Uses or Applications of Funds (With Calculations) (2024)

Read this article to learn about the important uses or application of funds and some practical hints.

Uses or Applications of Funds:

(a) Purchase of Fixed Assets/Investments:

When fixed assets (i.e. Plant and Machinery, Land and Building, Furniture and Fixture, etc.) or investments are purchased there is an outflow of funds, i.e., an application of funds. But if the fixed assets/investments are exchanged, there must not be any outflow of funds.

(b) Payment of Dividend and Taxes:

When dividend and taxes are paid, there is an outflow of funds, i.e. an application of funds (for the actual amount so paid). But if the dividends are proposed or if there is a provision for tax, there will not be any outflow of funds. Outflow of funds will arise only when actual payment is made.

(c) Redemption of Preference Shares:

When Preference Shares are redeemed, the same is treated as an outflow of fund since actual payment is made. But if Preference Shares are redeemed at a premium or at a discount, net amount must be recorded as an application of funds (i.e., in case of premium, face value plus premium, and, in case of discount, face value minus discount).

(d) Redemption of Debenture or Repayment of Loans:

When debentures are redeemed or loans are repaid the same should also be treated as an outflow of funds. Only the net amount should be considered (i.e. if redeemed or repaid at a premium or interest, the same should be taken as face value + Premium, or face/value plus interest) and, if redeemed at a discount, the face value minus discount should be the net amount.

(e) Other Non-trading Payments:

If there is any non-trading payment, the same should be treated as an outflow of funds.

(f) Funds Lost in Operation (i.e. Net Loss):

If there is any trading loss, the same is treated as an outflow of funds.

(g) Increase in Working Capital:

Increase in Working Capital is an outflow of funds since more current assets are generated or current liabilities are paid.

Illustration 1:

Indicate whether each of the following transactions would be a source or application of funds:

(a) Purchase of goods on account,

(b) Purchase of a plant on account,

(c) Sale of goods on account,

(d) Received cash from customers,

(e) Sale of goods for cash,

(f) Purchased a machine in exchange for long- term notes payable,

(g) Payment of expenses,

(h) Payment of accounts payable,

(i) Declaration of dividend payable in Cash,

(j) Sale of old furniture for Cash,

(k) Redemption of Debentures by converting them in Equity Shares.

(l) Depreciation to be provided for.

(m) Deposits of Cash into a Current Account,

(n) Fresh issue of Equity Shares,

(o) Goods Returned to the suppliers,

(p) Repayment of long-term loans.

Solution:

Sources: (j); (n).

Application: (b); (g); (p).

No effect: (a); (c); (d); (e); (f); (h); (i); (k); (l); (m); (o).

Some Practical Hints:

The following matters (adjustments) require special attention while preparing a Funds Flow Statement:

(1) Provision for Taxation:

Provision for taxation may be treated in the following two ways:

(a) Treated as an appropriation profit:

Under this treatment, the amount of tax, which should be provided out of profit, is to be debited to Profit and Loss Account, whereas the actual amount of tax which is to be paid is to be shown as an application in the ‘Statement of Sources and Applications of Funds’.

(b) Treated as a charge against profit:

Under the circ*mstances, provision for taxation is to be treated simply as a current liability, and, therefore, no adjustment is necessary either in Profit and Loss Account or in the ‘Statement of Sources and Applications of Funds’ as an application.

To sum up, the same should be treated in the following manner:

(1) When the amount of Provision for Taxation is given only in the liabilities side of the Balance Sheet:

For example:

It may be treated in the two following ways:

(a) Either:

It can be treated as Current Liabilities and, as such, they will be deducted from the total current assets while computing ‘Changes in Working Capital’.

(b) Or:

The amount for the year 2005 (i.e. 1st year) is to be shown as an ‘Application of Funds’ and the amount for the year 2006 (i.e. 2nd year) is to be recorded in the debit side of the Profit and Loss Account.

(c) When the amount of Provision for Taxation is given both in the liabilities side of the Balance Sheet and also in the adjustment by way of additional information.

For example:

Additional Information:

Tax paid during the year Rs. 10,000.

It may be treated as:

i.e. Rs. 10,000 will be shown as an ‘Application of Fund’ and Rs. 14,000 will be recorded in the debit side of Profit and Loss Account.

If provision of tax is given in the problem, in that case, the amount to be paid will be the balancing figure.

Same principle is to be applied for ‘Proposed Dividend’.

(2) Interim Dividend:

In case of Interim Dividend, however, the same should always be adjusted against Profit and Loss A/c (Adjusted).

The entry is:

In other words, Interim Dividend should appear in the debit side of P & L (Adjusted) A/c and the same will be shown as ‘Application of Funds’ since it is an item of appropriation of profit.

(3) Write-offs:

The following items should be written-off against Profit and Loss Account (Adjusted):

Goodwill, Preliminary Expenses, Discount on Issues of Shares and Debentures, Advertisem*nt Expenses A/c, etc.

(4) Provision for Depreciation:

It may be treated in the following two ways:

(i) Either it may be considered as a source of fund;

(ii) Or, it may be adjusted against Profit and Loss (Adjusted) A/c in order to find out the adjusted trading profit (the latter method is followed in this volume).

Consider the following cases one by one:

Case I:

Additional Information:

(1) A fixed asset costing Rs. 1, 00,000 (written-down value Rs. 60,000) was sold for Rs. 20,000, the loss being transferred to Profit & Loss A/c.

In this case, the Provision for Depreciation on Fixed Asset A/c and the Fixed Asset A/c will take the following form:

It is quite interesting to note that if the Provision for Depreciation account is not given in the liabilities side of the Balance Sheet or not deducted from the fixed asset from the assets side of the Balance Sheet, i.e., if it is given in the adjustment, the treatment will be changed. Because, fixed assets are given at written-down value.

Consider the following case:

Case II:

In this case, Provision for Depreciation on Land and Building Account and the Land and Building Account will be represented as:

Since, the W.D.V. of Land and Building Account is given, in order to find out the book value, accumulated depreciation of the opening and closing balances are to be added with the respective opening and closing balances of the Land and Building Account. And the actual amount of depreciation for the year is adjusted against Provision for Depreciation on Land and Building Account.

(5) Purchase and Sale of Fixed Assets and Profit or Loss on Sale thereon:

When any Fixed Asset (i.e. Plant and Machinery, Land and Building, Furniture and Fittings, etc.) is acquired or purchased, the same is treated as an ‘Application of Funds’. Similarly, when the same is sold, it is an item of ‘Sources of Fund’. But usually the asset is sold either at a profit or at a loss (i.e. profit, when selling price is more than the W.D.V. of the asset, and loss in the opposite case). The profit or loss on sale so made is to be adjusted against Profit and Loss (Adjusted) Account for ascertaining Trading Profit.

The amount of depreciation for this purpose should also be taken into consideration. When there is no provision for depreciation, the amount of depreciation will be adjusted in the usual manner, i.e. Profit and Loss Account will be debited and the corresponding Asset Account should be credited.

Consider the following cases:

Case I:

Where there is no Provision for Depreciation:

Additional Information:

(1) A Plant and Machinery costing Rs. 20,000 (W.D.V. Rs. 12,000) was sold for Rs. 5,000.

In this case, the Plant and Machinery Account will be represented as:

Both the amounts, i.e. loss on sale of Plant and Machinery and Depreciation on Plant and Machinery, will be shown in the debit side of Profit and Loss (Adjusted) Account.

Case II:

Where “Provision for Depreciation on Asset Account” is maintained, the same will be shown as:

Additional information:

(1) A plant costing Rs. 20,000 (W.D.V. Rs. 12,000) was sold for Rs. 10,000.

In this case, the Plant and Machinery Account, Provision for Depreciation on Plant and Machinery Account, and also the Plant and Machinery Disposal A/c will be shown as:

Thus, sale of Plant and Machinery is to be shown as a ‘Source of Fund’ and loss on sale of Plant and Machinery will be adjusted against Profit and Loss (Adjusted) Account and the depreciation on the plant sold is to be adjusted against Provision for Depreciation on Plant and Machinery Account.

(6) Provision against Current Assets:

Sometimes provisions are to be made against the anticipated losses on current assets, e.g. Provision for Bad and Doubtful Debts, Provision for Loss on Stock or Allowance for Inventory Loss, etc.

They can be treated in three ways:

(i) Either, the amount of such provision (say, provision for bad debt) may directly be deducted from the asset concerned (here, from Sundry Debtors) while calculating the schedule of changes in working capital, i.e. net amount is to be shown in the statement.

(ii) Or, the current assets should be shown at its gross amount and the amount of such provision may be added with the current liabilities and, thereafter, the same will be deducted from the total current assets while computing the schedule of changes in working capital.

Whatever method we follow the amount of increase or decrease in working capital will be the same.

(iii) Provision may also be treated as an internal reserve or surplus. Thus, the amount of such provision will not appear in the schedule of changes in working capital, while ascertaining the increase or decrease in working capital.

The current asset may be shown at its gross value. A separate Provision for Bad Debts Account will be opened and the balancing figure will either be transferred to the debit side of Profit and Loss (Adjusted) Account or added-back to Net Profit for the current year after debiting the provision in order to determine the funds from operation.