Master of Business Administration- MBA Semester 1

MB0041 – Financial Management & Accounting - 4 Credits

Assignment Set- 1 (60 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

1. What is accounting cycle? List the sequential steps involved in Accounting cycle?

The Accounting Cycle is a series of steps which are repeated every reporting period. The

process starts with making accounting entries for each transaction and goes through closing

the books. Use this tutorial for an overview of the accounting cycle, covering activities

required both during and at the end of the accounting period.

Accounting Cycle – Steps During the Accounting Period

These accounting cycle steps occur during the accounting period, as each transaction

occurs:

Identify the transaction through an original source document (such as an invoice, receipt ,

cancelled check, time card, deposit slip, purchase order) which provides:

date

amount

description (account or business purpose)

name and address of other party (if practical)

Analyze the transaction – determine which accounts are affected, how (increase or

decrease), and how much

Make Journal entries – record the transaction in the journal as both a debit and a credit

journals are kept in chronological order

journals may include sales journal, purchases journal, cash receipts journal, cash payments

journal, and the general journal

Post to ledger – transfer the journal entries to ledger accounts

ledger is kept by account

ledger accounts may be T-account form or include balances

(Learn more about the Chart of Accounts.)

Accounting Cycle: Steps at the end of the accounting period

These accounting cycle steps occur at the end of the accounting period:

Trial Balance – this is a calculation to verify the sum of the debits equals the sum of the

credits. If they don’t balance, you have to fix the unbalanced trial balance before you go on

to the rest of the accounting cycle. (If they do balance you could still have a problem, but at

least it balances!)

Adjusting entries – prepare and post accrued and deferred items to journals and ledger T-

accounts

Adjusted trial balance – make sure the debits still equal the credits after making the period

end adjustments

Financial Statements – prepare income statement, balance sheet, statement of retained

earnings, and statement of cash flows (this can occur at other points in time with appropriate

adjustments)

Closing entries – prepare and post closing entries to transfer the balances from temporary

accounts (such as the revenue and expenses from the income statement to owner’s equity

on the balance sheet).

After-Closing trial balance – final trial balance after the closing entries to make sure debits

still equal credits.

2. A. Bring out the difference between Indian GAAP and US GAAP norms?

Some of these major differences between US GAAP and Indian GAAP which give rise to

differences in profit are highlighted hereunder:

1. Underlying assumptions: Under Indian GAAP, Financial statements are prepared in

accordance with the principle of conservatism which basically means “Anticipate no profits

and provide for all possible losses”. Under US GAAP conservatism is not considered, if it

leads to deliberate and consistent understatements.

2. Prudence vs. rules : The Institute of Chartered Accountants of India (ICAI) has been

structuring Accounting Standards based on the International Accounting Standards ( IAS) ,

which employ concepts and `prudence' as the principle in contrast to the US GAAP, which

are "rule oriented", detailed and complex. It is quite easy for the US accountants to handle

issues that fall within the rules, while the International Accounting Standards provide a

general framework of accounting standards, which emphasise "substance over form" for

accounting. These rules are less descriptive and their application is based on prudence. US

GAAP has thus issued several Industry specific GAAP , like SFAS 51 ( Cable TV), SFAS 50

(Record and Music Industry) , SFAS 53 ( Motion Picture Industry) etc.

3. Format/ Presentation of financial statements: Under Indian GAAP, financial statements

are prepared in accordance with the presentation requirements of Schedule VI to the

Companies Act, 1956. On the other hand , financial statements prepared as per US GAAP

are not required to be prepared under any specific format as long as they comply with the

disclosure requirements of US GAAP. Financial statements to be filed with SEC include

4. Consolidation of subsidiary companies: Under Indian GAAP (AS 21), Consolidation of

Accounts of subsidiary companies is not mandatory. AS 21 is mandatory if an enterprise

presents consolidated financial statements. In other words, the accounting standard does

not mandate an enterprise to present consolidated financial statements but, if the enterprise

presents consolidated financial statements for complying with the requirements of any

statute or otherwise, it should prepare and present consolidated financial statements in

accordance with AS 21.Thus, the financial income of any company taken in isolation

neither reveals the quantum of business between the group companies nor does it reveal the

true picture of the Group . Savvy promoters hive off their loss making divisions into

separate subsidiaries, so that financial statement of their Flagship Company looks

attractive .Under US GAAP (SFAS 94),Consolidation of results of Subsidiary Companies is

mandatory , hence eliminating material, inter company transaction and giving a true picture

of the operations and Profitability of the various majority owned Business of the Group.

5. Cash flow statement: Under Indian GAAP (AS 3) , inclusion of Cash Flow statement in

financial statements is mandatory only for companies whose share are listed on recognized

stock exchanges and Certain enterprises whose turnover for the accounting period exceeds

Rs. 50 crore. Thus , unlisted companies escape the burden of providing cash flow

statements as part of their financial statements. On the other hand, US GAAP (SFAS 95)

mandates furnishing of cash flow statements for 3 years – current year and 2 immediate

preceding years irrespective of whether the company is listed or not .

6. Investments: Under Indian GAAP (AS 13), Investments are classified as Current and

Long term. These are to be further classified Government or Trust securities ,Shares,

debentures or bonds Investment properties Others-specifying nature. Investments classified

as current investments are to be carried in the financial statements at the lower of cost and

fair value determined either on an individual investment basis or by category of investment,

but not on an overall (or global) basis. Investments classified as long term investments are

carried in the financial statements at cost. However, provision for diminution is to be made

to recognise a decline, other than temporary, in the value of the investments, such reduction

being determined and made for each investment individually. Under US GAAP ( SFAS 115)

, Investments are required to be segregated in 3 categories i.e. held to Maturity Security

( Primarily Debt Security) , Trading Security and Available for sales Security and should be

further segregated as Current or Non current on Individual basis. Debt securities that the

enterprise has the positive intent and ability to hold to maturity are classified as held-to-

maturity securities and reported at amortized cost. Debt and equity securities that are bought

and held principally for the purpose of selling them in the near term are classified as trading

securities and reported at fair value, with unrealised gains and losses included in earnings.

All Other securities are classified as available-for-sale securities and reported at fair value,

with unrealised gains and losses excluded from earnings and reported in a separate

component of shareholders' equity

7. Depreciation: Under the Indian GAAP, depreciation is provided based on rates

prescribed by the Companies Act, 1956. Higher depreciation provision based on estimated

useful life of the assets is permitted, but must be disclosed in Notes to Accounts.( Guidance

note no 49) . Depreciation cannot be provided at a rate lower than prescribed in any

circumstance. Similarly , there is no compulsion to provide depreciation at a higher rate,

even if the actual wear and tear of the equipments is higher than the rates provided in

Companies Act. Thus , an Indian Company can get away with providing with lesser

depreciation , if the same is in compliance to Companies Act 1956. Contrary to this, under

the US GAAP , depreciation has to be provided over the estimated useful life of the asset,

thus making the Accounting more realistic and providing sufficient funds for replacement

when the asset becomes obsolete and fully worn out.

8. Foreign currency transactions: Under Indian GAAP(AS11) Forex transactions

( Monetary items ) are recorded at the rate prevalent on the transaction date .Year end

foreign currency assets and liabilities ( Non Monetary Items) are re-stated at the closing

exchange rates. Exchange rate differences arising on payments or realizations and

restatements at closing exchange rates are treated as Profit /loss in the income statement.

Exchange fluctuations on liabilities incurred for fixed assets can be capitalized. Under US

GAAP (SFAS 52), Gains and losses on foreign currency transactions are generally included

in determining net income for the period in which exchange rates change unless the

transaction hedges a foreign currency commitment or a net investment in a foreign entity .

Capitalization of exchange fluctuation arising from foreign liabilities incurred for acquiring

fixed assets does not exist. Translation adjustments are not included in determining net

income for the period but are disclosed and accumulated in a separate component of

consolidated equity until sale or until complete or substantially complete liquidation of the net

investment in the foreign entity takes place . US GAAP also permits use of Average monthly

Exchange rate for Translation of Revenue, expenses and Cash flow items, whereas under

Indian GAAP, the closing exchange rate for the Transaction date is to be taken for

translation purposes.

9. Expenditure during Construction Period: As per the Indian GAAP (Guidance note on

‘Treatment of expenditure during construction period' ) , all incidental expenditure on

Construction of Assets during Project stage are accumulated and allocated to the cost of

asset on completion of the project. Contrary to this, under the US GAAP (SFAS 7) , such

expenditure are divided into two heads – direct and indirect. While, Direct expenditure is

accumulated and allocated to the cost of asset, indirect expenditure are charged to revenue.

10. Research and Development expenditure: Indian GAAP ( AS 8) requires research and

development expenditure to be charged to profit and loss account, except equipment and

machinery which are capitalized and depreciated. Under US GAAP ( SFAS 2) , all R&D

costs are expenses except intangible assets purchased from others and Tangible assets that

have alternative future uses which are capitalised and depreciated or amortised as R&D

Expense. Under US GAAP, R&D expenditure incurred on software development are

expensed until technical feasibility is established ( SOP 81.1) . R&D Cost and software

development cost incurred under contractual arrangement are treated as cost of revenue.

11. Revaluation reserve : Under Indian GAAP, if an enterprise needs to revalue its asset

due to increase in cost of replacement and provide higher charge to provide for such

increased cost of replacement, then the Asset can be revalued upward and the unrealised

gain on such revaluation can be credited to Revaluation Reserve ( Guidance note no 57).

The incremental depreciation arising out of higher book value may be adjusted against the

Revaluation Reserve by transfer to P&L Account. However for window dressing some

promoters misutilise this facility to hoodwink the shareholders on many occasions. US

GAAP does not allow revaluing upward property, plant and equipment or investment.

12. Long term Debts: Under US GAAP , the current portion of long term debt is classified

as current liability, whereas under the Indian GAAP, there is no such requirement and hence

the interest accrued on such long term debt in not taken as current liability.

13. Extraordinary items, prior period items and changes in accounting policies: Under

Indian GAAP( AS 5) , extraordinary items, prior period items and changes in accounting

policies are disclosed without netting off for tax effects . Under US GAAP (SFAS 16)

adjustments for tax effects are required to be made while reporting the Prior period Items.

14. Goodwill: Under the Indian GAAP goodwill is capitalized and charged to earnings over

5 to 10 years period. Under US GAAP ( SFAS 142) , Goodwill and intangible assets that

have indefinite useful lives are not amortized ,but they are tested at least annually for

impairment using a two-step process that begins with an estimation of the fair value of a

reporting unit. The first step is a screen for potential impairment, and the second step

measures the amount of impairment, if any. However, if certain criteria are met, the

requirement to test goodwill for impairment annually can be satisfied without a

remeasurement of the fair value of a reporting unit.

15. Capital issue expenses: Under the US GAAP, capital issue expenses are required to

be written off when incurred against proceeds of capitals, whereas under Indian GAAP ,

capital issue expense can be amortized or written off against reserves.

16. Proposed dividend: Under Indian GAAP , dividends declared are accounted for in the

year to which they relate. For example, if dividend for the FY 1999-2000 is declared in Sep

2000 , then the corresponding charge is made in 2000-2001 as below the line item .

Contrary to this , under US GAAP dividends are reduced from the reserves in the year they

are declared by the Board. Hence in this case under US GAAP , it will be charged Profit and

loss account of 2000-2001 above the line.

17. Investments in Associated companies: Under the Indian GAAP( AS 23) , investment

in associate companies is initially recorded at Cost using the Equity method whereby the

investment is initially recorded at cost, identifying any goodwill/capital reserve arising at the

time of acquisition. The carrying amount of the investment is adjusted thereafter for the post

acquisition change in the investor’s share of net assets of the investee. The consolidated

statement of profit and loss reflects the investor’s share of the results of operations of the

investee.are carried at cost . Under US GAAP ( SFAS 115) Investments in Associates are

accounted under equity method in Group accounts but would be held at cost in the Investor’s

own account.

18. Preoperative expenses: Under Indian GAAP, (Guidance Note 34 - Treatment of

Expenditure during Construction Period), direct Revenue expenditure during construction

period like Preliminary Expenses, Project related expenditure are allowed to be Capitalised.

Further , Indirect revenue expenditure incidental and related to Construction are also

permitted to be capitalised. Other Indirect revenue expenditure not related to construction,

but since they are incurred during Construction period are treated as deferred revenue

expenditure and classified as Miscellaneous Expenditure in Balance Sheet and written off

over a period of 3 to 5 years. Under US GAAP ( SFAS 7) , the concept of preoperative

expenses itself doesn’t exist. SOP 98.5 also madates that all Start up Costs should be

expensed. The enterprise has to prepare its balance sheet and Profit and Loss Account as if

it were a normal running organization. Expenses have to be charged to revenue and Assets

are Capitalised as a normal organization. The additional disclosure include reporting of cash

flow, cumulative revenues and Expenses since inception. Upon commencement of normal

operations, notes to Statement should disclose that the Company was but is no longer is a

Development stage enterprise. Thus , due to above accounting anomaly, Accounts prepared

under Indian GAAP , contain higher charges to depreciation which are to be adjusted

suitably under US GAAP adjustments for indirect preoperative expenses and foreign

currencies.

19. Employee benefits: Under Indian GAAP, provision for leave encashment is accounted

based n actuarial valuation. Compensation to employees who opt for voluntary retirement

scheme can be amortized over 60 months. Under US GAAP, provision for leave

encashment is accounted on actual basis. Compensation towards voluntary retirement

scheme is to be charged in the year in which the employees accept the offer.

20. Loss on extinguishment of debt: Under Indian GAAP, debt extinguishment premiums

are adjusted against Securities Premium Account. Under US GAAP, premiums for early

extinguishment of debt are expensed as incurred.

B. What is Matching Principle? Why should a business concern follow this principle?

The Matching principle is a culmination of accrual accounting and the revenue recognition

principle. They both determine the accounting period, in which revenues and expenses are

recognized. According to the principle, expenses are recognized when obligations are

incurred (usually when goods are transferred or services rendered, e.g. sold), and offset

against recognized revenues, which were generated from those expenses (related on the

cause-and-effect basis), no matter when cash is paid out. In cash accounting—in contrast—

expenses are recognized when cash is paid out, no matter when obligations are incurred

through transfer of goods or rendition of services: e.g., sale.

If no cause-and-effect relationship exists (e.g., a sale is impossible), costs are recognized as

expenses in the accounting period they expired: i.e., when have been used up or consumed

(e.g., of spoiled, dated, or substandard goods, or not demanded services). Prepaid

expenses are not recognized as expenses, but as assets until one of the qualifying

conditions is met resulting in a recognition as expenses. Lastly, if no connection with

revenues can be established, costs are recognized immediately as expenses (e.g., general

administrative and research and development costs).

Prepaid expenses, such as employee wages or subcontractor fees paid out or promised, are

not recognized as expenses (cost of goods sold), but as assets (deferred expenses), until

the actual products are sold.

The matching principle allows better evaluation of actual profitability and performance

(shows how much was spent to earn revenue), and reduces noise from timing mismatch

between when costs are incurred and when revenue is realized.

Two types of balancing accounts exist to avoid fictitious profits and losses that might

otherwise occur when cash is paid out not in the same accounting periods as expenses are

recognized, because expenses are recognized when obligations are incurred regardless

when cash is paid out according to the matching principle in accrual accounting. Cash can

be paid out in an earlier or latter period than obligations are incurred (when goods or

services are delivered) and related expenses are recognized that results in the following two

types of accounts:

Accrued expense: Expense is recognized before cash is paid out.

Deferred expense: Expense is recognized after cash is paid out.

Accrued expenses is a liability with an uncertain timing or amount, but where the uncertainty

is not significant enough to qualify it as a provision. An example is an obligation to pay for

goods or services received FROM a counterpart, while cash for them is to be paid out in a

latter accounting period when its amount is deducted from accrued expenses. It shares

characteristics with deferred income (or deferred revenue) with the difference that a liability

to be covered latter is cash received FROM a counterpart, while goods or services are to be

delivered in a latter period, when such income item is earned, the related revenue item is

recognized, and the same amount is deducted from deferred revenues.

Deferred expenses (or prepaid expenses or prepayment) is an asset, such as cash paid out

TO a counterpart for goods or services to be received in a latter accounting period when the

obligation to pay is actually incurred, the related expense item is recognized, and the same

amount is deducted from prepayments. It shares characteristics with accrued revenue (or

accrued assets) with the difference that an asset to be covered latter are proceeds from a

delivery of goods or services, at which such income item is earned and the related revenue

item is recognized, while cash for them is to be received in a later period, when its amount is

deducted from accrued revenues.

Examples

Accrued expense allows one to match future costs of products with the proceeds from their

sales prior to paying out such costs.

Deferred expense (prepaid expense) allows one to match costs of products paid out and not

received yet.

Depreciation matches the cost of purchasing fixed assets with revenues generated by them

by spreading such costs over their expected life.

Accrued expenses

Accrued expense is a liability used—according to matching principle—to enable

management of future costs with an uncertain timing or amount.

For example, supplying goods in one accounting period by a vendor, but paying for them in a

later period results in an accrued expense that prevents a fictitious increase in the receiving

company's value equal to the increase in its inventory (assets) by the cost of the goods

received, but unpaid. Without such accrued expense, a sale of such goods in the period they

were supplied would cause that the unpaid inventory (recognized as an expense fictitiously

incurred) would effectively offset the sale proceeds (revenue) resulting in a fictitious profit in

the period of sale, and in a fictitious loss in the latter period of payment, both equal to the

cost of goods sold.

Period costs, such as office salaries or selling expenses, are immediately recognized as

expenses (and offset against revenues of the accounting period) also when employees are

paid in the next period. Unpaid period costs are accrued expenses (liabilities) to avoid such

costs (as expenses fictitiously incurred) to offset period revenues that would result in a

fictitious profit. An example is a commission earned at the moment of sale (or delivery) by a

sales representative who is compensated at the end of the following week, in the next

accounting period. The company recognizes the commission as an expense incurred

immediately in its current income statement to match the sale proceeds (revenue), so the

commission is also added to accrued expenses in the sale period to prevent it from

otherwise becoming a fictitious profit, and it is deducted from accrued expenses in the next

period to prevent it from otherwise becoming a fictitious loss, when the rep is compensated.

Deferred expenses

A Deferred expense (prepaid expenses or prepayment) is an asset used to enable

management of costs paid out and not recognized as expenses according to the matching

principle.

For example, when the accounting periods are monthly, an 11/12 portion of an annually paid

insurance cost is added to prepaid expenses, which are decreased by 1/12th of the cost in

each subsequent period when the same fraction is recognized as an expense, rather than all

in the month in which such cost is billed. The not-yet-recognized portion of such costs

remains as prepayments (assets) to prevent such cost from turning into a fictitious loss in the

monthly period it is billed, and into a fictitious profit in any other monthly period.

Similarly, cash paid out for (the cost of) goods and services not received by the end of the

accounting period is added to the prepayments to prevent it from turning into a fictitious loss

in the period cash was paid out, and into a fictitious profit in the period of their reception.

Such cost is not recognized in the income statement (profit and loss or P&L) as the expense

incurred in the period of payment, but in the period of their reception when such costs are

recognized as expenses in P&L and deducted from prepayments (assets) on balance

sheets.

Depreciation

Depreciation is used to distribute the cost of the asset over its expected life span according

to the matching principle. If a machine is bought for $100,000, has a life span of 10 years,

and can produce the same amount of goods each year, then $10,000 of the cost of the

machine is matched to each year, rather than charging $100,000 in the first year and nothing

in the next 9 years. So, the cost of the machine is offset against the sales in that year. This

matches costs to sales.

3. Prove that the accounting equation is satisfied in all the following transactions of

Mr. X

(a) Commence business with cash Rs.50000

(b) Paid rent in advance Rs.1000

(c) Purchased goods for cash Rs.18000 and Credit Rs.20000

(d) Sold goods for cash Rs.25000 costing Rs.22000

(e) Paid salary Rs.5000 and salary outstanding is Rs.3000

(f) Bought moped for personal use Rs.20000\

Sol.

Accounting Equation = Liabilities + Capital

Transaction

Assets

Cash + Stock

= Capabilities + Capital

= Creditor + Salary +

Capital

a) Commenced Business

With cash 50,000 50,000 + 0 = 0 + 0 + 50,000

c) Purchased goods for

cash 18000 and credit

20,000

New Equation

-18000 + 38000

32000 + 32000

= 20000 + 0 + 0

= 20,000 + 0 + 50,000

d) Sold goods per cash

Rs. 25,000

Costing Rs. 22,000

New Equation

+ 25,000 – 22,000

57,000 + 16,000

= 0 + 0 + 3000

= 20,000 + 0 + 53,000

b) Paid Rent in advance

1,000

New Equation

- 11,000 + 0

56,000 + 16,000

= 20,000 + 0 + 53,000

= 20,000 + 0 + 52,000

e) Paid Salary Rs. 5000

and Salary outstand is

Rs. 53,000

(-) 5000 + 0 = 0 + 0 (-) 5000

New Equation 51,000 + 16, 000 = 20,000 + 3000 + 44000

f) Bought Miper for

Personal use 20000 (-) 20,000 + 0 = 0 + 0 – 20,000

31,000 + 16,000 = 20,000 + 3000 + 24,000

Balance Sheet of X as at:

Liabilities Amount Assets Amount

Creditor 20,000 Cash in hand 31,000

Salary outstanding 3000 Stock 16,000

Capital 24,000

47,000 47,000

4. Following are the extracts from the Trial Balance of a firm as on 31st March 20X7

Dr Cr

Sundry Debtors 2,05,000

Provision for Doubtful Debts 10,000

Provision for Discount on Debtors 1,800

Bad Debts 3,000

Discount 1,000

Additional Information:

1) Additional Bad Debts required Rs.4,000

2) Additional Discount allowed to Debtors Rs.1,000

3) Maintain a provision for bad debts @ 10% on debtors

4) Maintain a provision for discount @ 2% on debtors

Required: Pass the necessary journal entries and show the relevant accounts

including final accounts.

Sol. Journal Entry

Particular Dr. Cr.

Bad Debts A/c Dr.

Discount Allowed Dr.

To sundry Debtors

(Being Discount Allowed

Dr.)

4000

1000

5000

Profit shares A/c Dr.

To Bad Debts

To discount Allowed

(Being P X L for Discount)

9000

7000

2000

P X L A/c Dr.

To provision for Doubtful

Debits

To provision for discount

on debtors.

12,200

10,000

2200

Profit & Loss A/c

Particular Amount Particular Amount

To provision for

Doubtful Debts 10,000

To provision for

discount 2200

To Bed dobts 3000

(+) Additional 4000 7000

To Discount

Allowed 1000

(+) Additional 1000 2000

Balance Sheet

Liabilities Amount Assets Amount

Provision for bad

debts 10,000

(+) Additional

10,000

20,000

Debtors 20,500

(-) Bad Debts 4000

(-) Discount 1000 200,000

Provision for

discount 1800

(+) Additional 2200 4000

5. A. Bring out the difference between trade discount and cash discount.

Cash Discount Trade Discount

Is a reduction granted by supplier from the invoice price in consideration of immediate or prompt payment

Is a reduction granted by supplier from the list price of goods or services on business consideration re: buying in bulk for goods and longer period when in terms of services

As an incentive in credit management to encourage prompt payment

Allowed to promote the sales

Not shown in the supplier bill or invoice

Shown by way of deduction in the invoice itself

Cash discount account is opened in the ledger

Trade discount account is not opened in the ledger

Allowed on payment of money Allowed on purchase of goods

It may vary with the time period within which payment is received

It may vary with the quantity of goods purchased or amount of purchases made

B. Explain the term (1) asset (2) liability with the help of examples.

(1) asset: assets are economic resources. Anything tangible or intangible that is capable of

being owned or controlled to produce value and that is held to have positive economic value

is considered an asset. Simplistically stated, assets represent ownership of value that can be

converted into cash (although cash itself is also considered an asset). The balance sheet of

a firm records the monetary value of the assets owned by the firm. It is money and other

valuables belonging to an individual or business. Two major asset classes are tangible

assets and intangible assets. Tangible assets contain various subclasses, including current

assets and fixed assets. Current assets include inventory, while fixed assets include such

items as buildings and equipment. Intangible assets are nonphysical resources and rights

that have a value to the firm because they give the firm some kind of advantage in the

market place. Examples of intangible assets are goodwill, copyrights, trademarks, patents

and computer programs, and financial assets, including such items as accounts receivable,

bonds and stocks.

(2) liability with the help of examples: a liability is defined as an obligation of an entity

arising from past transactions or events, the settlement of which may result in the transfer or

use of assets, provision of services or other yielding of economic benefits in the future.

All type of borrowing from persons or banks for improving a business or person income

which is payable during short or long time.

They embody a duty or responsibility to others that entails settlement by future transfer or

use of assets, provision of services or other yielding of economic benefits, at a specified or

determinable date, on occurrence of a specified event, or on demand;

The duty or responsibility obligates the entity leaving it little or no discretion to avoid it; and,

The transaction or event obligating the entity has already occurred.

Liabilities in financial accounting need not be legally enforceable; but can be based on

equitable obligations or constructive obligations. An equitable obligation is a duty based on

ethical or moral considerations. A constructive obligation is an obligation that can be inferred

from a set of facts in a particular situation as opposed to a contractually based obligation.

The accounting equation relates assets, liabilities, and owner's equity:

Assets = Liabilities + Owner's Equity

The accounting equation is the mathematical structure of the balance sheet.

The Australian Accounting Research Foundation defines liabilities as: "future sacrifice of

economic benefits that the entity is presently obliged to make to other entities as a result of

past transactions and other past events."

Regulations as to the recognition of liabilities are different all over the world, but are roughly

similar to those of the IASB.

Examples of types of liabilities include: money owing on a loan, money owing on a

mortgage, or an IOU.

Liabilities are debts and obligations of the business they represent creditors claim on

business assests. Example of Liabilities All kinds of payable 1) Notes payable - an written

promise. 2) Accounts Payable - an oral promise. 3) Interests Payable. 4) Sales Payable.

6. A fresh MBA student joined as trainee was asked to prepare Trial balance. He was

unable to submit a correct trial balance. You, as a senior accountant find out the

errors and rectify them. After redrafting the trial balance prepare trading and Profit

and loss account.

Particulars Debit Credit

Capital 7,670

Cash in Hand 30

Purchases 8,990

Sales 11,060

Cash at bank 885

Fixtures and Fittings 225

Freehold premises 1.500

Lighting and Heating 65

Bills Receivable 825

Return Inwards 30

Salaries 1.075

Creditors 1890

Debtors 5,700

Stock at 1st April 2007 3,000

Printing 225

Bills Payable 1,875

Rates, taxes and insurance 190

Discount received 445

Discount allowed 200

21,175 21,705

Adjustments:

1) Stock on hand on 31st March 2008 was valued at Rs.1800

2) Depreciate fixtures and fittings by Rs.25

3) Rs.35 was due and unpaid in respect of salaries

4) Rates and insurance had been paid in advance to the extent of Rs.40

Sol. Corrected Trial Balance as at 31st March 2008

Particulars Debit Amount Credit Amount

Capital 7,670

Cash in Hand 30

Purchases 8,990

Sales 11,060

Cash at bank 885

Fixtures and Fittings 225

Freehold premises 1.500

Lighting and Heating 65

Bills Receivable 825

Return Inwards 30

Salaries 1.075

Creditors 1890

Debtors 5,700

Stock at 1st April 2007 3,000

Printing 225

Bills Payable 1,875

Rates, taxes and insurance 190

Discount received 445

Discount allowed 200

22,940 22,940

Trading And Profit and Loss Account for the year ended 31st March 2008

Dr. Cr.

Particular Amount Rs. Particular Amount Rs.

To Opening Stock 3000 By Sales 11060

To Purchase 8990 Less returns 30 11030

To Gross Profit c/d 840 By Closing Stock 1800

12,830 12,830

To Salaries 1075 By Gross Profit c/d 840

Add Outstanding 35 1110 By Discount 445

To Lighting and

heating

65 By net loss Transit

and to capital a/c 490

To Printing 225

To Rates, Taxes

and Insurance 190

Less: Insurance

Unpaid 40 150

To Discount

Allowed 200

To Depreciation of

furniture & Fittings 25

1775 1775

Balance Sheet as at 31st March 2008

Liabilities Amount Assets Amount

Current Liabilities Current Assets

Creditors 1890 Cash in Hands 30

Bills Payable 1875 Cash at Bank 885

Outstanding Salary 35 Bill Receivable 825

Capital Debtors 5700

Opening Balance

7670

Closing Stock 1800

Unexpired Rates

and Insurance 40

Fixed Assets

Less: Net less 490 7180 Furniture and

fittings 225

Less: Deprecation

25 200

Free hold Promises 1500

10,980 10,980

Master of Business Administration- MBA Semester 1

MB0041 – Financial Management & Accounting - 4 Credits

(Book ID: 1130)

Assignment Set- 2 (60 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

1. Uncertainties inevitably surround many transactions. This should be recognized by

exercising prudence in preparing financial statement. Explain this concept with the

help of an example.

The last concept is about prudence or otherwise known as conservatism. It is the inclusion of

a degree of caution in the exercise of the judgments needed in making the estimates

required under conditions of uncertainty. Its purpose is to avoid the instances of

overstatement of assets or income and understatement of liabilities or expenses. Although

the said practice does not allow the creation of hidden reserves or the exercise of provisions,

the deliberate understatement of assets or income, nor the deliberate overstatement of

liabilities or expenses. Otherwise, it lacks the quality of reliability due to the lack of neutrality

of the financial statements. The preparers of financial statements need to assume the

presence of inevitable uncertainties that surround many events and circumstances.

Examples of which are the collectivity of doubtful receivables, the probable useful life of plant

and equipment, as well as the number of warranty claims that may occur. Such uncertainties

are recognized by the disclosure of their nature and extent, as well as through the exercise

of prudence in the preparation of financial statements. The four different non-management

stakeholder groups interested in the financial statements of an enterprise are the institutional

shareholders (investors or owners), the debt holders (also known as bondholders), the

government, and the employees.

The shareholders/debt holders are among the major recipients of the financial statements of

corporations. They range from individuals with relatively limited resources to large, well-

endowed institutions such as insurance companies and mutual funds. The decision made by

these parties includes shares to buy, retain, or sell, and the timing of the purchase or sale of

those shares. Typically, their decisions have a focus either on investment or on stewardship,

although in some cases, it is both. If the emphasis is on the choice of a portfolio of securities

that is consistent with the preferences of the investor for risk, return, dividend yield, liquidity

and so on, it is said to be investment focus. Otherwise, it is stewardship focus. The required

information for this choice varies significantly.

Consider approaches that intend to detect the improper pricing of securities by a

fundamental analysis approach compared to a technical analysis approach. The former

approach examines firm, industry and economy related information, where financial

statements play a major role. An important aspect is the prediction of the timing, amounts,

and uncertainties of the firm’s future cash flows. In contrast, it is through the examination of

the movement in security prices, security trading volume, and other related variables that the

technical analysis is able to detect the improper pricing of securities. Typically, financial

statement information is not examined in this approach.

When predicting the timing, amounts, and uncertainties of the firm’s future cash flows, the

past record of management in relation to the resources under its control can be an important

variable. The analysis undertaken for decisions by shareholders and investors can be done

by those parties themselves or by intermediaries such as security analysts and investment

advisors. Employees, on the other hand, are motivated by numerous factors. They might

have a vested interest in the continued profitability of their firm’s operations. Therefore,

financial statements for them serve as an important source of information regarding the

possible profitability and solvency of their company at present, as well as in the future. They

may also need them in monitoring the viability of their pension plans.

The demand of the government or regulatory agencies can arise in a diverse set of areas.

These include revenue raising (for income tax, sales tax, or value-added tax collection),

government contracting (for reimbursing suppliers paid on a cost-plus basis or for monitoring

whether the companies engaged in government business are earning excess profits), rate

determination (deciding the allowable rate of return that an electric utility can earn), and

regulatory intervention (determining whether to provide a government-backed loan

agreement to a financially distressed firm.

However, due to the diverse interest of the said individuals to the information contained in

the financial statements, conflicts may arise. For the shareholders/debt holders, the interest

of these parties lies in the fact that the money invested in the firm is their own money. They

would like to ensure that they are getting a good return on their investment. This is

measured by looking at how much profit the firm is making and whether their investment is

increasing in value. For shareholders in companies, this means they will get good dividends

and the market value of their shares will increase. They can also make capital gains, in case

these shares will be sold.

For the employees, they are part of the organization. As a part of the organization, they also

feel that their efforts contributed to the profitability of the firm. They would therefore be

delighted if they will be given incentives to their participation to the company’s achievement.

They might prefer to be given bonuses, salary increases, and other form of monetary

benefits. They might also prefer given stock options or promotions, depending on the

discretion of both parties. However, for the firm’s part, it means increases in the expenses of

the firm.

For the government, various ministries and departments have different interest in the firm’s

ability to pay taxes. They also see and review the enactment of laws for the industry and the

provision of social services to the public. The government may also want to ensure that the

firm complies with laws on, for example, wage payments and employee benefits. These are

for their benefit, as well as the benefit of the society as a whole.

2. A. When is the change in accounting policy recommended and what are the

disclosure requirements regarding the change in accounting policy?

Accounting policies are the specific principles, bases, conventions, rules and practices

applied by an entity in preparing and presenting financial statements. When a Standard or

an Interpretation specifically applies to a transaction, other event or condition, the accounting

policy or policies applied to that item shall be determined by applying the Standard or

Interpretation and considering any relevant Implementation Guidance issued by the IASB for

the Standard or Interpretation.

In the absence of a Standard or an Interpretation that specifically applies to a transaction,

other event or condition, management shall use its judgement in developing and applying an

accounting policy that results in information that is relevant and reliable. In making the

judgement management shall refer to, and consider the applicability of, the following sources

in descending order:

(a) the requirements and guidance in Standards and Interpretations dealing with similar and

related issues; and

(b) the definitions, recognition criteria and measurement concepts for assets, liabilities,

income and expenses in the Framework.

An entity shall select and apply its accounting policies consistently for similar transactions,

other events and conditions, unless a Standard or an Interpretation specifically requires or

permits categorisation of items for which different policies may be appropriate. If a Standard

or an Interpretation requires or permits such categorisation, an appropriate accounting policy

shall be selected and applied consistently to each category.

To ensure proper understanding of financial statements, it is necessary that all significant

accounting policies adopted in the preparation and presentation of financial statements

should be disclosed.

Such disclosure should form part of the financial statements. It would be helpful to the reader

of financial statements if they are all disclosed as such in one place instead of being

scattered over several statements, schedules and notes.

Examples of matters in respect of which disclosure of accounting policies adopted will be

required are contained in paragraph 14. This list of examples is not, however, intended to be

exhaustive.

Any change in an accounting policy which has amaterial effect should be disclosed. The

amount by which any item in the financial statements is affected by such change should also

be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or

in part, the fact should be indicated. If a change is made in the accounting policies which has

no material effect on the financial statements for the current period but which is reasonably

expected to have a material effect in later periods, the fact of such change should be

appropriately disclosed in the period in which the change is adopted.

Disclosure of accounting policies or of changes therein cannot remedy a wrong or

inappropriate treatment of the item in the accounts.

B. Explain IFRS.

International Financial Reporting Standards (IFRS) are Standards, Interpretations and the

Framework adopted by the International Accounting Standards Board (IASB).

Many of the standards forming part of IFRS are known by the older name of International

Accounting Standards (IAS). IAS were issued between 1973 and 2001 by the Board of the

International Accounting Standards Committee (IASC). On 1 April 2001, the new IASB took

over from the IASC the responsibility for setting International Accounting Standards. During

its first meeting the new Board adopted existing IAS and SICs. The IASB has continued to

develop standards calling the new standards IFRS.

IFRS are considered a "principles based" set of standards in that they establish broad rules

as well as dictating specific treatments.

International Financial Reporting Standards comprise:

International Financial Reporting Standards (IFRS) - standards issued after 2001

International Accounting Standards (IAS) - standards issued before 2001

Interpretations originated from the International Financial Reporting Interpretations

Committee (IFRIC) - issued after 2001

Standing Interpretations Committee (SIC) - issued before 2001

Framework for the Preparation and Presentation of Financial Statements

IAS 8 Par. 11

"In making the judgement described in paragraph 10, management shall refer to, and

consider the applicability of, the following sources in descending order:

(a) the requirements and guidance in Standards and Interpretations dealing with similar and

related issues; and

(b) the definitions, recognition criteria and measurement concepts for assets, liabilities,

income and expenses in the Framework."

3. Journalise the following transactions:

01.01.09 Bought goods for Rs.10,000

02.01.09 Purchased goods from X Rs.20,000

03.01.09 Bought goods from Y for Rs.30,000 against a current dated cheque

04.01.09 Purchased goods from Z [price list price is Rs.30,000 and trade

discount is 10%]

05.01.09 Bought goods of the list prce of Rs.1,25,000 from M less 20% trade

discount and 2% cash discount. Paid 40% of the amount by cheque

06.01.09 Returned 10% of the goods supplied by X

07.01.09 Returned 10% of the goods supplied by Y

4. Bring out the difference between Funds Flow Statement and Cash Flow Statement. Mention up to what point in time they are similar and from where the differences begin.Cash Flow Statement : Statement showing changes in inflow & outflow of cash during the period.Methods of cash flow:1.Direct Method : presenting information in Statement ofA. operating ActivitiesB. Investment ActivitiesC.Financial Activities2.Indirect Method :uses net income as base & make adjustments to that income(cash & non-cash)transactions.Funds Flow Statement :Statement showing the source & application of funds during the period.Major Difference:The Cash Flow S tatement allows investors to understand how a company's operations are running, where its money is coming from, and how it is being spent.Fund Flow Statement is showing the fund for the future activites of the Company.

The main differences are as follows:

1. A cash flow statement is concerned only with the change in cash position while a fund flow analysis/statement is concerned the change in working capital position

2. Cash is part of working capital and an improvement in cash position results in improvement in funds position but the reverse is not true.

3. A cash flow statement is merely a record of cash receipts and disbursements. It does not reveal any important changes involving the utilization/disposition of resources.

5. A. Determine the sales of a firm with the following financial dataCurrent Ratio 1.5Acid test ratio 1.2Current Liabilities 8,00,000Inventory Turnover ratio 5 times

Sol.

=

= 1.5 x 800,000 = C.A

Current Assets = 1,200,000

=

=

= 1.2 x 800,000 = 1200, 000 – Stock

Stock = 240,000

Average Stock = 1,20,000

=

=

Sales = 600,000

B. What is Du-Pont chart?DuPont Chart calculates the key components of any business for easy evaluation of performance.

Income Statement

Sales

Other Income

COGS

G&A

Depreciation

Other Expense

Gross Profit

OperatingExpenses

Earningsbefore interest& taxes (EBIT)

Interest Paid

Taxes

Net Profit

Sales

EBIT

Total Assets

Profit Margin

EBIT onAssets

Returnon   Equit y

Assets

Cash

Receivables Fixed

Assets

Sales

Total Assets

AssetsTurnover

Inventory

Other Assets

Current Assets

CurrentLiabilities

WorkingCapital

Liabilities & Equity

Payables

Notes Payables

Other Liability

CurrentLiabilities

Non-CurrentLiabilities

Capital

RetainedEarnings

TotalLiabilities

EndingNet Worth

Total

BeginningNet Worth

Leverage

6. From the following data calculate the: 1. Break-even point expressed in terms of sale amount/revenue 2. Number of units that must be sold to earn a profit of Rs.60,000 per year

Sales price (per unit) Rs.20Variable manufacturing cost per unit Rs.11Variable selling cost per unit Rs.3Fixed factory overheads (per year) 5,40,000Fixed selling cost (per year) 2,52,000

Sales Price = 20- Variable Cost = 14Contribution = 6

=

BEP = 2,640,000

= 14,2000 Units