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Funds from Operation: Problems and Solutions (P&L Adjustment Account)

Arjun EP

Published on: March 31, 2021

Funds from Operation

Fund from operation is the second step of fund flow statement.

It is found out from statement of fund from operation (profit and loss adjustment account).

It is prepared after preparing schedule change in working capital.

Net profit or loss of profit and loss account does not indicate actual funds earned or suffered during an accounting period.

Generally, non-operating and non-cash expenses are added to net profit.

Non-operating and non-cash incomes are deducted from net profit.

Positive value is fund from operation; negative value is loss from operation.

There are two methods to find out FFO; they are as follows:

(a) Add back method

(b) Profit and loss adjustment account

(A) Add Back Method

This method is started with net profit or net loss as it is shown by the income statement.

Non-operating and non-cash expenses are added to net profit.

But non-operating incomes are deducted from net profit.

The balancing figure of amount such obtained may be either funds from operation or loss from operation.

Statement of Funds from Operation

Particulars		Amount	Amount
Net profit			xxxx
Add:	Non-operating and non-cash expenses:
	Depreciation on fixed assets	xxxx
	Loss on sales of fixed assets	xxxx
	Loss on sale of investment	xxxx
	Amortization of goodwill	xxxx
	Amortization of patent, copy right and trade mark	xxxx
	Discount on share written off	xxxx
	Preliminary expenses written off	xxxx
	Transfer to general reserve	xxxx
	Interim dividend	xxxx
	Premium on redemption of debenture	xxxx	xxxx
Less:	Non-operating incomes:
	Profit on sale of fixed assets	(xxx)
	Transfer fee	(xxx)
	Interest, rent, commission and dividend received	(xxx)
	Refund of tax	(xxx)	(xxx)
Funds from operation			xxxx

(B) Profit And Loss Adjustment Account Method

This method is also started with net profit or net loss as it is shown by income statement or balance sheet.

Net profit is shown on debit side but net loss is shown on credit side of this account.

All non-operating and non-cash expenses are written on debit side but non-operating incomes are written on credit side.

If debit amount become more credit, it is considered as funds from operation.

Similarly, if credit amount become more than debit, it is considered as loss from operation.

Procedures for profit and loss adjustment account

Step 1:	First find out non-operating and non-cash expenses and income,
Step 2:	Write down non-operating and non-cash expenses in debit side,
Step 3:	Write down non-operating income in credit side,
Step 4:	If transaction(s) is in balance sheet as well as additional information, prepare ledger (working note) for fixed assets, investment, provision for tax or dividend,
Step 5:	After transferring, all non-operating and non-cash expenses or income and necessary entry from working note, find out fund from operation (operating profit).

Profit and Loss Adjustment Account

Non-operating and non-cash expenses	Amount	Non-operating income	Amount
To Net profit	xxxx	By Net loss	xxxx
To Depreciation on fixed assets	xxxx	By Appreciation on fixed assets	xxxx
To Goodwill written off	xxxx	By Tax refund	xxxx
To Trade mark written off	xxxx	By Rent received	xxxx
To Patents written off	xxxx	By Interest received	xxxx
To Preliminary expenses written off	xxxx	By Dividend received	xxxx
To Discount on issued of shares	xxxx	By Compensation received	xxxx
To Dividend (proposed/interim)	xxxx	By Discount on redemption of debentures	xxxx
To Premium on redemption of debentures	xxxx	By Premium on issue of shares	xxxx
To Reserve fund (increase)	xxxx	By Profit on sale of assets	xxxx
To General reserve	xxxx	By Profit on sales of investment	xxxx
To Sinking fund	xxxx	By Increase in share forfeiture	xxxx
To Dividend equalization fund	xxxx	By Operating profit or FFO (b/f)	xxxx
To Provision for tax	xxxx
To Tax paid	xxxx
To Loss on sale of assets	xxxx
To Loss on sales investment	xxxx
To Decrease in share forfeiture	xxxx
To Operating loss or LFO (b/f)	xxxx
	xxxx		xxxx

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Keep in Mind (KIM)

For student:
Operating expenses:	Non-operating expenses:
Admission fee	–
Monthly fee (tuition fee)	–
Exam free	–
Coaching expenses	–
School/college uniform	Informal dress
Canteen expenses	Restaurant expenses
Books and stationery	Novel and magazines
Internet expenses for study	Internet expenses for entertainment
Educational tour	Entertainment tour
Picnic from school and college etc.	Picnic with friends etc.

Decrease in goodwill is written off.
It is written in debit side of profit and loss adjustment account.
Increase in goodwill is cash outflow. It is written in outflow of fund flow statement.
Lack of net profit, balance of reserve and surplus, general reserve or reserve fund is taken.

Difference between Net Profit and Funds from Operation

Bases	Net profit	Funds from operation
Preparation	It is prepared to show net profit or net loss at the end of accounting period.	It is prepared to show funds or loss from operation at the end of accounting period
Record	It records all types of expenses and incomes.	It records only non-operating and non-cash expenses and non-operating incomes.
Format	Income statement has definite format prescribed by the company act.	There are two formats to determine funds from operation.
Bases of preparation	Trial balance and additional information are the bases of determination net profit.	Income statement and comparative balance sheet and additional information are the bases of determination of funds from operation.
Legal requirement	The determination of net profit is compulsory according to law.	The determination of funds from operation is optional for management.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

The information of profit and loss account for a fiscal year is provided to you ($/₹/Rs):

Net profit for the year	125,000	Depreciation on fixes assets	25,000
Profit on sale of investment	10,000	Amortization of goodwill	15,000
Transfer to reserve fund	10,000	Loss on sale of fixed assets	12,000
Discount on share written off	5,000

Required: Funds from operation

[Answer: FFO = Rs 182,000]

SOLUTION:

Profit and Loss Adjustment Account

Particulars	Amount	Particulars	Amount
To Net profit	1,25,000	By Profit on sale of investment	10,000
To Depreciation on fixed assets	25,000	By Funds from operation (FFO)	182,000
To Amortization of goodwill	15,000
To Transfer to reserve fund	10,000
To Loss on sales of fixed assets	12,000
To Discount on share written off	5,000
	192,000		192,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

The information of profit and loss account for a fiscal year is provided to you ($/₹/Rs):

Net loss for the year	25,000
Depreciation on fixes assets	15,000
Fixed asset sold (book value of Rs 25,000)	30,000
Amortization of copyright	12,000
Transfer to general reserve	10,000
Preliminary expenses written off	12,000
Interim dividend paid	15,000

Required: Funds from operation

[Answer: FFO = Rs 34,000]

SOLUTION:

Profit and Loss Adjustment Account

Particulars	Amount	Particulars	Amount
To Depreciation on fixed assets	15,000	By Net loss	25,000
To Amortization of copyright	12,000	By Profit on sale of fixed asset	5,000
To Transfer to general reserve	10,000	By Funds from operation	34,000
To Preliminary expenses written off	12,000
To Interim dividend paid	15,000
	64,000		64,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

The following is the trading and profit and loss account of City Book House for the year ended 31st December ($/₹/Rs):

Trading, Profit and Loss Account

Particulars	Amount	Particulars	Amount
To Opening stock	2,00,000	By Sales	7,50,000
To Purchase	3,00,000	By Closing stock	1,50,000
To Wages	1,00,000
To Factory overheads	55,000
To Gross profit c/d	2,45,000
	9,00,000		9,00,000
To Administrative expenses	75,000	By Gross profit b/d	2,45,000
To Selling expenses	55,000	By Commission on bike selling	15,000
To Distribution expenses	50,000	By Rent received (sublet)	25,000
To Depreciation	15,000	By Interest received on investment	15,000
To Provision for taxation	25,000
To Goodwill written off	10,000
To Loss on sales of plant	15,000
To Net profit c/d	55,000
	3,00,000		3,00,000

Required: Funds from operation

[Answer: FFO = Rs 65,000]

SOLUTION:

After leaving operating financial transactions, remaining transactions are taken to find out FFO

Profit and Loss Adjustment Account

Particulars	Amount	Particulars	Amount
To Net profit	55,000	By Commission received	15,000
To Depreciation	15,000	By Rent received	25,000
To Provision for taxation	25,000	By Interest received	15,000
To Goodwill written off	10,000	By Funds from operation	65,000
To Loss on sales of plant	15,000
	120,000		120,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

The following is the balance sheet of two fiscal years ($/₹/Rs):

Balance Sheet

Liabilities	2019	2020	Assets	2019	2020
Equity share capital	5,00,000	5,00,000	Land and building	4,45,000	6,75,000
Reserve and surplus	20,000	40,000	Goodwill	1,00,000	75,000
Profit and loss account	80,000	100,000	Stock	50,000	55,000
10% bank loan	1,50,000	1,50,000	Debtors	50,000	40,000
Bank overdraft	50,000	40,000	Cash at bank	1,75,000	125,000
Sundry creditors	1,00,000	1,20,000	Prepaid expenses	1,25,000	75,000
Bills payable	50,000	60,000	Preliminary expenses	40,000	30,000
Provision for depn	50,000	75,000	Discount on share	15,000	10,000
	10,00,000	10,85,000		10,00,000	10,85,000

Required: Funds from operation

[Answer: FFO = Rs 105,000]

SOLUTION:

Profit and Loss Adjustment Account

Particulars	Amount	Particulars	Amount
To Transfer to reserve and surplus	20,000	By Balance b/d	80,000
To Depreciation	25,000	By Fund from operating (FFO)	105,000
To Goodwill written off	25,000
To Preliminary expenses written off	10,000
To Discount on share written off	5,000
To Balance c/d	100,000
	185,000		185,000

Profit and Loss Adjustment Account

Particulars	Amount	Particulars	Amount
To Net profit (100,000 – 80,000)	20,000	By Operating profit (FFO)	105,000
To Increase in reserve and surplus	20,000
To Depreciation for the year	25,000
To Amortization of goodwill	25,000
To Amortization of preliminary exp.	10,000
To Amortization of discount on share	5,000
	185,000		185,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2E

ABC Company Ltd provides you following data:

Trading, Profit and Loss Account

Particulars	Amount	Particulars	Amount
To Opening stock	Nil	By Sales	350,000
To Purchase	200,000	By Closing stock	Nil
To Wages	50,000
To Gross profit	100,000
	350,000		350,000
To Salaries	20,000	By Gross profit	100,000
To Office expenses	10,000	By Dividend received	6,000
To Depreciation	10,000	By Profit on sales of plant	10,000
To Discount on issue of shares	2,000
To Preliminary expenses written off	10,000
To Goodwill written off	8,000
To Loss on sales of furniture	14,000
To Interim dividend	6,000
To General reserve	5,000
To Net profit	31,000
	116,000		116,000

Required: Funds from operation (FFO)

[Answer: FFO = Rs 70,000]

SOLUTION:

After leaving operating financial transactions, remaining transactions are taken to find out FFO

Profit and Loss Adjustment Account

Particulars	Amount	Particulars	Amount
To Net profit	31,000	By Dividend received	6,000
To Depreciation on assets	10,000	By Profit on sale of assets	10,000
To Discount on issue of shares	2,000	By Operating profit (FFO)	70,000
To Preliminary expenses written off	10,000
To Goodwill written off	8,000
To Loss on sales of furniture	14,000
To Interim dividend	6,000
To General reserve	5,000
	86,000		86,000

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PROBLEMS AND ANSWERS

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

The following is the profit and loss account for the March end 2020 ($/₹/Rs):

Profit and Loss Account

Particulars	Amount	Particulars	Amount
To Salary	65,000	By Gross profit b/d	1,45,000
To Advertisement	35,000	By Dividend received	7,000
To Miscellaneous expenses	25,000	By Interest received	3,000
To Depreciation	25,000	By Net loss c/d	20,000
To Patent written off	10,000
To Loss on sales of machine	15,000
	1,75,000		1,75,000

Required: Funds from operation

[Answer: FFO = Rs 20,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

The information of profit and loss account for a fiscal year is provided to you ($/₹/Rs):

Net profit for the year	75,000	Transfer to general reserve	10,000
Depreciation on fixes assets	25,000	Loss on sale of fixed assets	12,000
Profit on sale of investment	10,000	Discount on share written off	8,000
Amortization of goodwill	15,000

Required: Funds from operation

[Answer: FFO = Rs 135,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

The following is the profit and loss account for the year ended 31^st December 2020 ($/₹/Rs):

Profit and Loss Account

Particulars	Amount	Particulars	Amount
To Administrative expenses	75,000	By Gross profit b/d	2,45,000
To Selling expenses	55,000	By Rent received	12,000
To Distribution expenses	55,000	By Interest received	28,000
To Depreciation	25,000
To Provision for taxation	15,000
To Copy right written off	10,000
To Loss on sales of vehicle	5,000
To Net profit c/d	45,000
	2,85,000		2,85,000

Required: Funds from operation

[Answer: FFO = Rs 60,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

The following information is given to you ($/₹/Rs):

Particulars	Previous year	Current year
Profit and loss account	75,000	1,25,000
General reserve	45,000	65,000
Provision for depreciation	25,000	50,000
Discount on shares	25,000	15,000
Patent and copy right	40,000	25,000
Underwriting commission	15,000	10,000
Plant and machinery	1,50,000	2,50,000
Share capital	3,00,000	3,00,000