SECTION – A 201

(i) Discuss about accounting principles

Ans- 5 Principles of Accounting are :-

1. Revenue Recognition Principle - Revenue is the gross inflow of cash, receivables or other considerations

arising in the course of ordinary activities of an enterprise from the sale of goods, rendering of services and

use of enterprise resources by others yielding interests, royalties, and dividends.

2. Historical Cost Principle - According to Historical Cost principle, an asset is ordinarily recorded in the accounting

records at the price paid to acquire it at the time of its acquisition and the cost becomes the basis for the accounts

during the period of acquisition and subsequent accounting periods

3. Matching Principle - According to this principle, the expenses incurred in an accounting period should be

matched with the revenues recognized in that period, e.g., if revenue is recognized on all goods sold during a period,

the cost of those goods sold should also be charged to that period.

4. Full Disclosure Principle - According to this principle, the financial statements should act as a means of conveying

and not concealing. The financial statements must disclose all the relevant and reliable information which they purport

to represent so that the information may be useful for the users.

5. Objectivity Principle- According to this principle, the accounting data should be definite, verifiable and free from

the personal bias of the accountant.

In other words, this principle requires that each recorded transaction/event in the books of accounts should have

adequate evidence to support it.

ii. What is the purpose of balance sheet?

Ans- The purpose of the balance sheet is to reveal the financial status of a business as of a specific point in time. The statement

shows what an entity owns (assets) and how much it owes (liabilities), as well as the amount invested in the business (equity).

This information is more valuable when the balance sheets for several consecutive periods are grouped together, so that trends in

the different line items can be viewed.

There are several subsets of information that can be used to gain an understanding of the short-term financial status of an

organization. When the current assets subtotal is compared to the current liabilities subtotal, one can estimate whether a firm has

access to sufficient funds in the short term to pay off its short-term obligations.

(v) What is the purpose of marginal costing ?

Ans- Marginal cost is the change in the total cost when the quantity produced is
incremented by one. That is, it is the cost of producing one more unit of a good.
Purpose for Marginal Costing
 Variable cost per unit remains constant; any increase or decrease in production changes
the total cost of output.

 Total fixed cost remains unchanged up to a certain level of production and does not vary
with increase or decrease in production. It means the fixed cost remains constant in terms
of total cost.

 Fixed expenses exclude from the total cost in marginal costing technique and provide us
the same cost per unit up to a certain level of production.

(vii) What is the need for Ratio analysis ?

 Ans- Ratio analysis will help validate or disprove the financing, investment and operating decisions of the
firm. They summarize the financial statement into comparative figures, thus helping the management to
compare and evaluate the financial position of the firm and the results of their decisions.

 It simplifies complex accounting statements and financial data into simple ratios of operating efficiency,
financial efficiency, solvency, long-term positions etc.

 Ratio analysis help identify problem areas and bring the attention of the management to such areas. Some
of the information is lost in the complex accounting statements, and ratios will help pinpoint such
problems.

(viii) What is double – entry system of book keeping ?

Ans- Double-entry bookkeeping, in accounting, is a system of bookkeeping so named because every entry to
an account requires a corresponding and opposite entry to a different account. The double entry has two equal
and corresponding sides known as debit and credit. The left-hand side is debit and right-hand side is credit. For
instance, recording a sale of $100 might require two entries: a debit of $100 to an account named "Cash" and a
credit of $100 to an account named "Revenue.

(ix) What is the purpose of standard costing ?

Ans- Purposes Standard Costing System:

Standard costing systems help in planning operations and gaining insights into the probable impact
of managerial decisions on cost levels and profits. Standard costs are used for:

1. Establishing budgets.
2. Controlling costs and motivation and measuring efficiencies.
3. Promoting possible cost reduction.
4. Simplifying costing procedures and expediting cost reports.
5. Assigning costs to materials, work in process, and finished goods inventories.
6. Forming the basis for establishing bids and contracts and for setting sales prices.

SECTION – B
 Q. 2. What is zero based budgeting ? How is it done and what are its benefits ?
Give on example
Ans- Zero based budgeting in management accounting involves preparing the budget from the scratch
with a zero-base. It involves re-evaluating every line item of cash flow statement and justifying all the
expenditure that is to be incurred by the department.
Thus, zero-based budgeting definition goes as a method of budgeting whereby all the expenses for
the new period are calculated on the basis of actual expenses that are to be incurred and not on the
differential basis which involves just changing the expenses incurred taking into account change in
operational activity. Under this method, every activity needs to be justified, explaining the revenue that
every cost will generate for the company.
Zero Based Budgeting Advantages
1. Accuracy: Against the regular methods of budgeting that involve just making some arbitrary changes to
the previous year’s budget, zero-based budgeting makes every department relook each and every item of
the cash flow and compute their operation costs. This to some extent helps in cost reduction as it gives a
clear picture of costs against the desired performance.
2. Efficiency: This helps in efficient allocation of resources (department-wise) as it does not look at the
historical numbers but looks at the actual numbers
3. Reduction in redundant activities: It leads to the identification of opportunities and more cost-effective ways
of doing things by removing all the unproductive or redundant activities.
4. Budget inflation: Since every line item is to be justified, zero-based budget overcomes the weakness
of incremental budgeting of budget inflation.
5. Coordination and Communication: It also improves coordination and communication within the department
and motivates employees by involving them in decision-making.

Zero Based Budgeting Example

Let us take an example of a manufacturing department of a company ABC that spent $ 10 million
last year. The problem is to budget the expenditure for the current year. There are multiple ways
of doing so:

1. The board of directors of the company decides to increase/decrease the expenditure of the department by
10 percent. So the manufacturing department of ABC Ltd will get $ 11 million or $ 9 million depending on
the management’s decision.
2. The senior management of the company may decide to give the department the same amount as it got in
the previous year without hiring more people in the department, or increasing the production etc. This way,
the department ends up getting $ 10 million.
3. Another way is, as, against the traditional method, management may use zero-based budgeting in which
the previous year’s number of $ 10 million is not used for calculation. Zero-based budgeting application
involves calculating all the expenses of the department and justifying each of these. This reflects the
actual requirement of the manufacturing department of company ABC which may be $ 10.6 million.

Q. 3. What are different kinds of ratios calculated by managers ? Give significance

of each.
ANS- Types of Ratios
There are actually two ways in which financial ratios can be classified. There is the classical approach,
where ratios are classified on the basis of the accounting statement from where they are obtained. The
other is a more functional classification, based on the uses of the ratios and the purpose for which they
are calculated.

[A] Traditional Classification

Traditional Classification has three types of ratios, namely

Profit and Loss Ratios

Balance Sheet Ratios
Composite Ratios
1] Profit and Loss Ratios
When both figures are derived from the statement of Profit and Loss A/c we will call it a Profit and Loss
Ratio. It can also be known as Income Statement Ratio or Revenue Statement Ratio. One such example
is the Gross Profit ratio, which is the ratio of Gross Profit to Sales or Revenue. As you will notice, both
these amounts will be derived from the Profit and Loss A/c. Other examples include Operating ratio, Net
Profit ratio, Stock Turnover Ratio etc.

2] Balance Sheet Ratios

Just as above, if both the variables are obtained from the balance sheets, it is known as a balance sheet
ratio. When such a ratio expresses the relation between two accounts of the balance sheet, we also call
them financial ratios (other than accounting ratios).

Take for example Current ratio that compares current assets to current liabilities, both derived from the
balance sheet. Other examples include Quick Ratio, Capital Gearing Ratio, Debt-Equity ratio etc.

3] Composite Ratios
A composite ratio or combined ratio compares two variables from two different accounts. One is taken
from the Profit and Loss A/c and the other from the Balance Sheet. For example the ratio of Return on
Capital Employed. The profit (return) figure will be obtained from the Income Statement and the Capital
Employed is seen in the Balance Sheet. A few other examples are Debtors Turnover Ratio, Creditors
Turnover ratio, Earnings Per Share etc.
Types of ratios

[B] Functional Classification

Then we move onto the functional classification. These help us group the ratios according to the functions
they perform in our understanding and analysis of financial statements. This is a more accurate and useful
classification of ratios, and hence more commonly used as well. The types of ratios according to the
functional classification are

Liquidity Ratio
Leverage Ratios
Activity Ratios
Profitability Ratios
Coverage Ratios
1] Liquidity Ratios
A firm needs to keep some level of liquidity, so stakeholders can be paid when they are due. All assets of
the firm cannot be tied up, a firm must look after its short-term liquidity. These ratios help determine such
liquidity, so the firm may rectify any problems. The two main liquidity ratios are Current ratio and Quick
Ratio (or liquid ratio).

2] Leverage Ratios
These ratios determine the company’s ability to pay off its long-term debt. So they show the relationship
between the owner’s fund and the debt of the company. They actually show the long-term solvency of a
firm, whether it has enough assets to pay of all its stakeholders, as well as all debt on the Balance Sheet.
This is why they are also called Solvency ratios. Some examples are Debt Ratio, Debt-Equity Ratio,
Capital Gearing ratio etc.

3] Activity Ratios
Activity ratios help measure the efficiency of the organization. They help quantify the effectiveness of the
utilization of the resources that a company has. They show the relationship between sales and assets of
the company. These types of ratios are alternatively known as performance ratios or turnover ratios. Some
ratios like Stock Turnover, Debtors turnover, Stock to Working Capital ratio etc measure the performance
of a company.
4] Profitability Ratios
These ratios analyze the profits earned by an entity. They compare the profits to revenue or funds
employed or assets of an entity. These ratios reflect on the entity’s ability to earn reasonable returns with
respect to the capital employed. They even check the soundness of the investment policies and decisions.
Examples will include Operating Profit ratio, Gross Profit Ratio, Return on Equity Ratio etc.

5] Coverage Ratios
Shows the equation between profit in hand and the claims of outside stakeholders. These are
stakeholders that are required by the law to be paid, even in case of liquidation. So these types of ratios
ensure that there is enough to cover these payments to such outsiders. Some examples of coverage
ratios are Dividend Payout Ratio, Debt Service ratio etc.

Q. 5. What are final accounts & how are they prepared ? Show.
Ans- Definition

The accounts which are prepared at the final stage of the accounting cycle to know the profit or loss
and financial position of a business concern are called Final Accounts.
Explanation
Every businessman enters into business activities to earn profit. It is the accounting that shows profit
or loss of a business concern. The role of accounting is to compile the financial record of a business
in such a manner that yields the profit or loss of the business. We have already learned that all the
transactions of a business are in the first instance recorded in the books of the original entry. Then
these transactions are posted into ledgers in classified form.

These transactions are then summarized and arithmetical accuracy is checked by means of a “Trial
Balance”. After the preparation of “Trial Balance”, the next step is the preparation of “Final Accounts”.
The accounting cycle begins with the recording of transactions in the books of original entry and ends
with the preparation of “Final Accounts”. As these accounts are prepared at the final stage of the
accounting cycle that’s why these are called “Final Accounts”. These accounts consist of the
followings:

preparation of Final Accounts

The objectives of preparing final accounts are:-

1. To ascertain the results of transactions:

Final Accounts are prepared to know the profit earned or loss sustained by the business in a
particular period of time. In order to determine the profit and loss of business, trading and profit and
loss account or Income Statement is prepared.
2. To know the financial position of the business:

Besides the determination of profit and loss, the financial position of the business is measured
through final accounts. The financial position of the business is shown with the help of a balance
sheet.

Trial Balance: The basis of Final Accounts

The basis of Final Accounts is the Trial Balance. The trial balance includes all the balances of
ledger accounts. It includes the account balances of expenses, revenue, assets, liabilities, capital
and drawings. A trial balance has two columns, debit and credit. Debit balances usually represent
expenses, assets drawings and these appear in the debit column of trial balance.
Credit balances generally represent revenue, capital and liabilities and these appear in credit
column of trial balance. From trial balance Expenses and revenues are transferred to Trading
and Profit and Loss Account while assets, liabilities and drawings are transferred to Balance
Sheet.
Q. 6. What is cost accounting ? What are different tools used for it ? Explain purpose of each.
Ans- Cost accounting is an accounting method that aims to capture a company's costs of
production by assessing the input costs of each step of production as well as fixed costs,
such as depreciation of capital equipment. Cost accounting will first measure and record
these costs individually, then compare input results to output or actual results to aid
company management in measuring financial performance

Types of Costs
Fixed Costs are costs that don't vary depending on the amount of work a company is
doing. These are usually things like the payment on a building or a piece of equipment
that is depreciating at a fixed monthly rate.

Variable costs are costs tied to a company's level of production. An example could be a
coffee roaster which, after receiving a large order of beans from a far-away locale, has to
pay a higher rate for both shipping, packaging, and processing.

Operating costs are costs associated with the day-to-day operations of a business. These
costs can be either fixed or variable depending on the unique situation.

Direct costs are costs related to producing a product. If a coffee roaster spends five hours
roasting coffee, the direct costs of the finished product include the labor hours of the
roaster and the cost of the coffee beans. The energy cost to heat the roaster would be
indirect because it is inexact and difficult to trace.