Financial Accounting and Analysis 2077 Board Question Paper

The cash basis of accounting is a system where revenues are recorded only when cash is actually received, and expenses are recognized only when cash is actually paid out. It ignores credit transactions, accrued revenues, and outstanding expenses. Consequently, it does not adhere to the matching principle and is primarily used by small retail sole proprietorships and non-profit entities.

A contingent liability is a potential financial obligation whose existence and outcome depend on the occurrence or non-occurrence of one or more uncertain future events not wholly within the entity’s control (e.g., pending court lawsuits, product warranty claims, guarantees given for third parties). Under NFRS/NAS 37, if the liability is possible but not probable, it is disclosed in the Notes to the Financial Statements rather than recorded on the balance sheet.

The materiality convention states that financial statements should disclose all items that are significant enough to influence the economic decisions of users. Insignificant or immaterial items (e.g., purchasing a Rs. 200 calculator with a 5-year life) need not strictly comply with formal accounting rules (like depreciation over 5 years) and may be expensed immediately to reduce administrative overhead.

Value added is the wealth or economic enhancement generated by the productive efforts of an enterprise over a given period. It is measured as the difference between the gross market value of goods and services produced (Sales plus change in inventory) and the cost of bought-in materials and external services consumed in production:

Accounting Equation: $\text{Assets} = \text{Liabilities} + \text{Capital}$

Bills Receivable Book

(Note: Only acceptances received from customers/debtors are recorded in Bills Receivable Book. Acceptance given to Rita on Shrawan 21 is a Bills Payable).

Journal Entries of XYZ Company

1. On 1st Shrawan 2075 (Receipt of Loan):

   • Dr. Bank A/c ..................................................... Rs. 200,000
   • Cr. 15% Notes Payable A/c .................................... Rs. 200,000 (Being loan received from Civil Bank Ltd. against a 1-year 15% note).

2. On 31st Ashad 2076 (Repayment of Loan + 15% Interest):

   • Interest = $200,000 \times 15\% \times 1 = \text{Rs. } 30,000$. Total Payment = Rs. 230,000.
   • Dr. 15% Notes Payable A/c ............................. Rs. 200,000
   • Dr. Interest Expense A/c ................................. Rs. 30,000
   • Cr. Bank A/c ..................................................... Rs. 230,000 (Being note principal and interest paid in full on maturity).

Calculation of Gain/Loss on Early Redemption:

1. Carrying Value (Book Value) of Bond:
   $$\text{Carrying Value} = \text{Face Value} + \text{Unamortized Premium} = 200,000 + 12,000 = \text{Rs. } 212,000$$
2. Reacquisition (Call) Price:
   $$\text{Call Price} = 200,000 \times 105\% = \text{Rs. } 210,000$$
3. Gain / Loss:
   $$\text{Gain on Redemption} = \text{Carrying Value} - \text{Reacquisition Price} = 212,000 - 210,000 = \mathbf{\text{Rs. } 2,000 \text{ (Gain)}}$$
   (Since carrying value exceeds call price, the firm realizes a Gain of Rs. 2,000).

Calculation of Amount of Value Added:

1. Gross Value of Output:
   $$\text{Sales} + \text{Interest Received} + (\text{Closing Stock} - \text{Opening Stock})$$
   $$= 500,000 + 12,000 + (70,000 - 50,000) = 512,000 + 20,000 = \text{Rs. } 532,000$$
2. Cost of Bought-in Materials and Services:
   $$\text{Purchase} + \text{Carriage Inward} = 200,000 + 70,000 = \text{Rs. } 270,000$$
3. Amount of Value Added:
   $$\text{Value Added} = 532,000 - 270,000 = \mathbf{\text{Rs. } 262,000}$$
   (Employee salary of Rs. 90,000 and income tax of Rs. 10,000 are applications/distributions of value added, not bought-in deductions).

Preliminary Calculations:

1. Current Assets ($CA$):
   $$NWC = CA - CL \implies 500,000 = CA - 300,000 \implies CA = \text{Rs. } 800,000$$
2. Quick Assets ($QA$):
   $$QA = CA - \text{Inventory} = 800,000 - 350,000 = \text{Rs. } 450,000$$
3. Sales:
   $$\text{Operating Profit} = 10\% \times \text{Sales} \implies 60,000 = 0.10 \times \text{Sales} \implies \text{Sales} = \text{Rs. } 600,000$$
4. Long-Term Debt:
   $$\text{Debt} = \text{Capital Employed} - \text{Shareholders' Equity} = 1,200,000 - 800,000 = \text{Rs. } 400,000$$
5. Total Assets:
   $$\text{Total Assets} = \text{Fixed Assets} + CA = 600,000 + 800,000 = \text{Rs. } 1,400,000$$

Required Ratios:

a. Net Profit After Tax (NPAT):

b. Quick Ratio:

c. Debt to Total Capital (Capital Employed) Ratio:

d. Stock (Inventory) Turnover Ratio:

e. Return on Shareholders’ Equity (ROSE):

f. Net Profit Margin:

g. Total Assets Turnover Ratio:

(a) Inventory System Adopted:

ABC Enterprises is adopting the Periodic Inventory System because it determines physical inventory and cost of goods sold only by counting items at the end of the month rather than continuously after each transaction.

(b) Ending Inventory and COGS under FIFO (Periodic):

1. Total Available for Sale:

   • Dec 1: $700 \times 10 = \text{Rs. } 7,000$
   • Dec 6: $900 \times 12 = \text{Rs. } 10,800$
   • Dec 11: $1,000 \times 14 = \text{Rs. } 14,000$
   • Dec 20: $500 \times 14 = \text{Rs. } 7,000$
   • Dec 27: $200 \times 15 = \text{Rs. } 3,000$
   • Total Units Available: $700 + 900 + 1000 + 500 + 200 = \mathbf{3,300 \text{ units}}$
   • Cost of Goods Available for Sale: $7000 + 10800 + 14000 + 7000 + 3000 = \mathbf{\text{Rs. } 41,800}$

2. Units Sold & Ending Units:

   • Units Sold = $1,200 + 1,500 = 2,700 \text{ units}$
   • Ending Inventory Units = $3,300 - 2,700 = \mathbf{600 \text{ units}}$

3. Cost of Ending Inventory (from newest purchases - FIFO):

   • From Dec 27: $200 \text{ units} \times 15 = \text{Rs. } 3,000$
   • From Dec 20: $400 \text{ units} \times 14 = \text{Rs. } 5,600$
   • Ending Inventory Cost: $3,000 + 5,600 = \mathbf{\text{Rs. } 8,600}$

4. Cost of Goods Sold (COGS):

   $$COGS = \text{Cost of Goods Available} - \text{Ending Inventory} = 41,800 - 8,600 = \mathbf{\text{Rs. } 33,200}$$

(c) Income Statement for December 2020:

• Sales Revenue: $(1,200 \times 16) + (1,500 \times 18) = 19,200 + 27,000 = \text{Rs. } 46,200$

(a) Machinery Account (Straight-Line Method):

Annual Depreciation = $\frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life}} = \frac{500,000 - 0}{10} = \mathbf{\text{Rs. } 50,000 \text{ per year}}$.

Machinery Account (Dr. / Cr.)

(b) Difference Between Capital and Revenue Expenditure:

(a) Bank Reconciliation Statement of KK Company (as on 31st Chaitra 2075)

(Matches the bank statement balance of Rs. 25,000 perfectly).

(b) Difference Between Accounts Receivable and Notes Receivable:

1. Introduction

Financial statements (Balance Sheet, Income Statement, Cash Flow Statement) present condensed historical accounting figures. Financial statement analysis is the critical evaluation process of analyzing relationships between items to assess corporate financial health, operational efficiency, and future solvency.

2. Revealing Financial Strengths and Weaknesses

1. Assessing Liquidity Position (Short-Term Solvency):
   • Through current and quick ratios, analysis evaluates whether the firm possesses sufficient cash and liquid assets to satisfy maturing trade payables without defaulting.
2. Evaluating Long-Term Solvency & Capital Structure:
   • Debt-equity and interest coverage ratios reveal financial leverage risk. Low debt signifies resilience; excessive leverage warns of bankruptcy vulnerability.
3. Evaluating Operating Efficiency (Asset Turnover):
   • Inventory turnover and debtors’ collection periods reveal operational agility—identifying whether capital is trapped in obsolete stock or uncollected receivables.
4. Measuring Profitability and Return on Capital:
   • Gross profit margin, operating profit margin, and Return on Equity (ROE) measure how effectively management converts revenue into net wealth for shareholders.
5. Trend and Inter-Firm Benchmarking:
   • Cross-sectional comparison against industry leaders highlights cost leakages and competitive disadvantages.

3. Conclusion

Financial statement analysis transforms passive bookkeeping records into an actionable managerial diagnostic tool that guides investors, bankers, and executives in optimizing capital allocation.

1. Definition of Source Documents

A source document is an original physical or digital evidentiary document that records the essential details of a financial transaction (such as date, parties involved, purpose, quantities, prices, and authorized signatures). It serves as the primary verifiable legal proof and foundation upon which journal entries and ledger records are created.

2. Major Types of Source Documents

1. Cash Memo: Issued by a vendor when goods are sold for immediate cash payment.
2. Sales Invoice / Bill: Prepared by a seller when goods are sold on credit, specifying product descriptions, quantity, unit rates, trade discounts, and payment terms.
3. Purchase Bill / Supplier Invoice: The incoming invoice received from a vendor detailing credit purchases.
4. Receipt (Cash Receipt): An acknowledgment issued to a customer confirming receipt of cash, cheque, or electronic bank transfer.
5. Debit Note: Prepared and sent to a supplier when goods are returned (purchase return) or when an invoice has been overcharged, debiting the supplier’s account.
6. Credit Note: Issued to a customer upon receiving returned merchandise (sales return) or granting price allowances, crediting the customer’s account.
7. Cheque Counterfoil / Bank Deposit Slip: The retained bank counterfoil showing date, account number, payee name, and amount deposited or drawn.
8. Payment Voucher: An internal authorized voucher documenting cash/bank disbursements.

i. Journal Entries

ii. T-Accounts (Ledgers)

• Sales A/c: Cr. side by Accounts Receivable Rs. 170,000 $\implies$ Cr. Balance = Rs. 170,000.
• Accounts Receivable A/c: Dr. To Sales Rs. 170,000; Cr. By Bank Rs. 135,000, By Discount Rs. 15,000 $\implies$ Dr. Balance = Rs. 20,000.
• Accounts Payable A/c: Cr. By Equipment Rs. 60,000; Dr. To Cash Rs. 47,500, To Discount Rs. 2,500 $\implies$ Cr. Balance = Rs. 10,000.

iii. Cash and Bank Summary (Balances)

• Cash Balance: Initial 300,000 - Dep. to Bank 200,000 - Creditor 47,500 - Electricity 15,000 = Rs. 37,500.
• Bank Balance: Dep. 200,000 - Equip 100,000 + Debtor 135,000 - Wages 20,000 - Salary 25,000 - Rent 20,000 = Rs. 170,000.

iv. Trial Balance

i. Adjusted Trial Balance

ii. Statement of Profit and Loss (Income Statement)

iii. Statement of Financial Position (Balance Sheet)

1. Introduction

Financial accounting is the specialized discipline of accounting dedicated to the systematic recording, classifying, summarizing, analyzing, and reporting of an enterprise’s financial transactions in monetary terms. It produces formal general-purpose financial statements (Statement of Financial Position, Statement of Profit or Loss, Cash Flow Statement) in compliance with recognized reporting standards (NFRS/IFRS and GAAP).

2. Core Functions and Processes

1. Systematic Record-Keeping (Bookkeeping):
   • Applying the double-entry system to create chronological, verifiable journal and ledger records.
2. Periodic Measurement of Performance (Profitability):
   • Accurately matching operational revenues against incurred expenses over a fiscal period to determine true net profit or loss.
3. Depicting Financial Condition (Solvency):
   • Presenting an objective, audited view of corporate assets, liabilities, and owners’ equity at the close of the financial year.
4. Facilitating Accountability and Stewardship:
   • Enabling corporate boards and executive management to demonstrate fiduciary stewardship of capital entrusted to them by shareholders.

3. Primary Users of Financial Accounting Information

• Internal Users: Board of directors, CEO, and finance managers for operational planning and dividend decisions.
• External Users:
  • Investors & Shareholders: Evaluating profitability, risk, and capital safety.
  • Lenders & Financial Institutions: Assessing creditworthiness and debt-service capacity.
  • Tax Authorities (IRD Nepal): Determining corporate income tax and VAT compliance.
  • Regulatory Bodies (SEBON, Office of the Company Registrar): Ensuring statutory disclosure compliance.

4. Inherent Limitations of Financial Accounting

• Historical Cost Basis: Assets are carried at historical cost, failing to reflect modern market inflation or current replacement values.
• Excludes Qualitative Dimensions: Cannot capture employee morale, brand goodwill, leadership competency, or customer loyalty.
• Subject to Managerial Estimates: Depreciation life estimates and doubtful debt provisions involve subjective human judgment.

5. Conclusion

Financial accounting serves as the indispensable universal language of business, providing transparent, standardized financial reports that underpin investor trust and global capital markets.