Assignment Acc. & Finance Col Mba Semester 1

Assignment No. 1

ACCOUNTING & FINANCE (5566) Executive MBA/MPA

ZAHID NAZIR Roll.No. AB523655 Semester:Autumn 2008

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Question 1 a). State the group of persons having an interest in a business organization and examine the nature of their information needed. Differentiate between recordative, interpretative and auditive functions of Accounting. Marks: 10

(b) How can accounting reports, prepared on a historical basis after the close of a period, be useful to managers in directing the activities of business? Marks: 10

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a). There are several groups of people who have a stake in a business organization. They are the following: • • • • • • • • • •

Managers Shareholders Creditors Employees Customers Banks Financial Investors Suppliers Labour Union Potential Investors

Additionally the community at large has economic and social interest in the activities of such organizations. This interest is expressed at national level by the concern of government in various aspects of firm’s activities such as their economic well being, their contribution to welfare, their part in the growth of national product. Information needs of various users are:

SHAREHOLDERS & INVESTORS Since shareholders and other investors have invested their wealth in a business enterprise, they are interested in knowing about the profitability of the enterprise, the soundness of their investment and the growth prospects of the enterprise. Historically, business accounting developed to supply information to those who had invested their funds in business enterprises.

CREDITORS Creditors may be short term or long term lenders. Short term creditors include suppliers of materials, goods or services. They are Page 3 of 24

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normally known as trade creditors. Long term creditors are those who have lent money for a longer period, usually in the form of secured loans. The main concern of creditors is focused on the credit worthiness of the firm and its ability to meet its financial obligations. Therefore they are concerned with the liquidity of the firm, its profitability and financial soundness. In other words creditors are mainly interested in information which deals with the solvency, liquidity and profitability so that they could assess the financial standing of the firm.

EMPLOYEES The view that business organizations exist to maximize the returns to shareholders has been undergoing change as a result of social changes. A broader view is taken today of economic and social role of management. The importance of harmonious industrial relations b/w management and employees can not be over emphasized. That the employee has a stake in the outcomes of several managerial decisions is recognized. Greater emphasis on industrial democracy through employee participation in management decisions has important implications for the supply information to employees. Matters like settlement of wages, bonus and profit sharing rest on adequate disclosure of relevant facts.

GOVERNMENT In the mixed economy it is considered to be the responsibility of the government to direct the operation of the economic system in such a manner that it sub serves the common good. Controls and regulations on the operation of government agencies collect information about various aspects of activities of business organizations. All the information is very important in evolving policies for managing the economy.

MANAGEMENT Organizations may or may not exist for the sole purpose of profit. However, information needs of the managers of both kinds of Page 4 of 24

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organizations are almost the same, because the managerial process i.e. planning, organizing and controlling is the same. All these functions have one thing in common and it is that they all are concerned with making decisions, which have their own specific information requirements.

CONSUMERS Consumer organizations, media, welfare organizations and public at large are also interested in condensed accounting information in order to appraise the efficiency and social role of the enterprise in different sectors of the economy i.e. what levels of profits and outputs are being achieved and in what manner the growth is being planned by the enterprises in accordance with the national priorities.

Differentiate between recordative, interpretative and auditive functions of Accounting. RECORDATIVE FUCTION The recording and processing of information usually accounts for a substantial part of total accounting work. This type of accounting is called recordative . The processing method employed for recording may be manual, mechanical or electronic. Computers are also used widely in modern business for this purpose.

INTERPRETATIVE FUNCTION The analytical and interpretative work f accounting may be for internal or external uses and may range from snap answers to elaborated reports produced by extensive research. Capital project analysis, financial forecasts and analysis for reorganization, take over or merger often lead to research based reports.

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AUDITIVE FUNCTION It focuses on verification of transactions as entered in the books of account and authentication of financial standards. This function is done by public professional accountants.

b) The data reports are prepared on a historical basis in the following manner. First the data is created and collected on the basis of either historic or predictive method. The professional methods like: • Manual • Mechanical • Electronic After the historic data is collected, it is recorded in accordance with generally accepting accounting theory. A large number of transactions or events have to be entered in the books of original entry i.e. journal and ledgers in accordance with the classification scheme already decided upon. Professional methods lead to data recording which consist of accounting method. After this data is evaluated by different methods like internal auditing etc. At the end we get data reporting activity which may be internal or external.

Data Creation and Collection Historic

Professional Methods

Manual Mechanical Electronic

Predictive

Data Recording

Data Evaluation

Accounting Theory

Accounting Method

Budgetary Control Performance Analysis funds Flow Analysis Auditing

Data Reporting External

Internal

Scope of Accounting showing which reports are prepared

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Question 2 a). Examine the role of accounting concepts in the preparation of financial statements. Do you find any of the accounting concepts conflicting with each other? Give examples. Marks: 10 (b) The transactions for Shah transport service are as follows: 1. Shah invested Rs.600,000. 2. Truck was purchased by the business for Rs.430,000. 3. Equipment purchased on credit for Rs.9,000. 4. A bill of Rs 7,200 for transporting goods was sent to Mr. Abbassi. 5. Cash received Rs.6,000 from Mr. Abbasi 6. Received Rs.22,300 in Cash for transporting goods 7. Payment of Rs.5,000 was made for the equipment purchased in 3. 8. Paid expenses Rs.1,700 in cash. 9. Cash Rs.1,200 withdrawn from business for Shah’s personal use REQUIRED: i. Arrange the asset, liability and owners equity accounts in an equation. ii. Show by addition and subtraction the effects of the transactions on the balance sheet equation. Show new balance after each transaction and identify each owner’s equity transaction by type. Marks: 10

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a).

ACCOUNTING CONCEPTS Accounting concepts are the ground rules of accounting that are (or should be) followed in preparation of all accounts and financial statements. The four fundamental concepts are: 1).

Accruals concept: Revenue and expenses are taken account of when they occur and not when the cash is received or paid out.

2).

Consistency concept: Once an entity has chosen an accounting method, it should continue to use the same method, except for a sound reason to do otherwise. Any change in the accounting method must be disclosed.

3).

Going concern: It is assumed that the business entity for which accounts are being prepared is solvent and viable, and will continue to be in business in the foreseeable future.

4).

Prudence concept: Revenue and profits are included in the balance sheet only when they are realized (or there is reasonable 'certainty' of realizing them) but liabilities are included when there is a reasonable 'possibility' of incurring them. Also called conservation concept. Other concepts include

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5).

Accounting equation: Total assets of an entity equal total liabilities plus owners' equity.

6).

Accounting period: Financial records pertaining only to a specific period are to be considered in preparing accounts for that period.

7).

Cost basis: Asset value recorded in the account books should be the actual cost paid, and not the asset's current market value.

8).

Entity: Accounting records reflect the financial activities of a specific business or organization, and not of its owners or employees.

9).

Full disclosure: Financial statements and their notes (footnotes) should contain all pertinent data.

10). Lower of cost or market value: Inventory is valued either at cost or the market value (whichever is lower) to reflect the effects of obsolescence. 11). Maintenance of capital: Profit can be realized only after capital of the firm has been restored to its original level, or is maintained at a predetermined level.

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12). Matching: Transactions affecting both revenues and expenses should be recognized in the same accounting period. 13). Materiality: Relatively minor events may be ignored, but the major ones should be fully disclosed. 14). Money measurement: Accounting process records only those activities that can be expressed in monetary terms (with some exceptions, as in cost-accounting). 15). Monetary measurement: Only the activities measurable in terms of money should be recorded. 16)

Objectivity: Financial statements should be based only on verifiable evidence, comprising an audit trail.

17). Realization: Any change in the market value of an asset or liability is not recognized as a profit or loss until the asset is sold or the liability is paid off (discharged). 18). Unit of Measurement: Financial data should be recorded with a common unit of measure (dollar, pound sterling, yen, etc.). Also called accounting conventions, accounting postulates, or accounting principles. Page 10 of 24

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While going through all these concepts, we have developed a feeling that they come in conflict with each other. For example, a firm acquired a piece of land in 1975 at a price of Rs. 60,000. Factory premises were constructed in 1976 and operation started in 1977. The firm has a great success with a profit profile for the past 18 years. The balance sheet for the year 1995 is being prepared and land is required to be valued. The estimated current market price of this land is Rs.600,000. Should we recommend that land valued at Rs. 600,000. ? The answer is “NO”. Obviously land would be carded on balance sheet as its original cost of Rs. 60,000 only. This decision is supported by several of the concepts. First of all, the stability of purchasing power of money implied in the money measurement concept prevents us from recognizing increase in value as a result of changing price levels. Then the realization concept will not allow unrealized profits to be included as long as land is held by the firm and not sold away. We may note that the continuity or going concern concept makes any possible market value of land irrelevant for balance sheet because the firm has to continue in business and land will be needed by it for its own use. In this regard, it could be argued that if land was shown on the balance sheet as its estimated current market value, the owner might decide to discontinue the business, sell the land and retire. The estimate of current profit market value figure may be suspect. It raises many questions. Do we have a market quotation for an identical plot of land? Has a similar to land been sold recently and can we pick it up as verifiable evidence of the current market place? Is it possible to estimate the value of land without factory buildings and other facilities constructed on it? The answer is “NO” and the conservation concept will then deter us from accepting an estimate of market value since it can not be ascertained with reasonable accuracy.

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Question 3 Dr. Fazal Karim, a psychologist, moved from Shikarpur to set up an office in Islamabad. After one month, the business had the following assets. Cash in hand Rs. 2,800 Cash at bank Rs. 25,000 Debtors Rs. 12,680 Office Supplies Rs. 8,000 Office Equipment Rs. 70,500. The creditors were Rs.12,600 for purchase of office equipment on credit. During march 2004 following transaction were completed: a. Paid one month rent by cheque for the office Rs.3,500 b. Billed Rs.2,460 for services rendered to a client c. Paid Rs.3,000 by cheque for office equipment purchased d. Paid for office supplies Rs.1,000 in cash e. Received a cheque for Rs.23,800 for ICI for services provided to their employees f. Made payment on account owed Rs.3,600 by cheque g. Withdrew Rs.5,500 from bank for personal use h. Paid telephone bill Rs.970 i. Received Rs.1,290 cash from patients previously billed j. Purchased additional office equipment on credit Rs.33,600 k. Paid secretary’s salary Rs.3000 by cheque. REQUIRED: Prepare Balance Sheet after transactions a to k has occurred

Marks: 20

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DR. FAZAL KARIM (PSYCHOLOGIST)

BALANCE SHEET as on 31st March, 2004

Assets

(PKR)

Cash in Hand

2,120

Liabilities & Owners Equity Creditors

Cash at Bank

30,200

Capital

1,19,670

Debtors

13,850

Office Supplies

9,000

TOTAL

1,62,270

Office Equipments

1,07,100

TOTAL

1,62,270

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(PKR) 42,600

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Question 4 Following is the summarized Profit and Loss account of Khan Enterprises for five consecutive periods. Complete the same by supplying the missing information: 1 2 3 4 5 Sales Cost of Goods Sold Gross Profit Admin Expenses Selling & Distribution Exp Operating Profit Other Incomes Net Profit Before Tax Corporate Income Tax Profit after Tax

1000 500

3000 800 700

100 150

1000 300

200 200

150

1500 400 500

600

400 200

300 200

2500

5000 3000

1000 500 1000

300 150

500

800

Marks: 20

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1 1000

2 1500

3 3000

4 4000

5 5000

Cost of Goods Sold Gross Profit

500

800

2000

2500

3000

500

700

1000

1500

2000

Admin Expenses

100

300

300

400

400

Selling & Distribution Exp Operating Profit

150

200

300

500

600

250

200

400

600

1000

Other Incomes

150

100

200

400

500

Net Profit Before Tax Corporate Income Tax Profit after Tax

400

300

600

1000

1500

200

150

300

500

700

200

150

300

500

800

Sales

i.e. Gross Profit Net Profit Net Profit after tax Net Profit before tax

= = = =

Sales - Cost of goods sold Gross Profit - Expenses Net profit before tax - Income tax Operating Profit + Other Incomes

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Question 5 a). Equipment costing Rs.76,000 was purchased by Saqib Corporation, at the beginning of the current year. The company will depreciate the equipment by the declining-balance method, but it has not determined whether the rate will be at 150 percent or 200 percent of the straight line rate. The estimated useful life of the equipment is eight years. Prepare a comparison of the two alternative rates for management for the first two years Saqib Corporation owns the equipment. Marks: 10 b). What do you understand by cost accounting? State its objectives. Explain what is COST and its different elements in detail. Marks: 10

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a). Solution: Rate =

100 / Estimated Life

=

100 / 8

First rate

=

12.5 x 150%

=

18.75%

2nd Rate

=

12.5 x 200%

=

25%

Years

Computation

Depreciation Expense

Accumulative Depreciation

1st Rate 0

=

Book Value (PKR) 76,000

1

76,000 x 18.75%

14,250

14,250

61,750

2

61,750 x 18.75%

11,578

25,828

50,172

nd

2 Rate 0

76,000

1

76,000 x 25%

19,000

19,000

57,000

2

57,000 x 25%

14,250

33,250

42,750

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12.5

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b).

COST ACCOUNTING “Cost accounting is an approach to evaluating the overall costs that are associated with conducting business.” Generally based on standard accounting practices, cost accounting is one of the tools that managers utilize to determine what type and how much expenses is involved with maintaining the current business model. When it comes to measuring how wisely company resources are being utilized, cost accounting helps to provide the data relevant to the current situation. One of the many benefits of cost accounting is that it turns data into information, knowledge and wisdom about a business entity’s operations that is useful for: • • • •

measuring performance reducing or managing costs determining the fees or prices for goods and services deciding to authorize, modify or discontinue a program or activity

OBJECTIVES OF COST ACCOUNTING The Cost Accounting has following primary objectives. • It enables you to budget the production operations of your company; you can compare the actual performance of those operations against the budget to supply each level of management with the information essential to make timely, accurate and effective decisions. • It provides a detailed cost subledger to your company's General Ledger. These principal objectives are met through the use of the various data elements that are maintained in the Cost Accounting database. • Cost accounting is all about ascertaining the cost, controlling the cost and reducing the cost.

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COST The amount of expenses (actual / notional) incurred on or attributable to a given thing is called cost. However the term cost cannot be exactly defined. Its interpretation depends on: a). the nature of business or industry b). the context in which is used In a business where selling and distribution expenses are quite normal, the cost of article may be calculated without considering the selling and distribution overheads. For example, prime cost include expenditure on direct materials, direct labor and direct expenses. Money spent on material is termed as cost of material, that spent on labor as cost of labor and so on. However endeavor should be made to obtain as far as possible the accurate cost of a product or service.

ELEMENTS OF COST The elements of cost are shown in the following figure.

COST

Materials

Direct

Indirect

Labour

Direct

Expenses

Indirect

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Direct

Indirect

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The main elements of cost are: MATERIALS

i)

The substance from which the product is made is known as material. It may be in a raw or manufactured form. It can be direct as well as indirect. a). Direct Material All the materials which becomes integral part of the finished product is called direct material. Its examples are, all materials / components, primary packaging materials e.g. carton, wrapping etc. b). Indirect Material All materials which are used for purposes ancillary to the businesses and which cannot be assigned to specific physical units is called indirect materials. Examples are, consumable stores, printing and stationary material. ii).

LABOUR Human effort needed in which materials are converted into finished products is called labour. It is of two types. a). Direct Labour Labour which takes an active and direct part in the production of a particular product is called direct labour. Direct labour costs are traceable to specific product. b). Indirect Labour Labour which is not directly involved in the manufacturing of a product e.g. labour involved in transportation, warehouse labour, time keepers etc.

iii).

EXPENSES Page 22 of 24

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They can be direct or indirect a). Direct Expenses Expenses which can be directly, conveniently and wholly allocated to specific cost units are called direct expenses. Examples are, hiring of a specific equipment for a particular job, cost of defective work etc. b). Indirect Expenses Those expenses which cannot be directly, conveniently and wholly allocated to specific cost units are called indirect expenses. Examples are rent, lighting, insurance charges etc. Overheads include indirect materials, labour and expenses, so all indirect costs are overheads.

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