Question

Operating Profit Ratio of Star Ltd. is 20%. State, giving reason, which of the following transactions will (i) increase, (ii) decrease, or (ii) not alter the Operating Profit Ratio:

1. Purchase of Stock-in-Trade ₹ 1,00,000.
2. Purchase returns ₹ 20,000.
3. Revenue from Operations on sale of Stock-in-Trade ₹ 1,25,000.
4. Stock-in-Trade costing ₹ 25,000 withdrawn for personal use.

Assuming that operating cost is variable, i.e., varies with Revenue from Operations.

Answer 1

\[\text{Operating Profit Ratio} = \left( \frac{\text{Operating Profit}}{\text{Revenue from Operations}} \right) \times 100\]

(a) Purchase of Stock-in-Trade ₹ 1,00,000

Effect: No change

Reason: Purchasing goods increases both the total Purchases and the Closing Inventory by the exact same amount. Because these two movements cancel each other out in the calculation of Cost of Revenue from Operations (COGS), the COGS and the Revenue from Operations remain unchanged. Therefore, the ratio is unaffected.

(b) Purchase returns ₹ 20,000

Effect: No change

Reason: Purchase returns decrease both the total Purchases and the Closing Inventory by the exact same amount. This leaves the net Cost of Revenue from Operations (COGS) and the Revenue from Operations completely unchanged, having no effect on the ratio.

(c) Revenue from Operations on sale of Stock-in-Trade ₹ 1,25,000

Effect: No change

Reason: The question explicitly states that the operating cost is variable, meaning it varies proportionately with Revenue from Operations. When new sales are made, the operating cost increases in the exact same proportion (80%). Since both the revenue and operating profit increase proportionally, the percentage ratio remains constant.

Example: If initial Revenue = ₹10,00,000 and Operating Profit (20%) = ₹2,00,000, then Operating Cost is 80% (₹8,00,000).

For a new sale of ₹1,25,000, the variable operating cost increases by 80% of ₹1,25,000 = ₹1,00,000.

New Revenue = ₹11,25,000; New Operating Cost = ₹9,00,000; New Operating Profit = ₹2,25,000.

$\text{New Ratio} = \frac{2,25,000}{11,25,000} \times 100 = 20\%$ (No Change)

(d) Stock-in-Trade costing ₹ 25,000 withdrawn for personal use

Effect: No change

Reason: Goods withdrawn for personal use (Drawings) are deducted from Purchases and also reduce the Closing Inventory by the same amount. Since both variables decrease equally, the net Cost of Revenue from Operations (COGS) and Revenue from Operations are unchanged, resulting in no change to the final ratio.