Solution to Assignment _ Chapter 3 by nuhman10

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									Solution to Assignments of Chapter 3

1.What basic information balance sheet communicate ?

Ans. Balance sheet is position statement. It communicates information about assets,
liabilities and equity of an enterprise at a particular point in time.

2.Describe a vertical format of company balance sheet .

Ans. Vertical format of balance sheet helps to present information about assets ,
liabilities and equity in precise manner. Under this format balance sheet information is
classified into sources of funds and applications of funds. As per the basic principles of
double entry book keeping , sources should always be equal to applications.

Two major sources of funds are shareholders’ funds and loan funds. Shareholders funds
are further sub- classified into two categories , namely, share capital and reserve and
surplus. Share capital implies equity share capital and preference share capital. Reserves
and surplus imply accumulated revenue profit of the company and capital profit like
share premium and revaluation reserve. Loan funds may come from secured loans which
are obtained against security of asset(s) and unsecured loans.

Three major application of funds are (i) tangible and intangibles fixed assets titled as
gross block , (ii) investments and (iii) net current assets. The caption “ gross block”
covers all types fixed assets used in the business. They include tangible assets like land,
building , plant and machinery , furniture and fixture, vehicles and intangibles having
long live like patents, trade mark , copy rights , etc. Generally, fixed assets are shown at
gross value and then accumulated depreciation is deducted there from and net block is
also presented.

Assets shown under the head “Investments” are investments outside the business.
Whenever a company has some free cash it can either temporarily invest outside the
business as short term investments . Companies can also invest money in group in
subsidiaries , joint ventures and other group companies. I shall discuss with you about
group companies in Chapter 10.

Finally, no business can run simply with fixed asset. It needs working assets like
inventories, debtors, cash . These are called current assets. Also a business needs to give
various types of advances in the course of business like advances to employees, advance
tax , advance to suppliers, etc. These are clubbed with current assets and shown together
as “ Current Assets , Loans and Advances”.

Moreover, in the course of business , an enterprise incurs certain working liabilities like
goods and services purchased but not paid ( they are called trade creditors for goods
purchased on credit , and expense creditors for expense incurred but not paid). These are
also termed as current liabilities. In addition, an enterprise has to provide for certain
known liabilities which is certain to occur in future . Examples are retirement benefits
like gratuity payable to employees on retirement, warranty claim to be paid to customers
for non- satisfactory product/ service, tax liability which is to be assessed in the future,
dividend which has been planned to be paid but actually to be declared by the company in
its annual general meeting in future. These are called provisions. These items are
presented together as “ Current Liabilities and Provisions”. Net Current Assets are net of
Current Assets , Loans and Advances over Current Liabilities and Provisions.

A company incurs certain expenses like preliminary expenses ( which is incurred at the
time of formation of the company by way of legal fees, registration charges, etc.) , share
issue expenses ( incurred for issuing equity / preference shares ), debenture issue
expenses ( incurred for issuing debentures or taking loans by way of legal fees,
documentation charges, etc. ) and so on. These expenses are written off over a period of
time against profit earned by the company as these are capital expenditure by nature.
They are treated as miscellaneous expenditure . Miscellaneous expenditure to the extent
not written off is presented in the balance sheet as applications of funds.

If a company suffers loss , that is first adjusted against its accumulated profit ( other than
capital profit like share premium and revaluation reserve) . Any unadjusted loss is shown
as an application of funds.

Style of presentation of the Balance Sheet elements in a vertical format is given below:
                                     Balance Sheet
                                             Schedule     Figures at the      Figures at
                                                No.            end of         the end of
                                                              current          previous
                                                          financial year       financial
                                                                                  year
   I.     Source of funds
          1. Shareholders’ funds :
              a. Capital
              b. Reserves and Surplus
           2. Loan Funds :
             a. Secured Loans
            b. Unsecured Loans
       Total :
   II.    Applications of funds :
          1. Fixed Assets :
               a. Gross Block
              b. Less : Depreciation
             c. Net Block
             d. Capital Work-in-Progress

           2. Investments
Current Assets, Loans and Advances :
a. Inventories
b. Sundry debtors
c. Cash and Balance balances
d. Other current assets
e. Loans and advances
Less :
Current Liabilities and Provisions :
a. Liabilities
b. Provisions
Net Current Assets

4.Miscellaneous expenditure to the
extent not written off
5. Profit and Loss Account
Total :



3.What are the two major sources of funds as per company balance sheet? While studying
the balance sheet of company it appears that as a whole sources of funds increased
without any change in share capital and loan funds. What does it imply?

Ans. Shareholders’ funds and loan funds are two sources of funds. It implies increase in
reserves and surplus. The company’s profit has increased.

4.While studying the balance sheet of company it appears that as a whole sources of
funds increased but there is no change in share capital , there is a decline in reserve and
surplus but loan funds increased. What does it signify?

Ans. It signifies that the company might have suffered loss and keep its activities
functional the fund deficit was covered up by taking loans.

5.While studying the balance sheet of a company it appears that there is balance of profit
and loss account forming part of Application of Funds. What does it signify?

Ans. The company has suffered loss and there is no balance of general reserve and/or
profit and loss account for setting off that loss.

6.While studying the balance sheet of a company it appears that balance of
Miscellaneous Expenditure (forming part of Application of Funds) has reduced as
compared to the last balance sheet figure. What does it signify?
Ans. The company has written off a portion of Miscellaneous Expenditure during the
current year.

7. How is fixed asset presented in the balance sheet?

Ans. All items of fixed assets are included under the head “Gross Block”. Fixed assets
are carried at cost or revalued amount. Depreciation on fixed assets are deducted on
cumulative basis. The cumulative depreciation id termed as “Accumulated depreciation” .
“Gross Block” less “ Accumulative Depreciation” is termed as “ Net Block”.

8.Distinguished between tangible and intangible asset?

Ans. Tangible assets have physical characteristics ; examples are land, building , plant
and machinery , etc. Intangibles are non- monetary asset which do not have physical
substance. Examples are patents, trade marks, etc.

9.While studying the balance sheet of a company it appears that there is balance of
investments forming part of Application of Funds. What does it signify?

Ans. It signifies that the company has invested money outside the business. This may
signify short term parking of fund or long term strategic investments.

10.A company earned a PAT of Rs. 10 million . As per last balance sheet its balance of
profit and loss account is Rs. 2 million. Its equity share capital balance is Rs. 40 million.
The company proposes 20% dividend . How such information be presented in the
Appropriation part of the profit and loss account and in the balance sheet. The company
has to transfer minimum amount to reserve.

Ans.

11. Present the following information in a balance sheet as at 31.12.2002( figures are in
Rs. million):
 Share Capital 100 , Reserve ( 1.1.2002) 500 , Profit and Loss Account balance
(1.1.2002) 20 , PAT 70 , Proposed dividend 50% , Distribution tax 10% , Loans from
banks against security of fixed assets 400 , Loans from a Finance Company without any
security 300 , Loans to employees 20 , Investments in Group companies 100 , Gross
Block 2000 , Accumulated depreciation 500 , Fixed assets under construction 200 ,
unfinished goods 30 , Stock of raw material 100 , Stock of finished goods 50 , Sundry
Debtors 35 , Cash and bank balances 20 , Preliminary expenses to the extent not written
off 10 , Sundry creditors 85 , Provision for tax 40. There was no balance of investments
in the last balance sheet and net current assets balance as on 1.1.2002 was Rs. 10 million
only.
                                                       [ Total of sources 1335]

(a) Interpret the balance sheet information in the light of the following broad
management policy :
(1) The broad policy of the management is to maintain 1:1 relationship between
(2) It is better to maintain 1:1 relationship between current assets and current liabilities.

(b) 50% of the loan funds were raised during the latest financial year. How do you
interpret the financing policy of the company?

[ Hints : The company has paid very high dividend and is assumed to retain only
minimum profit. It is making fresh investments in the fixed assets as is evident from
capital work in progress balance . It can be presumed that Rs. 200 million fresh
investments in capital work in progress was financed through new loans.]

(c ) What do you think about the end use of the balance of loan funds since fresh loan
amounted to Rs. 350 million whereas fresh investments in fixed assets was only Rs. 200
million ?

Hints : Perhaps the balance was invested in net current assets and temporary parking through
investments.

12. On the basis of the following Balance Sheet of Ramchand & Sons Ltd. as at
31.12.2002 , do you think that the company has suffered cash loss and its operation is in
danger ?

                                         Rs. in million
 Balance Sheet as at                     31.3.2002 31.3.2001
 Share Capital                                  500      500
 General Reserve                                410      500
 Profit & Loss Account                            0       20
 Shareholders' Funds                            910     1020
 Secured Loans                                  500      500
 Unsecured Loans                                200      500
 Loan Funds                                     700     1000
 Total Sources                                1610      2020
 Gross Block                                  1500      1500
 Less Accumulated depreciation                  850      600
 Net Block                                      650      900
 Investments                                    500      800
 Current Assets, Loans & Advances             1370       900
 Less Current Liabilities &
 Provisions                                   1000           680
 Net Current Assets                            370           220
 Miscellaneous Expenditure nor
 written off                                    90          100
                                              1610         2020
Hints : As the change Reserves and Surplus does not exceed the change in accumulated depreciation , there
is no cash loss. The company has suffered accounting loss . There is fresh investment in fixed assets. The
company sold investments for repayment of loan.

The company has earned cash profit of Rs. 150 which got locked in current asset. Its current liabilities are
also increasing. So the financial position of the company is not in a good shape.

 Depreciation and amortizations                     260
 Negative change in Reserves & Surplus              110
 Cash profit                                        150




13. On the basis of the following Balance Sheet of Ramchand & Sons Ltd. as at
31.12.2002 , do you think that the company has adopted a proper financing policy ?

                                                Rs. in million
 Balance Sheet as at                            31.3.2002 31.3.2001
 Share Capital                                         500      500
 General Reserve                                       800      500
 Profit & Loss Account                                  30       20
 Shareholders' Funds                                 1330      1020
 Secured Loans                                         100      500
 Unsecured Loans                                       200      500
 Loan Funds                                            300     1000
 Total Sources                                       1630      2020
 Gross Block                                         1500      1500
 Less Accumulated depreciation                         850      600
 Net Block                                             650      900
 Investments                                           200      800
 Current Assets, Loans & Advances                    1370       900
 Less Current Liabilities &
 Provisions                                            680            680
 Net Current Assets                                    690            220
 Miscellaneous Expenditure nor
 written off                                            90            100
                                                      1630           2020

Hints :
The company has utilized the profit to repay loans. A good portion of its profit got blocked in the current
assets. It has even disposed off investments and utilized the sale proceeds for financing current assets/ debt
repayment. As a result of this there is a disproportionate rise in the proportion of shareholders’ funds . It
seems that the company does not have good projects to invest. However, it could have tried to reduce to
share capital through buy back of shares.

14. On the basis of the following Balance Sheet of Ashokchand & Sons Ltd. as at
31.12.2002 , interpret the growth strategy of the company ?
                                               Rs. in million
 Balance Sheet as at                           31.3.2002 31.3.2001
 Share Capital                                        500      500
 General Reserve                                      600      500
 Profit & Loss Account                                 30       20
 Shareholders' Funds                                1130      1020
 Secured Loans                                        500      500
 Unsecured Loans                                      500      500
 Loan Funds                                         1000      1000
 Total Sources                                      2130      2020
 Gross Block                                        2400      1500
 Less Accumulated depreciation                        850      600
 Net Block                                          1550       900
 Investments                                          200      800
 Current Assets, Loans & Advances                     970      900
 Less Current Liabilities &
 Provisions                                           680            680
 Net Current Assets                                   290            220
 Miscellaneous Expenditure nor
 written off                                           90           100
 Total Applications                                  2130          2020

Hints:
The company has earned a cash profit of Rs. 370 million and realized Rs. 600 million from sale of
investments. This amount has been invested in mostly in fixed assets and a minor portion has been invested
current assets. The assets growth has no corresponding growth in loan funds signifying slight
overdependence on the shareholders’ funds. Fixed asset utilization per rupee of current assets has been
reduced signifying tight planning of current assets. However, increase in current assets is not supported by
increase in current liabilities signifying more investments of owned funds in current assets. As whole there
is a inclination towards financing growth utilizing shareholders’ funds and lesser dependence on loan
funds. In case of cheap cost of loan funds, this may not prove to be a sound policy. Read Chapter Twelve to
understand value addition.

15.Comment on the following common size balance sheets of Apollo Tyres Ltd.

 Apollo Tyres Ltd.                 200203 200103             200003 199903           199803      199703
 SOURCES OF FUNDS
 :
 Share Capital                         6.18       4.63          4.92        5.43         5.3        5.54
 Reserves & Surplus                   48.08      47.32         49.69        46.3       42.73       39.76
 Total Shareholders Funds             54.26      51.95         54.61       51.72       48.03        45.3

 Secured Loans                        32.07      27.35         34.29       42.23       44.56       49.48
 Unsecured Loans                      13.67       20.7          11.1        6.04        7.41        5.22
 Total Loan Funds                     45.74      48.05         45.39       48.28       51.97        54.7
Total Funds Employed            100      100        100       100      100       100
APPLICATION OF
FUNDS :
Gross Block                   113.6    82.67      81.28     81.66    80.18      83.59
Less : Accumulated
Depreciation                  43.49     28.8      26.93     28.41    26.59      27.35
Net Block                     70.11    53.87      54.35     53.25    53.59      56.23
Capital Work in Progress        1.6     0.96       2.14      5.54     0.82       1.26
Total Fixed Assets            71.71    54.83      56.49     58.78    54.42      57.49
Investments                    9.52      8.2      10.47      4.53     4.86       5.12

Inventories                   24.18    27.12      25.05     25.25     17.2      24.02
Sundry Debtors                28.74    22.57      18.76     21.67    44.58      24.43
Cash and Bank Balance         11.29     7.18       6.07      9.42     6.77       6.41
Loans and Advances            30.32    23.53      23.31      17.7    17.28      19.39
Total Current Assets,
Loans & Advances              94.54     80.4      73.18     74.04    85.84      74.25
Less : Current Liabilities    61.61    34.33      32.75     30.07    38.73      33.43
Provisions                    16.65    10.98       9.31     10.46     9.86       7.79
Total Current Liabilities
& Provisions                  78.27    45.31      42.07     40.53    48.59      41.22
Net Current Assets            16.28    35.09      31.12     33.51    37.25      33.03
Miscellaneous Exp. not
w/off                          2.49     1.88       1.93      3.17     3.48       4.37
Total Assets                    100      100        100       100      100        100

For solution of Assignments 11-14 go to Solution to Assignment_Chapter 3 .xls

								
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