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Financial Accounting and Management 2019

 


Section A - Very Short Answer Type Questions

Each question carries 3 marks, and answers are required to be brief (not exceeding 75 words).

1. Define Financial Accounting.

Explanation: Financial accounting is a specialized branch of accounting that involves recording, summarizing, and reporting the transactions of a business to provide an accurate financial overview. It primarily focuses on preparing financial statements like the profit and loss account and balance sheet that are used by external stakeholders (e.g., investors, creditors) to make informed decisions.

2. Explain the meaning of the term ‘Journal’.

Explanation: A journal is the primary book of accounting where all financial transactions are recorded in chronological order. Each entry in the journal includes the date of the transaction, accounts affected, amounts debited and credited, and a brief description of the transaction. The process of recording in the journal is called "journalizing," and it serves as the first step in the accounting cycle.

3. Define Bookkeeping.

Explanation: Bookkeeping refers to the systematic process of recording financial transactions of a business on a daily basis. It involves maintaining records of purchases, sales, receipts, and payments, ensuring that all financial data is organized for further analysis and preparation of accounts.

4. What do you mean by a trial balance?

Explanation: A trial balance is a summary statement prepared at the end of an accounting period that lists all ledger accounts and their respective debit or credit balances. Its purpose is to ensure that the total debits equal the total credits, which verifies the accuracy of the bookkeeping entries.

5. What is the use of a cash book?

Explanation: A cash book is a financial journal that records all cash transactions (receipts and payments) of a business in chronological order. It serves the dual purpose of being a ledger as well as a journal and is used to keep track of the company’s cash inflows and outflows, ensuring proper cash management.

Section B - Short Answer Type Questions

Each question carries 7 marks, and answers should not exceed 200 words.

6. Distinguish Management Accounting from Financial Accounting.

Explanation:

Aspect Financial Accounting Management Accounting
Purpose To provide financial information to external stakeholders like investors, creditors, and regulators. To assist internal management in decision-making.
Focus Historical financial data and performance. Future planning, analysis, and decision-making.
Reports Prepared Balance sheet, profit and loss account, cash flow statement. Budgets, variance analysis, cost reports.
Regulations Governed by accounting standards (e.g., IFRS, GAAP). No strict regulations; internal focus.
Users External stakeholders. Internal management.

In essence, financial accounting focuses on accurate reporting of past data, while management accounting provides tools for strategic planning and internal operations.

7. What are the differences between cash flow statement and fund flow statement?

Explanation:

Aspect Cash Flow Statement Fund Flow Statement
Focus Tracks cash inflows and outflows during a period. Analyzes changes in financial position between two balance sheet dates.
Scope Restricted to cash and cash equivalents. Covers working capital and changes in funds.
Purpose Assess liquidity and cash management. Understand the sources and uses of funds.
Basis Actual cash transactions. Accrual basis; considers non-cash items like depreciation.
Statement Prepared Operating, investing, and financing activities. Sources and application of funds.

The cash flow statement is narrower, focusing solely on cash, whereas the fund flow statement provides a broader view of financial movements.

8. Explain the classification of balance sheet items.

Explanation:

A balance sheet is classified into two sections:

  1. Assets: What the business owns.

    • Current Assets: Short-term assets expected to be converted into cash within a year (e.g., cash, accounts receivable, inventory).
    • Non-Current Assets: Long-term assets used for operations (e.g., buildings, machinery, goodwill).

  2. Liabilities and Equity: What the business owes and the owner’s claim.

    • Current Liabilities: Obligations due within a year (e.g., accounts payable, short-term loans).
    • Non-Current Liabilities: Long-term obligations (e.g., bonds payable, long-term loans).
    • Equity: The owner's residual interest (e.g., share capital, retained earnings).

These classifications help in analyzing the financial health, liquidity, and stability of the business.

Section C - Long Answer Type Questions

Each question carries 15 marks, requiring detailed explanations.

9. Explain the different rules for journalizing the transactions with appropriate illustrations.

Explanation:

Journalizing refers to recording transactions in the journal, which is the first step in the accounting cycle. Transactions are recorded based on three golden rules of accounting, which depend on the type of account. The rules are:

1. Personal Accounts

  • Rule: Debit the receiver, Credit the giver.
  • Illustration:
    • A company receives cash of ₹10,000 from Mr. A.
      • Debit: Cash Account ₹10,000 (receiver)
      • Credit: Mr. A's Account ₹10,000 (giver).

2. Real Accounts

  • Rule: Debit what comes in, Credit what goes out.
  • Illustration:
    • Purchased furniture worth ₹5,000 for cash.
      • Debit: Furniture Account ₹5,000 (comes in)
      • Credit: Cash Account ₹5,000 (goes out).

3. Nominal Accounts

  • Rule: Debit all expenses and losses, Credit all incomes and gains.
  • Illustration:
    • Paid salary of ₹15,000.
      • Debit: Salary Account ₹15,000 (expense)
      • Credit: Cash Account ₹15,000 (outflow).

These rules ensure accurate recording and classification of transactions in the journal.

10. Compute the net income or net loss for the year for three independent cases.

Given:

  • Beginning Assets: ₹4,60,000
  • Ending Assets: ₹5,80,000
  • Beginning Liabilities: ₹2,20,000
  • Ending Liabilities: ₹2,80,000

Formula:

Net Income (or Loss)=(Ending Assets−Ending Liabilities)−(Beginning Assets−Beginning Liabilities)+Additional Capital−Withdrawals\text{Net Income (or Loss)} = (\text{Ending Assets} - \text{Ending Liabilities}) - (\text{Beginning Assets} - \text{Beginning Liabilities}) + \text{Additional Capital} - \text{Withdrawals}

Case (i): Dolly made no withdrawals or investments.

  • Additional Capital = ₹0, Withdrawals = ₹0

\text{Net Income} = (₹5,80,000 - ₹2,80,000) - (₹4,60,000 - ₹2,20,000) ]

\text{Net Income} = ₹3,00,000 - ₹2,40,000 = ₹60,000 ]

Case (ii): Dolly made an additional capital investment of ₹1,00,000.

  • Additional Capital = ₹1,00,000, Withdrawals = ₹0

\text{Net Income} = ₹60,000 - ₹1,00,000 = ₹40,000 (Loss) ]

Case (iii): Dolly made withdrawals of ₹40,000 but no additional investments.

  • Additional Capital = ₹0, Withdrawals = ₹40,000

\text{Net Income} = ₹60,000 - ₹40,000 = ₹20,000 ]

11. Explain the ratios related to Rainy Ltd.

Given Ratios:

  1. Gross Profit Ratio: 15%

    • Formula: Gross Profit Ratio=Gross ProfitNet Sales×100\text{Gross Profit Ratio} = \frac{\text{Gross Profit}}{\text{Net Sales}} \times 100
      • Indicates the profitability from core business operations.

  2. Stock Velocity: 6 months

    • Formula: Stock Velocity=Average InventoryCost of Goods Sold×12\text{Stock Velocity} = \frac{\text{Average Inventory}}{\text{Cost of Goods Sold}} \times 12
      • Reflects how quickly inventory is sold or replaced.

  3. Debtors Velocity: 3 months

    • Formula: Debtors Velocity=Average DebtorsNet Credit Sales×12\text{Debtors Velocity} = \frac{\text{Average Debtors}}{\text{Net Credit Sales}} \times 12
      • Indicates how efficiently a company collects receivables.

12. Explain the Traditional Theory of Cost of Capital and Capital Structure.

Explanation:

The Traditional Theory suggests there is an optimal capital structure that minimizes the cost of capital and maximizes the firm's value. It combines debt and equity in a way that reduces the overall cost of financing.

Key Points:

  1. Debt is cheaper than equity: Interest on debt is tax-deductible, reducing the cost of capital.
  2. Excess debt increases risk: Beyond a point, too much debt raises the firm's risk, increasing the cost of equity.
  3. Optimal capital structure: A balance between debt and equity minimizes the Weighted Average Cost of Capital (WACC).

Graphical Representation:

  • WACC vs. Debt Ratio: The curve initially decreases due to cheaper debt but rises after an optimal point due to risk.

13. What are the objectives of cash management? Explain the cash cycle.

Explanation:

Objectives of Cash Management:

  1. Liquidity Maintenance: Ensure sufficient cash for daily operations.
  2. Profit Maximization: Invest idle cash to earn returns.
  3. Minimizing Cost: Avoid excessive borrowing or holding surplus cash.
  4. Efficient Payments: Ensure timely payments to creditors and staff.
  5. Handling Uncertainty: Maintain a buffer for emergencies.

Cash Cycle:

The cash cycle is the time it takes for cash to be converted into inventory, then into sales, and finally back into cash.

Steps in the Cash Cycle:

  1. Purchase Inventory: Cash is used to buy raw materials.
  2. Production & Sales: Inventory is converted into finished goods and sold.
  3. Accounts Receivable: Cash is collected from customers.

Formula:

Cash Cycle=Inventory Conversion Period+Receivables Collection Period−Payables Deferral Period\text{Cash Cycle} = \text{Inventory Conversion Period} + \text{Receivables Collection Period} - \text{Payables Deferral Period}

This cycle reflects how efficiently a company manages its cash flows.


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