22.

Balance
B Sheet Equation
Balance sheet is a statement which depicts financial position of a unit as on particular date.
Assets and Liabilities are placed in the balance sheet as under:

Liabilities Amount Assets Amount

Capital and Reserves Fixed Assets
Opening Capital + Fresh Capital Land & Building
+Interest on Capital Machinery
+Profit during the year Furniture
(-)Drawings Vehicles
(-)Interest on Drawings Less Depreciation against each
Closing Capital & Reserves Total Fixed Assets
Long Term Liabilities: Non-Current Assets
Secured Loans Investments
Unsecured Loans Securities Etc.
Total Long term Liabilities Total Non-Current Assts
Current Liabilities Current Assets
Creditors and Bills Payable Cash and Bank Balance
Expenses Outstanding Debtors and Bills Receivable
Income Received in Advance Closing Stock
Advances from Customers Prepaid Expenses
Provisions against Liabilities Accrued Income
Short term bank borrowings like Advances to suppliers
CC and OD limit Etc.
Total Current Liabilities Total Current Assets
Intangible Assets
Goodwill, Patents, Trade Mak
Preliminary or Pre-operative Exp
Deferred Revenue Expenditure
Debit Balance of P&L account
Total Intangible Assets
TOTAL TOTAL
 Closing Capital = Opening Capital + Fresh Capital + Interest on Capital +Salary to
partners(if any) + Profit during the year - Drawings – Interest on Drawings
 Opening Capital = Closing Capital - Fresh Capital - Interest on Capital -Salary to
partners(if any) - Profit during the year + Drawings + Interest on Drawings

Assets = Liabilities + Capital

OR
Capital = Assets - Liabilities

 If Assets tend to increase, either Capital is increased or Liabilities increase.

 If Assets are purchase for cash, there will be no effect on Liability side
 Liabilities imply outside liabilities (Long term + Current)
 On the other hand, if assets increase and liabilities do-not increase, Capital is bound
to increase.

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Effect of transactions on Balance Sheet

1. Machinery purchased in cash

Machinery A/c ---------------------------------DR
To Cash

Here, Fixed Assets increase with corresponding decrease in Current Assets but without
any affect on Liabilities side.

2. Machinery purchased with bank loan

Machinery A/c ---------------------------------DR
To SBI Loan Account

Here, Fixed Assets increase with corresponding increase in Secured Loans. Therefore there
will be equal increase in Assets and Liabilities

3. Goods purchased on credit

Purchases A/c ---------------------------------DR
To Creditors

Here, Purchases increase. This will increase the Closing Stock i.e. Current Assets. On the
other side, it will tend increase creditors i.e. Current liabilities

4. Expenses like Rent and Salary paid in cash

Rent or Salary Account A/c ---------------------------------DR
To Cash

Here expenses increase. This will lead to lesser profit and this way, capital will be reduced.
On Assets side, it will reduce cash i.e. Current assets will be decreased.

5. Goods worth Rs. 8000 sold for Rs. 10000 on credit.

Debtors A/c ---------------------------------DR
To Sale

Here, Debtors increase by Rs. 10000/- with resultant increase in Current Assets.
On the other hand, profit will be Rs. 2000/- (Increase in sale by 10000/- and cost of goods
sold by 8000/-). It will lead to increase in Capital by Rs. 2000/-.

79
 23. Partnership
Partnership is relation between two or more persons associated together who have agreed
to share the profits of a business carried on by all or any of them acting for all.

Following points are important regarding Partnership:

1. Minimum members are 2 and Maximum are 20 (10 in case of Banks)

2. Limit is 50 in cases of Professional firms.
3. Recently limit on number of partners has increased to 100.
4. Partnership agreement may be oral or written.
5. If agreement is written, Partnership Deed is prepared which covers the rules and
regulations of the firm to which are partners are bound.
6. Partnership Deed is not mandatory.
7. In the absence of partnership deed, Partnership Act, 1932 applies which stipulates as
under:
 Profits and Losses are shared equally between the partners.
 No Interest is to be paid on Partners’ Capital.
 No interest is to be paid on Partners’ Drawings.
 No salary, remuneration is to be paid to partners.
 Fluctuating type of capital account will be maintained.
8. However, if different stipulations are there in the Partnership Deed, these will prevail.
9. Liability of Partners is Unlimited. They are severally and Jointly liable for the debts of
the firm.
10. Any one partner can bind the firm with his acts during ordinary course of business.
11. Registration of firm is done by Registrar of Firms (ROF). But it is not compulsory.
12. The drawback of Un-registered firm is that it cannot sue others.
13. A firm cannot become partner of another firm. However, a Company can become
partner of a firm.

Partners’ Capital Account: It is the following two types:

1. Fixed Capital Account :

Capital and Current Accounts are prepared separately. Capital remains Fixed
whereas Current account includes all transactions during the year.
2. Fluctuating Capital Account
No separate Current account is prepared. All transactions are posted in Capital
account.
Fixed Capital Account

By Opening Capital
To Closing Capital

Partners’ Current Account

To Drawings By Interest on Capital

To Interest on Drawings By fresh capital introduced
By Salary, Remuneration
By Commission
By Profit

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 Fluctuating Capital Account

To Drawings By Opening Capital

To Interest on Drawings By Interest on Capital
To Closing Capital By fresh capital introduced
By Salary, Remuneration
By Commission
By Profit

Valuation of Goodwill
Goodwill is reputation of the business valued in terms of money. It is real account,
but forms part of the Intangible Assets in the Balance Sheet. There are 3 methods to
calculate value of Goodwill.
1. Average Profit method
Goodwill is valued at multiplying average profits for required number of years.
Following is the example:
The profits of 3 years are 15000, 20000,10000. Calculate Goodwill of 4 years’
purchase of average profits

Average profits =(15000+20000+10000) / 3 = 45000/3=15000

Value of Goodwill = 15000*4=60000.

2. Super Profit method

Under this method Super profits are multiplied with nos. of purchase years.
Let Capital Employed =100000, Average Profits = 36000,
Normal rate of return = 10% - Calculate Goodwill of 4 years’ Super Profits

Normal Profits = 100000*10/100=10000

Super Profits = 36000-10000=26000
Goodwill = 26000*4=104000

3. Capitalization Method
Under this method, Capital is deducted from Capitalized Value of profits.
Let Capital = 100000, Normal Profits=26000, Normal Rate of return=10%

Capitalized Value of profits=26000*100/10=260000

Goodwill = 260000-100000=160000

When it is required to calculate Goodwill

 At the time of Admission of one or more partners in a firm
 At the time of Death or Retirement of any of the partners
 At the sale of Sale of business

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 Admission of Partner:
Goodwill is calculated as per one of the methods discussed above. The share of the New
Partner is brought by him besides his capital. The Capital is credited to his Personal Capital
Account. The share of Goodwill is distributed among Old partners in their Sacrificing Ratio.

Sacrificing Ratio is calculated as under:

Old Ratio – New Ratio
Example 1
Suppose two partners A & B were sharing profits in the ratio of 3:2. C is admitted for 1/4 th
part. Find New Ratio and Sacrificing ratio.
Solution
Old Ratio = 3:2
C’s share=1/4th
Remaining share for A & B = 1-1/4 = ¾
A’s share = ¾*3/5= 9/20
B’s share = ¾*2/5=6/20
C’s share = ¼ = 5/20
New Ratio= 9:6:5

Sacrificing Ratio of A = 3/5 – 9/20 =3/20

Sacrificing Ratio of B = 2/5 - 6/20 = 2/20
Sacrificing Ratio of A & B = 3:2-----------------------Ans.

Example 2
Suppose two partners A & B were sharing profits in the ratio of 2:1. C is admitted for 1/4 th
part which he receives 1/2 from A and 1/2 from B. Find Sacrificing ratio.
Solution
Old Ratio= 2:1
Sacrificing ratio = 1/2 : 1/2 = 1:1

Example 3
Suppose two partners A & B were sharing profits in the ratio of 3:2. New Ratio is 4:3:2. Find
sacrificing ratio.
Sacrificing Ratio of A = 3/5 – 4/9 =7/45
Sacrificing Ratio of B = 2/5 - 3/9 =3/45
Sacrificing Ratio of A & B = 7:3--------------------Ans.

Retirement/Death of Partner:
Goodwill is calculated as per one of the methods discussed above. The share of the Old
Partner is paid to him besides his capital. The share of Goodwill is contributed by the
remaining partners in their Gaining Ratio.

Gaining Ratio is calculated as under:

New Ratio – Old Ratio
Example 1
Suppose three partners A,B & C were sharing profits in the ratio of 6:5:3. A retires. How
much goodwill will be paid to A.
Solution
Goodwill is paid to retiring partner in the Gaining Ratio.
Gaining Ratio = New Ratio – Old Ratio
New Ratio between B & C = 5:3

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Gaining Ratio = 5:3 – 5:3 = 5:3
Goodwill is distributed in the ratio of 5:3--------------------Ans.

Example 2
Suppose three partners A,B & C were sharing profits in the ratio of 5:4:2. C retires and his
share will be taken up by A & B equally (1:1). How much goodwill will be paid to A.
Solution
Goodwill is paid to retiring partner in the Gaining Ratio.
Gaining Ratio = 1:1 (Given in the sum)
C;s share i.e. 2/11 will be distributed among A & B equally i.e. 2/22 to A and 2/22 to B.

New Ratio of A = 5/11 + 2/22 = 12/12

New Ratio of B = 4/11 + 2/22 = 10/22
New Ratio of A & B = 12/22:10/22 = 12:10 = 6:5------------------Ans.

Example 3
Suppose three partners A,B & C were sharing profits in the ratio of 2:1:1. B retires and New
Ratio between A & C is 3:2. Find gaining ratio.
Solution
Gaining Ratio= New Ratio-Old Ratio
A’s share=3/5-2/4 =2/20
C’s share = 2/5-1/4 = 3/20
Gaining Ratio between A & C = 2:3---------------Ans.

Calculation of Interest on Drawings when made throughout the year

Drawings made on which date – Period for which
every month throughout the interest is
year calculate
16th of each month 6 months
1st of each month 6.5 month
st
30/31 of each month 5.5 months

Revaluation Account
This account is prepared at the time of Admission as well as Retirement/Death of partners.
This account is credited with the amount of increase in value of assets and decrease in
value of liabilities. Amount lying in General Reserve and Other free reserves are also
credited. The balance in the account is transferred to old partner’s capital account (in case of
admission). In case of retirement, share of retiring partner is paid to him.

83
 24. Final Accounts of Banking Companies

All Banks are governed by Indian Companies Act, 1956 as well as Banking Companies Act,
1949. The Banks include Nationalized Banks, SBI and its subsidiaries, Foreign Banks,
Cooperative banks, RRBs and Private Sector Banks.

Section 5 of Banking Regulation Act stipulates that Banking is accepting of deposits of

money from public for the purpose of lending or investment. The deposits are repayable on
demand or otherwise by cheque, draft or otherwise.

Other Important provisions of Banking Regulation Act

 Section 8 prohibits the banks to engage in trading activities.

 Section 9 restricts the banks to hold Immovable property beyond a period of 7 years
except for own use.
 Section 29 stipulates that Balance Sheet of a Banking Company will be prepared on
“Form A of 3rd schedule”. Further, Profit and Loss Account will be prepared on
“Form B of 3rd Schedule.”
 Section 30 states that Balance sheet must be audited by qualified auditors.
 Section 31 & 32 – 3 copies of Balance Sheet & PL account will be submitted to RBI
within 3 months from end of the period. This period can be extended by another 3
months by RBI.
 Final accounts and Auditor’s report must be published in a newspaper within
maximum period of 6 months.
 Sec 17 states that at-least 20% of profits will be transferred to Statutory Reserve by
all the banks. Presently this limit has been raised to 25% by RBI.

3rd Schedule: Form “A”

Balance Sheet of _____Bank as on _________

Capital and Liabilities Schedule Amount

Capital 1
Reserves and Surplus 2
Deposits 3
Borrowings 4
Other Liabilities and Provisions 5
Assets
Cash and Balance with RBI 6
Balances with Banks and Money at call 7
and shot Notices
Investments 8
Advances 9
Fixed Assets 10
Other Assets 11
Total
Contingent Liabilities: Schedule 12 These are such type of liabilities which may or may
not arise in future. This figure does not form part of Total of Balance sheet but shown as
footnote. These are also called Off Balance Sheet Items. Such items are as under:

1. LC & LG as well as co-acceptance of bills.

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 2. Claims against banks not acknowledged as Debts.
3. Liability for partly paid up Investments.
4. Outstanding Forward exchange contracts.
5. Bills Rediscounted.

3rd Schedule: Form “B”

Profit and Loss Account of _____Bank for the year _________

Incomes Schedule Amount

Interest earned: It includes interest on Term 13
Loans, Cash Credit, Demand Loan, OD and
Rebate on Bills Purchased and Discounted
It also includes Income from Investments
Other Income : It includes Commission, 14
Brokerage, Profit on sale or revaluation of assets
and Misc. Income
Expenditure
Interest Expanded 15
Operating Expenses 16
Provisions and Contingencies --
Profit or Loss for the year
Appropriations
Transfer to Statutory Reserves (
Transfer to Other Reserves
Transfer to other Reserves
Proposed Dividend
Balance carried forward to Balance sheet
Total

 Statutory Reserve requirement is minimum 20% of Profits. However

RBI has prescribed that banks will maintain 25% of Profits as Reserve.
(Sec 17 of Banking Regulation Act, 1949)

Schedule 17 – Additional Disclosure

Following additional disclosures are required as foot-note in the Balance sheet:
1. Non-performing Assets
2. Movement of provisions held towards NPA
3. Movement of provisions held towards depreciation on Investments.
4. Asset Classification – Standard Assets, Sub-standard Assets, Doubtful Assets &
Loss Assets.
5. Income Recognition and Provisioning
6. Investments – SLR and Non- SLR. Further these are to be classified in 3 categories;
Held Till Maturity, Held for Trading and Available for Sale.
7. Provision for Depreciation
8. Repo and Reverse Repo transactions.
9. CDR Restructuring
10. Profit per Employee
11. Maturity pattern and ALM (Asset Liability Management)
12. AS-17 Segment Reporting
13. AS-18 Related Party Disclosure
14. AS-21 Consolidated Financial Statements

85
 25. JOINT STOCK COMPANY

A company is an artificial person created by law. The persons contribute money or money’s
worth to a common stock and it is used for common purpose. It is created by law and is a
legal person without physical existence. The persons who contribute money are
shareholders. The shares are transferable. Following are the features of a Company:

1. Artificial person
2. Perpetual succession
3. Common seal
4. Limited Liability
5. Transferability of shares

Types of Company

1. Statutory Company
2. Chartered Company
3. Foreign Company
4. Holding and Subsidiary Company
5. Company Limited by Shares and Company Limited by Guarantee
6. Unlimited Liability Company
7. Private Company and Public Company

Private Company and Public Company The most common types of companies are public
company and Private Company. The difference between the two is as under:

Private Company Public Company

1. Pvt. Limited is affixed against name 1. Ltd. Is affixed against name
2. Minimum nos. of members is 2 2. Minimum nos. of members is 7
3. Maximum nos. of members is 200 3. There is no limit on nos. of members
(Previously 50)
4. Prohibition on invitation to public to 4. Public is invited to subscribe for
subscribe for shares shares
5. Shares are not transferable 5. Shares are freely transferable
6. Minimum number of directors is 2 6. Minimum nos. of directors is 3
7. Certificate of Commencement is not 7. Certificate of Commencement is
required required
8. Minimum Capital is Rs. 1.00 lac 8. Minimum Capital is Rs. 5.00 lac

Types of Capital

1. Authorised Capital
2. Issued Capital
3. Subscribed Capital
4. Paid up Capital

 Minimum ratio of Authorised Capital : Subscribed Capital : Paid up

Capital is 4:2:1

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Accounting Entries in the books of Company: Suppose a Company issues share capital
of 100000 shares @Rs. 10 plus premium of Rs. 2/- payable as under:

On application----Rs.2/-, on allotment Rs. 3/-+2/-(premium), on 1 st Call Rs. 2.50 and on 2nd

and final call account Rs.2.50.

One share holder to whom 1000 shares were allotted, failed to pay first call. On subsequent
failure of 2nd call by him, his shares were forfeited. Later on, his shares were re-issued at a
price of Rs. 7/- to another person.

SOLUTION

Date Particulars LF Debit Credit

Date ofBank Account------------------------------------DR 200000
applicatio To Share Application Account 200000
n (Rs. 2/- per share received on application)
Date ofShare Application Account--------------------DR 200000
allotment To Share Capital Account 200000
(Share allotment made to all who applied
Date of Share Allotment Account-----------------------DR 500000
allotment To Share Capital Account 300000
To Share premium Account 200000
(Allotment money of Rs. 5/- per share Due)
Bank Account-------------------------------------DR 500000
To Share Allotment Account 500000
(Allotment money received)
1st Call Share First Call Account--------------------- -DR 250000
To Share Capital Account 250000
(Share First Call Rs. 2/50 per share Due)
Bank Account------------------------------------DR 247500
To Share First Call Account 247500
(Money due on first call received except 1000
shares)
nd
2 Call Share Second Call Account---------------- -DR 250000
To Share Capital Account 250000
(Share Second Call Rs. 2/50 per share Due)

Bank Account------------------------------------DR 247500

To Share Second Call Account 247500
(Money due on 2nd call received except 1000
shares)
Date of Share Capital account-------------------------Dr 10000
Forfeiture To Share First Call Account 2500
of Shares To Share Second Call Account 2500
To Share Forfeiture Account 5000
(1000 share forfeited )
Date of Bank Account-------------------------------------Dr 7000
Re-issue Share Forfeiture account-----------------------Dr 3000
To Share Capital account 10000
(1000 forfeited shares re-issued @7/-)
Date of Share Forfeiture account-----------------------Dr 2000
Re-issue To Capital Reserve Account 2000

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 (Balance in Forfeited account (5000-3000) =
2000 transferred to Capital reserve account

Share Forfeiture Account

“Share Forfeiture account” represents amount received by the company on account of

shares which are being forfeited.

When all the forfeited shares are re-issued, the balance in “Share Forfeited account” is
transferred to Reserve account

If all the shares are not re-issued, proportionate amount in respect of unsold shares is kept
in “Share Forfeiture account” and the remaining amount is transferred to Capital Reserve
Account.

Types of Shares

Shares are of two types:

1. Equity Shares and

2. Preference Shares

Equity shareholders are real owners. This is permanent capital not to be redeemed and
forms part of Tier-1 capital.

Preference Shares get preference at the time of receipt of dividend as well as at the time of
winding up of the company when capital is repaid. Preference shares are of the following
types:

1. Redeemable and Irredeemable preference shares

2. Cumulative and Non-cumulative preference shares
3. Participative and Non-participative preference shares

Share Premium Account: This is the amount charged from the shareholders over and
above the amount of Face value of shares. Share premium once received is not reversed
even if the shares are forfeited. Share Premium can be used for the following purposes:

1. Buy Back of Shares

2. Issue of Fully paid Bonus shares
3. Writing of Preliminary Expenses
4. Paying premium on Redemption of shares and Debentures.

Share at a Discount

1. Rate of Discount cannot exceed 10% of Face Value.

2. Only same class of shares can be issued at a discount.
3. For this, a resolution is required to be passed.

88
 4. Sanction of Company Law Board is required. Thereafter shares are to be issued
within 2 months of sanction.
5. No company can issue shares at a discount within 1 year of its formation..

Other Aspects

1. Single Call should not exceed 25% of the face value

2. Maximum 6% interest can be allowed on Calls in Advance
3. Shares issued for consideration other than Cash is called “Sweet Equity”.
4. Shares issued to Employees at a pre-determined price is called “ESOS i.e.
Employee Stock Option Scheme.”

Bonus Shares:

Bonus shares are the shares issued free of cost to the existing Shareholders. Bonus can be
given in two shapes:

1. Making partly paid shares into fully paid without demanding payment from
shareholders. Following reserves are used for the purpose:
 Capital Reserve, DRR, General Reserve and P& L Account
2. Issuance of Fully paid Bonus Shares. Following reserves are used for the purpose:
 Share Premium Account, CRR etc.
 Capital Reserve, DRR, General Reserve and P& L Account,

(Share Premium Account is used only for issuance of Fully Paid Bonus Shares)

89
 26. Final Accounts of Company

Balance Sheet of a Company is prepared on Part –I of Schedule VI –as per Indian Company
Act, 1956. Similarly Profit and Loss Account should be prepared in compliance of
requirements of Part-II of Schedule VI as per Indian Company Act, 1956. The Performa of
Balance sheet is as under:

Previous year’s Item Current Year’s

figures figures
Liabilities
Share Capital
Authorised Capital-------------------------------------------
Issued Capital------------------------------------------------
Subscribed Capital------------------------------------------
Paid up Capital------------------------------------------------ ---------------------
Reserves and Surpluses
Capital Reserve, Capital Redemption Reserve
(CRR), General Reserve, Share Premium Account,
Debenture Redemption Reserve (DRR), Sinking
Fund etc. ---------------------
Secured Loans
Debentures and Bonds
Loans and Advances (Term Loan)
Unsecured Loans
Fixed Deposits
Loans from Friends & Relatives
Current Liabilities & Provisions
Creditors, Bills Payable, Unclaimed Dividend,
Unexpired Discount, Outstanding Expenses &
Accrued Income
Proposed Dividend, Provision for Taxation and
other contingencies
Assets
Fixed Assets
Land, Building, Furniture, Vehicles, Plant and
Machinery
Non-Current Assets
Investments
Securities
Current assets
Cash and Bank balances
Debtors and Bills Receivables
Stocks and Spares
Loose Tools and Work in progress
Advance Payments
Accrued Income & Prepaid Expenses
Misc. Assets
Preliminary Expenses, Discount on Shares, Debit
Balance in PL Account, Deferred Revenue
Expenditure and Expenses on Issue of shares

90
CASE STUDY ON
ANALYSIS OF BALANCE SHEET

Extracts from financial statements of M/s. AB & Co. are as under:

Balance Sheet of M/s. AB & Co as on 31.3.2011 is as under

Liabilities Assets

Capital & Reserves 102000 Fixed Assets 100000

Bank Loan 50000 Stocks 10000

Sundry Creditors 25000 Debtors 30000

Bank OD 0 Pre-paid Expenses 2000

Bills Payable 15000 Cash in Hand 20000

Goodwill 20000

Preliminary Expenses 10000

Total 1920000 192000

Balance Sheet of M/s. AB & Co as on 31.3.2012 is as under

Liabilities Assets

Capital & Reserves 78000 Fixed Assets 150000

Bank Loan 100000 Stocks 20000

Sundry Creditors 30000 Debtors 30000

Bank OD 5000 Pre-paid Expenses

Bills Payable 12000 Cash in Hand 15000

Goodwill

Preliminary Expenses 10000

Total 225000 225000

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 Ist Year 2nd Year
Sales (Credit Sales ) 300000 270000
Net Profit before Interest 51000 84000
and Tax
Depreciation 4000 6000
Interest on long term 5000 10000
liabilities
Taxes 4000 6000

Analyze financial strengths and weaknesses of firm by conducting the following tests.

Short Term Liquidity Test

Long Term Solvency Test
Efficiency Test
Profitability Test

Short Term Liquidity Position:

It can be judged from the following Ratios:

1. Current Ratio
2. Acid Test Ratio

Current Ratio: Current Assets/ Current Liabilities

(Indicator of Short Term Liquidity Position)
Year 1
Current Assets = 10000+30000+2000+20000 = 62000
Current Liabilities = 25000+15000 = 40000
Current Ratio = 62000/40000 = 1.55 : 1
Year 2
Current Assets = 20000+30000+15000 = 65000
Current Liabilities = 30000+12000+5000= 47000
Current Ratio = 65000/47000 = 1.38 : 1

Acid Test Ratio = Quick Assets/ Current Liabilities

Quick Assets = Current Assets – Stock – Prepaid Expenses
Year 1
Quick Assets = 62000-10000-2000 = 50000
Current Liabilities = 25000+15000 = 40000
Quick Ratio = 50000/40000 = 1.25:1
Year 2
Quick Assets = 65000 – 20000 = 45000
Current Liabilities = 30000+12000+5000= 47000
Quick Ratio = 45000/47000 = 0.96 : 1

92
Long Term Solvency Test:
It can be judged from the following ratios:
TOL/TNW
Debt Equity Ratio
DSCR
TOL/TNW = Total Outside Liabilities
Tangible Net Worth)
(Indicator of Long Term Liquidity Position)
Year 1
Total Outside Liabilities = 50000+25000+15000 = 90000
Tangible Net Worth = Capital – Intangible Assets = 102000-30000 = 72000
TOL/TNW = 90000/72000 = 1.25 : 1
Year 2
Total Outside Liabilities =100000+30000+5000 + 12000 = 147000
Tangible Net Worth = Capital – Intangible Assets = 78000-10000 = 68000
TOL/TNW = 147000/68000 = 2.16 : 1

Debt Equity Ratio= Long Term Liabilities

TNW

Year 1
Long Term Liabilities = 50000
Tangible Net Worth = Capital – Intangible Assets = 102000-30000 = 72000
Debt Equity Ratio= 50000/72000=.69:1
Year 2
Long Term Liabilities = 100000
Tangible Net Worth = Capital – Intangible Assets = 78000-10000 = 68000
Debt Equity Ratio= 100000/68000=1.47:1

DSCR(debt service coverage ratio)

DSCR= Net Profit after tax but before Depreciation and Interest / interest and instalment
liability
Year 1
Net Profit after tax but before Depreciation and Interest = 51000 + 4000= 55000
(Supposing Income tax is zero)
Interest = 5000 Instalment of loan = 5000DSCR = 55000 / (5000+5000) =
55000/10000 = 5.5 times

Year 2
Net Profit after tax but before Depreciation and Interest = 84000+6000= 90000
(Supposing Income tax is zero)
Interest = 10000 Instalment of loan = 12000
DSCR = 90000 / (10000+12000) = 90000/22000 = 4.1 times

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Efficiency Test
Debtor Turnover Ratio =
Net Annual Credit Sales/Average Debtors

Year 1
Net Annual Credit Sales = 300000
Average Debtors = 30000
Debtor Turnover Ratio = 300000/30000=10 times
Average Collection Period = 365/10 = 36 days
Year 2
Net Annual Credit Sales = 270000
Average Debtors = 30000
Debtor Turnover Ratio = 270000/30000=9 times
Average Collection Period = 365/9 = 40 days

Stock Turnover Ratio =

Sales (or if cost of goods sold given) /Average Stock
Year 1
Sales = 300000
Average stock = 10000
Stock Turnover Ratio = 300000/10000 = 30 times
Average Inventory holding = 365/30 = 12 days

Year 2
Sales = 270000
Average stock = (10000+20000) / 2 = 15000
Stock Turnover Ratio = 270000/15000 = 18 times
Average Inventory holding = 365/18= 20 days

Profitability Test
ROCE (Return on Capital Employed Ratio) =
Net Profit Before Interest and Tax (NBIT) / Average Capital Employed * 100

NBIT = Net Profit+ Interest on Long term Liabilities + Taxes = 51000

Capital Employed Ist year = (Capital +Reserves +Surpluses) + Long Term Loans –
Intangible Assets
=102000 +50000 – 30000=122000
Capital Employed (2nd year) = 78000+100000-10000=168000

Average Capital Employed = (Opening Capital Employed + Closing Capital Employed) /2

= (122000+168000)/2 =145000

Year 1
ROCE = 51000/122000*100=42%
Year 2
ROCE = 84000/145000*100 = 58%

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Comments:
Although short term liquidity position of the firm has weakened yet the Ratio(1.38:1) is still
above satisfactory norms i.e. 1.33 : 1. The firm is required to maintain the ratio and should
not allow the same to slip further.

The Acid Test Ratio has deteriorated in the 2 nd year to below minimum level of 1:1 which
implies that the short term funds are blocked in stocks and pre-paid expenses.

Average Collection Period has increased from 36 days to 40 days which implies that the
short term funds of the firms are being blocked with debtors for more days and the firm
requires funding to carry on its day to day activities.

There is an alarming downfall in Inventory Turnover Ratio. Average Stock holding has risen
from 12 days in the first year to 20 days in the 2 nd year. Sales has decreased and Average
Stock has increased.

TOL/TNW indicates that the dependence on Outsiders has increased considerably. The
Owned funds have decreased and as such Long term Liquidity position is not satisfactory.
Further funding to the firm will further increase dependence on outsiders.

There is positive feature that ROCE has increased from 42% in the Ist year to 58% in the 2 nd
year. It implies that Assets created out of funds are being used efficiently in the business.

Although DSCR has decreased from 5.5 times to 4.1 times yet the ratio is above satisfactory
level and as such coverage of profits is acceptable.

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 Asset Classification

One of the important recommendations of Narsimham Committee was to adopt International

Accounting Practices and Accounting Standards with an objective of bringing transparency
in the Balance Sheet.

The major source of Income in the banks is in from Interest on loans, which is booked
initially and recovered later on i.e. on Accrual basis. If the same is not recovered within
reasonable time, the Income should not be recognized as per International Standards.

Narsimham Committee suggested as under:

1. Classification of assets into 4 categories:

 Standard Assets: The loan account which is not NPA.
 Sub-standard Assets: The loan account which is classified as NPA.
 Doubtful assets: The loan account which remains NPA for >1year
 Loss Assets: The loan account in which security is not available.

How and when the account becomes NPA?

Type of Account Period

TL becomes NPA if Interest/Principal remains Overdue More than 90 days
CC/OD becomes NPA if it remains out of order More than 90 days
The account is treated as out of order: if
 Outstanding balance is continuously above DP
 There are no credits in the account for >90 days
 Credit is not enough to cover interest during same
period
Bill becomes NPA if it remains Overdue for More than 90 days
Agriculture Loan account becomes NPA if overdue After 2 crop seasons
In case of Long duration crops After 1 crop season

KCC Account will be treated as NPA if it is out of order:

A KCC account will be treated as out of order in the following circumstances:

 There are no credits in the account continuously for two crop seasons/one crop
season (as the case may be) as on the date of balance sheet.
 The outstanding remains continuously in excess of the limit for two crop seasons/one
crop season (as the case may be) as on the date of balance sheet.
 The credits in the account are not sufficient even to cover the interest debited in
respect of the account for two crop seasons/one crop season (as the case may be).

Projects Under Implementation Involving Time Overrun

DCCO (Date of Commencement of Commercial Operations) for all project loans should be
fixed. If it fails to commence commercial operations within 6 Months, even if regular, will be
treated as NPA. For infrastructure Projects, the time period is 2 years.

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Asset Classification

Loan Account remains in Sub standard category for 1 year

Loan becomes Doubtful after remaining 1 year in D1 category for 1 year
Substandard category). D2 category from 1-3 years
(The account is transferred to Doubtful category directly D3 category beyond 3 years
if security loss is 50% or above)
Loan becomes Loss Asset If Loss of security is either 100%
or 90% or more.

Non- Financial reasons for account becoming NPA

1. Stock Statement not received for 3 Months.
2. Limit is overdue for renewal for 6 M.

Up-gradation of NPA into Standard Category

The account is upgraded on same day when the recovery is made.

Implications of Accounts after becoming NPA

1. Interest is not charged and not credited to Income head.
2. Interest accrued and credited to Income account but not recovered during
corresponding previous year will be reversed.
3. Provision is made for NPAs (Bad and Doubtful debts) from the current year’s profits.
Asset Classification – Borrower wise and not Facility wise
It means if one account of the borrower is classified as NPA, other accounts will also
be treated as NPAs even if these are regular.
Advances under Consortium
Each bank will take view of transferring account to NPA category on the basis of its
own recovery.
PROVISIONING NORMS

In terms of Monetary policy 2011-12, the revised norms of provisioning are as under:
Standard Assets

Classification Rate of provision

Direct SME and Direct Agriculture 0.25%
Others 0.40%
CRE-RH (Residential Housing) 0.75%
CRE Commercial Real Estate 1%
Teaser Housing Loans 2%
Restructured accounts classified as 2.75%
standard advances:
In the first two years from the date of
restructuring.
Restructured accounts earlier 2.75%
classified as NPA and later upgraded
to standard category:
In the first year from the date of up-
gradation.

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 Non-Performing Assets

Sub-standard Advances:

 Secured Exposures 15%

 Unsecured Exposures (abnitio unsecured) 25%
 Unsecured Exposures in respect of 20%
Infrastructure loan accounts where certain
safeguards such as escrow accounts are
available.
Doubtful Advances – Unsecured Portion 100%

Doubtful Advances- Secured Portion

 For Doubtful up to 1 year 25%

 For Doubtful>1 year and up to 3 years 40%
 For Doubtful >3 years 100%
Loss Assets : These are identified by auditors 100%
where security is eroded up to 90%

Some Important Equations:

1. Net NPAs = Gross NPAs – (Provision +DICGC/ECGC cover).
2. Provisioning Coverage Ratio = NPA Provision X 100
Gross NPAs
3. Provisioning Coverage Ratio should not be less than 70% of Gross NPAs as per
bank guidelines.
4. Amount of ECGC/DICGC guarantee cover must be excluded while calculating
provision in respect of Doubtful assets. But in case of Sub-standard assets, this
cover need not to be deducted.
5. In case of Doubtful Assets, Secured portion and Un-secured portion (Security
reduced subsequently) will be segregated and provision will be calculated
accordingly.
6. Advances against NSCs/KVPs/FDs/LIC Policies need not to be classified as NPAs
as long as Value of security covers the outstanding.

GOVT. GUARANTED ACCOUNTS

 STATE GOVT: It will be declared NPA as in other loan cases.
 CENTRAL GOVT: Continued to be Standard Assets till repudiation of guarantee by
the Central Govt. However interest would not be taken into income unless actually
received

Ex. 1
Account with Outstanding of Rs. 10.00 lac became Out of order on 22.1.11 and it became
NPA on 22.4.2011. The Value of Security at later stage is Rs. 7.00 lac. Calculate Provision
as on 31.3.12.
Solution
It is a Sub-Standard Asset as on 31.3.2012.
Provision is 1000000*15/100 = 150000/-

Ex. 2

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A loan account with outstanding of Rs. 10.00 lac and Value of Security Rs. 6.00 lac was
Sub-standard as on 30.3.2008. What will be provision as on 31.3.2012?
Solution
The account will be Doubtful (DI) on 30.3.2009, D2 on 30.9.2010, D3 on 30.3.2012.
Provision will as under:
Secured portion = 6.00*100/100 = 6.00 lac
Un-secured portion = 4.00*100/100 = 4.00 lac
Total Provision = 6+4 = 10.00 lac.

Ex. 3
A loan became Doubtful on 12.2.2009. The outstanding is 6.00 lac. What will be provision on
31.3.2012.
Solution
The Account will be categorized as Doubtful (D3) as on 12.2.2012. Provision is 100% of 6.00
lac = 6.00 lac

Ex. 4
D2 category account has outstanding--10.00 lac, DI/SI ----2.00 lac, Value of security ---6.00
lac
Solution
Un- Secured portion = 10-2-6 = 2.00 lac Provision = 2.00 * 100/100 = 2.00 lac
Secured portion = 6.00 * 40/100 = 2.40 lac
Total provision = 2.00 + 2.40 = 4.40 lac

Ex. 5
D2 Category loan is having outstanding 4.00 lac, Value of Security 1.50 lac and ECGC cover
50%. Calculate provision as on 31.3.2012.
Solution
Unsecured portion = 50% of (O/s – VS) = 50% (4.00 – 1.50) = 1.25 lac
Secured portion = 1.50 lac
Provision on Unsecured portion = 1.25*100/100 = 1.25 lac
Provision on Secured portion = 1.50*40/100 = 0.60 lac
Total provision = 1.25 +0.60 = 1.85 lac.

Ex. 6
A D2 category loan is having outstanding Rs. 6.00 lac. The Collateral Security is Rs. 3.00 lac
and Primary Security is Rs. 2.00 lac. There is also Guarantee of Rs. 10.00 lac. Calculate
provision.
Solution
Unsecured portion = O/s – Primary Security – Collateral = 6.00 – 2.00 -3.00 = 1.00 lac
Secured portion = 2.00 + 3.00 = 5.00 lac.
Provision on Unsecured portion = 1.00 *100/100 = 1.00 lac
Provision on Secured portion = 5.00*40/100 = 2.00 lac
Total provision = 1.00 + 2.00 = 3.00 lac.

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