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Question 2. What are financial statements? Name the major financial statements.
Answer: The Financial statements are the reports that result from the process of accounting which
allow the interested parties to evaluate the profitability and the solvency of the business. The
major financial statements are
• Profit and Loss Account
• Balance sheet
• Cash Flow statement
Question 3. What is the difference between balance sheet and profit & loss account?
Answer: The balance sheet is one of the most important financial statements of a company. It is
reported to investors at least once per year. It may also be presented quarterly, semiannually
or monthly. The balance sheet provides information on what the company owns (its assets),
what it owes (its liabilities), and the value of the business to its stockholders (the
shareholders' equity). The name, balance sheet, is derived from the fact that these accounts
must always be in balance. Assets must always equal the sum of liabilities and shareholders'
equity.
A company's income statement/profit and loss account statement is a record of its earnings or
losses for a given period. It shows all of the money a company earned (revenues) and all of
the money a company spent (expenses) during this period. It also accounts for the effects of
some basic accounting principles such as depreciation.
The income statement is important for investors because it's the basic measuring stick of
profitability. A company with little or no income has little or no money to pass on to its
investors in the form of dividends. If a company continues to record losses for a sustained
period, it could go bankrupt. In such a case, both bond and stock investors could lose some
or all of their investment. On the other hand, a company that realizes large profits will have
more money to pass on to its investors.
Reliability: Information is said to be reliable when it is free from errors, bias and can be
depended upon by the users to represent faithfully, which it purports to represent.
Comparability: Users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position and performance.
Question 5. What is meant by the quality of financial reporting? What is conservatism, and how does it affect
the quality of earnings?
Answer: The quality of financial reporting refers to how close the financial statements are to economic
reality. The closer the financial statements are to economic reality, the higher is the quality of
financial reporting. The less that management uses discretionary means to manipulate
earnings, the higher the quality of financial reporting. Conservatism means that management
should take great care not to overstate assets and revenues and not to understate liabilities and
expenses. The more conservative management IS in making accounting judgments, the higher
will be the quality of financial reporting.
Question 6. What are the major constraints on relevant and reliable financial statements?
Answer: 1 the major constraints are
Timeliness: If there is undue delay information becomes irrelevant.
Balance between cost and benefit: The benefits derived from information should exceed the
cost of providing it.
Balance between the various qualitative characteristics: In practice it has become necessary to
achieve an appropriate balance between the qualitative characteristics.
True and fair view presentation: There is no clarity in the term 'true and fair view' as required
by the Companies Act. The conceptual framework does not discuss this.
The advantages
1. Reduces to a reasonable extent eliminates confusing variations in the accounting
treatment.
2. Lays down disclosure requirements beyond that required by law.
m. To a limited extent facilitates comparison of financial statements globally.
Question I. Tell us what you know about Accounts Receivables and Payables?
Answer Accounts Receivable, normally abbreviated as AIR, is the money that is currently owed to a
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company by its customers. The reason why the customers owe money is that the product has
been delivered but has not been paid for yet. Companies routinely buy goods and services
from other companies using credit. Although typically AIR is almost always turned into cash
within a short amount of time, there are instances where a company will be forced to take a
write-off for bad accounts receivable if it has given credit to someone who cannot or will not
pay. This is why you will see something called allowance for bad debt in parentheses beside
the accounts receivable number.
Accounts Payable is the money that the company currently owes to its suppliers, its partners
and its employees. Basically, these are the basic costs of doing business that a company, for
whatever reason, has not paid off yet. One company's accounts payable is another company's
accounts receivable, which is why both terms are similarly structured. A company has the
power to push out some of its accounts payable, which often produces a short-term increase in
earnings and current assets.
Answer: Goodwill is considered to be one of the largest intangible assets, the value of which companies
want to reflect correctly in their financial statements. Accounting for this asset, poses many
challenges for accountants, as it is an unidentifiable intangible asset.
• Residuum approach
Under this method, goodwill is taken to be the difference between the purchase price and the
fair market value of an acquired company's assets.
Straight line Method: An equal amount is written off every year during the working life of an
asset so as to reduce the cost of the asset to nil or its residual value at the end of its useful life.
Reducing Balance Method: A fixed percentage of the diminishing value of the asset is written
off each year so as to reduce to its break up value at the end of its life.
Machine hour method: If it is practicable to keep a record of the actual running hours of each
machine, depreciation may be calculated on the basis of the hours for which the concerned
machine worked.
Question 19. Please tell how you can analyze a balance sheet vis-à-vis the performance of the company in the
capital market? Give examples with reference to some specific parameters.
Answer The analysis of a balance sheet can identify potential liquidity problems. These may signify
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the company's inability to meet financial obligations. An investor could also spot the degree to
which a company is leveraged, or indebted. An overly leveraged company may have
difficulties raising future capital. Even more severe, they may be headed towards bankruptcy.
These are just a few of the danger signs that can be detected with careful analysis of a balance
sheet.
Beyond liquidity and leverage, there are certain very important benchmarks and aspects,
which are helpful in the analysis of balance sheet.
• Revenues/Sales growth
• Bottom line growth
• Volume
• Market Capitalization
• Company management
• Return on Equity
• Debt-to-Equity Ratio
• Beta
• Earnings Per Share (EPS)
Question 20. Define FIFO and LIFO. Explain what effects that FIFO and LIFO have on the balance sheet
during a period of rising prices and during a period of falling prices?
Answer FIFO is the inventory cost flow assumption that treats the first goods in as the first goods
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sold. LIFO is the inventory cost flow assumption that treats the last goods in as the first
goods sold. In a period of rising prices, FIFO values inventory at current costs. However,
LIFO would value inventory at costs that the company could have incurred years ago. The
analyst should take the LIFO cost flow assumption into account and consider adjusting the
inventory of a company using LIFO upward to account for inflation.
Question 22. A financial accounting system provides information for external decision makers and a
management accounting system provides information for a firm's internal decision makers.
Consider the general information needs of these two categories of decision makers. How are
their information needs different? How are their information needs similar? What does your
consideration of these differences and similarities suggest about the relationship between the
financial accounting system and the management accounting system as components of the
overall accounting system?
Answer: The primary external users of accounting information are investors and creditors whose
decisions often require them to make comparisons between companies. To support these
inter company comparisons, they need information that is itself comparable. This requires
financial accounting information to be fairly standardized in terms of not only its basic
manner of presentation, but also in terms of how economic events are identified, measured,
and recorded. The information needs of internal users (i.e., managers) are generally more
focused on their single firm as they seek to plan and control its operations. Accordingly,
inter company comparability is less of a concern in managerial accounting, meaning that
standardization of accounting practice is not as important. However, like external users,
internal users will have some decisions that require information that is comparable between
companies. For example, year-end bonuses might be based on the company's performance
relative to other companies in the same industry. Therefore, the information needs of internal
and external users generally overlap somewhat. Accordingly, the financial and management
accounting systems are not two completely separate systems, but rather are partially
overlapping subsystems within the overall accounting system.
Question 23. What is the entry for Deferred Tax liability according to AS22?
Answer Deferred tax assets and liabilities should be distinguished from assets and liabilities
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representing current tax for the period. Deferred tax assets and liabilities should be disclosed
under a separate heading in the balance sheet of the enterprise, separately from current assets
and current liabilities.
The break-up of deferred tax assets and deferred tax liabilities into major components of the
respective balances should be disclosed in the notes to accounts.
The nature of the evidence supporting the recognition of deferred tax assets should be disclosed,
if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws.
MANAGEMENT ACCOUNTING
Question 1. What is a Cost? What do you mean by cost unit?
Answer: A Cost is a resource consumed to accomplish a specified objective. A Cost Unit is a unit of
output in the production of which the costs are incurred.
Answer Through the use of a "cost sheet", financial experts estimate the detailed cost in respect of a
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cost center or a cost unit and also makes inter-firm comparison by including cost data of
different firms.
Question 14. Can you identify the two basic tools used for CVP analysis?
Answer • Contribution margin analysis
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• Break-even analysis
Answer: Budgeting is a complex process, which maybe divided into the following phases:
Identification of potential investment opportunities: The planning body develops estimates of
future sales, which serve as the basis for setting production targets. This information is in turn
helpful in identifying required investments in plant and equipments.
Assembling of Investment Proposals: Investment proposals are defined by production
department and other departments are usually submitted in a standardized capital investment
proposal form. Investment proposals are usually classified into various categories for
facilitating decision-making, budgeting and control.
Decision-Making: A system of rupee gateways usually characterizes capital investment
decision-making. Under this system executives are vested with the power to okay investment
proposals up to certain limits.
Preparation of Capital Budget and Appropriations: - Projects involving smaller outlays and
which can be decided by executives at lower levels are often covered by a blanket
appropriation for expeditious action. Projects involving larger outlays are included in the
capital budget after necessary approvals.
Implementation: Translating an investment proposal into concrete project is a complex, time-
consuming and risk fraught task. Delays in implementation, which are common, can lead to
substantial cost overruns.
Answer A flexible budget is a budget, which by recognizing different cost behavior patterns, is
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designed to change as volume of output changes.
Question 24. In what way Activity Based Costing differs with the Traditional Methods of Costing?
Answer Activity Based Costing (ABC) captures costs and affects accounting practices which
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traditional costing fail to do so as explained below.
• Unlike traditional costing, ABC reveals the linkages amongst activities in different
departments
• The underlying principle of ABC is to trace the product cost whereas traditional by the
need to value stocks.
In ABC, costs are accumulated for each activity as a separate cost object while m traditional
costing costs is allocated based on various departments and functions.
CAPITAL STRUCTURE
Question 1. What kind of capital structure should a newly floated company adopt?
Answer: The capital structure of a newly floated company is dependent upon the management of the
company. However, before deciding an appropriate capital structure, a newly floated
company should bear in mind the rules and regulation regarding SEBI guidelines and norms
of the financial institutions. According to the guidelines issued by SEBI, a newly established
company with no previous track record can issue equity only at par unlike that of well
established companies who can issue their equity capital at premium to par value. According
to financial institutions normally the debt-equity norm for medium and large-scale projects is
1.5: 1.
Question 7. What is switching cost? Which industry has the lowest switching cost?
Answer: A barrier to entry is created by the presence of switching costs, that is, one-time costs facing
the buyer of switching from one supplier's product to another's. Switching cost may include
employee retraining costs, cost of new ancillary equipments, cost and time in testing and
quantifying a new source. If these switching costs are high then new entrant must offer a
major improvement in cost or performance in order for the buyer to switch from an
incumbent.
Question 8. If IRR were less than the cost of capital of capital what would you do?
Answer: While evaluating the feasibility of a project we compare the internal rate of return and cost of
capital. If IRR is less than the cost of capital, then the project is not viable and cannot be
accepted as the cost is less than the return, leading to loss in implementing the project.
Deferred Credit: Facility under which suppliers of plant and machinery offer to make the
payment over a period of time.
Incentive Sources: The aid given by goverment and its agencies like seed capital assistance,
capital subsidy and tax deferment or exemption.
Other Sources: These include public deposits, leasing and hire purchase.