Accounting and Finance

1. What is Journalising the Transactions?

Ans: Journalizing transactions, or "journalizing," is an essential step in the accounting process. It
involves recording business transactions in the accounting journal, which is also known as the
book of original entry. Each transaction is documented in chronological order and then used to
create the general ledger, which is the central repository of all financial transactions for a business.
Here are the steps involved in journalizing transactions:
1. Identify the Transaction: Determine what event has occurred and gather relevant documents,
such as receipts, invoices, or bank statements.
2. Analyze the Transaction: Understand the financial impact of the transaction and decide which
accounts are affected (e.g., assets, liabilities, equity, income, expenses).
3. Record the Transaction: Write a journal entry that includes the date, the accounts affected,
the amounts to be debited and credited, and a brief description of the transaction.
4. Post to Ledger: Transfer the information from the journal to the respective accounts in the
general ledger.

Here's an example of a journal entry:

Date: March 7, 2025
Accounts Debited: Cash $500
Accounts Credited: Service Revenue $500

Description: Received payment for services rendered.

Journalizing transactions helps ensure accurate financial records and supports the preparation of
financial statements.

2. Posting to Ledger and Preparing of Trial Balance?

Ans: Posting to the Ledger
After journalizing transactions, the next step is to post these entries to the ledger accounts. Here's
how it's done:
1. Transfer Data: Each journal entry is transferred to the respective ledger accounts. For
instance, if a journal entry affects the Cash account and the Service Revenue account, these
changes are reflected in the Cash and Service Revenue ledger accounts.
2. Debits and Credits: The debits and credits from the journal entry are posted to the
appropriate side (debit or credit) of the ledger account.
3. Running Balance: Update the running balance for each account after posting the entry.
Here's an example:
Journal Entry
Date: March 7, 2025
Accounts Debited: Cash $500
Accounts Credited: Service Revenue $500
Description: Received payment for services rendered.
Ledger Accounts

Cash Account:
Date Description Debit Credit Balance
March 7, 2025 Received payment for services $500 $500

Service Revenue Account:

Date Description Debit Credit Balance
March 7, 2025 Received payment for services $500 $500
Preparing a Trial Balance
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Once all transactions are posted to the ledger, a trial balance is prepared to ensure that total debits
equal total credits. The steps are:
1. List Accounts: List all the ledger accounts and their balances.
2. Calculate Totals: Calculate the total debits and total credits.
3. Ensure Equality: Make sure the total debits equal the total credits. If they don't, there may be
an error in the journalizing or posting process.

Example of a Trial Balance

Account Name Debit Credit

Cash $500
Service Revenue $500
Total $500 $500

4. What are Depreciation Methods (WDV, SLM/Fixed Installment method)?

Ans: Depreciation is the accounting process of allocating the cost of tangible assets over their
useful lives. It's a way to account for the decline in the value of an asset over time. There are
several methods to calculate depreciation, but two common methods are the Written Down Value
(WDV) method and the Straight-Line Method (SLM), also known as the Fixed Installment method.
Straight-Line Method (SLM) / Fixed Installment Method
The Straight-Line Method is the simplest and most used depreciation method. Here's how it works:
1. Formula:

Depreciation Expense = Cost of Asset−Salvage Value/Useful Life

2. Even Expense: The annual depreciation expense is the same every year.
3. Ease of Calculation: It’s straightforward to calculate.

Example: If you buy a machine for ₹100,000, and it has a salvage value of ₹10,000 after a useful
life of 10 years:

Annual Depreciation=100,000−10,000/10=₹9,000

So, you would depreciate the machine by ₹9,000 each year.

Written Down Value (WDV) Method

The Written Down Value method, also known as the Declining Balance method, calculates
depreciation based on a fixed percentage of the book value of the asset each year. Here's how it
works:
1. Formula:

Depreciation Expense = Book Value at Beginning of Year×Depreciation Rate

2. Decreasing Expense: The depreciation expense decreases each year because it's based on the
reducing book value of the asset.
3. Useful for Assets that lose value quickly in the initial years, like technology or vehicles.

Example: If you buy a machine for ₹100,000 and use a depreciation rate of 20%:
 Year 1 Depreciation: 100,000×0.20=₹20,000
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 Year 2 Depreciation: (100,000−20,000)×0.20=₹16,000
 Year 3 Depreciation: (100,000−20,000−16,000)×0.20=₹12,800

And so on.

Comparison

Depreciation
Method Key Feature Best For
Expense
Straight-Line Same amount each Assets with
Even depreciation
Method year consistent use
Written Down Higher initial Decreasing amount Assets that
Value depreciation each year depreciate rapidly

These methods help businesses allocate the cost of an asset in a way that matches its usage and
benefits over time. If you need more details or have specific examples in mind, just let me know!

5. Calculation For EPS?

Ans: Earnings Per Share (EPS) is a crucial financial metric used to measure a company's
profitability on a per-share basis. It helps investors understand how much profit a company is
generating for each outstanding share of common stock.
Calculation of EPS
The basic formula to calculate EPS is:

EPS = Net Income− Preferred Dividends/Average Outstanding Shares

Here’s a step-by-step breakdown:

1. Net Income: This is the company's total earnings after all expenses, taxes, and costs have been
deducted from total revenue.
2. Preferred Dividends: If the company has issued preferred stock, any dividends paid to
preferred shareholders are subtracted from the net income.
3. Average Outstanding Shares: This is the weighted average number of shares of common stock
that were outstanding during the reporting period.
Example
Let's say a company has the following financial information:
 Net Income: ₹5,000,000
 Preferred Dividends: ₹500,000
 Average Outstanding Shares: 1,000,000

EPS=5,000,000−500,000/1000,000=4,500,000/1,000,000=₹4.50

So, the EPS for this company would be ₹4.50, meaning the company earned ₹4.50 per share of
common stock during the reporting period.

Variations of EPS
1. Diluted EPS: This accounts for the potential dilution from convertible securities, such as stock
options, warrants, and convertible bonds. It provides a more conservative and comprehensive
view of earnings per share.
2. Adjusted EPS: This excludes certain items that are one-time or non-recurring, such as
restructuring charges or extraordinary items, to give a clearer picture of ongoing performance.

6. What is the Preparation of Common Size statements/ comparative balance sheet

Calculation of closing of cash balance?
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Ans: Common size statements are financial statements in which each line item is expressed as a
percentage of a base figure. This makes it easier to analyze and compare financial data across
different periods or companies.
Steps to Prepare a Common Size Income Statement:
1. Select a Base Figure: For income statements, the base figure is usually total revenue or sales.
2. Calculate Percentages: Divide each line item by the base figure and multiply by 100 to get the
percentage.

Example: If total sales are ₹1,000,000 and the cost of goods sold is ₹600,000, the common size
percentage for COGS is:
600,000/1,000,000×100=60%

Steps to Prepare a Common Size Balance Sheet:

1. Select a Base Figure: For balance sheets, the base figure is usually total assets.
2. Calculate Percentages: Divide each line item by the base figure and multiply by 100 to get the
percentage.

Example: If total assets are ₹2,000,000 and cash is ₹200,000, the common size percentage for
cash is:
200,000/2,000,000×100=10%

Comparative Balance Sheet

A comparative balance sheet presents financial data for multiple periods side by side, making it
easier to compare changes over time.
Steps to Prepare a Comparative Balance Sheet:
1. List Periods: Include financial data for at least two periods.
2. Show Changes: Calculate the absolute and percentage change for each line item between
periods.

Example:
2024 2025 Change
Account Change (%)
(₹) (₹) (₹)
Cash 50,000 60,000 10,000 20%
Accounts Receivable 30,000 35,000 5,000 16.67%

Calculation of Closing Cash Balance

The closing cash balance is the ending balance of cash for a specific period. It can be calculated
using the cash flow statement or by summarizing cash transactions.
Steps to Calculate Closing Cash Balance:
1. Start with Opening Balance: Begin with the cash balance at the beginning of the period.
2. Add Cash Inflows: Include all cash receipts, such as sales revenue, loans received, etc.
3. Subtract Cash Outflows: Deduct all cash payments, such as expenses, loan repayments, etc.
Example:
 Opening Cash Balance: ₹10,000
 Cash Inflows: ₹15,000 (sales) + ₹5,000 (loan received) = ₹20,000
 Cash Outflows: ₹8,000 (expenses) + ₹2,000 (loan repayment) = ₹10,000

Closing Cash Balance = Opening Cash Balance + Cash Inflows- Cash Outflows

Closing Cash Balance=10,000+20,000−10,000=₹20,000

7. What is the Calculation for NPV, PI, Payback Period?

Ans: Net Present Value (NPV)
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NPV is used to determine the value of an investment by comparing the present value of cash
inflows to the present value of cash outflows. The formula for NPV is:

NPV=∑(Ct(1+r)t)−C0

Where:
 Ct = Cash inflow at time t
 r = Discount rate
 t = Time period
 C0 = Initial investment

Example: Suppose you have an initial investment of ₹100,000 and expected cash inflows of
₹30,000, ₹40,000, and ₹50,000 over three years, with a discount rate of 10%.

NPV=30,000(1+0.10)1+40,000(1+0.10)2+50,000(1+0.10)3−100,000

NPV=30,0001.10+40,0001.21+50,0001.331−100,000

NPV=27,273+33,058+37,567−100,000=−2,102

In this example, the NPV is -₹2,102, indicating that the investment may not be profitable.

Profitability Index (PI)

The Profitability Index (PI) measures the relative profitability of an investment. It is calculated as:
PI = Present Value of Future Cash/Inflows Initial Investment

Example: Using the same cash inflows and discount rate as the NPV example:
Present Value of Future Cash Inflows=27,273+33,058+37,567=₹97,898

PI=97,898/100,000=0.98

A PI of less than 1 indicates that the investment is not profitable.

Payback Period
The Payback Period is the time it takes for an investment to generate cash flows sufficient to
recover the initial investment. The formula for a simple payback period is:

Payback Period = Initial Investment/Annual Cash Inflow

Example: If the initial investment is ₹100,000 and the annual cash inflow is ₹30,000:

Payback Period=100,000/30,000=3.33 years

This means it will take approximately 3.33 years to recover the initial investment.

Comparison
Metric Formula Interpretation
NPV>0NPV > 0
Net Present
∑(Ct(1+r)t)−C0 indicates
Value (NPV)
profitability
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Metric Formula Interpretation
Profitability PI>1PI > 1 indicates
Present Value of Future Cash Inflows/Initial Investment
Index (PI) profitability
Payback Shorter payback
Initial Investment/Annual Cash Inflow
Period period preferred

8. What is Operating Leverage, Financial Leverage, and combined leverage?

Ans: Operating Leverage
Operating leverage measures the degree to which a firm uses fixed costs in its operations. High
operating leverage means that a small change in sales can lead to a significant change in operating
income (EBIT). It is a result of having a higher proportion of fixed costs relative to variable costs.

Formula:
Degree of Operating Leverage (DOL)} = \frac{\text{% Change in EBIT}}{\text{% Change in Sales}}

Example: If a company's sales increase by 10% and its EBIT increases by 30%, the DOL is:

DOL=30%/10%=3

This means that a 1% change in sales results in a 3% change in EBIT.

Financial Leverage
Financial leverage measures the extent to which a firm uses debt to finance its operations. High
financial leverage indicates that a company has a higher proportion of debt in its capital structure.
It amplifies the effects of changes in EBIT on the firm's earnings per share (EPS).

Formula:
\text{Degree of Financial Leverage (DFL)} = \frac{\text{% Change in EPS}}{\text{% Change in
EBIT}}

Example: If a company's EBIT increases by 20% and its EPS increases by 40%, the DFL is:
DFL=40%/20%=2
This means that a 1% change in EBIT results in a 2% change in EPS.

Combined Leverage
Combined leverage, also known as total leverage, measures the total impact of operating and
financial leverage on a company's EPS. It combines both operating leverage and financial leverage
to show how a change in sales can lead to a change in EPS.

Formula:
Degree of Combined Leverage (DCL)=DOL×DFL

Example: If a company has a DOL of 3 and a DFL of 2, the DCL is:

DCL=3×2=6
This means that a 1% change in sales results in a 6% change in EPS.

Comparison
Type of Leverage Measure Impact
Operating Leverage DOL Impact of fixed costs on EBIT
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Type of Leverage Measure Impact
Financial Leverage DFL Impact of debt on EPS
Combined Leverage DCL Total impact of changes in sales on EPS

9. Accounting Equation, Dual Aspect Concept, and Importance of multiple ratios?

Ans: Absolutely! Let's break down these important accounting concepts and their significance.

Accounting Equation
The accounting equation is the foundation of double-entry bookkeeping and represents the
relationship between a company's assets, liabilities, and equity. It is expressed as:

Assets=Liabilities + Equity

Explanation:
 Assets: Resources owned by a company (e.g., cash, inventory, equipment).
 Liabilities: Obligations or debts the company owes to outsiders (e.g., loans, accounts payable).
 Equity: The owner's claim on the assets, also known as net assets or shareholders' equity.
This equation ensures that the balance sheet remains balanced, with assets always equaling the
sum of liabilities and equity.

Dual Aspect Concept

The dual aspect concept is a fundamental principle of accounting that states every financial
transaction has two equal and opposite effects. It underpins the double-entry system of
accounting, where each transaction is recorded in at least two accounts.

Example: If a company purchases equipment for ₹50,000 by paying cash:

 Debit: Equipment Account ₹50,000 (increase in assets)
 Credit: Cash Account ₹50,000 (decrease in assets)
This ensures that the accounting equation remains balanced and all transactions are accurately
recorded.

Importance of Multiple Ratios

Financial ratios are essential tools for analyzing a company's performance, financial health, and
operational efficiency. By comparing different aspects of a company's financial statements,
stakeholders can make informed decisions.
Here are some important financial ratios and their significance:
1. Liquidity Ratios:
o Current Ratio: Measures the company's ability to meet short-term obligations.
Current Ratio = Current Assets/Current Liabilities

 Quick Ratio: Measures the company's ability to meet short-term obligations without relying on
inventory.
Quick Ratio = Current Assets- Inventory/Current Liabilities

Profitability Ratios:
o Gross Profit Margin: Measures the efficiency of production and pricing strategies.
Gross Profit Margin=Gross Profit/Net Sales×100

Return on Equity (ROE): Measures the return generated on shareholders' equity.

ROE=Net Income/Average Shareholders’ Equity×100

Leverage Ratios:
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o Debt-to-Equity Ratio: Measures the degree of financial leverage used by the company.
Debt-to-Equity Ratio = Total Liabilities/Shareholders’ Equity

Interest Coverage Ratio: Measures the company's ability to pay interest on its debt.
Interest Coverage Ratio=EBIT/Interest Expense

Efficiency Ratios:
o Inventory Turnover Ratio: Measures how efficiently inventory is managed.
Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory

Accounts Receivable Turnover Ratio: Measures how efficiently receivables are collected.
Accounts Receivable Turnover Ratio = Net Credit Sales/Average Accounts Receivable

By analyzing these ratios, businesses can identify strengths, weaknesses, and areas for
improvement. Investors, creditors, and managers use these ratios to assess financial performance,
make strategic decisions, and ensure the company's long-term sustainability.

10. What is the Effective annual rate (EAR)?

Ans: The Effective Annual Rate (EAR) is a measure of the actual interest rate an investor or
borrower will earn or pay over a year, accounting for the effects of compounding. It's also known
as the Effective Annual Yield (EAY) or Annual Equivalent Rate (AER).
Calculation of EAR
The formula for calculating the Effective Annual Rate is:

EAR=(1+rn)n−1

Where:
 r = Nominal interest rate (annual interest rate)
 n = Number of compounding periods per year

Example

Let's say you have a nominal interest rate of 12% (0.12 as a decimal) compounded monthly (12
times a year):
EAR=(1+0.1212)12−1

EAR=(1+0.01)12−1

EAR=1.0112−1≈0.1268 or 12.68%
So, the Effective Annual Rate in this case would be approximately 12.68%, which is higher than the
nominal rate because of monthly compounding.

Importance of EAR

The EAR is a crucial metric because it provides a more accurate representation of the real interest
rate compared to the nominal rate. It helps investors and borrowers compare different financial
products with varying compounding periods on a consistent basis.

 For Borrowers: It indicates the true cost of a loan.

 For Investors: It shows the actual return on investment.

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11. Cost of Capital & its Components?
Ans: The cost of capital is essentially the cost of a company's funds—both debt and equity. It
represents the return expected by those who provide capital to the business, and it's crucial in
decision-making as it serves as a benchmark for evaluating investment opportunities. Think of it as
the rate a company needs to earn on its investment projects to maintain its market value and attract
funds.
Here are the key components of the cost of capital:
1. Cost of Debt: This is the effective rate that a company pays on its borrowed funds. It is
calculated after accounting for tax benefits since interest expenses are tax-deductible.
2. Cost of Equity: This is the return required by shareholders. Since equity investors take on more
risk than debt holders, the cost of equity is generally higher. This can be calculated using
models like the Capital Asset Pricing Model (CAPM).
3. Cost of Preferred Stock: If a company has preferred stock, it also needs to account for the
dividends paid to preferred shareholders. Preferred stock is a hybrid between debt and equity,
so it has its own cost.

The overall cost of capital is often calculated as a weighted average, known as the Weighted Average
Cost of Capital (WACC), which considers the proportion of each component in the company's capital
structure.

12. Sourcing of Long and short-term bonus share & Stock split?
And: When it comes to financing, businesses have various sources to tap into for both long-term and
short-term needs. Here's a breakdown:
Long-Term Sources of Finance
1. Equity Shares: Issuing new shares to investors.
2. Preference Shares: Shares that have preferential rights over equity shares in terms of
dividend payments.
3. Debentures: Long-term debt instruments issued by companies to borrow money.
4. Retained Earnings: Profits that are reinvested into the business instead of being distributed as
dividends.
5. Term Loans: Loans from banks and financial institutions with a repayment period exceeding
one year.
6. Venture Capital: Investment from venture capitalists in exchange for equity.
7. Asset Securitization: Converting assets into marketable securities.
8. International Financing: Raising funds through instruments like Euro issues, Foreign
Currency Loans, ADRs, FCCBs, and GDRs.
Short-Term Sources of Finance
1. Commercial Paper: Unsecured promissory notes issued by companies.
2. Trade Credit: Credit extended by suppliers.
3. Bank Overdraft: Facility allowing businesses to withdraw more than their account balance.
4. Bill of Exchange: A written order binding one party to pay a fixed sum of money to another
party on demand or at a predetermined date.
Bonus Shares
Bonus shares are additional shares given to existing shareholders without any additional cost, based
on the number of shares they already own. They are financed through:
1. Retained Earnings: Using accumulated profits to issue bonus shares.
2. Share Premium Account: Using the premium received on the issue of shares.
Stock Split
A stock split involves dividing existing shares into multiple shares to boost liquidity. It doesn't require
additional financing as it doesn't change the company's overall market capitalization. Instead, it
adjusts the number of shares and their price per share.
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12. What are the various factors of a firm’s dividend policy and factors behind dividend
payments?
Ans: Dividend policy is a crucial aspect of a company's financial strategy, impacting shareholders and
the company's overall financial health. Here are some key factors that influence a firm's dividend
policy:

Factors Influencing Dividend Policy:

1. Profitability: Firms with stable and high profitability are more likely to distribute dividends.
Higher profits enable companies to pay higher dividends.
2. Cash Flow Position: Even if a company is profitable, it needs sufficient cash flow to pay
dividends. Liquidity is essential for dividend payments.
3. Growth Opportunities: Companies with significant growth opportunities might retain
earnings to reinvest in the business rather than paying out dividends.
4. Debt Obligations: Firms with high levels of debt may prioritize debt repayment over dividend
payments to maintain financial stability.
5. Tax Considerations: The tax treatment of dividends can influence the dividend policy. For
instance, if dividends are taxed more heavily than capital gains, companies might opt to retain
earnings.
6. Shareholder Preferences: Companies might consider the preferences of their shareholders.
Some investors prefer regular income through dividends, while others prefer capital
appreciation.
7. Legal Constraints: Legal regulations can limit the number of dividends a company can pay. For
example, some jurisdictions require companies to maintain a minimum level of retained
earnings.
8. Market Conditions: Prevailing market conditions and economic environment can impact
dividend decisions. During economic downturns, companies might cut dividends to preserve
cash.
9. Competitor Practices: The dividend policies of competitors can influence a company's policy.
Firms might adjust their policies to remain competitive in attracting investors.
10. Managerial Attitudes: The philosophy and attitudes of the company's management toward
dividends play a significant role. Some managers prioritize reinvestment, while others
emphasize regular dividends.
11. Stability of Earnings: Companies with stable and predictable earnings are more likely to have
consistent dividend policies.

Factors Behind Dividend Payments:

1. Signaling: Paying dividends can signal to the market that the company is financially healthy
and confident about its prospects.
2. Investor Demand: Some investors, particularly income-focused investors, prefer dividends for
a steady income stream.
3. Retained Earnings Utilization: Companies might pay dividends to utilize retained earnings
effectively and avoid excess cash accumulation.
4. Shareholder Pressure: Institutional investors or activist shareholders might push for higher
dividends to receive returns on their investments.
5. Tax Considerations: Depending on the tax regime, dividends might be more tax-efficient for
some investors compared to capital gains.
6. Control Dilution: By paying dividends, companies can avoid diluting control through the
issuance of new shares.
7. Corporate Governance: Strong governance practices might encourage regular dividend
payments to enhance shareholder trust and satisfaction.3/7/2025
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By considering these factors, companies can develop a dividend policy that aligns with their financial
strategy, growth objectives, and shareholder expectations.