ASSIGNMENT - ACCOUNTING FOR MANAGERS

AMITY UNIVERSITY

MBA 1ST SEMESTER

PREPARED BY: AASHISH CHHABRA

MOBILE: +91- 9541492175

Email ID: Aashish.chharba69@gmail.com

Question1. a) What do you understand by the concept of conservatism? Why it
is also called the concept of prudence? Why it is not applied as strongly today
as it used to be in the Past?

Answer: Concept of Conservatism implies using conservatism while preparing

financial statements i.e. income should not be accounted for unless it has actually
been earned but expenses, even if just anticipated should be provided for. According
to this concept, revenues should be recognized only when they are realized, while
expenses should be recognized as soon as they are reasonably possible. For
instance, suppose a firm sells 100units of a product on credit for Rs.10, 000. Until the
payment is received, it will not be recorded in the accounting books. However, if the
firm receives information that the customer has lost his assets and is likely to default
the payment, the possible loss is immediately provided for in the firms books. The
rule is to recognize revenue when it is reasonably certain and recognize expenses
as soon as they are reasonably possible. The reasons for accounting in this manner
are so that financial statements do not overstate the companys financial position.

It is also called the concept of prudence as it essentially involves exercising

prudence in recording income and expenses/losses in the financial statements so
that anticipated income are not recorded whereas likely losses are provided for.

However, this concept is not applied as strongly today as it used to be in the past for
the reason that the modern world saw a considerable increase in corporate frauds
e.g. Enron case in USA and Satyam in India. Also, there is a decline in assuming
corporate social responsibilities due to superfluous issues of gaining publicity and
brand building. These two major issues call for increased transparency in financial
statements and hence, the decline in use of age old concept of conservatism.

Question1 (b) what is a Balance Sheet? How does a Funds Flow Statement
differ from a Balance Sheet ? Enumerate the items which are usually shown in
a Balance Sheet and a Funds Flow Statement.

Answer: A Balance Sheet is a type of financial statement of an entity, indicating the

financial position at a given point of time. It is the statement of Assets and Liabilities
as on a particular date. The various items of a Balance Sheet can be grouped under
two heads, viz: assets and liabilities.

Funds Flow statement determines the sources of cash flowing into the firm and the
application of that cash by the firm. The various items of a Funds Flow Statement
can be grouped under two heads, viz: inflow of funds (sources) or outflow of funds
(applications).

While the Balance Sheet shows only the monetary value of each source and
application of funds at the end of the year, funds flow statement depicts the extent of
changes in each source and application of funds during the year. If we take the
Balance Sheet for two consecutive years and work out the change for each item, we
are able to arrive at the Funds Flow Statement items.
The various items usually shown in a Balance Sheet are:
 Assets AMOUNT Liabilities AMOUNT

Fixed assets Shareholder's funds

(a) Gross block (a) Capital
(b) Less depreciation (b) Reserves and Surplus
(c) Net block
(d) Capital work-in-progress

Investments Loan funds

(a) Secured loans
(b) Unsecured loans

Current assets, loans, and Current liabilities and

advances provisions:
(a) Inventories
(b) Sundry debtors (a) Liabilities
(c) Cash and bank balances Sundry creditors
(d) Other current assets Outstanding expenses
(e) Loans and advances Provision for tax

Deferred Revenue Expenditure:

(a) Miscellaneous expenditure
(b) Profit and Loss account

Similarly, items in a Funds Flow Statement are:

Inflow of funds:
A decrease in assets
An increase in liabilities
An increase in shareholders funds

Outflow of funds:
An increase in assets
A decrease in liabilities
A decrease in shareholders funds
Question (a): Discuss the importance of ratio analysis for inter-firm and intra-
firm comparisons including circumstances responsible for its limitations .If
any

Answer: Ratio analysis implies the systematic use of ratios to interpret the financial
statements so that the strength and weaknesses of a firm as well as its historical
performance and current financial position can be determined. With the help of ratio
analysis conclusion can be drawn regarding several aspects such as financial health,
profitability and operational efficiency of the undertaking.

Ratio analysis is very useful in making inter-firm comparison as it helps to draw a

comparison between the entities within the same industry or otherwise following the
same accounting procedure. It provides the relevant financial information for the
comparative firms with a view to improving their productivity & profitability.

Ratio analysis helps in inter-firm comparison by providing necessary data. An inter-

firm comparison indicates relative position. It provides the relevant data for the
comparison of the performance of different departments. If comparison shows a
variance, the possible reasons of variations may be identified and if results are
negative, the action may be initiated immediately to bring them in line.

However, in spite of being such a useful tool, it is not free from its limitations. A single
ratio is of a limited use and it is essential to have a comparative study. The base
used for ratio analysis viz: financial statements have their own limitations. Also, they
consider only the quantitative aspects of business transactions where as there are
various others non-quantitative aspects such as quality of work force which
considerably affect profitability and productivity. Also, ratio analysis as a tool is also
limited by changes in accounting procedures/policies.

Question (b): Why do you understand by the term pay-out ratio? What
factors are taken into consideration while determining pay-out ratio? Should a
company follow a fixed pay-out ratio policy? Discuss fully.

Answer: Pay-out Ratio means the amount of earnings paid out in dividends to
shareholders. Investors can use the payout ratio to determine what companies are
doing with their earnings. It can be calculated as:

Payout Ratio: Dividends per Share

Earnings per Share

A very low payout ratio indicates that a company is primarily focused on retaining its
earnings rather than paying out dividends.

The pay-out ratio also indicates how well earnings support the dividend payment.
The lower the ratio, the more secure the dividend because smaller dividends are
easier to payout than larger dividends.

The major factor to be considered in determining the payout ratio is the dividend
policy of the company. Young, fast-growing companies are typically focused on
reinvesting earnings in order to grow the business. As such, they generally sport low
(or even zero) dividend payout ratios. At the same time, larger, more-established
companies can usually afford to return a larger percentage of earnings to
stockholders. Also, another factor to be considered is the type of industry in which
the company is operating. For example, the banking sector usually pays out a large
amount of its profits. Certain other sectors like real estate investment trusts are
required by law to distribute a certain percentage of their earnings.

Funds requirement of the company and its available liquidity is another factor which
is considered while determining the pay-out.

Some companies prefer to follow a fixed pay-out ratio policy irrespective of the
earnings made.

This is a welcome policy from the point of view of the investors. But, the company
should take into account various important factors such as its need for future
investment and growth, cash requirements and debt obligations.
Question (a): What is Master Budget? How it is different from Cash Budget?

Answer: The master budget is a summary of company's plans that sets specific
targets for sales, production, distribution and financing activities. It generally
culminates in cash budget, a budgeted income statement a budgeted balance sheet.
In short, this budget represents a comprehensive expression of management's plans
for future and how these plans are to be accomplished.

It usually consists of a number of separate but interdependent budgets. One budget

may be necessary before the other can be initiated. More one budget estimate
affects other budget estimates because the figure of one budget is usually used in
the preparation of other budget. This is the reason why these budgets are called
interdependent budgets.

The master budget is a comprehensive planning document that incorporates several

other individual budgets. A master budget is usually classified into two individual
budgets: the Operational budget and the financial budget. The operation budget
consists of eight individual budgets: Sales Budget, Production Budget, Direct
Material Budget, Direct Labor Budget, Factory overhead Budget, Ending inventory
budget, selling and administrative expenses budget, Budgeted income statement.

The second part of the master budget will include the financial budget. The financial
budget consists of two individual budgets Cash Budget and Budgeted Balance
Sheet.

Thus, cash budget is a part of Master budget. The Cash budget will show the effects
of all the budgeted activities on cash. By preparing - cash budge your business
management will be able to ensure that they have sufficient cash on hand to carry
out activities. It will also allow them enough time to plan for any additional financing
they might need during the budget period, and plan for investments of excess cash.
A cash budget should include all items that affect the business cash flow and should
also include three major sections; cash available, cash disbursements, and
financing.
Question (b): What are the various methods of inventory valuation? Explain
the effect of inventory valuation methods on profit during inflation. What are
the provisions of Accounting Standard 2 (AS-2) with regards to inventory
valuation?

Answer 3 b): The various methods of inventory valuation are:

i. FIFO (first-in-first-out) method

ii. LIFO (last-in-first-out) method

iii. Weighted average method

iv. Moving average method

v. Lower of cost or market value(LCM)

vi. Dollar value-LIFO

vii. Gross Profit method

viii. Retail method

During times of inflation, different methods have different effect on inflation.

FIFO gives the highest amount of gross profit because the lower unit costs of the first
units purchased is matched against revenues, especially in times of inflation. LIFO
gives the lowest amount of net income during inflationary times.

Average costs approach tends to give profit which lies in between that given by FIFO
and LIFO method.

AS per Accounting Standard of ICAI (AS-2), inventory cost should comprise of all
cost of purchases, cost of conversion and other costs incurred in bringing the
inventories to the present location and condition. Cost of purchases should be
exclusive of duties which are recoverable from the taxing authorities. (E.g. Cenvat)

Inventory should be valued at lower of cost or net realizable value. Inventory should
be valued on FIFO (First in First Out) method or weighted average method. [LIFO is
not permitted]. According to AS-2, inventory of raw materials should be valued at
cost, without considering excise duty, as manufacturer has availed credit of the
same. However, this reduces value of stock and hence profits are lower.
Question1: Describe the impact of different types of standards on motivations,
and specifically, the likely effect on motivation of adopting the labor standard
recommended for Geeta & Company by the engineering firm.

Different standards have different impact on motivation. In the given case, where the
labor standard recommended by the engineering firm is adopted by Geeta &
company, the six-month operation period showed a decline in production and an
unfavorable quantity variance for each of the six months in the said period. In the
other case where the management used the internally set labor standard, there was
a favorable quantity variance for the first three months; thereby implying that the
actual production was more than the standard production. In the fourth month, there
was no variance in production and in the fifth and sixth month, there was an
unfavorable variance, thereby implying that the actual production was less than
standard production.

Thus, we see that the standard recommended by the engineering firm had a
negative impact on motivation as it was less than the standard production. But, in the
case of internally set standards, there was a positive impact on motivation for first
three months; neutral in the fourth month; and negative impact in fifth and sixth
month.
Question 02: Please advise the company in reviewing the standards.

Answer: The labor standard recommended by the consulting firm should not be
used as a motivational device as it is having a negative impact.

The cost standard used for reporting had a positive or neutral impact for greater part
of the period and a negative impact for two months. Therefore, the company should
try and adopt labor standards similar to those ones.