Unit 2 Accounting and Auditing PYQ’s 17th Oct 2020 Shift 2

The correct answer is – Decrease in current ratio

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables.

Key Points

When the current ratio is 2:1, an equal increase in current assets and current liabilities would decrease the current ratio.

Let us understand this through an example;

Current Assets = Rs.200000 and Current Liabilities = Rs.100000

Current ratio = Current assets/Current liabilities = 200000/100000 = 2:1

Now let us increase the current assets and current liabilities by Rs.100000 and calculate the new current ratio ;

Current ratio = 300000/200000 = 1.5:1.

Thus, option 3 is the correct answer.

The correct answer is – 66.67%

An activity ratio is a type of financial metric that indicates how efficiently a company is leveraging the assets on its balance sheet, to generate revenues and cash. Commonly referred to as efficiency ratios, activity ratios help analysts gauge how a company handles inventory management, which is key to its operational fluidity and overall fiscal health.

Key Points

Activity Ratio = Capacity Ratio x Efficiency Ratio

Efficiency Ratio = Activity Ratio / Capacity Ratio

∴ Efficiency Ratio = 80 / 120

∴ Efficiency Ratio = 66.67%

Thus, option 4 is the correct answer.

The correct answer is – Rs. 80,000

Current Purchasing Power Accounting (CPPA):

1. This approach is also known as General Price Level Accounting.
2. Under this approach, the historic cost accounting data are adjusted on the basis of any established and approved general price index at a given date.
3. In India, the Wholesale Price Index (WPI) of the Reserve Bank of India (RBI) can be taken which shows the change in the value of the rupee in the past years.
4. This approach takes into account the changes in the value of items as a result of the general price level, but it does not account for changes in the value of individual items.

Key Points

The formula for the conversion of historic cost to the general price level is as under:

Conversion Factor = Index Converting To / Index Converting From

∴ Conversion Factor = 200/150 = 1.33333

The original invested capital is then multiplied by this conversion factor.

Value Of Machinery = 60000 x 1.33 = Rs. 80,000.

Thus, option 3 is the correct answer.

The correct answer is – Opening capital = Closing capital + Drawings – Additional capital – Profit

Opening Capital = Closing Capital + Drawings – Additional Capital – Profit + Loss

Key Points

1. The opening balance is the balance that is brought forward at the beginning of an accounting period from the end of a previous accounting period or when starting out.

2. The opening balance is the number of funds in a company’s account at the beginning of a new financial period.
3. It is the first entry in the accounts, either when a company is first starting up its accounts or after a year-end.
4. In an operating firm, the ending balance at the end of one month or year becomes the opening balance for the beginning of the next month or accounting year.
5. The opening balance may be on the credit or debit side of the ledger.
6. Opening Capital = Closing Capital + Drawings – Additional Capital – Profit + Loss

Thus, option 3 is the correct answer.

The correct answer is – 12 : 8 : 5

Old Profit Sharing Ratio (X and Y) = 3:2

Z is admitted for a 1/5th share.

New Profit Sharing Ratio (X and Y) = 1 – 1/5 = 4:5

A’s New Profit Sharing Ratio = 3/5 * 4/5 = 12/25

B’s New Profit Sharing Ratio = 2/5 * 4/5 = 8/25

A: B: C = 12/25: 8/25: 1/5

Using the L.C.M method to make denominators common,

New Profit Sharing Ratio Of A:B: C is 12:8:5

Thus, option 1 is the correct answer.

The correct answer is – A, B and D only

The objective of energy management and audit invariably includes following in business enterprises

A. Minimising cost of energy consumption

B. Minimising waste in energy consumption

D. Minimising environmental degradation

Key Points

Energy management is the process of monitoring, controlling, and conserving energy in a building or organization. The energy management process starts with an energy audit of a given location. Just as stated above, the goal is to find opportunities to improve efficiency.

• Energy today has become a key factor in deciding the product cost at a micro-level as well as in dictating the inflation and the debt burden at the macro level. Energy cost is a significant factor in economic activity at par with factors of production like capital, land, and labor.
• The imperatives of an energy shortage situation call for energy conservation measures, which essentially mean using less energy for the same level of activity.
• Energy Audit attempts to balance the total energy inputs with their use and serves to identify all the energy streams in the systems and quantifies energy usages according to its discrete function.
• Energy Audit helps in energy cost optimization, pollution control, safety aspects and suggests the methods to improve the operating & maintenance practices of the system.
• It is instrumental in coping with the situation of variation in energy cost availability, reliability of energy supply, the decision on appropriate energy mix, the decision on using improved energy conservation equipment, Instrumentations, and technology.
• The Energy Audit provides the vital information base for the overall energy conservation program covering essentially energy utilization analysis and evaluation of energy conservation measures.

Confusion Points

The energy-cum-environment audit allows simultaneous consideration of energy and environmental aspects. As a result, it is possible to identify options to reduce the overall cost of energy as well as pollution control. Also, some of the principles of energy cost reduction and pollution control are identical. However, it meticulously does not scale the harmful impacts of pollution on the health of the natives.

Therefore, option 3 is the correct answer.

The correct answer is – a-iii, b-i, c-ii, d-iv

The explanation of the above ratio:

1. Current Ratio:

• The current ratio compares all of a company’s current assets to its current liabilities. These are usually defined as assets that are cash or will be turned into cash in a year or less, and liabilities that will be paid in a year or less.
• The current ratio is sometimes referred to as the “working capital” ratio and helps investors understand more about a company’s ability to cover its short-term debt with its current assets.
• Weaknesses of the current ratio include the difficulty of comparing the measure across industry groups, overgeneralization of the specific asset and liability balances, and the lack of trending information.
• Current Ratio= Current Assets/Current Liabilities

2. Debtor turnover ratio :

• While calculating this ratio, only the net credit sales is to be taken into consideration.
• Ideally, a company compares its debtors turnover ratio with the companies that have similar business operations and revenue and lie within the same industry.
• The formula to compute Debtors Turnover Ratio is: Debtors Turnover Ratio = Net Credit Sales/Average Account Receivable.
• Where Average Account Receivable includes trade debtors and bill receivables.
• The higher the Debtors turnover ratio, the better is the credit management of the firm.

3. Interest coverage ratio:

• The interest coverage ratio is used to see how well a firm can pay the interest on outstanding debt.
• Also called the times-interest-earned ratio, this ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm.
• A higher coverage ratio is better, although the ideal ratio may vary by industry.
• The Formula for the Interest Coverage Ratio: Interest Coverage Ratio=Interest Expense/EBIT
• Where, EBIT=Earnings before interest and taxes

4. Debt Equity Ratio

• The debt-to-equity (D/E) ratio compares a company’s total liabilities to its shareholder equity and can be used to evaluate how much leverage a company is using.
• Higher leverage ratios tend to indicate a company or stock with higher risk to shareholders.
• However, the D/E ratio is difficult to compare across industry groups where ideal amounts of debt will vary.
• Investors will often modify the D/E ratio to focus on long-term debt only because the risk of long-term liabilities are different than for short-term debt and payables.
• Debt Equity Ratio= Total Liabilities/Total shareholder’s Equity

Therefore, the correct match is:

Hence Option 1 is correct.

The correct answer is – B and A only

Vouching refers to reviewing documentary evidence to see if it properly supports entries made in the accounting records. While vouching, and the auditor is looking for any errors in the amount recorded in the accounting records, as well as ensuring that the transactions are recorded in the correct accounts.

Key Points

A sales voucher is a form of a receipt or documentation commonly given to a buyer of supplies or goods. It typically serves as proof of purchase when a provider must order or deliver the goods at a later point.

Vouching of sales includes:

Sales Book:

• Sales book records only credit sales of goods to the customer.
• When the goods are sold, invoices are sent out and that only becomes the source document or voucher for recording transactions in the sales book.

Dispatch of goods:

• Dispatching of goods refers to an act of sending goods to a particular place which is undertaken by a logistic unit.
• The term “lead time” can be used to refer to the time elapsed between order and dispatch of goods.
• The document of dispatch clarifies that the goods have been transported or dispatched under the conditions specified.

An auditor verifies and vouches for both the Sales Book and Dispatch of goods documents to check that they support the entries made in them and the inventory is maintained accordingly or not.

Therefore, options B and A are only related to the vouching of sales.

Additional Information

Debit notes:

• A debit note is a document used by a vendor to inform the buyer of current debt obligations.
• It can provide information regarding an upcoming invoice or can serve as a reminder for funds currently due.
• It is used in case of Purchase Returns, escalation/de-escalation in price, any other expenses incurred by the vendor on behalf of the party.

Credit notes:

• A credit note is a document used when there has been an error in an already issued invoice, such as when a customer wishes to change their original order or an incorrect amount.
• In other words, it is issued in any scenario that would require the invoice to be changed or re-issued.
• It is used in case of Sales Return, issued by a seller to buyer informing that his account is credited.

The correct answer is – D only

Key Points

Process Costing:

• Process costing is an accounting methodology used when there is mass production of similar products, where the cost associated with individual units of output cannot be differentiated from each other.
• Under this concept, costs are calculated over a fixed period of time, summarized, and then allocated to all the units produced during that period of time on a consistent basis.
• Process costing is the only reasonable approach in many industries to determine product costs.
• Examples of industries where this type of production occurs include oil refining, food production, and chemical processing.

Therefore, Process Costing is appropriate for Oil refining firms.

Additional Information

Three types of Process Costing:

1) Weighted Average Cost: It assumes that all costs whether from a previous year or current one, are lumped together and assigned to produce units.

2) Standard Costs: It is similar to weighted average costs, but standard costs are assigned to production units rather than actual costs; after total costs are accumulated using standard cost, these total are compared to actual accumulated costs, and the difference is charged to a variance account.

3) First-in-First-out (FIFO) costing: FIFO is a more complex method as it creates layers of cost, one for any units of production that were started in the previous production period but not completed, and another layer for any production that is started in the current period.

The correct answer is – A, B, D only

Key Points

According to The Partnership Act, 1932:

A. All partners are bound to carry on the business of the firm to the greatest common advantage and shall not obtain a private advantage at the expense of the firm and if a partner carries on a rival business in competition with the partnership, the other partners are entitled to restrain him.

B. Where a partner is entitled to interest on the capital subscribed by him, such interest on capital is an appropriation and shall be payable only out of the profits of the firm.

C. Every outgoing partner or the estate of any partner who ceased to be a partner has the right to claim either a share in the profits of the firm till his account is finally settled or an interest rate of six percent per annum on his share in the firm’s property till his account is finally settled.

D. Expulsion of partner – Section 33 of the Partnership Act, 1932:

1. A partner may not be expelled by a firm by any majority of the partners, save in the exercise in good faith or powers conferred by contract between the partners.
2. The provisions of sub-sections (2), (3), and (4) of section 32 shall apply to an expelled partner as if he were a retired partner.

Therefore, Statements A, B, D only are false.

The correct answer is – A, B, E, C and D

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records.

Standard costs are assigned to production units rather than actual costs; after total costs are accumulated using standard cost, these total are compared to actual accumulated costs, and the difference is charged to a variance account.

Key Points

Process of Standard Costing:

1) Establishing standard costs:

• The first step is to set the standards on the basis of management’s expectations and the production engineer would anticipate the costs.
• While establishing the standard cost, more weightage is given to past records, the current plan of production, and future trends.
• Finally, the standard will be fixed in both quantity and costs.

2) Measurement/Determination of actual costs:

• After standards are set, the actual costs are determined for each element i.e. material, labor, and overheads.
• The actual costs can be measured using the invoices, accounts book, wage sheets, etc.

3) Comparison of actual and standard costs:

• The next step is to compare the actual costs that occurred with the standard costs determined earlier.
• The difference between them is known as a variance.

4) Identifying variances and causes of variance:

• If the variance is positive it is known as favorable variance, and if the variance is negative it is known as an unfavorable/adverse variance.
• After the comparison is complete, the next step is to find out the causes for favorable or adverse variance.
• Corrective measures must be taken to evaluate the overall performance.

5) Disposing the variances to cost and profit centers:

• The last step in the process is to dispose of the variance by transferring it to the costing profit and loss account.
• Another method is to carry forward the variances to the next financial year by crediting the same to a reserve account to be set off in a subsequent year.
• The favorable or adverse variance may cancel each other in the course of time and thus be disposed of.

Standard costing can be helpful in ascertaining the profitability of the business at any level of production.

Therefore, Option 1) is correct in the process of standard costing.

The correct answer is – B, A, D, C and E

The accounting cycle is a process designed to make financial accounting of the business activities easier for the business owners. it provides clear guidelines for recording, analyzing, and final reporting a business’s financial activities.

Key Points

Activities in the process of accounting:

1) Recording the business transaction in the books of entry:

• The first step in the accounting cycle is identifying transactions and recording them in the books of entry i.e. journal entry.
• Companies will have many transactions throughout the year so recordkeeping is essential for recording all types of transactions.
• Journal entries for every transaction must be created.
• The choice between accrual and cash accounting will dictate when transactions are officially recorded.

2) Journalising the transaction in the ledger accounts:

• Once transactions are recorded in journal entries, they must be posted in the general ledger accounts.
• The general ledger helps in the breakdown of all accounting activities by accounts.
• It allows a bookkeeper to monitor financial positions by account.

3) Preparation of the Trial Balance:

• After posting all ledger accounts, the trial balance is prepared.
• A trial balance tells a company its unadjusted balances in each account.
• The unadjusted trial balance is then analyzed by creating a worksheet that is used to ensure that debits and credits are equal.
• If there are any discrepancies then adjustments will need to be made.

4) Preparation of Annual Financial Statements:

• After the adjustments are recorded as journal entries wherever necessary, the company generates its financial statements.
• For most companies, this statement will include income statements, balance sheets, and cash flow statements.
• Lastly, a company closes its books at the end of the day on a specified closing date.
• The closing statement provides a report of analysis of performance over the period.

5) Deriving meaningful inferences for business decisions:

• With the help of financial statements and closing statements, business owners can derive a meaningful inference about their business activities.
• It helps to ensure accuracy, consistency, and efficient financial performance analysis.

Therefore, Option 4) is the correct process of accounting activities.