Question

Assuming that the Debt-Equity Ratio is 2 : I, state, giving reasons, which of the following transactions would (I) Increase; (ii) Decrease; (ii.) Not alter the Debt-Equity Ratio :

(i) Issue of new shares (Preference/Equity) for Cash.

(ii) Issue of new shares (Preference/Equity) against purchase of fixed asset.

(iii) Buy-back of its own shares by a Company.

(iv) Issue of Debentures for Cash.

(v) Issue of Debentures against purchase of fixed asset.

(vi) Repayment of Long-term Borrowings.

(vii) Conversion of Debentures into Equity Shares/Preference Shares.

(viii) Sale of a fixed asset at par.

(ix) Sale of a fixed asset at profit.

(x) Sale of a fixed asset at loss.

(xi) Purchase of a fixed asset on a credit of 2 months.

(xii) Purchase of a fixed asset on long-term deferred payment basis.

(xiii) Issue of Bonus Shares.

Answer 1

Statement showing the effect of various transactions on Debt-Equity Ratio :

$\begin{array}{ccc}\text{Tr. No.}& \text{Debt-Equity Ratio will}& \text{Reasons}\\ \left(i\right)& \text{Decrease}& \text{Long term debts remain unchanged but equity (shareholder's fund) is increased by the amount of cash received on issue of shares.}\\ \text{(ii)}& \text{Decrease}& \text{Long term debts remain unchanged but equity (shareholder's fund) is increased by the amount of share capital issued.}\\ \text{(iii)}& \text{Increase}& \text{Long term debts remain unchanged but equity (shareholder's fund) is decreased.}\\ \text{(iv)}& \text{Increase}& \text{Long term debts are increased but equity (shareholder's fund) remain unchanged.}\\ \text{(v)}& \text{Increase}& \text{Long term debts are increased but equity (shareholder' s fund) remain unchanged.}\\ \text{(vi)}& \text{Decrease}& \text{Long term debts are decreased but equity (shareholder' s fund) remain unchanged.}\\ \text{(vii)}& \text{Decrease}& \text{Long term debts are decreased and equity (shareholder' s fund) is increased by the same amount.}\\ \text{(viii)}& \text{Not Alter}& \text{Neither the Long-term debts nor the equity (shareholder' s fund) is affected.}\\ \text{(ix)}& \text{Decrease}& \text{Long term debts remain unchanged but equity (shareholder's fund) is increased by the amount of profit.}\\ \text{(x)}& \text{lncrease}& \text{Long term debts remain unchanged but equity (shareholder's fund) is decreased by the amount of loss.}\\ \text{(xi)}& \text{Not Alter}& \text{Neither the Long tenn debts nor the equity (shareholder's fund) is affected.}\\ \text{(xii)}& \text{Increase}& \text{Long term debts are increased but equity (shareholder's fund) remain unchanged by the amount of purchase.}\\ \text{(xiii)}& \text{Not Alter (See Note 1)}& \text{Neither the Long term debts nor the equity (Shareholder's Funds) is affected.}\end{array}$

Note (1) : Sometimes, a company issues additional equity shares to the existing equity shareholders in proportion of their existing shareholding in the company without charging any further payment. Such free shares are known as bonus shares. Bonus shares are issued out of reserves and surplus of the company. Hence, because of bonus shares, the reserves and surplus are converted into share capital of the company. Thus total equity (Total shareholder's fund) remain unchanged.