Chapter 1: Session 1

Introduction to Financial Accounting

Accounting is termedas the language of the business. Financial accounting is important branch
of accounting. It is associated with recording, classifying and summarizing financial
transactions and preparing statements relating to the business according to generally accepted
accounting concepts and conventions. It is mainly intended to aid all parties external to the
operating responsibility of company such as shareholders and creditors besides providing
information about the overall operational results of the business.
Concept of financial accounting: In general way, financial accounting is the statement of
information about a business or other type of organization so that executives or staff can assess
its financial growth and future results. The purpose of financial accounting is to ascertain the
results (profit or loss) of business operations during the particular period and to state the
financial position (balance sheet) as on a date at the end of the period.
Financial accounting is based upon the accounting equation.
Assets = Liabilities + Owners' Equity
This is a mathematical equation which must balance. In this, assets are valuable resource that
are owned by firm. They represent probable future economic benefit and arise as result of past
transactions or events. Liabilities are present obligations of the firm. They are probable future
sacrifices of economic remunerations which arise as the result of past transactions or events.
Owners' equity signifies the owners' residual interest in the assets of the business.
In management literature, it is thoroughly represented that financial accounting incorporates
the rules and procedures to express financial information about an organization. Individuals
who achieve high level knowledge of financial accounting can utilize this information to take
vital decisions based on the organization's perceived financial health and viewpoint. Such
decisions might include evaluating employment potential, lending money, granting credit, and
buying or selling ownership shares.

Basic features of financial accounting are as under:

Relevance: Financial accounting is decision-specific. It must be possible for accounting
information to influence decisions. This trait is important for developing statements.
Materiality: Information is material if its error or misstatement could influence the economic
decisions of users taken on the basis of the financial statements.
Reliability: Accounting must be precise or unbiased. It should be capable to be relied upon by
managers. Often information that is highly relevant isn't very reliable, and vice versa.
Understandability: Accounting reports should be clearly understood to accountant and by those
at whom the information is aimed.
Comparability: Financial reports from different periods should be comparable with one another
in order to derive meaningful conclusions about the trends in an entity's financial performance
and position over time. Comparability can be ensured by applying the same accounting policies
over time.
Importance of finance accounting: Financial accounting, is important for all types of
business entities. Financial accounting is useful for the recording of transactions. This function
of accounting is also known as bookkeeping. Because financial accounting uses the double-
entry system, each transaction affects two accounts, representing the two sides to a transaction.
Information is communicated to outside parties (users) through financial accounting. These are
people who are not directly involved in the business, but are interested in the operations of
business. This is done by providing the outside parties with financial statements of the
business. This gives them an idea of how the business is progressing.
Financial accounting is also vital for the communication of information for those within the
business too. These are known as internal users. Financial accounting is useful for
organizations as it provides small-business owners the ability to analyse their competitors and
also to evaluate various investment opportunities.

Users of Financial Accounting

1. The equity investor group, including existing and potential shareholders.They want to know
how effectively management is performing and how much profit they can withdraw from
the business for their own use.
2. The lender group, including existing and potential holders of debentures and loan stock,
banks providing long term loans, and providers of short-term secured and unsecured loans
and finance.They want to know if the company is earning adequately to pay them back
3. The employee group, including existing, potential and past employees.They want to know
their growth prospects, increments. Bonuses, promotion etc.
4. The analyst-adviser group, including financial analysts and journalists, economists,
statisticians, researchers, trade unions, stockbrokers and other providers of advisory
services such as credit rating agencies.They need information for their clients. For eg,
stockbrokers need information to advise investors, credit agencies want information to
advise potential suppliers of goods to the company, journalists need information for their
reading public, researchers need the information for their research etc
5. The business contact group, including customers, trade creditors and suppliers and, in a
different sense, competitors, business rivals and those interested in mergers, amalgamations
and takeover.Suppliers want to know about the company’s ability to pay its debts. The
customers need to know that the company is a secure source of supply and is in no danger
of closing down.
6. The government, including tax authorities, departments and agencies concerned with the
supervision of commerce and industry, and local authorities. Regulators like Registrar of
the company, Company Law Board, SEBI study company books of accountsto ensure the
compliance of various Acts. The Tax authorities, ED require the information for ensuring
accuracy of tax returns.
7. The public, including taxpayers, ratepayers, consumers and other community and special
interest groups such as political parties, consumer and environmental protection societies
and regional pressure groups.They want accounting information because enterprises affect
them in many ways, for eg by providing jobs and using local suppliers, or by affecting the
environment (eg pollution)
8. The auditor group including internal auditors as well as external auditors (statutory)need
the accounting information for the audit, i.e., for checking the accuracy of the books of
accounts and reporting compliance to the Companies Act.
Drawbacks of Finance Accounting

First disadvantage of financial accounting is that it allows subjective treatment of transactions.

Although, accounting is based on concepts and it follows "generally accepted accounting
principles", but there exists more than one principle for the treatment of any one item. This
permits alternative treatments within the framework of generally accepted accounting
principles.
Secondly, financial accounting is impacted by personal judgements in spite of the fact that
convention of objectivity is respected in accounting.To record certain events, estimates have to
be made which requires personal judgement. It is very difficult to expect precision in future
estimates and objectivity suffers.
Another demerit of financial accounting is that it overlooks important non-monetary
information. Financial accounting takes into consideration only those transactions and events
which can be labelled in money. The transactions and events, however important, if non-
monetary in nature are ignored i.e., not recorded.
Financial accounting does not give information on time. Financial accounting is designed to
supply information in the form of statements (Balance Sheet and Profit and Loss Account) for a
period, normally, one year. So the information is of historical interest and only post-mortem
analysis of the past can be conducted. The business requires timely information at frequent
intervals to enable the management to plan and take corrective action.
Financial accounting does not offer comprehensive analysis. The information supplied by the
financial accounting is in reality aggregate of the financial transactions during the course of the
year. Of course, it enables to study the overall results of the business activity during the
accounting period. For proper operation of the business, the information is required regarding
the cost, revenue and profit of each product but financial accounting does not provide such
detailed information product-wise.
Financial accounting does not reveal the present value of the business. In financial accounting,
the assets in the balance sheet are shown on the basis of going concern concept. Therefore, it is
presumed that business has comparatively longer life and will continue to exist indefinitely,
hence the asset values are at cost and not realisable values. The realised value of each asset if
sold today cannot be identified by studying the balance sheet.
To summarize, financial accounting are basically, financial statements means of
communicating financial information to parties outside the business organization. Financial
accounting is a subsection of accounting in which money is seen as a device to gauge financial
performance. Financial accounting includes the monitoring and controlling of the flow of
money into and out of a company. Those flows are documented on financial statements such as
the balance sheet, income statement and cash flow statement which provide insightful
information to external parties who have a vested interest in the company's performance.
 Chapter 1: Session 2
Generally Accepted Accounting Principle
Accounting Principles are the guidelines that assist the companies to record business
activities/transactions. Although these principles are not mandatory by law however,they are
generally accepted by accounting bodies world over. These guidelines are intended to promote
consistency in recording process and therefore help the accountants in tackling the dilemmas
that can arise while preparing financial statements.
Financial accountancy is directed by both local and international accounting standards.
Generally Accepted Accounting Principles is the standard framework for guidelines for
financial accounting used in any given jurisdiction. It encompasses the standards, conventions
and rules that accountants follow in recording and summarising and in the preparation of
financial statements. Conversely, International Financial Reporting Standards is a set of
international accounting standards stating how particular types of transactions and other events
should be reported in financial statements.

Accounting Principles (GAAP) are classified into:

A. Accounting Concepts; and
B. Accounting Conventions
Let us understand these concepts and conventions in detail.

A.Accounting Concepts are the basic assumptions that an accountant makes in order to record
a business transaction. These concepts are:
1. Separate Business Entity concept- It assumes that the owner and the business are two
different accounting entities and therefore there should be a careful separation for the owner’s
personal transactions with the business transaction. For example, if the owner invest capital in
the business, it is considered as liability of the business.
2. Going Concern Concept– It assumes that the business will continue for a very very long
period of time and will not wind up in the foreseeable future. This means that the business will
not have to sell its assets any time soon and therefore the assets would be valued at cost price
and not at its realizable value.
3. Money Measurement concept– This concept says that only those business transactions that
can be measured in terms of money are recorded in the books of accounts. So, an accountant
cannot record the honesty of the workers or any major change in the management.
4. Historical cost concept– It says that the assets of the business are to be recorded at its
acquisition cost and not at its market price or at its realizable value. For example, the business
purchases a machinery, the MRP of which is Rs 100000, at Rs 80000. It spends another 10,000
on its transport and installation. At the close of the accounting period, the re-sale value of the
machine is Rs 85000. The accountant would record it at Rs 90000 (Acquisition cost = Purchase
price + Transport + Installation charges) in this case due to Cost principle.
5. Duality concept– Also known as “Double Entry principle”, it says that for every transaction,
there are two impacts or in other words, for every debit there is a credit in the books of
accounts. For example, if the company purchases Furniture for Rs 20000 on credit, this means
there is an increase in the assets of the company and at the same time there is an increase in the
liability of Rs 20000 to be paid back in the near future.
6. Accounting Period Concept– This concept says that a business entity needs a regular period
to determine its profit as well as its financial position. So, it choosesa specific period of time to
complete the accounting cycle. Generally, this time period is a year called as the accounting
year. This time period is mentioned in the financial statements. For India, company follows 1st
April to 31st March as an accounting (financial) year (period).
7. Matching Concept– It says that the income of an accounting period is to be matched with the
expenses of that period to determine profit or loss of the business.The matching accounting
concept follows the realization concept. First, the revenue is recognized and then it is matched
with the costs associated.
8. Accrual concept– This concept says that revenue (income) of the period is recorded
irrespective of the fact whether it has been received or not. Similarly, expenses recognised for
the period is recorded in the same period irrespective of the fact whether it is paid or not. The
Companies Act mandates the accrual basis of accounting in India.
9. Revenue realisation concept– It says that in order to record an income or expense of the
period, one needs to recognise and associate it with that period, So revenue is recognised when
it is earned and expenses are recognised when it becomes due.

B. Accounting Conventions are the traditional usage or customs that the accountants world
over have been practicing since so long that they have become no less than law to be followed.
These conventions are as follows:

1. Convention of Full Disclosure – It says that all relevant information that might impact the
decision of the stakeholders of the business, should be disclosed in the financial statements. A
lot of external users (stakeholders) depend on the information provided by these financial
statements for take their investing/lending/buying/supplying decisions.
2. Convention of Materiality – It says that the material informationshould be included in the
financial statements but the immaterial information should be left out. The materiality of a
transaction will depend on its nature, value and its significance to the external user. It is
because of this convention that all petty expenses are clubbed together as general expenses or
miscellaneous expenses and written in the P/L account and not shown separately (individually).
3. Convention of Consistency - Once certain accounting policy for example a method of
calculating depreciation or valuating inventory, is decided by the company, it should not be
frequently changed. Only in case of a statutory requirement or if it is felt that the change in
policy will give a better representation of the business, the business entity is allowed to change
its accounting policy. Otherwise, the policies should be consistent for long periods of time to
allow inter-firm and inter-period comparisons and prevent manipulations.
4. Convention of Conservatism – It says “anticipate no profit but make provision for all
probable losses”. In other words, it states that states that profit should not be included until it is
realized but, losses even with the slightest possibility of happeningshould be included in the
financial statements. It is because of this convention that inventory is valued at cost price or
market price whichever is lower.
5. Substance over Form - It states that the that the economic substance of transactions and
events must be recorded in the financial statements rather than just their legal form in order to
present a true and fair view of the affairs of the business entity.
 Session - 3
Trial Balance

In the preparatory sessions, you must have learnt about the accounting cycle i.e. how a business
transaction is recorded into journal books and then classified into different heads by posting
these transactions into different ledgers. At the end of the accounting period, all these ledger
accounts are closed and their balances are transferred to trial balance.
Trial balance acts as bridge between these journal books and ledger accounts, collectively
known as books of accounts and, balance sheet and income statement (profit and loss account),
collectively known as final accounts of the company.
Methods of preparing Trial Balance
Totals Method – Here, the TB is prepared by taking the total of both debit and credit sides of
all the ledger accounts.
Balance Method – In this, only the accounts having closing balances are transferred to TB. The
ledgers would have either a debit or a credit closing balance. This method is widely used.
Composite Method – Also known as Total-cum-Balance method, it is a hybrid of the first two
methods where the ledgers accounts without closing balance are ignored and the total of the
remining ledger balances are transferred to the TB in the respective sides.

The debit and credit side of the TB should always match because of the duality concept of
accounting. A tallied TB indicates that the books of accounts are maintained accurately,
although it still does not guarantee an error free TB. A non-tallied TB is a confirmation that
there is an error in the books of accounts.

Types of Errors in Accounting

A) Errors that impact Trial Balance
B) Errors that do not impact Trial Balance

A) As mentioned earlier, when the Trial Balance does not tally, it means that there are errors in
the books of account. Following are the examples of the errors which usually affect the Trial
Balance and lead to non-matching.
 Omission of posting in one account: Both the debit and credit aspects of a transaction have to
be posted in the ledger accounts. If it is posted to the debit of one account and its posting to
the credit of the other concerned is omitted, the Trial Balance would not tally. For example,
an amount of Rs. 2000 received from Alex, correctly entered on the debit side of the cash
book but is not posted to the credit side of Alex’s Account. This error shall result in the lower
credit and hence the Trial Balance will not tally.
 . Double posting in one account: If by mistake an entry is posted twice to the debit or to the
credit of an account it would result in extra debit or credit and as such cause disagreement in
the Trial Balance. If, however, the whole entry is posted twice i.e., both the debit and the
credit aspects are posted twice, it won’t affect the Trial Balance. It is because both the debit
and the credit sides will be equally affected.
 Posting on the wrong side of an account: When an entry is posted on the wrong side of an
account i.e., instead of debit side it isposted on the credit side, it would also impact the Trial
Balance. In such a situation, the difference will be for double the amount. For example, Rs.
3000 received from Krishan which is correctly entered on the debit side of the Cash Book, but
while posting it to Krishan’s Account, it is wrongly posted to the debit side instead of the
 credit side. This would mean that a debit of Rs. 600 (Rs. 300 in Cash Account and Rs. 300 in
Krishan’s Account) has no corresponding credit. So, in the Trial Balance, the credit side will
be lower by Rs. 600.
 Posting wrong amount in an account: If an entry is posted to the correct side of an account
but there is an error in writing the amount, this would affect the Trial Balance. Suppose, in
the above example the entry is correctly posted on the credit side of Krishan’s Account but
the amount is wronglyput as Rs. 200. It would cause a difference of Rs. 100. In the Trial
Balance, the credit side will be lower by Rs. 100.
 Wrong totaling of the subsidiary book: If any subsidiary book is overcast or undercast, it
affects the concerned account in ledger. Suppose the correct total of Sales Journal is Rs.
5,600, but it is actually totaled as Rs. 5,300. The total of Sales Journal is posted to the credit
side of the Sales Account. So, the Sales Account will be short by Rs. 300, and the Trial
Balance will not tally.
 Omitting to post the total of a subsidiary book: If the total of a subsidiary book is not posted
to the concerned account, it would affect the Trial Balance. Such mistake relates only to the
account where posting was to be done and as such affects only one account. For example, the
total of Rs. 18,000 of Sales Journal is not posted to the credit of Sales Account, the credit side
on the Trial Balance will be lower by Rs. 18,000.
 Wrong totaling or balancing of an account: When an account is wrongly totaled or wrongly
balanced, this would affect the Trial Balance. Suppose the debit side of Shyam’s Account is
totaled as Rs. 1,300 instead of Rs. 1,100. It would lead to wrong balance in Shyam’s Account.
Consequently, the debit total in the Trial Balance will be higher by Rs. 200. Similarly, if the
totaling is correctly done but a mistake is committed in balancing the account, it would also
cause a difference in the Trial Balance.
 Omission of an account from Trial Balance: All accounts which show some balance must be
included in the Trial Balance. If the balance of any account is omitted in the Trial Balance, it
will not tally. In practice, cash book balances are often omitted from Trial Balance.
 Writing the balance of an account on the wrong side of the Trial Balance: If the balance of an
account which is to be shown in the debit column of the Trial Balance is actually shown in
the credit column, the Trial Balances will not tally. It will be affected by double the amount.
10. Wrong totaling of the Trial Balance: If a mistake is committed in totaling the Trial Balance
amount columns of the Trial Balance itself, the Trial Balance will not tally. Note that these
errors affect only one aspect (debit or credit). This upsets the debit-credit correspondence
leading to the disagreement of the Trial Balance.
Locating errors when the trial balancedoes not tally
When a Trial Balance disagrees, an attempt must be made to locate the errors and rectify them.
If all errors are rectified and the Trial Balance is revised, it will tally.
The following routine procedure is usually adopted for locating the errors.
a) Check the totals of both the debit and the credit columns of the Trial Balance.
If the difference still persists, ascertain the exact amount of difference; and then
i. Check whether an account with a balance equal to that difference has been entered twice
in the Trial Balance.
 ii. Take the half amount of difference, see whether there is any account with such balance in
the Trial Balance and, if so, check whether it is entered in the correct column or not. If an
account with a debit balance of Rs. 350 has been entered in the credit column, the debit
column becomes short by Rs. 700.
b) Verify whether (i) the balances of all the accounts are included in the Trial Balance, (ii)
they are entered in the correct column, and (iii) their amounts have been correctly written.
If no errors are found upto this stage, or the errors located have been duly corrected, but
still the Trial Balance does not tally, there is need to take further action. The following
steps can be taken:
c) Check the totals of the lists of sundry debtors and sundry creditors.
d) Check the totals and balances of all accounts in the ledger.
e) Check the totals and the postings of all subsidiary books.
f) Check the postings of all amounts equal to the difference in Trial Balance. It is possible
that a posting has been omitted. Similarly, check the postings of all amounts equal to half
the difference. It is possible that the amount has been posted on the wrong side of the
concerned account.
g) See that correct amounts have been brought forward from the previous pages.
h) Verify that all opening balances have been correctly entered in various accounts.
i) Compare the current year’s Trial Balance with that of the previous year. Anyvariation
noticed should be carefully checked.

B) Errors that do not impact Trial Balance:Following are the errors which do not affect the
Trial Balance at all:
1. Errors of Principle:When a transaction has not been recorded as per the rules of debit and
credit, or some other accounting principle has been ignored, the errors so arising are called
‘Errors of Principle’. For example:An expenditure incurred on repairs of machinery
debited to Machinery Account treating it as capital expenditure.However, as per rules it
should have been debited to Machinery Repair Account, as it is a revenue expenditure. It
is therefore an error of principle. This also does not affect the Trial Balance because the
debit has been duly recorded, though in the wrong account.
2. Errors of Omission: When a transaction is completely or partially omitted to be recorded
in books of account, it is called an ‘Error of Omission’. For example, if a credit purchase
of furniture from Ram is duly recorded in the Journal Proper but no posting is done in any
of the two accounts involved, then these will be termed as errors of complete omission.
The errors of complete omission do not affect the matching Trial Balance.
3. Errors of Commission: When an error is committed in recording a transaction in the
subsidiary book with a wrong amount, or is committed in posting it to a wrong account or
to the wrong side of an account, it is called an ‘Error of Commission’. If an error of
commission is committed while recording a transaction inany of the subsidiary books, it
shall not affect the Trial Balance because both the debit and the credit are equally affected.
 For eg.a machine of Rs. 5,000 purchased on credit is recorded in the journal for Rs. 5,500.
It means both the debit and the credit have been recorded for Rs. 5,500.
4. Compensating Errors: Those errors which nullify the effect of each other are called
‘Compensating Errors’. Such errors do not affect the Trial Balance. For example, while
posting an entry of Rs. 400 to the debit of Shyam’s personal account, we wrongly wrote
Rs: 600. Then, while posting an entry of Rs. 700 to the debit of some other account we
wrote Rs. 500. The first error will result in a higher debit of Rs. 200 whereas the second
error will result in a lower debit of Rs. 200. Thus, the effect of the first error is nullified by
the effect of the second error. So, the Trial Balance will not be affected.

Rectification of errors:
This depends upon the stage at which the errors are detected. These stages are:
 Before preparation of the Trial Balance
 After the Trial Balance but before the preparation of the final accounts

Before preparation of the Trial Balance

Till this time the ledger accounts are not closed, therefore it is easy to rectify errors at this
stage. There can two types of such errors:
• Errors where no journal entry is possible for its rectification: we have to go to the relevant
account(s) and put the figure on the right side of the account. No journal entry is necessary.
• Complete journal entry can be passed for its rectification: In this case rectification is done
with the help of a journal entry. Such rectification entries are passed in the journal proper.

After the Trial Balance but before the preparation of the final accounts
This means the ledger a/cs are already closed. To rectify such errors, journal entries are
passed. In other words if an account is to be debited for rectification, another account has to
credited by the same amount, otherwise the Trial Balance will not tally.
In case the error is difficult to detect, the difference is put to an artificial account created
temporarily to make the Trial Balance tally. Such an artificial account is known as
Suspense account.
The existence of the ‘Suspense A/c’ in the Trial Balance means there exist an error. Once
this error is detected, it is rectified by passing journal entries. Upon rectification of all such
errors, the Suspense account is automatically eliminated from the Trial Balance.
 Session – 4
Depreciation
Fixed assets wear out, are consumed or lose their value either because of use, time or
obsolescence due to technology and market change.Depreciation is viewed as a measurement
of the diminution in the value of the fixed assets.The following can be stated as causes of
depreciation:
• Wear and Tear
• Exhaustion
• Obsolescence
• Efflux of time
• Accidents
In other words, depreciation is the allocation of the cost of an asset to the periods that are expected to benefit from its use. It is
the gradual conversion of the cost of an asset into expense.
Accounting Standard (AS) – 6 requires that the company charge depreciation on a “systematic basis” to each accounting
period during the life of an asset. Its aim is to absorb the cost of using the assets to different accounting periods in a way so as
to give the true figure or profit or loss made by the business. Thus, the objective of depreciation can be:
• Ascertainment of true profits
• Presentation of true financial position
• Replacement of assets
The companies are required to use a particular method of calculating depreciation consistently and are not supposed to change
the same. However, in the following cases the change is allowed:
a) If the adoption of the new method is required by statute; or
b) For compliance with an accounting standard; or
c) If it is considered that the change would result in a more appropriate preparation or presentation of the financial
statements of the enterprise.

When a change in the method of depreciation is made, depreciation is recalculated as per the new method from the date of the
asset coming into use. The deficiency or surplus arising from retrospective re-computation of depreciation in accordance with
the new method is adjusted in the accounts in the year in which the method of depreciation is changed.
In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency is charged in the
statement of profit and loss. In case the change in the method results in surplus, the surplus is credited to the statement of
profit and loss. Such a change is treated as a change in accounting policy and its effect is quantified and disclosed.

Calculating Depreciation
The following information are required to calculate the depreciation:
• Cost of the asset
• Estimated scrap value
• Estimated useful life; orRate of depreciation
Methods of calculating depreciation
a) Uniform Charge Methods
a. Straight line/Fixed installment
b. Depletion method
c. Machine Hour rate method
b) Declining Charge/accelerated Depreciation
a. Diminishing Balance/WDV method
b. Sum of Years Digits method
c. Double Declining method
c) Other Methods
a. Inventory system
b. Annuity method
c. Depreciation Fund

Straight line/Fixed installment- Under the SLM, the depreciable amount of the asset is distributed equally over the life of
the asset.It is based on the assumption that depreciation arises solely from the passage of time, and the effect of usage on the
service value of the asset is insignificant.
 Original Cost  Installation Expenses  Salvage Value
Depreciation 
Life time in years
or
(Original Cost  Installation Expenses  Salvage Value)  0 0 of Depreciation
For example, a machine costs Rs 8,00,000 and is expected to realize Rs 80,000 at the end of its estimated useful life of six
years. To calculate the annual depreciation,the following steps would be there:
Depreciation = (Rs 8,00,000 – Rs 80,000)/ 6 years= Rs 1,20,000 p.a.
This means, every year Rs 120000 will be deducted from the value of the asset till it reaches its scrap value at the end of six
years.

Meritsof Straight-Line Method:

• Simple to understand and easy to apply/compute
• Asset value can be reduced to zero/scrap value
• Used particularly in case of leasehold properties, patents, etc..
Demeritsof Straight-Line Method:
• Same amount is charged irrespective of the usage.
• Total charge for use of asset goes on increasing i.e. repairs and depreciation.

Diminishing Balance Method: Depreciation is computed at a fixed rate percentage of the book value of the asset at the
beginning of an accounting period.
Thus, the depreciation expense for year 1 will be a certain % of the beginning book value (cost).From year 2 onwards, the
Depreciation charge would be related to the cost of the asset, less accumulated Depreciation at the beginning of the year.
Since the fixed percentage rate is applied to the beginning book value, the Depreciation expense will keep decreasing from
year to year.It is also known as Written-Down Value Method (WDV).
For example, if the asset is purchased for Rs.2, 00,000 and depreciation is to be charged at 10% p.a. on reducing balance
method, then

Depreciation for the 1st year = 10% on Rs.2, 00,000, i.e., Rs.20,000
Depreciation for the 2nd year = 10% on Rs.1, 80,000 i.e., (Rs.2, 00,000 –– Rs.20, 000)
= Rs. 18,000
Depreciation for the 3rd year = 10% on Rs.162, 000 i.e., (Rs.180, 000 - Rs.18, 000)
= Rs.16, 200 and so on.

Merits of Diminishing/Written down Value Method:

o Amount of depreciation decreases every year, so charge to asset is almost equal by adding repairs and
depreciation.
o Simple to understand and easy to follow
Demeritsof Diminishing/Written down Value Method:
o Asset value cannot be brought down to zero.

Sum of Years Digits method: In this method, the amount of depreciation goes on decreasing in the coming years.
Depreciation = No. of years (including the current year) of the remaining life of the asset * (Original cost less scrap value) /
Sum of all digits of the life of asset (in years)
Question: Use sum of the years' digits method of depreciation to prepare a depreciation schedule of the following asset:
Cost - $45,000; Salvage Value - $5,000; Useful Life in Years – 4; Asset is Depreciated Yearly
Solution: Sum of the Years' Digits = 1 + 2 + 3 + 4 = 10
Depreciable Base = $45,000 − $5,000 = $40,000
Year Depreciable Depreciation Depreciation Accumulated
Base Factor Expense Depreciation
1 $40,000 4/10 4/10 × 40,000 =16,000 $16,000
2 $40,000 3/10 3/10 × 40,000 =12,000 $28,000
3 $40,000 2/10 2/10 × 40,000 = 8,000 $36,000
4 $40,000 1/10 1/10 × 40,000 = 4,000 $40,000
 Session 5
Inventory valuation
Inventory is an asset of the business entity. It is basically a reserveof all materials held by the company for the purpose of
production or sale in the course of business in the near future. In accounting Inventory means and includes the following:
a) Stock of Raw material
b) Stock of Work in progress
c) Stock of Finished goods
d) Stores& spares
Therefore, it can be said that the inventory as assets are held for one of the following three reasons,
a) assets held for sale in the normal course of business
b) held for the purpose of production of goods
c) for the consumption in the production of such goods (any equipment or tools or materials the company requires in the
manufacturing process)
At the end of every financial year, the business entities have to make a roster of its inventory. This is done to ascertain the
value of cost of material used in the production process and the closing stock of the inventory. This closing balance is a very
important figure in preparing the final accounts of the company. It is shown on the asset side of the balance sheet and the
credit side of the Trading Account.

Valuation of Inventory

Inventory valuation is the cost associated with inventory of the business entity at the end of an accounting period say 31st
March or 31st December. The correct inventory valuation is crucial to have a fair representation of the company’s
finances. The following are the significance of inventory valuation:

1. It helps in ascertaining the income of the business: To determine the income (gross profit or loss) for the year the cost of
goods sold (COGS)is compared to the net revenue of an accounting period. The formulae for calculating the cost of goods
sold is as follows,

COGS = Opening Stock (Inventory)+ Purchases + Direct Expenses – Closing stock (Inventory)

The value of inventory mentioned above will impact the income in the following way:
a) When closing stock is overstated, net income for the accounting period will be more.
b) When closing stock is understated, net income for the accounting period will be less.
c) When opening stock is overstated, net income for the accounting period will be less.
d) When opening stock is understated, net income for the accounting period will be more.
2.It helps in determiningfinancial position of the business: Inventory (closing stock) are counted as current assets of a
business entity.If the value of the inventory is wrongly calculated, it will represent a wrong financial position on the
date of the balance sheet.

3. It helps in determiningliquidity position of the business: As a current asset, inventory is expected to be converted into
cash by way of sales within a period of one year. If it is held for a long period of time in the business, this means company’s
funds are stuck and cash availability is less indicating poor liquidity.

4. Inventory Valuation is required as Statutory Compliance: According to the Accounting Standard (AS2), all firms now
have to disclose the valuation of each class of inventory. The disclosure must include: -

 Accounting policies adopted for the inventory valuation

 The total amount of the inventories along with the classifications (raw materials, WIP, finished goods etc.)

Methods of Inventory Valuation:

Inventory is valued at cost price or market price (realizable value) whichever is less as per the convention of conservatism.
The valuation can be done through following either of the two systems given below:

1. Periodic Inventory method

2. Perpetual inventory method

In case of Periodic system, the quantity and value of the inventory is determined only at the end of the accounting period. In
this, the inventory verification is done by an actual physical count of the inventory on any given date. So, to determine the
closing stock a physical count of the inventory (numbers, weight etc.) is taken.

In case of Perpetual system, continuous recording of the stock is done. This means the inventory is recorded after every issue
or purchase/receipt of raw materials, final goods, work in progress etc. So, these records needs updating on a daily basis.In the
perpetual inventory system, the value of the closing stock is determined by the cost of goods issued and cost of goods sold.

The following equation gives the value of the closing inventory:

Opening Stock (Value known) + Purchases during the year (known) – COGS (known) = Closing Stock (Balancing Figure)

The valuation of the inventory/closing stock is done using one of the various inventory pricing methods, i.e.
1. FIFO,
2. LIFO,
3. Weighted Average Cost

FIFO (First In First Out) - In this method, stock materials are issued in the order of which they are purchased/received by
the company. This means the goods that came in first will also be issued first. So, the older stocks are considered to be issued
first, before the new stock items. Thus, the stock lying with the company at year end is the one with the latest market price.

One main advantages of this method is that it is easy to maintain and record. And the closing stock of the firm will be a
reflection of the current market value. It also has the added advantage of being logical, since it follows a more likely flow of
goods. But when the price of the goods fluctuates a lot the calculation by the FIFO method can get more difficult and
complicated.

LIFO (Last In First Out) – In this method, the goods that are received last are issued first. So, the issue of goods is made
from the latest purchase, and the previous purchases lie in stock.
While LIFO is a better method for matching the costs to the revenue,most companies used this method to manipulate their
stock valuation in the case of price-rise. Another disadvantage is that the stock at the year-end does not reflect the market
value of stocks. This is the reason why most tax authorities do not find LIFO and acceptable method of recording inventory.

Weighted Average Method (WAC) – In this method, average of the costs in the inventory is used in the cost of goods sold.
The quantity and price of goods both are taken into account to arrive at the average price of the inventory purchased by the
company. So if the company buy 100 goods at Rs 5/- and 200 goods at Rs 6/-, the weighted average price will be (100×5) +
(200×6) / 300 = 5.667/-
 Session – 6
Accounting Equation
Based on the duality concept, the accounting equation is a basic principle of accounting and a fundamental element of the
balance sheet. The equation is as follows:
Assets = Liabilities + Shareholder’s Equity

In other word, accounting equation sets the baseof double-entry accounting and highlights the formationof the balance sheet.
Double-entry accounting is a system where eachfinancial transaction impacts both sides of the accounting books. For every
debit there is a credit, for every change to an asset account, there is an equal change to a related liability or shareholder’s
equity account.
The balance sheet is classified into three mainsections and their several basic elements, i.e., Assets, Liabilities, and Capital
(Owner’s/Shareholder’s Equity).
Assets mean and include the following:
 Fixed assets like land & Building, Plant & Machinery, Furniture & Fixture etc and
 Current assets like Inventory, Debtors, Bills Receivable, Cash etc
Liabilities mean and include the following:
 Long term liabilities like Bank loan, long term debts, advances from FIs
 Current liabilities like creditors, bills payable, bank overdraft etc
Owner’s equity includes capital, profit or loss (retained earnings for companies)
The accounting equation shows the relationship between these items.

The accounting equation can also be structured as:

Liabilities = Assets - Owner Equity
or
Owner Equity = Assets - Liabilities

The accounting equation is a simple way to view the relationship of financial activities across a business. The balance sheet
basicallyascertainsthe filling in of each of the values in the equation, so the equation is not meant for actual use but is instead
a simplified representation of how the financial side of a business functions.

The rules of accounting equation may be summarised as below:

1. Increases in assets are debits;decreases in assets are credits.
2. Increases in capital are credits;decreases in capital are debits.
3. Increases in liabilities are credits;decreases in liabilities are debits.
4. Increases in incomes and gains are credits;decreases in incomes and gains are debits.
5. Increases in expenses and losses are debits;decreases in expenses and losses are credits.
Accounting equation examples
The following examples are connected to the same business. Take a look at how different transactions affect the accounting
equation. Then, see the business’s balance sheet at the end of this section.
Example 1: Aman starts a business selling printed T-shirts for IBS students and staff. He saves for a year before opening and
contribute Rs 10,000 to the new company. By doing this, he increaseshis business’s assets and owner’s equity by the same
amount:
Rs10,000 Assets (cash) = Liabilities + Rs10,000 Equity

Example 2: After forminghis company, Aman needs to buy equipment to print the T-shirts. He purchasesRs 2,000 of the
equipment on credit. In this situation, he gains a liability (debt) and an asset. His assets and liabilities increase by Rs 2,000, so
the equation looks like:
Rs 2,000 Assets (equipment) = Rs 2,000 Liabilities (creditors) + Equity

Example 3:As his T-shirt company grows, Aman gets an order for 50 shirts from a customer Meghna who pays Rs100 per
shirt, or Rs 5000 total. So, Aman gains an asset and equity from the transaction which looks like the following:
Rs 5000 Assets (cash) = Liabilities + Rs5000 Equity (income)

Expanded accounting equation

The expanded accounting equation shows the relationship between the profit and loss account and balance sheet. It highlights
how equity is created from its two main sources: revenue and owner contributions.
The expanded accounting equation:
Assets = Liabilities + Owner’s Equity + Revenue – Expenses – Drawings

Revenues are what the business earns through regular operations. Expenses are what it costs to provide the products and
services for the purpose of sale.
Certain patterns occur as figures in the expanded accounting equation change:
 Revenue increases owner’s equity
 Expenses decrease owner’s equity
 Owner’s draw decreases owner’s equity
The two sides of the equation must equal each other. If the expanded accounting equation is not balanced, thebooks of
accounts or financial reports are inaccurate.

Importance of accounting equation:

The accounting equation gives a clear picture of the business’s financial situation. One should calculate the accounting
equation to read the balance sheet. The accounting equation helps to understand the relationship between the financial
statements i.e., balance sheet and Profit &loss account. One can see how much money the business has in the bank and how
likely it is that the business will be able to meet all of its financial obligations. It can also tell you how much profit (or loss)
the business has retained since it started.
By using the accounting equation, one can see if the purchase of an asset can be financed with the business’s existing assets.
And, the equation reveals if one should pay off debts with assets (like cash) or by taking on more liabilities.
 Session 7
Capital and Revenue Expenditure
The happeningof expenditure during the course of business is verynormal. Generally, expenditure is incurred to increase the
efficiency of business and further returns. Expenditure means any payment in cash for some goods or services. It can also
mean the exchange of some valuable item in exchange for goods or services. Receipts and invoices keep the records of these
expenditures. There are two types of expenditures on the basis of time durations, given as below:
1. Capital expenditures
2. Revenue expenditures
A third type, hybrid of the first two is known as Deferred Revenue Expenditure.
The differencebetween the nature of capital and revenue expenditure is important as only capital expenditure is included in the
cost of fixed asset where as the revenue expenditure items are incorporated in the profit and loss account as day to day
expenses and income.

Capital Expenditure
Capital expenditure includes costs incurred on the acquisition of a fixed asset like land, building, vehicle, plant & machinery,
furniture etc. It also includes any subsequent expenditure that increases the earning capacity of an existing fixed asset.The cost
of acquisition not only includes the cost of purchases but also any additional costs incurred in bringing the fixed asset into its
present location and condition (e.g. delivery costs).
Capital expenditure, as opposed to revenue expenditure, is generally aninfrequent (rare)expenditure and its benefit is derived
over several accounting periods. Capital Expenditure may include the following:
 Purchase costs (less any discount received) of an asset
 Delivery costs
 Legal charges
 Installation costs
 Up gradation costs
 Replacement costs

Capital expenditure is shown in the assets side of the balance sheet.

Revenue expenditures
Those expenses incurred for which the full benefit is received during one accounting period is termed as revenue
expenditure.These implies the routine expenditure, that is incurred in the day to day business activities.Such expenses are
debited to Trading and Profit & loss Account. In other words, the expenditure which is incurred on a regular basis for
conducting the operational activities of the business are known as Revenue expenditure like the purchase of stock, carriage,
freight, etc. Revenue Expenditures does not result in an increase in the earning capacity of the business but only helps in
maintaining the existing earning capacity.Some examples of revenue expenditures are the cost of goods sold,salaries, rent,
electricity, repairs and maintenance expense etc.

Deferred Revenue Expenditure-

There are certain expenditures which are of revenue nature but the benefit of which is likely to be derived over a number of
years. Such expenditures are termed as “Deferred Revenue Expenditures”. The benefit of such expenditure generally lasts
between 3 to 7 years. The whole expenditure is not debited to the Profit and Loss Account of the current year but spread over
the years for which the benefit is likely to last, only a part of such expenditure is taken to Profit & Loss Account every year
and the unwritten portion is shown in the assets side of the Balance Sheet.
For Example, Amount spent of Rs. 5,00,000 on advertising to introduce a new product in the market and it is estimated that
the benefit will last for 5 years, then Rs. 1,00,000 will be charged every year to profit & loss account and balance amount
shown on the Assets side of the Balance Sheet.
In maintaining accounting records, it important to distinguish between capital and revenue expenditure items. This is because
these are treated differently in the financial statements.

Difference between Capital Expenditure and Revenue Expenditure-

Particulars Capital Expenditure Revenue Expenditure

Capital Expenditure is incurred

Revenue Expenditure is incurred for
Nature for the acquisition or erection of
the day to day running of the business.
a fixed asset.

The amount value of these

Amount of The amount spend on revenue
expenditures is usually very
expense expenditure are comparatively less
high

These expenditures serve long These expenditures serve short term

Term
term objectives of the business requirements of the business

Frequency of These expenditures are usually Revenue expenditures usually occur

occurrence non-recurring in nature very frequently – multiple times a year

Capital Expenditure is incurred Revenue Expenditure is incurred for

for the purpose of increasing the maintenance of earning capacity i.e.
Capacity
earning capacity of the for keeping the assets in an efficient
business. working order.

These may add value to the These do not add value to the existing
Adding value
existing assets assets

Capital Expenditure yields

Revenue Expenditure yields benefit for
Benefit benefit normally over a long
a maximum period of one year.
period.

Capitalization Yes No

Depreciation is charged on There is no Depreciation charged on

Depreciation
Capital Expenditure every year. Revenue Expenditure.

The assets acquired through

Resale capital expenditure can be The revenue expenses can not be sold
resold

Capital Expenditure is written

Accounting Revenue Expenditure is written in
in Balance Sheet under Fixed
treatment Trading or Profit and Loss Account.
Assets.

Capital Expenditure and Revenue Expenditure both are important for business for earning a profit in the present as well as in
subsequent years. Both have its own merits and demerits. In the case of a capital expenditure an asset has been purchased by
the company which generates revenue for upcoming years. On the other hand, no asset is acquired as such in the case of a
Revenue Expenditure.
 Session 8
Final Accounts for Sole Proprietor
Introduction
The final accounts for a sole trader business are the Income Statement (Trading and Profit & loss Account) and the Balance Sheet. The
final accounts give a picture of the financial position of the business. It shows where or not the business has made a profit or loss during
the accounting period and whether it is able to pay the debts as they become due. Let’s now have a look at the final accounts of a sole
proprietor business.

Final Accounts
After the trial balance is completed final accounts are prepared. The final accounts of a sole trader business include the Income Statement
(trading and Profit & loss account) and the balance sheet. The trial balance is the summary of the balances in all the accounts. Some of
these balances (those from the nominal accounts) affect the profit and are transferred to the Income statement; the others (real and
personal accounts) are transferred to the balance sheet. The Income Statement and the Balance Sheet are prepared at the end of each
financial period to record how well the business operated during that financial period.

Income Statement
One of the most important financial statements of any business is the Income Statement. It is used to determine the following:
1. how profitable a business is being run; and
2. comparing the results received with the results expected.

The Income Statement can be divided into two sections the trading account and the Profit & loss account. The gross profit which is the
amount of profit made before the expenses are deducted is calculated in the trading account. The purpose of the trading account is to
determine the gross profit made from sales. Therefore, the accounts that are directly related to buying and selling (trading) will be
transferred to the trading account. The accounts directly related to trading are:
 Sales
 Purchase
 Wages
 Sales Return
 Purchases Return
 Carriage Inwards
 Opening & Closing stock
 Power & Fuel

Gross profit is calculated as:

Gross Profit = Net Sales – Cost of Goods Sold (COGS)

Along with gross profit the net sales, cost of goods sold (COGS) and the cost of goods available for sale(COGAFS) is also calculated in
the trading account:

Net Sales = Sales – Sales Return (Return Inwards)

Net sales are the total sales figure after allowances have been made for sales returned to the business.

COGS = Cost of goods available for sale (COGAFS) – Closing Stock

COGAFS = Opening Stock + (Purchases – Purchases Return) + Carriage Inwards

The net profit of the business is calculated in the Profit & loss account. Net profit is the balance of profit after allowance is made for
revenue and expenses. It is calculated as:

Net Profit = Gross profit + Revenue – expenses

The revenue and expense charged to the Profit & loss account are those that are not directly related to trading but more to do with the
running of the business. Some of these accounts are:
 Rent

 Telephone
 Carriage outwards
 Discount allowed
 Discount received
 Commission received
 Commission paid
 Salary
 Advertisements
 Electricity
 Stationery
 Depreciation of assets
 Losses/Profit on sale of fixed assets
 Bad debts
 General Expenses

Balance Sheet

The other half of our final accounts is the Balance Sheet. The Balance Sheet is a financial statement showing the book values of the
assets, liabilities and capital at the end of the financial period as on a particular date. It shows what the business owes and what it owns.
The assets of the business are divided into two categories and recorded as follows

1. Non-Current Assets are assets that:

 are expected to be of use in the business for long time;

 are to be used in the business; and

 were not bought only for the purpose of resale.

Non-current assets are recorded in the balance sheet starting with those assets that will in the business the longest down to those that will
be kept for a shorter period. Example of non-current assets and the order of record are:
 Land and Buildings.

 Fixtures and Fittings.

 Machinery.
 Motor Vehicles.

2. Current Assets are recorded next. These are assets will change within the next twelve months. They are recorded as follows:
 Stock (goods bought for resale)

 Debtors (Customers who purchased goods from you on credit).

  Cash at Bank.
 Cash in Hand.

3. Current Liability - are debts that will be settled in one year or less. This includes:
 Creditors
 Bills Payable
 Bank Overdraft
 Other small loans

4. Non-current Liability –They are also referred to as long term liability and are those debts that take more than a year to redeem (pay
back). This includes large loans - secured (collateral attached) or unsecured.

5. Capital – This is what remains after you deduct liabilities from the (owner) assets. Capital denotes owner’s investment into the
business. Any profit incurred for the year belongs to the owner and therefore added to the Capital. Similarly, any amount/goods
withdrawn by the owner is treated as drawings and deducted from the capital.

Trading and Profit and Loss Account Format

Dr Cr
Amou
Particulars Particulars Amount
nt
Opening Stock Sales xxxxx
Purchases xxxx Less: Sales return xxx
Less: Purchase Returns xx Closing Stock
Carriage Inward Gross Loss
Excise Duty
Wages
Supervisor's Salaries
Production Manager salary
Gross Profit
XXXX XXXX
To Gross loss b/d To Gross profit b/d
Management expenses (O&A): Income:
To salaries By Discount received
To office rent, rates, and taxes By Commission received
To printing and stationery Non-trading income:
To Telephone charges By Bank interest
To Insurance By Rent received
To Audit fees By Dividend received
To Legal charges By Bad debts recovered
To Electricity charges Abnormal gains:
To Maintenance expenses By Profit on sale of machinery
To Repairs and renewals By Profit on sale of investments
To Depreciation By Net Loss
Selling distribution expenses: (transferred to Capital A/c)
To Salaries
To Advertisement
To Godown
 To Carriage outward
To Bad debts
To Provision for bad debts
To Selling commission
Financial expenses:
Bank charges
Interest on loan
Discount allowed
Abnormal losses:
To Loss on sale of machinery
To Loss onsale ofinvestments
To Loss by fire
To Net Profit
(transferred to capital a/c)

TOTAL TOTAL
BALANCE SHEET
as on or as at………………….
Liabilities Amount Assets Amount
Rs. Rs.
Capital: Fixed Assets:
Add: Net Profit Furniture
Less: Drawings Loose Tools
Less: Income Tax Motor Vehicle
Less: Life Insurance
Long Term Investments
Premium
Fixed Liabilities: Plant and Machinery
Long Term Loans Land and Buildings
Current Liabilities: Patents
Bank Overdraft Goodwill
Bill Payable Current Assets:
Sundry Creditors Cash in Hand
Outstanding Expenses Cash at Bank
Unearned Income Bills Receivable

Short-Term Investments

Sundry Debtors
Closing Stock
Prepaid Expenses(3)
Accrued Income
 Session 9
Accounting Treatment of Adjustment Entries

Adjusting entries refers to a set of journal entries recorded at the end of the accounting period to have an updated and accurate
balances of all the accounts. Adjusting entries are plainapplication of the accrual basis of accounting.
The rationale of adjusting entries is to display acorrectdepiction of the company’s financial position. The stakeholders can
have a complete look into the financial statements knowing that everything that occurred during the accounting period is
reported even if the cash inflows or outflows might have occurred at a later stage. A statement of finance prepared without
considering adjusting entries would misrepresent the financial health of the company.
The adjustments relate to the following:
 Closing stock
 Outstanding expenses
 Prepaid expenses
 Outstanding or accrued income
 Income received in advance or unearned income
 Depreciation
 Bad debts
 Provision for bad debts
 Provision for discount on debtors
 Interest on capital
 Interest on drawings

Rule: Any item given outside the Trial Balance will be recorded at two places on account of Dual Aspect concept.

Closing Stock: This is the inventory remaining with the company at the end of the accounting period. It is shown in the
credit side of the Trading account and also in the assets side of the balance sheet.
Outstanding Expenses: Expenses which have become due during the accounting period but not paid till the end of the year.
In order to ascertain true profit and loss made during the year, it is necessary that such outstanding expenses are taken into
account. Such outstanding expenses are added to the concerned account in the debit side of the Profit and Loss account and
also shown in the liabilities side of the balance sheet.

Prepaid Expenses: Expenses of next accounting period paid in advance in the current accounting period are known as
prepaid expenses. Since this expense is for the next accounting period, it should be deducted from the concerned account in
the debit side of the Profit and Loss account and also shown in the assets side of the balance sheet.

Outstanding Income: Income which has become due but not received yet. (Asset)Treatment: Added to the income received
in the credit side of the Profit and Loss account and then shown as an asset in the Balance sheet.

Accrued Income: Income which has been earned by the business but has not become due and therefore not received yet.
(Asset). Its treatment issimilar to Outstanding Income.

Income Received in advance: income which has been received by the business before being earned by it. (liability)
Treatment: Subtracted from the Income received in the Credit side of the Profit and Loss account and then shown as a
liability in the Balance sheet.
Depreciation:It is the process of allocating the cost of an asset, such as a building or a piece of equipment, over the
serviceable or economic life of the asset. It is also known as the loss in the value of fixed assets due to wear and tear
through its usage. It is a non-cash expenditure (loss) for the business and therefore shown in the debit side of the profit and
loss account.
Treatment: Calculate depreciation on the basis of the rate given. Charge this amount to the debit side of the Profit and Loss
account. In the Balance Sheet, reduce the value of that asset by this amount.

Bad Debts and Provision for Bad debts:Bad debt is the loss due to debtors (customers) not paying up the due amount for
their purchases from the company. Provision for bad debts is the estimated amount of bad debt that may arise
from accounts receivable (debtors) that have been issued but not yet collected.The usual practice is to calculate such
doubtful debts at a certain percentage, based on past experience on debtors.

Treatment: Charge this amount (additional bad debts) to the Debit side of the P&L A/c. If the Trial balance already has an
entry of Bad debts, ‘additional bad debts’ should be added to this amount. In the Balance Sheet, reduce the value of the
Debtors by this ‘additional Bad debts.
Add the amount of provision (new provision for bad debts) to the ‘Bad debts’ in the Debit side of the P&L A/c. If the Trial
balance already has an entry of Provision for Bad debts, this old provision should be subtracted from the total. In the
Balance sheet, reduce the value of Debtors by this new ‘provision for bad debts.

Discount allowed and Provision for Discount allowed: Cash discounts are allowed to debtors in order to encourage them to
make prompt payments. After providing for bad and doubtful debts, the balance of debtors represents debts due from sound
parties.They (good debtors) may try to pay their dues on time and avail themselves of the cash discounts permissible.
Hence, this discount should be anticipated and provided for. It is, therefore, the usual practice in business is to provide for
discount on debtors at certain percentage on good debts.

Treatment: Same as that of bad debts and provision for bad and doubtful debts

Interest on Capital: Sometimes, interest at a normal rate is allowed on the capital of the sole proprietor invested in the
business. This is necessary in order to assess the efficiency of the business. Otherwise the profits would include the interest
and appear at a higher rate.

The interest so charged is a loss to the business and gain to the proprietor. So it is debited to the Profit and Loss a/c and
added to the capital in the Balance Sheet.

Interest on Drawings: Drawings are money withdrawn by the proprietor from his capital. Just as the business allows interest
on capital, it charges interest on drawings. It is a gain to the business and a loss to the proprietor. So, it is credited to the
Profit and Loss a/c and deducted from the capital in the Balance Sheet.

Manager's Commission on Net Profit:Sometimes, in additional to his regular Salary, the manager is entitled to a
commission on Net Profit. This is done to induce him to take more interest in the business. Since, the Commission is
always calculated at the end of the accounting period. So, it is treated as Outstanding expenses. Therefore, the adjustment
entry for manager's commission will be as follows.

Treatment in Final Accounts:It will be recorded on the debit side of profit and loss Account. Because it's an expense for
business firm.On the other hand, It is shown on the Liabilities side as an outstanding expense.

Calculation:The manager's Commission can be calculated as:

a) After Charging commission on Net Profit:Net profit before charging commission × Rate/100+Rate

b) Before Charging Commission on Net Profit:Net profit before charging commission × Rate/100
 Session 10
Indian Accounting Standards (Ind AS)
Accounting Standards denotes the guidelines (standard of accounting)proposed by the ICAI and laid down by the Central
Government in consultation with the National Advisory Committee on Accounting Standards (NACAs) constituted under
section 210(1) of Companies Act, 1956.
The core purposeof Accounting Standards is to harmonize the variedaccounting policies and practices. These Accounting
Standards have been applied to do away withthe non-comparability of financial statements and the reliability to the financial
statements.
Before the introduction of Ind AS, financial statements were prepared on the basis of Accounting Standards (AS) which were
not in line with the standards and principles applicable globally (IFRS). Due to this, investors were not able to assess and
compare the financial position of Indian companies with other global companies. In order to make the financial statements
uniform, Ind AS were introduced which are converged form of IFRS (global standards). Moreover, introduction of Ind AS
will bring consistency in the accounting practices and principles followed by companies in India and other companies across
world, leading to enhanced accessibility and acceptability of financial statements by global investors.
Benefits of Ind AS
1.Global acceptability: Since Ind AS are converged form of IFRS, there is a wider acceptability and it gives confidence to the
user of financial statements.
2.Easy comparability of Financial Statements: Financial statements prepared using Ind AS are easily comparable with the
financial statements prepared by companies of other countries.
3. Changes in standards as per economic situations: Principles of Ind AS are revised/modified in case there is any major
change in economy. Ind AS 29 is ‘Financial Reporting in hyperinflationary Economies’ which deals with situations related to
inflation.
4. Attracts Foreign Investment: Adopting Ind AS may attract foreign investors to invest in Indian Companies as that will
ensure better comparability with similar companies across the globe.
5.Reduces financial statement preparation cost: For multinational companies, it will be beneficial as it will be able to use the
same accounting standards in all the global markets in which they operate. This will save preparation costs of aligning
financial statements of Indian company with other operations.

Sub Section(3A) to section 211 of Companies Act, 1956 requires that every Profit/Loss Account and Balance Sheet shall
comply with the Accounting Standards.

List of Indian Accounting Standards

Relevant
Ind AS Objective/ Deals with Accounting
standard or
Guidance note
Its main objective is to prepare first financial
Ind AS 101 – statements as per Ind AS containing high
First-time adoption of quality information that is transparent, N.A
Ind AS comparable and prepared at economical cost,
suitable starting point for accounting in
accordance with Ind AS.
Ind AS 102 – It deals with accounting of share-based Guidance note on
Share Based payments payment transactions and reflect effect of Employee Share
such payment on profit or loss and financial Based Plans
statements of entity.
Ind AS 103 – It applies to transaction or other event that AS 14
Business Combination meets the definition of a business
combination. This standard helps in
improving the relevance, reliability and
comparability of the information that a
reporting entity provides in its financial
statements about a business combination and
its effects.
Ind AS 104 – This standard specifies financial reporting for N.A.
Insurance Contracts insurance contracts by insurer entity.
Ind AS 105 – This standard specifies accounting for assets AS 24
Non-Current Assets Held held for sale, and presentation and disclosure
for Sale and of discontinued operations.
Discontinued Operations
Ind AS 106 – This standard specifies financial reporting for N.A.
Exploration for and exploration and evaluation of mineral
Evaluation of Mineral resources.
Resources
Ind AS 107 – This standard require entities to provide AS 32
Financial Instruments: disclosures related to financial instruments
Disclosures that will enable users to evaluate significance
of financial instruments for entity's financial
position and performance and nature and
extent of risks arising from financial
instruments to which the entity is exposed
during the period and at the end of the
reporting period, and how the entity manages
those risks.

Ind AS 108 – This standard discloses information to enable AS 17

Operating Segments users of its financial statements to evaluate
the nature and financial effects of the business
activities in which it engages and the
economic environments in which it operates.
Ind AS 109 – This Standard establish principles for AS 30, AS 31 and
Financial Instruments financial reporting of financial assets and Guidance note on
financial liabilities that will present relevant derivative
and useful information to users of financial contract
statements for their assessment of the
amounts, timing and uncertainty of an entity's
future cash flows.
Ind AS 110 – This standard establishes principles for the AS 21
Consolidated Financial presentation and preparation of consolidated
Statements financial statements when an entity controls
one or more other entities.
Ind AS 111 – This standard establishes principles for AS 27
Joint Arrangements financial reporting by entities that have an
interest in arrangements that are controlled
jointly (known as joint arrangements).
Ind AS 112 – This standard requires an entity to disclose AS 21, AS 23 and
Disclosure of Interests in information that enable users of its financial AS 27
Other Entities statements nature risk and effect of such
interest in other entities.
Ind AS 113 – This standard defines fair value, set outs N.A.
Fair Value Measurement framework for measuring fair value and
disclosures about fair value measurements.
Such fair measurement principle will apply
when another Ind AS requires or permits use
of fair value.
Ind AS 114 – This Standard specifies financial reporting Guidance note on
Regulatory Deferral requirements for regulatory deferral account accounting for
Accounts balances that arise when an entity provides rate regulated
goods or services to customers at a price or activities
rate that is subject to rate regulation.
Ind AS 115 – This Standard establishes principles that an AS 7 & AS 9
Revenue from Contracts entity shall apply to report useful information
with Customers to users of financial statements about nature,
amount, timing and uncertainty of revenue
and cash flows arising from a contract with a
customer.
Ind AS 1 – This standard sets out overall requirements AS 1
Presentation of Financial for presentation of financial statements,
Statements guidelines for their structure and minimum
requirements for their content to ensure
comparability.
Ind AS 2 – Its deals with accounting of inventories such AS 2
Inventories Accounting as measurement of inventory, inclusions and
exclusions in its cost, disclosure requirements,
etc.
Ind AS 7 – It deals with cash received or paid during the AS 3
Statement of Cash Flows period from operating, financing and
investing activities. It also shows any change
in the cash and cash equivalents of any entity.
Ind AS 8 – It prescribes criteria for selecting and AS 5
Accounting Policies, changing accounting policies together with
Changes in Accounting accounting treatments and disclosures.
Estimates and Errors
Ind AS 10 – It deals with any adjusting or non-adjusting AS 4
Events after Reporting event occurring after reporting date and
Period
Ind AS 12 – This standard prescribes accounting treatment AS 22
Income Taxes for income taxes. The principal issue in
accounting for income taxes is how to account
for the current and future tax
Ind AS 16 – This standard prescribes accounting treatment AS 10
Property, Plant and for Property, Plant And Equipment (PPE)
Equipment such as recognition of assets, determination of
their carrying amounts and the depreciation
charges and impairment losses to be
recognised in relation to them.
Ind AS 116 – This standard prescribes appropriate AS 19
Leases accounting policies and principle for lessees
and lessors.
Ind AS 19 – This standard prescribes accounting and AS 15
Employee Benefits disclosure requirements relating to employee
benefits.
Ind AS 20 – This Standard shall be applied in accounting AS 12
Accounting for for and in disclosure of, government grants
Government Grants and and in disclosure of other forms of
Disclosure of government assistance.
Government Assistance
Ind AS 21 – This Standard prescribes how to include AS 11
The Effects of Changes foreign currency transactions and foreign
n Foreign Exchange operations in the financial statements of an
Rates entity and how to translate financial
statements into a presentation currency.
Ind AS 23 – It provides borrowing cost incurred on AS 16
Borrowing Costs qualifying asset should form part of that asset,
it also guides on which finance cost should be
capitalised, conditions for capitalisation, time
of commencement and cessation of
capitalisation of borrowing cost.
Ind AS 24 – This standard ensures that an entity's financial AS 18
Related Party statements contains necessary disclosures to
Disclosures draw attention to the possibility that its
financial position and profit or loss may have
been affected by the existence of related
parties and by transactions and outstanding
balances.
Ind AS 27 – This Standard prescribes accounting and AS 13
Separate Financial disclosure requirements for investments in
Statements subsidiaries, joint ventures and associates
when an entity prepares separate financial
statements.
Ind AS 28 – This standard prescribes accounting for AS 23, AS 27
Investments in investments in associates and to set out
Associates and Joint requirements for the application of equity
Ventures method when accounting for investments in
associates and joint ventures.
Ind AS 29 – This standard will gives inclusive list of N.A.
Financial Reporting in characteristics that will categorise an
Hyperinflationary economy as hyper inflationary and reporting
Economies of operating results and financial position.
Ind AS 32 – This Standard establishes principles for AS 32
Financial Instruments: presenting financial instruments as liabilities
Presentation or equity and for offsetting financial assets
and financial liabilities.
Ind AS 33 – This Standard prescribe principles for the AS 20
Earnings per Share determination and presentation of earnings
per share
Ind AS 34 – This Standard prescribes minimum content of AS 25
Interim Financial an interim financial report and principles for
Reporting recognition & measurement in complete or
condensed financial statements for an interim
period.
Ind AS 36 – This Standard prescribe procedures that an AS 28
Impairment of Assets entity applies to ensure that an asset’s
carrying amount is not more than its
recoverable amount.
Ind AS 37 – This Standard ensures that appropriate AS 29
Provisions, Contingent recognition criteria and measurement bases
Liabilities and are applied to provisions, contingent liabilities
Contingent Assets and contingent assets and proper disclosures
are made in the notes to enable users to
understand their nature, timing and amount.
Ind AS 38 – This Standard prescribes accounting treatment AS 26
Intangible Assets for intangible assets. It specifies conditions
for recognition of intangible asset and how to
measure carrying amount at which intangible
asset should be recognised.
Ind AS 40 – This Standard prescribes accounting treatment AS 13
Investment Property for investment property and related disclosure
requirements.

Ind AS 41 – This Standard prescribes accounting treatment N.A.

Agriculture and disclosures related to agricultural activity.
Source:https://www.taxmann.com/blogpost/2000001685/list-of-indian-accounting-standards-with-explanation.aspx

Applicability of Indian Accounting Standards:

Ind AS are applicable to the following category of companies given below:

Mandatory requirement: Companies are required to follow Ind AS from Financial year 2015-2016. For Financial year 2018-
19, following is the limit for companies required to follow Ind AS:
 Companies whose equity or debt securities are listed or are in the process of being listed on any stock exchange in India or
outside India;
 Unlisted companies having net worth of Rs. 250 crore or more; and

 Holding, subsidiary, joint venture or associate companies of companies covered in point (1) and (2) above.

 Non-Banking Financial Companies (NBFCs

For 2018-19

 NBFCs having net worth of rupees five hundred crore or more;

 Holding, subsidiary, joint venture or associate companies of companies covered under point (1) above.

For 2019-20

 NBFCs whose equity or debt securities are listed or in the process of listing on any stock exchange in India or outside
India and having net worth less than Rs. 500 crore;

 NBFCs, that are unlisted companies, having net worth of Rs. 250 crore or more but less than Rs. 500 crore; and

 Holding, subsidiary, joint venture or associate companies of companies covered under point (1) and (2) above.

Voluntary applicability:Company may voluntarily apply Indian accounting standards (Ind AS).
Requirement to follow AS:
Corporate entities are required to follow standard of accounting (Ind AS where applicable) while preparing its financial
statements as per Section 129 of the Companies Act, 2013.

In case of conflict between Act and Indian Accounting standards:

In case there is any conflict between provisions of any applicable Actand Indian Accounting Standard (Ind AS), the
provisions of the Act shall prevail to that extent.
Topics

1. Depreciation

2. Ratio Analysis

3. Window Dressing

4. Cash flow Statement

DEPRECIATION

What is Depreciation?

Depreciation is the reduction in the value of assets due to wear and tear.

Every asset is subject to wear and tear in the ordinary course of its use and also with the passage
of time. The cost of the asset is allocated over time and considered as expense.

It is applied on long term assets which give benefits for many years. For example on plant &
machinery, vehicles, computers, furniture, building etc. Land is not subject to wear and tear and
thus depreciation is not levied on land but applicable on a building.

Considering depreciation as an expense is very much required for successful financial

management. For example, a driver gives his car for tourism purpose, he has to consider the fact
that car has a limited useful life and he needs to replace that after some years. For that, while
calculating its operation cost, he has to consider the cost of car, its life, the resale value after useful
life and add it to other expenses for calculating total cost.

Depreciation is also allowed as an expense as per income tax act and also as per companies act.
Although method of calculation is different under both acts and this difference also leads to
creation of Deferred tax asset or deferred tax liability.

Common Methods or Types of Depreciation

Written Down Value (WDV) Method

WDV method is the most common used method of depreciation. Also in income tax act,
depreciation is allowed as per WDV method only.

In this method depreciation is charged on the book value of asset and book value is decreased each
year by the depreciation.For eg- Asset is purchased at rs. 1,00,000 and depreciation rate is 10%
then first year depreciation is rs. 10,000(10% of rs. 1,00,000), second year depreciation is rs. 9,000
( 10% of 90,000 [1,00,000 – 10,000]) and third year depreciation is rs. 8,100 ( 10% of rs. 81,000
[90,000 – 9,000]).

This method is also called reducing balance method. In the WDV method, the amount of
depreciation goes on decreasing with time. An asset gives more value to a business in initial years
then later year, therefore, this method is considered as the most logical method of depreciation.

Formula for calculating depreciation rate (WDV) = {1 – (s/c)^1/n } x 100

n = Remaining useful life of the asset (in years)
s = Scrap value at the end of useful life of the asset
c= Cost of the asset/Written down value of the asset

Straight Line Method (SLM)

In this method, equal amount of depreciation is charged on the asset over its useful life. For
Example – asset is purchased for rs. 1,00,000 and useful life is 10 years with salvage value of Rs.
10,000 then depreciation is charged at Rs. 9,000 for each of the 10 years. (1,00,000 – 10,000)/10.

Formula for calculating depreciation rate (SLM) = (100 – % of resale value of purchase
price)/Useful life in years
Depreciation = Purchase Price * Depreciation Rate or (Purchase price – Salvage Value)/Useful
Life

There are also other methods of depreciation but they are not often used such as depreciation on
the basis of units of production.

In companies act the depreciation rate is also based on the number of shifts. Logically an asset is
expected to have a shorter life if it used extensively.
Example –

Cost of asset = 2,00,000

Salvage value = 30,000
Useful Life = 10 Years

And thus Depreciation rate as per SLM = (100-15)/10 = 8.5%

Depreciation rate as per WDV = 17.28

Year Depreciation as per SLM Depreciation as per WDV

1 17,000 34,560.53

2 17,000 28,588.38

3 17,000 23,648.23

4 17,000 19,561.75

5 17,000 16,181.43

6 17,000 13,385.24

7 17,000 11,072.23

8 17,000 9,158.92

9 17,000 7,576.24

10 17,000 6,267.04

Total Depreciation 1,70,000 1,70,000

Accounting for Depreciation

Depreciation is an expense and reduces the book value of an asset. Therefore a simple journal entry
is to be passed at the end of the year. For example

Depreciation A/c Dr 10,000

To Computer A/c 10,000
Thus depreciation is shown as an Indirect expense in the debit side of profit and loss account and
asset’s value is to be shown after the reduction of depreciation in the balance sheet.

Benefits/Need of charging depreciation

1. Tax Benefit – Depreciation is allowed as an expense under Income tax and therefore it is
important to consider it to save income tax.
2. Mandatory under companies act – It is compulsory to charge depreciation in profit and loss
account in companies act 2013.
3. Real Profit – If it is not considered then expenditure on behalf of fixed assets is not
considered and the profit may be shown as a high number especially in industries required
large plant and machinery. Also, this may lead to high distribution of earnings to
shareholders and thus non-availability of funds when business is in need to replace the
asset.

Solved Sums

1) Calculate the Rate of Depreciation under Straight Line Method (SLM) from the following:
Purchased a second-hand machine for Rs. 96,000, spent Rs. 24,000 on its cartage, repairs and
installation, estimated useful life of machine 4 years. Estimated residual value Rs. 72,000.

Answer:

Amount of Depreciation=Cost of Machine−Scrap Value of Machine Life in Years

=1,20,000−72,0004=Rs 12,000Rate of Depreciation=Amount of DepreciationCost of M
achine×100 =12,0001,20,000×100=10% p.a
 2) On 1st April, 2015, X Ltd. purchased a machine costing ₹ 4,00,000 and spent ₹ 50,000 on its
installation. The estimated life of the machinery is 10 years, after which its residual value will be
₹ 50,000 only. Find the amount of annual depreciation according to the Fixed Instalment Method
and prepare Machinery Account for t he first three years. The books are closed on 31st March
every year.

Answer:

Book of X Ltd.
Machinery Account
Dr. Cr.
Amount Amount
Date Particulars J.F. Date Particulars J.F.
(Rs) (Rs)
2015 2016
April Depreciation
Bank 4,00,000 Mar.31 40,000
01
April Bank (Erection Balance c/d
50,000 4,10,000
01 Expense)
4,50,000 4,50,000
2016 2017
April Depreciation
Balance b/d 4,10,000 Mar.31 40,000
01
Balance c/d 3,70,000
4,10,000 4,10,000
2017 2018
April Depreciation
Balance b/d 3,70,000 Mar.31 40,000
01
Balance c/d 3,30,000
 3,70,000 3,70,000

Calculation of Depreciation:

Depreciation p.a.=4,00,000+50,000−50,000(Scrap Value)10 years =Rs 40,0

00 p.a.

Question 3:

On 1st April, 2014, furniture costing Rs. 55,000 was purchased. It is estimated that its life is 10
years at the end of which it will be sold for Rs. 5,000. Additions are made on 1st April 2015 and
1st October, 2017 to the value of Rs. 9,500 and Rs. 8,400 (Residual values Rs. 500 and Rs. 400
respectively). Show the Furniture Account for the first four years, if Depreciation is written off
according to the Straight Line Method.

Answer:

Furniture Account
Dr. Cr.
Amount Amount
Date Particulars J.F. Date Particulars J.F.
(Rs) (Rs)
2014 2015
April Bank (F1) 55,000 March Depreciation 5,000
01 31 (F1)
March Balance c/d 50,000
31 (F1)
55,000 55,000
2015 2016
April Balance b/d (F1) 50,000 March Depreciation
01 31
April Bank (F2) 9,500 F1 5,000
01
F2 900 5,900
March Balance c/d
31
F1 45,000
F2 8,600 53,600
59,500 59,500
2016 2017
April Balance b/d March Depreciation
01 31
F1 45,000 F1 5,000
F2 8,600 53,600 F2 900 5,900
March Balance c/d
31
F1 40,000
F2 7,700 47,700
53,600 53,600
2017 2018
April Balance b/d March Depreciation
01 31
F1 40,000 F1 5,000
F2 7,700 47,700 F2 900
Oct. 01 Bank (F3) 8,400 F3 400 6,300

March Balance c/d

31
F1 35,000
F2 6,800
F3 8,000 49,800
56,100 56,100

Question 4:

On 1st April, 2014, A Ltd. purchased a machine for Rs. 2,40,000 and spent Rs. 10,000 on its
erection. On 1st October, 2014 an additional machinery costing Rs. 1,00,000 was purchased. On
1st October, 2016, the machine purchased on 1st April, 2014 was sold for Rs. 1,43,000 and on the
same date, a new machine was purchased at a cost of Rs. 2,00,000.
Dr. Cr.
Amoun Amoun
J.F J.F
Date Particulars t Date Particulars t
. .
(Rs) (Rs)
2014 2015
April 01 Bank (M1) 2,50,00 March Depreciation
0 31
Oct. 01 Bank (M2) 1,00,00 M1 12,500
0
M2 (6 2,500
Months
) 15,000
March Balance c/d
31
M1 2,37,50
0
M2 97,500 3,35,00
0
3,50,000 3,50,00
0
2015 2016
April 01 Balance b/d March Depreciation
31
M 2,37,50 M1 12,50
1 0 0
M 97,500 3,35,00 M2 5,000
2 0 17,500

March Balance c/d

31
M1 2,25,00
0
M2 92,500 3,17,50
0
3,35,00 3,35,00
0 0
2016 2016
April 01 Balance b/d Oct. 01 Depreciation (for 6 6,250
months)
M 2,25,00 Oct. 01 Bank (M1 sold) 1,43,00
1 0 0
M 92,500 3,17,50 Oct. 01 Profit and Loss (loss 75,750
2 0 on sale)
2017
 July 01 Bank (M3) 2,00,00 March Depreciation
0 31
M2 5,000
M3 (for 5,000
6
months) 10,000
March Balance c/d
31
M2 87,500
M3 1,95,00 2,82,50
0 0
5,17,50 5,17,50
0 0
2017 2018
April 01 Balance b/d March Depreciation
31
M 87,500 M2 5,000
2
M 1,95,00 2,82,50 M3 10,000
3 0 0 15,000
March Balance c/d
31
M2 82,500
M3 1,85,00 2,67,50
0 0
2,82,50 2,82,50
0 0

Answer:

Machinery Account

Working Notes:

1. Calculation of Deprecation
2. Calculation of profit or loss on sale of Machine 1

Amount
Particulars
(Rs)
Book Value on April 01, 2016 2,25,000
Less: Deprecation for six month (6,250)
Book Value on Oct. 01, 2016 2,18,750
Less: Sale Proceeds (1,43,000)
Loss on Sale of Machine 75,750

Question 5:

From the following transactions of a concern, prepare the Machinery Account for the year ended
31st March, 2018:

1st April, 2017 : Purchased a second-hand machinery for Rs. 40,000

1st April, 2017 : Spent Rs. 10,000 on repairs for making it serviceable.
30th September,
: Purchased additional new machinery for Rs. 20,000.
2017
31st December, 2017 : Repairs and renewals of machinery Rs. 3,000.
31st March, 2018 : Depreciate the machinery at 10% p.a.
 Answer:

Machinery Account
Dr. Cr.
Amount Amount
Date Particulars J.F. Date Particular J.F.
(Rs) (Rs)
2017 2018
Apr.01 Bank (M1) 50,000 Mar.31 Depreciation
Sept 30 Bank (M2) 20,000 M1 5,000
M2 (6 months) 1,000 6,000
Mar.31 Balance c/d
M1 45,000
M2 (6 months) 19,000 64,000
70,000 70,000

Note:

Repair and renewal made on December 31, 2017 will not be recorded in Machinery Account
because, this repair was made after putting the Machinery into use.

Q6.

Turn hill Corporation a Limited company purchased Machinery worth Rs. 4,90,000 on 1st April,
2012. They spent Rs. 10,000 on its installation. On 1st October, 2012, they Purchased another
Machine costing Rs.2,30,000 and spent Rs.20,000 on its installation. On 31st December, 2014 they
sold, the Machine purchased on 1st October, 2012 for Rs, 1,90,000. On the same day they
Purchased another Machine costing Rs. 2,80,000 and paid Rs.20,000 on installation of the same.
You are required to:
 Prepare Machinery Account for the FY 2012-13, 2013-14, 2014-15 charging
Depreciation @ 10% on Straight Line Method Basis. Working Notes will form a part
of your answer.
Working Note:
Particulars 1 2 3
2012-13
Purchased on 1/4/2012 500000
Purchased on 1/10/2012 250000
Less: Depn 31/3/2013 50000 12500
WDV as on 31/3/2013 450000 237500
2013-14
Less: Depn 31/3/2014 50000 25000
WDV as on 31/3/2014 400000 212500
2014-15
Less: Depn on 31/12/2014 18750
WDV as on 31/12/2014 193750
Less: Sale 190000
Loss 3750
Purchased on 31/12/2014 300000
Less: Depn 31/3/2015 50000 7500
WDV as on 31/3/2015 350000 292500

Machinery A/c
Date Particulars Rs. Date Particulars Rs.
4/1/2012 To Bank 500000 3/31/2013 By Depreciation 62500
10/1/2012 To Bank 250000 3/31/2013 By Bal. C/d 687500
750000 750000
4/1/2013 To Bal. b/d 687500 3/31/2014 By Depreciation 75000
3/31/2014 By Bal. C/d 612500
687500 687500
4/1/2014 To Bal. b/d 612500 12/31/2014 By Depreciation 18750
12/31/2014 To Bank 300000 12/31/2014 By Bank 190000
 12/31/2014 By Profit & Loss A/c 3750
3/31/2015 By Depreciation 57500
3/31/2015 By Bal. C/d 642500
912500 912500

Q7.

Magnum Logistics Purchased 4 Motor Trucks worth Rs.12,00,000 each for their newly started
Transport Business. These were purchased on 1st April, 2005. On 30th June 2006 they purchased 2
more trucks costing Rs.12,50,000 each and expanded their fleet. On 1st October 2007, one of the
trucks Purchased on 1st April, 2005, met with an accident and the insurance company paid a claim
of Rs. 9,00,000 against it.
The company replaced this truck with another truck costing Rs.13,00,000 on the same day.
You are required to:
 Prepare Motor Truck Account & Depreciation Account for the years 2005-06, 2006-
07, 2007-08, charging Depreciation @10% on SLM basis. Working Notes shall form
a part of your answer.
Working Note:
Particulars 1 2 3 4 5 6 7
2005-06
Purchased on 1/4/2005 1200000 1200000 1200000 1200000
Less: Depn on 31/03/2006 120000 120000 120000 120000
WDV as on 31/03/2006 1080000 1080000 1080000 1080000
2006-07
Purchased on 30/6/2006 1250000 1250000
Less: Depn on 31/03/2007 120000 120000 120000 120000 93750 93750
WDV as on 31/03/2007 960000 960000 960000 960000 1156250 1156250
2007-08
Less:Depn on 30/9/2007 60000
WDV as on 30/9/2007 900000
Less: Sale 900000
Profit/Loss 0
Purchased on 1/10/2007 1300000
Less: Depn on 31/3/2008 120000 120000 120000 125000 125000 65000
WDV as on 31/3/2008 840000 840000 840000 1031250 1031250 1235000

Truck A/c
Date Particulars Rs. Date Particulars Rs.
4/1/2005 To Bank 4800000 3/31/2006 By Depreciation A/c 480000
3/31/2006 By Bal. C/d 4320000
4800000 4800000
4/1/2006 To Bal. B/d 4320000 3/31/2007 By Depreciation A/c 667500
6/30/2006 To Bank 2500000 3/31/2007 By Bal. C/d 6152500
6820000 6820000
4/1/2007 To Bal. B/d 6152500 9/30/2207 By Depreciation A/c 60000
10/1/2007 To Bank 1300000 10/1/2007 By Bank 900000
3/31/2008 By Depreciation A/c 675000
3/31/2008 By Bal. C/d 5817500

7452500 7452500

Depreciation A/c
Date Particulars Rs. Date Particulars Rs.
3/31/2006 To Truck A/c 480000 3/31/2006 By Profit & Loss A/c 480000
480000 480000
3/31/2007 To Truck A/c 667500 3/31/2007 By Profit & Loss A/c 667500
667500 480000
10/1/2007 To Truck A/c 60000 3/31/2008 By Profit & Loss A/c 735000
3/31/2008 To Truck A/c 675000
 735000 735000

Q8.

Hilton India Limited purchased Machinery worth amount Rs. 19,00,000 on 1st July, 2009. They
spent Rs. 1,00,000 on its installation. On 1st April, 2010, they Purchased another Machine costing
Rs.5,00,000 and spent Rs.50,000 on its installation. On 31st December, 2011 they scrapped half
the Machine purchased on 1st July, 2009 for Rs. 7,50,000 that was damaged due to fire beyond
repairs. However, on the same day they Purchased another Machine costing Rs. 14,00,000 and
paid Rs.1,00,000 on installation of the same.
You are required to:
 Prepare Machinery Account for the 2009-10, 2010-11, 2011-12 charging Depreciation
@ 10% on Reducing Balance Method Basis. Working Notes will form a part of your
answer.
Working Note:
Particulars 1 2 3
2009-10 50% 50%
Purchased on 1/7/2009 1000000 1000000
Less: Depn on 31/3/2010 75000 75000
WDV as on 31/3/2010 925000 925000
2010-11
Purchased on 1/4/2010 550000
Less: Depn on 31/3/2011 92500 92500 55000
WDV as on 31/3/2011 832500 832500 495000
2011-12
Less: Depn on 31/12/2011 62438
WDV as on 31/12/2011 770063
Less: Sale 750000
Loss on Sale -20063
 Purchased on 1/12/2011 1500000
Less: Depn on 31/3/2012 83250 49500 37500
WDV as on 31/3/2012 749250 445500 1462500

Machine A/c
Date Particulars Rs. Date Particulars Rs.
7/1/2009 To Bank 2000000 3/31/2010 By Depreciation A/c 150000
3/31/2010 By Bal. C/d 1850000
2000000 2000000
4/1/2010 To Bal. C/d 1850000 3/31/2011 By Depreciation A/c 240000
4/1/2010 To Bank 550000 3/31/2011 By Bal. C/d 2160000
2400000 2400000
4/1/2011 To Bal. C/d 2160000 12/31/2011 By Depreciation A/c 62438
12/31/2011 To Bank 1500000 12/31/2011 By Bank 750000
12/31/2011 By Profit & Loss A/c 20063
3/31/2012 By Depreciation A/c 170250
3/31/2012 By Bal. C/d 2657250
3660000 3660000

Q9.

Excellent Ventures Limited is a Software manufacturer and distributor. The company Purchased
Fixed Assets worth Rs.4,80,000 for its efficient working and spent Rs. 20,000 on its installation
on 1st October, 2013. The company acquired additional Fixed Assets valued at Rs.3,50,000 and
spent Rs.10,000on its installation on January 01, 2014. On 1st April, 2014 ¼ of the Assets acquired
on 1st October, 2013 were damaged and had to be scrapped for Rs.75,000. These assets were
replaced by another lot of purchases worth Rs. 2,00,000.
Required:
 You are required to prepare, Fixed Assets Account & Depreciation Account using
DBM charging depreciation at 20% p.a. and showing detailed working notes to
substantiate your calculation for a period of 2013-14 and 2014-15.
 Working Note:
Particulars 1 2 3
2013-14
Purchased on 1/10/2013 125000 375000
Purchased on 1/1/2014 360000
Less: Depn on 31/3/2014 12500 37500 18000
WDV as on 31/3/2014 112500 337500 342000
Less: Sale 75000
Loss on Sale -37500
Purchased on 1/4/2014 200000
Less: Depn on 31/3/2015 67500 68400 40000
WDV as on 31/3/2015 270000 273600 160000

Fixed Asset A/c

Date Particulars Rs. Date Particulars Rs.
10/1/2013 To Bank 500000 3/31/2014 By Depreciation A/c 68000
1/1/2014 To Bank 360000 3/31/2014 By Bal. C/d 792000
860000 860000
4/1/2014 To Bal. B/d 792000 4/1/2014 By Bank 75000
4/1/2014 To Bank 200000 4/1/2014 By Profit & Loss A/c 37500
3/31/2015 By Depreciation A/c 175900
3/31/2015 By Bal. C/d 703600

992000 992000

Depreciation A/c
Date Particulars Rs. Date Particulars Rs.
3/31/2014 To Fixed Asset A/c 68000 3/31/2014 By Profit & Loss A/c 68000
68000 68000
3/31/2015 To Fixed Asset A/c 175900 By Profit & Loss A/c 175900
175900 175900
Q10.

New look Foundry acquired a Blast Furnace costing Rs.25,00,000 on 1st April 2010. On 1st
July,2011, another Blast Furnace was acquired for Rs.12,00,000. On 31st December, 2012 the
furnace acquired on 1st July, 2011 was sold for Rs.10,50,000. On the same day company acquired
another small furnace costing Rs.10,00,000.
Required:
 Blast Furnace Account
 Depreciation Account using charging 10% Depreciation DBM
 Show proper working notes

Working Note:
Particulars 1 2 3
2010-11
Purchased on 1/4/2010 2500000
Less: Depn on 31/3/2011 250000
WDV as on 31/3/2011 2250000
2011-12
Purchased on 1/7/2011 1200000
Less: Depn on 31/3/2012 225000 90000
WDV as on 31/3/2012 2025000 1110000
2012-13
Less: Depn on 31/12/2012 83250
WDV as on 31/12/2013 1026750
Less: Sale 1050000
Profit on Sale 23250
Purchased on 31/12/2012 1000000
Less: Depn on 31/3/2013 202500 25000
WDV as on 31/3/2013 1822500 975000
 Furnace A/c
Date Particulars Rs. Date Particulars Rs.
4/1/2010 To Bank 2500000 3/31/2011 By Depreciation 250000
3/31/2011 By Bal. C/d 2250000
2500000 2500000
4/1/2011 To Bal. B/d 2250000 3/31/2012 By Depreciation 315000
7/1/2011 To Bank 1200000 3/31/2012 By Bal. C/d 3135000
3450000 3450000
4/1/2012 To Bal. B/d 3135000 12/31/2012 By Depreciation 83250
12/31/2012 To Profit & Loss A/c 23250 12/31/2012 By Bank 1050000
12/31/2012 To Bank 1000000 3/31/2013 By Depreciation 227500
3/31/2013 By Bal. C/d 2797500

4158250 4158250

Depreciation A/c
Date Particulars Rs. Date Particulars Rs.
3/31/2011 To Furnace A/c 250000 3/31/2011 By Profit & Loss A/c 250000
250000 250000
3/31/2012 To Furnace A/c 315000 3/31/2012 By Profit & Loss A/c 315000
315000 315000
12/31/2012 To Furnace A/c 83250 3/31/2013 By Profit & Loss A/c 310750
3/31/2013 To Furnace A/c 227500
310750 310750
Practice Questions:

1) An asset was purchased for ₹ 10,500 on 1st April, 2011. The scrap value was estimated to to be
₹ 500 at the end of asset's 10 years' life. Straight Line Method of depreciation was used. The
accounting year ends on 31st March every year. The asset was sold for ₹ 600 on 31st March, 2018.
Calculate the following.
(i) The Depreciation expense for the year ended 31st March, 2012.
(ii) The net book value of the asset on 31st March, 2016.
(iii) The grain or loss on sale of the asset on 31st March, 2018

2) A Van was purchased on 1st April, 2015 for ₹ 60,000 and ₹ 5,000 was spent on its repair and
registration. On 1st October, 2016 another van was purchased for ₹ 70,000. On 1st April, 2017,
the first van purchased on 1st April, 2015 was sold for ₹ 45,000 and a new van costing ₹ 1,70,000
was purchased on the same date. Show the Van Account from 2015-16 to 2017-18 on the basis of
Straight Line Method, if the rate of Depreciation charged is 10% p.a. Assume that books are closed
on 31st March every year.

3 A company whose accounting year is a financial year, purchased on 1st July, 2014 machinery
costing ₹ 30,000.
It purchased further machinery on 1st January, 2015 costing ₹ 20,000 and on 1st October, 2015
costing ₹ 10,000.
On 1st April, 2016, one-third of the machinery installed on 1st July, 2014 became obsolete and
was sold for ₹ 3,000.
Show how Machinery Account would appear in the books of the company. It being given that
machinery was depreciated by Fixed Instalment Method at 10% p.a. What would be the value of
Machinery Account on 1st April, 2017?

Q1.

Turn hill Corporation a Limited company purchased Machinery worth Rs. 4,90,000 on 1 st April,
2012. They spent Rs. 10,000 on its installation. On 1st October, 2012, they Purchased another
Machine costing Rs.2,30,000 and spent Rs.20,000 on its installation. On 31st December, 2014 they
sold, the Machine purchased on 1st October, 2012 for Rs, 1,90,000. On the same day they
Purchased another Machine costing Rs. 2,80,000 and paid Rs.20,000 on installation of the same.
You are required to:
Prepare Machinery Account for the FY 2012-13, 2013-14, 2014-15 charging Depreciation @
10% on Straight Line Method Basis. Working Notes will form a part of your answer

2.

Magnum Logistics Purchased 4 Motor Trucks worth Rs.12,00,000 each for their newly started
Transport Business. These were purchased on 1st April, 2005. On 30th June 2006 they purchased 2
more trucks costing Rs.12,50,000 each and expanded their fleet. On 1st October 2007, one of the
trucks Purchased on 1st April, 2005, met with an accident and the insurance company paid a claim
of Rs. 9,00,000 against it.
The company replaced this truck with another truck costing Rs.13,00,000 on the same day.
You are required to:
 Prepare Motor Truck Account & Depreciation Account for the years 2005-06, 2006-
07, 2007-08, charging Depreciation @10% on SLM basis. Working Notes shall form
a part of your answer.
Q3.

Hilton India Limited purchased Machinery worth amount Rs. 19,00,000 on 1st July, 2009. They
spent Rs. 1,00,000 on its installation. On 1st April, 2010, they Purchased another Machine costing
Rs.5,00,000 and spent Rs.50,000 on its installation. On 31st December, 2011 they scrapped half
the Machine purchased on 1st July, 2009 for Rs. 7,50,000 that was damaged due to fire beyond
repairs. However, on the same day they Purchased another Machine costing Rs. 14,00,000 and
paid Rs.1,00,000 on installation of the same.
You are required to:
 Prepare Machinery Account for the 2009-10, 2010-11, 2011-12 charging Depreciation
@ 10% on Reducing Balance Method Basis. Working Notes will form a part of your
answer.
Q4.
Excellent Ventures Limited is a Software manufacturer and distributor. The company Purchased
Fixed Assets worth Rs.4,80,000 for its efficient working and spent Rs. 20,000 on its installation
on 1st October, 2013. The company acquired additional Fixed Assets valued at Rs.3,50,000 and
spent Rs.10,000 on its installation on January 01, 2014. On 1st April, 2014 ¼ of the Assets acquired
on 1st October, 2013 were damaged and had to be scrapped for Rs.75,000. These assets were
replaced by another lot of purchases worth Rs. 2,00,000.
Required:
 You are required to prepare, Fixed Assets Account & Depreciation Account using
DBM charging depreciation at 20% p.a. and showing detailed working notes to
substantiate your calculation for a period of 2013-14 and 2014-15.

Q5.

New look Foundry acquired a Blast Furnace costing Rs.25,00,000 on 1st April 2010. On 1st July,
2011, another Blast Furnace was acquired for Rs.12,00,000. On 31st December, 2012 the furnace
acquired on 1st July, 2011 was sold for Rs.10,50,000. On the same day company acquired another
small furnace costing Rs.10,00,000.
Required:
 Blast Furnace Account
 Depreciation Account using charging 10% Depreciation DBM
 Show proper working notes

Machinery A/c
Date Particulars Rs. Date Particulars Rs.
4/1/2012 To Bank 500000 3/31/2013 By Depreciation 62500
10/1/2012 To Bank 250000 3/31/2013 By Bal. C/d 687500
750000 750000
4/1/2013 To Bal. b/d 687500 3/31/2014 By Depreciation 75000
3/31/2014 By Bal. C/d 612500
687500 687500
4/1/2014 To Bal. b/d 612500 12/31/2014 By Depreciation 18750
12/31/2014 To Bank 300000 12/31/2014 By Bank 190000
12/31/2014 By Profit & Loss A/c 3750
3/31/2015 By Depreciation 57500
3/31/2015 By Bal. C/d 642500
912500 912500
Working Note:
Particulars 1 2 3
2012-13
Purchased on 1/4/2012 500000
Purchased on 1/10/2012 250000
Less: Depn 31/3/2013 50000 12500
WDV as on 31/3/2013 450000 237500
2013-14
Less: Depn 31/3/2014 50000 25000
WDV as on 31/3/2014 400000 212500
2014-15
Less: Depn on 31/12/2014 18750
WDV as on 31/12/2014 193750
Less: Sale 190000
Loss 3750
Purchased on 31/12/2014 300000
Less: Depn 31/3/2015 50000 7500
WDV as on 31/3/2015 350000 292500

Q2.
Truck A/c
Date Particulars Rs. Date Particulars Rs.
4/1/2005 To Bank 4800000 3/31/2006 By Depreciation A/c 480000
3/31/2006 By Bal. C/d 4320000
4800000 4800000
4/1/2006 To Bal. B/d 4320000 3/31/2007 By Depreciation A/c 667500
6/30/2006 To Bank 2500000 3/31/2007 By Bal. C/d 6152500
6820000 6820000
4/1/2007 To Bal. B/d 6152500 9/30/2207 By Depreciation A/c 60000
10/1/2007 To Bank 1300000 10/1/2007 By Bank 900000
3/31/2008 By Depreciation A/c 675000
3/31/2008 By Bal. C/d 5817500

7452500 7452500

Working Note:
Particulars 1 2 3 4 5 6 7
2005-06
Purchased on 1/4/2005 1200000 1200000 1200000 1200000
Less: Depn on 31/03/2006 120000 120000 120000 120000
WDV as on 31/03/2006 1080000 1080000 1080000 1080000
2006-07
Purchased on 30/6/2006 1250000 1250000
Less: Depn on 31/03/2007 120000 120000 120000 120000 93750 93750
WDV as on 31/03/2007 960000 960000 960000 960000 1156250 1156250
2007-08
Less:Depn on 30/9/2007 60000
WDV as on 30/9/2007 900000
Less: Sale 900000
Profit/Loss 0
Purchased on 1/10/2007 1300000
Less: Depn on 31/3/2008 120000 120000 120000 125000 125000 65000
WDV as on 31/3/2008 840000 840000 840000 1031250 1031250 1235000
Q3.
Machine A/c
Date Particulars Rs. Date Particulars Rs.
7/1/2009 To Bank 2000000 3/31/2010 By Depreciation A/c 150000
3/31/2010 By Bal. C/d 1850000

2000000 2000000
4/1/2010 To Bal. C/d 1850000 3/31/2011 By Depreciation A/c 240000
4/1/2010 To Bank 550000 3/31/2011 By Bal. C/d 2160000

2400000 2400000
4/1/2011 To Bal. C/d 2160000 12/31/2011 By Depreciation A/c 62438
12/31/2011 To Bank 1500000 12/31/2011 By Bank 750000
12/31/2011 By Profit & Loss A/c 20063
3/31/2012 By Depreciation A/c 170250
3/31/2012 By Bal. C/d 2657250
3660000 3660000

Working Note:
Particulars 1 2 3
2009-10 50% 50%
Purchased on 1/7/2009 1000000 1000000
Less: Depn on 31/3/2010 75000 75000
WDV as on 31/3/2010 925000 925000

2010-11
Purchased on 1/4/2010 550000
Less: Depn on 31/3/2011 92500 92500 55000
 WDV as on 31/3/2011 832500 832500 495000

2011-12
Less: Depn on 31/12/2011 62438
WDV as on 31/12/2011 770063
Less: Sale 750000
Loss on Sale -20063
Purchased on 1/12/2011 1500000
Less: Depn on 31/3/2012 83250 49500 37500
WDV as on 31/3/2012 749250 445500 1462500

Q4.

Q4.
Fixed Asset A/c
Date Particulars Rs. Date Particulars Rs.
10/1/2013 To Bank 500000 3/31/2014 By Depreciation A/c 68000
1/1/2014 To Bank 360000 3/31/2014 By Bal. C/d 792000
860000 860000
4/1/2014 To Bal. B/d 792000 4/1/2014 By Bank 75000
4/1/2014 To Bank 200000 4/1/2014 By Profit & Loss A/c 37500
3/31/2015 By Depreciation A/c 175900
3/31/2015 By Bal. C/d 703600

992000 992000
 Depreciation A/c
Date Particulars Rs. Date Particulars Rs.
3/31/2014 To Fixed Asset A/c 68000 3/31/2014 By Profit & Loss A/c 68000

68000 68000
3/31/2015 To Fixed Asset A/c 175900 By Profit & Loss A/c 175900
175900 175900

Working Note:
Particulars 1 2 3
2013-14
Purchased on 1/10/2013 125000 375000
Purchased on 1/1/2014 360000
Less: Depn on 31/3/2014 12500 37500 18000
WDV as on 31/3/2014 112500 337500 342000
Less: Sale 75000
Loss on Sale -37500
Purchased on 1/4/2014 200000
Less: Depn on 31/3/2015 67500 68400 40000
WDV as on 31/3/2015 270000 273600 160000

Q5.
Furnace A/c
Date Particulars Rs. Date Particulars Rs.
4/1/2010 To Bank 2500000 3/31/2011 By Depreciation 250000
 3/31/2011 By Bal. C/d 2250000

2500000 2500000
4/1/2011 To Bal. B/d 2250000 3/31/2012 By Depreciation 315000

7/1/2011 To Bank 1200000 3/31/2012 By Bal. C/d 3135000

3450000 3450000
4/1/2012 To Bal. B/d 3135000 12/31/2012 By Depreciation 83250

12/31/2012 To Profit & Loss A/c 23250 12/31/2012 By Bank 1050000

12/31/2012 To Bank 1000000 3/31/2013 By Depreciation 227500

3/31/2013 By Bal. C/d 2797500

4158250 4158250

Depreciation A/c

Date Particulars Rs. Date Particulars Rs.

3/31/2011 To Furnace A/c 250000 3/31/2011 By Profit & Loss A/c 250000

250000 250000
3/31/2012 To Furnace A/c 315000 3/31/2012 By Profit & Loss A/c 315000

315000 315000
12/31/2012 To Furnace A/c 83250 3/31/2013 By Profit & Loss A/c 310750

3/31/2013 To Furnace A/c 227500

310750 310750

Working Note:

Particulars 1 2 3

2010-11

Purchased on 1/4/2010 2500000

Less: Depn on 31/3/2011 250000

WDV as on 31/3/2011 2250000

2011-12
Purchased on 1/7/2011 1200000
Less: Depn on 31/3/2012 225000 90000
WDV as on 31/3/2012 2025000 1110000
2012-13
Less: Depn on 31/12/2012 83250
WDV as on 31/12/2013 1026750
Less: Sale 1050000
Profit on Sale 23250
Purchased on 31/12/2012 1000000
Less: Depn on 31/3/2013 202500 25000
WDV as on 31/3/2013 1822500 975000
THEORY OF RATIO ANALYSIS

What is Ratio Analysis and Ratio?

Ratio is an arithmetical or numerical relating one number to another. For example, if the
relationship between two numbers say, 8 and 4 is to be expressed, it will be expressed in the form
of a ratio 2:1

Ratio Analysis is one of the most important tools of financial management. Ratio analysis means
the process of computing, determining and presenting the relationships between items and/or
groups of items in the financial statements through accounting ratios. Since the analysis is normally
undertaken for the purpose of projecting financial position or profitability, knowledge of trends is
usually more significant than knowledge of present status only. An analysis of trends through ratio
analysis helps in appraisal of financial conditions, efficiency and profitability of a business. An
analyst of ratios studies the results of business operations as reflected in the relationships among
the items of balance sheet and operating statement. He asks the following questions and tries to
get the answer from the financial statements on:

1. The extent and character of the liabilities of the business.

2. The “net worth” of the business.
3. The ability of the business to meet its obligations as and when they arise.
4. The ability of the business to earn a “fair” return on its investments in the business.
5. The ability of the business to withstand possible setbacks from external and internal forces.
6. The resourcefulness and the ability of the business to raise new funds as and when required.

Objectives of Ratio Analysis:

Interpreting the financial statements and other financial data is essential for all stakeholders of a
commercial entity. Ratio Analysis hence becomes a vital tool for financial analysis and financial
management and thus decision making. Let us take a look at some objectives that ratio analysis fulfils.

The different types of ratios include:

 Liquidity Ratios
  Activity (or turnover) Ratios

 Solvency Ratios

 Profitability Ratios

The key objectives of ratio analysis include:

1] Measure of Profitability:

Profit is the ultimate aim and objective of every organization. So if I say that ABC firm earned a profit
of 5 lakhs last year, how will you determine if that is a good or bad figure? Its real context is required
to measure the profitability, which is provided by ratio analysis through the following ratios Gross
Profit Ratios, Net Profit Ratio, Expense ratio etc. These ratio provide a measure of the profitability of
a firm vis-a vis another variable. The management can use such ratios to find out problem areas facing
the company and make efforts to improve upon them further.

2] Evaluation of Operational Efficiency:

Certain ratios highlight the degree of efficiency of a company in the management of its assets and
other key resources. It is important that assets and financial resources be allocated and used efficiently
to avoid unnecessary expenses. Turnover Ratios and Efficiency Ratios will point out any
mismanagement of assets and this can help its performance.

3] Ensure Suitable Liquidity:

Every firm has to ensure that some of its assets are in liquid form i.e. in the form of cash or assets that
can be easily converted into cash and successfully generate cash whenever it is required. So
the liquidity of a firm is measured by ratios such as Current ratio and Quick Ratio. These help a firm
maintain the required level of short-term solvency.

4] Overall Financial Strength:

There are some ratios that help determine the firm’s long-term solvency. They help determine if there
is a strain on the assets of a firm or if the firm is over-leveraged. The management will need to quickly
rectify the situation to avoid liquidation of the entity anytime in future. Examples of such ratios
are Debt-Equity Ratio, Leverage ratios etc.

5] Comparison:

The organizations’ ratios must be compared to the industry standards at regular intervals. This helps
to get a better understanding of the entity’s financial health and its fiscal position. The management
then can initiate corrective action if the standards of the market are not being met by the company.
The ratios can also be compared to the previous years’ ratio’s to see the progress of the company.
This is known as trend analysis.

ADVANTAGES OF RATIO ANALYSIS:

When employed correctly, ratio analysis throws light on many problems of the firm and also
highlights some positives. Ratios are essentially whistleblowers, they draw the management’s
attention towards issues needing attention.

Ratio analysis will help validate or negate the financing, investment and operating decisions made
by it from time to time. They summarize the financial statement into comparative figures, thus
helping the management to compare and evaluate the financial position of the firm and the results
of their decisions. Its advantages are:

1) It simplifies complex accounting statements and financial data into simple ratios of
operating efficiency, financial efficiency, solvency, long-term positions etc. which are easy
to represent and understand.
2) Ratio analysis help identify the problem areas of the entity and draw the attention of the
management to such areas. Some of the information is lost in the complex accounting
statements, and ratios will help pinpoint such problems.
 3) Ratios allow the company to conduct comparisons with other firms, industry standards,
intra-firm comparisons etc. This will help the organization better understand its fiscal
position in the economy and adopt timely action to improve its own efficiency and
performance..

LIMITATIONS OF RATIO ANALYSIS:

While ratios are very important tools of financial analysis, they have some limitations, such as:

1) The firm can make some year-end changes to their financial statements, to improve their
ratios. Then the ratios end up being nothing but window dressing done in the accounts.
2) Ratios ignore the price level changes due to inflation. Many ratios are calculated using
historical costs, and they overlook the changes in price level between the periods. This does
not reflect the correct financial situation.
3) Accounting ratios completely ignore the qualitative aspects of the firm. They only take into
consideration the monetary aspects or quantitative variables. The Qualitative aspect is
ignored in the analysis.
4) There are no standardization of the definitions and formulas of the ratios. So firms may be
using different formulas for the ratios. One such example is Current Ratio, where some
firms take into consideration all current liabilities but others ignore bank overdrafts from
current liabilities while calculating current ratio.
5) And finally, accounting ratios do not resolve any financial problems of the company. They
are a means to the end, not the actual solution.

Different modes of expressing accounting ratios –

1. Pure ratio (3:2, 2:5)
2. Percentage (25%, 20%)
3. Rate (10 times)
Classification of accounting ratios –
1. Balance sheet ratios, also known as Static Ratios or Financial ratios
2. Income statement ratios are also known as Dynamic Ratios or Operational Ratios.
3. Inter statement ratios are also known as Inter-related ratios or Combined Ratios.
Ratios Expressed Formula Std. Used for measuring
as
Ratio
(if any)

A. FINANCIAL STABILITY, SOLVENCY, LIQUIDITY, BALANCE SHEET RATIOS

(1) Current Ratios

Pure Ratio Current Assets 2:1 - Short term
stability
Current Liabilities - Capitalisation
- Over/Under
Trading

(2) Liquid Ratio Pure Ratio Quick Assets 1:1 - Immediate

(Quick Ratio) solvency
Quick Liabilities

- Long term
stability
(3) Proprietory Percentage Proprietors Funds . 60% to - Capitalisation
Ratio 75% - Over/Under
(Asset Backing Fixed Assets + Current Assets trading
Ratio) - Overall
efficiency

(4) Capital Pure Ratio Pref.Share Cap + Debenture + loan

Gearing Ratio
Or Equity Share Cap + Res None - Trading on equity
Percentage

(5) Stock Pure Ratio Closing Stock 1:1 - Investments in

Working stocks
Capital Ratio Or Working Capital
Percentage
(6) Debt Equity Pure Ratio Long Term Debts Depends - Long term
Ratio on stability
Shareholders Funds industry

OR
Long Term Debts .

Shareholder Funds + Long Term Debts

B. MANAGEMENT EFFICIENCY RATIOS, REVENUE STATEMENT RATIOS:

(7) Gross Profit

Ratio Percentage Gross Profit X 100 Depend - Profitability vis-à-
s on vis Sales
Net Sales industr
y

(8) Operating Cost of Goods Sold + Operating Exp. X - Operating

Ratio 100 Efficiency
“ None
Net Sales

(9) Operating
Expenses “ Operating Expenses X 100 “
Ratios
Net Sales

(10) Group of
Expenses “ Relevant Group of Expenses X 100 “
Ratio
Net Sales
(11) Net Operating
Expenses “ Operating Profit X 100 “
Ratio
Net Sales

(12) Net Profit “ Operating Net Profit X 100 Depend - Profitability vis-à-
Ratio s vis sales
Net Sales
on
industr
y
OR
Net Profit (before tax) X 100
Net Sales

(13) Stock No. of Cost of goods sold Higher - Over/Under

Turnover times or the Trading
days Average Stock better
Ratio

(Op. Stock + Cl. Stock / 2)

C. OVERALL PROFITABILITY RATIOS, COMBINED RATIOS

(14) Return on
Capital Percentage Net Profit (before int & tax) X 100 Depends on - Profitability vis-
employed industry à-vis Investments
Capital Employed

(15) Return on Net Profit (after int & tax) X 100 Depends on - Profitability vis-
Proprietors industry à-vis Investments
funds “ Proprietors funds - Over/Under
Trading
(16) Return on Net Profit after tax & Pref Div X 100 None - Profitability vis-
Equity à-vis Investments
Capital “ Paid Up Equity share capital - Capitalisation
- Overall
Efficiency

(17) Earning per Rupees Net Profit (after tax) – Pref. Div. None - Profitability vis-
share à-vis Investments
No. of equity shares

(18) Dividend pay Percentage Div. per Equity share None

out
Ratio Earning per Equity Share Depends on - Funds ploughed
industry back into
business

(19) Price Earning Market price of share

Ratio No. of - Market
times Earning per share perception of
equity shares

(20) Debt Service No. of Net Profit (before tax) & int on At least 1
Ratio times Loan
- Capacity of
Interest on loans + Preference business to
Dividend + Annual debt installment service loans
due

No. of
(21) Debtors days
turnover Sundry Debtors + A/c. Receivable Credit - Over/Under
Ratio period Investments in
Average net credit sales X No. of granted to debtors
days in the year customers
 Credit - Promptness of
(22) Creditors period payment to
turnover No. of Sundry Creditors + Bills Payable granted to creditors
Ratio days suppliers
Average net credit purchases X

No. of days in the year

(23) Debt
collection “ No. of days in a year - - Indicates
Period promptness
Debtors turnover
in recovery of
debts
from debtors

(24) Collection Average Debtors X Given Days

period
Credit Sales

USES OF ACCOUNTING RATIOS IN A SUMMARISED FORM:

FOR MEASURING RATIOS TO BE USED

I. Profitability
(a) Vis-à-vis sales (i) Gross Profit Ratio
(ii) Net Profit Ratio
(b) Vis-à-vis investments (i) Return on capital employed
(ii) Return on proprietors funds
(iii) Return on equity capital
(iv) Earning per share
II. Financial Stability
(a) Long term stability (i) Proprietory Ratio
(ii) Debt Equity Ratio

(b) Short term stability (i) Current Ratio

(c) Immediate solvency (i) Liquid Ratio

III. Financial Management
(a) Over capitalisation or Under capitalisation (i) Proprietory Ratio
(ii) Return on proprietors equity
(iii) Current Ratio

(b) Over Trading or Under Trading (i) Proprietory Ratio

(ii) Current Ratio
(iii) Liquid Ratio
(iv) Stock Turnover Ratio
(v) Return on Proprietors funds

(c) Investments in Stocks (i) Stock Turnover Ratio

(ii) Liquid Ratio
(iii) Stock Working Capital Ratio

(d) Over Investments in receivables (i) Debtors Turnover Ratio

(e) Prompt payment of creditors (i) Creditors Turnover Ratio

(f) Trading on Equity (i) Capital Gearing Ratio

(ii) Debt Equity Ratio

(g) Operating Efficiency (i) Operating Ratio

(ii) Expenses Ratio

(h) Capacity to service loans (i) Debt Service Ratio

IV. Overall Efficiency (i) Stock Turnover Ratio
(ii) Proprietory and Current Ratio
(iii) .Return on proprietors equity

Preparation Of Financial Statements from Accounting Ratios

In order to prepare Profit & Loss A/c and Balance Sheet from the given ratios, it is necessary to
have an idea of relationship which exists between different terms used to compute ratios. The
following equations may be used to prepare final accounts:

Trading and Profit & Loss A/c.

Gross Profit = Sales – Cost of goods sold (1)

Hence Cost of goods sold = Sales – Gross Profit

Sales = Cost of goods sold + Gross Profit
Cost of Goods sold = Opening Stock + Materials consumed + Manufacturing Expenses –
Closing Stock
Operating Profit = Gross Profit – Operating Expenses
Operating Expenses = Administrative Expenses + Selling and Distribution Expenses +
Finance Expenses
Operating Profit = Sales – Operating Cost (2)
Operating Cost = Sales – Opening Profit
Sales = Operating Cost + Operating Profit
Operating Cost = Cost of goods sold + Operating Expenses
Net Profit after Interest but
before Tax = Operating Profit + Non- Operating Income – Non - Operating
Expenses
Net Profit after Interest
and Tax = N.P.BIT – I
Net Profit after Interest
and Tax = NPBT – T

Balance Sheet
Capital Employed = Fixed Assets + Working Capital (1)
Fixed Assets = Capital Employed – Working Capital
Working Capital = Capital Employed – Fixed Assets
Working Capital = Current Assets – Current Liabilities (2)
Current Assets = Working Capital – Current Liabilities
OR
Current Liabilities = Current Assets – Working Capital
Current Assets = Liquid Assets + Stock
Liquid Assets = Current Assets – Stock
Stock = Current Assets – Liquid Assets
Liquid Assets = Debtors + Cash and Bank
Debtors = Liquid Assets – Debtors

Capital Employed (Liability Side)

Capital Employed = Net Worth + Long Term Loans
Net Worth/
Proprietors Fund = Capital Employed – Long Term
Long Term Loans = Capital Employed – Net Worth
Net Worth = Share Capital + Reserves and Surplus
Equity Share Capital = Equity Net Worth – Reserves and Surplus
Reserves and Surplus = Equity Net Worth – Equity Share Capital

Stock Turnover Ratio Connects

Sales, Cost of Sales, Operating Profits and Stock.

Debtors Turnover Ratio Connects

Sales, Cost of Sales, Operating Profits and Debtors.

Stock to working Capital Ratio helps to ascertain composition of Working Capital or between
Current and Quick Assets.

Que. 1: From the following balance sheet of Sachin, Calculate current ratio, Liquid or Quick
Ratios, proprietary ratio and comment on the same.
 Balance Sheet as at March 31, 2014
Liabilities Rs. Assets Rs.

Share Capital 5,00,000 Fixed Assets 5,45,000

Reserves 2,50,000 Investments 50,000

Term loan from Bank 1,60,000 Stock-in-trade 3,45,000

Bank Overdraft 75,000 Debtors 1,50,000

Creditors: Bills Receivable 70,000

 For goods 1,60,000 Cheques in hand 25,000

 For expenses
15,000 Bank Balance 15,000
Bills Payable
45,000 Cash in hand 5,000

Total  12,05,000 Total  12,05,000

Quick assets = Current Assets – Inventories, prepaid expenses, deposits with customs, ports, trust,
excise, etc.

Therefore, Quick assets include Cash & Bank balances, Marketable investments, Debtors and Bills
Receivable.

Quick Liabilities = Current Liabilities minus Bank

Overdraft

Que. 2: “Cosmos India Ltd.”

Balance Sheet as on 31st December 2014

Liabilities Rs. Assets Rs.

 Capital Reserve 1,26,000 Copyright 1,00,000

General Reserve 1,20,000 Cash 21,000

Provision for Tax 50,000 Calls in Arrears 9,575

Commission received in 10,875 Plant & Machinery 4,20,000

Adv.
1,60,000 Debtors 3,00,425
15% Debentures
40,000 Prepaid Insurance 15,375
12% Bank Loan
2,00,000 Land & Building 5,00,000
6% Pref. Share Capital
10,00,000 Fixtures 25,000
Equity Share Capital
49,125 Furniture 75,000
Bills Payable
9,000 Preliminary Expenses 18,625
Profit and Loss A/c.
10,740 Goodwill 1,00,000
Bank Overdraft
15,000 Investment (Long 1,75,000
Share Premium Term)
1,89,260 2,00,700
Sundry Creditors Stock
19,300
Marketable
Investments

19,80,000 19,80,000

You are requested to rearrange above Balance Sheet in vertical form and compute the
following ratios.

a) Current Ratio. b) Proprietory Ratio. c) Capital Gearing Ratio.

Que. 3: Following is the balance sheet of Cricket limited as on 31st March 2014 –
Liabilities Rs. Assets Rs.
 Equity share capital 2,00,000 Goodwill 1,20,000
Capital reserves 40,000 Fixed assets 2,80,000
8% Mortgage loan 1,60,000 Stock 60,000
Trade creditors 80,000 Debtors 60,000
Bank overdraft 20,000 Investments (short term) 20,000
Provision for taxation 40,000 Cash in hand 60,000
Profit and loss account 60,000
T O T A L  6,00,000 T O T A L  6,00,000

Calculate ratios for testing –

A. Immediate solvency B. Short-term financial strength C. Long term financial
strength.

Que. 4: The following is the balance sheet of Pataudi limited as on 31st March 2014 –
Liabilities Rs. Assets Rs.
Share capital: Land and buildings 1,20,000
- 1,000 equity shares of Rs. 100/- each 1,00,000 Plant and machinery 1,60,000
- 1,000 9% pref.shares of Rs. 100/- 1,00,000 Goodwill 1,20,000
each 40,000 Investments (marketable) 20,000
General reserve 60,000 Debtors 60,000
Profit and loss account 1,60,000 Stock 60,000
8% Mortgage loan 80,000 Cash on hand 60,000
Sundry creditors 20,000
Bank overdraft 40,000
Provision for taxation
Total  6,00,000 Total  6,00,000
Compute the balance sheet ratios and comment on the liquidity, solvency and capital structure of
the company.

Que. 5: Shown below are the comparative balance sheets and operating data of Topa
International for the years ended on 31st December 2013, 2014 and 2015.
 2013 (Rs.) 2014 (Rs.) 2015 (Rs.)

Current assets:
- Cash 1,200 1,900 400
- Debtors
- Stock 14,800 12,400 10,400
14,800 16,200 19,800
Fixed assets (net):
30,800 30,500 30,600
- Equipments
- Buildings
- Land
9,800 12,000 12,800
15,700 16,300 18,000
5,000 5,000 5,000

30,500 33,300 35,800

Total Assets 61,300 63,800 66,400

Current liabilities:
- Bills payable 7,500 3,000 5,000
- Creditors
- Accrued liabilities 6,300 11,200 13,400
1,200 1,600 2,900
Long term loans: debentures (6%)
15,000 15,800 21,300

- - 5,500

Owners equity:
Equity capital (Rs. 100/- each) 30,000 30,000 30,000
Retained earnings 16,300 18,000 9,600

46,300 48,000 39,600

Total liabilities 61,300 63,800 66,400

Additional information –
2013 (Rs.) 2014 (Rs.) 2015 (Rs.)

Total sales 1,00,000 1,05,000 93,000

Net profit after tax 5,000 5,700 2,400

Dividend paid 3,000 3,000 1,000

You are required to –

1. Compute the following for each of the three years –
a) Current ratio b) Acid test ratio c) Proprietary ratio d) Return
on proprietary fund e) Return on equity capital.

2. Discuss the financial condition of the company as on 31st December 2013 to 15 and the
trends shown by the comparative data and the ratios.

Que.6: M/s. Sushant Ltd. presents the following Trading and Profit & Loss A/c for the year ended
31st March, 2012 and Balance Sheet as on that date.

Trading and Profit & Loss Account for the year ended 31st March, 2012

Particulars Rs. Particulars Rs.

To opening Stock 2,00,000 By Sales 12,00,000

To Purchases 5,00,000 By Closing Stock 4,00,000

To Wages 3,00,000
To Gross Profit c/d 6,00,000

16,00,000 16,00,000

To Salaries 1,50,000 By Gross Profit b/d 6,00,000

To Rent 60,000 5,000
 To Commission 12,000 By Profit on Sale of 15,000
Investment
To Advertising Expenses 20,000
By Interest
To Interest 83,000
To Depreciation 30,000
To Provision for Tax 50,000
To Net Profit c/d 2,15,000

6,20,000 6,20,000

To Proposed Dividend 80,000 By Balance b/f 1,85,000

To Preference Dividend 16,000 By Net Profit b/d 2,15,000
To Balance c/d 3,04,000

4,00,000 4,00,000

Balance Sheet as on 31st March, 2012

Liabilities Rs. Assets Rs.

Equity Share Capital (Rs. 100) 8,00,000 Land & Building 6,00,000
8% Preference Share Capital 2,00,000 Plant & Machinery 5,50,000
Reserve and Surplus 3,04,000 Furniture 4,00,000
7% Debentures 5,00,000 Investments 2,70,000
Loan from IDBI 6,00,000 Stock 4,00,000
Creditors 1,50,000 Debtors 2,00,000
Bills Payable 50,000 Bills Receivable 1,60,000
Provision for Tax 50,000 Advance Tax 30,000
Dividend Payable 96,000 Prepaid Expenses 40,000
Cash in Hand 20,000
Bank Balance 60,000
 Discounts on Issue of 20,000
Debentures

27,50,000 27,50,000

Additional Information:-

1. The market price of equity share as on 31st March, 2012 was Rs. 90/-.
2. Out of total sales, 30% are cash sales and out of total purchases, 50% are credit purchases. You
are required to calculate the following Ratios.
i. Return on Capital Employed
ii. Creditors Turnover Ratio
iii. Price Earnings Ratio
iv. Return on Equity Capital
v. Debt Services Ratio
vi. Debtors Turnover Ratio.
Vertical final accounts not expected.

Que.7:

The following is the summarized Profit & Loss A/c of M/s Hanuman Product Ltd. for the year
ending 31st March, 2014.

Profit & Loss Account

Particulars Rs. Particulars Rs.

To Opening Stock 5,00,000 By Sales 50,00,000

To Purchases 25,00,000 By Profit on sale of Asset 50,000

To Wages 25,000 By Interest 25,000

To Freight and Octroi 80,000 By Dividend 10,000

To Direct Expenses 75,000 By Closing Stock 7,50,000

 To Office Insurance 80,000
To Office Staff Salary 2,00,000
To General Managers Salary 50,000
To Staff Welfare Expenses 40,000
To Printing and Stationery 5,000
To Interest 50,000
To Audit Fees 15,000
To Office Rent 2,00,000
To Computer Repairs 75,000
To Advertising 2,50,000
To Bad Debts 5,000
To Travelling 20,000
To Commission 75,000
To Depreciation on Furniture 30,000
To Depreciation on Building 40,000
To depreciation on Vehicles 20,000
To Interim Dividend 50,000
To Loss on Sale of Asset 1,00,000
To Income Tax 50,000
To Net Profit 13,00,000

Total 58,35,000 Total 58,35,000

Calculate the following Ratios:

1. Gross Profit Ratio 2. Operating Ratio 3. Office Expenses Ratio.

Vertical statement of accounts not expected.

Que.8: Following is the Balance Sheet of Bliss and Happiness Ltd., as at 31st March, 2013.

Balance Sheet as on 31st March 2013

Liabilities Rs. Assets Rs.
Equity Share Capital 1,00,000 Machinery 2,96,000
General Reserve 70,000 Investments 1,12,000
10% Preference Capital 1,80,000 Stock in Trade 1,01,000
15% Debentures 1,20,000 Bills receivable 20,000
Trade Payables 1,22,000 Trade Receivables 49,000
Banks Overdraft 20,000 Cash and Bank 38,000
Provision for Tax 18,000 Profit and Loss A/c 14,000
Total 6,30,000 Total 6,30,000

Sales for the year Rs. 7,00,000; Gross Profit Rate – 25% and opening stock is Rs. 1,09,000. Profit
Before Tax for the year ending 31.03.2013 is Rs. 2,10,000. You are required to compute the
following ratios and comment on Current Ratio.

i. Current Ratio
ii. Acid Test Ratio
iii. Stock Turnover Ratio
iv. Capital Gearing Ratio
v. Proprietary Ratio
vi. Debt Equity Ratio (Debt / Net worth)
vii. Return on Capital Employed

Redrafting the given Balance Sheet in vertical format is not expected.

Que. 9: From the following particulars calculate:

(a) Debt Equity Ratio
(b) Capital Gearing Ratio
Rs.
Equity Share Capital 5,00,000
Preference Share Capital 2,00,000
Reserves 6,00,000
Term loan from Bank 5,00,000
Debentures 6,00,000

Que. 10: From the following details calculate –

1. Earning per share.
2. Dividend pay out ratio.
3. Price earnings ratio.

- Equity share capital (of Rs. 10/- each) Rs. 5,00,000.

- 10% Preference share capital Rs. 2,00,000.
- Profits before tax Rs. 6,00,000.
- Tax Rate – 40% + surcharge of 15% of tax.
- Dividend on equity shares 40%.
- Price of equity share on Bombay Stock Exchange Rs. 120.

Que. 11: From the following financial data compute capital gearing ratio –
5% Debentures – Rs. 24,000; Credit balance in profit and loss account – Rs. 5,000;
General reserve – Rs. 8,000; Equity capital – Rs. 1,52,000;
Total funds employed – Rs. 1,89,000.

Que. 12: From the following details of Mr. Ajay, calculate debtors turnover ratio and credit
turnover ratio and comment thereon. The normal period of credit given to customers is 60 days
and recd from suppliers is 45 days.
Rs.
Debtors 45,000
 Bills Receivable 36,000
Creditors 27,000
Bills Payable 18,000
Sales during the year 4,50,000
Purchases during the year 3,25,000
10% of sales and purchases are for cash.

Que. 13: Calculate from the following details furnished by Pardeshi Ltd.
(a) Current Ratio
(b) Liquid Ratio
(c) Credit Turnover Ratio and Average Credit Period
(d) Debtors Turnover Ratio and Average Credit Period
(e) Stock Turnover Ratio
Rs.

Stock 1,00,000

Debtors 1,40,000

Cash 60,000

Creditors 1,60,000

Bank Overdraft 30,000

Outstanding Expenses 10,000

Total Purchases 6,60,000

Cash Purchases 20,000

Gross Profit Ratio 33 1/3 %

Offer your comments on short-term credit position of the company; comment on individual ratio
is not desirable.

Que. 14:
The profit of a company is Rs. 50,000 after charging interest of Rs. 6,000 on debentures and
providing Rs. 24,000 on taxes; the assets of the company consist of fixed assets – Rs. 2,00,000;
current assets – Rs. 6,00,000 and preliminary expenses – Rs. 30,000. Discount on issue of
debentures is Rs. 10,000. Compute the return on capital employed.

Que. 15:
From the following information calculate Current Ratio, Liquid Ratio, Creditor’s Turnover
ratio and Average Credit Sales of Surya Ltd. and Chandra Ltd.

Particulars Surya Ltd. Chandra Ltd.

Credit to Debtors 3 months 3 months
Rs. Rs.
Stock 8,00,000 1,00,000
Debtors 1,70,000 1,40,000
Cash 30,000 60,000
Trade Creditors 2,80,000 1,50,000
Bills Payable 20,000 10,000
Bank Overdraft 40,000 30,000
Creditors for expenses 60,000 10,000
Total Purchases 9,30,000 6,60,000
Cash Purchases 30,000 20,000

Que. 16:

1) The current ratio of Bobby limited is 4.5:1 and the liquid ratio is 3:1; inventory is Rs. 6,00,000.
Calculate the current liabilities.
2) Total current liabilities of Rocky limited are Rs. 10,00,000 and the acid test ratio is 3:1.
Inventory is Rs. 5,00,000. Find out the current assets and compute the current ratio.
3) Inventory of Minky limited is Rs. 6,00,000. Total liquid assets are Rs. 24,00,000 and liquid
ratio is 2:1. Work out the current ratio.
4) Liquid ratio of Pinky limited is 2.5:1. Inventory is Rs. 12,00,000. Current ratio is 4:1. Assume
there is no bank overdraft. Find out the current liabilities.

Que. 17:

A company’s stock turnover was 5 times. Stock at close was Rs. 10,000 more than that at the
beginning of the year. The company’s practice is to value the stock at cost. Sales during the year
were Rs. 10,00,000 and gross profit margin was 25%. Ascertain the closing stock.

Que. 18: A Company’s shareholders equity is Rs. 1 Lac. Following are the ratios relating to the
balance sheet:

1. Current debts to total debts = 0.40

2. Total debts to owners equity = 0.60
3. Fixed assets to owners equity = 0.60
4. Total assets to turnover = 2 times
5. Inventory Ratio to sales = 8 times
From the following information prepare the balance sheet of the company.

Que. 19:

Debtors Velocity = 3 months

Stock Velocity = 8 times

G.P. Ratio = 25%

Gross Profit for the year is Rs.1,60,000. There are no long-term loans or overdraft. Reserves and
surplus amounted to Rs.56,000 and liquid assets are Rs.2,00,000. Closing stock is Rs.4,000 more
than the opening stock. Bills Receivable is Rs.10,000 and Bills Payable Rs.4,000.
Compute: (i) Sales (ii) Sundry Debtors (iii) Closing Stock (iv) Bank Balance.

Que. 20: Gross Profit Ratio of Jyoti Ltd. for the year 2014 was 25% and in the year 2015 it came
down to 15%. What could be the reasons for decrease in Gross Profit Ratio of the Company. (Give
only Four Reasons)

Que.21: From the following information, you are required to prepare a Balance Sheet in
Horizontal form:

Current Ratio 1.75

Liquid Ratio 1.25
Stock Turnover Ratio 9 times (Based on closing
stock)
Gross Profit Ratio
25%
Debtors collection period
1.5 months
Reserves and surplus to share capital
0.2
Cost of Goods sold to Fixed Assets
1.2
Capital Gearing (Long term Loans to share capital)
0.6
Fixed Assets to shareholders Funds
1.25
Sales for the year (All are no credit basis)
Rs. 12,00,000

Current Assets consisted on Cash, Stock & Debtors only. The company has not issued pref.
shares. There is no Bank overdraft and Fictitious Assets.

Que. 22: Complete the following Sheet from the information given below:
Balance sheet as on 31st December 2015

Liabilities Rs. Assets Rs.

Equity Share Capital (of Rs. ? Fixed Assets ?

100 each)
? Current Assets
Reserve & Surplus Stock
4,00,000 ?
10% Debentures Debtors
?
Current Liabilities Other Current Assets
? ?
Sundry Creditors 2,00,000
Other Current Liabilities ? ?

Following information is available:

1) Sales for the year Rs. 48 lakhs.

2) Gross Profit Ratio 25%.
3) Net profit after tax Rs. 2,00,000.
4) Purchases and sales on credit basis.
5) Debtors Turnover Ratio 12 times (Sales/Debtors).
6) Creditors Turnover Ratio 12 times (Cost of Sales/Creditors).
7) E.P.S. Rs. 20 per share.
8) Stock Turnover Ratio 10 times.
9) Debt Equity Ratio 0.25:1.
10) Current Ratio 1.6:1.

Que.23: Calculate Return on Capital employed and Return on properties fund from
following information.

Rs.

Equity Capital 3,00,000

General Reserves 4,00,000
 Profit & Loss A/c 1,50,000
Sundry Creditors 2,00,000

Operating profit 3,50,000 (Before Interest & Tax)

Long Term Loan 2,00,000 (at 12% p.a. Interest)
Tax rate is 30%.

Que.24: From the following information for the year ended 31st March, 2014 of M/s. NITIN LTD.

Prepare Balance- Sheet with as many details as possible.

Current Ratio 2
Gross profit Ratio 25 %

Debtors Turnover 4 times

Cost of goods sold to creditors [COGS/ creditors] 6

Stock Turnover [Cost of goods sold/ Closing stock] 6 times
Cash Balance is 10 % of Total Current Assets [Including Cash] Rs. 6,00,000
Fixed Assets at cost 1/4th of cost.
Accumulated Depreciation on fixed assets Rs. 1,25,000
Current Liabilities 2:3

Reserve and surplus is 25 % of Equity shares Capital

Debt Equity Ratio [Debt/Equity]

All purchase and sales are on credit basis.

Current Liability includes only Creditors and bills payable.

Que.25: M/s. Rajesh & Co. gives you the following information. Prepare trading and profit and
loss account for the year ended 31st March, 2014 and balance sheet as on that date in as much detail
as is possible.

Opening Stock Rs. 90,000

Stock Turnover Ratio 10 times
Net Profit Ratio on turnover 15%

Gross Profit Ratio on turnover 20%

Current Ratio 4:1
Long Term Loan Rs. 2,00,000
Depreciation on Fixed Assets @ 10% Rs. 20,000
Closing Stock Rs. 1,02,000
Credit allowed by suppliers One month
Average Debt collection period two months

On 31st March, 2014 current Assets consisted of stock, debtors and cash only. There was no bank
overdraft. All purchases were made on credit. Cash sales were 1/3rd of credit sales.

Que.26: Certain items of the annual accounts of AB Ltd. are missing as shown below :-

Dr. Trading and Profit & Loss Account for the year ending on 31st March, 2014
Cr.

Particulars Rs. Particulars Rs.

To Opening Stock 4,37,500 By Sales ?

To Purchases ? By Closing Stock ?

To Direct Expenses 1,09,375

 To Gross Profit ?

Total ? Total ?

To Administrative Expenses 2,66,000 By Gross Profit ?

To Interest on Debentures 37,500 By Commission 62,500

To Provision for Taxes ?

To Net Profit After Tax 3,30,000

Total ? Total ?

Balance Sheet as on 31st March, 2014

Liabilities Rs. Assets Rs.

Share Capital 6,25,000 Plant and Machinery 7,75,000

General Reserve ? Long Term Investment ?

Profit and Loss Account 1,34,375 Stock ?

(Including Opening Balance) Debtors ?

10% Debentures ? Bank Balance 78,000

Creditors ?

Proposed Dividend (C.Y.) ?

Provision for Taxes (C.Y.) ?

Total ? Total ?

You are required to complete the Financial Statements with the help of the following information:-

1) Current ratio is 2:1.

2) Stock turn over ratio is 1.60.
3) Proposed dividends are 25% of share capital.
4) Gross profit ratio is 50%.
 5) Transfer to General Reserves is 70% of proposed dividends.
6) Provision for Taxes is 50% of profit after tax.
7) There is no opening balance in General Reserve Account.
8) Creditors’ turn over ratio (on purchases and closing creditors) is 10:2.

Que.27: Profit & Loss A/c and Balance Sheet of SIDHARTH LTD. for the year ended 31st March
31, 2014:-

Dr. Trading, Profit & Loss Account for the year ended 31st March 2014
Cr.

Particulars Rs. Particulars Rs.

To Opening Stock 70,000 By Sales 9,00,000

To Purchases 5,40,000 By Closing Stock 80,000

To Wages 2,14,000

To Gross Profit c/d 1,56,000

9,80,000 9,80,000

To Salaries 26,000 By Gross Profit b/d 1,56,000

To Rent 5,000 By Interest on Investment 5,000

To Miscellaneous Expenses 15,000

To Selling Expenses 10,000

To Depreciation 30,000

To Interest 5,000

To Provision for Tax 20,000

To Net Profit c/d 50,000

1,61,000 1,61,000

Balance Sheet as on 31st March, 2014

Liabilities Rs. Assets Rs.

 Equity Share Capital (Rs. 10) 1,50,000 Fixed Assets 1,60,000
8% Preference Share Capital
1,00,000 (-) Depreciation 30,000 1,30,000
(Rs. 100)

Reserve & Surplus 62,000 Investment 1,00,000

10% Debenture 50,000 Stock 80,000

Bank Loan (Payable after 5 40,000 Debtors 60,000

years)

Creditors 60,000 Bills Receivable 50,000

Provision for Tax (C.Y.) 20,000 Cash 85,000

Bank Overdraft 20,000 Preliminary Expenses 5,000

Proposed Pref. Dividend 8,000

5,10,000 5,10,000

Note: Market value of Equity share is Rs. 12 and Dividend paid per Equity share is Rs. 2.

Calculate the following ratio:-

(a) Acid Test Ratio (b) Capital Gearing Ratio

(c) Operating Ratio (d) Dividend Payout Ratio
(e) Debt Service Ratio (f) Creditors Turnover Ratio
(g) Earning Per Share (h) Stock Turnover Ratio

Note: Vertical Final Account need not be prepared.

Que.28: Following is the profit and loss Account of Moon Enterprises LTD. for the year ended
31.03.2014

Particulars Rs. Particular Rs.

To Opening Stock 4,00,000 By Sales

To Purchases 9,80,000 Credit - 18,00,000

25,00,000
Cash - 7,00,000

To Wages 2,90,000 By Closing stock 6,00,000

To factory Expenses 1,90,000 By Sale of Scrap 10,000

To office Salaries 1,20,000 By Dividend Received 1,000

To General Administrative 1,30,000

Exps.

To Selling Expenses 1,12,500

To Depreciation on 2,50,000
Machinery

To Provision for Tax 1,40,500

To Trf .To Gen. Reserve 2,00,000

To Net Profit 2,98,000

31,11,000
31,11,000

You are required to compute the following ratio--

[1] Gross Profit Ratio

[2] Stock –Turnover Ratio

[3] Administrative Expenses Ratio

[4] Net Profit Before Tax ratio

Preparing Revenue Statement In Vertical Form is not required.

Que. 29: From the following information of X Engineering Co. completes the Proforma Balance
Sheet if sales are Rs. 16,00,000.

Sales to Net Worth 2.3 times

Current Liabilities to Net Worth 42 %
Total Liabilities to Net Worth 75 %
Current Ratio 2.9
Sales to Closing Inventory 4.5
Average Collection Period 64 days

Proforma Balance Sheet

Liabilities Rs. Assets Rs.

Net Worth ? Fixed Assets ?

Long term Liabilities ? Cash ?
Current Liabilities ? Stock in Trade ?
? Debtors ?

Calculations are to be made to the nearest rupee.

Que.30:

Following is trading and Profit & Loss Account for the year ended 31st March, 2014 and
Balance Sheet as on
 that date of Sudrshan Ltd.

Trading and Profit and Loss Account for the year ended 31st March 2014

Particulars ` Particulars `

To Opening stock 2,50,000 By Sales (Credit) 37,00,000

To Purchases 26,00,000 By closing stock 5,00,000
To Gross Profit c/d 13,50,000

Total 42,00,000 Total 42,00,000

To Administrative Expenses 2,70,000 By Gross Profit b/d 13,50,000

To Interest 72,000 By Profit on sales of Assets 50,000
To Rent 60,000
To Selling Expenses 1,00,000
To depreciation 1,20,000
To provision for Income Tax 2,78,000
To Proposed Dividend 1,00,000
To Net Profit c/f 4,00,000

Total 14,00,000 Total 14,00,000

Balance sheet As on 31st March, 2014

Liabilities ` Assets `

Equity Share Capital (` 10 each) 5,00,000 Fixed Assets (at cost) 12,00,000
11% Preference share capital 3,00,000 Short term investments 1,00,000
General Reserve 4,00,000 Trade Receivables
12% Debentures 6,00,000 (last year ` 9,00,000) 9,50,000
 Trade Payables 3,00,000 Inventories 5,00,000
Proposed Dividend 1,00,000 Cash and Bank Balance 1,50,000

Bank Overdraft 2,00,000 Discount on Issue of Debentures 60,000

Provisions for Depreciation 4,00,000

Provisions for income Tax 2,00,000

Total 30,00,000 Total 30,00,000

From the above information calculate following ratios and comment on current ratio.

1) Current Ratio
2) Inventory Turnover Ratio
3) Return on Proprietors Funds
4) Operating Ratio
5) Capital Gearing Ratio
6) Dividend Payout Ratio
7) Debtors Turnover Ratio

Assume 360 days in a year.

Note :- Drafting of Vertical Financial Statement is not expected.

WINDOW DRESSING

1.1 Define Window Dressing:

• Window dressing is actions taken to improve the appearance of a company's financial
statements.
• Window dressing is particularly common when a business has a large number of
shareholders, so that management can give the appearance of a well-run company to
investors who probably do not have much day-to-day contact with the business.

1.2 Why is window dressing done in Financial Statements:

(a) Improving the results: A company can show an improved financial results after window
dressing of financial statements is done in numerous ways. Examples include:
 It can postpone payments to enhance its cash balance and record a low bad-debt reserve to
make accounts receivable look stronger.
 By selling off fixed assets with substantial accumulated depreciation, the remaining assets
will be lightly depreciated, making it look as if the corporation was using only relatively
new equipment.
 Another depreciation trick is to switch from the accelerated to the straight-line method to
reduce current expenses.
 Corporations might offer customers discounts to accelerate purchases and increase the
period’s revenues.
 Another ploy is to defer supplier expenses until a later period.
(b) Misleading the Company’s Bankers:
One motivation for window dressing the Financial Statements is to help the entity qualify for a
bank loan. In practice all Financial institutions set standards that borrowers must meet to qualify
for the lowest-rate loans.
For example, the bank might demand a strong current ratio.
A high ratio indicates the company has enough cash and short-term assets to pay interest charges.
However, loans obtained in this way might cause an actual cash crunch when window dressing
can no longer hide the situation of weak cash flows. This increases the risk of default, resulting in
bankruptcy and liquidation.
(c) Hoodwinking the Shareholders
Another motivation for corporate window dressing is to artificially increase the stock prices.
Investors often examine the financial reports to determine how much they are willing to pay for
shares of stock. When a company artificially boosts its earnings using window dressing, investors
might bid up share prices to maintain or expand the stock’s price-to-earnings ratio. Executive
compensation is often tied to stock price performance. The disadvantage of masking the
corporation’s true condition is that shareholders don’t know they need to apply correctives, such
as passing resolutions, electing new board members or driving down the stock price, thereby
allowing the corporation’s root problems to go untreated. Over a period of time it becomes a curse
for the entity.
(d) Legal repercussions:
If the entire process of window dressing goes on unchecked, the entity might cross the line and
begin defrauding investors and cheating them unabated. For example, Enron created “special
purpose entities” that provided revenue while hiding liabilities. It also lied to auditors. The
company eventually folded and top executives went to prison. In its rarest form, executives simply
“cook the books,” or make up numbers to put onto the financial reports. The damage to investors
can be immense, as was the case in the Bernard Madoff scandal that led to Madoff’s long-term
incarceration.

It may also be used when a company wants to impress a lender in order to qualify for a loan. If a
business is closely held, the owners are usually better informed about company results, so there is
no reason for anyone to apply window dressing to the financial statements.

1.3 Window Dressing in Indian companies:

1. Tata Motors transferred 24% stake in Tata Automotive Components (TACO), a company
with revenue of $675 in FY07, to Tata Capital, a group company, and booked a profit of
Rs 110 crore in Q1 FY09. Management declined to disclose the valuation methodology.
Tata Motors also changed its methodology for calculating provisions for doubtful
 receivables, which resulted in higher reported EBITDA to the extent of Rs 50.7 crore (10%
of EBITDA).
2. TCS, the software major, increased its depreciation policy on computers from two years
to four years. As a result, Q1 FY09 PBT was higher by an estimated Rs 50 crore (4% of
net profit in 1QFY09). TCS followed cash-flow hedge accounting and till FY08, it used to
recognize hedging gains on effective hedges in its revenue line, thus boosting the reported
revenue growth and Ebit margin. In FY08, TCS had Rs 421crore from hedging gains, of
which, Rs 137 crore was included in the revenue line. However, from Q1 FY09, TCS is
expected to report all forex losses/gains below the Ebit line in other income. Thus, the
losses it had on its hedge position will no longer be booked in the operating line.
3. Jet Airways, changed its depreciation policy from WDV to SLM, and thereby wrote back
Rs 920 crore into its P&L, which helped the company to report profits during the quarter.
It also helped Jet to report a higher net worth, which will help in keeping reported gearing
low.
4. Dr Reddy’s adjusted mark to market losses (Q1 FY08) on outstanding $250 million of
hedges in the balance sheet, while P&L reflects forex gains realized.
5. Reliance Communications adjusted short-term quarterly fluctuations in foreign exchange
rates related to liabilities and borrowings to the carrying cost of fixed assets. The company
adjusted Rs 109 crore of realized and Rs 955 crore of unrealized forex losses in the above
manner. In addition, the company has not recognized Rs 399 crore of translation losses on
FCCBs, since the FCCBs can potentially get converted, although the FCCBs are out of
money. Adjusted for all the above, the company would have virtually no profits in Q1
FY09.

1.4 Methods of Window Dressing:

(a) Inventory: Management can manipulate inventory valuation by increasing the value of
inventory to increase the profitability of the company.
(b) Depreciation: For increasing the profitability of the company by changing the
depreciation method. From the WDV to the straight-line method.
 (c) Capital Expenditure: Management can manipulate Accounts by capitalizing on revenue
expenditures, by doing this debit side of profit and loss will decrease and the profitability
of the company will be increased.
(d) Cash/Bank: Company can manipulate cash and bank balance at the end of the year by
holding payment of vendor at the end of the year. By doing this at the end of the year
balance of cash and bank will be increased.
(e) Revenue: Revenue can be manipulated by increasing sales volume at the end of the year
by selling products at discount. It will show better performance of the company.

1.5 Advantages of Window Dressing for the company:

 The company can get fund from the financial institute by showing the better position of
financials
 Window dressing attract stakeholders
 Window dressing help reducing tax liability
 By showing good performance it shows the stability of the company
 It influences the market price of the company.
 It shows a good liquidity position of the company

1.5 Disadvantages of Window Dressing in Accounting:

 By doing window dressing it shows a false picture of financials of the company
 It can cause major loss to stakeholders because when the actual conditions will be released
in public they will start losing their money.
 Banks and the financial institutions will be insecure about getting repayment of their fund
and interest on that fund.
 The market price of company will fall and shareholders tend to lose their money
 There is a loss of tax to the government if the company has shown less profit in financials
 The company can reach a stage of bankruptcy
COMPANY FINAL ACCCOUNTS
Introduction:
There is no legal obligation for sole proprietorship and a partnership firm to prepare final accounts,
but companies have statutory obligations to keep proper books of accounts and to prepare its final
accounts every year in the manner as prescribed in the Companies Act. Chapter IX, Sections 128
to 138 of the Companies Act, 2013 deals with the legal provisions relating to the Accounts of
Companies. These sections including Schedule II and III were brought into force from 1st April
2014. The relevant rules pertaining to these provisions have also been notified. All these relevant
provisions/schedules and rules are applicable for the financial years commencing on or after 1st
April 2014.

Schedule III of The Companies Act, 2013:

According to Section 129 of the Companies Act, 2013, all the companies registered under this Act
will have to present its financial statements in Schedule III of the Act. The Schedule III of the
Companies Act, 2013 has been formulated to keep pace with the changes in the economic
philosophy leading to privatization and globalization and consequent desired changes/reforms in
the corporate financial reporting practices. It deals with the Form of Balance Sheet, Statement of
Profit and Loss, and disclosures to be made therein, and it applies uniformly to all the companies
registered under the Companies Act, 2013, for the preparation of financial statements of an
accounting year.

Presentation of Balance Sheet

A Balance Sheet is a statement of the financial position of an enterprise as at a given date, which
exhibits its assets, liabilities, capital, reserves and other account balances at their respective book
values.
Part-I – Form of Balance Sheet
Name of the Company: .............................................................
Balance Sheet as at: ..................................................................
Particulars Note Figure as at the Figures as at the
No. end of Current end of the
Reporting Previous
Period (Rs.) Reporting
Period (Rs.)
I. EQUITY AND LIABILITIES
(1) Shareholders’ Funds
(a) Share Capital
(b) Reserves & Surplus
(c) Money Received against Share
Warrants
(2) Share Application money pending
allotment
(3) Non-Current Liabilities
(a) Long-Term Borrowings
(b) Deferred Tax Liabilities (DTL)
(Net)
(c) Other Long-Term Liabilities
(d) Long-Term Provisions
(4) Current Liabilities
(a) Short-Term Borrowings
(b) Trade Payables
(c) Other Current Liabilities
(d) Short-Term Provisions
Total
II. ASSETS
(1) Non-Current Assets
(a) Fixed Assets
(i) Tangible Assets
(ii) Intangible Assets
(iii) Capital WIP
(iv) Intangible Assets under
Development
(b) Non-Current Investments
(c) Deferred Tax Assets (DTA) (Net)
(d) Long-Term Loans & Advances
 (e) Other Non-Current Assets
(2) Current Assets
(a) Current Investments
(b) Inventories
(c) Trade Receivables
(d) Cash & Cash Equivalents
(e) Short-Term Loans & Advances
(f) Other Current Assets
Total

DISCLOSURE REQUIREMENTS:
(A) For “EQUITY AND LIABILITIES” Items
Sch. III Disclosure Requirement Points to be considered
(1) Shareholders’ Funds
(a) Share Capital
For each Class of Share Capital (different classes of Preference Shares to be treated separately):
(a) Authorized Capital It is the maximum number and face/par value, of
each class of shares that a corporate entity may
issue in accordance with its instrument of
incorporation.
(b) Number of Shares Issued, Subscribed • Subscribed Share Capital” is “that portion of the
and Fully Paid, and Subscribed but not Issued Share Capital which has actually been
Fully Paid subscribed by the public and subsequently allotted
to the shareholders by the entity. This also includes
any Bonus shares issued to the Shareholders.
• “Paid-up Share Capital” is “that part of the
Subscribed Share Capital for which consideration
is cash or otherwise has been received. This also
includes Bonus Shares allotted and Shares issued
 otherwise than for cash against purchase
consideration, by the corporate entity.”
• If Shares are not fully called, then disclose the
called up value per share.
(c) Rights, Preferences and Restrictions • For Preference Shares, the rights include dividend
attaching to shares including restrictions and/or capital related rights. Further, Preference
on the distribution of Dividends and the Shares can be cumulative, non-cumulative,
Repayment of Capital redeemable, convertible, non-convertible, etc.
(d) Shares held in the Company held by its • Disclose number of Shares held by the entire
Holding Company or its ultimate Holding chain of Subsidiaries and Associates starting from
Company including Shares held by the Holding Company and ending right up to the
Subsidiaries or Associates of the Holding Ultimate Holding Company.
Company or the ultimate Holding • All such disclosures should be made separately
Company in aggregate representing for each class of Shares, (for both
Equity and Preference Shares).
(e) List of Shareholders holding more than • Date for computing the 5% limit should be taken
5% shares as on the Balance Sheet Date as the Balance Sheet date. So, if during the year,
any Shareholder held more than 5% Equity Shares
but does not hold as much at the Balance Sheet
date, disclosure is not required.
(1) (b) Reserves & Surplus
(h) Surplus, i.e., balance in Statement of Appropriations to the Profit for the year (including
P&L disclosing allocations & carried forward balance) is to be presented under
appropriations, such as, Dividend, Bonus the main head ‘Reserves and Surplus’. Under Sch
Shares and Transfer to/from Reserves, etc. III, the Statement of P&L will no longer reflect any
(Additions & Deductions since last appropriations, like Dividends transferred to
Balance Sheet to be shown under each of Reserves, Bonus Shares, etc.
specified heads)
Profit and Loss Account (Dr.): Debit Balance Statement of P&L shall be shown as a Negative
Figure under the head ‘Surplus’. Similar, the balance of ‘Reserves & Surplus’, after adjusting
Negative balance of Surplus, if any, shall be shown under the head ‘Reserves & Surplus’ even
if the resulting figure is in the negative.
(1) (c) Money Received Against Share Warrants
In case of Listed Companies, Share warrants are issued to Promoters & others in terms of the
Guidelines for Preferential Issues, viz. SEBI (Issue of Capital and Disclosure Requirements),
Guidelines, 2009. Effectively, Share Warrants are amounts which would ultimately form a part
of the Shareholder’s Funds. Since Shares are yet to be allotted against the same, these are not
reflected as a part of Share Capital, but as a separate line-item.
(2) Share Application Money Pending Allotment
Share Application Money not exceeding the Issued Capital and to the extent not refundable is
to be disclosed as a separate line item after “Share Holders Funds” and before “Non-Current
Liabilities”. If the Company’s Issued Capital is more than the Authorized Capital, and approval
of increase in Authorized Capital is pending, the amount of Share Application Money received
over and above the Authorized Capital should be shown under the head “Other Current
Liabilities”.
(3) Non-Current Liabilities
(3) (a) Long-Term Borrowings
Long-Term Borrowings shall be --
classified as –
(a) Bonds/Debentures,
(b) Terms Loans – (i) from Banks, and Loans with repayment period beyond 36 months are
(ii) from Other Parties, usually known as “Term Loans”. So, Cash Credit,
Overdraft and Call Money Accounts/ Deposits are
not covered by the expression “Term Loans”.
(c) Deferred Payment Liabilities, Deferred Payment Liabilities would include any
Liability for which payment is to be made on
deferred credit terms, e.g., Deferred Sales Tax
Liability, Deferred Payment for Acquisition of fixed
Assets, etc.
(d) Deposits,
(e) Loans & Advances from Related
Parties,
(f) Long-Term Maturities of Finance
Lease Obligations,
(g) Other Loans & Advances (specify
nature)
Note: Borrowings shall further be sub-classified as Secured and Unsecured. Nature of Security
shall be specified separately in each case.
(3) (b) Deferred Tax Liabilities (As per Accounting Standard-22)
(3) (c) Other Long-Term Liabilities
It shall be classified as –
(a) Trade Payables
(b) Others
(3) (d) Long-Term Provisions
Deposits classified under Borrowings would include
Deposits accepted from Public and Inter-Corporate
Deposits which are in the nature of Borrowings.
Loans and Advances from related parties are
required to be disclosed. Advances under this head
should include those Advances which are in the
nature of loans.
--
--
Sundry Creditors for Goods or Services, and
Acceptances should be disclosed as part of Trade
Payables. Disclosure Requirements under MICRO,
SMALL & MEDIUM ENTERPRISES
DEVELOPMENT (MSMED) Act will also be
required to be made in the annual Financial
Statements.
Amounts due under contractual obligations, e.g.,
payables in respect of statutory obligations, like
contribution to Provident Fund, Purchase of Fixed
Assets, Contractually Reimbursable Expenses,
Interest Accrued on Trade Payables, etc., should be
classified as “Others” and each such item should be
disclosed nature wise.
It shall be classified as – This should be classified into short-term and long-
(a) Provision for Employee Benefits term portions, and the latter amount should be
included here.
(b) Others (Specifying nature) --
(4) Current Liabilities
(4) (a) Short-Term Borrowings
1. Short-Term Borrowings shall be • Short-Term Borrowings will include all Loans
classified as – within a period of 12 months from the date of the
• Loans Repayable on demand– (i) from loan, Loans payable on demand, etc., but they will
Banks, & (ii) Other Parties, not include Current Maturity of Long-Term
• Loans and Advances from Related Borrowings (which should be treated only as “Other
Parties, Current Liabilities”).
• Deposits,
• Others Loans and Advances (specify
nature)
Security wise Classification: Borrowings shall further be sub-classified as Secured and
Unsecured. Nature of security shall be specified separately in each case
(4) (b) Trade Payables
It shall be classified as –  Liability for Capital Goods Purchases: Amount
(A) Total outstanding dues of micro due towards purchase of capital goods to be
enterprises and small enterprises; and disclosed under “Other Current Liabilities” with a
(B) Total outstanding dues of creditors suitable description.
other than micro enterprises and small
enterprises.”
(4) (c) Other Current Liabilities
It shall be classified as –
(a) Current maturities of Long-Term • The portion of Long Term Debts/ Lease
Debt, Obligations, which is due for payments within 12
(b) Current Maturities of Finance Lease months of the reporting date is required to be
Obligations, classified under “Other Current Liabilities”, while
 (c) Interest Accrued but not due on the balance amount should be classified under Long-
Borrowings, Term Borrowings.
(d) Interest Accrued and due on • Trade Deposits and Security Deposits which are
Borrowings, not in the nature of Borrowings should be classified
(e) Income Received in Advance, separately under Other Non-Current/ Current
(f) Unpaid Dividends, Liabilities.
(g) Application Money received for • Other Payables under this head may be in the
allotment of Securities and due for nature of statutory dues such as Withholding Taxes,
Refund and Interest Accrued thereon Service Tax, VAT, Excise Duty, etc.
(h) Unpaid Matured Deposits and Interest
Accrued thereon,
(i) Unpaid Matured Debentures and
Interest Accrued thereon,
(j) Other Payables (specify nature).
(4) (d) Short Term Provisions
It shall be classified as – (a) Provision for This should be classified into short-term and long-
Employee Benefits term portions, and the former amount should be
included here.
(b) Others (Specifying nature) This includes Provision for Dividend, Provision for
Taxation, Provision for Warranties, etc.

(B) For “ASSETS” Items

Sch. III Disclosure Requirement Points to be considered
(1) Non-Current Assets
(1) (a) (i) Tangible Assets (As per AS – 6, 10)
1. Classification shall be given as – Reconciliation: A Reconciliation of the Gross and
(a) Land, (b) Buildings, (c) Plant and Net Carrying Amounts of each Class of Assets at the
Equipment, (d) Furniture & Fixtures, (e) Beginning and End of the Reporting period showing
Vehicles, (f) Office Equipment, (g) Additions, Disposals, Acquisitions through
Others (Specify Nature). Business Combinations and other Adjustments and
 the related Depreciation and Impairment Losses /
Reversals shall be disclosed separately.
(1) (a)(ii) Intangible Assets
Classification shall be given as –
(a) Goodwill, (b) Brands / Trademarks, (c) Computer Software, (d) Mastheads and Publishing
Titles, (e) Mining Rights, (f) Copyrights, and Patents and Other Intellectual Property Rights,
Services and Operating Rights, (g) Recipes, Formula, Models, Designs and Prototypes, (h)
Licenses and Franchise, (i) Others (specify nature).
(1) (b) Non Current Investments
Non-Current Investments shall be • If a Debenture is to be redeemed partly within 12
classified as Trade Investments and months and balance again after 12 months, the
Other Investments, and further classified amount to be redeemed within 12 months should be
as Investments in – disclosed as current, and balance as Non-Current.
(a) Property, • “Trade Investment” is normally understood as an
(b) Equity Instruments, Investment made by a Company in Shares or
(c) Preference Shares, Debentures of another Company, to promote the
(d) Government / Trust Securities, trade or business of the first Company
(e) Debentures or Bonds,
(f) Mutual Funds,
(g) Partnership Firms, and
(h) Other Non-Current Investments
(specify nature).
(1) (c) Deferred Tax Asset (As per Accounting Standard – 22)
(1) (d) Long Term Loans And Advances
1. General Classification: Long-Term Capital Advances:
Loans and Advances shall be classified • It should be specifically included under Long-
as – Term Loans and Advances and hence, cannot be
(a) Capital Advances, included under Capital Work-In-Progress.
(b) Security Deposits, • Capital Advances are advances given for
(c) Loans and Advances to Related procurement of Fixed Assets which are Non-Current
Parties (giving details thereof), Assets. They are not realized back in cash, and over
(d) Other Loans and Advances (specify a period, get converted into Fixed Assets. Assets.
nature) Hence, they are always Long-Term Advances,
2. Securitywise Classification: The irrespective of when the Fixed Assets are expected
above shall be separately sub-classified to be received.
as – Other Loans and Advances should include all
(a) Secured, considered Good other items in the nature of advances recoverable in
(b) Unsecured, considered Good cash or kind, e.g., Prepaid Expenses, Advance Tax,
(c) Doubtful. CENVAT Credit Receivable, VAT Credit
3. Directors, etc.: Loans and Advances Receivable and Service Tax Credit Receivable
due by Directors or Other Officers of the which are not expected to be realized within the next
Company or any of them either severally 12 months or operating cycle whichever is longer,
or jointly with any other persons or from the Balance Sheet date.
amounts due by Firms or Private
Companies respectively in which any
Director is a Partner in a Director of a
Member should be separately stated.
(1) (e) Other Non-Current Assets
1. Other Non-Current Assets shall be • A Receivable shall be classified as ‘Trade
classified as – Receivable’ if it is in respect of the amount due on
(a) Long-term Trade Receivables account of goods sold or services rendered in the
(including Trade Receivables on normal course of business.
Deferred Credit Terms)
(b) Others (specify nature)
(2) Current Assets
(2) (a) Current Investments
Current Investments shall be classified as Principles given for Non-current Investments will
– also apply here. However, Trade vs Non-Trade
(a) Investments in Equity Instruments, Classification, is not required for Current
(b) Investment in Preference Shares, Investments.
(c) Investments in Government or Trust
Securities,
(d) Investments in Debentures or Bonds,
(e) Investments in Mutual Funds,
(f) Investments in Partnership Firms,
(g) Other Investments (specify nature).
(2) (b) Inventories
Inventories shall be classified as –
(a) Raw materials,
(b) Work In Progress,
(c) Finished Goods,
(d) Stock-in-Trade (in respect of goods acquired for Trading),
(e) Stores and Spares,
(f) Loose Tools,
(g) Others (specify nature)
Note: Goods-in-Transit shall be disclosed under the relevant subhead of Inventories. Mode of
Valuation shall be stated.
(2) (c) Trade Receivables
1. Aggregate amount of Trade Sch III requires separate disclosure of “Trade
Receivables outstanding for a period Receivables O/s for a period exceeding 6 months
exceeding 6 months from the date they from the date they become due for payment”, only
are due for payment should be separately for the current portion of Trade Receivables.
stated.
2. Securitywise Details: Trade
Receivables shall be separately
subclassified as –
(a) Secured, considered Good
(b) Unsecured, considered Good
(c) Doubtful.
3. Directors, etc: Debts due by Directors
or Other Officers of the Company or any
of them either severally or jointly with
any other person or debts due by Firms or
 Private Companies, respectively in
which any Director is a Partner, or a
Director, or a Member should be
separately stated.
(2) (d) Cash and Cash Equivalents
Cash and Cash Equivalents shall be classified as –
(a) Balances with Banks,
(b) Cheques, Drafts on Hand,
(c) Cash on Hand,
(d) Other (Specify nature).
(2) (e) Short Term Loans And
Advances
1. General Classification: Short-Term Loans and Advances shall be classified as –
(a) Loans and Advances to Related Parties (giving details thereof),
(b) Others (specify nature).
2. Securitywise Classification: The above shall also be sub classified as-
(a) Secured, considered Good,
(b) Unsecured, considered Good,
(c) Doubtful
3. Directors, etc.: Loans & Advances due by Directors or Other Officers of the Company or
any of them either severally or Jointly with any other person or amounts due by Firms or Private
Companies, respectively in which any Director is a Partner or a Director or a Member shall be
separately stated.
(f) Other Current Assets
This is an all-inclusive heading, which incorporates Current Assets which do not fit into any
other Asset Categories.

Special Point: Unamortised portion of share issue expenses, etc.

Schedule III does not deal with any accounting treatment of these items, and the same continues
to be governed by the respective AS / best practices. So, a Company can disclose the Unamortized
Portion of such expenses as “Unamortized Expenses”, under the head “Other Current/ Non-Current
Assets”, depending on whether the amount will be amortized in the next 12 months or thereafter

Part II-Form of Statement Of Profit And Loss

Name of the Company :…………………………………………………
Profit and Loss Statement for the year ended:……………………………………….. (Rs. in
……..)
Particulars Note Figure as at the Figures as at the
No. end of Current end of the
Reporting Previous
Period (Rs.) Reporting
Period (Rs.)
I. Revenue from Operations
II. Other Income
III. Total Revenue (I+II)
IV Expenses:
Cost of Materials Consumed
Purchases of Stock-In-Trade
Changes in Inventories of Finished
Goods / Work-in-progress and Stock-
In-Trade
Employee Benefits Expense
Finance Costs
Depreciation and Amortization
Expense
Other Expenses
Total Expenses
V Profit before Exceptional &
Extraordinary Items and Tax (III – IV)
VI Exceptional Items
 VII Profit before Extraordinary Items and
IAX (V-VI)
VIII Extraordinary Items
IX Profit before Tax (VII-VIII)
X Tax Expenses:
(1) Current Tax
(2) Deferred Tax
XI Profit /(Loss) for the period from
Continuing Operations (IX – X)
XII Profit /(Loss) from Discontinuing
Operations
XIII Tax Expense of Discontinuing
Operations
XIV Profit /(Loss) from Discontinuing
Operations (After Tax) (XII-XIII)
XV Profit / (Loss) for the period (XI +
XIV)
XVI Earnings per Equity Share:
(1) Basic
(2) Diluted

General Instructions for Preparation of Statement of Profit and Loss:

Item Description
Revenue from Operations For companies other than a Finance Company
Revenue from
(a) Sale of Products
(b) Sale of Services
(c) Other Operating Revenues
(d) Less : Excise Duty
For a Finance Company
 (a) Interest
(b) Other Financial Services Renevue
Finance Costs Finance Costs shall be classified as –
(a) Interest Expenses,
(b) Other Borrowing Costs,
(c) Applicable Net Gain / Loss on Foreign Currency
Transactions and Translation.
Other Income Other Income shall be classified as –
(a) Interest Income (in case of a Company other than a
Finance Company),
(b) Dividend Income,
(c) Net Gain/Loss on Sale of Investments,
(d) Other Non-Operating Income (Net of Expenses directly
attributable to such income).
Employee Benefits Expense (i) Salaries & Wages, (ii) Contribution to PF and Other
Funds, (iii) Expense on ESOP and Employee Stock
Purchase Plan (ESPP), (iv) Staff Welfare Expenses
Practice Problems
1. The authorized share capital of the company is Rs.10,00,000 dividend into 8%-5,000 preference
shares of Rs. 100 each. And 50,000 equity shares at Rs. 10 each. 50% of each class of shares
were issued to the public fully called up. Rs. 20 per share on 100-8% preference shares and Rs.
2 per share on 2,000 equity shares were not received.
Show the note on share capital forming a part of balance sheet.

2. Following is Trial Balance of Deva Ltd as on 31.03.2020.

Debit balances Rs. Credit balances Rs.
Fixed assets (Net Block) 7,50,000 Equity share capital (Rs 10 each fully 4,40,000
paid)
Investments 2,50,000 9% Pref. shares capital (Rs 100 each 1,00,000
fully paid)
Closing stock 3,75,000 Profit and loss statement 2,80,000
Debtors 1,22,500 Securities premium 30,000
Staff advance 1,00,000 Debentures redemption reserve 2,00,000
Prepaid expenses 45,000 General reserve 75,000
Advance to suppliers 27,500 8% Debentures 5,25,000
Cash in hand 12,500 Creditors 58,500
Bank balance 1,10,000 Bills payable 21,500
Provision for taxation 62,500

TOTAL 17,92,500 TOTAL 17,92,500

Additional information:
1) Entire Authorized share capital has been issued and subscribed
2) Of the debtors debts due for more than six months is Rs 22,500. All debts are unsecured and
considered to be good.
3) Ignore previous year's figure
After considering the above adjustments, prepare Balance sheet of the company as on
31.3.2020 as per schedule VI requirements.
3. The following is the Trial Balance of Saket Ltd. as on 31.03.2020.
Debit balances Rs. Credit balances Rs.
Land at cost 2,20,000 Equity capital (shares of Rs. 10 each) 3,00,000
Plant & machinery 6,08,000 10% Debentures 2,00,000
Trade receivables 1,00,000 General Reserve 1,30,000
Inventories (31.03.20) 86,000 Profit & Loss A/c 72,000
Bank 20,000 Securities premium 40,000
Purchases 3,20,000 Sales 7,00,000
Factory expenses 60,000 Trade payable 52,000
Administration expenses 30,000
Selling expenses 30,000
Debenture interest 20,000

TOTAL 14,94,000 TOTAL 14,94,000

Additional information:
1) The Authorized share capital of the company is 40,000 shares of RS. 10 each.
2) Depreciation is to be provided on plant & machinery at 10%.
3) Outstanding selling expenses are Rs. 1,500 and prepaid factory expenses are Rs. 2,000.
You are required to prepare Saket Ltd's balance sheet as on 31.03.2012 and statement of
profit & loss for the year ended 31.03.2020. Ignore previous year's figures and taxation.

4. The following is the trial balance of Onida Ltd. as on 31.03.2020.

Particulars Dr. Rs. Particulars Cr. Rs.
Land at cost 1,10,000 Equity capital (Share of Rs. 10 each) 1,50,000
Plant & machinery (cost Rs. 2,99,000 10% Debentures (Secured against plant 1,00,000
3,85,000) & machinery)
Debtors 46,000 General reserve 66,000
Stock at cost (31.03.2020) 52,000 Profit & loss A/c 35,000
Bank 15,000 Securities premium 20,000
Material consumed 1,50,000 Sales 3,50,000
 Other expenses 60,000 Creditors 25,000
Salary 15,000 TDS payable 6,000
Debenture interest 5,000

TOTAL 7,52,000 TOTAL 7,52,000

Additional information:
a) The authorized share capital of the company is 30,000 shares of Rs. 10 each.
b) Depreciation is to be provided on plant and machinery @ 10% on cost.
c) Debtors include Rs 6,000 outstanding for more than 6 months.
Prepare: Profit and Loss Statement for the year ended 31-3-20 and the Balance Sheet of Onida
Ltd. as on that date as per the provisions of the companies act taking into consideration the above
mentioned adjustments. Ignore previous year figures.

5. Sun Co. Ltd. is a registered company with an authorized share capital of Rs 70,000 divided into
7,000 equity shares of Rs. 10 each. Company’s Trial Balance as on 31-03-20 was as under:
Dr. Balances Rs Cr. Balances Rs
Building (cost Rs 50,000) 40,000 Share capital:
5000 equity shares of Rs 10 each 50,000
Furniture (cost Rs 5,000) 4,000 6% debentures of Rs 100 each 10,000
Vehicles (cost Rs 10,000) 6,500 Creditors 7,500
Equity shares of companies 20,000 Bills payable 4,000
(Market value Rs 22,000)
Stock in trade 20,000 General reserves 5,000
Debtors 17,000 Profit and loss statement (1-4-19) 2,000
Cash in bank 8,750 Gross profit 49,000
Salaries 10,000 Dividend income 700
Directors sitting fees 800
Audit fees 650
Debenture interest 500
 TOTAL 1,28,200 TOTAL 1,28,200
Adjustments:
1) Provide 10% depreciation p.a. on cost of fixed assets.
2) Dividend is proposed for the year @ 10%
3) Sundry debtors include debts which are due for more than 6 months Rs 4,000.
4) Ignore previous year figure and tax on proposed dividend.
Prepare Profit and Loss statement for the year ended 31-03-20 and balance sheet as per the
provisions of the Companies Act taking into a consideration the above mentioned
adjustments.
CASH FLOW STATEMENT
1. The following Comparative Balance Sheets of Essex World are given below for
31.03.2011 and 31.03.2012:

Liabilities 31.03.2011 31.03.2012 Assets 31.03.2011 31.03.2012

Accumulated Cash 4300 5800

Depreciation:
Machinery 300 750 Prepaid 200 200
Expense
Buildings 1200 1800 Debtors 8000 9000

S. Creditors 3300 4000 Stock 3200 4000

O/s Expenses 350 450 Investments 5000 3000

Debentures 4000 3500 Machinery 2500 4000

Share Capital 20000 20000 Buildings 7500 9000

P/L Account 2350 5200 Land 1000 1000

Provision for 200 300

Doubtful debts
31700 36000 31700 36000

Additional Information:
1. Dividend paid during 2012 was Rs. 2650
2. Investment Costing Rs.2000 were sold in 2012 for Rs. 2500
3. Machinery costing Rs.500, with accumulated Depreciation of Rs. 100, was
sold for Rs. 600 in 2012.
Prepare Cash Flow Statements.

2. The following Comparative Balance Sheets of Imagica Adlabs are given below
 for 2011 & 2012

LIABILITIES 2011 2012 ASSETS 2011 2012

Pref. Share 80,000 41,000 Cash 5,000 4,000

Capital
Share Capital 1,50,000 2,00,000 Goodwill 57,500 45,000

S. Creditors 27,500 35,000 Debtors 80,000 1,00,000

General 20,000 41,500 Stock 38,500 54,500

Reserves
Bills Payable 31,000 40,000 Investments 20,000 25,000

Provision for 20,000 8,000 Machinery 50,000 45,000

Tax
Bank Overdraft 70,000 98,000 Buildings 1,00,000 85,000

Plant 40,000 1,00,000

Bank 7,500 5,000

3,98,500 4,63,500 3,98,500 4,63,500

1 Depreciation of Rs. 5,000 on Machinery and Rs.15,000 be charged on Buildings.

2. Tax was duly paid.
3. Dividend for 2011 Rs. 21000 is paid.

Prepare Cash Flow Statements.

3. The following are the Balance Sheets of Cinderella Limited:

 (figures in 000)
LIABILITIES 2011 2012 ASSETS 2011 2012

Share Capital 850 950 Cash 6 9

Reserves 20 40 Prepaid 3.5 12

Expense
Bank 4 9 Debtors 81 65
Overdraft

S. Creditors 50 30 Stock 200 172

Mortgage Loan 5 35 Investments 6 12

Bills Payable 42 26 Machinery 12.5 18.5

P/L Account 48 60 Buildings 400 500

Provision for 2 5 Land 68.5 93

Doubtful debts
Furniture and 2.5 4.5
Fittings
Bills Receivable 86 97

Goodwill 150 171

Preliminary 5 1
Expenses

1021 1155 1021 1155

1. Depreciation is charged on Buildings at 4% on a cost of Rs. 4,50,000 and Plant and

Machinery at 8% on a cost of Rs. 4,00,000 on Fittings at 5% on a cost of Rs. 4,000

2. Investments costing Rs.8 ,000 were sold for Rs.5.500

 Prepare Cash Flow Statements.

Q4 The following are the Balance Sheets of SK Limited:

LIABILITIES 2017 2016 ASSETS 2017 2016

Share Capital 787500 675000 Plant 1350000 1125000

&Machinery
General Reserve 281250 225000 Accumulated dep (281250) (225000)

Capital Reserve 11250 - Net 1068750 900000

Profit & Loss A/c 229500 95625 Noncurrent Invts 192500 192500

10% Debentures 247500 360000 Inventories 303750 225000

Trade Payables 281250 180000 Trade 348750 298125

Receivables
O/S Liabilities 13500 22500 Prepaid 13500 11250
Expenses
Provision for 85500 78750 Cash Balance 10000 10000
taxation

1937250 1636875 1937250 1636875

Adjustments:
 1. During the year, Plant & Machinery with a book value of 11250
(accumulated depreciation Rs 33750) was sold for 9000.
2. During the year Investment costing 90000 was sold at a gain of 11250 which is
transferred to Capital Reserve & also Investment costing 90000 was purchased.
3. Tax of 61875 Paid during the year.
4. Dividend paid Rs.33750.
4. At the beginning of the year Debentures of 112500 were redeemed at par.
5. Interest on Debentures paid during the year 24750.

Q1.Ans.
CASH FLOW STATEMENT

PARTICULARS AMOUNT AMOUNT

CASH FROM OPERATING

ACTIVITIES
Profit & Loss A/c (Closing) 5200
Less: (Opening) 2350
2850
Add:
Depreciation on Machinery 550
Depreciation on Building 600
Proposed Dividend 2650
Less:
Profit on sale of Investment -500
Profit on sale of Machinery -200
5950
Changes in Current Asset & Current
liabilities
Increase in Creditors 700
Increase in O/s Expenses 100
Increase in RDD 100
Increase in Debtors -1000
Increase In Stock -800
CASH FROM OPERATING ACTIVITIES 5050 5050

CASH FROM INVESTING ACTIVITIES

Sale of Investment 2500
Sale of Machinery 600
Purchase of Machinery -2000
Purchase of Building -1500 -400

CASH FROM FINANCING ACTIVITIES

Dividend paid -2650
Redemption of Debentures -500 -3150

NET INCREASE IN CASH AND CASH

EQUIVALENTS 1500

CASH AND CASH EQUIVALENTS

(Opening) 4300

CASH AND CASH EQUIVALENTS (

Closing) 5800
Q2. Ans.
CASH FLOW STATEMENT

PARTICULARS AMOUNT AMOUNT

CASH FROM OPERATING

ACTIVITIES
General Reserve (Closing) 41500
Less: (Opening) 20000
21500

Add:
Depreciation on Machinery 5000
Depreciation on Building 15000
Provision for Taxation 8000
Proposed Dividend 21000
Goodwill written off 12500
83000
Changes in Current Asset & Current
liabilities
Increase in Creditors 7500
Increase in Bills Payable 9000
Increase in Debtors -20000
Increase In stock -16000
63500
Less:
Taxes Paid -20000
CASH FROM OPERATING ACTIVITIES 43500 43500

CASH FROM INVESTING ACTIVITIES

Purchase Investments -5000
Purchase Plant -60000 -65000

CASH FROM FINANCING ACTIVITIES

Dividend paid -21000
Redemption of Preference Shares -39000
Issue of Shares 50000 -10000

NET DECREASE IN CASH AND CASH

EQUIVALENTS -31500

CASH AND CASH EQUIVALENTS

(Opening) -57500
(Cash 5000+Bank 7500-Bank o/d 70000)
CASH AND CASH EQUIVALENTS (
Closing) -89000
(Cash 4000+Bank 5000-Bank o/d 98000)

Q3. Ans.
CASH FLOW STATEMENT
PARTICULARS AMOUNT AMOUNT
CASH FROM OPERATING
ACTIVITIES
PROFIT & LOSS (Closing) 60
Less: (Opening) 48
12
Add:
Depreciation on Plant & Machinery 32
Depreciation on Building 18
Depreciation on Furniture & Fittings 0.2
Loss on sale of Invt 2.5
Preliminary expenses written off 4
Transfer to Reserve 20
88.7
Changes in Current Asset & Current
liabilities
Decrease in Creditors -20
Decrease in Bills Payable -16
Increase in RDD 3
Decrease in Debtors 16
Decrease In stock 28
Increase in B/R -11
Increase in prepaid Expenses -8.5
CASH FROM OPERATING ACTIVITIES 80.2 80.2

CASH FROM INVESTING ACTIVITIES

Purchase Investments -14
Purchase Plant -38
Purchase Building -118
Purchase Furniture & Fittings -2.2
Purchase of Land -24.5
Goodwill Purchased -21
Sale of Investment 5.5
-212.2 -212.2
CASH FROM FINANCING ACTIVITIES
Mortgage Loan Taken 30
Issue of Shares 100 130
NET DECREASE IN CASH AND CASH
EQUIVALENTS -2
CASH AND CASH EQUIVALENTS
(Opening) 2
(Cash 6-Bank o/d 4)
CASH AND CASH EQUIVALENTS (
Closing) 0
(Cash 9-Bank o/d 9)

Q 4.Ans.
CASH FLOW STATEMENT
PARTICULARS AMOUNT AMOUNT

CASH FROM OPERATING

ACTIVITIES
Profit & Loss A/c (Closing) 229500
Less: (Opening) 95625
133875
Add:
Proposed Dividend 33750
Transfer to Reserve 56250
Provision for Taxation 68625
Depreciation on Plant & Machinery 90000
Interest on Debentures 24750
Loss on sale of Fixed Assets 2250
409500
Changes in Current Asset & Current
liabilities
Add: Increase in Trade Payables 101250
Less:
Increase In Inventories -78750
Increase in trade receivables -50625
Increase in prepaid Expenses -2250
Increase in O/s Expenses -9000
less: Income Tax Paid -61875
CASH FROM OPERATING ACTIVITIES 308250 308250

CASH FROM INVESTING ACTIVITIES

Sale of Investment 101250
Sale of Machinery 9000
Purchase of Machinery -270000
Purchase of Investment -90000 -249750
CASH FROM FINANCING ACTIVITIES
Issue of shares 112500
Dividend paid -33750
Redemption of Debentures -112500
Interest on debentures -24750 -58500
NET INCREASE IN CASH AND CASH
EQUIVALENTS 0

CASH AND CASH EQUIVALENTS

(Opening) 10000

CASH AND CASH EQUIVALENTS (

Closing) 10000
 Development of Reading Material for Semester I

Course Code SLAC 501

Course Title Accounting for Managers

Sessions Covered 21 to 30
Session No.: 21 – 24
Topic Discussed: Cash Flow
Statement Session Takeaways:
 Able to explain the meaning of cash flows from operating, investing & financing
activities
 Able to prepare a cash flow statement using indirect method

Cash Flow Statement

Cash flow statement shows inflows and outflows of the cash and cash equivalents. This
statement is prepared by companies which provide the users of financial statements additional
information about the sources and uses of cash and cash equivalents of a company.
Accounting Standard 3 deals with the provision of information about the historical changes
in cash and cash equivalents of an enterprise by means of a Cash Flow Statement.

Meaning of Cash & Cash Equivalents

According to AS-3, Cash consists of cash in hand and balance with bank plus demand
deposits, and ‘Cash equivalents’ includes short-term highly liquid investments that are readily
convertible into cash and are not subject to significant risk of changes in value. Cash flow
statement explains the flow of cash during the period in the following standard headings:
 Operating Activities
 Investing Activities
 Financing Activities

Operating Activities:
Under operating activities all cash flows relating to principal revenue-producing activities of
entity and other activities that are not investing or financing is considered. These are
activities that is generated or used in the core business of the entity.
Examples of cash flows from operating activities:
 Cash received from goods sold or services rendered
 Cash receipts from royalties, fees, commission and other revenue

Investing Activities:
Under Investing activities all cash flows relating to acquisition and disposal of long-term
assets and other investments are considered.
Examples of cash flows from investing activities:
  Property, plant and equipment, intangibles and other long-term assets e.g.
acquisition or disposal of equipment
 If money is invested in new machinery, it will help the entity to produce and sell
more goods, which in turn will generate more income in the future.

Financing Activities:
Under Financing Activities all cash flows relating to changes in the size and composition of
the contributed equity and borrowings done by the entity are considered.

Examples of cash flows from financing activities:

 Issue or redemption of shares
 Borrowing and repayment of debentures, loans, notes, bonds, mortgages and other
short or long-term borrowings

Classification of Certain Specific Items:

Interest Paid:
 Either under operating activity since paid out of revenues from operations or
 Financing activity since it represents the cost of obtaining a financial resource
Interest Received:
 Investment activity if it represents return on investments or
 Operating activity (if main business)
Dividend Received:
 Investment activity if it represents return on investments or
 Operating activity (if main business)
Income Taxes:
 Operating activities unless they can be specifically identified with financing
& investing activity
Sale of Non-current Assets:
 Should be classified as an investing activity only

Preparation of Cash Flow Statement

Cash flow from operating activities can be prepared either using the Direct method or the
Indirect method. Under Direct Method, major classes of gross cash receipts and gross cash
payments are disclosed.

Under Indirect Method adjustments are made to the net profit & loss for the effects of
transactions of a non-cash nature, any deferrals or accruals of past or future operating cash
 receipts or payments and all items of income or expense related with investing or financing cash
flows.

Operating Activities
The net cash flow from operating activities is arrived at by adjusting net profit or loss with
the following:
 Effect of non-cash items such as depreciation, provisions, deferred taxes
 All other items for which the cash effects are investing or financing cash flows.
 Working Capital Changes: changes in Current Assets & Current liabilities
 Income tax paid & extra ordinary items

Working Capital Changes

 Increase in Current Assets will result in cash outflow
 Decrease in Current Liabilities will result in cash outflow
 Increase in Current Liabilities will result in cash inflow
 Decrease in Current Assets will result in cash inflow

Example:
Determine the cash flow from operating activities using indirect method:
Rs.
Profit before tax for the year 200,000
Depreciation 40,000
Profit on sale of fixed assets 15,000
Investment income 10,000
Interest expense 100,000
Decrease in trade receivables 30,000
Increase in inventories 55,000
Increase in trade payable 18,000
Income taxes paid 25,000

Solution:
Rs.
Profit before taxation 200,000
Add: Depreciation 40,000
Less: Profit on sale of fixed assets (15,000)
Less: Investment income (10,000)
215,000
Decrease in trade receivables 30,000
Increase in inventories (55,000)
Increase in trade payable 18,000
Cash generated from operations 208,000
Income taxes paid (25,000)
Net cash from operating activities 183,000

Investing Activities

Investing Activities pertain to acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
An analysis of cash flows from investing activities is important because the cash flows
represent the extent to which expenditures have been made for resources intended to generate
future income and cash flows.

Few investing activities are:

 Cash payments for acquisitions of fixed assets including intangibles.
 Cash receipts from disposal of fixed assets.
 Cash payments to acquire shares, warrants or debt instruments of other enterprises or
interest in joint ventures (excluding those held for trading or dealing purposes or
which are cash equivalents).
 Cash receipts from disposal of shares, warrants and debt instruments of other
enterprises and interest in joint ventures (excluding those held for trading or dealing
purposes or which are cash equivalents).
 Cash advances and loans made to third parties (excluding loans, etc. made by
financial institutions in ordinary course of business which is operating cash flow).
 Cash receipts from repayments of advances and loans made to third parties (excluding
loans, etc. made by financial institutions in ordinary course of business which is
operating cash flow).

Example
For the following information determine the cash flow from investing activities.
1) Sale of building: book value ₹280,000 at a profit of ₹38,000
2) Sale of long-term investment: book value ₹340,000 at a loss of ₹17,000
3) Purchase of car for ₹540,000 out of which ₹300,000 is outstanding
4) Interest paid: ₹45,000

Solution
Cash flow from Investing Activities
₹
Sale of building (280,000 + 38,000) 318,000
Sale of long-term investment (340,000 - 17,000) 323,000
Purchase of car (540,000 - 300,000) (240,000)
Net cash flow from investing activities 401,000

Interest paid will come under the financing activities

Financing Activities

Financing activities result in changes in the equity capital, preference capital and borrowings
of the company. Cash flows generated from issue of shares, issue of debentures,
loans raised, redemption of debentures, repayment of loans, etc. are considered in investing
activities. Inflows and outflows related to the amount of capital and borrowings of the
enterprise are shown under this head and the net effect of these investing activities is
determined.

Note: In the case of a company other than Financial company, cash flows arising from
interest paid should be classified as cash flows from financing activities while interest and
dividends received is classified as cash flows from investing activities.

Example

From the following information, calculate the cash flow from the financing activities.
₹
Issue of 5% debentures at 2% discount 300,000 (Nominal value)
Issue of 15,000 shares for cash of ₹ 10 each at 5% premium 150,000 (Nominal value)
Repayment of loan including interest ₹ 80,000 120,000
Dividend paid 60,000

Solution
Cash flow from Financing Activities
₹
Proceeds from issue of debentures 2,94,000
Proceeds from issue of share capital 1,57,500
Term loan repayments (1,20,000)
Dividends paid (60,000)
Net cash flows from financing activities 2,71,500

Issue of share capital

Nominal value 150,000
5% premium 7,500
157,500
Issue of Debentures
Nominal value 300,000
2% Discount 6,000
294,00

Most companies prepare cash flow statements using the indirect method and indirect method
of cash flow statement preparation is discussed in detail.
Specimen Cash flow (Indirect Method)

Net Profit/Loss before Tax and Extraordinary Items

+ Deductions already made in Profit and Loss on account of xx
(Non-Cash items such as Depreciation, Goodwill to be Written-off)
+ Deductions already made in Profit and Loss on Account of x
(Non-operating items such as Interest)
– Additions (incomes) made in Profit and Loss on Account of Non-operating xx
Items such as Dividend Received, Profit on sale of Fixed Assets.
Operating Profit before Working Capital changes x
+ Increase in Current Liabilities
+ Decrease in Current Assets
– Increase in Current Assets xxx
– Decrease in Current Liabilities
Cash Flows from Operating Activities before Tax and Extraordinary Items xx
– Income Tax Paid x
+/– Effects of Extraordinary Items xx
A. Net Cash from Operating Activities x
xx
x
xx
x

xx
x
xx
x
xx
x
Cash flows from Investing Activities:
+ Proceeds from Sale of Assets xx
- Purchase of new Equipment/investments x
B. Net Cash from Investing Activities xx
x
xxx
Cash flows from Financing Activities:
+ Issues of share capital/debentures xx
- Repayment of loan/redemption of debentures x
- Payment of Dividend/interest xx
C. Net Cash from Financing Activities x
xx
x
xxx
Net increase/(decrease) in Cash & Cash Equivalents (A+B+C) xx
+ Cash and Cash Equivalents in the beginning 2,05,000 x
Cash and Cash Equivalents in the end 3,27,000 xx
x
xxx
Example
You are required to prepare a Cash flow statement for the year ended 31st March, 2016
with the following data:

Additional Information:
(i) Liability for income-tax for the accounting year 2014-15 was fixed at Rs.2,54,000
and hence, a refund of Rs.1,000 was received out of the advance tax paid for that year.
(ii) Book value of furniture sold during the year was Rs.5,000.
 Solution:

Cash flow statement of Sun Ltd for the year ended 31 March 2016 (Indirect Method)
Session No. : 25 - 26
Topic Discussed: Annual Report - Contents, how to read,
Limitations Session Takeaways:
 Understand the significance of annual report
 List down the contents & understand the significance of each component
 Be able to know where to look for information in the annual report
 Understand the importance of disclosure practices that increase the
transparency, & understand ability of financial information of a company.

Annual Report

Annual reports are published annually with the primary objective of sharing information with
shareholders and investors and also it is a regulatory requirement. Vital information relating
to companies operations and financial conditions are provided in an Annual report.
The initial few pages consist of images relating to the products, graphs relating to the
financial performance over a period of time and the later part of the report include detailed
financial and operational information.
Annual report contents are a primary source of information to the stakeholders. The
document provides detailed information about the company, management views and an
authentic financial record that helps investors make informed decisions for their future
investments. Annual reports are mostly available in the investors section of the respective
company’s website. They can also be searched for in google. Annual reports are in pdf format
and the number of pages varies from 80 pages to upto 300 pages. The latest version of the
annual report is usually available by June/July and sometimes few companies release it by
August September.
Contents of an Annual Report
The contents of an Annual Report vary from company to company. All reports include the
mandatory elements required by the securities regulatory body, few companies include
optional elements too.
Optional elements Mandatory elements
 Vision & Mission Statement  Directors’ Report
 Corporate Information  Management Discussion and Analysis
 Letter to shareholders  Report on Corporate Governance
 Financial highlights  Auditor’s report
 Financial Statements
 Income Statement
 Balance Sheet
  Cash flow statement
 Notes to accounts

1. Vision and Mission Statement

Vision statement provides the knowledge of where the company would like to be in the future
and mission statements explains what the company is, what they believe in and what it is
doing to be more successful in future. A company’s mission and vision statements provides
the users information on what the company stands for and where it wants to head in the
future.
2. Corporate Information
Corporate information includes details of management officials and others associated with
the company such as directors, bankers, auditors, and registered and corporate offices. Here
one can get detailed information about the board members and their designations. Investors
can find additional details of the company if the appointed auditor is reputed.
3. Letter to shareholders
Letter to the shareholder is written by the Chairman or CEO of the company to the
shareholders providing the analysis of the important events during the year including
problems & issues. The discussion also includes various revenue elements, expected growth
based on economic forecast and the general business environment. The letter also highlights
the risks which could have an adverse impact on the performance of the company and
remedial measures taken by the company.
4. Financial Highlights
Financial highlights provide a quick summary of the key financial performance indicators in
figures and supporting graphs. It also shows the growth/decline in revenue, earnings per
share, dividend growth for a period of past 5 to 10 years.
5. Directors’ report
The purpose of having a section for the directors’ report in the annual report is to have greater
corporate transparency. Directors’ report provides a summary of the financial performance of
the company, if the finances are in good shape, performance in the market, the growth plans
in the coming years and future prospects.
6. Management Discussion and Analysis (MD&A)
Management Discussion and Analysis MD&A is one of the key sections of an annual report
that today’s corporates have adopted to demonstrate their commitment to the company’s
vision and strategy. This short report discusses and analyses a company’s performance. It
covers results of operations and the adequacy of liquid and capital resources to fund
operations of the company’s future plans. This section can be a valuable tool in evaluating a
company because it contains some quantitative information that may not be covered in the
financial statement of the company.
The objectives of an MD&A are:
• It helps readers in understanding the numbers and financial conditions while also
explaining certain strategic and operational decisions that can largely impact the future
performance and position of the company.
• MD&A addresses the investor’s perception of the risks associated with the company.
7. Report on Corporate Governance
This report on corporate governance provides insights on corporate governance followed by a
company, structure of board of directors, brief background information on directors and
independent directors of the company, attendance of directors in board meetings and annual
general meetings, audit committees, compensation committees, remuneration of directors, re-
appointment of directors after completing the term, composition of sub- committees and
many others.
8. Auditor’s Report
The statutory auditor’s report provides their views, opinion and comments on correctness of
the financials of the company. The basic information like auditors’ names, firm name can
also be found here.
9. Financial Statements
Financial statements are written records that provide insights into the business activities and
core financial performance of the company. They consist of Income statement, balance sheet
and cash flow changes along with changes to equity. For a parent company there would be
two sets of financial statements, standalone and consolidated financial statements.
10. Notes to Accounts
Notes to accounts section provides details of the accounting policies followed by the
company for the preparation of financial statements, like – the depreciation method,
inventory valuation, forex/gain/losses, segmental reporting. To understand the changes in
accounting policies, it is advisable to go through the annual report for last 3 – 5 years that can
impact the revenue, key financial figures.
How to Read Annual Reports?
We should know why we want to read an annual report. Are we an investor looking to invest
in the company or an analyst who is analysing the performance of the company or an
employee who wants to know how the company is doing or a student who has to analyse an
annual report and write a report. The annual reports have a typical length of 150 to 200 pages,
though some as short of 80 pages and as long as 300 pages. Unless we know why we
are analysing, we would be lost. It is highly unlikely that annual reports are read from first
page to the last.
Have a guiding question so that the search is focussed and helpful in sorting through the
information.
Spend adequate time on narrative and the numbers. Spend sufficient time on Directors Report
which has adequate and summarised information on the activities held by the company, how
the year has been and the future prospects, the business risks faced, and significant change
planned in the near future.
For going through the numbers, spend some time on the summary given at the beginning of
the annual report which often contains graphs and tables on the key performance indicators.
Companies which are parent to other companies would have 2 set of financial statements,
Standalone and Consolidated. Go through to the financial statements, income statement, cash
flow statement and balance sheet to perform evaluation of the financial results.
Income statement gives an overview of the profit/loss earned during a year. First do a
vertical scan (up and down). Look at the key figures (revenue, operating income, expenses,
depreciation, net profit, taxes etc). Compute the ratios for the current year. Study the
important items of costs. Compare the absolute numbers and also do a relative comparison.
Next do a horizontal scan (with previous year). Scan the numbers and check if there is any
considerable change from the previous year. Is the change in any particular item or is the
increase/decrease uniform. Look at the numbers in absolute terms, and on percentage basis.
How has the performance of the company been in the current year? Is there a growth or
decline and by what percentage.

While scanning the Cash Flow Statement look at the starting and ending cash balance and
which cash inflows and outflows caused the cash balance to go up or down. Next, do a
vertical scan to look at the biggest line items and a horizontal scan to look for changes from
previous year.
On the balance sheet, look at the assets owned by the company and the liabilities and equity.
Look at the breakup of assets, investment in non-current assets, financial assets and current
assets, cash etc. How is the company financed? Do they have lot of debt or primarily equity?
Next compare with the previous year figures to look at significant changes that have occurred
from the previous year. Compute the relevant ratios for the current year and compare it with
previous years.
Have a summary of observations and decide on the items that need further investigation or
extra details. Go through the notes to the financial statements where detailed explanation of
what makes up certain items is provided.
 Limitations of Annual Report
The greatest disadvantage of the annual report is it is a general report aimed at a general
public. The report does not focus on any particular group of users. Parts of it will be of
interest to some readers, but not to others. The report is so long that the reader is lost in a sea
on information. However, it is the only feasible method of reaching a significant number of
people at a cost that is manageable.
Session No.: 27
Topic Discussed: Window Dressing and Creative
Accounting Session Takeaways:
 Concept, interpretation and impact of Concept of Window Dressing and Creative
Accounting
Key Words/Concepts: Creative Accounting, Window Dressing, Substance over Form

Window Dressing and Creative Accounting

Window dressing is a technique used by companies and financial managers alongwith top
management to manipulate financial statements and reports to show more favorable results
for a period than what they actually are. This may lead to mis-representation of financial
performance and thus its mis-interpretation. Although window dressing is illegal or
fraudulent, it is deceitful and is usually done to mislead investors. In short, window dressing
is a short-term strategy to make financial performance appear more steady and attractive than
they really are. Although window dressing does not amount to legal fraud in most
circumstances, it is usually done to mislead investors from the true company or fund
performance. Usually, it may result in twisting but not flouting the truth.

A company may resort to window dressing to portray itself as appealing as possible by

showing highly optimistic projections to attract new opportunities in terms of business,
finances, investors, credits and even consumers. But while doing so, it may have to resort to
unethical and / or illegal ways to change the numbers, orders, contracts etc. Such actions are
usually done just before the year end i.e. close the end of the accounting period. The company
may tweak its reported accounting figures to finally get a high stock price to entice
potential investors.

The ultimate goal is to lure more money and more people to improve and boost the bottom line for
better performance in the upcoming reporting periods. Some of the ways in which the financial figures
are manipulated are as follows:

i. Cash and Bank Balances: Delay the vendor payments to the next accounting period.
ii. Operating Expenses: Deflate expenses in current accounting period and defer recording them
to the next reporting period.
iii. Revenue Recognition Policy: Inflating revenue by recording higher sales in current reporting
period by raising invoices but were expected to be done in next period.
iv. Accounts Receivables: Not recording bad debts or creating enough reserve for bad and
doubtful debts.
 v. Depreciation Methods: Change in depreciation methods to reduce the charge of this expense
in the Income Statement to inflate profits.
Creative Accounting, on the other hand, is the exploitation of loopholes in financial regulations in
order to achieve benefits or display data in a misleadingly favourable light. It might not result in
illegal representation of financial reports but they stand manipulated. It may take help of deviating
from accounting policies, not following accounting standards and recommended practices.
Session No.: 28
Topic Discussed: Introduction to Financial Statement
Analysis Session Takeaways:
 Tools of FSA and their utility
Key Words/Concepts: Analysis, Comparative Analysis, Trend Analysis, Common Size
Statements, Ratio Analysis

Analysis & Interpretation of Financial Statements

Financial statements are prepared in absolute form and may not be useful to the management for the
purpose of decision-making process unless it is rendered into meaningful formats. For this purpose,
the figures recorded in financial statements are required to be re-arranged & analyzed. ‘Analysis’ of
financial statements implies breaking down of complex figures in financial statements into simple
elements & facts & arranging them in such a manner that they can be easily understood.

P & L account is generally analyzed into vertical presentation where starting with sales revenue,
profits in different stages is shown. Balance Sheet is analyzed in various ways as per requirement by
taking different groups of assets & liabilities.

Different Tools of Analysis –

1) Comparative Statements - (Horizontal analysis) - In this analysis, one or more statements

are compared with each other in terms of similar absolute figures contained therein. The
comparison can be among statements of same firm for different divisions or of different time
periods (Intra firm comparison) or statements of different firms (Inter firm comparison).
Income statements, Balance sheets etc. can be compared in this manner.

2) Common Size Statements - (Vertical Analysis) - It may be difficult to understand or to draw

conclusions from absolute figures given in any financial statements. Therefore, in the course
of comparison the figures in financial statements may be shown as comparative figures on a
common base. For ex. The cost elements like Material, Labour etc may be shown as % of
Total Cost or of Sales, or Fixed assets or Current assets may be shown as % or ratios of total
assets.

3) Trend Percentages - Based on horizontal analysis of the same firm for different consecutive
periods, trend analysis can be made. If sales, costs or profits of different periods are compared
with each other, a trend can be established from their movement. It may also help in
estimating the future movement provided the macro- economic changes are aligned into the
calculations.
 Rearrangement of Accounting & Financial Statements before analysis –
The financial statements as prepared under accounting process are not sufficient for providing
information for analysis. The statements may state profits & losses, assets & liabilities in detail. But
they still need to be regrouped & re-arranged for proper interpretation & for using them in various
analytical techniques. The presentation of Income Statement & Balance sheet may be done as follows
–

P & L a/c or Income Statement

Particulars Amount

Sales

(-) Cost of Goods Sold

(Material Consumed+ Wages+ Factory Expenses)

=Gross Profit

(+) Other Operating Incomes (Commission etc)

(-) Operating Expenses (Selling & Administration Expenses)

= Operating Profit

(+) Non-Operating Income

= Earnings Before Interest & Taxes

(-) Non-Operating Expenses (Interest & other financial charges)

= Earnings Before Taxes

(-) Income Tax

=Earnings After Tax

(-) Preference Dividend

= Earning for Equity holders

(-) Equity dividend

= Retained Earnings (Transferred to reserves etc.)

Balance sheet can also be rearranged as a ‘Statement of Affairs’ suitably. It may show groupings of
Assets & Liabilities as is required for analysis. Liabilities may be arranged on basis of Long term &
Current, Owner’s funds & Borrowed funds etc., while assets may be arranged under categories of
Fixed, Current, Investments etc.

4) Ratio analysis - A Ratio is a comparison of 2 absolute figures. It may be expressed as a

fraction (a/b =1/2); as a proportion (a: b = 1: 2); as percentages (a is 50% of b) or as a
description (a is half of b /b is two times a). An absolute figure may not convey much
meaning. It may therefore be important to study some figures as ratios i.e. in comparison with
each other. For ex. Profit by itself may not convey any meaning, but profit in comparison to
sales or to cost may express the profitability clearly.

Necessity of Ratio analysis –

Every management needs to know the strengths & weaknesses of business, the profitability, liquidity
& solvency positions. Ratio analysis is extremely useful in analyzing these things. It is a valuable tool
for management control. It can summarize & simplify data for managerial decision-making.
Management gets a valuable insight in areas like return on investment, capital structure, efficiency of
business operations etc. Management can discharge its functions of forecasting, planning, co-
ordination & communication more effectively on the basis of comparative analysis of past & present
performance given in terms of ratios. All stakeholders such as financial institutions, credit suppliers,
investors in finance markets ,to name a few, can also use ratios to evaluate performance of a firm.

Advantages –

1) Ratios simplify the understanding of financial statements.

2) Ratio analysis provides data for inter firm & intra-firm comparison without compromising the
secrecy of sensitive financial data.

3) Ratios indicate efficiencies of firms in different areas & serve as an instrument of management
control.

4) Ratios help in studying past trends & market trends. This helps the management in discharging its
basic functions like planning, co-ordination, communication & control. They also help in making
forecasts & estimations for future.

5) Ratios help in taking major investment decisions.

Limitations –

1) The benefit of ratio analysis depends to a great extent on the interpretation of ratios. Interpretation
is not always possible only on the basis of a single ratio. It needs supporting data
about financial position of a firm. To get the complete picture about financial health of a company, a
number of ratios are required to be computed & studied together.

2) Reliability of ratios depends on reliability of the data.

3) While comparing ratios of different firms, it must be seen that both the firms follow the same
accounting practices & bases. Otherwise the comparison is meaningless.

4) Inflation & price changes may distort the ratios over a period

5) Ratios should be studied with absolute figures & in view if the objective for calculating the ratios.
Otherwise they may give misleading picture.

6) Ratio analysis can be used effectively only if they are compared with standards & norms (for the
same firm, for other firms or for industry as a whole)
Session no 29
Topics discussed- Ratio Analysis, Importance of Ratio Analysis, Types of
Ratios Sessions takeaways-
 Understanding Importance of Ratio Analysis as tool for Financial
Statement Analysis.
Keywords/Concepts- Meaning of Ratio, Importance and limitation of Ratio Analysis, Types
of Ratios.

Ratio Analysis

Meaning of Ratio and Ratio Analysis:

A ‘Ratio’ indicates a relationship between 2 individual figures or a group figures expressed in
mathematical terms and connected with each other in some logical manner. In context of
financial statements, the individual figures are selected from Profit and Loss Statement and
Balance sheet.

Ratio Analysis: It is tool for financial statement analysis. A single accounting figure may not
communicate adequate meaningful information but when expressed in form of ratio (relative
to some other figure) provides a more meaningful interpretation. Inter-firm (comparing the
performance of same enterprise over a period of time) and Intra-firm (comparing the
performance of different enterprises belonging to the same sector/Industry for a particular
period) comparison and analysis can be done using the tool of ‘Ratio Analysis’.

Importance of Ratio Analysis:

It helps the stakeholders (users of financial statements) :

1) To analyse and draw conclusions about the financial performance of the company
(past, present, future).
2) It helps them understand strengths and weaknesses of a firm.
3) It helps them to interpret and understand the financial performance of the enterprise in
a better way.
Thus it is an important tool for forecasting, managerial control and facilitates
communication of financial information in a more meaningful way.

Limitations of Ratio Analysis:

1) For the ratio analysis to be meaningful and relevant the underlying financial
statements need to be accurate.
 2) Differences in accounting policies followed by different firms could make intra-
firm comparison of financial performance difficult.
3) Seasonal factors, inflation could impact the analytical ability of ratios
4) Financial Ratios provide clue and not conclusions about the financial condition and
performance of the businesses and hence their interpretation requires careful
evaluation of non-financial parameters as well.

Classification and Types of Ratios:

The ratios can be classified into 4 broad categories depending upon the information they
convey:

1) Liquidity Ratios: They help assess the short-term solvency/liquidity of the business.
2) Activity/Efficiency Ratios: They help evaluate the efficiency with which the
firm manages and utilises the assets to generate revenue.
3) Profitability Ratios: These ratios are indicator of profitability and operational
efficiency.
4) Leverage Ratios: They help understand the long-term stability and financial risk of
the business.
5) Market/Investment ratios: They help understand the link between financial
statements and market information.
 Session no 30
Topics discussed- Types of Ratios and their interpretation
Sessions takeaways- Use of Ratios as a tool for analysis and Interpretation of financial
statements.
Keywords/Concepts- Liquidity, Profitability, Efficiency, Leverage and Market ratios

Some Important ratios under each head and their interpretation

Liquidity Ratios:

1) Current Ratio: Current assets / Current liabilities

The current ratio measures a firm’s ability to pay off its short-term liabilities with its
current assets. The current ratio is an important measure of liquidity because short-term
liabilities are due within the next year. A low current ratio of less than 1 indicates that the
investment of the company in the current assets is not sufficient to meet its short term
liabilities. A very high current ratio indicates excessive investment in current assets like
Inventories, Receivables etc.
This ratio addresses the important question “Does the company have sufficient current
assets to meet its current liabilities with a margin of safety?”

2) Quick Ratio: Current assets-Inventories/Current liabilities

This ratio is also known as acid-test ratio. It is a more conservative measure of short
term liquidity. It excludes ‘Inventories’ from the current assets as they are the least
liquid assets amongst Receivables and Cash and Cash equivalents.
This ratio helps answer the question “Will my business be able to meet the current
obligations with short term assets if all the sales revenue should disappear?”

Activity/Efficiency Ratios

1) Total Assets turnover ratio: Sales or Cost of Goods sold/Total Assets

This ratio measures the efficiency with which the firm uses its total assets to generate
sales.
2) Fixed Assets turnover ratio: Sales or Cost of goods sold/Fixed Assets.
A high fixed asset ratio indicates efficient utilisation of fixed assets in generating
sales.
3) Inventory turnover ratio: Cost of goods sold or Sales/Average Inventory
A high inventory turnover ratio indicates a fast-moving inventory and indicate good
liquidity for the business.
4) Receivables turnover ratio: Credit sales/Average Receivables
 This ratio throws light on the collection and credit policy of the firm. It measures the
efficiency with which the business is managing its accounts receivables. A higher
ratio indicates faster conversion of receivables into cash.
5) Average Collection period: 365days or 52 weeks or 12 months/Receivables turnover
ratio. It indicates the average days/weeks/months taken to convert receivables into
cash.
6) Payables turnover ratio: Credit Purchases/Average Payables
This ratio reflects the credit terms granted by suppliers. A low ratio is favourable for
the business as it indicates liberal credit period offered by the suppliers
7) Average Payment period: 365days or 52 weeks or 12 months/Payables turnover ratio
It indicates the average days/weeks/months taken to make payment to the creditors.
Profitability Ratios:

1) Based on Sales:
 Net Profit Ratio: Net Profit (after tax)/Sales *100
It indicates the proportion of revenues that find their way into profits. A high ratio
indicates efficiency in managing costs.
 Operating Profit Ratio: Operating Profit or Earnings before Interest and
tax(EBIT)/ Sales *100.
It measures the percentage of sales in rupees that remain after the payment of
all costs and expenses except for interest and tax.

2) Based on Return on Assets/Investments:

 Return on Assets (ROA): Net Profit after tax(PAT)/Average Total Assets.
This ratio measures the profitability of the firm in terms of assets employed in
the firm.
 Return on Capital Employed (ROCE): Earnings before Interest and Tax
(EBIT)/ Capital Employed. Shareholders’ funds + long term debts.
The return on capital employed should be higher than cost of equity and debt.
 Return on Equity (ROE): Net Profit after tax and Preference
dividend/Shareholders funds *100.
Return on Equity measures the profitability of equity funds invested in the
firm. It reveals how profitably the owners’ funds have been utilised by the
firm/business.
 Earning per Share: Profit after tax and Preference dividend/Number of
equity shares outstanding.
It measures the profits available per share.

Leverage Ratios:
  Debt Equity Ratio: Long term debt/Shareholders’ Equity
It indicates the proportion of debt used in relation to equity. It is an indicator
of firm’s financial leverage. A high ratio indicates higher financial risk as it
means lesser protection to providers of debt.
 Debt to Total Assets Ratio: Total Debts/Total Assets.
This ratio measures the proportion of total assets financed by debt
 Capital Gearing Ratio: Preference share capital+ Debentures Other borrowed
funds/ Equity share capital + Reserves and Surplus
It shows the proportion of fixed Interest(dividend bearing) capital to funds
belonging to equity shareholders
 Proprietary Ratio: Shareholders funds/Total Assets
It indicates the proportion of total assets financed by shareholders
 Debt Service Coverage Ratio: Profit after tax+ Depreciation+ Interest/Interest
+Principal Repayment on Debt.
It measures the firm’s ability to service its debt i.e payoff current interest and
instalments.
 Interest Coverage Ratio: Earnings before Interest and Tax (EBIT)/Interest
It measures the firm’s ability to meet interest and other fixed obligations out of
its profits.

Market Ratios/Investment Ratios:

 Price Earning Ratio(P/E) ratio: Market Price per Share (MPS)/Earning per
Share.
It indicates the expectation of equity investors about the earnings of the firm.
 Dividend Yield Ratio: Dividend per Share/Earnings per Share
It indicates return in form of dividend on investment made by the
shareholders.

Users of Financial Ratios:

Investors- Shareholders Interested to know about the growth and

profitability of the Business. They will focus
on profitability ratios and market ratios like
Price/Earning ratio; Dividend yield ratio
Lenders Solvency and liquidity ratios. They are
concerned about the financial stability of the
business.
Creditors Liquidity ratios
Employees They will be concerned about overall
financial health and growth of the
organisation. They will be interested in
studying Profitability ratios .
Government They will analyse the financial statements
to determine tax liability of the business.
They would study the profitability ratios.
Management All the ratios.