NMIMS

FINANCIAL ACCOUNTING AND ANALYSIS

APPLICABLE FOR JUNE 2022 EXAMINATIONS

Question 1:-

For the following transactions, analyze the accounting transactions using the accounting
equation framework

1. Introduced Rs500000 through a cheque by the Owner as the Initial capital in the
business

2. Purchased goods on credit from Ms. Ritu at Rs 40000

3. Paid Rs 10000 as salary to the employees

4. Invested Rs200000 in a fixed deposit account

5. Paid school fees of the kid Rs 25000, from the business’s bank account.

Solution 1:-

The accounting equation states that a company's total assets are equal to the sum of
its liabilities and its shareholders' equity. This straightforward number on a company
balance sheet is considered to be the foundation of the double-entry accounting system.
The accounting equation ensures that the balance sheet remains balanced. That is, each
entry made on the debit side has a corresponding entry (or coverage) on the credit side.

The accounting equation is also called the basic accounting equation or the balance sheet
equation. The financial position of any business, large or small, is based on two key
components of the balance sheet: assets and liabilities. Owners’ equity, or shareholders'
equity, is the third section of the balance sheet. The accounting equation is a
representation of how these three important components are associated with each other.

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Assets represent the valuable resources controlled by the company, while liabilities
represent its obligations. Both liabilities and shareholders' equity represent how the assets
of a company are financed. If it's financed through debt, it'll show as a liability, but if it's
financed through issuing equity shares to investors, it'll show in shareholders' equity. The
accounting equation helps to assess whether the business transactions carried out by the
company are being accurately reflected in its books and accounts.

1. Introduced Rs. 5,00,000 through a cheque by the owner as the initial capital in the
business will increase bank A/C by Rs. 5,00,000 and capital A/C will also be increased by
Rs. 5,00,000 According to accounting equation-
ASSETS = LIABILITIES + CAPITAL so, here transaction increases one asset by 5 lakhs and at
the same time claims against the firm are also 5 lakhs in the form of capital, thus
balancing the equation ( 5 lakhs = 0 + 5 lakhs).
Journal entry will be –Bank A/C (Debit); Capital A/C (Credit)

2. Goods purchased on credit from Ms. Ritu will increase Stock A/C (Assets) by 40,000 and
will also increase Ms. Ritu Creditors A/c (Liabilities) by 40,000. According to accounting
equation-
ASSETS = LIABILITIES + CAPITAL so, here transaction increases one asset and at the same
time increases liability with same amount, thus balancing the equation.
(40,000 = 40,000 + 0 )
Journal entry will be – Purchases A/C (Debit); Ms. Ritu (Credit)

3. Paying salary to employees will reduce cash A/c by 10,000 and will also reduce capital
A/C by the same amount. According to accounting equation-
ASSETS = LIABILITIES + CAPITAL so, here transaction decreases one asset and at the same
time decreases capital with same amount as capital includes profits and salary is paid
out of profits, thus balancing the equation.
(- 10,000 = 0– 10,000)
Journal entry will be – Salary A/C (Debit); Cash A/C (Credit)

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4. Invested ₹ 2,00,000 in the fixed deposit account will decrease cash balance (Asset) by
Rs.2,00,000 and increase bank balance (Asset) by Rs.2,00,000.According to accounting
equation-
ASSETS = LIABILITIES + CAPITAL so, here transaction increases one asset and at the same
time decreases other asset with same amount, thus balancing the equation.
(2, 00,000 – 2, 00,000 = 0 + 0 )
Journal entry will be – Fixed deposit bank A/C (Debit); Cash A/C (Credit)

5. Paid school fees of kids of Rs. 25,000 from business’s bank account will reduce bank A/C
by Rs. 25,000 and will reduce capital by Rs. 25,000 as this is considered as drawings.
According to accounting equation-
ASSETS = LIABILITIES + CAPITAL so, here transaction decreases one asset and at the same
time decreases capital A/C with same amount, thus balancing the equation.
(-25,000 = 0 -25,000)
Journal entry will be – Drawings A/C (Debit); Bank A/C (Credit)

Question 2:-

You started learning the course of financial accounting and analysis in the MBA Program.
You learned about commonly used accounting terms. Discuss about any five terms which
are commonly used by the different users of accounting information for the sake of
understanding the financial statements.

Solution 2:-

Financial statements are written records that convey the business activities and the
financial performance of a company. Financial statements are often audited by government
agencies, accountants, firms, etc. to ensure accuracy and for tax, financing, or investing
purposes. Financial statements include:

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 Balance sheet
 Income statement
 Cash flow statement.

Investors and financial analysts rely on financial data to analyze the performance of a
company and make predictions about its future direction of the company's stock price. One
of the most important resources of reliable and audited financial data is the annual
report, which contains the firm's financial statements.

Terms which are commonly used by the different users of accounting information for the
sake of understanding the financial statements are:-

An income statement is one of the three important financial statements used for reporting

a company's financial performance over a specific accounting period also known as
the profit and loss statement or the statement of revenue and expense, the income
statement primarily focuses on a company’s revenues and expenses during a particular
period.

1. Net Income = Once expenses are subtracted from revenues, the statement produces a
company's profit figure called net income.

Types of Revenue:

Operating revenue is the revenue earned by selling a company's products or services.

Operating revenue is generated from the core business activities of a company.

Non-operating revenue is the income earned from non-core business activities. These

revenues fall outside the primary function of the business. Some non-operating revenue
examples include:

 Interest earned on cash in the bank

 Rental income from a property

Other income is the revenue earned from other activities. Other income could include gains
from the sale of long-term assets such as land, vehicles, or a subsidiary.

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Types of Expenses:

Primary expenses are incurred during the process of earning revenue from the primary
activity of the business. Typical expenses include employee wages, sales commissions, and
utilities such as electricity and transportation.

Expenses that are linked to secondary activities include interest paid on loans or debt.
Losses from the sale of an asset are also recorded as expenses.

The main purpose of the income statement is to convey details of profitability and the
financial results of business activities. However, it can be very effective in showing whether
sales or revenue is increasing when compared over multiple periods. Investors can also see
how well a company's management is controlling expenses to determine whether a
company's efforts in reducing the cost of sales might boost profits over time.

2. Shareholders' Equity

Shareholders' equity is a company's total assets minus its total liabilities. Shareholders'

equity represents the amount of money that would be returned to shareholders if all of
the assets were liquidated and all of the company's debt was paid off. Retained
earnings are part of shareholders' equity and are the amount of net earnings that were not
paid to shareholders as dividends. 

SE can be either negative or positive. Negative SE means a company's liabilities exceed its
assets. If it's positive, the company has enough assets to cover its liabilities. If a company's
shareholder equity remains negative, it is considered to be balance sheet insolvency. 

This is why many investors view companies with negative shareholder equity as risky or
unsafe investments. Shareholder equity alone is not a definitive indicator of a
company's financial health. If used in conjunction with other tools and metrics, the investor
can accurately analyze the health of an organization.

3. Dividend payout ratio

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The dividend payout ratio is the ratio of the total amount of dividends paid out to
shareholders relative to the net income of the company. It is the percentage of earnings
paid to shareholders via dividends. The amount that is not paid to shareholders is retained
by the company to pay off debt or to reinvest in core operations. It is sometimes simply
referred to as simply the payout ratio. The dividend payout ratio provides an indication of
how much money a company is returning to shareholders versus how much it is keeping on
hand to reinvest in growth, pay off debt, or add to cash reserves (retained earnings). 

4. Current ratio

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term
obligations or those due within one year. It tells investors and analysts how a company can
maximize the current assets on its balance sheet to satisfy its current debt and other
payables. A current ratio that is in line with the industry average or slightly higher is
generally considered acceptable. A current ratio that is lower than the industry average
may indicate a higher risk of distress or default. Similarly, if a company has a very high
current ratio compared with its peer group, it indicates that management may not be using
its assets efficiently. The current ratio is called current because, unlike some other liquidity
ratios, it incorporates all current assets and current liabilities. The current ratio is
sometimes called the working capital ratio.

The current ratio measures a company’s ability to pay current, or short-term, liabilities

(debts and payables) with its current, or short-term, assets, such as cash, inventory,
and receivables.

5. Inventory turnover ratio

Inventory turnover is a financial ratio showing how many times a company has sold and
replaced inventory during a given period. A company can then divide the days in the period
by the inventory turnover formula to calculate the days it takes to sell the inventory on
hand. Calculating inventory turnover can help businesses make better decisions on pricing,
manufacturing, marketing, and purchasing new inventory.

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Inventory turnover measures how fast a company sells inventory. A low turnover implies
weak sales and possibly excess inventory, also known as overstocking. It may indicate a
problem with the goods being offered for sale or be a result of too little marketing.

A high ratio, on the other hand, implies either strong sales or insufficient inventory. The
former is desirable while the latter could lead to lost business.

QUESTION 3:-

From the given information

(Amount in lakhs)
Cost of goods sold 580
Opening stock 40
Closing stock 70
Creditors at the beginning of the year 60
Creditors at the end of the year 100
Cash purchases 45
Original cost of equipment sold 400
Gain on equipment sold 50
Accumulated depreciation on the 80
equipment

Calculate:

a. Total purchases, credit purchases and payment to creditors.

b. Define the term Net book value, Accumulated depreciation calculate the net book
value and cash proceeds from sale of investment.

Solution 3a:-

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The cost of goods sold formula is calculated by adding purchases for the period to the
beginning inventory and subtracting the ending inventory for the period.

Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory

The beginning inventory for the current period is calculated as per the leftover inventory
from the previous year. Any additional inventory which has been purchased or produced is
added to the beginning inventory. To arrive at the Cost of Goods Sold, products that were
not sold are subtracted from the sum of beginning inventory and additional purchases.

This calculation does not work well for the manufacturing sector, since the cost of
goods sold can be comprised of items other than merchandise, such as direct labour.
These other components of the cost of goods make it more difficult to discern the
amount of total purchases.

In this total purchases = Closing stock – opening stock + cost of goods sold

Total purchases = 70, 00,000 – 40, 00,000 + 5, 80, 00,000

Total purchases = Rs. 6, 10, 00,000

Due to the credit purchase, an account receivable and an account payable are then created.
The account payable is the current liability for the buyer, and they will pay the supplier at an
agreed later date. The buyer should record it as a Credit Purchase.

Credit purchases = Total purchases – cash purchases

Credit purchases = 6,10,00,000 – 45,00,000

Credit purchases = Rs. 5,65,00,000

Payment to creditors = Creditors at the beginning of the year + credit purchases - Creditors
at the end of the year

Payment to creditors = 60,00,000 + 5,65,00,000 – 1,00,00,000

Payment to creditors = Rs. 5,25,00,000

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Solution 3b:-

Net book value is the amount at which an organization records an asset in its
accounting records. Net book value is calculated as the original cost of an asset, minus
any accumulated depreciation, accumulated depletion, accumulated amortization, and
accumulated impairment. Given these deductions, net book value represents an
accounting methodology for the gradual reduction in the recorded cost of a fixed asset.
It does not necessarily equal the market price of a fixed asset at any point in time.
Nonetheless, it is one of several measures that can be used to derive a valuation for a
business.Net book value can be mistaken for the market value of a business or an asset.
It may be substantially higher or lower than market value, since it is simply an
accounting measure; it is entirely unrelated to the supply and demand issues that are
the basis for a business or asset valuation.

The formula for calculating NBV is as follows:

Net Book Value = Original Cost of equipment – Accumulated Depreciation on equipment

Net Book Value =4, 00, 00,000 – 80, 00,000

Net Book Value =Rs. 3, 20, 00,000

Net book value is among the most common financial metrics around. It is especially true
when used to help give value to a company – either for the company’s own accounting
records, if the company is considering liquidation, or if another company is considering
taking over the business.

Accumulated depreciation is the cumulative depreciation of an asset up to a single point in

its life. Accumulated depreciation is a contra asset account, meaning its natural balance is a
credit that reduces the overall asset value.

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Accumulated depreciation is the total amount an asset has been depreciated up until a
single point. Each period, the depreciation expense recorded in that period is added to the
beginning accumulated depreciation balance. An asset's carrying value on the balance
sheet is the difference between its historical cost and accumulated depreciation. At the end
of an asset's useful life, its carrying value on the balance sheet will match its salvage value.

Accumulated depreciation appears on the balance sheet as a reduction from the gross
amount of fixed assets reported. It is usually reported as a single line item, but a more
detailed balance sheet might list several accumulated depreciation accounts, one for
each fixed asset type. The latter form of presentation is more useful to an investor,
since the proportion of accumulated depreciation to fixed assets provides an indicator
of the age of the reporting entity’s fixed assets; for example, a high proportion of
accumulated depreciation indicates that a firm’s fixed assets are old.

The original purchase price of the asset, minus all accumulated depreciation and any
accumulated impairment charges, is the carrying amount of the asset. Subtract this carrying
amount from the sale price of the asset. If the remainder is positive, it is a gain. If the
remainder is negative, it is a loss.

Cash proceeds from sale of investment = Net book value + gain on sale of equipment

Cash proceeds from sale of investment = 3, 20, 00,000 + 50, 00,000

Cash proceeds from sale of investment = Rs. 3, 70, 00,000

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