CMA (Cost & Management Accountancy) Final: Strategic Financial and Corporate Reporting Flashcards

24 sample cards from the Final: Strategic Financial and Corporate Reporting deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. What is the basis of accounting traditionally followed in Government Accounting in India, and how does it differ from commercial accounting?

   Government accounting in India is traditionally maintained on a cash basis (recording actual receipts and payments), whereas commercial accounting uses the accrual basis. Government accounts emphasise legislative control and appropriation rather than profit determination.

2. In Indian Government Accounting, what are the three parts of the Government Account (Consolidated Fund structure)?

   The Government Account is kept in three parts: (1) Consolidated Fund of India, (2) Contingency Fund of India, and (3) Public Account of India. Each is further divided into Revenue, Capital, and Debt/Loan sections.

3. Write the formulas for Net Present Value (NPV) and the decision rule for capital budgeting.

   $$NPV = \sum_{t=1}^{n} \frac{C_t}{(1+r)^{t}} - C_0$$ where $C_t$ is the net cash flow in period $t$, $r$ the discount rate and $C_0$ the initial outlay. Decision rule: accept the project if $NPV > 0$; for mutually exclusive projects choose the highest positive NPV.

4. Define the Internal Rate of Return (IRR) and its decision rule, including the IRR equation.

   IRR is the discount rate that makes NPV zero: $$\sum_{t=1}^{n} \frac{C_t}{(1+IRR)^{t}} - C_0 = 0$$ Decision rule: accept the project if $IRR >$ the cost of capital (hurdle rate); for independent projects accept all such projects.

5. Write the formula for the Profitability Index (PI) and its decision rule.

   $$PI = \frac{\text{Present value of future cash inflows}}{\text{Initial investment}}$$ Decision rule: accept the project if $PI > 1$ (equivalent to $NPV > 0$). PI is useful for ranking projects under capital rationing.

6. Write the discounted payback period concept and contrast it with simple payback.

   Simple payback is the time to recover the initial outlay from undiscounted cash flows. Discounted payback uses the present values of cash flows: it is the time $t$ at which $$\sum_{k=1}^{t} \frac{C_k}{(1+r)^{k}} = C_0$$ It accounts for the time value of money but still ignores cash flows after the cutoff.

7. In risk analysis of investments, what is sensitivity analysis and how does it differ from scenario analysis?

   Sensitivity analysis changes one input variable at a time (e.g. sales, cost, discount rate) to see its effect on NPV, identifying the most critical variables. Scenario analysis changes several variables together to form consistent scenarios (e.g. best, base, worst case) and evaluates NPV under each.

8. How is risk incorporated into capital budgeting through the risk-adjusted discount rate (RADR) and certainty-equivalent methods?

   RADR adds a risk premium to the risk-free rate so riskier projects are discounted at a higher rate, reducing NPV. The certainty-equivalent method converts risky cash flows into certain equivalents using factors $\alpha_t$ (between 0 and 1) and discounts them at the risk-free rate: $$NPV = \sum_{t=1}^{n} \frac{\alpha_t C_t}{(1+r_f)^{t}} - C_0$$

9. What is a 'real option' in capital budgeting, and name the main types.

   A real option is the right, but not the obligation, to take a future action (e.g. expand, defer, abandon) regarding a real (physical) investment, giving managerial flexibility that traditional NPV ignores. Main types: option to expand (growth), option to delay/defer, option to abandon, and option to switch inputs/outputs.

10. What is capital rationing, and distinguish hard from soft capital rationing?

    Capital rationing is the situation where limited capital forces a firm to select among acceptable (positive-NPV) projects. Hard rationing is imposed externally by capital markets (inability to raise funds); soft rationing is imposed internally by management policy (e.g. self-imposed budget limits).

11. Under single-period capital rationing with divisible projects, what ranking criterion maximises shareholder wealth?

    Rank projects by the Profitability Index (PV of inflows per rupee of investment) and select in descending PI order until the capital budget is exhausted. With indivisible projects, instead evaluate feasible combinations to find the set giving the highest total NPV within the constraint.

12. Write the formulas for the cost of equity using (a) the dividend growth (Gordon) model and (b) the CAPM.

    Dividend growth model: $$K_e = \frac{D_1}{P_0} + g$$ where $D_1$ is next year's dividend, $P_0$ the current price and $g$ the growth rate. CAPM: $$K_e = R_f + \beta (R_m - R_f)$$ where $R_f$ is the risk-free rate, $\beta$ the systematic risk and $(R_m - R_f)$ the market risk premium.

13. Write the formula for the after-tax cost of debt.

    $$K_d = i \,(1 - t)$$ where $i$ is the pre-tax interest (coupon/yield) rate and $t$ the marginal tax rate. For a redeemable bond an approximate yield is $$K_d = \frac{I(1-t) + \frac{(RV - NP)}{n}}{\frac{RV + NP}{2}}$$ where $I$ is interest, $RV$ redemption value, $NP$ net proceeds and $n$ years to maturity.

14. Write the formula for the Weighted Average Cost of Capital (WACC).

    $$WACC = K_e \frac{E}{V} + K_d (1-t)\frac{D}{V} + K_p \frac{P}{V}$$ where $E$, $D$, $P$ are the market values of equity, debt and preference capital, $V = E + D + P$, and $K_e$, $K_d$, $K_p$ are their respective costs. Weights should ideally be based on market values.

15. State the key proposition of the Net Income (NI) approach to capital structure.

    Under the NI approach, the cost of debt and cost of equity are assumed constant, so increasing the proportion of (cheaper) debt lowers the overall WACC and raises total firm value. Hence an optimal capital structure is reached at maximum debt (100% debt in the extreme).

16. State Modigliani–Miller Proposition I and II in a world with no taxes.

    Proposition I: the value of a firm is independent of its capital structure — $V_L = V_U$ — so WACC is constant. Proposition II: the cost of equity rises linearly with the debt-equity ratio: $$K_e = K_0 + (K_0 - K_d)\frac{D}{E}$$ where $K_0$ is the unlevered cost of capital, exactly offsetting the benefit of cheaper debt.

17. Under MM with corporate taxes, write the value of a levered firm.

    $$V_L = V_U + t \cdot D$$ where $V_U$ is the value of the unlevered firm, $t$ the corporate tax rate and $D$ the market value of debt. The term $t \cdot D$ is the present value of the interest tax shield, implying value increases with leverage.

18. Define operating, financial and combined leverage with their formulas.

    Degree of operating leverage: $$DOL = \frac{\text{Contribution}}{EBIT}$$ Degree of financial leverage: $$DFL = \frac{EBIT}{EBIT - I}$$ Degree of combined leverage: $$DCL = DOL \times DFL = \frac{\text{Contribution}}{EBIT - I}$$ measuring the sensitivity of EPS to a change in sales.

19. What is the trade-off theory of capital structure?

    The trade-off theory states that a firm chooses its optimal capital structure by balancing the tax-shield benefits of debt against the costs of financial distress and bankruptcy (and agency costs). The optimal debt level is where the marginal benefit of the tax shield equals the marginal cost of distress, maximising firm value.

20. Under Ind AS 1, what is the minimum set of components of a complete set of financial statements?

    (1) A balance sheet (statement of financial position); (2) a statement of profit and loss (including OCI); (3) a statement of changes in equity; (4) a statement of cash flows; (5) notes comprising significant accounting policies and other explanatory information; and a balance sheet at the beginning of the earliest comparative period when a retrospective restatement occurs.

21. Under Ind AS 115, how are contract assets, contract liabilities and receivables distinguished?

    A receivable is an unconditional right to consideration (only the passage of time is required). A contract asset is a right to consideration conditional on something other than time (e.g. future performance). A contract liability arises when the customer pays (or payment is due) before the entity transfers the goods/services.

22. Under Ind AS 109, how are equity investments not held for trading accounted for, and what is unusual about the OCI on disposal?

    On initial recognition an entity may make an irrevocable election to present subsequent fair value changes of such equity investments in OCI (FVOCI). Dividends go to profit or loss, but the gains/losses accumulated in OCI are never reclassified (recycled) to profit or loss on disposal — they may only be transferred within equity.

23. In step acquisitions under Ind AS 103, how is a previously held equity interest treated when control is obtained?

    When control is achieved in stages, the acquirer remeasures its previously held equity interest in the acquiree at its acquisition-date fair value and recognises any resulting gain or loss in profit or loss. This remeasured fair value is included in the consideration when computing goodwill.

24. In consolidation, how is a change in a parent's ownership interest in a subsidiary that does not result in loss of control accounted for?

    It is accounted for as an equity transaction (transaction between owners). No gain or loss is recognised in profit or loss and goodwill is not remeasured; the carrying amount of NCI is adjusted and any difference between the adjustment and the fair value of consideration is recognised directly in equity attributable to the parent.

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