Professional Documents
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ACCOUNTING ( CMA)
HANDBOOK
CS EXECUTIVE NEW SYLLABUS
INSPIRE ACADEMY
( Premium academy for CS & CMA course in Pune )
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- Accountancy refers to systematic know kedge of accounting .It explains why do and how to do various
aspects of accounting .
- Book keeping is a part of accounting and concerned with maintenance of books of accounts
External users include short-term creditors , long-term creditors, customers , tax authorities
,general public
✓ BRANCHES OF ACCOUNTING
Cost Accounting It is the process of accounting and controlling the cost of a product
operation or function .
✓ Internal Liability: These represent proprietor's equity, i.e., all those amount which are entitled
to the proprietor, like Capital, Reserves and Undistributed Profits.
✓ Contingent Liability: potential obligation that could be created depending on the outcome of
an event _not recorded in books of account_disclosed a note through in the financial
statements.
✓ Fictitious Assets :are not assets at all__appear on the asset side simply because of a debit
balance in a particular account not yet written off, e.g., provision for discount to creditors,
discount on issue of shares, etc.
✓ Wasting Assets: Such assets as mines, quarries, etc., that become exhausted or reduce in
value by their working are called wasting assets.
✓ Single Entry: It is an incomplete ‘double entry system_ the first entry is made to the debit of
an account, and the second entry to the credit of second account_ usually a cash book and
personal accounts are maintained.
✓ Double entry system :invented by Luca Pacioli _Every transaction has twofold aspects, i.e.,
one party giving the benefit and the other receiving the benefit _Every transaction is divided
into two aspects, debit and credit. One account is to be debited and the other account is to be
credited _Every debit must have its corresponding and equal credit_personal and impersonal
accounts are maintained_Helps in decision-making.
✓ Accounting principle :
Accounting Entity Principle Distinction is made between personal transactions and business
transactions and transactions of one business and other business entity .
Money Measurement Only those transactions which are capable of being expressed in money
Principle
are recorded .
Going concern Principle It is assumed that enterprise has neither the intention nor the necessity of
Consistency Principle Same accounting policy is followed from one accounting period to another
Prudence Principle Anticipated losses are recognized but anticipated profits are ignored .
✓ Accounting process
The two approaches for deciding an account are debited or credited.
(A) American Approach or Modern Approach
(B) British Approach or Traditional Approach
✓
Meaning of an Account An Account is a summary of relevant transactions at one place relating to
a particular head .
Classification of Account
(ii) As per accounting Equation Assets , capital ,Liabilities, Expense and Revenue
Approach
Origin of Debt and Credit The terms of debit and credit have their origin from the terms debito and credito
as used by lucafrapacioli .
Meaning of Debit Debt in relation to assets and expense represents an increase but in relation to
liabilities ,capital , revenue represents a decrease.
Meaning of Debit Credit in relation to assets and expense represents an decrease but in relation to
liabilities ,capital , revenue represents a increase.
For Real Accounts Debit what comes in Credit what comes out
For Nominal Accounts Debit all expenses and losses Credit all Gains and profits
Rules of debit and credit when Accounts are classified on Accounting Equation Basis
✓ JOURNAL
Meaning of Journal Journal is a book of prime entry in which transactions are recorded in
chronological order .
2. Explanation of Transaction
Meaning of Ledger 1. Ledger is a principal book which contains all the accounts to which transaction
recorded in the books of original entry are transferred .
Form of Ledger A ledger may be kept in the form of bound book , CDs or any other device
Utilities of a Ledger 1. It provides complete information about all accounts in one book .
2. It enables to ascertain what are the main items of revenues
3. It enables to ascertain what are the main items of Expenses
4. It enables to ascertain which are the assets and of what values
5. It enables to ascertain what are the liabilities and of what amounts .
6. If facilities the preparation of Final Accounts
Meaning of Posting Posting is the process of transferring the transactions recorded in the books of
original entry in the concerned account(s)
Subdivisions of Ledger
LEDGER
Meaning Subsidiary Books (special Journal ) are the books of original entry (or prime entry
) which are used to record the specific transactions of similar nature for the first
time on the basis of source documents .Thus subsidiary Books are part of journal
✓ CASH BOOK
As special Journal Cash book is special journal which is used to record all receipts and payments for
the first time on the basis of source documents
As a Ledger Cash Book is a ledger in the sense that it serves the purpose of Cash Account .
Cash book is both journal and ledger.
TYPES OF CASHBOOK
(a) Single Column It records only Cash Receipts and Cash Payments.
(b) Cash book with It records Cash Receipts and Cash Discount Allowed on debit side and Cash
Discount Column Payments and Cash Discount Received on credit side .
(c ) Three column Cash It records Cash Receipts ,Bank Receipts ,Cash Discount Allowed on debit side
Book and Cash Payments ,Bank Payments Cash discount Allowed on debit side and
Cash payments ,Bank Payments Cash discount Received on credit side .
(d) Petty Cash Book It records the payments of Petty Cash Expenses .
✓ Equity share capital: i) with voting rights; orii) with differential rights as to dividend or voting
or any other right.Preference share capital: preferential right with respect to—payment of
dividend at a fixed rate,in the case of a winding up
✓ Voting rights on preference shares: If a dividend has not been paid for a period of 2 years
or more,then preferences shareholders shall have a right to vote on all the resolutions
placed before a general meeting of the company.
✓ Issue of Shares at Discount : As per companies Act 2013, a company shall not issue
shares at a discount _exception : as provided in section 54 for issue of sweat equity shares
_ Any share issued by a company at a discounted price shall be void _ Penalty for not
following : To company - fine from one lakh rupees to five lakh rupees _ Punishment to
officer in default : imprisonment upto six months or fine from one lakh rupees to five lakh
rupees, or with both.
✓ Journal entries :
1. When application money is received : Bank a/c Dr _ To Share application a/c
2. When it is transferred to share capital : Share application a/c Dr _ To Share capital
3. When allotment money becomes due: Share allotment a/c Dr _To Share capital a/c
4. When allotment money is received : Bank a/c Dr _ To share allotment a/c
5. When first call becomes due : Share first call a/c Dr _To Share capital a/c
6. When first call money is received : Bank a/c Dr _ To share first call a/c
7. When final call money becomes due: Share final call a/c Dr _To Share capital a/c
8. When final call money is received : Bank a/c Dr _ To share final call a/c
In cases of premium :
Entry 3 : Share allotment a/c Dr_ To share capital _To security premium a/c
✓ A company is under a legal obligation to first offer the subsequent issue of shares to its
existing equity shareholders. This right is called rights issue.
✓ Company may issue fully paid up bonus shares to its members, in any manner out of (i) its
free reserves; (ii) the securities premium account; or (iii) the capital redemption reserve
account.
A+2 Issue of notice with Explanatory Statement (along with disclosures mentioned
below) to all members.
Within 7 days Making payment in cash to those shareholders whose offer has been accepted
from or return the share certificates to the shareholders forthwith.
completion of
Verification
Within 7 days Extinguish and physically destroy the share certificates of shares bought back.
from
completion of
Acceptance
After File requisite return in e-form SH 11 with MCA21 and a declaration signed by 2
completion of directors, one of whom shall be Managing Director, if there is one, in e-form SH
buy-back 15
UNDERWRITING
✓ Underwriting : contract entered into by the company with persons or institutions, called
underwriter _ they get commission called as “Underwriting commission.” _ underwriters may
be individuals, partnership firms or joint stock companies.
✓ Underwriter : takes complete responsibility of shares _ if shares or debentures are not taken
up by public in full then underwriter will take shares _ receives commission_ for all shares .
Broker : takes responsibility of limited shares _ if shares or debentures are not taken up by
public in full then broker will not take shares _ receives brokerage_ only for shares taken by
public.
✓ Types of underwriting : Complete Underwriting : whole of shares is underwritten, it is said
to be complete underwriting. Partial Underwriting : only a part of the issue of shares is
underwritten _ company is treated as “Underwriter” for the remaining part of the issue.
✓ Firm Underwriting : In case of normal underwriting, underwriter takes only those shares
which are not subscribed by normal public._In firm underwriting : there is definite commitment
by the underwriter to take up a specified number of shares irrespective of the number of
shares or debentures subscribed for by the public. _so total liability = net liability ( shares not
taken by public ) + firm shares.
✓ Underwriting commission : As per section 40(6) of the Companies Act 2013, for shares,
commission should not exceed 5% of the price at which the shares are issued or the amount
or rate authorized by the Articles, whichever is less. For debentures, commission should not
exceed 2.5% of the price at which the shares are issued or the amount or rate authorized by
DEBENTURES
✓ Redemtion of debentures :
1. Lumsum redemption : with DRR or DRF ( sinking fund)
2. Annual drawing
3. Purchase of own debentures
4. Conversion into shares
✓ Lumsum redemption :
Case 1 : When money is not invested - every year Transfer profit to Debenture
redemption reserve ( DRR)
Case 2 : When money is invested - every year Transfer profit to Debenture redemption
fund ( DRF) or sinking fund
✓ Purchase of own debentures :
Case 1 : when debentured are purchased & immediately cancelled
Debenture a/c Dr
Debenture interest a/c Dr
To bank
To profit on redemption
✓ Financial statements are reports prepared and issued by company management to give
investors and creditors additional information about their company’s performance and
financial standings.
✓ The four general purpose financial statements include: Income Statement,Balance
Sheet, Statement of Stockholders Equity, Statement of Cash flow.
✓ Financial statements are prepared by transferring the account balances on the adjusted trial
balance to a set of financial statement templates.
✓ Both public and private companies issue at least 4 financial statements to attract new
investors and raise funding for expansions.
✓ Financial sheets that are issued for time periods smaller than one year are called interim
statements.
✓ The annual financial statement form is prepared once a year and cover a 12-month period of
financial performance.
✓ IAS 7 Cash flow statement sets out requirements for the presentation of the cash flow
statement and related disclosures.
✓ The listed entity shall submit a compliance certificate to the exchange duly signed by both that
is by the compliance officer of the listed entity and the authorized representative of the share
transfer agent, wherever applicable, within one month of the end of each half of the financial
year.
✓ Depreciation may be defined as the gradual reduction in the value of an asset due to wear
and tear as in the case of physical assets like building, machinery, etc., or by mere passing
of time as in the case of lease, patent and copyright.
If depreciation is not provided, the value of assets shown in Balance Sheet will not present
the true and fair value of assets.
Two methods to calculate depreciation: straight line method and written down value
method.
✓ Provision Vs reserve : Provisions is to be made in respect of a liability which is certain to be
incurred, but its accurate amount is not known. Reserves are the amount set aside out of
profits. It is an appropriation of profits and not a charge on the profits.
✓ In accordance with Section 135(5) of the 2013 Act, the Board of each company covered under
the CSR requirement needs to ensure that the company spends, in every financial year, at
least 2% of its average net profits made during the three immediately preceding financial
✓ Provision Vs reserve :
Provision Reserve
It is created for specific purpose. It is created for probable purpose,
It is charge against profit and loss account. It is appropriation of profit.
It cannot be distributed as profit. It can be distributed as profit.
It cannot be invested in securities. It can be invested in securities.
It is a matter of financial prudence. It is made because of legal necessity.
long term provisions are shown under the heading “Non- It is shown under “Reserve & Surplus”
Current Liabilities” while short term provisions are shown
under the heading “Current Liabilities”.
✓ Revised format of Balance sheet as per Schedule III ( this format is given from exam
point of view ) :
Particulars
EQUITY AN LIABILITIES
Shareholders’ funds
Share Capital
Reserves and Surplus
Non-current liabilities
Long-term borrowings
Long-term provisions
✓ A holding company is one which acquires all or a majority of the equity shares of any other
company called subsidiary company in order to have control over the subsidiary company.
✓ Associate Company, in relation to another company, means a company in which that other company
has a significant influence, but which is not a subsidiary company of the company having such
influence and includes a joint venture company _control of at least twenty per cent of total share
capital, or of business decisions under an agreement.
✓ Wholly Owned Subsidiary Company -A company in which all the shares with voting rights
(i.e. 100%) are owned by the holding company, it is said to be a wholly owned subsidiary
company.
✓ Partly Owned Subsidiary Company -A company in which only the majority of shares
(more than 50%) are owned by the holding company, it is said to be a party owned
subsidiary.
✓ Small Shareholder: A shareholder who is holding shares of nominal value of INR 20,000 or
such other sum as may be prescribed.
✓ Minority Shareholder: Equity holder of a firm who does not have the voting control of the
firm, by virtue of his or her below fifty percent ownership of the firm’s equity capital
✓ Cost of acquisition : Money invested in shares of subsidiary company by the holding
company is called as investment in shares & amount paid for such investment is called as
cost of acquisition. I
✓ Intrinsic value : when all the shares of subsidiary company are held by holding company
then holding company has ownership in the all net assets of the subsidiary company ( net
assets = total assets – liability = equity holders fund). Such amount realized by holding
company is called as intrinsic value.
✓ Minority interest : If all the shares are not held by holding company then net assets or equity
holder’s fund ( share capital + reserve & surplus ) of subsidiary company is divided into holding
company & outsiders. In this case, the claim of outside shareholders in the subsidiary
company is called as “Minority Interest”
✓ Cost of Control : The “excess” amount paid (more than face value or book value of shares)
by the holding company to acquire ‘controlling interest’ in the subsidiary company.
✓ Treatment of pre-acquisition profit or loss : It is divided into holding company & minority
holders in their respective proportion. Share of minority holder is added to minority interest.
And share of holding company is added to intrinsic value because it is capital profit.
Advance or loan : When one company gives loan to other company then it appears as
loan on asset side of lending company & liability side of borrowing company. Then
cancel that amount from balance sheet of both company on consolidation.
Subtract amount of stock reserve from P & L a/c of holding company which appears in
consolidated balance sheet.
✓ Bonus shares :
(a) Issue of bonus shares out of capital profit (Pre-acquisition profits) : In this case
there will be no effect on accounting treatment
(b) Issue of bonus shares out of post acquisition profit : In this case, a part of the revenue
profits will get capitalized resulting in decrease of cost of control or increase in capital
reserve.
This is the difference between the total value of its output and the value of the inputs of materials
and services obtained from other enterprises. The value added is seen to be due to the combined
efforts of capital, management and employees, and the statement shows how the value added
has been distributed to each of these factors.
✓ The Value-Added Statement (VAS) is a voluntary disclosure and adds little information to that
contained in the income statement. It calculates total output by adding sales, changes in stock,
and other incomes, then subtracting depreciation, interest, taxation, dividends, and the
amounts paid to suppliers and employees.
✓ Economic value-added (EVA) measures the economic rather than accounting profit created
by a business after the cost of all resources including both debt and equity capital have been
taken into account.
✓ EVA = “Net Operating Profit after Taxes” - (Equity Capital X % Cost of Equity Capital)
✓ Market value-added (MVA) is the difference between the Company’s market and book value
of shares.
✓ Market Value-Added = Company’s total Market Value - Capital Invested
✓ Shareholder Value-Added (SVA) represents the economic profits generated by a business
above and beyond the minimum return required by all providers of capital.
✓ Financial statements generally refer to balance sheet or position statement and Statement
of Profit and Loss or income statement. a business may also prepare a statement of
retained earnings and a cash flow statement.
✓ Financial statements are prepared on the basis of (i) recorded facts; (ii) accounting
conventions; (iii) postulates; (iv) personal judgements, and (v) accounting standards and
guidance notes.
✓ A statement of changes in the financial position of a company can be found out in two ways :
(a) Working Capital Basis, i.e., Funds Flow Statement, and
(b) Cash Basis, i.e., Cash Flow Statement
✓ DISTINCTION BETWEEN FUNDS FLOW STATEMENT AND CASH FLOW STATEMENT
1. A cash flow statement is mainly dealt with changes in cash position, while a funds flow
statement is concerned with changed working capital.
2. For short-term financial analysis the cash flow statement is considered to be more useful
to management as compared to funds flow statement.
3. In the cash flow statement opening and closing balance (cash and equivalents) is given.
But a funds flow statement does not contain in opening and closing balances.
4. There is no legal requirement to prepare funds flow statement but cash flow statement is
to be prepared by every listed company as per the requirement of SEBI.
✓ Sources of Cash
✓ a)Internal Sources
Cash from operations is the main internal source. The net profit shown by the Profit and Loss
Account will have to be adjusted for non-cash items for finding out cash from operations. Some
of these items are as follows :
Depreciation
Amortization of intangible assets
Loss on sale of fixed assets
Gain from sale of fixed assets External Sources
b) The external sources of cash are :
Issue of New Shares _Raising Long-term Loans._Purchase of Plant and Machinery on
deferred payments _Short-term Borrowings-cash credit from bank _ Sale of Fixed Assets,
Investments, etc
✓ Fund flow statement also referred to as statement of “source and application of funds”
✓ Fund = Working capital = Current assets – Current liability
✓ Flow of funds include both “inflow” and “outflow”.
❖ Indirect Method :
Particulars Rs. Rs.
Net profit before tax& dividend
Add : adjustment for P & L a/c
_________________________________________
Net operating profit before working capital changes
Add :Changes for working capital
_________________________________________
Cash generated from operations
Less : Tax paid
______________________________________
Cash flow from operating activity
✓ IMP Accounts for investment activity : For purchase & sale of asset
Assets Account
Depreciation
✓ Accounting Standards (ASs) are written policy documents issued by expert accounting body
or by government or other regulatory body covering the aspects of recognition, measurement,
presentation and disclosure of accounting transactions in the financial statements.
✓ The objective of general purpose financial reporting is to provide financial information that is
useful to existing and potential investors, lenders and other creditors in making decisions
about providing resources to the entity.
✓ Two important characteristics of financial information relates to relevance and reliability
✓ Convergene of varied Accounting Standards with International Financial Reporting Standards
(IFRS) has gained worldwide momentum in recent years to ensure uniformity and
transparency in reporting standards.
✓ India has committed to convergence of its Indian Accounting Standards (Ind AS) with IFRS in
a phased manner beginning April 1,2016.
✓ A revised roadmap for implementation of Indian Accounting Standards (Ind AS) finalized by
the council of the ICAI (Institute of Chartered Accountants of India) and submitted to MCA
(Ministry of Corporate Affairs) for its consideration.
✓ (ICAI): The Institute of Chartered Accountants of India
(ASB): Accounting Standards Board
(IAS): International Accounting Standards
(IFRS): International Financial Reporting Standards
(IASC): International Accounting Standards Committee
(IFRIC): International Financial reporting Interpretations Committee
(IASC):International Accounting Standards Committee
(SIC): Standard Interpretations Committee
The Institute of Company Secretaries of India (ICSI)
The Institute of Chartered Accountants of India
The Institute of Cost Accountants of India
IFRS Foundation/International Accounting StandardsBoard (IASB)
International Public Sector Accounting Standards Board(IPSASB)
Financial Reporting Council (FRC) (UK)
European Financial Reporting Advisory Group (EFRAG)
Financial Accounting Standards Board (FASB
American Institute of Certified Public Accountants(AICPA)
Australian Accounting Standards Board (AASB)
The Institute of Chartered Accountants in Australia (ICAA)
Financial Reporting & Assurance Standards Canada (FRASC)
Canadian Institute of Chartered Accountants (CICA)
✓ Cost : Cost can be either real or imaginary. Imaginary cost are called as notional cost.
All opportunity cost are notional cost.
✓ Costing & cost accounting : Costing is just calculation cost whereas cost accounting
involves calculation of cost & keeping control on cost. cost accounting in achieving its
three basic objectives namely-cost ascertainment, cost control and cost presentation
✓ Cost Accountancy has been defined as “the application of costing and cost accounting
principles, methods and techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information derived there from
for the purpose of managerial decision making”.
✓ Cost accounting & financial accounting & management accounting : Costing :
determination of operational position _stock valued at cost_only internal user. Financial
accounting : financial position_stock valued at cost or market value whichever is
lower_internal & external user. Management accounting : involves both costing &
accounting _used for management control
✓ different bases of cost classification are:
(9) Cost for analytical and decision-making purposes (Opportunity, Sunk, Differential, Joint,
Common,Imputed, Out-of-pocket, Marginal, Uniform, Replacement).
✓ Differential Cost: change in costs due to change in the level of activity or pattern or
method of production.
✓ Opportunity cost = income forgone due to taking another option = non real cost =
imaginary cost = notional cost.
✓ Out-of-pocket Costs: for this cash is paid _ it is relevant for decision-making,
✓ Imputed Costs: These are notional costs appearing in the cost accounts only _ also called
imaginary cost.
✓ Discretionary Costs: These are "escapable" or "avoidable" costs. These can be avoided
if a particular course of action is not chosen.
✓ Sunk Cost: It is a cost which has already been incurred or sunk in the past _ not relevant
for decision making.
✓ Committed Cost: it has been already committed by the management_not relevant for
decision-making. Committed cost :unavoidable. discretionary costs : avoidable costs.
✓ Methods of costing :Job Costing :printing press, automobile garage, repair shop, ship-
building, house building, engine and machine construction, etc. Contract Costing
:building construction. Batch Costing .Terminal Costing.Operation Costing.Process
Costing .Unit or Single-output Costing .Operating Costing :railways, road transport,
water supply undertakings, telephone services, electricity companies, hospital services,
municipal services, etc. Multiple or Composite Costing :motor cars, aeroplanes,
machine tools, type-writers, radios, cycles, sewing machines, etc. Departmental Costing
When costs are ascertained department by department, the method is called
“Departmental Costing”.
Auditor shall continue in office till the expiry of 180 days from the closure
of Financial year or till he submit the report
RATIO ANALYSIS
✓ Balance sheet ratios :Both numerator & denominator in these ratio are taken from balance
sheet. e.g.Current ratio ,Liquidity ratio ,Proprietorship ratio
Income statement ratios : Here, both terms are taken from income statement.
Mixed ratios : Here, one term is taken from balance sheet & other is taken from income
statement. E.g Stock turnover ratio,Debtors turnover ratio ,
Turnover ratio : Stock turnover ratio, Debtors turnover ratio, Fixed asset turnover
Leverage ratio: Debt- equity ratio ,Capital gearing ratio ,Proprietary ratio
cost of sales
STR = ( use this formula when gross profit is known)
average stock
365 days
Stock velocity =Finished goods storage period = Stock Turnover ratio ( STR)
Net Sales
✓ Fixed Assets Turnover Ratio =Fixed Assets
Net sales
✓ Capital Turnover Ratio =Average Capital Employed
Profit After Tax
✓ Return on Equity = Equity
✓ Importance of Reporting :
Provides Information to various levels of management_Helps in Selection of relevant
information is included_Role in Control System_Helpful in Profitable Operation _Follow the
Principle of Management by Exception
Cost Routine
or
Irregular
✓ Marginal costing is the accounting system in which variable costs is charged to cost units
and fixed costs of the period are written-off in full against the aggregate contribution. Its special
value is in decision-making.This technique of costing is also known as “Variable Costing”,
“Differential Costing” or “Out-of-pocket” costing
✓ Absorption costing is a method of costing by which all direct costs and applicable
overheads are charged to products or cost centres for finding out the total cost of production.
Absorbed cost includes production cost as well as administrative and other costs. It is a
principle whereby fixed as well as variable costs are allotted to cost units, i.e. full costs are
charged to production.
✓ Sales
- Variable cost
---------------
Contribution
- Fixed cost
---------
Profit
✓ Angle of incidence : It is angle between sales line & cost line. _ Greater is the angle of
incidence, lower is the B.E.P. smaller is the angle of incidence, more is the BEP _If the break-
even point is low and angle of incidence is large, the margin of safety is large and the business
enjoys financial stability.
✓ Break-even point can be determined by the following methods:
1. Algebraic methods:
2. Graphic presentation:
✓ Cost driver is an activity which generate cost. Costs are grouped according to what
drives them or causes them tobe incurred.
✓ A Cost Object: It is an item for which cost measurement is required e.g. Product , job or
a customer.
✓ Cost drivers type of Pure Volume, Weighted Volume, Situational, Motivational.
✓ Cost pool is created for each activity and such activities are related with each type of
product to determine the cost of such product.
✓ Stages in developed ABC system as under:
Identify resources
Identify activities
Purchasing :Batch-level
VALUATION OF SHARES
✓ Need for valuation of shares arises inter alia in the following circumstances:
- Assessments under the Wealth Tax Act.
- Purchase of a block of shares which may or may not give the holder thereof a controlling
interest in the company.
- Purchase of shares by employees of the company where the retention of such shares is
limited to the period of their employment.
- Formulation of schemes of amalgamation, absorption, etc.
- Acquisition of interest of dissenting shareholders under a scheme of reconstruction.
- Compensating shareholders on the acquisition of their shares by the Government under
a scheme of rationalisation.
- Conversion of shares, say, conversion of preference shares into equity.
- Advancing a loan on the security of shares.
- Resolving a deadlock in the management of a private limited company on the basis of
the controlling block of shares being given to either of the parties.
Step 1 : Compute Net Operating Asset ( sum all asset less external liability less Preference
Share capital )
Step 2 : Add Value of Goodwill and Non operating Assets if any (eg. Investments)
Step 3 : Divide the aggregate of Step 1 & 2 by the number of shares outstanding as at
Valuation date.
✓ Yield method :
The Various Methods under this are Dividend Capitalisation Method Earnings Capitalisation
Method & Productivity Factor Method.
of return.
Step 3 : Capitalise the Dividend per share at above normal rate of return to arrive at value per
share.
DP
S X
Value per share = 100
NRR
EPS X100
Value per share =
NRR
Compute weighted average Profit After Tax (PAT) for the same period.
Step 4 : Ascertain Adjusted FMP ie., Future Maintenance Profit as per Step 3 adjusted for
changes in business.
Step 7 : Add : Non operating Assets (eg. Investments) to above value of business.
Step 2 : Ascertain from published sources the Price Earnings Multiples for similar size Company
operating in the same industry.
Average Profits Method, Super Profits Method, Capitalisation Method & Annuity Method.
Ascerain Profits of Normal year of the Business Return which shall be adjusted for
Step 1 : Ascertain Normal Rate of Return (NRR) for the Industry in which the Company whose
Goodwill being valued.
Step 3 : Compute actual capital employed - Either Terminal Capital employed or Average
Capital employed = Opening Capital Employed + Closing Capital 2 (or) = Closing Capital
employed - 1/2 the year profit
Shareholders Approach :
The Capital employed ascertained as above is referred as Liabilities side approach and is to be
adjusted for the changes in values of OperatingAssets and after excluding non operating Assets.
Capital employed can alternatively be calculated under the Assets side Approach as follows:
Step 4 : Compute Normal Profit ie., excess of actual profits (2) over normal profit (4)
Step 5 : Compute super profit ie., excess of actual profits (2) over
normal profit (4) Step 6 : Goodwill = No. of Years purchase x Super
Profits 3. Capitalisation Method Steps 1,2 and 3 same as in Super
profit method.
Step 5 : Goodwill = Excess of Normal Capital employed over Actual Capital Employed.
VALUATION METHODS
Cov (S,M)
β of a security can be calculated as β =
σM2
b. Arbitrage Pricing Theory- Arbitrage refers to the process of earning profit by taking advantage
of different pricing for the same asset.
The APT formula is:
E (rj) = rf + bj1RP1 + bj2RP2 + bj3RP3 + bj4RP4 + ... + bjnRPn
Effect of Arbitrage on the Price
To buy stock A and B the investor has to sell stock C. The buying pressure on stock A and B would
lead to increase in their prices. Conversely, selling of Stock C will result in fall in the price of stock C.
At lower price, there would be a rise in the expected return of stock C.
Arbitrage Pricing Theory Assumptions