Question # 1 (a).

how much accounting report can be prepared on a historical basis after the close of a period, are they useful to managers in directing the activities of a business? Ans: Accounting: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character and interpreting the results thereof. Scope of Accounting Data creation and collection It is the area, which provides raw material for accounting. The data collected historic in the sense that it refers to events, which have already taken place. After the historic data has been collected, it is recorded in accordance with generally accepted accounting theory. A large number of transactions or events have to be entered in the books of original entry (Journals) and ledgers in accordance with the classification scheme already decided upon. Data evaluation Evaluation of data includes controlling the activities of business with the help of budgets and standard costs (budgetary control), evaluating the performance of business, analyzing the flow of funds, and analyzingthe accounting information for decision-making purposes by choosing among alternative courses of action. Analytical and interpretative It is the work of accounting may be for internal or external uses and may range from snap answers to elaborate reports produced by extensive research. Data evaluation has another dimension and this can be known as the auditivework, which focuses on verification of transactions as entered in the books of account and authentication of financial statements. This work is done by public professional accountants. Data reporting It consists of two parts external and internal. External reporting refers to the communication of financial information (viz., earnings & financial and funds position) about the business to outside parties. e.g., shareholders, government agencies and regulatory bodies of the government. Internal reporting is concerned with the communication of results of financial analysis and evaluation to management for decision-making purposes. The central purpose of accounting is to make possible the periodic matching of costs (efforts) and revenues (accomplishments). This concepts the nucleus of accounting theory.

(b): Distinguish between management accounting and financial accounting? Financial Accounting Financial accounting dates from the development of large-scale business and the advent of Joint Stock Company (a form of business which enables the public to participate in providing capital in return for shares in the assets and the profits of the company). This means that the liability of a shareholder for the financial debts of the company is limited to the amount he had agreed to pay on the shares he bought. He is not liable to make any further contribution in the event of the companys failure or liquidation. The income statement is a statement of profit and loss made during the year of the report; and the balance sheet indicates the assets held by the firm and the monetary claims against the firm. The importance attached to financial accounting statements can be traced to the need of the society to mobilize the savings and channel then into profitable investments Management Accounting The advent of management accounting was the next logical step in the developmental process. The genesis of modern management with its emphasis on detailed information for decision-making provided a tremendous impetus to the development of management accounting. Management accounting is concerned with the preparation and presentation to accounting and control information in a form which assists management in the formulation of policies and in decision-making on various matters connected with routine or non-routine operations of business enterprise. Management accounting has thus shifted the focus of accounting from recording and analyzing financial transactions to using information for decisions affecting the future. While the reports emanating from financial accounting are subject to the conceptual framework of accounting, internal reports routine or non-routine are free from such constraints.

Question no 5 What is meaning of internal rate of return? Is there any relationship between internal rate and payback period? What is meant by net present value? Explain with suitable example. There are two principal methods for the economic and financial assessment of different investment Projects, static and dynamic. Capital Budgeting: Capital Budgeting is a project selection exercise performed by the business enterprise. Capital budgeting uses the concept of present value to select the projects. Capital budgeting uses tools such as payback period, net present value, internal rate of return, profitability index to select projects. Capital Budgeting Tools: 1. Net present value ( NPV ) 2. Internal rate of return ( IRR ) 3. Payback period ( PB ) The internal rate of return: The internal rate of return method, a process of dynamic investment appraisal, determines the interest rate r of the invested capital. The internal rate of return method can be used to assess the absolute advantages of an investment. When comparing different investments, the alternative with the highest internal rate of return is the most advantageous solution. The rate to look for is the one where the NPV will be zero. Payback Period: Payback period is the time duration required to recoup the investment committed to a project. Business enterprises following payback period use "stipulated payback period", which acts as a standard for screening the project. Calculation of Payback Period: When the cash inflows are uniform the formula for payback period is cash outflow divided by annual cash inflow. Here payback period is the time when cumulative cash inflows are equal to the outflows. inflows = outflows Payback Reciprocal Rate: The payback period is stated in terms of years. This can be stated in terms of percentage also. This is the payback reciprocal rate. Reciprocal of payback period = [1/payback period] x 100

Determination of Stipulated Payback Period: Stipulated payback period, broadly, depends on the nature of the business/industry with respect to the product, technology used and speed at which technological changes occur, rate of product obsolescence etc. Stipulated payback period is, thus, determined by the management's capacity to evaluate the environment vis-a-vis the enterprise's products, markets and distribution channels and identify the ideal business design and specify the time target. Net Present Value (Npv): Net present value of an investment/project is the difference between present value of cash inflows and cash outflows. The present values of cash flows are obtained at a discount rate equivalent to the cost of capital. Calculation Of Net Present Value (Npv): Let 'b' be the cash outflow in period 't' where t = 0,1,2,....n 'B' be the present value of cash outflows 'c' be the cash inflow in period 't'=0,1,2,........n 'C' be the present value of cash inflows 'K' be the cost of capital Then Present value of cash inflows Present value of cash outflows Net Present Value = = ( ( ( ( ) ) ) )

=Npv= (C-B) = =

( ( )

When the cash outflow is required for only one year i.e., in the present year, then the Net present value is calculated as follows: Net Present Value =

( (

) )

"I" is the initial investment (cash outflow) required by the project Net Present Value (Npv) Example: Assuming that the cost of capital is 6% for a project involving a lump sum cash outflow of Rs.8,200 and cash inflow of Rs.2,000 per annum for 5 years, the Net Present Value calculations are as follows: a) Present value of cash outflows Rs.8200 b) Present value of cash inflows

Present value of an annuity of Rs.1 at 6% for 5 years=4.212= Rs.8424 Present value of Rs.2000 annuity for 5 years = 4.212 X 2000 = Rs.8424 c) Net present value = present value of cash inflows - present value of cashoutflows = 8424 -8200 = Rs.224 Since the net present value of the project is positive (Rs.224), theProject is accepted. Internal Rate Of Return (Irr):

The internal rate of return method is also known as the yield method. The IRRof a project/investment is defined as the rate of discount at which the present value of cash inflows and present value of cash outflows are equal. IRR can be restated as the rate of discount, at which the present value of cash flow (inflows and outflows) associated with a project equal zero.

Computation of Internal Rate of Return (Irr) When Trial and error method is used to solve for the IRR, two rates are computed one that gives a small positive NPV, another that gives a small negative NPV. The IRR using the trial and error method will be:
{ Where r1 = smallest rate of interest r2 = highest rate of interest N1 = NPV at smallest rate N2 = NPV at highest rate ( )}

Internal Rate of Return (Irr) Example

A new machinery costs Rs.8,200 and generates cash inflow (after tax) per annum of Rs.2,000 during its life of 5 years. IRR method involves trial and error in the sense that one has to experiment with different rates of discount before arriving at the appropriate rate at which the equation 1 and 2 are satisfied.But when the cash inflows are by way of annuities the relevant interest factor is:

Trial And Error Method:

Through the trial and error method, wecan begin with a 10% discount rate. The net present value assuming a 10% discount rate is: (2000 x 3.7908) - 8200 = 7581.6 - 8200 = -618.4. Since the NPV is negative, we need to reduce the discount rate to arrive at a positive NPV. Hence, let us assume a discount rate of 5%. The net present value assuming a 5% discount rate is (2000 x 4.3295) - 8200 = 8659 - 8200 = 459.

 Now, we have to interpolate the IRR which lies between these two positive and negative NPV i.e., the discount rate that results in a 0 NPV. The IRR rule will be 5% +[(618.4/1077.4) x 5%] = 5% + 2% = 7%.