Accounting & Financial Management June 2016: What is ratio analysis? What are its advantages & limitations? Ratio analysis refers to the analysis and interpretation of the figures appearing in the financial statements (i.e., Profit and Loss Account, Balance Sheet and Fund Flow statement etc.). It is a process of comparison of one figure against another. It enables the users like shareholders, investors, creditors, Government, and analysts etc. to get better understanding of financial statements. Khan and Jain define the term ratio analysis as “the systematic use of ratios to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial conditions can be determined.” Ratio analysis is a very powerful analytical tool useful for measuring performance of an organisation. Accounting ratios may just be used as symptom like blood pressure, pulse rate, body temperature etc. The physician analyses these information to know the causes of illness. Similarly, the financial analyst should also analyse the accounting ratios to diagnose the financial health of an enterprise. Generally, ratio analysis involves four steps: (i) Collection of relevant accounting data from financial statements. (ii) Constructing ratios of related accounting figures. ADVERTISEMENTS:(ii?) Comparing the ratios thus constructed with the standard ratios which may be the corresponding past ratios of the firm or industry average ratios of the firm or ratios of competitors. (iv) Interpretation of ratios to arrive at valid conclusions. Advantages of Ratio Analysi: Ratio analysis is widely used as a powerful tool of financial statement analysis. It establishes the numerical or quantitative relationship between two figures of a financial statement to ascertain strengths and weaknesses of a firm as well as its current financial position and historical performance. It helps various interested parties to make an evaluation of certain aspect of a firm’s performance. The following are the principal advantages of ratio analysis: 1. Forecasting and Planning: The trend in costs, sales, profits and other facts can be known by computing ratios of relevant accounting figures of last few years. This trend analysis with the help of ratios may be useful for forecasting and planning future business activities. 2. Budgeting: Budget is an estimate of future activities on the basis of past experience. Accounting ratios help to estimate budgeted figures. For example, sales budget may be prepared with the help of analysis of past sales. 3. Measurement of Operating Efficiency: Ratio analysis indicates the degree of efficiency in the management and Utilisation of its assets. Different activity ratios indicate the operational efficiency. In fact, solvency of a firm depends upon the sales revenues generated by utilizing its assets.4. Communication: Ratios are effective means of communication and play a vital role in informing the position of and progress made by the business concern to the owners or other parties. 5. Control of Performance and Cost: Ratios may also be used for control of performances of the different divisions or departments of an undertaking as well as control of costs. Some of these limitations are: 1. Limitations of Financial Statements: Ratios are calculated from the information recorded in the financial statements. But financial statements suffer from a number of limitations and may, therefore, affect the quality of ratio analysis. 2. Historical Information: Financial statements provide historical information. They do not reflect current conditions. Hence, it is not useful in predicting the future. 3. Different Accounting Policies: Different accounting policies regarding valuation of inventories, charging depreciation etc. make the accounting data and accounting ratios of two firms non-comparable. 4. Lack of Standard of Comparison: No fixed standards can be laid down for ideal ratios. For example, current ratio is said to be ideal if current assets are twice the current liabilities. But this conclusion may not be justifiable in case of those concerns which have adequate arrangements with their bankers for providing funds when they require, it may be perfectly ideal if current assets are equal to or slightly more than current liabilities.5. Quantitative Analysis: Ratios are tools of quantitative analysis only and qualitative factors are ignored while computing the ratios. For example, a high current ratio may not necessarily mean sound liquid position when current assets include a large inventory consisting of mostly obsolete items. 2. What is cash book? Why we use triple column cash book? Cashbooks are simple accounting books that are used to record basic information about cash receipts and payments. Once available in hard copy form only, they are now often included in different types of money management software. Providing an easy way of keeping up with how much money is coming in and what bills are getting paid, this book can be effectively used by just about anyone. The design of the sheets in a cashbook is essentially a series of columns. Like any accounting book, there is room provided to add titles to each column. This allows the end user to decide how much information about each transaction will be entered into the book. Generally, the date of the transaction, the amount, source of the cash in or the recipient of the cash out, and the running balance of cash on hand are considered basic. Some users may prefer to also include a description column that allows more details about the reason for the transaction. Many office supply stores still carry the basic format. As a hard copy that is easy to keep around the home, it is a great and inexpensive way to keep up with the flow of cash into and out of the household. The cashbook can make reconciliation with the household budget a simple task, since it is possible to code each transaction to tie back easily with each category in the home budget. Along with the traditional hard copy version, many financial planning and budget programs will include a basic electronic template for tracking cash. Since the device is relatively easy to understand, even people who consider themselves to be unable to keep up a real accounting record will typically find that making entries is not difficult at all. Often, the software will offer tools to help customize the document to the needs of the end user. This helps to make it ideal for use in the home or with a small business.Types of Cash book A journal in which all cash payments and receipts (letting in bank withdrawals and deposits) are recorded 1st in chronological manner for posting to general ledger book. The cash book is regularly made up with the bank instructions as an internal auditing amount. And in larger company, it's generally divided into 2 divisions: (1) The cash expense journal in which all payments of cash (specified as accounts owed, operating cost, petty cash buys) are entered. (2) The cash receipts journal (day book) in which all receipts of cash (specified as accounts due, sale of assets, cash sales) are entered. Triple Column Cash Book: We know, when cash is received from the debtors, discount may be allowed to them. And when cash is paid to creditors, discount may be received from them. It means the cash and the discount are very much related to each other. Another interesting thing is that when the cash is received, the discount is allowed and both cash account and discount account are debited. On the other hand, when the cash is paid, the discount is received and both the cash account and the discount account are credited in the books of account. Thus in "Double Column Cash Book another ‘amount! column is provided on each side to record discount allowed and discount received’. It means the Cash Book now will have three "Amount Columns on each side, i.e. Cash Column, Bank Column and Discount Allowed Column on the debit side and Cash Column, Bank Column and Discount Received Column on the credit side. It may also be noted that when ‘Discount’ Column is added with both sides of Double Column Cash Book it becomes a "Treble or Three Column Cash Book". It must be remembered that the Discount Column in Treble Column Cash Book is not an account. Both the Discount Allowed Account and Discount Received Account are opened in the ordinary Ledger. These columns are memorandum columns only; they help us remember how much discount has been allowed or received. The totals of discount allowed and discount received columns from two sides of Cash Book are posted in Discount Allowed A/c and Discount Received A/c respectively in the Ledger. Why cash book is called Journal as well as ledger: Cash book is @ journal because the transactions are recorded in it for the first time from the source of document and from journal these transactions are posted to the respective account in the ledger. We can say cash book is a ledger also in the sense that it serves the purpose ofcash account also.As such cash book is journal as well as ledger, and hence it may call journalised ledger. Explain different accounting concepts? There are the necessary assumptions or conditions upon which accounting is based. Accounting concepts are postulates, assumptions or conditions upon which accounting records and statement are based. The various accounting concepts are as follows: 1, Entity Concept: For accounting purpose the “business” is treated as a separate entity from the proprietor(s). One can sell goods to himself, but all the transactions are recorded in the book of the business. This concepts helps in keeping private affairs of the proprietor away from the business affairs. E.g. If a proprietor invests Rs. 1,00,000/- in the business, it is deemed that the proprietor has given Rs. 1,00,000/- to the “business” and it is shown as a “liability” in the books of the business. Similarly, if the proprietor withdraws Rs. 10,000/- from the business, it is charged to them. 2. Dual Aspect Concept: As per this concept, every business transaction has a dual affect. For example, if Ram starts business with cash Rs. 1,00,000/- there are two aspects of the transaction: “Asset Account” and “Capital Account”. The business gets asset (cash) of Rs. 1,00,000/- and on the other hand the business owes Rs. 1,00,000/- to Ram. 3. Going Business Concept (Continuity of Activity): It is assumed that the business concern will continue for a fairly long time, unless and until has entered into a state of liquidation. It is as per this assumption, that the accountant does not take into account the forced sale values of assets while valuing them. 4, Money measurement concept: As per this concept, in accounting everything is recorded in terms of money. Events or transactions which cannot be expressed in terms of money are not recorded in the books of accounts, even if they are very important or useful for the business. Purchase and sale of goods, payment of expenses and receipt of income are monetary transactions which are recorded in the accounting books however events like deathof an executive, resignation of a manager are such events which cannot be expressed in money. 5. Cost Concept (Objectivity Concept): This concept does not recognize the realizable value, the replacement value or the real worth of an asset. Thus, as per the cost concept a) as asset is ordinarily recorded at the price paid to acquire it i.e. at its cost, and b) this cost is the basis for all subsequent accounting for the asset. For example, if a machine is purchased for Rs. 10,000/- it is recorded in the books at Rs. 10,000/- and even if its market value at the time of the preparation of the final account is Rs. 20,000/- or Rs. 60,000/- the same will not considered. 6. Cost-Attach Concept: This concept is also known as “cost-merge” concept. When a finished good is produced from the raw material there are certain process and costs which are involved like labor cost, power and other overhead expenses. These costs have a capacity to “merge” or “attach” 7. Accounting Period Concept: An accounting period is the interval of time at the end of which the income statement and financial position statement (balance sheet) are prepared to know the results and resources of the business. 8. Accrual Concept: The accrual system is a method whereby revenue and expenses are identified with specific periods of time like a month, half year or a year. It implies recording of revenues and expenses of a particular accounting period, whether they are received/paid in cash or not. 9. Period Matching of Cost and Revenue Concept: This concept is based on the period concept. Making profit is the most important objective that keeps the proprietor engaged in business activities. That is why most of the accountant’ time is spent in evolving techniques for measuring the profit/profitability of the concern. To ascertain the profit made during a period, it is necessary to match “revenues” of the period with the “expenses” of that period. Income (profit) earned by the business during a period is compared with the expenditure incurred to earn the revenue.10. Realization Concept: According to this concept profit, should be accounted for only when it is actually realized. Revenue is recognized only when sale is affected or the services are rendered. However, in order to recognize revenue, receipt of cash us not essential. Even credit sale results in realization as it creates a definite asset called “Account Receivable”. However there are certain exception to the concept like in case of contract accounts, hire purchase etc. Similarly incomes like commission interest rent etc, are shown in Profit and Loss A/c on accrual basis though they may not be realized in cash on the date of preparing accounts. 11. Verifiable Objective Evidence Concept: According to this concept all accounting transactions should be evidenced and supported by objective documents. These documents include invoices, contract, correspondence, vouchers, bills, passbooks, cheque etc. What is cash budget, What are its advantages? A cash budget is an estimation of a person's or a company's cash inputs and outputs over a specific period of time Cash budgets are generally used to estimate whether a company has a sufficient amount of cash to uphold regular operations. It can also be used to determine whether too much of a company’s cash is being spent in unproductive ways. By creating a cash budget - wherein a company develops a summary of the anticipated revenues, operating expenditures, sale and purchase of assets, and admission or settlement of debt - it is possible to determine when more cash resources are needed, as well as when there will be an excess of cash. Advantages The advantages of using cash budgeting are many. This tool helps determine whether cash balances remain sufficient to fulfill regular obligations and whether minimum liquidity and cash balance requirements stipulated by banks or internal company regulations are maintained. It also helps a company determine whether too much cash is retained that could be otherwise used in productive activities. Companies that borrow from banks need to monitor their cash coverage ratio and preparing a cash budget constitutes the first step in calculating this ratio.Cash budgets identify the amount of cash required to fulfill immediate, short-term obligations without utilization of overdraft protection or lines of credit. Businesses use this information to determine the extent of credit sales. Offering credit and extending credit periods usually increases sales. A company with excess cash can afford to sell on credit and thereby boost profitability. Conversely, a company hard-pressed for cash might decide to sell products at discounted prices for cash. Offering such discounts may be cheaper than the cost of overdraft fees or credit interest. Companies use cash budgets to make plans for The goal is to retain only the minimum required working capital, investing the surplus cash in productive ventures, such as making profitable investments, expanding production capacity, purchasing raw materials in bulk and in using cash to obtain favorable discounts. Companies hard- pressed for cash can take many steps to improve their position, such as reducing credit sales, postponing or reducing dividends, collecting credit early, rescheduling debt repayment and other payouts, cutting back on manufacturing products that require resources but do not yield much cash in the short term, and so on. Companies also look at a cash budget to determine the extent of cash available, if any, to finance capital expenditures. Preparing a cash budget sheds light on where cash goes. Individuals and companies can analyze each item of expenditure to determine the purpose of such expenditure and the value received in return for the expense. This allows them to cut down on unproductive expenses, bring in financial efficiency, and improve the quality of financial decisions. Disadvantages Cash budgets may also cause distortions. Cash inflows do not equate to profit. Cash inflows resulting from security deposits, fines, the sale of capital assets, or any other one-off, non-sustainable activity do not necessarily represent reliable ongoing sources of revenue. On the other hand, reduced cash flow need not always be a cause for concern. At times, selling items with long credit periods might result in a much larger profit in the long run and will more than cover the interest associated with securing short-term loans to meet immediate obligations. Managerial judgment is necessary to interpret the results. Cash budgets are susceptible to manipulation. For instance, making a huge payout a day or two before the end of period, instead of a day or two after the start of the next period, may be misleading. It restricts cash flow for one period and inflates cash flow for the other period. Even if company operations are experiencing a loss, postponing payouts might show a positive cash flow. Similarly, making payments early might result in negative cash flows, even when operations remain profitable. A bigger disadvantage is the reliance on estimates. Cash budgets use cash flow one year to allocate cash for the next year, when there is no guarantee that cash flow levels, or revenue and expenditure levels, willremain the same. Moreover, with cash budgets, management commits funds for various projects and expenditures and there is little opportunity to reallocate the funds based on changed circumstances, unless management decides to revise the budget as a whole. At times, non-financial factors have a major impact in decisions. For instance, a product might not generate much cash flow, or generate negative cash flow. People, however, might have a favorable association with the product, and equate the product with the company, providing intangible value. Making decisions based solely on a cash budget would leave this product as a prime candidate for the chopping block. Similarly, one bank may charge a slightly higher rate of interest, but also offer better customer service than a bank that charges low interest. With a cash budget, only the low interest rate counts. The advantages of cash budgeting make them an indispensible financial tool. Use and prepare them properly to experience the benefits, but understand the possibilities for distortion and other limitations too. Importance of ledger: The journal provides a complete listing of the daily transactions of a business. But it does not provide information about a specific account in one place. For example, to know how much cash balance we have, the accounting clerk would have to check all the journal entries in which cash is involved, and this is very laborious job; because there are hundreds or even thousands of cash transactions recorded on different pages of journal. To avoid this difficulty, the debit and credit of journalized transactions are transferred to ledger accounts. Thus all the changes for a single account are located in one place - in a ledger account. This makes it easy to determine the current balance of any account. The book in which accounts are maintained is called ledger. Generally, one account is opened on each page of this book, but if transactions relating to a particular account are numerous, it may extend to more than one page. All transactions relating to that account are recorded chronologically. From journal each transaction is posted to at least two concerned accounts - debit side of one account and credit side of another account. Remember that, if there are two accounts involved in a journal entry, it will be posted to two accounts in the ledger and if the journal entry consists of three accounts (compound entry) it will be posted to three different accounts in the ledger. The process of transferring information from journal to ledger accounts is known as posting. The goal of all transactions is ledger. Ledger is known as the destination of entries in journal but it must be remembered that transactions cannot berecorded directly in the ledger - they must be routed through journal. This concept is illustrated below: Transaction L Journal t Ledger So, the books in which all the transactions of a business concern are finally recorded in the concerned accounts in a summarized form is called ledger. Characteristics of Ledger Account: The ledger has the following main characteristics: 1. It has two identical sides - left hand side (debit side) and right hand side (credit side). 2. Debit aspect of all the transactions are recorded on the debit side and credit aspects of all the transactions are recorded on credit side according to date. . The difference of the totals of the two sides represents balance. The excess of debit side over credit side indicates debit balance, while excess of credit side over debit side indicates the credit balance. If the two sides are equal, there will be no balance. Generally the balance is drawn at the year end and recorded on the lesser side to make the two sides equal. This balance is know as dosing balance. . The closing balance of the current year becomes the opening balance of the next year. w a wu Types or Forms of Ledger Accounts: There are two forms of ledger accounts. These are: 1. Standard form 2. Self-balancing formStandard Form of Ledger Account: To understand clearly as to how to write the accounts in ledger, the standard form of an account is given below with two separate transactions: Date | Particulars J.R | Amount Date | Particalars J.R Amount | 2005 2005 Dec. |Cash A/C 1,200 Dec. Purchases 2,000 17 17 arc It appears that each account in the ledger has two similar sides - left hand side is called debit side (briefly Dr.) and right hand side (briefly Cr.) side. Now a days these two words are not used, because it is obvious that the left hand side is debit side and right hand side is credit side. Maintaining of ledger is a must in every accounting system. It is necessary as will be clear from its advantages. + Transactions relating to a particular person, item or heading of expenditure or income are grouped in the concerned account at one place. + When each account is periodically balanced it reflects the net position of that account. + Ledger is the stepping stone for preparing Trial Balance - which tests the arithmetical accuracy of the accounting books. + Since the entries recorded in the journal are referenced into ledger the possibility of errors of defalcations are reduced to the minimum. + Ledger is the destination of all entries made in journal or sub-journals. + Ledger is the “store-house” of all information which subsequently is used for preparing final accounts and financial statements. What is meant by operating, investing & financing activities in cash flow statement? Classification of Cash Flows: The statement of cash flows classifies cash receipts and cash payments by operating, investing, and financing activities. Transactions and other events characteristics of each kind of activity are as follows: 1. Operating activities 2. Investing activities3. Financing activities These business activities are briefly explained below: Operating Activities: Operating activities involve the cash effects of transactions that enter into the determination of net income, such as cash receipts from sales of goods and services and cash payments to suppliers and employees for acquisitions of inventory and expenses. Investing Activities: Investing activities generally involve long-term assets and include: + Making and collecting loans. + Acquiring and disposal of investments and productive long-lived assets, Financing Activities: Financing activities liability and stockholders; equity items and include: + Obtaining cash from creditors and repaying the amounts borrowed. + Obtaining capital from owners and providing them with a return, and return of, their investment. Examples of Typical Cash Receipts and Payments of a Business Enterprise Operating Activities Cash inflows: From sale of goods and services From retums on loans (interest) and on equity securities (dividend) Income Statement Cash outflows: Items To suppliers for inventory To employees for service To government for taxes To lenders for interest To others for expensesInvesting Activities Cash inflows: From sale of property, plant, and equipment. From sale of debt or equity securities of other entities. From collection of principal on loans to (Generally: ther entities 8 i " Asset Items Cash outflows: To purchase property, plant, and equipment. To purchase debt or equity securities of other entities. To make loans to entities. Einand F Cash inflows: From sale of equity securities. Generally ~ From issuance of debt (bonds and Frorag-tcnet notes): Liability and Prisows: Equity Items To stockholders as dividend. To redeem long-term debt or reacquire capital stock Some cash flows relating to investing or financing activities are classified as operating activities. For example, receipts of investment income (interest and dividends) and payments of interest to lenders are classified as investing or financing activities. Conversely, some cash flows relating to operating activities are classified as investing and financing activities. For example, the cash received from the sale of property, plant, and equipment at a gain, although reported in the income statement, is classified as an investing activity, and the effects of the related gain would not be included in the net cash flow from operating activities. Likewise a gain or loss on the payment of debt would generally be part of the cash outflow to the repayment of the amount borrowed, and therefore it is a financing activity.Explain the term capital Gearing in ratio analysis? Capital gearing ratio is 2 useful tool to analyze the capital structure of a company and is computed by dividing the common stockholders’ equity by fixed interest or dividend bearing funds. Analyzing capital structure means measuring the relationship between the funds provided by common stockholders and the funds provided by those who receive a periodic interest or dividend at a fixed rate. A company is said to be low geared if the larger portion of the capital is composed of common stockholders’ equity. On the other hand, the company is said to be highly geared if the larger portion of the capital is composed of fixed interest/dividend bearing funds. Formula: Common stockholders! equity Capital gearing ratio = Fixed cost bearing funds In the above formula, the numerator consists of common stockholders’ equity that is equal to total stockholders’ equity less preferred stock and the denominator consists of fixed interest or dividend bearing funds that usually include long term loans, bonds, debentures and preferred stock etc. All the information required to compute capital gearing ratio is available from the balance sheet. Example: The following information have been taken from the balance sheet of PQR limited: Year 2011: Common stockholders’ equity: $3,500,000 Preferred stock - 9%: $1,400,000 Bonds payable - 6%: $1,600,000 Year 2012: Common stockholders’ equity: $2,800,000Preferred stock ~ 9%: $1,800,000 Bonds payable - 6%: $1,400,000 We can compute the capital gearing ratio for the years 2011 and 2012 from the above information as follows: For the year 2011: Capital gearing ratio = 3,500,000 / 3,000,000 =7 : 6 (Low geared) For the year 2012: Capital gearing ratio = 2,800,000 / 3,200,000 = 7: 8 (Highly geared) The company has a low geared capital structure in 2014 and highly geared capital structure in 2012. Notice that the gearing is inverse to the common stockholders’ equity. + Highly geared >>> Less common stockholders’ equity + Low geared >>> More common stockholders’ equity Significance and interpretation: Capital gearing ratio is the measure of capital structure analysis and financial strength of the company and is of great importance for actual and potential investors. Borrowing is a cheap source of funds for many companies but a highly geared company is considered a risky investment by the potential investors because such a company has to pay more interest on loans and dividend on preferred stock and, therefore, may have to face problems in maintaining a good level of dividend for common stockholders during the period of low profits. Banks and other financial institutions reluctant to give loans to companies that are already highly geared.June 2015: Difference Between Journal & Ledger? No Journal Journal isa subsiciary book of account 1. itis the store house of recording transactions Transactions are recorded in journal in 2. chronological order of datas just after their occurrences, “Transactions are recarded in journal 3. without considering their nature of classification In journal explanston of entries of 4° transaction are shown 5,__ The formatof oumal contains five columns. «¢,_ Journal helps in preparing ledger ‘accounts corectly 7, Transactions are recorded in journal in * chranologeal atder of dates g._ The total results of transactions cannot be known from joumeal. 9. Injoumal ledger folio (LF) is written. 40. Preparation of ial balance is not possible fiom joumal. Accounts Principles: Ledger Ladger is the permanent and final book of accounts. It is termed as the means of classified transactions. Transactions are posted in ledger in classified form fram journal. Transactions are recorded in ledger in classified form under respective heads of accounts In ledger explanations of entries of sransactions are not needed Generally the ledger account of form contains eight cofumas — four in left and four in ight: But in statement format of ledger account contains six columns, The object of ledger is to know income and expenditures of different heads Ledger is prepared according to nature of accounts. Results of particular head of accounts can be known from ledger. In ledger journal folio (JF) is wrtten. Trial balance is prepared from ledger.(1) Entity Concept: Separate entity concept that business unit or a company is a body corporate and having a separate legal entity distinct from its proprietors, The proprietors or members are not liable for the acts of the company. But in the case of the partnership business or sole trader business no separate legal entity from its proprietors. Here proprietors or members are ible forthe acts of the firm, As per the separate entity concept of accounting it applies to all forms of business to determine the scope of what 4s to be recorded or what is to be excluded from the business books. For example, if the proprietor of the business invests Rs.50,000 in his business, it is deemed that the proprietor has given that much amount 10 the business as loan which will be shown as a liability for the business. On withdrawal of any amount it will bbe debited in cash account and credited in proprictor's capital account, In conctusion, this separate entity concept applies much larger in body corporate sectors than sole traders and partnership firms. (2) Dual Aspect Concept: According to this concept, every business transaction involves two aspects, namely, for every receiving of benefit and, there is a corresponding giving of benefit. The dual aspect concept is the basis of the double entry book keeping. Accordingly for every debit there is an equal and corresponding credit, The accounting equation of the dual aspect concept is: Capital + Liabilities = Assets (or) Assets = Equities (Capital) ‘The term Capital refers to funds provide by the proprietor of the business concern. On the other hand, the term liability denotes the funds provided by the creditors and debenture holders against the assets of the business. The term assets represents the resources owned by the business. For example, Mr.Thomas Starts business with cash of Rs.1,00,000 and building of Rs.5,00,000, then this fact is recorded at two places ; Assets Accounts and Capital Account. In other words, the business acquires assets of Rs.6,00,000 which is equal to the proprictor’s capital in the form of cash of Rs.1,00,000 and building worth of .5,00,000. The above relationship ean be shown in the form of accounting equation: Capital + Liabilities = Assets Rs.1,00,000 + Rs.5,00,000 = Rs.6,00,000(3) Accounting Period Concept: According to this concept, income or loss of a business can be analysed and determined on the basis of suitable accounting period instead of wait for a long period, ic., until ic is liquidated. Being a business in continuous affairs for an indefinite period of time, the proprietors. the shareholders and outsiders want to know the financial position of the concern, periodically. Thus, the accounting period is normally adopted for one year. At the end of the each accounting period an income statement and balance sheet are prepared. This concept is simply intended for a periodical ascertainment and reporting the true and fair financial position of the concern as a whole. (4) Going Concern Concept: It is otherwise known as Continue of Activity Concept. This concept assumes that business concer will continue for a long period to exit. In other words, under this assumption, the enterprise is normally viewed as a going concern and it is not likely to be liquidated in the near future. This assumption implies that while valuing the assets of the business on the basis of productivity and not on the basis of their realizable value or the present market value, at cost less depreciation till date for the purpose of balance sheet. It is useful in valuation of assets and liabilities, depreciation of fixed assets and treatment of prepaid expenses. (5) Cost Concept: This concept is based on “Going Concern Concept.” Cost Concept implies that assets acquired are recorded in the accounting books at the cost or price paid to acquire it, And this cost is the basis for subsequent accounting for the asset. For accounting purpose the market value of assets are not taken into account either for valuation or charging depreciation of such assets. Cost Concept has the advantage of bringing objectivity in the preparation and presentation of financial statements. In the absence of cost concept, figures showa in accounting records would be subjective and questionable. But due to inflationary tendencies, the preparation of financial statements on the basis of cost concept has become irrelevant for judging the true financial position of the business, (© Money Measurement Concept: According to this concept, accounting transactions are measured, expressed and recorded in tens of money. This concept excludes those transactions or events which ‘cannot be expressed in termes of money, For example, factors such as the skill of the supervisor, product policies, planning, employer-employee relationship canmot be recorded in accounts in spite of their importance to the business. This makes the financial statements incomplete, (7) Matching Concept: Matching Concept is closely related to accounting period concept. The chief tim of the business concem is to ascertain the profit periodically. To measure the profit for a particular period itis essential to match accurately the costs associated with the revenue. Thus, matching of costs and revenues related to a particelar period is called as Matching Concept. (8) Realization Concept: Realization Concept is otherwise known as Revenue Recognition Concept. ‘According to this concept, revenue is the gross inflow of cash, receivables or other considerations arising in the course of an enterprise from the sale of goods or rendecing of services from the holding of assets. If no sale takes place, no revenue is considered. However, there are certain exceptions to this concept Examples, Hire Purchase / Sale, Contract Accounts etc. (9) Accrual Concept: Accrual Concept is closely related to Matching Concept. According to this concept, revenue recognition depends on its realization and not accrual receipt. Likewise cost are recognized when they are incurred and not when paid. ‘The accrual concept ensures that the profit or loss shown is on the basis of full fact relating to all expenses and incomes. (10) Rupee Value Concept: This concept assumes that the value of rupee is constant. In fact, due to inflationary pressures, the value of rupee will be declining. Under this situations financial statements are prepared on the basis of historical costs not considering the declining value of rupee. Similarly depreciation is also charged on the basis of cost price. Thus, this concept results in underestimation of depreciation and overestimation of assets in the balance sheet and hence will not reflect the true position of the business.Types of accounts: Real, Personal and Nominal Accounts There are mainly three type of accounts in accounting: Real, Personal and Nominal accounts, personal accounts are classified under three subcategories: Artificial, Natural and Representative. If you fail to identify an account correctly as either a real, personal or nominal, in most cases, you will get the journal entries incorrect. 1. Real Accounts All assets of a firm, which are tangible or intan category “Real Accounts”. le, fall under the Tangible real accounts are related to things that can be touched and felt physically. A few examples of tangible real accounts are building, machinery, stock, land, etc. Intangible real accounts are related to things that can’t be touched and felt physically. A few examples of such real accounts are goodwill, patents, trademarks, ete. Golden rule for real accounts Example The transaction below shows the interaction of two different real accounts: one is furniture and the other is cash, both of them are assets of the company and hence classified as real accounts. + Purchased furniture for 10,000 in cashee me COC Cor le) Furniture is real a/c so Dr. What Furniture A/C Debit omes in Cash is a real a/c so Cr. What To Cash A/C Credit coos Ouk *Amount will be 10,000 in both debit and credit. 2. Personal Accounts These accounts are related to individuals, firms, companies, etc. A few examples of personal accounts include debtors, creditors, banks, outstanding/prepaid accounts, accounts of credit customers, accounts of goods suppliers, capital, drawings, etc. Natural personal accounts: This type of personal accounts is the simplest to understand out of all and includes all god’s creations who have the ability to deal, who, in most cases, are people. E.g. Kumar's A/C, Adam's A/C, etc. Artificial personal accounts: Personal accounts which are created artificially by law, such as corporate bodies and institutions, are called Artificial personal accounts. E.g. Pvt Ltd companies, LLCs, LPs, clubs, schools, etc. Representative personal accounts: Accounts which represent a certain person or a group directly or indirectly.E.g. Let’s say that wages are paid in advance to an employee - a wage prepaid account will be opened in the books of accounts. This wages prepaid account is a representative personal account indirectly linked to the person. Golden rule for personal accounts Debit the receiver Credit the giverThe transaction below demonstrates the interaction between two different personal accounts, one of which is a private limited company and the other one is a bank. + Paid Unreal Pvt Ltd. 24,000 by check aera PET oe Tle) Unreal Pvt Ltd. A/C Artificial personal so a/c Dr. the receiver To Bank A/C personal so a/c Cr *Amount will be 24,000 in both debit and credit. 3. Nominal Accounts Accounts which are related to expenses, losses, incomes or gains are called Nominal accounts. The dictionary meaning of the word “nominal” is “existing in name only” and the meaning remains absolutely true in accounting sense too, because nominal accounts do not really exist in physical form, but behind every nominal account money is involved. E.g. Purchase A/C, Salary A/C, Sales A/C, Commission received A/C, etc. The final result of all nominal accounts is either profit or loss which is then transferred to the capital account. Golden rule for nominal accounts Debit alll expenses & losses Credit all incomes & gainsThe following example shows a transaction where a nominal account deals with a real a/c. + Purchased good for 15,000 in cash Xr ee On| Debit /Credit Cie a) Nominal A/C so Purchase A/C IDr. all expenses Real A/C so Cr what To Cash A/C dst Amount will be 15,000 in both debit and credit. What is a Contra Entry? How is Contra Entry distinguished froth other entries? Contra Entry. The term ‘Contra’ refers to the opposite side. When both aspects (Debit and Credit) of a transaction are recorded in the same account but in different columns, each entry whether in the debit side or in the credit side shall be demand to be the contra entry of the other. Examples : Cash deposited into the hank Rs. 10,000. Here, Bank Account is to be debited and Cash Account is to be credited. Debit aspect is to be recorded in the debit side of the Three column Cash-Book (bank column) and credit aspect is to be recorded in the credit side (cash column). Cash withdrawn from Bank for office use Rs. 10,000. Here, Cash Account is to be debited and Bank Account is to be Credited. Debit aspect is to be recorded in the debit side of the three column Cash Book (bank column) and credit aspect is to be recorded in the credit side (bank column). In the above two cases Cash should be treated as contra of Bank and Bank’ s should be treated as contra of Cash. Contra entries are marked with letter ‘C’ in the Ledger Folio Column. Such entries are not posted in the Ledger as both accounts (i.e., Cash Account and Bank Account) involved appear in the cash book.Explain any five limitations of financial accounting? 1. Financial Accounting gives the net result of the trading or manufacturing concern for a specific period. It does not provide the result in product wise or process wise or area wise or branch wise. 2. Financial accounting does not provide the data relating to the cost of goods manufactured. Hence, the company is not able to fix the reasonable price, price reduction during depression, formulating marketing policies etc., 3. The conversion of a losing unit into a profitable one through cost control is possible with the help of financial accounting records. 4. Financial Accounting does not provide means for controlling. different elements of cost, reduction of expenses, elimination of wastage, measurement of level of efficiency etc., 5. The day-to-day income and expenses of a business concem are available from the financial records. Hence, the company is notable to control the cost. 6. Financial Accounting information is not useful for taking a decision relating to closing down a unit apparently making loss} introducing a new product or product-mix, entering into the foreign market etc., Importance of cash budget: Profit is not the same thing as cash. Since most budgets are prepared on the accrual basis of accounting (recognize revenue when earned and not when received; recognize expenses when incurred and not when paid), a master budget (rolling all department, branches, etc. into one main budget) will not be the same as a cash budget. The cash basis of accounting in contrast to the accrual basis of accounting recognizes revenue when received and recognizes expenses when paid. If credit sales are made, all receivables will not be collected at the same time. If expenses are charged, all payables will not have the same payment terms. When inventory and materials are purchased, they will not necessarily have to be paid at the same time. Therefore, adjustments have to be made taking the accrual budget to a cash budget to estimate the expected future cash flow of a business. Any capital expenditures, also, need to be considered when preparing a cash budget based on the purchase terms of the capital assets.Cash Budget A Must The cash budget is necessary to see the amount of expected cash inflows and outflows during a budget period. Keep in mind that there is a big difference between the statement of cash flows and a cash budget. The statement of cash flows looks backwards. It analyzes what transpired in a previous accounting period. It is important to know where the cash came from and where it went during that period of time, but a cash budget on the other hand looks forward. It estimates the amount of cash flow in future months or future periods, so management can predict if sufficient funds will be available to operate, service debt, purchase new equipment, or if there will be a need to borrow funds to operate the business until the cash flow returns to a level to sustain operations. Therefore, the cash budget is a forward-looking statement. Explain operating activities, investing activities & financing activities in cash flow statement? Cash flows are classified as operating, investing, or financing activities on the statement of cash flows, depending on the nature of the transaction. Each of these three classifications is defined as follows. + Operating activities include cash activities related to net income. For example, cash generated from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because revenues and expenses are included in net income. + Investing activities include cash activities related to noncurrent assets. Noncurrent assets include (1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to other entities. For example, cash generated from the sale of land and cash paid for an investment in another company are included in this category. (Note that interest received from loans is included in operating activities.) + Financing a ies include cash activities related to noncurrent liabilities and owners’ equity. Noncurrent liabilities and owners’ equity items include (1) the principal amount of long-term debt, (2) stock sales and repurchases, and (3) dividend payments. (Note that interest paid on long-term debt is included in operating activities.)Accounting Standards: Accounting standards are the written statements consisting of rules and guidelines, issued by the accounting institutions, for the preparation of uniform and consistent financial statements and also for other disclosures affecting the different users of accounting information. Accounting standards lay down the terms and conditions of accounting policies and practices by way of codes, guidelines and adjustments for making the interpretation of the items appearing in the financial statements easy and even their treatment in the books of account. Nature of Accounting Standards: On the basis of forgoing discussion we can say that accounting standards are guide, dictator, service provider and harmonizer in the field of accounting process. (i) Serve as a guide to the accountants: Accounting standards serve the accountants as a guide in the accounting process. They provide basis on which accounts are prepared. For example, they provide the method of valuation of inventories. (ii) Act as a dictator: Accounting standards act as a dictator in the field of accounting. Like a dictator, in some areas accountants have no choice of their own but to opt for practices other than those stated in the accounting standards. For example, Cash Flow Statement should be prepared in the format prescribed by accounting standard. ili) Serve as a service provider: ADVERTISEMENTS: Accounting standards comprise the scope of accounting by defining certain terms, presenting the accounting issues, specifying standards, explaining numerous disclosures and implementation date. Thus, accounting standards are descriptive in nature and serve as a service provider.(iv) Act as a harmonizer: Accounting standards are not biased and bring uniformity in accounting methods. They remove the effect of diverse accounting practices and policies. On many occasions, accounting standards develop and provide solutions to specific accounting issues. It is thus clear that whenever there is any conflict on accounting issues, accounting standards act as harmonizer and facilitate solutions for accountants. Objectives of Accounting Standards: In earlier days, accounting was just used for recording business transactions of financial nature. Its main emphasis now lies on providing accounting information in the process of decision making. For the following purposes, accounting standards are needed: (i) For bringing uniformity in accounting methods: Accounting standards are required to bring uniformity in accounting methods by proposing standard treatments to the accounting issue. For example, AS-6(Revised) states the methods for depreciation accounting. (ii) For improving the reliability of the financial statements: Accounting is a language of business, There are many users of the information provided by accountants who take various decisions relating to their field just on the basis of information contained in financial statements. In this connection, it is necessary that the financial statements should show true and fair view of the business concern. Accounting standards when used give a sense of faith and reliability to various users. They also help the potential users of the information contained in the financial statements by disclosure norms which make it easy even for 2 layman to interpret the data. Accounting standards provide a concrete theory base to the process of accounting. They provide uniformity in accounting which makes the financial statements of different business units, for different years comparable and again facilitate decision making. (iii) Simplify the accounting information: Accounting standards prevent the users from reaching any misleading conclusions and make the financial data simpler for everyone. Forexample, AS-3 (Revised) clearly classifies the flows of cash in terms of ‘operating activities’, investing activities’ and ‘financing activities’. (iv) Prevents frauds and manipulations: Accounting standards prevent manipulation of data by the management and others. By codifying the accounting methods, frauds and manipulations can be minimized. (v) Helps auditors: Accounting standards lay down the terms and conditions for accounting policies and practices by way of codes, guidelines and adjustments for making and interpreting the items appearing in the financial statements. Thus, these terms, policies and guidelines etc. become the basis for auditing the books of accounts.June 2014 Explain accounting concepts and accounting conventions? Accounting concepts and conventions as used in accountancy are the rules and guidelines by which the accountant lives. All accounts and accounting statements should be created, preserved and presented according to the concepts and conventions. -These generally accepted accounting principles are a set of rules and practices that are recognized as a general guide for financial reporting purposes. -Generally accepted means that these principles must have substantial authoritative support. Accruals Concept The Accruals concept assumes that revenue and expenses are taken account of when they occur and not when the cash is received or paid out. The purpose of this concept is to make sure that all revenues and costs are recorded in the appropriate statement at the appropriate time. The accrual concept under accounting assumes that revenue is realised at the time of sale of goods or services irrespective of the fact when the cash is received. Similarly, expenses are recognised at the time of services provided, irrespective of when cash is paid. In brief, accrual concept requires that revenue is recognised when realized, and expenses are recognised when they become due and payable without regard to the time of cash receipt or cash payment. Thus, when a profit statement is compiled, the cost of goods sold relevant to those sales should be recorded accurately and in full in that statement. Costs concerning a future period must be carried forward as a prepayment for that period and not charged in the current profit statement. For example, payments made in advance such as the prepayment of rent would be treated in this way. Similarly, expenses paid in arrears must, although paid after the period to that they relate, also be shown in the current period’s profit statement: by means of an accruals adjustment. Matching concept states that the revenue and the expenses incurred to earn the revenue must belong to the same accounting period. Therefore, the matching concept implies that all revenues earned during an accounting year, whether received/not received during that year and allcost incurred, whether paid/not paid during the year should be taken into account while ascertaining profit or loss for that year. It guides how the expenses should be matched with revenue for determining exact profit or loss for a particular period. Accruals Concept Revenue should be recognized in the accounting period in which it is earned. Matching Concept Expenses should be matched with revenues in the period in which the revenues are earned. (i.e. the need for prepaid expenses) Significance: -It helps in knowing actual expenses and actual income during a particular time period. -It helps in calculating the net profit of the business. Prudence Concept or Concept of Conservatism It is this concept more than any other that has given rise to the idea that accountants are pessimistic boring people!! Basically the concept says that whenever there are alternative procedures or values, the accountant will choose the one that results in a lower profit, a lower asset value and a higher liability value. The concept is summarised by the well known phrase ‘anticipate no profit and provide for alll possible losses’. Revenue and profits are included in the balance sheet only when they are realized (or there is reasonable ‘certainty’ of realizing them) but liabilities are included when there is a reasonable ‘possibility’ of incurring them. The Prudence Concept assumes: -Assets should not be overvalued -Liabilities should not be undervalued -The financial statements does not reflect overstatement or understatement of gains or losses but neutral -Profit or revenue only recorded when they are realized. Consistency Concept Because the methods employed in treating certain items within the accounting records may be varied from time to time, the concept of consistency has come to be applied more and more rigidly. Because of these sorts of effects, it is now accepted practice that when an entity chooses to treat items such as depreciation in a particular way in the accounts it should continue to use that method year after year. If it isNECESSARY to change the accounting method being employed then an explanation of the change and the effects it is having on the results must be shown as a note to the accounts being presented. Separate Entity Concept The business entity concept states that a business and the owner(s) are two separate Legal Entities. Being an artificial person, a company has an existence independent of its members. It can own property, enter into contract and conduct any lawful business in its own name. It can sue and can be sued in the court of law. A shareholder cannot be held responsible for the acts of the company. The best example here concerns that of the sole trader or one man business: in this situation you may have the sole trader taking money by way of ‘drawings’: money for his own personal use. Despite it being his business and apparently his money, there are still two aspects to the transaction: the business is ‘giving’ money and the individual is ‘receiving’ money. So, the affairs of the individuals behind a business must be kept separate from the affairs of the business itself. This concept restrains accountants from recording of owner's private/ personal transactions. It also facilitates the recording and reporting of business transactions from the business point of view. What are advantage and disadvantage of job costing? The following are some of the advantages of Job Costing. 1. The costs may be ascertained at any stage of completion of a job. This gives scope for control of costs by taking suitable steps. 2. The profit earned from each job is known separately in Job costing. 3. On completion of a job, each element of cost, selling price and profit can be compared with the estimates for the purpose of cost control and reduction so that the profit on each job is maximized in job costing. 4. Management can estimate the cost of job on the basis of past records in job costing. 5. The actual costs of previous job can be compared with present job executed. 6. The overhead recovery rates may be predetermined on the basis of budgets. 7. Trend analysis can be prepared through compilation of historical costs in job costing.8. There is no over or under recovery of overheads. 9. Budgetary control system is implemented since the estimating is followed in the job costing. 10. The spoilage and defectives arising out of each job can be easily find out and hence, they can be easily controlled. 11. Job costing is suitable for cost plus contracts. 12. Job costing facilitates pricing of each job. 13. Actual costs incurred were compared with predetermined costs. In this way, action may be taken to control the excessive overhead incurred. 14. In the case of Govt. job of contract, a certain percentage of profit is added with estimated cost and price of a job is agreed. What are the disadvantages or limitations of Job Costing? The following are the disadvantages or limitations of Job Costing. 1. There is no standardization of job in job costing. Hence, there is a need of close supervision. 2. More clerical work is required for maintaining detailed information in job costing. 3. Job costing is expensive. 4. There is no possibility of control of costs since the controlling steps are taken only after incurring the expenses in job costing. 5. The accurate cost information is not obtained since large number of small jobs is executed at a time in job costing. 6, The price of a job is fixed only on the basis of market condition not on the basis of past records. 7. Comparison of job costs becomes meaningless during the period of inflation. 8. No corrective action is possible, in case the actual profit is lower than estimated in job costing. what is bank reconciliation? A company’s general ledger account Cash contains a record of the transactions (checks written, receipts from customers, etc.) that involve its checking account. The bank also creates a record of the company's checking account when it processes the company's checks, deposits, service charges, and other items. Soon after each month ends the bank usually mails a bank statement to the company. The bank statement liststhe activity in the bank account during the recent month as well as the balance in the bank account. When the company receives its bank statement, the company should verify that the amounts on the bank statement are consistent or compatible with the amounts in the company's Cash account in its general ledger and vice versa. This process of confirming the amounts is referred to as reconciling the bank statement, bank statement reconciliation, bank reconciliation, or doing a "bank rec." The benefit of reconciling the bank statement is knowing that the amount of Cash reported by the company (company's books) is consistent with the amount of cash shown in the bank's records. Because most companies write hundreds of checks each month and make many deposits, reconciling the amounts on the company's books with the amounts on the bank statement can be time consuming. The process is complicated because some items appear in the company’s Cash account in one month, but appear on the bank statement in a different month. For example, checks written near the end of August are deducted immediately on the company's books, but those checks will likely clear the bank account in early September. Sometimes the bank decreases the company's bank account without informing the company of the amount. For example, a bank service charge might be deducted on the bank statement on August 31, but the company will not learn of the amount until the company receives the bank statement in early September. From these two examples, you can understand why there will likely be a difference in the balance on the bank statement vs. the balance in the Cash account on the company’s books. It is also possible (perhaps likely) that neither balance is the true balance. Both balances may need adjustment in order to report the true amount of cash. What is suspense account? A suspense account is an account in the general ledger that temporarily stores any transactions for which there is uncertainty about the account in which they should be recorded. Once the accounting staff investigates and clarifies the purpose of this type of transaction, it shifts the transaction ‘out of the suspense account and into the correct account(s). An entry into @ suspense account may be a debit or a credit. It is useful to have a suspense account, rather than not recording transactions at all until there is sufficient information available to create an entry to the correct account(s). Otherwise, larger unreported transactions may not be recorded by the end of a reporting period, resulting in inaccurate financial results. For example, a customer sends in a payment for $1,000 but does not specify which open invoices it intends to pay. Until the accounting staff can ascertain which invoices to charge, it temporarily parks the $1,000 inthe suspense account. In this case, the initial entry to place the funds in the suspense account is: Debit Credit] cash $1,000 Suspense account $1,009 The accounting staff contacts the customer, identifies which invoices are to be paid with the $1,000, and shifts the funds out of the suspense account with this entry: Debit Credit} ‘Suspense account $1,000 Accounts receivable $1,009 As another example, a supplier delivers an invoice for $2,500 of services, which is payable in 30 days. The accounting staff is uncertain which department will be charged with the invoice, so the accounting staff records the following initial invoice, while the department managers argue over who is responsible for payment: Debit Credit] ‘Suspense account $2,500 Accounts payable $2,500 The initial entry records the invoice in the accounts payable system in a timely manner, so that the company can pay it in 30 days. The department managers eventually decide that the office supplies account of the sales department should be charged with the expense, so the accounting staff records the following entry: Debit Credii ‘Supplies — Sales dept. $2,500 Suspense account $2,500 Regularly review the items in a suspense account, with the objective of shifting transactions into their appropriate accounts as soon as possible. Otherwise, the amounts in the account can grow to quite substantial proportions, and be very difficult to deal with months later, especially if there is minimal documentation of why transactions were initially placed in the account. Accordingly, there should be a daily measurement of the balance in the suspense account, which the controller uses as the trigger for ongoing investigations. Further, it is useful to track which transactions are repeatedly shunted into the suspense account, so that systems can be enhanced to make it easier to properly identify these items in the future, thereby keeping them out of the suspense account.The suspense account is classified as a current asset, since it is most commonly used to store payments related to accounts receivable. It is possible to also have a liability suspense account, to contain accounts payable whose disposition is still being decided. If so, the liability suspense account is classified as a current liability. All suspense account items should be eliminated by the end of the fisca year. Otherwise, a company is issuing financial statements that contain unidentified transactions, and which are therefore incorrect. What is cash flow statement? WHAT IT IS: A cash flow statement is the financial statement that measures the cash generated or used by a company ina given period. HOW IT WORKS (EXAMPLE): A cash flow statement typically breaks out a company’s cash sources and uses for the period into three categories: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. It is important to note that cash flow is not the same as net income, which includes transactions that did not involve actual transfers of money (depreciation is common example of a noncash expense that is included in net income calculations but not in cash flow calculations). Cash flow from operating activities are generally calculated according to the following formula: Cash Flows from Operations = Net income + Noncash Expenses + Changes in Working Capital Because working capital is a component of cash flow from operations, investors should be aware that companies can influence cash flow by lengthening the time they take to pay the bills (thus preserving their cash), shortening the time it takes to collect what’s owed to them (thus accelerating the receipt of cash), and putting off buying inventory (again thus preserving cash). Cash flow from investing activities primarily reflect the company's purchases or sales of capital assets (that is, assets with a useful life of more than one year that appear on the balance sheet). It is important to note that companies have some leeway about what items are or are not considered capital expenditures, and the investor should be aware of this when comparing the cash flow of different companies. Cash flow from financing activities typically reflect the company's purchase or sale of stock and any proceeds from or payments on debtfinancing. The measure varies with the different capital structures, dividend policies, or debt terms companies may have. What is fund flow statements? Funds flow statement is one of the tool of management accountant. Hence, it helps many ways to the management and outsiders. Uses, Benefits, Significance & Importance of Fund flow statement The following are the uses, significance or benefits of funds flow statement. 1. The financial resources of the company are analyzed in detail and disclose the changes made between the two balance sheet dates. 2. It gives an answer to the question of there is an inadequate liquid cash position in spite of business making more and more profits. 3. It shows the extent funds were received the ways of usage for a specific period. 4, It shows the possibility of paying more dividend than curfent earnings or paying normal dividend in the presence of net loss for the period. 5. The cost of capital of the business can be computed on the basis of the sources of funds flow statement: 6. It shows the usage of earned profits of the current year. 7. The sources of previous year funds flow statement may act as a guide for getting funds for future requirements. 8. Sometimes, the company has high liquid cash position even though, there is a net loss for the specific period. The reason for such position is find out through funds flow statement. 9..The application of funds can provide a basis for selection of investment proposals or future capital expenditure decisions. 10. The overall credit worthiness of the company can find out on seeing the funds flow statement. 11. The strength and weakness of financial position of the company are identified on seeing the funds flow statement. 12. It helps the management to allot the inadequate resources to meet the requirements of business at productive level. 13. It highlights the financial consequences of business operation. 14, It tests the effective use of working capital by the management during a particular period.15. It helps the managerr company to frame or change the financial policy of the 16, It suggests ways to improve working capital position of the company. State the meaning of budgeting budgetary control and explain different types of budget? BUDGET A budget is a plan expressed in quantitative, usually monetary term, covering a specific period of time, usually one year. In other words a budget is a systematic plan for the utilization of manpower and material resources. In a business organization, a budget represents an estimate of future costs and revenues. Budgets may be divided into two basic classes: Capital Budgets and Operating Budgets. Capital budgets are directed towards proposed expenditures for new projects and often require special financing. The operating budgets are directed towards achieving short-term operational goals of the organization, for instance, production or profit goals in a business firm. Operating budgets may be sub-divided into various departmental of functional budgets. The main characteristics of a budget are: 1. It is prepared in advance and is derived from the long-term strategy of the organization. 2. It relates to future period for which objectives or goals have already been laid down. Itis expressed in quantitative form, physical or monetary units, or both. Different types of budgets are prepared for different purposed e.g. Sales Budget, Production Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional budgets are afterwards integrated into a master budget, which represents an overall plan of the organization. ADVANTAGES OF BUDGETS A budget helps us in the following ways: 1. It brings about efficiency and improvement in the working of the organization.2. Itis a way of communicating the plans to various units of the organization. By blishing the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus minimizes the possibilities of buck passing if the budget figures are not met. 3. Itis a way or motivating managers to achieve the goals set for the units. 4. It serves as a benchmark for controlling on-going operations. 5. Ithelps in developing a team spirit where participation in budgeting is encouraged. 6. It helps in reducing wastage and losses by revealing them in time for corrective action. 7. It serves as a basis for evaluating the performance of managers. 8. It serves as a means of educating the managers. BUDGETARY CONTROL No system of planning can be successful without having an effective and efficient system of control. Budgeting is closely connected with control. The exercise of control in the organization with the help of budgets is known as budgetary control. ‘The process of budgetary control includes: 1. Preparation of various budgets. 2. Continuous comparison of actual performance with budgetary performance. 3. Revision of budgets in the light of changed circumstances. ‘A system of budgetary control should not become rigid. There should be enough scope of flexibility to provide for individual initiative and drive. Budgetary control isan important device for making the organization, More efficient on all fronts. It is an important tool for controlling costs and achieving the overall objectives. Types of budget: master budget operating budget financial budget cash budget static budget flexible budget capital expenditure budget, and+ program budget These budget types are briefly explained below. Master budget is the set of financial and operating budgets for a specific accounting period, usually the next fiscal or calendar year. Master budget is prepared quarterly or annually. The format of the master budget varies with business nature and size. Operating budgets are used in daily operations and are the basis for financial budgets. Operating budgets include the following: sales, production, direct materials, direct labor, overhead, selling and administrative expenses, cost of goods manufactured, and cost of goods sold. Financial budgets include a budgeted income statement and balance sheet, cash budget, and capital expenditures budget. Budgeted income statement and budgeted balance sheet are also called pro forma financial statements. Operating budget is the budget for income statement elements such as revenues and expenses. Financial budget is the budget for balance sheet elements. In other words, financial budget deals with the expected assets, liabilities, and stockholders’ equity. Cash budget is the budget for expected cash inflows and outflows during the specific period of time. Cash budget consists of four sections: receipts, disbursements, cash surplus or deficit, and financing section. The receipts section lists the beginning cash balance, cash collections from customers, and other receipts. The disbursements section shows all cash payments (characterized by purpose). The cash surplus (deficit) section provides the difference between cash receipts and cash disbursements. Finally, the financing section examines in detail expected borrowings and repayments during the period. Static (fixed) budget is the budget at the expected capacity level. Because static budget is fixed, it is usually used by stable companies. Also, this type of budget can be used by departments with operations independent from capacity levels. For example, operations of administrative and general marketing departments usually does not depend on the level of production and sales and is rather determined by the department’s management; as the result, static budget can be used by such departments. Flexible (expense) budget is the budget at the actual capacity level. Because flexible budget is dynamic, it is commonly used by companies. Flexible budget is adjusted to the actual activity of the company. It can be easily prepared using a computerized spreadsheet (e.g., Excel). At first, the relevant activity range is determined for the coming period. Next, costs that are expected be incurred over the relevant range are analyzed. These costs are then separated based on their cost behavior: fixed, variable, or mixed. Finally, the flexible budget for variable costs at different points throughout the relevant range is prepared. In otherwords, flexible budget matches expenses to specific revenue levels or activity levels. For example, utility costs can be tied to the number of machines in operation. Capital expenditure budget is the budget for expected investments in capital assets and long-term projects. It is usually prepared for 3 to 10 years. Investments in capital assets include purchasing fixed assets such as plant, land, buildings, machinery, equipment, and mineral resources. Long-term projects might be undertaken to develop new products, expand existing product lines, or reduce costs. Sometimes a capital project committee is created to overlook capital budgeting processes. Such a committee is typically separate from the budgeting committee. Program budget is the budget for a specific program or activity such as marketing, research and development, public relations, training, engineering, etc. Usually program budgets are created for product lines. As program budgets are typically created for activities of multiple departments, such budgets cannot be used for control purposes. Working capital: Working capital is the amount of a company's current assets minus the amount of its current liabilities. For example, if a company’s balance sheet dated June 30 reports total current assets of $323,000 and total current liabilities of $310,000 the company's working capital on June 30 was $13,000. If another company has total current assets of $210,000 and total current liabilities of $60,000 its working capital is $150,000. The adequacy of a company's working capital depends on the industry in which it competes, its relationship with its customers and suppliers, and more. Here are some additional factors to consider: * The types of current assets and how quickly they can be converted to cash. If the majority of the company's current assets are cash and cash equivalents and marketable investments, a smaller amount of working capital may be sufficient. However, if the current assets include slow- moving inventory items, a greater amount of working capital will be needed. * The nature of the company's sales and how customers pay. If a company has very consistent sales via the Internet and its customers pay with credit cards at the time they place the order, a small amount of working capital may be sufficient. On the other hand, a company in an industry where the credit terms are net 60 days and its suppliers must be paid in 30 days, the company will need a greater amount of working capital. * The existence of an approved credit line and no borrowing. An approved credit line and no borrowing allows a company to operate comfortably with a small amount of working capital.* How accounting principles are applied. Some companies are conservative in their accounting policies. For instance, they might have a significant credit balance in their allowance for doubtful accounts and will dispose of slow-moving inventory items. Other companies might not provide for doubtful accounts and will keep slow-moving items in inventory at their full cost. In short, analyzing working capital should involve more than simply subtracting current liabilities from current assets. Write short note on: Bad Debts: Bad debts expense often refers to the loss that a company experiences because it sold goods or provided services and did not require immediate payment. The loss occurs when the customer does not pay the amount owed. In other words, bad debts expense is related to a company's current asset accounts receivable. It is common to see two methods for computing the amount of bad debts expense: 1. direct write-off method 2. allowance method The direct write-off method requires that a customer's uncollectible account be first identified and then removed from the account Accounts Receivable. This method is required for U.S. income taxes and results in a debit to Bad Debts Expense and a credit to Accounts Receivable for the amount that is written off. The allowance method anticipates that some of the accounts receivable will not be collected. In other words, prior to knowing exactly which customers or clients will not be paying, the company will debit Bad Debts Expense and will credit Allowance for Doubtful Accounts for an estimated, anticipated amount. (The Allowance for Doubtful Accounts is a contra asset account that when combined with Accounts Receivable indicates a more realistic amount that will be turning to cash.) Many believe that the allowance method is the better method since 1) the balance sheet will be reporting a more realistic amount that will be collected from the company's accounts receivable, and 2) the bad debts ‘expense will be reported on the income statement closer to the time of the related credit sales.Capital: Capital can include cash or other assets introduced into a business by the owners: Generally speaking, the term ‘capital’ refers to any financial resources or assets owned by a business that are useful in furthering development and generating income. However, in different contexts, the term can have a variety of other meanings. Here are a few: + Capital can refer to funds raised to support a particular business or project. + Capital can also represent the accumulated wealth of a business, represented by its assets less liabilities. + Capital can also mean stock or ownership in a company. How it differs from money While it may seem that the term capital is almost the same as money, there is an important difference between the two. Money is used for the purchase and sale of goods or services within a company or between two companies or individuals and therefore has a more immediate purpose. Capital, however, also includes assets such as investments, stocks, and other assets that are more long-term and could benefit the company in the future. Capital involves the aspects of a company that help build and improve it, that form its base for generating revenue. Associated terms Other terms that relate to capital include: + Capital gains: increases in the value of stock and other assets when they are sold. + Capital structure: the mix of debt and equity in the business balance sheet. * Capital improvements: improvements made to capital assets. Tax on capital Because capital is owned by a company, it is protected. However, capital ownership can be transferred or sold and, in certain situations, faces tax.Capital that has appreciated in value over the course of a company’s ownership from time of purchase to time of sale (capital gains), could be liable to tax. These taxed amounts go to the public benefit Debitoor and capital Cloud-based invoicing and accounting software such as Debitoor, gives you the tools you need to manage the cashflow of your business. This includes registering assets, such as property, that can be considered capital. Drawings: Definition: Money or assets taken out of the company by the owners for personal use. Drawings by the owner of the company will need to be recorded in the balance sheet as a reduction in the assets and a reduction in the owners equity as an accounting record needs to be maintained to track money withdrawn from the business by its owners. An account is set up in the balance sheet to record the transactions taken place of money removed from the company by the owners. These are not to be confused with expenses or wages for the owners as these will be recorded in the company profit and loss account separately. Assets: Assets are sometimes defined as resources or things of value that are owned by a company. Some examples of assets which are obvious and will be reported on a company's balance sheet include: cash, accounts receivable, inventory, investments, land, buildings, and equipment. In addition, a company’s balance sheet will also report prepaid expenses as an asset. For instance, if a company is required to pay its rent at the beginning of each quarter (January 1, April 1, etc.) the portion that is prepaid (not used up) as of the balance sheet date will be listed as a current asset. A company may state that its employees are its most valuable asset. However, the employees cannot be included as an asset on the company’s balance sheet. Similarly, a company may have successfully promoted its products, services and brands throughout the world and the brands are now the company's most valuable assets. Yet these brands and trademarks cannot be reported as assets on the company’s balance sheet. (If a company purchases a brand from another company, the cost can be listed as an asset on its balance sheet.)As our examples indicate, the accountant 's definition of an asset has to be somewhat complicated in order to: + include prepaid expenses, deferred costs, and certain deferred income taxes, and + exclude a company's talented team, the patents and trademarks that were developed internally, and its image and reputation for excellence at a fair price. Liabilities: A liability is an obligation and it is reported on a company's balance sheet. A common example of a liability is accounts payable. Accounts payable arise when a company purchases goods or services on credit from a supplier. When the company pays the supplier, the company's accounts payable is reduced. Other common examples of liabilities include loans payable, bonds payable, interest payable, wages payable, and income taxes payable. Less common liabilities are customer deposits and deferred revenues. Deferred revenues come about when customers prepay a company for work to be done in a future accounting period. When the company performs the work, the liability will be reduced and the company will report the amount it earned as revenues on its income statement. Liabilities are also part of the accounting equation: Assets = Liabilities + Stockholders’ Equity. Liabilities are often viewed as claims on a company's assets. However, liabilities can also be thought of as a source of a company's assets.