Solution

Given Data

Total units available for sale = 700 + 800 + 900 + 600 + 400 = 3,400 units Total units sold = 1,200 + 1,300 = 2,500 units Ending inventory (units) = 3,400 − 2,500 = 900 units

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a. FIFO Method (Periodic Inventory System)

Cost of Goods Sold

Under FIFO, the earliest purchases are sold first. The 2,500 units sold are taken from the oldest layers:

Cost of Goods Sold = Rs. 30,600

Ending Inventory

The remaining 900 units come from the most recent purchases:

Ending Inventory = Rs. 13,000

Verification

Cost of goods available for sale = 7,000 + 9,600 + 12,600 + 8,400 + 6,000 = Rs. 43,600 COGS + Ending Inventory = 30,600 + 13,000 = Rs. 43,600 ✓

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b. Income Statement

Income Statement For the month ended Ashad 31

Net Loss = Rs. 13,300

Given: net fixed assets Rs 1,25,000; opening stock Rs 90,000; average inventory Rs 1,00,000; shareholders' equity Rs 5,00,000; debt-equity ratio 40%; inventory turnover 4 times; gross profit 20% of sales; return on equity 12%.

(a) Stock at end

$\text{Average inventory}=\frac{\text{Opening}+\text{Closing}}{2}\Rightarrow 1{,}00{,}000=\frac{90{,}000+\text{Closing}}{2}$

Closing stock = 2,00,000 − 90,000 = Rs 1,10,000

(b) Cost of sales

$\text{Inventory turnover}=\frac{\text{Cost of sales}}{\text{Average inventory}}\Rightarrow 4=\frac{\text{COGS}}{1{,}00{,}000}$

Cost of sales = Rs 4,00,000

(c) Sales

Gross profit is 20% of sales, so cost of sales is 80% of sales.

Sales = 4,00,000 ÷ 0.80 = Rs 5,00,000

(d) Net profit after tax

$\text{ROE}=\frac{\text{NPAT}}{\text{Equity}}\times100\Rightarrow 12=\frac{\text{NPAT}}{5{,}00{,}000}\times100$

NPAT = Rs 60,000

(e) Long-term debt

Debt = 40% × 5,00,000 = Rs 2,00,000. No current liabilities are given, so long-term debt = Rs 2,00,000.

(f) Fixed assets turnover

$=\frac{\text{Sales}}{\text{Net fixed assets}}=\frac{5{,}00{,}000}{1{,}25{,}000}=\textbf{4 times}$

(a) Machinery Account

Assumption: the machine is sold on 31 December 2024, after charging depreciation for the full year 2024.

Working note

$\text{Annual depreciation}=\frac{11{,}00{,}000-1{,}00{,}000}{10}=\text{Rs }1{,}00{,}000$

• 2022 (1 July to 31 December, 6 months): $1{,}00{,}000\times\frac{6}{12}=$ Rs 50,000
• 2023: Rs 1,00,000
• 2024: Rs 1,00,000
• Book value on 31 Dec 2024 = 11,00,000 − 50,000 − 1,00,000 − 1,00,000 = Rs 8,50,000
• Sale price Rs 9,00,000, so profit on sale = 9,00,000 − 8,50,000 = Rs 50,000

Machinery Account, 2022

Machinery Account, 2023

Machinery Account, 2024

(b) Accounts receivable and notes receivable

Financial statement analysis aims to identify the financial strengths and weaknesses of a firm. Discuss.

Meaning

Financial statement analysis is the process of reviewing and evaluating a firm's financial statements — the income statement, balance sheet, and cash flow statement — to understand its financial position, operating performance, and future prospects. It converts the raw figures in these statements into meaningful information by establishing relationships between different items, comparing figures over time (intra-firm comparison), and comparing them with other firms or industry averages (inter-firm comparison).

How analysis identifies financial strengths and weaknesses

1. Assessment of liquidity position. By computing ratios such as the current ratio and quick ratio, the analyst judges whether the firm can meet its short-term obligations. A high current ratio with a sound quick ratio indicates a liquidity strength; a low or declining ratio signals a weakness in working capital management.

2. Assessment of solvency and capital structure. Debt-equity ratio, debt to total capital ratio, interest coverage ratio, and proprietary ratio reveal the firm's long-term financial stability. A low, comfortably covered debt burden is a strength; excessive reliance on debt and weak interest coverage is a weakness, as it increases financial risk and the chance of insolvency.

3. Assessment of profitability. Gross profit ratio, net profit ratio, operating ratio, return on assets, and return on equity show how efficiently the firm generates profit from sales and from the funds invested. A rising trend in these ratios reflects operating efficiency and pricing power (strength); a falling trend reflects cost inefficiency or weak pricing (weakness).

4. Assessment of activity or efficiency. Inventory turnover, debtors turnover, creditors turnover, and total assets turnover indicate how productively the firm uses its assets. A high turnover means efficient use of resources; a slow turnover means idle or blocked funds — a weakness.

5. Trend and comparative analysis. By preparing comparative statements, common-size statements, and trend percentages over several years, the analyst distinguishes a temporary fluctuation from a persistent problem. Improvement over time is a strength; continuous deterioration is a weakness.

6. Inter-firm comparison. Comparing the firm's ratios with those of similar firms or industry norms shows whether it is performing above or below the standard. A ratio better than the industry average is a competitive strength; a ratio below it is a weakness requiring corrective action.

7. Assessment of earnings quality and stability. Analysis of the composition of profit, operating versus non-operating income, and the proportion of fixed and variable costs (operating leverage) shows how stable and sustainable the earnings are. A high proportion of operating income is a strength; heavy dependence on non-operating income is a weakness.

8. Detection of trends, and early warning signals. A falling gross margin, rising debtors collection period, growing inventory pile-up, or shrinking interest coverage act as warning signals of impending difficulty, allowing management to take timely corrective measures.

Techniques used

• Comparative statements (year-to-year comparison of items)
• Common-size statements (each item as a percentage of a common base)
• Trend analysis (base-year percentages)
• Ratio analysis (liquidity, solvency, activity, profitability)
• Cash flow analysis (operating, investing, and financing activities)
• Fund flow analysis

Conclusion

Thus, financial statement analysis is not merely a mechanical computation of ratios; it is a diagnostic tool. By studying the relationships among balance sheet and income statement items, comparing results across time and across firms, and interpreting the figures in the light of the firm's objectives and the economic environment, it clearly brings out where the firm is financially strong and where it is weak. On this basis, management, creditors, investors, and other stakeholders can take informed decisions — to strengthen the strong areas and correct the weak ones — which is precisely the purpose of financial statement analysis.

Source Documents

Meaning: A source document is the original, written record that provides the evidence and details of a business transaction. It is prepared at the time the transaction takes place, or immediately afterwards, and acts as the raw material from which accounting entries are made. Examples include cash memos, invoices (bills), receipts, debit notes, credit notes, pay-in-slips, cheque counterfoils, and debit/credit notes.

Concept: Every transaction must be supported by a document that proves it actually occurred. Such a document is called a source document because it is the source or origin of the accounting entry. The accounting process begins with the identification of transactions, and source documents are the means of that identification. From these documents, transactions are first recorded in the journal (or subsidiary books) and then posted to the ledger. Thus the sequence is:

$\text{Source Document} \rightarrow \text{Journal} \rightarrow \text{Ledger} \rightarrow \text{Trial Balance} \rightarrow \text{Financial Statements}$

Significance in the Accounting Process

1. Evidence of transactions: Source documents provide written proof that a transaction took place. Without them, a transaction cannot be verified or trusted.

2. Basis of recording: They supply the date, amount, parties involved, and nature of the transaction, which are the exact details needed to make a journal entry. Hence they form the basis of all book-keeping.

3. Accuracy and reliability: Since entries are made from original documents rather than memory, the chance of error and fraud is greatly reduced. Figures recorded are accurate and reliable.

4. Legal evidence: In case of disputes, tax audits, or legal proceedings, source documents serve as admissible evidence in a court of law or before tax authorities.

5. Audit facility: Auditors verify the accounts by checking entries against source documents. Their availability makes audit convenient and dependable.

6. Classification and analysis: Source documents help in classifying transactions (cash, credit, expense, income) and in analysing them for management decisions.

7. Control over assets: Documents such as vouchers and receipts help in controlling cash, stock, and other assets, and in fixing responsibility on concerned staff.

8. Preparation of financial statements: Since all entries ultimately flow from source documents, the correctness of the final accounts (trading, profit and loss account, and balance sheet) depends on them.

Conclusion: Source documents are the foundation of the accounting process. They ensure that accounting records are complete, accurate, verifiable, and legally acceptable, and they serve as the starting point of the whole accounting cycle.

Journal Entries

Ledger Balances

Cash A/c

Bank A/c

Debtors A/c: 3,00,000 − 2,00,000 = Rs 1,00,000 (Dr). Creditors A/c: 1,00,000 − 1,00,000 = nil.

Trial Balance as at 31 January