Question No. 2 - MMPC 004 - Accounting for Managers - MBA and MBA (Banking & Finance)

Solutions to Assignments

                            MBA and MBA (Banking & Finance)

MMPC 004 - Accounting for Managers

MMPC-004/TMA/JULY/2022

Question No. 2. Explain the following 
(a) Marginal Costing 
(b) Activity Based Costing

Solution: 

a)  Marginal Costing

Marginal costing in economics and managerial accounting refers to an increase or decrease in the total cost of production due to a change in the quantity of the desired output. It is variable, depending on the inclusion of resources required to produce or deliver additional unit(s) of a product or service.

Calculating marginal cost enables managers to make decisions on resource allocation, optimize the production and operation, control manufacturing costs, plan budget and profits, etc. It considers expenses incurred at each production stage, except for overhead pricing. The practice is common in manufacturing industries, allowing companies to achieve economies of scale.

Definition: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable cost is charged to units of cost, while the fixed cost for the period is completely written off against the contribution. 

Marginal cost is the change in the total cost when the quantity produced is incremented by one. That is, it is the cost of producing one more unit of a good. 

For example, let us suppose: 

Variable cost per unit = Rs 25 

Fixed cost = Rs 1,00,000 

Cost of 10,000 units = 25 × 10,000 = Rs 2,50,000 

Total Cost of 10,000 units = Fixed Cost + Variable Cost = 1,00,000 + 2,50,000 = Rs 3,50,000 

Total cost of 10,001 units = 1,00,000 + 2,50,025 = Rs 3,50,025 

Marginal Cost = 3,50,025 – 3,50,000 = Rs 25 

The term marginal cost implies the additional cost involved in producing an extra unit of output, which can be reckoned by total variable cost assigned to one unit. It can be calculated as: 

Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable Overheads

Characteristics of Marginal Costing 

•  Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of variability into fixed cost and variable costs. In the same way, semi variable cost is separated. 
• Valuation of Stock: While valuing the finished goods and work in progress, only variable cost are taken into account. However, the variable selling and distribution overheads are not included in the valuation of inventory.
• Determination of Price - the prices are determined on the basis of the marginal cost and marginal contribution.
• Profitability - the ascertainment of departmental and product's profitability is based on the contribution margin.

Features of Marginal Costing Features of marginal costing are as follows: 

 Marginal costing is used to know the impact of variable cost on the volume of production or output.  Break-even analysis is an integral and important part of marginal costing. 

 Contribution of each product or department is a foundation to know the profitability of the product or department. 

 Addition of variable cost and profit to contribution is equal to selling price. 

 Marginal costing is the base of valuation of stock of finished product and work in progress. 

 Fixed cost is recovered from contribution and variable cost is charged to production. 

 Costs are classified on the basis of fixed and variable costs only. Semi-fixed prices are also converted either as fixed cost or as variable cost.

Ascertainment of Profit under Marginal Cost 

‘Contribution’ is a fund that is equal to the selling price of a product less marginal cost. 

Contribution may be described as follows: 

Contribution = Selling Price – Marginal Cost 

Contribution = Fixed Expenses + Profit 

Contribution – Fixed Expenses = Profit

Marginal Costing Approach

The difference between product costs and period costs forms a basis for marginal costing technique, wherein only variable cost is considered as the product cost while the fixed cost is deemed as a period cost, which incurs during the period, irrespective of the level of activity. Facts Concerning Marginal Costing 

 Cost Ascertainment: The basis for ascertaining cost in marginal costing is the nature of cost, which gives an idea of the cost behavior, that has a great impact on the profitability of the firm. 

 Special technique: It is not a unique method of costing, like contract costing, process costing, batch costing. But, marginal costing is a different type of technique, used by the managers for the purpose of decision making. It provides a basis for understanding cost data so as to gauge the profitability of various products, processes and cost centers. 

 Decision Making: It has a great role to play, in the field of decision making, as the changes in the level of activity pose a serious problem to the management of the undertaking. 

Marginal Costing assists the managers in taking end number of business decisions, such as replacement of machines, discontinuing a product or service, etc. It also helps the management in ascertaining the appropriate level of activity, through break even analysis, that reflect the impact of increasing or decreasing production level, on the company’s overall profit.

Advantages of Marginal Costing 

The advantages of marginal costing are as follows: 

 Easy to operate and simple to understand. 

 Marginal costing is useful in profit planning; it is helpful to determine profitability at different level of production and sale. 

 It is useful in decision making about fixation of selling price, export decision and make or buy decision. 

 Break even analysis and P/V ratio are useful techniques of marginal costing. 

 Evaluation of different departments is possible through marginal costing. 

 By avoiding arbitrary allocation of fixed cost, it provides control over variable cost. 

 Fixed overhead recovery rate is easy. 

 Under marginal costing, valuation of inventory done at marginal cost. Therefore, it is not possible to carry forward illogical fixed overheads from one accounting period to the next period. 

 Since fixed cost is not controllable in short period, it helps to concentrate in control over variable cost.

b) Activity Based Costing

Activity-Based Costing (ABC) is a system of costing, where costs are first traced to activities and then to products. This costing system works with an assumption that activities are responsible for the costs that are incurred. As stated earlier, costs are charged to products based on the individual product's use for each activity. 

The Chartered Institute of Management Accountants, UK (CIMA) defines1 ABC as “an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilise cost drivers to attach activity costs to outputs”.

The important issues of the definition are as follows:

 

 ABC is a tactic to the costing and does monitoring of activities in a process. 

 It traces the consumption of resources and then the costing of resultant outputs. 

 In this, resources are assigned to activities and then activities to cost objects based on consumption estimates. 

 It utilises identified cost drivers to assign activity costs to depicted outputs. 

Another description of Activity-based costing is that it is a two-stage based costing method that allocates indirect costs and overheads to products and services. Some costs are tough to assign to a product or a service. It identifies the connection between overheads and manufactured products and gives indirect costs to the products. The method is less arbitrarily than the traditional costing system.

Features of Activity Based Costing (ABC) 

Features of Activity Based Costing are as follows: 

 ABC is a modern approach to the allocation of indirect costs. Costs allocated to each activity symbolise the resources consumed by the activity.
 As done in conventional costing, ABC is not restricted to the allocation of indirect costs to departments. It moves further to identify the individual activity for indirect cost allocation as the lowest unit. 

 Based on consumption, resources are allotted to each activity and then to cost objects. 

 ABC identifies the activities using the activity cost drivers and results in a more accurate cost calculation. 

 This approach facilitates easy identification of cost according to activities cost driver. 

 This costing method is suitable if there is more than one product in the manufacturing line and overheads have a high share in total cost. 

 This approach creates a straight cause and effect association with various resources. 

Development of Activity Based Costing 

Limits of the traditional costing system gave way for the development of ABC. The traditional arrangement segregates costs into fixed and variable. As the business grows, the costs become more complex, and then the traditional approach may not be appropriate for making complex decisions related to production and developing product strategies. The traditional methods facilitate financial reporting and primarily put prominence on calculating overhead rates for the valuation of stocks. It was seen that the traditional absorption costing approach could not go well with multi-product scenarios, so a change was in line. In fact, multiple-products scenario or product diversification requires accurate product cost ascertainment due to increasing market competition within the country and internationally. In the 1980s, ABC was first defined by Kaplan and Bruns2 . It was taken as the modern alternative to absorption costing, which could define product and profitability in a better way. It provides better information to make more effective decisions.

OBJECTIVES OF ACTIVITY BASED COSTING (ABC) 

Some objectives of ABC are listed as under: 

 To recognise several activities in the process of production, including the activities that add value. 

 To eliminate the non value-adding activities. 

 To put emphasis on the high-cost activities

 To incorporate activities based on distribution overheads. 

 To help in decision-making process in the identification of a suitable price of product and services. 

 To ensure accurate and precise cost determination of products and services. 

 To find options to improve the process and reduction of costs. 

MERITS AND DEMERITS OF ACTIVITY BASED COSTING (ABC) 

Merits 

 Removes Cross Subsidization Issues 

The traditional system gives rise to the issues of over and under-costing. Products may be subject to over-costing, which may result in under costing of other products. ABC may take care of this issue. ABC put the role of activities between costs and products and makes the relationship more explicit. 

 Deals with Complicated Processes 

There have been growth and development in all walks of life, including production of product and services. Due to this, complications in various processes have risen in the industries too. Now, there are cross-linkages in the production process and costing of products. The number of processes and activities involved in production has increased. ABC deals with these complications in costing that emerged due to processes. 

 Product Customisations 

Nowadays, production is being done with many variations, in terms of sizes, design etc. If the production takes place on one premise, the costing process will need refinement to price the products suitably. ABC helps here. 

 Identification of Cost Saving Chances 

In ABC, it is easier to identify cost saving opportunities. It considers costs to all areas, including various processes, products, managerial responsibility, customers, departments etc. It removes the issues related to the error of estimation.

In this system, costs are managed in the long run by controlling the activities that drive them. In other words, the aim is to manage the activities rather than costs. By managing the forces that cause the activities (cost drivers), costs will be managed long-term. Collecting and reporting on the significant activities a business engages in makes it possible to understand and manage costs more effectively.

Demerits 

 A Complex System 

ABC works with various cost pools and drivers. It is assumed to be more complex than the traditional system of product costing. This is one of the demerits. In fact, selection of drivers, common costs, driver rates etc., put forward a complex system. 

 Product and Process should be Fully Known 

One of the significant demerits is that the people who are employing ABC usually require significant experience in the products and processes of the industry. ABC is preferred if the firm uses cost-plus pricing, whereas marketbased prices may not favour it. 

 Rely on a sophisticated system 

ABC requires a minimum level of information technology in the organisation. Much data is needed and processed for implementing a particular decision. Small and new organisations may not take full advantage of ABC, due to poor information technology systems. 

 Consumes a lot of Time and efforts 

ABC is a time-consuming process. It comprises a number of steps and a lot of groundwork to start and complete the process. Organisations may put time and effort if they get utility out of the process. As mentioned earlier also, large manufacturing firms can utilise it better than small firms. 

 Increase in Indirect Costs 

Due to the high involvement of technology in ABC, indirect costs rise significantly.

PROCESS OF ACTIVITY BASED COSTING (ABC)

Stages in ABC 

Stages of ABC costing are mentioned as follows: 

• Identification of the organisational activities and manufacturing process For ABC, it is indispensable to study the organisational activities and manufacturing process to determine the number of stages involved. By this, all the activities involved in producing the product or service can be identified. ABC believes that activities cause cost.
• Classify the factors which determine the costs of an activity, known as cost drivers. According to CIMA, ‘cost driver is any factor which causes a change in the cost of an activity, e.g. the quality of parts received by an activity is a determining factor in the work required by that activity and therefore affects the resources required. An activity may have multiple cost drivers associated with it.’’4 As per this definition, in the traditional system of product costing, the number of cost drivers can be identified as direct labour hours, units produced, etc. In ABC, cost drivers are related more closely to the consumption of resources and activities. As mentioned earlier, ABC considers that activities bring about costs, so they are linked, and the identified cost drivers are the linkages amid them.
• Identify the costs of each activity, known as cost pools The cost pool concept is similar to the concept of the cost centre. CIMA defines cost pool as ‘the point of focus for the costs relating to a particular activity in an activity-based costing system. ‘It is the sum total of the cost elements allotted to an activity. The cost pool is taken as the point of focus to assign the total cost to an activity.
• Charge costs to the products It is known that ABC is the method of tracing and assigning costs:  from resources to activities and then  from activities to specific products  

Question No 1 - MMPC 004 - Accounting for Managers - MBA and MBA (Banking & Finance)

 

Solutions to Assignments

                            MBA and MBA (Banking & Finance)

MMPC 004 - Accounting for Managers

MMPC-004/TMA/JULY/2022

Question No. 1. Explain the following accounting concepts 
(a) Business Entity concept 
(b) Money measurement concept 
(c) Continuity concept 
(d) Accrual concept 

Solution:

a) Business Entity concept

The business entity concept states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. Doing so requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner. Without this concept, the records of multiple entities would be intermingled, making it quite difficult to discern the financial or taxable results of a single business. Here are several examples of the business entity concept:

• A business issues a $1,000 distribution to its sole shareholder. This is a reduction in equity in the records of the business, and $1,000 of taxable income to the shareholder.

• The owner of a company personally acquires an office building, and rents space in it to his company at $5,000 per month. This rent expenditure is a valid expense to the company, and is taxable income to the owner.

• The owner of a business loans $100,000 to his company. This is recorded by the company as a liability, and by the owner as a loan receivable.

There are many types of business entities, such as sole proprietorships, partnerships, corporations, and government entities.
Reasons for the Business Entity Concept
There are a number of reasons for the business entity concept, including the need to separately track taxes, financial performance, and financial position for each entity. It is also useful for when an organization is liquidated, to determine the amounts of payouts to the various owners. Further, the business entity concept is needed from a liability perspective, to ascertain the assets available in the event of a legal judgment against a business entity. And finally, it is not possible to audit the records of a business if the records have been combined with those of other entities and/or individuals.

Importance of Business Entity Concept in Accounting

Business entity concept is important in accounting for the following reasons:
1. The business entity concept is very important as it helps to measure the performance of a business separate from its owner and on different parameters such as cash flows, profitability, etc.
2. If the business organisation record mixes with the records of the business owners, it creates an inaccurate representation of the financial position of business. The business entity concept helps in preventing such an issue.
3. It helps the business in comparison of financial performance with other business organisations.
4. It helps in calculation of separate taxes for the business and its owners.
5. It helps in ascertaining the value of the assets and liabilities of a business in the event of any legal action taken against the business.

b) Money Measurement Concept

The money measurement concept states that a business should only record an accounting transaction if it can be expressed in terms of money. This means that the focus of accounting transactions is on quantitative information, rather than on qualitative information. Thus, a large number of items are never reflected in a company's accounting records, which means that they never appear in its financial statements. Examples of items that cannot be recorded as accounting transactions because they cannot be expressed in terms of money include:

• Employee skill level
• Employee working conditions
• Expected resale value of a patent
• Value of an in-house brand
• Product durability
• The quality of customer support or field service
• The efficiency of administrative processes

All of the preceding factors are indirectly reflected in the financial results of a business, because they have an impact on either revenues, expenses, assets, or liabilities. For example, a high level of customer support will likely lead to increased customer retention and a higher propensity to buy from the company again, which therefore impacts revenues. Or, if employee working conditions are poor, this leads to greater employee turnover, which increases labor-related expenses.

Problems with the Money Measurement Concept
The key flaw in the money measurement concept is that many factors can lead to long-term changes in the financial results or financial position of a business (as just noted), but the concept does not allow them to be stated in the financial statements. The only exception would be a discussion of pertinent items that management includes in the disclosures that accompany the financial statements. Thus, it is entirely possible that the key underlying advantages of a business are not disclosed, which tends to under-represent the long-term ability of a business to generate profits. The reverse is typically not the case, since management is encouraged by the accounting standards to disclose all current or potential liabilities in the notes accompanying the financial statements. In short, the money measurement concept can lead to the issuance of financial statements that may not adequately represent the future upside of a business. However, if this concept were not in place, managers could flagrantly add intangible assets to the financial statements that have little supportable basis.

Importance of Money Measurement Concept
As money is regarded as a common unit of recording transactions related to the income, profit, loss, capital, assets and liabilities of a business, it becomes easier to record and present business transactions into the financial statements such as Profit and Loss statement and Balance Sheet.

Advantages of Money Measurement Concept
Following are some of the advantages of the money measurement concept
1. It helps in maintaining business records by recording all transactions that are having monetary value.
2. It is helpful in preparation of financial statements (such as Profit and Loss Statement, Income Statement)
3. As the financial transactions are recorded in a proper manner, it becomes easy when two separate accounting periods are compared.
4. It provides a clear picture of the financial transactions and state of the business which help in assessing the investors in knowing the status of their investment.

c) Continuity Concept

• This concept facilitates preparation of financial statements. 

• On the basis of this concept, depreciation is charged on the fixed asset. 

• It is of great help to the investors, because, it assures them that they will continue to get income on their investments. 

• In the absence of this concept, the cost of a fixed asset will be treated as an expense in the year of its purchase. 

• A business is judged for its capacity to earn profits in future.

Importance of Going Concern Concept in Accounting

This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet; For example, a company purchases a plant and machinery of Rs.100000 and its life span is 10 years. According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for many years, it will not be proper to charge the amount from the revenues of the year in which the item is acquired. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset. 

Significance 

The following points highlight the significance of going concern concept; 

Going concern concept is very important for the generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The concept of going concern plays a significant role in the way assets are treated.

The concept of depreciation and amortization are based on the assumption that a business will continue to perform its operations in the near future (this period is the next 12 months after an accounting period).

Advantages of Going Concern Concept

Following are some of the advantages of the going concern concept

1.Companies during the formation years will be purchasing fixed assets that will be requiring expenditure upfront, but such assets will be providing the benefits spread over a long term, that is well beyond one accounting period. Therefore, the going concern concept provides a way to record the value of such assets.

2. It is the basis on which the profits and losses of the business are recorded for the year to which it belongs.

Disadvantages of Going Concern Concept

Listed below are some of the disadvantages of the going concern concept:

1. Financial statements are prepared at cost and not on the basis of current market value. In such a case, if the company in an event of liquidation, will have assets valued at the market value, and as such these values will be different from the value determined at cost.

2. In the event of business being liquidated, the financial statements will be calculated on the on going concern basis, which can be misleading for the stakeholders.

d) Accrual Concept

The meaning of accrual is something that becomes due especially an amount of money that is yet to be paid or received at the end of the accounting period. It means that revenues are recognised when they become receivable. Though cash is received or not received and the expenses are recognised when they become payable though cash is paid or not paid. Both transactions will be recorded in the accounting period to which they relate. Therefore, the accrual concept makes a distinction between the accrual receipt of cash and the right to receive cash as regards revenue and actual payment of cash and obligation to pay cash as regards expenses. 

The accrual concept under accounting assumes that revenue is realised at the time of sale of goods or services irrespective of the fact when the cash is received. For example, a firm sells goods for Rs 55000 on 25th March 2005 and the payment is not received until 10th April 2005, the amount is due and payable to the firm on the date of sale i.e. 25th March 2005. It must be included in the revenue for the year ending 31st March 2005. Similarly, expenses are recognised at the time services provided, irrespective of the fact when actual payment for these services are made. For example, if the firm received goods costing Rs.20000 on 29th March 2005 but the payment is made on 2nd April 2005 the accrual concept requires that expenses must be recorded for the year ending 31st March 2005 although no payment has been made until 31st March 2005 though the service has been received and the person to whom the payment should have been made is shown as creditor. In brief, accrual concept requires that revenue is recognised when realised and expenses are recognised when they become due and payable without regard to the time of cash receipt or cash payment.

Advantages of Accrual Basis of Accounting

The following are some of the advantages of accrual basis of accounting.

1. It helps the businesses in realising the true profit by providing a more realistic representation of the business.

2. Businesses that use an accrual basis of accounting are seen as more reliable than those using a cash basis method.

3. Auditing of financial statements is possible only when accrual basis is chosen as the method of accounting.

4. It allows for easy planning as the business accounts for all the revenues and expenses that will occur during the accounting period and prepare a budget accordingly.

Disadvantages of Accrual basis of Accounting

Following are some of the disadvantages of accrual basis of accounting:

1. Accrual basis of accounting can be complicated requiring more skill, time and resources.

2. It can give a skewed view of the short term financial position of the company.

MMPC 004 - Accounting for Managers - MBA and MBA (Banking & Finance)

Solutions to Assignments

                            MBA and MBA (Banking & Finance)

MMPC 004 - Accounting for Managers

MMPC-004/TMA/JULY/2022

Note: Attempt all the questions and submit this assignment to the coordinator of your study centre. (Last date of submission for July 2022 session is 31st October, 2022 and for January 2023 session is 30th April, 2023). 

Question No. 1. Explain the following accounting concepts 

(a) Business Entity concept 

(b) Money measurement concept 

(c) Continuity concept 

(d) Accrual concept                                                             CLICK HERE

Question No. 2. Explain the following 

(a) Marginal Costing 

(b) Activity Based Costing       CLICK HERE

Question No. 3. What is CVP analysis? Does it differ from break even analysis? How is break-even point calculated?       CLICK HERE

Question No. 4. Explain in detail the various contents of an Annual Report.       CLICK HERE

Question No. 5 From the following calculate cash from operations:

                                                                                                                                      CLICK HERE

Question No. 3 - MMPC 013 - Business Law - MBA and MBA (Banking & Finance)

Solutions to Assignments

                            MBA and MBA (Banking & Finance)

                            MMPC- 013 - Business Law

Question No. 3. 
What is a ‘Contract’? Discuss the essentials of a Valid Contract. 

Solution: 

A contract is an agreement enforceable in a court of law. An agreement is a set of reciprocal promises between the parties to the contract. These set of promises arises from an offer and acceptance from the parties to the contract. The contract may be express or implied i.e., it may be oral words or in writing and even inferred from the conduct of the parties.2 It may be bilateral or unilateral contract. The former one refers to the involvement of two parties and the latter refers one party alone can perform without the other.

Generally, the contract completes when the acceptance of the offeree is posted or put in to transmission. It was made at the place where the acceptance is received by the offeror. It was easy to determine the completion of contract when the parties negotiate in person. But it will be difficult to determine in case of negotiation by post, telegram, telephone and mail, etc. The contract in case of instantaneous contracts completes only when the communication of the acceptance is received by the offeror. In other words, the contract is said to be made at the place where the acceptance received but not at the place where it is transmitted.

The United Nations Commission on International Trade Law (UNCITRAL) adopted the Model Law on Electronic Commerce in 1996. As a result the Information Technology Act, 2000, governs the rules relating to the e-commerce contracts. The offeror and acceptor are substituted by expression soriginato15 and addressee. The electronic record sent by the originator may be received intact or it may vary. The addressee has to acknowledge the receipt of electronic record by communication automated or any mode or by conduct.16 The contract completes where the principal place of business of the originator, in case of more than one place of business of originator or addressee the principal place of business of the originator or addressee and in case of no place of business his usual place of residence will be considered as the completion of the contract for the purpose of jurisdiction.

Essentials of a valid Contract

Consideration, capacity to contract, free consent, and legality of consideration and object are some of the essentials of a valid contract. These are explained in detail below: 

1) Consideration: Consideration is one of the essential conditions for the validity of contract.18 The essential condition for the enforceability of simple contacts is consideration, and the rule is expressed by the Latin maxim: ex-nudopacto non orituractio which means out of nude pact no cause of action arises. It can be understood in the sense quid pro quo. “ A valuable consideration in the sense of the law may consist either some right, interest, profit or benefit accruing to one party, or some forbearance, detriment, loss or responsibility, given suffered undertaken by the other.”19 “An act or forbearance of one party or the promise thereof, is the price for which the promise of the other is brought and the promise thus given for value is enforceable.” “When at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promise to do or abstain from doing something, such act or abstinence or promise is called a consideration for the promise.”

The analysis of the above definitions says that the consideration may be executed or executory. In a contract to deliver a watch by A to B for Rs.100, A and B gained money and watch and in another stand point A and B lost watch and Rs.100, respectively. The law insists more upon the presence of the element of detriment to the promisee B and then the presence of benefit to the promisor A.

A promise from one party to the other and a promise from the other to the former support the consideration. In other words, the reciprocity of promises between the parties establishes the consideration. The absence of consideration makes the contract void. This principle has certain exceptions recognized under the provisions of law. They are: 

i) Where the contract reduced in to writing and registered and made out of natural love and affection between the parties standing in near relationship to each other. 

ii) Where the contract is to compensate the person who voluntarily rendered services in past. In other words, past services rendered at the desire of the promisor constitute a valid consideration in India. But under English law past consideration is not valid. 

iii) Where a promise is made to pay a time-barred debt does not require a fresh consideration. 

iv) Where a gift between the donor and donee is not affected for want of consideration if it is registered and attested by two witnesses. 

Though consideration is necessary it need not be adequate. The adequacy and sufficiency of consideration is immaterial. It is said that pepper corn is sufficient for purchase of an elephant. The consideration is to move from whom is the question to be determined for the enforceability of the contract. It must proceed or move from the promisee. Under English law a stranger to a consideration cannot sue. In other words, the promisee cannot sue the promisor if the consideration doesn’t move from him. But under Indian law, a stranger to consideration can sue.

The doctrine of consideration is not extended to the discharge of contract. The reciprocal promises between the parties constitute consideration. Subsequently if both the parties agree not to enforce the contract also constitute consideration in India. But it is not so in English law. Till 1947 the law of England applied the doctrine of consideration not only to the formation of a contract, but also to its discharge. It was pointed out that a creditor ‘might accept anything in satisfaction of his debt except a less amount of money’ A canary or pepper corn may be accepted in full discharge of a debt, but a part payment of the debt cannot be accepted so as to operate as full discharge of the debt. The following are the exceptions to the rule in Pinnel’s case. 

a) Under the scheme of composition if the debtor agrees to pay a portion of the debt discharges liability without application of the doctrine of consideration under English law. 

b) In case a third party pays a part of the amount less than the amount due from the debtor discharges the debtor without application of the doctrine of consideration under English law. 

c) The doctrine of estoppel or quasi-estoppel neutralized the rule in Pinnel’s case. 

Under Indian law, a contract may be discharged by what is called “an accord and satisfaction” i.e., mutually agreed settlement. The English law allows the delivery of horse against the payment of debt but not accept the delivery in future to discharge the debt. The part payment of debt is also not accepted as accord and satisfaction.

2) Capacity to Contract: There are certain persons in law who are incapable wholly or in part, of binding themselves by a promise or of enforcing a promise made to them. In mercantile contracts lexloci contractus i.e., the law of the place will prevail whereas in case of land lexsitus i.e., the law of the place where the land situate will be applicable. The incapacity of a party to enter into a contract will arise in two ways namely, on account of status, or on account of mental deficiency. The former would occur on the grounds of political consideration and expediency, the latter is imposed to protect the interest of the disabled person. 

The incapacity of a party is broadly divided into two; one which arises out of status of an individual for the following reasons: 

a) Political or Civil status e.g., where the contracting party is a ruler of a foreign state, Ambassador or envoy or alien enemy, or a convict or a bankrupt. 

b) Profession of the contracting person e.g., barrister 

c) Incorporation d) Marriage 

The other which arises from mental deficiency (soundness of mind) of the person contracting in case of: a) Minors 

b) Insane persons 

c) Idiots 

d) Drunken persons

The person below the age of 21 is called as an infant as per the Infant Relief Act, 1874 under the Common Law and the person below the age of 18 is a minor as per the Family Reforms Act, 1969, under English law and Indian law respectively. He is a person who is not a major. The Infant Relief Act, 1874 which modified the Common Law of England allows an infant to enter into a contract for the following: 

a) For necessaries 

b) Beneficial contracts of service 

c) Contracts involving recurring rights and duties e.g., an interest in property binding on him unless he rescind them either during infancy or within reasonable time of becoming a major 

d) An isolated act or a contract to pay for goods supplied other than necessaries, were voidable and not binding on him unless he ratified them within reasonable time after attaining majority.

Mutuality of mind: The parties to the contract must have consensus-ad-idem35 which means mutuality of mind as to the subject matter of the contract. The lack of mutuality of mind makes the contract void. ‘A’ had two houses namely ‘X’ and ‘Y’. ‘A’ enters into contract with ‘B’ to sell keeping ‘X’ house in his mind and ‘B’ entered into contract with ‘A’ by keeping ‘Y’ house in his mind. This results the contract void due to lack of consensus-ad-idem on the subject matter of the contract.

3) Free Consent: “The consent of the party to the contract is said to be free if it is not caused by; coercion, undue influence, fraud, misrepresentation and mistake. These are explained hereunder: 

i) Coercion: “The committing, or threatening to commit, any act forbidden by the Indian Penal code, or the unlawful detaining, or threatening to detain, any property to the prejudice, of any person whatever, with the intention of causing any person to enter in to an agreement.” The term duress in English law defined as causing, threatening to cause, bodily violence or imprisonment, with a view to obtain the consent of the other party to the contract. Coercion in Indian law has a much wider connotation than duress in English law. The main distinction between coercion and duress as the first denotes the offense forbidden by Indian Penal Code whereas the latter confined only to bodily violence and imprisonment. The presence of coercion or duressin both Indian and English law was an invalidating element for the enforceability of contract. 

ii) Undue Influence: This was also called as constructive fraud. It covers all the contracts where one party will be in a position to dominate the will of the other because of relationship while entering the contract. This influence can be presumed in existence among the following relationships: 

a. Parent and child 

b. Guardian and ward 

c. Trustee and beneficiary 

d. Spiritual master and Disciple 

e. Lawyer and client 

f. Doctor and patient 

The contract between the parties with above relationship turns it voidable by presuming the existence of undue influence of the former against the other. It is the burden on the former party to prove that he was not in dominating position and that his position was not used to obtain the consent of the other.

iii) Fraud: The following acts of a party to a contract establish fraud while entering into a contract with the other: 

a) the suggestion of a fact, of that which is not true by one who does not believe it to be true 

b) the active concealment of a fact by one having knowledge or belief of the fact 

c) a promise made without intention of performing it; 

d) any other act fitted to deceive 

e) any such act or omission as the law specially declares as fraudulent.  

The mere silence on the part of party does not amount to fraud. But silence amount to fraud where there is a duty on the party to speak. 

iv) Misrepresentation: A party may give his consent to enter into a contract because of misrepresentation of the other. These false statements or misrepresentations may be either inducing cause of contract. These statements may be called as innocent misrepresentation and willful or actionable misrepresentation which amounts to fraud. A misrepresentation consists of the following ingredients: 

a) Failure to disclosure of a fact 

b) Such non-disclosure must relate to a fact not to an opinion 

c) Such representation must be untrue 

d) It must be material to influence the other to enter into a contract.

Any representation made by a party with full knowledge of the fact that it is not true, or without belief in its truth or recklessly, not caring whether it is true or false, it is said to be fraudulent. Whenever the consent of the party is obtained in the absence of free consent the contract is voidable at the option of the party whose consent is not free because of the presence of coercion, or fraud, or misrepresentation. The aggrieved party of such voidable contract had an option to continue the contract or rescind the contract and entitled for damages. Further, the contract induced by undue influence can be set side or it is voidable at the option of the party whose consent was obtained by dominating the will of the aggrieved party. 

v) Mistake: While entering into a contract the parties to the contract may be under a mistake. This mistake may be as to a fact or law. Mistake of fact may be as to subject matter of the contract e.g., regarding the existence, quality or quantity etc.; nature of contract; person entering into contract. Mistake of law may be regarding foreign law, or ordinary law, law of our country, or private rights of the contracting parties. Another classification of these mistakes is bilateral and unilateral. A mistake of fact in the minds of both the parties negatives the consensus ad idem and the contract in such cases is void. Where both parties to an agreement are at mistake as to a matter of fact essential to the agreement, the agreement is void. This will come under the classification of bilateral mistake. In case of unilateral mistake, i.e., where only one party to a contract is under a mistake, the contract, generally speaking, is not valid. A contract is not merely voidable because it was caused by one of the parties to it being under mistake as to a matter of fact. A contract is not voidable because it was caused by mistake as to any law in force in India but a mistake as to a law not in force in India has the same effect as a mistake of fact.

4) Legality of Consideration and Object: Apart from the above essentials for the formation of a valid contract the legality of consideration and object48 is must. The unlawful agreements may be classified as follows: 

1) Illegal-where the agreement is contrary to the statute law 

2) Immoral- where it is opposed to public morals e.g., agreement for illicit cohabitation, or separation between husband and wife 

3) Opposed to public policy- where the agreement is forbidden as conflicting with the well-being of the state e.g., agreements tending to the abuse of legal process, agreements in restraint of trade, agreements in restraint of marriage, agreements in restraint of parental rights, etc.

Where a part of consideration or object of an agreement is unlawful the agreement is void. In case of non-separation of the unlawful part from the agreement the total transaction will be void. The rule applicable to separate the unlawful and lawful part is known as blue pencil rule. In such cases the lawful part which separated by drawing blue pencil lining from the unlawful part can be enforceable. A contract without consideration is said to be void with certain exceptions;

a) Every agreement in restraint of marriage of any person, other than a minor is void. 

b) An agreement in restraint of trade is void with an exception where goodwill is sold or as per the provisions of the Partnership Act, 1932. 

c) Any agreement in restraint of legal proceeding is void with an exception of arbitration agreement. 

d) Where the meaning of an agreement is not certain, or capable of being certain are void,

e) Agreement by way of wager is void.

f) The performance of the contract is depending on the happening or non-happening of an event at a future date is called as contingent contract. If the happening of the event is impossible the contract becomes void.

g) The enforcement of a contingent contract is possible before the impossibility of its occurrence. The promise of A to pay B a sum of money if B marries C. C marries D. Marriage between B and C is impossible during the life time of A makes the agreement void.

h) The contingent contract to do or not to do within a specified becomes void after the expiry of the time.

i) Any agreement contingent on impossible events is void.

Question No. 4 - MMPC 013 - Business Law - MBA and MBA (Banking & Finance)

Solutions to Assignments

                            MBA and MBA (Banking & Finance)

                            MMPC- 013 - Business Law

Question No. 4. 

Describe the process of Corporate Insolvency Resolution with the help of an example. 

Solution: 

The Corporate Insolvency Resolution Process (‘CIRP’) is a recovery mechanism for the creditors of a corporate debtor. A corporate debtor means a company or Limited Liability Partnership (‘LLP’) that owes a debt to its creditors.

The Insolvency and Bankruptcy Code, 2016 (‘IBC’) lays down the provisions for conducting insolvency or bankruptcy of individuals, partnership firms, LLP and companies. However, the process of insolvency and liquidation of corporate debtors under the IBC applies where the minimum default amount is Rs.1 crore only.

Creditors Under IBC

When a company or LLP becomes insolvent or commits a default, the financial creditor, operational creditor or the corporate debtor can file an application to initiate the CIRP by the Adjudicating Authority, i.e. National Company Law Tribunal (‘NCLT’). 

A financial creditor is a person to whom the business owes a financial debt and includes a person to whom such debt is legally transmitted or assigned. A financial debt means a debt along with interest disbursed against the consideration for the value of money and includes- 

• The amount borrowed against the payment of interest.
• The amount raised by acceptance under the acceptance credit facility or its dematerialised equivalent.
• The amount raised under the note purchase facility or the issue of notes, bonds, loan stock, debentures or any other similar instrument. 
• The amount of the liability relating to a lease or hire purchase contract that is deemed as capital or finance lease under the Indian Accounting Standards or such other accounting standards.
• Receivables discounted or sold other than the receivables sold on a non-recourse basis.
• The amount raised under any other transaction, including any purchase agreement or forward sale having the commercial effect of a borrowing.
• Any derivative transaction entered in connection with benefit from or protection against fluctuation in any price or rate.
• Any counter-indemnity obligation relating to a bond, indemnity, guarantee, documentary letter of credit or other instrument issued by a financial institution or bank.
• The amount of liability relating to any of the indemnity or guarantee for any of the points mentioned above.

An operational creditor is a person to whom the business owes an operational debt and includes persons to whom such amount has been legally transferred or assigned for services or goods given by them. 

An operational debt means a claim relating to the provision of services or goods, including debt or employment regarding payment of dues arising under any law in force and payable to the Central Government, State Government or local authority.

Process of Corporate Insolvency Resolution

The conduct of the CIRP (CIRP) of a corporate debtor is provided in Part II of the IBC, which are as follows-

Initiation of CIRP

The financial creditor can initiate the CIRP against the corporate debtor by applying to NCLT. The operational creditor should first give a demand notice of an unpaid invoice to the corporate debtor demanding the default payment amount. When the operational creditor does not receive payment from the corporate debtor after the expiry of ten days of delivery of the demand notice or invoice demanding payment, he can apply to NCLT for initiating the CIRP.

A partner or member of the corporate debtor authorised to initiate CIRP or a person in charge of managing the affairs or who has control and supervision over the financial affairs of the corporate debtor can initiate the CIRP with NCLT. 

NCLT will pass an order within fourteen days of either admitting or denying the CIRP application. The CIRP will commence from the admission date of the application by NCLT. The CIRP completion period is 180 days from the admission date of the CIRP application. 

Declaration of Moratorium and Public Announcement

After the admission of the CIRP application, NCLT will pass an order- 

• Declaring a moratorium for prohibiting certain actions and transactions.
• Causing a public announcement of initiating the CIRP and call for the submission of claims.
• Appointing an interim resolution professional. 

NCLT orders on the CIRP commencement date declaring the moratorium for prohibiting the following- 

• Continuation or institution of suits or proceedings against the corporate debtor.
• Encumbering, transferring, disposing of or alienating by the corporate debtor of its assets or beneficial interest or legal right.
• Any action to recover, foreclose or enforce any security interest created by the corporate debtor relating to its property, including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. 
• Recovery of any property by a lessor or owner, where the property is in possession or occupied by the corporate debtor.

The public announcement of the CIRP should contain the following information- 

• Name and address of the corporate debtor. 
• Name of the authority under which the corporate debtor is registered or incorporated.
• Last date for submission of claims.
• Details of the interim resolution professional who will be responsible for receiving claims and take over the management of the corporate debtor.
• Penalties for misleading or false claims.
• The date of closure of the CIRP, i.e. 180th day from the admission date of the CIRP application.

The interim resolution professional appointed will have the following powers relating to the corporate debtor from the date of his appointment-

• Management of the affairs of the corporate debtor.
• Exercise the powers of the board of directors or partners of the corporate debtor and suspension of the powers of the director or partner of the corporate debtor.
• Officers and managers of the corporate debtor will have to report to the interim resolution professional and give access to the records and documents of the corporate debtor.
• Financial institutions having and maintaining accounts of the corporate debtor will act on the instructions of the interim resolution professional and furnish all available information relating to the corporate debtor.

Committee of Creditors

The interim resolution professional will constitute a committee of creditors after collating all received claims against the corporate debtor and determining its financial position. The committee of creditors will consist of all the financial creditors of the corporate debtor. 

The committee of creditors should hold the first meeting within seven days of the constitution of the committee. The committee of creditors in their first meeting should decide to either appoint or replace the interim resolution professional through a majority vote of not less than 66% of the voting share of the financial creditors.

Appointment of Resolution Professional

When the committee of creditors decide to continue with the interim resolution professional appointed by NCLT as the resolution professional, it should communicate its decisions to NCLT, the interim resolution professional and the corporate debtor.

When the committee of creditors decides to replace the interim resolution professional, it should file an application to NCLT to appoint the proposed resolution professional along with his written consent. 

NCLT should forward the name of the proposed resolution professional submitted by the committee of creditors to the Insolvency and Bankruptcy Board of India (‘Board’) for its confirmation. NCLT shall appoint the proposed resolution professional after receiving confirmation from the Board. 

The resolution professional will conduct the entire CIRP and manage and control the operations of the corporate debtor during the CIRP.

Preparation of Information Memorandum

The resolution professional should prepare an information memorandum in the form and manner containing the relevant information as specified by the Board to formulate a resolution plan. A resolution applicant should submit a resolution plan prepared on the basis of the information memorandum to the resolution professional. 

The resolution applicant is the person who submits a resolution plan either individually or jointly with any other person. The resolution professional will examine each resolution plan submitted to him for confirming that each resolution plan-

• Provides for the payment of the insolvency resolution process costs as specified by the Board prioritising the payment of all other debts of the corporate debtor.
• Provides for the payment of debts of the operational creditors as specified by the Board.
• Provides for managing the affairs of the corporate debtor after approval of the resolution plan.
• Supervision and implementation of the resolution plan.
• It does not contradict the provisions of the law(s) in force. 
• Confirms to such other requirements specified by the Board.

The resolution professional will present the resolution plan after its examination to the committee of creditors for its approval. The committee of creditors can approve the resolution plan by a vote of not less than 66% of the voting share of the financial creditors.

Approval of Resolution Plan

The resolution plan for the revival of the company or LLP should be approved within 180 days from the commencement of the CIRP by the creditors. However, NCLT can extend the period of 180 days by another 90 days. 

NCLT will pass an order approving the resolution plan approved by the committee of creditors after being satisfied that the resolution plan meets the requirements of the IBC. NCLT order of approval of the resolution plan will be binding on the corporate debtor and its employees and members.

NCLT order of approval of the resolution plan will also be binding on the guarantors and stakeholders involved in the resolution plan and the creditors, including the Central or State Government or any local authority.

NCLT can pass an order to reject the resolution plan if it is satisfied that the resolution plan does not meet the requirements laid down under the IBC. When NCLT passes the order of rejection of the resolution plan, it will pass an order of the liquidation of the corporate debtor. 

After the approval of the liquidation of the corporate debtor, the committee of creditors will appoint the liquidator to sell the corporate debtor’s assets and share them among the stakeholders. The distribution of the assets will be made as per the provisions of the IBC.