Professional Documents
Culture Documents
Note: Please attempt all the questions and send them to the Coordinator of the Study
Centre you are attached with.
Q.1 “Accounting is closely connected with control”. Elaborate the statement and
discuss the role of accounting feedback in the process of control.
Solution: Controls are an integral part of any organization's financial and Accouting Process
Controls consists of all the measures taken by the organization for the purpose of Internal
accounting control and of procedures designed to promote and protect management practices,
both general and financial. Following are the role played by accounting in the process of control.
Cash receipts
To ensure that all cash intended for the organization is received, promptly deposited, properly
recorded, reconciled, and kept under adequate security.
Cash disbursements
To ensure that cash is disbursed only upon proper authorization of management, for valid
business purposes, and that all disbursements are properly recorded.
Petty cash
To ensure that petty cash and other working funds are disbursed only for proper purposes, are
adequately safeguarded, and properly recorded.
Payroll
To ensure that payroll disbursements are made only upon proper authorization to bona fide
employees, that payroll disbursements are properly recorded and that related legal requirements
(such as payroll tax deposits) are complied with.
Fixed assets
To ensure that fixed assets are acquired and disposed of only upon proper authorization, are
adequately safeguarded, and properly recorded.
Additional internal controls are also required to ensure proper recording of SALES and other
revenues, accurate, timely financial reports and information returns, and compliance with other
government regulations.
Achieving these objectives requires your organization to clearly state procedures for handling
each area, including a system of checks and balances in which no financial transaction is handled
by only one person from beginning to end. This principle, called segregation of duties, is central
to an effective internal controls system. Even in a small nonprofit, duties can be divided up
between paid staff and volunteers to reduce the opportunity for error and wrongdoing. For
example, in a small organization, the director might approve payments and sign checks prepared
by the bookkeeper or office manager. The board treasurer might then review disbursements with
accompanying documentation each month, prepare the bank reconciliation, and review canceled
checks.The board and executive director share the responsibility for setting a tone and standard of
accountability and conscientiousness regarding the organization's assets and responsibilities. The
board, usually through the work of the finance committee, fulfills that responsibility in part by
approving many aspects of the internal control accounting system. Common areas requiring board
attention include:
Check issuance
The number of signatures on checks, dollar amounts which require board approval or board
signature on the check, who authorizes payments and financial commitments, etc.
Deposits
How payments made in cash (for admissions, raffles, weekly collection plate, etc.) will be
handled, etc.
Transfers
If and when the general fund can borrow from restricted funds, etc.
Personnel policies
Salary levels, vacation, overtime, compensatory time, benefits, grievance procedures, severance
pay, evaluation, and other personnel matters.
As your profit changes and matures, and your funding and programs change, you will need to
periodically review the internal accounting control system which you have established and
modify it to include new circumstances (bigger staff, more restricted funding, etc.) and
regulations (such as receiving federal awards with increased compliance demands.)
===============================================================
Q.2 You are required to prepare a Schedule of changes in working capital and a Funds
Flow Statement from the Balance Sheets of Amazon Ltd as on 31st Dec. 2008 and
2009.
Additional information:
a) Depreciation provided on plant was Rs. 8,000 and on Buildings Rs. 8,000
b) Provision for taxation made during the year Rs. 38,000
c) Interim dividend paid during the year Rs. 16,000
===============================================================
Q.3 Take a suitable example and explain the impact of cost and volume changes
on the profits of a business.
=========================================================================
Q.4 The Finance Director of Ritoria Ltd thinks that the project with the higher NPV
should be chosen whereas its Managing Director thinks that the one with the
higher IRR should be undertaken, especially as both projects have the same initial
outlay and length of life. The company anticipates a cost of capital of 10% and the
net after tax
Year 0 1 2 3 4 5
(Cash Flows figs 000)
Project X Rs. (200) 35 80 90 75 20
Project Y Rs. (200) 218 10 10 4 3
-200/(1.1)=-200
35/1.1=31.82
80/1.21=66.21
90/1.331=67.62
75/1.4641=51.23
20/1.61051=12.42 here 200-all 5 above
For y:
-200/1.1=-200
218/1.1=198.18
10/1.21=8.26
10/1.331=7.51
4/1.4641=2.73
3/1.61051=1.86
BY IRR METHOD:
=========================================================================
Q.5 What are the different factors that a finance manager needs to consider while
taking decisions regarding his/her firm’s capital structure. Explain each of these
factors in detail.
The cost of capital is the rate of return that the enterprise must pay to satisfy the providers of
funds. The cost of equity is the return that ordinary stockholders expect to receive from their
investment. The cost of loan stock is the rate, which the company must provide its lenders. The
weighted average cost of capital (WACC) firm’s capital structure is the average of the cost of its
equity, preferred stocks and loan stocks.
An ideal mix of debt, preference stocks and common equity can maximizes the share prices. Debt
capital is regarded, as cheap source of finance to the business but will also increase the finance
risk of the company. Common stocks regarded as less risky but might lead to loss of voting rights
if bought by outsiders.
Business risk
Risk associated with the nature of the industry the business operates and if the business risk is
higher the optimal capital structure is required.
Tax position
Debt capital is regarded as cheaper because interest payable is deductible for tax purposes.
Advantage not much for businesses with unrelieved tax losses, depreciation tax shield as they
already have an existing lower tax burden.
Financial flexibility
Depends on how easy a business can arrange finance on reasonable terms under adverse
conditions. Flexibility in raising finance will be influenced by the economic environment
(availability of savers and interest rates) and the financial position of the business.
Managerial style
How much to borrow also depend on managers approach to finance risk. Conservative managers
will usual try to keep the debt equity ratio low.
Business risk
The variability in operating income caused but inherent factors of the business other than debt
financing. Can be influenced by changes in prices, variability of inputs, sales volume, and
competition levels.
Finance risk
Additional variability in return that arises because the financial structure contains debt. Finance
risk measured through gearing/leverages ratios.
FINANCIAL GEARING
Extent to which debt finances firms total capital structure
Debt equity ratio: Total debt
Total assets
TIE RATIO
= Earnings before interest and tax
Interest charges
OPERATIONAL GEARING
Measures to what extent are fixed costs used in firms operations. Breakeven point analysis will
measure the relationship between sales volume, variable cost and the fixed costs. Breakeven
point is the level of sales where the firm is neither making profits nor losses i.e. Sales value
equals costs.
Financial gearing can reach very high levels, with companies preferring to raise additional capital
for expansion by means of loans rather than issuing new equity, but there are limits.
Restrictions on further borrowing might be contained in the denture trust deed for a company’s
current debenture stocks in issue.
Occasionally, there might be borrowing restriction in the articles of association.
Lenders might want security for extra loan which the would be borrowers cannot provide.
Lenders might simply be unwilling to lend more to a company with high gearing or low interest
cover.
Extra borrowing beyond a safe level will cost more interest. Companies might not be willing to
borrow at these rates.
Apart from the limitations stated above, there are other side effects associated with high gearing
which may include the following:
Financial distress where obligations to the conditions are not met or they are met with difficulties
Costs: - Loss of key suppliers
Uncertain customers
Low asset value
Loss of staff moral
Legal costs
Agency costs in trying to negotiate additional loan facilities through an agent.
High interest rates
Need to sign loan covenants thereby loosing financial freedom
Borrowing cap
Limits set by lenders on amount available
Financial slack – Highly geared firms fail to seize opportunities as they arise due to unwillingness
of lenders for more fund advancements.
High gearing might send bad signals on company’s liquidity to employees as well as lenders
Loss of decision making on certain areas to lenders due to loan covenants
Despite mentioning all the limitations and cost of high gearing mentioned above company’s still
uses debt capital. Apart from being cheaper than share capital the following attributes compels
the company to use the debt capital.
Motivation – Regarded as cheaper source of income
New issue stocks may dilute holding
Operational and strategic staff more cautious on utilization of funds
Flexibility in arrangement than equity
================================================
“Top management’s risk-taking propensity affects the firm’s capital structure”. The amount of debt
that top managers feel is manageable affects the overall debt ratio of the firm since the
owners most often have to personally guarantee the loan in order to acquire one. amd also that
owners attitude towards risk seem to influence
the choice of capital structure. As debt increases the risk inflate, hence, a riskaverse
organization will probably use debt to a less extent than a risk-willing organization.
This proposal about top management’s risk awareness affecting capital structure is supported
by claim that SMEs’ equity level plays impact of their owners’ attitudes towards risk. In case
SMEs need
external financing they will prefer short-term debt before long-term debt since the latter
reduce management’s operability and short-term debt do not include restrictive covenants
“Top management’s goals for the firms will affect the firm’s capital structure”. Not all managers
strive
for profit maximizing; growth can sometimes be considered more important .
=========================================================================
=========================================================================
=================================THE END================================