[CBSE] Q. 48 Solution of Accounting Ratios TS Grewal Class 12 (2023-24)

Solution of Question number 48 of the Accounting Ratios of TS Grewal Book 2023-24 CBSE Board?

When Debt to Equity Ratio is 2, State, giving reason, whether this ratio will increase, decrease or will have no change in each of the following cases:

[Ans.: (i) Decrease; (ii) Decrease; (iii) Decrease.]

Solution:-

Solution:-

(i) Sale of Land (Book value ₹ 4,00,000) for ₹ 5,00,000

The sale of land at a profit (₹ 4,00,000 book value sold for ₹ 5,00,000) can impact the debt-to-equity ratio, depending on how the proceeds are used. Let’s break this down:

Debt-to-Equity Ratio Formula:

= Debt/Equity

1. Impact of the Sale:
   • The book value of the land (₹ 4,00,000) is removed from assets, and the sale proceeds (₹ 5,00,000) are added to cash or bank balances.
   • A profit of ₹ 1,00,000 (sale price ₹ 5,00,000 minus book value ₹ 4,00,000) is recognized and added to reserves/retained earnings, increasing shareholders’ equity.
2. Debt Unchanged:
   • If the company does not use the proceeds to pay off debt, the total debt remains unchanged.
3. Final Effect:
   • Since shareholders’ equity increases due to the profit, the denominator of the ratio increases, leading to a lower debt-to-equity ratio (better financial position).

(ii) Issue of Equity Shares for the purchase of Plant and Machinery worth ₹ 10,00,000;

The issuance of equity shares for purchasing plant and machinery worth ₹ 10,00,000 affects the debt-to-equity ratio as follows:

Debt-to-Equity Ratio Formula:

= Debt/Equity

1. Impact of the Transaction:
   • The purchase of plant and machinery does not involve cash or debt; instead, equity shares are issued to finance the purchase.
   • This transaction increases shareholders’ equity, as the equity capital rises by ₹ 10,00,000 due to the issuance of shares.
2. Debt Unchanged:
   • Since no debt is taken on to finance the purchase, the total debt remains unchanged.
3. Final Effect:
   • The denominator of the ratio (shareholders’ equity) increases while the numerator (total debt) stays the same. This results in a lower debt-to-equity ratio, indicating an improved financial position with reduced leverage.

(iii) Issue of Preference Shares for redemption of 13% Debentures, worth ₹ 10,00,000.

The issuance of preference shares for the redemption of 13% debentures worth ₹ 10,00,000 impacts the debt-to-equity ratio as follows:

Debt-to-Equity Ratio Formula:

= Debt/Equity

1. Impact of the Transaction:
   • Debenture Redemption: By redeeming ₹ 10,00,000 worth of 13% debentures, the company’s total debt decreases since debentures are part of long-term liabilities.
   • Issuance of Preference Shares: Preference shares are part of shareholders’ equity, so issuing them increases equity.
2. Final Effect:
   • The numerator (total debt) decreases, and the denominator (shareholders’ equity) increases. This results in a lower debt-to-equity ratio, reflecting reduced leverage and an improved financial position.

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