Q.There are two statements : Statement I : The balance in the Statement of Profit and Loss in the Balance Sheet of Samta Ltd. showed a deficit of ₹ 2,00,000 on 31.03.2023 and a surplus of ₹ 3,00,000 on 31.3.2024. ₹ 5,00,000 will be considered as profit earned during the year for preparing Cash Flow Statement. Statement II : On 31.03.2023 the goodwill account of Zeeta Ltd. showed a balance of ₹ 4,00,000 and on 31.03.2024 it showed a balance of ₹ 5,00,000. ₹ 1,00,000 will be considered as goodwill acquired during the year for the preparation of Cash Flow Statement. Choose the correct option from the following : (A) Both the Statements are true. (B) Both the Statements are false. (C) Statement I is true, Statement II is false. (D) Statement II is true, Statement I is false.
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Start your 14-day free trial to unlock the full solution →Both Statement I, which calculates the profit earned during the year for Cash Flow Statement purposes, and Statement II, which identifies goodwill acquired during the year, are correct based on standard accounting principles.
Let's break down each statement to understand the underlying accounting concepts and their treatment in the preparation of a Cash Flow Statement.
Concept and Treatment
Statement I: Profit and Loss Balance for Cash Flow Statement
The Statement of Profit and Loss (P&L) balance shown in the Balance Sheet represents the accumulated profits or losses of the company up to that date. When preparing a Cash Flow Statement (CFS) using the indirect method, we need to determine the profit earned during the current year to arrive at the Net Profit Before Tax and Extraordinary Items. This figure is crucial because it forms the starting point for adjusting non-cash items and non-operating items to calculate cash flow from operating activities.
If the P&L balance shifts from a deficit (an accumulated loss, which is a debit balance) to a surplus (an accumulated profit, which is a credit balance), the profit generated during the year must have been sufficient to first cover the entire opening deficit and then create the closing surplus. The sum of these two amounts represents the total profit available for appropriation during the year.
Statement II: Goodwill Account for Cash Flow Statement
Goodwill is an intangible asset. An increase in the balance of any asset account, including goodwill, generally indicates that the asset has been acquired during the accounting period. In the context of a Cash Flow Statement, the acquisition of an asset (whether tangible like machinery or intangible like goodwill) is classified as a cash outflow under Investing Activities. This is because cash is used to purchase long-term assets that are expected to generate future economic benefits for the business. Conversely, a decrease in goodwill could be due to its amortisation (a non-cash expense) or its sale (a cash inflow).
Working Notes
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Working Note 1: Calculation of Profit Earned During the Year (Statement I)
- Opening Balance of Statement of Profit and Loss (as on 31.03.2023) = Deficit of ₹ 2,00,000 (This is a debit balance).
- Closing Balance of Statement of Profit and Loss (as on 31.03.2024) = Surplus of ₹ 3,00,000 (This is a credit balance).
To calculate the profit earned during the year, we need to determine the total change from the opening deficit to the closing surplus.
- Amount of profit required to cover the opening deficit = ₹ 2,00,000
- Amount of profit required to create the closing surplus = ₹ 3,00,000
- Total Profit Earned During the Year = ₹ 2,00,000 (to cover deficit) + ₹ 3,00,000 (to create surplus) = ₹ 5,00,000. …
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