[CBSE] Q. 49 Solution of Accounting Ratios TS Grewal Class 12 (2023-24)

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Solution of Question number 49 of the Accounting Ratios of TS Grewal Book 2023-24 CBSE Board?

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Debt to Equity Ratio of a company is 0.5 : 1. Which of the following would increase, decrease or not change it:

(i) Issue of Equity Shares;

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(ii) Cash received from debtors;

(iii) Redemption of debentures;

(iv) Purchased goods on credit?

[Ans.: (i) Decrease; (ii) No change; (iii) No change; (iv) No change.]

Solution:-

(i) Issue of Equity Shares;

The issue of equity shares directly impacts the debt-to-equity ratio in the following way:

  1. Debt-to-Equity Ratio Formula:

= Debt/Equity

  1. Impact of Equity Shares:
    • When equity shares are issued, the shareholders’ equity increases because the funds raised from the issue are added to the equity capital of the company.
    • This increases the denominator of the debt-to-equity ratio.
  2. Debt Unchanged:
    • The issuance of equity shares does not involve borrowing, so total debt remains unchanged.
  3. Final Effect:
    • Since shareholders’ equity rises, the debt-to-equity ratio decreases, indicating reduced financial leverage and a stronger equity base.

(ii) Cash received from debtors;

The receipt of cash from debtors does not directly affect the debt-to-equity ratio. Here’s why:

  1. Debt-to-Equity Ratio Formula:

= Debt/Equity

  1. Impact of Cash Receipt:
    • When cash is received from debtors, there is simply a reallocation within the current assets—accounts receivable decreases, and cash increases by the same amount.
    • This transaction does not affect total debt (numerator) or shareholders’ equity (denominator).
  2. Final Effect:
    • Since neither debt nor equity changes, the debt-to-equity ratio remains unchanged.

(iii) Redemption of debentures;

The redemption of debentures affects the debt-to-equity ratio as follows:

  1. Debt-to-Equity Ratio Formula:

= Debt/Equity

  1. Impact of Redemption:
    • When debentures are redeemed, the company’s long-term debt decreases, as debentures are part of long-term liabilities.
    • The payment for redemption usually comes from cash or bank balances, which does not directly impact shareholders’ equity.
  2. Final Effect:
    • As the numerator (total debt) decreases while the denominator (shareholders’ equity) remains constant, the debt-to-equity ratio decreases. This indicates reduced leverage and an improved financial position.

(iv) Purchased goods on credit?

If we consider debt only as long-term liabilities, the purchase of goods on credit typically does not directly affect the debt-to-equity ratio. Here’s why:

  1. Debt-to-Equity Ratio Formula:

= Debt/Equity

  1. Impact of the Transaction:
    • When goods are purchased on credit, it creates current liabilities, such as accounts payable.
    • Current liabilities are not included in the debt figure for the debt-to-equity ratio if we’re only focusing on long-term liabilities.
    • Therefore, neither the numerator (long-term liabilities) nor the denominator (shareholders’ equity) changes.
  2. Final Effect:
    • Since there is no change in long-term debt or equity, the debt-to-equity ratio remains unchanged.

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Anurag Pathak
Anurag Pathak

Anurag Pathak is an academic teacher. He has been teaching Accountancy and Economics for CBSE students for the last 18 years. In his guidance, thousands of students have secured good marks in their board exams and legacy is still going on. You can subscribe his Youtube channel for free lectures

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