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 firms 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 companys 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 1 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. 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 2

(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 (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: 3

Inflow of funds: A decrease in assets An increase in liabilities An increase in shareholders funds Outflow of funds: An increase in assets A decrease in liabilities A decrease in shareholders 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. 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 4

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 payout ratio to determine what companies are doing with their earnings. It can be calculated as: A very low payout ratio indicates that a company is primarily focused on retaining its earnings rather than paying out dividends.

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 payout than larger dividends. The major factor to be considered in determining the payout ratio is the dividend policy of the company. Young, fast-growing companies are typically 5

focused on reinvesting earnings in order to grow the business. As such, they generally sport low (or even zero) dividend payout 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 IIYear III Current Ratio Acid Test Ratio 265% 278% 302% 115% 110% 99% 3.00 3.25

Working Capital Turnover2.75 (times) Receivables Turnover 9.83

8.41 6

7.20

Average Collection Period37 (Days)

43

50

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 Net Sales 22% 23% 25%

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 Worth16.4%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 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 7

(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 Dr. Cr. 8 PARTICULARS To opening stock To purchases To wages To salaries To Sunday office expenses To Gross Profit c/d TOTAL To Discount allowed To Bad debts w/o To Depreciation 2,000 34,500 Furniture @5% Machinery @10% 36,500 AMOUNT 1,50,000 3,69,000 1,80,000 1,50,000 1,08,750 23,250 9,81,000 7,000 8,000 PARTICULARS By Cash Sales By Credit Sales By closing stock AMOUNT 61,000 7,80,000 1,40,000

TOTAL By Gross Profit b/d By Discount received By misc income By net loss c/d

9,81,000 23,250 4,000 2,000 26,750

To interest on loan from Dass TOTAL

4,500 58,500 TOTAL 58,500

Balance Sheet as at 31st Mar 2004

LIABILITIES OWNERS CAPITAL Op balance 5,16,000 Less drawings 40,000 Less loss 26,750 UNSECURED LOAN Dass @9% CURRENT LIABILITIES & PROVISIONS Sundry Creditors Wages outstanding Interest on loan

AMOUNT

ASSETS FIXED ASSETS

AMOUNT

4,49,250

1,00,000

1,25,000 20,000 4,500

Machinery 3,45,000 Less dep 34,500 Net block 3,10,500 Furniture 40,000 Less dep 2,000 Net block 38,000 3,48,500 INVESTMENTS CURRENT ASSETS,LOANS & ADVANCES Stock 1,40,000 Sundry Debtors 1,93,000 Bank 16,000 Unexpired insurance 1,250 TOTAL 6,98,750

TOTAL

6,98750 9

WORKING NOTES: 1)Opening balance of Owners 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 its dayto-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 shortterm 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 or acid-test ratio, net working capital to determine the liquidity of the firm. 10

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 companys short-term and long-term ability to pay its debts. 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 11

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 suspects severe liquidity problems with inventory and receivables. Formula Cash Equivalents + Marketable Securities Current Liabilities 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 12

Current Assets - Current Liabilities 13

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 book 125 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 200820,125 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) Profitability Profits from present production Sales Direct material 96,000 Direct labour 1,20,000 Direct expenses 19,000 Variable factory ohds 25,000 14 Variable S&D overheads 5,000 30,000 Net Profits 2,75,000 Fixed costs Fixed factory overheads 1,75,000 Fixed admve 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. 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. =

5,40,000

2,35,000

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 15

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).

16

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 excise duty, as manufacturer has availed credit of the same. However, this reduces value of stock and hence profits are lower. 17

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 sixmonth 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 producton. 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. 18

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

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. 19

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 retainedearnings, 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) All of the above 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) Will be recorded in a contra account, Discount on Notes Receivable, by Co 16b)Balance sheet and statement of cash flows.

17c) Has no affect on working capital at all. 18b) The company produced more sales in 2006 for each dollar invested in assets. 19a) Rs. 170 unfavorable 20

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. 33a) the corporation must have adequate retained earnings. 34c) Operating activities. 35d) Additional information. 36d) All of the above. 37c) Nominal Accounts.

38d) Both (a) and (b) above. 39c) Both (a) and (b) above. 40d) All of the above