MB0041 - FINANCIAL AND MANAGEMENT ACCOUNTING

Q1. Inventory in a business is valued at the end of an accounting period, at either

cost or market price, whichever is lower. This is accepted convention or a practice
in accounting.
Give a small introduction on accounting conventions and elucidate all the eight
accounting conventions.
[Introduction of accounting convention, Explanation of all the 8 types of conventions]
Answer: Accounting Conventions
Accounting conventions are the rules based on which accounting takes place and these rules are
universally accepted. There are ten types of accounting conventions, namely convention of
income recognition, convention of expense, convention of matching cost and revenue,
convention of historical cost, convention of full disclosure, convention of double aspect,
convention of modifying, convention of materiality, convention of consistency, and convention
of conservatism. They are explained briefly in the following sections.
1.

Convention of income recognition

According to this concept, revenue is considered as being earned on the date on which it is
realized, i.e., the date on which goods and services are transferred to customers for cash or for
promise.
2. Convention of matching cost and revenue
According to this concept, revenue earned during a period is compared with the expenditure
incurred to earn that income, irrespective of whether the expenditure is paid during that period
or not. This is also called matching cost and revenue principle.
3. Convention of historical costs
This convention says that all transactions must be recorded at a value at which they were
incurred. Such a value is called Historical Cost and this principle is called the Convention of
Cost. An asset or transaction may have many other values associated with it like market value
or replacement cost. But all assets are recorded at the cost of acquisition and this cost is the
basis for all subsequent accounting for the assets. The expenses and the goods purchased are
shown at the value at which they are incurred.
4. Convention of full disclosure
This convention requires a business to disclose the following:

All the accounting policies adopted in the preparation and presentation of financial
statements.
If there is any change in the accounting policies in the current year as compared to the
previous year/s, the effects of such changes and the reason/s thereof.
The implications (in terms of money value) on the financial statements due to such change.
5. Convention of double aspect
This concept states that every transaction has two aspects. One is the receiving aspect and the
other is the giving aspect. In accounting language, these two aspects are called debit and
credit. The claims on assets will always be equal to the assets. The claims on assets may be of
the owners or of the outsiders (creditors). While the claims of owners are called Equity or
Capital, the claims of outsiders are called Liabilities. Therefore, total liabilities are equal to total
assets. This concept gives rise to the balance sheet equation, i.e., Assets=Liabilities + Capital.
The following balance sheet illustrates this.
6. Convention of materiality
This convention states that the benefit derived from measuring, recording, and processing a
transaction should justify the cost of doing it.
7.

Convention of consistency

This convention requires that the accounting policies must be consistently applied year after
year. Consistency is required to help comparison of financial data from one period to another.
Once a method of accounting is adopted, it should not be changed. A change in an accounting
policy may be done only when:
It is required by law
It is felt that the new policy reflects the financial performance or position better than the old
policy
Such changed policy must be consistently applied for the subsequent periods. As stated under
the full disclosure convention, the change in the accounting policy along with the reason/s and
the financial implications on the financial statements should be disclosed to the users.
8. Convention of conservatism or prudence
Accountants follow the rule anticipate no profits but provide for all anticipated
losses. Whenever loss is anticipated, sufficient provisions should be made. But if a profit is
anticipated, it should not be recorded until it is actually realised.

Q2. Analyse the following transactions according to traditional approach.

a. 1.1.2011 Sunitha started his business with cash Rs. 5,00,000
b. 2.1.2011 Borrowed from Malathi Rs. 5,00,000
c. 2.1.2011 Purchased furniture Rs. 1,00,000
d. 4.1.2011 Purchased furniture from Meenal on credit Rs. 1,50,000
e. 5.1.2011 Purchased goods for cash Rs. 50,000
f. 6.1.2011 Purchased goods from Ram on credit Rs. 2,50,000
g. 8.1.2011 Sold goods for cash Rs. 1,25,000
h. 8.1.2011 Sold goods to Shyam on credit Rs. 55,000
i. 9.1.2011 Received cash from Shyam Rs. 25,000
j. 10.1.2011 Paid cash to Ram Rs. 90,000
[ Filling in all the details in the table for all the transactions. Each transaction
carries one
mark(1*10=10)]
Answer:
Sl.
No.

Accounts
Involved

Nature of Affects
Account

Debit/
Credit

Cash a/c
Capital a/c

Real
Personal

Cash is coming in
Sunita is the giver

Debit
Credit

Cash a/c
Loan from
Malathi

Real
Personal

Cash is coming in
Malathi is the giver

Debit
Credit

Furniture a/c
Cash a/c

Real
Real

Furniture is coming in
Cash is going out

Debit
Credit

Furniture a/c
Meenl a/c

Real
Personal

Furniture is coming in
Meenal is the giver

Debit
Credit

Purchase a/c
Cash a/c

Nominal
Real

Purchase is an expense
Cash is going out

Debit
Credit

Purchase a/c
Rams a/c

Nominal
Personal

Purchase is an expense
Ram is the giver

Debit
Credit

Cash a/c
Sales a/c

Real
Nominal

Cash is coming in
Sales is revenue

Debit
Credit

Shyams a/c
Sales a/c

Personal
Nominal

Shayam is the receiver

Sales is revenue

Debit
Credit

Cash a/c
Shyams a/c

Real
Personal

Cash is coming in
Shyam is the giver

Debit
Credit

Rams a/c
Cash a/c

Personal
Real

Ram is the receiver

Cash is going out

Debit
Credit

Q3. The following items are found in the trial balance of M/s Sharada Enterprise
on 31st
December, 2000.
Sundry Debtors Rs.160000
Bad Debts written off Rs 9000
Discount allowed to Debtors Rs. 1800
Reserve for Bad and doubtful Debts 31-12-1999 Rs. 16500
Reserve for discount on Debtors 31-12-1999 Rs. 3200
You are required to provide the bad and doubtful debts at 5% and for discount on
debtors at 2%. Show the adjustments for bad debts, bad debts reserve, discount
account, and provision for discount on debtors.
[Calculation and Workings, Conclusion]
Answer:

Solution:
The amount debited to P&L account towards RBD is computed as follows:
Old RBD
=Rs.
(-) Bad debts
=Rs.
Balance
=Rs.
New RBD @5% on160000 = Rs.
RBD to be provided

=Rs.

16500
9000
7500
8000
500 (8000-7500)

The amount debited to P&L account towards Reserve for Discount on Debtors is computed as
follows:
Rs.160000 Rs.8000 (New RBD)=
Good Debtors
Old Reserve for
Discount on Drs
Less Discount on Drs
Balance Reserve
New Reserve for
Discount at 2%
On good Drs 152000
Reserve for Discount to
be
provided now

=Rs.152000
=Rs.3200
=Rs.1800
=Rs.1400

=Rs.3040

=Rs.1640 (3040 -1400)

Conclusion:
In the balance sheet, the Sundry debtors are reduced by bad debts shown outside the trial
balance, the new RBD, discount on debtors shown outside the trial balance and the new Reserve
for discount on debtors.

Q4. The reports prepared in financial accounting are also used in the management
accounting. But there are few major differences between financial accounting and
management accounting. Explain the differences between financial accounting
and management accounting in various dimensions. (Writing down all the
differences between the financial and management accounting)

Answer:
Dimension

Financial accounting

Management accounting

Users

The primary users of financial

accounting information are
external users like shareholders,
creditors, government authorities,
employees, etc.

The primary users of

management accounting are
internal users like top, middle,
and lower level managers.

Purpose

Reporting financial performance

and financial position to enable
the users to take financial
decisions.

To help the management in

planning, decision making,
monitoring, and controlling.

Need

It is a statutory requirement. What

to report, how to report, how much
to report, when to report, in which
form to report, etc. are stipulated
by Law or Standards.

It is optional. What to report,

how to report, how much to
report, when to report, in which
form to report, etc. are decided
by the management as per the
needs of the company or
management.

Expression
of
information

Accounting information is always

expressed in terms of money.

Management accounting may

adopt any measurement unit
like labour hours, machine
hours, or product units for the
purpose of analysis.

Reporting
timing and
frequency

Financial data is presented for a

definite period, say one year or a
quarter.

Reports are prepared on a

continuous basis, monthly,
weekly, or even daily.

Time
perspective

Financial accounting focuses on

historical data.

Management accounting is
oriented towards the future.

Sources of
principles

Financial accounting is a
discipline by itself and has its own
principles, policies and
conventions (GAAP).

Management accounting
makes use of other disciplines
like economics, management,
information system, operation
research, etc.

Reporting
entity

Overall organisation

Responsibility centres within

the organisation

Form of
reports

Income statement (Profit and Loss

a/c)
Balance sheet

MIS reports
Performance reports
Control reports

Cash flow statement

Cost statements
Variance statements
Budgets
Estimate statements
Flowcharts

Q5 Draw the Balance Sheet for the following information provided by Sandeep
Ltd..
a. Current Ratio : 2.50
b. Liquidity Ratio : 1.50
c. Net Working Capital : Rs.300000
d. Stock Turnover Ratio : 6 times
e. Ratio of Gross Profit to Sales : 20%
f. Fixed Asset Turnover Ratio : 2 times
g. Average Debt collection period : 2 months
h. Fixed Assets to Net Worth : 0.80
i. Reserve and Surplus to Capital : 0.50

(Preparation of Balance sheet (Includes all the ratios) 10

Solution:
The Balance Sheet is given below:
Liabilities
Captal
Reserves and Surplus
Long-term Debt
Current Liabilities
Total

Rs.
500000
250000
150000
200000
1100000

Assets
Fixed Assets
Inventories
Debtors
Bank
Total

Rs.
600000
200000
250000
50000
1100000

Working Notes:
If Current Liabilities

=1

Current Assets

=2.5

Working Capital(2.5-1)

= 1.5

=300000

Therefore Current Assets(2.5/1.5)x300000

=500000

Current Liabilities(1/1.5)x300000

=200000

Liquidity Ratio

=1.5

Current Liabilities

=200000

Therefore Liquid Assets(200000x1.5)

=300000

Inventories(Current asset-Liquid Asset)

=200000

Stock Turnover ratio =6 times

Cost of sales(6x200000)

=1200000

Gross Profit Ratio =20%

Gross Profit
If Sales is 100; Gross Profits is 20
Hence cost of sales is (100-20)=80
Therefore Gross Profit is (20/80)x1200000

=300000

Sales(cost of Sales +Gross Profit)

1500000

Fixed Asset Turnover ratio

=2 times

(Cost of Sales/Fixed Assets)

Therefore Fixed Assets(1200000/2)

=600000

Debtors Collection Period =2 months

(Months in a year/ Debtors Turnover)
Debtors Turnover Ratio(12/2)

=6 times

(Sales/Debtors)
Debtors(1500000/6)

=250000

Fixed Assets to Shareholders Net worth =0.80

Shareholders net worth (600000/0/80)

=750000

Reserves and Surplus to Capital =0.50

If capital is 1: reserves and surplus is 0.5
Reserves and surplus + capital= shareholders
net worth(0.5+1=1.5)
Reserves and Surplus (7500000x(0.5/1.5)

=250000

Therefore share capital

=500000

Q6. Write the main differences between cash flow analysis and fund flow analysis.
Following is the balance sheet for the period ending 31st March 2011 and 2012. If
the current years net loss is Rs.38,000, Calculate the cash flow from operating
activities.

(Differences between cash flow and fund flow analysis, Preparation of statement showing cash
flow from operating activities) 4, 6
Solution: Difference between Cash Flow Analysis and Fund Flow Analysis
Table 10.1 shows the differences between cash flow analysis and fund flow analysis.
Cash Flow Analysis

Fund Flow Analysis

1. It is concerned only with the

change in cash position

It is concerned with change in

1. working
capital position between two balance
sheet dates.

2. It is merely a record of cash

receipts and disbursements

2. Net effect of receipts and

disbursements are recorded.

Cash is part of working capital

3. and
3. An improvement in funds positions
therefore an improvement in
need not result in improvement in
cash
cash
position results in improvement
in
position
the funds position
4. It is cash based

4. It is accrual based

Statement showing cash flows from operating activities

Net Loss

( 38,000 )

ADD: Decrease in Current Assets

Provision for doubtful debts

1,200

Stock

2,000

Prepaid expenses

200

Increase in current liabilities

Outstanding expenses
Bills payable

200
2,000
+ 5,600
__________
(32,400 )

DEDUCT ; Increase in current assets

Short term loan

3,000

Bills receivable

10,000

Creditors

22,000
+ 35,000
________

Net cash loan in operating activities

( 67,400 )