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Take an Indian company which has adopted balance score card successfully and explain how it had derived benefits out of this framework.
Answer: The Balanced scorecard The Balanced Score Card is a framework for integrating measures derived from strategy. While retaining financial measures of past performance, the Balanced Score Card introduces the drivers of future financial performance. (Figure 1) The drivers (customer, internal business process, learning & growth perspectives) are derived from the organizations strategy translated into objectives and measures. The Balanced Score Card is more than a measurement system it can be used as an organizing framework for their management processes. The real power of the Balanced Score Card is when it is transformed from a measurement system to a management system. It fills the void that exists in most management systems the lack of a systematic process to implement and obtain feedback about strategy TATA motors have adopted balance score card framework successfully and yields benefits from that.
Case Study: TATA Motors CVBU (Commercial Vehicle Business Unit) TATA Motors Commercial Vehicle Business Unit enhances balanced scorecard framework. Tata Motors is the largest and most prominent market leader in the manufacture of commercial business vehicles in India. In the year 2000, its Commercial Vehicles Business Unit (CVBU) suffered its first loss in its more than fifty years history. This loss was massive. It was in the tune of Rs. 108.62 Million. This prompted Tata Motors to take a profound look into itself; to find reason in this debacle. Subsequently, the executive director of CVBU, Mr. Ravi Kant, called for stringent cost cutting across unit operations, supported by more effective formulation and execution of strategy. To augment this process, the management of Tata Motors resolved to adopt the Balanced Scorecard and Performance Framework as the key tool in the endeavor to rebuild the Organizational Performance Chart. The challenge here was to undertake deployment of the Balanced Scorecard across all the functional units and departments of the CVBU. Soon, however, with the process underway, the real problem revealed itself. It turned out that the manual nature of the review procedures of such a huge structure was well neigh impossible, being, at best, extremely difficult to implement and incredibly time consuming. A watertight solution was needed; quickly. After further examination of the situation, a decision was taken to implement a Balanced Scorecard Automation Tool that would centralize, integrate and collate the data, providing rapid review and analytical functionality and presenting a rapid and comprehensive one view picture of organizational performance. Commencing this process, the CVBU management reviewed many solution providers and evaluated each of them upon the basis of a variety of diverse factors. At the end of this exhaustive process, a solution was decided in the form of COVENARK Strategist, a prominent Balanced Score Card Automation Tool developed by MPOWER Information Systems to integrate with the existing ERP and legacy systems with the help of data integration suite.
The results were immediate and spectacular. Within two years of this, CVBU had turned over to register a profit of Rs. 107 Million from the loss of Rs. 108.62 Million, accounting for a whopping 60% of TATA Motors inventory turnover. The success path of Balanced Score Card did not stop here. In the beginning CVBU has started the Balanced Scorecard with only Corporate Level Scorecard; at this time they have expanded it to six Hierarchical Levels with three hundred and thirty one Scorecards, additionally looking forward to proliferate it to the lowest level of organizational structure. In this way, balanced scorecard framework played a vital role in the success story of TATA Motors CVBU.
Q2. What is DuPont analysis? Explain all the ratios involved in this analysis. Your answer should be supported with the chart.
Answer:
A method of performance measurement that was started by the DuPont Corporation in the 1920. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as DuPont identity.
DuPont analysis tells us that ROE is affected by three things: 1. 2. 3. Operating efficiency, which is measured by profit margin Asset use efficiency, which is measured by total asset turnover Financial leverage, which is measured by the equity multiplier
ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)
Investopedia explains DuPont Analysis It is believed that measuring assets at gross book value removes the incentive to avoid investing in new assets. New asset avoidance can occur as financial accounting depreciation methods artificially produce lower ROEs in the initial years that an asset is placed into service. If ROE is unsatisfactory, the DuPont analysis helps locate the part of the business that is under performing. The DuPont System expresses the Return on Assets as: ROA = OPM * ATR The Operating Profit Margin Ratio is a measure of operating efficiency and the Asset Turnover Ratio is a measure of asset use efficiency. The DuPont System expresses the Return on Equity as: ROE = (ROA Interest Expense/Average Assets) * EM The Equity Multiplier is a form of leverage ratio and measures financial efficiency. Below figure shows the DuPont Analysis for a farm operation
DuPont Analysis for Two Farms Sr.No. 1 2 3 4 5 6 Operating profit margin ratio Asset turnover ROA (1*2) Interest expense to avg. farm assets Equity multiplier ROE (3-4) * 5 Farmer A 0.30 0.20 0.060 0.05 2.00 0.02 Farmer B 0.12 0.36 0.043 0.03 1.50 0.02
Farmer A and Farmer B each have a 2 % ROE. The components of the ratios indicate that the sources of the weakness of the farms are different. Farmer A has a stronger profit margin ratio but lower asset turnover compared to Farmer B. Furthermore, Farmer A has a higher leverage ratio than Farmer B. The weak ratios for each farm may be decomposed into components to determine the potential sources of the weakness. To improve asset turnover Farmer A needs to increase production efficiency or price levels or reduce
current or noncurrent assets. To improve profit margins, Farmer B needs to increase production efficiency or price levels more than costs or reduce costs more than revenue. The DuPont analysis is an excellent method to determine the strengths and weaknesses of a farm. A low or declining ROE is a signal that there may be a weakness. However, using the analysis you can better determine the source of weakness. Asset management, expense control, production efficiency or marketing could be potential sources of weakness within the farm. Expressing the individual components rather than interpreting ROE itself may identify these weaknesses more readily.
Q3. Accounting Principles are the rules based on which accounting takes place and these rules are universally accepted. Explain the principles of materiality and principles of full disclosure. Explain why these two principles are contradicting each other. Your answer should be substantiated with relevant examples.
Answer:
Principle of materiality : While important details of financial status must be informed to all relevant parties, insignificant facts which do not influence any decisions of the investors or any interested group, need not be communicated. Such less significant facts are not regarded as material facts. What is material and what is not material depends upon the nature of information and the party to whom the information is provided. While income has to be shown for income tax purposes, the amount can be rounded off to the nearest ten and fraction does not matter. The statement of account sent to a debtor contains all the details regarding invoices raised, amount outstanding during a particular period. The information on debtors furnished to Registrar of Companies need not be in detail. Principle of Full Disclosure The business enterprise should disclose relevant information to all the parties concerned with the organization. It means that any information of substance or of interest to the average investors will have to be disclosed in the financial statements. The Companies Act, 1956 requires that income statement and balance sheet of a company must give a fair and true view of the state of affairs of the company. If change has a material effect in current period and the effect of change is ascertainable the amount of change should be disclosed. If the change has a material effect in current period and the effect of change is not ascertainable wholly or in part, the fact should be disclosed. If change has no material effect in current period but which is reasonably accepted to have a material effect in later periods, the fact of such change should be appropriately disclosed. Materiality principle: Accountants follow the materiality principle, which states that the requirements of any accounting principle may be ignored when there is no effect on the users of financial
information. Certainly,tracking individual paper clips or pieces of paper is immaterial and excessively burdensome to any company's accounting department. Although there is no definitive measure of materiality, the accountant's judgment on such matters must be sound. Several thousand dollars may not be material to an entity such as General Motors, but that same figure is quite material to a small, family-owned business. Full disclosure means to disclose all the details of a security problem which are known. It is a philosophy of security management completely opposed to the idea of security through obscurity. The concept of full disclosure is controversial, but not new; it has been an issue for locksmiths since the 19th century. Full disclosure requires that full details of security vulnerability are disclosed to the public, including details of the vulnerabilityand how to detect and exploit it. The theory behind full disclosure is that releasing vulnerability information results in quicker fixes and better security. Fixes are produced faster because vendors and authors are forced to respond in order to save face. Security is improved because the window of exposure, the amount of time the vulnerability is open to attack, is reduced. The full disclosure principle states that any future event that may or will occur, and that will have a material economic impact on the financial position of the business, should be disclosed to probable and potential readers of the statements. Such disclosures are most frequently made by footnotes. For example, a hotel should report the building of a new wing, or the future acquisition of another property. A restaurant facing a lawsuit from a customer who was injured by tripping over a frayed carpet edge should disclose the contingency of the lawsuit. Similarly, if accounting practices of the current financial statements were changed and differ from those previously reported, the changes should be disclosed. Changes from one period to the next that affect current and future business operations should be reported if possible. Changes of this nature include changes made to the method used to determine depreciation expense or to the method of inventory valuation; such changes would increase or decrease the value of ending inventory, cost of sales, gross margin, and net income or loss. All changes disclosed should indicate the dollar effects such disclosures have on financial statements.
Q4. Explain any two types of errors that are disclosed by trial balance with examples and rectification entry. Note - Avoid giving examples given in the self- learning material. Answer:
Errors affecting Trial Balance (or Errors Disclosed by Trial Balance): If the Trial Balance does not tally, it will indicate that certain errors have been committed which have affected the agreement of the Trial Balance. The accountant will then proceed to find out the errors and ultimately the errors will be located. Such errors are called 'Errors Disclosed by Trial Balance or Errors which affect the agreement of Trial Balance. Until such errors are rectified, the Trial Balance will not agree. Some of these types of errors are as follows: Wrong Casting: If the total of the Cash Book or some other Subsidiary Book is wrong, the Trial Balance will not tally. For example, the total of the Purchase book has been added Rs. 2000 in excess. When this total will be posted to the debit side of the purchase account, it will also show an excess debit of Rs. 2000 and hence, the Trial Balance will not tally. Posting to the Wrong Side: If instead of posting an amount on the debit side of an account, it is
posted on the credit side, or vice versa, the Trial balance will not tally. For example, goods for Rs. 2000 from Gopal. If instead of posting the amount on the credit side of Gopal's account it is posted to his debit, the debit side of the Trial Balance will exceed the credit by Rs. 4,000. Posting of Wrong Amount: The Trial Balance will not tally if the posting in an account is made with an incorrect amount. For example, goods for Rs. 600 have been purchased from Mahendra. If, it has been correctly entered in the Purchase Book or purchase account, but while posting to Mehendra's account, in credit side (correct side) the amount posted is Rs. 60 instead of Rs. 600, the Trial Balance will not tally. Omission of Posting of One Side of an Entry: For example if Rs. 500 have been received from Ram and correctly entered in the Cash Book or Cash Account but if it is omitted to be posted on the credit side of Ram's Account, the Trial Balance will not tally.
Double Posting in a Single Account: For example if Rs. 500 have been received from Shyam Lal and correctly entered in the Cash Account, but if it is posted twice on the credit side of Shyam Lal's account, the Trial Balance will not tally. Errors of Totaling and Balancing of Accounts in the Ledger: Errors may occur in the totaling of debit or credit sides of accounts in the Ledger or in the balancing of accounts in the Ledger. Because the balances of accounts are transferred to the Trial Balance, Then the Trial balance will not tally.
An error is an unintentionally committed mistake. When the Trial Balance does not tally it is a clear indication that there are some errors in the preparation of accounts. The errors may be committed at various stages
1. 2. 3. 4. 5.
Journalizing, Posting, Casting (totaling), Balancing, Transferring to trial balance and so on.
Mere tallying of the trial balance does not ensure an error free statement. There are certain errors such as errors of omission, error of principle and compensating errors are not disclosed by trial balance while errors of casting, posting to wrong side of an account or posting a wrong amount can be detected by trial balance.
Errors whether disclosed or not disclosed by trial balance, have to be corrected or rectified in order to obtain the correct picture of profit or loss. It should be remembered that errors will have their impact not only on profit but also on the asset and liability position of the business organization.
Posting a wrong amount: This mistake may occur while posting an entry from subsidiary book to ledger.
Example: Cash received from Krupa Rs. 1250 is posted to Krupas ledger account Rs. 1520, while its correct posted in cash a/c
Rectification entry:
Krupa account
To Suspense a/c
Rs. 270
Omitting to post an entry from subsidiary book to ledger: If an entry made in the subsidiary book does not get posted to ledger, the trial balance does not tally.
Example: Stationery bill paid Rs.2000 recorded in cash account but is not posted to Stationery account at all.
Rectification entry:
Stationery account
To Suspense a/c
Rs. 2000
Relevance of Data:
Financial accounting data are expected to be objective and verifiable. However, for internal use the manager wants information that is relevant even if it is not completely objective or verifiable. By relevant, we mean appropriate for the problem at hand. For example, it is difficult to verify estimated sales volumes for a proposed new store at good Vibrations, Inc., but this is exactly the type of information that is most useful to managers in their decision making. The managerial accounting information system should be flexible enough to provide whatever data are relevant for a particular decision.
data, for example, information about customer satisfaction is tremendous importance even though it would be difficult to express such data in monitory form.
Segments of an Organization:
Financial accounting is primarily concerned with reporting for the company as a whole. By contrast, managerial accounting forces much more on the parts, or segments, of a company. These segments may be product lines, sales territories divisions, departments, or any other categorizations of the company's activities that management finds useful. Financial accounting does require breakdowns of revenues and cost by major segments in external reports, but this is secondary emphasis. In managerial accounting segment reporting is the primary emphasis.
Managerial Accounting
Not Mandatory:
Financial accounting is mandatory; that is, it must be done. Various out side parties such as Securities and exchange commission (SEC) and the tax authorities require periodic financial statements. Managerial accounting, on the other hand, is not mandatory. A company is completely free to do as much or as little as it wishes . No regularity bodies or other outside agencies specify what is to be done, for that matter, weather anything is to be done at all. Since managerial accounting is completely optional, the important question is always, "Is the information useful?" rather than, "Is the information required?"
Summary:
Financial Accounting
Reports to those outside the organization owners, lenders, tax authorities and regulators. Emphasis is on summaries of financial consequences of past activities.
Managerial Accounting
Reports to those inside the organization for planning, directing and motivating, controlling and performance evaluation. Emphasis is on decisions affecting the future.
Objectivity and verifiability of data are emphasized. Precision of information is required. Only summarized data for the entire organization is prepared.
Detailed segment reports about departments, products, customers, and employees are prepared. Need not follow Generally Accepted Accounting Principles (GAAP). Not mandatory.
Must follow Generally Accepted Accounting Principles (GAAP). Mandatory for external reports.