Professional Documents
Culture Documents
Unit - 1
Accounting Defination According for historical function and
managerial function Scope of accounting Financial accounting and
Management accounting Managerial uses Differences.
Accounting
standards
International
Accounting
standards.
Unit-2
Double entry system of accounting - Accounting books
Preapartion of journal and ledger, subsidiary books - Errors and
rectification Preparation of trial balance and final accounts.
Unit - 3
Financial Statement Analysis - Financial statements - Nature of
financial statements - Limitations of financial statements - Analysis of
interpretation -Types of analysis -- External vs Internal analysis Horizontal vs Vertical analysis - Tools of analysis - Trend analysis Common size statements -Comparative statements.
Ratio Analysis - Types - Profitability ratios - Turnover ratios Liquidity ratios - Proprietary ratios - Market earnings ratios - Factors
affecting efficiency of ratios - How to make effective use of ratio
analysis - Uses and limitation of ratios - Construction of Profit and
Loss Account and Balance Sheet with ratios and relevant figures Inter-firm, Intra-firm comparisons.
Unit -4
Fund Flow Statements - Need and meaning - Preparation of
schedule of changes in working capital and the fund flow statement Managerial uses and limitation of fund flow statement.
Unit-5
Budgeting and Budgetary Control: Preparation of various types
of budgets - Classification of budgets - Budgetary control system Mechanism -Master budget.
Unit-6
Capital Budgeting System - Importance - Methods of capital
expenditure appraisal - Payback period method - ARR method - DCF
methods - NPV and
IRR methods - Their rationale - Capital rationing.
LESSON
TITLE
1.
Accounting an Introduction
2.
Management Accounting
3.
4.
5.
Financial
Statements
of
Profit-making
Entities
Manufacturing-cum-Trading Organisations
6.
7.
Errors Management
8.
9.
10.
Ratio Analysis
11.
12.
13.
14.
Capital Budgeting
15.
Case Study
LESSON - 1
ACCOUNTING: AN INTRODUCTION
Learning outcomes; on completion of this chapter, you should be able
to:
Explain the nature of accounting.
Identify the various branches of accounting.
Explain the process of creation of financial statements and their
interpolation.
Explain the various objectives of financial statements.
Identify the various uses of accounting information.
INTRODUCTION
Accounting discipline deals with measurement of economic
activities affecting inflow and outflow of economic resources to develop
useful information for decision making. At household level information
about outflow and inflow of cash resources helps -.0 assess financial
position
and
plan
household
activities.
At
Government
level,
on
various
activities
(developmental
and
non
thereby
creating
economic
information
about
business
NATURE OF ACCOUNTING:
1.2 Accounting
i.
is man-made;
ii.
iii.
iv.
is a systematic exercise;
v.
is judgmentat at times;
vi.
vii.
is essentially a language;
viii.
ix.
manage
the
activities
of
the
enterprise( management)
lend
money
to
the
financial information)
enterprises(
banks
and
intend
to
make
investment
in
the
enterprises(mvestors)
authorities)
formulate
fiscal
and
monetary
policies
(other Government
department)
Internal
users
inside
the
judgement
and decision
by the users"
BRANCHES OF ACCOUNTING
Financial Accounting:
It
primarily
concentrates
on
creation
of
financial
Accepted
Accounting
Principles
(GAAP),
Conceptual
analysis
independent
examinations
by
chattered
1. Recording:
The process of creation of financial information starts with the
occurrence of a business transaction which can be Qualified. The
transaction is evidenced by some document such as Sales bill, Pass
book, Salaries slip etc., The systematic record of those transactions is
chronological order (i.e. the order in which they occur ) is made in a
book called JOURNAL BOOK. The four basic questions need to be
addressed while recording namely, what to record, when to record,
how to record and at what value to record?
3. Summarizing:
Basic aim of accounting is to create financial information in a
form which will be useful to the decision makers. To achieve this end,
accounts containing classified information in the ledger book are
balanced. After balancing of the ledger book, account balances are
listed statement giving names of theses accounts and their balance is
called " TRIAL BALANCE " on the basts of trail balance, summaries
are prepared to give useful information about the financial results
during a time period and the financial position at a point of time.
Reporting of summarizes of the business transaction is done in the
form of financial statements which are known as FINAL ACCOUNTS.
According to international Accounting standard - 1 the term financial
statements covers balance sheet, income statements or profit and loss
accounts, notes and other statements and explanatory material which
are identified as being part of the financial statements. The process of
creation of financial information can be summarized as follows:
Analysis of
business
transaction
evidenced
by source
document
Recording
Journal
Book
Classificati
on in ledger
book
Summariza
tion first in
trial
balance
and then in
financial
Comparative statement
However
to
analyze
and
interpret
these
financial
Financial
Managers:
For
managing
business
profitably
information
concern.
By
analyzingihistorical
information
provided
by
of accounting
inflation
accounting
involves
extensive
conversation
of
essentially
operates
within
legal
LESSON - 2
MANAGEMENT ACCOU NTING
Federation
of
Accountants
(IFAC)
defined
of
relevant
economic
information
relating
to
an
Formulation
of
plans
to
meet
objectives
(long-term
planning)
Formulation
of
short-term
operation
plans
American
Accounting
Association
defines
Management
thereby
achieve
organisational
control
and
enhance
organisational effectiveness"
The Management Accounting is used by management to plan
the activity, evaluate performance, ensure integrity of financial
information and to irnplement the system of reporting that is linked to
organisational
responsibilities
and
contributes
to
the
effective
comprises
the
preparation
of
financial
reports
for
non-
tax
accounting
and
information
systems.
Providing
methods
and
techniques
for
evaluating
the
Accountant
is
one
of
the
best
assets
for
to expected
business
managing
surplus
funds,
controlling
working
capital etc,
Short-term ad hoc decisions: This includes analysing data for
taking decisions c i pricing, product introduction, acceptance of
special orders etc.
Managing the organisation of information system: This includes
not only organising the enterprise's financial data but fulfilling
the information needs of all the segments of the organisation.
term
'Management
Accountant'
has
many
Director,
work Management
decision
support
for
decision
makers.
Management
Accounting is more concerned with decision making and a key role for
Management
Accountant
is
acting
as
provider
of
financial
than
management-Government,
Creditors,
Investors,
Owners, etc. At times, Financial Accounting follows windowdressing tactics in order to project a better than actual image of
the enterprise. Management Accounting is concerned more with
generating information for the use of internal management and
hence the information reflects the real or really expected
position.
an
estimation.
This
provides
the
necessary
rapidly
to
in
case
of
Management
Accounting.
In
Financial
information
viz.,
quantities
of
materials
TABLE
1.1:
MANAGEMENT
ACCOUNTING
vs.
FINANCIAL
ACCOUNTING
Nature
1. Governed by
Fianacial Accounting
Company law etc.
Management
Accoutning
Needs of managers
2. Basic functions
Transaction
Decision
support
recording,
Provision
of
Publication
3. Users
of Management
external
financial information
statements
Internal
4. Availibility
External
Publicly available
Confidential
5. Time focus
6. Period
As appropriate
7. Main emphasis
Explanation
8. Speed
prepartion
9. Form
of whole of entity
presentations
Segmented to control
10.
Style and Standardized
details
Tailored
Objective,
11.
Criteria
12.
Unit
account
of
13.
Nature of
data
units
to
requirement
and
verifiable summarized
and consistent
Money
understandable
Somewhat technical
use
accountants
by
non-
LESSON - 3
THEORY BASE OF ACCOUNTING - ACCOUNTING STANDARDS
that
accounting
information
contained
in
financial
accountancy
body
relating
to
various
aspects
of
measurement,
treatment and disclosure of accounting transactions and events
They also
aspects
followed
for
15 accounting
Institute
of
Chartered
Accountants
of
India,
fully
Constitution of ASB :
The consistitution of ASB gives adequate representation to all
interested parties and, at present, it consists of members of the
council and representatives to industry, banks, Company Law Board,
Central Board of Direct Taxes and the Comptroller and Auditor
General of India, Security Exchange Board of India etc,
Functions of ASB :
The main function of ASB is to fomralate accounting standards. While
formulating accounting standards, ASB takes into consideration the
applicable laws, customs, usage and business environment. The
Institute is the member of International Accounting Standards
Committee (IASC) and has agreed to support the objectives of IASC.
While formulating standards, it gives due consideration to the
International Accounting Standards (IAS) issued by IASC and tries to
integrate them, to the extent possible, in the light of conditions and
practices prevailing in India. It also reviews the accounting standards
at periodical intervals.
by way of
The
presentation
and
disclosure
requirements
in
e) Lastly, the council of the institute considers the final draft of the
proposed standard, and if found necessary, modifies the same
in consultation with ASB. The accounting standard on the
relevant subject is then issued under the authority of the
council.
The
accounting
standards
issued
by
the
ICAI-are
adopted
by
the
enterprise
in
the
preparation
and
level
of
production.
Overheads
other
than
production
The cash flow statement should report cash flows coring the
period classified by operating, investing and financing activities. An
enterprise should report cash Hows from operating activities using
either (a) direct method; or (b) indirect method. The inflow and outflow
from
the
investing
and
financing
activities
should
be
shown
accounting
assumption
of
going
concern
is
not
balance
sheet
date
that
represent
material
changes
and
AS-5 (Revised) Net Profit or Loss for the Period, Prior hems and
Changes in Accounting Policies :
extraordinary items.
of
enterprise
resources
yielding
interest,
royalties
and
the seller of goods has transferred the property in goods tci the
buyer along with significant risks and rewards of the ownership
and seller has no effective control over goods transferred;
Fixed asset is an asset held with the intention of being used for
the purpose of producing or providing goods or services and is not he!
d for :he sais in the notarial course of business.
purchase price and other attributable cost of bringing the asset to its
working condition for its intended use. Financing costs relating to
deferred credits or to borrowed funds attributable to construction or
acquisition of fixed assets for the period up to the completion of
construction or acquisition of fixed assets should also be included in
the gross book value of the asset to which it relates. When a fixed
asset is acquired in exchange or in part exchange for another asset,
the cost of the asset required should be recorded either at fair market
value or at the net book value of the asset given up, adjusted for any
balancing; payment or receipt of cash or other consideration.
Subsequent expenditures related to an item of fixed asset should be
added to its book value only if they increase the future benefits from
the existing asset beyond its previously assessed standards of
performance. Material items retired from active use and held for
disposal should be stated at the lower of their net book value and; net
54haracteri value.
should
he
recorded
in
the
books
only
when
some
consideration in money or moneys worth has been paid for it. A proper
disclosure of the gross and net book value of the asset as well as
relevant amount, if the assets are stated at revalued amounts should
be made.
should
disclose
distinctly
in
current
the
investments
financial
and
statements.
long-term
A
current
Current
investments
should
be
carried
in
the
financial
other
things,
the
disclosure
of
accounting
policy
for
of
the
financial
statements
of
either
party
to
the
schemes should be charged to the statement of profit and loss for the
period. The accounting treatment of gratuity and other benefit
schemes will depend on the type of arrangement which the employer
has chosen to make. Any alterations in the retirement benefit costs
should be charged or credited to the statement of profit and loss as
they arise in accordance with AS-5.
LESSON-4
PRACTICAL BASE OF ACCOUNTING ORIGIN AND ANALYSIS OF
BUSINESS TRANSACTIONS
Accounting
process
begins
with
the
origin
of
business
transactions are
Document.
Rs. 5,00,000 cash and furniture worth Rs. 20, 000 invested by
the owner in the business.
Introduction of Rs.5,00,000 cash increases business cash by
Rs. 5,00,000 and it creates analysis obligation to pay Rs. 5,00,000 to
the owner which is recorded as capital. In terms of accounting
equation its effect is as
follows:
worth
Rs.20,000
is
provided
by
the
11.
+ Furniture
(Rs.20,000)
= Capital
- +(5,00,000 + 20,000
Rs. 5,20,000
)
Rs.5,20,000
Furniture
(Rs.5,00,000
(Rs.20,000)
(Rs.1,90,000)
(Rs.5,20,000)
Rs. 10,000)
+ Building
(Rs. 2,00,000)
-7,10,000
12.
= Rs.7,10,000
Cash +
Bank
(Rs.4,90,000
13.
Capital
(Rs.5,20,000)
(Rs. 3,00,000)
+ Furniture
+ Building
-7,10,000
14.
= Rs.7,10,000
building :
Cash +
Capital
Bank
(Rs.1,90,000
(Rs. 3,00,000)
(Rs.1,90,000)
(Rs.5,20,000)
- Rs. 1,90,000)
+ Furniture
- Rs. 1,90,000)
+ Building
Rs. 5,20,000
15.
= Rs. 5,20,000
Cash
+ Bank
(Rs.1,90,000
+ Stock of goods
= Creditors + Capital
(Rs.70,000)
(Rs.20,000)
(Rs. 1,10,000)
(Rs.5,20,000)
16.
50,000)
+ Furniture
+ Building
(Rs. 20,000)
(Rs.2,00,000)
Rs. 5,40,000
Rs.5,40,000
17.
personal use:
It decreases cash by Rs.40,000 and goods by Rs.20,000. At the same
time, it decreases capital by Rs.60,000 as shown below:
Cash
+ Bank
(Rs. 1,10,000)
(Rs.70,000
Capital
(Rs. 1,40,000
(Rs.20,000)
(Rs.5,20,000
- 50,000)
-Rs,20,000)
Rs.60,000) + Furniture
(Rs. 20,000)
+ Building
(Rs.2,00,000)
Rs. 4,80,000
= Rs.4,80,000
Balance Sheet
Liabilities
Capital
Creditors
Amount
Assets
4,65,000 Cash
20,000 Bank
Stock
Furniture
Building
4,85,000
amount
1,25,000
1,10,000
30,000
20,000
2,00,000
4,85,000
1)
Assets Account
2)
Liability Account
3)
Capital Account
Transactio
n
Assets
No.
Creditor
Furniture
Cash +
Bank +
Stock+
s for
Building
Building
Trade
Creditor
Capital
s+
1.
5,00,000
20,000
+
-
5,20,000
2.
5,00,000
20,000
5,20,000
- 10,000
+2,00,00
4,90,000
20,000
0
2,00,000
1,90,000
1,90,000
5,20,000
+3,00,00
3,00,000
1,90,000
0
3,00,000
20,000
20,000
1,90,000
5,20,000
-1,90,000
1,90,000
1,10,000
20,000
20,000
1,90,000
-
5,20,000
- 50,000
+70,00
+ 20,000
6.
1,40,000
1,10,000
0
70,000
20,000
20,000
20,000
5,20,000
7.
- 40,000
1,00,000
1,10,000
-20,000
50,000
20,000
20,000
20,000
- 60,000
4,60,000
8.
+ 25,000
1,25,000
1,10,000
-20,000
30,000
20,000
20,000
20,000
+ 50,000
4,65,000
3.
4.
5.
ii.
iii.
Illustration:
Prepare a statement showing analysis of transactions, title
and nature of affected accounts, relevant rule of recording and the
account to be debited and credited on the basis of transactions of Mr.
X for the month of December,1998. Transactions for the month of
December, 1998, were as
follows
1. Received cash form debtors
2. Deposited cash in bank
3. Payment to creditors by
Rs.
20,000
4,000
4,000
cheque
4. Machine purchased for
5. Traveling Expenses
10,000
5,000
Title and
Nature of
Account
Cash
Debit
Asset
increase in
Rs. 20,000
Decrease
Debtor
assets
Credit
the amount
Asset
Credit
Debtors
Deposited
Analysis
due from
decrease in
debtors
Increase
Bank
asset
Debit
asset
increase in
Rule
balance
Decreases
asset
Cash - asset
Entry
Debit cash
Debit bank
Credit cash
Credit
cash in
decrease
hand
increase
asset
Debit
Debit
Creditors
decrease in
creditors
Liability
liability
decreases
Bank
Credit
bank
Asset
decrease in
Payment
to Decreases
creditors
by amount
cheque
payable to
Rs.4,000
creditors
balance
asset
Credit Bank
Machinery
Increases
Machinery
Debit
Debit
machinery
asset
increase in
machinery
purchased
Rs.10,000
asset
Decreases
Cash - asset
Credit cash
cash in
Credit
hand
decrease in
asset
Expenses
Traveling
Traveling
incurred on
expense-
Debit
traveling
expenses
travel
Temporary
increase in
Expenses
Rs.5000
increases
capital
expenses
cash in
(Expense)
hand
decreases
Debit
Credit cash
decrease in
asset
1. Valuation of Assets :
Various valuation accounts generally opened to account for
decreae in the value of assets are provision for discount on debtors
account, provision for doubtful debts account, stock reserve
account, investment fluctuation reserve account, provision for (or
accumulated) depreciation account and so on. The accounts are
opened to bring and report assets at their reduced level.
provision
depreciation)
for
depreciation
account
(or
accumulated
2. Valuation of Liabilities:
Like provision for discount on debtors, Provision for
discount on creditors account is created. As per conservation
principle, it should not be provided because anticipated gains are not
taken into account. But it is analysts accepted accounting practice to
make provision for discount on creditors. It results in decrease in
liabilities. As decrease in liabilities are debited, valuation accounts
recording decrease in liabilities are debited. Conversely, valuation
account recording in increase in liabilities are credited. This rule is as
follows:
Traditional Approach
Both
accounting
equation
approach
and
traditional
Personal Accounts:
Accounts recording transactions with a person or group of
persons are called personal accounts. These accounts are necessary,
in particular, to record credit transactions. Personal accounts are of
following types.
1. Natural person(s)
Accounts are accounts of individual living beings and
include accounts ;of individuals such as Ramesh capital account. Ram
account, Neha account and so on.
which
are
not
personal
are
termed
as
impersonal accounts and are divided into real and nominal accounts.
Real Accounts:
Real Accounts relate to properties of a business enterprise
which can be tangible or intangible.
Nominal Accounts:
Accounts relating to income, revenue, gain, expenses and
losses are termed as nominal accounts. Example of nominal accounts
are salaries, rent, commission, discount allowed, rent received, sales
interest received etc. For recording changes in personal, real and
'nominal accounts, following rules are followed.
Transactions
Analysis
Title and
Rule
Entry
Nature of
Introduction
of
cash
owners
Business
Account
Cash-Real
is personal
the giver
the Credit
Capital
cash
deposited
bank
Bank
Bank-Personal
Debit
in receives
receiver
cash
Business
Cash Real
gives
goes out
Building
cash
Building
purchased
comes in
Building Real
Building
Credit
credit
Purchase
giver
Credit X
Debit what Debit Goods
goods
cash
giver
of Goods
for are
comes
received
Cash
Payment
Goods Real
Cash Real
in
in
paid
of Service of Salary
salary to an the
employee
the
Nominal
Debit
expenses
employee
utilized
Credit cash
Business
Credit what
goes out
for
service
utilized
of Building
Rent
building
due is
used Rent
by
outstanding
business
personal
rent
all Debit
expenses
Credit
Credit
Rent
rent
the outstanding
giver
for (representative)
the
period is
payable
Note: Rent payable or outstanding is a personal account and shows he
amount payable to the owner of the building.
1. Scientific System:
Double entry system records, classifies and summarizes
business transactions in a systematic manner and thus, produce
useful information for decision-makers. It is more scientific as
compared to single entry system of book-keeping.
Purchase of goods increases goods held for resale and sale of goods
decreases goods. Goods in hand are called Stock or Inventory.
Suppose goods costing Rs.5,000 are purchased and goods costing
Rs.4,000
are
sold
for
Rs.6,500.
theoretically
effect
of
these
Debit stock
Credit stock
5,000
5,000
Rs.
6,500
4,000
2,500
Rs.
5,000
5,000
6,500
6,500
Rs.
1,000
account)
Credit purchases (Asset / Real account)
1,000
Debit
closing
stock
(Asset
The gross profit along with other incomes is compared with indirect
expenses to find out net profit ( or loss) during an accounting period.
Then net profit ( or loss) is transferred to capital account Assuming
there are no expenses, net profit is equal to Rs.2,500. ( i.e. sales
(6500) - cost of sales (4000)). The entry for transfer of net profit to
capital account is as follows:
Debit
profit
and
loss
Rs.
(nominal 2,500
Account)
Credit capital (capital Account)
2,500
Debit purchases
Credit cash
Rs.
195 (Revenue A/C)
180
Credit Discount
15
A/C)
Allowed
Credit sales
195 (Revenue
A/C)
Received
Books of Seller
Books of Purchaser
Debit Cash 1,100 (Real A/C)
Debit Purchaser 1,100 (Real A/C)
Credit Sales 1,100 (Revenue A/C) Credit Cash
1,100 (Real A/C)
Credit Sales tax payable 100
(Represtative personal A/C)
Debit bank
Credit P
Rs.
5,000 (Personal Account)
5,000 (Personal Account)
But if cheque is deposited on, say 5.2,1999, the entries are as follows:
On 31.1.1999
Debit bank
Credit P
(Real Account)
(Account)
On 5.2.1999
Debit bank
Credit cash
(Personal Account)
(Real Account)
2. Cheques received are not crossed 'Account Payee '. Crossed cheques
are recorded in bank column directly.
5. Bad debts:
Bad debts refer to the amount of debt that cannot be
recovered form the credit customers. At the time when business
enterprise becomes definite about the non-recovery of assets certain
sum from debts, the amount receivable is reduced by crediting debtors
account. As the amount non-recoverable is a loss, it is debited to a
new account, called bad debts account and, at the end of the
accounting period, it is transferred to profit and loss account. Thus,
entry for recording bad debts is as under.
Debit Bad debts (Nominal / Temporary Capital A/C)
Credit Debtors(Group personal / Asset A/C)
LESSON - 5
FINANCIAL STATEMENTS OF PROFIT-MAKING ENTITIES
MANUFACTURING-CUM-TRADING ORGANISATIONS
contrast, a
Manufacture-cum-Trader's
basic
operation
those
of
'Raw
In
fact
the
"Income
statement
of
The 'Direct Costs' are those which do not lose their existence in
the final product. Indirect costs are those which are not direct costs.
Hence, for the manufacture of furniture, cost in incurred on wood is a
'Direct Material Cost' whereas cost incurred on nails and fevicol used
is a 'indirect Material cost'. The reason is that whereas wood has not
lost its existence in the final furniture made,
nails and fevicol have lost it. Similarly, the cost paid to person who is
actually making the furniture (also called carpenter) is called 'Direct
labour Cost' whereas cost paid to a person who is supervising many
carpenters Is an example of Indirect Labour Cost'. '
namely,
Factory;
Office
and
Administration
and
Selling
and
Dr.
Manufacturing Account
Cr.
To Opening Stock Raw
xxx
By Scrap
Material
To Purchaser of Raw By Rebates
Material
xxx
By Purchases returns
To Freight Inward
xxx
By Subsidies
To Duties and Taxes
xxx
By Duty Draw Back
To Fatory Overheads
xxx
By Closing stock-Raw
Material
To Opening Stock Work
xxx
By Closing stock in progress
Work in process
By Cost manufactured
Goods transferred to
trading account
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Manufacturing A/c
Dr.
However, this profit is not realised unless goods are sold to the
ultimate customer by the trading division. Hence if finished goods
remain unsold at the end of the accounting period it leads to valuation
of the finished goods at a price which is more than the cost of these
goods to the business as a whole. The excess represents the
'Unrealised profit' contained in the value of the stock. This valuation of
inventory violates the principle of 'Lower of cost or market value' as
Dr.
VALUATION
OF
INVENTORIES
IN
MANUFACTURING
DEPARTMENT
The value of inventory is computed by adding cost of purchase,
cost off conversion, and other cost incurred in the normal course of
business in bringing; the inventories up to their present location and
condition. However, as per AS-2, the inventory is valued at lower of
cost or market price characterised by the net realizable value.
The
First out (FIFO), Weighted Average or Last in First out (LIFO) formulae
as per recommendation of AS-2. The value of raw material should be
based on cost of purchase and other cost incurred in the normal
course of business in bringing the inventories up to their present
location and condition. The value of finished goods inventory should
be based on cost of manufacture which includes besides direct
material, direct labour and other direct costs, the fair proportion of
factory overheads. The WIP is commonly valued at factory cost.
However, while valuing it, the concepts of Equivalent Unit is used.
According
to
institute
of Cost
and
Management
accountants,
Hence
Illustration
1:
From
the
following
particulars,
prepare
the
Unit
1,000
10,000
500
Rs.
10,000
1,10,000
?
10,000
15,000
85,000
Factory
Office
Other Factory Oveheads
Opening Stock Work in Purchase (40% complete)
Closing Stock Work in Process (30% complete)
1,500
3,000
40,000
50,000
30,000
15,000
?
Dr.
Particulars
To Direct Wages
To Factory
Overheads (2)
To Opening Stock
- WIP
Manufacturing Account
Unit
Amount
Particulars
1,000
10,000 By Closing Stock Raw Material
By Closing Stock
10,000 1,10,000 - WIP (3)
10,000 By Trading A/c
[cost of finished
goods transferred to
trading account (3)
(b.f.)]
85,000
1,500
Unit
Cr.
Amount
500
3,000
6,000
27,000
9,000
2,67,000
12,500
3,00,000
70,000
15,000
12,500 3,00,000
Working Notes:
= (1,10,000 + 10,000)
10,000
= Rs. 12
= Rs. 6,000
2. Factory Overheads
Indirect Factory wages
= 40,000
= 30,000.
70,000
Units
% of completion
Equivalent units
60 %
900
7,500
100 %
7,500
3,000
30 %
900
9,300
=
=
=
1,24,000***
85,000
70,000
2,79,000/9,300
Rs. 27,000
process
Value of finished goods
units
2,25,000
Rs. 2,67,000
* Opening stock at the beginning of the year was 40% complete and
hence % completed during the year was remaining 60%.
** Total finished goods transferred during the year is 9,000. Since
1,500 units are from the opening stock of WIP, the remaining (7,500
units) must be those which were started and finished during the year
on the basis of cost flow assumption of FIFO.
*** 10,000 (Opening stock +RM) + 1,10,000 (Purchases) - 6,000
(Closing Stock) +1 0,000 (Freight) = Rs. 1,24,000.
LESSON - 6
FINANCIAL STATEMENTS OF NON-PROFIT-MAKING ENTITIES
On
the
other
hand,
primary
objective
of
non-profit
Non-profit
institutions,
organisations
clubs,
political
include
associations,
hospitals,
educational
religious
institutions,
a)
b)
c)
d)
Some Peculiar Items: Though the rules for preparing profit and loss
account of' commercial organisations and income and expenditure
account of non-profit. organisations are same, but there are some
items which are peculiar to non-profit organisations. Items peculiar to
non-trading organisations are as follows:
a)
b)
c)
etc.
depend
upon
Government
grant
for
their
of
surplus,
amount
charged
from
students,
d)
e)
f)
g)
h)
i)
j)
k)
l)
However,
m)
certain items for which a fund exists, then expenses are not
debited to income and expenditure account but deducted from
specific fund account. Similarly,
Match Fund
Add
income
10,000
from
5,000
matches
15,000
12,000 3,000
n)
Dr.
Dr.
To Income A/c
For income received in advance
Income A/c
Dr.
p)
Life
membership
fund
Sometimes,
member
of a
non
Building
Fruniture
Library Books
16% Investmetns (1-198)
Salaries
Amount (Dr.)
2,50,000
40,000
60,000
2,00,000
Admission Fees
Tution Fees
Rent of Hall
Creditors for Books
Supplied
2,00,000 Miscllanoues
Receipts
Amount (Cr.)
5,000
2,00,000
4,000
6,000
12,000
Stationery
General Expenses
1,40,000
25,000
4,00,000
8,000
Investments
8,00,000
Additional Information;
1) Tuition fees receivable for the year 1998 amounted to Rs.
10,000.
2) Salaries payable for the year 1998 amounted to Rs. 12,000
3) Furniture
costing
8,00,000
Dr. Income and Expenditure Account for the year ending December 31, 1998 Cr.
To Salaries
2,00,000
By Tution Fees
2,00,000
Add
12,000 2,12,000 Add
10,000 2,10,000
Outstanding
To Stationery
Outstanding
15,000 By
Annual
1,40,000
Goverenment
Grant
To
Annual
6,000
Sports Expenses
To
General
8,000 By
Expenses
To Depreciation
on Furniture
On 10,000 (for
5,000
Fees
By Rent of Hall
500
4,000
By
year)
12,000
Miscellanoues
On 30,000 (for 1
3,000
Receipts
3,500 By Interest on
year)
To Deprecitation
12,500
on Building
To Depreciation
12,000 Add
on
Admission
Investment
Library
Books
To Excess
Income
Expenditure
of
over
8,000
Interest
1,34,000
Accured
24,000
32,000
4,03,00
4,03,000
Liabilities
Outstanding
Salary
Creditors
Amount
12,000 Cash
for
6,000 Bank
for
25,000 Tution
Assets
Amount
1,000
20,000
Books
Supplied
Donation
Library Books
Capital Fund
Fees
Receivable
Accounted
Interest
On 1-1-98
Add Surplus
10,000
4,00,000
1,34,000
24,000
on
Investment
Investments
5,34,000 Furniture on 11-98
Add purchased
20,000
30,000
10,000
on 1-7-1998
Less
40,000
3,500
36,500
Depreciation
Library Books
Less
60,000
12,000
48,000
2,50,000
12,500
2,37,500
Deprcaition
Building
Less
Depreciation
5,77,00
5,77,000
It is real account. All receipts are recorded on its debit side and
all payments are credited.
b)
c)
d)
5)
6)
side
bank.
Itlis closed at the end of the year It is balanced at the end of the
7)
and
the
balance
carried
only irrespective of their effect on flow and revenue nature provided they
of cash.
affect flow of cash.
8) It records transactions of current It records transactions of previous
year only.
years,
current
year
and
Amount
4,000 Cash
Assets
Amount
1,000
1,59,000 Bank
Outstanding
40,000
2,000
Subscription
Furniture
Building
20,000
1,00,000
1,63,000
1,63,000
Amount
1,000 Cash
Assets
Amount
900
Outstandin
g
Capital
fund
On 1-1-98
Bank
1,59,000
20,000
Outstanding
3,000
Subscriptio
Add
4,500
n
1,63,000 Investments
30,000
Surplus
Add
600
30,600
Accrued
Interest
Furniture
20,000
on 1-1-98
Less sold
Building
Less
5,000
1,00,000
5,000
15,000
95,000
Depreciatio
n
1,64,50
1,64,50
ii)
fact,
these
two
statements
plus
some
additional
iii)
iv)
a)
b)
sheet
and
additional
information
and
adjusted
c)
1)
2)
3)
4)
5)
6)
given, and balance sheet in the beginning and at the end are
required;
7)
When balance sheet at the beginning and at the end along with
additional information is given, and Receipts and Payments
account and Income and Expenditure account for the year are
required;
8)
When raw information is given, and all the basic statements are
to be prepared;
9)
accounts
of
non-profit
organisation
are
to
be
prepared;
10)
Accounts of hospitals;
11)
a)
b)
Case III: When in receipts and Payments account the balance of bank
is given as per pass book.
Case IV: When trial balance along with additional information is given
and few basic statements are to prepared.
It has already been emphasized that accounts of non-profit making
entities are not materially different from the accounts of a profitmaking entity. Hence, if information is given in the form of trial
balance it does not poses a special problem (See Illustration 1), All
account have to be analysed to find out whether they result in
generation of deficit/surplus or are accounts of assets / liabilities. The
statements are prepared in the usual manner.
and payment
account and balance sheet from the information given in the question.
To prepare receipt and payment account from income and expenditure
account, all items appearing in income and expenditure account
should be analysed one by one to find out their effect on flow of cash.
To recapitulate, income and expenditure account records all incomes
and expenses of the current period on accrual basis. Therefore, the
information appearing in the income and expenditure account is to be
adjusted in the light of additional information given in the question to
find out inflow and outflow of cash on account of incomes and
expenses respectively. Then, information about capital receipts and
capital payments included in additional information is analysed and
recorded in the receipt and payment account After recording all
receipts and payments and opening balance of cash and bank, the
Case VI: When both Receipt and Payment Account and Income and
Expenditure Account along with additional information are given, and
balance sheet in the beginning and at the end are required.
a)
b)
c)
d)
Case VII: When balance sheet at the beginning and at the end of the
period along with additional information are given, and receipts and
payments account or income and expenditure account for the year are
required:
Case VIII: When raw information is given and basic statements are to
be prepared: When raw information is given, it virtually involves the
writing of entire books of accounts of non-profit organisations, Due
care mast be taken In recording transactions in these books. All
receipts and payments should be recorded in the receipts and
payments account. All expenses and incomes should be posted to
income and expenditure account keeping in mind the whole
discussion we had so far. Hence, recurring items will find their way to
income and expenditure account and non-recurring would be taken to
balance sheet., the assets and liabilities at the end of the year are
enumerated in the closing balance sheet. The opening balance sheet is
normally prepared to find out the missing figure of capital fund in the
beginning of the year.
LESSON - 7
ERRORS MANAGEMENT
Type of Errors
1.
2.
3.
balance
agrees.
Thus,
4.
ERROR MANAGEMENT
The whole idea of error management can be executed in three steps,
namely:i.
Prevention of errors,
ii.
The best way to manage the errors is to prevent them from occurring
in the accounts prepared by the business concern. As is said,
"Prevention is better than cure". It is the responsibility of the
management to prevent errors. The management can prevent the
errors in the nature of fraud by exercising an effective internal control
system. It should also curb its own tendencies to window dress the
accounts in order to present their report card in a colourful manner. It
should not allow the prejudice and bias to enter the accounts where it
is avoidable.
The errors other than fraud are caused by the following reasons:
i)
i)
Errors
which do not
of the
ii)
b)
c)
d)
e)
f)
g)
h)
i)
If stil! the error is not detected, recheck all the entries in the
genera! journal for any possible omission, ' commission,
principle and self compensating errors.
Entry Passed:
Landlord Account
Dr.
5,000
To cash Account
5,000
Entry Required:
Rent Account
5,000
To cash Account
5,000
Dr.
Dr. 5,000
To Landlord Account
5,000
Furniture Account
Dr.
5,000
To cash Account
5,000
Entry Required:
Purchases Account
Dr.
5,000
To cash Account
5,000
Purchase Account
Dr. 5,000
To Furniture Account
5,000
Cash Account
Dr. 5,000
To Naresh Account
5,000
Entry Required:
Cash Account
Dr. 5,000
To Ramesh Account
5,000
Naresh Account
Dr. 5,000
To Ramesh Account
5,000
4) Rs. 5,000 goods purchased on credit from Mr. Anil wrongly posted
to the debit side of Anil's account and purchases book total Rs.
25,000 posted to debit side of purchases account as Rs. 15,000.
Purchase Account
Dr.
10,000
To Anil Account
10,000
Dr.
9,000
To Sales Account
9,000
Dr.
Sales Account
Cr.
Dr.
500
To Suspense Account
500
Dr. 1,000
To Suspense Account
1,000
3) Rs. 1,000 cash received from X has not heen posted to his
account : This amount should have been posted to credit side of X
Dr.
1,000
To X
1,000
4) Sales return from V Rs. 700 has been posted to Y's account as
Rs. 70 :
Rs. 700 should have been credited to Y's account. As the amount
actually credited is just Rs. 70, Rs. 630 more should be credited to Y's
account. To complete double entry, suspense accouni is debited by Rs.
630 as follows:
Suspense Account
Dr.
630
To YA/c
630
5) Rs. 4,000 cash paid to a creditor has been posted to the credit side
of creditor's account: Rs. 4,000 cash paid to a creditor should have
been debited To creditor account but ft is actually credited to creditors
account. To have correct balance in creditors account Rs. 8,000
should be debited to creditors accounf. Debiting of double amount i.e.,
Rs. 8,000 nullfiles the effect of wrong credit of Rs. 4,000 and ensures
correct debit of Rs. 4,000. The journal entry' | passed for this is as
follows:
Creditors Account
Dr.
3,000
To Suspense Account
8,000
Above entries are posted to suspense account as follows;
Dr
Suspense Account
Cr.
To
Difference
trial
in
7,870
balance
(balancing figure)
To X
1,000
To Y
630
By Purchase A/c
500
By Sales A/c
1,000
By Creditors
8,000
Errors and Profit : Errors will effect profit only when nominal
accounts recorded in income statement are affected. Effect of
abovementioned errors and their effect on profit is explained as
follows:
a)
70,000.
Correct
profit
can
be
calculated
by
b)
c)
Non-posting
of
discount
received
balance
reduces
d)
12,000.
reduced by Rs 12,000 to
e)
Effect on profit
Errors (a), (b), (c) and (d) do not affect nominal accounts and
therefore, have no effect on profits.
Error (e) affects nominal accounts. This error increases offices
expenses reduces the amount of purchases. As a result, gross profit is
Rectification
of Accounts or in
the next
accounting period
The management should make every conceivable effort to
prevent occurrence of the errors in the accounts. However, if still some
errors creep in the accounts, they should be detected and rectified
before the flnalisation of accounts. But if despite the best of their
efforts the management is not able to trace the errors, the difference
should be put to the Suspense A/c and accounts finalized. The
suspense account should be shown in the balance sheet til! such time
itscauses are ascertained.
In the next accounting period, the rectification should be done
as and when tfye error is detected. However, the method of
rectification will depend upon whether the account affected is a
nominal account or any other account. If the account affected is other
than nominal, the rectification is done in the usual manner,' For
example, the amount received from X inadvertently recorded in Y's
account and left untraced last year will be rectified in the current year
by debiting X and crediting Y. Had this error been traced last year
itself, the same rectification entry would have followed.
Dr.
10,000
To Sales Account
10,000
Suspense Account
Dr
10,000
To Profit & toss Adjustment Account
10,000
The profit and loss adjustment account is closed by transfer to
the current year profit and loss account as a prior period item. Hence,
the profit of current year clearly reflects the effect of the errors of the
past period.
A close look at the following examples will make more clear the
mechanism of rectification (a) if its is done in the same accounting
period; and (b) if it is done in the next accounting period;
i) Purchase book is undercast by Rs. 5,000:
Rectification entry ij it is done in the accounting period of the error
Purchase Account
Dr.
5,000
To Suspense Account
5,000
Dr. 5,000
To Suspense Account
5,000
ii) Rent paid of Rs. 2,000 debited to landlord account and included in
the list of
debtors:
Dr. 2,000
To Debtors Account
2,000
Rectification entry if it is done in the next accounting period
Profit & Loss Adjustment Account
To Debtors Account
2,000
Dr. 2,000
Dr.
1,000
To Purchase Account
1,000
Dr.
1,000
Profit
&
Loss
Adjustment
Account
1,000
iv) Cash received of Rs. 4,000 from X shown on the debit of Y's
account: Rectification entry if if is done in the accounting period of the
error itself.
Suspense Account
Dr.
8,000
To X Account
4,000
Dr.
Note that the entry is same in both the cases. The basic reason is
jthat the account affected is not a nominal account.
Illustration 1;
A book keeper while preparing his trial balance finds that the
debit exceeds by Rs. 7,250. Being required to prepare the final
account he places the difference to a suspense account. In the next
year the following mistakes were discovered:
a)
b)
c)
d)
e)
f)
Draft the joyrnal entries for rectifying the above mistakes and prepare
the suspense account and profit and loss adjustment account,
Journal
a)
Suspense A/c
Dr. 8,000
wrong
recording
of
8,000
sales
as
Dr. 2,500
Drawings
inadvertently
c)
2,500
made
last
year
as
repairs
now
shown
rectified)
Krishna A/c
Dr. 1,300
1,300
d)
Dr. 650
650
Dr. 1,500
To Raghubir A/c
1,500
debit
side
of
his
account
f)
Dr. 1,500
To Suspense A/c
(Being
1,500
depreciation
not
shown
last
Dr.
To
Suspense Account
Cr.
Profit
&
Loss
Adjustment A/c
To Raghubir A/c
8,000
By balance b/d
1,500
By
Profit
&
7,250
Loss
2,250
Adjustment A/c
Dr.
Cr.
To Clerk's
9,500
Profit & Loss Adjustment Account
9,500
Persona]
650
By Suspense A/c
8,000
A/c
To suspense A/c
To Profit & Loss
2,250
7,600
By Drawings A/c
2,500
Adjustment
A/c
(Transfer)
10,500
10,500
LESSON - 8
ACCOUNTS FROM INCOMPLETE RECORDS-SINGLE ENTRY
SYSTEM
SALIENT FEATURES
a)
Incomplete
Double
Entry
System
Dual aspect
of a
b)
according
to
the
information
principles of
c)
double
entry
system,
varying
according
to
d)
c)
d)
Limitations
of Single
Entry
System.
Single
entry
system
has
following limitations;
a)
b)
accounting
records
maintained.
Hence,
arithmetical
c)
d)
e)
f)
g)
cannot be employed
by
h)
Liabilities
Creditors
Bills payable
Outstanding
expenses
Unearned income
Loans
Capital (Balancing
Amount
Assets
Amount
Cash
Bank
Debtors
Bills receivable
Stock
Prepaid expenses
figure)
Accrued income
Fixed assets
Distinction Between Statement of Affairs and Balance Sheet :
Following are the points of difference between a statement of affairs
and a balance shed.
a)
or
bases
on
estimates
(if
records
are
not
b)
c)
d)
a)
b)
c)
By Profit before
adjustment as shown in
Capital Account
Conversion Method
Accounts maintained under single entry system are not
sufficient to extract trial balance at the end of the accounting period.
As a result, final accounts or financial statements cannot be prepared
from incomplete records unless steps are taken for their completion.
Under
conversion
method,
cash
accountant,
debtors
account,
for
solving
examination
problems,
above
mentioned
b)
c)
d)
Dr.
Cr.
To balance b/d
(Debtor in the beginning)
To Sales A/c
(Credit sales)
To Bills receivable A/c
(Bill dishonoured)
year)
Dr.
Cr.
To balance b/d
(Balance in the beginning)
To Debtors A/c
(Bills drawn during the year)
Dr.
Cr.
Dr.
By balance b/d
(Creditors in the beginning)
By purchases A/c
(Credit purchases)
By Bills payable A/c
(Bills payable dishonoued)
Cr.
To Cash A/c
(B/P paid on due dates)
To Creditors A/c
(B/P dishonoured)
By balance b/d
(B/P in the beginning)
By Creditors A/c
(Bills accepted during the
year)
To balance c/d
(B/P at the end)
Gross Profit Ratio: Sometimes, gross profit ratio (i.e. Gross profit /
Net sales x 100) is given in the question. In that, case, the amount of
gross profit figure in trading account, calculation of missing
information about any one of the items recorded in trading account
can take place. Items recorded in trading account are opening stock,
purchases, direct expenses and closing stock.
Illustration 1:
following
details:
Stock on 1-4-98
Rs.
17,000
Stock on 31-3-999
Purchases during 1998-99
Sales during 1998-99
Gross profit ratio
12,000
000
1,28,000
25%
Dr.
Cr.
To Opening Stock
To Purchases
To Direct Expenses
(Balancing figure)
To Gross Profit
(25%
of
Rs.
17,000 By Sales
77,000 By Closing Stock
14,000
1,28,000
12,000
1,28,000)
1,40,000
1,40,000
Illustration 2:
Data Ram maintains his records on single entry system.
While
records of. business takings and payments have been kept, these have
not been reconciled with cash in hand. From time to time cash has
been paid into a bank account and cheques thereon have been drawn
both for business use and private purposes. From the following
information, prepare the final accounts for the year 1998:
Assets and liabilities at the beginning and at the end of the period
have given below:
Stock
Bank Balance
Cash in hand
1-1-1998
20,000
8,000
300
31-12-1998
15,000
12,000
400
Debtors
Creditors
Investments
14,000
27,300
50,000
20,000
30,000
50,000
1,50,000
59,700
26,000
1,22,000
2,50,000
1,60,000
97,700
7,000
2,000
1,000
4,600
During the year, cash amounting to Rs. 20,000 was stolen from
the till, ucods worth Rs. 24,000 were withdrawn from private use. No
record has been kept of amounts taken from cash for personal use
and a difference in cahs amounting to Rs. 7,300 is treated as private
expenses.
Dr.
To balance b/d
To Sales A/c
To Debtors A/c
(balancing figure)
Cash A/c
300 By Defalcation
2,50,000 By Bank A/c
1,42,000 By Drawings A/c
By Purchases A/c
(1,600,000-57,700)
By Wages A/c
By Delivery Expenses
A/c
By Rent& Rates A/c
By Lighting A/c
By General Exp. A/c
By balance c/d
3,92,300
Cr.
20,000
1,50,000
7,300
1,02,300
97,700
7,000
2,000
1,000
4,600
400
3,92,300
Bank A/c
Dr.
To balance b/d
To Cash A/c
To
Capital
A/c
Cr.
26,000
1,22,000
57,700
(Dividend)
(balancing figure)
By balance c/d
2,17,000
Dr.
12,000
2,17,000
To balance b/d
To Sales A/c
(balancing
1,42,000
20,000
figure)
1,62,000
Dr.
To balance c/d
Sundry Creditors
30,000 By balance b/d
By Purchases A/c (balancing
1,62,000
Cr.
27,300
2,700
figure)
30,000
30,000
Amount
Assets
27,300 Stock
65,000 Bank
Cash
Debtors
Investments
92,300
Amount
20,000
8,000
300
14,000
50,000
92,300
Trading & Profit & Loss A/c for the year ended 31-12-98
To Opening Stock
20,000 By Sales :
A/c
To Wages
To Purchaes :
Cash
97,700 Cash
Credit
By closing Stock
1,60,000
2,50,000
1,48,000
15,000
A/c
Credit
Less Drawings
To Gross Profit
2,700
1,62,000
24,000
To Business Payment
A/c
To Rent & Rates A/c
To Lighting A/c
To General Expenses A/c
To delivery Expenses A/c
To Defalcation A/c
1,38,700
1,56,600
4,13,000
4,13,000
1,56,600
2,000
1,000
4,600
7,000
20,000
1,56,600
1,56,600
Amount
65,000
59,700
1,24,700
57,300
Assets
Investment
Stock
Debtors
Amount
50,000
15,000
20,000
67,400 Bank
12,000
30,000 Cash
97,400
400
97,400
b)
c)
d)
system,
as
the
system
is
adjusted
according
to
c)
d)
g)
h)
Financial
position
Under
double
entry
system,
i)
of historical
costs.
2.
3.
The net income disclosed by the profit and toss account is not
absolute but only relative.
4.
5.
The profit and loss account does not disclose factors like quality
of product, efficiency of the management etc.,
6.
There are certain assets and liabilities which are not disclosed
by the balance sheet. For example the most tangible asset of a
company is its management force and a dissatisfied labour force
is its liability which are not disclosed by the balance sheet.
7.
8.
9.
10.
11.
12.
13.
14.
Financial
statements
do
not
disclose
the
changes
in
15.
Income Statement
There is no legal format for the profit and loss A/C. Therefore, it
can be presented in the traditional T form, or vertically, in statement
form. An example of the two formats is given as under.
Manufacturing,
Trading
and
profit
and
loss
A/C
of
Dr
Cr
Particulars
To opening stock
Raw materials
Work in progress
To purchases of raw
materials
To manufacturing wages
To carriage inwards
To other Factory Expenses
Rs.
Particualrs
By cost of finished Goods
c/d
xxx By closing stock
xxx
Raw materials
Work in progress
xxx
xxx
xxx
xxx
xxx
Rs.
Xxxx
xxx
xxx
By sales
xxx By closing stock of
xxx
xxx
xxx
goods
To cost of Finished goods
finished
goods
xxx By Gross Loss c/d
xxx
xxx
xxx
xxx By Gross profit b/d
xxx By Miscellaneous Receipts
xxx
xxx
xxx
Expense
To Interest and financial
xxx
xxx
xxx
xxx
xxx By Balance b/d
xxx
xxx
b/d
To Gross Profit c/d
expenses
To provision for Income-tax
To Net Profit c/d
To net loss b/d
To general reserve
To Dividend
To Balance c/f
xxx
xxx
xxx
Rs.
Rs.
xxxx
xxx
xxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
(2)
Gross Profit
(1) (2)
Less: Operating Expenses
Office and Administration Expenses
Selling and Distribution Expenses
Operating Profit
Add: Non-operating Income
Less: Non-oprating Expenses (including Interest)
Profit before Tax
Less : Tax
Profit After Tax
Appropriations
Transfer to reserves
Dividend declared /paid
Surplus carried to Balance sheet
xxxx
xxx
xxx
xxx
xxx
Xxxx
Xxx
xxxx
xxx
xxxx
xxx
xxxx
xxxx
xxx
xxx
xxxx
Balance Sheet
The Companies Activities, 1956 stipulates that the Balance
sheet of a joint stock company should be prepared as per part I of
schedule VI of the Activities. However, the statement form has been
emphasized upon by accountants for the purpose of analysis and
Interpretation.
The
permission
of
the
Centra!
Government
is
of
Rs.
Assets
xxx Fixed Assets:
1. Goodwill
Issued,
up capital
Secured Loans
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Rs.
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Debentures
Add: Outstanding Interest
xxx
xxx
xxx
Fixed Deposits
Short-term
loans
and
advances
Current
and
Liabilities
or
xxx adjusted)
xxx
1. Preliminary expenses
Provisions
2.
Discount
xxx
xxx Profit
3.
(Loss),
xxx if any
received
in
advance
4. unclaimed Dividends
5. Other Liabilities
xxx
xxx
B. Provisions
6. Provisions for Taxation
7. Proposed Dividends
8.
Proposed
funds
&
xxx
xxx
xxx
pension
fund contingent
on
Issue
xxx
of
shares
and debentures
3. Underwriting Commssion
A. Current Liabilites
1. Bills Payable
2. Sudnry Creditors
Income
xxx
and
Loss
xxx
xxx
account
liabilities
not
Provided for
xxx
xxx
Particulars
Schedule No.
I. Source of funds
1. Share holders funds
a. capital
b. Reserves and surplus
2. Loans funds
a. Secured Loans
b. Unsecured Loans
Total
II. Application of funds
1. Fixed Assets
a. Gross Block
b. less Deprciation
c. Net block
d. Capital work in progress
Current
Previous
year
Year
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
2. Investments
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Particulars
Rs.
ASSETS
Current Assets
Cash and Bank Balances
Debtors
Stock
Other Current Assets
(1)
xxxx
xxxx
xxxx
xxxx
xxxx
Fixed Assets
Less: Depreciation
Investments
(2)
Total (1) + (2)
LIABILITIES
Current Liabilities :
Bills Payable
Creditors
Other Current Liabilities
(3)
Long Term Debt
Debentures
Other Long-term Debts
(4)
Capital and Reserves
Share Capital
Reserves and surplus
(5)
Total Long term funds
Total (3)+(4)+(5)
xxxx
xxxx
xxxx
xxxx
xxxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxxx
Particulars
Rs.
Particulars
Rs.
To
transfer
to
Reserves
To Dividend
xxx By
Last
years
xxx
balance
xxx By Current Years net
xxx
profit
(Transferred
xxx
xxx By Excess provisions
(which are no longer
required)
By
Reserves
xxx
withdrawn
(if any)
xxx
xxxx
xxx
Illustration: 1
From
the
following
information,
prepare
vertical
Income
Statement.
Sales
Opening stock
Closing stock
Purchases
Operating Expenses
2,00,000
10,000
15,000
40,000
12,000
Rs.
Rs.
2,00,000
10,000
40,000
50,000
15,000
35,000
1,65,000
12,000
1,53,000
4,000
1,49,000
74,500
74,500
Gross Profit
Less: operating expenses
Operating profit
Less: non-operating expenses
Profit before tax
Less: Income tax (50%)
Net profit after tax
Illustration: 2
Particulars
Sales
Cost of goods sold
Administration expenses
Selling expenses
Non -operating expenses
Non-operating expenses
Sales returns
Tax rate
Rs.
58,000
47,600
1,016
1,840
140
96
2000
43.75%
Rs.
65,200
49,200
1,000
1,920
155
644
1,200
43.75%
Solution:
Comparative Income Statement of Mohan Ltd., for the years
2000 and 2001.
Particulars
Sales
Less Returns
Net sales
Less: Cost of Goods sold
Gross Profit
(A)
Less: Operating expenses
Administration expenses
Selling expenses
Total operating expenses (B)
Operating profit
(A)-(B)
Add: non - operating incomes
Less: non- operating expenses
2000
2001
Rs.
58,000
2,000
56,000
47,600
8,400
Rs.
65,200
1,200
64,000
49,200
14,800
1,016
1,840
2,856
5,544
96
5,640
140
5,500
2,406
3094
1,000
1,920
2,920
11,880
644
12,524
155
12,369
5,411
6,958
Comparative Statements
Trend Analysis
Ration Analysis
The first three topics are covered in this chapter and the rest are
discussed in the subsequent chapters in detail.
ii.
iii.
iv.
v.
Percentage of totals.
Weaknesses:
Inter-firm comparison can be misleading if the firms are not
identical in size and age and when they follow different accounting
procedures with regard to depreciation, inventory valuation etc.,
Inter-period comparison may also be misleading if the period
has witnessed changes in accounting policies, inflation, recession etc.
Illustration 3:
The following is the profit and loss account of Ashok Ltd., for
the years 2000 and 2001. Prepare comparative Income Statement and
comment on the profitability of the undertaking.
Particulars
To Cost of
goods sold
To Office
2000
2001
Particulars
Rs.
Rs.
2,31,625 2,41,950 By Sales
23,266
27,068 Less
expenses
45,912
expenses
To Loss on
627
57,816
5,794
6,952
3,54,934
4,10,173
1,896
1,750 By Other
sale of
Tax
To Net
2001
Rs.
4,17,125
Returns
To Interest
fixed
To Income
2000
Rs.
3,60,728
incomes :
21,519
40,195 By Discount
2,125
35,371
on purchase
44,425 By Profit on
1,500
Profit
sale of land
3,60,457 4,13,379
3,60,457
4,13
,379
Solution:
ASHOK LTD.
Comparative Income Statement for the years ending 2000 and 2001
Particulars
Sales
Less: Sales returns
Less: Cost of goods
sold
Gross Profit
Operating Expenses:
Office
Increase (+)
Decrease (-)
Decrease (-)
Amount
Percentages
3,60,728 4,17,125
5,794
6,952
3,54,934 4,10,173
2,31,625 2,41,950
(Rs.)
+56,397
+1.158
+55,239
+ 10,325
+15.63
+19.98
+15.56
+4.46
1,23,309 1,68,223
+44.914
+36.42
23,266
27,068
+3,802
+ 16.34
expenses
Selling
45,912
57,816
+11,904
+25.93
expenses
Total operating
69,178
84,884
+15,706
+22.70
Less: Other
54,131
5,523
59,654
2,764
83,339
3,206
86,545
1,925
+29,208
-2,317
+26.891
-839
+53.96
-41.95
+45.08
-30.35
expenses
Profit before tax
Less: Income tax
Net Profit after tax
56,890
21,519
35,371
84,620
40,195
44,425
+27,730
+18,676
+9,054
+48.74
+86.79
+25.60
expenses
Operating profit
Add: Other incomes
Illustration: 4
The following are the Balance Sheets of Gokul Ltd., for the years
ending 31s1 December, 2000,2001.
Particulars
2000
Liabilities
Equity share capital
Preference share capital
Reserves
Profit and Loss a/c
Bank overdraft
Creditors
Provision for taxation
Proposed Dividend
Total
2001
Rs.
Rs.
2,00,000
1,00,000
20,000
15,000
50,000
40,000
20,000
15,000
4,60,000
3,30,000
1,50,000
30,000
20,000
50,000
50,000
25,000
25,000
6,80,000
2,40,000
40,000
1,00,000
20,000
10,000
40,000
10,000
4,60,000
3,50,000
50,000
1,25,000
60,000
12,000
53,000
30,000
6,80,000
Fixed Assets
Less: Depreciation
Stock
Debtors
Bills Receivable
Prepaid expenses
Cash in hand
Cash at Bank
Total
Solution:
Comparative Balance Sheet
31st Dec.
31st Dec.
Inerease(+)
Increase(+)
2000
2001
Decrease(-)
Decrease(-)
Rs.
Rs.
Amount(Rs.)
Percentages
50,000
83,000
+33,000
+66
20,000
1,00,000
40,000
60,000
1,25,000
50,000
+40,000
+25,000
+10,000
+200
+25
+25
10,000
12,000
+2,000
+20
2,20,00
2,40,000
3,30,000
3,50,000
+1,10,000
+1,10,000
+50
+45.83
Total Assets
4,60,000
6,80,000
2,20,000
47.83
Bank overdraft
Creditors
Proposed dividend
50,000
40,000
15,000
50,000
50,000
25,000
+10,000
+10,000
+25
+66.67
20,000
25,000
+5,000
+25
1,25,000
1,50,000
+25,000
+20
Liabilities
Capital and Reserve:
Equity share capital
2,00,000
3,30,000
+1,30,000
+65
Preference
1,00,000
1,50,000
+50,000
+50
capital
Reserves
20,000
30,000
+10,000
+50
15,000
20,000
+5,000
+33.33
3,35,000
5,30,000
+1,95,000
+58.21
Particulars
ASSETS
Current Assets:
Cash at bank and in
hand Bills receivable
Debtors
Stock
Prepaid expenses
LIABILITIES
Current Liabilities:
Total
Current
share
Total Liabilities
4,60,000
6,80,000
+2,20,000
+47.83
Interpretation:
1.
2.
The fixed assets purchased was for Rs, 1,10,000. As there are
no long-term funds, it should have been purchased partly from
Share Capital.
3.
Reserves and Profit and Loss a/c increased by 50% and 33.33%
respectively. The company may issue bonus shares in near
future.
4.
Illustration: 5
Common Size Income Statement of XYZ Ltd., for the year ended
31st March, 2001.
Particulars
Sales
Amount (Rs.)
(A)
% to Sales
14,00,000
100
Raw materials
5,40,000
16.4
Direct wages
2,30,000
16.4
Faciory expenses
1,60,000
11.4
9,30,000
66.4
(A) -
4,70,000
33.6
Administrative
1,10,000
7.9
distribution
80,000
5.7
2,80,000
20.0
40,000
2.9
3,20,000
22.9
60,000
43
2,60,000
18.6
80,000
5.7
1,80,000
12.9
(B)
GrossProfit
(B)
Less:
expenses
Selling
and
expenses
Operating Profit
Add: Non-operative income
Less:
Non-operating
expenses
Profit before tax
Less: Income tax
Profit after tax
Particulars
Amount (Rs.)
% to Total
ASSETS
Fixed Assets
Land
50,000
5.3
Buildings
1,10,000
11.7
2,50,000
26.6
Raw materials
80,000
8.5
Work-in-progress
50,000
5.3
Finished goods
1,60,000
17.0
Sundry debtors
2,10,000
22.4
30,000
3.2
9,40,000
100.0
2,50,000
26.6
1,00,000
10.6
General reserve
1,60,000
17.0
80,000
8.5
2,20,000
23.4
40,000
4.3
Bills payable
90,000
9.6
9,40,000
100.0
Current Assets :
Inventory
Cash at Bank
Total
Capital and Liabiltiies
Debentures
Current Liabilities
Sundry Creditors
llustration: 6
2000
Rs.
12,000
To Cost of goods
sold
To Administrative
expenses
To
Selling
expenses
To Net Profit
2001
Particulars
Rs.
1 5,000 By Net Sales
400
400
600
800
2000
Rs.
16,000
3,000
3,800
16,000
20,000
16,000
2000
2001
Net sales
Rs.
%
Rs.
%
16,000 100.00 20,000 100.00
12,000
Gross
Profit
Less:
7500
4,000
25.00
5,000
25.00
400
2.50
400
2.00
Operating
expenses
Administration
expenses
Selling expenses
Total
75.00 15,000
600
Operating 1,000
3.75
800
4.00
6.25
1,200
6.00
18.75
3,800
19.00
expenses
Net Profit
3,000
2001
Rs.
20,000
20,000
Illustration: 7
Following are Balance sheet of Vinay Ltd. for the year ended 31 st
December 2000 and 2001.
Liabilities
Equity capital
2000
2001
Rs.
Rs.
1,00,000
Assets
2000
Rs.
2001
Rs.
1 ,20,000 1,75,000
Pref. Capital
50,000
75,000 Stock
20,000
25,000
Reserves
10,000
15,000 Debtors
50,000
62,500
P&L A/c
7,500
10,000
30,000
Creditors
20,000
20,000
26,500
Provision
10,000
5,000
15,000
for taxation
Proposed
7,500
12,500
2,30,000
3,40,000
dividends
2,30,000 3,40,000
Solution;
Particulars
Rs.
Capital & Reserves:
Equity Capital
2000
%
1,00,000
Rs.
2001
%
43,48 1 ,65,000
48.53
Pref. Capital
Reserves
P&L A/c
50,000
10,000
7,500
1,67,500
21,74
4.34
3.26
72.82
75,000
15,000
10,000
2,65,000
22.05
4.41
2.95
77.94
Bank overdraft
Creditors
Provisions for taxation
25,000
20,000
10,000
10.87
8.70
4.35
25,000
25,000
12,500
7.35
7.35
3.68
Proposed dividends
(ii)
Total Liabilities (ij + (ii)
7,500
62,500
2,30,000
3.26
27.18
100.00
12,500
75,000
3,40,000
3.68
22.06
100.00
1,20,000
52.17
1,75,000
51.47
20,000
50,000
10,000
8.70
21.74
4.34
25,000
62,500
30,000
7.35
18.38
8.82
(i)
Current Liabilities:
(a)
Cash al bank
Cash in hand
20,000
8.70
26,500
7.79
5,000
2.18
15,000
4.41
(b)
1,10,000
47.83 1,65,000
48.53
Total Asses (a + b) 2,30,000 100.00
3,40,000 100.00
Interpretation :
(1)
(2)
(3)
(4)
TREND ANALYSIS
In trend analysis ratios of different items are calculated for
various periods for comparison purpose.
.done
by
trend
percentage,
diagrammatic representation.
trend
and
graphic
and
Illustration: 8
From the following data, calculate trend percentage taking 1999
as base.
Particulars
1999
Rs.
2000
Rs.
2001
Rs.
Sales
50,000
75,000 1,00,000
Purchases
40,000
60,000
72,000
Expenses
5,000
8,000
15,000
Profit
5,000
7,000
13,000
Solution:
Particulars
1999 Rs.
2000
Rs.
Rs.
Rs.
Purchases
Rs.
1999
2000
2001
40,000
60,000
72,000
100
150
180
Expenses
5,000
8,000
15,000
100
160
300
Profit
5,000
7,000
13,000
100
140
260
Sales
50,000
75,000
1,00,000
100
150
200
Illustration: 9
From the following data, calculate trend percentages (1999 as
base)
Particulars
1999
2000
2001
Rs.
Rs.
Rs.
Cash
Debtors
200
400
240
500
160
650
Stock
600
800
700
450
600
750
Land
800
1,000
1,000
Buildings
1,600
2,000
2,400
Plant
2,000
2,000
2,400
Solution:
Particulars
Rs.
Rs.
Cash
200
240
160
100
120
80
Debtors
400
500
650
100
125
163
450
600
Other
Current
750
100
133
167
Assets
Total
100
130
137
100
125
125
Buildings
100
125
150
Plant
100
100
120
100
114
132
Assets
Fixed Assets:
Land
LESSON-10
RATIO ANALYSIS
INTRODUCTION
The financial statements viz. the income statement, the Balance
sheet The Income statement, the Statement of retained earnings and
the Statement of changes in financial position report what has
actually happened to earnings during a specified period. The balance
sheet presents a summary of financial position of the company at a
given point of time. The statement of retained. earnings reconciles
income earned during the year and any dividends distributed with the
change in retained, earnings between the start and end of the
financial. year under study. The statement of changes in financial
position provides a summary of funds flow during the period of
financial statements.
interrelationship
among
the
figures
appearing
in
the
CATEGORIES OF RATIOS
The ratio analysis is made under six broad categories as follows:
Profitability ratios
Activity ratios
Operating ratios
Debt-Equity Ratio
Proprietary Ratio
Dividend Cover
Interest Cover
1. Debt-Equity Ratio:
Capital is derived from two sources: shares and loans. It is quite
hkely for only shares to be issued when the company is formed, but
loans are invariably raised at some later date. There are numerous
reasons for issuing loan capital. For instance, the owners might want
to increase their investment but avoid the'risk which attaches to share
capital, and they can do this by making a secured loan. Alternatively,
management might require additional finance which the shareholders
The use of debt capital has direct implications for the profit
accruing to the ordinary shareholders, and expansion is often
financed in this manner with the objective of increasing the
shareholders' rate of return. This objective is achieved only if the rate
earned on the additional funds raised exceeds that
payable to the
The
shareholders
of
highly
geared
company
reap
Shareholders Equity
Total assets (tan gible)
The ratio compares long-term debt to the net worth of the firm
i.e., the capital and free reserves less intangible assets. This ratio is
finer than the debt-equity ratio and includes capital which is invested
in fictitious assets like deferred expenditure and carried forward
tosses. This ratio would be of more interest to the contributories of
long-term finance to the firm, as the ratio gives a S factual idea of the
assets available to meet the long-term liabilities.
Fixed Assets
Long - term Funds
6. Proprietor Ratio :
It express the relationship between net worth and total asset
Net worth
Total Assets
Net
worth
Equity
Share
Capital-t-Preference
Share
7. Interest Cover:
Profil before interest depreciationand tax
Interest
8. Dividend Cover :
Net Profit after tax
Dividend
value in money, the most liquid of assets. It refers to the ability to pay
in cash, the obligations that -are due.
The
1. Current Ratio :
This ratio measures the solvency of the company in the shortterm. Current assets are those assets which can be converted into
cash within a year. Current liabilities and provisions are those
liabilities that are payable within a year. A current ratio 2:1 indicates
a highly solvent position. A current ratio 1.33:1 is considered by
banks as the minimum acceptable level for providing working capital
finance. The constituents of the current assets are as important as the
current assets themselves for evaluation of a company's solvency
position, A very high current ratio will have adverse impact on the
profitability of the organisation. A high current ratio may be due to the
piling up of inventory, inefficiency in collection of debtors, high
balances in Cash and Bank accounts without proper investment
2. Quick Ratio or Liquid Ratio:
obligations.
Since
bank
overdraft
is
secured
by
the
Current Liabilities
1. Inventory :
Sales
Average Inventory
Average inventory =
The higher the stock turn over rate the lower the stock turnover
period the better, although the ratios will vary between companies. For
example, the stock turnover rate in a food retailing company must be
higher than the rate in a manufacturing concern. The level of
Inventory
X 100
Current Assets
2. Debtors :
The three main debtor ratios are as follows:
Average debtors
X 365
Credit Safes
ratio indicates
the
efficiency
of
the
credit
control
3. Creditors:
(i) Creditors Turnover Period
The measurement of the creditor turnover period shows the
average time taken to pay for goods and services purchased by the
company. The formula is:
Average creditors
Purchases
X 365
This ratio will be analysed further with ratios for each main
category of asset This is a difficult set of ratios to interpret as asset
values are based on historic cost An increase in the fixed asset figure
may result from the replacement of an asset at an increased price or
the purchase of an additional asset intended to increase production
capacity. The later transaction might be expected to result in
increased sales whereas the former would more probably be reflected
in reduced operating costs.
Working capital
This ratio indicates the extent of working capital turned over in
achieving sales of the firm.
Capital employed
This ratio indicates, efficiency in utilisation of capital employed
in generating revenue.
Profitability Ratios
The purpose of study and analysis of profitability ratios are to
help assess the adequacy of profits earned by the company and also to
discover
whether
profitability
is
increasing
or
declining.
The
X 100
Invested capital
ROI consists of two components viz, I. Profit margin, and fl.
Investment turnover, as shown below:
ROI
= Net profit
Investment
= Net profit
Sales
Sales
Investment in assets
It will be seen from the above formula that ROI can be improved
by increasing one or both of its components viz., the profit margin and
the investment turnover in any of the following ways:
The obvious generalisations that can be made about the ROI formula
are that any action is beneficial provided that it:
Boosts sales
xxx
xxx
xxx
A/c
Capital employed
xxx
xxx
xxx
xxx
xxx
xxx
return.
In
selecting
amongst
alternative
long-term
(EBIT 1) (1 T)
N
(EBIT I ) (1 T) - DP
N
Where
EPS is one of the most important ratios which measures the net
profit earned per share. EPS is one of the major factors affecting the
dividend policy of the firm and the market prices of the company.
Growth in EPS is more relevant for pricing of shares from absolute
EPS. A steady growth in EPS year after year indicates a good track of
profitability.
Sales
Sales
The ratio measures the gross profit margin on the total net sales
made by the company. The grosi, profit represents the excess of sales
proceeds during the
cost,
before
taking
1 period
into
under
observation
over
their
(i)
the
(ii)
Price cuts:
during period
(iii)
X 100
Sales
The ratio is designed to focus attention on the net profit margin
arising from business operations before interest and tax is deducted.
The convention is to express profit after tax and interest as a
percentage of sales. A drawback is that the percentage which results,
varies depending on the sources employed to finance business activity;
interest is charged 'above the line while dividends are deducted 'below
the line'. It is for this reason that net profit i.e. earnings before interest
and tax (EBIT) is used.
This ratio reflects nt: profit margin on the total sales after
deducting all expenses but before deducting interest and taxation.
This ratio measures the efficiency of operation of the company. The
net
profit
is
arrived
at
from
gross
profit
after
deducting
measure will depict the correct trend of performance where there are
erratic fluctuations in the tax provisions from year to year. It is to be
observed that majority of the costs debited to the profit and loss
account are fixed in nature and any increase in sales will cause the
cost per unit to decline because of the spread of same fixed cost over
the increased number of units sold.
X 100
Sales
7. Return on Assets :
This ratio is calculated as follows:
X 100
Total assets
The profitability, of the firm is measured by establishing relation
of net profit with the total assets of the organisation. This ratio
indicates the efficiency of utilisation of assets in generating revenue.
X 100
Net worth
funds.
This
ratio
is
an
important
yardstick
of
Operating Ratios
The ratios of all operating expenses (i.e. materials used, labour,
factory-overheads, administration and selling expenses) to sales is the
operating ratio. A comparison of the operating ratio would indicate
whether the cost content is high or low in the figure of sales. If the
annual
comparison
shows
that
the
sales
has
increased
the
1.
= MaterialsConsumed
X 100
Sales
2.
X 100
= Labour Cost Sales
Sales
3.
X 100
= Factory Expenses
Sales
4.
X 100
= Administrative Expenses
Sales
5.
expenses ratio
1.
2.
Dividend yield
3.
Book value
4.
Price/Earnings ratio
2. Dividend Yield
Dividend per share
X 100
Market price
3. Book Value:
Equity Capitalf +Reserves - Prqfit&Lass debit balance.
Total number of equity shares;
This ratio indicates the net worth per equity share. The book
value is a reflection of the past earnings and the distribution policy of
the company. A high book value indicates that a company has huge
reserves and is a potential bonus candidate. A low book value signifies
liberal distribution policy of bonus and dividends, or alternatively, a
poor track record of profitability. Book value is considered less
relevant for the m^ker price as compared to EPS, as it reflects the past
record whereas the market discounts the future prospects.
It
compared with:
a norm or a target
the ratios achieved in other com; arable companies (intercompany comparisons), and
Debt-equity ratio
(b)
Liquid ratio
(c)
(d)
Share Capital
Reserve
Profit and Loss a/c
Secured Loans
Creditors
Provisions for taxation
Rs.
1,00,000
20,000
30,000
80,000
50,000
20,000
3,00,000
Assets
Goodwill
Fixed assets (Cost)
Stock
Debtors
Advances
Cash
Rs.
60,000
1,40,000
30,000
30,000
10,000
30,000
3,00,000
Solution:
(a) Debt-equity ratio =
Outsiders Funds
Shareholders Funds
Outsider's Funds
Rs.
Shareholders'
Rs.
Secured Loans
Funds
80,000 Share Capital
Creditors
50,000 Reserves
20,000
30,000
1,00,000
1,50,000
1,50,000
70,000
= 0.47:1
1,50,000
Fixed Assets
Current Liabilities
Fixed Assets = 1,40,000
Cash
30,000
Stock
30,000
Debtors
30,000
Advances
10,000
1,00,000
1,40,000
= 1.4:1
1,00,000
Fixed Assets
Net worth
Share Capital
Reserves
P & L a/c
1,00,000
20,000
30,000
1,50,000
20,000
1,30,000
1,40,000
1,30,000
= 1.08:1
Current ratio
(b)
Quick ratio
(c)
(d)
Operating ratio
(e)
Liabilities
Equity
Capital
shares)
Profit
Rs.
Share
(Rs.
and
account
Creditors
Bills payable
10
loss
Assets
1,00,000 Plant
Rs.
and
6,40,000
Machinery
1,04,000 Cash
2,00,000 Debtors
80,000
1, 60,000
3,60,000
Less: Provision for
3,20,000
bad
Other
debts
40,000
20,000 Stock
Current
4,80,000
liabilities
Prepaid Insurance
16,92,000
12,000
16,92,000
4,00,000
30,80,000
9,20,000
6,80,000
2,40,000
1,20.000
1,20,000
Rs. 3,00,000
Stock
Rs. 4,00,000
Solution:
(a) Current ratio =
Current Assets
Current Liabilities
Current Assets
Rs.
Current Liabilities
Cash
Creditors
Rs.
1,04,000
Debtors
Stock
4,80,000 Other
2,00,000
Current
20,000
Liabilities
Prepaid insurance
12,000
9,72,000
Current ratio
Liquid Assets
3,24,000
9,72,000
3:1
3,24,000
Current Liabilities
Liquid assets
Cash Debtors
(Rs.)
1,60,000
3,20,000
4,80,000
Liquid ratio =
4,80,000
= 1.48:1
3,24,000
= 4,00,000 + 4,80,000
= 4,40,000
= 7 times
4,40,000
X 100
= 30,80,000 + 6,80,000 + 40,00,000
40,00,000
1,20,000
= 12%
X 100
10,00,000
Illustration 3: The following are the Trading and P&L A/c for the year
ended 31st December 2001 and the Balance Sheet as on that date of
K. Ltd.
Trading and P & L A/c
Particulars
To Opening Stock
To Purchases
To Wages
To Gross Profit
Rs.
Particulars
9,950 By Sales
54,5.25 By Closing Stock
1,425
34,000
Rs.
85,000
14,900
To
Administrative
99,900
99,900
34,000
Expenses
To Selling Expenses
3,000 By Interest
300
To Financial Expenses
600
of shares
To Loss on sale of assets
400
To Net Profit
15,000
34,900
34,900
Balance Sheet
Liabilities
Rs.
Share Capital
Assets
Reserves
Current Liabilities
13,000 Stock
P&LA/c
6,000 Debtors
Cash at Bank
48,000
Solution:
(a) Current ratio
Current Assets
Current Liabilities
Rs.
15,000
8,000
14,900
7,1000
3,000
48,000
Current Assets
(Rs.)
Cash at Bank
Current liabilities
Debtors
Stock
3,000
Rs. 13,000
7,100
14,900
25,000
Current ratio
Rs. 1.923:1
= 25,000
13,000
Operating expenses
Operating Ratio
= 51,000
= 19,500
= 51,000 + 19,500
X 100
= 82.94%
85,000
9,950 + 14,900
2
= 12,425
51,000
= 4.1 times
12,425
Net Profit
= 100
Net Sales
= 15,000
= 17.65%
= 100
85,000
= Net Sales
Fixed Assets
= 85,000
= 3.7 times
23,000
Illustration 4; The following is the Trading and Profit and Loss a/c
and Balance Sheet of a firm.
Rs.
Particulars
To Opening Stock
10,000 By Sales
To Purchases
50,000
1,15,000
To Administrative Expenses
Rs.
1,00,000
15,000
1,15,000
50,000
To Interest
3,000
To Selling Expenses
12,000
To Net Profit
20,000
50,000
50,000
Balance Sheet
Liabilities
Rs.
Capital
Assets
Rs.
50,000
30,000
Creditors
25,000 Stock
15,000
Bills Payable
15,000 Debtors
15,000
Bills receivable
12,500
Cash at Bank
17,500
Furniture
20,000
1,60,000
1,60,000
10,000
55,000
65,000
1 5,000
50,000
Average Stock = Opening Stock + Closing Stock
2
= 10,000 + 15,000
= 12,500
= 4 times
12,500
Current Assets
(Rs.)
Current Assets
Rs.
Current liabilities
Rs.
Stock
15,000 Creditors
25,000
Debtors
15,000
B/R
12,500
Cash at Bank
17,500
60,000
40,000
= 1.5:1
40,000
(b) Gross Profit Ratio = Gross Profit
X 100
= 50%
Net Sales
X 100
Net Sales
= 20%
= 20,000
1,00,000
= 100
Net Sales
Cost of goods sold = 50,000
Operating expenses
(Rs.)
15,000
12,000
27,000
Operating ratio
77 %
1,00,000
(Rs.)
Liquid Assets
Cash at Bank
Bills Receivable
Debtors
Rs.
Current liabilities
17,500 Creditors
12,500 Bills Payable
15,000
45,000
X 100
Rs.
25,000
15,000
40,000
Shareholder's Furuis
(Rs.)
1,00,000
Rs. 1,60,000
20,000
1,20,000
= 75%
X 100
1,60.000
(ii)
(iii)
Return on investment
(i)
= 75%
= 40%
= 60%
= 15% x 4
Illustration
6:
There
= 60%
are
three
companies
in
the
country
Net Sales
A Ltd.
300
255
125
B Ltd.
1,500
1,200
750
C Ltd.
1,400
1,050
1,250
A Ltd.
300
255
45
125
36%
B Ltd.
1,500
1,200
300
750
40%
C Ltd.
1,400
1,050
350
1,250
28%
(A) / (B) x 1 00
Analysis:
Basing on the return on capital employed, B
Ltd., is the
7:
Calculate
the
P/E
ratio
from
the
following:
(Rs.)
50,00,000
5,00,000
25,00,000
10,00,000
30,00,000
5,00,000
Operating Profit
25,00,000,
Income-taxRate50%
(Rs.)
Operating Profit
Less: Interest on
Secured Loans @ 15%
25,00,000
3,75,000
1,25,000
5,00,000
20,00,000
10,00,000
10,00,000
2,50,000
Rs. 10,00,000
= Rs. 4
Rs. 2,50,000
= Rs. 50
P/E Ratio
= 12.50
50,00,000
70,00,000
1,20,00,000
Additional information:
Profit after tax at 50%
Rs. 15,00,000
Deprication
Rs. 6,00,000
10%
(ii)
(iii)
(iv)
Solution:
(i) The cover for the Preference and Equity dividends:
Profit after tax
= Preference dividend + Equity dividend
= Rs. 15,00,000
= 1.25 times
= Rs. 14.29
Rs.7,00,000
= Rs.200
= 14 times
Rs. 14.29
15,00,000
Add: Depreciation
6,00,000
21,00,000
LESSON-II
FUNDS FLOW ANALYSIS
INTRODUCTION
The Profit and Loss account and Balance Sheet statements are
the
common
organisation.
important
The
Profit
accounting
statements
and
account
Loss
of
business
provides
financial
The Funds flow statement contain all the details of the financial
resources which have became available during an accounting period
and the ways in which those resources have been used up. This
statement discloses the amounts raised from various sources of
finance during a period and. then explains how that finance has been
used in the business. This statement is valuable in interpretation of
the accounts.
Concept of'Fund
Concept of Flow
The flow of funds refer to transfer of economic values from one
asset equity to another. When 'funds' mean working capital, flow of
funds refers to movement of funds which cause a change in working
capital of the organisation. To identify a 'flow' of funds, we have to
understand the difference between Current and Non-Current account
Liabilities
1. Non-Current Liabilities
Equity Share Capital
Preference Share Capital
Reserves and Surplus
Debentures
Long-term loans
Rs.
XXX
XXX
XXX
XXX
Non-Current Liabilities
Assets
II. Non-Current Assets
Land
Buildings
Plant and Machinery
Less: Depreciation
Furniture and Fittings
Rs.
XXX
XXX
XXX
Vehicles
Patents
XXX
XXX
XXX
XXX
Goodwill
XXX
Preliminary expenses
XXX
XXX
balance)
Total (A)
XXX
Total (A)
XXX
Total (A)
XXX
Trade Creditors
XXX
Inventories
XXX
Bank Overdraft
XXX
Trade Debtors
XXX
XXX
Bills Receivable
XXX
XXX
XXX
XXX
Investments Temporary)
XXX
Total (B)
Grand Total (A+B)
XXX
XXX
Total (B)
Grand Total (A+B)
XXX
XXX
General Rule
Transactions which involve one Current Account and one NonCurrent Account results in a flow of funds.
Table
2:
PROFORMA
OF
STATEMENT
OF
SOURCES
AND
APPLICATION
OF FUNDS
Stage 1: Statement of Sources and Application of Funds of XYZ Ltd.,
for the year ended 31st March, 2001.
Rs.
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
changes in w.c)
Total
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
changes in w.c)
Total
xxx
Sources
Rs.
Applications
Rs.
Issue of Debentures
capital
xxx Redemption of Debentures:
Raising
loans
of
xxx
xxx
xxx
of
long-term xxx
(fixed) assets :
Non-trading
of
long-term xxx
Investments
receipts xxx Purchase
such as dividends
investments
Sale
of
long-term xxx Payment of Dividends
xxx
Investments
Net Decrease in Working xxx Payment of tax*
xxx
Capital
Net Increase in Working Capital
xxx
xxx
xxx
statement
Application, of Funds.
follows
the
Statement
of
Sources
and
shown. The changes taking place with respect to each account should
add up to equal the ; net change in working capital, as shown by the
The relation between Stage I and Stage II is given below in the figure:
Stage I :
capital
has
been
used
up,
i.e.
list
the
Stage IIl :
SOURCES OF FUNDS
The funds inflow into the organisation will come from the following
sources:
The provision for tax made in the profit and loss account is to
be added back to the reported profit The actual amount paid as
tax is to be shown as the' application of funds in the funds flow
statement. The provision for tax, if it' is shown in the balance
sheet, need not be considered for calculation of funds! generated
fro operations.
The long-term funds injected into the business during the year
by issue of new shares or debentures and by raising long-term loans.
If any premium is collected, that is also form part of funds raised from
the above said sources of finance.
APPLICATION OF FUNDS
1.
2.
3.
Distribution of Dividends
4.
The amount Rs. 35,000 is transferred to Adjusted Profit and Loss a/c
and the tax paid Rs.25,000 is shown on the applications side of the
Funds Flow Statement
Particulars
31-3-2000
Rs.
50,000
10,000
5,000
P&L A/c
Provision for Taxation
Proposed Dividends
31-23-2001
Rs.
80,000
15,000
10,000
Additional Information
1)
Rs.
2)
2,500
Particulars
To Income Tax A/c
(tax paid|)
Rs.
Particulars
2,500 By balance b/d
(opening balance)
Rs.
10,000
To Balance c/d
(closing balance)
7,500
Particulars
To Dividend A/c
Rs.
Particulars
1,000 By Balance b/d
17,500
Rs.
5,000
(Opening balance)
(closing balance
6,000
11,000
Rs.
Particulars
7,500 By Balance b/d
Taxation
A/c
To proposed Dividend
Rs.
50,000
(opening balance)
43,500
Operations
(bal. fig.)
To Balance c/d
80,000
(closing balance
93,500
93,500
(ii)
Rs.
Particulars
5,000 By Balance b/d
35,000 By Adjusted P&L A/C
Rs.
30,000
10,000
(balancing figure)
40,000
40,000
Machinery A/c
Particulars
To Balance b/d
To Share Capital
Rs.
Particulars
80,000 By cash (sales)
20,000 By Accumulated
Rs.
7,000
5,000
depreciation
1,15,000 By Adjusted P & L A/c
To Cash-Purchases
(balancing figure)
(Loss on sale)
By Balance c/d
3,000
2,00,000
2,15,000
2,15,000
Accumulated Depreciation A/c
Particulars
To Accumulated
Depreciation A/c
To Machinery A/c (Loss
on sale)
To Balance c/d
Rs.
Particulars
Rs.
3,000 By
Funds
25,000
from
(i)
28,000
53,000
(ii)
(iii)
Rs.
1,32,500
1,97,500
45,000
of the year
Provision for Depreciation on Plant at the end of the
61,000
year
During the year, a plant costing Rs. 65,000 was purchased in
exchange for fully paid debentures. An old Plant costing Rs. 40,000
was sold for Rs.34,000. Depreciation provided on the same amounted
to Rs.18,000.
Particulars
To Machinery A/c
Rs.
Particulars
Rs.
4,24,000
(Depn.
of sold Machine)
To Closing balance c/d
27,000
4,51,000
4,51,000
Illustration 8 :
Extracts from Balance Sheets
Particulars
As on 31st
As on 31st March
March,
2001
2000
Rs.
4,00,000
2,00,000
Rs.
5,00,000
1,50,000
Additional Information :
(i)
(ii)
Particulars
Rs.
To Machinery A/c
Particulars
Rs.
4,24,000
(Depn.
of sold Machine)
To Closing balance c/d
27,000
4,51,000
Rs.
To Balance c/d
Particulars
Rs.
4,00,000
By Machinery A/c
50,000
By Cash-Issue (balancing
50,000
figure)
5,00,000
5,00,000
Rs.
Particulars
To cash (Application)
To Balance c/d
Rs.
2,00,000
50,000
figure)
2,50,000
2,50,000
1.
2.
3.
4.
Illustration 9 :
Prepare a statement showing changes in working capital
Particulars
2000
Assets
Cash
Debtors
Stock
Land
Total
Capital & Liabilities
Share Capital
Creditors
Retained earnings
Total
2001
60,000
2,40,000
1,60,000
1,00,000
5,60,000
94,000
2,30,000
1,80,000
1,32,000
6,36,000
4,00,000
1,40,000
20,000
5,60,000
5,00,000
90,000
46,000
6,36,000
Particulars
Current Assets
Cash
Debtors
Stock
2000
60,000
2,40,000
1,60,000
4,60,000
2001
94,000
2,30,000
1,80,000
5,04,000
Increase
Decrease
(+)
(-)
34,000
10,000
20,000
Current Liabilities
Creditors
Working Capital (CA-
1,40,000
3,20,000
CL)
Net increase in
90,000
4,14,000
50,000
94,000
94,000
Working Capital
4,14,000
4,14,000
1,04,000
1,04,000
Liabilities
2000
2001
Assets
2000
2001
1,00,000
1,25,000
Goodwill
2,500
General Reserve
25,000
30,000
Buildings
1,00,000
95,000
P&L A/c
15,250
15,300
Plant
75,000
84,500
Bank Loan
35,000
67,600
Stock
50,000
37,000
(Long-term)
Creditors
75,000
Debtors
40,000
32,100
15,000
17,500
Bank
4,000
Cash
250
300
2,65,250
2,55,400
Share Capital
2,65,250
2,55,400
Additional Information:
(i)
(ii)
(iii)
Provision for tax was made during the year Rs. 16,500.
2000
2001
Increas
Decrease
(-)
(+)
Current Assets
Cash
Bank
250
-
Debtors
Stock
300
4,000
50
4,000
40,000 32,100
50,000 37,000
7,900
13,000
90,250 73,400
Current Liabilities
Creditors Working
75,000
75,000
15,250 73,400
8,150
58,150
Capital
73,400 73,400
79,050
79,050
Rs.
Application
Rs.
Funds from
45,050
Purchase of Plant
16,500
operations
Issue of Shares
25,000
14,000
Hank Loan
32,600
Dividend paid
11,500
Goodwill paid
2,500
Net increase in
58,150
Working Capital
1,02,650
1,02,650
Working Notes:
Share Capital A/c
Particulars
To Balance c/d
Rs.
1,25,000
Particulars
By Balance b/d
By Bank a/c
1,25,000
Rs
1,00,000
25,000
1,25,000
Rs.
30,000
Particulars
By Balance b/d
By P&L a/c
30,000
Rs.
25,000
5,000
30,000
Rs.
Particulars
To Bank a/c
14,000
By Balance b/d
15,000
To Balance c/d
17,500
By P&L a/c
16,500
31,500
Rs.
31,500
Rs.
67,600
67,600
Particulars
By Balance b/d
By Bank a/c
Rs.
35,000
2,600
67,600
Particulars
Rs.
1,00,000
By
Depreciation
Rs.
5,000
95,000
1,00,000
Plant A/c
Particulars
To Balance c/d
Rs.
Particulars
Rs.
75,000
By Depreciation a/c
7,000
(P&L a/c)
To Bank
16,500
By Balance c/d
84,500
91,500
91,500
Goodwill A/c
Particulars
To Bank
Rs.
2,500
Particulars
Rs.
By Balance c/d
2,500
2,500
2,500
5,000
16,500
Dividends paid
Depreciation:
On Buildings
On Plant
11,500
5,000
7,000
45,000
60,300
15,250
45,050
2000
2001
Assets
2000
2001
24,000
24,000
General Reserve
28,000
36,000 Buildings
80,000
P&L A/c
32,000
26,000 Plant
74,000
72,000
Creditors
16,000
10,800 Investments
20,000
22,000
60,000
46,800,
4,000
6,400
36,000
3 8,000
13,200
30,400
Bills payable
Provision for Tax
2,400
32,000
Provision for
800
1,600 Stock
36,000 Bills
receivable
1,200 Debtors
72,000
doubtful debts
Cash & Bank
balances
3,11,200 3,11,600
3,11,200 3,11,600
Additional Information:
(i)
(ii)
(iii)
2000
Increase
Decrease
in W.C.
in W.C.
2001
13,200
30,400
17200
36,000
4,000
60,000
1,13,200
38,000
6,400
46,800
1,21,600
2,000
2,400
800
1,200
2,400
1,600
800
16,000
10,800
5,200
19,200
94,000
13,600
1,08,000
13,200
400
Increase in Working
14,000
14,000
Capital
1,08,000
1,08,000
27,600
27,600
Application
Rs.
72,000
Rs.
Purchase of Plant
6,000
operations
Tax paid
34,000
Purchase of investments
Interim dividend paid
2,000
16,000
14,000
72,000
72,000
Working Notes:
Provision for Taxation A/c
Particulars
Rs.
Particulars
Rs:
To Balance c/d
32,000
To Balance c/d
28,000
70,000
70,000
Plant A/c
Particulars
To Balance c/d
To Balance (Purchase)
Rs.
Particulars
Rs:
74,000 By Depreciation
8,000
72,000
80,000
80,000
Buildings A/c
Particulars
To Balance c/d
Rs.
Particulars
Rs:
80,000 By Depreciation
8,000
By Balance c/d
72,000
80,000
80,000
Investments A/c
Particulars
Rs.
To Balance b/d
Particulars
Rs.
To Bank (Purchase)
22,000
2,000
22,000
22,000
Non-fund
operating
Rs.
and
items
Nonalready
Particulars
Rs.
By Balance on (31-12-200)
32,000
72,000
8,000
38,000
Depreciation on Plant
8,000
Depreciation on Buildings
8,000
Interim dividend
16,000
26,000
1,04,000
1,04,000
Rs.
Particulars
Rs.
36,000
By Balance
28,000
By P&L a/c
8,000
36,000
36,000
Liabilities
2000
Share Capital
4,00,000
General
80,000
Reserve
P&L A/c
64,000
Bank Loan
3,20,000
(Long term)
Creditors
3,00,000
Provision for
2001
Assets
2000
2001
4,00,000
4,80,000
Buildings
1,40,000 Machinery
3,60,000
2,60,000
78,000 Stock
2,00,000
2,52,000
80,000 Debtors
1,60,000
1,28,000
60,000
1,04,000
18,000
80,000
Taxation
12,24,000 11,38,000
12,24,000
11,38,000
Additional Information :
(i)
(ii)
Assets
of
another
company
were
purchased
for
(iv)
(v)
2000
2001
Increase in
Decrease
W.C.
in W.C.
Current Assets
Cash at Bank
1,04,000
18,000
86,000
Debtors
1,60,000 1,28,000
32,000
Stock
2,00,000 2,52,000
52,000
4,64,000 3,98,000
Current Liabilities
Creditors
Working 3,00,000 2,60,000
40,000
Capital
1,64,000 1,38,000
1,64,000 1,38,000
Decrease in working
26,000
26,000
capital
1,64,000 1,64,000
1,18,000
1,18,000
Funds Flow Statement for the year ending 31st Dec. 2001
Sources
Rs.
Application
Issue of Shares
Sale of Machinery
Buildings
76,000 Bank Loan paid
Funds from
operations
Decrease
in
Rs.
75,000
2,40,000
84,000
70,000
Working Capital
4,69,000
4,69,000
Working Notes:
Provision for Taxation A/c
Particulars
Rs.
Particulars
Rs.
To Cash
60,000
To Balance b/d
90,000
1,50,000
1,50,000
Machinery A/c
Land and Buildings A/c
Particulars
To Balance b/d
Rs.
Particulars
Rs.
24,000
By
Sale
Machinery
By Balance c/d
3,60,000
of
76,000
2,60,000
3,60,000
Rs.
Particulars
Rs.
45,000
To Share Capital
To Cash
75,000
5,25,000
4,80,000
5,25,000
Rs.
Particulars
Rs.
80,000
60,000
1,40,000
1,40,000
Rs.
To Machinery
To
Land
Buildings
To Provision
&
Particulars
45,000 By
Funds
Rs.
from 3,17,000
Operations
for
90,000
tax
To General
60,000
Reserve
To Dividends paid
84,000
To Closing
78,000
balance
3,81,000
3,81,000
is
to
ascertain
the
funds
generated
from
2.
3.
4.
For instance, when shares are issued for cash, the same is shown in
funds flow statement as a source of funds whereas in profit and loss account
it is now shown as income.
5.
1.
2.
3.
Usefulness:
Funds
Flow.
Statement
is
useful
for
the
4.
In
5.
(1)
(3)
(4)
helps
the
management
in
taking
decisions
(5)
(6)
New items are not disclosed: The funds flow statement does
not disclose any new or original items which affect the financial
position of the business. The funds flow statement simply
rearranges the data given in conventional financial statements
and schedules.
LESSON-12
CASH FLOW ANALYSES
INTRODUCTION
Cash flow statement provides information about the cash
receipts and payments of a firm for a given period. It provides
important information that compliments the profit and loss account
and balance sheet. The information about the cash-flows of a firm is
useful in providing users or financial statements with a basis to
assess the ability of the enterprise to generate cash and cash
equivalents and the needs of the enterprise to utilise these cash flows.
The economic decisions that are taken by users require an evaluation
of the ability of an enterprise to generate cash and cash equivalents
and the timing and certainly of their generation. The statement deals
with the provision of information about the historical changes in cash
equivalents of an enterprise by means of a cash flow statement which
classifies cash flows during the period from operating) investing and
financing activities.
It
means
the
movement
of
cash
into
the
The cash flow statement during a period is classified into three main
categories of cash inflows and cash outflows:
Operating
activities
include
cash
effects
of
those
transactions and events that enter into the determination of net profit
or loss. Following are examples of cash flows from operating activities:
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Cash
receipts
from
disposal
of
fixed
assets
(including
intangibles)
Cash
payments
to
acquire
shares,
warrants,
or
debt
Financing activities are activities that result in changes in the size and
composition of the owners capital (including preference share capital
Payment of dividend
Profit and Loss Account : The profit and loss account of the
current period enables to determine the amount of cash
provided by or used in operations during the accounting period
after making adjustments for non-cash, current assets and
current liabilities.
Cash Flow Statement of XYZ Ltd. for the year ending 31" March
2001
Source
Rs.
Opening Balances
Application
Rs.
Opening Balances
Cash
Bank
Cash Inflows
Redemption of Redeemable
XXX
Preference Shares
XXX Redemption of Debentures
XXX
Issue of Shares
XXX
XXX
XXX
XXX
and Investments
Non Trading Receipts
XXX Bank
XXX
XXX
XXX
Note : The Cash Flow Statement can also be presented in the vertical
form. However, the horizontal form given above is convenient and is
more commonly used.
Illustration: 1
From the following information, you are required to ascertain cash
flow operation
Particulars
Net Profit
Debtors
31.12.2000
42,000
31.12.2001
70,000
40,000
Bills Receivable
Creditors
Bills payable
Stock
8,000
47,000
15,000
58,000
13,000
50,000
10,000
65,000
70,000
2,000
3,000
5,000
75,000
5,000
7,000
5,000
17,000
58,000
From the following balances, you are required to calculate cash from
operations:
Particulars
December December
Debtors
Bill Receivable
Creditors
Bills Payable
Outstanding Expenses
Prepaid Expenses
Accrued Income
Income Received in Advance
Profit made during the year
31 2000
50,000
10,000
20,000
8,000
1,000
800
600
300
-
31 2001
47,000
12,500
25,000
6,000
1200
700
750
250
1,30,000
1,30,000
3,000
5,000
200
100
1,38,000
2,500
150
2,000
50
4,700
1,33,600
Illustration: 3
From the following information, calculate cash from operations
Particulars
P&LA/c (credit)
Debtors
Bills Receivable
Prepaid Rent
Prepaid Insurance
Goodwill
Depreciation
Creditors
2000
2001
40,000
20,000
20,000
2,000
1,000
20,000
32,000
20,000
50,000
26,000
12,000
3,000
800
14,000
40,000
30,000
50,000
8,000
200
10,000
Depreciation
8,000
Goodwill
6,000
32,200
82,200
6,000
1,000
40,000
47,000
35,200
From the following balance sheets of Sulekha Ltd. you are required to
prepare a cash flow statement
Liabilities
2001
2000
Share capital
Rs.
3,00,000
Trade editors
1,05,000
P&L A/c
Assets
2000
Rs.
45,000
Rs.
70,500
67,500 Debtors
1,80,000
1,72,500
1,20,000
1,35,000
75,000
99,000
4,20,000
4,77,000
Rs.
3,75,000 Cash
15,000
Land
4,20,000
2007
4,77,000
Rs.
Application
Rs.
24,000
75,000 Decrease
37,500
Cash
Creditors
19,500 Closing balance
Operating
Profit
in
Trade
70,500
7,500
1,47,000
1,47,000
Illustration: 5
From the following balance sheets of Zindal Ltd/prepare cashflow
statement.
2000 2007
Liabilities
Share Capital
8% redeemable
Shares
General reserve
Pref.
Assets
2000 2007
600
800 Goodwill
230
180
300
400
340
140 Plant
160
400
80
P&L Account
60
Proposed dividend
84
Creditors
110
96 Debtors
320
400
154
218
40
60
100 Stock
Bills Payable
40
32 Cash in hand
30
20
80
20
16
Total
1354 1634
1354 1634
Additional information:
1)
2)
3)
1. Plant Account
Particulars
Particulars
Rs.
20,000
on 1-1-2001
To Purchases-cash
Rs.
4,00,000
on 31-12-2001
4,20,000
2.
4,20,000
Particulars
Rs.
Particulars
Rs.
40,000
on 1-1-2001
By cash (salesbalancing figure)
By closing balance on 3,40,000
31-12-2001
4,00,000
3.
4,00,000
Cash
Rs.
Particulars
1-1-2001
To closing balance 1,00,000 By P&L Account
on 31-12-2001
Rs.
80,000
90,000
(balancing figure)
1,70,000
1,70,000
96,000
2001:
Less: Balance of P&L A/c on 1-1-2001:
Add: Profit used for reserves &
60,000
provisions:
Proposed dividend
Interim dividend
Provisions for taxation
Transfer to general reserve
Add : Profit used for writing off non-
1,00,000
40,000
90,000
60,000
36,000
2,90,000
3,26,000
cash A/c:
Goodwill
Depreciation:
Plant
Land & Building
50,000
20,000
40,000
1,10,000
4,36,000
56,000
4,92,000
80,000
64,000
20,000
1,64,000
3,28,000
8,000
3,20,000
Rs.
Cash out-flows
Rs.
2,60,000
84,000
40,000
dividend
Income-tax paid
3,20,000 Redemption of Pref.
70,000
1,00
Shares
Sale of land & bldg.
Issue of shares
20,000
2,00,000
1,00,000
5,54,000
Closing balance on
31-12-2001
Cash in hand
Cash in bank
20,000
16,000
5,90,000
5,90,000
Illustration: 6
From the following information you are required to prepare a Cash
Flow Statement of Shanti Stores Ltd for the year ended 31" December,
2001
Balance Sheets
Liabilities
Share Capital
2000
70,000
2001
2000
2001
50,000
91,000
15,000
40,000
5,000
20,000
20,000
7,000
2,000
4,000
92,000
1,62,000
70,000 Plant
Machinery
Inventory
Secured Loans
Repayable (2001)
Creditors
Assets
40,000 Debtors
14,000
Tax payable
1,000
39,000 Cash
3,000 Prepaid
General Exp.
P&L A/c
7,000
10,000
92,000 1,62,000
Profit & Loss A/c for the year ended 31" December, 2001
Particulars
Rs.
Particulars
To Opening Inventory
15,000 By sales
To Purchases
To Gross Profit c/d
To General Expenses
To Depreciation
To Taxes
Rs.
1,00,000
40,000
1,40,000
27,000
4,000
27,000
27,000
To Dividend
7,000
To Balance c/d
4,000
11,000
11,000
Working Notes:
Machinery A/c
Particulars
Rs. Particulars
To Balance b/d
(Opening balance)
By Depreciation a/c
Rs.
8,000
91,000
49,000
99,000
99,000
Rs. Particulars
By Balance b/d
1 ,000
To Balance c/d -
closing balance
Rs.
(current year)
4,000
3,000
5,000
5,000
(Rs.)
Net Profit
4,000
Add: Depreciation
8,000
Taxes
4,000
16,000
Rs.
Funds from Operations
16,000
25,000
41,000
15,000
Increase in Inventory
25,000
2,000
42,000
1,000
Rs.
Application
Cash Outflow
20,000 Machine Purchased
40,000 Taxes Paid
Dividends paid
Cash lost in Operations
Closing cash Balance
60,000
Rs.
49,000
2,000
1,000
1,000
7,000
60,000
Illustration: 7
The following are the balance Sheets of X Ltd. For the year ending 31 st
December 2000 and 2001
Particulars
Liabilities
Share Capital
2000
Rs.
2,00,000
2001
Rs.
3,00,000
1,20,000
1,60,000
Sundry creditors
60,000
50,000
40,000
50,000
Proposed Dividend
20,000
30,000
4,40,000
5,90,000
2000
2001
Rs.
Rs.
1,60,000
2,00,000
40,000
60,000
2,00,000
2,60,000
18,000
24,000
1,82,000
2,36,000
8,000
16,000
1,60,000
2,18,000
Debtors
60,000
80,000
Cash
30,000
40,000
4,40,000
5,90,000
Particulars
Assets:
Fixed Assets
Add: Additions
Less: Depreciation
Investments
Stock
Additional information:
1)
Taxes Rs. 44,000 and dividend Rs. 24,000 were paid during the
year 2001
2)
The net profit for the year 2001 before depreciation Rs. 1,34,000
Rs.
Opening Balance of
Cash
(1-1-2001)
Application
Rs.
Cash Outflows
Cash inflows:
Taxes paid
60,000
44,000
24,000
8,000
Increase in Stock
58,000
Increase in debtors
20,000
Decrease in creditors
10,000
40,000
2,64,000
2,64,000
Working Notes:
Fixed Assets a/c
Particulars
To Balance
To Bank a/c
Rs.
Particulars
Rs.
2,60,090
60,000
2,60,000
2,60,000
Investments a/c
Particulars
To Balance b/d
Rs.
Particulars
Rs.
16,000
To Bank
50,000
(Balancing figure)
94,000
16,000
Rs.
Particulars
Rs.
To Bank
44,000
By Balance c/d
44,000
To Balance c/d
50,000
By P & L a/c
50,000
94,000
94,000
Rs.
Particulars
Rs.
To Bank
24,000
To Balance c/d
30,000
54,000
54,000
Non-cash
and
non-operating
1,60,000
6,000
34,000
54,000
94,000
2,54,000
items
1,20,000
1,20,000
1,34,000
Illustration: 8
From the following Balance Sheets of Exe. Ltd. Make out the
statement of sources and uses of cash:
Liabilities
2000
2001
Assets
2000
2001
Equity Share
Rs.
Rs.
3,00,000 4,00,000 Goodwill
Rs.
1,15,000
Rs.
90,000
Capital
8% Redeemable
2,00,000
1,70,000
80,000
2,00,000
1,60,000
2,00,000
Preference Share
Buildings
Capital
General Reserve
40,000
70,000 Plant
30,000
48,000 Debtors
Account
Proposed
42.000
50,000 Stock
77,000
1,09,000
Dividend
Creditors
55,000
83,000 Bills
20,000
30,000
Bill Payable
20,000
Receivable
16,000 Cash in Hand
15,000
10,000
Provision for
40,000
10,000
8,000
Taxation
6,77,000 8,17,000
6,77,000 8,17,000
Additional information:
a) Depreciation of Rs. 10,000 and Rs. 20,000 have been charged
on Plant and Land and Building respectively in 2001.
Working Notes:
Rs.
To Depreciation on
plant
To Depreciation
Particulars
to
20,000 By
buildings
Funds
Rs.
30,000
from
2,18,000
operations
(balancing figure)
25,000
To Provision of taxation
45,000
To Interim dividend
20,000
To Dividend proposed
50,000
To Transfer to
30,000
General Reserve
To Balance c/d
48,000
2,48,000
(ii)
2,48,000
Particulars
Rs.
Particulars
Rs.
To Bank
40,000
To Balance c/d
45,000
85,000
85,000
Rs.
Particulars
2,00,000 By Depreciation
Rs.
20,000
By Bank (sale)
10,000
By Balance c/d
1,70,00
2,00,000
2,00,000
Rs.
To Balance b/d
Particulars
80,000 By Depreciation
To Bank (purchase)
Rs.
10,000
2,00,000
2,10,000
2,10,000
2,18,000
28,000
2,46,000
4,000
40,000
32,000
10,000
86,000
1,60,000
Cash flow statement for the year ending 31st December 2001
Cash Balance as on 11-2001
Cash in hand
1 5,000 Redemption
Land
Payments
of
and
Building
Funds from operations
Increase in creditors
50,000
20,000
interim
dividend
1,00,000 Payment of tax
Issue of Shares
of
of
Redeemable
10,000 Preference share
Cash at bank
Sale
Rs.
42,000
35,000
1,30,000
4,000
40,000
Increase in stock
32,000
Increase in B/R
10,000
10,000
Cash at bank
8,000
3,81,000
3,81,000
Illustration: 9
Balance Sheets of XYZ Ltd. as on 1-1-2000 and 31-12-2001 was as
follows:
Liabilities
Capital
Creditors
Bank loan
Bills Payable
1-1-2001
1,25,000
1,40,000
65,000
20,000
31-12-2001
1,53,000
1,44,000
50,000
30,000
Assets:
Cash
Debtors
Stock
Machinery
Land
Buildings
Goodwill
3,50,000
3,77,000
20,000
30,000
45,000
80,000
90,000
65,000
20,000
3,50,000
17,000
80,000
35,000
65,000
80,000
70,000
30,000
3,77,000
Cash Flow Statement for the year ending 31st December 2001
Sources
Rs.
Applications
Cash inflows:
Building Purchased
Sale of Machinery
Sale of Land
Increase in creditors
Rs.
5,000
12,000
15,000
4,000 Goodwill
10,000
10,000 Drawings
27,000
Decrease in stock
50,000
17,000
1,36,000
1,36,000
Machinery a/c
Sources
To Balance b/d
To Bank (Purchase)
Rs.
Applications
Rs.
7,000
4,000
a/c
By P & L a/c (Loss on sale)
By Balance c/d
1,27,000
1,000
1,15,000
1,27,000
Land a/c
Particulars
To Balance b/d
Rs.
Particulars
90,000 By Bank (Purchase)
By Balance c/d
90,000
Rs.
10,000
80,000
90,000
Buildings a/c
Particulars
To Balance b/d
To Bank (Purchases)
Particulars
To Balance b/d
To Bank
Rs.
Particulars
65,000 By Balance c/d
5,000
70,000
Goodwill a/c
Rs.
Particulars
20,000 By Balance c/d
10,000
30,000
Rs.
70,000
70,000
Rs.
30,000
30,000
Rs.
Particulars
15,000 By Balance c/d
50,000
65,000
Rs.
65,000
65,000
Rs.
Particulars
4,000 By Balance c/d
50,000 By P & L a/c
54,000
Rs.
35,000
19,000
54,000
55,000
19,000
1,000
20,000
75,000
Capital a/c
Particulars
Rs.
Particulars
Rs.
To Drawings (Balancing
figure)
To Balance c/d
1,25,000
55,000
1,80,000
Despite the above limitations, cash flow statement is a very useful tool
of financial analysis. It discloses the volume and speed at which cash
flows in various segments of the business and the amount of capital
tied-up in a particular segment.
LESSON- 13
BUDGETING AND BUDGETARY CONTROL
BUDGET
BUDGETING
BUDGETARY CONTROL
the
organisation
and
the
authority
and
responsibility
of
different
levels
of
management
and
reporting
and
information
service
so
that
Advantages of Budgeting
it
economises
Communication
is
increased
throughout
the
firm
and
People are made responsible for items of cost and revenue, i.e.
areas of responsibility are clearly delineatea.
Problems in Budgeting
(i)
(ii)
in a way which is
BUDGETING PROCESS
The method by which the annual budget is prepared will differ from
organisation to organisation. In some organisations budgeting may be
a well organised, well documented procedures while in others the
budget may be prepared in a rather ad hoc and disorganised manner.
The budget process is shown in the following figure. The steps in
budgeting process representative to all organisations is given below:
1.
Specification
and
Communication
of
Organisational
Objectives :
organisational
objectives.
It
is
essential
to
understand,
2.
3.
Establishment
Responsibility:
of
Clear
Ones
of
Authority
and
4.
The
entire
organisation
is
divided
into
different
5.
Quarterly,
organisational
schemes
forecast
Capital
6.
modernisation,
diversification
and
revision
of
7.
(a)
and
planning
to
each
person
in
the
for
decision
making,
economic
and
financial
(b)
(c)
(d)
centers
within
the
organisation,
measured
8.
Procedures
in
management
information
system
in
the
organisation.
Forecasting sales
demand,
the
appropriate
level
of
advertising
and
PREPARATION OF BUDGETS
1.
Production Budget
2.
the budgeted
production
during the
period
considered under the budget" For this purpose the plant capacity is
expressed
in
terms
of
convenient
units
of
measurement
like
3.
4.
The direct labour budget will ensure that the plan will make the
required number of employees of relevant grades and suitable skills
available at the right times. It specifies the direct labour requirement,
of various products as envisaged in the production budget. The direct
labour budget will be developed for both direct labour hours and direct
labour cost. After the labour requirements relating to different grades
are finalized, estimated rate per hour and labour cost per unit is
arrived at:
Illustration 1:
Product
Operation
1
2
18
-
42
12
30
24
The factory works 8 hours per day, 6 days in a week. The budget
quarter is taken as 13 weeks and during a quarter, lost hours due to
leave and holidays and other causes are estimated to be 124.
Product
1
2
3
9,000 units
15,000 units
12,000 units
Product
1
3
1,000 units
2,000 units
(a) Production budget, (b) Direct labour hours for each product
operation-wise, (c) Number of workers required for each operation.
Product 1
Product 2
Product 3
9,000
15,000
12,000
1,000
2,000
10,000
15,000
14,000
5,000
4,000
10,000
10,000
10,000
built up
Total
Less:
Carry- (opening)
over stock
Budgeted
Production
(b)
Operation I
Particulars
Product 1
Product 2
. Product 3
18
42
30
10,000
10,000
10,000
10,000 x 18
60
10,000 x 42
60
10,000 x 30
60
3,000 hrs.
7,000 hrs.
5,000 hrs.
(minutes)
Budget Production (units)
Product 1
Product 2
. Product 3
12
24
(minutes)
10,000
-
10,000
10,000
10,000 x 12
60
10,000 x 24
60
2,000 hrs.
4,000 hrs.
Operation III
Particulars
Product 1
Product 2
. Product 3
10,000
10,000
10,000
(minutes)
Budget Production (units)
10,000 x 9
60
10,000 x 6
60
1,500 hrs.
1,000 hrs.
(c)
624 hours
124 hours
500 hours
Now, the requirements for manpower for each operation can be worked
out.
Manpower Requirement:
Total direct labour hrs./ Total available hours required per man
a. Operation I
b. Operation II
c. Operation III
= 15,000/500
= 6,000/500
= 2,500/500
= 30 men
= 12 men
= 5 men
Now, manpower budget for the quarter can be prepared for the three
products and for each operation. The same is given below:
Operation
Hr.
rate
Rs.
2.00
2.50
II
III
Total
5.
3.00
Product I
D.I.
Hrs.
Cost
Rs.
3,000 6,000
-
1,500 4,500
Product II
D.L.
Hrs.
7,000
Cost
Rs.
14,000
Product 3
D.L.
Hrs.
5,000
Cost
Rs.
Total
D.L.
Hrs.
No. of
workers
Cost
Rs.
30
2,000
6,000
15,000
12
1,000
3,000
2,500
7,500
47
Illustration 2:
Gama
Engineering
Company
Limited
manufacturers
two
Months
Product X
Product Y
January
500
1,400
February
600
1,400
March
800
1,200
April
1,000
1,000
May
1,200
800
June
1,200
800
July
1,000
980
It is anticipated that:
(a)
(b)
Finished units equal to half the anticipated sales for the next
month will be in stock at the end of each month (including
June 2001).
The budgeted production and production costs for the year ending 31 st
June, 2001 are as follows:
Particulars
Product X
Product Y
(units)
11,000
12,000
(Rs.)
12
19
(Rs.)
(Rs.)
33,000
48,000
Production
(b)
Summarised production cost budget for the 6 monthperiod January to June 2001.
(a) Production Budget (for the 6 months ending 30th June, 2001)
(units)
Particulars
Jan. Feb.
March April
May
June
600
500
Product X
Closing Stock
300
400
500
Sales
500
600
800
250
300
400
600
1,000 1,200
1,200
1,600 1,800
1,700
500
600
600
550
700
900
1,100 1,200
1,100
Product Y
Closing stock
700
Sales
600
500
400
400
450
1,400
800
800
2,100
1,200
1,250
500
400
400
900
800
850
700
1,400
700
600
1,300 1,100
X-5,550 units
Y-6,350 units
Unit
Total Cost
Unit Cost
Cost
12
66,600
19
Direct wages
27,750
44,450
Manufacturing
16,650
25,400
20
1,11,000
30
Direct materials
Total Cost
1,20,650
charges
Total
1,90,500
6.
Formulation of policies,
(b)
(c)
7.
activities:
(a)
(b)
Secure orders.
Selling
expenses
include
salesmen's
salaries,
commissions,
(b)
8.
9.
The
capital
expenditure
budget
represents
the
expected
Original appropriation
Unutilised appropriation
10.
Manpower Budget
11.
12.
Capital Budget
(2)
Negotiation of Budgets :
After the master budget is accepted and agreed upon by all the
levels
of
organisational
hierarchy,
it
will
be
passed
on
for
Budget Monitoring:
1.
budgets
including
capital
expenditure
budgets
are
2.
3.
Illustration 3:
Prepare a cash budget for the three months ending 30th June,
2001 from the information given below:
a.
(Rs.)
Month
Sales
Materials
Wages
Overheads
February
14,000
9,600
3,000
1,700
March
15,000
9,000
3,000
1,900
April
16,000
9,200
3,200
2,000
May
17,000
10;000
3,600
2,200
June
18,000
10,400
4,000
2,300
b.
Credit Terms:
Sales/ Debtor - 10% sales are on cash, 50% of the credit sales are
collected next month and the balance in the following month.
Creditors
c.
Materials
2 months
Wages
month
Overheads
month
d.
(ii)
(iii)
(iv)
(v)
Working Notes:
Collection from Sales/ Debtors
Month
Calculation
April
May
June
February
6,300
March
6,750
6,750
April
10% of 16,000
1,600
7,200
7,200
10% of 17,000
1,700
7,650
10% of 18,000
1,800
May
June
April
May
June
Total
6,000
3,950
3,000
6,000
16,650
46,950
14,650 15,650
Dividend
1,000
1,000
Advanced against
vehicle
9,000
9,000
29,650
62,950
9,600
9,000
9,200
27,800
Wages*
3,150
3,500
3,900
10,550
Overhead*
1,950
2,100
2,250
6,300
Capital Expenditure
2,000
2,000
2,000
6,000
2,000
2,000
29,350
62,650
300
300
3,950
3,000
FLEXIBLE BUDGETING
Steps in Preparation
The steps involved in preparation of flexible budget are as
follows:
Classify
all
costs
into
fixed,
variable
and
semi-variable
categories.
Importance
Flexible
budget
enable
an
organisation
to
predict
its
Flexible
budgets
enables
more
accurate
assessment
of
Disadvantages
Illustration 4:
a) Selling price
b) Variable cost
c) Semi-variable cost
d) Fixed cost
2.
60%
70%
80%
(units)
6,000
60,000
7,000
70,000
8,000
80,000
18,000
21,000
24,000
6,000
6,000
6,000
3,000
3,500
4,000
20,000
47,000
20,000
50,500
24,000
58,000
19,500
22,000
(A)
Costs:
Variable cost (@ Rs.3)
Semi-variable cost
Fixed component
Variable component (@ Re.0.50 per unit)
Fixed cost
Total cost
Profit
(B)
(Rs.)
Capacity Levels
Sales
(@ Rs.9)
60%
70%
80%
9.00
(Rs.3.00 + Re.0.50)
3.50
5.50
(Rs.)
Present Profit
13,000
(Rs.20,000 + Rs.6,000)
Desired Contribution
Required Output
Desired Contribution
Contribution per unit
Rs.39,000
Rs.5.50
= 7,091 units
26,000
39,000
1,091
6,000
x 100
= 18.18%
1,091 units
LESSON-14
CAPITAL BUDGETING
MEANING OF CAPITAL BUDGETING
and
carrying
out
through
systematic
investment
The future benefits will occur to the firm over a series of years.
(1)
Large Investment:
(2)
The funds involved in capital expenditure are not only large but
more or less permanently blocked also in long-term investment. The
longer the time, the greater the risk involved. Greater the risk
involved,
greater
is
the
need
for
careful
planning
of
capital
An unsound investment
decision may prove to, be fatal to the very existence of the firm. Hence
a careful planning is essential:
(3)
Irreversible in Nature :
(4)
(5)
HI
fixed
assets. An unwise decision may prove disastrous and fatal to the very
existence of the concern. The future growth and profitability of the
firm depends upon the investment decision taken today. Capital
expenditure projects exercise a great impact on the profitability of the
firm for a very long time.
(6)
National Importance:
Investment decision taken by individual concern is of national
nature
of
projects,
their
numbers,
complexities
and
various
disciplines
for
their
effective
administration,
such
as
(1)
is the conception
of a profit-making idea.
(3)
(b)
In-dependent proposals
(c)
Contingent proposals
machine
for
production.
Here
choosing
the
highly
Contingent
or
Dependent
Proposals
are
those
whose
(4)
Establishing Priorities
(5)
Final Approval
alternative
capital
budgets.
When
capital
expenditure
proposals are finally selected, funds are allocated for them. Projects
are then sent to the budget committee for incorporating them in the
capital budget.
(6)
Implementing Proposals
Preparation
of
capital
expenditure
budgeting
and
(7)
Performance Review
Last but not the least important step in the capital budgeting
process is an evaluation of the performance of the project, after it has
been fully implemented. It is the duty of the top management or
executive committee to ensure that funds are spent in accordance
with the allocation made in the capital budget. A control over such
capital expenditure is very much essential and for that purpose a
monthly report showing the amount allocated, amount spent, amount
approved but not spent should be prepared and submitted to the
controller. The evaluation is made through post completion audit by
way of comparison of actual expenditure on the project with the
budgeted one, and also by comparing the actual return from the
The funds available with the firm are always limited and it is
not possible to invest funds in all the proposals at a time.
Therefore,
The
that
is,
higher
the
profitability,
the
greater
because
profitability and risk are directly related, that is, higher the
profitability, the greater the risk and vice-versa. The goal of financial
management of a firm is the worth maximisation of the firm, and in
order to achieve this goal, the management must select those projects
which deserve first priority in terms of their profitability. While
evaluating, two basic principles are kept in mind, namely, the bigger
benefits are always preferable to small ones and that early benefits are
always better than the deferred ones. The essential property of sound
evaluation technique is that it should maximise the shareholders'
wealth. The following other characteristic should also be possessed by
a sound investment evaluation criterion:
(1)
It
should
provide
means
of
distinguishing
between
(3)
(4)
(5)
(6)
Traditional Methods:
in
Traditional
Approach
to Pay-back period
Method.
3. Rate of Return Method or Accounting Method.
TRADITIONAL METHODS
(1)
If the annual cash inflows are constant, the pay-back period can
be computed by dividing cash outlay (original investment) by annual
cash inflows. For instance, if a project requires Rs. 10,000 as initial
investment and it will generate an annual cash inflow of Rs.2,500 for
ten years, the pay-back period will be 4 years, calculated as follows:
(b)
Initial Investment
Annual Cash Inflow
Rs. 10,000
Rs. 2,500
= 4 years
Year
Annual Cash
Cumulative Cash
1
2
3
4
5
Inflows
Rs.
3,000
4,000
2,500
2,000
2,000
Inflow
Rs.
3,000
7,000
9,500
11,500
13,500
Machine M
4 years
Rs.9,000
Rs.500
Rs. 6,000
Rs.800
Rs. 1,200
Machine N
5 years
Rs. 18,000
Rs.800
Rs. 8,000
Rs. 1,000
Rs. 1,800
Solution:
Statement showing annual cash inflows
800
6,000
8,000
6,500
8,800
800
1,000
1,200
1,800
2,000
2,800
4,500
6,000
Pay-back Period
Original Investment
Annual Average Cash Inflow
Rs.9,000
Rs.4,500 = 2 years
Rs.18,000
Rs.6,000
= 3 years
with highest pay-back period. Thus, if die firm has to choose among
two mutually exclusive projects, project with shorter pay-back period
will be selected.
1)
2)
3)
4)
5)
(1)
It does not take into account the cash inflows earned after the
pay-back period and hence the true profitability of the project
cannot be correctly assessed.
(2)
(3)
(4)
It may be difficult to determine the minimum acceptable payback period, it is usually, a subjective decision.
(5)
(6)
(7)
(8)
It doe not take into account the life of the project, depreciation,
scrap-value, interest factor etc. Because, a rupee tomorrow is
worthless than a rupee today.
(2)
(a)
Post pay-back profitability = Annual Cash Inflow (Estimated Life Pay-back Period)
Cost (Rs.)
Economic Life (in years)
Estimated Scrap (in Rs.)
Annual Savings
Project X
1,40,000
10
10,000
25,000
Project Y
1,40,000
10
14,000
20,000
Project Y
1.
Cost
2.
Savings
3.
Pay-back period
4.
Economic Life
5.
1,40,000
1,40,000
25,000
20,000
5.6 years
7 years
10 years
10 years
Surplus Life
4.4 years
3 years
6.
1,10,000
60000
7.
1,10,000
60,000
(B)
Rs.
50,000
Operating Savings:
1st year
5,000
2nd year
20,000
3rd year
30,000
4th year
30,000
5th year
10,000
Pay-back period
Year
Annual
Cumulative
Savings Rs.
5,000
Savings Rs.
5,000
20,000
25,000
30,000
55,000
Rs.50,000- Rs.25,000
Rs.30,000
Rs.25,000
= 2 + Rs.30,000
= 2 years 10 months
(ii)
Years
Savings
PV Factor
Rs.
1
5,000
0.9091
Discounted
Cumulative
Savings
Rs.
Discounted Savings
Rs.
4,546
4,546
20,000
0.8265
16,530
21,076
30,000
0.7513
22,539
43,615
30,000
0.6830
20,490
64,105,
(C)
Pay-back Reciprocal
(3)
earnings are selected and others are ruled out. The return on
investment can be expressed in several ways, as follows:
(a)
x 100
Project giving a higher rate of return will be preferred over those giving
lower rate of return.
(b)
(c)
Total Profit
Net Investment
x 100
(d)
Average Annual
Net Investment / 2
x 100
Project A
Rs.20,000
4 years
Project B
Rs.30,000
5 years
Project A
Rs.
2,000
1,500
1,500
1,000
6,000
Project B
Rs.
3,000
3,000
2,000
1,000
1,000
10,000
Solution:
Project A
Project B
Rs.
Rs.
6,000
10,000
4 years
5 years
1,500
2,000
Investment
20,000
30,000
1-500
2,000
1,500
2,000
Average Return on
Average Investment
This method may not reveal true and fair view in the case of
long-term investments.
It does not take into consideration the cash flows which is more
important than the accounting profits.
The discounted cash flow method is an improvement on the payback method as well as accounting rate of return. This method is
based on the fact that future value of money will not be equal to the
present value of money. That is, discounted cash flow technique
recognises that Re. one of today (cash outflow) is worth more than Re.
one received at a future date (cash inflow). Die time adjusted or
discounted cash flow method take into account the profitability and
also the time value of money. The discounted cash flow method for
evaluating capital investment proposals are of three types:
1.
Life Estimated
Capital Cost
Net earning after tax:
Machine I
Machine II
3 years
Rs.
10,000
3 years
Rs.
10,000
1st year
2nd year
3rd year
8,000
6,000
4,000
2,000
7,000
10,000
Solution:
Calculation of Net Present Value (10%)
Machine I
Year
PV Factor
0.909
Cash
Machine II
Present
Cash
Present
0.826
6,000
4,956
7,000
5,782
0.751
4,000
3,004
10,000
7,510
15,232
15,110
10,000
10,000
5,232
5,110
It is more difficult to
2.
than the cost figure, we try a higher rate of interest and go through
the procedure again. Conversely, if the present value is lower than the
cost, lower the interest rate and repeat the process. The interest rate
that brings about this equality is defined as the internal rate of
return. This rate of return is compared to the cost of capital and the
project having higher difference, if they are mutually exclusive, is
adopted and other one is rejected. As this determination of internal
rate of return involves a number of attempts to make the present value
4 years
Rs. 15,000
2nd year
Rs.20,000
3rd year
Rs.30,000
4th year
Rs.20,000
Solution:
Calculation of Internal Rate of Return
Annual
PVF
PVF
PVF
Cashflow
15,000
10%
0.909
13,635
12%
0.892
PV
14%
13,380 0.877 13,155
15%
0.869
13,035
20,000
0.856
16,520
0.797
-0.756
15,120
30,000
0.751
22,530
0.711
0.657
19,710
20,000
0.683
13,660
0.635
0.571
11,420
Year
PVF
PV
PV
66,345
63,350
PV
60,595
59,285
=14.45%
3.
Profitability Index =
Rs.20,000
Rs. 15,000
Rs.25,000
4th year
Rs. 10,000
Solution:
Calculation of Profitability Index
Year
Cash Inflows
PV Factor at
10%
PV Rs.
Rs.
20,000
9.909
18,180
15,000
0.826
12,390
25,000
0.751
18,775
10,000
0.683
6,830
Total
56,175
=
=
=
Rs.56,175
Rs.50,000
6,175
PV Cash Inflow
Initial Cash Outflow
56,175
50,000
= 1.1235
CAPITAL RATIONING
Capital
rationing is
a situation
where a firm
has more
Thus capital
firm has not only to select profitable investment proposals but also to
rank the projects from the highest to lowest priority
before tax but after depreciation during the expected life of the
machine are given below:
Year
Machine A
Rs.
15,000
20,000
2500
15,000
10,000
1
2
3
4
5
Machine B
Rs.
5,000
15,000
20,000
30,000
20,000
Solution :
Computation of profit after tax
year
Machine A
Machine B
Profit
Tax at
Profit
Profit
Tax at
Profit
before tax 50% after tax before tax 50% after tax
Rs.
Rs.
Rs.
_ Rs.
15,000
7,500
7,500
5,000
2,500
2,500
20,000
10,000
10,000
15,000
7,500
7,500
25,000
12,500
12,500
20,000
10,000
10,000
15,000
7,500
7,500
30,000
15,000
15,000
10,000
5,000
5,000
20,000
10,000
10,000
Total
85,000
42,500
42,500
90,000
45,000
45,000
Average profit
Machine A
Rs. 42,000
Machine B
Rs. 45,000
after tax
5 = Rs. 8,500
Investment
Average
Investment
Average Return on
Investment
Average Return on
Average
5 = Rs. 9000
Rs. 60,000
Rs. 60,000
Rs. 60,000
2 =
Rs. 30,000
Rs. 8,500
60,000
2 =
Rs. 30,000
Rs. 9,000
x 100 = Rs. 14.17%
Rs. 8,500
30,000
Rs. 60,000
Rs. 9,000
x 100 = Rs. 28.34%
30,000
Investment
Estimated Life
Cost of Machine
Cost of indirect materials
Estimated savings in scrap
Additional cost of maintenance
Estimated savings in direct
wages:
Employees not required
Wages per employee
Model X
Rs.
5 years
1,50,000
6,000
10,000
19,000
Model Y
Rs.
6 years
2,50,000
8,000
15,000
27,000
150
600
200
600
Solution:
Profitability Statement
Model X
Model Y (Rs)
(Rs)
10,000
15,000
90,000
1,35,000
1,00,000
1,35,000
year scrap
Wages (150x600)
(200x600)
Total Savings
Less: Additional Cost
Cost of indirect
8,000
materials 6,000
Cost of Maintenance
19,000
25,000
27,000
35,000
Additional Earnings
Less: Tax @ 50%
Cash flow (annual)
Less: Depreciation:
75,000
37,500
37,500
30,000
1,50,000 5
Net Increase in
earnings
Pay-back period:
1,00,000
50,000
50,000
41,667
2,50,000 6
7,500
8,333
1,50,000
37,500
2,50,000
= 4 years
50,000
= 5 years
Cost of Machine
Annual Cash Flow
7,500
8,300
1,50,000 x100 =
5%
Automatic
Ordinary
Machine
Rs.
Machine
Rs.
costs
are estimated as follows:
Sales
1,50,000
Costs:
1,50,000
Materials
50,000
50,000
Labour
Variable Overhead
12,000
24,000
60,000
20,000
Solution:
Annual Sales
Automatic Machine
Ordinary Machine
Rs.
Rs.
1,50,000
1,50,000
50,000
50,000
Labour
60,000
12,000
Overheads 24,000
Marginal Profit
86,000
20,000
1,30,000
64,000
20,000
2,24,000
3 years
60,000
20,000
1 _
64,000 5 2
32
= Rs. 1,28,000
= 3 years
20,000 (8-5
yrs.)
= Rs. 1,00,000
Year
1
2
3
4
5
6
0.87
0.76
0.66
0.57
0.50
0.43
Solution:
Calculation of Net Present Value
Year
Cash Inflows
PV Factor
Present Values
1
2
3
4
5
('000) Rs.
Nil
100
160
240
300
0.87
0.76
0.66
0.57
0.50
('000) Rs.
Nil
76.0
105.60
136.80
150.00
600
0.43
258.00
Total
Less: Cash Outlay
Net Present Value
726.40
500.00
226.40
End of year
Project I
Rs.
48,000
32,000
20,000
Nil
24,000
12,000
1
2
3
4
5
6
Project II
Rs.
20,000
24,000
36,000
48,000
16,000
8,000
Year
Factor
0.909
0.826
0.751
0.683
0.621
0.564
Solution:
Calculation of Net Present Value
Year
Project I
Project II
PV
PV of
PV of
Net Cash
Net Cash
Factor
Project I
Project
Inflows
Rs.
Inflows
Rs.
@ 10%
Rs.
11
Rs.
48,000
20,000
9.909
43,632
18,130
32,000
24,000
0.826
26,432
19,8.24
20,000
36,000
0.751
15,020
27,036
Nil
48,000
0.683
Nil
32,784
24,000
16,000
0.62.1
14,904
9,936
12,000
8,000
0.564
6,768
4,512
Total 1,06,756
Less: Cash Outlay
Net Present Value
1,12,272
1,00,000
1,00,000
6,756
12,272
Profit X
Profit Y
Rs.
Rs.
Initial Investment
20,000
30,000
Estimated Life
5 years
5 years
1,000
2,000
Scrap Value
Year
Profit X
Profit Y
Rs.
Rs.
5,000
20,000
10,000
10,000
10,000
5,000
3,000
3,000
2,000
2,000
Solution :
Cash Flows
Year
1
2
3
4
5
6
Project X
Project Y
Rs.
Rs.
5,000
20,000
10,000
10,000
PV of Re.1
@10%
Project Y
Rs.
Rs.
0.909
4,545
18,180
10,000
5,000
0.836
0.751
8,260
8,510
8,260
3,755
3,000
2,000
3,000
2,000
0.683
0.621
2,049
1,242
2,049
1,242
1,000
2,000
0.621
621
24,227
20,000
4,227
1,242
34,728
30,000
4,728
Year
Machine A Cash
Machine B Cash
Inflow
Rs.
Inflow
Rs.
15,000
5,000
20,000
1 5,000
25,000
20,000
15,000
30,000
10,000
20,000
year
PV Factor @ 10%
discount
0.909
0.826
0.751
0.683
0.621
(b)
(c)
(d)
Solution:
Year
Cash Inflow
Cumulative Cash
Rs.
Inflow
Rs.
15,000
15,000
20,000
35,000
25,000
60,000
15,000
75,000
10,000
85,000
Pay-back Period = 2+
15,000
25,000 = 2.6 years
(b) Machine B
Year
Cash Inflow
Cumulative Cash
Rs.
Inflow
Rs.
5,000
5,000
15,000
20,000
20,000
40,000
30,000
70,000
20,000
90,000
10,000
30,000 = 3.33 years
Rs.85,000
Average Return
Rs.85,000 5 = Rs.17,000
17,000
50,000
x 100 = 34%
Machine B
Total Returns
Rs.90,000
Average Return
Rs.90,000 5 = Rs.18,000
18,000
50,000
x 100 = 36%
PV
PV
@ 10%
Rs.
Machine A
Rs.
Machine B
Machine B
Rs.
Machine A
Rs.
0.909
15,000
5,000
13,635
4.545
0,826
20,000
15,000
16,520
12,390
0.751
25,000
20,000
18,775
15,020
0.683
15,000
30,000
10,245
20,490
0.621
10,000
20,000
6,210
12,420
65,385
64,865
50,000
50,000
15,385
14,865
Total
Less: Cash Outlay
Net Present Value
Probability Index
Present Values
Machine A = Cost of Investment
65,385
=
50,000
= 1.308
64,865
Machine B = 50,000
= 1.297
ADAMS COMPANY
Balance Sheet
July 31,19
Assets
Cash
4,800
Equity
Liabilities:
Accounts
9,600
62,400
43,200
receivable
Land
36,000
60 days)
Accounts payable
Building
60,000
Total liabilities
Office equipment
12,000
Owner's Equity
Ed Adams, capital
122,400
105,600
16,800
122,400
BAKER COMPANY
Balance Sheet
July 31,19 ___
Assets
Cash
24,000
Equity
Liabilities:
Accounts
48,000
receivable
Land
Building
Office equipment
7,200
days)
Accounts payable
12,000
Total liabilities
1,200
Owner's Equity
Ed Adams, capital
92,400
14,400
9,600
24,000
68,400
92,400
Questions :
(1)
Assume that you are a banker and that each company has
applied to you for a 90-day loan of $ 12,000. Which would you
consider to be the more favourable prospect?
(2)
CASE- 2
BUSINESS DECISION
(ii)
(iii)
Gallai felt
that some consideration should be given to the wear and tear on the
canoes and equipment but he agreed with Fell that for the present
purpose the canoes and equipment should be listed in the balance
sheet at the original cost. The supplies remaining on hand had cost $
40 and Fell felt that he could obtain a refund for this amount by
returning them to the supplier.
Questions :
1.
2.
information
available,
it
is
not
possible
to
3.
CASE-3
BUSINESS DECISION
Condensed
comparative
financial
statements
for
PACIFIC CORPORATION
Comparative Balance Sheets
As of May 31
(in thousands of dollars)
Assets
Year 3 Year 2
Current assets
Plant
and
equipment
(net
depreciation)
Total assets
Year l
3,960
2,610
3,600
of 21,240 19,890
14,400
25,200 22,500
18,000
2,214
2,052
1,800
Long-term liabilities
4,716
3,708
3,600
liabilities
12,600 12,600
5,670
&
4,140
8,100
4,500
18,000
Pacific
PACIFIC CORPORATION
Comparative Income Statements
For Years May 31
(in thousands of dollars)
Assets
Year 3
Year 2
Year l
Net sales
90,000
75,000
60,000
58,500
46,500
36,000
31,500
28,500
24,000
Operating expenses
28,170
25,275
21,240
3,330
3,225
2,760
Income taxes
1,530
1,500
1,260
Net income
1,800
1,725
1,500
270
465
405
stock in Year 2)
Cash dividends per share
063
1.11
1.50
Questions ;
1.
Prepare
three-year
comparative
balance
sheet
in
2.
period,
expressing
all
items
as
percentage
3.
4.
to
whom
the
stock
would
be
attractive
or
unattractive.
CASE-4
BUSINESS DECISION
Proposal No.1:
premium stamps
Quantity sold
Selling price per unit
Manufacturing cost per unit
500,000 boxes
$0.70
$0.40
in
unit
Proposal No. 1
sales 50%
Proposal No. 2
30%
volume
Decrease in manufacturing 10%
5%
10% of sales
8% of sales
None
10% of sales
None
8% of sales
$ 0.06 per box
5% of sales
Questions:
1.
2.
Current Year
Proposal No. 2
PART-A
(5x8= 40 marks)
2.
What are the different types of errors, how this can be managed
well?
3.
4.
5.
State the difference between cash flow and fund flow statement.
6.
7.
Building
Furniture
Library Books
16% Investments
(1-1-98)
Amount
(Dr.)
2,50,000 Admission Fees
Cr.)
5,000
2,00,000
4,000
for
Books
6,000
Salaries
Stationery
15,000 Annual
General Expenses
8,000
rant
Donations
library books
6,000 Capital Fund
Cash
1,000
Bank
12,000
Government
1,40,000
Received for
25,000
4,00,000
8,000
8,00,000
Additional Information:
1)
2)
3)
4)
8.
A book keeper while preparing his trial balance finds that the
debit exceeds by Rs. 7,250. Being required to prepare the final
account he places the difference to a suspense account. In the
next year the following mistakes were discovered:
a)
b)
c)
d)
e)
f)
Draft the journal entries for rectifying the above mistakes and prepare
the suspense account and profit and loss adjustment account
Journal
a) Suspense A/c
Dr.
8,000
8,000
Dr.
2,500
2,500
c) Krishna A/c
Dr.
1,300
1,300
Dr.
650
650
1,500
To Raghubir A/c
1,500
2,250
2,250
PART - B
(4 x 15 = 60 marks)
9.
have been drawn both for business use and private purposes.
From the following information, prepare the final accounts for
the year 1998:
Stock
Bank Balance
1-1-1998
20,000
8,000
31-12-1998
15,000
12,000
Cash in hand
300
400
Debtors
14,000
20,000
Creditors
27,300
30,000
Investments
50,000
50,000
1,50,000
59,700
26,000
1,22,000
2,50,000
1,60,000
97,700
7,000
2,000
1,000
4,600
During the year, cash amounting to Rs. 20,000 was stolen from the
till. Goods worth Rs. 24,000 were withdrawn from private use. No
record has been kept of amounts taken from cash for personal use
and a difference in calls amounting to Rs. 7,300 is treated as private
expenses.
10.
Liabilities
Assets
2000
2001
Goodwill
2,500
General
25,000
30,000
Buildings 1,00,000
Reserve
P&L A/c
15,250
15,300
Plant
75,000
84,500
Bank Loan
35,000
67,600
Stock-
50,000
37,000
(Long-term)
Creditors
75,000
Debtors
40,000
32,100
17,500
Bank
4,000
Cash
250
300
Provision
2000
for 15,000
2001
95,000
Tax
2,65,250 2,55,400
2,65,250 2,55,400
Additional Information:
(i)
(ii)
(iii)
11.
Provision for tax was made during the year Rs. 16,500.
From the following Balance Sheets of Exe. Ltd. Make out the
statement of sources and uses of cash:
Liabilities
Equity Share
Capital
2000
2001
Assets
2000
2001
1,15,000
90,000
8% Redeemable
Preference Share
2,00,000 1,70,000
Buildings
Capital
General Reserve
40,000
30,000
Account
Proposed
42,000
Dividend
Creditors
55,000
Bill Payable
Provision for
70,000 Plant
80,000 2,00,000
48,00 Debtors
1,60,000 2,00,000
50,000 Stock
77,000 1,09,000
83,000. Bills
20,000
30,000
20,000
Receivable
16,000 Cash in
15,000
10,000
40,000
Hand
50,000 Cash at
10,000
8,000
Taxation
Bank
6,77,000 8,17,000
6,77,000 8,17,000
Additional info
(a)
2.
(b)
(c)
Gama
Engineering
Company
Limited
manufacturers
two
Months
Product X
Product Y
January
February
500
600
1,400
1,400
March
800
1,200
April
May
1,000
1,200
1,000
800
June
July
1,200
1,000
800
980
It is anticipated that:
(a)
(b)
Finished units equal to half the anticipated sales for the next
month will be in stock at the end of each month (including
June 2001).
The budgeted production and production costs for the year ending 3l rt
June, 2001 are as follows:
Particulars
Production
Direct materials per unit
Direct wages per unit
Other manufacturing charges
(Units)
(Rs.)
(Rs.)
(Rs.)
Product X
11,000
12
5
33,000
Product Y
12,000
19
7
48,000
Production
budget
showing
the
number
of
units
to
be
b)
13.
Year
Machine A cash
Machine B cash
1
2
3
4
5
Inflow
Rs.
15,000
20,000
25,000
15,000
10,000
Inflow
Rs.
5,000
15,000
20,000
30,000
20,000
Year
PV Factor @ 10%
1
2
3
4
5
discount
0.909
0.826
0.751
0.683
0.621
(b)
(c)
(d)
14.
Following are Balance sheet of Vinay Ltd. for the year ended 31 st
December 2000 and 2001.
Liabilities
2000
Rs.
Equity capital
2001
Assets
Rs.
2000
Rs.
2001
Rs.
1,20,000 1,75,000
Pref. Capital
50,000
(Net)
75,000 Stock
Reserves
10,000
15,000 Debtors
50,000
62,500
P&L A/c
7,500
10,000 Bills
10,000
30,000
20,000
receivable
25,000 Cash at
20,000
26,500
10,000
Bank
12,500 Cash in
5,000
15,000
Creditors
Provision for
taxation
Proposed dividends
20,000
25,000
hand
7,500
12,500
2,30,000 3,40(000
2,30,000 3,40,000
Prepare a common size balance sheet and interpret the same.
15.
PACIFIC CORPORATION
Comparative Balance Sheets
As of May 31
(in thousands of dollars)
Assets
Current assets
Plant and equipment
(net
of
depreciation)
Total assets
Liabilities & Stockholder's Equity
Current liabilities
Long-term liabilities
Capital stock ($10 par)
Retained earnings
Total liabilities & stockholder's
equity
Year 3
$
3,960
21,240
Year 2
$
2,610
19,890
Year 1
$
3,600
14,400
25,200
22,500
18,000
2,214
4,716
12,600
5,670
25,200
2,052
3,708
12,600
4,140
22,500
1,800
3,600
8,100
4,500
18,000
PACIFIC CORPORATION
Comparative Income Statements
For Years May 31
(in thousands of dollars)
Assets
Net sales
Cost of goods sold
Gross Profit on sales
Operating expenses
Income before Income taxes
Income taxes
Net income
Cash dividends paid (plus 20% in
stock in Year 2)
Cash dividends per share
Year 3
$
90,000
58,500
31,500
28,170
3,330
1,530
1,800
270
Year 2
$
75,000
46,500
28,500
25,275
3,225
1,500
1,725
465
Year 1
$
$ 60,000
36,000
24,000
21,240
2,760
1,260
1,500
405
0.63
1.11
1.50
Questions:
1.
2.
period,
expressing
all
items
as
percentage
3.
4.
to
unattractive.
whom
the
stock
would
be
attractive
or