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Question sir pls answer these question, Iam feeling difficulty in answering.
Q1. What do you mean by ‘accounting’? Explain the various concepts of accounting and the need for having accounting standards?
Q2. The balance sheets of ABC Ltd. as on 31-3-2008 and 31-3-2007 are as given below:
ABC Ltd.
Balance Sheets
31-3-08
31-3-07
Sources of Funds
Share Capital
5,000
4,000
Reserves and Surplus
General Reserve
1,000
800
P&L A/c
400
200
Share Premium
1,000
-
Capital Reserve
1,000
500
3,400
1,500
Secured Loans
4,000
3,000
Unsecured Loans
3,000
1,000
Total
15,400
9,500
Applications of Funds
Fixed Assets –Gross Block
12,000
10,000
Less: Accumulated Depn.
3,000
2,000
Net Block
9,000
8,000
Capital Work-in-progress
3,000
-
Investments
2,000
5,00
Current Assets, Loans and Advances
A. Current Assets
Inventories – Raw materials
700
600
Work-in-progress
250
300
Finished goods
150
200
Sundry Debtors
1,200
1,300
Prepayments
200
150
Cash and Bank Balances
500
400
3,000
2,950
B. Loans and Advances
Advance tax
1,400
9,00
Loans to employees (long-term)
1,000
5,00
5,400
4,350
Less: Current Liabilities of Provisions
A Current Liabilities
Sundry Creditors
8,00
9,50
Outstanding Expenses
4,00
3,00
B. Provisions
Provisions for Retirement
Benefits of employees
3,50
3,00
Tax Provision
1,450
1,000
Proposed Dividend
1,000
8,00
4,000
3,350
Net Current Assets
1,400
1,000
Total
15,400
9,500
Additional Information:
1.Actual tax liability for 2006-07was Rs. 950 lacs;
2.A piece of machinery costing Rs. 500 lacs, accumulated depreciation Rs. 200 lacs was sold for Rs. 250 lacs. The loss was charged to profit and loss account;
3.A portion of secured loan as on 31-3-07 amounting to Rs. 400 lacs was converted into equity at a premium Rs. 200 lacs. There was also fresh issue of equity at 100% premium.
4.Out of secured loans as on 31-3-08 Rs 500 lacs were short-term loans.
5.Out of unsecured loans, short-term loans were to the extent of Rs. 400 lacs and Rs. 500 lacs respectively as on 31-3-07 and 31-3-08.
6.Out of investments Rs. 200 lacs were current investments as on 31-3-07 and Rs. 500 lacs were current investments as on 31-3-08.
7.There was a revaluation of fixed assets during 2007-08 and the revaluation profit Rs. 500 lacs was charged to capital reserve.
From the information given above, you are required to prepare:
a) Statement showing changes in working capital
b) Funds flow statement.
Q3. Explain briefly the technique of marginal costing. In what ways do you consider this
technique useful in management accounting?
Q4. Ravi Co Ltd. is considering the following investment projects:
Cash flows (Rs.)
Projects Year0 Year1 Year2 Year3
A -10,000 +10,000 - -
B -10,000 +7,500 +7,500 -
C -10,000 +2,000 +4,000 +12,000
D -10,000 +10,000 +3,000 +3,000
a)Rank the projects according to each of the following methods :
(i) Pay back (ii) ARR (iii) IRR and
(iv) NPV- assuming discount rates of 10% and 30%
b)Assuming that the projects are independent, which one should be accepted?
If the projects are mutually exclusive, which project is the best?
Answer RAGHAVA,
HERE IS SOME USEFUL MATERIAL.
OTHER QUESTIONS ARE OUT OF MY EXPERTISE AREA.
REGARDS
LEO LINGHAM
Q1. What do you mean by ‘accounting’? Explain the various concepts of accounting and the need for having accounting standards?
HERE IS SOME USEFUL MATERIAL.
REGARDS
LEO LINGHAM
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WHAT IS ACCOUNTING?
Quite simply, accounting is a language: a language that provides information about the financial position of an organization. When you study accounting you are essentially learning this specialized language. By learning this language you can communicate and understand the financial operations of any and all types of organizations.
This is because the information required by most organizations is very similar and can be broken down into three main categories:
ACCOUNTING INTRODUCTION
Operating Information
This is the information that is needed on a day-to-day basis in order for the organization to conduct its business. Employees need to get paid, sales need to be tracked, the amounts owed to other organizations or individuals need to be tracked, the amount of money the organization has needs to be monitored, the amounts that customers owe the organization need to be checked, any inventory needs to be accounted for: the list goes on and on. Operating information is what constitutes the greatest amount of accounting information and it provides the basis for the other two types of accounting information.
Financial Accounting Information
This is the information that is used by managers, shareholders, banks, creditors, the government, the public, etc… to make decisions involving the organization and its operations. Shareholders want information about what their investment is worth and whether they should buy or sell shares, bankers and other creditors want to know whether the organization has an ability to pay back money lent, managers want to know how the company is doing compared to other companies. This type of information would be very difficult to extract if every company used a different system for recording their financial position. Financial accounting information is subject to a set of ground rules that dictate how the information is reported and this ensures uniformity.
Managerial Accounting Information
In order for the managers of a company to make the best decisions for a company they need to have specific information prepared. They use this information for three main management functions: planning, implementation and control. Financial information is used to set budgets, analyze different options on a cost basis, modify plans as the need arises, and control and monitor the work that is being done.
As you can see, accounting is a multifaceted system involving different people with different needs and after analyzing the various uses and applications of accounting information the American Accounting Association has come up with this definition: “the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information.”
In order to facilitate the informed use of this financial information, accounting has come to be based on specified rules or conventions called “principles.” These principles provide general laws or rules that are used to guide accounting activity and are called Generally Accepted Accounting Principles, or GAAP for short. These principles are established by the Financial Accounting Standards Board (FASB) which is a nongovernmental agency funded by the accounting profession and contributions from business organizations. While there is no legal obligation for companies to adhere to GAAP, there are strong practical reasons to do so. From auditing to reporting earning to the US Securities Exchange Commission to applying for a loan, there are very compelling reasons for organizations to conform to the generally accepted standard.
What Is The End Result Of All This Accounting Information? We’ve talked about the reason for maintaining accounting information and the end result of all of this recording is the preparation of financial statements. These statements let people see, at a glance, the financial position of an organization. These statements provide summaries of the operating information and are used extensively by people within and external to the company. The statements fall into one of two categories:
Status/Stock – these statements show the financial status of an organization at one specified instant in time. Stock reports = a snapshot.
Flow Report – these statements show the flow of financial information over a period of time. Flow reports = motion picture
GAAP requires the preparation of three different statements:
Balance Sheet
A Balance Sheet is a status report that shows information about the organization’s resources at one given time. Examples of information found on a balance sheet are how much cash is in the bank, what is owed to creditors, and the value of the company’s assets.
Income Statement
An Income Statement (also called a Statement of Earnings, Statement of Operations, or a Profit and Loss Statement) is a report that shows the flow of revenues (amounts earned from business activity) and expenses (amounts paid in the course of operations) over a given period of time, typically a month, quarter, or year.
Statement of Cash Flow
As the name suggests, this is also a flow statement that details the movement of cash through the organization over a specified period.
The whole purpose of accounting is to provide information that is useful and relevant for interested parities when making decisions regarding the company and its operations. In order to do that effectively, a specific language and subsequent rules have been developed for users of the information. By learning accounting you learn these rules and can then communicate financial information with others in a comprehensible and comparable manner.
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CONCEPTS OF ACCOUNTING
Accounting is the language of business and it is used to communicate financial information. In order for that information to make sense, accounting is based on 12 fundamental concepts. These fundamental concepts then form the basis for all of the Generally Accepted Accounting Principles (GAAP). By using these concepts as the foundation, readers of financial statements and other accounting information do not need to make assumptions about what the numbers mean.
For instance, the difference between reading that a truck has a value of $9000 on the balance sheet and understanding what that $9000 represents is huge. Can you turn around and sell the truck for $9000? If you had to buy the truck today, would you pay $9000? Or, perhaps the original purchase price of the truck was $9000. All of these assumptions lead to very different evaluations of the worth of that asset and how it contributes to the company’s financial situation.
For this reason it is imperative to know and understand the eleven key concepts.
ELEVEN KEY ACCOUNTING CONCEPTS
Entity
Accounts are kept for entities and not the people who own or run the company. Even in proprietorships and partnerships, the accounts for the business must be kept separate from those of the owner(s).
Money-Measurement
For an accounting record to be made it must be able to be expressed in monetary terms. For this reason, financial statements show only a limited picture of the business. Consider a situation where there is a labor strike pending or the business owner’s health is failing; these situations have a huge impact on the operations and financial security of the company but this information is not reflected in the financial statements.
Going Concern
Accounting assumes that an entity will continue to operate indefinitely. This concept implies that financial statements do not represent a company’s worth if its assets were to be liquidated, but rather that the assets will be used in future operations. This concept also allows businesses to spread (amortize) the cost of an asset over its expected useful life.
Cost
An asset (something that is owned by the company) is entered into the accounting records at the price paid to acquire it. Because the “worth” of an asset changes over time it would be impossible to accurately record the market value for the assets of a company. The cost concept does recognize that assets generally depreciate in value and so accounting practice removes the depreciation amount from the original cost, shows the value as a net amount, and records the difference as a cost of operations (depreciation expense.) Look at the following example:
Truck $10,000 purchase price of the truck
Less depreciation $ 1,000 amount deducted as a depreciation expense
Net Truck: $ 9,000 net book-value of the truck
The $9000 simply represents the book value of the truck after depreciation has been accounted for. This figure says nothing about other aspects that affect the value of an item and is not considered a market price.
Dual Aspect
This concept is the basis of the fundamental accounting equation:
Assets = Liabilities + Equity
Assets are what the company owns.
Liabilities are what the company owes to creditors against those assets
Equity is the difference between the two and represents what the company owes to its investors/owners.
All accounting transactions must keep this equation balanced so when there is an increase on one side there must be an equal increase on the other side or an equal decrease on the same side.
Objectivity
The objectivity concept states that accounting will be recorded on the basis of objective evidence (invoices, receipts, bank statement, etc…). This means that accounting records will initiate from a source document and that the information recorded is based on fact and not personal opinion.
Time Period
This concept defines a specific interval of time for which an entity’s reports are prepared. This can be a fiscal year (Mar 1 – Feb 28), natural year (Jan 1 – Dec 31), or any other meaningful period such as a quarter or a month.
Conservatism
This requires understating rather than overstating revenue (income) and expense amounts that have a degree of uncertainty. The rule is to recognize revenue when it is reasonably certain and recognize expenses as soon as they are reasonably possible. The reasons for accounting in this manner are so that financial statements do not overstate the company’s financial position. Accounting chooses to err on the side of caution and protect investors from inflated or overly positive results.
Realization
Revenues are recognized when they are earned or realized. Realization is assumed to occur when the seller receives cash or a claim to cash (receivable) in exchange for goods or services. This concept is related to conservatism in that revenue (income) is only recorded when it actually occurs and not at the point in time when a contract is awarded. For instance, if a company is awarded a contract to build an office building the revenue from that project would not be recorded in one lump sum but rather it would be divided over time according to the work that is actually being done.
Matching
To avoid overstatement of income in any one period, the matching principle requires that revenues and related expenses be recorded in the same accounting period. If you bill $20,000 of services in a month, in order to accurately represent the income for the month you must report the expenses you incurred while generating that income in the same month.
Consistency
Once an entity decides on one method of reporting (i.e. method of accounting for inventory) it must use that same method for all subsequent events. This ensures that differences in financial position between reporting periods are a result of changed in the operations and not to changes in the way items are accounted for.
Materiality
Accounting practice only records events that are significant enough to justify the usefulness of the information. Technically, each time a sheet of paper is used, the asset “Office supplies” is decreased by an infinitesimal amount but that transaction is not worth accounting for.
By understanding and applying these principles you will be able to read, prepare, and compare financial statements with clarity and accuracy. The bottom-line is that the ethical practice of accounting mandates reporting income as accurately as possible and when there is uncertainty, choosing to err on the side of caution.
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ACCOUNTING STANDARDS
A common standard for accounting and reporting. Accounting
Standards contain the principles governing accounting
practices and determine the appropriate treatment of
financial transactions.
1.DISCLOSURE OF ACCOUNTING POLICIES
2.VALUATION OF INVENTORIES
3.CASH FLOW STATEMENTS
4.CONTINGENCIES AND EVENTS OCCURING AFTER BALANCE SHEET DATE
5.NET PROFIT OR LOSS FOR THE PERIOD,PRIOR PERIOD AND CHANGES IN ACCOUNTING ESTIMATES
6.DEPRICIATION ACCOUNTING
7.ACCOUNTING FOR CONSTRUCTION
CONTRACTS
8.ACCOUNTING FOR RESEARCH AND
DEVELOPMENT
9.REVENUE RECOGNITION
10.ACCOUNTING FOR FIXED ASSETS
11.ACCOUNTING FOR EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES
12.ACCOUNTING FOR GOVERNMENT GRANTS
13.ACCOUNTING FOR INVESTMENTS
14.ACCOUNTING FOR AMALGAMATIONS
15.ACCOUNTING FOR RETIREMENT BENEFITS IN THE FINANCIAL STATEMENTS OF EMPLOYERS
16.ACCOUNTING FOR BORROWING COSTS
17.SEGMENTAL REPORTING
18.RELATED PARTY DISCLOSURES
19.LEASES
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Q3. Explain briefly the technique of marginal costing. In what ways do you consider this
technique useful in management accounting?
Marginal costing - definition
Marginal costing distinguishes between fixed costs and variable costs as convention ally classified.
The marginal cost of a product –“ is its variable cost”. This is normally taken to be; direct labour, direct material, direct expenses and the variable part of overheads.
Marginal costing is formally defined as:
‘the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Its special value is in decision making’. (Terminology.)
The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Thus
MARGINAL COST =
VARIABLE COST DIRECT LABOUR
+
DIRECT MATERIAL
+
DIRECT EXPENSE
+
VARIABLE OVERHEADS
CONTRIBUTION =SALES - MARGINAL COST
The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. The meaning is usually clear from the context.
Theory of Marginal Costing
The theory of marginal costing as set out is as follows:
In relation to a given volume of output, additional output can normally be obtained at less than proportionate cost because within limits, the aggregate of certain items of cost will tend to remain fixed and only the aggregate of the remainder will tend to rise proportionately with an increase in output. Conversely, a decrease in the volume of output will normally be accompanied by less than proportionate fall in the aggregate cost.
The theory of marginal costing may, therefore, by understood in the following two steps:
If the volume of output increases, the cost per unit in normal circumstances reduces. Conversely, if an output reduces, the cost per unit increases. If a factory produces 1000 units at a total cost of $3,000 and if by increasing the output by one unit the cost goes up to $3,002, the marginal cost of additional output will be $.2.
If an increase in output is more than one, the total increase in cost divided by the total increase in output will give the average marginal cost per unit. If, for example, the output is increased to 1020 units from 1000 units and the total cost to produce these units is $1,045, the average marginal cost per unit is $2.25. It can be described as follows:
additional cost-$45 / additional units-20 =$2.25.
The ascertainment of marginal cost is based on the classification and segregation of cost into fixed and variable cost. In order to understand the marginal costing technique, it is essential to understand the meaning of marginal cost.
Marginal cost means the cost of the marginal or last unit produced. It is also defined as the cost of one more or one less unit produced besides existing level of production. In this connection, a unit may mean a single commodity, a dozen, a gross or any other measure of goods.
For example, if a manufacturing firm produces X unit at a cost of $ 300 and X+1 units at a cost of $ 320, the cost of an additional unit will be $ 20 which is marginal cost. Similarly if the production of X-1 units comes down to $ 280, the cost of marginal unit will be $ 20 (300–280).
The marginal cost varies directly with the volume of production and marginal cost per unit remains the same. It consists of prime cost, i.e. cost of direct materials, direct labor and all variable overheads. It does not contain any element of fixed cost which is kept separate under marginal cost technique.
Marginal costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output.
There are different phrases being used for this technique of costing. In UK, marginal costing is a popular phrase whereas in US, it is known as direct costing and is used in place of marginal costing. Variable costing is another name of marginal costing.
Marginal costing technique has given birth to a very useful concept of contribution where contribution is given by: Sales revenue less variable cost (marginal cost)
Contribution may be defined as the profit before the recovery of fixed costs. Thus, contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus profit (C = F + P).
In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixed cost (C = F). this is known as break even point.
The concept of contribution is very useful in marginal costing. It has a fixed relation with sales. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales.
The principles of marginal costing
The principles of marginal costing are as follows.
For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the ‘relevant range’). Therefore, by selling an extra item of product or service the following will happen.
Revenue will increase by the sales value of the item sold.
Costs will increase by the variable cost per unit.
Profit will increase by the amount of contribution earned from the extra item.
Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item.
Profit measurement should therefore be based on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge units of sale with a share of fixed costs.
When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs. Fixed costs are unaffected, and no extra fixed costs are incurred when output is increased.
Features of Marginal Costing
The main features of marginal costing are as follows:
Cost Classification
The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique.
Stock/Inventory Valuation
Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method.
Marginal Contribution
Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.
Advantages and Disadvantages of Marginal Costing Technique
Advantages
Marginal costing is simple to understand.
By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.
It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead.
The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.
It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate.
Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management.
It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.
Disadvantages
The separation of costs into fixed and variable is difficult and sometimes gives misleading results.
Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.
Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent.
Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.
Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same.
Control affected by means of budgetary control is also accepted by many. In order to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.
In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.
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