Financial Accounting and Analysis 2079 Board Question Paper

Two primary importances of financial accounting are:

1. Systematic Record Keeping and Fraud Prevention: It maintains a chronological, orderly, and permanent record of all financial transactions under the double-entry system, preventing memory failure, errors, and misappropriation of company assets.
2. Determining Operational Results and Solvency: It enables management, investors, lenders, and tax authorities to ascertain the net profit or loss (through the Income Statement) and the exact financial position and solvency (through the Statement of Financial Position/Balance Sheet).

The going concern concept is a fundamental accounting assumption that an enterprise will continue its business operations for the foreseeable future and has neither the intention nor the necessity of liquidation or drastically curtailing the scale of its operations.

Significance:

• Long-term assets are recorded at historical cost less accumulated depreciation rather than immediate net realizable liquidation value.
• Prepaid expenses and deferred charges can legitimately be carried forward as assets to future accounting periods.

Receivables represent monetary claims against debtors, clients, or other parties. The primary types are:

1. Accounts Receivable (Trade Debtors): Oral or informal open-credit promises by customers to pay for goods or services delivered, typically due within 30 to 90 days.
2. Notes Receivable: Formal, written promissory notes or negotiable bills of exchange signed by the debtor, specifying a stated principal sum, maturity date, and designated interest rate.
3. Other / Non-Trade Receivables: Non-operational claims such as interest receivable, loans/advances to employees, insurance claim receivables, and refundable income taxes.

A Value Added Statement (VAS) is a modern financial reporting statement that reveals the gross economic wealth created by an enterprise through its manufacturing, trading, or service operations during an accounting period, and demonstrates how that value added has been allocated among its primary stakeholders:

• Employees: Wages, salaries, and welfare benefits.
• Government: Corporate income taxes, duties, and levies.
• Providers of Capital: Dividends to shareholders and interest to debenture holders/banks.
• Reinvested in Business: Depreciation reserves and retained profits for future growth.

A contingent liability is a potential obligation whose existence and outcome depend on the occurrence or non-occurrence of one or more uncertain future events that are not wholly within the control of the enterprise.

Key Examples:

• Pending lawsuits or disputed damages in court.
• Warranties and guarantees given on behalf of subsidiaries or third parties.
• Discounted bills of exchange not yet matured.

Reporting: Under NAS 37 / NFRS, if the outflow of resources is possible but not probable, it is not recognized in the balance sheet but must be disclosed in the Notes to Financial Statements.

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

Detailed Transaction Working:

1. Sale of Goods: Total Sales Price = Cash (Rs. 10,000) + Debtors (Rs. 15,000) = Rs. 25,000.
   • Profit = Rs. 5,000, so Cost of Goods Sold (Inventory reduction) = Rs. 25,000 - Rs. 5,000 = Rs. 20,000.
   • Cash increases by Rs. 10,000, Debtors increase by Rs. 15,000, Inventory decreases by Rs. 20,000 (Net Assets: +Rs. 5,000).
   • Profit increases Owner’s Capital by +Rs. 5,000.
2. Payment of Wages: Total Cash Paid = Rs. 28,000 (Assets: -Rs. 28,000).
   • Advance Wages (Prepaid Asset) = +Rs. 4,000 (Assets: +Rs. 4,000; Net Asset impact = -Rs. 24,000).
   • Incurred Wage Expense = Rs. 24,000 (Capital: -Rs. 24,000).

Statement of Value Added

1. Calculation of Gross Output Value:

$$\begin{aligned} \text{Sales Revenue} &= \text{Rs. 120,000} \\ \text{Add: Increase in Inventory (Closing Stock } 22,000 - \text{Opening Stock } 20,000) &= \text{Rs. 2,000} \\ \text{Add: Other Operating Income (Rent Received)} &= \text{Rs. 12,000} \\ \hline \textbf{Gross Output Value} &= \mathbf{\text{Rs. 134,000}} \end{aligned}$$

2. Cost of Bought-in Materials and External Services:

$$\begin{aligned} \text{Purchases of Raw Materials / Goods} &= \text{Rs. 60,000} \\ \text{Power and Fuel} &= \text{Rs. 8,000} \\ \hline \textbf{Total Bought-in Consumables} &= \mathbf{\text{Rs. 68,000}} \end{aligned}$$

(Note: Staff salary of Rs. 24,000 and Income tax of Rs. 4,000 are applications/distributions of value added, not bought-in external costs).

3. Net Value Added:

$$\text{Value Added} = \text{Gross Output Value} - \text{Bought-in Costs} = 134,000 - 68,000 = \mathbf{\text{Rs. 66,000}}$$

Purchase Book (Journal)

In the Books of MM Grocery Shop

Journal Entries

Computation of Gain or Loss on Early Redemption of Bonds

1. Carrying (Book) Value of Bonds:

$$\begin{aligned} \text{Carrying Value} &= \text{Face Value of Bonds} - \text{Unamortized Discount} \\ &= \text{Rs. 100,000} - \text{Rs. 4,000} = \mathbf{\text{Rs. 96,000}} \end{aligned}$$

2. Reacquisition / Call Price:

$$\text{Call Price} = 103\% \text{ of Face Value} = \text{Rs. 100,000} \times 1.03 = \mathbf{\text{Rs. 103,000}}$$

3. Gain or Loss:

$$\begin{aligned} \text{Loss on Early Redemption} &= \text{Call Price Paid} - \text{Carrying Value} \\ &= 103,000 - 96,000 = \mathbf{\text{Rs. 7,000}} \end{aligned}$$

Conclusion: GG Company incurred a Loss on Early Redemption of Bonds of Rs. 7,000.

Detailed Financial Ratio Analysis

Step-by-Step Computations:

a. Amount of Sales:

$$\begin{aligned} \text{Operating Profit} &= 15\% \text{ of Sales} = \text{Rs. 60,000} \\ \text{Sales} &= \frac{60,000}{0.15} = \mathbf{\text{Rs. 400,000}} \end{aligned}$$

b. Inventory at End:

$$\begin{aligned} \text{Cost of Goods Sold (COGS)} &= 80\% \text{ of Sales} = 0.80 \times 400,000 = \text{Rs. 320,000} \\ \text{Inventory Turnover Ratio} &= \frac{\text{COGS}}{\text{Average Inventory}} = 8 \text{ times} \\ \text{Average Inventory} &= \frac{320,000}{8} = \text{Rs. 40,000} \\ \text{Average Inventory} &= \frac{\text{Beginning Inventory} + \text{Ending Inventory}}{2} \\ 40,000 &= \frac{60,000 + \text{Ending Inventory}}{2} \\ 80,000 &= 60,000 + \text{Ending Inventory} \implies \mathbf{\text{Ending Inventory} = \text{Rs. 20,000}} \end{aligned}$$

c. Current Ratio:

$$\begin{aligned} \text{Current Assets} &= \text{Quick Assets} + \text{Ending Inventory} = 180,000 + 20,000 = \text{Rs. 200,000} \\ \text{Current Liabilities} &= \text{Rs. 100,000} \\ \text{Current Ratio} &= \frac{\text{Current Assets}}{\text{Current Liabilities}} = \frac{200,000}{100,000} = \mathbf{2 : 1} \end{aligned}$$

d. Debt to Total Capital Ratio:

$$\begin{aligned} \text{Shareholders' Equity} &= \text{Equity Share Capital} + \text{General Reserve} - \text{Preliminary Expenses} \\ &= 200,000 + 100,000 - 20,000 = \text{Rs. 280,000} \\ \text{Long-Term Debt} &= \text{Rs. 150,000} \\ \text{Total Capital} &= \text{Long-Term Debt} + \text{Shareholders' Equity} = 150,000 + 280,000 = \text{Rs. 430,000} \\ \text{Debt to Total Capital Ratio} &= \frac{\text{Long-Term Debt}}{\text{Total Capital}} = \frac{150,000}{430,000} = \mathbf{0.3488 \text{ or } 34.88\%} \end{aligned}$$

e. Return on Shareholders’ Equity (ROE):

$$\begin{aligned} \text{Operating Profit (EBIT)} &= \text{Rs. 60,000} \quad (\text{Interest not provided, so EBT} = \text{Rs. 60,000}) \\ \text{Less: Tax @ 25\%} &= 25\% \times 60,000 = \text{Rs. 15,000} \\ \text{Net Profit After Tax (EAT)} &= 60,000 - 15,000 = \mathbf{\text{Rs. 45,000}} \\ \text{ROE} &= \frac{\text{Net Profit After Tax}}{\text{Shareholders' Equity}} \times 100\% = \frac{45,000}{280,000} \times 100\% = \mathbf{16.07\%} \end{aligned}$$

g. Dividend Per Share (DPS):

$$\begin{aligned} \text{Number of Equity Shares} &= \frac{\text{Equity Share Capital}}{\text{Par Value per Share}} = \frac{200,000}{100} = 2,000 \text{ shares} \\ \text{Dividend Per Share (DPS)} &= \frac{\text{Total Equity Dividend}}{\text{Number of Shares}} = \frac{20,000}{2,000} = \mathbf{\text{Rs. 10 per share}} \end{aligned}$$

h. Net Profit Margin:

$$\text{Net Profit Margin} = \frac{\text{Net Profit After Tax}}{\text{Sales}} \times 100\% = \frac{45,000}{400,000} \times 100\% = \mathbf{11.25\%}$$

Inventory Valuation and Comparative Income Statement (Periodic System)

1. Analysis of Units and Total Goods Available for Sale:

• Jan. 1 (Beginning): $700 \text{ units} \times \text{Rs. 10} = \text{Rs. 7,000}$
• Jan. 11 (Purchase): $1,000 \text{ units} \times \text{Rs. 14} = \text{Rs. 14,000}$
• Jan. 20 (Purchase): $500 \text{ units} \times \text{Rs. 14} = \text{Rs. 7,000}$
• Jan. 27 (Purchase): $200 \text{ units} \times \text{Rs. 15} = \text{Rs. 3,000}$
• Total Goods Available for Sale: $\mathbf{2,400 \text{ units}} \text{ costing } \mathbf{\text{Rs. 31,000}}$

Units Sold & Disposed:

• Sales: Jan. 17 ($1,200$) + Jan. 31 ($500$) = $1,700 \text{ units}$.
• Sales Revenue = $(1,200 \times 21) + (500 \times 26) = 25,200 + 13,000 = \mathbf{\text{Rs. 38,200}}$.
• Damaged Units = $50 \text{ units}$.
• Sound Ending Inventory on Hand = $2,400 - 1,700 - 50 = \mathbf{650 \text{ units}}$.

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Part a: Ending Inventory and COGS

Method 1: LIFO (Periodic System)

Under Periodic LIFO, the sound ending inventory (650 units) comes from the earliest units (Beginning Inventory):

$$\text{Ending Inventory} = 650 \text{ units} \times \text{Rs. 10} = \mathbf{\text{Rs. 6,500}}$$

The damaged stock (50 units) is also from the remaining opening stock:

$$\text{Abnormal Loss on Damaged Goods} = 50 \text{ units} \times \text{Rs. 10} = \mathbf{\text{Rs. 500}}$$

$$\begin{aligned} \text{Cost of Goods Sold (COGS)} &= \text{Cost of Goods Available} - \text{Ending Inventory} - \text{Damaged Inventory} \\ &= 31,000 - 6,500 - 500 = \mathbf{\text{Rs. 24,000}} \end{aligned}$$

(Verification: Sold 1,700 units = 200 @ 15 + 500 @ 14 + 1,000 @ 14 = 3,000 + 7,000 + 14,000 = Rs. 24,000).

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Method 2: Weighted Average Costing (Periodic System)

$$\text{Weighted Average Cost per Unit} = \frac{\text{Total Cost of Goods Available}}{\text{Total Units Available}} = \frac{\text{Rs. 31,000}}{2,400 \text{ units}} = \mathbf{\text{Rs. 12.9167 per unit}}$$

• Ending Inventory (650 units): $650 \times 12.9167 = \mathbf{\text{Rs. 8,396}}$
• Abnormal Loss on Damaged Goods (50 units): $50 \times 12.9167 = \mathbf{\text{Rs. 646}}$
• Cost of Goods Sold (1,700 units): $1,700 \times 12.9167 = \mathbf{\text{Rs. 21,958}}$

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Part b: Comparative Income Statement for January 2022

Part (a): Machinery Account (Diminishing Balance Method @ 15% p.a.)

Working Notes:

1. Total Initial Cost (Magh 1, 2076): $\text{Rs. } 90,000 + \text{Rs. } 10,000 = \mathbf{\text{Rs. 100,000}}$.
2. Depreciation for 2076: From Magh 1 to Chaitra 31 = 3 months.
   $$\text{Depreciation} = 100,000 \times 15\% \times \frac{3}{12} = \mathbf{\text{Rs. 3,750}}$$
   Book Value on 1st Baisakh 2077 = $100,000 - 3,750 = \mathbf{\text{Rs. 96,250}}$.
3. Depreciation for 2077 (Full Year):
   $$\text{Depreciation} = 96,250 \times 15\% = \mathbf{\text{Rs. 14,438}}$$
   Book Value on 1st Baisakh 2078 = $96,250 - 14,438 = \mathbf{\text{Rs. 81,812}}$.
4. Sale at end of Ashwin 2078 (6 months: Baisakh to Ashwin):
   $$\text{Depreciation for 6 months} = 81,812 \times 15\% \times \frac{6}{12} = \mathbf{\text{Rs. 6,136}}$$
   Book Value at Sale = $81,812 - 6,136 = \mathbf{\text{Rs. 75,676}}$. Sale Consideration = $\text{Rs. } 80,000$.
   $$\text{Profit on Sale} = 80,000 - 75,676 = \mathbf{\text{Rs. 4,324}} \quad (\text{Transferred to P\&L A/C})$$
5. New Machinery (Purchased End of Ashwin 2078 for Rs. 120,000): Held for 6 months (Kartik to Chaitra):
   $$\text{Depreciation} = 120,000 \times 15\% \times \frac{6}{12} = \mathbf{\text{Rs. 9,000}}$$
   Closing Book Value = $120,000 - 9,000 = \mathbf{\text{Rs. 111,000}}$.

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In the Books of the Company

Machinery Account

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Part (b): Depreciation Concept and Reasons

Definition: Under NAS 16 (Property, Plant and Equipment), depreciation is the systematic allocation of the depreciable amount of a tangible fixed asset over its estimated useful economic life. It represents an operational non-cash expense reflecting gradual exhaustion of service capacity.

Primary Reasons for Depreciating Long-Lived Assets:

1. Adherence to Matching Principle: It matches the cost of an asset against the revenues generated by that asset across its productive service life.
2. True and Fair View: Fixed assets must be shown on the Statement of Financial Position at their net recoverable historical cost rather than inflated acquisition prices.
3. Internal Fund Retention for Asset Replacement: Depreciation reduces reported distributable profits without any immediate cash outflow, thereby preserving liquid cash inside the entity to fund the purchase of replacement assets at the end of their useful lives.
4. Tax Shield: Depreciation is a tax-deductible operational expense under the Nepal Income Tax Act 2058, lowering taxable income and income tax liability.

Part (a): Bank Reconciliation Statement of Info-Tech Company

As on 30th Poush 2079

Both adjusted balances perfectly reconcile at Rs. 13,300.

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Part (b): Difference Between Capital Income and Revenue Income

Financial Statement Analysis: Definition and Objectives

1. Definition of Financial Statement Analysis

Financial statement analysis is the critical process of systematically evaluating, transforming, comparing, and interpreting the relationships among various financial items contained in an enterprise’s balance sheet, income statement, and cash flow statement.

Through standard analytical tools (such as ratio analysis, common-size statements, comparative analysis, trend analysis, and cash flow evaluation), raw historical accounting figures are converted into meaningful strategic intelligence regarding the firm’s liquidity, solvency, operating efficiency, and profitability.

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2. Key Objectives of Financial Statement Analysis

1. Evaluating Operational Profitability:
   • Measures how effectively the entity generates surplus on sales and investments using metrics like Gross Profit Margin, Net Profit Margin, Return on Assets (ROA), and Return on Equity (ROE).
2. Assessing Short-Term Liquidity:
   • Evaluates the firm’s capacity to meet its maturing current obligations without liquidating non-current assets, verified through Current Ratio and Quick (Acid-Test) Ratio.
3. Determining Long-Term Solvency and Financial Stability:
   • Investigates the capital structure and debt-absorption capacity of the enterprise to ensure ongoing survival and timely repayment of loan principals and interest (Debt-Equity Ratio, Interest Coverage Ratio).
4. Measuring Managerial and Asset-Utilization Efficiency:
   • Gauges how productively the enterprise deploys its inventory, receivables, working capital, and fixed assets (Inventory Turnover Ratio, Debtors Collection Period, Total Assets Turnover).
5. Facilitating Forecasting, Budgeting, and Strategic Decision Making:
   • Identifies financial trends and structural patterns over multiple years, assisting top management in formulating capital expenditure budgets, pricing models, and dividend policies.
6. Guiding External Investors and Creditors:
   • Supplies banks, institutional financiers, credit-rating agencies, and potential shareholders with the objective empirical evidence needed to extend credit lines or purchase equity shares.

Cash Flow Statement: Concept and Organizational Importance

1. Meaning of Cash Flow Statement

Under NAS 07 / NFRS, a Cash Flow Statement (CFS) is a mandatory financial statement that summarizes the actual gross inflows and outflows of cash and cash equivalents of an enterprise during a specified accounting period. It segregates cash movements into three fundamental business activities:

1. Operating Activities: Cash generated or absorbed by principal revenue-producing operational activities (cash collections from customers, cash paid to suppliers/employees, tax paid).
2. Investing Activities: Cash flows relating to the acquisition and disposal of long-term productive assets (Property, Plant, and Equipment) and investments not included in cash equivalents.
3. Financing Activities: Cash flows resulting from transactions with owners and long-term lenders (issuing shares, borrowing/repaying loans, debenture redemption, dividends paid).

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2. Importance of Cash Flow Statement for an Organization

1. Highlighting Cash vs. Profit Discrepancies:
   • While the Income Statement operates on the accrual basis (recording credit sales and non-cash depreciation), the Cash Flow Statement focuses strictly on realized liquidity. A company may report high paper profits while facing insolvency due to trapped receivables and inventory.
2. Assessing Solvency and Liquidity Health:
   • Clearly reveals whether an entity’s core day-to-day operations generate sufficient cash to sustain normal business without relying on external bank loans or dilutive equity offerings.
3. Planning Debt Servicing and Dividends:
   • Financial executives utilize the CFS to verify if projected operating cash flows can service scheduled interest payments, repay maturing principal, and distribute dividends to shareholders.
4. Evaluating Capital Investment Capabilities:
   • Indicates how much free cash flow is available to fund capital expenditure, technological upgrades, and acquisitions without straining liquid operational reserves.
5. Effective Working Capital and Treasury Management:
   • Assists management in identifying cash deficits or idle cash surpluses in advance, ensuring optimal deployment in marketable short-term securities.

Comprehensive Accounting Solution for Consultant Agency

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Part a: Journal Entries for the Month of Baishakh

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Part b: Triple Column Cash Book

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Part c: Ledger Accounts

1. Cash Account

• Total Debits: Rs. 1,190,000 | Total Credits: Rs. 907,000 | Balance c/d (Dr.): Rs. 283,000

2. Bank Account

• Total Debits: Rs. 800,000 | Total Credits: Rs. 130,000 | Balance c/d (Dr.): Rs. 670,000

3. Accounts Receivable Account

4. Accounts Payable Account

(No credit purchases or outstanding supplier transactions occurred during the month, so balance is Nil).

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Part d: Trial Balance as on 30th Baishakh

Comprehensive NFRS Financial Statements

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i. Adjusted Trial Balance

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ii. Statement of Profit or Loss (as per NFRS)

For the period ended on the reporting date

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iii. Statement of Financial Position (as per NFRS)

As at the reporting date

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iv. Statement of Cash Flows (as per NFRS - Direct Method)

Users of Accounting Information and Their Information Needs

Accounting is universally recognized as the language of business. It systematically identifies, measures, records, and communicates economic data about an organization to interested stakeholders.

These users are broadly classified into two distinct groups: Internal Users and External Users.

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1. Internal Users (Inside the Organization)

Internal users are directly involved in the governance, strategic planning, daily administration, and operational management of the business:

1. Board of Directors and Senior Executive Management:
   • Why they need it: They require comprehensive managerial accounting reports, budgets, variance analyses, and segment profitability metrics to evaluate operational efficiency, allocate corporate resources, establish product pricing, plan future capital expansions, and monitor departmental performance against organizational goals.
2. Departmental Managers (Production, Sales, HR, Finance):
   • Why they need it: Production managers inspect cost-per-unit trends to eliminate waste; sales managers evaluate product line contribution margins and distributor credit limits; human resource managers evaluate wage incentive schemes; treasury managers monitor daily cash flow forecasts to manage working capital.
3. Internal Auditors:
   • Why they need it: To assess internal control mechanisms, prevent fraudulent transactions, verify compliance with institutional policies, and safeguard corporate assets.

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2. External Users (Outside the Organization)

External users are external entities, institutions, and individuals whose economic decisions are linked to the organization:

1. Existing Shareholders and Potential Investors:
   • Why they need it: Current shareholders assess management stewardship, return on equity (ROE), and dividend yields to decide whether to hold or sell their equity shares. Potential investors analyze historical earnings stability, price-to-earnings (P/E) ratios, and long-term financial health before committing capital.
2. Short-Term Creditors and Trade Suppliers:
   • Why they need it: They evaluate the entity’s short-term liquidity and working capital health (Current Ratio, Quick Ratio, and inventory turnover). This enables them to determine whether to extend credit lines and set payment credit terms (e.g., 30 or 60 days).
3. Long-Term Lenders and Commercial Banks:
   • Why they need it: Financial institutions inspect debt-to-equity ratios, cash flow projections, and the interest coverage ratio to evaluate the borrower’s solvency, collateral adequacy, and capacity to service principal and interest on term loans and debentures.
4. Employees and Trade Unions:
   • Why they need it: Employees and collective bargaining units review company profitability to negotiate fair wage increases, bonus entitlements, retirement benefits, and to ensure job security and corporate continuity.
5. Government and Regulatory Authorities (Inland Revenue Department, Company Registrar, SEBON):
   • Why they need it: The Inland Revenue Department (IRD) verifies compliance with the Income Tax Act 2058 and VAT Act 2052 to assess corporate tax liabilities. The Securities Board of Nepal (SEBON) and the stock exchange monitor listed companies for timely disclosure of audited statements to protect public investors.
6. Customers and Business Partners:
   • Why they need it: Long-term industrial clients and distribution partners assess the firm’s ongoing viability to guarantee uninterrupted supply of vital spare parts, maintenance contracts, and warranty services.
7. Researchers, Financial Analysts, and General Public:
   • Why they need it: Equity research analysts issue buy/hold/sell recommendations based on financial statement modeling; economists analyze corporate data to gauge sectoral economic growth; environmental and social groups verify corporate social responsibility (CSR) spending.

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Summary Matrix