Question

NCERT Solutions Class 12, Accountancy Part-II, Chapter- 4, Analysis of Financial Statements

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Concepts covered in Class 12 Accountancy Part-II Chapter- 4 Analysis of Financial Statements, are-

• Meaning of financial analysis
• Significance of financial analysis
• Trend analysis
• Tools of financial analysis
• Limitations of financial analysis

Our NCERT Solutions for Class 12 Accountancy provide in-depth explanations to assist students with their homework and assignments. By mastering and extensively practicing the chapter’s concepts through these solutions, you can effectively secure top marks in your exams. Begin your preparation today to achieve excellence in your exams.

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Answer 1

NCERT Solutions Class 12, Accountancy Part-II, Chapter- 4, Analysis of Financial Statements

Short Answers

1. List the techniques of Financial Statement Analysis.

Solution:

The most commonly used techniques of Financial Statement Analysis are as listed below:

1. Common Size Financial Statements

2. Trend Analysis

3. Comparative Financial Statements

4. Cash Flow Statement

5. Fund Flow Statement

6. Ratio Analysis

2. Distinguish between Vertical and Horizontal Analysis of financial data.

Solution:

Basis of Comparison	Horizontal Analysis	Vertical Analysis
Meaning	It is the comparative evaluation of a financial statement of two or more periods for calculating relative and absolute variances for every line of the item	It is the analysis of financial data, which is independent of time and items relating to the financial information of the company and its impact on the performance of the company.
Purpose	To specify changes in financial performance between two comparable accounting periods	To compare a financial item as a percentage of the base figure
Comparison of	Intra-firm comparison	Both intra and inter-firm comparison
Usefulness	The growth or decline of an item is represented here	It is useful in predicting and determining the relative proportion of an item in the financial statement to a common item in the financial statement

3. State the meaning of Analysis and Interpretation.

Solution:

Analysis and interpretation is a critical and systematic examination of the financial statement. It presents the financial data in a systematic manner and also establishes a cause-and-effect relationship with all the items of financial statements. Analysis and interpretation is all about presenting financial data which is self-explanatory and easy to understand. It helps users of accounting information in assessing the status of the financial performance of the business for a time period, and enables them to take proper decisions regarding the finance policy of the firm.

4. State the importance of Financial Analysis.

Solution:

Financial analysis is of great importance for the various users of accounting information. Financial statements such as Balance Sheets, Income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income, which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analysed. There are various methods which help in analysing financial statements and make them useful for various accounting users.

The following are the essential reasons for performing financial analysis:

1. It is very helpful in determining the financial viability and profit-earning capacity of the firm.

2. It is helpful in evaluating the business solvency in the long term

3. It is useful in comparing the financial status of a firm in comparison to other competitor firms

4. It helps management in decision-making and drafting plans and also establishes a robust and effective control mechanism

5. What are Comparative Financial Statements?

Solution:

Comparative financial statements refer to statements which enable comparison that is both intra and inter-firm and is based on a period of time. These statements help various users of accounting information in evaluating the financial progress of a firm in relative terms. These statements express the data in absolute figures or as percentage change and absolute change that occurs in the item of the financial statement over a period of time. The data presented in financial statements are self-explanatory and easy to understand. When items of the financial statement are treated with the same accounting policies and practices over a fixed period of time, then the comparative data derived from such statements bear meaningful comparisons.

Two common types are as follows:

1. Comparative Income Statement

2. Comparative Balance Sheet

6. What do you mean by Common Size Statements?

Solution:

Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet, total and net sales are highlighted in percentage. The analysis based on these statements is called Vertical Analysis.

Two types of Common Size Statements are as follows:

1. Common Size Income Statements

2. Common Size Balance Sheet

Long Answers

1. Describe the different techniques of financial analysis and explain the limitations of financial analysis.

Solution:

The following different techniques are used for financial analysis:

1. Cash Flow Analysis: This analysis focuses on the inflow and outflow of cash and cash equivalents from the various activities of a business, namely investing, operating and financing activities during an accounting period. This helps in analysing cash payments and the reason for receipt, and the respective changes in cash balances during the accounting year.

2. Ratio Analysis: This method highlights the relationship between items of the Balance Sheet and Income Statements. It is helpful in determining the efficiency, profitability and solvency of a firm. This analysis expresses the financial items as fractions, percentages or proportions. Also, it determines the qualitative relationship among different financial variables. It also serves as a source of information regarding the performance, viability and financial position of a firm.

3. Trend Analysis: This technique studies the trends in operating performance and financial position of the business over a period of many years in succession. In such a study, any particular year is considered as the base year, and the rest years are expressed as a percentage of the base year’s figures. It helps in identifying problems and inefficiency along with detecting operating efficiency and the financial position of the firm.

4. Comparative Statements: These statements use figures from two accounting periods that help determine financial position and profitability. It also enables to do intra and inter-firm comparisons and, therefore, determines the efficiency of the firm in relative terms. It uses both percentages as well as absolute terms. This analysis is known as Horizontal analysis.

5. Common Size Statements: Common Size Statements are those statements where the items are displayed as percentages of a common base figure instead of absolute figures. It is helpful for proper analysis between companies (inter-firm comparison) or between time periods of the same company (intra-firm comparison). In these statements, the relationship between items present in financial statements and common items like balance sheet, total and net sales are highlighted in percentage. The analysis based on these statements is called Vertical Analysis.

It has the following limitations:

1. It fails to depict changes in accounting policy and procedures.

2. These statements provide the interim report and hence have incomplete information.

3. These statements lack qualitative aspects like growth prospects and managerial efficiency and express only in monetary terms.

4. Financial analysis is based on accounting concepts and conventions and hence is unreliable as it does not take the current market value of items.

5. It involves personal bias and judgements of the accountant; for example, in the case of depreciation, different methods can be charged for the same item.

6. It does not take into account the change in the price level. Only nominal values are considered.

Answer 2

2. Explain the usefulness of trend percentages in the interpretation of the financial performance of a company.

Solution:

Trend analysis is a form of analysing financial data, and it is expressed as a percentage for each year. It helps the accounting user in evaluating the financial performance of the business and also forms an opinion of various tendencies by which businesses can predict future trends.

The importance of trend analysis is as follows:

1. Predicting the trends of business which is forecasting future trends in business.

2. Trends are expressed as percentages which are less time-consuming and easy to follow.

3. It becomes a popular financial analysis method due to trends being expressed in percentages which makes evaluating the financial performance and operating efficiency of the firm relatively simpler.

4. It presents a broader picture of the performance of the company in terms of finance, viability and efficiency.

3. What is the importance of comparative statements? Illustrate your answer with particular reference to the comparative income statement.

Solution:

Comparative statements have the following importance:

1. It presents financial data in a simple form, with year-wise data being presented in a side-by-side fashion, making the presentation neat and enabling intra and inter-firm comparisons more conclusive.

2. Presentation is very effective for drawing insights quickly and easily

3. It assists the management in drafting future plans and forecast trends which is achieved by analysing the profitability and operating efficiency of a business over time.

4. Comparative analysis helps the easy detection of problems. Early detection helps take corrective measures and align the business to meet the desired target.

4. What do you understand by analysis and interpretation of financial statements? Discuss its importance.

Solution:

Financial analysis is of great importance for the various users of accounting information. Financial statements such as balance sheets, income sheets and other sources of financial data provide ample information on the various expenses and sources of profit, loss and income, which is helpful in determining the financial status of a business. Financial data is not making any meaningful contribution until it is analysed. There are various methods which help in analysing financial statements and make them useful for various accounting users.

The following reasons are essential for performing financial analysis:

1. It is very helpful in determining the financial viability and profit-earning capacity of the firm

2. It is helpful in evaluating the solvency of the business in the long term

3. It is useful in comparing the financial status of a firm in comparison to other competitor firms

4. It helps management in decision-making, drafting plans and also in establishing a robust and effective control mechanism

5. Explain how common size statements are prepared, giving an example.

Solution:

The two Common Size Statements that are most commonly prepared are as follows.

1. Common Size Balance Sheet

2. Common Size Income Statements 

Common Size Statement is prepared in a columnar form for analysis. In a Common Size Statement each item of the financial statements is compared to a common item. The analyses based on these statements are commonly known as Vertical Analysis.

The following are the columns prepared in a Common Size Statement.

i) Particulars Column: This column shows the various financial items under their respective heads.

ii) Amount Columns: These columns depict the amount of each item, sub-totals and the gross total of a particular year.

iii) Percentage or Ratio Columns: These columns show the proportion of each item to the common item either in terms of percentage or ratio.

The Common Size Statements can be presented in the following two ways.

Method 1

1. Percentage Column is shown beside the Amount Column of the year to which percentage column belongs. 

Method 2

Amount Columns are shown first and their percentage columns are shown  after the Amount Columns.

The preparation of the Common Size Statements can be better understood by the help of the following example.

Working Note: 

Percentage (Previous Year) = \(\frac{\text{Previous Year Absolute Figure}}{\text{Balance Sheet Total of Previous Year}} \times100\) 

Percentage (Current Year) = \(\frac{\text{Current Year Absolute Figure}}{\text{Balance Sheet Total of Current Year}} \times100\)

For example,

Percentage of Equity Share Capital (Previous Year) = \(\frac{400000}{1000000} \times 100 = 40\%\)

Percentage of Equity Share Capital (Current Year) = \(\frac{600000}{1320000} \times 100 = 45.45\%\)

Preparation

Step 1: Title of the Common Size Statement, i.e. ‘Common Size Balance Sheet’ is written on the top of the statement.

Step 2: In the ‘Particulars’ column, the various items of the Balance Sheet are shown under the headings of ‘Assets’ and ‘Equity and Liabilities’.

Step 3: In the ‘Amount’ column, amount of the items are shown in the ‘Year’ column to which they belong

Step 4: The Assets and Liabilities are totaled and are shown separately for each year.

Step 5: In the ‘Percentage’ column, the percentage of each item in comparison to the Total of Balance Sheet are shown. 

Answer 3

Numerical Questions

1. Following are the balance sheets of Alpha Ltd. as at March 31^st, 2016 and 2017:

Particulars	2016 Rs.	2017 Rs.
I. Equity and Liabilities
Equity share capital	2,00,000	4,00,000
Reserves and surplus	1,00,000	1,50,000
Long-term borrowings	2,00,000	3,00,000
Short-term borrowings	50,000	70,000
Trade payables	30,000	60,000
Short-term provisions	20,000	10,000
Other current liabilities	20,000	30,000
Total	6,20,000	10,20,000
II. Assets
Fixed assets	2,00,000	5,00,000
Non-current investments	1,00,000	1,25,000
Current investments	60,000	80,000
Inventories	1,35,000	1,55,000
Trade receivables	60,000	90,000
Short term loans and advances	40,000	60,000
Cash at bank	25,000	10,000
Total	6,20,000	10,20,000

You are required to prepare a Comparative Balance Sheet.

Solution:

2. Following are the balance sheets of Beta Ltd. at March 31^st, 2016 and 2017:

Particulars	2016 Rs.	2017 Rs.
I. Equity and Liabilities
1. Shareholders' Funds
(a) Share capital	4,00,000	3,00,000
(b) Reserves and surplus	1,50,000	1,00,000
2. Non-Current Liabilities
(a) Loan from IDBI	3,00,000	1,00,000
3. Current Liabilities
(a) Short-term borrowings	70,000	50,000
(b) Trade payables	60,000	30,000
(c) Other current liabilities	1,10,000	1,00,000
(d) Short-term provisions	10,000	20,000
Total	11,00,000	7,00,000
II. Assets
1. Non-Current Liabilities
(a) Fixed assets	4,00,000	2,20,000
(b) Non-current investments	2,25,000	1,00,000
2. Current Assets
(a) Current investments	80,000	60,000
(b) Stock	1,05,000	90,000
(c) Trade receivables	90,000	60,000
(d) Cash and cash equivalents	1,00,000	85,000
(e) Short term loans and advances	1,00,000	85,000
Total	11,00,000	7,00,000

Prepare Comparative Balance Sheet.

Solution:

Answer 4

3. Prepare Comparative Income Statement from the following information:

Particulars	2016-17 Rs.	2015-16 Rs.
Freight Outward	20,000	10,000
Wages (office)	10,000	5,000
Manufacturing Expenses	50,000	20,000
Stock adjustment	(60,000)	30,000
Cash purchases	80,000	60,000
Credit purchases	60,000	20,000
Returns inward	8,000	4,000
Gross profit	(30,000)	90,000
Carriage outward	20,000	10,000
Machinery	3,00,000	2,00,000
Charge 10% depreciation on machinery	10,000	5,000
Interest on short-term loans	20,000	20,000
10% debentures	20,000	10,000
Profit on sale of furniture	20,000	10,000
Loss on sale of office car	90,000	60,000
Tax rate	40%	50%

Solution:

 

Working Notes:

1) Calculation of Net Sales 

Net Sales = Cost of Goods Sold + Gross Profit - Sales Return

or, Net Sales = Purchases + Manufacturing Expenses + Change in Inventory + Gross Profit - Sales Return

Net Sales (2016) = 80,000 + 20,000 +30,000 + 90,000 - 4,000 = Rs 2,16,000

Net Sales (2017) = 1,40,000 + 50,000 - 60,000 - 30,000 - 80,000 = Rs 92,000

2) Calculation of Finance Cost

Finance Cost = Interest on short-term loans + Interest on 10% Debentures

Finance Cost (2016) = 20,000 + 1,000 = Rs 21,000

Finance Cost (2017) = 20,000 + 2,000 = Rs 22,000

3) Calculation of Other Expenses

Other Expenses = Freight Outward + Carriage Outward + Loss on sale of office car

Other Expenses (2016) = 10,000 + 10,000 + 60,000 = Rs 80,000

Other Expenses (2017) = 20,000 + 20,000 + 90,000 = Rs 1,30,000

4. Prepare Comparative Income Statement from the following information:

Particulars	2015-16 Rs.	2016-17 Rs.
Manufacturing expenses	35,000	80,000
Opening stock	30,000	60% of closing stock
Sales	9,60,000	4,50,000
Returns outward	4,000 (out of credit purchase)	6,000 (out of cash purchase)
Closing stock	150% of opening stock	1,00,000
Credit purchases	1,50,000	150% of cash purchase
Cash purchases	80% of credit purchases	40,000
Carriage outward	10,000	30,000
Building	1,00,000	2,00,000
Depreciation on building	20%	10%
Interest on bank overdraft	5,000	-
10% debentures	2,00,000	20,00,000
Profit on sale of copyright	10,000	20,000
Loss on sale of personal car	10,000	20,000
Other operating expenses	20,000	10,000
Tax rate	50%	40%

Solution:

Working Notes:

1) Calculation of Net Purchases and Change in Inventory 

Net Purchases of stock in Trade = Cash Purchases + Credit Purchases - Purchases Returns

2013 = 120000 + 150000 - 4000 = Rs 266000

2014 = 40000 + 60000 - 6000 = Rs 94000

Change in Inventory = Opening Stock - Closing Stock

2013 = 30000 - 45000 = Rs (15000)

2014 = 60000 - 100000 = Rs (40000)

2) Calculation of Finance Cost

Finance Cost = Interest on Bank Overdraft + Interest on Debentures

Finance Cost (2016) = 5,000 + 20,000 = Rs 25,000

Finance Cost (2017) = 0 + 20,000 = Rs 20,000

3) Calculation of Other Expenses

Other Expenses = Carriage outward + Manufacturing expenses + Other operating expenses

Other Expenses (2016) = 10,000 + 35,000 + 20,000 = Rs 65,000

Other Expenses (2017) = 30,000 + 80,000 + 10,000 = Rs 1,20,000

Answer 5

5. Prepare a Common size statement of profit and loss of Shefali Ltd. with the help of following information:

Particulars	2015-16 (Rs)	2016-17 (Rs)
Revenue from operations	6,00,000	8,00,000
Indirect expense	25% of gross profit	25% of gross profit
Cost of revenue from operations	4,28,000	7,28,000
Other incomes	10,000	12,000
Income tax	30%	30%

Solution:

 

Working Notes:

1) Calculation of Other Expenses

Other Expenses = Indirect Expenses = % of Gross Profit

Gross Profit = Net Sales −- Revenue from Operations 

For 2016, Gross Profit = ₹(6,00,000 - 4,28,000) = ₹1,72,000

For 2017, Gross Profit = ₹(8,00,000 - 7,28,000) = ₹72,000 

2016 = 172000 × 25% = ₹ 43000

2017 = 72000 × 25 % = ₹ 18000

6. Prepare a Common Size balance sheet from the following balance sheet of Aditya Ltd. and Anjali Ltd.:

Particulars	Aditya Ltd. Rs.	Anjali Ltd. Rs.
I. Equity and Liabilities
a) Equity share capital	6,00,000	8,00,000
b) Reserves and surplus	3,00,000	2,50,000
c) Current liabilities	1,00,000	1,50,000
Total	10,00,000	12,00,000
II. Assets
a) Fixed assets	4,00,000	7,00,000
b) Current assets	6,00,000	5,00,000
Total	1,00,0000*	12,00,000

The total of Liabilities side must be equal to the total of Assets side, therefore, it should be 10,00,000.

Solution: