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Yes. A producer strikes his equilibrium when he produces that amount of output at which the difference between total revenue and total cost is maximum. Because, gross profit = TR – TC.

Yes. Falling MC means that the cost of producing an additional unit of output tends to reduce. In a situation when price is constant (as under perfect competition) this would mean a situation when the difference between the firm’s TR and TVC tends to increase. This means a situation when firm’s gross profit (TR – TVC) tends to rise. Why should a firm not increase output when its gross profits are rising? Certainly it will. Therefore, it is only when MC is rising that the firm will find its equilibrium output.

1. When the TC rises at a diminishing rate, the MC declines. 

2. When the rate of increase in TC stops, the MC is at its minimum. 

3. When the rate of increase in TC starts rising, the MC is increasing.

Financial statements are the summarised reports of recorded-facts and are prepared following the accounting concepts, conventions and requirements of Law. The American Institute of Certified Public Accountants states the nature of financial statements as, “the statements prepared for the purpose of presenting a periodical review of report on progress by the management and deal with the status of investment in the business and the results achieved during the period under review. 

The following points explain the nature of financial statements. 

(i) Recorded Facts :Financial statements are prepared on the basis of facts in the form of cost data recorded in accounting books. The original cost or historical cost is the basis of recording transactions. The figures of various accounts such as cash in hand, cash at bank, bills receivable, sundry debtors, fixed assets, etc are taken as per the figures recorded in the accounting books. The assets purchased at different times and at different prices are put together and shown at costs. As these are not based on market prices, the financial statements do not show current financial condition of the concern. 

(ii) Accounting Conventions: Certain accounting conventions are followed while preparing financial statements. The convention of valuing inventory at cost or market price, whichever is lower, is followed. The valuing of assets at cost less depreciation principle for balance sheet purposes is followed. • The convention of materiality is followed in dealing with small items like penci’s, pens, postage stamps, etc. In this way the use of accounting conventions makes financial statements comparable, simple and realistic. 

(iii) Based on Concepts: Financial statements are prepared on certain basic assumptions (prerequisites) known as Concepts such as going concern concept, money measurement concept, realisation concept, etc. Going concern concept assumes that the enterprise is treated as a going concern and exists for a longer period of time. So the assets are shown on historical cost basis. Money measurement concept assumes that the value of money will remain the same in different periods. While, preparing profit and loss account the revenue is included in the sales of the year in which the sale was undertaken even though the sale price may be received over a number of years. The assumption is known as realisation concept. 

(iv) Personal Judgements: Under more than one circumstance, facts and figures presented through financial statements are based on personal opinion, estimates and judgements. The depreciation is provided taking into consideration the useful economic life of fixed assets. Provisions for doubtful debts are made on estimates and personal judgments. In valuing inventory, cost or market value, whichever is less is being followed.

Financial statements are very useful to an organisation but still , 

They suffer from the following limitations 

(i) Historical Data :Financial statements are prepared on the basis of historical cost. Since the purchasing power of money is changing, the values of assets and liabilities shown in financial statement do not reflect current market situation. 

(ii) Assets May not Realise: Accounting is done on the basis of certain conventions. Some of the assets may not realise the stated values, if the liquidation is forced on the company. Assets shown in the balance sheet reflect merely unexpired or unamortised cost. 

(iii) Bias: Financial statements are the outcome of recorded facts, accounting concepts and conventions used and personal judgments made in different situations by the accountants. Hence, bias may be observed in the results, and the financial position depicted in financial statements may not be realistic. 

(iv) Aggregate Information: Financial statements show aggregate information but not detailed information. Hence, they may not help the users in decision-making much. 

(v) Vital Information Missing: Balance sheet does not disclose information relating to loss of markets, and cessation of agreements, which have vital bearing on the enterprise. 

(vi) No Qualitative Information: Financial statements contain only monetary information but not qualitative information like industrial relations, industrial climate, labour relations, quality of work, etc. 

(vii) They are Only Interim Reports: Profit and loss account discloses the profit/loss for a specified period. It does not give an idea about the earning capacity over time similarly, the financial position reflected in balance sheet is true at that point of time, the likely change on a future date is not depicted.

A public company is defined as a company that offers a part of its ownership in the form of shares, debentures, bonds, securities to the general public through stock market:

The nature of the financial statements depends upon the following aspects; 

1. Recorded facts: The items recorded in the financial statements reflect their original cost i.e. the cost at which they were acquired. Consequently, financial statements do not reveal the current market price of the items. Further, financial statements fail to capture the inflation effects. 

2. Conventions: The preparation of financial statements is based on some accounting conventions like, Prudence Convention, Materiality Convention, Matching Concept, etc. The adherence to such accounting conventions makes financial statements easy to understand, comparable and reflects the true and fair financial position of the company. 

3. Accounting Assumptions: These basic accounting assumptions like Going Concern Concept, Money Measurement Concept, Realisation Concept, etc are called as postulates. While preparing financial statements, certain postulates are adhered to. The nature of these postulates is reflected in the nature of the financial statements. 

4. Personal Judgments: Personal value judgments play an important role in deciding the nature of the financial statements. Different judgments are attached to different practices of recording.transactions in the financial statements. Thus, personal judgments determine the nature of the financial statements to a great extent.

When shares are issued to the general public, the minimum amount that must be subscribed by the public so that the company can allot shares to the applicants is termed as Minimum Subscription. As per the Company Act of 1956, the Minimum Subscription of share cannot be less than 90% of the issued amount. If the Minimum Subscription is not received, the company cannot allot shares to its applicants and it shall immediately refund the entire application amount received to the public.

Buy-back of shares means repurchasing of its own shares by a company from the market for reducing the number of shares in the open market.

The various parties that are directly or indirectly interested in the financial statements of a company can be categorized into the following two categories Internal Parties. 

The following are the various internal accounting users who are directly related to the company:

(a) Owner: The owner's is/are interested in the profit earned or loss incurred during an accounting period. They are interested in assessing the profitability and viability of the capital invested by them in the business. 

(b) Management: The financial statements help the management in drafting various policies measures, facilitating planning and decision making process. The financial statements also enable management to exercise various cost controlling measures and to remove inefficiencies. 

(c) Employees and workers: They are interested in the timely payment of wages and salaries, bonus and appropriate increment in their wages and salaries. With the help of the financial statements they can know the amount of profit earned by the company and can demand reasonable hike in their wages and salaries. 

External Parties: There are various external users of accounting who need accounting information for decision making, investment planning and to assess the financial position of the business. The various external users are given below. 

(a) Banks and other financial institutions: Banks provide finance in the form of loans and advances to various businesses. Thus, they need information regarding liquidity, creditworthiness, solvency and profitability to advance loans. 

(b) Creditors: These are those individuals and organisations to whom a business owes money on account of credit purchases of goods and receiving services; hence, the creditors require information about credit worthiness of the business. 

(c) Investors and potential investors: They invest or plan to invest in the business. Hence, in order to assess the viability and prospectus of their investment, creditors need information about profitability and solvency of the business. 

(d) Tax “authorities: They need information about sales, revenues, profit and taxable income in order to determine the levy various types of tax on the business. 

(e) Government: It needs information to determine national income, GDP, industrial growth, etc. The accounting information assist the government in the formulation of various policies measures and to address various economic problems like employment, poverty etc. 

(f) Researchers: Various research institutes like NGOs and other independent research institutions like CRISIL, stock exchanges, etc. undertake various research projects and the accounting information facilitates their research work. 

(g) Consumers: Every business tries to build up reputation in the eyes of consumers, which can be created by the supply of better quality products and post-sale services at reasonable and alfordable prices. Business that has transparent financial records, assists the customers to know the correct cost of production and accordingly assess the degree of reasonability of the price charged by the business for its products and, thus, helps in repo building of the business. 

(h) Public: Public is keenly interested to know the proportion of the profit that the business spends on various public welfare schemes; for example, charitable hospitals, funding schools, etc. This information is also revealed by the profit and loss account and balance sheet of the business.

Any one of the following arrangements can be made by company to fulfill the required amount for the redemption of debentures.

• Redemption of debentures from the fresh issue of shares and debentures.
• Redemption of debentures out of capital.
• Redemption of debenture out of profit.

Following are the methods of redemption of debentures :

• To pay total amount on particular date.
• Payment through instalments.
• Purchase of own debentures from the open market.
• By converting debentures into shares.

Redemption of debentures means repayment of debentures.

The word Debenture is derived from a Latin word ‘debere’ which means to borrow. A debenture is issued in the form of a certificate under the seal of a company and containing a contract for the repayment of the principal sum after a fixed period of time and payment of interest at regular intervals, generally half yearly. Debentures are issued by a company for acquiring long-term borrowings. 

Types of Debenture:

• Redeemable Debentures: The debentures which are repayable on a specified date are called redeemable debentures. 

• Irredeemable Debentures: If there is no fixed time by which the company is bound to pay back the money then it is known as irredeemable debentures. These debentures are also called perpetual debentures. 

• Convertible Debentures: Debentures which can be converted into equity shares after a specified period of time are known as convertible debentures. 

• Non-convertible Debentures: Debentures which cannot be converted into equity shares after a specified period of time are known as non-convertible debentures. 

• Secured Debentures: If debentures are issued with a charge on the assets of the company as security it is known as Secured debentures. The charge may be fixed i.e., on specified asset, or it may be floating. Secured debentures are also known as mortgaged debentures. 

• Unsecured Debentures: if debentures are issued with merely a promise of payment without having any charge on any assets as security is known as, unsecured debentures. So these debentures are also known as naked or simple debentures. 

• Registered Debentures: Registered debentures are those which are duly recorded in the register of debenture holders maintained by the company. These can be transferred only through a regular transfer deed. 

• Bearer Debentures: Bearer debentures are those which are not recorded in the register of debenture holders maintained by the company.

When a debenture holder can conveit his/her debentures into shares or new debentures after the expiry of a specified period of time, then it is known as redemption of debentures by conversion. As the company does not need to pay any. funds for the redemption, so there is no need to maintain Debenture Redemption Reserve (DRR). The new shares or debentures may be issued at par, premium or at discount.

If a debenture holder exercises the conversion option, then the issue price of shares must be equal to or less than the amount actually received from debentures.

Accounting Treatment

For amount due to debenture holders 

Debenture A/c Dr 

To Debenture holders A/c 

(Debentures redeemed) 

For discharging liability to the debenture holders . 

Debenture holders A/c Dr 

To Shares/Debentures (New) A/c 

(Debenture holder amount discharged)

Irredeemable Debentures are those debentures which may not be redeemed during the life of a Company. They can only be paid off in the event of winding up of the Company. The holder of such debenture will enjoy interest on these debentures throughout the life of the company. Now-a-days no company issue irredeemable debentures.

Capital Reserve is a reserve that is created out of capital profits. Capital profits are those profits arising out of those activity which are not part of the business operations e.g., premium on issue of share and debentures, profits of sale of fixed asset, profit on redemption on debenture and profit on reissue of forfeited share and so on. 

A capital reserve can be utilised for meeting the future capital losses. Here it is to be remembered that capital reserve cannot be used for distributing dividend to the share holders but bonus shares can be issued out of the capital reserve.

When debentures are issued below its par value (or the face value) but are redeemed at price higher than its par value, then it is termed as issue of debenture at discount and redeemable at premium. The difference between the issue price and the redemption price is treated as loss on issue of debenture.

(c) Loss on issue of debentures account

Normal Profit = Capital Employed x N.R.R.

 2,00,000 x \(\frac{10}{100}\) = Rs 20,000

Super profit = Average Profit – Normal Profit

= 40,000 – 20,000 = Rs 20,000

Goodwill = 20,000 x 2.487 = Rs 49,740

Under this method, goodwill is calculated as certain years of purchase of average profits of the past years. The number of years of purchase is generally determined on the basis of the average period a new business will take in order to bring it to the current state of the existing business.

The nature of the goodwill can be described as follows: 

1. Goodwill is a tangible fixed asset. It is tangible because it has no physical existence. It cannot be seen or touched.

2. It has a definite value depending on the profitability of the business enterprise. 

3. It cannot be separated from the business. 

4. It helps in earning more profit and attracts more customers. 

5. It can be purchased or sold only when the business is purchased or sold in full or in part.

Goodwill is calculated by multiplying the weighted average profit by a certain number of years of purchase. 

Goodwill = Weighted average profit x Number of years purchase

In this method, weights are assigned to each year’s profit. Weighted profit is ascertained by multiplying the weights assigned with the respective year’s profit.

Weighted average profit = (Total of weight profits)/(Total of weight)

Actual Average Profit of 5 years 

\(= \frac { Rs. \,45,000 + Rs. \,50,000 + Rs. \,55,000 + Rs. \,70,000 + Rs. \,80,000 }{ 5 }\)
 \(= \frac { Rs.\ 3,00,000 }{ 5 }\)= Rs 60,000
Normal Profit = Rs 5,00,000 x \(\frac{8}{10}\) = Rs 40,000
Super Profit = Rs 60,000 – Rs 40,000 = Rs 20,000
Goodwill = Super Profit x No. of Years Purchase
= Rs 20,000 x 3 = Rs 60,000

(1)Capitalization Method:
Under this method, goodwill can be calculated in two ways :
(i) By capitalizing the average profit
(ii) By capitalizing the super profit
(2) Capitalizing the Average Profit Method: Under this method, first of all we calculate the average profit and then we assess the capital needed for earning such average profit on the basis of normal rate of return. Such capital is also called Capitalized Value of Average Profit. It is calculated as under.

Capitalized Value of Average Profit 

= Average Profit x \(\frac {\textit{100}}{\textit{Normal Rate of Return}} \)

Goodwill = Capitalized Value of Profit – Capital Employed

Under average profit method (Average profit)/(Normal rate of return) x 100.

Super profit =  Average profit – Normal profit.

(a) Average profit – Normal profit

(c) 3, 4, 1, 2

Capitalisation method: 

Under Capitalisation method, goodwill is the excess of capitalised value of average profit of the business over the actual capital employed in the business.

Goodwill = Total capitalised value of the business – Actual capital employed 

The total capitalised value of the business is calculated by capitalising the average profits on the basis of the normal rate of return. 

Capitalised value of the business = (Average profit )/(Normal rate of return) x 100

Actual capital employed = Fixed assets (excluding goodwill) + Current assets – Current liabilities

1. When there is a change in the profit-sharing ratio. 

2. When a new partner is admitted into a firm. 

3. When an existing partner retires from the firm or when a partner dies. 

4. When a partnership firm is dissolved.

Capital employed = fixed assets + current assets – current liabilities 

= 5, 00, 000 – 2, 00, 000 

= 3, 00, 000 

Normal profit = Capital employed x Normal rate of return 

= 3,00,000 x 12.8/100

= 3, 75, 000 

Super profit = Average profit – Normal profit 

= 60, 000 – 37, 500 

= 22, 500

 Goodwill = Super profit x Number of years of purchase 

= Rs. 22,500 x 2 

= Rs. 45,000

Super profit method normal profit is Normal profit = Capital employed x Normal rate of return.

(d) All of these

Super profit = Average profit – Normal profit 

= 14, 000 – Rs. 4, 000 = Rs. 10, 000 

Goodwill = Super profit x Present value of annuity factor 

= Rs. 10,000 x 3.352 

= Rs. 33, 520

(c) Goodwill under Annuity method – Average profit x Present value of annuity factor

(d) Rs. 15,000

Calculation of goodwill under simple average profit method is Total profit = (Total profit) = (Total profit)/(Number of years).

Admission of Partner : Admission of a partner means new partner being admitted in the firm. 

Methods of calculation of goodwill : The different methods of calculation of goodwill are:

1. Year’s purchase method :

(i) Average Profit Base
(A) Simple Average Method : Actual average profits of past few years earned by the firm called Future Maintainable Profit or Expected Profits.

Points to be Noted :
(a) if net profit&show an Increasing or decreasing trend, calculate weighted, average in place of simple average.
(b) income from non-trading investments should be deducted from net profits.
(c) Abnormal profit of any year, say profit on sale of land or speculation profit should be deducted from the profit of that year.
(d) Abnormal loss or abnormal expenses should be added in net profit.
(e) Fair remuneration of the proprietor is also to be deducted from average profits.

After making above adjustments such adjusted profits should be considered for valuation of goodwill. These are called Average Maintainable Profits.

Average Profit = \(\frac {\textit{Total adjusted profits}}{\textit{No.of year}} \)

Actual average profit = Average profit – Remuneration of partners
Goodwill = Actual average profit x No. of years purchases