management accounting - centum

UNIT - I

MANAGEMENT ACCOUNTING - INTRODUCTION

SECTION – A (2 MARKS)

1. What is Management Accounting?

It is the study of managerial aspects of Accounting. It is a tool to exercise decision

making. It provides information to the management to use it as a base for decision

making.

2. Define Management Accounting.

Management Accounting is the presentation of accounting information in such a

way as to assist management in the creation of policy and in the day today

operations of an undertaking – I.C.M.A

3. What are the duties of Management Accountant?

Collection of Information

Evaluation of Information

Interpretation of Information

Reporting of Information

4. What are the Functions of Management Accountant?

Planning for Control

Reporting

Evaluation of Various Policies and Programmes

Administration of Tax

Protection of Assets

SECTION – B (5 MARKS)

1. What are the Characteristics of Management Accounting?

Providing Financial information

Use of Special techniques and Concepts

Cause and Effect Analysis

Decision Making

Achievement of Objectives

Improving Efficiency

Forecasting

2. What are the tools and Techniques of Management Accounting?

Financial policy and Accounting

Analysis of Financial Statements

Historical Cost Accounting

Budgetary Control

Standard Costing

Marginal Costing

Management Information System.

3. What are the Merits of Management Accounting?

Increase in Efficiency

Effective Planning

Performance Evaluation

Profit Maximisation

Reliability

Elimination of Wastages

Effective Communication

Employee Morale

Control and Co-ordination

4. What are the limitations of Management Accounting?

Dependence for basic records

Personal Bias

Only a Tool

Provided only Data

Resistance to Change

Costly to Install

5. What are the steps involved in Installation of Management Accounting System?

Organisation Manual

Preparation of Various forms and Reports

Requisite Staffing

Classification of Accounts

Setting up Cost Centres

Introducing Accounting techniques

Providing the usage of OR Techniques

SECTION – C (10 MARKS)

1. Explain the Scope of Management Accounting

Financial Accounting

Cost Accounting

Budgeting and Forecasting

Inventory Control

Statistical Analysis

Analysis of Data

Internal Audit

Tax Accounting

2. Explain the Objectives and Functions of Management Accounting.

Presentation of Data

Aid of Planning and Forecasting

Help in organizing

Decision Making

Effective Control

Communication of Management Policies

Effective Control

Incorporation of Non – Financial information

Co-ordination

Motivating Employees

3. Distinction between Financial Accounting and Management Accounting.

Financial Accounting Management Accounting

Concerned with External Reporting Concerned with Internal Reporting

Records the Past and Present Concerned with future plans and Operations

Historical and Objective Management Accounting is Subjective

Analyses the data of the business as a whole Evaluates Performance of different

Departments, Divisions

Financial Accounts are prepared as per the

guidelines laid down by Companies Act and

IT Act

The Management Accountant has flexibility

in following different standards set by the

management.

Reports are prepared periodically Reports are prepared as and when required

Records the Transactions as per established

Conventions and Principles

Management Accounting does not have any

set of rigid principles

4. Distinction between Cost Accounting and Management Accounting.

Cost Accounting Management Accounting

Purpose is to ascertain and control Cost of

Product and Services

Purpose is to provide information to

Management for performing the functions of

planning, directing and controlling.

Accounting is based on Historical and Present

data.

Deals with future projections on the basis of

historical and present cost data

Established procedures and practices are

followed

No such practices and Procedures

Uses Quantitative Information Uses both Qualitative and Quantitative

Information

It is mainly concerned with Cost

Ascertainment and Control

Includes Financial Accounting, Cost

Accounting, Budgeting, Tax Planning and

Reporting to Management

UNIT - II

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS


1. What are Financial Statements?

Financial Statements refer to formal and original statements prepared by a

business concern to disclose its financial information. Financial Statements are

prepared for the purpose of presenting a periodical review or report on the

progress by the management and deal with:

i. Status of Investments in the business

ii. Results achieved during the period under review.

2. What are the types of Analysis of Financial Statements?

Types of Analysis

On the basis of Information used

External Analysis

Internal Analysis

On the basis of modus operandi used

Horizontal Analysis

Vertical Analysis

3. What are the Techniques and Tools of Financial Statement Analysis?

Ratio Analysis

Cash Flow Analysis

Funds Flow Analysis

Comparative Financial Statements

Common Size Financial Statements

Net Working Capital Analysis

Trend Analysis.

4. How do you show the following items in a Comparative Income Statement?

Particulars 31 – 03 – 2009 31 – 03 – 2010

Sales 1000000 1200000

Cost of Sales 800000 1050000

Solution

COMPARATIVE INCOME STATEMENT

Particulars 31 – 03 – 09 31 – 03 – 10 Increase (+) / Decrease (-)

Rs. %

Sales 1000000 1200000 + 200000 +20

Less: Cost of Sales 800000 1050000 +250000 +31.25

Gross Profit 200000 150000 -50000 -25

5. How do you show the following items in a Common Size Income Statement?

Particulars 31 – 03 – 2009 31 – 03 – 2010

Sales 1000000 1600000

Less: Cost of Sales 800000 1200000

Gross Profit 200000 400000

Solution

COMMON SIZE INCOME STATEMENT

Particulars 31 – 03 – 2009 31 – 03 – 2010

Rs. % Rs. %

Sales 1000000 100 1600000 100

Less : Cost of Sales 800000 80 1200000 75

Gross Profit 200000 20 400000 25

6. How do you show the following items in a Common Size Balance Sheet?

Particulars 31 – 03 – 2009 31 – 03 – 2010

Total of Balance Sheet 2000000 2400000

Fixed Assets 800000 1200000

Inventories 400000 600000

Solution

COMMON SIZE BALANCE SHEET

Particulars 31 – 03 – 2009 31 – 03 – 2010

Rs. % Rs. %

Total of Balance Sheet 2000000 100 2400000 100

Fixed Assets 800000 40 1200000 50

Inventories 400000 20 600000 25

7. How do you deal with the following items in a Comparative Balance Sheet?

Particulars 31 – 03 – 2009 31 – 03 – 2010

Fixed Assets 4000000 5000000

Current Assets 1000000 900000

Share Capital 500000 600000

Solution

COMPARATIVE BALANCE SHEET


Rs. %

Fixed Assets 4000000 5000000 +1000000 +25

Current Assets 1000000 900000 -100000 -10

Share Capital 500000 600000 +100000 +20

8. Calculate Trend Percentages for the following taking the year 2004 as Base Year:

Particulars 2004 2005 2006 2007 2008

Sales 500000 600000 650000 700000 800000

Cost of Sales 400000 440000 500000 520000 560000

Solution

Trend Percentages (2004 as Base Year)

Rs. % ( Base Year 2004)

Particulars 2004 2005 2006 2007 2008 2004 2005 2006 2007 2008

Sales 500000 600000 650000 700000 800000 100 120 130 200 160

Cost of Sales 400000 440000 500000 520000 560000 100 110 125 130 140

9. Explain the Nature of Financial Statements.

Based on recorded facts

Accounting Conventions and Principles

Postulates

Personal Judgements

10. What are the functions / Importance of Financial Statements?

For the Management: To take effective decisions

To fulfill the functions of operation and control

For the Financiers: Customer’s Financial Position, Solvency

Customer’s Credit Standing and Profitability

For the Creditors Extension of Trade Credit

For the Investors Earning Capacity

Growth Potential

Efficiency of Management


1. Following is the Profit & Loss A/c of Shekar Fibres Limited for the year ended

31.03.2009 & 31.03.2010. You are required to prepare a Common Size Income

Statement:

Profit & Loss Account

Particulars 31.03.2009 31.03.2010 Particulars 31.03.2009 31.03.2010

To Cost of Goods Sold 300 375 By Net Sales 400 500

To Operating Expenses

Administrative 10 10

Selling 15 20

To Profit 75 95

400 500 400 500

Solution:

COMMON SIZE INCOME STATEMENT

Particulars 31 – 03 – 2009 31 – 03 – 2010

Rs. % Rs. %

Sales 400 100 500 100


Gross Profit 100 25 125 25

Less : Operating Expenses

Administration 10 2.5 10 2

Selling 15 3.75 20 4

Total 25 6.25 30 6

Operating Profit 75 18.75 95 19

Add: Non – Operating Income - - - -

75 18.75 95 19

Less : Non Operating Expenses - - - -

Net Profit 75 18.75 95 19

2. From the following information, show the results of operations of a

manufacturing concern using Trend Percentages with 1987 as Base Year:

Amount in Thousands (Rs.)

Particulars 1990 1989 1988 1987

Sales 1300 1200 950 1000

Cost of Goods Sold 728 696 589 600

Gross Profit 572 504 361 400

Selling Expenses 120 110 97 100

Net operating Profit 452 394 264 300

Solution

TREND PERCENTAGES FOR INCOME STATEMENT (1987 AS BASE YEAR)

Amount in Thousands (Rs.) Trend Percentage ( Base Year 1987)

Particulars 1990 1989 1988 1987 1987 1988 1989 1990

Sales 1300 1200 950 1000 100 95 120 130

Cost of Goods Sold 728 696 589 600 100 98 116 121

Gross Profit 572 504 361 400 100 90 126 143

Selling Expenses 120 110 97 100 100 97 110 120

Net operating Profit 452 394 264 300 100 88 131 151

3. From the following details below, prepare a Common Size Income Statement of

Lively Limited:

Particulars Year Ending 31.03.2009 Year Ending 31.03.2010

Sales 200000 500000

Cost of Sales 100000 220000

Operating Expenses 20000 30000

Non – Operating Expenses 30000 35000

Solution

Common Size Income Statement of Lively Limited:

Particulars 31 – 03 – 2009 31 – 03 – 2010

Rs. % Rs. %

Sales 200000 100 500000 100


Gross Profit 100000 50 280000 56

Less : Operating Expenses 20000 10 30000 6

Operating Profit 80000 40 250000 50

Add: Non – Operating Income - - - -

80000 40 250000 50

Less : Non Operating Expenses 30000 15 35000 7

Net Profit 50000 25 215000 43

4. From the following data, you are required to calculate Trend Percentages taking

2007 as Base Year:

Rs. in Thousands

Particulars 2007 2008 2009 2010

Cash 100 120 80 140

Debtors 200 250 325 400

Stock 300 400 350 500

Other Current Assets 50 75 125 150

Land 400 500 500 500

Buildings 800 1000 1200 1500

Plant 1000 1000 1200 1500

Total 2850 3345 3780 4690

Solution:

TREND PERCENTAGES (BASE YEAR 2007)

Particulars Rs. in Thousands Trend Percentage ( Base Year 2007)

2007 2008 2009 2010 2007 2008 2009 2010

Cash 100 120 80 140 100 120 80 140

Debtors 200 250 325 400 100 125 162.5 200

Stock 300 400 350 500 100 133 117 167

Other Current Assets 50 75 125 150 100 150 250 300

Total (A) 650 845 880 1190 100 130 136 183

Land 400 500 500 500 100 125 125 125

Buildings 800 1000 1200 1500 100 125 150 187.5

Plant 1000 1000 1200 1500 100 100 120 150

Total (B) 2200 2500 2900 3500 100 114 132 159

Total 2850 3345 3780 4690 100 117 133 165

5. What are the Limitations of Financial Statements?

Information shown in Financial Statements is not precise since it is based

on conventions and rules developed there from

Financial Statements are influenced by personal opinions, Judgements and

subjective views and whims of accountants.

Financial Statements are dumb because they cannot speak themselves.

Balance Sheet of a Concern is a static document as it discloses the

financial position of a concern on a particular date.

Financial Statements of one period may not be comparable with that of

statements of other periods due to differences in conditions and changes in

economic situation.

6. What are the Objectives of Analysis and Interpretation of Financial Statements?

i. To interpret the profitability and efficiency of various business

activities.

ii. To measure the managerial efficiency of the firm.

iii. To measure short term and long term solvency of the business.

iv. To ascertain earning capacity in future period.

v. To determine future potential of the concern.

vi. To measure utilisation of various Assets

vii. To compare operational efficiency of similar concerns engaged in

the same industry.

7. What are the Limitations of Financial Statement Analysis?

i. Nature of Financial Statements is historical.

ii. Results of Analysis cannot be considered as Judgements or

Conclusion.

iii. If Financial Statements are manipulated by Window Dressing,

analysis based on those figures will be mis leading or meaning

less.

iv. Results of Analysis may be interpreted differently by different

users.

v. Frequent changes in Accounting Policies and Methods makes the

statements incomparable.

vi. Rising Inflation erodes the value of money in the present day

economic situation, which reduces the validity of Analysis.


1. Explain are the Techniques and Tools of Financial Statement Analysis?

Ratio Analysis

An Analysis of Financial statements based on ratios is known as Ratio Analysis

A Ratio is a mathematical relationship between two or more items taken from

financial statements. Ratio Analysis is the process of computing, determining and

presenting the relationship of items. It is helpful to management and outsiders to

diagnose the financial health of a business concern. It helps in measuring the

Profitability, Solvency and Activity of a firm.

Cash Flow Analysis

Cash Flow Analysis depicts the Inflow and Outflow of Cash. Cash Flow

Statement is the devise for such Analysis. It highlights causes which bring

changes in Cash position between two Balance Sheet dates.

Funds Flow Analysis

Funds Flow Statement signifies Sources and Applications of Funds. The term

Funds refers to Working Capital. Funds Flow Analysis shows Internal and

External sources of Working Capital and the way funds have been used. Funds

Flow Analysis is helpful in judging credit worthiness, financial planning and

budget preparation.

Comparative Financial Statements

These Statements summarise and present related data for a number of years.

These Statements normally comprise Comparative Profit & Loss Account and

Comparative Balance Sheet, Comparative statements of change in Total capital as

well as Working capital. These statements helps in making inter – period and inter

– firm comparison and also highlight the trends in performance efficiency and

financial position.

Common Size Statements:

Common Size Statements indicate the relationship of various items with some

common items (expressed as a percentage of Common item). In the income

statements, sales figure is taken as basis and all other figures are expressed as a

percentage of sales. Similarly in the Balance Sheet, total assets and liabilities is

taken as base and all other figures are expressed as percentage of this total.

Net Working Capital Analysis

Schedule of Changes in Working Capital is prepared to disclose net changes in

working capitals on two specific dates (Generally Two Balance Sheet Dates). It is

prepared from Current Assets and Current Liabilities on the specified dates to

show net increase or decrease in working capital.

Trend Analysis:

Trend signifies a tendency and as such the review and appraisal of tendency in

accounting variables are nothing but trend analysis. Trend Analysis is carried out

by calculating Trend Ratios and / or by plotting the accounting data on graph

paper or chart. Trend Analysis is significant for forecasting and budgeting.

2. From the following Balance Sheets of X Limited , You are required to prepare

a Common Size Balance Sheet

BALANCE SHEET AS ON 31 ST DECEMBER

Liabilities 2009 2010 Assets 2009 2010

Equity Capital 300000 1200000 Land & Buildings 100000 450000

Liability for Expenses 9000 17000 Plant & Machinery 300000 750000

Retained Earnings 50000 33000 Stock 60000 217000

Sundry Creditors 91000 100000 Debtors 115000 160000

Debentures 150000 250000 Cash 10000 5000

Bills Receivable 10000 15000

Prepaid Expenses 5000 3000

Total 600000 1600000 Total 600000 1600000

SolutionCOMMON SIZE BALANCE SHEET OF X LIMITED FOR THE YEARS 2009 AND 2010

Assets 2009 2010

Rs. % Rs. %

FIXED ASSETS

Land & Buildings 100000 16.67 450000 28.13

Plant & Machinery 300000 50.00 750000 46.87

TOTAL (A) 400000 66.67 1200000 75.00

CURRENT ASSETS

Stock 60000 10.00 217000 13.56

Debtors 115000 19.17 160000 10.00

Cash 10000 1.67 5000 0.31

Bills Receivable 10000 1.67 15000 0.94

Prepaid Expenses 5000 0.83 3000 0.19

TOTAL(B) 200000 33.33 400000 25.00

TOTAL (A + B) 600000 100.00 1600000 100.00

LIABILITIES AND CAPITAL

Current Liabilities

Liability for Expenses 9000 1.50 17000 1.06

Sundry Creditors 91000 15.17 100000 6.25

TOTAL (A) 100000 16.67 117000 7.31

Long Term Liabilities

Debentures 150000 25 250000 15.63

TOTAL (B) 150000 25 250000 15.63

TOTAL LIABILITIES (A + B = C) 250000 41.67 367000 22.94

CAPITAL AND RESERVES

Equity Capital 300000 50 1200000 75

Retained Earnings 50000 8.33 33000 2.06

TOTAL (D) 350000 58.33 1233000 77.06

TOTAL LIABILITIES AND CAPITAL 600000 100.00 1600000 100.00

3. Prepare a Comparative Income Statement of Vinayaka Travels Limited for the

Years ending 31st March 2006 and 31st March 2007 from the following:

Particulars 31 – 03 – 2006 31 – 03 – 2007

Purchases less Returns 80000 150000

Other Direct Expenses 20000 50000

Sales 180000 260000

Office Expenses 20000 25000

Selling Expenses 10000 15000

Finance Expenses 10000 8000

Profit 40000 12000

Solution

COMPARATIVE INCOME STATEMENT


Rs. %

Sales (A) 180000 260000 +80000 +44.44

Less: Cost of Sales

Purchases less returns 80000 150000 +70000 +87.5

Other Direct Expenses 20000 50000 +30000 +150

Total (B) 100000 200000 +100000 +100

Gross Profit (C) = (A) – (B) 80000 60000 -20000 -25

Administration Expenses

Office Expenses 20000 25000 +5000 +25

Selling Expenses 10000 15000 +5000 +50

Total (D) 30000 40000 +10000 +33.33

Operating Profit (E) = (C) – (D) 50000 20000 -30000 -60

Less : Non Operating Expenses

Finance Expenses 10000 8000 -2000 -20

Total (F) 10000 8000 -2000 -20

Net Profit (E) – (F) 40000 12000 28000 -70

4. From the following Balance Sheets of X Limited , You are required to prepare

a Comparative Balance Sheet




6% Preference Capital 300 300 Plant & Machinery 400 410

Reserves 200 245 Stock 200 300

8% debentures 100 150 Debtors 200 300

Bills Payable 50 75 Cash 100 140

Sundry Creditors 250 350

Total 1300 1520 Total 1300 1520

Solution

COMPARATIVE BALANCE SHEET OF X LIMITED

Particulars 2009 2010 Increase (+) / Decrease (-)

ASSETS Rs. %

FIXED ASSETS

Land & Buildings 400 370 -30 -7.5

Plant & Machinery 400 410 +10 +2.5

TOTAL (A) 800 780 -20 -2.5

CURRENT ASSETS

Stock 200 300 +100 +50

Debtors 200 300 +100 +50

Cash 100 140 +40 +40

TOTAL(B) 500 740 +240 +48

TOTAL (A + B) 1300 1520 +220 +16.92

LIABILITIES AND CAPITAL

Current Liabilities

Bills Payable 50 75 +25 +50

Sundry Creditors 250 350 +100 +40

TOTAL (A) 300 425 125 +41.67

Long Term Liabilities

8% Debentures 100 150 +50 +50

TOTAL (B) 100 150 +50 +50

TOTAL LIABILITIES (A + B = C) 400 575 +175 +43.75

CAPITAL AND RESERVES

Equity Capital 400 400 - -

6% Preference Share Capital 300 300 - -

Reserves 200 245 +45 +22.5

TOTAL (D) 900 945 +45 +5

TOTAL LIABILITIES AND CAPITAL 1300 1520 +220 16.92

UNIT - III

RATIO ANALYSIS


1. What is Ratio Analysis?

A ratio is mathematical relationship between two items expressed in

Quantitative form. It is the process of determining and presenting the

relationship of items and groups of items in the Financial Statements.

Ratios may be expressed in Proportion, Times or Percentages.

2. What are the advantages of Ratio Analysis?

Forecasting

Managerial Control

Facilitates Communication

Measuring Efficiency

Facilitating Investment Decisions

Useful in Measuring Financial Solvency

Inter firm Comparisons

3. What are the Limitations of Ratio Analysis?

Ratios are means and not an end.

Practical Knowledge required for Analyst.

Non – Availability of Standards or Norms

Extent of Accuracy of Financial Information

Consistency in preparation of Financial Statements

Time Lag and Change in Price Level.

4. How do you Classify Ratios by Function?

Profitability Ratios Turnover Ratios Solvency Ratios

Gross Profit Ratio Stock Turnover Proprietary Ratio

Net Profit Ratio Debtors Turnover Debt – Equity Ratio

Operating Ratio Creditors Turnover Fixed Assets Ratio

Operating Profit Ratio Working Capital Turnover Capital Gearing Ratio

Current Ratio

Liquid Ratio

Cash Position Ratio


1. Compute (a) Pay out ratio and (b) Retained Earnings ratio from the following

data.

Rs.

Net Profit 10000

Provision for Tax 5000

Preference Dividend 2000

No. of Equity Shares 3000

Dividend per Equity Share Re. 0.40

Solution:

Net Profit 10000

Less: Provision for Tax 5000

-------

Net profit after Tax 5000


-------

Net profit after Tax and Dividend 3000

-------

Earnings per Share = Net Profit after Tax & Dividend

---------------------------------------

No. of Equity Shares

= 3000 / 3000 = Re.1.00

Pay Out ratio = Dividend per Equity Share / Earnings per Share x 100

= 0.40 / 1 x 100

= 40%

Retained Earnings Ratio = 1 – Pay Out Ratio

= 1 – 40%

= 60%

2. Calculate Stock Turnover Ratio from the following Trading Account:

Trading Account

Particulars Rs. Particulars Rs.

To Opening Stock 40000 By Sales 200000

To Purchases 100000 By Closing Stock 20000

To Freight 10000

To Gross Profit 70000

220000 220000

Solution:

Cost of Goods Sold = Sales – Gross Profit

= 200000 – 70000

= 130000

Average Stock = (Opening stock + Closing Stock)

---------------------------------------

2

= (40000 + 20000) / 2

= 30000

Stock Turnover Ratio = Cost of Goods sold

-----------------------

Average Stock

= 130000 / 30000

= 4.33 Times

3. Kuberan & Co. makes both cash and credit sales. From the following information,

Calculate Average Collection Period:

Particulars Rs.

Total Sales 200000

Cash Sales 40000

Sales Returns 14000

Debtors (31-12-2010) 18000

Creditors ( 31-12-2010) 20000

Provision for bad debts (31-12-2010) 2000

Bills Receivable ( 31-12-2010) 4000

Net Credit Sales = Total Sales – Cash Sales – Sales Returns

= 200000 – 40000 – 14000

= 146000

Accounts Receivable = Bills receivable + Debtors

= 18000 + 4000

= 22000

Debtors Turnover = Net Credit Sales / Accounts Receivable

= 146000 / 22000

= 6.636 Times

Average Collection Period = No of Days in a Year / Debtors Turnover

= 365 / 6.636

= 55 days

4. From the following figures calculate the Creditors turnover ratio and the average

age of Accounts Payable:

Particulars Rs.

Credit Purchases during 2010 100000

Creditors on 1-1-2010 20000

Creditors on 31-12-2010 10000

Bills payable on 1-1-2010 4000

Bills payable on 31-12-2010 6000

Solution:

Average Creditors = (Opening Creditors + Closing Creditors) / 2

= (20000 + 10000) / 2

= 15000

Average Bills Payable = (4000 + 6000) / 2

= 5000

Average Accounts Payable = Average Creditors + Average Bills Payable

= 15000 + 5000

Creditors Turnover Ratio = Credit Purchases / Average Accounts Payable

= 100000 / 20000

= 5 Times

Average Age of Accounts Payable = No of days in a Year / Creditors Turnover

= 365 / 5

= 73 Days


1. From the Following Balance Sheet, Calculate

(a) Current Ratio.

(b) Liquid Ratio.

(c) Debt Equity Ratio.

(d) Proprietary Ratio.

Balance Sheet

Rs. Rs.

Share Capital 500000 Fixed Assets 1400000

Reserves 300000 Stock 500000

6% Debentures 1100000 Debtors 200000

Bank Overdraft 100000 Cash 100000

Creditors 200000

2200000 2200000

Solution:

(a) Current Ratio = Current Assets

-------------------

Current Liabilities

Current Assets =Stock + Debtors + Cash

= 500000+200000+100000

= 800000

Current Liabilities =Bank Overdraft + Creditors

= 100000 + 200000

= 300000

Current Ratio = 800000/300000

= 2.67: 1

(b) Liquid Ratio = Liquid Assets

---------------

Current Liabilities

Liquid Assets = Current Assets – Stock

= 800000 – 500000

= 300000

Liquid Ratio = 300000/300000

= 1:1

(c) Debt Equity Ratio = Total long-term debt

----------------------------

Shareholders funds

Shareholders funds = Share Capital + Reserves + Profit

= 500000+ 300000

= 800000

Total long-term debt = Debentures

= 1100000

Shareholders funds = 1100000

---------------

800000

= 1.375: 1

(d) Proprietary Ratio = Share holder’s funds

------------------

Tangible assets

= 800000

-------------

2200000

= 0.36: 1

2. Calculate Profitability Ratios:

Rs.

Sales 1000000

Gross Profit 300000

Administration expenses 10000

Selling expenses 20000

Loss on sale of plant 2000

Dividend received 4000

Depreciation 6000

Net Profit 266000

Solution:

Gross Profit Ratio = Gross Profit / Sales x 100

= 300000 / 1000000 x 100

= 30%

Net Profit Ratio = Net Profit / Sales x 100

= 266000 / 1000000 x 100

= 26.60%

Operating Ratio = (Cost of Goods Sold + Operating Expenses) / Sales x 100

= (700000 + 36000) / 1000000 x 100

= 736000 / 1000000 x 100

= 73.60 %

Operating Profit Ratio= Operating Profit / Sales x 100

= 264000 / 1000000 x 100

= 26.40 %

Working Notes

Cost of Goods Sold =Sales – Gross Profit

Operating Expenses = Administration Exp.+ Selling Exp. + Depreciation

Operating Profit = Gross Profit – Operating Expenses

3. Following are the details relating to the trading activities of A Ltd.

Stock Velocity - 8 months

Debtor’s Velocity - 3 months

Creditor’s Velocity - 2 months

Gross Profit Ratio - 25%

Gross profit for the year Rs.400000; Bills receivable Rs.25000 and Bills payable

Rs.10000. Closing Stock of the year is Rs.10000 more than the opening stock. Find out.

(a) Sales (b) Debtors (c) Closing Stock and (d) Creditors

Solution:

Gross Profit Ratio = Gross Profit

--------------- x 100

. Sales

25 = 400000

---------- x 100

Sales

Sales = 400000 x 100

-----------------

25

Sales = 1600000


= 1600000 – 400000

= 1200000

Stock Turnover Ratio = Cost of Goods Sold

------------------------

Average Stock

1200000

----------------- = 1.5 times

Average Stock

Average Stock = 1200000

------------

1.5

= 800000

Let Opening Stock = Rs. X

Closing Stock = Rs. X + 10000

Average Stock = Opening Stock + Closing Stock

----------------------------------------

2

= X + X + 10000

----------------------

2

800000 = 2X + 10000

------------------

2

1600000 = 2X + 10000

2X = 1590000

X = 1590000

-----------

2

X = 795000

Opening Stock (x) = 795000

Closing Stock = X + 10000

= 795000 + 10000

Closing Stock = Rs.805000

Debtors Turnover Ratio = Net Credit Sales

-------------------

Accounts Receivable

4 times (12/3) = 1600000

-----------------------------

Accounts Receivable

Accounts Receivable = 1600000

-----------

4

= 400000

Accounts Receivable = Bills Receivable + Debtors

400000 = 25000 + Debtors

Debtors = 400000 – 25000

Debtors = 375000

Creditors Turnover = Net Credit Purchase

-------------------------

Accounts Payable

Net Credit Purchases = Cost of Goods sold + Closing Stock–Opening Stock

= 1200000 + 805000 – 795000

= 1210000

6 Times (12/2) = 1210000

-------------------

Accounts Payable

Accounts Payable = 1210000 / 6

= 201667.

Accounts Payable = Bills Payable + Creditors

201667 = 10000 + Creditors

Creditors = 201667 – 10000

Creditors = 191667.

4. From the following details prepare statement of proprietary funds with as many

details as possible.

(i) Stock Velocity = 6

(ii) Capital Turnover Ratio = 2

(iii) Fixed Assets Turnover Ratio = 4

(iv) Gross Profit Turnover Ratio = 20 per cent

(v) Debtors Velocity = 2 months

(vi) Creditors Velocity = 73 days

The Gross Profit was Rs.60,000. Reserves and surplus amount to Rs.20,000. Closing

Stock was Rs.5,000 in excess of opening stock.

Solution:

Gross Profit Ratio = 20%

Gross Profit

--------------- x 100 = 20

Sales

60000 x 100 =20

----------

Sales

Sales = 60000 x 100

---------------

20

Sales = 300000


= 300000 – 60000

= 240000

Stock Turnover Ratio = Cost of Goods Sold

------------------------

Average Stock

6 = 240000

-----------

Average Stock

Average Stock = 240000 / 6

Average Stock = 40000

Let opening Stock = X


Average Stock = X+X+5000

--------------

2

40000 = 2X+5000

------------

2

2X + 5000 = 80000

2X = 75000

X = 75000 / 2

X = 37500

Opening Stock = 37500


= 37500 + 5000

= 42,500

Fixed Assets Turnover Ratio = Net Sales

--------------

Fixed Assets

4 = 300000

-----------

Fixed Assets

Fixed Assets = 300000

-----------

4

Fixed Assets = 75000

Debtors Turnover Ratio = 2 Months

Debtors Turnover = 12 / 2

= 6 times

6 = Net Credit Sales

----------------------

Accounts Receivable

6 = 300000

-----------

Accounts Receivable

Accounts Receivable = 300000 / 6

= 50000

Debtors = 50000

(Assume Bills Receivable = NIL)

Creditors Turnover = 73 days

= 365 / 73

= 5 times

5 = Net Credit Purchase

-------------------------

Accounts Payable

Net Credit Purchases = Cost of Goods Sold +Closing Stock–Opening Stock

= 240000 + 42500 – 37500

= 245000

5 = 245000

--------------

Accounts Payable

Accounts Payable = 245000 / 5

= 49000

Creditors = 49000

(Assume Bills Payable = NIL)

Capital Turnover Ratio = 2 Times

Net Sales

------------------ ---- = 2

Capital Employed

240000

---------------- = 2

Capital Employed

Capital Employed = 240000 / 2

= 120000

Capital Employed = Share Capital + Reserves

120000 = Share Capital + 20000

Share Capital = 120000 - 20000

Share Capital = 100000

STATEMENT OF PROPRIETOR’S FUNDS

Particulars Rs. Rs. Rs.

Proprietor’s funds

Share Capital 100000

Reserves and Surplus 20000 120000

Proprietor’s funds

represented by

Fixed Asset: (A) 75000

Current Assets:

Stock 42500

Debtors 50000

Other Current Assets

(Balancing Figure)

1500 94000

Less: Current Liabilities

Creditors 49000 49000 45000

Working Capital (B)

Capital Employed (A)+

(B)

120000

5. From the following details, find out

(a) Current assets

(b) Current Liabilities

(c) Liquid assets

(d) Stock

Current Ratio 2.5; Liquid Ratio: 1.5; Working Capital Rs.90000.

Solution:

Current Ratio = 2.5

Current Assets 2.5

------------------ = -----

Current Liabilities 1

Let Current Liabilities= X

Current Assets = 2.5 X

Working Capital = Current Assets – Current Liabilities

90000 = 2.5 X – X = 1.5 X

X = 90000

---------

1.5

X = 60000

Current Liabilities = 60000

Current Assets = 60000 x 2.5

Current Assets = 150000

Liquid Ratio = 1.5

Liquid Assets

------------------ = 1.5

Current Liabilities

Liquid Assets

------------------ = 1.5

60000

Liquid Assets = 60000 X 1.5

= 90000

Stock = Current Assets – Liquid Assets

= 150000 – 90000

= 60000.

UNIT IVFUNDS FLOW STATEMENT, CASH FLOW STATEMENT AND

BUDGETARY CONTROL

SECTION A (2 MARKS)

1. What is “Fund Flow Statement”?

‘Flow’ means change. ‘Funds’ is interpreted as ‘working capital’ in the context of

funds flow statement. Thus, ‘Funds flow’ is ‘change in working capital’. Flow of

funds implies any changes in working capital. These changes are a continuous

process, day after day, as and when transactions take place. So, the changes in

working capital may be called ‘Flow’. It can be ‘Inflow’ or ‘Outflow’ of working

capital.

2. What is Working Capital?

Gross Working Capital = Total of Current Assets.

Net Working Capital = Excess of Current Assets over Current Liabilities.

3. Give some examples of Current Assets?

Cash in hand and Cash at Bank.

Accounts Receivable.

Inventories.

Advances recoverable in Cash.

Prepaid expenses.

4. What are the ‘Principles’ for preparation of Working Capital Statement?

Increase in Current Asset - Increases Working Capital

Decrease in Current Asset - Decreases Working Capital

Increase in Current Liability - Decrease Working Capital

Decrease in Current Liability - Increases Working Capital

5. Give some examples of Current Liabilities?

Accounts Payable.

Borrowings on Short term basis.

Outstanding expenses.

Incomes received in advance.

Tax Payable and Dividend Payable.

6. What is mean by Cash Flow Statement?

‘Cash Flow’ includes cash inflows and out flows – cash receipts and cash

payments – during a period. Movements of cash are vital importance to the

management. The short term liquidity and short term solvency positions of a firm

are dependent on its cash flow.

7. What are the advantages of Cash Flow Statement?

Historical analysis as guide to forecasting.

Effective cash management.

Formulation of financial policies.

Preparations of cash budget.

Short term financial decisions.

Liquidity position.

Revelations.

8. What are the Limitations of Cash Flow Statement?

It discloses inflows and outflows of cash alone.

Cash balance of the Cash flow statement will be altered by postponing

payment for purchases to delaying collection of receivables, etc.

Non cash items of expenses and incomes are excluded in Cash Flow

Statement. So it cannot provide a comprehensive picture of a firm’s

financial position.

9. Calculate the Net cash flow from financing activities from the following details:

Rs.

Issue of Debentures for Cash 2000000

Long term loan from Bank 500000

Redemption of Pref. shares 600000

Purchase of Land 900000

Solution:

Computation of Net cash flow from Financing Activities

Issue of Debentures for Cash 2000000

Long term loan from Bank 500000

Redemption of Pref. shares (600000)

-------------

Net cash flow from Financing Activities 19,00,000

---------------

10. Calculate the Amount of depreciation for 2010:

Provision for Depreciation on 1-1-2010 Rs.200000

Provision for Depreciation on 31-12-2010 Rs.250000

Depreciation on Fixed assets sold during the year Rs. 20000

Solution:

Rs.

Provision for Depreciation on 1-1-2010 200000

Depreciation on Fixed assets sold during the year (20000)

-----------

180000

Depreciation for the Year 70000

-----------

Provision for Depreciation on 31-12-2010 250000

----------

11. Ascertain the Amount of Profit or Loss on sale of Machinery

Rs.

Cost of Machinery 100000

Accumulated depreciation on Machinery 30000

Sale value of Machinery 85000

Solution:

Cost of Machinery 100000

Accumulated depreciation on Machinery (30000)

----------

Book value of Machinery 70000

Sale value of Machinery 85000

----------

Profit on Sale of Machinery 15000

----------

12. Compute the amount of dividend paid during 2010:

Rs.

Proposed dividend on 1-1-2010 50000


Dividend debited to P&L Appropriation a/c 60,000

Solution



Dividend debited to P&L Appropriation a/c 60,000

Dr. Cr

PROPOSED DIVIDEND A/C

To Cash

(Balancing Figure)

70000 By Balance b/d 50000

To Balance c/d 40000 By P/L Appropriation A/c 60000

110000 110000

13. Compute the Cash Flow from Operating Activities:

Rs.

P&L a/c balance on 31-3-2010 400000

P&L a/c balance on 31-3-2009 250000

Transfer to General Reserve 50000

Depreciation on Fixed Assets 10000

Solution

Rs.

P&L a/c as on 31-3-2010 400000

P&L a/c as on 31-3-2009 (250000)



------------

Cash Flow from Operating Activities 210000

------------

14. Define Budget.

I.C.M.A. defines a budget as “A financial and quantitative statement, prepared

prior to a defined period of time, of the policy to be pursued during that period for

the purpose of attaining a given objective.”

15. What is Budget?

A budget is the monetary and quantitative expression of business plans and

policies to be pursued in the future period of time. A Budget is an account of

probable future Income and Expenditure. A Budget is an estimate relating to

future period.

16. Define Budgeting.

“The entire process of preparing the budgets is known as budgeting” – J.BATTY

In the words of Rowland and Harr:

“Budgeting may be said to be the act of building budgets”.

Thus budgeting is a process of making the budget plans.

17. What are the Essential Features of a Budget?

A budget is a financial statement but it can be a statement of quantities also with

or without monetary data.

Budget is prepared for a particular period and it is prepared in advance.

Budget is a detailed plan of the policy to be pursued during the period for which

the budget is prepared. The function of the budget is to attain a specific objective.

18. Define ‘Budgetary Control’.

I.C.M.A defines “Budgetary Control” as “the establishment of budgets, relating

the responsibilities of executives to the requirements of a policy, and the

continuous comparison of actual with budgeted results either to secure by

individual action the objectives of that policy or to provide a basis for its

revision”.


1. What are the Benefits of Fund Flow Statement?

It shows how the funds were obtained and used during a period.

The sources are useful in computation of cost of capital of the

business.

A detailed analysis of sources of funds in the past acts as a guide

for obtaining funds for future requirements.

It gives indication of any weakness or strength in the general

financial position of a firm.

It throws light on the financial consequences of business

operations.

It can be compared with relevant budgets to assess the usage of

funds as per plans.

2. What are the Limitations of Fund Flow Statement?

1. It is historical in nature.

2. It is nothing but ‘secondary data’.

3. It is a summarised presentation of figures and cannot provide

information about changes on a continuous basis.

4. The effect of transactions between current assets and liabilities is

not shown in the Statement.

5. It also ignores transactions between long term assets and liabilities.

6. It is not generally considered as a sophisticated technique of

financial analysis.

3. Distinction between Funds Flow Statement and Balance sheet

Funds Flow Statement Balance Sheet

It shows changes in working capital

between two Balance Sheet dates.

It shows the position of assets and liabilities .

It shows only those items which cause

changes in working capital.

It shows the real and personal accounts of a

business, reflected in the assets and liabilities.

It aims at presenting flow of funds over a

period.

It aims at depicting the financial position of a

business.

It is a tool for financial analysis which is

useful to the management.

It is the culmination of the accounting process

of a period which is useful to stakeholders.

It is based on the data forming part of the

income statement and the Balance Sheet.

It is based on the Trial Balance and additional

information relating to a firm.

It is prepared after the financial accounts

are completed.

It is prepared after the income statement is

completed.

4. What are the Sources and Applications of funds?

SOURCES OF FUNDS APPLICATIONS OR USES OF FUNDS

I. Internal sources

(1) Funds from operations

II. External Sources

(1) Issue of Equity shares

(2) Issue of Preference shares

(3) Issue of Debentures

(4) Public deposits accepted

(5) Long-tern loans from banks

and other institutions

(6) Sale of fixed assets

(7) Sale of long term

investments

(1) Purchase of fixed assets

(2) Purchase of Long term Investments

(3) Redemption of preference shares

(4) Redemption of debentures.

(5) Repayment of long-term loans, bank

loans and public deposits

(6) Payment of dividend.

(7) Payment of tax liability

(8) Outflow of funds on account of

operations.

5. Calculation Funds from Operations from the following Profit & Loss A/c


To Expenses Paid 100000 By Gross Profit 200000

To Depreciation 40000 By Gain on Sale of Machinery 20000

To Loss on Sale of Building 15500

To Discount 500

To Goodwill 12000

To Net profit 52000

220000 220000

Solution

Computation of Funds from Operations

Net Profit for the Year : 52000

Add:

Goodwill Written off : 12000

Depreciation on Machinery : 40000

Loss on Sale of Building : 15500 67500

--------

119500

Less:

Gain on Sale of Machinery : 20000

--------

Funds from Operations : 99500

-------

6. Following are the Balance Sheets of a Company as on 31st December 2009 and

31st December 2010. You are required to Calculate Funds form Operations:

Particulars 31 – 12 – 2009 31 – 12 – 2010

Profit & Loss Appropriation A/c 30000 40000

General Reserve 20000 25000

Goodwill 10000 5000

Preliminary Expenses 6000 4000

Provision for Depreciation on Machinery 10000 12000

Solution


Closing Balance of profit & Loss Appropriation A/c : 40000

Less: Opening Balance of profit & Loss Appropriation A/c : 30000

---------


Add:

Transfer to General Reserve : 5000

Goodwill Written off : 5000

Preliminary Expenses written off : 2000

Depreciation on Machinery : 2000 14000

--------

Funds from Operations 24000

--------

7. From the following information relating to Bright Limited, Calculate Funds lost in

Operations:

Net Loss for the Year : 90000

Dividend Received : 7000

Depreciation Charged : 10000

Profit on Sale of Assets : 5000

Refund of Tax : 2000

Solution

Computation of Funds Lost in Operations

Net Loss for the Year : (90000)

Add:

Depreciation Charged : 10000

--------

(80000)

Less:


Profit on Sale of Assets : 5000

Refund of Tax : 2000 14000

--------

Funds Lost in Operations (94000)

--------



To Salaries 10000 By Gross Profit 200000

To Rent 3000 By Profit on Sale of Machines 5000

To Commission 2000 By Dividend Received 2000

To Discount Allowed 1000 By Refund of Tax 3000

To Provision for Depreciation 14000

To Transfer to General Reserve 20000

To Loss on Sale of Investments 5000

To Provision for Taxation 10000

To Discount on Issue of Debentures 2000

To Preliminary Expenses 3000

To Selling Expenses 20000

To Net Profit 120000

210000 210000

Solution



Add:

Provision for Depreciation : 14000


Loss on Sale of Investments : 5000

Provision for Taxation : 10000

Discount on Issue of Debentures : 2000

Preliminary Expenses : 3000 54000

-------

174000

Less:

Profit on Sale of Machinery : 5000


Refund of Tax : 3000 10000

--------


---------

9. Distinguish between Fund Flow Analysis and Cash Flow Analysis.

FUND FLOW ANALYSIS CASH FLOW ANALYSIS

Prepared by based on the working capital

concept of ‘funds’

Prepared by based on the cash concept of

‘funds’

Accounting is based on ‘Accrual concept’

or accrual basis of accounting

Accounting is based on ‘cash concept’ or

cash basis of accounting

It differentiate between two period of It shows the cash position over the same

balance sheet dates accounting period

Fund flow is more useful for Long term

decision making.

Cash flow is more useful in short term

financial decisions.

10. From the following balances you are required to calculate Cash from Operating

Activities.

Particulars 31-12-2009

Rs.

31-12-2010

Rs.

Debtors 50000 47000


Creditors 20000 25000

Bills Payable 8000 6000

Outstanding Expenses 1000 1200


Accrued Income 600 750

Income received in advance 300 250

Profit made during the year - 130000

Solution:

Computation of Cash from Operating Activities

Net Profit for the Year: 130000

Decrease in Debtors 3000

Decrease in Prepaid expenses 100

Increase in Creditors 5000

Increase in Outstanding expenses 200

Increase in Bills Receivable (2500)

Increase in Accrued Income (150)

Decrease in Bills Payable (2000)

Decrease in Income received in Advance (50)

---------

Cash from Operating Activities 133600

---------

11. What are the Objectives of Budgetary Control?

Planning

Coordination

Efficiency and Economy

Increase in Profitability

Anticipation of future capital expenditure

Control

Deviations

12. What are the Advantages of Budgetary Control?

o Maximisation of Profits

o Effective Coordination

o Evaluation of Executive Performance

o Clear-Cut Goals and Targets

o Economy in Operations

o Revelation of Ineffectiveness

o Correction of Performance Continuously

o Introduction of Incentive Schemes of Remuneration

o Shutting Down of unprofitable products and activities.

13. What are the Limitations of Budgetary Control?

o Prediction of uncertain future

o Changes of Conditions

o Complacence

o Difficulty in Coordination

o Conflict among Different Departments

14. What are the Essentials of Budgetary Control?

o Top Management Support

o Clearly defined Organisational structure

o Efficient Accounting System

o Reporting of Deviation

o Motivation

o Realistic Targets

o Participation of all Department Concerned

o Flexibility

15. What are the Preliminary steps for Installation of Budgetary Control System in

Organisation?

o Organisation for Budgeting

o Budget Controller

o Budget Committee

o Budget Centres

o Budget Manual

o Budget Period

o Determination of Key factor

16. What are the Steps for Installation of Budgetary Control System in Organisation?

o Determination of Key factor

o Making Forecasts

o Evaluation of Alternative Combination of Factors

o Preparation of Various Functional Budgets

o Preparation of Master Budget

17. How are Budgets Classified?

A. According to Time

1. Long-Term Budgets

2. Short-Term Budgets

3. Current Budgets

B. Based on Functions

1. Functional or Subsidiary budgets

Purchase Budget

Cash Budget

Production Budget

Sales Budget

Materials Budget

2. Master Budget

C. Basis of Flexibility

1. Fixed Budget

2. Flexible Budget

18. What are the types of Budgets?

Sales Budget

Production Budget

Materials Budget

Labour Budget

Overhead budget

Research and development budget

Capital Expenditure Budget

Cash Budget

19. The following figures relating to product ‘Duper’ for the quarter ending 31-3-

2010 are available:

Budgeted sales: January 3,00,000 Units

February 2,40,000 Units

March 3,60,000 Units

Stock position: 1-1-2010 – 50% of January’s Budgeted sales.

31-3-2010 – 80,000 units

31-1-2010 – 40% of February’s Budgeted sales.

28-2-2010 – 60% of March’s Budgeted sales.

You are required to prepare a production budget for the quarter ending 31-3-2010.

Solution

Production Budget for the Quarter Ending 31 – 03 - 2010Particulars January February March

Budgeted Sales 300000 240000 360000

Add: Desired Closing Stock 96000 216000 80000

396000 456000 440000

Less: Estimated Opening Stock 150000 96000 216000

Budgeted Production (Units) 246000 360000 224000

20. From the following figures, Prepare Raw Materials Purchase Budget.

Particulars Materials in Units

A B C D

Estimated Opening stock 16,000 6,000 24,000 2,000

Estimated Closing stock 20,000 8,000 28,000 4,000

Estimated Consumption 1,20,000 44,000 1,32,000 36,000

Standard Price per Unit(Rs.) 0.25 0.05 0.15 0.10

Solution

Particulars A B C D

Estimated Consumption 120000 44000 132000 36000

Add: Desired Closing Stock 20000 8000 28000 4000

140000 52000 160000 40000

Less: Estimated Opening Stock 16000 6000 24000 2000

Budgeted Production (Units) 124000 46000 136000 38000Purchase Price per Unit 0.25 0.05 0.15 0.10

Purchase Cost 31000 2300 20400 3800

21. A manufacturing unit plans to sell 1,10,000 units in the first week, 1,20,000 units

in the second week, 1,30,000 units in the third week and 1,40,000 units in the 4th

week. At the beginning of the 1st week there are 14,000 units in stock. At the end

of each week the company plans to have an inventory equal to one fifth of the

sales of the next week. How many units must be manufactured in each week?

Solution

Particulars Week I Week II Week III

Estimated Sales 110000 120000 130000

Add: Closing Stock 24000 26000 28000

134000 146000 158000

Less: Opening Stock 14000 24000 26000

Budgeted Production (Units) 120000 122000 132000

Production for 4th Week cannot be computed because Week V closing stock cannot be

found.

22. Prepare a Production Budget from the following information

Product Estimated Stock

On 1-1-10

(units)

Estimated sales during

Jan to Mar 2010

(units)

Desired Stock

On 31-3-10

(units)

R 2,000 10,000 3,000

S 3,000 15,000 5,000

U 4,000 13,000 3,000

P 3,000 12,000 2,000

Solution:

Production Budget for Products R, S, U and P for Quarter Ending March 2010

Particulars R S U P

Estimated Sales 10000 15000 13000 12000

Add: Desired Closing Stock 3000 5000 3000 2000

13000 20000 16000 14000

Less: Estimated Opening Stock 2000 3000 4000 3000

Budgeted Production (Units) 11000 17000 12000 11000

23. The sales director of Future Problem & Co. reports that next year he expects to

sell 1,00,000 units of a particular product. The Production Manager consults the

store keeper and casts his figures as follows:

Two kinds of raw materials ‘P’ and ‘Q’ are required for manufacturing the

product. Each unit of the product requires 2 units of P and 3 units of Q. The

estimated opening balances at the commencement of next year are

Finished product - 20,000 units

Raw material ‘P’ - 24,000 units

Raw material ‘Q’ - 30,000 units

The desirable closing balances at the end of next year are:

Finished product - 28,000 units

Raw material ‘P’ - 26,000 units

Raw material ‘Q’ - 32,000 units

Prepare production budget and materials purchase budget for the next

year.

Solution:

Estimated Production : Estimated Sales + Desired Closing Stock

– Estimated Opening Stock

: 100000 + 28000 – 20000

: 108000 Units

MATERIALS PURCHASE BUDGET

Particulars Raw Material – P

(In Units)

Raw Material – Q

(In Units)

Estimated Consumption 216000

(108000 x 2)

324000

(108000 x 3)

Add: Desired Closing Stock 26000 32000

242000 356000

Less: Estimated Opening Stock 24000 30000

Budgeted Purchases (Units) 218000 326000

24. What are the important elements of Performance Budgeting?

Laying down of Objectives

Classification of Activities

Fixation of Standards

Accounting System

Decentralised Responsibility Structure and Delegation

Performance Reporting


1. The financial position of Jayanth on 31st Dec. of 2009 and 2010 was as follows:

31-12-2009 31-12-2010

Assets Rs. Rs.

Land 25,000 25,000

Buildings 45,000 56,000

Machinery 90,000 95,000

Debtors 32,000 26,000

Stock 18,000 13,000

Cash 4,000 2,000

2,14,000 2,17,000

Liabilities

Creditors 42,000 25,500

Long-term Loan 25,000 20,000

Capital 1,47,000 1,71,500

2,14,000 2,17,000

During the year 2010, Jayanth has withdrawn Rs.8,500 for personal use. Depreciation

provision on machinery was Rs.28,000 on 31-12-2009 and Rs.35,000 on 31-12-2010.

You are required to prepare a Funds Flow Statement.

Solution

SCHEDULE OF CHANGES IN WORKING CAPITAL

01.01.2010 31.12.2010 WORKING CAPITAL (Rs.)Current Assets INCREASE DECREASE Debtors 32,000 26,000 6000

Stock 18,000 13,000 5000

Cash 4,000 2,000 2000

Current LiabilitiesCreditors 42000 25500 16500

TOTAL 16500 13000NET INCREASE IN WORKING CAPITAL 3500

20000 20000


Net Profit for the Year : 33000Add:Depreciation on Machinery : 7000

---------Funds from Operations 40000

---------

FUNDS FLOW STATEMENT

SOURCES:

Funds from Operations : 40000---------

TOTAL 40000---------

APPLICATIONS

Purchase of Buildings : 11000Purchase of Machinery : 12000Repayment of Long Term Loan : 5000Drawings made during the year : 8500Increase in Working Capital : 3500

---------TOTAL 40000

---------

2. From the following Balance Sheets, Prepare Funds Flow Statement

Liabilities 1-1-10

Rs.

31-12-10

Rs.

Assets 1-1-10

Rs.

31-12-10

Rs.

Creditors 40000 44000 Cash 10000 7000

Mrs. Somu’s Loan 25000 - Debtors 30000 50000

Loan from Canara Bank 40000 50000 Stock 35000 25000

Capital 125000 153000 Machinery 80000 55000

Land 40000 50000

Buildings 35000 60000

230000 247000 230000 247000

During the year a machine costing Rs.10,000(accumulated depreciation Rs.3,000) was

sold for Rs.5,000.The Provision for depreciation against machinery as on 1-1-2010 was

Rs.25,000 and on 31-12-2010 was Rs.40,000. Net profit for the year 2010 amounted to

Rs.45,000. Prepare the Funds Flow Statement.

SolutionSCHEDULE OF CHANGES IN WORKING CAPITAL

01.01.2010 31.12.2010 WORKING CAPITAL (Rs.)Current Assets INCREASE DECREASECash 10000 7000 3000

Debtors 30000 50000 20000

Stock 35000 25000 10000

Current LiabilitiesCreditors 4000

TOTAL 20000 17000NET INCREASE IN WORKING CAPITAL 3000

20000 20000


Net Profit for the Year : 45000Add:Depreciation on Machinery : 18000Loss on sale of Machinery : 2000 20000

---------Funds from Operations 65000

---------

FUNDS FLOW STATEMENTSOURCES:

Funds from Operations : 65000Sale of Machinery : 5000Loan from Canara Bank : 10000

---------TOTAL 80000

---------APPLICATIONS

Purchase of Buildings : 25000Purchase of Land : 10000Repayment of Mrs.Somu’s Loan : 25000Drawings made during the year : 17000Increase in Working Capital : 3000

---------TOTAL 80000

---------

3. From the following Balance Sheets, Prepare Funds flow Statement:


Equity Share Capital 300000 400000 Goodwill 115000 90000

Preference Share Capital 150000 100000 Buildings 200000 170000

General Reserve 40000 70000 Plant 80000 200000

Profit & Loss A/c 30000 48000 Debtors 160000 200000

Proposed Dividend 42000 50000 Stock 77000 109000

Creditors 55000 83000 Bills Receivable 20000 30000

Bills Payable 20000 16000 Cash in Hand 15000 10000

Provision for Taxation 40000 50000 Cash at Bank 10000 8000

677000 817000 677000 817000

Additional Information:

1. Depreciation on Plant Rs.10000 and on Buildings Rs.20000 charged in 2010

2. An Interim Dividend of Rs.20000 was paid in 2010.

3. Income Tax of Rs.35000 was paid during 2010.

Solution

SCHEDULE OF CHANGES IN WORKING CAPITAL

Current Assets 2009 2010 WORKING CAPITAL (Rs.)

INCREASE DECREASE

Debtors 160000 200000 40000

Stock 77000 109000 32000

Bills Receivable 20000 30000 10000

Cash in Hand 15000 10000 5000

Cash at Bank 10000 8000 2000

Current Liabilities

Creditors 55000 83000 28000

Bills Payable 20000 16000 4000

TOTAL 86000 35000

NET INCREASE IN WORKING CAPITAL 51000

86000 86000


Closing Balance of Profit & Loss Appropriation A/c : 48000

Less: Opening Balance of Profit & Loss Appropriation A/c : 30000

---------


Add:


Provision for Taxation : 45000

Goodwill written off : 25000

Interim Dividend paid : 20000

Proposed Dividend : 50000

Depreciation on Plant : 10000

Depreciation on Buildings : 20000 200000

---------

Funds from Operations 218000

---------

FUNDS FLOW STATEMENT

SOURCES:

Issue of Equity Share Capital : 100000


Sale of Buildings : 10000

---------

328000

---------

APPLICATIONS

Redemption of Preference Shares : 50000

Purchase of Plant : 130000

Income Tax paid : 35000

Interim Dividend paid : 20000

Proposed Dividend : 42000

Increase in Working Capital : 51000

---------

328000

---------

4. Senthil Velavan Corporation made a profit of Rs.3,70,250 after considering the

following:

Particulars Rs.



Loss on Sale of Machine 600


Provision for Doubtful Debts 1200

Profit on sale of Fixed Assets 2500

Amortisation of Development Cost 5000

The following additional information is given to you:


Rs.

31-12-2010

Rs.


Bills payable 15000 13000

Outstanding expenses 7000 6000

Debtors 36000 39000

Bills receivable 12000 10500

Prepaid expenses 1600 1700

You are required to determine Cash from Operating Activities.

Solution

CASH FROM OPERATING ACTIVITIES

Net Profit for the Year 370250

Transfer to reserve 20000

Provision for Taxation 50000

--------

Net profit before Tax and Extra Ordinary Items 440250


Loss on sale of Machinery 600

Provision for doubtful debts 1200

Amortisation of Development Cost 5000

Profit on Sale of Fixed Assets (2500)

-----------

Operating profit before Working Capital changes 452050



Decrease in Outstanding Expenses (1000)

Increase in Debtors (3000)

Decrease in Bills Receivable 1500

Increase in Prepaid Expenses (100)

----------

452450

Income Tax paid 50000

---------


---------

Note: Entire Provision for Tax is assumed to be paid off as Tax.

Provision for Doubtful debts is not reduced from Debtors

5. The Comparative Balance Sheets of Mr. Wheldon for the two years were as

follows:

Liabilities 2009

Rs.

2010

Rs.

Assets 2009

Rs.

2010

Rs.

Capital 150000 175000 Land & Buildings 110000 150000

Loan from Bank 160000 100000 Machinery 200000 140000

Creditors 90000 100000 Stock 50000 45000

Bills payable 50000 40000 Debtors 70000 80000

Loan from IFC 25000 Cash 20000 25000

450000 440000 450000 440000


sold for Rs.13,000.The Provision for depreciation against machinery as on 31-12-2009

was Rs.50,000 and on 31-12-2010 was Rs.85,000. Net profit for the year 2010 amounted

to Rs.60,000. Prepare a Cash Flow Statement.

CASH FLOW STATEMENT (AS – 3)

Operating Activities


Depreciation 45000

Loss on Sale of Machinery 2000

---------

Operating Profit before Working Capital Changes 107000

Decrease in Stock 5000




----------


Investing Activities

Purchase of Land & Buildings (40000)

Sale of Machinery 13000 (27000)

--------

75000

Financing Activities

Loan from IFC 25000

Repayment of Bank Loan (60000)

Drawings (35000) (70000)

---------

5000

Cash and Cash Equivalents at the beginning of the Year 20000

---------

Cash and Cash Equivalents at the end of the Year 25000

---------

6. From the following Balance Sheets, Prepare Cash flow Statement:


Equity Share Capital 300000 400000 Goodwill 115000 90000

Preference Share Capital 150000 100000 Buildings 200000 170000

General Reserve 40000 70000 Plant 80000 200000

Profit & Loss A/c 30000 48000 Debtors 160000 200000

Proposed Dividend 42000 50000 Stock 77000 109000

Creditors 55000 83000 Bills Receivable 20000 30000

Bills Payable 20000 16000 Cash in Hand 15000 10000

Provision for Taxation 40000 50000 Cash at Bank 10000 8000

677000 817000 677000 817000

Additional Information:

Depreciation on Plant Rs.10000 and on Buildings Rs.20000 charged in 2010

An Interim Dividend of Rs.20000 was paid in 2010.

Income Tax of Rs.35000 was paid during 2010.

Solution


Transfer to reserve 30000

Provision for Taxation 45000

Interim Dividend 20000

Proposed Dividend 50000

--------

Net profit before Tax and Extra Ordinary Items 163000


Goodwill Written off 25000

-----------

Operating profit before Working Capital changes 218000


Increase in Bills Receivable (10000 )

Increase in Stock (32000 )



----------

160000

Income Tax paid 35000

---------


Investing Activities

Sale of Buildings 10000

Purchase of Plant (130000) (120000)

-----------

5000

Financing Activities

Issue of Equity Share Capital 100000

Redemption of Preference Share Capital (50000)

Interim Dividend (20000)

Proposed Dividend (42000) (12000)

--------

(7000)

Cash and Cash Equivalents at the beginning of the Year 25000

(Cash + Bank = 15000 + 10000)

--------

Cash and Cash Equivalents at the end of the Year 18000

(Cash + Bank = 10000 + 8000) --------

7. On the basis of the following particulars, draw up a flexible budget for overhead

expenses and determine the overhead rates at 70% 80% and 90% plant capacity.

Particulars 70%

Rs.

80%

Rs.

90%

Rs.

Variable Overheads:

Indirect Labour

Indirect Materials

-

-

12,000

4,000

-

-

Semi-Variable Overheads:

Power(30% Fixed)

Repairs(40% Fixed)

-

-

20,000

2,000

-

-

Fixed Overheads:

Depreciation

Insurance

Salaries

-

-

-

11,000

3,000

10,000

-

-

-

Total Overhead Expenses - 62,000 -

Estimated Direct Labour Hours - 1,24,000 -

Solution FLEXIBLE BUDGET FOR OVERHEAD EXPENSES AT 70%, 80% AND 90% CAPACITY LEVELS

Particulars 70%

Rs.

80%

Rs.

90%

Rs.

Variable Overheads

Indirect Labour 10500 12000 13500

Indirect Materials 3500 4000 4500

TOTAL (A) 14000 16000 18000

Semi-Variable Overheads:

Power

Variable 12250 14000 15750

Fixed 6000 6000 6000

Repair

Variable 1050 1200 1350

Fixed 800 800 800

TOTAL (B) 20100 22000 23900

Fixed Overheads

Depreciation 11000 11000 11000

Insurance 3000 3000 3000

Salaries 10000 10000 10000

TOTAL (C) 24000 24000 24000

Total Overheads (A + B + C) 58100 62000 65900

Estimated Direct Labour hours 108500 124000 139500

Overhead Rate per Hour 0.535 0.500 0.472

8. The expenses budgeted for production of 10,000 units in a factory are furnished

below:

Particulars Per Unit

Rs.

Materials 70

Labour 25

Variable Overheads 20

Fixed Overheads (Rs.1,00,000) 10

Variable Expenses (Direct) 5

Selling Expenses (10% Fixed) 13

Distribution Expenses (20% Fixed) 7

Administration Expenses (50,000)

(Fixed for all levels)

5

Total Cost per Unit (to make and sell) 155

Prepare a Flexible Budget for 6000 Units and 8000 Units

Solution

FLEXIBLE BUDGET FOR THE PRODUCTION OF 10000, 8000 AND 6000 UNITS

Particulars 10000 units 8000 units 6000 units

Per Unit

Rs.

Total

Rs.

Per Unit

Rs.

Total

Rs.

Per Unit

Rs.

Total

Rs.

Materials 70 700000 70 560000 70 420000

Labour 25 250000 25 200000 25 150000

Variable Overheads 20 200000 20 160000 20 120000

Fixed Overheads 10 100000 12.5 100000 16.67 100000

Variable Expenses 5 50000 5 40000 5 30000

Selling Expenses

Variable 11.7 117000 11.70 93600 11.7 70200

Fixed 1.3 13000 1.625 13000 2.17 13000

Distribution Expenses

Variable 5.6 56000 5.60 44800 5.6 33600

Fixed 1.4 14000 1.75 14000 2.33 14000


(Fixed)

5.0 50000 6.25 50000 8.33 50000

Total 155.00 1550000 159.425 1275400 166.80 1000800

9. With the following data for 60% activity, prepare a budget at 80% activity.

Production at 60% Capacity - 600 units

Materials - Rs.100 per unit

Labour - Rs.40 per unit

Direct Expenses - Rs.10 per nit

Factory Expenses - Rs.40,000 (40% fixed)

Administration Expenses - Rs.30,000 (60% fixed)

Solution

FLEXIBLE BUDGET FOR THE PRODUCTION OF 600 AND 800 UNITS

Particulars 60% capacity - 600 units 80% capacity - 800 units

Per Unit

Rs.

Total Per Unit

Rs.

Total

Materials 100 60000 100 80000

Labour 40 24000 40 32000

Direct Expenses 10 6000 10 8000

Factory Expenses

Variable 40 24000 40 32000

Fixed 26.67 16000 20 16000


Variable 20 12000 20 16000

Fixed 30 18000 22.5 18000

TOTAL 266.67 160000 252.5 202000

10. A firms expects to have Rs.25,000 in Bank on 1st May 2009 and requires you to

prepare an estimate of cash position during the 3 months. May-July 2009. The

following information is made available:

Months Sales

Rs.

Purchase

Rs.

Wages

Rs.

Factory

Expenses

Rs.

Office

Expenses

Rs.

Selling

Expenses

Rs.

March 50,000 30,000 6,000 5,000 4,000 3,000

April 56,000 32,000 6,500 5,500 4,000 3,000

May 60,000 35,000 7,000 6,000 4,000 3,500

June 80,000 40,000 9,000 7,500 4,000 4,500

July 90,000 40,000 9,500 8,000 4,000 4,500

Other Information:

i. 20% of Sales is for Cash, remaining amount is collected in the

month following that of sale.

ii. Suppliers supply goods at 2 months credit.

iii. All expenses are paid in the month following the one in which they

are incurred.

iv. The company pays Dividends to Shareholders and Bonus to

Workers of Rs.10,000 and Rs.15,000 respectively in the month of

May.

v. Plant has been ordered and is expected to be received in June. It

will cost Rs.80,000

vi. Income Tax Rs.25,000 is payable in July.

Solution

CASH BUDGET FOR THREE MONTHS ENDING 31ST JULY 2009

Particulars May June July

Opening Cash Balance 25000 7300 (63200)

Add: Estimated Cash Receipts

Cash Sales 12000 16000 18000

Cash Receivable from Debtors 44800 48000 64000

TOTAL RECEIPTS 56800 64000 82000

Total Cash Available (I) 81800 71300 18800

Less: Estimated Cash Payments

Cash payable to Suppliers 30000 32000 35000

Wages 7000 9000 9500

Factory Expenses 5500 6000 7500

Office Expenses 4000 4000 4000

Selling Expenses 3000 3500 4500

Dividends to Shareholders 10000 - -

Bonus to Workers 15000 - -

Payment for Plant - 80000 -

Income Tax - - 25000

TOTAL PAYMENTS (II) 74500 134500 85500

Closing Cash Balance 7300 (63200)

Overdraft

(66700)

Overdraft

Note: Since nothing is mentioned about lag in payment of Wages, they are

assumed to be paid in respective months

11. Prepare Cash Budget for Months of April, May and June from the following data.

MONTHS SALES PURCHASES WAGES

February 1,80,000 1,24,800 12,000

March 1,92,000 1,44,000 14,000

April 1,08,000 2,43,000 11,000

May 1,74,000 2,46,000 10,000

June 1,26,000 2,68,000 15,000

1. 50% of credit sales is realised in the month following the sale and

the other 50% in the second month following.

2. Creditors are paid in the month following the month of purchase.

3. Wages are paid at the end of the respective month.

4. Cash at bank – 1st April – Rs.25,000.

Solution

CASH BUDGET FOR THREE MONTHS ENDING 30th JUNE

Particulars April May June

Opening Cash Balance 25000 56000 (47000)

Add: Estimated Cash Receipts

Cash Receivable from Debtors

February 90000 - -

March 96000 96000 -

April - 54000 54000

May - - 87000

TOTAL RECEIPTS 186000 150000 141000

Total Cash Available (I) 211000 206000 94000

Less: Estimated Cash Payments

Cash payable to Suppliers 144000 243000 246000

Wages 11000 10000 15000

TOTAL PAYMENTS (II) 155000 253000 261000

Closing Cash Balance 56000 (47000)

Overdraft

(167000)

Overdraft

12. Prepare a Selling Overheads Budget from the Estimates given below:

Rs.

Advertisement 1,000

Salaries to the department 1,000

Expenses of the sales department (fixed) 750

Salaries and Dearness allowance 3,000

Commission at 1% on sales effected (other than those of agents)

Carriage Outwards estimated at 5% on sales.

Agent’s Commission – 6 1/2 % on sales.

The Sales during the period were estimated as follows:.

Rs.80,000 including Agent’s sales Rs.8,000

Rs.90,000 including Agent’s sales Rs.10,000

Rs.1,00,000 including Agent’s sales Rs.10,500

Solution

SELLING OVERHEADS BUDGET

Particulars

Estimated Sales

Rs.80000 Rs.90000 Rs.100000

Fixed Selling Overheads

Advertisement 1000 1000 1000

Salaries 1000 1000 1000

Expenses 750 750 750

Salaries and Dearness Allowance 3000 3000 3000

Total Fixed Overheads (A) 5750 5750 5750

Variable Selling Overheads

Commission (Other than those of Agents) 720 800 895

Carriage Outwards 4000 4500 5000

Commission to Agents 520 650 682.5

Total Variable Overheads (B) 5240 5950 6577.50

Total Selling Overheads 10990 11700 12327.50

UNIT – V

CAPITAL BUDGETING


1. What is Capital Budgeting?

Capital Budgeting refers to Long Term Planning for:

a. Investment in Projects and Fixed Assets

b. Methods of Financing the approved Projects

2. Define Capital Budgeting.

“Capital Budgeting is the firm’s formal process for the acquisition and investment

of Capital” – Hampton John.J

“Capital Budgeting is Long Term planning for making and Financing proposed

capital outlays” – Charles T.HornGren

3. What are the important aspects of Capital Budgeting Decisions?

i. Cash outflow needed for a proposal

ii. Required return on Investments

iii. Measurement of Returns from Investment Proposals

iv. Ranking of Investment Proposals

v. Assessment of Risk or Uncertainty involved in projects.

4. What are the methods of Capital Budgeting

Traditional Methods:

i. Pay Back Method

ii. Accounting Rate of Return Method

Discounted Cash Flow Methods:

Net present Value Method

Profitability Index Method

iii. Internal Rate of Return Method

5. Compute Pay Back period for the following

Original Investment : Rs.30000

Annual Cash Flow : Rs.15000

Solution

Pay Back Period = Original Investment / Annual Cash Flow

= 30000 / 15000

= 2 Years

6. A project costs Rs.500000 and yields annually a profit of Rs.80000 after

Depreciation at 12% per annum but before tax at 50%. Calculate Pay Back

Period.

Solution

Profit after Depreciation before Tax : Rs.80000

Less: Tax at 50% of Profits : Rs.40000

------------‘

Rs.40000

Add; Depreciation @12% on Rs.500000 : Rs.60000

------------

Annual Cash Inflows : Rs.100000

-------------

Pay Back Period = Cost of the Project /Annual Cash Flow

= 500000 / 100000

= 5 Years

7. Calculate present values at 10% per annum for a period of 5 Years.

Solution

Year Present Value of Re.1

At 10% Discounting Factor

1 1.000 x 100 / 110 = 0.909

2 0.909 x 100 / 110 = 0.826

3 0.826 x 100 / 110 = 0.751

4 0.751 x 100 / 110 = 0.683

0.683 x 100 / 110 = 0.621

8. An Investment proposal is expected to result in an average annual Income of

Rs.6,00,000 after depreciation and tax. If the Investment needed is Rs.30,00,000

initially, compute ARR on original Investment.

Solution

Accounting Rate of Return on Original Investment

= Annual Income after Depreciation and Tax

---------------------------------------------------- X 100

Original Investment

= 600000

--------- X 100 = 20%

3000000

9. A Project requires an Investment of Rs.400000 and it is estimated to result in cash

inflows of Rs.480000 after discounting at Cost of Capital rate of 10%. Compute

the Net Present Value and Profitability Index. Should the Project be accepted?

Net Present Value = Present Value of Cash Inflows – Cost of the Project

= 480000 – 400000

= Rs.80000

Conclusion: Project is to be accepted because of positive N.P.V

Profitability Index = Present Value of Cash Inflows / Cost of the Project

= 480000 / 400000

= 1.20

Conclusion: Project is to be accepted because Profitability Index is more than 1.

10. A Company has an Investment Opportunity costing Rs.40000 with the following

expected net cash flow (after tax and before depreciation)

Year Net Cash Inflows

1 7000

2 7000

3 8000

4 9000

5 8000

6 9000

7 10000

Determine the Pay Back Period

Solution:

Year Cash Inflow Cumulative Cash Inflow

1 7000 7000

2 7000 14000

3 8000 22000

4 9000 31000

5 8000 39000

40000

6 9000 48000

7 10000 58000

Initial Investment : Rs.40000

Pay Back Period : 5 Years + 1000 / 9000

: 5.11 Years


11. What are the features of Capital Budgeting?

It involves investment of Funds in the present for achieving future benefits

Future benefits are usually spread over several years

Investment of Funds is in Long Term activities which are usually Non –

Flexible

The Project in which the Investment is to be made will determine the

financial future of the organisation.

Each project involves huge amount of Funds

Capital Expenditure Decisions are Irreversible.

12. What are the factors influencing Capital Budgeting Decisions?

Availability of Funds

Future Earnings

Legal Compulsions

Degree of Uncertainty of Risk

Urgency

Research and Development Projects

Obsolescence

Competitor’s Activities

Intangible factors

13. Explain the Importance of Capital Budgeting?

Huge Amount of Investments

Permanent and Irreversible commitment of Funds

Long term Impact on Profitability

Growth and Expansion

Cost Over Runs

Alternatives

Multiplicity of Variables

Top Management Activity


1. Explain the methods of Capital Budgeting.

TRADITIONAL METHODS:

Pay Back Method

It is also called Pay out Method. It is the time span in which a project ‘pays for

itself’ through surplus cash flows. It is the period within which investment in

Fixed Assets can be recovered.

Merits:

Simple to Understand

Easy to Calculate

Loss through obsolescence is minimised as short term projects are

preferred.

Demerits:

It ignores post payback period returns

It completely ignores time value of money.

It does not measure profitability.

It does not make use of Cost of Capital.

Accounting Rate of Return Method

This method takes into account the total earnings expected from an Investment

proposal over its full time. The method is called Accounting Rate of Return

Method because it uses the accounting concept of Profit.

Merits:

Easy to Understand and Operate

Measures Profitability

Method is based on net Earnings

Demerits:

It ignores time value of money.

Reliability of A.R.R method is affected due to various concepts of

Investment

DISCOUNTED CASH FLOW METHODS:

Net present Value Method

It recognizes the time value of money. Cash flows arising at different periods of

time are not comparable unless their equivalent present values are found. The net

present values of all inflows and outflows of cash occurring during the entire life

of a project is determined by discounting these flows by the firm’s cost of capital

or some other pre-determined rate.

Merits:

It recognizes the time value of Money

It considers earnings over the entire life of the Project which makes true

assessment of profitability possible.

Demerits

It is complicated to understand and operate.

Comparing different projects with different Investments becomes difficult.

Profitability Index Method

It is also called Benefits Cost Ratio. It is only a refinement of Net Present Value

Method. It shows the relationship between present value of cash inflows and

present value of Cash outflows. This method is also known as Excess Present

value Index Method.

Merits

It is useful in ranking two or most projects

It recognizes the time value of Money

It considers earnings over the entire life of the Project which makes true

assessment of profitability possible.

More suitable for comparative assessment of Projects

Demerits

It is complicated to understand and operate.

Comparing different projects with different Investments becomes difficult.

Internal Rate of Return Method

Internal Rate of Return is that rate of return at which the present values of Cash

Inflows and Cash Outflows are equal. I.R.R discounts the total cash flows to the

level of Zero.

Merits

It takes into account Time Value of Money

It considers the profitability of a project over its entire economic life.

Cost of Capital is not a pre-requisite for applying I.R.R method

It provides for ranking of various proposals because it is a percentage

return

Demerits

Discounting rate is unknown factor

The assumption of I.R.R that the earnings are re-invested at I.R.R for the

remaining life of the project is not a justifiable assumption.

2. Vijay & Co. is considering investing in a project requiring a capital outlay of

Rs.200000. Forecast for annual income after depreciation but before tax is as

follows:

Year Rs.

1 100000

2 100000

3 80000

4 80000

5 40000

Depreciation may be taken as 20% on original Cost and taxation at 50% of net

income.

You are required to evaluate the project according to each of the following

methods:

1. Pay Back Method

2. Rate of Return on Original Investment

3. Rate of Return on Average Investment

4. Discounted Cash Flow Method (Cost of Capital 10%)

5. Excess Present Value Index.

Solution:

Particulars Year 1 Year 2 Year 3 Year 4 Year 5

Annual Income after Depreciation Before Tax 100000 100000 80000 80000 40000

Less: Taxation @50% 50000 50000 40000 40000 20000

Annual Income after Depreciation and after Tax 50000 50000 40000 40000 20000

Add: Depreciation @20% of the Cost of the Project 40000 40000 40000 40000 40000

Annual Cash Inflows 90000 90000 80000 80000 60000

1. Pay Back Period:

Year Cash Inflow Cumulative Cash Inflow

1 90000 90000

2 90000 180000

200000

3 80000 260000

4 80000 340000

5 60000 400000



: 2.25 Years

2. Rate of Return on Original Investment


= Average Annual Income (After Depreciation and Tax)

---------------------------------------------------------------

X 100

Original Investment

= 40000 / 200000 x 100

= 20%

Note: Average Annual Income = (50000 + 50000 + 40000 + 40000 + 20000) / 5

= 40000

3. Rate of Return on Average Investment


= Average Annual Income (After Depreciation and Tax)

---------------------------------------------------------------

X 100

Average Investment

= 40000 / 100000 x 100

= 40%

Note: Average Annual Income = (50000 + 50000 + 40000 + 40000 + 20000) / 5

= 40000

Average Investment = Original Investment / 2

= 200000 / 2 = Rs.100000


Year Annual Cash Inflows

Rs.

P.V of Re.1

at 10% (D.C.F)

Present Value of Cash Inflows

Rs.

1 90000 0.909 81810

2 90000 0.826 74340

3 80000 0.751 60080

4 80000 0.683 54640

5 60000 0.621 37260

308130

Present Value of the Project : Rs.308130

(-)Cost of the Project : Rs.200000

Net Present Value : Rs.108130

5. Excess Present Value Index

Excess Present Value Index = Present Value of Cash Inflows / Cost of the Project

= 308130 / 200000

= 1.541

Decision: The Project is acceptable on the basis of all the methods

3. A choice is to be made between two competing proposals which require an equal

investment of Rs.50000 and are expected to generate net cash flows as under:

End of Year Project I

Rs.

Project II

Rs.

1 25000 10000

2 15000 12000

3 10000 18000

4 Nil 25000

5 12000 8000

6 6000 4000

The Cost of Capital of the Company is 10%. Which Project should be chosen?

Why?

Evaluate the Project Proposals under:

Pay Back Method

Discounted Cash Flow Method

Solution:

1. Pay Back Period:

Year Project I Project II

Cash Inflow Cumulative Cash Inflow Cash Inflow Cumulative Cash Inflow

1 25000 25000 10000 10000

2 15000 40000 12000 22000

3 10000 50000

18000 40000

50000

4 Nil 50000 25000 65000

5 12000 62000 8000 73000

6 6000 68000 4000 77000

Project I


Pay Back Period : 3 Years

Project II



: 3.4 Years

Decision : Project I is better because of Lower Pay Back Period.


Project I


Rs.

P.V of Re.1

at 10% (D.C.F)


Rs.

1 25000 0.909 22725

2 15000 0.826 12390

3 10000 0.751 7510

4 Nil 0.683 0

5 12000 0.621 7452

6 6000 0.564 3384

TOTAL 53461

Present Value of the Project: Rs.53461



Excess Present Value Index


= 53461 / 50000

= 1.069

Project II


Rs.

P.V of Re.1

at 10% (D.C.F)


Rs.

1 10000 0.909 9090

2 12000 0.826 9912

3 18000 0.751 13518

4 25000 0.683 17075

5 8000 0.621 4968

6 4000 0.564 2256

TOTAL 56819






= 56819 / 50000

= 1.136

Decision: Project II is better because of higher NPV and Profitability Index

for the same Investment

4. K Limited considers purchasing any one of the following two alternative

machines. The details are as given below:

PARTICULARS MACHINE X MACHINE Y

Cost of Machine Rs.600000 Rs.1000000

Life Time (Years) 4 5

Savings in Scrap Rs.90000 Rs.100000

Savings in Labour Rs.280000 Rs.360000

Additional Cost per Annum

Supervision Rs.20000 Rs.30000

Maintenance Rs.12000 Rs.20000

Indirect Materials Rs.8000 Rs.10000

Tax Rate 50% 50%

Using Discounted Cash Flow Method, prepare a statement of Profitability and

recommend the profitable machine. (Discounting Factor 12%)

STATEMENT OF PROFITABILITY

PARTICULARS MACHINE X MACHINE Y

INCOME – A Rs. Rs.

Savings in Scrap 90000 100000

Savings in Labour 280000 360000

TOTAL (A) 370000 460000

Additional Cost – B

Supervision 20000 30000

Maintenance 12000 20000

Indirect Materials 8000 10000

TOTAL (B) 40000 60000

Income before Depreciation & Tax 330000 400000

Less: Depreciation

(Cost of Machine / Life Time)

150000 200000

Income after Depreciation before Tax 180000 200000

Less: Tax @50% 90000 100000

Net Income (after Depreciation & Tax) 90000 100000

Add : Depreciation 150000 200000

Net Annual Cash Inflows 240000 300000

MACHINE X


Rs.

P.V of Re.1

at 12% (D.C.F)


Rs.

1 240000 0.893 214320

2 240000 0.797 191280

3 240000 0.712 170880

4 240000 0.639 153360

TOTAL 729840






= 729840 / 600000

= 1.2164

MACHINE X


Rs.

P.V of Re.1

at 12% (D.C.F)


Rs.

1 300000 0.893 267900

2 300000 0.797 239100

3 300000 0.712 213600

4 300000 0.639 191700

5 300000 0.567 170100

TOTAL 1082400






= 1082400 / 1000000

= 1.0824

Decision:

Model X is better because of higher Net Present Value and Higher Present

Value Index.

MODEL QUESTION PAPER - 1

SECTION A (10 X 2 = 2O MARKS)

ANSWER ANY TEN QUESTIONS

ALL QUESTIONS CARRY EQUAL MARKS

1. Define Management Accounting

2. What are Funds from operations?

3. What is a Cash Flow Statement?

4. What are the types of Analysis of Financial Statements?

5. How do you show the following items in a Common Size Income Statement?

Particulars 31 – 03 – 2009 31 – 03 – 2010

Sales 200000 400000

Less: Cost of Sales 140000 240000

6. A Project requires an Investment of Rs.600000 and it is estimated to result in cash

inflows of Rs.675000 after discounting at Cost of Capital rate of 10%. Compute

the Net Present Value and Profitability Index. Should the Project be accepted?

7. Calculate Present Value of Re.1 at 12% Discounting factor for 5 Years

8. Define Budget.

9. What is Payback Period?

10. What is Net Present Value?

11. Calculate Stock Turnover ratio

Cost of Goods Sold : Rs.65000

Sales : Rs.100000

Average Stock : Rs.15000

12. From the following information Prepare Funds Flow Statement;

Issue of Shares : Rs.100000

Funds from Operations Rs.200000

Redemption of Debentures Rs.180000

Increase in Working Capital Rs.120000

SECTION B (5 X 5 = 25 MARKS)

ANSWER ANY FIVE QUESTIONS


13. Distinction between Financial Accounting and Management Accounting.

14. From the following details below, prepare a Common Size Income Statement of

Lively Limited:

Particulars Year Ending 31.03.2009 Year Ending 31.03.2010

Sales 350000 550000

Cost of Sales 200000 330000

Operating Expenses 60000 80000

Non – Operating Expenses 25000 45000

15. Compute (a) Pay out ratio and (b) Retained Earnings ratio from the following

data.

Rs.

Net Profit 10000



No. of Equity Shares 3000

Dividend per Equity Share Re. 0.40

16. Kuberan & Co. makes both cash and credit sales. From the following information,

Calculate Average Collection Period:

Particulars Rs.

Total Sales 200000

Cash Sales 40000

Sales Returns 14000

Debtors (31-12-2010) 18000

Creditors ( 31-12-2010) 20000

Provision for bad debts (31-12-2010) 2000

Bills Receivable ( 31-12-2010) 4000



To Expenses Paid 100000 By Gross Profit 200000

To Depreciation 40000 By Gain on Sale of Machinery 20000

To Loss on Sale of Building 15500

To Discount 500

To Goodwill 12000

To Net profit 52000

220000 220000

18. From the following balances you are required to calculate Cash from Operating

Activities.


Rs.

31-12-2010

Rs.

Debtors 50000 47000



Bills Payable 8000 6000

Outstanding Expenses 1000 1200


Accrued Income 600 750

Income received in advance 300 250

Profit made during the year - 130000

19. The following figures relating to product ‘Duper’ for the quarter ending 31-3-

2010 are available:

Budgeted sales: January 3,00,000 Units

February 2,40,000 Units

March 3,60,000 Units

Stock position: 1-1-2010 – 50% of January’s Budgeted sales.

31-3-2010 – 80,000 units

31-1-2010 – 40% of February’s Budgeted sales.

28-2-2010 – 60% of March’s Budgeted sales.

You are required to prepare a production budget for the quarter ending 31-3-2010.

SECTION C (3 X 10 = 30 MARKS)

ANSWER ANY THREE QUESTIONS


20. From the following Balance Sheets of X Limited , You are required to prepare a

Common Size Balance Sheet




Liability for Expenses 9000 17000 Plant & Machinery 300000 750000

Retained Earnings 50000 33000 Stock 60000 217000

Sundry Creditors 91000 100000 Debtors 115000 160000

Debentures 150000 250000 Cash 10000 5000



Total 600000 1600000 Total 600000 1600000

21. Following are the details relating to the trading activities of A Ltd.

Stock Velocity - 8 months

Debtor’s Velocity - 3 months

Creditor’s Velocity - 2 months

Gross Profit Ratio - 25%

Gross profit for the year Rs.400000; Bills receivable Rs.25000 and Bills payable

Rs.10000. Closing Stock of the year is Rs.10000 more than the opening stock. Find

out (a) Sales (b) Debtors (c) Closing Stock and (d) Creditors

22. From the following Balance Sheets, Prepare Funds Flow Statement

Liabilities 1-1-10

Rs.

31-12-10

Rs.

Assets 1-1-10

Rs.

31-12-10

Rs.

Creditors 40000 44000 Cash 10000 7000

Mrs. Somu’s Loan 25000 - Debtors 30000 50000

Loan from Canara Bank 40000 50000 Stock 35000 25000

Capital 125000 153000 Machinery 80000 55000

Land 40000 50000

Buildings 35000 60000

230000 247000 230000 247000


sold for Rs.5,000.The Provision for depreciation against machinery as on 1-1-2010 was

Rs.25,000 and on 31-12-2010 was Rs.40,000. Net profit for the year 2010 amounted to

Rs.45,000. Prepare the Funds Flow Statement.

23. The expenses budgeted for production of 10,000 units in a factory are furnished

below:

Particulars Per Unit

Rs.

Materials 70

Labour 25

Variable Overheads 20

Fixed Overheads (Rs.1,00,000) 10

Variable Expenses (Direct) 5

Selling Expenses (10% Fixed) 13

Distribution Expenses (20% Fixed) 7

Administration Expenses (50,000)

(Fixed for all levels)

5

Total Cost per Unit (to make and sell) 155

Prepare a Flexible Budget for 6000 Units and 8000 Units

24. Vijay & Co. is considering investing in a project requiring a capital outlay of

Rs.200000. Forecast for annual income after depreciation but before tax is as

follows:

Year Rs.

1 100000

2 100000

3 80000

4 80000

5 40000

Depreciation may be taken as 20% on original Cost and taxation at 50% of net

income.

You are required to evaluate the project according to each of the following

methods:

Pay Back Method

Rate of Return on Original Investment

Rate of Return on Average Investment

Discounted Cash Flow Method (Cost of Capital 10%)


management accounting - centum

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