when there is some residual of the asset.
This method is suitable in those cases where the receipts are
expected to decline as the asset gets older and, it is believed that the
allocation of depreciation of depreciation ought to be related
estimating useful life of an asset one must begin with the
consideration of its physical life and the modifications, if any,
made, factors of obsolescence and experience with similar
assets. In fact, the economic life of an asset is shorter than
To Bank A/c 60,000
(Being the purchase of lease)
31.12.90 Depreciation A/c Dr. 13920.7
To Depreciation Fund A/c 13920.7
(Being annual amount of depreciation as
per sinking fund tables)
31.12.90 Depreciation Fund Investment A/c Dr. 13920.7
To Bank A/c 1392
example that under machine hour rate method the amount of
depreciation is closely related with the frequency of use of an asset. The
simplicity in calculations and under standing is the main advantage of
this methods. However, it can be used only in case
3 18000 = Rs. 3600
2 18000 = Rs. 2400
1 18000 = Rs. 1200
12.6.5 Annuity Method
Sofar we have described such methods of charging depreciation
which ignore the interest factor. Also, some times it becomes
inconvenient for a company to follow
Units of output
Acquisition cost Scrap value
Example: If a mine is purchased for 50,000 and it is estimated that
the total quantity of mineral in the mine is 1,00,000 tonnes, the rate of
depreciation would be:
50,000 = Rs. 0.5
Hence, the ra
Date Particulars Rs. Date Particulars Rs.
1.1.93 To Bank A/c 50000 31.12.93 By Balance c/d 50000
1.1.94 To Balance b/d 50000 31.12.94 By Balance c/d 50000
1.1.95 To Bank A/c 50000 31.12.95 By Balance c/d 50000
1.1.96 To Bank A/c 50000 31.12.
(i) This method keep into account interest on money spent on
the purchase of the asset.
(ii) The value of the asset become zero at the end of life.
(i) This method is comparatively more difficult than the
methods discussed so far.
transferred to the Profit and loss account.
12.6 METHODS OF CALCULATING DEPRECIATION
The following are various methods of depreciation in use:
1. Fixed instalment method or straight line method.
2. Machine hour rate method.
3. Diministing Balance method.
Less Subscriptions received in advance 900 2,400
3. Salaries and wages:
As per Income and Expenditure Account 9,500
Add Outstanding (beginning) paid in 1998 for 1997 800
Less Outstanding not paid in 1998 900
4. Misc. expenses:
31.12.92 To Bank A/c 14616.7
1.1.92 To Balance b/d 28537.4 31.12.92 By Balance c/d 43885.0
31.12.92 To Bank A/c 15347.6
1.1.93 To Balance b/d 43885.0 31.12.93 By Bank a/c 45200.0
To Dep. Fund a/c 1315.0
31.12.93 Depreciation fund A/c Dr. 61315.0
To lease A/c 61315.0
(Being the transfer of depreciation fund
A/c to lease A/c)
31.12.93 Lease A/c Dr. 1315.0
To PCL A/c 1315.0
(Being Balance of lease A/c transferred to
1.1.94 Lease A/c Dr. 7
94500 for 1 year
Dec. 31 By Balance c/d 85050
1.192 To Balance
85050 31.12.91 By Bank (sale pro) 5000
Jan. 1 By Profit Loss account loss
on sale (16650-5000)
Dec. 31 By Depreciation 6840
Dec. 31 By Balance c/d 61560
to the Profit & Loss Account of the business concerns. It shows the
classified summary of incomes, expenses and losses for current
accounting period along with the excess of income over expenditure (i.e.
Surplus) or excess of expenditure over income (i.e.
To Annual sports meet
3,000 By Printing and stationery 900
To Annual day
2,000 By Annual day celebration
By Interest on bank loan 300
By Annual sports meet
By Sports equipment (5) 800
By Cash B
To Annual day celebration
Less donations 2,000 1,000
To Interest on bank loan 300
To Depreciation on sports
To Excess of income over
Prepare (i) Receipts and Payments Account for the year 19
December. Prepare the machinery account for five years charging
depreciation according to straight line method.
Date Particulars Rs. Date Particulars Rs.
1990 To Bank 22000 Dec. 31 By Depreciation 4000
Jan. 1 To Bank 2000 By
(i) For receiving interest:
Bank A/c Dr.
To Depreciation Fund A/c
(ii) For setting aside the amount of depreciation
Profit and loss A/c Dr.
To depreciation Fund A/c
Note: In the last year no investment will be made, because the
amount is immediately r
26 Financial Management
SOURCES OF FINANCE
Sources of finance mean the ways for mobilizing various terms of
finance to the industrial
concern. Sources of finance state that, how the companies are
mobilizing finance for their
requirements. The companies be
Market value of Debentures = 4,00,000
Value of firm = 10,80,000
Overall cost of capital =
Thus, it is evident that with the increase in debt financing, the value of
the firm has
increased and the overall cost of capital has i
where I= 12,00,000 at 7% = 84,000
Modigliani and Miller Approach
Modigliani and Miller approach states that the financing decision of a
firm does not affect
the market value of a firm in a perfect
amounts up to and including Rs. 50 lakh and 18% for additional
amounts above Rs. 50 lakh.
The equity shares (face value of Rs. 10) of the company have a current
market value of
Rs. 40. This is expected to fall to Rs. 32 if debts exceeding Rs. 50 lakh
Equity capitalization Rate:
(a) If the firm uses no debt 10%
(b) If the firm uses Rs. 25,000 debentures 11%
(c) If the firm uses Rs. 4,00,000 debentures 13%
Assume that Rs. 5,00,000 debentures can be raised at 6% rate of interest
Rs. 4,00,000 debe
Money Market Instruments
2. Based on Ownership
Sources of Finance may be classified under various categories based on
Sources of Financing 27
An ownership source of fin
1. What is financial statement?
2. What is financial statement analysis?
3. Discuss various types of financial statement analysis.
4. Explain various methods of financial statement analysis.
5. What are the differences between fund flow and cash flow?
Net operating income = Rs. 2,00,000
Overall cost of capital = 10%
Market value of the firm (V)
= Rs. 20,00,000
Market value of the firm =Rs. 20,00,000
Less: market value of Debentures= Rs. 8,00,000
(a) A Company expects a net income of Rs. 1,00,000. It has Rs. 2,50,000,
The equality capitalization rate of the company is 10%. Calculate the
the firm and overall capitalization rate according to the net income
2. Differentiate the capital structure and financial structure.
3. What is optimum capital structure?
4. Discuss the various factors affecting the capital structure.
5. Explain the capital structure theories.
6. XYZ Ltd., expects a net income of Rs. 1,50,
Abinaya company Ltd. expresses a net operating income of Rs. 2,00,000.
Rs. 8,00,000 to 7% debentures. The overall capitalization rate is 10%.
(a) Calculate the value of the firm and the equity captialization rate (or)
cost of equity
according to th
ABC Ltd., needs Rs. 30,00,000 for the installation of a new factory. The
expects to yield annual earnings before interest and tax (EBIT) of
Rs.5,00,000. In choosing
a financial plan, ABC Ltd., has an objective of maximizing earnings per