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MCS-035: ACCOUNTANCY

Q-1:
Ans :
LIMITATIONS OF RATIO ANALYSIS
The reader of financial statements must understand the basic limitations associated with ratio
analysis. As analytical tools, ratios are attractive because they are simple and convenient. But too
frequently, decisions are based on only these simple computations. The ratios are only as good as
the data upon which they are based and the information with which they are compared.
One important limitation of ratios is that they are based on historical cost, which can lead to
distortions in measuring performance. By failing to incorporate changing price information,
many believe that inaccurate assessments of the enterprise's financial condition and performance
result.
Also, investors must remember that where estimated items (such as depreciation and
amortization) are significant, income ratios lose some of their credibility. Income recognized
before the termination of the life of the business is an approximation. In analyzing the income
statement, the user should be aware of the uncertainty surrounding the computation of net income.
As one writer aptly noted, "The physicist has long since conceded that the location of an electron is
best expressed by a probability curve. Surely an abstraction like earnings per share is even more
subject to the rules of probability and risk."
Probably the greatest criticism of ratio analysis is the difficult problem of achieving comparability
among firms in a given industry. Achieving comparability among firms requires that the analyst (1)
identify basic differences existing in their accounting principles and procedures and (2) adjust the
balances to achieve comparability.
Basic differences in accounting usually involve one of the following areas:
Inventory valuation (FIFO, LIFO, average cost).
Depreciation methods, particularly the use of straight-line versus accelerated depreciation.
Capitalization versus expense of certain costs, particularly costs involved in developing natural resources.
Capitalization of leases versus noncapitalization.
Investments in common stock carried at equity, and fair value.
Differing treatments of postretirement benefit costs.
Questionable practices of defining discontinued operations, impairments, and extraordinary items.
The use of these different alternatives can make a significant difference in the ratios computed. For
example, in the brewing industry, at one time Anheuser-Busch noted that if it had used average
cost for inventory valuation instead of LIFO, inventories would have increased approximately
$33,000,000. Such an increase would have a substantive impact on the current ratio. Several

studies have analyzed the impact of different accounting methods on financial statement analysis.
The differences in income that can develop are staggering in some cases. The average investor
may find it difficult to grasp all these differences, but investors must be aware of the potential
pitfalls if they are to be able to make the proper adjustments.
Finally, it must be recognized that a substantial amount of important information is not included in
a company's financial statements. Events involving such things as industry changes, management
changes, competitors' actions, technological developments, government actions, and union
activities are often critical to a company's successful operation. These events occur continuously,
and information about them must come from careful analysis of financial reports in the media and
other sources. Indeed many argue, under what is known as the efficient market hypothesis, that
financial statements contain "no surprises" to those engaged in market activities. They contend that
the effect of these events is known in the marketplace and the price of the company's stock adjusts
accordingly well before the issuance of such reports.

Role of Ratio Analysis in in the interpretation of Financial Statement :
It helps in evaluating the firms performance:

With the help of ratio analysis conclusion can be drawn
regarding several aspects such as financial health, profitability and
operational efficiency of the undertaking. Ratio points out the operating
efficiency of the firm i.e. whether the management has utilized the firms
assets correctly, to increase the investors wealth. It ensures a fair return to
its owners and secures optimum utilization of firms assets

It helps in inter-firm comparison:

Ratio analysis helps in inter-firm comparison by providing necessary
data. An interfirm comparison indicates relative position.It provides the
relevant data for the comparison of the performance of different
departments. If comparison shows a variance, the possible reasons of
variations may be identified and if results are negative, the action may be
intiated immediately to bring them in line.

It simplifies financial statement:

The information given in the basic financial statements serves no
useful Purpose unless it s interrupted and analyzed in some comparable
terms. The ratio analysis is one of the tools in the hands of those who want
to know something more from the financial statements in the simplified
manner.

It helps in determining the financial position of the concern:

Ratio analysis facilitates the management to know whether the
firms financial position is improving or deteriorating or is constant over the
years by setting a trend with the help of ratios The analysis with the help of
ratio analysis can know the direction of the trend of strategic ratio may help
the management in the task of planning, forecasting and controlling.


It is helpful in budgeting and forecasting:

Accounting ratios provide a reliable data, which can be compared,
studied And analyzed.These ratios provide sound footing for future
prospectus. The ratios can also serve as a basis for preparing budgeting
future line of action.

Liquidity position:

With help of ratio analysis conclusions can be drawn regarding the
Liquidity position of a firm. The liquidity positon of a firm would be
satisfactory if it is able to meet its current obligation when they become
due. The ability to met short term liabilities is reflected in the liquidity ratio
of a firm.

Long term solvency:

Ratio analysis is equally for assessing the long term financial ability of
the Firm. The long term solvency s measured by the leverage or capital
structure and profitability ratio which shows the earning power and
operating efficiency, Solvency ratio shows relationship between total
liability and total assets.

Operating efficieny:

Yet another dimension of usefulness or ratio analysis, relevant from
the View point of management is that it throws light on the degree
efficiency in the various activity ratios measures this kind of operational
efficiency.


Q-2
Ans : Meaning of Capital Budgeting Capital expenditure budget or capital
budgeting is a process of making decisions regarding investments in fixed assets
which are not meant for sale such as land, building, machinery or furniture. The
word investment refers to the expenditure which is required to be made in
connection with the acquisition and the development of long-term facilities
including fixed assets. It refers to process by which management selects those
investment proposals which are worthwhile for investing available funds. For this
purpose, management is to decide whether or not to acquire, or add to or replace
fixed assets in the light of overall objectives of the firm. What is capital
expenditure, is a very difficult question to answer. The terms capital expenditure
are associated with accounting. Normally capital expenditure is one which is
intended to benefit future period i.e., in more than one year as opposed to revenue
expenditure, the benefit of which is supposed to be exhausted within the year
concerned.









CHARACTERISTICS OF CAPITAL BUDGETING

Creative Search for Profitable Opportunities:
The concept of the profit making idea must be embodied in the capital facility.
Profitable opportunities for the companys invested capital must be turned up. A
corporations future profitability and growth are linked to the soundness of its
capital expenditure policy.
Long-Range Capital Planning
To provide consistent benchmarks for proposals originating in all parts of the
organisation, it is necessary to have some kind of a plan sketched and for the future
even though it is a tentative plan
Short-Range Capital Planning:
The purpose of preparing a short-range capital budget is to force the operating
management to submit the bulk of its capital proposals early enough to give the top
management an indication of the companys credit demands for funds
Measurement of Project Worth:
In order to permit an objective of the projects, the productivity of the proposed
outlay will have to be measured properly.


Screening and Selection:
A screening standard should be set in the light of the supply of cash available for
capital expenditures, the cost of money to the company, and the attractiveness of
alternative investment opportunities
Control of authorized Outlays;
Control has to be exercised by the top management in order to ensure that the
facility conforms to the specifications and that the outlay expenditure is incurred, it
is most difficult to change the course of expenditure.

















CAPITAL BUDGETING PROCESS
Capital budgeting is process of selecting best long term investment project .
Capital budgeting is long term planning for making and financing proposed capital
out laying
Steps for capital budgeting process
1. Identification involved in capital budgeting proposals
2. Screening the proposal
3. Evaluation of various proposals
4. Fixing the priorities
5. Final approval and planning the capital expenditure
6. Implementing the proposal
7. Performance review
Identification of Potential Investment Opportunities: The capital budgeting process
begins with the identification of potential investment opportunities. Usually, the
planning body (it can be an individual or a committee, formal or informal)
develops estimates for future sales which serve as the basis of setting production
targets. This information, in turn, helps one to identify required investments in
plant and equipment.

For imaginative identification of investment ideas, it is helpful to: (a) monitor
external environment regularly to scout for investment opportunities; (b) formulate
a well defined corporate strategy based on a thorough analysis of strengths,
weakness, opportunities, and threats; (c) share corporate strategy and perspectives
with persons who are involved in the process of capital budgeting, and (d) motivate
employees to make suggestion.
Assembling of investment Proposals: Investment proposals identified by the
production department and other departments are usually submitted on a
standardized capital investment proposal form. Generally, most of the proposals
are routed through several persons before the reach the capital budgeting
committee or some other body which assembles them. The purpose of this is
primarily to ensure that the proposal is viewed from different angles. It also helps
in creating a climate for the coordination of interrelated activities.

Investment proposals are usually classified into various categories for facilitating
decision making budgeting and control. An illustrative classification is given
below:
Replacement investments
Expansion investments
New product investments
Obligatory and welfare investments.

Decision Making: A system of rupee gateway usually characteristics the capital
investment decision making in practice. Under this system, executives are vested
with the power to okay investment proposals up to certain limits. For example, in
one company the plant superintendent can okay investment outlay up to Rs
100,000 the works manager up to Rs 500,000 and the managing director up to Rs
2,000,000. Investments requiring higher outlays need the approval of the board of
directors.

Preparation of capital Budget and Appropriations: Projects involving smaller
outlays and those can be decided by executives at lower levels are often covered by
a blanket appropriation for expeditious action. Projects which need larger outlays
are included in the capital budget after necessary approvals. Before undertaking
such projects, an appropriate order is usually required. The purpose of this check is
mainly to ensure that the funds position of the firm is satisfactory at the time of
implementation of the project. Further it provides an opportunity to review the
project before implementation.
Implementation: Translating an investment proposal into a concrete project is a
complex, risky and time consuming task. Delays in implementation, which are
common, may lead to substantial cost overruns. For expeditious implementation at
reasonable cost, the following are helpful.

1. Adequate formulation of projects: the major reason for delay is inadequate
formulation of projects. In other words, if necessary homework in terms of
preliminary studies and comprehensive detailed formulation of the project
has not been done, many surprises and shocks are likely to spring on the
way. Hence, the need for adequate formulation of the project cannot be over
emphasized.
2. Use of the principle of responsibility accounting: Assigning specific
responsibilities to project managers for completing the project within the
defined time frame and cost limits is helpful for expeditious execution and
cost control.
3. Use of network techniques: For project planning and control several network
techniques such as PERT (Program Evaluation Review Techniques) and CPM
(Critical Path Method ) are available. With the help of these techniques
monitoring of a project becomes easier.


Advantages
By working at home you save on many hidden costs associated with going to work. These include
costs of commuting, car wear and tear, fuel, road taxes, parking as well as indirect costs such as
expensive professional wardrobes and the dry-cleaning of those. Often you can also save on older
childrens care arrangements although for younger children it is highly unadvisable to forgo the
childcare arrangement and try to balance close care and supervision with the demands of the job.
Flexibility
This doesnt just relate to timings either although the flexibility to determine your own work hours to
some extent is the most important aspect of this. You can also determine your environment, lighting,
temperature, setting, mood; basically work in the framework that suits you best and makes you
happiest and most productive.
Less distractions
Coworkers banter and distractions, unnecessary interruptions, unimportant meetings can all be
avoided if you are safely at home and sealed off in your own environment which you have
barricaded from any possible interruptions.
Proximity to home and family
For many, the physical proximity to family and the convenience of being at home are tremendously
comforting. For parents it can be especially pacifying to know that they are very near to their children
and available should they be needed for any reason. This also applies in the case of elderly care.
Less stress
The stress of commuting in bumper-to-bumper traffic at rush hour in many countries is extremely
counterproductive and can lead to disgruntled workers who are already exhausted and worn before
they have even begun their day. This is especially true where the workplace is far from the office.
Other stresses often cited include unfriendly coworkers, a suboptimal work environment and
constant distractions.
More productivity
Removed from the stresses and distractions of the workplace and working independently in their
own preferred environment at their own pace, professionals are often a lot happier and a lot more
productive.
Better health
Often with long commutes and anywhere from 1 to 3 hours a day spent getting to and from the
workplace both physical and mental health are adversely impacted; the former as the gym hours are
usually the first to go and the latter due to the stresses associated with both the commute and the
workplace itself. By working at home the commuting time saved enables you to resume physical
exercise, to go for a long walk for example before and after work or to join a local gym.
Better work/life balance
Work/life balance, the aspiration of the modern professional, is often achieved and tuned to
satisfaction through a working at home arrangement, particularly when a professional has the
flexibility to report into the office and work from the office partially as an option and can fine-tune the
arrangement to achieve the most optimal balance.
Disadvantages
Isolation
Often, professionals working from home complain of isolation and loneliness given their removal
from their bosses and coworkers and th is can be very depressing to some. Since the workplace
provides a location to meet people and make friends for many, professionals working from home
have to be more creative and resourceful in getting to know people and in staying in touch with their
colleagues.
Distractions
Although office distractions are avoided by working at home, different distractions may arise.
Interruptions from children, work, neighbours, friends, family may be very disruptive and special
efforts must be made to make it known that you are actually working and unavailable for interruption
within work hours despite your physical presence at home.
Difficulty in separating home from work
The temptation to engage in household matters since you are at home is often very strong. Suddenly
you may start feeling obliged to clean the home, do the shopping, the childcare, the cooking, the
home finances and the socializing all while meeting the full requirements of the job too. It is essential
to draw the line between home and work so as to avoid both areas suffering.
Work doesnt end
Since there is no-one looking over your shoulder enforcing strict hours you may feel tempted to work
endlessly. This pressure to work endlessly may be compounded by the fact that you feel there are
greater expectations made of you as a home-worker or by self-imposed pressures to prove yourself
and your abilities in this arrangement. Moreover the lack of physical separation between home and
work may add to this pressure to work endlessly.
Alienated from daily company developments
A lot can change from day to day in a company and you may find yourself removed from important
developments such as staff changes, new business, changes in company direction, new competitive
intelligence etc.
Danger of being overlooked for promotion
The danger of being overlooked for promotions and career development opportunities is quite real
when you are away from the office and other more visible employees are actively and aggressively
vying for them. An open line of communication with management and regular visits to the office are
critical in order to prove your dedication and commitment to your career and to prevent the out-of-
sight-out-of-mind syndrome.
Need for high self-discipline
Working from home is not for anyone. It takes a lot of dedication, self-control and discipline to
motivate yourself to persevere in working at home alone over the long run without succumbing to the
distractions and losing drive and momentum. Often a partial arrangement where you report into the
office once or twice a week is the optimal arrangement as it allows for close interaction with
colleagues and supervisors and ensures you remain in touch with company developments while still
permitting you the comfort and convenience of working from home.