T.S. Grewal Class 12 Vol 3 Chapter 4 Q.63 - Accounting Ratios

Question 63

State, with reason, whether the Proprietary Ratio will improve, decline, or not change because of the following transactions, if the Proprietary Ratio is 0.8:1:
(i) Obtained a loan of ₹5,00,000 from State Bank of India, payable after five years.
(ii) Purchased machinery of ₹2,00,000 by cheque.
(iii) Redeemed 7% Redeemable Preference Shares ₹3,00,000.
(iv) Issued equity shares to the vendor of building purchased for ₹7,00,000.
(v) Redeemed 10% Redeemable Debentures of ₹6,00,000.

Solution

Transaction	Impact
Obtained a loan of ₹5,00,000 from State Bank of India, payable after five years	Decline — Total Assets increase by ₹5,00,000 (cash coming in), while Shareholders’ Funds remain unchanged (it is a liability, not equity).
Purchased machinery of ₹2,00,000 by cheque	No Change — Cash decreases and Machinery increases by the same ₹2,00,000, so Total Assets and Shareholders’ Funds are both unaffected in total.
Redeemed 7% Redeemable Preference Shares ₹3,00,000	Decline — both Shareholders’ Funds and Total Assets decrease by ₹3,00,000 simultaneously; since the ratio starts below 1 (Shareholders’ Funds < Total Assets), an equal decrease to both moves the ratio further from 1, i.e. it declines.
Issued equity shares to the vendor of building purchased for ₹7,00,000	Improve — a non-cash transaction where both Shareholders’ Funds and Total Assets increase by ₹7,00,000 simultaneously; since the ratio starts below 1, an equal increase to both moves it closer to 1, i.e. it improves.
Redeemed 10% Redeemable Debentures of ₹6,00,000	Improve — Total Assets decrease by ₹6,00,000 (cash going out) while Shareholders’ Funds (Debentures are not equity) remain unchanged, so dividing by a smaller Total Assets increases the ratio.