Options: Meaning and Types of Options

 Q. What do you understand by the term Option ? Write in detail various types of options. 

Ans. MEANING OF OPTION: Options is the form of derivative in which a specified security can be bought or sold at a specified price at some future date at current price or exercise price. These are different to other financial investments such as shares, commodities and currencies. These instruments are based on other financial instruments, therefore, they derive their value from other asset. In the options contract, one party grants the right to buy a specific asset at a specific price to other party. The person who grants the right is known as ‘Option writer’ and the person who has received the right to buy is called as ‘Option buyer.’

The right to sell a security is called as ‘Put option’ and the right to buy is the ‘call option’.

These are like futures contract as they are made to minimise the risk. Options also help the investor in earning profits from changes in share prices without investing the full price of the contract. One obtains the full right over the specified asset without buying them outright. These are also helpful in protecting from fluctuations in the value of the investment.

TYPES OF OPTIONS: The call options and put options are the two types of options:

1. Call Option: The call option provides the right to buyer for buying an underlying asset at the strike price on or before the expiration date. The buy has to pay the premium in return of the right to seller.

2. Put Option: This provides the right to seller to sell an underlying asset at a strike price on or before the expiration date. The seller receives the amount of premium in return of that right granted.

The options can also be classified on the basis of expiration time. On this basis, they may be divided in American and European Options. American Options refers to that options, which can be executed at anytime on or before the expiry date whereas European Options refers to those which can be executed only on the expiry date.  

The other categorisation may be done on the basis of method of their trade. Under this categorisation, the options may be divided in two types: Exchange Traded Options and Over The Counter Option. Exchange Traded Options are those which are traded on recognised exchanges. Over the counter options are those which are not traded on exchanges, rather they are directly traded by buyer and seller. There are no standardised strike prices and expiration dates. 

In addition to these, there are some other complex types of options also. These may be divided into following two types.

I. Simple Options: Various types of simple options are as follows: 

(1) Stock Options: The options created on particular stocks are called as stock options. Every stock is not allowed for options trading by SEBI. SEBI has permitted only certain stocks that meet its stringent criteria. 

(2) Index Options: This option is written on the exchange indices such as CNX, Nifty 50, CNX IT and Bank Nifty, Sensex, etc. The trade is made on the general movement of stock market index movement. They are settled by payment of cash. The amount of settlement depends upon the difference between the closing price of index and strike price of option. 

(3) Commodity Options: Commodity options are derivatives contract which give the right to buy or sell a specific commodity at a pre-determined price at some point of time in future. A commodity option contract establishes a specific price at which the contract may be exercised. It has an expiration date.

(4) Bond Options: A bond option is an option to buy or sell a bond at a specific price on or before the expiry date. They provide the right to the investors, but not the obligation. It provide investors with a tool for hedging interest rate fluctuations. 

(5) Currency Options: These are exchange traded with pre-defined maturities. These provide safeguard against the adverse exchange rate fluctuations.  Like other options, they provide right to sell or buy foreign currency at a fixed price at some future date. 

(6) Options on Futures: As the name states, this type of options is the combination of futures and options. An option on a futures contract is the right, but not the obligation to buy or sell a particular future contract at a specific price on or before a certain expiration date.

II. Exotic Options: Exotic options are not traded on exchanges and are mainly traded over-the-counter. The terms of the options are negotiated by brokers or dealers. They are more complex in nature and are customised by combining the various types of options. These are as follows:

(1) Range Forward: It is a variation of regular forward contract which is used primarily to hedge the risk. This contract involves taking to opposite positions in options. It is set up in a way that they involve simultaneous sale and purchase of put options and call options on the same amount of principal and the same maturity but the exercise price is different. The range forward contract is used to reduce the cost of hedging to zero level. It is done by a hedger by receiving the premium on sales and paying the premium on purchase of options.

(2) Ratio Range Forward (RRF): It is the flexible variation of a range forward. They differ in amount. In these call and put positions are unequal. The investors choose the ratio of two amounts to bring down the upfront fees.

(3) Swaptions: It is a combination of swap and option. It provides its owner the right but not the obligation to enter into an interest rate swap on a specified date. In return, buyer pays a premium to the seller. Call swaptions and put swaptions are the two types of it. In the put option, the holder has a right to receive a fixed interest payment. But in the call option, the holder has to pay a fixed interest payment.

Vouching of Receipts: Special Points to Which an Auditor Must Pay Attention

 Q. What are the special points to which an auditor must pay special attention in vouching receipts (debit side of cash book) ?

Ans. Vouching of the Receipts side of a cashbook is more complicated as compared to the vouching of the payment side because the evidence of receipts is not direct since the payment of such receipts is made to other parties and the entries in the cash book is made internally.

The auditor therefore, needs to be extra careful in checking the receipts side in a cash book. He must keep in mind the following: 

1. Internal Checking: The auditor needs to satisfy himself that the internal check system in operation is good and reasonably reliable. He needs to understand the rules and regulations for issuing receipts, making records thereof and dealing with banks, etc. This becomes necessary to ensure that there is no misappropriation of funds, which can only be done by a thorough examination. For example, check a few items at random and if he finds them to be in order and free from irregularities, he has the reason to assume the remaining ones will be correct. 

2. List of Receipts: The auditor needs to examine that all receipts received in a day and the amount of cash thererof s recording in a list of receipts, and that the same are recorded in the diary or the rough cash book and later in the cash book. He must check the two from time to time. 

3. Reconciliation of Cash Books: At the start of the audit, the auditor should examine the rough cash book or the diary and compare it with the cashbook, because there is always the possibility that some items recorded in the rough cash book might not have been recorded in the cash book.

4. Receipt Issue System: Another point to be noted by the auditor is that there is Receipt Issue System, and a proper control over the use of Receipt Book. He should keep in mind the following points:

(i) That all receipts are on printed forms.

(ii) That there is a counterfoil or carbon copy of each receipt.

(iii) That all receipts and receipt books are separately and consecutively numbered. 

(iv) That the particulars in the receipts, i.e. the date, amount, name, etc. are the same as recorded in the cashbook.

(v) Blank Receipt Books must be in the custody of an authorised and responsible member of the staff.

(vi) The receipt must be signed by the authorized member(s) of the staff.

(vii) There should be no other signature on the receipt except that of the authorised signatory. 

(viii) If there is a system under which a receipt accompanies the receipt of cash, search your receipt (usually known as delivery note) should be properly signed before its return to the customer.

(ix) There should be a strict observance of the system of keeping the counterfoil or carbon copy of each receipt.

(x) In case a receipt of the written wrongly or has to be cancelled for any reason, it should not be taken out of the Receipt Book, and the word ‘Cancelled’ should be written on the receipt.

5. Bank Deposit System: In case the recepts are deposited in the bank, then the total of the receipts deposited should be reconciled with the bank’s pay-in-slips. It also needs to be checked that the counterfoils of the bank’s pay-in-slips are duly signed and stamped by the bank’s officer.

6. Abiding by the Rules: In case there are any other rules in vogue for granting receipts, making records thereof or dealing with the bank, these should be strictly be adhered to. 

Important Items of Receipts Side (Debit Side)

1. Cash Sales: The system of internal check of cash sales is of utmost importance in a business.  The auditor should check the carbon duplicates of the cash memos with the summaries of cash sales. He should compare the sales abstract with the cash analysis and then check up the cash book. In case the auditor detects any discrepancy, he should immediately inform the client.

The possibilities of fraud or misappropriation are more in cash sales. The auditor, therefore, must be extra careful in vouching cash sales. As Lancaster has very aptly put it, “Vouching of sales is more difficult than that of purchases.”

Vouchers: Carbon duplicates of cash memos, salesman’s abstracts, cashier’s summaries. 

2. Cash Received from Debtors: Firstly, it is necessary to ensure that the staff who receives cash from the debtors is not involved in making the statement of such receipts. Whatever the amount received from the debtors is acknowledged by a receipt which is issued. The cash received from debtors can be vouched by referring to the counterfoils of the receipts issued to them.

The auditor should pay special attention to the discount allowed to customers and the bad debts that are written off. He should acquaint himself with the method and rate of granting discount. The discount rates should not exceed the percentage that has been predefined. The auditor should enquire who has the authority to write off bad debts and if these are written off by thè authorised person. 

Vouchers: Receipt counterfoils, details of the account, correspondence and authorisation certificates of concerned officials.

3. Amount Received from Bills Receivable: The auditor needs to check the cash receipts of the bills receivable for which the relevant amounts have been received and Bills Receivable Book with the Cash Book and the Pass Book. He should also scrutinise the rebate that has given on bill received prior to the due date, and make sure that rebate given on such bill conforms to the accepted norms of the business. The amount deducted at discount or rebate on these bills should be debited in the discount account. 

The auditor needs to pay special attention to the bills that have matured, but the amount of the bills has not been received, and should get a certificate from the authorised person that the payment has not been received. He should investigate further to make sure that the dishonoured or retired bills have not been paid and that there is no discrepancy or misappropriation. 

Vouchers: Bill Receivable Book, Cash Book, Pass Book.

4. Income from Interest and Dividend:  Interest and dividend are receivable from different sources and, as such, their vouchers are also different. Interest is normally received from: (i) Investments, (ii) Loans and (iii) Deposits in Banks. The rate of interest on investments and security is the fixed rate and should be checked with the help of the counterfoils of interest coupons. In the case of interest received on a loan given to borrower, the relevant agreement between the borrower and the business should be checked to determine the rate of interest. At the same time, it should be checked whether or not the interest received has been recorded in the account books on the relevant dates. If the interest is received on fixed deposit in the bank, such income should be vouched with the Bank Pass Book or the Interest Statement that can be obtained from the bank. 

In case of receipt of dividends, three vounchers, namely: counterfoils, share certificates, dividend warrants and letters received along with the cheques need to be examined.  If such income is collected through the bank, the passbook needs to be referred to. The auditor should make sure that the income so received or accrued has been accounted for in the books of accounts and the balance sheet.

Vouchers: Pass Book, agreements, schedule, counterfoils, dividend warrants.

5. Rent Received: To vouch the rent received, it is necessary to examine the relevant lease deeds or rent agreements and assertain the amount of rent payable and the provisions regarding repairs. The auditor should check the counterfoils of the rent receipts issued to the tenants. If any agents are appointed to collect rent, the accounts or statements submitted by them should be checked. The auditor needs to be particularly careful to check the outstanding rent because the rent might have been received but shown as outstanding and the rent amount may have been misappropriated.

Vouchers: Lease deeds and agreements, rent rolls, accounts received from agents, counterfoils, correspondence.

6. Commission Received: As a general rule, there is an agreement between the business and the parties from whom the commission is receivable. The rate of the commission payable can be found from such agreement, and the amount of commission paid can be ascertained from the statement of commission. The entries made in the cashbook can be vouched from the counterfoils of receipts. If the commission has been received in respect of goods received on consignment, the amount of commission should be vouched by comparing it with the copy of account sale sent to the consignor. In case it is necessary, the auditor can make the required calculations himself. 

Vouchers: Commission agreement, statement of commission, receipt counterfoils, correspondence.

7. Subscription Received: The receipt that is given when a subscription is received should be confirmed by checking the relevant counterfoil. The amounts of subscriptions received can be vouched with the help of the subscriptions register and receipt counterfoils. The auditor should also check the subscriptions received in advance end the outstanding subscriptions at the end of the accounting year.

Vouchers: Register of subscriptions, counterfoils, correspondence.

8. Proceeds of Hire Purchase: The auditor needs to examine the Hire Purchase Agreement to assertain the duration of the agreement, the amount of installments payable by the close of the accounting period. It should be kept in mind that the installment is not credited in sales account — it has to be properly apportioned between sales and interest.

Vouchers: Hire purchase agreement, receipt counterfoils, correspondence. 

9. Proceeds from Sale of Investments: Investments are normally sold through brokers. The brokers send a sold note that contains the details of the amounts received from the sale and the commission chargable by the broker. Vouching the sale proceeds of investments is done by the sold note of the brokers. It is therefore important to check the broker's sold note. In case there is any agreement or correspondence related to the sale of investments, it should also be examined.

If the investments have been sold cum-dividend, it should be assertain that the dividend has been received and apportioned between capital and revenue. In case the sale of investment is ex-dividend, the relevant entry must be checked by the auditor.

Vouchers: Broker’s sold note, receipt counterfoils, correspondence. 

10. Receipts from the Sale of Other Assets: When whenever the fixed assets of a business are sold, they are sold through: (i) or sales representative or a broker and (ii) an auction of the assets. In case the sale is through the medium of a sales representative or a broker, it can be vouched by examining the note of the broker or the sales representative. If the sale of assests is by auction, the auctioneer’s note needs to be examined to vouch the transaction. Besides this, if a sale deed or a contact of sale is the medium, such deed or contract should be examined by the auditor. Thus the auditor can scrutinise the sale proceeds of assets by the broker’s or auctioneer’s note, or the sale deed or sale contract.

Vouchers: Broker’s or auctioneer’s note, sale deed or contract, correspondence.

11. Claims Received Under Insurance Policy: In case of any claims received under an insurance policy, the vouching is done by examining the insurance policy, the claim letter, they accounts surddeed by the valuer and insurer, and the correspondence between the client and the insurer.

Vouchers: Report of the valuer and insurer, correspondence, Bank Pass Book.

12. Refund of Income Tax: While vouching the refund of income tax,  the auditor should ensure that the amount so received is duly entered in the account books of the business. Besides this, the claim for such refund, related correspondence and the statement of the tax authority should also be examined.

Vouchers: Claim for tax refund, related correspondence, etc.

13. Bad debts Recovered: Under the provisions of the Insolvency Act, when a person or a business is declared to be insolvent, the court appoints a liquidator who takes over the assets of the insolvent, and pays the creditors of the insolvent, and pays the creditors of insolvent proportionately to their credit from the money realised from the sale of the assets taken over. The amount so received by the creditors is called bad debts dividend. Vouching for the recovery of bad debts is done by examining the dividend letters, receipts and related correspondence.

Vouchers: Dividend letters, receipts, correspondence.

14. Receipts from Sale of Shares: In order to vouch such receipts, the auditor should use the register of members, or the allotment register and the share register. In this context, he should also refer to the ‘Minutes Books’ of the meetings of Board of Directors. 

15. Remittance from agents: Every agent makes out a detail of his account and sends it to the organization. Normally, the detail is forwarded to an employee,  in every organization, who examines these details minutely and thereafter, makes enries in the cashbook based on these details.

While examining amounts received from agents, the auditor should consider the detail received from the agent as the voucher, and tally it with the entries in the cashbook.

Vouchers: Correspondence with agents, details received from agents. 

16. Other Receipts: The documents related to such receipts should be examined.  In case such documents are not available, the auditor should correspond with the concerned parties to vouch such receipts.

voching receipts debit side cash book auditor special points 

Responsibility Accounting: An Important Device for Control and Performance Evaluation

 Q. “Responsibility Accounting is an important device for control.” Discuss. 

Ans. Meaning of Responsibility Accounting: Responsibility accounting is a specific technique of managerial control wherein responsibilities of various individuals or groups are identified in terms of work, revenue or cost so that the concerned person or group may be held responsible for cost variances, if any. Responsibility accounting refers to the various tools used by managerial accountants to measure the performance of people and departments in order to ensure that the achievement of the goals set by the top management. Therefore, responsibility accounting represents a method of measuring the performance of various departments of an organization.

In the words of William, L. Ferrara, “The essence of responsibility accounting is the accumulation of costs and revenue according to areas of responsibility in order that deviations from standard cost and budgets can be identified with the person or group responsible.”

VK. Responsibility Accounting is an important device for control. It means that responsibility accounting is used as a controlling device by top management for controlling the performance of managers. The performance is constantly compared to the standards set and it is very useful in exercising cost control. The statement “Responsibility Accounting is an important device for control.”  is clarified by the following facts:

(1) Decentralisation of Decision Making: It enables the management to consider the organisational structure to result in effective delegation of authority and placement of responsibility. So, it enables the manager to take right decision.

(2) Better System of Control: This system enables the management to delegate authority to responsibility centers while retaining overall control with itself. It is used as a controlling device by top management for controlling the performance of other managers.

(3) Comparison of Performance: In this system, the organisation has divided into various responsibility centres and each centre is responsible for its costs. The actual performance of each responsibility centre is regularly measured and compared with the budgeted figures. It encourages the setting of realistic goal. 

(4) Helpful in Planning and Decision-Making: Responsibility accounting helps not only in control but in planning and decision making also.

(5) Improves Performance: This is a system of accounting in which cost data are reported to managers of various cost centers. In this system, budgets are prepared and actual performance is recorded and reported to the top management. The assigning of tasks to the managers of different centres act as a motivational factors.  It is rightly said that “the aim of responsibility accounting is not to place blame. Instead, it is to evaluate performance and provide feedback so that future operations can be improved.”

(6) Responsibility accounting system makes easy in application of Budgetary Control System.

(7) On the basis of this accounting system, the control system may be introduced more effectively and efficiently. 

(You have to write importance of Responsibility Accounting in this question.)

Q. “The aim of responsibility accounting is not to place blame. Instead, it is to evaluate performance and provide feedback so that future operations can be improved.” Discuss.

Mention this in last. 

Hence, The aim ........... Modify as per question.

Bases for Market Segmentation in industrial markets.

 Q. Explain in detail various bases for market segmentation. 

Ans. Division of market into several segments is called market segmentation. Two broad classification of segmenting market are macro segmentation and micro segmentation. This is the one of the most common methods applied in industrial markets.

Bases for Market Segmentation in industrial markets.

1. Macro Segmentation: The macro bases of segmentation are based on the industry and organizational characteristics. Organizational characteristics include demographics, end-use markets, product applications, etc. This information can easily be collected by the industrial marketer from the secondary sources and also from the marketer’s information system. These macro variables are :

I. Industry Characteristics: An industrial marketer must list down industries, the product or service can be sold to. An industry has a unique requirements of products, purchase in a particular manner and requires certain level of quality of the product. Therefore, it is important that a company makes an in-depth study of the requirements of the industry before it starts to woo companies of that industry.

II. Organizational variables: Following features are included in this part:

(a) Organization size: The organization size is one of the most practical and easily identifiable criteria. 

(b) Geographic Location: Geographic location informs a company in detail about the culture as well as the communication requirements. It also relates to culture, language and business attitudes. For example, a company would adopt a different bidding strategy for an Asian customer with an American customer. 

III. Customer Variables: These includes the following:

(a) Level of Competition: The level of competition in the customer’s industry plays an important role in the segmentation of the industrial markets. If the market competition is higher, then it will not attract the newcomers. 

(b) Purchasing Decision: This criterion can only be applied to newcomers. In cases of long-term relationship, which is usually the objective of most industrial businesses, the qualified supplier is normally aware of the purchase requirement.

IV. Application Variables: Following variables are included in this:

(a) Product Application: Various products are used in different ways. For example, the small electrical switches are used in the production of small household appliances, computers, televisions, etc. Hence, markets can segmented on the basis of product application.

(b) Purchasing Situation: Another real life criterion for the market segmentation is the purchasing situation. The purchasing situations can be classified as new task, modified re-buy or straight re-buy. Due to increased competition and globalization in most of the established industries, companies are focusing on small number of markets, analyze them and then establish long-term relationship with the customers. This is because they believe that it is cheaper to keep an existing customer than to find a new one. Analyzing purchase situation helps the companies to maintain good relations with their customers.

Purchase Situation Variables: The following are the different purchase situation variables:

(i) Purchasing Policies: Market segmentation may also be based on the purchasing process of the customers. While some customers prefer agreement based on supplier’s cost, other purchasers negotiate from a market based price. Some also use bids or prefer to take on lease.

(ii) Purchasing Criteria: Market can be further segmented on the basis of the purchasing criteria employed by the buyers across organizations. This criteria can be performance, economic, integrate, adaptive or legalistic criteria. This criteria vary in their degree of importance, depending on the purchase situation.

(iii) Organization of Purchasing Function: The organization of the purchasing function to some extent determine the size and operation of a company’s purchasing unit. While in some buying, centers plant managers and top managers would be involved, in some others, the external sources of expertse would be depended upon for making purchase decisions.

(iv) Inventory Requirements: Segmentation can also be made on the basis of inventory requirements of the various firms. Organizations can be segmented so as to avoid targeting those customers whose inventory requirements cannot be met. However, if the supplies are capable enough, then markets that use MRP and JIT systems can be targeted. Search targets are required to be highly competent.Suppliers who can deliver defect free products,  on time and on a regular schedule basis. 

2. Micro Segmentation: Micro segmentation include the understanding of markets, market information, decision making unit, etc. This type of segmentation requires the collection of large amount of primary data. “Micro segments are homogeneous groups of buyers within the macro segments” (Webster, 2003). Following are the basis of micro segmentation:

I. Purchasing Objectives: The objectives of purchasing are different from organization to organization. Companies have different purchasing philosophies. Large organisation stresses upon quality as well as service, on the other hand, the small organization look for better bargain and discounts. Further, the order supply, quality and servicing are also essential variables. If marketers are not able to meet the requirements of buyers, they should avoid such customers. 

II. Choice criteria: A company’s choice criteria will depend on how it has decided to compete in its own market. Therefore, a buyer will not Budge on quality because it is making a premium product and another will not budge (change one’s position, opinion or demand, especially unwillingly / compromise on price) on price because it is making a value for money product. A seller needs to understand what each of its buyer is trying to achieve. The buyer who is buying premium products will be willing to pay a higher price if the seller offers ti increase the quality of its products, and the buyer who is buying value for money products will be willing to buy products of lower quality if the seller offers to reduce its price. Therefore, a seller needs to have different marketing mix when its buyers have different choice criteria, and salespeople will need to emphasize on different benefits with different clients.

III. Buying Decision Criteria: It includes product quality, delivery,  technical support, price, supply continuity. The marketer miĝht divide the market based on supplier profiles that appear to be preferred by decision-makers, e.g. high quality, prompt delivery, premium price vs. standard quality, prompt delivery, low price.

IV. Structure of the Decision-Making Unit: It can be one of the most effective criteria. Buying in an individual unit is done by the group of members and is not the task of an individual. There are multiple factors which affect the buying as the members can be different from different departments like marketing, production, engineering, research and development and also purchase. So, when marketer understands the members involved in purchase, it can lead to the identification of meaningful segment.

V. Personal Characteristics: Decision-making is done by the human beings and the personal characteristics of the decision maker play a great role in this process. So, it is also possible to segment the market on the basis of the personal characteristics of the individuals involved in purchasing. For example, segmentation can be done on the basis of demographics, personality, non-task motives, individual perceptions and risk management strategies. But the problem in this basis is that data would be literally impossible to obtain.

VI. Evaĺuating Potential Segments: Industrial markete has an array of segmentation variables to choose from. Research may be worthwhile to identify the most appropriate of those variables. Moreover, since customer’s need and competitor’s activities are constantly changing, a marketer must review his segmentation strategy periodically. After identifying target segments, the marketer must access their profitability by differentiating the marketing program to each multiple target segments.  Hence, a first approximation of cost benefit analysis is necessary before a detailed segment issue analysis is begun. The potential profit and competitive situation of various segments may then be evaluated. 

VII. Market Profitability Analysis: Four primary elements are involved in analyzing the profitability of any potential segments:

• Market potential, the most optimistic estimate of the amount of product that an entire market will purchase in a given period of time.

• Sales potential, the most optimistic estimate of company's share of market potential in a given time period.

• Sales forecast, the estimate of a company's expected sales in a given time period.

• Profitability, the differences between potential renew and the cost of serving and manufacturing customers.