Accounts 2019 Final

A unit of Realwaves (P) Ltd
MBA CLASSES
st
I SEMESTER
ACCOUNTING
FOR
MANAGEMENT
Dear Student,
Welcome to the World of Knowledge
I have the pleasure of presenting this study material to you. It

contains exhaustive practical and Theory. It covers all the aspects
which will bring in to focus all important concepts that you need
to study in order to fortify yourself for your examination. The
subject will be taught by eminent professor who are highly
experienced and well versed with the job.
The Institute is very exhaustive and wholly concept based.
Also, the Institute is very systematic, well planned and absolutely
time- bound. For a change, say good bye to mechanical learning. I
am sure you will feel that the study is a pleasurable job and not a
painful exercise.
I wish you a very happy study time.
BEST OF LUCK!
PUNEET MORE
Director
M-105
ACCOUNTING FOR MANAGEMENT
Course/Paper : M-105 MBA Semester-I

No. of Lecture Hrs/week: 03 Internal Marks: 30
Total No of Lectures Hrs: 42 External Marks: 70
No. of Tutorial Hrs/week:01 Exam Time: 3 Hrs
Section -A
Module I: Introduction to Accounting (4 Hours)
Need and Types of Accounting, Users of Accounting, concepts and conventions of Accounting, Accounting
Equations.
Module II: Elementary Preparation of Books of Accounts (6 Hours)

Journals, ledgers and trial balance. Final Accounts, Trading, Profit Loss account with adjustments, Balance
Sheets
Module III: Financial Statements (6 Hours)

Concept and application, Income statement, statement of change in financial position
Module IV: Analysis of Financial Statements (6 Hours)
Comparative, common size and trend analysis, Ratio Analysis, Cash flow Statement as per AS3, Analyzing
Balance sheet using spread sheet
Module V: Accounting Standards and Introduction to IFRS (6 Hours)

IFRS and proposed changes in Indian Accounting Standards.
Module VI: Inferences and Interpretations from Published Financial Statement (4 Hours)
Module VII: Emerging issues in Financial Accounting (4 Hours)

Introduction, Price level Change, Zero based Budgets, Responsible Accounting
Module VIII: Valuation (6 Hours)
Valuation of goodwill, Inventory, Depreciations
Section B
At least One Case Study from each module
Note: 50% of the Questions will be Numerical & Cases/Inferences based.
Practical Components:
 Collecting Annual reports of the companies and analyzing the financial statements using different
techniques and presenting the same in the class.
 Analyzing the companies' cash flow statements and presenting the same in the class.
 Exposing the students to usage of accounting software's (Preferably Tally)
 Analysis of Balance Sheet using Excel
SR NAME OF CHAPTER PAGE
NO. NO.
1 MODULE 1 1.1
CHP 1 - INTRODUCTION TO ACCOUNTING
2 MODULE 2 - ELEMENTARY PREPARATION OF

BOOKS OF ACCOUNTS
Chp 2 - Journal 2.1
Chp 3 - Ledger 3.1
Chp 4 - Financial statement (without adjustment) 4.1
Chp 5 - Financial statement (with adjustment) 5.1
3 MODULE 3 6.1
CHP 6 - FINANCIAL STATEMENTS – FUND FLOW
STATEMENT
4 MODULE 4 - ANALYSIS OF FINANCIAL STATEMENT

Chp 7 - Comparative financial statement 7.1
Chp 8 - Common size 8.1
Chp 9 - Trend analysis 9.1
Chp 10 -Ratio analysis 10.1
Chp 11 -Cash flow statement 11.1
5 MODULE 5 12.1
CHP 12 - ACCOUNTING STANDARDS AND
INTRODUCTION TO IFRS
6 MODULE 6 13.1
CHP 13 - INFERENCES AND INTERPRETATIONS
FROM PUBLISHED FINANCIAL STATEMENT
7 MODULE 7 14.1
CHP 14 - EMERGING ISSUES IN FINANCIAL
ACCOUNTING
MODULE 8
8 CHP 15 -VALUATION OF GOODWILL 15.1
CHP 16 - INVENTORY 16.1
CHP 17 - DEPRECIATION 17.1
Time Table of MBA I and III Semester
SEMESTER I III
Commencement of
01.08.19 02.07.19
Classes
First Mid Term 30.09.19 19.08.19
Second Mid Term 14.11.19 04.11.19
Last Working Day 18.11.19 16.11.19
Commencement of
21.11.19 18.11.19
Practical Exams
Commencement of
05.12.19 04.12.19
Theory Exams
Winter Break 25.12.19 to 31.12.19

A unit of Realwaves (P) Ltd Introduction
CHAPTER 1 INTRODUCTION TO ACCOUNTING

DEFINITIONS
“Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events, which are in part at least of a financial character and
interpreting the results thereof.”
FEATURES OF ACCOUNTING
(i) Recording of financial transactions only: Only those transactions and events are recorded in
accounting, which are of financial character. There are so many transactions in the business, which
are very important for business, but which cannot be measured and expressed in terms of money and
hence such transactions will not be recorded. For example, the quarrel between the production
manager and the sales manager, resignation by an able and experienced manager, strike by
employees and starting of a new business by the other competitor etc. though these events affect the
earnings of the business adversely but as no one can measure the effect of such events in terms of
money, these will not be recorded in the books of the business.
(ii) Recording: Accounting is the art of recording business transactions according to some specified
rules. In a small business where the number of transactions is quite small, all transactions are first of
all recorded in a book called “Journal”. But in a big business where the number of transactions is
quite large, the journal is further sub-divided into various subsidiary books such as (I) ‘Cash Book’
for recording cash transactions; (II) ‘Purchases Book’ for recording credit purchases of goods; (III)
‘Sales Book’ for recording credit sales of goods; (IV) ‘Purchases Return Book’ for recording the
return of credit purchases; (V) ‘Sales Return Book’ for recording the return of credit sales, etc. the
number of subsidiary books to be maintained depends on the size and nature of the business.
(iii) Classifying: After recording the transactions in journal or subsidiary books, the transactions are
classified. Classification is the process of grouping the transactions of one nature at one place in a
separate account. The book in which various accounts are opened is called “Ledger.”
(iv) Summarizing: Summarizing is the art of presenting the classified data in a manner, which is
understandable and useful to management and other users of such data. This involves the balancing
of ledger accounts and the preparation of trial balance with the help of such balances. Final accounts
are prepared with the help of trial balance, which include trading and profit & loss account and a
balance sheet. Trading account is prepared for calculating gross profit or gross loss during the year.
Profit and loss account is prepared to ascertain the net profit or net loss during the year. Balance
sheet is prepared to present the financial position of the business.
ACCOUNTING CYCLE
Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Mansarovar: 69/318,VT Road, Mansarovar
Contact: 9829959536,7737733360,9928001210 1.1
Transaction
Trading & Profit and Loss

Account Journal
& Balance sheet
Trial Balance Ledger
OBJECTIVES / FUNCTIONS/ SCOPE OF ACCOUNTING
(i) To keep systematic record of business transactions: The main objective of accounting is to
keep complete record of business transactions according to specified rules. Complete record of
business transactions helps to avoid the possibility of omission and fraud.
(ii) To calculate profit or loss: The second main objective of accounting is to ascertain the net
profit earned or loss suffered on account of business transactions during a particular period. For this
purpose Trading & Profit and Loss account of the business is prepared at the end of each accounting
period.
(iii) To ascertain the financial position of the business: For a businessman, merely ascertaining
profit & loss of the business is not sufficient. The businessman must also know the financial health
of the business. For this purpose, after preparing the Profit and Loss account a statement called
‘balance sheet’ is prepared which shows the assets and their values on the one hand and the
liabilities and capital on the other hand.
(iv) To ascertain the progress of the business from year to year.
(v) To provide information’s to various parties: Another main objective of accounting is to

communicate the accounting information to various interested parties like owners, investors,
creditors, banks, employees and government authorities etc. the information helps them in taking
sound and judicious decisions about the business entity.
NEED OF ACCOUNTING
The need of accounting is as follows:

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1) Business Forecasting: Every business tries to forecast its future activities on the basis of the past
experience and present practices. It wants to determine the policies and programs well in advance.
For example, a business may like to know the quantity and quality of goods to be manufactured in
future. Accounting provides this facility to the business.
2) Correct Decision-Making: Every business house has to take many economic and financial
decisions, for example, determination of price on the basis of cost, imports-exports, increase, or
decrease in investments, distribution of dividend, bonus, etc. All such decisions should be taken with
utmost care. Any wrong decision taken may bring in many difficulties and problems. An appropriate
and consistent accounting system helps in taking various decisions in the business.
3) Correct Taxation: A business house has to pay many taxes such as income-tax, sales tax, excise
duty, customs, etc. The quantum of all taxes depends on the results shown by the financial accounts.
A proper accounting system followed in the business helps in determining correct amount of taxes.
4) Replacing Memory: Business transactions are innumerable, varied, and complex, as such it is
quite impossible to memorize each and every transaction. Accounting records these transaction in
writing and thus it is not necessary that the businessman should memorize all the transactions.
5) Assessing the Performance of the Business: Accounting keeps proper and systematic record of
all business transactions. Income statements are prepared with these records and one is able to know
the profit earned and the loss suffered by the business.
6) Assessing the Financial Status of the Business: Financial position of the business is displayed
through position statement, i.e., balance sheet of the business. The statement is prepared at the end of
the accounting year and reflects the true position of assets and liabilities of the business on a
particular date.
7) Documentary Evidence: Accounting records can also be used as evidence in the court to
substantiate the claim of the business. These records are based on documentary proof. Every entry is
supported by authentic vouchers. That is why; the court accepts these records as evidence.

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8) Assisting in Realization of Debts: In ' Accounts' personal ledger accounts of all the parties are
prepared. The personal account shows the exact amount due from the debtors. The statements of
accounts are sends to debtors to verify the entries and also to make early payment of the amount due.
The account can also be used to prove the claim of the business against the debtors in the court.
9) Preventing and Detecting Frauds: The proper accounting system and effective arrangement of
internal check prevents leakage of goods and cash. In case cheating takes place, theft or
embezzlement is made and fraud is committed, accounting helps in detection of these losses and also
fixes responsibility for it. Proper accounting prevents employees from committing fraud.
10) Helpful to Management: Accounting is useful to the management in various ways. It enables
the management to assess the achievements of its performance. Actual performance can be
compared with the desired performance or with the performance of previous years. The weaknesses
of the business can be identified and corrective measures can be applied to remove them. Various
profitability, sales, and liquidity ratios can be calculated, the actual performance can be evaluated
and effective line of action can be decided for the future. Funds flow statement can also be prepared
to understand the additional funds earned during the year and their application.
FUNCTIONS OF ACCOUNTING
The functions of accounting are as follows:
1) Identifying: Identifying the business transactions from the source documents.
2) Recording: This is the basic function of accounting. It is essentially concerned with not only
ensuring that all business transactions of financial character are recorded but also that they are
recorded in an orderly manner. Recording of transactions is done in 'journal' or 'subsidiary books'.
The number of subsidiary books to be maintained will be according to the nature and size of the
business.
3) Classifying: Classification is concerned with the systematic analysis of recorded facts, with a
view to group transactions or entries of one nature at one place. This is done in the book called
"Ledger". The ledger contains different pages of individual account heads under which all financial
transactions of similar nature are collected.
For example, the expenses may be classified under various heads like travelling, communication,
and printing. And stationery, advertisement, etc. All the entries in the Ledger shall flow based on the
entries passed in the Journal. The ledger accounts will help in knowing the total expenditure under
various heads for a given period.
4) Summarizing: This involves presenting the classified data in a manner, which is understandable
and useful to the internal as well as external end-users of financial statements. This process involves
preparation of (a) Trial Balance, (b) Income Statement, and (c) Balance Sheet.
5) Analyzing: It establishes the relationship between the items of the profit and loss account and the
balance sheet. The purpose of analyzing is to identify The financial strength and weakness of the
business. It provides the basis for interpretation.

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6) Interpreting: This is the final function of the accounting. The recorded financial data is
interpreted in a manner that the end-users can make a meaningful judgment about financial condition
and profitability of the business operations. The data is also used for preparing the future plans and
framing of policies for executing such plans.
7) Communicating: It is concerned with the transmission of summarized, analyzed, and interpreted

information to the users to enable them to make reasoned decisions.
Communication is preceded by an accounting cycle through which the identified and measured
transactions and events pass. Accounting performs a basic function of a language, that is, to serve as
a means of communication. It is an information system which communicates the accounting
information to the users (whether internal or external) to enable them to make reasoned decisions. As
an information system, accounting may be viewed as under:
BOOK-KEEPING AND ACCOUNTING

"Book-Keeping' and 'Accounting' are different from each other, though some people take them as
synonymous terms. In fact, book-keeping is the primary stage of accounting and is concerned mainly
with the recording of financial transactions of a business. A book-keeper is mainly responsible for
keeping all the records of a business or only a segment thereof. His work is of a clerical nature and
in modern times, it is being increasingly done through the use of electronically, mechanical and
computerized devices.
Accounting is the higher stage of book-keeping. It is primarily concerned with designing the
scientific system of-recording, classifying and summarizing the recorded data and also interpreting
them for internal and external use. The responsibility of an accountant is greater than a book-keeper.
An accountant must have a higher degree of conceptual understanding and analytical skill than that
required by a book-keeper.
Book-keeping is a routine work and a book-keeper, if instructed properly, can record the
routine transactions efficiently even though he may not have much knowledge of accounting
principles. In short, a book-keeper records the transactions while an accountant finds out the results
and decides different matters on their basis. In fact, accounting starts where book-keeping ends.
Thus, both the systems of accounting have one thing common, i.e., book-keeping
Systems of Book-Keeping
Book-keeping is the art of recording the business transactions in a systematic and regular manner.
This recording of transactions may be done according to any one of the following two systems:
1) Double Entry System: Under this system, every business transaction has two-fold effect, i.e., it
touches two accounts at a time. If one account is debited, the other account will have to be credited
with the same amount. For example, if goods are purchased for cash, goods are coming in the

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business and cash is going out of the business. Hence, Purchase account will be debited and Cash
account will be credited. Double entry system is used by most of the accountants as it is the only
system that fulfils all objectives of systematic accounting. The following basic accounting equations
are based on double entry system:
Assets = Liabilities + Capital
Liabilities = Assets - Capital
Capital = Assets - Liabilities
2) Single Entry System: This system may be termed as an incomplete double entry system. This
system has been developed by some small-scale business concerns who, for their convenience, keep
only some essential records. This system is not reliable as all records are not kept.
According to Kohler, "It is a system of book-keeping in which as a rule only records of cash and
personal accounts are maintained, it is always incomplete double entry, varying with circumstances".
Difference between Book-Keeping and Accounting

Basis of Difference Book-Keeping Accounting
1) Scope Recording and maintenance of It is not only recording and maintenance
books of accounts. of books of accounts but also includes
analysis, interpreting and
communicating the information.
2) Stage Primary stage. Secondary stage.
3) Objective To maintain systematic records of To ascertain the net result of the
business transactions. business operation.
Often routine and clerical in
4) Nature nature. Analytical and executive in nature.
5)Responsibility A book-keeper is responsible for An accountant is also responsible for the
recording business transactions. work of a book-keeper.
6) Knowledge level The book-keeper is not required The accountant is required to have
to have higher level of knowledge higher level of knowledge than that of
than that of an accountant. book-keeper.
7) Supervision The book-keeper does not
supervise and check the work of An accountant supervises and checks
an accountant. the work of the book-keeper.
8) Staff involved Senior staff performs the accounting
Work is done by the junior staff work.
of the organization.
In book-keeping, accounting The methods of reporting and
9) Principle of concepts and conventions are interpretation accounting may vary from
accountancy followed. firm to firm.
TYPES OF ACCOUNTING
In order to satisfy needs of different people interested in the accounting information, different types
of accounting have developed. They can broadly be classified as follows:

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1) Financial Accounting: It is the original form of accounting. It is mainly confined to the

preparation of financial statements for the use of outsiders like shareholders, debenture holders,
creditors, banks and financial institutions. The financial statements, i.e., the profit and loss account
and the balance sheet, show them the manner in which operations of the business have been
conducted during a specified period.
The object of financial accounting is to find out the profitability and to provide information
about the financial position of the concern. Two principal statements of financial accounting are
Income and Expenditure Statement, and Balance Sheet. The income and expenditure statement is
prepared for a particular period, e.g., a year. All revenue transactions relating to that period are
included in this statement with a view to determine the profitability of the concern. The balance
sheet is prepared on a particular date and it determines the financial position of the concern on that
date.
2) Management Accounting: Management accounting is comprised of two words 'management and

'accounting'. It is the study of managerial aspect of accounting. The emphasis of management
accounting is to redesign accounting in such a way that is helpful to the management information of
policy, control of execution and appreciation of effectiveness.
According to American Accounting Association, "Management Accounting includes the method
and concepts necessary for effective planning, for choosing among alternative business actions and
for control through the evaluation and interpretation of performances".
Management accounting covers various areas such as cost accounting, budgetary control, inventory
control, statistical methods, internal auditing, etc.
3) Cost Accounting: It is the process of accounting and controlling the cost of a product, operation,
or function. The purpose of this branch of accounting is to ascertain the cost, to control the cost and
to communicate information for decision-making.
According to ICMA, London, cost accounting is "The process of accounting for cost which begins
with the recording of income and expenditure and ends with the preparation of periodical statements
and reports for ascertaining and controlling costs".
USERS OF ACCOUNTING
Accounting is primarily required for the proprietors and management. Accounting information of a
business house is useful not only to the owners but also to many internal and external parties. A
classification of such interested groups in accounting disclosures may be done as under:

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Users of Accounting
Internal Users External Users
Internal Users
The internals users of accounting information are as follows:
1) Owners/Proprietors: The business is done with a primary objective of making profit. The
accounting records reflect the profitability, financial position and the financial soundness of the
business.
2) Managers: In case of large industrial organizations, where the owners and managers are different,
the managers are responsible for the day-to-day affair of the business. The accounting records
provide the vital information of the performance of the business and analysis, which in turn helps the
management to improve the performance by taking corrective actions.
3) Employees: The employees are interested in the job security and the future growth. Both of these
are related to the performance of the business. .
External Users
The externals users of accounting information are as follows:
1) Creditors: Creditors are the persons who have extended credit to the company. The creditors
include the suppliers of goods and services, bankers and other lenders. The financial statements help
them in ascertaining the liquidity position of the business, i.e., the ability to meet the financial
obligation, as and when they fall due.
2) Prospective Investors: A prospective investor is interested in knowing the financial strength of

the business. The expected rate of return on investment could be estimated based on the study of the
financial statements.
3) Government: The government is interested in the financial statements from the point of view of
taxation, compliance to corporate and labour laws.
4) Customers: Customers, who have developed loyalty to a business, are interested in the
continuance of the business. They are also interested in knowing the future plans of the organization
with which they can also link their growth.
5) Researchers: Researchers need financial information for testing financial hypothesis and
development of theories and models. .
6) Foreigners: The whole world has now become one big market due to modem means of transport
and communication. Many foreign agencies and entrepreneurs are interested to have collaboration
with Indian enterprises.

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Hence, the foreigners are interested to know the profitability and financial position of various
enterprises of this country. On the basis of accounting information, the foreigners make up their
mind for imports, exports also.
7) Others: Some other persons/parties are also interested in accounting information:
i) Entrepreneurs: Entrepreneurs venture to enter a particular business only after studying the
profitability and financial position of business units already working in that field.
ii) Tax Authorities: Authorities of income-tax, sales tax, etc, require accounting information of the
concerned business units.
iii) Trade Associates: Trade associations consolidate and compare the performance of their member
units and, if needed, demand certain concessions, exemptions or subsidies from the government.
This is done only after compiling the accounting information of the member units.
iv) Stock Exchanges: Stock exchanges require accounting information of companies in connection
with listing of securities and various dealings on the exchange.
v) Media: Newspapers, magazines and electronic media as radio, television, etc., collect accounting
information of various units and undertakings for bringing them to the notice of government and
masses.
vi) Political Parties: Political parties use accounting disclosures of public undertakings and various
industries in placing their views in the parliament, legislative assemblies as well as in public
meetings in order to prove economic progress of otherwise.
LIMITATIONS OF ACCOUNTING
Following are the limitations of accounting:
1) Recording of Monetary Transactions Only: Accounting records only such transactions which
can be expressed in terms of money. It has no place for recording non-monetary or non-financial
transactions, though these matters also have a significant role in affecting the soundness of the
business. For example, efficiency of the management, political situation, government policy, market
competitions, consumer preferences, etc., do affect the financial results and financial position of a
business, but these are not at all recorded in accounting.
2) Based on Some Estimates: The business results are drawn by accounting on some real and some
assumed estimates. For example, the valuation of stock, determination of depreciation, maintenance
of provisions and reserves are done in different concerns in different manners of their own choice.
Thus, the results and the position will change with change in the practice.
3) No Consideration of Price Level Changes: Accounting adopts the cost concept and hence, does
not consider the changes in the price level from time to time. This is very serious limitation of
accounting.

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4) Showing Imaginary Assets: Certain items find place in the assets side of the balance sheet while
in fact those are not the real and tangible assets. For example, goodwill, patents, preliminary
expenses, discount on shares and debentures, are not real assets, but are shown in the assets side of
the balance sheet.
5) May be Manipulated: Accounting may be manipulated to satisfy the wishes of the management.
An accountant may show the business results low or high as may be required by the management, by
manipulating the accounting data. This can be done by omitting certain accounts, by increasing or
decreasing the amounts of certain items, by under-estimating or over-estimating the value of assets,
etc, such types of manipulation are term as "Window Dressing".
6) Bound Under Certain Concepts: these are the following conditions in which accounting tools
are necessary:
i) The concept of a going concern presumes that the business will be carried on for an indefinite
period. With this concept in View, one can show different assets in the balance sheet at their book
value (i.e., cost - depreciation) and not at market price. Sometimes, an asset may be valueless in the
market, but it is continued to be shown in the books of account. Accounting in this manner will not
show the current sale price of the business.
ii) The concept of conservatism suggests that "Profits should not be anticipated but all possible
losses must be provided for". For example, stock must be valued at cost or market price, whichever
is less. Accounting under this concept sometimes gives untrue results.
iii) Concept of materiality suggests that accounting should disclose all the material (i.e., important)
information and immaterial or unimportant information may be avoided. This concept sometimes
creates confusion in identifying whether information is material or immaterial.
PRINCIPLES OF ACCOUNTING
(i) Business entity concept: According to this concept, business is treated as a unit separate and
distinct from its owners, creditors, managers & others. In other words, the owner of a business is
always considered as distinct and separate from the business he owns. Business unit should have a
completely separate set of books and we have to record business transactions from firm’s point of
view and not from the point of view of the proprietor. The proprietor is treated as a creditor of the
business to the extent of capital invested by him in the business. The capital is treated as a liability of
the firm because it is assumed that the firm has borrowed funds from its own proprietors instead of
borrowing it from outside parties.
(ii) Money measurement concept: Only those transactions and events are recorded in accounting,
which are capable of being expressed in terms of money. An event, even though it may be very
important for the business, will not be recorded in the books of the business unless its effect can be
measured in terms of money with a fair degree of accuracy. For example, accounting does not record
a quarrel between the production manager & sales manager; it does not report that a strike is
beginning and it does not reveal that a competitor has placed a better product in the market. These
facts or happenings cannot be expressed in money terms and thus are not recorded in the books.

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(iii) Going concern concept: As per this concept it is assumed that the business will continue to exit
for a long period in the future. The transactions are recorded in the books of the business on the
assumption that it is continuing enterprise.
(iv) Accounting period concept: A business has compulsorily to adopt financial year beginning on
1st April and ending on 31st March in the next calendar year as its accounting period. Apart from this,
companies whose shares are listed on the stock exchange are required to publish quarterly results to
depict the profitability and financial position at the end of three months period.
(v) Cost concept or historical cost concept: According to this concept, an asset is ordinarily
recorded in the books of accounts at the price at which it was acquired. This cost becomes the basis
of all subsequent accounting for the asset. The cost concept or historical cost concept does not mean
that assets will be continuously shown at their acquisition price for as long as the business entity
owns them. Their cost is systematically reduced from year to year by charging depreciation and the
assets are shown in the balance sheet at cost less depreciation.
(vi) Dual aspect concept: According to this concept, every business transaction is recorded as
having a dual aspect. In other words, every transaction affects at least two accounts. If one account is
debited, any other account must be credited. The system of recording transactions based on this
concept is called as ‘Double Entry System’. It is because of this principle that the two sides of the
balance sheet are always equal and the following accounting equations hold good at any point of
time:
Assets = Liabilities + Capital
Or
Capital = Assets – Liabilities
(vii) Matching concept: This concept is very important for correct determination of net profit.
According to this concept, in determining the net profit from business operations, all costs, which are
applicable to revenue of the period, should be charged against that revenue.
BASIC ACCOUNTING TERMS

BALANCE SHEET
PROFORMA OF BALANCE SHEET
Balance sheet as on or as at …….

Liabilities Amt Assets Amt
Current liabilities: Current assets:
Bank overdraft Cash in hand
Bills payable Cash at bank
Sundry creditors Bills receivable
Outstanding expenses Short term investments
Unearned income Sundry debtors
Fixed liabilities: Closing stock

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Long term loans Prepaid expenses
Reserves Accrued income
Capital Long term investments
Add: net profit Fixed assets:
Less: drawings Furniture
Less: income tax Loose tools
Less: life insurance premium Motor vehicle
Plant & machinery
Land & buildings
Patents
Goodwill
(1) Assets: Anything, which is in the possession or is the property of a business enterprise including
the amounts due to it from others, is called an asset. In other words, anything, which will enable a
business enterprise to get cash or a benefit in future, is an asset. Thus, cash and bank balances, stock,
furniture, machinery, land & building, bills receivable, money owing by debtors etc. are all assets.
(i) Fixed assets: Fixed assets refer to those which are held for continued use in the business for the
purpose of producing goods or services and are not meant for resale.
(ii) Current assets: Current assets are those assets which are meant for sale or which the
management would want to convert into cash within one year. For example, ‘debtors’ are expected
to be converted into cash within a reasonable short period, stock is continuously sold and bills
receivables are also converted into cash.
(a) Debtors: The term debtors represents those persons or firms to whom goods have been sold or
services rendered on credit and payment has not been received from them. E.g., if goods worth `
10000 have been sold to Mohan on credit, he will continue to remain the debtor of the business so
long as, he does not make the full payment.
(b) Stock: The term ‘stock’ means the value of those goods which are lying unsold at the end of
accounting period. The stock may be of two types:
Opening Stock & Closing Stock. The term Opening Stock means the value of goods lying unsold at
the beginning of the accounting period whereas the term Closing Stock means the value of goods
lying unsold at the end of the accounting period.
Types of stock: In case of a manufacturer, there can be Opening & Closing Stock of three types:
(1) Stock of raw material: It includes stock of raw materials purchased for using them in the
products manufactured but still lying unused. E.g., the value of cotton in case of cloth mills is the
stock of raw material.
(2) Stock of work in progress: It is also termed as stock of partly finished goods. It means goods in
semi- finished form. Such goods need further processing for converting into finished products.
(3) Stock of finished goods: It includes the stock of those goods which have been completely
processed and are ready for sale but are lying unsold at the end of the accounting period.

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(iii) Tangible and intangible assets: Tangible assets are those assets, which can be seen touched. In
other words, which have a physical existence such as land, building, plant, furniture, stock, cash etc.
Intangible assets are those assets which do not have a physical existence and which cannot be
seen or felt. E.g., goodwill, patents, trade marks & prepaid expenses. Intangible assets are also
valuable assets. E.g., with the help of patents (know- how) businessman is able to produce goods and
his goodwill helps in attracting customers easily. Therefore the intangible assets help the firm in
earning profits as much as the tangible assets.
(2) Liability: It refers to the amount, which the firm owes to outsiders (expecting the amount owed
to proprietors).
(i) Long term liabilities or fixed liabilities: These refer to those liabilities will fall due for payment
in a relatively long period (normally after more than one year). e.g. Long terms loans & debentures
etc.
(ii) Current liabilities: Current liabilities refer to those liabilities which are to be paid in near future
(normally within one year) e.g. bank overdraft, bills payable, creditors, outstanding expenses and
short term loans etc.
(iii) Creditors: The term creditors represents those persons or firms from whom goods have been
purchased or services procured on credit and payment has not been made to them. E.g., if goods
worth ` 5000 are purchased from Govind on credit, he will continue to remain the creditor of the
firm so long as, the full payment is not made to him.
(3) Capital: It refers to the amount invested by the proprietor in a business enterprise. It is the
amount with the help of which goods and assets are purchased in the business.
(4) Goods: Goods are those things, which are purchased for resale. In other words, goods are the
commodities in which the business deals. E.g. if cloth merchant purchases cloth, the cloth will be
termed as ‘purchases’. But if the same cloth merchant purchases some furniture, say chairs and a
sofa set for the seating of customers, the furniture so purchased will not be termed as purchases, but
will be an asset of his business and in this case ‘Furniture A/c’ will be debited instead of ‘Purchases
A/c’.
(5) Purchases: The term purchases is used only for the purchase of ‘goods’ in which the business
deals. In case of a manufacturing concern ‘goods’ means acquiring of raw material for the purpose
of conversion into finished product and then sale. In case of trading concern ‘goods’ are those things,
which are purchased for resale. E.g., if a cloth dealer purchases cloth for sale, the cloth so purchased
will be called ‘goods’. However, if the same cloth dealer purchases furniture for seating the
customers, such furniture will not be termed as goods, but it will be an ‘asset’.
The term purchases includes both cash purchases and credit purchases of goods.
Purchase returns: When purchased goods are returned to the suppliers these are known as purchase
returns. Such returns are also termed as ‘returns outwards’.
(6) Sales: The term ‘sales’ is used only for those goods, which are purchased for resale purchases.
The term ‘sales’ is never used for the sale of assets. E.g., if a cloth dealer sells cloth, it will be
termed as sales, but if the same cloth dealer sells old furniture or a typewriter, it will not be termed
as sales.
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The term sales include both cash and credit sales.
Sales returns: Some customers might return the goods sold to them. These are termed as sales
returns or ‘returns inwards.’
(7) Loss: When total expenses exceed the total revenues there is loss. e.g. If revenues are ` 100000
and expenses are ` 120000, the loss will be ` 20000. Second, it refers to some fact or activity against
which firm receives no benefit. E.g. Loss due to fire, theft, accident etc.
(8) Profit: It is the excess of total revenues over total expenses of a business enterprise for an
accounting period. Profit increases the investment of the owners.
(9) Discount: It is a rebate or an allowance given by the seller to the buyer. It is of two types:
(i) Trade discount: When discount is allowed by a seller to its customers at a fixed percentage on
the list or catalogue price of the goods it is called trade discount. It is not recorded in the books of
accounts as it is deducted in the invoice or cash memo itself from the gross value of goods.
(ii) Cash discount: When discount is allowed to the customers for making prompt payment it is
called cash discount. E.g. if a seller allows 2% discount for payment within a week it will be called
cash discount. It is always recorded in the books of accounts.
(10) Drawing: Any cash or value of goods withdrawn by the owner for personal use or any private
payments made out of business funds are called drawings.
MEANING OF ACCOUNTING EQUATION
An accounting equation is a statement of equality between the resource and the resources which
finance the resources and is expressed as follows:
Resource = Sources of Finance
Resources mean the Assets. The Assets refer to the tangible objected (e.g. Land & Building, Plant
& Machinery, Furniture, Investment, Stock, Debentures, Bank Balance, Cash Balance) or Intangible
(e.g. Patents, Trademarked, Copyright) owned by an enterprise and carrying probable future
benefits.
Sources of finance mean Equities and includes Internal Source (or Internal equity) (i.e. Capital)
and External Source (or External Equity) (i.e. Liabilities).
Capitals refer to the amount invested in an enterprise by its owners.
Liabilities are the financial obligations of an enterprise other than owner’s funds.
Thus, the aforesaid accounting equation may be expressed as follows:
Total Assets = Total Equities Or
Assets = Internal Equity + External Equity

Or
Assets = Capital + Liabilities

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Since the liabilities holders have a definite and prior claim against the assets, the capital is also
called a residual of assets over liabilities and may be expressed as follows:
Capital = Assets - Liabilities
This equation is fundamental in the sense that it gives fundamental to the double entry book keeping.
The equation holds good for all transaction and events and at all period of time since every
transaction and event has two aspects.
Analysis of Transactions Using Accounting Equation
An accounting equation may be developed by taking the steps given below:

Steps involved in developing an Accounting Equation
Step 1 → Ascertain the variables (i.e., Assets, Liabilities or Capital) of an equation affected by a
transaction.
Step 2 → Find out the effect (in terms of increase or decrease) of a transaction on the variables of an
Equation
Step 3 → Show the effect on the appropriation side of an equation and ensure that the total of right
hand Side is equal to the total of left hand side.
Accounting Equation to Record Capital Brought – in
PRACTICE QUESTIONS OF Accounting Equation

QUESTION 1. (Preparation of accounting equation) From the following transactions, prepare an
accounting equation :
(i) Aamir started business with cash ` 1,00,000
(ii) He purchased goods worth ` 20,000
(iii) He purchased furniture forth ` 10,000
(iv) He sold goods costing ` 9,000 for ` 11,000
(v) He sold goods costing ` 1,000 for ` 600
SOLUTION
Transactions Assets = Liabilities + Capital
Cash + Stock + Furniture = Liabilities + Capital
` ` ` ` `
(i) Started business 1,00,000 + 0 + 0 = 0 + 1,00,000
with cash ` 1,00,000
New equation 1,00,000 + 0 + 0 = 0 + 1,00,000
(ii) Purchased goods –20,000 + 20,000 + 0 = 0 + 0

worth ` 20,000
New equation 80,000 + 20,000 + 0 = 0 + 1,00,000
(iii) Purchased –10,000 + 0 + 10,000 = 0 + 0

furniture for ` 10,000

Contact: 9829959536,7737733360,9928001210 1.15
New equation 70,000 + 20,000 + 10,000 = 0 + 1,00,000
(iv) Sold goods +11,000 – 9,000 + 0 = 0 + 2,000

costing ` 9,000
for ` 11,000
New equation 81,000 + 11,000 + 10,000 = 0 + 1,02,000
(v) Sold goods costing +600 – 1,000 + 0 = 0 –400

` 1,000 for ` 600
New equation 81,600 + 10,000 + 10,000 = 0 + 1,01,600
1,01,600 = 1,01,600

(i) Nazeer started a business with ` 50,000
(ii) He purchased goods worth ` 10,000
(iii) Commission received in advance ` 5,000
(iv) Sold goods costing ` 8,000 for ` 10,000
(v) Additional capital introduced ` 25,000
SOLUTION
Cash + Stock Commission received + Capital
in advance
` ` ` `
(i) Started business 50,000 + 0 = 0 + 50,000
with cash ` 50,000
New equation 50,000 + 0 = 0 + 50,000
(ii) Purchased goods –10,000 + 10,000 = 0 + 0

worth ` 10,000
New equation 40,000 + 10,000 = 0 + 50,000
(iii) Commission +5,000 + 0 = 5,000 + 0

received in advance
` 5,000
New equation 45,000 + 10,000 = 5,000 + 50,000
(iv) Sold goods +10,000 – 8,000 = 0 + 2,000

costing ` 8,000
for ` 10,000
New equation 55,000 + 2,000 = 5,000 + 52,000
(v) Introduced +25,000 + 0 = 0 + 25,000

additional capital
` 25,000
New equation 80,000 + 2,000 = 5,000 + 77,000
82,000 = 82,000

Contact: 9829959536,7737733360,9928001210 1.16
(i) Mr. Anwar started a business with capital ` 2,00,000
(ii) He purchased goods for ` 20,000
(iii) Purchased machinery costing ` 10,000 from Mr. Abdul on credit
(iv) Withdrew ` 30,000 for personal use
(v) Sold goods costing ` 4,000 for ` 3,000
SOLUTION
Cash + Stock + Machinery = Creditors + Capital
` ` ` ` `
(i) Started business 2,00,000 + 0 + 0 = 0 + 2,00,000
New equation 2,00,000 + 0 + 0 = 0 + 2,00,000
(ii) Purchased goods –20,000 + 20,000 + 0 = 0 + 0

for ` 20,000
New equation 1,80,000 + 20,000 + 0 = 0 + 2,00,000
(iii) Purchased 0 + 0 + 10,000 = +10,000 + 0

machinery costing
` 10,000 from Abdul
on credit
New equation 1,80,000 + 20,000 + 10,000 = 10,000 + 2,00,000
(iv) Drawings –30,000 + 0 + 0 = 0 – 30,000

` 30,000
New equation 1,50,000 + 20,000 + 10,000 = 10,000 + 1,70,000
(v) Sold goods costing +3,000 – 4,000 – 1,000

` 4,000 for ` 3,000
New equation 1,53,000 + 16,000 + 10,000 = 10,000 + 1,69,000
1,79,000 = 1,79,000
QUESTION 4. (Preparation of accounting equation) OM Traders started a business with cash `

1,21,000. In respect of his business, following transactions were recorded.
(`)
(a) Purchased goods on credit 32,500
(b) Paid wages 2,500
(c) Withdrew for personal use 21,600
(d) Paid to creditors in full settlement 32,000
(e) Purchased furniture for 2,510
(f) Telephone charges paid 18,000
Show an accounting equation on the basis of above transactions:
SOLUTION

Contact: 9829959536,7737733360,9928001210 1.17
Cash + Stock + Furniture = Creditors + Capital
` ` ` ` `
Opening entry 1,21,000 + 0 + 0 = 0 + 1,21,000
New equation 1,21,000 + 0 + 0 = 0 + 1,21,000
(a) Purchased goods 0 + 32,500 + 0 = 32,500 + 0
on credit ` 32,500
New equation 1,21,000 + 32,500 + 0 = 32,500 + 1,21,000
(b) Paid wages –2,500 + 0 + 0 = 0 – 2,500
for 2,500
New equation 1,18,500 + 32,500 + 0 = 32,500 + 1,18,500
(c) Withdrew for –21,600 + 0 + 0 = 0 – 21,600
personal use
` 21,600
New equation 96,900 + 32,500 + 0 = 32,500 + 96,900
(d) Paid to creditors –32,000 + 0 + 0 = –32,500 + +500
in full settlement
` 32,000
New equation 64,900 + 32,500 + 0 = 0 + 97,400
(e) Purchased –2,510 + 0 + 2,510 = 0 + 0
furniture for
` 2,510
New equation 62,390 + 32,500 + 2,510 = 0 + 97,400
(f) Telephone charges –18,000 + 0 + 0 = 0 – 18,000
paid ` 18,000
New equation 44,390 + 32,500 + 2,510 = 0 + 79,400
79,400 = 79,400
QUESTION 5. (Preparation of accounting equation) Mr. Raashid started a business with cash `
50,000. During the year the following transactions took place :
(i) He purchased goods for ` 20,000
(ii) He purchased furniture for ` 5,000
(iii) He purchased machinery for ` 7,000
(iv) He purchased goods for ` 2,000 from Mr. Lawaz
(v) He sold goods costing ` 3,000 for ` 4,000
(vi) He purchased goods for ` 4,000 from Mr. Labeeb in cash
(vii) He sold goods to Khursheed costing ` 8,000 at a loss of ` 1,000 in cash
Prepare an accounting equation
SOLUTION

Cash + Stock + Furniture + Machineary = Creditors + Capital
` ` ` ` ` `
Started business with 50,000 + 0 + 0 + 0 = 0 + 50,000
cash ` 50,000
New equation 50,000 + 0 + 0 + 0 = 0 + 50,000
(i) Purchased goods –20,000 + 20,000 + 0 + 0 = 0 + 0

Contact: 9829959536,7737733360,9928001210 1.18
for ` 20,000
New equation 30,000 + 20,000 + 0 + 0 = 0 + 50,000
(ii) Purchased –5,000 + 0 + 5,000 + 0 = 0 + 0
furniture for ` 5,000
New equation 25,000 + 20,000 + 5,000 + 0 = 0 + 50,000
(iii) Purchased –7,000 + 0 + 0 + 7,000 = 0 + 50,000
machinery for ` 7,000
New equation 18,000 + 20,000 + 5,000 + 7,000 = 0 + 0
(iv) Purchased goods 0 + 2,000 + 0 + 0 = 2,000 + 50,000
from Mr. Lawaz for
` 2,000
New equation 18,000 + 22,000 + 5,000 + 7,000 = 2,000 + 50,000
(v) Sold goods costing +4,000 + 3,000 + 0 + 0 = 0 + 1,000
` 3,000 for ` 4,000
New equation 22,000 + 19,000 + 5,000 + 7,000 = 200,0 + 51,000
(vi) Purchased goods –4,000 + 4,000 + 0 + 0 = 0 + 0
from Mr. Labeeb in
cash for ` 4,000
New equation 18,000 + 23,000 + 5,000 + 7,000 = 2,000 + 51,000
(vii) Sold goods to +7,000 + 8,000 + 0 + 0 = 0 – 1,000
Khursheed costing `
8,000 at a loss of `
1,000 in cash
New equation 25,000 + 15,000 + 5,000 + 7,000 = 2,000 + 50,000
52,000 = 52,000
QUESTION 6. (Preparation of accounting equation) Prepare an accounting equation on the basis of

the following :
(`)
(a) X started business with cash 1,20,000
(b) Purchased goods for cash 22,000
(c) Furniture purchased for cash 3,000
(d) Commission received 7,200
(e) Sold goods (costing ` 12,000) 21,000
(f) Expenses paid 800
(g) Sold goods on credit (Costing ` 1,500) 2,000
(h) Paid rent 12,000
SOLUTION
The accounting equation prepared on the basis of above transactions is as follows :

Cash + Stock + Furniture + Debtors = Creditors + Capital
` ` ` ` ` `
(a) X started business 1,20,000 + 0 + 0 + 0 = 0 + 1,20,000
New equation 1,20,000 + 0 + 0 + 0 = 0 + 1,20,000
(b) Purchased goods –22,000 + 22,000 + 0 + 0 = 0 + 0

Contact: 9829959536,7737733360,9928001210 1.19
for cash ` 22,000
New equation 98,000 + 22,000 + 0 + 0 = 0 + 1,20,000
(c) Furniture –3,000 + 0 + 3,000 + 0 = 0 + 0
purchased for Cash
` 3,000
New equation 95,000 + 22,000 + 3,000 + 0 = 0 + 1,20,000
(d) Commission +7,200 + 0 + 0 + 7,000 = 0 + 7,200
received ` 7,200
New equation 1,02,000 + 22,000 + 3,000 + 0 = 0 + 1,27,200
(e) Sold goods (Costing +21,000 – 12,000 + 0 + 0 = 0 + 9,000
` 12,000) For ` 21,000
New equation 1,23,200 + 10,000 + 3,000 + 0 = 0 + 1,36,200
(f) Expenses paid –800 + 0 + 0 + 0 = 0 + 800
` 800
New equation 1,22,400 + 10,000 + 3,000 + 0 = 200,0 + 1,35,400
(g) Sold goods on 0 – 1,500 + 0 + 2,000 = 0 + 500
credit (Costing ` 1,500
for ` 2,000
New equation 1,22,400 + 8,500 + 3,000 + 2,000 = 0 + 1,35,900
(h) Paid rent ` 12,000 –12,000 + 0 + 0 + 0 = 0 – 12,000
New equation 1,10,400 + 8,500 + 3,000 + 2,000 = 2,000 + 1,23,900
1,23,900 = 1,23,900
QUESTION 7. (Preparation of accounting equation) Amar commenced business with a capital of `

75,000 on 1st April, 2013. The various transactions that took place during the year were as follows :
(i) Purchased furniture worth ` 7,000 for office use.
(ii) Bought Machinery for ` 10,000
(iii) Purchased goods from Jitinder for ` 5,000
(iv) Purchased goods from Hari in cash ` 8,000
(v) Sold goods (costing ` 4,000) at a profit of 25% on cost
(vi) Withdrew cash for private use ` 2,000
(vii) Deposited into bank account ` 1,000
(viii) Expenses paid ` 2,000
Prepare an accounting equation to give effect to the above transactions.
SOLUTION
Cash + Furniture + Machinery + Stock + Bank = Creditors + Capital
` ` ` ` ` ` `
Amar started 75,000 + 0 + 0 + 0 + 0 = 0 + 75,000
business with cash `
75,000
New equation 75,000 + 0 + 0 + 0 + 0 = 0 + 75,000
(i) Purchased
furniture worth –7,000 + 7,000 + 0 + 0 + 0 = 0 + 0
` 7,000 for office
use
New equation 68,000 + 7,000 + 0 + 0 + 0 = 0 + 75,000
(ii) Bought

Contact: 9829959536,7737733360,9928001210 1.20
Machinery for –10,000 + 0 + 10,000 + 0 + 0 = 0 + 0
for ` 10,000
New equation 58,000 + 7,000 + 10,000 + 0 + 0 = 0 + 75,000
(iii) Purchased
goods from Jitinder 0 + 0 + 0 + 5,000 + 0 = 5,000 + 0
for ` 5,000
New equation 58,000 + 7,000 + 10,000 + 5,000 + 0 = 5,000 + 75,000
(iv) Purchased goods
from Hari in cash –8000 + 0 + 0 + 8,000 + 0 = 0 + 0
` 8,000
New equation 50,000 + 7,000 + 10,000 + 13,000 + 0 = 5,000 + 75,000
(v) Sold goods
(Costing ` 4,000) at +5000 + 0 + 0 – 4,000 + 0 = 0 + 1,000
a Profit of 25% on
cost
New equation 55,000 + 7,000 + 10,000 + 9,000 + 0 = 5,000 + 76,000
(vi) Withdrew cash
for private use –2,000 + 0 + 0 + 0 + 0 = 0 – 2,000
` 2,000
New equation 53,000 + 7,000 + 10,000 + 9,000 + 0 = 5,000 + 74,000
(vii) Deposited into
bank account ` –1,000 + 0 + 0 + 0 + 1,000 = 0 + 0
1,000
New equation 52,000 + 7,000 + 10,000 + 9,000 + 1,000 = 5,000 + 74,000
(viii) Expenses paid
` 2,000 –2,000 + 0 + 0 + 0 + 0 = 0 – 2,000
New equation 50,000 + 7,000 + 10,000 + 9,000 + 1,000 = 5,000 + 72,000
77,000 = 77,000

(i) Mr. Fazal started a business with cash ` 20,000
(ii) He took bank loan ` 1,00,000
(iii) He purchased goods for ` 15,000
(iv) He sold 50% of goods at a profit of 20%
(v) He sold 10% of the remaining goods at a profit of 10%
SOLUTION
Cash + Stock = Bank Loan + Capital
` ` ` `
(i) Started business 20,000 + 0 = 0 + 20,000
with cash ` 20,000
New equation 20,000 + 0 = 0 + 20,000
(ii) Bank Loan +1,00,000 + 0 = +1,00,000 + 0
` 1,00,000
New equation 1,20,000 + 0 = 1,00,000 + 20,000
(iii) Purchased –15,000 + 15,000 = 0 + 0
goods for ` 15,000
New equation 1,05,000 + 15,000 = 1,00,000 + 20,000
(iv) Sold 50% of goods +9,000 – 7,500 = 0 + 1,500

Contact: 9829959536,7737733360,9928001210 1.21
at a profit of 20%
New equation 1,14,000 + 7,500 = 1,00,000 + 21,500
(v) Sold 10% of the +825 – 750 = 0 + 75
remaining goods at a
profit of 10%
New equation 1,14,825 + 6,750 = 1,00,000 + 21,575
1,21,575 = 1,21,575
(i) Abdul Hafiz started a business with cash ` 5,00,000
(ii) Purchased goods for ` 30,000
(iii) Paid rent ` 1,000
(iv) Cash withdrawn ` 1,000 for personal use
(v) Interest on drawings charged @ 5%
SOLUTION
Cash + Stock = Liabilities + Capital
` ` ` `
(i) Started business 5,00,000 + 0 = 0 + 5,00,000
New equation 5,00,000 + 0 = 0 + 5,00,000
(ii) Purchased goods –30,000 + 30,000 = 0 + 0
for ` 30,000
New equation 4,70,000 + 30,000 = 0 + 5,00,000
(iii) Paid rent ` 1,000 –1,000 + 0 = 0 + 1,000
New equation 4,69,000 + 30,000 = 0 + 4,99,000
(iv) Cash withdrawn ` –1,000 + 0 = 0 – 1,000
1,000 for personal use
New equation 4,68,000 + 30,000 = 0 + 4,98,000
(v) Interest on 0 + 0 = 0 + 50
drawings charged = 0 – 50
@ 5%
New equation 4,68,000 + 30,000 = 0 + 4,98,000
4,98,000 = 4,98,000
QUESTION 10. (Preparation of accounting equation) Mr. X commenced his business on 1st April,
2013 by introducing capital of ` 50,000. During the year, following transactions had taken place
Amount (`)
(a) Bought Furniture for cash 16,000
(b) Purchased goods for 20,000
(c) Sold goods (costing ` 8,500) to Ram for cash 16,000
(d) Purchased goods from Mohan 11,000
(e) Introduced additional capital 13,000
(f) Commission received in advance 1,500
(g) Paid to Creditors ` 9,500 in full settlement
(h) Bought Fax Machine for his personal use 8,000
(i) Rent paid for the year 8,000
(j) Payment for stationery 200
Contact: 9829959536,7737733360,9928001210 1.22
(k)Sold goods (costing ` 10,000) for ` 12,000. Out of which ` 1,000
received in cash
Show the above transactions in accounting equations
SOLUTION
Cash + Furniture + Stock + Debtors + Income = Creditors + Capital
received in adavance
` ` ` ` ` ` `
Commenced business 50,000 + 0 + 0 + 0 = 0 + 0 + 50,000
New Balance
50,000 + 0 + 0 + 0 = 0 + 0 + 50,000
(a) Bought Furniture
–16,000 + 16,000 + 0 + 0 = 0 + 0 + 0
for cash
New Balance 34,000 + 16,000 + 0 + 0 = 0 + 0 + 50,000
(b) Purchased goods
for ` 20,000 –20,000 + 0 + 20,000 + 0 = 0 + 0 + 0
New Balance 14,000 + 16,000 + 20,000 + 0 = 0 + 0 + 50,000
(c) Sold goods (costing
for ` 8,500) to Ram for +16,000 + 0 – 8,500 + 0 = 0 + 0 + 7,500
cash
New Balance 30,000 + 16,000 + 11,500 + 0 = 0 + 0 + 57,500
(d) Purchased
goods from Mohan 0 0 + 11,000 + 0 0 + 11,000 + 0
New Balance 30,000 + 16,000 + 22,500 + 0 = 0 + 11,000 + 57,500
(e) Introduced
additional capital +13,000 0 0 0 0 + 0 + 13,000
New Balance 43,000 + 16,000 + 22,500 + 0 = 0 + 11,000 + 70,500
(f) Commission
received in advance +1,500 0 0 + 0 +1,500 + 0 + 0
New Balance 44,500 + 16,000 + 22,500 + 0 = +1,500 + 11,000 + 70,500
(g) Paid to creditors
` 9,500 in full –9,500 + 0 + 0 + 0 0 –11,000 + 1,500
settlement
New Balance 35,000 + 16,000 + 22,500 + 0 = +1,500 + 0 + 72,000
(h) Bought Fax
Machine for his –8,000 + 0 + 0 + 0 0 + 0 – 8,000
personal use
New Balance 27,000 + 16,000 + 22,500 + 0 = +1,500 + 0 + 64,000
(i) Rent paid for the
year –8,000 + 0 + 0 + 0 0 0 – 8,000
New Balance +19,000 + 16,000 + 22,5000 + 0 = 1,500 + 0 + 56,000
(j) Payment for
stationery –200 0 0 0 0 + 0 – 200
New Balance +18,800 + 16,000 + 22,500 + 0 = +1,500 + 0 + 55,800
(k) Sold goods (costing
` 10,000) for ` 12,000; +1,000 + 0 –10,000 + 11,000 0 0 + 2,000
` 1,000 in cash
New Balance +19,800 + 16,000 + 12,500 + 11,000 = +1,500 + 0 + 57,800
59,300 = 59,300
QUESTION 11. (Preparation of accounting equation) From the following particulars of Mr. Ram,
prepare the accounting equation :
(a) Started business with cash for ` 2,50,000 and Building ` 10,00,000
(b) Paid into bank ` 1,00,000
Contact: 9829959536,7737733360,9928001210 1.23
(c) Purchase machinery for cash ` 20,000
(d) Purchased goods for cash ` 1,00,000
(e) Sold goods (costing ` 2,000) for cash ` 2,400
(f) Expenses outstanding worth ` 1,000
(g) Received securities deposit from tenants ` 3,500
(h) Sold goods to Mohan (costing ` 10,000) for ` 9,000
(i) Paid telephone expenses ` 18,100
SOLUTION
Cash + Buildings + Bank + Machinery + Stock + Debtors = O/s + Security + Capital
exp.
` ` ` ` ` ` ` ` `
(a) Mr. Ram 2,50,000 + 10,00,000 + 0 + 0 + 0 + 0 = 0 + 0 + 12,50,000
started business
with cash &
building
New Balance 2,50,000 + 10,00,000 + 12,50,000

(b) Paid into bank
` 1,00,000 –1,00,000 + 0 + 1,00,000 + 0 + 0 + 0 = 0 + 0 + 0
New Balance 1,50,000 + 10,00,000 + 1,00,000 + 0 + 0 + 0 = 0 + 0 + 12,50,000
(c) Purchased
machinery –20,000 + 0 + 0 + 20,000 + 0 + 0 = 0 + 0 + 0
for cash ` 20,000
New Balance 1,30,000 + 10,00,000 + 1,00,000 + 20,000 = + 12,50,000
(d) Purchased
goods for cash ` –1,00,000 + 0 + 0 + 0 +1,00,000 + 0 = 0 + 0 + 0
1,00,000
New Balance 30,000 + 10,00,000 + 1,00,000 + 20,000 +1,00,000 = 0 + 0 + 12,50,000
(e) Sold goods
(costing ` 2,000) +2,400 + 0 + 0 + 0 – 2,000 + 0 = 0 + 0 + 400
for cash ` 2,400
New Balance 32,400 + 10,00,000 + 1,00,000 + 20,000 + 98,000 = + 12,50,400
(f) Expenses
outstanding 0 + 0 + 0 + 0 + 0 + 0 = 1,000 + 0 – 1,000
worth ` 1,000
New Balance 32,400 + 10,00,000 + 1,00,000 + 20,000 + 98,000 = 1,000 + 0 + 12,49,000
(g) Received
securities deposit +3,500 + 0 + 0 + 0 + 0 + 0 = 0 + 3,5000 + 0
from tenants
` 3,500
New Balance 35,900 + 10,00,000 + 1,00,000 + 20,000 + 98,000 = 1,000 + 3,500 + 12,49,000
(h) Sold goods to
Mohan (costing 0 + 0 + 0 + 0 – 10,000 + 90,000 0 –1,000
` 10,000) for
` 9,000
New Balance 35,900 + 10,00,000 + 1,00,000 + 20,000 + 88,000 + 9,000 = 1,000 + 3,500 + 12,48,400
(i) Paid telephone
expenses –18,100 + 0 + 0 + 0 0 0 = – 18,100
` 18,100
New Balance 17,800 + 10,00,000 + 1,00,000 + 20,000 + 88,000 + 9,000 = 1,000 + 3,500 + 12,30,300
12,34,800 = 4,500 + 12,30,300
*****

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A unit of Realwaves (P) Ltd Journal
CHAPTER 2 JOURNAL
Meaning
Journal is a book of original entry in which the transactions are recorded first of all, as and when
they take place.
FORMAT OF JOURNAL
JOURNAL
Date Particulars Ledger Amount Dr. (`) Amount Cr. (`)
folio
(1) (2) (3) (4) (5)
Classification of accounts
Classification of Accounts
Personal Accounts Impersonal Accounts
Real Accounts Nominal Accounts
Natural Personal Artificial Personal Representative Personal

Accounts Accounts Accounts
Tangible Real Intangible Real

Accounts Accounts
(A) Personal Accounts: The accounts, which relate to an individual, firm, company or institutions
are called personal accounts. Accounts of Mohan, Accounts of Ram Chander, Accounts of D.C.M
limited, Accounts of Delhi university, bank account, capital account of the proprietor, drawings
account of the proprietor etc. are examples of personal accounts.
Rule: Rule for recording a transaction in personal accounts in simple words is
“DEBIT THE RECEIVER
CREDIT THE GIVER”
(i) Natural personal Accounts: Accounts of ‘natural persons’ means the accounts of human beings.
E.g., Mohan’s Account, Sohan’s Account, Shubhi’s Accounts, Neha’s Account etc. Proprietor’s
Capital Account, Proprietor’s Drawings Account, Debtors Account, Creditors Accounts are also
included in this category.

Mansarovar: 69/318, VT Road, Mansarovar
Contact: 9829959536,7737733360,9928001210 2.1
(ii) Artificial personal Accounts: These accounts do not have physical existence as human being
but they work as personal accounts. E.g., any firm’s account, any limited company’s account, any
institution’s account and any bank’s account. These are treated as artificial persons for the recording
of business transactions. These accounts also include the accounts of clubs, insurance companies and
the accounts of government departments, which are recognized as ‘persons’ in the business dealings.
(iii) Representative personal Accounts: When an account represents a particular person or group
of persons, it is treated as a Representative personal Account. “Salaries Outstanding Account” is the
account, which represents the account of all the persons to whom salaries have to be paid. This is
therefore termed as ‘Representative personal Account’. Other e.g. of the Representative personal
Accounts are, prepaid insurance account, accrued interest account and unearned commission account
etc.
(B) Impersonal Accounts: These accounts are classified into Real & Nominal accounts they are as
follows:
(i) Real Accounts: The accounts of all those things whose value can be measured in terms of money
and which are the properties of the business are termed as Real Accounts. Such as cash account,
furniture account, machinery account, goodwill account etc.
Rule: Rule for recording a transaction in real accounts in simple words is
“DEBIT WHAT COMES IN
CREDIT WHAT GOES OUT”
(a) Tangible Real Accounts: Tangible real accounts are the accounts of those things which can be
touched, felt, measured, purchased, sold etc. e.g. of such accounts are cash account, stock account,
furniture account, land account etc.
(b) Intangible Real Accounts: These accounts represent such things, which cannot be touched, but,
of course, their value can be measured in terms of money. E.g., goodwill account, patents account,
trade marks account, copyrights accounts etc.
(ii) Nominal Accounts: These accounts include the accounts of all expenses and incomes. E.g. of
nominal accounts relating to expenses are salaries paid, rent paid, discount allowed, bad debts etc.
E.g. of nominal accounts relating to incomes are commission received, interest received, discount
received etc.
Rule: Rule for recording a transaction in nominal accounts in simple words is
“DEBIT ALL EXPENSES & LOSSES

CREDIT ALL INCOMES & GAINS”
Illustration: 1
Enter the following transactions in the journal of Manish:
1994 Particulars Amt (`)

June 1 Manish started business with cash 50000
2 Purchased goods for cash 20000
4 Purchased goods from Harish 12000

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5 Purchased furniture for cash 6000
7 Sold goods for cash 13000
9 Sold goods to Pravesh 15000
10 Paid cash to Harish 8000
12 Received cash from Pravesh 10000
16 Purchased goods from Anish for cash 7500
17 Purchased goods from Anish 5000
18 Sold goods to Tanish for cash 12600
19 Sold goods to Tanish 7000
20 Bought machinery for cash 8000
24 Withdrew cash from office for personal use 2500
27 Paid rent 400
29 Paid wages 450
30 Paid salary to Ramesh 1200
30 Received commission 200
Ans: Total: ` 176600
Illustration: 2
Record the following transactions in the journal of Vishal:

May 1 Commenced business with cash 500000
2 Goods purchased from Sohan for cash 50000
3 Goods purchased from Mohan 120000
4 Goods returned to Mohan 5000
8 Goods sold to Rohan 40000
12 Rohan returned 10% of goods
Illustration: 3
Record the following transactions in the journal of Naresh:

June 1 Paid cash to Mahesh 9600
And discount received from him 400
4 Received cash from Ganesh 4900
And discount allowed to him 100
10 Goods sold to Suresh 30000
12 Suresh returned goods 2000
14 Received cash from Suresh ` 27500 in full
settlement of his account
20 Sold goods to Rajesh of the list price of ` 60000
at 10% trade discount.
23 Purchased goods from Dinesh of the list price of
` 20000 at 15% trade discount.

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Illustration: 4
Give journal entries for the following transactions in the books of Pratap Rai:

March1 Started business with cash 100000
2 Cash purchases 48000
3 Sold goods to ram 10000
6 Returned defective goods by ram 1000
8 Received cash from ram 8800
And discount allowed 200
9 Shyam sold goods to us 20000
10 Khush purchased goods from us 12000
10 Paid insurance premium 500
12 Paid for life insurance premium of Sh. Pratap Rai 2000
15 Paid cash to Shyam 13780
and discount allowed to him 220
18 Bought goods from Pawan, list price ` 15000 less
20% trade discount
22 Paid to Pawan 8000
26 Received cash from Khush 6000
31 Paid wages ` 400, advertisement expenses ` 250
and salaries paid ` 1500
31 Received interest 100
Illustration: 5
Pass journal entries in the books of Raghu from the following transactions:
1994
June 1 Raghu started business with cash ` 80000; goods ` 40000 & furniture ` 20000
. 2 Sold goods to Nandu of the list price of ` 20000 at trade discount of 10%
4 Nandu returned goods of the list price of ` 4000
8 Received from Nandu ` 14150 in full settlement of his account.
10 Purchased goods from Chandu of the list price of ` 10000 at 15% trade discount
13 Returned goods to Chandu of the list price of ` 1000
16 Settled the account of Chandu by paying cash, under a discount of 4%
18 Purchased goods from Anil ` 5000; Sunil ` 10000
19 Paid cash to Anil ` 1900 and discount received ` 100
20 Paid ` 9800 to Sunil in full settlement of his account.
20 Bought a ‘table fan’ for ` 1200 for the domestic use of Raghu.
25 Sold goods for cash of the list price of ` 8000 at 10% trade discount and 3% cash discount.
30 Paid rent ` 800; trade expenses ` 700 & traveling expenses ` 380.
Illustration: 6
Journalise the following transactions in the books of Sanjeet bros:

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(a) ` 1000 due from Archeet are now bad debts.

(b) Goods worth ` 2000 were used by the proprietor.
(c) Charge depreciation @10% p.a. for two months on machine costing ` 30000
(d) Provide interest on capital of ` 150000 at 6% p.a for 9 months.
(e) Manjeet who owed us ` 2000 becomes insolvent and a final dividend of 60 paise in a rupee is
received from his estate.
(f) Goods costing ` 8000 sold to Paramjeet for ` 10000.
Ans: Total: ` 22250
Illustration: 7
Enter the following transactions in the journal of Manoj:

March1 Manoj started business with cash 60000
2 Purchased furniture for cash 10000
4 Purchased goods for cash 25000
5 Bought goods from Kamlesh 15000
6 Sold goods for cash 36000
8 Sold goods to Hari 30000
10 Paid cash to Kamlesh 15000
14 Received cash from Hari 18000
16 Purchased goods from Sohan 6000
18 Purchased goods from Sohan for cash 8000
20 Paid rent for the office 1000
27 Paid salary to Gopal 1200
28 Received cash from Hari 12000
29 Withdrew cash from office for personal use 4000
30 Wages paid 7200
30 Bought machinery for cash 8000
Illustration: 8
Enter the following transactions in the journal of Sahil:
Oct 1 Purchased goods from Anil for cash 40000
3 Purchased goods from Atul 75000
6 Returned goods to Atul 3000
8 Paid cash to Atul 50000
10 Sold goods to Charu 100000
12 Charu returned 20% of goods
15 Paid rent 2000
20 Sahil withdrew for personal use 10000
Illustration: 9

Contact: 9829959536,7737733360,9928001210 2.5
Enter the following transactions in the journal of Ganesh:
March3 Sold goods to dev 100000
5 Received from dev in full settlement of his 98000
account.
6 Sold goods to Manmohan 80000
8 Manmohan returned goods 1000
15 Received from Manmohan in full settlement of 78200
his account
16 Received cash from ram 19500
20 Paid cash to Pawan 4700
and discount received to him 300
25 Sold goods to Varun of the list price of ` 25000
at 20% trade discount.
Illustration: 10
Pass journal entries in the books of Harish from the following transactions:
Jan 1 Commenced business with cash 50000
2 Purchased goods from Subhash 20000.
4 Sold goods to Ramnath 15000
6 Ramnath returned defective goods 1000
10 Received cash from Ramnath 13800
12 Gopal sold goods to us 10000
14 Paid to Gopal in full settlement of his account
after deducting 5% discount
15 Paid rent 1000
16 Paid rent of Harish’s residence 500
18 Purchased goods for cash from Govind for `
6000 at 20% trade discount
20 Purchased goods from Govind for ` 10000 at
20% trade discount
24 Paid to Govind ` 7850 in full settlement of his
account
25 Paid to Subhash ` 4750; discount received rs 250
Paid wages ` 400; salaries ` 4000; advertisement
31 expenses ` 800 and trade
expenses ` 1000
Illustration: 11
Enter the following transactions in the journal of Raja:

Contact: 9829959536,7737733360,9928001210 2.6
2005 Particulars
Jan 10 Purchased goods from Ravi of the list price of ` 50000 at 15% trade discount
13 Returned goods to Ravi of the list price of ` 2000
15 Paid cash to Ravi ` 40000 in full settlement of his account
20 Purchased goods from Vicky of the list price of ` 60000 at 10% trade discount
22 Returned goods to Vicky of the list price of ` 5000
25 Paid cash to Vicky ` 49000 in full settlement of his account
Ans: Total: ` 193000. Cash discount on Jan 15 ` 800 & on Jan 25 ` 500.
*****

Contact: 9829959536,7737733360,9928001210 2.7
A unit of Realwaves (P) Ltd Ledger & Trial Balance
CHAPTER 3 LEDGER AND TRIAL BALANCE
Meaning
Business transactions are first entered in journal or special purpose subsidiary books. The next step
is to transfer the entries to respective accounts in ledger. In other words, all entries recorded in
journal or special purpose subsidiary books are classified and in order to ascertain the position of a
particular account, all transactions relating to that particular account are collected at one place in the
ledger.
Advantages of ledger
(i) All accounts are opened on separate pages in this book. Hence, all the transactions pertaining to
an account are collected at one place in the ledger.
(ii) Any type of information relating to the business can be easily obtained from the ledger, such as
(1) how much amount each customer owes to the firm; (2) how much amount the firm owes to each
creditor; (3) how much is the amount of purchase & sales during a particular period; (4) how much
amount has been paid or received on account of various items, and (5) what is the ultimate position
of assets & capital.
(iii) A trading and profit & loss account can only be prepared with the help of a ledger balances.
(iv) A balance sheet can also be prepared with the help of a ledger balance, which depicts the
financial position of the business.
PROFORMA OF LEDGER
DR NAME OF ACCOUNT CR
Date Particulars J.F Amount (`) Date Particulars J.F Amount
(`)
TRIAL BALANCE
MEANING: All the businessmen after completion of postings from journal or subsidiary books to
the ledger want to verify accuracy of the posting. For this purpose a statement is prepared wherein
the balances of all the accounts in the ledger are incorporated. The statement so prepared is called
‘Trial Balance’.
DEFINITIONS
“Trial Balance is the list of debit and credit balances, taken out from ledger. It also includes the
balances of cash and bank taken from cash book”.
OBJECTIVES OR NEED OR FUNCTIONS OF PREPARING TRIAL BALANCE

The following are the objectives or functions of preparing trial balance:

Contact: 9829959536,7737733360,9928001210 3.1
 To ascertain the arithmetical accuracy of the ledger accounts.
 To help in locating errors.
 To obtain a summary of the ledger accounts
 To help in the preparation of final accounts.
PROFORMA OF TRIAL BALANCE
SR.NO NAME OF ACCOUNTS L.F BALANCE BALANCE (CR)

(DR)
Illustration: 1
Enter the following transactions in the journal & also prepare the ledger & trial balance of Sahil:
Oct 1 Purchased goods from Anil for cash 40000
3 Purchased goods from Atul 75000
6 Returned goods to Atul 3000
8 Paid cash to Atul 50000
10 Sold goods to Charu 100000
12 Charu returned 20% of goods
15 Paid rent 2000
20 Sahil withdrew for personal use 10000
Illustration: 2 Year 2012

The following Trial Balance has been prepared by unexperienced Accountant. Redraft it in correct
form.
Trial Balance (for the year ended 31st December, 2009)

S. No. Particulars L.F. Debit Credit
Amount Amount
1) Capital Account 8,000
2) Purchases Account 10,000
3) Sales Account 8,000
4) Drawings 4,000
5) Sales Returns 3,000
6) Bad Debts 1,000
7) Sundry Debtors 6,000
8) Sundry Creditors 8,000
9) Cash in Hand 3,000
10) Commission Received 1,000
11) Bills Payable 2,000
Total 27,000 27,000

Contact: 9829959536,7737733360,9928001210 3.2
Ans: Trial Balance (for the year ended 31st Dec, 2009)
S. No. Particulars L.F. Debit Credit
Amount Amount
1) Capital Account 8,000
2) Purchases Account 10,000
3) Sales Account 8,000
4) Drawings 4,000
5) Sales Returns 3,000
6) Bad Debts 1,000
7) Sundry Debtors 6,000
8) Sundry Creditors 8,000
9) Cash in Hand 3,000
10) Commission Received 1,000
11) Bills Payable 2,000
Total 27,000 27,000
*****

Contact: 9829959536,7737733360,9928001210 3.3
A unit of Realwaves (P) Ltd FS without Adustment
CHAPTER 4 FINANCIAL STATEMENT WITHOUT

ADJUSTMENT
Meaning
Financial statements refer to such statements, which report the profitability and the financial position
of the business at the end of accounting period. The term financial statements includes at least two
basic statements which are as under:
(i) Income statement (or trading and profit and loss account) which shows results of business
operations during an accounting period, and
(ii) Statement of financial position (or balance sheet) which shows financial position of an enterprise
at a specified point of time.
OBJECTIVES OF PREPARING FINANCIAL STATEMENTS

(i) To present a true and fair view of the financial performance (i.e. profit / loss) of the business;
(ii) To present a true and fair view of the financial position (i.e. assets / liabilities) of the business.
USERS OF FINANCIAL STATEMENTS

The management, investors, creditors, employees, government etc use information provided by
financial statements.
PROFORMA OF TRADING ACCOUNT

Trading A/c (for the year ended….)
Particulars Amt Particulars Amt
To opening stock By sales
To purchases Less: sales return or return
Less: purchase returns / return inwards
outward By closing stock
To wages By gross loss (if any)
To wages & salaries transferred to P&L A/c
To direct expenses (balancing figure)
To carriage / carriage inwards
To carriage on purchase
To gas, fuel & power
To freight, octroi & cartage
To manufacturing expenses, or
productive expenses
To factory expenses such as:
Factory lighting
Factory rent etc.
To dock charges & clearing charges
To import duty or custom duty
To gross profit transferred to

P&L A/c (balancing figure)

Contact: 9829959536,7737733360,9928001210 4.1
Illustration: 1
Prepare a trading A/c for the year ended 31st December 01 from the following balances:

Opening stock 40000 Purchase return 12000
Purchases 200000 Sales return 20000
Sales 500000 Carriage on purchase 8000
Freight & octroi 6500 Carriage on sales 10000
Wages 30000 Factory rent 12000
Factory lighting 10800 Office rent 7500
Coal, gas & water 2200 Import duty 32000
Closing stock is valued at ` 60000
Ans: Gross profit = 210500
PROFORMA OF P&L A/C
P&L A/c (for the year ending….)

To gross loss b/d (transferred from By gross profit b/d (transferred
trading A/c) from trading A/c)
Office expenses: By rent from tenant
To salaries By rent (CR)
To salaries & wages By discount received or
To rent, rates & taxes discount (CR)
To printing & stationery By commission received
To postage & telegram By interest on investments
To lighting By dividend on shares
To insurance premium By bad debts recovered
To telephone charges By apprentice premium
To legal charges By profit on sale of assets
To audit fees By income from other sources
To traveling expenses By miscellaneous receipts
To establishment expenses By net loss (if any)
To trade expenses Transferred to capital a/c
To general expenses
Selling & distribution expenses:
To carriage outwards or carriage on sales
To advertisement
To commission
To brokerage
To bad debts
To export duty
To packing charges
To delivery van expenses
To stable expenses
Miscellaneous expenses:
To discount

Contact: 9829959536,7737733360,9928001210 4.2
To sales tax
To repairs
To depreciation
To interest (DR)
To bank charges
To entertainment expenses
To conveyance expenses
To donation & charity
To loss on sale of assets.
To net profit transferred to capital A/c
Illustration: 2
From the following particulars, prepare a P&L A/c for the year ending 31st December, 02
Particulars ` Particulars `
Gross profit 210500 Discount allowed 3000
Trade expenses 2000 Lighting 780
Carriage on sales 10000 Commission received 840
Office salaries 15800 Bad debts 1200
Postage & telegram 720 Discount (Cr) 600
Office rent 7500 Interest on loan 2200
Legal charges 400 Stable expenses 1400
Audit fee 1600 Export duty 2300
Donation 1100 Miscellaneous receipts 500
Sundry expenses 360 Unproductive expenses 4100
Selling expenses 5320 Traveling expenses 2500
Ans: Net profit = 150160
Illustration: 3
Calculate gross profit & net profit from the following:
Opening stock 200000 Commission paid 2400
Purchases 1900000 Commission recd 6000
Sales 2500000 Traveling expenses 4800
Purchase returns 70000 Office expenses 3500
Sales returns 100000 Interest on long term loans 22000
Wages 80000 Dividend on investments 2800
Advertising 12000 Printing & stationery 3600
Salaries 178000 Loss on sale of machinery 35000
Rent & taxes 62000 Carriage outwards 1400
Lighting 15000 Loss by theft 25100
Gain on sale of building 50000
Closing stock was valued at ` 250000 Ans: Gross profit = 540000, Net profit = 234000

Contact: 9829959536,7737733360,9928001210 4.3
PROFORMA OF A BALANCE SHEET
Balance sheet as on or as at …….

Current liabilities: Current assets:
Bank overdraft Cash in hand
Bills payable Cash at bank
Sundry creditors Bills receivable
Outstanding expenses Short term investments
Unearned income Sundry debtors
Fixed liabilities: Closing stock
Long term loans Prepaid expenses
Reserves Accrued income
Capital Long term investments
Add: net profit Fixed assets:
Less: drawings Furniture
Less: income tax Loose tools
Less: life insurance premium Motor vehicle
Plant & machinery
Land & buildings
Patents
Goodwill
Illustration: 4
From the following balances of Siya Saree Bhandar, prepare a balance sheet as on 31st Dec 2007.
Particulars Debit Credit

Plant & machinery 80000
Land & building 60000
Furniture 15000
Cash in hand 2000
Bank overdraft 18000
Debtors & creditors 32000 24000
Bills receivable & bills payable 10000 6000
Closing stock 40000
Investments (short term) 8000
Capital 150000
Drawings 13000
Net profit 62000
260000 260000
Ans: Total of balance sheet = 247000
Illustration: 5
From the following trial balance of Shri Rai Bahadur prepare trading & profit & loss A/c for the year
ending 31st December 2006 and balance sheet as on that date. The closing stock on 31st December
2006 was valued at ` 25000.

Contact: 9829959536,7737733360,9928001210 4.4
Debit balances ` Credit balances `

Stock (1.1.2006) 20000 Sundry creditors 15000
Purchases 75000 Purchase returns 3000
Sales return 8000 Sales 250000
Freight & carriage 7500 Commission 3300
Wages 36500 Capital 170000
Salaries 12000 Interest on bank deposit 2000
Repairs 1200 Bills payable 6200
Trade expenses 4000
Rent & taxes 24000
Cash in hand 5700
Bills receivable 4000
Debtors 55000
Withdrawals (drawings) 16600
Bank deposit 20000
449500 449500
Ans: Gross profit = 131000, Net profit = 95100, Total of balance sheet = 269700
Illustration: 6
Given below is the trial balance of Shree Gopi Chand as on 31st march, 2004. You are required to
prepare a trading & profit & loss A/c for the year ended 31st march, 2004. & Balance sheet as at that
date:
Debit ` Credit `
Opening stock 45000 Sundry creditors 22100
Purchases 120000 Return outwards 2500
Return inwards 3200 Sales 350000
Carriage inwards 2400 Capital 200000
Office furniture 8000 Loan from bank 24000
Carriage outwards 1500 Discount received 2000
Sundry debtors 68000 Commission 1600
Dock charges 5000
Factory Electric power 10000
Fuel, gas & water 12000
Bad debts 1100
Advertisement 25000
Salary 36000
Cash in hand 8100
Cash at bank 30000
Motor vehicles 58000
Motor repairs 3000
Interest on bank loan 2400
Rent & insurance 24500
Business premises 106000
Household expenses 33000
602200 602200

Contact: 9829959536,7737733360,9928001210 4.5
Stock at the end ` 75000
Illustration: 7
The following balances taken from books of Sh. Murli Manohar, prepare trading & P&LA/c for the
year ended 31st mar, 03 & a bal sheet as on that date. Stock in hand on 31st mar, 03 was ` 56000.
Name of accounts Dr Cr
Stock at commencement 15320
Purchases & Sales 100000 120000
Return 2200 3000
Drawings & capital 10000 130000
Cartage 2200
Factory heating & lighting 6600
Works expenses 15200
Rent recd 7300
Cash at shop 800
Accounts receivable
Kapil 8000
Jadeja 5000
Yadav 1500
Accounts payable
Parbhakar 16000
Tendulkar 7540
Horses & carts 25000
Rent paid 15000
Fire insurance premium 4800
Life insurance premium 6000
Bank overdraft 67000
Bank interest 2400
Telephone expenses 3000
Sales tax paid 5200
Salaries & wages 32240
Freehold property 81000
Audit fees 1500
352960 352960
Ans: Gross profit = 37480, Net loss = 19360, Total of balance sheet = 187300
Illustration: 8
From the following balances prepare a trading, P&L A/c and balance sheet
Carriage on goods purchased 8000 Cash in hand 2500
Carriage on goods sold 3500 Bankers A/c (Cr) 30000
Manufacturing expenses 42000 Motor car 60000
Advertisement 7000 Drawings 8000

Contact: 9829959536,7737733360,9928001210 4.6
Freight & Octroi 4400 Audit fees 2700
Lighting 6000 Plant 153900
Customers a/c 80000 Repairs to plant 2200
Suppliers a/c 61000 Stock at the end 76000
Duty & clearing charges 5200 Purchases less return 160000
Postage & telegram 800 Commission on purchases 2000
Fire insurance premium 3600 Incidental trade expenses 3200
Patents 12000 Investments 30000
Income tax 24000 Interest on investments 4500
Office expenses 7200 Capital a/c 100000
Sales less returns 520000
Rent 12000
Discount paid 2700
Discount on purchases 3400
*****

Contact: 9829959536,7737733360,9928001210 4.7
A unit of Realwaves (P) Ltd FS with Adjustment
CHAPTER 5 FINANCIAL STATEMENT WITH

ADJUSTMENT
Objectives or need of adjustments
(i) To ascertain the true net profit or loss of the business.
(ii) To ascertain the true financial position of the business.
(iii) To make a record of the transactions omitted from the books.
(iv) To rectify the errors committed in the books of accounts.
(v) To make a record of such expenses which have accrued but not been paid.
(vi) To make a record of such incomes which have accrued but not been received.
Explanation of adjustments
(i) Closing stock: The amount of goods unsold at the end of the year is called closing stock.
Treatment in final accounts: The closing stock is given outside the trial balance. Closing stock will
be shown at two places. i.e. on the credit side of the trading A/c and on the assets side of the balance
sheet.
If the closing stock appears inside the trial balance, it will be shown only on the assets side of the
balance sheet.
(ii) Outstanding expenses or expenses due but not paid: These are the expenses, which have been
left unpaid on the date of preparation of final A/c’s.
Treatment in final accounts: Outstanding expenses on the one hand, will be added to the concerned
expenses on the debit side of trading or P&L A/c and on the other hand, will also be shown on the
liabilities side of the balance sheet.
Example: extracts of trial balance as on 31st December, 04.

Name of accounts Dr balance Cr balance
Wages paid 22000
Salary paid 5500
Adjustments:
Wages ` 2000 & salary ` 500 are outstanding.
Effects on final A/c:

Trading A/c
To wages 22000
Add: outstanding wages 2000 24000
Profit & loss A/c
To salary 5500
Add: outstanding salary 500 6000
Balance sheet

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Liabilities Amt Assets amt
Outstanding wages 2000
Outstanding salary 500
(iii) Prepaid expenses or unexpired expenses or expenses paid in advance: These are the
expenses, which have been paid in advance for the next year during the current year itself.
Treatment in final accounts: Prepaid expenses on the one hand, will be deducted from the
concerned expenses on the debit side of trading or P&L A/c and on the other hand, will also be
shown on the assets side of the balance sheet.
Example: extracts of trial balance as on 31st Dec, 01

Insurance account 2000
Adjustment:
Prepaid insurance amounted to ` 500

Profit & loss A/c
To insurance 2000
Less: prepaid insurance 500 1500
Balance sheet
Prepaid insurance 500
(iv) Depreciation: Depreciation is the loss or fall in the value of fixed assets due to their constant
use & expiry of time.
Treatment in final accounts: Depreciation on the one hand, will be shown on the debit side of P&L
A/c because it is loss or expense and on the other hand, will also be deducted from the value of the
concerned asset on the assets side of the balance sheet.
Machinery 50000
Furniture 8000
Adjustment:
Machinery is to be depreciated @ 10% p.a & furniture @ 20 % p.a.
Effects on final A/c

Profit & loss A/c
To depreciation on:
Machinery 5000
Furniture 1600

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Balance sheet
Machinery 50000
Less: Dep 5000 45000
Furniture 8000
Less: Dep 1600 6400
Illustration: 1
From the following trial balance of Sh. Ramanand Sagar, prepare trading & P&L A/c for the year
ended 31st Dec, 00 & a balance sheet as on that date:
Dr balance ` Cr balance `
Opening stock 20000 Sales 270000
Purchases 80000 Purchase return 4000
Sales return 6000 Discount 5200
Carriage inwards 3600 Sundry creditors 25000
Carriage outwards 800 Bills payable 1800
Wages 42000 Capital 75000
Salaries 27500
Furniture 8000
Sundry debtors 52000
Bills receivable 2500
Cash in hand 6300
Traveling expenses 3700
Lighting (factory) 1400
Rent & taxes 7200
General expenses 10500
Insurance 1500
Drawings 18000
381000 381000
Adjustments:
(i) Stock on 31st Dec, 00 was valued at ` 24000 (market value ` 30000)
(ii) Wages outstanding for Dec, 00 amounted to ` 3000
(iii) Salaries outstanding for Dec, 00 amounted to ` 2500
(iv) Prepaid insurance amounted to ` 300
(v) Provide depreciation on plant & machinery at 5% & on furniture at 20%.
Ans: Gross profit = 142000, Net profit = 87700, Balance sheet = 177000
(v) Accrued income or income earn but not receivable: It is quite common that certain items of
income such as interest on securities, commission, rent etc, are earned during the current year but
have not been actually received by the end of the current year. Such incomes are known as ‘accrued
incomes’ or ‘earned incomes’.
Treatment in final accounts: Such incomes on the one hand, will be added on the credit side of the
P&L A/c and on the other hand, will be shown on the assets side of the balance sheet because the
amount is yet to be received.

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Commission received 1500
Adjustments:
Commission earned but not received ` 300

Profit & loss A/c
By commission 1500
Add: accrued commission 300 1800
Balance sheet
Accrued commission 300
(vi) Unearned income or income received in advance: It may also happen that a certain income is
received in the current year but the whole amount of it does not belong to the current year. Such
portion of this income, which belongs to the next year, is known as ‘unearned income’ or ‘income
received but not earned’.
Treatment in final accounts: Such incomes on the one hand, will be deducted from the concerned
income on the credit side of P&L A/c and on the other hand, will also be shown on the liabilities side
of the balance sheet.

Rent received 3900
Adjustments:
Rent received but not earned ` 300

Profit & loss A/c
By rent 3900
Less: unearned rent 300 3600
Balance sheet
Unearned rent 300
(vii) Interest on capital:

Treatment in final accounts: Interest on capital is an expense for the business & hence it is shown
on the debit side of profit & loss A/c. at the same time, it is a gain to the proprietor and hence is
added to his capital.

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(viii) Interest on drawings: Occasionally, the proprietor draws cash or goods for his personal use.
Such withdrawals are termed as drawings. If the firm pays interest on capital, it is fully justified that
it should also charge interest on the drawings.
Treatment in final accounts: Interest on drawings is a gain to the business and hence it is shown on
the credit side of P&L A/c. at the same time, it is an expense from the proprietors view and hence
will be deducted from the capital on the liabilities side of the balance sheet.

Capital A/c 50000
Drawings A/c 8000
Adjustments:
Charge ` 300 as interest on drawings.
Charge ` 500 as interest on capital.

Profit & loss A/c
To interest on capital 500 By interest on drawings 300
Balance sheet
Capital 50000
Less: drawings 8000
42000
Less: interest on drawings 300
Add: interest on capital 500 42200
(ix) Interest on loan: Generally, item of ‘loan’ appears on the credit side of the trial balance. It
means that the amount has been borrowed from some person or from the bank etc. loan is a liability
of the firm & the interest on such loan will be an expense.
On the contrary, if the item of ‘loan’ appears on the debit side of trial balance it means that the
amount has been lent to outsiders. It will be an asset in this case and interest on such loan will be an
income for the firm.
Treatment in final accounts: Assuming that the loan appears on the credit side of the trial balance,
interest on it will be an expense and hence will be recorded on the debit side of P&L A/c.
outstanding amount of such interest will also be added to loan a/c on the liabilities side of the
balance sheet.

Loan from bank @ 12 % p.a 10000
Adjustments:
Interest on loan is due for the whole year.

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Profit & loss A/c
To interest on loan 1200
Balance sheet
Loan from bank 10000
Add: outstanding interest 1200 11200
Illustration: 2
From the following trial balance of Shree Ved Vyas, prepare trading & P&L A/c for the year ended
31st Dec, 02 & balance sheet as on that date:
Particulars Dr balance Cr balance
Purchases & Sales 275000 520000
Return inwards 15000
Return outwards 9000
Carriage 12400
Wages & Salaries 58600
Trade expenses 2200
Rent 13000
Insurance 2000
Audit fees 1200
Printing & advertising 5500
Commission 1000
Opening stock 36000
Cash in hand 12800
Cash at bank 26800
Bank loan 20000
Interest on loan 1500
Capital 250000
Drawings 15000
Fixed assets 300000
877300 877300
Adjustments:
(i) Stock at the end ` 60000
(ii) Depreciate fixed assets by 10%
(iii) Commission earned but not received amounts to ` 400
(iv) Rent received in advance ` 1000
(v) Allow 8% interest on capital and charge ` 900 as interest on drawings.

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(x) Bad debts: Persons to whom goods have been sold on credit are known as ‘Debtors’. Sometimes
due to the dishonesty, death or insolvency of a debtor, full amount is not recovered from him. When
it becomes certain that a particular amount will not be recovered it is know as ‘bad-debts’.
Treatment in final accounts: Bad debts of ` 1000 given in adjustments will be added to the bad
debts of ` 800 on the debit side of the P&L A/c and the amount of ` 1000 will also be deducted from
debtors on the assets side of the balance sheet.

Bad debts 800
Adjustments:
Write off further bad debts ` 1000

Profit & loss A/c
To bad debts 800
Add: further bad debts 1000 1800
Balance sheet
Less: bad debts 1000 19000
(xi) Provision for bad & doubtful debts: Even after deducting the amount of actual bad debts from
the debtors, the list of debtors at the end of the year may include some debts which are either bad or
doubtful. As the amount of actual loss on account of current year bad debts would be known only in
the next year when the amount is realized from debtors, a provision is created to cover any possible
loss on account of bad debts likely to occur in future. Such a provision is created at a fixed
percentage on debtors every year is called ‘Provision for bad & doubtful debts’
Treatment in final accounts: The amount of Provision for bad & doubtful debts on the one hand, is
shown on the debit side of the P&L A/c and on the other hand, is deducted from sundry debtors on
the assets side of the balance sheet.

Debtors 60000
Adjustments:
Create a Provision for bad & doubtful debts @ 5% on debtors

Profit & loss A/c
To Provision for bad & 3000
doubtful debts

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Balance sheet
Less: Provision 3000 57000
for bad & doubtful
debts

Bad debts account 800
Provision for doubtful debts 1.1.04 2500
(old provision)
Debtors 80000
Adjustments:
Create a Provision for doubtful debts @ 5% on debtors

Profit & loss A/c
To Provision for doubtful
debts A/c:
Bad debts 800
Add: new provision 4000
4800
Less: old provision 2500 2300
Balance sheet
Less: New Provision
(5% on ` 80000) 3000 76000
(xii) When bad debts are given in adjustments: Sometimes, bad debts are given in adjustments. In
such a case, on the one hand, these further bad – debts will be written on the debit side of the profit
& loss A/c and on the other hand, will also be deducted from debtors on the assets side. New
provision in this case, will be calculated on the amount of debtors, which remain after deducting the
amount of bad – debts there from.
Example: The following balances appeared in the trial balance of M/s Kapil Traders as on 31st Dec,
06.
Particulars `
Bad debts 500
Provision for bad debts 2000
The partners of the firm agreed to record the following adjustments in the books of the firm. Further
bad debts ` 300; maintain provision for bad debts 10%.

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Effects on final A/c
Profit & loss A/c
To Provision for doubtful
debts A/c:
Bad debts 500
Add: further bad debts 300
800
Add: new provision 3020
3820
Less: old provision 2000 1820
Balance sheet
Less: further bad debts 300
30200
Less: New Provision
(10% on 30200) 3020 27180
Illustration: 3
Prepare trading, profit & loss A/c and balance sheet from the following particulars as on 31st Dec, 03
Particulars Dr balance Cr balance
Cash in hand 2000
Cash at bank 18000
Purchases & sales 220000 350000
Return inwards 6000
Carriage on purchases 4400
Carriage on sales 2100
Fuel & power 15500
Stock (1.1.03) 36000
Bad debts 6200
Bad debts provision 2500
Capital 217000
Investments 20000
Interest on investments 2000
Loan from X @ 18% p.a 10000
Repairs 1520
General expenses 10600
Land & buildings 180000
Wages & salaries 18000
Miscellaneous receipts 120
Bills Payable 5200
Stationery 2000
624320 624320

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Information:
(i) Write off ` 2000, as bad debts & provision for doubtful debts is to be maintained at 5% on
debtors.
(ii) Loan from X was taken on 1st may, 03. No interest has been paid so far.
(iii) Included in general expenses is insurance premium ` 1200 paid for one year ending 31st march,
04.
(iv) 1/3 of wages & salaries are to be charged to trading A/c & the balance to P&L A/c.
(v) Entire stationery was used by the proprietor for own purpose.
(vi) Closing stock was valued at ` 50000.
(xiii) Provision for discount on debtors: Year 2010

Treatment in final accounts: Such provision is shown on the debit side of the P&L A/c & is also
deducted from sundry debtors on the assets side of the balance sheet.

Bad debts account 3600
Provision for doubtful debts 1.4.01 7500
Debtors 200000
Adjustments:
(i) Write off further bad debts ` 2000.
(ii) Provision for doubtful debts is to be maintained at 5% on sundry debtors.
(iii) Create a provision for discount on sundry debtors at 2%
Effects on final A/c: Profit & loss A/c

To Bad debts 3600 By provision for bad 7500
Add: further bad debts 2000 debts
5600
Add: new provision
(5% on 198000 i.e.
20000-2000) 9900 15500
To provision for discount

(2% on 188100 i.e.
198000-9900) 3762
Balance sheet

Less: further bad debts 2000
198000
Less: New Provision
For doubtful debts
(5% on 198000) 9900
188100

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Less: provision for
discount
(2% on 188100) 3762 184338
(xiv) Adjustments relating to goods:

A) Loss of goods:
Example: Goods worth ` 10000 were burnt by fire and the insurance company has accepted a claim
of 70%.
Treatment in final accounts: ` 10000 will be deducted from purchases on the debit side of trading
A/c; ` 3000 will be shown on the debit side of P&L A/c and ` 7000 will be shown on the assets side
of the balance sheet.
B) Loss of fixed assets: If some fixed asset of the firm is destroyed by some accident such as fire
etc. the loss will be shown on the debit side of P&L A/c and also deducted from the value of asset on
the assets side of the balance sheet.
Illustration: 4
From the following adjustments & with the help of trial balance prepare a trading A/c, P&L A/c and
balance sheet as on 31st Dec, 00.
Insurance charges 2400 Capital 170000

Salaries & wages 19400 Sales 120000
Cash in hand 200 Return outwards 1200
Cash at bank 26500 Provision for doubtful debts 400
Trade exp 400 Discount 800
Postage & telegram 800 Rent of premises sublet for one year 1200
Drawings 6000 to 30th June, 01
Plant & machinery: Sundry creditors 20000
Balance on 1st Jan, 00 120000
Addition on 1st July, 00 5000
Stock on 1st Jan, 00 15000
Purchases 82000
Return inward 2000
Furniture & fixtures 5000
Freight & duty 2000
Carriage outwards 500
Rent, rates & taxes 4600
Printing & stationery 1000
313600 313600
Adjustments:
(i) Stock on 31st Dec, 00 was valued at ` 24000 stationery unused at the end was ` 250.
(ii) The provision for doubtful debts is to be maintained at 6% on sundry debtors.
(iii) Create a provision for discount on sundry debtors at 2%

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(iv) Write off ` 800 as bad debts
(v) Insurance is paid up to 31st march, 01
(vi) Provide depreciation on plant & machinery @ 10 % p.a
(vii) A fire occurred on 25th Dec, 00 in the godown & stock of the value of ` 6000 was destroyed. It
was insured and the insurance co. admitted a claim of ` 4000.
Ans: Gross profit = 50200, Net profit = 7124, Balance sheet total = 191724
(xv) Charity in the form of goods:

Treatment in final accounts: On the one hand, the amount will be deducted from purchases
because it reduces the goods purchased for resale & on the other hand, it will also be shown on the
debit side of P&L A/c because it is business expense.
(xvi) Goods distributed as free samples:

Treatment in final accounts: It will be deducted from purchases in the trading A/c & will also be
shown on the debit side of P&L A/c because it is an expense of business.
(xvii) Drawings in goods:

Treatment in final accounts: It will be deducted from purchases in the trading A/c & will also be
deducted from the capital on the liabilities side of the balance sheet as drawings.
(xviii) Managers commission on net profit: Sometimes, in addition to his regular salary, the
manager is entitled to a commission on net profit. This is done to induce him to take more interest in
the business. Since the commission is always calculated at the end of the accounting period, it is
treated as outstanding expenses.
Treatment in final accounts: On the one hand, it will be recorded on the debit side of P&L A/c
because it is a business expense & on the other hand, shown on the liabilities side as an outstanding
expense.
Method of calculating the commission: This commission may be based:

(a) On profits before charging such commission.
(b) On profits after charging such commission
(a) On profits before charging such commission: Suppose, the profit earned by the firm before
allowing the managers commission is ` 22000 and the manager is entitled to a commission of 10%
on net profit before charging his commission, the commission will be calculated as follows:
Managers commission = 22000 x 10 = ` 2200
100
(b) On profits after charging such commission: Suppose, the profit earned by the firm before
allowing the managers commission is ` 22000 and the manager is entitled to a commission of 10%
on net profit remaining finally after charging his commission, the commission will be calculated as
follows:
Managers commission = 22000 x 10 = ` 2000

110

Following balances have been extracted from the books of Shri Ram Rayons on 31st March 2011:-

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Opening stock Rs. 15,000; Purchases Rs. 50,000; Sales Rs. 80,000; Return Inward Rs. 300; Return
Outward Rs. 2,000; Debtors Rs. 40,500; Fixed deposit in Bank Rs. 10,000; Creditors Rs. 25,000;
B/RRs. 11,400; B/P Rs. 8,000; Interest received on Fixed deposit Rs. 900; Drawings Rs. 6,300; Cash
Rs 1,000; Capital Rs. 37,300; Discount (Dr.) Rs. 600; Commission (Cr) Rs. 2200; Repairs Rs. 800;
Wages Rs. 2,400; Salaries for 11 months Rs. 5,500; Advertisement Rs. 1,200; Trademark Rs. 1,500;
Building Rs. 10,000; Bad debt Rs. 800; Provision for bad debts Rs. 1,900. .
Prepare Final Account for the year under 31st March 2011 after taking into consideration of
following adjustments:
(1) Stock on 31st March 2011 Rs. 28,400.

(2) Interest accrued on fixed deposit in Bank for 3 months, commission received in advance Rs 400.
(3) Further bad debts Rs. 500 and maintain provision for bad debts at 5% on debtors.
(4) Depreciate building by 5%
(5) Goods worth Rs. 300 were donated for which no entry was made in the books.
(6) Provide for manager's commission 5% on net profit after charging this commission.
Ans: Gross profit = 43000, Net profit = 33524, balance sheet total = 10100
*****

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A unit of Realwaves (P) Ltd Fund Flow Statement
CHAPTER 6 FUND FLOW STATEMENT

Meaning
The financial statements of the business indicate assets, liabilities and capital on a particular date and
also the profit or loss during a period. But it is possible that there is enough profit in the business
and the financial position is also good and still there may be deficiency of cash or of working capital
in business. If the management wants to find out as to where the cash is being utilized, financial
statements cannot help. Therefore, a statement is prepared of the sources and applications of funds
from where working capital comes and where it is utilized. This is called funds flow statement.
Funds flow statement is a summary report of financial operations of a business firm, which
brings into light the changes in financial items of balance sheets prepared at two different dates. The
effectiveness of financial management in procuring funds from various sources and using them
effectively for generating income without sacrificing the financial health of the firm is reflected in
this statement.
Definitions
Anthony, R.N: “Funds flow statement is a statement prepared to indicate the increase in the cash
resources and the utilization of such resources of a business during the accounting period.
Balance sheet
Capital & liabilities Assets

Non- current accounts Non- current accounts
1. Equity share capital Goodwill
2. Preference share capital Land
3. General reserve Building
4. Securities (share) premium Plant & machinery
5. Capital reserve Furniture & fittings
6. Capital redemption reserve (CRR) Vehicle
7. Profit & loss A/c – profit Patents
8. Debentures Trade mark
9. Long term loans Long term investments
10. Provision for depreciation Preliminary expenses
11. Underwriting commission Profit & loss A/c – loss
Discount on issue of shares & debentures.
Current accounts Current accounts
Provision for taxation Stock or inventory
Proposed dividend Temporary or short term investments /
Creditors or accounts payable marketable securities
Bills payable Short term loans & advance
Bank overdraft Bills receivable
Outstanding expenses Debtors
Short term loans & deposits Advance tax
Provision against current assets Cash in hand & at bank
Income tax due Prepaid expenses
Dividends payable
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Funds flow statement is prepared on the basis of ‘working capital concept’. Under this method the
following two statements are prepared:
(i) Schedule of changes in working capital
(ii) Funds flow statement
Schedule of changes in working capital

The statement or schedule of changes in working capital discloses the changes in individual items of
current assets & current liabilities between two dates & their effect on working capital.
RULES WHILE ASSERTING THE INCREASE OR DECREASE IN WORKING

CAPITAL
 Increase in current assets increases working capital
 Decrease in current assets decreases working capital
 Increase in current liabilities decreases working capital
 Decrease in current liabilities increases working capital
Thus, working capital will increase when there is an increase in current assets & decrease in current
liabilities, whereas working capital will decrease when there is a decrease in current assets &
increase in current liabilities. Thus, we find that changes in the items of current assets are positively
correlated to the changes in working capital. On the other hand, changes in the items of current
liabilities are inversely related to the changes in working capital.
The net increase in working capital is treated as use of funds & the net decrease in working
capital is treated as source of funds and is shown in the funds flow statement.
STATEMENT OR SCHEDULE OF CHANGES IN WORKING CAPITAL

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Items Previous Current year Effect on working capital
year (Rs) (Rs) Increase Decrease
(A) Current assets:
 Cash at bank xxx xxx
 Cash in hand xxx xxx
 Stock in trade xxx xxx
 Debtors xxx xxx
 Bills receivable xxx xxx
 Advance payment xxx xxx
 Short term investment xxx xxx
 Prepaid expenses xxx xxx
 Accrued income xxx xxx
Total (A) xxx xxx xxx xxx
(B) Current liabilities:

 Short term loans xxx xxx
 Bank overdraft xxx xxx
 Creditors xxx xxx
 Bills payable xxx xxx
 Outstanding expenses xxx xxx
 Unclaimed dividend xxx xxx
Total (B) xxx xxx xxx xxx
Net working capital (A – B) xxx xxx
Increase / decrease in working xxx xxx
capital
Illustration: 1
From the following balance sheets of M/s Parvati & co. ltd for the year ending 31st march, 06 & 07.
Prepare a statement of changes in working capital:
Items 2006 (Rs) 2007 (Rs)
Liabilities:
Share capital 500000 600000
Reserves & surplus 200000 400000
Borrowings 300000 500000
Current liabilities:
Sundry creditors 150000 200000
Bills payable 100000 70000
1250000 1770000
Assets:
Fixed assets 750000 1000000
Investments 100000 300000
Current assets:
Inventories 200000 220000
Debtors 100000 80000
Bills receivable 70000 100000
Cash / bank balance 30000 70000
1250000 1770000

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Ans: Increase in working capital = 50000
Illustration: 2
The following is the balance sheet of Bharat builder’s ltd as at 31st march, 06. With the
corresponding figures of the previous year:
Items 31st march, 31st march,
06 05
Assets:
Fixed assets
Land & building (less depreciation) 370000 394600
Plant & machinery (less depreciation) 50000 29680
Current assets, loans & advances:
Stock in trade 220000 152500
Sundry debtors 166000 156000
Advance payment to contractors 10000 2000
Cash with bank 20000 10000
870000 763280
Liabilities:
Share capital issued
3500 equity shares of Rs 100 each 350000 350000
General reserve 174000 110000
Surplus in P&L A/c 80000 70000
Secured loans from banks 16000 -
870000 763280
Ans: Increase in working capital = 94280
Funds flow statement
This funds flow statement has two parts:

(i) Sources of funds (ii) Uses or Application of funds.
The amount of net increase or decrease as shown in funds flow statement should be equal to the
amount shown by the schedule of working capital changes.
Funds flow statement (in account form)

Sources of funds Amt (Rs) Uses of funds Amt (Rs)
From operations (trading profits) xxx Trading losses xxx
Issue of shares xxx Redemption of preference shares xxx
Issue of debentures xxx Buy – back of shares
Raising long terms loans xxx Redemption of debentures xxx
Sale of fixed assets / investments xxx Purchase of fixed assets / xxx
Non- trading receipts xxx investments xxx

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DECREASE IN WORKING xxx Payment of dividend & tax
CAPITAL (if any) INCREASE IN WORKING xxx
CAPITAL (if any) xxx
xxx xxx
Adjusted profit & loss A/c

Particular Amt Particular Amt
To depreciation on fixed assets xxx By bal b/d (opening balance) xxx
To fictitious & immortal xxx By profit on sale of fixed assets
Assets written off: By dividend received xxx
Goodwill xxx By tax refunds
Patents xxx By profit on redemption of xxx
Trade mark xxx debenture xxx
Preliminary exp. xxx FUND FROM OPERATION xxx
To discount on issue of shares & xxx (balancing figure)
debentures xxx
To loss on sale of fixed assets xxx
To general reserve xxx
To proposed dividend xxx
To interim dividend xxx
To provision for tax xxx
To bal c/d (closing balance) xxx
LOSS FROM OPERATION xxx
(balancing figure)
xxx xxx
Illustration: 3
From the following balance sheets you are required to prepare schedule of changes in working
capital & statement of flow of funds:
Items 31.3.06 31.3.07 Items 31.3.06 31.3.07
Capital 160000 170000 Cash at bank 8000 18000
P&L -appropriation A/c 29000 49000 Debtors 33000 39000
Creditors 18000 10000 Stock 18000 14000
Mortgage - 10000 Land 100000 100000
Plant 48000 68000
207000 239000 207000 239000
Ans: Increase in working capital = 20000, funds from operation = 20000
Illustration: 4
From the following balance sheets of Bharat co. ltd prepare (i) statement showing changes in
working capital (ii) a fund flow statement for 2005 – 06
Balance sheets of Bharat co. ltd

Liabilities 31.3.05 31.3.06 Assets 31.3.05 31.3.06
Share capital 150000 125000 Goodwill 10000 5000
P&L A/c 75000 60000 Land 27000 15000
Loans payable (during 20000 - Long term 10000 15000

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2005) investments
Bills payable 35000 20000 Closing stock 120000 87000
Trade creditors 45000 50000 Debtors 90000 98000
Cash 63000 32000
Preliminary expenses 5000 3000
325000 255000 325000 255000

Ans: Decrease in working capital = 26000, Loss from operation = 8000
Illustration: 5
From the following balance sheets of Parvati ltd as on 31st Dec 03 & 04, you are required to prepare
funds flow statement for the year ending 31st Dec, 03 & schedule of changes in working capital.
Liabilities 2003 2004 Assets 2003 2004
Reserves & surplus 65000 70000 Building 90000 80000
Sundry creditors 15000 12800 Machinery 75000 80000
Bills payable 6000 4000 Investments 15000 18000
Prov. for taxation 15000 20000 Stock 60000 50000
Prov. for doubtful debts 1000 1200 Book Debts 20000 22000
Cash at bank 12000 31000
302000 308000 302000 308000
Additional information:
(a) Dividend paid during the year 2004 @ 10%
(b) Depreciation charged on machinery was Rs 1000 in 2004
(c) Provision for taxation of Rs 22000 was made during 2004.
Purchase / Sale of fixed assets
Illustration: 6
Extract from the balance sheet of a company are:
Particulars 1.4.04 31.3.05

Balance of machinery A/c 2500 3500
Balance of P&L A/c 1500 3000
It is further informed that depreciation amounting to Rs 5000 was written off during the year & a
machine whose book value was Rs 1200 was sold for Rs 700.
Solution:
Machinery A/c
To bal b/d (opening bal) 2500 By Cash A/c 700
To cash a/c (balancing 7200 By P&L A/c (loss on sale Rs 500
figure being further 12000- 7600)
purchases) By depreciation a/c 5000
By bal c/d (closing bal) 3500
9700 9700

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Adjusted P&L A/c

To loss on sale of machinery 500 By bal b/d 1500
To depreciation A/c 5000 By F.F.O 7000
To bal c/d 3000
8500 8500
Illustration: 7
Extract from the balance sheet of a company are:
Balance of fixed assets (at cost) 6000 6500
Accumulated depreciation 2000 2500
Balance of P&L A/c 1500 3000
During the year a machine costing Rs 600, accumulated depreciation thereon Rs 300, was sold for
Rs 400.
Solution:
Fixed assets A/c
To bal b/d (opening bal) 6000 By Cash A/c (sale) 400
To P&L A/c 100 By prov. depreciation A/c 300
To cash (balancing figure 1100 By bal c/d (closing bal) 6500
being further purchases)
7200 7200
Provision depreciation A/c

To fixed assets a/c 300 By bal b/d (opening bal) 2000
To bal c/d (closing bal) 2500 By P&L A/c (balancing 800
figure being depreciation for
the year)
2800 2800
Illustration: 8
Following are the Extract from the balance sheet of a company on two different dates:
Profit and loss A/c 50000 80000
Provision for taxation 10000 15000
Proposed dividends 5000 10000
(i) Tax paid during the year 2005 – 06 Rs 2500
(ii) Dividends paid for the period 2005 – 06 Rs 1000
Solution:

Contact: 9829959536,7737733360,9928001210 6.7
Provision for taxation A/c
To income tax A/c 2500 By bal b/d (opening bal) 10000
To bal c/d (closing bal) 15000 By P&L A/c (provision made 7500
in the current year)
17500 17500
Proposed dividend A/c

To dividend A/c (dividend 1000 By bal b/d (opening bal) 5000
paid during the year) By P&L A/c (Proposed 6000
To bal c/d (closing bal) 10000 dividend for the current year)
11000 11000
Adjusted P&L A/c

To Provision for taxation A/c 7500 By bal b/d (opening bal) 50000
To proposed dividend A/c 6000 By F.F.O (bal fig) 43500
To bal c/d (closing bal) 80000
93500 93500
Illustration: 9
The following are the summaries of the balance sheets of a co. as on 31st march, 05 & 06
Items 31.3.05 31.3.06
Profit & loss A/c 250000 350000
Depreciation fund 80000 120000
Bank loan 160000 80000
Proposed dividends 40000 60000
Provision for taxation 40000 55000
1090000 1400000
300000 400000
Land & building (at cost) 460000 630000
Plant & machinery (at cost) 180000 200000
Inventories 100000 155000
Cash & bank balance 1090000 1400000
(a) A machinery, which was purchased, for Rs 60000 was sold for Rs 4000. The book value of the
machine was Rs 6000. The company also purchased new equipments during the year.
(b) The company had issued new shares to the extent of Rs 200000 for cash.
(c) Tax paid during the year amounted to Rs 43000.
You are required to prepare statement of changes in working capital & statement of sources &
application of funds.

Contact: 9829959536,7737733360,9928001210 6.8

The balance sheet of Bharat machinery ltd as on March 31, 05 & 06 are as follows:
Items 31.3.05 31.3.06
Assets:
Plant & machinery 627000 970000
Less: accumulated depreciation 127000 170000
500000 800000
Land & building 80000 120000
Stock 100000 75000
Cash 20000 20000
850000 1175000
Liabilities & capital:
Profit & loss A/c 100000 160000
General reserve 50000 70000
Outstanding exps. 7000 5000
850000 1175000
(i) Depreciation of Rs 50000 has been charged on plant & machinery during the year 2006
(ii) A piece of machinery was sold for Rs 8000 during the year 2006. It has cost Rs 12000,
depreciation of Rs 7000 has been provided on it.
Prepare a schedule of changes in working capital & a statement showing the sources & application
of funds for the year 2006.
Ans: Decrease in working capital = 60000, funds from operation = 127000
Illustration: 11
Balance sheets of M/s ram & sons as on 1st April, 05 & 31st march, 06 were as follows:
Creditors 40000 44000 Cash 10000 7000
Mrs. ram’s loan 25000 - Debtors 30000 50000
Loan from P.N 40000 50000 Stock 35000 25000
bank Machinery 80000 55000
Capital 125000 153000 Land 40000 50000
Building 35000 60000
230000 247000 230000 247000
During the year a machine costing Rs 10000 (accumulated depreciation Rs 3000) was sold for Rs
5000. The balance of provision for depreciation against machinery as on 1st April, 05 was Rs 25000.
& On 31st mar, 06 Rs 40000. Drawings for the year 2005-06 amounted to Rs 17000.
You are required to prepare schedule of changes in working capital & funds flow statement.
Purchase / Sale of Investments

Contact: 9829959536,7737733360,9928001210 6.9
Illustration: 12
Items 31.3.05 31.3.06
Assets:
Machinery at cost 410000 540000
Investment (long term) 30000 80000
Liabilities:
P&L A/c 60000 70000
Provision for depreciation 90000 130000
During the year investments costing Rs 30000 were sold for Rs 28000. A machine was sold for Rs
25000. It had cost Rs 40000 & accumulated depreciation on it was Rs 8500.
Solution:
Adjusted P&L A/c
To loss on sale of investments 2000 By bal b/d (opening bal) 60000
To loss on sale of machinery 6500 By F.F.O (bal fig) 67000
To depreciation on machinery 48500
127000 127000
Machinery A/c
To bank A/c (balancing figure 170000 By prov. depreciation a/c 8500
being purchases) By P&L A/c (loss on sale) 6500
By bal c/d (closing bal) 540000
580000 580000
Provision for depreciation A/c

To machinery A/c 8500 By bal b/d 90000
To bal c/d 130000 By P&L A/c (current year 48500
depreciation)
138500 138500
Investment A/c
To bank A/c (balancing figure 80000 By P&L A/c (loss on sale) 2000
being purchases) By bal c/d (closing bal) 80000
110000 110000
Increase / Decrease in share capital & long term liabilities
Illustration: 13

Contact: 9829959536,7737733360,9928001210 6.10
Balance sheet of Y ltd.
Items 2006 2007
Debenture A/c 150000 250000
It is given that the company has issued 1250 debentures of Rs 100 each during the year. Out of
these, 500 debentures were issued for the purchase of a machine & the balance for cash.
Solution:
Debentures A/c
To bank A/c (balancing figure 25000 By bal b/d (opening bal) 150000
being redemption of debentures By machinery A/c 50000
in cash) By bank A/c 75000
275000 275000
Thus, Rs 75000 from issue of debentures is a source of funds & Rs 25000 for redemption of
debentures is use of funds. Debentures amounting to Rs 50000 issued for purchasing of machine is
neither a source nor use of funds as in this transaction both the accounts affected are non current
accounts, hence there is no change in working capital.
In absence of P&L A/c balance we will take Opening & Closing balance of General Reserve.
Illustration: 14
From the following balance sheets of Ajay mitra ltd as on 31st march, 05 & 06. you are required to
prepare funds flow statement for the year ending 31st march, 06 & schedule of changes in working
capital.

General reserve 65000 70000 Building 90000 80000
Sundry Creditors 15000 12800 Machinery 75000 80000
Bills payable 6000 4000 Investments 15000 18000
Provision for 15000 20000 Stock 60000 50000
taxation Book Debts 20000 22000
Provision for 1000 1200 Bills receivable 5000 7000
doubtful debts Cash at bank 12000 31000
302000 308000 302000 308000
(a) Dividend paid during the year @ 10%
(b) Depreciation charged on machinery was Rs 10000 in 2005- 06
(c) Provision for taxation of Rs 22000 was made during 2005-06
Over & under valuation of stock

Sometimes, the closing stock of the previous year is over valued or under valued by the firm by
mistake. This mistake is rectified in the current year by bringing the stock at its actual cost. In such
cases, while preparing the funds flow statement the current assets of the previous are increased by

Contact: 9829959536,7737733360,9928001210 6.11
the amount of under valuation in schedule of working capital changes and the balance of profit &
loss A/c of the previous year (opening balance of adjusted profit & loss A/c) by the same account. In
case of over valuation the process is reversed)
Illustration: 15
Items 31.3.05 31.3.06
Assets:
Current assets 240000 375000
Liabilities:
Reserves & surplus 110000 270000
Current liabilities 70000 145000
Stock, which was valued at Rs 100000 in 2004-05 was written up to, cost Rs 90000 for preparing
the profit & loss A/c of 2005-06.
Solution:
Statement of changes in working capital
Items 2005 2006 Increase Decrease
Current assets (a) 250000 375000 125000
(240000 + 10000)
Current liabilities (b) 70000 145000 75000
Net working capital (a-b) 180000 230000
Increase in working capital 50000 50000
230000 230000 125000 125000
Writing up of opening stock in 2005-06 by Rs 10000
Adjusted reserves & surplus A/c

By opening stock (written up
in 2006) 10000
To balance c/d 270000
Illustration: 16
Following are the balance sheets of M/s Oswal hosiery mills at the beginning and end of the year
2005-06.
Items 31.3.05 31.3.06
Assets:
Cash & bank balance 90000 90000
Temporary investments 110000 74000
Prepaid expenses 1000 2000
Stock in trade 82000 106000
Land & building 150000 150000
Machinery 52000 70000
552000 535000
Liabilities:

Contact: 9829959536,7737733360,9928001210 6.12
Outstanding expenses 13000 12000
16% debentures 90000 70000
Depreciation fund on machinery 40000 44000
Reserve for contingencies 60000 60000
Profit & loss A/c 16000 23000
552000 535000
(i) 10% dividend was paid in cash
(ii) New machinery for Rs 30000 was purchased but old machinery costing Rs 12000 was sold for
Rs 4000 (accumulated depreciation Rs 6000)
(iii) Rs 20000, 16% debentures were redeemed by purchase in the open market to Rs 96. for a
debenture of Rs 100.
(iv) Investments of Rs 36000 were sold at book value.
Prepare a schedule of changes in working capital & a statement showing sources & application of
funds.
Solution:
Debenture A/c
To bank a/c 19200 By bal b/d 90000
To profit on redemption of 800
debentures
90000 90000
Ans: Decrease in working capital = 27000, funds from operation = 41200
Illustration: 17 - Year 2012 Nov

Following are the summarized balance sheets of LKM ltd as on 31st march, 2011 and 2012.
(in lakhs)
Liabilities 2011 (Rs) 2012 Assets 2011 2012
Equity share capital 50.00 55.00 Goodwill 5.00 4.20
Capital reserve - 2.50 Land & building 20.00 18.00
General reserve 4.00 6.00 Plant & machinery 22.00 31.00
Profit & loss account 5.30 6.70 Investment 2.00 3.50
Proposed dividend 8.00 11.00 Stock 8.60 12.70
Bills payable 2.00 1.80 Sundry debtors 10.20 13.00
Sundry creditors 3.50 4.60 Bills receivable 1.00 0.70
Provision for tax 4.00 5.00 Cash in hand & bank 7.20 8.90
Share issue Exp 0.80 0.60
76.80 92.60 76.80 92.60
(i) A machine (original cost Rs 2,80,000; Book Value Rs 1,70,000) was sold during the year for Rs
1,50,000.

Contact: 9829959536,7737733360,9928001210 6.13
(ii) Depreciation for 2011-12 was amounted to Rs 3,00,000 on plant and machinery and Rs 50,000
on land and building.
(iii) A piece of land had been sold out on 01-11-2011 and the profit on the sale has
been credited in capital reserve.
(iv) Rs 40,000 is received as dividend including Rs 15,000 pre-acquisition profit, which is credited
to investment account.
(v) An interim dividend of Rs 2,50,000 has been paid during the year 2011-12.
(vi) Income tax paid during the year 2011-12, amounted to Rs 3,80,000.
Required:
(A) Prepare a schedule of changes in the working capital.
(B) Prepare funds flow statement as on31'March, 2012. (12 marks)
Solution:
Schedule of change in working capital
Particulars 2011 2012 Increase Decrease
Current assets:
Stock 860000 1270000 410000
Debtors 1020000 1300000 280000
Bills receivable 100000 70000 30000
Cash 720000 890000 170000
Bills payable 200000 180000 20000
Sundry creditors 350000 460000 110000
Increase in working capital 740000
880000 880000
Profit /loss adjustment account

To depreciation on P&M 300000 By balance b/d 530000
To depreciation on L&B 50000 By dividend received 25000
To P&M (loss on sale) 20000
To interim dividend 250000
To provision for tax 480000 Fund from operation 2615000
To goodwill 80000
To share issue expense 20000
To general reserve 200000
To proposed dividend 1100000
3170000 3170000
Fund flow statement

Contact: 9829959536,7737733360,9928001210 6.14
Source Amt Application Amt
Sale of L&B 400000 Increase in working capital 740000
Dividend received 40000 Purchase of P&M 1370000
Issue of equity share capital 500000 Interim dividend paid 250000
Fund from operation 2615000 Tax paid 380000
Sale of P&M 150000 Purchase of investment 165000
Dividend paid 800000
3705000 3705000
Working notes:
Bank A/c Dr 40000
To dividend received 40000
Dividend received A/c Dr 40000

To profit & loss adjust A/c 25000
To investment 15000
Investment A/c
To balance b/d 200000 By dividend received 15000
To bank 165000 By balance c/d 350000
365000 365000
Land & building A/c
To balance b/d 2000000 By depreciation 50000
To capital reserve 250000 By bank 400000
By balance c/d 1800000
2250000 2250000
Plant & machinery A/c
To balance b/d 2200000 By depreciation 300000
To bank 1370000 By bank 150000
By P/L 20000
By balance c/d 3100000
3570000 3570000
Provision for tax A/c
To bank 380000 By balance c/d 400000
To balance c/d 500000 By P/L 480000
880000 880000

Contact: 9829959536,7737733360,9928001210 6.15
Theory Question
Year 2013
(a)What is the meaning of the term fund? How do you treat the following items In the preparation of
fund flow statement:
(1) Proposed dividend and interim dividend
(2) Provision for tax
(3) Provision against current asset
Ans: Meaning of Fund & Fund Flow Statement

The 'funds' ordinarily means cash and wealth, but here it means cash in short term and working
capital in long term. This is why the term fund is used as 'cash' in cash flow statement and as
'working capital' in funds flow statement.
The funds flow statement consists of two terms 'Fund' and 'Flow'. Fund may be interpreted as cash or
working capital or all financial resources. Flow means change. Funds flow statement is a method by
which one studies the changes in the financial position of a business enterprise between beginning
and ending financial statements dates. It is a statement showing sources and uses of funds for a
period of time.
I.C.W.A. in glossary of Management Accounting terms defines funds flow statement as, "A
statement prospective or retrospective, setting out the sources and applications of the funds of an
enterprise. The purpose of the statement is to indicate clearly the requirement of hinds and how they
are proposed to be raised and the efficient utilization and application of the same".
Treatment of Proposed Dividend and Interim Dividend

It may also be treated as both current and non-current liability. In case, of its treatment as current
liability, this item will be shown in the schedule. The excess of current year's proposed dividend
over the previous year is written at the decrease or credit column of the schedule. In the same way, if
current year's proposed dividend is lesser than the previous year's dividend, the shortage is written at
the increase op the debit side of schedule. It will be convenient to treat it as non-current liability, if
certain additional information or adjustments are given.
While treating proposed dividend as non-current liability, it is not shown in the schedule. Previous
year's proposed dividend is supposed to have been paid during the current year, so it is shown pt the
application side. The current year's proposed dividend is supposed to have been charged out of
current year's profit and loss account; such it is as added to Net profit to calculate funds from
operation.
Interim dividend is the dividend paid in between two balance sheet dates. It is a non-operating item
and as such is adjusted in the calculation of profits from operation. Interim dividend paid is actually
an appropriation of profit and hence should be debited to the adjusted profit and Loss account while
arriving at’ trading profit' and shown as an application in fire fund flow statement.
Treatment of Provision fop Tax

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It may be treated as both current and non-current liability. In case provision for taxation is supposed
to be current liability, it will be taken in 'Statement of changes in working capital'. If current year's
provision for taxation is more than the previous year; the excess credited or written at the decrease
side of the statement. If previous year's provision is more than the current year’s provision the
treatment is vice-versa. For example, if previous year's provision and current year's provision are
20,000 and 25,000 respectively, it will be shown in the statement as under:
Particulars Previous Year Current Year Increase (Dr.) Decreases (Cr.)

Provision for 20,000 25,000 …………… 5,000
taxation
The statement shows net decrease in the working capital. It will be shown at the sources side of
funds flow statement and thus result in an increase of funds by Rs 5,000.
Provision against Current Assets

This includes the provision for bad and doubtful debts, provision for loss on inventories. (or
allowance for inventory loss), etc. They may be treated as a current liability or an item of
appropriation.
In the former case, (there may be two possible alternatives. In the first case, current asset may be
shown net of provision or allowance. Alternatively, current asset may be show# at gross value while
the amount of provision of allowance will be included as an item of current liability. The effect on
working capital will, however, be the same under both the alternatives.
In case of treatment as appropriation, the amount of provision made during the current year should
be debited to the adjusted profit and loss account. This will ultimately have the effect of increasing
the funds from operations.
b) Funds from operations
Ans: Funds from Operations

The 'funds' ordinarily means cash and wealth, but here it means cash in short term and working
capital in long term. This is why; the term fund is used as 'cash' in cash flow statement and as
'working capital' in funds flow statement. The working capital is the excess of current assets over
current liabilities. The term 'operation' means the day-to-day affairs of the business. It refers to those
activities which are trading. Non-trading items, such as depreciation, loss on sale of assets, writing
off of fictitious assets as goodwill, preliminary expenses, discount or loss on issue of shares and
debentures are taken as non-operational. Non-trading gains i.e., gain on sale of assets, refund of tax
or receipts of compensation are not treated as operational.
Funds from operation are therefore, an operating surplus. In other words, it may be calculated as
calculation of funds from operation.
*****

Contact: 9829959536,7737733360,9928001210 6.17
A unit of Realwaves (P) Ltd Comparative Statement
CHAPTER 7 COMPARATIVE FINANCIAL

STATEMENT
Comparative Statement
The comparative financial statements are statements of the financial position at different periods; of
time. The elements of financial position are shown in a comparative form so as to give an idea of
financial position of two or more periods. Two financial statements (balance sheet & income
statement) are prepared in comparative form for financial analysis purposes.
The two comparative statements are:
(i) Balance sheet, and
(ii) Income statement
(i) Comparative Balance sheet: The comparative balance sheet is the study of the trend of the same
items, group of items and computed items in two or more balance sheets of the same business
enterprise on different dates. The changes in periodic balance sheet items reflect the conduct of a
business. The changes can be observed by comparison of the balance sheet at the beginning and at
the end of a period and these changes can help in forming an opinion about the progress of an
enterprise.
FORMAT OF COMPARATIVE BALANCE SHEET
Comparative balance sheet as on…….

Particulars Past year Current year Absolute Percentage
(`) (`) Change Change
Assets
(1) Current Assets xxx xxx xxx xxx
Sundry debtors xxx xxx xxx xxx
Marketable securities xxx xxx xxx xxx
Stock xxx xxx xxx xxx
Cash balances xxx xxx xxx xxx
Total Current Assets (A) xxx xxx xxx xxx
(2) Fixed Assets
Building xxx xxx xxx xxx
Machinery xxx xxx xxx xxx
Furniture xxx xxx xxx xxx
Total Fixed Assets (B) xxx xxx xxx xxx
Total Assets (A + B) xxx xxx xxx xxx
Liabilities
(3) Current Liabilities
Sundry creditors xxx xxx xxx xxx
Bills payable xxx xxx xxx xxx
Outstanding (Misc exp) xxx xxx xxx xxx
Total Current Liabilities (C) xxx xxx xxx xxx
(4) Long term Liabilities

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Equity shares xxx xxx xxx xxx
Debenture xxx xxx xxx xxx
Reserves & surplus xxx xxx xxx xxx
Total Long term liabilities (D) xxx xxx xxx xxx
Total liabilities (C + D) xxx xxx xxx xxx
Illustration: 1
From the following balance sheet of Shubhi ltd. prepare a comparative balance sheet & comment on
the financial position of the concern
Liabilities 1984 ` 1985 ` Assets 1984 ` 1985 `

Equity shares 220000 250000 Building 140000 170000
Debenture 100000 120000 Machinery 120000 150000
Reserves & surplus 60000 80000 Furniture 60000 4000
Sundry creditors 40000 25000 Sundry debtors 40000 60000
Bills payable 35000 40000 Marketable 55000 30000
Outstanding (Misc 20000 - securities 40000 55000
exp) Stock 20000 10000
475000 515000 Cash balances 475000 515000
Solution:
Comparative balance sheet (as on 31st Dec, 1984 and 1985)
Particulars 1984 1985 (`) Absolute Percentage
(`) change change
ASSETS
(i) Current assets
Sundry debtors 40000 60000 20000 50.00
Marketable securities 55000 30000 -25000 -45.45
Stock 40000 55000 15000 37.50
Cash balances 20000 10000 -10000 -50.00
Total current assets (A) 155000 155000 - -
(ii) Fixed assets
Buildings 140000 170000 30000 21.43
Machinery 120000 150000 30000 25.00
Furniture 60000 40000 -20000 -33.00
Total fixed assets (B) 320000 360000 40000 12.50
Total assets (A+B) 475000 515000 40000 8.42
LIABILITIES
(iii) Current liabilities
Sundry creditors 40000 25000 -15000 -37.00
Bills payable 35000 40000 -5000 14.29
Outstanding (misc. exp) 20000 - -20000 -100.00
Total current liabilities (C) 95000 65000 -30000 -31.58
(iv) Long term liabilities
Equity shares 220000 250000 30000 13.64
Debentures 100000 120000 20000 20.00

Contact: 9829959536,7737733360,9928001210 7.2
Reserves and surplus 60000 80000 20000 33.33
Total long term liabilities (D) 380000 450000 70000 18.42
Total liabilities (C+D) 47500 515000 40000 8.42
Illustration: 2
The following are the balance sheet of a concern for the years 1993 & 1994. Prepare a comparative
balance sheet and study the financial position of the concern.
Liabilities 1993 ` 1994 ` Assets 1993 ` 1994 `

Equity share capital 600000 800000 Land &Building 370000 270000
Reserves & surplus 330000 222000 Plant &Machinery 400000 600000
Debenture 200000 300000 Furniture & fixtures 20000. 25000
Long term loans on 150000 200000 Other fixed assets 25000 30000
Mortgage Cash in hand & 20000 80000
Bills payable 50000 45000 at bank
Sundry creditors 100000 120000 Bills receivables 150000 90000
Other current 5000 10000 Sundry debtors 200000 250000
liabilities Stock 250000 350000
Prepaid expenses - 2000
1435000 1697000 1435000 1697000
Solution:
Comparative balance sheet (as on 31st Dec, 1984 and 1985)
Particulars 1993 1994 Absolute Percentage
(`) (`) change change
ASSETS
(i) Current assets
Cash in hand and at bank 20000 80000 60000 300
Bills receivables 150000 90000 -60000 -40
Sundry debtors 200000 250000 50000 25
Stock 250000 350000 100000 40
Prepaid expenses - 2000 2000
Total current assets (A) 620000 772000 152000 24.552
(ii) Fixed assets
Land & Buildings 370000 270000 -100000 -27.03
Plant & Machinery 400000 600000 200000 50.00
Furniture & fixtures 20000 25000 5000 25.00
Other fixed assets 25000 30000 5000 20.00
Total fixed assets (B) 815000 925000 110000 13.49
Total assets (A+B) 1435000 1697000 262000 18.26
LIABILITIES
(iii) Current liabilities
Bills payable 50000 45000 -5000 -10
Sundry creditors 100000 120000 20000 20
Other current liabilities 5000 10000 5000 100
Total current liabilities (C) 155000 175000 20000 12.9
(iv) Long term liabilities

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Debentures 200000 300000 100000 50
Long term loans on mortgage 150000 200000 50000 33
Equity share capital 600000 800000 200000 33
Reserves & surplus 330000 222000 -108000 -32.73
Total long term liabilities (D) 1280000 1522000 242000 18.9
Total liabilities (C+D) 1435000 1697000 262000 18.26
(2) Comparative Income Statement: The income statement gives the results of the operations of a
business. The comparative income statement gives an idea of the progress of a business over a
period of time. The changes in absolute data in money values and percentages can be determined to
analyse the profitability of the business. The analyst must explain the following items in income
statement:
 Increase/decrease in sales
 Increase/decrease in cost of goods sold
 Increase/decrease in gross profit
 Increase/decrease in operating profit
 Increase/decrease in operating expenses
 Increase/decrease in non operating expenses
 Analysis of various items of income
 Increase/decrease in net profit
FORMAT OF COMPARATIVE INCOME STATEMENT
Comparative income statement for the year ending on…..
Particulars Past Current year Absolute Percentage

year (`) change change
(`)
(1) Net sales xxx xxx xxx xxx
(2) Less: cost of goods sold xxx xxx xxx xxx
(3) Gross profit (1 – 2) xxx xxx xxx xxx
(4) Less: Operating expenses xxx xxx xxx xxx
Office & administration expenses xxx xxx xxx xxx
Selling & distribution expenses xxx xxx xxx xxx
(5) Operating profit (3 – 4) xxx xxx xxx xxx

(6) Add: non – operating income xxx xxx xxx xxx
(7) Less: non operating expenses xxx xxx xxx xxx
(8) Net profit (5 + 6 – 7) xxx xxx xxx xxx
(9) Less: tax xxx xxx xxx xxx
(10) Profit after tax (8 – 9) xxx xxx xxx xxx
Illustration: 3
From the following information relating to Ram ltd. prepare a comparative income statement
showing the percentage increase or decrease in 2005 over 2004

Contact: 9829959536,7737733360,9928001210 7.4
Particulars 2004(`) 2005(`)
Sales 600000 900000
Material consumed 300000 480000
Manufacturing, office & selling expenses 200000 280000
Income tax 50000 70000
Profits 50000 70000
Solution:
Comparative income statement of Ram ltd
Particulars 2004 2005 Absolute change Percentage change
(`) (`) Increase / decrease
Sales 600000 900000 300000 300000 x 100 = 50%
600000
Less: cost of 300000 480000 180000 180000 x 100 = 60%
materials 300000
Gross profit 300000 420000 120000 120000 x 100 = 40%
300000
Less: manufacturing 200000 280000 80000 80000 x 100 = 40%
office & selling exp 200000
Net profit 100000 140000 40000 40000 x 100 = 40%
100000
Less: income tax 50000 70000 20000 20000 x 100 = 40%
50000
Net profit after tax 50000 70000 20000 20000 x 100 = 40%
50000
Illustration: 4
The income statement of a concern is given for the year ending on 31st Dec, & 2002 and 2003.
Rearrange the figures in a comparative form and study the profitability position of the concern.
Net Sales 785 900
Cost of goods sold 450 500
Operating expenses:
General & administrative expenses 70 72
Selling expenses 80 90
Non operating expenses:
Interest paid 25 30
Income tax 70 80
Solution:
Comparative income statement for the year ended 31st Dec 2002 and 2003
Particulars 2002 2003 Absolute change Percentage
` (000) ` (000) Increase / decrease change
Net Sales 785 900 115 14.65
Less: cost of goods sold 450 500 50 11.0
Gross profit 335 400 65 19.40

Contact: 9829959536,7737733360,9928001210 7.5
Operating expenses:
General & administrative exp 70 72 2 2.8
Selling expenses 80 90 10 12.5
Total operating expenses 150 162 12 8.0
Operating profit 185 238 53 28.65
Less: other deductions interest 25 30 5 20
paid
Net profit before tax 160 208 48 30.0
Less: income tax 70 80 10 14.3
Net profit after tax 90 128 38 42.22
*****

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A unit of Realwaves (P) Ltd Common size Statement
CHAPTER 8 COMMON SIZE STATEMENT
Common size statement

The common size statements, balance sheet & income statements are shown in analytical
percentages. The figures are shown as percentages of total assets, total liabilities & total sales. The
total assets are taken as 100 & different assets are expressed as a percentage of the total. Similarly,
various liabilities are taken as a part of total liabilities. These statements are also known as
component percentage or 100 percent statements because every individual item is stated as
percentage of the total 100.
(1) Common size balance sheet: A statement in which balance sheet items are expressed as the
ratio of each asset to total assets and the ratio of each liability is expressed as a ratio of total
liabilities is called common size balance sheet.
Illustration: 1
The balance sheet of P & Co. and S & Co. are given below:
Balance sheet as on 31st Dec 2004

Liabilities P & Co S & Co. Assets P & Co S & Co.
Preference share 120000 160000 Land &Building 80000 123000
capital 150000 400000 Plant &Machinery 334000 600000
Equity share capital 14000 18000 Temporary investment 1000 40000
Reserves & surplus 115000 130000 Inventories 10000 25000
Long term loans 2000 - Book debts 4000 8000
Bills payable 12000 4000 Prepaid expenses 1000 2000
Sundry creditors 15000 6000 Cash & bank balances 8000 10000
Proposed dividend 438000 808000 438000 808000
Solution:
Common size balance sheet as on 31st Dec 2004

Particulars S & Co. K & Co.
Amount ` Percentage Amount ` Percentage
ASSETS
(i) Fixed assets
Land & Buildings 80000 18.26 123000 15.22
Plant & Machinery 334000 76.26 600000 74.62
Total fixed assets 414000 94.52 723000 89.48
(ii) Current assets
Temporary investments 1000 0.23 40000 4.95
Inventories 10000 2.28 25000 3.08
Book debts 4000 0.91 8000 0.99
Prepaid expenses 1000 0.23 2000 0.25
Cash & bank balance 8000 1.83 10000 1.25

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Total current assets 24000 5.48 85000 10.52
Total assets 438000 100.00 808000 100.00
LIABILITIES
(iii) Share capital & reserves
Preference share capital 120000 27.39 160000 19.80
Equity share capital 150000 34.25 400000 49.50
Reserves and surplus 14000 3.19 18000 2.23
Total capital & reserves 284000 64.83 578000 71.53
Long term loans 115000 26.25 130000 16.09
(iv) Current liabilities
Bills payable 2000 0.46 - -
Sundry creditors 12000 2.74 4000 0.49
Outstanding expenses 15000 3.44 6000 0.74
Proposed dividend 10000 2.28 90000 11.15
39000 8.92 100000 12.38
Total liabilities 438000 100.00 808000 100.00
Illustration: 2
From the following information, prepare common size balance sheet of Roop K. Goyal
Liabilities 2003 (in lacs) 2004 (in lacs)

Equity of capital 4 5
9% Redeemable Preference Share capital 2 2.50
Creditors 2 1.00
Bills payable .50 1.00
8.50 9.50
Assets 2003 (in lacs) 2004 (in lacs)
Fixed assets 5 4.0
Debtors 2 3.0
Stock 1 1.0
Bills receivable - .50
Cash .50 1.00
8.50 9.50
Solution:

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Common size balance sheet as on 31st Dec 2003 and 2004

Particulars 2003 2004
Liabilities
Equity share capital 4 47 5 52.60
9% preference capital 2 23.5 2.50 26.30
(redeemable)
Creditors 2 23.5 1.00 10.55
Bills payable .50 6.0 1.00 10.55
Total liabilities 8.50 100 9.50 100
Assets
Fixed assets 5.0 59.00 4.00 42.20
Debtors 2.0 23.50 3.00 31.65
Stock 1.0 11.70 1.00 10.55
Bills receivable - - .50 5.25
Cash .50 5.80 1.00 10.55
Total assets 8.50 100 9.50 100
Illustration: 3
The following are the balance sheets of X Ltd and Y Ltd. for the year ending 31st Dec, 1994.
Liabilities X Ltd Y Ltd Assets X Ltd Y Ltd

Equity share capital 250000 170000 Land &Building 350000 275000
Preference share 120000 80000 Plant &Machinery 270000 300000
capital 50000 70000 Temporary investment 72000 12000
Reserves & surplus 350000 279000 Book debts 47500 25000
Loans 25000 14000 Prepaid expenses 35400 -
Bills payable 18000 8000 Cash & bank balances 48690 21000
Dividend declared 823590 633000 823590 633000
Present the data in such a way that proper analysis is possible.
Solution:
Common size balance sheet of X Ltd and Y ltd

Particulars X ltd Y ltd
Capital & reserves:
Equity share capital 250000 30.4 170000 26.9
Preference share capital 120000 14.6 80000 12.6
Reserves & surplus 50000 6.1 70000 11.1
Total capital & reserves 420000 51.1 320000 50.6
Loans 350000 42.5 279000 44.1
Current liabilities

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Bills payable 25000 3.00 14000 2.2
Sundry creditors 18000 2.20 8000 1.3
Outstanding expenses 8590 1.00 4500 0.6
Dividend declared 2000 0.20 7500 1.2
Total current liabilities 53590 6.40 34000 5.3
Total liabilities 823590 100.00 633000 100.00
ASSETS
(i) Fixed assets
Land & Buildings 350000 42.5 275000 43.5
Plant & Machinery 270000 32.8 300000 47.4
Total fixed assets 620000 75.3 575000 90.9
(ii) Current assets
Investments (Temporary) 72000 8.7 12000 1.9
Book debts 47500 5.7 25000 3.9
Prepaid expenses 35400 4.4 - -
Cash & bank balance 48690 5.9 21000 3.3
Total current assets 203590 24.7 58000 9.1
Total assets 823590 100.00 633000 100.00
(2) Common size income statement: The items in income statement can be shown as percentages
of sales to show the relation of each item to sales. A significant relationship can be established
between items of income statement & volume of sales. The increase in sales will certainly increase
selling expenses & not administrative or financial expenses.
Illustration: 4
Following are the income statements of a company for the years ending 31st dec. 2003 & 2004.
Particulars 2003(` in ‘000’) 2004(` in ‘000)
Sales 500 700
Miscellaneous income 20 15
520 715
Expenses:
Cost of sales 325 510
Office expenses 20 25
Selling expenses 30 45
Interest 25 30
400 610
Net profit 120 105
520 715
Solution:
Common size income statement for the year ended 31st Dec 2002 and 2003
Amount Percentage Amount Percentage
Sales 500 100.00 700 100.00
Less: cost of sales 325 65.00 510 72.86

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Gross profit 175 35.00 190 27.14
Operating expenses:
Office expenses 20 4.00 25 3.58
Selling expenses 30 6.00 45 6.42
Total operating expenses 50 10.00 70 10.00
Operating profit (G.P – O.E) 125 25.00 120 17.14
Miscellaneous income 20 4.00 15 2.14
Total income 145 29.00 135 19.28
Less: non operating expenses: 25 5.00 30 4.28
interest
Net profit 120 24.00 105 15.00
Illustration: 5
From the income statement given below, you are required to prepare a common size income
statement
Income statements for the year ending 31st Dec 1986 & 1987

Sales 140000 165000
Less: Cost of goods sold 85000 105000
Gross profit 55000 60000
Operating Expenses:
Selling & distribution expenses 12000 16000
Administrative expenses 10000 11000
Total Operating Expenses 22000 27000
Net income before tax 33000 33000
Income tax (40%) 13200 13200
Net income 19800 19800
Solution:
Common size income statement for the year ending 1986 and 1987
Amount Percentage Amount Percentage
Sales 140000 100.00 165000 100.00
Less: cost of sales 85000 60.72 105000 63.63
Gross profit 55000 39.28 60000 36.37
Operating expenses:
Selling & distribution expenses 12000 8.57 16000 9.70
Administrative expenses 10000 7.14 11000 6.67
Total operating expenses 22000 15.71 27000 16.37
Net income before tax 33000 23.57 33000 20.00
Income tax (40%) 13200 9.42 13200 8.00
Net income after tax 19800 14.15 19800 12.00
*****

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A unit of Realwaves (P) Ltd Trend Analysis
CHAPTER 9 TREND ANALYSIS

TREND ANALYSIS
Meaning and Definition of Trend Analysis

The word 'trend' means future possibilities. An efficient and effective management tries to know the
actual performance and also discovers future prospects of the business. Trend analysis acquaints us
with the profitability and the short term and long term liquidity of the business. In addition, it also
discovers the future prospects of the business in terms of profitability, operational efficiency and
financial soundness of the enterprise.
Trend analysis is also trend as Intra - Firm comparison, wherein financial statements of the same
enterprise for two or more years are compared. Trend analysis is also named as Index analysis,
horizontal analysis, because each accounting variable is placed horizontally.
According to Kohler's, Trend analysis is defined as "the average of time series data in order that a
smooth curve showing general growth or decline may be developed for some past period of time".
Objectives of Trend Analysis

The objectives of trend analysis are as follows:
1) Indicating actual and prospective performance of the business.
2) Indicating profitability of the enterprises.
3) Showing operational efficiency of the business.
4) Manifesting short term and long term financial soundness of the enterprises.
5) Assisting in decision making regarding future line of action.
Computation of Trend Analysis

The following points should be considered while computing the trend index percentages:
1) Same accounting principles and practices should be followed.
2) The base year should be clearly selected. It should be a normal year of business activities.
3) Trend percentages should be studied after considering the absolute figures on which they are
based. Further every item in the base statements is stated at 100.
4) Trend index percentages should be calculated only for items having logical relationship with one
another.
5) Trend index percentages of each item in another statement is calculated with reference to the same
item in the base statement by using the following formula:
CurrentYear x l00
BaseYear
Illustration: 1
From the following data relating to the ABC & Co. for the year 2009 to 2012, calculate the trend
percentages (taking 2009 as base year):
Particulars 2009 2010 2011 2012

Net Sales 2,00,000 1,90,000 2,40,000 2,60,000
Less: Cost of goods sold 1,20,000 1,17,800 1,39,200 1,45,600
Gross Profit 80,000 72,200 1,00,800 1,14,400
Less: Expenses 20,000 19,400 22,000 24,000
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A unit of Realwaves (P) Ltd Trend Analysis
Net Profit 604)00 52,800 78,800 90,400
Trend Percentages
Particulars 2009 2010 2011 2012
Net Sales 100 95.0 120.0 130.0
Less: Cost of goods sold 100 98.2 116.0 121.3
Gross Profit 100 90.3 126.0 143.0
Less: Expenses 100 97.0 110.0 120.0
Net Profit 100 88.0 131.3 150.6
Interpretation: On the whole, the 2010 was a bad year but the recovery was made during 2011 with
increase in volume as well as profits. The figures of 2010 when compared with 2009 reveal that the
Sales have reduced by 5%, but the cost of goods sold and the Expenses have decreased only by 1.8%
and 3% respectively.
This means that a substantial portion of the cost of goods sold and expenses is fixed in nature. This
resulted in decrease in net profit by 12%. The position was recovered in 2011 and 2012. Again, the
increase in net profit by 31.3% (2011) and 50.6% (2012) is much more than the increased in sales by
20% and 30% respectively.
****

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A unit of Realwaves (P) Ltd Ratio Analysis
CHAPTER 10 RATIO ANALYSIS
Introduction
The main aim of ratio analysis is to have better understanding of performance and financial position
of a firm. It helps us to draw interpretations and conclusion about performance and position of the
firm.
Meaning & definition

The term ‘Ratio analysis’ refers to the numerical relationship between two variables. It is the most
important tool of evaluating the efficiency and effectiveness of a concern in various areas.
Significance of Ratio analysis

(i) Determine long-term solvency: Ratio analysis is necessary for measuring long – term solvency.
A concern with good solvency can easily get long-term loans with low interest rate.
(ii) Helps in inter & intra firm comparison: Ratio analysis is used for comparing efficiency &
ability of a concern with that of other firms & within different units of same concern.
(iii) Helps in trend analysis: Ratios are used to show whether financial position of the firm is
improving or declining over years. With the help of this, one can ascertain, whether trend is
favorable or unfavorable.
(iv) Determine liquidity: Ratio analysis is used to determine liquidity position of the firm. Liquidity
condition is said to be satisfied if it is able to meet its current obligations as and when they mature.
(v) Operational efficiency: Ratio analysis acts as one of the important tools for measuring
efficiency of the management. Various turnover ratios measure operational efficiency of the firm.
(vi) Helps in communication: Ratio analysis plays an important role in informing about the
progress made by the firm and other parties. So, communication by simplified form using simple
ratio is easy.
Classification of ratios
(1) Liquidity ratios: These ratios are used to measure the ability of the firm to meet its short-term
obligations out of its short-term resources. Such ratios highlight short-term solvency of the firm.
Examples of such ratios are:
 Current ratio
 Liquid or quick ratio
 Absolute liquidity ratio
(2) Activity or efficiency ratios: These ratios enable the management to measure the effectiveness
or the usages of the resources at the command of the firm. Following ratios are included in this
category:
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 Stock turnover ratio
 Debtors turnover ratio
 Creditors turnover ratio
 Total assets turnover ratio
 Fixed assets turnover ratio
 Current assets turnover ratio
 Working capital turnover ratio
 Capital turnover ratio
(3) Profitability ratios: These ratios are intended to measure the end result of business operations
i.e. profitability. Profitability is a measure of the ability to make a profit expressed in relation to the
sales or investments & as such the following ratios are computed in this category:
 Based on sales
 Gross profit ratio
 Operating ratio
 Expenses ratio
 Operating profit ratio
 Net profit ratio
 Based on capital or investments
 Return on capital employed
 Return on net worth or shareholders funds
 Return on equity shareholders fund
 Return on total assets
(4) Capital structure or leverage ratios: These ratios help in measuring the financial contribution
of the owners as compared to that of creditors & also the risk in debt financing. The long-term
solvency of the business can be examined by using leverage ratios. Following are such important
ratios:
 Debt equity ratio
 Proprietory ratio
 Solvency or debt to total assets ratio
 Fixed assets to net worth ratio
 Capital gearing ratio
 Interest coverage or debt service ratio
 Dividend coverage ratio
(5) Investment analysis ratios: These ratios are helpful to the shareholders in analyzing the
perspective investment in the company shareholders are able to know the future market price of their
investment with the help of these ratios. Following ratios are included in this category:
 Earning per share
 Price earnings ratio
 Dividend per share
 Dividend yield ratio
 Dividend payment ratio
 Earning yield ratio

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Thus, ratio are classified with different points of views, but from analytical point of view, the
functional classification is more appropriate as it highlights the utility of different ratios.
(i) Liquidity ratios: Liquidity refers to firm’s ability to meet its current financial obligations when
they arise. Liquidity ratios study the firm’s short-term solvency and its ability to pay liabilities. The
liquidity ratio provides a measure of liquidity of the firm by establishing relationship between its
current assets & current liabilities.
(a) Current ratios: Current ratios is defined as relationship between current assets & current
liabilities. It is also known as working capital ratio or 2:1 ratio. It is calculated as follows:
Current ratios = Total Current Assets

Total Current Liabilities
Current liabilities Current assets

Creditors Cash & bank balance
Bills payable Debtors
Bank overdraft Bills receivable
Short term loans Stock
Outstanding expenses Short – term investments
Income tax payable or marketable securities
Unclaimed dividend Prepaid expenses
Provision for tax Advance payment
Proposed dividend
Interpretation & Significance.

If the current ratio is higher, it is good from the creditors point of view but extremely high current
ratio is not good from the management’s point of view. In such a case, (i) more funds of the firm
would be employed in unproductive uses (like inventory) which do not fetch any return; (ii) it is the
indicator of a firms poor investment policy (iii) poor credit management due to over extended
accounts receivable. Similarly a low & declining current ratio would indicate: (i) an inadequate
margin of safety to the creditors, i.e. firm has no sufficient cash to pay its liabilities, (ii) shortage of
working capital in the business i.e. firm is trading out of its resources.
Ideal current ratio: A current ratio of 2:1 is considered satisfactory.

(b) Liquidity or quick ratio: Liquidity ratio is the measure of the instant debt paying ability of the
business enterprise; hence it is also called ‘Quick ratio’ or ‘Acid test ratio’. This ratio establishes the
relationship between quick/ liquid current assets & current liabilities. The formula used is:
Liquidity or quick ratio = Liquidity or quick

Current Liabilities
= Current Assets – (Stock + Prepaid exps)
Current Liabilities
Interpretation & Significance.

Liquid ratio is considered to be superior to current ratio in evaluating the liquidity position of the
firm. Generally speaking, a liquid ratio of 1:1 is considered satisfactory. It implies that the liquid
assets of the firm are just equal to the current/ quick liabilities. Sometimes, a situation arises when
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the firm has to meet its current liabilities immediately. In such cases, it can pay off these liabilities
out of its quick assets of equal value without any difficulty. Thus, liquidity ratio is an indication of a
firms ability to meet unexpected demand for working capital.
Ideal quick ratio: A quick ratio of 1:1 is considered as an ideal ratio. If the liquid ratio is more than
1:1, the financial position of the firm seems to be sound & good. On the other hand, if the ratio is
less than 1:1, the financial position of the firm is unsound.
Illustration: 1
Equity share capital 400000 Plant & machinery 500000
Profit & loss A/c 40000 Stock 80000
Debentures 160000 Sundry debtors 60000
Sundry creditors 100000 Cash in hand 50000
Provision for tax 20000 Cash at bank 20000
Prepaid expenses 10000
720000 720000
Calculate the following ratios: (i) current ratio (ii) quick ratio
Ans: (i) 1.833:1 (ii) 1.08:1
(c) Absolute liquidity ratio: This is also known as super quick ratio. This ratio considers only
absolute liquidity available with the firm. Absolute liquid assets include cash in hand, cash at bank
and marketable securities.
It is calculated as follows:
Cash ratio = Cash in hand & bank + Marketable securities
Total current liabilities
Interpretation
If absolute liquidity ratio is 1:1, this indicates that firm has enough cash to pay its creditors.
Illustration: 2
Following in the balance sheet of Lokesh ltd as on 31st march, 05
Share capital Fixed assts
8000 equity shares of ` 100 800000 Building 340000
each Furniture 228000
Reserves & surplus Machinery 220000
General reserve 40000 Investment 40000
Capital reserve 16000 Current assets
Current liabilities Stock 20000
Creditors 12000 Debtor 14000
Bills payable 8000 Bills receivable 10000
Outstanding expenses 4000 Cash & bank balance 4000
Marketable securities 4000
880000 880000

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Calculate absolute liquidity ratio
Ans: 0.33:1
(ii) Activity ratios: Activity ratios are also known as turn over ratios. It is a measure of movement
& indicates as to how frequently an account has turned over during a period. It shows how
efficiently the assets of a firm are being utilized. These ratios are usually calculated with reference to
sales/ cost of goods sold and are expressed in terms of rate. The activity ratio is calculated for all the
specific assets. Some of the important activity ratios are as follows:
(a) Stock or inventory turnover ratio (I/T ratio): Inventory turnover ratio establishes relationship
between cost of goods sold during the year by a firm. Generally, firm must have sufficient stock to
meet the demand of business, but it must not be too large also, which shows unnecessary blockage of
capital in inventory or stock, it is calculated by using the following formula:
Inventory turnover ratio = Cost of goods sold / Net sales
Average inventory
Where, Average inventory = Opening stock + Closing stock

2
Cost of goods sold = Opening stock + Purchase + Direct expenses - Closing stock
Or
Cost of goods sold = Net sales – Gross profit
Illustration: 3
An enterprise has an opening stock of ` 400000 & the closing stock of ` 500000. The net sales made
during the year amounted to ` 2400000 to give a gross profit of 25% of selling price. Find out
inventory turnover ratio.
Ans: 4 times
I/T ratio is extended to find out number of days of inventory holding.

Days of inventory holding = 12/ 365
Stock turnover ratio
Where, 360/ 365 is number of days in a year.
Illustration: 4
Compute the stock turnover ratio with the help of the following figures relating to Meenashi ltd.
Trading A/c for the year ending 31st march, 06.
To Opening stock 15920 By Sales 78000
To Purchases 39000 By Closing stock 14400
To Carriage inwards 1000
To Gross profit 36480
92400 92400
Ans: 2.74 times & 133 days

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(b) Debtors or receivables turnover ratio (R/T ratio): This ratio establishes the relationship
between net credit sales & average receivable of the year.
Debtors or receivables turnover ratio = Annual Net Credit Sales

Average Receivable (Drs + B/R)
Net credit sales means gross credit sales less returns, if any,
Average receivable = Opening Debtors & B/R + Closing Debtors & B/R
2
This ratio measures how rapidly debts are collected. A high ratio shows shorter time lag between
credit sales & cash collection. On the other hand, low ratio indicates that debts are not being
collected rapidly. To judge the efficiency of this ratio, it must be compared with the ratio in previous
period.
Average collection period: Average collection period is totally dependent on Debtors turnover
ratio. It means number of days over which debtors & B/R, remains uncollected. It can be computed
in the following manner:
Average collection period = 12 months or 365 days

Debtors turnover ratio
Illustration: 5
From the following information, calculate Debtors turnover ratio & Average collection period.
Total sales for the year 175000
Cash sales 20% of total sales
Sales return (out of credit sales) 10000
Sundry Drs: opening 8000
Closing 12000
Ans: 13 times & 28.07 days or 0.92 months
(c) Payable or creditors turnover ratio (P/T ratio): The P/T ratio shows velocity of debt payment
by the firm. It compares the annual credit purchases with the average payables (creditors & bills).
The main objective of this ratio is to determine the efficiency with which creditors are managed. It is
calculated as follows:
Payable or creditors turnover ratio = Annual net credit purchases
Average payables (Creditors + B/P)
Where, net credit purchases = Gross credit purchase – Return to suppliers
Average payables = Opening Creditors & B/P + Closing Creditors & B/P
2
The low turnover indicates liberal credit terms granted by suppliers. On the other hand , high
turnover reflects that accounts are to be settled rapidly. Thus, lower the ratio better is the liquidity
position of firm & higher the ratio, lesser is the liquidity position of the firm.
Average payment period = Months or days in year

Creditors turnover
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Illustration: 6
Compute (i) Debtors turnover ratio (ii) debtors velocity (iii) Creditors turnover ratio (iv) Creditors
velocity (v) stock turnover ratio from the following:
Debtors 40000 50000
Creditors 50000 40000
Stock 30000 50000
Transactions during the year
Cash recd from Debtors 90000
Cash paid to Creditors 60000
Cash sales 60000
Cash purchases 40000
Return inwards 10000
Ans: (i) 2.44 times (ii) 152 days (iii) 1.22 times (iv) 299 days (v) 1.87 times
(d) Total assets turnover ratio: This ratio expresses the relationship between cost of goods sold or
net sales & total assets or investments of a firm. It is also called ‘ total investment turnover ratio’ &
is calculated by using the following formula:
Total assets turnover ratio = Net sales or Cost of goods sold

Total assets
Components:
Total assets mean all fixed & current assets but the provision for depreciation is adjusted in it. A few
experts exclude fictitious assets like preliminary expenses, underwriting commission, discount on
shares & debentures etc. but include intangible assets such as goodwill, patents, trademark etc.
Interpretation:
This ratio indicates the number of times the assets are turned over in a year in relation to sales. A
higher total assets turnover ratio is the indicator of effective utilization of investment in assets,
whereas lower assets turnover ratio indicates that assets are not properly utilized in comparison to
sales. Thus, there is an over investment in assets. Extremely high ratio means over- trading in the
business.
(e) Fixed assets turnover ratio: This ratio is an indicator of the extent to which investment in fixed
assets contribute in generation of sales. This ratio expresses the relationship between fixed assets
(less depreciation) & net sales or cost of goods sold. Investments are excluded from fixed assets, as
they do not affect sales. It is calculated by using the following formula:
Fixed assets turnover ratio = Sales / Cost of goods sold

Fixed assets (Less Depreciation)
Interpretation
This ratio reveals firms ability to generate sales per rupee of investment in fixed assets. A high ratio
indicates intensive utilization of fixed assets whereas a lower ratio means under utilization of fixed
assets & excessive investment in fixed assets.

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(f) Current assets turnover ratio: This ratio establishes relationship between current assets & net
sales or cost of goods sold. Following formula is used to calculate this ratio:
Current assets turnover ratio = Sales / Cost of goods sold.

Current assets
Interpretation
It lay major emphasis on the effectiveness & use of current assets.
(g) Working capital turnover ratio: This ratio maintains a relationship between net sales or cost of
goods sold & working capital, expressed as follows:
Working capital turnover ratio = Sales / Cost of goods sold.

Net working capital
Interpretation
This ratio indicates how efficiently working capital is utilized in making sales. A high ratio indicates
over trading i.e. low investment in working capital and more profits. On the other hand, low ratio
reveals under trading i.e. funds are not utilized properly.
(h) Capital turnover ratio: This ratio establishes the relationship between net sales or cost of goods
sold & capital employed. Capital employed is calculated either by deducting current liabilities from
total assets or by adding long term loans in shareholders funds (share capital + reserves & surplus).
Fictitious & non-trading assets are excluded from assets. It is calculated using the following formula:
Capital turnover ratio = Sales / Cost of goods sold.

Capital employed
Capital employed = Total Assets – Current liability – Fictitious Assets
Capital employed = Shareholders Fund + Long term debts - Fictitious Assets
Shareholders Fund = Equity shareholder + Preference shareholder + Reserves + P/L Cr

balance
Long term debts = Bank loan + Debentures
Interpretation:
Efficient use of capital symbolizes profit earning capacity & managerial efficiency of the business.
A higher ratio indicates the quicker rotation of capital to generate higher sales, which leads to higher
profit ability. On the contrary a lower ratio will indicate that either the capital is lying idle or the
capital is not being used efficiently to generate enough sales.
Illustration: 7
The following is the balance sheet of Sanchit co. ltd as on 31st march, 06.

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Share capital 80000 Fixed assets 160000
General reserve 30000 Debtors 60000
P&L A/c 50000 Bills receivable 20000
Mortgage loan @ 10 % 80000 Cash at bank 50000
Creditors 40000 Preliminary expenses 10000
Bills payable 20000
300000 300000
Sales during the year 2005- 06 amounted to ` 160000, which yield a gross profit of 25%.
Calculate (i) capital turnover ratio (ii) fixed assets turnover ratio (iii) working capital turnover ratio
(iv) current assets turnover ratio (v) total assets turnover ratio
Ans: (i) 0.52 times (ii) 0.75 times (iii) 1.71 times (iv) 0.92 times (v) 0.41 times
(iii) Profitability ratios: The main objective of every business firm is to earn profit. It is possible
only when resources of the firm are effectively utilized. The firm’s ability to earn maximum profit
by the best utilization of its resources is called profitability. Profit refers to the absolute quantity of
profit, whereas profitability refers to the ability to earn profit.
There are two types of profitability ratios. First, profitability ratios based on sales, second,
profitability ratios based on capital and assets.
Profitability ratios based on sales

From profit point of view, it is significant that adequate profit should be earned on each unit of sales.
(1) Gross profit ratio: This ratio expresses the relationship of gross profit on sales to net sales in
terms of percentage. Expressed as a formula, the gross profit ratio is:
Gross profit ratio = Gross profit x 100
Net sales
Or
Gross profit ratio = Net sales – Cost of goods sold x 100
Net sales
Interpretation:
This ratio measures the trading effectiveness and basic profit earning potentiality of a firm. The
higher the ratio, the greater will be the margin and that is why it is also called, ‘ margin ratio’. An
increase in the gross profit ratio may be the result of one or all of the following:
(i) Higher selling price but cost of goods remaining the same.
(ii) Lower cost of goods sold but selling price remaining the same.
On the contrary, a low gross profit ratio is the indication of the fact (i) profits are declining in
comparison to sales (ii) production costs are much more due to inability to purchase raw material on
reasonable terms, inefficient use of plant & machinery and over investment.
(2) Operating ratio: This ratio expresses the relationship between operating costs & net sales.
Operating costs refer to cost of goods sold plus operating expenses. Expressed as a formula:
Operating ratio = Operating costs x 100

Net sales

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Or
Operating ratio = Cost of goods sold + Operating expenses x 100
Net sales
Components:
The operating expenses include office & administration expenses (salary, rent, depreciation,
directors fee, electricity, insurance etc) & selling & distribution expenses. Financial expenses such as
interest, discount, provision for bad debts, provision for taxation.
Interpretation & significance:

This ratio indicates the operational efficiency & profit earning capacity of the business. Lower the
operating ratio, the higher the operating profits.
(3) Operating profit ratio: This ratio is also called operating profit margin (OPM). It establishes the
relationship between operating profits & net sales. Operating profit means the net profit arising from
the normal operations & activities of the business operating profit is calculated by subtracting all
direct & indirect expenses relating to main business from net sales.
Operating profit ratio = Operating profit x 100

Net sales
OR
Operating profit ratio = Gross profit – Operating Expenses x 100
Net sales
Interpretation:
The higher the operating profit ratio, the better would be the operational efficiency of the firm. A
higher operating profit ratio means that a firm has been able not only to increase its sales but also
been able to cut down its operating expenses.
(4) Expenses ratio: These ratios reveal the relationship of different expenses to net sales. Important
expenses ratios are calculated using the following formulae:
(a) Material consumed ratio = Material consumes x 100

Net sales
(b) Manufacturing exp. Ratio = Manufacturing expenses x 100

Net sales
(c) Administrative exp. Ratio = Administrative expenses.x 100

Net sales
(d) Selling & Distribution exp ratio = Selling & Distribution expenses x 100
Net sales
(e) Finance exp ratio = Finance expenses x 100

Net sales

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(f) Non operating exp ratio = Non operating expenses x 100
Net sales
Interpretation:
Expenses ratio reveals the managerial efficiency & profit earning capacity of the firm. If these ratios
are compared over a period of time with the ratios of similar firm as well as with the previous ratios
of the same firm, the saving or over spending of each item can be ascertained. While interpreting the
expenses ratios, it should be kept in view that certain fixed expenses would decrease as sales
increase, but variables expenses would remain constant.
(5) Net profit ratio: This ratio measures the relationship between net profit & sales of a firm. Net
profit is the excess of revenue over expenses during a particular accounting period. The net profit
ratio is determined by dividing the net profit by sales & expressed as percentage. The formula used
is as follows:
Net profit ratio = Net Profit (After tax) x 100
Net sales
Or
Net profit ratio = Net Profit (Before tax) x 100
Net sales
Illustration: 8
The following is the trading & P&L A/c of Paintax Ltd for the year ended 31st march, 2006.

To Stock 60000 By sales 820000
To Purchases 420000 Less: Return 20000 80000
To Wages 28000 By Closing stock 100000
To Carriage Inward 8000
To Gross profit c/d 384000
900000 900000
To Office exp 48000 By Gross profit b/d 384000
To Selling & Distribution exp 56000 By Non operating income 4600
To Non operating exp 3400
To Net profit 281200
388600 388600
Calculate:
(a) Gross profit ratio (b) Operating profit ratio (c) Operating ratio (d) Expenses ratio (e) Net profit
ratio.
Ans: (a) 48% (b) 35% (c) 65% (d) (i) Office exp = 6% (ii) S & D exp = 7% (iii) Non- operating exp
= 0.425% (e) 35.15%
Profitability ratios based on capital

The efficiency of an enterprise is judged by the amount of profits. But, sometimes the conclusions
drawn on the basis of profit to sales ratios may be misleading, as the amount of profit depends to a
great extent upon the volume of investment in assets or capital employed in the business.

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(1) Return on capital employed: The primary objective of making investment in any business is to
obtain adequate return on capital invested therefore, to measure the overall profitability of the firm,
it is essential to compare profit with capital employed. It is also called ‘Return on Investment’ (ROI)
Return on capital employed = Net profit (Before Interest & Tax) x 100
Capital employed
Capital employed means ‘Gross capital employed’ & ‘Net capital employed’. Gross capital
employed means the total assets used in the business. Net capital employed means total assets minus
current liabilities. While calculating capital employed. (i) Non- trading investments (ii) Idle assts
(iii) Intangible assets like goodwill, patents, trademark whose realizable value is nil, (iv) Fictitious
assets like preliminary exp, underwriting commission, discount on issue of shares & debentures etc.
should be excluded from assets.
(2) Return on net worth or shareholders funds / equity: This ratio express the percentage
relationship between net profit (after interest & tax) & net worth or share holders funds.
Return on shareholders fund = Net profit (After Tax & Interest) x 100
Shareholders funds or Net worth
Components:
Net worth or shareholders funds include preference share capital as well as equity shareholders
funds, which in turn comprise equity share capital, share premium & reserves & surplus (after
adjusting the accumulated losses & fictitious assets). The net profits are after deducting interest &
tax but before deducting dividend on preference shares. It is the final income that is available for
distribution as dividends to shareholders.
Significance:
This ratio measures the amount of earnings for each rupee that the shareholders invested in the
company. The higher the ratio the more favorable is the interpretation of the company’s use of its
resources contributed by the shareholders. This ratio can be composed with that of other units
engaged in similar activities as also with the industry on average.
Illustration: 9
The following information is obtained from the books of a company:
Particulars Amt Amt
Issued & subscribed capital:
30000 equity shares of ` 10 each 300000
1500, 10% preference share of ` 100 each 150000
450000
Reserves & surplus
General reserve 45000
Capital reserve 75000
Reserve for contingencies 30000 150000
Net profit before interest & tax 225000
Interest charges 45000
Tax rate 50%

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Calculate return on shareholders funds.
Ans: 13.04%
(3) Return on equity shareholders funds: This ratio is calculated by dividing the profit available
for equity shareholders by the equity shareholders funds expressed as a formula the ratio is:
Return on equity shareholders funds=Net profit after tax–Preference dividend x 100

Equity shareholders funds
Interpretation:
This ratio is the best measure of a company’s profit earning capacity. The higher the ratio, the better
the performance & prospectus of the company. It provides adequate test to evaluate whether a
company has earned satisfactory return for its equity shareholders or not. The adequacy of the return
can be measured by comparing it with the return of the previous year or of companies engaged in
similar business or with the overall industry average. The investors can decide to invest or not to
invest in the equity shares of a company by comparing it with the normal rate of return in the market.
Illustration: 10
Following is the balance sheet of Bansal Ltd as on 31st march, 2006.
Equity share capital Fixed assets 800000
40000 equity shares of ` 10 400000 Current assets 380000
each Under writing commission 20000
12% preference share capital 200000
Reserves 50000
P&L a/c 220000
15% Debentures 100000
Current liabilities 230000
1200000 1200000
Profit for the current year before payment of interest & tax amounted to ` 355000. Rate of tax 50%.
You are required to calculate (i) Return on equity shareholders funds (ii) Return on investment
(ROI)
Ans: (i) 23.54% (ii) 37.36%
4. Return on total assets: Profitability can also be measured by establishing relationship between
the net profit & total assets. Total assets means all net fixed assets, current assets and non- trading
investments. Fictitious assets are excluded.
Return on total assets = Net profit After tax x 100

Total Assets
Interpretation:
This ratio measures the profit ability of investments, which reflects managerial efficiency. The
higher the ratio the better is the profit earning capacity of the firm or vice- versa.
LEVERAGE RATIOS

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This is another category of financial ratios and is also known as capital structure ratios. The long-
term solvency of a firm can be examined by using leverage ratios. It may be defined as financial
ratios, which throw light on long-term solvency of a firm as reflected in its ability to assure long-
term creditors. So, leverage ratios are calculated to measure financial risk, capital structure also
includes coverage ratios which are computed to ascertain the firms capacity for regular payment of
interest & dividend. Some of these ratios are discussed below:
(i) Debt equity ratio: Debt equity ratio reveals the relationship between internal & external sources
of funds of a firm.
Debt equity ratio = Debt

Net worth
Or
Debt equity ratio = Total long term debts
Total shareholders fund
Interpretation:
Long-term debts includes long term loan from bank, IFC, IDBI, mortgage loans, debentures and
other long-term loans. Whereas, a shareholders fund includes equity share capital, preference share
capital and all accumulated reserves & surplus. In this case, very high ratio is not good for the
owner. This leads to increased interference of creditors in the management of the firm. In this case,
1:1 ratio is said to be reasonable. Both low & high debt equity ratios are not desirable. Low debt
equity ratios are not desirable. Low debt equity ratios provides safety margin to creditor due to high
state of owners in capital of company.
Illustration: 11
Balance sheet of an enterprise shows the following information:
Particulars Amt
Equity share capital 750000
Preference share capital 250000
Reserves 1250000
Debts 3500000
6750000
Calculate the Debt equity ratio of the firm
Ans: 1.55:1
(ii) Proprietory ratio: This ratio is also known as Net worth to total assets ratio. It establishes
relationship between proprietors funds & total assets, which is expressed as follows:
Proprietory ratio = Proprietors funds

Total Assets
Where, Proprietors funds = Share capital (equity & preference) + all reserves & surplus + all
undistributed profits – undistributed loss (if any)
Total assets = All current assets & fixed assets but fictitious assets are excluded or deducted.

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Interpretation:
This ratio highlights the general financial strength of the firm. It is of great importance to creditors
since it enables them to find out the proportion of shareholders funds in the total assets used in the
business. For example: the proprietory ratio of 0.7:1 will indicate that out of one rupee assets of the
firm proprietors have invested 70 paisa and outsiders 30 paisa. So, the higher the ratio, the more
secured is the position of creditors & the lower the ratio the greater is the risk to the creditors.
Therefore, a higher ratio is an indication of sound financial position of the firm as it is less
dependent on outside working capital. A ratio of above 50% is generally considered safe for the
creditors.
(iii) Solvency ratio or debt to total assets ratio: Solvency refers to ability of a firm to pay its
outside liabilities. It examines capital structure of the business. It establishes relationship between
total outside debts & total assets of an enterprise, which is calculated as below:
Solvency ratio = Total outside Debts

Total Assets
Total outside Debts = Long term debts + Short term debts
Interpretation:
This ratio measures the proportion of total assets provided by creditors (long term as well as short
term) of the firm i.e. what part of assets is being financed from loans. If total assets are more than
external liabilities, the firm is treated as solvent. So, the higher the ratio, the greater is the amount of
creditors that is being used to generate profits for the owners of the firm.
(iv) Fixed assets ratio: This ratio is also called the ‘Fixed assets to long term funds ratio’. As per
sound financial policy, acquisition of fixed assets should be financed from long-term funds only to
test whether this policy is properly followed or not, this ratio is calculated. It expresses the
relationship between fixed assets & long-term funds.
Fixed assets ratio = Fixed assets

Long-term funds
Components:
Long-term funds include equity share capital, preference share capital, all reserves & surplus &
long-term loans. Fixed assets mean net fixed assets i.e. fixed assets after deducting depreciation.
Illustration: 12
From the following calculate (a) debt equity ratio (b) proprietory ratio (c) solvency ratio (d) fixed
assets to net worth ratio.

7500, equity shares of ` 10 each Fixed assets (less depreciation) 219810
fully paid up 75000 Stock 49460
2500, 10% preference shares of Trade debtors 11710
` 10 each fully paid up 25000 Cash at bank 26020
Reserves & surplus 84500

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7% debentures 100000
307000
307000
Ans: (a) .542:1 (b) 0.6:1 (c) .399:1 (d) 2.19:1
(v) Capital gearing ratio: The capital-gearing ratio is mainly used to analyse the capital structure of
a company. This ratio establishes the relationship between variable cost bearing & fixed cost bearing
capital in the capital structure of a company.
Capital gearing ratio = Variable cost bearing capital

Fixed cost bearing capital
Or
Capital gearing ratio = Equity to shareholders funds
Debentures + Preference shares
Components:
Fixed cost bearing capital includes funds supplied by debenture holders & preference shareholders,
on which interest or dividend at a fixed rate is paid. Variance cost bearing capital includes equity
shareholders funds including reserves & surplus.
Interpretation:
The capital-gearing ratio indicates the proportion of equity share capital & fixed income being
securities to total capital employed in the business. A higher gear ratio (equity share capital is
proportionately higher than fixed cost bearing capital) is the indication of lesser-fixed financial
charges i.e. interest & thus more profits to the business. Such a situation is known as low gearing.
On the contrary, a high gear ratio (equity capital is proportionately less than fixed cost bearing
capital) is the indication of over – burden of fixed financial charges.
(vi) Interest coverage ratio or debt service ratio: This ratio measures the debt measures the debt
servicing capacity of a firm and particularly, where payment of fixed interest on long term loans is
concerned.
Debt service ratio = Net profit (Before Interest & Tax)

Fixed interest charges
Interpretation:
The interest coverage ratio is very significant from the lenders point of view. It gives an idea of the
number of times the fixed interest charges are covered by net earnings of the firm out of which they
will be paid. The higher the ratio, the more is the interest paying capacity of the firm & safety
margin available to long term creditors.
Illustration: 13
Calculate capital gearing ratio from the following information given below:
Particulars X. Co (`) Y. Co (`)
Equity share capital 100000 100000
5% preference share capital 50000 100000

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6% debentures 20000 50000
General reserves 30000 25000
P&L A/c 20000 25000
Ans: X. Co = 2.14:1, Y. Co = 1:1
Illustration: 14
From the following information calculate Interest coverage ratio or debt service ratio:
Net income after tax 156370
Tax rate 50% of net charges
Fixed interest charges 14750
Ans: 22 times (approx)
(vii) Dividend coverage ratio / preference dividend coverage ratio: This ratio measures the
ability of a firm to pay dividend on preference shares, which carry a fixed rate of dividend. It is
calculated by dividing the net profits after tax by the amount of preference share dividend. The ratio
is expressed in number of times of net profits after taxes.
Preference dividend coverage = Net profit After Tax & Interest

Preference dividend
Interpretation:
This ratio like interest coverage ratio indicates the safety margin available to preference
shareholders. As a rule, the higher the dividend coverage ratio, the better it is from the preference
shareholders point of view.
Investment analysis or Market value ratio

These ratios are helpful to the shareholders in analyzing their present and perspective investment.
These ratios also enable them in forecasting the future market price of their investments.
(i) Earnings per share – EPS: The rate of dividend on shares depends upon the amount of profits
earned by the firm. Whatever profit remains, after meeting all expenses & paying preference share
dividend, belongs to equity shareholders. These are the profit earned on equity share capital. The
earning per share (EPS) is calculated by dividing the profit available to equity shareholders by the
number of shares issued.
Earnings per share = Profit After Tax – Preference Dividend

Number of equity shares
Interpretation:
This is the most popular ratio as it measures the profitability of a firm from the shareholders point of
view. The higher the ratio, the better are the performance & prospectus of the company & the greater
would be the market price of a company’s shares or vice- versa. The higher earnings per share help
the company in raising additional capital without any difficulty.
(ii) Price- earning ratio – P/E ratio: The price earning ratio expresses the relationship between the
market price of a share & earning per share. In other words, it indicates, how many times is the
market price of a share to its earnings.

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Price earning ratio = Market price per share or MPS

Earning per share or EPS
Interpretation:
Price earning ratio helps in the assessment of the profitability of a firm from the point of view of
equity shareholders. It indicates the market opinion of the earning capacity of a share & the future
prospects of the company. That is why, many investors while purchasing shares, do not consider any
factor other than this. A higher price- earning ratio is the indication of over valuation of shares or
vice- versa. This ratio is used in determining the future market price & rate of capitalization of a
share.
(iii) Dividend per share – DPS: The EPS ratio represents to what extent the profits belong to the
owners of a firm. But, it is customary in all companies to retain a part of profits in the business &
distribute only the balance as dividend among shareholders. Thus, DPS ratio represents the dividend
paid to the shareholders on per share basis. The DPS ratio is calculated by dividing the dividend paid
to equity shareholders by the number of equity shares issued. Expressed as formula the ratio is:
Dividend per share = Dividend paid to equity shareholders

Number of equity shares outstanding
Interpretation:
This ratio represents to what extent the profits have been received by the owners as dividend. An
investor, desiring more income would like to invest in the shares of a high dividend paying
company. It should be noted that dividend per share is not a measure of profitability of a company,
since retained earnings might have been utilized for payment of dividend. This increases the
distributable amount without increasing the number of shares.
(iv) Dividend yield ratio: This ratio is yet another profitability ratio from the standpoint of equity
shareholders. The dividend yield ratio expresses the relationship between the dividend per share &
market value per share, thus:
Dividend yield ratio = Dividend per share (DPS) x 100

Market price per share (MPS)
E.g.: If a dividend of 40% is declared on a share of face value of ` 10. Whose market price is ` 50,
then the actual return to the investor would be only 8.
Interpretation:
This ratio shows the rate of return to shareholders in the form of dividend based on the market price
of the share i.e. actual rate of dividend on his investment. The dividend yield ratio is also a popular
ratio but its adequacy can be measured only by a comparison with the ratio of similar firms or
industry average.
(v) Dividend pay out (D/P) ratio: The objective of this ratio is to ascertain, what percentage of net
profits after tax has been distributed among shareholders in the form of cash dividend & what
percentage is retained in the business. Thus, dividend pay out ratio gives the percentage of earnings
that are distributed through dividends & is usually expressed as a percentage.
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Dividend pay out ratio = Dividend per share x 100

Earnings per share
Interpretation:
Of the earnings have been distributed as dividends & 60% have been retained by the company. A
ratio of less than 100 % implies ploughing back a portion of the profits in the business, while a ratio
of higher than 100% indicates that distribution of a portion of the reserves as dividends. Thus a
company, which distributes a lower portion of its earnings in the form of dividends, will be
financially stronger and is likely to expand & grow faster rate.
(vi) Earning yield ratio: It is defined as ratio of earnings per share to the market value per ordinary
or equity share i.e.
Earning yield ratio = Earnings per share
Market value per share
It is just a reserve of P/E ratio. It evaluates the profitability of a firm in terms of market price of
shares and is a useful measure from the point of view of investors.
Illustration: 15
From the following particulars compute (i) Earnings per share (ii) Price earning ratio (iii)
Earning yield ratio (iv) Dividend yield ratio (v) Dividend pay out ratio.
`
Profit after tax 135000
Tax rate 60%
Depreciation 30000
Market price of equity share 30
Equity share dividend 20%
10% 15000 preference shares of ` 10 each 150000
40000, equity share of ` 10 each 400000
Ans: (i) ` 3 (ii) 10:1 (iii) 10% (iv) 6.67% (v) 66.67%
Illustration: 16
From the following ratios of imperial chemicals ltd and its industry averages, what inferences would
you draw about the company’s strengths and weaknesses in terms of liquidity, solvency and
profitability.
Ratios Company Industry
Current ratio 1.86: 1 2.2: 1
Stock turn over ratio 2.51 times 2.8 times
Collection period 55 days 56 days
Net profit (before tax) ratio 14.08% 11.9%
Return on shareholders equity 10.1% 10.9%
Illustration: 17
From the following ratio, calculated from the financial statements of Avinash ltd, you are required to
draw inferences about the efficient use of assets and the potential sources of trouble.

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Ratios Year 1 Year 2 Year 3
Current assets turnover ratio 1.36 1.55 1.59
Debtors turnover 2.80 3.30 3.19
Inventory turnover 3.46 4.10 3.91
Fixed assets turnover 3.75 2.29 2.58
Total assets turnover 1.00 0.92 0.98
Illustration: 18
Below are the selected ratios for two companies in the same industry along with the industry
average:
Ratios A B Industry
Current ratio 221% 561% 241%
Acid test ratio 121% 301% 131%
Debt assets ratio 36% 5% 35%
Operating expenses ratio 18% 17.5% 20%
No. of times interest earned 6 12 5
Stock turnover 8.5 6.5 7.0
Rate of return on total assets 17% 10% 13.5
Year 2012
S. No. Ratio Name Industry Average Excellentguru.com

Ratio Ratio
1) Current Ratio 2.4 2.5
2) Acid Test Ratio 1.5 1.07
3) Stock Turn-over Ratio 8 4
4) Debtor Collection Period 36 40
5) Solvency Ratio 40% 46.7%
6) Debt Equity Ratio 2:1 1.35:1
7) Coverage Ratio 6 5.56
8) Net Profit Margin 7% 7.7%
9) Price to Earning Ratio 15 4.88
10) Return on Total Assets 11% 8.2%
Based on the Ratio Analysis, as a company secretary, prepare a report of consideration of your
Board of Directors clearly bringing out the reasons in respect of identified problem areas and giving
suggestions to solve them.
Illustration: 19
Using following information, compute balance sheet as given below:
Total debt to net worth: 0.5 to 1
Turnover of total assets: 2
Gross profit: 30%
Average collection period: 40 days
Inventory turnover: 3 times
Acid test ratio: 0.75 to 1

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Balance sheet
Notes & accounts 400000 Cash
payable 600000 Accounts receivable
Common stock Inventory
(SHF) Plant & equipment
Retained earning
Solution:
Balance sheet
Notes & accounts 500000 Cash 41666
payable Accounts receivable 333334
Common stock (SHF) 400000 Inventory 700000
Retained earning 600000 Plant & equipment 425000
1500000 1500000
Working notes:
(i) Debt to net worth = Total Debt
Net worth (Common stock + Retained earnings)
0.50 = Total debt

1000000 = Total debt = ` 500000
(ii) Total assets turnover = Sales = 2.0 = sales = sales = ` 3000000

Total assets 1500000
(iii)Gross profit Ratio = Gross Profit x 100

Sales
= 30 = Gross profit x 100

3000000
Cost of goods sold = Sales – Gross profit

= 3000000 – 900000 = ` 2100000
(iv) Accounts receivable turnover ratio = 360 days

Average collection period
9 = 3000000 = Average debtors = 3000000 = ` 333334 (approx)

Average debtors 9

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(v) Inventory turnover ratio = Cost of goods sold
Closing inventory
3 = ` 2100000 = Closing inventory = 2100000 = ` 700000
Closing Inventory 3
(vi) Acid test ratio = Liquid assets

Current Liabilities
0.75 = Liquid assets = Liquid assets = ` 375000
500000
` 375000 = Cash + Accounts Receivable
` 375000 – ` 333334
= ` 41666 (Cash)
Illustration: 20
Following is the format of trading & profit & loss accounts. Fill in the blanks and compute these
accounts with the help of given ratios:
Trading & profit & loss a/c
To cost of goods sold 135000 By sales
To gross profit c/d
To operating expense By gross profit b/d

To non operating exp 5000
To net profit
Accounting ratios:
(i) Gross profit to cost of goods sold 331/3%
(ii) Net profit to sales 12%
Solution:
Trading & profit & loss a/c
To cost of goods sold 135000 By sales 180000
To gross profit c/d 45000
1800000 1800000
To operating expense (b/f) 18400 By gross profit b/d 45000
To non operating exp 5000
To net profit 21600
45000 45000
Working notes:
(a) Gross profit to cost of goods sold = Gross profit x 100

Cost of goods sold
33 1 = Gross profit x 100
3 ` 135000

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Gross profit = ` 135000 x 100 = ` 45000
3
(b) Sales = cost of goods sold + gross profit
= 135000 + 45000 = ` 180000
(c) Net profit Ratio = Net profit x 100

180000
= Net profit = 180000 x 12 = ` 21600
100
Illustration: 21
Assume that a firm has owners equity of ` 100000 and the ratios for the firm are:
Short term debt to total debt = 0.40
Total debt to owners equity = 0.60
Fixed assets to owners equity = 0.60
Total assets turnover = 2 times
Inventory turnovers = 8 times
From the information given above, complete the following balance sheet:
Balance sheet
liabilities Amt Assets Amt
Short term debts Cash
Long tem debts Inventory
Total debts Total current assets
Owners equity Fixed assets
Total capital & liabilities Total assets
Solution:
Balance sheet as at
liabilities Amt Assets Amt
Short term debts 24000 Cash 60000
Long tem debts 36000 Inventory 40000
Total debts 60000 Total current assets 100000
Owners equity 100000 Fixed assets 60000
Total capital & liabilities 160000 Total assets 160000
Working notes:
(i) Owners equity = 100000 hence
Total debts = 100000 x 0.60 = 60000 &
Fixed assets = 100000 x 0.60 = 60000
(ii) Total capital & liabilities

Total debts + owners equity
60000 + 100000 = 160000
(iii) Total assets = total capital & liabilities = 160000
(iv) Current assets = total assets – fixed assets

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= 160000 – 60000 = 100000
(v) Sales are twice as much as total assets i.e.

160000 x 2 = 320000
(vi) Inventory is 1/8 th of sales i.e. = 320000 /8 = ` 40000
(vii) Cash = current assets – inventory

= 100000 – 40000 = 60000
(viii) If total debt = 60000

Then, short term debt = 60000 x 0.40 = 24000
(ix) Long term debt = total debt – short term debt

= 60000 – 24000 = ` 36000

From the following information, prepare a summarized Balance Sheet as at 31st March, 2002:
Working Capital Rs 2,40,000
Bank overdraft Rs 40,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus Rs 1,60,000
Current ratio 2.5
Liquid ratio 1.5 (6 marks)
Solution: Balance sheet

Capital 800000 Fixed assets 720000
Reserves & surplus 160000 Stock 160000
Bank overdraft 40000 Current assets 240000
Sundry creditors/other CL 120000
1120000 1120000
Illustration: 23
From the following information, prepare a summarized balance sheet as at 31st march, 1990:
Working capital ` 120000
Reserves & surplus ` 80000
Bank overdraft ` 20000
Fixed assets/ proprietary ratio 0.75
Current ratio 2.5
Liquid ratio 1.5
Your working should form part of the answer.
Ans: balance sheet total = ` 560000
Illustration: 24 - Year 2005 May

With the help of the following information complete the Balance Sheet of MNOP Ltd.
Equity share capital Rs 1,00,000
The relevant ratios of the company are as follows:

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Current debt to total debt 40%
Total debt to owner’s equity 60%
Fixed assets to owner’s equity 60%
Total assets turnover 2 Times
Inventory turnover 8 Times
(7 marks)
Solution:
Balance sheet
Owner equity 100000 Fixed assets 60000
Current debt 24000 Cash Balance 60000
Long term debt 36000 Inventory 40000
160000 160000

Using the following data, complete the Balance Sheet given below:
Gross Profits Rs 54,000
Shareholders’ Funds Rs 6,00,000
Gross Profit Margin 20%
Credit sales to Total sales 80%
Total Assets turnover .24 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.8
Long-term Debt to Equity 40%
Balance sheet
Creditors ………….. Cash ……………
Long-term debt …………… Debtors …………….
Shareholders’ funds ………….. Inventory …………….
Fixed Assets …………….

Creditors 60000 Cash 42000
Long term debt 240000 Debtors 12000
Shareholders funds 600000 Inventory 54000
Fixed assets 792000
900000 900000
Year 2011
Prepare the Balance Sheet of SKY Ltd.
Stock Velocity 6
Capital turnover ratio 2
Fixed assets turnover ratio 4
Gross Profit ratio 20%
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Debt Collection Period 2 months
Creditors Payment Period 73 days
The gross profit was Rs 60,000 Closing Stock was Rs 10,000 in excess of opening stock.
Capital 1,20,000 Fixed Assets 60,000
Creditors 50,000 Closing Stock 45,000
Debtors 50,000
Cash (Balancing figure) 16,500
1,70,000 1,70,000
Year 2013
(a) B Raj & Co. sells goods in cash as well ps on credit (though not on differed instalments terms).
The following particulars are extracted from the books of accounts for the calendar year 1998:
Total gross sales 100000
Cash sales (included in above) 20000
Sales returns 7000
Total debtor for sales as on 03.12.1999 9000
Bills receivables on 03.12.1999 2000
Provision for doubtful debts on 31.12.1998 1000
Total creditors 31.12.1998 10000
Calculate the average collection period.
Ans:
Total Net Credit Sales = Gross Sales - Cash Sales - Sales Returns = 1,00,000 - 20,000 - 7,000 =
73,000
Debtors Turnover = Credit Sales = 73000 = 6.63
Debtors + BR 9000+2000
Average Collection Period = 365 = 55 days

6.63
(b) Following items appear in the account of Operations limited as on 31 December 2000
Cash 48,600
Land and building 8,00,000
Deposits and payments in advance 62.000
Stock 3,72,000
Trade creditors 4,05,750
General reserve 1,00,000
Debtors 5,23,000
Bills receivables 22,600
Plant and machinery at cost
Less: Depreciation 5,44,000
Debentures repayable (secured) 2,50,000
Bank overdraft 52,000
Equity shares of Rs 10 1,00,000
Profit and loss account balance 2,17,000
Proposed equity dividend for year 2000 (net) 86,250
Trade investments 20,000
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Provision for taxation 1,24,000
Dividend reserve 1,40,000
Bills payable 18,000
Net sales for the year 2000 21,82,400
Net profit for the year 2000 before taxation and 3,27,830
dividends
The value of all fixed assets reflects current levels and adequate depreciation has been provided. You
are required to arrange the above items in the form of a financial statement to show following:
(a) Return on Capital Employed Ans: 19.20%
(b) Stock Fixed Assets Ans: 27.33%
(c) Current ratio Ans: 1.5:1
(d) Debtors Turn over Ratio Ans: 4 Times
Ans:
Statement of Financial Position
Particulars Rs Rs
Current Assets:
Cash 48,600
Deposits and Payments in Advance 62,000
Stock 3,72,000
Debtors 5,23,000
Bills Receivables 22,600
Total 10,28,200
Current Liabilities:
Trade Creditors 4,05,750
Bank Overdraft 52,000
Provision for Tax 1,24,000
Bills Payable 18,000
Total 5,99,750
Working Capital 4,29,250
Trade Investment 20,000
Add: Fixed Assets:
Land and Building 8,00,000
Plant and Machinery 5,44,000 13,44,000
Capital Employed 17,93,250
Less: Long-term Liabilities:
Debenture 2,50,000
15,43,250
Shareholders Fund:
Equity Share 10,00,000
Profit and Loss A/c 2,17,000
Proposed Equity Dividend 86,250
Dividend Reserve 1,40,000
General Reserve 1,00,000 15,43,250
Year 2014

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Prepare trading A/c and balance sheet from the following particulars of Vaidhya Ltd.
Stock turnover - 6times
Creditor payment period - 2 months
Gross profit margin - 20%
Gross profit - Rs 60,00,000
Capital Turnover Ratio -4
Debit collection period - 3 months
Excess of closing stock over opening stock - Rs. 5,00,000
Assume that no cash purchases and cash sales are made. Bank balance is the balancing figure in the
balance sheet.
*****

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A unit of Realwaves (P) Ltd Cash Flow
CHAPTER 11 CASH FLOW
Meaning
Cash flow statement is a statement, which summarizes sources of cash or inflows and uses of cash or
outflows of a business firm between two balance sheet dates. This statement enumerates net effect of
the business transactions on cash and takes into account the receipts and the payments of cash.
Objectives or significance or uses of cash flow statement

Cash flow statement has an important role in the cash management. It also helps management
in making plans for the future. A projected cash flow statement or a cash budget enables the
management to have cash available whenever needed and put it to some profitable or productive use
in it is surplus.
(i) Useful in efficient cash management: Cash flow statement is most useful in the evaluation of
financial policies and cash position. By this way the management can ascertain its cash requirements
and availability of cash resources. The management can also make a plan for arrangement of funds if
they fall short and can put it to some profitable use in case it is surplus.
(ii) Disclosure of the movement of cash: With the help of cash flow statement one can analyse the
causes of increase or decrease in cash balance.
(iii) Helpful in forecasting: The analysis of cash flow statement of different years helps in
forecasting.
Distinction between funds flow statement and cash flow statement.
Basis of difference Fund flow statement Cash flow statement

1. Object Its object is to reveal the sources Its object is to reveal the sources &
& uses of working capital uses of cash
2. Usefulness It is useful in long term financial It is useful for short term financial
planning as in the long run the planning, as it enables the
firm is interested in working management to assess its ability to
capital. meet short-term commitments.
3. Effect of the In fund flow statement effect of In cash flow statement effect of the
transactions the transactions on working transactions on cash is observed.
capital is observed
4. Funds from While preparing fund flow While preparing cash flow statement
operations v/s cash statement from operations are cash from operations are calculated
from operations. calculated
5. Preparation of Schedule of change in working Schedule of change in working

schedule of change capital Schedule of change in capital is not prepared for cash flow
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in working capital working is prepared while statement. The effect of current
preparing fund flow statement assets & liabilities taken for
6. Opening & computation of cash from
closing cash operations.
balances
Opening & closing cash balances Opening & closing cash balances are
are not shown in funds flow shown in cash flow statement
statement. These are shown in
Schedule of change in working
capital
Calculation of cash flows from operating activities
Particulars Amt Amt

Net profit before tax & extra ordinary items xxx
Add: Non cash & Non operating items which have already been
debited to P&L A/c
(a) Depreciation xxx
(b) Transfer to reserves & provisions xxx
(c) Provision for doubtful debts xxx
(d) Goodwill / preliminary expeneses written off xxx
(e) Other intangible assets written off such as discount or loss on xxx
issue of shares / debentures, underwriting commission etc.
(f) Loss on sale or disposal of fixed assets / investments xxx
(g) Interest dividend xxx
(h) Foreign exchange loss xxx xxx
xxx
Less: Non cash & Non operating items which have already been
credited to P&L A/c
(a) Gain on sale of fixed assets xxx
(b) Profit on sale of investments xxx
(c) Income from interest on dividends on investments xxx
(d) Appreciation xxx
(e) Foreign exchange gain xxx xxx
Operating profit before working capital changes xxx
Adjustment for changes in current Assets & liabilities.

Add: Decrease in accounts of current assets (except cash &
equivalents) such as:
Decrease in trade debtors xxx
Decrease in Bills receivable xxx
Decrease in inventories /stock in trade xxx
Decrease in prepaid expenses etc. xxx
Increase in accounts of current liabilities (except bank overdraft)
such as.

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Increase in creditors xxx
Increase in bills payable xxx
Increase in outstanding expenses xxx xxx
xxx
Less: Increase in accounts of current assets (as stated above) xxx
Decrease in accounts of current assets (as stated above) xxx xxx
Cash generated from (used in) operations before tax. xxx
Less: Income tax paid. xxx

Net cash from operating activities xxx
Cash flow statement (account form)
For the period ending on ……..
Sources Amt (`) Application / Uses Amt (`)

Cash / bank balance in the xxx Overdraft in the beginning xxx
beginning. Cash outflows:
Cash inflows: Cash loss from operations xxx
Cash from operations xxx Redemption of pref. Share xxx
Issue of share capital capital
Equity share capital xxx Redemption of debentures xxx
Pref. Share capital xxx Repayment of long term loans xxx
Issue of debentures xxx Repayment of fixed deposits / xxx
Long term loan xxx public deposits
Fixed deposits / public xxx Purchase of fixed assets xxx
deposits accepted Purchase of long term xxx
Sale of long term investments xxx investments
Refund of income tax xxx Cash dividend paid xxx
Dividend received xxx Cash & bank balance at the xxx
Sale of import license xxx end
Overdraft at the end xxx
xxx xxx
Format of cash flow statement (AS- III)
ABC Ltd
Cash flow statement (indirect method) for the year ended…..
Particulars ` `
(A) Cash flows from operating activities
Net profit before tax & extraordinary items xxx
Adjustment for:
Depreciation & amortization xxx
Provision for doubtful debts xxx
Foreign exchange gain / loss xxx
Gain / loss on sale of fixed assets / investments xxx
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Dividend interest xxx xxx
OPERATING PROFIT BEFORE WORKING CAPITAL xxx
CHANGES
Adjustment for changes in: xxx

Bills receivable xxx
Debtors xxx
Inventories xxx
Prepaid expenses xxx xxx
Bills payable xxx
Creditors xxx
Cash generated from operations xxx
Less: income tax paid
Cash before extraordinary items xxx
Extraordinary items xxx
Net cash from operating activities
(B) Cash flows from investing activities xxx

Purchase of fixed assets xxx
Proceeds from sale of fixed assets xxx
Purchase of investments xxx
Proceeds from sale of investments xxx
Interest received xxx
Dividend received xxx
Loans to subsidiaries xxx
Net cash from investing activities
(C) Cash flows from financing activities
Proceeds from issue of share capital / debentures xxx
Proceeds from long term borrowings xxx
Repayment of long term debts xxx
Redemption of debentures xxx
Redemption of preference shares xxx
Dividend paid xxx
Interest paid xxx
Net cash from financial activities xxx
Net increase / decrease in cash & cash equivalents (A + B + C) xxx
Cash & cash equivalents as at the beginning of the year xxx
Cash & cash equivalents at the end of the year xxx
Illustration: 1
The following are the summarized balance sheet of Rajendra ltd as on 31st march, 05 & 06
Equity share capital 80000 80000 Fixed assets 82000 80000
9% preference share capital - 20000 Less: depreciation 22000 30000
General reserve 4000 4000 60000 50000
P&L A/c 2000 2800 Debtors 40000 48000
Debentures 12000 14000 Stock 60000 70000

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Creditors 24000 22000 Prepaid expenses 600 1000
Provision for tax 6000 8000 Cash 2400 7000
Proposed dividend 10000 11600
Bank overdraft 25000 13600
163000 176000 163000 176000

You are required to prepare a cash flow statement assuming that tax & proposed dividend for last
year has been paid in the current year.
Ans: (A) Cash flow from operating activities = 2000
(B) Cash flow from investing activities = 2000
(C) Cash flow from financing activities = 12000.
Illustration: 2
Following is the balance sheet of S.K ltd as at 31st march 05 & 06
Equity share capital 300000 350000 Land & building 230000 390000
Securities premium - 30000 Plant & 85400 140000
General reserve 45000 65000 machinery
P&L A/c 30000 80800 Furniture 5500 6500
14% Debentures - 70000 Stock 82400 95700
Sundry creditors 85000 90700 Sundry debtors 75000 85500
Provision for tax 22500 40500 Bank balance 34200 44300
Proposed dividend 30000 35000
512000 762000 512000 762000
Depreciation written off during the year
Land & building 60000
Furniture 1200
You are required to prepare a cash flow statement
(B) Cash flow from investing activities = (326800)
Illustration: 3
From the following balance sheet & additional information, prepare cash flow statement
Share capital 60000 67500 Fixed assets 30000 42000
Creditors 15000 22500 Stock 15000 10500
P&L A/c 22500 34500 Debtors 45000 67500
Outstanding exp 4500 7500 Cash 7500 9000
Income recd in 3000 1500 Prepaid expenses 4500 3000
advance Deferred expenses 3000 1500
105000 133500 105000 133500
An old machine has been sold for ` 6000. The written down value of the machine was ` 4500.
Dividend ` 6000 has been paid during the year and ` 3000 depreciation has been charged.

Contact: 9829959536,7737733360,9928001210 11.5

Illustration: 4
Balance sheet of M/s Ram & Shyam as on 1st April, 05 & 31st march, 06 were as follows:
Creditors 40000 44000 Cash 10000 7000
Mrs. Ram’s loan 25000 - Debtors 30000 50000
Loan from P.N Stock 35000 25000
bank 40000 50000 Machinery 80000 55000
Capital 125000 153000 Land 40000 50000
Building 35000 60000
230000 247000 230000 247000
During the year a machine costing ` 10000 (accumulated depreciation ` 3000) was sold for ` 5000.
The balance of provision for depreciation against machinery as on 1st April, 05 was ` 25000 & on
31st march, 06 ` 40000. Net profit for the year 2005 – 06 amounted to ` 45000.
You are required to prepare cash flow statement giving necessary working notes.
(C) Cash flow from financing activities = (32000).
Illustration: 5
The following are the summarized balance sheets of Philips India as on march 31, 05 & 06
Share capital 900000 900000 Fixed assets 800000 640000
General reserve 600000 620000 Investments 100000 120000
P&L A/c 112000 136000 Stock 480000 420000
Creditors 336000 268000 Debtors 420000 910000
Provision for tax 150000 20000 Bank 298000 394000
Mortgage loan - 540000
2098000 2484000 2098000 2484000

(i) Investments costing ` 16000 were sold during the year for ` 17000.
(ii) Provision for tax made during the year was ` 18000
(iii) During the year part of the fixed assets costing ` 20000 were sold for ` 24000.
(iv) Dividend paid during the year amounted to ` 80000.
You are required to prepare a cash flow statement.
Ans: (A) Cash flow from operating activities = (369000)
(B) Cash flow from investing activities = 5000
Illustration: 6
From the following details relating to the accounts of Grow more ltd. Prepare cash flow statement.
Share capital 1000000 800000 Plant & 700000 500000
Reserve 200000 150000 machinery

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P&L A/c 100000 60000 Land & building 600000 400000
Debentures 200000 - Investments 100000 -
Provision for tax 100000 70000 Sundry debtors 500000 700000
Proposed 200000 100000 Stock 400000 200000
dividend Cash on hand / 200000 200000
Sundry creditors 700000 820000 bank
2500000 2000000 2500000 2000000

(i) Depreciation @ 25% was charged on the opening value of plant & machinery.
(ii) During the year one old machine costing ` 50000 (w.d.v ` 20000) was sold for ` 35000
(iii) ` 50000 were paid towards income tax during the year.
(iv) Building under construction was not subject to any depreciation.
Prepare cash flow statement.
Year 2012
The following are the summarised Balance Sheet of Shree- Vas India Limited as on March 31st 2008
and 2009:
Share Capital 4,50,000 4,50,000 Plant and 4,00,000 3,20,000
Machinery
General Reserve 3,00,000 3,10,000 Investments 50,000 60,000
Profit and Loss 56,000 68,000 Inventory 2,40,000 2,10,000
Account
Creditors 1,68,000 1,34,000 Debtors 2,10,000 4,55,000
Provision for 75,000 10,000 Cash and Bank 1,49,000 1,97,000
Taxation
Mortgage loan - 2,70,000
10,49,000 12,42,000 10,49,000 12,42,000
Additional Information:
a) Investment costing Rs 8,000 were sold during the year for Rs 8,500.
b) Provision for Tax made during the year was Rs 9,000.
c) During the year part of the plant and machinery costing Rs 10,000 were sold for Rs 12,000. The
profit was included in Profit and Loss account.
d) Dividend paid during the year amounted to Rs 44,080.
You are required to prepare Cashflow Statement in new format as per Accounting Standard 3
(Revised) by indirect method.

Contact: 9829959536,7737733360,9928001210 11.7
Ans: According to as per AS-3 (Revised)
Cashflow Statement
Particulars Rs Rs
1) Cashflow from Operating Activities:
Closing Balance as Per P&L AIc 68,000
Less: Opening Balance as Per P&L A/c 56,000 12,000
Add: Appropriation of Fund:
Interim Dividend 44,080
Provision for Tax 9,000
Transfer to Reserve 10,000 63,080
Net Profit before Tax and Extraordinary Items 75,080
Add: Non-Operating Expenses:
Depreciation 70,000
Less: Non-Operating Incomes:
Profit on Sale of Investments (500)
Profit on Sale of Plant and Machinery (2,000) 67,500
1,42,580
Add: Decrease in Current Assets and Increase in Current Liabilities:
Decrease in Stock (2,40,000 -2,10,000) 30,000
Less: Increase in Current Assets and Decrease in Current Liabilities:
Increase in Debtors(Rs 4,55,000-Rs 2,10,000) 2,45,000
Decrease in Creditors (Rs 1,68,000 -1,34,000) 34,000 (279000)
(106420)
Less: Income Tax Paid (74000)
Net Cash used in Operating Activity (A) (180420)
2) Cashflow from Investing Activities:
Purchase of Investment (18000)
Sale of Plant and Machinery 12000
Sale of Investment 8500
Net Cash from Investing Activities (B) 2500
3) Cashflow from Financing Activities:
Mortgage Loan 270000
Dividend Paid (44080)
Net Cash from Financing Activities (C) 225920
4) Net Increase in Cash and Cash Equivalents (A + B + C) 48000
5) Cash and Cash Equivalents at the Beginning of the Year 149000
6) Cash and Cash Equivalents at the End of the Year 197000
Working Notes:
Dr. Machinery Account Cr

Particulars Rs Particulars Rs
To Balance b/d 4,00,000 By Bank A/c 12,000
To Profit and Loss A/c 2,000 By Depreciation A/c 70,000
(Balancing Figure)
By Balance c/d 3,20,000
4,02,000 4,02,000

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Dr. Provision for Taxation Account Cr

To Bank (Balancing Figure) 74,000 By Balance b/d By Profit and Loss 75,000
A/c
To Balance c/d 10,000 By Profit and Loss A/c 9,000
84000 84000
Dr. Investment Account Cr

To Balance b/d 50,000 By Bank 8,500
To Profit and Loss A/c 500 By Balance c/d 60,000
To Bank (Balancing Figure) 18,000
68,500 68,500
Year 2013
The Balance Sheet of B 31.12.1993:
Share Capital 2,00,000 2,50,000 Land 2,00,000 1,90,000
General 50,000 60000 Machinery 1,50,000 1,69,000
Reserve
P&L 30,500 30,600 Stock 1,00,000 74,000
Bank Loan 70,000 Debtors 80,000 64.200
(Long- term)
Sundry 1,50000 1,35,200 Cash 500 600
Creditors
Provision for 30000 35,000 Bank 5000
Taxation Goodwill
5,30,500 5,10,800 5,30,500 5,10,800
The following additional information for the year ended 31st December 1993 is also available:
1) Dividend of Rs 23,000 was paid.
2) Depreciation written-off machinery Rs 12,000.
3) Assets of another company were purchased for a consideration of Rs 50,000 payable in shares.
4) The following assets were purchased - Stock Rs 20,000, Machinery Rs 25,000. Machinery was
further purchased for Rs 8,000.
5) Income tax provided during the year Rs 33,000.
6) Loss on sale of machinery Rs 200 was written-off to general reserve.
Prepare a cash flow statement traditional approach and as per AS-3
Ans: According to as per AS-3 (Revised)

Cash flow Statement
Particulars Rs Rs
1) Cash from Operating Activities
Closing Balance of Profit and Loss A/c 30,600
Add: Dividend Paid 23,000
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Depreciation on Land 10,000
Depreciation on Machinery 12,000
Provision for Tax 33,000
Transfer to General Reserve 10,200
1,18,800
Less: Opening Balance of Profit and Loss 30,500
A/c
Operating Profit 88,300
Add: Decrease in Stock 46,000
Decrease in Debtors 15,800
1,50,100
Less: Decrease in Creditors 14,800
Cash before Tax 1,35,300
Tax Paid 28,000
Net Cash from Operating Activities (A) 1,07,300
2) Cash from Investing Activities
Sale of Machinery 1,800
Machinery Purchased (8,000)
Net Cash from Investing Activities (B) (6,200)
3) Cash from Financing Activities
Bank Loan Repaid (70,000)
Dividend Paid (23,000)
Net Cash from Financing Activities (C) (93,000)
A+B+C 8,100
Opening Balance of Cash and Bank 500
Closing Balance of Cash and Bank (8,000+ 600) 8,600
Working Notes:
Dr. Machinery Account Cr
To Balance b/d 1,50,000 By Depreciation 12,000
To Cash 8,000 By Sale of Machinery - Cash 1,800
To Vendor Company 25,000 (Balancing figure)
By Loss on Sale of Machinery 200
By Balance c/d 1,69,000
183000 183000
Dr. Provision for Taxation Account Cr
To Cash(Balancing figure) 28,000 By Balance b/d 30,000
To Balance c/d 35,000 By P&L A/c 33,000
63000 63000

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Cash flow statement (indirect method)
AS III
Particulars Amt Amt
(A) Cash flow from operating activity
Net profit before tax
Add: P/L Adjustment Debit side (non-operating expenses)
Less: P/L Adjustment Credit side (non-operating income)
Add: Increase in Current Liabilities, Decrease in Current Assets
Less: Decrease in Current Liabilities, Increase in Current Assets
Less: Tax paid

Net cash flow from operating activity (A)
(B) Cash flow from investing activity

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Interest received
Dividend received
Net cash flow from investing activity (B)
(C) Cash flow from financing activity
( )
Interest paid ( )
Dividend paid
Net cash flow from financing activity (C)

A+B+C
Add: (opening balance of cash & bank) – opening balance of

overdraft
(closing balance of cash & bank) – closing balance of overdraft

Contact: 9829959536,7737733360,9928001210 11.12
Cash flow statement (indirect method)
AS III
Particulars Amt Amt
(A) Cash flow from operating activity
Net profit before tax
Add: P/L Adjustment Debit side (non-operating expenses)
Less: P/L Adjustment Credit side (non-operating income)
Add: Increase in Current Liabilities, Decrease in Current Assets
Less: Decrease in Current Liabilities, Increase in Current Assets
Less: Tax paid

Net cash flow from operating activity (A)
(B) Cash flow from investing activity

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Interest received
Dividend received
Net cash flow from investing activity (B)
(C) Cash flow from financing activity
( )
Interest paid ( )
Dividend paid
Net cash flow from financing activity (C)

A+B+C
Add: (opening balance of cash & bank) – opening balance of

overdraft
(closing balance of cash & bank) – closing balance of overdraft

Contact: 9829959536,7737733360,9928001210 11.14
Theory Question
Year 2012
Highlights some techniques of Financial Analysis.
Ans: Techniques of Financial Analysis

Following are the techniques of financial analysis:
1) Comparative Financial Statements: The comparative financial statements are statements of the
financial position at different periods of time. The elements of financial position are shown in a
comparative form so as to give an idea of financial position at two or more periods. Any statement
prepared in a comparative form will be covered in comparative statements.
2) Trend Analysis: The word 'trend' means future possibilities. An efficient and effective
management tries to know the actual performance and also discovers future prospects of the
business. Trend analysis acquaints us with the profitability and the short term and long term liquidity
of the business. In addition, it also discovers the future prospects of the business in terms of
profitability, operational efficiency and financial soundness of the enterprise.
3) Common-Size Financial Statements: The common-size statements, balance sheet and income
statements are shown in analytical percentages. The figures are shown as percentages of total assets,
total liabilities and total sales. The total assets are taken as 100 and different assets are expressed as a
percentage of the total. Similarly, various liabilities are taken as a part of total liabilities. These
statements are also known as component percentage or 100 percent statements because every
individual item is stated as a percentage of the total 100. The short-comings in comparative
statements and trend percentages where changes in items could not be compared with the totals have
been covered up. The analyst is able to assess the figures in relation to total values.
4) Funds Flow Analysis: The funds flow statement consists of two terms 'Fund' and 'Flow'. Fund
may be interpreted as cash or working capital or all financial resources. Flow means change. Funds
flow statement is a method by which one studies the changes in the financial position of a business
enterprise between beginning and ending financial statements dates. It is a statement showing
sources and uses of funds for a period of time.
5) Cash Flow Analysis: A statement of changes in the financial position of firm on cash basis is
called a cash flow analysis/statement. Such a statement enumerates net effects of the various
business transactions on cash and takes into account receipts and disbursements of cash. A cash flow
statement summarizes the causes of changes in cash position of a business enterprise between dates
of two balance sheets. Cash flow statement is a statement of changes of financial position in business
due to inflow or outflow of cash and their statement is required for short-range business premises.
6) Ratio Analysis: One of the most important financial tools which have come to be used very
frequently for analyzing the financial strengths and weaknesses of the enterprise is ratio analysis.
Ratio analysis is a technique of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making certain decisions.
Year 2013
Define a cash flow statement and analyses its uses.

Contact: 9829959536,7737733360,9928001210 11.17
Ans: Meaning of Cash Flow Statement
Cash plays a very important role in the entire economic life of a business. A firm needs cash to make
payments to its suppliers, to incur day-to-day expenses and to pay salaries, wages, interest and
dividends, etc. In fact, what blood is to a human body, cash is to a business enterprise. It is very
essential for a business to maintain an adequate balance of cash. But many a times, a concern
operates profitably and yet it becomes very difficult to pay taxes and dividends. This may be
because:
1) Although huge profits have been earned yet cash may not have been received or
2) Even if cash has been received;
It may have drained out (used) for some other purposes. This movement of cash is of vital
importance to the management.
A statement of changes in the financial position of firm on cash basis is called a cash flow
analysis/statement. Such a statement enumerates net effects of the various business transactions on
cash and takes into account receipts and disbursements of cash. A cash flow statement summarizes
the causes of changes in cash position of a business enterprise between dates of two balance sheets.
Cash flow statement is a statement of changes of financial position in business due to inflow or
outflow of cash and their statement is required for short-range business premises.
Uses of Cash Flow Statement

The uses of cash flow statement are as follows:
1) Helps in Efficient Cash Management: Cash flow statement helps in evaluating financial policies
and cash position, cash is the basis for all operations and hence a projected cash flow statement will
enable the management to plan and coordinate the financial operations properly.
2) Disclose the Movements of Cash: Cash flow statement discloses the complete story of cash
movement. The increase or decrease in cash and the reason therefore can be known. It discloses the
reasons for low cash balance in spite of heavy operating profits or for heavy cash balance in spite of
low profits. However, comparison of original forecast with the actual results highlights the trends of
movement of cash, which may otherwise go undetected.
3) Discloses Success or Failure of Cash Planning: The extent of success or failure of cash planning
can be known by comparing the projected cash flow statement with the actual cash flq\y statement
and necessary remedial measures can be taken.
4) Helpful in Declaring Dividends etc: Cash flow statement is very helpful in declaring dividends
etc. This statement can supply information regarding availability of cash. If cash is available,
dividend can be paid. Thus, it helps to understand the liquidity. It must be paid within 42 days.
5) Useful in Preparing a Cash Budget: Cash flow statement prepared for the future period is useful
in preparing a cash budget.
6) Useful to Outsiders: Cash flow statement helps the investors, bankers, lenders, suppliers of credit
etc; to analyse the financial position of the enterprise and they can take proper decision on the basis
of such analysis.
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Year 2014
What do you mean by cash flow statement? How do you treat following items in the preparation of
cash flow statement:-
(i) Interim Dividend
(ii) Provision for taxation
(iii) Accumulated Depreciation
(iv) Provision for doubtful Debts.
*****

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A unit of Realwaves (P) Ltd Introduction to IFRS
CHAPTER 12 ACCOUNTING STANDARDS AND

INTRODUCTION TO IFRS
ACCOUNTING STANDARDS
Introduction
The uniform, definite and universally accepted accounting rules developed by International
Accounting Standards Committee (IASC) are known as Accounting Standard. It was felt that there
were different accounting concepts, conventions, customs, traditions and rules prevailing in different
nations leading to misunderstanding, uncertainty and often resulting in scandal. Confusion prevailed
at the national level also.
Accounting terminology was not standardized. It was left to the users of accounting to
interpret the accounting terms suiting their interest. It was therefore, the urgent need to develop
universally accepted and internationally standardized accounting terminology, commonly known as
Accounting standard. Introduction of Accounting standard was necessary to prevent financial
scandals and business failures.
Accounting Standards are defined as the policy documents issued by a recognized expert accounting
body relating to various aspects of measurement, treatment and disclosure of accounting transactions
and events.
Features of Accounting Standards

The features of accounting standards are as follows:
1) Accounting standards determine the norm of accounting policy and transactions.
2) Accounting standards determine the most suitable method from the available methods for solving
one or more accounting problems.
3) Accounting standards determine those limitations in which Accountant perform his work.
4) Accounting standards provide the information to different parties using the financial statements.
5) Accounting standards provide uniformity in accounting work. It removes the effect from adopting
different policies and transactions.
Scope of Accounting Standards

The scope of accounting standards are as follows:
1) Efforts will be made to issue Accounting Standards which are in conformity with the provisions
of the applicable laws, customs, usages and business environment in India. However, if a particular
Accounting Standard is found to be not in conformity with law, the provisions of the said law will
prevail and the financial statements should be prepared in conformity with such law.
2) The Accounting Standards by their very nature cannot and do not override the local regulations
which govern the preparation and presentation of financial statements in the country. However, the
ICAI will determine the extent of disclosure to be made in financial statements and the auditor's
report thereon. Such disclosure may be by way of appropriate note explaining the treatment of
particular items. Such explanatory notes will be only in the nature of clarification and therefore need
be treated as adverse comments on the related financial statements.

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3) The Accounting Standards are intended to apply only to items which are material. Any limitations
with regard to the applicability of a specific Accounting Standard will be made clear by the ICAI.
from time to time. The date from which a particular Standard will come into effect, as well as the
class of enterprises to which it will apply, will also be specified by the ICAI. However, no standard
will have retroactive application, unless otherwise stated.
Objectives/Needs of Accounting Standard

The main objective of accounting standards is to harmonize the diverse accounting policies and
practices at present in use in India. However, harmonization does not mean that accounting standards
should become very rigid. In fact, harmonization of accounting standards does permit flexibility to
make the necessary adjustments to suit their purpose.
Globalization of business, promotion of external trade, internationalization of financing
institutions, emergence of UNO and IMF, etc., necessitated the development of International
Accounting standard. The needs of Accounting Standards are as follows:
1) Uniform Standard Presentation of Accounts: Financial Accounting as we know is not very
exact science. To some extent it is the subject of interpretation. The presence of different concepts,
conventions, customs, traditions and practices created confusion and checked free, fair and smooth
flow of financial activities. In necessitated uniformity in the concepts, conventions and practices.
The emergence of International Accounting Standard was a remedy.
2) Removal of Ambiguity: Accounting is the vital part of business activities. Certain accounting
terms and practices are ambiguous and confusing, just as valuation of stock, items of current
liabilities, methods of depreciation, etc. Accounting standards are needed to remove ambiguity.
3) Prevention of Accounting Scandals: Ambiguity, confusion and inexactness in the meaning of

accounting terminology generates accounting scandals leading to the failure of the business. For
example, the term price may mean as cost price, sale price, purchase price, printed price, trade price
and market price, etc. Everyone packs up the meaning of his own choice. As such standardization of
accounting terminology is necessary for preventing misuse of accounting terminology.
4) Globalization of Business: Business, these days is global entity. We have got many multinational
corporations working in different countries with different currency, rules and practices. If every
country is allowed to follow its own practice, external trade cannot flourish. A lot of confusion will
be created. The smooth and fair flow of the global business needs international accounting standard.
5) Internationalization of Financial Institutions: These days Banks and Financial institutions have
assumed global status. Their activities are not restricted within their countries alone. The successful
implementation of these activities needed that financial accounting must be standardized
internationally.
Benefits of Accounting Standards

The benefits of accounting standards are as follows:
1) Reduction in Variations: Standards reduce to a reasonable extent or eliminate altogether

confusing variations in the accounting treatments used to prepare financial statements.

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2) Disclosure Beyond that Required by Law: There are certain areas where important information
is not statutorily required to be disclosed. Standards may call for disclosure beyond that required by
law.
3) Facilitates Comparison: The application of accounting standards would, to a limited extent,

facilitate comparison of financial statements of companies situated in different parts of the world and
also of different companies situated in the same country. However, it should be noted in this respect
that differences in the institutions, traditions and legal systems from one country to another give rise
to differences in accounting standards practiced in different countries.
INDIAN ACCOUNTING STANDARDS
Accounting Standards Board of India

The Institute of Chartered Accountants of India, recognizing the need to harmonize the diverse
accounting policies and practices at present in use in India, constituted an Accounting Standards
Board (ASB) on April 21, 1977. The main function of the Accounting Standard Board is to
formulate Accounting Standards so that such standards will be established by Council of Institute of
Chartered Accountant of India.
Objectives and Functions of the Accounting Standards Board of India

The following are the objectives of the Accounting Standards Board:
1) To conceive of and suggest areas in which Accounting Standards need to be developed.
2) To formulate Accounting Standards with a view to assisting the Council of the ICAI in evolving
and establishing Accounting Standards in India.
3) To examine how far the relevant International Accounting Standard/International Financial
Reporting Standard can be adapted while formulating the Accounting Standard and to adapt the
same.
4) To review, at regular intervals, the Accounting Standards from the point of view of acceptance or
changed conditions, and, if necessary, revise the same.
5) To provide, from time to time, interpretations and guidance on Accounting Standards.
6) To carry such other functions relating to Accounting Standards.
Procedure for Issuing Accounting Standards

The following procedure will be adopted for formulating Accounting Standards:
Step 1: To determine the broad areas in which accounting standards need to be formulated and the
priority in regard to the selection thereof,
Step 2: To hold a dialogue with the representatives of the government, public sector undertakings,
industry and other organizations for ascertaining their views.
Step 3: On the basis of the work of the study groups and the dialogue with the representatives, to
prepare and issue the exposure of draft of the proposed standard for comments by members of the
Institute and the public at large.
Step 4: To finalize the draft of the proposed standard after taking into consideration the comments
received.
Step 5: To submit the final draft of the proposed standard to the Council of the Institute.
The Council of the Institute will consider the final draft of the proposed standard, and if found
necessary, modify the same in consultation with ASB. The accounting standard on the relevant
subject will then be issued under the authority of the Council.

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Accounting Standards issued by ICAI

Mandatory from
No. Title accounting period
beginning on or after
AS 1 Disclosure of Accounting Policies. 1.4.1991
AS 2 Valuation of Inventories. 1.4.1999
AS 3 (Revised) Cash Flow Statements. 1.4.2000
AS 4 (Revised) Contingencies and Events occurring after Balance Sheet Date. 1.4.1995
Prior Period and Extraordinary Items and Changes in Accounting
AS 5 (Revised) Policies. 1.4.1996
AS 6 (Revised) Depreciation Accounting. 1.4.1995
AS 7 Accounting for Construction Contracts. 1.4.2003
AS 8 Accounting for Research and Developments. 1.4.1991
AS 9 Revenue Recognition. 1.4.1991
AS 10 Accounting for Fixed Assets. 1.4.1991
AS11(Revised 2003) Accounting for the Effects of Changes in Foreign Exchange Rates. 1.4.2004
AS 12 Accounting for Government Grants. 1.4.1995
AS 13 Accounting for Investments. 1.4.1995
AS 14 Accounting for Amalgamations. 1.4.1994
Accounting for Retirement Benefits in Employer's
AS 15 Financial Statements. 1.4.1995
AS 16 Borrowing Costs. 1.4.2000
AS 17 Segment Reporting. 1.4.2001
AS 18 Related Party Disclosures. 1.4.2001
AS 19 Leases. 1.4.2001
AS 20 Earnings per share. 1.4.2001
AS 21 Consolidated Financial Statements. 1.4.2001
AS 22 Accounting for Taxes on Income. 1.4.2001
AS 23 Accounting for Investments in Consolidated Financial Statements. 1.4.2002
AS 24 Discontinuing Operations. 1.4.2004
AS 25 Interim Financial Reporting. 1.4.2002
AS 26 Intangible Assets. 1.4.2003
AS 27 Financial Reporting of Interest in Joint Ventures. . 1.4.2002
AS 28 Impairment of Assets. 1.4.2004
AS 29 Provisions. Contingent Liabilities and Contingent Asset. 1.4.2004
AS 30 Financial Instruments: Recognition and Measurements 1.4.2009
AS 31 Financial Instruments: Presentation 1.4.2009
AS 32 Financial instruments: Disclosure 1.4.2009
Notes

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1) AS 3 and AS 17 are mandatory for those enterprises whose equity or debt securities are listed on a
recognized stock exchange in India or enterprises who are in the process of issuing equity or debts
securities that will be listed on a recognized stock exchange in India and all commercial, industrial
businesses whose turnover for the accounting period is more than Rs 50 Crore.
2) AS 20 are mandatory for those enterprises whose equity shares or potential equity shares are listed
on a recognized stock exchange in India.
3) AS 21 is mandatory if an enterprise presents consolidated financial statements. This accounting

standard does not make it mandatory to consolidate the financial statement for an enterprise. But the
enterprises, which is presenting a consolidated financial statement shall prepare in accordance with
AS 21.
4) AS 22 comes into effect in respect of accounting periods commencing on or after 1.4.2001. It is

mandatory in following cases:
i) All the enterprises whose equity or debt securities are listed on a recognized stock exchange in
India and enterprises which are in the process of issuing equity or debt securities that will be listed
on a recognized stock exchange in India;
ii) All the enterprises of a group, if a parent presents consolidated financial statements and
accounting standard is mandatory in nature in respect of any of the enterprises of that group in terms
of (i) above;
iii) All the accounting period commencing on or after 1.4.2002, in respect of companies not covered
by (i) or (ii) above.
iv) All the accounting periods commencing from 1.4.2003, in respect of all other enterprises.
Compliance with the Accounting Standards
1) The Accounting Standards will be mandatory from the respective date(s) mentioned in the
Accounting Standard(s). The mandatory status of an Accounting Standard implies that while
discharging their attest (confirmed) functions, it will be the duty of the members of the Institute to
examine whether the Accounting Standard is complied with in the presentation of financial
statements covered by their audit. In the event of any deviation from the Accounting Standard, it will
be their duty to make adequate disclosures in their audit reports so that the users of financial
statements may be aware of such deviation.
2) Ensuring compliance with the Accounting Standards while preparing the financial statements is
the responsibility of the management of the enterprise. Statutes governing certain enterprises require
of the enterprises that the financial statements should be prepared in compliance with the Accounting
Standards. For example, the Companies Act, 1956 (Section 211), and the Insurance Regulatory and
Development Authority (Preparation of Financial Statements and Auditor's Report of Insurance
Companies) Regulations, 2000.
3) Financial Statements cannot be described as complying with the Accounting Standards unless
they comply with all the requirements of each applicable Standard.
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)
Introduction

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The International Financial Reporting Standards (IFRS), established by the IASB, are increasingly
recognized as a mature and rigorous set of rules for the preparation of the financial statements of
many large and multinational companies and are accepted by most security market authorities. IFRS
are also used as the basis for national accounting requirements (partially or in full) or as an
international benchmark for countries which develop their own requirements.
Table below gives an overview of the IFRS as of September 2005. The table comprises both
the main standards (IFRS) and the interpretations of the Standing Interpretation Committee (SIC)
and International Financial Reporting Interpretation Committee (IFRIC).
Conceptual Framework
CF Framework for the Preparation and Presentation of Financial Statements
IAS 40 Investment property.
IAS 41 Agriculture
IFRS 1 First-time Adoption of International Financial Reporting Standards
IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts

IFRS 5 Non-current Assets held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
Interpretations
SIC 7 Introduction of the Euro (IAS 21)
SIC 10 Government Assistance - No Specific Relation to Operating Activities (IAS 20)
SIC 12 Consolidation - Special Purpose Entities (IAS 27)
SIC 13 Jointly Controlled Entities - Non-Monetary Contributions by Ventures (IAS 31)
SIC 15 Operating Leases - Incentives (IAS 17)
SIC 21 Income Taxes - Recovery of Revalued Non-Depreciable Assets (IAS 12)
SIC 25 Income Taxes - Changes in the Tax Status of an Enterprise or its Shareholders IAS (12)
SIC 27 Evaluating the Substance of Transactions involving the Legal Form of a Lease
SIC 29 Disclosure - Service Concession Arrangements
SIC 31 Revenue - Barter Transactions Involving Services
SIC 32 Intangible Assets - Web Site Costs
IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities
IFRIC 2 Members Shares in Co-operative Entities and Similar Instruments
IFRIC 3 Emission Rights (withdrawn by the Board in June 2005)
IFRIC 4 Determining Whether an Arrangement contains a Lease
IFRIC 5 Rights to interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds

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Features of IFRS
Following are the main features of IFRS:
1) Principle-Based Approach: The principle-based approach of IFRS implies that the standards
rely primarily on principles and specified desirable regulatory outcomes rather than detailed,
prescriptive rules. This approach gives more importance to substance (over form) and allows
management to exercise judgment/discretion in application. In short, management has greater
flexibility in selecting accounting methods and in estimating accounting figures when preparing
financial statements. In turn, a rule based approach offers less flexibility in aligning business
objectives and processes with regulatory outcomes and forces specific treatments when precise
criteria are met.
2) Fair Value Accounting: Fair value accounting represents a departure from the traditional
historical cost principle. IFRS puts a much greater emphasis on fair value than that rendered under
earlier Canadian GAAP. It primarily responds to the needs of investors which are given deliberate
importance in IFRS compared to other users. Since investors need market based values to make
decisions regarding buying or selling stocks, many items in financial statements are required or
eligible for fair value accounting under IFRS.
3) Comprehensive Income: Comprehensive income is a major development in the recent evolution

of accounting standards and a central notion in the conceptual framework of IFRS. It is a new feature
reflecting all revenues, expenses, gains and losses that are to be recognized according to accounting
standards during a period, and is summarized in a separate financial statement named the Statement
of Comprehensive Income. It is formed of Iwo components. The first corresponds to the bottom line
(profit or loss) of the income statement as it is commonly measured, incorporating gains and losses
on transactions with outside parties and a number of unrealized gains and losses on items measured
at fair value through profit or loss. The second component of the statement of comprehensive income
relates to unrealized gains and losses caused primarily by fair value adjustments.
4) Consolidation: The entity theory underlies the application of the consolidation technique in
IFRS. It requires that assets and liabilities of subsidiaries be measured at their full fair value on the
date of acquisition. Consequently, minority interest (called non-controlling interest) is measured at
fair value at the same date. This is a major difference compared with Canadian GAAP which does
not recognize the fair value adjustments related to minority interest.
5) Transparency: Transparency represents another major characteristic of IFRS. It relates to the

assumption that markets are efficient and that all of the information communicated to users of
financial statements is accurately and reliably incorporated in stock prices. This represents the
qualitative characteristic of completeness (IASB, 2001) which allows users, particularly investors, to
make decisions based on all the relevant information.
Needs for IFRS

The needs of IFRS are as follows:
1) Level of Confidence: The key benefit will a common accounting system that is perceived as
stable, transparent, and fair to investors across the world, whether local or foreign.

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2) Risk Evaluation: IFRS will eliminate barriers to cross-border listings and will be beneficial for
investors who generally ascribe a risk premium if the underlying financial information is not
prepared in accordance with international standards.
3) Merger and Takeover Activity: Cross-border mergers and acquisitions will get a boost by making
it easier for the parties involved in as far as redrawing the financial statements is concerned.
4) Investments: Foreign investors will be attracted to economies where IFRS-complaint financial

statements are the norm.
*****

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CHAPTER 13 INFERENCES AND

INTERPRETATIONS FROM PUBLISHED
FINANCIAL STATEMENT
INFERENCES AND INTERPRETATIONS FROM PUBLISHED FINANCIALSTATEMENTS
Introduction
Financial statement analysis is not an end in itself but is performed for the purpose of providing
information that is useful in making lending and investing decisions. An understanding of analytical
methods associated with financial statement analysis is extremely using when interpreting and
analyzing financial reports of published financial statements.
The analysis of financial statements should include all publicly available information, not
just the statements themselves. Why? When analyzing a company, we need to understand what's
driving the figures that appear on the financial statements.
The analysis needs to be placed in some context: Is the company meeting its corporate goals
(which can be found on websites and in annual reports)? And there are broader factors that affect the
company under scrutiny: How is the economic environment affecting its results? In a recession you'd
expect a food producer to be doing better on the sales front than a maker of plasma television sets...
Accounting treatments are also important when scrutinizing financial statements. Turn to the
'notes' accompanying the financial statements. Has there been a change in the accounting method
used, and, if so, why? If there has, be careful when using figures from the statements in ratio analysis
and forecasting (more on this later), as the results will be distorted.
Financial Statement of John Limited

The balance sheets of John Limited (JL) as at 31 December 2004 and as at 31 December 2005 and
its income statements for the years 2004 and 2005 are placed as follows:
Balance Sheets of John Limited (JL) Amount (in Rs)
Liabilities 31/12/05 31/12/04 Assets 31/12/05 31/12/04

Net Worth 1,370 1,070 Goodwill 200 200
Long-term Debt 400 500 Intangible Assets 45 50
Deferred Tax 60 50 Property Plant and Equipment 400 400
Liabilities Debt
Short-term 100 100 (Net)
Investments 150 100
Trade Creditors 50 40 Inventories 235 255
Prepaid Expenses 5 5
Receivables 650 550
Cash and Bank 295 200
Total 1,980 1,760 Total 1,980 1,760

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Income Statement of John Limited (JL)

Amount (in Rs)
Expenses 2005 2004 Income 2005 2004

Opening Stock (Finished goods) 60 40 Sales 3,300 3,000
Raw Material. 1,485 1,200 Other Income 12 10
Employee Compensation 200 180 Closing Stock (Finished 60 60
Power and Fuel 35 30 goods)
Goods)goods)
Other Manufacturing Expenses 500 410
Research and Development. 50 180
Depreciation 80 80
Advertising 120 130
Other Marketing and Selling 105 100
Expensesand Administrative
General 160 160
ExpensesExpenses
Training 70 90
Re-structuring Expenses 10 10
Interest 35 40
Tax Expenses (Including deferred 132 120
tax)
Net Profit. 330 300
Total 3372 3,070 Total 3372 3,070
Interpretation:
1) Overall performance in the year 2005 is worse than the year 2004.
2) Return on equity in the year 2005 is 23.0769% which is lower than that in the year 2004, i.e.,
26.7857%.
3) In absence of information on the performance of the industry leader or the industry average, we
cannot comment on whether the performance of the firm is worse or better than the benchmark ratio,
if any.
4) For internal purposes, top management compares actual performance in terms of budget
performance by comparing ratio based on actual performance with budget ratios.
5) Return on capital in the year 2005 is 25.6833% which is lower as compared to that in the year
2004 i.e 29.0130%, which is primarily due to pressure on market realisation. This might be because
of serious competition in the export market.
6) Asset turnover has also gone down marginally, presumably because of increase in investments
outside the business from Rs 100 at the end of the year 2004 to Rs 150 at the end of the year 2005.
However, 'investments' have been considered as an operating asset because JL has parked the surplus
cash temporarily in securities in the capital market until an investment opportunity is identified.
7) The year 2005 was a bad year for JL. The gross margin (PBDIT/Sales) in the year 2005 at 17.48%
is marginally lower than that in the year 2004 at 18.00%.
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8) The firm could maintain the margin almost at previous year's level in spite of significant increase
in the cost of raw material. The raw material to sales ratio in the year 2005 was 45% as against 40%
in the previous year. This reflects that the firm could not pass on the increase in raw material cost to
customer.
9) The firm could manage the shock of increase in the cost of raw material but at the cost of long-
term health of the firm. The research expense had gone down alarmingly in the year 2005. It was
1.52% of sales in the year 2005 as against 13.67% in the year 2004. Training expenses in the year
2005 was 2.12% of sales as against 3.00% of sales in the year 2004. Similarly, advertising expense
in the year 2005 was at 3.64% of sales as against 4.33% of sales in the year 2004. Other operating
expenses are fixed in nature. Those were marginally higher in the year 2005 as compared to the
previous year due to the effect of inflation.
10) It is not unusual that in a bad year the management of a firm reduces allocation to discretionary
activities like advertising, training, and research and development. Those activities and related
expenses are called discretionary because no input-output relationship can be established for those
activities. Profit for a year can be increased by reducing those expenses, because reduction on those
activities does not adversely affect the revenue for the year. However, reduction has the potential to
harm the long-term health of the firm.
11) Net fixed assets turnover has gone up from 4.6154 in the year 2004 to 5.1163 in the year 2005.
However, this does not signify improvement in productivity. The 10% growth in revenue is
presumably due to inflation. There is no material increase in the net fixed assets. Therefore, the
increase in the net fixed asset turnover cannot be interpreted as an improvement in productivity.
12) Working capital turnover at 2.7848 in the year 2005 .is lower than the same at 2.9703 in the year
2004. This trend is not unusual when the firm faces pressure on price due to increased competition.
In the year 2005, the firm faced higher competition and pressure on price. The receivables turnover
has slowed down in the year 2005, which shows that the firm had to extend longer credit to
customers. The average collection period in the year 2005 was approximately 72 days as against
approximately 67 days in the year 2004.
13) The cash balance at the end of the year 2005 was 8.94% of net sales. At the end of the year 2004,
it was 6.675 of sales. The firm is holding cash balance in excess of the amount that an average
manufacturing firm holds. Usually 3 to 5% is considered normal for a manufacturing company. It is
quite possible that the firm collected dues from customers in last few days of the accounting year to
present a better picture about collection of 'receivables'. We should work with average holding based
on weekly or daily data to make the analyses more meaningful. This observation is applicable to all
the turnover ratios.
Financial Statements of ABC Ltd.
ABC LTD Income statement (for the year ended 31st December 2008)
(Rs in Crore)
Net sales 1602.4
Cost of goods sold 1172.8
Gross margin 429.6
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Operating expenses:
Selling 210.0
General and administrative Expenses 91.2
Total operating expenses 301.2
Operating income 128.4
Other expenses (interest) (22.8)
Profit before tax 105.6
Income tax (67.2)
Net income before extraordinary gain 38.4
Gain on sale of assets 2.6
Net earnings 41.0
ABC Ltd. Balance Sheet (As on 31 Dec. 2008) (Rs in Crore)

Assets
Current Assets:
Cash 122.4
Marketable Securities 65.6
Trade Receivables (Net) 522.4
Inventory 362.4
Other Current Assets 47.6
Total Current Assets 1,120.4
Land, Plant and Equipment (Net) 864.2
Other Non-current Assets 37.8
Total Assets 2,022.4
Liabilities and Owners Equity
Current Liabilities:
Accounts Payable 340.6
Notes Payable 100.0
Other Current Liabilities 81.8
Total Current Liabilities. 522.4
Long-term Liabilities (4%) 300.0
Total Liabilities 822.4
Owners Equity:
Equity Capital Rs 10 per Share 800.0
Surplus:
Surplus of current year 100.0
Retained earnings 300.0
Total surplus 400.0
Total owners equity 1200.0
Total liabilities and owners equity 2022.4
Interpretation:
1) Income Statement: For analysing profit-earning capacity of the company, how much of each
rupee of sales is spent for cost of goods sold, selling and administrative expenses should be known.
Here from each rupee of sales, 73.2 paisa is spent for cost of goods sold, 13.1 paisa for selling
expenses and 5.7 paisa for administrative expenses. That means (73.2% + 13.1% + 5.7%) 92% of
sales is spent and 8% is left as operating income or EBIT. Again, out of this 8%, 1.4% is spent for
interest, and 4.2% for income tax. Only 2.4% is left as net earnings accrued in favour of the owners.
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2) Distribution of Total Assets: Profit emerges from the sale of goods produced through the
interaction of current and fixed assets. In the absence of an appropriate mix between these two types
of assets, neither the production nor the volume of profit will be achieved at desired level. Here per
rupee of total assets, 55.4 paisa has been invested in current assets and 44.6 paisa in fixed and other
non-current assets. Moreover, 25.8 paisa of current asset remains tied-up with the customers.
However, inventory constitutes only 17.9%, i.e., more than one-sixth of the total assets. Then only
6.1% of total assets remained left for meeting day-to-day exigencies of business.
3) Analysis of Owners' Equity and Total Liabilities: Such an analysis reveals the proportion of
the fund employed in the business contributed by owners and debt-holders. Here, owners contributed
59.3%, while debt-holders provided 40.7% of the total fund. Again out of 59.3% of owners' share,
they have contributed directly 39.6% and the remaining 19.7% developed out of their retained
earnings. For total liabilities, out of 40.7%, current liabilities comprise 25.8%, which does not
require interest payment. Remaining 14.9% of the total assets is provided by long-term debt-holders,
who are entitled to get 4% interest on their contribution.
Positive points of the enterprise are its solvency position. Its accounts receivable comprise 25.8% of
total assets, while its accounts payable comprise only 16.8%. The company's long-term solvency
position is also good, since its long-term debt constitutes only 14.9% of total fund employed in the
business. But the negative aspect is that (73.1% + 13.1%) 86.2% of the total sales is used to meet the
cost of goods sold and selling expenses. If sales volume decreases for any reason the company will
be in trouble. Hence, attempt should be made to minimize the cost of goods sold and enhance the
volume of sales. The company, it is expected, will be able to develop quickly if these steps are taken.
Balance Sheet of Vijaya Appliances Pvt. Ltd.
Following is the Balance Sheet of Vijaya Appliances Pvt. Ltd., Hyderabad for the year ended 31
March, 2007 and 31 March, 2008:

Equity Capital 3,00,000 4,95,000 Fixed Assets (Net) 3,60,000 5,25,000
Preferential Capital 1,50,000 2,25,000 Stock 60,000 75,000
Reserves 30,000 45,000 Debtors 1,50,000 1,87,500
Profit and Loss A/c 22,500 30,000 Bills Receivable 30,000 90,000
Bank Overdraft 75,000 75,000 Prepaid Expenses 15,000 18,000
Creditors 60,000 75,000 Cash at Bank 60,000 79,500
Provision for Taxation 30,000 37,500 Cash in Hand 15,000 45,000
Proposed Dividends 22,500 37,500
6,90,000 10,20,000 6,90,000 10,20,000
Interpretation:
On evaluation of assets and liabilities of Vijaya Appliances Pvt. Ltd., Hyderabad between two
periods, i.e., 31.03.2007 .and 31.03.2008, the following inferences are drawn:

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1) In 2008 current assets were increased from 47.83% to 48.53% showing a positive sign on an
overall basis and cash balance increased by 49,500
2) Fixed assets were increased from Rs 3,60,000 to 5,25,000 in 2007 and these were acquired from
the issue of addition capital in 2008.
3) Current liabilities were decreased from 27.18% to 22.06% is 2008 which indicates the company in
cautious in management of current liabilities.
4) On comparing current assets with current liabilities, the company can pay off the current liabilities
from current assets without borrowing further. The liquidity position is strong.
5) The overall financial position is satisfactory.
Financial Statements of New India Assurance Company

Income Statement
Operating Results 2010-11 (CY) 2009-10 (PY)
Gross Global Premium 96.92 83.46
Premium Ceded for Risk Transfer (25) (23.43)
Net Premium Income 71.92 60.03
Adjustment for Unearned Premium (7.19) (2.92)
Net Earned Premium 64.73 57.11
Net Incurred Claims (65.24) (51.32)
Acquisition Cost and Management Expenses (25.92) (22.98)
Net Underwriting Results (26.43) (17.19)
Investment Income Earned 22.32 20.78
Net Profit or (Loss) (4.11) 3.59.
Adjustment for Income Tax Paid or Refunds (0.1) 0.31
Dividend Proposed Nil (0.85)
Fund Transferred to Reserves (4.21) 3.05
Balance Sheet Analysis of General Insurance Co.
Balance Sheet (As at 31 March 2013) (Figures in rupees billion)
Assets Rs Liabilities Rs
Net Fixed Assets 1.57 Shareholders' Fund 238.43
Investments 284.78 Policy-holders' Fund 127.91
Loans and Advances 55.81 Fund for Re-insurers 13.26
Cash and Bank Balances 53.04 Other Creditors 8.02
Deferred Assets 2.39
397.59 397.59
Interpretation:
1) Income Statement: The company's overall portfolio comprises of domestic business of Rs 70.97
billion and overseas business of Rs 14.67 billion totalling Rs 82.25 billion of gross direct. Added to
it is another Rs 14.67 billion from ‘reinsurance accepted' business producing a gross income of Rs
96.92 billion reflecting an increase of 16% over the corresponding period of last year. Growth not
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with standing, the underwriting results produced a deficit of Rs 26.43 billion during the period due to
adverse claim experience from health insurance, motor third party claims and catastrophe losses
from Japan Tsunami, New Zealand earthquake and Muscat Typhoon. The negative results during the
period under review may also be due to increased reserve strain of 4.27 billion due to additional
reserve created for unexpired risk during 2010- 11. The company has decided right thing by not
proposing any dividend during the current year following net loss in its operations. The ultimate net
effect of the negative results was reflected in dwindling of accumulated reserves to service policy
holders and shareholders during the years to follow.
2) Balance Sheet Analysis: The foregoing analysis of financial statement indicates-the company's
ability to meet its obligations to policy-holders. Total debt owed by the company is Rs 159.16 billion
against net worth of Rs 238.43 billion showing a debt-equity ratio of 67%. This means for every Rs
100 of liabilities, the company has got liquid assets worth Rs 67 as on 31 March 2013. It is the
responsibility of any company to service its capital as well as external debtors that indicate its
financial strength during a particular period. In the instant case, the relationship between
shareholders' fund and policy-holders' fund is 1.86: 1. This means the company has got sufficient
fund in terms of net worth-to meet its full obligations to policy-holders at any given time, although
its net worth is reported to have declined by Rs 3.19 billion during 2013 against last year. There may
be an immediate necessity to pay-off the liability on outstanding claims for 789.56 billion and the
amount due to re-insurers for 713.26 billion totalling an amount of Rs 102.82 billion. The company
has quick assets to meet this immediate obligation in terms of cash and bank balances in the region
of 753.04 billion and short-terms loans and advances of 755.81 billion totalling a fund of Rs 108.85
billion. This is what is known- in financial parlance as acid rest ratio which is a relationship between
quick assests and immediate liability. This ratio shows a figure of 1: 1.05 indicating an availability
of immediate fund of Rs 105 for every Rs 100 of liability.
The company has reported its financial state of affairs in an abridged form as per Schedule VI - Part
A of the Companies Act, 1956 showing its total assets of Rs 397.59 billion which equates to its total
liabilities during the period under review. However, this figure may be re-grouped in form of various
assets that will demonstrate how the company is servicing its shareholders and policy-holders as well
as to the re-insurers that offered protection against various losses.
Financial Statements of Tata Steel

Balance Sheet of Tata Steel (As at.31st March 2009)
Particulars March 2009 March 2008 March 2007
(Rs in Millions) (Rs in Millions) (Rs in Millions)
Liabilities:
Share Capital 62,034.50 62,033.00 7,277.30
Reserves and Surplus 2,35,011.50 2,10,974.30 1,33,684.20
Net Worth (1) 2,97,046.00 2,73,007.30 1,40,961.50
Secured Loans (2) 39,130.50 35,205.80 37,589.20!
Unsecured Loans (3) 2,30,331.30 1,45,011.10 58,864.10
Total Liabilities (1+2 + 3) 5,66307.80 433324.20 2,37,414.80
Assets:
Gross Block 2,00370.10 1,64,795.90 1,60,294.90
Less: Acc. Depreciation 90,624.70 82,234.80 74,863.70
Net Block (A) 1,09,945.40 82,561.10 85,431.20

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Capital Work-in-Progress (B) 34,876.80 43,674.50 24,974.40
Investments (C) 4,23,717.80 41,031.90 61,061.80
Inventories 34,804.70 26,049.80 23,329.80
Sundry Debtors 6,359.80 5,434.80 6,316.30
Cash at Bank 15,906.00 4,650.40 76,813.50
Loans and Advances 58,846.10 3,45,828.40 40,259.50
i) Current Assets 1,15,916.60 3,81,963.40 1,46,719.10
Current Liabilities 89,657.60 68,422.60 63,492.40
Provisions 29,341.90 29,135.20 19,304.60
ii) Current Liabilities 1,18,999.50 97,557.80 82,797.00
Net Current Assets (i - ii) (D) -3,082.90 2,84,405.60 63,922.10
Miscellaneous Expenses (E) 1,050.70 1,551.10 2,025.30
Total Assets (A + B + C + D + E) 5,66307.80 4,53,224.20 2,37.414.80
Profit and Loss Statement - Tata Steel

Particulars March 2009 March 2008 March 2007
(Rs in Millions) (Rs in Millions) (Rs in Millions)
Sales 2,43,483.20 1,96,544.10 1,74,526.60
Other Income 3,053.60 3,472.80 4,851.40
Total Income 2,46,536.80 2,00,016.90 1,79,378.00
Raw Material Cost 82,794.40 60,248.00 56,799.50
Excise 24,952.10 25,370.20 23,041.80
Other expenses 43972.30 28480.50 25547.80
Operating profit 91764.40 82445.40 69137.50
Interest name 14895.00 9290.30 2512.50
Gross profit 76869.40 73155.10 66625.0
Depreciation 9734.00 8346.10 8192.90
Profit before tax 70189.00 68281.80 63283.50
Tax 21148.70 23802.80 20404.70
Net profit 49040.30 44479.00 42878.80
Other non recurring income 2977.10 2391.30 -657.30
Reported profit 52017.40 46870.30 42221.50
Equity dividend 11689.50 11689.30 9439.10
Interpretations for Balance Sheet and Profit and Loss Statement

Interpretations of Balance Sheet (Rs in Millions)
Particulars 2007 2008 2009 Remarks
Short-term liquidity available is very
Current Assets 1,46,719.10 3,81,963.40 1,15,916.60 less.
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Fixed Assets 1,71,467.4 1,67,267.5 5,68,540 Fixed assets have increased due to
increase in investment.
82,797 97,557.80 1,18,999.50 (i) Substantial increase in liabilities.
Current Liabilities (ii) Liquidity position is not good.
Long-Term 96,453.3 1,80,216.9 2,69,461.8 Debts have increased because of more
Liabilities investment.
Interpretations of Profit and Loss Statement (Rs in million)

Particulars 2007 2008 2009 Remarks
Sales 1,74,526.6 1,96,544 10 2,43,483.20 Sales have increased by 39.5%
Raw Material Cost 56,799.50 60,248.00 82,794.40 Expenses have increased.
Operating Profit 69,137.50 82,445.40 91,764.40 Operating profit has increased.
Profit before Tax 63,283.50 68,281.80 70,189.00 PBT has increased.
(PBT)
Net Profit 42,878.80 44,479.00 49,040.30 Net profit has increased marginally.
INFERENCES FROM PUBLISHED FINANCIAL STATEMENT THROUGH RATIO, CASH

FLOW & FUND FLOW
Illustration: 1 (Through ratio)

From the following ratios of imperial chemicals ltd and its industry averages, what inferences would
you draw about the company’s strengths and weaknesses in terms of liquidity, solvency and
profitability.
Ratios Company Industry

Current ratio 1.86: 1 2.2: 1
Stock turn over ratio 2.51 times 2.8 times
Collection period 55 days 56 days
Net profit (before tax) ratio 14.08% 11.9%
Return on shareholders equity 10.1% 10.9%
Illustration: 2
From the following ratio, calculated from the financial statements of Avinash ltd, you are required to
draw inferences about the efficient use of assets and the potential sources of trouble.
Ratios Year 1 Year 2 Year 3
Current assets turnover ratio 1.36 1.55 1.59
Inventory turnover 3.46 4.10 3.91
Fixed assets turnover 3.75 2.29 2.58
Total assets turnover 1.00 0.92 0.98
Illustration: 3
Below are the selected ratios for two companies in the same industry along with the industry
average:
Ratios A B Industry
Current ratio 221% 561% 241%
Acid test ratio 121% 301% 131%
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Debt assets ratio 36% 5% 35%
Operating expenses ratio 18% 17.5% 20%
No. of times interest earned 6 12 5
Stock turnover 8.5 6.5 7.0
Rate of return on total assets 17% 10% 13.5
Can we say on the basis of above ratios and information that company B is better than company A
because its ratio are better in 6 out of 8 areas (all except stock turnover and rate of return on total
assets)? Company B is better than the industry average in the same six categories?
Illustration: 4 (Inferences through cash flow)

Following is the cash flow statement published by Swadeshi company ltd in their annual report for
the year 2005-06
Statement of cash flows- indirect method
Swadeshi company ltd: Statement of cash flows (for the year ended march, 2006)
` `
Cash flows from operating activities
Net profit before income tax and extraordinary item 70000
Adjustments to reconcile net profit to net cash flow from
operating activities
Depreciation 98000
Provision for doubtful debts 12000
Gain on sale of plant & machinery (6000)
Loss on sale of investments 9000
Interest expense 22000
Interest income (7000)
Operating profit before working capital changes 198000
Increase in debtors (including bad debts written off) (44000)
Increase in inventories (58000)
Decrease in prepaid expenses 2000
Increase in bills payable 8000
Decrease in creditors (22000)
Cash generated from operations 84000
Income tax paid (15000)
Cash flow before extraordinary item 69000
Extraordinary item: proceeds from earthquake insurance claim 3000
Net cash provided by operating activities 72000
Cash flows from investing activities
Purchase of plant & machinery (173000)
Proceeds from sale of plant & machinery 22000
Purchase of investments (26000)
Proceeds from sale of investments 42000
Interest received 7000
Net cash used in investing activities (128000)
Cash flows from financing activities
Proceeds from insurance of share capital 100000
Repayment of unsecured loan (1000)
Redemption of secured loan (27000)
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Dividend paid (25000)
Interest paid (22000)
Net cash provided by financing activities 25000
Net decrease in cash and cash equivalents (31000)
Cash and cash equivalents at beginning of period 51000
Cash and cash equivalents at end of period 20000
Supplemental schedule of non-cash investing and financing activities

(i) The company purchased machinery for ` 49000 on unsecured credit
(ii) The company converted secured debentures of ` 50000 to equity shares of ` 10 at par.
Disclosure of accounting policy: for purposes of the statement of cash flows, the company considers
all highly liquid debt instruments purchased with an original maturity of three months or less to the
cash equivalents.
You are required to analyze the cash flow statement of Swadeshi company ltd and the inferences,
which you will draw from such analysis.
*****

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CHAPTER 14 EMERGING ISSUES IN

FINANCIAL ACCOUNTING
EMERging issues in financial accounting
Price level changes
Introduction
Price level changes are also known as 'Price Level Accounting'. Prices do not remain constant over a
period of time. They tend to change due to various economic, social or political factors. Changes in
the price levels cause two types of economic condition, inflation and deflation.
There is reciprocal relationship between the value of money and general price-level. Where there is
rise in general price level, the purchasing power of money (as a result its value also) decreases and
vice-versa. Rise in general price-level is called inflation and fall in general price-level is called
deflation. These changes in the price level vitiate the accounting statements because profit, loss,
assets, liabilities etc. are shown in these statements in money-terms only which itself changes due to
changes in price-level. Financial Statements prepared at historical cost fail to depict time and fair
view of financial position and correct profit due to changes in value of money (i.e, changes in price-
level). When there is inflation i.e., value of money is declining, the step taken for eliminating the
impact of inflation on financial statements is known as 'Accounting for Inflation' or 'Price-level
Accounting' or simply 'Inflation Accounting'.
Meaning and Definition of Price Level Changes/Price Level Accounting

Accounting for price-level is that accounting technique by which transactions are recorded at current
prices and the effect of changes in price-level on accounting items is neutralized or such effects are
made clear along with transections recorded at historical costs. Few definitions given by the experts
are given below:
According to J Batty, "The term revaluation accounting is used to denote the methods used for
overcoming the problems connected with fixed assets replacement in a period of rising prices".
According to J. Batty, "Complete revaluation accounting adjusts all fixed assets to current values
and, in addition, attempts to ensure that capital are maintained intact through consideration of the
loss (or gain) in purchasing power of current assets".
According to H. Chakravarty, 'The principle of replacement accounting is that for determination of

income, revenues are matched not against actual cost but against what is expected cost for
replacement of stock sold and the portion of assets depleted in the process of business operation".
Features of Price Level Accounting
The features of price level changes accounting are as follows:

1) The recording procedure is automatic.
2) The unit of measurement is not assumed to be stable.

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3) It considers all elements of the financial statements and is not concerned only with fixed assets or
closing stocks.
4) Realization principles are not followed rigidly, particularly, when recording long-term loans and
fixed assets at the current value.
Reasons for the Emergence of Price Level Accounting

It is revealed from the discussion made thus far that the distorted pictures presented by financial
statements in the case of inflation are due to the factors mentioned below. Since price level
accounting is needed to reflect these illusory and distorted pictures, these factors are also considered
responsible for the emergence of price level accounting:
1) Presentation of incorrect picture by financial statements during the period of price-level changes
because of showing the fixed assets at cost;
2) At the time of rise in prices, reporting of notional and overstated profit due to over valuation of
stock and lower amount of depreciation charged.
3) Erosion of capital due to more payment of dividend and tax than what is due on the basis of real
profit;
4) Difficulties in asset replacement on account of deficiency of fund due to inflation;
5) Inadequacy of working capital due to rise in price-level;
6) Losses on holding monetary assets like cash, debtors etc. and gains on monetary items of
liabilities.
Techniques of Price Level Accounting

Number of techniques has been developed by Professional Institute and Accountants to deal with
inflationary condition. The important among them are:
1) Current Purchasing Power Method (CPP Method): Under this method the values of various
items of profit and loss account and the balance sheet are changed in tune with the changes in price-
level. This is done with the help of approved general price index number. Almost in each country,
the government prepares and publishes the general price index numbers. Index numbers are also
being constructed by few important economic and financial journals, newspapers, trade associations
etc. Cost of living index numbers, wholesale price index numbers, product-value index numbers. In
India, index numbers published by the Reserve Bank of India are considered to be more suitable.
2) Replacement Cost Accounting Method (RCA Method): Replacement cost accounting method
is an improvement over current purchasing power method. As pointed out, the main drawback of
CPP is that it did not take into account the individual price index of a particular asset. On the
contrary, replacement cost accounting method makes use of individual price index numbers. Thus,
under this method a number of index number are used. However, the availability of these various
index numbers is difficult in practice. Critics of this method have rejected it on the plea that it lacks
objectivity.
3) Current Value Accounting Method (CVA Method): Under this method of price-level
accounting all the assets and liabilities are shown in the Balance Sheet at current value. The value of
net assets both at the beginning and at the end is found out and the difference between these two
values of net assets is considered as profit or loss. Here also it is very difficult to determine the
relevant current values of items to be shown in the Balance Sheet.

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4) Current Cost Accounting Method (CCA Method): The current cost accounting technique has
been preferred to the current purchasing power technique of price level changes accounting as it is a
complete system of price level changes accounting. The financial statements prepared under this
technique provide more realistic information and makes a distinction between; profits earned from
business operations and the gains a rising from changes in price levels. As depreciation under CCA
is provided on current cost, the method prevents overstatement of profits and keeps the capital intact.
The effect of holding monetary items in terms of gains and losses having on impact on the finance of
the business is also highlighted.
Advantages of Price Level Accounting

An enterprise can be benefited in number of ways by employing price level changes accounting. The
important among them are:
1) It gives accurate picture of profitability by matching current revenues with current costs.
2) It keeps the capital of the enterprise intact by stopping payments of dividends and taxes out of its
capital as is done under historical accounting.
3) It depicts the true and fair view of the financial position of a concern as current values of the items
are considered in the preparation of balance sheet.
4) It makes possible the profitability comparative study of the enterprises set up at different periods.
5) It helps the enterprises to replace the assets when required with more ease as depreciation is
charged on current value of the assets.
6) It can satisfy the social obligation of the business in its real spirit by providing accurate financial
information to the various interested parties.
7) It helps the company to have realistic price for its shares in the investment market.
8) Revaluation of assets shows the true value of investment in a business. This leads to the
calculation of a return on capital employed which is a positive indication of efficiency.
9) During the period of inflation issuing materials on LIFO basis and calculating the depreciation on
replacement cost basis will indicate the profits at realistic figures.
10) Showing the current value of fixed assets will help to establish a realistic price for company's
equity capital and thereby shows to reduce the danger of take-over bids.
Disadvantages of Price Level Accounting

The price level changes accounting suffers from following limitations:
1) Price level changes accounting is a complicated, confusing and time consuming process as it
requires a heavy work of calculations and adjustments.
2) An ordinary person fails to understand, analyze and interpret the adjusted financial statements.
3) It can make the information disclosed by financial statements more inaccurate if proper
conversion method is not adopted. Normally people may convert the items on the basis most suited
to them.
4) This system is not suitable for income tax purposes as the depreciation charged on current values
of fixed assets is not allowed under the Income Tax Act, 1961.
5) It is a continuous process that involves constant adjustments in the financial statement,
6) Profits are overstated under this method during deflation as lesser depreciation will be charged to
fixed assets.

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ZERO BASE BUDGETING

MEANING
 The method of preparing traditional budget is to take previous year expenditure level as base
and, in most cases; an addition is made to allow for increase in cost.
 In zero base budgeting, like traditional budgeting neither the previous expenditure is taken as
base nor incremental approach is followed, but each budget is prepared from “Scratch” i.e.
zero base.
 In other words, budget is prepared without considering the previous budget or current years
actual performance on the assumption that budget for the next year is ‘zero’ so long the
demand for a project or activity is not justified for each rupee.
DEFINITION
According to Peter A Phyrr “Zero base budgeting is an operating, planning and budgeting process
which requires each manager to justify his entire budget requests in detail from scratch (hence zero
base). Each manager states why he should spend any money at all. This approach requires that all
activities be indentified as decision packages which would be evaluated by systematic analysis
ranked in order of importance”
FEATURES OF ZERO BASE BUDGETING
(i) The budget allotment to any decision unit should be first justified by the manager of that decision
unit. He should justify his request without making reference to previous level of expenditure in his
decision unit.
(ii) Activities are identified as decision packages and then the latter are ranked in order of priority.
(iii) Decision packages are evaluated by systematic analysis linking them with clearly laid down
firms objectives.
(iv) A frank relationship exists between superiors & subordinates.
(v) Available resources are directed towards alternatives in order of priority to ensure optimal
results.
TRADITIONAL BUDGETING V/S ZERO BASE BUDGETING
Traditional budgeting Zero base budgeting

Nature It is accounting oriented and mainly It is decision oriented and makes all
lays its emphasis on previous year projects & programmes old & new to
expenditure. complete for scarce resources.
Basis Past expenditure forms the basis for A decision unit is broken down into
future demand for inflation and new decision packages which are ranked
demands on priority basis.
Decisive The top management takes decisions This responsibility is specified to the
officer as regards the amount to be spent on a manager of a decision unit.
decision unit.
Approach It makes a routine approach and is not It is a straight forward approach and
clear and distinctive highlights priority projects
distinctively.
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PROCESS OF ZERO BASE BUDGETING
Determination of objectives of budgeting
Identification of decision units
Development of decision packages
Ranking of decision packages
Preparation of budget and allocation of resources
(i) Determination of objectives of budgeting

 The objectives may be to effect cost reduction or analyze & drop the projects which are not
beneficial or which do not help in achieving firms objectives.
(ii) Identification of decision units

 In Zero base budgeting, an organization is divided into decision units
 A decision unit is a tangible activity or group of activities for which a single manager has the
responsibility for successful performance.
 The manager of the decision unit has to justify the relative budget proposals.
(iii) Development of decision packages

 After identification of decision unit, the manager of each decision unit formulates decision
packages.
 A decision package is a budget request which should contain the following:
 A description of the function or activity
 The goals or objectives of the function or activity
 Specific measures of performance
 Benefits to be derived from financing the activity
 Consequences of its non-funding
 The projected costs of the package
 Alternative ways of performing the same activity
(iv) Ranking of decision packages

 Decisions packages are presented to the next level of management for ranking purposes.
Ranking implies determining the priorities among the available decision packages
 The objective of such ranking is to put the limited resources at the disposal of the
organization to the best use.
(v) Preparation of budget and allocation of resources

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 The last step in Zero base budgeting process is top allocate the limited resources of the
organization to different decision units on the basis of the consolidated ranking of decision
packages
 Once top management has a consolidated ranking of decision packages, a cut off is
established for accepting packages based on funds available. All the packages within the
funding ceiling are accepted and others rejected.
 After allocation of resources to the decision units, the decision unit budget is prepared by
adding all the decision packages which have been approved for that decision unit.
ADVANTAGES OF ZERO BASE BUDGETING
(i) Effective allocation resources: It provides the organization with a systematic way to evaluate
operations & programmes of activity. It enables management to allocate resources according to the
priority of programmes because decision packages are ranked in order of priority.
(ii) Objective budgeting: It enables departmental budgets to be approved on the basis of cost
benefit comparison rather than open to arbitrary units or increases in budget estimates. Thus,
objectives of the firm are linked to budgets.
(iii) Quick budget adjustments: The ranked list of approved decision packages can be readily used
during the operating year to pinpoint the activities to be reduced or expended if allowable
expenditure level changes. The managers can go up the ranked list of packages to reduce the costs.
(iv) Cost control: It ensures through examination of every function. Managers are required to
evaluate the need for every programme and consider the alternative ways of performing the
operations. This results in better cost control.
(v) Flexibility: If available resources vary from the budgeted estimates during the budget year,
decision packages can be reduced on the basis of priority ranking of the packages.
(vi) Better planning and communication: Long term goals and plans can be linked with the annual
budgets through zero base budgets. This not only facilitates quantification of costs and benefits of
contemplated decisions, but enables managers to communicate problems and opportunities to the
higher management.
(vii) Prompt corrective action: Activities that are poorly operated and managed are readily
identified throughout the zero base budgeting process and follow up view. This enables top
management to take appropriate action to eliminate these problems.
RESPONSIBILITY ACCOUNTING
Introduction
Responsibility budgeting and accounting is a well-known generic practice for managing
organizations that produce goods or deliver- services, whether for sale or not. Systemic features of
responsibility budgeting arid accounting include delegated and
reused responsibility for resource utilization and results. Usually, budgets are performance targets,
while accounts measure their degree of accomplishment with some accuracy. Responsibility

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budgeting and accounting is theoretically appealing – and widely practiced in the private sector -
because it solves problems of organizational coordination and control as they rise in pursuing such
goals as routinely cost-effective operations.
Meaning and Definition of Responsibility Accounting

The systems of costing like standard costing and budgetary control are useful to management for
controlling the costs. In those systems the emphasis is on the devices of control and not on those
who use such devices. Responsibility accounting is a system of control where responsibility is
assigned for the control of costs. The persons are made responsible for the control of costs.
Responsibility accounting is a reporting system that compiles revenue, cost, and profit
information at the level of those individual managers most directly responsible for them. The intent
is to provide this information to those people most able to act upon it, as well as to judge their
performance with it.
According to Anthony and Reece, "Responsibility accounting is that type of management
accounting that collects and reports both planned actual accounting information in terms of
responsibility centres".
According to Charles T. Horngreen, "Responsibility accounting is a system of accounting that

recognizes various decision centres throughout an organization and traces costs to the individual
manages who are primarily responsible for making decisions about the costs in questions".
In responsibility accounting the emphasis is on men rather than on systems. For example, if Mr. X
manager of a department prepares the cost budget of his department, then he will be made
responsible for keeping the budgets under control. X will be supplied with full information of costs,
incurred by his department. In case the costs are more than the budgeted costs, then X will try to find
out reasons and take necessary corrective measures. X will be personally responsible for the
performance of his department
Features of Responsibility Accounting

An analysis of the definitions given above reveals the following important features of responsibility
accounting:
1) Inputs and Outputs or Costs and Revenues: The implementation and maintenance of
responsibility accounting system is based upon information relating to inputs and outputs.
2) Planned and Actual Information or Use of Budgeting: Effective responsibility accounting

requires both planned and actual financial information. It is not only the historical cost and revenue
data but also the planned future data which essential for the implementation of responsibility
accounting system.
3) Identification of Responsibility Centres: The whole concept of responsibility accounting is

focused around identification of responsibility centres. The responsibility centres represent the
sphere of authority or decision points in an organization. In a small firm, one individual or a small
group of individuals, who are usually the owners, may possibly manage or control the entire
organization. However, for effective control, a large firm is, usually, divided into meaningful
segments, departments or divisions. These sub-units or divisions of organization are called
responsibility centres.

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4) Transfer Pricing Policy: In a large scale enterprise having decentralized divisions, there is a
common practice of transferring goods and services from one segment of the organization to
another. In such situations, there is a need to determine the price at which the transfer should take
place so that costs and revenues could be properly assigned.
5) Performance Reporting: Responsibility account is a control device. A control system to be

effective should be such that deviations from the plans must be reported at the earliest so as to take
corrective action for the future. The deviations can be known only when performance is reported.
Thus, responsibility accounting system is focused on performance reports also known as
'responsibility reports', prepared for each responsibility unit.
Objectives of Responsibility Accounting

The objective of responsibility accounting may be classified into three basic categories:
1) Determination of Contribution of a Division: The performance of a responsibility centre can be

measured in terms of its efficiency and/or in terms of its effectiveness. Efficiency measures the
relationship of inputs to output; and the relationship between output and the goals of the organisation
is called effectiveness. Efficiency" is a relative terms that lower the consumption of resources (input)
to turn out a given amount of output, the greater is the efficiency. A particular responsibility centre
may be found more/less efficient if the cost of production in a month is lower higher than in one
preceding following month.
2) Evaluation of Quality of Performance: Responsibility accounting is used to measure the

performance of managers and it, therefore, influences the way the managers behave. In discussing
responsibility accounting, we must take behavioral considerations into account. It is for this reason
that responsibility accounting domains a discussion of how managers are influenced by the nature of
accounting information they receive.
3) Motivation Consistent with Organizational Goals: As observed earlier, any performance

measurement system can be expected to influence the behaviour of the managers affected by it.
Divisional performance measurement (responsibility accounting) should be designed in such a way
that, in seeking to achieve their own goals, divisional managers will simultaneously work to achieve
the goals of the firm. This is called "goal congruence." This can be ensured through a system of
incentives, for example, bonus for good performance, and so on.
Responsibility Centres
A responsibility centre is like an engine in that it has inputs, which are physical quantities of
material, hours of various types of labour, and a variety of services; it works with these resources
usually; working capital and fixed assets are also required. As a result of this work, it produces
outputs, which are classified either as goods, if they are tangible or as services, if they are intangible.
These goods or services go either to other responsibility centres within the company or to customers
in the outsides world.
This responsibility centre may be a very small sub-unit of the organization, as an individual could be
made responsible for one machine used in manufacturing operations, or it may be very big division
of the organization, such as a divisional manager could be responsible for achieving a certain level
of profit from the division and investment under his control.

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Types of Responsibility Centres
The responsibility centres are generally classified into following categories:
1) Cost or Expense Centres: Costs are ascertained by cost centres or by cost units or by both. A
cost centre is a location, person or item of equipment (or group of these) in or connected with an
undertaking, in relation to which costs may be ascertained and used for the purposes of cost control.
By analyzing the definition, it can be known that the cost centres are of two kinds, viz.
i) Impersonal cost centre consisting of a location or item of equipment (or group of these) and
ii) A personal cost centre consisting of a person or group of persons.
2) Profit Centres: A profit centre is a segment of business, which is responsible for the cost it incurs
as well as the revenue it generates. It should be able to identify all costs pertaining to the profit
centre and the revenue it generates. A profit centre should have operational independence. The
manager of a profit centre should be free to make decisions in regard to the purchases of materials
economically from outside volume of production, product mix, methods of manufacture, utilization
of labour and equipment etc.
3) Investment Centres: An investment centre is a profit centre in which imports are measured in
terms of expense and outputs are measured in terms of revenues, and in which assets employed are
also measured - the excess of revenue over expenditure then being related to assets employed in the
profit centre. The manager of investment centre is accountable for production and sales decisions
along with the investment decision.
4) Revenue Centres: Revenue centres are those organizational units in which outputs are measured
in monetary terms. These centres are marketing organizations and they are not directly responsible
for profits. The main objective of revenue centres is to maximize revenues.
Steps of Responsibility Accounting

Following steps are followed in responsibility accounting;
Step 1: Determination of Responsibility Centres: This is the first and foremost step in
responsibility accounting. For effective planning and control purposes, responsibility is classified
into various responsibility centres:
1) Cost centres,
2) Profit centres, and
3) Investment centres.
These centres are explained in responsibility centres (below).
Step 2: Setting up of Targets: The second step in the process of establishing the responsibility
accounting system is to enlist the targets of the responsibility centre only through the advisory role
of responsibility manager.
Step 3: Tracking of Performance: The third step involved in the establishment of responsibility
accounting is the comparison of the performance with the predetermined standards. If any deviation
occurs between the above mentioned standards, the observed/identified deviations will be reported to
the top level management.

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Step 4: Correction of Deviated Course of Action: The deviated course of action is corrected
through the directions from the top level management to the responsibility manager, to maintain the
uninterrupted flow of work in the future.
The above enlisted steps are not only involved in the process of assigning the responsibilities, but
also in enhancing the level of performance through the controlling of costs.
Advantages of Responsibility Accounting

The advantages of responsibility accounting are as follows:
1) Assigning of Responsibility: Each and every individual in the organization is assigned some
responsibility and they are accountable for their work. Everybody knows what is expected of him.
The responsibility can easily be identified and satisfactory and unsatisfactory performances of
various persons are known.
2) Improves Performance: The assigning of tasks to specific persons acts as a motivational factor
too. The person's incharge for different activities know that their performance will be reported to the
top management. They will try to improve their performance.
3) Helpful in Cost Planning: Under the system of responsibility accounting full information is
collected about costs and revenue. This data is helpful in planning of future costs and revenues,
fixing of standards and preparing of budgets.
4) Delegation and Control: This system enables management to delegate authority while retaining
overall control. The authority is delegated according to the requirements of the task assigned. On the
other hand, responsibility of various persons is fixed which is helpful in controlling their work.
5) Helpful in Decision-Making: Responsibility accounting is not only a control device but also
helpful in decision- making. The information collected under this system is helpful to management
in planning its future action. The past performance, of various cost centres also helps in fixing their
future targets. So this system enables management to take important decisions.
6) Manageable Size: A big organization is subdivided into smaller units which are of manageable
size.
7) Opportunity to Gain Valuable Managerial Skill: Responsibility centres managers have an

opportunity to gain valuable managerial skill that in turn provides the firm with a pool of potential
top managers.
Disadvantages of Responsibility Accounting

The introduction of responsibility accounting may cause the following disadvantages for the
enterprise:
1) Difficult Process: The clear cut distinction between controllable and uncontrollable - a basic
requisite for efficient responsibility accounting system is practically a difficult process.
2) Require More Effort: The responsibility centre may act in the best interest of its own, but not in
the corporate interest.
This situation demands the effort on the part of management to bring harmonization and co-
ordination between different segments of the enterprise.
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3) Provides Irrelevant Information: The preparation of responsibility accounting reports is not an

easy job. Measures should be taken to avoid irrelevant information.
4) Time Consuming: The preparation of feedback report may consume some time and till a report is
submitted to management for corrective action, the problem might have further worsened.
*****

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A unit of Realwaves (P) Ltd Valuation of Goodwill
CHAPTER 15 VALUATION OF GOODWILL

Valuation of Goodwill
Meaning and Definition of Goodwill

Goodwill is the value of the reputation of the firm which the business builds up due to its efficient
service to its customers and quality of its products. It is a value of all favourable attributes relating to
a business enterprise. It is not merely the past reputation but its continued existence in future that
makes goodwill a valuable asset. It cannot be seen or touched. It is an intangible asset but not a
fictitious asset. '
According to Lord Macnaughton, "Goodwill is a thing very easy to describe, but very difficult to
define. It is the benefit and advantage of good name, reputation, and connection of a business. It is
the one thing which distinguishes an old; established business from a new business as it first starts.
Goodwill is composed of variety of elements. It differs in its composition in different trades and in
different business in the same trade".
According to Dicksee, "When a man pays for goodwill, he pays for something which places him in
the position of being able to earn more money than he would be able to do by his own unaided
efforts".
Thus, goodwill is the present value of a firm's anticipated excess earnings in future and the efforts
had already made in the past Goodwill really arises only if firm is able to earn higher profit than
normal.
Characteristics of Goodwill
The characteristics of goodwill are as follows:
1) Goodwill is an intangible real asset.
2) Goodwill is inherent in business. It cannot be separated or sold in part or isolation.
3) The value of goodwill (self-generated) has no relation to the amount incurred.
4) It is difficult to calculate the exact cost of self-generated goodwill.
5) Goodwill is shown in the books only when some payment has been made or acquired at some
cost.
6) Goodwill may be negative also. It happens when purchase price of an acquired company is less
than the fair value of its net assets.
7) Intangible long-lived assets including goodwill are usually converted to expenses over a number
of accounting periods.
The periodic write-off is specifically called amortization.
8) Internally generated goodwill is not recognized as an asset because it is not an identifiable
resource controlled by the enterprise that can be reliably measured.
9) The difference between the market value of the enterprise and the carrying amount of net assets
may be due to many factors and hence this difference cannot be treated as goodwill.
10) Goodwill cannot be sold in isolation. The old firm must cease to exist.
Factors Affecting Goodwill

Goodwill relates to the profit earning capacity of the firm. Thus, the goodwill of a firm is affected by
the following factors.

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The factors are:
1) Quality: If the firm enjoys good reputation for the quality of its products, there will be a ready
sale and the value of goodwill, therefore, will be high.
2) Nature of Business: A business having a stable demand is able to earn more profit and therefore
has more goodwill.
3) Location: If the business is located in a prominent place, its value will be more.
4) Efficient Management: If the management is capable, the firm will earn more profits and that
will raise the firm's value.
5) Competition: When there is no competition or competition is negligible, the value of those

businesses will be high.
6) Advantage of Patents: Possession of trademarks, patents or copyrights will increase the firm's
value.
7) Time: A business establishes reputation in course of time which is running for long period on
profitable line.
8) Customers' Attitude: The type of customers which a firm has is important. If the firm has more
customers, the value will be high.
Methods of Valuation of Goodwill

There are four methods of valuation of goodwill:
Average Profit Method

Under this method, past profits of a number of years profits are taken into consideration. Such profits
are totaled-up and their average is found-out. The goodwill therefore, should be calculated by
multiplying the past average profits by the number of years during which the anticipated profits are
expected to accrue. It is based on the assumptions of no change in the overall situation. In the form
of formula,
Value of Goodwill = Actual/Average Profit x Number of Years'

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1) Actual/Average Profit = Total Profits

Total Number of Years for which Profit and Loss is given
The following adjustments should be taken into account while calculating and loss average profit:
i) Abnormal loss of a year such as loss from fire or theft, etc., should be added back to the profit of
that year.
ii) Abnormal income of a year such as income from speculation or lottery, etc., should be deducted
out of the profit of that year.
iii) Normal expenses of a year, if not deducted out of profits, should be deducted out of the profit of
that year.
iv) Normal income of a year, if not added in the profits, should be added to the profit of that year.
v) Remuneration of proprietor of a year should be deducted out of the profits of that year.
2) Number of years' purchase means for how many years, the firm will earn the same amount of
profit because of its previous efforts, after being purchased by another firm.
After making these adjustments the average profit is known as actual average profit or average
maintainable profit in future.
Illustration: 1
Goodwill of a firm is valued at three year's purchase of the average profits of the last five years. The
profits are as under:
Year Rs Year Rs
2007 50,000 Profit 2010 60,000 Profit
2008 20,000 Loss 2011 80,000 Profit
2009 10,000 Profit
Calculate the value of goodwill.

Ans: Rs 1,08,000.
Illustration: 2
P Ltd. purchased a running business of Mr. Q on 1st January 2012. The profits earned by Mr. Q for
the last four years were-as under:
Particulars Rs
Year ending 31" December, 2008 2,10,000
Additional Information
i) Included in the profits of the year 2011, a non-recurring item of profit of Rs 25,000.
ii) Profit for the year ending 31sl December 2009 is affected by loss by fire of Rs 20,000.
iii) The closing stock for the year ending 31st December 2010 was over-valued by Rs 10,000.
iv) Acquisition of this business will require replacement of existing manager who was getting a
salary of Rs 10,000 p.m. The new manager is to be employed at a monthly salary of Rs 12,000.

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v) Additional insurance premium is required to be made at Rs 500 p.m.
Calculate goodwill at 2 year's purchase of average profit.
Ans: Rs 3,97,500
Weighted Average Profit Method

This method is a modified version of the simple average profit method. Under this method each
year's profit loss is multiplied by the respective number of weights, i.e., 1, 2, 3, 4, etc., in order to
find-out value of product and the total of products is then divided by the total of weights in order to
ascertain the weighted average profits. Thereafter, the weighted average profit is multiplied by the
agreed number of years' purchase to find-out the value of goodwill.
Formulas
i) Weighted Average Profit = Total products of profits/losses
Total of Weights
ii) Value of Goodwill = Weighted Average Profit x Number of Years' Purchase
Weighted average profit method for valuation of goodwill is better than the simple average method
because it gives a higher weightage to the profits to the recent years. However, weighted average
should be used only if specified.
Illustration: 3
The profits of the firm for the year ended 31st March of the last five years were as follows:
2008 – Rs 18,000; 2009 – Rs 22,000; 2010 – Rs 25,000; 2011 – Rs 30,000; 2012 – Rs 40,000.
Calculate the value of goodwill on the basis of three years' purchase of weighted average profit after
weights 1,2,3,4, and 5 respectively to the profits.
Ans: Rs 91,401
.
Super Profits Method
Super profits mean the profit earned by a firm over and above the normal profit earned by other
firms in the same business. It is calculated by deducting from the profit in any year:
1) Interest on capital at market value, and
2) Reasonable salary of the proprietor or the partners.
Formulas
1) Super Profits = Actual Profits (Average) - Normal or Reasonable Profits
2) Normal Profits = Normal Rate of Return x Capital Employed in the Firm

100
3) Goodwill = Numbers of Years Purchase x Super Profits .
Note the following points:

1) Average profits are usually more reliable than a single year's profit.
2) Normal profits are calculated by multiplying the capital employed by the rate of yield expected by
investors in the industry concerned and dividing by 100.

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3) A business where the retiring partner was the main guiding force for success will have goodwill
based on one or two years' purchase of profits. Three to five years' purchase is common in other
cases.
4) If the profits are declining, the number of years' purchase of goodwill will probably be one or two
years.
In this method of valuation of goodwill, the super profit is multiplied by an agreed figure. This gives
the value of goodwill.
Illustration: 4
A firm's net profits during the last three years were Rs 1,00,000, Rs 1,10,000 and Rs 1,20,000. The
capital employed in the firm is Rs 6,00,000. A normal return on the capital is 10%. Calculate the
value of goodwill on the basis of three years' purchase of super profit.
Ans: Rs 1,50,000
Illustration: 5
A firm earned net profits during the last seven years as follows:
Year Profit/Loss (Rs) Year Profit/I.oss (Rs)
2005 20,000 Profit 2009 2,70,000 Profit
2006 70,000 Loss 2010 3,00,000 Profit
2007 40,000 Loss 2011 3,20,000 Profit
2008 2,50,000 Profit
The capital invested in the firm is Rs 12,00,000. Normal rate of return in the similar type of business
is 10 % value of goodwill on the basis of 2 ½ years' purchases of average super profits earned during
the above mentioned seven years.
Ans: Rs 75,000
Capitalization Method
Under capitalization method, capital value of business profit is to be found-out. Capital value means
to find-out the capital needed for earning profit and this capital needed is treated as goodwill. Thus,
it is known as capitalization method.
There are two methods for valuing goodwill under this method:
Capitalization of Actual/Average Profit Method

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Value of Goodwill = Capitalized Value of Average Profit - Actual Capital Employed (or Net Assets)
According to this method, the following steps should be adopted:

1) Actual/average profit is calculated in the same manner as in the average profit method.
2) Capitalized value of actual/average profit = Actual/Average Profit x 100
Normal Rate of Return
3) Actual Capital Employed (or Net Assets) = Total Assets (excluding goodwill) minus Outside
Liabilities.
Illustration: 6
From the figuresgiven below, calculate goodwill according to the capitalisation of Average Profits
I Method:
l) Actual Average Profits = Rs 72,000
2) Normal Rate of Return = 10%
3) Assets = Rs 9,70,000
4) Outside Liabilities = Rs 4,00,000
Ans: 15000
Illustration: 7
From the following particulars, calculate the value of goodwill by capitalisation method:
Average Profit of a Firm during the Past Few Years Rs 50,000
Normal Rate of Return in a Similar Type of Business 20%
Net Tangible Assets of the Firm Rs 1,60,000
Ans: Rs 90,000
Capitalization of Super Profit Method

As the name suggests, this method tries to assess the capital needed for earning the super profit. The
capitalised value of super profit (excess of future maintainable profits over normal profit on capital
employed) is called goodwill. To ascertain the value of goodwill under this method, Super Profit of
the business and Normal Rate of Return are required and then the following formula is used:
Goodwill as per Capitalisation Method = Super Profit x l00

Normal Rate of Return
Illustration: 8
The following are the profits made by a firm for the last five years:
Year Profit (Rs)
2008 30,000
2009 40,000
2010 70,000
2011 1,00,000
2012 110000
The capital employed by the firm is Rs 600000 and the normal rate of return is 10%. Compute the
amount of goodwill of the firm under capitalization of super profit method.
Illustration: 9

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Mr. A died on 20th December, 2012. The balance sheet of his business on 31st March, 2012 was as
under:
Liabilities Rs Assets Rs
Capital 7,50,000
Buildings 5,00,000
Trade Creditors 3,75,000
Furniture 5,000
Income Tax Payable 1,00,000
Motor Vehicle 47,500
Stock-in-Trade 1,75,000
Sundry Debtors 3,47,500
Cash 1,50,000
12,25,000 12,25,000
The net profits of the business for the five years ended 31st march, 2012 were Rs 387500, Rs
466700, Rs 112240, Rs 92960 and Rs 104240. Mr A was actively engaged m the business but did
not draw salary. The debts due to the business are all good and on a revaluation the value of the
fixed assets are as follows:
Building – Rs 750000, furniture – Rs 7500 and motor vehicle – Rs 100000. Assuming the
management remuneration for the services of the proprietor to be Rs 5000 per month and 12 percent
is the fair return on investment, calculate the amount of goodwill by capitalising super profits.
Ans: 436517
Year 2014
Calculate the value of goodwill by (i) 3 year's purchase of actual average profits; (ii) 10 year's purchase
of super profit; and (iii) Capitalization method from the following information:-
(a) Average capital employed Rs 4,00,000.
(b) Net trading profits of past four years:- Rs 68,000; Rs 75,000; Rs 80,000; and Rs 92,000.
(c) Normal rate of return in similar type of business is 15%. .
(d) Net profit of last 2 years includes the income from non-trade investment Rs. 3,000 per annum.
(e) Fair remuneration of owner for his services Rs 15,000 per annum.
****

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A unit of Realwaves (P) Ltd Inventory
CHAPTER 16 INVENTORY
Meaning and Definition of Inventory

The dictionary meaning of inventory is 'stock of goods, or a list of goods'. The word 'Inventory' is
understood differently by various authors. In accounting language it may mean stock of finished
goods only. In a manufacturing concern, it may include raw materials, work in process and stores,
etc. to understand the exact meaning of the work 'inventory' we may study it from the usage side or
from the 'side of point of entry' in the operations.
International Accounting Standard Committee (I.A.S.C) defines inventories as, "Tangible

property
1) Held for sale in the ordinary course of business,
2) In the process of production for such sale or,
3) To be consumed in the process of production of goods or services for sale".
American Institute of Certified Public Account (AICPA) defines, "Inventory in the sense of tangible
goods, which are held for sale, in process of production and available for ready consumption".
Inventory includes the following things:
1) Raw Material,
2) Work-in-Progress,
3) Consumables,
4) Finished goods,
5) Spares.
Inventory means all the materials, parts, supplies, expense tools and in process or finished products
recorded on the books by an organization and kept in its stocks, ware houses or plant for some
period of time.
Costs for Inventory

The classical inventory analysis identifies four major cost components.
1)Purchase Cost: This refers to the nominal cost of inventory. It is the purchase price for the items
that are bought from outside sources, and the production cost if the items are produced within the
organization.
2)Ordering Cost/Set-up Cost: Ordering cost is incurred whenever the inventory is replenished. It
includes costs associated with the processing and chasing of the purchase order, transportation,
inspection for quality, expediting overdue orders and so on. It is also known as the procurement cost.
3)Carrying Cost: This cost is also known as the holding cost or the storage cost, carrying cost
represents the cost that is associated with storing an item in inventory. It is proportional to the
amount of inventory and the time over which it is held.
4) Stock out Cost: Stock out cost means the cost associated with not serving the customers. Stock
outs imply shortages. A shortage can evoke different reactions from customers. It would result in a
backorder or lost sales. In case of backorder the sales are not lost, they are only delayed.
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Inventory Systems
There are two inventory systems, viz. periodic inventory system and perpetual inventory system.
1) Periodic Inventory System: Periodic inventory system is a method of ascertaining inventory by

taking an actual physical count (or measure or weight) of all the inventory items ‘on hand at a
particular date on which information about inventory is required. The cost of goods sold is calculated
as a residual figure (which includes lost goods also) as under:
Cost of Goods Sold = Opening Inventory + Purchases - Closing Inventory
2) Perpetual Inventory System: It is also known as Automatic Inventory System.

According to the Chartered Institute of Management Accountants London, it is "A system of
records maintained by the controlling department, which reflects the physical movements of stocks
and their current balance".
Perpetual Inventory System is a method of recording inventory balances after each receipt and issue
in order to ensure accuracy of perpetual inventory records, physical stocks should be checked and
compared with recorded balances. The discrepancies, if any, should be investigated and adjusted in
the accounts properly. The closing inventory is calculated as a residual figure (which includes lost
goods. Also) as under:
Closing Inventory = Opening Inventory + Purchases - Cost of Goods Sold.
Methods of Valuation of Inventory

Goods issued from stores should be priced at the value at which they are carried in stock. But there
can be a situation where the material may have been purchased at different times and at different
prices with varying discounts, taxes etc. Because of this the problem arises as to how the goods
issues to production are to be valued. There are several methods for handling this situation. These
methods may be grouped and explained as follows: grouped and explained as follows:
Methods of Valuation of Inventory
Cost Price Average Price Current Price
Specific price Simple Average Replacement Price

FIFO • Periodic NIFO
LIFO • Moving
HIFO Weighted Average
Base stock price • Periodic
• Moving
Cost Price Method
In this method, the materials issued are priced at their actual cost and this involves identification of
each lot purchased. This method is suitable only in the case of materials purchased for a specific job.
The most common methods frequently used under this method are discussed below in detail.
First In First Out (FIFO) Method

Under this method materials received first are issued first. After the first lot of the material
purchased is over, the next lot is taken up for issue. As such, the materials are issued in the order in
which they are received in the stores. The pricing of the issue of the first lot is done at the rate of

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purchase of the first lot. Similarly, the pricing pattern follows for the subsequent lots. The closing
stock in this method is valued at the latest purchase price and thus it represents the current conditions
as far as possible. This method is considered more suitable in times when the prices show the falling
trend. The reason is that higher rate of material purchased earlier stands recovered in costs and the
closing stock is shown at the current prices.
Period Implications of. FIFO Method

1) In periods of Rising Prices
Higher income is reported since old costs (which are lower than the
current costs) are matched with current revenues.
As result, income tax liability increase.
2) In periods of Falling Lower income is reported since old costs (which are higher than the
Prices content costs) are matched with current revenue.
As a result income tax liability
Advantages
1) It is very simple to understand.
2) It is issued on the basis of purchases.
3) The materials are issued at purchase price.
4) It is most advantageous during the moment of falling prices due to lower cost of replacement
through purchases against the issues.
5) The closing stock reflects the market price due to recent purchase of materials.
Disadvantages
1) If too many purchases and issues are price changes frequently, this method involves cumbersome
calculations;
2) It produces higher profits and higher tax liability in periods of rising prices. Conversely, it
produces lower profits and lower taxes in periods of falling prices;
3) Comparison between similar jobs becomes difficult when price changes frequently;
4) Adjustment of rejected materials and returns of excess materials become difficult;
5) This method does not ensure that oldest material will be used first, as they may get mixed up with
current materials purchased at different price.
Last In First Out (LIFO) Method

It is based on the assumption that the goods which are received last are issued first. This assumption
is made for the purposes of assigning costs and not for the purposes of the physical flow of goods.
The physical flow of goods therefore, need not necessarily coincide with the pattern of cost flow
assumption.
It uses the price of the last lot received for all the issues until all units from this lot have been
issued after which the price of previous lot received is used for pricing and so on. In case a new lot is
received, new lot becomes the last lot and its price is used for pricing the issues in the manner
explained above.
Cost of Materials Issued represents the cost of latest purchases. Cost of Closing Stock represents the
cost of earlier purchases.
Implication of LIFO Method in periods of rising or falling prices

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Period Implications of LIFO Method

1) In periods of Rising Lower income is reported since current costs (which are higher than the old
Prices costs) are matched with current revenues. As a result, income tax liability is
reduced.
2) In Periods of Higher income is reported since current costs (which are lower than the old
Falling Prices costs) are matched with current revenues. As a result, income tax liability is
increased. "
Advantages
1) The concept is simple in nature and is readily understood. It is also easy to use.
2) When prices are rising, this method given best results as issues are priced at the current market
price.
3) This method gives realistic product cost as material cost is charged at recent purchase price.
4) Unrealized gains from stock are minimized and the figure of profit is arrived at on a conservative
basis.
Disadvantages
1) Stock value does not show current market price.
2) If too many purchases and issues are made and price changes frequently, this method also
involves cumbersome calculations;
3) Comparison between similar jobs becomes difficult, if materials of different lots are used in these
jobs;
4) In times of rising, prices profits and taxes will be lower whereas profits and taxes will be higher in
times of falling prices;
5) The valuation of stock is neither acceptable to income-tax authorities nor to the accounts
department for preparation of financial accounts.
6) The method is not realistic since it does not conform to the physical flow of materials.
Distinction between FIFO and LIFO Method
Basis of FIFO LIFO

Distinction
1) Basic Assumption Goods received first are issued first. Goods received last are issued first.
2) Cost of Goods Cost of goods sold represents cost of Cost of goods sold represents cost of
Sold earlier purchases. recent purchases.
3) Ending Inventory Ending inventory represents cost of Ending inventory represents cost of
recent purchases. earlier purchases.
4) In case of Rising Higher income is reported since old Lower income is reported since current
prices costs (which are lower than current Costs (which are higher than the old
costs) are matched with current costs) are matched with current revenue.
revenue. As a result, income tax As result, income tax liability is
liability is increased. reduced.
5) Distortion in Balance Sheet shows the ending Balance Sheet is distorted because
Balance Sheet inventory at a value nearer the ending
current market price. inventory is understated at old costs.

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Illustration: 1
Ram purchases an item at the rate of ` 20 per piece from Shyam. 2000 units of the item are required
per year. What should be the EOQ if the cost per order is 5 and inventory carrying cost is 20% of
purchase price.
Ans: EOQ = 70.71 & 71 unit
Illustration: 2
A dealer has to supply 200 unit of a product. He gets the product at ` 25 per unit from the
manufacture. The cost of ordering & transportation from the manufacture is ` 37.5 per order. The
cost of holding inventory is 7.5 % per year of the cost of product. Find EOQ & TC.
Ans: EOQ = 89.44, TC = 5167.75
Illustration: 3
A raw material has a demand of 5000 units per year. The cost of one procurrent is ` 50 & the holding
cost per unit is ` 2.40 per year. Find EOQ & no. of order
Ans: EOQ = 456 unit, no. Of order = 10.96
Hint No. of order = R/EOQ
Illustration: 4
Calculate EOQ & total cost (including purchase cost) from the following data:
Annual demand – 2500 unit
Unit price – ` 2.50
Ordering cost – ` 4.00 per order
Storage rate – 1 % per year
Interest rate – 12% per year
Obsolescence rate – 7 % per year
Ans: EOQ = 200 unit, TC = 6350
Illustration: 5
A purchase manager place order each time for a lot of 500 unit of a particular item. From the
available data the following results are obtained.
Inventory carrying cost – 40%
Ordering cost per order – ` 600
Cost per unit – ` 50
Annual demand – 1000 unit
Find out the loss to the organization due to the ordinary policy.
Ans: loss (56200-54899) = 1301
Illustration: 6
The purchase manager of a company has collected the following data for one of the A– class items:
Interest on the lock up capital – 20 %
Order processing cost (`) for each order – ` 1000
Inspection cost per lot – 500
Follow up cost for each order – 800
Pilferage while holding inventory – 5%
Other holding cost – 15%
Other procurrent cost per order – 1700

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Annual demand – 10000 units
Cost per item – ` 100
Discount for a minimum order quantity of 1500 items is 10%. What should be the ordinary policy of
the purchase manager?
Ans: EOQ = 1414, TC = 1056568.5, EOQ = 1500, TC = 953667
Illustration: 7
A company needs 1000 units annually of an article. The cost per article is ` 20. Order cost per order
is ` 25 and carrying cost is 25% of the cost of article per unit annually. If the company orders 500 or
more units than a discount of 5% is available, determine the most suitable solution.
Ans: EOQ = 100 unit, TC = 20500, EOQ = 500, TC = 20237.5
Illustration: 8
In a factory raw material A and B are used weekly as follows:
Normal Usage …………150 kg
Maximum Usage ……………….225 kg
Minimum Usage ………………..75 kg
Re-order Quantity A 1200 kg
B 1800 kg
Reorder Period A 4 to 6 weeks

B 2 to 4 weeks
Calculate for each raw martial:
(i) Reorder level
(ii) Maximum stock level
(iii) Minimum stock level
(iv) Average stock level
Ans (i) A = 1350units B = 900units (ii) A = 2250units B = 2550units (iii)A = 600units B = 450units
(iv)A = 1425units B = 1500units
Illustration: 9
In a Company raw martial is used weekly as following:
Normal Usage 50 units
Minimum Usage 25 units
Maximum Usage 100 units
Reorder Quantity 300 units
Reorder Period 1 to 3 weeks.
Determine the following:
(i)Reorder Level (ii) Minimum Level (iii) Maximum Level and (iv) Average Level
Ans: (i) 300 units (ii) 200 units (iii) 575 units (vi) 387.5 units
I. First In, First Out or FIFO method
Illustration: 10
The particulars of receipts and issues of an item of stores for the month of august, 2007 are as
follows:

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2007, august
1 Opening balance 500 tones @ `.10 per tone
5 Issue (Req No. 323) 300 tones
9 Receipt (G.R. No. 215) 600 tones @ 11 per tone
14 Issue (Req No. 423) 250 tones
20 Receipt (G.R. No. 222) 100 tones @ ` 12 per tone
27 Issue (Req. No. 524) 400 tones
Material is issued on the basis of First In, First Out (FIFO) method. Prepare stores ledger account on
the basis of above particulars.
Solution: store ledger account (FIFO method)

Description………….. Maximum stock level………..
Code no……………… Minimum stock level………...
Unit: tones Re-ordering level……………..
Date Receipts Issues Balance Rate for

Aug G.R.No. Quantity Rate ` Req. Quantity Rate ` Quantity ` further
2007 or (tones) ` No. (tones) ` (tones) issues
M.R. No Tones – `
1 Opening 500 10 5000 500 5000 500-10
balance
5 323 300 10 3000 200 2000 200-10
9 G.R. 215 600 11 6600 800 8600 200-10
14 433 200 10 600-11
50 11 2550 550 6050 550-11
20 G.R.222 100 12 1200 650 7250 550-11
100-12
27 524 400 11 4400 250 2850 150-11
100-12
II. Last In, First Out or LIFO method
Illustration: 11
Solve Illustration: 10 as per LIFO method
Solution: store ledger account (LIFO method)

Code no……………… Minimum stock level………...

M.R. No Tones – `
1 Opening 500 10 5000 500 5000 500-10
balance
5 323 300 10 3000 200 2000 200-10
9 G.R. 215 600 11 6600 800 8600 200-10

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600-11
14 433 250 11 2750 550 5850 200-10
350-11
20 G.R.222 100 12 1200 650 7050 200-10
350-11
100-12
27 524 100 12 4500 250 2550 200-10
300 11 50-11
III. Average price method

The most important drawback in the first in first out and the last in first out methods is that the cost
of production of various jobs under completion during the same period comes out to be different
when material purchased at different rates is issued to them. In order to avoid this drawback the
average price method is used:
(i) Simple average method
(ii) Weighted average method
(i) Simple average method: If the material kept in the bin was purchased at different prices, then by
dividing the sum of all the values by the number of values we get the simple average value. Simple
average price means “A price which is calculated by dividing the total of the price of the materials in
stock, from which the materials to be priced could be drawn, by the number of prices in that total”.
Illustration: 12
Solve Illustration: 10 as per Simple average method
Solution: store ledger account (Simple average method)

Code no……………… Minimum stock level…………

M.R. No Tones – `
1 Opening 500 10 5000 500 5000 10
balance
5 323 300 10 3000 200 2000 10
9 G.R 215 600 11 6600 800 8600 10+11
2
=10.50
14 423 250 10.50 2625 550 5975 10.5
20 G.R 222 100 12 1200 650 7175 11.25

27 524 400 11.25 4500 250 2675 11.25
(ii) Weighted average method: The main drawback in simple average method is that the various
purchase prices of a material are given equal importance in this method, whether the quantity
purchased at that rate is small or large. In order to estimate this drawback, weighted average method
is used. Weighted average price is “A price which is calculated by dividing the total cost of materials

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in stock, from which the material to be priced could be drawn by the total quantity of materials in
stock”.
Illustration: 13
Solve Illustration: 19 as per weighted average method
Solution: store ledger account (Weighted average method)

Code no……………… Minimum stock level…………
Aug G.R.No. Quantity Rate ` Req. Quantity Rate ` ` Quantity ` further
2007 or (tones) ` No. (tones) (tones) issues
M.R. No Tones –
`
1 Opening 500 10 5000 500 5000.00 5000
balance 500
=10.00
5 323 300 10 3000.00 200 2000.00 2000
200
= 10.00
9 G.R 215 600 11 6600 800 8600.00 8600
800
=10.75
14 423 250 10.75 2687.50 550 5912.50 5912.50
550
= 10.75
20 G.R 222 100 12 1200 650 7112.50 7112.50
650
= 10.94
27 524 400 10.94 4376.00 250 2736.50 2736.50
250
= 10.94
Illustration: 14
The following are the details of receipts and issues of an item of stores in a factory for the month of
December, 2007:
Receipts Issues
Date Quantity Rate Date Quantity
1 500 kg. ` 20(opening balance) 3 70 kg
14 20kg ` 20(return) 4 100kg
20 200 kg ` 22 7 80 kg
27 15 kg ` 20(return) 16 200 kg
25 200 kg
Issues are to be priced on the basis of first in first out. The stock verifier of the factory reported a
shortage of 5 kg. On 15th December and 7 kg on 31st December. Prepare a stores ledger account.
Solution:

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Stores Ledger Account.

Dec G.R.No. Qty Rate ` Req. Quantity Rate ` Quantity ` further
M.R. No Tones – `
1 500 20 10000 500 10000 500-20
3 70 20 1400 430 8600 430-20
4 100 20 2000 330 6600 330-20
7 80 20 1600 250 5000 250-20
14 20 20 400 270 5400 270-20
15 shortage 5 20 100 265 5300 265-20
16 200 20 4000 65 1300 65-20
20 200 22 4400 265 700 65-20
200-22
25 65 20
135 22 4270 65 1430 65-22
27 15 20 300 80 1730 65-22
15-20
31 shortage 7 22 154 73 1576 58-22
15-20
****

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A unit of Realwaves (P) Ltd Depreciation
CHAPTER 17 DEPRECIATION
Explain the concept of depreciation. What is the need for charging depreciation and what are
the causes of depreciation?
Every business acquires fixed assets for its use in the business over a period of time. As the benefits
of these assets can be availed over a long period of time (due to their regular use), there exists
continuous wear and tear and consequently fall in their value. This fall in the value of fixed assets
(due to regular use or expiry of time) is termed as depreciation.
A machinery that costs Rs 1,00,000 and its useful life of 10 years, its depreciation will be calculated
as:
1. To ascertain true net profit or net loss− correct profit or loss can be ascertained when all
the expenses and losses incurred for earning revenues are charged to profit and loss account.
Assets are used for earning revenues and its cost is charged in form of depreciation from
profit and loss account.
2. To show true and fair view of financial statements− If depreciation is not charged, assets
are shown at higher value than their actual value in the balance sheet; consequently, the
balance sheet does not reflect true and fair view of financial statements.
3. For ascertaining the accurate cost of production− Depreciation on plant and machinery
and other assets, which are engaged in production, is included in the cost of production. If
depreciation is not included, cost of production is underestimated, which will lead to low sale
price and thus leads to low profit.
4. Distribution of dividend out of profit− If depreciation is not charged, which leads to
overestimating of profit and consequently more profit is distributed as dividend, out of
capital instead of the profit. This leads to the flight of scarce capital out of the business.
5. To provide funds for replacement of assets− Unlike other expenses, depreciation is not a
cash expense. So, the amount of depreciation charged will be retained in the business and
will be used for replacement of fixed assets after its useful life.
6. Consideration of tax− If depreciation is charged, then profit and loss account will disclose
lesser profit as to when the depreciation is not charged. This depicts reduced profit and thus
the business will be liable for lesser tax amount.
Below are given the causes for depreciation.
1. Constant use− Due to constant use of the fixed assets there exists normal wear and tear that
leads to fall in the value of fixed assets.
2. Expiry of time− With the passage of time, whether assets are used or not, its effective life
decreases. The natural forces like rain, weather, etc. lead to deterioration of the fixed assets.

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3. Obsolescence− Due to the fast technological innovations and inventions today’s assets may
be outdated by tomorrow’s sophisticated assets. This leads to the obsolescence of fixed
assets.
4. Expiry of legal rights− If an asset is acquired for a specific period of time, then, whether the
asset is put to use or not, its value becomes zero at the end of its useful life. For example, if a
land is acquired for Rs 1,00,000 for 25 years on lease, then each year its value depreciates
by of its gross value. At the end of the 25th year, the value of the lease will be zero.
5. Accident− An asset may lose its value and damage may happen to it due to mishaps such as
a fire accident, theft or a natural calamity. The loss due to accident is permanent in nature.
6. Permanent fall in value− Generally, we do not record fluctuations in the market price of the
fixed assets in the books. However, if the fall in market price is permanent, it is accounted,
which leads to a fall in the value of fixed assets in the books.
Straight line method and written down value method of depreciation
Straight Line method

It is a simple method of charging depreciation. Under this method, depreciation is charged on the
original cost of an asset, at a fixed rate of percentage. In this method, amount of depreciation
remains same from year to year and asset’s value becomes zero at the end of its useful life.
Amount of depreciation is calculated as under:
Advantages of Straight Line Method

1. It is simple to calculate.
2. Asset can be completely written off, i.e., asset can be depreciated until the net scrap value is
zero.
3. Same amount of depreciation is charged every year. Therefore, it helps in easy comparison of
Profit and Loss Account for different years.
4. It is used for assets that have low repairs and maintenance expenses and are continuously
used over a period of time.
Limitations of Straight Line Method

1. Burden of deprecation is more on profit and loss account in the later years, when repair and
maintenance costs increase, as asset becomes older.
2. Value of asset becomes zero in the books even if asset is still in usable condition in business.
Uses of Straight Line Method

1. This method is useful where repairs and maintenance expenses on asset are low.
2. It is also useful when an asset is continuously used from one year to another.
3. It is useful when the value of assets, such as patent, copyright, goodwill, etc., becomes zero
Written Down Value Method

This method is applicable where depreciation is charged on the diminishing balance, i.e., book value
of the asset. In this method, asset’s value goes on diminishing year after year and the amount of
depreciation declines.
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Rate of depreciation is calculated as follows:
Where,
R represents rate of depreciation
n represents expected useful life of the asset
s represents the scrap value
c represents the cost of the asset
Advantages of Written Down Value Method

1. It is based on the logical assumption that asset is used more in the earlier years, so more cost
is charged in form of depreciation.
2. It is suitable for the assets where repairs are more in the later years, as depreciation is lesser
and on a whole the combined burden of depreciation and repairs exerts equal pressure on the
net profit over years.
3. This method is accepted by the income tax authorities.
4. As more depreciation is charged in the earlier years, so the loss due to obsolescence of the
asset is reduced.
Limitations of Written Down Value Method

1. It is difficult to calculate and is a time consuming process.
2. The value of an asset cannot be zero, thus the asset cannot be completely written off.
3. There arises shortage of funds for replacement of new asset. This happens due to the fact that
the amount of depreciation is retained and used in the business. Consequently, at the end of
the useful life of an old asset, business finds it difficult to arrange funds for its replacement.
Uses of Written Down Value Method

1. It is useful when assets have long life.
2. It is useful for those assets that require more repair and maintenance costs in the later years.
3. It provides easy calculation to provide depreciation of additional asset purchased during a
year.
Difference between Straight Line Method and Written Down Value Method
Basis of Difference Straight Line Method Written Down Method

Basis for calculation Depreciation is calculated on the Depreciation is calculated on the
original cost of an asset. reducing balance, i.e., the book value
of an asset.
Amount of Equal amount is charged each year Diminishing amount of depreciation
depreciation over the effective life of the asset. (on the written down value of asset)
is charged each year over the
effective life of the asset.
Book value of asset Book value of the asset becomes Book value of the asset can never be
zero at the end of its effective life. zero.
Suitability It is suitable for the assets like, It is suitable for assets that needs
patents, copyrights, land and more repairs and maintenance costs

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buildings, etc., which have lesser in the later years like, plant and
possibility of obsolescence and machinery, car, etc.
lesser repair charges.
Effect of depreciation Unequal effect over the life of the Equal effect over the life of the asset,
and repair on profit asset, as depreciation remains same as depreciation is high and repairs
and loss account over the years but repair cost are less in the initial years but in the
increases in the later years. latter years the repair cost increases
and depreciation cost decreases.
Recognition under It is not recognized under the It is recognized under the Income
Income Tax Act Income Tax Act. Tax Act.
Methods of recording depreciation

Describe in detail two methods of recording depreciation. Also give the necessary journal entries.
The two methods of recording depreciation are diagrammatically presented below.
1. Charging depreciation to Asset Account− Under this method, depreciation is directly credited to
the asset account and no separate account is prepared for provision of depreciation. Under this
method, the original cost of an asset and the total amount of depreciation cannot be determined from
the Balance Sheet, as the Asset Account appears at its written down value.
Journal entries for depreciation are given below.
When depreciation is charged to Assets Account
Depreciation A/c Dr.
To Assets A/c
(Depreciation charged to Assets Account)
Closing of Depreciation Account
Profit and Loss A/c Dr.
To Depreciation A/c
(Depreciation transferred to Profit and Loss Account)
2. Creating Provision for Depreciation Account− Under this method, depreciation is not credited
to the Assets Account; in fact, it is credited to the provision for Depreciation Account. At the year
end, asset is shown at the original cost in the Balance Sheet and total depreciation up to the date of
Balance Sheet is shown as Provision for Depreciation Account.
Journal entries for depreciation are:
Charging Depreciation
Depreciation A/c Dr.
To Provision for Depreciation A/c
(Depreciation charged)
Closing of Depreciation Account
Profit and Loss A/c Dr.
To Depreciation A/c
(Depreciation account is transferred to Profit and Loss Account)
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When the asset is sold, the accumulated depreciation on that asset is credited to the Asset Account
by passing the following Journal entry:
Provision for Depreciation A/c Dr.
To Asset A/c
(Accumulated depreciation transferred to Assets Account)
Determinants of depreciation
1. Total cost of asset− The total cost of an asset is taken into consideration for ascertaining the
amount of depreciation. The expenses incurred in acquiring, installing and constructing of
assets and bringing the assets to their usable condition are included in the total cost of asset.
2. Estimated useful life− Every asset having it’s useful life other than it’s physical life, in
terms of number of years, units, etc. are considered to estimate the effective life of a fixed
asset. For example, land has indefinite life; however, if business acquires a piece of land on
lease for 25 years, it’s useful life is considered to be 25 years.
3. Estimated scrap value− It is estimated as the net realisable value or sale value of an asset at
the end of it’s effective life. It is deducted from the total cost of an asset. For example,
furniture is acquired at Rs 50,000 with it’s effective life of 10 years.
After 10 years, furniture will be sold at Rs 10,000. So, depreciation is charged as:
Straight line method (SLM)
Illustration: 1
Calculate the rate of depreciation under straight line method (SLM) in each of the following
alternative cases:
Case Purchase Price of Expenses to be Estimated Expected Useful
Machine Capitalized Residual Value Life
(a) 80,000 20,000 40,000 4 years
(b) 17,000 3,000 2,000 10 years
Ans: (a) 15% (b) 9%
Illustration: 2
On 1st January 2010, X Ltd. purchased a second-hand machine for Rs 52,000 and spent Rs 2,000 as
shipping and forwarding charges, Rs 5,000 as import duty, Rs 500 as carriage inwards, Rs 1,500 as
repair charges, Rs 500 as installation charges, Rs 400 as brokerage of the middleman and Rs 100 for
an iron pad. It was estimated that the machine will have a scrap value of Rs 2,000 at the end of its

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useful life which is 20 years. On 30th Sept 2010 repairs & renewals amounted to Rs 2,000. On 1st
July 2012, this machine was sold for Rs 30,600.
Required: Prepare the machinery account for the first three years.
Illustration: 3
Kumaran Brothers purchased a Machinery on 1.1.2010 for Rs 5,00,000. On 1.1.2012 the machinery
was sold for Rs 4,00,000. The firm charges depreciation at the rate of 15% per annum on Straight
Line Method. The books are closed on 31" March every year. Prepare Machinery account and
Depreciation account.
Written Down Value or Diminishing or Reducing Balance Method
Illustration: 4
On 1.1.2009 a machine was purchased for Rs 1,00,000. On 30.9.2011 anew machine was purchased
for Rs 20,000 installation expenses being Rs 5,000.
Show the Machinery Account up to 31st Dec. 2012 assuming that the rate of depreciation was 10%
on written down value method.
Illustration: 5
A company whose accounting year is the calendar year purchased on 1st April, 2009 machinery
costing Rs 30,000. It further purchased machinery on 1st October 2009 costing Rs 20,000 and on 1st
July 2010, costing Rs 10,000. On January 2011 one third of the machinery which was installed on
1st April 2009 became obsolete and was sold for Rs 3,000.
Show how the machinery account would appear in the books of company. The depreciation to be
charged at 10% written down value method.
Illustration: 6
On 1st April, 2009 Ram Traders, Bhopal purchased machinery for Rs 50,000. On 1st October, 2009,
they purchased further machinery costing Rs 10,000. On Is' October, 2011 they sold for Rs 24,000
the machine purchased on 1st April, 2009 and bought another machine for Rs 12,000 on the same
date. Depreciation was provided on machinery @ 10% p.a. under diminishing Balance Method. The
financial year closes on every 31st March, prepare Machinery A/c. and Depreciation A/c. for the
years of 2009-10, 10-11 and 11-12.
Change in the Method of Depreciation
Illustration: 7
Rohan Son's purchased a machine for Rs 2,00,000 on January 1,2009. The machine was depreciated
at 10% p.a. under the written down value method. On January 1, 2012 the firm decided to change the
method of depreciation from Diminishing Balance method to Fixed Installment method without
changing the rate with retrospective effect from Jan. 1, 2009. Prepare machine account from 2009 to
2012.
Illustration: 8
A Ltd. purchased on 1-1-2007 a second hand plant for Rs 2,50,000 and immediately spent Rs 50.000
on overhauling and installing it. On 1-7-2007. Additional machinery costing Rs 2,00000 was

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purchased. On 1-7-2009, the plant bought on 1-1-2007 became obsolete and was sold for Rs 50,000
on the same day a new plant was purchased it a cost of Rs 4,00,000.
Depreciation was provided annually on 31st December every year at 10% p.a. on original cost.
However from 2010 the company changed this method and adopted written down value method
changing depreciation at 15%.
Show the plant account as it would appear in the books of the company for the year 2007 to 2011.
Year 2014
(a) What do you mean by 'Depreciation'? How depreciation is different from Amortization,
Depletion, obsolescence, and dilapidation?
(b) In 2010, a company acquired a mine at a cost of Rs 5,00,000. The estimated resource of minerals
is 50,00,000 tonnes, of which 80% is expected to be realized. The first 3 years raisings are 1,50,000;
2,00,000 and 2,50,000 tonnes respectively. Calculate depreciation for 2010, 2011 & 2012 under
depletion method.
*****

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.-:
'rr--' -
Rorr No. tLMp.lXXblq Total No ofPages: []

ln +qqg43IRrut3
t-l 1M6115
F{ NI.B.A I Sem. (Nlain & Back) Exam. Jan. 2014
\o
!t Nl-105 A Accounting for Management
e
Fl
Time: 3 Hours Maximum Marks: 70

Min. Passing Marks: 28
Instructions to Candidates : -
1)Theqrrestionpaperisdividedintwosections.
. 2) There are sections A & B. Section A contains 6 questions out of which the
candidate is required to attempt any 4 questions. Section B contains short
- case study/application based question which is compulsory.
3) All questions are carrying equal marks.
1. 2.
SECTTON.A
"Accounting concepts are different from accounting conventions". Explain any 6
accounting concepts. [6+8]
t@ Write short notes on:-
(a) Users of Accounting
(b) Responsibleaccounting
(c) Zerobasedbudgetary
(d) Return on capital Employed [1+4+3+3)
Q.3 (a) What do you mean by 'Depreciation'? How depreciation is different from
. Amo rtization,Depletion, obsoleScence, and dilapidation? l7l
[1M611s] Page 11 of4 l4e60l
(b) ln 2010, a company acquired a mine at a cost of Rs. 5,00,000.
The estimated
resource of minerars is 50,00,000 tonnes,
of which g0% is expected to be
realised. The first 3 years raisings are 1,50,000;2,00,000 ,
and z,so,ooo tonnes
respectively' Calculate depreciation for 2010,
&
z0ll 2012 under depletion
method
t71
Q'4 calculate the value of goodwill by (i) 3 year's purchase of actual average
profits;
(ii) l0 year's purchase of super profit; and (iii) Capitalization
methoa rrom ttie
fol lowin g information : -
(b) Net trading profits oipurt fbur years::
Rs 68,000; Rs 75,000; Rs g0,000; and Rs 92,000.
(c) Ncrmal rate of return in similar type of business

is r5%.
(d) Net profit of last 2 years includes the irrcome from non-trade
investment
Rs. 3,000 per annum
(e) Fair remuneration of owner for his services Rs

r 5,000 per annum lr 4j
Q'5 what do you mean by cash flow statement? How do you

treat following items in the
preparation of cash flow statement:_
(i) Inrerim Dividend
(iii) Accumulated Depreciation
(iv) Provision for doubtful Debts.

[14]
'l
.
Q.6 Following balances have been extracted from the bloks of Shri Ram Rayons on
31't March 2011 :-
Opening stock Rs. 15,000; Purchases Rs. 50,000; Sales Rs. 80,000; Return Inu,ard
Rs. 300; Return Outward Rs. 2,00.0; Debtors Rs. 40,500; Fixed deposit in tsank
Rs. 10,000; Creditors Rs. 25,000; B/R Rs. 11,400; B/P Rs. 8,000; Interest received on
o
is. 900; Drawings Rs. 6,300; cash Rs 1,000; capitalr Rs. 37,300;
Fixed deposit
Discount (Dr) Rs. 600; Commission (cr) Rs. 2,200; .Repairs Rs. g00;
Wages Rs. 2,400; Salaries for 1l months Rs. 5,500; Advertisement Rs. I,200;
Trademark Rs. 1,500; Building Rs. 10,000; Bad debt Rs. 800; Provision for bad debts
Rs. 1,900.
Prepare Final Accqunt for the'year under 31't March i011 after taking into
consideration of following adjustmentsl
(1) Stock on 31't March 2011 Rs. 28,400.
(2) Interest accrued on fixed deposit in Bank for 3 months, commission received in
advance Rs 400.
(3) Further bad debts Rs. 500 anct maintain provision for bad debts at 5o/o ondebtors.
(4) Depreciate building by 5%
(5) Goods worth Rs. 300 were donated for which no entry was made in the books.
(6) Provide for rganager's commission 5% on". net profit after charging this
,-:
' commission. t14l
Page 3 of4
[1M511s] i l4e6ol
. Q,7 Prepare trading Nc andbalance sheet frorn the following particulars of Vaidhya Ltd.
Stock tumover - 6tirnes : :
Creditor pay,ment period 2. months

--
Gross profit - Rs 60,00,000
.,.
Debit collection period = 3 months
Fxcess of closirig stock over opening stock

- Rs. 5,00,000
Assume that no cash purchases and cash sales are made. Bank balanrce is.thelalancing
figure in the balance sheet.

:- t14l
---------X----------X----------
[1M611s] ,. [496t]l
l
.t
[Total No. of Pages :
M.B.A. I Semester (Main & Back) Examination - 2015

M - 105 A Accounting for Management
Maximum Marks
-_*----**irr; *as@:1l{arks : 28
Instructions to Candidates:
1) The question paper is afviaea in two sections.
2) ' Tltere are sections A&8. Section A contains 6 questions out of which the
candidate is required to attempt qny 4 questions. Section B contains short
case study/application base I question which is compulsory.
i) lU.guestions are carrying equal marlrs.
Section - A
1. a) Prove that the Accounting Equation is satisfied in the following transactions
sheet ofAshirwad after final transaction:-
Rs.
1) Ashirwad commenced business with cash 1,00,000
ii) Bought goods from chouhan 25,000
iii) Bought furniture on credit from suhani 10,000
rg Ashirwad invested additional capital 15,000
' v) Paid salary' 3,000
vi) Paid cash to Suhani 5,000
vii) Cash purchases 40,000 (7)
,/
"/
' b/" "Accounting
\'\'r statements should present a true and fair view of the business as
they are analysed by many internal and external parties". Comment . {7}
2. Write short notes on the following:
a) Methods of accounting for price ievel changes
b) Types of responsibility centres {7+7)
\--ffiorn the following balances of Shaurya as at 31't march z}l3,you are required to
prepare the trading and profit and loss account for the year ended 31't March ,2013
1M 611S,/zors (1) [Contd....

andabalance sheet as at that dateldftef makirg the neceEs4ry adjustment.
Rs.
Shaurya's Capital 80,000'"^
Shaurya's Drawings 6,@{
@*)O,OOO
Plant and Machinery balance l.4.2An
- 3l'B't\B
Plant and machinery addition on t.l}.z}lz -i1.t.2Dl3 (4ifrOO
estock on 1.4.2012 15,000,--
*.P{nchase 82,000/
, .'.*- !.- -.t*;-+ - ,/'-
-.-.
2,00v
_
Keturn Inwards
PSund.y DEbtors 20,600
\Fumiture andFixturgs 5,Wo
iFreight and duty 2,[email protected]
Carriage outward s00
Rent, Rates and Taxes 4,64Y
' Printing and Stationary 800-
Trade Expenses qw:
Sundry creditors 10,00Q_-
Sales 1,20,400/-
- RefiuU ou,Lwafd .,-":---:==- r,000/
Postage and Telegram 800-
'tProvision for doubtful debts tgq
Discount (Cr.) 80q--
Rent of premises sublet for a year to 30e Sept., 2013 1200
4trrrurance charges 700
Salaries andwages 21,30U-
Cash in hand 6,20V
Cash at bank 2A,5AV
Adjustments:
a 'PL)y on 31't March, 2013 was valued at Rs. 14,600.
-Stock
vr{ Write offRs.600 as bad debts.
iii) . A provision for doubtful debts is to be maintainpd,at 5!o on Sundry Deptors.
l9 Cneate a provision for di5count on Debtors and reserve for discount on creditors
(
atila/o.
lM 6115' (2)
g#€'
-,/
f3!ae for depreciationon
,JY.plantand furniture and fixtures at lloh
* machinery at 20%oper annum.
per annum and on
-* Insurance prepaid was Rs.100. (14)

a) A firm purchased a machi for Rs.3.70.000 on April, 2A09.and
ffi
1't
immediately spent Rs. orylr repairs . On
The machine
ilr Rs. 2,80,000 tpber, 201.1
', s\vlz
'' -i-ll+o \" 15 Oct.2012 thS
-4 '1t"-3
Depreciation was charged @g-w. oa fixed iirstillmeni uurEuuiE"
April, 20I0,Jhe rate *as chang.d to 15% p metirod
was adopted. Prepare
@t for 4 years. c_ffiutations are to be
made to the nearest rupee and for th. y.g.n&d Jl.:Maich.- (8)
b) Define economic order quantity. How can it be computed? (t+2)
c) Iilustrate the reasons for valuation of goodwill. (3)
5. a) The following are the ratios relating to the activities ofActivist Traders Ltd:
Debtors velocity (months) J
Stock velocity (months) 8
-
Creditors velocity (months 2
Gres+arofr+r€tis(%) 25
Gross profit forthe current year ended December 3 r amounts to Rs. 4,00,000.
' closing stock ofthe year is Rs. 10,000 above the opening stock. Bills receivable
amount to Rs. 25,000 and bills payable to Rs. 10,000. Find out:
r) Sales, ii) Sundry debtors,
iii) Closing stock, and rv) Sundry creditors. (8)
b) What is the purpose ofpreparing the statement of changes in financial position?
,- How does it differ from the balance sheet or income statement? (3+3)
-6/
v _eqco-]llting Standards ensure the consistency and comparability of, Financial
Statemeirt". Explain $4)
Section - B
7. Draw inferences from the given published bash flow statement: (14)
20tt-t2 2At2-t3
(A) Net profit before Tax and extraordinary itern 3,50,4,114 2,56,74,V25
Adjustment for:
Depreciation (Net) 58,76,975 55,51,703
Miscellaneous Expenses Written off 21,79,769 27,03,012
interest Paid 37,83,972 49,08,23A
lM 611s (3) [Contd....

-,
Interest R'eceived (3,36,368) (1,36,,256)
Profit/Loss on sale of investment (2,11,276) (6,38,991)
Loss on sale of fixed assets 4,94,234 9,63,430
Dividend Received 3.i6,190 5Q.10s
Operating profit b efore w orking capitai changes 4,65,07,049 4,02,53,730
Adjustrne:rt for changes in:
:
Trade and other receivables 7,48,62,863 38,80,531

Inve{o;ies .
17,20,184 l,a8$7,278
Other current bssets, loans & advances 8i,593 8,43,796
Trade and other payable 61.31.218 4.82.241
Cash generated from own operations 3,95,77,180 5,46,09,946
Direcrtax paid 98.64.108 9t"74.349
Net cash from operating activities (TotalA) 2,97 J3,472 4,54,35,597
(B) cash flow from investing activities
Purchase offixed assets (40,98,807) (66,28,249)
Sale of fixed assets 1,63,500 3,87,500
Purchase/sale of inveStment(net) Q9,03,229) (1,a4,29,313)
Inter corporate deposit (13,90,000) (16,3434A)
Bills ofexchange
Interest received 3,36,368 1,36,256
Dividendreceived 3.16.190 50.105
Net cash used in investing activities (Total B) (75,65,978) 1,48,49,361
(C) cash flow in financingActivities
Increase in borrowings (74,82,715) 1,34,82,102)
Dividendpaid (1,40,55,984) (1,08,26,438)
Interest paid (37.83.7e2) (49.08.230)
Net cash used in financing activities (Total C) (2,53,22,491) (2,92,16,770)
Total (A+B+C) {31,75,397) 73,69,466
Opening cash/cash equivalents 52,43,382 38,73,916
Closing casir/cash equivalents 2,A,67,995 .52,43,382
lM 61X5 (4)
RollNo. TotalNo of Pages: [l
rn
F{ 1M6115
F{ M. B. A. I Sern. (Main/Back) Bxam., Jan. 2016
\0 M-105 A Accounting for Management
E
trl
Time: 3 Hours Maximum Marks: 70

Min. Passing Marks: 28
Instructions to Candidates :
'(i) The question paper is divided in two sections.
(ii) There are sections A & B. Section A contains 6 questions out of
which the candidate is required to attempt any 4 questions.
Section B contains short case study / application based question
which is compulsory.
(iii) All questions carry equal marks. i';:-.lt'iEET ivlCfil
iii:liiGS 'i .. .j t:.
I. NIL 2. NIL
SECTION.A
Q.1 Discuss in detail the concepts and conventions of accounting. [6+8=14]
Q2 What is the importance of ratio analysis to management? Explain briefly any two
ratios each for measuring. 2-elr-.o l4+5+5=l4l
tJl
(a) Profitability and
(b) Liquidity
Q.3 . What considerations are necessary in the selection of accounting policies? Give
requirement of the disclosure of accounting policies as per accounting standardl.
,.. (AS-1). [4+10=741
MORE EDUCATIOH Puneet M*re - 773773. .36A
MBA Coaching Ciasses
* Business Mathematics
[1M611s] [31ool
o Aceouniing f*r Managernent
e Managerial Econnmics
\
s Live & Recorded Batch in Rajasthan
{).4 The following balances were ascerlained from the account books of Mohit on tl4l
31't December, 2015
Capital Account 50,000

Opening Stock 10,000
Discount 500
Goodwill
Provision for doubtful debts _-jo'oo: 3,000
B/R and B/P :Doo 2,000
Cash in hand ---f; o0
Wages 9,000
Purchases & Sales PUNEIT MCRr 8O,OOO 1,20,000 ,1
Retu *qa--t -yTv-s-;-5--2000 3.000nef

Carriage in words frALWAVES z,ooo
Factory Rent
Commission 2,000
Machinery 20,000
Fumiture 6,000
Debtors aird creditor 30,000 20,000
Insurance premium 1,800
Salary - 11 months 4,400
Loanto Ram on 1.7.15 at I27o P.a. interest 10,000
Tread mark 8,800
2,00,000 2,00,000
Taking into consideration the following adjustrnents, prepare trading and profit and
loss account for the year ending 31" December, 2075 and a balance sheet on that date:
(i) Closing stock { 30,000.
(ii) Goods costilg < 1,800 was sent to a custoryleln.qp, 31't Dec, 2015 on sale or
approval which was recorded as Sales fo, < 2,6ffii mistake.
(iii) Charge depreciation @70%o p.h. on machinery and furniture.
(iv). Interest on Capital @lA7o p.a. is payable.
(v) Write of further bad debts for t 500 and increase the provision for doubtful debts
by.t 1,500.
(vi) r/tPafi of the commission relates to next year. letLl' Cb1
Q.5 Oil India is a bulk distributor of high octane petrol. A periodic inventory of petrol on
hand is taken when the books are closed at the enci of each month. The following
sufirmary of information is available for the month of June, 2015: 17+7=14)
[1M61"1s] Pagb 2 of + [31001

Sales 9,45,000
General administration cost 25,000
Opening Stock: 100000 Litres @ { 3per litre 3,00,000
Ptircha# (including freight)
June 1, 20b000 litrEs @ t z.tS per litre
June 30, 100000 litres @ < 3.03 per litre
Closing Stock June 30: 1,30,000 Litres
Compute the value of inventory on June 30, by the first in first out and weighted
averise methods of inventory costing.
All m-aterial has been issuedbefore June,30.
Q.6 From the following balance sheet of 'A' Ltd. Prepare a statement of changes in
and funds flow statement.t for the ear ended tl4l
31't march,2015
31.3.2014 31.3.2015
Assets
Goodwill 1,00,000 80,000
Machinery at cost 4,10,000 5,40,000
Investment (long-term ) 30,000 80,000
I]UI.'JE[I fuiCftE
Discount on issue of
Debentures 5,000
9B29S5g53ri
{"*Jll!.3f,t1 fr-la
:::fti,-V l,'.,*:r t,' ,-- ",}
Cash at bank 1,20,000 1,30,000
Sundry Debtors 80,000 1,90,000
Stock in ffade 40,000 55,000
7,85,000 10,75,000
3t.3.2014 31.3.2015
Liabilities ?
Share capital 3,00,000 3,50,000
Debentures 1,50,000 2,50,000

Profit and loss account 60,000 70,000
Provision for depreciation on
machinery 90,000 1,30,000
Sundry creditors 75,000 1,10,000
Bills payable 10,000 15,0(x)
7,85,000 10,75,000
[1M6r1s] Page 3 of4 [31ool

During the year investment costing < 30,000 were sold for ( 28,000. A machine was
sold for { 25,000. It had cost t 40,000 and accumulated depreciation on it was
{ 9,500.
,/ABC Ltd. gives you the rouo*ffiIoEilffiil3ou

LECTION.B
1.1 statement
are required to prepare cash f'tow
using indirect method as per As-3 (Revi for the year ended 3l.3.Zol5:
Balance Sheet as on..
31.3.r4 31.3.15
t
Liabilities
Capital 50,00,000 50,00,000
Retained earnings 26,s0,000 36,90,000
Debentures 9,00,000
Current Liabilities
Creditors 8,80,000 8,20,000 MORE EDUCATION
Bank Loan 1,50,000 3,00,000
Liability for expenses 3,30,000 2,70,000 IVIBA rr:lrhrrr, (-lit.,Lt j
Dividend Payable 1,50,000 3,00.000 r BusinessMathernatics
91,60,000 1,12,80.000
" Acccuntin6 For
Management
Assets
r Manageriel[conanrics
Plant and machinery 27,30,000 40,70,000
Irss- Depreciation Ll ,'i .:.l, llr.i.::rra:tii IJ.::::li tl, ii;1,;:.-iI;tr.,
6,10,000 7,90,000
21,20,000 32,90,000 Punept Mo re- 2237733350
Cdrrent Assets
Debtors 22,40,000 26,40.000
.)+
Cash 15,20,000 18,20,000
Marketable securities 11,90,000 1500,000
Inventories 20,10,000 19,20,000
Prepaid Expenses 90,000 1,20,000
91,60,000 1,12,90,000
Additional Information :
(a) Net profit for the year ended 31't March, 2015 after charging deryeciation
< 1,80/D0 is t 22,4&000.
(b) ABC Ltd. declared <tividend of t 12, 00,000 for the year 2014-15. tl4l
[1F,{S115] Page 4 of 4 [31CI01

[' btal No. of Pages :
l,n
I.r
M.B.A. I Semester (Main&Back) Examination Dec. -2016
I
\o
-
M-105 A Accounting for Management
F'{
=
Time : 3 Hours Maximum Marks :74
Min. Passing Marks :28
Instructions to Cundidates
i) The question poper is divided in two sections.
iil There are sections A & B. Section A contains 6 questions out of which the
I
case study/application base question which is compulsory.
iiil All questions are carrying equal marks.
SECTION . A
1. o'Accounting principles are a body of doctrines
commonly associated witlr the
theory andprocedures ofaccounting serving as an explanation ofcurrentpractices".
Comment (14)
Write short notes on :
.ta.
a) Zera Based Budgeting. @ (6)

b) Income statement. C (3)
c) Final accounts. (5)
3. Ahe following
@
su--a.i7.d balance sheets of Mo
a7;-r,ia limi
Ahe followine are the summarized Molherlndia limited as on
arc.n Jl. lul) -
..2 , March3l,20l1 t1
,
Liabilities 2014 2015 Assets 24ru 2015

Share capital 4,50,000 4,50,000 ,#Plant& 4,00,000 3,20,000
Machinery
P8{,LA/C 56,000 68,000 Investments 5 0,000 60,000
4b
Creditors L,68,000 1,34,000 .Jnventory 2,40,000 2,10,000
' Provision for 75000 10,000 rtebtors 2,10,000 4,55 "000
taiation
Mortgage loan 2,7 0,000 Cash and bank L,49,000 ,r97,000
14149,000 12142,000 10149,000 12,42,000
1M6115 lzorc (1) [Contd....
.i ?
*rqo, ltfu'tr'$il,tr
q*-f'Lcnr\)
)ztu,,lZ%S
i) Investment costing Rs. 8000 were sold during the Year for Rs. 8500.
ii) Provision,for tax made during the year was Rs. 9000
iii) During th6 year part of the plant and machinery costing Rs. 10,000 were sold for ,(
Rs. 12000 the profit was included in profit ilnd loss account. 0$
rr) Dividendpaid during the year amounted to Rs. 44,080.
a You are required to prepare cash flow statement in new format as perAccounting standard
-$
S ,3
(\eyised) by indirectmethod.
tr?Wefollowinginformation,computethevalueofgoodwillbyusingAnnuity
(8)
N ^f ,/ ii)t Average capital employed Rs. 4,0d,000 (h
:l li' , Normal Rate of profit l2o/o. \_7
fl No- $fi)
\\-/ p*f,t f- tt. y.ur 2Ol2-13 Rs. 62000 ,2013-t4Rs. 59000 and2014-15
.\ lY/
/-\, t,},(|if,tlo'rorr",
f/ ivlX-Profit for year 2013-14
2ot3-t4has at afte.r
been arrived at
h?$_hggn writting off abnormal
afterwriting
f\.ffi^s[::*t}i::3,,tt1profitfortheyear20l4-l5includeSanon.recurring
p-^$"/nF/
", y.fi: will is to be varued
"> Good valued on the basis
basrs ot
of annutty
annuity ot of
of 3 year purchase ot
Wr/
W/
/ ',/q
D ./ p
iltjii:
The Annual requirement of a company's factory working 300 days ayear, are
9000 units of a Raw material costing Rs. l0 per unit, placing eacil order costs
Rs. 45 and the carrying cost is Rs. 10% per year of average inventory. You
Ks.
d ,*/
e
'.13/
\ .SPr/ are required to calculate the economic order quantify. k\ (6)
:};f write notes on: (:{
,S a) Responsible Accounting .a A9 v (6)
b) Price tevel change aq i;;
c) Methods of depreciation valuation. S- , ' (4)
6. " The analysis and interpretation ofthe financial statement results\Pthe presentation
of information." Explain illustrate your answer with suitable example. (14)
SECTION I B
(Case Study)
7. From the given information make out a Balance sheet of XYZ ltd. With as many
details as possible:
Rs
Sales '
r 800000 '7c
b)')- tq *t oc
Total Assets turnover 03.0
(1 t(ctcLt ,:l ,e?zot
Fixed absets turnover 05.0
Current Assets Turnover 07.5
Inventory turnover
1c19t'u'i a o A
20.0
Debtors Turnover 15,0
02.5
0l .00(one)
**
02.00 (14)
.1,
li'-
lqtvn
",1M6115 (2)
VIDEO AVAILABLE FOR
WWW.MOREEDUCATION.IN ALL PRACTICAL & THEORY SUBJECT RTU MBA CLASSES SINCE 2005
Roil No. I vltllt {J*tdo O Total No of Pages, p
M. B. A. I Sem. (Main/Back) Exam,, Dec" 2017

vr-l0sA Accounting for Managememt
3 Hours
Maximum Marks: 70
Instructions to Candidates Vflin. Fassing Marks:28
:
f!.. The question paper is divided in two sections.
("){*:,:,f
i;,i:il,tiy*frrft;;;:;iii;rryrr;:;l:f :;,?"1:{,y,2*B
contains short case"riiy i\iiiirifioi toria"{"q'iZir"ion
L leLrLLt which is
(,rrl "f,f{l"oo's carry equar marks.'
v' r (a) IJerrne Accounting. List the major users of

Accounting. Explain the various types
of Accounting with suitable examples.
l7l
(b) "Accounting. principles forms the back-bone
but the principres accepted world wide." Explain-
-- - - ---- -^.,'
of Accounting. These *. no, *L,
t7)
O'' cash Flow Statement from the followjng Balance
Sheet of ABC engineering
Iffil"te
Liabilities t
MORE EDUCATION Buildings
9829959536
2015 2016 <
Share Capital
2Ar5 <
17,00,000 19,35,000
Assets 2016 {
Reserves 9,00,000 10,00,000
.10,000 93,700 Plant
& Machinery 2,50,000 3,70,000
Profit & Loss Furniture and
Appropriation a/c 1,00,000 1,30,000 Fittings
Provision for 5,000 6,000
70.000 50,000 Cash
Dividends 2,0a0 2,200
1,00,000 95,000 Debtors 1,00,000 45,000
Creditors 9,000 19,000 Accounts
Bank Overdraft 14,000 13,000 Receivables 9,000 9,000
Bills payable 10,000 70,000 Stock 4,00,000 3,43,700
Loan on Mortgage
Prepaid
Expenses 3,000 3,100
Investment L,64,000 1,70,000
Goodwill 3,00,000 3,43,700
Preliminary
Expenses 10,000
20,42,000 22,,94,700 20,42,000 22,94,700
[1M61 r s] Page L af 4
132401
JAIPUR-VIDHYADHAR NAGAR 418 MANSAROVAR PLAZA PRATAP NAGAR

VIDEO AVAILABLE FOR
Additional information: -
(a) Depreciation is charged on building at 3 percent of cost < 9,00,000. On plant and
Machinery at 8 percent of cost < 4,00,000. On fixtures and fittings at 5 percent
< 8,000.
(b) Investment, were purchased and interest received < 3,000 was used in writing
down the book value of investments.
(c) The declared dividend for 2016 was paid and the interim dividend of ( 20.000
paid out of the Profit and Loss Appropriation Account.
From the following Trial Balan ," fffio*o

"H*".T,# ,{#{^I[];Tros Prepare
his Trading and Prcfit & Loss alc for the year ended 31't March 2017 and a Balance
Sheet as on the date: tr4)
1 e tq* {ao x) (v't Joto/
_, Cu{rtal , 2,00,000
,.Dralvtngs L
' 'r' 20,000 L
Salbs 3 1,00,000 3
1,00,000 q
,D"btorsV
A,Purchases Returns f 6,000 5
/BlP 6 29,000 6
./ Bad Debts + 2,000 +

.Printing & Stationary g
' 4,000 8
.Interest on Bank Depositq 500 et
,,/Loan from Mohan to 9,000 lo

ft
./Carriage on Sales I I 3;000
TDiscount Received I L 2,000 (z
&JVlanufacturing Expen s e s /;l 75,000 1,3
le
MORE EDUCATION 9829959536
rSalaries l t{ 22,400
TFactory Rentl J 9,000 (9
.- Investment I 6 t6 5,000
TFurniture tT 60,000 11
,Purchases lg
'rCreditors 6,00,000 l8
tq 1,20,000 tq
'*,zSales Returfi
Lo 14,000 A"/
9o
/RlR L'r .,!!# 60,000 2-t
"/Advertising n- 4,000 LL
JDiscount Allowed L3 1,000 z3
lVtunt & Machtneryzv 90,000 Lv
LT 22,0W 2J
'
/Depreciatiofl on Plant & Machinery Zd 4,500 z6
4tock1.4fl6 27. L,37,000 7 7
4rade Expdnses L8 5,000 2"8
,rCash in Hand Lq 58;000 Lq
'rrtash at Bank 3o 7q000 3 0
,rChosing Stock was T 50,000 3f
[1M611"s] Page 2 of 4 rc24a1

VIDEO AVAILABLE FOR
QAZ$l^t" Notes on : -
f @ Indian Accounting standards t4l
.6 Zero Based Budgets t41
@ ResponsibleAccounting 141
,$ X"ounting Equation tzl
Q.5 (a) ,Etomthe following information, compute the value of goodwill by using annuity
,/ Method: 171
/ (i) Average Capital Employed <4,00,000.
(ii) Normal Rate of Profit 12Vo.
(iii) Profit for the year 2013-14 has been arrived at after writing off abnormal
loss of { 2,0(X), and profit for the year 2014-2015 includes a non-recurring
' income of t 3000.
(iv) the year z0rz-r3 (62,000; z0t3-14 <se,000 u"o ,oto-,.irurpJ(tvfwa
igtri::
(v) Goodwill is to be valued on the bdsis of annuity of 3 year's purchase of
super profit.
gt' f refrigerator manufacturer purchases 1,600 units of a certain component from
( M. His annual usage is 1,600 units. The order placing cost is { 100 per order and
the cost of carrying one unit for a year is 7 70Vo of cost per unit which is t 80. ZpO
Calculate the economic ordering quantity. t7l
ar$$- From the following figures prepare Comparative Balance Sheet, using t7l
4 (i) Increase or decrease in absolute data in terms of rupee amount, and
(ii) Increase or decrease in absolute data in terms of percentages.
'
Infotech Pvt. Limited
Balance Sheets
As on 31"' March .2016 and 201 (Rs. In Lakhs)
Liabilities 20t6 Rs.) 20t1 (Rs.) Assets 20t6 (Rs.) 20t1 (Rs")
Preference Share Capital 80 90 Fixed Assets 500 600
Equity Share Capital 340 320 Less: Depreciation 100 n5
Net Block 400 475
Reserves and Surplus 150 225 Capital work-in-progres s 150 190
Long-term Borrowings 300 400 Investments 100 r67
Current Liabitities and Current Assets
provisions :
(i) Stock 2AA 150
(i) Sundry Liabilities t20 132 (ii) Receivables 100 225

(ii) Provisions 60 90 (iii) Cash & Bank 100 50
Balances
Total 1,050 1,257 Total 1,050 r257
[rM6L 1s] t'''9, H/ ^Y^ge 3 of 4 ( q, 7/t,[ 3zqol

VIDEO AVAILABLE FOR
9frf
*5n€
{<6) Write Notes on:-

.{n _Income statement (with Example) t41
'M Methods of Depreciation (with example) t3l
SECTION.B
Case Studv
is the Balance Sheet of M/s. Weldone Ltd. as on 31't March,z}ll

ffrU.rlowing
Liabilities Rs. Assets Rs.
Equity Share Capital 3,00,000 Land 50,000
Preference Share Capital 4,00,000 Building 3,00,000
General Reserve 50,000 Plant & Machinery 3,00,000
Profit & Loss Account 50,000 Furniture '', 40,000
\
L2Vo Debentures 2,00,000 Debtors 2.00,000
Trade Creditors 60,000 Stock 1,50,000
Outstanding Expenses 15,000 Cash 40,000
Provision for Taxation 20,000 Prepaid Expenses 10,000
Proposed Dividends 30.000 Preliminary Expenses 35.000
LI,,25,000 LL,25,000

From the particulars you are required to calculate and interpretate: -
Current Ratio 3" L t21
-81
p DebtEquityRatio , Z( l rl/
' ,Zg , t3l
*fi) Capital Gearing Ratio qS, I 6 7 1, 0033 t3l
a6
' Liquid Ratio t. IL t21
Ff Solvency Ratio,.*-- '- ,Zq,g / tzl
Proprietary natio . 1o L 8/ , t3 ) t2)
"g 7
[rM611s] Page 4 of 4 l324ol

'otat No. of Pages :
t,n
F{
in".{ MBA I Semester (Main&Back) Examination, Dec. - 2018
\o M-105A Accounting for Managernent
E
F{ l(MMJxx G?a
Time : 3l{ours Wlaximumr Marks z 70
Min. Passing Max'ks z 28
Instructions to Candidates:
I) The question pqper is divided in two sections.
2) There are sections A & B. Section A contains 6 questions out of which the
I
case study/application base question which is compulsory.
3) All questions are carrying equal marlrs.
A
Section -
Define Management Accounting. Write the application and scope of
Ya) ManagementAccounting. Q)
b) What do you mean by GAAP? Write the various concepts ofAccounting in
/ rndia. Q)
n
2o From the following trial balance ofAK traders prepare final accounts for the year
ending3l't December 201 5.
Particulars AmountDr: Es.) AmountCr: Es.)
Capital 57 ,5 00
Plant And Machinery 69,000
Scooter 9,2A4 :
Returns ' 5,290 3,680
Stock (1 January, 20A6) 18,400
Purchases and Sales 77 ,7 4A 1,28,880
Bad - debts 690
Carriage 1,610
Trade Expenses 2,7 60
1M6115 t2ot8 (1) [Contd.,..

Bad - Debts Provisions I ,610
Bank - Loan 1 1,500
Interest on Bank - Loan 690
Commission 2,070
Insurance and Taxes 4,600
Scooter Expenses 5,980
Salaries 10,120
Cash-in-hand 4,600
Cash - at - Back 6,07 0
Debtors and Creditors 6,900 18,400
2.23,650 2.23,650
1) Stock on31-12-2015 was valued at Rs. 9,980.

2) Salaries have been paid for 11 months.
3) l}Yo p.a. interest on loan has to be paid.
4) Write offRs. 460 as further Bad - debts and maintain bad - debts provisions
at 5%o on debtors.
5) Commission includes Rs. 690 being commission received in advance.
6) Depreciate Plant and Machinery by 5% and Scooter by l5%. (14)
3. Explain the meaning of IFRS. How manyAccounting standards had been introduced
inlndia?Explainany l0ofthem. (4+5+5:14)
The following are the summarised Balance Sheets of rhother India limited as on
March 31,2015 and 2016.
Balance Sheets
Liabilities 2015 Es.) 2016 (Rs.) Asets 2015(Rs.) 2016(Rs.)
Share capital 4,50,000 4,50,000 Plant & Machinery;< 4,00,000 3,20,000
General Reserve 3,00,000 3,10,000 Investments J< 50,000 60,000
P & L alc 56,000 68,000 Inventory C+ 2,40,000 2,10,000
Creditors Uv 1,68,000 1,34,000 Debtors Lh 2,10,000 4,55,000
Provision forTaxation * 75,000 10,000 Cash and bank 1,49,000 1,97,000
Mortgage Loan - 2,70,000
10.49.000 12,42,000 10.49,000 12,42,000
1M6115 (2) qbcoo

A dditional fnformation :
-
rt Investm'ent costing Rs. 8,000 were sold during the year
for Rs. g,500.
ii) Provision for tax made during the year was Rs. 9,000.
iii) During the year part of the Plant & Machinery costing Rs. 10,000
were sold
for Rs. 12,000 the profit was included in profit and Loss Account.
rD Dividend paid during the year amounted to Rs. 44,ogo.
You are required to prepare cash Flow statement in new format

as per
Accounting standard 3 (Revised) by indirect method.
(14)
-
5. Write notes on:
a) Responsible.Accounting
(s)
b) Zero Based Budgeting
(s)
c) TrendAnalysis.
(4)
The following information relates to the business
of a partnership firm a
a
a) Average Capital employed in the business Rs. 50,00,000.
b) Net tradiffirofit ofthe*,{par q,''d

the past three y.fl, (after;axalion) wgre ,*r#
Rs. 10,20,000; Rs. 6,40,000 and Rs. 7,40,06fl* ,, --l$,l$ t,so'*-
c) Reasonable Return Expected in the same type of business
is l0 percent. R
d) Fair remuneration to the partners for their services is Rs.
2,10,000. \ O buz0
Calculate the value ofgoodwill -
t) on the basis of five year's purchase of the annual average super profits
ii) tr\- 3s,''til
on the basis of capitalising the annual average super profit at the reasonable )6uJ
return of lUYo; and.
.*rrf.d
r(
iii) on the basis on an annuity,of super profit, taking the present
value of
annuify of one rupee for five years at l0 percent interesi
is Rs. 3.7g1.
Comment as to which method (out of the above) is more
appropriate and
why?
(14)
1M6115 (3)
[Contd....
I
Section - B (ComPulsory)
Fro m the following annual statemegt of ZLtd,calculate the following
s, ratios
l.
/ (4)
il Gross Profit Ratio, , \6'-'
CurrentRatio, tc Q')
w'
(4)
Liquid Ratio, \i
f)d) Return on Investment Ratio-z
^
"b\
n{ (4)
.Trading Profit & Loss A/c

For the Year ended 3lst March 2016'
Rs. Rs.
To material consumed :
By Sales 85,000
OBening Stopk 9,050 By profit on sales of investment 600
Purcha;n 54.525 By Interest on Investrnent 300
63,575 Ld
(P
tr ess : Closing Stock 11,0Q0 49,575
To Caniage trnwards L',425
To Office Expenses 15,000
To Sales Expenses 3,000
To Finaneial ExPenses 1,500
To Loss on Sale of Fixed Assets 400
To Net Profit 15,000

8sp00
85,900
Balance Sheet
Rs. Aseb Rs.
Liabilities
Share capital :
Fixed Assets :
Buildings 15,000
2000 equity share of
20,000 Plant 8,000 23,000
Rs. 10 to each FullY Paid
++
General Reserve 9,000 CurrentAssets:
Profit & loss Alc 6,000 Stock in Tradott 14,000 tX

3,000 Debtors 7,000
Bank Overdraft
Bills receivable 1,000
Sundry Creditors :
Bank Balance 3,000 25,000

For Expenses 2,000
8,000 10,000
p
For others
4^S"
48,000 /'/" 48.000
Lx,
1Nr6115 (4)

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A unit of Realwaves (P) Ltd

I have the pleasure of presenting this study material to you. It

I wish you a very happy study time.

Course/Paper : M-105 MBA Semester-I

Module II: Elementary Preparation of Books of Accounts (6 Hours)

Module III: Financial Statements (6 Hours)

Module V: Accounting Standards and Introduction to IFRS (6 Hours)

Module VII: Emerging issues in Financial Accounting (4 Hours)

2 MODULE 2 - ELEMENTARY PREPARATION OF

4 MODULE 4 - ANALYSIS OF FINANCIAL STATEMENT

First Mid Term 30.09.19 19.08.19

Second Mid Term 14.11.19 04.11.19

Last Working Day 18.11.19 16.11.19

Winter Break 25.12.19 to 31.12.19

CHAPTER 1 INTRODUCTION TO ACCOUNTING

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Trading & Profit and Loss

Trial Balance Ledger

OBJECTIVES / FUNCTIONS/ SCOPE OF ACCOUNTING

(iv) To ascertain the progress of the business from year to year.

(v) To provide information’s to various parties: Another main objective of accounting is to

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

1) Identifying: Identifying the business transactions from the source documents.

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

7) Communicating: It is concerned with the transmission of summarized, analyzed, and interpreted

BOOK-KEEPING AND ACCOUNTING

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Difference between Book-Keeping and Accounting

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

1) Financial Accounting: It is the original form of accounting. It is mainly confined to the

2) Management Accounting: Management accounting is comprised of two words 'management and

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Internal Users External Users

2) Prospective Investors: A prospective investor is interested in knowing the financial strength of

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

7) Others: Some other persons/parties are also interested in accounting information:

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

BASIC ACCOUNTING TERMS

PROFORMA OF BALANCE SHEET

Balance sheet as on or as at …….

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

MEANING OF ACCOUNTING EQUATION

Assets = Internal Equity + External Equity

Assets = Capital + Liabilities

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

An accounting equation may be developed by taking the steps given below:

PRACTICE QUESTIONS OF Accounting Equation

(ii) Purchased goods –20,000 + 20,000 + 0 = 0 + 0

(iii) Purchased –10,000 + 0 + 10,000 = 0 + 0

Vidhyadhar Nagar: F – 45, Balaji Tower – I, Behind Vishal Mega Mart.

(iv) Sold goods +11,000 – 9,000 + 0 = 0 + 2,000

(v) Sold goods costing +600 – 1,000 + 0 = 0 –400

QUESTION 2. (Preparation of accounting equation) From the following transactions, prepare an

(ii) Purchased goods –10,000 + 10,000 = 0 + 0

(iii) Commission +5,000 + 0 = 5,000 + 0

(iv) Sold goods +10,000 – 8,000 = 0 + 2,000