Accounting for ManagerialDecision

(As Per the Revised Syllabus of S.Y.BMS., 2014-15, Sem. III,University of Mumbai)

Winner of “Best Commerce Author – 2013-14” by Maharashtra Commerce AssociationLion Dr. Nishikant Jha

ICWA, PGDM (MBA), M.Com., Ph.D., D. Litt. [USA],CIMA Advocate [CIMA U.K.], BEC [Cambridge University],

International Executive MBA [UBI Brussels, Belgium, Europe],Recognise UG & PG Professor by University of Mumbai.

Recognise M. Phil. & Ph.D. Guide by University of Mumbai.Assistant Professor in Accounts & (HOD) BAF, Thakur College of Science & Commerce.Visiting faculty in KPB Hinduja College for M.Phil. & M.Com., University of Mumbai.

CFA & CPF (USA), CIMA (UK), Indian & International MBA, CA & CS Professional Course.

Prof. Nimesh JotaniyaPGDFM, M.Com., UGC-NETAssistant Professor in Accounts

Thakur College of Science & Commerce.

Dr. Arvind UbaleMMS, M.Com., MSW, ICWAI, Ph.D., UGC Net & Maha - SET,

HOD, Accountancy Department, Coordinator of BMS & BBI, Vartak College, Vasai Road.

MUMBAI NEW DELHI NAGPUR BENGALURU HYDERABAD CHENNAI PUNE LUCKNOW AHMEDABAD ERNAKULAM BHUBANESWAR INDORE KOLKATA GUWAHATI

© AuthorsNo part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form orby any means, electronic, mechanical, photocopying, recording and/or otherwise without the priorwritten permission of the publisher.

First Edition : 2015

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Preface

It is a matter of great pleasure to present this new edition of the book on Accounting forManagerial Decision to the students and teachers of Bachelor of Commerce S.Y.BMS started byUniversity of Mumbai. This book is written on lines of revised syllabus instituted by theuniversity. The book presents the subject matter in a simple and convincing language.

In keeping with the aims of the book, we have attempted to present the text in a lucid andsimple style; the treatment is comprehensive and by and large non-mathematical. Another notablefeature of this volume is that the discussions of the concepts and theories are invariably followedby exhaustive illustrative problems. To test the understanding of the readers as also to enablethem to have sufficient practice, a large number of exercises have also been given at the end ofthe chapters.

The syllabus contains a list of the topics covered in each chapter which will avoid thecontroversies regarding the exact scope of the syllabus. The text follows the term wise, chapter-topic pattern as prescribed in the syllabus. We have preferred to give the text of the section andrules as it is and thereafter added the comments with the intention of explaining the subject to thestudents in a simplified language. While making an attempt to explain in a simplified language,any mistake of interpretation might have crept in.

This book is a unique presentation of subject matter in an orderly manner. This is a student-friendly book and tutor at home. We hope the teaching faculty and the student community willfind this book of great use.

We are extremely grateful to Mr. K.N. Pandey of Himalaya Publishing House Pvt. Ltd., fortheir devoted and untiring personal attention accorded by them to this publication.

We owe a great many thanks to a great many people who helped and supported us during thewriting of this book which includes Principal, HOD, and Students of BMS Section.

We gratefully acknowledge and express our sincere thanks to the following people withoutwhose inspiration, support, constructive suggestions of this book would not have been possible.

Mr. Jitendra Singh Thakur (Trustee, Thakur College) Dr. Chaitaly Chakraborty (Principal, Thakur College) Mrs. Janki Nishikhant JhaWe welcome suggestions from students and teachers for further improvement of quality of

book.

— Authors

Syllabus

Accounting for Managerial DecisionLearning Objectives:

1. To acquaint Management learners with basic accounting fundamentals

2. To develop financial analysis skills among learners.

3. The course aims at explaining the core concepts of business finance and its importance inmanaging a business.

Unit Name of the Topic No. of LecturesUnit 1 Analysis and Interpretation of Financial Statements: 15

1. Study of balance sheet of limited companies schedule VI-(New.). Study of Manufacturing, Trading, Profit and LossA/c of Limited Companies- Schedule VI (New)

2. Vertical Form of Balance Sheet and Profit & Loss A/c-Trend Analysis, Comparative Statement & Common Size

Unit 2 Ratio Analysis and Interpretation: (Based on vertical form offinancial statements) including conventional and functionalclassification restricted to:

15

1. Balance sheet ratio: Current ratio, Liquid Ratio, StockWorking Capital Ratio, Proprietory Ratio, Debt EquityRatio, Capital Gearing Ratio.

2. Revenue Statement Ratios: Gross Profit Ratio, ExpensesRation, Operating Ratio, Net Profit Ratio, Net OperatingProfit Ratio, Stock Turnover Ratio, Debtors Turnover,Creditors Turnover Ratio

3. Combined Ratios: Return on Capital Employed (includingLong-term borrowings), Return on Proprietors Fund (ShareHolder Fund and Preference Capital), Return on EquityCapital, Dividend Payout Ratio, Debt Service Ratio,

4. Different Modes of Expressing Ratios: Rate, Ratio,Percentage, Number. Limitations of the use of Ratios.

Unit 3 Preparation of Cash Flow Statement (Accounting Standard-3(revised)

15

Unit 4 Working Capital: Concept, Estimation of Requirements in Caseof Trading & Manufacturing Organizations.

15

Receivables Management: Meaning & Importance, Credit PolicyVariables, Methods of Credit Evaluation (Traditional andNumerical-credit Scoring); Monitoring the Debtors Techniques[DSO, Ageing Schedule]

Question Paper PatternQuestion Paper Pattern for Periodical Class Test for Courses at UG ProgrammesWritten Class Test 20 Marks

Sr. No. Particulars Marks

1 Match the Column/Fill in the Blanks/Multiple Choice Questions(1/2 Mark each)

05 Marks

2 Answer in One or Two Lines (Concept-based Questions)(1Mark each)

05 Marks

3 Answer in Brief (Attempt any two of the three) (5 Marks each) 10 Marks

Semester End ExaminationDuration: 21/2 Hrs. Maximum Marks: 75All Questions are Compulsory carrying 15 Marks each. Questions to be Set: 05

Sr. No. Particulars Marks

Q.1 Objective Questions 15 Marks

(a) Sub-questions to be asked 10 and to be answered any 08(b) Sub-questions to be asked 10 and to be answered any 07(*Multiple Choice/True or False/Match the Column, Fill in the Blanks)

Q.2

Q.2

Full Length Practical QuestionORFull Length Practical Question

15 Marks

15 Marks

Q.3

Q.3

Full Length Practical QuestionORFull Length Practical Question

15 Marks

15 Marks

Q.4

Q.4

Full Length Practical QuestionORFull Length Practical Question

15 Marks

15 Marks

Q.5

Q.5

(a) Theory Questions(b) Theory QuestionsORShort NotesTo be Asked 05To be Answered 03

08 Marks07 Marks

15 Marks

Note: Full length question of 15 marks may be divided into two sub-questions of 08 and 07 marks.

Contents

1. Introduction to Managerial Decision 1 – 7

2. Analysis and Interpretation of Accounts 8 – 58

3. Ratio Analysis 59 – 139

4. Cash Flow Statement 140 – 197

5. Working Capital Concept 198 – 259

MEANING AND OBJECTIVE OF FINANCIAL STATEMENTFinancial statements are compilation of financial data, collected and classified in a systematic manner

according to the accounting principles, to assess the financial position of an enterprise as regards to itsprofitability, operational efficiency, long and short-term solvency and growth potential.

Financial statements are basic and formal means through which management of .an enterprise makepublic communication of financial information along with select quantitative details. They are structuredfinancial representation of the financial position, performance and cash flows of an enterprise. Many usersare rely on the general purpose financial statements as the major source of financial information andtherefore, financial statements should be prepared and presented in accordance with their requirement. Ofcourse, some of the users may have the power to obtain, information in addition to that contained in thefinancial statements. That does not undermine the dependence of the general users on the informationcontents of the financial statements.

Financial statements provide information about the financial position, performance and cash flows ofan enterprise that is useful to wide range of users in making economic decisions. It means to show theresults of the stewardship of management, or the accountability of management for the resources entrustedto it.Part I – Form of Balance Sheet

CurrentLiabilities

Non-currentAssets

CurrentAssets

Assets

Shareholders’Funds

Balance Sheet

Non-currentLiabilities

Equities andLiabilities

ShareApplication Money

PendingAllotment

Fig. 1

Chapter

1Introduction to

Managerial Decision

2 Introduction to Managerial Decision

Break-up of Equities and Liabilities

Current LiabilitiesNon-currentLiabilities

Money Received againstShare

Warrants

Share Application MoneyPending Allotment

Equities and Liabilities

Short-termProvisions

Shareholders’ Funds

Long-termProvisions

Reserves and Surplus

ShareCapital

Short-term Borrowing

TradePayables

Deferred TaxLiability (Net)

OtherCurrent

Other Long-termLiabilities

Long-term

Borrowings

Fig. 2Break-up of Assets

Assets

Non-current Assets Current Assets

Fixed Assets Current Investments

Non-currentInvestments

Inventories

Deferred Tax Asset(DTA)

Long-term Loans andAdvances

Other Non-currentAssets

Short-term Loans andAdvances

Trade Receivables

Cash and CashEquivalents

Other Current Assets

Fig. 3

Introduction to Managerial Decision 3

1.3 Part I: Form of Balance SheetName of the Company:..........................Balance Sheet as at:...............................

Particulars Note

Figure as at the Endof the Current

Reporting Period

Figure as at the Endof the Previous

Reporting Period` `

I. Equity and Liabilities:1. Shareholder’s Funds

(a) Share Capital(b) Reserves and Surplus(c) Money Received against Share Warrants

2. Share Application Money Pending Allotment3. Non-current Liabilities:

(a) Long-term Borrowings(b) DTL (Net)(c) Other Long-term Liabilities(d) Long-term Provisions

4. Current Liabilities:(a) Short-term Borrowings(b) Trade Payables(c) Other Current Liabilities(d) Short-term Provisions

TotalII.Assets:

1. Non-current Assets:(a) Fixed Assets:

(i) Tangible Assets(ii) Intangible Assets(iii) Capital WIP(iv) Intangible Assets under Development

(b) Non-current Investment(c) DTA (Net)(d) Long-term Loans and Advances(e) Other Non-current Assets

2. Current Assets(a) Current Investments(b) Inventories(c) Trade Receivables(d) Cash and Cash Equivalents(e) Other Current Assets

TotalIllustration 1: The following information has been extracted from the books of account of Hero Ltd.

as at 31st March, 2014.Particulars Dr. (` ’000) Cr. (` ’000)

Administration expenses 480Cash at bank and on hand 228Cash received on sale of fittings 10Long-term loan 70Investments 200Depreciation on fixture, fittings, tools and equipment (1st April, 2013) 260Distribution costs 102Factory closure costs 60Fixture, fittings, tools and equipment (at cost) 680Profit and Loss Account (1st April, 2013) 80Purchase of equipment 120Purchase of goods for resale 1,710

4 Introduction to Managerial Decision

Sales (Net of Excise Duty) 3,000Share capital (1,00,000 shares of ` 10 each fully paid) 1,000Stock (1st April, 2013) 140Trade creditors 80Trade debtors 780

4,500 4,500

Additional Information:(a) The stock at 31st March, 2014 (valued at the lower of cost or net realisable value) was estimated to

be worth ` 2,00,000.(b) Fixtures, fittings, tools and equipment all are related to administration. Depreciation is charged at a

rate of 20% per annum on cost. A full year’s depreciation is charged in the year of acquisition, butno depreciation is charged in the year of disposal.

(c) During the year to 31st March, 2014, the company purchased equipment of ` 1,20,000. It also soldsome fittings (which had originally cost ` 10,000 and for which depreciation of ` 30,000 had beenset aside.

(d) The average income tax for the company is 50%. Factory closure cost is to be presumed as anallowable expenditure for income tax purpose.

(e) The company proposes to pay a dividend of 20% per equity share.Prepare Hero Ltd.’s Profit and Loss Account for the year ended 31st March, 2014 and Balance Sheet

as at that date in accordance with the Companies Act, 1956 in the Vertical Form along with the Notes onAccounts containing only the significant accounting policies. (T.Y. BAF, Modified, M.U.)Solution: Hero Ltd.

Balance Sheet as at 31st March, 2014 (` in ’000)Particulars Note No. As at 31st

March, 2014A. Equity and Liabilities:

1. Equity:(a) Share capital 1 1,000(b) Reserve and surplus 2 150(c) Money received against share warrants

2. Share application money pending allotment3. Non-current Liabilities:

(a) Long-term borrowing 3 70(b) Deferred tax liabilities (Net)(c) Other long-term liabilities(d) Long-term provisions

4. Current Liabilities:(a) Short-term borrowings(b) Trade payables(c) Other current liabilities 4 80(d) Short-term provisions 5 470

Total (1 + 2 + 3 + 4) 1,770B. Assets:

1. Non-current Assets:(a) Fixed Assets

(i) Tangible assets 6 360(ii) Intangible assets

(iii) Capital work-in-progress(iv) Intangible assets under development

(b) Non-current investments 7 200(c) Deferred tax assets (Net)(d) Long-term loans and advances(e) Other non-current assets

2. Current Assets:

Introduction to Managerial Decision 5

(a) Current investment(b) Inventories 8 200(c) Trade receivables 9 780(d) Cash and cash equivalents 10 228(e) Short-term loans and advances(f) Other current assets

Total (1 + 2) 1,770

Hero Ltd.Profit and Loss Statement for the year ended 31st March, 2014 (` in ’000)

Particulars Note No. As at 31stMarch, 2014

A. Revenue from Operation: 11 3,000Less: Excise duty

B. Other Income 3,000C. Total Revenue (A + B)D. Expenses:

(a) Cost of material consumed(b) Purchase of products for sale 1,710(c) Charges in inventories of finished goods, work-in-progress

and products for sale (140 – 200) (60)(d) Employees cost/benefit expenses(e) Finance cost(f) Depreciation and amortization expenses 148(g) Product development expenses/Engineering expenses(h) Other expenses 12 602(i) Expenditure transfer to capital and other account

Total Expenses 2,400E. Profit before exceptional and extraordinary items and tax (C – D) 600F. Exceptional itemsG. Profit before tax from continuing operations (E – F) 600H. Extraordinary items 60I. Profit before tax from continuing operations (H – I) 540J. Tax Expenses:

(a) Current Tax(b) Deferred Tax

K. Profit after tax for the year from continuing operations (G – H)270

L. Profit (loss) from discontinuing operationsTax expenses from discontinuing operations

270

M. Profit (loss) from discontinuing operations (after tax) (J – K)N. Profit (loss) for the period (I + L) 270

Balance brought forward from previous year 80Profit available for appropriation 350Appropriation:Proposed dividend 200Transfer to General Reserve 30 230Balance carried forward 120

O. Earning per equity share:(a) Basic(b) Diluted

6 Introduction to Managerial Decision

Note 1: Share CapitalParticulars As at 31st

March,2014

Authorised, issued, Subscribed and Paid-up Share Capital:1,00,000 Equity shares of ` 10 eachTotal

1,0001,000

Reconciliation of Share CapitalFor Equity Share As at 31st

March, 2014Nos. Amount

(`)Opening Balance as on 01/01/11(Figure in ’000)

100 1,000

Add: Fresh issue (including bonusshares, right shares, split shares,share issued other than cash)Less: Buyback of shares 100 1,000Total 100 1,000

Note 2: Reserves and SurplusParticulars As at 31st

March, 2014General Reserve 30Profit and Loss A/c 120Total 150

Note 3: Long-term BorrowingsParticulars As at 31st

March, 2014Long-term loan 70Total 70

Note 4: Trade PayablesParticulars As at 31st

March, 2014Sundry Creditors 80Total 80

Note 5: Short-term ProvisionsParticulars As at 31st

March, 2014Proposed dividend (20% on` 10,00,000) 200Provision for Taxation 270Total 470

Note 6: Tangible AssetsParticulars As at 31st

March, 2014Fixtures, fitting, tools and equipmentat cost – Opening 680Add: Additions 120Less: Sale/disposed 30Less: Depreciation (262 + 148)

408362

Total 362

Note 7: Non-current InvestmentsParticulars As at 31st

March, 2014Investments 200Total 200

Note 8: InventoriesParticulars As at 31st

March, 2014Stock 200Total 200

Note 9: Trade ReceivablesParticulars As at 31st

March, 2014Trade Debtors (more than six monthsconsidered good)

780

Total 780

Note 10: Cash and cash operationParticulars As at 31st

March, 2014Cash at Bank and on hand 228Total 228

Note 11: Revenue from operationParticulars As at 31st

March, 2014Sales (net of Excise Duty) 3,000Total 3,000

Note 12: Other ExpensesParticulars As at 31st

March, 2014Administrative Expenses 480Distribution Expenses 102Loss on sale of Fixed Assets 20Total 602

Working Notes: (` in ’000)Particulars (`) (`)

(1) Tangible Assets:Furniture and FixtureGross BlockAs on 1/4/2012 680Add: Additions during the year 120

800Less: Deductions during the year 60

Introduction to Managerial Decision 7

As on 31/3/2013 740Depreciation

As on 1/4/2012 260For the year (20% on 740 148

408Less: Deduction during the year 30

As on 31/3/2013 378Net block as on 31/3/2013 362

(2) Provision for taxationProfit as per profit and loss account 540Add back: Loss on sale of asset (short-term capital loss) 20Depreciation 148

168708

Less: Depreciation under Income Tax Act 168540

Provision for tax @ 50% 270It has been assumed that depreciation calculated under Income Tax Act amounts to ` 1,68,000.