Master of Business Administration- MBA Semester 1 Reg No.

: 511011932

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

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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

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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,

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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.

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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

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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.

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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.

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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

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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

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(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
Assets = Capabilities + Capital
= Creditor + Salary +
Transaction Cash + Stock 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 -18000 + 38000 = 20000 + 0 + 0
New Equation 32000 + 32000 = 20,000 + 0 + 50,000
d) Sold goods per cash
Rs. 25,000
Costing Rs. 22,000 + 25,000 – 22,000 = 0 + 0 + 3000
New Equation 57,000 + 16,000 = 20,000 + 0 + 53,000
b) Paid Rent in advance
1,000 - 11,000 + 0 = 20,000 + 0 + 53,000
New Equation 56,000 + 16,000 = 20,000 + 0 + 52,000
e) Paid Salary Rs. 5000
and Salary outstand is (-) 5000 + 0 = 0 + 0 (-) 5000
Rs. 53,000
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

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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. 4000
Discount Allowed Dr. 1000
To sundry Debtors
(Being Discount Allowed 5000
Dr.)
Profit shares A/c Dr. 9000
To Bad Debts 7000
To discount Allowed 2000
(Being P X L for Discount)
P X L A/c Dr. 12,200
To provision for Doubtful 10,000
Debits 2200
To provision for discount
on debtors.

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

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To Discount
Allowed 1000
(+) Additional 1000 2000

Balance Sheet
Liabilities Amount Assets Amount
Provision for bad Debtors 20,500
debts 10,000 (-) Bad Debts 4000
(+) Additional 20,000 (-) Discount 1000 200,000
10,000
Provision for
discount 1800
(+) Additional 2200 4000

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

Cash Discount Trade Discount

Is a reduction granted by supplier Is a reduction granted by supplier from the

from the invoice price in list price of goods or services on business
consideration of immediate or consideration re: buying in bulk for goods
prompt payment and longer period when in terms of services

As an incentive in credit
management to encourage Allowed to promote the sales
prompt payment

Not shown in the supplier bill or Shown by way of deduction in the invoice
invoice itself

Cash discount account is opened Trade discount account is not opened in the
in the ledger ledger

Allowed on payment of money Allowed on purchase of goods

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

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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.

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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

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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 65 By net loss Transit
heating 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 Closing Stock 1800
7670
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

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MB0041 – Financial Management & Accounting - 4 Credits

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.

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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

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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,

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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

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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 of
A. operating Activities
B. Investment Activities
C.Financial Activities
2.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:

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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 data

Current Ratio 1.5
Acid test ratio 1.2
Current Liabilities 8,00,000
Inventory Turnover ratio 5 times

Sol.
Current Assets
current Ratio =
Current Liabilities

Current Assets
= 1.5 =
800, 000

= 1.5 x 800,000 = C.A

Current Assets = 1,200,000

Current Assets − Stock

= Acid Test Ratio =
Current Liablities
1, 200, 000 − Stock
= 1.2 =
800, 000

= 1.2 x 800,000 = 1200, 000 – Stock

Stock = 240,000

Average Stock = 1,20,000

Cost of Goods Sold

= Stock Turnover Ratio =
Average Stock

Sales - Gross Profit

= 5=
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.

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Income Statement

Sales
Gross
Profit
Other Earnings
Income before
interest EBIT
& taxes EBIT on
(EBIT) Assets
COGS
Total
Net Profit Assets
G&A Operating Interest
Expenses Paid
Sales Profit
Depreciation Margin
Taxes
Return
on Equity
Other
Expense

Assets

Cash

Sales
Receivables Assets
Fixed Turnover
Assets
Total
Inventory Assets

Current
Other Assets Assets
Working
Capital

Current
Liabilities

Liabilities & Equity

Payables
Current
Liabilities
Total
Notes Liabilities
Payables
Non- Total
Current
Leverage
Liabilities
Other

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Liability
Capital
Beginning
Net Worth
Ending
Retained
Net
Earnings
Worth

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.20

Variable manufacturing cost per unit Rs.11
Variable selling cost per unit Rs.3
Fixed factory overheads (per year) 5,40,000
Fixed selling cost (per year) 2,52,000
Sales Price = 20
- Variable Cost = 14
Contribution =6
Contribution
P /V =
Sales
6
= P /V = ×100 = 30%
20

Fixed Cost
Break Even Point =
P / V Ratio

79,2000
=
30%

BEP = 2,640,000

Fixed Cost + Desired Profit

Sales in Unit at Desired Profit =
P / V Ratio
79,2000 + 60,000
=
30%
2,84,0000
=
20

= 14,2000 Units

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