Financial Accounting and Analysis

Question 1: You visited Subway that’s the fast food restaurant to purchase a
Combo worth Rs 499. The restaurant paid for the raw material and utilities
amounting Rs105 for each sale. In addition to that, the restaurant also paid for
certain expenses in cash in total Rs 50 per sale.
Discuss how these financial transactions will be recorded by way of journal entry,
and also, discuss the various stages of the whole accounting process. (10 Marks)

Answer.
While journalizing the given transactions of the above question, we will first journalize
the recording of the expenses of raw material and utilities and also the overhead
expenses of a particular sale to their proper expense accounts. Then, we will journalize
the payment of such expenses. Secondly, we will record the sale as income to the
proper account and also record the receipt of the sale in the Bank or Cash account of
the company. Lastly, all expense and income entries will be posted in the Profit & Loss
statement. Here are the journal entries:

S.No. Particulars Debit Credit

Amount Amount
1. Raw Materials & Utilities A/c 105
To Expenses Payable A/c 105
(Being raw materials & utilities expenses
recorded)
2. Overhead Expenses A/c 50
To Expenses Payable A/c 50
(Being overhead expenses recorded)
3. Income Receivable A/c 499
To Sales A/c 499
(Being revenue recorded on sale of combo)
4. Cash A/c 499
To Income Receivable A/c 499
(Being amount received in cash on sale of
combo)
5. Expenses Payable A/c 155
To Cash A/c 155
(Being expenses paid in cash)
1308 1308

As it can be seen in the above table, the entries for recording the expenses and
incomes have been done first. It has been assumed that the payment of expenses is
allowed on a credit basis and can be done after the receipt of revenue from sale of the
product. The recording of journal entries is actually the first step in the process of
accounting.

The accounting process is comprised of four major steps:

1. Journalizing: The first step is the journalizing of the transactions wherein the
transactions are journalized into journal entries and the transactions are recorded
so that the next step can be undertaken.
2. Posting: The second step is an automated step which is done when the entries
are posted into different accounts. The accounts in which the entries are
recorded in the first step, like the Raw Materials and Utilities A/c, Overhead
Expenses A/c and the Sales A/c in our question are now prepared and their
balances are then carried forward in the next step.

3. Trial Balancing: The next step is to finalize all the accounts and list out their
balances in one single statement called the trial balance. This statement gives a
brief of how every account stands as on the closing date of the books of
accounts.

4. Statement Preparation: The last step is the preparation of financial statements as

per the trial balance so that the information can be presented in a way that can
be easily understood by a layman and can also be used easily for other
calculations and comparisons.

Conclusion: Hence, this is the whole accounting process which majorly consists of four
steps. The journalizing of the transactions is considered the most important of these
steps and is done all the year-long while the last two steps are done at the end of the
reporting period. The second step i.e. posting of entries in the accounts can be done on
a continuous basis or on regular intervals.

Question 2: The Companies Act 1956 was the first Act which governs the various
Companies registered in India. However, in the year 2013, the Act was amended
holistically to bring more transparency in terms of accountability, presentation
and disclosure aspects in relation to various financial information of a company.

However one of your friend is of the opinion that there is only one difference
between the two Act, that is , the presentation of financial statements , previously
it was governed by Schedule VI and now Schedule III governs it.
Now, you are assigned with the task of convincing your friend that there is a huge
difference between the two Acts, by briefing him on atleast five other points of
differences between the two. (10 Marks)
Answer.

Answer: The Companies Act, 2013 was an act that was made to increase transparency
in the workings of the corporations that run their businesses in India. It came into force
on September 12, 2013 initially with a few changes. The Companies Act, 2013 replaced
the erstwhile Companies Act, 1956. The new act was introduced in stages where few
sections of the act were notified and made applicable at regular intervals while the
corresponding sections of the previous act were made inapplicable. By April 2014, a
total of 184 sections had been notified of the Companies Act, 2013. The Companies
Act, 2013 is an act that has introduced many changes over the Companies Act, 1956.
The presentation of the financial statements is just one of these changes. Apart from
that, there have been many changes including the disclosure of certain items or
transactions, the accounting methods and the limits for various rules. These changes
have been a step towards the increased transparency of companies towards their
stakeholders so that there is lower chance of any company or any the management of
any company trying to earn profit by engaging in activities that are not in the interest of
the stakeholders.

A few changes brought on by the Companies Act, 2013 are as follows:

1. Introduction of One Person Company: The Companies Act, 1956 provided

that a company need have at least 7 members, if it is a public company and at
least 2 members, if it is a private company. Hence, in any case, at least 2 people
were needed to start a company and get it registered as such under the
Companies Act, 1956. Any business started by a single member, called a sole
proprietorship would not be acceptable as a registered company.
However, Companies Act, 2013 has now provided that a single person can also
now start a company alone. This type of company is called One Person
Company and a One Person Company has its own set of rules that are to be
followed under the Companies Act, 2013.

2. Internal Audit provisions: As per the Companies Act, 1956, there was no
mandate that dictated that it was compulsory for any type of company to appoint
an internal auditor and have an internal audit conducted at regular basis.
However, this has been amended in the Companies Act, 2013 where conduct of
Internal Audit and the appointment of an internal auditor is now compulsory for
 prescribed classes of companies. This is provided by Section 138 of the
Companies Act 2013. The companies who are prescribed are:
a. Listed companies
b. Unlisted companies having
i. A paid up share capital of Rs. 50 crore or more, or
ii. Turnover of Rs. 200 crore or more in the preceding financial year,
or
iii. Loans from banks of Rs. 100 crore or more in the preceding
financial year, or
iv. Outstanding deposits of Rs. 25 crore or more in the preceding
financial year
c. Private companies having
i. Turnover of Rs. 200 crore or more in the preceding financial year,
or
ii. Loans from banks of Rs. 100 crore or more in the preceding
financial year.

3. Fixation of financial year: As per the Companies Act, 1956, there was no
compulsion for companies to close their books of accounts on a particular date.
The companies were expected to maintain their books for a certain period and
were free to close them on the date they chose. However, under the Companies
Act, 2013, the books of accounts are now to be closed compulsorily on 31 st
March of every year by every company. This has been done to ensure uniformity
in the accounts of all the companies that are registered in India. This will ensure
that a layman shareholder does not have any problems while understanding the
books of accounts of different companies and can also compare two companies
easily on the basis of their books of accounts.

4. Maximum number of shareholders: As per the Companies Act, 1956, the

maximum number of shareholders that a private company could have was 50
excluding the past and present members. A private company could not have
shareholders more than this. The Companies Act, 2013 has brought a change in
this by increasing this maximum number by a significant amount to 200. This has
been a relief for private companies as they can now segregate their shares in
lower amounts to a larger number of shareholders.

5. Application of premium received on shares: Section 78(2) of the Companies

Act, 1956 provided that the premium received on issue of shares by a company
could be used to write off the preliminary expenses or the commission paid or the
discount allowed on the issue of shares or debentures of the company. However,
this has been significantly amended by the Companies Act, 2013 wherein
 Section 52(3) provides that any company that maintains its accounts as per the
prescribed Accounting Standards cannot use the securities premium received to
write off the preliminary expenses or the commission paid or the discount allowed
on the issue of shares or debentures. This has been done to ensure that the
provisions of the law governing the companies are in line with the Accounting
Standards governing the books of accounts of these companies.

Conclusion: Hence, it can be seen that mere improvement in presentation is not the
sole objective of the introduction of Companies Act, 2013. The Companies Act, 2013
has been introduced to bring about changes much bigger than that. Presentation of the
financial statements as per Schedule III instead of Schedule VI is just a consequence of
these changes. There have been many other changes besides the ones mentioned
above and all of these changes point out to an improvement in the disclosure
requirements and uniformity in the disclosures of the companies so as to empower the
shareholder by making the companies provide them with the correct knowledge of the
position of its assets and liabilities.
Question 3: The following information pertains to the Income statement of Beta
Ltd.

a. Redraft the information in the vertical form of Income statement and also,
calculate Earnings After Taxes (EAT) (5 Marks)
Answer.

Beta Ltd.
Income Statement
Percentage
S.No. Particulars Amount (%)
1 Sales 1258000 100
2 COGS (a+b+c+d+e-f)
a. Opening Stock 50000
b. Purchases 500000
c. Direct Expenses 150000
d. Manufacturing Expenses 67550
e. Depreciation 15840
f. Closing Stock 102500 680890 54.1248
3 Gross Profit (1-2) 577110 45.8752
4 Operating Expenses(a+b)
a. Administration Expenses 68420
b. Selling & Distribution Expenses 45000 113420 9.015898
5 EBIT(3-4) 463690 36.8593
6 Interest on loan 46510 3.697138
7 Earnings after interest (5-6) 417180 33.16216
8 Non-Operating Income
a. Profit on sale of securities 25540 25540 2.030207
 9 Non-Operating Expenses
a. Loss on sale of Machinery 15000
b. Preliminary expenses written off 4700 19700 1.565978
10 Earnings before taxes(7+8-9) 423020 33.62639
11 Taxes paid 25500 2.027027
12 Earnings after taxes(10-11) 397520 31.59936

b. Calculate the gross profit ratio and operating profit ratio. Discuss, how they
differ from each other? (5 Marks)
Answer.

Gross Profit
Gross Profit Ratio= ∗100
Net Sales
577110
Gross Profit Ratio= ∗100=45.8752%
1258000

Operating Profit ( EBIT )

Operating Profit Ratio= ∗100
Net Sales

463690
Operating Profit Ratio= ∗100=36.8593 %
1258000

The gross profit ratio and the operating profit ratio are two ratios which seem to be very
similar but have a slight difference.
The gross profit ratio is the ratio which is calculated by dividing the gross profit by sales.
The gross profit is calculated by deducting the cost of goods sold from the net revenue.
This is the profit that shows the gross amount a firm has earned on the sale of its
goods. The ratio shows the gross earnings percentage.

The operating profit ratio is calculated by dividing the operating profit by sales. The
operating profit is calculated by deducting all the costs that have been used in the
operations of the company. All non operating expenses are kept out of its ambit. This
ratio shows the earnings as per the operating expenses of the firm.