Page 249 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

notes 2. Normal Rate of Return or Profit: Normal rate of return or profit is that rate which investors
in general expect on their investments in a particular type of industry. In other words, that
rate of earning which satisfies the investors is the normal rate of return. This normal rate of
return differs from industry to industry. In examination problems, generally normal rate
of return is given. In an extreme case, the normal rate of return or earning is not mentioned
the student should assume the normal rate of return basing his judgment on merits of the
case. At the time of assuming the normal rate of return the students should keep in mind
the following points:

(a) Pure rate of return: That rate of return which one can earn by investing his funds
without incurring any risk e.g., purchasing government securities.
(b) Rate of business risk: If more risk is attached to an investment, there will be high rate
of return. Risk depends on the nature of the business.
(c) Rate of financial risk: That rate which covers risks connected with the finance of a
business concerned.

(d) Rate of return: The addition of the above three will be normal rate of return.
The normal rate of return of an industry is also affected by the bank rate, the period for
which investment is made, risk attached to the investment and the general economic and
political situations.
3. Capital Employed: For the purpose of valuation of goodwill, capital employed can be
calculated by any one of the following two methods:

(a) Assets Side Approach: If we take the total of all assets, that is called gross capital
employed. And net capital employed or capital employed means total of all assets
minus current liabilities. In this approach to calculate the net capital employed or
capital employed, all assets of the business are totalled excluding intangible assets as
goodwill, useless patents, trademarks, non-trading investments, fictitious assets as
preliminary expenses and discount on issue of shares or debentures etc. All the fixed
assets of the business should be taken at their replacement cost. Similarly, all current
liabilities should be taken at their current price. The entire procedure under assets
side approach can be understood in the following steps:

calculation of capital employed
`
All Tangible Assets (excluding Goodwill, useless
Patents and Trademarks, Non-trading Investments
Preliminary Expenses and Discount on Issue of Shares and Debentures)
at replacement cost. xxxx
Less: All external liabilities at current cost
Preference shares capital (if these are non-participating) xxx xxxx
Preference shares capital (if these are non-participating) xxx xxxx
(b) Liability Side Approach: Capital employed can also be calculated from the items of the
liability side of the balance sheet by adding to Share Capital (paid up), all Profits,
various Reserves, Profit on Revaluation of Fixed Assets and Liabilities and deducting
there from Loss on Revaluation of Fixed Assets, Debit Balance of Profit and Loss
Account shown in the Balance Sheet, Fictitious Assets and Non-Trading Assets.
Thus, the procedure can be summarised:

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