 # NCERT Solution For Class 12 Accountancy Chapter 5 - Accounting Ratios

NCERT Solutions are said to be extremely helpful while preparing for the CBSE Class 12 Accountancy examinations. This study material is the best resource available to students, and the NCERT Solutions collected by the subject-matter experts are accurate.

NCERT Solution For Class 12 Accountancy Chapter 5 – Accounting Ratios furnishes us with all-inclusive data for all the concepts. As the students would have already learnt the basics of the subject of Accountancy in Class 11, the Class 12 NCERT Solutions is a continuation of it; it explains the concepts in a great way.

### Access NCERT Solutions for Class 12 Accountancy Chapter 5 – Accounting Ratios

Short Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5

1. What do you mean by Ratio Analysis?

It is a quantitative analysis of data present in a financial statement. It shows the relationship between items present in the Balance sheet and the Income Statement. It helps in calculating operational efficiency and solvency and in determining the profitability of a firm. Ratio is a statistical measure which helps in comparing relationships between two or more figures. Analyzing ratios presents vital pieces of information to accounting users about the firm’s financial position, performance and viability. It also helps in setting up new policies and frameworks by the management.

2. What are the various types of ratios?

Ratios can be classified into two types:

2. Functional Classification

Traditional Classification: Traditional classification is based on financial statements such as Balance sheets and P & L accounts. The ratios are divided on the basis of accounts of financial statements and are as follows:

i. Income Statement Ratios such as Gross Profit Ratios

ii. Balance Sheet Ratios such as Debt Equity Ratio, Current Ratio

iii. Composite Ratio: Ratios that contain elements from both Trading and P & L Account.

Functional Classification: These ratios are based on the functional need of calculating ratios. This ratio helps calculate the solvency, liquidity, profitability and financial performance of a business. Such ratios are:

i. Liquidity Ratio: Ratios used to determine the solvency of short term

ii. Solvency Ratio: Ratios used to determine the solvency of long term

iii. Activity Ratio: Ratios used for determining the operating efficiency of the business. These ratios are related to sales and the cost of goods sold.

iv. Probability Ratio: Ratios used to determine the financial performance and viability of the firm.

3. What relationships will be established to study:

a. Inventory Turnover

d. Working Capital Turnover

a. Inventory Turnover Ratio: This ratio is a relationship between the cost of goods sold and the average inventory maintained during a particular time period. It determines the efficiency with which a firm is able to manage its inventory. b. Trade Receivables Turnover Ratio: Debtors turnover ratio, also known as the Receivables Turnover Ratio, is a measure used to check how quickly a credit sale is converted into cash. It shows the efficiency of a business firm in collecting debts from customers. c. Trade Payables Turnover Ratio: It is also known as Creditor’s turnover ratio or account payable turnover ratio and is a liquidity ratio that measures the average number of times a firm pays its creditors in the course of an accounting period. It is used to measure the short-term liquidity of the firm. d. Working Capital Turnover Ratio: The working capital turnover ratio is used to measure the efficiency of a company in using its working capital to support sales. It is a ratio based on which a firm’s operations are funded, and the corresponding revenue generated from the business is calculated. 4. The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they become due. What are the ratios used for this purpose?

A firm’s liquidity is measured by its capability to pay long-term dues. These dues include principal amount payment on the due date and interest payment on a regular basis. Long term solvency of a firm can be determined by the following ratios:

a. Debt-Equity Ratio: This ratio shows the relationship between owner funds (equity) and borrowed funds (debt). A lower debt-equity ratio provides more security to the people who are lending to the business. It also shows that a company is able to meet long-term dues or responsibilities. b. Total Assets to Debt Ratio- It is based on the relationship between total assets and long-term loans. It shows what percentage of the company’s total assets are financed by creditors. A higher total assets to debt ratio makes the firm able to meet long-term requirements and provides more security to lenders. c. Interest Coverage Ratio: This ratio is used to determine the easiness with which a company is able to pay interest on outstanding debts. It is calculated by dividing earnings before interest and taxes with interest payments. Having a higher interest coverage ratio means that company is able to meet its obligations skilfully. 5. The average age of inventory is viewed as the average length of time inventory is held by the firm or as the average number of day’s sales in inventory. Explain with reasons.

Inventory Turnover Ratio: This ratio is a relationship between cost of goods sold and the average inventory maintained during a particular time period. It determines the efficiency with which a firm is able to manage its inventory. It shows the average length for which the firm holds the inventory.

Long Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5

1. What are liquidity ratios? Discuss the importance of current and liquid ratio.

For determining the short-term solvency of a business liquidity ratios are essential. There are two types of liquidity ratios:

1. Current Ratio

2. Liquid Ratio/ Quick Ratio

1. Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as: Current assets are those assets which can be easily converted into cash, whereas Current liabilities are liabilities that need to pay within that accounting period

Importance of Current Ratio

Current ratio helps in determining a firm’s ability to pay off the current liabilities on time. If there is more of current assets as compared to current liabilities, it provides a source of security to the creditors. The ideal ratio is 2:1 (Current Assets: Current Liabilities)

2. Liquid Ratio– It deals with the relationship between liquid assets and current liabilities. This ratio determines if the firm has sufficient funds for paying off the current liabilities on an immediate basis. It can be calculated as: Importance of Liquid Ratio

It is helpful in determining if a firm has funds that can be sufficient to pay off liabilities. It does not include stock or prepaid expenses as both these are not easily converted to cash. A ratio of 1:1 is ideal for maintaining the liquid ratio.

2. How would you study the solvency position of the firm?

A firm’s solvency position can be best studied with the help of a group of ratios called Solvency Ratios. These ratios measure the financial position of the firm by measuring its ability to pay long-term liabilities, these long-term liabilities include principal amount payments on the due date and interest payments on a regular basis. The following ratios are used to determine the long-term solvency of a business.

1. Debt-Equity Ratio: This ratio shows the relationship between owner funds (equity) and borrowed funds (debt). A lower debt-equity ratio provides more security to the people who are lending to the business. It also shows that a company is able to meet long-term dues or responsibilities. 2. Total Assets to Debt Ratio: It is based on the relationship between total assets and long-term loans. It shows what percentage of the company’s total assets are financed by creditors. A higher total assets to debt ratio makes the firm able to meet long-term requirements and provides more security to lenders. 3. Interest Coverage Ratio: This ratio is used to determine the easiness with which a company is able to pay interest on outstanding debts. It is calculated by dividing earnings before interest and taxes with interest payments. Having a higher interest coverage ratio means that company is able to meet its obligations skilfully. .

d. Proprietary Ratio– This ratio shows the relationship between Total Assets and Shareholders’ funds. It is helpful in revealing the financial position of a business. A higher ratio ensures a greater degree of security for creditors. It is shown as: 3. What are important profitability ratios? How are these worked out?

Profitability ratios are calculated on the basis of profit earned by a business. This ratio gives a percentage which is used to assess the financial condition of a business

1. Return on Assets: This ratio measures the earnings per rupee from assets which are invested in the company. A higher profit ratio is good for the company.

Return on Assets = Net Profit ÷ Total Assets

2. Return on Equity: This ratio deals with measuring the profitability of equity fund that is invested by the company. It also measures how the owner’s funds are utilised profitably to generate company revenues. A high ratio represents the better position of a company.

Return on Equity = Profit after Tax ÷ Net worth

Where Net worth = Equity share capital, and Reserve and Surplus

3. Earnings per share: This ratio helps in measuring profitability from an ordinary shareholder’s viewpoint. A high ratio represents a well off company.

Earnings per share = Net Profit ÷ Total no of shares outstanding

4. Dividend per share: This ratio measures the amount of dividend that is distributed by the company to its shareholders at the end of an accounting period. A high ratio represents that the company has surplus cash.

Dividend per share= Amount Distributed to Shareholders ÷ No of Shares outstanding

5. Price Earnings Ratio: A profitability ratio that is used by an investor to check for the share price of the company, which can be undervalued or overvalued. It also indicates an expectation about the company’s earnings and payback period for the investors.

Price Earnings Ratio = Market Price of Share ÷ Earnings per share

6. Return on capital employed: This ratio is all about the returns earned by the company from the funds invested in the business by its owners. A high ratio is indicative of a better position for the company.

Return on capital employed = Net Operating Profit ÷ Capital Employed × 100

7. Gross Profit: Gross profit ratio or GP ratio is a profitability ratio that deals with the relationship between gross profit and the total net sales revenue. This ratio is used to evaluate the operational performance of the business. 8. Net Profit: This is a profitability ratio that deals with the relationship between net profit after tax and net sales. It is calculated by dividing the net profit (after tax) by net sales. 4. The current ratio provides a better measure of overall liquidity only when a firm’s inventory cannot easily be converted into cash. If inventory is liquid, the quick ratio is a preferred measure of overall liquidity. Explain.

Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as: Current assets are those assets which can be easily converted into cash, whereas Current liabilities are liabilities that need to pay within that accounting period

Importance of Current Ratio

Current ratio helps in determining a firm’s ability to pay off the current liabilities on time. If there is more of current assets as compared to current liabilities, it provides a source of security to the creditors. The ideal ratio is 2:1 (Current Assets: Current Liabilities)

2. Liquid Ratio– It deals with the relationship between liquid assets and current liabilities. This ratio determines if the firm has sufficient funds to pay off the current liabilities on an immediate basis. It can be calculated as: Importance of Liquid Ratio

It is helpful in determining if a firm has funds that can be sufficient to pay off liabilities. It does not include stock or prepaid expenses as both these are not easily converted to cash. A ratio of 1:1 is ideal for maintaining the liquid ratio.

The current ratio is best suited for businesses where the available stock or inventories cannot be converted to cash easily. Examples of such industries can be locomotive companies, heavy machinery manufacturing companies etc., as heavy machinery, and tools cannot be sold easily. Similarly, businesses that can easily convert or get sold off prefer the liquid ratio as a measure to determine their liquidity. A service company is more likely to use liquid ratio as no stock is maintained.

There will be some instances when companies tend to change the ratio method used and choose accordingly. If a company is not maintaining any stock or inventory, liquid ratio is the best option, while if stock forms the majority of the company’s assets, then current ratio is the best choice, as the liquid ratio of such a firm will be very low and that can create a negative impact on creditors. In such a case, current ratio is a better choice to determine the overall liquidity.

Numerical Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5

1. Following is the Balance Sheet of Raj Oil Mills Limited as at March 31, 2017. Calculate Current Ratio.

 Particulars (₹) I. Equity and Liabilities: 1. Shareholders’ funds a) Share capital 7,90,000 b) Reserves and surplus 35,000 2. Current Liabilities a) Trade Payables 72,000 Total 8,97,000 II. Assets 1. Non-current Assets a) Fixed assets Tangible assets 7,53,000 2. Current Assets a) Inventories 55,800 b) Trade Receivables 28,800 c) Cash and cash equivalents 59,400 Total 8,97,000 Current Assets = Inventories +Trade Receivables + Cash

= 55,800 + 28,800 + 59,400

= ₹ 1, 44,000

Current Liabilities = Trade Payables = ₹ 72,000

2. Following is the Balance Sheet of Title Machine Ltd. as at March 31, 2017.

 Particulars Amount ₹. I. Equity and Liabilities 1. Shareholders’ funds a) Share capital 24,00,000 b) Reserves and surplus 6,00,000 2. Non-current liabilities a) Long-term borrowings 9,00,000 3. Current liabilities a) Short-term borrowings 6,00,000 b) Trade payables 23,40,000 c) Short-term provisions 60,000 Total 69,00,000 II. Assets 1. Non-current Assets a) Fixed assets Tangible assets 45,00,000 2. Current Assets a) Inventories 12,00,000 b) Trade receivables 9,00,000 c) Cash and cash equivalents 2,28,000 d) Short-term loans and advances 72,000 Total 69,00,000

Calculate Current Ratio and Liquid Ratio.

1. Current Ratio Current Assets = Inventories +Trade Receivables + Cash + Short term Loans and Advances

= 12, 00,000 + 9, 00,000 + 2, 28,000 + 72,000

= ₹ 24, 00,000

Current Liabilities = Trade Payables + Short-term Borrowings + Short-term Provisions

= 23, 40,000 + 6, 00,000 + 60,000

= ₹ 30, 00,000

2. Quick Ratio Quick Assets = Trade Receivables + Cash + Short term Loans and Advances

= 9, 00,000 + 2, 28,000 + 72,000

= ₹ 12, 00,000

3. Current Ratio is 3.5:1. Working Capital is ₹ 90,000. Calculate the amount of Current Assets and Current Liabilities.  or, Current Assets = 3.5 Current Liabilities (1)

Working Capital = Current Assets − Current Liabilities

Working Capital = 90,000

or, Current Assets − Current Liabilities = 90,000

or, 3.5 Current Liabilities − Current Liabilities = 90,000 (from 1)

or, 2.5 Current Liabilities = 90,000  4. Shine Limited has a current ratio 4.5:1 and quick ratio 3:1; if the inventory is 36,000, calculate current liabilities and current assets. or, or, 4.5 Current Liabilities = Current Assets or, or, 3 Current Liabilities = Quick Assets

Quick Assets = Current Assets − Inventory = Current Assets − 36,000Quick Assets = Current Assets – Inventory = Current Assets – 36,000

Current Assets − Quick Assets = 36,000

or, 4.5 Current Liabilities − 3 Current Liabilities = 36,000

or, 1.5 Current Liabilities = 36,000

or, Current Liabilities = 24,000

Current Assets = 4.5 Current Liabilities 5. Current liabilities of a company are ₹ 75,000. If current ratio is 4:1 and liquid ratio is 1:1, calculate value of current assets, liquid assets and inventory.  Or, 4 × 75,000 = Current Assets

Or, Current Assets = 3, 00,000 Or, Liquid Assets = 75,000

Inventory = Current Assets − Liquid Assets

= 3, 00,000 − 75,000

= 2, 25,000

6. Handa Ltd. has inventory of ₹ 20,000. Total liquid assets are ₹ 1, 00,000 and quick ratio is 2:1. Calculate current ratio. or,  Current Assets = Liquid Assets + Inventory

= 1, 00,000 + 20,000

= 1, 20,000 7. Calculate debt equity ratio from the following information:

 ₹ Total Assets 15,00,000 Current Liabilities 6,00,000 Total Debts 12,00,000  Long Term Debts = Total Debts − Current Liabilities Or, 8. Calculate Current Ratio if:

Inventory is ₹ 6, 00,000; Liquid Assets ₹ 24, 00,000; Quick Ratio 2:1. Or,  Current Assets = Liquid Assets + Inventory  9. Compute Stock Turnover Ratio from the following information:

 ₹ Net Revenue from Operations 2,00,000 Gross Profit 50,000 Inventory at the end 60,000 Excess of inventory at the end over inventory in the beginning 20,000 10. Calculate following ratios from the following information:

(i) Current ratio (ii) Acid test ratio (iii) Operating Ratio (iv) Gross Profit Ratio

 ₹ Current Assets 35,000 Current Liabilities 17,500 Inventory 15,000 Operating Expenses 20,000 Revenue from Operations 60,000 Cost of Goods Sold 30,000 iv) 11. From the following information calculate:

(i) Gross Profit Ratio (ii) Inventory Turnover Ratio (iii) Current Ratio (iv) Liquid Ratio (v) Net Profit Ratio (vi) Working capital Ratio:

 ₹ Revenue from Operations 25,20,000 Net Profit 3,60,000 Cast of Revenue from Operations 19,20,000 Long-term Debts 9,00,000 Trade Payables 2,00,000 Average Inventory 8,00,000 Current Assets 7,60,000 Fixed Assets 14,40,000 Current Liabilities 6,00,000 Net Profit before Interest and Tax 8,00,000

(i)    12. Compute Gross Profit Ratio, Working Capital Turnover Ratio, Debt Equity Ratio and Proprietary Ratio from the following information:

 ₹ Paid-up Share Capital 5,00,000 Current Assets 4,00,000 Revenue from Operations 10,00,000 13% Debentures 2,00,000 Current Liabilities 2,80,000 Cost of Revenue from Operations 6,00,000  13. Calculate Inventory Turnover Ratio if:

Inventory in the beginning is ₹. 76,250, Inventory at the end is 98,500, Gross Revenue from Operations is ₹. 5, 20,000, Sales Return is ₹. 20,000, and Purchases is ₹. 3, 22,250. 14. Calculate Inventory Turnover Ratio from the data given below:

 ₹ Inventory in the beginning of the year 10,000 Inventory at the end of the year 5,000 Carriage 2,500 Revenue from Operations 50,000 Purchases 25,000 15. A trading firm’s average inventory is ₹ 20,000 (cost). If the inventory turnover ratio is 8 times and the firm sells goods at a profit of 20% on sale, ascertain the profit of the firm. Let Sale Price be ₹ 100

Then Profit is ₹ 20

Hence, the Cost of Revenue from Operations = ₹ 100 − ₹ 20 = ₹ 80

If the Cost of Revenue from Operations is ₹ 80, then Revenue from Operations = 100 16. You are able to collect the following information about a company for two years:

 2015-16 2016-17 Trade receivables on Apr. 01 ₹. 4,00,000 ₹ 5,00,000 Trade receivables on Mar. 31 ₹ 5,60,000 Stock in trade on Mar. 31 ₹. 6,00,000 ₹ 9,00,000 Revenue from operations (at gross profit of 25%) ₹. 3,00,000 ₹ 24,00,000

Calculate Inventory Turnover Ratio and Trade Receivables Turnover Ratio. 17. From the following Balance Sheet and other information, calculate following ratios:

(i) Debt-Equity Ratio (ii) Working Capital Turnover Ratio (iii) Trade Receivables Turnover Ratio

 Balance Sheet as at March 31, 2017 Particulars Note No. ₹. I. Equity and Liabilities: 1. Shareholders’ funds a) Share capital 10,00,000 b) Reserves and surplus 9,00,000 2. Non-current Liabilities Long-term borrowings 12,00,000 3. Current Liabilities Trade payables 5,00,000 Total 36,00,000 II. Assets 1. Non-current Assets a) Fixed assets Tangible assets 18,00,000 2. Current Assets a) Inventories 4,00,000 b) Trade Receivables 9,00,000 c) Cash and cash equivalents 5,00,000 Total 36,00,000

Additional Information: Revenue from Operations ₹. 18, 00,000

1. Debt-Equity Ratio Debt = Long Term Borrowings = ₹ 12,00,0000

Equity = Share Capital + Reserve and Surplus

= 10, 00,000 + 9, 00,000

= ₹ 19, 00,000

2. Working Capital Turnover Ratio Revenue from Operations = ₹ 18, 00,000

Working Capital = Current Assets – Current Liabilities

= 18, 00,000 – 5, 00,000

= ₹ 13, 00,000 Net Credit Sales = ₹ 18, 00,000

Average Trade Receivables = ₹ 9, 00,000

18. From the following information, calculate the following ratios:

i) Quick Ratio

ii) Inventory Turnover Ratio

iii) Return on Investment

 ₹. Inventory in the beginning 50,000 Inventory at the end 60,000 Revenue from operations 4,00,000 Gross Profit 1,94,000 Cash and Cash Equivalents 40,000 Trade Receivables 1,00,000 Trade Payables 1,90,000 Other Current Liabilities 70,000 Share Capital 2,00,000 Reserves and Surplus 1,40,000

(Balance in the Statement of Profit & Loss A/c)   19. From the following, calculate (a) Debt Equity Ratio (b) Total Assets to Debt Ratio (c) Proprietary Ratio.

 ₹ Equity Share Capital 75,000 Preference Share Capital 25,000 General Reserve 45,000 Balance in the Statement of Profits and Loss 30,000 Debentures 75,000 Trade Payables 40,000 Outstanding Expenses 10,000  20. Cost of Revenue from Operations is ₹ 1, 50,000. Operating expenses are ₹ 60,000. Revenue from Operations is ₹ 2, 50,000. Calculate Operating Ratio. 21. Calculate the following ratio on the basis of following information:
(i) Gross Profit Ratio (ii) Current Ratio (iii) Acid Test Ratio (iv) Inventory Turnover Ratio (v) Fixed Assets Turnover Ratio

 ₹. Gross Profit 50,000 Revenue from Operations 1,00,000 Inventory 15,000 Trade Receivables 27,500 Cash and Cash Equivalents 17,500 Current Liabilities 40,000 Land & Building 50,000 Plant & Machinery 30,000 Furniture 20,000   Average Inventory = 15,000*

Note: As the values for inventory in the beginning and inventory at the end is not given, the amount of inventory is taken as average.  22. From the following information calculate Gross Profit Ratio, Inventory Turnover Ratio and Trade Receivables Turnover Ratio.

 ₹ Revenue from Operations 3,00,000 Cost of Revenue from Operations 2,40,000 Inventory at the end 62,000 Gross Profit 60,000 Inventory in the beginning 58,000 Trade Receivables 32,000   Note: In this solution, the Trade Receivables are assumed to be the Average Trade Receivables

Concepts covered in this chapter –

• Meaning of accounting ratios
• Objectives of accounting ratios
• Types of ratios
• Liquidity ratios
• Solvency ratios
• Profitability ratios

### Conclusion

NCERT Solutions for Class 12 Accountancy Chapter 5 provide a wide range of illustrative examples, which assist the students in comprehending and learning quickly. The above-mentioned are the illustrations for the Class 12 CBSE syllabus. For more solutions and study materials of NCERT solutions for Class 12 Accountancy, visit BYJU’S or download the app for more information.

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NCERT Solutions for Class 12 Accountancy Part II