MB0041 - Financial and Management Accounting Semester - 1 Assignment Set - 2

MB0041 - Financial and Management Accounting Semester - 1

Assignment Set - 2

Q.1 Selected financial information about Vijay merchant company is given below:

	2009	2010
Sales	43000	69000
Cost of goods sold	32500	57000
Debtor	3000	7200
Inventory	5500	11400
Cash	800	1500
Other current asset	2700	4000
Other current liabilities	11000	16000

Compute the current ratio, quick ratio, and average debt collection period and inventory turnover for 2009 and 2010. State whether there is a favorable or unfavorable change in liquidity from 2009 to 2010. At the beginning of 2009, the company had debtors of Rs.2500 and inventory of Rs.3000.

Ans :2009

1. Current ratio =Current Asset/ Current Liabilities

= debtor+ cash+ inventory+ other current asset/ current liabilities

=3000+800+5500+2700/ 11000 =1.09

2. Quick ratio= Current Asset- Inventory/ current liabilities

= 3000+800+2700/ 11000= 0.59

3. Average collection Period

Avg. trade debtor= opening debtor+ closing debtor/2

= 2500+3000/2=2750

Avg. collection period= avg.trade debtor *no. of working days/ net sales

= 2750 * 365/ 43000= 23.34 = 23 days

4. Inventory turnover ratio

Inventory turnover ratio= cost of goods sold/ avg. inventory= 32500 / 3000+5500/2= 32500/ 4250= 7.6 times.

2010

1. Current ratio =Current Asset/ Current Liabilities

= debtor+ cash+ inventory+ other current asset/ current liabilities

= 7200+ 11400+ 1500+ 4000/ 16000= 1.50

2. Quick ratio= Current Asset- Inventory/ current liabilities

= 7200+ 1500+ 4000/ 16000= 0.79

2. Average collection Period

Avg. trade debtor= opening debtor+ closing debtor/2

= 3000 + 7200 /2 =5100

Avg. collection period= avg.trade debtor * no. of working days/ net sales

= 5100/69000 * 365 = 26.9 or 27 days.

2. Inventory turnover ratio

Inventory turnover ratio= cost of goods sold/ avg. inventory= 57000 / 5500 +11400 /2= 69000/ 8450 = 6.74 times.

As the liquid ratio of 2010 is more than 2009, there is a favorable change in the firm’s liquidity in 2010 than 2009.

Q.2 Explain different methods of costing. Your answer should be studded with examples (preferably firm name and product) for each method of costing.

Ans: Costing refers to the techniques and process of determining costs of a product manufactured or a service rendered. The method of costing depends upon the nature of the product, production method and specific business condition. For example, in cement and steel industry, raw material passes through different stages or process and production is done on continuous bases while in cases of construction of a house or contract to build a metro rail/ fly over/ under pass the job is for a specific purpose and each job is different from the other. In service industry like hospitality industry, software development, back office processing work etc process costing technique is used.

Methods of costing

1. Job costing

1. Batch costing
2. Contract costing
3. Composite costing

2. Process costing

1. Unit costing
2. Operating costing
3. Operation costing

1. Job costing

It is used in those business concerns where production is carried out as per specific order and customer’s specification.

1. Batch costing

This method is used to determine the cost of a group of identical products. The batch consist of similar products is a unit and not a single item within the batch. E.g. Production of tablets, nuts & bolts, components and spare parts.

2. Contract costing

This method is based on the principle of job costing and used by house builders and civil contractors. The contract becomes the cost unit for which relevant cost are determined. E.g. Construction of an apartment, housing colony, airports, flyovers etc.

3. Composite costing

In this method of costs are accumulated for different components of the product and then combined because the nature of the product is complex. E.g. manufacturing of aero planes, motor vehicles, and computers.

2. Process costing

This method is used in those industries where manufacture is done continuously thereby it is difficult to trace costs to specific units. The total cost is averaged for the numbers of units manufactured.

1. Unit costing

This method is used when a single item is produced and the final product is composed for homogenous units. The cost per unit is obtained by dividing the total cost by the total number of units manufactured. E.g. sugar industry, cement, fertilizer, chemicals, petroleum refining, LPG, paper etc.

2. Operating costing

This method is used by service industries. The unit cost differs among these services depending upon the nature of services being rendered. E.g. passenger mile, bed in a hospital, per student in a college.

3. Operation costing

This product costing is used when conversion activities are very similar across products lines but the direct materials differ significantly. E.g. the professional basket balls are covered with genuine leather whereas the scholastic basket balls are covered with imitation leather.

Q.3 State the importance of differentiating between the fixed costs and variable costs in managerial decision.

Ans: Fixed expenses remain constant in aggregate amount and do not vary with the increase or decrease in production up to a particular level of output. Just contrary to this, variable expenses increases or decreases in proportion to increase or decrease in output and remain constant per unit of output. Fixed expenses per unit continue to vary with the increase or decrease in production because these expenses remain constant up to a certain level of production. Thus, fixed overhead lead to different costs per units at different level of production. On account of this, a special technique known as marginal costing has been developed which excludes fixed over head entirely from cost of production and gives us the same cost per unit up to particular level of output. Thus under this technique fixed expenses are not allocated to cost units but are charged against “fund” which arise out of excess of selling price over total variable costs.

The marginal costing helps the management in taking many policy decisions. The vital areas where these concepts are applied directly are as follows:

• Level of activity planning: Normally, the management will consider different levels of production or selling activities to decide optimum level of activity. Such periodic exercise shall put the organization in the right tract to achieve its goal. Since the optimum level of activity results in the maximum contribution per units, the planning can become a perfect execution tool.
• Alternative methods of production: with the help of marginal costing techniques, its possible to undertake decision about the alternative methods of production. All the decision should be focused at the greater contribution so that profit can be maintained ata balanced level.
• Make or buy decision: Depending upon the situational ambience, the management can have a blue print on a vital decision. Management can think of outsourcing the production activities or to undertake it within its purview. Based on the comparative statement of cost of manufacture with the purchase price, decision can be taken.
• Fixation of selling price: while pricing a product, the marginal costing techniques can come handy. While fixing a price for a product, it is prudent to take in top account the recovery of marginal cost in addition to get a reasonable contribution to cover fixed overheads. Pricing will be at ease once the marginal cost and overall profitability of the concern are known.
• Selection of optimum sales mix: the product mix plays an important role when a firm produces more than one product. The main focus will on profit maximization. With the help of marginal costing techniques, it is possible to decide the best product mix which results in maximum profit to the firm.
• New product introduction: when a firm intends to diversify its activities or to expand its existing markets, with the help of marginal costing techniques. By fixing the time horizon to recover the fixed costs and profit, decision can be taken for the introduction of new products.
• Balancing of profits: As the economic trends gets changed on account of government fiscal policies and regulations, competition at the regional, national, and international levels, marginal costing techniques can aid to bring out facts with regard to maintain a desired level of profits.
• Final balancing decision: If the sales of the product were not encouraging to cover the fixed costs, it is quite natural that firm may decide about its continuance. This may lead to dovetailing or completely closing down the operations. Marginal costing helps the management to take a sound decision.

Q.4 Following are the extracts from the trial balance of a firm as at 31st March 2009

Name of the account

	DR	CR
Sundry debtor	205000
Bad debt	3000

Additional Information

1) After preparing the trial balance, it is learnt that Mr. X a debtor has become insolvent and nothing could be recovered from him and, therefore the entire amount of Rs.5,000 due from him was irrecoverable.

2) Create 10% provision for doubtful debt.

Required: Pass the necessary journal entries and show the sundry debtors account, bad debts account, and provision for doubtful debts account, P&L a/c and Balance sheet as at 31st March 2009.

Ans:

1. Bad debt a/c………dr. Rs. 5000

To Mr. X a/c Rs. 5000

(Being amount due from Mr. X proved to be bad)

2. Profit & loss a/c………dr. Rs.20000*

To Provision for Bad 7 doubtful debts Rs.20000

(Being bad debt provision created @ 10% )

*Working note

Provision for bad debt = 205000- 5000= 200000 *10%=20000

Preparation of ledger accounts

Sundry Debtor A/c

Dr	Amount	Cr	Amount
To balance c/d	5000 5000	By bad debt a/c By balance b/d	5000 5000 5000

Bad debt A/c

Dr	Amount	Cr	Amount
To Sundry Debtor	5000 5000		5000 5000

Provision for bad and doubtful debt A/c

Dr	Amount	Cr	Amount
To balance c/d	20000 20000	By P/L a/c By balance b/d	20000 20000 20000

Profit & loss A/c

Dr	amount	Cr	Amount
To bad debt... 3000 Add. Bad debt Written off 5000 Add. New provision Created 20000	28000

Balance Sheet

Liabilities	Amount	Assets	Amount
		Sundry Debtor …205000 Less: Additional bad debt w.f. 5000 200000 Less: provision for Bad debt 20000	180000

Q.5 A change in credit policy has caused an increase in sales, an increase in discounts taken, a decrease in the amount of bad debts, and a decrease in investment in accounts receivable. Based upon this information, the company’s (select the best one and give reason).

• 1) Average collection period has decreased.
• 2) Percentage discount offered has decreased.
• 3) Accounts receivable turnover has decreased.
• 4) Working Capital has increased.

Ans: The effects of change in the credit policy are:

• An increase in sales
• An increase in discount taken
• A decrease in bad debts
• A decrease in account receivables.

Now we have to find out the appropriate cause:

First no.4 Working capital has increased. An increase in working capital indicates that the business has either increased current assets (that is has increased its receivables, or other current assets) or has decreased current liabilities. It means the firm, has increased its investment in account receivables or debtors. But it is not satisfying the no.4 effect which is “a decrease in account receivables”.

Then no.3 Account receivable turnover has decreased. Account receivable turnover is also known as debtor turnover ratio. A higher debtor turnover ratio indicates more efficient management of debtors/ sales or more liquid debtors. Similarly lower debtor turnover ratio indicates inefficient management of debtors/ sales and less liquid debtors. If debtor turnover ratio has been decreased and debtors are less liquid then bad debt will increase. But it is not satisfying no. 3 effect which is “a decrease in bad debt”.

Then no.2 Percentage discount offered has decreased. Firms offer cash discounts to induce their customers to make prompt payments. Cash discounts have implications on sales volume, average collection period, investment in receivables, incidence of bad debts and profits. Providing a small cash discount would be beneficial for the seller as it would allow him to have access to the cash sooner. The sooner a seller receives the cash, the earlier he can put the money back into the business to buy more supplies and/or grow the company further. Here the firm is providing lower discounts to the customers. By doing this the firm can recover the cash sooner, thereby reducing the chances of bad debts. By providing cash discounts it can induce the buyers. Hence thereby it increases sales volume. Cash discount induces the buyer for prompt payment, so there is less chance of credit sales and decrease in account receivables. Also the cash discount enables the customer to buy at a lesser price. So they pay immediately to avail discounted price. Thus it increases the amount of discount taken. So this reason is appropriate for all the outcomes of the change in the credit policy.

Then no.1 Average collection period has decreased. The average collection period represents the number of days for which a firm has to wait before its receivables are converted in to cash. It measures the quality of debtors. Generally, the shorter the average collection period the better is the quality of the debtors as a short collection period implies quick payments by debtors. Similarly, a higher collection period implies as inefficient collection performance which in turn adversely affect the liquidity or short term paying capacity of the firm out of its current liabilities. As noted above shorter collection period results in more liquid debtors who make quick payments, thereby reducing the chances of bad debts. If the firm is providing more discounts then more consumers will be attracted, thereby increasing the sales. If the debtors are more liquid, then there will be an obvious reduction in the account receivables. However, this reason is more appropriate than the previous one, for all the outcomes of the change in the credit policy.

Q.6 Identify the users of accounting information.

Ans: Accounting reports are designed to meet the common information needs of most decision makers. These decisions include when to buy, hold or sell the enterprise share. It assesses the ability of the enterprise to pay its employees, determine distributed profits and regulates the activities of the enterprise. Investors and lenders are the most obvious users of accounting information.

1. Investors: Investors may be broadly classified as retail investors, high net worth individuals, institutional investors both domestic and foreign. As chief provider of risk capital, investors are keen to know both the return from their investment and the associated risk. Potential investors need information to judge prospect for their investment.
2. Lenders: Banks, financial institutions and debenture holders are the main lenders and they need information about the financial stability of the borrower enterprise. They are interested in information that would enable them to determine whether their borrower has the capability to repay the loans along with the interest due on it. They also use the information for monitoring the financial condition of the borrowers.
3. Regulators, rating agencies and security analyst: investors and creditors seek the assistance of information specialist in assessing prospective returns. Equity analyst, bond analyst and credit rating agencies offer a wide range of information in the form of answering queries on television shows, providing trends in business news papers on a particular stock, offer valuable information in seminars, discussion groups, meeting and interviews. Security analyst obtain valuable information including insider information by means of face to face meeting with the company officials, visit their premises and make constant enquiry using e-mails, teleconference and video conference.
4. Management: management needs information to review the firm’s short term solvency and long term solvency. It has come to ensure effective utilization of resources, profitability in terms of turnover and investment. It has to decide upon the courses of action to be taken in future. Management may also be interested in acquiring other business which is undervalued. When managers receive commission or bonus related profit or other accounting measures, they have a natural interest in understanding how these numbers are computed. Further when faced with a hostile takeover attempt, they communicate additional financial information with a view to boosting the firm’s stock price.

5. Employees, trade unions and tax authorities: Employees are keen to know about the general health of the organization in terms of stability and profitability. Current employees have a natural interest in the financial condition of the firm as their compensation will depend upon the financial performance of the firm. Potential employees may use financial information to find out the future prospect of the firm. Trade union use reports for negotiating wage package, declaration of bonus and other benefits. Tax authorities need information to assess the tax liabilities of the firm.
6. Customers: customers have an interest in the accounting information about the continuation of company especially when they have established a long term involvement with or dependant on the company.
7. Government and regulatory agencies: Government and the regulatory agencies require information to obtain timely and correct information, to regulate the activities of the enterprise if any. They seek information when tax laws need to be amended, to provide institutional support to lagging industries. The regulatory agencies use financial reports to take action against the firm when appropriate returns are not filled in times or to take appropriate action against the firm when complaints/misappropriation are being logged. Stock exchange has a legitimate interest in financial reports of publicly held enterprises to ensure efficient operation of capital market.
8. The public: Every firm has a social responsibility. Firms depend on local economy to meet their varied needs. They may get patronage from local government in the form of capital subsidy, cheap land and tax sops in the form of tax holidays for certain period of time. Prosperity of the enterprise may lead to prosperity of the economy both directly and indirectly. Published financial statement assist public by providing information about the trends and recent developments of the firm.