fin621 subjective curent paper solved on 19-02-2011

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Question # 1:
State and explain any five generally acceptable accounting principles. 5 I) Entity principle: specific business entity separate from personal affairs of the
owner(s).
ii) Cost principle: valuation and recording of assets at cost.
iii) Going-concern assumption: connected with cost principle, assets acquired for use and
not for resale.
IV) Objectivity principle: definite, factual basis for assets valuation; measuring
transactions objectively.
v) Stable currency principle. The currency remains more or less stable and rate of
inflation is almost zero.
vi) Adequate disclosure concept: facts necessary for proper interpretation of statements;
Subsequent events”, lawsuits against the business, assets pledged as securities/collaterals,
contingent liabilities etc; reflected in Notes.
Question # 2:
What is the effect of financial leverage on the earnings of the firm? When
leverage is advantageous? 3
Leverage: It means operating a business with borrowed money. It should be used to earn
a return (on assets or equity) greater than cost of borrowing i.e. interest. Alternate term for this is “Gearing”. This is opposite of Debt ratio. Low equity ratio indicates extensive
use of leverage i.e. borrowings.
With leverage the financial risk is high and possibility that company may not pay back
money borrowed and has entered bankruptcy. Advantage of it was that company can not
pay dividends and fewer shares in the profit of company. Debt financing can be done to
avoid giving up shares of ownership of the company. Unofficial financing known as trade

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