Synopsis faruk

DIPLOMA IN ISLAMIC BANKING EXAMINATION Management Accounting & Financial Management (204) April-2017 Class-1 K S Omar Faruk ACA1 Absorption Costing Absorption costing is a method for accumulating fixed and variable costs associated with the production process and apportioning them to individual products. Thus, a product may absorb a broad range of costs. These costs are not recognized as expenses in the month when an entity pays for them. Instead, they remain in inventory as an asset until such time as the inventory is sold; at that point, they are charged to cost of goods sold. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) require that an entity use absorption costing to record the value of inventory in its financial statements.

Absorption Costing Components The key costs assigned to products under an absorption costing system are: 

Direct materials. Those materials that are included in a finished product.



Direct labor. The factory labor costs required to construct a product.



Variable manufacturing overhead. The costs to operate a manufacturing facility, which vary with production volume. Examples are supplies and electricity for production equipment.



Fixed manufacturing overhead. The costs to operate a manufacturing facility, which do not vary with production volume. Examples are rent and insurance.

It is possible to use activity-based costing (ABC) to allocate overhead costs for inventory valuation purposes under the absorption costing methodology. However, ABC is a timeconsuming and expensive system to implement and maintain, and so is not very costeffective when all you want to do is allocate inventory to be in accordance with GAAP or IFRS. You should charge sales and administrative costs to expense in the period incurred; do not assign them to inventory, since these items are not related to goods produced, but rather to the period in which they were incurred.

Absorption Costing Steps The steps required to complete a periodic assignment of costs to produced goods is: 1. Assign costs to cost pools. This is comprised of a standard set of accounts that are always included in cost pools, and which should rarely be changed.

1

Member, the Institute of Chartered Accountants of Bangladesh Vice President, Islami Bank Bangladesh Ltd. Member, Technical & Research Committee (Standing Committee), ICAB Professional Development Committee, ICAB Review Committee for Published Accounts & Reports, ICAB Guest Speaker, the Institute of Chartered Accountants of Bangladesh Former; Company Secretary, Al-Arafah Islami Bank Ltd. Director (Finance and Accounts), the Dhaka Jute Mills Ltd. Email: ksfaruk@gmail.com

2. Calculate usage. Determine the amount of usage of whatever activity measure is used to assign overhead costs, such as machine hours or direct labor hours used.

3. Assign costs. Divide the usage measure into the total costs in the cost pools to arrive at the allocation rate per unit of activity, and assign overhead costs to produced goods based on this usage rate.

Overhead Absorption Absorbed overhead is manufacturing overhead that has been applied to products or other cost objects. Overhead is usually applied based on a predetermined overhead allocation rate. Overhead is over absorbed when the amount allocated to a product or other cost object is higher than the actual amount of overhead, while the amount is under absorbed when the amount allocated is lower than the actual amount of overhead.

For example, Higgins Corporation budgets for a monthly manufacturing overhead cost of Tk. 100,000, which it plans to apply to its planned monthly production volume of 50,000 widgets at the rate of Tk. 2 per widget. In January, Higgins only produced 45,000 widgets, so it allocated just Tk. 90,000. Also, the actual amount of manufacturing overhead that the company incurred in that month was Tk. 98,000. Therefore, Higgins experienced Tk. 8,000 of under absorbed overhead.

In February, Higgins produced 60,000 widgets, so it allocated Tk. 120,000 of overhead.

Also, the actual amount of manufacturing overhead that the company incurred in that month was Tk. 109,000. Therefore, Higgins experienced Tk. 11,000 of over absorbed overhead.

Absorption Costing Problems Since absorption costing requires the allocation of what may be a considerable amount of overhead costs to products, a large proportion of a product's costs may not be directly traceable to the product. Direct costing does not require the allocation of overhead to a product, and so may be more useful than absorption costing for incremental pricing decisions where you are more concerned with only the costs required to build the next incremental unit of product.

It is also possible that an entity could generate extra profits simply by manufacturing more products that it does not sell. This situation arises because absorption costing requires fixed manufacturing overhead to be allocated to the total number of units produced - if some of those units are not subsequently sold, then the fixed overhead costs assigned to the excess units are never charged to expense, thereby resulting in increased profits. A manager could falsely authorize excess production to create these extra profits, but it burdens the entity with potentially obsolete inventory, and also requires the investment of working capital in the extra inventory.

Marginal Costing Like process costing or job costing, marginal costing is not a distinct method of ascertainment of cost but is a technique which applies existing methods in a particular manner so that the relationship between profit & the volume of output can be clearly brought out. Marginal costing ascertains marginal or variable costs & the effect on profit, of the changes in volume or type of output, by differentiating between variable costs & fixed costs. To any type of costing such as historical, standard, process or job; the marginal costing technique may be applied.

Under the process of marginal costing, from the cost components, fixed costs are excluded.

The difference which arises between the variable costs incurred for activities & the revenue earned from those activities is defined as the gross margin or contribution. It may relate to total sales or may relate to one unit.

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The calculation of contribution for a specific product or group of products is done as follows: Sales Revenue Less Variable cost of production Contribution

X X X

For the business as a whole, contributions earned by specific products or group of products, are added so as to calculate the ‘pool’ of total contribution. The fixed costs of the business are paid from this ‘pool’ & then the part of the total contribution which remains becomes the profit of the business as a whole.

A typical format for marginal costing statement is as below: Product types or departments

A

B

C

Total

Sales Revenue Less Variable cost of production

X

X

X

X

X

X

X

X

Contribution Less: Fixed Costs Total Profit

X

X

X

X X X

Under marginal costing, for the calculation of profits for individual products or departments, no attempt is made- only calculation of individual contributions is done. The fixed cost does not allocated to or gets absorbed by the individual products or departments. Thus, accounting techniques relating to the treatment of fixed costs will not influence the decisions which are based on marginal costing system.

Examples of typical problems which require executive decisions are: a. At a lower price should a particular order be accepted or declined? b. Should purchase of a particular component be made from an outside supplier or manufactured within the factory? c. Concentration should be given on which products? d. By which profit-mix, profit will be maximized? e. What should be the effect on the business when an existing department is being closed or a new department is being opened? f. To make up for wage rise, what should be the additional volume of business? g. How by change in sales volumes or sales prices, the level of profit of business be influenced?

Features of Marginal Costing: a. Classification of costs into fixed costs & variable costs is done under marginal costing system. Also semi-fixed or semi-variable cots get further classified into fixed & variable elements. b. To the product, only variable elements of cost, which constitute marginal cost, are attached. c. After the marginal cost & marginal contribution are taken into consideration; price is fixed. d. From the total contribution for any period, fixed cost for the period are deducted. e. The profitability of a department or product is decided by the marginal contribution. f. At variable production cost, the valuation of work-in-progress & finished product is made.

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Advantages of Marginal Costing: a. As there is involvement of computation of variable costs only in marginal costing, it is easy to understand & operate the same. b. Among different products or departments, arbitrary apportionment of fixed costs is avoided & the under-recovery or over-recovery problems are eliminated. c. Any attempt of measurement of relative profitability of different products or different departments becomes complicated due to the arbitrary apportionment of fixed costs. d. Analysis of contribution, break even charts & analysis of cost-volume-profit-analysis are resulted out of a marginal costing system; for making short term decisions all of these are important. e. More uniform & realistic figures are resulted out of marginal costing system because fixed overhead costs are excluded from valuation of stock & work-in-progress. f. Apportionment of responsibility of control can be more easily done since to each level of management only variable costs are presented over which they have control. g. The effects of their decisions can be more readily seen by all levels of managementsometimes even before taking of an action.

Disadvantages of Marginal Costing: a. The process of separating semi-variable or semi-fixed costs into their variable & fixed elements is an arbitrary exercise which at different levels of output may be subject to fluctuations & inaccuracy. Consequently, a substantial degree of error may be contained in the basic cost information which is used in decision making process. b. When selling prices are based on marginal costs, great care need to be exercised, as in the long run, all fixed overheads should be covered by the prices & a reasonable margin over & above the total costs should be left. c. Under many circumstances, the deduction of contribution made by some production units may be difficult. Thereby the effectiveness of the system is lost. d. Since on the basis of variable costs only the valuation of stock of finished goods & work-in-progress is done, they are always understated. As result profit is also understated. e. More effective utilization of present resources or by expansion of resources or by mechanization, increased production & sales may be effected. The disclosure of this fact cannot be done by marginal costing.

Marginal Costing Vs. Absorption Costing The difference between marginal costing & absorption costing is as below: 1. Under marginal costing: for product costing & inventory valuation, only variable cost is considered whereas, under absorption costing; for product costing & inventory valuation, both fixed cost & variable cost are considered.

2. Under marginal costing, there is a different treatment of fixed overhead. Fixed cost is considered as period cost & by Profit/Volume ratio (P/V ratio), profitability of different products is judged. On the other hand, under absorption costing system, the fixed cost is charged to cost of production. A reasonable share of fixed cost is to be borne by each product & thereby subjective apportionment of fixed overheads influences the profitability of product.

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3. Under marginal costing, the presentation of data is so oriented that total contribution & contribution from each product gets highlighted. Under absorption costing, the presentation of cost data is on conventional pattern. After deducting fixed overhead, the net profit of each product is determined.

4. Under marginal costing, the unit cost of production does not get affected by the difference in the magnitude of opening stock & closing stock. Whereas, under absorption costing, due to the impact of the related fixed overheads, the unit cost of production get affected by the difference in the magnitude of opening stock & closing stock.

The situations where the absorption costing is more appropriate than marginal costing Absorption may be used to refer to absorption costing. This is a technique which ensures the documentation and accounting of all production costs of products or services. This is also called full costing.

Absorption costing allows companies to clearly and completely show information about their financial condition. It also allows companies to price more accurately, ensuring that the final price of a product or service takes into account the actual costs that went into them. This is particularly useful for small businesses which need to give more consideration to overhead expenses.

Absorption costing is taken in opposition to variable costing. Under variable costing, which may also be referred to as direct costing, only variable expenses are included in the computation. Therefore, fixed manufacturing costs are not included in the computation.

Since variable costing focuses more on expenses which can be modified or adjusted, it helps management plan and make decisions on how expenses can be minimized. Data taken from absorption costing shows the entire picture, together with fixed costs, so does not conveniently provide this information. On the other hand, since variable costing only shows part of the picture, it may not be taken by investors as reliable information. Also, since fixed costs are included in the computation of absorption costing, it might be more beneficial to use this information when sales change, since the figures won’t fluctuate too much.

Effects of opening & closing stock on profit: When income statements under absorption costing & marginal costing are compared, the under mentioned points should be considered: 1. The results under both the methods will be same in situations where sales & production coincide i.e., there is neither opening stock nor closing stock.

2. Profit under absorption costing will be more than the profit under marginal costing, when closing stock is more than the opening stock. The reason behind this is that, under absorption costing, a portion of fixed overhead, instead of being charged to the current period, is charged to the closing stock & carried over to the next period.

3. Profit shown under absorption costing will be lower than the profit shown under marginal costing, when closing stock is less than the opening stock. The reason behind this is that, under absorption costing, to the current period, a portion of fixed cost related to previous year is charged.

Reconciliation of results of absorption costing & marginal costing: When comparison of the results of absorption costing & marginal costing is undertaken, the adjustments for under- absorbed & / or over absorbed overheads becomes necessary.

Under absorption costing, on the basis of normal level of activity, the fixed overhead rate is predetermined. A situation of under-absorption &/or over-absorption arises when there is a difference between actual level of activity & normal level of activity.

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(i) Under-absorbed fixed overhead = Excess of normal level of activity over actual level of activity * Fixed overhead rate per unit.

If there is under-absorption, the profit under absorption costing, before comparison with profit as per marginal costing, should be reduced with under-absorbed fixed overheads.

Alternatively, by adding the under-absorbed fixed overhead to the cost of production, the same objective can be achieved. (ii) Over absorbed Fixed overhead = Excess of actual level of activity over normal level of activity * Fixed overhead rate per unit.

If there is over absorption, then before the comparison of profit as per absorption costing with the profit as per marginal costing, with over-absorbed fixed overheads, the profit under absorption costing should be increased. Alternatively, by reducing the over-absorbed fixed overhead from the cost of production, the same objective can be achieved.

Problem 1: For a particular product, the following cost data is given: Per unit (Tk. ) 20 12 4 52000 units

Selling Price Variable cost Fixed cost Normal production

For the four consecutive periods, the following additional data are given: Period 1

Period 2 Period 3

Period 4

Total

Units

Units

Units

Units

Units

-

-

12000

4000

Production

52000

60000

48000

60000

Sales

52000

48000

56000

64000

220000 220000 -

-

12000

4000

-

Opening stock

Closing stock

Prepare a statement showing the profit for different periods under both marginal costing method & absorption costing method.

Solution:

Under Marginal Costing

Particulars

Period 1

Sales – (i) Opening stock Production Total Less: Closing stock Cost of goods Sold (ii) Contribution (i) –(ii) Less: Fixed Cost 52000 units @ 4 Profit

K S Omar Faruk ACA

(Figure in Taka)

Period 2

Period 3

Period 4

1040000 624000 624000 -___

960000 720000 720000 144000

1120000 144000 576000 720000 48000

624000 416000

576000 384000

672000 448000

768000 512000

208000 208000

208000 176000

208000 240000

208000 304000

Total

1280000 4400000 48000 2640000 720000 2640000 768000 -____ 2640000 1760000 832000 928000

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Under Absorption Costing (Figure in Taka) Particulars Sales – (i)

Period 2

Period 1

Period 3

Period 4

Total

1040000

960000

1120000

1280000

-

-

192000

64000

Cost of Production Tk. 16 per unit

832000

960000

768000

960000

3520000

Total

832000

960000

960000

1024000

3520000

-

192000

64000

-

-__

832000

768000

896000

1024000

-

32000

32000

3520000 64000

(Notes 1)

(Notes 3)

Opening stock @ Tk. 16 per unit

Less: Closing stock @ Tk. 16 per unit Cost of goods sold (Actual) Less: Over-absorbed Overheads

832000

736000

896000 16000 (Notes 2)

992000

3456000 16000

832000

736000

912000

992000

3472000

208000

224000

208000

288000

928000

Add: Under-absorbed Overheads Cost of Sales after adjusting under/over absorbed overheads- (ii) Profit [(i) – (ii)

4400000

Notes: The following adjustments should be carried out for the purpose of comparison of results of absorption costing & marginal costing: 1. The normal capacity is 52000 units. Actual production during the period is 60000 units. That means there is over-absorption of fixed overhead amounting Tk. 32000 [(60000 units – 52000 units) * Tk. 4].

2. Actual production is 4 8000 units which are less than normal production by 4000 units. That means there is under-absorption of fixed overhead amounting Tk. 16000 [(52000 units – 48000 units) * Tk. 4].

3. Actual production is 60000 units which are more than normal production by 8000 units. That means there is over-absorption of fixed overhead amounting Tk. 32000 [(60000 units – 52000 units) * Tk. 4].

There is difference of profits under both the methods. The reasons of such difference are: 1. Period 1: During this period, since no opening or closing stock is there, there is no difference in profit figures under both the methods.

2. Period 2: During this period, profit under Absorption costing is more than that of Marginal costing by Tk. 48000. This is due to the fact that fixed cost of 12000 units @ Tk. 4 is being carried forward for the next year.

3. Period 3: During this period, profit under Absorption costing is less than that of Marginal costing by Tk. 32000. This is due to the fact that by 8000 units opening

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stock is more than that of closing stock. As a result, to the cost of production of current year, a portion of last year’s fixed overhead is being charged.

4. Period 4: During this period, profit under Absorption costing is less than that of Marginal costing by Tk. 16000. This is due to the fact that to the cost of production of current years, the fixed overhead relating to opening stock is being charged.

Presentation of data: The difference of presenting the data under marginal costing & absorption costing is summarized in the under mentioned table: Marginal Costing Sales

Absorption Costing XXX Sales

Less: Variable Cost Manufacturing

XXX

Administration

XXX

Selling

XXX

Contribution

Less: Manufacturing cost of goods sold (including fixed manufacturing overheads)

Less: Fixed cost XXX

Administration

XXX

Selling

XXX

Profit

XXX XXX

XXX XXX

Manufacturing

XXX

Less: Administration & Selling Expenses Profit

XXX XXX

XXX XXX

Note: Profits figure under the two methods will be different, if there are opening & closing inventories.

Problem- 1.

ABC Ltd. manufactures a single product. The following figures relate to the product for one year period.

Sales and production (units) 800 Taka Sales 16,000 Production costs Variable 6,400 Fixed 1,600 Sales and distribution costs Variable 3,200 Fixed 2,400 The normal level of activity for the year is 800 units. Fixed costs are incurred evenly throughout the year and actual fixed costs are the same as budgeted. A predetermined overhead absorption rate is used for the year. There were no inventories of the product at the beginning of the year. In the first quarter, 220 units were produced and 160 units sold.

Calculate the profit using: (i) Absorption costing, (ii) Marginal costing

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Problem- 2.

Following data relates to a manufacturing company: Number of units produced each year

6,000

Variable cost per unit: Direct materials

Tk. 2

Direct labor

Tk. 4

Variable Manufacturing Overhead

Tk. 1

Variable selling and Administrative expenses

Tk. 3

Fixed costs per year: Fixed manufacturing overhead

Tk. 30,000

Fixed selling and administrative expenses

Tk. 10,000

Units in beginning inventory

0

Units produced

6,000

Units Sold

5,000

Units in ending inventory

1,000

Selling price per unit

Tk. 20

Selling and administrative expenses: Variable per unit Fixed per year

Tk. 3 Tk. 10,000

Required: 1. Prepareincome statementsusing: a. Absorption costing system b.Variable costingsystem 2. Prepare a reconciliation schedule

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Solution Absorption Costing Income Statement Sales (5,000 units×Tk. 20 per unit)

Tk. 100,000

Less cost of goods sold: Beginning inventory

Tk. 0

Add Cost of goods manufactured (6,000 units × Tk. 12per unit)

Tk. 72,000

Goods available for sale

Tk. 72,000

Less ending inventory

Tk. 12,000 ----------

Cost of goods sold

Tk. 60,000

Gross Margin (Tk. 100,000 – Tk. 60,000)

Tk. 40,000

Less selling and administrative expenses Variable selling and administrative expenses (5,000 × 3)

Tk. 15,000

Fixed selling and administrative expenses

Tk. 10,000 Tk. 25,000

Net operating income(Tk. 40,000 – Tk. 25,000)

Tk. 15,000 ========

Variable Costing Income Statement Sales (Tk. 5,000units×Tk. 20 per unit)

Tk. 100,000

Less variable expenses: Variable cost of goods sold: Beginning inventory

Tk. 0

Add variable manufacturing costs (6,000 units×Tk. 7 per unit)

Tk. 42,000

Goods available for sale

Tk. 42,000

Less ending inventory (1,000 units×Tk. 7 per unit)

Tk. 7,000

Variable cost of goods sold

Tk. 35,000

variable selling and administrative expenses (5,000 units × Tk. 3 per unit)

Tk. 15,000 50,000

Contribution margin(Tk. 100,000 − Tk. 50,000)

50,000

Less fixed expenses: Fixed manufacturing overhead

Tk. 30,000

Fixed selling and administrative expenses

Tk. 10,000 Tk. 40,000

Net operating Income(Tk. 50,000 − Tk. 40,000)

Tk. 10,000 =======

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Problem- 3 Huda Motors assembles and sells motor vehicle. It uses an actual costing system, in which unit costs are calculated on a monthly basis. Data relating to March and April are: Unit data: Beginning Inventory Production sales Variable cost data: Manufacturing costs per unit produced Distribution cost per unit sold Fixed costs data Manufacturing costs Marketing costs Selling price per motor vehicles is Tk. 48,000

March

April

0 1000 700

300 800 1040

20000 6000

20000 6000

4000000 1200000

4000000 1200000

Required: i. Present Income statement for Huda Motors in March and April under (a) Variable costing and (b) Absorption costing ii. Explain the differences between (a) and (b) for March and April

Solution Basic data Production units Sales units Opening Inventory units Closing Inventory units

March 1000 700 0 300

April 800 1040 300 60

Income Statement under Variable costing (A) Sales Variable manufacturing costs Add: Opening Inventory @ 20000 per units Cost of goods available for sale Less: Closing Inventory 20000 per units Variable cost of goods sold Variable distribution cost (B) Total Variable cost (C) Contribution- (A-B) Fixed cost: Manufacturing costs Marketing costs (D) Total Fixed cost Net Income (C-D) K S Omar Faruk ACA

March 33600000 20000000 0 20000000 6000000 14000000 4200000 18200000 15400000

April 49920000 16000000 6000000 22000000 1200000 20800000 6240000 27040000 22880000

4000000 1200000 5200000 10200000

4000000 1200000 5200000 17680000 Page 11

Income Statement under Absorption costing March 33600000

April 49920000

20000000

16000000

4000000

4000000

24000000

20000000

0

7200000

24000000

27200000

7200000

1500000

16800000

25700000

Add: distribution cost- Variable

4200000

6240000

Add: Marketing costs - Fixed

1200000

1200000

22200000

33140000

11400000

16780000

March

April

20,000 4,000

20,000

(A) Sales Variable manufacturing costs Fixed Manufacturing costs Add: Opening Inventory Cost of goods available for sale Less: Closing Inventory Cost of goods sold

(B) Total cost Net Income (C-D)

Working Note-1 Cost of Opening Inventory per unit Variable costs per unit Fixed costs per unit (4000000/1000) (4000000/800)

24000

5,000 25000

7200000

1500000

10200000

17680000

Net Income under Absorption costing

11400000

16780000

Difference to be explained

-1200000

900000

300

(240)+60

4,000

5,000

1200000

900000

Cost of Opening Inventory 300*24000 / 60*25000 Explanation: Net Income under Variable costing

Increase (decrease) in Inventory in unit (Opening Inventory-Closing Inventory) Fixed cost Included in inventory under Absorption Costing Difference explained

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April 2016 a. Define marginal cost and marginal costing. Discuss usefulness and limitations of marginal costing. b. ABC limited sells its products at Tk. 30 per unit. The company uses a First in First Out actual costing system. A new fixed manufacturing overhead allocation rate is computed each year by dividing the actual fixed manufacturing overhead cost by the actual production costs.

The following simplified data are related to its first two years of operation: year-I year-II Sales (units) 1000 1200 Production (unit) 1400 1000 Costs (Tk.) Variable manufacturing 7,000 5,000 Fixed manufacturing 7,000 7,000 Variable marketing and administration 10,000 12,000 Fixed marketing and administration 4,000 4,000 Required: i. Prepare income statement based on: a. Absorption costing and b. Variable costing for each year. ii. Give reasons for the difference in the answer.

Solution Basic data

Year-I

Production units Sales units Opening stock units Closing stock units

1400 1000 400

Year-II 1000 1200 400 200

Income Statement under Absorption costing Amount in Taka

Sales Manufacturing cost-Variable Manufacturing cost-Fixed Add: Opening stock Cost of goods available for sale less: Closing stock Cost of goods sold Marketing and administration costs -Variable -Fixed Total cost Net Income (Sales-Total cost)

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Year-I

Year-II

30,000 7000 7000 14000 14000 4000 10000

36,000 5000 7000 12000 4000 16000 2400 13600

10000 4000 24000 6000

12000 4000 29600 6400

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Working Note i. Cost per unit year in I= 14,000÷1400=Tk. 10 ii. Cost per unit year in II= 12,000÷1000=Tk. 12 iii. Closing stock value in year I= 400 unit @ 10=4000 iv. Closing stock value in year II= 200 unit @ 12=2400

Income Statement under Marginal/Variable costing Amount in Taka

Sales (A) Manufacturing cost-Variable Add: Opening stock Cost of goods available for sale Less: Closing stock Cost of goods sold Variable Marketing and administration costs Total Variable cost (B) Contribution (A-B) Fixed cost- Manufacturing -Administration Total Fixed Cost Net Income (Sales-Total cost)

Year-I

Year-II

30,000 7000 7000 2000 5000 10000 15000 15000 7000 4000 11000 4000

36,000 5000 2000 7000 1000 6000 12000 18000 18000 7000 4000 11000 7000

Reason for difference in profit: Reason for difference in profit under marginal costing and absorption costing is the difference in the valuation of stocks.

Year-I

Year-II

Profit under Absorption costing

6000

6400

Profit under marginal costing

4000

7000

Difference in profit to be explained

2000

-600

(0×5) 0

(400×5) 2000

(400×5) 2,000

(200×7) 1400

2,000

-600

Fixed cost Included in Opening stock Fixed cost Included in Closing stock Increase/(Decrease) of fixed cost in Inventory (Closing stock-Opening stock) Differences are explained

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DIPLOMA IN ISLAMIC BANKING EXAMINATION Management Accounting & Financial Management (204) April-2017 Class-2 Master Budget Definition The master budget is the aggregation of all lower-level budgets produced by a company's various functional areas, and also includes budgeted financial statements, a cash forecast, and a financing plan. The master budget is typically presented in either a monthly or quarterly format, and usually covers a company's entire fiscal year. An explanatory text may be included with the master budget, which explains the company's strategic direction, how the master budget will assist in accomplishing specific goals, and the management actions needed to achieve the budget. There may also be a discussion of the headcount changes that are required to achieve the budget.

A master budget is the central planning tool that a management team uses to direct the activities of a corporation, as well as to judge the performance of its various responsibility centers. It is customary for the senior management team to review a number of iterations of the master budget and incorporate modifications until it arrives at a budget that allocates funds to achieve the desired results. Hopefully, a company uses participative budgeting to arrive at this final budget, but it may also be imposed on the organization by senior management, with little input from other employees.

What is 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. For instance, payroll must be paid every two weeks and utilities must be paid every month. The cash budget allows management to predict short falls in the company's cash balance and correct the problems before payments are due.

Likewise, the cash budget allows management to forecast large amounts of cash. Having large amounts of cash sitting idle in bank accounts is not ideal for companies. At the very least, this money should be invested to earn a reasonable amount of interest. In most cases, excess cash is better used to expand and develop new operations than sit idle in company accounts. The cash budget allows management to predict cash levels and adjust them as needed.

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Purposes of Cash Budgeting Properly preparing your cash budget will show how cash flows in and out of your business.

Also, it may then be used in planning your short-term credit needs. In today's financial world, you are required by most financial institutions to prepare cash budgets before making capital expenditures for new assets as well as for expenditures associated with any planned expansion. The cash budget determines your future ability to pay debts as well as expenses.

For example, preliminary budget estimates may reveal that your disbursements are lumped together and that, with more careful planning, you can spread your payments to creditors more evenly throughout the entire year. As a result, less bank credit will be needed and interest costs will be lower. Banks and other credit-granting institutions are more inclined to grant you loans under favorable terms if your loan request is supported by a methodical cash plan. Similarly, businesses that operate on a casual day-to-day basis are more likely to borrow funds at inopportune times and in excessive amounts. Without planning, there is no certainty that you will be able to repay your loans on schedule. However, once you've carefully mapped out a cash budget, you will be able to compare it to the actual cash inflows and outflows of your business. You will find that this comparison will go a long way in assisting you during future cash budget preparation. Also, a monthly cash budget helps pinpoint estimated cash balances at the end of each month which may foresee short-term cash shortfalls.

Importance Of Cash Budget The importance of cash budget may be summarized as follow:1. Helpful in Planning. Cash budget helps planning for the most points out cash surplus, or deficiency at selected point of management to arrange for the deficiency before time or to surplus money as profitable as possible without any threat to the

efficient use of cash. It time and enables the plan for investing the liquidity.

2. Forecasting the Future needs. Cash budget forecasts the future needs of funds, its time and the amount well in advance. It, thus, helps planning for raising the funds through the most profitable sources at reasonable terms and costs.

3. Maintenance of Ample cash Balance. Cash is the basis of liquidity of the enterprise.

Cash budget helps in maintaining the liquidity. It suggests adequate cash balance for expected requirements and a fair margin for the contingencies.

4. Controlling Cash Expenditure. Cash budget acts as a controlling device. The expenses of various departments in the firm can best be controlled so as not to exceed the budgeted limit.

5. Evaluation of Performance. Cash budget acts as a standard for evaluating the financial performance.

6. Testing the Influence of proposed Expansion Programme. Cash budget forecasts the inflows from a proposed expansion or investment programme and testify its impact on cash position.

7. Sound Dividend Policy. Cash budget plans for cash dividend to shareholders, consistent with the liquid position of the firm. It helps in following a sound consistent dividend policy.

8. Basis of Long-term Planning and Co-ordination. Cash budget helps in coordinating the various finance functions, such as sales, credit, investment, working capital etc. it is an important basis of long term financial planning and helpful in the study of long term financing with respect to probable amount, timing, forms of security and methods of repayment.

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Uses of Cash Budget Map Inflows and Outflows The primary use of a cash budget is that it allows a company to map out expected inflows and outflows of cash during a specified period of time, usually a year. This map will take into account when the company expects to receive revenues and when it may need to spend those revenues on expenses not covered in the operating budget. This serves as a road map, giving the company a rough outline of how much cash it will need during the year.

Predict Cash Shortages One advantage of cash budgeting is that this method can be used to accurately predict when the company will have less cash on hand than it might need to run the business. This gives the company the option to plan ahead and either shift cash inflows or obtain additional funds in advance. By predicting cash flow trends, the company can avoid having a midyear cash crunch.

Show Potential Surpluses In addition to predicting cash shortages, cash budgeting is an excellent tool for predicting when a company will have more money than it would normally expect. By detecting surpluses, particularly long-term surpluses, the company can potentially target other uses for this money. Investing the money back into the business is generally more profitable in the long term than keeping large cash reserves.

Calculate Borrowing If the company discovers in the course of preparing its cash budget that it will have a cash shortage that cannot be resolved by diverting funds from other sources, the company may choose to borrow money. By knowing how much cash it will have on hand, the company will be able to ascertain how much money it needs to borrow as well as when it will be able to repay the loan.

METHODS OF PREPARATIONS OF CASH BUDGET 1. The Adjusted Net Income Method: It require that a pro-forma income statement should be prepared for each desired interim period of the budget period. The net income figures for each period are then adjusted to a cash basis by deleting the transactions that are affecting the income statement but not the cash balance or the items which affect then one without affecting the other. This adjusted figure is taken as cash profit (or loss) during that period. This is taken as net increase or decrease in cash balance during that period.

2. The Pro-forma Balance Sheet Method: It requires the preparation of as many as pro-forma sheets as there are interim periods in the cash budget. Each item of the balance except cash is projected for each period, and the cash balance is ascertained in accordance with the accounting equation i.e., Total Assets = Total Liabilities + Capital. The balancing figure of the pro-forma balance sheets is taken as the cash balance. A negative cash balance or a cash balance falling below minimum desirable balance would, of course, indicate a need for borrowing funds or otherwise adjusting the flow to make up the anticipated shortage of cash.

3. Receipt and payment methods of cash budget: Cash budget, under this method, is a statement projecting the cash inflows & outflows (receipt & disbursements) of the firm over various interim period of the budget period. For each period, the expected inflows are put against the expected outflows to find out if there is going to be any surplus or deficiency in a particular period. Surplus, if any, during a particular period may be carried forward to the next period or steps may take to make short term investments of this surplus. Deficiencies, if any, must be arranged for within the same period from some short term sources of finance such as bank credit etc.

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While preparing the cash budget, the desired minimum cash balance is considered at the end of the cash budget period. I f a firm is preparing monthly cash budget , then the cash balance at the end of each month must be equal to the desired cash balance. If not ,then arranged must be made /planned to increase the cash balance at that time by procuring funds from some or other source.

Problem-1 M&M limited operates a retail business. Purchases are sold at cost plus 33⅓.

Month

Budgeted sales (Tk)

Labour cost (Tk)

Expenses incurred (Tk)

January

40,000

3,000

4,000

February

60,000

3,000

6,000

March

160,000

5,000

7,000

April

120,000

4,000

7,000

i. It is a management policy to have sufficient inventory in hand at the end of each month to meet half of the next month’s sales demand. ii. Suppliers for materials and expenses are paid in the month after the purchases are made/expenses incurred. Labour is paid in full by the end of each month. iii. Expenses include a monthly depreciation charge of Tk. 2,000. iv. 1) 75% of sales are for cash v. 2) 25% of sales are on one month’s credit. vi. The company will buy equipment costing Tk. 18,000 for cash in February and will pay a dividend of Tk.20,000 in March. The opening cash balance at 1 February is Tk. 1,000.

Prepare a cash budget for February and March with comments on the result.

Cash budget February

March

Receipts Receipts from sales

55,000

135,000

Trade payables Expense payables

37,500 2,000

82,500 4,000

Labour Equipment purchase Dividend Total payments Receipts less payments

3,000 18,000

5,000

60,500 (5,500)

20,000 111,500 23,500

Opening cash balance b/f Closing cash balance c/f

1,000 (4,500)

(4,500) 19,000

Payments

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WORKINGS Receipts in February 75% of Feb sales (75% 60,000) 45,000 25% of Jan sales (25% 40,000) 10,000 55,000 Receipts in March 75% of Mar sales (75% 160,000) 120,000 25% of Feb sales (25% 60,000) 15,000 135,000 Purchases For Jan sales For Feb sales For Mar sales

January (50% of 30,000) (50% of 45,000)

Taka 15,000 22,500

February

Taka

22,500 (50% of 45,000) (50% of 120,000)

22,500 60,000 82,500

37,500 These purchases are paid for in February and March.

Expenses Cash expenses in January (4,000 – 2,000) and February (6,000 – 2,000) are paid in February and March respectively. Depreciation is not a cash item.

Problem-2 ABC Co. wishes to arrange overdraft facilities with its Bankers during the period April to June, 2010, when it will be manufacturing mostly for stock. Prepare a cash budget for the above period from the following data, indicating the extent of the bank facilities the company will require at the end of each month: Sales /TK

Purchases /TK

Wages/ TK

February 2010

180,000

124,800

12,000

March 2010

192,000

144,000

14,000

April 2010

108,000

243,000

11,000

May 2010

174,000

246,000

10,000

June 2010

126,000

268,000

15,000

(ii) 50% of credit sales are realized in the month of following the sales and the remaining 50% in the second month following. Creditors are paid in the month following the month of purchase. (iii) Cash at bank on 1‐4‐2010 estimated Tk. 25,000.

Problem-3 You are presented with the budgeted data shown in Annex A for the period November 2015 to June 2016 by your firm. It has been extracted from the other functional budgets that have been prepared. You are also told the following. (a) Sales are 40% cash, 60% credit. Credit sales are paid two months after the month of sale. (b) Purchases are paid in the month following purchase. (c) 75% of wages are paid in the current month and 25% the following month. (d) Overheads are paid the month after they are incurred. The overhead figures include monthly depreciation of Tk. 2,000. (e) Dividends are paid three months after they are declared.

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(f) Capital expenditure is paid two months after it is incurred. (g) The opening cash balance is Tk. 15,000.

Annex A Sales Purchases Wages Overheads Dividends declared

Nov2015

Dec 015

Jan 2016

Feb2016

Mar2016

Apr2016

May2016

June2016

80,000 40,000 10,000 12,000

100,000 60,000 12,000 12,000 20,000

110,000 80,000 16,000 17,000

130,000 90,000 20,000 17,000

140,000 110,000 24,000 17,000

150,000 130,000 28,000 22,000

160,000 140,000 32,000 22,000

180,000 150,000 36,000 22,000 40,000

30,000

Capital expenditure

40,000

Prepare cash budget for the above period for the period from January to June-2016

Solution Receipts Sales revenue: Cash Credit Payments Purchases Wages: 75% 25% Overheads Dividends Capital expenditure

Net cash flow Opening balance Closing balance

Jan 2016

Feb 2016

Mar2016

Apr2016

May2016

June2016

44,000 48,000 92,000

52,000 60,000 112,000

56,000 66,000 122,000

60,000 78,000 138,000

64,000 84,000 148,000

72,000 90,000 162,000

60,000

80,000

90,000

110,000

130,000

140,000

12,000 3,000 10,000

15,000 4,000 15,000

21,000 6,000 15,000

24,000 7,000 20,000

27,000 8,000 20,000

85,000

114,000

18,000 5,000 15,000 20,000 30,000 178,000

152,000

181,000

235,000

7,000 15,000 22,000

(2,000) 22,000 20,000

(56,000) 20,000 (36,000)

(14,000) (36,000) (50,000)

(33,000) (50,000) (83,000)

(73,000) (83,000) (156,000)

DIB, April 2016 a. What is the Primary Purpose of a Cash Budget? b. Reliance Ltd. is the merchandising company and sells a wide range of products. Since sales of the company have grown rapidly over the few years, the company is planning to take investment facilities from an Islamic bank to meet the working capital requirement. Mr. Amjad Hossain, Managing Director of the company has just approached the company’s bank with a request for investment facilities of Tk. 6,00,000 (for 180 days), as it will assist the company in acquiring inventories. As the company had some difficulty in paying off its dues in the past, the relationship officer of the bank has asked for a cash budget to help in determining whether the Investment should be granted or not. For preparing cash budget following data is available for six months (From January to June-2016), during which the investment facilities will be used: a. On January 1, the start of the investment period, cash balance will be Tk. 156,000 and accounts receivable Tk. 910,000 of which Tk. 845,000 will be collected during January and Tk. 45,000 will be collected during February. The remainder will be uncollected. b. Past experience shows that 30% of a month’s sales are collected in the month of sale, 60% in the month following sale, and 8% in the second month following sale. The other 2% represents bad debts that are never collected. Budgeted sales and expenses for the six months are as follows: K S Omar Faruk ACA

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Particulars

January

February

March

1200,000

1,800,000

2,100,000

3,150,000 3,675,000

5,512,500

720,000

1,080,000

1,260,000

1,890,000 2,205,000

3,307,500

Payroll

54,000

81,000

94,500

141750

165,375

248,063

Lease Payments

90,000

90,000

90,000

90,000

90,000

90,000

420,000

480,000

540,000

617,143

694,286

793,469

60,000

60,000

60,000

60,000

60,000

Sales Purchases

Advertising Equipment purchases

48,000

Depreciation

60,000

April

May

June

c. Merchandise purchases are paid in full during the month following purchase. Accounts payable Tk. 1200,000 for merchandise purchased on December 31, which will be paid during January. d. In preparing the cash budget, assume that Tk. 600,000 Investment facilities will be sanctioned in January and repaid in June. Profit of Tk. 42,000 will be charged against the Investment.

Requirement: Prepare a cash budget showing month-wise and total budgeted figures from January to June 2016.

Cash budget of Reliance Ltd January

February

March

April

May

June

Total

Current month sales

360,000

540,000

630,000

945,000

1,102,500

1,653,750

5,231,250

Last month sales

846,000

720,000

1,080,000

1,260,000

1,890,000

2,205,000

8,001,000

Second last month sales

-

43,200

96,000

144,000

168,000

252,000

703,200

Cash collections

Loan Total collection

600,000

600,000

1,806,000

1,303,200

1,806,000

2,349,000

3,160,500

4,110,750

14,535,450

1,200,000

720,000

1,080,000

1,260,000

1,890,000

2,205,000

8,355,000

Payroll

54,000

81,000

94,500

141,750

165,375

248,063

784,688

Lease payments

90,000

90,000

90,000

90,000

90,000

90,000

540,000

Advertising Equipment purchases Loan and interest

420,000

480,000

540,000

617,143

694,286

793,469

3,544,898

Cash payments Purchases

48,000

1,812,000

Cash surplus/(deficit)

48,000

1,371,000

642,000

642,000

1,804,500

2,108,893

2,839,661

3,978,532

13,914,586

-6,000

-67,800

1,500

240,107

320,839

132,218

620,864

Opening balance

156,000

150,000

82,200

83,700

323,807

644,646

156,000

Closing balance

150,000

82,200

83,700

323,807

644,646

776,864

776,864

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September-2016 1. What use is the cash budget?

2. From the Information given below, Prepare a cash budget for the three months ended on June 2016, Months Sales Materials Wages Overheads 17,000 February 1,40,000 96,000 30,000 19,000 March 1,50,000 90,000 30,000 20,000 April 1,60,000 92,000 32,000 22,000 May 1,70,000 1,00,000 36,000 23,000 June 1,80,000 1,04,000 40,000 Other Information are: i. 15% sales are on cash, 40% of the credit sales are collected next months and balance in the following month; ii. Credit terms are: Materials 2 months, Wages half month and overhead one month. iii. Cash and bank balance on 1st April, 2016 is expected to be Tk. 60,000. iv. Plant and machinery, purchased from leasing company, will be installed in February, 2016 at a cost of Tk. 9,60,000, the monthly installment of Tk 20,000 is payable from April onwards. v. Tk. 1,00,000 will be received from the buyer of the dismantled machine in May. vi. Dividends from investments Tk. 15,000 are expected to be received in June. vii. Dividend of Tk 20,000 will be paid on 1st June. viii. Advance income tax to be paid in June Tk. 20,000.

Solution Cash budget for the three months ended on June 2016,

Particulars

April

May

June

Total

24,000

25,500

27,000

76,500

122,400

130,900

139,400

392,700

Cash collections Cash sale-Current month sales Collection from debtors

100,000

Sale Proceeds of Machine Dividend

100,000 15,000

15,000

146,400

256,400

181,400

584,200

Purchases

96,000

90,000

92,000

278,000

Payroll

31,000

34,000

38000

103,000

Overhead

19,000

20,000

22,000

61,000

Lease payments

20000

20,000

20,000

60,000

Dividend

20,000

20,000

Income Tax

20,000

20,000

Total collection Cash payments

Total Payment

166,000

164,000

212,000

542,000

Cash surplus/(deficit)

-19,600

92,400

-30,600

42,200

Opening balance

60000

40,400

132,800

60000

Closing balance

40,400

132,800

102,200

102,200

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DIPLOMA IN ISLAMIC BANKING EXAMINATION Management Accounting & Financial Management (204) April-2017 For Self Study K S Omar Faruk ACA

Financial Ratios Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios can be used to analyze trends and to compare the firm's financials to those of other firms. In some cases, ratio analysis can predict future bankruptcy.

Financial ratios can be classified according to the information they provide. The following types of ratios frequently are used:     

Liquidity ratios Asset turnover ratios Financial leverage ratios Profitability ratios Dividend policy ratios

Liquidity Ratios Liquidity ratios provide information about a firm's ability to meet its short-term financial obligations. They are of particular interest to those extending short-term credit to the firm.

Two frequently-used liquidity ratios are the current ratio (or working capital ratio) and the quick ratio.

The current ratio is the ratio of current assets to current liabilities: Current Assets Current Ratio

=

Current Liabilities Short-term creditors prefer a high current ratio since it reduces their risk. Shareholders may prefer a lower current ratio so that more of the firm's assets are working to grow the business.

Typical values for the current ratio vary by firm and industry. For example, firms in cyclical industries may maintain a higher current ratio in order to remain solvent during downturns.

One drawback of the current ratio is that inventory may include many items that are difficult to liquidate quickly and that have uncertain liquidation values. The quick ratio is an alternative measure of liquidity that does not include inventory in the current assets. The quick ratio is defined as follows: Current Assets - Inventory Quick Ratio

=

Current Liabilities The current assets used in the quick ratio are cash, accounts receivable, and notes receivable.

These assets essentially are current assets less inventory. The quick ratio often is referred to as the acid test.

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Finally, the cash ratio is the most conservative liquidity ratio. It excludes all current assets except the most liquid: cash and cash equivalents. The cash ratio is defined as follows: Cash + Marketable Securities Cash Ratio

=

Current Liabilities The cash ratio is an indication of the firm's ability to pay off its current liabilities if for some reason immediate payment were demanded.

Asset Turnover Ratios Asset turnover ratios indicate of how efficiently the firm utilizes its assets. They sometimes are referred to as efficiency ratios, asset utilization ratios, or asset management ratios. Two commonly used asset turnover ratios are receivables turnover and inventory turnover.

Receivables turnover is an indication of how quickly the firm collects its accounts receivables and is defined as follows: Annual Credit Sales Receivables Turnover

=

Accounts Receivable The receivables turnover often is reported in terms of the number of days that credit sales remain in accounts receivable before they are collected. This number is known as the collection period. It is the accounts receivable balance divided by the average daily credit sales, calculated as follows: Accounts Receivable Average Collection Period = Annual Credit Sales / 365 The collection period also can be written as: 365 Average Collection Period = Receivables Turnover Another major asset turnover ratio is inventory turnover. It is the cost of goods sold in a time period divided by the average inventory level during that period: Cost of Goods Sold = Inventory Turnover Average Inventory The inventory turnover often is reported as the inventory period, which is the number of days worth of inventory on hand, calculated by dividing the inventory by the average daily cost of goods sold: Average Inventory Inventory Period = Annual Cost of Goods Sold / 365 K S Omar Faruk ACA

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The inventory period also can be written as: 365 Inventory Period = Inventory Turnover Other asset turnover ratios include fixed asset turnover and total asset turnover.

Financial Leverage Ratios Financial leverage ratios provide an indication of the long-term solvency of the firm. Unlike liquidity ratios that are concerned with short-term assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt.

The debt ratio is defined as total debt divided by total assets: Total Debt Debt Ratio = Total Assets The debt-to-equity ratio is total debt divided by total equity: Total Debt Debt-to-Equity Ratio = Total Equity Debt ratios depend on the classification of long-term leases and on the classification of some items as long-term debt or equity.

The times interest earned ratio indicates how well the firm's earnings can cover the interest payments on its debt. This ratio also is known as the interest coverage and is calculated as follows: EBIT Interest Coverage = Interest Charges where EBIT = Earnings Before Interest and Taxes Equity Multiplier The ratio of a company’s total assets to its stockholder’s equity. The equity multiplier is a measurement of a company’s financial leverage. Companies finance the purchase of assets either through equity or debt, so a high equity multiplier indicates that a larger portion of asset financing is being done through debt. The multiplier is a variation of the debt ratio.

The ratio is calculated fairly simply. For example, a company has assets valued at Tk. 30 million and stockholder equity of Tk1 million. The equity multiplier value would be 3.0 (Tk 30 million / Tk. 10 million), meaning that one third of a company’s assets are financed by equity.

Profitability Ratios Profitability ratios offer several different measures of the success of the firm at generating profits.

The gross profit margin is a measure of the gross profit earned on sales. The gross profit margin considers the firm's cost of goods sold, but does not include other costs. It is defined as follows: Sales - Cost of Goods Sold Gross Profit Margin =

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Sales Return on assets is a measure of how effectively the firm's assets are being used to generate profits. It is defined as: Net Income = Return on Assets Total Assets Return on equity is the bottom line measure for the shareholders, measuring the profits earned for each dollar invested in the firm's stock. Return on equity is defined as follows: Net Income = Return on Equity Shareholder Equity

Dividend Policy Ratios Dividend policy ratios provide insight into the dividend policy of the firm and the prospects for future growth. Two commonly used ratios are the dividend yield and payout ratio.

The dividend yield is defined as follows: Dividends Per Share = Dividend Yield Share Price A high dividend yield does not necessarily translate into a high future rate of return. It is important to consider the prospects for continuing and increasing the dividend in the future.

The dividend payout ratio is helpful in this regard, and is defined as follows: Dividends Per Share Payout Ratio = Earnings Per Share

Use and Limitations of Financial Ratios Attention should be given to the following issues when using financial ratios:  A reference point is needed. To to be meaningful, most ratios must be compared to historical values of the same firm, the firm's forecasts, or ratios of similar firms.  Most ratios by themselves are not highly meaningful. They should be viewed as indicators, with several of them combined to paint a picture of the firm's situation.  Year-end values may not be representative. Certain account balances that are used to calculate ratios may increase or decrease at the end of the accounting period because of seasonal factors. Such changes may distort the value of the ratio. Average values should be used when they are available.  Ratios are subject to the limitations of accounting methods. Different accounting choices may result in significantly different ratio values.

June-July-2013 (MA) a) b)

What is Price Earning (P/E) Ratio?

What is Receivable-Turnover Ratio?

c)

Balance Sheet as at 31.12.12 of M/s. Sincere Ltd. is as follows: Paid-up Capital General Reserve Long- term Investments

K S Omar Faruk ACA

6,00,000 Land & Building 1,55,000 Plant & Machineries 80,000 Inventory

1,60,000 5,60,000 1,06,000 Page 26

Short-term Investments Accounts Payable

78,000 Accounts Receivable 53,000 Cash at Bank Tk. 9,66,000

1,10,000 30,000 Tk. 9,66,000

Additional Information: Tax rate-30%, Net Profit Before Tax-Tk. 1, 12,000, Sales- Tk. 14, 50,000 and Cost of Goods Sold- Tk. 12, 36,000.

You are required to calculate: i) iv) vii)

Current Ratio; Inventory Turnover Ratio; Equity Multiplier.

ii) v)

Acid Test Ratio; Total Asset Turnover;

iii) vi)

Gross Profit Margin; Return on Equity; and

October-2011 (MA) The Balance Sheet, Income Statement and the industry average of financial ratios of Mina Computer Limited are given below:

Assets Cash Receivables Inventories Total Current Assets Net Fixed Assets

Amount Tk. 77,500 3,36,000 2,41,500 6,55,000 2,92,500

Total Assets

Tk. 9,47,500

Particulars Sales Cost of goods sold Materials Labor Heat, Light, Power Indirect Labor Depreciation Gross Profit General and Administrative Expenditure Selling Expenditure Earnings before Profit and

K S Omar Faruk ACA

Balance Sheet As at 31 December 200A Equity& Liabilities Amount Accounts Payable Tk. 1,29,000 Notes Payable 84,000 Other Current Liabilities 1,17,000 Total Current Liabilities 3,30,000 Long Term Liabilities 2,56,500 Common Equity 3,61,000 Total Liabilities & Equities

Tk. 9,47,500

Income Statement For the year ended 31 December 200A Amount Tk. 16,07,500 7,17,000 4,53,000 68,000 1,13,000 41,500____

30,000 1,15,000_____

13,92,500_ 2,15,000

1,45,000_

Page 27

Taxes (EBPT) Financial Expenses Earnings before Tax Income Tax Net Income

70,000 24,500_ 45,500 18,200 27,300

Industry norms are: (i) Current ratio:2.5 (ii)Acid test ratio:1.5 (iii) Inventory Turnover:2.2 times (iv)Average collection period: 90 days (v) Debt ratio: 0.33 (vi) Profit coverage :7 (vii) Total Asset Turnover:0.75 (viii) Fixed Assets Turnover:1.00 (ix) Operating Profit Margin:20% (x) Return on Common Equity:9%.

Requirement: Calculate the relevant ratios for the firm to compare with the industry norms. Also comment on the following aspects: (a) (b) (c) (d)

Liquidity of the firm Management Efficiency and Profitability Financing Techniques of the firm Common Stockholders receiving return on their investment.

From Investment Management 1. (April)-2011 The following are the Summarised Trading, Profit & Loss Account of Three Star Ltd. for the year ended 31st December 2010, and a Balance Sheet of the company as on that date: Trading, Profit and Loss Account Particulars To opening stock To Purchase

Amount Particulars 9,950/- By Sales 54,525/- By Closing Stock.

To Carriage inward To Gross Profit Total

1,425/34,000/99,900/-

To Office Exp. To Selling Exp.

15,000/- By Gross Profit b/d 3,000/- By profit on Sale of Shares

To Financial Exp. To Loss on Sale of an Asset To Net Profit Total

Total

1,500/- By Profit on Investment 400/15,900/34,900/-

Total

20

20

Amount 85,000/14,900/-

99,900/34,000/600/300/-

34,900/-

Balance Sheet Liabilities

K S Omar Faruk ACA

Taka

Assets

Taka

Page 28

Shares cap: 2,000 ordinary shares of Tk.10 each Reserves

20,000/- Land Buildings

15,000/-

9,000/- Plant

8,000/-

Profit & Loss Account

6,000/- Stock

14,000/-

Bank Investment

3,000/- Debtors

7,000/-

Sundry Creditors

8,000/- Bill Receivables

1,000/-

Outstanding Exp.

2,000/- Cash & Bank Balance

3,000/-

Total 48,000/Total 48,000/Calculate the following Ratios: i) Gross profit Ratio ii) Debt Equity Ratio iii) Liquidity Ratio iv) Fixed Assets Turnover.

2. April-2008 The following is the Balance Sheet of K-2 Company Ltd. for the year ended 31st Dec-2007.

Balance Sheet

Capital and Liabilities Equity and Share Capital Capital Reserve 12% Mortgage Investment Sundry Creditors Bank Overdraft Provision for Taxation Profit and Loss Account

Amount 4,00,000 80,000 2,00,000 1,60,000 40,000 80,000 1,20,000 10,80,000

Assets Good will Fixed Assets Stock Investment (Short term) Cash

Amount 2,40,000 5,60,000 1,20,000 40,000 1,20,000

10,80,000

Showing the full working, calculate the following ratios, giving the formulae and also state the purpose of these ratios serve: i) Current Ratio; ii) Quick Ratio; iii) Proprietary Ratio; and iv) Debt Equity Ratio.

3. (August-2008) The following is the Balance Sheet of XYZ Company Ltd. for the year ended 31st Dec-2007.

Balance Sheet Liabilities Paid up Shares of Tk. 10 each Reserve Profit and Loss Account Secured Investment Sundry Creditors Provision for Taxation Total

Amount 1,00,000 20,000 30,000 80,000 50,000 20,000 3,00,000

Assets Good will Fixed Assets (at cost) Stock Sundry Debtors Investment (Short term) Cash Balance

Amount 60,000 1,40,000 30,000 30,000 10,000 30,000 3,00,000

Calculate the following ratios from the given Balance Sheet: i) Debt Equity ratio ii) Liquidity ratio iii) Fixed assets to Current assets ratio iv) Fixed Assets turnover ratio.

K S Omar Faruk ACA

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4. (March)-2010 a) What are the different major types of ratios? Why are they calculated? b) Total sales for the year 2009 was Tk. 27,00,000 and the balance sheet of Alfa Co. Ltd. as on 31st December 2009 was as follows: Capital and Liabilities Sundry Creditors Outstanding expenses Notes payable Long Term debts Reserves Paid up capital

(Tk.) 5,00,000 2,00,000 3,00,000 8,00,000 2,00,000 10,00,000

Assets and Properties Cash in hand Sundry debtors Short Term investment Inventory Goodwill Fixed Assets

30,00,000

(Tk.) 3,00,000 3,00,000 10,00,000 3,00,000 1,00,000 10,00,000 30,00,000

Calculate the following ratios: i) Current ratio; ii) Quick ratio; iii) Inventory Turn over ratio; iv) Debt equity ratio; v) Debt to total Asset ratio; vi) Fixed Asset Turnover ratio.

April-2012 What is ratio analysis? What are the internal and external uses of ratio analysis? Distinguish between ratio analysis and trend analysis.

Following are the comparative ratios of two companies. Compare the merits of respective ratios and find out which of two companies is in a better position in each of the following ratios. Justify your answer:

1.

2.

3.

4.

5.

6.

Name of the Ratio Current Ratio Interest Coverage Ratio Debt Equity Ratio Receivable Turnover Ratio Payable Turnover Ratio Average Collection Period

K S Omar Faruk ACA

Alpha Co. 2:1 4:1 5:1 6 7 60 days

Beta Co. 6:1 6:1 6:1 9 10 50 days

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