NCERT Solutions for Class 12 Chapter 5 Accounting Ratios
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NCERT Solutions for Class 12 Chapter 5 Accounting Ratios

Test your Understanding – I

  1. State whether the following statements are True or False:
    1. Financial accounting provides information about the financial performance and financial position of a business. False
    2. Management accounting is mainly concerned with providing information to external users. True
    3. Cost accounting is a part of management accounting. True
    4. Cost accounting is only concerned with recording the costs. False
    5. Financial accounting helps in investment decisions. True
    6. Management accounting helps in controlling costs. False

Test your Understanding – II

  1. The following groups of ratios are primarily measure risk:
    • A. liquidity, activity, and profitability
    • B. liquidity, activity, and inventory
    • C. liquidity, activity, and debt
    • D. liquidity, debt and profitability
  2. The _________ ratios are primarily measures of return:
    • A. liquidity
    • B. activity
    • C. debt
    • D. profitability
  3. The _________ of business firm is measured by its ability to satisfy its short-term obligations as they become due:
    • A. activity
    • B. liquidity
    • C. debt
    • D. profitability
  4. _________ ratios are a measure of the speed with which various accounts are converted into revenue from operations or cash:
    • A. activity
    • B. liquidity
    • C. debt
    • D. profitability
  5. The two basic measures of liquidity are:
    • A. inventory turnover and current ratio
    • B. current ratio and liquid ratio
    • C. gross profit margin and operating ratio
    • D. current ratio and average collection period
  6. The _________ is a measure of liquidity which excludes _______, generally the least liquid asset:
    • A. current ratio, trade receivable
    • B. liquid ratio, trade receivable
    • C. current ratio, inventory
    • D. liquid ratio, inventory

Test your Understanding – III

  1. The _________ is useful in evaluating credit and collection policies.
    • A. average payment period
    • B. current ratio
    • C. average collection period
    • D. current asset turnover
  2. The ___________ measures the activity of a firm’s inventory.
    • A. average collection period
    • B. inventory turnover
    • C. liquid ratio
    • D. current ratio
  3. The ___________ may indicate that the firm is experiencing stockouts and lost sales.
    • A. average payment period
    • B. inventory turnover ratio
    • C. average collection period
    • D. quick ratio
  4. ABC Co. extends credit terms of 45 days to its customers. Its credit collection would be considered poor if its average collection period was.
    • A. 30 days
    • B. 36 days
    • C. 47 days
    • D. 37 days
  5. ___________ are especially interested in the average payment period, since it provides them with a sense of the bill-paying patterns of the firm.
    • A. Creditors
    • B. Shareholders
    • C. Managers
    • D. Lenders and suppliers
  6. The __________ ratios provide the information critical to the long run operation of the firm.
    • A. solvency
    • B. Quick ratio
    • C. Debt ratio
    • D. Gross profit ratio

Short Answer Questions

What do you mean by Ratio Analysis?

Ratio analysis is an important tool of financial statement analysis that represents the relationship between two accounting numbers. Its objective is to provide a deeper analysis of the profitability, liquidity, solvency, and activity levels in a business. It also helps identify problem areas as well as strong areas of the business.

What are various types of ratios?

There are several types of ratios, including:

  • Liquidity Ratios: Current ratio, acid-test (quick) ratio.
  • Solvency Ratios: Debt equity ratio, total assets to debt ratio, proprietary ratio, interest coverage ratio.
  • Activity Ratios: Inventory turnover, trade receivables turnover, trade payables turnover, working capital turnover, fixed assets turnover, current assets turnover.
  • Profitability Ratios: Gross profit ratio, operating ratio, net profit ratio, return on investment (capital employed), earnings per share, book value per share, dividend per share, price/earning ratio.

What relationships will be established to study:

a. Inventory turnover: It measures the number of times inventory is sold and replaced over a period. It is calculated as the cost of goods sold divided by average inventory.

b. Trade receivables turnover: This ratio measures how efficiently a company collects its receivables. It is calculated as net credit sales divided by average trade receivables.

c. Trade payables turnover: This ratio measures how quickly a company pays off its suppliers. It is calculated as net credit purchases divided by average trade payables.

d. Working capital turnover: This ratio measures how efficiently a company uses its working capital to support sales. It is calculated as net sales divided by average working capital.

The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they become due. What are the ratios used for this purpose?

The ratios used to measure a business firm's liquidity include:

  • Current Ratio: Current assets divided by current liabilities.
  • Quick Ratio (Acid-Test Ratio): Quick assets (current assets minus inventories and prepaid expenses) divided by current liabilities.

The average age of inventory is viewed as the average length of time inventory is held by the firm for which explain with reasons.

The average age of inventory is the average number of days that inventory is held by a firm before it is sold. It is an important measure because it indicates how efficiently a firm is managing its inventory. A shorter average age means faster inventory turnover and more efficient inventory management, reducing holding costs and the risk of obsolescence. It is calculated by dividing 365 days by the inventory turnover ratio.

Liquidity Ratios: Definition and Importance

Current Ratio

Definition: Measures a company's ability to cover its short-term liabilities with its short-term assets.

Formula:
Current Ratio = Current Assets / Current Liabilities

Importance: Provides a snapshot of the company's overall liquidity position.

Liquid (Quick) Ratio

Definition: Similar to the current ratio but excludes inventory from current assets.

Formula:
Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Importance: A more stringent measure, indicating a company's ability to pay short-term obligations with its most liquid assets.

Example Calculations

Calculating Current Ratio

Example 1: From the balance sheet of Raj Oil Mills Limited as at March 31, 2017:

Current Ratio = 2:1

Calculating Current and Liquid Ratios

Example 2: From the balance sheet of Title Machine Ltd. as at March 31, 2017:

Current Ratio = 0.8:1
Liquid Ratio = 0.4:1

Working Capital Example

Example 3: Given the working capital and current ratio:

Current Assets = Rs. 1,26,000