DEPARTMENT OF COMMERCE

RAJAGIRI COLLEGE
CHAPTER – 1
FINAL ACCOUNTS OF INSURANCE
COMPANY

1. What do you mean by the term Insurance?

Insurance is a form of contract or agreement under which one party agrees in return of
a consideration to pay an agreed amount of money to another party to make good for a loss,
damage, injury to something of value in which the insured has a pecuniary interest as a result
of some uncertain event.
In short the term insurance means a protection against risk of loss.

2. What do you mean by the term Insurer and the Insured?

The company or corporation which insures or provides assurance of life or property is
known as Insurer (Insurance Company). The person whose risk is covered is called the
insured (Individual or firm)

3. What is a “Policy”?
When an agreement or contract of insurance is put in writing it is known as a policy.

4. What is “Premium”?
The consideration in return for which the insurer agrees to make good the loss is
known as Premium. In case of Life insurance, the premium received is to be shown under two
sub-headings in the Revenue account- First Year Premium and Renewal premium.
In short premium is the consideration received from the insured by the insurance co;
as per the contract of insurance. It is the main source of income for a life insurance co; &
shown under schedule 1.

5. What do you mean by ‘Single Premium’ and ‘Renewal Premium’?

In case of a policy holder pays the entire premium in a lump-sum it is referred to as
‘single premium’. Renewal premiums are the premiums paid by the policy holder in
installments during later years.

6. What are the different types of General Insurance?

Insurance such as marine insurance, accident insurance, burglary, fidelity, third party,
workmen’s compensation, consequential loss etc..are the different types of General
Insurance. Under this type of insurance the insurer undertakes to indemnify the loss suffered
by the insured on happening of a certain event in the event in consideration for a fixed
premium.

7. Write a short note on IRDA?

IRDA means “Insurance Regulatory and Development Authority of India”. In order to
regulate the insurance business, the Government set up in 1996, the ‘Insurance Regulatory
Authority (IRA)’. Now this authority is known as the Insurance Regulatory Authority. In
2002 the authority came with regulations for the preparation of the financial statement of
insurance companies.
8. What do you mean by “Claim”?
The amount payable either on maturity of the policy or on death of the insured in
discharge of Life Insurance contract is called claims. It includes claims by death or claims by
maturity from which reinsurance claims is deducted or net amount is shown under Schedule 4
“Benefits Paid”.

9. What do you mean by Annuity?

It is an annual payment which a life insurance company guarantees to pay for lump-
sum money received in the beginning. It is an expense and shown under Schedule 4 “Benefits
Paid”.

10. What do you mean by ‘Consideration for Annuities Granted’?

Any lump-sum payment received by the insurance company in lieu of granting
annuity is called “consideration for annuities granted”. It is shown as an income and included
in the head “Other Income”.

11. What are the different types of insurance?

From the accounting point of view, insurance may be divided into two types, they are;
a) Life Insurance:
Under this type of insurance the corporation guarantees to pay a certain sum
of money to the policy holder on reaching a certain age or on his death or maturity which
ever is earlier. Life Insurance has both the element of protection and investment.
b) General Insurance:
It includes all other types of insurance except life insurance as fire, accident,
marine, etc…

12. What are the different methods of maintenance of books of Insurance Companies?
For maintaining accounts, two types of books are kept;
1) Statutory Books: The following books are maintained by all insurance offices;
a) Register of Policies:
This register will contain, the particulars in respect of each policy issued by
the insure such as the name and address of the policy holder, the date when the policy was
effected and record of the assignment of policy, if any etc…
b) Register of Claims:
It contains the particulars of each claim such as date of claim, name and
address of claimants, the date on which the claim was discharged, date and ground for
rejection, in case the claim is rejected etc…
c) The Register of Licensed Insurance Agents:
It contains the particulars of various insurance agents, their names, addresses,
particulars of business done and commission due to them etc…
2) Subsidiary Books:
It contains First year’s premium cash book, Renewal premium cash book,
Agency and branch cash book, petty cash book, claims cash book, Bank cash book,
commission register, lapsed and cancelled policies book, journal, Agency ledger, policy loan
ledger, General loan ledger etc…

13. What do you mean by “Surrender”?

In case a policy holder is not in a position to pay the future premiums on his policy,
he may surrender his rights under the life insurance policy to the life insurance corporation.
The corporation will pay him the surrender value of the policy as per the rules of the
corporation. The amount so paid appears as an expense under the head “Benefits Paid”,
Schedule 4, in the Revenue Account.

14. What is “Direct Commission”?

The insurance companies pay commission to their agents who bring business to them.
Such commission paid by the insurance company to its agents directly for acquiring business
is termed as “Direct Commission”.

15. What is “Re-Insurance”?

In order to reduce the risk of an insurance company which accepts a business of more
value, the company may transfer some portion of the business received to another insurance
company, which is termed as ‘Re-insurance’.
Thus, the premium received from such a business will have to be given by the original
insurer to the reinsurer which is termed as “Premium on Reinsurance Ceded”. It is an item
of expense and deducted from the premium income.
Similarly “Premium on Re-insurance Accepted” or received is an income and
added to premium.

16. What is Commission on Re-insurance Accepted & Commission on Re-insurance

Ceded?
The insurance companies pay commission to those insurers who have given them
business through reinsurance. Commission paid to such insurers is termed as ‘commission on
reinsurance accepted’. It is an item of expense for the company paying the commission. It is
added to the commission under ‘schedule 2’.
Similarly “commission on reinsurance ceded” is an income and hence deducted form
commission income.

17. What do you mean by ‘Bonus’, what are the different types of bonus?
It is the share of profit which a policy holder gets from the life insurance company. As
per rules 95% of the profit earned should be distributed as bonus to policy holders. The
different types of bonus are;
a) Bonus in Cash:
This is the amount of bonus paid in cash. It is an expense which is debited to
revenue A/C.
b) Bonus in Reduction of Premium:
Instead of paying bonus in cash the company may deduct the amount from the
premium payable by the policy holder. While preparing Revenue Account, if bonus in
reduction of premium is required to be adjusted, the amount should be debited to revenue
account and the same is added to the premium to be shown on the credit side.
c) Reversionary Bonus:
If the portion of profit payable as a bonus to the policy holders on maturity of
the policy, it is paid along with the policy amount. It is an item of expense.

18. What are the different types of Insurance Policies?

a) Endowment Policy:
It is a policy which matures on the policy holder, reaching a certain age or on his
death, which ever is earlier.
b) With Profit Policy:
A policy which entitles the policy holder, in addition to guaranteed sum payable
on maturity, a share in the profit made by the life insurance corporation.
c) Without Profit Policy:
A policy which entitles the policy holder to get only a fixed sum on maturity of
the policy is known as without profit policy.
d) Whole Life Policy:
It is a policy which matures only on the death of the insured.

19. What do you mean by surrender value?

It is the present cash value of the policy which a policy holder gets from the
corporation on surrendering all the rights of the policy, if the holder is unable to pay the
further premium. The amount paid as surrender value is an item of expenditure and is shown
under the head “Benefits paid” Schedule 4.

20. What is Life Insurance Fund?

This represents the excess of revenue receipts over revenue expenditure relating to life
business. The fund is available to meet the aggregate liability on all policies outstanding.
Revenue Account is prepared every year to ascertain the balance of Life Insurance Fund at
the end of the financial year. In preparation of revenue account opening balance of the life
insurance fund will be the starting point.

21. What is Revenue Account of Insurance Company?

It is an account which is prepared in Form-A of the First Schedule of the Insurance
Act, 1938. The object of preparing the revenue account is to find out the life insurance fund.
The revenue account is prepared on mercantile basis. This account does not disclose profit.

22. What do you mean by Net Liability?

On a particular date liability of the life insurance corporation is to be calculated as the
premiums to be received in future will generally be less than the amount payable as claims.
There is a gap between claims which are expected to arise and premiums which are expected
to be received. This gap is termed as ‘Net Liability’.

23. What is a Valuation Balance Sheet?

For the purpose of ascertaining profit the insurance company should calculate its net
liability on all outstanding policies. The net liability is compared with life insurance fund on a
particular date for calculating surplus or deficiency. This comparison is made by preparing a
Valuation Balance Sheet.

24. What is Actuaries?

For the purpose of ascertaining profit the insurance company should calculate its net
liability on all outstanding policies. This calculation is done by experts who are known as
Actuaries.

25. What are the steps for ascertaining profit of the Life Insurance Business?

a) Surplus is ascertained by preparing a Valuation Balance Sheet.

b) Add: Interim Bonus Paid, if any;
c) Less: Expenses outstanding
The resulting figure will be the true profit of the insurance company.
26. What is Actuarial Valuation?
The Life Insurance Corporation of India makes the valuation of its net liability every
year in order to ascertain its profits. This is done by a person known as actuary (i.e. a person
who is well versed in the intricacies of life insurance). The process by which net liability is
ascertained by an actuary is called actuarial valuation.

27. What do you mean by Reserve for Unexpired Risk?

Generally, general insurance policies are issued for a short period. The policies are
issued at any date of the year. As a result, many of them may be unexpired at the end of the
year. Therefore the entire premium so received cannot be treated as an income for the current
year only. A portion of that amount should be carried forward to the next year in order to
cover the unexpired risks. This is known as reserve for unexpired risks.
In case of Fire & Accident the reserve for unexpired risk is 50% of the net premium
and in case of marine insurance it is 100% of the net premium.
28. What is Additional Reserve?
Sometimes the company may maintain more reserves for unexpired risks than the
prescribed level. This is called Additional Reserve.

29. State the difference between Life Insurance and General Insurance:

LIFE INSURANCE GENERAL INSURANCE

1. Life insurance is carried on by Life General Insurance business is carried on by
Insurance Corporation of India. General Insurance Corporation of India.

2. It includes only the life Assurance It includes all other types of business such as
Business. fire insurance, marine insurance, accident
insurance, burglary insurance fidelity and third
party insurance.

3. The corporation guarantees to pay a The insurer undertakes to indemnify the loss
certain sum of money to the policy suffered by the insured on the happening of a
holder on reaching a certain age or death certain event in consideration for a fixed
which ever is less. premium.

4. Life Insurance policy is taken for a long General Insurance is taken for a short period,
period of time, say 10 , 15 of 20 years. one year.

5. Revenue account is prepared to ascertain Revenue account is prepared to find out profit
the life insurance fund at the end of the or loss.
period.

6. Revenue account is prepared in Form A Revenue account is prepared in form B.

7. It is a contract of guarantee. It is a contract of indemnity.

 8. Premium is payable monthly, quarterly, Premium is payable annually.
half yearly or annually

9. Premium is fixed on the basis of age & Premium is based on the degree of risk of loss
health of the insured. involved.

10.Double insurance is common. Double insurance is not common, reinsurance

is common.

30. What is Double Insurance?

When the same subject matter is insured with two or more insurers to cover the same
risk, it is called ‘Double Insurance’. It is a case of over insurance. For example a person
insures his house for Rs 100,000 with two companies. But in the event of total loss the
insured will not get the total amount from both the insurance company, he will only get the
actual amount of loss sustained by him, i.e., each insurance company will contribute only
proportionate amount of actual loss.

31. Explain the difference between Double Insurance and Re-Insurance?

DOUBLE INSURANCE RE-INSURANCE

1. The same subject matter is insured with The insured insures the subject matter only
two with one insurer and the insurer, in turn
or more insurers to cover the same risk. reinsures the whole or part of the risk with
another insurer.

2. Contract between the original insured Contract between two or more insurance
and companies.
other insurance companies.
Device of redistribution of risk among the
3. There is no redistribution or transfer or insurance companies.
risks
already insured. Common in all types of insurance
(particularly in general insurance)
4. Common in life insurance.
The insured will have rights only against
the original insurer. He has no connection
5. The insured will have different and with the reinsurers.
separate
rights in relation to all insurers
 CHAPTER – 2
FINAL ACCOUNTS OF BANKING
COMPANIES

1. What do you mean by Banking?

Banking means the accepting, for the purpose of lending or investment, of deposits of
money from the public repayable on demand or otherwise and withdrawable by cheque, draft,
order or otherwise.

2. What are the features of Bank’s accounting system?

a) Entries in the personal ledgers are made directly from the vouchers.
b) From such entries in the personal ledgers each day summary sheets in total are
prepared which are posted to the control accounts in the general ledger.
c) The general ledger trial balance is extracted and agreed everyday.
d) All the entries in the personal ledgers and summary sheets are checked by persons
other than those who made the entries with the result that most clerical mistakes are detected
before another day begins.
e) A trial balance of detailed personal ledgers is prepared periodically(generally after
two weeks)and get agreed with the general ledger control accounts.
f) Two vouchers are prepared for every transaction not involving cash-one debit
voucher and another credit voucher.

3. Which are the principle books of accounts maintained by the Banking Companies?
The principle books of accounts kept are;
a) Cash Book:
This book gives the summary of the Receiving Cashier’s Counter Cash Book
and Paying
Cashiers Counter Cash Book.
b) General Ledger:
This ledger contains control accounts for the subsidiary ledger listed above and
accounts of expensed and assets not covered by the subsidiary ledgers.
c) Registers and Memorandum:
The following are the chief registers and memorandum books kept by a bank;
1) Demand Draft, 2) Bills for Collection Register, 3) Share Security Register, 4)
Safe Custody Register, 5) Jewellery, 6) Letter of Credit Register, 7) Safe Deposit Vault
Register, 8) Standing Order Register.

4. What do you mean by Slip System of Posting? (2002, 05, 07 B.com)

It is a method of rapid posting of books of accounts kept on double entry system. In
this system, posting is made from slips prepared inside the organisation itself or from slips
filled in by its customers. So entries are not made in the books or original entry or subsidiary
book. But posting of entries is done by slips. These slips serve as en evidence for the entry in
the ledgers.

5. What do you mean by Cash Credit?

It is an arrangement by which the customer is granted the right to borrow money from
time to time up to a certain limit. Cash Credit is usually given on hypothecation or pledge of
stock. The bank usually charges a high rate of interest on the actual amount withdrawn than
that charged on a loan.
6. Explain the Advantages and Disadvantages of Slip System of Posting?
Advantages:
a) It saves a lot of time since the slips are prepared by the customers themselves.
b) Subsidiary books are avoided as posting is done from slips.
c) It provides a good system of internal check.
d) It reduces the possibility of errors and frauds.
e) Entries can be recorded with minimum delay as slips can easily pass from hand to
hand among clerks concerned.
Disadvantages:
a) Slips may be lost, destroyed or misappropriated as these are loose.
b) Books cannot be verified if subsidiary books are not kept.
c) It becomes very difficult and expensive to keep a date-wise record of a large
number of slips.
d) Many customers feel difficulty on account of the slip system.

7. What do you mean by Non-Banking Assets?

A bank cannot acquire certain assets, but it can always lend against the security of
such assets. In case of failure on the part of the loanee to repay the loans the bank may have
to take possession of such assets. These are called Non- Banking Assets. These are shown in
the balance sheet under “Other Assets” under schedule 11.

8. What do you mean by Non-Performing assets?

Non-performing assets means a credit facility in respect of which the principal
repayment installment is in arrear for more than 12 months or payment of interest installment
is in arrear for more than 6 months beyond the due date. Further, if one of the accounts of a
borrower comes under the category of non-performing assets, all the accounts of that
borrower other than loans with a liability of less than Rs.
25, 000 will be treated as Non-Performing Assets.

9. When does a Non Performing Asset becomes Performing Asset?

If an account has been regularized before the balance sheet date by payment of
overdue amount through genuine sources the account need not be treated as non-performing
assets. The bank should however ensure that the account remains in order subsequently.

10. What do you mean by Over Draft?

This is a facility available to a customer who operates a current account with the bank.
In case of bank overdraft, the customer is permitted to over draw money up to a certain limit.
This facility is beneficial to the customers as he has to pay interest only upon the sum over
drawn by him and not upon the maximum limit of the overdraft.

11. What do you mean by Overdue?

Any amount due to the bank under any credit facility is overdue if it is not paid on the
due date fixed by the bank.

12. What do you mean by Statutory Liquid Ratio?

Over and above the cash reserve, every banking company is required to maintain in
India in cash, gold and unencumbered securities, and an amount which shall not be less than
25% of its time and demand liabilities in India. This is known as Statutory Liquid Ratio. The
Reserve Bank of India has the power to increase this ratio up to 40%. The current SLR is
19.5% (w.e.f 1.7.2018)

13. What do you mean by Cash Reserve?

According to section 42 of the Reserve Bank of India Act, every scheduled bank has
to maintain a sum equal to atleast 3% of its time and demand liabilities as cash reserves with
the Reserve Bank of India. The reserve Bank has the power to increase this percentage up to
15% by a notification in the Official Gazette. A non-scheduled bank has to maintain similar
balances either in cash or as deposit with the Reserve Bank.

14. Explain the Classification of Bank’s Advances?

a) STANDARD ASSETS:
Standard asset is one which does not disclose any problem and which does not
carry more than normal risk attached to the business. Such asset is considered as performing
asset.
b) SUB-STANDARD ASSETS:

Sub-standard asset is one which has been classified as a non-performing asset

for a period not exceeding 18 months. There is no promise of recovering the dues in full,
having regard to the value of security or current network of the borrower or the guarantor.

c) DOUBTFUL ASSETS:
A doubtful asset is one which has remained in sub-standard category for a period exceeding
18 months. However with effect from March 31st 2005 an asset would be classified as
doubtful if it remained in the sub-standard category for 12 months.

d) LOSS ASSETS:
A loss asset is one where loss has been identified by a bank or internal auditors
or the RB inspection but the amount but the amount has not been written off, wholly or
partly. Such asset is not realisable, although there may be some salvage or recovery value.

15. How do we make provisions against bank’s assets?

a) STANDARD ASSETS:
A general provision of minimum of 0.40% of the total standard assets should be
made as a matter of caution,
b) SUB-STANDARD ASSETS:
A general provision of 15% of the total outstanding should be made. And in case
of unsecured portion 25%
c) DOUBTFUL ASSETS:
i) In this case, if the advance is not covered by securities, 100% provision is required.
ii) In case if the advance is secured, provision is made depending on the period for which
the asset remained doubtful on the following basis.

Period for which asset have remained doubtful % of provision

Up to one year 25%
0ne to three years 40%
More than three years 100%
d) LOSS ASSETS:
In this case the entire asset is written off. If the assets are to remain in the books
for any reason, then 100% of the amount should be provided.

16. Which are the items included in provisions and contingencies?

i) Provision for bad and doubtful debts. ii) Provision for taxation iii) Provision for
diminution in the value of investments iv) transfers to contingencies and other similar items.

17. What do you mean by Rebate on Bills Discounted?

It means unearned discount for those bills that will mature after the date of closing the
accounts. Rebate on bills discounting is deducted from interest and discount earned under the
schedule 13, which is shown in the profit and loss account. It is also included in schedule 5
other liabilities, in the liability side of balance sheet.

18. What do you mean by Bills for Collection?

These are bills or drafts drawn by the seller of goods on the purchasers and sent to the
bank for collection against delivery of documents. The banks hand over the documents
authorizing the delivery of goods to the borrower only after the collection of the amount of
the bill. Some bills are left uncollected at the end of the year; they are to be shown as a foot
note of the balance sheet.

19. What do you mean by Branch Adjustments?

A bank having several branches will receive periodical statements from them
regarding the inter-branch transactions. It is possible that some entries may remain
unadjusted in the head office of the bank at the close of the financial year. Such entries are
recorded in the head under the sub-heading ‘Inter-Office Adjustment’. If inter-adjustment
Debit is given it should be shown under the head “Other Assets”, Schedule number 11 and if
it is a Credit balance it should be shown under the head “Other Liabilities” Schedule number
5.

20. What are Contingency accounts in the context of Banking Companies?

These are provisions made for meeting contingencies on various accounts such
provision for taxation which are not shown clearly in the Balance Sheet but are included in
schedule 5 to be shown Balance Sheet.

21. What is a Statutory Reserve in the context of Banking Companies?

It is compulsory for every banking company to make a transfer of 25% of the current
year profit before declaring any dividend every year to a reserve called “Statutory Reserve”.
However, if the aggregate amount is not less than the paid up capital of a company may be
exempted from this restrictions only on leave granted by the Central Government.

22. What is Money at Call and Short Notice?

This represents temporary loans to bill brokers, stock brokers and other banks. If the
loan is given for one day it is called “money at call” and if the loan cannot be called back on
demand and will require at least a three days notice for calling it back it is called “money at
short notice”. This item is included in schedule 7 of the bank balance sheet.
23. What do you mean by Discounting of Bills?
It means making the payment of the bill before the maturity date of the bill. While
making payment of the bill, the bank deducts discount for unexpired period for the amount of
the bill discounted. The bank keeps the bill with it till the maturity date and gets its payment
for the customer on the due date.
 CHAPTER – 3 & 4

AMALGAMATION, ABSORPTION &

RECONSTRUCTION OF COMPANIES

1. What do you mean by Amalgamation?

When two or more existing companies go into liquidation and a new company is
formed to take over the business of the liquidating companies, it is called amalgamation. The
new company is called the “Purchasing Company” and the companies which are
amalgamated are known as “Vendor Company”. The term Amalgamation simply means
combination of two or more companies.
E.g. A Co; and B Co; liquidates to form a new company known as AB Company
Limited
The above concept has been modified by the Accounting Standard 14.

2. What do you mean by Absorption?

The term Absorption is used when one existing company (usually bigger one) purchases
the business of another existing company (usually smaller one) which goes into liquidation. It
refers to internal reorganization of the financial structure of the company.
. E.g. A Co; absorbs B Co; [the new company will be only A Ltd]

3. What do you mean by Reconstruction of company?

Reconstruction means the reconstruction of a company’s financial structure.
Reconstruction may be external reconstruction or internal reconstruction.

4. What do you mean by Internal Reconstruction?

Internal reconstruction refers to the internal reorganization of the financial structure of a
company. It is an internal reorganization by alteration by way of reduction of share capital. In
other words, internal reconstruction means the reduction of capital to cancel any paid up
share capital which is lost or unrepresented by the available assets. This is generally resorted
to write off the past accumulated losses of the company. Under this scheme the existing
company continues in its legal entity form and can take the advantage of carry forward and
set off the past losses. E.g. ‘Share of Rs.10 reduced to Rs. 5’

5. What do you mean by External Reconstruction?

Under this an existing company is liquidated and a new company is formed in order to
take over the business of the liquidated company. External reconstruction is generally
resorted to in case of company having accumulated past losses, the book value of assets are
not shown at their true value. E.g. “India Company” goes into liquidation and a new
company is formed in the name “New India Company”

6. What is Transferor Company and Transferee Company?

The company that sells its business to another company is called the “Transferor
Company or Vendor Company”. The company that takes over or purchases the business of
the another company is called “Transferee company or Purchasing company”
7. Explain the differences between Internal Reconstruction and External
Reconstruction?

EXTERNAL RECONSTRUCTION
INTERNAL RECONSTRUCTION
1. In this case the company does not lose its In this case the company loses its identity i.e.
identity. its name and existence.

2. Here the company continues its existence. Here the company is liquidated.

3. This is generally resorted by those This is generally resorted to in case of a

companies which is being reorganized company having past accumulated losses.
internally.

4. There is no question of calculating Purchase consideration to be given by the

purchase consideration. transferee company is to be calculated.

5. Capital reduction account is opened to Realisation account is opened to ascertain the

which all reduction of capital is profit or loss to the equity share holders by the
transferred and the amount is utilized to scheme of external reconstruction.
write off accumulated losses such as
goodwill, preliminary expenses, fictitious
assets etc…

6. The debenture holders, creditors and bank These parties will have to be settled.
overdraft etc may continue.

8. What do you mean by dissenting shareholders?

Dissenting shareholders are those shareholders who do not give consent to the scheme
of amalgamation entered into by the prescribed majority of shareholders. Such shareholders
refuse to transfer their share to the transferee company.

9. What is the treatment of dissenting shareholders?

The paid up capital held by the dissenting shareholders must be transferred to a
separate shareholders account named Dissenting Shareholders Account. Any premium they
receive or discount they suffer as per the agreement must be adjusted through realisation
account and their claim is settled by paying cash.

10. What is the difference between Liabilities and Trade liabilities?

The term liabilities will mean all liabilities to third parties i.e., excluding company
and shareholders. But the term liabilities will include trade creditors and bills payable. It will
exclude other liabilities to third parties as bank overdraft, debentures, outsider’s expenses
etc...

11. What are the situations requiring the external reconstruction?

External reconstruction is generally resorted to in case of a company having
accumulated past losses and the book values of assets are not shown at their true value.
12. State the circumstances when the reduction of share capital becomes unlawful?
a) When the reduction is not sanctioned by the court.
b) When it is not mentioned in the Articles.
c) When the company does not pass an ordinary resolution at the general meeting
regarding reduction.

13. What do you mean by Purchase Consideration?

Purchase consideration is the amount paid by the transferee (Purchasing) company to
the shareholders of the transferor (Vendor) company as the price of the business or assets
taken over.
While determining the amount of purchase consideration payment made to debenture
holders should not be considered as a part of purchase consideration.

14. What are the different methods of Purchase Consideration?

a) Lump Sum Method:
When the transferee (Purchasing) company agrees to pay a fixed sum to the
transferor (Vendor) company, is called Lump Sum Method of payment of purchase
consideration. There is no need of calculating purchase consideration as it is given in the
problem.

b) Net Asset or Net worth Method:

Under this method the purchase consideration is calculated by ascertaining the
net worth of the assets taken over by the transferee company.
Net worth = Agreed value of assets taken over – Agreed value of liabilities taken
over.

c) Net payment Method:

Under this method purchase consideration is calculated by adding the various
payments in the form of shares, securities, cash etc… made by the transferee (purchasing)
company. The aggregate of the total payment made by the transferee company to the
transferor company represents the Net Payment Method.
d) Share Exchange or Intrinsic value Method:
Under this method purchase consideration is calculated on the basis of the
intrinsic value of shares. The intrinsic value of shares is the value calculated by dividing the
net assets available for equity shareholders by the number of shares. This value determines
the ratio of exchange of shares between the transferee and the transferor companies.

15. What are the demerits of Amalgamation?

a) Amalgamation may reduce the reputation of the amalgamated company.
b) It is very expensive.
c) Amalgamation necessitates the formation of a new company which requires
various formalities
needed for the formation of a company.

16. What are the different types of Amalgamation?******

From the accounting point of view there are two types of amalgamation they are;
a) Amalgamation in the nature of Merger.
b) Amalgamation in the nature of Purchase.
1) AMALGAMATION IN THE NATURE OF MERGER OR POOLING INTEREST
METHOD
An amalgamation can be treated as an amalgamation in the nature of merger if it
satisfies the following conditions;
a) All the assets and liabilities of the transferor company becomes, after
amalgamation the assets and liabilities of the transferee company.
b) More than 90% of the shareholders of the transferor company after amalgamation,
becomes the shareholders of the transferee company.
c) The shareholders of the transferor company, is discharged by allotting shares in
the transferee company after amalgamation. Except cash will be paid in respect of fraction of
shares.
d) The business of the transferor company is intended to be carried on, after
amalgamation, by the transferee company.
e) No adjustment is to be made in the value of the assets and liabilities of the
transferor company,when they are incorporated in the financial statements of the transferee
company, except to ensure uniformity of accounting policies.

2) AMALGAMATION IN THE NATURE OF PURCHASE

Under this type of amalgamation generally one company acquires another company
and equity shareholders of the combining entities do not continue to have proportionate share
in the equity of the transferee company or the business of the acquired company (transferor)
is not intended to be combined after the amalgamation.

17. What are the objectives of amalgamation?

a) Elimination of competition.
b) Price maintenance by regulating output.
c) Securing larger share of the market.
d) Building-up goodwill.
e) Avoiding duplication and reducing costs.
f) Promoting research and development.

18. What is the treatment of debentures?

According to Accounting Standard (AS-14) payment of debentures of the vendor
company by the new company will not be included in the purchase consideration. The
debentures are transferred to realisation account just like transfer of any other liability. The
entry for payment will only appear in the books of new company.
If the debentures of the vendor company are taken by the purchasing company and if
they are discharged at a premium by the purchasing company, the premium payable on
redemption of debentures shall be debited to “Goodwill Account” in the books of purchasing
company.

Students are advised to read the questions carefully and identify whether the
amalgamation is in the nature of merger of purchase.
There is no difference among amalgamation, absorption and external
reconstruction for accounting purposes as per AS-14. These are only classified into two
merger and purchase.
The point of differences shall be as under;
19. What is the difference between amalgamation in the nature of merger &
purchase?****

MERGER PURCHASE
1.There is a general pooling of assets Here one company acquires another
and liabilities of transferor companies as company, as a consequence the
well as the shareholder’s interest. As the shareholders of the transferor company
shareholders continue in the new normally do not continue.
company.

2. Assets, liabilities and reserves of the Assets, liabilities and reserves of the
transferor company are recorded by transferor company are recorded either at
the transferee company at their book book value or at revised value.
values.

3. The balance of P & L of the transferor The balance of the P & L account of the
company is aggregated with the transferor company is not included in the
balance of the P & L account of the books of the transferee company.
transferee company.

4. All reserves, both capital & revenue Only statutory reserves of the transferor
of the transferor company are merged company are taken in the books of
into the reserves of the transferee transferee company in order to preserve
company their identity.

5. It is always intended to continue the It may not be intended to continue the

business of transferor company. business of the transferor company.

6. All assets of the transferor company All assets of the transferor company may or
becomes the assets of the transferee may not become the assets of the
company. transfereeCompany.

7. Purchase consideration is usually Purchase consideration is usually valued at

valued at the par value of the shares. market price of shares issued.
20. What is the difference between Pooling of Interest method and Purchase
Method?***

POOLING OF INTEREST METHOD PURCHASE METHOD

1. It is adopted in the case of It is adopted in the case of amalgamation

amalgamation in the nature of merger. in the nature of purchase.

2. All assets, liabilities, reserves and Only assets and liabilities taken over from
surplus of the transferor company are the transferor company are taken in the
taken into the balance sheet of the balance sheet of the transferee company at
transferee company at book value. the book value or agreed value.

3. It does not record any acquired assets It reveals all hidden assets and liabilities of
and liabilities that were not previously the transferor company by recording them
recorded in the books of the transferor at fair value in the books of the transferee
company. company.

4. The difference between the purchase The difference between the purchase
consideration and share capital of the consideration and the net assets taken over
transferor company is adjusted against of the transferor company is recorded as
reserves. goodwill or capital reserve, as the case
may be.

5. No amalgamation Adjustment Amalgamation Adjustment Account is

Account is opened in the books of the opened in the books of the transferee
transferee company. company to carry forward statutory
reserve, if any.

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