accounting of share capital
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ACCOUNTING OF SHARE CAPITAL ( III SEM BBM)
To issue shares a company follows a definite procedure which is controlled and regulated by the Companies Act and
Securities Exchange Board of India (SEBI). There are different ways of issue of shares which may be:
(A) For consideration other than cash
(B) For cash
(A) Issue of shares for consideration other than cash
Sometimes shares are issued to the promotors of the company in lieu of the services provided by them during the
incorporation of the compnay. The issue price of these shares is normally debited to ‘Goodwill A/c’ and journal entry is
made as follows :
Goodwill A/c Dr
To Share Capital A/c
In case a company does not have sufficient funds for the purchase of fixed assets or for payment to creditors it may
offer and allot its shares to vendors/ creditors in lieu of cash. Any allotment of shares against which cash is not to be
received is called ‘issue of shares for consideration other than cash’. For example building is purchased and payment is
made by issuing shares. In case of purchase of assets like building, machinery, stock of materials,etc. the following
journal entry is made :
1. Assets A/c Dr
To Vendors/Creditors A/c
(Assets purchased)
2. Vendors/Creditors A/c Dr
To Share Capital A/c
(Issue of shares of Rs…….each fullly paid up)
(B) Issue of Shares for cash
In general, shares are issued for cash. The company may call the share money either in one instalment or in two or
more instalments. But company always collects this money through its bankers.
(i) Receipt of share money in one instalment
The company may receive the share money in one instalment along with application. In this case the following journal
entries are made in the books of the company
1. On Receipt of Application Money
Bank A/c Dr
To Share Application A/c
(Application money received on ….shares of Rs…each)
2. On transferring the Application Money
Share Application A/c Dr
To Share Capital A/c
(Application money transferred to share capital A/c)
(ii) Share money received in two or more instalments
Instead of receiving payment in one instalment i.e. at the time of application the company collects it in two or more
instalments. The first, instalment which the appplicants have to pay along with the applications for shares is known as
application money. On the allotment of shares the allottees are required to pay the second instalment which is termed
as allotment money.
If the company decides to call the share money in more than two instalments the other instalment is/are termed as call
money (i.e. first-call, second call or final call).
In the above case the transactions are recorded in journal as given below :
(a) On receipt of application money
(i) Bank A/c Dr
To Share Application A/c
(Reciept of share application money for …. Shares @ Rs.. per share)
(b) On allotment of shares
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After receiving the application for shares within the prescribed time, the Board of Directors of the company proceed to
allot shares. On allotment of shares the applicaion money is transferred to Share Capital A/c. For this the following
journal entry is made :
Share Application A/c Dr
To Share Capital A/c
(Share application for …. Shares @ Rs… per share transferred to share
capital A/c)
Allotment Money becoming due and received
On the allotment of shares the amount receivable on the next instalment i.e. on allotment becomes due. The following
entry is made for recording the amount due :
(i) Allotment money becoming due
Share Allotment A/c Dr
To Share Capital A/c
(Share allotment money due on …. shares @Rs ... per share)
(ii) Receipt of allotment money
On the receipt of share allotment money the following journal entry is made:
Bank A/c Dr
To Share Allotment A/c.
(Receipt of the amount due on allotment of … shares)
Calls on shares
After the receipt of application and allotment money the money that remains unpaid can be called up by the company
as and when required. Thus a call is a demand made by the company asking the shareholders to remit the called up
amount on shares allotted to them.
The company may demand the remaining money in more than two instalments. The amount called after the allotment is
known as call money. There may be one or more calls, depending on the funds requirements of the company.
When only one call is made Call Money is Due :
Share First and Final Call A/c Dr
To Share Capital A/c.
(Call money due on …. share @ Rs … per share).
Receipt of call money
The following journal entry is made for receipt of call money:
Bank A/c Dr
To Share First & Final call A/c
(call money due on … shares @ Rs ... per share received)
Note : If the company makes more than one call the same accounting
treatment is followed for recording the second call or third call money due and their receipt. The last call made is
termed as final call
FULL, UNDER AND OVER SUBSCRIPTION
A company decides to issue number of shares to raise capital. It invites public to buy these shares. Now there may be
three situations :
I. Full Subscription
Company may receive applications equal to the number of shares company has offered to people. It is called full
subscription. In case of full subscription the journal entries will be made as follows :
(a) On receipt of application money
Bank A/c Dr
To Share Application A/c
(Application money received for ......... shares)
(b) On allotment of shares
Share Application A/c Dr
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To Share Capital A/c
(Application money of shares transferred to capital A/c on their allotment)
II. The company does not receive application equal to the number of shares offered for subscription, there may be two
situations :
(i) under subscription
(ii) over subscription
(i) Under subscription
The issue is said to have been under subscribed when the company receives applications for less number of shares than
offered to the public for subscription. In this case company is not to face any problem regarding allotment since every
applicant will be alloted all the shares applied for. But the company can proceed with allotment provided the
subscription for shares is at least equal to the minimum required number of shares termed as minimum subscription.
(ii) Over Subscription
When company receives applications for more number of shares than the number of shares offered to the public for
subscription it is a case of over subscription. A company cannot allot more shares than what it has offered. In case of
over subscription, company has the following options :
Option I
(i) Rejection of Excess Applications and Money Returned
The company may reject the applications for shares in excess of the shares offered for issue and a letter of rejection is
sent to such applicants. In this case the application money received from these applicants is refunded to them in full.
The journal entry made is as follows:
Share Application A/c Dr
To Bank A/c
(Application money on … shares refunded to the applicants)
(ii) Excess application money adjusted towards sums due on allotment.
Journal entry made is :
Shares Application A/c Dr
To Share Allotment A/c
(Excess application money adjusted towards sums due on allotment)
If the application money received on partially accepted applications is more than the amount required for adjustment
towards allotment money, the excess money is refunded. However, if the Articles of the company so authorise, the
directors may retain the excess money as calls in advance to be adjusted against the call/calls falling due later on and
the following entry is made :
Share Application A/c Dr
To Call-in-advance A/c
(The adjustment of excess share application money retained as call-in advance
in respect of ... shares).
Option II
Partial acceptance of Applications.
In some cases the company accepts the applications for subscription partially. It means that the company does not allot
the full number of shares applied for. For example if an applicant has applied for 5000 shares and is allotted only 2000
shares, then the applications is said to have been partially accepted. The company may evolve some formula of
accepting applications partially or making proportionate allotment/ the Prorata allotment which means that the
applicants are allotted shares proportionately. In such a case the company adjusts the excess share money received on
application towards share allotment money due on partially accepted applications. The journal entry recording the
adjustment of application money towards share allotment money, is as under :
Share Application A/c Dr
To Share Allotment A/c
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(Share application money transferred to Share Allotment Account in
respect of ... shares).
ISSUE OF SHARES AT PREMIUM
A company can issue its shares at their face value. When company issues its shares at their face value, the shares are
said to have been issued at par. Company can also issue its shares at more than or less than its face value i.e, at
‘Premium’ or at ‘Discount’ respectively. When shares are issued at premium or at discount an accounting treatment
different from shares issued at par is required. Let us discuss issue of shares at premium.
Issue of shares at premium
If a company issues its shares at a price more than its face value, the shares are said to have been issued at Premium.
The difference between the issue price and face value or nominal value is called ‘Premium’. If a share of Rs 10 is issued
at Rs 12, it is said to have been issued at a premium of Rs 2 per share. The money received as premium is transferred to
Securities Premium A/c. A company issues its shares at premium only when its financial position is very sound. It is a
capital gain to the company. The Premium money may be demanded by the company with application, allotment or with
calls. The Companies Act has laid down certain restrictions on the utilisation of the amount of premium. According to
Section 78 of this Act, the amount of premium can be utilised for :
(i) Issuing fully-paid bonus shares;
(ii) Writing off preliminary expenses, discount on issue of shares,
underwriting commission or expenses on issue;
(iii) Paying premium on redemplion of Preference shares or Debentures.
Further, the company may demand the total amount of premium in more than one instalment. In case the company
doesn’t specify the particular call with which Securities Premium is to be paid it is supposed to be called at the time of
Allotment.
Accounting Treatment of premium on Issue of Shares
Following is the accounting treatment of Premium on issue of shares :
(a) Securities premium collected with share Application money : If the Securities premium is collected on application and
the company has taken decision about the allotment of shares, the following journal entry is made :
Share Application A/c. Dr
To Securities Premium A/c
(The amount of Securities premium received on application of the allotted shares is transferred to Securities Premium
A/c)
(b) Premium collected with Allotment money or Calls.
If the company decides to demand the premium with share Allotment or/and share call money, the journal entry made
is:
Share Allotment A/c Dr
Or/and
Share Call A/c Dr
To Securities Premium A/c
Adjustment of share premium due on……shares @Rs…….per share.)
ISSUE OF SHARES AT DISCOUNT
When the issue price of share is less than the face value, shares are said to have been issued at discount. For example if
a company issues its shares of Rs 100 each at Rs. 90 each, the shares are said to be issued at discount. The amount of
discount is Rs 10 per share (i.e. Rs 100 – Rs 90). Discount on shares is a loss to the company.
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Section 79 of Companies Act 1956 has laid down certain conditions subject to which a company can issue its shares at a
discount. These conditions are as follows :
(i) At least one year must have elapsed from the date of commencement of business;
(ii) Such shares are of the same class as had already been issued;
(iii) The company has sanctioned such issue by passing a resolution in its General meeting and the approval of the court
is obtained.
(iv) Discount should not be more than 10% of the face value of the share and if the company wants to give discount
more than 10%, it will have to obtain the sanction of the Central Government.
Accounting Treatment of Shares Issued at Discount
The amount of discount is generally adjusted towards share allotment money and the following journal entry is made:
Share Allotment A/c Dr
Discount on issue of shares A/c Dr
To Share Capital A/c
Allotment money due on….shares @Rs ……per share after allowing
discount @Rs ……….per share.
CALLS IN ADVANCE AND CALLS IN ARREARS
If a shareholder pays any amount to company before it is demanded, it is called Call-in-Advance. This amount is put in a
separate account known as Calls-in-Advance A/c. This amount is not shown as capital of the company, till such time the
company makes a demand from all the shareholders. Call-in-Advance A/c is shown on the liabilities side of the Balance
Sheet. For example if a company issued shares of Rs 10 on which it has already called Rs 5. Against the uncalled portion
of Rs 5 per share the company makes a call Rs 3 per share, the entry for call money due will be made only for Rs 3 per
share. Now suppose a shareholder pays Rs 5 per share including the uncalled amount of Rs 2 per share along with the
call money, it means he has paid Rs 2 per share in advance, which will be
credited to calls in Advance A/c. The company is required to pay interest on this amount @ 6% till the date of its
appropriation.
Accounting treatment
Following journal entry is made for calls-in-advance.
Bank A/c Dr
To Calls-in-Advance A/c
(Calls in advance received on…….shares @ Rs …….per share)
Appropriation of calls-in-Advance A/c say in the final call Journal entry will be :
Calls-in-Advance A/c Dr
To Share Final call A/c
(Calls in advance amount adjusted)
For interest given on Calls-in-Advance
Journal entry will be
Interest on calls-in-Advance A/c Dr
To Bank A/c
(Interest paid on the amount of Call-in-Advance
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Calls in arrears
When the company sends notice to the shareholders to pay allotment and /or call money, it has to be paid by them
within the specified time period. If it is not paid by any one or more of the shareholders, the unpaid amount becomes
arrears due from them. Such arrears are transferred to an account termed as Calls-in-Arrears A/c. The company is
authorised to charge interest on calls-in-Arrears @ 5% p.a. for the intervening peroid. (The period between date of non-
receipt of the due amount and the date of actual receipt of the due amount).
Accounting Treatment
The following journal entry is made to record Calls-in-Arrears:
Calls-in-Arrears A/c Dr
To Share Allotment/Call A/c
(Share allotment/ Call money not received on …. shares)
When the unpaid balance is received later on the following journal entry is made:
Bank A/c Dr
To Calls in Arrears A/c
(Amount due on allotment/ call remaining unpaid now received on shares.)
A Company purchased a running business from M/S Sahni Brothers for a sum of Rs. 1,50,000, payable as Rs.1,20,000/-
in fully paid Equity shares of Rs. 10 each and balance in cash. The assets and liabilities consisted of the following:
Plant & Machinery Rs.40,000 Building Rs.40,000
Stock Rs.50,000 Sundry Debtors Rs.30,000
Cash Rs.20,000 Sundry Creditors Rs.20,000
Pass necessary Journal entries in the company’s books
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Amagamation, and Absorption ( III sem BBM)
a. Following are the ba
1. Give the formula for calculating the claim amount by applying average clause
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A fire occurred on 15-9-90 in the premises of Firestone Co. Ltd. From the following figures, calculate the amount of claim
to be lodged with the insurance company for loss of stock:
Stock at cost as on 1-1-89 Rs.20,000
Stock at cost as on 1-1-90 Rs.30,000
Purchases during 1989 Rs.40,000
Purchases from 1-1-90- to 15-9-90 Rs.88,000
Sales during 1989 Rs.60,000
Sales from 1-1-90 to 15-9-90 Rs.1,05,000
During the current year, cost of purchases has risen by 10% above last year’s level. Selling prices have gone up by
5%. Salvage value of stocks after fire was Rs.2,000.
Section C
A fire occurred in the godown of AB Ltd. on 9-3-2010 destroying the entire stock. The book and records were salvaged
form, which the following particulars were ascertained.
Sales for the year 2009 Rs.10,01,000
Sales for the period from 1-1-10 to 8-3-10 Rs.3,00,000
Purchases for the year 2009 Rs.8,00,000
Purchases for the period from 1-1-10 to 8-3-10 Rs.1,25,000
Stock on 1-1-09 Rs.3,31,100
Stock on 31-12-09 Rs.3,85,000
The company has been following the practice of valuing stock of goods at actual cost plus 10%. Included in the
stock on 1-1-83 were some shop-soiled goods which originally cost Rs.2,000, but were valued at Rs.1,100. These goods
were sold during the year 1983 for Rs.1,000. Subject of this, the rate of gross profit and the basis of valuation of stock
were uniform. Compute the fire claim.
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Himalaya Ltd.’s Profit and Loss Account for the year ended
31st December 2005 is given below. You are required to calculate the working capital requirements under operating
cycle method.
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Trading and Profit & Loss Account
For the year
ended 31st
December, 2005
Particulars
Rs. Particulars Rs.
To Opening
stock:
Raw Materials
Work-in-Progress
Finished Goods
To Purchases
(Credit)
To Wages & Mfg.
Expenses
To Gross Profit
c/d
To Administrative
Exp.
To Selling and
Dist.Exp.
To Net Profit
Total
10,000
30,000
5,000
35,000
15,000
1,50,000
15,000
10,000
30,000
55,000
By Sales (Credit)
By Closing stock:
Raw Materials
Work-in-progress
Finished Goods
By Gross Profit
b/d
Total
1,00,000
11,000
30,500
8,500
1,50,000
55,000
55,000
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Prepare an estimate of working capital requirements from the following
information of a
trading concern: (a) Projected Annual Sales 1,00,000
(b) Selling Price Rs.8 per unit
(c) Profit Margin on Sales 25%
(d) Average Credit Period
Allowed to Customers
8 weeks
(e) Average Credit Period
Allowed by Suppliers
4 weeks
(f) Average Stock Holding
in terms of Sales
Requirement
12 weeks
(g) Allow 10% for Contingencies
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Meaning of financial system
Financial system is a set of inter-related activities working together to achieve some
predetermined purpose or goal. It includes different markets, the institutions, instruments,
services and mechanisms which influence the generation of savings, investment capital
formation and growth.
Functions of financial system
A financial system performs the following functions:
· It serves as a link between savers and investors. It helps in utilizing the mobilized
savings of scattered savers in more efficient and effective manner.
· It channelised flow of saving into productive investment.
· It assists in the selection of the projects to be financed and also reviews the
performance of such projects periodically.
· It provides payment mechanism for exchange of goods and services.
· It provides a mechanism for the transfer of resources across geographic boundaries.
· It provides a mechanism for managing and controlling the risk involved in mobilizing
savings and allocating credit.
· It promotes the process of capital formation by bringing together the supply of saving
and the demand for investible funds.
· It helps in lowering the cost of transaction and increase returns. Reduce cost motives
people to save more.
· It provides you detailed information to the operators/players in the market such as
individuals, business houses, Government
Components of Indian financial system
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Financial System and Economic Development
Financial system plays an important role in the economic development. The role of the
financial system is to gather or pool money from people and businesses that have more than
they need currently and transmit those funds to those who can use them for either
consumption or investment. The larger the flow of funds and the more efficient their allocation
is, the better the economic output and welfare of the economy and society.
A financial system provides services that are essential in a modern economy. The use of a
stable, widely accepted medium of exchange reduces the costs of transactions. It facilitates
trade and, therefore, specialization in production. Financial assets with attractive yield,
liquidity and risk characteristics encourage saving in financial form. By evaluating alternative
investments and monitoring the activities of borrowers, financial intermediaries increase the
efficiency of resource use. Access to a variety of financial instruments enables an economic
agent to pool, price and exchange risks in the markets. Trade, the efficient use of resources,
saving and risk taking are the cornerstones of a growing economy. In fact, the country could
make this feasible with the active support of the financial system. The financial system has
been identified as the most catalyzing agent for growth of the economy, making it one of the
key inputs of development.
In other words, the purpose of the financial system is to transfer funds from savers to the
borrowers in the most effective and efficient possible manner. The following are the ways of
transferring money:
· Direct Financing: In direct financing borrowers and savers exchange money and financial
instruments directly. Borrowers or deficit units issue financial claims (they are claims against
someone else’s money at a future date) on themselves and sell directly to savers or surplus
units for money. The savers hold the financial claims as interest bearing instruments and they
can sell it in financial markets. Upon agreed time or maturity date borrowers have to give back
the savers principle plus the agreed interest rate.
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· Indirect Financing: A problem that arises from direct financing brought the usage of indirect
financing. Sometimes the savers or surplus units can’t wait to hold financial claims till maturity
date therefore they sell the financial claims to the financial intermediation and take their funds
from them to do whatever they please.
Financial market
A financial market is the place where financial assets are created or transferred. Financial
market is the place where all the financial transactions take place. Financial market includes
money market and capital market. Money market is the place where transactions take place
for short period and on the other hand in capital market transactions are made for a longer
period.
The main functions of financial market are:
1. To facilitate creation and allocation of credit and liquidity.
2. To serve as intermediaries for mobilization of savings.
3. To assist process of balanced economic growth.
4. To provide financial convenience.
Money market
Slice of the financial markets that deal with short term financial assets called near
money, which are highly liquid (can be quickly converted to money)
It deals with short term funds meaning having maturity of upto a year.
It does not literally deal in money/cash but close substitutes of money such as T-
bills, promissory notes, commercial paper etc. that can be quickly converted to
cashwithout making any losses and that too at low transaction costs.
It constitutes of Central Bank, Commercial Banks, NBFCs, etc.
Transactions take place via oral communication without the help of brokers unlike
capital markets where transactions take place formally on stock exchanges.
It comprises of submarkets like: Call Money Market, Acceptance and Bill Market.
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To make available a parking place in order to make use of short term surplus.
To offer room to overcome short term deficits.
To allow the central bank to influence and control liquidity in the economy by means of
intervention in this market.
To provide access to users of short-term funds so that they can meet their
requirements quickly, adequately, and at reasonable costs.
Functions of Money Markets:
Monetary Equilibrium: To maintain equilibrium in demand/supply of short term funds.
Economic Growth: It facilitates economic growth by making short term funds available
to different units in economy like agriculture, SSIs etc.
Promote Trade and Industry: It offers finance to trade and industry and also bill
discounting facilities.
Aiding Monetary Policy: It is one of the means which helps in effective implementation
of the monetary policy.
Capital Formation: It encourages savings/investment in the economy by providing
investment avenues for short term.
Non inflationary source of Finance to Government: Eg. By issuing Treasury Bill
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Some of the important money market instruments are briefly discussed below:
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers
Call/Notice-Money Market: Call/Notice money is used for a very short period. Call/notice money
is used for intraday transactions. Intervening holidays and/or Sunday are excluded for this
purpose. Thus money, borrowed on a day and repaid on the next working day is "Call Money".
When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money".
No collateral security is required to cover these transactions.
Term Money: Inter-bank market for deposits of maturity beyond 14 days is referred to as the
term money market. The entry restrictions are the same as those for Call/Notice Money except
that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.
Treasury Bills: Treasury Bills are short-term (up to one year) borrowing instruments of the
union government. It is an IOU of the Government. It is a promise by the Government to pay a
stated sum after expiry of the stated period from the date of issue. Treasury bills are issued for
a period of 14 days, 91 days, 182 days and 364 days. They are issued at a discount to the face
value, and on maturity the face value is paid to the holder. The rate of discount and the
corresponding issue price are determined at each auction.
Certificate of Deposits: Certificates of Deposit (CDs) is a negotiable money market instrument
and issued in dematerialized form or as a Usance Promissory Note, for funds deposited at a
bank or other eligible financial institution for a specified time period. Guidelines for issue of
CDs are presently governed by various directives issued by the Reserve Bank of India, as
amended from time to time. CDs can be issued by (i) scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial
Institutions that have been permitted by RBI to raise short-term resources within the umbrella
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limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An
FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with
other instruments viz., term money, term deposits, commercial papers and inter-corporate
deposits should not exceed 100 per cent of its net owned funds, as per the latest audited
balance sheet.
Commercial Paper: CP is a note in evidence of the debt obligation of the issuer. On issuing
commercial paper the debt obligation is transformed into an instrument. CP is thus an
unsecured promissory note privately placed with investors at a discount rate to face value
determined by market forces. CP is freely negotiable by endorsement and delivery. A company
shall be eligible to issue CP provided – (a) the tangible net worth of the company, as per the
latest audited balance sheet, is not less than Rs. 4 crore;
(b) Company has been sanctioned working capital limit by bank/s or all-India financial
institution/s; and (c) the borrowal account of the company is classified as a Standard Asset by
the financing bank/s. The minimum maturity period of CP is 7 days. The minimum credit rating
shall be P-2 of CRISIL or such equivalent rating by other agencies
IMPORTANCE OF MONEY MARKET
If the money market is well developed and broad based in a country, it greatly helps in the
economic development of a country. The central bank can use its monetary policy effectively
and can bring desired changes in the economy for the industrial and commercial progress in
the country. The importance of money market is given, in brief, as under:
(i) Financing Industry: A well developed money market helps the industries to secure short
term loans for meeting their working capital requirements. It thus saves a number of industrial
units from becoming sick.
(ii) Financing trade: An outward and a well knit money market system play an important role in
financing the domestic as well as international trade. The traders can get short term finance
from banks by discounting bills of exchange. The acceptance houses and discount market help
in financing foreign trade.
(iii) Profitable investment: The money market helps the commercial banks to earn profit by
investing their surplus funds in the purchase of. Treasury bills and bills of exchange, these
short term credit instruments are not only safe but also highly liquid. The banks can easily
convert them into cash at a short notice.
(iv) Self sufficiency of banks: The money market is useful for the commercial banks
themselves. If the commercial banks are at any time in need of funds, they can meet their
requirements by recalling their old short term loans from the money market.
(v) Effective implementation of monetary policy: The well developed money market helps the
central bank in shaping and controlling the flow of money in the country. The central bank
mops up excess short term liquidity through the sale of treasury bills and injects liquidity by
purchase of treasury bills.
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(vi) Encourages economic growth: If the money market is well organized, it safeguards the
liquidity and safety of financial asset This encourages the twin functions of economic growth,
savings and investments.
(vii) Help to government: The organized money market helps the government of a country to
borrow funds through the sale of Treasury bills at low rate of interest The government thus
would not go for deficit financing through the printing of notes and issuing of more money
which generally leads to rise in an increase in general prices.
(viii) Proper allocation of resources: In the money market, the demand for and supply of loan
able funds are brought at equilibrium The savings of the community are converted into
investment which leads to pro allocation of resources in the country
Capital market
The capital market is the place where transactions take place for more than a year. Capital
market instruments are equity shares, preference shares, convertible preference shares, non-
convertible preference shares etc. and in the debt segment debentures, zero coupon bonds,
deep discount bonds etc.
Capital market can also be classified as
1. Primary market
2. Secondary market
3. Derivative market
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Primary market: The primary market is that part of the capital markets that deals with the
issuance of new securities. Companies, governments or public sector institutions can obtain
funding through the sale of a new stock or bond issue.
Features of primary markets are:
· The primary market is the market where the securities are sold for the first time. Therefore it
is also called the new issue market.
· In a primary market securities are issued by the company directly to investors.
· Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business.
· The primary market performs the crucial function of facilitating capital formation in the
economy.
· The financial assets sold can only be redeemed by the original holder.
Secondary market: Secondary market is the place where existing securities are bought and
sold. The secondary market for a variety of assets can vary from loans to stocks, from
fragmented to centralized, and from illiquid to very liquid. The major stock exchanges are the
most visible example of liquid secondary markets – in this case, for stocks of publicly traded
companies. Exchanges such as the New York Stock Exchange, NASDAQ and the American
Stock Exchange provide a centralized, liquid secondary market for the investors who own
stocks that trade on those exchanges. Most bonds and structured products trade “over the
counter,” or by phoning the bond desk of one’s broker-dealer.
Derivative market: The derivatives markets are the financial markets for derivatives. The
market can be divided into exchange traded derivatives and over-the-counter derivatives. The
legal nature of these products is very different as well as the way they are traded, though
many market participants are active in both
Types of Derivatives: The most commonly used derivatives contracts are forwards, futures and options, which we shall discuss these in detail in the FMM-II later. Here we take a brief look at various derivatives contracts that have come to be used.
Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.
Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
Warrants: Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter.
LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years.
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Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options.
Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:
Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency and Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
Swaptions: Swaptions are options to buy or sell a swap that will become operative at the
expiry of the options. Thus a swaption is an option on a forward swap. Rather than have
calls and puts, the swaptions market has receiver swaptions and payer swaptions. A
receiver swaption is an option to receive fixed and pay floating. A payer swaption is an
option to pay fixed and receive floating
Capital market instruments
Capital market instruments
DEEP DISCOUNT BONDS
A bond that sells at a significant discount from par value and has no coupon rate or lower coupon rate than the prevailing rates of fixed-income securities with a similar risk profile. They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures.
Ex-IDBI deep discount bonds for Rs 1 lac repayable after 25 years were sold at a discount price of Rs. 2,700.
EQUITY SHARES WITH DETACHABLE WARRANTS
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A warrant is a security issued by company entitling the holder to buy a given number of shares of stock at a stipulated price during a specified period. These warrants are separately registered with the stock exchanges and traded separately. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends.
Ex-Essar Gujarat, Ranbaxy, Reliance issue this type of instrument.
FULLY CONVERTIBLE DEBENTURES WITH INTEREST
This is a debt instrument that is fully converted over a specified period into equity shares. The conversion can be in one or several phases. When the instrument is a pure debt instrument, interest is paid to the investor. After conversion, interest payments cease on the portion that is converted. If project finance is raised through an FCD issue, the investor can earn interest even when the project is under implementation. Once the project is operational, the investor can participate in the profits through share price appreciation and dividend payments
SWEAT EQUITY SHARES
The phrase `sweat equity' refers to equity shares given to the company's employees on favorable terms, in recognition of their work. Sweat equity usually takes the form of giving options to employees to buy shares of the company, so they become part owners and participate in the profits, apart from earning salary. This gives a boost to the sentiments of employees and motivates them to work harder towards the goals of the company.
The Companies Act defines `sweat equity shares' as equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called.
DISASTER BONDS
Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-yield debt instrument that is usually insurance linked and meant to raise money in case of a catastrophe. It has a special condition that states that if the issuer (insurance or Reinsurance Company) suffers a loss from a particular pre-defined catastrophe, then the issuer's obligation to pay interest and/or repay the principal is either deferred or completely forgiven.
Ex- Mexico sold $290 million in catastrophe bonds, becoming the first country to use a World Bank program that passes the cost of natural disasters to investors. Goldman Sachs Group Inc. and Swiss Reinsurance Co. managed the bond sale, which will pay investors unless an earthquake or hurricane triggers a transfer of the funds to the Mexican government.
GLOBAL DEPOSITORY RECEIPTS/ AMERICAN DEPOSITORY RECEIPTS
A negotiable certificate held in the bank of one country (depository) representing a specific number of shares of a stock traded on an exchange of another country. GDR facilitate trade of
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shares, and are commonly used to invest in companies from developing or emerging markets. GDR prices are often close to values of related shares, but they are traded and settled independently of the underlying share.
Listing on a foreign stock exchange requires compliance with the policies of those stock exchanges. Many times, the policies of the foreign exchanges are much more stringent than the policies of domestic stock exchange. However a company may get listed on these stock exchanges indirectly – using ADRs and GDRs. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR.
But the ADRs and GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the India
FOREIGN CURRENCY CONVERTIBLE BONDS(FCCBs)
A convertible bond is a mix between a debt and equity instrument. It is a bond having regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. FCCB is issued in a currency different than the issuer's domestic currency.
The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt-financing costs.
Advantages
Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies because, as it may appear to be more stable and predictable than their domestic currency
Gives issuers the ability to access investment capital available in foreign markets Companies can use the process to break into foreign markets The bond acts like both a debt and equity instrument. Like bonds it makes regular
coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock
It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component
Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company
stocks Advantages to investors
Safety of guaranteed payments on the bond Can take advantage of any large price appreciation in the company’s stock Redeemable at maturity if not converted Easily marketable as investors enjoys option of conversion in to equity if resulting to
capital appreciation Disadvantages
Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs
FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange
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In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity
DERIVATIVES
A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of some underlying asset typically commodity, bond, equity, currency, index, event etc. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative.
Derivatives are usually broadly categorized by:1. The relationship between the underlying and the derivative (e.g. forward, option, swap)2. The type of underlying (e.g. equity derivatives, foreign exchange derivatives and credit
derivatives)3. The market in which they trade (e.g., exchange traded or over-the-counter)
Futures
A financial contract obligating the buyer to purchase an asset, (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency.
Options
A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is called 'strike price'. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right. Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy. So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right. As the seller of the contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract is called as premium.
The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract.
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GOLD ETF
Gold Exchange Traded Fund (ETF) is a financial instrument like a mutual fund whose value depends on the price of gold. In most cases, the price of one unit of a gold ETF approximately reflects the price of 1 gram of gold. As the price of gold rises, the price of the ETF is also expected to rise by the same amount. Gold exchange-traded funds are traded on the major stock exchanges including Zurich, Mumbai, London, Paris and New York There are also closed-end funds (CEF's) and exchange-traded notes (ETN's) that aim to track the gold price.
PARTICIPATORY NOTES
Also referred to as "P-Notes" Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. These are issued by FIIs to entities that want to invest in the Indian stock market but do not want to register themselves with the SEBI. RBI, which had sought a ban on PNs, believes that it is tough to establish the beneficial ownership or the identity of ultimate investors. Interest rate securities
The interest paid on the nominal amount of capital market securities (called the coupon rate) appears on the certificate received by the holder (the investor) of such a security. This coupon rate is one of the parameters used to determine the consideration paid for the security when traded in the secondary market. Most securities are issued at a fixed coupon rate such as the Eskom 168 (E168) security that is issued at a coupon rate of 11%. This means that the registered holder of an Eskom E168 certificate will receive 11% interest per year (NACSA) on the nominal amount of the instrument. The nominal amounts are in multiples of R1 million, and the interest on the E168 is paid biannually on 1 June and 1 December. The holder of an E168 with a nominal value of R1 million will thus receive R55 000 on 1 June and R55 000 on 1 December. Certain securities are, however, issued at a variable coupon rate, where the coupon rate is then linked to a well-known interest rate such as the prime overdraft rate or the 90-day BA rate.
Capital market securities are physical certificates and the issuer of the security keeps a register of owners. This register is used by the borrower (issuer) to pay interest to the lender (owner of the security) on the interest payment dates indicated on the certificate. When an instrument is sold to a new owner in the secondary market, the buyer is registered as the new owner on the settlement date of the transaction. For administrative purposes the register of the issuer closes for registration of new owners, normally one month prior to the interest payment date. The date when the register closes is known as the last day to register (LDR). This means that the person or company who is registered as the owner one month before the interest payment date (on LDR), will receive the interest on the payment date.
If a bond is sold and settled between the LDR and the interest payment date, the seller will receive the interest payment. The buyer is then known to buy the instrument "ex interest" (without interest). However, if a transaction takes place before the LDR, the buyer buys the instrument "cum interest" (including interest), because he will be registered as the owner before the register closes, and will receive the next interest payment.
Zero-rated coupons
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Long-dated (securities with long terms to maturity) zero-rated coupons are capital market instruments issued by borrowers of money. These instruments do not earn interest on the capital amount invested by the lender, and are therefore issued and traded at a discount on the nominal value, similar to discount instruments in the money market such as BAs and treasury bills.
The market value (nominal value less discount) of zero (or nil)-rated coupon bonds depends on the yield that the investor (lender) expects on his investment. The redemption amount, which is the only cash inflow for the investor, is equal to the nominal value of the bond, and is thus known to the investor. Since the redemption date is also known, the investor can calculate the amount that he is willing to pay for the bond according to the yield (expressed in terms of interest rate) that he wants to earn on the investment. This yield on zero-rated coupon bonds is normally linked to the market rate on long-term (capital market) investments.
Asset-backed bonds
Where an asset exists which represents cash inflow stream such as a normal loan or investment, a bond can be issued to fund this asset. The bond income is then derived or backed by the income stream of the asset. The performance on the bond is then dependent on the asset performance.
Zero-rated coupon bonds
A simple way of determining the trading value of these assets is by expressing the nominal value of the coupon as a percentage of the nominal value plus the yield that the investor wants to earn on his investment over the period,.
Interest rate bonds
To calculate the consideration that the buyer of a bond would pay to the seller, all the cash flows belonging to the buyer should be discounted back to the settlement date, at the rate at which the transaction is done. The "all-in-price" of a bond is this present value that expresses the consideration that the buyer of a bond would pay to a seller, and takes into account the next interest payment that the buyer would receive if the transaction was cum interest, or the next interest payment that the seller would receive if the transaction was ex interest.
Secured Premium Notes
SPN is a secured debenture redeemable at premium issued along with a detachable warrant, redeemable after a notice period, say four to seven years. The warrants attached to SPN gives the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN holder has an option to sell back the SPN to the company at par value after the lock in period. If the holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/ premium on redemption in installments as decided by the company. The conversion of detachable warrants into equity shares will have to be done within the time limit notified by the company.
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Ex-TISCO issued warrants for the first time in India in the year 1992 to raise 1212 crore.
Significance of capital market
A sound and efficient capital market is extremely vital for the economic development of a
nation.
The following points clearly bring out the role and significance of capital market in India.
i)CAPITAL FORMATION:
Capital market encourages capital formation as it ensures speedy economic development. The
process of capital formation includes collection of saving effective mobilisation of these
savings for productiveinvestment.
Thus three distinctive inter-related activities i.e. collection of savings, mobilisation of savings
and investment lead to capital formation in the country.
The volume of capital formation depend s on the efficiency and intensity with which these
activities are carried on.
ii) ECONOMIC GROWTH:
~ Capital market plays a vital role in the growth and development of an economy by
channelising funds in developmental and productive investments. ~ The financial
intermediaries channel funds into those investments that are more important for economic
development.
iii) INDUSTRIAL DEVELOPMENT:
~ Capital market promotes industrial development and motivates industrial entrepreneurship.
~ It provides cheap, adequate and diversified funds for industrial purposes such as expansion,
modernisation, technological upgradation, establishment of new units, etc.
~ It also provides services like provision of underwriting facilities, participation in equity
capital, credit-rating, consultancy services, etc.
vi) MODERNISATION AND REHABILITATION OF INDUSTRIES:
~ Capital markets also contribute towards modernisation and rehabilitation of industries.
~ Developmental financial institutions like IDBI, IFCI, ICICI, etc provide finance to industries to
adopt modern techniques and new upgraded machinery. They also participate in the equity
capital of industries.
v) RIVIVAL OF SICK UNITS:
~ Commercial and financial institutions provide adequate funds to viable sick unit to overcome
their industrial sickness. ~ Bank and FIs may also write off a part of the loan or re-schedule the
loan to offer payment flexibility to weak units.
vi) TECHNICAL ASSISTANCE:
~ The financial intermediaries in the capital market stimulate industrial entrepreneurship by
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providing technical and advisory services like preparation of feasibility reports, identifying
growth potential, and training entrepreneurs in project management. This promotes industrial
investment and leads to economic development.
vii) DEVELOPMENT OF BACKWARD AREAS:
~ Capital markets provide funds for projects in backward area and facilitate their economic
development. Long-term funds are also provided for development projects in backward / rural
areas.
viii) EMPLOYMENT GENERATION:
~ Capital markets provide Direct Employment in capital market related activities like stock
markets, banks and financial institutions. Indirect Employment is provided in all the sectors of
the economy through various funds disbursed for developmental projects.
ix) FOREIGN CAPITAL:
~ Capital markets make it possible to generate foreign capital by enabling Indian firms to raise
capital from overseas market through bonds and other securities. Such foreign exchange
funds have a great impact on the economic development of the nation. Moreover, foreign
direct investments (FDIs) also bring in foreign capital as well as foreign technology that leads
to greater economic development.
x) DEVELOPMENT OF STOCK MARKETS:
~ Capital markets lead to development of stock markets by encouraging investors to invest in
shares and debentures and to trade in stocks. FIIs are also allowed to deal in Indian stock
exchange.
Differences between money market and capital market
Money market is distinguished from capital market on the basis of the maturity period, credit
instruments and the institutions:
1. Maturity Period:
The money market deals in the lending and borrowing of short-term finance (i.e., for one year
or less), while the capital market deals in the lending and borrowing of long-term finance (i.e.,
for more than one year).
2. Credit Instruments:
The main credit instruments of the money market are call money, collateral loans,
acceptances, bills of exchange. On the other hand, the main instruments used in the capital
market are stocks, shares, debentures, bonds, securities of the government.
3. Nature of Credit Instruments:
The credit instruments dealt with in the capital market are more heterogeneous than those in
money market. Some homogeneity of credit instruments is needed for the operation of
financial markets. Too much diversity creates problems for the investors.
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4. Institutions:
Important institutions operating in the' money market are central banks, commercial banks,
acceptance houses, nonbank financial institutions, bill brokers, etc. Important institutions of
the capital market are stock exchanges, commercial banks and nonbank institutions, such as
insurance companies, mortgage banks, building societies, etc.
5. Purpose of Loan:
The money market meets the short-term credit needs of business; it provides working capital
to the industrialists. The capital market, on the other hand, caters the long-term credit needs
of the industrialists and provides fixed capital to buy land, machinery, etc.
6. Risk:
The degree of risk is small in the money market. The risk is much greater in capital market.
The maturity of one year or less gives little time for a default to occur, so the risk is minimised.
Risk varies both in degree and nature throughout the capital market.
7. Basic Role:
The basic role of money market is that of liquidity adjustment. The basic role of capital market
is that of putting capital to work, preferably to long-term, secure and productive employment.
8. Relation with Central Bank:
The money market is closely and directly linked with central bank of the country. The capital
market feels central bank's influence, but mainly indirectly and through the money market.
9. Market Regulation:
In the money market, commercial banks are closely regulated. In the capital market, the
institutions are not much regulated.
Financial Services
Financial services can be defined as the products and services offered by institutions like
banks of various kinds for the facilitation of various financial transactions and other related
activities in the world of finance like loans, insurance, credit cards, investment opportunities
and money management as well as providing information on the stock market and other issues
like market trends
Financial services refer to services provided by the finance industry. The finance industry
encompasses a broad range of organizations that deal with the management of money. Among
these organizations are banks, credit card companies, insurance companies, consumer finance
companies, stock brokerages, investment funds and some government sponsored enterprises.
Functions of financial services
1. Facilitating transactions (exchange of goods and services) in the economy.
2. Mobilizing savings (for which the outlets would otherwise be much more limited).
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3. Allocating capital funds (notably to finance productive investment).
4. Monitoring managers (so that the funds allocated will be spent as envisaged).
5. Transforming risk (reducing it through aggregation and enabling it to be carried by those
more willing to bear it).
Characterstics and Features of Financial Services
i) Customer-Specific: Financial services are usually customer focused. The firms providing
these services, study the needs of their customers in detail before deciding their financial
strategy, giving due regard to costs, liquidity and maturity considerations. Financial services
firms continuously remain in touch with their customers, so that they can design products
which can cater to the specific needs of their customers. The providers of financial services
constantly carry out market surveys, so they can offer new products much ahead of need and
impending legislation. Newer technologies are being used to introduce innovative, customer
friendly products and services which clearly indicate that the concentration of the providers of
financial services is on generating firm/customer specific services.
ii) Intangibility: In a highly competitive global environment brand image is very crucial. Unless
the financial institutions providing financial products and services have good image, enjoying
the confidence of their clients, they may not be successful. Thus institutions have to focus on
the quality and innovativeness of their services to build up their credibility.
iii) Concomitant: Production of financial services and supply of these services have to be
concomitant. Both these functions i.e. production of new and innovative financial services and
supplying of these services are to be performed simultaneously.
iv) Tendency to Perish: Unlike any other service, financial services do tend to perish and hence
cannot be stored. They have to be supplied as required by the customers. Hence financial
institutions have to ensure a proper synchronization of demand and supply.
v) People based services: Marketing of financial services has to be people intensive and hence
it’s subjected to variability of performance or quality of service. The personnel in financial
services organisation need to be selected on the basis of their suitability and trained properly,
so that they can perform their activities efficiently and effectively.
vi) Market Dynamics: The market dynamics depends to a great extent, on socioeconomic
changes such as disposable income, standard of living and educational changes related to the
various classes of customers. Therefore financial services have to be constantly redefined and
refined taking into consideration the market dynamics. The institutions providing financial
services, while evolving new services could be proactive in visualising in advance what the
market wants, or being reactive to the needs and wants of their customers.
Scope of Financial Services
Financial services cover a wide range of activities. They can be broadly classified into two,
namely:
i. Traditional. Activities
ii. Modern activities.
i. Traditional Activities
Traditionally, the financial intermediaries have been rendering a wide range of services
encompassing both capital and money market activities. They can be grouped under two
heads, viz.
1. Fund based activities and
2. Non-fund based activities.
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Fund based activities: The traditional services which come under fund based activities are the
following:
Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary
market activities).
Dealing in secondary market activities.
Participating in money market instruments like commercial
Papers, certificate of deposits, treasury bills, discounting of bills etc.
Involving in equipment leasing, hire purchase, venture capital, seed capital,
Dealing in foreign exchange market activities. Non fund based activities
Non fund based activities
Financial intermediaries provide services on the basis of non-fund activities also. This can be
called ‘fee based’ activity. Today customers, whether individual or corporate, are not satisfied
with mere provisions of finance. They expect more from financial services companies. Hence a
wide variety of services, are being provided under this head. They include:
Managing the capital issue — i.e. management of pre-issue and post-issue activities
relating to the capital issue in accordance with the SEBI guidelines and thus enabling the
promoters to market their issue.
Making arrangements for the placement of capital and debt instruments with
investment institutions.
Arrangement of funds from financial institutions for the clients’ project cost or his
working capital requirements.
Assisting in the process of getting all Government and other clearances.
ii. Modern Activities
Beside the above traditional services, the financial intermediaries render innumerable services
in recent times. Most of them are in the nature of non-fund based activity. In view of the
importance, these activities have been in brief under the head ‘New financial products and
services’. However, some of the modern services provided by them are given in brief
hereunder.
Rendering project advisory services right from the preparation of the project report till
the raising of funds for starting the project with necessary Government approvals.
Planning for M&A and assisting for their smooth carry out.
Guiding corporate customers in capital restructuring.
Acting as trustees to the debenture holders.
Recommending suitable changes in the management structure and management style
with a view to achieving better results.
Structuring the financial collaborations / joint ventures by identifying suitable joint
venture partners and preparing joint venture agreements.
Rehabilitating and restructuring sick companies through appropriate scheme of
reconstruction and facilitating the implementation of the scheme.
Hedging of risks due to exchange rate risk, interest rate risk, economic risk, and
political risk by using swaps and other derivative products.
Managing In- portfolio of large Public Sector Corporations.
Undertaking risk management services like insurance services, buy-hack options etc.
Advising the clients on the questions of selecting the best source of funds taking into
consideration the quantum of funds required, their cost, lending period etc.
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Guiding the clients in the minimization of the cost of debt and in the determination of
the optimum debt-equity mix.
Promoting credit rating agencies for the purpose of rating companies which want to go
public by the issue of debt instrument.
Undertaking services relating to the capital market, such as 1)Clearing services,
2)Registration and transfers, 3)Safe custody of securities, 4)Collection of income on securitie
Financial Institutions
Financial institutions include the banking and non-banking institutions. Financial institutions
are the intermediaries who facilitate smooth functioning of the financial system by making
investors and borrowers meet. They mobilize savings of the surplus units and allocate them in
productive activities promising a better rate of return. Financial institutions also provide
services to entities seeking advice on various issues ranging from restructuring to
diversification plans. They provide whole range of services to the entities who want to raise
funds from the markets elsewhere. Financial institutions act as financial intermediaries
because they act as middlemen between savers and borrowers.
Role of financial institutions
In transferring resource allocation from direct financing to indirect financing, financial
institutions provide the following five basic services:
· Currency Alteration: Buying financial claims denominated in one currency and selling financial
claims denominated in another currencies.
· Quantity Divisibility: Financial institutions are capable in producing a broad range of quantity
from one dollar to many millions, by gathering from different people.
· Liquidity: Easy to liquidate the instruments by buying direct financial claims with low liquidity
and issuing indirect financial claims with more liquidity.
· Maturity Flexibility: Creating financial claims with wide range of maturities so as to balance
the maturity of different instruments so as to reduce the gap between assets and liabilities.
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· Credit Risk Diversification (Portfolio Investment): By purchasing a broad range of instruments,
financial institutions are able to diversify the risk.
.
Commercial banks
The main functions of commercial banks are shown below-
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Primary functions: The primary functions of banks are as follows:
Acceptance of Deposits: The first important function of a bank is to accept deposits of
money from the public. Those people who can save a portion of their income can deposit it in
banks. For this purpose the banks maintain various types of accounts like fixed deposit
account, current deposit account and savings deposit account etc. through which they accept
deposits from the public. The banks are liable to return the amount to the depositors as and
when demanded by the depositors. Those who deposit their savings in various bank accounts
are known as accountholders or depositors. They are the customers of the bank. The banks
pay interest on the deposited amount to the accountholders. Moreover, it ensures safety of
depositors’ funds. The main deposit schemes provided by commercial banks are as follows-
Fixed Deposit Account: A fixed deposit account is open for a long period of time
covering three to five years. The bank pays higher rate of interest on this account depending
on the period of time for which the account has been opened. The depositor cannot withdraw
the money before the expiry of the fixed period. In case of urgency, the depositor can
withdraw the money but he will lose in terms of interest. Fixed deposits are important for the
commercial banks because the funds can be invested for a long period of time.
Current Deposit Account: Current deposit accounts are generally opened by business
organisations. The main advantage of this account is that the accountholder can withdraw
more money than the balance in his account. Therefore, a businessman can withdraw more
money in times of emergency. The excess amount is granted by bank as loan, known
as overdraft. The bank charges interest on the overdrawn amount. The banks do not pay any
interest on this account but charges a small amount as incidental charge.
Savings Deposit Account: A savings deposit account can be opened with a bank with
a small amount and the bank pays interest on the deposited amount. The depositor can go on
depositing any amount. However, there are certain restrictions on the withdrawal of money
from this account. Cheque book facility is provided with this account by the bank. The saving
deposit account holder can deposit cheques, drafts, share warrants etc. drawn in his favour
with the bank for collection. Collection of cheques, drafts etc. on behalf of the customer is an
agency function performed by banks, which we will discuss during the discussion of Secondary
functions of banks latter in this unit.
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Recurring Deposit Account: In this account the depositor can deposit a fixed amount of money
every month. The period of deposit may vary from 1 to 10 years. At the end of the period the
deposited amount along with interest is paid back to the depositor
When a customer deposits money in a bank, it results in a debtor- creditor relationship
between the banker and the customer. The banker is the debtor and the customer is the
creditor. However, the demand for payment must be made by the creditor (customer) in
proper manner
Advancing Loans: The next important function of a bank is to provide loans and advances to
the customers. After satisfying itself about the creditworthiness of the borrower, the bank
provides loans to the borrower
The borrower may be an individual or a partnership firm or a company etc. Now- a- day
the banks provide home loan, car loan, personal loan, educational loan etc. according to the
needs of the individual borrowers. The banks also meet the short- term, medium- term and
long- term credit needs of business firms. The bank charges interest on the loan amount.
Generally, the interest charged by the banks on loans is more than the interest allowed by
them on deposits. The banks provide financial assistance to the borrowers in various forms,
like loans, cash credit, overdraft and discounting of bills of exchange.
Loan: Banks grant loans to the borrowers against the security of certain assets, which
may be fixed assets, share certificates or savings certificates (National Savings Certificate,
Fixed Deposit Receipt etc.). The loans may be for short- term i.e. covering one year or long-
term i.e. covering more than one year. A loan is granted to the borrower either in cash or by
credit to his account and he can withdraw the whole amount at a time or in instalments. But he
has to pay interest on the whole amount of loan till he repays the loan.
Cash credit: It is an arrangement under which the borrower opens an account with the
bank. The loan amount is credited to his account and the borrower can withdraw from his
account. The main advantage of this arrangement is that the borrower can withdraw the
money according to his needs. The bank charges interest only on the amount withdrawn by the
borrower and not on the entire amount of loan.
Overdraft: Overdraft facility is available only to the current account holders of the
bank. Under this arrangement, the current account holders can withdraw more money than the
balanceavailable from his account. However, it is a temporary arrangement and the bank
charges interest on the overdrawn balance. The maximum amount that the account holder can
withdraw is fixed at the time of opening the account.
Discounting of bills: In trade and business, when credit transactions take place, it is a
common practice to draw bills of exchange by the creditor (seller) on the debtor (buyer) for the
amount due. The debtor is required to accept the bill and he will make the payment on the
maturity of the bill i.e. on due date. The creditor has to wait till the maturity of the bill to get
the payment. Now, what the creditor can do is that instead of waiting till the maturity of the
bill, he can sell the bill to the bank. The bank will make the payment to him after deducting a
certain percentage as commission. On maturity of the bill, the bank collects the amount from
the debtor. If the debtor fails to make payment, the bank can recover the amount from the
34
customer (Creditor). The main advantage of this facility is that the creditor gets money
immediately.
Credit Creation: Another function of banks is to create credit. Creation of credit is the
natural outcome of the process of advancing loans that we have discussed above. In
advancing loan to the borrower, the bank opens an account in his name and credits the loan
amount to that account instead of giving cash to him. The borrower can withdraw the money
from the account. Thus, in the process of advancing loans, the bank creates bank
deposits which results in increasing the money supply in the economy. This is known as credit
creation function of commercial banks.
Secondary Functions: The secondary functions of banks are as under:
Agency functions: The banks perform a number of functions on behalf of the
customers, known as agency functions. The various agency functions of banks are-
Collecting cheques, drafts, interest, rent, dividend etc. on behalf of the customer and
deposit the amount in the account of the customer;
Making payment for cheques, bills, insurance premium, rent etc. on the instructions of
the customers;
Making purchases and sales of shares, debentures, bonds etc. on behalf of the
customers;
Acting as trustee or executor for the customer;
Acting as financial guarantor on behalf of the importer in foreign trade;
Filing income- tax return on behalf of the customer.
General Utility Services: The banks provide general utility services not only to the customers
but also to the general public against a fee. Some of these services are –
Providing locker facility for safe keeping of valuables, important documents etc.;
Providing business information. The banks collect data regarding economic conditions,
financial conditions, trends in share market etc. and supply them to the customers;
Issuing travelers’ cheques to the travelers. The travelers are not required to carry cash
with them while traveling. They can easily encash the travelers’ cheques as and when required
with the banks with whom the issuing bank has banking arrangements;
Issuing letter of credit on behalf of the importer (buyer) in favour of the exporter
(seller). This function helps the parties in settling payments in international trade;
Issuing credit cards: This helps the customer to make purchases on credit from certain retail
shops and service firms. The payment will be made by the issuing bank from the concerned
customer’s account.
35
Price and Non price competition
Non-price competition refers to a situation where one of the following two things happens:
Buyers compete with each other to acquire a good on a basis other than price. Such
competition occurs in a situation of excess demand: at the given price, the demand for the
good exceeds the supply. The typical cause for excess demand is a price ceiling, though it
may also be caused by sticky prices or unforeseen dramatic changes in supply or demand.
Sellers compete with each other to sell a good on a basis other than price. Such
competition occurs in a situation of excess supply: at the given price, the supply for the
good exceeds the demand. The typical cause for excess supply is a price floor.
Non-price competition is a marketing strategy "in which one firm tries to distinguish
its product or service from competing products on the basis of attributes like design and
workmanship" The firm can also distinguish its product offering through quality of service,
extensive distribution, customer focus, or any other sustainable competitive advantage other
than price. It can be contrasted with price competition, which is where a company tries to
distinguish its product or service from competing products on the basis of low price. Non-price
competition typically involves promotional expenditures (such as advertising, selling staff, the
locations convenience, sales promotions, coupons, special orders, or free gifts), marketing
research, new product development, andbrand management costs.
Firms will engage in non-price competition, in spite of the additional costs involved, because it
is usually more profitable than selling for a lower price, and avoids the risk of a price war.
36
Although any company can use a non-price competition strategy, it is most common
among oligopolies and monopolistic competition, because firms can be extremely competitive
In a competitive market, various firms vie for the business of the same potential buyers. They
often do so by cutting costs whenever they can, which allows them to pass the savings on to
customers in the form of lower prices. However, trying to offer a lower price than a competitor
is not the only way of competing. Other methods can prove even more effective for firms,
though they can sometimes have downsides as well.
Quality
If consumers must choose between two products of the same price but they can see that one
is of a higher quality, they generally pick the product of higher quality. In this way, if a firm can
figure out how to produce an item at a cost comparable to what its competitor charges but
make it of higher quality, that firm may be able to steal the market from its competitor.
However, a problem with this approach is that it may take some time for consumers to realize
any difference in quality.
Perception and Branding
In some cases, little possibility of quality differentiation exists between two products. For
instance, in the United States, blue jeans have little actual quality variability from one producer
to another. For this reason, a number of producers compete by manufacturing a perception of
high quality with their brands. This allows some companies to charge higher prices for
seemingly identical products because consumers see value in the brand itself. However, the
long-term sustainability of such an approach may be difficult because, as such brand
advantages arise through consumer trends, consumer trends may also lead to their demise.
For instance, if consumers no longer see a clothing brand as fashionable, the manufacturer
may not be able to continue charging high prices for its products.
Product Design
In some cases, firms may compete by changing the design of their products to make them
more appealing without significantly changing production costs or quality levels. Such a
strategy can prove effective at stealing business from competitors, but it can also backfire,
because it can cause the company to alienate its existing consumers, who may be knowingly
choosing the existing design over other products with different designs specifically because it
appeals to their tastes.
Product Differentiation
Not all consumers are the same. Markets consist of men and women from diverse age, ethnic
and economic groups. Such groups tend to gravitate toward particular products as a bloc. For
this reason, firms should not expect a single product to appeal to every consumer in a market.
By offering a range of similar products geared toward different market sectors, firms can
expand their market base. However, such product differentiation can result in significantly
higher overhead costs for production.
Sales Structure
When two firms are competing with similar products, one may be able to enjoy more market
share and a deeper level of penetration due to a more effective and aggressive sales structure.
By engaging in direct sales, firms can appeal to prospective buyers who otherwise would not
feel compelled to buy due to advertising or other kinds of marketing. Multilevel marketing is
one way in which firms rapidly build their consumer base. However, by turning buyers into
sellers as well, such schemes may require significantly higher prices.
Examples:
Public services: non-price competition among buyers
37
Public services, many of which are offered for free, or at the same low cost, may suffer from
non-price competition. There may be long queues (waiting lines) for access to public services.
Here, people are paying for the free service by spending their time in line. However, the
economic value of this payment is not captured by anybody.
Limited quantity, low price: non-price competition among buyers
For commodities for which there is a market shortage, people may compete with each other to
get to the few places selling the commodity. Thus, people may start waiting outside the shop
selling the commodity hours before it opens (see queueing), or pay others to purchase the
good for them, or travel long distances looking for shops that still have the commodity.
Entry deterrence
In business, strategic entry deterrence refers to any action taken by an existing business in a
particular market that discourages potential entrants from entering into competition in that
market. Such actions, or barriers to entry, can include hostile takeovers, product
differentiation through heavy spending on new product development, capacity expansion to
achieve lower unit costs, and predatory pricing. These actions are sometimes deemed anti-
competitive and could be subject to various competition laws.
Limit pricing
In a particular market an existing firm may be producing a monopoly level of output, and
thereby making supernormal profits. This creates an incentive for new firms to enter the
market and attempt to capture some of these profits. One way the incumbent can deter entry
is to produce a higher quantity at a lower price than the monopoly level, a strategy known
as limit pricing. Not only will this reduce the profits being made, making it less attractive for
entrants, but it will also mean that the incumbent is meeting more of the market demand,
leaving any potential entrant with a much smaller space in the market. Limit pricing will only
be an optimal strategy if the smaller profits made by the firm are still greater than those risked
if a rival entered the market. It also requires commitment, for example the building of a
larger factory to produce the extra capacity, for it to be a credible deterrent.
Signalling
The incumbent firm has an advantage of being the “first mover” and can therefore act in a way
that it knows will influence the entrant’s decision. If we assume imperfect knowledge (i.e. the
incumbent firm’s costs are only known privately) the entrant can only make assumptions about
the incumbent’s cost structure through its price and output levels. Therefore, the incumbent
can use these as asignal to any potential entrant.
One way of using this advantage to deter entry is to charge a price less than
the monopoly level. If an entrant is considering entry in a number of similar markets, a low
cost incumbent can signal its efficiency to a potential entrant through lowering prices – thereby
discouraging what the entrant believes would be unprofitable entry. Signalling needs to be
credible to be effective – a low cost firm must be able to show that it can withstand lower
profits for an extended period of time, which it would not be able to if it had higher costs.
Pre emptive deterrence
An incumbent who is trying to strategically deter entry can do so by attempting to reduce the
entrant’s payoff if it were to enter the market. The expected payoffs are obviously dependent
38
on the amount of customers the entrant expects to have – therefore one way of deterring entry
is for the incumbent to “tie up” consumers.
The strategic creation of brand loyalty can be a barrier to entry – consumers will be less likely
to buy the new entrant’s product, as they have no experience of it. Entrants may be forced
into expensive price cuts simply to get people to try their product, which will obviously be a
deterrent to entry.
Similarly, if the incumbent has a large advertising budget, any new entrant will potentially
have to match this in order to raise awareness of their product and a foothold in the market – a
large sunk cost that will prevent some firms entering.
Predatory pricing
In a legal sense, a firm is often defined as engaging in predatory pricing if its price is below its
short-run marginal cost, often referred to as the Areeda-Turner Law and which forms the basis
of US antitrust cases. The rationale for this action is to drive the rival out of the market, and
then raise prices once monopoly position is reclaimed. This advertises to other potential
entrants that they will encounter the same aggressive response if they enter.
In the short run, it would be profit maximizing to acquiesce and share the market with the new
entrant. However, this may not be the firm’s best response in the long run. Once the
incumbent acquiesces to an entrant, it signals to other potential entrants that it is “weak” and
encourages other entrants. Thus the payoff to fighting the first entrant is also to discourage
future entrants by establishing its “hard” reputation.
Prisoners dilemma
The prisoner's dilemma is a example in game theory that shows why two individuals might
not cooperate, even if it appears that it is in their best interest to do so.
In economics
Advertising is sometimes cited as a real life example of the prisoner’s dilemma.
When cigarette advertising was legal in the United States, competing cigarette manufacturers
had to decide how much money to spend on advertising. The effectiveness of Firm A’s
advertising was partially determined by the advertising conducted by Firm B. Likewise, the
profit derived from advertising for Firm B is affected by the advertising conducted by Firm A. If
both Firm A and Firm B chose to advertise during a given period the advertising cancels out,
receipts remain constant, and expenses increase due to the cost of advertising. Both firms
would benefit from a reduction in advertising. However, should Firm B choose not to advertise,
Firm A could benefit greatly by advertising. Nevertheless, the optimal amount of advertising by
one firm depends on how much advertising the other undertakes. As the best strategy is
dependent on what the other firm chooses there is no dominant strategy and this is not a
prisoner's dilemma but rather is an example of a stag hunt. The outcome is similar, though, in
that both firms would be better off were they to advertise less than in the equilibrium.
Sometimes cooperative behaviors do emerge in business situations. For instance, cigarette
manufacturers endorsed the creation of laws banning cigarette advertising, understanding that
this would reduce costs and increase profits across the industry. This analysis is likely to be
pertinent in many other business situations involving advertising.
Another example of the prisoner's dilemma in economics is competition-oriented
objectives. When firms are aware of the activities of their competitors, they tend to pursue
policies that are designed to oust their competitors as opposed to maximizing the performance
39
of the firm. This approach impedes the firm from functioning at its maximum capacity because
it limits the scope of the strategies employed by the firms.
Without enforceable agreements, members of a cartel are also involved in a (multi-player)
prisoners' dilemma. 'Cooperating' typically means keeping prices at a pre-agreed minimum
level. 'Defecting' means selling under this minimum level, instantly stealing business (and
profits) from other cartel members. Anti-trust authorities want potential cartel members to
mutually defect, ensuring the lowest possible prices for consumers.
Capacity expansion
Many firms would like to expand their operations and capture more market share. But capacity expansion involves risks. If demand does not rise with capacity, the company may find itself burdened with overheads. At the same time, if capacity is not built in time, competitors may move ahead and grab market share. So, capacity expansion decisions have to be made carefully. One useful tool in this context is game theory. Companies can put themselves in the shoes of competitors and try to outguess them . At the same time, capacity expansion may sometimes be possible in increments. Companies can keep studying the business environment and learn before they decide to make more investments in capacity.
The risk associated with capacity expansion is largely due to uncertainty regarding the
following factors:
i) Future demand – quantity and price realisationii) Future prices of inputsiii) Technological advancesiv) Reactions of competitorsv) Impact on industry capacity
Market saturation
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In economics, "market saturation" is a term used to describe a situation in which a product has
become diffused (distributed) within amarket; the actual level of saturation can depend
on consumer purchasing power ; as well as competition, prices, and technology.
For example, in advanced economies an extremely high percentage of households own
refrigerators (more than 97% of households). Hence, the diffusion rate is more than 97%, and
the market is said to be saturated; i.e. further growth of sales of refrigerators will occur
basically only as a result of population growth and in cases where one manufacturer is able to
gain market share at the expense of others.
To give another example, in advanced western households, and depending on the economy,
the number of automobiles per family is greater than 1. To the extent that further market
growth (i.e. growth of the demand for automobiles) is constrained (the main buyers already
own the product), the market is said to be basically saturated. Future sales depend on several
factors including the rate of obsolescence (at what age cars are replaced), population growth,
and societal changes such as the spread of multi-car families.
First mover advantage
First-mover advantage or FMA is the advantage gained by the initial occupant of a market
segment. This advantage may stem from the fact that the first entrant can gain control of
resources that followers may not be able to match. Sometimes the first mover is not able to
capitalise on its advantage, leaving the opportunity for another firm to gain second-mover
advantage.
FMA is the sometimes insurmountable advantage gained by the initial or "first-moving"
significant occupant of a new market segment. This advantage may stem from the fact that
the first entrant can gain control of resources that followers may not be able to match.
Originally made apparent by the ever booming Internet phenomenon, it has recently been on
the decline due to the recent economic situation. It is important to note that the first-mover
advantage refers to the first significant company to move into a market, not merely the first
company. In order for a company to try and become a first-mover that company needs to
figure out if the overall rewards outweigh the beginning/underlying risks. Sometimes first-
movers are rewarded with huge profit margins and a monopoly like status. Other times the
first-mover is not able to capitalize on its advantage, leaving the opportunity for other firms to
compete effectively and efficiently versus their earlier entrants. These individuals then gain a
second-mover advantage.
These are;
1. Technological leadership
2. Preemption of scarce assets
3. Switching costs and buyer choice under uncertainty
First mover Disadvantages
Although in some cases being a first mover can create an overwhelming advantage, in some
cases products that are first to market do not succeed. These products are victims of First
Mover Disadvantages. These disadvantages include: "free-rider affects, resolution of
technological or market uncertainty, shifts in technology or customer needs, and incumbent
inertia". Delving into each of these deeper we see:
1. Free-rider affects
2. Resolution of technological or market uncertainty
3. Shifts in technology or customer needs
4. Incumbent inertia
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The Net Income theory and Net Operating Income theory stand in extreme forms. Traditional
approach stands in the midway between these two theories. This Traditional theory was
advocated by financial experts Ezta Solomon and Fred Weston. According to this theory a
proper and right combination of debt and equity will always lead to market value enhancement
of the firm. This approach accepts that the equity shareholders perceive financial risk and
expect premiums for the risks undertaken. This theory also states that after a level of debt in
the capital structure, the cost of equity capital increases.
Example:
Let us consider an example where a company has 20% debt and 80% equity in its capital
structure. The cost of debt for the company is 9% and the cost of equity is 14%. According to
the traditional approach the overall cost of capital would be:
The Net Income theory and Net Operating Income theory stand in extreme forms. Traditional
approach stands in the midway between these two theories. This Traditional theory was
advocated by financial experts Ezta Solomon and Fred Weston. According to this theory a
proper and right combination of debt and equity will always lead to market value enhancement
of the firm. This approach accepts that the equity shareholders perceive financial risk and
expect premiums for the risks undertaken. This theory also states that after a level of debt in
the capital structure, the cost of equity capital increases.
WACC = (Weight of debt x cost of debt) + (Weight of equity x cost of equity)
⇒ (20% x 9%) + (80% x 14%)
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⇒ 1.8 + 11.2 ⇒ 13%
If the company wants to raise the debt portion in the capital structure to be 50%, the cost of
debt as well as equity would increase due to the increased risk of the company. Let us assume
that the cost of debt rises to 10% and the cost of equity to 15%. After this scenario, the overall
cost of capital would be:
WACC = (50% x 10%) + (50% x 15%)
⇒ 5 + 7.5 ⇒ 12.5%
In the above case, although the debt-equity ratio has increased, as well as their respective
costs, the overall cost of capital has not increased, but has decreased. The reason is that debt
involves lower cost and is a cheaper source of finance when compared to equity. The increase
in specific costs as well the debt-equity ratio has not offset the advantages involved in raising
capital by a cheaper source, namely debt.
Now, let us assume that the company raises its debt percentage to 70%, thereby pushing
down the equity portion to 30%. Due to the increased and over debt content in the capital
structure, the firm has acquired greater risk. Because of this fact, let us say that the cost of
debt rises to 15% and the cost of equity to 20%. In this scenario, the overall cost of capital
would be:
WACC = (70% x 15%) + (30% x 20%)
⇒ 10.5 + 6 ⇒ 16.5%
This decision has increased the company's overall cost of capital to 16.5%.
The above example illustrates that using the cheaper source of funds, namely debt, does not
always lower the overall cost of capital. It provides advantages to some extent and beyond
that reasonable level, it increases the company's risk as well the overall cost of capital. These
factors must be considered by the company before raising finance via debt.
View Source: http://bit.ly/traditional-
approach _____________________________________________________________
Net Income (NI) Approach
Net Income theory was introduced by David Durand. According to this approach, the capital
structure decision is relevant to the valuation of the firm. This means that a change in the
financial leverage will automatically lead to a corresponding change in the overall cost of
43
capital as well as the total value of the firm. According to NI approach, if the financial leverage
increases, the weighted average cost of capital decreases and the value of the firm and the
market price of the equity shares increases. Similarly, if the financial leverage decreases, the
weighted average cost of capital increases and the value of the firm and the market price of
the equity shares decreases.
Assumptions of NI approach:
There are no taxes The cost of debt is less than the cost of equity. The use of debt does not change the risk perception of the investors
44
______________________________________________________________
Net Operating Income Approach
Net Operating Income Approach was also suggested by Durand. This approach is of the
opposite view of Net Income approach. This approach suggests that the capital structure
decision of a firm is irrelevant and that any change in the leverage or debt will not result in a
45
change in the total value of the firm as well as the market price of its shares. This approach
also says that the overall cost of capital is independent of the degree of leverage.
Features of NOI approach:
At all degrees of leverage (debt), the overall capitalization rate would remain constant. For a given level of Earnings before Interest and Taxes (EBIT), the value of a firm would be equal to EBIT/overall capitalization rate.
The value of equity of a firm can be determined by subtracting the value of debt from
the total value of the firm. This can be denoted as follows:
Value of Equity = Total value of the firm - Value of debt
Cost of equity increases with every increase in debt and the weighted average cost of capital (WACC) remains constant. When the debt content in the capital structure increases, it increases the risk of the firm as well as its shareholders. To compensate for the higher risk involved in investing in highly levered company, equity holders naturally expect higher returns which in turn increases the cost of equity capital.
Example:
Let us assume that a firm has an EBIT level of $50,000, cost of debt 10%, the total value of
debt $200,000 and the WACC is 12.5%. Let us find out the total value of the firm and the cost
of equity capital (the equity capitalization rate).
Solution:
EBIT = $50,000
WACC (overall capitalization rate) = 12.5%
Therefore, total market value of the firm = EBIT/Ko ⇒ $50,000/12.5% ⇒ $400,000
Total value of debt =$200,000
Therefore, total value of equity = Total market value - Value of debt
⇒ $400,000 - $200,000 ⇒ $200,000
Cost of equity capital = Earnings available to equity holders/Total market value of equity
shares
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Earnings available to equity holders = EBIT - Interest on debt
⇒ $50,000 - (10% on $200,000) ⇒ $30,000
Therefore, cost of equity capital = $30,000/$200,000 ⇒ 15%
Verification of WACC:
10% x ($200,000/$400,000) + 15% x ($200,000/$400,000) ⇒ 12.5%
Effect of change in Capital structure (to prove irrelevance)
Let us now assume that the leverage increases from $200,000 to $300,000 in the firm's capital
structure. The firm also uses the proceeds to re-purchase its equity stock so that the market
value of the firm remains the same at $400,000.
EBIT = $50,000
WACC = 12.5% (overall capitalization rate)
Total market value of the firm = $50,000/12.5% ⇒ $400,000
Less: Total market value of debt ⇒ $300,000
Therefore, market value of equity = $400,000 - $300,000 ⇒ $100,000
Equity-capitalization rate = ($50,000 - [10% on $300,000)/$100,000 ⇒ 20%
Overall cost of capital =
10% x $300,000/$400,000 + 20% x $100,000/$400,000 ⇒ 12.5%
The above example proves that a change in the leverage does not affect the total value of the
firm, the market price of the shares as well as the overall cost of capital.
_______________________________________________________________
Modigliani Millar Approach
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Modigliani Millar approach, popularly known as the MM approach is similar to the Net operating
income approach. The MM approach favors the Net operating income approach and agrees
with the fact that the cost of capital is independent of the degree of leverage and at any mix of
debt-equity proportions. The significance of this MM approach is that it provides operational or
behavioral justification for constant cost of capital at any degree of leverage. Whereas, the net
operating income approach does not provide operational justification for independence of the
company's cost of capital.
Basic Propositions of MM approach:
At any degree of leverage, the company's overall cost of capital (ko) and the Value of the firm (V) remains constant. This means that it is independent of the capital structure. The total value can be obtained by capitalizing the operating earnings stream that is expected in future, discounted at an appropriate discount rate suitable for the risk undertaken.
The cost of capital (ke) equals the capitalization rate of a pure equity stream and a premium for financial risk. This is equal to the difference between the pure equity capitalization rate and ki times the debt-equity ratio.
The minimum cut-off rate for the purpose of capital investments is fully independent of the way in which a project is financed.
Assumptions of MM approach:
Capital markets are perfect. All investors have the same expectation of the company's net operating income for the
purpose of evaluating the value of the firm. Within similar operating environments, the business risk is equal among all firms. 100% dividend payout ratio. An assumption of "no taxes" was there earlier, which has been removed.
Arbitrage process
Arbitrage process is the operational justification for the Modigliani-Miller hypothesis. Arbitrage
is the process of purchasing a security in a market where the price is low and selling it in a
market where the price is higher. This results in restoration of equilibrium in the market price
of a security asset. This process is a balancing operation which implies that a security cannot
sell at different prices. The MM hypothesis states that the total value of homogeneous firms
that differ only in leverage will not be different due to the arbitrage operation. Generally,
investors will buy the shares of the firm that's price is lower and sell the shares of the firm
that's price is higher. This process or this behavior of the investors will have the effect of
increasing the price of the shares that is being purchased and decreasing the price of the
shares that is being sold. This process will continue till the market prices of these two firms
48
become equal or identical. Thus the arbitrage process drives the value of two homogeneous
companies to equality that differs only in leverage.
Limitations of MM hypothesis:
Investors would find the personal leverage inconvenient. The risk perception of corporate and personal leverage may be different. Arbitrage process cannot be smooth due the institutional restrictions. Arbitrage process would also be affected by the transaction costs. The corporate leverage and personal leverage are not perfect substitutes. Corporate taxes do exist. However, the assumption of "no taxes" has been removed
later.
Find Gross Annual value in the case of following properties
Particulars House1 House 2 House 3 House 4 House 5
Municipal
value
52000 100000 60000 75000 180000
Fair rental
value
60000 102000 68000 70000 185000
Standard rent NA 90000 70000 60000 175000
Actual/Annual
rent
55000 95000 72000 72000 168000
Period of
vacancy
------ ------- ------- 8 months 1 month
Unrealized
rent
---- ----- 5000 ---- 42000
Find the Gross Annual Value of a house property whose municipal valuation is Rs. 80,000, fair rent is Rs. 90,000 and standard rent is Rs. 75,000.The house is let out to a third party for a monthly rent of Rs. 7,000 for 10 months and remains vacant for the remaining part of the year
49
Income from salary Assessment year 2012-13
1. Mr. Ram joins TQS Ltd. on 1 -5-2009 on a salary of Rs. 15,000 p.m. From Aug 1, 2011 his salary is increased to Rs. 18,000 p.m. Compute salary chargeable to tax for the PY 2011-12 if (a) Salary falls due on last day of each month. (b) Salary becomes due on the first day of next month.
Ans: (a) Rs. 2,04,000; (b) Rs. 2,01,000
2. Mr. Gopinath joins a company on 1-6-2007 on a salary of Rs. 12,000 p.m.. From 1-12-2011 his salary is increased to Rs. 16,000 p.m. Compute his basic salary for the AY 2012-13 assuming that (a) Salary falls due on last day of each month. (b) What would be your answer if he joins the company on 1-6-2011? (c) What would be your answer if he resigns from the company on 31-1 -2012.
Ans: (a) Rs. 1,60,000; (b) Rs. 1,36,000 (c) Rs. 1,28,000
3. Mr. T joins as an education officer in an educational institute in the grade of 12,000-500-15,000 from 1-7-2009. Compute his basic salary for the AY 2012-13 assuming that (a) salary falls due on last day of each month. (b) salary become due on the first day of next month.
Ans: (a) Rs. 1,48,500; (b) Rs. 1,48,000
4. Compute Gross Salary from following information for tire AY 2012-13: Salary after tax deduction of Rs. 2,000 1,44,000 Advance salary due for April 2012 received in March 2012 8,000 Arrears of salary already taxed in the PY 2010-11 5,000 Arrears of salary not taxed earlier 7,000 Bonus not yet received 16,000
Ans: Rs. 1,77,000
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5. Ramlal Joins Gopi Ltd. on Oct 1, 2007 in the pay scale of Rs.12,000 – Rs.1,000 – Rs.18,000 (salary at the time of joining is fixed at Rs.15,000) As per the terms of employment salary becomes ―due on the first day of the next month, and it is generally paid on the fifth day of the next month. Find out the salary taxable for the assessment year 2012-13
Ans: Rs. 2,16,000
6. Up till 30th June, 2011, Radha is in the employment of Shyam Ltd. on the fixed salary of Rs.23,000 per month which becomes ―due on the first day of the next month. On July 1, 2011, Radhe joins Bharat Ltd. (salary being Rs.30,000 per month which becomes ―due on the last day of each month.) Salary is actually paid on the 7th day of next month in both cases. Find out the amount of salary chargeable to tax for the assessment year 2012-13.
Ans: Rs. 92,000 + Rs. 2,70,000 = Rs. 3,62,000
Mr. Shiv retires on 15th October2010, after serving 30 years and 7 months. He gets Rs.4,80,000 as gratuity. His salary details are given below: FY 2011-12: Salary Rs.18,000 pm D.A. 60% of salary. 40% forms part of retirement benefits. FY 2010-11: Salary Rs.16,000 pm D.A. 60% of salary. 40% forms part of retirement benefits Determine his gross salary in the following cases: (i) He retires from government service. (ii) He retires from seasonal factory in a private sector, covered under Payment of Gratuity Act, 1972. (iii) He retires from non-seasonal factory, covered by Payment of Gratuity Act, 1972 (iv) He retires from private sector, not covered by payment of Gratuity Act
Ram lal, an employee of Sita (P)Ltd. retired from the his job on 15-07-2011. At the time of such retirement, his basic salary was Rs. 8,600 p.m. He was also entitled to dearness allowance @ 30% of his basic salary. 70% of the D.A. forms part of the salary for retirement benefits. He had worked with his employer for 12 years 10 months and 15 days. He got an increment of Rs. 600 in his basic salary w.e.f 1-6-2011. At the time of his retirement, the company paid him a gratuity of Rs. 1,90,000. He is not covered under the payment of Gratuity Act. Also compute his gross salary for the A.Y. 2012-13.
Ans: Rs. 1,69,052
51
Mr. Deendayal retired from his job w.e.f. 1-12-2011. He had joined the service on 1-1-99. He gets an increment in his basic salary amounting to Rs. 1,000 every year on 1st July. At the time of his retirement he was getting a basic salary of Rs. 15,000 p.m. He was also entitled to D.A. @ 20% of basic salary and a turnover based commission @ 1% of the total sales achieved by him. Total turnover achieved by him for the 12 months ending on 30-11-11 was Rs. 8,00,000 spread evenly over the year. Bonus received Rs. 30,000. He received a sum of Rs. 1,80,000 as gratuity. Compute his gross salary for the A.Y. 2012-13.
Ans: Rs. 2,64,731
4. Mr. Ganesh is getting a salary of Rs. 9,400 pm since 1.1.11 and dearness allowance of Rs.4,500 pm, 30% of which is a part of retirement benefits. He retires on 30th November 2011 after 30 years and 11 months of service. His pension is fixed at Rs.3,800 pm. On 1st February 2012 he gets 3/4ths of the pension commuted at Rs.1,59,000. Compute his gross salary for the previous year 2011-12 in the following cases:
(i) If he is a government employee, getting gratuity of Rs.1,90,000 (ii) If he is an employee of a private company, getting gratuity of Rs.1,90,000 (iii) If he is an employee of a private company but gets no gratuity.
5. Mr. Hariom retired from his job w.e.f. 1-10-2011 after serving for 15 yrs. and 8 months. At the time of retirement he was getting the following remuneration: (i) Salary Rs. 6,000 p.m. (ii) D.A. @ 40% of salary (20% of which forms part of salary for retirement benefits). (iii) Commission 1000 p.m.
On retirement, he received a sum of Rs. 2,50,000 as gratuity. He was entitled to a pension of Rs. 3,000 p.m. w.e.f. 1-10-2011. From 1-2-2012 he got 80% of his pension commuted and received a sum of Rs. 3,20,000 as commuted pension. Compute his gross salary for the A.Y. 2012-13.
Ans: Rs. 4,57,667
Kalicharan Joined a Job in the grade of Rs. 12,000 – 400 - 14,000 – 500 - 18,000 – 1,000 – 24,000 on 1-7-98 and resigned from the service on 15-12-2011. He was also entitled to D.A. @ 60% which forms part of salary for retirement benefits. In addition of his salary he received on retirement a gratuity of Rs. 2,80,000. He was entitled to a pension of Rs. 5,000 p.m. w.e.f. 16-12-2011. He got 60% of his pension commuted w.e.f. 1-2-2012 and received a sum of Rs. 3,00,000 as commuted pension. Compute his gross salary for A.Y. 2012-13.
Ans: Rs. 4,82,633
Mr. Raghunath was employed with Ravidev (P) Ltd. He retired from his job w.e.f. 1-11-2011 after completing a service of 22 yrs. and 8 months. He furnishes you following information in respect of his remuneration: Basic salary Rs. 15,800 p.m. (at the time of retirement) D.A. 80% of Basic salary (20% of which forms part of salary for Retirement benefits). Last increment Rs. 800 w.e.f. 1-8-2011 He is entitled to received pension of Rs. 4,000 p.m. He commuted the 50% portion of his pension on 1-2-2012 and received a sum of Rs. 1,60,000 as commuted pension. In addition to this, he received a gratuity of Rs. 3,58,000. He was entitled to 35 days leave for every year of service. He received leave encashment amounting to Rs. 90,000 on account of accumulated leave (unavailed leave at the time of retirement) of 260 days. Compute his gross salary for A.Y. 2012-13 assuming that he is not covered under payment of Gratuity Act.
Ans: Rs. 4,27,805
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INCOME TAX
Computation of HRA
1. Ascertain the amount of taxable and exempted HRA from the following cases
Particulars Case I Case II Case III Case IV
Basic salary per month 5000 6000 6500 7500
DA as % of basic 20% 10% 15% 20%
DA forming part of retirement benefits ( %
of DA)
40% Nil 20% Nil
HRA received from Company per month 2000 2700 2900 3500
HRA paid by the employee per month 2100 2600 2950 3600
Place of residence Delhi Bangalor
e
Chennai Mysore
2. Compute taxable and exempted HRA from the following information:
Salary 3500 pm, DA 1000 pm (enters retirement benefits), CCA 200 pm, HRA received 1000
pm Commission on turnover 6000 pa. The employee stays in Kolkota and rent paid by him is
Rs.1500 pm.
3. Mr. R is employed in Hubli on a monthly salary of Rs.5500. Employer pays him an HRA of
1200 pm, but actual rent paid by him is 1800 pm. He is also getting a commission of 2% on
turnover achieved by him and the turnover is 150000 pa. Compute his gross salary for
assessment year 2012-13
4. Compute taxable HRA and gross salary for the assessment year 2012-13
Particulars Mr A Mr.B
Place of stay Mumbai Bangalore
Basic salary 8000 pm 5000 pm
DA ( 70% forms part of retirement
benefits)
1500 pm 3000 pm
Sales achieved for 1% commission 30 lakhs 22 lakhs
53
HRA received from company 4000 pm 2400 pm
Rent paid by employee 2400 pm 5000 pm
5. Mr. G is an employee of XLR Ltd Chennai, working and staying in Bangalore. He gets a basic
salary of Rs.12000 pm, DA 30% of basic ( 50% enters retirement benefits), CCA 5000 pm, HRA
4500 pm. The rent paid by him is Rs.5200 per month. Compute his taxable HRA and Gross
salary for the assessment year 2012-13
INCOME TAX
GRATUITY
1. Mr Shah, accounts manager retired from JK Ltd on 15/1/2012 after a service of 30 years and
7 months. His salary is 25000 pm upto 30/9/2011 and 27000 thereafter. He also gets 2000 pm
as DA ( 55% forms part of retirement benefits). He is not covered by payment of gratuity act.
He receives 8 lakhs as gratuity. Compute taxable and exempted gratuity for the previous year.
2. Mr Surya is an employee of IPC Ltd. After serving for 38 years and 11 months he retires on
28/2/2012. He was drawing a monthly salary of 15000 pm in calendar year 2010, 16000 pm in
2011 and 18000 pm from 1/1/2012 to 28/2/2012. On retirement he received a gratuity of 4
lakhs. Compute taxable gratuity assuming he is not covered by payment of gratuity act
3. R retires on 8/1/2011 after serving KT Ltd for 19 years and 7 months. At the time of
retirement his basic salary was 14000 pm and DA 8000 pm ( not covering retirement benefits).
On his retirement he received 6 lakhs as gratuity. Compute exempted amount of gratuity, if he
is covered under payment of gratuity act.
4. Vinod who is in part time employment with GT Ltd GY Ltd furnishes the following
information
Particulars GT Ltd GY Ltd
Basic salary per month 10000 6000
DA 40% of basic ( forming part of
retirement benefits
50% of basic ( 40% enters
retirement benefits)
Date of retirement 1/12/2011 15/1/2012
Period of service 22 years and 11 months 20 years and 4 months
Amount of gratuity received 143000 120000
Date of increment in basic
salary
1/4/2011 1/8/2011
Amount of last increment 1000 5000
Compute taxable and exempted amount of gratuity
5. Smt. S, who is not covered under payment of gratuity act, received 376000 as gratuity when
she retired on 24/8/2011, after completing a service of 34 years and 9 months. Her last salary
drawn was basic 20000 pm, servant allowance 750 pm. Basic salary of 20000 is after giving an
54
increment of 1000 from janauary 2011. Calculate exempted gratuity if (a) salary falls due on
last day of the month (b) salary falls due on first day of the month
INCOME TAX
PENSION
1. X retires from P Ltd on 31/7/2011. He gets a pension of 1000 pm upto 31/12/2011. With
effect from 1/1/2012, he gets 60% of his pension commuted for 170000. Compute taxable
pension and exempted pension if (a) X gets gratuity (b) X does not get gratuity
2. Mr T retired from central government service on 30/6/2011. He gets pension of 750 pm upto
31/12/2011. On 1/1/2012 he gets 1/3 of his pension commuted for 66000. Calculate taxable
pension, if salary falls due on last day of each month
3. Mr. Eshwar retired from ACA Ltd on 30/6/2011. He gets a pension of 4000 pm upto
31/12/2011. On 1/1/2012 he gets 40% pension commuted for 52800. Calculate taxable pension
of (a) Eshwar does not get gratuity (b) Eshwar gets gratuity
4. Mr Suresh is getting a pension of 2000 pm from a private company. During the previous
year he got 2/3 of his pension commuted and received 123000. Compute exempted amount of
pension if (a) he gets gratuity (b) he does not get gratuity
5. Calculate taxable pension of Mr Q who was working with TAFE Ltd and retires on 30/4/2011.
Upto 31/12/2011 his pension is fixed at Rs.12000 pm. On the same date he commutes 2/3 of
his pension for 64000. Calculate taxable pension if he receives and does not receive gratuity
6. Mr. Shobhit is getting a pension of Rs. 8,000 per month from a company. During the
previous year he got his three-fourth pension commuted and received Rs. 7,20,000. Compute
the exempted amount assuming if he also received gratuity.
7. A retired from service on 31.3.2011 and started getting pension of Rs. 6,000 monthly. On
1.1.2012 A commuted one-fourth of pension and received Rs. 90,000. Calculate taxable
amount of pension for the Assessment Year 2012-13 if the assessee has not received gratuity
at the time of retirement.
8. Mr. Reddy retires from Private Service on 30th April, 2011 and his pension has been fixed at
Rs. 3,000 p.m. He gets 1/2 of his Pension commuted and gets Rs. 1,50,000. He also received
Rs. 75,000 as gratuity. He gets his Pension commuted in January 2012.. Calculate taxable
pension.
55
Geeta is entitled to get a pension of Rs. 1,500 per month from Rajdeeo Ltd. She gets three-fifths of the pension commuted and receives Rs. 90,000. Compute the taxable portion of commuted value of pension when (i) she does not receive gratuity; (ii) receives Rs. 50,000 as gratuity.
56
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CA (Chartered Accountancy) course consists of the following groups and subjects
Group Subjects
Fundamentals of AccountingQuantitative AptitudeGeneral EconomicsMercantile Law
AccountancyCosting & Financial ManagementCorporate & Business Law, Ethics & CommunicationIncome Tax, VAT & Service Tax
Advanced AccountancyAuditing & AssuranceInformation Technology & Strategic Management
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Advanced Management AccountingDirect TaxesIndirect Taxes
CA CPT
It is an entry level test for Chartered Accountancy Course. It is a test of four subjects i.e. Accounting, Mercantile Laws, General Economics and Quantitative Aptitude. It is an objective based examination. You should register with the institute at least 60 days prior to the first day of the month in which examination is held.
BatchRegistrationCommence
Classes Commence
April Batch 1st week of February 1st week of April
June Batch 1st week of May 3rd week of June
October Batch 1st week of August 1st week of October
57
Class duration - 2 1/2 - 3 months Classes conducted at "ICSI" centre, Bangalore
Course fee Rs. 4000/- ( Rupees four thousand only)
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Course Duration - 5 to 6 months Classes conducted at "ICSI" centre Bangalore
Course fee Rs. 8000 (Rupees eight thousand only)
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CA CPT
Minimum Number of students : 20
Total Income for the institute 20 x 4000 Rs80000
BatchRegistration Commence
Classes Commence
February Batch 1st week of February 2nd fortnight of February
September Batch 1st week of August 1st week of September
58
CA IPCC/PCC
Minimum number of students 20
Total income for the institute 20 x 8000 160000
CA Final
Minimum number of students
Minimum number of students 20
Total income for the institute 20 x 10000 200000
Total income from from CA CPT, PCC and Final 240000
Less: Expenses ( roughly 50%) 120000
Net Income for the institute 120000
Anirudh has a property whose municipal value is 130000 and fair rental value is 110000.
Standard rent 120000. The property is let out for 11000 per month throughout the previous
59
year. One month rent is unrealized. Municipal tax paid is 10% of municipal value. Interest on
loan is 40000. Compute income from house property for the assessment year 2012-13
Ganesh has a property in Mysore which has a municipal value of 250000. The fair rental value
and standard rent is 200000 and 210000 respectively. The property was let out for the period
from 1-4-2011 to 31-12-2011 at a monthly rent of 20000. Unrealized rent is for one month.
Municipal tax of 8% on municipal value is shared equally between tenant and landlord. Interest
on borrowed capital is 65000. Compute income from HP of Mr. Ganesh for assessment year
2012-13
Prem owns a house in Bangalore. During the previous year 2/3 portion was self occupied and
1/3 portion was let out for residential purposes for a monthly rent of 8000 per month. MV of
the property was 300000, FRV was 270000 and SR was 330000. He paid a municipal tax of
10% on MV. A loan of 25 lakhs was taken for the construction of the property in 2008. He paid
a sum of Rs 188000 towards repayment of loan which includes Rs.120000 as interest in the
previous year. Compute income from house property of Prem for the previous year 2011-12
Ravish owns a house in Delhi. Compute his income from house property for assessment year
2012-13 from the following information:
MV 200000, FRV 252000, SR 240000
Actual rent 23000 per month
MT due 20% of municipal value
MT paid 50% of the due
Expenses on repair Rs.20000
Insurance premium 5000
R had borrowed 12 lakhs @ 10% on 1-7-2009 for the construction of the house and the
construction was completed on 28/2/2011.
Break even point
1. You are given the following data for the years 2010 and 2011
Particulars 2010 2011
Sales 30 lakhs 45 lakhs
Profit 3 lakhs 6 lakhs
Calculate
60
a. PV Ratio
b. Fixed cost
c. Break even point
d. Margin of safety for two periods
e. Sales required to earn a profit of 7.50 lakhs
f. Profit when sakes are 20 lakhs
61
2. You are given the following data of a Company
Sales 10 lakhs
Direct material 3.30 lakhs
Direct labour 2.25 lakhs
Manufacturing expenses 2.50 lakhs( 1 lakh variable)
Administration expenses 1.00 lakh( 50% fixed)
Selling expenses 0.45 lakhs( 100% variable)
Calculate:
a. PV ratio (b)Margin of safety (c)Sales required to earn a profit of 1 lakh
(d)Profit when sales are 9 lakhs
3 Calculate the profit earned. Fixed cost Rs.5,00,000. Variable cost R.10 per unit.
Selling price Rs.15 per unit. Output 150,000 units
4. Find the fixed costs : Sales Rs.2,00,000. Variable Cost Rs.40,000. Profit Rs.30,000
5. Sales Rs.1,50,000. Profit Rs.40,000. Fixed cost 30000. Find variable cost
6. Calculate break even point and margin of safety.
Fixed cost Rs.1,60,000. Variable cost per unit Rs.2 and Selling price per unit Rs.18. Also
compute the margin of safety if the company is earning a profit of Rs.36,000.
For the assessment year 2012-13 Mr. Joseph submits the following information:
Particulars House 1 House 2Fair rent 350000 320000Municipal value 360000 350000Standard rent 300000 500000Annual rent 600000 420000Unrealized rent of previous year 2011-12 10000 80000Unrealized rent of previous year 2010-11 ---- 300000Vacant period ( number of months) 2 4Loss on account of vacancy 100000 140000Municipal taxes paid 40000 50000Repairs 40000 50000Insurance 20000 30000Land revenue 25000 40000Ground rent 66000 82000Interest on borrowed capital by mortgaging House I ( funds used for construction of House II)
140000
Nature of occupation Let out for residence Let out for business
Determine the income from house property
Mr Akhil owns two houses. The details are given below: compute income from HP
Particulars House 1 House 2Let out 1-4-2011 to 30-6-2011 (rent
being 6000 per month)1-7-2011 to 31-3-2012 ( rent
being 13000 per month)Self occupied 1-7-1011 to 31-3-2012 1-4-2011 to 30-6-2011MV 60000 100000FRV 70000 95000SR 66000 110000Rent for let out period 18000 117000
62
Interest on borrowed capital
2000 40000
MT paid 10000 17000
Mr. X owns a residential house property. It has two equal units – Unit I and Unit II. While unit I is self occupied by Mr X for his residential purpose, Unit II is let out @ 6000 per month. Rent of 2 months could not be recovered. MV of the property is 130000, FRV 140000 and SR 125000. Municipal tax of 12% of MV is paid by Mr.X. Other expenses of previous year include repairs 1250, insurance 600 .Interest on borrowed capital ( borrowed in 1997) for construction of property Rs.63000. Find the income from HP for assessment year 2012-13
Find Gross Annual value in the case of following properties
Particulars House1 House 2 House 3 House 4 House 5
Municipal value 52000 100000 60000 75000 180000
Fair rental value 60000 102000 68000 70000 185000
Standard rent NA 90000 70000 60000 175000
Actual/Annual rent 55000 95000 72000 72000 168000
Period of vacancy ------ ------- ------- 8 months 1 month
Unrealized rent ---- ----- 5000 ---- 42000
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1. R Ltd. which makes only one product, sells 10,000 units of its product making a loss of Rs. 10,000. Variable cost per unit of the product is Rs. 8 and the fixed cost is Rs. 30,000.
Calculate (i) the number of units to break-even; (ii) the number of units to earn a profit of Rs. 6,000; (iii) the amount of profit from a sale of 20,000 units
2. A Company had incurred fixed expenses of 4,50,000, with sales of Rs.15,00,000 and earned a profit of Rs.3,00,000 during the first half year. In the 2nd half, it suffered a loss of Rs.1,50,000.
Calculate:(i)The profit-volume ratio, break-even-point and margin of safety for the first half year. (ii) Expected sales-volume for the second half year assuming that selling price and
fixed expenses remained unchanged during the second half year.
(iii) The break-even point and margin of safety for the whole year.
3. ABC Ltd. & MNO Ltd. sell identical products in identical markets. Their budgeted income statement for the year 2010-11 are follows: ABC MNO Rs. Rs.Sales 5,00,000 6,00,000Less: Variable cost _4,00,000 _1,80,000 Contribution 1,00,000 4,20,000Less: Fixed Cost _20,000 _2,70,000Budgeted profits 80,000 1,50,000
Calculate: BEP for each company; Sales at which each company will earn a profit of Rs. 60,000; Sales at which both companies will have same profits
4. I co. & II co. have decided to merge into one company. The operating details of two companies are as follows:
Company I Company II Percentage of capacity utilisation 90 60Sales (Rs.) 5,40,00,000 3,00,00,000Variable costs (Rs.) 3,96,00,000 2,25,00,000Fixed costs (Rs.) 80,00,000 50,00,000
Assuming that these two companies merge into one, determine:a. the break-even sales of the merged company, b. the profitability of the merged company at the 80% level of capacity utilisation, c. the turnover of the merged company required to earn a profit of Rs. 75,00,000, and d. the percentage increase in selling price necessary to sustain an increase in fixed overheads by 5% when the merged company is working at a capacity to earn a profit of Rs. 75,00,000.
1. KC Company produces a single article. Following is the cost data given for its product:
64
Selling price per unit Rs.20 Marginal cost per unit Rs.12Fixed cost per annum Rs 800
Calculate: (a) PV ratio (b) BEP (c) sales to earn a profit of Rs.1000 (d) profit at a sale of Rs.6000 (e) new BEP if selling price is reduced by 10%
2. Lucky & Co has given you the following data:
Selling price per unit Rs.20 Direct material cost per unit Rs.8Direct labour cost per unit Rs 2 Variable overhead per unit Rs.2Fixed cost (total) Rs.20000
Find out (a) PV ratio (b) BEP in value (c) MOS at a sale of 100000 (d) profit if sales are 20% above BEP (e) Sales to make a profit of Rs.5000 (f) PV ratio if the selling price is increased by 10% (g) Break even sales, if the selling price is increased by 10% (h) Break even sales, if the fixed overhead is increased by 20%
3. From the following information calculate BEP
Sales Rs 200000 Variable cost Rs.120000 Fixed cost Rs.30000
Also calculate (a) new BEP if selling price is reduced by 10% (b) New BEP if variable cost increases by 10% (d) New BEP if fixed cost increases by 10%
4. S Ltd gives the following information:
Particulars Variable cost (% of sales) Fixed costDirect material 32.8 ----Direct labor 28.4 -----Factory overhead 12.6 189000Distribution overhead 4.1 58400General administration overhead 1.1 66700 Budgeted sales for the next year 1850000
You are required to determine (a) BEP sales value (b) profit if actual sales drop by 10% (c) profit if actual sales increase by 5%
5. A multi product company furnishes the following data for the year 2010
Particulars I half year II half year
Sales Rs.45000 Rs.50000Total cost Rs.40000 Rs.43000
Calculate: (a) PV ratio (b) BEP (c) profit when sales is 85000 (d) sales required to get a profit of 11000 (e) variable cost for two periods
1. ABC Ltd has prepared the following budget estimates for the year 2011-12
Sales (in units) 15000Fixed expenses Rs.34000Sales value Rs.150000Variable cost Rs.6 per unit
You are required to (a) find out the PV ratio, BEP and MOS (b) calculate the revised PV ratio, BEP and MOS in each of the following cases
Decrease of 10% in sales Increase of 10% in variable costs Increase of sales volume by 2000 units Increase of Rs.6000 in fixed costs
2. R Ltd manufactures a machine which has the following cost structure
65
Material Rs 40 Labor Rs 10 Overhead Rs 4Selling price Rs.90
Sales during the current year are expected to be Rs.1350000 and fixed cost Rs.140000Under a wage agreement an increase of 10% is payable to all direct workers from the beginning of next year, while material costs are expected to increase by 7.5%, variable overhead by 5% and fixed cost by 3%.
You are required to calculate
a. the new selling price if the current PV ratio is to be maintainedb. The quantity to be sold during the forthcoming year to yield the same amount of profit
as in the current year assuming the selling price remains at Rs.90
3. SS Ltd furnishes its cost structure which is as follows:
Material Rs.50 LaborRs.80 Variable overhead 75% of labor cost
Fixed overhead of the company amounts to Rs.240000 per annum and the selling price is Rs.230 each
a. determine the number of units for break evenb. How may units have to be made and sold in a year to make a profit of Rs. 1 lakhc. If the selling price is reduced by Rs.15 each, how many units have to be sold to break
even
4. From the following information calculate variable cost
Sales 100000 units @ Rs.12 each, Fixed cost Rs.28000, Profit Rs.200000
1. You are given the following Data:
Sale Price Rs350 per unit, Variable cost Rs.200 per unit, Fixed cost 1650000.Ascertain :- (a) BEP (b) selling price per unit if BEP is brought down to 15000 units (c) selling price per unit if BEP is brought down to 10000 units
2. ABC Ltd has prepared the following budget estimates for the year 2011-12
Sales (in units) 15000Fixed expenses Rs.34000Sales value Rs.150000Variable cost Rs.6 per unitYou are required to (a) find out the PV ratio, BEP and MOS (b) calculate the revised PV ratio, BEP and MOS in each of the following cases
Decrease of 10% in sales Increase of 10% in variable costs Increase of sales volume by 2000 units Increase of Rs.6000 in fixed costs
3. A company sold in two successive periods 7000 units and 9000 units and has incurred a loss of 10000 and earned a profit of 10000 respectively. The selling price is Rs.100.
You are required to calculate:
(a) fixed cost (b) the number of units to break even (c) the number of units to earn a profit of Rs.40000
4. A company has annual fixed cost of 14 lakhs. In 2010 the sales amounted to 60 lakhs compared to 45 lakhs in 2009. The profit in 2010 was 420000 higher than in 2009. At what level does the company break even? Determine the profit or loss on a sales volume of 80 lakhs
5. The price structure of a product is as follows:
Particulars Per unit ( in Rs)
66
Material 60 Labor 20Variable overheads 20 Fixed overheads 50Profit 50Selling price 200
This is based on the manufacture of one lakh cycles per annum. The company expects that due to competition they will have to reduce the selling price, but they want to keep the existing profits intact. What level of production will have to be reached ( how many units will have to be manufactured and sold) to get the same amount of profits if:
a. the selling price is reduced by 10%b. the selling price is reduced by 20%
1. Mr. A is owner of two house properties, which are let out. The details for the financial year 2011-12 are as follows:
Property A Property BMunicipal valuation 60,000 50,000Fair tent 70,000 60,000Actual rent received p.m. SOP 10,000Municipal tax paid by the owner (including Rs. 1000 oflast year) 4000 10,000Interest on loan taken forthe marriage of his daughter(Property B is mortgaged) 20,000Interest on loan forRenovation 40,000 -Interest on loan borrowedfor construction (startedafter 01.04.99 andcompleted before 1.4.2003) 1,60,000Property B was lying vacant for two months during the year. The assessee has appointed a Caretaker for both the properties and he is paid a salary of Rs. 1000/- per month.The assessee had another house which was given on rent (upto the A.Y 2006-2007). In 2008-09, it was sold. When it was let out, the assessee could not realize rent of Rs. 25,000 However, after a court order, the tenant has now paid the same. On account of the said court orders, the assessee has also received Rs. 1,00,000/- as arrears of rent
Compute income from house property for the assessment year 2012-13
2.Mr G furnishes the following information for the assessment year 2012-13. Compute his income from house property.
Particulars House 1 House 2 House 3 House 4MV 12500 16000 12000 30000FRV 13500 14000 12900 27500Standard rent NA NA NA 22900Nature of occupation SOP Own business Let out Let outRent per month --- ---- 750 2750Period of vacancy --- ---- ---- 4 monthsUnrealized rent --- --- 1.5 months ----MT due and paid 12% 10% 9% 10%Recovery of unrealized rent of PY 2009-10( claimed as deduction earlier)
---- ---- 12000 ----
Receipt of arrears of rent --- --- ---- 8500Date of commencement of construction
June 2005 May 2005 April 2005 June 2005
Date of completion of construction
Dec 2007 Dec 2007 Dec 2007 Dec 2007
A loan of Rs 4 lakhs was taken from Canara Bank on 1-4-2005 @ 12% and it is still outstanding. The amount of loan is equally utilized for all the houses. Interest for the previous year 2011-12 is due and not paid. Interest on unpaid interest is 4850.
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1. Mr. G and N constructed their houses on a piece of land purchased by them at Kolkata. The
built-up area of each house was 1,000 sq ft. Ground floor and an equal area in the First floor.
Mr. G started construction on 1.7.2010. Mr. G occupied the entire house on 1.4.2011. Mr. N
occupied the Ground floor on 1.7.2011 and let-out the first floor for a rent of ` 20,000 p.m.
However, the tenant vacated the house on 31.12.2011 and Mr. N occupied entire house during
1.1.2012 to 31.3.2012.
Following are the other information :
(i) Fair Rental Value of each unit (Ground floor/First floor) ` 2,00,000 p.a.
(ii) Municipal Value of each unit (Grount floor/First floor) ` 90,000 p.a.
(iii) Municipal taxes paid by G – ` 12,000 N – ` 12,000
(iv) Repair and Maintenance charges paid by G – ` 40,000 N – ` 50,000
Mr. G has availed a housing loan of ` 16.00 Lakhs @ 12% p.a. on 1.4.2010. N has availed a
housing loan of ` 18.00 Lakhs @ 10% p.a. on 1.7.2010. No repayment was made by either of
them till 31.3.2012. Compute Income from House Property of G and N for the A.Y. 2012-13.
2. Mr M constructed a residential house in Chennai in February 2008 for 30 lakhs. Part of the
cost of construction was met by borrowal of 20 lakhs from HDFC bank @ 12.5%. The loan was
taken in June 2006. The loan outstanding at the beginning of the current year was 12 lakhs.
Rate of interest applicable for current year was reduced by 3.5%. He had also borrowed from
relatives Rs.4 lakhs @ 15%. Nothing was repaid. The property was let out after completion.
In the assessment year 2008-09, M was allowed a deduction of 50000 for
irrecoverable/unrealized rent. Out of this amount Rs.40000 was recovered and received in the
previous year 2011-12. The annual value as per Chennai Corporation is 80000. The property was
let out to a company for a rent of 20000 per month in the previous year 2011-12. The half yearly
municipal tax on the property was fixed by Corporation only in August 2011 at Rs.15000 for
every half year. From 1-4-2008 M paid tax dues in September 2011 upto half year ending 31-3-
2011. Compute IFHP for A/Y 2012-13
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3. Vineet had been working with M Ltd. Jaipur, since 1-10-1997. He was entitled to the
following
emoluments:
1. Basic salary w.e.f. 1-1-2011 ` 6,000 p.m.
2. Dearness allowance 50% of basic salary (40% of which forms part of salary for retirement
benefits)
3. House rent allowance ` 750 per month. He pays ` 1,000 per month as rent
He resigned from his job on 1.1.2012 and shifted to Delhi. He received a Gratuity of 1,35,000
from his previous employer and is covered by payment of gratuity act.
Compute his income from salary for assessment year 2012-13.
Cost
Budgetary control
1. The expenses budgeted for production of 10000 units in a factory are furnished below:
Rs. per UnitMaterial 70Labour 25Variable Overheads 20Fixed overheads (Rs.100000) 10Variable expenses (direct) 5Selling expenses (10% direct) 13Distribution expenses (20% fixed) 7Administration Expenses (Rs.50000) 5Total 155Prepare a budget for the purpose of (a)8000 units and (b)6000 units. Assume that administration expenses are rigid for all levels of production.
2. From the following data, prepare a flexible budget for production of 40000 units and 75000 units, distinctly showing variable cost and fixed cost as well as total cost. Also indicate element-wise cost per unit. Budgeted output is 100000 units and budgeted cost per unit is as follows:
Rs.Direct Material 95Direct Labour 50Production overhead (variable) 40Production overhead (fixed) 5Administration overhead (fixed) 5Selling overhead (10% fixed) 10Distribution overhead (20% fixed) 15
3. Z limited has prepared the budget for the production of 100000 units from a costing period as under:
Per Unit (Rs.)Raw Materials 10.08Direct Labour 3.00Direct Expenses 0.40Works overhead (60% fixed) 10.00Administration overhead (80% fixed) 1.60Sales overhead (50% fixed) 0.80Actual production in the period was only 60000 units. Prepare budgets for the original and revised levels of output.
4. With the following data at 60% activity, prepare a budget at 80% and 100% activity.
Production at 60% capacity 600units
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Materials Rs.120 per unitLabour Rs.50 per unitExpenses Rs.20 per unitFactory Expenses Rs.60000 (40% fixed)Administration Expenses Rs.40000 (60% fixed)
5. For production of 10000 Electrical Irons, the following are budgeted expenses:Per Unit Rs.
Direct materials60
Direct labour 30Variable overhead 25Fixed overhead (Rs.150000) 15Variable expenses (direct)
5Selling expenses (10% fixed) 15Administration expenses (Rs.50000 rigid of all levels of production)
5Distribution expenses (20% fixed)
5Total cost of sales per unit
160
Prepare a budget for production of 6000, 7000 & 8000 irons, showing distinctly marginal cost and total cost.
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Cost Budgetary control
1. At a capacity level of 2500 units for article P, the cost details are given below. Material cost 70000 100% varyingLabour cost 30000 100% varyingPower 4000 80% varyingRepairs 6000 75% varyingStores 2000 100% varyingInspection 1200 20% varyingDepreciation 20000 100% fixedAdministration overhead 10800 20% varyingSelling overhead 6000__ 50% varying 150000
Calculate the cost per unit of the product, showing at production levels of 2000 units & 3000 units, the individual expenses.
2. A factory is currently running at 50% capacity & produces 5000 units at a cost of Rs 90 per unit as per below details:
Material 50 Wages 15 Factory overheads 15 (40% fixed) Administration overheads 10 (50% fixed)
The current selling price is 100 per unit. Material cost per unit at 60% capacity increases by 2% whereas selling price per unit falls by 2%. However, material cost per unit increases at 80% capacity working, by 5% & selling price per unit falls by 5%.
Prepare a marginal cost statement showing for the three capacity levels showing the total cost & profit.
3. Mira Ltd. manufactures 5,000 units of Product ‘Jeo’ at a cost of Rs.120 per unit. Presently, the company is utilizing 50% of the total capacity. The information pertaining to cost per unit of the product is as follows:
Material Rs.40 Labor Rs.30 Factory overheads Rs.20 (40% fixed)Administrative overheads Rs.30 (80% fixed)Other information:i. The current selling price of the product is Rs.160 per unit.ii. At 60% capacity level – Material cost per unit will increase by 4% and current selling price per unit will reduce by 5%.iii. At 90% capacity level – Material cost per unit will reduce by 2% and current selling price per unit will reduce by 8%.Prepare a flexible budget for 60% level and 90% level activity
4. Vairavi Ltd. has furnished the following information pertaining to its product:Direct material Rs.50Direct labor Rs.40Production overheads Rs.50 (40% fixed)Selling & administrative overheads Rs.40 (50% fixed)Normal Production 1,800 unitsPrepare a budget for 1,600 units and 1900 units
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5. Apna Ltd. has furnished the following information relating to cost at a capacity level of 10,000 units:
Material cost 1,25,000 (100% variable)Labour cost 1,15,000 (100% variable)Power 11,250 (80% variable)Repairs and maintenance 12,000 (75% variable)Stores 11,000 (100% variable)Inspection 1,500 (20% variable)Administration overheads 15,000 (100% fixed)Selling overheads 13,000 (50% variable)Depreciation 40,000 (100% fixed)Prepare a budget of 12,600 units and 15000 units
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Red Blu Ltd. has estimated 40% of total sales as cash sales and payments for credit sales to be received is as follows:i. 40% of credit sales in the month of sales.ii. 30% of credit sales in the first month following the month of sales.iii. 25% of credit sales in the second month following the month of sales.iv. 5% is non-recoverable.The company has furnished the following expected total sales for a period of six months:Month SalesJanuary 2007 Rs.1,00,000February 2007 Rs.1,40,000March 2007 Rs.1,50,000April 2007 Rs.2,00,000May 2007 Rs.1,70,000June 2007 Rs.2,00,000The estimated cash inflows of the company in the month of April 2007 will be
A Ltd. Sells its products at ` 40/unit. In a period if the company manufactures and sells 12,000 units, it incurs a loss of ` 2/unit and if the volume increase to 18,000 units, it earns a profit of ` 3.50/unit. The break –even point in rupees is
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Advanced financial accounting (AFA)
HOLDING COMPANY ACCOUNTS
Meaning of holding company:
A company that that holds more than 50% of the share capital of the other company is known as a holding company
Terms used in holding company accounts
Cost of control or goodwill:
If the amount paid by the holding company for the shares of subsidiary company is more than its proportionate share in the net asset of the subsidiary company as on the date of acquisition, the difference is considered as goodwill of holding company
If the amount paid by the holding company for the shares of subsidiary company is less than its proportionate share in the net asset of the subsidiary company as on the date of acquisition there will be capital reserve in holding company.
Net assets of the subsidiary company consist of share capital, accumulated profits and reserve after adjustment, accumulated losses as on the date of acquisition
It goodwill already exists in the balance sheet of holding company or both the goodwill thus calculated, will be added up to the existing goodwill. Capital Reserve will be deducted from Goodwill. In short, net amount resulting from goodwill and capital Reserve will be shown in the consolidated Balance sheet.
Minority interest
Minority interest means outsiders interest. It is treated as liability and shown in consolidated Balance sheet as current liability. This amount is basically intrinsic value of shares held by minority shareholders.
Capital profits Profits earned prior to the date acquisition of shares
Revenue profits Profits earned after the date of acquisition of shares
Pre accquisition periodThe period upto the date of acquisition of shares
Post acquisition period
The period after the date of acquisition of shares
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Income tax
Leave salary/Leave encashment
1. Mr. Raghunath was employed with Ravidev (P) Ltd. He retired from his job w.e.f. 1-11-2011
after completing a service of 22 yrs. and 8 months. He furnishes you following information in
respect of his remuneration:
Basic salary Rs. 15,800 p.m. (at the time of retirement)
D.A. 80% of Basic salary (20% of which forms part of salary for Retirement benefits).
Last increment Rs. 800 w.e.f. 1-8-2011
He was entitled to 35 days leave for every year of service. He received leave encashment
amounting to Rs. 90,000 on account of accumulated leave (unavailed leave at the time of
retirement) of 260 days. Compute exempted and taxable leave salary for the assessment year
2012-13
2. Mr. Narendra retired from HS Ltd on 31-12012 after a service of 5 years and received
Rs.75000 as leave salary. His accumulated leave was 225 days @ 45 days per year for 5 years.
He has not availed any earned leave during his service and utilized only casual leave. His
salary at the time of retirement was 16000 per month consisting of Basic 10000, DA 3000. CCA
2000 and special allowance 1000. He is also eligible for a monthly pension of 30% of basic
from 1-2-2012. Compute his gross salary for assessment year 2012-13
3. Mr. V is an employee of Veeyem Ltd. After 23 years and 8 months of service he retired and
the time of retirement received 4 lakhs as leave salary. He was entitled for 40 days leave for
every year of service and while in service had availed 4 months leave. Salary at time of
retirement was 14000 per month. Compute exempted and taxable leave salary for assessment
year 2012-13
4. Mr C retires from InfoMedia Solutions Ltd after 22 years and 3 months of service. He
received 146000 as leave encashment on 28/10/2011, the date of his retirement. His employer
allows him 2 months leave for every year of service. 15 months salary has already been
encashed by him while in service. Calculate exempted and taxable leave salary for the
previous year 2011-12
Gratuity and pension
Kalicharan Joined a Job in the grade of Rs. 12,000 – 400 - 14,000 – 500 - 18,000 – 1,000 –
24,000 on 1-7-98 and resigned from the service on 15-12-2011. He was also entitled to D.A. @
60% which forms part of salary for retirement benefits. In addition of his salary he received on
retirement a gratuity of Rs. 2,80,000. He was entitled to a pension of Rs. 5,000 p.m. w.e.f. 16-
12-2011. He got 60% of his pension commuted w.e.f. 1-2-2012 and received a sum of Rs.
3,00,000 as commuted pension. Compute his gross salary for A.Y. 2012-13.
Ans: Rs. 4,82,633
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Cost
Cash budget
1. A company expects to have Rs.37500 cash in hand on 1st April, and requires you to prepare an estimate of cash position during the three months, April, May & June. The following information is supplied to you:
Sales (Rs.)
Purchases (Rs.)
Wages (Rs.)
Factory expenses
(Rs.)
Office expenses
(Rs.)
Selling expenses
(Rs.)February 75000 45000 9000 7500 6000 4500March 84000 48000 9750 8250 6000 4500April 90000 52000 10500 9000 6000 5250May 120000 60000 13500 11250 6000 6570June 135000 60000 14250 14000 7000 7000
Other Information:1. Period of credit allowed by suppliers – 2 months2. 20% of sales is for cash and period of credit allowed to customers for credit is one
month.3. Delay in payment of all expenses – 1 month4. Income tax of Rs.57500 is due to be paid on June 15th.5. The company is to pay dividends to shareholders and bonus to workers of Rs.15000
and Rs.22500 respectively in the month of April.6. Plant has been ordered to be received and paid in May. It will cost Rs.120000.
2. Prepare a Cash Budget for the three months ending 30 th June 2006 from the information given below:
Period (2006) Sales (Rs.) Materials (Rs.) Wages (Rs.) Overheads (Rs.)
February 14000 9600 3000 1700March 15000 9000 3000 1900April 16000 9200 3200 2000May 17000 10000 3600 2200June 18000 10400 4000 2300
a. Credit terms are: sales and debtors – 10% sales are on cash, 50% of the credit sales are collected next month and the balance in the following month.
b. Lag in payment Materials 2 Months
Wages ¼ monthOverheads ½ month
(c). Cash and bank on 1st April, 2006 is expected to be Rs.6000(d). Other relevant information are:
i. Plant and machinery will be installed in February 2006 at a cost of Rs.96000. The monthly instalment of Rs.2000 is payable from April onwards.
ii. Dividend @ 5% on Preference Share capital of Rs.200000 will be paid on 1st June.
iii. Advance to be received for sale of vehicles Rs.9000 in June.iv. Dividends from investments amounting to Rs.1000 are expected to be
received in June.v. Income tax (advance) to be paid in June is Rs.2000
3. A company is expecting to have Rs.25000 cash in hand on 1st April 2006 and it requires you to prepare cash budget for the three months. April to June 2006. The following information is supplied to you.
Period (2006) Sales (Rs.) Purchases (Rs.) Wages (Rs.) Expenses (Rs.)February 70000 40000 8000 6000March 80000 50000 8000 7000April 92000 52000 9000 7000May 100000 60000 10000 8000June 120000 55000 12000 9000
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Other Information:(a) Period of credit allowed by suppliers is two months:(b) 25% of sale is for cash and the period of credit allowed to customers for credit sale
is one month;(c) Delay in payment of wages and expenses one month(d) Income tax Rs.25000 is to be paid din June 2006.
4. Prepare a cash budget for the period April to June from the following data, indicating the extent of the bank facilities the company will require at the end of each month.
Period (2006) Sales (Rs.) Purchases (Rs.) Wages (Rs.)February 180000 124000 12000March 192000 144000 14000April 108000 243000 11000May 174000 246060 10000June 126000 268000 15000
50% of the sales are realised in the following the sales and the remaining 50% in the second month following. Creditors are paid in the month following the month of purchase. Cash at bank on 1st April 2006 is Rs.25000.
5. You are Given the following information
Month Sales Purchases Wages Production overheads
Selling overheads
Jan 100000 40000 10000 6000 6000
Feb 120000 45000 15000 6500 6500
March 150000 35000 18000 7000 6600
April 160000 30000 20000 7700 6800
May 175000 25000 22000 8000 6200
June 200000 20000 24000 8500 6300
The company has a policy of selling its goods at 50% cash and the balance on credit. On credit sales, 50% is paid in the following month and balance 50% two months from the sale. Purchases are paid one month from the month of purchase. Wages are paid in the following month and overheads are also paid in the following month. The company plans a capital expenditure, in the month of April, for Rs. 25,000.The company has a opening balance of cash of Rs. 40,000 on 1st April 2010. Prepare a cash budget for April to June.
6. Prepare a cash budget for the months of August and September from the following information assuming sales are cash sales
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Income Tax
Income from salaries
1. Mr.Z has joined ICC Ltd. on 1 st July 2008 in the scale of `15,000-1,500-21,000-2,500-31,000. Compute gross salary for the previous year 2011-12.
2. Mr.Kabir is getting a salary of `12,000 p.m. w.e.f. 1.4.2010. He is promoted w.e.f. 31.12.2010 and got arrears of `75,000. Bonus for the year 2011-12 is ` 15,000 remains outstanding but bonus of ` 12,000 for the year 2010-11 was paid on 1 stJanuary 2012. In March 2012, he got two months salary i.e. April and May 2012 inadvance. Compute the gross salary for the assessment year 2012-13
3. R submits the following information regarding his salary income for the year 2011-12: Basic salary ` 15,000 p.m.; D.A (forming part of salary) 40% of basic salary; City Compensatory Allowance ` 300 p.m.; Children Education Allowance ` 400 pm per child for 3 children; Transport Allowance ` 1,000 p.m. He is provided with a rent free unfurnished accommodation which is owned by the employer. The fair rental value of the house is ` 24,000 p.a. Compute the gross salary assuming accommodation is provided in a city where population is (a) exceeding 25 lakhs (b) exceeding 10 lakhs but not exceeding 25 lakhs (c) less than 10 lakhs
4. Aniket joined a company on 1.7.2011 and was paid the following emoluments and allowed perquisities as under :
Emoluments :Basic Pay ` 35,000 per month; D.A. ` 20,000 per month; Bonus ` 20,000 per annum.
Perquisities :(i) Furnished accommodation owned by the employer and provided free of cost;(ii) Value of furniture therein ` 3,60,000; Hire charges of Furniture provided ` 20,000 p.a.(iii) Motor car owned by the company (with engine c.c. less than 1.6 litres) along with chauffeur for official and personal use, expenses met by Employer.(iv) Sweeper salary paid by company ` 1,500 per month; amount recovered @ ` 200 pm.(v) Watchman salary paid by company ` 1,500 per month; amount recovered @ ` 300 pm.(vi) Educational facility for 2 children provided free of cost. The school is owned and maintained by the company. Elder child studies in class V and younger child in class II. Tuition fee per month ` 1,600 & ` 900 respectively.(vii) Loan of ` 5,00,000 repayable within 7 years given on 1.10.2011 for purchase of a house. No repayment was made during the year; let charged
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by employer @ 2% p.a. Interest chargeable as per Income Tax Act @ 10% p.a.(viii) Interest free loan for purchase of computer ` 50,000 given on 1.2.2012. No repayment was made during the year;(ix) Corporate membership of a club. The initial fee of ` 1,00,000 was paid by the company. Aniket paid the bills for his use of club facilities.
You are required to compute the income of Aniket under the head “Salaries” in respect of assessment year 2012-13.
Income Tax
Income from salaries:
1. Mr X retired from AB Ltd on 1-2-2012 after 20 years and 9 months of service. He joined PQ Ltd on the same day and remained in service till 31-3-2012. He furnishes the following information:
AB LTD PQ LTD
Basic salary 24000 pm Basic salary 18000 pmDA ( enters ) 3000 pm EA 2400 pmCommission on sales 12000 pa Fixed allowance 600 pmGratuity received 315000 HRA 1500 pm(Not covered) Leave salary received 9000
Compute income from salary for assessment year 2012-13
2. Mr M is an Area Manager of SN Steels Ltd. During the financial year 2011-12 he gets the following emoluments from the employer:
Basic salary upto August 2011
20000 per month Children education allowance
500 pm for 2 children
Basic salary from September 2011
25000 per month Hostel allowance 380 pm for 2 children
Transport allowance
2000 per month CCA 300 per month
Contribution to RPF 15% of basic Tiffin allowance 5000 pa ( actual expenses 3700 pa)
Tax on employment paid by employer Rs.2500. Compute income from salaries for previous year 2011-12
3. Mrs. L is working for an MNC in Kolkota. She is in continuous service since 1965 and receives the following emoluments for the year ending 31-3-2011. Compute her income from salary for assessment year 2012-13
Basic salary 50000 pmDA 20000 pm (forming part of retirement benefits)Bonus 2 months basicCommission on sales 150000 per annum
Contribution of employer and employee to RPF 300000 each. Interest credited to RPF @ 8.5% 60000Rent free unfurnished accommodation provided by company for which company pays a rent of 70000 per annum.
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Entertainment allowance 30000 per annum. Hostel allowance for 3 children 5000 each
4. Mr Pankaj retired from central government service in Bangalore on 30-6-2011 and furnished the following information. Compute his income from salary for assessment year 2012-13
Salary 6000 pmPension 3000 pm from July 2010 to November 2010On 1-12-2010 he got 1/3 of his pension commuted for 120000.
INCOME TAX
Mr Suraj a marketing manager in Mumbai furnished the following information for the year ending 31-3-2011
Basic salary 100000 per monthDA 50000 per monthBonus 2 months basicContribution to RPF 15% of basic + DARent free unfurnished accommodation was provided by the company at Mumbai and the accommodation was owned by the company.Compute his income from salary for assessment year 2012-13
Mr. Kishore a resident of Delhi provides the following information for the previous year
Salary including DA 1080000 paBonus 172800 paContribution to RPF 108000 paRent paid by the employer for flat provided to Mr. Kishore 270000 paCost of furniture provided by the employer for the above flat 240000Rent recovered from the employee by the company 108000Gas, electricity and water 54000 pa
Mr. Kishore was provided with small car (self driven) also for personal use. It is not possible to determine the expenditure on personal use and all expenses were borne by the employer. Compute his income from salary for assessment year 2012-13
Mr. Dinesh a chief executive at Chennai appointed on contract basis for 2 years furnishes the following information for assessment year 2012-13.
Basic pay and DA 324000 paSpecial allowance 15000 paHRA 72000 paServant allowance 4500 paGas, electricity and water 4500 paConveyance allowance for private purpose 18000 pa
He resides in his own house, the annual let out value is 54000. Municipal tax paid 9000 pa.Compute his income from salary for assessment year 2012-13
Ramlal Joins a Gopi Ltd. on Oct 1, 2006 in the pay scale of Rs.12,000 – Rs.1,000 – Rs.18,000 (salary at the time of joining is fixed at Rs.15,000) As per the terms of employment salary becomes ―due on the first day of the next month, and it is
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generally paid on the fifth day of the next month. Find out the salary taxable for the assessment year 2012-13 Ans: Rs. 2,16,000
Mr. Narayan draws following emoluments from a private Ltd Company for the PY 2011-12.
Case 1 Case 2 Place of stay Pune Mumbai Basic Salary 8,000 p.m. 5,000 p.m.Dearness allowance (70% forms part of salary) 1,500 p.m. 3,000 p.m. Commission 1% p.a. based on sales. Sales achieved by the employee p.a. 30,00,000 22,00,000 Arrears of salary of 06-07 (not taxed earlier) 5,000 nil House rent allowance 4,000 p.m. 2,400 p .m. Rent paid 2,400 p.m. 5,000 p.m. Compute taxable house rent allowance & Gross Salary for the AY 2012-13. Ans: Case 1: Rs. 1,82,060; Case 2: Rs. 1,18,000 [Taxable HRA: 33,060/Nil]
Ratio analysis
Gross profit Rs. 80,000
Gross profit to cost of goods sold ratio 1/3
Stock velocity 6 times
Opening stock Rs. 36,000
Accounts receivable velocity (year of 360 days) 72 days
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Accounts payable velocity 90 days
Current assets Rs. 1,50,000
Bills receivable 20,000
Bills payable 5,000
Fixed assets turnover ratio 8 times
Prepare balance sheet with as many details as possible.
Solution:
A)Working Notes
I.i. Cost of goods sold = Gross profit 3 times
= 80,000 3 = Rs. 2,40,000
2) Sales = Cost of goods sold + Gross profit
= Rs. 2,40,000 + Rs. 80,000 = Rs. 3,20,000
3) Average stock:
4).Closing Stock:
or Closing stock = Average stock 2 – Opening stock = 40,000 2 – Rs. 36,000 = Rs. 80,000 – Rs. 36,000 = Rs. 44,000
5)Accounts receivable:
Note: All sales have been assumed to be credit sales.6)Debtors = Accounts receivable – Bills receivable = Rs. 64,000 – Rs. 20,000 = Rs. 44,000
7)Accounts payable:
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8)Creditors = Accounts payable – Bills receivable
= Rs. 62,000 – Rs. 5,000 = Rs. 57,0009)Fixed assets
I.
Note: For the calculation of fixed assets turnover ratio it is cost of goods sold (not sales) which is taken into consideration.
Note: In the absence of information average debtors and average creditors have been taken as debtors and creditors at the end respectively.
From the following particulars, prepare the Balance Sheet of X Ltd., which has only one class of share capital:
i) Sales for the year Rs. 20,00,000.
ii) G.P. ratio – 25%.
iii) Current assets ratio – 1.50.
iv) Quick assets (cash and debtors) ratio 1.25.
v) Stock turnover ratio – 15.
vi) Debts collection period – 1 ½ months.
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vii) Turnover to fixed assets 1.5.
vii) Ratio of reserves to share capital – 0.33 (i.e. 1/3).
ix) Fixed assets to net worth 0.83 (i.e. 5/6).
(The term turnover refers to cost of sales and the term stock to closing stock).
Solution:I. Working Notes:
(1) Closing Stock: Sales Rs. 20,00,000
Less: Gross Profit 25% on sales Rs. 5,00,000 Cost of goods sold Rs. 15,00,000 �
As the term stock relates to closing stock, Rs. 1,00,000 is the closing stock
(2) Fixed assets:
As the term turnover refers to cost of sales
(3)Share capital and reserves:
As the ratio of reserves to share capital is 1:3 out of net worth Rs. 3,00,000 are reserves and the rest share capital (i.e., Rs. 9,00,000).
(4)Book Debts:
( 5)Current Liabilities:
Current assets ratio = 1.5
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Quick assets ratio = 1.25
Stock to current liabilities 0.25
Current liabilities will be 4 times the stock = Rs. 4,00,000.
(6)Cash:
Current assets ratio = 1.5.
As the current liabilities are Rs. 4,00,000, the total of current assets would be Rs. 6,00,000.
Cash = Current assets – (Stock and debtors)
= Rs. 6,00,000 – (1,00,000 + 2,50,000)
= Rs. 2,50,000
Corporate accounting I ( Common for 3 sem B com and BBM)
From the following particulars, prepare Profit and Loss Appropriation Account :
a) Profit and Loss account balance from last year Rs. 62,500.
b) Net profit for the year before tax Rs. 5,40,000 (provision for tax 40%)
c) Transfer to General Reserve Rs. 52,500. Dividend Equalisation Fund Rs. 40,000 and Development Reserve Rs. 37,500.
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d) Dividend on 7.5% preference shares Rs. 3,00,000
e) Dividend at 12.5% on 50,000 equity shares of Rs. 10 each, Rs. 7.50 called up (Calls in arrears Rs. 13,000)
f) Corporate dividend tax 16.23%.
The following Trial Balance has been extracted from the books of Amar Ltd. as on 31-3-2011. You are required to prepare :
a) Profit and Loss Account for the year ended 31-3-2011 and b) Balance sheet as on that date.
Debit Balances Credit Balances
Land and Building 1,40,000 Share capital 2,00,000(Original cost Rs. 3,00,000) General Reserve 30,000Furniture 8,000 8% debentures 1,00,000(Original Cost Rs. 15,000) Bank overdraft 1,500Plant and Machinery 1,00,000 Sundry creditors 10,000(Original Cost Rs. 2,00,000) Securities Premium 6,000Investments 6,000 Gross profit 1,14,000Preliminary expenses 4,000 Sinking fund 40,000Advance Income tax 8,000 Profit and Loss A/cPrinting and Stationery 1,200 (1-4-2010) 8,500Stock on 31-3-2001 1,28,000Salaries 8,000Debtors 70,000Cash on hand 2,000Cash at bank 24,000Interest 2,000Debenture interest 4,000Director’s fees 2,000Rent, rates and insurance 2,800
5,10,000 5,10,000
Adjustments :
1) Provide depreciation on : a) Land and Buildings at 5% on straight line basis. b) Furniture and Plant and Machinery at 20% on reducing balance basis.2) Provide Rs. 5,000 for bad debts.3) Provide for audit fees Rs. 2,500, Provision for Income Tax Rs. 14,000 and debenture interest for 6 months.4) Insurance prepaid Rs. 8005) Write off half of preliminary expenses.6) Directors have recommended :
a) Transfer of Rs. 10,000 to Sinking Fundb) Transfer of Rs. 4,000 to General reservec) Equity dividend at 8% on paid up capital.
7) Provide for Corporate Dividend Tax 16.23%
Corporate accounting I ( Common for 3 sem B com and BBM)
From the following trial balance of PQR Ltd as on 31-3-2011, prepare the company final accounts, after considering the following adjustments:
a. Closing stock 120000b. Depreciate building by 10%c. Accrued interest on investments 12000d. Taxation provision 25000e. Transfer 25000 to reserve fundf. Write off bad debts by 10000
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Particulars Debit CreditCalled up capital 300000Reserve Fund 150000Furniture 40000Buildings 80000Wages 50000Debtors and creditors 160000 180000Investments 60000Interim dividend 30000Audit fees 10000Directors fees 15000Freight charges 15000Stationery 12000Purchases and sales 240000 380000Returns 20000 10000Bills of exchange 50000 20000Machinery 80000P & L appropriation a/c 20000Cash at bank 58000Forfeited shares 10000Calls in arrears 20000Goodwill 50000Stock ( opening) 60000Salaries 20000Total 1070000 1070000
Prepare balance sheet of GK Ltd from the following balances as on 31-3-2011
Equity share capital 500000 Plant & machinery 60000012% preference share capital 400000 Freehold property 300000Goodwill 100000 10% debentures 400000Sundry debtors 140000 Closing stock 200000Bank overdraft 60000 Sundry creditors 60000Cost of issue of shares 40000 Unclaimed dividend 50000Advertisement suspense 90000
Corporate accounting I ( Common for 3 sem B com and BBM)
Following is the trial balance of GreenWay Ltd as at 31-3-2011
Particulars Debit CreditShare Capital 800000Land & Building 340000Plant & machinery 660000Computer 40000Preliminary expenses 20000Furniture 29000Calls in arrears 6000Cash in hand and at bank 12000Sundry creditors 120000
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Reserve Fund 60000P & L appropriation 45400Purchase and returns 960000 20000Sales and returns 28000 12312005% tax free Government Bonds ( Face value 40000)
36000
Bills receivable 58000Goodwill 36000Motor vehicles 40000Debtors 83000Interim dividend 38000Repairs 3000Advertisement 10000Audit fees 4000Carriage outwards 15000Wages 92000Insurance 20000Stock ( opening) 190000General expenses 170006% debentures of Rs.100 400000Bank overdraft 70000Debenture interest (less tax 20%) 9600Total 2746600 2746600
Additional information:
a. Closing stock 325000b. RBD at 5% on debtorsc. Depreciate all fixed assets by 5%d. Prepaid insurance 12000e. Reserve fund to be increased by 3000f. Final dividend at 10% (provide for dividend tax @ 16.23%)g. Wages outstanding 3000h. Debenture interest is outstanding for the second halfi. Write off 10% of preliminary expenses
Prepare final accounts of the company.
Prepare Cash Budget for the month of March 2005 from the following data : (i) Cash Balance on 1 March 2005, Rs. 25,000(ii) Sales in February 2005, Rs. 70,000(iii) Purchase in January 2005, Rs. 2,000(iv) Drawing for the year 2005, Rs. 2,400Note :(i) Credit allowed on sales is one month.(ii) Credit allowed on purchases is two months.(iii) Sales commission @ 3% is paid after one month.
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Income from salary
Mr. Dinesh is employed as General Manager of an MNC in Mysore drawing a salary of 15000 per month. The company provided him with an accommodation for which 10% of basic salary is deducted. Actual rent paid by the company for the accommodation is 120000 pa. He is also provided a big car for his official and personal use, but maintenance expenses for the same are borne by assessee himself. He is in receipt of bonus equal to 2 month salary. Compute his income from salary for the assessment year 2012-13
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Mr. Srikanth is an assistant manager of a private company in Mangalore since 1988. He has submitted the following information for the previous year 2011-12. Compute his income from salary:(a) Basic salary 46000 pa (b) DA 5000 pm ( 200 pm enters retirement benefits) (c) Educational allowance for 2 children @ 150 pm per child (d) Commission @ 1% o a sale of 10 lakhs (e) Entertainment allowance @ 700 pm (f) He resides in a flat of the company. Its market rent is 2000 pm. A watchman and cook have been provided by the company at the flat who are paid 400 pm each (g) He has been provided with a motor car of 1.8 Litre Engine capacity for his official and personal use. The running and maintenance costs are borne by the company. (h) Employer contribution to RPF is 8000 pa and interest credited to this find @ 13% is 16250. (i) Rent of the flat recovered from Srikant is 4600 pa. (j) tax deducted at source from his salary 6000 pa.
Income from salary
Mr. Dinesh is employed as General Manager of an MNC in Mysore drawing a salary of 15000 per month. The company provided him with an accommodation for which 10% of basic salary is deducted. Actual rent paid by the company for the accommodation is 120000 pa. He is also provided a big car for his official and personal use, but maintenance expenses for the same are borne by assessee himself. He is in receipt of bonus equal to 2 month salary. Compute his income from salary for the assessment year 2012-13
Mr. Srikanth is an assistant manager of a private company in Mangalore since 1988. He has submitted the following information for the previous year 2011-12. Compute his income from salary:(a) Basic salary 46000 pa (b) DA 5000 pm ( 200 pm enters retirement benefits) (c) Educational allowance for 2 children @ 150 pm per child (d) Commission @ 1% o a sale of 10 lakhs (e) Entertainment allowance @ 700 pm (f) He resides in a flat of the company. Its market rent is 2000 pm. A watchman and cook have been provided by the company at the flat who are paid 400 pm each (g) He has been provided with a motor car of 1.8 Litre Engine capacity for his official and personal use. The running and maintenance costs are borne by the company. (h) Employer contribution to RPF is 8000 pa and interest credited to this find @ 13% is 16250. (i) Rent of the flat recovered from Srikant is 4600 pa. (j) tax deducted at source from his salary 6000 pa.
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Corporate accounting I ( common for 3 sem B Com and 3 sem BBM)
The authorized capital of EXE Limited is Rs.500000 consisting of 6% 2000
preference shares of Rs.100 each and 30000 equity shares of Rs.100 each. The
following is the trial balance of the company as at 31-3-2012
Particulars Debit Particulars Credit
Investment at cost 50000 Creditors 87850
Purchases 490500 6% preference share
capital
200000
Selling expenses 79100 Equity capital 200000
Opening stock 145200 5% mortgage debentures 150000
Salaries & wages 52000 Miscellaneous income 4250
Cash in hand 12000 P & L a/c 28500
Interim preference dividend for 6
months
6000 Sales 670350
Discount on debentures 2000 Bank overdraft 150000
Preliminary expenses 1000
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Bills receivable 41500
Interest on overdraft 7800
Interest on debentures ( I half year) 3750
Debtors 50100
Freehold property 350000
Furniture at cost 35000
Income tax paid in advance 10000
Technical know how fees paid 150000
Audit fees 5000
Total 149095
0
149095
0
Prepare final accounts of the company after considering the following additional
information:
a. Closing stock 250000
b. Salaries and wages outstanding 4500
c. Preference dividend to be paid for full year
d. Equity dividend at 6% ( provide corporate dividend tax)
e. Write off 50% of discount on debentures and preliminary
expenses
f. Balance debenture interest to be provided
g. Depreciate furniture by 5%
h. A provision of 5% is required for bad and doubtful debts
i. Technical know how fees paid is to be written off over a period
of 10 years
Corporate accounting I ( common for 3 sem B Com and 3 sem BBM)
Following is the trial balance of WS Ltd as on 31-3-2012. Prepare its final accounts
after considering the additional information:
Particulars Rs Particulars Rs
Opening stock 60000 Sundry creditors 45000
Purchases 320000 Provision for income tax 45000
Wages 90000 P & L account 38000
Power and Fuel 15000 General reserve 100000
Manufacturing expenses 35000 Equity share capital 300000
Carriage outwards 20000 6% preference share capital 200000
Carriage inwards 10000 6% debentures 200000
Salaries 60000 Salaries and wages unpaid 25000
Insurance 10000 Sales 770000
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Debtors 90000 Interest received on Govt
securities
2000
Bank balance 6000 Sinking Fund 90000
4% Govt securities ( 100000) 90000
Debenture interest 6000
Land & Building 300000
Plant & machinery 450000
Directors fees 10000
Audit fees 6000
Income tax paid 41000
Dividend paid on preference
shares
6000
Interim dividend on equity
shares
30000
Preliminary expenses 20000
Goodwill 140000
Total 181500
0
Total 181500
0
Additional information:
a. Closing stock 190000
b. Depreciate plant and machinery by 8%
c. Write off 2000 from debtors and provide 5% towards bad debts
d. Insurance is prepaid to the extent of 1000
e. Preference dividend to be paid in full and final equity dividend is
Rs.38000
f. Provide corporate dividend tax at applicable rates
g. Transfer Rs.5000 each to general reserve and sinking fund
h. Write off 10% from preliminary expenses
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INCOME TAX
Aniket joined a company on 1.7.2011 and was paid the following emoluments and allowed
perquisities as under :
Emoluments : Basic Pay ` 35,000 per month; D.A. ` 20,000 per month; Bonus ` 20,000 per
month.
Perquisities :
(i) Furnished accommodation owned by the employer and provided free of cost;
(ii) Value of furniture therein ` 3,60,000; Hire charges of Furniture provided ` 20,000 p.a.
(iii) Motor car owned by the company (with engine c.c. less than 1.6 litres) along with chauffeur
for official and personal use, expenses met by Employer.
(iv) Sweeper salary paid by company ` 1,500 per month; amount recovered @ ` 200 pm.
(v) Watchman salary paid by company ` 1,500 per month; amount recovered @ ` 300 pm.
(vi) Educational facility for 2 children provided free of cost. The school is owned and maintained
by the company. Elder child studies in class V and younger child in class II. Tuition fee per month
` 1,600 & ` 900 respectively.
(vii) Loan of ` 5,00,000 repayable within 7 years given on 1.10.2011 for purchase of a house. No
repayment was made during the year; Int charged by employer @ 2% p.a. Interest chargeable as
per Income Tax Act @ 10% p.a.
(viii) Interest free loan for purchase of computer ` 50,000 given on 1.2.2012. No repayment was
made during the year;
(ix) Corporate membership of a club. The initial fee of ` 1,00,000 was paid by the company.
Aniket paid the bills for his use of club facilities.
You are required to compute the income of Aniket under the head “Salaries” in respect of
assessment year 2012-13.
Mr. Hemanth is an employee of a private company in Bangalore. During the financial year 2011-
12 he furnishes the following information:
Basic salary 13500 per month, DA 35% of basic ( 60% forms part of retirement benefits), HRA
4000 per month ( actualrent paid 5000 per month), Children education allowance Rs.50 per
month for three children. Helper allowance 300 pm ( actual spent 200 pm), Bonus 25000 pa.
Leave encashment 13500. Advance salary 14000. Entertainment allowance 250 per month
Mr. Hemanth is also provided with free use of a small car for both personal and official use.
During the year the company reimbursed 19200 towards medical expenses.
His contribution to RPF is 14% of salary and company also contributes similar amount. Interest
credited on RPF amounted to 18000 at 12%. Profession tax paid by him is Rs.200 per month.
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Compute his income from salary for the assessment year 2012-13
Cost
Contract costing:
1. SV construction Limited have obtained a contract for the construction of a bridge. The value of the contract is 12 lakhs and the work commenced on 1 st October 2009. The following details are shown in their books for the year ended 30 th September 2010.
Plant purchases 60000, wages paid 340000, materials issued to site 336000,site expenses 8000, general overhead apportioned 32000, wages accrued 2800, materials at site on 30-9-2010 4000, direct expenses accrued 1200, work not yet certified 14000.
Cash received (80% of work certified) 600000. Life of the plant purchases is 5 years and the scrap value in nil
Prepare contract account for the year ended 30 th September 2010.
2. A railway contractor makes up his accounts upto 31 st march every year. Contract No.SER/15 for the construction of a culvert between mandya and maddur started on 1-7-2010. The costing records showed the following information as at 31-3-2010.
Material 31540Labour 75300Foreman salary 11700
A machine costing 25000 has been on site for 73 days. Its working life is estimated at 5 years and its scrap value is 1000.
A supervisor who is paid 18000 per annum has spent approximately six months on the contract.All administration and other expenses amount to 17000 Material at site on 31-3-2010 amounted to 2500
The contract price is 3lakhs. At the end of the year 2/3 of the contract was completed for which amount, the architect certificate has been issued and 160000 has so far been received on account.
Prepare contract account as on 31-3-2010
3. The following information relates to a building contract for 10 lakhs and for which 80% of the value of WIP as certified by the architect is being paid by the Contractee.
Particulars Year 2008 Year 2009 Year 2010
Materials issued 120000 145000 84000Direct wages 110000 155000 110000Direct expenses 5000 17000 6000Site expenses 2000 2600 500Work certified 31 st Dec 235000 750000 1000000Work uncertified 2800 8000 NilMaterial at site 2000 5000 8000Value of plant issued 14000 Nil Nil
The value of plant at the end of 2008, 209 and 2010 was 11200, 7000 and 3000 respectively.Prepare contract account for three years
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Cost
Contract costing:
M/s Promising Company undertook a contract for erecting sewerage treatment plant for Prosperous municipality for a total value of 24 lakhs. It was estimated that the job would be completed by 31-3-2011.
You are asked to prepare the contract account for the year ending 31 st march 2011 from the following particulars:
Materials 300000Wages 600000Overhead charges 120000Special plant 200000Work certified was for 1600000 and 80% of the same was received in cashMaterial lying on site 40000Depreciate plant by 10%5% of the value of material issued and 6% of wages may be taken to have been incurred for the portion of the work completed, but not yet certified.
A firm of building contractors began to trade on 1-1-2011. The following was the expenditure on a contract for 6 lakhs
Materials issued from stores 150000Materials purchased for contract 40000Plant installed at cost 70000Wages paid 240000Site expenses 22000Establishment expenses 10000Site expenses accrued 3000Wages accrued 4000
Out of the plant and materials charged to contract, plant which cost 5000 and materials costing 4000 were lost. Some part of the materials costing 2500 were sold at a profit of 500. On 31-12-2011, plant costing 2000 was returned to stores and plant which cost 3000 was transferred to some other contract.
The work certified was 480000 and 80% of the same was received in cash. The cost of work done but not yet certified was 3000. Charge depreciation on plant at 10% pa.
Prepare contract a/c, contractee a/c and give an extract of the balance sheet
Prepare Contract a/c and Contractee a/c assuming that the amount due from the Contractee was duly received
Direct materials 20250Direct wages 15500Stores issued 10500Loose tools 2400Tractor Expenses: Fuel, oil etc 2300Tractor Expenses: wages of drivers 3000Other direct charges 2650
The contract price was 90000 and it tool 13 weeks for completion. The value of loose tools and stores returned at the end of the period were 200 and 3000 respectively. The plant was also
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returned at a value of 16000 after charging depreciation at 20%. The value of tractor was 20000 and deprecation was to be charged to the contract @ 15% pa. The administrative expenses and office expenses are to be provided at 10% of works cost.
Cost
BEP
S Ltd gives the following information:
Particulars Variable cost (% of sales) Fixed costDirect material 32.8 ----Direct labor 28.4 -----Factory overhead 12.6 189000Distribution overhead 4.1 58400General administration overhead 1.1 66700 Budgeted sales for the next year 1850000
You are required to determine (a) BEP sales value (b) profit if budgeted sales drop by 10% (c) profit if budgeted sales increase by 5%
A multi product company furnishes the following data for the year 2010
Particulars I half year II half year
Sales Rs.45000 Rs.50000Total cost Rs.40000 Rs.43000
Calculate: (a) PV ratio (b) BEP (c) profit when sales is 85000 (d) sales required to get a profit of 11000 (e) variable cost for two periods
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Cost
Process costing
A material used in a building is produced in three different consecutive processes.
Particulars Process 1 Process 2 Process 3Raw material used ( 1000 tons) Rs.100000Wages 87500 39500 10710Weight lost ( % of input) 5% 10% 20%Scrap ( Sale price Rs.50 per ton) 50 tons 30tons 51 tonsSale price per ton of finished goods Rs.350 Rs.500 Rs.800
Management expenses were 17500 and selling expenses Rs.10000. 2/3 of the output of process 1 and 50% of the output of process 2 are passed to next process and the balance is sold. The entire output of process 3 is sold. Prepare process accounts and statement of profit
A product passes through three processes A B and C. The details are given below: prepare process accounts and P & L account
Particulars Process A Process B Process CUnits introduced 10000Cost per unit Rs.100Sundry materials 10000 15000 5000Labor 30000 80000 65000Direct expenses 6000 18150 27200Selling price per unit of output Rs.120 Rs.165 Rs.250
Management expenses during the year were 80000 and selling expenses were 50000. These are not allocable to any processes. Actual output of the three processes wereA 9300, B 5400 and C 21002/3 of output of process A and one half of process B was passed to next process and balance were sold. The entire output of process C was sold. The normal loss of three processes was A 5%, B 15% and C 20%.The loss of process A was sold at Rs.2 per unit, that of B at Rs.5 per unit and Process C at Rs.10 per unit.
BEP
S Ltd gives the following information:
Particulars Variable cost (% of sales) Fixed costDirect material 32.8 ----Direct labor 28.4 -----Factory overhead 12.6 189000Distribution overhead 4.1 58400General administration overhead 1.1 66700 Budgeted sales for the next year 1850000
You are required to determine (a) BEP sales value (b) profit if budgeted sales drop by 10% (c) profit if budgeted sales increase by 5%
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