MB0041 Financial and Management Accounting

Q.1 Explain the tools of Management accounting? Tools of Management Accounting Management Accounting uses the following tools or techniques to fulfill its responsibilities and duties towards management. . Financial Statements are indicators of two significant factors that include profitability and financial soundness. Analysis and interpretation of financial statements enables full diagnosis of the profitability and financial soundness of the firm. Analysis means methodical classification of the data given in the financial statements. Methodical classification enables comparison of the various interconnected figures with each other. Interpretation explains the meaning and significance of the data. Funds Flow Analysis is an important tool for management accountant. It reveals the changes in working capital position, the sources from which the working capital was obtained and the purpose for which it was used. It also reveals the changes that have taken place behind the Balance Sheet. Financial Statement Analysis Funds Flow Analysis Cash Flow Analysis Costing Techniques that includes marginal costing, differential costing, standard costing, and responsibility costing Budgetary control Management Reporting

Cash Flow Statement identifies the sources and application of cash. It is prepared on the basis of actual or estimated data. It depicts the changes in the cash position from one period to another. A projected cash flow or a cash budget will help the management in ascertaining how much cash will be available to meet obligations to trade creditors, to pay bank loans and to pay dividends to the shareholders.

Standard Costing is the preparation and use of standard costs, their comparison with actual costs and the analysis of variance. It discloses the cost of deviations from standards. It aims at assessing the cost of a product, process or operation under standard operating conditions.

Budgetary Control has become an essential tool of management for controlling costs and to maximize profit. It helps to compare the current performance with preplanned performance thereby correcting the deviations if any.

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MB0041 Financial and Management Accounting

Management Reporting System is an organized method of providing each manager with all the data and only those data which he needs for his decisions, when he needs them and in a form which aids his understanding and stimulates his action.

Q.1

Explain the Various accounting Concepts and Principles?

Solution :

Accounting Concepts
Concepts : Concepts take the form of assumptions or conditions, which guide the accountants while preparing accounting statements. Types of Accounting Concepts As said earlier, concepts are the basic assumptions or conditions upon which the science of accounting is based. There are five basic concepts of accounting, namely business entity concept, which is also termed as separate entity concept, going concern concept, money measurement concept, periodicity concept and accrual concept. Each concept is discussed below. Business Separate Entity Concept : The essence of this concept is that business is a separate entity and it is different from the owner or the proprietor. It is an economic unit which owns its assets and has its own obligations. This enables the business to segregate the transactions of the company from the private transactions of the proprietor(s). Going concern concept : The fundamental assumption is that the business entity will continue fairly for a long time to come. There is no reason why an enterprise should be promoted for a short period only to liquidate the business in the foreseeable future. This assumption is called going concern concept. This concept forms the basis for the distinction between expenditure that will yield benefit over a long period of time (Fixed Assets) and expenditure whose benefit will be exhausted in the short term (Current Asset). Similarly liabilities are classified as short term liabilities and long term liabilities. Money Measurement Concept : All transactions of a business are recorded in terms of money. An event or a transaction that cannot be expressed in money terms, cannot be accounted in the books of accounts. Periodicity Concept : The time interval for which accounts are prepared is an important factor even though we assume long life for a business. The accounting period could be half year or even a quarter. The financial statements should be prepared at the end of each accounting period so that income statement shows profit or loss for that accounting period. So also a balance sheet is prepared to depict the financial position of the business. Accrual Concept : Profit earned or loss suffered for an accounting period is the MBA I Semestar Sikkim Manipal University Page 2 of 14

MB0041 Financial and Management Accounting

result of both cash and credit transactions. It is possible that certain incomes are earned but not received and similarly certain expenses incurred but not yet paid during an accounting period. But it is relevant to consider them while computing the financial results just because they are related to the specific accounting period.

Accounting Principles
Accounting Principles : Accounting Principles are the rules basing on which accounting takes place and these rules are universally accepted. Principle of Income Recognition : According to this concept, revenue is considered as being earned on the date on which it is realized, i.e., the date on which goods and services are transferred to customers for cash or for promise. It should further be noted that it is the amount which the customers are expected to pay which shall be recorded. In effect, only revenue which is actually realized should be taken to profit and loss account. Unrealized revenue should not be taken into consideration for determining the profit. Principle of Expense : Expenses are different from payments. A payment becomes expenditure or an expense only when such payment is revenue in nature and made for consideration. Principle of Matching Cost and Revenue : Revenue earned during a period is compared with the expenditure incurred to earn that income, whether the expenditure is paid during that period or not. This is matching cost and revenue principle, which is important to find out the profit earned for that period. Here costs are reported as expenses in the accounting period in which the revenue associated with those costs is reported. Principle of Historical Costs : This is called cost principle. All assets are recorded at the cost of acquisition and this cost is the basis for all subsequent accounting for the assets. The expenses and the goods purchased are shown at the value at which they are incurred. The value of the assets is constantly reduced by charging depreciation against their cost to present their book value in the balance sheet. Principle of Full Disclosure : The business enterprise should disclose relevant information to all the parties concerned with the organization. It means that any information of substance or of interest to the average investors will have to be disclosed in the financial statements. Double Aspect Principle : This concept is the most fundamental one for accounting. A business entity is an independent unit and it receives benefits from some and gives benefits to some other. Benefit received and benefit given should always match and balance. Modifying Principle : The modifying principle states that the cost of applying a principle should not be more than the benefit derived from. If the cost is more than the benefit, then that principle should be modified. This is called cost-benefit principle. There should be flexibility in adopting a principle and the advantage out MBA I Semestar Sikkim Manipal University Page 3 of 14

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of the principle should over weigh the cost of implementing the principle. Principle of Materiality : While important details of financial status must be informed to all relevant parties, insignificant facts which do not influence any decisions of the investors or any interested group, need not be communicated. Such less significant facts are not regarded as material facts. What is material and what is not material depends upon the nature of information and the party to whom the information is provided. While income has to be shown for income tax purposes, the amount can be rounded off to the nearest ten and fraction does not matter. The statement of account sent to a debtor contains all the details regarding invoices raised, amount outstanding during a particular period. The information on debtors furnished to Registrar of Companies need not be in detail. Principle of Consistency : Consistency is required to help comparison of financial data from one period to another. Once a method of accounting is adopted, it should not be changed. For instance if stock is valued under FIFO method in first year it should be valued under the same method in the subsequent years also. Likewise if the firm chooses to depreciate assets under diminishing balance method, it should continue to do so year after year, unless the management takes a policy decision to change the depreciation method. Any change in the accounting methods should be informed to the concerned authorities with justification. Principle of Conservatism or Prudence : Accountants follow the rule anticipate no profits but provide for all anticipated losses . Whenever risk is anticipated sufficient provision should be made. The value of investments is normally taken at cost, even if the market value is higher than the cost. If the market value expected is lower than the cost, then provision should be made by charging profit and creating investment fluctuation fund. This is the principle of conservatism and it does not mean that the income or the value of assets should be intentionally under stated.

Q.2 Pass journal entries for the following transactions. 1. Madan commenced business with cash Rs. 70000. 2. Purchased goods on credit 14000. 3. Withdrew for private use 3000. 4. Goods purchased for cash 12000. 5. Paid wages 5000.
Solution :

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MB0041 Financial and Management Accounting

Transacti Accounts affected in books of Account to be debited and on No. the business account to be credited 01. Capital account and cash Cash account being real account is account debited and Capital account being personal account is credited. 02. Goods account and creditors Goods account being real account is account debited and creditors account being personal account is credited. 03. Personal drawings account and Drawings account being personal cash account account is debited and cash account being real account is credited. 05. Goods account and cash account Goods account being real account is debited and cash account being real account is credited. 05. Wages account and cash account Wages account being nominal account is debited and cash account being real account is credited. Journal Entries for the month of . D r.(Rs.) Cr.(Rs.)

1. Capital a/c Dr.

To 70,000

70,000 Cash a/c.

(Being started business with cash)

2. Goods a/c Dr.

14,000

14,000 To Creditors a/c.

(Being goods purchase on credit)

3. Drawings a/c Dr.

To 3,000

3,000 Cash a/c

(Being drawing for personal use)

4. Goods a/c Dr.

To 12,000

12,000 Cash a/c

(Being goods purchased on cash)

5. Wages a/c Dr.

To 5,000 (Being wages paid)

5,000 Cash a/c.

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MB0041 Financial and Management Accounting Accounting equations for the transactions
Transacti on 1. 2. 3. 4. 5. End Equation -3,000 12,00 0 -5,000 50,00 0 Asset = Cash + 70,00 0 Good + 14,00 0 12,00 0 26,00 0 76,000 0 0 14,000 76,000 -5,000 62,000 Debtor s+ Furnitur e+= Liabilities + Owners Equity Creditor Madans s+ Capital 70,000 14,000 -3,000

Q.3 Explain the various types of errors disclosed by Trial Balance ?
Solution : Trial Balance According to J R Batliboi, Trial balance is a statement, prepared with the debit and credit balances of Ledger accounts to test the arithmetical accuracy of the books. According to Carter, Trial Balance is the list of debit and credit balances, taken out from ledger. It also includes the balances of cash and bank taken from cash book.

Objectives of Trial Balance

It is a list of balances of all ledger accounts and the cash book. It is just a statement, and not an account. It is just a working paper. It can be prepared at any time during the accounting period, say at the end of every month, every quarter, every half year or every year. Usually it is prepared at the end of accounting year before preparing the final accounts.

It is always prepared on a particular date and not for a particular period. It is prepared to check the arithmetical accuracy of the ledger accounts. If the books are arithmetically accurate, the total of all debit balances of a trial balance will be equal to the total of all credit balances.

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A tallied Trial Balance is not conclusive proof of the accuracy of the books of accounts since certain type of errors remain even when the Trial Balance tallies. Objectives or Need or functions of preparing Trial Balance The following are the objects or functions of preparing trial balance : To ascertain the arithmetical accuracy of the ledger accounts : The trial balance provides a useful check upon the ledger postings. If a trial balance tallies, it is proved that the posting to the ledger accounts is correct. In other words, it ensures that both the aspects of each transaction have been posted into the ledger i.e., debit aspects have been posted on the debit side and the corresponding credit aspects on the credit side. To help in the detection or location of errors : If a trial balance does not tally, it indicates that some errors have occurred and the accountant will then proceed to locate such errors. Even a small difference in the trial balance is to be given the same importance and attention as a large difference because it may be possible that there may be a number of errors which have offset the effect of one another, resulting in a small composite difference. To obtain a summary of the ledger accounts : A Trial Balance serves as a summary of all the ledger accounts. Scanning the Trial Balance enables one to know the assets, liabilities, expenses, incomes etc. For the preparation of Final Accounts : As the trial balance contains the list of all the Ledger accounts, it provides a basis for further processing of accounting data i.e., preparation of final accounts namely Trading and Profit and Loss Account and a Balance Sheet. Types of Errors : Errors affecting Trial Balance (or Errors Disclosed by Trial Balance): If the Trial Balance does not tally, it will indicate that certain errors have been committed which have affected the agreement of the Trial Balance. The accountant will then proceed to find out the errors and ultimately the errors will be located. Such errors are called Errors Disclosed by Trial Balance or Errors which affect the agreement of Trial Balance. Until such errors are rectified, the Trial Balance will not agree. Some of these types of errors are as follows: Wrong Casting : If the total of the Cash Book or some other Subsidiary Book is wrong, the Trial Balance will not tally. For example, the total of the Purchase book has been added Rs. 2000 in excess. When this total will be posted to the debit side of the purchase account, it will also show an excess debit of Rs. 2000

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and hence, the Trial Balance will not tally. Posting to the Wrong Side : If instead of posting an amount on the debit side of an account, it is posted on the credit side, or vice versa, the Trial balance will not tally. For example, goods for Rs. 2000 from Gopal. If instead of posting the amount on the credit side of Gopals account it is posted to his debit, the debit side of the Trial Balance will exceed the credit by Rs. 4,000. Posting of Wrong Amount : The Trial Balance will not tally if the posting in an account is made with an incorrect amount. For example, goods for Rs. 600 have been purchased from Mahendra. If, it has been correctly entered in the Purchase Book or purchase account, but while posting to Mehendras account, in credit side (correct side) the amount posted is Rs. 60 instead of Rs. 600, the Trial Balance will not tally. Omission of Posting of One Side of an Entry : For example if Rs. 500 have been received from Ram and correctly entered in the Cash Book or Cash Account but if it is mmitted to be posted on the credit side of Rams Account, the Trial Balance will not tally. Double Posting in a Single Account : For example if Rs. 500 have been received from Shyam Lal and correctly entered in the Cash Account, but if it is posted twice on the credit side of Shyam Lals account, the Trial Balance will not tally. Errors of Totalling and Balancing of Accounts in the Ledger : Errors may occur in the totaling of debit or credit sides of accounts in the Ledger or in the balancing of accounts in the Ledger. Because the balances of accounts are transferred to the Trial Balance, Then the Trial balance will not tally.

Errors not affecting Trial Balance : Defects/Limitations of Trial Balance (Or errors not disclosed by Trial Balance):

Main object of preparing a Trial Balance is to check the accuracy of the accounts. However, the equality of debits and credits of the Trial Balance does not mean that there are absolutely no errors in the books of accounts. There may be number of errors which may remain undetected in spite of the agreement of a Trial Balance. As such, it is true to say that Trial Balance is not a conclusive proof of the accuracy of the books of accounts. There are certain

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errors which do not affect the agreement of the Trial Balance. Such errors are also called limitations of Trial Balance. Errors of Omission : If a transaction remains altogether unrecorded either in the Journal or in Subsidiary Books, it will be termed as an error of omission, such an error will not affect the agreement of a Trial Balance, as neither the transaction has been entered on the debit side of an account nor on the credit side of any other account. The omission will not affect the Trial Balance in any way, because neither has it been recorded on the debit side of Rams account nor on the credit side of sales account. Errors of Commission : If a wrong amount is entered either in the Journal or subsidiary Books, the Trial Balance will not tally because the same amount (Wrong amount) will be posted in both the accounts affected by the transaction. For example, sale of goods to Ram on credit for Rs. 420 has been entered in the Journal as Rs. 240, Ram being debited with Rs. 240, and sales account being credited with Rs. 240. In spite of the inaccuracy in both the accounts, the Trial Balance will tally. Compensating Errors : If the effect of one error is neutralized by the effect of some other error, such errors are called compensation errors. For example, while posting on the debit side of Anils account, Rs. 50 is posted instead of Rs. 500 and while posting on the debit side of Sunils account Rs. 500 is posted instead of Rs. 50. These two mistakes will nullify the effect of each other and in spite of the errors in both the accounts, the Trial Balance will still agree. Errors of Principle : When some fundamental principle of Accountancy is violated while recording a transaction, the error is termed as error of principle. These errors are committed in those case where a proper distinction between capital and revenue items is not made, i.e., a capital expenditure is treated as a revenue expenditure or vice-versa. These errors may be of two types: a) When revenue expenditure is treated as capital expenditure: For example if the amount spent on the repair of old machinery is debited to machinery account (Real Account) instead of repairs account (Nominal Account). b) When a capital expenditure is treated as revenue expenditure: For example, if the purchase of furniture is treated as an ordinary purchase and is thus debited to purchase account instead of furniture account, it will be an error of principle. Similarly, if amount spent on the extension of building is debited to repairs account instead of building account; it is also an error of principle.

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MB0041 Financial and Management Accounting

Errors of Posting in Wrong Account : If, while posting from the books of original entry, posting is made to a wrong account but on the correct side, the error will not affect the agreement of Trial Balance. If, for example, goods are sold to Ram on credit but Shyams account is debited in place of Rams account in Ledger, the Trial Balance would tally in spite of errors in both the accounts.

Q. 4

From the following balances extracted from Trial balance, prepare Trading Account.
The closing stock at the end of the period is Rs. 56000 Particulars Amount in Rs. Stock on 1-1-2004 70700 Returns inwards 3000 Returns outwards 3000 Purchases 102000 Debtors 56000 Creditors 45000 Carriage inwards 5000 Carriage outwards 4000 Import duty on materials received 6000 from abroad Clearing charges 7000 Rent of business shop 12000 Royalty paid to extract materials 10000 Solution : Trading Account

for the year ending ..

Dr. Particulars To Stock as on 0101-2004 To Purchases Less (-) Returns Outwards To Carriage Inwards To Import Duty To Clearing Charges To Royalty To Fire Insurance To Wages 10200 0 3000 99000 5000 6000 7000 10000 2000 8000 Rs. 70700 Particulars By Sales Less(-) Returns Inwards By Closing Stock 25000 0 3000 247000 56000 Cr. Rs.

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To Gas, Electricity, Water To Gross Profit TOTA L 4000 91300 303000 TOTA L 303000

Q. 5

Differentiate Financial Accounting and Management accounting?

Solution : Distinction between Financial Accounting and Management Accounting Financial accounting is the preparation and communication of financial information to outsiders such as creditors, bankers, government, customers and so on. Another objective of financial accounting is to give complete picture of the enterprise to shareholders. Management accounting on the other hand aims at preparing and reporting the financial data to the management on regular basis. Management is entrusted with the responsibility of taking appropriate decisions, planning, performance evaluation, control, management of costs, cost determination etc., For both financial accounting and management accounting the financial data is the same and the reports prepared in financial accounting are also used in management accounting But the following are major differences between Financial accounting and Management accounting.

Financial accounting * The primary users of financial accounting information are shareholders, creditors, government authorities, employees etc., Accounting information is always expressed in terms of money.

Management accounting Top, middle and lower level managers use the information for planning and decision making. Management accounting may adopt any measurement unit like labour hours, machine hours or product units for the purpose of analysis. Reports are prepared on continuous basis, monthly or weekly or even daily. Management accounting oriented towards Future. is

Financial data is presented for a definite period, say one year or a quarter. Financial accounting historical data. focuses on

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* Financial accounting is a discipline by itself and has its own principles, policies and conventions. Management accounting makes use of other disciplines like economics, management, information system, operation research etc.,

Q. 6

Following is the Balance Sheet of M/s Srinivas Ltd. You are required to prepare a Fund Flow Statement.
Particulars Equity Share capital Profit & Loss Trade Creditors Mortgage Short term loans Accrued expenses Total 2006 50,000 14,750 29,000 10,000 15,000 8,000 1, 26,750 2007 65,000 17,000 31,000 15,000 16,500 7,500 1, 52,000 Particulars Cash balances Debtors Investment Fixed Assets Less: Depreciation Goodwill Stock Total 2006 10,000 25,000 5,000 50,000 (5,250) 5,000 37,000 1, 26,750 2007 13,000 27,000 nil 80,000 (7000) nil 39,000 1, 52,000

Solution : Schedule of Changes in Working Capital Balance as on Particulars Current Assets Cash Debtors Stock Total Current assets, Say A 10,000 25,000 37,000 72,000 13,00 0 27,00 0 39,00 0 79,00 0 3,000 2,000 2,000 2006 2007 Increa se Decrea se

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Current liabilities Trade Creditors Short term loans Accrued expenses Total current liabilities, say B Working capital (A-B) Net increase in Working capital Total 29,000 15,000 8,000 52,000 20,000 4,000 24,00 0 31,00 0 16,50 0 7,500 55,00 0 24,00 0 24,00 0 7,500 4,000 7,500 500 2,000 1,500

Adjusted Profit & Loss Account Particulars To Depreciation To Goodwill Amount( Rs.) 1,750 5,000 Particulars By Balance b/d By Funds generated from operations (Balancing figure) Amount( Rs.) 14,750 12,500

To Dividend To Balance c/d TOTAL

3,500 17,000 27,250 TOTAL 27,250

Fund Flow Statement Particulars Issue of Fresh quity Sale of investment Loan on mortgage Fund from operations TOTAL Amount( Rs.) 15,000 5,000 5,000 12,500 37,500 TOTAL 37,500 Particulars Purchase of fixed assets Payments dividends Increase in working capital of Amount( Rs.) 30,000 3,500 4,000

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