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SYLLABUS

ACCOUNTING FOR MANAGERS

MBA–1st SEMESTER, M.D.U., ROHTAK

External Marks : 70 Time : 3 hrs.

Internal Marks : 30

UNIT-I Financial Accounting-concept, importance and scope, accounting principles, journal, ledger, trial balance,
UNIT-I
Financial Accounting-concept, importance and scope, accounting
principles, journal, ledger, trial balance, depreciation (straight line and
diminishing balance methodology), preparation of final accounts with
adjustments.
UNIT-II
Ratio analysis, fund flow analysis, cash flow analysis.
UNIT-III
Management accounting-concept, need, importance and scope; cost
accounting-meaning, importance, methods, techniques and
classification of costs, inventory valuation.
UNIT-IV

Budgetary control-meaning, need, objectives, essentials of budgeting, different types of budgets; standard costing and variance analysis (materials, labour); marginal costing and its application in managerial decision making.

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ACCOUNTING FOR MANAGERS

MBA 1st Semester (DDE)

UNIT – I

Define Accounting. Explain its Nature. Accounting :- (i) Trading, Profit & Loss Account. (ii) Balance
Define Accounting. Explain its Nature.
Accounting :-
(i)
Trading, Profit & Loss Account.
(ii)
Balance Sheet.

Q.

Ans.

Accounting is often called the language of business. The

basic function of any language is to communicate. Accounting communicates the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are :–

Definition of Accounting :–

According to American Institute of Certified Public Accountants:–

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof.

According to R.N. Anthony :–

Nearly every business enterprise has accounting system. It is a means of collecting, summarizing, analyzing and reporting in monetary terms, informations about business.

Feature or Characteristics or Nature of Accounting :–

(1)

Recording of Financial Transactions only :– Only those transactions and events are recorded in accounting which can be expressed in terms of money. Those transactions which cannot be expressed in terms of money are not recorded in accounting like the value of human resource, strike by employees, and change in managerial policies etc.

Recording :– Accounting is the art of recording of business transactions according to some specified rules. In a small business where number of transactions is quite small, all transactions are first of all recorded in a

(2)

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book called Journal. But in a big business where the number of transactions is quite large, the Journal is further sub-divided into various subsidiary books such as:-

(i) Cash Book (ii) Purchase Book (iii) Sales Book (iv) Purchase Return Book (v) Sales
(i)
Cash Book
(ii)
Purchase Book
(iii)
Sales Book
(iv)
Purchase Return Book
(v)
Sales Return Book.
The number of subsidiary books to be maintained depends on the size and
nature of the business.
(3)
Classifying :– After recording the transactions in journal or subsidiary
books, the transactions are classified. Classification is the process of
grouping the transactions of one nature at one place, in a separate
account. The books in which various accounts are opened is called
“Ledger”.
(4)
Summarising :– Summarising involves the balancing of Ledger accounts
and the preparation of Trial Balance with the help of such Balances.
Financial Statements are prepared with the help of trial balance. Financial
statements are includes:-
(i)
Trading, Profit & Loss Account
(ii)
Balance Sheet.
(5)
Interpretation of the Results :– In accounting the results of business are
presented in such a manner that the parties interested in the business
such as proprietors, managers banks, creditors etc. can have full
information about the profitability and the financial position of the
business.
(6)
Communicating :–
It refers to transmission of summarized and
interpreted information to a variety of users. The users are:-
(i)
Creditors
(ii)
Investors
(iii)
Lenders
(iv)
Government
(v)
Proprietors
(vi)
Management
(vii)
Banks etc.
Q.
Define Accounting. Also explain its Importance.
Ans.
Accounting :–
Accounting is often called the language of business. The

basic function of any language is to communicate. Accounting communicates

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the results of the business to the users of accounting information to enable them to

the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are:-

(i)

Trading, Profit & Loss Account.

(ii)

Balance Sheet.

Definition of Accounting :–

Helpful in Management of Business :– following:- (i) (ii) (iii)
Helpful in Management of Business :–
following:-
(i)
(ii)
(iii)

According to American Institute of Certified Public Accountants :–

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof.

Importance of Accounting :–

(1)

Management needs a lot of

information for the efficient running of the business. All such information is provided by the accounting which helps the management in the

Helpful in Planning :– Management would like to know whether the sales are increasing or decreasing and also the speed of increase in the cost of production. All such information is provided by the accounting, which helps the management in estimating the future sales and expenses. It also helps them to estimate the cash receipts and cash disbursements during the next accounting period.

Helpful in Decision-Making :– At times, the Management has to take a number of decisions. Accounting provides all the informations required for making such decisions.

Helpful in Controlling :– Management would like to see that the cost incurred is reasonable and that no department is overspending. Accounting provides information to the management in this regard.

(2) Provides Complete and Systematic Record :– Business transactions have grown in size and complexity and it is not possible to remember each and every transaction. Accounting keeps a prompt and systematic record of all the transactions and summarizes them in order to provide a true picture of the activities of the business entity.

(3) Information regarding Profit or Loss :– Accounting reports the net result of business activities of an accounting period. For this purpose Trading and Profit & Loss Account of the business is prepared at the end of each accounting period. All the items relating to purchase, sales, expenses and revenues (Income) of the business are recorded in Trading, Profit & Loss Account.

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If Revenues >Expenses-—————————————Profit If Revenues< Expenses-—————————————Loss

(4)

Information Regarding Financial Position :–

For a businessman,

merely ascertaining profit or loss of the business is not sufficient. The businessman must also know the financial health of the business. For this purpose a statement called Balance Sheet is prepared which shows the assets on the one hand and the liabilities and capital on the other hand. Balance Sheet describe the following :

(i) How much the business has to recover from Debtors? (ii) How much the business
(i)
How much the business has to recover from Debtors?
(ii)
How much the business has to pay to Creditors?
(iii)
How much the business has in the form of
(a)
Cash-in-hand
(b) Cash at Bank
(c)
Closing Stock
(d) Fixed Assets.
Enables Comparative Study :–
(i)
Creditors
(ii)
Investors
(iii)
Lenders
(iv)
Government
(v)
Proprietors
(vi)
Management
(vii)
Banks etc.

(5)

By keeping a systematic record

accounting helps the owners to compare one years costs, expenses, sales and profit etc. with those of other years. Such a comparison provides the useful information on the basis of which important decisions can be taken more judiciously.

(6)

Provide Informations to Various Parties :– Another main objectives of accounting is to communicate the accounting information to various users like:

(7)

To Know the Liquidity Position :– Another objective of accounting is to provide information about liquidity position. For this purpose it prepares a Cash Flow Statement. It depicts inflows and outflows of cash from operating, investing and financing activities.

(8)

To File Tax Returns :– One of the main objectives of accounting is to provide bases for filing tax returns relating to income tax, sales tax, value added tax, service tax, etc.

(9) Facilitates Sale of Business :– If a business entity is being sold, the accounting information can be utilized to determine the proper purchase price.

(10) Helpful in Raising Loans :– Accounting information is of great help while raising loans from banks or other financial institutions. Such institutions

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before sanctioning loan screen various financial statements of the firm such as final accounts, fund

before sanctioning loan screen various financial statements of the firm such as final accounts, fund flow statement, cash flow statement etc.

(11) Helpful in Prevention and Detection of Errors and Frauds.

Q. Define Accounting. Also explain its Scope.

Ans. Accounting :– Accounting is often called the language of business. The

basic function of any language is to communicate. Accounting communicates the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are:-

(i) Trading, Profit & Loss Account. (ii) Balance Sheet. Economic Events :– Identification :– of
(i)
Trading, Profit & Loss Account.
(ii)
Balance Sheet.
Economic Events :–
Identification :–
of financial character and relate to the organization.

Definition of Accounting :–

According to American Institute of Certified Public Accountants :–

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof.

Scope of Accounting :– In order to appreciate the exact nature and scope of accounting, we must understand the following aspects of accounting:

(1)

Accounting records only economic events. An

economic event is a transaction which can be measured and expressed in terms of money.

(2)

(3)

(4)

It means determining what transactions are to be

recorded. It involves observing events and selecting those events that are

Measurement :– It means quantification of business transactions into financial terms by using monetary units.

Recording :– Accounting is the art of recording of business transactions according to some specified rules. In a small business where number of transactions is quite small, all transactions are first of all recorded in a book called Journal. But in a big business where the number of transactions is quite large, the Journal is further sub-divided into various subsidiary books such as:-

Cash Book Purchase Book Sales Book Purchase Return Book Sales Return Book. 148
Cash Book
Purchase Book
Sales Book
Purchase Return Book
Sales Return Book.
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The number of subsidiary books to be maintained depends on the size and nature of the business.

(5)

Classification :– After recording the transactions in journal or subsidiary books, the transactions are classified. Classification is the process of grouping the transactions of one nature at one place, in a separate account. The books in which various accounts are opened is called Ledger.

Summarising :– Summarising involves the balancing of Ledger accounts and the preparation of Trial Balance with the help of such Balances. Financial Statements are prepared with the help of trial balance. Financial statements are includes:-

(6)

(i) Trading, Profit & Loss Account (ii) Balance Sheet. Communication :– interpreted information to a
(i)
Trading, Profit & Loss Account
(ii)
Balance Sheet.
Communication :–
interpreted information to a variety of users. The users are:-
(i)
Creditors
(ii)
Investors
(iii)
Lenders
(iv)
Government
(v)
Proprietors
(vi)
Management
(vii)
Banks etc.
Accounting :–

(7)

It refers to transmission of summarized and

(8) Interpretation of the Results :– In accounting the results of business are presented in such a manner that the parties interested in the business such as proprietors, managers banks, creditors etc. can have full information about the profitability and the financial position of the business.

Q.

Define Accounting. Explain its Objectives Or Functions and Branches Or Types.

Ans.

Accounting is often called the language of business. The

basic function of any language is to communicate. Accounting communicates the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are:-

(iii)

Trading, Profit & Loss Account.

(iv)

Balance Sheet.

Definition of Accounting :– According to American Institute of Certified Public Accountants :–

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“ Accounting is the art of recording, classifying and summarizing in a significant manner and

Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof.

Objectives or Functions of Accounting:- objectives, functions or utility of accounting:-

(1) To keep a Systematic record of business transactions :– The main objective of accounting is to maintain complete record of business transactions according to some specified rules. For this purpose all the business transactions are first of all recorded in Journal or Subsidiary Books and then posted into Ledger.

(2)

to calculate the net profit earned or loss suffered during a particular

The following are the main

is is recorded in Trading, Profit & Loss Account. If Revenues >Expenses
is
is
recorded in Trading, Profit & Loss Account.
If Revenues >Expenses -—————————————Profit
If Revenues< Expenses-—————————————Loss
To know the exact reasons leading to net profit or net loss.
To ascertain the progress of the business from year to year.
To prevent and detect errors and frauds.
of
users.
a

To Calculation Profit or Loss :– The second main objective of accounting

period. For this purpose Trading and Profit & Loss Account of the business

prepared at the end of each accounting period. All the items relating to

purchase, sales, expenses and revenues (Income) of the business are

(3)

(4)

To Know the Financial Position of the business :– For a businessman, merely ascertaining profit or loss of the business is not sufficient. The businessman must also know the financial health of the business. For this purpose a statement called Balance Sheet is prepared which shows the assets on the one hand and the liabilities and capital on the other hand.

(5)

(6)

(7)

(8)

To Provide Informations to Various Parties :– Another main objectives

accounting is to communicate the accounting information to various

To Know the Liquidity Position :– Another objective of accounting is to provide information about liquidity position. For this purpose it prepares

Cash Flow Statement. It depicts inflows and outflows of cash from operating, investing and financing activities.

To File Tax Returns :– One of the main objectives of accounting is to provide bases for filing tax returns relating to income tax, sales tax, value added tax, service tax, etc.

(9)

Branches OR Types of Accounting :– Branches of accounting are :

(1)

Financial Accounting :– It covers the preparation and interpretation of

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financial statements and communication to the users of accounts. The final step of financial accounting is the preparation of Trading and Profit & Loss Account and the Balance Sheet.

The main purpose of Management

Management Accounting :–

Accounting is to present the accounting information in such a way as to assist the management in planning and controlling the operations of a business. The management accountant uses various techniques and concepts to make the accounting data more useful for managerial decision making.

(2)

on the basis of this accounting. a Social Responsibility Accounting :– Accounting Principle :–
on the basis of this accounting.
a
Social Responsibility Accounting :–
Accounting Principle
:–

(3) Tax Accounting :– The branch of accounting which is used for tax purpose is called tax accounting. Income Tax and Sale Tax are computed

(4)

Cost Accounting :– The main purpose of cost accounting is to calculate the total cost and per unit cost of goods produced and services rendered by

business. It also estimates the cost in advance and helps the management in exercising strict control over cost.

(5)

The society provides the

infrastructure and the facilities without which business cannot operate at all. Hence the business also has a responsibility to the society. There is a growing demand for reports on activities which reflect the contribution of an enterprise to the society. Social responsibility accounting is the process of identifying, measuring and communicating the contribution of a business to the society. In social responsibility accounting techniques have been developed for measuring the cost of these contribution and the benefits to the society.

Q.

What do you mean by Accounting Principles or (GAAP)? Explain and illustrate fully.

Ans. The accounting statements are needed by

various parties who have interest in the business, namely, proprietors, investors, creditors, government and many other. Accounting statements disclose the profitability and solvency of the business to various parties. It is therefore, necessary that such statements should be prepared according to some standard language and set rules. These rules are usually called General Accepted Accounting Principles(GAAP).

Kinds of Accounting Principles

various

doctrine,

:– Accounting principles are described by

terms

such

as

assumptions,

conventions,

concepts,

postulate etc. These principles can be classified mainly into two categories:-

(A) Accounting Concepts or Assumptions (B) Accounting Conventions. 151
(A)
Accounting Concepts or Assumptions
(B)
Accounting Conventions.
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Kinds of Accounting Principles Accounting Concepts or Assumptions Accounting Conventions Business Entity

Kinds of Accounting Principles

Kinds of Accounting Principles Accounting Concepts or Assumptions Accounting Conventions Business Entity
Kinds of Accounting Principles Accounting Concepts or Assumptions Accounting Conventions Business Entity
Kinds of Accounting Principles Accounting Concepts or Assumptions Accounting Conventions Business Entity
Kinds of Accounting Principles Accounting Concepts or Assumptions Accounting Conventions Business Entity

Accounting Concepts or Assumptions

Accounting

Conventions Business Entity Concept Convention of Full Disclosure Money Measurement Concept Convention of
Conventions
Business Entity Concept
Convention
of Full Disclosure
Money Measurement Concept
Convention
of Consistency
Going Concern Concept
Convention
of Conservatism
Accounting Period Concept
Convention
of Materiality
Historical Cost Concept
Dual Aspect Concept
Revenue Recognition Concept
Matching Concept
Accrual Concept
Objectivity Concept

(A)

Accounting Concepts or Assumptions :– Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. The word concept means idea or notion, which has universal application. These accounting concepts provide a foundation for accounting process. No enterprise can prepare its financial statements without considering these basic concepts or assumptions. These concepts guide how transactions should be recorded and reported. Following may be treated as basic concepts or assumptions :

(1)

The Business Entity Concept :– Entity concept states that business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner. Business transactions are recorded in the business books of accounts and owners transactions in his personal books of accounts. Business unit should have a completely separate set of books and we have to record business transactions from firms point of view and not from the point of view of the proprietor.

Example :–

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(i) The proprietor is treated as a creditor of the business to the extent of
(i)
The proprietor is treated as a creditor of the business to the extent of
capital invested by him in the business. The capital is treated as a
liability of the firm because it is assumed that the firm has borrowed
funds from its own proprietors instead of borrowing from outside
parties. It is for the reason that we also allow interest on capital and
treat it as an expense of the business.
(ii)
Similarly, the amount withdrawn by the proprietor from the business
for his personal use is treated as his drawings.
(iii)
The proprietor’s house, his personal investment in securities, his
personal car and personal income and expenditure are kept separate
from the accounts of the business entity.
(iv)
If the proprietor has some other business entity doing another
business, the records of that business should also be kept separate.
The concept of separate entity is applicable to all forms of business
organizations, i.e. sole proprietorship, partnership or a company.
(2)
Money Measurement Concept :–
As per this concept, only those
transactions, which can be measured in terms of money are recorded.
Transactions, even if, they affect the results of the business materially, are
not recorded if they are not convertible in monetary terms. Transactions
and events that cannot be expressed in terms of money are not recorded in
the business books. For example, accounting does not record a quarrel
between the production manager and sales manager; it does not report
that a strike is beginning and it does not reveal that a competitor has
placed a better product in the market. These facts or happenings cannot
be expressed in money terms and thus are not recorded in the books.
Example :–
A business on a particular day has 5000 Kilograms of raw
materials, 5 Machines, 100 Chairs and 20 Fans. All these things cannot be
added up unless expressed in terms of money. In order to make a record of
these items, these will have to be expressed in monetary terms such as Raw
Materials Rs. 25000, Machines Rs. 200000, Chairs Rs. 5000 and Fans Rs.
8000. As such, to make accounting records relevant, simple, understandable
and homogeneous, they are expressed in a common unit of measurement i.e.,
money.
(3) Going Concern Concept :– As per this concept it is assumed that the
business will continue to exist for a long period in the future. The
transactions are recorded in the books of the business on the assumption
that it is a continuing enterprise.

Example :–

(i) It is on this concept that we record fixed assets at their original cost and depreciation is charged on these assets without reference to their market value.

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(ii) It is also because of the going concern concept that outside parties enter into

(ii)

It is also because of the going concern concept that outside parties enter into long-term contracts with the enterprise, gives loans and purchase the debentures and shares of the enterprise.

(iii)

Another example of this concept is that Prepaid Expenses, which have no realizable value are shown as assets in the balance sheet, because the benefits of such expenses will be received in future.

(4)

(5)

Accounting Period Concept :–

According to this concept accounts

should be prepared after every period & not at the end of the life of the entity. Usually this period is one calendar year i.e. 1 Jan to 31 December or from 1 April to 31 March. According to Amended Income Tax Law, a business has compulsorily to adopt financial year beginning on 1 April and ending on 31 March. Apart from this, companies whose shares are listed on the stock exchange are required to publish quarterly results to depict the profitability and financial position at the end of three months period.

st st st st st st Benefits :– (i) (ii) (iii) Limitations :–
st
st
st
st
st
st
Benefits :–
(i)
(ii)
(iii)
Limitations :–

Historical Cost Concept or Cost Concept :– According to this concept, an asset is ordinarily recorded in the books of accounts at the price at which it was purchased or acquired. This cost becomes the basis of all subsequent accounting for the asset. Since the acquisition cost relates to the past, it is referred to as historical cost. This cost is the basis of valuation of the assets in the financial statements.

Example :– If a business purchases a building for Rs. 500000, it would be recorded in the books at this figure. Subsequent increase or decrease in the market value of the building would not be recorded in the books of accounts.

It is highly objective and free from bias. Market values of assets are difficult to be determined. Market values of the assets may change from time to time and it will be extremely difficult to keep track of up and down of the market price.

(i)

Assets for which nothing is paid will not be recorded. Thus a favourable location, brand name and reputation of the business, knowledge and technological skill built inside the enterprise will remain unrecorded though these are valuable assets.

(ii)

Historical cost-based accounts may lose comparability.

(iii)

Many assets do not have acquisition cost.

(iv)

During periods of inflation, the figure of net profit disclosed by profit and loss account will be seriously distorted because depreciation

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(6)

(7)

(8)

based on historical costs will be charged against revenues at current prices. (v) Information based upon historical cost may not be useful to management, investors, creditors etc.

Dual Aspect Concept :–

According to this concept, every business

transaction is recorded as having a dual aspect. In other words, every transaction affects atleast two accounts. If one account is debited, any

other account must be credited. The system of recording transactions

time:- Assets = Liabilities + Capital OR Capital = Assets - Liabilities Assets = Liabilities
time:-
Assets
=
Liabilities + Capital
OR
Capital
=
Assets - Liabilities
Assets
= Liabilities + Capital
Rs. 6 Lacs = Rs. 1 Lac + Rs. 5 Lacs
Revenue Recognition (Realisation) Concept :–
st
th
st
th

based on this concept is called as Double Entry System. It is because of this principle that two sides of the Balance Sheet are always are equal and the following accounting equation will always hold good at any point of

Example :– X commences business with Rs. 5 Lacs in cash and takes a loan of Rs. 1 Lac from the bank, and these 6 Lacs are used in buying some assets, say, plant & machinery. The equation will be as follows:

Revenue means the

amount which is added to the capital as a result of business operations. Revenue is earned by sale of goods or by providing a service. Concept of revenue recognition determines the time or the particular period in which the revenue is realized. Revenue is deemed to be realized when the title or ownership of the goods has been transferred to the purchaser and when he has legally become liable to pay the amount. It should be remembered that revenue recognition is not related with the receipt of cash.

Example :– For example, if a firm gets an order of goods on 1 January, supplies the goods on 20 January and receives the cash on 1 April, the revenue will be deemed to have been earned on 20 January, as the ownership of goods was transferred on that day.

Matching Concept :–

determination of net profit. According to this concept, all expense are matched with the revenue of that period should only be taken into consideration. This principle is based on accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of cash. This principle helps us in finding Net profit or Loss. Following points must be considered while matching costs with revenue:

This concept is very important for correct

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(i) (ii) (iii) When an item of revenue is included in the profit and loss

(i)

(ii)

(iii)

When an item of revenue is included in the profit and loss account, all expenses incurred on it, whether paid or not, should be show as expenses in the profit and loss account.

When some expenses, say insurance premium is paid partly for the next year also, the part relating to next year will be shown as an expense only next year and no this year.

Similarly, income receivable must be added in revenues and incomes received in advance must be deducted from revenues.

Objectivity Concept :– (i) (ii) (iii) Conventions of Full Disclosure :–
Objectivity Concept :–
(i)
(ii)
(iii)
Conventions of Full Disclosure :–

(9)

Accrual Concept :– In accounting, accrual basis is used for recording transactions. It provides more appropriate information about the performance of business enterprise as compared to cash basis. Accrual concept applies equally to revenues and expenses. In accrual concept revenue is recorded when sales are made whether cash is received or not. Similarly, according to this concept, expenses are recorded in the accounting period in which they assist in earning the revenues whether the cash is paid for them or not.

(10)

This concept requires that accounting

transaction should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts.

(B)

Accounting Conventions :– An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants. Accounting conventions differ from concept in respect to the following:

Accounting concepts are established by law while accounting conventions are guidelines based upon general agreement.

There is no role of personal judgment or individual bias in the adoption of accounting concepts whereas they may play a crucial role in following accounting conventions.

There is uniform adoption of accounting concepts in different enterprise while it may not be so in case of accounting conventions.

Following are the main accounting conventions :–

(1)

This principle requires that all

significant information relating to the economic affairs of the enterprise

should be completely disclosed. The principle is so important that the companies Act makes ample provisions for the disclosure of essential information in the financial statements of a company. The proforma and contents of Balance Sheet and Profit and Loss Account are prescribed by Companies Act. Various items or facts which do not find place in accounting statements are shown in the Balance Sheet by way of footnotes. Such as :

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(i)

Contingent Liabilities.

(ii)

If there is a change in the method of valuation of stock, or for providing depreciation or in making provision for doubtful debts, it should be disclosed in the Balance Sheet by way of a footnote.

(iii)

Market value of investments should be given by way of a footnote.

(2) Convention of Consistency :– According to this principle, accounting principles and methods should remain
(2)
Convention of Consistency :– According to this principle, accounting
principles and methods should remain consistent from one year to
another. These should not be changed from year to year. If a firm adopts
different accounting principles in two accounting periods, the profits of
current period will not be comparable with the profits of the preceding
period.
(3)
Convention of Conservatism :–
According to this principle, all
anticipated losses should be recorded in the books of accounts, but all
anticipated gains should be ignored. In other words, conservatism is the
policy of playing safe. When there are many alternative values of an asset,
an accountant should choose the method which leads to the lesser value.
Examples of the application of the principle of conservatism :–
(i)
Valuation of closing stock – ‘cost or market price’ whichever is less.
(ii)
Provision for Doubtful Debts on Debtors.
(iii)
Joint Life Policies are recorded at Surrender Values.
Effects of Principle of Conservatism :–
(i)
(ii)
Profit & Loss account will disclose lower profits in comparison to the
actual profits.
Balance sheet will discloses understatement of assets and
overstatement of liabilities in comparison to the actual values.
(4) Convention of Materiality :– This convention is an exception to the
convention of full disclosure. According to this convention, all the items
having significant economic effect should be disclosed in financial
statements and any insignificant item which will only increase the work of
the accountant should not be disclosed in the financial statements. It
should be noted that what is material for one concern may be immaterial
for another. Thus, the accountant should judge the important of each
transaction to determine its materiality.
Q.
Give Classification Of Accounts. What are the Rules of Journalising?
Ans.
Classification of Accounts :–
Classification of Accounts are:

Classification of Accounts

of Accounts are: Classification of Accounts Personal Accounts Impersonal Accounts Real Accounts
of Accounts are: Classification of Accounts Personal Accounts Impersonal Accounts Real Accounts
of Accounts are: Classification of Accounts Personal Accounts Impersonal Accounts Real Accounts
of Accounts are: Classification of Accounts Personal Accounts Impersonal Accounts Real Accounts
of Accounts are: Classification of Accounts Personal Accounts Impersonal Accounts Real Accounts

Personal Accounts

Impersonal Accounts

of Accounts Personal Accounts Impersonal Accounts Real Accounts Nominal Accounts 157 footer
of Accounts Personal Accounts Impersonal Accounts Real Accounts Nominal Accounts 157 footer
of Accounts Personal Accounts Impersonal Accounts Real Accounts Nominal Accounts 157 footer
of Accounts Personal Accounts Impersonal Accounts Real Accounts Nominal Accounts 157 footer
of Accounts Personal Accounts Impersonal Accounts Real Accounts Nominal Accounts 157 footer

Real Accounts

Nominal Accounts

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1. Personal Accounts :– The accounts which relate to an individual, firm, company or an

1. Personal Accounts :– The accounts which relate to an individual, firm, company or an institution are called personal accounts. Account of Mohan, Account of D.C.M. Limited, Capital Account of proprietor, etc. are the examples of Personal Accounts. This account is further classified into three categories:-

2.

(i) Natural Personal Accounts :– beings like Ram, Rita, etc.

It relates to transactions of human

(ii) Artificial Personal Account :– These accounts do not have a physical existence as human
(ii)
Artificial Personal Account :–
These accounts do not have a
physical existence as human beings but they work as personal
accounts. For example: Government, Companies (private or limited),
Clubs, Co-operative Societies etc.
(iii)
Representative Personal Accounts :–
These are not in the name of
any person or organization but are represented as personal account.
For Example: Outstanding liability account or prepaid account,
capital account, drawings account.
Golden Rule of Personal Account :–
Debit the Receiver
Credit the Giver
Impersonal Account :–
Accounts which are not personal such as
machinery account, cash account, rent account etc. These can be further
sub-divided as follows :–
(i)
Real Account : –
Accounts which relate to assets of the firm but not
debt. For example accounts regarding Land, Building, Investment,
Fixed Deposits etc., are real accounts Cash-in-hand and Cash at
Bank are also real.
Golden Rule of Real Account :–
Debit what comes in.
Credit what goes out.
(ii)
Nominal Account :–
Accounts which relates to expenses, losses,
gains, revenue etc. like salary account, interest paid account,
commission received account.
Golden Rule of Nominal Account :–

Debit all expense & Losses. Credit all Incomes & Gains.

Q. Define Accounting Cycle OR Process of Accounting.

Ans. Accounting Cycle

accounting procedures which are repeated in the same order during each accounting period. The accounting cycle may be shown as below:-

:–

An accounting cycle is a complete sequence of

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Transactions Books of Original Entry: 1. Cash Book 2. Purchase Book Trading, Profit & Loss
Transactions
Books of Original Entry:
1. Cash Book
2. Purchase Book
Trading, Profit &
Loss A/c and
Balance Sheet
3. Sales Book
Journal
4. Purchase Return Book
5. Receivable Book
Bills
6. Payable Book
Bills
7. Journal Proper
Ledger
Trial Balance
Diagram : Accounting Cycle
(1)
Identification of Transaction :–
Accounting deals with business
transactions which are monetary in nature. In other words, the
transactions which cannot be measured and expressed in terms of money
cannot be recorded in accounting.
(2) Journal :– Journal is one of the basic book of original entry in which
transactions are recorded in a chronological (day-to-day) order according
to the principles of double entry system. When the size of business is a
small one, it may be possible to record all transactions in the journal but
when the size of the business grows and the number of transactions is very
large journal is sub-divided into a number of books called subsidiary
Books.
There are five columns in journal which are:-
PROFORMA OF JOURNAL
Date Particulars L.F. Amount Dr. Amount Cr.
(1) (2) (3) (4) (5)
(i)
Date :–
In the first column, date of transaction is entered. The year
and month is written only once, till they change.
(ii)
Particulars :–
Each transactions affects two accounts out of which

one account is debited and other account is credited.

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(iii) Ledger Folio or L.F. :– All entries from the journal are later posted into

(iii)

Ledger Folio or L.F. :–

All entries from the journal are later posted

into the ledger accounts. The page number of the ledger account where the posting has been made from the journal is recorded in the L.F. column of the journal.

(iv)

Amount Dr. :–

In the fourth column, the amount of the account being

debited is written.

(v)

Amount Cr. :–

In the fifth column, the amount of the account being

credited is written. Ledger :– Business transactions are first recorded in journal or Subsidiary books.
credited is written.
Ledger :–
Business transactions are first recorded in journal or
Subsidiary books. The next step is to transfer the entries to respective
accounts in ledger. This process is called ledger
Dr.
Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
Each ledger account is divided into two equal parts. The left-hand side is
known as the debit side and the right-hand side as the credit side.
As shown above, there are four columns on each side of an account:-
(i)
Date :–
The date of the transaction is recorded in this column.
(ii)
Particulars :–
Each transaction affects two accounts.
(iii)
Journal Folio or J.F. :–
In this column page number of the journal or
subsidiary book from which the particular entry is transferred, is
entered.
(iv)
Amount :–
The amount is entered in this column.
Trial Balance :–
When posting of all the transactions into ledger is
completed and the accounts are balanced off, it becomes necessary to
check the arithmetical accuracy of the accounting work. For this purpose,
the balance of each and every account in the ledger is put on a list. The list
so prepared is called a trial balance.
PROFORMA OF TRIAL BALANCE

(3)

(4)

Name of the Accounts L.F. Dr. Balances Cr. Balances

Name of the Accounts L.F. Dr. Balances Cr. Balances
Name of the Accounts L.F. Dr. Balances Cr. Balances
Name of the Accounts L.F. Dr. Balances Cr. Balances
Name of the Accounts L.F. Dr. Balances Cr. Balances
Name of the Accounts L.F. Dr. Balances Cr. Balances
Name of the Accounts L.F. Dr. Balances Cr. Balances
Name of the Accounts L.F. Dr. Balances Cr. Balances

Features of a Trial Balance :–

(i) It is a list of balances of all ledger accounts and the cash book

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(ii)

(iii)

(iv)

(v)

(vi)

It is just a statement and not an account. It is neither a part of double entry system, nor does it appear in the actual books of accounts. It is just a working paper. It can be prepared at any time during the accounting period, say, at the end of every month, every quarter, every half year or every year. It is always prepared on a particular date and not for a particular period. It is prepared to check the arithmetical accuracy of the ledger accounts. If the books are arithmetically accurate, the total of all debit balances of a trial balance will be equal to the total of all credit balances.

(vii) (i) To ascertain the arithmetical accuracy of the ledger accounts. (ii) To help in
(vii)
(i)
To ascertain the arithmetical accuracy of the ledger accounts.
(ii)
To help in locating errors
(iii)
To obtain a summary of the ledger accounts
(iv)
To help in the preparation of final accounts.
Trading, Profit & Loss Account And Balance Sheet
Trading Account.
Profit and Loss Account.
Balance Sheet.
Write a Short Note On Double Entry System.
Double Entry System
:–
Assets
=
Liabilities + Capital

Objectives of Preparing Trial Balance :–

(5)

:– After having

checked the accuracy of the book of accounts through preparation of Trial Balance, businessman wants to ascertain the profit earned or loss suffered during the year and also the financial position of his business at the end of the year. For this purpose he prepares Final Accountswhich are also termed asFinancial Statements. These include the following:-

Q.

Ans. According to Double Entry System, every

transaction has two fold-aspects- debit and credit and both the aspects are to

be recorded in the books of accounts. We may define the Double Entry System as the system which records both the aspects of transactions. This principle proves accounting equation i.e. both sides of Balance Sheet always equal.

Advantages of Double Entry System :– mentioned advantages :

This system affords the under

(1)

Scientific System

(2)

Complete Record of Every Transaction

(3)

Preparation of Trial Balance

(4)

Preparation of Trading & Profit & Loss A/c

(5)

Knowledge of financial position of the Business

(6)

Knowledge of Various Informations.

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Q. (7) Comparative Study (8) Lesser possibility of Fraud. (9) Help management in decision making.

Q.

(7)

Comparative Study

(8)

Lesser possibility of Fraud.

(9)

Help management in decision making.

(10) Legal Approval (11) Suitable for All types of Businessmen.

Define

Depreciation?

Depreciation.

What

are

the

Causes

&

Methods

of

Ans.

Depreciation :– “Depreciation may be defined as the permanent and 1. 2. 3. 4. 5.
Depreciation
:–
“Depreciation
may
be
defined
as
the
permanent
and
1.
2.
3.
4.
5.
1. By Constant Use.
2. By Obsolescence
3. By expiry of time.
4. By Accident.

In every business there are certain assets of a fixed

nature that are needed for the conduct of business operations. Some examples of such assets are Building, Plant & Machinery, Motor Viechles, Furniture, office Equipments etc. These assets have a definite span of life after the expiry of which the assets will lose their usefulness for the business operations. Fall in the value & utility of such assets due to their constant use and expiry of time is termed as depreciation.

Definition of Depreciation :–

According to William Pickles

continuing

diminution in the quality, quantity or the vale of an asset.

Features of Depreciation :–

Depreciation is decline in the value of fixed assets (except Land) Such fall is of a permanent nature. Depreciation is a continuous process because value of assets will decline by their constant use. Depreciation decreases only the book value of the asset, not the market value. Depreciation is a non-cash expense. It does not involve any cash outflow.

Causes of Depreciation :–

5. By expiry of legal rights.

6. By Depletion

7. By permanent fall in market price.

Need, Importance or objects of providing depreciation :–

1. For ascertaining the truth profit or loss.

2. For showing the truth true and fair viewof the financial position.

3. To ascertain the accurate cost of production.

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4. To provide funds for replacement of assets.

5. To prevent the distribution of profits out of capital.

6. For avoiding over payment of Income tax.

7. Other objectives.

Factors determining the amount of Depreciation :–

3. 1. Total Cost of the Asset. 2. Estimated life of Asset. Estimated Scrap Value.
3.
1. Total Cost of the Asset.
2. Estimated life of Asset.
Estimated Scrap Value.
Methods of providing or Allocating Depreciation :–
1. Straight Line Method.
2. Written Down Value Method.
3. Annuity Method.
4. Depreciation Fund Method.
5. Insurance Policy Method.
6. Revaluation Method.
7. Depletion Method.
8. Machine hour rate Method.
Q.
Explain Straight Line Method of Depreciation with the help of an
Example.
Ans.
Straight Line Method :–
This method is also termed as Original Cost
Method because under this method depreciation is charged at a fixed
percentage on the original cost of the asset. The amount of depreciation
remains equal from year to year and as such this method is also known as
‘Equal Installment Method’, or ‘Fixed Installment Method’. Under this method,
the amount of depreciation is calculated by deducting the scrap value from the
original cost of the asset and then by dividing the remaining balance by the
number of years of its estimated life.
Yearly Depreciation =
Original Cost of the Asset – Estimated Scrap Value
————————————————————————
Estimated Life of the Asset.
Merits of Straight Line Method :–
1.
Simplicity :–
Calculation of Depreciation under this method is very
simple and as such the method is widely popular.
2.
Equality of Depreciation Burden :–
Under this method, equal amount of
depreciation is debited to profit & loss account of each year. Hence, the
burden of depreciation on each year’s net profit is equal.
3.
Assets can be completely written off :–
Under this method, the book

value of an asset can be reduced to net scrap value or zero value, which is not possible under some other methods.

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4. Knowledge of original cost and upto date depreciation :– under this method, the original

4. Knowledge of original cost and upto date depreciation :–

under this

method, the original cost of the asset is shown in the Balance Sheet and the upto-date depreciation is shown as a direct deduction from it.

Demerits of Straight Line Method :–

1. Difficulty in Computation :–

When there are different machines having

different life-span, the computation of depreciation becomes complicated because depreciation on each machine will have to be calculated

separately. 2. Unequal pressure in later years :– Repairs charges go on increasing year by
separately.
2. Unequal pressure in later years :–
Repairs charges go on increasing year
by year as the asset becomes older but as the equal depreciation is
charged under this method each year.
3. Omission of Interest factor :–
This method does not take into
consideration the loss of interest on the amount invested in the asset.
4. Unrealistic to write off the vale of asset to zero :–
Sometimes, even after
the value of an asset is reduced to zero in the books, it continues to be used
in the business in actual practice
5. Difficulty in the determination of scrap value :–
It is quite difficult to
assess the true scrap value of the asset after a long period, say 15 or 20
years from the date of its installation.
Suitability
:– This method is suitable for those assets whose useful life can be
renewals.
Example :–
Birla Cotton Mills purchased a machinery on 1 May, 1991 for Rs. 90,000. On 1
July, 1992 it purchased another machinery for Rs. 40,000.
st
st
On 31 March, 1993 it sold off the first machine purchased on 1991 for Rs.
58,000 and on the same date purchased a new machinery for Rs. 1,00,000.
Depreciation is provided at 20% p.a. on the original cost method. Accounts are
closed each year on 31 December. Show the Machinery Account for three years
st
st
Dr.
Machinery Account
Cr.
Date
Particulats
J.F.
Amount
Date
Particulars
J.F.
Amount
1991
1991
May 1
To Bank A/c
90,000
Dec.31
12,000
Dec.31
By depreciation A/c
(for 8 months)
By Balance C/d
78,000
90,000
90,000
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1992 1992 Jan1 To Balance B/d To Bank A/c 78,000 Dec31 By Depreciation A/c July1
1992
1992
Jan1
To Balance B/d
To Bank A/c
78,000
Dec31
By Depreciation A/c
July1
40,000
(i)
18,000
(ii)
4,000
22,000
Dec31
(for 6 months)
By Balance C/d
(i)
60,000
(ii)
36,000
96,000
1,18,000
1,18,000
1993
1993
Jan1
To Balance B/d
(i) 60,000
Mar.31
58,000
Mar.31
4,500
(ii)
36,000
96,000
By Bank A/c
By Dep. A/c
(for 3 months)
Mar.
To Bank A/c
1,00,000
Dec. 31
By Dep. A/c
31
(ii)
8,000
23,000
Mar.
To Profit & Loos
(iii)
15,000
31
A/c (Profit On
machine)
Rs. 58,000+
4,500-60,000
2,500
Dec.31
By Bal. C/d
(ii)
28,000
(iii)
85,000
1,13,000
1,98,500
1,98.500
1994
Jan.1
To Bal. B/d
1,13,000
(ii)
28,000
(iii) 85,000
Q.
Discuss the Merits And Demerits Of Providing Depreciation By
Diminishing Balance Method?
Ans.
Written Down Value Method
:– Under this method, as the value of asset

goes on diminishing year after year, the amount of depreciation charged every year also goes on declining.

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For Example if a machine is purchased for Rs. 10,000 and depreciation is to be

For Example if a machine is purchased for Rs. 10,000 and depreciation is to be charged at 10% p.a. according to written down value method, the depreciation will be charged as under:-

1 Year on Rs. 10,000 @ 10%

st

2 Year on Rs. 9,000 (10,000-1,000) @ 10%

3 Year on Rs. 8,100 (9,000-900) @ 10%

and so on.

nd

rd

=1,000

= 900

= 810

Easy Calculation :– method, even if some new assets are purchased year after year. Equal
Easy Calculation :–
method, even if some new assets are purchased year after year.
Equal Charge against income :–
remains almost equal year after year.
No induce pressure in later years :–
years should be more in comparison to the later years.
Balance of asset is never written off to zero :–
the assets is never reduced to zero.
Approved method by Income Tax Authorities :–
providing depreciation is permissible under Income Tax Regulations.
Asset can not be completely written off. :–
Omission of Interest Factor :–

consideration the loss of interest on the amount invested in the asset.

Difficulty in determining the rate of depreciation :–

method, the rate of providing depreciation cannot be easily decided.

It will be observed from the above calculations that each years depreciation is calculated on the book value of the asset at the beginning of that year, rather than on the original cost. As the value of asset and also the depreciation charged on its goes on reducing year after year, this method is known as Reducing Installment Method.

Merits of Written Down Value Method :–

1.

It is easy to calculate the depreciation under this

2.

In this method, the total burden on

profit & Loss account in respect of depreciation and repairs put together

3.

The efficiency of machine is more in

the earlier years than in later years. Hence, the depreciation in first few

4.

5.

This method ensures that

This method of

Demerits of Written Down Value Method :–

1.

Under this method, the value

of an asset, even if it becomes obsolete and useless, cannot be reduced to

zero and some balance, however small, would continue on asset account.

2.

3.

This method does not take into

Under this

Knowledge of original cost & up to date depreciation not possible :– Under this method, the original cost of various assets is not shown in the Balance Sheet.

Example :– A company had bought machinery for Rs. 100000 including there

4.

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in a boiler worth Rs 10000 depreciation was charged on reducing balance method at the rate of 10% p.a. for first five year and machinery account was credited accordingly. During the fifth year, the boiler becomes useless on account of damages. The damaged boiler is sold for Rs. 2000 prepares the machinery account for five years.

MACHINERY ACCOUNT

Dr. Cr. Date Particulars Amount Date Particulars Amount Year To Bank A/c 90000 Year By
Dr.
Cr.
Date
Particulars
Amount
Date
Particulars
Amount
Year
To Bank A/c
90000
Year
By Dep.
Ist
To Bank A/c
10000
Ist
(i)
9000
10000
(Boiler)
(ii)
1000
By Bal. C/d
(i)
81000
(ii)
9000
9000
100000
100000
Year
To Bal. B/d
Year
By Dep.
II
(i)
81000
II
(i)
8100
(ii)
9000
(ii)
900
9000
90000
By Bal. C/d
(i)
72900
81000
(ii)
8100
90000
90000
Year
To Bal. B/d
Year
By Dep.
III
(i)
72900
III
(i)
7290
(ii)
8100
(ii)
810
81000
By Bal. C/d
8100
(i)
65,610
(ii)
7290
81000
81000
Year
To Bal. B/d
Year
By Dep.
IV
(i)
65610
72900
IV
(i)
6561
7290
(ii)
7290
(ii)
729
By Bal. C/d
(i)
59049
65610
(ii)
6561
72900
72900
Year
To Bal. B/d
Year
By Bank
2000
V
(i)
59049
V
By P & L A/c
4561
(ii)
6561
65610
(6561-2000)
By Dep.
By Bal. C/d
5905
53144
65610
65610
Year
To bal B/d
53144
VI
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Q. What do you mean by Final Accounts? What is their Necessity? Ans. Final Accounts

Q.

What do you mean by Final Accounts? What is their Necessity?

Ans.

Final Accounts :–

Financial Statements refers to such statements which

report the profitability and the financial position of the business at the end of

accounting period. The term financial statements include the following:-

(1) Trading Account (2) Profit and Loss Account. (3) Balance Sheet (1) Trading Account :–
(1)
Trading Account
(2)
Profit and Loss Account.
(3)
Balance Sheet
(1) Trading Account :– Trading account is prepared for calculating the gross
profit or gross loss arising or incurred as a result of the trading activities of
a business. In other words, it is prepared to show the result of
manufacturing, buying and selling of goods.
Need and Importance of Trading Account :–
(i)
It provides information about Gross Profit and Gross Loss.
(ii)
It provides information about the direct expenses.
(iii)
Comparison of closing stock with those of the previous years.
(iv)
It provides safety against possible losses.
Format of a Trading Account: Trading Account
(for the year ending————————————)
Dr.
Cr.
Particulars`
Amount
Particulars
Amount
Rs.
Rs.
To Opening Stock
To Purchases
Less : Purchase Reture
OR
Return Outward
To Wages
To Wages & Salaries
To Direct Expenses
To Carriage or
To Carriage Inwards or
To Carriage on Purchase
To Gas, Fuel and Power
To Freight, Octroi and Cartage
To Manufacturing Expenses
or Productive Expenses.
To Factory Expense, Such as
Factory Lighting, Factor Rent Etc.
To Dock Charges
To Import duty or Custom Duty
To Royalty
To Gross Profit
Transferred to P & L A/c
(Balancing Figure)
By Sales
Loss Sales Return
OR
Returns In wards
By Closing Stock
By Gross Loss (if any)
Transferred to P & L A/c
(Balancing Figure)
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(2)

Profit & Loss Account :–

Trading account only disclose the gross profit

earned as a result of buying and selling of goods. However, a businessman has to incurr a number of expenses which are not taken into trading account. Hence a businessman is more interested in knowing the net profit earned or net loss incurred during the year.

A profit and loss account is an account into which all gains and losses are collected, in order to ascertain the excess of gains over the losses or vice- versa.

Need and Importance of Profit & Loss Account :– (i) To Ascertain the Net Profit
Need and Importance of Profit & Loss Account :–
(i)
To Ascertain the Net Profit & Net Loss
(ii)
Comparison with previous year’s profit.
(iii)
Control on Expenses
(iv)
Helpful in preparation of the balance Sheet
Format of Profit And Loss Account : Profit And Loss A/c
(
for the year ending
)
Particulars`
Amount
Particulars
Amount
Rs.
Rs.
To Gross Profit B/d
(transferred from trading A/c)
By Gross Prfit B/d
(Transferred from trading
A/c)
To Office Expenses :
To Salaries
To Salaries & Wages
To Rent, Rate and Taxes
To Printing & Staionery
To Lighting
To Telephone Charges
To Audit Fees etc.
By Rent form tenant
By Discount Received
By Commission Received
By Any Other Income
By Net Loss (if any)
Transferred to Capital A/c
To Selling & Distribution Expense:
To Carriage outward or Carriage
on sales
To Advertisement
To Commission
To Bed-Debts
To Export Duty
To Parcking Exp etc.
To Miscellaneous Expenses :
To Discount/Discount Allowed
To Repairs
To Depreciation
To Interest
To Bank Charges etc.
To Net Profit
(Transferred to Capital A/c)
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(3) Balance Sheet :– After ascertaining the net profit or net loss of the business

(3)

Balance Sheet :–

After ascertaining the net profit or net loss of the

business enterprise, the businessman would also like to know the exact financial position of his business. For this purpose a statement is prepared which contains all the assets and liabilities of the business enterprise. The statement so prepared is called a Balance Sheet.

Balance Sheet (As on Or As At --------------)

Particulars` Amount Particulars Amount Rs. Rs. Current Liabilities : Current Assets : Bank Overdraft Bill
Particulars`
Amount
Particulars
Amount
Rs.
Rs.
Current Liabilities :
Current Assets :
Bank Overdraft
Bill Payable
Sundry Creditors
Outstanding Expenses
Unearned Income
Fixed Liabilities :
Long Term Loans
Cash-in-Hand
Cash at Bank
Bills Receivables
Short Term Investments
Sundry Debtors
Closing Stock
Prepaid Expenses
Accrued Income
Reserves:
Fixed Assets:
Capital:
Add: Net profit
Less: Drawings
Less: Income Tax
Less: Life Insurance Premium
Less: Net Loss
Furniture
Loose Tools
Motor Vehicle
Long-term investments
Plant & machinery
Land & Building
Patents
Goodwill
Need and Importance of Balance Sheet :–
1.
2.
3.

The main purpose of preparing balance sheet is to ascertain the true financial position of the business at a particular point of time. It gives exact information about the exact amount of capital at the end of the year and the addition or deduction made into it in the current year It helps in finding out whether the firm is solvent or not.

4.

It helps in preparing the opening entries at the beginning of the next year.

Q.

What is the necessity of doing adjustments? Give some adjustment entries with their explanation.

Ans.

Adjustments :–

In order to ascertain the true profit or loss of the business

for a particular year, it is necessary that all expenses and incomes relating to that year are taken into consideration. For example, if we want to ascertain the net profit for the year ended on 31 December and rent for the month of

st

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December has not yet been paid, it would be proper to include such rent along with the other expenses of the year. Similarly, it often happens that certain incomes, like interest, dividend, etc. are earned but not received during the year. Adjustment for such incomes must be made in the current year itself, so that the profit and loss account may disclose the correct amount of net profit or loss and the balance sheet may present the true financial position of the business.

Simply stated, while preparing final accounts it must be detected whether there is a transaction

(i) Which has been omitted to be recorded in the books, or (ii) Which has
(i)
Which has been omitted to be recorded in the books, or
(ii)
Which has been wrongly recorded in the books, or
(iii)
Of which only one aspect has been recorded in the books.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
Closing Stock :–
Treatment in Final Accounts :–
(i)

Entries passed for such transactions are called adjustment entries.

Need of Adjustments :–

To ascertain the true Net Profit or loss of the business. To ascertain the true financial position of the business. To make a record of the transactions omitted from the books To rectify the errors committed in the books of accounts To make a record of such expenses which have been accrued but have not been paid. To make a record of such incomes which have accrued but have not been received. To provide for depreciation and other provisions.

Explanation of Important Adjustments :–

(1)

The amount of goods unsold at the end of the year is

called closing stock. It is valued at Cost Price or Realisable Value, whichever is less. The basic principle underlying the valuation of closing stock is that anticipated losses should be taken into account, but all unrealized gains should be ignored.

If the closing stock appears outside the Trial Balance, it will be shown at two places, i.e., on the Credit side of the Trading A/c and on the Assets side of the Balance Sheet.

(2)

(ii) If the closing stock appears inside the Trial Balance, it will be shown only on the Assets side of the Balance Sheet.

These are the

Outstanding Expenses Or Expenses Due but not Paid :–

expenses which have been incurred during the year but have been unpaid

on the date of preparation of final accounts.

Treatment in Final Accounts :–

(i) If outstanding expenses have been mentioned inside the Trial

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Balance, they will be shown on the liabilities side only. (ii) If outstanding expenses have

Balance, they will be shown on the liabilities side only.

(ii) If outstanding expenses have been mentioned outside the Trial Balance, then on the one hand, it will be added to the concerned expenses on the debit side of Trading or Profit and Loss Account and on the other hand, will also be shown on the liabilities side of the Balance Sheet.

Prepaid expenses Or Unexpired Expenses Or Expenses Paid in

Advance :– These are the expenses which have been paid in advance for the next year during the current year itself.

(3)

Treatment in Final Accounts :– (i) (ii) Depreciation :– due to their constant use and
Treatment in Final Accounts :–
(i)
(ii)
Depreciation :–
due to their constant use and expiry of time.
Accrued Income or Income Receivable :–
Treatment in Final Accounts :–
(i)
(ii)

If Prepaid expenses have been mentioned inside the Trial Balance, they will be shown on the Assets side only. If Prepaid expenses have been mentioned outside the Trial Balance, then on the one hand, it will be deducted from the concerned expenses on the debit side of Trading or Profit and Loss Account and on the other hand, will also be shown on the Assets side of the Balance Sheet.

(4)

Depreciation is the loss or fall in the value of fixed assets

Treatment in Final Accounts :– Depreciation on the one hand, will be shown on the debit side of the Profit and Loss Account and on the other hand, will also be deducted from the value of the concerned asset on the Asset side of the Balance Sheet.

(5)

It is quite common that certain

items of income such as interest, commission etc are earned during the current year but have not been actually received by the end of the current year. Such incomes are known as Accrued Incomesor Earned Incomes

If accrued incomes have been mentioned inside the Trial Balance, they will be shown on the Assets side only. If Accrued incomes have been mentioned outside the Trial Balance, then on the one hand, It will be shown on the credit side of the Profit & Loss Account and on the other hand, will be shown on the assets side of the Balance Sheet.

It may also

happen that a certain income is received in the current year but the whole

Unearned Income Or Income Received in Advance :–

(6)

amount of it does not belong to the current year. Such portion of this income which belongs to the next year is known as Unearned Income or Income received but not earned.

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Treatment in Final Accounts :–

(i)

If Unearned incomes have been mentioned inside the Trial Balance, they will be shown on the Liabilities side only.

(ii)

If Accrued incomes have been mentioned outside the Trial Balance, then on the one hand, It will be deducted from the concerned income on the Credit side of the Profit & Loss Account and on the other hand, will be shown on the Liabilities side of the Balance Sheet.

(7)

(8)

(9)

Interest on Capital :–

Usually in order to ascertain the true efficiency of

by the proprietor in the business. Interest on Drawings :– interest on drawings. Interest on
by the proprietor in the business.
Interest on Drawings :–
interest on drawings.
Interest on Loan :–
(i)
(ii)

the business, interest at a normal rate is charged on the capital invested

Treatment in Final Accounts :– Interest on capital is an expense for the business and hence it is shown on the debit side of Profit & Loss Account. At the same time, it is a gain to the proprietor and hence is added to his capital.

Occasionally, the proprietor draws cash or goods

for his personal use. Such withdrawals are terms as Drawings. If the firm pays interest on capital, it is fully justified that it should also charge

Treatment in Final Accounts :– Interest on drawings is a gain to the business and hence it is shown on the credit side of Profit & Loss Account. At the same time, it is an expense from the proprietors view and hence will be deducted from the capital.

Generally, item of Loan appears on the credit side of the Trial Balance. It means that the amount has been borrowed from some person or the bank etc. Loan is a liability of the firm and the interest on such loan will be an expense. It up-to-date interest has not been paid on the Loan, the unpaid interest will have to be calculated and will be treated just like outstanding expenses. Treatment in Final Accounts :When Loan appears on the credit side of the Trial Balance, interest on it will be an expense and hence will be recorded on the debit side of Profit & Loss Account. Outstanding amount of such interest will also be added to Loan Account on the Liabilities side of the Balance Sheet. On the contrary, if the item of loan appears on the debit side of Trial Balance, it will mean that the amount has been lent to outsider. It will be an asset in this case and interest on such loan will be an income for the firm.

Treatment in Final Accounts :– When Loan appears on the Debit side of the Trial Balance, interest on it will be an income and hence will be recorded on the credit side of Profit & Loss Account and will also be added to Loan Account on the assets side of the Balance Sheet.

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(10) (11) (12) (13) (14) Bad Debts :– as Debtors. Sometimes due to the dishonesty,

(10)

(11)

(12)

(13)

(14)

Bad Debts :–

as Debtors. Sometimes due to the dishonesty, death or insolvency of a debtor, full amount is not received from him. When it becomes certain that a particular amount will not be recovered it is known a s B a d - Debts.

Treatment in Final Accounts :–

(i)

Persons to whom goods have been sold on credit are known

If Bad-debts are given in the adjustments or outside the Trial Balance, they will be shown on the debit side of the Profit & Loss Account and will also be deducted from the Debtors on the assets side of the Balance Sheet.

(ii) Provisions for Bad and Doubtful Debts :– Provisions for Discount on Debtors :– Provisions
(ii)
Provisions for Bad and Doubtful Debts :–
Provisions for Discount on Debtors :–
Provisions for Discount on Creditors :–
Sundry Creditors on the Liabilities side of the Balance Sheet.

If Bad-Debts are given inside the trial balance, it will be shown on the debit side of the Profit & Loss Account.

Even after deducting the

amount of actual bad-debts from the debtors, the list of debtors at the end of the year include some debts which are either bad or doubtful. A provision is created to cover any possible loss on account of bad-debts likely to occur in future. Such a provision is created at a fixed percentage on debtors every year and is called provisions for bad and doubtful debts.

Treatment in Final Accounts :The amount of provision for doubtful debts on the one hand, is shown on the debit side of the Profit and Loss Account and on the other hand, is deducted from Sundry debtors on the assets side of the Balance Sheet.

It is a normal practice in the

business to allow cash discount to those debtors from whom the payment is received promptly or with a fixed period. Discount thus allowed will be an expense of the business. It should be noted that discount will be allowed only to those debtors who will make prompt payment.

Treatment in Final Accounts :– Such provision is shown on the debit side of the profit & loss account and is also deducted from Sundry Debtors on the Assets side of the Balance Sheet.

Such provision is shown on the

credit side of the Profit & Loss account and is also deducted from the

Abnormal Loss :–

Sometimes losses occur due to some abnormal

circumstances such as accident, fire, flood, earthquakes etc. Such losses

are called abnormal losses. These may be divided into two categories:

(i) Loss of Goods :– It will be that on the one hand, the loss
(i)
Loss of Goods :– It will be that on the one hand, the loss of goods will
deducted from the purchase on the Debit side of Trading Account and
it will also be shown on the debit side of Profit & Loss Account
(ii)
Loss of Fixed Assets :– If some fixed assets of the firm is destroyed by
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(15)

(16)

(17)

(18)

(19)

some accident, then the loss will be shown on the debit side of P&L A/c and also deducted from the value of Asset on the assets side of the Balance Sheet.

Charity in the Form of Goods :–

given away as charity. On the one hand, the amount will be deducted from purchase and on the other hand it will also be shown on the debit side of P&L A/c.

Goods Distributed as Free Samples :–

Occasionally, certain amount of goods is

Drawings in Goods :– Deferred Revenue Expenditure :– Manager’s Commission on Net Profit :– regular
Drawings in Goods :–
Deferred Revenue Expenditure :–
Manager’s Commission on Net Profit :–
regular salary, the manager is entitled to a commission on net profit.
Methods of Calculating the Commission :–
(i) On Profits before charging such commission: The formula is:
Rate

Sometimes the goods which the

business deals in are distributed as free samples for the purpose of advertising these goods. On the one hand, the amount will be deducted from purchase and on the other hand it will also be shown on the debit side of P&L A/c.

If the proprietor of the business has taken some

goods for his personal use from the business, it is known as Drawings in

Goods. It will be deducted from purchase in the Trading Account and will also be deducted from the Capital on the liabilities side of the Balance Sheet as Drawings.

There are certain expenditures which

are revenue in nature but the benefit of which is likely to be derived over a

number of years. Such Expenditures are termed as Deferred Revenue Expenditure. As such, the whole of such expenditure is not debited to the Profit and Loss Account of the current year but spread over the years for which the benefit is likely to last. Thus, only a part of such expenditure is taken to Profit & Loss Account every year and the unwritten off portion is allowed to stand on the assets side of the Balance Sheet.

Sometimes, in addition to his

Treatment in Final Accounts :– On the one hand, it will be recorded on the debit side of P& L A/c and on the other hand, shown on the liabilities side as an outstanding expense.

Managers Commission = Net Profit x ————

100

(ii) On Profits after charging such commission: The formula is:

Rate Managers Commission = Net Profit x ———————— 100 + Rate

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MBA 1st Semester (DDE)

UNIT – II Q. What is Ratio Analysis? Explain its Objectives and Limitations. Also give
UNIT – II
Q.
What is Ratio Analysis? Explain its Objectives and Limitations. Also
give its classification.
Ans. Absolute figures expressed in monetary terms in financial
Ratio
:–
statements by themselves are meaningless. These figures often do not convey
much meaning unless expressed in relation to other figures. Thus, we can say
that the relationship between two figures, expressed in arithmetical terms is
called a ‘ratio.’
According to R.N. Anthony
A ratio is simply one number expressed in terms of another. It found by dividing
one number into the other.
Ratio Analysis discloses the position of business, so it is a very important tool of
financial analysis. But ratio analysis suffers from a no. of limitations. These
limitations should be kept in mind while making use of the Ratio Analysis.
Objectives of Ratio Analysis :–
(1)
Helpful in Analysis of Financial Statements :–
Ratio analysis is an
extremely useful device for analyzing the financial statement. It helps the
bankers, creditors, investors, shareholder etc. in acquiring enough
knowledge about the profitability and financial health of the business.
(2)
Simplification of Accounting Data :–
Accounting ratio simplifies and
summarizes a long array of accounting data and makes them
understandable. It discloses the relationship between two such figures
which have a cause and effect relationship with each other.

(3)

Helpful in Comparative Study :–

comparison of profitability and financial soundness can be made between one firm and another in the same industry. Similarly, comparison of current year figures can also be made with those of previous years with the help of ratio analysis.

With the help of ratio analysis

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(4)

Current years

ratios are compared with those of the previous years and if some weak

Helpful in Locating the Weak Spots of the Business :–

spots are thus located, remedial measures are taken to correct them.

Helpful in Forecasting :–

forecasting and preparing the plans for the future.

Estimate about the Trend of the Business :–

(5)

(6)

Accounting ratios are very helpful in

If accounting ratios are

profits and other important facts. Fixation of Ideal Standards :– Effective Control :– Study of
profits and other important facts.
Fixation of Ideal Standards :–
Effective Control :–
Study of Financial Soundness :–
False accounting date gives false ratios :–

prepared for a number of years, they will reveal the trend of costs, sales,

(7)

Ratio helps us in establishing ideal

standards of the different items of the business. By comparing the actual ratios calculated at the end of the year with the ideal ratios, the efficiency of the business can be easily measured.

(8)

Ratio Analysis discloses the liquidity, solvency and

profitability of the business enterprise. Such information enables management to assess the changes that have taken place over a period of time in the financial activities of the business. It helps them in discharging their managerial functions, e.g. planning, organizing, directing, communicating and the controlling more effectively.

(9)

Ratio analysis discloses the position of

business with different view-points. It discloses the position of business with the liquidity point of view, solvency point of view, profitability point of view etc. With the help of such a study we can draw conclusions regarding the financial health of the business enterprise.

Limitations of Ratio Analysis :–

1.

Accounting ratios are

calculated on the basis of data given in profit & Loss account and balance-

sheet. There are certain limitations of financial statements, and hence the ratios calculated on the basis of such, financial statements will also have the same limitation.

Comparison not possible if different firms adopt different accounting

policies :– There may be different accounting policies adopted by different

firms with regard to providing depreciation etc. For example, one firm may

2.

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adopt the policy of charging dep. On Straight Line Method, while other may charge on

adopt the policy of charging dep. On Straight Line Method, while other

may charge on written-down-value method. Such difference makes the

accounting ratios incomparable.

3.

4.

5.

6.

7.

8.

Ratio Analysis becomes Less Effective Due to Price Level Changes :–

Price level over the years goes on changing, therefore, the ratios of various

years cannot be compared.

Ratios may be misleading in the absence of absolute data :– Limited Use of a
Ratios may be misleading in the absence of absolute data :–
Limited Use of a Single Ratio :–
conclusion.
Lack of Proper Standard :–
actual ratio may be compared.
Ratios alone are not adequate for Proper Conclusions :–

For e.g. X

Co. produces 10 Lakh meters of cloth in 1992 and 15 Lakh meters in 1993, the progress is 50%. Y Co. raises production from 10 thousand meters in 1992 to 20 thousand meters in 1993, the progress is 100%. Comparison of these two firms made on the basis of ratio will disclose that the second firm is more active that the first firm. Such conclusion is quite misleading because of the difference in size of the two firms, it is therefore essential to study the ratios along-with the absolute data on which they are base.

The analyst should not merely rely on a

single ratio. He should study several connected ratios before reaching a

Circumstances differ from firm to firm hence

no single standard ratio can be fixed for all the firms against which the

Ratios derived

from analysis of statements are not sure indicators of good or bad financial position and profitability of a firm. They merely indicate the probability of favorable or unfavorable position. The analyst has to carry out further investigations and exercise his judgment in arriving at a correct diagnosis.

Effect of Personal ability and bias of the Analyst :–

point to keep in mind is that different persons draw different meaning of different terms. One analyst persons draw different meaning of different terms. One analyst may calculate ratios on the basis of profit after interest and tax, while other may consider profit after interest but before tax

Another important

Classification of Ratios :– Ratios may be classified into the four categories. Classification of ratios can be explained with the help of following diagram:

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Classification of Ratios

Liquidity Ratios Or Short-term Solvency Ratios Leverage Or Capital Structure Ratios Activity Or Profitability
Liquidity Ratios
Or Short-term
Solvency Ratios
Leverage Or
Capital Structure
Ratios
Activity Or
Profitability
Turnover
Ratios
Ratios
Current Ratio
Liquid Ratio
Debt Equity Ratio
Debt to Total Funds
Ratio
Proprietary Ratio
Fixed Assets to
Proprietor’s fund Ratio
Capital Gearing Ratio
Interest Coverage Ratio
Stock Turnover Ratio
Debtors Turnover Ratio
Average Collection Period
Creditors Turnover Ratio
Average Payment Period
Fixed Assets Turnover
Ratio
Working Capital
Turnover Ratio
Profitability Ratios
based on Sales
Profitability Ratios based
on Investment
Gross Profit Ratio
Net Profit Ratio
Operating Ratio
Expenses Ratios
Return on Capital Employed
Return on Shareholder’s Fund
(i) Return on Total
Shareholder’s Funds
(ii)
Return on Equity’s
Shareholder’s funds
(iii) Earning Per Share
(iv) Dividend per Share
(v)
Price Earning Ratio
Q.
Explain the Important Ratios calculated for Evaluating the Short-
Term Solvency Position of a Company.

OR

Q. Explain the Liquidity Ratios in detail.

Ans. Liquidity Ratios :– Liquidityrefers to the ability of the firm to meet its

current liabilities. The liquidity ratios, therefore, are also called Short-term

Solvency Ratios.These ratios are used to assess the short-term financial position of the concern.

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Liquidity ratios include two ratios :– 1. Current Ratio:– This ratio explains the relationship between

Liquidity ratios include two ratios :–

1. Current Ratio:– This ratio explains the relationship between current assets

and current liabilities of a business. The formula for calculating the ratio is:

Current Ratio

=

Current Assets —————————————— Current Liabilities

Current Assets :– Current assets include those assets which can be converted into cash within a years time.

CONSTITUENTS OF CURRENT ASSETS 1. Cash-in-hand and Bank balances 2. Bills Receivables 3. Sundry Debtors
CONSTITUENTS OF CURRENT ASSETS
1.
Cash-in-hand and Bank balances
2.
Bills Receivables
3.
Sundry Debtors (less provision for bad debts)
4.
Short-term Loans and Advances
5.
Inventories of Stock, as :
(a)
Raw materials,
(b)
Work-in process
(c)
Stores and spares
(d)
Finished goods
7.
Prepaid Expenses
8.
Accrued Incomes
CONSTITUENTS OF CURRENT LIABILITIES
1. Bills Payables
2. Sundry Creditors or Accounts Payable
3. Accrued or Outstanding Expenses
4. Short-term Loans, Advances and Deposits.
5. Dividends Payables.
6. Bank Overdraft
7. Provision for Taxation, if it does not amount to
appropriation of profits

Current Liabilities :All liabilities which are payable within one year are known as current liabilities.

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Ideal Ratio :– According to accounting principle, a current ratio of 2:1 is supposed to be an ideal ratio. It means that current assets of a business should, atleast, be twice of its current liabilities. The reason of assuming 2: 1 as the ideal ratio is that the current assets include such assets as stock, debtors etc., from which full amount cannot be realized in case of need. Hence, even half the amount is realized from the current assets on time, the firm can still meet its current liabilities in full.

Significance :– This ratio is used to assess the firms ability to meet its short- term liabilities on time. According to accounting principle, a current ratio of 2:1 is assumed to be an ideal ratio. If the current ratio is less than 2:1, it indicates lack of liquidity and shortage of working capital. But a much higher ratio, even though it is beneficial to the short-term creditors, is not necessarily good for the company. A much higher ratio than 2:1 may indicate the poor investment policies of the management. A much higher ratio may be considered to be adverse from the view point of management on account of the following reasons:

2.

Liquid ratio explains the relationship between liquid

Liquid Ratio :– Liquid Ratio = Liquid Assets ————————————- Current Liabilities CONSTITUENTS
Liquid Ratio :–
Liquid Ratio =
Liquid Assets
————————————-
Current Liabilities
CONSTITUENTS OF LIQUID ASSETS
1. Cash-in-hand and Bank balances
2. Bills Receivables
3. Sundry Debtors (less provision for bad debts)
4. Short-term Loans and Advances
5. Temporary Investment of Surplus Funds
6. Accrued Incomes

assets and current liabilities of a business. The formula for calculating the ratio is :

Liquid Assets :– Liquid assets include those assets which will yield cash very shortly. All current assets except stock and prepaid expenses are included in liquid assets.

OR Liquid Assets= Current Assets- Stock – Prepaid Expenses

Ideal Ratio :– According to accounting principle, a liquid ratio of 1:1 is supposed to be an ideal ratio. It means that liquid assets of a business should, atleast, be equal to its current liabilities. The higher the ratio, the better it is, because the firm will able to pay its current liabilities more easily.

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Significance :– An ideal Liquid ratio is said to be 1:1. If it is more,

Significance :– An ideal Liquid ratio is said to be 1:1. If it is more, it is considered to be better. The idea is that for every rupee of current liabilities, there should atleast be one rupee of liquid assets. This ratio is a better test of short-term financial position of the business other than the current ratio, as it considers only those assets which can be easily and readily converted into cash. Liquid ratio thus is a more rigorous test of liquidity than the current ratio and, when used together with current ratio, it gives a better picture of the short- term financial position of the business.

Q. Explain the Important Ratios Calculated for Evaluating the Long - Term Solvency Position of
Q.
Explain the Important Ratios Calculated for Evaluating the Long -
Term Solvency Position of a Company.
OR
Q.
Explain the Capital Structure Ratios in detail
Ans. Capital Structure Ratios :– These ratios are calculated to assess the
ability of the firm to meet its long term liabilities when they become due. Long
term creditors including debenture holder and primarily interested to know
whether the co. has ability to pay regular interest due to them and to repay the
principal amount when it become due. These ratios includes the following
ratios:-
These ratios include the following:
1.
Debt Equity Ratio :–
Debt
Debt Equity Ratio= —————
Equity
OR
Long term Loans
—————————————
Shareholder’s funds
Debt :– These refer to long-term liabilities which mature after one year. These
include Mortgage Loan, Debenture, Bank Loan, Loan from financial
institutions, Public Deposits etc.
Shareholder’s Funds :–
Equity Share Capital, Preference Share capital,
Securities premium, General Reserve, Capital Reserve, other reserves and
credit balance of profit & loss a/c.
However, accumulated losses and fictitious assets remaining to the written off
like preliminary expenses, underwriting commission, share issue expense etc,
should be deducted.

Significance :– This ratio is calculated to assess the liability of the firm to meet its long-term liabilities. Generally, debt equity ratio of 2:1 is considered safe. If the debt equity ratio is more that that, it shows a rather risky financial position from the long term point of view, as it indicates that more and more funds invested business are provided by long-term lenders. A high debt equity ratio is a danger-signal for long-term lenders.

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2. Debt to Total Funds Ratio :–

Debt Debt to total funds ratio= ————— OR Debt+ Equity

Long term loans ———————————————————— long term loans+ shareholders Funds

Generally, debt to total fund ratio is (.67:1) is considered

satisfactory. In other words, the proportion of long term loans should not more than 67% of total funds. A high ratio than this is generally treated an indicator of risky financial position from the long-term point of view, because it means

Significance :–

Proprietary Ratios :– Equity Proprietary Ratio = —————————— Equity + Debt Fixed Assets to
Proprietary Ratios :–
Equity
Proprietary Ratio = ——————————
Equity + Debt
Fixed Assets to Proprietor’s Ratio :–
Fixed Assets
Fixed Assets to Proprietor’s Ratio= ———————————————
Proprietor’s funds (net worth)
Capital Gearing Ratio :–

that the firm depends too much upon outside loans for its existence.

3.

Significance :– This ratio should be 33% or more than that. In other words, the proportion of shareholders funds to total funds be 33% or more. A higher proprietary ratio is generally treated an indicator of sound financial position from long-term point of view.

4.

Significance :– The ratio indicates the extent to which proprietors funds are sunk into fixed assets. Normally, the purchase of fixed assets should be financed by proprietors funds. If this ratio is less than 100%, it would mean that proprietors funds are more than fixed assets and a part of working capital is provided by the proprietors.

5.

Equity Share Capital+ Reserves + P&L (Cr.) Balance Capital Gearing Ratio=——————————————————————————— Fixed Cost bearing capital

Fixed Cost bearing capital = Preference share capital+ Debenture+ Long term loans

Significance :A high gearing will be beneficial to equity shareholders when the rate of interest/dividend payable on fixed cost bearing capital is lower than the rate of return on investment in business.

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6. Interest Coverage Ratio :– Net Profit before interest & tax Interest Coverage Ratio =

6. Interest Coverage Ratio :–

Net Profit before interest & tax Interest Coverage Ratio = —————————————————— Fixed Interest Charges

Significance :– This ratio indicates how many times the interest charges are covered by the profits available to pay interest charges. A long term lenders in finding out whether the business will earn sufficient profits to pay the interest charges regularly. The higher ratio more secure the lender is in respect of payment of interest regularly. An interest coverage ratio of 6 to 7 times is considered appropriate.

Q.

Ans. Activity Ratios :– These ratios are calculated on the basis of cost of sales

Explain the Activity Ratios Or Turnover Ratios in detail. Inventory Turnover Ratio :– Inventory Turnover
Explain the Activity Ratios Or Turnover Ratios in detail.
Inventory Turnover Ratio :–
Inventory Turnover Ratio
=
Cost of Goods Sold
—————————————
Average Stock
Cost of goods sold can be calculated by two ways :–
Cost of Goods Sold = Sales – Gross Profit
OR

or sales, therefore, these ratios are also called as Turnover Ratios. Turnover indicates the speed or number of items the capital employed has been rotated in the process of doing business. In other words, these ratios indicated how efficiently the capital is being used to obtain sales; how efficiently the fixed assets are being used to obtain sales; and how efficiently the working capital and stock is being used to obtain sales. Higher turnover ratios indicate the better use of capital or resources and in turn lead to higher profitability. Turnover ratios include the following:

1)

This ratio indicates whether inventory has

been efficiently used or not. This ratio indicates the relationship between

the cost of goods sold during the year and average stock kept during that year. The formula for calculating the ratio is :

Cost of Goods Sold = Opening Stock + Purchases + Carriage + Wages + Other Direct Expenses Closing Stock

Opening Stock + Closing Stock Average Stock = ——————————————————

2

Significance :– This ratio shows the speed with which the stock is rotated into sales or the number of times the stock is turned into sales during the year. The higher the ratio, the better it is, since it indicates that stock is selling quickly. In

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a business where stock turnover ratio is high, goods can be sold at a low margin of profit and even then the profitability may be quite high.

This ratio indicates the time within which the

stock is converted into sales. This ratio is computed by the following formula:

12months/ 52 weeks/ 365 days Inventory Holding Period = —————————————————— Stock Turnover Ratio

(2)

Inventory Holding Period :–

Debtors Turnover Ratio :– calculating the ratio is: Net Credit Sales Debtors Turnover Ratio =
Debtors Turnover Ratio :–
calculating the ratio is:
Net Credit Sales
Debtors Turnover Ratio = ————————————————————
Average Debtors + Average B/R
Net Credit Sales = Total Sales – Cash Sales
Opening Debtors + Closing Debtors
Average Debtors = ————————————————————————
2
Opening B/R + Closing B/R
Average B/R = —————————————————
2

Inventory holding period can be calculated in days or months or weeks.

(3)

This ratio indicates the relationship between

credit sales and average debtors during the year. The formula for

Bills receivable are added in debtors for the purpose of calculation of this ratio. While calculating this ratio, provision for bad and doubtful debts is not deducted from total debtors, so that it may not give a false impression that debtors are collected quickly. Debtors turnover ratio can be calculated on the basis of total sales instead of credit sales.

Significance :– This ratio indicates the speed with which the amount is collected from debtors. The higher the ratio, the better it is, since it indicates that amount from debtor is being collected more quickly. The more quickly the debtors pay, the less the risk from bad debts, and so the lower the expenses of collection and increase in the liquidity of the firm.

(4)

the amount is collected from debtors and bills receivable. This ratio can be computed by the following three formulas:

Average Collection Period :–

This ratio indicates the time within which

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First Formula :– Average Debtors + Average B/R Average Collection Period =

First Formula :–

Average Debtors + Average B/R Average Collection Period = —————————————————— Credit Sales per day

Net Credit Sales of the Year Credit Sales per Day = ———————————————— 365 Second Formula
Net Credit Sales of the Year
Credit Sales per Day = ————————————————
365
Second Formula :–
Average Debtors x 365
Average Collection Period = ————————————————
Net Credit Sales
Third Formula :–
12 months/ 365 days/ 52 weeks
Average Collection Period = —————————————————
Debtor Turnover Ratio
Significance :– This ratio shows the time in which the customers are paying for
credit sales. For example, in a business average collection period is 30 days. It
means that, on an average, if sale is made today, the cash will be collected
actually after 30 days, i.e., 30 days credit sales are locked up in debtors.
(5)
Creditors Turnover Ratio :–
This ratio indicates the relationship between
credit purchases and average creditors during the year. The formula for
calculating the ratio:
Net Credit Purchases
Creditors Turnover Ratio = ——————————————————
Average Creditors + Average B/P
Net Credit Purchase = Total Purchases – Cash Purchase

Opening Creditors + Closing Creditors Average Creditors = ———————————————————————

2

Opening B/P + Closing B/P Average B/P = ————————————————

2

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This ratio can be calculated on the basis of total purchases instead of credit purchases.

Significance :– This ratio indicates the speed with which the amount is being paid to creditors. The higher the ratio, the better it is, since it will indicate that the creditors are being paid more quickly which increases the credit worthiness of the firm.

(6)

This ratio indicates the time which is

normally taken by the firm to make payment to its creditors. This ratio can be calculated by the following three formulas:

Average Payment Period :–

Average Payment Period = Average Creditors + Average B/P —————————————————— Credit
Average Payment Period =
Average Creditors + Average B/P
——————————————————
Credit Purchase per day
Average Creditors x 365
Average Payment Period = ———————————————
Net Credit Purchases
12months/ 52 weeks/ 365 days
Average Payment Period = ——————————————————
Creditors Turnover Ratio
Working Capital Turnover Ratio :–
calculating the ratio is:

Cost of Goods Sold Working Capital Turnover Ratio = ———————————— Working Capital

First Formula :–

Second Formula :–

Third Formula :–

Significance :– This ratio shows the time in which the creditors are paid for credit purchases. The lower the ratio, the better it is, because a shorter payment period implies that the creditors are being paid rapidly.

(7)

This ratio indicates the relationship

between cost of goods sold and working capital. The formula for

Working Capital = Current Assets – Current Liabilities

Significance :– This ratio indicates how efficiently working capital has been utilised in making sales. This ratio is of particular importance in non- manufacturing concerns where current assets play a major role in generating sales. This ratio shows the number of times on which working capital has been

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rotated in producing sales. A high working capital turnover ratio shows efficient use of working

rotated in producing sales. A high working capital turnover ratio shows efficient use of working capital and quick turnover of current assets like stock and debtors.

Q.

Explain the Important Ratios Calculated for evaluating the Profitability of a Company.

OR

Q.

Ans. Profitability Ratios :– The main object of every business is to earn profits.

Explain the Profitability Ratios in detail

Profitability Ratios Based on Sales :– Gross Profit Ratio :– profit and sales. The formula
Profitability Ratios Based on Sales :–
Gross Profit Ratio :–
profit and sales. The formula for computing this ratio is:
Gross Profit
Gross profit Ratio= —————————x 100
Net Sales
Gross Profit = Sales – Cost of Goods Sold
Net Sales = Sales – Sales Return.
Net Profit Ratio :–
and sales. It may be calculated by two methods:
Net Profit Ratio :–
Net Profit
Net Profit Ratio= ———————— x100
Net Sales

A business must be able to earn adequate profits in relation to the risk and

capital invested in it. The efficiency and the success of a business can be measured with the help of profitability ratios. Profitability Ratios can be determined on the basis of either sales or investment into business.

(A)

This ratio shows the relationship between gross

(1)

These ratios include the following

Significance :This ratio measures the margin of profit available on sales. The higher the gross profit ratio, the better it is. No ideal standard is fixed for this ratio, but the gross profit ratio should be adequate enough not only to cover the operating expenses but also to provide for depreciation, interest on loans, dividends and creation of reserves.

(2)

This ratio shows the relationship between net profit

(i)

Net Profit= Gross Profit- All Indirect Expenses + All indirect Incomes

(ii) Operating Net Profit Ratio :–

Operating Net Profit Operating Net Profit Ratio = ————————————— x100 Net Sales

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Operating Net Profit= Gross Profit- Operating Expenses

Operating Expenses= Office and Administration Expenses, Selling and distribution expenses, Bad debts, Discount, Interest on short-term debts.

Significance :– This ratio measures the rate of net profit earned on sales. It helps
Significance :– This ratio measures the rate of net profit earned on sales. It
helps in determining the overall efficiency of the business operations. An
increase in the ratio over the previous year shows improvement in the overall
efficiency and profitability of the business.
(3)
Operating Ratio :–
This ratio measures the proportion of an enterprise’s
cost of sales and operating expenses in comparison to its sales:
Cost of Goods Sold + Operating Expenses
Operating Ratio : ————————————————————— X 100
Net Sales
Cost of goods sold can be calculated by two ways :–
Cost of Goods Sold = Sales – Gross Profit
OR
Cost of Goods Sold = Opening Stock + Purchases + Carriage + Wages +
Other Direct Expenses – Closing Stock
Operating Expenses = Office and Administration Expenses, Selling and
distribution Expenses, Bad debts, Discount, Interest on short-term debts
Significance :–
Operating ratio is a measurement of the efficiency and
profitability of the business enterprise. The ratio indicates the extent of sales
that is absorbed by the cost of goods sold and operating expenses. Lower the
operating ratio, the better it is, because it will leave higher margin of profit on
sales.
(4)
Expenses Ratios :–
These ratios indicate the relationship between
expenses and sales. The ratio may be calculated as:
Material Consumed
(i) Material Consumed Ratio = ————————————— X 100
Net Sales

(ii)

(iii)

Direct Labour Cost

Direct Labour Cost Ratio = —————————————X 100 Net Sales

Factory Expenses

Factory Expenses Ratio = ———————————— X 100 Net Sales

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(B) (1) Profitability Ratios Based on Investment in the Business :– ratios reflect the true

(B)

(1)

Profitability Ratios Based on Investment in the Business :–

ratios reflect the true earning capacity of the resources employed in the enterprise Sometimes the profitability ratios based on sales are high whereas profitability ratios based on investment are low. These may be classified into two categories:

Return on Capital Employed

These

(2) Return on Shareholder’s Funds (1) Return on Capital Employed :– This ratio reflects the
(2)
Return on Shareholder’s Funds
(1)
Return on Capital Employed :–
This ratio reflects the overall profitability
of the business. This ratio is also known as ‘Rate of Return’ or ‘Yield on
Capital’. The ratio is computed as under:
Profit before Interest, tax and dividends
Return on Capital Employed = —————————————————— X 100
Capital Employed
Capital Employed :– This can be computed by any of the following two
methods:
Capital Employed = Debt + Equity – Non Operating Assets
OR
Capital Employed = Fixed Assets + Current Assets – Current Liabilities
(2)
Return on Shareholder’s Funds :–
Return on shareholders funds
measures only the profitability of the funds invested by shareholders.
There are several measures to calculate the return on shareholder’s
funds:
(i)
Return on Total Shareholder’s Funds :–
The ratio is computed as under:
Net profit After Interest and Tax
Return on Total Shareholder’s Funds = ———————————————— X 100
Total Shareholder’s Funds
Total Shareholder’s Funds = Equity Share Capital + Preference Share
Capital + All Reserves + P&L A/c Balance – Fictitious assets
Significance :– This ratio reveals how profitably the proprietor’s funds have
been utilized by the firm. A comparison of this ratio with that of similar firms
will throw light on the relative profitability and strength of the firm.

(ii) Return on Equity Shareholder’s Funds :–

under:

This ratio is computed as

Net profit After Interest, Tax and Preference Dividend

Return on Equity Shareholder’s Funds = —————————————————— X 100

Equity Shareholder’s Funds

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Equity Shareholders Funds = Equity Share Capital + All Reserves + P&L A/c Balance Fictitious Assets

Significance :– This ratio measures how efficiently the equity shareholders funds are being used in the business.

This ratio measures the profit available to

the equity shareholders on a per share basis. This ratio is computed as under:

(iii) Earning Per Share (E.P.S.) :–

Net Profit – Dividend on Preference Shares Earning Per Share =
Net Profit – Dividend on Preference Shares
Earning Per Share = ———————————————————————
Number of Equity Shares
Significance :– This ratio is helpful in the determination of the market price of
the equity share of the company.
(iv)
Dividend Per Share :–
Profit remaining after payment of tax and
preference dividend are available to equity shareholders. But all of these
are not distributed among them as dividend. Out of these profits, a portion
is retained in the business and remaining is distributed among equity
shareholders as dividend.
Dividend Paid to Equity Shareholders
Dividend Per Share = —————————————————————
Number of Equity Shares
(v)
Dividend Payout Ratio Or D.P. :–
This ratio is computed as under:
D.P.S
D. P. = —————— X 100
E.P.S
(vi)
Earning and Dividend Yield :–
EPS
Earnings Yield = ——————————————— X 100
Market Value Per Share
DPS
Dividend Yield = ———————————————— X 100
Market Value Per Share

(vii)

Price Earnings(P.E) Ratio :

Market price of the share P.E. Ratio = ————————————————— EPS

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Q. What is Fund Flow Statement? How is it prepared? Ans. Meaning of Fund Flow

Q.

What is Fund Flow Statement? How is it prepared?

Ans.

Meaning of Fund Flow Statement :–

The balance sheet of a firm discloses

the position of assets, liabilities and capital at the end of a particular year. But it does not disclose the causes of changes in these items between the end of previous year and the end of current year. Therefore, an additional statement called Fund Flow Statementis prepared to show the changes in assets, liabilities and capital between the dates of two balance sheets.

Meaning of Funds :– In a limited sense, the term ‘fund’ means ‘cash’. But this
Meaning of Funds :– In a limited sense, the term ‘fund’ means ‘cash’. But this
is not the correct meaning of the term ‘fund’ because there are many
transactions in the business which do not result in inflow or outflow of cash but
certainly result in the inflow or outflow of funds. As such, the term ‘fund’ stands
for ‘Net Working Capital”.
Meaning of Flow :– The term ‘flow’ means change or movement. Therefore, the
term ‘Flow of Funds’ means increase or decrease in working capital. If a
transaction results in the increase of working capital, it is said to be a source of
funds and if the transaction results in the decrease of working capital, it is said
to be an application of funds. If the transaction does not result in any change in
the working capital, it is said that it does not result in the flow of fund.
Preparation of Fund Flow Statement :– For preparing Fund Flow Statement
we have to prepare the following three statements:
(1)
Schedule of Changes in Working Capital :–
This schedule considers only
current assets and current liabilities, at the beginning and at the end of
the year. This schedule shows either increase or decrease in working
capital.
SCHEDULE OF CHANGES IN WORKING CAPITAL
Particulars
Amount
As on
………
Amount
As on
………
Increase in
Working
Capital
Decrease in
Working
Capital
Current Assets:
Cash-in-hand
Cash at Bank
Debtors
Closing Stock
Short Term
investments
Bills Receivables
Prepaid Expenses
Other current assets
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Total Current Assets Current Liabilities: Bank Overdraft Bills Payable Creditors Provision for Taxation
Total Current Assets
Current Liabilities:
Bank Overdraft
Bills Payable
Creditors
Provision for Taxation
Proposed Dividend
O/s Expenses
Unclaimed Dividend
Total Current Liabilities
Working Capital (Current
Assets –Current Liabilities)
Net Increase or Decrease
in Working Capital
(2)
Calculation of Funds from Operations
:–
In order to
prepare a funds
flow statement it is necessary to ascertain the sources and application of
funds. Main source of fund in a business is funds from operations
STATEMENT SHOWING ‘FUNDS FROM OPERATIONS’
Particulars
Amount
Net Profit As per Profit & Loss A/c
(A) Items to be Added back to Net Profit:
(a)
Non-Fund Items:
(i)
Depreciation.
(ii)
Goodwill written off.
(iii)
Preliminary Expenses.
(iv)
Patent Rights, Trade Marks and Copy Rights.
(v)
Discount on issue of Debentures & Shares.
(vi)
Deferred Revenue Expenditure such as,
Advertisement Suspense A/c.
(b)
Non- Trading Losses:
(i) Loss on sale of Fixed Assets
(ii) Appropriation of Profit:
Transfer to General Reserve
Transfer to Sinking Fund
Transfer to Dividend
Equalisation Fund etc.
(i) Proposed Dividend
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  (ii) Provision for Taxation (B) Items to be Deducted from Net Profit (i)
 

(ii)

Provision for Taxation

(B)

Items to be Deducted from Net Profit

(i)

Profit on sale of Fixed Assets

(ii)

Receipt of Dividend

(iii)

Re-Transfer of Excess Provisions

Fund Flow Statement :– Fund Flow Statement is prepared to show the changes in assets, liabilities and capital between the dates of two balance sheets. It discloses the causes of changes in the items of balance sheet between the end of the previous year and the end of current year. Thus, by preparing this statement, the management can find out the basic reasons for changes in the assets, liabilities and capital of the firm between two balance sheets.

FORMAT OF FUND FLOW STATEMENT :– FUND FLOW STATEMENT Sources of Funds Applications of Funds
FORMAT OF FUND FLOW STATEMENT :–
FUND FLOW STATEMENT
Sources of Funds
Applications of Funds
1. Funds from Operations
1. Loss from Operations
2. Issue of Shares
2. Buy back of Equity shares and
Redemption of Preference Shares
3. Issue of Debentures
3. Redemption of Debentures
4. Raising Long-Term Loans
4. Repayment of Long-Term Loans
5. Sale of Fixed Assets
5. Purchase of Fixed Assets
6. Non-Trading Receipts
6. Non-Trading Payments
Q. What is Fund Flow Statement? What are the uses and Limitations of
Fund Flow Statement?

Ans.

the position of assets, liabilities and capital at the end of a particular year. But

it does not disclose the causes of changes in these items between the end of previous year and the end of current year. Therefore, an additional statement called Fund Flow Statementis prepared to show the changes in assets, liabilities and capital between the dates of two balance sheets.

Uses of Fund Flow Statement :–

Meaning of Fund Flow Statement :–

The balance sheet of a firm discloses

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1. Helpful in Finding the Answers to Some Important Financial Questions :– A fund flow statement is prepared to give satisfactory answer to the following questions:

What have been the main sources and applications of funds during the period? How much funds have been generated from business operations? Where did the profits go? Why are dividends not larger? How was the expansion in plant and Equipment financed? How was the repayment of long term debt accomplished? How was the increase in Working Capital financed?

(i)

(ii)

(iii)

(iv)

(v) (vi) (vii) Helpful in Financial Analysis :– It enables to know whether the funds
(v)
(vi)
(vii)
Helpful in Financial Analysis :–
It enables to know whether the funds have been properly used :–
Helpful in proper Management of Working Capital :–
Help in the presentation of Budget for the next period :–

2.

A fund flow statement provides a

complete analysis of the financial position of a firm. This objective is not achieved by the balance sheet because it gives a static view of the financial position of a business by showing the assets and liabilities at a particular point of time.

A

It provides more reliable figures of profit and loss of the business :–

3.

fund flow statement gives a much more reliable figure of the profits of the

business than the figures shown by profit and loss account is affected by the personal decisions of management in deciding the amount of depreciation and other adjustments regarding the writing off of preliminary expenses etc.

The

fund flow statement enables the management to know whether the funds have been properly used in purchasing various assets or repaying loans etc.

4.

5.

While managing

working capital in a business, it becomes essential to ensure that it should

neither be excessive nor inadequate. A fund flow statement indicates the excessiveness or inadequacy in working capital.

6.

If a fund flow

statement is prepared for next year, it will enable the management to plan

its financial resources properly. The firm will know how much funds it requires, how much the firm can manage internally and how much it should arrange from outside source. This is helpful in preparing the budgets for the future period.

Sometimes, there may be

sufficient

profits but the distribution may not be possible due to its

adverse effect on the liquidity and working capital of the business.

7. Helpful in Determining Dividend Policy :–

Limitations of Fund Flow Statement :–

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1. Fund flow statement ignores certain non-fund transactions. 2. It reveals only the changes in

1. Fund flow statement ignores certain non-fund transactions.

2. It reveals only the changes in working capital and does not show the changes in cash position.

3. It is historical in nature because it reports what has happened in the past.

4. Since it is based on opening and closing balance sheets and the profit and loss account, it is not an original statement.

What is Cash Flow Statement? Give the Format of Cash Flow Statement Or How is it prepared?

Q.

Ans. Cash Flow Statement :– A cash-flow statement is a statement showing inflows and outflows
Ans.
Cash Flow Statement :–
A cash-flow statement is a statement showing
inflows and outflows of cash during a particular period. In other words, it is a
summary of sources and applications of cash during a particular span of time.
It analyss the reason for changes in balance of cash between the two balance
sheet dates. The term ‘cash’ here stands for cash and cash equivalents. A cash-
flow statement can be for the past or can be projected for a future period.
FORMAT OF CASH FLOW STATEMENT :– A cash flow statement may be
prepared either by direct or indirect method. Format under indirect method is
given below:
XYZ LTD.
CASH FLOW STATEMENT for the year ending………………
(Indirect Method)
Particulars
Amount
Amount
(A)
Cash Flows from Operating Activities :–
Net profit before Tax
Add : Non-Cash Expenses
:
Non-operating Expenses
Operating Profit before Working Capital Changes
Add : Decrease in Current Assets
:
Increase in Current Liabilities
Less : Increase in Current Assets
(
)
:
Decrease in Current Liabilities
(
)
Cash generated from operating activities
Income Tax paid
(
)
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ACCOUNTING FOR MANAGERS
ACCOUNTING FOR MANAGERS
Cash flows before extraordinary items (+) or (-) Extraordinary items Net Cash from Operating Activities
Cash flows before extraordinary items
(+) or (-) Extraordinary items
Net Cash from Operating Activities
(B)
Cash Flows from Investing Activities :–
(
)
Purchase of fixed assets
Sale of fixed assets
Purchase of investments (long-term)
Sale of Investment (long-term)
Interest received
Dividend received
(
)
Net Cash from Investing Activities
(C)
Cash Flows from Financing Activities:
Proceeds from
Proceeds from
issue of share capital
long-term borrowings
Repayments of long-term borrowings
Interest paid
Dividend paid
(
)
(
)
(
)
Net Cash from Financing Activities
Net Increase or decrease in cash and cash
equivalents ( A+B+C)
Cash and cash equivalent at the
beginning
of the period
Cash and Cash equivalent at the end
of the period
Q.
What
is
Cash
Flow
Statement.
Discuss
Its
main
Uses
and
Limitations?

A cash-flow statement is a statement showing

inflows and outflows of cash during a particular period. In other words, it is a

summary of sources and applications of cash during a particular span of time. It analysis the reason for changes in balance of cash between the two balance sheet dates. The term cashhere stands for cash and cash equivalents. A cash- flow statement can be for the past or can be projected for a future period.

Uses of Cash Flow Statement :–

Ans.

Cash Flow Statement :–

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1. 2. Useful for short-term financial planning :– provides information for planning the short-term financial

1.

2.

Useful for short-term financial planning :–

provides information for planning the short-term financial needs of the firm. Since it provides information regarding the sources and utilization of

cash during a period, it becomes easier for the management to assess whether it will have adequate cash to meet day-to-day expenses and pay the creditors in time.

A cash flow statement prepared

Useful in preparing the Cash Budget :–

A cash flow statement

for the future period in helpful in preparing a cash budget. It informs the management
for the future period in helpful in preparing a cash budget. It informs the
management about the surplus or deficit periods of cash. It helps in
planning the investment of surplus cash in short-term investments and to
plan short-term credit in advance for deficit period.
3.
Study of the trend of cash receipts and payments :–
A cash flow
statement reveals the speed at which the cash is being generated from
debtors, stock and other current assets and the speed at which the
current liabilities are being paid. It enables the management to assess the
true position of the cash in nature.
4.
It explains the deviation of cash from earnings :–
A firm may earn huge
profits yet it may have paucity of cash or when it suffered a loss it may still
have plenty of cash. A cash flow statement explains the reasons for it.
5.
Helpful in making Dividend Decisions :–
Dividend must be paid within
42 days of its declaration. Hence the management takes the help of cash
flow statement to ascertain the position of cash generated from operating
activities which can be used for payment of dividend.
6.
Study of the Trend of Cash Receipts and Payments :–
A cash-flow
statement reveals the speed at which the cash is being generated from
debtors, stock and other current assets and the speed at which the
current liabilities are being paid. It enables the management to assess the
true position of the cash in future.
Limitations of Cash Flow Statement :–
1.
It does not present true picture of the liquidity of a firm because the
liquidity does not depend upon cash alone.
2.
The possibility of window-dressing is higher in case of cash position in
comparison to the working capital position of a firm.

3.

4.

Cash flow statement ignores non-cash charges.

It is prepared on cash basis and hence ignores one of the basis concepts of accounting, namely accrual concept.

Distinction between Fund Flow Statement and Cash Flow Statement.

Q.

Ans. Distinction between Fund Flow Statement and Cash Flow Statement:

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ACCOUNTING FOR MANAGERS
ACCOUNTING FOR MANAGERS
BASIS FUND FLOW STATEMENT CASH FLOW STATEMENT 1. Basis of Analysis It discloses the causes
BASIS
FUND FLOW
STATEMENT
CASH FLOW
STATEMENT
1.
Basis of
Analysis
It discloses the causes of
changes in working capital.
It discloses the
cause of changes
in cash position.
2.
Interpretation
Sound funds position doesn’t
mean sound cash position
because inflow of funds
doesn’t necessarily involve
inflow of cash.
Sound cash position
means sound funds
position as inflow of
cash necessarily
involves inflow
of funds.
3.
Difference in
the method of
preparation
In case of fund flow analysis,
an increase in a current
liability or decrease in a
current assets results in
decrease in working capital
In case of cash flow
analysis an
increase
&
vice-versa.
or
decrease in a
current assets
results in increase
in cash &
vice-versa.
4. Usefulness
It is more useful for long-term
financial planning.
It is more useful for
short-term financial
planning.
5. Schedule of
Changes in
Working Capital
Schedule of changes in
working capital is also
preparing to study the
changes in current assets
and current liabilities.
No separate
schedule is
prepared with the
cash flow statement
as the changes in
current assets and
current liabilities
are shown by way of
adjustment in profit
to arrive at cash
flow from operating
activities.
6.
Opening &
closing Balance
of Cash
Opening & closing balance
of cash are not shown in fund
flow statement, as they are
shown in schedule of changes
in working capital.
Opening & closing
balance of cash are
shown in this
statement
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7. Principles of This is prepared on ‘ accrual basis ’ of accounting This is

7.

Principles of

This is prepared on accrual basisof accounting

This