Accounting for Manager

Accounting for Manager

Assignment - A

Question 1a): What do you understand by the concept of conservatism? Why it is also
called the concept of prudence? Why it is not applied as strongly today as it used to be in
the Past?

Answer:

Concept of Conservatism implies using conservatism while preparing financial statements i.e.
income should not be accounted for unless it has actually been earned but expenses, even if
just anticipated should be provided for. According to this concept, revenues should be
recognized only when they are realized, while expenses should be recognized as soon as they
are reasonably possible. For instance, suppose a firm sells 100units of a product on credit for
Rs.10, 000. Until the payment is received, it will not be recorded in the accounting books.
However, if the firm receives information that the customer has lost his assets and is likely to
default the payment, the possible loss is immediately provided for in the firm’s books. The rule
is to recognize revenue when it is reasonably certain and recognize expenses as soon as they
are reasonably possible. The reasons for accounting in this manner are so that financial
statements do not overstate the company’s financial position.

It is also called the concept of prudence as it essentially involves exercising prudence in

recording income and expenses/losses in the financial statements so that anticipated income
are not recorded whereas likely losses are provided for.

However, this concept is not applied as strongly today as it used to be in the past for the reason
that the modern world saw a considerable increase in corporate frauds e.g. Enron case in USA
and Satyam in India. Also, there is a decline in assuming corporate social responsibilities due
to superfluous issues of gaining publicity and brand building. These two major issues call for
increased transparency in financial statements and hence, the decline in use of age old concept
of conservatism.

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Question 1 b): What is a Balance Sheet? How does a Funds Flow Statement differ from a
Balance Sheet? Enumerate the items which are usually shown in a Balance Sheet and a
Funds Flow Statement.

Answer: A Balance Sheet is a type of financial statement of an entity, indicating the financial
position at a given point of time. It is the statement of Assets and Liabilities as on a particular
date. The various items of a Balance Sheet can be grouped under two heads, viz: assets and
liabilities.

Funds Flow statement determines the sources of cash flowing into the firm and the application
of that cash by the firm. The various items of a Funds Flow Statement can be grouped under
two heads, viz: inflow of funds (sources) or outflow of funds (applications).

While the Balance Sheet shows only the monetary value of each source and application of
funds at the end of the year, funds flow statement depicts the extent of changes in each source
and application of funds during the year.

If we take the Balance Sheet for two consecutive years and work out the change for each item,
we are able to arrive at the Funds Flow Statement items.

The various items usually shown in a Balance Sheet are:

Assets side:
(1) Fixed assets

a) Gross block
b) Less depreciation
c) Net block
d) Capital work-in-progress

(2)Investments

(3)Current assets, loans, and advances:

a) Inventories
b) Sundry debtors
c) Cash and bank balances

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d) Other current assets

e) Loans and advances

(4)Deferred Revenue Expenditure:

a) Miscellaneous expenditure to the extent not written off or adjusted

b) (Profit and Loss account

Liabilities side:

(1)Shareholder's funds
a) Capital
b) Reserves and Surplus

(2)Loan funds
a) Secured loans
b) Unsecured loans

Current liabilities and provisions:

(a) Liabilities
 Sundry Creditors
 Outstanding expenses
 Provision for tax

Similarly, items in a Funds Flow Statement are:

Inflow of funds:
 A decrease in assets
 An increase in liabilities
 An increase in shareholder’s funds Outflow of funds:
 An increase in assets
 A decrease in liabilities
 A decrease in shareholder’s funds

Question 2a: Discuss the importance of ratio analysis for inter-firm and intra-firm
comparisons including circumstances responsible for its limitations .If any

Answer: Ratio analysis implies the systematic use of ratios to interpret the financial statements
so that the strength and weaknesses of a firm as well as its historical performance and current
financial position can be determined. With the help of ratio analysis conclusion can be drawn
regarding several aspects such as financial health, profitability and operational efficiency of
the undertaking.

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Ratio analysis is very useful in making inter-firm comparison as it helps to draw a comparison
between the entities within the same industry or otherwise following the same accounting
procedure. It provides the relevant financial information for the comparative firms with a view
to improving their productivity & profitability.

Ratio analysis helps in intrafirm comparison by providing necessary data. An interfirm

comparison indicates relative position. It provides the relevant data for the comparison of the
performance of different departments. If comparison shows a variance, the possible reasons of
variations may be identified and if results are negative, the action may be initiated immediately
to bring them in line.

However, in spite of being such a useful tool, it is not free from its limitations. A single ratio
is of a limited use and it is essential to have a comparative study. The base used for ratio
analysis viz: financial statements have their own limitations. Also, they consider only the
quantitative aspects of business transactions where as there are various other non-
quantitative aspects such as quality of work force which considerably affect profitability and
productivity. Also, ratio analysis as a tool is also limited by changes in accounting
procedures/policies.

Question 2b: Why do you understand by the term 'pay-out ratio'? What factors are taken
into consideration while determining pay-out ratio? Should a company follow a
fixed pay-out ratio policy? Discuss fully.

Answer: Pay-out Ratio means the amount of earnings paid out in dividends to shareholders.
Investors can use the pay-out ratio to determine what companies are doing with their earnings.
It can be calculated as:

A very low pay-out ratio indicates that a company is primarily focused on retaining its earnings
rather than paying out dividends.

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The pay-out ratio also indicates how well earnings support the dividend payment. The lower
the ratio, the more secure the dividend because smaller dividends are easier to pay-out than
larger dividends.

The major factor to be considered in determining the pay-out ratio is the dividend policy of the
company. Young, fast-growing companies are typically focused on reinvesting earnings in
order to grow the business. As such, they generally sport low (or even zero) dividend pay-out
ratios. At the same time, larger, more-established companies can usually afford to return a
larger percentage of earnings to stockholders. Also, another factor to be considered is the type
of industry in which the company is operating. For example, the banking sector usually pays
out a large amount of its profits. Certain other sectors like real estate investment trusts are
required by law to distribute a certain percentage of their earnings.

Funds requirement of the company and its available liquidity is another factor which is
considered while determining the pay-out.

Some companies prefer to follow a fixed pay-out ratio policy irrespective of the earnings made.

This is a welcome policy from the point of view of the investors. But, the company should take
into account various important factors such as its need for future investment and growth, cash
requirements and debt obligations.

Question 3a: From the ratios and other data given below for Bharat Auto Accessories
Ltd. indicate your interpretation of the company's financial position, operating efficiency
and profitability.
Year
I Year II Year III

Current Ratio 265% 278% 302%

Acid Test Ratio 115% 110% 99%

Working Capital Turnover 2.75 3.00 3.25

(times)

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Receivables Turnover 9.83 8.41 7.20

Average Collection Period 37 43 50

(Days)

Inventory to Working 95% 100% 110%

Capital
Inventory Turnover 6.11 6.01 5.41
(times)
Income per Equity Share 5.10 4.05 2.50

Net Income to Net Worth 11.07 8.5% 7.0%

Operating Expenses to 22% 23% 25%

Net Sales

Sales increase during the 10% 16% 23%

Cost of goods sold to Net 70% 71% 73%

Sales

Dividend per share Rs. 3 Rs.3 Rs.3

Fixed Assets to Net Worth 16.4% 18% 22.7%

Net Profit on Net Sales 7.03% 5.09% 2.0%

Answer: The financial position of a concern is mainly judged by its current ratio, acid test
ratio, working capital turnover, fixed assets to net worth.

In the given case of Bharat Auto Accessories Ltd, the current ratio has gone up from 265% to
302% over a period of three years. It is a measure of the degree to which current assets cover
current liabilities (Current Assets / Current Liabilities). A high ratio indicates a good
probability the enterprise can retire current debts. However, the acid test ratio has gone down
from 115% to 99%, which is not a very good sign. It is a measure of the amount of liquid assets
available to offset current debt (Cash + Accounts Receivable / Current Liabilities). A healthy

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enterprise will always keep this ratio at 1.0 or higher. Also, the fixed asset to net worth ratio is
16.4% for Yr. I and has gone up to 22.7% for Yr. III. This ratio is a measure of the extent of an
enterprise's investment in non-liquid and often over valued fixed assets

(Fixed Assets / Liabilities + Equity). A ratio of .75 or higher is usually undesirable as it

indicates possible over-investment.

The operating efficiency of a concern can be viewed by its receivables turnover, average
collection period, inventory turnover, operating expenses to net sales. The receivables turnover
has gone down from 9.83 to 7.20, reflecting that expenses as a percentage of revenue or
earnings has gone down over the three year period, which is a good sign. An increasing average
collection period indicates that the concern is offering too liberal credit terms and has
inefficient credit collection. The inventory turnover has gone down from 6.11 to 5.41 times
indicating declining sales and excessive inventory which again reflects poor operating
efficiency.

The operating expense to net sales has increased from 22% to 25% which indicates that the
organization has lowered its ability to generate profits in case of declining revenues.

The indicators of profitability are income per equity share, net income to net worth, and net
profit on net sales. All these ratios have declined considerably over the three year period. This
indicates declining profitability over the years.

Thus, on a review of the various ratios, we conclude that Bharat Auto Accessories Ltd does not
have a strong financial position, is not very efficient in its operations and is undergoing a period
of declining profitability.

Question 4: Trading and Profit and Loss Account for the yr. ended 31st Mar 2004

Answer) Trading and Profit and Loss Account for the yr ended 31st Mar 2004

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Dr. Cr.

PARTICULARS AMOUNT PARTICULARS AMOUNT

To opening stock 1,50,000 By Cash Sales 61,000
To purchases 3,69,000 By Credit Sales 7,80,000
To wages 1,80,000
To salaries 1,50,000 By closing stock 1,40,000
To Sunday office expenses 1,08,750
To Gross Profit c/d 23,250

TOTAL 9,81,000 TOTAL 9,81,000

To Discount allowed 7,000 By Gross Profit b/d 23,250

To Bad debts w/o 8,000 By Discount received 4,000
To Depreciation By misc income 2,000

- Furniture @5% By net loss c/d 26,750

2,000
- Machinery @10% 36,500
34,500

To interest on loan from Dass 4,500

TOTAL 58,500 TOTAL 58,500

Balance Sheet as at 31st Mar 2004

LIABILITIES AMOUNT ASSETS AMOUNT

FIXED ASSETS
OWNER’S CAPITAL
Op balance 5,16,000 Machinery 3,45,000
Less drawings 40,000 Less dep 34,500
Less loss 26,750 4,49,250 Net block 3,10,500
Furniture 40,000
UNSECURED LOAN Less dep 2,000
Dass @9% 1,00,000 Net block 38,000 3,48,500
INVESTMENTS
CURRENT LIABILITIES & CURRENT ASSETS,LOANS &
PROVISIONS ADVANCES
Sundry Creditors 1,25,000 Stock 1,40,000
Wages outstanding 20,000 Sundry Debtors 1,93,000
Interest on loan 4,500 Bank 16,000
Unexpired insurance 1,250

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TOTAL 6,98750 TOTAL 6,98,750

WORKING NOTES:

1) Opening balance of Owner’s capital = stock + debtors + bank + machinery + furniture

–sundry creditors
=1,50,000 +1,81,000+5,000+2,50,000+40,000-1,10,000 =5,16,000

Question (5a) What procedure would you adopt to study the liquidity of a business firm?

Answer: Liquidity is the ability of the firm to convert assets into cash. It is also called
marketability or short-term solvency. In other words, it is the ability of the firm to meet itsday-
to-day obligations.

In order to study the liquidity of the firm, we need to thoroughly examine its asset structure,
mainly the current assets. The current assets, viz: stock, debtors, bank balance and other current
assets need to be seen to determine at what rate a firm can convert these into cash. A business
that collects its accounts receivable in an average of 20 days generally has more cash on hand
than a business that requires 45 days. Similarly, a business that turns over its inventory 15 times
a year has more cash on hand than a company that turns its inventory only 10 times a year. A
business which keeps surplus cash or an idle bank balance may be readily able to meet its short-
term or daily obligations but it is not effectively utilizing its cash flow.

Another factor to determine the liquidity is to see the profitability of the firm. The more
profitable the firm is, the more cash resources it shall have.

Last, but not the least, we use make use of certain financial ratios like current ratio, quick
oracid-test ratio, net working capital to determine the liquidity of the firm.

Question 5 b: Who are all the parties interested in knowing this accounting information?

Answer: The various parties interested in determining the liquidity of the firm would be the
business owners and managers, bankers, investors, creditors and financial analysts.

Business owners and managers use ratios to chart a company's progress, uncover trends and
point to potential problem areas in a business. One can also use ratios to compare your
company's performance with others within the industry.

Bankers and investors look at a company's ratios when they are trying to decide if they want to
lend you money or invest in your company.

Creditors are interested in the company’s short-term and long-term ability to pay its debts.

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Financial analysts, who frequently specialize in following certain industries, routinely assess
the profitability, liquidity, and solvency of companies in order to make recommendations about
the purchase or sale of securities, such as stocks and bonds.

Question 5c: What ratio or other financial statement analysis technique will you adopt
for this.
Answer: The relevant ratios used to assess the liquidity of the firm are current ratio, quick or
acid – test ratio, cash ratio and net working capital.
Current Ratio
Provides an indication of the liquidity of the business by comparing the amount of current
assets to current liabilities. A business's current assets generally consist of cash, marketable
securities, accounts receivable, and inventories. Current liabilities include accounts payable,
current maturities of long-term debt, accrued income taxes, and other accrued expenses that are
due within one year. In general, businesses prefer to have at least one dollar of current assets
for every dollar of current liabilities. However, the normal current ratio fluctuates from industry
to industry. A current ratio significantly higher than the industry average could indicate the
existence of redundant assets. Conversely, a current ratio significantly lower than the industry
average could indicate a lack of liquidity.

Formula
Current Assets
Current Liabilities

Acid Test or Quick Ratio

A measurement of the liquidity position of the business. The quick ratio compares the cash plus
cash equivalents and accounts receivable to the current liabilities. The primary difference
between the current ratio and the quick ratio is the quick ratio does not include inventory and
prepaid expenses in the calculation. Consequently, a business's quick ratio will be lower than
its current ratio. It is a stringent test of liquidity.

Formula
Cash + Marketable Securities + Accounts Receivable
Current Liabilities

Cash Ratio
Indicates a conservative view of liquidity such as when a company has pledged its receivables
and its inventory, or the analyst suspect’s severe liquidity problems with inventory and
receivables.

Formula
Cash Equivalents + Marketable Securities
Current Liabilities

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Working Capital
Working capital compares current assets to current liabilities, and serves as the liquid reserve
available to satisfy contingencies and uncertainties. A high working capital balance is
mandated if the entity is unable to borrow on short notice. The ratio indicates the short-
term solvency of a business and in determining if a firm can pay its current liabilities when
due.

Formula

Current Assets - Current Liabilities

Assignment - B

Answer 1:
1) Bank balance as per pass book of Priya & Co. as on 28th Feb.2008:

(Rs.) (Rs.)

Cr. Balance as per cash book on 28th Feb 15,000

Less: interest charged by bank not recorded in cash book 500
Bank charges made by bank not recorded in cash book125
Cheques paid into bank but not yet credited 6,250 6,875
8,125
Add: Cheques issued but not yet presented 7,500
Dividends collected directly by bank 4,500 12,000

Bank balance as per pass book of Priya & Co as on 28th Feb 2008 20,125

Answer 2a:

Decision whether new product should be introduced –

Sale price of new product 2000@Rs.60 = Rs.1, 20,000

Less: Direct costs – Direct material 2000@16 =Rs.32,000
Direct labour 2000@15 =Rs.30,000
Direct expenses 2000@1.5 =Rs. 3,000 Rs.65,000
Indirect costs-Variable factory overheads
2000@2.00 =Rs. 4,000
Variable selling & distribution overheads
2000@1.50 =Rs. 3,000 Rs. 7,000
Rs.72,000
CONTRIBUTION from new product =
Rs.48,000

Answer 2b)

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Profitability –
Profits from present production
Sales 5,40,000
Direct material 96,000
Direct labour 1,20,000
Direct expenses 19,000 2,35,000

Variable factory ohds 25,000

Variable S&D overheads 5,000 30,000

Net Profits 2,75,000

Fixed costs
Fixed factory overheads 1,75,000
Fixed adm’ve overheads 20,000
Fixed S&D overheads 19,000 2,14,000
Net Profits Rs.61,000

Answer 3 a)

The master budget is a summary of company's plans that sets specific targets for sales,
production, distribution and financing activities. It generally culminates in cash budget,a
budgeted income statement a budgeted balance sheet. In short, this budget represents a
comprehensive expression of management's plans for future and how these plans are to be
accomplished.

It usually consists of a number of separate but interdependent budgets. One budget may be
necessary before the other can be initiated. More one budget estimate effects other budget
estimates because the figures of one budget is usually used in the preparation of other budget.
This is the reason why these budgets are called interdependent budgets.

The master budget is a comprehensive planning document that incorporates several other
individual budgets. A master budget is usually classified into two individual budgets: the
Operational budget and the financial budget. The operation budget consists of eight individual
budgets: Sales Budget, Production Budget, Direct Material Budget, Direct Labour Budget,
Factory overhead Budget, Ending inventory budget, selling and administrative expenses
budget, Budgeted income statement.

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The second part of the master budget will include the financial budget. The financial budget
consists of two individual budgets – Cash Budget and Budgeted Balance Sheet.

Thus, cash budget is a part of Master budget. The Cash budget will show the effects of all the
budgeted activities on cash. By preparing a cash budget your business management will be able
to ensure that they have sufficient cash on hand to carry out activities. It will also allow them
enough time to plan for any additional financing they might need during the budget period, and
plan for investments of excess cash. A cash budget should include all items that affect the
business cash flow and should also include three major sections; cash available, cash
disbursements, and financing.

Answer 3 b)
The various methods of inventory valuation are:
i. FIFO(first-in-first-out) method
ii. LIFO(last-in-first-out)method
iii. Weighted average method
iv. Moving average method
v. Lower of cost or market value(LCM)
vi. Dollar value-LIFO
vii. Gross Profit method
viii. Retail method

During times of inflation, different methods have different effect on inflation.

FIFO gives the highest amount of gross profit because the lower unit costs of the first units
purchased are matched against revenues, especially in times of inflation. LIFO gives the lowest
amount of net income during inflationary times.

Average costs approach tends to give profit which lies in between that given by FIFO and LIFO
method.

AS per Accounting Standard of ICAI (AS-2), inventory cost should comprise of all cost of
purchases, cost of conversion and other costs incurred in bringing the inventories to the present
location and condition. Cost of purchases should be exclusive of duties which are recoverable
from the taxing authorities. (E.g. Cenvat).

Inventory should be valued at lower of cost or net realisable value. Inventory should be valued
on FIFO (First in First Out) method or weighted average method. [LIFO is not permitted].
According to AS-2, inventory of raw materials should be valued at cost, without considering

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excise duty, as manufacturer has availed credit of the same. However, this reduces value of
stock and hence profits are lower.

CASE STUDY

Question 1: Describe the impact of different types of standards on motivations, and

specifically, the likely effect on motivation of adopting the labor standard recommended
for Geeta & Company by the engineering firm.

Answer: Different standards have different impact on motivation. In the given case, where the
labor standard recommended by the engineering firm is adopted by Geeta & company, the six-
month operation period showed a decline in production and an unfavourable quantity variance
for each of the six months in the said period. In the other case where the management used the
internally set labour standard, there was a favourable quantity variance for the first three
months; thereby implying that the actual production was more than the standard production. In
the fourth month, there was no variance in production and in the fifth and sixth month, there
was an unfavourable variance, thereby implying that the actual production was less than
standard production.

Thus, we see that the standard recommended by the engineering firm had a negative impact on
motivation as it was less than the standard production. But, in the case of internally set
standards, there was a positive impact on motivation for first three months; neutral in the fourth
month; and negative impact in fifth and sixth month.

Question 2: Please advise the company in reviewing the standards.

Answer: The labour standard recommended by the consulting firm should not be used as a
motivational device as it is having a negative impact.

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The cost standard used for reporting had a positive or neutral impact for greater part of the
period and a negative impact for two months. Therefore, the company should try and adopt
labour standards similar to those ones.

Assignment - C

1d) Assets are measured using the cost concept.

2a) Overstatement of Capital

d)Understatement of Assets

3d) Assets = Liabilities + Owners' Equity.

4 c) Net income increases retained earnings on the statement of retained earnings, which
ultimately increases retained earnings on the balance sheet.

5 d) Journalizing

6d) Most likely an error was- made in posting journal entries to the general ledger or in
preparing the trial balance

7c) Supplies, Rs2, 300; Supplies Expense, Rs6, 500.

8d) Fund decreases

9a) Cash

10a) All sources and uses of resources

11c) Interest expense

12d) Literal cash on hand or on demand deposit, plus cash equivalents.

13b) Accommodate changes in activity levels

14d) One place that the reader of an annual report would be able to identify that a company
changed inventory methods is the footnotes to the financial statements.

15b) Is the interest explicitly included in the amount of the note.

16b) Balance sheet and statement of cash flows.

17c) Reduces working capital.

18b) The Company produced more sales in 2006 for each dollar invested in assets.

19a) Rs. 170 unfavorable

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20 b) Standards are developed using past costs and are available at a relatively low cost.

21c) help in fixing selling price.

22c) Direct wages and production overheads.

23. b) Imputed cost.

24c) Arise from additional capacity.

25c) Recovered from the customer.

26d) Nowhere in the Cash Book.

27b) Rs.26, 220

28c) Commission.

29b) Liabilities.

30c) When the goods are transferred from the seller to the buyer.

31a) Petty cash.

32d) both a and b above.

33 all of the above.

34c) Operating activities.

35d) Additional information.

36d) All of the above.

37c) Nominal Accounts.

38d) Both (a) and (b) above.

39d) Both (a) and (b) above.

40d) All of the above

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