Tuesday, February 19, 2013

Ignou Solved Assignment - MCO:05

Answer of Question no.1.

Management Accounting
The term management accounting refers to accounting for the management. Management accounting provides necessary information to assist the management in the creation of policy and in the day-to-day operations. It enables the management to discharge all its functions i.e. planning, organization, staffing, direction and control efficiently with the help of accounting information. Management accounting is not a specific system of accounts, but could be any form of accounting which enables a business to be conducted more effectively and efficiently.

In the words of R.N. Anthony “Management accounting is concerned with accounting information that is useful to management”.

According to Anglo American Council of Productivity “Management accounting is the presentation of accounting information is such a way as to assist management in the creation of policy and in the day-to-day operations of an undertaking”.-

Management accounting in the words of Robert S. Kaplan, is a system that collects, classifies, summaries, analyses and reports information that will assist managers in their decision making and control activities.

Therefore management accounting requires the collection, analysis and interpretation financial data in order to assist the management in taking various important decisions.

Functions of Management Accounting
Main objective of management accounting is to help the management in performing its functions efficiently. The major functions of management are planning, organizing, directing and controlling. Management accounting helps the management in performing these functions effectively. Some of the important functions of Management are given below:

Presentation of Data: Traditional Profit and Loss Account and the Balance Sheet are not analytical for decision making. Management accounting modifies and rearranges data as per the requirements for decision making through various techniques.

Aid to Planning and Forecasting: Management accounting is helpful to the management in the process of planning through the techniques of budgetary control and standard costing. Forecasting is extensively used in preparing budgets and setting standards.

Decision Making: Management accounting provides comparative data for analysis and interpretation for effective decision making and policy formulation.

Communication of Management Policies: Management accounting conveys the policies of the management downward to the personnel effectively for proper implementation.

Effective Control: Standard costing and budgetary control are integral part of management accounting. These techniques lay down targets, compare actual with standards and budgets to evaluate the performance and control the deviations.

Incorporation of non-financial information: Management accounting considers both financial and non-financial information for developing alternative courses of action which leads to effective and accurate decisions.

Co ordination: The targets of different departments are communicated to them and their performance is reported to the management from time to time. This continual reporting helps the management in coordinating various activities to improve the overall performance.

Limitations of Management Accounting
Management accounting suffers from the following limitations:

a)      Based on Accounting Information: Management accounting derives information from past financial accounting and cost accounting records. If the past records are not reliable, it will affect the effectiveness of management accounting.

b)      Wide scope: Management accounting has a very wide scope incorporating many disciplines. This results in inaccuracy and other practical difficulties.

c)       Costly: The installation of management accounting system requires a large organization. Hence, it is very costly and only big concerns can afford to adopt it.

d)      Evolutionary Stage: Management accounting is still in its initial stages. Tools and techniques are not fully developed. This creates doubts about the utility of management accounting.

e)      Opposition to Change: Introduction of management accounting system requires a number of changes in the organization structure, rules and regulations. This rearrangement is not generally liked by the people involved.

f)       Intuitive Decisions: Management accounting helps in scientific decision making. Yet, because of simplicity and personal factors the management has a tendency to arrive at decisions by intuition.
g)      Not an Alternative to Management: Management accounting will not replace the management and administration. It is a tool of the management. Decisions are of the management and not of the management accountant.

Answer of Question no.2.

Cash Flow Statement :
A Cash Flow Statement is similar to the Funds Flow Statement, but while preparing funds flow statement all the current assets and current liabilities are taken into consideration. But in a cash flow statement only sources and applications of cash are taken into consideration, even liquid asset like Debtors and Bills Receivables are ignored.
A Cash Flow Statement is a statement, which summarises the resources of cash available to finance the activities of a business enterprise and the uses for which such resources have been used during a particular period of time. Any transaction, which increases the amount of cash, is a source of cash and any transaction, which decreases the amount of cash, is an application of cash.

Simply, Cash Flow is a statement which analyses the  reasons for changes in balance of cash in hand and at bank between two accounting period. It shows the inflows and outflows of cash.

Objectives of Cash Flow statement :
Short-term financial Planning :- To provides useful information which helps the management in taking short-term investment decisions.

Helpful in preparing Cash Budget :- A Cash Budget is an estimate of cash receipts and disbursement for a future period of time. Cash Flow Statement aims to help the management to prepare Cash Budget. A comparison of cash budget and cash flow statement reveals the extent to which the sources of the business were generated and used as per the plans of the business.

Measurement of Liquidity :- Liquidity means ability of a business enterprise to pay off its liabilities when due. Cash Flow Statement helps to know about the sources where from the cash will be available to pay off the liabilities.

Dividend Decisions :- The Capacity of the firm to pay dividends to shareholders depend on the generation of cash flows. Cash flow statement aims at helping the management to know about the sources of cash to pay off dividend.

Prediction of sickness :- With the help of preparing cash from operation a business enterprise may come to know about cash losses in operation. It helps to predict this type of sickness.

Future Guide: - Most of the users are interested to assess the ability of the firm in generating future cash flows, its timing and certainty. These questions can be answered by analysing the cash flow statement.

The use of cash in investing and financing Transaction :- Information in cash flow statement would be useful to find out as to how cash has been obtained from investing and financing activities and how cash has been used to invest and repay borrowings etc. The statement would be useful to users to ascertain the following :
a)      The change in the net assets of the business.

b)      The change in the financial structure.

c)       The financing of expansion.

d)      The utilisation of finance obtained by the enterprise.

e)      The impact of investing and financing activities on the cash cash balance of the enterprise.

Difference between investing and financing activities
Investing Activities: Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Examples of Investing Activities
Cash payments to acquire fixed assets (including intangibles) and also payments for capitalized research and development costs and self constructed fixed assets.
Cash receipts from the disposal of fixed assets (including intangibles).
Cash flow from purchase or sale of shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for trading or dealing purposes).
Cash receipts from repayments of advances and loans made to third parties (other than advances and loans of financial enterprises).

Financing Activities: Financing activities are the activities that result in change in the size and composition of the owners’ capital (including preference) share capital in the case of a company) and borrowing of the enterprise.

Examples of Financing Activities
Cash proceeds from the issue of shares or other similar instruments.
Cash proceeds from the issue of debentures, loan notes, bonds and other short term borrowings.
Buy-back of equity shares.
Cash repayments of the amounts borrowed including redemption of debentures.

Answer of Question no.3.

Cash Budget
A cash budget is a budget or plan of expected cash receipts and disbursements during the period. These cash inflows and outflows include revenues collected, expenses paid, and loans receipts and payments. In other words, a cash budget is an estimated projection of the company's cash position in the future.

Management usually develops the cash budget after the sales, purchases, and capital expenditures budgets are already made. These budgets need to be made before the cash budget in order to accurately estimate how cash will be affected during the period. For example, management needs to know a sales estimate before it can predict how much cash will be collected during the period. Management uses the cash budget to manage the cash flows of a company. In other words, management must make sure the company has enough cash to pay its bills when they come due.

Methods of Preparation of Cash Budget
(1) Receipts and Payments Method
(2) Adjusted Profit and Loss Method or Adjusted Earnings Method or Cash Flow Method. 
(3) Projected Balance-Sheet Method.

The above methods of preparing cash budget represent different approaches.
(1) Receipts and Payments Method: It is the most simple and popular method of preparing cash budget. The method is most commonly used in forecasting the short term cash position. It is just like receipts and payment method in technique. It shows yearly cash position with proper breakups by quarters and months. For the purpose of preparing cash budget under this method, cash information’s are collected from other budgets such as sales budget, salary and wages budget, overhead budgets, material budget etc. 

Under this method cash budget is divided into two parts. One part shows the timing and the amount of cash receipts and other part shows the timing and the amount of cash disbursements. In preparing cash budget, total budgeted cash receipts are added to the opening balance of cash and then the total budgeted disbursements are deducted there from to know the closing balance of cash. If opening cash balance and estimated total cash receipts are much larger than the estimated payments, there will be cash balance at close and management should take the necessary steps, to invest surplus funds for short period. On the other hand, if there is cash shortage, the management must plan the borrowings for short period to manage the deficiency. It is a sound vehicle for exercising control over day-to­ - day transactions. This method is not suitable for long term cash forecasting.

(2) Adjusted Profit and Loss Method or Adjusted Earnings Method or Cash Flow Method: The method is suitable for preparing the long term estimates of cash inflows and outflows. It is also called cash-flow statement. Under this method, profit and loss account is adjusted to know the cash estimates. This method is useful in budgetary control technique. Under this method, closing cash balance can be known by adding profits for the period to the opening cash balance because the theory is based on the elementary assumption that profits of a business are equal to cash. Thus if we assume that there are no credit transactions, capital transactions, accruals, provisions, stock fluctuations, or appropriations of profit, the balance of profit as shown by the profit and loss account should b equal to the cash balance in the case book. However, such a situation will never exist in actual practice, the assumption needs adjustments.

The principal advantage of the adjusted net income method of cash forecasting is that it provides a close watch on working capital changes and enables the firm to anticipate its short term financing requirements. Its major drawback is that it does not permit the tracing of cash flow even though it is an excellent device for showing the cumulative impact of fund flows.

(3) Projected Balance-Sheet Method: This method is similar to that of profit and loss adjustment method, a budgeted balance sheet is prepared for the next period showing all items of assets and liabilities except cash balance which is found out as the balancing figure of the two sides of balance sheet. If the asset side exceeds the liability side the balance shall reveal the bank overdraft and if the liability side is heavier than the asset side, the difference represents the bank balance.

The Projected balance sheet contains all of the line items found in a normal balance sheet, except that it is a projection of what the balance sheet will look like during future budget periods. It is compiled from a number of supporting calculations, the accuracy of which may vary based on the realism of the inputs to the budget model.
The Projected balance sheet is extremely useful for testing whether the projected financial position of a company appears to be reasonable ranging from 2 to 5 years and provide a rough picture of a firm’s financing needs and availability of investable surplus in future. It is also helpful in long-term cash forecasts which are helpful in planning the outlays of capital expenditure projects and planning the raising of long-term funds.

From the above definition, it is clear that for long term cash forecast projected Balance-Sheet Method is more useful that other methods of Cash Budgeting.

Answer of Question no.4.

Answer of Question no.5.

(a) P/V Ratio = (Contribution/Sales)*100  = (200000/800000)*100  = 25%

(b) B.E.P = Fixed cost / PV Ratio = 60000 / 25%  = 240000

(c) Profit = (Expected Sales*PV Ratio) – Fixed Cost = (1200000*25%) – 60000 = 240000

(d) Margin of Safety = Profit / PV Ratio  = 240000 / 25% =  960000 (Profit as per c above since sales are identical)

(e) Desired Sales = (Fixed cost + Desired Profit) / PV Ratio =(60000+280000) / 25% = 1360000

(f) Additional Sales Required = Increase in fixed cost / PV Ratio = 12000 / 25%  = 48000.