INDIAN INSTITUTE OF MANAGEMENT RANCHI

End-term Examination: Financial Reporting and Analysis (FRA)

Duration: 120 minutes Term I: MBA (2020-22) Total Marks: 100

Name…………………………….. Reg.No……… Marks scored………….

All questions are compulsory.

Q1. Tension Begins Manufacturing Company was organized five years ago and manufactures toys.
Its most recent three years’ balance sheets and income statements are reproduced below:

Tension Begins MANUFACTURING CORPORATION

Balance Sheets- June 30, Year 5, Year 4 and Year 3
Year 5 Year 4 Year 3
Assets
Cash 12,000 15,000 16,000
Accounts Receivable, net 183,000 80,000 60,000
Inventory 142,000 97,000 52,000
Other current assets 5,000 6,000 4,000
Plant and equipment, net 160,000 110,000 70,000
Total Assets 502,000 308,000 202,000

Liabilities and Shareholder’s Equity

Accounts Payable 147,800 50,400 22,000
Federal income tax payable 30,000 14,400 28,000
Long-term liabilities 120,000 73,000 22,400
Common stock, INR 5 par value 110,000 110,000 80,000
Retained earnings 94,200 60,200 49,600
Total liability and equity 502,000 308,000 202,000

Tension Begins MANUFACTURING CORPORATION

Consolidated income statements- June 30, Year 5, Year 4 and Year 3
Year 5 Year 4 Year 3
Net Sales 1,684,000 1,250,000 1,050,000
Cost of goods sold (927,000) (810,000) (512,000)
Gross Profit 757,000 440,000 538,000
Marketing and administrative (670,000) (396,700) (467,760)
costs
Operating income 87,000 43,300 70,240
Interest cost (12,000) (7,300) (2,240)
Income before income tax 75,000 36,000 68,000
 Income tax (30,000) (14,400) (28,000)
Net income 45,000 21,600 40,000

A reconciliation of retained earnings for years ended June 30, Year 4, and Year 5, follows:

Tension Begins MANUFACTURING CORPORATION

Statement of Retained Earnings- June 30, Year 5 and Year 4
Year 5 Year 4
Balance, beginning 60,200 49,600
Add: Net income 45,000 21,600
Subtotal 105,200 71,200
Deduct: Dividends paid (11,000) (11,000)
Balance, ending 94,200 60,200

Additional Information:

1. All sales are on account.

2. Long-term liabilities are owed to the company’s bank.

3. Terms of sale are net 30 days.

Required:

a. Compute the following measures for both Years 4 and 5: [20 marks]

(1) Working capital.

(2) Current ratio.

(3) Acid-test ratio.

(4) Accounts receivable turnover.

(5) Collection period of receivables.

(6) Inventory turnover.

(7) Days to sell inventory.

(8) Total Debt-to-equity ratio.

(9) Times interest earned.

(10) Gross profit margin and net income margins

b. Based on your analysis in (a) prepare a half-page report yielding a recommendation on whether to
grant a loan to Tension Escalates Manufacturing. Support your recommendation with relevant
analysis. [5 marks]
Q2. Pain Ltd was formed on December 18, 2019, via the merger of Agony International and Tension,
Inc. The company owns the rights to franchises and brands including Fake, Forged, Phony, Sham,
Replica and Bogus.

The consolidated entity got off to a bad start when it was revealed that Agony International executives
had been committing “widespread and systemic” accounting fraud with intent to deceive investors.
When the company announced that it had discovered “potential accounting irregularities” the stock
dropped from INR 360 to INR 190 per share. Eventually the stock would fall to as low as INR 60 per
share as the company struggled to convince investors about management’s integrity.

According to the company’s own investigation, Agony International executives had inflated earnings
by over INR 650 million over a three-year period using several tactics, including: (1) failing to timely
record returned credit card purchases and membership cancellations, (2) improperly capitalizing and
amortizing expenses related to attracting new members, and (3) recording fictitious sales.

Required (not more than half a page in legible writing, additional pages will simply be unread):

a) For each of three fraudulent tactics employed by Agony International, identify an analysis
technique that could have identified the accounting improprieties.
b) Both the investors and the management of Tension Inc. had relied on audited financial
statements in making decisions regarding Agony International. What do you believe was the
external auditor’s culpability in not detecting these fraudulent practices?

[10 marks]

Q3. Agony begins Ltd created its financial statements pertaining to year ended 31st March 2020
and Balance sheet as on 31st March 2020, it is given as under:

Liabilities INR cr Assets INR cr

Equity share capital 30 Fixed Assets (at WDV) 90
General Reserves 10 Inventories 40
Long term loans 100 Debtors 30
Trade creditors 50 Cash & Bank balances 10
P&L A/c 20
Total 190 Total 190

While creating the financial statements, the concerned company did not write off bad debts to the
tune of INR 4 crores, did not provide for outstanding salary expenses amounting up to INR 10 crores
and understated their inventories (as on 31st March 2011) by INR 5 crores.

You are required to compute current ratio and long-term debt to equity ratio of the company so that
the above noted errors/ omissions are rectified in the company financials. (Clearly state the working,
without which marks will not be given) [20 marks]

Q4. After saving lots of money for her dream venture, Divya finally opened her art venture.
However, since she never paid attention in her accounting classes, she is clueless on how to assess
the efficiency of her new art venture. Help her in analyzing how her venture has performed in both
the years:

Fill the table with the below numbers, show the workings and then calculate the ratios asked from
a to e.

All numbers in INR Year 2 Year 1

Cash Sales Your Father's birth year in 4 digits* 10000 75% of cash sales Year 2
Credit Sales Your Mothers’ birth year in 4 digits* 10000 75% of credit sales Year 2
Total Sales Sum of cash and credit sales Sum of cash and credit sales
Net income 50% of credit sales number 50% of credit sales number
Investment 18,000,000.0 40,500,000.0
Cash on hand 4,579,296.0 3,223,704.0
Cash expenses 38,138,408.0 29,748,943.0
Accounts receivable
(net of bad debt 3,192,790.0 2,107,393.0
allowance)

Eg. If your Father’s birth year is 1963, cash sales will be 1963*10000 = INR 19,630,000

a. What has been the net profit margin in year 1 and year 2
b. What has been the investment turnover in year 1 and year 2
c. What has been the return on investments for both the years, comment on the performance
d. Has she been effective in managing cash in both the years?
e. What are the accounts receivable days for both the years? What can you comment on the
credit policy of the venture based on the available information?

[20 marks]

Q5. Tension Escalates Pvt Ltd (a manufacturing company) commenced all their business activities
from 1st April 2019 and during the year ended 31st March 2020 the company recorded sales of INR
155 lakhs, EBDIT of INR 41 lakhs, EBIT of INR 27 lakhs, PBT of INR 17 lakhs and PAT of INR 13 lakhs.
The balance sheet of the company as on 31st March 2020 is given as under. (Remember these are
first year of operations as the company started on 1st April 2019).

Liabilities INR (lakhs) Assets INR (lakhs)

Equity share capital 51 Fixed Assets 120
Revaluation reserve 20 Inventories 50
P&L Account 10 Trade debtors 70
Long term loans 100 Cash & Bank balance 10
Trade creditors 60
Outstanding tax dues 2
Outstanding interest charges 7
250 250

Based on this information answer the below questions. What will be the amount asked as reported
by the company during the year ended 31st March 2020:

a. Net cash flow from Financing activities

 b. Net cash flow from Operating activities
c. Net cash flow from Investing activities
[15 marks]
Q6. Respond to the two parts:

Part A: M/s Roast Ltd wishes to manipulate their financials in such a manner so as to show a higher
“Profit before tax (PBT)” and higher “Net Assets” figure in their financials. However, the said company
is not inclined to tamper with the “Gross Profit” or “Net book value of fixed assets” figure in any
manner whatsoever. You are required to suggest a “creative accounting” measure that might meet
the desired objective.

Part B: A profitable company (currently encountering severe cash crunch, but with brilliant future
prospects) wishes to raise money from the market in such a manner so as to ensure that the returns
attributable to such new finance may be provided for in the company books during the current
operating year, but may actually be paid years later. Based on such information you are required to
state – what action the company is contemplating while raising money from the market.

[10 marks]