Spring / February 2012

Master of Business Administration MBA Semester 1 MB0041 Financial and Management Accounting 4 Credits
(Book ID: B1130) Assignment Set 1 (60 Marks) Q1). The Balanced Score Card is a framework for integrating measures derived from strategy. Take an Indian company which has adopted balance score card successfully and explain how it had derived benefits out of this framework. Answer: TATA motors have adopted balance score card framework successfully and yields benefits from that. Case Study: TATA Motors CVBU (Commercial Vehicle Business Unit) TATA Motors Commercial scorecard framework. Vehicle Business Unit enhances balanced

Tata Motors is the largest and most prominent market leader in the manufacture of commercial business vehicles in India. In the year 2000, its Commercial Vehicles Business Unit (CVBU) suffered its first loss in its more than fifty years history. This loss was massive. It was in the tune of Rs. 108.62 Million. This prompted Tata Motors to take a profound look into itself; to find reason in this debacle. Subsequently, the executive director of CVBU, Mr. Ravi Kant, called for stringent cost cutting across unit operations, supported by more effective formulation and execution of strategy. To augment this process, the management of Tata Motors resolved to adopt the Balanced Scorecard and Performance Framework as the key tool in the endeavor to rebuild the Organizational Performance Chart. The challenge here was to undertake deployment of the Balanced Scorecard across all the functional units and departments of the CVBU. Soon, however, with the process underway, the real problem revealed itself. It turned out that the manual nature of the review procedures of such a huge structure was well neigh impossible, being, at best, extremely difficult to implement and incredibly time consuming. A watertight solution was needed; quickly. After further examination of the situation, a decision was taken to implement a Balanced Scorecard Automation Tool that would centralize, integrate and collate the data, providing rapid review and analytical functionality and presenting a rapid and comprehensive one view picture of organizational performance. Commencing this process, the CVBU management reviewed many solution providers and evaluated each of them upon the basis of a variety of diverse factors. At the end of this exhaustive process, a solution was decided in the

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Spring / February 2012 form of COVENARK Strategist, a prominent Balanced Score Card Automation Tool developed by MPOWER Information Systems to integrate with the existing ERP and legacy systems with the help of data integration suite. The results were immediate and spectacular. Within two years of this, CVBU had turned over to register a profit of Rs. 107 Million from the loss of Rs. 108.62 Million, accounting for a whopping 60% of TATA Motors inventory turnover. The success path of Balanced Score Card did not stop here. In the beginning CVBU has started the Balanced Scorecard with only Corporate Level Scorecard; at this time they have expanded it to six Hierarchical Levels with three hundred and thirty one Scorecards, additionally looking forward to proliferate it to the lowest level of organizational structure. In this way, balanced scorecard framework played a vital role in the success story of TATA Motors CVBU. Q2). What is DuPont analysis? Explain all the ratios involved in this analysis. Your answer should be supported with the chart. Answer: A method of performance measurement that was started by the DuPont Corporation in the 1920. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as DuPont identity. DuPont analysis tells us that ROE is affected by three things: 1. Operating efficiency, which is measured by profit margin 2. Asset use efficiency, which is measured by total asset turnover 3. Financial leverage, which is measured by the equity multiplier ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity) Investopedia explains DuPont Analysis It is believed that measuring assets at gross book value removes the incentive to avoid investing in new assets. New asset avoidance can occur as financial accounting depreciation methods artificially produce lower ROEs in the initial years that an asset is placed into service. If ROE is unsatisfactory, the DuPont analysis helps locate the part of the business that is under performing. The DuPont System expresses the Return on Assets as: ROA = OPM * ATR The Operating Profit Margin Ratio is a measure of operating efficiency and the Asset Turnover Ratio is a measure of asset use efficiency. The DuPont System expresses the Return on Equity as: ROE = (ROA Interest Expense/Average Assets) * EM

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Spring / February 2012 The Equity Multiplier is a form of leverage ratio and measures financial efficiency. Below figure shows the DuPont Analysis for a farm operation Figure: DuPont Analysis for Farm Operations

DuPont Analysis for Two Farms Sr.No. Farmer A Farmer B 1 2 3 4 5 6 Operating profit margin ratio 0.30 0.12 Asset turnover 0.20 0.36 ROA (1*2) 0.060 0.043 Interest expense to avg. farm assets 0.05 0.03 Equity multiplier 2.00 1.50 ROE (3-4) * 5 0.02 0.02

Farmer A and Farmer B each have a 2 % ROE. The components of the ratios indicate that the sources of the weakness of the farms are different. Farmer A has a stronger profit margin ratio but lower asset turnover compared to Farmer B. Furthermore, Farmer A has a higher leverage ratio than Farmer B.

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Spring / February 2012 The weak ratios for each farm may be decomposed into components to determine the potential sources of the weakness. To improve asset turnover Farmer A needs to increase production efficiency or price levels or reduce current or noncurrent assets. To improve profit margins, Farmer B needs to increase production efficiency or price levels more than costs or reduce costs more than revenue. The DuPont analysis is an excellent method to determine the strengths and weaknesses of a farm. A low or declining ROE is a signal that there may be a weakness. However, using the analysis you can better determine the source of weakness. Asset management, expense control, production efficiency or marketing could be potential sources of weakness within the farm. Expressing the individual components rather than interpreting ROE itself may identify these weaknesses more readily. Q3). Accounting Principles are the rules based on which accounting takes place and these rules are universally accepted. Explain the principles of materiality and principles of full disclosure. Explain why these two principles are contradicting each other. Your answer should be substantiated with relevant examples. Answer: Principle of materiality: While important details of financial status must be informed to all relevant parties, insignificant facts which do not influence any decisions of the investors or any interested group, need not be communicated. Such less significant facts are not regarded as material facts. What is material and what is not material depends upon the nature of information and the party to whom the information is provided. While income has to be shown for income tax purposes, the amount can be rounded off to the nearest ten and fraction does not matter. The statement of account sent to a debtor contains all the details regarding invoices raised, amount outstanding during a particular period. The information on debtors furnished to Registrar of Companies need not be in detail. Principle of Full Disclosure The business enterprise should disclose relevant information to all the parties concerned with the organization. It means that any information of substance or of interest to the average investors will have to be disclosed in the financial statements. The Companies Act, 1956 requires that income statement and balance sheet of a company must give a fair and true view of the state of affairs of the company. If change has a material effect in current period and the effect of change is ascertainable the amount of change should be disclosed. ??If the change has a material effect in current period and the effect of change is not ascertainable wholly or in part, the fact should be disclosed. ??If change has no material effect in current period but which is reasonably accepted to have a material effect in later periods, the fact of such change should be appropriately disclosed.

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Spring / February 2012 Materiality principle: Accountants follow the materiality principle, which states that the requirements of any accounting principle may be ignored when there is no effect on the users of financial information. Certainly, tracking individual paper clips or pieces of paper is immaterial and excessively burdensome to any companys accounting department. Although there is no definitive measure of materiality, the accountants judgment on such matters must be sound. Several thousand dollars may not be material to an entity such as General Motors, but that same figure is quite material to a small, family-owned business. Full disclosure means to disclose all the details of a security problem which are known. It is a philosophy of security management completely opposed to the idea of security through obscurity. The concept of full disclosure is controversial, but not new; it has been an issue for locksmiths since the 19th century. Full disclosure requires that full details of security vulnerability are disclosed to the public, including details of the vulnerability and how to detect and exploit it. The theory behind full disclosure is that releasing vulnerability information results in quicker fixes and better security. Fixes are produced faster because vendors and authors are forced to respond in order to save face. Security is improved because the window of exposure, the amount of time the vulnerability is open to attack, is reduced. The full disclosure principle states that any future event that may or will occur, and that will have a material economic impact on the financial position of the business, should be disclosed to probable and potential readers of the statements. Such disclosures are most frequently made by footnotes. For example, a hotel should report the building of a new wing, or the future acquisition of another property. A restaurant facing a lawsuit from a customer who was injured by tripping over a frayed carpet edge should disclose the contingency of the lawsuit. Similarly, if accounting practices of the current financial statements were changed and differ from those previously reported, the changes should be disclosed. Changes from one period to the next that affect current and future business operations should be reported if possible. Changes of this nature include changes made to the method used to determine depreciation expense or to the method of inventory valuation; such changes would increase or decrease the value of ending inventory, cost of sales, gross margin, and net income or loss. All changes disclosed should indicate the dollar effects such disclosures have on financial statements. Q4) Explain any two types of errors that are disclosed by trial balance with examples and rectification entry. Answer: An error is an unintentionally committed mistake. When the Trial Balance does not tally it is a clear indication that there are some errors in the preparation of accounts. The errors may be committed at various stages Journalizing, Posting, Casting (totaling), Balancing, Transferring to trial balance and so on.

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Spring / February 2012 Mere tallying of the trial balance does not ensure an error free statement. There are certain errors such as errors of omission, error of principle and compensating errors are not disclosed by trial balance while errors of casting, posting to wrong side of an account or posting a wrong amount can be detected by trial balance. Errors whether disclosed or not disclosed by trial balance, have to be corrected or rectified in order to obtain the correct picture of profit or loss. It should be remembered that errors will have their impact not only on profit but also on the asset and liability position of the business organization. Posting a wrong amount: This mistake may occur while posting an entry from subsidiary book to ledger. Example: Cash received from Krupa Rs. 1250 is posted to Krupas ledger account Rs. 1520, while its correct posted in cash a/c Rectification entry: Krupa account To Suspense a/c Dr. Rs. 270 Rs. 270

Being excess credit given to Krupa a/c rectified. Q5). Distinguish between financial accounting and management accounting. Answer: Financial Accounting vs. Management Accounting Business is a diverse field and involves knowledge in various subjects. In business, one must know about finance, economics, marketing, and accounting, among other things. Accounting is the most challenging among them because it involves recording, summarizing, analyzing, verifying and reporting the results of business and financial transactions. Accounting also has various fields; two of the most commonly used are Financial Accounting and Management Accounting. Listed below are their features. Financial Accounting Financial accounting is concerned with the preparation of financial statements for the use of the stockholders, suppliers, banks, employees, government agencies and the owners of the business enterprise. It is intended to aid in the reduction of problems that may arise in the day to day transactions of the business. It publishes an annual report that summarizes an organizations financial data that are taken from their records.

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Spring / February 2012 It is governed by local and international accounting standards. Its main purpose is to produce financial statements, provide information that can be used in the decision making and planning and to help an organization meet regulatory requirements. It is a legal requirement of all publicly traded organization. Management Accounting Management accounting is concerned in providing basis for decision making and use of information by managers within an organization. It helps identify, measure, accumulate, analyze and interpret information to be used in planning, evaluation and control to ensure the proper use of an organizations resources. It also provides financial reports to shareholders, creditors, regulatory agencies and tax agencies. Management accounting involves sales forecasting reports, budget and comparative analysis, feasibility studies and merger or consolidation reports. It is intended to provide information that is more a forecast than a background, to managers within the organization, is confidential and is computed by using information systems rather than general financial accounting standards. It is used in strategic, performance and risk management. Management accounting has the following concepts: Cost accounting which is a central element is managerial accounting. Grenzplankostenrechnung (GPK) which a German costing method that provides ways on how to calculate costs that are assigned to a product or service. Lean accounting which is accounting for lean enterprise. Resource consumption accounting (RCA) which provides managers with information to support an organizations optimization. Throughput accounting which recognizes modern production processes need for each other. Transfer pricing which is used in manufacturing and banking. Q6). XYZ Ltd provides the following information.

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Spring / February 2012 January 1 65,000 13,000 15,000 16,000 90,000 12,000 6,000 30,000 30,000 32,000 December 31 1,05,000 20,000 20,000 30,000 84,000 8,000 5,000 58,000 42,000 36,000

Sundry Debtors Cash in hand Cash at Bank Bills Receivable Inventory Bills Payables Outstanding expenses Sundry Creditors Bank Overdraft Short term Loans

Prepare a schedule of changes in working capital Hint: Net Working capital: Jan 1st 89000 and Dec31st 110000

Answer:

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Spring / February 2012 Schedule of changes in working capital: Balance on Jan 1 as Dec 31 Effect of WC Increase Decrease

Details Current Assets Cash in hand Cash at Bank Sundry Debtors Bills Receivable Inventory Total Current Assets(A) Current Liabilities Sundry Creditors Bills Payables Outstanding expenses Bank overdraft Short term loans Total Current Liabilities(B) Working Capital (A)-(B) Net Increase in working capital(balanci ng figure)

13,000 15,000 65,000 16,000 90,000 1,99,000

20.000 20,000 1,05,000 30,000 84,000 2,59,000

7,000 5,000 40,000 14,000 6,000

30,000 12,000 6,000 30,000 32,000 1,10,000 89,000 21,000

58,000 12,000 6,000 42,000 36,000 1,49,000 1,10,000

4,000 1,000 -

28,000 12,000 4,000

21,000

1,10,000

1,10,000

71,000

71,000

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