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ACCOUNTING OF SHARE CAPITAL ( III SEM BBM) To issue shares a company follows a definite procedure which is controlled and

regulated by the Companies Act and Securities Exchange Board of India (SEBI). There are different ways of issue of shares which may be: (A) For consideration other than cash (B) For cash (A) Issue of shares for consideration other than cash Sometimes shares are issued to the promotors of the company in lieu of the services provided by them during the incorporation of the compnay. The issue price of these shares is normally debited to Goodwill A/c and journal entry is made as follows : Goodwill A/c Dr To Share Capital A/c In case a company does not have sufficient funds for the purchase of fixed assets or for payment to creditors it may offer and allot its shares to vendors/ creditors in lieu of cash. Any allotment of shares against which cash is not to be received is called issue of shares for consideration other than cash. For example building is purchased and payment is made by issuing shares. In case of purchase of assets like building, machinery, stock of materials,etc. the following journal entry is made : 1. Assets A/c Dr To Vendors/Creditors A/c (Assets purchased) 2. Vendors/Creditors A/c Dr To Share Capital A/c (Issue of shares of Rs.each fullly paid up) (B) Issue of Shares for cash In general, shares are issued for cash. The company may call the share money either in one instalment or in two or more instalments. But company always collects this money through its bankers. (i) Receipt of share money in one instalment The company may receive the share money in one instalment along with application. In this case the following journal entries are made in the books of the company 1. On Receipt of Application Money Bank A/c Dr To Share Application A/c (Application money received on .shares of Rseach) 2. On transferring the Application Money Share Application A/c Dr To Share Capital A/c (Application money transferred to share capital A/c) (ii) Share money received in two or more instalments Instead of receiving payment in one instalment i.e. at the time of application the company collects it in two or more instalments. The first, instalment which the appplicants have to pay along with the applications for shares is known as application money. On the allotment of shares the allottees are required to pay the second instalment which is termed as allotment money. If the company decides to call the share money in more than two instalments the other instalment is/are termed as call money (i.e. firstcall, second call or final call). In the above case the transactions are recorded in journal as given below : (a) On receipt of application money (i) Bank A/c Dr To Share Application A/c (Reciept of share application money for . Shares @ Rs.. per share) (b) On allotment of shares After receiving the application for shares within the prescribed time, the Board of Directors of the company proceed to allot shares. On allotment of shares the applicaion money is transferred to Share Capital A/c. For this the following journal entry is made :

Share Application A/c Dr To Share Capital A/c (Share application for . Shares @ Rs per share transferred to share capital A/c) Allotment Money becoming due and received On the allotment of shares the amount receivable on the next instalment i.e. on allotment becomes due. The following entry is made for recording the amount due : (i) Allotment money becoming due Share Allotment A/c Dr To Share Capital A/c (Share allotment money due on . shares @Rs ... per share) (ii) Receipt of allotment money On the receipt of share allotment money the following journal entry is made: Bank A/c Dr To Share Allotment A/c. (Receipt of the amount due on allotment of shares) Calls on shares After the receipt of application and allotment money the money that remains unpaid can be called up by the company as and when required. Thus a call is a demand made by the company asking the shareholders to remit the called up amount on shares allotted to them. The company may demand the remaining money in more than two instalments. The amount called after the allotment is known as call money. There may be one or more calls, depending on the funds requirements of the company. When only one call is made Call Money is Due : Share First and Final Call A/c Dr To Share Capital A/c. (Call money due on . share @ Rs per share). Receipt of call money The following journal entry is made for receipt of call money: Bank A/c Dr To Share First & Final call A/c (call money due on shares @ Rs ... per share received) Note : If the company makes more than one call the same accounting treatment is followed for recording the second call or third call money due and their receipt. The last call made is termed as final call FULL, UNDER AND OVER SUBSCRIPTION A company decides to issue number of shares to raise capital. It invites public to buy these shares. Now there may be three situations : I. Full Subscription Company may receive applications equal to the number of shares company has offered to people. It is called full subscription. In case of full subscription the journal entries will be made as follows : (a) On receipt of application money Bank A/c Dr To Share Application A/c (Application money received for ......... shares) (b) On allotment of shares Share Application A/c Dr To Share Capital A/c (Application money of shares transferred to capital A/c on their allotment) II. The company does not receive application equal to the number of shares offered for subscription, there may be two situations :

(i) under subscription (ii) over subscription (i) Under subscription The issue is said to have been under subscribed when the company receives applications for less number of shares than offered to the public for subscription. In this case company is not to face any problem regarding allotment since every applicant will be alloted all the shares applied for. But the company can proceed with allotment provided the subscription for shares is at least equal to the minimum required number of shares termed as minimum subscription. (ii) Over Subscription When company receives applications for more number of shares than the number of shares offered to the public for subscription it is a case of over subscription. A company cannot allot more shares than what it has offered. In case of over subscription, company has the following options : Option I (i) Rejection of Excess Applications and Money Returned The company may reject the applications for shares in excess of the shares offered for issue and a letter of rejection is sent to such applicants. In this case the application money received from these applicants is refunded to them in full. The journal entry made is as follows: Share Application A/c Dr To Bank A/c (Application money on shares refunded to the applicants) (ii) Excess application money adjusted towards sums due on allotment. Journal entry made is : Shares Application A/c Dr To Share Allotment A/c (Excess application money adjusted towards sums due on allotment) If the application money received on partially accepted applications is more than the amount required for adjustment towards allotment money, the excess money is refunded. However, if the Articles of the company so authorise, the directors may retain the excess money as calls in advance to be adjusted against the call/calls falling due later on and the following entry is made : Share Application A/c Dr To Call-in-advance A/c (The adjustment of excess share application money retained as call-in advance in respect of ... shares). Option II Partial acceptance of Applications. In some cases the company accepts the applications for subscription partially. It means that the company does not allot the full number of shares applied for. For example if an applicant has applied for 5000 shares and is allotted only 2000 shares, then the applications is said to have been partially accepted. The company may evolve some formula of accepting applications partially or making proportionate allotment/ the Prorata allotment which means that the applicants are allotted shares proportionately. In such a case the company adjusts the excess share money received on application towards share allotment money due on partially accepted applications. The journal entry recording the adjustment of application money towards share allotment money, is as under : Share Application A/c Dr To Share Allotment A/c (Share application money transferred to Share Allotment Account in respect of ... shares). ISSUE OF SHARES AT PREMIUM

A company can issue its shares at their face value. When company issues its shares at their face value, the shares are said to have been issued at par. Company can also issue its shares at more than or less than its face value i.e, at Premium or at Discount respectively. When shares are issued at premium or at discount an accounting treatment different from shares issued at par is required. Let us discuss issue of shares at premium. Issue of shares at premium If a company issues its shares at a price more than its face value, the shares are said to have been issued at Premium. The difference between the issue price and face value or nominal value is called Premium. If a share of Rs 10 is issued at Rs 12, it is said to have been issued at a premium of Rs 2 per share. The money received as premium is transferred to Securities Premium A/c. A company issues its shares at premium only when its financial position is very sound. It is a capital gain to the company. The Premium money may be demanded by the company with application, allotment or with calls. The Companies Act has laid down certain restrictions on the utilisation of the amount of premium. According to Section 78 of this Act, the amount of premium can be utilised for : (i) Issuing fully-paid bonus shares; (ii) Writing off preliminary expenses, discount on issue of shares, underwriting commission or expenses on issue; (iii) Paying premium on redemplion of Preference shares or Debentures. Further, the company may demand the total amount of premium in more than one instalment. In case the company doesnt specify the particular call with which Securities Premium is to be paid it is supposed to be called at the time of Allotment. Accounting Treatment of premium on Issue of Shares Following is the accounting treatment of Premium on issue of shares : (a) Securities premium collected with share Application money : If the Securities premium is collected on application and the company has taken decision about the allotment of shares, the following journal entry is made : Share Application A/c. Dr To Securities Premium A/c (The amount of Securities premium received on application of the allotted shares is transferred to Securities Premium A/c) (b) Premium collected with Allotment money or Calls. If the company decides to demand the premium with share Allotment or/and share call money, the journal entry made is: Share Allotment A/c Dr Or/and Share Call A/c Dr To Securities Premium A/c Adjustment of share premium due onshares @Rs.per share.) ISSUE OF SHARES AT DISCOUNT When the issue price of share is less than the face value, shares are said to have been issued at discount. For example if a company issues its shares of Rs 100 each at Rs. 90 each, the shares are said to be issued at discount. The amount of discount is Rs 10 per share (i.e. Rs 100 Rs 90). Discount on shares is a loss to the company. Section 79 of Companies Act 1956 has laid down certain conditions subject to which a company can issue its shares at a discount. These conditions are as follows : (i) At least one year must have elapsed from the date of commencement of business; (ii) Such shares are of the same class as had already been issued; (iii) The company has sanctioned such issue by passing a resolution in its General meeting and the approval of the court is obtained.

(iv) Discount should not be more than 10% of the face value of the share and if the company wants to give discount more than 10%, it will have to obtain the sanction of the Central Government.

Accounting Treatment of Shares Issued at Discount The amount of discount is generally adjusted towards share allotment money and the following journal entry is made: Share Allotment A/c Dr Discount on issue of shares A/c Dr To Share Capital A/c Allotment money due on.shares @Rs per share after allowing discount @Rs .per share. CALLS IN ADVANCE AND CALLS IN ARREARS If a shareholder pays any amount to company before it is demanded, it is called Call-in-Advance. This amount is put in a separate account known as Calls-in-Advance A/c. This amount is not shown as capital of the company, till such time the company makes a demand from all the shareholders. Call-in-Advance A/c is shown on the liabilities side of the Balance Sheet. For example if a company issued shares of Rs 10 on which it has already called Rs 5. Against the uncalled portion of Rs 5 per share the company makes a call Rs 3 per share, the entry for call money due will be made only for Rs 3 per share. Now suppose a shareholder pays Rs 5 per share including the uncalled amount of Rs 2 per share along with the call money, it means he has paid Rs 2 per share in advance, which will be credited to calls in Advance A/c. The company is required to pay interest on this amount @ 6% till the date of its appropriation. Accounting treatment Following journal entry is made for calls-in-advance. Bank A/c Dr To Calls-in-Advance A/c (Calls in advance received on.shares @ Rs .per share) Appropriation of calls-in-Advance A/c say in the final call Journal entry will be : Calls-in-Advance A/c Dr To Share Final call A/c (Calls in advance amount adjusted) For interest given on Calls-in-Advance Journal entry will be Interest on calls-in-Advance A/c Dr To Bank A/c (Interest paid on the amount of Call-in-Advance Calls in arrears When the company sends notice to the shareholders to pay allotment and /or call money, it has to be paid by them within the specified time period. If it is not paid by any one or more of the shareholders, the unpaid amount becomes arrears due from them. Such arrears are transferred to an account termed as Calls-in-Arrears A/c. The company is authorised to charge interest on calls-in-Arrears @ 5% p.a. for the intervening peroid. (The period between date of non-receipt of the due amount and the date of actual receipt of the due amount).

Accounting Treatment The following journal entry is made to record Calls-in-Arrears: Calls-in-Arrears A/c Dr To Share Allotment/Call A/c (Share allotment/ Call money not received on . shares) When the unpaid balance is received later on the following journal entry is made:

Bank A/c Dr To Calls in Arrears A/c (Amount due on allotment/ call remaining unpaid now received on shares.)

A Company purchased a running business from M/S Sahni Brothers for a sum of Rs. 1,50,000, payable as Rs.1,20,000/- in fully paid Equity shares of Rs. 10 each and balance in cash. The assets and liabilities consisted of the following: Plant & Machinery Stock Rs.50,000 Rs.40,000 Building Rs.40,000 Sundry Debtors Rs.30,000

Cash Rs.20,000 Sundry Creditors Rs.20,000 Pass necessary Journal entries in the companys books

Amagamation, and Absorption ( III sem BBM) a. Following are the ba

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Give the formula for calculating the claim amount by applying average clause

A fire occurred on 15-9-90 in the premises of Firestone Co. Ltd. From the following figures, calculate the amount of claim to be lodged with the insurance company for loss of stock: Stock at cost as on 1-1-89 Stock at cost as on 1-1-90 Purchases during 1989 Purchases from 1-1-90- to 15-9-90 Sales during 1989 Sales from 1-1-90 to 15-9-90 of stocks after fire was Rs.2,000. Rs.20,000 Rs.30,000 Rs.40,000 Rs.88,000 Rs.60,000 Rs.1,05,000

During the current year, cost of purchases has risen by 10% above last years level. Selling prices have gone up by 5%. Salvage value

Section C A fire occurred in the godown of AB Ltd. on 9-3-2010 destroying the entire stock. The book and records were salvaged form, which the following particulars were ascertained. Sales for the year 2009 Sales for the period from 1-1-10 to 8-3-10 Purchases for the year 2009 Purchases for the period from 1-1-10 to 8-3-10 Stock on 1-1-09 Stock on 31-12-09 Rs.10,01,000 Rs.3,00,000 Rs.8,00,000 Rs.1,25,000 Rs.3,31,100 Rs.3,85,000

The company has been following the practice of valuing stock of goods at actual cost plus 10%. Included in the stock on 1-1-83 were some shop-soiled goods which originally cost Rs.2,000, but were valued at Rs.1,100. These goods were sold during the year 1983 for Rs.1,000. Subject of this, the rate of gross profit and the basis of valuation of stock were uniform. Compute the fire claim.

Himalaya Ltd.s Profit and Loss Account for the year ended 31st December 2005 is given below. You are required to calculate the working capital requirements under operating cycle method.

Trading and Profit & Loss Account For the year ended 31 December,
st

Rs.

Particulars

Rs.

2005 Particulars To Opening stock: Raw Materials Work-in-Progress Finished Goods To Purchases (Credit) To Wages & Mfg. Expenses To Gross Profit c/d To Administrative Exp. To Selling and Dist.Exp. To Net Profit Total

10,000 30,000 5,000 35,000 15,000 1,50,000 15,000 10,000 30,000 55,000

By Sales (Credit) By Closing stock: Raw Materials Work-in-progress Finished Goods By Gross Profit b/d Total

1,00,000 11,000 30,500 8,500 1,50,000 55,000 55,000

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Prepare an estimate of working capital requirements from the following information of a trading concern: (a) (b) (c) (d) (e) (f) Projected Annual Sales Selling Price Profit Margin on Sales Average Credit Period Allowed to Customers Average Credit Period Allowed by Suppliers Average Stock Holding in terms of Sales Requirement (g) Allow 10% for Contingencies 12 weeks 4 weeks 1,00,000 Rs.8 per unit 25% 8 weeks

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Meaning of financial system Financial system is a set of inter-related activities working together to achieve some predetermined purpose or goal. It includes different markets, the institutions, instruments, services and mechanisms which influence the generation of savings, investment capital formation and growth.

Functions of financial system A financial system performs the following functions: It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner. It channelised flow of saving into productive investment. It assists in the selection of the projects to be financed and also reviews the performance of such projects periodically. It provides payment mechanism for exchange of goods and services. It provides a mechanism for the transfer of resources across geographic boundaries. It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit. It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds. It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to save more. It provides you detailed information to the operators/players in the market such as individuals, business houses, Government Components of Indian financial system

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Financial System and Economic Development Financial system plays an important role in the economic development. The role of the financial system is to gather or pool money from people and businesses that have more than they need currently and transmit those funds to those who can use them for either consumption or investment. The larger the flow of funds and the more efficient their allocation is, the better the economic output and welfare of the economy and society. A financial system provides services that are essential in a modern economy. The use of a stable, widely accepted medium of exchange reduces the costs of transactions. It facilitates trade and, therefore, specialization in production. Financial assets with attractive yield, liquidity and risk characteristics encourage saving in financial form. By evaluating alternative investments and monitoring the activities of borrowers, financial intermediaries increase the efficiency of resource use. Access to a variety of financial instruments enables an economic agent to pool, price and exchange risks in the markets. Trade, the efficient use of resources, saving and risk taking are the cornerstones of a growing economy. In fact, the country could make this feasible with the active support of the financial system. The financial system has been identified as the most catalyzing agent for growth of the economy, making it one of the key inputs of development. In other words, the purpose of the financial system is to transfer funds from savers to the borrowers in the most effective and efficient possible manner. The following are the ways of transferring money: Direct Financing: In direct financing borrowers and savers exchange money and financial instruments directly. Borrowers or deficit units issue financial claims (they are claims against someone elses money at a future date) on themselves and sell directly to savers or surplus units for money. The savers hold the financial claims as interest bearing instruments and they can sell it in financial markets. Upon agreed time or maturity date borrowers have to give back the savers principle plus the agreed interest rate. Indirect Financing: A problem that arises from direct financing brought the usage of indirect financing. Sometimes the savers or surplus units cant wait to hold financial claims till maturity date therefore they sell

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the financial claims to the financial intermediation and take their funds from them to do whatever they please. Financial market A financial market is the place where financial assets are created or transferred. Financial market is the place where all the financial transactions take place. Financial market includes money market and capital market. Money market is the place where transactions take place for short period and on the other hand in capital market transactions are made for a longer period.

The main functions of financial market are: 1. To facilitate creation and allocation of credit and liquidity. 2. To serve as intermediaries for mobilization of savings. 3. To assist process of balanced economic growth. 4. To provide financial convenience. Money market

Slice of the financial markets that deal with short term financial assets called near money, which
are highly liquid (can be quickly converted to money)

It deals with short term funds meaning having maturity of upto a year. It does not literally deal in money/cash but close substitutes of money such as T-bills, promissory
notes, commercial paper etc. that can be quickly converted to cash without making any losses and that too at low transaction costs.

It constitutes of Central Bank, Commercial Banks, NBFCs, etc. Transactions take place via oral communication without the help of brokers unlike capital markets
where transactions take place formally on stock exchanges.

It comprises of submarkets like: Call Money Market, Acceptance and Bill Market.

To make available a parking place in order to make use of short term surplus. 14

To offer room to overcome short term deficits. To allow the central bank to influence and control liquidity in the economy by means of
intervention in this market.

To provide access to users of short-term funds so that they can meet their requirements quickly,
adequately, and at reasonable costs. Functions of Money Markets:

Monetary Equilibrium: To maintain equilibrium in demand/supply of short term funds. Economic Growth: It facilitates economic growth by making short term funds available to different
units in economy like agriculture, SSIs etc.

Promote Trade and Industry: It offers finance to trade and industry and also bill discounting
facilities.

Aiding Monetary Policy: It is one of the means which helps in effective implementation of the
monetary policy.

Capital Formation: It encourages savings/investment in the economy by providing investment


avenues for short term.

Non inflationary source of Finance to Government: Eg. By issuing Treasury Bill

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Some of the important money market instruments are briefly discussed below: 1. Call/Notice Money 2. Treasury Bills 3. Term Money 4. Certificate of Deposit 5. Commercial Papers

Call/Notice-Money Market: Call/Notice money is used for a very short period. Call/notice money is used for
intraday transactions. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions.

Term Money: Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money
market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

Treasury Bills: Treasury Bills are short-term (up to one year) borrowing instruments of the union
government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue. Treasury bills are issued for a period of 14 days, 91 days, 182 days and 364 days. They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

Certificate of Deposits: Certificates of Deposit (CDs) is a negotiable money market instrument and issued in
dematerialized form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other

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instruments viz., term money, term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

Commercial Paper: CP is a note in evidence of the debt obligation of the issuer. On issuing commercial
paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery. A company shall be eligible to issue CP provided (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) Company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. The minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies IMPORTANCE OF MONEY MARKET If the money market is well developed and broad based in a country, it greatly helps in the economic development of a country. The central bank can use its monetary policy effectively and can bring desired changes in the economy for the industrial and commercial progress in the country. The importance of money market is given, in brief, as under: (i) Financing Industry: A well developed money market helps the industries to secure short term loans for meeting their working capital requirements. It thus saves a number of industrial units from becoming sick. (ii) Financing trade: An outward and a well knit money market system play an important role in financing the domestic as well as international trade. The traders can get short term finance from banks by discounting bills of exchange. The acceptance houses and discount market help in financing foreign trade. (iii) Profitable investment: The money market helps the commercial banks to earn profit by investing their surplus funds in the purchase of. Treasury bills and bills of exchange, these short term credit instruments are not only safe but also highly liquid. The banks can easily convert them into cash at a short notice. (iv) Self sufficiency of banks: The money market is useful for the commercial banks themselves. If the commercial banks are at any time in need of funds, they can meet their requirements by recalling their old short term loans from the money market. (v) Effective implementation of monetary policy: The well developed money market helps the central bank in shaping and controlling the flow of money in the country. The central bank mops up excess short term liquidity through the sale of treasury bills and injects liquidity by purchase of treasury bills. (vi) Encourages economic growth: If the money market is well organized, it safeguards the liquidity and safety of financial asset This encourages the twin functions of economic growth, savings and investments. (vii) Help to government: The organized money market helps the government of a country to borrow funds through the sale of Treasury bills at low rate of interest The government thus would not go for deficit financing through the printing of notes and issuing of more money which generally leads to rise in an increase in general prices.

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(viii) Proper allocation of resources: In the money market, the demand for and supply of loan able funds are brought at equilibrium The savings of the community are converted into investment which leads to pro allocation of resources in the country Capital market The capital market is the place where transactions take place for more than a year. Capital market instruments are equity shares, preference shares, convertible preference shares, non-convertible preference shares etc. and in the debt segment debentures, zero coupon bonds, deep discount bonds etc.

Capital market can also be classified as 1. Primary market 2. Secondary market 3. Derivative market

Primary market: The primary market is that part of the capital markets that deals with the issuance of new
securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. Features of primary markets are: The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market.

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In a primary market securities are issued by the company directly to investors. Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business. The primary market performs the crucial function of facilitating capital formation in the economy. The financial assets sold can only be redeemed by the original holder.

Secondary market: Secondary market is the place where existing securities are bought and sold. The
secondary market for a variety of assets can vary from loans to stocks, from fragmented to centralized, and from illiquid to very liquid. The major stock exchanges are the most visible example of liquid secondary markets in this case, for stocks of publicly traded companies. Exchanges such as the New York Stock Exchange, NASDAQ and the American Stock Exchange provide a centralized, liquid secondary market for the investors who own stocks that trade on those exchanges. Most bonds and structured products trade over the counter, or by phoning the bond desk of ones broker-dealer.

Derivative market: The derivatives markets are the financial markets for derivatives. The market can be
divided into exchange traded derivatives and over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both

Types of Derivatives: The most commonly used derivatives contracts are forwards, futures and options, which we shall discuss these in detail in the FMM-II later. Here we take a brief look at various derivatives contracts that have come to be used.

Forwards:

A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at todays pre-agreed price.

Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain Options:

time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

Warrants: Options generally have lives of up to one year, the majority of options traded on options LEAPS:

exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years.

Baskets: Swaps:

Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options. Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency and Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction. Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating

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Capital market instruments

Capital market instruments

DEEP DISCOUNT BONDS

A bond that sells at a significant discount from par value and has no coupon rate or lower coupon rate than the prevailing rates of fixed-income securities with a similar risk profile. They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures. Ex-IDBI deep discount bonds for Rs 1 lac repayable after 25 years were sold at a discount price of Rs. 2,700.

EQUITY SHARES WITH DETACHABLE WARRANTS

A warrant is a security issued by company entitling the holder to buy a given number of shares of stock at a stipulated price during a specified period. These warrants are separately registered with the stock exchanges and traded separately. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. Ex-Essar Gujarat, Ranbaxy, Reliance issue this type of instrument.

FULLY CONVERTIBLE DEBENTURES WITH INTEREST

This is a debt instrument that is fully converted over a specified period into equity shares. The conversion can be in one or several phases. When the instrument is a pure debt instrument, interest is paid to the investor. After conversion, interest payments cease on the portion that is converted. If project finance is raised through an FCD issue, the investor can earn interest even when the project is under implementation.

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Once the project is operational, the investor can participate in the profits through share price appreciation and dividend payments

SWEAT EQUITY SHARES

The phrase `sweat equity' refers to equity shares given to the company's employees on favorable terms, in recognition of their work. Sweat equity usually takes the form of giving options to employees to buy shares of the company, so they become part owners and participate in the profits, apart from earning salary. This gives a boost to the sentiments of employees and motivates them to work harder towards the goals of the company. The Companies Act defines `sweat equity shares' as equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

DISASTER BONDS

Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-yield debt instrument that is usually insurance linked and meant to raise money in case of a catastrophe. It has a special condition that states that if the issuer (insurance or Reinsurance Company) suffers a loss from a particular pre-defined catastrophe, then the issuer's obligation to pay interest and/or repay the principal is either deferred or completely forgiven. Ex- Mexico sold $290 million in catastrophe bonds, becoming the first country to use a World Bank program that passes the cost of natural disasters to investors. Goldman Sachs Group Inc. and Swiss Reinsurance Co. managed the bond sale, which will pay investors unless an earthquake or hurricane triggers a transfer of the funds to the Mexican government.

GLOBAL DEPOSITORY RECEIPTS/ AMERICAN DEPOSITORY RECEIPTS

A negotiable certificate held in the bank of one country (depository) representing a specific number of shares of a stock traded on an exchange of another country. GDR facilitate trade of shares, and are commonly used to invest in companies from developing or emerging markets. GDR prices are often close to values of related shares, but they are traded and settled independently of the underlying share. Listing on a foreign stock exchange requires compliance with the policies of those stock exchanges. Many times, the policies of the foreign exchanges are much more stringent than the policies of domestic stock exchange. However a company may get listed on these stock exchanges indirectly using ADRs and GDRs. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR. But the ADRs and GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the India

FOREIGN CURRENCY CONVERTIBLE BONDS(FCCBs)

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A convertible bond is a mix between a debt and equity instrument. It is a bond having regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. FCCB is issued in a currency different than the issuer's domestic currency. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt-financing costs.

Advantages Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies because, as it may appear to be more stable and predictable than their domestic currency Gives issuers the ability to access investment capital available in foreign markets Companies can use the process to break into foreign markets The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks Advantages to investors Safety of guaranteed payments on the bond Can take advantage of any large price appreciation in the companys stock Redeemable at maturity if not converted Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation Disadvantages Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity

DERIVATIVES

A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of some underlying asset typically commodity, bond, equity, currency, index, event etc. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative.

Derivatives are usually broadly categorized by: 1. The relationship between the underlying and the derivative (e.g. forward, option, swap) 2. The type of underlying (e.g. equity derivatives, foreign exchange derivatives and credit derivatives) 3. The market in which they trade (e.g., exchange traded or over-the-counter)

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Futures

A financial contract obligating the buyer to purchase an asset, (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency. Options

A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is called 'strike price'. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right. Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy. So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right. As the seller of the contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract is called as premium. The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract.

GOLD ETF

Gold Exchange Traded Fund (ETF) is a financial instrument like a mutual fund whose value depends on the price of gold. In most cases, the price of one unit of a gold ETF approximately reflects the price of 1 gram of gold. As the price of gold rises, the price of the ETF is also expected to rise by the same amount. Gold exchange-traded funds are traded on the major stock exchanges including Zurich, Mumbai, London, Paris and New York There are also closed-end funds (CEF's) and exchange-traded notes (ETN's) that aim to track the gold price.

PARTICIPATORY NOTES

Also referred to as "P-Notes" Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. These are issued by FIIs to entities that want to invest in the Indian stock market but do not want to register themselves with the SEBI. RBI, which had sought a ban on PNs, believes that it is tough to establish the beneficial ownership or the identity of ultimate investors. Interest rate securities

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The interest paid on the nominal amount of capital market securities (called the coupon rate) appears on the certificate received by the holder (the investor) of such a security. This coupon rate is one of the parameters used to determine the consideration paid for the security when traded in the secondary market. Most securities are issued at a fixed coupon rate such as the Eskom 168 (E168) security that is issued at a coupon rate of 11%. This means that the registered holder of an Eskom E168 certificate will receive 11% interest per year (NACSA) on the nominal amount of the instrument. The nominal amounts are in multiples of R1 million, and the interest on the E168 is paid biannually on 1 June and 1 December. The holder of an E168 with a nominal value of R1 million will thus receive R55 000 on 1 June and R55 000 on 1 December. Certain securities are, however, issued at a variable coupon rate, where the coupon rate is then linked to a well-known interest rate such as the prime overdraft rate or the 90-day BA rate. Capital market securities are physical certificates and the issuer of the security keeps a register of owners. This register is used by the borrower (issuer) to pay interest to the lender (owner of the security) on the interest payment dates indicated on the certificate. When an instrument is sold to a new owner in the secondary market, the buyer is registered as the new owner on the settlement date of the transaction. For administrative purposes the register of the issuer closes for registration of new owners, normally one month prior to the interest payment date. The date when the register closes is known as the last day to register (LDR). This means that the person or company who is registered as the owner one month before the interest payment date (on LDR), will receive the interest on the payment date. If a bond is sold and settled between the LDR and the interest payment date, the seller will receive the interest payment. The buyer is then known to buy the instrument "ex interest" (without interest). However, if a transaction takes place before the LDR, the buyer buys the instrument "cum interest" (including interest), because he will be registered as the owner before the register closes, and will receive the next interest payment. Zero-rated coupons

Long-dated (securities with long terms to maturity) zero-rated coupons are capital market instruments issued by borrowers of money. These instruments do not earn interest on the capital amount invested by the lender, and are therefore issued and traded at a discount on the nominal value, similar to discount instruments in the money market such as BAs and treasury bills. The market value (nominal value less discount) of zero (or nil)-rated coupon bonds depends on the yield that the investor (lender) expects on his investment. The redemption amount, which is the only cash inflow for the investor, is equal to the nominal value of the bond, and is thus known to the investor. Since the redemption date is also known, the investor can calculate the amount that he is willing to pay for the bond according to the yield (expressed in terms of interest rate) that he wants to earn on the investment. This yield on zero-rated coupon bonds is normally linked to the market rate on long-term (capital market) investments. Asset-backed bonds

Where an asset exists which represents cash inflow stream such as a normal loan or investment, a bond can be issued to fund this asset. The bond income is then derived or backed by the income stream of the asset. The performance on the bond is then dependent on the asset performance.

Zero-rated coupon bonds

A simple way of determining the trading value of these assets is by expressing the nominal value of the coupon as a percentage of the nominal value plus the yield that the investor wants to earn on his investment over the period,.

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Interest rate bonds

To calculate the consideration that the buyer of a bond would pay to the seller, all the cash flows belonging to the buyer should be discounted back to the settlement date, at the rate at which the transaction is done. The "all-in-price" of a bond is this present value that expresses the consideration that the buyer of a bond would pay to a seller, and takes into account the next interest payment that the buyer would receive if the transaction was cum interest, or the next interest payment that the seller would receive if the transaction was ex interest.

Secured Premium Notes

SPN is a secured debenture redeemable at premium issued along with a detachable warrant, redeemable after a notice period, say four to seven years. The warrants attached to SPN gives the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN holder has an option to sell back the SPN to the company at par value after the lock in period. If the holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/ premium on redemption in installments as decided by the company. The conversion of detachable warrants into equity shares will have to be done within the time limit notified by the company. Ex-TISCO issued warrants for the first time in India in the year 1992 to raise 1212 crore.

Significance of capital market A sound and efficient capital market is extremely vital for the economic development of a nation. The following points clearly bring out the role and significance of capital market in India. i)CAPITAL FORMATION: Capital market encourages capital formation as it ensures speedy economic development. The process of capital formation includes collection of saving effective mobilisation of these savings for productiveinvestment. Thus three distinctive inter-related activities i.e. collection of savings, mobilisation of savings and investment lead to capital formation in the country. The volume of capital formation depend s on the efficiency and intensity with which these activities are carried on.

ii) ECONOMIC GROWTH: ~ Capital market plays a vital role in the growth and development of an economy by channelising funds in developmental and productive investments. ~ The financial intermediaries channel funds into those investments that are more important for economic development. iii) INDUSTRIAL DEVELOPMENT: ~ Capital market promotes industrial development and motivates industrial entrepreneurship.

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~ It provides cheap, adequate and diversified funds for industrial purposes such as expansion, modernisation, technological upgradation, establishment of new units, etc. ~ It also provides services like provision of underwriting facilities, participation in equity capital, creditrating, consultancy services, etc. vi) MODERNISATION AND REHABILITATION OF INDUSTRIES: ~ Capital markets also contribute towards modernisation and rehabilitation of industries. ~ Developmental financial institutions like IDBI, IFCI, ICICI, etc provide finance to industries to adopt modern techniques and new upgraded machinery. They also participate in the equity capital of industries. v) RIVIVAL OF SICK UNITS: ~ Commercial and financial institutions provide adequate funds to viable sick unit to overcome their industrial sickness. ~ Bank and FIs may also write off a part of the loan or re-schedule the loan to offer payment flexibility to weak units. vi) TECHNICAL ASSISTANCE: ~ The financial intermediaries in the capital market stimulate industrial entrepreneurship by providing technical and advisory services like preparation of feasibility reports, identifying growth potential, and training entrepreneurs in project management. This promotes industrial investment and leads to economic development. vii) DEVELOPMENT OF BACKWARD AREAS: ~ Capital markets provide funds for projects in backward area and facilitate their economic development. Long-term funds are also provided for development projects in backward / rural areas. viii) EMPLOYMENT GENERATION: ~ Capital markets provide Direct Employment in capital market related activities like stock markets, banks and financial institutions. Indirect Employment is provided in all the sectors of the economy through various funds disbursed for developmental projects. ix) FOREIGN CAPITAL: ~ Capital markets make it possible to generate foreign capital by enabling Indian firms to raise capital from overseas market through bonds and other securities. Such foreign exchange funds have a great impact on the economic development of the nation. Moreover, foreign direct investments (FDIs) also bring in foreign capital as well as foreign technology that leads to greater economic development. x) DEVELOPMENT OF STOCK MARKETS: ~ Capital markets lead to development of stock markets by encouraging investors to invest in shares and debentures and to trade in stocks. FIIs are also allowed to deal in Indian stock exchange. Differences between money market and capital market Money market is distinguished from capital market on the basis of the maturity period, credit instruments and the institutions:

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1. Maturity Period: The money market deals in the lending and borrowing of short-term finance (i.e., for one year or less), while the capital market deals in the lending and borrowing of long-term finance (i.e., for more than one year). 2. Credit Instruments: The main credit instruments of the money market are call money, collateral loans, acceptances, bills of exchange. On the other hand, the main instruments used in the capital market are stocks, shares, debentures, bonds, securities of the government. 3. Nature of Credit Instruments: The credit instruments dealt with in the capital market are more heterogeneous than those in money market. Some homogeneity of credit instruments is needed for the operation of financial markets. Too much diversity creates problems for the investors. 4. Institutions: Important institutions operating in the' money market are central banks, commercial banks, acceptance houses, nonbank financial institutions, bill brokers, etc. Important institutions of the capital market are stock exchanges, commercial banks and nonbank institutions, such as insurance companies, mortgage banks, building societies, etc. 5. Purpose of Loan: The money market meets the short-term credit needs of business; it provides working capital to the industrialists. The capital market, on the other hand, caters the long-term credit needs of the industrialists and provides fixed capital to buy land, machinery, etc. 6. Risk: The degree of risk is small in the money market. The risk is much greater in capital market. The maturity of one year or less gives little time for a default to occur, so the risk is minimised. Risk varies both in degree and nature throughout the capital market. 7. Basic Role: The basic role of money market is that of liquidity adjustment. The basic role of capital market is that of putting capital to work, preferably to long-term, secure and productive employment. 8. Relation with Central Bank: The money market is closely and directly linked with central bank of the country. The capital market feels central bank's influence, but mainly indirectly and through the money market. 9. Market Regulation:

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In the money market, commercial banks are closely regulated. In the capital market, the institutions are not much regulated.

Financial Services Financial services can be defined as the products and services offered by institutions like banks of various kinds for the facilitation of various financial transactions and other related activities in the world of finance like loans, insurance, credit cards, investment opportunities and money management as well as providing information on the stock market and other issues like market trends Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are banks, credit card companies, insurance companies, consumer finance companies, stock brokerages, investment funds and some government sponsored enterprises. Functions of financial services 1. 2. 3. 4. 5. Facilitating transactions (exchange of goods and services) in the economy. Mobilizing savings (for which the outlets would otherwise be much more limited). Allocating capital funds (notably to finance productive investment). Monitoring managers (so that the funds allocated will be spent as envisaged). Transforming risk (reducing it through aggregation and enabling it to be carried by those more willing

to bear it). Characterstics and Features of Financial Services i) Customer-Specific: Financial services are usually customer focused. The firms providing these services, study the needs of their customers in detail before deciding their financial strategy, giving due regard to costs, liquidity and maturity considerations. Financial services firms continuously remain in touch with their customers, so that they can design products which can cater to the specific needs of their customers. The providers of financial services constantly carry out market surveys, so they can offer new products much ahead of need and impending legislation. Newer technologies are being used to introduce innovative, customer friendly products and services which clearly indicate that the concentration of the providers of financial services is on generating firm/customer specific services. ii) Intangibility: In a highly competitive global environment brand image is very crucial. Unless the financial institutions providing financial products and services have good image, enjoying the confidence of their clients, they may not be successful. Thus institutions have to focus on the quality and innovativeness of their services to build up their credibility. iii) Concomitant: Production of financial services and supply of these services have to be concomitant. Both these functions i.e. production of new and innovative financial services and supplying of these services are to be performed simultaneously. iv) Tendency to Perish: Unlike any other service, financial services do tend to perish and hence cannot be stored. They have to be supplied as required by the customers. Hence financial institutions have to ensure a proper synchronization of demand and supply. v) People based services: Marketing of financial services has to be people intensive and hence its subjected to variability of performance or quality of service. The personnel in financial services organisation need to be selected on the basis of their suitability and trained properly, so that they can perform their activities efficiently and effectively.

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vi) Market Dynamics: The market dynamics depends to a great extent, on socioeconomic changes such as disposable income, standard of living and educational changes related to the various classes of customers. Therefore financial services have to be constantly redefined and refined taking into consideration the market dynamics. The institutions providing financial services, while evolving new services could be proactive in visualising in advance what the market wants, or being reactive to the needs and wants of their customers. Scope of Financial Services Financial services cover a wide range of activities. They can be broadly classified into two, namely: i. ii. Traditional. Activities Modern activities.

i. Traditional Activities Traditionally, the financial intermediaries have been rendering a wide range of services encompassing both capital and money market activities. They can be grouped under two heads, viz. 1. Fund based activities and 2. Non-fund based activities. Fund based activities: The traditional services which come under fund based activities are the following:

Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary market

activities). Dealing in secondary market activities. Participating in money market instruments like commercial Papers, certificate of deposits, treasury bills, discounting of bills etc. Involving in equipment leasing, hire purchase, venture capital, seed capital, Dealing in foreign exchange market activities. Non fund based activities

Non fund based activities Financial intermediaries provide services on the basis of non-fund activities also. This can be called fee based activity. Today customers, whether individual or corporate, are not satisfied with mere provisions of finance. They expect more from financial services companies. Hence a wide variety of services, are being provided under this head. They include:

issue.

Managing the capital issue i.e. management of pre-issue and post-issue activities relating to the

capital issue in accordance with the SEBI guidelines and thus enabling the promoters to market their

Making arrangements for the placement of capital and debt instruments with investment

institutions. Arrangement of funds from financial institutions for the clients project cost or his working capital

requirements. Assisting in the process of getting all Government and other clearances.

ii. Modern Activities Beside the above traditional services, the financial intermediaries render innumerable services in recent times. Most of them are in the nature of non-fund based activity. In view of the importance, these activities have been in brief under the head New financial products and services. However, some of the modern services provided by them are given in brief hereunder.

Rendering project advisory services right from the preparation of the project report till the raising

of funds for starting the project with necessary Government approvals. Planning for M&A and assisting for their smooth carry out.

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Guiding corporate customers in capital restructuring. Acting as trustees to the debenture holders. Recommending suitable changes in the management structure and management style with a view

to achieving better results. Structuring the financial collaborations / joint ventures by identifying suitable joint venture partners

and preparing joint venture agreements. Rehabilitating and restructuring sick companies through appropriate scheme of reconstruction and

facilitating the implementation of the scheme. Hedging of risks due to exchange rate risk, interest rate risk, economic risk, and political risk by

using swaps and other derivative products. Managing In- portfolio of large Public Sector Corporations. Undertaking risk management services like insurance services, buy-hack options etc. Advising the clients on the questions of selecting the best source of funds taking into consideration

the quantum of funds required, their cost, lending period etc. Guiding the clients in the minimization of the cost of debt and in the determination of the optimum

debt-equity mix. Promoting credit rating agencies for the purpose of rating companies which want to go public by

the issue of debt instrument. Undertaking services relating to the capital market, such as 1)Clearing services, 2)Registration and

transfers, 3)Safe custody of securities, 4)Collection of income on securitie

Financial Institutions

Financial institutions include the banking and non-banking institutions. Financial institutions are the intermediaries who facilitate smooth functioning of the financial system by making investors and borrowers meet. They mobilize savings of the surplus units and allocate them in productive activities promising a better rate of return. Financial institutions also provide services to entities seeking advice on various issues ranging from restructuring to diversification plans. They provide whole range of services to the entities who want to raise funds from the markets elsewhere. Financial institutions act as financial intermediaries because they act as middlemen between savers and borrowers.

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Role of financial institutions In transferring resource allocation from direct financing to indirect financing, financial institutions provide the following five basic services: Currency Alteration: Buying financial claims denominated in one currency and selling financial claims denominated in another currencies. Quantity Divisibility: Financial institutions are capable in producing a broad range of quantity from one dollar to many millions, by gathering from different people. Liquidity: Easy to liquidate the instruments by buying direct financial claims with low liquidity and issuing indirect financial claims with more liquidity. Maturity Flexibility: Creating financial claims with wide range of maturities so as to balance the maturity of different instruments so as to reduce the gap between assets and liabilities. Credit Risk Diversification (Portfolio Investment): By purchasing a broad range of instruments, financial institutions are able to diversify the risk. .

Commercial banks

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The main functions of commercial banks are shown below-

Primary functions: The primary functions of banks are as follows:

Acceptance of Deposits: The first important function of a bank is to accept deposits of money from the public. Those people who can save a portion of their income can deposit it in banks. For this purpose the banks maintain various types of accounts like fixed deposit account, current deposit

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account and savings deposit account etc. through which they accept deposits from the public. The banks are liable to return the amount to the depositors as and when demanded by the depositors. Those who deposit their savings in various bank accounts are known as accountholders or depositors. They are the customers of the bank. The banks pay interest on the deposited amount to the accountholders. Moreover, it ensures safety of depositors funds. The main deposit schemes provided by commercial banks are as follows-

Fixed Deposit Account: A fixed deposit account is open for a long period of time covering three to five years. The bank pays higher rate of interest on this account depending on the period of time for which the account has been opened. The depositor cannot withdraw the money before the expiry of the fixed period. In case of urgency, the depositor can withdraw the money but he will lose in terms of interest. Fixed deposits are important for the commercial banks because the funds can be invested for a long period of time.

Current Deposit Account: Current deposit accounts are generally opened by business organisations. The main advantage of this account is that the accountholder can withdraw more money than the balance in his account. Therefore, a businessman can withdraw more money in times of emergency. The excess amount is granted by bank as loan, known as overdraft. The bank charges interest on the overdrawn amount. The banks do not pay any interest on this account but charges a small amount as incidental charge.

Savings Deposit Account: A savings deposit account can be opened with a bank with a small amount and the bank pays interest on the deposited amount. The depositor can go on depositing any amount. However, there are certain restrictions on the withdrawal of money from this account. Cheque book facility is provided with this account by the bank. The saving deposit account holder can deposit cheques, drafts, share warrants etc. drawn in his favour with the bank for collection. Collection of cheques, drafts etc. on behalf of the customer is an agency function performed by banks, which we will discuss during the discussion of Secondary functions of banks latter in this unit.

Recurring Deposit Account: In this account the depositor can deposit a fixed amount of money every month. The period of deposit may vary from 1 to 10 years. At the end of the period the deposited amount along with interest is paid back to the depositor

When a customer deposits money in a bank, it results in a debtor- creditor relationship between the banker and the customer. The banker is the debtor and the customer is the creditor. However, the demand for payment must be made by the creditor (customer) in proper manner Advancing Loans: The next important function of a bank is to provide loans and advances to the customers. After satisfying itself about the creditworthiness of the borrower, the bank provides loans to the borrower

The borrower may be an individual or a partnership firm or a company etc. Now- a- day the banks provide home loan, car loan, personal loan, educational loan etc. according to the needs of the individual borrowers. The banks also meet the short- term, medium- term and long- term credit

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needs of business firms. The bank charges interest on the loan amount. Generally, the interest charged by the banks on loans is more than the interest allowed by them on deposits. The banks provide financial assistance to the borrowers in various forms, like loans, cash credit, overdraft and discounting of bills of exchange.

Loan: Banks grant loans to the borrowers against the security of certain assets, which may be fixed assets, share certificates or savings certificates (National Savings Certificate, Fixed Deposit Receipt etc.). The loans may be for short- term i.e. covering one year or long- term i.e. covering more than one year. A loan is granted to the borrower either in cash or by credit to his account and he can withdraw the whole amount at a time or in instalments. But he has to pay interest on the whole amount of loan till he repays the loan.

Cash credit: It is an arrangement under which the borrower opens an account with the bank. The loan amount is credited to his account and the borrower can withdraw from his account. The main advantage of this arrangement is that the borrower can withdraw the money according to his needs. The bank charges interest only on the amount withdrawn by the borrower and not on the entire amount of loan.

Overdraft: Overdraft facility is available only to the current account holders of the bank. Under this arrangement, the current account holders can withdraw more money than the balanceavailable from his account. However, it is a temporary arrangement and the bank charges interest on the overdrawn balance. The maximum amount that the account holder can withdraw is fixed at the time of opening the account.

Discounting of bills: In trade and business, when credit transactions take place, it is a common practice to draw bills of exchange by the creditor (seller) on the debtor (buyer) for the amount due. The debtor is required to accept the bill and he will make the payment on the maturity of the bill i.e. on due date. The creditor has to wait till the maturity of the bill to get the payment. Now, what the creditor can do is that instead of waiting till the maturity of the bill, he can sell the bill to the bank. The bank will make the payment to him after deducting a certain percentage as commission. On maturity of the bill, the bank collects the amount from the debtor. If the debtor fails to make payment, the bank can recover the amount from the customer (Creditor). The main advantage of this facility is that the creditor gets money immediately.

Credit Creation: Another function of banks is to create credit. Creation of credit is the natural outcome of the process of advancing loans that we have discussed above. In advancing loan to the borrower, the bank opens an account in his name and credits the loan amount to that account instead of giving cash to him. The borrower can withdraw the money from the account. Thus, in the process of advancing loans, the bank creates bank deposits which results in increasing the money supply in the economy. This is known as credit creation function of commercial banks.

Secondary Functions: The secondary functions of banks are as under:

Agency functions: The banks perform a number of functions on behalf of the customers, known as agency functions. The various agency functions of banks are-

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Collecting cheques, drafts, interest, rent, dividend etc. on behalf of the customer and deposit the amount in the account of the customer;

Making payment for cheques, bills, insurance premium, rent etc. on the instructions of the customers; Making purchases and sales of shares, debentures, bonds etc. on behalf of the customers; Acting as trustee or executor for the customer; Acting as financial guarantor on behalf of the importer in foreign trade; Filing income- tax return on behalf of the customer.

General Utility Services: The banks provide general utility services not only to the customers but also to the general public against a fee. Some of these services are

Providing locker facility for safe keeping of valuables, important documents etc.; Providing business information. The banks collect data regarding economic conditions, financial conditions, trends in share market etc. and supply them to the customers; Issuing travelers cheques to the travelers. The travelers are not required to carry cash with them while traveling. They can easily encash the travelers cheques as and when required with the banks with whom the issuing bank has banking arrangements;

Issuing letter of credit on behalf of the importer (buyer) in favour of the exporter (seller). This function helps the parties in settling payments in international trade;

Issuing credit cards: This helps the customer to make purchases on credit from certain retail shops and service firms. The payment will be made by the issuing bank from the concerned customers account.

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Price and Non price competition Non-price competition refers to a situation where one of the following two things happens:

Buyers compete with each other to acquire a good on a basis other than price. Such competition

occurs in a situation of excess demand: at the given price, the demand for the good exceeds the supply. The typical cause for excess demand is a price ceiling, though it may also be caused by sticky prices or unforeseen dramatic changes in supply or demand.

Sellers compete with each other to sell a good on a basis other than price. Such competition occurs

in a situation of excess supply: at the given price, the supply for the good exceeds the demand. The typical cause for excess supply is a price floor.

Non-price competition is a marketing strategy "in which one firm tries to distinguish its product or service from competing products on the basis of attributes like design and workmanship" The firm can also distinguish its product offering through quality of service, extensive distribution, customer focus, or any other sustainable competitive advantage other than price. It can be contrasted with price competition, which is where a company tries to distinguish its product or service from competing products on the basis of low price. Non-price competition typically involves promotional expenditures (such as advertising, selling staff, the locations convenience, sales promotions, coupons, special orders, or free gifts), marketing research, new product development, andbrand management costs. Firms will engage in non-price competition, in spite of the additional costs involved, because it is usually more profitable than selling for a lower price, and avoids the risk of a price war. Although any company can use a non-price competition strategy, it is most common among oligopolies and monopolistic competition, because firms can be extremely competitive In a competitive market, various firms vie for the business of the same potential buyers. They often do so by cutting costs whenever they can, which allows them to pass the savings on to customers in the form of lower prices. However, trying to offer a lower price than a competitor is not the only way of competing. Other methods can prove even more effective for firms, though they can sometimes have downsides as well. Quality If consumers must choose between two products of the same price but they can see that one is of a higher quality, they generally pick the product of higher quality. In this way, if a firm can figure out how to produce an item at a cost comparable to what its competitor charges but make it of higher quality, that firm may be able to steal the market from its competitor. However, a problem with this approach is that it may take some time for consumers to realize any difference in quality. Perception and Branding

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In some cases, little possibility of quality differentiation exists between two products. For instance, in the United States, blue jeans have little actual quality variability from one producer to another. For this reason, a number of producers compete by manufacturing a perception of high quality with their brands. This allows some companies to charge higher prices for seemingly identical products because consumers see value in the brand itself. However, the long-term sustainability of such an approach may be difficult because, as such brand advantages arise through consumer trends, consumer trends may also lead to their demise. For instance, if consumers no longer see a clothing brand as fashionable, the manufacturer may not be able to continue charging high prices for its products. Product Design In some cases, firms may compete by changing the design of their products to make them more appealing without significantly changing production costs or quality levels. Such a strategy can prove effective at stealing business from competitors, but it can also backfire, because it can cause the company to alienate its existing consumers, who may be knowingly choosing the existing design over other products with different designs specifically because it appeals to their tastes. Product Differentiation Not all consumers are the same. Markets consist of men and women from diverse age, ethnic and economic groups. Such groups tend to gravitate toward particular products as a bloc. For this reason, firms should not expect a single product to appeal to every consumer in a market. By offering a range of similar products geared toward different market sectors, firms can expand their market base. However, such product differentiation can result in significantly higher overhead costs for production. Sales Structure When two firms are competing with similar products, one may be able to enjoy more market share and a deeper level of penetration due to a more effective and aggressive sales structure. By engaging in direct sales, firms can appeal to prospective buyers who otherwise would not feel compelled to buy due to advertising or other kinds of marketing. Multilevel marketing is one way in which firms rapidly build their consumer base. However, by turning buyers into sellers as well, such schemes may require significantly higher prices.

Examples:

Public services: non-price competition among buyers Public services, many of which are offered for free, or at the same low cost, may suffer from non-price competition. There may be long queues (waiting lines) for access to public services. Here, people are paying for the free service by spending their time in line. However, the economic value of this payment is not captured by anybody. Limited quantity, low price: non-price competition among buyers For commodities for which there is a market shortage, people may compete with each other to get to the few places selling the commodity. Thus, people may start waiting outside the shop selling the commodity hours before it opens (see queueing), or pay others to purchase the good for them, or travel long distances looking for shops that still have the commodity. Entry deterrence In business, strategic entry deterrence refers to any action taken by an existing business in a particular market that discourages potential entrants from entering into competition in that market. Such actions, or barriers to entry, can include hostile takeovers, product differentiation through heavy spending on new product development, capacity expansion to achieve lower unit costs, and predatory pricing. These actions are sometimes deemed anti-competitive and could be subject to various competition laws.

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Limit pricing In a particular market an existing firm may be producing a monopoly level of output, and thereby making supernormal profits. This creates an incentive for new firms to enter the market and attempt to capture some of these profits. One way the incumbent can deter entry is to produce a higher quantity at a lower price than the monopoly level, a strategy known as limit pricing. Not only will this reduce the profits being made, making it less attractive for entrants, but it will also mean that the incumbent is meeting more of the market demand, leaving any potential entrant with a much smaller space in the market. Limit pricing will only be an optimal strategy if the smaller profits made by the firm are still greater than those risked if a rival entered the market. It also requires commitment, for example the building of a larger factory to produce the extra capacity, for it to be a credible deterrent. Signalling The incumbent firm has an advantage of being the first mover and can therefore act in a way that it knows will influence the entrants decision. If we assume imperfect knowledge (i.e. the incumbent firms costs are only known privately) the entrant can only make assumptions about the incumbents cost structure through its price and output levels. Therefore, the incumbent can use these as asignal to any potential entrant. One way of using this advantage to deter entry is to charge a price less than the monopoly level. If an entrant is considering entry in a number of similar markets, a low cost incumbent can signal its efficiency to a potential entrant through lowering prices thereby discouraging what the entrant believes would be unprofitable entry. Signalling needs to be credible to be effective a low cost firm must be able to show that it can withstand lower profits for an extended period of time, which it would not be able to if it had higher costs. Pre emptive deterrence An incumbent who is trying to strategically deter entry can do so by attempting to reduce the entrants payoff if it were to enter the market. The expected payoffs are obviously dependent on the amount of customers the entrant expects to have therefore one way of deterring entry is for the incumbent to tie up consumers. The strategic creation of brand loyalty can be a barrier to entry consumers will be less likely to buy the new entrants product, as they have no experience of it. Entrants may be forced into expensive price cuts simply to get people to try their product, which will obviously be a deterrent to entry. Similarly, if the incumbent has a large advertising budget, any new entrant will potentially have to match this in order to raise awareness of their product and a foothold in the market a large sunk cost that will prevent some firms entering. Predatory pricing In a legal sense, a firm is often defined as engaging in predatory pricing if its price is below its shortrun marginal cost, often referred to as the Areeda-Turner Law and which forms the basis of US antitrust cases. The rationale for this action is to drive the rival out of the market, and then raise prices once monopoly position is reclaimed. This advertises to other potential entrants that they will encounter the same aggressive response if they enter. In the short run, it would be profit maximizing to acquiesce and share the market with the new entrant. However, this may not be the firms best response in the long run. Once the incumbent acquiesces to an entrant, it signals to other potential entrants that it is weak and encourages other entrants. Thus the payoff to fighting the first entrant is also to discourage future entrants by establishing its hard reputation.

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Prisoners dilemma The prisoner's dilemma is a example in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interest to do so. In economics Advertising is sometimes cited as a real life example of the prisoners dilemma. When cigarette advertising was legal in the United States, competing cigarette manufacturers had to decide how much money to spend on advertising. The effectiveness of Firm As advertising was partially determined by the advertising conducted by Firm B. Likewise, the profit derived from advertising for Firm B is affected by the advertising conducted by Firm A. If both Firm A and Firm B chose to advertise during a given period the advertising cancels out, receipts remain constant, and expenses increase due to the cost of advertising. Both firms would benefit from a reduction in advertising. However, should Firm B choose not to advertise, Firm A could benefit greatly by advertising. Nevertheless, the optimal amount of advertising by one firm depends on how much advertising the other undertakes. As the best strategy is dependent on what the other firm chooses there is no dominant strategy and this is not a prisoner's dilemma but rather is an example of a stag hunt. The outcome is similar, though, in that both firms would be better off were they to advertise less than in the equilibrium. Sometimes cooperative behaviors do emerge in business situations. For instance, cigarette manufacturers endorsed the creation of laws banning cigarette advertising, understanding that this would reduce costs and increase profits across the industry. This analysis is likely to be pertinent in many other business situations involving advertising. Another example of the prisoner's dilemma in economics is competition-oriented objectives. When firms are aware of the activities of their competitors, they tend to pursue policies that are designed to oust their competitors as opposed to maximizing the performance of the firm. This approach impedes the firm from functioning at its maximum capacity because it limits the scope of the strategies employed by the firms. Without enforceable agreements, members of a cartel are also involved in a (multi-player) prisoners' dilemma. 'Cooperating' typically means keeping prices at a pre-agreed minimum level. 'Defecting' means selling under this minimum level, instantly stealing business (and profits) from other cartel members. Antitrust authorities want potential cartel members to mutually defect, ensuring the lowest possible prices for consumers.

Capacity expansion Many firms would like to expand their operations and capture more market share. But capacity expansion involves risks. If demand does not rise with capacity, the company may find itself burdened with overheads. At the same time, if capacity is not built in time, competitors may move ahead and grab market share. So, capacity expansion decisions have to be made carefully. One useful tool in this context is game theory. Companies can put themselves in the shoes of competitors and try to outguess them . At the same time, capacity expansion may sometimes be possible in increments. Companies can keep studying the business environment and learn before they decide to make more investments in capacity. The risk associated with capacity expansion is largely due to uncertainty regarding the following factors: i) ii) iii) iv) v) Future demand quantity and price realisation Future prices of inputs Technological advances Reactions of competitors Impact on industry capacity

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Capacity Expansion Risks

Enterprise Risk Management

Vertical Integration Risks

Diversification Risks

Technology Risks

Enterprise Risk Management

M&A Risks

Environmental Risks

Political Risks

Legal and Reputation Risks

Financial Risks

Marketing Risks

Human Resources Risks

Market saturation In economics, "market saturation" is a term used to describe a situation in which a product has become diffused (distributed) within amarket; the actual level of saturation can depend on consumerpurchasing power; as well as competition, prices, and technology. For example, in advanced economies an extremely high percentage of households own refrigerators (more than 97% of households). Hence, the diffusion rate is more than 97%, and the market is said to be saturated; i.e. further growth of sales of refrigerators will occur basically only as a result of population growth and in cases where one manufacturer is able to gain market share at the expense of others. To give another example, in advanced western households, and depending on the economy, the number of automobiles per family is greater than 1. To the extent that further market growth (i.e. growth of the demand for automobiles) is constrained (the main buyers already own the product), the market is said to be basically saturated. Future sales depend on several factors including the rate of obsolescence (at what age cars are replaced), population growth, and societal changes such as the spread of multi-car families.

First mover advantage First-mover advantage or FMA is the advantage gained by the initial occupant of a market segment. This advantage may stem from the fact that the first entrant can gain control of resources that followers may not be able to match. Sometimes the first mover is not able to capitalise on its advantage, leaving the opportunity for another firm to gain second-mover advantage. FMA is the sometimes insurmountable advantage gained by the initial or "first-moving" significant occupant of a new market segment. This advantage may stem from the fact that the first entrant can gain control of resources that followers may not be able to match. Originally made apparent by the ever booming Internet phenomenon, it has recently been on the decline due to the recent economic situation. It is important to note that the first-mover advantage refers to the first significant company to move into a market, not merely the first company. In order for a company to try and become a first-mover that company needs to figure out if the overall rewards outweigh the beginning/underlying risks. Sometimes first-movers are rewarded with huge profit margins and a monopoly like status. Other times the first-mover is not able to

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capitalize on its advantage, leaving the opportunity for other firms to compete effectively and efficiently versus their earlier entrants. These individuals then gain a second-mover advantage. These are; 1. Technological leadership 2. Preemption of scarce assets 3. Switching costs and buyer choice under uncertainty First mover Disadvantages Although in some cases being a first mover can create an overwhelming advantage, in some cases products that are first to market do not succeed. These products are victims of First Mover Disadvantages. These disadvantages include: "free-rider affects, resolution of technological or market uncertainty, shifts in technology or customer needs, and incumbent inertia". Delving into each of these deeper we see: 1. Free-rider affects 2. Resolution of technological or market uncertainty 3. Shifts in technology or customer needs 4. Incumbent inertia

The Net Income theory and Net Operating Income theory stand in extreme forms. Traditional approach stands in the midway between these two theories. This Traditional theory was advocated by financial experts Ezta Solomon and Fred Weston. According to this theory a proper and right combination of debt and equity will always lead to market value enhancement of the firm. This approach accepts that the equity shareholders perceive financial risk and expect premiums for the risks undertaken. This theory also states that after a level of debt in the capital structure, the cost of equity capital increases.

Example:

Let us consider an example where a company has 20% debt and 80% equity in its capital structure. The cost of debt for the company is 9% and the cost of equity is 14%. According to the traditional approach the overall cost of capital would be:

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The Net Income theory and Net Operating Income theory stand in extreme forms. Traditional approach stands in the midway between these two theories. This Traditional theory was advocated by financial experts Ezta Solomon and Fred Weston. According to this theory a proper and right combination of debt and equity will always lead to market value enhancement of the firm. This approach accepts that the equity shareholders perceive financial risk and expect premiums for the risks undertaken. This theory also states that after a level of debt in the capital structure, the cost of equity capital increases.

WACC = (Weight of debt x cost of debt) + (Weight of equity x cost of equity)

(20% x 9%) + (80% x 14%)

1.8 + 11.2 13%

If the company wants to raise the debt portion in the capital structure to be 50%, the cost of debt as well as equity would increase due to the increased risk of the company. Let us assume that the cost of debt rises to 10% and the cost of equity to 15%. After this scenario, the overall cost of capital would be:

WACC = (50% x 10%) + (50% x 15%)

5 + 7.5 12.5%

In the above case, although the debt-equity ratio has increased, as well as their respective costs, the overall cost of capital has not increased, but has decreased. The reason is that debt involves lower cost and is a cheaper source of finance when compared to equity. The increase in specific costs as well the debt-equity ratio has not offset the advantages involved in raising capital by a cheaper source, namely debt.

Now, let us assume that the company raises its debt percentage to 70%, thereby pushing down the equity portion to 30%. Due to the increased and over debt content in the capital structure, the firm has acquired greater risk. Because of this fact, let us say that the cost of debt rises to 15% and the cost of equity to 20%. In this scenario, the overall cost of capital would be:

WACC = (70% x 15%) + (30% x 20%)

10.5 + 6 16.5%

This decision has increased the company's overall cost of capital to 16.5%.

The above example illustrates that using the cheaper source of funds, namely debt, does not always lower the overall cost of capital. It provides advantages to some extent and beyond that reasonable level, it

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increases the company's risk as well the overall cost of capital. These factors must be considered by the company before raising finance via debt. View Source: http://bit.ly/traditionalapproach _____________________________________________________________ Net Income (NI) Approach

Net Income theory was introduced by David Durand. According to this approach, the capital structure decision is relevant to the valuation of the firm. This means that a change in the financial leverage will automatically lead to a corresponding change in the overall cost of capital as well as the total value of the firm. According to NI approach, if the financial leverage increases, the weighted average cost of capital decreases and the value of the firm and the market price of the equity shares increases. Similarly, if the financial leverage decreases, the weighted average cost of capital increases and the value of the firm and the market price of the equity shares decreases.

Assumptions of NI approach:

There are no taxes The cost of debt is less than the cost of equity. The use of debt does not change the risk perception of the investors

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______________________________________________________________

Net Operating Income Approach

Net Operating Income Approach was also suggested by Durand. This approach is of the opposite view of Net Income approach. This approach suggests that the capital structure decision of a firm is irrelevant and that any change in the leverage or debt will not result in a change in the total value of the firm as well as

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the market price of its shares. This approach also says that the overall cost of capital is independent of the degree of leverage.

Features of NOI approach:

At all degrees of leverage (debt), the overall capitalization rate would remain constant. For a given level of Earnings before Interest and Taxes (EBIT), the value of a firm would be equal to EBIT/overall capitalization rate. The value of equity of a firm can be determined by subtracting the value of debt from the total value of the firm. This can be denoted as follows:

Value of Equity = Total value of the firm - Value of debt

Cost of equity increases with every increase in debt and the weighted average cost of capital (WACC) remains constant. When the debt content in the capital structure increases, it increases the risk of the firm as well as its shareholders. To compensate for the higher risk involved in investing in highly levered company, equity holders naturally expect higher returns which in turn increases the cost of equity capital.

Example:

Let us assume that a firm has an EBIT level of $50,000, cost of debt 10%, the total value of debt $200,000 and the WACC is 12.5%. Let us find out the total value of the firm and the cost of equity capital (the equity capitalization rate).

Solution:

EBIT =

$50,000

WACC (overall capitalization rate) =

12.5%

Therefore, total market value of the firm = EBIT/Ko $50,000/12.5% $400,000

Total value of debt =$200,000

Therefore, total value of equity = Total market value - Value of debt

$400,000 - $200,000 $200,000

Cost of equity capital = Earnings available to equity holders/Total market value of equity shares

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Earnings available to equity holders = EBIT - Interest on debt

$50,000 - (10% on $200,000) $30,000

Therefore, cost of equity capital = $30,000/$200,000 15%

Verification of WACC:

10% x ($200,000/$400,000) + 15% x ($200,000/$400,000) 12.5%

Effect of change in Capital structure (to prove irrelevance)

Let us now assume that the leverage increases from $200,000 to $300,000 in the firm's capital structure. The firm also uses the proceeds to re-purchase its equity stock so that the market value of the firm remains the same at $400,000.

EBIT = $50,000

WACC = 12.5% (overall capitalization rate)

Total market value of the firm = $50,000/12.5% $400,000

Less: Total market value of debt $300,000

Therefore, market value of equity = $400,000 - $300,000 $100,000

Equity-capitalization rate = ($50,000 - [10% on $300,000)/$100,000 20%

Overall cost of capital =

10% x $300,000/$400,000 + 20% x $100,000/$400,000 12.5%

The above example proves that a change in the leverage does not affect the total value of the firm, the market price of the shares as well as the overall cost of capital. _______________________________________________________________

Modigliani Millar Approach

Modigliani Millar approach, popularly known as the MM approach is similar to the Net operating income approach. The MM approach favors the Net operating income approach and agrees with the fact that the

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cost of capital is independent of the degree of leverage and at any mix of debt-equity proportions. The significance of this MM approach is that it provides operational or behavioral justification for constant cost of capital at any degree of leverage. Whereas, the net operating income approach does not provide operational justification for independence of the company's cost of capital.

Basic Propositions of MM approach:

At any degree of leverage, the company's overall cost of capital (ko) and the Value of the firm (V) remains constant. This means that it is independent of the capital structure. The total value can be obtained by capitalizing the operating earnings stream that is expected in future, discounted at an appropriate discount rate suitable for the risk undertaken. The cost of capital (ke) equals the capitalization rate of a pure equity stream and a premium for financial risk. This is equal to the difference between the pure equity capitalization rate and ki times the debt-equity ratio. The minimum cut-off rate for the purpose of capital investments is fully independent of the way in which a project is financed.

Assumptions of MM approach:

Capital markets are perfect. All investors have the same expectation of the company's net operating income for the purpose of evaluating the value of the firm. Within similar operating environments, the business risk is equal among all firms. 100% dividend payout ratio. An assumption of "no taxes" was there earlier, which has been removed.

Arbitrage process

Arbitrage process is the operational justification for the Modigliani-Miller hypothesis. Arbitrage is the process of purchasing a security in a market where the price is low and selling it in a market where the price is higher. This results in restoration of equilibrium in the market price of a security asset. This process is a balancing operation which implies that a security cannot sell at different prices. The MM hypothesis states that the total value of homogeneous firms that differ only in leverage will not be different due to the arbitrage operation. Generally, investors will buy the shares of the firm that's price is lower and sell the shares of the firm that's price is higher. This process or this behavior of the investors will have the effect of increasing the price of the shares that is being purchased and decreasing the price of the shares that is being sold. This process will continue till the market prices of these two firms become equal or identical. Thus the arbitrage process drives the value of two homogeneous companies to equality that differs only in leverage.

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Limitations of MM hypothesis:

Investors would find the personal leverage inconvenient. The risk perception of corporate and personal leverage may be different. Arbitrage process cannot be smooth due the institutional restrictions. Arbitrage process would also be affected by the transaction costs. The corporate leverage and personal leverage are not perfect substitutes. Corporate taxes do exist. However, the assumption of "no taxes" has been removed later.

Find Gross Annual value in the case of following properties Particulars Municipal value Fair rental value Standard rent Actual/Annual rent Period of vacancy Unrealized rent House1 52000 60000 NA 55000 --------House 2 100000 102000 90000 95000 ----------House 3 60000 68000 70000 72000 ------5000 House 4 75000 70000 60000 72000 8 months ---House 5 180000 185000 175000 168000 1 month 42000

Find the Gross Annual Value of a house property whose municipal valuation is Rs. 80,000, fair rent is Rs. 90,000 and standard rent is Rs. 75,000.The house is let out to a third party for a monthly rent of Rs. 7,000 for 10 months and remains vacant for the remaining part of the year

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Income from salary

Assessment year 2012-13

1. Mr. Ram joins TQS Ltd. on 1 -5-2009 on a salary of Rs. 15,000 p.m. From Aug 1, 2011 his salary is increased to Rs. 18,000 p.m. Compute salary chargeable to tax for the PY 2011-12 if (a) Salary falls due on last day of each month. (b) Salary becomes due on the first day of next month. Ans: (a) Rs. 2,04,000; (b) Rs. 2,01,000 2. Mr. Gopinath joins a company on 1-6-2007 on a salary of Rs. 12,000 p.m.. From 1-12-2011 his salary is increased to Rs. 16,000 p.m. Compute his basic salary for the AY 2012-13 assuming that (a) Salary falls due on last day of each month. (b) What would be your answer if he joins the company on 1-6-2011? (c) What would be your answer if he resigns from the company on 31-1 -2012. Ans: (a) Rs. 1,60,000; (b) Rs. 1,36,000 (c) Rs. 1,28,000

3. Mr. T joins as an education officer in an educational institute in the grade of 12,000-500-15,000 from 17-2009. Compute his basic salary for the AY 2012-13 assuming that (a) salary falls due on last day of each month. (b) salary become due on the first day of next month. Ans: (a) Rs. 1,48,500; (b) Rs. 1,48,000

4. Compute Gross Salary from following information for tire AY 2012-13: Salary after tax deduction of Rs. 2,000 1,44,000 Advance salary due for April 2012 received in March 2012 8,000 Arrears of salary already taxed in the PY 2010-11 5,000 Arrears of salary not taxed earlier 7,000 Bonus not yet received 16,000 Ans: Rs. 1,77,000

5. Ramlal Joins Gopi Ltd. on Oct 1, 2007 in the pay scale of Rs.12,000 Rs.1,000 Rs.18,000 (salary at the time of joining is fixed at Rs.15,000) As per the terms of employment salary becomes due on the first day of the next month, and it is generally paid on the fifth day of the next month. Find out the salary taxable for the assessment year 2012-13

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Ans: Rs. 2,16,000

6. Up till 30th June, 2011, Radha is in the employment of Shyam Ltd. on the fixed salary of Rs.23,000 per month which becomes due on the first day of the next month. On July 1, 2011, Radhe joins Bharat Ltd. (salary being Rs.30,000 per month which becomes due on the last day of each month.) Salary is actually paid on the 7th day of next month in both cases. Find out the amount of salary chargeable to tax for the assessment year 2012-13. Ans: Rs. 92,000 + Rs. 2,70,000 = Rs. 3,62,000

Mr. Shiv retires on 15th October2010, after serving 30 years and 7 months. He gets Rs.4,80,000 as gratuity. His salary details are given below: FY 2011-12: Salary Rs.18,000 pm D.A. 60% of salary. 40% forms part of retirement benefits. FY 2010-11: Salary Rs.16,000 pm D.A. 60% of salary. 40% forms part of retirement benefits Determine his gross salary in the following cases: (i) He retires from government service. (ii) He retires from seasonal factory in a private sector, covered under Payment of Gratuity Act, 1972. (iii) He retires from non-seasonal factory, covered by Payment of Gratuity Act, 1972 (iv) He retires from private sector, not covered by payment of Gratuity Act

Ram lal, an employee of Sita (P)Ltd. retired from the his job on 15-07-2011. At the time of such retirement, his basic salary was Rs. 8,600 p.m. He was also entitled to dearness allowance @ 30% of his basic salary. 70% of the D.A. forms part of the salary for retirement benefits. He had worked with his employer for 12 years 10 months and 15 days. He got an increment of Rs. 600 in his basic salary w.e.f 1-6-2011. At the time of his retirement, the company paid him a gratuity of Rs. 1,90,000. He is not covered under the payment of Gratuity Act. Also compute his gross salary for the A.Y. 2012-13. Ans: Rs. 1,69,052 Mr. Deendayal retired from his job w.e.f. 1-12-2011. He had joined the service on 1-1-99. He gets an increment in his basic salary amounting to Rs. 1,000 every year on 1st July. At the time of his retirement he was getting a basic salary of Rs. 15,000 p.m. He was also entitled to D.A. @ 20% of basic salary and a turnover based commission @ 1% of the total sales achieved by him. Total turnover achieved by him for the 12 months ending on 30-11-11 was Rs. 8,00,000 spread evenly over the year. Bonus received Rs. 30,000. He received a sum of Rs. 1,80,000 as gratuity. Compute his gross salary for the A.Y. 2012-13. Ans: Rs. 2,64,731

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4. Mr. Ganesh is getting a salary of Rs. 9,400 pm since 1.1.11 and dearness allowance of Rs.4,500 pm, 30% of which is a part of retirement benefits. He retires on 30th November 2011 after 30 years and 11 months of service. His pension is fixed at Rs.3,800 pm. On 1st February 2012 he gets 3/4ths of the pension commuted at Rs.1,59,000. Compute his gross salary for the previous year 2011-12 in the following cases: (i) If he is a government employee, getting gratuity of Rs.1,90,000 (ii) If he is an employee of a private company, getting gratuity of Rs.1,90,000 (iii) If he is an employee of a private company but gets no gratuity. 5. Mr. Hariom retired from his job w.e.f. 1-10-2011 after serving for 15 yrs. and 8 months. At the time of retirement he was getting the following remuneration: (i) Salary Rs. 6,000 p.m. (ii) D.A. @ 40% of salary (20% of which forms part of salary for retirement benefits). (iii) Commission 1000 p.m. On retirement, he received a sum of Rs. 2,50,000 as gratuity. He was entitled to a pension of Rs. 3,000 p.m. w.e.f. 1-10-2011. From 1-2-2012 he got 80% of his pension commuted and received a sum of Rs. 3,20,000 as commuted pension. Compute his gross salary for the A.Y. 2012-13. Ans: Rs. 4,57,667 Kalicharan Joined a Job in the grade of Rs. 12,000 400 - 14,000 500 - 18,000 1,000 24,000 on 1-798 and resigned from the service on 15-12-2011. He was also entitled to D.A. @ 60% which forms part of salary for retirement benefits. In addition of his salary he received on retirement a gratuity of Rs. 2,80,000. He was entitled to a pension of Rs. 5,000 p.m. w.e.f. 16-12-2011. He got 60% of his pension commuted w.e.f. 1-2-2012 and received a sum of Rs. 3,00,000 as commuted pension. Compute his gross salary for A.Y. 2012-13. Ans: Rs. 4,82,633

Mr. Raghunath was employed with Ravidev (P) Ltd. He retired from his job w.e.f. 1-11-2011 after completing a service of 22 yrs. and 8 months. He furnishes you following information in respect of his remuneration: Basic salary Rs. 15,800 p.m. (at the time of retirement) D.A. 80% of Basic salary (20% of which forms part of salary for Retirement benefits). Last increment Rs. 800 w.e.f. 1-8-2011 He is entitled to received pension of Rs. 4,000 p.m. He commuted the 50% portion of his pension on 1-22012 and received a sum of Rs. 1,60,000 as commuted pension. In addition to this, he received a gratuity of Rs. 3,58,000. He was entitled to 35 days leave for every year of service. He received leave encashment amounting to Rs. 90,000 on account of accumulated leave (unavailed leave at the time of retirement) of 260 days. Compute his gross salary for A.Y. 2012-13 assuming that he is not covered under payment of Gratuity Act. Ans: Rs. 4,27,805

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INCOME TAX Computation of HRA 1. Ascertain the amount of taxable and exempted HRA from the following cases Particulars Basic salary per month DA as % of basic DA forming part of retirement benefits ( % of DA) HRA received from Company per month HRA paid by the employee per month Place of residence Case I 5000 20% 40% 2000 2100 Delhi Case II 6000 10% Nil 2700 2600 Bangalore Case III 6500 15% 20% 2900 2950 Chennai Case IV 7500 20% Nil 3500 3600 Mysore

2. Compute taxable and exempted HRA from the following information: Salary 3500 pm, DA 1000 pm (enters retirement benefits), CCA 200 pm, HRA received 1000 pm Commission on turnover 6000 pa. The employee stays in Kolkota and rent paid by him is Rs.1500 pm. 3. Mr. R is employed in Hubli on a monthly salary of Rs.5500. Employer pays him an HRA of 1200 pm, but actual rent paid by him is 1800 pm. He is also getting a commission of 2% on turnover achieved by him and the turnover is 150000 pa. Compute his gross salary for assessment year 2012-13 4. Compute taxable HRA and gross salary for the assessment year 2012-13 Particulars Place of stay Basic salary DA ( 70% forms part of retirement benefits) Sales achieved for 1% commission HRA received from company Rent paid by employee Mr A Mumbai 8000 pm 1500 pm 30 lakhs 4000 pm 2400 pm Mr.B Bangalore 5000 pm 3000 pm 22 lakhs 2400 pm 5000 pm

5. Mr. G is an employee of XLR Ltd Chennai, working and staying in Bangalore. He gets a basic salary of Rs.12000 pm, DA 30% of basic ( 50% enters retirement benefits), CCA 5000 pm, HRA 4500 pm. The rent paid by him is Rs.5200 per month. Compute his taxable HRA and Gross salary for the assessment year 2012-13

INCOME TAX GRATUITY

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1. Mr Shah, accounts manager retired from JK Ltd on 15/1/2012 after a service of 30 years and 7 months. His salary is 25000 pm upto 30/9/2011 and 27000 thereafter. He also gets 2000 pm as DA ( 55% forms part of retirement benefits). He is not covered by payment of gratuity act. He receives 8 lakhs as gratuity. Compute taxable and exempted gratuity for the previous year. 2. Mr Surya is an employee of IPC Ltd. After serving for 38 years and 11 months he retires on 28/2/2012. He was drawing a monthly salary of 15000 pm in calendar year 2010, 16000 pm in 2011 and 18000 pm from 1/1/2012 to 28/2/2012. On retirement he received a gratuity of 4 lakhs. Compute taxable gratuity assuming he is not covered by payment of gratuity act 3. R retires on 8/1/2011 after serving KT Ltd for 19 years and 7 months. At the time of retirement his basic salary was 14000 pm and DA 8000 pm ( not covering retirement benefits). On his retirement he received 6 lakhs as gratuity. Compute exempted amount of gratuity, if he is covered under payment of gratuity act. 4. Vinod who is in part time employment with GT Ltd GY Ltd furnishes the following information Particulars Basic salary per month DA GT Ltd 10000 40% of basic ( forming part of GY Ltd 6000 50% of basic ( 40% enters retirement benefits) 15/1/2012 20 years and 4 months 120000 1/8/2011 5000

retirement benefits Date of retirement 1/12/2011 Period of service 22 years and 11 months Amount of gratuity received 143000 Date of increment in basic salary 1/4/2011 Amount of last increment 1000 Compute taxable and exempted amount of gratuity

5. Smt. S, who is not covered under payment of gratuity act, received 376000 as gratuity when she retired on 24/8/2011, after completing a service of 34 years and 9 months. Her last salary drawn was basic 20000 pm, servant allowance 750 pm. Basic salary of 20000 is after giving an increment of 1000 from janauary 2011. Calculate exempted gratuity if (a) salary falls due on last day of the month (b) salary falls due on first day of the month

INCOME TAX PENSION 1. X retires from P Ltd on 31/7/2011. He gets a pension of 1000 pm upto 31/12/2011. With effect from 1/1/2012, he gets 60% of his pension commuted for 170000. Compute taxable pension and exempted pension if (a) X gets gratuity (b) X does not get gratuity 2. Mr T retired from central government service on 30/6/2011. He gets pension of 750 pm upto 31/12/2011. On 1/1/2012 he gets 1/3 of his pension commuted for 66000. Calculate taxable pension, if salary falls due on last day of each month

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3. Mr. Eshwar retired from ACA Ltd on 30/6/2011. He gets a pension of 4000 pm upto 31/12/2011. On 1/1/2012 he gets 40% pension commuted for 52800. Calculate taxable pension of (a) Eshwar does not get gratuity (b) Eshwar gets gratuity 4. Mr Suresh is getting a pension of 2000 pm from a private company. During the previous year he got 2/3 of his pension commuted and received 123000. Compute exempted amount of pension if (a) he gets gratuity (b) he does not get gratuity 5. Calculate taxable pension of Mr Q who was working with TAFE Ltd and retires on 30/4/2011. Upto 31/12/2011 his pension is fixed at Rs.12000 pm. On the same date he commutes 2/3 of his pension for 64000. Calculate taxable pension if he receives and does not receive gratuity 6. Mr. Shobhit is getting a pension of Rs. 8,000 per month from a company. During the previous year he got his three-fourth pension commuted and received Rs. 7,20,000. Compute the exempted amount assuming if he also received gratuity. 7. A retired from service on 31.3.2011 and started getting pension of Rs. 6,000 monthly. On 1.1.2012 A commuted one-fourth of pension and received Rs. 90,000. Calculate taxable amount of pension for the Assessment Year 2012-13 if the assessee has not received gratuity at the time of retirement. 8. Mr. Reddy retires from Private Service on 30th April, 2011 and his pension has been fixed at Rs. 3,000 p.m. He gets 1/2 of his Pension commuted and gets Rs. 1,50,000. He also received Rs. 75,000 as gratuity. He gets his Pension commuted in January 2012.. Calculate taxable pension.

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Geeta is entitled to get a pension of Rs. 1,500 per month from Rajdeeo Ltd. She gets three-fifths of the pension commuted and receives Rs. 90,000. Compute the taxable portion of commuted value of pension when (i) she does not receive gratuity; (ii) receives Rs. 50,000 as gratuity.

Project proposal for CA coaching classes CA (Chartered Accountancy) course consists of the following groups and subjects Group Fundamentals of Accounting Quantitative Aptitude General Economics Mercantile Law Subjects

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Accountancy Costing & Financial Management Corporate & Business Law, Ethics & Communication Income Tax, VAT & Service Tax Advanced Accountancy Auditing & Assurance Information Technology & Strategic Management Financial Reporting Strategic Financial Management Corporate Laws and Secretarial Practice Advanced Auditing Advanced Management Accounting Direct Taxes Indirect Taxes

CA CPT It is an entry level test for Chartered Accountancy Course. It is a test of four subjects i.e. Accounting, Mercantile Laws, General Economics and Quantitative Aptitude. It is an objective based examination. You should register with the institute at least 60 days prior to the first day of the month in which examination is held.

Batch April Batch June Batch October Batch

Registration Commence 1st week of February 1st week of May 1st week of August

Classes Commence 1st week of April 3rd week of June 1st week of October

Class duration - 2 1/2 - 3 months Classes conducted at "ICSI" centre, Bangalore Course fee Rs. 4000/- ( Rupees four thousand only)

CA IPCC/PCC Course as per CA IPCC/PCC format

Batch February Batch September Batch

Registration Commence 1st week of February 1st week of August

Classes Commence 2nd fortnight of February 1st week of September

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Course Duration - 5 to 6 months Classes conducted at "ICSI" centre Bangalore Course fee Rs. 8000 (Rupees eight thousand only) CA Finals Course as per the CA Finals format

Class Duration - 6 months Course fee Rs. 10000 ( Rupees ten thousand only) CA Crash Course CA Crash Course conducted by well experienced faculty to cover entire syllabus in a short time. Suggested for students looking to score high marks. Normally the Crash Course is conducted in Feb & August

CA CPT Minimum Number of students : 20 Total Income for the institute 20 x 4000 Rs80000

CA IPCC/PCC Minimum number of students 20 Total income for the institute 20 x 8000 CA Final Minimum number of students Minimum number of students 20 Total income for the institute 20 x 10000 200000 160000

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Total income from from CA CPT, PCC and Final Less: Expenses ( roughly 50%) Net Income for the institute

240000 120000 120000

Anirudh has a property whose municipal value is 130000 and fair rental value is 110000. Standard rent 120000. The property is let out for 11000 per month throughout the previous year. One month rent is unrealized. Municipal tax paid is 10% of municipal value. Interest on loan is 40000. Compute income from house property for the assessment year 2012-13 Ganesh has a property in Mysore which has a municipal value of 250000. The fair rental value and standard rent is 200000 and 210000 respectively. The property was let out for the period from 1-4-2011 to 31-122011 at a monthly rent of 20000. Unrealized rent is for one month. Municipal tax of 8% on municipal value is shared equally between tenant and landlord. Interest on borrowed capital is 65000. Compute income from HP of Mr. Ganesh for assessment year 2012-13

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Prem owns a house in Bangalore. During the previous year 2/3 portion was self occupied and 1/3 portion was let out for residential purposes for a monthly rent of 8000 per month. MV of the property was 300000, FRV was 270000 and SR was 330000. He paid a municipal tax of 10% on MV. A loan of 25 lakhs was taken for the construction of the property in 2008. He paid a sum of Rs 188000 towards repayment of loan which includes Rs.120000 as interest in the previous year. Compute income from house property of Prem for the previous year 2011-12 Ravish owns a house in Delhi. Compute his income from house property for assessment year 2012-13 from the following information: MV 200000, FRV 252000, SR 240000 Actual rent 23000 per month MT due 20% of municipal value MT paid 50% of the due Expenses on repair Rs.20000 Insurance premium 5000 R had borrowed 12 lakhs @ 10% on 1-7-2009 for the construction of the house and the construction was completed on 28/2/2011.

Break even point 1. You are given the following data for the years 2010 and 2011 Particulars Sales Profit Calculate a. b. c. d. e. PV Ratio Fixed cost Break even point Margin of safety for two periods Sales required to earn a profit of 7.50 lakhs Profit when sakes are 20 lakhs 2010 30 lakhs 45 lakhs 3 lakhs 6 lakhs 2011

f.

2. You are given the following data of a Company Sales Direct material Direct labour Manufacturing expenses ( 1 lakh variable) Administration expenses 10 lakhs 3.30 lakhs 2.25 lakhs 2.50 lakhs 1.00 lakh

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( 50% fixed) Selling expenses ( 100% variable) Calculate: 0.45 lakhs

a.

PV ratio (b)Margin of safety (c)Sales required to earn a profit of 1 lakh

(d)Profit when sales are 9 lakhs 3 Calculate the profit earned. Fixed cost Rs.5,00,000. Variable cost R.10 per unit. Selling price Rs.15 per unit. Output 150,000 units 4. Find the fixed costs : Sales Rs.2,00,000. Variable Cost Rs.40,000. Profit Rs.30,000 5. Sales Rs.1,50,000. Profit Rs.40,000. Fixed cost 30000. Find variable cost 6. Calculate break even point and margin of safety. Fixed cost Rs.1,60,000. Variable cost per unit Rs.2 and Selling price per unit Rs.18. Also compute the margin of safety if the company is earning a profit of Rs.36,000.

For the assessment year 2012-13 Mr. Joseph submits the following information: Particulars Fair rent Municipal value Standard rent Annual rent Unrealized rent of previous year 2011-12 Unrealized rent of previous year 2010-11 Vacant period ( number of months) Loss on account of vacancy Municipal taxes paid Repairs Insurance Land revenue Ground rent Interest on borrowed capital by mortgaging House I ( funds used for construction of House II) Nature of occupation Determine the income from house property Mr Akhil owns two houses. The details are given below: compute income from HP Particulars Let out Self occupied MV FRV SR Rent for let out period Interest on borrowed capital MT paid House 1 1-4-2011 to 30-6-2011 (rent being 6000 per month) 1-7-1011 to 31-3-2012 60000 70000 66000 18000 2000 10000 House 2 1-7-2011 to 31-3-2012 ( rent being 13000 per month) 1-4-2011 to 30-6-2011 100000 95000 110000 117000 40000 17000 House 1 350000 360000 300000 600000 10000 ---2 100000 40000 40000 20000 25000 66000 140000 Let out for residence House 2 320000 350000 500000 420000 80000 300000 4 140000 50000 50000 30000 40000 82000

Let out for business

Mr. X owns a residential house property. It has two equal units Unit I and Unit II. While unit I is self occupied by Mr X for his residential purpose, Unit II is let out @ 6000 per month. Rent of 2 months could not be recovered. MV of the property is 130000, FRV 140000 and SR 125000. Municipal tax of 12% of MV is paid by Mr.X. Other expenses of previous year include repairs 1250, insurance 600 .Interest on borrowed

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capital ( borrowed in 1997) for construction of property Rs.63000. Find the income from HP for assessment year 2012-13 Find Gross Annual value in the case of following properties Particulars Municipal value Fair rental value Standard rent Actual/Annual rent Period of vacancy Unrealized rent House1 52000 60000 NA 55000 --------House 2 100000 102000 90000 95000 ----------House 3 60000 68000 70000 72000 ------5000 House 4 75000 70000 60000 72000 8 months ---House 5 180000 185000 175000 168000 1 month 42000

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1. R Ltd. which makes only one product, sells 10,000 units of its product making a loss of Rs. 10,000. Variable cost per unit of the product is Rs. 8 and the fixed cost is Rs. 30,000. Calculate (i) the number of units to break-even; (ii) the number of units to earn a profit of Rs. 6,000; (iii) the amount of profit from a sale of 20,000 units 2. A Company had incurred fixed expenses of 4,50,000, with sales of Rs.15,00,000 and earned a profit of Rs.3,00,000 during the first half year. In the 2nd half, it suffered a loss of Rs.1,50,000. Calculate: (i)The profit-volume ratio, break-even-point and margin of safety for the first half year. (ii) Expected sales-volume for the second half year assuming that selling price and fixed expenses remained unchanged during the second half year. (iii) The break-even point and margin of safety for the whole year.

3. ABC Ltd. & MNO Ltd. sell identical products in identical markets. Their budgeted income statement for the year 2010-11 are follows: ABC MNO Rs. Rs. Sales 5,00,000 6,00,000 Less: Variable cost _4,00,000 _1,80,000 Contribution 1,00,000 4,20,000 Less: Fixed Cost _20,000 _2,70,000 Budgeted profits 80,000 1,50,000 Calculate: BEP for each company; Sales at which each company will earn a profit of Rs. 60,000; Sales at which both companies will have same profits

4. I co. & II co. have decided to merge into one company. The operating details of two companies are as follows: Company I Company II Percentage of capacity utilisation 90 60 Sales (Rs.) 5,40,00,000 3,00,00,000 Variable costs (Rs.) 3,96,00,000 2,25,00,000 Fixed costs (Rs.) 80,00,000 50,00,000 Assuming that these two companies merge into one, determine: a. the break-even sales of the merged company, b. the profitability of the merged company at the 80% level of capacity utilisation, c. the turnover of the merged company required to earn a profit of Rs. 75,00,000, and d. the percentage increase in selling price necessary to sustain an increase in fixed overheads by 5% when the merged company is working at a capacity to earn a profit of Rs. 75,00,000.

1. KC Company produces a single article. Following is the cost data given for its product: Selling price per unit Fixed cost per annum Rs.20 Rs 800 Marginal cost per unit Rs.12

Calculate: (a) PV ratio (b) BEP (c) sales to earn a profit of Rs.1000 (d) profit at a sale of Rs.6000 (e) new BEP if selling price is reduced by 10%

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2. Lucky & Co has given you the following data: Selling price per unit Rs.20 Direct labour cost per unit Rs 2 Fixed cost (total) Rs.20000 Direct material cost per unit Variable overhead per unit Rs.2 Rs.8

Find out (a) PV ratio (b) BEP in value (c) MOS at a sale of 100000 (d) profit if sales are 20% above BEP (e) Sales to make a profit of Rs.5000 (f) PV ratio if the selling price is increased by 10% (g) Break even sales, if the selling price is increased by 10% (h) Break even sales, if the fixed overhead is increased by 20% 3. From the following information calculate BEP Sales Rs 200000 Variable cost Rs.120000 Fixed cost Rs.30000

Also calculate (a) new BEP if selling price is reduced by 10% (b) New BEP if variable cost increases by 10% (d) New BEP if fixed cost increases by 10% 4. S Ltd gives the following information: Particulars Direct material Direct labor Factory overhead Distribution overhead General administration overhead Budgeted sales for the next year 1850000 You are required to determine (a) BEP sales value (b) profit if actual sales drop by 10% (c) profit if actual sales increase by 5% 5. A multi product company furnishes the following data for the year 2010 Particulars Sales Total cost I half year Rs.45000 Rs.40000 II half year Rs.50000 Rs.43000 Variable cost (% of sales) 32.8 28.4 12.6 4.1 1.1 Fixed cost -------189000 58400 66700

Calculate: (a) PV ratio (b) BEP (c) profit when sales is 85000 (d) sales required to get a profit of 11000 (e) variable cost for two periods

1. ABC Ltd has prepared the following budget estimates for the year 2011-12 Sales (in units) Fixed expenses Sales value Variable cost 15000 Rs.34000 Rs.150000 Rs.6 per unit

You are required to (a) find out the PV ratio, BEP and MOS (b) calculate the revised PV ratio, BEP and MOS in each of the following cases Decrease of 10% in sales Increase of 10% in variable costs Increase of sales volume by 2000 units Increase of Rs.6000 in fixed costs

2. R Ltd manufactures a machine which has the following cost structure Material Selling price Rs 40 Rs.90 Labor Rs 10 Overhead Rs 4

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Sales during the current year are expected to be Rs.1350000 and fixed cost Rs.140000 Under a wage agreement an increase of 10% is payable to all direct workers from the beginning of next year, while material costs are expected to increase by 7.5%, variable overhead by 5% and fixed cost by 3%. You are required to calculate a. b. the new selling price if the current PV ratio is to be maintained The quantity to be sold during the forthcoming year to yield the same amount of profit as in the current year assuming the selling price remains at Rs.90

3. SS Ltd furnishes its cost structure which is as follows: Material Rs.50 LaborRs.80 Variable overhead75% of labor cost

Fixed overhead of the company amounts to Rs.240000 per annum and the selling price is Rs.230 each a. b. c. determine the number of units for break even How may units have to be made and sold in a year to make a profit of Rs. 1 lakh If the selling price is reduced by Rs.15 each, how many units have to be sold to break even

4. From the following information calculate variable cost Sales 100000 units @ Rs.12 each, Fixed cost Rs.28000, Profit Rs.200000

1. You are given the following Data: Sale Price Rs350 per unit, Variable cost Rs.200 per unit, Fixed cost 1650000. Ascertain :- (a) BEP (b) selling price per unit if BEP is brought down to 15000 units (c) selling price per unit if BEP is brought down to 10000 units 2. ABC Ltd has prepared the following budget estimates for the year 2011-12 Sales (in units) 15000 Fixed expenses Rs.34000 Sales value Rs.150000 Variable cost Rs.6 per unit You are required to (a) find out the PV ratio, BEP and MOS (b) calculate the revised PV ratio, BEP and MOS in each of the following cases Decrease of 10% in sales Increase of 10% in variable costs Increase of sales volume by 2000 units Increase of Rs.6000 in fixed costs

3. A company sold in two successive periods 7000 units and 9000 units and has incurred a loss of 10000 and earned a profit of 10000 respectively. The selling price is Rs.100. You are required to calculate: (a) fixed cost (b) the number of units to break even (c) the number of units to earn a profit of Rs.40000 4. A company has annual fixed cost of 14 lakhs. In 2010 the sales amounted to 60 lakhs compared to 45 lakhs in 2009. The profit in 2010 was 420000 higher than in 2009. At what level does the company break even? Determine the profit or loss on a sales volume of 80 lakhs 5. The price structure of a product is as follows: Particulars Per unit ( in Rs)

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Material Labor Variable overheads Fixed overheads Profit Selling price

60 20 20 50 50 200

This is based on the manufacture of one lakh cycles per annum. The company expects that due to competition they will have to reduce the selling price, but they want to keep the existing profits intact. What level of production will have to be reached ( how many units will have to be manufactured and sold) to get the same amount of profits if: a. b. the selling price is reduced by 10% the selling price is reduced by 20%

1. Mr. A is owner of two house properties, which are let out. The details for the financial year 2011-12 are as follows: Property A Property B Municipal valuation 60,000 50,000 Fair tent 70,000 60,000 Actual rent received p.m. SOP 10,000 Municipal tax paid by the owner (including Rs. 1000 of last year) 4000 10,000 Interest on loan taken for the marriage of his daughter (Property B is mortgaged) 20,000 Interest on loan for Renovation 40,000 Interest on loan borrowed for construction (started after 01.04.99 and completed before 1.4.2003) 1,60,000 Property B was lying vacant for two months during the year. The assessee has appointed a Caretaker for both the properties and he is paid a salary of Rs. 1000/- per month. The assessee had another house which was given on rent (upto the A.Y 2006-2007). In 2008-09, it was sold. When it was let out, the assessee could not realize rent of Rs. 25,000 However, after a court order, the tenant has now paid the same. On account of the said court orders, the assessee has also received Rs. 1,00,000/- as arrears of rent Compute income from house property for the assessment year 2012-13 2.Mr G furnishes the following information for the assessment year 2012-13. Compute his income from house property. Particulars MV FRV Standard rent Nature of occupation Rent per month Period of vacancy Unrealized rent MT due and paid Recovery of unrealized rent of PY 2009-10( claimed as deduction earlier) Receipt of arrears of rent Date of commencement of construction Date of completion of construction House 1 12500 13500 NA SOP ------12% -----June 2005 Dec 2007 House 2 16000 14000 NA Own business --------10% -----May 2005 Dec 2007 House 3 12000 12900 NA Let out 750 ---1.5 months 9% 12000 ---April 2005 Dec 2007 House 4 30000 27500 22900 Let out 2750 4 months ---10% ---8500 June 2005 Dec 2007

A loan of Rs 4 lakhs was taken from Canara Bank on 1-4-2005 @ 12% and it is still outstanding. The amount of loan is equally utilized for all the houses. Interest for the previous year 2011-12 is due and not paid. Interest on unpaid interest is 4850.

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1. Mr. G and N constructed their houses on a piece of land purchased by them at Kolkata. The built-up area of each house was 1,000 sq ft. Ground floor and an equal area in the First floor. Mr. G started construction on 1.7.2010. Mr. G occupied the entire house on 1.4.2011. Mr. N occupied the Ground floor on 1.7.2011 and let-out the first floor for a rent of ` 20,000 p.m. However, the tenant vacated the house on 31.12.2011 and Mr. N occupied entire house during 1.1.2012 to 31.3.2012. Following are the other information : (i) Fair Rental Value of each unit (Ground floor/First floor) ` 2,00,000 p.a. (ii) Municipal Value of each unit (Grount floor/First floor) ` 90,000 p.a. (iii) Municipal taxes paid by G ` 12,000 N ` 12,000 (iv) Repair and Maintenance charges paid by G ` 40,000 N ` 50,000 Mr. G has availed a housing loan of ` 16.00 Lakhs @ 12% p.a. on 1.4.2010. N has availed a housing loan of ` 18.00 Lakhs @ 10% p.a. on 1.7.2010. No repayment was made by either of them till 31.3.2012. Compute Income from House Property of G and N for the A.Y. 2012-13. 2. Mr M constructed a residential house in Chennai in February 2008 for 30 lakhs. Part of the cost of construction was met by borrowal of 20 lakhs from HDFC bank @ 12.5%. The loan was taken in June 2006. The loan outstanding at the beginning of the current year was 12 lakhs. Rate of interest applicable for current year was reduced by 3.5%. He had also borrowed from relatives Rs.4 lakhs @ 15%. Nothing was repaid. The property was let out after completion. In the assessment year 2008-09, M was allowed a deduction of 50000 for irrecoverable/unrealized rent. Out of this amount Rs.40000 was recovered and received in the previous year 2011-12. The annual value as per Chennai Corporation is 80000. The property was let out to a company for a rent of 20000 per month in the previous year 2011-12. The half yearly municipal tax on the property was fixed by Corporation only in August

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2011 at Rs.15000 for every half year. From 1-4-2008 M paid tax dues in September 2011 upto half year ending 31-3-2011. Compute IFHP for A/Y 2012-13 3. Vineet had been working with M Ltd. Jaipur, since 1-10-1997. He was entitled to the following emoluments: 1. Basic salary w.e.f. 1-1-2011 ` 6,000 p.m. 2. Dearness allowance 50% of basic salary (40% of which forms part of salary for retirement benefits) 3. House rent allowance ` 750 per month. He pays ` 1,000 per month as rent He resigned from his job on 1.1.2012 and shifted to Delhi. He received a Gratuity of 1,35,000 from his previous employer and is covered by payment of gratuity act. Compute his income from salary for assessment year 2012-13.

Cost Budgetary control 1. The expenses budgeted for production of 10000 units in a factory are furnished below: Rs. per Unit Material 70 Labour 25 Variable Overheads 20 Fixed overheads (Rs.100000) 10 Variable expenses (direct) 5 Selling expenses (10% direct) 13 Distribution expenses (20% fixed) 7 Administration Expenses (Rs.50000) 5 Total 155 Prepare a budget for the purpose of (a)8000 units and (b)6000 units. Assume that administration expenses are rigid for all levels of production. 2. From the following data, prepare a flexible budget for production of 40000 units and 75000 units, distinctly showing variable cost and fixed cost as well as total cost. Also indicate element-wise cost per unit. Budgeted output is 100000 units and budgeted cost per unit is as follows: Rs. Direct Material 95 Direct Labour 50 Production overhead (variable) 40 Production overhead (fixed) 5 Administration overhead (fixed) 5 Selling overhead (10% fixed) 10 Distribution overhead (20% fixed) 15 3. Z limited has prepared the budget for the production of 100000 units from a costing period as under: Per Unit (Rs.) Raw Materials 10.08 Direct Labour 3.00 Direct Expenses 0.40 Works overhead (60% fixed) 10.00 Administration overhead (80% fixed) 1.60 Sales overhead (50% fixed) 0.80 Actual production in the period was only 60000 units. Prepare budgets for the original and revised levels of output. 4. With the following data at 60% activity, prepare a budget at 80% and 100% activity.

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Production at 60% capacity Materials Labour Expenses Factory Expenses Administration Expenses

600units Rs.120 per unit Rs.50 per unit Rs.20 per unit Rs.60000 (40% fixed) Rs.40000 (60% fixed)

5. For production of 10000 Electrical Irons, the following are budgeted expenses: Direct materials Direct labour Variable overhead Fixed overhead (Rs.150000) Variable expenses (direct) Selling expenses (10% fixed) Administration expenses (Rs.50000 rigid of all levels of production) Distribution expenses (20% fixed) Total cost of sales per unit Per Unit Rs. 60 30 25 15 5 15 5 5 160

Prepare a budget for production of 6000, 7000 & 8000 irons, showing distinctly marginal cost and total cost.

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Cost

Budgetary control

1. At a capacity level of 2500 units for article P, the cost details are given below. Material cost Labour cost Power Repairs Stores Inspection Depreciation Administration overhead Selling overhead 70000 30000 4000 6000 2000 1200 20000 10800 6000__ 150000 100% varying 100% varying 80% varying 75% varying 100% varying 20% varying 100% fixed 20% varying 50% varying

Calculate the cost per unit of the product, showing at production levels of 2000 units & 3000 units, the individual expenses. 2. A factory is currently running at 50% capacity & produces 5000 units at a cost of Rs 90 per unit as per below details: Material 50 Wages 15 Factory overheads 15 (40% fixed) Administration overheads 10 (50% fixed) The current selling price is 100 per unit. Material cost per unit at 60% capacity increases by 2% whereas selling price per unit falls by 2%. However, material cost per unit increases at 80% capacity working, by 5% & selling price per unit falls by 5%. profit. Prepare a marginal cost statement showing for the three capacity levels showing the total cost &

3. Mira Ltd. manufactures 5,000 units of Product Jeo at a cost of Rs.120 per unit. Presently, the company is utilizing 50% of the total capacity. The information pertaining to cost per unit of the product is as follows: Material Rs.40 Labor Rs.30 Factory overheads Rs.20 (40% fixed) Administrative overheads Rs.30 (80% fixed) Other information: i. The current selling price of the product is Rs.160 per unit. ii. At 60% capacity level Material cost per unit will increase by 4% and current selling price per unit will reduce by 5%. iii. At 90% capacity level Material cost per unit will reduce by 2% and current selling price per unit will reduce by 8%. Prepare a flexible budget for 60% level and 90% level activity 4. Vairavi Ltd. has furnished the following information pertaining to its product: Direct material Rs.50 Direct labor Rs.40 Production overheads Rs.50 (40% fixed) Selling & administrative overheads Rs.40 (50% fixed)

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Normal Production 1,800 units Prepare a budget for 1,600 units and 1900 units 5. Apna Ltd. has furnished the following information relating to cost at a capacity level of 10,000 units: Material cost 1,25,000 (100% variable) Labour cost 1,15,000 (100% variable) Power 11,250 (80% variable) Repairs and maintenance 12,000 (75% variable) Stores 11,000 (100% variable) Inspection 1,500 (20% variable) Administration overheads 15,000 (100% fixed) Selling overheads 13,000 (50% variable) Depreciation 40,000 (100% fixed) Prepare a budget of 12,600 units and 15000 units

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Red Blu Ltd. has estimated 40% of total sales as cash sales and payments for credit sales to be received is as follows: i. 40% of credit sales in the month of sales. ii. 30% of credit sales in the first month following the month of sales. iii. 25% of credit sales in the second month following the month of sales. iv. 5% is non-recoverable. The company has furnished the following expected total sales for a period of six months: Month Sales January 2007 Rs.1,00,000 February 2007 Rs.1,40,000 March 2007 Rs.1,50,000 April 2007 Rs.2,00,000 May 2007 Rs.1,70,000 June 2007 Rs.2,00,000 The estimated cash inflows of the company in the month of April 2007 will be A Ltd. Sells its products at ` 40/unit. In a period if the company manufactures and sells 12,000 units, it incurs a loss of ` 2/unit and if the volume increase to 18,000 units, it earns a profit of ` 3.50/unit. The break even point in rupees is

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Advanced financial accounting (AFA) HOLDING COMPANY ACCOUNTS Meaning of holding company: A company that that holds more than 50% of the share capital of the other company is known as a holding company Terms used in holding company accounts Cost of control or goodwill: If the amount paid by the holding company for the shares of subsidiary company is more than its proportionate share in the net asset of the subsidiary company as on the date of acquisition, the difference is considered as goodwill of holding company If the amount paid by the holding company for the shares of subsidiary company is less than its proportionate share in the net asset of the subsidiary company as on the date of acquisition there will be capital reserve in holding company. Net assets of the subsidiary company consist of share capital, accumulated profits and reserve after adjustment, accumulated losses as on the date of acquisition It goodwill already exists in the balance sheet of holding company or both the goodwill thus calculated, will be added up to the existing goodwill. Capital Reserve will be deducted from Goodwill. In short, net amount resulting from goodwill and capital Reserve will be shown in the consolidated Balance sheet. Minority interest Minority interest means outsiders interest. It is treated as liability and shown in consolidated Balance sheet as current liability. This amount is basically intrinsic value of shares held by minority shareholders. Capital profits Profits earned prior to the date acquisition of shares Revenue profits Profits earned after the date of acquisition of shares Pre accquisition period The period upto the date of acquisition of shares Post acquisition period The period after the date of acquisition of shares

72

73

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Income tax Leave salary/Leave encashment 1. Mr. Raghunath was employed with Ravidev (P) Ltd. He retired from his job w.e.f. 1-11-2011 after completing a service of 22 yrs. and 8 months. He furnishes you following information in respect of his remuneration: Basic salary Rs. 15,800 p.m. (at the time of retirement) D.A. 80% of Basic salary (20% of which forms part of salary for Retirement benefits). Last increment Rs. 800 w.e.f. 1-8-2011 He was entitled to 35 days leave for every year of service. He received leave encashment amounting to Rs. 90,000 on account of accumulated leave (unavailed leave at the time of retirement) of 260 days. Compute exempted and taxable leave salary for the assessment year 2012-13 2. Mr. Narendra retired from HS Ltd on 31-12012 after a service of 5 years and received Rs.75000 as leave salary. His accumulated leave was 225 days @ 45 days per year for 5 years. He has not availed any earned leave during his service and utilized only casual leave. His salary at the time of retirement was 16000 per month consisting of Basic 10000, DA 3000. CCA 2000 and special allowance 1000. He is also eligible for a monthly pension of 30% of basic from 1-2-2012. Compute his gross salary for assessment year 2012-13 3. Mr. V is an employee of Veeyem Ltd. After 23 years and 8 months of service he retired and the time of retirement received 4 lakhs as leave salary. He was entitled for 40 days leave for every year of service and while in service had availed 4 months leave. Salary at time of retirement was 14000 per month. Compute exempted and taxable leave salary for assessment year 2012-13 4. Mr C retires from InfoMedia Solutions Ltd after 22 years and 3 months of service. He received 146000 as leave encashment on 28/10/2011, the date of his retirement. His employer allows him 2 months leave for every year of service. 15 months salary has already been encashed by him while in service. Calculate exempted and taxable leave salary for the previous year 2011-12 Gratuity and pension Kalicharan Joined a Job in the grade of Rs. 12,000 400 - 14,000 500 - 18,000 1,000 24,000 on 1-798 and resigned from the service on 15-12-2011. He was also entitled to D.A. @ 60% which forms part of salary for retirement benefits. In addition of his salary he received on retirement a gratuity of Rs. 2,80,000. He was entitled to a pension of Rs. 5,000 p.m. w.e.f. 16-12-2011. He got 60% of his pension commuted w.e.f. 1-2-2012 and received a sum of Rs. 3,00,000 as commuted pension. Compute his gross salary for A.Y. 2012-13. Ans: Rs. 4,82,633

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Cost Cash budget 1. A company expects to have Rs.37500 cash in hand on 1st April, and requires you to prepare an estimate of cash position during the three months, April, May & June. The following information is supplied to you: Sales (Rs.) Purchases Wages Factory Office Selling (Rs.) (Rs.) expenses expenses expenses (Rs.) (Rs.) (Rs.) February 75000 45000 9000 7500 6000 4500 March 84000 48000 9750 8250 6000 4500 April 90000 52000 10500 9000 6000 5250 May 120000 60000 13500 11250 6000 6570 June 135000 60000 14250 14000 7000 7000 Other Information: 1. Period of credit allowed by suppliers 2 months 2. 20% of sales is for cash and period of credit allowed to customers for credit is one month. 3. Delay in payment of all expenses 1 month 4. Income tax of Rs.57500 is due to be paid on June 15th. 5. The company is to pay dividends to shareholders and bonus to workers of Rs.15000 and Rs.22500 respectively in the month of April. 6. Plant has been ordered to be received and paid in May. It will cost Rs.120000. 2. Prepare a Cash Budget for the three months ending 30th June 2006 from the information given below: Period (2006) Sales (Rs.) Materials (Rs.) Wages (Rs.) Overheads February 14000 9600 3000 March 15000 9000 3000 April 16000 9200 3200 May 17000 10000 3600 June 18000 10400 4000 a. Credit terms are: sales and debtors 10% sales are on cash, 50% of the credit sales are collected next month and the balance in the following month. b. Lag in payment Materials 2 Months Wages month Overheads month (c). Cash and bank on 1st April, 2006 is expected to be Rs.6000 (d). Other relevant information are: i. Plant and machinery will be installed in February 2006 at a cost of Rs.96000. The monthly instalment of Rs.2000 is payable from April onwards. ii. Dividend @ 5% on Preference Share capital of Rs.200000 will be paid on 1 st June. iii. Advance to be received for sale of vehicles Rs.9000 in June. iv. Dividends from investments amounting to Rs.1000 are expected to be received in June. v. Income tax (advance) to be paid in June is Rs.2000 3. A company is expecting to have Rs.25000 cash in hand on 1st April 2006 and it requires you to prepare cash budget for the three months. April to June 2006. The following information is supplied to you. Period (2006) February March April May June Sales (Rs.) 70000 80000 92000 100000 120000 Purchases (Rs.) 40000 50000 52000 60000 55000 Wages (Rs.) 8000 8000 9000 10000 12000 Expenses (Rs.) 6000 7000 7000 8000 9000

(Rs.) 1700 1900 2000 2200 2300

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Other Information: (a) Period of credit allowed by suppliers is two months: (b) 25% of sale is for cash and the period of credit allowed to customers for credit sale is one month; (c) Delay in payment of wages and expenses one month (d) Income tax Rs.25000 is to be paid din June 2006.

4. Prepare a cash budget for the period April to June from the following data, indicating the extent of the bank facilities the company will require at the end of each month. Period (2006) Sales (Rs.) Purchases (Rs.) February 180000 124000 March 192000 144000 April 108000 243000 May 174000 246060 June 126000 268000 50% of the sales are realised in the following the sales and the remaining 50% in the second month following. Creditors are paid in the month following the month of purchase. Cash at bank on 1st April 2006 is Rs.25000. 5. You are Given the following information Month Jan Feb March April May June Sales 100000 120000 150000 160000 175000 200000 Purchases 40000 45000 35000 30000 25000 20000 Wages 10000 15000 18000 20000 22000 24000 Production overheads 6000 6500 7000 7700 8000 8500 Selling overheads 6000 6500 6600 6800 6200 6300

Wages (Rs.) 12000 14000 11000 10000 15000

The company has a policy of selling its goods at 50% cash and the balance on credit. On credit sales, 50% is paid in the following month and balance 50% two months from the sale. Purchases are paid one month from the month of purchase. Wages are paid in the following month and overheads are also paid in the following month. The company plans a capital expenditure, in the month of April, for Rs. 25,000. The company has a opening balance of cash of Rs. 40,000 on 1st April 2010. Prepare a cash budget for April to June. 6. Prepare a cash budget for the months of August and September from the following information assuming sales are cash sales

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Income Tax Income from salaries 1. Mr.Z has joined ICC Ltd. on 1 st July 2008 in the scale of `15,000-1,500-21,0002,500-31,000. Compute gross salary for the previous year 2011-12. 2. Mr.Kabir is getting a salary of `12,000 p.m. w.e.f. 1.4.2010. He is promoted w.e.f. 31.12.2010 and got arrears of `75,000. Bonus for the year 2011-12 is ` 15,000 remains outstanding but bonus of ` 12,000 for the year 2010-11 was paid on 1 st January 2012. In March 2012, he got two months salary i.e. April and May 2012 in advance. Compute the gross salary for the assessment year 2012-13 3. R submits the following information regarding his salary income for the year 2011-12: Basic salary ` 15,000 p.m.; D.A (forming part of salary) 40% of basic salary; City Compensatory Allowance ` 300 p.m.; Children Education Allowance ` 400 pm per child for 3 children; Transport Allowance ` 1,000 p.m. He is provided with a rent free unfurnished accommodation which is owned by the employer. The fair rental value of the house is ` 24,000 p.a. Compute the gross salary assuming accommodation is provided in a city where population is (a) exceeding 25 lakhs (b) exceeding 10 lakhs but not exceeding 25 lakhs (c) less than 10 lakhs 4. Aniket joined a company on 1.7.2011 and was paid the following emoluments and allowed perquisities as under : Emoluments : Basic Pay ` 35,000 per month; D.A. ` 20,000 per month; Bonus ` 20,000 per annum. Perquisities : (i) Furnished accommodation owned by the employer and provided free of cost; (ii) Value of furniture therein ` 3,60,000; Hire charges of Furniture provided ` 20,000 p.a. (iii) Motor car owned by the company (with engine c.c. less than 1.6 litres) along with chauffeur for official and personal use, expenses met by Employer. (iv) Sweeper salary paid by company ` 1,500 per month; amount recovered @ ` 200 pm. (v) Watchman salary paid by company ` 1,500 per month; amount recovered @ ` 300 pm. (vi) Educational facility for 2 children provided free of cost. The school is owned and maintained by the company. Elder child studies in class V and younger child in class II. Tuition fee per month ` 1,600 & ` 900 respectively. (vii) Loan of ` 5,00,000 repayable within 7 years given on 1.10.2011 for purchase of a house. No repayment was made during the year; let charged by employer @ 2% p.a. Interest chargeable as per Income Tax Act @ 10% p.a.

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(viii) Interest free loan for purchase of computer ` 50,000 given on 1.2.2012. No repayment was made during the year; (ix) Corporate membership of a club. The initial fee of ` 1,00,000 was paid by the company. Aniket paid the bills for his use of club facilities. You are required to compute the income of Aniket under the head Salaries in respect of assessment year 2012-13.

Income Tax Income from salaries: 1. Mr X retired from AB Ltd on 1-2-2012 after 20 years and 9 months of service. He joined PQ Ltd on the same day and remained in service till 31-3-2012. He furnishes the following information: AB LTD Basic salary DA ( enters ) Commission on sales Gratuity received (Not covered) 24000 pm 3000 pm 12000 pa 315000 PQ LTD Basic salary EA Fixed allowance HRA Leave salary received 18000 pm 2400 pm 600 pm 1500 pm 9000

Compute income from salary for assessment year 2012-13 2. Mr M is an Area Manager of SN Steels Ltd. During the financial year 2011-12 he gets the following emoluments from the employer: Basic salary upto August 2011 Basic salary from September 2011 Transport allowance Contribution to RPF 20000 per month 25000 per month 2000 per month 15% of basic Children education allowance Hostel allowance CCA Tiffin allowance 500 pm for 2 children 380 pm for 2 children 300 per month 5000 pa ( actual expenses 3700 pa)

Tax on employment paid by employer Rs.2500. Compute income from salaries for previous year 2011-12 3. Mrs. L is working for an MNC in Kolkota. She is in continuous service since 1965 and receives the following emoluments for the year ending 31-3-2011. Compute her income from salary for assessment year 2012-13 Basic salary DA Bonus Commission on sales 50000 pm 20000 pm (forming part of retirement benefits) 2 months basic 150000 per annum

Contribution of employer and employee to RPF 300000 each. Interest credited to RPF @ 8.5% 60000 Rent free unfurnished accommodation provided by company for which company pays a rent of 70000 per annum. Entertainment allowance 30000 per annum. Hostel allowance for 3 children 5000 each

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4. Mr Pankaj retired from central government service in Bangalore on 30-6-2011 and furnished the following information. Compute his income from salary for assessment year 2012-13 Salary 6000 pm Pension 3000 pm from July 2010 to November 2010 On 1-12-2010 he got 1/3 of his pension commuted for 120000.

INCOME TAX Mr Suraj a marketing manager in Mumbai furnished the following information for the year ending 31-3-2011 Basic salary 100000 per month DA 50000 per month Bonus 2 months basic Contribution to RPF 15% of basic + DA Rent free unfurnished accommodation was provided by the company at Mumbai and the accommodation was owned by the company. Compute his income from salary for assessment year 2012-13 Mr. Kishore a resident of Delhi provides the following information for the previous year Salary including DA Bonus Contribution to RPF Rent paid by the employer for flat provided to Mr. Kishore Cost of furniture provided by the employer for the above flat Rent recovered from the employee by the company Gas, electricity and water 1080000 pa 172800 pa 108000 pa 270000 pa 240000 108000 54000 pa

Mr. Kishore was provided with small car (self driven) also for personal use. It is not possible to determine the expenditure on personal use and all expenses were borne by the employer. Compute his income from salary for assessment year 2012-13 Mr. Dinesh a chief executive at Chennai appointed on contract basis for 2 years furnishes the following information for assessment year 2012-13. Basic pay and DA Special allowance HRA Servant allowance Gas, electricity and water Conveyance allowance for private purpose 324000 pa 15000 pa 72000 pa 4500 pa 4500 pa 18000 pa

He resides in his own house, the annual let out value is 54000. Municipal tax paid 9000 pa. Compute his income from salary for assessment year 2012-13 Ramlal Joins a Gopi Ltd. on Oct 1, 2006 in the pay scale of Rs.12,000 Rs.1,000 Rs.18,000 (salary at the time of joining is fixed at Rs.15,000) As per the terms of employment salary becomes due on the first day of the next month, and it is generally paid on the fifth day of the next month. Find out the salary taxable for the assessment year 2012-13 Ans: Rs. 2,16,000 Mr. Narayan draws following emoluments from a private Ltd Company for the PY 2011-12.

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Case 1 Case 2 Place of stay Pune Mumbai Basic Salary 8,000 p.m. 5,000 p.m. Dearness allowance (70% forms part of salary) 1,500 p.m. 3,000 p.m. Commission 1% p.a. based on sales. Sales achieved by the employee p.a. 30,00,000 22,00,000 Arrears of salary of 06-07 (not taxed earlier) 5,000 nil House rent allowance 4,000 p.m. 2,400 p .m. Rent paid 2,400 p.m. 5,000 p.m. Compute taxable house rent allowance & Gross Salary for the AY 2012-13. Ans: Case 1: Rs. 1,82,060; Case 2: Rs. 1,18,000 [Taxable HRA: 33,060/Nil]

Ratio analysis

Gross profit

Rs. 80,000 1/3

Gross profit to cost of goods sold ratio Stock velocity Opening stock 6 times Rs. 36,000

Accounts receivable velocity (year of 360 days) Accounts payable velocity 90 days

72 days

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Current assets Bills receivable Bills payable

Rs. 1,50,000 20,000 5,000 8 times

Fixed assets turnover ratio

Prepare balance sheet with as many details as possible. Solution: A)Working Notes I.

i.

Cost of goods sold = Gross profit 3 times

= 80,000 3 = Rs. 2,40,000 2) Sales = Cost of goods sold + Gross profit = Rs. 2,40,000 + Rs. 80,000 = Rs. 3,20,000 3) Average stock:

4).Closing Stock: or Closing stock = Average stock 2 Opening stock = 40,000 2 Rs. 36,000 = Rs. 80,000 Rs. 36,000 = Rs. 44,000 5)Accounts receivable:

Note: All sales have been assumed to be credit sales. 6)Debtors = Accounts receivable Bills receivable = Rs. 64,000 Rs. 20,000 = Rs. 44,000 7)Accounts payable:

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8)Creditors = Accounts payable Bills receivable

= Rs. 62,000 Rs. 5,000 = Rs. 57,000 9)Fixed assets

I.
Note: For the calculation of fixed assets turnover ratio it is cost of goods sold (not sales) which is taken into consideration.

Note: In the absence of information average debtors and average creditors have been taken as debtors and creditors at the end respectively.

From the following particulars, prepare the Balance Sheet of X Ltd., which has only one class of share capital: i) Sales for the year Rs. 20,00,000. ii) G.P. ratio 25%. iii) Current assets ratio 1.50. iv) Quick assets (cash and debtors) ratio 1.25. v) Stock turnover ratio 15.

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vi) Debts collection period 1 months. vii) Turnover to fixed assets 1.5. vii) Ratio of reserves to share capital 0.33 (i.e. 1/3). ix) Fixed assets to net worth 0.83 (i.e. 5/6). (The term turnover refers to cost of sales and the term stock to closing stock). Solution: I. Working Notes: (1) Closing Stock: Sales Rs. 20,00,000 Less: Gross Profit 25% on sales Rs. 5,00,000 Cost of goods sold Rs. 15,00,000 ?

As the term stock relates to closing stock, Rs. 1,00,000 is the closing stock (2) Fixed assets:

As the term turnover refers to cost of sales (3)Share capital and reserves:

As the ratio of reserves to share capital is 1:3 out of net worth Rs. 3,00,000 are reserves and the rest share capital (i.e., Rs. 9,00,000). (4)Book Debts:

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( 5)Current Liabilities: Current assets ratio Quick assets ratio = 1.5 = 1.25 0.25

Stock to current liabilities

Current liabilities will be 4 times the stock = Rs. 4,00,000. (6)Cash: Current assets ratio = 1.5. As the current liabilities are Rs. 4,00,000, the total of current assets would be Rs. 6,00,000. Cash = Current assets (Stock and debtors) = Rs. 6,00,000 (1,00,000 + 2,50,000) = Rs. 2,50,000

Corporate accounting I ( Common for 3 sem B com and BBM)

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From the following particulars, prepare Profit and Loss Appropriation Account : a) Profit and Loss account balance from last year Rs. 62,500. b) Net profit for the year before tax Rs. 5,40,000 (provision for tax 40%) c) Transfer to General Reserve Rs. 52,500. Dividend Equalisation Fund Rs. 40,000 and Development Reserve Rs. 37,500. d) Dividend on 7.5% preference shares Rs. 3,00,000 e) Dividend at 12.5% on 50,000 equity shares of Rs. 10 each, Rs. 7.50 called up (Calls in arrears Rs. 13,000) f) Corporate dividend tax 16.23%. The following Trial Balance has been extracted from the books of Amar Ltd. as on 31-3-2011. You are required to prepare : a) Profit and Loss Account for the year ended 31-3-2011 and b) Balance sheet as on that date. Debit Balances Land and Building (Original cost Rs. 3,00,000) Furniture (Original Cost Rs. 15,000) Plant and Machinery (Original Cost Rs. 2,00,000) Investments Preliminary expenses Advance Income tax Printing and Stationery Stock on 31-3-2001 Salaries Debtors Cash on hand Cash at bank Interest Debenture interest Directors fees Rent, rates and insurance 1,40,000 8,000 1,00,000 6,000 4,000 8,000 1,200 1,28,000 8,000 70,000 2,000 24,000 2,000 4,000 2,000 2,800 5,10,000 Adjustments : 1) Provide depreciation on : a) Land and Buildings at 5% on straight line basis. b) Furniture and Plant and Machinery at 20% on reducing balance basis. 2) Provide Rs. 5,000 for bad debts. 3) Provide for audit fees Rs. 2,500, Provision for Income Tax Rs. 14,000 and debenture interest for 6 months. 4) Insurance prepaid Rs. 800 5) Write off half of preliminary expenses. 6) Directors have recommended : a) Transfer of Rs. 10,000 to Sinking Fund b) Transfer of Rs. 4,000 to General reserve c) Equity dividend at 8% on paid up capital. 7) Provide for Corporate Dividend Tax 16.23% Credit Balances Share capital General Reserve 8% debentures Bank overdraft Sundry creditors Securities Premium Gross profit Sinking fund Profit and Loss A/c (1-4-2010) 2,00,000 30,000 1,00,000 1,500 10,000 6,000 1,14,000 40,000 8,500

5,10,000

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Corporate accounting I ( Common for 3 sem B com and BBM)


From the following trial balance of PQR Ltd as on 31-3-2011, prepare the company final accounts, after considering the following adjustments: a. b. c. d. e. f. Closing stock 120000 Depreciate building by 10% Accrued interest on investments 12000 Taxation provision 25000 Transfer 25000 to reserve fund Write off bad debts by 10000 Debit Credit 300000 150000

Particulars Called up capital Reserve Fund Furniture Buildings Wages Debtors and creditors Investments Interim dividend Audit fees Directors fees Freight charges Stationery Purchases and sales Returns Bills of exchange Machinery P & L appropriation a/c Cash at bank Forfeited shares Calls in arrears Goodwill Stock ( opening) Salaries Total

40000 80000 50000 160000 60000 30000 10000 15000 15000 12000 240000 20000 50000 80000 58000

180000

380000 10000 20000 20000 10000

20000 50000 60000 20000 1070000

1070000

Prepare balance sheet of GK Ltd from the following balances as on 31-3-2011 Equity share capital 12% preference share capital Goodwill Sundry debtors Bank overdraft Cost of issue of shares Advertisement suspense 500000 400000 100000 140000 60000 40000 90000 Plant & machinery Freehold property 10% debentures Closing stock Sundry creditors Unclaimed dividend 600000 300000 400000 200000 60000 50000

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Corporate accounting I ( Common for 3 sem B com and BBM) Following is the trial balance of GreenWay Ltd as at 31-3-2011 Particulars Share Capital Land & Building Plant & machinery Computer Preliminary expenses Furniture Calls in arrears Cash in hand and at bank Sundry creditors Reserve Fund P & L appropriation Purchase and returns Sales and returns 5% tax free Government Bonds ( Face value 40000) Bills receivable Goodwill Motor vehicles Debtors Interim dividend Repairs Advertisement Audit fees Carriage outwards Wages Insurance Stock ( opening) General expenses 6% debentures of Rs.100 Bank overdraft Debenture interest (less tax 20%) Total Additional information: Debit 340000 660000 40000 20000 29000 6000 12000 120000 60000 45400 20000 1231200 Credit 800000

960000 28000 36000 58000 36000 40000 83000 38000 3000 10000 4000 15000 92000 20000 190000 17000

400000 70000 9600 2746600 2746600

a. Closing stock 325000


b. RBD at 5% on debtors c. Depreciate all fixed assets by 5% d. Prepaid insurance 12000 e. Reserve fund to be increased by 3000 f. Final dividend at 10% (provide for dividend tax @ 16.23%) g. Wages outstanding 3000 h. Debenture interest is outstanding for the second half i. Write off 10% of preliminary expenses Prepare final accounts of the company.

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Prepare Cash Budget for the month of March 2005 from the following data : (i) Cash Balance on 1 March 2005, Rs. 25,000 (ii) Sales in February 2005, Rs. 70,000 (iii) Purchase in January 2005, Rs. 2,000 (iv) Drawing for the year 2005, Rs. 2,400 Note : (i) Credit allowed on sales is one month. (ii) Credit allowed on purchases is two months. (iii) Sales commission @ 3% is paid after one month.

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Income from salary Mr. Dinesh is employed as General Manager of an MNC in Mysore drawing a salary of 15000 per month. The company provided him with an accommodation for which 10% of basic salary is deducted. Actual rent paid by the company for the accommodation is 120000 pa. He is also provided a big car for his official and personal use, but maintenance expenses for the same are borne by assessee himself. He is in receipt of bonus equal to 2 month salary. Compute his income from salary for the assessment year 2012-13 Mr. Srikanth is an assistant manager of a private company in Mangalore since 1988. He has submitted the following information for the previous year 2011-12. Compute his income from salary: (a) Basic salary 46000 pa (b) DA 5000 pm ( 200 pm enters retirement benefits) (c) Educational allowance for 2 children @ 150 pm per child (d) Commission @ 1% o a sale of 10 lakhs (e) Entertainment allowance @ 700 pm (f) He resides in a flat of the company. Its market rent is 2000 pm. A watchman and cook have been provided by the company at the flat who are paid 400 pm each (g) He has been provided with a motor car of 1.8 Litre Engine capacity for his official and personal use. The running and maintenance costs are borne by the company. (h) Employer contribution to RPF is 8000 pa and interest credited to this find @ 13% is 16250. (i) Rent of the flat recovered from Srikant is 4600 pa. (j) tax deducted at source from his salary 6000 pa.

Income from salary Mr. Dinesh is employed as General Manager of an MNC in Mysore drawing a salary of 15000 per month. The company provided him with an accommodation for which 10% of basic salary is deducted. Actual rent paid by the company for the accommodation is 120000 pa. He is also provided a big car for his official and personal use, but maintenance expenses for the same are borne by assessee himself. He is in receipt of bonus equal to 2 month salary. Compute his income from salary for the assessment year 2012-13 Mr. Srikanth is an assistant manager of a private company in Mangalore since 1988. He has submitted the following information for the previous year 2011-12. Compute his income from salary: (a) Basic salary 46000 pa (b) DA 5000 pm ( 200 pm enters retirement benefits) (c) Educational allowance for 2 children @ 150 pm per child (d) Commission @ 1% o a sale of 10 lakhs (e) Entertainment allowance @ 700 pm (f) He resides in a flat of the company. Its market rent is 2000 pm. A watchman and cook have been provided by the company at the flat who are paid 400 pm each (g) He has been provided with a motor car of 1.8 Litre Engine capacity for his official and personal use. The running and maintenance costs are borne by the company. (h) Employer contribution to RPF is 8000

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pa and interest credited to this find @ 13% is 16250. (i) Rent of the flat recovered from Srikant is 4600 pa. (j) tax deducted at source from his salary 6000 pa.

92

93

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Corporate accounting I ( common for 3 sem B Com and 3 sem BBM) The authorized capital of EXE Limited is Rs.500000 consisting of 6% 2000 preference shares of Rs.100 each and 30000 equity shares of Rs.100 each. The following is the trial balance of the company as at 31-3-2012 Particulars Investment at cost Purchases Selling expenses Opening stock Salaries & wages Cash in hand Interim preference dividend for 6 months Discount on debentures Preliminary expenses Bills receivable Interest on overdraft Interest on debentures ( I half year) Debtors Freehold property Furniture at cost Income tax paid in advance Technical know how fees paid Audit fees Total Debit 50000 490500 79100 145200 52000 12000 6000 2000 1000 41500 7800 3750 50100 350000 35000 10000 150000 5000 1490950 Particulars Creditors 6% preference share capital Equity capital 5% mortgage debentures Miscellaneous income P & L a/c Sales Bank overdraft Credit 87850 200000 200000 150000 4250 28500 670350 150000

1490950

Prepare final accounts of the company after considering the following additional information:

a. Closing stock 250000


b. Salaries and wages outstanding 4500 c. Preference dividend to be paid for full year d. Equity dividend at 6% ( provide corporate dividend tax) e. Write off 50% of discount on debentures and preliminary expenses f. Balance debenture interest to be provided g. Depreciate furniture by 5% h. A provision of 5% is required for bad and doubtful debts i. Technical know how fees paid is to be written off over a period of 10 years

Corporate accounting I ( common for 3 sem B Com and 3 sem BBM) Following is the trial balance of WS Ltd as on 31-3-2012. Prepare its final accounts after considering the additional information:

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Particulars Opening stock Purchases Wages Power and Fuel Manufacturing expenses Carriage outwards Carriage inwards Salaries Insurance Debtors Bank balance 4% Govt securities ( 100000) Debenture interest Land & Building Plant & machinery Directors fees Audit fees Income tax paid Dividend paid on preference shares Interim dividend on equity shares Preliminary expenses Goodwill Total Additional information: a. Closing stock 190000

Rs 60000 320000 90000 15000 35000 20000 10000 60000 10000 90000 6000 90000 6000 300000 450000 10000 6000 41000 6000 30000 20000 140000 1815000

Particulars Sundry creditors Provision for income tax P & L account General reserve Equity share capital 6% preference share capital 6% debentures Salaries and wages unpaid Sales Interest received on Govt securities Sinking Fund

Rs 45000 45000 38000 100000 300000 200000 200000 25000 770000 2000 90000

Total

1815000

b. Depreciate plant and machinery by 8% c. Write off 2000 from debtors and provide 5% towards bad debts d. Insurance is prepaid to the extent of 1000 e. Preference dividend to be paid in full and final equity dividend is Rs.38000 f. Provide corporate dividend tax at applicable rates g. Transfer Rs.5000 each to general reserve and sinking fund h. Write off 10% from preliminary expenses

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INCOME TAX Aniket joined a company on 1.7.2011 and was paid the following emoluments and allowed perquisities as under : Emoluments : Basic Pay ` 35,000 per month; D.A. ` 20,000 per month; Bonus ` 20,000 per month. Perquisities : (i) Furnished accommodation owned by the employer and provided free of cost; (ii) Value of furniture therein ` 3,60,000; Hire charges of Furniture provided ` 20,000 p.a. (iii) Motor car owned by the company (with engine c.c. less than 1.6 litres) along with chauffeur for official and personal use, expenses met by Employer. (iv) Sweeper salary paid by company ` 1,500 per month; amount recovered @ ` 200 pm. (v) Watchman salary paid by company ` 1,500 per month; amount recovered @ ` 300 pm. (vi) Educational facility for 2 children provided free of cost. The school is owned and maintained by the company. Elder child studies in class V and younger child in class II. Tuition fee per month ` 1,600 & ` 900 respectively. (vii) Loan of ` 5,00,000 repayable within 7 years given on 1.10.2011 for purchase of a house. No repayment was made during the year; Int charged by employer @ 2% p.a. Interest chargeable as per Income Tax Act @ 10% p.a. (viii) Interest free loan for purchase of computer ` 50,000 given on 1.2.2012. No repayment was made during the year; (ix) Corporate membership of a club. The initial fee of ` 1,00,000 was paid by the company. Aniket paid the bills for his use of club facilities. You are required to compute the income of Aniket under the head Salaries in respect of assessment year 2012-13. Mr. Hemanth is an employee of a private company in Bangalore. During the financial year 201112 he furnishes the following information: Basic salary 13500 per month, DA 35% of basic ( 60% forms part of retirement benefits), HRA 4000 per month ( actualrent paid 5000 per month), Children education allowance Rs.50 per month for three children. Helper allowance 300 pm ( actual spent 200 pm), Bonus 25000 pa. Leave encashment 13500. Advance salary 14000. Entertainment allowance 250 per month Mr. Hemanth is also provided with free use of a small car for both personal and official use. During the year the company reimbursed 19200 towards medical expenses.

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His contribution to RPF is 14% of salary and company also contributes similar amount. Interest credited on RPF amounted to 18000 at 12%. Profession tax paid by him is Rs.200 per month. Compute his income from salary for the assessment year 2012-13

Cost Contract costing: 1. SV construction Limited have obtained a contract for the construction of a bridge. The value of the contract is 12 lakhs and the work commenced on 1 st October 2009. The following details are shown in their books for the year ended 30 th September 2010. Plant purchases 60000, wages paid 340000, materials issued to site 336000,site expenses 8000, general overhead apportioned 32000, wages accrued 2800, materials at site on 30-9-2010 4000, direct expenses accrued 1200, work not yet certified 14000. Cash received (80% of work certified) 600000. Life of the plant purchases is 5 years and the scrap value in nil Prepare contract account for the year ended 30 th September 2010. 2. A railway contractor makes up his accounts upto 31 st march every year. Contract No.SER/15 for the construction of a culvert between mandya and maddur started on 1-7-2010. The costing records showed the following information as at 31-3-2010. Material 31540 Labour 75300 Foreman salary 11700 A machine costing 25000 has been on site for 73 days. Its working life is estimated at 5 years and its scrap value is 1000. A supervisor who is paid 18000 per annum has spent approximately six months on the contract. All administration and other expenses amount to 17000 Material at site on 31-3-2010 amounted to 2500 The contract price is 3lakhs. At the end of the year 2/3 of the contract was completed for which amount, the architect certificate has been issued and 160000 has so far been received on account. Prepare contract account as on 31-3-2010 3. The following information relates to a building contract for 10 lakhs and for which 80% of the value of WIP as certified by the architect is being paid by the Contractee. Particulars Materials issued Direct wages Direct expenses Site expenses Work certified 31 st Dec Work uncertified Material at site Value of plant issued Year 2008 120000 110000 5000 2000 235000 2800 2000 14000 Year 2009 145000 155000 17000 2600 750000 8000 5000 Nil Year 2010 84000 110000 6000 500 1000000 Nil 8000 Nil

The value of plant at the end of 2008, 209 and 2010 was 11200, 7000 and 3000 respectively.

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Prepare contract account for three years

Cost Contract costing: M/s Promising Company undertook a contract for erecting sewerage treatment plant for Prosperous municipality for a total value of 24 lakhs. It was estimated that the job would be completed by 31-3-2011. You are asked to prepare the contract account for the year ending 31 st march 2011 from the following particulars: Materials 300000 Wages 600000 Overhead charges 120000 Special plant 200000 Work certified was for 1600000 and 80% of the same was received in cash Material lying on site 40000 Depreciate plant by 10% 5% of the value of material issued and 6% of wages may be taken to have been incurred for the portion of the work completed, but not yet certified.

A firm of building contractors began to trade on 1-1-2011. The following was the expenditure on a contract for 6 lakhs 150000 40000 70000 240000 22000 10000 3000 4000

Materials issued from stores Materials purchased for contract Plant installed at cost Wages paid Site expenses Establishment expenses Site expenses accrued Wages accrued

Out of the plant and materials charged to contract, plant which cost 5000 and materials costing 4000 were lost. Some part of the materials costing 2500 were sold at a profit of 500. On 31-122011, plant costing 2000 was returned to stores and plant which cost 3000 was transferred to some other contract. The work certified was 480000 and 80% of the same was received in cash. The cost of work done but not yet certified was 3000. Charge depreciation on plant at 10% pa. Prepare contract a/c, contractee a/c and give an extract of the balance sheet Prepare Contract a/c and Contractee a/c assuming that the amount due from the Contractee was duly received 20250 15500 10500 2400

Direct materials Direct wages Stores issued Loose tools

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Tractor Expenses: Fuel, oil etc Tractor Expenses: wages of drivers Other direct charges

2300 3000 2650

The contract price was 90000 and it tool 13 weeks for completion. The value of loose tools and stores returned at the end of the period were 200 and 3000 respectively. The plant was also returned at a value of 16000 after charging depreciation at 20%. The value of tractor was 20000 and deprecation was to be charged to the contract @ 15% pa. The administrative expenses and office expenses are to be provided at 10% of works cost.

Cost BEP
S Ltd gives the following information: Particulars Direct material Direct labor Factory overhead Distribution overhead General administration overhead Budgeted sales for the next year 1850000 You are required to determine (a) BEP sales value (b) profit if budgeted sales drop by 10% (c) profit if budgeted sales increase by 5% A multi product company furnishes the following data for the year 2010 Particulars Sales Total cost I half year Rs.45000 Rs.40000 II half year Rs.50000 Rs.43000 Variable cost (% of sales) 32.8 28.4 12.6 4.1 1.1 Fixed cost -------189000 58400 66700

Calculate: (a) PV ratio (b) BEP (c) profit when sales is 85000 (d) sales required to get a profit of 11000 (e) variable cost for two periods

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Cost Process costing A material used in a building is produced in three different consecutive processes. Particulars Raw material used ( 1000 tons) Wages Weight lost ( % of input) Scrap ( Sale price Rs.50 per ton) Sale price per ton of finished goods Process 1 Rs.100000 87500 5% 50 tons Rs.350 Process 2 39500 10% 30tons Rs.500 Process 3 10710 20% 51 tons Rs.800

Management expenses were 17500 and selling expenses Rs.10000. 2/3 of the output of process 1 and 50% of the output of process 2 are passed to next process and the balance is sold. The entire output of process 3 is sold. Prepare process accounts and statement of profit A product passes through three processes A B and C. The details are given below: prepare process accounts and P & L account Particulars Units introduced Cost per unit Sundry materials Labor Direct expenses Selling price per unit of output Process A 10000 Rs.100 10000 30000 6000 Rs.120 Process B Process C

15000 80000 18150 Rs.165

5000 65000 27200 Rs.250

Management expenses during the year were 80000 and selling expenses were 50000. These are not allocable to any processes. Actual output of the three processes were A 9300, B 5400 and C 2100 2/3 of output of process A and one half of process B was passed to next process and balance were sold. The entire output of process C was sold. The normal loss of three processes was A 5%, B 15% and C 20%. The loss of process A was sold at Rs.2 per unit, that of B at Rs.5 per unit and Process C at Rs.10 per unit.

BEP
S Ltd gives the following information: Particulars Direct material Direct labor Factory overhead Distribution overhead Variable cost (% of sales) 32.8 28.4 12.6 4.1 Fixed cost -------189000 58400

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General administration overhead Budgeted sales for the next year 1850000

1.1

66700

You are required to determine (a) BEP sales value (b) profit if budgeted sales drop by 10% (c) profit if budgeted sales increase by 5%

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