NCERT Solution for Class 12 Accountancy Part 2 Chapter 5 – Accounting Ratios

NCERT solution for class 12 Accountancy Part 2 Chapter 5 – Accounting Ratios

Short Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5

5. The average age of inventory is viewed as the average length of time inventory is held by the firm for which explain with reasons.

Inventory Turnover Ratio: This ratio is a relationship between cost of goods sold and the average inventory maintained during a particular time period. It determines the efficiency with which a firm is able to manage its inventory.

It shows the average length for which firm holds the inventory.

Long Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5

1. What are liquidity ratios? Discuss the importance of current and liquid ratio.

For determining the short-term solvency of a business liquidity ratios are essential. There are two types of liquidity ratios:

1. Current Ratio

2. Liquid Ratio/ Quick Ratio

1. Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as:

Current assets are those assets which can be easily converted into cash whereas Current liabilities are liabilities that need to paid within that accounting period

Importance of Current Ratio

Current ratio helps in determining a firm’s ability to pay off the current liabilities on time. If there is more of current assets as compared to current liabilities, it provides a source of security to the creditors. The ideal ratio is 2:1 (Current Assets: Current Liabilities)

2. Liquid Ratio– It deals with the relationship between liquid assets and current liabilities. This ratio determines if the firm has sufficient funds for paying off the current liabilities on an immediate basis. It can be calculated as:

Importance of Liquid Ratio

It is helpful in determining if a firm has funds that can be sufficient to pay off liabilities. It does not include stock or prepaid expenses as both these are not easily converted to cash. A ratio of 1:1 is ideal for maintaining the liquid ratio.

2. How would you study the solvency position of the firm?

A firm’s solvency position can be best studied with the help of group of ratios called as Solvency Ratios. These ratios measure the financial position of the firm by measuring its ability to pay long term liabilities, these long term liabilities include principal amount payments on due date and interest payments on a regular basis. Following ratios are used to determine long term solvency of a business.

1. Debt-Equity Ratio: This ratio shows the relationship between owner funds (equity) and borrowed funds (debt). A lower debt-equity ratio provides more security to the people who are lending to the business. It also shows that a company is able to meet long term dues or responsibilities.

2. Total Assets to Debt Ratio: It is based on the relationship between total assets and long term loans. It shows what percentage of company’s total assets are financed by creditors. A higher total assets to debt ratio makes the firm able to meet long term requirements and provides more security to lenders.

3. Interest Coverage Ratio: This ratio is used to determine the easiness with which a company is able to pay interest on the outstanding debts. It is calculated by dividing earnings before interest and taxes with interest payments. Having a higher interest coverage ratio means that company is able to meet its obligations skilfully.

.

d. Proprietary Ratio– This ratio shows the relationship between Total Assets and Shareholders fund. It is helpful in revealing the financial position of a business. A higher ratio ensures a greater degree of security for creditors. It is shown as:

3. What are important profitability ratios? How are these worked out?

Profitability ratios are calculated on the basis of profit earned by a business. This ratio gives a percentage which is used to assess the financial condition of a business

1. Return on Assets: This ratio measures the earning per rupee from assets which are invested in the company. A higher profit ratio is good for the company.

Return on Assets = Net Profit ÷ Total Assets

2. Return on Equity: This ratio deals with measuring profitability of equity fund that is invested by the company. It also measures how owner’s funds are utilized profitably to generate company revenues. A high ratio represents the better position of a company.

Return on Equity = Profit after Tax ÷ Net worth

Where Net worth = Equity share capital, and Reserve and Surplus

3. Earnings per share: This ratio helps in measuring profitability from an ordinary shareholder’s viewpoint. A high ratio represents a well off company.

Earnings per share = Net Profit ÷ Total no of shares outstanding

4. Dividend per share: This ratio measures the amount of dividend that is distributed by the company to its shareholders at the end of an accounting period. A high ratio represents that the company is having surplus cash.

Dividend per share= Amount Distributed to Shareholders ÷ No of Shares outstanding

5. Price Earnings Ratio: A profitability ratio that is used by an investor to check for share price of the company which can be undervalued or overvalued. It also indicates an expectation about the company’s earning and payback period for the investors.

Price Earnings Ratio = Market Price of Share ÷ Earnings per share

6. Return on capital employed: This ratio is all about the returns earned by the company from the funds invested in the business by its owners. A high ratio is indicative of a better position for the company.

Return on capital employed = Net Operating Profit ÷ Capital Employed × 100

7. Gross Profit: Gross profit ratio or GP ratio is a profitability ratio that deals with the relationship between gross profit and the total net sales revenue. This ratio is used to evaluate the operational performance of the business.

8. Net Profit: This is a profitability ratio that deals with relationship between net profit after tax and net sales. It is calculated by dividing the net profit (after tax) by net sales.

4. The current ratio provides a better measure of overall liquidity only when a firm’s inventory cannot easily be converted into cash. If inventory is liquid, the quick ratio is a preferred measure of overall liquidity. Explain.

Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as:

Current assets are those assets which can be easily converted into cash whereas Current liabilities are liabilities that need to paid within that accounting period

Importance of Current Ratio

Current ratio helps in determining a firm’s ability to pay off the current liabilities on time. If there is more of current assets as compared to current liabilities, it provides a source of security to the creditors. The ideal ratio is 2:1 (Current Assets: Current Liabilities)

2. Liquid Ratio– It deals with the relationship between liquid assets and current liabilities. This ratio determines if the firm has sufficient funds for paying off the current liabilities on an immediate basis. It can be calculated as:

Importance of Liquid Ratio

It is helpful in determining if a firm has funds that can be sufficient to pay off liabilities. It does not include stock or prepaid expenses as both these are not easily converted to cash. A ratio of 1:1 is ideal for maintaining the liquid ratio.

Current ratio is best suited for businesses where the available stock or inventories cannot be converted to cash easily. Examples of such industries can be locomotive companies, heavy machinery manufacturing companies etc. as heavy machinery, tools which cannot be sold easily. Similarly, businesses that can easily convert or get sold off prefer the liquid ratio as a measure to determine their liquidity. A service company is more likely to use liquid ratio as no stock is maintained.

There will be some instances when companies tend to change the ratio method being used and chose accordingly. If a company is not maintaining any stock or inventory, liquid ratio is the best option, while if stock forms the majority of the company’s assets then current ratio is the best choice as the liquid ratio of such a firm will be very low and that can create a negative impact on creditors. In such case, current ratio is a better choice to determine the overall liquidity.

Numerical Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5

1. Following is the Balance Sheet of Raj Oil Mills Limited as at March 31, 2017. Calculate Current Ratio.

Current Assets = Inventories +Trade Receivables + Cash

= 55,800 + 28,800 + 59,400

= ₹ 1, 44,000

Current Liabilities = Trade Payables = ₹ 72,000

2. Following is the Balance Sheet of Title Machine Ltd. as at March 31, 2017.

Calculate Current Ratio and Liquid Ratio.

1. Current Ratio

Current Assets = Inventories +Trade Receivables + Cash + Short term Loans and Advances

= 12, 00,000 + 9, 00,000 + 2, 28,000 + 72,000

= ₹ 24, 00,000

Current Liabilities = Trade Payables + Short-term Borrowings + Short-term Provisions

= 23, 40,000 + 6, 00,000 + 60,000

= ₹ 30, 00,000

2. Quick Ratio

Quick Assets = Trade Receivables + Cash + Short term Loans and Advances

= 9, 00,000 + 2, 28,000 + 72,000

= ₹ 12, 00,000

3. Current Ratio is 3.5:1. Working Capital is ₹ 90,000. Calculate the amount of Current Assets and Current Liabilities.

or, Current Assets = 3.5 Current Liabilities (1)

Working Capital = Current Assets − Current Liabilities

Working Capital = 90,000

or, Current Assets − Current Liabilities = 90,000

or, 3.5 Current Liabilities − Current Liabilities = 90,000 (from 1)

or, 2.5 Current Liabilities = 90,000

4. Shine Limited has a current ratio 4.5:1 and quick ratio 3:1; if the inventory is 36,000, calculate current liabilities and current assets.

or,

or, 4.5 Current Liabilities = Current Assets

or,

or, 3 Current Liabilities = Quick Assets

Quick Assets = Current Assets − Inventory = Current Assets − 36,000Quick Assets = Current Assets – Inventory = Current Assets – 36,000

Current Assets − Quick Assets = 36,000

or, 4.5 Current Liabilities − 3 Current Liabilities = 36,000

or, 1.5 Current Liabilities = 36,000

or, Current Liabilities = 24,000

Current Assets = 4.5 Current Liabilities

5. Current liabilities of a company are ₹ 75,000. If current ratio is 4:1 and liquid ratio is 1:1, calculate value of current assets, liquid assets and inventory.

Or, 4 × 75,000 = Current Assets

Or, Current Assets = 3, 00,000

Or,

Liquid Assets = 75,000

Inventory = Current Assets − Liquid Assets

= 3, 00,000 − 75,000

= 2, 25,000

6. Handa Ltd. has inventory of ₹ 20,000. Total liquid assets are ₹ 1, 00,000 and quick ratio is 2:1. Calculate current ratio.

or,

Current Assets = Liquid Assets + Inventory

= 1, 00,000 + 20,000

= 1, 20,000

7. Calculate debt equity ratio from the following information:

Long Term Debts = Total Debts − Current Liabilities

Or,

8. Calculate Current Ratio if:

Inventory is ₹ 6, 00,000; Liquid Assets ₹ 24, 00,000; Quick Ratio 2:1.

Or,

Current Assets = Liquid Assets + Inventory

9. Compute Stock Turnover Ratio from the following information:

10. Calculate following ratios from the following information:

(i) Current ratio (ii) Acid test ratio (iii) Operating Ratio (iv) Gross Profit Ratio

iv)

11. From the following information calculate:

(i) Gross Profit Ratio (ii) Inventory Turnover Ratio (iii) Current Ratio (iv) Liquid Ratio (v) Net Profit Ratio (vi) Working capital Ratio: 

(i)

12. Compute Gross Profit Ratio, Working Capital Turnover Ratio, Debt Equity Ratio and Proprietary Ratio from the following information:

13. Calculate Inventory Turnover Ratio if:

Inventory in the beginning is ₹. 76,250, Inventory at the end is 98,500, Gross Revenue from Operations is ₹. 5, 20,000, Sales Return is ₹. 20,000, and Purchases is ₹. 3, 22,250.

14. Calculate Inventory Turnover Ratio from the data given below:

15. A trading firm’s average inventory is ₹ 20,000 (cost). If the inventory turnover ratio is 8 times and the firm sells goods at a profit of 20% on sale, ascertain the profit of the firm.

Let Sale Price be ₹ 100

Then Profit is ₹ 20

Hence, the Cost of Revenue from Operations = ₹ 100 − ₹ 20 = ₹ 80

If the Cost of Revenue from Operations is ₹ 80, then Revenue from Operations = 100

16. You are able to collect the following information about a company for two years:

Calculate Inventory Turnover Ratio and Trade Receivables Turnover Ratio.

17. From the following Balance Sheet and other information, calculate following ratios:

(i) Debt-Equity Ratio (ii) Working Capital Turnover Ratio (iii) Trade Receivables Turnover Ratio

Additional Information: Revenue from Operations ₹. 18, 00,000

1. Debt-Equity Ratio

Debt = Long Term Borrowings = ₹ 12,00,0000     

Equity = Share Capital + Reserve and Surplus

= 10, 00,000 + 9, 00,000

= ₹ 19, 00,000

2. Working Capital Turnover Ratio

Revenue from Operations = ₹ 18, 00,000

Working Capital = Current Assets – Current Liabilities

= 18, 00,000 – 5, 00,000

= ₹ 13, 00,000

3. Trade Receivables Turnover Ratio

Net Credit Sales = ₹ 18, 00,000

Average Trade Receivables = ₹ 9, 00,000

18. From the following information, calculate the following ratios:

i) Quick Ratio

ii) Inventory Turnover Ratio

iii) Return on Investment

(Balance in the Statement of Profit & Loss A/c)

19. From the following, calculate (a) Debt Equity Ratio (b) Total Assets to Debt Ratio (c) Proprietary Ratio.

20. Cost of Revenue from Operations is ₹ 1, 50,000. Operating expenses are ₹ 60,000. Revenue from Operations is ₹ 2, 50,000. Calculate Operating Ratio.

21. Calculate the following ratio on the basis of following information:
(i) Gross Profit Ratio (ii) Current Ratio (iii) Acid Test Ratio (iv) Inventory Turnover Ratio (v) Fixed Assets Turnover Ratio

Average Inventory = 15,000*

Note: As the values for inventory in the beginning and inventory at the end is not given, the amount of inventory is taken as average.

22. From the following information calculate Gross Profit Ratio, Inventory Turnover Ratio and Trade Receivables Turnover Ratio.

Note: In this solution, the Trade Receivables are assumed to be as the Average Trade Receivables