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Accounting Ratios — Accountancy STD 12 Commerce — Question

CBSE BoardEnglish MediumSTD 12 CommerceAccountancyAccounting Ratios6 Marks
Question
When Debt to Equity Ratio is 2, state giving reason, whether this ratio will increase or decrease or will. have no change in each of the following cases:
  1. Sale of Land (Book value ₹ 4,00,000) for ₹ 5,00,000.
  2. Issue of Equity Shares for the purchase of Plant and Machinery worth ₹ 10,00,000.
  3. Issue of Preference Shares for redemption of 13% Debentures, worth ₹ 10,00,000.
✓

Answer

Debt-Equity Ratio = 2 : 1
Let Long-term loan = ₹ 20,00,000
Shareholders’ Funds = ₹ 10,00,000
  1. Sale of Land (Book Value ₹ 4,00,000) for ₹ 5,00,000 - Decrease
Reason: This transaction will result increase in Shareholders’ Funds by ₹ 1,00,000 as profit on sale of Land.

Shareholders’ Funds after adjusting profit on sale of land = 10,00,000 + 1,00,000 = ₹ 11,00,000

$\text{Debt-Equity Ratio}=\frac{20,00,000}{11,00,000}=1.81:1$
  1. Issue of Equity share for the purchase of plant and Machinery worth ₹ 10,00,000 - Decrease.
Reason: This transaction will increase the amount of Shareholders Fund by ₹ 10,00,000 in the form of equity shares and have no effect on Long-term Loans.

$\text{Debt-Equity Ratio}=\frac{20,00,000}{(10,00,000+10,00,000)}=1:1$
  1. Issue of preference Shares for redemption of 13% Debentures worth ₹ 10,00,000- Decrease.
Reason: This transaction will lead to decrease in Long-term Loan by ₹ 10,00,000 in the form of redemption of debentures and increase in Shareholders’ Funds with the same amount in the form of Preference Shares.

$\text{Debt-Equity Ratio}=\frac{(20,00,000-10,00,000)}{(10,00,000+10,00,000)}=0.5:1$

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