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SURESH KUMAR SUTHAR 2 Roll No: 520776763 3 BCA 3rd Semester 4 BC0044 01

Accounting and Financial Management

1. Ans: Accounting concepts and conventions as used in accountancy are the rules and guidelines by that the accountant lives. All formal accounting statements should be created, preserved and presented according to the concepts and conventions that follow. The Entity Concept The Going concern Concept The Accruals or matching concept The Consistency Concept Prudence concept What are the basic accounting concepts? Explain their implications.

The Entity Concept Otherwise known as the 'accounting entity' concept. The idea here is that the financial transactions of one individual or a group of individuals must be kept separate from any unrelated financial transactions of those same individuals or group. The best example here concerns that of the sole trader or one man business: in this situation you may have the sole trader taking money by way of 'drawings': money for his own personal use. Despite it being his business and apparently his money, there are still two aspects to the transaction: the business is 'giving' money and the individual is 'receiving' money. So, the affairs of the individuals behind a business must be kept separate from the affairs of the business itself. Going concern This concept is the underlying assumption that any accountant makes when he prepares a set of accounts. That the business under consideration will remain in existence for the foreseeable future. In addition to being an old concept of accounting, it is now, for example, part of UK statute law: reference to it can be found in the Companies Act 1985. Without this concept, accounts would have to be drawn up on the 'winding up' basis. That is, on what the business is likely to be worth if it is sold piecemeal at the date of the accounts. The winding up value would almost certainly be different from the going concern value shown. Such circumstances as the state of the market and the availability of finance are
1 SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

important considerations here. Accruals Otherwise known as the matching principle. The purpose of this concept is to make sure that all revenues and costs are recorded in the appropriate statement at the appropriate time. Thus, when a profit statement is compiled, the cost of goods sold relevant to those sales should be recorded accurately and in full in that statement. Costs concerning a future period must be carried forward as a prepayment for that period and not charged in the current profit statement. For example, payments made in advance such as the prepayment of rent would be treated in this way. Similarly, expenses paid in arrears must, although paid after the period to that they relate, also be shown in the current period's profit statement: by means of an accruals adjustment. Consistency Because the methods employed in treating certain items within the accounting records may be varied from time to time, the concept of consistency has come to be applied more and more rigidly. For example, because there can be no single rate of depreciation chargeable on all fixed assets, every business has potentially a lot of discretion over the precise rate it chooses to use. However, if it wishes, a business may vary the rates at which it charges depreciation and alter the profits it reports at the same time. Consider the effects on profit of charging depreciation at 15% this year on 10,000 worth of fixed assets and then charging depreciation at 10% next year on the same 10,000 worth of fixed assets. This year you would charge 1,500 against profits and next year it would be only 1,000, using the straight line method of providing for depreciation. Because of these sorts of effects, it is now accepted practice that when a company chooses to treat items such as depreciation in a particular way in the accounts it should go on using that method year after year. If it is NECESSARY to change the method being employed or the rates being charged then an explanation of the change and the effects it is having on the results must be shown as a note to the accounts being presented. Prudence: Otherwise known as conservatism. It is this concept more than any other that has given rise to the idea that accountants are pessimistic boring people!! Basically the concept says that whenever there are alternative procedures or values, the accountant will choose the one that results in a lower profit, a lower asset value and a higher liability value. The concept is summarized by the well known phrase 'anticipate no profit and provide for all possible losses'. Thus, undue optimism can never be part of the make up of an accountant! The danger is that if an optimistic view of profits is given then dividends may be paid out of profits that have not been earned. Objectivity The objectivity concept requires an accountant to draw up any accounts, and further analysis, only on the basis of objective and factual information. Thus, this concept attempts to ensure that if, for example, 100 accountants were to draw up a set of accounts for one business, there would be 100 identical accounting statements prepared. Everyone would be obtaining and using only facts. The problem here is that there are many aspects of accounting ensuring that objectivity
1 SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

cannot be universally applicable in the preparation of accounts. For example, with fixed assets: the cost of a van must be known at its purchase: say 30,000. However, how long will this van be in service? I say five years, my colleague could say 10 years. If I prepare the accounts using the straight line method of depreciation calculation, I would provide 30,000 5 = 6,000 each year for depreciation; my colleague would charge 30,000 10 = 3,000 each year for depreciation; and both of us could be correct! The problem is that with an issue such as depreciation we are not always able to be objective. Cost This concept is based on the notion that only the costs paid to acquire an asset are relevant and thus should be the only costs to be shown in the accounts. For example, fixed assets are shown on the balance sheet at the price paid to acquire them; that is, their historic cost less depreciation written off to date. There is a problem in this area. That is the one of value. The accountant will rarely talk of value in this context since the use of such a term implies personal bias. After all, the value of an asset as far as I am concerned may be different to the value of the same asset as far as you may be concerned. The application of the cost concept ensures that subjective judgments play no part in the drawing up of accounting statements. Monetary Measurement The money measurement concept is one of the simpler concepts. It simply and clearly states that only those transactions that are true financial transactions may be accounted for. That is, only those transactions that may be expressed in money values (whatever the currency) are of interest to the accountant. Realisation The realisation concept helps the accountant to determine the point at that he feels that a transaction is certain enough for the profit to be made on it to be calculated and taken to the profit and loss account. Realisation occurs when a sale is made to a customer. The basic rule is that revenue is created at the moment a sale is made, and not when the account is later settled by cheque or by cash. Thus, profit can be taken to the profit and loss account on sales made, even though the money has not been collected. The sale is deemed to be made when the goods are delivered, and thus profit cannot be taken to the profit and loss account on orders received and not yet filled. An exception to this rule would be a long term contract that involve payments on account before completion of the work.

SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

2.

Is the agreement of trail balance a conclusive proof of the accuracy

of a book keeper? If not, what are the errors, which remain undetected by the trail balance? Ans: No. There certain errors which will disturb the Trial Balance in the sense that me Trial balance will not agree. Following are the errors: Error of Principle: An error committed because of lack of proper knowledge of accounting principle or concept. Error of Omission: Omission of recording a transaction the primary books. Error of Commission: Error of posting the amount in one account instead of another account. Compensation Error: One error compensates the other error by an identical amount. Trading Account: It shows the gross profit or loss earned or incurred by a business entity during an accounting period. Profit and Loss Account: It shows the net profit or loss earned or incurred by a business entity during an accounting period. Profit and Loss Appropriation Account: It shows the distribution of partnership profits among partners. Balance Sheet: It shows the position of assets and liabilities of a business entity as on a particular date. Suspense Account: It is an artificial account which appears n the Trial Balance to account for undetected errors. Once the errors are detected and rectified, the Suspense Account stands eliminated. Gross Profit: It is arrived at by deducting the direct cost of goods sold from sales proceeds. Net Profit: Ills the residual of gross profit after setting oft indirect expenses arid, of course, it includes other income. Errors and their Rectification These errors are easy to detect and their rectification is also srnp1e. For example, it the debit column total of the Trial 8alance exceeds the credit column total, the
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possibilities may be a 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 which 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 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 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, an error of commission has occurred. Finally, if the effect of one error is set off by another error, then it is a case of a compensating error. For example, if the Sales Account is under cast by Rs.10,000 and say, the salary account is also under cast by the same amount, these errors get cancelled and hence will not affect the Trial Balance.

SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

3. 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 31 st March 2008. Trail Balance as at 31st March 2008 Stock as on 1-4-2007 Purchases & Sales Returns Capital Drawings Land and Buildings Furniture & Fittings Sundry Debtors and Creditors Cash in Hand Investments Interest Commission Direct expenditure Postages, Stationery and Phones Fire Insurance Premium Salaries Bank Over Draft Additional Information : i) ii) iii) iv) v) Ans: Closing Stock is Valued at Rs. 65,000 Goods worth Rs.500 are reported to have been taken away Interest on Investments Rs.500is yet to be received Depreciation is to be provided on Land & Buildings @ 5% Make provision for Doubtful debts @ 5% Dr.(Rs.) Cr. (Rs.) 62500 90300 137200 2200 1300 30000 4500 30000 8000 25000 3500 10000 7500 2500 2000 11000 259000 40000 259000 45000 2500 3000

by the proprietor for his personal use at home during 07-08

and on Furniture & Fittings @10%

Trading A\c of Mr. Ram as on 31st March 2008 Dr Cr Date Particular Rs Amt Date Particular To Opening Stock 62500 By Sales To Purchase 90300 Less Returns Less Returns 1300 89000 By Closeing Stock
1 SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

Rs 137200 2200

Amt 135000 65000

To Gross Profit c\f Total

48500 200000

Total

200000

P&L A\c of Mr. Ram as on 31st March 2008 Dr Cr Date Particular Rs Amt Date Particular To Drawing (Personal Use) 500 By Gross Profit b/f To Direct Expenditure 7500 By Interest (+) Interest on To Postages, 2500 Investment Stationery and Phones By Commison To Fire Insurance Premium 2000 To Salaries 11000 To Deprication 2300 To RDD 1250 To Net Profit c\f Total 27450 54500

Rs 2500 500

Amt 48500 3000 3000

Total

54500

Balance sheet of Mr. Ram as on 31st March 2008 Liabilities Rs Amt Assets Capital 30000 30000 Land and Buildings Drawing 4500 (-) Dep (-) Goods Taken personal use 500 4000 Furniture & Fittings P&L A\c 27450 29250 (-) Dep Investment Creditors 45000 (+) Intrest on
1 SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

Rs 30000 1500 8000 800 10000 500

Amt 28500 7200 10500

Bank Over Draft

40000

Investment Stock Sundry debtors (-) Doubtful debts Cash In Hand

65000 25000 1250 23750 3500

Total

138450

Total

138450

4. Explain the factors affecting financial plans. Ans: Factors Affecting Financial Plan Nature of Industry: The nature of the industry in which the company is performing is a major factor which affects financial plans. A labour-intensive industry requires less capital than a capital-intensive industry.

SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

o Status of the company in the industry: The status of the company is a factor which has to be considered while drawing a financial plan. If the company is a wellrecognized and a reputed one, it will have no problems in raising finance at short notices. But on the other hand, if the company is a new entrant into the field, it will need time to establish itself and therefore raising money is slightly difficult, especially so if the company wants to go public. New firms may find it easier and better to take loans and function rather than going public. o Alternative Sources of finance: The Finance Manager will assess the alternative sources of funds and get the cheapest source of funds. He should also verify the conditions attached to the funds he procures, that are the contractual restrictions placed by the lenders. o Attitude of management towards control: If the management wants to have control over the firm, it may not go in for the equity form of finance for control vests with equity shareholders and it gets diluted with every new issue of equity shares. Such companies prefer to raise additional amounts by debenture issue or bond issue. o Extent of working capital requirements: The Finance Manager formulates his plan considering the short and long term financial needs of the firm. Short term funds required to finance working capital needs are to be procured through short term sources only. It is always a prudent policy to use short term avenues for short term requirements and long term needs can be funded by the issue of shares and debentures. o Capital structure: Capital of a firm has two components debt and equity. The proportion of these should be so decided that the company gets the advantage of leverage. Running the company with loans and debentures will certainly help equity share holders to get more income but the company is also functioning under a great risk. o Flexibility: This is one important factor that should be kept in mind while planning. The financial plan should be flexible enough to adjust to the needs of the changing conditions. There should be flexibility to raise the amount from any source and similarly the repayments may be done any time the company has excess funds. The firm should also have the flexibility of substituting one form of financing with another if the arises. o Government policy with regard to financial controls, statutory provisions and controls should be considered. The SEBI guideline should be strictly adhered to wherever applicable and necessary permissions from concerned authorities should be taken if necessary. 5. The investment, financing and dividend decisions are interlinked. Comment. Ans: Financial management, the part of finance that is the topic of our course, is a bit easier to characterize than is finance more generally. It consists of making value Maximizing decisions about capital. The productive resources of a corporation,
1 SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

Proprietorship, family, or other entity comprise its capital. The most essential of decisions regarding capital are how to obtain it and how to satisfy the claimholders from whom financing is obtained (financing decisions and value-disbursement decisions) and how to employ it (investment decisions and operating decisions). For a business organization, financial contracts such as stocks, Bonds, loans, and other securities are marketed to (ultimately) individuals. Banks and other financial in situations may serve as crucial intermediaries, because of their special expertise, information, or large pool of available funds. When a firm raises money via financial contracts, it has decided to use external financing. External financing is particularly important for growing firms whose business model is in the early stages of being implemented. Many dotcom firms are an extreme example. In contrast, most firms use internal financing most of the time. That is, they rely on cash produced in the course of doing business as the main source of funds to maintain and grow the business.2 The point of financing decisions is to generate the cash resources necessary to purchase the many types of assets needed to run the business. The funds raised pursuant to a firms financing decisions are invested in physical and human capital, i.e., productive assets, which are used to generate goods and services for sale to individuals. When we speak of the investment decision in managerial finance, we are referring to the decision to invest in either tangible long-lived real resources (plant, property, equipment, and the like) or intangible long-lived real resources (patents, trademarks, business relationships). This contrasts with an individuals investment decision which might be centered around financial assets such as stocks and bonds, which are claims on the benefits generated by productive assets, as opposed to the productive assets themselves. For a firm, the point of investment decisions is to choose assets that will generate cash revenue, and ultimately, new value. . Coincident with and subsequent to its investment decision, the firm must decide how to employ the productive assets it has obtained. Additionally, it must make ongoing decisions about how to obtain and use shorter-lived resources. The point of operating decisions is to use long-lived assets, and to obtain and use shorter-lived resources, to generate value. The firm that creates value will, at some point, need to pay it out to the parties who have financed it (and even to some parties who have not financed it, such as the government via taxes). Some disbursement decisions are essentially pre-determined at the time of a financing decision. An example of such a pre-determined disbursement decision is the decision to make interest payments on a loan. Other disbursement decisions are only loosely connected to the original financing decision. An example is the decision to pay dividends. The point of value-disbursement decisions may be to provide a stream of cash benefits that is uniquely attractive to the firms suppliers of financing, or to signal confidence in the firms ability to generate cash. Alternatively, the value-disbursement decision may be simply the residual effect of the other three major decisions. Once a firm has decided on financing, investing, and operating, the amount it can pay out to stockholders is completely determined t he firm simply pays out what is left over. Financing, investing, operating, and value-disbursement decisions are obviously interlinked. Most obviously, firms make investment decisions with operating decisions in mind. Similarly, firms make financing decisions with valuedisbursement decisions in mind. Additionally, the lines between these decision areas are a bit blurry in practice. In practical analysis, it is not

SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

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always useful to make fine distinctions. In our discussions, we will sometimes find it useful to focus on the investment/operating decision as a single unit.

SURESH KUMAR SUTHAR Roll No: 520776763 BC0044 01 ACCOUNTING AND FINANCIAL MANAGEMENT

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