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

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 II

Year III

Current Ratio

265% 278%

302%

Acid Test Ratio

115% 110%

99%

Working Capital Turnover 2.75

(times)
Receivables Turnover
9.83

3.00

3.25

8.41

7.20

Average Collection Period 37

(Days)

43

50

Inventory to Working
Capital
Inventory Turnover
(times)
Income per Equity Share

95%

100%

110%

6.11

6.01

5.41

5.10

4.05

2.50

Net Income to Net Worth

11.07 8.5%
%
22%
23%

7.0%

10%

16%

23%

70%

71%

73%

Rs. 3

Rs.3

Rs.3

Operating Expenses to
Net Sales
Sales increase during the
year
Cost of goods sold to Net

25%

Sales
Dividend per share

Fixed Assets to Net Worth 16.4% 18%

22.7%

Net Profit on Net Sales

2.0%

7.03% 5.09%

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

(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:

Answer)

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

AMOUNT
1,50,000
3,69,000
1,80,000
1,50,000
1,08,750
23,250

PARTICULARS
By Cash Sales
By Credit Sales

AMOUNT
61,000
7,80,000

By closing stock

1,40,000

TOTAL

9,81,000

TOTAL

9,81,000

To Discount allowed
To Bad debts w/o
To Depreciation

7,000
8,000

Furniture @5%

By Gross Profit b/d

By Discount received
By misc income

23,250
4,000
2,000

By net loss c/d

26,750

TOTAL

58,500

2,000
-

36,500

Machinery @10%
34,500

To interest on loan from Dass

4,500

TOTAL

58,500

Balance Sheet as at 31st Mar 2004

LIABILITIES

AMOUNT

OWNERS CAPITAL
Op balance 5,16,000
Less drawings 40,000
Less loss
26,750

4,49,250

UNSECURED LOAN
Dass @9%

1,00,000

CURRENT LIABILITIES &

PROVISIONS
Sundry Creditors
Wages outstanding
Interest on loan

1,25,000
20,000
4,500

TOTAL

6,98750

ASSETS
FIXED ASSETS
Machinery 3,45,000
Less dep
34,500
Net block
3,10,500
Furniture
40,000
Less dep
2,000
Net block
38,000
INVESTMENTS
CURRENT ASSETS,LOANS &
ADVANCES
Stock
Sundry Debtors
Bank
Unexpired insurance
TOTAL

AMOUNT

3,48,500

1,40,000
1,93,000
16,000
1,250
6,98,750

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 day-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 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.)

Cr. Balance as per cash book on 28th Feb

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
Add: Cheques issued but not yet presented
Dividends collected directly by bank

(Rs.)

15,000

6,875
8,125

7,500
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)
Profitability
Profits from present production
Sales
Direct material 96,000
Direct labour 1,20,000
Direct expenses 19,000
Variable factory ohds 25,000

5,40,000

2,35,000

14

Variable S&D overheads 5,000

Net Profits
Fixed costs
Fixed factory overheads 1,75,000
Fixed admve overheads 20,000
Fixed S&D overheads 19,000
Net Profits

30,000
2,75,000

2,14,000
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.
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 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 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:
standards.

Please

advise

the

18

company

in

reviewing

the

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
1 d) Assets are measured using the cost concept.
2 a) Overstatement of Capital
d)

Understatement of Assets

3 d) Assets = Liabilities + Owners' Equity.

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

earnings,

5 d) Journalizing
6 d) Most likely an error was- made in posting journal entries to the general ledger or in
preparing the trial balance
7 c) Supplies, Rs2, 300; Supplies Expense, Rs6, 500.
8 d) Fund decreases
9 a)Cash
10 a) All sources and uses of resources
11 c) Interest expense
12 d) All of the above
13 b) Accommodate changes in activity levels
14 d) 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.
15 b) Will be recorded in a contra account, Discount on Notes Receivable, by Co
16 b)Balance sheet and statement of cash flows.
17 c) Has no affect on working capital at all.
18 b) The company produced more sales in 2006 for each dollar invested in assets.
19 a) Rs. 170 unfavorable

20

20 b) Standards are developed using past costs and are available at a relatively low cost.
21 c) help in fixing selling price.

22 c) Direct wages and production overheads.

23. b) Imputed cost.
24 c) Arise from additional capacity.
25 c) Recovered from the customer.
26 d) Nowhere in the Cash Book.
27 b) Rs.26, 220
28 c) Commission.
29 b) Liabilities.
30 c) When the goods are transferred from the seller to the buyer.
31 a) Petty cash.
32 d) both a and b above.
33 a) the corporation must have adequate retained earnings.
34 c) Operating activities.
35 d) Additional information.
36 d) All of the above.
37 c) Nominal Accounts.
38 d) Both (a) and (b) above.
39 c) Both (a) and (b) above.
40 d) All of the above

21