# Terms of inflation effect accounting ratios

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terms of inflation effect, accounting ratios calculated have distortions and become deceptive. Sometimes, gain over time in sales, net income and other key figures disappear when the accounting data are adjusted for changes in price levels. 4. Accounting ratios are not totally dependable and they much be used after giving due weight age to general economic conditions, industry situation, position of firms within the industry, mode of operations, size of firm, diversity of product which can make the business enterprises completely dissimilar and thus affect the computation of accounting ratios. 5. The different methods of computation also influence the utility of accounting ratios. The different concepts used for determining numerator and denominator in a particular accounting ratio will not help in drawing reliable conclusions even in identical situations. 6.3.6 STEPS INVOLVED IN PREPARATION OF RATIO ANALYSIS 1. Compilation of financial data 2. Study of data 3. Systematic classification of data 4. Scientific arrangement of classified groups of data 5. Establishing relationship with related data for further comparison 6. Supplementing with appropriate comments 7. Analysis 8. Interpretation of the analysis Illustration. 1 The following figures are extracted from the balance sheet of ABC ltd as on 31 st December 2015 and 2016 2015 2016 Rs. Rs. Stock 25000 40000 Debtors 10000 16000 Cash at bank 5000 4000 Creditors 8000 15000 Bills payable 2000 3000 Provision for taxes 5000 7000 Bank overdraft 5000 15000

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75 Calculate the current ratio and acid test ratio for the two years Solution: Current assets: = Stock + Debtors + Cash at Bank = Rs. 25000 + Rs.10000 + Rs.5000 = Rs.40000 (2006) = Rs.40000 + Rs.16000 + Rs.4000 = Rs.60000 (2007) Current liabilities: = Creditors + bills payable + provision for taxes + overdraft = Rs.8000 + Rs.2000 + rs.5000 + Rs.5000 = Rs.20000 (2006) = Rs.15000 + Rs.3000 + Rs.7000 + Rs.15000 = Rs.40000 (2007) Liquid assets = Rs.10000 + Rs.5000 = Rs.15000 (2006) = Rs.16000 + Rs.4000 = Rs.20000 (2007) Liquid liabilities = Rs.8000 + Rs.2000 + Rs.5000 = Rs.15000 (2006) = Rs.15000 + Rs.3000 + Rs.7000 = Rs.25000 (2007) Currentassets Currentration = Currentaliabilities Rs.40000 2015 = = 2:1 Rs.20000 Rs.60000 2016 = = 1.5:1 Rs.20000 Liquidassets Acidtestratio = = 2:1 Liquidliabilities Rs.15000 2015 = = 1:1 Rs.15000 Rs.20000 2016 = = 0.8:1 Rs.25000
76 Illustration 2. Rs. Equity share capital 1000000 10% pref. share capital 500000 18 % debentures 800000 Loan at 15 % (long period) 140000 Current liabilities 300000 General reserve 800000 Find out capital gearing from the above particulars Solution: 10% pref. share capital + 18% debentures + long period Loan Capital gearing ratio = Equity share capital + General reserve Rs.500000 + Rs.800000 + Rs.140000 = Rs.1000000 + Rs.800000 Rs.1440000 = Rs.1800000 = 0.8 Since the ratio is less than one, it is low geared. Illustration 3. Rs. Preference share capital 300000 Equity share capital 1100000 Capital reserve 500000 Profit & loss account 200000 6% debentures 500000 Sundry creditors 240000 Bills payable 120000 Provision for taxation 180000 Outstanding creditors 160000

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77 Calculate Debt equity ratio Solution: External equities Debt equity ratio = Internal equities Rs. 120000 Debt equity ratio = Rs. 210000 = 0.57 or 4:7 It means that for every four rupees worth of the creditors investment, the shareholders have invested seven rupees. That is external are equal to 57% of shareholders fund.
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• Spring '12
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