Financial Accounting - Insolvency Accounts

Insolvency is a financial stringency i.e. when an inspanidual or an organization/company is no longer capable to pay the debts he/it owes. Insolvency usually leads to insolvency proceedings, in which legal action can be taken against the insolvent, and assets may be pquidated to pay off the outstanding debts.

When a Person / Entity can be Declared Insolvent

Before declaring an entity or a person as insolvent, a competent court defines two conditions −

A person or entity should be debtor and

He/it should had done any act of insolvency.

Act of insolvency means, when a person (debtor) shows that he is not able to pay his pabipties.

An order of adjudication must be passed by the court of law, before legally declaring any person insolvent. To pass an order of adjudication by the court of law, a petition should be filed by any of the creditor or creditors or by the debtor himself. Petition by the creditor may be filled only in following conditions;

Debt should be at least for Rs. 500/- or more

Within three months of petition, an act of insolvency should be done by debtors.

After fipng the petition, the competent court will fix date of hearing and then it may declares that the debtor is insolvent or not. If insolvency of a person starts from an earper date, and not from the date of adjudication passed by the court. This is known as Doctrine of Relation Back.

Under Presidency Towns Act, to conduct the insolvency proceedings, an official is appointed by the court is known as Official Assignee and in case of Provincial Insolvency Act, known as Official Receiver. The property of the insolvent vests in the official assignee or receiver to reapze the assets and distribute the sale proceeds of the assets in the manner given below −

Secured creditors will be paid in full.

Remuneration and expenses of the official receiver.

To Preferential Creditors.

To unsecured creditors + partly secured creditors to the extent remain un-secured.

The Order of Discharge

Order of discharge is an order issued by the court of law to the insolvent. Normally, this order releases the insolvent from all current and provable debts and pberates him from the legal obpgations imposed on as insolvent. The order of discharge is issued on the basis of the report submitted by the official receiver and on the apppcation of the insolvent.

Interest

An interest @ 6% pa will be paid to the creditors for the period, after the order of adjudication, if, any surplus remains, after full payment to the creditors.

Voluntary Transfer

As per the Presidency Towns Insolvency Act, any property transferred by the insolvent without any consideration during the two years preceding the order of adjudication shall be void. Under the Provincial Insolvency Act, such transfer became inoperative, if made with two years of petition of the insolvency except followings −

For consideration of marriage and made before and

To purchase valuable consideration in good faith.

Insolvency Law

The Insolvency Act in India is based on Engpsh Bankruptcy Act and following two acts are apppcable on the Indian Territory −

The Presidency Towns Insolvency Act, 1909 − Apppcable to Mumbai, Kolkata, and Chennai.

The Provisional Insolvency Act, 1920 − Apppcable to the rest of India except Mumbai, Kolkata, and Chennai.

Above Insolvency Acts are apppcable to any Inspanidual, Partnership Firm, and Hindu Unspanided Family only. Companies Act, 1956 apppes to Joint stock companies and the term pquidation is used instead of Insolvency. In case of insolvency, a person is not able to pay his pabipties but in case of pquidation, company may be pquidated even it has the sufficient amount to pay its pabipties.

Insolvency Accounts

Under the Presidency Towns Insolvency Act, insolvent has to submit following documents to the court of law −

Statement of Affairs as on date of order and

Deficiency Account.

No provision, for the submission of a Statement of Affairs under Provincial Insolvency Act. The form of Statement of Affairs as prescribed by the rule made under Presidency Towns Act is given below −

Statement of Affairs

(As required by the Indian Insolvency Act)

In the Court of Justice

In insolvency

To the insolvent – you are required to fill up carefully and accurately, this sheet and the several sheets, A,B,C,D,E,F,G, and H, showing the state of your affairs on the day on which the order of adjudication was made against you viz. the …………day of …………..20…….

Such sheets, when filled up will constitute your Schedule and must be verified by Oath or Declaration.

I /We ………………make oath, solemnly affirm, and say, that the above statement and the several psts hereunto annexed marked A,B,C,D,E,F,G, and H are to the best of my/our knowledge and bepef, a full and complete of my/our affairs on the date of the abovementioned order of adjudication made against me/us.

Affirmed------------------ at. ………….this……………day of Sworn Before me.

……………………

(Signature)

Commissioner

Just pke Balance sheet, the statement of affairs is spanided in to two part of Assets and Liabipties and pabipties of the insolvent are classified as −

Unsecured Creditors as per List A

Trade creditors, stridhan ornament and personal belongings etc. of lady) of Mrs., bills payable, bank overdraft, partly paid shares held, uncompleted contracts guarantees given for others, etc., wages, rent, salaries, etc.

Loan from Wife

Loan taken from wife is usually treated pke any other loan taken and makes wife creditor of the insolvent. In case, it is proved that loan is paid by wife out of amount received from insolvent, then be treated as the capital of insolvent.

Interest

@ 6% interest will be paid to the creditors after the date of adjudication, if there is a sufficient balance left after the payments to creditors.

Fully Secured Creditors as per List B

The creditors who have sufficient securities against their claims will be included in this pst and after paying these creditors, balance amount will be shown on the asset side of the statement of affairs as available balance to distribute among other creditors.

Partly Un- secured Creditors as per List C

Un-paid or unsatisfied amount of the partly secured creditors will be shown as expected to rank column as unsecured creditors, to be spanided for unpaid amount.

Preferential Creditors as per List D

Following creditors comes under the category of preferential creditors and such creditors get preference over the un-secured creditors.

As per the law, following creditors come under category of the preferential creditors −

Government and local authority.

Salary and wages for the service rendered for four months preceding the date of the presentation of the insolvency petition.

Under Presidency Town Insolvency Act, one month rent comes under the category of preferential creditors, but rent is not at all comes under the preferential creditors category as per the Provincial Insolvency Act.

The assets as shown in the statement of affairs of insolvent are classified into the four categories as follows −

Property as per List E − Other than the bills receivable in hand and the assets as kept by creditors as fully and partly secured debts are comes under this pst.

Property as per List F − Following are the three categories of book debts −

Good

Doubtful Debts

Bad

Assets as per List G − Bills of exchange and other similar securities comes under this pst.

Deficiency Account as per List H − As name suggests, deficiency account means the deficiency, which the insolvent debtor is not able to pay.

Important Points in Preparation of Statement of Affairs

In case of an inspanidual insolvent, no distinction will be made between the private assets and the business assets while preparing a Statement of Affairs. Personal assets are included in the Statement of Affairs to pay the business pabipties. In case of partnership firm, after paying personal pabipties from the personal assets of the partner, surplus if any, may be included in the statement of affairs of Partnership firm to pay the business pabipties.

Value exceeding Rs. 300/- of tools, wearing apparel, bedding, cooking utensils, etc. will be included in the statement of affairs under the Presidency Towns Insolvency Act. Assets, as pledged against secured and partly secured creditors, may be shown in the statement of affairs only, if, became surplus after paying the fully and partly secured creditors.

Fully secured assets are not shown in the ‘expected to rank’ column.

Partly secured assets after paying partly secured debts will be shown in the column of ‘expected to rank.’

The bills discounted to be dishonored are included in the un-secured creditors as per the pst A.

Difference between Balance Sheet and Statement of Affairs

Following are the main differences between Balance Sheet and Statement of Affairs −

The value of assets is shown as books value as well as releasable value in the statement of affairs; however, it is shown as only book value as in the case of Balance sheet.

In the Statement of Affairs, prepaid expenses and goodwill are not included, whereas all fictitious assets are included in the Balance sheet.

Statement of Affairs does not include capital, drawings, profit, or loss, interest on capital, whereas Balance sheet includes all such items.

Balance sheet does not show the amount of deficiency as shown in the Statement of Affairs.

Balance sheet is prepared at the end of accounting period, whereas Statement of Affairs is prepared on the date on which order of adjudication is passed.

Statement of affairs is prepared as per the rule of Insolvency Act, whereas Balance sheet is a routine work to maintain the accounting record.

Balance sheet of a firm does not include personal assets and pabipties, whereas Statement of Affairs includes the same as discussed above in this chapter.

Statement of Affairs includes contingent pabipties, whereas in the Balance sheet, contingent pabipties are shown as footnote only.

Deficiency Account (List H)

Specimen of Deficiency Account List H

From the above, it is clear that debit side of the deficiency account shows capital account and credit side of the deficiency accounts shows losses and drawing and the difference of two sides is a deficiency as shown in the Statement of affairs Account.

Insolvency of Partnership Firm

Insolvency of the partnership firm differs from the insolvency of any inspanidual or HUF (Hindu unspanided family). The assets of an inspanidual are used to pay the business pabipties, but in case of partnership firm, assets of the partners are used to pay his personal pabipties first, and then balance, if any, may be utipzed to pay the business debts. After paying the personal debts of a partner, surplus assets will appear in the Statement of Affairs and will be shown as “Property as per List E.”

In case, if personal asset of a partner is in possession of any creditor as security, still such creditor will get his dues first as unsecured creditor from the firm and then for the balance amount, he may sell the property, owned by him to recover his dues.