UNIT - V

INTRODUCTION TO FINANCIAL ACCOUNTING CONCEPTS

History of Accounting:
Accounting is as old as civilization itself. From the ancient relics of Babylon, it can be well
proved that accounting did exist as long as 2600 B.C. However, in modern form accounting based
on the principles of Double Entry System came into existence in 17th Century. Fra Luka Paciolova,
a Franciscan monk and mathematician published a book De computic et scripturies in 1494 at
Venice in Italy. This book was translated into English in 1543. In this book he covered a brief
section on ‘book-keeping’.

Origin of Accounting in India:

Accounting was practiced in India thousand years ago and there is clear evidence for this.
In his famous book Arthashastra, Kautilya dealt with not only politics and economics but also the
art of proper keeping of accounts. However, the accounting on modern lines was introduced in
India after 1850 with the formation joint stock companies in India.

Definition of Accounting:

Smith and Ashburne: “Accounting is a means of measuring and reporting the results of economic
activities.”

R.N. Anthony: “Accounting system is a means of collecting summarizing, analysing and reporting
in monetary terms, the information about the business.

American Institute of Certified Public Accountants (AICPA): “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.”

Thus, accounting is an art of identifying, recording, summarizing and interpreting business

transactions of financial nature. Hence accounting is the Language of Business.
 BOOK-KEEPING AND ACCOUNTING

According to G.A. Lee the accounting system has two stages.

1. The making of routine records in the prescribed form and according to set rules of all
events with affect the financial state of the organization; it is known as Book Keeping and
2. The summarization from time to time of the information contained in the records, its
presentation in a significant form to interested parties and its interpretation as an aid to
decision making by these parties is known is Accounting.

Book – Keeping: Book – Keeping involves the chronological recording of financial transactions
in a set of books in a systematic manner.

Accounting: Accounting is concerned with the maintenance of accounts giving stress to the
design of the system of records, the preparation of reports based on the recorded date and the
interpretation of the reports.

Distinction between Book – Keeping and Accountancy

Thus, the terms, book-keeping and accounting are very closely related, though there is a
subtle difference as mentioned below.

1. Object: The object of book-keeping is to prepare original books of Accounts. It is restricted

to journal, subsidiary book and ledge accounts only. On the other hand, the main object of
accounting is to record analyse and interpret the business transactions.

2. Level of Work: Book-keeping is restricted to level of work. Clerical work is mainly

involved in it. Accountancy on the other hand, is concerned with all level of management.

3. Principles of Accountancy: In Book-keeping Accounting concepts and conventions will be

followed by all without any difference. On the other hand, various firms follow various methods
of reporting and interpretation in accounting.

4. Final Result: In Book-Keeping it is not possible to know the final result of business every
year,
1Q) Define Accounting and Explain its Origin?

2Q) Explain Distinction between Accounting and Book keeping?

3Q) Define Accounting and Briefly Explain Book Keeping?

 ADVANTAGES OF ACCOUNTING

The role of accounting has changed from that of a mere record keeping during the 1 st
decade of 20th century of the present stage, which it is accepted as information system and
decision-making activity. The following are the advantages of accounting.

1. Provides for systematic records: Since all the financial transactions are recorded in the
books, one need not rely on memory. Any information required is readily available from
these records.
2. Facilitates the preparation of financial statements: Profit and loss accountant and
balance sheet can be easily prepared with the help of the information in the records. This
enables the trader to know the net result of business operations (i.e. profit / loss) during
the accounting period and the financial position of the business at the end of the
accounting period.
3. Provides control over assets: Book-keeping provides information regarding cash in
hand, cash at bank, stock of goods, accounts receivables from various parties and the
amounts invested in various other assets. As the trader knows the values of the assets he
will have control over them.
4. Provides the required information: Interested parties such as owners, lenders,
creditors etc., get necessary information at frequent intervals.
5. Comparative study: One can compare the present performance of the organization with
that of its past. This enables the managers to draw useful conclusion and make proper
decisions.
6. Less Scope for fraud or theft: It is difficult to conceal fraud or theft etc., because of
the balancing of the books of accounts periodically. As the work is divided among many
persons, there will be check and counter check.
7. Tax matters: Properly maintained book-keeping records will help in the settlement of
all tax matters with the tax authorities.
8. Ascertaining Value of Business: The accounting records will help in ascertaining the
correct value of the business. This helps in the event of sale or purchase of a business.
9. Documentary evidence: Accounting records can also be used as an 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. As such, Courts accept these records as
evidence.
 10. Helpful to management: Accounting is useful to the management in various ways. It
enables the management to assess the achievement of its performance. The weakness of
the business can be identified and corrective measures can be applied to remove them
with the helps accounting.

6. LIMITATIONS OF ACCOUNTING

The following are the limitations of accounting.

1. Does not record all events: Only the transactions of a financial character will be recorded
under book-keeping. So it does not reveal a complete picture about the quality of human
resources, location advantage, business contacts etc.
2. Does not reflect current values: The data available under book-keeping is historical in
nature. So they do not reflect current values. For instance, we record the value of stock at
cost price or market price, whichever is less. In case of, building, machinery etc., we adopt
historical cost as the basis. In fact, the current values of buildings, plant and machinery
may be much more than what is recorded in the balance sheet.
3. Estimates based on Personal Judgment: The estimate used for determining the values of
various items may not be correct. For example, debtors are estimated in terms of
collectability, inventories are based on marketability, and fixed assets are based on useful
working life. These estimates are based on personal judgment and hence sometimes may
not be correct.
4. Inadequate information on costs and Profits: Book-keeping only provides information
about the overall profitability of the business. No information is given about the cost and
profitability of different activities of products or divisions.

BASIC ACCOUNTING CONCEPTS

Accounting is a system evolved to achieve a set of objectives. In order to achieve the goals, we
need a set of rules or guidelines. These guidelines are termed here as “BASIC ACCOUNTING
ONCEPTS”. The term concept means an idea or thought. Basic accounting concepts are the
fundamental ideas or basic assumptions underlying the theory and profit of FINANCIAL
ACCOUNTING. These concepts help in bringing about uniformity in the practice of
accounting. In accountancy following concepts are quite popular.

1. BUSINESS ENTITY CONEPT: In this concept “Business is treated as separate from the
proprietor”. All the transactions recorded in the books of Business and not in the books of
proprietor. The proprietor is also treated as a creditor for the Business.
2. GOING CONCERN CONCEPT: This concept relates with the long life of Business. The
assumption is that business will continue to exist for unlimited period unless it is dissolved due
to some reasons or the other.

3. MONEY MEASUREMENT CONCEPT: In this concept “Only those transactions are

recorded in accounting which can be expressed in terms of money, those transactions which
can not be expressed in terms of money are not recorded in the books of accounting”.

4. COST CONCEPT: According to this concept, can asset is recorded at its cost in the books
of account. i.e., the price, which is paid at the time of acquiring it. In balance sheet, these assets
appear not at cost price every year, but depreciation is deducted and they appear at the amount,
which is cost, less classification.

5. ACCOUNTING PERIOD CONCEPT: every Businessman wants to know the result of his
investment and efforts after a certain period. Usually one-year period is regarded as an ideal
for this purpose. This period is called Accounting Period. It depends on the nature of the
business and object of the proprietor of business.

6. DUAL ASCEPT CONCEPT: According to this concept “Every business transactions has
two aspects”, one is the receiving benefit aspect another one is giving benefit aspect. The
receiving benefit aspect is termed as “DEBIT”, whereas the giving benefit aspect is termed as
“CREDIT”. Therefore, for every debit, there will be corresponding credit.

7. MATCHING COST CONCEPT: According to this concept “The expenses incurred during
an accounting period, e.g., if revenue is recognized on all goods sold during a period, cost of
those good sole should also Be charged to that period.

8. REALISATION CONCEPT: According to this concept revenue is recognized when a sale

is made. Sale is

Considered to be made at the point when the property in goods posses to the buyer and he
becomes legally liable to pay.

ACCOUNTING CONVENTIONS

Accounting is based on some customs or usages. Naturally accountants here to adopt that usage
or custom.

They are termed as convert conventions in accounting. The following are some of the important
accounting conventions.

1.FULL DISCLOSURE: According to this convention accounting reports should disclose

fully and fairly the information. They purport to represent. They should be prepared honestly
and sufficiently disclose information which is if material interest to proprietors, present and
potential creditors and investors. The companies ACT, 1956 makes it compulsory to provide
all the information in the prescribed form.
2.MATERIALITY: Under this convention the trader records important factor about the
commercial activities. In the form of financial statements if any unimportant information is to
be given for the sake of clarity it will be given as footnotes.

3.CONSISTENCY: It means that accounting method adopted should not be changed from year
to year. It means that there should be consistent in the methods or principles followed. Or else
the results of a year Cannot be conveniently compared with that of another.

4. CONSERVATISM: This convention warns the trader not to take unrealized income in to
account. That is why the practice of valuing stock at cost or market price, whichever is lower
is in vague. This is the policy of “playing safe”; it takes in to consideration all prospective
losses but leaves all prospective profits.
ACCOUNTING PROCESS / ACCOUNTING CYCLE
The following Steps included in Accounting Process
The various steps of the accounting process are:

1. Identify the Transaction

Identifying the business transaction is the initial step in the process of accounting. The business
entity has to identify financial and monetary transactions. Therefore, only those transactions
that are monetary are recorded. Also, the transactions that belong to the business are to be
recorded, and not the owner’s transactions are included in the books of accounts of the business.
2. Recording of the Transactions in the Journal
After identifying the transactions, the second step of the accounting process is to create the
Journal entry for every accounting transaction. The point of recording transactions is based on
the policy followed by the entity for accounting, i.e. accrual basis or cash basis of accounting.
In the accrual basis of accounting, the revenues and expenses are recorded in the entity’s books
in the period when they are earned and incurred, respectively, regardless of the actual cash
receipt and payment. However, in the case of cash accounting, the transactions are recorded
only when the actual cash is received/paid. In a dual entry system, every transaction affects at
least two accounts, i.e., one account is debited, and another account is credited. For example,
if the purchases are made in cash, the purchases account will be debited (purchases increase),
and the cash account is credited (cash decreases).
3. Posting in the Ledger
After recording the transaction in the Journal, the individual accounts are then posted in the
general ledger. t helps the owner/accountant know each account’s balance individually. For
example, all the debits and credits of the bank account are transferred to the ledger account,
which helps to know the increase and decrease in bank balance during a period. Finally, we can
determine the ending bank balance from it.
4. Unadjusted Trial Balance
The company’s trial balance is prepared to check whether the debits are equal to the credits or
not. The trial balance’s main purpose is to identify any errors made during the above process.
The trial balance reflects all the accounts balances at the given time. After the preparation of
the trial balance, it is checked that the total of all credits is equal to the total of all debts, and if
the total is not the same, then an error is to be identified and corrected. There can be other
reasons for the error, but firstly, an accountant tries to locate the error by preparing the trial
balance. Also, trial balance helps to know the balances of all accounts in a summarized form.
5. Adjusting Journal Entries
When the accrual basis of accounting is followed, some of the entries are to be made at the end
of the accounting year, such as entries of expenses that may have been incurred but are not
booked in the Journal and entries of some income that may be earned by the business but are
not yet recorded in the books. For example, the interest amount on a fixed deposit is earned
each year, but it is accumulated in the fixed deposit amount. This interest income is to be
recorded in the books of accounts yearly because the interest is earned yearly, no matter the
amount will be received together after the maturity of the fixed deposit.
6. Adjusted Trial Balance
After all the adjusting entries are made, again, a trial balance is to be prepared before preparing
the financial statements to check that all the credits are equal to the debits after the adjustment
entries are made.
7. Preparation of Financial Statements
After all the above steps are completed, the financial statements of the company are prepared
to know the actual financial position, the profitability position, and the cash flow position of
the business. The statements that are prepared for knowing the above positions are a statement
of profit and loss for knowing the profitability position, the balance sheet for getting the
financial position, and the cash flow statement to know the changes in cash flows from the
three activities of the business (operating, investing and financing activities).
8. Closing Entries
Finally, the accounting cycle ends with this step. These entries transfer the temporary account
balances to a permanent account. The temporary accounts are the accounts whose balances end
in a single accounting year, such as sales, purchases, expenses, etc. These balances are first
transferred to the income statement and then to the permanent account, i.e., the profit/loss is
transferred to the retained earnings account. It should be cleared that only temporary accounts
are closed, not the permanent ones (accounts that are balance sheet accounts such as fixed
assets, debtors, inventory, etc.)
After closing entries are made, the trial balance is again prepared to check that the debit equals
the credit, and the accounting cycle starts again with the beginning of another accounting year.
 CLASSIFICATION OF BUSINESS TRANSACTIONS

All business transactions are classified into three categories:

1.Those relating to persons

2.Those relating to property (Assets)

3.Those relating to income & expenses

Thus, three classes of accounts are maintained for recording all business transactions. They
are:

1.Personal accounts
2.Real accounts
3.Nominal accounts

1.Personal Accounts: Accounts which are transactions with persons are called “Personal
Accounts”. A separate account is kept on the name of each person/firm for recording the
benefits received from, or given to the person/firm in the course of dealings with him.

E.g.: Krishna’s A/C, Gopal’s A/C, SBI A/C, Nagarjuna Finance Ltd. A/C, Obul Reddy & Sons
A/C , HMT Ltd. A/C, Capital A/C, Drawings A/C etc.

2.Real Accounts: The accounts relating to properties or assets are known as “Real Accounts”.
Every business needs assets such as machinery, furniture etc, for running its activities .A
separate account is maintained for each asset owned by the business .

E.g.: cash A/C, furniture A/C, building A/C, machinery A/C etc.

3.NominalAccounts: Accounts relating to expenses, losses, incomes and gains are known as
“Nominal Accounts”. A separate account is maintained for each item of expenses, losses,
income or gain.

E.g.: Salaries A/C, stationery A/C, wages A/C, postage A/C, commission A/C, interest A/C,
purchases A/C, rent A/C, discount A/C, commission received A/C, interest received A/C, rent
received A/C, discount received A/C.

Before recording a transaction, it is necessary to find out which of the accounts is to be debited
and which is to be credited. The following three different rules have been laid down for the
three classes of accounts….
1.Personal Accounts: The account of the person receiving benefit (receiver) is to be debited
and the account of the person giving the benefit (given) is to be credited.

Rule: “Debit----The Receiver

Credit---The Giver”
2.Real Accounts: When an asset is coming into the business, account of that asset is to be
debited. When an asset is going out of the business, the account of that asset is to be credited.

Rule: “Debit----What comes in

Credit---What goes out”

3. Nominal Accounts: When an expense is incurred or loss encountered, the account
representing the expense or loss is to be debited. When any income is earned or gain made, the
account representing the income of gain is to be credited

Rule: “Debit----All expenses and losses

Credit---All incomes and gains”

Some of the Transactions are given below:

1. TRANSACTIONS: Any sale or purchase of goods of services is called the

transaction.
Transactions are two types.
[a]. cash transaction: cash transaction is one where cash receipt
or payment is involved in the exchange.
[b]. Credit transaction: Credit transaction will not have cash,
either received or paid, for something given or received
respectively.
2.GOODS: Fill those things which a firm purchase for resale are called goods.
3.PURCHASES: Purchases means purchase of goods, unless it is stated otherwise it
also represents the Goods purchased.

4.SALES: Sales means sale of goods, unless it is stated otherwise it also represents
these goods sold.

5.EXPENSES: Payments for the purchase of goods as services are known as expenses.

6.REVENUE: Revenue is the amount realized or receivable from the sale of goods or
services.
 7.ASSETS: The valuable things owned by the business are known as assets. These are
the properties Owned by the business.

8.LIABILITIES: Liabilities are the obligations or debts payable by the enterprise in

future in the term Of money or goods.

9. DEBTORS: Debtors means a person who owes money to the trader.

10.CREDITORS: A creditor is a person to whom something is owned by the business.

11.DRAWINGS: cash or goods withdrawn by the proprietor from the Business for his
personal or Household is termed to as “drawing”.

12.RESERVE: An amount set aside out of profits or other surplus and designed to meet
contingencies.

13.ACCOUNT: A summarized statements of transactions relating to a particular person,

thing, Expense or income.

14.DISCOUNT: There are two types of discounts.

a. cash discount: An allowable made to encourage frame payment or

before the expiration of the period allowed for credit.
b. Trade discount: A deduction from the gross or catalogue price
allowed to traders who buys them for resale.

JOURNAL

The first step in accounting therefore is the record of all the transactions in the books of original
entry viz., Journal and then posting into ledges.

JOURNAL: The word Journal is derived from the Latin word ‘journ’ which means a day.
Therefore, journal means a ‘day Book’ in day-to-day business transactions are recorded in
chronological order.

Journal is treated as the book of original entry or first entry or prime entry. All the business
transactions are recorded in this book before they are posted in the ledges. The journal is a
complete and chronological (in order of dates) record of business transactions. It is recorded in
a systematic manner. The process of recording a transaction in the journal is called
“JOURNALISING”. The entries made in the book are called “Journal Entries”.
 The proforma of Journal is given below.

Date Date Particulars L.F. no Debit Credit

RS. RS.

1998 Jan 1 Purchases account 10,000/-

To cash account 10,000/-

(being goods purchased for

cash)

Mahesh started a business with a capital of 3,00,000/- on 1st April, 2018. Journalize the given
transactions in the books of Mahesh for the month of April, 2018.

April 2nd deposited cash in bank 1,50,000/

April 4th purchased stock 70,000/

April 7th purchased goods from sekhar 60000

April 10th furniture purchased at Raju traders 5,000/

April 12th sales 40,000/

April 15th postage 100/

April 18th rent and repairs 1200/

April 20th sales to Aravind 75,000/

April 22nd cheque issued to Raju traders 4800/

April 24th cash received from Aravind 73,000/ as full settlement.

April 27th drawings 10,000 for his personal.

April 29th paid commission 300/

April 30th paid salaries to workers 6000/

April 30th wages paid 3000/-

Journal Entries in the books of Mahesh on 30th April, 2018

Date Particulars L.F Debit Credit

No Rs. Rs.

1st April Cash a/c . . . . . . . . . . . . . . Dr. 3,00,000

To Capital a/c 3,00,000

(Being business started)

2nd April Bank a/c … . . . . . . . . . . . .Dr. 1,50,000

To Cash a/c 1,50,000

(Being cash deposited in bank)

4th April Purchases a/c . . . ……. …. Dr. 70,000

To Cash a/c 70,000

(Being goods purchased for cash)

7th April Purchases a/c . . . . . . . . . . Dr. 60,000

To Sekhar a/c 60,000

(Being credit purchases made)

10th April Furniture a/c ….. . . . . . . . . . . . Dr. 5,000

To Raju traders a/c 5,000

(Being furniture purchased on credit)

12th April Cash a/c .. . . . . . . . . . . . . . . . . Dr. 40,000

To Sales a/c 40,000

(Being goods sold for cash)

15th April Postage a/c . . . . . . . . . . . . . . . . Dr. 100

To Cash a/c 100

(Being postal charges paid)

18th April Rent and repairs a/c . . . . . . . . . Dr. 1,200

To Cash a/c 1,200

 (Being expenses made on rent and repairs)

20th April Aravind a/c . . . . . . . …… . . . . . Dr. 75,000

To Sales a/c 75,000

Being goods sold for credit)

22nd April Raju Traders a/c . . . . . . . . . . . ..Dr, 5,000

To Bank a/c 4,800

To Discount a/c 200

(Being cheque issued to Raju traders)

24th April Cash a/c . . . . . . . . . . . . . . . . . Dr. 73,000

Discount a/c . . . . . . . . . . . . . . Dr. 2,000

To Aravind a/c 75,000

(Being cash received from Aravind)

27yh Capital a/c . . . . . . . . . . . . . . . . Dr. 10,000

April
To cash a/c 10,000

(Being cash withdrawn for personal

29th April Commission a/c ………. .. . … . … Dr. 300

To cash a/c 300

(Being cash paid as commission)

30th April Salaries a/c . . . . . . . . . . . . . . . . . Dr. 6,000

To Cash a/c 6,000

(Being salaries paid)

30th April Wages a/c . . . . . . . . . . . . . . . . . . Dr. 3,000

To Cash a/c 3,000

(Being wages paid)

LEDGER

All the transactions in a journal are recorded in a chronological order. After a certain period, if
we want to know whether a particular account is showing a debit or credit balance it becomes
very difficult. So, the ledger is designed to accommodate the various accounts maintained the
trader. It contains the final or permanent record of all the transactions in duly classified form.
“A ledger is a book which contains various accounts.” The process of transferring entries from
journal to ledger is called “POSTING”.

Posting is the process of entering in the ledger the entries given in the journal. Posting into
ledger is done periodically, may be weekly or fortnightly as per the convenience of the
business. The following are the guidelines for posting transactions in the ledger.

1. After the completion of Journal entries only posting is to be made in the ledger.
2. For each item in the Journal a separate account is to be opened. Further, for each new
item a new account is to be opened.
3. Depending upon the number of transactions space for each account is to be determined
in the ledger.
4. For each account there must be a name. This should be written in the top of the table.
At the end of the name, the word “Account” is to be added.
5. The debit side of the Journal entry is to be posted on the debit side of the account, by
starting with “TO”.
6. The credit side of the Journal entry is to be posted on the debit side of the account, by
starting with “BY”.

Proforma for ledger: LEDGER BOOK

Purchases account
Date Particulars Lf. Amount Date Particulars Lf. amount
no no
 sales account
Date Particulars Lfno Amount Date Particulars Lfno amount

cash account
Date Particulars Lfno Amount Date Particulars Lfno amount

Questions:

1Q. Briefly Explain classification of Accounts and its rules?

2Q. Briefly Explain Journal?

3Q. Journalise the following transactions?

January 1. Commenced business with a capital of Rs.1,00,000

January 2. Cash deposited in the bank Rs.40,000
January 3. Bought furniture for cash Rs.10,000
January 4. Bought goods for cash from Rajeev. 5,000
January 5. Sold goods for cash 20,000
January 6. Purchased goods from Chandra 20,000
January 7. Goods sold to dharma 15,000
January 20. Received interest 2,500
January 31. Paid rent 4,000
January 31. Paid salary to manager 10,000
4Q. Briefly Explain about the Ledger?
Ledger Posting:

Mahesh started a business with a capital of 3,00,000/- on 1st April, 2018. Journalize the given
transactions in the books of Mahesh for the month of April, 2018.

April 2nd deposited cash in bank 1,50,000/

April 4th purchased stock 70,000/

April 7th purchased goods from Sekhar 60,000

April 10th furniture purchased at Raju traders 5,000/

April 12th sales 40,000/

April 15th postage 100/

April 18th rent and repairs 1200/

April 20th sales to Aravind 75,000/

April 22nd cheque issued to Raju traders 4800/

April 24th cash received from Aravind 73,000/ as full settlement.

April 27th drawings 10,000 for his personal.

April 29th paid commission 300/

April 30th paid salaries to workers 6000/

April 30th wages paid 3000/-

Journal Entries in the books of Mahesh on 30th April, 2018

Date Particulars L.F Debit Credit

No Rs. Rs.

1st April Cash a/c . . . . . . . . . . . . . . Dr. 3,00,000

To Capital a/c 3,00,000

(Being business started)

2nd April Bank a/c … . . . . . . . . . . . .Dr. 1,50,000

To Cash a/c 1,50,000

(Being cash deposited in bank)

4th April Purchases a/c . . . ……. …. Dr. 70,000

 To Cash a/c 70,000

(Being goods purchased for cash)

7th April Purchases a/c . . . . . . . . . . Dr. 60,000

To Sekhar a/c 60,000

(Being credit purchases made)

10th April Furniture a/c ….. . . . . . . . . . . . Dr. 5,000

To Raju traders a/c 5,000

(Being furniture purchased on credit)

12th April Cash a/c .. . . . . . . . . . . . . . . . . Dr. 40,000

To Sales a/c 40,000

(Being goods sold for cash)

15th April Postage a/c . . . . . . . . . . . . . . . . Dr. 100

To Cash a/c 100

(Being postal charges paid)

18th April Rent and repairs a/c . . . . . . . . . Dr. 1,200

To Cash a/c 1,200

(Being expenses made on rent and repairs)

20th April Aravind a/c . . . . . . . …… . . . . . Dr. 75,000

To Sales a/c 75,000

Being goods sold for credit)

22nd April Raju Traders a/c . . . . . . . . . . . ..Dr, 5,000

To Bank a/c 4,800

To Discount a/c 200

(Being cheque issued to Raju traders)

24th April Cash a/c . . . . . . . . . . . . . . . . . Dr. 73,000

Discount a/c . . . . . . . . . . . . . . Dr. 2,000

 To Aravind a/c 75,000

(Being cash received from Aravind)

27yh Capital a/c . . . . . . . . . . . . . . . . Dr. 10,000

April
To cash a/c 10,000

(Being cash withdrawn for personal

29th April Commission a/c ………. .. . … . … Dr. 300

To cash a/c 300

(Being cash paid as commission)

30th April Salaries a/c . . . . . . . . . . . . . . . . . Dr. 6,000

To Cash a/c 6,000

(Being salaries paid)

30th April Wages a/c . . . . . . . . . . . . . . . . . . Dr. 3,000

To Cash a/c 3,000

(Being wages paid)

Dr. Cash Account Cr.

Date Particulars Rs. Date Particulars Rs.

1/4 To Capital A/C 3,00,000 2/4 By Bank A/c 1,50,000

12/4 To Sales A/c 40,000 4/4 By Purchases A/c 70,000

24/4 To Aravind A/c 73,000 15/4 By Postage A/c 100

18/4 By Rent & Rates A/c 1,200

27/4 By Capital A/c 10,000

29/4 By Commission A/c 300

30/4 By Salaries A/c 6,000

30/4 By Wages A/c 3,000

 30/4 By Balance C/d 1,72,400

4,13,000 4,13,000

1/5 To Balance B/d 1,72,400

Dr. Capital Account Cr.

Date Particulars Rs. Date Particulars Rs.

27/4 To Cash A/c 10,000 ¼ By Cash A/c 3,00,000

30/4 Balance C/d 2.90,000

3,00,000 3,00,000

----------- 1/5

By Balance B/d 2,90,000

Dr. Bank Account Cr.

Date Particulars Rs. Date Particulars Rs.

2/4 To Cash A/c 1,50,000 22/4 By Raju Traders A/c 4,800

30/4 By Balance C/d 1,45,200

1,50,000 1,50,000

1/5 To Balance B/d 1,45,200 ----------

Dr. Purchases Account Cr.

Date Particulars Rs. Date Particulars Rs.

4/4 To Cash A/c 70,000

7/4 To Sekhar A/c 60,000

30/4 By Balance C/d 1,30,000

1,30,000 1,30,000

1/5 To Balance B/d 1,30,000

Dr. Sekhar Account Cr.

Date Particulars Rs. Date Particulars Rs.

7/4 By Purchases A/c 60,000

30/4 To Balance C/d 60,000

60,000 60,000

----------- 1/5 By Balance B/d 60,000

Dr. Furniture Account Cr.

Date Particulars Rs. Date Particulars Rs.

10/4 Raju Traders A/c 5,000

30/4 By Balance C/d 5,000

5,000 5,000

1/5 To Balance B/d 5,000

Dr. Raju Traders Account Cr.

Date Particulars Rs. Date Particulars Rs.

22/4 To Bank /c 4,800 10/4 By Furniture A/c 5,000

22/4 To Discount A/c 200

5,000 5,000

Dr. Sales Account Cr.

Date Particulars Rs. Date Particulars Rs.

12/4 By Cash A/c 40,000

30/4 To Balance C/d 1,15,000 20/4 By Aravind A/c 75,000

1,15,000 1,15,000

1/5 By Balance B/d 1,15,000

Dr. Postage Account Cr.

Date Particulars Rs. Date Particulars Rs.

15/4 To Cash A/c 100

30/4 By Balance C/d 100

100 100

1/5 To Balance B/d 100

Dr. Rent & Repairs Account Cr.

Date Particulars Rs. Date Particulars Rs.

18/4 To Cash A/c 1,200

30/4 By Balance C/d 1,200

1,200 1,200

1/5 To Balance B/d 1,200

Dr. Aravind Account Cr.

Date Particulars Rs. Date Particulars Rs.

20/4 To Sales A/c 75,000 24/4 By Cash A/c 73,000

24/4 By Discount A/c 2,000

75,000

----------- 75,000

Dr. Discount Account Cr.

Date Particulars Rs. Date Particulars Rs.

24/4 To Aravind A/c 2,000 22/4 By Raju Traders A/c 200

30/4 By Balance C/d 1,800

2,000 2,000

1/5 To Balance B/d 1,800

Dr. Commission Account Cr.

Date Particulars Rs. Date Particulars Rs.

29/4 To Cash A/c 300

30/4 By Balance C/d 300

300

1/5 To Balance B/d 300

Dr. Salaries Account Cr.

Date Particulars Rs. Date Particulars Rs.

30/4 To Cash A/c 6,000

30/4 By Balance C/d 6,000

6,000 6,000

1/5 To Balance B/d 6,000

Dr. Wages Account Cr.

Date Particulars Rs. Date Particulars Rs.

30/4 To Cash A/c 3,000

30/4 By Balance C/d 6,000

3,000 6,000

1/5 To Balance B/d 3,000

TRIAL BALANCE

Particulars Debit Credit

Cash a/c 1,72,400

Capital a/c 2,90,000

Bank a/c 1,45,200

Purchases 1,30,000

Sekhar a/c 60,000

Furniture a/c 5,000

Sales a/c 1,15,000

Postages 100

Rent & repairs a/c 1,200

Discount a/c 1,800

Commission 300

Salaries 6,000

Wages 3,000

4,65,000 4,65,000

TRAIL BALANCE

The first step in the preparation of final accounts is the preparation of trail balance. In the double entry
system of book keeping, there will be credit for every debit and there will not be any debit without
credit. When this principle is followed in writing journal entries, the total amount of all debits is equal
to the total amount all credits.

A trail balance is a statement of debit and credit balances. It is prepared on a particular date with the
object of checking the accuracy of the books of accounts. It indicates that all the transactions for a
particular period have been duly entered in the book, properly posted and balanced. The trail balance
doesn’t include stock in hand at the end of the period. All adjustments required to be done at the end of
the period including closing stock are generally given under the trail balance.
DEFINITIONS: SPICER AND POGLAR: A trail balance is a list of all the balances standing on the
ledger accounts and cash book of a concern at any given date.

J.R. BATLIBOI: A trail balance is a statement of debit and credit balances extracted from the ledger
with a view to test the arithmetical accuracy of the books.

Thus, a trail balance is a list of balances of the ledger accounts and cash book of a business concern at
any given date.

PROFORMA FOR TRAIL BALANCE:

Trail balance for MR…………………………………… as on …………

NO NAME OF ACCOUNT DEBIT CREDIT

AMOUNT(RS.) AMOUNT(RS.)
(PARTICULARS)

Trail Balance

59 Specimen of trial balance

1 Capital Credit Loan

2 Opening stock Debit Asset

3 Purchases Debit Expense

4 Sales Credit Gain

5 Returns Debit Loss

inwards

6 Returns Debit Gain

outwards

7 Wages Debit Expense

8 Freight Debit Expense

9 Transport Debit Expense

expenses
10 Royalties on Debit Expense
production

11 Gas, fuel Debit Expense

12 Discount Credit Revenue

received

13 Discount Debit Loss

allowed

14 Bas debts Debit Loss

15 Dab debts Credit Gain

reserve

16 Commission Credit Revenue

received

17 Repairs Debit Expense

18 Rent Debit Expense

19 Salaries Debit Expense

20 Loan Taken Credit Loan

21 Interest Credit Revenue

received

22 Interest paid Debit Expense

23 Insurance Debit Expense

24 Carriage Debit Expense

outwards

25 Advertisements Debit Expense

26 Petty expenses Debit Expense

27 Trade expenses Debit Expense

28 Petty receipts Credit Revenue

29 Income tax Debit Drawings

30 Office Debit Expense

expenses
31 Customs duty Debit Expense

32 Sales tax Debit Expense

33 Provision for Debit Liability

discount on
debtors

34 Provision for Debit Asset

discount on
creditors

35 Debtors Debit Asset

36 Creditors Credit Liability

37 Goodwill Debit Asset

38 Plant, Debit Asset

machinery

39 Land, Debit Asset

buildings

40 Furniture, Debit Asset

fittings

41 Investments Debit Asset

42 Cash in hand Debit Asset

43 Cash at bank Debit Asset

44 Reserve fund Credit Liability

45 Loan advances Debit Asset

46 Horse, carts Debit Asset

47 Excise duty Debit Expense

48 General Credit Liability

reserve

49 Provision for Credit Liability

depreciation

50 Bills receivable Debit Asset

51 Bills payable Credit Liability

52 Depreciation Debit Loss

53 Bank overdraft Credit Liability

54 Outstanding Credit Liability

salaries

55 Prepaid Debit Asset

insurance

56 Bad debt Credit Revenue

reserve

57 Patents & Debit Asset

Trademarks

58 Motor vehicle Debit Asset

59 Outstanding Credit Liability

rent
Proforma of Trail balance for MR…………………………………… as on
…………
N NAME OF ACCOUNT DEBIT CREDIT
O AMOUNT(RS.) AMOUNT(RS.)
(PARTICULARS)

Capital XXX

Opening stock XXX

Wages XXX

Purchases XXX

Sales XXX

Returns inwards XXX

Returns outwards XXX

Freight XXX

Transport expenses XXX

Royalties on production XXX

Gas, fuel XXX

Discount received XXX

Discount allowed XXXX

Bad debts XXX

Bad debts reserve XXX

Commission received XXX

Repairs XXX

Rent XXX

Salaries XXX

Loan Taken XXX

Interest received XXX

Interest paid XXX

XXX
Insurance XXX

Carriage outwards XXX

Advertisements XXX

Petty expenses XXX

Trade expenses XXX

Petty receipts XXX

Income tax XXX

Office expenses XXX

Customs duty XXX

Sales tax XXX

Provision for discount on debtors XXX

Provision for discount on creditors

XXX
Debtors
XXX
Creditors
XXX
Goodwill
XXX
Plant, machinery
XXX
Land, buildings
XXX
Furniture, fittings
XXX
Investments
XXX
Cash in hand
XXX
Cash at bank
XXX
Reserve fund
XXX
Loan advances
XXX
Horse, carts
XXX
Excise duty
XXX XXX
General reserve
 Provision for depreciation XXX

Bills receivable XXX

Bills payable XXX

Depreciation XXX

Bank overdraft XXX

Outstanding salaries XXX

Prepaid insurance XXX

Bad debt reserve XXX

Patents & Trademarks XXX

Motor vehicle XXX

Advantages of Trial Balance

There are several advantages of preparing a trial balance:

1. Identifying Errors:

One of the primary advantages of trial balance is that it helps in identifying errors in the
accounting records. If the total debits and credits do not match, it indicates that there is an
error in the records. This could be due to a number of reasons such as incorrect posting,
mathematical errors, or even fraud. By identifying errors early on, the company can take
corrective measures to rectify them before they cause any significant damage.

2. Easy Detection of Fraud:

Fraud is a common problem in the business world, and it can be difficult to detect. However,
trial balance can help in identifying fraudulent activities. For instance, if a transaction is
recorded twice, it will result in an imbalance in the trial balance. This could indicate that
someone is trying to manipulate the accounts by creating false transactions. By identifying
such discrepancies early on, the company can take steps to prevent fraud.

3. Facilitates Preparation of Financial Statements:

Trial balance provides a summarized version of the ledger balances, which can be used to
prepare financial statements. Without trial balance, preparing financial statements can be a
time-consuming and tedious process. Trial balance ensures that the ledger balances are
accurate, which in turn ensures that the financial statements are also accurate.
4. Saves Time and Effort:

Trial balance saves time and effort by providing a summary of the ledger balances. Without
trial balance, accountants would have to go through each account in the ledger to ensure that
the balances are accurate. This can be a time-consuming process and is prone to errors. Trial
balance makes the process more efficient by providing a summary of the balances.

5. Facilitating Decision Making:

Finally, trial balance can help facilitate decision-making in your hotel. By providing accurate
and up-to-date financial information, you can make informed decisions about your firm’s
operations and future plans. This can help you identify areas for improvement, optimize your
resources, and drive growth.

Questions:

1Q. Define Trial Balance? Explain different elements in the Trial Balance?

2Q. Briefly Explain advantages of Trial Balance?

3Q. Briefly Explain Debit side elements of Trial Balance?

 FINAL ACCOUNTS

INTRODUCTION: The main object of any Business is to make profit. Every trader generally
starts business for the purpose of earning profit. While establishing Business, he brings his own
capital, borrows money from relatives, friends, outsiders or financial institutions, then
purchases machinery, plant, furniture, raw materials and other assets. He starts buying and
selling of goods, paying for salaries, rent and other expenses, depositing and withdrawing cash
from Bank. Like this he undertakes innumerable transactions in Business.

The number of Business transactions in an organization depends up on

the size of the organization. In small organizations the transactions generally will be in
thousands and in big organizations they may be in lacks. As such it is humanly impossible to
remember all these transactions. Further it may not be possible to find out the final result of the
Business without recording and analysing these transactions.

Accounting came in practice as an aid to human memory by maintaining

a systematic record of Business transactions.

FINAL ACCOUNTS

In every business, the business man is interested in knowing whether the business has resulted
in profit or loss and what the financial position of the business is at a given time. In brief, he
wants to know (i)The profitability of the business and (ii) The soundness of the business.

The trader can ascertain this by preparing the final accounts. The final accounts are prepared
from the trial balance. Hence the trial balance is said to be the link between the ledger accounts
and the final accounts. The final accounts of a firm can be divided into two stages. The first
stage is preparing the trading and profit and loss account and the second stage is preparing the
balance sheet.
TRADING ACCOUNT

The first step in the preparation of final account is the preparation of trading account.
The main purpose of preparing the trading account is to ascertain gross profit or gross loss as
a result of buying and selling the goods.

Trading account of MR……………………. for the year ended …………………

Particulars Amount Particulars Amount

To opening stock XXXX By sales xxxx

To purchases xxxx Less: returns xxx XXXXX

Less: returns xxxx XXXX By closing stock XXXXX

To carriage inwards XXXX

To wages XXXX

To freight XXXX

To customs duty, octroi XXXX

To gas, fuel, coal, XXXX

Water XXXX

To factory expenses XXXX

To other man. Expenses XXXX

To productive expenses XXXX

To gross profit c/d XXXX

XXXX XXXX

Finally, a ledger may be defined as a summary statement of all the transactions relating to a
person, asset, expense or income which have taken place during a given period of time. The
up-to-date state of any account can be easily known by referring to the ledger.

PROFIT AND LOSS ACCOUNT

The business man is always interested in knowing his net income or net profit.Net profit
represents the excess of gross profit plus the other revenue incomes over administrative, sales,
Financial and other expenses. The debit side of profit and loss account shows the expenses and
the credit side the incomes. If the total of the credit side is more, it will be the net profit. And
if the debit side is more, it will be net loss.

PROFIT AND LOSS A/C OF MR…………………….FOR THE YEAR

ENDED…………

PARTICULARS AMOUNT PARTICULARS AMOUNT

TO office salaries Xxxxxx By gross profit b/d Xxxxx

TO rent, rates,taxes Xxxxx Interest received Xxxxx

TO Printing and stationery Xxxxx Discount received Xxxx

TO Legal charges Commission received Xxxxx

Audit fee Xxxx Income from

investments
TO Insurance Xxxx
Dividend on shares
TO General expenses Xxxx Xxxx
Miscellaneous
TO Advertisements Xxxxx Xxxx
investments
TO Bad debts Xxxx
Rent received
TO Carriage outwards Xxxx xxxx

TO Repairs Xxxx

TO Depreciation Xxxxx

TO interest paid Xxxxx

TO Interest on capital Xxxxx

TO Interest on loans Xxxx

TO Discount allowed Xxxxx

TO Commission Xxxxx

TO Net profit-------→ Xxxxx

(transferred to capital a/c)

XXXXX XXXXX
BALANCE SHEET

The second point of final accounts is the preparation of balance sheet. It is prepared often in
the trading and profit, loss accounts have been compiled and closed. A balance sheet may be
considered as a statement of the financial position of the concern at a given date.

DEFINITION: A balance sheet is an item wise list of assets, liabilities and proprietorship of
a business at a certain state.

J.R.botliboi: A balance sheet is a statement with a view to measure exact financial position of
a business at a particular date.

Thus, Balance sheet is defined as a statement which sets out the assets and liabilities of a
business firm and which serves to ascertain the financial position of the same on any particular
date. On the left-hand side of this statement, the liabilities and the capital are shown. On the
right-hand side all the assets are shown. Therefore, the two sides of the balance sheet should
be equal. Otherwise, there is an error somewhere.

BALANCE SHEET OF ………………………… AS ON …………………………………….

Liabilities and capital Amount Assets Amount

Creditors Xxxx Cash in hand Xxxx

Bills payable Xxxx Cash at bank Xxxx

Bank overdraft Xxxx Bills receivable Xxxx

Loans Xxxx Debtors Xxxx

Mortgage Xxxx Closing stock Xxxx

Reserve fund Xxxx Investments Xxxx

Capital xxxxxx Furniture and fittings Xxxx

Add: Plats machinery

Net Profit xxxx Land & buildings Xxxx

-------
Patents, copyrights Xxxx
xxxxx
-------- Goodwill Xxxx
Less:
Drawings xxxx XXXX Prepaid expenses xxxx
---------
Outstanding incomes Xxxx

Trade marks Xxxx

XXXXX XXXXX
Advantages: The following are the advantages of final balance.

1. It helps in checking the arithmetical accuracy of books of accounts.

2. It helps in the preparation of financial statements.
3. It helps in detecting errors.
4. It serves as an instrument for carrying out the job of rectification of entries.
5. It is possible to find out the balances of various accounts at one place.
Questions:

1. Examine the following trial balance and adjustments of Swaraj Emporium;

prepare trading, profit and loss account and balance sheet for the year ended
December 31, 2017.

Particulars Debit Credit

Rs. Rs.
Sundry Debtors 64,000
Opening stock 44,000
Cash in hand 70
Machinery 35,000
Sundry creditors 21,300
Trade expenses 2,150
Sales 2,69,000
Salaries 4,450
Carriage outwards 800
Rent 1,800
Bills payables 15,000
Purchases 2,37.740
Discounts 2,200
Business premises 69,000
Capital 1,59,000
Cash at bank 3,090
------------ --------------
4,64,300 4,64.300
2. Define Balance sheet and Explain elements of Balance sheet?
3. Define Profit and Loss account and Explain elements of Profit and Loss account?
 FINANCIAL ANALYSIS THROUGH RATIOS

Ratio Analysis

Absolute figures are valuable but they standing alone convey no meaning unless compared
with another. Accounting ratio show inter-relationships which exist among various accounting
data. When relationships among various accounting data supplied by financial statements are
worked out, they are known as accounting ratios.

Accounting ratios can be expressed in various ways such as:

1. a pure ratio says ratio of current assets to current liabilities is 2:1 or

2. a rate say current assets are two times of current liabilities or
3. a percentage say current assets are 200% of current liabilities.
Each method of expression has a distinct advantage over the other the analyst will selected that
mode which will best suit his convenience and purpose.

Uses or Advantages or Importance of Ratio Analysis

Ratio Analysis stands for the process of determining and presenting the relationship of items
and groups of items in the financial statements. It is an important technique of financial
analysis. It is a way by which financial stability and health of a concern can be judged. The
following are the main uses of Ratio analysis:

(i) Useful in financial position analysis: Accounting reveals the financial position of the
concern. This helps banks, insurance companies and other financial institution in lending
and making investment decisions.
(ii) Useful in simplifying accounting figures: Accounting ratios simplify, summaries and
systematic the accounting figures in order to make them more understandable and in lucid
form.

(iii) Useful in assessing the operational efficiency: Accounting ratios helps to have an idea
of the working of a concern. The efficiency of the firm becomes evident when analysis is
based on accounting ratio. This helps the management to assess financial requirements and
the capabilities of various business units.

(iv) Useful in forecasting purposes: If accounting ratios are calculated for number of years,
then a trend is established. This trend helps in setting up future plans and forecasting.

(v) Useful in locating the weak spots of the business: Accounting ratios are of great
assistance in locating the weak spots in the business even through the overall performance
may be efficient.

(vi) Useful in comparison of performance: Managers are usually interested to know which
department performance is good and for that he compare one department with the another
department of the same firm. Ratios also help him to make any change in the organisation
structure.

Limitations of Ratio Analysis: These limitations should be kept in mind while making
use of ratio analyses for interpreting the financial statements. The following are the main
limitations of ratio analysis.

1. False results if based on incorrect accounting data: Accounting ratios can be correct
only if the data (on which they are based) is correct. Sometimes, the information given
in the financial statements is affected by window dressing, i. e. showing position better
than what actually is.
2. No idea of probable happenings in future: Ratios are an attempt to make an analysis of
the past financial statements; so they are historical documents. Now-a-days keeping in
view the complexities of the business, it is important to have an idea of the probable
happenings in future.
3. Variation in accounting methods: The two firms’ results are comparable with the help
of accounting ratios only if they follow the some accounting methods or bases.
Comparison will become difficult if the two concerns follow the different methods of
providing depreciation or valuing stock.
4. Price level change: Change in price levels make comparison for various years difficult.
5. Only one method of analysis: Ratio analysis is only a beginning and gives just a fraction
of information needed for decision-making so, to have a comprehensive analysis of
financial statements, ratios should be used along with other methods of analysis.
6. No common standards: It is very difficult to by down a common standard for
comparison because circumstances differ from concern to concern and the nature of
each industry is different.
7. Different meanings assigned to the some term: Different firms, in order to calculate
ratio may assign different meanings. This may affect the calculation of ratio in different
firms and such ratio when used for comparison may lead to wrong conclusions.
8. Ignores qualitative factors: Accounting ratios are tools of quantitative analysis only.
But sometimes qualitative factors may surmount the quantitative aspects. The
calculations derived from the ratio analysis under such circumstances may get distorted.
9. No use if ratios are worked out for insignificant and unrelated figure: Accounting ratios
should be calculated on the basis of cause-and-effect relationship. One should be clear
as to what cause is and what effect is before calculating a ratio between two figures.

Ratio Analysis: Ratio is an expression of one number is relation to another. It is one of the
methods of analysing financial statement. Ratio analysis facilities the presentation of the
information of the financial statements in simplified and summarized from. Ratio is a
measuring of two numerical positions. It expresses the relation between two numeric
figures. It can be found by dividing one figure by another ratios are expressed in three ways.

1. Jines method
2. Ratio Method
3. Percentage Method
Classification of ratios: All the ratios broadly classified into four types due to the interest
of different parties for different purposes. They are:

1. Profitability ratios
2. Turn over ratios
3. Financial ratios
4. Leverage ratios

1. Profitability ratios: These ratios are calculated to understand the profit positions of
the business. These ratios measure the profit earning capacity of an enterprise. These
ratios can be related its save or capital to a certain margin on sales or profitability of
capital employ. These ratios are of interest to management. Who are responsible for
success and growth of enterprise? Owners as well as financiers are interested in
profitability ratios as these reflect ability of enterprises to generate return on capital
employ important profitability ratios are:
Profitability ratios in relation to sales: Profitability ratios are almost importance of
concern. These ratios are calculated to focus the end results of the business activities
which are the sole meritorious of overall efficiency of organisation.

gross profit
1. Gross profit ratio= X100
Nest sales

Note: Higher the ratio the better it is

Net profit after interest & Tax

2. Net profit ratio: X 100
Net sales

Note: Higher the ratio the better it is

Note: Higher the ratio the better it is cost of goods sold= opening stock + purchase +
wages + other direct expenses- closing stock (or) sales – gross profit.
Note: Lower the ratio the better it is

Profitability ratios in relation to investments:

Net profit after tax & latest depreciation X100
share holders funds
1. Return on investments:
Shareholders’ funds = equity share capital + preference share capital + receives &
surpluses +undistributed profits.

Note: Higher the ratio the better it is

2. Return on equity capital: = Net Profit after tax & interest - preferencedivident X100
equity share capital

Note: Higher the ratio the better it is

II. Turn over ratios or activity ratios:

These ratios measure how efficiency the enterprise employees the resources of assets at its
command. They indicate the performance of the business. The performance of an enterprise is
judged with its save. It means ratios are also called efficiency ratios.

These ratios are used to know the turn over position of various things in The turnover ratios
are measured to help the management in taking the decisions regarding the levels maintained
in the assets, and raw materials and in the funds. These ratio s are measured in ratio method.

cost of goods sold

1. Stock turnover ratio =
average stock

Here,
opening stock + closing stock
Average stock =
2
Note: Higher the ratio, the better it is

5. Debtors turnover ratio= credits sales or sales

average debtors

5(i) Debtors collection period = 365 (or) 12

Turnove ratio
Note: Higher the ratio the better it is

Here,
opening debitors + closing bebtors
Average debtors =
2
Debtors = debtors + bills receivable

Note: Higher the ratio the better it is.

 credit purchasers or purchases
6. Creditors turnover ratio = average credetors

365 (or) 12
6 (i) creditors collection period = Creditor turnover ratio

Here,
opening + closing credetors
Average creditors = 2

Creditors = creditors + bills payable.

Note: lower the ratio the better it is.

3. Financial ratios or liquidity ratios:

Liquidity refers to ability of organisation to meet its current obligation. These ratios are used
to measure the financial status of an organisation. These ratios help to the management to make
the decisions about the maintained level of current assets & current libraries of the business.
The main purpose to calculate these ratios is to know the short terms solvency of the concern.
These ratios are useful to various parties having interest in the enterprise over a short period –
such parties include banks. Lenders, suppliers, employees and other.

The liquidity ratios assess the capacity of the company to repay its short-term liabilities. These
ratios are calculated in ratio method.

current assets
Current ratio = current liabilitie s

Note: The ideal ratio is 2:1

i. e., current assets should be twice. The current liabilities.

quick assets
Quick ratio or liquid ratio or acid test ratio: current liabilitie s

Quick assets = cash in hand + cash at bank + short term investments + debtors + bills
receivables short term investments are also known as marketable securities.

Here the ideal ratio is 1:1 is, quick assets should be equal to the current liabilities.

absolute liquid assets

Absolute liquid ratio=
current liabilitie s
Here,

Absolute liquid assets=cash in hand + cash at bank + short term investments + marketable
securities.

Here, the ideal ratio is 0,0:1 or 1:2 it, absolute liquid assets must be half of current liabilities.

Leverage ratio of solvency ratios: Solvency refers to the ability of a business to honour long
item obligations like interest and instalments associated with long term debts. Solvency ratios
indicate long term stability of an enterprise. These ratios are used to understand the yield rate
if the organisation.

Lenders like financial institutions, debenture, holders, banks are interested in ascertaining
solvency of the enterprise. The important solvency ratios are:

outsiders funds Debt

1. Debt – equity ratio = share holders funds Equity

Here,

Outsiders’ funds = Debentures, public deposits, securities, long term bank loans + other long-
term liabilities.

Shareholders’ funds = equity share capital + preference share capital + reserves & surpluses
+ undistributed projects.

The ideal ratio is 2:1

share holder funds

2. Proprietary ratio or equity ratio = total assets
The ideal ratio is 1:3 or 0.33:1

3. Capital – gearing ratio:

Fixed Interest Bearing Debt
= _________________________
Equity Shareholders’ Funds

higher gearing ratio is not good for a new company or the company in which future earnings
are uncertain.

❖ Fixed Interest-Bearing Debt: Long-term loans, debentures, bonds, etc.

❖ Equity Shareholders' Funds: Share capital + retained earnings – any losses.

❖ High Gearing: More debt than equity.

o Higher financial risk.
o More vulnerable to interest rate changes.
 ❖ Low Gearing: More equity than debt.
o Lower risk.
o May indicate underutilization of debt leverage.

Questions:

1. Briefly Explain Different types of Ratios?

2. The following data is extracted from the financial statements of a firm dealing in
fertilisers. The fertiliser business, in general, has an inventory ratio of 6 times.

Identify the following ratios.

a. Inventory turnover ratio

b. Average period of the holding the stock

Sundry debtors Rs, 45,000

Closing stock Rs. 30,000
Sales Rs.4,00,000
Sales returns Rs.20,000
Opening stock Rs.40,000
Closing stock Rs.40,000
60% of the sales are credit sales.

3. Given the following data relating to firm X and firm Y in the hosiery business,
calculate which firm is handling its debtors and creditors position efficiently with the
help of debtors and creditors turnover ratios.

Particulars Firm - A Firm - B

Debtors (1-1-2017) 8,000 12,000

Debtors (31-12-2017) 16,000 14,000
Creditors (1-1-2017) 32,000 28,000
Sales (75% credit) 2,50,000 3,60,000
Purchases (50% credit) 1,50,000 2,25,000
Furniture 25,000 35,000
Cash 5,000 8,000
Creditors (31-12-2017) 26,000 42,000
 FINAL ACCOUNTS PROBLEMS WITH ANSWERS

1. Examine the following trial balance and adjustments of Swaraj Emporium; prepare
trading, profit and loss account and balance sheet for the year ended December 31,
2017.

Particulars Debit Credit

Rs. Rs.
Sundry Debtors 64,000
Opening stock 44,000
Cash in hand 70
Machinery 35,000
Sundry creditors 21,300
Trade expenses 2,150
Sales 2,69,000
Salaries 4,450
Carriage outwards 800
Rent 1,800
Bills payables 15,000
Purchases 2,37.740
Discounts 2,200
Business premises 69,000
Capital 1,59,000
Cash at bank 3,090
------------ --------------
4,64,300 4,64.300

Adjustments:

1. Closing stock Rs.24,900

2. Rent was unpaid to the extent of Rs.170/-
3. Outstanding trade expenses were Rs.300/-
4. Written off bad debts Rs.800/-
5. Provide 5% for doubtful bad debts
6. Depreciate plant ad machinery @10% per annum
7. Business premises are to be depreciated by 2% per annum.
Solution:

Dr Trading account of Swarajya Emporium for the year ended 31st December, 2017
Cr

Particulars Amount Particulars Amount

To Opening stock 44,000 By Sales 2,69,000

To Trade expenses 2,150 2,450 By Closing stock 24,900

Add: outstanding expenses 300

-------

To Purchases 2,37,740

To Gross profit 9,710

(Transfer to profit & loss a/c)

2,93,900
2,93,900
Profit and loss account of Swarajya Emporium for the year ended 31st December, 2017

Dr Cr

Particulars Amount Particulars Amount

To Bad debts written off 800 By Gross profit

9,710
To Doubtful bad debts 3,160

To Depreciation on machinery 3,500

To Salaries 4,450

To Carriage outwards 800

To Rent 1,800
Add: Outstanding rent 170 8,550
1,970 By Net loss
____
(Transfer to Capital a/c)
To Discounts allowed 2,200
To Depreciation on business 1,380
premises.

------------
18,160
18,160
 Balance Sheet in the books of Swarajya as on 31st December 2017

Liabilities and capital Amount Assets Amount

Capital 1,59,000 Sundry Debtors 64,000

Less: Net loss 8,550 1,50,450 Less: Bad debts 800

----------

Sundry creditors 21,300 63,200

Less: Doubtful bad debts 3,160
Outstanding trade expenses 300 60,040
_____
Outstanding rent 170 Cash in hand 70

Bills Payables 15,000 Plant 35,000 31,500

Less: Depriciation@10% 3,500

_____

Business premises 69,000

67,620
Less.Depriciation@2% 1380

--------

Closing stock
24,900
Cash in Bank
3,090

1,87,220 1,87,220
2. The trial balance of Kamal as on 31st march, 2016 reveals the following
information. Prepare Final accounts for the following information:

Particulars Debit Credit

Plant and machinery * 1,60,000

Purchases 1,36,000

Sales returns 2,000

Opening stock 60,000

Discount 700

Bank charges 150

Sundry debtors * 90,000

Salaries * 13,600

Wages 20,000

Frights 1,500

Carriage outwards 2,400

Rents and Rates 4,000

Advertisements’ 4,000

Cash in hand 13,800

Capital 2,00,000

Sales 2,50,000

Purchase returns 6,550

Discounts 1,600

Sundry Creditors 50,000

5,08,150 5,08,150
Adjustments:

1. Closing stock 70,000/-

2. Written off bad debts on Debtors @4%
3. Depreciation on plant and machinery @10%
4. Salaries yet to be paid Rs. 500/-

ANS.:

Dr. Trading Account in the books of Kamal on 31st march, 2016 Cr.

Particulars Rs. Particulars Rs.

To Opening Stock 60,000 By Sales 2,50,000

To Purchases 1,36,000 Less: Returns 2,000 2,48,000

Less: Returns 6,550 1,29,450 ----------

------ By Closing Stock 70,000

----
20,000
To Wages
1,500
To Frights

1,07,050
To Gross Profit

3,18,000 3,18,000

Dr Profit and Loss Account in the books of Kamal on 31st march, 2016 Cr.

Particulars Rs. Particulars Rs.

To Depreciation on machinery 16,000 By Gross Profit 1,07,050

To Discount 700 By Discount received 1,600

To Bank Charges 150

To Bad debts written off 3,600

To Salaries 13,600

Add: Outstanding Salaries 500 14,100

 ---------

To Carriage outwards 2,400

To Rents and Rates 4,000

To Advertisements 4,000

To Net Profit 63,700

1,08,650 1,08,650

Balance Sheet in the books of Kamal on 31st march, 2016

Liabilities Rs. Assets Rs.

Capital 2,00,000 Plant and machinery 1,60,000

Add: Net Profit 63,700 2,63,700 Less: Depreciation @10% 16,000 1,44,000

----------- -------

Closing Stock 70,000

Outstanding Salaries 500 Sundry Debtors 90,000

Sundry Creditors 50,000 Less: Bad debts@4% 3,600 86,400

----------

Cash on hand 13,800

3,14,200 3,14,200
3Q. From the following trial balance of Vikranth Foundry Works, prepare trading account,
profit & loss account and balance sheet for the year ending March 31, 2018

Particulars Debit Particulars Credit

Rs. Rs.

Electricity 14,000 Interest 16,000

Land 1,40,000 Discount 6,000
Interest 16,000 Sales 5,00,000
Wages 50,000 Returns 10,000
Opening stock 20,000 Sundry creditors
Rent 24,000 Capital 60,000
Purchases 3,0 0,000 Bills payables 3,02,000
Office expenses 30,000 Debentures 15,000
Building 4,00,000 3,00,000
Salaries 90,0.00
Power and gas 30,000
Returns 20,000
Furniture 15,000
Sundry debtors 60,000
-------------
12,09,000 12,09.000

Adjustment: - Closing stock Rs.24,000

ANS.:

Trading Account in the books of Vikranth Poultry Works at the year ended 31st March,
2018.

Dr. Cr.

Particulars Rs. Particulars Rs.

To Opening stock By Sales 5,00,000

20,000
To Purchases 3,00,000 Less: Sales returns 20,000 4,80,000

Less: Returns 10,000 -----------

2,90,000
---------- By Closing Stock 24,000

50,000
To wages

To Power and gas 30,000

By Gross Profit 1,14,000

_________

5,04,000 5,04,000

Profit and Loss Account in the books of Vikranth Poultry Works at the year ended 31st
March, 2018.

Dr. Cr.

Particulars Rs. Particulars Rs.

To Electricity Bill 14,000 By Gross Profit 1,14,000

To Interest 16,000 By Interest 16,000

To Rent 24,000 By Discount 6,000

To Office Expenses 30,000

To Salaries 90,000

By Net Loss 38,000

(Transfer to Capital Account)

1,74,000 1,74,000

Balance Sheet in the books of Vikranth Poultry Works at the year ended 31st March,
2018.

Liabilities Rs. Assets Rs.

Capital: 3,02,000 Land 1,40,000

Less: Net Loss 38,000 2,64,000 Buildings 4,00,000

_______ Furniture 15,000

Debentures 3,00,000 Sundry Debtors 60,000

Bills Paybles 15,000 Closing stock 24,000

Sundry Creditors 60,000

6,39,000 6,39,000
 FINANCIAL ANALYSIS THROUGH RATIOS

Ratio Analysis

Absolute figures are valuable but they standing alone convey no meaning unless compared
with another. Accounting ratio show inter-relationships which exist among various accounting
data. When relationships among various accounting data supplied by financial statements are
worked out, they are known as accounting ratios.

Accounting ratios can be expressed in various ways such as:

1. a pure ratio says ratio of current assets to current liabilities is 2:1 or

2. a rate say current assets are two times of current liabilities or
3. a percentage say current assets are 200% of current liabilities.
Each method of expression has a distinct advantage over the other the analyst will selected that
mode which will best suit his convenience and purpose.

Uses or Advantages or Importance of Ratio Analysis

Ratio Analysis stands for the process of determining and presenting the relationship of items
and groups of items in the financial statements. It is an important technique of financial
analysis. It is a way by which financial stability and health of a concern can be judged. The
following are the main uses of Ratio analysis:

(i) Useful in financial position analysis: Accounting reveals the financial position of the
concern. This helps banks, insurance companies and other financial institution in lending
and making investment decisions.
(ii) Useful in simplifying accounting figures: Accounting ratios simplify, summaries and
systematic the accounting figures in order to make them more understandable and in lucid
form.

(iii) Useful in assessing the operational efficiency: Accounting ratios helps to have an idea
of the working of a concern. The efficiency of the firm becomes evident when analysis is
based on accounting ratio. This helps the management to assess financial requirements and
the capabilities of various business units.

(iv) Useful in forecasting purposes: If accounting ratios are calculated for number of years,
then a trend is established. This trend helps in setting up future plans and forecasting.

(v) Useful in locating the weak spots of the business: Accounting ratios are of great
assistance in locating the weak spots in the business even through the overall performance
may be efficient.

(vi) Useful in comparison of performance: Managers are usually interested to know which
department performance is good and for that he compare one department with the another
department of the same firm. Ratios also help him to make any change in the organisation
structure.

Limitations of Ratio Analysis: These limitations should be kept in mind while making
use of ratio analyses for interpreting the financial statements. The following are the main
limitations of ratio analysis.

1. False results if based on incorrect accounting data: Accounting ratios can be correct
only if the data (on which they are based) is correct. Sometimes, the information given
in the financial statements is affected by window dressing, i. e. showing position better
than what actually is.
2. No idea of probable happenings in future: Ratios are an attempt to make an analysis of
the past financial statements; so they are historical documents. Now-a-days keeping in
view the complexities of the business, it is important to have an idea of the probable
happenings in future.
3. Variation in accounting methods: The two firms’ results are comparable with the help
of accounting ratios only if they follow the some accounting methods or bases.
Comparison will become difficult if the two concerns follow the different methods of
providing depreciation or valuing stock.
4. Price level change: Change in price levels make comparison for various years difficult.
5. Only one method of analysis: Ratio analysis is only a beginning and gives just a fraction
of information needed for decision-making so, to have a comprehensive analysis of
financial statements, ratios should be used along with other methods of analysis.
6. No common standards: It is very difficult to by down a common standard for
comparison because circumstances differ from concern to concern and the nature of
each industry is different.
7. Different meanings assigned to the some term: Different firms, in order to calculate
ratio may assign different meanings. This may affect the calculation of ratio in different
firms and such ratio when used for comparison may lead to wrong conclusions.
8. Ignores qualitative factors: Accounting ratios are tools of quantitative analysis only.
But sometimes qualitative factors may surmount the quantitative aspects. The
calculations derived from the ratio analysis under such circumstances may get distorted.
9. No use if ratios are worked out for insignificant and unrelated figure: Accounting ratios
should be calculated on the basis of cause-and-effect relationship. One should be clear
as to what cause is and what effect is before calculating a ratio between two figures.

Ratio Analysis: Ratio is an expression of one number is relation to another. It is one of the
methods of analysing financial statement. Ratio analysis facilities the presentation of the
information of the financial statements in simplified and summarized from. Ratio is a
measuring of two numerical positions. It expresses the relation between two numeric
figures. It can be found by dividing one figure by another ratios are expressed in three ways.

1. Jines method
2. Ratio Method
3. Percentage Method
Classification of ratios: All the ratios broadly classified into four types due to the interest
of different parties for different purposes. They are:

1. Profitability ratios
2. Turn over ratios
3. Financial ratios
4. Leverage ratios

1. Profitability ratios: These ratios are calculated to understand the profit positions of
the business. These ratios measure the profit earning capacity of an enterprise. These
ratios can be related its save or capital to a certain margin on sales or profitability of
capital employ. These ratios are of interest to management. Who are responsible for
success and growth of enterprise? Owners as well as financiers are interested in
profitability ratios as these reflect ability of enterprises to generate return on capital
employ important profitability ratios are:
Profitability ratios in relation to sales: Profitability ratios are almost importance of
concern. These ratios are calculated to focus the end results of the business activities
which are the sole meritorious of overall efficiency of organisation.

gross profit
1. Gross profit ratio= x 100
Nest sales

Note: Higher the ratio the better it is

Net profit after interest & Tax

2. Net profit ratio: X 100
Net sales

Note: Higher the ratio the better it is

3. Operating ratio (Operating expenses ratio)

Cost of goods sold + operating exenses

X 100
Net sales

4. Operating profit ratio Operating

= profit X100
Net sales

Net: Lower the ratio the better it is

 Note: Higher the ratio the better it is cost of goods sold= opening stock + purchase +
wages + other direct expenses- closing stock (or) sales – gross profit.

Operating expenses:

= administration expenses + setting, distribution expenses operating profit= gross profit

– operating expense.

Expenses ratio = concern expense X 100

Net sales

Note: Lower the ratio the better it is

Profitability ratios in relation to investments:

Net profit after tax & latest depreciation X100
share holders funds

1. Return on investments:
Shareholders’ funds = equity share capital + preference share capital + receives &
surpluses +undistributed profits.

Note: Higher the ratio the better it is

2. Return on equity capital: Net

= Profit after tax & interest - preferencedivident X100
equity share capital

Note: Higher the ratio the better it is

Net profit after tax - preferecnedivident

3. Earnings per share=
No. of equity shares

operating profit
4. Return on capital employed = X100
capital employed

N. P. after tax and interest

5. Return on total assets =
Total Assets
Here, capital employed = equity share capital + preference share capital + reserves &
surpluses + undistributed profits + debentures+ public deposit + securities + long term loan
+ other long term liability – fictious assets ( preliminary expenses & profit & loss account
debt balance)
II. Turn over ratios or activity ratios:

These ratios measure how efficiency the enterprise employees the resources of assets at its
command. They indicate the performance of the business. The performance of an enterprise is
judged with its save. It means ratios are also called efficiency ratios.

These ratios are used to know the turn over position of various things in The turnover ratios
are measured to help the management in taking the decisions regarding the levels maintained
in the assets, and raw materials and in the funds. These ratio s are measured in ratio method.

cost of goods sold

1. Stock turnover ratio =
average stock

Here,
opening stock + closing stock
Average stock =
2

Note: Higher the ratio, the better it is

sales
2. Working capital turnover ratio =
working capital

Note: Higher the ratio the better it is working capital = current assets – essential liabilities.

sales
3. Fixed assets turnover ratio = fixed assets

Note: Higher the ratio the better it is.

sales
3 (i) Total assets turnover ratio is = total assets

Note: Higher the ratio the better it is.

Sales
4. Capital turnover ratio = Capital employed
Note: Higher the ratio the better it is

5. Debtors turnover credits sales or sales ratio=

average debtors

5(i) Debtors collection period = 365 (or) 12

Turnove ratio

Here,
opening debitors + closing bebtors
Average debtors =
2
Debtors = debtors + bills receivable

Note: Higher the ratio the better it is.

credit purchasers or purchases

6. Creditors turnover ratio = average credetors

365 (or) 12
6 (i) creditors collection period = Creditor turnover ratio

Here,
opening + closing credetors
Average creditors = 2

Creditors = creditors + bills payable.

Note: lower the ratio the better it is.

3. Financial ratios or liquidity ratios:

Liquidity refers to ability of organisation to meet its current obligation. These ratios are used
to measure the financial status of an organisation. These ratios help to the management to make
the decisions about the maintained level of current assets & current libraries of the business.
The main purpose to calculate these ratios is to know the short terms solvency of the concern.
These ratios are useful to various parties having interest in the enterprise over a short period –
such parties include banks. Lenders, suppliers, employees and other.
The liquidity ratios assess the capacity of the company to repay its short term liabilities. These
ratios are calculated in ratio method.

current assets
Current ratio = current liabilitie s

Note: The ideal ratio is 2:1

i. e., current assets should be twice. The current liabilities.

quick assets
Quick ratio or liquid ratio or acid test ratio: current liabilitie s

Quick assets = cash in hand + cash at bank + short term investments + debtors + bills
receivables short term investments are also known as marketable securities.

Here the ideal ratio is 1:1 is, quick assets should be equal to the current liabilities.

absolute liquid assets

Absolute liquid ratio=
current liabilitie s
Here,

Absolute liquid assets=cash in hand + cash at bank + short term investments + marketable
securities.

Here, the ideal ratio is 0,0:1 or 1:2 it, absolute liquid assets must be half of current liabilities.

Leverage ratio of solvency ratios: Solvency refers to the ability of a business to honour long
item obligations like interest and instalments associated with long term debts. Solvency ratios
indicate long term stability of an enterprise. These ratios are used to understand the yield rate
if the organisation.

Lenders like financial institutions, debenture, holders, banks are interested in ascertaining
solvency of the enterprise. The important solvency ratios are:

outsiders funds Debt

1. Debt – equity ratio = share holders funds Equity

Here,
Outsiders’ funds = Debentures, public deposits, securities, long term bank loans + other long-
term liabilities.

Shareholders’ funds = equity share capital + preference share capital + reserves & surpluses
+ undistributed projects.

The ideal ratio is 2:1

share holder funds

2. Proprietary ratio or equity ratio = total assets
The ideal ratio is 1:3 or 0.33:1

3. Capital – greasing ratio:

(equity share capital + reserves & surplusses + undistributed projects)

= (Outsiders funds + preferenceshare capital )

Here,

higher gearing ratio is not good for a new company or the company in which future
earnings are uncertain.

outsiders funds
4. Debt to total fund ratio = capital employed

Capital employed= outsiders funds + shareholders’ funds = debt + equity.

The ideal ratio is 0.6.7 :1 or 2:3

Questions:

1. Briefly Explain Different types of Ratios?

2. The following data is extracted from the financial statements of a firm dealing in
fertilisers. The fertiliser business, in general, has an inventory ratio of 6 times.

Identify the following ratios.

a. Inventory turnover ratio

b. Average period of the holding the stock

Sundry debtors Rs, 45,000

Closing stock Rs. 30,000
Sales Rs.4,00,000
 Sales returns Rs.20,000
Opening stock Rs.40,000
Closing stock Rs.40,000
60% of the sales are credit sales.

3. Given the following data relating to firm X and firm Y in the hosiery business,
calculate which firm is handling its debtors and creditors position efficiently with the
help of debtors and creditors turnover ratios.

Particulars Firm - A Firm - B

Debtors (1-1-2017) 8,000 12,000

Debtors (31-12-2017) 16,000 14,000
Creditors (1-1-2017) 32,000 28,000
Sales (75% credit) 2,50,000 3,60,000
Purchases (50% credit) 1,50,000 2,25,000
Furniture 25,000 35,000
Cash 5,000 8,000
Creditors (31-12-2017) 26,000 42,000
 RATIO ANALYSISPROBLEMS AND SOLUTIOS:

1. From the following Balance Sheet of XYZ Co. Ltd. Calculate A. Current Ratio and B
Quick Ratio.
Liabiolities Rs. Assets Rs.

Preferential Share Lands and

capital 1,00,000 Buildings 2,25,000
Equity share capital 1,50,000 Plant and
General Reserve 2,50,000 machinery 2,50,000
Debentures 4,00,000 Furniture 1,00,000
Creditors 2,00,000 Stock 2,50,000
Bills payables 50,000 Debtors 1,25,000
Outstanding expenses 50,000 Cash at bank 2,50,000
Profit ad Loss account 1,00,000 Cash in hand 1,25,000
Bank load 2,00,000 Prepaid expenses 50,000
Marketable 1,25,000
securities
15,00,000 15,00,000

current assets
A. Current ratio =
current liabilitie s

Current Assets:-
Stock 2,50,000
Debtors 1,25,000
Cash at bank 2,50,000
Cash in hand 1,25,000
Prepaid expenses 50,000

Marketable securities 1,25,000

------------
Total current assets 9,25,000
------------
Current Liabilities:-
Creditors 2,00,000
Bills paybles 50,000
Outstanding expenses 50,000
-----------
Current Liabilities 3,00,000
-----------
Current ratio = 9,25,000/3,00,000 =3.08:1
Quick Ratio:-
quick assets
Quick ratio or liquid ratio or acid test ratio: =
current liabilitie s
Quick Assets = Current Assets – (Closing stock + Prepaid expenses)
9,25,000 – (2,50,000 + 50,000)
=9,25,000 – 3,00,000 =6,25,000
Quick Ratio = 6,25,000/3,00,000 = 2.08:1

2. The following is a extract of a balance sheet of a company during the last year. Compute
Current Ratio and Quick Ratio
Lands and buildings 50,000
Plant and machinery 1,00,000
Furniture and fixture 25,000
Closing stock 25,000
Sundry debtors 12,500
Wages prepaid 2,500
Sundry creditors 8,000
Rent outstanding 2,000
A. Current Assets = Closing stock + Sundry debtors + Wages prepaid
=25,000 +12,500 + 2,500 = 40,000
Current Liabilities = Sundry creditors + Rent outstanding
= 8,000 + 2,000 = 10,000
Current Ratio – 40,000/10/000 = 4:1
Quick Assets = Current assets – (Stock + Prepaid expenses)
40,000 – (25,000 + 2,500)
= 40,000 – 27,500 = 12,500
Quick Ratio = 12,500/10,000 =1.25:1
3. A firm sold goods worth Rs.5,00,000/- and its gross profit is 20% of its sale value. The
inventory at the beginning of the year was Rs.16,000/- and at the end of the year was
Rs.14,000/-. Compute inventory turn over ratio and also the inventory holding period.
A. Cost of goods sold = sales – gross profit
Gross profit = 20% of sales value
= 5,00,000X20/100 = 1,00,000
Cost of goods sold = 5,00,000 – 1,00,000
= 4,00,000
Average inventory = ½(opening stock + closing stock)
= ½(16,000 + 14,000)
= 15,000
Inventory turnover ratio = Cost of goods sold/Average inventory
= 4,00,000/15,000 =26.66 times
The inventory holding period = 365 days / inventory turnover ratio
= 365 / 26.66
= 13.69 days or 14 days.
4. A firm’s sales during the year was Rs.4,00,000/- of which 60% were on credit basis. The
balance of debtors of the beginning and end of the year were 25,000/- ad 15,000/-
respectively. Calculate debtors turn over ratio and also find out debt collection period.
A. Credit sales = 60% of total sales
= 4,00,000 X 60/100
= 2,40,000/-
Average debtors = ½(Opening debtors + Closing debtors)
= ½(25,000 + 15,000)
= 20,000
Debtors turnover ratio = Credit sales / Average Debtors
= 2,40,000 / 20,000
= 12 times
Debt collection period = 365 days / Debtors turnover ratio
= 365 / 12
= 30.41 days

RATIO ANALYSISPROBLEMS AND SOLUTIOS:

5. The earnings before interest and taxes (EBIT) of a company is Rs.5,60,000/-. Its fixed
commitments include payment of 10% on 7,000 debentures of Rs.100/- each. It is subject
to tax of 30% per annum. Calculate Interest coverage ratio.
A. Net profit before interest and taxes = 5,60,000
Fixed interest charges on the debentures = (7,000X100) X 10/100
= 70,000
Interest coverage ratio = EBIT/Net Interest
= 5,60,000/70,000
= 8 times
6. A firm’s net sales is 50,000/- and cost of goods sold is Rs.20,000/-. The details of
expenses are as given below.

Administrative expenses 3,000/-

Selling and distribution expenses 4,000/-

Loss on sale of fixed asset 3,000/-

Interest on investment 2,000/-

Taxes 20%

Calculate the net profit ratio.

A. Sales 50,000
Less: Cost of goods sold 20,000
______
 Gross profit 30,000
Less: Administrative expenses 3,000
Selling and distribution expenses 4,000
--------
7,000
---------
Net profit 23,000
Add: Interest on investment(non-operating) 2,000
----------
25,000
Less: loss on sale of asset 3,000
---------
22,000
Less: Taxes @ 20% 4,400
---------
Net profit after taxes 17,600
---------
Net profit Ratio = (Net profit after taxes/ Net sales) X 100%
= 17,600/50,000 X 100

= 35.20%

7. The following data is extracted from the financial statements of a firm dealing in
fertilisers. The fertiliser business, in general, has an inventory ratio of 6 times.

Determine and interpret the following ratios.

a. Inventory turnover ratio

b. Average period of the holding the stock

Sundry debtors Rs, 45,000

Closing stock Rs. 30,000
Sales Rs.4,00,000
Sales returns Rs.20,000
Opening stock Rs.40,000
Closing stock Rs.40,000

60% of the sales are credit sales.

To determine the Inventory Turnover Ratio and the Average Period of Holding Stock, let's analyse the
provided data:
Given Data:

Sales: ₹4,00,000
Sales Returns: ₹20,000
Net Sales = Sales - Sales Returns = ₹4,00,000 - ₹20,000 = ₹3,80,000
Opening Stock: ₹40,000
Closing Stock: ₹40,000
Sundry Debtors: ₹45,000
Credit Sales: 60% of Net Sales = 60% of ₹3,80,000 = ₹2,28,000

Note: The Closing Stock is mentioned twice with different amounts (₹30,000 and ₹40,000). For
consistency, we'll use ₹40,000 as the closing stock.

a. Inventory Turnover Ratio Formula:

Inventory Turnover Ratio = Cost of Goods Sold (COGS)/ Average Inventory

However, the COGS is not directly provided. Assuming that the firm operates with a gross profit
margin of 25%, the COGS would be 75% of Net Sales.

COGS = 75% × ₹3,80,000 = ₹2,85,000

COGS=75%×₹3,80,000 = ₹2,85,000

Average Inventory = Opening Stock + Closing Stock/2 =₹ 40,000 +₹ 40,000/ 2 = ₹40,000

Inventory Turnover Ratio = ₹ 2,85,000/ ₹ 40,000 = 7.125 times

b. Average Period of Holding Stock Formula:

Average Holding Period (in days) = 365 Days/ Inventory Turnover Ratio

= 365/ 7.125 = 51.23 Days

Interpretation:

Inventory Turnover Ratio: The firm turns over its inventory approximately 7.13 times a year. This
indicates a relatively efficient inventory management, especially when compared to the industry
average of 6 times.

Average Holding Period: On average, the firm holds its inventory for about 51 days before it is sold.
This is shorter than the industry average of approximately 61 days (365/6), suggesting better
inventory efficiency.

Conclusion:

The firm's inventory management appears to be more efficient than the industry average, with a
higher turnover ratio and a shorter holding period. This efficiency can lead to reduced holding costs
and improved liquidity.

8. Given the following data relating to firm X and firm Y in the hosiery business, calculate
which firm is handling its debtors and creditors position efficiently with the help of
debtors and creditors turnover ratios.
 Particulars Firm - A Firm - B

Debtors (1-1-2017) 8,000 12,000

Debtors (31-12-2017) 16,000 14,000
Creditors Purchases (50% credit) 32,000 28,000
(1-1-2017) 2,50,000 3,60,000
Sales (75% credit) 1,50,000 2,25,000
Furniture 25,000 35,000
Cash 5,000 8,000
Creditors (31-12-2017) 26,000 42,000

A. Debtors’ turnover ratio = (Credit sales / Average debtors)

From the given problem, Credit sales is 75% of total sales

DEBTORS TURNOVER RATIO

Particulars Firm – A Firm – B
Credit sales
1,50,000X75/100, 2,25,000X75/100 1,87,500 2,70,000
Average debtors
½(opening + closing debtors) 12,000 13,000
Debtors’ turnover
1,87,500/12,000 & 2,70,000/13,000 15.6 times 20.76times
Average debt collection period=
(365 / 15.6) & 2,70,000 / 13,0000 23.6 days 17.58 days

Note: The debtor’s turnover ratio of Y(20.76 times) is better than that of X (15.6 times).
This indicates that the firm Y is collecting its average debtors 20.76 times which is
higher than firm X.

CREDITORS TURNOVER RATIO

Particulars Firm X Firm Y
Creditors turnover ratio = credit purchases / average creditors
Credit purchases = 60% of 1,50,000 60% of 2,25,000
90,000 1,35,000
Average creditors = (32,000+26,000)/2 (28,000+42,000)/2
= 29,000 35,000
Creditors turnover ratio = 90,000/29,000 1,35,000/35,000
3.1 times 3.8 times
From the above creditors turnover ratio, it is clear that Firm X is slower than firm Y in
repaying its debt.