FINANCIAL ACCOUNTING

Question 1. What is the primary objective of Financial Accounting?

Answer The primary objective of the Financial Accounting is to communicate and Provide
:
information to the investors and creditors on the economic activities of the firm enterprise
that will help them in their investment decisions.

Question 2. What are financial statements? Name the major financial statements.
Answer: The Financial statements are the reports that result from the process of accounting which
allow the interested parties to evaluate the profitability and the solvency of the business. The
major financial statements are
• Profit and Loss Account
• Balance sheet
• Cash Flow statement

Question 3. What is the difference between balance sheet and profit & loss account?
Answer: The balance sheet is one of the most important financial statements of a company. It is
reported to investors at least once per year. It may also be presented quarterly, semiannually
or monthly. The balance sheet provides information on what the company owns (its assets),
what it owes (its liabilities), and the value of the business to its stockholders (the
shareholders' equity). The name, balance sheet, is derived from the fact that these accounts
must always be in balance. Assets must always equal the sum of liabilities and shareholders'
equity.
A company's income statement/profit and loss account statement is a record of its earnings or
losses for a given period. It shows all of the money a company earned (revenues) and all of
the money a company spent (expenses) during this period. It also accounts for the effects of
some basic accounting principles such as depreciation.
The income statement is important for investors because it's the basic measuring stick of
profitability. A company with little or no income has little or no money to pass on to its
investors in the form of dividends. If a company continues to record losses for a sustained
period, it could go bankrupt. In such a case, both bond and stock investors could lose some
or all of their investment. On the other hand, a company that realizes large profits will have
more money to pass on to its investors.

Question 4. What are the principal qualitative characteristics of financial statements?

Answer: The principle characteristics of financial statements are the attributes that make the
information provided in the financial statements useful to the users. The principle qualitative
characteristics are
Understandability: They should be readily understandable to the users. For this purpose users
are deemed to have reasonable knowledge of business and economic activities.
Relevance: To be useful information must be relevant to the decision-making needs of the
users.

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Reliability: Information is said to be reliable when it is free from errors, bias and can be
depended upon by the users to represent faithfully, which it purports to represent.
Comparability: Users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position and performance.

Question 5. What is meant by the quality of financial reporting? What is conservatism, and how does it affect
the quality of earnings?
Answer: The quality of financial reporting refers to how close the financial statements are to economic
reality. The closer the financial statements are to economic reality, the higher is the quality of
financial reporting. The less that management uses discretionary means to manipulate
earnings, the higher the quality of financial reporting. Conservatism means that management
should take great care not to overstate assets and revenues and not to understate liabilities and
expenses. The more conservative management IS in making accounting judgments, the higher
will be the quality of financial reporting.

Question 6. What are the major constraints on relevant and reliable financial statements?
Answer: 1 the major constraints are
Timeliness: If there is undue delay information becomes irrelevant.

Balance between cost and benefit: The benefits derived from information should exceed the
cost of providing it.
Balance between the various qualitative characteristics: In practice it has become necessary to
achieve an appropriate balance between the qualitative characteristics.
True and fair view presentation: There is no clarity in the term 'true and fair view' as required
by the Companies Act. The conceptual framework does not discuss this.

Question 7. What are the golden rules of Accounting?

Answer: The golden Rules of Accounting are:
• Debits always equal Credits
• Increases do not necessarily equal Decreases
• Assets - Liabilities = Owner's Equity (The accounting equation)

Question 8. What is Fundamental Accounting equation?

Answer: Accounting equation is a mathematical expression used to describe the relationship between
the assets, liabilities and owner's equity of the business model. The basic accounting equation
states that assets equal liabilities and owner's equity, but can be modified by operations
applied to both sides of the equation, e.g., assets minus liabilities equal owner's equity.

Question 9. What are Accounting Standards? List few advantages.

Answer: Accounting Standards are rules and criteria of accounting measurement evolved by several
accounting standard setting bodies established in developing and developed countries.

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• International Accounting Standard Board (IASB) - International Accounting Standards.

• Financial Accounting Standards Board (F ASB) - US Generally Acceptable Accounting
Practices (specifically Statements on Financial Accounting Standards).
• In India - Institute of Chartered accountants of India - Accounting Standards.

The advantages
1. Reduces to a reasonable extent eliminates confusing variations in the accounting
treatment.
2. Lays down disclosure requirements beyond that required by law.
m. To a limited extent facilitates comparison of financial statements globally.

Question 10. Discuss the GAAP measures used in India.

Answer The financial statements are prepared under the historical cost convention, m accordance with
:
Indian Generally Accepted Accounting Principles ("GAAP") comprising of the accounting
standards issued by the Institute of Chartered Accountants of India and the provisions of the
Companies Act, 1956, as adopted consistently by the company. All income and expenditure
having a material bearing on the financial statements are recognized on the accrual basis. The
preparation of the financial statements in conformity with GAAP requires, that the
management of the company ("Management") make estimates and assumptions, that affect the
reported amounts of revenue and expenses of the period, reported balances of assets and
liabilities and disclosures relating to contingent assets and liabilities as of the date of the
financial statements. Examples of such estimates include, expected contract costs to be
incurred to complete software development, provision for doubtful debts, future obligations
under employee retirement benefit plans and the useful lives of fixed assets. Actual results
could differ from those estimates.

Question I. Tell us what you know about Accounts Receivables and Payables?
Answer Accounts Receivable, normally abbreviated as AIR, is the money that is currently owed to a
:
company by its customers. The reason why the customers owe money is that the product has
been delivered but has not been paid for yet. Companies routinely buy goods and services
from other companies using credit. Although typically AIR is almost always turned into cash
within a short amount of time, there are instances where a company will be forced to take a
write-off for bad accounts receivable if it has given credit to someone who cannot or will not
pay. This is why you will see something called allowance for bad debt in parentheses beside
the accounts receivable number.
Accounts Payable is the money that the company currently owes to its suppliers, its partners
and its employees. Basically, these are the basic costs of doing business that a company, for
whatever reason, has not paid off yet. One company's accounts payable is another company's
accounts receivable, which is why both terms are similarly structured. A company has the
power to push out some of its accounts payable, which often produces a short-term increase in
earnings and current assets.

Question 12. Tell me something about Accounting for goodwill.

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Answer: Goodwill is considered to be one of the largest intangible assets, the value of which companies
want to reflect correctly in their financial statements. Accounting for this asset, poses many
challenges for accountants, as it is an unidentifiable intangible asset.

Question 13. Can you provide us a suitable definition of goodwill?

Answer: Goodwill as an intangible asset can be defined from two approaches:

• Residuum approach
Under this method, goodwill is taken to be the difference between the purchase price and the
fair market value of an acquired company's assets.

• Excess profits approach

Under this method, the present value of the projected future excess earrings over normal
earnings for similar businesses is recorded as goodwill. Due to uncertainty of future earnings,
valuing goodwill using this method is difficult.

Question 14. What is debenture redemption reserve?

Answer: The companies (Amendment) Act 2000 require every company to create debenture redemption
reserve for redemption of debentures out of appropriation of profits every year until
redemption. This reserve cannot be utilized by the company except for the purpose of
redemption.

Question 15. What is deferred revenue expenditure?

Answer: Deferred revenue expenditures represent types of assets whose usefulness do not expire in the
year of their occurrence but generally expires in the near future. These types of expenditures are
carried forward and are written off in future accounting periods. Sometimes, we make some
revenues expenditure but it eventually becomes a capital asset (generally of an intangible
nature). Example, if we undertake substantial repairs to the existing building, the deterioration
of the premises may be avoided. If we charge the whole expenditure during the current, the
current year expenses are affected. However, since the benefit of this expenditure is enjoyed
over a number of years. So, to overcome this only a part of the expenditure is charged current
year and the balance carried forward and written off gradually during the future periods.

Question 16. What are contingent liabilities?

Answer: These are liabilities, which materialize on the happening or non-happening of an event.
Contingent liabilities are not real liabilities and as such do not appear in the liability side of
balance sheet. But are disclosed by way of a note in the balance sheet.

Question 17. What is depreciation? List few methods of providing depreciation.

Answer It is common knowledge that when an asset is used over a period of time, it looses its value.
:
This loss in value is called depreciation. Pickles defines it as "the permanent and continuing
diminution in the quality, quantity or value of an asset" Depreciation is the continuous
shrinkage of book value of an asset.
Few method of depreciation are

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Straight line Method: An equal amount is written off every year during the working life of an
asset so as to reduce the cost of the asset to nil or its residual value at the end of its useful life.

Reducing Balance Method: A fixed percentage of the diminishing value of the asset is written
off each year so as to reduce to its break up value at the end of its life.

Machine hour method: If it is practicable to keep a record of the actual running hours of each
machine, depreciation may be calculated on the basis of the hours for which the concerned
machine worked.

Question 18. What do you understand by "contract account"?

Answer Account in which posting data for contracts or contract items are processed for which the
:
same collection/payment agreements apply. Contract accounts are managed on an open item
basis within contract accounts receivable/payable.

Question 19. Please tell how you can analyze a balance sheet vis-à-vis the performance of the company in the
capital market? Give examples with reference to some specific parameters.
Answer The analysis of a balance sheet can identify potential liquidity problems. These may signify
:
the company's inability to meet financial obligations. An investor could also spot the degree to
which a company is leveraged, or indebted. An overly leveraged company may have
difficulties raising future capital. Even more severe, they may be headed towards bankruptcy.
These are just a few of the danger signs that can be detected with careful analysis of a balance
sheet.

Beyond liquidity and leverage, there are certain very important benchmarks and aspects,
which are helpful in the analysis of balance sheet.

• Revenues/Sales growth
• Bottom line growth

• ROI - Return on Investment

• Volume

• Market Capitalization

• Company management

• PSR (Price-to-Sales Ratio)

• Return on Equity

• Debt-to-Equity Ratio

• Beta
• Earnings Per Share (EPS)

Question 20. Define FIFO and LIFO. Explain what effects that FIFO and LIFO have on the balance sheet
during a period of rising prices and during a period of falling prices?

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Answer FIFO is the inventory cost flow assumption that treats the first goods in as the first goods
:
sold. LIFO is the inventory cost flow assumption that treats the last goods in as the first
goods sold. In a period of rising prices, FIFO values inventory at current costs. However,
LIFO would value inventory at costs that the company could have incurred years ago. The
analyst should take the LIFO cost flow assumption into account and consider adjusting the
inventory of a company using LIFO upward to account for inflation.

Question 21. What are marketable securities?

Answer: Marketable securities are cash substitutes. Marketable securities are investments with short-
term maturities with little risk due to interest rate fluctuations. Examples of marketable
securities include Treasury Bills, Negotiable Certificates of Deposit, and Commercial Paper.

Question 22. A financial accounting system provides information for external decision makers and a
management accounting system provides information for a firm's internal decision makers.
Consider the general information needs of these two categories of decision makers. How are
their information needs different? How are their information needs similar? What does your
consideration of these differences and similarities suggest about the relationship between the
financial accounting system and the management accounting system as components of the
overall accounting system?
Answer: The primary external users of accounting information are investors and creditors whose
decisions often require them to make comparisons between companies. To support these
inter company comparisons, they need information that is itself comparable. This requires
financial accounting information to be fairly standardized in terms of not only its basic
manner of presentation, but also in terms of how economic events are identified, measured,
and recorded. The information needs of internal users (i.e., managers) are generally more
focused on their single firm as they seek to plan and control its operations. Accordingly,
inter company comparability is less of a concern in managerial accounting, meaning that
standardization of accounting practice is not as important. However, like external users,
internal users will have some decisions that require information that is comparable between
companies. For example, year-end bonuses might be based on the company's performance
relative to other companies in the same industry. Therefore, the information needs of internal
and external users generally overlap somewhat. Accordingly, the financial and management
accounting systems are not two completely separate systems, but rather are partially
overlapping subsystems within the overall accounting system.

Question 23. What is the entry for Deferred Tax liability according to AS22?
Answer Deferred tax assets and liabilities should be distinguished from assets and liabilities
:
representing current tax for the period. Deferred tax assets and liabilities should be disclosed
under a separate heading in the balance sheet of the enterprise, separately from current assets
and current liabilities.
The break-up of deferred tax assets and deferred tax liabilities into major components of the
respective balances should be disclosed in the notes to accounts.

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The nature of the evidence supporting the recognition of deferred tax assets should be disclosed,
if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws.

Question 24. What is Sec 72A of Income Tax Act?

Answer: Incentive for amalgamation extended to hotels and certain banks - Sec. 72A.
The benefit of carry forward and set off of accumulated losses and unabsorbed depreciation
would be extended in the case of amalgamation of a company owning a hotel with another
company or an amalgamation of a banking company with the State Bank of India or its
subsidiary or other specified banks. Two additional conditions for amalgamating a company will
have to be fulfilled, viz. that it should have been engaged in the business for at least 3 years
during which the accumulated loss has occurred or the unabsorbed depreciation has accumulated
and it has held continuously as on the date of amalgamation at least 3/ 4ths of the book value of
fixed assets held by it two years prior to the date of amalgamation.

Question 25. What is Section 80CCC (I)?

Answer: Deduction under section 80CCC (I)
This section was introduced with effect from Annual Year 1997-98. Under this section "Jeevan
Suraksha' Pension Plan of LIC of lndia is most popular option. 'Jeevan Suraksha' Pension Plan is
a contributory Pension Plan and contributions paid to LIC of India can be reduced from taxable
income subject to maximum of Rs.10, 000/- p.a. Accordingly a person who is in 31.5% tax
bracket can save income tax of Rs.3, 150/- (including surcharge) by contributing Rs.10,000/-
towards Jeevan Suraksha' Pension Plan in a year.

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MANAGEMENT ACCOUNTING
Question 1. What is a Cost? What do you mean by cost unit?
Answer: A Cost is a resource consumed to accomplish a specified objective. A Cost Unit is a unit of
output in the production of which the costs are incurred.

Question 2. What is Budget?

Answer: Budget is a quantitative representation of the policy to be pursued during a specified period
of time for purpose of attaining predefined objectives.

Question 3. What is Standard cost?

Answer: It is a predetermined or forecast estimate of cost to manufacture a single unit, or a number of
units of a product, during a specific immediate future unit of a product.

Question 4. What is a standard costing?

Answer: It is the preparation and use of standard costs, their comparison with actual costs, and
analysis of variances to their causes & points of incidence.

Question 5. What is a direct cost?

Answer: A cost which can be economically identified with a specific saleable cost unit.

Question 6. What do you understand by cost center?

Answer: It is a smaller segment of activity or area of responsibility for which costs can be
accumulated. Responsibility in a cost center is restricted to costs only.

Question 7. How is investment center different from cost center?

Answer: Investment center is a profit center whose performance is measured by its return on capital
employed. Cost center is a smaller segment of activity or area of responsibility for which
costs can be accumulated. Responsibility in a cost center is restricted to costs only.

Question 8. How does standard costing affect performance?

Answer: A control technique which compares standard costs and revenues with actual results to obtain
variances which are used to stimulate improved performance.

Question 9. How do you calculate opportunity cost?

Answer: The value of a benefit sacrificed in favor of an alternative course of action.

Question 10. What is EOQ?

Answer Economic Order Quantity-It represents the quantity of goods ordered which minimizes the
:
sum of inventory ordering costs and carrying costs

Question 11. How do the financial experts use "cost sheet"

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Answer Through the use of a "cost sheet", financial experts estimate the detailed cost in respect of a
:
cost center or a cost unit and also makes inter-firm comparison by including cost data of
different firms.

Question 12. How do you identify direct labor?

Answer Labor that is directly identifiable with a specific product or activity.
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Question 13. What is the importance of Cost-Volume-Profit Analysis?
Answer Managing cost is one of the most important aspects of a successful business. A firm should
:
have a clear understanding of the financial impact of every decision it takes. For example,
when a firm acquires loan, its fixed cost increases due to increase in payment by way of
interest. In such a situation, a firm should be able to analyze sales volume required to cover the
additional cost incurred.
Cost-Volume-Profit (CVP) Analysis evaluates various business decisions and helps the
finance manager to account for any deviation caused in the profits, by manipulating cost and
sales of the firm. CVP analysis can also be stated as the relationship between cost (fixed and
variable), volume (in units or in rupees) and profit.

Question 14. Can you identify the two basic tools used for CVP analysis?
Answer • Contribution margin analysis
:
• Break-even analysis

Question 15. What is BEP analysis?

Answer Break-Even analysis is an analytical technique to study the relationship between fixed assets,
:
variable costs, profits and sales. The Break-Even Point (BEP) represents the level of sales at
which the operating income and operating costs are equal so that profit is zero.

Question 16. How do you calculate contribution margin?

Answer The difference between the selling price and the variable cost of a product or service. Both the
:
per-unit manufacturing and non-manufacturing variable costs are deducted from the selling
price to determine the contribution margin. In aggregate, contribution margin is the difference
between total sales and total variable costs.
Contribution Margin Ratio = Sales - Variable Costs / Sales

Question 17. What is break-even point for a company?

Answer The activity level that yields zero profit. It is the level at which there is neither profit nor loss.
:
Here the total revenue equals the total costs.

Question 18. How do you calculate absorption costing?

Answer A product costing method in which all costs of production, direct and indirect, fixed and
:
variable, are included in the cost of products. Also called full costing.

Question 19. What is budgeting process and its various forms?

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Answer: Budgeting is a complex process, which maybe divided into the following phases:
Identification of potential investment opportunities: The planning body develops estimates of
future sales, which serve as the basis for setting production targets. This information is in turn
helpful in identifying required investments in plant and equipments.
Assembling of Investment Proposals: Investment proposals are defined by production
department and other departments are usually submitted in a standardized capital investment
proposal form. Investment proposals are usually classified into various categories for
facilitating decision-making, budgeting and control.
Decision-Making: A system of rupee gateways usually characterizes capital investment
decision-making. Under this system executives are vested with the power to okay investment
proposals up to certain limits.
Preparation of Capital Budget and Appropriations: - Projects involving smaller outlays and
which can be decided by executives at lower levels are often covered by a blanket
appropriation for expeditious action. Projects involving larger outlays are included in the
capital budget after necessary approvals.
Implementation: Translating an investment proposal into concrete project is a complex, time-
consuming and risk fraught task. Delays in implementation, which are common, can lead to
substantial cost overruns.

Performance Review: This is a feedback device. It is a means of comparing actual

performance with projected performance. It may be conducted most appropriately when
operations of the project are stabilized.

Question 20. What do you understand by Zero-based Budgeting?

Answer A method of budget review and evaluation that requires all projects and programs, new and
:
old, to justify all resources. Each project starts the budget evaluation process without a
resource commitment even if it is an ongoing project. The main idea behind ZBB is to
challenge. The existence of every budgeting unit and every budget period.

Question 21. How a company can be benefited by Zero-Based Budgeting?

Answer There are plenty of reasons. Such as:
:
1. Results in efficient allocation of resources as it is based on needs and
benefits managers to find out cost effective ways to improve operations
11. Drives

m. Detects inflated budgets

IV. Useful for service department where the output is difficult to identify

v. Increases staff motivation by providing greater initiative and responsibility m decision-

making
VI. Increases communication and coordination within the organization

V11. Identifies and eliminates wastage and obsolete operations

Question 22. Can you define flexible budget?

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Answer A flexible budget is a budget, which by recognizing different cost behavior patterns, is
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designed to change as volume of output changes.

Question 23. Why is it important to calculate variance for a company?

Answer: Variances represent deviations of actual performance from standard performance. There can
be cost variances, profit variances and sales value variances. Variances can be favorable or
unfavorable depending upon their impact on the profits of the organization.

Question 24. In what way Activity Based Costing differs with the Traditional Methods of Costing?
Answer Activity Based Costing (ABC) captures costs and affects accounting practices which
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traditional costing fail to do so as explained below.

• Unlike traditional costing, ABC reveals the linkages amongst activities in different
departments

• The underlying principle of ABC is to trace the product cost whereas traditional by the
need to value stocks.

In ABC, costs are accumulated for each activity as a separate cost object while m traditional
costing costs is allocated based on various departments and functions.

Question 25. Why is activity-based costing, so important?

Answer Cost attribution to cost units on the basis of benefits received from indirect activities, i.e.
:
ordering, setting-up, assuring quality, etc. Activity-based costing (also called activity
accounting) emphasizes links between performance of particular activities and the demands
that those activities make on the organization's resources.

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CAPITAL STRUCTURE

Question 1. What kind of capital structure should a newly floated company adopt?
Answer: The capital structure of a newly floated company is dependent upon the management of the
company. However, before deciding an appropriate capital structure, a newly floated
company should bear in mind the rules and regulation regarding SEBI guidelines and norms
of the financial institutions. According to the guidelines issued by SEBI, a newly established
company with no previous track record can issue equity only at par unlike that of well
established companies who can issue their equity capital at premium to par value. According
to financial institutions normally the debt-equity norm for medium and large-scale projects is
1.5: 1.

Question 2. Tell us something about negative capital and its worth?

Answer: Upon any liquidation of partnership interest, the agreement requires partner having negative
working capital that the partner whose accumulated losses and drawing are more than his
capital contribution is required to pay to the partnership in cash the amount of any negative
balance in her capital account.

Question 3. What do you understand by cost of capital?

Answer: The minimum rate of return a firm must earn on its investment in order to satisfy the
expectations of investors who provide the funds to the firm. It is often measured as the
weighted arithmetic average of the cost of various sources of finance tapped by the firm.

Question 4. What is Weighted Average Cost of Capital (WACC)?

Answer: In the long run, the company wants a balanced capital structure (the right mix of debt and
equity) and for financing any investment project, it tries to maintain its capital structure intact.
Thus the correct measure in evaluating a project is the overall cost of capital. This is the
weighted average cost of capital from various sources. The weight is the proportion of each
source of funds in the capital structure. The average cost of capital will change if the capital
structure changes.

Question 5. What are agency costs?

Answer: Creditors insist on certain restrictions in the form of restrictive covenants in the contract and
they entail certain legal and enforcement costs. These costs impair the operating efficiency of
the firm. Such costs are called agency costs.

Question 6. What are bankruptcy costs?

Answer: In the real world, assets of a bankrupt firm cannot be sold at their economic value. But they
can be sold at a discount and the firm has to incur certain legal and administrative costs. This
entails significant costs in the form of sharply impaired operational efficiency. These are
called Bankruptcy costs. As the Debt equity ratio increases, the bankruptcy costs also
increase.

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Question 7. What is switching cost? Which industry has the lowest switching cost?
Answer: A barrier to entry is created by the presence of switching costs, that is, one-time costs facing
the buyer of switching from one supplier's product to another's. Switching cost may include
employee retraining costs, cost of new ancillary equipments, cost and time in testing and
quantifying a new source. If these switching costs are high then new entrant must offer a
major improvement in cost or performance in order for the buyer to switch from an
incumbent.

Question 8. If IRR were less than the cost of capital of capital what would you do?
Answer: While evaluating the feasibility of a project we compare the internal rate of return and cost of
capital. If IRR is less than the cost of capital, then the project is not viable and cannot be
accepted as the cost is less than the return, leading to loss in implementing the project.

Question 9. What is project finance?

Answer: The amount required to meet the cost of the project is called project finance. The means of
project finance are: Share Capital, Term Loans, and Debenture Capital.

Deferred Credit: Facility under which suppliers of plant and machinery offer to make the
payment over a period of time.

Incentive Sources: The aid given by goverment and its agencies like seed capital assistance,
capital subsidy and tax deferment or exemption.
Other Sources: These include public deposits, leasing and hire purchase.

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