All About ACCOUNTING..!!

ACCOUNTING

1
What is ACCOUNTING…? All About ACCOUNTING..!!

What is accounting?

• The language of business.

• A means to communicate financial information.

• A way to convey information about a business to users.

2
What is Need of ACCOUNTING…? All About ACCOUNTING..!!

Managers, investors, and other internal groups

want the answers to two important questions:

How well did the

organization perform?

Where does the

organization stand?

3
What is Need of ACCOUNTING…? All About ACCOUNTING..!!

Accountants answer these questions

with two major financial statements:

Income Statement

Balance Sheet

4
What is Balance Sheet…? All About ACCOUNTING..!!

Balance Sheet

The balance sheet (also called statement of

financial position or statement of financial
condition) is a snapshot of the financial status
of an organization at a point in time.

5
What is Balance Sheet…? All About ACCOUNTING..!!

Balance Sheet
Assets = Equities
Assets are economic resources that are expected
to benefit future activities of the organization.

Equities are the claims against, or interests in,

the assets of the organization.

6
What is Income Statement…? All About ACCOUNTING..!!

Income Statement

The income statement measures

the performance of an organization
by matching its accomplishments
(revenue from customers, which
is usually called sales) and its
efforts (cost of goods sold and
other expenses).

7
What is Revenue…? All About ACCOUNTING..!!

Revenues
Revenues are increases in ownership
claims arising from the delivery
of goods or services.
Revenues must be earned.
Revenues must be realized.

8
What is Expenses All About ACCOUNTING..!!

Expenses
Expenses are decreases in
ownership claims arising
from delivering goods or
services or using up assets.

9
What is Profit All About ACCOUNTING..!!

Profits
Profits (or earnings or income) are
the excess of revenues over expenses.

10
Who are Users of Accounting…? All About ACCOUNTING..!!

Who users accounting information?

• Owners

• Managers

• Investors (including potential)

• Analysts on their behalf

• Creditors (including potential)

• Government (tax assessment)

• Regulators

• Customers
11
Types of ACCOUNTING…? All About ACCOUNTING..!!

Accounting has two main divisions:

• Financial accounting

Primarily prepared for users external to the company.

Revenues, earnings, assets, etc.

• Management accounting

Primarily for internal purposes

Costing, budgeting, net present value, etc.

12
What is MANAGEMENT ACCOUNTING…? All About ACCOUNTING..!!

Management Accounting is comprised of two words “

Management” and “Accounting”.

It is the study of managerial aspects of accounting.

The emphasis of management accounting is to redesign

accounting in such a way that it is helpful to the
management in formulation of policy, control of execution
and appreciation of effectiveness.

Management accounting is a system that helps management

in carrying out their functions more efficiently.

13
 All About ACCOUNTING..!!

GAAP

14
What is GAAP…? All About ACCOUNTING..!!

General Accepted Accounting Principle is a technical term that

encompasses the conventions, rules and procedures necessary to
define accepted accounting practices at a particular time.

GAAP are common set of accounting principles, standards and procedures

that companies use while preparing their financial statement.

Accounting Principle can be classified into two categories:

1. Accounting Concepts

2. Accounting Conventions

15
What is Accounting Conventions…? All About ACCOUNTING..!!

Accounting Concepts may be considered as traditions which guide the

accountants while preparing the accounting statements

Accounting Conventions:-

1. Consistency

2. Full Disclosure

3. Conservation

4. Materiality

16
What is Accounting Concept…? All About ACCOUNTING..!!

Accounting Concepts may be considered basic assumptions or conditions

upon which the science of accounting is based.

Accounting Concepts:-

1. Separate Legal Entity 9.Realisation Concept.

2. Money Measurement

3. Going Concern

4. Cost Concept

5. Accounting Period

6. Dual Aspect

7. Matching Concept

8. Accrual concept
17
 All About ACCOUNTING..!!

Inventory
Valuation

18
What is Inventory …? All About ACCOUNTING..!!

Inventory is stock of goods, its includes raw material, work in

progress, consumables, finished goods, spares.

The investment in inventory is very high in a undertaking. About

90% of the working capital is invested in inventory. Therefore
a proper planning is required for purchase, issue & vendor
selection.

The purpose of inventory management is that neither there should

be over-stocking nor there should be under-stocking of
inventory.

Overstocking=Reduction in liquidity

Under stocking = Stoppage in production cycle.

19
Inventory All About ACCOUNTING..!!

20
Example of Inventory Valuating All About ACCOUNTING..!!

• Mueller Hardware has a storage barrel full of nails.

• The barrel was restocked three times with 100 pounds

of nails being added at each restocking.

• The first batch cost Mueller 100/-, the second batch

cost Mueller 110/-, and the third batch cost Mueller
120/-.

• The barrel was never allowed to empty completely and

customers have picked all around in the barrel as they
bought nails from Mueller

• At the end of the accounting period, Mueller weighs

the barrel and decides that 140 pounds of nails are on
hand
21
Example of Inventory Valuating All About ACCOUNTING..!!

The methods from which to choose are varied, generally

consisting of one of the following:

• First-in, first-out (FIFO)

• Last-in, first-out (LIFO)

• Weighted-average

22
FIFO All About ACCOUNTING..!!

CALCULATIONS: With first-in, first-out, the oldest cost is matched

against revenue and assigned to cost of goods sold.
Conversely, the most recent purchases are assigned to units
in ending inventory. For Mueller's nails the FIFO calculations
would look like this:

23
LIFO All About ACCOUNTING..!!

CALCULATIONS: Last-in, first-out is just the reverse of FIFO;

recent costs are assigned to goods sold while the oldest costs
remain in inventory:

24
Average Cost All About ACCOUNTING..!!

CALCULATIONS: The weighted-average method relies on average

unit cost to calculate cost of units sold and ending inventory

25
What is Inventory Valuation All About ACCOUNTING..!!

Valuation of inventory bears direct relation on the determination

of income of the company.

If all the material are purchased at same rate there will be no

problem in valuation of inventory. But because of different
market condition the valuation of inventory can be done in
different ways.

There are many methods of valuing inventory, the most important

being;

1. FIFO

2. LIFO

3. AVERAGE COST
26
What is FIFO…? All About ACCOUNTING..!!

First In First Out

• This method assumes that oldest material is issued first and at

its original rate at which it is received.

• Ie. Unit cost are apportioned to cost of production according to

their chronological order.

• This method is beneficial in case of falling price

27
Advantages of FIFO…? All About ACCOUNTING..!!

First In First Out- Advantages

1. Rational

2. Material cost correctly ascertained

3. Useful when price are falling

4. Simple to understand

5. Closing stock value in balance sheet is more realistic

28
Disadvantages of FIFO…? All About ACCOUNTING..!!

First In First Out- Disadvantages

1. Possibility of more clerical error

2. Sometimes more than one price has to be use to value one

issue

3. In case of frequent price fluctuation the pricing becomes

different

29
What is LIFO…? All About ACCOUNTING..!!

Last In First Out

• In this method issue is done in the reverse order of purchase.

• Material received last in the stores is issued first

• More appropriate in rising price

• Also known as replacement cost method

30
What is LIFO…? All About ACCOUNTING..!!

Last In First Out (Advantage)

• No profit No loss as material are issued at cost price

• Production Cost represents recent cost

• Suitable in rising price

31
What is LIFO…? All About ACCOUNTING..!!

Last In First Out (Disadvantage)

• May result in clerical error as every time issue is made price

may be revised

• Comparison between different jobs is difficult

• The stock in hand is valued at price which is not current

market price

• More than one price can be used for valuing issue of material
of single requisitions.

32
Example All About ACCOUNTING..!!

Discuss the effect of adopting LIFO and FIFO on profit with the
help of following figures

Jan-1 Opening Balance-10 units @ 30/-

Jan 10 Purchased 10 unit @ 33/-

Jan 12 Issued 10

Jan 31 Closing Balance-10 unit

Feb-3 Purchase-10 unit @36/-

Feb-12 Issued-10 units

Feb-28 Purchased-10 units @ 40/-

33
Average Method All About ACCOUNTING..!!

The principle on which average method is based is that

all of the material in the stores is mixed up and
cannot be issued from any particular lot

Types of Average Stock Method

1. Simple Average method

2. Weighted average method

34
Simple Average Method All About ACCOUNTING..!!

Simple Average method

Price is calculated by dividing total of the prices of

material in the stock with the number of prices used
in the total

Eg 1000units purchased @ 10/-

2000units purchased @ 11/-

3000units purchased @ 12/-

Then the issue price of next issue will be

10+11+12/3 = 11 35
Weighted Average Method All About ACCOUNTING..!!

Weighted Average method

Price is calculated by dividing total cost of material in

the stock with the total quantity of material

Eg 1000units purchased @ 10/-

2000units purchased @ 11/-

3000units purchased @ 12/-

Then the issue price of next issue will be

(1000*10)+(2000*11)+(3000*12)/(1000+2000+3000)
= 11.33/-
36
 All About ACCOUNTING..!!

Inventory
Management

37
What is Inventory Management…? All About ACCOUNTING..!!

Inventory Management:-

The investment in inventory in most of the manufacturing,

wholesale, retail trade is very high. In industries like sugar, the
raw material cost is as high as 68.75% and in steel industry
also it count to about 65.33%. About 90% of working capital is
invested in inventory management.

Inventory Management will determine

• What to purchase

• How much to purchase

• From where to purchase

• When to purchase
38
Objective of Inventory Management…? All About ACCOUNTING..!!

Objectives of Inventory Management:-

1. To ensure continuous supply of materials, spares & finished goods so

that production should not suffer at any time & customer demand
should also be met.

2. To avoid over-stocking & under-stocking of inventory.

3. To maintain investment in inventory at optimum level

4. To maintain material cost at minimum, so that cost of production is

minimum.

5. To eliminate duplication in ordering or replenishing stock.

6. To minimize losses due to wastage & damage.

7. To ensure perpetual inventory control

8. To facilitate furnishing of data for short-term & long-term planning &

39
Tools of Inventory Management…? All About ACCOUNTING..!!

Tools of Inventory Management:-

1. Determination of stock level.

2. Determination of safety stock.

3. Determination of EOQ.

4. A.B.C Analysis.

5. Preparation of inventory report

6. Perpetual Inventory system

7. JIT Control System

40
Determination of Inventory level…? All About ACCOUNTING..!!

Determination of Inventory level:-

An efficient inventory management requires that a firm should maintain

an optimum level of inventory where inventory cost is minimum, at
the same time there should be no stock out. Various stock level are
fixed for this.

(a) Minimum Level :- This represent the quantity which must be

maintained in hand at all times. Minimum level depends on:-

• Lead time

• Rate of consumption]

• Nature of material

MINIMUM STOCK LEVEL=REORDER LEVEL-(NORMAL

CONSUMPTION *NORMAL REORDER LEVEL)

41
Determination of Inventory level…? All About ACCOUNTING..!!

Re-order level -When the quantity of the material reaches a

certain figure then fresh order is sent to get the material
again. The order is sent before the material reaches the
minimum level. Reorder level is fixed between minimum &
maximum level. It depends on following factors :-

• Rate of consumption

• Lead time

• Maximum quantity of material required in a day.

• Nature of material

RE-ORDER LEVEL= (MAXIMUM CONSUMPTION * MAXIMUM

REORDER PERIOD)

42
Determination of Inventory level…? All About ACCOUNTING..!!

Maximum level –It is that quantity of the material beyond which

a firm should not exceed its stock. If stock reaches beyond this
level it is over stocking. Maximum level depends on following
factors :-

• Rate of consumption

• Lead time

• Maximum quantity of material required in a day.

• Nature of material

• Availability of capital for purchase of material.

• Availability of space for storing the material

• Cost of maintaining the stores.

43
Determination of Inventory level…? All About ACCOUNTING..!!

• Availability of material at any point of time.

• Restrictions imposed by the government.

• This possibility of change in fashions will also affect the maximum

level.

MAXIMUM STOCK LEVEL = RE-ORDER LEVEL + RE-ORDER

QUANTITY – (MINIMUM CONSUPTION * MINIMUM RE-
ORDERING PERIOD)

Average stock level- The average stock level is average of minimum

stock & maximum stock.

Danger level-It is that level beyond which the material should not fall in
any case.

DANGER LEVEL= (AVERAGE CONSUMPTION * MAXIMUM RE-ORDER

PERIOD FOR EMERGENCY PURCHASE)
44
Determination of Safety Stock…? All About ACCOUNTING..!!

Safety Stock– Safety stock is a buffer to meet some

unanticipated increase in usage. The usage of inventory
cannot be perfectly forecasted. It fluctuates over a period of
time. The demand for material may fluctuate & delivery of
inventory may also be delayed & in such a situation the
firm can face a problem of stock-out. The stock out can
prove costly by effecting in smooth working of concern.

In order to protect against this situation firm usually maintains

some stock this stock is known as safety stock.

45
Inventory Order Cycle All About ACCOUNTING..!!

Order quantity, Q
Demand
rate
Inventory Level

Reorder point, R

0 Time
Lead Lead
time time
Order Order Order Order
placed receipt placed receipt

46
Determination levels…? All About ACCOUNTING..!!

From the following information, calculate minimum

stock level, maximum stock level and reorder
level :-

• Max Consumption-200 units per day

• Min Consumption-150 units per day

• Normal Consumption-160 units per day

• Re-order period-10-15 days

• Re-order quantity-1600 units

• Normal re-order period-12 days

47
Determination of EOQ…? All About ACCOUNTING..!!

Economic order quantity– is the level of inventory that

minimizes the total inventory holding costs and ordering
costs. The framework used to determine this order quantity
is also known as Wilson EOQ Model. The model was
developed by F. W. Harris in 1913. But still R. H. Wilson is
given credit for his early in-depth analysis of the model.

Ordering cost are the cost which is associated with the

purchasing or ordering of material. E.g. Cost of staff posted
for ordering of goods, transportation expenses, inspection
cost. This cost is also called buying cost. The planning
commission of India has estimated these cost between 10%
to 20%.

Carrying cost are the cost of holding the inventory. E.g. Cost
48
of capital invested, storage cost, insurance cost, loss if
Determination of EOQ…? All About ACCOUNTING..!!

Underlying assumptions

(a) The ordering cost is constant.

(b) The rate of demand is constant

(c) The lead time is fixed

(d) The purchase price of the item is constant i.e. no discount is

available

EOQ is the level of the inventory where ordering cost and

carrying cost remains equal.

49
EOQ Cost Model All About ACCOUNTING..!!

Annual
cost ($) Total Cost
Slope = 0
CcQ
Carrying Cost =
Minimum 2
total cost

CoD
Ordering Cost =
Q

Optimal order Order Quantity, Q

Qopt

50
Determination of Total Cost…? All About ACCOUNTING..!!

cost function: EOQ is the level of the inventory where ordering cost
and carrying cost remains equal.

Total Cost = purchase cost + ordering cost + holding cost

Purchase cost=(purchase unit price × annual demand quantity.)

Purchase cost =(P×D)

Ordering cost: This is the cost of placing orders: each order has a fixed
cost C, and we need to order D/Q times per year.

Ordering cost=C × D/Q

Holding cost: the average quantity in stock (between fully replenished

and empty) is Q/2,

Holding cost = H × Q/2

51
Determine EOQ All About ACCOUNTING..!!

Find out EOQ from following information

Annual usage-6000units

Cost of material per unit-20/-

Cost of receiving and placing order-60/-

Annual carrying cost of one unit- 10% of inventory

value

52
EOQ Analysis… All About ACCOUNTING..!!

A manufacturing company uses 6400unit of

material per year. The unit cost is 6/-, and the
carrying cost is 25% of unit cost. If the cost of
procurement is 75/- determine

1. EOQ

2. Number of order per annum

3. Time period between two consecutive order.

53
EOQ Analysis… All About ACCOUNTING..!!

X ltd produces a product which has a monthly

demand of 4000 units. The product requires a
component X which is purchased at 20/-.For every
finished product, one unit of the component is
required. The ordering cost is 120/- per order and
the holding cost is 10%p.a

You are required to calculate

1. EOQ

2. If the minimum lot size to be supplied is 4000unit,

what is extra cost, the company has to incur
54
EOQ Analysis (Decision making)… All About ACCOUNTING..!!

An Enterprise requires 90000 units of a component

in a year. The cost per unit is 3/-.Ordering cost id
6/- per unit

1. What is EOQ

2. What should the firm do if the supplier offers

discount as below

At 4500 units – Discount offered is 2%

At 6000 units – Discount offered is 3 %

55
ABC Analysis… All About ACCOUNTING..!!

Usually a firm has to maintain several types of inventories. It is

not desirable to keep the same degree of control on all the
items. The firm should pay maximum attention to those
items whose value is the highest. The firm should,
therefore, classify inventories to identify which items should
receive the most effort in controlling. The firm should be
selective in its approach to control investment in various
types of inventories. This analytical approach is called the
ABC analysis and tends to measure the significance of each
item of inventories in terms of its value.

56
ABC Analysis… All About ACCOUNTING..!!

ABC analysis helps to concentrate more effort on category A

since greatest monetary advantage will come by controlling
these items.

The control on C category items are kept under minimum

control.

The control on B category items are moderate.

Like ABC control VED analysis is also used in few industries for
controlling inventory

V – Vital – without which production will stop.

E – Essential – Which is essential for production.

D – Desirable – Without which there will be no effect on

production but is desirable
57 for production.
Perpetual Inventory System… All About ACCOUNTING..!!

Perpetual Inventory System may be defined as a system of records

maintained by the controlling department, which reflects the
physical movement of stock & their current balance.

Procedure of Perpetual Inventory System

1. The up to date position in stores ledger and bin cards should be

made to know the current balances of the stores.

2. The stores are selected in rotation for checking the items

physically.

3. The stores which are not checked are marked.

4. Physical stock checking is done & tallied with the records.

5. Final report is signed by cost accountant.

58
 All About ACCOUNTING..!!

Analysis of
Financial
Statement

59
What is Analysis of Financial Statement…? All About ACCOUNTING..!!

FINANCIAL ANALYSIS is the process of critically examining in detail

accounting information given in the financial statement.

FINANCIAL ANALYSIS is largely a study of relationship among the

various financial factor in a business as disclosed by a single set of
statement and a study of trend of these factors.

FINANCIAL INTERPRETATION is closely related to financial analysis.

Interpretation is thus drawing of inference & stating what the figures in
the financial statement really mean.

The analysis & interpretation of financial statement is to determine the

significance & meaning of the financial statement data.

60
Objective of Financial All About ACCOUNTING..!!
Analysis….!

(1)To assess the present & future earning capacity or profitability of the
concern
(2)To assess the operating efficiency of the concern as a whole & various
departments.
(3)To assess the short term & long term solvency of the concern.
(4) To have a comparative study in regard to one firm with another or one
department with another.
(5) For forecasting & preparation of budget.
(6)To assess the stability of the firm
(7) For decision making.

61
What is Ratio Analysis …? All About ACCOUNTING..!!

RATIO is the arithmetical expression of the relationship of one

number to another. It may be defined as the indicated quotient of
two mathematical expression.

FINANCIAL RATIO is the relationship between two accounting

figures expressed mathematically.

FINANCIAL RATIO ANALYSIS is a technique of analysis &

interpretation of the financial figures in the financial statement. It
is the process of establishing & interpretation various ratios for
decision making.

62
What is Ratio Analysis …? All About ACCOUNTING..!!

A single ratio in itself does not convey much of sense. To make ratio
useful it has to be further interpreted. The interpretation of ratio can
be made in following ways:

• Single absolute ratio

• Group ratio

• Historical Comparison

• Inter-firm Comparison

63
3. Classification of Ratios…!! All About ACCOUNTING..!!

Ratios

Traditional Functional Significance

Balance
P&L A/c Mixed Liquidity Solvency Turnover Profitability Primary Secondary
sheet

64
What is Traditional Classification…? All About ACCOUNTING..!!

Balance sheet Ratio deals with the relationship between two balance
sheet figures. e.g. Current ratio, Liquidity ratio, Debt-equity ratio, Capital
Gearing ratio.

Profit & Loss Account Ratio deals with the relationship between two
profit & loss figures. e.g. Gross Profit Ratio, Operating Ratio, Net Profit
Ratio.

Mixed Ratio exhibit the relationship between the figures of profit & loss
account and balance sheet. E.g. Stock turnover ratio, Debtors Turnover
ratio, Creditor Turnover ratio.

65
What is Functional Classification…? All About ACCOUNTING..!!

Liquidity Ratio deals with the ratios which measures the short-term
solvency or financial position of a firm. This ratio are calculated upon the
short-term paying capacity of a concern. E.g. Current ratio, Liquid ratio,
Absolute liquid ratio.

Solvency or Leverage Ratio Long-term solvency ratio conveys a firms

ability to meet the interest cost & repayment schedules of its long-term
obligations .e. g. Debt-Equity Ratio, Coverage Ratio, Capital Gearing ratio,
Proprietary Ratio.

Activity or Turnover Ratio are calculated to measure the efficiency

with which the resources of a firm are employed. They indicate the speed
with which assets are being converted into sales. E.g. Stock turnover
ratio, Debtors turnover ratio, Creditor turnover ratio.

Profitability Ratio measures the result of the business operations or

overall performance & effectiveness of the firm. E.g. Gross profit ratio,
66
What is Significance Classification…? All About ACCOUNTING..!!

Primary Ratio deals with the ratios which are of prime importance to a
concern. E.g. Return on capital.

Secondary Ratio are ratio which support the primary ratio. E.g. the
relationship of operating profit to sales or the relationship of sales to total
assets of the firm.

67
 All About ACCOUNTING..!!

Liquidity Ratio

68
What is Liquidity ratio…? All About ACCOUNTING..!!

Liquidity Ratio deals with the ratios which test the ability of a concern
to meet its current obligation as & when due.

The short term obligation are met by realizing amounts from current,
floating or circulating assets. To measure liquidity following ratios
should be calculated:-

1. Current Ratio

2. Liquid Ratio

3. Absolute Liquid Ratio

69
What is Current ratio…? All About ACCOUNTING..!!

Current Ratio may be defined as the relationship between current

assets & current liability. This ratio is also known as working capital
ratio.

Current ratio is current assets to current liability

Interpretation of current ratio:

A relatively high current ratio indicate that the firm is liquid & has ability
to pay its current liability. Where as a relatively low current ratio
indicate that the firm is not liquid. A ratio of 2:1 is referred as s
banker’s rule of thumb or a standard for the current ratio.

70
Calculate Current ratio…? All About ACCOUNTING..!!

Stock-60000/- Debtors-70000/-

Cash-20000/- Bills Receivables-30000/-

Prepaid Expenses-10000/- Land & Building-100,000/-

Goodwill-50000/- Creditors-20000/-

Bills Payable-15000/- Tax Payable-18000/-

Outstanding Expenses- 7000/- Bank Overdraft-25000/-

Debenture-75000/-

71
What is Liquidity ratio…? All About ACCOUNTING..!!

Liquidity Ratio is a more rigorous test of liquidity than the current ratio.
Current assets include inventory & prepaid expenses which are not
easily convertible into cash within a short period.

Quick ratio is Liquid assets to Current liability

Interpretation of Quick ratio:

A relatively high liquid ratio indicate that the firm is liquid & has ability to
pay its current liability. Where as a relatively low liquid ratio indicate
that the firm is not liquid. A ratio of 1:1 is referred a standard for the
liquid ratio.

72
What is Absolute Liquidity ratio…? All About ACCOUNTING..!!

Absolute Liquidity Ratio is the most rigorous test of liquidity.

Quick ratio is Absolute liquid assets to Current liability

Interpretation of Quick ratio:

A relatively high ratio indicate that the firm is liquid & has ability to pay
its current liability. Where as a relatively low ratio indicate that the
firm is not liquid. A ratio of .50:1 is referred a standard for the
absolute liquid ratio.

73
 All About ACCOUNTING..!!

Solvency Ratio

74
What is Solvency Ratio…? All About ACCOUNTING..!!

Solvency Ratio may be defined as the ratio which test the ability of
concern to meet long-term obligation.

The following ratio serve the purpose of determining the solvency

of the concern:

1. Debt-Equity

2. Fixed Asset to Net worth

3. Capital Gearing Ratio

75
What is Debt-Equity Ratio…? All About ACCOUNTING..!!

Debt-Equity Ratio , also known as External-Internal Ratio is calculated

to measure the relative claims of the outsider

Debt-Equity Ratio is Outsiders Fund to Shareholder Fund

Outsiders Fund is external equity & includes all debt & liability to the
outsiders, whether long term or short term. E.g. Debenture, Bank
loan, Mortgages or other current liability.

Shareholder’s Fund consist of equity share capital , Preference share

capital, Capital reserve, Revenue reserve and reserves representing
accumulated profit & surplus like reserves for contingencies, sinking
fund etc.

IF CURRENT LIABILITY IS NOT INCLUDED IN DEBT-EQUITY, THE RATIO IS

NAMED AS LONG-TERM DEBT TO SHAREHOLDER’S FUND.

76
What is Debt-Equity Ratio…? All About ACCOUNTING..!!

Interpretation of Debt-Equity Ratio

The debt-Equity ratio is calculated to measure the extent to which debt

financing has been used in the business. The ratio indicate the
proportionate claims of owner & the outsider against the firm’s
assets.

A ratio of 1:1 is considered as a satisfactory ratio although there cannot

be any rule of thumb

A low ratio is considered as favorable from the long-term creditors point

of view because a high proportion of owner’s fund provide more
margin. A high ratio provide a less margin of safety for them at the
time of liquidation.

77
What is Debt-Equity Ratio…? All About ACCOUNTING..!!

The following figure relate to the liability side of a company:

50000, Equity share of 10/-each, fully paid-500000/-

20000, 9% Preference Shares of 10/- each, fully paid-200000/-

General Reserve-50000/-

Share Premium-25000/-

Profit & Loss A/c-125000/-

7% Debenture-140000/-

Montage Loan-60000/-

Creditor-129000/-

Bills Payable-74500/-

Find Debt-Equity & Comment on this ratio

78
What is Fixed Asset to Net Worth Ratio…? All About ACCOUNTING..!!

Fixed Asset to Net Worth Ratio, is calculated to measure the

relationship between Fixed assets of the company & shareholder’s
Fund.

Fixed Asset to Net Worth Ratio is Fixed Assets (After

Depreciation) to Shareholder’s Fund.

Shareholder's fund is same as net worth.

INTERPRETATION OF THE RATIO:

This ratio indicates the extent to which shareholder’s fund are sunk into
Fixed asset. Generally the fund for fixed assets should be financed
from shareholder’s fund.

If the ratio is less than 100% that implies that the owner has put part of
his fund in working capital & if the ratio is more than 100% it implies
that owner has not got sufficient fund to finance fixed asset.
79
What is Capital Gearing Ratio…? All About ACCOUNTING..!!

Capital Gearing Ratio, establishes the relationship between fixed

interest bearing security & Shareholder’s fund.

Capital Gearing Ratio is Fixed Interest Bearing Security to

Shareholder’s Fund.

INTERPRETATION OF THE RATIO:

A Company is said to be highly geared if the major shares of the total

capital is in the form of fixed interest bearing securities or if this ratio
is more than 1.

If this ratio is less than 1, it is said to be low geared.

If it is exactly 1, it is said to be evenly geared.

80
 All About ACCOUNTING..!!

Profitability
Ratio

81
What is Profitability Ratio…? All About ACCOUNTING..!!

Profitability Ratio may be defined as the ratio which test the profit
making capacity of the company and indicates overall performance of
the company

The following ratio serve the purpose of determining the

profitability of the concern

• Net Profit Ratio

• Gross Profit Ratio

• Return on Capital Employed

• Return on Fixed Assets

• Earning Per Share

• Price Earning Ratio

82
What is G.P & N.P Ratio…? All About ACCOUNTING..!!

Gross-Profit Ratio measures the relationship of gross profit to net

sales. The ratio should be expressed in percentage.

Interpretation of G.P ratio This ratio indicates the extent to which

selling price of goods per unit may decline without resulting in losses
on operations of a firm. It reflects the efficiency with which a firm
produces its products.

Net-Profit Ratio measures the relationship of net profit to net sales. The

ratio should be expressed in percentage.

Interpretation of N.P ratio This ratio indicates the firm’s capacity to

face adverse economic conditions such as price competition ,low
demand etc. Higher the ratio better the profitability.

83
What is Operating Ratio…? All About ACCOUNTING..!!

Operating Ratio measures the relationship between cost of goods sold

and other operating expenses on the one hand and sales on the
other. In other words, it measures the cost of operations per rupee of
sales. The ratio should be expressed in percentage.

OPERATING RATIO IS OPERATING COST DIVIDED BY NET SALES

OPERATING COST IS COST OF GOODS SOLD PLUS OPERATING

EXPENSES.

Operating expense consist of:-

1. Administrative & office expenses.

2. Selling & Distribution expense

Operating ratio indicate the percentage of net sales that is consumed by

operating cost. Higher the ratio less favorable it is for the company.
84
What is Return on capital…? All About ACCOUNTING..!!

Return on Capital also known ROI is the relationship between net

profit before tax and the proprietors fund. The ratio should be
expressed in percentage.

INTERPRETATION OF THE RATIO:

This ratio is one of the most important ratios used for measuring the
overall efficiency of a firm. This ratio indicates how well the resources
of a firm are used, higher the ratio better it is for the firm. This ratio
should be used for trend analysis & inter-firm comparison.

85
What is Return on Equity capital…? All About ACCOUNTING..!!

Return on equity Capital :Equity shareholders are the real owner of

the company. The rate of dividend varies with the availability of profit.
Therefore return on capital employed is the relationship between
profit of the company available to equity shareholders and equity
share capital.

This ratio is more meaningful to the equity shareholders who are

interested to know the profit earned by the company

Higher the ratio better it is for the company.

86
 All About ACCOUNTING..!!

Turnover Ratio

87
What is Turnover Ratio…? All About ACCOUNTING..!!

Turnover Ratio may be defined as the ratio which measures the

efficiency or effectiveness with which a firm manager its resources &
assets. This ratio is also known as activity ratio.

The following ratio serve the purpose of determining the activity

level of the concern

1. Inventory Turnover ratio

2. Debtor Turnover ratio

3. Creditor Turnover ratio

4. Fixed Asset Turnover ratio

88
What is Stock Turnover Ratio…? All About ACCOUNTING..!!

Stock Turnover Ratio also known as stock velocity. It would indicate

whether inventory has been efficiently used or not.

Inventory turnover ratio indicates the number of times the stock has
turned over during a period of time & evaluate the efficiency with
which the firm is able to manage the inventory.

INVENTORY TURNOVER RATIO IS COST OF GOODS SOLD TO

AVERAGE INVENTORY

Inventory turnover ratio measures the velocity of conversion of stock into

sales.

Higher ratio indicates efficient management, as it indicates stock is

converted into sales in less time & hence less capital is blocked in
inventory.

Low ratio indicates high investment in inventory. Accumulated , obsolete

89
What is Debtor Turnover Ratio…? All About ACCOUNTING..!!

Debtor Turnover Ratio indicates the velocity of debt collection by a

firm. Also it indicates the number of times debtors are turned over
during a year.

Debtor turnover ratio is Credit Sales to Average Debtor.

Trade Debtor is Sundry Debtors & Bills Receivable.

Debtor velocity indicates the number of times the debtors are turned over
during a year.

Higher the value of debtor turnover the more efficient is the management
of debtors. But a very high ratio ratio indicates inability of firm to sell.

Average collection period represent the number of days for which a firm
has to wait before receivables are converted into cash.

90
What is Creditor Turnover Ratio…? All About ACCOUNTING..!!

Creditor Turnover Ratio indicates the velocity of debt payment by a

firm. Also it indicates the number of times Creditors are turned over
during a year.

Creditor turnover ratio is Credit Purchase to Average Creditor.

Trade Creditor is Sundry Creditors & Bills Payable.

Creditor velocity indicates the number of times the creditor are turned
over during a year.

91
Reverse Journey to balance sheet All About ACCOUNTING..!!

From the following information, Draw up the balance sheet

Current Ratio=2.5

Liquid ratio=1.5

Net working capital=300,000/-

Stock turnover ratio (Cost of sales/closing stock) =6 times

Gross profit ratio=20%

Fixed asset ratio=2 times

Average debt collection period=2 month

Fixed assets : Shareholders Net worth=1:1

Reserve: Share Capital= 0.5 : 1

92
 All About ACCOUNTING..!!

Accounting for
Transportation
undertaking

93
 All About ACCOUNTING..!!

Transportation companies may be divided into

(a) Railway

(b) Roadways

(c) Shipping

(d) Airways

Transportation companies carry goods & passengers for one place to

another against some fare which they collect either at the point of
boarding or on the way or at the point of unloading or destination

94
Railway Transportation ? All About ACCOUNTING..!!

The station master or the booking clerk of each station prepares a

statement showing the total number of tickets sold to different station
which must agree with the opening & closing balances of tickets.

A summary is made at the end of each week with the total amount of
sales so realized which will be forwarded to the cashier of the
respective division.

Total collection are added up to find out total of each division & zone.

The divisional cashier deposits the total collection into bank

For Income from other sources like advertisement a separate account is

prepared

95
Railway Transportation ? All About ACCOUNTING..!!

For purchase & issue of coal, petrol, diesel etc separate account is
prepared.

At the same time account for wages & salary, lubricants, engineering
goods, tyres etc separate account is prepared.

At the end of the year, after making distinction between revenue &
capital expenditure, Final account is prepared.

Capital and Revenue Accounts.- The accounts of a railway presented

in such a form as to facilitate a review of the finances of the railway
as a commercial undertaking are known as "Capital and Revenue
Accounts". The Capital and Revenue Accounts of a railway are
compiled every year and included in the Annual Report of the railway.
The various processes of accounting followed in Railway Accounts
Offices lead up to these accounts.

96
Railway Transportation ? All About ACCOUNTING..!!

After the books for a financial year have been closed and after the final
accounts current have been submitted, the following accounts and
returns should be compiled

(a) The Capital and Revenue Accounts (Section II of the Annual Report-
Financial Statements).

(b) The Finance Accounts.

(e) The Debt Head Report.

(d) Statement of Voted and Charged Expenditure.

(e) Appropriation Accounts and connected Returns

97
Airways Transportation ? All About ACCOUNTING..!!

After the books for a financial year have been closed and after the final
accounts current have been submitted, the following accounts and
returns should be compiled

(a) The Capital and Revenue Accounts (Section II of the Annual Report-
Financial Statements).

(b) The Finance Accounts.

(e) The Debt Head Report.

(d) Statement of Voted and Charged Expenditure.

(e) Appropriation Accounts and connected Returns

98