Exercise 1: Preparing a Balance Sheet

This exercise demonstrates the preparation of a balance sheet using provided balances for Titan Company as of March 31, 2015.

Provided Balances for Titan Company (March 31, 2015)

• Cash: ₹210 crore
• Inventory: ₹187 crore
• Receivables: ₹4,047 crore
• Fixed Assets & Marketable Securities (Combined): ₹738 crore
• Loan: ₹100 crore
• Payables (Suppliers and Others): ₹2,346 crore

Preparing the Balance Sheet

Calculate Equity:

• Using the accounting equation:

• Equity = Assets - Liabilities

• Total Assets = ₹210 + ₹4,047 + ₹187 + ₹738 = ₹5,182 crore

• Total Liabilities = ₹100 + ₹2,346 = ₹2,446 crore

• Equity = ₹5,182 - ₹2,446 = ₹2,736 crore

Exercise 2: Recording Transactions, Preparing Financial Statements, and Business Analysis

This exercise involves recording financial transactions, preparing a Profit & Loss (P&L) account and a Balance Sheet, and analyzing the financial health of a new business.

Scenario

A friend has been selling electronic gadgets through an e-commerce portal for six months and wants an analysis of the business's performance. The following transactions occurred during the six-month period:

1. Invested capital: ₹20 lakhs (Cash)
2. Paid warehouse deposit: ₹5 lakhs
3. Borrowed from Yes Bank: ₹30 lakhs (Annual interest: 20%, payable on June 30th and December 31st)
4. Imported goods from China (on credit): ₹380 lakhs
5. Cash sales (including VAT/GST of ₹20 lakhs): ₹480 lakhs
6. VAT/GST payment: ₹20 lakhs
7. Commission paid to e-commerce portal: ₹32 lakhs
8. Monthly operating expenses (excluding rent and interest): ₹3 lakhs
9. Monthly rent: ₹50,000
10. Unsold inventory on June 30th: ₹60 lakhs
11. Outstanding payable to Chinese supplier on June 30th: ₹20 lakhs

Recording Transactions Using the Accounting Equation

The accounting equation is: Assets = Liabilities + Equity + Revenue - Expenses

Transaction	Asset Name	Asset Value (₹ lakhs)	Liabilities (₹ lakhs)	Equity (₹ lakhs)	Revenue (₹ lakhs)	Expenses (₹ lakhs)	Expense Name
Invested Capital	Cash/Bank	+20		+20
Warehouse Deposit	Warehouse Deposit	+5
	Cash/Bank	-5
Loan from Yes Bank	Cash/Bank	+30	+30
Purchase of Inventory (on credit)	Inventory	+380	+380
Cash Sales (incl. VAT/GST ₹20 lakhs)	Cash/Bank	+480	+20 (VAT/GST)		+460
Payment of VAT/GST	Cash/Bank	-20	-20 (VAT/GST)
Commission Paid	Cash/Bank	-32				-32	Commission
Operating Expenses (6 months)	Cash/Bank	-18				-18	Operating Expenses
Rent (6 months)	Cash/Bank	-3				-3	Rent
Interest Payable (6 months: 300.20.5)	Interest Payable		+3			-3	Interest
Cost of Sales (380-60)	Inventory	-320				-320	Cost of Sales
Payment to Supplier (380-20)	Cash/Bank	-360	-360

Preparing the Profit & Loss Account (P&L)

Profit & Loss Account

For the Six Months Ending June 30, 2015

Particulars	Amount (₹ lakhs)
Revenue	460
Less: Cost of Sales	320
Gross Profit	140
Less: Operating Expenses	18
Less: Rent	3
Less: Commission	32
Profit Before Interest	87
Less: Interest Expense	3
Profit Before Tax (PBT)	84

Preparing the Balance Sheet

Balance Sheet

As of June 30, 2015

Liabilities and Equity	Amount (₹ lakhs)	Assets	Amount (₹ lakhs)
Equity Capital	20	Inventory	60
Add: Profit for the Period	84	Warehouse Deposit	5
Total Equity	104	Cash/Bank	92
Loan from Yes Bank	30
Payables	20
Interest Payable	3
Total Liabilities	53
Total Liabilities & Equity	157	Total Assets	157

Analysis of Business Performance

• The business generated a profit before tax of ₹84 lakhs on an initial investment of ₹20 lakhs in just six months. This indicates a strong performance.
• The gross profit margin (Gross Profit / Revenue) is (140/460) * 100 = approximately 30.4%, which suggests healthy pricing and cost management.
• The business has a significant amount of cash (₹92 lakhs) on hand, indicating good liquidity.
• The business has some outstanding payables (₹20 lakhs) and interest payable (₹3 lakhs). These are relatively small compared to the cash balance and profitability, so they don't pose an immediate concern.

Exercise 3: Analyzing Changes in Financial Statements

This exercise focuses on interpreting changes in balance sheet values between two years (Year 1 and Year 2) to understand the underlying business activities.

Provided Data

We have comparative balance sheet information for two years. Our task is to explain the changes in the following line items:

• Current Assets
• Non-Current Assets
• Current Liabilities
• Non-Current Liabilities
• Paid-Up Capital
• Retained Earnings

Analysis of Changes

Here's a breakdown of the changes and possible explanations:

1. Current Assets (Decreased from ₹1,13,624 to ₹30,442):

   A significant decrease in current assets suggests:

   • Lower Inventory Levels: The company is holding less inventory, potentially due to improved inventory management or decreased sales.
   • Faster Collection of Receivables: The company is collecting payments from customers more efficiently, reducing outstanding receivables.

   Summary: Improved working capital management (faster collections and lower inventory) or declining sales.

2. Non-Current Assets (Decreased from ₹4,10,976 to ₹1,98,014):

   A substantial decrease in non-current assets is unusual, as companies typically invest in these assets for growth. Possible reasons include:

   • Sale of a Division/Significant Assets: The company may have sold off a business unit or a large portion of its fixed assets as part of a restructuring effort.
   • Major Restructuring: The company may be downsizing or divesting assets to streamline operations.

   Summary: Likely due to divestiture or significant restructuring.

3. Current Liabilities (Decreased from ₹56,142 to ₹40,220):

   A decrease in current liabilities indicates:

   • Payment of Liabilities: The company has paid off some of its short-term obligations to suppliers, lenders, etc.

   Summary: Improved short-term liquidity and financial position.

4. Non-Current Liabilities (Decreased Significantly):

   A substantial decrease in non-current liabilities could be due to:

   • Repayment of Loans: The company has repaid a significant portion of its long-term debt.
   • Debt Restructuring/Waiver: Lenders may have agreed to reduce the company's debt burden (loan waiver) as part of a financial restructuring. This often happens when a company faces financial distress.

   Summary: Debt reduction through repayment or restructuring.

5. Paid-Up Capital (Decreased from ₹2,14,000 to ₹1,73,000):

   A decrease in paid-up capital suggests:

   • Share Repurchase: The company has bought back some of its own shares from the market.
   • Capital Restructuring: The company may have undergone a reorganization of its share capital structure.

   Summary: Share buyback or capital restructuring.

6. Retained Earnings (Changed from Positive ₹13,785 to Negative ₹3,644):

   A shift from positive to negative retained earnings (a deficit) clearly indicates:

   • Net Loss in Year 2: The company incurred a net loss during Year 2, which has eroded its accumulated profits.

   Summary: The company operated at a loss in Year 2.

   Exercise 4: Matching Accounting Concepts and Conventions to Transactions

This exercise involves matching accounting concepts and conventions to specific business transactions.

Provided Information

Matching Transactions to Concepts

Here's the analysis and matching of each transaction:

1. 300 kg of cotton waste purchased for machine shops and used for cleaning:

   • Concept: Materiality (H)
   • Explanation: Although cotton waste technically qualifies as an asset, its value is insignificant compared to the company's overall operations. Therefore, it's expensed immediately upon purchase rather than being tracked as inventory.

2. A manufacturer of electronic goods follows the FIFO (First-In, First-Out) method for inventory valuation and continues to use the same method for a new product:

   • Concept: Consistency (C)
   • Explanation: The consistency concept requires that a company use the same accounting methods from period to period to ensure comparability of financial statements.

3. A recent national level HR survey shows the company improved its ranking from 10th to 2nd position:

   • Concept: Money Measurement (I)
   • Explanation: This information is not recorded in the accounting books because it lacks a monetary value. Accounting transactions must be quantifiable in monetary terms.

4. A restaurant supplied ₹800 worth of meals to the owner's family:

   • Concept: Entity (D)
   • Explanation: The entity concept treats the business as a separate legal entity from its owners. This transaction should be recorded as a drawing (if treated as a withdrawal by the owner) or as a receivable from the owner.

5. Credit sales of ₹100 lakhs with a credit period of 30 days are recorded as revenue:

   • Concept: Accrual (A)
   • Explanation: The accrual concept dictates that revenue is recognized when earned, regardless of when cash is received. In this case, revenue is recognized at the time of sale, even though payment is due later.

6. A gold jewelry maker has raw gold inventory costing ₹30 lakhs. The current market value is ₹38 lakhs:

   • Concept: Conservatism (B)
   • Explanation: The conservatism principle dictates that assets should be valued at the lower of cost or market value. Therefore, the inventory will be recorded at ₹30 lakhs, even though its market value is higher.

7. Salary for March is paid on April 3rd but is accounted for in March:

   • Concept: Matching (G)
   • Explanation: The matching principle requires that expenses be recognized in the same period as the related revenue. Since the salary expense relates to work performed in March, it is recorded in March, even if paid in April.

8. Telecom spectrum fee, giving the right to use the spectrum for 20 years, is paid and treated as an asset, amortized over 20 years:

   • Concepts: Going Concern (E) and Historical Cost (F)
   • Explanation:
     • Going Concern (E): The decision to amortize the fee over 20 years is based on the assumption that the business will continue to operate for that period.
     • Historical Cost (F): The initial recording of the asset is at its historical cost (the amount paid).

9. Two identical machines were imported one month apart. Due to exchange rate differences, the first machine cost ₹20 lakhs, and the second cost ₹19.4 lakhs:

   • Concept: Historical Cost (F)
   • Explanation: The machines are recorded at their respective historical costs (₹20 lakhs and ₹19.4 lakhs). The exchange rate difference is reflected in the actual cost paid for each machine.

Exercise 5: Analyzing Changes in Financial Statements and Profit Utilization

This exercise analyzes changes in a pharmaceutical company's balance sheet over three years to determine profit for each year and how that profit was utilized.

Provided Data (All values in millions)

Item	Year 2	Year 3	Year 4
Assets	400	420	430
Liabilities to Outsiders	225	215	215
Equity Share Capital	4	6	0
Reserves and Surplus	196	189	209
Dividends Declared		30	45

Calculating Profit for Year 3

Profit for Year 3 can be calculated using the following formula:

Profit (Year 3) = Closing Reserves & Surplus (Year 3) + Dividends (Year 3) - Opening Reserves & Surplus (Year 3)

• Closing Reserves & Surplus (Year 3): 189
• Dividends (Year 3): 30
• Opening Reserves & Surplus (Year 3) (which is the same as closing balance of Year 2): 196

Profit (Year 3) = 189 + 30 - 196 = 23 million

Calculating Profit for Year 4

Similarly, profit for Year 4 is:

Profit (Year 4) = Closing Reserves & Surplus (Year 4) + Dividends (Year 4) - Opening Reserves & Surplus (Year 4)

• Closing Reserves & Surplus (Year 4): 209
• Dividends (Year 4): 45
• Opening Reserves & Surplus (Year 4) (which is the same as closing balance of Year 3): 189

Profit (Year 4) = 209 + 45 - 189 = 65 million

How the Company Used Its Profit

Year 3

The company earned a profit of 23 million. The dividend declared was 30 million. This means that the company distributed more than its current year profit as dividends. The additional 7 million was likely taken from accumulated reserves from previous years.

Summary: The entire profit of 23 million and 7 million from reserves were distributed as dividends.

Year 4

The company earned a profit of 65 million and declared dividends of 45 million. This leaves 20 million of profit. Let's analyze how this remaining 20 million was used:

• Increase in Assets: Assets increased from 420 million to 430 million, a change of +10 million.
• Decrease in Liabilities: Liabilities to outsiders decreased from 225 million to 215 million, a change of -10 million.

The accounting equation is: Assets = Liabilities + Equity

Changes in the equation must balance. The increase in assets (10 million) and the decrease in liabilities (10 million) are balanced by the 20 million retained profit (part of equity).

Summary: The profit of 65 million was used as follows:

1. Dividend Payment: 45 million
2. Purchase of Assets: 10 million
3. Repayment of Liabilities: 10 million

Explanation of Equity Share Capital Changes

• Year 3: Equity share capital increased from 4 million to 6 million. This signifies issuance of new shares raising 2 million in capital.
• Year 4: Equity share capital decreased from 6 million to 0 million. This shows that the company has bought back all outstanding shares, returning the 6 million to shareholders. This is a significant event.

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