Accounting for Manager

Assignment - A
Question 1a): What do you understand by the concept of conservatism? Why it is a
lso called the concept of prudence? Why it is not applied as strongly today as i
t used to be in the Past?
Answer: Concept of Conservatism implies using conservatism while preparing finan
cial statements i.e. income should not be accounted for unless it has actually b
een earned but expenses, even if just anticipated should be provided for. Accord
ing 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 ce
rtain and recognize expenses as soon as they are reasonably possible. The reason
s for accounting in this manner are so that financial statements do not overstat
e 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 incre
ase in 1

corporate frauds e.g. Enron case in USA and Satyam in India.Also, there is a dec
line 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 co
ncept 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 usuall
y shown in a Balance Sheet and a Funds Flow Statement.
Answer: A Balance Sheet is a type of financial statement of an entity, indicatin
g 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 c
an be grouped under two heads, viz: assets and liabilities.
Funds Flow statement determines the sources of cash flowing into the firm and th
e application of that cash by the firm. The various items of a Funds Flow Statem
ent 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 applica
tion 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 a
ssets 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) Su
ndry debtors (c) Cash and bank balances (d) Other current assets (e) Loans and a
dvances (4) Deferred Revenue Expenditure: (a) Miscellaneous expenditure to the e
xtent 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) Liabil
ities
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 liabilit
ies A decrease in shareholders funds Question 2a: Discuss the importance of ratio
analysis for inter-firm and intra-firm comparisons including circumstances resp
onsible for its limitations .If any Answer: Ratio analysis implies the systemati
c use of ratios to interpret the financial statements so that the strength and w
eaknesses 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 dr
awn regarding several aspects such as financial health, profitability and operat
ional efficiency of the undertaking. Ratio analysis is very useful in making int
er-firm comparison as it helps to draw a comparison between the entities within
the same industry or otherwise following the same accounting procedure. It provi
des 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 int
erfirm 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 limitatio
ns. 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 ow
n limitations. Also, they consider only the quantitative aspects of business tra
nsactions where as there are various other non-quantitative aspects such as qual
ity of work force which considerably affect profitability and productivity. Also
, ratio analysis as a tool is also limited by changes in accounting procedures/p
olicies. Question 2b: Why do you understand by the term pay-out ratio ? What fa
ctors are taken into consideration while determining pay-out ratio? Should a com
pany follow a fixed pay-out ratio policy? Discuss fully.
Answer: Pay-out Ratio means the amount of earnings paid out in dividends to shar
eholders. Investors can use the payout ratio to determine what companies are doi
ng with their earnings. It can be calculated as:
A very low payout ratio indicates that a company is primarily focused on retaini
ng 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 dividen
d policy of the company. Young, fast-growing companies are typically 5

focused on reinvesting earnings in order to grow the business. As such, they gen
erally 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 usua
lly pays out a large amount of its profits. Certain other sectors like real esta
te investment trusts are required by law to distribute a certain percentage of t
heir earnings.
Funds requirement of the company and its available liquidity is another factor w
hich 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 compa
ny should take into account various important factors such as its need for futur
e 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 po
sition, operating efficiency and profitability. Year I Year II Current Ratio Aci
d Test Ratio 265% 278% 115% 110% 3.00 8.41 Year III 302% 99% 3.25 7.20
Working Capital Turnover 2.75 (times) Receivables Turnover 9.83
6

Average Collection Period 37 (Days) Inventory to Working Capital Inventory Turno

ver (times) Income per Equity Share Net Income to Net Worth Operating Expenses t
o Net Sales Sales increase during the year Cost of goods sold to Net Sales Divid
end per share Net Profit on Net Sales Rs. 3 95% 6.11 5.10
43 100% 6.01 4.05
50 110% 5.41 2.50 7.0% 25% 23% 73% Rs.3 22.7% 2.0%
11.07 8.5% % 22% 23% 10% 70% 16% 71% Rs.3
Fixed Assets to Net Worth 16.4% 18% 7.03% 5.09%
Answer: The financial position of a concern is mainly judged by its current rati
o, 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 Liabil
ities). A high ratio indicates a good probability the enterprise can retire curr
ent 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 hea
lthy enterprise will always keep this ratio at 1.0 or higher. Also, the fixed as
set 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-liqui
d and often over valued fixed assets
7

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

irable 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 expen
ses as a percentage of revenue or earnings has gone down over the three year per
iod, which is a good sign. An increasing average collection period indicates tha
t the concern is offering too liberal credit terms and has inefficient credit co
llection. The inventory turnover has gone down from 6.11 to 5.41 times indicatin
g declining sales and excessive inventory which again reflects poor operating ef
ficiency.
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 de
clining revenues.
The indicators of profitability are income per equity share, net income to net w
orth, and net profit on net sales. All these ratios have declined considerably o
ver the three year period. This indicates declining profitability over the years
. Thus, on a review of the various ratios, we conclude that Bharat Auto Accessor
ies 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: Tr
ading and Profit and Loss Account for the yr ended 31st Mar 2004 Trading and Pro
fit and Loss Account for the yr ended 31st Mar 2004
Answer)
Dr. 8
Cr.

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 Depre
ciation 2,000
Machinery @10% 34,500
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
Furniture @5% 36,500
To interest on loan from Dass TOTAL Balance Sheet as at 31st Mar 2004 LIABILITIE
S OWNERS CAPITAL Op balance 5,16,000 Less drawings 40,000 Less loss 26,750 UNSECU
RED LOAN Dass @9% CURRENT LIABILITIES & PROVISIONS Sundry Creditors Wages outsta
nding Interest on loan
4,500 58,500 TOTAL 58,500
AMOUNT
ASSETS FIXED ASSETS Machinery 3,45,000 Less dep 34,500 Net block 3,10,500 Furnit
ure 40,000 Less dep 2,000 Net block 38,000 INVESTMENTS CURRENT ASSETS,LOANS & AD
VANCES Stock Sundry Debtors Bank Unexpired insurance TOTAL
AMOUNT
4,49,250
1,00,000
3,48,500
1,25,000 20,000 4,500
1,40,000 1,93,000 16,000 1,250 6,98,750
TOTAL
6,98750
9

WORKING NOTES: 1) Opening balance of Owners capital = stock + debtors + bank + ma

chinery + furniture sundry creditors = 1,50,000 +1,81,000+5,000 +2,50,000+40,000
-1,10,000 =5,16,000 What procedure would you adopt to study the
Question (5a)
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 abil
ity 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 a
sset structure, mainly the current assets. The current assets, viz: stock, debto
rs, bank balance and other current assets need to be seen to determine at what r
ate a firm can convert these into cash. A business that collects its accounts re
ceivable in an average of 20 days generally has more cash on hand than a busines
s 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 effec
tively 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 cas
h resources it shall have. Last, but not the least, we use make use of certain f
inancial ratios like current ratio, quick or acid-test ratio, net working capita
l to determine the liquidity of the firm.
10

Question 5 b: Who are all the parties interested in knowing this accounting info
rmation?
Answer: The various parties interested in determining the liquidity of the firm
would be the business owners and managers, bankers, investors, creditors and fin
ancial analysts.
Business owners and managers use ratios to chart a company s progress, uncover t
rends and point to potential problem areas in a business. One can also use ratio
s 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 interest
ed in the companys short-term and long-term ability to pay its debts.
Financial analysts, who frequently specialize in following certain industries, r
outinely assess the profitability, liquidity, and solvency of companies in order
to make recommendations about the purchase or sale of securities, such as stock
s and bonds. Question 5c: What ratio or other financial statement analysis techn
ique will you adopt for this. Answer: The relevant ratios used to assess the liq
uidity of the firm are current ratio, quick or acid test ratio, cash ratio and n
et working capital. Current Ratio Provides an indication of the liquidity of the
business by comparing the amount of current assets to current liabilities. A bu
siness s current assets generally consist of cash, marketable securities, accoun
ts receivable, and inventories. Current liabilities include accounts payable, cu
rrent maturities of long-term debt, accrued income taxes, and other accrued expe
nses that are 11

due within one year. In general, businesses prefer to have at least one dollar o
f current assets for every dollar of current liabilities. However, the normal cu
rrent ratio fluctuates from industry to industry. A current ratio significantly
higher than the industry average could indicate the existence of redundant asset
s. Conversely, a current ratio significantly lower than the industry average cou
ld 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 compare
s the cash plus cash equivalents and accounts receivable to the current liabilit
ies. 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 + Accoun
ts Receivable Current Liabilities Cash Ratio Indicates a conservative view of li
quidity 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 Wor
king capital compares current assets to current liabilities, and serves as the l
iquid reserve available to satisfy contingencies and uncertainties. A high worki
ng 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 i
f 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 2
8th Feb.2008 : (Rs.) (Rs.)
Cr. Balance as per cash book on 28th Feb Less: interest charged by bank not reco
rded in cash book 500 Bank charges made by bank not recorded in cash book 125 Ch
eques paid into bank but not yet credited 6,250 Add: Cheques issued but not yet
presented Dividends collected directly by bank 7,500 4,500
15,000
6,875 8,125 12,000 20,125
Bank balance as per pass book of Priya & Co as on 28th Feb 2008
Answer 2a: Decision whether new product should be introduced Sale price of new p
roduct 2000@Rs.60 = Rs.1,20,000 Less: Direct costs Direct material 2000@16 =Rs.3
2,000 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 sel
ling & distribution overheads 2000@1.50 =Rs. 3,000 Rs. 7,000 Rs.72,000 CONTRIBUT
ION from new product = Rs.48,000 Answer 2b) Profitability Profits from present p
roduction 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 1,7
5,000 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 culminat
es in cash budget,a budgeted income statement a budgeted balance sheet. In short
, this budget represents a comprehensive expression of management s plans for fu
ture 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 bu
dget. This is the reason why these budgets are called interdependent budgets. Th
e master budget is a comprehensive planning document that incorporates several o
ther individual budgets. A master budget is usually classified into two individu
al budgets: the Operational budget and the Financial budget. The operation budge
t 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 fina
ncial 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 1
5

your business management will be able to ensure that they have sufficient cash o
n 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 t
he business cash flow and should also include three major sections; cash availab
le, cash disbursements, and financing.
Answer 3 b)
The various methods of inventory valuation are: i) FIFO(first-in-first-out) meth
od ii) LIFO(last-in-first-out)method iii) Weighted average method iv) Moving ave
rage method v) Lower of cost or market value(LCM) vi) Dollar value-LIFO vii) Gro
ss Profit method viii) Retail method During times of inflation, different method
s have different effect on inflation. FIFO gives the highest amount of gross pro
fit because the lower unit costs of the first units purchased are matched agains
t revenues, especially in times of inflation. LIFO gives the lowest amount of ne
t 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 Stan
dard of ICAI (AS-2), inventory cost should comprise of all cost of purchases, co
st of conversion and other costs incurred in bringing the inventories to the pre
sent location and condition. Cost of purchases should be exclusive of duties whi
ch are recoverable from the taxing authorities. (e.g. Cenvat). 16

Inventory should be valued at lower of cost or net realisable value. Inventory s

hould 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 cr
edit of the same. However, this reduces value of stock and hence profits are low
er.
17

CASE STUDY
Question 1:
Describe the impact of different types of standards
on motivations, and specifically, the likely effect on motivation of adopting th
e labor standard recommended for Geeta & Company by the engineering firm.
Answer: Different standards have different impact on motivation. In the given ca
se, where the labor standard recommended by the engineering firm is adopted by G
eeta & company, the six-month operation period showed a decline in production an
d an unfavourable quantity variance for each of the six months in the said perio
d. In the other case where the management used the internally set labour standar
d, there was a favourable quantity variance for the first three months ; thereby
implying that the actual production was more than the standard producton. In th
e fourth month, there was no variance in production and in the fifth and sixth m
onth, there was an unfavourable variance, thereby implying that the actual produ
ction was less than standard production. Thus, we see that the standard recommen
ded by the engineering firm had a negative impact on motivation as it was less t
han 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 four
th month; and negative impact in fifth and sixth month.
Question 2: standards.
Please
advise
the
company
in
reviewing
the
18

Answer: The labour standard recommended by the consulting firm should not be use
d 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 peri
od and a negative impact for two months. Therefore, the company should try and a
dopt labour standards similar to those ones.
19

Assignment - C 1 d) Assets are measured using the cost concept. 2 a) Overstateme

nt of Capital d) Understatement of Assets
3 d) Assets = Liabilities + Owners Equity. 4 c) Net income increases retained e
arnings on the statement of retained which ultimately increases retained earning
s on the balance sheet. 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)Ca
sh 10 a) All sources and uses of resources 11 c) Interest expense 12 d) All of t
he above 13 b) Accommodate changes in activity levels 14 d) One place that the r
eader of an annual report would be able to identify that a company changed inven
tory methods is the footnotes to the financial statements. 15 b) Will be recorde
d in a contra account, Discount on Notes Receivable, by Co 16 b)Balance sheet an
d 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 earnings,
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 fr
om 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