Certificate Program in Marketing & HRM

Introduction to Accounting

Exercises

November 27-28, 2010

Indian Institute of Technology, Bombay

Prepared by:

Dr. Abhijit P. Phadnis

 Table of Contents

1. WHY LEARN ACCOUNTING & FINANCE?..........................................................................................................3

2. WHAT IS A COMPANY?......................................................................................................................................3
3. RESOURCES FOR BUSINESS.................................................................................................................................3
4. MONETARY ‘RESOURCES’ OF AN ENTERPRISE ..................................................................................................5
5. FINANCING A BUSINESS ....................................................................................................................................5
6. SOURCES OF FUNDS (LIABILITIES) .....................................................................................................................6
7. IDEA CELLULAR STANDALONE INCOME STATEMENT (PROFIT & LOSS ACCOUNT) .......................................6
8. IDEA CELLULAR STANDALONE BALANCE SHEET ............................................................................................7
9. IDEA CELLULAR STANDALONE CASH FLOW STATEMENT.................................................................................8
10. CLASSIFICATION OF ITEMS ..............................................................................................................................8
11. ACCOUNTING OF TRANSACTIONS ON FINANCIAL STATEMENTS ...................................................................9
12. CONSTRUCTING FINANCIAL STATEMENTS ...................................................................................................10
13. IMPACT ANALYSIS .........................................................................................................................................12
14. WORKING CAPITAL MANAGEMENT ............................................................................................................12
15. ANALYSIS OF FINANCIAL PERFORMANCE.....................................................................................................14
16. BREAK-EVEN POINT 1....................................................................................................................................18
17. BREAK-EVEN POINT 2....................................................................................................................................19

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1. Why learn accounting & finance?

You just read three questions on the screen. Do write down what you think in the space
below:

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

2. What is a company?

There are different forms of business organizations. There is a proprietary concern, there
are partnerships, there are co-operative societies and there are companies. What is a
company? What do you think are its advantages?

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

_______________________________________________________________________________

3. Resources for business

For every business to come into being & then run efficiently, different resources are
required to be able to offer a product that would satisfy the needs of customers. Out of
these resources, some are in the nature of services, they cannot be held in stock and hence

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are consumed as soon as sourced. Thus, they are for immediate use. Some others, in the
form of goods, can be held in stock and then consumed according to our requirement. We
can call them as resources to be consumed in the short term. Some resources are not for
consumption in the short term but are rather used over long term and they form
infrastructure of business. Some such resources can be bought and therefore, legally
owned by the enterprise. Some others can be hired or rented by the enterprise. Some
resources can be either owned or hired. In the following table, please list important
resources that in your view are required for running a business. You may take example
based on the business that you have exposure to:

Resource Immediate or Owned or Hired or

Short Term or Both
Long Term

Please note, as soon as a resource is consumed, we say a cost is incurred. Thus, most
resources in the nature of services get consumed immediately and thus cost is born. The
resources used in the short term such as raw materials inventory get consumed once the
inventory is issued to production and gets used up. Resources used for the long-term get
consumed very gradually but they do get consumed.

Resources which are owned and are available for use are called as assets. Resources which
are hired cannot be called as assets since their ownership is with someone else.

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4. Monetary ‘Resources’ of an enterprise

We listed earlier various resources which are required to run a business and satisfy
customer need. While most resources that you would have listed above are in the nature
of goods and services, while running the business, resources in the form of money also
play a very important part. Money is used as a medium of business. In addition to the
cash and bank balances that we hold, we also hold various financial claims on third
parties. Cash & bank balances and such financial claims can be called as monetary assets
of the company. Can you please visualize such monetary assets in the context of the
business you had taken example of to solve the previous exercise?

1. ___________________________________________________________________________
2. ___________________________________________________________________________
3. ___________________________________________________________________________
4. ___________________________________________________________________________
5. ___________________________________________________________________________

5. Financing a business

Creation of a large enterprise would not have been possible unless there was someone
who was willing to finance this enterprise at various stages of its life of over last so many
decades. Can you visualize who are these people who finance creation & ongoing running
& expansion of an enterprise? There are some people who put money into the company;
there are some others who do not directly provide money to the enterprise. On the other
hand, they provide some goods or services without insisting on immediate payment.
While listing these direct and indirect financers, begin with those who take the highest
amount of risk and end with those who take relatively lower risk.

Direct financiers
1. ___________________________________________________________________________
2. ___________________________________________________________________________
3. ___________________________________________________________________________
4. ___________________________________________________________________________
Indirect financiers
5. ___________________________________________________________________________
6. ___________________________________________________________________________
7. ___________________________________________________________________________
8. ___________________________________________________________________________

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6. Sources of funds (Liabilities)

As we have discussed earlier, different people finance a business directly or indirectly.

Whenever such finance is sought, till the time the company pays for it either by repaying
the loan or paying the bills of suppliers of goods & services, it creates a liability for the
company. From the following items, identify which would appear in the list of liabilities
of the company.
1. Loan taken from a bank not yet fully repaid: ___________________________________
2. Painting contractor’s bill paid as soon as work done: ____________________________
3. Advance paid to supplier of raw materials: _____________________________________
4. Travel undertaken but travel agent’s bill not yet paid: ____________________________

7. Idea Cellular Standalone Income Statement (Profit & Loss Account)

2009-10 2008-09
Rs. Million
1,18,502 98,383
Service Revenue
801 215
Other income
1,19,303 98,598
Total Income
5,699 4,677
Employee Cost
34,394 20,762
Network Operating Expenditure
12,945 10,959
License & WPC charges
17,453 18,159
Roaming & access charges
11,344 8,146
Subscriber Acquisition & Servicing Expenditure
4,067 4,266
Advertising & Business Promotion Expenditure
4,457 3,825
Administration & Other Expenses
28,944 27,804
Profit before Depreciation, Interest & Tax
2,063 4,507
Interest
13,666 10,967
Depreciation
1,846 1,461
Amortization of intangible assets
(317) -
Surplus from prepayment of loan
11,687 10,869
Profit before tax and extra ordinary items
- -
Current tax
1,151 764
Deferred tax
- 93
Fringe Benefit Tax
10,536 10,012
Net profit

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8. Idea Cellular Standalone Balance Sheet

Rs. Million 31.3.2010 31.3.2009

Sources of funds
Share capital 32,998 31,001
Employees stock options outstanding 444 182
Reserves and surplus 85,093 85,814
Shareholders’ funds 1,18,535 1,16,997
Secured loans 59,886 55,649
Unsecured loans 5,378 20,144
Loan Funds 65,264 75,793
Deferred tax liabilities (net) 2,256 1,425
Total 1,86,055 1,94,215
Application of funds
Gross block 2,28,344 1,55,627
Less: depreciation 79,073 47,399
Net block 1,49,271 1,08,228
Capital work-in-progress 4,626 17,218
Fixed assets 1,53,897 1,25,446
Investments 27,551 49,288
Current assets, loans and advances
Inventories 467 427
Sundry debtors 4,301 3,296
Cash and bank balances 2,804 23,444
Other current assets 1,244 1,331
Loans and advances 30,003 19,140
Sub-total 38,819 47,638
Less:
Current liabilities and provisions
Current liabilities 36,797 31,224
Provisions 1,378 987
Sub-total 38,175 32,211
Net current assets 644 15,427
Profit & Loss A/c (Accumulated loss) 3,963 4,054
Total 1,86,055 1,94,215

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9. Idea Cellular standalone cash flow statement

Rs. Crs. 2009-10 2008-09

Operating Cash Flow (1) 19,851 18,637

Investing Cash Flow (2) (20,959) (76,554)

Financing Cash Flow (3) (25,306) 76,390

Net Change in Cash (1+ 2+ 3) (26,414) 18,473

(Net cash flow for the year)

If the net cash flow (i.e. net

change in cash) is negative, it
implies that the cash balance at
the end of the year became less to
that extent.

10. Classification of items

In the following table certain ‘information’ pieces have been listed in the first column. In the
second column, please indicate its type by classifying into one of the following type: Revenue,
Cost, Inflow, Outflow, Asset, and Liability. In the third column, please indicate in which
financial statement (balance sheet, income statement, cash flow statement) you are going to
see this item:

Information Type Financial Statement

Owned Office Equipment being used
at Head Office
Administrative expenses incurred
Collection from customers during the
year
Inventory of packing materials at the
end of the year
Balance in the bank account at the

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 Information Type Financial Statement
end of the year
Sales during the year
Amount of outstanding loan at the
end of the year
Commission expenses incurred
during the year
Receivables from customers (bills yet
to be collected)
Dues to creditors as at the end of the
financial year (bills yet to be paid)

11. Accounting of transactions on financial statements

In the following table, various business transactions have been listed. Each business
transaction is likely to have an impact on some or all the three financial statements. Please
visualize how each transaction would have a direct impact on the three financial statements.

Transaction Cash Flow Statement Statement of Balance Sheet

(Inflows/outflows) earnings (Income/ (Assets/ Liabilities)
Expenses)
Credit Sale to Sales (Income) go up Receivables (Asset)
customers go up
(Example)
Salaries paid to sales
staff
Collection from
customers
Purchases from
suppliers on credit
New computers
purchased & paid
for immediately
Loan taken from a
commercial bank
Depreciation cost
accounted for
during the year
Interest expenses
incurred but not yet
paid to the bank

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12. Constructing financial statements

Based on the following transactions during the period beginning with inception of Star Home
Textile Industries Ltd. (SHTIL) i.e. January 1, 2009 till December 31, 2009, construct financial
statements of the company. The company was set up for manufacture and exports of terry
towels, bed linens and other home textiles.

Through a public issue of shares the company raised Rs. 50 Million. This money was received
in company’s bank accounts.

Company also raised a loan of Rs. 50 Million from financial institutions. Interest of Rs. 4
Million has accrued for the period ended December 31, 2009 but would be falling due for
payment only later.

With the money raised from public and financial institutions, the company has purchased
machinery worth Rs. 80 Million. This machinery has been put to use immediately. The
machinery depreciates with every passing year to the extent of 10 % of its original value. The
company recognizes depreciation to this extent.

Company has around 100 employees. The annual salary cost is Rs. 10 Million and has been
fully paid for.

Company incurs Selling & Administration expenses totaling to Rs. 6 Million. Out of this
expense equal to Rs. 1 Million are yet to be paid by the company.

During the year, the company purchased raw material worth Rs. 150 Million. The company
has not paid for the entire material purchased. Rs. 30 Million is yet to be paid to the suppliers.
Out of this material worth Rs. 25 Million is available in stock at the end of the year.

Company has been able to notch up sales (mostly exports) of Rs. 175 Million. Some of the
most renowned retail chains are the customers of the company and the company had to
extend credit to them. Thus, only Rs. 135 Million only could be collected.

In addition one customer has already booked an exclusive order with the company and has
paid an advance of Rs. 5 Million.

The tax rate applicable to the company is 10 % since it is in mostly exports and this tax has not
yet been paid. You may round off the number.

Due to the initial financing done by the company, which is yet to be fully deployed in further
capacity creation, the company has some temporary liquidity. The company has invested this
amount of Rs. 15 Million in a time deposit.

Use this data to construct a Profit & Loss account and a balance sheet. Please construct a cash
flow statement also.

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 Star Home Textile Industries Ltd.
Profit & Loss Account for the year 2009

Expenses Revenue
Purchase of raw materials Sales
Salary Closing Stock (Inventory)
Selling & Administration expenses (Instead of reducing stock
Depreciation from purchases, it has been
Interest expenses written along with sales)
Tax
Net Profit
Total Total

Star Home Textile Industries Ltd.

Balance Sheet as on 31.12.2009

Liabilities Assets
Share Capital Fixed Assets
Reserves & Surplus Less: Depreciation
Surplus in Profit & Loss account Net Fixed Assets
Secured Loans Investments
Loan from Financial Institutions Time Deposit
Current Liabilities & Provisions Current Assets
Advance received from customers Dues from customers
Creditors for materials Closing Stock (Inventory)
Creditors for expenses Balance in bank account
Interest accrued but not due
Provision for Taxation
Total Total

Star Home Textile Industries Ltd.

Cash Flow Statement for the year 2009

Receipts Payments
Opening Balance Nil Purchase of Machinery
Proceeds of Issue of Shares Payment of Salary
Loan proceeds received Selling & Administration Exp.
Collection of receivables Payment to Suppliers of Raw
Materials
Collection of advance Investment in Time Deposit
Closing Balance
Total Total

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13. Impact analysis

For the purpose of this exercise, visualize the spillover effect.

What if loan of Rs. 100 million was taken instead of Rs. 50 million?

__________________________________________________________________________________

__________________________________________________________________________________

What if purchases were done of Rs. 170 million instead of Rs. 150 million? Assume that the
company continued to operate at the same level of operational efficiency.

__________________________________________________________________________________

__________________________________________________________________________________

What if collection from customers was Rs. 155 million instead of Rs.135 million?

__________________________________________________________________________________

__________________________________________________________________________________

14. Working Capital Management

Pristine Consumer Products Ltd. (‘Pristine‘) was set up about 15 years ago and over the years
it has made steady progress and grown quite significantly in size. The company is now a Rs.
200 Crore turnover company having come a long way from a very modest beginning of Rs. 10
Lakh turnover in the first year of operations.

Its distribution reach is pretty good, spread across the country and the company has
maintained excellent relationship with its distributors. Its manufacturing location is in
Maharashtra and there has been a pretty good track record of Industrial relations. The
company now feels that it is poised for a rapid growth due to opportunities in domestic as
well as exports sector. However, competition is now hotting up with one multinational
having recently offered a similar product line in India.

The growth can come only through expansion of capacities since it is finding its production
capacity a constraint. Following information is also available.

1) The company has invested most of the surplus cash generated in the business in
modernization of its plant & machinery and some surplus funds have been invested in
marketable securities.

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2) With a view to maintain strong relationship with dealers, currently it is offering liberal
credit terms. The official credit period is about 45 days. However, the company does not
collect its debt on an average before 67 days. Also, at times, it takes more time to realize its
dues to the fact that the distributors are spread out across the country.
3) The company in turn has been enjoying some decent credit from its suppliers amounting
to 90 days and suppliers are ‘OK’ even if payment is stretched much beyond this period in
view of their dependency on Pristine. Given a choice they may have resisted this
approach.
4) The company has recently hired a new General Manager who has been complaining about
lack of financial discipline in the organization and he feels that there were more risks
trying to expand in the absence of financial discipline. He cites as an example, the
inventory ordering methods in the organization, which he feels are not very scientific
resulting in overstocking of most inventory items as well as shortage of some inventory
items. He also feels that the company’s Work In Progress levels are pretty large and even
capacity utilization could be improved by streamlining some work processes. Also, he felt,
the time it takes to reach the distributor and thus consequent level of finished stocks were
also high.
5) The Finance Manager of Pristine feels that there is an urgent need to put in place some
‘budgetary control measures’ to percolate financial discipline within the organization and
he felt that financial education was also a must.
6) The expenditure on creating additional capacity is approximately Rs. 40 Crores. The
company would be able to borrow this sum by stretching itself a bit. However, there is a
natural concern that by borrowing this entire amount would mean a significantly larger
interest burden on the company which may not be taken kindly by the shareholders of the
company. This would mean at least a temporary dip into its profits as it will take some
time before the investments starts paying off.

Given the current situation and growth agenda of the company, what would be your
recommendation on steps required to be taken by the company before it embarks upon the
expansion program

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15. Analysis of financial performance

Following is the summary financial data of Ultratech Cement. The previous year’s data is
provided since the latest data was not available yet.

Ultratech Statement of earnings (Income Statement or Profit & Loss Account)

2008-09
Gross sales 7,160.42
Less: Excise duty 777.34
Net sales 6,383.08
Other income 103.56
Increase /(Decrease) in stock 88.76
Total Income 6,575.40
Raw Material Consumed 676.58
Manufacturing Expenses 2,420.17
Purchase of Finished Products 19.50
Employee Cost 217.67
Selling, distribution, Administration & Other Expenses 1,431.51
Profit before Depreciation, Interest & Tax 1,809.97
Depreciation 323.00
Profit before Interest & tax 1,486.97
Interest 125.51
Profit before tax and extra ordinary items 1,361.46
Current tax 197.54
Deferred tax 180.58
Fringe Benefit Tax 6.32
Net profit 977.02

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Ultratech Balance Sheet

Rs. In Crore
31.3.2009
Sources of funds
Share capital 124.49
Employees stock options outstanding 1.68
Reserves and surplus 3,475.93
Shareholders’ funds 3,602.10
Secured loans 1,175.80
Unsecured loans 965.83
Loan Funds 2,141.63
Deferred tax liabilities (net) 722.93
Total 6,466.66
Application of funds
Gross block 7,401.02
Less: depreciation 2,765.33
Net block 4,635.69
Capital work-in-progress 677.28
Fixed assets 5,312.97
Investments 1,034.80
Current assets, loans and advances
Inventories 691.97
Sundry debtors 186.18
Cash and bank balances 104.49
Loans and advances 378.97
Sub-total 1,361.61
Less:
Current liabilities and provisions
Current liabilities 1,120.92
Provisions 121.8
Sub-total 1,242.72
Net current assets 118.89
Total 6,466.66

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Based on the data provided above calculate ratios mentioned in the table below:

Particulars 2009
Liquidity Ratios
Current Ratio

Current Assets
______________
Current Liabilities*

* Include provisions as well since they are also

payable in the near term
Liquid Ratio

Liquid Assets*
________________
Current Liabilities

* Current Assets other than inventory. Assume Loans

& Advances to be liquid.
Capital Structure Ratio
Long Term Debt*
__________________
Shareholders’ Funds

*Include deferred tax liabilities also since they would

be payable to the government over medium to long
term
Interest Cover Ratio
Profit Before Interest & Tax
_________________________
Interest

Asset Turnover Ratios

Total Assets

Net Sales
_____________
Total Assets*

*Exclude investments since that money is not directly

productive in generating sales. Also, exclude capital
work-in-progress since it signifies investments into
new assets & capacities which are not yet installed
and hence, are not fully functional.

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 Particulars 2009
Fixed Assets Turnover

Net Sales
_____________
Fixed Assets*

* As mentioned above, exclude capital work in

progress since these assets are not yet installed and
inclusion of such assets would distort asset
productivity calculation.
No. of days inventory

Inventory
________________________
Cost of goods sold per day*

* Can be derived as raw material consumption +

manufacturing expenses + purchase of finished
goods)
No. of days receivable (DSO)

Receivables
_____________
Sales per day

Sales should be taken as gross sales for this purpose

since receivables are inclusive of taxes & duties.
Profitability Ratios
Net Profit Margin

Net Profit
_____________
Total Income

* Assuming other income does not have any extra-

ordinary income
Operating Profit Margin

Operating Profit (PBIT)

_____________________
Operating Income*

* Operating income would be the same as total

income since we have assumed that other income
does not have any extra-ordinary income

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 Particulars 2009
Cost composition (in relation to net sales)
Raw material consumed (% of sales)
Manufacturing expenses (% of sales)
Employee cost (% of sales)
Selling, distribution, Admin. & Other Expenses
(% of sales)
Interest & Finance Charges (% of sales)
Average borrowing cost

Interest and finance charges

________________________
Secured + Unsecured Loans
Depreciation (% of sales)
Return on Investment
Profit After Tax
__________________
Shareholders’ Funds

Profit Before Interest & Tax

__________________________
Capital Employed
Market measures
E P S = Net profit / No. of equity share
P/ E Ratio

Price per share (assume Rs. 900)

_____________________________
E. P. S.

16. Break-even point 1

Based on the following simple data of a dosa joint, let us build our understanding of a few
concepts, the application of which we will see in the next exercise. This dosa joint has a
couple of employees in addition to the owner himself working full time. Taking into account
various costs associated with running the dosa joint such as rent, electricity, depreciation on
the furniture & other gadgets, salaries of the employees, notional salary of the owner, the
fixed costs work out to Rs. 2,000 per day. This dosa joint does not offer a variety of dosas, let’s
assume. It sells only its ‘Jumbo Masala Dosa’ which sells at Rs. 25. The variable costs
associated with each Dosa are Rs. 5. This Jumbo Masala Dosa is very popular and sells 150
units per day in spite of the fact that the customers have to manage with a standing facility for
eating. For the price it sells, it does offer an excellent value for money.

Based on the above data, calculate the following:

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 a. Margin per dosa (defined as selling price less variables per dosa)
b. Margin in %
c. Break-even point in number of dosas: This can simply be derived as the non-variables
per day divided by the margin per dosa
d. Break-even point in sales value: This can be derived in two ways. It can be derived by
multiplying to the number of dosas derived as per ‘c’ above by the selling price. It can
also be derived by dividing the non-variables cost by margin in % derived as per b
above.
e. Margin of safety in number of dosas: this can be derived by reducing the break-even
point expressed in number of dosas from the current number of dosas sold
f. Margin of safety in sales value: this can be derived by multiplying to the margin of
safety in units by the selling price or alternatively it can be derived by reducing break-
even point in sales value from current sales value
g. Margin of safety in %: this can be derived by dividing by the margin of safety (either
in units or value) by current sales in units or value respectively
h. Profit before interest & tax:

17. Break-even point 2

Using the data of Ultra-tech Cement and based on the following assumptions, calculate the
following data based on a contribution income statement:
a. Total variable costs
b. Total fixed costs
c. Contribution Margin %
d. Break-even point (in Rs. Crs.)
e. Margin of safety (in Rs. Crs.)
f. Margin of safety in %
g. Operating Leverage
h. Financial Leverage
i. Total Leverage

Assumptions:

a. 80% of manufacturing expenses are variable in nature, remaining are fixed

b. Employee costs are 85% fixed and balance are variable (incentive based)
c. 50% of selling, distribution and administration expenses are fixed.
d. Interest & finance charges are fixed in nature

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