MB0041 Financial and Management Accounting

Master of Business Administration- MBA Semester 1 MB0041 Financial and Management Accounting (Book ID:B1130) Assignment Set- 1

Q 1.

The Balanced Score Card is a framework for integrating measures derived from strategy. Take an Indian company which has adopted balance score card successfully and explain how it had derived benefits out of this framework. The Balanced Score Card is a framework for integrating measures derived from strategy. Take an Indian company which has adopted balance score card successfully and explain how it had derived benefits out of this framework. The Balanced scorecard The Balanced Score Card is a framework for integrating measures derived from strategy. While retaining financial measures of past performance, the Balanced Score Card introduces the drivers of future financial performance. (Figure 1) The drivers (customer, internal business process, learning & growth perspectives) are derived from the organizations strategy translated into objectives and measures. The Balanced Score Card is more than a measurement system it can be used as an organizing framework for their management processes. The real power of the Balanced Score Card is when it is transformed from a measurement system to a management system. It fills the void that exists in most management systems the lack of a systematic process to implement and obtain feedback about strategy The Balanced scorecard The Balanced Score Card is a framework for integrating measures derived from strategy. While retaining financial measures of past performance, the Balanced Score Card introduces the drivers of future financial performance. (Figure 1) The drivers (customer, internal business process, learning & growth perspectives) are derived from the organizations strategy translated into objectives and measures. The Balanced Score Card is more than a measurement system it can be used as an organizing framework for their management processes. The real power of the Balanced Score Card is when it is transformed from a measurement system to a management system. It fills the void that exists in most management systems the lack of a systematic process to implement and obtain feedback about strategy

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MB0041 Financial and Management Accounting

MB0041 Financial and Management Accounting

Q 2.

What is DuPont analysis? Explain all the ratios involved in this analysis. Your answer should be supported with the chart. A method of performance measurement that was started by the DuPont Corporation in the 1920. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as DuPont identity.

Ans.

DuPont analysis tells us that ROE is affected by three things: 1. Operating efficiency, which is measured by profit margin 2. Asset use efficiency, which is measured by total asset turnover 3. Financial leverage, which is measured by the equity multiplier

ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)

Investopedia explains DuPont Analysis It is believed that measuring assets at gross book value removes the incentive to avoid investing in new assets. New asset avoidance can occur as financial accounting depreciation methods artificially produce lower ROEs in the initial years that an asset is placed into service. If ROE is unsatisfactory, the DuPont analysis helps locate the part of the business that is under performing. The DuPont System expresses the Return on Assets as: ROA = OPM * ATR The Operating Profit Margin Ratio is a measure of operating efficiency and the Asset Turnover Ratio is a measure of asset use efficiency. The DuPont System expresses the Return on Equity as: ROE = (ROA Interest Expense/Average Assets) * EM The Equity Multiplier is a form of leverage ratio and measures financial efficiency. Below figure shows the DuPont Analysis for a farm operation

MB0041 Financial and Management Accounting

Figure: DuPont Analysis for Farm Operations

DuPont Analysis for Two Farms Sr.No. 1 2 3 4 5 6 Operating profit margin ratio Asset turnover ROA (1*2) Interest expense to avg. farm assets Equity multiplier ROE (3-4) * 5 Farmer A Farmer B 0.30 0.20 0.060 0.05 2.00 0.02 0.12 0.36 0.043 0.03 1.50 0.02

Farmer A and Farmer B each have a 2 % ROE. The components of the ratios indicate that the sources of the weakness of the farms are different. Farmer A has a stronger profit margin ratio but lower asset turnover compared to Farmer B. Furthermore, Farmer A has a higher leverage ratio than Farmer B.
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MB0041 Financial and Management Accounting

The weak ratios for each farm may be decomposed into components to determine the potential sources of the weakness. To improve asset turnover Farmer A needs to increase production efficiency or price levels or reduce current or noncurrent assets. To improve profit margins, Farmer B needs to increase production efficiency or price levels more than costs or reduce costs more than revenue. The DuPont analysis is an excellent method to determine the strengths and weaknesses of a farm. A low or declining ROE is a signal that there may be a weakness. However, using the analysis you can better determine the source of weakness. Asset management, expense control, production efficiency or marketing could be potential sources of weakness within the farm. Expressing the individual components rather than interpreting ROE itself may identify these weaknesses more readily.

MB0041 Financial and Management Accounting

Q 3.

Accounting Principles are the rules based on which accounting takes place and these rules are universally accepted. Explain the principles of materiality and principles of full disclosure. Explain why these two principles are contradicting each other. Your answer should be substantiated with relevant examples. Principle of materiality : Accountants follow the materiality principle, which states that the requirements of any accounting principle may be ignored when there is no effect on the users of financial information. Certainly, tracking individual paper clips or pieces of paper is immaterial and excessively burdensome to any company's accounting department. Although there is no definitive measure of materiality, the accountant's judgment on such matters must be sound. Several thousand dollars may not be material to an entity such as General Motors, but that same figure is quite material to a small, familyowned business. While important details of financial status must be informed to all relevant parties, insignificant facts which do not influence any decisions of the investors or any interested group, need not be communicated. Such less significant facts are not regarded as material facts. What is material and what is not material depends upon the nature of information and the party to whom the information is provided. While income has to be shown for income tax purposes, the amount can be rounded off to the nearest ten and fraction does not matter. The statement of account sent to a debtor contains all the details regarding invoices raised, amount outstanding during a particular period. The information on debtors furnished to Registrar of Companies need not be in detail. Principle of Full Disclosure : Full disclosure means to disclose all the details of a security problem which are known. It is a philosophy of security management completely opposed to the idea of security through obscurity. The concept of full disclosure is controversial, but not new; it has been an issue for locksmiths since the 19th century. Full disclosure requires that full details of security vulnerability are disclosed to the public, including details of the vulnerability and how to detect and exploit it. The theory behind full disclosure is that releasing vulnerability information results in quicker fixes and better security. Fixes are produced faster because vendors and authors are forced to respond in order to save face. Security is improved because the window of exposure, the amount of time the vulnerability is open to attack, is reduced. The full disclosure principle states that any future event that may or will occur, and that will have a material economic impact on the financial position of the business, should be disclosed to probable and potential readers of the statements. Such disclosures are most frequently made by footnotes. For example, a hotel should report the building of a new wing, or the future acquisition of another property. A restaurant facing a lawsuit from a customer who was injured by tripping over a frayed carpet edge should disclose the contingency of the lawsuit. Similarly, if accounting practices of the current financial statements were changed and differ from those previously reported,
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MB0041 Financial and Management Accounting

the changes should be disclosed. Changes from one period to the next that affect current and future business operations should be reported if possible. Changes of this nature include changes made to the method used to determine depreciation expense or to the method of inventory valuation; such changes would increase or decrease the value of ending inventory, cost of sales, gross margin, and net income or loss. All changes disclosed should indicate the dollar effects such disclosures have on financial statements. The business enterprise should disclose relevant information to all the parties concerned with the organization. It means that any information of substance or of interest to the average investors will have to be disclosed in the financial statements. The Companies Act, 1956 requires that income statement and balance sheet of a company must give a fair and true view of the state of affairs of the company. If change has a material effect in current period and the effect of change is ascertainable the amount of change should be disclosed. If the change has a material effect in current period and the effect of change is not ascertainable wholly or in part, the fact should be disclosed. If change has no material effect in current period but which is reasonably accepted to have a material effect in later periods, the fact of such change should be appropriately disclosed.

MB0041 Financial and Management Accounting

Q 4.

Explain any two types of errors that are disclosed by trial balance with examples and rectification entry. Note - Avoid giving examples given in the self learning material. Types of Errors that are disclosed by trial balance: Accountants prepare trial balance to checks this correctness of accounts. If total of debits balances does not agree with the total of credit balances, it is a clear cut indication that certain errors have been committed while recording the transactions the books of original entry or subsidiary books. All errors of accounting procedure can be classified as errors of principle: -When a transaction is recorded again the fundamental principles of accounting, it is an error of principle. For Example if revenue expenditure is treated as capital expenditure or vice versa. Clerical Error: Errors of Omission when a transaction is either wholly or partially not recorded in the books, it is an error of omission. Error of Commission: When an entry is inco09rrctly recorded either wholly or partially incorrect posting, calculation, casting or balancing. Compensating errors: Sometimes an error is counter-balanced by another in such a way that is not disclosed by the trial balance. Correction of Errors in next accounting period: As stated earlier, that it is advisable to locate and rectify the error before preparing the final accounts for the year. But in certain cases when after considerable search, the accountant fails to locate the error and he is in a hurry to prepare the final accounts of the business for filing the return for sales tax or income tax purposes, he transfers the amount of difference of trial balance to a newly opened suspense Account In the next accounting period as and when the errors are located these are corrected with references to suspense account. When all the error are disclosed and rectified the suspense count shall be closed automatically. Those errors which do not affect the trial balance cant be corrected with the help of suspense account.

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For Example - It is found that debit total of trial balance was less by Rs. 500/- for the reason that Wilsons account was not debited with Rs. 500/- the following rectifying entry is required to be passed. From the point of view of rectification of the error, these can be
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MB0041 Financial and Management Accounting

divided into 2 groups: Error affecting one account only Errors affecting two or more accounts Errors affecting one account: -Casting error , error of posting, carry forward, balancing, Omission from Trial balance. Such errors should first of all be located and rectified. These are rectified either with the help of journal entry of by giving an explanatory note in the account concerned. Rectification: - All types of errors in accounts can be rectified at two stages: -1.Before preparation of the final accounts2.After Preparation of the final accounts Errors rectified within the accounting period. The Proper method of correction of an error is to pass journal entry in such a way that it corrects the mistake that has been committed also gives effect to the entry that should have been passed, But while errors are being rectified before the preparation of final accounting.

MB0041 Financial and Management Accounting

Q 5. Ans.

Distinguish between financial accounting and management accounting. The differences between management accounting and financial accounting include: 1. Management accounting provides information to people within an organization while financial accounting is mainly for those outside it, such as shareholders 2. Financial accounting is required by law while management accounting is not. Specific standards and formats may be required for statutory accounts such as International Financial Reporting Standards. 3. Financial accounting covers the entire organization while management accounting may be concerned with particular products or cost centres. Managerial accounting is used primarily by those within a company or organization. Reports can be generated for any period of time such as daily, weekly or monthly. Reports are considered to be "future looking" and have forecasting value to those within the company. Financial accounting is used primarily by those outside of a company or organization. Financial reports are usually created for a set period of time, such as a fiscal year or period. Financial reports are historically factual and have predictive value to those who wish to make financial decisions or investments in a company. Management Accounting is the branch of Accounting that deals primarily with confidential financial reports for the exclusive use of top management within an organization. These reports are prepared utilizing scientific and statistical methods to arrive at certain monetary values which are then used for decision making. Such reports may include: Sales Forecasting reports Budget analysis and comparative analysis Feasibility studies Merger and consolidation reports Financial Accounting, on the other hand, concentrates on the production of financial reports, including the basic reporting requirements of profitability, liquidity, solvency and stability. Reports of this nature can be accessed by internal and external users such as the shareholders, the banks and the creditors. Regulation and standardization While financial accountants follow Generally Accepted Accounting Principles set by professional bodies in each country, managerial accountants make use of procedures and processes that are not regulated by a standard-setting bodies. However, multinational companies prefer to employ managerial accountants who have passed the Certified Management Accountant certification. The CMA is an examination given by the Institute of Management Accountant, a professional organization of Accounting professionals. This certification is different. Time Period Managerial Accounting provides top management with reports that are futureoriented, while Financial Accounting provides reports based on historical information. There is no time span for producing managerial accounting statements but financial accounting statements are generally required to be produced for the period of 12 previous months. Other differences There is no legal requirement for an organization to use management accounting but publicly-traded firms (limited companies or whose shares are bought and sold on an open market) must, by law, prepare financial account statements.
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MB0041 Financial and Management Accounting

In management accounting systems there is no requirement for an independent external review but financial accounting annual statements must be audited by an independent CPA firm. In management accounting systems, management may be concerned about how reports will affect employees behaviour whereas management concerns are about the adequacy of disclosure in financial statements.

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MB0041 Financial and Management Accounting

Q 6.

XYZ Ltd provides the following information.

Sundry Debtors Cash in hand Cash at Bank Bills Receivable Inventory Bills Payables Outstanding expenses Sundry Creditors Bank Overdraft Short term Loans

January 1 65,000 13,000 15,000 16,000 90,000 12,000 6,000 30,000 30,000 32,000

December 31 1,05,000 20,000 20,000 30,000 84,000 8,000 5,000 58,000 42,000 36,000

Prepare a schedule of changes in working capital Hint: Net Working capital: Jan 1st 89000 and Dec31st 110000 Ans. Schedule of changes in working capital: Balance as on Details Current Assets Cash in hand Cash at Bank Sundry Debtors Bills Receivable Inventory Total Current Assets(A) Current Liabilities Sundry Creditors Bills Payables Outstanding expenses Bank overdraft Short term loans 30,000 12,000 6,000 30,000 32,000 58,000 12,000 6,000 42,000 36,000 1,49,000 1,10,000 4,000 1,000 28,000 12,000 4,000 13,000 15,000 65,000 16,000 90,000 1,99,000 20.000 20,000 1,05,000 30,000 84,000 2,59,000 7,000 5,000 40,000 14,000 6,000 Jan 1 Dec 31 Effect of WC Increase Decrease

Total Current Liabilities(B) 1,10,000 Working Capital (A)-(B) 89,000

21,000
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21,000

MB0041 Financial and Management Accounting

Net Increase in working capital(balancing figure) 1,10,000 1,10,000 71,000 71,000

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