Question (1) What Is Over Capitalization? How Do We Know Over Capitalization Has Occurred?

Question (1) What is over capitalization? How do we know over capitalization has occurred?
Answer:
Over-capitalization arises when the present capital of the company is not effectively or properly used. Overcapitalization refers to a state where the amount of shares issued by the company is more than the required amount. In
this case, the earning of the company is not able to sell its securities at par-value. The presence of over capitalization
brings an unhappy situation in the company. In other words, a company is over-capitalized when its actual profits are
not sufficient to pay interest and dividends at proper rates.
By following way we will come to know that over-capitalization has occurred:
1. Actual capitalization of the company exceeds the capitalization warranted by the activity levels.
2. Earnings are lower than the expected returns.
3. There is a fall in the rate of dividends declaration.
4. There is a fall in the market value or the market price of the share of the company.
5. If a company borrows a large sum of money and has to pay a rate of interest higher than its rate of earning, the
results will be over-capitalization.
6. Over-capitalization may often result when an excessive amount is paid for goodwill and for fixed assets acquired
from the vendor company or from promoters or other people associated with the company, or when unduly
high amounts are spent on establishment.
7. Sometimes a company acquires assets like plant, machinery and buildings during a boom period. The price paid
is naturally high. If the boom disappears and a slump sets in, the real value of such assets will greatly decline and
a large part of the company's capital would be lost even though the books will still show the assets an the capital
at their previous figures. Such a company is over-capitalized because its real earnings capacity will suffer a
setback due to a fall in the value of assets, whereas the capital will stand at its original figures.
Question (2) Explain the steps involved in funds flow statement.

Answer:
Financial statements do not give the complete financial information. These statements give the information of funds on
a particular date. The purpose of preparation of fund flow statements is to know about from where funds are coming
and where being invested. The funds flow statements is generally prepared from the data identifiable and profit and loss
account and balance sheets. Fund flow statement is also called as sources and application of funds. It shows the detail of
funds business received from sources and the amount of funds the business used for different purposes in the year.
According to Robert Anthony, the fund flow statement describes the sources from which additional funds were derived
and the uses to which these funds were put.
Main purposes of fund flow statement are:
To help to understand the changes in assets and assets sources which are not readily evident in the income
statement or financial statement
To inform as to how the loans to the business have been used.
To point out the financial strengths and weaknesses of the business.
Format of fund flow statement:
Sources
Applications
Fund from operation
Fund lost in operation
Non-trading incomes
Non-operating expenses
Issue of shares
Redemption of redeemable preference share
Issue of debentures
Redemption of debentures
Borrowing of loans
Repayment of loans
Acceptance of deposits
Repayment of deposits
Sale of fixed assets
Purchase of fixed assets
Sale of investments
Purchase of long term instruments
Decrease in working
Increase in working capital
capital
Steps in preparation of fund flow statement:
1. Preparation of schedule changes in working capital
2. Preparation of adjusted profit and loss account
3. Preparation of accounts for non-current items
4. Preparation of the fund flow statement.
Question (3) Explain permanent and temporary working capital?

Answer:
Working capital management involves managing the different components of current assets and current liabilities. It is
an effort to try to maintain a healthy relationship between current assets and current liabilities so that satisfactory level
of working capital is maintained. It is very important for a firm to maintain a satisfactory level of working capital,
otherwise there are chances of the firm becoming insolvent and going bankrupt.
Further permanent and temporary working capital are explained as:
Permanent Working Capital:
It is the minimum working capital required for producing predetermined production
Permanent working is the minimum investment kept in the form of inventory of raw materials, work in process, finished
goods, stores & spare, and book debts to facilitate uninterrupted operation of a firm.
Though this investment is stable in the short run, it certainly varies in the long run depending upon the expansion
programmers undertaken by a firm. It may increase or decrease over a period of time.
The minimum level of current assets maintained in a firm is usually known as permanent or regular working capital.
Temporary Working Capital:

It is the additional current assets required for temporary period, and it is above permanent WC
A firm is required to maintain an additional current asset temporarily over and above the permanent working capital to
satisfy cyclical demands. Any additional working capital apart from permanent working capital required to support the
changing production and sales activities is referred to as temporary or variable working capital.
In Other words, an amount over and above the permanent level of working capital is temporary, fluctuating or variable
working capital.
At times, additional working capital is required to meet the unforeseen events like floods, strikes, seasonal production
and price hike tendencies contingencies.
Question (4) Following are the extracts from the trial balance of a firm as on 31 March 20x7.
Dr.
Cr.
Sundry Debtors
2,05,000
Provision for Doubtful Debts
10,000
Provision for Discount on Debtors
1,800
Bad Debts
3,000
Discount
1,000
Additional information:
1. Additional Bad Debts required Rs.4,000
2. Additional Discount allowed to Debtors Rs.1,000
3. Maintain a provision for bad debts @ 10% on debtors
4. Maintain a provision for discount @ 2% on debtors
Required: Pass the necessary journal entries and show the relevant accounts including final accounts
Answer:
Particulars
Profit & Loss A/C
Provision for bad debts
(Being provision for bad debts created on 10% debtors for anticipated bad debts)
Debit
17500
Profit & Loss A/C

To provision for discount on debtors A/C
(being provision for discount on debtors created on 2% debtors)
3900
Credit
17500
3900
Question (5) Explain the objectives of cash management?

Answer:
Cash management is a broad term that refers to the collection, concentration, and disbursement of cash. Cash is the
most important current asset for a business operation. It is the force that drives business activities and also the ultimate
output expected by the owners. The firm should keep sufficient cash at all times. Excessive cash will not contribute to
the firms profit and shortage of cash will disrupt its manufacturing operations.
Cash management is concerned with:
a) Management of cash flows into and out of the firm
b) Cash management within the firm
c) Management of cash balances held by the firm
Objectives of cash management are as follows:
To make Payment According to Payment Schedule :In the normal course of functioning, a firm will have to make many payments by cash to its employees, suppliers,
infrastructure bills, etc. it will also receive cash through sales of its products and collection of receivables. Both these do
not happen simultaneously. A basic objective of cash management is therefore to meet the payment schedule in time.
Timely payment will help the firm to maintain its credit worthiness in the market and to foster good relationship with
creditors and suppliers. The other advantage of meeting the payments in time is that it prevents bankruptcy that arises
out of firm inability to honor its commitments.
To minimize Cash Balance :By keeping excessive reserves is also not desirable as a fund in its original form is idle cash and non earning assets. It is
not profitable for firms to keep huge balances. A low level of cash balance may mean failure to meet the payment
schedule. The aim of cash management Is therefore to have an optimal level of cash by bringing about a proper
synchronization of inflows and outflows and check the spells of cash deficits and cash surpluses.
Question (6) Why wealth maximization is superior to profit maximization?

Answer:
Profit maximization is a traditional approach which is claimed to be the main goal of any kind of business, small or big.
Profit equals to revenues subtracted by expenses. It is needed for business survival; pay rents, employees salary, capital,
research and development. If a business doesnt yield any profit, it can be said that theyre on danger in term of survival
because profit is the main objective.
Wealth maximization is the new approach and claimed to be superior to profit maximization. Wealth maximization
means increasing shareholders wealth. The term wealth here is the market price of capital invested by shareholders.
When the net worth of a business increased the wealth of shareholder is also increased. Unlike profit maximization,
wealth maximization serves shareholders objective; get good return and safety of their capital. If profit maximization is
an objective of a business, wealth maximization is the tools to maintain the objectives. Wealth equals to present value of
cash flows subtracted by cost. Since wealth maximization is based on cash flow, it can avoid any ambiguity in accounting
the profit. While profit maximization is based on profit, it is kind of hazy. There are many kind of profit it can be gross
profit, net profit, in wealth maximization, the future cash flows are discounted at an appropriate discounted rate to
represent their present value.
Profit is important in yearly basis. It gives happiness and understanding in a short term basis. Profit will be distributed or
taxed by Government. Meanwhile, wealth should be maximized with top priority. It helps the company to stand in the
market on long term basis. If the wealth increases, the asset of the company increases. It helps to buy land, property,
shares etc. Wealth gives reputation for the future of the company.

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Question (1) What is over capitalization? How do we know over capitalization has occurred?

Question (2) Explain the steps involved in funds flow statement.

Question (3) Explain permanent and temporary working capital?

Temporary Working Capital:

Profit & Loss A/C

Question (5) Explain the objectives of cash management?

Question (6) Why wealth maximization is superior to profit maximization?

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