MS- 04: Accounting and Finance for Managers

ASSIGNMENT

Course Code : MS-04

Course Title : Accounting and Finance for
Managers
Assignment Code : 01/TMA/SEM-II/2010
Coverage : All Blocks

Attempt All the Questions.

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Ques.1 Explain the following accounting concept

1. Concept of conservatism
2. Cost Concept
3. Periodicity Concept
4. Money Measurement Concept

Solutions :
1. The Conservatism (Prudence) Concept
As the term suggests its traditional approach of playing safe or being cautious in
recognising all the possible losses but ignoring all probable profits. This is also known as
prudence concept implying the common and accepted behaviour of accounting or
providing for future losses. Though this approach leads to creation of secret reserves and
understatement of income; it also of safeguards the interest of outsiders by preventing the
management from recognising unrealised, profits and providing for all future losses.
There are few instances, which illustrate the acceptance and adherence of this concept.
1. Inventories are valued at lower of cost or market price.
2. Providing for doubtful debts and discount allowed to debtors but ignoring the
probable discount received from creditor till the time final payments are made.
3. All the fixed assets are valued on historical costs irrespective of their market price
except in the case of revaluation of business.
4. Preference of written down value method over straight-line method of
depreciation, since the earlier one, provides for more depreciation in the initial years of
use.
5. Valuing Joint Life Insurance Policy at its surrender value irrespective of amount
of instalments paid.
2. Cost Concept
According to this concept, all transactions and events are recorded in the book" of
account at the actual price involved. This price is called cost. All assets are carried in the
books of accounts from year to year at their acquisition cost (also called historical cost)
irrespective of any change in their market value. Acquisition cost is considered highly
objective, reliable, definite and free from bias. Thus when a machine is purchased for Rs.
5 lakhs, transportation expenses are Rs. 20,000, installation expenses are Rs. 10,000, the
machine is valued at Rs. 5,30,000. This is the historical cost of machine.
However, the cost concept creates difficulties in its application in the following
situations:
(a) When due to price rise, the prices of all commodities go up substantially, the financial
position of a firm depicted on cost concept basis does not reflect true picture.
(b) Financial statements of two or more firms set up at different points of time prepared
on historical cost basis are not comparable due to changes in prices.
(c) Depreciation is computed on historical cost. This understates depreciation when
current value of an asset is very high. So it becomes necessary to revalue the assets.
(d) This concept implies recording of all assets for which costs have been incurred but the
assets like managerial competence, reputation or goodwill of the firm acquired over a
period of time are not recorded.
(e) The exception to this concept of valuing assets at cost irrespective of its market value
is the valuation of inventories. According to AS-2, inventories should be valued at cost or
market price whichever is lower.
In spite of the limitations, cost concept is still considered highly objective and free from
bias.

3. The Time Period Concept (Periodicity Concept)

This concept indicates that the profitability of a business is to be measured periodically.
The period for which income is measured is called the accounting period. For the purpose
of external reporting, the accounting period is generally one year. Thus, accounting profit
is the result of completed transactions during the accounting period. For income tax
purposes, a business has compulsorily to adopt financial year beginning on 1st April in
any calendar year and ending on 31st March in the next calendar year as its accounting
year. However, for internal reporting the profitability report can be prepared monthly,
quarterly or half yearly depending on the nature of project to facilitate better control and
evaluation of performance.

4.Money Measurement Concept

In accounting, a record is made only of those facts or transactions that can be expressed
in monetary terms. It provides a common yardstick, i.e., money for measuring, recording
and summarizing the transaction. Events, which cannot be expressed in money terms, do
not find a place in account books. For example, salary paid to manager is recorded in
account books but his competence, which cannot be expressed in monetary terms, is not
recorded in the books. The application of money measurement concept makes
accountingdata and information relevant, simple, understandable, homogeneous and
comparable.
The main advantage of money measurement concept is that even a layman is able to
understand and appreciate the things stated in terms of money. However, the concept
suffers from the following flaws:
a. Money does not have a constant value. The value of money changes because of
inflation or deflation in the country.
b. All business assets cannot be measured in money terms. It is very difficult to
calculate the value of goodwill or measure the competency or morale of employees.

(Solution for Q. 2 is contributed by Sunny Verma.)

Ques.2: The following is the Trial Balance of a trader as at 31st December, 2001:

Debit Balances Rs. Credit Balances Rs.

Stock (1-1-2001) 46,800 Neeru’s capital account 1,08,090
Sales returns 8,600 Sales 2,89,600
Purchases 2,43,100 Purchases returns 5,800
Freight and carriage 18,600 Sundry creditors 14,800
Rate, Rent etc. 5,700 Bank loan at 6% 20,000
Salaries and wages 9,300 Income from investments 250
Sundry debtors 24,000 Discounts 4,190
Bank Interest 900
Printing and 14,600
advertisement 8,000
Cash at Bank 5,000
Investments 1,800
Furniture and fittings 7,540
Discounts 3,910
General expense 700
Audit Fees 600
Insurance 2,330
Travelling expenses 870
Postage and telegrams 380
Cash in hand 30,000
Deposit with Pran 10,000
Drawing Account 4,42,730 4,42,730

Adjustments:
(i) Stock at the end was Rs. 78,600
(ii) Included amongst the debtors is Rs. 3,000 due from Zeenat and included
amongst the creditors is Rs. 1,000 due to her.
(iii) The effect of advertising not yet expired, a quarter of the amount ‘Printing and
Advertising’ is to be carried forward to the next year.
(iv) Reserve 2 per cent for discount on Debtors and create a bad debts reserve at 5
percent.
(v) A depreciation of 10% p.a. is to be written off Furniture and fittings.
 (vi) Wages owing on 31st December, 2001 is Rs. 300, salaries owing Rs. 500 and
carriage owing Rs. 100.
(vii) Prepaid insurance is Rs. 80.
(viii) Furniture which stood at Rs. 600 in books Ist January, 2001 was disposed of at
Rs. 290 on June, in part exchange for new furniture costing Rs. 520. A net
invoice at Rs. 230 was passed through the purchase-day book.
(ix) Purchase Invoice amounting to Rs. 400 had been omitted from the books.
(x) A Neon-sign costing Rs. 100 is included in Advertising.
(xi) Two dishonored cheques for Rs. 200 and Rs. 300 respectively has not been
entered in the cast book. The first for Rs. 200 is known to be bad. In the case
of a second cheque for Rs. 300, it is expected that 75% of it would be realized.
(xii) Private purchase amounting to Rs. 600 had been included in the Purchase Day
Book.
(xiii) Charge full year’s interest on Deposit with Pran at 7% p.a.
(xiv) Provide for interest on Bank loan for the amount due.
Prepare Final Accounts.

Solution :
Trading account for the year ended 31st December, 2001.
Dr Cr.
Particulars Rs. Particulars Rs.
To opening stock 46,800 By Sales 2,89,600
To purchases Less: Sales
2,43,100 Returns 8,600 2,81,000
Less: --------
Purchase
Returns (-) 5,800
Less:
Capatilised (-) 230
Less:
Drawings (-) 600
Add:
Omitted
Purchases (+) 400 2,36,870 By Closing Stock 78,600
------
To Freight & 18,700
Carriage
To Gross Profit 57,230
Total 3,59,600 Total 3,59,600
Profit & Loss Account for the year ended 31st December, 2001

Dr. Cr.
Particulars Rs. Particulars Rs.
To rates & rents 5,700 By Gross Profit 57,230
To Salaries &
Wages 9,300 By income from 250
+ O/S Wages 300 Investments
+O/S Salaries 500
------ 10,100 By Discount 4,190

To bank interest 900 By interest on

To print & Deposit with 2,100
Advt. 14,500 Pran
Less: C/f To next
year (-) 3625
---------------------
10,875
(-) Neon
Sign board 100 10,775
--------------------

To interest on loan 1,200

To discount allowed 7,540
To general expenses 3,910
To audit fees 700
To insurance 600
Less : Prepaid 80
520

To traveling exp. 2330

To postages &
telegrams 870
To bad debt reserve 1,200
To discount on
Debtors reserve 456
To depreciation on
furniture 172
To loss on sale of
furniture 310
To net profit 17,087

Total 63,770 Total 63,770

Balance sheet as on 31st Dec, 2001

Liabilities & Assets Rs.

Capital Rs.
Capital : Furniture &
Opening 1,08,090 Fittings 1,800
Drawing (-) 10,000
Private (-) 600 -sold (-) 600
Purchasing +New Purchase 520
1,720
+Net profit 17,087 1,14,577
Less: Depriciation@
Bank load 10% (-) 172
@ 6% 20,000
Deposit with 1,548
Add: Interest Pran 31,000
@ 6% 1,200 21,200 Add interest
@7% 2,100

Sundry 32,100
Creditors 14,800 15,200 Sundry Debtors
Add : Omitted 400 Balance 24,000
Bad debt
Outstanding wages 300 reserve@ 5%
(-) 1,200
Outstanding salaries 500 22,800

Discount on
debtors@2% 456
----------------------
22,344
Cash at bank
Cash in hand
Closing stock 8,000
Prepaind Advt. 380
Prepaid Insurance 78,600
Neon sign board 3,625
80
100

Total 1,51,777 Total 1,51,777

(Solution for question no. 3 is contributed by Farida)

Q.3 : From the following Balance Sheets of Sriramco, prepare

(a) Statement of Changes in Working Capital, and (b) Funds Flow Statement: Balance
Sheet of Sriramco as on 31st December…
2000. 2001
Assets Rs. Rs.
Goodwill 90,000 80,000
Land and Buildings 2,80,000 2,00,000
Plant 1,00,000 2,00,000
Investments 30,000 40,000
Book Debts 1,80,000 2,10,000
Stock 80,000 1,20,000
Cash in hand and at Bank 40,000 45,000
Preliminary Expenses 20,000 10,000
8,20,000 9,05,000

Liabilities
Share Capital
Equity Share Capital 4,00,000 5,00,000
10% Red. Pref. Share Capital 2,00,000 1,00,000
Capital Reserve - 30,000
General Reserve 60,000 80,000
P. and L. Account 30,000 45,000
Proposed Dividend 60,000 60,000
Sundry Creditors 30,000 45,000
Provision for Taxation 40,000 45,000
8,20,000 9,05,000

The following additional information is also available

(a) A machine has been sold for Rs. 40,000 whose written down value was Rs. 36,000.
Depreciation of Rs. 15,000 has been charged on plant in 2001;
(b) A piece of land had been sold out in 2001 and the profit on the sale has been credited
to
capital reserve;
(c) An interim dividend of Rs. 30,000 has been paid in 2001;
(d) Income tax paid during 2001 amounts to Rs. 45,000;
(e) Preference Shares were redeemed at 5% premium.
Solution:
Statement of change in working capital:

2001 2002 + -
Current Assests
Debtors 180000 210000 300000
Stocks 80000 120000 40000
Cash 40000 45000 5000
75000
Current
Liabilities
Creditors 30000 45000 15000
Provision for 40000 45000 5000
Tax
Increase in 20000
working
capital

Fund Flow Statement

A. Sources of Funds

1. Funds from Operations 51000

2. Issue of Equity Share 10000
3. Sale of Machine 40000
101000

B. Uses of Funds:

1. Payment of Tax 45000

2. Payment of Dividend 30000
3. Redemption of Preference 100500
share
175500
 Decrease in Working Capital (B-A) = 74,500/-

Working Note:

Funds from Operation

Closing balance of P&L Account 2001 = 45000

Add

1. Depreciation = 15000
2. Provision of Tax = 5000
3. Amount written off Goodwill = 10000
4. Amount written off Preliminary Exp. = 10000
85000

Less

Profit on Sale of Machine = 4000

Profit on Sale of Land = 30000
Funds from Operation = 510000/-

Ques. 4 : The capital structure of Bombay Refrigeration Company Ltd. Consists of an

equity share capital of Rs. 3, 00,000 (share of Rs. 10 par value) and Rs.
3,00,000 10% debentures. Sales increased by 20% from 30,000 to 36,000
units, the selling price is Rs. 10 per unit. Variable cost Rs.6 Per unit and fixed
costs amount to Rs. 50,000 The company’s tax rate is 50%.

You are required to compute the degree of operating leverage, degree of financial
leverage and degree of combined leverage.

Solution: not solved yet……

Ques. 5: The following details relates to the two machines X and Y:

Machine X Machine Y
Cost Rs. 56,125 Rs.56,125
Estimated Life 5 years 5 years
Estimated salvage value Rs. 3,000 Rs. 3,000
Working Capital required in the beginning Rs.10,000 Rs. 20,000
Annual income after tax and depreciation:

Year Rs. Rs.

I 3,275 11,375
II 5,375 9,375
III 7,375 7,375
IV 9,375 5,375
V 11,375 3,375

Overhauling charges at the end of third year Rs. 25,000 on machine X. Depreciation has
been charged at straight line method. Discount rate is 10%? P.V.F. at 10% for five years
are 0.909, 0.826, 0.751, 0.683 and 0.621. Suggest which project should be accepted.

Solution : not solved yet…………

Ques. 6: Discuss the concept of working capital what shall be the repercussions if the
firm has
a) Shortage of working capital
b) Excess of working capital

Solutions :
Every business concern should have adequate working capital to run its business operations.
It should have neither redundant or excess working capital nor inadequate or shortage of
working capital. Both excess as well as short working capital positions are bad for any business.
However, out of the two, it is the inadequacy of working capital which is more dangerous
from the point of view of the firm.

a) Shortage of working capital

Disadvantages or Dangers of Inadequate Working Capital
1. A concern which has inadequate working capital cannot pay its short-term liabilities
in time. Thus, it will lose its reputation and shall not be able to get good credit
facilities.
2. It cannot buy its requirements in bulk and cannot avail of discounts, etc.
3. It becomes difficult for the firm to exploit favourable market conditions and
undertake profitable projects due to lack of working capital.
4. The firm cannot pay day-to-day expenses of its operations and its creates
inefficiencies, increases costs and reduces the profits of the business.
5. It becomes impossible to utilize efficiently the fixed assets due to non-availability
of liquid funds.
6. The rate of return on investments also falls with the shortage of working capital.

b)Excess or Inadequate Working Capital

Disadvantages of Redundant or Excessive Working Capital

1. Excessive Working Capital means ideal funds which earn no profits for the business and
hence the business cannot earn a proper rate of return on its investments.
2. When there is a redundant working capital, it may lead to unnecessary purchasing and
accumulation of inventories causing more chances of theft, waste and losses.
3. Excessive working capital implies excessive debtors and defective credit policy which
may cause higher incidence of bad debts.
4. It may result into overall inefficiency in the organization.
5. When there is excessive working capital, relations with banks and other financial
institutions may not be maintained.
6. Due to low rate of return on investments, the value of shares may also fall.
7. The redundant working capital gives rise to speculative transactions.

Ques 7: What is dividend and why is dividend decision important?

Solution:
The word dividend is derived from 'dividendum' which means total divisible sum. The
expression dividend has two meanings. For an existing company, i.e., going concern, the
dividend is the distribution of divisible profits by a joint stock company to its
shareholders by way of return on their investments in the shares after complying with the
provisions of the Companies Act and Articles of Association of the company. In the case
of winding up, it means a division of the realised assets among the creditors and
contributors according to their respective rights. The legal provisions as to dividends for a
company as a going concern are summarised as under:

1. Dividends cannot be paid except out of profits. As such the payment of dividend
is ruled out when there is loss except where the Central or State' Government has
guaranteed the payment of dividends by the company (Section 205).

2. Dividend must be paid within 42 days of declaration (Section 207).

3. Dividend is payable only to a registered shareholder or on his order to his banker.

However where a company has issued share warrants in pursuance of Section 114,
dividend is to be paid to the bearer of such warrantor to his banker.

4. Articles normally provide (as Article 88 of. Table A) that dividends may be paid
up in proportion to the amount paid up on each share (Section 93). In the absence .of such
provision, dividends are payable on the nominal amount of each share and not on the
amount paid. [Oak Bank Oil Company Vs. Crum (1882) & App. Cas. 65 H.L.]

5. No dividend is paid on calls-in-advance; it would be unjust if the same sum paid

on shares carried interest and dividend at the same time.

6. Where calls are in arrears, the company can make provision in the articles
prohibiting the payment of dividends on shares on which full amount has not been paid.
Otherwise dividend is payable only on the amount actually paid up.

7. The amount of dividend payable to shareholders may be rounded off to the

nearest rupees. Thus where such amount contains a part of a rupee consisting of paisa,
then, if such part is fifty paisa or more, it shall be increased to one rupee and if such part
is less than fifty paisa, it shall be ignored. .

Sources of dividend:
There are three sources from which dividends may be declared,
namely: (i) current year's profits, (ii) past profits remaining undistributed and (iii) moneys
provided by Government.
The dividend decision is difficult decision because of conflicting objectives and also
because of lack of specific decision-making techniques. It is not easy to lay down an
optimum dividend policy which would maximize the long-run wealth of the shareholders.
The factors affecting dividend policy are grouped into two broad categories.
1. Ownership considerations
2. Firm-oriented considerations
Ownership considerations: Where ownership is concentrated in few people, there are no
problems in identifying ownership interests. However, if ownership is decentralized on a
wide spectrum, the identification of their interests becomes difficult.
Various groups of shareholders may have different desires and objectives. Investors
gravitate to those companies which combine the mix of growth and desired dividends.
Firm-oriented considerations: Ownership interests alone may not determine the
dividend policy. A firm's needs are also an important consideration, which include the
following:
· Contractual and legal restrictions
· Liquidity, credit-standing and working capital
· Needs of funds for immediate or future expansion
· Availability of external capital.
· Risk of losing control of organization
· Relative cost of external funds
· Business cycles
· Post dividend policies and stockholder relationships.

Contributed by Farida, Sunny Verma & Pinkki Manohar