Practice questions for end-term exam

1. Why do we require a trading account and profit

& loss account? Why not prepare just one
account? How are these two financial statements
useful to a business?
Ans - A trading account and a profit & loss account serve distinct but complementary
purposes in financial reporting. The trading account focuses on the gross profit or loss
from core business activities, such as buying and selling goods. It helps businesses
understand the direct profitability of their core operations. On the other hand, the profit &
loss account provides a comprehensive view of all revenues and expenses, including
operational and non-operational activities, to determine the net profit or loss for the
period.
These two statements are useful because they give a detailed and segmented view of
the business's financial performance. The trading account allows businesses to pinpoint
inefficiencies in the cost of goods sold, while the profit & loss account offers a broader
perspective on overall profitability, including indirect costs like administrative expenses
and taxes.
Understanding these distinctions can help businesses make informed decisions about
pricing, cost management, and overall financial strategy. Imagine how powerful it would
be to pinpoint exactly where your business is thriving or struggling

2. What items will go into the trading account

and what items will go into the P & L account?
Ans - The trading account and profit and loss account are two key financial statements used
to determine a business's profitability. Here's a breakdown of what items go into each:
Trading Account:

Sales: The total revenue generated from selling goods or services.

Purchases: The cost of goods purchased for resale.
Opening stock: The value of inventory at the beginning of the accounting period.
Closing stock: The value of inventory at the end of the accounting period.
 Direct expenses: Expenses directly related to the buying and selling of goods, such as
freight inward, carriage outwards, and warehouse expenses.

The trading account calculates the gross profit or gross loss by subtracting the total cost of
goods sold (purchases + opening stock - closing stock) from the total sales.

Profit and Loss Account:

Gross profit/loss: The balance from the trading account.

Indirect expenses: Expenses not directly related to the buying and selling of goods, such as
office expenses, salaries, rent, and advertising.
Other income: Any additional income sources, such as interest received or rental income.
Other expenses: Any additional expenses not covered in the trading account or indirect
expenses.

The profit and loss account calculates the net profit or net loss by subtracting total expenses
from total income (gross profit + other income).

In summary:

The trading account focuses on the buying and selling of goods and determines the gross
profit or loss.
The profit and loss account focuses on all income and expenses of the business and
determines the net profit or loss.

Example:

| Item | Trading Account | Profit and Loss Account |

| Sales | $100,000 | |
| Purchases | $60,000 | |
| Opening stock | $10,000 | |
| Closing stock | $15,000 | |
| Freight inward | $5,000 | |
| Salaries | | $20,000 |
| Rent | | $10,000 |
| Advertising | | $5,000 |

Trading Account:

Gross profit = Sales - (Purchases + Opening stock - Closing stock) = $100,000 - ($60,000 +
$10,000 - $15,000) = $45,000

Profit and Loss Account:

Net profit = Gross profit - (Salaries + Rent + Advertising) = $45,000 - ($20,000 + $10,000 +
$5,000) = $10,000

3. Can net profit be greater than gross profit?

Explain with reasons.

Ans- No, net profit cannot be greater than gross profit. Here's why:

Definitions
- Gross Profit: This is the profit a company makes after deducting the cost of
goods sold (COGS) from its sales revenue. It reflects the efficiency of production
and sales before accounting for operating expenses and other costs.

- Net Profit: This is the profit remaining after all operating expenses, interest,
taxes, and any other non-operating costs have been deducted from gross profit. It
represents the overall profitability of a business.

Explanation
1. Components:
- Gross profit is the starting point in the profit calculation.
- To arrive at net profit, you subtract all other expenses (operating and non-
operating) from gross profit.
 2. Mathematical Relation:
- The formula is:

Text {Net Profit} = text {Gross Profit} - text {Total Expenses}

- Since total expenses (which include operating costs, interest, and taxes) are
always a positive value, net profit must be less than or equal to gross profit.

3. Scenarios:
- If a business has no operating expenses or other costs, net profit can equal
gross profit.
- If expenses exceed gross profit, the net profit will be negative, indicating a
loss.

Conclusion
In summary, net profit cannot exceed gross profit because net profit is derived by
subtracting expenses from gross profit. The structure of these calculations
ensures that net profit will always be less than or equal to gross profit.

4. Why is depreciation an expense when it does

not involve any cash outflow? Explain
Depreciation is an expense because it represents the consumption of the asset's
value over time. Even though there's no direct cash outflow associated with
depreciation, it reflects the fact that the asset is wearing out or becoming obsolete.
Here's a breakdown of why depreciation is considered an expense:

1. Matching Principle: This accounting principle states that expenses should be

recognized in the same period as the revenue they help generate. For
example, if a machine is used to produce goods sold during the current year,
the depreciation expense for that machine should be recognized in the same
year.
2. Cost Allocation: Depreciation is a way to allocate the cost of a long-term
asset over its useful life. This provides a more accurate picture of the
business's profitability and financial health.
3. Tax Deduction: Depreciation is generally tax-deductible. This means that
businesses can reduce their taxable income by claiming depreciation
expenses, resulting in lower tax liabilities.
Example:
If a company purchases a machine for $10,000 with a useful life of 5 years, the
annual depreciation expense would be $2,000 ($10,000 / 5 years). While there's no
cash outflow for depreciation, the company's income statement will show a $2,000
expense, reflecting the consumption of the machine's value.

In essence, depreciation is an expense because it recognizes the economic reality

that assets lose value over time, even if there's no immediate cash outlay. By
recording depreciation, businesses can accurately measure their profitability and
comply with accounting principles.

5. Why not we consider PBT for calculating EPS?

Explain

EPS is calculated using net income, not PBT.

Here's why:
1. Relevance to Shareholders: EPS is a key metric that reflects the profitability
of a company on a per-share basis. Shareholders are interested in the
amount of profit that each share of the company generates after all expenses,
including taxes, have been deducted. PBT, on the other hand, does not
consider the impact of taxes, which can vary significantly across different
companies and jurisdictions.
2. Comparability: Using net income for EPS calculations ensures that the
metric is comparable across different companies. Since net income is the
bottom-line figure on the income statement after all expenses, including taxes,
have been deducted, it provides a more accurate representation of the
company's overall financial performance.
3. Investment Decisions: Investors often use EPS to evaluate the value of a
company's stock. A higher EPS generally indicates that the company is
generating more profit per share, which can make it more attractive to
investors. By using net income for EPS calculations, investors can make more
informed decisions about their investments.
In summary, while PBT is a useful metric for understanding a company's profitability
before taxes, it's not directly relevant to shareholders who are interested in the
company's after-tax earnings. For this reason, EPS is calculated using net income,
which provides a more accurate and comparable measure of a company's
profitability on a per-share basis.

6. What should PE ratio be compared with? Why?

Explain with reasons.
The PE ratio should be compared with:
1. Industry average: Each industry has its own typical PE ratio range.
Comparing a company's PE to the industry average can help determine
whether it is overvalued, undervalued, or fairly valued.
2. Historical PE: Comparing a company's current PE to its historical PE can
provide insights into whether the stock is trading at a premium or discount
compared to its past performance.
3. Benchmark indices: Comparing a company's PE to a relevant benchmark
index, such as the S&P 500 or the Nifty 50, can give a broader perspective on
the company's valuation relative to the overall market.
4. Growth rate: The PE ratio should also be considered in conjunction with the
company's growth rate. A higher PE might be justified for a company with
strong growth prospects.
5. Dividend yield: For companies that pay dividends, the PE ratio can be
compared to the dividend yield to assess the overall return on investment.
Reasons for comparison:
 Valuation: Comparing the PE ratio helps determine whether a stock is
overvalued or undervalued. A high PE might suggest that the stock is
overvalued, while a low PE could indicate undervaluation.
 Relative performance: Comparing the PE ratio to industry averages,
historical PE, and benchmarks provides a context for understanding how the
company is performing relative to its peers and the market.
 Investment decisions: Investors can use the PE ratio to make informed
decisions about whether to buy, sell, or hold a particular stock.
 Risk assessment: A high PE ratio might suggest that the stock is riskier, as
investors are paying a premium for future growth.
It's important to note that the PE ratio is just one of many factors to consider when
making investment decisions. It should be used in conjunction with other financial
metrics and qualitative analysis to get a complete picture of a company's value.
6. What is the ideal debt-equity ratio? Why?
Explain.
Ans - The ideal debt-equity ratio varies depending on industry, company size,
and risk tolerance. There is no one-size-fits-all answer. However, here are some
general guidelines:

 Low debt-equity ratio: This indicates a company is financed primarily by

equity, which is generally considered safer as it doesn't require interest
payments. However, a very low debt-equity ratio can limit growth
opportunities.
 High debt-equity ratio: This indicates a company is financed primarily by
debt, which can increase financial risk due to interest payments and the
potential for default. However, a moderate level of debt can enhance returns
on equity.
 Optimal debt-equity ratio: The optimal debt-equity ratio for a company
depends on various factors, including:
o Industry: Some industries, such as utilities and real estate, typically
have higher debt-equity ratios due to the capital-intensive nature of
their businesses.
o Company size: larger companies often have more access to debt
financing and can handle higher debt levels.
o Risk tolerance: A company's management team and investors may
have different risk tolerances, which can influence their preferred debt-
equity ratio.
o Economic conditions: During economic downturns, high debt levels
can increase financial risk.
In general, a debt-equity ratio between 0.5 and 1.5 is often considered
acceptable. However, it's important to analyse each company's specific
circumstances to determine the ideal ratio.
Why is the debt-equity ratio important?
 Financial risk: A higher debt-equity ratio indicates higher financial risk due to
interest payments and the potential for default.
  Return on equity: A moderate level of debt can enhance returns on equity by
leveraging assets.
 Creditworthiness: A lower debt-equity ratio can improve a company's
creditworthiness and access to financing.
 Industry standards: The debt-equity ratio should be compared to industry
standards to assess a company's relative financial risk.
It's important to note that the debt-equity ratio is just one of many financial
metrics that should be considered when evaluating a company's financial
health. Other factors, such as profitability, liquidity, and asset turnover, should also
be taken into account.

7. What is the use of a Common Size Financial

Statement? Explain with an example.

A common size financial statement is a financial statement that expresses all

items as a percentage of a base figure. This allows for easier comparison of
financial data across different companies or over time, regardless of their size.
Common size financial statements are typically prepared by dividing each item
on the income statement by total revenue and each item on the balance sheet
by total assets. This makes it easier to compare the relative importance of different
items within each statement.
Example:

Item Company A Company B

Sales $100,000 $200,000

Cost of goods sold $60,000 $120,000

Gross profit $40,000 $80,000

Operating expenses $20,000 $40,000

Net income $20,000 $40,000

Common size income statement:

Item Company A Company B

Sales 100% 100%

Cost of goods sold 60% 60%

Gross profit 40% 40%

Operating expenses 20% 20%

Net income 20% 20%

In this example, both Company A and Company B have the same gross profit
margin (40%) and net profit margin (20%), even though they have different
sales figures. This shows that their profitability is comparable, regardless of their
size.
Common size financial statements are useful for:
 Comparing companies of different sizes: This is because the common size
format eliminates the effect of size differences.
 Analysing trends over time: By comparing common size financial
statements from different periods, it is easier to identify trends and changes in
a company's financial performance.
 Identifying areas for improvement: Common size financial statements can
help to identify areas where a company's performance is lagging behind its
peers or industry benchmarks.
 Evaluating the efficiency of operations: By analysing the relative size of
different items on the income statement and balance sheet, it is possible to
assess the efficiency of a company's operations.
8. Asset turnover ratio should be less than 1: 1. Is
this statement correct? Explain with reasons.

The statement "Asset turnover ratio should be less than 1:1" is not necessarily
correct. The asset turnover ratio can vary significantly depending on the industry and
the specific business model. Here’s an explanation:

Asset Turnover Ratio Defined

- Formula: The asset turnover ratio is calculated as:

{Asset Turnover Ratio} = {{Net Sales}} {{Average Total Assets}}

- This ratio measures how efficiently a company uses its assets to generate sales.

Interpretation
1. Ratio Greater Than 1:
- A ratio greater than 1 indicates that the company generates more sales than the
value of its assets, which can be a sign of efficient asset management.
- Many retail and service businesses tend to have asset turnover ratios greater
than 1, as they can generate substantial sales with relatively low asset bases.

2. Ratio Less Than 1:

- A ratio less than 1 means that the company’s sales are less than its total assets.
This can be common in capital-intensive industries (like manufacturing, utilities, or
transportation) where significant investment in fixed assets is necessary.
- In such cases, a lower asset turnover ratio might be acceptable or even
expected, as high-value assets are needed to support operations.

Industry Variations
- Capital-Intensive Industries: Industries such as utilities, telecommunications, or
manufacturing often have lower asset turnover ratios because they require large
investments in fixed assets.
- Retail and Service Industries: These sectors typically have higher ratios due to their
ability to generate high sales relative to lower asset bases.

Conclusion
The appropriate level of the asset turnover ratio is context-dependent. It is essential
to compare the ratio to industry averages and consider the specific operational
model of the business. Thus, stating that the asset turnover ratio should be less than
1:1 is misleading without considering these factors. A ratio of 1 or greater can
indicate efficient asset utilization, while a lower ratio may be acceptable in certain
contexts.

9. What does interest coverage ratio measure?

How does the ratio help lenders? Explain

The interest coverage ratio measures a company's ability to meet its interest
payments on debt obligations. It is calculated by dividing earnings before interest
and taxes (EBIT) by interest expense.

A high interest coverage ratio indicates that a company has ample earnings to cover
its interest payments, which is a positive sign for lenders. A low interest coverage
ratio, on the other hand, suggests that a company may struggle to meet its debt
obligations, which is a risk for lenders.

Here are some ways in which the interest coverage ratio helps lenders:

Assessing creditworthiness: Lenders use the interest coverage ratio to assess a

company's creditworthiness and determine whether it is a good credit risk. A high
interest coverage ratio suggests that the company is more likely to repay its debt.
 Setting interest rates: Lenders use the interest coverage ratio to set interest rates
on loans. A company with a high interest coverage ratio may be able to obtain a
lower interest rate.
Monitoring debt repayment: Lenders use the interest coverage ratio to monitor a
company's ability to repay its debt over time. A declining interest coverage ratio may
indicate that the company is facing financial difficulties.

In conclusion, the interest coverage ratio is a valuable tool for lenders to assess a
company's creditworthiness, set interest rates, and monitor debt repayment. A high
interest coverage ratio is generally a positive sign for lenders, while a low interest
coverage ratio may indicate increased risk.
10. Calculate debt-equity ratio from the
following:

Equity Rs. S. Rs.

Share 5,00,00 Creditor 1,00,00
Capital 0 s 0

Retained Rs. Advance Rs.

Earnings 15,00,0 received 50,000
00 from
custome
rs

Long- Rs. Secured Rs.

term 5,00,00 loans 10,00,0
Borrowin 0 (apart 00
gs from
borrowin
gs
shown
earlier)

Short- Rs. Unsecur Rs.

term 2,50,00 ed loans 2,50,00
Borrowin 0 (apart 0
gs from
borrowin
gs
shown
earlier)
Hint: be clear about the components of equity
and debt

Ans - To calculate the debt-equity ratio, we need to identify the total debt and total
equity from the provided information.

Components

1. Total Equity:
- Equity Share Capital: Rs. 5,00,000
- Retained Earnings: Rs. 15,00,000

Total Equity: {Total Equity} = {Equity Share Capital} + {Retained Earnings} =

5,00,000 + 15,00,000 = Rs. 20,00,000

2. Total Debt:
Total debt includes both long-term and short-term borrowings. We will sum all forms
of borrowings.

- Long-term Borrowings: Rs. 5,00,000

- Secured Loans: Rs. 10,00,000
- Short-term Borrowings: Rs. 2,50,000
- Unsecured Loans: Rs. 2,50,000

Total Debt:

{Total Debt} = {Long-term Borrowings} + {Secured Loans} + {Short-term Borrowings}

+ {Unsecured Loans}

{Total Debt} = 5,00,000 + 10,00,000 + 2,50,000 + 2,50,000 = Rs. 20,00,000

Debt-Equity Ratio Calculation
Now we can calculate the debt-equity ratio using the formula:

{Debt-Equity Ratio} = {Total Debt}} {{Total Equity}}

{Debt-Equity Ratio} = {20,00,000}/ {20,00,000} = 1:1

Conclusion
The debt-equity ratio is 1:1, indicating that the company's debt and equity are
balanced in terms of financing.

11. Why should we not consider inventory value

while calculating quick ratio? Explain

Ans - Inventory is excluded from the quick ratio calculation because it is

considered a less liquid asset. While inventory can be converted into cash, it takes
time to sell and may not be easily realized at its full value, especially in the short
term.
The quick ratio, also known as the acid-test ratio, is a liquidity ratio that measures a
company's ability to meet its short-term obligations using its most liquid assets. It is
calculated as follows:
Quick Ratio = (Current Assets - Inventory) / Current Liabilities

By excluding inventory, the quick ratio provides a more conservative estimate of a

company's ability to pay its short-term debts. It focuses on the company's highly
liquid assets, such as cash, cash equivalents, and marketable securities, which can
be quickly converted into cash to meet current obligations.
In summary, inventory is excluded from the quick ratio calculation because it
is less liquid and may not be readily convertible into cash in the short term.
This provides a more accurate assessment of a company's liquidity and its ability to
meet its immediate financial obligations.

12. Why cannot we calculate fixed cost per unit

of the finished product? Explain.
Ans - Fixed costs cannot be calculated per unit of the finished product
because they do not vary with changes in production volume. Fixed costs
remain constant within a relevant range of production. This means that whether a
company produces 100 units or 1,000 units, the total fixed costs will remain the
same.
Calculating fixed cost per unit would lead to a misleading analysis of costs
and profitability. For example, if a company produces 100 units and has total fixed
costs of $10,000, the fixed cost per unit would be $100. However, if the company
increases production to 1,000 units, the fixed cost per unit would decrease to $10.
This is not an accurate representation of the true cost of each unit.
To accurately analyse costs and profitability, it is important to distinguish
between fixed and variable costs. Variable costs change in direct proportion to
changes in production volume, while fixed costs remain constant. By understanding
the behaviour of both fixed and variable costs, companies can make informed
decisions about pricing, production levels, and profitability.
In summary, fixed costs cannot be calculated per unit of the finished product
because they do not vary with changes in production volume. This is why it is
important to distinguish between fixed and variable costs when analysing costs and
profitability.
13. What are the uses of marginal costing
method?
Ans - Marginal costing, also known as variable costing, is a method of costing
that allocates only variable costs to products. Fixed costs are treated as period
expenses and are not allocated to products. This method is particularly useful for:
1. Short-term decision-making: Marginal costing provides a clear picture of the
incremental cost of producing one more unit of a product. This information is
valuable for making short-term decisions such as whether to accept or reject a
special order, whether to produce a product in-house or outsource it, and
whether to continue or discontinue a product line.
2. Performance evaluation: Marginal costing can be used to evaluate the
performance of different product lines or departments. By comparing the
contribution margin (sales revenue minus variable costs) of each product or
department, it is possible to identify the most profitable areas of the business.
3. Cost-volume-profit analysis: Marginal costing is a key tool for cost-volume-
profit analysis, which helps managers understand the relationship between
sales volume, costs, and profits. By analysing the break-even point,
contribution margin ratio, and margin of safety, managers can make informed
decisions about production levels, pricing, and sales volume.
4. Budgeting and forecasting: Marginal costing can be used to prepare
budgets and forecasts. By separating fixed and variable costs, it is possible to
estimate the impact of changes in sales volume on profits.
5. Inventory valuation: Marginal costing can be used to value inventory for
internal reporting purposes. Under marginal costing, inventory is valued at
variable cost, which can provide a more accurate picture of the true cost of
goods sold.
In summary, marginal costing is a valuable tool for short-term decision-
making, performance evaluation, cost-volume-profit analysis, budgeting and
forecasting, and inventory valuation. By separating fixed and variable costs,
marginal costing provides managers with the information they need to make
informed decisions and improve the profitability of their businesses.

14. If I want to price a product, how can it use the

concept of variable cost and fixed cost.
Ans - Using Variable and Fixed Costs for Product Pricing
Understanding variable and fixed costs is crucial for effective product pricing. Here's
how you can leverage these concepts:

1. Contribution Margin Analysis:

Calculate Contribution Margin: Subtract variable costs per unit from selling price per
unit.
Determine Break-Even Point: Divide total fixed costs by contribution margin per unit.
This tells you how many units you need to sell to cover your fixed costs.
Set Price Above Break-Even: To make a profit, your selling price should be above
the break-even point.
2. Target Profit Pricing:
Set Target Profit: Determine the desired profit margin for your product.
Calculate Target Sales Revenue: Add target profit to total fixed costs.
Determine Target Sales Units: Divide target sales revenue by selling price per unit.
Adjust Pricing: If the target sales units are unrealistic, adjust the selling price
accordingly.
3. Markup Pricing:
Determine Markup Percentage: Decide on the percentage markup you want to apply
to variable costs.
Calculate Selling Price: Multiply variable cost per unit by (1 + markup percentage).
4. Value-Based Pricing:
Assess Perceived Value: Determine how much customers are willing to pay for your
product based on its features, benefits, and perceived quality.
Set Price: Set a price that aligns with the perceived value and covers your variable
and fixed costs.
5. Competitive Pricing:
Analyze Competitors: Research the pricing strategies of your competitors.
Differentiate: If your product has unique features or benefits, you might be able to
justify a premium price.
Match or Undercut: Decide whether to match, undercut, or exceed your competitors'
prices based on your value proposition and market position.
Key Considerations:

Demand Elasticity: How sensitive is demand to price changes? If demand is elastic,

a small price increase can lead to a significant decrease in sales.
Cost Structure: The relative proportion of fixed and variable costs can impact pricing
strategies. A high proportion of fixed costs may necessitate higher sales volumes to
cover costs.
Market Positioning: Your desired market position (premium, value, or economy) will
influence your pricing strategy.
Long-Term Goals: Consider your long-term objectives, such as market share,
profitability, and brand image, when setting prices.
By carefully analyzing variable and fixed costs, you can develop a pricing strategy
that maximizes profitability while meeting your business goals.
15. A business does not have any profit or loss.
What is the financial term used to describe this
situation?
Ans - Break-even point is the financial term used to describe a situation where a
business has no profit or loss. It is the point at which a company's total revenue
equals its total costs.

In other words, the business has earned just enough to cover its expenses, but has
not made a profit or incurred a loss.

1. Explain the relationship between sales, variable cost, contribution, fixed

cost and profit at breakeven point. Try permutation and combination.

Ans - Break-Even Point: A Balancing Act

At the break-even point, a business neither makes a profit nor a loss. This means
that its total revenue exactly equals its total costs. Let's break down the components
involved:

Key Terms:

 Sales: The total revenue generated by selling goods or services.

 Variable Cost: Costs that change directly in proportion to changes in
production or sales volume.
 Contribution: The difference between sales revenue and variable costs. It
contributes towards covering fixed costs and generating profit.
 Fixed Cost: Costs that remain constant within a relevant range of activity,
regardless of changes in production or sales volume.
 Profit: The difference between total revenue and total costs.
The Break-Even Equation:

 Total Revenue = Total Costs

 Sales Volume Selling Price Per Unit = (Fixed Costs + Variable Costs Per
Unit Sales Volume)

Permutation and Combination of Relationships:

1. Contribution Margin and Fixed Costs:

 At the break-even point, the total contribution margin equals the total fixed
costs.
 Contribution Margin = Fixed Costs
2. Sales Volume and Break-Even Point:
 The break-even point can be calculated using the following formula:
o Break-Even Point (in units) = Fixed Costs / Contribution Margin
Per Unit
 A higher contribution margin per unit means a lower break-even point, making
the business more profitable.
3. Variable Cost and Profit:
 If variable costs increase, the contribution margin decreases, leading to a
higher break-even point and lower profitability.
 Conversely, if variable costs decrease, the contribution margin increases,
leading to a lower break-even point and higher profitability.
4. Fixed Cost and Profit:
 If fixed costs increase, the break-even point increases, meaning the business
needs to sell more units to cover its costs and start making a profit.
 If fixed costs decrease, the break-even point decreases, making it easier for
the business to achieve profitability.
In essence, at the break-even point:
 Total revenue = Total costs
 Contribution margin = Fixed costs
 Profit = 0
By understanding these relationships, businesses can make informed decisions
about pricing, production levels, and cost management to achieve profitability.
16. State if the following common size P & L
account is correct or not.
Sales Rs. 100% Express
25,00,0 ed as a
00 % to
total
sales

Other Rs. (1/25,00,000) % Express

Income 1,00,00 ed as a
0 % to
total
sales

Manufactur Rs. (5,00,000/12,00 Express

ing 5,00,00 ,000) % ed as a
Expenses 0 % to
total
expens
es

Administra Rs. (5,00,000/12,00 Express

tion 5,00,00 ,000) % ed as a
Expenses 0 % to
total
expens
es

Publicity Rs. (2,00,000/12,00 Express

Expenses 2,00,00 ,000) % ed as a
0 % to
 total
expens
es

Note: I have shown the formulae and not the

calculations for you to easily check.
Ans - To determine if the common size P&L account is correct, let’s analyze the
formulas and the figures provided.

Common Size P&L Account Analysis

1. Sales:
- Sales: Rs. 25,00,000
- Percentage: 100% (This is correct as sales are always 100% of total sales.)

2. Other Income:
- Other Income: Rs. 1,00,000
- Percentage Calculation:
{Percentage} = {1,00,000} {25,00,000} ) times 100 = 4%

- Provided Percentage: (1/25,00,000) %) (This is incorrect. It should be expressed

as {1,00,000} {25,00,000} times 100).)

3. Manufacturing Expenses:
- Manufacturing Expenses: Rs. 5,00,000
- Percentage Calculation:
- Assuming total expenses (not provided directly) is Rs. 12,00,000.

{Percentage} = ({5,00,000} {12,00,000}) times 100 = 41.67%

 - Provided Percentage: ((5,00,000/12,00,000) %) (This is correct, but needs the
calculation to reflect a percentage.)

4. Administration Expenses:
- Administration Expenses: Rs. 5,00,000
- Percentage Calculation:

{Percentage} = {5,00,000} {12,00,000} ) times 100 = 41.67%

- Provided Percentage: (5,00,000/12,00,000) %) (This is correct, but like the

manufacturing expenses, needs calculation clarity.)

5. Publicity Expenses:
- Publicity Expenses: Rs. 2,00,000
- Percentage Calculation:
{Percentage} = {2,00,000} {12,00,000} ) times 100 = 16.67%

- Provided Percentage: (2,00,000/12,00,000) %) (Again, this is correct but requires

calculation clarity.)

Conclusion
- Overall Accuracy:
- The Sales and Manufacturing, Administration, and Publicity Expenses
percentages are structured correctly but need numerical representation in
percentage terms.
- The Other Income percentage is incorrectly calculated as it should be expressed
relative to total sales.

In summary, while the format shows the relationships, the percentages provided for
Other Income and clarity in all expense calculations need adjustment to be fully
correct.
17. State if the following common size B/S is
correct or not.

Equity Share Rs. 25,00,000 25/65100

Capital
Reserves & Rs. 40,00,000 25/65100
Surplus
Secured Rs. 5,00,000 5/65100
Loans
Non-current Rs. 50,00,000 50/70100
Assets
Current Rs. 20,00,000 50/70100
Assets

Note: I have shown the formulae and not the calculations for you to
easily check.

Ans - To determine if the common size balance sheet (B/S) is correct, let’s analyze
the figures and their corresponding percentages based on the provided formulas.

Common Size B/S Analysis

1. Total Assets and Total Liabilities

- Total Liabilities (equity + loans):
- Equity Share Capital: Rs. 25,00,000
- Reserves & Surplus: Rs. 40,00,000
- Secured Loans: Rs. 5,00,000
- Total Liabilities:

= 25,00,000 + 40,00,000 + 5,00,000 = Rs. 70,00,000

2. Total Assets:
 - Non-current Assets: Rs. 50,00,000
- Current Assets: Rs. 20,00,000
- Total Assets:

= 50,00,000 + 20,00,000 = Rs. 70,00,000

Percentage Calculations

Total Liabilities (or Total Assets) = Rs. 70,00,000

1. Equity Share Capital:

- Formula: {25,00,000} {70,00,000})
- Calculation:

{Percentage} = ({25,00,000} {70,00,000}) times 100 = 35.71%

- Provided: ({25} {65100}) (This does not correspond to the total liabilities.)

2. Reserves & Surplus:

- Formula: ({40,00,000} {70,00,000})
- Calculation:

{Percentage} = ({40,00,000} {70,00,000}) times 100 = 57.14%

- Provided: ({40} {65100}) (This does not correspond to the total liabilities.)

3. Secured Loans:
- Formula: ({5,00,000} {70,00,000})
- Calculation:
 {Percentage} = ({5,00,000} {70,00,000} ) times 100 = 7.14%

- Provided: ({5} {65100}) (This does not correspond to the total liabilities.)

4. Non-current Assets:
- Formula: ({50,00,000} {70,00,000})
- Calculation:

{Percentage} = ({50,00,000} {70,00,000} ) times 100 = 71.43%

- Provided: ({50} {70100}) (This does not correspond to the total assets.)

5. Current Assets:
- Formula: ({20,00,000} {70,00,000})
- Calculation:

{Percentage} = ({20,00,000} {70,00,000} ) times 100 = 28.57%

- Provided: ({50} {70100}) (This does not correspond to the total assets.)

Conclusion
- Overall Accuracy: The percentages provided in the common size balance sheet do
not correctly represent the financial figures as expressed against the total assets or
total liabilities.
- The formulas ({25} {65100}), ({40} {65100}), ({5} {65100}), etc., are incorrect as they
do not relate to the correct total (Rs. 70,00,000).

Thus, the common size balance sheet is not correct due to the incorrect percentage
calculations.
18. Calculate the PE ratio:

EPS: Rs. 100

Market Price: Rs. 10,000

How do you determine if this ratio is good or bad

or ideal?

Ans - Calculation of PE Ratio

The Price-to-Earnings (PE) ratio is calculated using the following formula:

{PE Ratio} = {{Market Price per Share}} {{Earnings per Share (EPS)

Given:
- EPS: Rs. 100
- Market Price: Rs. 10,000

Calculation
{PE Ratio} = {10,000}{100} = 100

Interpretation of the PE Ratio

1. Understanding the Ratio:

 - A PE ratio of 100 means investors is willing to pay Rs. 100 for every Rs. 1 of
earnings.
- This can indicate high expectations for future growth.

2. Evaluating if it's Good or Bad:

- Industry Comparison: The ideal PE ratio can vary widely by industry. Compare it
to the average PE ratio for similar companies or the industry average.
- If the PE ratio is significantly higher than the industry average, it might suggest
overvaluation or high growth expectations.
- If it is lower, it could indicate undervaluation or lack of growth prospects.

3. Historical Context:
- Compare the current PE ratio to the company's historical PE ratio. A substantial
increase could indicate that the stock is overvalued.

4. Market Conditions:
- In a bullish market, higher PE ratios are common as investors are optimistic
about future earnings. In a bearish market, lower ratios may be more typical.

5. Growth Expectations:
- High PE ratios often reflect expectations of high future growth. If the company
has strong growth potential, a high PE might be justified.

6. Risk Assessment:
- Consider the company’s stability and risk profile. High PE ratios may be more
acceptable for companies with stable and predictable earnings.

Conclusion
To determine if a PE ratio of 100 is good, bad, or ideal, you must evaluate it in the context of the
industry average, historical performance, market conditions, and growth prospects. Generally, a PE
ratio this high could indicate that investors expect significant future growth, but it also suggests that
the stock might be overvalued unless justified by strong fundamentals.