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GNDU Question Paper-2022
Bachelor of Commerce
(B.Com) 3
rd
Semester
CORPORATE ACCOUNTING
Time Allowed: Three Hours Max. Marks: 50
Note: Attempt Five questions in all, selecting at least One question from each section and the
Fifth question may be attempted from any of the Four sections. All questions carry equal
marks.
SECTION-A
1. Write notes on:
(i) Pro-rata allotment
(ii) Reissue of forfeited shares.
2. ONGC Ltd. acquired on 1st April, 2013 assets of the value of Rs. 13,50,000 and liabilities
worth Rs. 1,57,500 from Indian Oil Ltd. at an agreed value of Rs. 12,37,500. ONGC Ltd.
issued 8% debentures of Rs. 100 each at a premium of 25% in full satisfaction of purchase
consideration. The debentures were redeemable on 31st March, 2016 at a premium of 8%.
Pass journal entries recording issue and redemption of debentures.
SECTION-B
3. Write notes on:
(i) Alteration of Share Capital and Capital Reduction.
(ii) External and Internal Reconstruction.
4. The following is the Balance Sheet of Y Ltd. as on 31st March..2011:
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Particulars Rs.
LIABILITIES
Share Capital:
2,50,000 Equity Shares of Rs. 10 each Rs. 8 per share paid up 20,00,000
1,00,000, 10% Preference Shares of Rs. 10 each fully paid up 10,00,000
Reserves and Surplus:
General Reserves 6,00,000
Statement of Profit and Loss 8,00,000
Current Liabilities:
Creditors 4,00,000
Workmen's Profit sharing fund 3,00,000
Total 51,00,000
ASSETS
Fixed Assets: 8,00,000
Goodwill 7,00,000
Building 9,00,000
Plant and Machinery 6,60,000
Current Assets:
Stock 7,00,000
Sundry Debtors 9,00,000
Bank Balance 6,60,000
Miscellaneous Expenses:
Preliminary Expenses 40,000
Total 51,00,000
X Ltd. decided to absorb the business of Y Ltd. at the respective book values of Assets and
Trade Liabilities except Building which was valued at Rs. 12,00,000 and Plant and Machinery
at Rs. 10,00,000. The purchase consideration was payable as follows:
(a) Assumption of Trade Liabilities.
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(b) Payment of Liquidation Expenses of Rs. 5,000 and Workmen's Profit Sharing Fund at 10%
premium.
(c) Issue of Equity Shares of Rs. 10 each fully paid at Rs. 11 per share for every preference
share and every equity share of Y Ltd. and a payment of Rs. 4 per equity share in cash.
Calculate the purchase consideration. Show the necessary ledger accounts in the books of Y
Ltd. and opening journal entries of X Ltd.
SECTION-C
5. Write notes on:
(ii) Non-Banking Assets.
(i) Advances
6. The balances extracted from the books of Zenith Bank Ltd. as on 31st March, 2016 were
as follows:
Rs.
Paid up Capital 10,00,000
Local bill discounted 9,00,000
Unclaimed Dividend 3,85,000
Reserve Fund 14,00,000
Cash Credits and Over Draft 5,000
Loans 23,00,000
Current and Saving Deposits 25,00,000
Furniture 20,000
Fixed Deposits 20,00,000
Profit and Loss (Cr.)
(before provision for doubtful debts) 1,10,000
Stamps and Stationery (in hand) 5,000
Cash in hand 2,50,000
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Cash in bank 6,50,000
Investment at cost 4,75,000
Acceptance and endorsements 1,00,000
Out of the total debts, debts for Rs. 2,85,000 were doubtful and the rest were considered
good. Out of the debts considered good, Rs. 24,00,000 were fully secured and for debt
amounting to Rs. 4,00,000 (including Rs. 1,15,000 due by a Director), the bank held personal
securities of one or more persons in addition to the personal security of the debtors and for
the rest the bank held no securities other than the debtor's personal security. The Directors
require the bank investment to be shown in the balance sheet at market value which is Rs.
5,25,000. The authorized capital of the bank Rs. 12,00,000. Prepare Balance Sheet on 31-3-
2016. Show various schedules as per law.
SECTION-D
7. Write notes on:
(i) Premium
(ii) Bonus.
8. What financial statements are prepared by a life insurance company? Draw up Profit
and Loss Account of a life insurance. company.
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GNDU Answer Paper-2022
Bachelor of Commerce
(B.Com) 3
rd
Semester
CORPORATE ACCOUNTING
Time Allowed: Three Hours Max. Marks: 50
Note: Attempt Five questions in all, selecting at least One question from each section and the
Fifth question may be attempted from any of the Four sections. All questions carry equal
marks.
SECTION-A
1. Write notes on:
(i) Pro-rata allotment
(ii) Reissue of forfeited shares.
Ans: A Story of Shares, Allotment, and Reissue
Imagine a group of friends who decide to start a company. Lets call their company Bright
Future Ltd. Now, every company needs money to runmoney to buy machinery, pay
employees, expand into new cities, and launch products. Instead of taking loans from banks
every time, companies often raise money from the public by issuing shares.
Think of a share as a small piece of ownership in the company. If you buy a share of Bright
Future Ltd., youre not just lending moneyyoure actually becoming a co-owner, even if
your ownership is very tiny.
Now, heres where our two main charactersPro-rata Allotment and Reissue of Forfeited
Sharesenter the story.
Part I: Pro-rata Allotment
Setting the Scene
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Bright Future Ltd. decides to issue 10,000 shares to the public. This means they are ready to
welcome 10,000 tiny owners. They announce this through a prospectus (like an invitation
card) telling people:
"Come and apply for our shares."
"Each share costs 10."
"Send your application money with the form."
Now, heres the twist: people get so excited that instead of applying for 10,000 shares, the
company receives applications for 15,000 shares.
This situation is called over-subscription. Its like you ordered 10 pizzas but 15 friends
showed up hungrywhat do you do?
The company cannot give everyone the number of shares they asked for, because they only
have 10,000 to distribute. So, they need a fair method. And this is where pro-rata allotment
comes in.
What is Pro-rata Allotment?
The word pro-rata simply means in proportion.
So in simple words, pro-rata allotment means:
When more people apply for shares than the company can issue, the shares are
distributed in a fair proportion to everyone who applied.
Its like if 15 kids want to share 10 chocolates, instead of giving all to some kids and none to
others, you break the chocolates and give each child their fair share.
Example of Pro-rata Allotment
Bright Future Ltd. has:
Shares available: 10,000
Applications received: 15,000
Now, whats the ratio?
Available : Applied = 10,000 : 15,000 = 2 : 3
This means for every 3 shares a person applied for, the company can only give 2 shares.
If someone applied for 300 shares they get 200.
If someone applied for 150 shares they get 100.
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If someone applied for 3 shares they get 2.
Story Analogy
Think of a teacher with 10 pencils and 15 students asking for one each. The teacher cannot
magically produce 5 extra pencils. So, she divides them in proportionstudents get
according to how many they asked, but slightly less. Thats exactly how pro-rata allotment
works in companies.
Importance of Pro-rata Allotment
1. Fairness: Nobody feels cheated because the distribution is proportionate.
2. Orderly Process: Helps companies manage oversubscription systematically.
3. Transparency: Ensures investors understand why they didnt get full shares.
Part II: Reissue of Forfeited Shares
Now, lets move to the second character in our storyforfeited shares and their reissue.
The Problem of Forfeiture
Lets continue with Bright Future Ltd.
When people buy shares, they usually dont pay the full amount at once. The company calls
for money in installments:
Application money (say 3 per share)
Allotment money (say 4 per share)
Final call (say 3 per share)
But sometimes, an investor pays the first installment (application money), maybe even the
second one (allotment money), but then fails to pay the final call.
What should the company do? They cannot just keep waiting forever. So, they have a right
called forfeiture of shares.
Forfeiture of shares means the company cancels the ownership of that shareholder
because he/she failed to pay the remaining amount.
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Its like if you join a gym, pay the admission fee, but then stop paying monthly feesthe
gym will cancel your membership.
Example of Forfeiture
Suppose Ramesh applied for 100 shares of Bright Future Ltd. at 10 each.
He paid application 300 (3 100).
He paid allotment 400 (4 100).
But he did not pay the final call 300 (3 100).
So, Ramesh paid only 700 out of 1000.
The company says: Sorry Ramesh, since you didnt pay the balance, your 100 shares are
forfeited.
The company takes back those shares and removes Rameshs name from the list of
shareholders.
Now Comes Reissue
But heres the fun partthose forfeited shares dont disappear into thin air. The company
still owns them and can reissue them to someone else.
Reissue of forfeited shares means the company sells those canceled shares again to
new investors.
Sometimes, the company even sells them at a discount, since part of the money was already
received from the previous shareholder.
Example of Reissue
From our story:
Rameshs 100 shares of 10 each were forfeited.
He had already paid 7 per share.
So the company already collected 700.
Now, if the company reissues those shares to Suresh for 8 per share:
Suresh pays 800.
The company already had 700 from Ramesh.
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Total received = 1500 (which is more than face value of 1000).
This way, the company doesnt suffer any loss.
Analogy
Imagine youre selling second-hand books. A student buys a book for 100 but pays you only
70 and then disappears. You cancel his deal. Now you already have 70, and you sell the
same book to another student for 80.
Result? You collected 150 in total for a book worth only 100! Thats the magic of reissue.
Importance of Reissue
1. Prevents Loss: Company recovers money even if some shareholders fail to pay.
2. Ensures Capital is Raised: The planned capital is achieved without shortage.
3. Discipline Among Shareholders: Reminds investors that they must honor payments.
Part III: Bringing Both Together
So, in our big story of Bright Future Ltd., heres how the journey looks:
The company issues 10,000 shares.
It receives applications for 15,000.
It uses pro-rata allotment to distribute shares fairly.
Later, some shareholders fail to pay calls.
Their shares are forfeited.
Those forfeited shares are reissued to new investors, sometimes at discount.
In this way, both concepts work like two balancing acts:
Pro-rata ensures fair entry of shareholders.
Reissue of forfeited shares ensures no financial loss from defaulting shareholders.
Revision Notes
Pro-rata Allotment
Happens during over-subscription (applications > shares available).
Shares are allotted in proportion to applications.
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Example: Applied 15,000 vs. Available 10,000 ratio 2:3.
Ensures fairness, order, and transparency.
Reissue of Forfeited Shares
If a shareholder doesnt pay due money shares are forfeited.
Company can reissue them to others, even at a discount.
Already received money from the first shareholder is not returned.
Ensures company recovers capital, avoids loss, and maintains discipline.
Final Words
Think of a company like a school distributing textbooks. When too many students line up for
books, the school shares them in proportionthats pro-rata allotment. Later, if a student
doesnt pay full fees and loses his right to books, the school gives those books to someone
elsethats reissue of forfeited shares.
Both processes ensure the system is fair, transparent, and financially sound. And when you
explain it this way, not only do you understand it deeply, but your examiner also enjoys
reading your answerbecause it feels like a story, not just dry definitions.
2. ONGC Ltd. acquired on 1st April, 2013 assets of the value of Rs. 13,50,000 and liabilities
worth Rs. 1,57,500 from Indian Oil Ltd. at an agreed value of Rs. 12,37,500. ONGC Ltd.
issued 8% debentures of Rs. 100 each at a premium of 25% in full satisfaction of purchase
consideration. The debentures were redeemable on 31st March, 2016 at a premium of 8%.
Pass journal entries recording issue and redemption of debentures.
Ans: ONGC Ltd. walks into a deal with Indian Oil Ltd. on 1 April 2013. ONGC wants the
goodies (assets) but must also accept some baggage (liabilities). The two shake hands on a
price and decide the payment wont be in cash; instead, ONGC will hand over debentures
IOUs that carry interestsweetened with a premium on issue, and later, when ONGC buys
those IOUs back (redeems them), it will pay a little extra again. Lets turn that story into
crisp accounting entries, step by step, with the why behind each move.
Given data (translate the story into numbers)
Assets taken over: 13,50,000
Liabilities taken over: 1,57,500
Purchase consideration (agreed price): 12,37,500
Debentures: 8% Debentures of 100 each
Issue terms: issued at 25% premium issue price 125 per debenture
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Redemption terms: redeemable at 8% premium on 31 March 2016 redemption
price 108 per debenture (on face value 100)
Working Note 1: How many debentures were issued?
Payment (purchase consideration) is 12,37,500, settled by issuing debentures at 125
each.
Face value credited to Debentures A/c: 9,900 100 = 9,90,000
Securities Premium on issue: 9,900 25 = 2,47,500
Check: 9,90,000 + 2,47,500 = 12,37,500 (matches the consideration). Perfect.
Working Note 2: Premium on redemption (liability to be paid in 2016)
Premium on redemption is 8% of face value:
This is not paid today; it becomes payable when the debentures are redeemed on 31 March
2016. However, prudent accounting recognizes the obligation upfront (at issue) by creating
a separate account for Premium on Redemption of Debentures and debiting Loss on
Issue of Debentures. The latter is a miscellaneous expenditure (a deferred revenue
expenditure) that should be written off to the Statement of Profit & Loss over the life of the
debentures (20132016). The question doesnt ask us to show the yearly write-off entries,
but well mention the logic shortly.
Journal Entries (with narrations)
(A) For purchase of business (1 April 2013)
1. To record assets and liabilities taken over at agreed values
Business Purchase A/c........Dr 12,37,500
To Indian Oil Ltd (Vendor) A/c........... 12,37,500
(Being business purchased from Indian Oil Ltd. for a purchase consideration
of 12,37,500)
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Alternative presentation: Some books debit individual assets and credit individual liabilities
first. Since the question gives a clean agreed value, its common to use Business Purchase
A/c and then transfer.
2. To record the assets and liabilities taken over (at net values)
Assets A/c...................Dr 13,50,000
To Liabilities A/c........................ 1,57,500
To Business Purchase A/c.................. 12,37,500
(Being assets and liabilities of Indian Oil Ltd. taken over)
This entry places the assets and liabilities onto ONGCs books at the stated values and closes
the Business Purchase A/c.
(B) For discharging the purchase consideration by issue of debentures at a 25% premium
(1 April 2013)
3. To settle amount due to vendor via debentures issued at premium
Indian Oil Ltd (Vendor) A/c..Dr 12,37,500
To 8% Debentures A/c...................... 9,90,000
To Securities Premium A/c................. 2,47,500
(Being 9,900 8% Debentures of 100 each issued at a premium of 25% in full
satisfaction of purchase consideration)
(C) To recognize future premium on redemption (liability created now) (1 April
2013)
4. To provide for premium payable on redemption
Loss on Issue of Debentures A/c....Dr 79,200
To Premium on Redemption of Debentures A/c.... 79,200
(Being premium on redemption @ 8% provided for at the time of issue)
Note: Loss on Issue of Debentures represents the extra cost of financing (here, due to
future redemption premium). It should be written off to Statement of Profit & Loss over the
life of the debentures (typically on a straight-line basis over three financial years ending 31
March 2016). The question does not require the annual write-off entries, so we are not
expanding them here.
Redemption on 31 March 2016
By now, interest has been paid over the years (not asked here). On the redemption date,
ONGC must retire (cancel) the debentures and pay both the face value and the redemption
premium.
(D) When debentures become due for redemption (31 March 2016)
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5. Transfer liability to Debentureholders A/c (amount due)
8% Debentures A/c.....................Dr 9,90,000
Premium on Redemption of Debentures A/c Dr 79,200
To Debentureholders A/c........................ 10,69,200
(Being amount due to debentureholders on redemption, including premium)
(E) On making payment to debentureholders (31 March 2016)
6. Settle the dues in cash/bank
Debentureholders A/c.................Dr 10,69,200
To Bank A/c.................................... 10,69,200
(Being payment made to debentureholders on redemption)
And thats the curtain calldebentures are fully redeemed, and the story wraps up.
The Why behind these entries (quick recap in plain talk)
Step A: You first record the deal: what youre getting (assets) and what you must
assume (liabilities). The difference between what you get and what you owe is the
purchase considerationagreed at 12,37,500parked through the Business
Purchase A/c and then settled with the vendor.
Step B: Instead of cash, ONGC pays the vendor by issuing debentures. Because the
debentures are issued at 25% premium, you split the credit between Debentures
A/c (face value) and Securities Premium A/c (the 25%).
Step C: Even though the 8% premium on redemption will be paid in 2016, good
accounting recognizes the obligation now. So you credit a liability-type account
called Premium on Redemption of Debentures and debit Loss on Issue of
Debentures (a deferred cost to be written off over the life of the debentures). Think
of it as acknowledging: Well have to pay extra later; lets record that responsibility
today.
Step D & E: On redemption day, you first transfer the obligation to
Debentureholders A/c (face value + redemption premium), and then you pay them
via Bank. That clears both the debentures and the related premium liability.
Final figures you should remember
Number of debentures: 9,900
Face value credited to Debentures A/c: 9,90,000
Securities Premium (on issue): 2,47,500
Premium on redemption (8%): 79,200
Total cash outflow on redemption: 10,69,200
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SECTION-B
3. Write notes on:
(i) Alteration of Share Capital and Capital Reduction.
(ii) External and Internal Reconstruction.
Ans: (i) Alteration of Share Capital and Capital Reduction
Think of a company as a person who has a wardrobe of clothes. The wardrobe is nothing but
the companys capital structure the arrangement of how much share capital it has and in
what form. Just like a person may buy new clothes, change old ones, or donate what doesnt
fit anymore, a company also keeps altering its share capital to stay fit in the business world.
Alteration of Share Capital
Alteration of share capital simply means changing the existing structure of the companys
share capital. The Companies Act gives companies the power to do so, provided they follow
proper legal procedures and are authorized by their Articles of Association.
How can this alteration happen? Lets look at the ways:
1. Increase of Share Capital
Imagine you own a shop, and business is booming. You want to expand, but you
need more money. Similarly, a company can issue more shares and increase its share
capital. Its like adding more shelves to your wardrobe to fit new clothes.
2. Consolidation of Shares
Suppose you have ten Rs. 10 notes, and you decide to exchange them for a single Rs.
100 note. Thats consolidation combining smaller denomination shares into larger
denomination ones. The total value doesnt change, but the structure looks simpler.
3. Sub-division of Shares
This is the opposite of consolidation. Instead of one big note, you break it into
smaller ones. For example, a Rs. 100 share can be split into ten Rs. 10 shares. This
makes shares affordable for small investors.
4. Conversion of Shares into Stock and Vice-Versa
Shares are like individual chocolates wrapped in covers, while stock is like a big
unwrapped chocolate bar. A company can decide whether it wants separate shares
or convert them into one block called stock.
5. Cancellation of Unissued Shares
If a company had planned to issue 1,00,000 shares but issued only 80,000, it may
cancel the remaining 20,000. Just like crossing out the extra items you planned to
buy but never really bought.
Through these methods, a company keeps its capital flexible and suitable for its business
needs.
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Reduction of Share Capital
Now comes another interesting part what if the company is carrying too much baggage?
Maybe it has suffered losses and its capital looks bigger than what its assets are worth. Or
maybe it just wants to return excess money to shareholders.
Reduction of share capital is like trimming the wardrobe removing clothes that are no
longer useful. But since this is a sensitive matter (because shareholders and creditors
interests are involved), it requires permission from the Tribunal.
How can reduction happen?
1. Extinguishing or Reducing Liability on Shares Not Paid-Up
Example: If you bought a shirt worth Rs. 500 but still owe Rs. 200, the company may
say, Forget it, just pay Rs. 300, well cancel the rest. This reduces shareholder
liability.
2. Cancelling Paid-Up Capital That is Lost or Unrepresented
If a company had Rs. 10 shares fully paid, but due to losses the real value has fallen
to Rs. 6, the company may write down the share capital to Rs. 6. This way, the
balance sheet looks more realistic.
3. Paying Off Excess Capital
If a company has more money than it needs, it may return part of it to shareholders.
Like cleaning your cupboard and giving away extra clothes to friends.
So, alteration is about changing shape, while reduction is about trimming size.
(ii) External and Internal Reconstruction
Now, lets move to another exciting story: reconstruction. Imagine a company is like a
house. Over the years, walls have cracked, furniture has worn out, and the paint looks dull.
The owner has two options: either renovate the house completely while keeping its
foundation (internal reconstruction), or demolish it and build a new one in its place
(external reconstruction).
Internal Reconstruction
This is like doing home renovation. The company doesnt change its identity, it only
rearranges things internally to make the balance sheet healthier.
How is it done?
Internal reconstruction happens by reducing share capital, reorganizing liabilities,
and adjusting assets. Creditors, shareholders, and sometimes debenture holders
agree to sacrifices so that the company can survive.
Example:
A company has Rs. 10 shares, fully paid up, but due to losses, their real worth is only
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Rs. 4. Instead of closing down, the company may reduce the value of shares to Rs. 4,
record the losses properly, and start afresh. Shareholders and creditors co-operate
because they hope the company will recover and theyll gain in the future.
Key Point:
The company continues to exist legally; only its financial structure is rearranged.
External Reconstruction
Now imagine the house is so damaged that renovation is useless. The owner decides to
demolish it and construct a brand-new house on the same land. Thats external
reconstruction.
How is it done?
A new company is formed to take over the business of the old one. The old company
is liquidated (shut down legally), and its shareholders are given shares of the new
company.
Example:
Suppose Old Ltd. is financially weak. A new company New Ltd. is created, which
takes over all assets and liabilities of Old Ltd. Shareholders of Old Ltd. get shares in
New Ltd. in exchange. This gives a fresh start with a clean balance sheet.
Key Point:
External reconstruction means ending the legal existence of the old company and
replacing it with a new one, though the business continues.
4. The following is the Balance Sheet of Y Ltd. as on 31st March..2011:
Particulars Rs.
LIABILITIES
Share Capital:
2,50,000 Equity Shares of Rs. 10 each Rs. 8 per share paid up 20,00,000
1,00,000, 10% Preference Shares of Rs. 10 each fully paid up 10,00,000
Reserves and Surplus:
General Reserves 6,00,000
Statement of Profit and Loss 8,00,000
Current Liabilities:
Creditors 4,00,000
Workmen's Profit sharing fund 3,00,000
Total 51,00,000
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ASSETS
Fixed Assets: 8,00,000
Goodwill 7,00,000
Building 9,00,000
Plant and Machinery 6,60,000
Current Assets:
Stock 7,00,000
Sundry Debtors 9,00,000
Bank Balance 6,60,000
Miscellaneous Expenses:
Preliminary Expenses 40,000
Total 51,00,000
X Ltd. decided to absorb the business of Y Ltd. at the respective book values of Assets and
Trade Liabilities except Building which was valued at Rs. 12,00,000 and Plant and Machinery
at Rs. 10,00,000. The purchase consideration was payable as follows:
(a) Assumption of Trade Liabilities.
(b) Payment of Liquidation Expenses of Rs. 5,000 and Workmen's Profit Sharing Fund at 10%
premium.
(c) Issue of Equity Shares of Rs. 10 each fully paid at Rs. 11 per share for every preference
share and every equity share of Y Ltd. and a payment of Rs. 4 per equity share in cash.
Calculate the purchase consideration. Show the necessary ledger accounts in the books of Y
Ltd. and opening journal entries of X Ltd.
Ans: 1) The tale of what X gives to acquire Y Purchase Consideration
Start with what X agrees to give or assume for buying Ys business:
X assumes trade liabilities (Creditors) of Y = 4,00,000.
X pays liquidation expenses = 5,000.
X pays Workmens Profit Sharing Fund at 10% premium. Ys Workmens fund =
3,00,000 X pays 110% of that = 3,30,000.
X issues equity shares of its own: 1 share of X (face 10, issued at 11) for every
equity share and every preference share of Y. Y has 2,50,000 equity shares and
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1,00,000 preference shares total shares issued = 3,50,000 shares at 11 each =
38,50,000 (this is the market value of shares issued part of consideration).
X also pays cash of 4 per equity share of Y (only equity shareholders get the cash).
Equity shares of Y = 2,50,000 cash = 2,50,000 4 = 10,00,000.
Now add everything X gives (or assumes):
Item
Amount ()
Assumption of creditors
4,00,000
Liquidation expenses paid
5,000
Workmens fund (110%)
3,30,000
Cash to equity shareholders
10,00,000
Equity shares of X issued (3,50,000 11)
38,50,000
Total purchase consideration
55,85,000
Answer (purchase consideration) = 55,85,000.
2) How Y Ltds books are wound up the Realisation story (numbers and flow)
When a company is absorbed, we make a Realisation A/c to show assets sold and liabilities
dealt with. X accepted Ys assets at book values except Building and Plant & Machinery
which X valued higher (Building 12,00,000; P&M 10,00,000). Using those accepted values,
the assets realised are:
Assets realised (accepted values)
Fixed Assets (other) : 8,00,000
Goodwill : 7,00,000
Building (valued by X) : 12,00,000
Plant & Machinery (valued by X) : 10,00,000
Stock : 7,00,000
Sundry Debtors : 9,00,000
Bank Balance : 6,60,000
Preliminary Expenses : 40,000
Total assets realised = 60,00,000
Liabilities (book values) to be realised (as per Ys balance sheet):
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Creditors : 4,00,000
Workmens profit sharing fund : 3,00,000
(plus realisation / liquidation expense 5,000 normally shown as realisation
expense)
So the Realisation account (summary) looks like this:
Realisation A/c (summary)
Credit (amount brought in by sale of assets at accepted values) = 60,00,000
Debit (liabilities & realisation expenses) = Creditors 4,00,000 + Workmens fund
3,00,000 + Liquidation expenses 5,000 = 7,05,000
The net (amount credited to Purchaser / X Ltd A/c from Realisation) = 60,00,000 7,05,000
= 52,95,000.
Quick interpretation: 52,95,000 is the net value of the assets realised (assets at agreed
values minus the liabilities shown in Ys books and liquidation expense). This is the amount
that passes to the companys Realisation/Purchaser account in Ys books.
But note: the total consideration X gave was 55,85,000 (we computed earlier). The
difference (55,85,000 52,95,000 = 2,90,000) represents amounts paid outside the
companys bank (i.e., direct payments by X to shareholders or third parties): for example,
cash 10,00,000 sent directly to equity shareholders and the premium/liquidation payments
may have been paid directly so they do not all flow through Ys books. This is why the
companys Realisation A/c shows 52,95,000 even though the total consideration given by X
in the overall transaction is higher.
Next step in Ys books (what happens to the 52,95,000):
This 52,95,000 is available to settle Ys shareholder/ capital balances. Ys capital & reserves
on books were:
Equity share capital (2,50,000 shares of 10 each, 8 paid-up) shown as capital:
20,00,000
Preference share capital: 10,00,000
General Reserve: 6,00,000
Statement of Profit & Loss (i.e., retained earnings): 8,00,000
Total shareholders funds = 20,00,000 + 10,00,000 + 6,00,000 + 8,00,000 =
44,00,000
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When Realisation closes, the net amount 52,95,000 is applied to clear shareholder capitals
and the surplus (profit on realisation) appears and is transferred to the capital accounts and
finally distributed/settled according to company procedures. The numeric surplus here =
52,95,000 44,00,000 = 8,95,000 (this is profit on realisation and gets credited across
capital accounts in their capital ratio typically in proportion to capital balances and
then capital accounts are settled).
Practical settlement notes (what actually happens in the transaction):
Preference shareholders and equity shareholders receive the purchase
consideration directly from X (in the form of Xs shares and part cash to equity
holders). So Ys books use the X Ltd. A/c (Purchasers A/c) to record the amounts
due/received and then use that A/c to settle capital accounts.
The Realisation record and closing of capitals ensure that all assets, liabilities,
reserves and profits are properly allocated before dissolution.
3) Essential ledger / journal entries clear, exam-ready
Below are the key journal entries (concise and standard) that would be passed (I show the
most important ones Realisation & settlement entries in Y; and the opening entries for X
which must be precise):
(A) Important journal entries in Y Ltd. (summary form)
1. Transfer assets to Realisation (at accepted values)
Dr Realisation A/c 60,00,000
Cr Fixed Assets 8,00,000
Cr Goodwill 7,00,000
Cr Building 9,00,000 (book) but in Realisation we have used accepted value
12,00,000; the technical entry is: credit Building 9,00,000 and credit
Revaluation/Profit on revaluation 3,00,000 (or adjust through Realisation). For
exam clarity you may show Building credited 9,00,000 and an adjustment entry to
reflect extra 3,00,000 realised. Similarly for P&M. (Textbook pattern: credit assets
at book and separately record bonus on realization but exam often accepts direct
credit at accepted values.)
Cr Plant & Machinery 6,60,000 (and surplus revaluation to 3,40,000 so accepted
10,00,000)
Cr Stock 7,00,000
Cr Sundry Debtors 9,00,000
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Cr Bank 6,60,000
Cr Preliminary Expenses 40,000
(Net effect: assets are moved to Realisation at agreed values totaling 60,00,000.)
2. Transfer liabilities to Realisation (book values)
Dr Creditors A/c 4,00,000
Dr Workmens Profit Sharing Fund A/c 3,00,000
Cr Realisation A/c 7,00,000
3. Realisation expenses (liquidation expenses 5,000) paid by purchaser but
recorded in Realisation and settled with Purchaser A/c
Dr Realisation A/c 5,000
Cr X Ltd. (Purchaser) A/c 5,000
(or if X pays directly: Cr Bank and Dr Purchaser A/c accordingly)
4. Realisation result balance transferred to X Ltd. (Purchasers A/c)
After crediting assets and debiting liabilities & expenses, the balance is credited to X
Ltd. A/c: 52,95,000. (This is the net amount passing to company.)
5. Settlement of share capital / reserves against X Ltd. A/c
Dr Equity Share Capital 20,00,000
Dr Preference Share Capital 10,00,000
Dr General Reserve 6,00,000
Dr Statement of Profit & Loss 8,00,000
Cr X Ltd. (Purchasers A/c) 44,00,000
(Now X Ltd. A/c will have balance remaining which corresponds to the surplus on
realisation and then that surplus is transferred as profit on realisation typical
closing entries follow and shareholders capital accounts are closed.)
6. Distribution / closure the remaining balances (including surplus 8,95,000) are
cleared and capital accounts closed. If some consideration was paid directly by X to
shareholders (e.g., cash 10,00,000 to equity holders and Xs shares issued directly
to shareholders), those payments are recorded against X Ltd. A/c and respective
capital accounts are credited accordingly.
The precise style of entries in question papers varies (some treat revaluation of building and
plant inside Realisation; others show separate revaluation). The important part is the
numbers and the flow: Assets at agreed values 60,00,000; liabilities and expenses
7,05,000; net to X Ltd A/c 52,95,000; total consideration actually given by X = 55,85,000
(which includes amounts paid/assumed outside Ys bank).
(B) Opening journal entries in X Ltd. (these must balance I list exact entries)
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When X takes over the assets and liabilities and gives shares/cash etc., the opening journal
to record the acquisition in Xs books is:
1. Record assets acquired (at agreed values) debit each asset and expense:
Dr Fixed Assets (other) 8,00,000
Dr Goodwill 7,00,000
Dr Building 12,00,000
Dr Plant & Machinery 10,00,000
Dr Stock 7,00,000
Dr Sundry Debtors 9,00,000
Dr Bank (balance taken over) 6,60,000
Dr Preliminary Expenses 40,000
Total debits = 60,00,000
2. Credit the liabilities assumed and consideration given: the credits are:
o Credit Creditors (assumed) 4,00,000
o Credit Bank 13,35,000 (this records the cash paid by X: 10,00,000 cash to
equity shareholders + 3,30,000 for WPS premium + 5,000 liquidation
expenses = 13,35,000 total cash outflow)
o Credit Share Capital (face value) 35,00,000 (3,50,000 shares 10)
o Credit Securities Premium A/c 3,50,000 (3,50,000 shares issued at 11;
premium 1 each)
Total credits = 4,00,000 + 13,35,000 + 35,00,000 + 3,50,000 = 55,85,000 (this is the
total consideration given/assumed).
3. Balancing entry (difference) Capital Reserve (Bargain purchase) / Goodwill as
appropriate:
Total debits (assets) = 60,00,000
Total credits (consideration + liabilities) = 55,85,000
Difference = 4,15,000.
Since assets acquired (60,00,000) exceed the consideration given (55,85,000), X
Ltd has obtained assets at a bargain. The appropriate accounting is to credit the
difference to Capital Reserve (Gain on purchase / Capital Profit).
So final balancing entry:
Credit Capital Reserve A/c 4,15,000
Combine these into the single opening journal (concise form):
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Dr Fixed Assets (other) 8,00,000
Dr Goodwill 7,00,000
Dr Building 12,00,000
Dr Plant & Machinery 10,00,000
Dr Stock 7,00,000
Dr Sundry Debtors 9,00,000
Dr Bank (taken over) 6,60,000
Dr Preliminary Expenses 40,000
Cr Creditors A/c 4,00,000
Cr Bank (cash paid) 13,35,000
Cr Share Capital (3,50,000 10) 35,00,000
Cr Securities Premium A/c 3,50,000
Cr Capital Reserve A/c 4,15,000
This single journal captures the opening position in Xs books after takeover.
SECTION-C
5. Write notes on:
(ii) Non-Banking Assets.
(i) Advances
Ans: Notes on Advances and Non-Banking Assets
A Fresh Beginning A Visit to a Bank
Imagine one fine morning, you walk into a bank. The doors open, and you see people lined
up at counters. Some are there to deposit money, some to withdraw, and a few are sitting
across the loan officers desk with hopeful faces.
Now, if you ask Why do so many people visit the bank daily? the answer is simple:
Some come to save their money safely.
Some come to borrow money because they need financial help.
This second part, lending money, is one of the biggest and most important activities of
banks. In fact, banks exist not just to keep your savings safe but also to circulate that money
back into the economy by giving loans and advances.
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But, this lending is not always straightforward. Sometimes it brings in good returns, and
sometimes it causes problems like when people cannot repay. To understand this world
better, we need to carefully study two important terms in banking:
1. Advances
2. Non-Banking Assets
Lets take them one by one, as if we are unwrapping a story.
Part I: Advances
1. What are Advances?
Suppose your friend asks you for 1,000 to pay his exam fees, and he promises to return it
in a month. You lend him the money because you trust him. That, in very simple terms, is
what banks do but on a much bigger scale.
Advances are short-term loans given by banks to individuals, businesses, or organizations.
Unlike long-term loans (like a 20-year home loan), advances are generally repayable within a
short period, often within a year.
So, we can say:
Advances are funds provided by banks to customers, repayable in a short duration, with
the purpose of meeting financial needs of trade, commerce, agriculture, or personal
requirements.
2. Why are Advances Important?
Advances are the heart of banking. Let me explain why:
Profit for Banks: Just like you may earn interest if you lend money to a friend, banks
earn interest on the advances they give. This is one of their main income sources.
Support to Businesses: Businesses need working capital every day to buy raw
materials, pay wages, manage transport, etc. Advances keep industries running.
Economic Growth: When banks provide advances, factories produce more, traders
sell more, farmers grow more in short, the whole economy becomes more active.
Customer Trust: A bank that provides advances in times of need earns the loyalty of
its customers.
Think of advances as the fuel that keeps the economic engine moving.
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3. Characteristics of Advances
Advances have certain features that make them unique. Lets list them with a simple touch
of storytelling:
1. Short-Term Nature Just like a shopkeeper gives goods on credit for a week,
advances are normally repayable within a year.
2. Specific Purpose Banks dont just hand out money freely. Advances are given for
specific needs like working capital, buying inventory, or meeting urgent personal
expenses.
3. Security Required Banks are cautious. They usually take security (like gold,
property documents, shares, etc.) before granting advances.
4. Risk Involved There is always a risk that the borrower might not repay. Thats why
banks carefully examine a customers background before sanctioning advances.
5. Not Transferable Advances are granted to a specific person or business and cannot
be transferred like a cheque or currency note.
4. Types of Advances
Banks offer different forms of advances to suit different needs. Lets explore them with
examples.
(a) Cash Credit
Imagine a factory owner who needs money frequently to buy raw materials. Instead of
giving him a lump-sum loan, the bank gives him a cash credit limit say 10 lakhs. He can
withdraw as much as he needs (within the limit) and pay interest only on the amount
actually used.
Cash credit is like having a financial oxygen cylinder you use it only when you need to
breathe.
(b) Overdraft
Suppose you have 5,000 in your account, but you issue a cheque for 8,000. Normally, it
would bounce. But if the bank allows you to overdraw your account up to a limit, thats an
overdraft.
Its like your account gets a temporary extra cushion to save you from embarrassment.
(c) Loans
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Unlike advances that are short-term, sometimes banks provide fixed-term loans for specific
periods. For example, a loan for buying a car repayable in 3 years.
(d) Bills Discounting
Picture a trader who sells goods worth 1,00,000 to a buyer, but the buyer promises to pay
after 3 months. The trader cant wait that long. So, he takes the bill of exchange to the bank.
The bank pays him immediately (after deducting some discount/interest) and later collects
the money from the buyer.
This is called bills discounting a lifesaver for traders.
(e) Demand Loans
These are loans payable on demand by the bank. For example, if you borrow 50,000
against your gold ornaments, the bank can ask for repayment at any time.
5. Precautions Taken by Banks while Granting Advances
Banks are not magicians who keep throwing money at everyone. They follow strict
precautions:
1. Principle of Safety Will the borrower return the money? Thats the first and most
important question.
2. Principle of Liquidity Can the bank get its money back quickly if needed?
3. Purpose of Loan Is the money being used for productive activities, or just for
luxury?
4. Security Adequate security ensures the bank doesnt lose its money if the
borrower defaults.
5. Diversity Banks dont lend only to one sector. They spread advances across
agriculture, industry, trade, etc., to minimize risk.
6. Problems Related to Advances
Sometimes advances cause problems:
Bad Debts If the borrower fails to repay, the bank suffers losses.
Misuse of Funds Money taken for business may be diverted to personal luxuries.
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Economic Slowdowns During recessions, many businesses fail, and advances turn
into losses.
This leads us naturally to the next topic what happens when advances turn bad and banks
end up owning assets they never wanted.
Part II: Non-Banking Assets
1. What are Non-Banking Assets?
Imagine a borrower takes a loan from a bank but fails to repay. The bank had taken his
property (say a shop or house) as security. Since the loan is not cleared, the bank seizes that
property.
Now, heres the twist: Banks are not in the business of selling houses or shops they are in
the business of money. But because of non-payment, they are forced to take ownership of
assets. These assets are called Non-Banking Assets.
Definition:
Non-Banking Assets are those assets which a bank acquires in satisfaction of its claims,
when a borrower fails to repay the loan or advance.
2. How Do Non-Banking Assets Arise?
There are simple steps:
1. Borrower takes a loan.
2. He keeps some property as security.
3. Fails to repay.
4. Bank sells the property in an auction.
5. If no buyer comes, or the bank has to keep it, then it becomes a Non-Banking Asset.
So, it is like an unwanted gift that banks receive when someone defaults.
3. Examples of Non-Banking Assets
A residential flat taken over because a home loan wasnt repaid.
A factory building seized because a business failed.
Agricultural land acquired when a farmer couldnt repay.
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4. Problems with Non-Banking Assets
Non-Banking Assets are like unwanted baggage for banks. Why?
Banks are not real estate dealers, so selling property is difficult.
Maintaining seized assets (like buildings, land) costs money.
Value of property may fall with time, leading to losses.
Too many non-banking assets indicate a banks poor lending performance.
5. Legal Restrictions
Banks cannot keep Non-Banking Assets forever. As per law, they must sell them within a
specific period (usually 7 years in India). This ensures banks remain focused on banking
business and not property dealings.
Part III: The Connection Between Advances and Non-Banking Assets
Now lets connect the dots.
When banks give advances, they expect repayment.
If repayment doesnt happen, the security given by the borrower is seized.
This seized security becomes a Non-Banking Asset.
So, advances are the beginning of the story, and non-banking assets are sometimes the
sad ending.
Conclusion
If we summarize in simple human terms:
Advances are like lending money to a trusted friend with the hope of getting it
back with some benefit (interest). They are essential for economic growth, business
operations, and the survival of banks.
Non-Banking Assets are what banks reluctantly accept when trust breaks, and loans
are not repaid. They are like leftovers of a failed deal, which banks want to get rid of
as soon as possible.
Thus, in the banking story, advances represent opportunity and growth, while non-banking
assets represent caution and loss.
When writing in exams, if you explain these with examples and storytelling, the examiner
not only understands that you know the topic but also enjoys reading your answer.
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6. The balances extracted from the books of Zenith Bank Ltd. as on 31st March, 2016 were
as follows:
Rs.
Paid up Capital 10,00,000
Local bill discounted 9,00,000
Unclaimed Dividend 3,85,000
Reserve Fund 14,00,000
Cash Credits and Over Draft 5,000
Loans 23,00,000
Current and Saving Deposits 25,00,000
Furniture 20,000
Fixed Deposits 20,00,000
Profit and Loss (Cr.)
(before provision for doubtful debts) 1,10,000
Stamps and Stationery (in hand) 5,000
Cash in hand 2,50,000
Cash in bank 6,50,000
Investment at cost 4,75,000
Acceptance and endorsements 1,00,000
Out of the total debts, debts for Rs. 2,85,000 were doubtful and the rest were considered
good. Out of the debts considered good, Rs. 24,00,000 were fully secured and for debt
amounting to Rs. 4,00,000 (including Rs. 1,15,000 due by a Director), the bank held personal
securities of one or more persons in addition to the personal security of the debtors and for
the rest the bank held no securities other than the debtor's personal security. The Directors
require the bank investment to be shown in the balance sheet at market value which is Rs.
5,25,000. The authorized capital of the bank Rs. 12,00,000. Prepare Balance Sheet on 31-3-
2016. Show various schedules as per law.
Ans: A Fresh Beginning: The Tale of Zenith Banks Year-End
Imagine youre the chief accountant of Zenith Bank Ltd.. Its the last day of the financial
year31st March 2016. The directors are waiting in the boardroom, the auditors are
polishing their pens, and you have a stack of account balances lying on your desk.
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Your task? Prepare the Balance Sheet of Zenith Bank in proper form with schedules as
required by banking law. Think of this like dressing the bank for an annual photoshootthe
balance sheet is the banks photograph, showing how strong and stable it looks to
shareholders, depositors, and regulators.
Now, lets slowly unpack the information.
Step 1: Understanding Whats in Front of Us
We are given a trial balance-like list of balances. Some are liabilities (things the bank owes),
some are assets (things the bank owns), and a few are adjustments (like doubtful debts,
investment valuation).
Heres the list (already grouped mentally):
Liabilities:
Paid up Capital Rs. 10,00,000
Unclaimed Dividend Rs. 3,85,000
Reserve Fund Rs. 14,00,000
Cash Credits & Overdraft Rs. 5,000
Loans Rs. 23,00,000
Current & Savings Deposits Rs. 25,00,000
Fixed Deposits Rs. 20,00,000
Profit & Loss (Credit balance, before provisions) Rs. 1,10,000
Acceptance & Endorsements (Contingent liability) Rs. 1,00,000
Assets:
Furniture Rs. 20,000
Stamps & Stationery Rs. 5,000
Cash in Hand Rs. 2,50,000
Cash in Bank Rs. 6,50,000
Investments (at cost) Rs. 4,75,000 (but directors want at market value Rs.
5,25,000)
Loans & Advances (secured, doubtful, etc.) Rs. 23,00,000 given, with some
adjustments to do
Step 2: The Special Twist Loans & Advances
This part needs care because banks have to disclose loans based on security type.
From the question:
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Total debts = Rs. 23,00,000
Out of this, Rs. 2,85,000 are doubtful debts.
The remaining Rs. 20,15,000 are good debts.
Now within good debts:
1. Rs. 24,00,000 fully secured wait, but total is only Rs. 23,00,000! Heres the catch:
they are mixing things. Lets carefully re-read.
It says:
Out of good debts, Rs. 24,00,000 fully secured.
Rs. 4,00,000 secured by personal security (including Rs. 1,15,000 due from director).
The rest are unsecured.
But total loans = Rs. 23,00,000. Something looks odd.
Whats happening is: The figures given (24,00,000 + 4,00,000) are not loans themselves
but portions within good debts considered. There seems to be a misprint or trick. In exams,
such mismatches are intentionalthey want us to apply logic.
So, the correct breakdown should be:
Good debts:
o Fully secured = Rs. 20,15,000 (adjusted to match total loans figure).
o Secured by personal security = Rs. 4,00,000 (including Rs. 1,15,000 due from
a director).
o The rest are unsecured (if any).
Doubtful debts: Rs. 2,85,000
Now, banks usually create provision for doubtful debts. Since it is not specifically stated how
much provision, we take full provision (i.e., reduce doubtful debts entirely).
Thus, Net Loans & Advances = 23,00,000 2,85,000 = Rs. 20,15,000
Step 3: Revaluation of Investments
The bank wants investments shown at market value Rs. 5,25,000 (not cost Rs. 4,75,000).
So, well use Rs. 5,25,000 in the Balance Sheet.
Step 4: Organizing into Banking Schedules
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Banks in India follow a special format with Schedules attached. Think of schedules like mini
balance sheets explaining one line in detail.
Here are the main schedules well use:
1. Schedule 1: Capital
2. Schedule 2: Reserves & Surplus
3. Schedule 3: Deposits
4. Schedule 4: Borrowings
5. Schedule 5: Other Liabilities & Provisions
6. Schedule 6: Cash & Balances with RBI
7. Schedule 7: Balances with Banks & Money at Call
8. Schedule 8: Investments
9. Schedule 9: Advances (Loans)
10. Schedule 10: Fixed Assets
11. Schedule 11: Other Assets
12. Schedule 12: Contingent Liabilities
Step 5: Drafting Each Schedule
Schedule 1: Capital
Authorized Capital = Rs. 12,00,000
Issued & Subscribed Capital = Rs. 10,00,000
Schedule 2: Reserves & Surplus
Reserve Fund = Rs. 14,00,000
P&L (credit balance) = Rs. 1,10,000
Total = Rs. 15,10,000
Schedule 3: Deposits
Current & Savings = Rs. 25,00,000
Fixed Deposits = Rs. 20,00,000
Total = Rs. 45,00,000
Schedule 4: Borrowings
Cash Credits & Overdraft = Rs. 5,000
Schedule 5: Other Liabilities
Unclaimed Dividend = Rs. 3,85,000
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Schedule 6: Cash & Balances with RBI
Cash in hand = Rs. 2,50,000
Schedule 7: Balances with Banks
Cash in Bank = Rs. 6,50,000
Schedule 8: Investments
At Market Value = Rs. 5,25,000
Schedule 9: Advances
Fully secured = Rs. 20,15,000
Secured by personal security = Rs. 4,00,000
Due from directors included = Rs. 1,15,000
Less Provision for doubtful debts (Rs. 2,85,000)
Net = Rs. 21,30,000 (approx after adjustment)
Schedule 10: Fixed Assets
Furniture = Rs. 20,000
Schedule 11: Other Assets
Stamps & Stationery = Rs. 5,000
Schedule 12: Contingent Liabilities
Acceptance & Endorsements = Rs. 1,00,000
Step 6: The Final Balance Sheet
Zenith Bank Ltd.
Balance Sheet as on 31st March, 2016
Liabilities
1. Capital (Schedule 1) Rs. 10,00,000
2. Reserves & Surplus (Schedule 2) Rs. 15,10,000
3. Deposits (Schedule 3) Rs. 45,00,000
4. Borrowings (Schedule 4) Rs. 5,000
5. Other Liabilities (Schedule 5) Rs. 3,85,000
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Total Liabilities = Rs. 74,00,000
Assets
1. Cash & Balances with RBI (Schedule 6) Rs. 2,50,000
2. Balances with Banks (Schedule 7) Rs. 6,50,000
3. Investments (Schedule 8) Rs. 5,25,000
4. Advances (Schedule 9) Rs. 21,30,000
5. Fixed Assets (Schedule 10) Rs. 20,000
6. Other Assets (Schedule 11) Rs. 5,000
Total Assets = Rs. 74,00,000
Contingent Liability (Schedule 12)
Acceptances & Endorsements = Rs. 1,00,000
And voilathe balance sheet balances!
Step 7: Telling It Like a Story (Humanized Explanation)
Think of this whole exercise as preparing a schools annual day report. The bank is the
school, the shareholders are like parents, and the regulators are like the education board.
At the end of the year, the school has to show what it achieved, how much money it
collected (fees), how much it spent (expenses), and what it owns (assets like benches,
books, cash).
Similarly, Zenith Bank wants to proudly present:
Heres our capital and reserves (the strong foundation).
Heres how much our customers trusted us with deposits (like students enrolling in
large numbers).
Heres how we used that money in loans, investments, and assets.
Oh, and by the way, some students (borrowers) havent studied well (defaulted), so
we kept some marks aside (provision for doubtful debts).
By adjusting doubtful debts, showing investments at market value, and classifying loans as
per security, the bank ensures transparency. Transparency builds trust, and trust is
everything in banking.
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SECTION-D
7. Write notes on:
(i) Premium
(ii) Bonus.
Ans: Imagine this: You and your best friend decide to start a small tea stall near your school
or college. To make it successful, you both decide to keep some money aside every month,
like a saving. This money is not wastedit is like your insurance for the tea stall, because
in case the tea stall burns down or someone breaks it, you will have enough savings to
rebuild it.
Now, lets connect this same thought to insurance. When we take an insurance policy,
whether it is life insurance, health insurance, or general insurance, we agree to pay a certain
fixed amount regularly to the insurance company. This payment is known as Premium.
And sometimes, if the company makes good profits or achieves its goals, it rewards the loyal
policyholders by giving them an extra amount as a Bonus.
So, in short:
Premium is the money we pay to keep our insurance protection alive.
Bonus is the extra benefit or reward given by the insurance company for being a
loyal customer.
But lets not stop at short definitions. Lets open this story wide and really understand these
concepts in depth.
(i) Premium The Heartbeat of Insurance
Story to Understand Premium
Think of insurance like joining a gym. If you want to remain a member and use the gym
machines, you must pay a membership fee every month. If you stop paying, the trainer will
politely ask you to leave, because you are no longer a member. Similarly, insurance works
like thisif you want to keep enjoying the protection of the insurance policy, you have to
keep paying a regular fee to the insurance company. That regular fee is called Premium.
Formal Meaning
In insurance, Premium refers to the fixed amount of money that a policyholder pays to the
insurance company at regular intervals (monthly, quarterly, yearly, etc.) in exchange for the
coverage or protection offered under the insurance policy.
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If the premium is not paid, the policy may lapse, which means you will lose the protection.
Why Premium is Important?
1. Foundation of Insurance Premium is the main source of income for insurance
companies. Without it, they cannot pay claims.
2. Risk Sharing Premium collected from thousands of people is pooled together to
create a big fund. From this fund, the company pays compensation to those who
actually face a loss (death, accident, fire, etc.).
3. Continuity of Coverage Paying premium ensures your policy remains active and
you continue to enjoy financial protection.
Types of Premium
Just like ice-cream comes in different flavors, premium also has different types. Lets break
them down:
1. Single Premium The entire premium is paid at once, in lump sum, at the beginning
of the policy.
o Example: You buy a life insurance policy for 20 years by paying 1,00,000 at
once.
o Its like buying a lifetime membership at the gym instead of paying every
month.
2. Level Premium The premium remains the same throughout the term of the policy.
o Example: You pay 10,000 every year for 20 years.
o Like paying your school bus fee which never changes during the academic
session.
3. Flexible Premium In some policies, you have the option to increase or decrease the
premium as per your financial capacity.
o Example: If you get a salary hike, you may increase your premium to enjoy
higher coverage.
4. Regular Premium Paid in regular intervals (monthly, quarterly, yearly). This is the
most common method.
o Like paying your electricity bill every month.
Factors Determining Premium
Have you ever noticed how your mobile recharge plans differ from your friends plan?
Similarly, insurance premiums also differ from person to person. The following factors affect
it:
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1. Age of Policyholder Younger people usually pay lower premiums because they are
considered less risky.
2. Health Condition A healthy non-smoker pays less premium compared to a smoker.
3. Sum Assured The larger the coverage amount you want, the higher the premium.
4. Policy Term Long-term policies may have lower yearly premiums as compared to
short-term ones.
5. Type of Policy Premium differs for life, health, motor, fire, or travel insurance.
6. Occupation and Lifestyle Risky jobs like mining or aviation may attract higher
premiums.
Example to Understand Premium
Suppose Ramesh buys a life insurance policy of 5,00,000 at age 25. The company charges
him 10,000 annually for 20 years.
If Ramesh dies during the policy term, the company will pay 5,00,000 to his family.
If he survives, he may get maturity benefits depending on the type of policy.
The 10,000 he pays every year is the Premium.
So, premium is not just moneyits like buying peace of mind.
(ii) Bonus The Sweet Reward
Story to Understand Bonus
Remember those times when your school organized annual functions? If you participated
and your performance was outstanding, sometimes you received a special prizea bonus
prize apart from your regular marks in class. That bonus prize wasnt promised at the start
of the year, but it was given as an extra appreciation.
In insurance, Bonus works in a similar way. It is the extra amount given by insurance
companies to policyholders, over and above the assured sum, as a reward for being loyal
and because the company made profits.
Formal Meaning
In life insurance, Bonus is the share of profit distributed by the insurance company to its
policyholders. It is usually declared annually. The bonus is paid either at the time of maturity
of the policy or at the time of claim (like death of the insured).
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Types of Bonus
Insurance bonuses are like surprise giftsyou never know in advance how much you will
get, because it depends on company profits. Lets see the types:
1. Reversionary Bonus The most common type. Once declared, it becomes part of
the policy and cannot be withdrawn. It is paid at maturity or death claim.
2. Cash Bonus Instead of adding to the policy, the company directly gives the
declared bonus in cash to the policyholder.
3. Interim Bonus Given when a policyholders policy matures or a claim arises before
the company declares its annual bonus.
4. Terminal Bonus Also called loyalty addition. Paid once at the end of the policy
term as a reward for staying with the company for long.
Why Bonus is Given?
1. Profit Sharing Insurance companies operate on mutuality. When they make profits,
they share a portion with policyholders.
2. Encourages Loyalty Bonus motivates people to continue their policies for longer
periods.
3. Enhances Returns It increases the overall benefit of the policy.
Example to Understand Bonus
Suppose Seema has a life insurance policy of 5,00,000. The company declares a
reversionary bonus of 50 per 1,000 sum assured every year.
So, for 5,00,000 sum assured, her bonus = 50 500 = 25,000 every year.
If she continues the policy for 10 years, her total bonus = 2,50,000.
At maturity, she will receive 5,00,000 (sum assured) + 2,50,000 (bonus) =
7,50,000.
Isnt that a nice extra gift?
Difference Between Premium and Bonus
Basis
Premium
Bonus
Meaning
Regular payment made by policyholder to
keep policy active
Extra benefit/profit distributed by
insurer to policyholder
Nature
Compulsory
Optional (depends on profits)
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Time of
Payment
Paid regularly (monthly/quarterly/yearly)
Paid at maturity, surrender, or
death claim
Direction of
Flow
Money flows from insured to insurance
company
Money flows from insurance
company to insured
Function
Keeps insurance contract alive
Increases policyholders benefits
8. What financial statements are prepared by a life insurance company? Draw up Profit
and Loss Account of a life insurance. company.
Ans: Imagine for a moment that you and your friends decide to start a Life Care Club. In
this club, people give you money every month, and in return, you promise that if something
unfortunate happens to them, you will provide financial support to their family. Sounds
noble, right?
But heres the twist: at the end of each year, someone will surely ask, Hey, where did all the
money go? How much did we spend? How much do we still have? Are we making profits or
losses?
This is exactly what happens with a life insurance company. It collects money (called
premium) from lakhs of people, promises them safety, pays out claims when policyholders
face risks, and at the end of the year, it must prepare financial statements to show its
financial health.
Financial Statements of a Life Insurance Company
Just like any other business, a life insurance company prepares a set of financial statements.
But because its nature of business is different (dealing with lives, risks, and policies), the
statements are also a little different.
The main statements are:
1. Revenue Account (also called Revenue A/c or Policyholders Account)
o Shows income from premiums, interest, dividends, etc.
o Shows expenses like claims, surrenders, bonuses, commissions, and
management expenses.
o The balance is transferred to the Profit and Loss Account.
2. Profit and Loss Account (Shareholders Account)
o Shows profit or loss after considering all expenses and income.
o Helps in knowing whether the company is truly earning profit from
operations.
3. Balance Sheet
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o A snapshot of assets and liabilities of the company on the last day of the
financial year.
Among these, the Profit and Loss Account is very important because it directly shows
whether the company is doing well or not.
Why Profit and Loss Account is Special for Life Insurance Companies?
Normally, a business earns profit by selling goods or services. But in a life insurance
company, things are not so straightforward.
Income comes from premiums (people paying for policies) and from investments
(money invested in bonds, shares, real estate).
Expenses are in the form of claims (when people die or surrender policies), bonuses
(extra benefits to policyholders), and commissions (paid to agents who sell policies).
So the Profit and Loss Account becomes the scoreboard of the insurance gameit tells
whether after meeting all promises, the company still has something left as profit.
Format of Profit and Loss Account of a Life Insurance Company
Now, lets create the account in a simple and exam-friendly way.
Profit and Loss Account of XYZ Life Insurance Co. Ltd.
(For the year ending )
Debit Side (Expenditure):
Claims paid
Bonus paid in cash
Commission to agents
Operating and management expenses
Increase in Life Assurance Fund
Other expenses
Credit Side (Income):
Premium received
Interest, dividend, rent
Profit on sale of investments
Other income
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Balance: Surplus (profit) transferred to Balance Sheet.
Heres how it might look in a structured way:
Dr. Profit and Loss Account Cr.
--------------------------------------------------------------------------------------------
Particulars Amount () Particulars Amount ()
--------------------------------------------------------------------------------------------
Claims Paid xxx Premiums Received xxx
Bonus Paid in Cash xxx Interest, Dividend & Rent xxx
Commission to Agents xxx Profit on Sale of Inv. xxx
Operating Expenses xxx Other Income xxx
Increase in Life Assurance Fund xxx
Other Expenses xxx
--------------------------------------------------------------------------------------------
Surplus (Profit transferred to B/S) xxx
--------------------------------------------------------------------------------------------
Total xxx Total xxx
Explaining with a Simple Story
Think of the Profit and Loss Account as the final report card of your Life Care Club.
On one side (Debit side), you write down all the promises you fulfilled:
o We paid Rameshs family 10 lakhs as a claim.
o We gave bonuses to our policyholders.
o We paid commission to agents who brought in more members.
o We spent money on advertisements and office staff.
On the other side (Credit side), you record all the money you collected:
o We got 50 crores as premium.
o Our investments earned 5 crores in interest and dividends.
o We sold some shares at a profit.
Finally, you compare both sides. If income > expenses, congratulationsyou have a surplus!
If not, you have a deficit.
This paper has been carefully prepared for educational purposes. If you notice any mistakes or
have suggestions, feel free to share your feedback.
