2025-2026

When Debt to Equity Ratio is 2, state giving reason, whether this ratio will increase or decrease or will have no change in each of the following cases:
(i) Sale of Land (Book value ₹4,00,000) for ₹5,00,000; (ii) Issue of Equity Shares for the purchase of Plant and Machinery worth ₹10,00,000; (iii) Issue of Preference Shares for redemption of 13% Debentures, worth ₹10,00,000.

Answer:

Debt-Equity Ratio = 2:1

Let Long-term loan = ₹20,00,000

Shareholders’ Funds = ₹10,00,000

(i) Sale of Land (Book Value ₹4,00,000) for ₹5,00,000-Decrease

Reason: This transaction will result increase in Shareholders’ Funds by ₹1,00,000 as profit on sale of Land.

Shareholders’ Funds after adjusting profit on sale of land = 10,00,000 + 1,00,000 = ₹11,00,000

Debt equity ratio= 20,00,000/11,00,000=1.81:1

(ii) Issue of Equity share for the purchase of plant and Machinery worth ₹10,00,000-Decrease

Reason: This transaction will increase the amount of Shareholders Fund by ₹10,00,000 in the form of equity shares and have no effect on Long-term Loans.

Debt equity ratio= Long-term Debt /equity=20,00,000/20,00,000=1:1

(iii)Issue of preference Shares for redemption of 13% Debentures worth ₹10,00,000-Decrease

Reason: This transaction will lead to decrease in Long-term Loan by ₹10,00,000 in the form of redemption of debentures and increase in Shareholders’ Funds with the same amount in the form of Preference Shares.

Debt equity ratio= Long-term Debt /equity=20,00,000-10,00,000/10,00,000+10,00,000=5:1

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

Answer:

Debt Equity Ratio = 0.5:1

Let Long- term Loan be = ₹5,00,000

Shareholders’ Funds = ₹10,00,000

Debt equity ratio= Debt /equity=5,00,000/10,00,000=0.5:1

(i) Issue of Equity shares- Decrease

Reason: Issue of equity shares results in increase in Shareholders’ Funds in the form of equity shares but there will be no change in Long-term Loan.

Example: Issue of equity share ₹5,00,000

Shareholders’ Funds after issue of equity shares = 10,00,000 + 15,00,000

= ₹15,00,000

Debt equity ratio= Debt /equity=5,00,000/15,00,000=0.33:1

(ii) Cash received from Debtors- No Change

Reason: Cash received from debtors will increase one current asset in the form of cash and decrease other asset in the form of debtors. This transaction will have no effect on Long-term Loan and Shareholders’ Funds.

(iii) Redemption of Debentures- Decrease

Reason: This transaction will result decrease in Long-term Loans in the form of reduction in debtors and no change in Shareholders’ Funds.

Example: Redemption of Debentures ₹2,00,000

Long-term Loan = 5,00,000 − 2,00,000 = 3,00,000

Debt equity ratio after redemption of debenture = Debt /equity=3,00,000/10,00,000=0.3:1

(iv) Purchased of goods on Credit- No Change

Reason: Neither Long-term loan nor share holders’ funds will be affected by this transaction because purchase of goods results no change in Long-term Loan and Shareholders’ Funds.

Balance Sheet had the following amounts as at 31st March, 2021:

Calculate ratios indicating the Long-term and the Short-term financial position of the company.

Answer:

(i) Debt-Equity Ratio is an indicator of Long-term financial health. It shows the proportion of Long-term loan in comparison of shareholders’ Funds.

Debt-Equity Ratio = Long Term Debts/Equity

Debt = Loan from IDBI @ 9% = 30,00,000

Equity = 10% Preference Share Capital + Equity Share Capital + Reserves & Surplus

= 5,00,000 + 15,00,000 + 4,00,000 = 24,00,000

Debt-Equity Ratio = 30,00,000/24,00,000 = 1.25:1

(ii) Current Ratio is an indicator of short-term financial portion. It shows the proportion of Current Assets in comparison of Current Liabilities.
Current Ratio = Current Assets/Current Liabilities

Current Assets = 12,00,000

Current Liabilities = 8,00,000

Current Ratio = 12,00,000/8,00,000 = 1.5:1

Note: In the above question, Securities Premium Reserve is not considered while computing Equity because it is already included in the amount of Reserves and Surplus.

Assuming That the Debt to Equity Ratio is 2 : 1, state giving reasons, which of the following transactions would (i) increase; (ii) Decrease; (iii) Not alter Debt to Equity Ratio:
(i) Issue of new shares for cash.
(ii) Conversion of debentures into equity shares
(iii) Sale of a fixed asset at profit.
(iv) Purchase of a fixed asset on long-term deferred payment basis.
(v) Payment to creditors.

Answer:

Let’s take Debt and Equity as ₹2,00,000 and ₹1,00,000

Debt to Equity Ratio=Debt/Equity

=2,00,000/1,00,000=2:1

(i) Issue of new shares for cash (say ₹50,000)

Debt to Equity Ratio =2,00,000/1,00,000+50,000=1.33:1(Decrease)

(ii) Conversion of debentures into equity shares (say ₹50,000)
 
Debt to Equity Ratio =2,00,000/1,00,000+50,000=1.33:1(Decrease)

(iii) Sale of a fixed asset at profit (say ₹50,000 profit)

Debt to Equity Ratio =2,00,000/1,00,000+50,000=1.33:1(Decrease)

(iv) Purchase of fixed asset on long term payment basis (say ₹50,000)

Debt to Equity Ratio =2,00,000+50,000/1,00,000=2.5:1(Increase)

(v) Payment to creditors (say ₹50,000)

 Debt to Equity Ratio =2,00,000/1,00,000=2:1(No Change)

From the following Balance Sheet of ABC Ltd. as at 31st March, 2022, Calculate Debt to Equity Ratio:

Answer:

Long-term Debt = Debentures = 2,50,000

Equity = Equity Share Capital + 10% Preference Share Capital + Reserves and Surplus

= 5,00,000 + 5,00,000 + 2,40,000 = 12,40,000

Debt equity ratio= Long-term Debt /equity=2,50,000/12,40,000=0.2:1