PB0004 Financial and Management Accounting

(3 Credits)
Assignment 1

1. What are the basic accounting concepts? Explain their implications.

Ans. A renowned Accountant once observed that ‘Accounting was born without
notice and reared in neglect.’ Accounting was first practiced and then
theorized. Certain ground rules were initially set for financial accounting:
these rules arose out of conventions. Therefore, these are called
accounting concepts.

The basic accounting concepts are-

a) The Entity Concept

b) Money Measurement Concept
c) The Cost Concept
d) The Going Concern Concept
e) The Periodicity Concept
f) The Accrual Concept
g) The Matching Concept
h) Concept of Prudence
i) The Realization Concept

1) The Entity Concept: A business is an artificial entity distinct from its

proprietor(s). A business entity is an economic unit that owns its assets
and has its own obligations. The owner(s) may have personal bank
accounts, real estate, and other assets, but these will not be considered as
assets of the business. A business entity may be in the form of a sole
proprietorship form of business, the sole proprietor is considered fully
responsible for the welfare of the entity and, in the eyes of law, the sole
proprietor and the business are not considered to have a separate existence.
For accounting purposes, however, they are separate entities. A
partnership form of business has more than one owner who has “agreed to
share profits of a business carried on by all or any of them acting for all”.
A corporate entity is a separate legal entity, entirely divorced from its
owners (called equity shareholders). A sole proprietorship business
normally comes to an end with the expiry of the owner, a partnership firm
may cease to operate or, at least, there will be reconstruction of the
agreement on the expiry of an owner (called partner) but a corporate entity
 is not disturbed at all on the expiry of any equity is not disturbed at all on
the expiry of any equity shareholder

2) Money Measurement Concept: Each transaction and event must be

expressible in monetary terms. If an event cannot be expressed in
monetary terms, it cannot be considered for accounting purposes. For
example, if you successfully pass a Distance Learning Programmes of a
University, it will give you a great deal of satisfaction. But that
satisfaction cannot be expressed in monetary terms. Hence such an event
is not fit for accounting. On other hand, if you are robbed of Rs. 1,000 in a
train journey, the loss suffered can definitely be expressed in monetary
terms. This concept implies that the legal currency of a country should be
used for such measurement.

3) The Cost Concept: Assets such as land, buildings, plant and machinery
etc, and obligations, such as loans, public deposits, should be recorded at
historical cost (i.e. cost as on acquisition). For example, the land
purchased by a business entity two years back at a cost of Rs. 10 Lakh
should be shown, as per the cost concept, at the same amount even today
when the current price of the land may have increased five-fold. Thus, the
greatest limitation of this concept is that it distorts the true worth of an
asset by sticking to its original cost.

4) The Going Concern Concept: One common argument put forward by the
proponents of cost concept is that the assets are shown at its original cost
(net of depreciation) because these are meant for use for a long period of
time and not for immediate resale. Therefore, the cost concept rests on the
assumption that an entity would continue its operation for a long time. An
entity is said to be a going of curtailing materially the scale of the
operations’. This concept is considered as one of the fundamental
accounting assumptions. The valuation principle of assets and liabilities
depend on this concept. If an entity is not a going concern, its assets and
liabilities are to be valued in a altogether different manner.

5) The Periodicity Concept: The activities of a going concern are

continuous flows. In order to judge the performance of a business entity,
one cannot wait for eternity to see the business coming to a halt.
Therefore, the best way to judge a business is to have a periodic
performance appraisal. Such a period to measure business performance is
called an accounting period. The result of operations of an entity are
measured periodically, i.e., in each accounting period. Different business
unit may follow different accounting periods depending on convenience.
For example, one entity may follow calendar year as the accounting
period, while the other one may follow the fiscal year (April to March) as
 the accounting period. However, in India, the Income Tax Act, 1961
prescribes that each business unit should follow a uniform accounting
period, i.e., the fiscal year. The companies Act, 1956 has no such
prescription. Therefore, for tax purpose, every business entity should
follow uniform year, i.e., fiscal year, whereas for accounting purpose,
there is no restriction.

6) The Accrual Concept: It suggests that incomes and expenses should be

recognized as and when they are earned and incurred, irrespective of
whether the money is received or paid in connection thereof. This concept
is used by all businesses that disclose their financial statements to various
interested parties. In fact, the Companies Act, 1956 provides that accrual
concept have to be maintained for practically all purposes. The alternative
to the accrual basis of accounting is called ash basis of accounting. The
law in India provides that in cases where accrual concept cannot be
followed under any circumstances cash basis may be followed.

7) The Matching Concept: The inherent concept involved in accrual

accounting is called matching concept. Revenue earned in an accounting
year is offset (matched) with all the expenses incurred during the same
period to generate that revenue, thus providing a measure of the overall
profitability of the economic activity. Thus, matching concept is very vital
to measure the financial results of a business. The timing of incurring
expenses and earning revenues does not always match. For example, in
case of a seasonal business, majority of sales may take place only in four
months of a year whereas fixed expenses, majority of sales may take place
only in four months of a year whereas fixed expenses like salaries, rent
etc. are incurred throughout the year. Matching concept suggests that the
expenses incurred to generate revenue are to be matched against that
revenue to find out the profitability.

8) Concept of Prudence: It says ‘anticipate no profits but provide for all

possible losses’. Prudence is the ‘inclusion of a degree of caution in the
exercise of the judgments needed in making the estimates required under
conditions of uncertainty, such that asset or income or not, overstated and
liabilities or expenses are not understated.’ Expected losses should be
accounted for but not anticipated gains.

9) The Realization Concept: The realization concept tells that to recognize

revenue it has to be realized’. Realization principle does not demand that the
revenue has to be received in cash. Revenue from sales transactions should be
recognized when the seller of goods has transferred to the buyer the property
in the goods for a price and no uncertainty exists regarding
 10) The consideration that it will be derived from the sale of goods. Revenue
arising from the use by others of enterprises resources yielding interest, royalties
and dividends should only be recognized when no uncertainly exists as to its
measurability and collectivity.

2. Enter the following transactions in a cashbook with cash, bank and discount
columns.
2008
Jan.1 Commenced business with Rs.16,000 in cash
Jan.2 Paid into bank Rs. 14,500
Jan.3 Bought goods for Rs. 3,850 and paid by cheque.
Jan.4 Bought furniture for cash Rs. 680
Jan.5 Sold goods for cash Rs. 2,600 and deposited the same into bank.
Jan.10 Bought goods for Rs. 4,850 and paid by cheque.
Jan.11 Bought stationery for Rs. 185
Jan.15 Received cash from Hegde Rs.680 allowing him a discount of Rs. 20
Jan.20 Paid Raj his dues by cheque Rs. 240 receiving a discount of Rs.10
Jan.25 Paid Chandra by cheque Rs. 400
Jan.26 Sold goods for cash Rs. 585 and remitted the same into the bank.
Jan.27 Our cheque to Chandra returned dishonored.
Jan.29 Drew cheque for salary Rs. 2,365
Jan.31 Drew cheque for personal use Rs 100
 3. The following financial information is furnished by Aditya Mills Ltd. for
the current year :
Balance Sheet as on 31-3-2008
Liabilities Amount Assets Amount
Equity Share Capital 1000000 Plant & Equipment 640000
Retained Earnings 368000 Land & Buildings 80000
Sundry Creditors 104000 cash 160000
Bills Payable 200000 Sundry Debtors 320000
Other Current Liabilities 20000 Stock 480000
Prepaid Insurance 12000
1692000 1692000

Income statement as on 31-3-2008

Sales 4000000
Less : Cost of Goods Sold 3080000
Gross Profit 920000
Less : Operating Expenses 680000
Operating Profit 240000
Less : Taxes (0.35) 84000
Net Profit after taxes 156000

Calculate :
(i) Current ratio
(ii) Acid-Test ratio
(iii) Stock Turnover Ratio
(iv) Debtors Turnover Ratio
(v) Creditors Turnover ratio
(vi) Gross Profit Ratio
(vii) Net Profit Ratio
(viii) Return on equity capital
 Answer
Aditya Mills Ltd.

Calculation of following ratios:

1) Current ratio
2) Acid-Test ratio
3) Stock Turnover ratio
4) Debtors Turnover ratio
5) Creditors Turnover ratio
6) Gross Profit ratio
7) Net Profit ratio
8) Return on equity capital

1) Current ratio: Current Assets_

Current Liabilities

= ___Cash+ Sundry Debtors+ Stock+ Prepaid Insurance__

Sundry Creditors+ Bills Payable+ Other Current Liabilities

=1,60,000+ 3,20,000+ 4,80,000+ 12,000

1,04,000+ 2,00,000+ 20,000

Current ratio=9,72,000 = 3:1

3,24,000

Company is having current assets of Rs. 3 for every Re. 1 of current

liabilities. As the ideal ration is 2:1, the current ratio is very satisfactory.

2) Acid-Test ratio: = Liquid Assets (Current Assets- Stock+ Prepaid Insurance)

Liquid Liabilities

=1,60,000+ 3,20,000- 4,80,000+ 12,000

1,04,000+ 2,00,000+ 20,000
 = 12,000 = 0.037:1
3,24,000

Company’s immediate resources for meeting current liabilities are a little

less than obligations. Its financial position cannot be said to be very
strong. This fact was supported by current ratio also.

3) Stock Turnover ratios = Cost of goods sold

Average Inventory at Cost

= Sales-Gross Profit
Closing Stock

= 30,80,000 = 6.41:1
4,80,000

4) Debtors Turnover ratio = Sales

Average Debtors

= 40,00,000 = 12.5 times

3,20,000

( Note: Sales= Credit Sales)

5) Creditors Turnover ratio = Credit Purchases

Creditors

Credit Purchases =Cost of goods sold= Purchases- Closing stock

= 30,80,000 = X - 4,80,000
= X = 30,80,000+ 4,80,000
 = Purchases = 35,60,000

Therefore, Creditors = Capital turnover ratio

Capital turnover ratio= Sales = 40,00,000

Capital 13,68,000

Capital turnover ratio = 2.92 times

Credit Turnover ratio= 35,60,000= Rs. 12,19,178.08

2.92

(Note: Capital includes Equity share capital+ Retained Earnings)

(Referred to B.com final Book for Debtors and Creditors Turnover

ratio)

6) Gross Profit ratio = Gross Profit*100

Net Sales

= 9,20,000 * 100
40,00,000

Gross Profit ratio = 23%

7) Net Profit ratio = Net Profit*100

Net Sales

= 1,56,000*100
 40,00,000

Net Profit ratio = 3.9

8) Return on equity capital =

Net profit after interest, tax and preference dividend *100

Equity shareholders funds

= _____1,56,000____*100
10,00,000+3,68,000

Return on equity capital = 11.40

4. What is the significance of the term “variance” related to standard

costing? What types of variances are computed for
(a) Materials, (b) Labour and (c) Overheads.

Ans. Variance is the difference between a standard cost and the actual cost
incurred during a period. Analysis of individual variances to determine the
extent of deviation and their causes is called variance analysis. Thus, it
involves two elements:

1. Measurement of individual variances and

2. Identification of causes of each variance

Standard cost is different from ‘estimated cost’. Estimated cost is

computed before actual production is commenced. It may be based only
on estimates of different factors affecting costs. It need not involve the
scientific measurement of various factors affecting production. But
standard cost is pre-determined more scientifically taking into
consideration all elements of production and costs. It considers both
internal and external factors.

Standards are established for each element of cost, viz., material, labour
and overheads.
 1) Standards for Material: The standard for material include (a) material
quantity (usage) standard and (b) material price standard.

Material Quantity Standard: This standard pre-determines the kind,

quality and quantity of materials to be used to produce a desired product.
Generally, the Product-engineering Department prepares these details
considering normal wastage of materials.

Material Price Standard: Standard price should be determined for

different types of materials. It is difficult to establish standard price
because material prices are influenced by external factors like market
conditions, price fluctuations…. Etc. Usually standard prices are
established based on past data and the expected changes in the prices.
Ordering cost and stock carrying cost are also included in the material
prices.

2) Standards for Labour: Standards are set for direct labour in terms of
cost and efficiency (quantity) called labour cost standard and labour usage
efficiency standard.

Labour Cost (or Labour Rate) Standard: It is the standard price

determined for each type of direct labour. These rates are fixed on the
basis of current rates, rates fixed by the government or agreements with
labour unions and the experience of labourers.

Labour Efficiency Standards (Labour Usage Standard): It refers to the

standard time to be taken for each of labour for each operation. Labour
time standards are fixed on the basis of past experience and scientific
studies like work-study and time and motion study. Allowances are made
for fatigue, normal idle time etc.

3) Standards for Overhead Costs: Fixing the standards for overhead

costs is complicated because these costs are partly fixed and partly
variable. Standards are fixed based on standard capacity.

Standards are determined for fixed and variable overheads individually

according to the functions e.g., manufacturing, administration and selling
and distribution. Standard overhead rates are arrived at by dividing the
total standard overheads by standard units of production.

_______________________________________________________________________
_
5. “The Analysis of flow of funds through an organization can be very
useful to the management”. Elucidate.

Ans. Fund may be interpreted in various ways as (a) Cash, (b) Total
current assets, (c) Net working capital, (d) Net current assets. For the
purpose of fund flow statement the term fund means net working capital.
The flow of fund will occur in a business, when a transaction results in a
change i.e., increase or decrease in the amount of fund.

Fund Flow Statement describes the sources from which additional funds
were derived and the uses to which these funds were put.

Different Names of Fund-flow Statement

1. A Funds Statement
2. A statement of sources and uses of fund
3. A statement of sources and applications of fund
4. Where got and where gone statement
5. Inflow and outflow of fund statement

The main purposes of Fund Flow Statement are:

1. The help to understand the changes in assets and asset sources which
are not readily evident in the income statement or financial statement..

2. To inform as to how the loans to the business have been used.

3. To point out the financial strengths and weakness of the business.

The steps involved in the preparation of Fund Flow Statement are:

1. Preparation of schedule changes in working capital.

2. Preparation of adjusted profit and loss account.

3. Preparation of accounts for non-current items.

3.Preparation of the fund flow statement.

PB0004 Financial and Management Accounting

(3 Credits)
Assignment 2
1. “Is the agreement of trial balance a conclusive proof of the accuracy
of a book keeper? If not, what are the errors, which remain
undetected by the trial balance?

Ans. There are certain errors which will disturb the Trial Balance in the sense
that the Trail Balance will not agree. These errors are easy to detect and
their rectification is also simple. For example, if the debit column total of
the Trial Balance exceeds the credit column total, the possibilities may be
casting error in any account, posting of a wrong amount and a balancing
error. These errors are easy to detect and you can, within a short time,
Arrive at an agreed Trial Balance. In the era of advanced information
technology, when you will be using software packages for accounting
purposes, the possibility of these types of errors and consequently, a
disagreed Trial Balance is nil.

However, there are certain errors that are not detected through a Trial
Balance. In other words, a Trial Balance would agree in spite of these
errors. These errors are very difficult to detect because you will not be
aware of such errors. The examples of such errors are errors of principle,
errors of omission, errors of commission, compensating errors, etc.

An error committed because of lack of knowledge of the basic of

accounting principles is called an error of principle. For example, wages
paid for installation of machinery is debited to Wages Account instead of
Machinery account.

If a transaction is not recorded in the journal, it will not be reflected in the

ledger transaction is not recorded in the journal, it will not be reflected in
the ledger and subsequently, in the Trial Balance. This is an error of
omission.

If the amount received from Mr. X is wrongly posted in the account of Mr.
Y, and by another error, then it is a case of compensating error. For
example, if the sales account is under cast by the same amount, these
errors are cancelled and hence will not affect the Trial Balance.

Rectification of errors depends on the stage at which the errors are

detected. There are mainly 2 stages in the accounting process when errors
can be detected:

Stage 1: Before preparation of the Trial Balance

As the Trial Balance is not prepared it implies that the ledger balances are
not drawn, i.e., account in closed. So, it becomes easy to rectify errors
 detected at this stage. There are can be two types of errors.

a) An error affecting only one account or more than one account in such a
way that no journal entry is possible for its rectification;

b) An error affecting two or more accounts in such a way that a complete

journal entry can be passed for its rectification.

Stage 2: After the trial but before the final accounts

Once the Trial Balance is prepared, all ledger balances are drawn. In that
case, to rectify any error, it should be done in such a way that the Trial
Balance agrees. In other words, if an account is to debited for rectification,
another account has to be credited by the same amount. Otherwise, the
Trial Balance will not tally. This is possible only if the rectification is
done with the help of journal entries.

So far as types (b) errors of stage 1 are concerned, the process of

rectifying the errors is exactly the same in stage 2 as well. The same
journal entries are to be passed. The difficulty arises with type (a) errors of
stage 1. This is because type (a) errors do not have necessary information
to complete journal entry.

One type (a) errors are detected, these are to be rectified by passing
journal entries and, upon rectification of all such errors, the Suspense
Account will be automatically eliminated from the Trial Balance. The
technique for passing journal entries cases is to put the suspense account
to fill in the unknown side or the difference in amount.

2. From the following trail balance extracted from the books of Mr. Ram, prepare
Trading A/c, P&L A/c and Balance Sheet for the year ending 31st March 2008.
 Trail Balance as at 31st March 2008
Dr.(Rs.) Cr. (Rs.)
Stock as on 1-4-2007 62500
Purchases & Sales 90300 137200
Returns 2200 1300
Capital 30000
Drawings 4500
Land and Buildings 30000
Furniture & Fittings 8000
Sundry Debtors and Creditors 25000 45000
Cash in Hand 3500
Investments 10000
Interest 2500
Commission 3000
Direct expenditure 7500
Postages, Stationery and
Phones 2500
Fire Insurance Premium 2000
Salaries 11000
Bank Over Draft 40000
259000 259000

Additional Information :
i)Closing Stock is Valued at Rs. 65,000
ii)Goods worth Rs.500 are reported to have been taken away by the
proprietor for his personal use at home during 07-08
iii)Interest on Investments Rs.500is yet to be received
iv)Depreciation is to be provided on Land & Buildings @ 5% and on
Furniture & Fittings @10%
v)Make provision for Doubtful debts @ 5%

Ans
In the Books of Mr. Ram Trading Account for the year ended 31 March 2008.

Dr. Cr.s

Particulars Rs. Amount Particulars Rs. Amount

To opening 62,500 By Sales 1,37,200
stock
 To 90,30 Less: 2,200 1,35,000
Purchases 0 Returns
Less: 1,300 89,000 By Closing 65,000
Returns Stock

To Gross 48,500
Profit c/d
2,00,000 2,00,000

Profit and Loss Account for the year ended 31March 2008
Dr. Cr.

Particulars Amount Particulars Amount

To Direct 7,500 By Gross Profit 48,500
expenditure b/d
To Postages, 2,500 By Commission 3,000
Stationery
And Phones
To Fire Insurance 2,000 By Interest 2,500
Premium
To Salaries 11,000 By interest 500
received
To deprecation on 1,500
Land and Buildings
To deprecation on 800
Furniture
To Debtors account 1,250
To Net Profit c/d 27,950
54,500 54,500

Balance Sheet as on 31 March 2008

Dr. Cr.

Liabilities Rs Amount Assets Rs Amount

Capital 30,000 Land and 30,000
Buildings
Add: Net 27,950 Less: 1,500 28,500
Profit Deprecation
@ 5%
Less: Goods 500 Furniture and 8,000
used for Fittings
personal use
Less: 4,500 Less: 800 7,200
Drawings Deprecation
 @ 10%
52,950 Sundry 25,000
Debtors
Bank 40,000 Less: 1,250 23,750
Overdraft Provision @
5%
Sundry 45,000 Cash 3,500
Creditors
Investments 10,000
Closing Stock 65,000
1,37,950 1,37,950

Working Notes:

1. Provision for Doubtful Debts

Debtors as per Trial Balance : 25,000
Less: Doubtful Debts @ 5% : 1,250
Sundry Debtors : 23,750

2. Deprecation on Furniture and Fittings

Furniture and Fittings : 8,000
Less: Depreciation @ 10% : 800
Furniture : 7,200

3. Deprecation on Land and Buildings

Land and Buildings : 30,000
Less: Depreciation @ 5% : 1,500
Land and Buildings : 28,500

3. The sales and profit of a manufacturing concern for the year 2007
and 2008 is as follows:

2007 2008
Sales Rs 1,50,000 Rs 2,00,000
Cost Rs 1,44,000 Rs 1,90,000
Determine:
a) P/V ratio
b) Fixed Cost
c) Break-Even Point
d) Profit at Sales of Rs. 2,50,000
e) Sales to earn a desired profit of Rs. 20,000.

Ans.

Firstly, Profit for 2007 and 2008

Profit= Sales – Cost
Year 2007 X= 1,50,000 – 1,44,000
X= 6,000

X= 2,00,000- 1,90,00
Year 2008 X= 10,000

a) P/V ratio:

P/V ratio= Changes in Profit * 100

Changes in Sales

= 10,000-6,000 * 100
50,000

P/V ratio = 8%

b) Fixed Cost:

= PV ratio * Sales – Profit

Year (2007) = 8% * 1,50,000 – 6,000

= 12,000 – 6000
= 6,000

Year (2008) = 8% * 2,00,000 – 10,000

= 16,000 – 10,000
= 6,000

c) Break Even Point

 = BEP= Fixed Expenses
P/V ratio

= 6,000 = 75,000
8%

BEP = 75,000

d) Profit at Sales of Rs. 2,50,000.

Profit = Sales * P/V – FC

= 2,50,000 * 8 - 6,000
100

Profit at Sales of Rs. 2,50,000 = 14,000

e) Sales to earn a desired profit of Rs. 20,000

= Sales = Desired Contribution * Selling price

P/V ratio

= Fixed Cost + Desired Profit * Sales

P/V ratio

= 6,000 + 20,000
8%

= 26,000
8%

Sales to earn a desired profit of Rs. 20,000 = 3,25,000.

4. Define the budgetary control and discuss the objectives of

introducing a budgetary control system in the business organization.

Ans. Budgetary control is a system of planning and controlling costs. It is

a process of continuous comparison of actual performances and costs with
that of budgets. ICMA London defines budgetary control as “the
establishment of budgets relating to responsibilities of executives to the
requirement of budgets relating to responsibilities of executives to the
requirement of a policy and continuous comparison of actual with
budgeted results either to secure by individual action the objectives of that
policy or to provide a basis for its revision.”

Objectives of Budgetary Control:

1. Planning the policies: A budget is a plan of the policies to be pursued

during a given period for achieving the given objectives, Budgetary
control compels effective planning of all operations well in time.

2. Co-ordinating activities: Various departments and sections of the firm

are involved in the task of preparing budgets. It develops team spirit and
secures co-operation from all departments to achieve the common
objective of the firm.

3. Controlling costs: Budgets are prepared for every important function

and department. Actual performances are compared with that of budgets.
This facilities control over different activities and costs.

4. Increases efficiency: Well thought plans, carefully selected course of

action and system of continuous evaluation of performances help to
increase to overall efficiency of the firm.

Budgetary Control system in the business organization

One type of Budgetary Control cannot be adopted for all firms. The
following steps are necessary to prepare suitable budgets and effective
implementation of the budgetary control system.

1. Preparation of organizational chart: Authority and responsibility of

all executives should be clearly defined. This will enable the identification
of accountability of each executive.

2. Preparation of budget centers: Budget centre is a section of the

organization selected for the purpose of budgetary control. E.g., sales,
production, plant capacity etc.

3. Appointment of Budget Committee: Generally, a Committee is

appointed for approval of budgets prepared by the Departmental Heads, it
may make amendments, if necessary, before approving the budgets. It has
been compare the actual performances and recommend remedies, if
necessary. This Committee will consist of General Manager and various
Heads of Departments, e.g., sales, production, purchase, finance,
personnel etc. Budget Controller or Budget Officer is the leader of the
Committee. However, in small concerns, the Chief Accountant will be
responsible for the preparation of various budgets and of the co-ordination
of various activities of budgetary control.

4. Preparation of Budget Manual: It is a document which defines the

responsibilities of the person responsible for successful budgetary control
system. It also lays down the forms, records and reports necessary for the
system.

5. Determination of budget period: The period for which the budget is

prepared and remains effective is called budget period. This period may be
very long, one year or even months, or weeks.

6. Determination of Key factor or budget factor: Key factor is one,

which will limit the volume of output of an undertaking. Key factor
influences all other budgets. Therefore, it is to be identified before the
preparation of other budgets. The budget relating to the key factor should
be prepared first and other functional budgets are to be prepared in the
light of this budget.