedHigh
Record KeepingHO maintains accountsBranch maintains accounts
Financial StatementsPrepared by HOPrepared by the branch
SuitabilitySmall branchesLarge branches

6. Advantages and Disadvantages of Branch Accounting

6.1 Advantages:

✔ Helps in performance evaluation of branches.
✔ Facilitates better control and fraud detection.
✔ Helps in tax compliance and financial reporting.
✔ Aids in decision-making for expansion and cost control.

6.2 Disadvantages:

❌ Increases accounting complexity.
❌ Requires additional administrative effort.
❌ Can lead to mismanagement if not properly monitored.

Departmental Accounting

1. Introduction to Departmental Accounting

1.1 Meaning and Concept of Departmental Accounting

Departmental accounting is a system of accounting in which the financial transactions of various departments within an organization are recorded separately. This enables businesses to determine the profitability of each department, control expenses, and allocate resources efficiently. It is widely used in multi-departmental organizations such as retail chains, hotels, and manufacturing companies with multiple production units.

1.2 Objectives of Departmental Accounting

The main objectives of departmental accounting include:

  1. Assessment of Departmental Performance – To analyze the revenue, costs, and profitability of each department separately.
  2. Cost Control – To monitor departmental expenses and reduce unnecessary costs.
  3. Resource Allocation – To allocate funds and resources efficiently among various departments.
  4. Comparative Analysis – To compare the performance of different departments within the same organization.
  5. Profitability Analysis – To determine which departments contribute the most to the organization’s overall profit.
  6. Decision-Making – To assist management in making strategic decisions about departmental operations.

2. Types of Departments in Departmental Accounting

Departments can be classified into two broad categories:

2.1 Revenue-Generating Departments

These departments directly contribute to the organization’s revenue. Examples include:

  • Sales Department – Responsible for selling goods and services.
  • Production Department – Engaged in manufacturing products for sale.
  • Retail Outlets – If a company operates multiple stores, each store is treated as a department.

2.2 Service or Support Departments

These departments do not generate direct revenue but provide essential services to revenue-generating departments. Examples include:

  • Human Resource Department – Manages employee relations and recruitment.
  • Accounts and Finance Department – Handles financial transactions and reporting.
  • Administration Department – Oversees organizational policies and general administration.
  • Maintenance Department – Ensures the upkeep of equipment and facilities.

3. Basis of Allocation of Departmental Expenses

Expenses in a multi-departmental organization need to be allocated systematically to determine the true financial performance of each department. Expenses can be classified as direct or indirect:

3.1 Direct Expenses

These are expenses that can be directly attributed to a specific department without the need for apportionment. Examples include:

  • Salaries of department-specific employees
  • Cost of materials used exclusively by a particular department
  • Rent for premises occupied by a single department
  • Depreciation of department-specific machinery

3.2 Indirect Expenses

Indirect expenses benefit multiple departments and must be allocated based on a logical basis. Some common allocation methods include:

ExpenseBasis of Allocation
RentFloor space occupied by each department
ElectricityElectricity meter reading or floor space
Depreciation of General AssetsValue of assets used by each department
Advertising ExpensesSales revenue of each department
General Administrative ExpensesNumber of employees in each department

Proper allocation ensures accurate profitability calculations and cost control for each department.

4. Methods of Departmental Accounting

Various methods are used to maintain departmental accounts, depending on the size and complexity of the organization.

4.1 Separate Books for Each Department

  • Each department maintains its own set of accounting records.
  • Separate financial statements are prepared for each department.
  • Suitable for large organizations with semi-autonomous departments.

Advantages:

  • Detailed financial data for individual departments.
  • Easier identification of profitable and non-profitable departments.
  • Greater accountability within departments.

Disadvantages:

  • High administrative costs due to multiple record-keeping systems.
  • Complex consolidation of financial data.

4.2 Columnar Books (Single Book System)

  • A single set of accounting records is maintained, with separate columns for each department in the ledger accounts.
  • Suitable for small to medium-sized organizations.

Advantages:

  • Simpler and cost-effective.
  • Reduces duplication of records.

Disadvantages:

  • Less detailed compared to maintaining separate books.
  • Difficult to segregate shared expenses in some cases.

5. Preparation of Departmental Trading and Profit & Loss Account

The departmental Trading and Profit & Loss Account is prepared to determine the gross and net profit for each department.

5.1 Departmental Trading Account

This account records sales, purchases, opening and closing stock, and direct expenses for each department.

Format of Departmental Trading Account:

ParticularsDept A (₹)Dept B (₹)Dept C (₹)Total (₹)
Opening StockXXXXXXXXXXXXXXXX
Add: PurchasesXXXXXXXXXXXXXXXX
Less: Closing StockXXXXXXXXXXXXXXXX
Cost of Goods SoldXXXXXXXXXXXXXXXX
Add: Gross ProfitXXXXXXXXXXXXXXXX
Total Sales RevenueXXXXXXXXXXXXXXXX

5.2 Departmental Profit & Loss Account

This account includes indirect expenses allocated to each department to determine the net profit.

Format of Departmental Profit & Loss Account:

ParticularsDept A (₹)Dept B (₹)Dept C (₹)Total (₹)
Gross Profit (from Trading A/c)XXXXXXXXXXXXXXXX
Less: Indirect ExpensesXXXXXXXXXXXXXXXX
Net ProfitXXXXXXXXXXXXXXXX

6. Relevant Accounting Standards

In India, departmental accounting is influenced by various accounting standards prescribed by the Institute of Chartered Accountants of India (ICAI).

6.1 Accounting Standard (AS) 17: Segment Reporting

AS 17 requires organizations to report financial performance for different business segments separately. It is highly relevant for departmental accounting as it:

  • Defines business segments based on products, services, or geographical regions.
  • Mandates disclosure of revenue, expenses, and profits for each segment.
  • Helps in understanding departmental financial performance.

7. Advantages and Disadvantages of Departmental Accounting

7.1 Advantages

✔ Provides insights into the profitability of each department.
✔ Helps management make better financial and operational decisions.
✔ Facilitates performance comparison between departments.
✔ Enables efficient cost control and resource allocation.

7.2 Disadvantages

✖ Complexity in allocating indirect expenses fairly.
✖ Increases record-keeping and administrative workload.
✖ Risk of financial misrepresentation if allocation bases are not chosen correctly.