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Master of Business Administration- MBA Semester 1

MB0041 – Financial Management & Accounting - 4 Credits

Assignment Set- 2 (60 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

1. Uncertainties inevitably surround many transactions. This should be recognized by

exercising prudence in preparing financial statement. Explain this concept with the

help of an example.

The last concept is about prudence or otherwise known as conservatism. It is the inclusion

of a degree of caution in the exercise of the judgments needed in making the estimates

required under conditions of uncertainty. Its purpose is to avoid the instances of 

overstatement of assets or income and understatement of liabilities or expenses. Although

the said practice does not allow the creation of hidden reserves or the exercise of 

provisions, the deliberate understatement of assets or income, nor the deliberate

overstatement of liabilities or expenses. Otherwise, it lacks the quality of reliability due

to the lack of neutrality of the financial statements. The preparers of financial statements

need to assume the presence of inevitable uncertainties that surround many events andcircumstances. Examples of which are the collectivity of doubtful receivables, the

probable useful life of plant and equipment, as well as the number of warranty claims that

may occur. Such uncertainties are recognized by the disclosure of their nature and extent,

as well as through the exercise of prudence in the preparation of financial statements.

The four different non-management stakeholder groups interested in the financial

statements of an enterprise are the institutional shareholders (investors or owners), the

debt holders (also known as bondholders), the government, and the employees.

The shareholders/debt holders are among the major recipients of the financial statements

of corporations. They range from individuals with relatively limited resources to large,

well-endowed institutions such as insurance companies and mutual funds. The decision

made by these parties includes shares to buy, retain, or sell, and the timing of the

purchase or sale of those shares. Typically, their decisions have a focus either on

investment or on stewardship, although in some cases, it is both. If the emphasis is on the

choice of a portfolio of securities that is consistent with the preferences of the investor

for risk, return, dividend yield, liquidity and so on, it is said to be investment focus.

Otherwise, it is stewardship focus. The required information for this choice varies

significantly.

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Consider approaches that intend to detect the improper pricing of securities by a

fundamental analysis approach compared to a technical analysis approach. The former

approach examines firm, industry and economy related information, where financial

statements play a major role. An important aspect is the prediction of the timing,

amounts, and uncertainties of the firm’s future cash flows. In contrast, it is through the

examination of the movement in security prices, security trading volume, and other

related variables that the technical analysis is able to detect the improper pricing of 

securities. Typically, financial statement information is not examined in this approach.

When predicting the timing, amounts, and uncertainties of the firm’s future cash flows,

the past record of management in relation to the resources under its control can be an

important variable. The analysis undertaken for decisions by shareholders and investors

can be done by those parties themselves or by intermediaries such as security analysts and

investment advisors. Employees, on the other hand, are motivated by numerous factors.They might have a vested interest in the continued profitability of their firm’s operations.

Therefore, financial statements for them serve as an important source of information

regarding the possible profitability and solvency of their company at present, as well as in

the future. They may also need them in monitoring the viability of their pension plans.

The demand of the government or regulatory agencies can arise in a diverse set of areas.

These include revenue raising (for income tax, sales tax, or value-added tax collection),

government contracting (for reimbursing suppliers paid on a cost-plus basis or for

monitoring whether the companies engaged in government business are earning excess

profits), rate determination (deciding the allowable rate of return that an electric utility

can earn), and regulatory intervention (determining whether to provide a government-

backed loan agreement to a financially distressed firm.

However, due to the diverse interest of the said individuals to the information contained

in the financial statements, conflicts may arise. For the shareholders/debt holders, the

interest of these parties lies in the fact that the money invested in the firm is their own

money. They would like to ensure that they are getting a good return on their investment.

This is measured by looking at how much profit the firm is making and whether their

investment is increasing in value. For shareholders in companies, this means they will get

good dividends and the market value of their shares will increase. They can also make

capital gains, in case these shares will be sold.

For the employees, they are part of the organization. As a part of the organization, they

also feel that their efforts contributed to the profitability of the firm. They would

therefore be delighted if they will be given incentives to their participation to the

company’s achievement. They might prefer to be given bonuses, salary increases, and

other form of monetary benefits. They might also prefer given stock options or

promotions, depending on the discretion of both parties. However, for the firm’s part, it

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means increases in the expenses of the firm.

For the government, various ministries and departments have different interest in the

firm’s ability to pay taxes. They also see and review the enactment of laws for the

industry and the provision of social services to the public. The government may also want

to ensure that the firm complies with laws on, for example, wage payments and employee

benefits. These are for their benefit, as well as the benefit of the society as a whole.

2. A. When is the change in accounting policy recommended and what are the

disclosure requirements regarding the change in accounting policy?Accounting policies are the specific principles, bases, conventions, rules and practices

applied by an entity in preparing and presenting financial statements. When a Standard or

an Interpretation specifically applies to a transaction, other event or condition, the

accounting policy or policies applied to that item shall be determined by applying the

Standard or Interpretation and considering any relevant Implementation Guidance issued

by the IASB for the Standard or Interpretation.

In the absence of a Standard or an Interpretation that specifically applies to a transaction,

other event or condition, management shall use its judgement in developing and applying

an accounting policy that results in information that is relevant and reliable. In making the

judgement management shall refer to, and consider the applicability of, the following

sources in descending order:

(a) the requirements and guidance in Standards and Interpretations dealing with similar

and related issues; and

(b) the definitions, recognition criteria and measurement concepts for assets, liabilities,

income and expenses in the Framework.

An entity shall select and apply its accounting policies consistently for similar

transactions, other events and conditions, unless a Standard or an Interpretation

specifically requires or permits categorisation of items for which different policies may be

appropriate. If a Standard or an Interpretation requires or permits such categorisation, an

appropriate accounting policy shall be selected and applied consistently to each category.

To ensure proper understanding of financial statements, it is necessary that all significant

accounting policies adopted in the preparation and presentation of financial statements

should be disclosed.

Such disclosure should form part of the financial statements. It would be helpful to the

reader of financial statements if they are all disclosed as such in one place instead of 

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being scattered over several statements, schedules and notes.

Examples of matters in respect of which disclosure of accounting policies adopted will be

required are contained in paragraph 14. This list of examples is not, however, intended to

be exhaustive.

Any change in an accounting policy which has amaterial effect should be disclosed. The

amount by which any item in the financial statements is affected by such change should

also be disclosed to the extent ascertainable. Where such amount is not ascertainable,

wholly or in part, the fact should be indicated. If a change is made in the accounting

policies which has no material effect on the financial statements for the current period

but which is reasonably expected to have a material effect in later periods, the fact of 

such change should be appropriately disclosed in the period in which the change is

adopted.

Disclosure of accounting policies or of changes therein cannot remedy a wrong orinappropriate treatment of the item in the accounts.

B. Explain IFRS.

International Financial Reporting Standards (IFRS) are Standards, Interpretations and the

Framework adopted by the International Accounting Standards Board (IASB).

Many of the standards forming part of IFRS are known by the older name of International

Accounting Standards (IAS). IAS were issued between 1973 and 2001 by the Board of the

International Accounting Standards Committee (IASC). On 1 April 2001, the new IASB took

over from the IASC the responsibility for setting International Accounting Standards.

During its first meeting the new Board adopted existing IAS and SICs. The IASB has

continued to develop standards calling the new standards IFRS.

IFRS are considered a "principles based" set of standards in that they establish broad rules

as well as dictating specific treatments.

International Financial Reporting Standards comprise:

International Financial Reporting Standards (IFRS) - standards issued after 2001

International Accounting Standards (IAS) - standards issued before 2001

Interpretations originated from the International Financial Reporting Interpretations

Committee (IFRIC) - issued after 2001

Standing Interpretations Committee (SIC) - issued before 2001

Framework for the Preparation and Presentation of Financial Statements

IAS 8 Par. 11

"In making the judgement described in paragraph 10, management shall refer to, and

consider the applicability of, the following sources in descending order:

(a) the requirements and guidance in Standards and Interpretations dealing with similar

and related issues; and

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(b) the definitions, recognition criteria and measurement concepts for assets, liabilities,

income and expenses in the Framework."

3. Journalise the following transactions:

01.01.09 Bought goods for Rs.10,000

02.01.09 Purchased goods from X Rs.20,000

03.01.09 Bought goods from Y for Rs.30,000 against a current dated cheque

04.01.09 Purchased goods from Z [price list price is Rs.30,000 and trade

discount is 10%]

05.01.09 Bought goods of the list price of Rs.1,25,000 from M less 20% trade

discount and 2% cash discount. Paid 40% of the amount by cheque

06.01.09 Returned 10% of the goods supplied by X

07.01.09 Returned 10% of the goods supplied by Y

Solution01.01.09 Purchases A/c. Dr 10,000.00

Cash / Bank A/c. Cr 10,000.00

02.01.09 Purchases A/c. Dr 20,000.00X’s A/c. Cr 20,000.00

03.01.09 Purchases A/c. Dr 30,000.00Bank A/c. Cr 30,000.00

04.01.09 Purchases A/c. Dr – Rs 30,000Z’s A/c. Cr 27000.00Trade Discount A/c. Cr 3000.00

05.01.09 Purchases Dr 1,25,000M’s A/c. 58,800Bank A/c. 39,200Trade Disc 25,000Cash Disc 2,000

06.01.09 X’s A/c. Dr 2,000Purchase Returns A/c. Dr 2,000

07.01.09 Y’s A/c. Dr 3,000Purchase Returns A/c. Dr 3,000

4. Bring out the difference between Funds Flow Statement and Cash Flow Statement.Mention up to what point in time they are similar and from where the differencesbegin.

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Cash Flow Statement : Statement showing changes in inflow & outflow of cash during theperiod.Methods of cash flow:1.Direct Method : presenting information in Statement of A. operating ActivitiesB. Investment ActivitiesC.Financial Activities2.Indirect Method :uses net income as base & make adjustments to that income(cash &non-cash)transactions.Funds Flow Statement :Statement showing the source & application of funds during theperiod.Major Difference:The Cash Flow Statement allows investors to understand how a company's operations arerunning, where its money is coming from, and how it is being spent.Fund Flow Statement is showing the fund for the future activites of the Company.

The main differences are as follows:

1. A cash flow statement is concerned only with the change in cash position while afund flow analysis/statement is concerned the change in working capital position

2. Cash is part of working capital and an improvement in cash position results inimprovement in funds position but the reverse is not true.

3. A cash flow statement is merely a record of cash receipts and disbursements. It doesnot reveal any important changes involving the utilization/disposition of resources. 

5. A. Determine the sales of a firm with the following financial dataCurrent Ratio 1.5

Acid test ratio 1.2

Current Liabilities 8,00,000

Inventory Turnover ratio 5 times

Sol.

Current Assetscurrent Ratio

Current Liabilities=

= 1.5800,000

Current Assets=

= 1.5 x 800,000 = C.A

Current Assets = 1,200,000

=Current Assets Stock 

 Acid Test RatioCurrent Liablities

−=

=1,200,000

1.2800,000

Stock −=

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= 1.2 x 800,000 = 1200, 000 – Stock

Stock = 240,000

Average Stock = 1,20,000

= Cost of Goods Sold Stock Turnover Ratio AverageStock 

=

=Sales-GrossProfit

51,20,000

=

Sales = 600,000

B. What is Du-Pont chart?DuPont Chart calculates the key components of any business for easy evaluation of performance.

Income Statement

Sales

OtherIncome

COGS

G&A

Depreciation

Other

Expense

GrossProfit

OperatingExpenses

Earningsbefore

interest& taxes(EBIT)

InterestPaid

Taxes

Net Profit

Sales

EBIT

TotalAssets

ProfitMargin

EBIT onAssets

Returnon Equity

Assets

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Cash

Receivables

Inventory

Other Assets

FixedAssets

CurrentAssets

CurrentLiabilities

Sales

Total

Assets

WorkingCapital

AssetsTurnover

Liabilities & Equity

Payables

NotesPayables

OtherLiability

CurrentLiabilities

Non-CurrentLiabilities

Capital

RetainedEarnings

TotalLiabilities

EndingNetWorth

Total

Beginning

Net Worth

Leverage

6. From the following data calculate the:1. Break-even point expressed in terms of sale amount/revenue2. Number of units that must be sold to earn a profit of Rs.60,000 per year

 

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Sales price (per unit) Rs.20

Variable manufacturing cost per unit Rs.11

Variable selling cost per unit Rs.3

Fixed factory overheads (per year) 5,40,000

Fixed selling cost (per year) 2,52,000

Sales Price = 20

- Variable Cost = 14Contribution  = 6

Contribution/

Sales P V  =

=6

/ 100 30%20

 P V  = × =

Fixed CostBreak EvenPoint =

/  P V Ratio

79,2000=30%

BEP = 2,640,000

Fixed Cost + Desired ProfitSales in Unit at Desired Profit =

/  P V Ratio

79,2000 + 60,000=

30%

2,84,0000=

20

= 1,42,000 Units