Cash Flow Statement (Direct Method) for the Current Year

The closing cash of Rs 30,000 agrees with the cash at bank in the current year balance sheet.

Working Notes

W.N. 1: Cash received from customers

$300{,}000 + 45{,}000 - 60{,}000 = 285{,}000$

(Sales plus opening debtors less closing debtors.)

W.N. 2: Cash paid to suppliers

Purchases = COGS + closing inventories − opening inventories = $120{,}000 + 75{,}000 - 30{,}000 = 165{,}000$

Cash paid = purchases + opening payables − closing payables = $165{,}000 + 40{,}000 - 30{,}000 = 175{,}000$

W.N. 3: Cash paid for operating expenses

$87{,}000 - 30{,}000 \text{ (depreciation)} - 12{,}000 \text{ (interest, shown separately)} = 45{,}000$

W.N. 4: Income tax paid

$30{,}000 + 45{,}000 - 45{,}000 = 30{,}000$

(Opening provision plus charge for the year less closing provision.)

W.N. 5: Purchase of fixed assets

W.N. 6: Sale proceeds of plant

$\text{Book value } 15{,}000 + \text{gain } 12{,}000 = 27{,}000$

W.N. 7: Dividend paid

$15{,}000 + 30{,}000 - 30{,}000 = 15{,}000$

(Opening provision plus dividend proposed for the year less closing provision.)

Users of Accounting Information

Accounting information is used by many parties who have an interest in the financial position, profitability and cash flows of a business. They are broadly classified into two groups: internal users and external users.

A. Internal Users (inside the organisation)

1. Owners / Proprietors – They need information to know the profit earned, the value of their investment and the safety of their capital. It helps them decide whether to invest more, withdraw capital or close the business.
2. Management – Managers need accounting information for planning, controlling, decision-making, budgeting, pricing and performance evaluation of different departments.
3. Employees – They need information about the profitability and stability of the firm to claim higher wages, bonus, provident fund and to ensure job security.

B. External Users (outside the organisation)

1. Investors / Shareholders – They need information to judge the earning capacity and financial strength of the company before buying, holding or selling shares.
2. Creditors / Lenders – Banks and financial institutions need information to assess the creditworthiness and repaying capacity of the business before granting loans.
3. Suppliers / Trade Creditors – They need information to decide whether to supply goods on credit and to fix the credit period and limit.
4. Customers – They need information about the continuity and reliability of the business so that they are assured of regular supply of goods and services.
5. Government and Regulatory Bodies – They need information to assess tax liability (income tax, VAT, excise), to formulate economic policies and to regulate business activities.
6. Employees' Unions and Labour Organisations – They use it to negotiate wages, bonus and other benefits.
7. Researchers, Academicians and General Public – They use it for study, research, comparison of firms and to know the contribution of the business to society.
8. Competitors – They use it to compare performance and frame their own competitive strategies.

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Why These Users Need Accounting Information

Accounting information is needed because it serves the following purposes:

1. To know the profit or loss – The income statement shows the result of business operations for a period. Owners, management and the government need this to judge performance and tax liability.

2. To know the financial position – The balance sheet reveals assets, liabilities and capital. Creditors, investors and owners use it to judge solvency and the safety of their funds.

3. For decision-making – Management needs cost, revenue and profit data to decide on product mix, make-or-buy, expansion, pricing and investment. Investors use it to decide whether to buy or sell securities.

4. For planning and controlling – Budgets and standards are prepared from past accounting data. Actual results are compared with budgets to control cost and improve efficiency.

5. To assess creditworthiness – Banks and suppliers examine liquidity and profitability ratios to decide whether to lend or supply on credit.

6. For tax assessment and compliance – The government needs reliable records to determine income tax, VAT and other duties payable by the business.

7. To ensure accountability and transparency – Owners (especially in joint stock companies) are separated from management. Accounting information enables them to check whether managers have used resources honestly and efficiently.

8. For distribution of profit – Dividend, bonus and profit-sharing decisions require accurate knowledge of distributable profit.

9. To attract additional capital – Sound financial statements help the business raise loans and issue new shares by building the confidence of lenders and investors.

10. For comparison and evaluation – Inter-firm and intra-firm comparison of results over time helps in measuring growth, efficiency and competitive position.

11. For settlement of disputes – In case of partnership dissolution, insolvency or legal disputes, accounting records provide the basis for settlement of claims.

12. For social welfare and policy formulation – The general public and the government use accounting data to measure the social and economic contribution of business and to frame national policies.

Conclusion

Thus, accounting information serves a wide range of users — owners, management, employees, investors, creditors, suppliers, customers, government and the public. Each user needs it for a different purpose, but the common aim is to obtain reliable financial facts for informed judgement and decision-making. Hence, accounting is rightly called the "language of business".

Given: current ratio = 2, current liabilities = Rs 200,000, prepaid expenses = Rs 48,000, inventory = Rs 90,000, debentures = Rs 200,000, shareholders' equity = Rs 600,000, operating profit = Rs 100,000 (10% of sales), tax rate = 25%.

(a) Net profit after tax

Tax = 25% of 100,000 = Rs 25,000

$\text{NPAT} = 100{,}000 - 25{,}000 = \text{Rs } 75{,}000$

(b) Sales

$\text{Sales} = \frac{100{,}000}{10\%} = \text{Rs } 1{,}000{,}000$

(c) Quick ratio

Current assets = 2 × 200,000 = Rs 400,000

Quick assets = 400,000 − 90,000 (inventory) − 48,000 (prepaid expenses) = Rs 262,000

$\text{Quick ratio} = \frac{262{,}000}{200{,}000} = 1.31 : 1$

(d) Inventory turnover ratio

Cost of goods sold = Sales − Operating profit = 1,000,000 − 100,000 = Rs 900,000

$\text{ITR} = \frac{900{,}000}{90{,}000} = 10 \text{ times}$

(e) Debt to total capital ratio

Total capital = Debentures + Equity = 200,000 + 600,000 = Rs 800,000

$\frac{200{,}000}{800{,}000} \times 100 = 25\%$

(f) Return on shareholders' equity

$\frac{75{,}000}{600{,}000} \times 100 = 12.5\%$

(g) Net profit margin

$\frac{75{,}000}{1{,}000{,}000} \times 100 = 7.5\%$

Data: opening 500 units @ Rs 10 = Rs 5,000; purchases 1,000 @ Rs 12 = Rs 12,000, 500 @ Rs 13 = Rs 6,500, 200 @ Rs 11 = Rs 2,200.

Total units available = 2,200; total cost = Rs 25,700. Units sold = 1,200 + 500 = 1,700; closing units = 500.

Sales = 1,200 × 15 + 500 × 20 = 18,000 + 10,000 = Rs 28,000

(a) Weighted average method (periodic)

$\text{Average cost} = \frac{25{,}700}{2{,}200} = \text{Rs } 11.6818 \text{ per unit}$

(b) LIFO method (periodic)

The 1,700 units sold are costed from the latest purchases backwards:

Ending inventory = the 500 units of the oldest (opening) stock @ Rs 10 = Rs 5,000

Gross profit = 28,000 − 20,700 = Rs 7,300

Check: COGS + ending inventory = 20,700 + 5,000 = Rs 25,700, the total cost of goods available.

Machinery Account for the three years ending 31 Chaitra 2078, 2079 and 2080. Depreciation is 15% p.a. on original cost (straight line), charged for the months the asset is held in each year.

Working notes

1. First machinery (cost Rs 4,00,000)

Book value at sale = 4,00,000 − (45,000 + 60,000 + 45,000) = Rs 2,50,000

Profit on sale = 3,00,000 − 2,50,000 = Rs 50,000

2. Second machinery (cost Rs 2,00,000)

Bought on Chaitra 30, 2078, the last day of the year, so no depreciation is charged in 2078. In 2079 and 2080 it is 2,00,000 × 15% = Rs 30,000 a year.

Machinery Account

The closing balance of Rs 1,40,000 is the book value of the second machinery (2,00,000 − 30,000 − 30,000).

(a) Bank Reconciliation Statement as at Ashad 2081

Starting from the cash book balance (Rs 14,800), the items that the cash book has not yet recorded are adjusted first.

Now the bank statement balance is adjusted to the same figure to prove it.

Both balances agree at Rs 17,000.

(b) Bad debts

Meaning. Bad debts are the amounts due from credit customers (debtors) that cannot be recovered and are written off as a loss of the business. They are an expense in the statement of profit or loss.

Methods of estimating bad debts. Because the exact amount is not known at the year end, a provision is made on an estimate, using one of these methods:

1. Percentage of credit sales method. Bad debts are estimated as a fixed percentage of the year's credit sales, based on past experience. For example, 2% of credit sales of Rs 10,00,000 gives Rs 20,000. This is an income statement approach as it matches the expense to the sales of the year.
2. Percentage of accounts receivable method. A fixed percentage of the closing debtors balance is taken as the provision. For example, 5% of debtors of Rs 4,00,000 gives Rs 20,000. This is a balance sheet approach, as it states receivables at their expected collectible value.
3. Ageing schedule method. Debtors are grouped by how long they have been outstanding (for example 0–30 days, 31–60 days, over 90 days), and a higher percentage is applied to older balances because they are less likely to be collected. The total of these amounts is the required provision. It is the most accurate of the three.

Lease: Meaning, Features and Discussion

Meaning of Lease

A lease is a legal contract under which one party (the lessee) obtains the right to use and possess an asset or property owned by the other party (the lessor) for a specified period of time, in return for periodic payment called rent.

The given statement — "A lease is a legal contract under which one party agrees to pay rent properly owned by the other party" — correctly captures the essence of a lease. The party using the property does not own it; ownership remains with the lessor, while only the right of use is transferred to the lessee against periodic rent.

Parties to a Lease

Essential Features of a Lease

1. Legal contract – A lease is enforceable by law. It creates a legal relationship between the lessor and the lessee, and both are bound by its terms and conditions.
2. Two parties – There must be a lessor (owner) and a lessee (user). The lessor need not be the absolute owner but must have the legal right to lease the asset.
3. Transfer of right of use, not ownership – Only the right to use and possess the asset is transferred. Ownership (title) remains with the lessor. This is the most important feature of a lease.
4. Periodic rent – The lessee agrees to pay rent, usually in periodic instalments (monthly, quarterly or annually), as compensation for the use of the asset.
5. Specified period – A lease is valid for a definite period. It may be operating (short-term, cancellable) or financial (long-term, non-cancellable).
6. Asset – The subject matter may be land, building, machinery, equipment, vehicle, computer, etc.
7. Terms and conditions – The contract specifies rent, duration, maintenance responsibility, renewal, termination and purchase option clauses.
8. Return or transfer of asset – At the end of the lease period, the asset is returned to the lessor or purchased by the lessee as per the agreement.

Discussion of the Statement

The statement is true and complete in its basic sense, because:

• "Legal contract" – A lease is not merely a verbal understanding; it is a legally binding agreement. If either party violates the terms, the aggrieved party can seek legal remedy.
• "One party agrees to pay rent" – The lessee pays rent as consideration for using the asset. Rent is the economic return to the lessor for parting with the right of use.
• "Properly owned by the other party" – The asset legally belongs to the lessor. The lessee gets only the right of possession and use, not ownership. This distinguishes a lease from a purchase (where ownership transfers) and from hire purchase (where ownership transfers after the last instalment).

However, the statement can be expanded to make it more complete:

• A lease is not only about paying rent; it also involves transfer of the right to use the asset for a specified period.
• The lessor may be the owner or a person authorized to lease (e.g., a head lessee sub-leasing).
• The contract must satisfy the essentials of a valid contract — offer, acceptance, consideration (rent), capacity, free consent and lawful object.

Conclusion

Thus, a lease is a legal contract in which the lessor transfers the right of use of an asset to the lessee for a specified period against periodic rent, while ownership remains with the lessor. The given statement is correct in substance, and it highlights the two key elements of a lease — legal contract and payment of rent for using another's property.

Value Added Statement

Meaning of Value Added Statement

A Value Added Statement (VAS) is a financial statement that shows the wealth created by a business organisation through its own efforts during a particular period, and how that wealth is distributed among the various stakeholders — employees, providers of capital (lenders and shareholders), the government, and the business itself for reinvestment.

Value added is the difference between the value of output (sales revenue plus other income) and the value of inputs purchased from outside (materials, supplies, services, etc.). In simple terms:

$\text{Value Added} = \text{Value of Output} - \text{Value of Inputs Purchased from Outside}$

The statement is prepared in two parts:

Part A — Generation of Value Added

Part B — Application (Distribution) of Value Added

Thus, the VAS reports the total value added and its distribution among the parties who contributed to its creation. It is also called the "value added income statement" or "wealth statement".

Advantages of Value Added Statement

The main advantages of preparing a value added statement are as follows:

1. Measures the true earning capacity of the firm. Value added shows the wealth actually created by the organisation's own productive effort, after deducting the cost of goods and services bought from outsiders. It is therefore a better indicator of performance than profit, which can be distorted by accounting policies.

2. Wider and more meaningful view of performance. Profit is a narrow concept that concerns mainly the shareholders. Value added takes a broad view and shows the benefit going to all stakeholders — employees, lenders, government, shareholders and the firm itself. Hence it reflects the total contribution of the enterprise to society.

3. Useful for employees and trade unions. The statement shows the share of value added going to employees. This helps workers and trade unions in wage negotiations, bonus claims and collective bargaining, as they can see the firm's capacity to pay.

4. Basis for productivity-linked incentive schemes. Since value added measures the net wealth created, it can be used to link wages, bonus and incentives to productivity. A rise in value added per employee indicates improved efficiency and justifies higher rewards.

5. Helps in judging the firm's contribution to the national economy. The value added statement shows how much the firm contributes to Gross Domestic Product (GDP) and how much it pays to the government by way of taxes and duties. It is thus useful for national income accounting and for assessing the social responsibility of business.

6. Better indicator of growth and efficiency. Comparison of value added over the years, or value added per rupee of capital employed or per employee, gives a clear picture of the firm's growth, efficiency and productivity trends.

7. Useful to investors and lenders. Investors and financial institutions can judge the firm's ability to pay interest, dividend and repay loans, since value added represents the total pool from which all such payments are made. A firm with high value added is generally in a stronger position to meet its obligations.

8. Encourages a team spirit and motivation. By showing that employees, capital providers and the government all share in the wealth created, the statement promotes a sense of partnership among the stakeholders and motivates employees to work for higher value added.

9. Simple and easy to understand. The value added statement is prepared in a simple, non-technical manner. Even a layman can understand how much wealth the business has generated and how it has been shared, which improves the image of the business before the public.

10. Aids management in decision making. Management can use the statement to identify the share of each stakeholder group, to control costs of bought-out materials and services, and to plan the distribution of value added in a balanced manner so as to satisfy all parties.

11. Complements the traditional financial statements. The VAS does not replace the profit and loss account and balance sheet; it supplements them by providing additional information about the creation and distribution of wealth. Together they give a more complete picture of the firm's affairs.

12. Improves corporate image and social accountability. A firm that openly discloses its value added and its distribution is seen as transparent and socially responsible. This builds public confidence and goodwill, which is valuable in the long run.

Conclusion

The value added statement is a useful financial reporting tool that measures the wealth created by a business and shows how it is distributed among employees, lenders, government, shareholders and the business itself. Its advantages lie in its broad, social and productivity-oriented view of performance, which makes it valuable to management, employees, investors, the government and society at large.

Accounting Information

Accounting information is the financial and economic data about a business organisation that is collected, recorded, classified, summarised and communicated to interested parties in the form of financial statements and reports. It includes figures such as profit or loss, assets, liabilities, capital, revenue, expenses, cash position and cash flows, presented through the income statement, balance sheet, statement of cash flows and other reports. It is the final output of the accounting process, which begins with the recording of transactions and ends with the communication of results to users. Accounting information is expressed mainly in monetary terms and is prepared according to generally accepted accounting principles so that it is reliable and comparable. It may be quantitative (profit, sales, debt) or qualitative (notes, disclosures, accounting policies) in nature.

Importance of Accounting Information for Stakeholders

Accounting information is important for every stakeholder because each group depends on it to make informed economic decisions. Its importance for the major stakeholders is explained below:

1. Owners/Shareholders: Owners invest capital in the business and bear the ultimate risk. Accounting information shows the profitability, financial position and earning capacity of the organisation. It helps them judge whether their investment is safe and earning a fair return, and to decide whether to buy, hold or sell shares.

2. Management: Management needs accounting information for planning, controlling and decision-making. Cost and revenue data help in fixing prices, preparing budgets, comparing actual performance with standards, controlling wastage and choosing among alternative courses of action.

3. Creditors and Lenders: Banks and suppliers supply loans and credit. They study the balance sheet and cash flow statements to assess the repaying capacity, liquidity and solvency of the business before granting credit or loans and while monitoring repayment.

4. Investors and Potential Investors: Existing and prospective investors use accounting information to evaluate the risk and return of investment. Profit trends, dividend records and net worth figures guide their investment decisions.

5. Government and Regulatory Bodies: The government needs accounting information to assess tax liability (income tax, VAT), to frame fiscal and economic policies, and to regulate business activities. Reliable accounts also help in checking evasion and fraud.

6. Employees and Trade Unions: Employees are interested in the profit and stability of the organisation because their wages, bonus, job security and retirement benefits depend on it. Accounting information is the basis for wage negotiations and profit-sharing schemes.

7. Consumers and Customers: Customers want a regular supply of quality goods at reasonable prices. Accounting information reveals the cost structure and profitability, which helps in judging whether prices charged are fair and whether the firm can continue supply.

8. Suppliers and Creditors for Goods: Suppliers of raw materials and goods on credit check the creditworthiness of the firm through its financial statements before granting trade credit.

9. Managers, Auditors and Researchers: Auditors verify the accounts, researchers and analysts use them for study and comparison, and managers use them for performance appraisal of departments.

Conclusion

Thus, accounting information is the language of business that records and communicates the financial results of an organisation. It is important for every stakeholder because it provides the basis for rational decision-making, protects their interests, ensures accountability and transparency, and helps in the efficient allocation of resources in the economy.

Why organizations follow the accrual basis rather than the cash basis

Under the cash basis, revenue is recorded only when cash is received and expenses only when cash is paid. Under the accrual basis, revenue is recorded when it is earned (i.e., when the right to receive it arises) and expenses are recorded when they are incurred (i.e., when the obligation arises), regardless of when cash actually changes hands. Organizations prefer the accrual basis for the following reasons:

1. True and fair profit determination. By matching revenue earned in a period with the expenses incurred to earn it (the matching principle), accrual accounting gives the correct profit or loss of the period. Cash basis profit is distorted — a sale made on credit in one year but collected in the next year is wrongly shown as income of the later year.

2. Proper recognition of assets and liabilities. Accrual accounting records receivables (debtors, accrued income) and payables (creditors, outstanding expenses, accrued expenses) that the cash basis ignores. This gives a complete and realistic picture of the financial position.

3. Matching principle and revenue recognition. It applies the revenue recognition principle (revenue when earned) and the matching principle (expenses when incurred), which are the core concepts of accounting.

4. Comparability of financial statements. Since the same rules are applied every period, results of different years and of different organizations can be compared meaningfully. Cash-basis figures fluctuate merely with the timing of receipts and payments.

5. Better decision-making and planning. Owners, managers, creditors and investors get reliable information about future cash inflows (receivables) and outflows (payables), which helps in budgeting, credit policy and investment decisions.

6. Legal and professional requirement. Company law, tax authorities and accounting standards (NFRS/IFRS) generally require the accrual basis for preparing financial statements, and auditors insist on it. It is also needed for correct computation of taxable income.

7. Performance evaluation. Managers' performance is judged on sales made and costs incurred during the period, not on when cash was collected or paid, so accrual accounting gives a fair basis for evaluating responsibility centres.

Conclusion. Although the cash basis is simple and closely tied to liquidity, it fails to show the real earning capacity and financial position of an organization. Hence, for correct profit, complete disclosure of assets and liabilities, comparability and sound decision-making, every organization follows the accrual basis of accounting.

Working figures

• Closing stock Rs 20,000 is credited to Purchase, so the cost of goods sold is 110,000 − 20,000 = Rs 90,000.
• Rent expired = Rs 18,000; prepaid rent remaining = 24,000 − 18,000 = Rs 6,000.
• Interest on loan = 6,000 + 2,000 outstanding = Rs 8,000 (equal to 10% of Rs 80,000).
• Depreciation = 15% × 200,000 = Rs 30,000.

$\text{PBT} = 260{,}000 + 20{,}000 - 90{,}000 - 10{,}000 - 30{,}000 - 18{,}000 - 30{,}000 - 8{,}000 = \text{Rs } 94{,}000$

$\text{Tax} = 25\% \times 94{,}000 = \text{Rs } 23{,}500$

(a) Adjustment entries

(b) Adjusted trial balance

(c) Statement of profit or loss (as per NFRS)

(d) Statement of financial position (as per NFRS)

Reading the income statement of the second year

The statement gives gross profit as Rs 450,000. Total charges below gross profit are:

$\text{Net income} = 450{,}000 - 380{,}000 = \text{Rs } 70{,}000$

Profit before tax and appropriation

$450{,}000 - 250{,}000 - 10{,}000 - 10{,}000 = \text{Rs } 180{,}000$

Profit after tax = 180,000 − 60,000 = Rs 120,000; after the proposed dividend of Rs 50,000 the retained profit is Rs 70,000.

Cash flow from operating activities (indirect method) before changes in working capital

Changes in the current assets and current liabilities between the two balance sheet dates are then added or deducted, and income tax paid is subtracted, to reach net cash from operating activities.

Other cash flow items arising from this statement

• Investing: sale of fixed assets with book value Rs 60,000 and loss of Rs 10,000 gives sale proceeds of Rs 50,000 (inflow).
• Financing: interest paid on debenture Rs 10,000, premium paid on redemption Rs 10,000, the face value of debentures redeemed, and dividend paid are shown as financing outflows.

(a) Inventory system adopted by ABC Enterprises

ABC Enterprises counts and records inventory only at the end of each month. Therefore, it is using the periodic inventory system (also called the physical inventory system). It is not using a perpetual inventory system.

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(b) Ending inventory and cost of goods sold under LIFO — Periodic

Units available for sale:

Units sold:

• Ashad 19: 900 units
• Ashad 30: 900 units
• Total sales = 1,800 units

Ending inventory units:

[ 2,800 - 1,800 = 1,000 \text{ units} ]

Under periodic LIFO, the most recent purchases are charged to cost of goods sold first.

Cost of goods sold:

Ending inventory:

Answer:

• Cost of goods sold = Rs. 18,600
• Ending inventory = Rs. 8,500

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(c) Income Statement

ABC Enterprises
Income Statement
For the month ended Ashad 30, 2079

Net result: ABC Enterprises has a net loss of Rs. 3,000 for Ashad 2079.

Working

Cost of machine = purchase price + transportation + installation = 5,50,000 + 10,000 + 10,000 = Rs 5,70,000.

Depreciable amount = cost − salvage value = 5,70,000 − 20,000 = Rs 5,50,000.

Depreciation rate (service-hours method):

$\frac{5{,}50{,}000}{90{,}000\ \text{hours}} = \text{Rs } 6.1111 \text{ per machine hour}$

Machinery Account

The book value of the machine at the end of Year 3 is Rs 2,27,778.

Accounting vs Accountancy

In short: Accountancy is the knowledge and accounting is its application. Accountancy is the tree; accounting is one of its branches.

Bank Reconciliation Statement as on 30th Shrawan 2079

First, adjust the cash book for items the bank has handled but the company has not recorded correctly.

Then reconcile this with the bank statement balance:

Both routes give the same corrected balance, so the statement reconciles. The correct cash balance of the company is Rs 45,000.

The unrecorded items (collection, interest, NSF, bank charges and the payment error) need journal entries in the company's books, while the deposit in transit and the outstanding cheque do not, as they will clear in the next period.

Capital Income vs Revenue Income

Key point: Capital income is related to the capital structure of the business and is not available for distribution as profit, whereas revenue income is related to the operating performance of the business and forms part of the profit available for distribution.

Meaning and Types of Lease, and Criteria for Identifying a Capital Lease

1. Meaning of Lease (3 marks)

A lease is a contractual agreement between two parties — the lessor (owner of the asset) and the lessee (user of the asset) — under which the lessor grants the lessee the right to use a specific asset (such as land, building, machinery, or equipment) for an agreed period of time in return for periodic payments called lease rentals.

Key features:

• It is a contractual agreement between the lessor and the lessee.
• The ownership of the asset remains with the lessor; only the right of use is transferred to the lessee.
• The lessee makes periodic payments (rentals) to the lessor.
• The asset is returned to the lessor at the end of the lease period, unless the agreement provides otherwise.
• It is an alternative to purchasing an asset through own funds or borrowing.

2. Types of Lease (3 marks)

(a) On the basis of ownership and transfer of risks and rewards

1. Finance Lease (Capital Lease) A lease in which substantially all the risks and rewards incidental to ownership of the asset are transferred to the lessee. The lessee treats the asset as its own, records it in the books, and charges depreciation. Ownership may or may not be transferred at the end of the lease term.

2. Operating Lease A lease other than a finance lease. Here the risks and rewards of ownership remain with the lessor. The lease period is short, and the lessee simply records the lease rent as an expense. The lessor is responsible for maintenance, insurance, and taxes.

(b) On the basis of the method of payment

3. Sale and Leaseback The owner of an asset sells it to another party (lessor) and immediately leases it back for continued use. The seller becomes the lessee. It provides immediate cash to the seller while retaining the use of the asset.

4. Direct Lease A lease in which the lessor purchases the asset directly from the manufacturer or dealer and leases it to the lessee. The lessor is not the original user of the asset.

5. Leveraged Lease A lease involving three parties — the lessor, the lessee, and a lender (financier). The lessor borrows a large part of the purchase price from the lender and contributes the rest as equity, then leases the asset to the lessee.

(c) On the basis of the lessee's status

6. Domestic Lease — both lessor and lessee are residents of the same country. 7. International (Cross-border) Lease — the lessor and lessee belong to different countries.

3. Criteria for Identifying a Capital Lease (4 marks)

According to NAS 17 / IAS 17 (Leases), a lease is classified as a finance (capital) lease if it transfers substantially all the risks and rewards incidental to ownership. The following are the criteria — any one of them being satisfied makes the lease a capital lease:

1. Transfer of ownership: The lease transfers ownership of the asset to the lessee by the end of the lease term.

2. Bargain purchase option: The lessee has the option to purchase the asset at a price sufficiently lower than its fair value at the date the option becomes exercisable, so that it is reasonably certain at the inception of the lease that the option will be exercised.

3. Lease term: The lease term covers the major part (generally 75% or more) of the estimated economic life of the asset.

4. Present value of lease payments: At the inception of the lease, the present value of the minimum lease payments amounts to substantially all (generally 90% or more) of the fair value of the leased asset.

5. Nature of the asset: The leased assets are of such a specialised nature that only the lessee can use them without major modification.

6. Loss borne by the lessee: If the lessee cancels the lease, the losses incidental to the cancellation are borne by the lessee.

7. Gains/losses on fair value: Gains or losses from fluctuations in the fair value of the residual asset accrue to the lessee.

8. Similar lease alternative: The lessee can continue the lease for a secondary period at a rent substantially lower than the market rent.

Conclusion: If any one or more of the above criteria are met, the lease is identified as a capital (finance) lease; otherwise, it is treated as an operating lease.

Meaning of Value Added Statement

Value Added Statement (VAS) is a financial statement that shows the wealth created by a business organisation through its own and its employees' efforts during a particular period, and how that wealth is distributed among the stakeholders — employees, providers of capital (lenders and shareholders), the government, and the business itself for reinvestment.

In other words, it is a statement that reconciles the value added (value of output minus cost of bought-in materials and services) with its application or distribution among the parties who contributed to creating that value. It is also known as a "value added report" and is treated as a supplementary financial statement, often presented along with the profit and loss account.

Value Added can be expressed as:

$\text{Value Added} = \text{Value of Output} - \text{Cost of Bought-in Materials and Services}$

where value of output includes sales revenue plus other income, and bought-in items include raw materials consumed, power and fuel, and other external services.

Advantages of Value Added Statement

1. Measures true wealth creation: It shows the actual wealth generated by the organisation's own efforts, rather than profit, which can be distorted by accounting policies and non-operating items.

2. Shows distribution to stakeholders: It clearly reveals how the created wealth is shared among employees, lenders, shareholders, the government (taxes) and retained in the business, promoting transparency and accountability.

3. Useful for employees and trade unions: Since it highlights the share of employees in value added, it serves as a fair basis for wage negotiation, bonus and productivity-linked incentive schemes.

4. Better indicator of productivity and efficiency: Value added per employee or per rupee of capital employed measures operational efficiency and productivity more meaningfully than sales or profit figures.

5. Helps in performance comparison: It allows comparison of performance between firms, industries and different periods, since value added is less affected by differences in capital structure and accounting methods.

6. Aids in decision making and planning: Management can use it to evaluate the contribution of different divisions, decide on resource allocation, and frame growth and diversification policies.

7. Improves corporate image and social reporting: It highlights the organisation's contribution to society through wages, taxes and other payments, thereby improving its public image and social responsibility reporting.

8. Useful to investors and creditors: It provides an indication of the firm's ability to pay interest, dividends and taxes, and to generate funds for future growth.

The question as printed gives only the Statement of Profit and Loss; the Statement of Financial Position for the two years is not reproduced, so the balance-sheet changes cannot be taken from the question. The cash flow statement is therefore set out by the method below, and every figure that comes from the profit and loss account is worked out. The balance-sheet adjustments are shown as the formulae to apply once the opening and closing figures are read from the statement.

1. Cash flow from operating activities (indirect method)

*Treat this item according to how the balance sheet shows the debenture premium (written off from a premium account, or an expense paid in cash). If it was paid in cash it is not added back.

If the cash-flow statement is prepared by the direct method, cash from customers = sales − increase in debtors, where debtors rise by the credit sales not yet collected out of Rs 10,00,000; cash paid to suppliers = cost of goods sold + increase in stock − increase in creditors; and operating expenses paid = Rs 1,30,000 adjusted for outstanding expenses.

2. Cash flow from investing activities

Purchase of fixed assets is found from:

$\text{Purchases} = \text{Closing FA} + \text{Depreciation (2,70,000)} + \text{BV of assets sold (60,000)} - \text{Opening FA}$

3. Cash flow from financing activities

4. Net change in cash

$\text{Net increase/(decrease) in cash} = \text{Operating} + \text{Investing} + \text{Financing}$

Add the opening cash and bank balance to obtain the closing cash, and agree it with the cash and bank balance in the closing Statement of Financial Position.