Analysis of Financial StatementsClass 12 Accountancy Part 2 NCERT Solutions
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Q1Questions for Practice
List the techniques of Financial Statement Analysis.
Solution
According to Section 4.4 of the chapter, the most commonly used techniques (or tools) of financial analysis are:
- Comparative Statements: Also known as horizontal analysis, these statements compare financial data over different periods.
- Common Size Statements: Also known as vertical analysis, these statements express each item as a percentage of a common base.
- Trend Analysis: This involves studying operational results and financial position over a series of years to identify trends.
- Ratio Analysis: This technique establishes and describes the significant relationships between various items of the financial statements.
- Cash Flow Analysis: This refers to the analysis of the movement of cash into (inflows) and out of (outflows) an organization, summarized in a Cash Flow Statement.
Q2Questions for Practice
Distinguish between Vertical and Horizontal Analysis of financial data.
Solution
The distinction between Vertical and Horizontal Analysis of financial data is as follows:
| Basis | Horizontal Analysis | Vertical Analysis |
|---|---|---|
| Meaning | It is the analysis of financial statements for a number of years. | It is the analysis of financial statements of one accounting period. |
| Methodology | It involves comparing the same item across different time periods (e.g., Sales of 2016 vs. Sales of 2017). | It involves comparing different items within the same accounting period (e.g., Expenses as a percentage of Sales for 2017). |
| Tools Used | The primary tool for horizontal analysis is the Comparative Statement (Comparative Balance Sheet and Comparative Statement of Profit and Loss). | The primary tools for vertical analysis are the Common-Size Statement and Ratio Analysis. |
| Objective | The main objective is to analyze the trend and direction of performance and financial position over time. | The main objective is to analyze the structural relationship of various items within a single financial statement. |
| Alternate Name | It is also known as Dynamic Analysis or Time Series Analysis. | It is also known as Static Analysis or Cross-Sectional Analysis. |
Q3Questions for Practice
State the meaning of Analysis and Interpretation.
Solution
As explained in Section 4.1, 'Analysis' and 'Interpretation' are two complementary parts of financial statement analysis.
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Analysis: The term 'analysis' means the simplification of financial data by methodical classification. It involves breaking down the complex information contained in financial statements into more manageable and understandable parts. This is done by regrouping and establishing relationships between various financial facts and figures.
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Interpretation: The term 'interpretation' means explaining the meaning and significance of the data that has been simplified through analysis. It involves drawing conclusions and making judgments about the firm's profitability, operational efficiency, and financial health based on the analyzed data.
In essence, analysis is useless without interpretation, and interpretation is impossible without analysis. Together, they form a judgmental process to understand past performance and predict future conditions.
Q4Questions for Practice
State the importance of Financial Analysis?
Solution
Financial analysis is of great importance to various users as it helps in identifying the financial strengths and weaknesses of a firm. Its significance, as described in Section 4.2, can be understood from the perspective of different stakeholders:
- For Finance Manager: It helps in making rational decisions related to managerial performance, corporate efficiency, and creditworthiness. It is a vital tool for financial control and corrective action.
- For Top Management: It helps in measuring the success of operations, appraising individual performance, and ensuring that the firm's resources are used efficiently.
- For Trade Payables (Creditors): It helps them assess the firm's liquidity and its ability to meet short-term obligations.
- For Lenders (Long-term Debt providers): It is important for them to analyze the firm's long-term solvency, profitability over time, and ability to pay interest and repay the principal.
- For Investors: It helps them analyze the firm's present and future profitability and earning capacity, which is crucial for making decisions to buy, sell, or hold shares.
- For Labour Unions: They analyze financial statements to assess if the company can afford a wage increase.
- For Others: Economists and researchers use it to study business and economic conditions, while government agencies use it for purposes like taxation, price regulation, and policy-making.
Q5Questions for Practice
What are Comparative Financial Statements?
Solution
Comparative Financial Statements, as explained in Section 4.5, are statements that show the profitability and financial position of a firm for different periods of time in a comparative format. They typically apply to the two main financial statements: the Statement of Profit and Loss and the Balance Sheet.
These statements are prepared by providing columns for the figures of the current year, the previous year, the absolute change (increase or decrease) in figures, and the percentage change. This format allows users to see not only the financial data for different periods but also the extent and direction of changes.
The key purpose of comparative statements is to identify the trends in performance and financial position. This form of analysis is also known as 'horizontal analysis' because it involves comparing figures across two or more time periods.
Q6Questions for Practice
What do you mean by Common Size Statements?
Solution
Common Size Statements, as described in Section 4.6, are financial statements where each item is expressed as a percentage of a common base item. This type of analysis is also known as 'vertical analysis' or 'component percentage statement'.
- In a Common Size Statement of Profit and Loss, each item (like cost of materials, operating expenses, etc.) is shown as a percentage of 'Revenue from Operations', which is taken as the base (100%).
- In a Common Size Balance Sheet, each asset is shown as a percentage of 'Total Assets', and each liability or equity item is shown as a percentage of 'Total Equity and Liabilities'.
The primary utility of common size statements is that they facilitate comparison. They are useful for intra-firm comparison over different years to study structural changes. They are also immensely useful for inter-firm comparison, especially between companies of different sizes, as all figures are brought to a common base of 100.
Q7Questions for Practice
Describe the different techniques of financial analysis and explain the limitations of financial analysis.
Solution
Financial analysis is the process of evaluating the financial information in financial statements to make decisions. The most common techniques and limitations are as follows:
Techniques of Financial Analysis (as per Section 4.4):
- Comparative Statements: These statements present financial data for two or more periods side-by-side to show absolute and percentage changes. It helps in identifying the direction and trend of performance. This is also known as horizontal analysis.
- Common Size Statements: These statements express all items as a percentage of a common base (e.g., Revenue from Operations for the P&L Statement, and Total Assets for the Balance Sheet). This is useful for comparing companies of different sizes and for studying the internal structure of the financial statements. This is also known as vertical analysis.
- Trend Analysis: This technique involves calculating the percentage change of various items for a series of years, with one year selected as the base year. It helps in observing long-term changes and shifts in the business.
- Ratio Analysis: This is a widely used tool that describes the relationship between various items of the financial statements. Ratios help in assessing a firm's profitability, solvency, liquidity, and efficiency.
- Cash Flow Analysis: This involves the preparation and analysis of a Cash Flow Statement, which shows the inflows and outflows of cash from operating, investing, and financing activities. It helps in assessing the cash-generating ability of a firm.
Limitations of Financial Analysis (as per Section 4.7):
Financial analysis is a powerful tool, but it suffers from certain limitations, many of which stem from the limitations of the financial statements themselves.
- Ignores Price Level Changes: Financial statements are prepared at historical cost and do not account for the effects of inflation, which can distort the analysis.
- Affected by Accounting Policies: The analysis can be misleading if the firm changes its accounting procedures (e.g., method of depreciation). Comparability is lost unless such changes are known and adjusted for.
- Based on Historical Data: Financial analysis is a study of past reports. While it provides a basis for future prediction, it is not a guarantee of future performance.
- Ignores Non-Monetary Aspects: The analysis only considers monetary information. Qualitative factors like the quality of management, employee morale, and brand reputation are ignored, even though they are crucial for a firm's success.
- Does Not Reflect Current Position: Since statements are based on accounting concepts and conventions (like the going concern concept), the values of assets may not reflect their current market value.
Q8Questions for Practice
Explain the usefulness of trend percentages in interpretation of financial performance of a company.
Solution
Trend analysis, or the calculation of trend percentages, is a valuable technique for interpreting the financial performance of a company over a series of years. Its usefulness, as mentioned in Section 4.4, lies in providing a long-run view of the business, which can highlight basic changes and significant shifts in its nature and performance.
The key steps involve selecting a base year and expressing the financial data of all subsequent years as a percentage of the base year's data. The usefulness of this process can be explained as follows:
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Identifying Long-Term Trends: By looking at the trend percentages of key items like sales, profits, and expenses over several years, an analyst can determine whether the company is on a path of growth, stagnation, or decline. A consistently rising trend in sales and profits is a positive sign, while a rising trend in expenses relative to sales could indicate declining efficiency.
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Detecting Problems: A change in the direction of a trend can signal a problem. For example, if the trend percentage for inventory is rising much faster than the trend for sales, it may indicate that the company is accumulating unsold stock, which could lead to liquidity issues.
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Evaluating Management Performance: Trend analysis provides a basis for evaluating the performance of management over time. Consistent positive trends may point towards good management, while erratic or declining trends may suggest poor management or unstable business conditions.
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Facilitating Forecasting: By observing the historical trend, an analyst can make more informed predictions about the future. While the past is not a perfect predictor of the future, understanding the trajectory of performance provides a solid foundation for forecasting.
For example, if trend percentages show that sales have increased by 100% over five years while the cost of goods sold has increased by 150%, it clearly indicates that the company's profitability margins are eroding, which is a significant insight for any analyst.
Q9Questions for Practice
What is the importance of comparative statements? Illustrate your answer with particular reference to comparative income statement.
Solution
Comparative statements are a crucial tool of financial analysis because they present financial data from different accounting periods in a side-by-side format, allowing for easy comparison. The primary importance of these statements lies in their ability to show the direction of change, the trend of performance, and the magnitude of change in both absolute and percentage terms. This helps users understand not just where the company stands, but also where it is headed.
This form of horizontal analysis is important for:
- Identifying Trends: It helps in identifying the trend of key performance indicators like revenue, expenses, and profits over time.
- Highlighting Strengths and Weaknesses: A significant increase in sales is a strength, while a disproportionate increase in expenses is a weakness. Comparative statements make these changes easy to spot.
- Facilitating Decision Making: By understanding the trends, management, investors, and creditors can make more informed decisions about the future course of action.
Illustration with a Comparative Income Statement:
A comparative income statement (or Statement of Profit and Loss) is particularly useful for analyzing the operational performance of a company. Let us consider the example of BCR Co. Ltd. from the textbook (Illustration 1).
Comparative Statement of Profit and Loss of BCR Co. Ltd.
(for the year ended March 31, 2016 and 2017)
| Particulars | 2015-16 (Rs.) | 2016-17 (Rs.) | Absolute Change (Rs.) | Percentage Change (%) |
|---|---|---|---|---|
| Revenue from operations | 60,00,000 | 75,00,000 | 15,00,000 | 25.00 |
| Add: Other incomes | 1,50,000 | 1,20,000 | (30,000) | (20.00) |
| Total Revenue | 61,50,000 | 76,20,000 | 14,70,000 | 23.90 |
| Less: Expenses | 44,00,000 | 50,60,000 | 6,60,000 | 15.00 |
| Profit before tax | 17,50,000 | 25,60,000 | 8,10,000 | 46.29 |
| Less: Tax | 6,12,500 | 10,24,000 | 4,11,500 | 67.18 |
| Profit after tax | 11,37,500 | 15,36,000 | 3,98,500 | 35.03 |
From this statement, an analyst can derive important insights:
- Revenue Growth: Revenue from operations grew by a healthy 25%.
- Expense Control: Expenses grew by only 15%, which is slower than the revenue growth. This is a positive sign of operational efficiency.
- Profitability Improvement: Because expenses grew slower than revenue, the Profit Before Tax increased by a significant 46.29%. This shows that the company has improved its profitability margins.
- Area of Concern: Other income has decreased by 20%, which may require further investigation.
Thus, the comparative income statement provides a dynamic view of the company's performance, highlighting both positive and negative trends, which is far more insightful than looking at a single year's statement in isolation.
Q10Questions for Practice
What do you understand by analysis and interpretation of financial statements? Discuss its importance.
Solution
Meaning of Analysis and Interpretation of Financial Statements
As defined in Section 4.1, 'Financial Statement Analysis' is the process of critically evaluating the financial information contained in the financial statements to understand the firm and make decisions about its operations. It involves two distinct but complementary processes:
-
Analysis: This is the process of simplifying the financial data by methodically classifying it. It involves regrouping the information and studying the relationships among various financial facts and figures. For example, calculating the percentage change in sales over two years is analysis.
-
Interpretation: This is the process of explaining the meaning and significance of the analyzed data. It involves drawing conclusions about the operational efficiency, financial health, and future prospects of the firm. For example, concluding that a 20% increase in sales combined with only a 10% increase in costs indicates improved efficiency is interpretation.
Analysis is a prerequisite for interpretation; one cannot exist without the other. Together, they transform raw financial data into meaningful information for decision-making.
Importance of Financial Analysis
The importance of financial analysis lies in its ability to reveal the strengths and weaknesses of a firm, which is crucial for various stakeholders (as detailed in Section 4.2):
- Assessing Profitability and Efficiency: Analysis helps in assessing the current profitability and operational efficiency of the firm as a whole and its different departments. This helps judge the overall financial health.
- Understanding Financial Position: It helps in ascertaining the relative importance of different components of the firm's financial position, such as the mix of assets and liabilities.
- Identifying Reasons for Change: By comparing data over time, analysis helps identify the specific reasons for changes in the profitability and financial position of the firm.
- Assessing Solvency and Liquidity: It is vital for judging the ability of the firm to repay its short-term and long-term debts. This is of particular interest to creditors and lenders.
- Forecasting and Decision Making: By understanding past performance and current position, analysts can make better forecasts about the future prospects of the firm. This enables stakeholders like investors and management to make informed decisions regarding investments, operations, and financing.
- Facilitating Comparisons: It allows for both intra-firm comparison (comparing the firm's own performance over time) and inter-firm comparison (comparing the firm with others in the same industry).
Q11Questions for Practice
Explain how common size statements are prepared giving an example.
Solution
Common size statements are financial statements in which amounts are shown as percentages of a common base. This process converts absolute figures into relative figures, making them easy to compare. This is also known as vertical analysis.
Preparation of Common Size Statements
The procedure for preparing common size statements, as outlined in Section 4.6, is as follows:
-
Choose a Common Base: A common base is selected, which is taken as 100%.
- For the Statement of Profit and Loss, the base is usually 'Revenue from Operations'.
- For the Balance Sheet, the base is 'Total Assets' or 'Total Equity and Liabilities'.
-
Calculate Percentages: Each item in the financial statement is then expressed as a percentage of the chosen base.
- For the Statement of P&L:
(Item Amount / Revenue from Operations) * 100 - For the Balance Sheet:
(Item Amount / Total Assets) * 100
- For the Statement of P&L:
-
Present in a Comparative Format: The statements are usually prepared for two or more periods to allow for comparison of the component percentages over time.
Example: Common Size Balance Sheet
Let's prepare a common size balance sheet using the data for XRI Ltd. for the year ended March 31, 2017 (from Illustration 7).
Balance Sheet of XRI Ltd. as at March 31, 2017
| Particulars | Absolute Amount (Rs.) |
|---|---|
| I. Equity and Liabilities | |
| Share capital | 12,00,000 |
| Reserves and surplus | 5,00,000 |
| Long-term borrowings | 5,00,000 |
| Trade payables | 10,50,000 |
| Total | 32,50,000 |
| II. Assets | |
| Plant & machinery | 8,00,000 |
| Goodwill | 12,00,000 |
| Non-current investments | 10,00,000 |
| Inventories | 2,50,000 |
| Total | 32,50,000 |
Preparation Steps:
- Common Base: The common base is Total Assets (or Total Equity & Liabilities), which is Rs. 32,50,000. This is 100%.
- Calculate Percentages for each item:
- Share Capital % = (12,00,000 / 32,50,000) * 100 = 36.92%
- Reserves and Surplus % = (5,00,000 / 32,50,000) * 100 = 15.38%
- Plant & Machinery % = (8,00,000 / 32,50,000) * 100 = 24.62%
- And so on for all other items.
Common Size Balance Sheet of XRI Ltd. as at March 31, 2017
| Particulars | Absolute Amount (Rs.) | Percentage of Total (%) |
|---|---|---|
| I. Equity and Liabilities | ||
| Share capital | 12,00,000 | 36.92 |
| Reserves and surplus | 5,00,000 | 15.38 |
| Long-term borrowings | 5,00,000 | 15.38 |
| Trade payables | 10,50,000 | 32.32 |
| Total | 32,50,000 | 100.00 |
| II. Assets | ||
| Plant & machinery | 8,00,000 | 24.62 |
| Goodwill | 12,00,000 | 36.92 |
| Non-current investments | 10,00,000 | 30.77 |
| Inventories | 2,50,000 | 7.69 |
| Total | 32,50,000 | 100.00 |
This format clearly shows that in 2017, intangible assets (Goodwill) constituted the largest portion (36.92%) of the company's total assets.
Q12Questions for Practice
Following are the balance sheets of Alpha Ltd., as at March 31, 2016 and 2017. You are required to prepare Comparative Balance Sheet.
Particulars March 31, 2016 (Rs.) March 31, 2017 (Rs.) I. Equity and Liabilities 1. Shareholders' Funds (a) Share Capital 2,00,000 4,00,000 (b) Reserve & Surplus 1,00,000 1,50,000 2. Noncurrent Liabilities (a) Long Term Borrowings 2,00,000 3,00,000 3.Current Liabilities (a) Short term borrowings 50,000 70,000 (b) Trade Payables 30,000 60,000 (c) Other Current Liabilities 20,000 10,000 (d) Short Terms Provisions 20,000 20,000 Total 6,20,000 10,20,000 II. Assets 1. Non-Current Assets (a) Fixed Assets 2,00,000 5,00,000 (b) Non-Current Investments 1,00,000 1,25,000 2. Current Assets (a) Current Investments 60,000 80,000 (b) Inventories 1,35,000 1,55,000 (c) Trade Receivables 60,000 90,000 (d) Cash and Cash Equivalents 25,000 10,000 (e) Short term Loans & Advances 40,000 60,000 Total 6,20,000 10,20,000
Solution
Comparative Balance Sheet of Alpha Ltd.
as at March 31, 2016 and 2017
| Particulars | March 31, 2016 (Rs.) | March 31, 2017 (Rs.) | Absolute Change (Increase/Decrease) (Rs.) | Percentage Change (%) |
|---|---|---|---|---|
| I. Equity and Liabilities | ||||
| 1. Shareholders' Funds | ||||
| (a) Share Capital | 2,00,000 | 4,00,000 | 2,00,000 | 100.00 |
| (b) Reserve & Surplus | 1,00,000 | 1,50,000 | 50,000 | 50.00 |
| 2. Non-Current Liabilities | ||||
| (a) Long Term Borrowings | 2,00,000 | 3,00,000 | 1,00,000 | 50.00 |
| 3. Current Liabilities | ||||
| (a) Short term borrowings | 50,000 | 70,000 | 20,000 | 40.00 |
| (b) Trade Payables | 30,000 | 60,000 | 30,000 | 100.00 |
| (c) Other Current Liabilities | 20,000 | 10,000 | (10,000) | (50.00) |
| (d) Short Term Provisions | 20,000 | 20,000 | 0 | 0.00 |
| Total | 6,20,000 | 10,20,000 | 4,00,000 | 64.52 |
| II. Assets | ||||
| 1. Non-Current Assets | ||||
| (a) Fixed Assets | 2,00,000 | 5,00,000 | 3,00,000 | 150.00 |
| (b) Non-Current Investments | 1,00,000 | 1,25,000 | 25,000 | 25.00 |
| 2. Current Assets | ||||
| (a) Current Investments | 60,000 | 80,000 | 20,000 | 33.33 |
| (b) Inventories | 1,35,000 | 1,55,000 | 20,000 | 14.81 |
| (c) Trade Receivables | 60,000 | 90,000 | 30,000 | 50.00 |
| (d) Cash and Cash Equivalents | 25,000 | 10,000 | (15,000) | (60.00) |
| (e) Short term Loans & Advances | 40,000 | 60,000 | 20,000 | 50.00 |
| Total | 6,20,000 | 10,20,000 | 4,00,000 | 64.52 |
Q13Questions for Practice
Following are the Balance Sheets of Beta Ltd., as at March 31, 2016 and 2017.
Particulars March 31, 2016 (Rs.) March 31, 2017 (Rs.) I. Equity and Liabilities 1. Shareholders' Funds (a) Share Capital 4,00,000 3,00,000 (b) Reserves and surplus 1,50,000 1,00,000 2. Non-Current Liabilities (a) Long term IDBI 3,00,000 1,00,000 3. Current Liabilities (a) Short term borrowings 70,000 50,000 (b) Trade payables 60,000 30,000 (c) Other current liabilities 1,10,000 1,00,000 (d) Short term provisions 10,000 20,000 Total 11,00,000 7,00,000 II. Assets 1. Non-Current Liabilities (a) Fixed Assets 4,00,000 2,20,000 (b) Non-current Investments 2,25,000 1,00,000 2. Current Assets (a) Current Investments 80,000 60,000 (b) Inventories 1,05,000 90,000 (c) Trade Receivables 90,000 60,000 (d) Cash and Cash Equivalents 1,00,000 85,000 (e) Short term loans & Advances 1,00,000 85,000 Total 11,00,000 7,00,000
Prepare comparative Balance Sheet.
Solution
Comparative Balance Sheet of Beta Ltd.
as at March 31, 2016 and 2017
| Particulars | March 31, 2016 (Rs.) | March 31, 2017 (Rs.) | Absolute Change (Increase/Decrease) (Rs.) | Percentage Change (%) |
|---|---|---|---|---|
| I. Equity and Liabilities | ||||
| 1. Shareholders' Funds | ||||
| (a) Share Capital | 4,00,000 | 3,00,000 | (1,00,000) | (25.00) |
| (b) Reserves and surplus | 1,50,000 | 1,00,000 | (50,000) | (33.33) |
| 2. Non-Current Liabilities | ||||
| (a) Long term borrowings (IDBI) | 3,00,000 | 1,00,000 | (2,00,000) | (66.67) |
| 3. Current Liabilities | ||||
| (a) Short term borrowings | 70,000 | 50,000 | (20,000) | (28.57) |
| (b) Trade payables | 60,000 | 30,000 | (30,000) | (50.00) |
| (c) Other current liabilities | 1,10,000 | 1,00,000 | (10,000) | (9.09) |
| (d) Short term provisions | 10,000 | 20,000 | 10,000 | 100.00 |
| Total | 11,00,000 | 7,00,000 | (4,00,000) | (36.36) |
| II. Assets | ||||
| 1. Non-Current Assets | ||||
| (a) Fixed Assets | 4,00,000 | 2,20,000 | (1,80,000) | (45.00) |
| (b) Non-current Investments | 2,25,000 | 1,00,000 | (1,25,000) | (55.56) |
| 2. Current Assets | ||||
| (a) Current Investments | 80,000 | 60,000 | (20,000) | (25.00) |
| (b) Inventories | 1,05,000 | 90,000 | (15,000) | (14.29) |
| (c) Trade Receivables | 90,000 | 60,000 | (30,000) | (33.33) |
| (d) Cash and Cash Equivalents | 1,00,000 | 85,000 | (15,000) | (15.00) |
| (e) Short term loans & Advances | 1,00,000 | 85,000 | (15,000) | (15.00) |
| Total | 11,00,000 | 7,00,000 | (4,00,000) | (36.36) |
Q14Questions for Practice
Prepare Comparative Statement of profit and loss from the following information.
Particulars 2015-16 (Rs.) 2016-17 (Rs.) Freight Outward 20,000 10,000 Wages (office) 10,000 5,000 Manufacturing Expenses 50,000 20,000 Stock adjustment (60,000) 30,000 Cash purchases 80,000 60,000 Credit purchases 60,000 20,000 Return inward 8,000 4,000 Gross profit (30,000) 90,000 Carriage outward 20,000 10,000 Machinery 3,00,000 2,00,000 10% depreciation on machinery 10,000 5,000 Interest on short-term loans 20,000 20,000 10% debentures 20,000 10,000 Profit on sale of furniture 20,000 10,000 Loss on sale of office car 90,000 60,000 Tax rate 40% 50%
Solution
Working Notes:
- The data provided is not in the standard format of a Statement of Profit and Loss. We need to rearrange it. Revenue from Operations is not given, but Gross Profit is. We will start from there.
- Operating Expenses will include Wages (office), Carriage Outward, and Depreciation.
- Non-Operating Incomes/Expenses include Profit on sale of furniture (income), Loss on sale of office car (expense), and Interest on Debentures/Loans (expense).
- Interest on 10% Debentures for 2015-16 = 10% of 20,000 = Rs. 2,000. For 2016-17 = 10% of 10,000 = Rs. 1,000.
Comparative Statement of Profit and Loss
for the years ended March 31, 2016 and 2017
| Particulars | 2015-16 (Rs.) | 2016-17 (Rs.) | Absolute Change (Rs.) | Percentage Change (%) |
|---|---|---|---|---|
| I. Gross Profit | (30,000) | 90,000 | 1,20,000 | (400.00) |
| II. Add: Other Operating Income | - | - | - | - |
| III. Less: Operating Expenses | ||||
| Wages (Office) | 10,000 | 5,000 | (5,000) | (50.00) |
| Carriage Outward | 20,000 | 10,000 | (10,000) | (50.00) |
| Depreciation on Machinery | 10,000 | 5,000 | (5,000) | (50.00) |
| Total Operating Expenses | 40,000 | 20,000 | (20,000) | (50.00) |
| IV. Operating Profit (I - III) | (70,000) | 70,000 | 1,40,000 | (200.00) |
| V. Add: Non-Operating Income | ||||
| Profit on Sale of Furniture | 20,000 | 10,000 | (10,000) | (50.00) |
| VI. Less: Non-Operating Expenses | ||||
| Loss on Sale of Office Car | 90,000 | 60,000 | (30,000) | (33.33) |
| Interest on Short-term Loans | 20,000 | 20,000 | 0 | 0.00 |
| Interest on Debentures (WN 4) | 2,000 | 1,000 | (1,000) | (50.00) |
| Total Non-Operating Expenses | 1,12,000 | 81,000 | (31,000) | (27.68) |
| VII. Profit Before Tax (IV + V - VI) | (1,62,000) | (1,000) | 1,61,000 | 99.38 |
| VIII. Less: Tax (Note) | - | - | - | - |
| IX. Profit After Tax | (1,62,000) | (1,000) | 1,61,000 | 99.38 |
Note: Tax is not calculated as there is a loss in both years.
Q15Questions for Practice
Prepare Comparative Statement of Profit and Loss from the following information:
Particulars 2015-16 (Rs.) 2016-17 (Rs.) Manufacturing expenses 35,000 80,000 Opening stock 30,000 60% of closing stock Sales 9,60,000 4,50,000 Returns outward 4,000 (out of credit purchase) 6,000 (out of cash purchase) Closing stock 150% of opening stock 1,00,000 Credit purchases 1,50,000 150% of cash purchase Cash purchases 80% of credit purchases 40,000 Carriage outward 10,000 30,000 Building 1,00,000 2,00,000 Depreciation on building 20% 10% Interest on bank overdraft 5,000 - 10% debentures 2,00,000 20,00,000 Profit on sale of copyright 10,000 20,000 Loss on sale of personal car 10,000 20,000 Other operating expenses 20,000 10,000 Tax rate 50% 40%
Solution
Working Notes:
For 2015-16:
- Revenue from Operations (Sales): 9,60,000
- Cash Purchases = 80% of 1,50,000 = 1,20,000
- Total Purchases = 1,50,000 (Credit) + 1,20,000 (Cash) = 2,70,000
- Net Purchases = 2,70,000 - 4,000 (Returns) = 2,66,000
- Closing Stock = 150% of 30,000 = 45,000
- Cost of Revenue from Operations = Opening Stock + Net Purchases + Manufacturing Exp. - Closing Stock = 30,000 + 2,66,000 + 35,000 - 45,000 = 2,86,000
- Depreciation on Building = 20% of 1,00,000 = 20,000
- Interest on Debentures = 10% of 2,00,000 = 20,000
For 2016-17:
- Revenue from Operations (Sales): 4,50,000
- Opening Stock = 60% of 1,00,000 = 60,000
- Credit Purchases = 150% of 40,000 = 60,000
- Total Purchases = 40,000 (Cash) + 60,000 (Credit) = 1,00,000
- Net Purchases = 1,00,000 - 6,000 (Returns) = 94,000
- Cost of Revenue from Operations = 60,000 + 94,000 + 80,000 - 1,00,000 = 1,34,000
- Depreciation on Building = 10% of 2,00,000 = 20,000
- Interest on Debentures = 10% of 20,00,000 = 2,00,000
- Loss on sale of personal car is ignored as it is not a business expense.
Comparative Statement of Profit and Loss
for the years ended March 31, 2016 and 2017
| Particulars | 2015-16 (Rs.) | 2016-17 (Rs.) | Absolute Change (Rs.) | Percentage Change (%) |
|---|---|---|---|---|
| I. Revenue from Operations | 9,60,000 | 4,50,000 | (5,10,000) | (53.13) |
| II. Other Income | ||||
| Profit on Sale of Copyright | 10,000 | 20,000 | 10,000 | 100.00 |
| III. Total Revenue (I + II) | 9,70,000 | 4,70,000 | (5,00,000) | (51.55) |
| IV. Expenses | ||||
| Cost of Revenue from Operations | 2,86,000 | 1,34,000 | (1,52,000) | (53.15) |
| Carriage Outward | 10,000 | 30,000 | 20,000 | 200.00 |
| Other Operating Expenses | 20,000 | 10,000 | (10,000) | (50.00) |
| Depreciation on Building | 20,000 | 20,000 | 0 | 0.00 |
| Interest on Bank Overdraft | 5,000 | - | (5,000) | (100.00) |
| Interest on Debentures | 20,000 | 2,00,000 | 1,80,000 | 900.00 |
| Total Expenses | 3,61,000 | 3,94,000 | 33,000 | 9.14 |
| V. Profit Before Tax (III - IV) | 6,09,000 | 76,000 | (5,33,000) | (87.52) |
| VI. Less: Tax | ||||
| @50% (2015-16) | 3,04,500 | |||
| @40% (2016-17) | 30,400 | |||
| Tax Expense | 3,04,500 | 30,400 | (2,74,100) | (90.02) |
| VII. Profit After Tax (V - VI) | 3,04,500 | 45,600 | (2,58,900) | (85.03) |
Q16Questions for Practice
Prepare a Common size statement of profit and loss of Shefali Ltd. with the help of following information:
Particulars 2015-16 (Rs.) 2016-17 (Rs.) Revenue from operations 6,00,000 8,00,00 Indirect expense 25% of gross profit 25% of gross profit Cost of revenue from operations 4,28,000 7,28,000 Other incomes 10,000 12,000 Income tax 30% 30%
Solution
Working Notes:
For 2015-16:
- Gross Profit = Revenue from operations - Cost of revenue from operations = 6,00,000 - 4,28,000 = 1,72,000
- Indirect Expense = 25% of 1,72,000 = 43,000
- Profit before Tax = Gross Profit + Other Income - Indirect Expense = 1,72,000 + 10,000 - 43,000 = 1,39,000
- Income Tax = 30% of 1,39,000 = 41,700
For 2016-17:
- Gross Profit = 8,00,000 - 7,28,000 = 72,000
- Indirect Expense = 25% of 72,000 = 18,000
- Profit before Tax = 72,000 + 12,000 - 18,000 = 66,000
- Income Tax = 30% of 66,000 = 19,800
Common Size Statement of Profit and Loss of Shefali Ltd.
for the years ended March 31, 2016 and 2017
| Particulars | 2015-16 | 2016-17 | Percentage of Revenue from Operations (%) |
| :--- | :--- | :--- | :--- | :--- |
| | Absolute Amount (Rs.) | Absolute Amount (Rs.) | 2015-16 | 2016-17 |
| I. Revenue from Operations | 6,00,000 | 8,00,000 | 100.00 | 100.00 |
| II. Other Income | 10,000 | 12,000 | 1.67 | 1.50 |
| III. Total Revenue (I + II) | 6,10,000 | 8,12,000 | 101.67 | 101.50 |
| IV. Expenses | | | | |
| Cost of Revenue from Operations | 4,28,000 | 7,28,000 | 71.33 | 91.00 |
| Indirect Expense | 43,000 | 18,000 | 7.17 | 2.25 |
| Total Expenses | 4,71,000 | 7,46,000 | 78.50 | 93.25 |
| V. Profit Before Tax (III - IV) | 1,39,000 | 66,000 | 23.17 | 8.25 |
| VI. Less: Income Tax | 41,700 | 19,800 | 6.95 | 2.48 |
| VII. Profit After Tax (V - VI) | 97,300 | 46,200 | 16.22 | 5.77 |
Q17Questions for Practice
Prepare a Common Size balance sheet from the following balance sheet of Aditya Ltd., and Anjali Ltd.:
Particulars Aditya Ltd. (Rs.) Anjali Ltd. (Rs.) I. Equity and Liabilities 1. Shareholder's Funds a) Equity share capital 6,00,000 8,00,000 b) Reserves and surplus 3,00,000 2,50,000 2. Current liabilities 1,00,000 1,50,000 Total 10,00,000 12,00,000 II. Assets 1. Non current assets a) Fixed assets 4,00,000 7,00,000 2. Current assets 6,00,000 5,00,000 Total 10,00,000 12,00,000
Solution
Common Size Balance Sheet
as at ...
| Particulars | Aditya Ltd. | Anjali Ltd. | Percentage of Total Assets (%) |
| :--- | :--- | :--- | :--- | :--- |
| | Absolute Amount (Rs.) | Absolute Amount (Rs.) | Aditya Ltd. | Anjali Ltd. |
| I. Equity and Liabilities | | | | |
| 1. Shareholders' Funds | | | | |
| a) Equity Share Capital | 6,00,000 | 8,00,000 | 60.00 | 66.67 |
| b) Reserves and Surplus | 3,00,000 | 2,50,000 | 30.00 | 20.83 |
| (Total Shareholders' Funds) | (9,00,000) | (10,50,000) | (90.00) | (87.50) |
| 2. Current Liabilities | 1,00,000 | 1,50,000 | 10.00 | 12.50 |
| Total Equity and Liabilities | 10,00,000 | 12,00,000 | 100.00 | 100.00 |
| II. Assets | | | | |
| 1. Non-Current Assets | | | | |
| a) Fixed Assets | 4,00,000 | 7,00,000 | 40.00 | 58.33 |
| 2. Current Assets | 6,00,000 | 5,00,000 | 60.00 | 41.67 |
| Total Assets | 10,00,000 | 12,00,000 | 100.00 | 100.00 |
Calculation Example (Aditya Ltd.):
- Base (Total Assets) = 10,00,000 (100%)
- Equity Share Capital % = (6,00,000 / 10,00,000) * 100 = 60.00%
- Fixed Assets % = (4,00,000 / 10,00,000) * 100 = 40.00%
Calculation Example (Anjali Ltd.):
- Base (Total Assets) = 12,00,000 (100%)
- Equity Share Capital % = (8,00,000 / 12,00,000) * 100 = 66.67%
- Fixed Assets % = (7,00,000 / 12,00,000) * 100 = 58.33%
Q1Test your Understanding - I
Fill in the blanks with appropriate word(s): Analysis simply means-data. Interpretation means-data. Comparative analysis is also known as - analysis. Common size analysis is also known as - analysis. The analysis of actual movement of money inflow and outflow in an organisation is called-analysis.
Solution
- Analysis simply means simplification of financial data.
- Interpretation means explaining the meaning and significance of the data.
- Comparative analysis is also known as horizontal analysis.
- Common size analysis is also known as vertical analysis.
- The analysis of actual movement of money inflow and outflow in an organisation is called cash flow analysis.
Q1Test your Understanding - II
The financial statements of a business enterprise include:
(a)
Balance sheet
(b)
Statement of Profit and loss account
(c)
Cash flow statement
(d)
All the above
Solution
(d) All the above
As stated in the chapter summary, an annual report contains the basic financial statements, which are the Balance Sheet, Statement of Profit and Loss, and Cash Flow Statement.
Q2Test your Understanding - II
The most commonly used tools for financial analysis are:
(a)
Horizontal analysis
(b)
Vertical analysis
(c)
Ratio analysis
(d)
All the above
Solution
(d) All the above
Horizontal analysis (like comparative statements), vertical analysis (like common-size statements), and ratio analysis are all listed in Section 4.4 as commonly used techniques of financial analysis.
Q3Test your Understanding - II
An Annual Report is issued by a company to its:
(a)
Directors
(b)
Auditors
(c)
Shareholders
(d)
Management
Solution
(c) Shareholders
While directors, auditors, and management use the annual report, it is primarily prepared and issued for the shareholders (owners) of the company to inform them about the company's performance and financial position.
Q4Test your Understanding - II
Balance Sheet provides information about financial position of the enterprise:
(a)
At a point in time
(b)
Over a period of time
(c)
For a period of time
(d)
None of the above
Solution
(a) At a point in time
The Balance Sheet is a statement of the assets, liabilities, and equity of a company on a specific date (e.g., as at March 31, 2017). It represents the financial position at that particular moment, not over a period.
Q5Test your Understanding - II
Comparative statements are also known as:
(a)
Dynamic analysis
(b)
Horizontal analysis
(c)
Vertical analysis
(d)
External analysis
Solution
(b) Horizontal analysis
Section 4.4 on Tools of Analysis of Financial Statements explicitly states, "Comparative figures indicate the trend and direction of financial position and operating results. This analysis is also known as 'horizontal analysis'."
Q1Test your Understanding - III
State whether each of the following is True or False :
(a)
The financial statements of a business enterprise include cash flow statement.
(b)
Comparative statements are the form of horizontal analysis.
(c)
Common size statements and financial ratios are the two tools employed in vertical analysis.
(d)
Ratio analysis establishes relationship between two financial statements.
(e) Ratio analysis is a tool for analysing the financial statements of any enterprise.
(f) Financial analysis is used only by the creditors.
(g) Statement of profit and loss account shows the operating performance of an enterprise for a period of time.
(h) Financial analysis helps an analyst to arrive at a decision.
(i) Cash Flow Statement is a tool of financial statement analysis.
(j) In a Common size statement each item is expressed as a percentage of some common base.
Solution
(a) True. The chapter summary lists the Cash Flow Statement as one of the basic financial statements in an annual report.
(b) True. Section 4.4 clearly states that comparative statement analysis is also known as 'horizontal analysis'.
(c) True. Common size statements are a form of vertical analysis. While not explicitly stated that financial ratios are 'vertical', they analyze relationships within the statements for a single period, which aligns with the principle of vertical analysis.
(d) True. Ratio analysis describes the relationship between various items, often from both the balance sheet and the statement of profit and loss.
(e) True. Ratio analysis is listed as a key technique of financial analysis applicable to any enterprise.
(f) False. Section 4.2 states that financial analysis is useful to many parties, including management, investors, lenders, labour unions, and others, not just creditors.
(g) True. The Statement of Profit and Loss reports the operating results (revenues and expenses) over a specific accounting period.
(h) True. The primary purpose of financial analysis is to evaluate financial information to understand the firm and make decisions.
(i) True. Cash Flow Analysis, which results in the Cash Flow Statement, is listed in Section 4.4 as one of the most commonly used techniques of financial analysis.
(j) True. Section 4.6 defines a common size statement by stating that each item is expressed as a percentage of a common base, such as revenue from operations or total assets.