Commerce

 

CLASS 11TH 

NCERT

COMMERCE

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CLASS 12TH 

NCERT

SUBJECT: Accountancy

PARTNERSHIP

Q1: What is Partnership? What are its features?

Ans: When two or more than two persons agree to carry on business for mutual distribution of profits and losses, they are said to have formed a partnership. They act both as an agent and principal of the firm.

                According to section 4 of the Indian partnership act 1932’ Partnership is the relation between persons who have agreed to share the profits of the business carried by all or any of them acting for all. The persons who have entered into partnership with one another are called individually ‘partners’ and collectively as ‘firm’. The name under which the business is carried is called a firm.

Features or characteristics of Partnership

         The following are the essential features of a partnership firm:

1.  Plurality of persons: Partnership is association of two or more persons agreeing to carry on business and share profits and losses.

2.  Agreement: In order to have a partnership, it is necessary that there must be an agreement between partners, the agreement to form a partnership may be in writing or oral.

3.  Lawful business: It is essential that the partnership is farmed for doing lawful business to earn profits.

4.  Sharing of profits: It is essential that the partners share profits of the firm according to pre determined ratio.

5.  Voluntary Association: A partnership is a voluntary association of individuals.

6.  Business can be carried on by all or any of them acting for all.

Q2:   What is Partnership Deed? What are its contents?

Ans: Partnership is an agreement between persons to carry on business. The agreement entered into between partners may be either oral or written. But, it is always desirable to have a written agreement so as to avoid misunderstanding and disputes in future. When the agreement is in written form, it is called partnership deed. It must be duly signed by the partners, stamped and registered.

              The partnership deed generally contains the following:

1.  Name of the firm.

2.  Place of business.

3.  Nature of business.

4.  Names and addresses of all partners.

5.  Capital to be contributed by each partner.

6.  Profit sharing ratio between the partners.

7.  Whether interest is to be allowed on capitals.

8.  Whether any partner is to be allowed salary.

9.  Duties of each partner.

10.              Methods of valuation of goodwill in case of admission, retirement and death of a partner.

Q3: What are the advantages or benefits of partnership deed?

Ans: Following are the advantages of Partnership deed:

1.   Partnership deed can help us in solving the disputes among the partners.

2.  Partnership deed can also solve the issue of termination.

3.  A partnership deed sets out the intention of forming the partnership.

4.  It facilitates the smooth functioning of business.

Q4: What are various rights and duties of Partners?

Ans: Right of Partners:

1.  Every partner has a right to take part in the conduct and management of business.

2.  Every partner has a right to be consulted and heard in all matters affecting the business of partnership.

3.  To share profits as agreed to, in partnership agreement.

4.  A partner has a right not to allow the admission of a new partner.

5.  To get the interest on loan at the rate given in partnership deed or 6% as per law.

6.  To be the owner of the property of the partnership firm.

Duties of Partners:

1.  Every partner is bound to attend diligently to his duties of the business.

2.  To be compensated by the firm for any loss incurred by him.

3.  No partner act outside the parameters of his authority.

4.  No partner can transfer the interest of the firm to any other person.

Q5: What is profit and loss appropriation account what are its features?

Ans: The profit and loss appropriation account is an extension of the profit and loss account. The main intention of preparing a profit and loss appropriation account is to show the distribution of profits among the partners. This account is debited with interest on capital of the partners, partner’s salaries and commission etc. and credited with net profits and interest on drawings of partners. The balance of profit and loss appropriation account is transferred to the capital account or current account of the partners according to their profit sharing ratio.

Features of Profit & Loss appropriation account:

1.  Profit & loss appropriation account is a nominal account.

2.  It is prepared with the object of calculating divisible profit.

3.  The entries in this account is guided by the partnership deed or partnership act.

4.  It is prepared by partnership firms and companies.

5.  It is an extension of profit and loss account.

Q6:  Give specimen/format of profit and loss appropriation account?

Ans: Format of Profit & loss appropriation account:

Particulars	Amount	Particulars	Amount
To interest on capitals: A                                  x x x B                                  x x x    T Partners Salaries: A                                  x x x B                                  x x x   To Partners commission To Reserve   To profit transfer to: A’s capital A/c   (or) A’s current A/c B’s Capital A/c   (or) B’s current A/c	x x x       x x x   x x x x x x       x x x   x x x	By net profits (before adjustments)     By interest on Drawings A                                      x x x B                                      x x x	x x x         x x x
	x x x		x x x

 

 

 

 

Q7: What is difference between Profit & loss account and Profit & loss appropriation account?

Ans:  Following are the main points of difference between profit and loss account and profit and loss appropriation account:

Profit & loss Account	Profit & loss Appropriation Account
1.  It shows how the profit is earned or loss is incurred. 2.  It is prepared after trading account.   3.  Items debited to this account are expenses (charge against profit). 4.  It is prepared by all types of business. 5.  This account has neither opening nor closing balance.	1.  It shows how the net profit is appropriated 2.  It is prepared after profit & loss appropriation. 3.  Items debited to this account are appropriation. 4.  It is prepared by partnerships and companies. 5.  This account may have both opening and closing balance.

 

Q8: What are the rules for charging interest on drawing?

Ans: Interest on drawing is computed on the basis of the period for which the money was withdrawn. The partners may make drawings from the firm in different manners. Interest on drawings under different situations may calculated as follows:-

1.  When fixed amount is withdrawn on the first day of every month then interest will be charges for 6 ½ months.

2.  When the fixed amount is withdrawn on the last day of every month, interest will be charged for 5 ½ months.

3.  When fixed amount is withdrawn in the middle of every month, interest will be charged for six months.

4.  When fixed amount is withdrawn in the beginning of each quarter, interest will be charges for an average period of 7 ½ months.

5.  When fixed amount is withdrawn in the middle of each quarter, interest will be charged for an average period of 6 months.

6.  When fixed amount is withdrawn at the end of each quarter, interest will be charged for an average period of 4 ½ months.

 

 

Q9: What do you mean by fixed and fluctuating capital?

Ans: Fixed capitals: When capitals are kept as fixed amounts, normally opening and closing balances of capitals remains same except under special circumstances when capital account is credited with additions make to capital and is debited with any capital drawings. All other adjustments in respect of interest on capital, salaries, share of profits/losses and interest on drawings are made in a separate account called partner’s current account.

        Fluctuating Capital: When capitals are kept as fluctuating amounts, all adjustments relating to partners in respect of interest on capital, salaries. Sharing of profits/loss & interest on drawings are made in their capital accounts. Hence there is no scope for the preparation of partner’s current accounts.

Q10: What do you mean by past adjustments?

Ans: Sometimes after closing the accounts of partnership firms it is discovered that there were some errors or omissions in the accounts, E.g, interest on capital or drawings may have seen omitted, charged or allowed at higher rates or lower rates, profits or losses may have been distributed among the partners in wrong ratio and so on. In order to rectify these errors and omissions, accounts are adjusted either through profits & loss adjustment account or directly through the capital accounts by passing on adjustment entry.

Q11: What do you mean by Guarantee of minimum profit?

Ans: Sometimes a partner may be guaranteed a minimum of his share in profits. Such a guarantee may be provided by one or some or all of the partners in an existing profit sharing ratio or in some other agreed ratio. If in any year the actual share of profits is less than the guaranteed amount, the deficiency is borne by the guaranteeing partners in their agreed ratio.

Q12: What are the provisions applicable in the absence of partnership deed?

Ans: Following are the provisions applicable in the absence of partnershipdeed:

1.  No interest on capital is to be allowed to any partner.

2.  No interest on drawings is to be charged to any partner.

3.  No salary or commission is to be allowed to any partner.

4.  Profit or losses are divided equally among the partners.

5.  Interest on loan is allowed @ 6% p.a. to partners.

 

GOODWILL

Q1: What do you mean by Goodwill?

Ans: Goodwill is the reputation of business it shows the value of a firm in terms of reputation. If a company has a brand that has a certain reputation and status in the market. This can be measured to have a lesser or greater value, this value is called goodwill.

                 Goodwill is the value of reputation of the firm in respect of profits expected in future over and above the normal rate of profits. It is thus, the present value of a firm’s anticipated excess earnings. Goodwill is created through various activities such as; quality production, harmonious relations with customers integrity etc.

Q2: What are the factors which affect the value of goodwill?

Ans: Following are the main factors which affects the value of goodwill:

1.  Favourable location: A centrally located firm in the market will attract more customers.

2.  Efficiency of management: A well-managed firm earns a higher profit and so the value of goodwill also be high.

3.  Market situation: The monopoly condition leads to earning high profits which lead to higher value of goodwill.

4.  Quality of products: A good quality is better accepted by the customers.

5.  After sale services: This increases consumer satisfaction. The consumer feeds that he is being cared for. This leads to increase in turnover and profits.

Q3: What is the need for valuation of goodwill?

Ans: Goodwill needs to be valued in the following situations:

1.  At the time of change in profit sharing ratio.

2.  At the time of admission of new partner in the business.

3.  At the time of retirement of a partner from the firm.

4.  At the time of death of a partner.

5.  At the time of sale of firms business.

6.  At the time of emigration of two or more firms.

Q4: Name various methods of valuation of goodwill?

Ans: 1. Average profit method.

        2. Weighted average profit method.

        3. Super profit method.

        4. Capitalization method.

        5. Annuity method.

 Q5: What is average profit method of goodwill?

Ans: Under this method, an average of the profits of certain given years is calculated. The value of the goodwill is calculated at an agreed number of year’s purchases of the average profit. Thus the goodwill is calculated as follows:

       Value of goodwill = Average profit x number of years purchase

                   Number of year’s purchase means for how many years. The firm will earn the some amount of profit because of its past efforts after change of ownership.

Q6: What is super profit method of valuation of Goodwill?

Ans: The term super profit refers to the excess profits made by firm over normal profit. The valuation of goodwill in such a case depends upon the following factors:

1.  Average capital: Employed in the business which is taken equal to total assets outside liabilities.

2.  Normal profit: It is calculated on the basis of normal rate of return applied to capital employed.

3.  Average expected profit: This is calculated on the basis of past profits adjusted in the light of future expectations.

4.  Super profit: The difference between overage expected profit and normal profit is the amount of super profit.

5.  No. of years: The amount of super profit is multiplied by the number of years for which the super profit is expected to continue.

Q7: What is capitalization method of valuation of goodwill?

Ans: In this method, goodwill is the amount of capital saved. Normally business men invest capital to operate business activities & earn profit with the efficient utilization of capital. If the business earns more profit by investing lesser amount of capital as compared to other business, who earned same amount of the profit with more amount of capital, the saved amount is assumed to be goodwill.

              Goodwill = Capital required to be invested for earning of profit – Actually employed.

     Required capital = Profit earned x 100/rate of returns

ADMISSION

Q1: What are the effects of admission of new partner?

Ans: The effects of admission of a new partner are:

1.  The old partnership comes to an end and new partnership is commenced.

2.  New or Incoming partner becomes entitled to share future profits of the firm and the combined shares of the old partners get reduced.

3.  New or Incoming partner contributes an agreed amount of capital to the firm.

4.  New or Incoming partner acquires right on the assets and also becomes liable for the liabilities of the firm.

5.  Adjustment is made in regard to accumulated profits and losses.

6.  Assets are revalued and liabilities are reassessed. The net change is adjusted in existing partner’s capital accounts.

7.  The goodwill of the firm is valued and adjusted to sacrificing partner’s capital accounts.

Q2: What is new profit sharing ratio?

Ans: The new profit sharing ratio is the ratio in which all the partners, including the new    partner, share the future profits and losses of the firm.

Q3: What is sacrificing ratio?

Ans: Sacrificing ratio is the ratio in which the old or existing partners forego the share of profit in favour of the new or incoming partner. It can be defined to be Ratio in which the new partner is given the share by the old partners is the sacrificing ratio.

                    The purpose of sacrificing ratio is to determine the amount of compensation the new partner should pay to the old partners for the share of profits sacrificed by them. 

 

RETIREMENT OF PARTNERS

Q1: What is Gaining Ratio?

Ans: The Ratio in which the continuing partners acquire the outgoing (retired or deceased) partner’s share is called the Gaining Ratio. This ratio is calculated by deduction old share from the new share in profits.

               The gaining ratio is calculated when a partner retires from a firm or dies. Calculation of gaining ratio is necessary for adjusting the retiring partner’s share of goodwill. Remaining (continuing) partners will pay the amount of goodwill to the retiring partner in their gaining ratio.

Q2: What amount is due to a retiring partner?

                                     OR

     What Items are credited or debited to Retiring Partner capital account?

Ans: The retiring partner becomes entitled to amount due to him, which includes:

Ø Balance in his Capital/Current Account.

Ø Share of goodwill.

Ø Share in the gain/loss on revaluation of assets and reassessment of liabilities.

Ø Share of accumulated profits (losses) and reserves.

Ø Interest on capital, salary, etc., from the data of the Balance Sheet to the date of retirement. Drawings & interest on drawings is debited for that period to the concerned Partner’s Capital Account.

Q3: What is Revaluation account? Give a format of revaluation account?

Ans: At the time of admission/retirement of a new partner, it is always desirable for him as well as existing/continuing partners to make a revaluation of all the assets & liabilities of the firm. For the purpose of revaluation of assets and liabilities an account called ‘Revaluation Account’ is opened in the books of firm. The main object of preparing this account is to find out the net results of revaluation (profit/loss). Revaluation Account (being a nominal account) is debited with any decreases in the value of assets and increase in the value of liability. Similarly this account is credited with any increase in the value of assets and any decrease in the value of outside liabilities profit/loss on revaluation is credited or debited to old partner’s capital account in their old profit sharing ratio.

      A format of revaluation account with imaginary figures is given as follows:-

REVALUATION A/C

To Plant and Machinery A/c (decrease in value) To Furniture A/c (decrease in value) To Sundry Creditors To Profit T/F to: A’s capital A/c = 4,500 B’s capital A/c = 4,500	10,000   5,000     1,000 9,000	By Land & Building A/c (Increase in value)   By investments (Appreciation in value)	15,000     10,000
	25,000		25,000

 

Q4: What is Joint Life Policy?

Ans: A Joint Life Policy refers to an insurance policy taken by the partnership firm on the joint lives of all the partners. The amount of such a policy is payable by the Insurance Company either on death of any partner or on its maturity whichever is earlier. The policy may also be surrendered before its maturity.

                The objective behind taking out a Joint Life Policy is to make provision for the payment of the amount due to the executors of a deceased partner so that the working capital of the firm may not be adversely affected to that extent.

Q5: What is Surrender value?

Ans: Surrender Value is the value of the insurance policy that an insurance company pays on the surrender of a policy before the date of its maturity.

 

 

 

 

 

 

DISSOLUTION OF PARTNERSHIP

Q1: What do you mean by Dissolution of Partnership?

Ans: The dissolution of partnership between or among at the partners of a firm is called the dissolution of the firm. The partnership firm comes into existence as a result of agreement between partners. Similarly, it can be dissolved if and when partners decide mutually to discontinue it. In case of dissolution of a firm, the business of the firm is closed down its affairs are wound up. The assets are realized and the liabilities are paid off. The dissolution of a partnership may or may not result in the dissolution of the firm but the dissolution of the firm will always result in the dissolution of the partnership.

Q2: How are accounts settled after dissolution?

Ans:

1.  Treatment of Losses:- Losses including deficiencies of capital are to be paid in the following order.

Ø First out of profits of the firm;

Ø Then out of capitals of the partners;

Ø Lastly by partners individually in their profit-sharing ratio.

 

2.  Application of Assets:- The assets of the firm, including any sum contributed by the partners to make up the deficiencies of capital shall be applied in the following manner and order:

Ø In paying firm’s debts to the third parties;

Ø In paying to each partner rateably what is due to him on account of advances;

Ø In paying to each partner rateably what is due to him on account of capital;

Ø The surplus, if any shall be disturbed among the partners in their profit sharing ratio.

Q3: Name various modes of dissolution of firm?

Ans: The modes by which a firm may be dissolved are:

1.  By Mutual Agreement:

2.  Compulsory Dissolution: A firm may be compulsory dissolved:

a.   When all the partners or all the partners except one become insolvent.

b.  When business of the firm becomes unlawful.

 

3.  By Notice:

4.  On Happening of an Event: A firm may be dissolved in any of the following events, if the Partnership Deed so provides.

5.  Dissolution by Court: A court may pass order for the dissolution of the firm when:

a.   A partner becomes a person of unsound mind.

b.  A partner is permanently incapacitated.

c.   A partner is found guilty of misconduct.

Q4: What is Realisation Account?

Ans: Realisation account is an account prepared to see the net result of realisation on dissolution of partnership firm. This account is debited with book value of assets as shown in the firm’s balance sheet (except cash balance, debit balances of partner’s capital accounts or current accounts, undisturbed loss). It is credited with outside liabilities and any reserve against any specific assets.

       Amount realized from sale of assets is credited in the account and payments made for liabilities are debited in this account. This account is further debited with expenses on realization. The profit or loss shown by this account is credited or debited to partner’s capital a/c (as the case may be).

 

 

 

 

 

 

 

 

 

 

 

 

Q5: Give format a proforma of realisation account?

Ans: Give a proforma of realisation account with imaginary figures Realisation account:

Particulars	Amount DR	Particulars	Amount DR
To Sundry Assets Land and building .......... Plant and machinery ....... Investment            .......... Furniture and fixtures ...... Sundry Debtors     .......... Stock in hand        ..........   To Cash A/c (Payment to creditors) To partner capital a/c (liability discharged by partner) To Cash A/c Payment for bank loan To Cash A/c (Dissolution Expenses) To Profit T/F to A.  Capital A/c __________ B.  Capital A/c __________	..............     ..............             ...............	By Sundry liabilities Creditors     .............. Bank           ..............   By provisions   By cash A/c (Sale of Assets) By partner capital a/c (Asset taken by partners) By loss T/F to   As cap A/c     ...........   Bs Cap A/c    ...........	.............. ..............                         ...............

 

Q6: What is difference between Realisation Account and Revaluation Account?

Ans:  

Realisation Account	Revaluation Account
It records the disposal of assets and discharge of liabilities.	It records the net effects of revaluation of assets and liabilities.
It is prepared to know the profit or loss on disposal of assets and discharge of liabilities.	It is prepared to adjust the value of assets and liabilities.
It is prepare at the time of dissolution of the firm.	It is prepared at the time of admission, retirement or death of a partner.
All assets and liabilities are recorded in this account at their full value.	Here only the change in the value is recorded.
It is prepared only once in the life of the firm i.e; at the time of dissolution of the firm.	It may be prepared many times during the life of the firm. It is prepared every time there is change in the constitution of the firm.

SHARE CAPITAL

Q1: What do you mean by share?

Ans: The capital of a company is divided into different units with definite value and these units are called shares. In other words, a share is the smallest denomination of share capital. The holders of shares are called shareholders or members of a company. They are entitled to a dividend out of the profit earned by the company. A company can issue two types of shares:

1.  Preference shares

2.  Equality shares

Q2:  What is share capital? What are various kinds of share capital?

Ans: The part of the capital of a company that comes from the issue of shares is called share capital. In other words, the amount required by the company for its business activities is raised by the issue of share, the amount so raised is called share capital of the company.

Kinds of Share capital:

1.  Authorised capital: This is the amount of capital with which the company intends to get itself registered. This is the amount of share capital which a company is authorised to issue.

2.  Issued capital: It is the part of authorized capital which is actually issued by the company for public subscription.

3.  Subscribed capital: It is that part of issued capital which have actually been taken up by the public.

4.  Called up capital: It is that part of subscribed capital which is called up by the company.

5.  Paid up capital: It is that part of called up capital which is actually paid up by the members or shareholders.

Q3: What are preference shares and equity shares?

Ans: Preference Shares: Shares which enjoy the preferential rights, on to divided and repayment of capital in the event of winding up of a company over the equity shares are called preference shares. The preference shares get a fixed rate of dividend. Holders of these shares do not have voting power.

        Equity Shares: Equity shares are those shares which are not preference shares. Equity shareholders will get dividend and repayment of capital after meeting the claims of preference shareholders. There will be no fixed rate of dividend. It may vary from year to year. This rate of dividend is determined by the directors of the company in view of the profit earned.

Q4: What do you mean by sweat equity shares?

Ans: Sweat equity shares means such equity shares as are issued by a company to its directors or employees at a discount or for consideration other than cash. Sweat equity shares is a form of compensation by the business to their owners and employees.                                         

Q5: What is share certificate?

Ans: A share certificate is a certificate issued by a company certifying that on the date the certificate is issued, a certain person is the registered owner of shares in the company. It is stamped with the common seal of the company and signed.

Q6: What is Reserve capital?

Ans: It is the capital, which has not been called up by the company and it has decided not to call the uncalled capital, except on its winding up, by passing a special resolution. So the reserve portion of the subscribed capital becomes reserve capital and it will available only to the creditors in case of liquidation of the company.

Q7: What is difference between Reserve capital and Capital reserve?

Ans:                  Reserve capital                                         Capital reserve     

It is that part of capital which is issued and can be issued only when company goes under liquidation.	It is not earned by the company in normal course of business, rather it is created out of capital profits by the company.
To create reserve capital, a special resolution is required to be passed.	No need of passing any special resolution at the time of creation of capital reserve.
It is a part of capital which is not received.	It is a part of profit which is earned & received.
It is not disclosed in the company’s balance sheet.	It is disclosed in the company’s balance sheet.

 

Q8: What is capital reserve?

Ans: Capital reserve is not earned by the company in normal course of business, rather it is created out of capital profits by the company. The reserve which is created out of capital profit is known as capital reserve.

Q9: What do you mean by under subscription?

Ans: Shares are said to be undersubscribed when the number of shares applied for is less than the number of shares offered. In such a case, the accounting entries are made on the basis of the number of shares applied. In such a case, it must be ensured whether the company has received ‘minimum subscription’ or not because without minimum subscription the procedure of share issue cannot proceed further legally.

Q10: What do you mean by over subscription?

Ans: Shares are said to be oversubscribed when no. of shares applied is more than the no. of shares offered to the public for subscription but subscribed capital can never exceed issued capital. In other words, a company cannot allot shares more than offered for subscription.                                                                                                                                   The company may treat the excess applications received in the following ways:

a.   Certain applications may straight away be rejected.

b.  Partial allotment may be made. It means allotment of similar number of shares than the number of shares applied for.

c.   Pro rata allotment may be done. It means allotment is made to each applicant or some applicants on a proportionate basis.

Q11: What do you mean by issue of shares at a discount?

Ans: Shares are said to be issued at a discount when they are issued at a price lower than the face value of the share. The excess of face value over the issue price is called as “discount on shares”.

                      Discount on issue of shares is to be treated as a “loss of capital nature” and is to be debited to a separate a/c called “discount on issue of shares a/c”. In the preparation of balance sheet “discount on issue of shares a/c” is to be shown as a fictitious asset. This account is gradually written off against any capital reserve or it can be written off through profit and loss a/c

Q12: What are the circumstances/conditions under which a company can issue shares at a discount?

Ans: According to the section 79 of the companies act, a company can issue shares at a discount only if the following conditions are fulfilled:

1.  The shares must belong to a class already issued.

2.  The issue must be authorized by an ordinary resolution of the company.

3.  The sanction of the company law tribunal must be obtained.

Q13: What do you mean by issue of shares at a premium?

Ans: Shares are said to be issued at premium when they are issued at a price higher than the face value of shares. The excess of issue price over the face value is called as the amount of premium on shares.

                     Premium on issue of shares is treated as a capital receipt and is to be credited to a separate a/c called ‘securities premium a/c’. This a/c is shown on the liability side of the balance sheet under the head of ‘Reserves and Surpluses’. Premium on shares a/c is utilized to write of any fictitious assets like preliminary expenses, ‘discount on issue of shares’ or ‘commission paid on issue of shares or debentures’ etc.

Q14: What do you mean by Private Placement of shares?

Ans: Private Placement of shares: It refers to an issue, which is not a public issue but are offered to a selected group of persons:

Q15: What do you mean by Public Issue of shares?

Ans: Public Issue of Shares: It means an invitation to public to subscribe to the securities offered through a propectous.

Q16: What do you mean by Employees Stock Option Scheme (ESOS)?

Ans: Employees Stock Option Scheme means a scheme under which the company grants option (a right but not an obligation) to an employee to apply for shares of the company at a predetermined price.

Q17: What is Pro-rata allotment of shares? Explain with examples?

Ans: In the case of over-subscription, it is not possible to allot shares to all applicants. The company may make pro-rata allotment to applicants. In case of pro-rata allotment each class of applicant receives the shares in proportion to shares applied for. For example, if shares issued are 1,000 and the shares applied are 1,500 then the proportion of shares applied to allotment is 15:10 or 3:2.

Q18: What is meant by Forfeiture of Shares? Or When does a company forfeit its shares?

Ans: If a shareholder fails to pay any call made on him, the company may cancel his shares. This cancellation of shares for non-payment of call money due is known as Forfeiture of Shares.

                    The effect of forfeiture of shares is that the defaulting shareholder loses all his rights in shares and ceases to be a member. The name of the shareholder is removed from the register of members and the amount already paid by him of shares is forfeited. The amount already paid by shareholder on shares is debited to capital a/c and credited to share forfeiture a/c.

Q19: What are the journal entries passed in respect of forfeiture of shares and their reissue?

Ans: The following entries are passed in respect of forfeiture of shares and their reissue:

1.  Share Capital A/c Dr.

To share forfeiture A/c

To calls in arrears A/c

To Unpaid calls A/c                          OR

(Being forfeiture of shares due to non-payment of call money)

2.  For reissue of forfeited shares:

Cash A/c                      Dr.

Share forfeiture A/c      Dr.

                To share capital A/c

3.  For T/F of net gain on forfeiture to capital reserve:

Share forfeiture A/c

                To capital reserve A/c

Q20: What do you mean by participating preference shares?

Ans: The holder of participating preferences shares, in addition to the fixed rate of dividends, has a right to participate in the surplus of profits which remains after payment to equity shareholders. At the time of winding up, in addition to their shares, these shareholders have a right to participate in the surplus of assets which remains after payment of equity shareholders.

Q21: What do you mean by non participating preferences shares?

Ans: The holders of this type of shares have no right either to participate in the surplus of profit or to participate in the surplus of assets which remain after payment to equity shareholders.

                    If the Articles of Associations are silent all preference shares are assumed to be only cumulative and non participating.

Q23: What do you mean by Calls in arrears?

Ans: calls is arrears refer to that [art of called up money which has not yet been paid by the shareholder till the last day fixed for the payment there of. The total of the unpaid amount is transferred to “Calls in arrears A/C”. The amount of calls is arrears is shown by way of deduction from the called up capital in the balance sheet.  

        The directors can charge interest on calls in arrears at a rate specified in the “Articles of Association” but if the articles are silent interest at the rate not exceeding 5% p.a. can be charged on calls in arrears.

Q24: What do you mean by minimum subscription?

Ans: Minimum subscription means the minimum amount that must be raised from the issue of shares to meet the basic needs of the business operations of the company. The minimum subscription of capital cannot be less than 90% of the issued amount. According to the SEBI guideline, if this condition is not satisfied, the company has to refund the entire subscription amount received, to the shareholders. If a delay occurs 8 days, the company shall be liable to pay interest @ 15%.

Q25: What do you mean by stocks?

Ans: Under section 94 (1) of the company’s Act of 1956, when all the shares of the company have been fully paid up, they may be converted into stock if so authorized by the Articles of Association. It is another type of unit of capital of a company. Conversion of shares into stock is made because it is a convenient method of denoting the capitals of the company. Share capital of the company cannot be offered directly in the form stock.

 

 

 

Q26: What is the difference between Shares & Stocks?

Ans: Following are the points of difference between shares and stocks:

Shares	Stocks
Shares may be fully paid up or partly paid up.	Stocks are fully paid up.
Shares may be issued when a company is incorporated.	Stocks cannot be issued under such circumstances only fully paid shares may be converted into stock.
Shares cannot be divided below the face value of each share.	Stock is a convenient method of transferring because it can be used or transferred in fractional parts.
Shares are serially numbered.	Stocks are not numbered.
Shares are of equal nominal value.	Stocks may be divided into unequal amounts.

 

Q27: What do you mean by ‘Rights issue’?

Ans: In case a company wants to make a further issue of shares, the issue must first be offered to the existing equity shareholders. This offer is known as ‘right issue’. The existing shareholders may except or reject the offer. The shareholders can sell their right in full or in portion to another person. If the shareholders have neither subscribed nor transferred their right then the company can offer the issue to the public.

Q28: What do you mean by underwriting shares?

Ans: An underwriter means one who guarantees the sale of shares and debentures within a specified period of time. The underwriter will take up the unsubscribed portion of shares or debentures and pay for them. For the services rendered by the underwriter, they are entitled to a commission of 5% (maximum) of the issue price of debentures. No underwriting commission is payable on shares and debentures not offered to the public.

Q29: What is a bonus share?

Ans: Bonus shares are the shares which are issued by a company with the object of capitalization of profits. Normally, companies have to pay dividend to the shareholders in the form of cash. But, the bonus paid in the form of cash may affect the company’s working capital position. In order to avoid the outflow of cash from business and at the same time to satisfy the shareholder, the company may resort to issuing bonus shares to the existing equity shareholders by adopting the guidelines given by the government. Normally, bonus shares are also issued when company has large accumulated reserves and it wants to capitalise these reserves for making it a permanent capital of the company.

Q30: What do you mean by ‘Calls in advance’?

Ans: ‘Calls in advance’ refers to the amount paid by the share holders in excess of the amount due from them. A company may accept calls in advance only if ‘Articles of Association’ authorize to do so. The amount received as calls in advance in transferred to a separate account called ‘calls in advance a/c’. ‘Calls in advance a/c’ is gradually closed up by making necessary adjustments. In this account at the time when actual calls are made on the shareholders any balance appearing in ‘calls in advance’ a/c is separately shown on the liability side of company’s balance sheet.

                   The board of directors must pay interest on calls in advance at a rate specified in the Articles. However. If the articles are silent interest on calls in advance is to be paid at the rate not exceeding 6%.

Q31: What do you mean by Preliminary Expenses?

Ans: Preliminary expenses are those expenses which are incurred in connection with the formation and incorporation of a company.

        Preliminary Expenses include:-

a.   Cost of drafting and printing different documents for registration of a company.

b.  Stamp duty on necessary documents and registration fees.

c.   Stamp duty on authorized capital.

d.  Underwriting commission payable capital etc.

Preliminary expenses written off against any gain of capital nature or they may be written of gradually over a no. of years through profit and loss account. The unwritten portion of Preliminary expenses is shown on the asset side of Balance sheet as a fictions asset.

Q32: What is a contingent liability? Give examples?

Ans: Contingent liabilities are subjective liabilities or conditional liabilities of a company. These refer to the claims which are uncertain to arise. Such liabilities may or may not occur. Contingent liabilities are shown in the balance sheet only in the form of foot note. Their amount is not included in the total of the Balance Sheet. The important examples of contingent liabilities are:-

1.  Claims against the company not acknowledged as debts.

2.  Arrears of cumulative dividend.

3.  Liabilities for bills discounted.

4.  Penalty or incomplete contracts.

Q33: What do you mean by financial statements?

Ans: Financial statements are basically organized summaries of detailed information about the financial position and performance of the enterprise. Traditionally the financial statements are used to denote only 2 basic statements:-

1.  Trading and profit & loss a/c which shows the financial performance of business operation during an accounting period. It is also called “Income statement”.

2.  Balance sheet which shows the financial position and liability position of an enterprise at a particular point of an enterprise at a particular point of time. The statement is also called ‘position statement’.

            In modern times, in addition to the two basic statements, a statement of retained earnings, profit and loss appropriation a/c, a cash flow statement are also prepared in practice.

Q34: What do you mean by a reserve?

Ans: A reserve refers to the profits retained in the business not having any of the attributes of a provision. Reserves can be kept for general or for specific purposes. Creation of a reserve is an appropriation of profit.

         The objectives of creating a reserve include:-

1.  To strength the financial position of the business.

2.  To meet unforeseen abnormal losses.

3.  To provide funds for modernization and expansion of plant and machinery.

4.  To equalize the dividend during the periods of inadequate profits.

Basically, reserves are of 2 types:-

1.  Revenue Reserves                   2.  Capital Reserves

Revenue Reserves can further be of 2 types:-

1.  General Reserves                    2.  Specific Reserves.

 

Q35: What do you mean by Provision?

Ans: Provision refers to the amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. It also refers to the amount written off or retained by way of providing for depreciation, Renewals or decrease in the value of assets.

1.  Provision for depreciation.

2.  Provision for taxation.

3.  Provision for doubtful debts.

4.  Provision for contingencies.

5.  Provision for repairs and renewals.

Q36: What is the difference between reserves and provisions?

Ans:

S.No.	Provision	Reserve
1	A provision is created for a particular purpose and can be utilized only for that particular purpose.	It is not necessary that a fund created be only utilized for a particular purpose.
2	It is a charge against the profits & is required to be created irrespective of the amount of profits.	A reserve is an appropriation out of profits & can be created only if profits have been earned.
3	A provision is shown on the debit side of ‘P&L A/C’.	A reserve is shown on the debit side of ‘P&L Appropriation A/C.
4	A provision cannot be utilized for distribution by way of dividend.	A reserve can be utilized for distribution by way of dividend.
5	A provision is made mainly because of legal necessity.	A reserve is a matter of financial prudence.

 

 

 

 

 

 

 

DEBENTURES & REDEMPTION

Q1: What do you mean y debentures? What are its features?

Ans: Debentures may be defined as a document issued by the company as an evidence of debt. It is the acknowledge of the company’s indebtedness to its holders. The persons who invest money in debentures are known as debenture holders. They are creditors of the company. Debentures are therefore called ‘creditor ship securities’.

        The following are the main features of debentures:

1.  It is a document or certificate which acknowledges the debt of a company.

2.  It is issued under the common seal of the company.

3.  Payment of principal amount and interest is fixed and is stated in the debenture.

Q2: What are various types of Debentures?

Ans: Debentures can be classified on the basis of:

1.  Security

2.  Redemption

3.  Records

4.  Coupon Rate

5.  Convertibility

 

i.            FROM SECRUITY POINT OF VIEW:-

a.   Mortgage or Secured Debentures:- Are those debentures which are secured by either a fixed charge or a floating charge on the assets of the company.

b.  Unsecured Debentures:- Are those debentures that are not secured by a fixed charge or floating charge on assets.

 

ii.          FROM REDEMPTION POINT OF VIEW:-

a.   Redeemable Debentures:- Are those debentures that are repaid by the company at the end of a specified period in lump sum or in instalment.

b.  Irredeemable Debentures:- On the other hand, are those debentures that are not repayable during the life-time of the company.

 

iii.       FROM RECORDS POINT OF VIEW:-

a.   Registered Debentures:- Are those debentures in respect of which the name, addresses and particulars of holding of the debenture holders are entered in a register kept by the company.

b.  Bearer Debentures:- Are transferable by mere delivery. The company keeps no record of such debenture holders.

Q3: Give the points of difference between ‘Share & Debenture’?

Ans: Distinguish between Share & Debenture:-

Basis	Share	Debenture
Ownership	A share represents share capital. Hence, a shareholder is the owner.	A debenture represents a debt taken by the company. Therefore, a debenture holder is a creditor.
Dividend/Interest	Return on share is called dividend.	Return on debenture is called interest.
Convertible	Equity on shares cannot be converted.	Debenture can be convertible.
Voting Right	A shareholder has a right to attend and vote in the general meetings.	A debenture holder has no such right.
Repayment	Normally, the amount of share is not returned during the life-time of the company.	Debentures are issued for a definite period.
Forfeiture	Shares can be forfeited for non-payment of allotment and call moneys.	Debentures cannot be forfeited for non-payment of call moneys.

 

Q4: Briefly explain the meaning of Bond?

Ans: Bond is similar to that of debenture, both in terms of contents and texture. The term ‘Bond’ is associated with the debt instrument which does not bear the rate of interest and the issue price but bears the maturity value.

Q5: What is meant by ‘Debentures issued as Collateral Security’?

Ans: Issue of debentures as collateral security means issue of debentures as a subsidiary or secondary. Collateral security means security in addition to the prime security. It is only to be realised when the prime security fails to pay the amount of the loan.

 

Q6: What is issue of Debentures for Consideration other than Cash?

Ans: Debentures can also be issued for consideration other than cash. Debentures can be issued to vendors against purchase of assets or for purchase of a business.

Q7: What do you mean by redemption of debentures? Discuss various methods of redemption of debentures?

Ans: Redemption of debentures refers to the discharge of liability on account of debentures. Debentures can be redeemed at any time, either at par or at premium or at discount. Terms of redemption are generally given in the prospectus inviting applications for debentures.

        At the time of redemption of debentures, the following three problems require attention:

1.  Time of redemption of debentures.        

2.  Amount to be paid on redemption.

3.  Arrangement of source of funds for redemption.                                       

The major sources where from debentures can be redeemed may be:

1.  Raising Fresh Capital                           3.  Utilizing surplus funds.

2.  Utilizing accumulated profits.               4.  Realizing the assets

Methods of Redemption of debentures: The following are the various methods of redemption of debentures.

1.  Redemption of debentures after fixed period in Lumpsum: Debentures may be redeemed as a lumpsum on a specified date mentioned under the terms of issue. The amount to be paid may be the face value of debentures or a premium according to the terms of issue.

2.  Redemption of debentures by periodical drawings: Under this method certain portion of debentures is redeemed periodically. This is done by having a draw of lottery. The slips bearing the numbers of outstanding debentures are put in a drum and the required numbers of slips are drawn out. Those debenture holders whose numbers are on the slips drawn out, are then repaid according to the terms of issue.

3.  Redemption of debentures by purchase in the open market and cancellation: A company may reserve with itself the right to purchase its own debentures in the open market. The purchase of debentures may be cancelled immediately or retained by the company as investment and subsequently the company may reissue the debenture or cancel them.

4.  By conversion into shares: A company may issue convertible debenture giving option to the debenture holders to exchange their debenture for equity shares or preference shares in the company. When the debenture holders excise this option and the company issues the shares, it is referred to as ‘redemption by conversion’.

Q8: What is debenture trust Deed?

Ans: Debenture Trust Deed: Debenture Trust Deed is a document by the company whereby trustees are appointed to protect the interest of debenture holders before they are offered for public subscription.

Q9: Name various source of Redemption?

Ans: Source of Redemption.

1.  Out of Capital                  3. By conversion into New Shares Debentures

2.  Out of Profit

Q10: State, in brief, the SEBI Guidelines regarding Debenture Redemption reserve (DRR)?

Ans: As per SEBI Guidelines, an amount equal to 25% of the debenture issue must be transferred to DRR before the beginning of redemption. In other words, before redemption, at least an amount equal to 25% of the debentures issue must stand to the credit of DRR Account.

Q11: What do you understand by redemption of Debentures Out of profits?

Ans: Redemption of debentures out of profits means the amount utilized out of profits for repayment to debenture holders. It is the amount transferred from Profit & Loss Appropriation Account to an account titled Debenture Redemption Reserve Account.

Q12: State the meaning of Redemption of Debentures out of Capital?

Ans: When debentures are redeemed without adequate profits being transferred from profit and loss Appropriation Account to the Debenture Redemption Reserve (DRR) Account, at the time of redemption of debenture, means redemption of debentures out of capital.

 

ANALYSIS OF FINANCIAL STATEMENT

Q1: Meanings of Analysis of Financial Statements?

Ans: The process of critical evaluation of the financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm is called ‘Financial Statement Analysis’. It is basically a study of relationship among various financial facts and figures as given in a set of financial statements, and the interpretation thereof to gain an insight into the profitability and operational efficiency of the firm to assets its financial health and future prospects.

                      The term ‘Financial Analysis’ includes both ‘analysis and interpretation’. The term analysis means simplification of financial data by methodical classification given in the financial statements. Interpretation means explaining the meaning and significance of the data. These two are complimentary to each other. Analysis is useless without interpretation, and interpretation without analysis is difficult or even impossible.

Q2: What are the objectives of Financial Statement Analysis?

Ans: To be more specific, the analysis is undertaken to serve the following purposes (Objectives):

a.   To assets the current profitability and operational efficiency of the firm as a whole as well as its different departments so as to judge the financial health of the firm.

b.  To ascertain the relative importance of different components of the financial position of the firm.

c.   To identify the reasons for change in the profitability/financial position of the firm.

d.  To judge the ability of the firm to repay its debt and assessing the short-term as well as the long-term liquidity position of the firm.

Q3: Name various methods/techniques/tools of analysis of financial statements?

Ans: The following techniques can be used in the connection with analysis and interpretation of financial statements:

a.   Comparative financial statements or analysis.

b.  Common measurement statements or analysis.

c.   Fund flow statement or analysis.

d.  Trend percentage analysis.

e.   Networking capital analysis.

f.    Cash flow statement or analysis.

g.   Ratio analysis.

Q4: What are various parties interested in the analysis of financial statements?

Ans: The following parties are interested in the analysis of financial statements.

a.   Shareholder: They are interested in earning capacity of the business and its financial soundness.

b.   Debenture holders: Debenture holders are interested in short term and long term financial position of the business.

c.   Creditors: Creditors are interested in liquidity position of the concern.

d.  Financial Institutions: Financial institutions are interested in earning capacity and financial soundness.

e.   Investors: Investors are interested in the future growth and financial soundness.

f.    Labour Unions: Labour Unions are interested in the profitability of the business.

g.   Tax Authorities: Tax authorities are interested that a concern should follow tax laws and procedures.

h.  Stock Exchanges: Stock exchanges are interested in protecting the interests of investors.

i.    Management: Management is interested in formulating and identified the business plans and in decision making.

Q5: What are the limitations of analysis of financial statements?

Ans: The major limitations of analysis of financial statement include the following:

a.   The analysis ignores the quality of elements like quality of management, quality of labour force, public relations etc.

b.  The analysis of financial statements is not free from bias because the accountant has made to choice out of various alternatives available.

c.   Financial statements are based on historical costs only and hence the analysis the price level changes.

d.  Financial statement analysis gives the estimated position and not the real position because the financial statements are prepared on going concern basis as against liquidation basis.

e.   Financial do not present the value of human resources.

Q6: What are the significance/importance/advantages of financial statement analysis?

Ans: Financial statement analysis is helpful in assessing the financial position, profitability and future prospects of a business. The importance of financial analysis is summarised as follows:

a.   Financial analysis helps in measuring the operational efficiency of the business by calculating profitability ratios.

b.  It helps in measuring short term and long term financial position of the business through the calculation of current and liquid ratios, debt equity ratios, proprietary ratios etc.

c.   Financial statement analysis helps in measuring the profitability of the business with the help of profitability and operating ratios.

d.  Analysis of financial statements is an effective tool for simplifying, systematising and summarising the monotonous figures.

e.   This analysis helps in making intra firm and inter firm comparison through the preparation of comparative statements and common size statements.

f.    Financial statement analysis helps in indicating the trend of achievements and indicating the future prospects of the business.

g.   This analysis helps in assessing the growth potential of the business.

h.  Financial statement analysis helps in forecasting budgeting and planning future line of action.

 

 

 

 

 

 

 

 

Tools of Financial Statement

Q1: What do you mean by comparative financial statements?

Ans: Comparative financial statements is a tool of financial analysis that depicts change in each time of financial statement in both absolute amount and percentage term, taking the item in proceeding accounting period as base.

                  Comparative statements compares financial date at two pints of time and helps in deriving meaningful conclusions regarding the changes in financial position and operating results. Hence statement showing financial data for two or more than two years, placed side by side to facilitate comparison is called comparative financial statements. Such statements can be intra firm or inter firm.     

                Comparison and analysis of financial statements may be carry out using the following tools:

a.   Comparative balance sheet.

b.  Comparative income statement.

c.   Common size statement.

Q2: What are objectives or significance of comparative financial statements?

Ans: The main objectives of comparative financial statement is to study the magnitude and direction of changes in financial position and performance of business enterprise. The other objectives are as follows;

a.   To simplified the date and draw conclusions about changes in operating results and financial position.

b.  To make inter period/ inter firm comparison.

c.   To indicate the trends of the business in various fields over a period of time.

d.  To enable forecasting about future.

e.   To indicate the strengths and weaknesses of the firm.

f.    To compare the performance with the average performance of other firms.

Q3: What do you mean by comparative income statement?

Ans: Comparative income statements disclose the net profit or net loss resulting from the operational of business. Such statement shows the operating results for a number of accounting periods so that changes in absolute data or in terms of percentage from one period to another period may be seen. In such statements the figures are shown:

a.   In absolute monetary value.

b.  Increase or a decrease in absolute values.

c.   By way of percentage.

Objectives of comparative income statements

Following are the objectives of comparative income statements.

a.   To analysis income and expenditure for two or more years.

b.  To analysis increase or decrease in income and expenditure in rupee amount as well as in percentage.

c.   To measure the efforts of firm.

d.  To review the past operational activities and their effect on the profitability of the firm.

Q4: What do you mean by comparative balance sheet?

Ans: Comparative balance sheet is the balance sheet which is prepared in such a farm so as to reflect the financing and investing activities of the business for two or more accounting period. These statements facilitate the horizontal analysis because each statement the figures are shown:

a.   In absolute monetary value.

b.  Increase or decrease in absolute values.

c.   By way of percentage.

Objectives of comparative balance sheets:

Following are the objectives of comparative balance sheet:

a.   To analyse or more information of assets and liabilities of two or more comparative dates in absolute monetary value.

b.  To analyse increase or decrease in values of assets and liabilities in rupee amounts as well as in percentage.

c.   To measure the financial position of an enterprise.

d.  To review the past financing and investing activities and their effect on the financial position of the enterprise.

 Q5: What do you mean by common size financial statements?

Ans: A simple common size financial statements are those statements in which figures reported are converted to some common ways. Vertical analysis is required for an interpretation of underlying causes of changes over a period of time. For this, items in the financial statements are presented as percentages to total of these items and a common base for comparison is provided.

                    Common size financial statements are of two types:

i.        Common size income statement.

ii.          Common size balance sheet.

 

a.   Common size income statements: In such a statement, net sales figure is assumed to be equal to 100 and other figures of expenses are expressed at the percentage of sale. Comparative income statements for different periods help to reveal the efficiency or otherwise of in carrying any cost or expenses. If it is being prepared for two firms. It shows the relative efficiency of cost items for the two firms.

b.   Common size balance sheet: In common size balance sheet, total assets or liabilities is taken as 100 and all the figures are express as percentage of total. Comparative common size balance sheet for different periods helps to highlight the trends in different items. If it is prepared for different firms in an industry, it facilitates to judge the relative soundness and helps in understanding other financial strategies.   

Q6: What do you mean by trend percentage analysis?

Ans: This analysis is an important tool of horizontal financial analysis. This analysis enables to know the change in the financial function and operating efficiency between the time period chosen. By studying the trends of each item we can know the direction of changes and based upon the direction of changes, the opinions can be formed. This method is immensely helpful in making a comparative study of the financial statements of several years.

 

 

 

 

 

 

 

 

 

RATIO ANALYSIS

Q1: What do you mean by ratio analysis? Discuss importance/ advantages/ significance of ratio analysis?

Ans: Ratio analysis is one of the powerful tools of the financial analysis. Ratio can be defined as the indicated quotient of two mathematical expressions. Ratio is an arithmetical relationship between two figures. Ratios based on financial statements are called ‘Financial ratios’ or ‘accounting ratios’.

                    Ratio analysis is a process of computing, determining and presenting the relationship of items of financial statements to provide a meaningful understanding of the performance and financial position of a business concern. A ratio can be used as a yardstick for evaluating the financial position and performance of a business concern. In short, ratio analysis is a technique of analyzing the financial statements by computing accounting ratios and interpreting it to draw meaningful conclusions.

        Accounting ratios can be expressed as:

a.   A pure ratio                 b.  A rate               c.  A percentage.

Importance/Advantages/Significance of Ratio Analysis:- Ratio analysis is an important technique of financial analysis. It is way by which financial stability and health of a concern can be judged.

1.  Useful in financial position analysis: Accounting ratios reveal the financial position of the concern. This helps the banks, insurance companies and other financial institutions in leading and making investment decisions.

2.  Useful in simplifying accounting figures: Accounting ratio simplify, summarise and systematize the accounting figures in order make them more understandable and in lucid form.

3.  Useful in assessing the operational efficiency: Accounting ratios diagnose the financial health by evaluating liquidity, solvency, profitability etc. this helps the management to assess the financial requirements and the capabilities of various business units.

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

5.  Useful in locating the weak spots of the business: Weaknesses in financial structure due to incorrect policies in the past or present are revealed through accounting ratios.

6.  Useful in comparison of performance: Accounting ratios can be used for making inter firm and intra firm comparisons of performance. Ratios also help to make change in the organization structure.

Q2: What are the limitations of ratio analysis?

Ans: Ratio analysis is very important in revealing the financial position and soundness of the business. However, this analysis suffers from several limitations which restrict its use.                                                            The limitations are as follows:-

1.  False accounting data give false ratio: Accounting ratios can be correct only if the data on which they are based are correct.

2.  Limited used of single ratio: A single ratio cannot provide full information on a particular aspect.

3.  Limited Comparability: Ratios of one firm cannot always be compared with the performance of other firm if uniform accounting policies are not adopted by them.

4.  Qualitative factors are ignored: Ratio analysis is only a quantitative analysis. It ignores the qualitative aspects of the firm how-so-ever important it may be.

5.  Ignores price level changes: Price level over the years goes on changing and therefore, the ratio of various years cannot be compared.

6.  Only one method of analysis: Ratio analysis is only a beginning and gives just a fraction of information needed for decision making.

7.  Lack of proper standard: There is no single standard ratio which is universally accepted and against which a comparison can be made. It renders interpretations of ratios difficult.

8.  Different meanings assigned to same term: Different firms in order to calculate ratios may assign different meanings and as such these ratios may lead to wrong conclusions.

Q3: What are the various objectives of ratio analysis?

Ans: Financial ratios are true test of profitability, efficiency and financial soundness of the firm. These ratios have following objectives.

1.  Measuring the profitability of the business through various profitability ratios.

2.  Determining the operational efficiency of the business by calculating operating ratios or activity ratios.

3.  Assessing the solvency of the business by calculating solvency ratios.

4.  Measuring financial position of the business by calculation liquidity and solvency ratios.

5.  Facilitating inter firm and intra firm comparison.

6.  Indicating overall efficiency of the business by calculating financial ratios.

7.  Making budgeting and forecasting and drawings meaningful conclusions for future decision making.

8.  Simplifying, summarizing and systematizing accounting figures for making them understandable.

Q4: Name important accounting ratios?

Ans: Accounting ratios can be classified into categories:

1.  Liquidity ratio                         3.  Operating ratios or Activity ratios

2.  Solvency ratios                       4.   Profitability ratios

Q5: What do you mean by liquidity ratios?

Ans: Liquidity means ability of a firm to pay its current liabilities in time. Liquidity ratios are used to measure the ability of the concern to meet short term obligations as and when they become due. These ratios show the short term financial solvency of the concern and therefore, these ratios are also called ‘short term solvency ratios’.

                  The bankers, suppliers of goods (creditors) and other short term creditors are interested in the liquidity of the concern. Liquidity ratios include the following 2 ratios.

1.  Current ratio                     2.  Quick ratio

Q6: What do you mean by current ratio?

Ans: Current ratio is a ratio which establishes relationship between current assets and current liabilities. This ratio is also called a working capital Ratio.

                  The objective of computing this ratio is to measure the abilities of the firm to meet its short term obligations and to ascertain the short term financial strength of the business. In other words, the objective of this ratio is to measure the safety margin for short term creditors. There are two components of this ratio.

a.   Current Assets               b.  Current Liabilities

         Current Ratio = Current Assets                                                                                    Current Liabilities

          It indicates rupees of current assets available for each rupee of current liability. Higher the ratio greater the margin of safety for short term creditors and vice-versa. A current ratio of 2:1 is considered a satisfactory ratio.

Note: The ratio of current Assets over current liabilities should not be very high such as 10:1. Then it shows the firms inefficiency to utilize resources.

Q7: What are current assets? Give examples?

Ans: Current assets are those assets which are either already in cash or which are usually converted into cash within a short period of 12 months.        Examples of current assets are:

1.          Cash balance.

2.          Bank balance.

3.          Sundry debtors (after deducting provision).

4.          Bills receivable.

5.                  Marketable securities or short term investment or gilt aged securities or investments.

6.          Stock of raw materials.

7.          Stock of work in progress/Semi finished goods.

8.          Stock of finished goods.

9.          Prepared expenses.

10.              Incomes accrued.

11.              Advance payment of tax.

Q8: What are current liabilities? Give examples?

Ans: Current liabilities are those liabilities which are required to be paid within a short period of 12 months.                                                                    Examples of current liabilities are:

1.  Sundry creditors.

2.  Bills payable.

3.  Outstanding expenses.

4.  Bank overdraft.

5.  Dividend payable or provision for dividend.

6.  Tax payable or provision for dividend.

7.  Short term loans and advances.

8.  Unclaimed dividend.

9.  Incomes received in advance.

Q9: What do you mean by quick ratio?

Ans: Quick ratio is a ratio which establishes relationship between quick assets and current liabilities. This ratio is also called ‘liquid ratio’ and ‘acid test ratio’. The objectives of computing this ratio is to measure the ability of the firm to meet the short term obligations as and when due without relying upon the realization of stock. The ratio is computing by dividing the quick assets by current liabilities. In the form of a formula, this ratio is expressed as:-

       Quick Ratio = Quick Assets                                                                      Current Liabilities 

       Quick assets = Current assets – stock – prepaid expenses.

           It indicates rupees of quick assets available for each rupee of current liability. A quick ratio of 1:1 is considered satisfactory.                            {Note:- Sometimes quick liability is written instead of the current liabilities. The difference between the two is that bank overdraft is not included in quick liabilities}.                                                                 Quick liabilities = Current liabilities – Bank overdraft.                             Current Assets = Quick assets + Stock + Prep. Expenses.

Q10: What is the difference current ratio and quick ratio?

Ans:

S. No.	Current Ratio	Quick Ratio
1	Current ratio establishes relationship between current assets and current liabilities.	Quick ratio establishes relationship between quick assets and current liabilities.
2	It measures the ability to meet the current obligations falling due within a year.	Quick ratio measures the ability of the business to meet current obligations without relying upon sale of inventories (Stock).
3	Satisfactory current ratio is taken as 2:1.	Satisfactory quick ratio is taken as 1:1.
4	Formula for current ratio is              Current Assets              Current Liabilities	Formula for computing quick ratio is       Quick Assets           Current Liabilities

 

 

 

 

Q11: What are quick assets? Give examples?

Ans: Quick assets refer to those current assets which can be converted into cash immediately or at a short notice without a loss of value.                 Examples:-

1.  Cash in hand.

2.  Cash at bank.

3.  Debtors (after provision for bad debts).

4.  Marketable securities.

5.  Short term loans and advances.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Statement

Q1: What do you mean by cash flow statement? Discuss its importance?

Ans: A cash flow statement can be defined as a statement which summarizes sources of each inflow and uses of cash out flows of a firm during a particular period of time. Such a statement can be prepared from the data made available from comparative balance sheet, profit and loss account and additional information. This statement reports cash receipts and cash payments classified according to major activities during the period. It reports a net cash inflow or net cash outflow for each activity and for the overall business. It also reports from where cash has come and how it has been spend.

        Usefulness of Cash Flow Statement: Cash flow statement is very useful to management for short term planning due to the following reasons:

1.  This statement is often used as an indicator of the amount, timing and certainty of future cash flows.

2.  It determines the ability of the concern to pay dividend and other commitments.

3.  It helps in efficient cash management and is useful in evaluating financial position and cash position.

4.  It enables the management to identify a magnitude and direction changes in cash.

5.  It discloses success or failure of cash planning. It also provides a better measure for inter – period and inter – firm comparison.

6.  It enables the users to evaluate the changes in financial structure (including its liquidity and solvency).

7.  It helps in evaluating management decision.

8.  It announces the comparability of reports of operating performance by different enterprises.

Q2: What are the objectives of cash flow statement?

Ans: The objectives of cash flow statement are:

1.  To ascertain specific sources from which cash and cash equivalents were generated by the business.

2.  To ascertain specific uses for which cash and cash equivalents were used by the business.

3.  To ascertain the net change in cash and cash equivalents and showing difference between total sources and total uses between the dates of balance.

Q3: What do you by operating activities? Give examples of operating activities?

Ans: Operating activities are the principal revenue activities of the enterprise. These activities generally result from the transactions and other events that enter into the determination of net profit or loss.                             The examples of Cash flows from operating activities are:-

1.  Cash receipts from sale of goods and rendering of services.

2.  Cash receipts from royalties, fees, commission, and other revenue.

3.  Cash payment to supplies for goods and other services.

4.  Cash payment to and behalf of employees.

5.  Cash payments or refund of income tax unless they can be specifically identified with financing and invested activities.

6.  Cash receipts and payment related to future contracts, forward contracts, when these contracts are held for dealing or trading purposes.

Q4: What do you mean by investing activities?

Ans: Investing activities are those activities which involve cash inflows and outflows from acquisition and disposal of long term assets and other investments not included in cash equivalents.

1.  Cash payment to acquire fixed assets.

2.  Cash receipts from disposal of fixed assets.

3.  Cash payment from disposal of shares or debt instruments of other enterprises.

4.  Cash receipts from disposal of shares or debt instruments of other enterprises held as long term investments.

5.  Cash advances and loans made to 3^rd parties.

6.  Cash receipts from the repayment of advances and loans made to 3^rd parties.

Q5: What do you mean by financing activities?

Ans: Financing activities are those activities that result in the changes in the size and composition of owner’s capital and borrowings of the enterprise.

        Examples of cash flows arising from financing activities are:

1.  Cash proceeds from issuing shares.

2.  Cash proceeds from issuing debentures, loans bonds etc.

3.  Cash repayment of amount borrowed.

4.  Cash payments to redeem preference shares.

5.  Repayment of dividend.

Q6: What do you mean by cash equivalents?

Ans: Cash equivalents are short term highly liquid investment that are readily convertible into known amount of cash and which are subject to an insignificant risk of changes in value.

                  Cash equivalent are held for the purpose of meeting short term cash commitments rather than for investment or other purposes.

Q7: What is difference between Cash Flow Statement and Funds Flow Statement?

Ans:

Cash Flow Statement	Funds Flow Statement
It deals with flow of cash in hand, bank balance payable on demand and cash equivalents.	It deals with flow of net working capital, i.e. Current Assets Current Liabilities.
It analysis balances of current assets and current liabilities to determine various sources and uses of cash.	It does not analyse change in the structure of net working capital.
It is used for short range planning as cash Projections are more relevant for immediate future.	It is useful for long range planning. Moreover, cash projections for a long period of time are not very accurate.
There is a direct relationship between changes in current liabilities and changes in cash.	There is an inverse relationship between changes in current.
Changes in current assets and changes in cash are inversely related.	There is a direct relationship between changes in current assets and changes in working capital.

 

 Compiled by Mr. Imran sir

Mr. Imran Sir
Cell: 9797936211