OBJECTIVE COMMERCE FOR ALL COMPETITIVE EXAMS. (CA, ICWA, CS, BBA, MBA, M. Com. etc.)

By Vivek K. Gupta & Manoj Kaushik Revised by

Dr. O.P. Sharma

Revised and Enlarged Edition

UPKAR PRAKASHAN, AGRA–2

© Publishers Publishers UPKAR PRAKASHAN (An ISO 9001 : 2000 Company)

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ISBN : 978-81-7482-149-2

Price : 199.00 (Rs. One Hundred Ninety Nine Only) Code No. 985

Printed at : Printed at : Repro Knowledgecast Limited, Thane

DEDICATED TO OUR REVERED PARENTS

Preface to the Revised Edition It is a pleasant moment indeed to place the Fourth revised and refined edition of "OBJECTIVE COMMERCE" before examinees appearing in Commerce based Competitive examinations. In this revised edition most of the chapters have been rewritten and some major and substantial changes have also been made. The main redeeming and distinct features of this revised edition are as under : * *

*

All contents and question-answers have been framed in a systematic manner. At the end of each chapter summarised hints and analysis of important concepts of commerce are provided so that candidates can assess the understanding of the subject matter. Keeping in view the specific requirements of the candidates, a fresh and novel approach to the study of commerce is adopted.

We are deeply indebted to the students, readers and subject experts for their constant encouragement and cooperation throughout the process of bringing out this revised edition successfully. Any constructive suggestion and guidance for further improvement of the book will be gratefully acknowledged.

—Authors

CONTENTS

SECTION-I ✰ Important Equations and Formulae............................................................

3–20

SECTION-II ✰ Accounting Fundamentals ........................................................................

23–47

✰ Partnership Accounts ...............................................................................

48–62

SECTION-III ✰ Company Accounts (Introduction, Shares & Debentures) ........................

65–85

✰ Schedule VI of the Companies Act, 1956 (Balance Sheet format) ............

86–93

✰ Company Accounts—(Final Accounts) .....................................................

94–98

SECTION-IV ✰ Financial Management .............................................................................. 101–148 ✰ Financial Analysis and Ratios Analysis ..................................................... 149–161 ✰ Cash Flow and Funds Flow Statement ...................................................... 162–172 ✰ Cost-Volume-Profit or BEP Analysis ......................................................... 173–176

SECTION-V ✰ New Corporate Laws ................................................................................ 179–191 ✰ Business or Mercantile Laws .................................................................... 192–198

SECTION-VI ✰ Auditing ..................................................................................................... 201–215 ✰ Cost Accounting ........................................................................................ 216–224

( viii )

SECTION-VII ✰ Indian Partnership Act, 1932 .................................................................... 227–229 ✰ The Payment of Gratuity Act, 1972 ........................................................... 230–232 ✰ Consumer Protection Act, 1986 ................................................................ 233–235 ✰ The Industrial Disputes Act, 1947 ............................................................. 236–237 ✰ The Income Tax Act, 1961 ........................................................................ 238–240 ✰ The Payment of Bonus Act, 1965 ............................................................. 241–245 ✰ Insurance Act, 1938 (including IRDA, 1999) ............................................ 246–256

SECTION-VIII ✰ The Securities and Exchange Board of India (SEBI) Act, 1992 ................ 259–262 ✰ The Foreign Exchange Management Act (FEMA), 1999........................... 263–265 ✰ The Competition Act, 2002 (Including CCI) ............................................... 266–268 ✰ The National Food Security Act (NFSA), 2013 .......................................... 269–271

Section I

✰

Important Equations and Formulae

Obstacles are those frightful things you see when you take your eyes off —Henry Ford your goal .

IMPORTANT EQUATIONS AND FORMULAE OWNER’S EQUITY Owner’s Equity = Assets – Liabilities Assets = Liabilities + Capital Liabilities = Assets – Owner’s Equity or Capital or Net worth Owner’s Equity = Paid up Capital + Reserve & Surplus or Retained Earnings Retained Earnings = Capital Reserve + Revenue Reserve + Other Reserve or Undistributed Profits Assets = Owner’s Equity + External Liabilities Assets = Income + Gains + Liabilities – Expenses – Losses or Expenses + Losses + Assets = Incomes + Gains + Liabilities Balance Sheet Equation in Short Form A = L+C

Here,

C = A–L

A—Assets

L = A–C

C—Capital

A – C – L = Zero

L—Liabilities

FUNDS FLOW ANALYSIS Total Sources = Total Uses or Increase in Equity + Decrease in Assets = Increase in Assets + Decrease in Equity

Statement of Sources and Application of Funds Sources of Funds

Application of Funds

1. Operating Profit or 1. Operating Loss or Trading Profit Trading Loss 2. Issue of Share Cap- 2. Redemption of Prefital. erence Share Capital. 3. Issue of Debentures 3. Redemption of Debentures. 4. Raising of Long- 4. Repayment of Longterm Loans. term Loans. 5. Sale of Non-current 5. Purchase of NonAssets current Assets. 6. Sale of Assets.

Fixed 6. Purchase of Fixed Assets.

7. Non-trading Re- 7. Non-trading payceipts or Nonment (i.e., dividend trading Incomes paid) 8. Decrease in Work- 8. Increase in Working ing Capital. Capital.

Identification of Sources and Uses of Funds Sources of Funds : ● Increase in liabilities or capital or credit balances; and ● Decrease in assets or debit balances. Uses of Funds : ● Increase in assets or debit balances and ● Decrease in liabilities or capital or credit balances. ● Sources of Funds – Application of Funds = Increase in Working Capital ● Application of Funds – Sources of Funds = Decrease in Working Capital

4A | O. Com. Schedule of Changes in Working Capital Items Current Assets : Cash Bank Stock B/R Debtors

Current Year

Changes in Working Capital Last Year Increase Decrease

Sources of Cash (Inflows)

Uses of Cash (Outflows)

1. Cash from Business 1. Loss from Business Operation. Operation. — — — — —

— — — — —

Total A Current Liabilities : B/P Creditors Provision for Tax

Cash Flow Statement

— — —

— — —

Fixed 2. Purchase of Fixed Assets.

3. Raising Loans.

3. Redemption of P. Shares.

4. Issue of Shares/ 4. Redemption Debentures. Debentures.

of

5. Other Cash Re- 5. Repayment of Loans. ceipts. 6. Payment of taxes and dividends. Note : This statement considers only items relating to cash.

Total B Increase/Decrease in working capital

Working Capital =

2. Sale of Assets.

Current Assets – Current Liabilities

— Increase in Current Asset increases Working Capital. — Decrease in Current Asset reduces Working Capital. — Increase in Current Liability reduces Working Capital. — Decrease in Current Liability increases Working Capital.

CASH FLOW ANALYSIS Cash Flows = Changes in cash and cash equivalents Cash = Cash in hand + cash at bank + demand deposits Cash Equivalents = Highly liquid short term investments i.e. Treasury Bills, Deposit Certificates, Commercial Papers, Money Market Deposits, Marketable Securities etc.

Calculation of Cash from Business Operation (i) Income-Expenditure Method— Cash from Operation = Cash Sales – Cash Purchases – Operating expenses paid in Cash. (ii) Net Profit Method— Rs. Net Profit as per P & L A/c ……… Add : (a) Non-Cash Expenses ……… (b) Decrease in Current Assets ……… (Except Cash & Bank, Debtors, B/R and Loans Granted) (c) Increase in Current Liabilities (Except Bank Overdraft) ……… Total Lessl Cash from Operation

……… ……… ………

Examples of Non-Cash Transactions (i) Depreciation on Fixed Assets. (ii) Profit or Loss on Sales of Fixed Assets.

O. Com. | 5A (iii) Profit or Loss on Revaluation of Fixed Assets. (iv) Amortisation of Intangible Assets. (v) Creation of Reserves. (vi) Amortisation of Deferred Revenue Expenses.

RATIO ANALYSIS Leverage Ratios or Capital Structure Ratios or Long-term solvency Ratios Debt-Equity Ratio Debt = Equity Or External Equities = Internal Equities Long term Borrowings Or = E.S. Capital + P.S. Capital + Reserve & Surplus – Fictitious Assets Shareholders Equity Ratio Shareholders Equity = Total assets (Tangible) Debt to Net Worth Ratio Long-term debt = Net Worth Capital Gearing Ratio Fixed Cost Bearing Funds = Variable Cost Bearing Funds Fixed assets to Long-term funds Ratio Fixed assets = Long-term funds Proprietory Ratio Proprietors’ Funds or Net Worth = Total Tangible Assets Debt Service Coverage Ratio =

PAT + Dep. + Int. + Other Non Cash expenses Interest + Periodic loan installment

Dividend Coverage Ratio Net Profit after Tax and Pref. Dividend = Dividend Interest Cover =

Profit before Interest‚ depreciation and Tax Interest

Short-Term Solvency Ratios or Liquidity Ratios Current Ratio or Working Capital Ratio Current Assets‚ Loans & Advances = Current Liabilities & Provisions Quick or Liquid Ratio or Acid Test Ratio Current Assets‚ Loan & Advances – Inventories = Current Liabilities & Provisions – Bank Overdraft Absolute Liquid Ratio (Super Quick Ratio) Absolute Liquid Assets = Current Liabilities & Provisions Absolute Liquid Assets = Cash in hand + Cash at Bank + Marketable Securities Cash Position Ratio Cash + Marketable Securities = Current Liabilities Profitability Ratio Net Profit Net Profit Ratio = × 100 Sales (Net) Return on Capital Employed (ROCE) or Return on Investment (ROI) Profit ROI = × 100 Capital invested Net Profit Sales Or = × × 100 Sales Capital invested ROI is known as overall Profitability Ratio Earning Per Share (EPS) (i) EPS when Debt and Equity used (EBIT – I) (1 – T) = N (ii) EPS when Dept, Preference and (EBIT – I) (1– T) – Dp Equity used = N Where, EBIT = Earnings before Interest and Tax I = Interest T = Rate of Corporate Tax Dp = Preference Dividend N = Number of Equity Shares Cash Earning Per Share (Cash EPS) Net Profit + Depreciation Cash EPS = No. of Equity Shares

6A | O. Com. Gross Profit Ratio Sales – Cost of goods sold = × 100 Sales Gross Profit Or = × 100 Sales Net Profit Ratio Net Profit before Interest and Tax = × 100 Sales Cash Profit Ratio Cash Profit = × 100 Sales Cash Profit = Net profit + Depreciation Return on Assets Net Profit after Tax and Interest Or = Total Assets excluding Fictitious Assets × 100 Net Profit after Tax + Interest = × 100 Total assets Return on Shareholders funds or Return on Net Worth Net Profit after interest and tax = × 100 Net Worth Net Worth (Shareholders Funds) = Equity Shares + Preference shares + Reserves and Surplus - Losses Operating Profit Operating Profit Ratio = Sales Activity or Turnover Ratios Inventory Turnover Ratio Cost of goods sold = Average inventory Sales Or = Average inventory Average Inventory Op. Stock + Cl. Stock = 2 Stock Velocity Average Stock = Average daily cost of goods sold 12 months/52weeks/365 days Or = Stock Turnover Ratio Debtors Turnover Ratio Net Credit sales = Average Debtors and B/R

Average Debtors Collection Period (in days) Average Debtors = × 365 Net Credit Sales Bad debts to Sales Ratio Bad Debts = Sales Creditors Turnover Period (in days) Average Creditors = × 365 Net Credit Purchases Creditors Turnover Ratio Net Credit purchases = Average Creditors Creditors’ Velocity Or Debt Payment Period Average Trade Creditors = Average Net Credit Purchases per day 12 months/52weeks/365 days Or = Creditors Turnover Ratio Fixed Assets Turnover Ratio Sales = Fixed Assets Total Assets Turnover Ratio Sales = Total Assets Working capital Turnover Ratio Sales = Working Capital Sales to Capital Employed Ratio Sales = Capital Employed Capital Turn Over Cost of Sales = Capital Employed Operating Ratios Operating Ratio Operating Cost = × 100 Net Sales [Operating cost = Cost of goods sold + Other Operating exps.] [Cost of goods sold = Opening Stock + Purchases + Wages + Other Direct Expenses – Closing Stock] Net Operating Profit Ratio = 100 – Operating Ratio

O. Com. | 7A Material Cost Ratio Material consumed = × 100 Sales Labour cost Ratio Labour Cost = × 100 Sales Factory Overhead Ratio Factory expenses = × 100 Sales Administrative Expenses Ratio Administrative expenses = × 100 Sales Selling and Distribution Expenses ratio Selling and distribution expenses = × 100 Sales Market Test Ratios Dividend Payout Ratio Dividend per Share = Earnings per Share Dividend Yield Dividend per Share = ×100 Market Price Book Value Equity Capital + Reserves – Debit balance of Profit and Loss A/c = No. of Equity Shares Price – Earnings Ratio or P/E Ratio Current market price per Share = Earnings per Share MPS Or = EPS

CAPACITY RATIOS Efficiency Ratio : Efficiency ratio reveals the input-output relationship. Input is available in terms of hours worked. Output is converted into standard hours to determine the relationship of input and output. It is a very important ratio and it reveals the extent of efficiency or inefficiency of production during the related period. It can be referred to as a hypothetical

hours which measures the amount of work which should be performed in one hour according to standard. Efficiency Ratio Output expressed in terms of standard hours = × 100 Actual hours spent for producing that output Activity ratio : This ratio refers to the relationship between output expressed in terms of standard hours and the budgeted standard hours. In other words, following three steps are involved in determining this ratio: a. Actual output should be expressed in terms of standard hours. b. Budgeted output should be expressed in standard hours. c. Percentage relationship of (a) and (b) should be expressed. This ratio highlights the actual level of activity in comparison to budget activity level. This ratio reveals how effectively or ineffectively actual efforts were made in comparison to budgeted estimates. Activity ratio is expressed as under: Activity Ratio Actual output in standard hours = × 100 Budgeted output in standard hours Productivity Ratio SH per Actual Production = × 100 Actual Hours Worked Calendar ratio : It refers to the relationship between actual number of working days in a period and the number of working days in the related budget period: Calendar Ratio Actual No. of working days in a period = × 100 No. of working days in related budgeted period Actual capacity usage ratio : This ratio refers to the relationship between actual number of working hours and

8A | O. Com. the maximum possible number of working hours in a period as per budget : Actual Capacity Usage Ratio Actual hours worked × 100 Maximum possible working hours Actual usage of budgeted capacity ratio : =

This ratio refers to the relationship between actual number of working hours and the budgeted number of working hours for that period. While actual capacity usage ratio refers to the utilization of available capacity, actual usage of budgeted capacity ratio stresses the utilization of budgeted capacity only: Actual Usage of Budgeted Actual working hours = × 100 Budgeted hours Standard capacity usage ratio : This ratio refers to the relationship between budgeted hours and maximum possible working hours in a budget period. Standard Capacity Usage Ratio =

Budgeted hours × 100 Maximum possible no. of working hours

WORKING CAPITAL MANAGEMENT Gross Working Capital = Total Current Assets Working Capital = Current Assets – Current Liabilities

Net Working Capital =

Total Current Assets – Total Current Liabilities Gross Operating Cycle = Raw material conversion period + Work-in-process conversion period + Finished goods conversion period + Book debts conversion period Net Operating Cycle = Gross Operating Cycle – Payment deferral period

Working Capital Leverage C.A = T.A. – Δ C.A Where, C.A. = Current assets T.A. = Total assets (i.e. Net fixed assets + Current assets) Δ C.A = Change in current assets Operating Cycle Approach of Estimating Working Capital

(Estimated Cost of goods sold ×

) + Desired cash balance

Operating Cycle 365

MANAGEMENT OF INVENTORY OR STOCK Economic Order Quantity (EOQ) 2 AB CS Where, A = Annual consumption in Units B = Cost of placing an order C = Cost per Unit S = Storage and other inventory carrying cost EOQ is known as optimum quantity of material which is purchased and kept in a single lote. Inventory Levels ● Re-order Level = Maximum Consumption Rate × Maximum Re-order Period Or = (Lead Time × Usage Rate per day) + Safety Stock ● Minimum Stock Level / Safety Stock = Re-order level – (Average or Normal Usage × Average lead Time) ● Maximum Stock Level = Re-order level + Economic Order Quantity – (Minimum usage × Minimum lead time) Or = EOQ + Safety Stock ● Danger level = Minimum Rate of Consumption × Minimum Re-order Period or Danger level = Average Consumption × Lead time for emergency purchases EOQ =

O. Com. | 9A ●

●

●

Average Stock level 1 = (Minimum Stock Level + Maxi2 mum Stock Level) 1 Or = Minimum Stock Level + Reorder 2 Quantity Inventory Performance Index Actual Materials Turnover Ratio = Standard Materials Turnover Ratio × 100 Optimum Production Run Size =

Production

= Cost of Sales + Closing Stock – Opening Stock Purchases = Closing Stock + Usage – Opening Stock Segregation of variable Component of Semi variable Cost Change in Total cost = Change in level of activity

CAPITAL BUDGETING

⎯⎯ √

2UP I

where, U = No. of units to be produced within one year P = Set up cost per production run I = Carrying cost per unit per annum

TREASURY MANAGEMENT Baumol’s Cash Management Model C =

BUDGETING AND BUDGETARY CONTROL

2 BT

I

Where, C = Optimal transaction size B = Fixed cost per transaction T = Estimated cash payments during the period I = Interest on marketable securities per annum . Miller-Orr Cash Management Model (3/4 × Transaction Cost × Variance of cash flows)1/3 =3 Interest rate Return Point Spread = Lower limit + 3 Cash Proportion Ratio Cash balance = Current assets Cash Turnover Ratio Sales per period = Initial cash balance Cash Conversion Cycle = Inventory conversion period + Receivable conversion period – Payable deferral period

I.

In case of equal Annual Cash Inflows : Payback Period Initial Investment/cost = Uniform Annual Cash Inflows II. In case of unequal Annual Cash Inflows : Payback Period = Calculation of investment recovery time by accumulation of the cash inflows (inclusive of depreciation) year by year until the cash inflow equal the amount of original investment. Payback Period Reciprocal 1 = × 100 Payback Period Post Payback Period Profitability = Total Cash Inflows in Life – Initial Cost Or = Annual Cash Inflows × (Total Life – Payback Period) Accounting Rate of Return (ARR) Average Annual Profit after Tax & Dep. = Average or initial investment ×100 Average investment Initial investment + Salvage value = 2 Average Rate of Return or ARR Average Annual Cash Inflows – Annual Dep. = × 100 Average Investment

9 7 98 78 81 87 14 7 894 72 8818 214 7194 428 92 12 4 9 2