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Course Code : MCS-035

Course Title : Accountancy and Financial Management
Assignment Number : MCA (III)/035/Assignment/2018-19
Maximum Marks : 100
Weightage : 25%
Last Dates for Submission : 15th October, 2018 (For July, 2018 Session)
15th April, 2019 (For January, 2019 Session)

Question 1
(a) “Describe various ratios that are likely to help management of a manufacturing company
forming an opinion on the solvency position of business.
Ans.
Financial ratios are indicators used to analyze an entityâ??s financial performance. Financial ratios
are used by bankers, creditors, shareholders and accountants to evaluate data presented on an
entityâ??s financial statements. Depending on the results of the evaluations, bankers and creditors
may choose to extend or retract financing and potential shareholders may adjust the level of
commitment in a company. Financial ratios are important tools that judge the profitability, efficiency,
liquidity and solvency of an entity.
Profitability Ratios
Profitability ratios help users of an entityâ??s financial statements determine the overall effectiveness
of management regarding returns generated on sales and investments. Commonly used profitability
ratios are gross profit margin, operating profit margin and net profit margin. Gross profit margin
measures profitability after considering cost of goods sold, while operating profit margin measures
profitability based on earnings before interest and tax expense. Net profit margin is often referred to
as the bottom line and takes all expenses into account.
Efficiency Ratios
Ratios that measure the effectiveness of managementâ??s decision making are referred to as
efficiency ratios. Efficiency ratios evaluate turnover and the return on investments. Examples of
efficiency ratios are inventory turnover, sales to receivables and return on assets. Inventory turnover
measures the number of times an entire stock of inventory is repurchased while sales to receivables
compares trade receivables to revenues. In both situations, a higher number indicates a higher level
of efficiency when selling inventory and collecting receivables. Return on assets compares net
income before taxes to total assets and helps show the efficiency of management when using assets
to generate profits.
Liquidity Ratios
Liquidity ratios help financial statement users evaluate a companyâ??s ability to meet its current
obligations. In other words, liquidity ratios evaluate the ability of a company to convert itscurrent
assets into cash and pay current obligations. Common liquidity ratios are the current ratio and the
quick ratio. The current ratio is calculated by dividing current assets by current liabilities. According
to Thomson Reuters, a general rule of thumb is to have a current ratio of 2. The quick ratio, or acid
test, helps determine a companyâ??s ability to pay obligations that are due immediately.
Solvency Ratios
Solvency, or leverage, ratios, judge the ability of a company to raise capital and pay its obligations.
Solvency ratios, which include debt to worth and working capital, determine whether an entity is
able to pay all of its debts. In practice, bankers often include leverage ratios as debt covenants in
contract agreements. Bankers want to ensure the entity can maintain operations during difficult

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financial periods. The debt to worth ratio calculation is total liabilities divided by net worth.
Working capital is calculated by subtracting current liabilities from current assets.

(b) Under what circumstances may NPV and IRR give conflicting recommendations? Which
criteria should be followed in such circumstances and why?
Ans.

NPV and IRR

(i) In the net present value method, the present value is determined by discounting the future cash
flows of a project at a predetermined or specified rate called the cut off rate based on cost of capital.
But under the internal rate of return method, the cash flows are discounted at a suitable rate by hit
and trial method which equates the present value so calculated to the amount of the investment.
Under IRR method, discount rate is not predetermined or known as is the case in NPV method.
(ii) The NPV method recognizes the importance of market rate of interest or cost of capital. It arrives
at the amount to be invested in a given project so that its anticipated earnings would recover the
amount invested in the project at market rate.
Contrary to this, the IRR method does not consider the market rate of interest and seeks to determine
the maximum rate of interest at which funds invested in any project could be repaid with the earnings
generated by the project.
(iii) The basic presumption of NPV method is that intermediate cash inflows are reinvested at the
cut off rate, whereas, in the case of IRR method, intermediate cash flows are presumed to be
reinvested at the internal rate of return.

(iv) The results shown by NPV method are similar to that of IRR method under certain situations,
whereas, the two give contradictory results under some other circumstances. However, it must be
remembered that NPV method using a predetermined cut -off rate is more reliable than the IRR
method for ranking two or more capital investment proposals.

Conflict between NPV and IRR Results:

In case of mutually exclusive investment proposals, which compete with one another in such a
manner that acceptance of one automatically excludes the acceptance of the other, the NPV method
and IRR method may give contradictory results, The net present value may suggest acceptance of
one proposal whereas, the internal rate of return may favour another proposal.

Such conflict in rankings may be caused by any one or more of the following
problems:
(i) Significant difference in the size (amount) of cash outlays of various proposals under
consideration.
(ii) Problem of difference in the cash flow patterns or timings of the various proposals, and
(iii) Difference in service life or unequal expected lives of the projects.

Question 2
What is meant by working capital management? What factors would you like to take into
consideration in estimating the working capital requirement of a concern? Discuss the
repercussions if a firm has inadequate working capital.

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Ans. Working capital management refers to a company's managerial accounting strategy

designed to monitor and utilize the two components of working capital, current assets and
current liabilities, to ensure the most financially efficient operation of the company. The primary
purpose of working capital management is to make sure the company always maintains sufficient
cash flow to meet its short-term operating costs and short-term debt obligations.
Factors Affecting the Working Capital:
The firm must estimate its working capital very accurately because excessive working capital results
in unnecessary accumulation of inventory and wastage of capital whereas shortage of working capital
affects the smooth flow of operating cycle and business fails to meet its commitment.
1. Length of Operating Cycle:
The amount of working capital directly depends upon the length of operating cycle. Operating cycle
refers to the time period involved in production.

2. Nature of Business:
The type of business, firm is involved in, is the next consideration while deciding the working
capital. In case of trading concern or retail shop the requirement of working capital is less because
length of operating cycle is small.
3. Scale of Operation:
The firms operating at large scale need to maintain more inventory, debtors, etc. So they generally
require large working capital whereas firms operating at small scale require less working capital.
4. Business Cycle Fluctuation:
During boom period the market is flourishing so more demand, more production, more stock, and
more debtors which mean more amount of working capital is required.
5. Seasonal Factors:
The working capital requirement is constant for the companies which are selling goods throughout
the season whereas the companies which are selling seasonal goods require huge amount during
season as more demand, more stock has to be maintained and fast supply is needed whereas during
off season or slack season demand is very low so less working capital is needed.

inadequate working capital :-

1. The firm is unable to take advantages of new opportunities or adapt to change.

2. Trade discounts are lost. A firm with sufficient working capital is able to finance larger stocks and can
therefore place large orders.
3. Cash discounts are lost. Some firms will try to persuade their debtors to pay early by offering cash
discounts.
4. The advantages of being able to offer a credit line to customers are forgone.
5. Financial reputation is lost due to non-payment of trade creditors on time.
6. Creditors may apply to the court for winding up if the firm fails to pay their obligations on time.

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Question 4
Write short notes on the following:
(a) Provision for bad and doubtful debts
(b) Interest on Capital
(c) Provision for discount on Creditors
(d) Treatment of abnormal loss in final accounts
Ans.

(a) The provision for bad debts might refer to the balance sheet account also known as the
Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for Uncollectible
Accounts. In this case, the account Provision for Bad Debts is a contra asset account (an asset
account with a credit balance). It is used along with the account Accounts Receivable in order
for the balance sheet to report the net realizable value of the accounts receivable.
Some companies might use the description provision for bad debts on its income statement in order to
report the credit losses that pertain to the period shown on the income statement. In that case, it would
be an the income statement account. AccountingCoach.com prefers that the income statement account
have the title of Bad Debt Expense or Uncollectible Account Expense.

(b)

C ) To motivate the debtors to make prompt payments, cash discount may be allowed to them. After
providing provision for bad and doubtful debts, the remaining debtors are called as good debtors.
They may pay their dues in time and avail themselves of the cash discount permissable. So a
provision for discount on good debtors at a certain percentage may have to be created. Example:
The Trial Balance as on 31st March 2004 shows the following: Sundry debtors Rs. 45,000
Adjustment: Create 2% provision for discount on Debtors.

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d)

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Ans.5

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