MODEL TEST PAPER

MBA I
Accounting for Managers – MS 107

Question 1: Explain the following concepts/conventions used in Accounting with rationale of

them: -
i. Business Entity concept
The business entity concept (also known as separate entity and economic entity concept)
states that the transactions related to a business must be recorded separately from those of
its owners and any other business. In other words, while recording transactions in a
business, we take into account only those events that affect that particular business; the
events that affect anyone else other than the business entity are not relevant and are
therefore not included in the accounting records of the business.

This concept is very important because if transactions of a business are mixed up with that
of its owners or other businesses, the accounting information would lose its usability. The
business entity concept of accounting is of great importance because of the following
reasons:

1. The business entity concept is essential to separately measure the performance of a

particular business in terms of profitability and cash flows etc.
2. It helps in assessing the financial position of each and every business separately on a
particular date.
3. It becomes difficult and impossible to audit the records of a business if they are
intermingled with those of different entities/individuals.
4. The concept ensures that each and every business entity is taxed separately.
5. The employment of business entity concept is very general among business organizations.
If a company ignores this concept, it would not be able to compare its financial
performance with that of others in the industry.

ii. Convention of Conservatism

This accounting convention is generally expressed as to “anticipate all the future losses and
expenses, without considering the future incomes and profits unless they are actually
realized.” This concept emphasizes that profits should never be overstated or anticipated.
This convention generally applies to the valuation of current assets as they are valued at
cost or market price whichever is lower. The conservatism principle can also be applied
to recognizing estimates. For example, if the collections staff believes that a cluster of
receivables will have a 2% bad debt percentage because of historical trend lines, but
the sales staff is leaning towards a higher 5% figure because of a sudden drop in
 industry sales, use the 5% figure when creating an allowance for doubtful accounts,
unless there is strong evidence to the contrary.

iii. Money measurement concept

The money measurement concept states that a business should only record
an accounting transaction if it can be expressed in terms of money. This means that
the focus of accounting transactions is on quantitative information, rather than on
qualitative information. Thus, a large number of items are never reflected in a
company's accounting records, which means that they never appear in its financial
statements. Examples of items that cannot be recorded as accounting transactions
because they cannot be expressed in terms of money include:

1. Employee skill level

2. Employee working conditions
3. Expected resale value of a patent
4. Value of an in-house brand
5. Product durability

The key flaw in the money measurement concept is that many factors can lead to long-
term changes in the financial results or financial position of a business (as just noted),
but the concept does not allow them to be stated in the financial statements.

iv. Materiality concept

Materiality states that all material facts must be a part of the accounting process. But immaterial
facts, i.e. insignificant information should be left out. The materiality of a transaction will
depend on its nature, value and its significance to the external user. If the information can affect
a person’s investing decision then it is definitely a material fact. The main objective of
Materiality Principle is to provide guidance for the accountant to prepare entity financial
information. And the most important thing is to make sure that information using by
shareholders and investors are sufficient enough for them in making the correct decision.
The information, size, and nature of transactions are considered material if the omission or
error of it could potentially lead to the decision of users of financial information.

Question 2:
a) How does depreciation help in creation of reserve for a firm? Illustrate with the help
of an example?
The term depreciation is used to denote decrease in value but in accounting, this term is
used to denote decrease in the book value of fixed asset. Depreciation is the permanent and
continuous decrease in the book value of a fixed asset due to use, affluxion of time,
obsolescence, expiration of legal rights or any other cause.
An analysis of the definition given above highlights the characteristics of depreciation as
follows :
 a) It is related to fixed assets only.
b) It is a fall in the book value of an asset.
c) The fall in the book value of an asset is due to the use of the asset in business operations,
effluxion of time, obsolescence, expiration of legal rights or any other cause.
d) It is a permanent decrease in the book value of an asset.
e) It is a continuous decrease in the book value of an asset.

Depreciation is taken as an operating expense while calculating funds from operations. The
accounting entries are:
i) Depreciation A/c Dr.
To Fixed Asset A/c
ii) Profit and Loss A/c Dr.
To Depreciation
Thus, effectively the profit & loss account is debited while the fixed asset account is
credited with the amount of depreciation. Since, both profit and loss account and the fixed
asset account are non-current accounts, depreciation is a non-fund item. It is neither a
source nor an application of funds. It is added back to operating profit to find out funds
from operations since it has already been charged to profit but it does not decrease funds
from operations. Depreciation should not, therefore, be taken as a ‘source of funds’. If
depreciation was really a source of funds by itself, any enterprise could have improved its
funds position at will, by merely increasing the periodical depreciation charge. However,
depreciation can be taken as a source of funds in a limited sense because of three reasons:
1. Depreciation finds its way into current assets through charging of overheads(including
depreciation). The value of closing inventory may include depreciation of fixed assets as
an element of cost.
2. Depreciation does not generate funds but it definitely saves funds. For example, if the
business had taken the fixed assets on hire, it would have been required to pay rent for
them. Since it owns fixed assets, it saves outflow of funds which would have otherwise
gone out in the form of rent.
3. Depreciation reduces taxable income and therefore, income tax liability for the period is
reduced. This will be clear with the following example:
Particular Case I Case II
Income before Depreciation 75,000 75,000
Depreciation Provided (A) Nil 15,000
Taxable Income 75,000 60,000
Income tax say at 50 percent 37,500 30,000
Net income after (B) 37,500 30,000
Net flow of funds after tax (A) + (B) 37,500 45,000
The above example shows that in Case II, the net flow of funds is more by Rs. 7,500 as
compared to Case I. This is because on account of depreciation charge being claimed as an
expense, tax liability has been reduced by Rs. 7,500 in case of Case II. It may therefore be
 said that true funds flow from depreciation is the opportunity saving of cash outflow
through taxation.

b) Distinguish between Trial Balance and Balance sheet.

Basically, the trial balance is an internal document. And the balance sheet is prepared to
disclose the financial affairs of the company to external stakeholders. In simple terms, a
balance sheet is an extension of the accounts recorded in the trial balance. Trial Balance is
a part of the accounting process, that shows the debit and credit balances received from the
ledger accounts. Whereas, the Balance Sheet is the statement that shows the company’s
financial status by reviewing the capital, liabilities, and assets on a particular date.
Following are the main points of difference between trial balance and balance sheet:

Trial Balance Balance Sheet

It is prepared to verify the arithmetical
accuracy of books of accounts
It is prepared with balances of all the ledger
accounts
It is not a part of final accounts
It is prepared before the preparation of final
accounts
It may be prepared a number of time in an
accounting year.
Generally, it includes opening stock but
not closing stock.
There is no rule for arranging the ledger
balances in it.
It is not required to be filed to anybody.
Auditor need not to sign it.
It is prepared to disclose the true financial
position of the business
It is prepared with the balances of assets
and liabilities accounts.
It is an important part of final accounts.
It is prepared after the preparation of
trading and profit and loss account.
It is generally prepared once at the end of
accounting year.
It always includes closing stock but not
opening stock.
Assets and liabilities must be shown in it
according to the rule of marshaling.
It must be filed with the registrar of
companies if the business is a company.
Auditor must sign it.

c) Why few errors do not have any impact on Trial balance? Give example.
Trial balance is prepared when transactions posted into the accounts are balanced up. The
trial balance is then prepared to check the accuracy of those posted transaction. It is normal
sometimes that some errors may be apparent but despite this, they may not affect the trial
balance. It is very important for any accounting officer to note that these may occur in one
way or another. The various errors that do not effect the Trial Balance are:
1. Error of Omission: This is where the full transaction is omitted from the books of
accounts. For example sold goods to Miss Brown for $100. No entry was made in either
the sales account nor Miss Brown account. To correct Credit: Seles $100 Debit: Miss
Brown $100.
2. Error of original entry: This is where wrong original amount in accounts are recorded
in both accounts. For example, a $30 sale to Mr. Brown was wrongly entered as $50 in
both the sales account and Mr. Brown’s account How to correct Debit: Sales account
$20 Credit: Mr. Brown $20
 3. Error of commission: This is where the correct amount is entered but in the wrong
PERSON’S account. For example sales of goods to Mr. A were entered in Mr. B
account How to correct Debit: Mr. A Credit: Mr. B
4. Error of principles: This is where the correct amount is entered but in the wrong
CATEGORY of account. F or example purchase of fixed asset $500 was entered in
expenses account How to correct Debit: Fixed asset Credit: Expense
5. Complete reversal of entry: This is where the correct amount is entered and in the
correct account but on the wrong side of both account. For example we have received
cash $500 from Mr. Z. The correct entry should be Cash=Debit and Mr. Z=Credit but
we have recorded as Mr. Z=Debit and Cash=Credit. How to correct Debit: Cash
(500*2=1000) Credit: Mr. Z (500*2=100)
6. Error of transition: This is where the sequence of digits of a figure in a transaction is
switched. For example sales amount to $123 to M r. brown were entered as $321. How
to correct Debit: Sales(321-123=198) Credit: Mr. Brown(321-123=198).

Q3. From the following Trial Balance of M/s Sameer & Co., Bhopal, prepare a Trading
and Profit& Loss Account for the year ending 31st March, 2007 and also a Balance
Sheet as on the date:
 Adjustments:
1. Closing Stock (31.3.2007) Rs. 3,625.
2. Provide 10% depreciation per annum on all types of fixed assets.
3. Allow interest on capital @ 5% per annum. No interest is to be charged on drawings.
4. Increase Bad Debt Reserve to Rs. 1,750.
5. Make a provision for Commission to General Manager on Gross Profit @ 2%.

Solution: TRADING and PROFIT & LOSS ACCOUNT of M/s. Sameer & Co.
For the year ending 31st March, 2007
 BALANCE SHEET of M/s. Sameer & Co.
As on 31st March, 2007

Note: *Carriage is treated as carriage inwards, hence shown in trading accounts. If treated as carriage
outwards, it has to appear in profit and loss account..

Q4. A new machine has been installed in a factory for carrying out production process
smoothly. The expenses for installing the machine are as follows:

Estimated life of the machine in years is 12. The factory is expected to work 300 days
in a year, 8 hours per day, and the capacity utilization of machine is estimated 80%.
The machine occupies 20% of the factory area and the supervisor devotes one-eighth
of his time on the machine.
 Compute the machine hour rate for the machine.

Solution:

Machine life is 12 years

Depreciation = Rs. 2,88,000/12 Years = Rs. 24,000 per annum
Working hours per annum = 300 days X 8 hours X 80% = 1,920 hours
Power cost = 8 units X Rs. 3 = Rs. 24 per hour

Machine Hour Rate = Total Overheads / Working Hours

Machine Hour Rate = 3,08,080 / 1920
= Rs. 160.46 per hour

Q5. What is budgeting? How budgetary control does helps in envisaging cost control in
an organization? What are the major limitations of budgetary control?
 Budgeting has come to be accepted as an efficient method of short-term planning and
control. The technique of budgeting is an important application of Management
Accounting. It is a versatile tool and has helped managers cope with many problems
including inflation.
The Chartered Institute of Management Accountants, England, defines a 'budget' as
under: “A financial and/or quantitative statement, prepared and approved prior to define
period of time, of the policy to be persued during that period for the purpose of attaining a
given objective.”
Essentials of a Budget
An analysis of the above said definitions reveal the following essentials of a budget:
1) It is prepared for a definite future period.
(2) It is a statement prepared prior to a defined period of time.
(3) The Budget is monetary and/or quantitative statement of policy.
(4) The Budget is a predetermined statement and its purpose is to attain a given objective.
A budget, therefore, be taken as a document which is closely related to both the managerial
as well as accounting functions of an organization.

Budgetary Control is the process of establishment of budgets relating to various activities

and comparing the budgeted figures with the actual performance for arriving at deviations,
if any. Accordingly, there cannot be budgetary control without budgets. Budgetary Control
is a system which uses budgets as a means of planning and controlling. According to
I.C.M.A. England Budgetary control is defined by Terminology as the establishment of
budgets relating to the responsibilities of executives to the requirements of a policy and the
continuous comparison of actual with the budgeted results, either to secure by individual
actions the objectives of that policy or to provide a basis for its revision.
Budgeting is a forward planning. It serves basically as a tool for management control; it is
rather a pivot of any effective scheme of control. Budgeting and cost control includes the
detailed estimation of costs, the setting of agreed budgets, and control of costs against that
budget. Its goals are to:
i. determine the income and expenditure profiles for the work;
ii. develop budgets and align with funding;
iii. implement systems to manage income and expenditure.
Budgetary control does helps in envisaging cost control in an organization through the
following ways:
1. Planning: As a manager looks forward over a period of business and prepares, he may
consider how much material or staff is needed. When a budget shows expected sales over
the same period, the manager can take budgeted costs of sales and work backwards to
determine raw materials needs or labor hours required. Effective managers will consider
adjustments based on current market conditions that may vary from the time the budget
was devised.
2. Prioritizing: Comparing year-to-date performance to the budget may help a manager
decide how to approach a problem or challenge. For example, if labor costs in a particular
 area are higher than budget, but new equipment purchases are under budget, a manager
might requisition a new machine that helps reduce labor moving forward.
3. Continuous Improvement: An effective manager is not just looking to meet budget, but
also looks for ways to improve. With weekly or monthly performance numbers compared
to budget, a manager is a first-level systems analyst for operations. Working at floor level,
for example, a manager could work with employees for ways to increase throughput or
reduce waste. The budget often provides clues as to where effort is most effectively focused
to produce improved financial performance.
4. Forecasting: One year's budget often serves as a basis for the following year, and when
managers are involved in the budgeting process, each of the previous steps can be applied
looking forward. Managers may be in a unique position to observe the effects of improved
staff training, for example, as a contributor to improved performance. Forecasting becomes
a chance for an effective manager to reach beyond the bounds of his department to suggest
changes that may create better conditions for financial success the following year.

Limitations of Budgetary Control

Budgetary Control is an effective tool for management control. However, it has certain
important limitations which are identified below:
1) The budget plan is based on estimates and forecasting. Forecasting cannot be
considered to bean exact science. If the budget plans are made on the basis of
inaccurate forecasts then the budget progamme may not be accurate and ineffective.
2) For reasons of uncertainty about future, and changing circumstances which may
develop later on, budget may prove short or excess of actual requirements.
3) Effective implementation of budgetary control depends upon willingness, co-operation
and understanding among people reasonable for execution. Lack of co-operation leads to
inefficient performance.
4) The system does not substitute for management. It is mere like a management tool.
5) Budgeting may be cumbersome and time consuming process.

Question 6: The Indian Construction Co. Ltd. has undertaken the construction of a bridge over the
River Yamuna for a Corporation. The value of the contract is ` 15,00,000 subject to retention of
20% until one year after certified completion of the contract, and final approval of the
Corporation’s engineer. The following are the details as shown in the books on 30th June, 2015.
Prepare (a) Contract Account, (b) Contractee’s Account, and (c) show how it would appear in the Balance
Sheet.

Solution:

Question 7: Pragati Company manufactures a product P by mixing three raw materials. For every
100kg of output, 125kg of raw material input are used. In April 1997, there was an output of
5,600kg of P. the standard and actual particulars of April, 1997 are as follows :
Calculate all material variances. The actual quantity of material used was 7,000kg.

Solution:

Material cost variance = Standard Cost of Actual Output – Actual Cost

= Rs.1,96,000 – 2,15,600 = Rs.19,600 (A)

Material price variance = (Standard Price – Actual Price) x Actual quantity

I = (Rs.40 – 42) x 42,000kg = Rs.8,400 (A)

II = (Rs.20 – 16) x 1,400kg = Rs.5,600 (F)
III = (Rs.10 – 12) x 1,400kg = Rs.2,800 (A)
= Rs.14,000 (A)

Material usage variance = (Standard quantity – Actual quantity) x Standard price

I = (3,500kg – 4,200) x Rs.40 = Rs.28,000 (A)

II = (2,100kg – 1,400) x Rs.20 = Rs.14,000 (F)
III = (1,400kg – 1,400) x 10 = NIL
= Rs.14,000 (F)

Material Mix variance = (Revised Standard quantity – Actual quantity) x Standard price
 I = (3,500kg – 4,200) x Rs.40 = Rs.28,000 (A)
II = (2,100kg – 1,400) x Rs.20 = Rs.14,000 (F)
III = (1,400kg – 1,400) x Rs.10 = NIL
= Rs.14,000 (A)

Material yield variance = (Standard yield – Actual yield) x Material cost per unit of Output

= (5,600 – 5,600) x Rs.35 = NIL

Question 8:
a) Do you agree that activity-based costing is a more refined system of charging of
overhead cost to products than the traditional method? Explain.
b) Explain life-cycle cost analysis as a tool of management?

Ans 8(a)

Activity Based costing:

Activity based costing may be defined as a technique which involves identification of costs with
each cost driving activity and making it as the basis for absorption of costs over different products
or jobs.
The Chartered Institute of Management Accountants(CIMA), London , defines it as “technique of
cost attribution to cost units on the basis of benefits received from indirect activities, e.g. ordering,
setting up, assuring quality”.
According to Horngren , “ABC is a system that focuses on activities as fundamental cost objects
and utilises cost of these activities as building blocks or compiling the costs of other cost objects”.

Basics of ABC:
ABC assigns costs to products by tracing expenses to “activities”. Each Product is charged based
on the extent to which it used an activity. The primary objective of ABC is to assign costs that
reflect/mirror the physical dynamics of the business provides ways of assigning the costs of
indirect support resources to activities, business processes, customers, products. It recognises that
many organisational resources are required not for physical production of units of product but to
provide a broad array of support activities.
Cost of a product is the sum of the costs of all activities required to manufacture and deliver the
product. Products do not consume costs directly. Money is spent on activities which are consumed
by product/Services.

Distinction between traditional absorption costing and activity based Costing

Basis Traditional Costing Activity Based Costing

Effectiveness of The objective of product costing and The objective of product
purposes pricing decisions are not effectively costing and pricing decisions
served by traditional costing. are more effectively served
by adopting ABC systems.
 Basis of In traditional costing overhead costs are Under ABC system,
Identification identified to department. overhead costs are identified
to each major activity.
Terms used Popular terms are basis of allocation or Under ABC system, cost
apportionment. drivers are fewer in number
for the purpose of charging
overheads to products.
Methodology Reallocation to production centres is done ABC system uses separate
in traditional system. rates for support centres and
there is no reallocation to
production centres.

We can summarise the main difference between ABC and traditional costing by following picture:
 Traditional method

Costs
Products

 Activity-based allocation method

Costs Activities
Products

The objectives of product costing and pricing decisions are more effectively served by adopting
ABC systems. Under ABC system , overhead costs are identified to each major activity instead of
the department as under traditional costing system. It results in greater number of cost centres
under ABC system. The term ‘cost driver’ is not used in traditional costing system. Under ABC
system cost drivers are fewer in number for the purpose of charging overheads to products.
ABC system also uses separate rates for support centres and there is no reallocation to production
centres. Traditional costing system reveals less accurate costs as compared to ABC system. Thus
one can conclude that activity-based costing is a more refined system of charging of overhead cost
to products than the traditional method.
Ans. 8(b): Life cycle costing
In case of traditional costing system, the cost of the product is usually computed on the basis of
visible cost which primarily consist of manufacturing costs, viz., materials, labour & overheads
incurred for the product during a particular period. Invisible costs such as research & development
costs, after service costs, etc., are usually ignored.
Life-cycle costing is based on the basic premise that for decision making, all costs, whether capital
or revenue, whether upstream(e.g., research & development) or downstream (e.g., customer
service), incurred during all phases of the product life-cycle, are relevant. The product’s life-cycle
starts from the time of inception of the productForecasting
by the manufacturer to abandonment of the product
by the customer.
Life-cycle of a product differs from product to product. For example in case of an automobile it
may be 10 years, while in the cases of a fashion goods item it may be only one year. The costs
incurred during the life cycle of a product or project can be classified in the following six
categories:
i. Research & development
ii. Product design costs
iii. Manufacturing costs
iv. Marketing costs
v. Distribution costs
vi. Customer service costs

Life-cycle costing, therefore, involves consideration of all costs associated with the product
during its life-span, i.e., costs incurred as some people put it, from ’cradle to grave’ or ‘womb
to bomb.’
CIMA defines life-cycle costing as ‘the practice of obtaining over the lifetimes the best use of
physical assets at the lowest total cost to the entity.’
Utility Life-cycle Costing is helpful in managerial decision making as follows:
1. Pricing decision Useful information is provided to the management for pricing the
products of the organization. In case of some products, the development period is
long while in case of others, it may be short. The situation may be reverse in case
of manufacturing costs. The management must therefore take all these aspects into
consideration while fixing the prices of the different products.
2. Focuses on both visible and invisible costs Full costs associated with each product,
whether visible or invisible, are given due focus. This considerably broadens the
perspective of the business manager and considerably helps in decision making.
3. Overall view A cost statement prepared under traditional costing has a calendar
based focus. In other words, its information is limited to the accounting period for
which it has been prepared. A cost statement prepared as per life cycle costing gives
 information regarding all costs associated with the products over its total life-span.
Hence, the management can take an overall view about the product.
4. Facilitates capital budgeting decision Capital budgeting decision is basically a long
term investment decision. The life- cycle consisting consider both capital and
revenue costs over the entire life-span of the product or project. Hence, it helps in
making better appraisal of different projects and considerably facilitates the capital
budgeting decision process.