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FINANCIAL STATEMENT ANALYSIS

Steps involved in Financial Statement Analysis

The term Financial analysis, also known as analysis and interpretation of

1. Determine the scope and objective for financial statement analysis

financial statements is a process of evaluating the relationship between

One must have clear idea about the purpose and extent of analysis that is need to

component parts of a financial statement to obtain a better understanding of a

be carried out.

firms position and performance. According to Myers, Financial statement

2. Study and comprehend the contents of financial statements

analysis is largely a study of relationships among the various financial factors in

3. Collection of relevant information

business as disclosed by a single set of statements and a study of the trend of

Sufficient number of years of financial statements should be collected.

these factors as shown in a series of statements.

Additional

Objectives of Financial Statement Analysis

Information or data, if needed should also be gathered.

1) To ascertain the profitability and efficiency of the business operations.

4. Re arrange the data

2) To estimate the earning capacity of the firm.

The available data should be properly rearranged or regrouped. so that they can

3) To judge the short-term and long-term solvency of the company.

be made suitable for analysis.

4) To ascertain the debt capacity of the organization.

5. Analysis of collected data using analytical tools

5) To decide on the future prospects of the concern.

Now one can apply appropriate tool to analyse the data. tools like Comparative

6) To find out the efficiency in the utilization of assets.

statements, common-size statements, trends, calculate ratios, etc.can be applied

7) To facilitate inter-firm comparison.

6. Interpretation

8) To aid intra-firm comparison.

The facts revealed by the analysis should be properly interpreted, taking into

9) To facilitate leverage analysis.

account Relevant quantitative and qualitative factors.

10) To help prospective investors in their investment decision.

7. Presentation in suitable form


1

The interpretation drawn from the analysis should be presented in a form which

Worthiness, quality of human resources, reputation, etc.

serves the purpose for which the financial statements are analyzed.

2) They ignore changes in price level.

Types of Financial Analysis

3) The assumption that past happenings may get reflected in the future may not

On the basis of Material used :

hold good.

1. External Analysis: Analysis is done on the basis of published financial

4) Interpretation is based on personal judgment of the analyst, which may be

statements. This type of analysis is done by outsiders like creditors, suppliers

biased.

,investors and government agencies who do not have access to Internal

5) Window dressing, which is the major drawback of financial statements will

accounting records of the company.

have an impact on the analysis.

2. Internal Analysis: Analysis is done on the basis of internal and unpublished

Tools and Techniques for Analysis of Financial Statements

records. It is done by persons like executives and other authorized officials, who

The following are the most important tools are used for analysis,

have access to internal accounting. Records of the firm is called internal analysis.

1) Common size statements

On the basis of Modus Operandi:

2) Comparative statements

1. Horizontal Analysis: Here, every item in the financial statement is analyzed

3) Trend analysis

over a numberof years, order to ascertain its trend. Comparative statements and

4) Ratio analysis

Trend percentages arethe two tools used in this type of analysis.

5) Fund Flow analysis

2. Vertical Analysis: It refers to the study of relationship between various items

6) Cash Flow analysis

in a specificyears financial statement. Common size financial statements and

7) Cost-Volume Profit Analysis

financial ratios are the twotools used in this analytical mode.


Limitations of Financial Statement Analysis
1) Financial statements do not take into account qualitative factors like credit
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Measures the liquidity and solvency position of firm.

Facilitates management in decision making.

Helps prospective investors in arriving at an investment decision.

Aids management to initiate corrective action.

relationship between two related accounting figures and is calculated by dividing

Supplies management with inputs to aid in their forecasting and planning.

one by another. Ratio analysis is a technique used for analysis and interpretation

Ratio analysis Facilitates inter-firm comparison.

Ratio analysis helps in effective control over the business through the

RATIO ANALYSIS
Meaning of Ratio Analysis
According to accounting parlance Ratio may be defined as a numerical

of financial statements It helps us to analyze and understand the financial affairs

measuring of actual performancesand comparing it with the planned


and the strength and weakness ofa firm. Extent and quality of analysis and
interpretation depends on the use of apt type of ratio and on the talent of the

performance..

Supplies required information to the interest parties like owners, crs, govt
etc..

caliber analyst.

It brings to light financial strength and weakness of a firm.

Objectives of Financial Statement Analysis


1) To ascertain the profitability and efficiency of the business operations.

Limitation of Ratio Analysis

2) To estimate the earning capacity of the firm.

3) To judge the short-term and long-term solvency of the company.

Differences in the definition of ratios make their calculations and


interpretation Ambiguous.

4) To ascertain the debt capacity of the organisation.

5) To decide on the future prospects of the concern.

Financial statements form the basis for calculation of Ratios. Such

6) To find out the efficiency in the utilization of assets.

statements suffer from several limitations. Ratios derived from them are

7) To facilitate inter-firm comparison.

also suffer from such limitations.

8) To aid intra-firm comparison.

ratios invalid.

9) To facilitate leverage analysis.


10) To held prospective investors in their investment decision.
Importance or Uses of Ratio Analysis

Ratios ignore Changes in price level, which render the interpretation of

It is difficult to find out a proper basis for comparison.

Ratios just provide quantitative input, and its analysis and interpretation
is subject to the personal bias and competence of the analyst.

Ratio analysis Helps in understanding the general efficiency of mgnt.

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Ratios reflect the postmortem analysis of the past affairs of the firm. and
the past need not necessarily be an indicator of the future.

Financial statements are subject to serious limitation called window-

These ratios are calculated to check the short term repaying capacity of a
business. It is further classified into three types. They are
1. Current ratio

dressing. ratios are calculated from such statements. Hence users of such
ratios while making a decision should be careful.

2. Liquid ratio

Liquid Assets .
Current Liabilities

3. Absolute liquid ratio

Absolute liquid Assets


Current Liabilities

While preparing financial statements, different firms follow different


accounting Policies. Hence, interpretation made by

comparing these

ratios will not depict a real picture.

Current Assets .
Current Liabilities

Calculation of a single ratio may not give out the end result required and

THESE THREE RATIOS ARE ALSO CALLED AS LIQUIDITY RATIOS

hence one may be required to calculate several ratios. Too many ratios

LONG TERM SOVENCY RATIOS

can make decision making process confusing and time consuming.


Tools and Techniques for Analysis of Financial Statements
The most important tools are
1) Common size statements

These ratios are calculated in order to check the repaying capacity of the
business in a long run. Therefore it is called as long term solvency ratios. It is
further classified into two types. They are
1. Debt equity ratio

2) Comparative statements
3) Trend analysis

Total long term debts


Share holder funds

Long term debts = Debentures + long term loans and advances or long term
borrowings.

4) Ratio analysis
5) Fund Flow analysis

Share holder funds = Equity shares + Preference shares + reserves + surplus


[profits].

6) Cash Flow analysis


. SOLVENCY RATIOS

2. Proprietary ratio

These ratios are calculated to test the repaying capacity of a business


regarding its borrowing. It is further classified into two types. They are
1. Short term solvency ratios
2. Long term solvency ratios
SHORT TERM SOLVENCY RATIOS

Share holder funds.


Total tangible Assets

Total tangible assets = Current Assets + Fixed Assets.


. PROFITABILITY RATIOS
These ratios are calculated in order to know the profit earning capacity of a
business. It is further classified into four types. They are

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1. Office and administrative expenses.


1. Gross profit ratio

Gross profit X 100


Sales

2. Selling and distribution expenses.


NON OPERATING EXPENSES

Gross profit = Sales Cost of goods sold

These expenses are not essential or important to run or operate a business.

Sales = Cost of goods sold + Gross profit

Example

Cost of goods sold = Sales Gross profit

1. Depreciation

(OR)

2. Loss on sale of Assets

Cost of goods sold = [Opening stock + Purchases Closing stock] + all direct
expenses are to be debited in trading account.

3. Good will written off


4. Financial expenses like interest, dividend etc
5. Preliminary expenses or formation expenses or promotional expenses

2. Net profit ratio

Net profit
Sales

X 100

NON OPERATING INCOMES


These incomes are unusual in nature. Without these incomes and gains one

Net profit = Gross profit all expenses and losses + all incomes and gains.

can operate or run the business. Example


1. Financial incomes like interest, dividend etc.

3. Operating cost ratio

Operating cost
Sales

X 100

2. Profit on sale of Assets.


3. Bad debts recovered.

Operating cost = cost of goods sold + all operating expenses and losses.

4. Refund of Income tax.


IN ALL RATIOS SALES = SALES SALES RETURNS.

4. Operating profit ratio

Operating profit
Sales

X 100

. TURN OVER RATIOS

Operating profit = Gross profit All operating expenses.


(OR)
Operating profit = Net profit + All non operating expenses and losses All

It is classified into five types. They are


1. Stock TO ratio (OR) Inventory turnover ratio

Cost of goods sold


Average stock

non operating incomes and gains.


Average stock

OPERATING EXPENSES
These expenses are essential or very important to run or operate a business.
Example
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= Opening stock + Closing stock


2
2. Fixed Assets turnover ratio =
Sales
.
Fixed Assets

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III TURNOVER RATIOS ARE TO BE EXPRESSED IN TERMS OF TIMES.


Example 4 times, 3 times, 2 times etc.

Fixed Assets = Fixed Assets Depreciation.


3. Capital turnover ratio

Sales
.
Capital employed

1. Capital gearing ratio: it analyses the capital structure of the company.

Capital employed = Share holder funds + Total long term debts.


4. Debtors turnover ratio

Net credit sales


.
Average accounts receivable

This ratio measures the relationship between fixed interest and dividend
bearing funds and equity share holders funds.
Long term loans + debentures + preference share capital
Equity share holders funds

Credit sales = Total sales Cash sales


Net credit sales = Credit sales Sales returns

Alpha manufacturing co. has drawn up the following profit and loss a/c for the
year ended 31st March, 2006.

Average accounts receivable


= Opening debtors & bills receivable + Closing debtors & bills receivable
2

5. Creditors turnover ratio

Net credit purchases

Average accounts payable

Particulars

26,000 By Sales

To Purchase

80,000 By Closing Stock

To Wages

24,000

To Manufacturing Exp.

16,000

To Gross Profit

52,000
1,98,000

Net credit purchases = Credit purchases Purchase returns

To Selling and

Average accounts payable

Distribution Exp.
To Administrative Exp.

= Opening creditors & bills payable + Closing creditors & bills payable
2

To General Expenses

I
SOLVENCY RATIOS ARE TO BE EXPRESSED IN TERMS OF
PROPORTIONS.
Example 4:1, 3:1, 2:1 etc.

PROFITABILITY RATIOS ARE TO BE EXPRESSED IN TERMS OF


PERCENTAGE.
Example 40%, 30%, 20% etc.

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Particulars

To opening stock

Credit purchases = Total purchases Cash purchases

II

Rs.

To value of furniture lost


by fire
To Net Profit

4,000 By Gross Profit

22,800 By Compensation for


acquisition of land

Rs.
1,60,000
38,000

1,98,000
52,000

4,800

1,200
800
28,000
56,800

56,800

You are required to find out:


(a) Gross profit ratio (b) Net profit ratio (c) Operating ratio (d) Operating

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N.P to Net sales ratio.

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11. Netprofit ratio


12. Operating ratio.
Balance sheet as on 31.12..1997
Liabilities

Rs

Issued capital:

Assets

Rs

40,00,000

Building

30,00,000

Reseves

18,00,000

Plant

16,00,000

Creditors

26,00,000

Stock

29,69,000

Profit&loss a/c

6,00,000

Drs

14,20,000

6% Debentures

6,00,000

Bank

6,20,000

Total

96,00,000

40,000 shares of Rs.100 each

96,00,000

Profit & Loss Account


Particulars

Rs.

Particulars

Rs.

To Opening stock

19,90,000

By sales

1,70,00,000

To purchases

1,09,05,000

By closing stock

29,80,000

To Diorect expenses

2,85,000

To Gross profit C/d

68,00,000
1,99,80,000

1,99,80,000

From the following Balance sheet and Profit and loss account as on 31.12.1997 youare required to

To administration expenses

30,00,000

By gross profit b/d

68,00,000

calculate the below given ratios :

To selling and distribution

6,00,000

By non operating income

1,80,000

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

expenses

Current ratio
Quick ratio
Fixed asset ratio
Debt equity ratio
Proprietary ratio
Stock turn over ratio
Fixed asset turn over ratio
Return on capital employed
Debtor turn over ratio
Creditor turn over ratio

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To financial expenses

3,00,000

To non-operaring expenses

80,000

To net profit

30,00,000
69,80,000

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1. Current ratio :Current assets


Current liabilities
=

= 40, 00,0,00 +18, 00,000 + 6, 00,000


50,00,000
26,00,000

= 64, 00,000
5. Proprietary ratio =

= 1.92

Share holders fund


Total tangible assets

Current assets = stock + debtors + Bank = 29,60,000 + 14,20,000 + 6,20,000 = 50,00,000

Creditor = 26,00,000

= 64,00,000
96,00,000

2. Quick ratio = quick assets


Current liabilities
=

= 0.67

20,40,000
26,00,000

6. Stock turn over ration = cost of sales


Average stock

= 0.78
3. Fixed asset ratio =
fixed asset
Long term funds

Cost of sales = sales gross profit = 1,70,00,000 68,00,000 = 1,02,00,000

Average stock = opening stock + closing stock


2

46,00,000
19,90,000 + 29,80,000
2

70,00,0000
= 0.66
Fixed assets = building + plant = 30,00,000 + 16,00,000 = 46,00,000

= 24,85,000
Stock turn over ratio =

Long term funds = share capital + reserves + Profit & loss a/c + debentures

== 4.10 times.

= 40, 00,0,00 +18, 00,000 + 6,00,000 + 6,00,000

7. Fixed asset turn over ratio =

= 70, 00,000
4. Debt- equity ratio = long term debt
Share holders fund
= 6, 00,000
64, 00,000
= 0.094
Long term debt = debenture = 6, 00,000
Share holder fund = share capital + reserves + Profit & loss a/c

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1,02,00,000
24,85,000

cost of sales
Fixed assets

Cost of sales = 1,02,00,000


Fixed assets = building + plant = 30,00,000 + 16,00,000
= 46,00,000
Fixed asset turn overratio =1,02,00,000
46,00,000
= 2.22 times
8. Return on capital employed = profit before interest and taxX 100
Capital employed

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Profit before interest and tax = net profit + non operating expenses +
Interest Non- operating income
= 30,00,000 + 80,000 + 3,00,000 - 1,80,000
= 32,00,000
Capital employed = share capital + reserves + Profit & loss a/c + debentures
= 40, 00,0,00 +18, 00,000 + 6,00,000 + 6,00,000
= 70, 00,000
Return on capital employed =32,00,000X 100
70, 00,000
= 45.71%

9. Debtor turn over ratio = credit sales


Average debtors
= 1,70,00,000
14,20,000
= 11.97 times
10. Debt collection period = days or months in a year
Debtor turn over ratio
= 12 months
1 month
11.97
11. Creditor turn over ration = credit purchases

Net sales
= 30,00,000 X 100
1,70,00,000
= 17.64%
14. Operating ratio = cost of sales + Adm. expenses + selling expenses X 100
Sales
= 1,02,00,000 + 30,00,000 + 6,00,000 X 100
1,70,00,000
= 81.17%

Accounts payable
= 1,09,05,000
26,00,000
= 4.19 times
12. Creditor payment period = days or months in a year
Creditor turn over ratio
= 12 months
4.19
= 2.86 months
13. Net profit ratio = net profit X 100

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FUNDS FLOW ANALYSIS

statement describes the sources from which additional funds were derived

Introduction of Fund

and the use of which these funds were put. Funds flow

Fund means working capital. If current assets of company is more than current

To facilitate fund flow analysis, accounts shown in Balance Sheet can be

liability of business, it is called working capital and working capitals other name

classified as shown below:

is Fund.

Accounts shown in Balance Sheet

Fund = Working capital = Current assets Current liability

1. Current Accounts

a. Current Assets: Eg: Cash, Debtors, Stock,

33. Meaning of Fund Flow Statement


The term Funds has three different meanings. In a narrow sense, it means

b. Current Liabilities: Eg: Creditors, Bills, Payable, etc.,

cash only. In a broad sense, the term fund refers to all financial resources. In

2. Non-Current Accounts :

another sense , fund refers to Working Capital, which is the excess of Current

a. Fixed Assets : Eg: Machinery, Land & Building

Assets over Current Liabilities. In Fund Flow Statement, the word Fund means

b. Fixed Liabilities: Eg: Equity Capital, Preference

Working Capital. The term flow signifies change.

Capital

A Fund Flow Statement highlights the changes in working capital during a

Flow of fund takes place only when a transaction involves one current Account

period. It is popularly known as Statement of Sources and Application of

and one non-current account. For example, purchase of building which is non-

Funds. If a transaction results in increase in working capital, it is called sources

current Account, for cash which is a current account. Transaction between two

of funds. If a transaction decreases working capital, it is construed as

current accounts for example, cash paid to suppliers or two non-current accounts

application of funds. If it does not affect working

like issue of shares as consideration for purchase of building ,does not result in

Definition of fund flow statement

flow of funds. Transaction taking place between Current Accounts and Non-

Fund flow statement is a statement which shows the inflow and out flow of

Current Accounts only will generate funds. Thus, flow of funds can be

funds between two dates of balance sheet. So, it is known as the

represented as follows:

statement of changes in financial position. We all know that balance sheet

Current Accounts -------- Non-Transaction leading to flow of funds--------

shows our financial position and inflow and outflow of fund affects it. So,

Current Accounts

in company level business, it is very necessary to prepare fund flow

1.

statement to know what the sources are and what are applications of fund

The following steps are involved in the preparation of Fund Flow Statement:

Steps involved in the Preparation of Fund Flow Statement [16]

between two dates of balance sheet. Generally, it is prepare after getting

1) Preparation of Schedule of changes in Working Capital.

two year balance sheet. According to Prof. Anthony, The funds flow

2) Preparation of accounts for non-current items.

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3) Calculation of funds from operation through the Preparation of Adjusted

3) It depicts the reasons for changes in working capital.

Profit and Loss account.

4) It helps in working capital management.

4) Preparation of Fund Flow Statement.

5) Sources of funds reveal how the firm has funded its development projects in
the past, whether and to what extent from internal and external sources.

Step 1.Preparation of Schedule of changes in Working Capital:


Making

of

statement

of

Changes

of

Working

Capital

6) Analysis of Application of funds reveals how the resources were used in

For making of fund flow statement. It is very necessary to make

the past. This can act as a guide while planning future funds deployment.

statement of changes of working capital. Because net increase in

7) It gives a general idea about the overall financial management of the

working capital is use of fund and net decrease in working capital is

business.

source of fund. So, it is duty of accountant to make statement of changes

8) Acts as a guideline for efficient use of scarce resources.

of working capital. Making of statement of changes working capital is

9) Helps banks and financial situations to assess the credit worthiness and
repaying capacity of the firm.

very easy and simple.


We take two balance sheets, one is current year balance sheet and other is

10) Aids management in formulating financial policies in areas like dividend

previous year balance sheet. Then we separate current assets and current

declaration, creating reserves, etc

liabilities. If current assets are more than previous year current assets, it

8 . Limitations of Fund Flow Statement


1) It is not original in nature and is only a re-arrangement of data given in

means increase in working capital.


If current assets are less than previous year current assets, it means decrease in

financial statements.

working capital. Because, relationship between current assets and working

2) When both aspects of a transaction involve current account, they are

capital is positive and if any changes in current assets, working capital will

ignored in this statement.

change in same direction. If current liabilities are more than previous year

3) When both aspects of a transaction involve non-current account, they

current liabilities, it means decrease in working capital. If current liabilities are

are not considered in this statement.

less than previous year current liabilities, it means increase in working capital.

4) It depicts the past position and not the future.

Relationship between working capital and current liabilities are inverse.

5) It is not a ideal tool for financial analysis.


6) Changes in cash position are more important that working capital.

7 What are the importance or uses of Fund Flow Statement?


1) It shows how and from what sources funds were raised and they were used.
2) It shows the consequences of business operations, thus enabling management
to take remedial measures.
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9. Steps involved in the Preparation of Fund Flow Statement [FORMAT]


1) Preparation of Schedule of changes in Working Capital.
2) Opening of accounts for non-current items.

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3) Preparation of Adjusted Profit and Loss account.

Schedule of changes in Working Capital

4) Preparation of Fund Flow Statement.


10. What are the different kinds of ratios available to help the management?
i.Profitability ratios,

Effect on Working
Previous

ii. Activity ratios.

Particulars

Current
Year
Rs.

iii.Balancesheet rarios

Increase

Decrease

Rs.
Rs.

3. Distinguish between funds flow and cash flow statements?


1.
2.
3.
4.
5.
6.

Capital

Year
Rs.

Current Assets:

Basis of preparation
Basis of accounting
Changes shown
Usefulness
Short term solvency
Interdependence

Cash

Xxx

Xxx

Xxx

Bank

Xxx

Xxx

Xxx

Bills Receivable

Xxx

Xxx

Xxx

4. What is funds flow statement ? Explain the steps involved in the

Debtors

Xxx

Xxx

Xxx

preparation of funds flow statement.

C.A.

Xxx

Xxx

It refers to the statement showing the changes in working capital and sources and

Current Liabilities:
Bills Payable

Xxx

Xxx

Creditors

Xxx

Xxx

Bank Overdraft

Xxx

Xxx

C.L.

Xxx

Xxx

Net Working

Xxx

Xxx

application of funds

Xxx

i. Preparation of schedule of changes in working capital


ii. Preparation of funds from operation
iii .Preparation of funds flow statement.
Following are the rules for preparing the schedule
Particulars
(i) Increase in Current asset during current year

.
Impact on Working
Capital
Increase
-

Xxx

Capital (CA-CL)

(ii) Decrease in Current asset during current year

Decrease

Net Increase or

(iii) Increase in Current liabilities during current year

Increase

Decrease

(iv) Decrease in Current liabilities during current year

Increase

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Xxx

Total

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Increase Decrease

Decrease

Increase

Xxx

Xxx

xxx

Xxx

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2) Opening of accounts for non-current items

[examples: Refund of tax, profit on sale of asset, Dividend received, Loss on

These are prepared, wherever warranted, to ascertain the sources or


application of funds. While preparing, additional information, if any, regarding
such accounts should also be considered.

sale of asset, etc.]

For instance, if opening and closing value of a machine given in balance


sheet are Rs. 1, 00,000 and Rs. 1, 25, 000, and as additional information, it is
given that depreciation charged during the year is Rs. 25, 000, the Machine
account will appear as follows:
Dr

Machine A/c
Particulars

To bal b/d
To Cash [Purchase of machine]

Amount
Rs.

Particulars

Cr
Amount
Rs.

1,00,000 By Depreciation
50,000 By bal c/d

25,000
1,25,000

1,50,000

1,50,000

The balancing figure of Rs. 50,000 represents purchase of machine involving


outflow or application of funds.
3) Preparation of Adjusted Profit and Loss A/c
This is opened to ascertain Funds from operation or Funds lost in
operation.
A fund from operation is the only internal source of funds. The net profit, earned
by the business is known as the internal source. But such net profit shown by
Profit and Loss A/c should be adjusted for Non-fund and Non-operating
items.

Dr
Particulars
To Depreciation on FA
To Goodwill, Patent, Preliminary expenses written off
To Transfer to reserves
To interim dividend Proposed
To Proposed Dividend (if

Amount
Xxx
Xxx

Particulars
By Balance b\d
By profit on sale of asset

Cr
Amou
nt
Xxx
Xxx

Xxx
Xxx

By Refund of income tax


By profit on sale of asset

Xxx
Xxx

Xxx

By Dividend received

Xxx
Xxx

Xxx *

To Provision for tax (if taken


as non-current item)
To Loss on sale of asset

Xxx

Income from Investment


By profit on sales
investment

Xxx

By Funds from operation

To Balance b\d

Xxx

taken as non-current item)

To funds lost in operation

Xxx

Xxx *
Xxx

xxx

The balancing figure in the Adjusted Profit and Loss A/c is either, Funds from
operation or Funds lost in operation.

Non-fund items are those income and expenses charged to Profit and Loss A/c
that does not involve any outflow of fund [examples: writing back of
Provision for tax, Depreciation, Transfer to General Reserve, etc.]

4)

Non-operating items are those income and expenses charged to Profit and Loss

of finds on another along with the data generated in the above three steps.

A/c which are not directly related to business operations of the company.
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Preparation of Fund Flow Statement

This is prepared by incorporating sources of funds on one side, and application

Following is the specimen of Fund Flow Statement:

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STATEMENT OF CHANGES IN WORKING CAPITAL

Fund Flow Statement for the Period

Particulars

Sources of Funds

Amount

Funds from operation

Xxx (1)

Issue of
shares/debentures

Xxx

Application of
Funds

Effects on Working

Increase

Funds lost in
operation
Redemption of

Xxx (1)

Preference shares,

Current Assets:
Stock-in-Trade
Debtors
Cash
CA

Xxx

Purchase of fixed

asset/investment

2004 Rs.

Amount

Debentures
Sale of fixed

2003 Rs.

Xxx

asset/investment

Xxx

Long term loans taken

Xxx

Repayment of long
term loans

Xxx

Decrease in Working
capital

Xxx (2)

Payment of tax

Xxx

Payment of dividend

Xxx

Current Liabilities:
Creditors
CL
Net working
capital(CA-CL)
Net Incre in worki capital

1,21,000
1,81,000
48,000

1,36,000
1,70,000
70,000

3,50,000

3,76,000

1,06,000
1,06,000
2,44,000

62,000
3,06,000

Increase in Working
capital

15,000

Capital
Decrease
-

11,000
22,000

70,000

36,000

70,000
3,06,000

73,000

3,06,000

11,000

62,000
73,000

73,000

2. Prepare a Statement of changes in Working Capital from the following

Xxx (2)

Balance Sheets of Ram Seth Company


st

Xxx

xxx

1. From the following Balance Sheet prepare a schedule of changes in working capital
Liabilities

2003 Rs.

2004 Rs.

Assets

Share capital

3,00,000

3,75,000

Creditors

1,06,000

Profit & Loss A/c

14,000

4,20,000

Ramu Vasu MBA MPhil

2003 Rs.

2004 Rs.

Machinery

70,000

1,00,000

70,000

Stock in Trade

1,21,000

1,36,000

31,000

Debtors

1,81,000

1,70,000

Cash

48,000

70,000

4,20,000

4,76,000

4,76,000

BALANCE SHEET as on 31 December


Liabilities 2003 Rs. 2004 Rs.
Assets
Equity
5,00,000 5,00,000 Fixed Assets
capital
Debentures 3,70,000 4,50,000 Long-term
Investments
Tax
77,000
43,000
Work-inPayable
progress
Creditors
96,000
1,92,000 Stocks
Interest
37,000
45,000
Debtors
Payable
Dividend
50,000
35,000
Cash
Payable
11,30,000 12,65,000

Accounting For Management [Type text]

2003 Rs.
6,00,000

2004 Rs.
7,00,000

2,00,000

1,00,000

80,000

90,000

1,50,000
70,000

2,25,000
1,40,000

30,000

10,000

11,30,000 12,65,000
Page 18

STATEMENT OF CHANGES IN WORKING CAPITAL

3. From the following Income Statement ascertain the amount of funds from operations:

Effect on Working
Particulars

2003

Capital
Increase
Decrease

2004

(+)

(-)

Current Assets:
Cash

30,000

10,000

20,000

Debtors

70,000

1,40,000

70,000

Stocks

1,50,000

2,25,000

75,000

Work-in-progress

80,000

90,000

10,000

3,30,000

4,65,000

CA

Current Liabilities:
Tax Payable

77,000

43,000

34,000

Creditors

96,000

1,92,000

96,000

Interest Payable

37,000

45,000

8,000

Dividend Payable

50,000

35,000

15,000

2,60,000

3,15,000

70,000

1,50,000

80,000

80,000

1,50,000

1,50,000

2,40,000

2,04,000

CL
Working Capital
(CA C L)
Net Increase in
Working Capital

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4. From the following details, calculate funds from operations.

Ramu Vasu MBA MPhil

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Note: Non-operating items are not given. Hence, the difference between
the P&L a/c treated as funds from operations.

During the year ended 31st December 2005


a) Dividend paid Rs.23,000
b) Depreciation written off: Machinery Rs.14,000; Building Rs.10,000
c) Income tax paid Rs. 28,000 .
Prepare the following statements Statement of changes in working capital
Fund flow statement

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Ramu Vasu MBA MPhil

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Ramu Vasu MBA MPhil

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1. Depreciation ofRs.10, 000 and Rs.20, 000 have been charged on plant
and building respectively.
2. A dividend of Rs.20,000 has been paid
3. Income tax of Rs.35,000 has been paid.
Solution: 1. Schedule of changes in working capital :- Increase in working capital
is Rs.51,000
2.Funds from operation :- Rs.1,76,000
3. funds flow statement:- 2,86,000
6. From the following prepare cash flow statement

5.From the following prepare funds flow statement (June 2013)

Particulars

1991

1992

Particulars

1991

1992

Equity share

3,00,000 4,00,000 Goodwill

1,15,000 90,000

1,50,000 1,00,000 Building

2,00,000 1,70,000

General reserve

40,000

70,000

plant

80,000

30,000

48,000

Drs

1,60,000 2,00,000

42,000

50,000

stock

77,000

1,09,000

55,000

83,000

Bills

20,000

30,000

capital
Particulars
Equity share
capital
Redeemable
pref.share.capital
General reserve
Profit and loss
Acc
Proposed
dividend
Creditors

2004
2005
Particulars
3,00,000 4,00,000 Goodwill

2004
1,15,000

2005
90,000

1,50,000 1,00,000 Building

2,00,000

1,70,000

40,000
30,000

70,000
48,000

plant
Drs

80,000
1,60,000

2,00,000
2,00,000

Profit and loss

42,000

50,000

stock

77,000

1,09,000

Proposed

55,000

83,000

20,000

30,000

dividend

Bills payable
Provision for tax

20,000
16,000
40,000
50,000
6,77,000 8,17,000

Bills
receivable
cash
Bank

15,000
10,000
6,77,000

10,000
8,000
8,17,000

pref.share.capital

Additional information:

Ramu Vasu MBA MPhil

Redeemable

2,00,000

Acc

Creditors

receivable
Bills payable

20,000

16,000

cash

15,000

10,000

Provision for tax

40,000

50,000

Bank

10,000

8,000

6,77,000 8,17,000

Accounting For Management [Type text]

6,77,000 8,17,000

Page 26

Comparative financial statements

Additional information:
1.Depreciation ofRs.10, 000 and Rs.20, 000 have been charged on plant and
building respectively.

Common size statement


Trend analysis

2.A dividend of Rs.20,000 has been paid during 1992

9.who are the parties interested in the Analysis of financial statements?

3.Income tax of Rs.35,000 has been paid during 1992

Creditors

Solution:

Debtors
Customers

1. Cash from operation :- Rs.1,60,000


2. Funds from operation :- Rs.2,18,000

Employees

3. Cash flow statement |- Rs. 2,95,000

Research organizations

1. From the following prepare a balance sheet:-

Govt

Current ratio 2.5

Tax authorities

Liquid ratio 1.5

Owners

Proprietary ratio (fixed asset / proprietary fund) 0.75

Stock exchanges

Working capital Rs.60,000

Investors

Reserves and surplus Rs.40,000

Management

Bank over draft Rs.10,000

10.state the limitations of financial statement analysis.

Solution:-

Based on past data

Current assets Rs.1,00,000

Reliability of figures

Current liabilities: Rs.40,000

Different interpretations

Capital Rs.2,00,000

Price level changes

Fixed assets Rs.1,80,000

Change in accounting methods

8.What are the various methods used for analysis and interpretation of
financial statements?(June 2013).
Ratio analysis
Cash flow analysis
Funds flow analysis
Ramu Vasu MBA MPhil

Limitation of the tools of analysis


What is Cash Flow Analysis? Write down the steps in preparation of a cash Flow
statement.
A cash flow analysis portrays the changes in the cash position between
two accounting periods.

Accounting For Management [Type text]

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Uses: It also provides a clear insight to the management about the different

III Steps: Cash flow statement

sources of cash inflows and the different uses or applications for which cash is

Particulars

needed. It helps in taking short erm financial decisions and also in the

Opening balances: Cash & Bank

preparation of cash budget for the next period. Steps:

Add: sources of cash

I step: Statement of funds from operations

Cash from operations

Particulars120092

Rs.

Net Profit as per P&L a/c


Add: Depreciation on FA
Loss on sale of
FA/investments

Rs.

Issues of shares

Xxx

Issue of debentures

Xxx

Sale of fixed assets and investments

Xxx

Lont term

Rs.

Rs.
xxx

Xxx

Goodwill written off

Xxx

Transfer to general reserve

Xxxx
Xxxx

Xxx
Less: Profit on sale of FA

xxx

2.What are the different kinds of ratios available to help the management?
Xxx

i.Profitability ratios,

II Step statement of cash from operations


Particulars

ii. Activity ratios.


Rs.

Funds from operation

Rs.

iii.Balancesheet rarios
xxx

Add: Increase in current liabilities

xxxx

1.basis of preparation

Decrease in current assets other than cash


&bank

2.basis of accounting
xxxx

Less: Increase in current assets other than cash&

xxxx

3.changes shown

xxxx

4.usefulness

xxx

5.shorterm solvency

bank
Decrease in current liabilities
Cash from operations (or)outflow

Ramu Vasu MBA MPhil

3. Distinguish between funds flow and cash flow statements?

6.interdependence
xxx

xxxx

4. What is funds flow statement ? Explainthe steps involved in the

xxxx

preparation of funds flow statement.

Accounting For Management [Type text]

Page 28

It refers to the statement showing the changes in working capital and sources and

Solution: 1. Schedule of changes in working capital :- Increase in working

application of funds

capital is Rs.51,000

i.preparation of schudule of changes in working capitl

2.Funds from operation :- Rs.1,76,000

ii.prepration of funds from operation

3. funds flow statement:- 2,86,000

iii.perparation of funds flow statement

6. From the following prepare cash flow statement

5.From the following prepare funds flow statement (June 2013)


Particulars
Equity share

2004

2005

Particulars

3,00,000 4,00,000 Goodwill

Particulars

2004

2005

Equity share

1,15,000

90,000

capital

capital
Redeemable

2,00,000

1,70,000

pref.share.capital

General reserve

40,000

70,000

plant

80,000

30,000

48,000

Drs

1,60,000 2,00,000

42,000

50,000

stock

77,000

1,09,000

55,000

83,000

Bills

20,000

30,000

pref.share.capital

plant

80,000

2,00,000

Profit and loss

Profit and loss

30,000

48,000

Drs

1,60,000

2,00,000

Acc
Proposed

50,000

stock

77,000

1,09,000

dividend
Creditors

83,000

Bills

20,000

Bills payable

20,000

16,000

cash

15,000

10,000

Provision for tax

40,000

50,000

Bank

10,000

8,000

6,77,000

8,17,000

6,77,000 8,17,000

receivable

30,000

receivable

2,00,000

dividend
Creditors

55,000

1992

2,00,000 1,70,000

70,000

42,000

1991

1,50,000 1,00,000 Building

40,000

Proposed

Particulars

1,15,000 90,000

General reserve

Acc

1992

3,00,000 4,00,000 Goodwill

Redeemable
1,50,000 1,00,000 Building

1991

Bills payable

20,000

16,000

cash

15,000

10,000

Provision for tax

40,000

50,000

Bank

10,000

8,000

6,77,000 8,17,000

6,77,000 8,17,000

Additional information:

Additional information:

1.Depreciation ofRs.10, 000 and Rs.20, 000 have been charged on

4. Depreciation ofRs.10, 000 and Rs.20, 000 have been charged on plant

plant and building respectively.


2.A dividend of Rs.20,000 has been paid during 1992

and building respectively.


5. A dividend of Rs.20,000 has been paid
6. Income tax of Rs.35,000 has been paid.
Ramu Vasu MBA MPhil

3.Income tax of Rs.35,000 has been paid during 1992


Solution:
Accounting For Management [Type text]

Page 29

4. Cash from operation :- Rs.1,60,000

3. Different interpretations

5. Funds from operation :- Rs.2,18,000

4. Price level changes

6. Cash flow statement |- Rs. 2,95,000

5. Change in accounting methods

8.What are the various methods used for analysis and interpretation of

6. Limitation of the tools of analysis

financial statements?(June 2013).


a. Ratio analysis
b. Cash flow analysis
c. Funds flow analysis
d. Comparative financial statements
e. Common size statement
f. Trend analysis
9.who are the parties interested in the Analysis of financial statements?
i. Creditors
ii. Debtors
iii. Customers
iv. Employees
v. Research organizations
vi. Govt
vii. Tax authorities
viii. Owners
ix. Stock exchanges
x. Investors
xi. Management
10.state the limitations of financial statement analysis.
1. Based on past data
2. Reliability of figures
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UNIT- V ACCOUNTING IN COMPUTERISED ENVIRONMENT

very expensive. Obtaining the computer systems, procuring the required software

PART A

packages, training the personnel in computer etc., would lead to high cost.

1. Name the basic type of computers.

Further, it involves very high maintenance cost.

Computers can be basically classified into two categories, viz; (i) Analog

9.What is a computer?

Computers (ii) Digital Computers

A computer is an electronic device which accepts data, processes the data

2.What is an 'analog' computer?

accepted and provides results. The data accepted by the computer is called input.

Analog Computers deals with variables that are measured along a continuous

The result provided by the computer is output. The input is fed into the computer

scale and recorded to some pre-determined degree of accuracy.

in coded language or in plain language

3.What is a 'digital' computer?

10.What is coding?

Digital Computers are those that operate on discrete data. It can perform

Conversion of the data in the language understandable,Convenient representation

mathematical operations of addition, subtraction, multiplication and division. It

of value of an item of data

provides complete accuracy

11.What is coding logic?

4.What is a 'hybrid' computer?

The idea behind coding is called coding logic. The identification of items, based on

A computer which combines the features of Analog and Digital computer, is

code is called coding logic.

called Hybrid Computer.

12.State any four requisites of a coding system.

5.What is meant by computerised accounting?

The code should be simple, but not complicated.Each code must represent only

A computerized accounting system is an accounting information system that

one item.It should be as compact as possible to minimise storage

processes the transaction and events as per Generally Accepted Accounting

requirements.It should be so designed to reduce errors in handling.

Principles (GAAP) to produce as per user requirements

13.Bring out any two advantages of coding.

6.Bring out any two advantages of computerising the data.

.Coding results in saving of storage space. Hence, more data can be entered in

in space technology,in the field of medical research,in applied science and

less space.It results in saving of time in entering data and in data transmission.

technology,in industrial research.

14.What is a file?

7.State any two advantages of computerised accounting

A data file or file is a compilation of related data records maintained or stored in

Results are obtained at high speed.Time-consumption is less.

some pre-arranged order.

8.What are the disadvantages of computerised accounting?

15.What is a master file?

Although, the cost of accounting is economical, the cost of installing the system is

A master file stores data regarding an entity in a system, the nature of which is

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Page 31

that it does not change often, but is referred frequently. A master file holds
information that does not change often, but is required often. However, such files

processed, and summarized into financial statements and reports. An


accounting system can be represented by the following graphic.

are to be purged periodically (updated once in a while). Generally, master files


are indexed for fast retrieval of data.
16.What is a transaction file?
A transaction file holds data regarding transactions that take place in a system.
A transaction file holds information that changes frequently and which are large

The purpose of accounting is to provide information used in decision

in nature. These files are to be purged very frequently.

making. Accounting may be viewed as a system (a process) that converts data

17.State the between Master File and Transaction File.

into useful information.

Master fileholds information which does not change often but are required often

Information processes include:

where as Transaction fileholds information which changes very frequently.

1.

Recording

18.State any four documents which form source for data in computerised

2.

Maintaining

accounting?

3.

Reporting

The usual documents (i.e., sources of data) from which data are collected and
entered

into

computer,

as

part

of

computer

accounting

Every business has numerous processes. Some simple, others complex


and cumbersome. But as the business grows, acquires new customers, enters new

are:Invoices,Vouchers,Receipts,Debit Notes

markets and keeps pace with constant changes in statutory regulations... the

19.Name any four outputs of computerized accounting

company will need to maintain highly accurate and up-to-date accounting,

The output obtained from computerised accounting are:

inventory and statutory records.

Trial Balance,Profit and Loss A/c,BalanceSheet,Cash Flow Statements

This is where a computerized accounting helps simplify, integrate, and

20. Mention some of the prepackaged Software used in Accounting?

streamline all the business processes, cost-effectively and easily.

Categories

COMPUTERIZED ACCOUNTING SYSTEM

of

Accounting

Software,

Personal

Accounting

BusinessAccounting,Tally ERP 9.0, Oracle E-Business Suite

A computerized accounting system saves a great deal of time and effort,

Part B

considerably reduces (if not eliminates) mathematical errors, and allows for

1. THE ACCOUNTING SYSTEM

much more timely information than does a manual system. In a real-time

Accounting is the method in which financial information is gathered,

environment, accounts are accessed and updated immediately to reflect activity,


thus combining steps 2 and 3 as discussed in the preceding section. The need to

Ramu Vasu MBA MPhil

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test for equality of debits and credits through trial balances is usually not

2.

Complete Visibility

required in a computerized system accounting since most systems test for

Computerized accountings giving the company sufficient time to

equality of debit and credit amounts as they are entered. If someone were to

plan, increase the customer base, and enhance customer satisfaction. With

attempt to input data containing an inequality, the system would not accept the

Computerized accounting the company will have greater visibility into

input. Since the computer is programmed to post amounts to the various accounts

the day-to-day business operations and access to vital information.

and calculate the new balances as new entries are made, the possibility of

3.

Enhanced User Experience


Computerized accounting allows the company to enter data in a

mathematical error is markedly reduced.

variety of ways which makes work a pleasure. Adapting to the specific

Computers may also be programmed to record some adjustments

business needs is possible.

automatically at the end of the period. Most software programs are also able to
prepare the financial statement once it has been determined the account balances

4.

Accuracy, Speed

are correct. The closing process at the end of the period can also be done

Computerized accounting has User-definable templates which

automatically by the computer. Human judgment is still required to analyze the

provides fast, accurate data entry of the transactions; thereafter all documents and

data for entry into the computer system correctly. Additionally, the accountants

reports can be generated automatically, at the press of a button.

knowledge and judgment are frequently required to determine the adjustments

5.

Scalability

that are needed at the end of the reporting period. The mechanics of the system,

Computerized accounting adapts to the current and future needs of

however, can easily be handled by the computer.

the business, irrespective of its size or style.

2. WHAT IS THE SALIENT FEATURES OF COMPUTERIZED

6.

Computerized accounting has the ability to handle huge volumes

ACCOUNTING?
1.

Power

of transactions without compromising on speed or efficiency.

Fast, Powerful, Simple and Integrated


Computerized accounting is designed to automate and integrate all

7.

For Improved Business Performance

the business operations, such as sales, finance, purchase, inventory and

Computerized accounting is a highly integrated application that

manufacturing. With Computerized accounting, accurate, up-to-date

transforms the business processes with its performance enhancing

business information is literally at the fingertips. The Computerized

features which encompass accounting, inventory, reporting and statutory

accounting combine with enhanced MIS, Multi-lingual and Data

processes. This helps the company access information faster, and takes

organization capabilities to help the company simplify all the business

quicker decisions. Computerized accounting also guarantees real-time

processes easily and cost-effectively.

optimization of operations and enhanced communication.

Ramu Vasu MBA MPhil

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The computer systems safeguard all the classified information in a

8. Quick Decision Making


Generates real-time, comprehensive MIS reports and ensures

encryption, and biometrics.

access to complete and critical information, instantly.

5) Accuracy:

9. Complete Reliability
Computerized accounting makes sure that the critical financial

IS

THE

ADVANTAGES

IMPORTANCE

The computer systems enable you to process information with supreme


accuracy. The accuracy of the systems helps in reducing the

information is accurate, controlled and safe from data corruption.


3. WHAT

systematic manner. There are various tools available like pass word,

OF

turnaround time for preparation of financial statements for all the


entities that are interested in the financial statements.

COMPUTER SYSTEM IN ACCOUNTING?

6) Internal Control Systems:

1) Faster and efficient processing of information: In the current business environment the volumes of business are

The internal control systems are highly efficient in the computerized

extremely high and of tumultuous multitude. In order to process the ever

environment. They do not allow manipulations to take place

burgeoning information it is important that some tools expedite our

easily. Even if there is a scope of manipulation, the internal

work. It is highly cumbersome to attain such efficiency manually. Thus

control systems keep a tab that manipulations can be detected.

computer systems help us process voluminous information in real-time.


2) Automatic generation of accounting documents like invoices, cheques,

7) Real time transfer of funds:Transfer of money due to computerization has developed at a rapid
speed. The speed at which money gets transferred from one place

and statement of accounts: In order to carry out transactions day in and day out we need

to the other in the world has taken the world of business by storm.

documents like invoices, cheques and statements of account.

Banks are busy developing new technology to increase the

These documents are readily prepared by the computer system

efficiency of free flow of funds.


8) Convenience:

thus reducing the burden of manually.

Computerization has lead to customer convenience. ATM facilities have

3) MIS (Management Information Systems) generation:


The computerized system helps us in generating various reports that

increased the customers abilities to withdraw money from any

become very essential and crucial for management to base their

place at any point in time. Such facilities are only possible

judgments upon. MIS has become an extremely important decision

because of highly computerized accounting environment that

making tool in contemporary times.

facilitates such transactions.

4) Security of Information:
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4. WHAT

IS

THE

NEED

AND

REQUIREMENTS

OF

13. Accounting Queries


There are accounting queries which are based on some

COMPUTERSIED ACCOUNTING?
The need for computerised accounting arises from advantages of

external parameters. For example, a query to identify customers


who have not made the payments within the permissible credit

speed, accuracy and lower cost of handling the business transactions.

period can be easily answered by using the structured query

9. Numerous Transactions
The computerised accounting system is capable of
handling large number of transactions with speed and accuracy.

language (SQL) support of database technology in the


computerised accounting system. But such an exercise in a
manual accounting system is quite difficult and expensive in

10. Instant Reporting


The computerised accounting system is capable of offering
quick and quality reporting because of its speed and accuracy.

terms of manpower used. It will still be worse in case the credit


period is changed.
14. On-line facility

11. Reduction in paper work


A manual accounting system requires large physical

Computerised accounting system offers online facility to

storage space to keep accounting records/books and vouchers/

store and process transaction data so as to retrieve information to

documents. The requirement of stationery and books of accounts

generate and view financial reports.

along with vouchers and documents is directly dependent on the

15. Scalability

volume of transactions beyond a certain point. There is a dire need

Computerised accounting system are fully equipped with

to reduce the paper work and dispense with large volumes of

handling the growing transactions of a fast growing business

books of accounts. This can be achieved by introducing

enterprise. The requirement of additional manpower in Accounts

computerised accounting system.

department is restricted to only the data operators for storing


additional vouchers. There is absolutely no additional cost of

12. Flexible reporting


The reporting is flexible in computerised accounting
system as compared to manual accounting system. The reports of

processing additional transaction data.


16. Accuracy

a manual accounting system reveal balances of accounts on

The information content of reports generated by the

periodic basis while computerized accounting system is capable of

computerized accounting system is accurate and therefore quite

generating reports of any balance as when required and for any

reliable for decisionmaking. In a manual accounting system the

duration which is within the accounting period.

reports and information are likely to be distorted, inaccurate and

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The computer cannot make a decision like human beings.

therefore cannot be relied upon. It is so because it is being

It is to be guided by the user.

processed by many people, especially when the number of


transactions to be processed to produce such information and

4. Maintenance
Computer requires to be maintained properly to help

report is quite large.

maintain its efficiency. It requires a neat, clean and controlled

17. Security
Under manual accounting system it is very difficult to
secure such information because it is open to inspection by any

temperature to work efficiently.


5. Dangers for Health

eyes dealing with the books of accounts. However, in

Extensive use of computer may lead to many health

computerised accounting system only the authorised users are

problems such as muscular pain, eyestrain, and backache, etc.

permitted to have access to accounting data. Security provided by

This affects adversely the working efficiency and increasing

the computerised accounting system is far superior compared to

medical expenditure.

any security offered by the manual accounting system.

ADVANTAGES

5. WHAT IS THE LIMITATIONS OF A COMPUTER AND

The main advantages of a computerized accounting system are listed below:


1. Speed

COMPURISED ACCOUNTING
The limitations of computer are depending upon the operating
environment they work in. These limitations are given below as:

Automatic document production


2. Accuracy
3. Up-to-date information

1. Cost of Installation
Computer hardware and software needs to be updated

4. Availability of information

from time to time with availability of new versions. As a result

5. Management information

heavy cost is incurred to purchase a new hardware and software

6. GST/VAT return

from time to time.

7. Legibility
8. Efficiency

2. Cost of Training
To ensure efficient use of computer in accounting, new
versions of hardware and software are introduced.

10. Cost savings

This requires training and cost is incurred to train the staff personnel.
3. Self Decision Making
Ramu Vasu MBA MPhil

9. Staff motivation

11. Reduce frustration


12. The ability to deal in multiple currencies easily

Accounting For Management [Type text]

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13. Redundant data storage permits efficient generations of some reports

system. It does away the necessity to create and maintain journals, ledgers, etc.,

14. Increase revenue while lowering operating costs and enhancing

which are essential part of manual accounting. Some of the commonly used
accounting softwares are Tally, Cash Manager, Best Books, etc.

competitive advantage of the company.

Accounting software is used to implement a computerised accounting.

6. DISADVANTAGES OF COMPUTERIZED ACCOUNTING

7.

1.

Transactions orientation only

The computerised accounting is based on the concept of database. It is basic

2.

Periodic not real time reporting

software which allows access to the data contained in the data base. It is a system

3.

Limited flexibility for ad hoc reports

to manage collection of data insuring at the same time that it remains reliable and
confidential.

ROLE OF COMPUTERS IN ACCOUNTING


The most popular system of recording of accounting transactions is

manual which requires maintaining books of accounts such as Journal, Cash


Book, Special purpose books, ledger and so on. The accountant is required to

Following are the components of Computerised accounting software:


1. Preparation of accounting documents
Computer helps in preparing accounting documents like Cash Memo,

prepare summary of transactions and financial statements manually. The

Bills and invoices etc., and preparing accounting vouchers

advanced technology involves various machines capable of performing different

2. Recording of transactions

accounting functions, for example, a billing machine. This machine is capable of

Every day business transactions are recorded with the help of computer

computing discount, adding net total and posting the requisite data to the relevant

software. Logical scheme is implied for codification of account and transaction.

accounts.

Every account and transaction is assigned a unique code. The grouping of

With substantial increase in the number of transactions, a machine was

accounts is done from the first stage. This process simplifies the work of

developed which could store and process accounting data in no time. Such

recording the transactions.

advancement leads to number of growing successful organisations. A newer

3. Preparation of Trial Balance and Financial Statements

version of machine is evolved with increased speed, storage, and processing

After recording of transaction, the data is transferred into Ledger account

capacity. A computer to which they were connected operated these machines. As

automatically by the computer. Trial Balance is prepared by the computer to

a result, the maintenance of accounting data on a real-time basis became almost

check accuracy of the records. With the help of trial balance the computer can be

essential. Now maintaining accounting records become more convenient with the

programmed to prepare Trading, Profit and Loss account and Balance Sheet.

computerised accounting.

These components can be shown as :

The computerised accounting uses the concept of databases. For this

COMPONENTS OF COMPUTERISED ACCOUNTING SOFTWARE

purpose an accounting software is used to implement a computerized accounting


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These steps can be explained with an example making use of Automatic


Recording of Transaction in
respective voucher

Teller Machine (ATM) facility by a Bank-Customer.


1. Data Entry :
Processing presumes data entry. A bank customer operates an
ATM facility to make a withdrawal. The actions taken by the customer

Purchase

Sales

constitute data which is processed after validation by the computerised


personal banking system.

Ledger

2. Data Validation :
It ensures the accuracy and reliability of input data by comparing

Trial Balance

the same with some predefined standards or known data. This validation
Trading,
Profit & Loss
Account

is made by the Error Detection and Error Correction procedures. The


Balance
Sheet

control mechanism, wherein actual input data is compared with


predetermined norm is meant to detect errors while error correction
procedures make suggestions for entering correct data input. The Personal

8.

WHAT ARE THE STEPS IN COMPUTERISED ACCOUNTING

Identification Number (PIN) of the customer is validated with the known

Transaction processing system (TPS) is the first stage of computerized

data. If it is incorrect, a suggestion is made to indicate the PIN is invalid.

accounting system. The purpose of any TPS is to record, process, validate and

Once the PIN is validated, the amount of withdrawal being made is also

store transactions that occur in various functional areas of a business for

checked to ensure that it does not exceed a pre-specified limit of

subsequent retrieval and usage. TPS involves following steps in processing a

withdrawal.

transaction: Data Entry, Data Validation, Processing and Revalidation, Storage,

3. Processing and Revalidation :


The processing of data occurs almost instantaneously in case of

Information and Reporting.


It is one of the transaction processing systems which is concerned with

Online Transaction Processing (OLTP) provided a valid data has been fed

financial transactions only. When a system contains only human resources it is

to the system. This is called check input validity. Revalidation occurs to

called manual system; when it uses only computer resources, it is called

ensure that the transaction in terms of delivery of money by ATM has

computerised system and when it uses both human and computer resources, it is

been duly completed. This is called check output validity.

called computer-based system.


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4. Storage :
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Processed actions, as described above, result into financial


transaction data i.e. withdrawal of money by a particular customer, are

operates on such database using the required interface and also takes the
required reports by suitable transformations of stored data into information.

stored in transaction database of computerized personal banking system.

Therefore, the fundamentals of computerised accounting include all the basic

This makes it absolutely clear that only valid transactions are stored in the

requirements of any database-oriented application in computers. On the basis of

database.

the discussions, these are the following differences between manual accounting
and computerised accounting

5. Information :
The stored data is processed making use of the Query facility to

The primary objectives of the accounting function in an organization are

produce desired information.

to process financial information and to prepare financial statements at the end of

6. Reporting :
Reports can be prepared on the basis of the required information

ARE

THE

BASIC

REQUIREMENTS

the accounting period. Companies must systematically process financial


information and must have staff who prepares financial statements on a monthly,

content according to the decision usefulness of the report.


9. WHAT

10. WHAT ARE THE OBJECTIVES OF ACCOUNTING SYSTEM

OF

THE

quarterly, and/or annual basis.


To meet these primary objectives, a series of steps is required.

COMPUTERISED ACCOUNTING SYSTEM


The basic requirements of any computerised accounting system are the

Collectively these steps are known as the accounting cycle. The steps, applicable
to a manual accounting system, are described below. Later, there will be a brief

followings:

discussion of a computerized processing system.

1. Accounting framework
It is the application environment of the computerised accounting
system. A healthy accounting framework in terms of accounting
principles, coding and grouping structure is a pre-condition for any
computerized accounting system.

THE STEPS OF THE CYCLE


1. Collect and analyze data from transactionsand events:
As transactions and events related to financial resources occur, they are
analyzed with respect to their effect on the financial position of the
company. As an example, consider the sales for a day in a retail

2. Operating procedure
A well-conceived and designed operating procedure blended with suitable

establishment that are collected on a cash register tape. These sales

operating environment of the enterprise is necessary to work with the

become inputs into the accounting system. Every organization establishes

computerised accounting system.

a chart of accounts that identifies the categories for recording transactions

The computerised accounting is one of the database-oriented applications


wherein the transaction data is stored in well- organized database. The user
Ramu Vasu MBA MPhil

and events. The chart of accounts for the retail establishment mentioned
earlier in this paragraph will include Cash and Sales.

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to the ledger, all amounts recorded on the debit side of accounts (i.e.,

2. Journalize transactions:
After collecting and analyzing the information obtained in the
first step, the information is entered in the general journal, which is

recorded on the left side) must equal all amounts recorded on the credit
side of accounts (i.e., recorded on the right side).

called the book of original entry. Journalizing transactions may be

Preparing an unadjusted trial balance tests the equality of debits and credits as

done continually, but this step can de done in a batch at the end of the

recorded in the general ledger. If unequal amounts of debits and credits are

day if data from similar transactions are being sorted and collected, on

found in this step, the reason for the inequality is investigated and corrected

a cash register tape, for example. At the end of the day, the sales of

before proceeding to the next step. Additionally, this unadjusted trial

$4,000 for cash would be recorded in the general journal in this form:

balance provides the balances of all the accounts that may require
adjustment in the next step.

3. Post to general ledger:


The general journal entries are posted to the general

5. Prepare adjustments:

ledger, which is organized by account. All transactions for the

Period-end adjustments are required to bring accounts to

same account are collected and summarized; for example, the

their proper balances after considering transactions and/or events

account entitled Sales will accumulate the total value of the

not yet recorded. Under accrual accounting, revenue is recorded

sales for the period. If posting were done daily, the Sales

when earned and expenses when incurred. Thus, an entry may be

account in the ledger would show the total sales for each day as

required at the end of the period to record revenue that has been

well as the cumulative sales for the period to date. Posting to

earned but not yet recorded on the books. Similarly, an adjustment

ledger accounts may be less frequent, perhaps at the end of each

may be required to record an expense that may have been incurred

day, at the end of the week, or possibly even at the end of the

but not yet recorded.


6. Prepare an adjusted trial balance:

month.

As with an unadjusted trial balance, this step tests the

4. Prepare an unadjusted trial balance:


At the end of the period, double-entry accounting requires that debits and

equality of debits and credits. However, assets, liabilities, owners

credits recorded in the general ledger be equal.Debit and credit merely

equity, revenues, and expenses will now reflect the adjustments

signify position left and right, respectively. Some accounts normally

that have been made in the previous step. If there should be

have debit balances (e.g., assets and expenses) and other accounts have

unequal amounts of debits and credits or if an account appears to

credit balances (e.g., liabilities, owners equity and revenues). As

be incorrect, the discrepancy or error is investigated and

transactions are recorded in the general journal and subsequently posted

corrected.

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7. Prepare financial statements:

3.

greater accuracy

Financial statements are prepared using the corrected

4.

more timely reports

balances from the adjusted trial balance. These are one of the

5.

better control

primary outputs of the financial accounting system.

But the questions are: Will you achieve these results? And how quickly?

8. Close the accounts:

One of the biggest mistakes an agency can make is to believe that an accounting

Revenues and expenses are accumulated and reported by

system in trouble can be improved by putting it on the computer. This is virtually

period, either a monthly, quarterly, or yearly. To prevent their not

never the case: a mess put in to the computer can be worse than a mess on ledger

being added to or comingled with revenues and expenses of

paper.

another period, they need to be closed outthat is, given zero

THE PREREQUISITES FOR COMPUTERIZING YOUR ACCOUNTS

balancesat the end of each period. Their net balances, which

The most important factor to consider when deciding whether to

represent the income or loss for the period, are transferred into

computerize the accounting system is the accounting expertise of responsible

owners equity. Once revenue and expense accounts are closed,

people at your agency. People, not computers, do accounting. Computers add

the only accounts that have balances are the asset, liability, and

numbers very quickly, and enable you to enter the number into the system once

owners equity accounts. Their balances are carried forward to the

for it to appear in all journals, ledgers and other reports.

next period.

However, a human being has to decide where to enter that information

9. Prepare a post-closing trial balance:

and then to keep the data into the system. Someone in the organization still has to

The purpose of this final step is two-fold: to determine that

understand debits and credits, decide what account code to charge each

all revenue and expense accounts have been closed properly and

transaction to, determine whether an error has been made and, if so, how to

to test the equality of debit and credit balances of all the balance

correct that error. So, computerizing the accounting function does not

sheet accounts, that is, assets, liabilities and owners equity.

automatically lead to greater accuracy or better control.


It is important to have "clean," that is accurate, up-to-date beginning

11. WHY SHOULD YOU COMPUTERIZE YOUR ACCOUNTING


SYSTEM?

balances to enter into your new computerized accounting system. This is one

Most organizations seek the following benefits from accounts

area where "garbage in, garbage out" really applies. Many organizations choose
to enter data starting from audited financial statements to get them off to a fresh

automation:

start.

1.

increased efficiency

2.

lower costs (less staff time supporting accounting activities)

Ramu Vasu MBA MPhil

12. What accounting software should you purchase?

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Well, there is no one definite answer to this question. To

No way. Since there are so few controls for spreadsheet software,

understand why, imagine answering the question, What's the best car to

numbers can be easily changed, damaging the integrity of your financial reports.

buy? In order to answer, you would first need to ask questions such as:

However, you can export, or electronically transfer, data from your accounting

How many passengers do you normally have? How much are you willing

system into a spreadsheet package such as Lotus or Excel to prepare more

to spend? What features are important to you?

customized reports.

One of these considerations might outweigh all of the others.

Similarly, it is not a good idea to keep your books on database software

Once you have all the information, there might be two or three cars which

which does not have the controls or reporting capability of accounting software.

meet the criteria. The final decision will be based on personal preference.

Finally, many consultants do not recommend using checkbook software for

A similar set of questions and circumstances can be applied to selecting

nonprofit bookkeeping. The attraction of checkbook software is that it is easy to

an accounting software package.

use. However, most nonprofits outgrow checkbook software quickly because it

13. What to look for when selecting a accounting software package?


The following factors often play an important role in the final selection of
accounting software's:

does not use double-entry bookkeeping and its reporting capabilities are often
very limited.
15. PLANNING FOR A COMPUTERIZED ACCOUNTING SYSTEM
Selecting accounting software is a major responsibility that takes a

i.

How many checking accounts are permitted?

ii.

Can the software handle the payroll function, including W-2s

considerable amount of careful planning. After all, if the selected program fails

and 1099s? How easily?

to meet the organization's needs or the accounting staff is not adequately trained

Is there room to grow into the software? Will it be able to

to operate it, the business could be thrown into turmoil, losing much time and

accommodate your needs as they become more sophisticated?

money.

iii.

iv.

Does the software include security features which prevent

a. WHERE TO BEGIN

unauthorized personnel from accessing and/or manipulating data

b. SAFEGUARDING DATA

in the accounting system?

c. SOFTWARE LINKS

v.

What installation and ongoing support is available?

vi.

How long has the company been in business?

vii.

Are there user groups or other support mechanisms outside of

16. Distinguish between manual accounting and computerized accounting?

the vendor?
14. Why can't we just put the books on spreadsheet software?
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18. What are the Features?


a. Processing by one or more computers
b. Operated by the entity or by a third party
c. Processing with the help of one or more computer software e.g.
Tally
d. Software used may be a generic software purchased from the
market (package software) or
e. May be developed specifically for the business (custom
software)
19. Role / Benefits / Advantages
a) Speeding up the process
b) Automation of ledger posting, Trial balance and subsidiary
ledger
c) Accuracy
17 What are the Significance of Computerized Accounting
System?
a. Inventory control

d) Reduced error
e) Eliminating duplication of work
f) Immediate availability of information

b. Production planning

g) Easy access

c. Budgeting and Variance analysis

h) Flexibility

d. Plant capacity utilization

i) Better quality of work, clean and neat

e. Quality control

j) Scalable

f. Market research

k) Lower operating cost

g. Purchase accounting

l) Improved efficiency

h. Sales accounting

m) Relieves employee monotony

i. Payroll accounting

n) Facilitates standardization

j. Informationmanagement, etc.

o) Minimization of frauds

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20. What are the Limitations / Disadvantages

23. What are the Coding Procedure?

a) Security / Integrity / Virus / Hacking

Maintaining the Hierarchy of Ledgers

b) May lead to unemployment

Maintaining Hierarchy of Ledgers

c) High cost of installation

a) Accounting master files are created with codes and description

d) Requires special skills for operation

of accounts

e) Frequent repairs

b) In a hierarchical coded system reports can be generated based

f) Frequent power failures

on codes
c) General ledger, Debtors ledger and Creditors ledger are

21. What are the Features of A/cg Software


a) On-screen input and print outs

automatically created by any standard software

b) Automatic updating

d) At the time of creation, some of the account heads are indicated

c) Automatic stock adjustments

to the system as cash, bank, debtors and creditors

d) Integration of database with the accounting programme


e) Automatic calculation of payroll

purchases to creditors a/c

22. Codification and Grouping of Accounts - Coding System


1.

Codification refers to allotting code numbers to accounts in a


hierarchical structure

2.

3.

e) The system then automatically posts sales to debtors a/c and

24. Explain the Prepackaged Accounting Software?


Prepackaged Software
a) Prepackaged

software

are

generic

accounting

systems

Accounts are first systematically grouped into Major Heads such

purchased from the market rather than developed in-house (ex:

as:

Tally accounting Software)


b) These Software are easy to use, relatively inexpensive and

1.

Assets

2.

Liabilities

3.

Revenue Receipts

c) The installation of these Software are very simple

4.

Capital Receipts

d) A network version is generally available which works on client-

5.

Revenue Expenditure

6.

Capital Expenditure, etc.

readily available

server architecture
e) User manuals guide the user on how to use the Software

The sub-groups or Minor Heads could be Cash or Receivables

f) Vendor provides regular updates.

or Payables and so on.


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Configuring / Customizing / Installing Prepackaged Software


a) Creation of Company, name, address, contact details, PAN,
CST/TNGST, etc

e) Bank Book
f) Cash Purchase Book
g) Purchase Return register

b) Defining accounting period

h) Stock movement register

c) Creation of chart of accounts in master file with codes

i) Journal Book

d) Each a/c to be classified according to type

j) Petty Cash Book

e) Opening balances need to be entered

k) General Ledger

f) Creating master files for customer, supplier, product, etc.

l) Stock Ledger

g) Defining system of valuation such as LIFO, FIFO, Weighted

m) Purchase Book

average, etc

n) Creditors Ledger
o) Subsidiary Ledger

List of Master Files


a) Typically, any standard prepackaged Software will have the
following master file screens:

p) Production register
q) Sales Book

1. Company master file

r) Debit Note Register

2. Accounts master file

s) Debtors Ledger

3. Sub ledger master file

t) Consumption Register

4. Customer master file

1. Document printing options such as trial balance, POs, challans,

5. Vendor master file

declaration forms and invoices printing

6. Product master file

2. Bank reconciliation reports

7. Division master file

3. MIS reports like aging of debtors, slow moving and non-

25. List

of

Following reports are common to most Software:

Reports

moving stock, etc.


4. House keeping section provides:

a) Cash Book

1. System maintenance features

b) Cash Sales Book

2. Taking back-up and system restore

c) Sales Return register

3. Clean-up, fine tuning and re-indexing of Software, etc.

d) Credit Note Register


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developed on the basis of requirement specifications provided

Advantages of Prepackaged Software

by the user organization.

a) Easy to install

2. The need for customized accounting software could be:

b) Relatively inexpensive
c) Easy to use

1. Unique nature of the business or

d) Backup procedure is simple

2. The functionality desired may not available in pre-

e) Flexibility

packaged software.

f) Very effective for small and medium size businesses

Advantages of Customized Software


1. Uncommon functions can also be computerized

Disadvantages of Prepackaged Software


a) Does not cover peculiarities of specific business

2. The input screens and input documents can be matched for ease

b) Does not cover all functional areas

of data entry

c) Customization may not be possible in most such software

3. Reports can be designed as desired

d) Reports generated are not sufficient or serve the purpose

4. Additional MIS reports can be included

e) Lack of security

5. Bar-code scanners can be used as input devices

f) Bugs in the software

6. The system can align with the organizational structure of the


company.

Considerations Involved in Selection?


a) Some of the criteria for selection of prepackaged Software
could be the following:

Disadvantages of Customized Software


1. Ambiguous specifications resulting in a defective or incomplete

1. Fulfillment of business requirements

system

2. Completeness of reports

2. Presence of bugs in the software

3. Ease of use

3. Incomplete documentation

4. Cost

4. Inadequate change management procedure resulting in system

5. Reputation of the vendor

compromise

6. Regular updates.

5. Poor vendor support and lack of access to source code

Customized Accounting Software

6.

Delay in completion of the software.

1. Customized accounting software is one where the software is

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Part A (10 x 2 = 20 Marks)


1. What is Forfeiture of Shares?
2. List the disadvantages of HRM?
3. What are the Tools and Techniques used by Management Accountant?
4. What are the objectives of Financial Accounting?
5. Definition Company?
1. Define Accounting.
2. What are the Function of accounting?
3. Define Cost Accounting
4. Define the HRA.
5. Define Inflation accounting.
Part B
6. (a) Generally Accepted Accounting Principles (GAAP)?
(b) What are the methods of human resources?

[6]
[7]

7. (a) What are the functions of financial accounting? And its advantages and
limitation?

[7]

(b) Distinguish between cost account and Management accounts?

Purchased
75,000
Opening Stock
25,000
Establishment Expenses
15,000
Wages
2,000
Insurance
1,000
Commission Received
4,500
Sundry Debtors
28,100
Bank Balance
20,000
Sundry creditors
10,000
Interest (Cr)
3,000
The following adjustment are to be made:
a) The closing stock was Rs.32,000
b) Outstanding wages Rs. 500 and Outstanding interest 900.
c) Prepaid Insurance Rs. 300
d) Commission received on advance Rs. 300
e) Allow interest on capital @10%
f) Depreciation Building 2.5 % , Furniture & Motor Van @10%
g) Charge interest on Drawing Rs. 500
h) Accrued Interest Rs. 500.
6. (a) What are the techniques used in Inflation Accounting?

[6]

(b) Explain the various Statutory Books that are maintained by a


[6]

8. From the following Balance of Mr. Rajan for the year ending on
31.3.2014
[14]

company.

[7]

7. (a) What are the advantages of human resources accounting?

[7]

(b) What is the difference between financial account and Management


Capital
1,00,000
Drawings
18,000
Buildings
15,000
Furniture
7,500
Motor Van
25,000
Loan from Hari @12% interest
15,000
Interest paid above
900
Sales
1,00,000
Ramu Vasu MBA MPhil

accounts?

[6]

8. From the following prepare final accounts for the year ended
31.3.2014
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[14]
particulars
capital
Plant
Sales
Purchases
Returns
Opening stock
Discount
Bank charges
Creditors
Salaries
Manufacturing
wages
Carriage (in)
Carriage(out)
Debtors
Bad debt provision
Rent and rates
Advertisement
Cash
Bank
Total

Debit Rs.

Credit Rs
50,000

80,000
1,77,000
60,000
1000
30,000
350
75

750
800
25000

6800
10000

525

Personal account(persons and artificial persons) Debit the receiver


and Credit the giver
Real account(tangibles, assets, cash,etc.) - Debit what comes in and
Credit what goes out
Nominal account Debit all expenses/loses and Credit all
incomes/gains
4. Explain management accounting information?
Management Accounting is concerned with providing necessary
information to the management in such a way as to enable it to

2,54,075

discharge its management functions efficiently.


Management accounting is concerned with the supply of information

Adjustments:
a. Closing stock Rs.35000
b. Depreciate plant by 6%
c. Interest on capital 5% pa.
d. Bad debt provision to be adjusted to Rs.500

which is useful to management in decision-making for the efficient


functioning of the enterprise and, thus, in maximising profits. It is the
reproduction of financial statements (Profit and Loss Account and

1. What are the different ways by which alteration of share capital of


company can be carried out?

1. Historical cost accounting Vs Inflation accounting


2. Adjustment items
3. Use of index numbers
a. It replaces monetary unit of measurement
b. It provides a uniform measuring rod.
c. It provides a tool for comparison of diverse resources.
d. It advocates its use for restating assets as well as shareholders
capital.
It presents information to the proprietors, showing how their funds are utilized.
3. What are the golden Rules of Accounting?

750
1200
45000
10000
2000
900
6000
2,54,075

Consolidation or subdivision of the existing shares in to shares of larger or


smaller denominations.
Conversion of fully paid up shares in to stocks and vice versa
Cancellation of unissued shares
2. What are the issues in inflation accounting?

Balance Sheet) in such a way as will enable the management to take


decisions and to control activities.

Increase of share capital by issue of new shares


Ramu Vasu MBA MPhil

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5. What is compound journal entry?

6. (b) Write the pro forma of vertical balance sheet.

[6]

a. Journal is a systematic recording of business transaction keeping


the golden rules of accounting.
b. A compound journal entry is a simple journal entry in which there
will be more than one debit or credit .
Part B
(a) Write the format of journal, ledger and trial balance?

Ramu Vasu MBA MPhil

[7]

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7. (a) Write the format of final accounts.

[7]

Application of 8000 shares were rejected and the remaining applications


were allotted the 50000 shares on pro-rate basis. The excess money on
application was adjusted towards the amount due on allotment.
The first and final call was made in due course the amount due received
with the exception of 1000 shares.
These share were forfeited And subsequently re- issued as full played for
Rs 8 Per share pass the journal enters for the above transaction.

(b) What is the difference between cost account and Management


accounts?

[14]

[6]

8. The company issued 50,000 equity share of Rs 10 each at


premium of Rs 3 per share payable as follow.
a. Application 4
b. Allotment - 5 (Including of premium)
c. First Call and Final call Rs 4 per Share.
Subscription received for 70,000 share.

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