Influence of Business/Accounting Transactions on Funds (Working Capital)

Funds Flow Cash Flow • Funds Flow Analysis • Study Notes •     ... 567 ...

All Business/Accounting Transactions influence the Balance Sheet

Every accounting transaction has it effect on the balance sheet. To understand this we need to look at the process of final accounting during which we prepare the balance sheet.

Route to the Balance Sheet

All nominal accounts are closed - to ascertain profits

To ascertain the profits/losses made by the organisation during the accounting period, all the nominal accounts are closed (at the end of the accounting period) by transfer to either the manufacturing account , trading account or profit and loss account as the case may be.

The balance in the Profit and Loss account which we call Net Profit represents the residue of the nominal account balances.

Profits are capitalised

The P and L a/c balance is either added to the Capital (profits increase capital) or to the profit and loss appropriation account which is shown as a distinct account in the balance sheet, by transferring it to the respective account.

P/L appropriation a/c represents owners capital accumulated through profits. Thus it can be treated a personal account.

We use the term special nominal accounts for such accounts, which seem to be nominal accounts by their name, but are not and whose balances are carried forward to the subsequent accounting periods.

Balance Sheet is prepared

Balance sheet is a position statement, showing the ledger balances in real, personal and special nominal accounts as at a particular point of time (the last day of the accounting period).

It is an abstract of the ledger account balances after finalising and capitalising profits

All accounting transactions affect the Balance Sheet

Every accounting transaction would affect two ledger accounts. The affected ledger accounts may be personal, real or nominal.

Since the personal or real account balances are shown in the balance sheet, we can say that those transactions which affect the personal or real accounts, affect the balance sheet.

The residue of the nominal account balances i.e. the net profit/loss is capitalised by transfer to capital account or to the profit and loss appropriation account thereby getting into the balance sheet.

Thus accounting transactions which affect nominal accounts can also be assumed to be affecting the balance sheet,

Cross Transactions influence the Fund (Working Capital)

Balance Sheet is made up of Current Assets, Current Liabilities, Non-Current Assets and Non-Current Liabilities.
+ All accounting transactions affect the balance sheet.
⇒ All accounting transactions affect one or more of Current Assets, Current Liabilities, Non-Current Assets and Non-Current Liabilities.

All accounting transactions may influence funds

From
Working Capital = Current Assets - Current Liabilities;
(Or) = Non-Current Liabilities - Non-Current Assets

we can say that any transaction that brings about a change in one or more of Current Assets, Current Liabilities, Non-Current Assets or Non-Current Liabilities may result in a change in Fund or Working Capital.

+ All accounting transactions affect one or more of Current Assets, Current Liabilities, Non-Current Assets and Non-Current Liabilities.
⇒ All accounting transactions may influence the fund or working capital.

We use may because there are some accounting transactions which do not bring about a change in fund or working capital.

Accounting transactions not influencing funds

We see no change in working capital, where, on account of a transaction, there is a

change by the same amount in the same direction in

a current asset and a current liability
(Or) a non current asset and a non current liability

change by the same amount in opposite directions in

two current assets
(Or) two current liabilities
(Or) two non-current assets
(Or) two non-current liabilities

Cross Transactions : Accounting transactions influencing funds

We see a change in working capital, where, on account of a transaction, there is a

change by the same amount in the same direction in

a current asset and a non-current liability
(Or) a current liability and a non current asset

change by the same amount in opposite directions in

a current asset and a non-current asset
(Or) a current liability and a non-current liability

Cross Transactions

Cross transactions are accounting transactions involving one account which falls in the current area and another account which falls in the non-current area of the balance sheet and which change in the same direction when one of them is an asset and the other is a liability or in opposing directions when both are either assets or liabilities.

Cross transactions is an idea used in the topic funds flow analysis. Such transactions influence i.e. bring about a change in fund or working capital.

Transactions not influencing Fund (Working Capital) - illustrations

Consider, the following consolidated balance sheet
Balance Sheet of M/s __ as on 30th June __
LiabilitiesAmountAssetsAmount
Non-Current Liabilities
Current Liabilities 		89,00,000
15,00,000 		Non-Current Assets
Current Assets 		80,00,000
24,00,000
 1,04,00,0001,04,00,000

From the above balance sheet,

Working Capital = Current Assets - Current Liabilities
= 24,00,000 - 15,00,000
= 9,00,000
(Or) = Non-Current Liabilities - Non-Current Assets
= 89,00,000 - 80,00,000
= 9,00,000

An accounting transaction will not influence the fund or working capital when it brings about a change in

• A Current Asset and a Current Liability in the same direction

Payment made to Creditors 50,000
Dr. Creditor a/c
Cr. Cash/Bank a/c 		Current Liability
Current Asset 		Decrease
Decrease

After taking into account the affect of the above transaction,

Current Assets (Changed) = Current Assets (old) - Decrease
= 24,00,000 - 50,000
= 23,50,000

Current Liabilities (Changed) = Current Liabilities (old) - Decrease
= 15,00,000 - 50,000
= 14,50,000

Working Capital (Changed) = Current Assets (Changed) - Current Liabilities (Changed)
= 23,50,000 - 14,50,000
= 9,00,000

There is no change in working capital.

• A Non-Current Asset and a Non-Current Liability in the same direction

Issue of Shares/Debentures valued 4,00,000 in exchange for buying an asset
Dr. Fixed Asset a/c
Cr. Debentures a/c 		Non-Current Asset
Non-Current Liability 		Increase
Increase

After taking into account the affect of the above transaction,

Non-Current Assets (Changed) = Non-Current Assets + Increase
= 80,00,000 + 4,00,000
= 84,00,000

Non-Current Liabilities (Changed) = Non-Current Liabilities (old) + Increase
= 89,00,000 + 4,00,000
= 93,00,000

Working Capital (Changed) = Non-Current Liabilities (Changed)
- Non-Current Assets (Changed)
= 93,00,000 - 84,00,000
= 9,00,000

There is no change in working capital.

• Two Current Assets in opposing directions

Payment received from Debtors 1,00,000.
Dr. Cash/Bank a/c
Cr. Debtors a/c 		Current Asset
Current Asset 		Increase
Decrease

After taking into account the affect of the above transaction,

Current Assets (Changed) = Current Assets + Increase - Decrease
= 24,00,000 + 1,00,000 - 1,00,000
= 24,00,000

Working Capital (Changed) = Current Assets (Changed) - Current Liabilities
= 24,00,000 - 15,00,000
= 9,00,000

There is no change in working capital.

• Two Current Liabilities in opposing directions

Bills drawn by Creditors Accepted 48,000
Dr. Creditors a/c
Cr. Bills Payable a/c 		Current Liability
Current Liability 		Decrease
Increase

After taking into account the affect of the above transaction,

Current Liabilities (Changed) = Current Liabilities + Increase - Decrease
= 15,00,000 + 48,000 - 48,000
= 15,00,000

Working Capital (Changed) = Current Assets - Current Liabilities (Changed)
= 24,00,000 - 15,00,000
= 9,00,000

There is no change in working capital.

• Two Non-Current Liabilities in opposing directions

Issuing Debentures worth 3,50,000 towards the Preference Shareholders dues
Dr. Preference Shares a/c
Cr. Debentures a/c 		Non-Current Liability
Non-Current Liability 		Decrease
Increase

After taking into account the affect of the above transaction,

Non-Current Liabilities (Changed) = Non-Current Liabilities + Increase - Decrease
= 89,00,000 + 3,50,000 - 3,50,000
= 89,00,000

Working Capital (Changed) = Non-Current Liabilities (Changed) - Non-Current Assets
= 89,00,000 - 80,00,000
= 9,00,000

There is no change in working capital.

• Two Non-Current Assets in opposing directions

Purchasing an Asset worth 2,40,000 in Exchange for an Old Asset
Dr. New Asset a/c
Cr. Old Asset a/c 		Non-Current Asset
Non-Current Asset 		Increase
Decrease

After taking into account the affect of the above transaction,

Non-Current Asset (Changed) = Non-Current Assets + Increase - Decrease
= 80,00,000 + 2,40,000 - 2,40,000
= 80,00,000

Working Capital (Changed) = Non-Current Liabilities - Non-Current Assets (Changed)
= 89,00,000 - 80,00,000
= 9,00,000

There is no change in working capital.

Non Cross Transations

Where both the ledger accounts affected by an accounting transaction belong to the same area of the balance sheet i.e. either current or non-current, then the transaction would be a non cross transaction.

Non Cross transaction is an identification relevant to the topic funds flow analysis. Such transactions would not result in a change in fund or working capital.

Cross Transaction - Transactions influencing Fund (Working Capital) - illustrations

Consider, the following consolidated balance sheet
Balance Sheet of M/s __ as on 30th June __
LiabilitiesAmountAssetsAmount
Non-Current Liabilities
Current Liabilities 		89,00,000
15,00,000 		Non-Current Assets
Current Assets 		80,00,000
24,00,000
 1,04,00,0001,04,00,000

From the above balance sheet,

Working Capital = Current Assets - Current Liabilities
= 24,00,000 - 15,00,000
= 9,00,000
(Or) = Non-Current Liabilities - Non-Current Assets
= 89,00,000 - 80,00,000
= 9,00,000

An accounting transaction will influence the fund or working capital when it brings about a change in

• A Current Asset and a Non-Current Asset in opposing directions

  • Purchase of an Asset valued 4,00,000 for cash
    Dr. Fixed Asset a/c
    Cr. Cash a/c     		Non-Current Asset
    Current Asset     		Increase
    Decrease

    After taking into account the affect of the above transaction,

    Current Assets (Changed) = Current Assets (old) - Decrease
    = 24,00,000 - 50,000
    = 23,50,000

    Non-Current Asset (Changed) = Non-Current Asset (old) + Increase
    = 80,00,000 + 4,00,000
    = 84,00,000

    Working Capital (Changed) = Current Assets (Changed) - Current Liabilities
    = 20,00,000 - 15,00,000
    = 5,00,000
    (Or) = Non-Current Liabilities - Non-Current Assets (Changed)
    = 89,00,000 - 84,00,000
    = 5,00,000

    Working capital has changed from 9,00,000 to 5,00,000.

  • Sold Land 5,60,000 and received consideration through a cheque
    Dr. Bank a/c
    Cr. Land a/c     		Current Asset
    Non-Current Asset     		Increase
    Decrease

    After taking into account the affect of the above transaction,

    Current Assets (Changed) = Current Assets (old) + Increase
    = 24,00,000 + 5,60,000
    = 29,60,000

    Non-Current Asset (Changed) = Non-Current Asset (old) - Decrease
    = 80,00,000 - 5,60,000
    = 74,40,000

    Working Capital (Changed) = Current Assets (Changed) - Current Liabilities
    = 29,60,000 - 15,00,000
    = 14,60,000
    (Or) = Non-Current Liabilities - Non-Current Assets (Changed)
    = 89,00,000 - 74,40,000
    = 14,60,000

    Working capital has changed from 9,00,000 to 14,60,000.

• A Current Asset and a Non-Current Liability in the same direction

  • Issued a cheque for 2,35,000 to clear a Long term loan
    Dr. Long Term Loan a/c
    Cr. Bank a/c     		Non-Current Liability
    Current Asset     		Decrease
    Decrease

    After taking into account the affect of the above transaction,

    Current Assets (Changed) = Current Assets (old) - Decrease
    = 24,00,000 - 2,35,000
    = 21,65,000

    Non-Current Liability (Changed) = Non-Current Liability (old) - Decrease
    = 89,00,000 - 2,35,000
    = 86,65,000

    Working Capital (Changed) = Current Assets (Changed) - Current Liabilities
    = 21,65,000 - 15,00,000
    = 6,65,000
    (Or) = Non-Current Liabilities (Changed) - Non-Current Assets
    = 86,65,000 - 80,00,000
    = 6,65,000

    Working capital has changed from 9,00,000 to 6,65,000.

  • Partner introduced capital by endorsing bills receivable worth 85,000
    Dr. Bills Receivable a/c
    Cr. Partners Capital a/c     		Current Asset
    Non-Current Liability     		Increase
    Increase

    After taking into account the affect of the above transaction,

    Current Assets (Changed) = Current Assets (old) + Increase
    = 24,00,000 + 85,000
    = 24,85,000

    Non-Current Liability (Changed) = Non-Current Liability (old) + Increase
    = 89,00,000 + 85,000
    = 89,85,000

    Working Capital (Changed) = Current Assets (Changed) - Current Liabilities
    = 24,85,000 - 15,00,000
    = 9,85,000
    (Or) = Non-Current Liabilities (Changed) - Non-Current Assets
    = 89,85,000 - 80,00,000
    = 9,85,000

    Working capital has changed from 9,00,000 to 9,85,000.

• A Current Liability and a Non-Current Asset in the same direction

  • Purchased an Asset and accepted a Bills Payable for the amount due 5,00,000
    Dr. Fixed Asset a/c
    Cr. Bills Payable a/c     		Non-Current Asset
    Current Liability     		Increase
    Increase

    After taking into account the affect of the above transaction,

    Non-Current Assets (Changed) = Non-Current Assets (old) + Increase
    = 80,00,000 + 5,00,000
    = 85,00,000

    Current Liability (Changed) = Current Liability (old) + Increase
    = 15,00,000 + 5,00,000
    = 20,00,000

    Working Capital (Changed) = Current Assets - Current Liabilities (Changed)
    = 24,00,000 - 20,00,000
    = 4,00,000
    (Or) = Non-Current Liabilities - Non-Current Assets (Changed)
    = 89,00,000 - 85,00,000
    = 4,00,000

    Working capital has changed from 9,00,000 to 4,00,000.

  • Settled creditors account 2,90,000 by giving away long term investments
    Dr. Creditors a/c
    Cr. Investments a/c     		Current Liability
    Non-Current Asset     		Decrease
    Decrease

    After taking into account the affect of the above transaction,

    Current Liability (Changed) = Current Liabilities (old) - Decrease
    = 15,00,000 - 2,90,000
    = 12,10,000

    Non-Current Asset(Changed) = Non-Current Assets (old) - Decrease
    = 80,00,000 - 2,90,000
    = 77,10,000

    Working Capital (Changed) = Current Assets - Current Liabilities (Changed)
    = 24,00,000 - 12,10,000
    = 11,90,000
    (Or) = Non-Current Liabilities - Non-Current Assets (Changed)
    = 89,00,000 - 77,10,000
    = 11,90,000

    Working capital has changed from 9,00,000 to 11,90,000.

• A Current Liability and a Non-Current Liability in the opposite directions

  • Issued Debentures to creditors worth 4,00,000
    Dr. Creditors a/c
    Cr. Debentures a/c     		Current Liability
    Non-Current Liability     		Decrease
    Increase

    After taking into account the affect of the above transaction,

    Non-Current Liabilities (Changed) = Non-Current Liabilities (old) + Increase
    = 89,00,000 + 4,00,000
    = 93,00,000

    Current Liability (Changed) = Current Liability (old) - Decrease
    = 15,00,000 - 4,00,000
    = 11,00,000

    Working Capital (Changed) = Current Assets - Current Liabilities (Changed)
    = 24,00,000 - 11,00,000
    = 13,00,000
    (Or) = Non-Current Liabilities (Changed) - Non-Current Assets
    = 93,00,000 - 80,00,000
    = 13,00,000

    Working capital has changed from 9,00,000 to 13,00,000.

  • Bills payable accepted for the amount due to a partner on his capital account 1,20,000
    Dr. Partners Capital a/c
    Cr. Bills Payable a/c     		Non-Current Liability
    Current Liability     		Decrease
    Increase

    After taking into account the affect of the above transaction,

    Current Liabilities (Changed) = Current Liabilities (old) + Increase
    = 15,00,000 + 1,20,000
    = 16,20,000

    Non-Current Liabilities(Changed) = Non-Current Liabilities (old) - Decrease
    = 89,00,000 - 1,20,000
    = 87,80,000

    Working Capital (Changed) = Current Assets - Current Liabilities (Changed)
    = 24,00,000 - 16,20,000
    = 7,80,000
    (Or) = Non-Current Liabilities - Non-Current Assets (Changed)
    = 87,80,000 - 80,00,000
    = 7,80,000

    Working capital has changed from 9,00,000 to 7,80,000.

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