SYBBI MANAGEMENT ACCOUNTING NOTES SEM III

SYBBI MANAGEMENT ACCOUNTING NOTES SEM III

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S.Y. BBI : SEM III


MANAGEMENT
ACCOUNTING








NOTES BY:
SUNNY PUNJABI

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INDEX


Sr. No. Topic Page No.
1 Introduction To Management Accounting 3 – 06
2 Working Capital Requirement 07 – 24
3 Corporate Financial Statements 25 – 29
4 Ratio Analysis 30 – 34
5 Bonus Shares 35 - 42

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CHAPTER 1 INTRODUCTION TO MANAGEMENT ACCOUNTING

Definition:-
It Is The Presentation Of The Accounting Information In Such A Way As To Assist Management In The Creation Of
Policy And In Day To Day Operation Of An Undertaking .
Introduction
Management Accounting Is The Process Of Preparing Management Reports And Accounts That Provide Accurate
And Timely Financial And Statistical Information To Managers To Make Short-Term And Long-Term Decisions. It
Identifies, Measures, Analyzes, Interprets, And Communicates Information To Enable An Organization To Pursue
Its Goals.
Management Accounting Differs From Financial Accounting. While Financial Accounting Provides Information To
People Inside And, More Importantly, People Outside The Organization, Management Accounting Is Mostly Aimed
At Aiding Managers Inside The Organization With Decision Making.
The Role Of Management Accounting In An Organization
1. Helping Forecast The Future:
Forecasting Aids Decision-Making And Answering Questions, Such As: Should The Company Invest In More
Equipment? Should It Diversify Into Different Markets? Should It Buy Another Company? Management
Accounting Helps In Answering These Critical Questions And Forecasting The Future Trends In Business.
2. Helping In Make-Or-Buy Decisions:
Is It Cheaper To Procure Materials Or A Product From A Third Party Or Manufacture Them In-House? Cost
And Production Availability Are The Deciding Factors In This Choice. Through Management Accounting,
Insights Will Be Developed Which Will Enable Decision-Making At Both Operational And Strategic Levels.
3. Forecasting Cash Flows:
Predicting Cash Flows And The Impact Of Cash Flow On The Business Is Essential. How Much Cost Will The
Company Incur In The Future? Where Will Its Revenues Come From And Will The Revenues Increase Or
Decrease In The Future? Management Accounting Involves Designing Of Budgets And Trend Charts, And
Managers Use This Information To Decide How To Allocate Money And Resources To Generate The
Projected Revenue Growth.
4. Helping Understand Performance Variances:
Business Performance Discrepancies Are Variances Between What Was Predicted And What Is Actually
Achieved. Management Accounting Uses Analytical Techniques To Help The Management Build On Positive
Variances And Manage The Negative Ones.
5. Analyzing The Rate Of Return:

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Before Embarking On A Project That Requires Heavy Investments, The Company Would Need To Analyze
The Expected Rate Of Return (Ror). If Given Two Or More Investment Opportunities, How Should The
Company Choose The Most Profitable One? In How Many Years Would The Company Break Even On A
Project? What Are The Cash Flows Likely To Be? These Are All Vital Questions That Can Be Answered
Through Management Accounting.
Tools And Techniques Of Management Accounting
A Number Of Tool And Techniques Have Been Used Under Management Accounting To Help Management In
Achieving The Desired Goals. For This The Management Accountant Normally Uses The Following Tool And
Techniques:
(i) Financial Planning: Financial Planning Is The Process Of Deciding In Advance About The Financial
Activities Necessary For The Organisation To Achieve The Desired Objectives. It Includes Determining
Both Long Term And Short Term Financial Objectives, Formulating Financial Policies And Developing
The Financial Procedures Etc. Financial Policies May Relate To The Determination Of The Capital
Requirement, Sources Of Funds, Determination And Distribution Of Income, Use Of Debt And Equity
Capital And The Determination Of The Optimum Level Of Investment In Various Areas.

(ii) Financial Statement Analysis: Financial Statements Are Analysed To Make Data More Meaningful.
Comparative Statement Analysis, Common Size Statement Analysis, Trend Analysis, Ratio Analysis,
Cash Flow Analysis Etc. Are The Major Techniques Of Financial Statement Analysis Used In
Management Accounting.

(iii) Decision Making: Management Accounting Helps The Management Through The Techniques Of
Marginal Costing, Differential Costing, Capital Budgeting, Cash Flow Analysis, Discounted Cash Flow
Etc. To Select The Best Alternative Which Will Maximise The Profits Of The Business.

(iv) Control Techniques: Management Should Ensure That The Plan Formulated By It Has Been Translated
Into Action. Standard Costing And Budgetary Control Techniques Are Useful Control Techniques Used
By Management.

(v) Statistical And Graphical Techniques: Management Accountant Uses Various Statistical And Graphical
Techniques In Order To Make The Information More Meaningful And Presentation Of The Same In
Such A Form So That It May Help The Management In Decision Making. The Techniques Of Linear
Programming, Statistical Quality Control, Investment Chart, Sales And Earning Chart Etc. Are Of Vital
Use.

(vi) Reporting: Management Accountant Prepares The Necessary Reports For Providing Information To
The Different Levels Of Management By Proper Selection Of Data To Be Presented, Organisation Of
Data Or Selecting The Appropriate Method Of Reporting.

Management Accounting Uses Activity-Based Costing To Decide What To Produce, How Much To Spend On A
Product, How Much It Will Cost To Service A Customer, And What Customers And Products Are Profitable. They
Find The Answers To These Integral Questions So That Senior Management Can Focus On Maximizing Revenue.

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Information Deluge Has Transformed How Companies Operate. Companies Can No Longer Take Vital Decisions
Without Considering The Implications And Outcomes. They Can Use Intelligent Analysis And Management
Accounting To Invest Smartly, And At The Same Time Prepare Quickly For Events That Might Impact Them
Negatively.
The Scope Or Field Of Management Accounting Is Very Wide And Broad Based And It Includes A Variety Of Aspects
Of Business Operations. The Main Aim Of Management Accounting Is To Help Management In Its Functions Of
Planning, Directing, Controlling And Areas Of Specialization Included Within The Admit Of Management
Accounting. The

Scope Of Management Accounting Can Be Studied As Follows:

1. Financial Accounting

Financial Accounting Forms The Basis For Analysis And Interpretation For Furnishing Meaningful Data To The
Management. The Control Aspect Is Based On Financial Data And Performance Evaluation, On Recorded Facts And
Figures. So, Management Accounting Is Closely Related To Financial Accounting In Many Respects.

2. Cost Accounting

Cost Accounting Is The Process And Techniques Of Ascertaining Cost. Planning, Decision Making And Control Are
The Basic Managerial Functions. The Cost Accounting System Provides The Necessary Tool For Carrying Out Such
Functions Efficiently. The Tools Includes Standard Costing, Inventory Management, Variable Costing Etc

3.Budgeting And Forecasting

Budgeting Means Expressing The Plans, Policies And Goals Of The Firm For A Definite Period In Future. Forecasting
On The Other Hand, Is A Prediction Of What Will Happen As A Result Of A Given Set Of Circumstances. Forecasting
Is A Judgement Whereas The Budgeting Is An Organizational Object. These Are Useful For Management
Accounting In Planning.

4. Inventory Control

Inventory Is Necessary To Control From The Time It Is Acquire Till Its Final Disposal As It Involves Large Sum. For
Controlling Inventory, Management Should Determine Different Level Of Stock. The Inventory Control Technique
Will Be Helpful For Taking Managerial Decisions.

5. Statistical Method

Statistical Tools Not Only Make The Information More Impressive, Comprehensive And Intelligible But Also Are
Highly Useful For Planning And Forecasting.

6. Interpretation Of Data

Analysis And Interpretation Of Financial Statements Are Important Part Of Management Accounting. After
Analyzing The Financial Statements, The Interpretation Is Made And The Reports Drawn From This Analysis Are
Presented To The Management. Interpreting The Accounting Data To The Authorities In The Management Is The
Principal Task Of Management Accounting.

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7. Reporting To Management

The Interpreted Information Must Be Communicated To Those Who Are Interested In It. The Report May Cover
Profit And Loss Account, Cash Flow And Funds Flow Statements Etc.

8. Internal Audit And Tax Accounting

Management Accounting Studies All The Tax Matters To Assist The Management In Investment Decisions Vis-A-
Vis Tax Planning As A Resource To Enjoy Tax Relief.

Internal Audit System Is Necessary To Judge The Performance Of Every Department. Management Is Able To
Know Deviations In Performance Through Internal Audit. It Also Helps Management In Fixing Responsibility Of
Different Individuals.

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CHAPTER 2 WORKING CAPITAL REQUIREMENT
Introduction :
The Term Working Capital Is Commonly Used For The Capital Required For Day-To-Day Working In A Business
Concern, Such As For Purchasing Raw Material, For Meeting Day-To-Day Expenditure On Salaries, Wages, Rents
Rates, Advertising Etc. But There Are Much Disagreement Among Various Financial Authorities (Financiers,
Accountants, Businessmen And Economists) As To The Exact Meaning Of The Term Working Capital.
Definition And Classification Of Working Capital :
Working Capital Refers To The Circulating Capital Required To Meet The Day To Day Operations Of A Business
Firm. Working Capital May Be Defined By Various Authors As Follows:
1. According To Weston & Brigham -
“Working Capital Refers To A Firm’s Investment In Short Term Assets, Such As Cash Amounts Receivables,
Inventories Etc.
2. Working Capital Means Current Assets.
— Mead, Baker And Malott
3. “The Sum Of The Current Assets Is The Working Capital Of The Business”
— J.S.Mill
Working Capital Is Defined As “The Excess Of Current Assets Over Current Liabilities And Provisions”.
The Term “Working Capital” Is Often Referred To “Circulating Capital” Which Is Frequently Used To Denote Those
Assets Which Are Changed With Relative Speed From One Form To Another I.E., Starting From Cash, Changing To
Raw Materials, Converting Into Work-In-Progress And Finished Products, Sale Of Finished Products And Ending
With Realization Of Cash From Debtors.
Working Capital Has Been Described As The “Life Blood Of Any Business.
Working Capital May Be Classified In Two Ways
A) Concept Based Working Capital
B) Time Based Working Capital
Concepts Of Working Capital
1. Gross Working Capital: It Refers To The Firm’s Investment In Total Current Or Circulating Assets.
2. Net Working Capital: The Term “Net Working Capital” Has Been Defined In Two Different Ways:

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I. It Is The Excess Of Current Assets Over Current Liabilities. This Is, As A Matter Of Fact, The Most Commonly
Accepted Definition. Some People Define It As Only The Difference Between Current Assets And Current Liabilities.
The Former Seems To Be A Better Definition As Compared To The Latter.
Ii. It Is That Portion Of A Firm’s Current Assets Which Is Financed By Long-Term Funds.
3. Permanent Working Capital:
This Refers To That Minimum Amount Of Investment In All Current Assets Which Is Required At All Times To Carry
Out Minimum Level Of Business Activities. In Other Words, It Represents The Current Assets Required On A
Continuing Basis Over The Entire Year.
Tandon Committee Has Referred To This Type Of Working Capital As “Core Current Assets”.
The Following Are The Characteristics Of This Type Of Working Capital:
1. Amount Of Permanent Working Capital Remains In The Business In One Form Or Another. This Is
Particularly Important From The Point Of View Of Financing. The Suppliers Of Such Working Capital Should
Not Expect Its Return During The Life-Time Of The Firm.
2. It Also Grows With The Size Of The Business. In Other Words, Greater The Size Of The Business, Greater Is The
Amount Of Such Working Capital And Vice Versa Permanent Working Capital Is Permanently Needed For The
Business And Therefore It Should Be Financed Out Of Long-Term Funds.
4. Temporary Working Capital:
The Amount Of Such Working Capital Keeps On Fluctuating From Time To Time On The Basis Of Business Activities.
In Other Words, It Represents Additional Current Assets Required At Different Times During The Operating Year.
For Example, Extra Inventory Has To Be Maintained To Support Sales During Peak Sales Period. Similarly,
Receivable Also Increase And Must Be Financed During Period Of High Sales. On The Other Hand Investment In
Inventories, Receivables, Etc., Will Decrease In Periods Of Depression. Suppliers Of Temporary Working Capital Can
Expect Its Return During Off Season When It Is Not Required By The Firm. Hence, Temporary Working Capital Is
Generally Financed From Short Term Sources Of Finance Such As Bank Credit.
5. Negative Working Capital:
This Situation Occurs When The Current Liabilities Exceed The Current Assets. It Is An Indication Of Crisis To The
Firm.
Need For Working Capital
Working Capital Is Needed Till A Firm Gets Cash On Sale Of Finished Products. It Depends On Two Factors:
I. Manufacturing Cycle I.E. Time Required For Converting The Raw Material Into Finished Product; And
Ii. Credit Policy I.E. Credit Period Given To Customers And Credit Period Allowed By Creditors.

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Thus, The Sum Total Of These Times Is Called An “Operating Cycle” And It Consists Of The Following Six Steps:
I. Conversion Of Cash Into Raw Materials.
Ii. Conversion Of Raw Materials Into Work-In-Process.
Iii. Conversion Of Work-In-Process Into Finished Products.
Iv. Time For Sale Of Finished Goods—Cash Sales And Credit Sales.
V. Time For Realisation From Debtors And Bills Receivables Into Cash.
Vi. Credit Period Allowed By Creditors For Credit Purchase Of Raw Materials, Inventory And Creditors For Wages
And Overheads. Chart For Operating Cycle Or Working Capital Cycle.
Determinants Of Working Capital :
The Factors Influencing The Working Capital Decisions Of A Firm May Be Classified As Two Groups, Such As
Internal Factors And External Factors. The Internal Factors Includes, Nature Of Business Size Of Business, Firm’s
Product Policy, Credit Policy, Dividend Policy, And Access To Money And Capital Markets, Growth And Expansion
Of Business Etc. The External Factors Include Business Fluctuations, Changes In The Technology, Infrastructural
Facilities, Import Policy And The Taxation Policy Etc. These Factors Are Discussed In Brief In The Following Lines.
I. Internal Factors
1. Nature And Size Of The Business The Working Capital Requirements Of A Firm Are Basically Influenced By The
Nature And Size Of The Business. Size May Be Measured In Terms Of The Scale Of Operations. A Firm With Larger
Scale Of Operations Will Need More Working Capital Than A Small Firm. Similarly, The Nature Of The Business -
Influence The Working Capital Decisions. Trading And Financial Firms Have Less Investment In Fixed Assets. But
Require A Large Sum Of Money To Be Invested In Working Capital. Retail Stores, Business Units Require Larger
Amount Of Working Capital, Where As, Public Utilities Need Less Working Capital And More Funds To Invest In
Fixed Assets.
2. Firm’s Production Policy The Firm’s Production Policy (Manufacturing Cycle) Is An Important Factor To Decide
The Working Capital Requirement Of A Firm. The Production Cycle Starts With The Purchase And Use Of Raw
Material And Completes With The Production Of Finished Goods. On The Other Hand Production Policy Is Uniform
Production Policy Or Seasonal Production Policy Etc., Also Influences The Working Capital Decisions. Larger The
Manufacturing Cycle And Uniform Production Policy – Larger Will Be The Requirement Of Working Capital. The
Working Capital Requirement Will Be Higher With Varying Production Schedules In Accordance With The Changing
Demand.
3. Firm’s Credit Policy The Credit Policy Of A Firm Influences Credit Policy Of Working Capital. A Firm Following
Liberal Credit Policy To All Customers Require Funds. On The Other Hand, The Firm Adopting Strict Credit Policy
And Grant Credit Facilities To Few Potential Customers Will Require Less Amount Of Working Capital.

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4. Availability Of Credit The Working Capital Requirements Of A Firm Are Also Affected By Credit Terms Granted By
Its Suppliers – I.E. Creditors. A Firm Will Need Less Working Capital If Liberal Credit Terms Are Available To It.
Similarly, The Availability Of Credit From Banks Also Influences The Working Capital Needs Of The Firm. A Firm,
Which Can Get Bank Credit Easily On Favorable Conditions Will Be Operated With Less Working Capital Than A
Firm Without Such A Facility.
5. Growth And Expansion Of Business Working Capital Requirement Of A Business Firm Tend To Increase In
Correspondence With Growth In Sales Volume And Fixed Assets. A Growing Firm May Need Funds To Invest In
Fixed Assets In Order To Sustain Its Growing Production And Sales. This Will, In Turn, Increase Investment In
Current Assets To Support Increased Scale Of Operations. Thus, A Growing Firm Needs Additional Funds
Continuously.
6. Profit Margin And Dividend Policy The Magnitude Of Working Capital In A Firm Is Dependent Upon Its Profit
Margin And Dividend Policy. A High Net Profit Margin Contributes Towards The Working Capital Pool. To The
Extent The Net Profit Has Been Earned In Cash, It Becomes A Source Of Working Capital. This Depends Upon The
Dividend Policy Of The Firm. Distribution Of High Proportion Of Profits In The Form Of Cash Dividends Results In A
Drain On Cash Resources And Thus Reduces Company’s Working Capital To That Extent. The Working Capital
Position Of The Firm Is Strengthened If The Management Follows Conservative Dividend Policy And Vice Versa.
7. Operating Efficiency Of The Firm Operating Efficiency Means The Optimum Utilisation Of A Firm’s Resources At
Minimum Cost. If A Firm Successfully Controls Operating Cost, It Will Be Able To Improve Net Profit Margin Which,
Will, In Turn, Release Greater Funds For Working Capital Purposes.
8. Co-Ordinating Activities In Firm The Working Capital Requirements Of A Firm Is Depend Upon The Co-Ordination
Between Production And Distribution Activities. The Greater And Effective The Co-Ordinations, The Pressure On
The Working Capital Will Be Minimized. In The Absence Of Co-Ordination, Demand For Working Capital Is
Reduced.
Ii. External Factors
1. Business Fluctuations Most Firms Experience Fluctuations In Demand For Their Products And Services. These
Business Variations Affect The Working Capital Requirements. When There Is An Upward Swing In The Economy,
Sales Will Increase, Correspondingly, The Firm’s Investment In Inventories And Book Debts Will Also Increase.
Under Boom, Additional Investment In Fixed Assets May Be Made By Some Firms To Increase Their Productive
Capacity. This Act Of The Firm Will Require Additional Funds. On The Other Hand When, There Is A Decline In
Economy, Sales Will Come Down And Consequently The Conditions, The Firm Try To Reduce Their Short-Term
Borrowings. Similarly The Seasonal Fluctuations May Also Affect The Requirement Of Working Capital Of A Firm.
2. Changes In The Technology The Technological Changes And Developments In The Area Of Production Can Have
Immediate Effects On The Need For Working Capital. If The Firm Wish To Install A New Machine In The Place Of
Old System, The New System Can Utilise Less Expensive Raw Materials, The Inventory Needs May Be Reduced
There By Working Capital Needs.

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3. Import Policy Import Policy Of The Government May Also Effect The Levels Of Working Capital Of A Firm Since
They Have To Arrange Funds For Importing Goods At Specified Times.
4. Infrastructural Facilities The Firms May Require Additional Funds To Maintain The Levels Of Inventory And Other
Current Assets, When There Is Good Infrastructural Facilities In The Company Like, Transportation And
Communications.
5. Taxation Policy The Tax Policies Of The Government Will Influence The Working Capital Decisions. If The
Government Follow Regressive Taxation Policy, I.E. Imposing Heavy Tax Burdens On Business Firms, They Are Left
With Very Little Profits For Distribution And Retention Purpose. Consequently The Firm Has To Borrow Additional
Funds To Meet Their Increased Working Capital Needs. When There Is A Liberalised Tax Policy, The Pressure On
Working Capital Requirement Is Minimised. Thus The Working Capital Requirements Of A Firm Is Influenced By The
Internal And External Factors.
Importance Or Advantages Of Adequate Working Capital
Working Capital Is The Life Blood And Nerve Centre Of A Business. Just As Circulation Of Blood Is Essential In The
Human Body For Maintaining Life, Working Capital Is Very Essential To Maintain The Smooth Running Of A
Business. No Business Can Run Successfully Without An Adequate Amount Of Working Capital. The Main
Advantages Of Maintaining Adequate Amount Of Working Capital Are As Follows:
1. Solvency Of The Business:
Adequate Working Capital Helps In Maintaining Solvency Of The Business By Providing Uninterrupted Flow Of
Production.
2. Goodwill:
Sufficient Working Capital Enables A Business Concern To Make Prompt Payments And Hence Helps In Creating
And Maintaining Goodwill.
3. Easy Loans:
A Concern Having Adequate Working Capital, High Solvency And Good Credit Standing Can Arrange Loans From
Banks And Other On Easy And Favourable Terms.
4. Cash Discounts:
Adequate Working Capital Also Enables A Concern To Avail Cash Discounts On The Purchases And Hence It
Reduces Costs.
5. Regular Supply Of Raw Materials:
Sufficient Working Capital Ensures Regular Supply Of Raw Materials And Continuous Production. 6. Regular
Payment Of Salaries, Wages And Other Day-To-Day Commitments: A Company Which Has Ample Working Capital
Can Make Regular Payment Of Salaries, Wages And Other Day-To-Day Commitments Which Raises The Morale Of
Its Employees, Increases Their Efficiency, Reduces Wastages And Costs And Enhances Production And Profits.

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7. Exploitation Of Favourable Market Conditions:
Only Concerns With Adequate Working Capital Can Exploit Favourable Market Conditions Such As Purchasing Its
Requirements In Bulk When The Prices Are Lower And By Holding Its Inventories For Higher Prices.
8. Ability To Face Crisis:
Adequate Working Capital Enables A Concern To Face Business Crisis In Emergencies Such As Depression Because
During Such Periods, Generally, There Is Much Pressure On Working Capital.
9. Quick And Regular Return On Investments:
Every Investor Wants A Quick And Regular Return On His Investments. Sufficiency Of Working Capital Enables A
Concern To Pay Quick And Regular Dividends To Its Investors As There May Not Be Much Pressure To Plough Back
Profits. This Gains The Confidence Of Its Investors And Creates A Favourable Market To Raise Additional Funds I.E.,
The Future.
10. High Morale:
Adequacy Of Working Capital Creates An Environment Of Security, Confidence, High Morale And Creates Overall
Efficiency In A Business. Excess Or Inadequate Working Capital Every Business Concern Should Have Adequate
Working Capital To Run Its Business Operations. It Should Have Neither Redundant Or Excess Working Capital Nor
Inadequate Or Shortage Of Working Capital. Both Excess As Well As Short Working Capital Positions Are Bad For
Any Business. However, Out Of The Two, It Is The Inadequacy Of Working Capital Which Is More Dangerous From
The Point Of View Of The Firm.
Disadvantages Of Redundant Or Excessive Working Capital
1. Excessive Working Capital Means Ideal Funds Which Earn No Profits For The Business And Hence The Business
Cannot Earn A Proper Rate Of Return On Its Investments.
2. When There Is A Redundant Working Capital, It May Lead To Unnecessary Purchasing And Accumulation Of
Inventories Causing More Chances Of Theft, Waste And Losses.
3. Excessive Working Capital Implies Excessive Debtors And Defective Credit Policy Which May Cause Higher
Incidence Of Bad Debts.
4. It May Result Into Overall Inefficiency In The Organization.
5. When There Is Excessive Working Capital, Relations With Banks And Other Financial Institutions May Not Be
Maintained.
6. Due To Low Rate Of Return On Investments, The Value Of Shares May Also Fall.
7. The Redundant Working Capital Gives Rise To Speculative Transactions.
Disadvantages Or Dangers Of Inadequate Working Capital

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1. A Concern Which Has Inadequate Working Capital Cannot Pay Its Short-Term Liabilities In Time. Thus, It Will
Lose Its Reputation And Shall Not Be Able To Get Good Credit Facilities.
2. It Cannot Buy Its Requirements In Bulk And Cannot Avail Of Discounts, Etc.
3. It Becomes Difficult For The Firm To Exploit Favourable Market Conditions And Undertake Profitable Projects
Due To Lack Of Working Capital.
4. The Firm Cannot Pay Day-To-Day Expenses Of Its Operations And Its Creates Inefficiencies, Increases Costs And
Reduces The Profits Of The Business.
5. It Becomes Impossible To Utilize Efficiently The Fixed Assets Due To Non-Availability Of Liquid Funds. 6. The Rate
Of Return On Investments Also Falls With The Shortage Of Working Capital.
Working Capital Policy / Approaches
It Can Be Explained By Two Approaches:
 Conservative Approach
 Aggressive Approach

Conservative Approach:

A Firm Financing Its Common Permanent Assets & Also With Long Term Financing & Less Risky So Far As
Insolvency Is Concerned. However Funds May Be Invested In Such Investment Which Fetches Small Returns To
Build Up Liquidity.

Aggressive Approach:

The Firm Uses Only Short Term Financing. In This Approach, The Firm Finances A Part Of The Permanent Assets
With Short Term Financing. This Approach Refers To More Risky But May At Returns To The Assets.

Operating Cycle

The Duration Of Time Required To Complete The Following Sequence Of Events, In Case Of Manufacturing Firm, Is
Called The Operating Cycle:
1. Conversion Of Cash Into Raw Materials.
2. Conversion Of Raw Materials Into Work-In-Progress.
3. Conversion Of Work In Process Into Finished Goods.
4. Conversion Of Finished Goods Into Debtors And Bills Receivables Through Sales.
5. Conversion Of Debtors And Bills Receivables Into Cash.

The Length Of Cycle Will Depend On The Nature Of Business. Non Manufacturing Concerns, Service Concerns And
Financial Concerns Will Not Have Raw Material And Work-In-Process So Their Cycle Will Be Shorter. Financial
Concerns Have A Shortest Operating Cycle.

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Proforma For Working Capital Estimates
Trading Concern

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Manufacturing Concern



Approaches To Working Capital Estimation:

In Estimation Of Working Capital Two Approaches Can Be Used In Practice: (A) Total Approach And (B) Cash Cost
Approach

Total Approach:

In This Method Of Estimation All Costs Including Depreciation And Profit Margin Are Included. Unless It Is Asked
Specifically, The Estimation Of Working Capital Under Total Approach Is Suggested.

Cash Cost Approach:

Under This Approach, Working Capital Is Estimated On The Basis Of Cash Cost. Depreciation Is Excluded From The
Cost Of Sales. The Profit Margin Is Also Not Considered While Estimation Of Investment In Debtors Balances.

Various Components Of Operating Cycle

It May Be Calculated As Follows:

A)Raw Material Shortage Period =
Average Stock Of Raw Material
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B) WIP Holding Period =
Average Wip Inventory
Average Cost Of Production Per Day


C) Finished Goods Storage Period

=
Estimated Production (In Units)∗ Direct Lab Permit 12 Months
360 Days


Or
=
Average Stock Of Finished Goods
Average Cost Of Goods Sold Per Day


D) Debtors Collection Period =
Average Goods Debtors
Average Credit Sale Per Day


E) Credit Period Available To Suppliers =
Average Rate Credit
Average Credit Purchase Per Day


Operating Cycle = R+W+F+D-C

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PROBLEMS ON WORKING CAPITAL REQUIREMENT
P-1 The cost sheet of PQR Ltd. Gives the following data :
Particulars Cost Per Unit Rs.
Raw Material 50
Direct Labour 20
Overheads (Including Depreciation Of Rs. 10) 40
Total Cost 110
Profit 20
Selling Price 130
Average raw material in stock is for one month. Average material in work in progress is for half month. Credit
allowed by suppliers is one month. Debtors are allowed credit of one month. Average time lag in payment of
wages is 10 days. Average time lag in payment of overheads is 30 days 25% of the sales are on cash basis. Cash
balance is expected to be Rs. 1,00,000. Finished goods lie in the warehouse for one month.
Prepare a statement of working capital needed to finance a level of activity of 54,000 units of output. Production
is carried on evenly throughout the year and wages and overhead accrue similarly.
State clearly assumption you make.
P-2 The management of Gemini Enterprises has called for a statement showing the working capital required to
finance a level of activity of 1,80,000 units of output for the year. The cost structure for the company’s product for
the above-mentioned level of activity is detailed below :
Particulars
Cost Per Unit
Rs.
Raw Material 20
Direct Labour 5
Overheads (Including Depreciation Of Rs. 5 Per Unit) 15
Total Cost 40
Profit 10
Selling Price 50
Additional Information:
i. Minimum cash balance desired Rs. 20,000.
ii. Raw materials are held, in stock, on an average, for two months.
iii. Work in progress (assume 50% completion stage) will approximate to half a month’s production.
iv. Finished goods remain in warehouse, on an average, for one month.
v. Suppliers of raw materials extend one month’s credit and debtors are given two month’s credit. Cash sales
are 25% of total sales.
vi. There is a time lag in payment of wages of one month and of half a month in the case of overheads.
P-3 Prepare Estimate of Working Capital requirement.
Details of A Ltd. cost per unit
Materials 40

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Labour 20
Variable selling expenses 4
Fixed Expenses:
Manufacturing = Rs. 6,000 p.m.
Administration = Rs. 48,000 p.a.
Selling = 20% of administration is selling fixed costs.
Depreciation = 10% p.a. on cost of machine of Rs. 12 lacs. Selling Price = Rs. 96 per unit.

Output
Units
Sales
Units
Year 1 6,000 5,000
Year 2 9,000 8,500
Additional Information:
a) Stock of raw materials = 2.25 months’ consumption.
b) Debtors and creditors time lag = 1 month.
c) Creditors for expenses = 1 month.
d) Cash balance of one month’s administration and selling expenses will be maintained.
e) Finished goods will be valued on weighted average office cost basis.
Find the amount of working capital required for both the years.
P-4 Re- write the following statement of changes in working capital by calculating the missing figures:
Statement of Changes in Working Capital
Particulars 31-12-2019 31-12-2020 Working Capital Increase/ (Decrease)
(A) Current Assets
Stock 1,00,000 ? 20,000
Debtors ? 70,000 ?
Cash 10,000 15,000 ?
Bank 25,000 ? 25,000
Bills Receivables 30,000 25,000 ?
Prepaid Expenses 5,000 ? 1,000
(A) ? ? ?
Current Liabilities
Creditors 20,000 ? (10,000)
Bills Payables 10,000 5,000 ?
Outstanding Wages 3,000 ? 1,000
Outstanding Salary ? 4,000 ?
(B) 40,000 ? -
Working Capital (A-B) ? ? -
Increase In Working Capital

35,000

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60,000

P-5 M/S Jayam Ltd. Sells its products on a gross profit of 20% on sales. The following information is extracted from
its annual accounts for year ended 31
st
march, 2002.
Rs.
Sales at three months credit 40,00,000
Raw material 12,00,000
Wages paid (average time lag 15 days) 9,60,000
Manufacturing Expenses paid (one month in arrears) 12,00,000
Administrative Expenses paid (one month in arrears) 4,80,000
Sales Promotion Expenses (Payable half-yearly in advance) 2,00,000

P-6 X Ltd. Manufactured and sold 1,000 D.V.D sets in the year 2019. The production cost per unit was as under:
Particulars Rs.
Material 1,500
Labour 750
Overheads 450
Total Cost 2,700
Profit 300
Selling Price 3,000
For the year 2020 it is estimated that:
a) The output and sales will be 1,500 D.V.D. sets
b) Selling price per unit will be Rs. 3,600/-
c) Overheads will increase by 20%.
d) Price of material will rise by 10%.
e) Labour cost will rise by 20%.
It is also estimated that:
a) Cash in hand and with bank should always be Rs. 75,000/-.
b) Customers allowed credit as under:
i. 50% of sales against acceptance of bill for 2 months.
ii. 50% of sales on one month credit.
c) 60% of Raw Material requirement will be obtained from the suppliers from China by making 2 months
advance payment and 40% of Raw Material purchased on 1 month credit.
d) Finished goods will remain in warehouse for one month.
e) Raw material remain in stock for a half month before issue to production.
f) Wages are paid one month in arrears.
g) Material will be in process for half month. (Valued at cost of material plus 50% of labour and overheads).

P-7 The following data is furnished to you regarding two companies A and B operating in the same industry.
Particulars A B
Raw material stock (in terms of days pumrchase) 75 72

20. 20

Work in process stock (in terms of days of cost of goods sold)
Finished goods stock (in terms of days of cost of goods sold)
Average collection period ( in days)
Average payment period (in days)
36
54
72
60
30
40
90
48
i. Calculate the operating cycle in case of each of the two companies.
ii. Also suggest steps you would take to reduce the operating cycle.
iii. What will be effect of reducing the operating cycle?
P-8 The board of Directors of Alka Ltd. Require you to prepare a statement showing the working capital
requirements forecast for a level of activity of 1,56,000 units of production. The following information is available
for your calculation:
Particulars Cost Per Unit Rs.
Raw Material 90
Direct Labour 40
Overheads 75
Total Cost 205
Profit 60
Selling Price 265
a) Raw material are in stock on an average for one months.
b) Materials are in process on an average two weeks.
c) Finished goods are in stock, on an average for one month
d) Credit allowed by the suppliers- one month.
e) Time lag in payment from debtors- two months.
f) Time lag in payment of wages – one and half weeks.
g) Lag in payment of overheads - one month.
20% of the output is sold against cash. cash in hand and at bank is expected to be Rs. 60,000. It is assumed that
production is carried on evenly throughout the year. Wages and overheads accrue similarly and a time period of 4
weeks is equivalent to a month.

P-9 R Ltd. Furnishes following details and requests you to prepare a statement showing the requirements of
working capitals for the year 2020.
Particulars Budget For 2020
Production Capacity 30,000 Units
Production 80%
Cost Structure:
Raw Material Rs. 40 P.U.
Other Direct Material Rs. 30 P.U.
Wages Rs. 20 P.U.

21. 21

Overheads: Fixed Rs. 10,000 P.M.
Variable Rs. 10 P.U.
Profit 20% On Sales

a) Fixed overheads payable quarterly in advance.
b) Raw material remain in stock for two months.
c) Other direct material in stock for one month.
d) The production process takes one month. WIP valuation to be made raw material and other direct
material at cost and 50% of wages and overheads (variable).
e) Finished goods remain in stock for two months (to be valued at direct cost).
f) Raw material purchased from suppliers against advance payment of three months and other direct
material suppliers allow credit of two months.
g) Time lag in payment of wages two months.
h) Cash balance to be maintained at Rs. 75,000.
i) Credit allowed to customers as under (valued at selling price)
i. 50% of invoice price against acceptance of Bill for three months.
ii. 25% of invoice price time lag three months.

P-10 Form the following information prepare an estimate of working capital required to finance a level of activity
of 3,12,000 units p.a. (52 weeks) and how will you finance the working capital.
Particulars Per Unit (Rs.)
Raw Material 90
Wages 40
Overheads:
Manufacturing 30
Administrative 40
Selling 10

210
Profit 40
Selling Price 250

Other Information:
a) Raw materials are held in stock for a period of 4 weeks.
b) Materials remain in process for 2 weeks requiring 50% wages and 40% overheads.
c) Finished goods remain in stock for a period of 4 weeks.
d) Credit allowed to customers is 8 weeks but 20% of the invoice price is collected immediately.
e) Time lag in payment of wages is 1.5 weeks and in overheads is 4 weeks.
f) Credit available from suppliers is 4 weeks but 20% of the creditors are paid 4 weeks in advance.
g) Bank balance is to be maintained at Rs. 60,000.
P-11 Tasty Ltd. is presently operating at 50% level producing 30,000 packets of snack foods and proposes to
increase capacity utilization in the coming year by 25% over existing level of production.

22. 22

The following data has been supplied:
Particulars Per Unit (Rs.)
Raw Material 4
Wages (Variable) 2
Overheads (Variable) 2
Fixed Overheads 1
Profit 3
Selling Price 12

i. Raw material will remain in stores for 1 month before being issued for production.
ii. Material will remain in process for further 1 month.
iii. Suppliers grant 3 months credit to the company.
iv. Finished goods remain in godown for 1 month.
v. Debtors are allowed credit for 2 months.
vi. Lag in wages and overheads payments is 1 month and these expenses accrue evenly throughout the
production cycle.
vii. No increase either in cost of inputs or selling price is envisaged.
viii. Prepare an estimate of working capital requirement at the new level, assuming that a minimum cash
balance of Rs. 20,000 has to be maintained.
P-12 The following is a cost sheet of a company producing 48,000 similar types of products every year.
Particulars Per Unit (Rs.)
Raw Material 80
Labour 40
Factory Overheads 30
Selling & Distribution
cost 20
Net Profit 30
a) Raw material will remain in stock for 2 months.
b) Finished goods remain in godown for 3 months.
c) Credit allowed by suppliers of materials is 2 months.
d) Credit allowed to customers is 3 months.
e) Factory overheads are paid at the end of the month.
f) Company has a policy to have bank balance of at least Rs. 1,50,000 on any date and cash holding worth 3
months factory overhead.
g) 20% of the total sale is for cash.
You are required to prepare a statement of working capital requirements.

23. 23

P-13 Hindustan cables Ltd. Sells its goods in domestic as well as in foreign market. Domestic selling prices are at
40% gross profit on sales after considering depreciation and the export prices are 10% below the domestic prices.
Following are the estimated annual figures for next year:
Particulars Rs. Rs.
Sales: domestic
Export
Material consumption
Wages (time lag 1 month)
Manufacturing expenses (1 month in arrears)
Depreciation
Administration expenses (1 month in arrears)
Sales promotion expenses (payable quarterly in advance)
1,80,000
36,000

2,16,000
54,000
42,000
66,000
18,000
60,000
30,000
The company maintains stocks of raw materials and of finished goods each for 1 month as also a cash balance of
Rs. 25,000.
The domestic and foreign customers get 2 and 3 months credit respectively, while the suppliers give 2 months
credit.
Ascertain the working capital requirement keeping additional 10% contingencies.
P-14 From the following information available to you, on 1st January, prepare the working capital requirement
forecast for the year.
Production during the previous year was 30,000 units. It is planned that this level of activity should be maintained
during the current year. The expected ratios of the cost to selling prices are Raw materials 60%, Direct wages 10%
and Overheads 20%. Raw materials are expected to remain in stores for an average of 2 months before issue to
production. Each unit of production is expected to be in process for 1 month, the raw materials being fed into the
pipeline immediately and the labour and overheads cost accruing evenly during the month. Finished goods will be
in the storehouse approximately for 3 months before being dispatched to customer. Creditors allow months credit
from the date of delivery of raw materials Credit allowed to debtors is 3 months from the date of dispatch. Selling
price is Rs. 10 per unit. The cycle of production and sales is regular. Wages are paid 15 days in arrears. Cash in
hand with the company is normally Rs. 20,000. Assume 30 days to a month.
P-15 The Board of Directors of Maria Ltd. Requires you to prepare working capital estimation for the coming year.
The details of the company are as follows:
The number of units being produced currently are 50,000 units per annum.

24. 24

The Raw material cost is Rs. 180 per unit.
The Wages are Rs. 40 per unit.
The Fixed Overheads are Rs. 100 per unit.
The Selling Price Per unit is Rs. 680.
Other Details are:
a) Raw material are in store on an average for 1 month along with finished goods.
b) Material in progress is on an average for 15 days.
c) Credit allowed by suppliers is for 1 month.
d) Time lag in collection from debtors is 4 months.
e) Time lag in payment of wages is 1 month and that of overheads it is 3 months.
f) 20% of the output is sold against credit. Cash In hand and in Bank is expected to be Rs. 3,00,000.
P-16 Amartax Ltd. is going to produce and sell 5,000 units per month in the year 2020. The material required per
unit is Rs. 550. The direct labour is Rs. 12,00,000 per month. The other direct expenses are Rs. 1,26,00,000 per
annum. The selling price is fixed by calculating profit at 20% on cost price.
Calculate requirement of working capital for 2020 by taking into consideration following information:
a) Stock of raw material will be for two months.
b) Process time is one month.
c) Stock of finished goods will be for 1.5 months.
d) Credit allowed to customer is two months.
e) Time lag in payment of wages is one month and the direct expenses in arrear of 15 days.
f) 20% of material is purchased on cash basis and suppliers of 80% material give 2 months credit
g) Cash required is 15% of net working capital.
P-17 Vineeth & Co. is going to produce and sell 5,000 units per month in the year 2020. The material required per
unit is Rs. 55. Direct labour cost Rs. 1,20,000 per month. The overhead expenses amounted to Rs. 12,60,000 p.a.
The sale price is fixed by Calculating profit at 20% on sale price. Calculate requirement of working capital for 2020
by taking into consideration following information:
a) Stock of raw material will be two months.
b) Process time is one month.
c) Stock of finished goods will be 1.5 months.
d) Credit allowed to 50% customers is two month and the balance 50% customers are given one month
credit.
e) 25% of expenses are paid one month in advance and the balance 75% is paid after one month.
f) Time lag in payment of wages is one month.
g) 20% of material is purchased on cash basis and 80% material on 1.5 month's credit.
h) Cash required is 20% of net working capital.

25. 25

CHAPTER 3 PROBLEMS ON CORPORATE FINANCIAL STATEMENTS

P-1 From The Information Given Below Prepare Balance Sheet In A Vertical Form Suitable For Analysis.




















P-2 The Balance Sheet Of XYZ Ltd. Is Given For The Year 2021. Convert Them Into Vertical Balance Sheet.
Liabilities Rs. Assets Rs.
Equity Shares 1,91,000 Building 2,00,000
Capital Reserve 70,000 Plant & Machinery 55,000
Revenue Reserve & Surplus 30,000 Furniture 20,000
Trade Creditors 40,000 Freehold Property 12,000
Bills Payable 60,000 Goodwill 30,000
Bank Overdraft 80,000 Cash Balance 20,000
Provisions 20,000 Sundry Debtors 35,000

Inventories 57,000

Investment (Temporary) 42,000

Bills Receivable 20,000

4,91,000

4,91,000

P-3 The Following Is The Balance Sheet Of ABC Ltd. As On 31
st
March, 2021. You Are Required To Present It In
Vertical Form.
Liabilities Rs. Assets Rs.
Equity Share Capital 3,00,000 Goodwill 80,000
Particulars (Rs. '00s)
Current Account With Bank Of India 50,000
Land & Building 8,00,000
Advance Payments 62,000
Stock 2,73,000
Creditors 4,06,000
Debtors 5,23,000
Bills Receivable 21,000
Plant & Machinery 5,44,000
12% Debentures 2,50,000
Loan From Directors 52,000
Equity Share Capital 10,00,000
Profit & Loss A/C 2,17,000
Trade Investments 20,000
Proposed Dividend 86,000
Advance Tax 1,00,000
Provision For Taxation 2,64,000
Bills Payable 18,000
General Reserve 1,00,000

26. 26

Reserves & Surplus 1,50,000 Land & Building 1,50,000
10% Mortgage Debentures 2,15,000 Plant & Machinery 2,00,000
Sundry Creditors 1,30,000 Patents Rights 21,500
Bank Overdraft 40,000 Stock-In-Trade 1,43,500
Provision For Tax 35,000 Sundry Debtors 2,40,000

Cash In Hand 5,000

Cash At Bank 10,000

Preliminary Expenses 20,000

8,70,000

8,70,000

P-4 Profit & Loss A/C For The Year Ended 31-03-2021.
Particulars Rs. Particulars Rs.
To Opening Stock 76,250 By Sales 6,02,350
To Purchases 3,15,250 Less : Returns 10,000 5,92,350
To Freight & Carriage 7,000 By Closing Stock

98,500
To Staff Salaries 20,000 By Interest On Bonds

1,500
To Sales Salaries 15,300 By Dividend On Shares

3,750
To Interest On Debentures 1,200 By Profit On Sale Of Shares

3,900
To Rent 2,700
To Printing & Stationary 2,500
To Advertising 4,700
To Sales Discount 2,400
To Depreciation 9,300
To Insurance 1,000
To Electricity 350
To Salesmen's Travelling Expenses 2,000
To Bad Debts 3,400
To Telephone Expenses 750
To Legal Charges 6,400
To Directors Fees 48,000
To Loss On Sale Of Bonds 3,500
To Provision For Claim For Damages 1,650
To Net Profit 1,76,350


7,00,000

7,00,000
Prepare The Above In Vertical Form Suitable For Analysis.
P-5 From The Following Trial Balance Of Jyoti Ltd. As On 31
st
March, 2021, Prepare Vertical Revenue Statement
For The Year Ended 31
st
March,2021 And Vertical Balance Sheet As On That Date After Making The Necessary
Adjustments:
Particulars Rs. Rs.
Equity Share Capital 11,00,000
Plant & Machinery 12,00,000
Sales 37,00,000
Purchases 17,00,000

27. 27

Sundry Debtors 9,00,000
Sundry Creditors 8,50,000
Wages 3,50,000
Opening Stock 1,20,000
Salaries 1,80,000
Advertisement 75,000
Telephone Charges 35,000
Furniture 2,00,000
Investment (Long Term) 5,00,000
Interest Received 40,000
Loss On Sale Of Furniture 20,000
Commission 60,000
Profit & Loss A/C 1,20,000
Interim Dividend 50,000
General Reserve 1,00,000
Cash At Bank 3,20,000
Bills Receivable 2,00,000
59,10,000 59,10,000
Adjustments:
a) Stock On 31
st
March, 2021 Was Valued At Rs. 3,00,000.
b) Make Provision Of Rs. 3,00,000 For Income Tax.
c) Depreciate Plant & Machinery @ 20% And Furniture @ 10%.

P-6 Balance Sheet Of RT Ltd., As On 31/03/2021
Liabilities Rs. Assets Rs.
Preference Share Capital _ Fixed Assets 7,00,000
Equity Share Capital 5,00,000 Investments (At Cost) 1,00,000
Reserves & Surplus 1,35,000 Stock 1,50,000
12% Debentures 2,00,000 Debtors 2,36,000
Sundry Creditors 1,50,000 Cash 24,000
Bank Overdraft 50,000
Provision For Tax 75,000
Proposed Dividend 1,00,000


12,10,000

12,10,000
Rearrange The Above In Vertical Form Suitable Analysis.
P-7 The Accountant Of A Company Submits The Following Financial Statements For 2021.
Trading And Profit And Loss A/C For The Year Ended 31
st
March,2021.
Expenses Rs. Income Rs.
To Opening Stock 35,000 By Sales 8,30,000
To Purchases 7,50,000 By Closing Stock 80,000
To Gross Profit 1,25,000
9,10,000 9,10,000
To Depreciation 18,000 By Gross Profit 1,25,000

28. 28

To Other Expenses 37,000 By Interest 5,000
To Tax Provision 20,000
To Proposed Dividend 8,000
To Net Profit 47,000
1,30,000 1,30,000
Balance Sheet As At 31
st
March,2021.
Liabilities Rs. Assets Rs.
Share Capital 1,50,000 Cash 24,000
Bank Overdraft 19,000 Stock 80,000
Creditors 13,000 Debtors 69,000
Depreciation Provision 27,875 Land & Building 46,075
Tax Provision 20,000 Machinery 64,300
Proposed Dividend 8,000 Prepaid Expenses 750
Profit & Loss A/C 90,000 Goodwill 10,000
Preliminary Expenses 3,500
Loan 30,000
3,27,875 3,27,875
Rearrange The Above In Vertical Form Suitable Analysis.
P-8 Given Below Is The Balance Sheet Of TY Ltd.
Balance Sheet As On 31
st
March, 2021
Liabilities Rs. Assets Rs.
Share Capital 3,75,000 Goodwill 62500
Capital Reserve 4000 Land 1,14,500
General Reserve 60205 Premises 1,25,000
Debenture Redemption Fund 84000 Plant 93758
Profit & Loss A/C 37554 Furniture 16650
5% Debentures 1,57,500 3% G.P. Notes 2019 76400
Sundry Creditors 36950 Stock 1,17,815
Proposed Dividend 18750 Debtors 1,01,971
Provision For Taxation 10000 Cash At Bank 60140


Advance Tax 1550


Preliminary Expenses 13675
Total 7,83,959 Total 7,83,959
Rearrange The Balance Sheet In Vertical Form And Calculate The Following:
(1) Current Assets (2) Quick Assets (3) Intangible Assets (4) Fictitious Assets (5) Fixed Assets (6) Fixed Liabilities
(7) Proprietor’s Funds (8) Working Capital (9) Total Funds Employed (10) Secured Loan (11) Owned Funds.

P-9 You Are Given The Following Information Of MT Ltd. Prepare Vertical Statement.
Trial Balance As On 31/03/2021
Particulars Debit Credit
Rs. Rs.

29. 29

Land & Building 25,50,000
Machinery 8,00,000
Furniture 3,00,000
Debtors 5,00,000
Cash & Bank Balance 1,00,000
Creditors 30,00,000
Outstanding Expenses 20,000
Sales 30,00,000
Purchases 15,00,000
Opening Stock 3,00,000
Administrative Expenses 3,70,000
General Reserve 7,44,000
Selling Expenses 1,10,000
Share Capital 20,00,000
Unsecured Loan 4,66,000
65,30,000 65,30,000
Closing Stock As On 31/03/2021 Was Rs. 4,00,000.

P-10 Balance Sheet Of ABC Ltd., As On 31/03/2021
Liabilities Rs. Assets Rs.
Equity Share Capital 50,00,000 Fixed Assets 87,80,000
10% Preference Share Capital 20,00,000 Investments In Shares 10,00,000
General Reserve 45,67,000 Other Investments 8,00,000
12% Debentures 25,00,000 Stock 45,80,000
Fixed Deposits From Public 12,00,000 Debtors 34,67,800
Sundry Creditors 43,20,000 Advances 5,90,000
Expenses Payable 8,10,000 Cash & Bank Balance 20,49,200
Provision For Tax 8,70,000


2,12,67,000 2,12,67,000
Convert Them Into Vertical Balance Sheet.

30. 30

CHAPTER NO 4 RATIO ANALYSIS
P-1 From The Following Given Below Prepare Balance Sheet In A Vertical Form, Suitable For Analysis & Calculate
The Following Ratios:
a) Capital gearing ratio b) Proprietory ratio
c) Current ratio d) Liquid ratio e) Stock to working capital
Particulars Amount Particulars Amount
Cash at bank 12500 Land & Building 200000
Expenses paid in advance 15500 Stock 68250
Creditors 101500 Debtors 130750
Bills receivables 5250 Plant & Machinery 136000
12% Debentures 62500 Loan from director 100000
Equity share capital 250000 (repayable after 3 years)
Profit & loss A/C (Cr.) 54250

P-2 Following Are The Balance Sheet Of X Ltd. As On 31
st
March, 2020 & 31
st
March, 2021.
Liabilities 2020 2021 Assets 2020 2021
Share capital 450000 660000 Building & equipment 450000 500000
Retained earning 231000 200000 Land 80000 80000
Provision for income tax 84000 --- Patents 55000 65000
Debenture 220000 180000 Accounts receivables 54000 46000
Accounts payable 58000 64000 Inventories 300000 312000
Other Curr. Liabilities 21000 33000 Prepaid expenses 6000 4000
Cash 119000 130000
1064000 1137000 1064000 1137000
Calculate following ratios for two years after preparing vertical format
a)Debt- Equity Ratio b) Quick Ratio c) stock to working ratio d) proprietory ratio
P-3 Without Preparing Vertical Balance Sheet
Liabilities Amount Assets Amount
Equity share capital 500000 Fixed assets 1300000
General reserves 300000 Investment 400000
Securities premium 25000 Stock 850000
10%debentures 750000 Sundry debtors 500000
Profit & loss a/c 740000 Prepaid expenses 40000
Sundry debtors 230000 Advance income tax 78000
Bank overdraft 395000 Cash & bank balance 62000
Provision for taxation 180000 Share issue expenses 10000

31. 31

Proposed equity dividend 150000 Preliminary expenses 30000
3270000 3270000
You are required to compute the following ratio and give your comments on each ratio with reference to standard
ratio – 1) Current Ratio 2) Liquid ratio 3) Proprietory ratio 4) stock working capital
P-4 Following Is The Balance Sheet Of Bliss & Happiness Ltd. As At 31st March, 2021.
Liabilities Amount Assets Amount
Equity share capital 100000 Machinery 296000
General reserve 70000 Investment 112000
10% Preference capital 180000 Stock in trade 101000
15% Debenture 120000 Bills receivable 20000
Trade payables 122000 Trade receivables 49000
Bank overdraft 20000 Cash & bank 38000
Profit & loss a/c 14000
630000 630000
1) Current ratio 2) Acid ratio 3) Capital gearing ratio 4) Proprietory ratio 5) Return on capital employed
P-5 Following Is The Profit &Loss A/C Of Saurav & Co. For The Year Ended 31
st
March, 2021. Prepare Vertical
Income Statement For The Purpose Of Analysis.
Particulars Amount Particulars Amount
(in Lacs) (in lacs)
To opening stock 700 By cash sales 520
2000
credit Sales 1500
2020
(-) Returns 20
To Purchases 900 By Closing stock 600
To Wages 150 By Dividend on Investment 10
To Factory expenses 350 By profit on sale of furniture 20
To Office salaries 25
To Postage & Telegram 5
To Office Rent 39
To Manager salary 6
To Sales salaries 12
To Advertisement 18
To Delivery Expense 20
To Loan Interest 20
To Depreciation on-
on office furniture 10
on plant 30
on Delivery Van 20

32. 32

To Loss on sales of van 5
To Income tax 175
To Net Profit 145
2630 2630
Calculate –
1) Gross profit ratio 2) operating cost ratio excluding financial expenses 3) stock turnover ratio
P-6 Z Ltd Showing Trading Activities For The Year Ended 31
st
March 2021.
Particulars Amount Particulars Amount
Sales 1057000 Provision for taxation 100000
Closing stock 460000 Salaries 35750
Purchases 835000 Salesmen’s salaries 14250
Loss on sales of shares 45000 Depreciation 36000
Advertisement 32750 Sales return 57000
Rent 18750 Depreciation on Van 8000
Profit on sale of shares 25000 Printing & stationery 17500
Opening stock 225000 Audit fees 12000
Dividend received on shares
Prepare vertical form & compute following ratios
1) Gross profit ratio 2) Operating ratio 3) Selling &distribution expenses to sales ratio
4) Net profit ratio
P-7 Following Is The Profit & Loss A/C Moon Enterprises For The Year Ended 31
st
March 2021
Particulars Amount Particulars Amount
To Opening stock 400000 By sales
To Purchases 980000 Credit 1800000
To wages 290000 Cash 700000
To Factory expenses 190000 By closing stock 600000
To office salaries 120000 By sale of scrap 10000
To general admin expenses 130000 By Dividend received 1000
To selling expenses 112500
To depreciation 250000
To provision for tax 140500
To Transfer to general reserve 200000
To net profit 298000
3111000 3111000
You are required to compute the following ratio
1) Gross profit ratio 2) Stock-turnover ratio 3) administrative exp ratio 4) Net profit before tax ratio

33. 33

P-8 The Accountant Of A Company Submits The Following Financial Statements For 2021.
Trading And Profit And Loss A/C For The Year Ended 31
st
March,2021
Expenses Rs. Income Rs.
To Opening Stock 30,000 By Sales 4,00,000
To Purchases 3,00,000
By Closing
Stock 50,000
To Gross Profit 1,20,000
4,50,000 4,50,000
To Expenses 20,000 By Gross Profit 1,20,000
To Tax Provision 40,000
To Proposed Dividend 20,000
To Net Profit 40,000
1,20,000 1,20,000

Balance Sheet As At 31
st
March,2021
Liabilities Rs. Assets Rs.
Share Capital 2,00,000 Machinery 80,000
Reserve 10,000
Land &
Building 20,000
Profit & Loss A/C 30,000 Stock 50,000
Creditors 50,000 Debtors 80,000
Cash At Bank 60,000
3,27,875 3,27,875
Calculate The Following Ratios And Comment:
a) Stock Turnover Ratio
b) Debtor Turnover Ratio
c) Creditors Turnover Ratio
d) Return On Capital Employed
e) Return On Proprietor’s Fund
P-9 X ltd. Presents you the following balance sheet as at 31
st
March, 2021:
Liabilities Rs. Assets Rs.
2,500, Equity Shares 25,000 Fixed Assets 43,750
8% Preference Share Capital 5,000 Investments 12,500
Reserve Fund 20,000 Stock 15,000
6% Debentures 10,000 Sundry Debtors 6,750
Sundry Creditors 15,000 Bank Balance 3,500
Provision For Tax 2,500 Preliminary Expenses 4,000
Profit And Loss Account (After Tax) :
8,000

Previous Year , 500

34. 34

Current Year 7,500

85,500

85,500
Additional information:
Tax provided during the current year Rs. 2,500.
Calculate the following ratios: (a) return on capital employed (b) current ratio (c) Return on proprietor’s fund (d)
proprietory ratio.
P-10 Complete the following balance sheet of ATS Ltd.
Liabilities Rs. Assets Rs.
Share Capital 30,00,000 Plant And Equipment ?
Reserves And Surplus 45,00,000 Inventory ?
Long Term Loans ? Sundry Debtors ?
Current Liabilities 10,00,000 Cash ?
Total ? Total ?

Debt equity ratio 1:2, total assets turnover is 2/5, inventory turnover is 9 times, acid test ratio is 1, ACP 45 days,
gross profit margin is 10%. Assume 360 days per year, 100% credit sales.
P-11 Complete the Balance Sheet of Titanic Ltd.
Liabilities Rs. Assets Rs.
Share Capital 20,00,000 Fixed Assets ?
Reserves And Surplus ? Current Assets ?
Long Term Loans 2,00,000 Stock ?
Current Liabilities ? Debtors
Cash ?
Total ? Total ?

Ratios of the company are :

a) Reserves & surplus to share capital ratio 1:1.

b) Sales to net worth ratio is 1.5:1
c) Sales to debtors ratio is 6:1
d) G.P. Ratio is 20% on sales
e) Net working capital rs.12 lakhs.
f) Stock turnover ratio 6 times.
g) Current ratio 2.5:1
h) Acid test ratio 1.5:1
Net worth = share capital + reserves and surplus.

35. 35

CHAPTER 5 BONUS SHARES
Bonus Shares :

When the additional shares are allotted to the existing shareholders without receiving any additional payment
from them, it is known as issue of bonus shares.
Bonus shares are allotted by capitalizing the reserves and surplus. Issue of bonus shares results in the conversion
of the company's profits into share capital.
Therefore it is termed as capitalization of company's profits. Since such shares are issued to the equity
shareholders in proportion to their holdings of equity share capital of the company, a shareholder continues to
retain his / her proportionate ownership of the company. Issue of bonus shares does not affect the total capital
structure of the company.
It is simply a capitalization of that portion of shareholders' equity which is represented by reserves and surpluses.
It also does not affect the total earnings of the shareholders. Issue of Bonus Shares is more or less a financial
gimmick without any real impact on the wealth of the shareholders. Still firms issue bonus shares and
shareholders look forward to issue of bonus shares.

Reasons for issuing Bonus Shares

1. The bonus issue tends to bring the market price per share within a more reasonable range.
2. It increases the number of outstanding shares. This promotes more active trading.
3. The nominal rate of dividend tends to decline. This may dispel the impression of profiteering. 4. Share capital
base increases and the company may achieve a more spectacular size in the eyes of the investing company.
5. Shareholders regard a bonus issue as a strong indication that the prospects of the company have brightened
and they can reasonably look for an increase in total dividend.
6. It improves the prospects of raising additional funds.

Regulation of Bonus Issues Important regulatory provisions governing issue of bonus shares are:

1. The bonus issue is made out of free reserves built out of the profits or share premium collected in cash only.
2. The residual reserves after the proposed capitalization shall be at least 40% of the increased paid up capital.

Stock Splits :

In a stock split the face value per share is reduced and the number of shares is increased proportionately.
A stock split is similar to a bonus issue from economic point of view. But there are some differences from the
accounting point of view.

Difference between Bonus Issue and Stock Split Bonus Issue Stock Split

1. The par value of share is unchanged. 1. The par value of share is reduced. 2. A part of the
reserves is capitalized. 2. There is no capitalization of reserves.

Advantages of issue of bonus shares to the company

1. Conservation of Cash: Issue of bonus shares does not involve cash outflow. The company can retain earnings as
well as satisfy the desire of the shareholders to receive dividend.

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2. Keeps the EPS at a reasonable level: A company having high EPS may face problems both from employees and
consumers. Employees may feel that they are underpaid. Consumers may feel that they are being charged too
high for the company's products. Issue of bonus shares increases the number of shares and reduces the earning
per share.
3. Increases the marketability of company's shares: Issue of bonus shares reduces the market price per share. The
price of the share may come within the reach of ordinary investors. This increases the marketability of shares.
4. Enhances prestige of the company: By issuing bonus shares, the company increases its credit standing and its
borrowing capacity. It reflects financial strength of the company.
5. It helps in financing its projects: By issuing bonus shares, the expansion and modernization programmes of a
company can be easily financed. The company need not depend on outside agencies for finances.
6. Retention of managerial control: Any new issue of shares has a danger of dilution of managerial control over
the company.
Since bonus shares are issued to the existing shareholders in proportion to their current holdings, there is no
threat of dilution of managerial control over the company.

Advantages to the shareholders

1. Tax benefits: When a shareholder receives dividend in cash, it adds to his total income and is taxed at usual
income tax rates. From this point of view the bonus shares increase the wealth of shareholders. In case the
shareholder requires cash he can sell his additional shares.
2. Indication of higher future profits: Issue of bonus shares is generally an indication of higher future profits. This
is because a company declares a bonus issue only when its earnings are expected to increase.
3. Increase in future dividend: The shareholder will get more dividends in the future even it the company
continues to offer existing cash dividend per share.
4. High psychological value: Issue of bonus shares is usually perceived positively by the market. This tends to
create greater demand for the company's shares. In fact, always the share prices rise at the declaration of bonus
shares.

Limitations of Bonus Issues Disadvantages for the company:

1. Issue of bonus shares leads to an increase in the capitalization of the company. The increased capitalization can
be justified only if there is increase in the earning capacity of the company.
2. After the issue of the bonus shares the shareholders expect the existing rate of dividend per share to continue.
It is really a challenging task for the company to retain the existing rate of dividend per share.
3. Issue of bonus shares prevents new investors from becoming the shareholders of the company (no doubt they
can buy the shares in the secondary market).

Disadvantages to the shareholders:
1. Some shareholders may prefer cash dividend to stock dividend, such shareholders may feel disappointed
(no doubt they can very well sell their bonus shares and get their money)

SEBI Guidelines for Issue of Bonus Shares
1. The bonus issue can be made only out of free reserves built out of the genuine profits or securities premium
collected in cash.
2. Reserves created by revaluation of fixed assets are not available for issue of bonus shares
3. The bonus issue cannot be made unless the partly-paid shares, if any, existing, are made fully paid-up

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4. The declaration of bonus issue, in lieu of dividend, cannot be made
5. Once the company announces bonus issue after the approval of Board of Directors, the proposal must be
implemented within a period of six months from the date of such approval and it does not have option of changing
the decision
6. If there is no provision in the Articles for the capitalization of reserves, the company must pass a Resolution at
its General Body Meeting to make provisions in the Articles
7. If consequent to the issue of bonus shares, the subscribe and paid-up capital exceeds the authorized capital, a
Resolution shall be passed by the company at its General Body Meeting for increasing the authorized capital
Funds or Sources for Bonus Issue
A .Revenue Reserves/Profits
1. Credit balance in the profit and loss account
2. General Reserves
3. Credit balance in the Sinking Fund Account for the redemption of a liability after the redemption of the
liability
4. Dividend equalization reserve
B. Capital Reserves/profits
1. Profit prior to incorporation
2. Profit on sale of fixed assets or business
3. Capital Redemption Reserve created for redemption of preference share
4. Security Premium collected in cash only
Note: Capital Redemption Reserve Account and Security Premium Account can be utilized only for issuing fully
paid bonus shares
Accounting Treatment
Bonus share can be issued at par or at premium. Bonus share can be given:
a) By making partly paid shares as fully paid
b) By issuing fully paid shares
ACCOUNTING ENTRIES IN BONUS SHARES
1st Case:
In this case, when a company provides bonus issue for converting their partly paid up shares into fully paid shares
and for providing the bonus issue amount from company reserves, the following entry must be followed:
1. General Reserve A/c Dr. xxxxxx
Free Reserve A/c Dr. xxxxxx

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Capital Reserve A/c Dr. xxxxxx
Revenue Reserve A/c Dr. xxxxxx
Dividend Equalization Fund Account Dr. xxxxxx
Profit and Loss A/c Dr. xxxxxx
To Bonus to Equity Shareholders account xxxxxx
(Being Bonus declared for making fully paid up shares)

2. Entry for the amount due on final call of shares amount:
Final Call share A/c Dr. xxxxx
To Share capital A/c xxxxx
(Being the Final call made due)
3. Entry for adjustment of final call amount out of company’s profit:
Bonus to Shareholder A/c Dr. xxxxx
To Final call share A/c xxxxx
(Being shares made fully paid up at Rs. xxxxx)
2nd Case:
In the 2nd case, when new bonus shares are issued to shareholders out of company reserves, the
following entry should be passed:
4. Entry for providing amount of Bonus:
General Reserve A/c Dr. xxxxxx
Capital Reserve A/c Dr. xxxxxx
Capital Redemption Reserve A/c Dr. xxxxxx
Share Premium A/c Dr. xxxxx
Profit and Loss A/c Dr xxxxxx
To Bonus to shareholder A/c xxxxx
(Being the bonus declared for fully paid shares)
5. Entry for issuing of Bonus Shares:
Bonus to Equity Shareholder A/c Dr. xxxxxx
To Equity share capital A/c xxxxxx
(Being the bonus shares to be issued)
Problems On Bonus Shares
P-1 Given Below Is The Balance Sheet Of Inbox Ltd. As On 31-03-2021
Liabilities Rs. Assets Rs.
2000 Equity Shares Of Rs. 200 Each, Rs. 160 Paid Up 3,20,000 Fixed Assets 7,00,000
Securities Premium A/C 60,000 Current Assets 4,00,000
Capital Reserve 70,000
General Reserve 1,00,000
P & L A/C 3,00,000

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Creditors 2,50,000
11,00,000 11,00,000
The Directors Recommended The Following Proposals With A View To Capitalizing All Possible Ledger Balances. In
Case Of P & L A/C The Maximum Permissible Amount To Be Used For Capitalization Purpose Is Rs. 1,90,000. The
Entire Balance In The Capital Reserve Represents Reserve Created By Revaluation Of Land.
Proposal I : Existing Shares May Be Made Fully Paid Up.
Proposal II :Each Share Holder Is To Be Given Fully Paid Bonus Shares @ Premium Of 12.5% For The Remaining
Amount In Proportion To The Holdings.
Required :
i. Revised Balance Sheet After Proposal I But Before Proposal Ii.
ii. Revised Balance Sheet After Both The Above Proposals.
iii. Number Of Shares To Be Issued As Fully Paid-Up Bonus Shares.
iv. Total Number Of Equity Shares After All The Above Proposals.
P-2 The Following Particulars Appear In The Balance Sheet Of P Limited Company.
Balance Sheet Of P Ltd. As On At 31.03.2021
Liabilities Rs. Assets Rs.
Share Capital
Authorised:
20,000 Equity Shares Of Rs. 10 Each
2,00,000 Sundry Assets 1,26,000
Issued And Paid Up :
10,000 Shares Of Rs. 10 Each Rs. 8 Paid Up
80,000
Reserves & Surplus :
Securities Premium A/C 2,000
Capital Redemption Reserve 4,000
General Reserve 40,000
1,26,000 1,26,000
The Company Declared Bonus :
1. Proposal For Making The Partly Paid Shares As Fully Paid Up Shares And
2. Proposal For The Issue Of 1,000 Fully Paid Up Shares Of Rs. 10 Each To The Existing Shareholders. For This
Purpose , General Reserve Should Be Utilized To The Minimum Extent.
You Are Required To Show The Balance Sheet.
i. Revised Balance Sheet After Proposal I But Before Proposal Ii.
ii. Revised Balance Sheet After Both The Above Proposals.
P-3 Super Shoppe’s Balance Sheet As On 31.03.2021 Is As Follows : (Rs. In Lakh)

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Liabilities Rs. Assets Rs.
Share Capital
(20,000 Equity Shares Of Rs. 10 Each)
2 Plant & Machinery 15
Reserves & Surplus 14 Investments 2
Term Loans 2 Current Assets 4
Current Liabilities 3
21 21
Prepare The Balance Sheet As On 31.03.2021 After Incorporating The Following Transactions Made During The
Financial Year 2020-21:
1. Plant & Machinery Is Revalued At Rs. 25 Lacs And A Revaluation Reserve Was Created.
2. Super Shoppe Issued Bonus Shares In The Ratio Of 1: 1.
3. After Bonus Issues, The Shares Are Split Into Shares Of Re. 1 Each.
4. After Bonus And Stock Split, Super Shoppe Made A Right Issue Of Two Lacs Equity Shares Of Re. 1 Each At
A Premium Of Rs. 10 Each And A Public Issue Of 5,00,000 Equity Shares Of Re. 1 Each At A Premium Of Rs.
15 Each.
P-4 Given Below Is The Balance Sheet Of K Ltd. As On 31-03-2021
Liabilities Rs. Assets Rs.
2000 Equity Shares Of Rs. 100 Each Rs. 80 Paid Up 1,60,000 Fixed Assets 3,50,000
Securities Premium A/C 30,000 Current Assets 2,00,000
Capital Reserve 35,000
General Reserve 50,000
P & L A/C 1,50,000
Creditors 1,25,000
5,50,000 5,50,000
The Directors Recommended The Following Proposals With A View To Capitalizing All Possible Ledger Balances.
1. In Case Of P & L A/C The Maximum Permissible Amount To Be Used For Capitalization Purpose Is Rs.
95,000.
2. Rs. 22,500 Out Of Capital Reserve Represents Reserve Created By Revaluation Of Fixed Assets.
Proposal I : Existing Shares May Be Made Fully Paid Up.
Proposal II : Each Share Holder Is To Be Given Fully Paid Bonus Shares @ Premium Of 18% For The Remaining
Amount In Proportion To The Holdings.
Required :
i. Revised Balance Sheet After Proposal I But Before Proposal Ii.
ii. Revised Balance Sheet After Both The Above Proposals.
iii. Number Of Shares To Be Issued As Fully Paid-Up Bonus Shares.
iv. Total Number Of Equity Shares After All The Above Proposals.

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P-5 The Following Particulars Appear In The Balance Sheet Of S Limited Company.
Balance Sheet Of S Ltd. As On At 31.03.2021
Liabilities Rs. Assets Rs.
Share Capital
Authorised:
20,000 Equity Shares Of Rs.
10 Each
2,00,000 Sundry Assets 1,26,000
Issued And Paid Up :
10,000 Shares Of Rs. 10 Each
Rs. 6 Paid Up
60,000
Reserves & Surplus :
Securities Premium A/C 12,000
Capital Redemption Reserve 4,000
General Reserve 50,000
1,26,000 1,26,000
The Company Declared Bonus :
1. Proposal For Making The Partly Paid Shares As Fully Paid Up Shares And
2. Proposal For The Issue Of 1,000 Fully Paid Up Shares Of Rs. 10 Each To The Existing Shareholders. For This
Purpose , General Reserve Should Be Utilized To The Minimum Extent.
You Are Required To Show The Balance Sheet.
iii. Revised Balance Sheet After Proposal I But Before Proposal Ii.
iv. Revised Balance Sheet After Both The Above Proposals.
P-6 The Following Particulars Appear In The Balance Sheet Of X Limited Company.
Balance Sheet Of X Ltd. As On At 31.03.2021
Liabilities Rs. Assets Rs.
Share Capital
Authorised:
10,000 Equity Shares Of Rs. 10 Each
1,00,000 Sundry Assets 2,00,000
Issued And Paid Up :
10,000 Shares Of Rs. 10 Each Rs. 8 Paid Up
80,000
Reserves & Surplus :
Securities Premium A/C 6,000
Capital Redemption Reserve 44,000
General Reserve 70,000
2,00,000 2,00,000
Necessary Resolution Were Passed :
(a) Partly Paid Up Shares To Be Converted Into Fully Paid-Up Shares.

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(b) Issue 2,000 Fully Paid Up Bonus Shares Of Rs. 10 Each To The Existing Shareholders.
Pass Necessary Journal Entries To Record The Above And Prepare Revised Balance Sheet.