Answer of Q.N.1.
Ratio analysis
is one of the techniques of financial analysis to evaluate the financial
condition and performance of a business concern. Simply, ratio means the
comparison of one figure to other relevant figure or figures.
According to Myers,
“Ratio analysis of financial statements is a study of relationship among
various financial factors in a business as disclosed by a single set of
statements and a study of trend of these factors as shown in a series of
statements."
There are
various groups of people who are interested in analysis of financial position
of a company used the ratio analysis to work out a particular financial
characteristic of the company in which they are interested.
Following are the various classes of ratio used by various
users to assess the financial soundness and efficiency of a company:
(A) Liquidity Ratios:
(i) Short term
solvency ratio
(ii) Long term
solvency ratio
(B) Profitability Ratios
(C) Activity Ratios/ Turnover
Ratios
(D) Financial Ratios
The above groups are further
classified into following parts:
(i) Short term solvency ratio:
(a) Current
ratio
(b) Liquid
ratio/Acid Test ratio
(c) Absolute
liquid ratio
(ii) Long term solvency ratio:
(a)
Equity ratio
(b)
Debt ratio
(c)
Equity ratio
(d)
Net income to debt
service ratio
(iii) Profitability ratio:
(a)
Gross Profit Ratio
(b)
Net Profit Ratio
(c)
Operating Net Profit
Ratio
(d)
Operating Ratio
(e)
Return on Investment
or Return on Capital Employed
(f)
Return on Equity
(g)
Earning Per Share
(iv) Activity Ratios/ Turnover Ratios:
(a)
Capital Turnover Ratio
(b)
Fixed Assets Turnover
Ratio
(c)
Working Capital
Turnover Ratio
(d)
Stock Turnover Ratio
(e)
Debtors Turnover Ratio
(f)
Creditors turnover
ratio
(v) Financial Ratios:
(a)
Debt-Equity Ratio
(b)
Proprietary Ratio
(a)
Capital Gearing Ratio
(c)
Debt to Total Funds
Ratio
(d)
Fixed Assets Ratio
(e)
Interest Coverage
Ratio
Meaning, Objective and
Method of Calculation of some of the important ratios are as follows:
Current
Ratio: Current
ratio is calculated in order to work out firm’s ability to pay off its
short-term liabilities. This ratio is also called working capital ratio. This
ratio explains the relationship between current assets and current liabilities
of a business. It is calculated by applying the following formula:
Current Ratio = Current
Assets/Current Liabilities
Current Assets includes Cash in
hand, Cash at Bank, Sundry Debtors, Bills Receivable, Stock of Goods,
Short-term Investments, Prepaid Expenses, Accrued Incomes etc.
Current Liabilities includes Sundry Creditors, Bills Payable, Bank
Overdraft, Outstanding Expenses etc.
Objective and Significance: Current
ratio shows the short-term financial position of the business. This ratio
measures the ability of the business to pay its current liabilities. The ideal
current ratio is supposed to be 2:1. In case, if this ratio is less than 2:1,
the short-term financial position is not supposed to be very sound and in case,
if it is more than 2:1, it indicates idleness of working capital.
Liquid
Ratio: Liquid
ratio shows short-term solvency of a business. It is also called acid-test
ratio and quick ratio. It is calculated in order to know whether or not current
liabilities can be paid with the help of quick assets quickly. Quick assets
mean those assets, which are quickly convertible into cash.
Liquid Ratio = Liquid
Assets/Current Liabilities
Liquid assets includes Cash in hand, Cash at Bank, Sundry Debtors,
Bills Receivable, Short-term investments etc. In other words, all current
assets are liquid assets except stock and prepaid expenses.
Current liabilities includes Sundry Creditors, Bills Payable, Bank
Overdraft, Outstanding Expenses etc.
Objective and Significance:
Liquid ratio is calculated to work out the liquidity of a business. This ratio
measures the ability of the business to pay its current liabilities in a real
way. The ideal liquid ratio is supposed to be 1:1. In case, this ratio is less
than 1:1, it shows a very weak short-term financial position and in case, it is
more than 1:1, it shows a better short-term financial position.
Gross
Profit Ratio: Gross Profit Ratio shows the relationship between Gross
Profit of the concern and its Net Sales. Gross Profit Ratio can be calculated
in the following manner: -
Gross Profit Ratio = Gross
Profit/Net Sales x 100
Where Gross Profit = Net Sales – Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses –
Closing Stock
And Net Sales = Total Sales – Sales Return
Objective and Significance: Gross Profit Ratio provides guidelines
to the concern whether it is earning sufficient profit to cover administration
and marketing expenses and is able to cover its fixed expenses. This ratio can
also be used in stock-inventory control. Maintenance of steady gross profit
ratio is important .Any fall in this ratio would put the management in
difficulty in the realisation of fixed overheads of the business.
Net
Profit Ratio: Net Profit Ratio shows the relationship between Net Profit
of the concern and Its Net Sales. Net Profit Ratio can be calculated in the
following manner: -
Net Profit Ratio = Net
Profit/Net Sales x 100
Where, Net Profit = Gross Profit – Selling and Distribution Expenses –
Office and Administration Expenses – Financial Expenses – Non Operating
Expenses + Non Operating Incomes.
And Net Sales = Total Sales – Sales Return
Objective and Significance:
In order to work out overall efficiency of the concern Net Profit ratio is
calculated. This ratio is helpful to determine the operational ability of the
concern. While comparing the ratio to previous years’ ratios, the increment
shows the efficiency of the concern.
Operating Profit Ratio:
Operating Profit Ratio shows the relationship between Operating Profit and Net
Sales. Operating Profit Ratio can be calculated in the following manner: -
Operating Profit Ratio =
(Operating Profit/Net Sales) x 100
Where Operating Profit = Gross Profit – Operating Expenses
Or Operating Profit = Net Profit + Non Operating Expenses – Non
Operating Incomes
And Net Sales = Total Sales – Sales Return
Objective and Significance: Operating
Profit Ratio indicates the earning capacity of the concern on the basis of its
business operations and not from earning from the other sources. It shows
whether the business is able to stand in the market or not.
Operating
Ratio: Operating
Ratio matches the operating cost to the net sales of the business. Operating
Cost means Cost of goods sold plus Operating Expenses.
Operating Ratio = Operating
Cost/Net Sales x 100
Where Operating Cost = Cost of goods sold + Operating Expenses
(Operating Expenses = Selling and Distribution Expenses, Office and
Administration Expenses, Repair and Maintenance.)
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses –
Closing Stock
Or Cost of Goods Sold = Net sales – Gross Profit
Objective and Significance: Operating
Ratio is calculated in order to calculate the operating efficiency of the
concern. As this ratio indicates about the percentage of operating cost to the
net sales, so it is better for a concern to have this ratio in less percentage.
The less percentage of cost means higher margin to earn profit.
Debt-Equity
Ratio: Debt
equity ratio shows the relationship between long-term debts and shareholders
funds’. It is also known as ‘External-Internal’ equity ratio.
Debt Equity Ratio =
Debt/Equity
Where Debt (long term loans)
include Debentures, Mortgage Loan, Bank Loan, Public Deposits, Loan from
financial institution etc.
Equity (Shareholders’ Funds) = Share Capital (Equity + Preference) +
Reserves and Surplus – Fictitious Assets
Objective and Significance: This
ratio is a measure of owner’s stock in the business. Proprietors are always
keen to have more funds from borrowings because:
(i) Their stake in the business
is reduced and subsequently their risk too
(ii) Interest on loans or
borrowings is a deductible expenditure while computing taxable profits.
Dividend on shares is not so allowed by Income Tax Authorities.
The normally acceptable
debt-equity ratio is 2:1.
Proprietary
Ratio:
Proprietary Ratio establishes the relationship between proprietors’ funds and
total tangible assets. This ratio is also termed as ‘Net Worth to Total Assets’
or ‘Equity-Assets Ratio’.
Proprietary Ratio =
Proprietors’ Funds/Total Assets
Where Proprietors’ Funds = Shareholders’ Funds = Share Capital (Equity
+ Preference) + Reserves and Surplus – Fictitious Assets
Total Assets include only Fixed Assets and Current Assets. Any
intangible assets without any market value and fictitious assets are not
included.
Objective and Significance: This
ratio indicates the general financial position of the business concern. This
ratio has a particular importance for the creditors who can ascertain the
proportion of shareholder’s funds in the total assets of the business. Higher
the ratio, greater the satisfaction for creditors of all types.
indicates that how many times the
profit covers the interest. It measures the margin of safety for the lenders.
The higher the number, more secure the lender is in respect of periodical
interest.
Stock
Turnover Ratio: Stock turnover ratio is a ratio between cost of goods sold
and average stock. This ratio is also known as stock velocity or inventory
turnover ratio.
Stock Turnover Ratio = Cost of
Goods Sold/Average Stock
Where Average Stock = [Opening Stock + Closing Stock]/2
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses –
Closing Stock
Objective and Significance: Stock
is a most important component of working capital. This ratio provides
guidelines to the management while framing stock policy. It measures how fast
the stock is moving through the firm and generating sales. It helps to maintain
a proper amount of stock to fulfill the requirements of the concern. A proper
inventory turnover makes the business to earn a reasonable margin of profit.
Debtors’
Turnover Ratio: Debtors turnover ratio indicates the relation between net
credit sales and average accounts receivables of the year. This ratio is also
known as Debtors’ Velocity.
Debtors Turnover Ratio = Net
Credit Sales/Average Accounts Receivables
Where Average Accounts Receivables = [Opening Debtors and B/R + Closing
Debtors and B/R]/2
Credit Sales = Total Sales – Cash Sales-Return Inward
Objective and Significance: This
ratio indicates the efficiency of the concern to collect the amount due from
debtors. It determines the efficiency with which the trade debtors are managed.
Higher the ratio, better it is as it proves that the debts are being collected
very quickly.
Debt
Collection Period: Debt collection period
is the period over which the debtors are collected on an average basis. It
indicates the rapidity or slowness with which the money is collected from
debtors.
Debt Collection Period = 12
Months or 365 Days/Debtors Turnover Ratio
Or
Debt Collection Period =
Average Trade Debtors/Average Net Credit Sales per day
Or
365 days or 12 months x
Average Debtors/Credit Sales
(360 days can also be used
instead of 365 days)
Objective and Significance: This
ratio indicates how quickly and efficiently the debts are collected. The
shorter the period the better it is and longer the period more the chances of
bad debts. Although no standard period is prescribed anywhere, it depends on
the nature of the industry.
Answer of Q.N.2.
Journal Entries in
the Books of Sanjay Ltd.
Particulars
|
L.F.
|
Amount
(Dr.)
|
Amount
(Cr.)
|
Bank Account
Dr.
To Equity Share
Application Account
(Being the
application money received on 15000 equity shares @ Rs. 3 each)
|
45000
|
45000
|
|
Equity Share
Application Account
Dr.
To Equity Share Capital
Account
To Equity Share
Allotment Account
(Being the
application money transferred to share capital and excess money transferred
to share allotment account)
|
45000
|
30000
15000
|
|
Equity Share
Allotment Account Dr.
To Equity Share
Capital Account
To Securities
Premium Account
(Being the
allotment money due on 10000 shares @ Rs. 5 each including premium of Rs. 2)
|
50000
|
30000
20000
|
|
Bank Account Dr.
To Equity Share
Allotment Account
(Being the
allotment money received on 10000 equity shares @ Rs. 5 each after adjusting
excess application money)
|
35000
|
35000
|
|
Equity Share 1st
Call Account
Dr.
To Equity Share
Capital Account
(Being the 1st
call money due on 10000 shares @ Rs. 2 each)
|
20000
|
20000
|
|
Bank Account
Dr.
To Equity Share 1st
Call Account
(Being the 1st
call money received on 10000 equity shares @ Rs. 2 each)
|
20000
|
20000
|
|
Equity Share
Final Call Account
Dr.
To Equity Share
Capital Account
(Being the 1st
call money due on 10000 shares @ Rs. 2 each)
|
20000
|
20000
|
|
Bank Account
Dr.
To Equity Share
Final Call Account
(Being the final
call money received on 10000 equity shares @ Rs. 2 each)
|
20000
|
20000
|
Balance Sheet of
Sanjay Ltd.
Liabilities
|
Amount
|
Assets
|
Amount
|
Called up and
Paid up capital:
10000 equity
shares @ Rs. 10 each
Securities
Premium
|
100000
20000
|
Cash At Bank
|
120000
|
Total
|
120000
|
Total
|
120000
|
Answer of Q.N.3 (a).
Dissolution of Partnership:
Dissolution of a partnership means the termination of connections
with the firm by some of the partners of the firm, and remaining partners of
the firm continuing the business of the firm under the same firm’s name under
an agreement. Hence, admission, retirement and a death of a partner are
considered dissolution of partnership. The dissolution of partnership may take place in any of the following
ways:
(a)
Change
in existing profit sharing ratio among partners;
(b)
Admission
of a new partner;
(c)
Retirement
of a partner;
(d)
Death
of a partner;
(e)
Insolvency
of a partner;
(f)
Completion
of the venture, if partnership is formed for that; and
(g)
Expiry
of the period of partnership, if partnership is for a specific period of time;
In case of
dissolution of firm a new partnership agreement is formed, this is why the old
partnership comes to an end and a new partnership begins.
Modes of Dissolution
of a Partnership Firm:
The dissolution of partnership between
all the partners of a firm is called the "dissolution of the firm". A
firm may be dissolved with the consent of all the partners or in accordance
with a contract between the partners. The Indian Partnership Act, 1932 provides
that a partnership firm may be dissolved in any of the following modes:
(a)
Compulsory
dissolution;
(b)
Dissolution
on the happening of certain contingencies;
(c)
Dissolution
by notice of partnership at will;
(d)
Dissolution
by the court.
i)
Compulsory Dissolution: A firm is dissolved by the
adjudication of all the partners or of all the partners but one as insolvent,
or by the happening of any event which makes it unlawful for the business of
the firm to be carried on or for the partners to carry it on in partnership.
However, where more than one separate
venture or business or undertaking is carried on by the firm, the illegality of
one or more ventures or businesses or undertakings shall not by itself cause
the dissolution of the firm in respect of its lawful ventures, businesses and
undertakings.
ii)
Dissolution on the Happening of Certain Contingencies: Subject to contract between the
partners, a firm is dissolved:
(a)
if
constituted for a fixed term, by the expiry of that term;
(b)
if
constituted to carry out one or more adventures or undertakings, by the
completion thereof;
(c)
by
the death of a partner; and
(d)
By
the adjudication of a partner as an insolvent.
iii)
Dissolution by Notice of Partnership at Will: Where the partnership is at will, the
firm may be dissolved by any partner giving notice in writing to all the other
partners of his intention to dissolve the firm.
The firm is dissolved as from the date
mentioned in the notice as the date of dissolution or, if no date is so
mentioned, as from the date of the communication of the notice.
iv) Dissolution by Court: A court may order a
partnership firm to be dissolved in the following cases:
(a)
When
a partner becomes of unsound mind
(b)
When
a partner becomes permanently incapable of performing his/her duties as a
partner,
(c)
When
partner deliberately and consistently commits breach of agreements relating to
the management of the firm;
(d)
when
a partner’s conduct is likely to adversely affect the business of the firm;
(e)
when
a partner transfers his/her interest in the firm to a third party;
(f)
When the court regards dissolution to be just and equitable.
Answer of Q.N. 3 (b).
The capital of a joint stock company is
divided into shares which are collectively called ‘Share Capital’. Share
capital refers to the amount that a company can raise or has raised by the
issue of shares.
The share capital may be classified as
below:
(a)
Nominal/Authorized/Registered Capital: This
is the amount of the capital which is stated in Memorandum of Association and
with which the company is registered. Nominal capital is the maximum amount
which the company is authorised to raise from the public.
(b)
Issued Capital: Issued capital is that part of
the nominal capital, which is offered to the public for subscription. The
balance of the nominal capital, which is not offered to the public for
subscription, is called unissued capital.
(c)
Subscribed Capital: Subscribed
capital is that part of the issued capital, which is applied for by the public.
The balance of the issued capital, which is not subscribed for by the public is
called, unsubscribe capital.
(d)
Called up Capital:
This is the amount of the capital that the shareholders have been called to pay
on the shares subscribed for by them. The amount of the subscribed capital,
which is not called, is known as uncalled capital.
(e)
Paid up Capital: This represents that part of the
called up capital, which is actually received by the company. The amount of the
called-up capital, which not paid by the shareholders, is called as unpaid
capital or calls in arrears.
(f)
Reserve Capital: A company may by special
resolution determine that any portion of its share capital which has not been
already called up shall not be capable of being called-up, except in the event
of winding up of the company. Such type of share capital is known as
reserve-capital.
Answer of Q.N. 4.
(a) Difference
between Departmental Accounts and Branch Accounts
The main distinctions between
Departmental Accounts and Branch Accounts are given below:
Basis of Distinction
|
Departmental Accounts
|
Branch Accounts
|
Maintenance of Accounts
|
All accounts are maintained at one place &
departmental trading and profit and loss account is prepared accordingly
|
In case of branch, all branch accounts are kept
at Head Office except cash, customers and stock registers are maintained at
branch. But in case of independent branch all accounts are kept at branch and
a branch prepares its own trading and Profit & Loss Account.
|
Allocation of Common Expenses
|
Departments are not geographically separated from
each other, so problem of allocation of common expenses among different
departments arises.
|
As branches are geographically separated from
each other so the problem of allocation of common expenses among different
branches does not arises.
|
Adjustments &
Reconciliation of Accounts
|
The question of adjustments and reconciliation of
accounts does not arise in departmental accounts
|
In case of independent branch some adjustments
and reconciliation of head office and the branch accounts are required to be
done at the end of the year.
|
Problem of foreign currency
|
The problem of conversion of foreign currency
into home currency does not arise.
|
The problem of conversion of foreign branch
figures may arise at the time of finalization of accounts of head office.
|
(b) Differences
Between Hire Purchase System and Installment Purchase System:
Basis
of Difference
|
Hire-Purchase
System
|
Installment
Purchase
|
Nature of
Contract
|
It is a contract of hiring
|
It is a contract of sale
|
Ownership
|
It is transferred by seller to buyer only after
payment of all installments
|
It is transferred by seller to buyer, immediately
on signing the contract.
|
Position
of Buyer
|
In this case, the buyer is like a bailee
|
In this case, the buyer is not in the position of
a bailee
|
Risk of
loss or damage to goods
|
Such risk is on the seller
|
Such risk is on the buyer
|
Repossession
and goods by seller
|
On default of payment of any installment by the
buyer, the seller can repossess the goods
|
On default and payment of any installment by the
buyer, seller cannot repossess the goods, but can file a suit in the court of
law against the buyer for the recovery of unpaid price.
|
Return of goods
|
The buyer can exercise the option of return of
goods
|
The buyer cannot exercise the option of return of
goods
|
Right of
disposal to the buyer
|
The buyer cannot dispose the goods, until the
payment of last installment. If disposed, the third party buyer does not get
a better title
|
The buyer has the right to dispose the goods,
even if all installments are not yet paid.
|
(c) Difference
between Reserve Capital and Capital Reserve
Basis of
Difference
|
Reserve
Capital
|
Capital
Reserve
|
Meaning
|
Reserve Capital is the part
of uncalled capital, which shall not be called except in the event of winding
up of the company.
|
It is that part of the
reserves which is not free for distribution as dividend.
|
Creation
|
It is created out of
uncalled capital.
|
It is created out of capital
profits.
|
Optional/ Mandatory
|
It is not mandatory to
create Reserve Capital.
|
Capital Reserve is
mandatory to be created in case of profit on reissue of forfeited shares.
|
Disclosure
|
It is not to be disclosed
in the Balance Sheet of the company.
|
Capital Reserve is to be
shown in liability side of the balance sheet of the company under the heading
of ’Reserve and Surplus.’
|
Writing of Capital
Losses
|
Reserve Capital cannot be
used to write off capital losses.
|
Capital Reserve is used to
write off capital losses and to issue bonus shares to shareholder.
|
(d) Difference Between Average Profit
method and Super Profit method
Average Profits Method: In this method, normal past business profits of a number of years
are taken into account. Such profits are totaled up and their average is
arrived at. The average profits are multiplied by the number year’s purchases
to arrive at the value of goodwill.
Super Profit
Method: Super Profits means profits earned
in excess of the normal Profit, i.e., Actual Profit –Normal. Normal profits
mean the profit which the firms could normally earns in a particular business.
Difference between Average
Profits and Super Profits
Basis
|
Average Profits
|
Super Profits
|
1. Meaning
|
It is the average
of the profits of the past few years.
|
It is the excess
of average profits over normal profits.
|
2. Normal Rate of
Return
|
Normal rate of
return is not relevant in the calculation of average profits.
|
Normal rate of
return is considered while calculating super profit.
|
3. Relevance of
Valuing Goodwill
|
It is relevant
for average profits method, super profits method and capitalization methods
of valuation of goodwill
|
Super profit is
relevant for super profit method and capitalization of super profit method of
valuation of goodwill.
|
Answer of Question no. 5.
(a)
Inter-Branch Transactions
Where
there are numbers of branches, inter-branch transactions are likely to take
place, e.g., cash or goods sent by one branch to another or expenses incurred
by one branch on behalf of another. Such
transactions are usually adjusted assuming that they were entered into under the
instructions from the H.O. Suppose
Kolkata branch transfers some goods to Mumbai branch under the directions of
the H.O. The entries will be as follows:
1.
|
In the books of Kolkata Branch:
Head
Office A/c
Dr
To Goods Supplied to Branch A/c
|
XXX
|
XXX
|
2.
|
In the books of Mumbai Branch:
Goods
received from Branches A/c
Dr
To Head Office A/c
|
XXX
|
XXX
|
3.
|
In the books of Head Office:
Mumbai
Branch A/c Dr
To Kolkata Branch a/c
|
XXX
|
XXX
|
Note: Inter-branch transactions
without the knowledge of head office may be passed as between the branches only
in the usual manner.
(b) Partnership Deed
Partnership deed:
A partnership is formed by an agreement. This
agreement may be oral or in writing. Though the law does not expressly require
that the partnership agreement should be in writing, it is desirable to have it
in writing. A document, which contains the terms of partnership, as agreed to
by the partners is called ‘Partnership Deed.’
Contents of the Deed:
a)
Name of the firm and its permanent address.
b)
Names and addresses of the partners.
c)
Nature of Business.
d)
Methods of evaluating of assets and liabilities.
e)
Date of commencement of partnership.
f)
Amount of capital to be contributed by each
partner.
g)
Interest of Capital, if provided the rate of
interest must be specified.
h)
Drawings
by the partners, Interest on Drawings, if charged, the rate of
interest should also be specified.
i)
Accounting Period of the Firm: -The period after
which the final accounts of the firm are to be prepared. Whether yearly or
half-yearly and the date on which accounts are to be closed every year.
j)
Profit and loss sharing ratio: Partners must
agree as to the ratio in which they will be distributing profit or loss. In the
absence of any agreed ratio profit or loss will be shared equally
k)
Partner’s salary: If any partner is allowed
salary, it should be mentioned in the partnership deed and the amount of salary
should also be specified.
l)
Duration of partnership: The period for which the
partnership has established and the mode of dissolution of partnership.
(c) Issue of Share at Premium
If Shares are issued at a price, which is
more than the face value of shares, it is said that the shares have been issued
at a premium. The Company Act 1956 does
not place any restriction on issue of shares at a premium but the amount
received, as premium has to be placed in a separate account called Securities
Premium Account.
Under Section
78 of the Company Act 1956, the amount of security premium may be
used only for the following purposes:
(a)
To write off the preliminary expenses of the
company.
(b)
To write off the expenses, commission or discount
allowed on issued of shares or debentures of the company.
(c)
To provide for the premium payable on redemption of
redeemable preference shares or debentures of the company.
(d)
To issue fully paid bonus shares to the shareholders
of the company.
(e)
In purchasing its own shares (buy back).
(d) Profit Prior to Incorporation
"Profit
prior to incorporation" is the profit earned or loss suffered during the
period before incorporation. Suppose, A company buys XYZ company on 1st Jan.
2010 and it has to incorporate at 1st April 2010. Then profit between 1st Jan.
2010 and 1st April 2010 will be profit prior to incorporation.It is a capital
profit and is not legally available for distribution as dividend because a
company cannot earn a profit before it comes into existence. Profit earned
after incorporation is revenue profit, which is available for dividend. This
profit is transfer the capital reserve but if any loss is occurred than that is
transfer to goodwill account.
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