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Financial Accounting

Liquidation of Companies
The word liquidation has not been used anywhere in the Companies Act, 1956. It is the word
winding-up which has been used in this act. The word liquidation is used for winding-up by
many persons. Liquidation is means by which the dissolution of a company is brought about
and its assets realised and applied in payment of its debts and when all the debts are paid, off
the balance, if any, remaining is paid back to the members in proportion to the contributions
made by them towards the capital of the company.
Liquidation of company can take place under both the cases namely when the company is
insolvent and when the company is not insolvent. When the companys position is very
sound, then its members may like to wind it for re-incorporation with extended objects or for
amalgamation with one or more companies.
Winding-up or liquidation of company may take place in any one of the following ways

voluntary winding-up,
Winding up under supervision of the court,
Winding-up by the court or compulsory winding-up.

Voluntary winding-up of the companies

When member and creditors of the company decide to wind-up of the company without
intervention of the court, it is known as voluntary winding-up of a company.
Voluntary winding-up is very common because there are not so many restrictions in this type
of winding-up as are found in case of other types of winding-up.
Voluntary winding-up can take place under the following circumstances;
When the period, if any, fixed for the duration of the company by the articles has
expired, or the event, if any, has occurred on the occurrence of which he articles
provide that the company is to be dissolved, and the company in general meeting
passes a resolution requiring the company for winding-up voluntarily.
Where a company was formed for a fixed period or the articles had provided that the
company was to be dissolved on the happening of certain events, the company may
be wound up by passing of a simple resolution by bare majority at a general meeting,
If the period fixed had expired or the events have happened1.
If the company passes a special resolution that the company be wound up voluntarily.
However prosperous and solvent a company may be, if the members wish the
company to be wound up, they can do so by passing a special resolution to that effect
1. S.M Shukla, financial accounting 685 (Sahitya bhawan publication, Agra,5th ,edn.,2013).
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and no reason need be given. No articles of the company can prevent the exercise of
this statutory right.
Date of winding-up: Voluntary winding-up is treated to have commenced from the date on
which resolution for the same is passed.

Types of voluntary liquidation

1) Members Voluntary winding-up,
2) Creditors voluntary winding-up.

Members Voluntary winding-up

When the members of the company decide to wind it up even when its financial position is so
sound that it can pay all its debts, this winding up is called Members voluntary winding-up.
When it is proposed o wind up a company voluntarily, its directors or in the case the
company which has more than two directors, the majority of the directors, may at a meeting
of the board , make a declaration by the affidavit to the effect that they have made a full
enquiry into the affairs of the company, and that they are of the opinion that the company has
no debts and in case of company has debts, it will be able to pay its debts in full within the
period of three years from commencement of winding-up. This type of declaration by the
directors of the company is called declaration of solvency.
This declaration of solvency must be made within five weeks immediately preceding the date
of passing of the resolution for winding-up the company and it must be delivered to the
registrar for registration before that date2.

Procedure for members voluntary winding-up

1. As soon as the affairs of the company are fully wound-up, the liquidator should made
up an account of the winding-up and call a meeting of the company. He places his
account (known as liquidators final statement of the account) before this meeting.
This meeting is the last meeting of the company. Liquidator should send a company of
his account and statement of the registrar within one week of this meeting.
2. On the receipt of the above statement and account, registrar will register them and
after three months of this registration company will be completely wound-up.

2. S.M Shukla, financial accounting 685 (Sahitya bhawan publication, Agra,5th ,edn.,2013)
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Financial Accounting
Liquidation under supervision of the court
At any time after a company has passed resolution for voluntary winding-up, the court may
make an order that the voluntary winding-up shall continue, but subject to such supervision
of the court and with such liberty for the creditors, contributories or others to apply to the
court, and generally on such terms and conditions as the court think just. This type of
liquidation is called liquidation under supervision of the court3

Liquidators statement of account

The required to prepare an account of winding up known as Liquidators Final Statement of
Account after the affairs of the company are fully wound up. This account takes the form of
Cash Account. The main job of the liquidator is to collect the assets of the company and
realize them and distribute the money realized among right claimants. For this purpose the
Cash Book is maintain for the purpose of recording the receipts and payments and is required
to submit an abstract of the Cash Book to the court in case of compulsory winding up and to
the company in ease of voluntary winding up.
The following receipts are shown on the debit side of this account4:
1. Amount realized on sale of assets.
2. Amount received from delinquent directors and other officers of the company.
3. Contributions made by the contributors.
On the credit side of the account, he records the payments made in the following


Payment of secured creditors and dues to workmen up to their claim or up to the
amount of securities held by secured creditors as per section 529. The balance of
secured creditors left unsatisfied (i.e., when the claims of the secured creditors are
more than the amount realized by sale of. securities) will be added to unsecured
Cost of winding up (i.e., legal charges).
Liquidators remuneration.
Payment of creditors (e.g., debentures) having a floating charge on the assets of the
company. Interest on debentures should be paid upto the date of actual payment to
the debenture holders and not only upto the dale of liquidation provided the company

3.S.M Shukla, financial accounting 685 (Sahitya bhawan publication, Agra,5th ,edn.,2013)
4 visited on 23/09/15
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is solvent. But if the company is insolvent, interest is payable upto the dale of
commencement of insolvency proceedings.
5. Payment of preferential creditors.
6. Payment of unsecured creditors. This may also include liability in -respect of
dividend declared but not paid but the payment of dividend due will be paid only
after the amount due to outsiders is paid.
7. Amount paid to preference shareholders.
8. Amount paid to equity shareholders.
The various claims will be satisfied by the liquidator in the order mentioned above. So, if the
money available with the liquidator is exhausted after paying, say, debenture holders partly or
fully, payments will not be possible to unsecured creditors, preference shareholders and
equity shareholders.
In the preparation of the Liquidators Statement of Account, the principle of double entry is
not involved. It is only a statement although presented in the form of an account. It is a
summary of the Cash Book after the start of the liquidation.

valuation of goodwill and shares

Goodwill is an invisible fixed asset. It is created through a process which carries a certain
value but cannot be seen or touched. It is an attracting force which helps in attracting
customer As a result of this, business organisation succeeds in earning additional profits. Its
value depends upon popularity, image, prestige, honesty, fairness, economic position and
sound relation of the business. Capacity to earn additional profit is a result of this is termed as
goodwill. Goodwill is the value of the reputation of the concern, it consists the benefits a
business enjoys in connection with its customer, employees and other third party. It is also
said that, goodwill is the present value of a firms anticipating excess earning. .

Factors determining the value of goodwill

Various factors affecting the value of goodwill are as follows:
1. Nature of business. It means the prevailing competition, level of risk involved, govt.
Regulations, nature of demands etc. If the existing business units are earning more than
normal profits and have secured monopolistic position, they will be enjoying more goodwill.
2. Favourable location. It is very well known that certain cities or places are most suitable
for particular industries; business having units falling under same areas can enjoy the
goodwill by selling more products. It must be noted that goodwill arises in a particular
locality only because shopping space is limited in relation to demand for it.
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3. Capital requirements. Amount of capital required for a business is also influence the
value of goodwill. The business requiring less capital can realise higher amount of goodwill
than another business earning less profits with a huge amount of capital.
4. Life of the business. Time also increases the value of goodwill. Business running on
profitable lines for the last many years enjoys more goodwill as compared to the recent
started business.
5. Trade name. A firm which possesses the necessary patents and trademarks for selling its
products will have built up good reputation and enjoys goodwill.
6. Special contracts. Where a business is having special contracts in hand giving exceptional
profits, the goodwill of the business will be much higher.
7. Managerial ability. The efficiency, skill and ability of the managerial personnel is also an
important factor on which value of goodwill depends. The efficient management helps in
increasing profits in the business which in turn, increases the value of goodwill.
8. Risk involved in the business. The value of goodwill is likely to be higher in the low risk
business. On the contrary, if the business is purely of speculative nature and is very risky, the
goodwill will have very little value.
9. Profit trends. When the last years records of the business shows the constantly increasing
profits, it will lead to attract higher value for its goodwill.
10.Nature and extent of competition. The value of goodwill of a business is is greatly
affected by the degree of competition. If the competition is negligible or if there is no
competition, the value of goodwill will be more or vice-versa.
11.Quality of products. The business units which enjoys good commercial reputation for the
quality of their products, they have a high value of goodwill.
12. Money market conditions. When easy money market conditions prevail, there would be
more buyers willing to buy an established business and pay a higher price for the goodwill or
13.Types of customers. Commercial value of goodwill depends upon the types of
customers. They may be classified according to the distinctive features viz. Cat, dog and rat.
The valuation will depend upon the degree of attachment of business with personnel
character of the owner.
14.Miscellaneous factors. Besides these above mentioned factors, the value of goodwill is
also affected by employer-employee relation. Technical know-how possessed by the business,
future prospects of the industry, research and development efforts, and govt. Policies etc.
Need for value of goodwill. It depends on the form of business organisation.

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Financial Accounting

Sole traders: under the sole traders form of business organisation the need for the
valuation of goodwill may arise in the following circumstances:

a. When the business is sold.

b. When a new person is admitted in the firm and the firm becomes a partnership firm.
c. When the business is converted into a company.

Partnership firm: Under the partnership form of business organisation the need for
the valuation of goodwill may arise in the following circumstances:

a. When a new partner is admitted to a partnership firm.

b. When an existing partner retires or dies.
c. When there exists any change in the profit sharing ratio of the existing partners.
d. When whole of the partnership firm is sold out to any other firm or person.
e. When a partnership firm is converted into a company.
f. When there is a case of amalgamation of two firms.

Companies: In case of a company, the need for valuation of goodwill may arise in the
following circumstances:

a. When there is a situation of amalgamation of two companies.

b. When the business of the company is sold to another existing company.
c. When one class of the shares is converted to another.
d. When a company acquires the controlling interest in the company and becomes a
holding company.
e. When there arises a need for the valuation of the shares of the company.
f. When shares of the company are not listed on the stock exchange and they have to be
valued for taxation purposes.
Generally the goodwill is classified into two categories
Purchased goodwill
Non purchased goodwill or raised goodwill.
Purchased goodwill: This type of goodwill arises only when a business enterprise is acquired
by another business enterprise and the price paid is more than the net asset acquired, such
goodwill is recognised by the accounting profession and is also shown in the balance sheet.

Methods of valuation of goodwill

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1. Arbitrary assessment method: The value of goodwill under this method is arrived at by
mutual agreement between the vendor of a business and its buyer. The amount agreed to be
payable for goodwill is the excess of purchase price over the net assets taken over. For
example, A ltd. purchases the business of B ltd. and it is mutually agreed upon that A ltd. will
pay to B ltd. a sum of Rs. 5, 00,000 on account of goodwill.
Although very simple, this me is not a reliable and scientific method based on a
yardstick of performance of business. The value of goodwill being based on future
maintenance profits, the earning capacity of business must be considered while valuing
goodwill. If formation regarding earning capacity is not available, this method cannot be
2. Average profits method. Under this method, goodwill is valued as under:
Goodwill = average profit X no. Of years of purchase
In this case profit means future expected trading profit.
For this purpose following adjustments are to be done:
Balance of profit and loss
Add: (i) all abnormal losses (if already debited)
Like loss by fire or theft, loss on sale of
Fixed assets.
Less: (i) all abnormal incomes (if already credited)
Like insurance claim income from lottery or speculation, profit on sale of fixed assets.
(ii) Non-trading incomes, like income from investment (non-trade), rent from building let out
(iii) Normal expenses (if not already debited)
Adjusted trading profit
Average profit may be calculated as
(i) Simple averages
Simple average = total profits of some years/no.of years.
Weighted profit = total of products of profits & weights/total of weights.
Under this method, goodwill is valued on basis of an agreed no. Of years purchase of
average adjusted profit. The number of years selected depends upon the probable
maintenance of past profit in future years.

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3. Super profits methods. It is the excess of the average profits over the normal profits based
on normal rate of return for representative firm in industry. For computation of super profit,
the following three factors are required.
Capital employed
Normal rate of return
Normal profit
Where capital employed = fixed assets + trade investments + current assets debentures
current liabilities.
Paid up equity and preference share capital + accumulated balance on capital reserves,
general reserves and credit balance in profit and loss revaluation profits or loss
fictitious assets non assets.

Goodwill under super average method

Goodwill = super profit x no. Of years purchase
Where super profit = average adjusted profit normal profit
Normal profit = capital employed x normal rate of return
4. Annuity method. Under this method the value of goodwill is calculated by finding the
present worth of an annuity paying the super profit (per year) over the estimated period
discounted at the appropriate rate of interest.
Goodwill = super profits x value of an annuity.
Mostly the value of annuity at the normal rate of profit and is same for number of years for
which purchase of super profit method is to be applied is given. If in case of the value of
annuity is not given the same is calculated by applying the formula
5. Capitalisation method. There are two methods of calculation of goodwill under
capitalisation method, viz.
Capitalisation of average trading profit: under this method normal capital
employed is be found out by capitalising average trading profit. Normal capital
employed means the amount of capital must be invested in the same class of business
to earn such average trading profit. But if actual capital employed is less than the
normal capital employed, then such difference will be the goodwill of the firm.
Capitalisation of super profit: In this method goodwill is calculated by capitalising
the super profit at the normal rate of return. This method attempt to determine the
amount of capital needed for earning super profit. Under this method,
Goodwill = super profit x 100/normal rate of return.
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Following are some of the main features of purchased goodwill:
a. It arises only when there is a purchase of business from one party to another.
b. It is reflected by the purchase transaction.
c. Its cost could depend upon the future maintainable profits.
d. It can be shown in the asset side of the balance sheet in the books of accounts at the end of
the financial year.
Non-purchased goodwill: it is also known as raised goodwill being no cost is paid for
acquiring this goodwill. This goodwill arises only when a business generates its own
goodwill over a period of time. The value of raised goodwill depend upon the various factors
such as favourable location life time of business, trade mark and patent right special contracts
The main features of such goodwill are:
1. It is internally generated.
2. No cost is placed for it.
3. It is not reflected by a purchase consideration.
4. It is not shown in the balance sheet.
5. Value of goodwill is based on the subjective judgement of the value.
Goodwill can also be classified on some other basis which is known as zoological
classification although this type of goodwill does not have any effect on the
accounting treatment of goodwill in the books of accounts.
The following are the types of goodwill under zoological classification:
1. Dog goodwill
2. Cat goodwill
3. Rat goodwill
Dog goodwill: it arises when reputation of firm due to person instead of place. Like as the
nature of dog who always follows its master wherever he goes. On the same way goodwill
moves with movement of person. This type of goodwill can be seen in case of doctors,
accountant, teachers and lawyers etc.
Cat goodwill: This type of goodwill is attached with the place instead of persons. Same like
the nature of cat, who always attach more with the house than the person living there in. In
this type of goodwill, the owner of the business may change but customer will go to the same
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Rat goodwill: This type of goodwill not arises due to reticular place or person. Same as the
nature of rat who has no attachment with place or person. There in this case it is difficult to
ascertain that whether there is any goodwill of not.
Need for valuation of shares:
Following are the circumstances, necessitating valuation of shares:
1. At the time of amalgamation and absorption.
2. When unquoted shares are to be bought or sold.
3. At the time of converting preference shares or debentures into equity shares.
4. Where a portion of shares is to be given by a member of proprietary company to another
member as a member cannot sell it in the open market it become necessary to certify the fair
5. For the valuation of the assets of a finance or investment trust company.
6. At the time of assessment by the income tax authorities for the purpose of estate duty,
capital gain, wealth tax and gift tax.
7. When the company is nationalised and the compensation is payable by the govt.
8. When a company acquires majority shares of another company for the purpose of acquiring
a controlling interest in another company.
9. When shares are pledged as a security against loan
10. At the time of paying court fees.
11. When shares are purchased by the employees of a company to be kept by them during the
tenure of their service.
12. At the time of purchase and sale of shares in private companies.
13. When partners hold shares of a company for ascertaining the amount to be distributed
amongst them on dissolution of firm.
14. For satisfying dissentient shareholders in the case of reconstruction of a company under
section 494.
Factors affecting valuation of shares.
1. The basic or principle factor in the valuation of shares is the dividend yield that the
investor expects to get as compared to the normal rate prevailing in the market in the same
2. Growth prospects of the company.
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3. Demand and supply of shares.
4. The nature of the business of the company concerned.
5. Dividend policy of the company and %age of dividend declared in the part.
6. Part performance of the company.
7. Govt. Policies in relation to companys business.
8. Accumulated reserves of the company.
9. Economic climate
10. The income yielding capacity of the company.
11. Size of the business.
12. Net asset position of the company.
13. Availability of the ready market for future sale.
14. Management of the company.
15. Prospects of bonus or right issue.
16. Political factors prevalent peace and prosperity in the country and govt.s attitude towards
the industry.

Methods of valuation of shares.

1. Net assets method or intrinsic value or net worth method. As the name suggest, that the
value of shares under this method is calculated by dividing the net assets of the business by
no. Of equity shares. all the assets from the asset side of balance sheet are sum up than deduct
the liabilities appearing on liabilities side also less any probable loss or expenses the value
arrived is the amount available for equity shareholders.
While calculating the value of net assets if it is necessary to understand that the non-trading
assets like investments should also be included and all the assets should be taken in their
market value. If the preference share capital appears in the balance sheet than the total
amount of preference share capital and the payment of any type of dividend in arrears on
them should also be deducted from the total value of assets:
Value of per share = net assets for equity shares/ no. Of equity shares.

1. It is very simple and logical method for calculating the value of shares.
2. This method is mostly used by taxation authorities.
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3. Present value of goodwill is also considered under this method.
4. As the net realisable value of assets is taken into consideration this is useful for company
going liquidation.
5. Preference shares capital also given preferences or priority over equity and deducted from
assets like other liability.

1. This method is not suitable for growing company.
2. As goodwill is taken into consideration, it is difficult to calculate the value of goodwill.
3. This method leads to personal bias as the market price of the asset is to be quoted which is
very difficult to ascertain.
4. This method is not a reliable one, as it includes the intangible asset such as goodwill, trade
2. Yield method or earning capacity or market value method.
Under this method the value of the shares are calculated on the basis of its prospective
earnings. Market value of assets and liabilities is not considered. The value of shares is
calculated by comparing the expected earnings of the company with normal rate of return on
investments. This method is based on the philosophy that shareholders value the return which
he received and not the earnings of the company.
The calculation under this method is divided into three parts.
a. Calculation of expected rate of return
Profits available from dividend to equity/paid up equity share capital x 100
b. Value of equity shares:
Expected rate of return/normal rate of return x paid up value of share.

Value of shares in case of majority holdings is ascertained by the method based

Upon the expected rate of earnings where as in case of minority holdings the value of shares
is better calculated by adopting expected rate of dividend rather than expected rate of
dividend rather than expected rate of earnings, main reason being small investors generally
interested in the dividend rather than the expected rate of earnings.
Value of shares = possible rate of dividend/normal rate of dividend x paid up value of share

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a. This method is most reasonably accepted being this method is based upon comparison
expected rate of return with normal rate of return.
b. This method is useful in case of minority holdings since they are interested in the profits
earned by the company.
c. It is best suited to a company which is a going concern.

a. It may have to face problems while selecting the normal rate of return.
b. Major drawback is that it doesnt take into consideration the value of net assets of the
c. It is not suitable for the company which is going into losses for the past few years.
d. The method contains various difficulties while application of this method.
e. Predicting the future maintainable profits is quite difficult.
3. Fair value method.
As we had already discussed the two methods of calculating the value of shares
Net asset method
Yield earning method
But both have some drawbacks say net asset method is not suitable where the company is
having the phase of super profits where as yield earning method is not fit where the
expansion plans are undertaken in the company.
The formula applied to get the value of share is:
fair value of shares = intrinsic value+ yield value/2
where intrinsic value is the value of share calculated by net asset method.

This method of valuation of goodwill is suitable to apply under condition of availability of
information. Various information is required for implementing the formula viz. Normal rate
of return, value of all assets and outside liabilities etc. It is suitable where the market
information related to normal rate of return is readily available. Value of all assets and outside
liabilities is clearly mentioned so that the value of business could be easily ascertainable.
Moreover the future maintainable profits of the company can be easily predicted on the basis
of past data.
1. Net Assets Basics [Excluding the goodwill]
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All Assets
[Excluding goodwill and factious assets]
Less: all liabilities (including preference share capital. but excluding equity paid up capital
and reserves & surplus)
Value per Equity share=Net Tangible Assets/no. Of Equity shares
[B] Net assets Basics [including goodwill]
All Assets
[Excluding fictitious assets]
Less: All liabilities [including Preference share capital and reserves & surplus]
Value per Equity Share=Net Assets/No. Of Equity Shares
2. Earnings capacity or yield basics or market value method
(A) Valuation based on rate of return:
(b) (I) valuation based on rate of dividend
Value per Share= possible Rate of Dividend/Normal Rate of Dividend*paid-up Value
per dividend
Where, Possible Rate of Dividend=Total profits available for dividend/Equity paid up
Calculations of total profits available for dividend;
Profit after tax
Less: transfer to reserve
Transfer to debenture redemption fund
Preference dividend
Total profits available for equity dividend
(II) Valuation Based on rate of Earning
Value for share= possible earning rate/normal earning rate*paid up value per share
Where possible rate of earning=actual profit earned/capital employed*100

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Capital employed includes equity paid up capital +preference share capital + reserve and
surplus +long term borrowing fictitious assets.
Actual profit earned means profit after tax but before debenture interest and preference
(B) Valuation based on price earning ratio(P/E ratio)
Market value per share = price earning ratio x earning per share.
Where, earning per share = profits available for equity shares/no. Of equity shares
(C) Valuation based on productivity factor
Productivity factor = average weighted adjustment profit (after tax)/average weighted net
worth (i.e. shareholders fund) X 100
Maintainable profit = net worth on valuation date X productivity factor.
Maintainable profit for equity shares = maintainable profit transfer to reserve dividend on
preference shares.
Capitalisation of maintainable profit for equity shares =
Maintainable profit for equity shares X 100/normal rate of return
Value for equity shares = capitalised value / no. Of equity shares
3. Dual basis as fair value method
Value per share = (value per share on net assets basis + value per share on earning basis)/2

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