Financial Acccounting MBA KUK

FINANCIAL ACCOUNTING
Instructional Resource
Lalit Wadhwa Asstt. Prof. In Management

Geeta Institute of Management & Technology, KKR
MBA 1st Semester, Kurukshetra University
Lalit Wadhwa, Assistant Professor in Management, Geeta Instititute of Management &Technology, Kanipla, Kurukshetra
SYLLABUS FINANCIAL ACCOUNTING CP-106
Note: The Examiner will set the question paper in two parts encompassing the entire syllabus. Part A will comprise 10 short answer type questions of 5 marks each. Part B will comprise of 5 questions of 10 marks each. A student is required to attempt any eight questions from the part A and any 3 questions from part B. Objectives: The basic purpose of this course is to develop an insight of postulates, principles and techniques of accounting and application of financial and accounting information for planning decisionmaking and control. Course Contents: Financial Accounting - Concept, Importance and Scope. Generally accepted accounting principles, Preparation of Financial Statements with special reference to analysis of a Balance Sheet and Measurement of Business Income; Financial Statement Analysis; Ratio analysis- liquidity, solvency and profitability ratios. Funds Flow Analysis; Cash Flow Analysis Cost Accounting - Nature &Scope of costing; Preparation of cost sheet; Marginal costing and absorption costing: Managerial application of marginal costing. Break even analysis; Responsibility Accounting - Concept and Objectives. Responsibility Centers; Budgeting: Types of budgets & their preparation, performance budgeting and Zero based budgeting. Standard costing - organization and establishing a standard costing system. Variance AnalysisClassification of variances, Material cost. Labour cost, Overhead cost and sales variances; Inflation Accounting concept, impact of inflation on corporate financial statements; Human Resource Accounting - Concept and Approaches; IFRS-An introduction. Accounting software: Tally.
Suggested Readings: 1. Anthnoy R.N. & Reece J S. Accounting Principals. Ilomevvood Illinois. Richard D. Irwin. 1995 2. Batacharya S.K.& Dearden .1. Accounting for Management- Text and Cases. Vikas New Delhi 1996 3. Heitger LE and Matulich Serge Financial Accounting. McGraw Hill, New York. 1990 4. Horngren C T, Sundem G F and Stratton W. Introduction to Management Accounting. Prentice Hall of India New Delhi. 1994. 5. Khan M Y & Jain P K. Management Accounting. Tata McGraw-Hill, New Delhi. 6. Sahaf M A Management Accounting - Principles & Practice, New Delhi, Vikas Publishing House 2009. The list of cases and specific references including recent articles will be announced in the class
CONTENTS
1. FINANCIAL ACCOUNTING 1.1 Definitions 1.2 Features of Accounting 1.3 Objective of Accounting 1.4 Book Keeping and Accounting 1.5 Difference between book keeping and Accounting 1.6 Branches of Accounting 1.7 Accounting as Information system 1.8 Classification of Accounts 1.9 Users of Accounting informations 1.10 Basis of Accounting 1.11 Double entry system 1.12 Basis Of Accounting 1.13 Accounting Equation 1.14 Advantages of Accounting 1.15 Limitations of Accounting ACCOUNTING PRINCIPLES 2.1 Basics Concepts or Assumption s 2.2 Basic Principles 2.3 Modified Principle FINAL ACCOUNTS OF JOINT STOCK COMPANY RESPONSIBILITY ACCOUNTING 4.1 Introduction 4.2 Definition 4.3 Steps of Responsibility Accounting 4.4 Pre-requisites of an Effective Responsibility Accounting 4.5 Objectives of Responsibility Accounting 4.6 Advantages of Responsibility Accounting 4.7 Disadvantages of Responsibility Accounting COST ACCOUNTING 5.1 Cost 5.2 Elements of Cost 5.3 Classification of Cost 5.4 Cost Accounting 5.5 Cost Accountancy 5.6 Objective of Cost Accounting 5.7 Advantages of Cost Accounting 5.8 Limitation of Cost Accounting 5.9 Difference between Financial and Cost Accounting STANDARD COSTING 6.1 Definitions 1 11
2.
12 16
3. 4.
17 18 19 23
5.
24-32
6.
33 49
6.2 6.3 6.4 6.5 6.6
7.
Process of Standard Costing Advantages of Standard Costing Disadvantages of Standard Costing Standard Costing and Budgetary Control Variances 6.6.1 Material Variances 6.6.2 Labour Variances BUDGETARY CONTROL 7.1 Meaning of Budget, Budgeting and Budgetary control 7.2 Requirements of Budgetary Control 7.3 Objectives of Budget 7.4 Advantages of Budgetary Control 7.5 Types of Budget 7.6 Zero base Budgeting 7.7 Performance Budgeting MARGINAL COSTING 8.1 Definitions 8.2 Advantages of Marginal Costing 8.3 Disadvantages of Marginal Costing 8.4 Difference between Absorption Costing and Marginal Costing 8.5 Main areas of decision making 8.6 Cost-volume-profit-Relationship INFLATION ACCOUNTING 9.1 Introduction 9.2 Definition 9.3 Impact Of Inflation on Corporate Financial Statements 9.4 Significance of Inflation Accounting 9.5 Limitation of Inflation Accounting 9.6 Methods of Inflation Accounting FUND FLOW STATEMENT 10.1 Definitions 10.2 Objectives, Uses and Importance of Fund Flow Statement 10.3 Limitation of Fund Flow Statement 10.4 Preparation of Fund Flow Statement CASH FLOW STATEMENT 11.1 Meaning 11.2 Difference between fund flow statement and cash flow statement 11.3 Objective of cash flow statement 11.4 Utility, importance and advantages 11.5 Preparation of cash flow statement RATIO ANALYSIS 12.1 Meaning 12.2 Liquidity Ratios 12.3 Leverage Ratio 12.4 Turnover Ratio 12.5 Profitability Ratio based of sale
50 - 59
8.
60 67
9.
68 - 71
10.
72 78
11.
79 83
12.
84 96
12.6 13.
Profitability Ratio based of investment 97 100
14.
INTERNATIONAL FINANCIAL REPORTING STANDARDS 13.1 Introduction 13.2 Definition 13.3 Difference Between IFRS and GAAP 13.4 International Financial Reporting Standards 13.5 Advantages and Disadvantages of IFRS 13.6 Need For IFRS HUMAN RESOURCE ACCOUNTING 14.1 Introduction 14.2 Importance of Human Resource Accounting 14.3 Objective of Human Resource Accounting 14.4 Limitations of Human Resource Accounting 14.5 Approaches of Human Resource Accounting Question Bank Model Test Paper References
101 104
105 113 114 119 120
CHAPTER I FINANCIAL ACCOUNTING
Objectives: The important objectives are : 1. To introduce the subject Financial Accounting 2. To discuss the meaning and definition of Accounting 3. To identify the uses and users of Accounting informations
In the modern times during the course of business , a businessman deals with a large number of persons-customers, suppliers, middleman, institutions etc. He keeps various types of assets as cash, stock of goods ,furniture, plant, investments ,building etc. He has to incur various exp. and he receives so many type of incomes. Obviously this is not possible for a human being to remember all transactions relating to person, property ,payment and earnings. Therefore it require a system of recording. Moreover such a record must be based on a definite and well tried system, as to enable him to secure accurate information regarding the cumulative effect of business transaction. The branch of knowledge which deals with the systematic recording of transaction is called book keeping. Accounting starts when the book keeping ends. Actually Accounting summarizes the informations collected recorded by a book keeper. Accounting is an art of identification of economic transactions and recording, classifying, summarizing, analyzing and interpreting the transactions of concern to know the results thereof. 1.1 Definitions
As per American Accounting Association: Accounting is the process of identifying , measuring and communicating information to permit judgment and decisions by the users. In 1941, The American Institute of Certified Public Accountant(AICPA) defined accounting as follows: Accounting is the art of recording, classifying and summarizing in significant manner and in terms of money, transactions and events which are , in part, at least of a financial character and interpreting the results thereof. R.N. Anthony: An Accounting system is a means of collecting, summarizing , analyzing and reporting in monetary terms, informations about the business
Smith and Ashburne: Accounting is the science of recording and classifying business transactions and events, primarily of a financial character and the art of making significant summaries , analysis and interpretations of these transactions and events and communicating the results to persons who must make decisions or form judgments 1.2 Features / Functions / Accounting Process:
Recording: In Accounting only those transactions are recorded which can be measured in the terms of money only. For example if there is a quarrel between sales manager and purchase manager it can not be recorded. In accounting transactions of qualitative nature are ignored. Classifying: In Accounting, the second step is to accumulate the transactions of same nature in a book which is called ledger. Summarizing: In the third step, Trial balance , Trading, P&L A/C & Balance Sheet is prepared. Preparation of trial balance is the part of book keeping while Trading, P&L A/C & Balance sheet is the part of final a/c. Analyzing: In the next step after preparation of financial statements these are analyzed with the help of fund flow statement, cash flow statement, and ratio analysis. Interpreting: In the last step the analysis is interpreted so that result can be known and the decisions can be made.
Accounting process / Accounting Cycle
Recording
Classifying
Interpreting
Summarizing
Analyzing
1.3
Objectives of Accounting: 1. To know the profit and loss: The main objective of accounting is to know the profit or loss during the year. How much gross profit or gross loss and Net profit or net loss.. 2. To know the financial position: The another objective of accounting is to know the financial position. How much the assets the concern has and how much the liabilities the concern is having. 3. For comparison: With the help of Accounting we can compare the financial performance of concern with another concern and with the last year also. 4. For systematic recording : Accounting provides systematic recording of transactions of the concern which are of financial nature. 5. Provides information: Accounting also provides information to the various parties external as well as internal: (i) To the owners (ii) To the management (iii) To the investors (iv) To the creditors (v) To the government (vi) To the employees (vii) To the bank
1.4
Book-keeping and Accounting
Book-keeping is made of two words Book and Keeping where Book means all types of books which are used to record the business transactions in business and keeping means recording all the entries and business transactions in the account books in a systematic manner as per rules and principles of accounts. Hence, Book-keeping means, an the art of recording the business transactions in the books of accounts in a proper form. A book-keeper may be responsible for keeping the financial records of a business. The main definitions of book-keeping are as under: 1. J.R. Batliboi: Book-keeping is the art of recording business dealings in a set of books. 2. R.N. Carter: Book-keeping is the science and art of correctly recording in the book of accounts, all those business transactions that results in the transfer of money or money worth. 3. Spicer and Pegler: Bookkeeping is an art of recording business transactions in a systematic manner.
1.5
Difference between Book-keeping and Accounting
There is no line of demarcation between Bookkeeping and Accounting instead they have a close relationship. It cannot be separated so easily. However, on the basis of working, the difference between the two is as under:
S. No. 1. 2. 3. 4. 5. Basis of Differences Transactions Posting Simplicity Total and Balance Objects Book-keeping Trading transactions are recorded in primary books. Entries are posted in ledger from journal and subsidiary books. The work of Book-keeping is simple It includes totalling of journal and finding of balances of ledger. The object of Book-Keeping is to write all trading transactions in a reasonable manner. In Book-keeping entries of adjustments and rectification of errors are not included. Scope of Books-keeping is narrow. Final Account is not pre-pared in Book-keeping Accounting Entries written in primary books are checked and verified. Posting are checked whether correctly posted or not. The work of Accounting is difficult. On the basis of balances of ledger final accounts are prepared. The objects of accounting is to analysis the transactions written in the books. Accounting includes entries of adjustments and rectification of errors. Scope off Accounting is wide. Final Account preparation is must.
6.
Adjustments and Rectification of errors Scope Final Accounts
7. 8.
1.6
Branches of Accounting There are following branches of accounting 1. 2. 3. 4. 5. 6. Financial Accounting Cost Accounting Management Accounting Social responsibility Accounting Human Resource Accounting Tax Accounting Accounting as information system:
1.7
Accounting is basically an information system because it provides the necessary, timely and relevant information. As an information system Accounting is involved in the process of converting inputs into outputs. Step of accounting as information system includes:1. 2. 3. 4. Input Process Output Report to users
Accounting as Information System
Input Business Transactions (Purchase, Sales, Exp. Income)
Process Recording Classifying, Analysing
Output Financial Statements (Profit & Loss A/C, B/S) Reports to users User of Accounting Information
Source: Gowda J. Made, Accounting for Managers, Himalaya Publications, 2007, pp7 1.8 Classification of Accounts
There are 3 types of accounts, namely personal accounts, real accounts, nominal accounts. a) i) ii) iii) b) i) Personal accounts. Natural persons accounts. Artificial persons accounts. Representative persons accounts. Impersonal accounts Real accounts a. Tangible Real Accounts b. Intangible Accounts Nominal Accounts Users of Accounting Information:
ii) 1.9
Users of accounting information are many and they can be classified into two broad categories as internal parties and external parties.
Board of Directors Chairman Internal Parties Managing Directors Functional Manager Others
Users of Accounting Information User with direct financial stake
Shareholders Debenture holders Lender
Employees Supplier
External Parties Customers Tax authorities Users with indirect financial stake Trade Unions
Press General Public
Source: Gowda J. Made, Accounting for Managers, Himalaya Publications, 2007, pp8
1.10
Basis of Accounting The following are the main basis of recording business transactions:
(a) Cash Basis. Under this system, actual cash receipts and actual cash payments are recorded. Credit transactions are not recorded at all until the cash is actually received or paid. The Receipts and Payments Account prepared in case of non-trading concerns such as a charitable institution, a club, a school as the best example of cash system. This system does not make a complete record of financial transactions of a trading period as it does not record outstanding transactions like outstanding expenses and outstanding incomes. The system being based on a record of actual cash receipts and actual cash payments will not be able to disclose correct profit or loss for a particular period and will not exhibit true financial position of the business on a particular day. (b) Accrual Basis. Under this all transactions relating to a period are recorded in the books of account, i.e., in addition to actual receipts and payments of cash income receivable and expenses payable are also recorded. This gives a complete picture of the financial transactions of the business as it makes a record of all transactions relating to a period. This being based on a complete record of the financial transaction discloses correct profit or loss for a particular period and also exhibits true financial position of the business on a particular day. (c) Mixed System. Under this system both cash basis and actual basis are followed. Some records are kept under cash basis whereas others are kept under accrual basis. 1.11 Double Entry System
This system owes its origin to an Italian merchant names Luco Pacioli who wrote the first book entitled De Computis et Scripturis on double entry accounting in the year 1494. We have seen earlier that every business transaction has two aspects, i.e., when we receive something we give something else in return. For example, when we purchase goods for cash, we receive goods and give cash in return; similarly in a credit sale of goods, goods are given to the customer and the customer becomes debtor for the amount of goods sold to him. This method of writing every transaction in two accounts is known as Double Entry System of Accounting. Off the two accounts, one account is given debit while the other account is given credit with an equal amount. Thus, on any date, the total of all debits must be equal to the total of all credits because every debit has a corresponding credit. Rules of Double Entry System There are separate rules of the double entry system in respect of personal, real and nominal accounts which are discussed below:
1. Personal Accounts. These accounts record a businesss dealings with persons or firms. The person receiving something is given debit and the person giving something is given credit. For example, if Vijay sells goods to Viney on credit, Vineys Account will be given debit (in Vijays books) as he is the receiver of goods and Vijays Account will be credited (in Vineys Books) as he is the giver of goods. When Viney makes the payment for these goods, Vijays Account will be debited in Vineys books as he is the receiver of cash Vineys Account will be given credit in Vijays book as he is the giver of cash. 2. Real Accounts. There are the accounts of assets. Asset entering the business is given debit and asset leaving the business is given credit. For example, when goods are sold for cash. Cash Account will be given debit as cash comes in and Purchases (of Goods) Account will be given credit in Vijays books as he is the giver of cash. 3. Nominal Accounts. These accounts deal with expenses, incomes, profits and losses. Accounts of expenses and losses are debited and accounts of incomes and gains are credited. For example, when rent is paid to the landlord, rent Account will be debited as it is an expense and Cash Account (real account) will be credited as it goes out. Similarly, when commission is received, Cash Account will be debited as cash is received and Commission Account will be credited as it is an income. Thus, the rule is debit all expenses and losses and credit and gains. The rules of the double entry system are shown in the following chart: RULES OF THE DOUBLE ENTRY
Personal Accounts Real Accounts Nominal Accounts
Debit the Receiver
Credit the Giver
Debit what comes in
Credit what Goes Out
Debit Expenses and Losses
Credit Incomes and Gains
1.12
Basis of Accounting
In general, accounting is known as the recording of financial transactions. In this process, accountants are required to recognize revenues and costs. Following are the bases of accounting for measuring the business income: 1) Cash Basis of Accounting:
This is the system of accounting under which revenues and expenses are recognized and recorded only when they are received in cash. Similarly, expenses will be recorded when they are paid in cash. No recording is made if an income or expense is merely due. Under cash basis, income is measured as the excess of cash receipts over cash payment.
Thus, cash basis of accounting is not a sound system as it violates generally accepted accounting principles. Financial statements do not show true and fair view of financial position and operational results. However, cash basis of accounting is used by small business and service organizations and professionals like advocates, medical practitioners, chartered accountants and non profit organizations. 2) Accrual Basis of Accounting:
Accrual means recognition of revenues as it is earned and of costs as they are incurred irrespective of the fact when revenues are received and costs are paid. Accrual basis of accounting is the method of recording transactions by which revenues, costs, assets, and liabilities are reflected in the accounts in the period in which they accrue. Accrual basis of accounting is based on the revenue-recognition principle and the matching principle. This basis is also known as mercantile system of accounting. 1.13 Accounting Equation
American accounts have derived the rules of debit and credit through accounting equation which is given below: Assets = Equities The equation is based on the principle that accounting deals with property and rights to property and the sum of the properties owned is equal to the sum of the rights to the properties. The properties owned by a business are called assets and the rights to properties are known as liabilities or equities of the business. Equities may be divided into equities of creditors representing debts of the business known as liabilities and equity of the owner known as capital. Keeping in view the two types of equities the equation given above can be stated as below: Assets = Liabilities + Capital Roles of Accounting Equation 1. Regarding Assets: Increases in assets are debits and decreases in assets are credits. 2. Regarding Liabilities: Increases in capital are credits and decreases are debits. 3. Regarding Capital: Increases in capital are credits and decreases are debits. 4. Regarding Expenses
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Increases in expenses are debits: decreases are credits. 5. Regarding Incomes or Profits: Increases in Incomes or profits are credits, decreases are debits. ILLUSTRATION Give Accounting equation for the following for the following transactions of Hitesh for the year 2008. (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) Started business with cash Rs. 18,000. Paid rent in advance Rs. 400. Purchased goods for cash Rs. 5,000 and on credit Rs. 2,000. Sold goods for cash Rs. 4,000 (costing Rs. 2,400). Rent paid Rs. 1,000 and rent outstanding Rs. 200. Bought motor-cycle for personal use Rs. 8,000. Purchased equipments for cash Rs. 500. Paid to creditors Rs. 600. Depreciation on equipment Rs. 25. Business expenses Rs. 400.
Solution Every transaction has two fold aspect, means it will be considered at least two items, we can discuss the concept of accounting equation with the solution as follows:
S No. Rent OutStanding Rs. (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) Equities Creditors Rs. Capital Rs. 18,000 18,000 18,000 +1,600 2,000 19,600 +200 -1,200 200 2,000 18,400 -8,000 200 2,000 10,400 200 2,000 10,400 -600 200 1,400 10,400 -25 200 1,400 10,375 -400 200 1,400 9,975 Rs. 200+Rs. 1,400+Rs. 9,975=Rs. 11,575 +2,000 2,000 Cash Assets Rent in Stock of Advance Goods Rs. Rs. Equipment
Total
Rs. Rs. 18,000 -400 +400 17,600 400 -5,000 +7,000 12,600 400 7,000 +4,000 -2,400 16,600 400 4,600 -1,000 15,600 400 4,600 -8,000 7,600 400 4,600 -500 +500 7,100 400 4,600 500 -600 6,500 400 4,600 500 -25 6,500 400 4,600 475 -400 6,100 400 4,600 475 Rs. 6,100+Rs. 400+Rs. 4,600+Rs. 475=Rs. 11,575
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1.14
Advantages of Accounting: 1. Compliment of memory: As everyone has limited memory. No one can remember everything. Accounting provides informations which are recorded. 2. Comparative study: With the help of accounting we can compare the financial performance of concern with another concern and with the last year also. 3. Proof in a court: The proper Accounting can use as a proof in a court when there is dispute of business with the third party. 4. Purchase and sale of business: Accounting provides the purchase consideration of business which helps in easy valuation of business. 5. Helpful in detection of error or fraud: Proper accounting help in the prevention and detection of error and fraud. 6. Helpful in determination of tax liability: With the help of accounting profit can be ascertained so that it can be taxed. 7. Helpful in goodwill determination: With the help of accounting we can calculate the amount of goodwill.
1.15
Limitations of Accounting: 1. Based on accounting concepts and conventions: The subject Accounting is based on some irrelevant concepts and conventions. For example as per principle of conservatism anticipated losses are considered as actual losses and anticipated profits are not considered as actual profits. 2. Influenced by personal judgments: Some accountants valued the closing stock as per FIFO and some valued the stock as per LIFO. Some accountants consider original cost method and some consider written down value method for depreciation. 3. Window dressing: False information are shown in the books. For example profit can be increase by showing false sales to get the loan. Similarly profit can be reduced by showing more expenses to avoid the tax. 4. Ignorance of qualitative information; As we know Accounting is an art of recording classifying summarizing analyzing and interpreting the financial transactions of the concern . qualitative transactions are ignored in Accounting. 5. Ignore price level change: Generally accounts are prepared on the basis of historical cost other than stock . In Accounting ,price level changes are ignored.
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CHAPTER II ACCOUNTNG PRINCIPLES
Objectives: The important objectives are : 1. To discuss GAAPs and the Accounting environment 2. To distinguish between Accounting concepts and conventions. 3. Appreciate the importance of Accounting concepts and conventions
Accounting is an art of recording, classifying, summarizing, analyzing and interpreting the transactions of the concern which are in part at least of financial nature to know the results. This Accounting is useful for debtors, creditors, Govt. investors, lenders, and other parties who are linked with the concern directly or indirectly. To give the uniform understanding to these various parties some uniform principles are formed by Accounting professionals, these are called principles. The Accounting profession has certain concepts, conventions, standard language and terminologies to enable the interested parties to understand the subject matter in the same sense as the accountant wants to communicate. These accounting rules are usually called General Accepted Accounting Principles (GAAP). These are also called as concepts, conventions, doctrines, axioms and postulates. The principles which are used in the preparation of accounts are called concepts. But the principle which are used for the presentation of accounts are called conventions. Accounting principles can be classified into the following three groups.: 2.1 (i) Basic concepts or assumptions: Business entity concept: As per business entity concept, business and business man both are separate entities. The amount invested by business man is capital and this is the liability of business, it is to be returned by the business to the business man. Similarly the amount which the business man takes from business this is an asset of the business which the business has to recover from the businessman. For example the businessman has invested Rs 1,00,000 in the business(capital) is the liability of the business and similarly the amount which the business man has withdrawn from the business ( say 5000) is an asset of the business. Going concern concept : As per this concept, all the transactions records in books on the assumptions that concern is going on for ever in future, it is not going to expire. On the basis of the same assumption there is a concept of depreciation which is shown as exp. in p& l a/c. If we purchase any asset only depreciation of the asset for
(ii)
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the same year is shown as exp. Classification of asset and liabilities as short term and long term is also based on the same assumption. The following are the cases where going concern concept is not valid: 1. When an enterprise was set up for a particular purpose which has been achieved or to be achieved shortly. 2. When a company is declared sick by BIFR. 3. When an enterprise has been in the grip of severe financial crisis and in expected to wind up shortly. 4. When a receiver or liquidator has been appointed in case of a company which is to be liquidated. Money measurement concept: As per money measurement concept only those transactions are shown which can be measured in the terms of money only. Qualitative transactions are ignored. For example efficiency of managers , there is a quarrel between sales manager and purchase manager , this is a qualitative transaction it can not be recorded in the books because you can measure it in the terms of money. The advantage of expressing business transactions in terms of money is that money serves a common denominator by means of which heterogeneous facts about a business can be expressed in terms of numbers (i.e. money) which are capable of additions and subtractions. It can be illustrated by taking the following example. A business unit has the following assets on December 31, 2008. Cash in hand and at bank Rs. 25,000, Sundry Debtors Rs. 48,500, Bills Receivable Rs. 6,500, Motor Cars 5, Stock 6,000 tons, Furniture 100 chairs and 20 tables, Machines 7, Building space 5,000sq. metres, Land 10 acres. The items given in different units of measurement cannot be added together to get an idea of the total value of the assets owned by the business. To get an idea of the total value of the assets, all items should be expressed in terms of money as given below: Cash in hand and at bank Rs. 25,000, Sundry Debtors Rs. 48,500, Bills receivable Rs. 6,500, Motor Cars Rs. 1,15,000, Stock Rs. 4,00,000, Furniture Rs. 5,000, Machines Rs. 2,50,000, Building Rs. 4,40,000, Land Rs. 1,00,000, Total = Rs. 13,90,000. Money measurement concept of accounting has two major limitations as given below: (i) It restricts the scope of accounting because it is not capable of recording transactions which cannot be expressed in terms of money. (ii) It does not be take care of the effects of inflation because it assumes a stability of the money measurement unit. Generally business entity concept and money measurement concept are called fundamental accounting concepts.
(iii)
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(iv)
Accounting period concept: As per Accounting period concept the transactions are recorded for the period of 12 months so that it can be useful for the various parties. Accounting period may be from1 Jan to 31 Dec or 1st April of year to 31 march of next year . Income Tax Act gives recognizes to 1st April of year to 31 march of next year. It may from Deepawali to next Deepawali or Holi to next Holi. Basic principles: Principle of revenue realization: As per this principle revenue can be recognized on the following basis: (a) Cash basis: As we receive the cash we will treat it as revenue means we can record the revenue only when we received the cash. (b) Sales basis: As per this basis we can consider the revenue as we sold the goods either we receive the cash or not. (c) production basis: As per this basis we can consider the revenue as we produce the goods either we sold it or not
2.2 1.
2.
Principle of matching concept: Matching concept does not mean that we have to show only those exp. which are directly relating to that particular income but all the exp. relating to that particular period. All the exp relating to that period are shown either these are paid or not. If any exp. is paid in advance it must be reduced. Let us taken an example to make the matching concept clear. A businessman purchases 100 table fans at a cost of Rs. 30,000. He paid Rs. 1,000 as freight and insurance, Rs. 200 as octroi and carriage and rent outstanding was Rs. 2,000. He sells all table fans at a price of Rs. 40,000 against which should be matched cost of table fans Rs. 30,000, freight and insurance Rs. 1,000, octroi and carriage Rs. 200 and outstanding rent Rs. 2,000. The net profit of the period not paid for and sale price of some of table fans may not have been realized as yet on account of being sold on credit. It may be remembered that profit and cash are not synonymous because their nature is different. For example, if a business has made a profit of Rs. 1,00,000, it does not mean that it has the same amount of cash or cash in increased by the same amount. It is because there are outstanding expenses and creditors and outstanding debtors. The profit earned will increase the capital of the business on the liabilities side and a corresponding increase in the assets of the business will be made. Similarly, an increase in cash does not mean increase in profit. Cash may have increased because of issue of shares or sale of a fixed asset. Thus, income is tied to increase in owners equity and has direct link to changes in cash.
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3.
Principle of full disclosure: As per this principle all the information of the concern are shown in the books so that it can be useful for the various parties. Verifiability objectivity of dual aspect: As per this principle every transaction has two fold aspect. This is also called as double entry system. If one account is debited another will be credited with the same amount. This can be discussed with the following example: Business started with cash of Rs 50,000 and goods purchased from ramesh of rs 20,000. Accounting equation is used : Assets = Capital + Liabilities Cash + stock = capital + creditor 50,000+ 20,000 = 50,000+ 20,000 Verifiability objective of evidence concept: This principle explains that all the transactions recorded in the books on the basis of some evidence. For example asset is recorded on the basis of invoice, sale and purchase of goods are also recorded on the basis of invoice, expenses are recorded on the basis of vouchers. Modified principles: Principle of materiality: Whether something should be disclosed or not in the financial statements will depend on whether it is material or not. Materiality depends on the amount involved in the transaction. For example, minor expenditure of Rs. 10 for the purchase of waste basket may be treated as an expense off the period rather than an asset. Customs also influence materiality. For example, only round figures (to the nearest rupee) may be shown in the financial statements to make the figures manageable without affecting the accounting data. Similarly, for income tax purpose the income has to be rounded to nearest ten rupees. The term materiality is a subjective term. The accountant should record an item as material even though it is of small amount if its knowledge seems to influence the decision of the proprietors or auditors or investors. For example, commission paid to sole selling agents should be disclosed separately in the Profit and Loss Account. Similarly, amount due to directors or others officers of the bank should be disclosed separately in the Balance Sheet of a bank to know the amount of advances due from the directors or officers who are managing the affairs of the bank. The Companies Act, 1956 also lays emphasis or separate disclosure of material items. Part II of schedule VI states that any item of expenses which exceeds 1% of the total revenue of the company or Rs. 5,000 whichever in higher should be shown as a separate and distinct item against an appropriate head in the Profit and Loss Account. Para 17 of AS-1 also states that financial
4.
5.
2.3 1.
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statements should disclose all material items the knowledge of which might influence the decisions of the user of the financial statements. 2. Principle of consistency: There must not be any change in the method of Accounting from year to year. For example if stock is valued at FIFO in any year It should not be changed to LIFO. There should not be change in such a way until and unless it is necessary for the better presentation of accounts. Similarly any particular method of depreciation(say straight line) is used in any one year it should not be changed in coming year. The rationale for following the convention of consistency is made clear in the following example: For example, a company purchased a fixed asset for Rs. 1,00,000 and it charges depreciation @ 20% on straight line method. At the end of the second year, the book value of the assets will be:
Cost of the fixed asset Less: 20% depreciation for 1 year Less: 20% depreciation for 2nd year Book value at the end of 2nd year Now, if the method is changed to reducing balance method in the second year, the book value of the asset at the end of 2nd year will be: Cost of the fixed asset Less: 20% depreciation for 1st year Less: 20% depreciation for 2nd year ( Book value at the end of 2nd year ) Rs. 1,00,000 20,000 80,000 20,000 60,000 Rs. 1,00,000 20,000 80,000 16,000 64,000
3.
Principle of conservatism/ prudence : Conservatism principle can be understand with the following example: a) All the anticipated losses are considered as actual losses in the accounts while anticipated profits are not considered as actual profit. b) Closing stock is valued at cost or market price whichever is less, while all the assets are valued at cost. c) Provision for bad debts. d) Provision for fluctuation in the value of investment.
4.
Principle of timelines: Accounts should be prepared with the books with in the proper period so that it can be useful for the various parties. Principle of industry practice : Any principle which is applied in any industry can become the accounting principle.
5.
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CHAPTER III FINAL ACCOUNTS OF JOINT STOCK COMPANY
Objectives: Understand the different items of balance sheet of joint stock company
Every company must prepare the final account every year. At every annual general meeting of a company the board of directors of the company shall lay before the company. (a) (b) Balance Sheet as at the end of the year. Profit & Loss a/c for that period and Sec 211 of the Indian company Act,1956 requires that the final accounts of companies shall be in the prescribed form given under schedule. The prescribed form of balance sheet has been given in part I of schedule VI . No standard form for profit and loss a/c has been prescribed in part II of schedule VI. However it has been laid down as to what it shall contain and disclose. According to Schedule VI, a Balance sheet should be shown first and Profit and loss a/c shall be annexed to it. In our curriculum only performa of balance sheet of company so we will discuss the Balance Sheet, how company has to show the items in Balance sheet.
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CHAPTER IV
RESPONSIBILITY ACCOUNTING Objectives: The important objectives are : 1. To discuss the concept of responsibility accounting. 2. To acquaint with advantages and disadvantages of responsibility accounting.
4.1 INTRODUCTION:
Responsibility accounting is an underlying concept of accounting performance measurement systems. The basic idea is that large diversified organizations are difficult, if not impossible to manage as a single segment, thus they must be decentralized or separated into manageable parts. These parts, or segments are referred to as responsibility centers that include: 1) revenue centers, 2) cost centers, 3) profit centers and 4) investment centers. This approach allows responsibility to be assigned to the segment managers that have the greatest amount of influence over the key elements to be managed. These elements include revenue for a revenue center (a segment that mainly generates revenue with relatively little costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of profitability for a profit center (a segment that generates both revenue and costs) and return on investment (ROI) for an investment center (a segment such as a division of a company where the manager controls the acquisition and utilization of assets, as well as revenue and costs). Large organizations have operating activities which are voluminous. Controlling such activities in details & in every sphere is not possible for the top management. The top management has the total authority & responsibility. For the purpose of controlling efficiently, the total authority & responsibility is decentralized by forming small segments which are called responsibility centers & to these centers, specific costs & revenues are allocated. The evaluation of performance of each responsibility center is done at the periodical intervals on the basis of pre-determined targets. 4.2 DEFINITION: Responsibility accounting may be known as decentralization of responsibility center so that desired control can be ensured & thereby the goal of the organization can be attained. Responsibility accounting involves the following: a. Entire organization is divided into small responsibility centers; b. In terms of revenues & costs, the responsibility of each responsibility center is fixed; c. In terms of its predetermined target, the performance of each responsibility center is measured.
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4.3 STEPS OF RESPONSIBILITY ACCOUNTING Following steps are followed in responsibility accounting: Step1: Determinations of Responsibility Centres: This is the first and foremost step in responsibility accounting. For effective planning and control purposes, responsibility is classified into various responsibility centres: 1. Cost Centres: A cost centre may be determined according to location which may be a division, department, sales area, stock-yard, tool room and administrative office, etc. Costs are accumulated in respect of a person who may be a Works manager, Sales manager, Purchase manager, Personal manager, Finance Manager, or that of foreman, store-keeper, salesman, section officer, etc. The objective cost centre is to reduce the cost and cost control 2. Revenue Centres: Revenue centres are those organizational units in which outputs are measured in monetary terms. These centres are marketing organizations and they are not directly responsible for profits. The main objective of revenue centres is to maximize revenues. Each values centre is also an expense centre so far as marketing expense for that responsibility centre. The primary measurement, however, is revenue. Revenue centres are not charged for the cost of goods that they market. Consequently, they are not profit centres, because this important expense item is For Example, a marketing organization is a sales revenue centre. Such a centre is devoted to increasing the revenue and assumes no responsibility for production. In this centre, the manager is responsible for the level of revenue or outputs of a centre, measured in monetary terms, but are not responsible for the costs of the goods or services that they centres offers. 3. Profit Centres: A profit centre is a segment of business, which is responsible for the cost it incurs as well as the revenue it generates. It should be able to identify all costs pertaining to the profit centre and the revenue it generated. A profit centre should have operational independence. The manager of a profit centre should be free to make decisions in regard to the purchases of materials economically from outside volume of production mix, methods of manufacture, utilization of labour and equipment etc. 4. Investment Centres: An investment centres is a profit centre in which imports are measured in terms of expense and outputs are measured in terms of revenues, and in which assets employed are also measured-the excess of revenues over expenditure then being related to assets employed in the profit centre. The manager of investment centre is accountable for production and sales decisions along with the investment decision. Step II: Assigning Targets Step III: Measuring Actual Performance
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Step IV: Calculate deviations and take corrective action to remove deviation. 4.4 PRE-REQUISITES OF EFFECTIVE RESPONSIBILITY ACCOUNTING: The pre-requisites of the effective responsibility accounting are the following: a. Under the supervision of a manager should be each responsibility center & for the purpose of operating, it must be separable & identifiable. b. The independent measurement of performance of each center must be capable of being done. c. Each responsibility center should have clearly set targets. d. Each responsibility centers budget should set targets which should be neither too high nor too low i.e., the budget should be one which can be realised. e. The top management should fully support the system. f. All managers of responsibility centers should participate in the formulation of plans & policies relating to responsibility centers for the purpose of providing motivation. g. For sincere performance of each responsibility center the organizational environments must be conducive. 4.5 OBJECTIVES OF RESPONSIBILITY ACCOUNTING: The objectives of responsibility accounting are the following: a. Overall organizational goals are broken down into small goals, each of the small goals is meant for better achievement of a responsibility center. b. With the attached responsibility each responsibility center is tied up & there is adequate authority so that responsibility can be discharged. c. At the end of a period, evaluation is done of the performance of each responsibility center & comparison of the performance is done with the predetermined targets. d. Thorough study is made of the achievements which are above or below the targets & remedial measures are adopted. e. Assessment is made of the contribution made by each responsibility center & examination is done of how far its possible for the contribution to fulfilling its share in the ultimate organizational growth. f. Emphasize is given on the control of cost through planning.
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g. Use is made of the principle of management by exception for the purpose of recording only those data where the actual performance of responsibility center falls short of the set target & where the variance is beyond the reasonable limit.
4.6 ADVANTAGES OF RESPONSIBILITY ACCOUNTING: For the purpose of exercising control, responsibility accounting is an important tool in the hands of management. For the purpose of effecting efficient control on operations & achieving the organizational goal, responsibility accounting system should be introduced by the organizations which have large dimensions & complex & operations which are decentralized. Since for the purpose of achieving the overall goal in a piecemeal way; to various responsibility centers, overall responsibility & authority are decentralized, continuous communication should be there between the overall responsibility center & various subresponsibility centers. Thus a communication system is automatically established by responsibility accounting. The following advantages can be expected from responsibility accounting system: a. Assigning of Responsibility: Allocation is made of all the activities of the organization, all the items of income & expenditure including capital expenditure to the well defined responsibility centers. Profit of each responsibility center is also identified. It should be understood by the manager of the centre what has to be performed by him with what resources & in what time period. He gets the things done by making his own way without any interference. Thus much importance is given to human resources. b. Detection of Loopholes: There is a relationship between efforts & achievement, thereby, loopholes, if any, in the operations gets easily detected. c. Cost-Consciousness: Among the managers & their subordinates, cost-consciousness gets generated which results in automatically reducing cost. d. Weak Areas: It becomes easy to detect the weak areas in the organization. So for the purpose making the weak areas strong, corrective measures are taken. e. Management by Exception: By recording the negative variances between the actual performance & target, introduction of management by exception can be done. f. Budgetary Control: For the purpose of exercising best managerial control over the affairs of the organization & achieving the desired goal, responsibility accounting system & budgetary control system can work together. g. Belongingness: As realistic goals are fixed for a responsibility centre, its achievement by the employees becomes easy. Their contribution can be assessed by themselves for the purpose of achieving the goal of the organization as a whole. A sense of belonging to the
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organization is created among the employees by the systematic responsibility accounting as the reward of the employees for accomplishment is not unsatisfactory. h. Helpful and Decision Making: As managers of responsibility centers are allowed to sit with the top management for exchanging of views & opinions, appropriate decision making is almost assumed. As against expected advantages there are also some apprehended disadvantages. 4.7 DISADVANTAGES OF RESPONSIBILITY ACCOUNTING: The following are the apprehended disadvantages of responsibility accounting: a. Solely upon the sincere efforts put in by the managers of the responsibility centers, the success of the responsibility accounting depends. Whether the system will succeed or not shall be decided by the personal factors of the managers. b. The place of good management cannot be ever taken by the responsibility accounting because the latter is only a tool in the hands of the former. c. Although theoretically, the manager of each organization is given free hand, in actual practice, neglect of employees reaction, interference etc. is often noticed. Thus, in the way of proper discharging of responsibility, this stands. d. In modern organizations, among the departments, inter-relations & inter-departments are mostly observed. So it becomes almost impossible to demarcate responsibility centers by clear-cut outlines. e. Manager of the responsibility center prepares & communicates performance reports. The desired result will not be achieved by the responsibility accounting system, if there is any shortcoming in the report. f. Remuneration, future prospects, rewards, good working condition, welfare work & many others account for the individual interest of employees. Co-operation from the employees may be required where there is a clash between individual interest & the organizational interest. In brief we can say the responsibility accounting which provides so many advantages, but it is a difficult process which require more efforts, more time consuming and some times which provides some irrelevant informations.
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CHAPTER V COST ACCOUNTING
Objectives: 1. 2. 3. 4. To understand the concept of cost, elements of cost and classification of cost. To explain the meaning of Cost Accounting, Cost Accountancy and costing. To distinguish between financial Accounting and Cost Accounting To understand the different techniques of costing
5.1
Cost
Cost means all the expenses incurred to produce a thing. For proper control and managerial decisions, management is to be provided with necessary data to analyze and classify costs. For the same purpose cost is classified by elements of cost, by nature of expenses. 5.2 Elements of cost 1. Material 2. Labour 3. Expenses We can understand the concept of cost with the help of cost sheet. Cost sheet is a statement used to record the expenses incurred to know the cost.
Particulars Direct material Direct labour Direct exp Prime cost Factory exp/works exp. Factory cost /works cost Office and administration exp. Office cost / cost of production Selling and distribution exp. Selling cost/Total cost Profit Selling price Cost Sheet Amount Units produced
1. Prime cost: Direct material + Direct labour + Direct exp. 2. Factory cost: Prime cost + factory exp.
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3. Cost of production: factory cost + office and administration exp. 4. Total cost: Cost of production + selling and distribution exp. Now all these terms will be examined in detail one by one. 1. Direct Materials are those materials which can be identified in the product and can be conveniently measured and directly charged to the product. Thus, these materials directly enter the production and form a part of the finished product. For example, timber in furniture making, cloth in dress making and bricks in building a house. The following are normally classified as direct materials: (i) (ii) (iii) (iv) All raw materials like jute in the manufacture of gunny bags, pig iron in foundry, and fruits in canning industry. Materials specifically purchased for a specific job, process or order like glue for book-binding, starch powder for dressing yarn. Parts or components purchased or produced like batteries for transistor-radios and tyres for cycles. Primary packing materials like cartons, wrapping, cardboard boxes, etc. used to protect finished product from climatic conditions or for easy handling inside the factory
2.
Direct Labor is all labour expended in altering the construction, composition, confirmation or condition of the product. In simple words, it is that labour which can be conveniently identified or attributed wholly to a particular job, product or process or expended in converting raw materials into finished goods. Wages of such labour are known as direct wages. Thus, it includes payment made to the following groups of labour. (i) (ii) (iii) Labour engaged on the actual production of the product or carrying out of an operation or process. Labour engaged in aiding the manufacture by way of supervision, maintenance, tools setting, transportation of material etc. Inspectors, analysts etc. specially required for such production.
3.
Direct Expenses (or Chargeable Expenses). All expenses which can be identified to a particular cost centre and hence directly charged to the centre are known as direct expenses. In other words all expenses (other than direct materials and direct labour) incurred specifically for a particular product, job, department etc. are called direct expenses. These are directly charged to the product. Examples of such expenses are royalty, excise duty, hire charges of a specific plant and equipment, cost of any experimental work carried out specially for a particular job, travelling expenses incurred in connection with a particular contract or job etc.
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4.
Overheads may be defined as the aggregate of the cost of indirect materials, indirect labour and such other expenses including services as cannot conveniently be charged direct to specific cost units. Thus overheads are all expenses other than direct expenses. In general terms, overheads comprise all expenses incurred for or in connection with the general organization of the whole or part of the undertaking i.e., the cost of operating supplied and services used by the undertaking and including the maintenance of capital assets. The main groups into which overheads may be sub-divided are: (i) Manufacturing Overheads: (ii) Administration Overheads (iii) Selling Overheads; (iv) Distribution Overheads and (v) Research and Development Overheads. (i) Manufacturing or Production or Works Overhead. It is indirect expenses of operating the manufacturing divisions of a concern and covers all indirect expenditure incurred by the undertaking from the receipt of the order until its completion ready for despatch either to the customer or to the finished goods store. Examples, of such expenses are: depreciation and insurance charges on fixed assets like plant and machinery, works, building, and electric equipments and floating assets like stores, finished goods etc.; repairs and maintenance of fixed assets; electricity charges; coal and other postage, telegrams and telephone charges; welfare services like canteen and recreation clubs; medical services like dispensary and hospital and service department expenses. It also includes wages of indirect works, indirect materials such as lubricants, cotton wastes and other factory supplies, salaries and other costs related to tool room, design and drawing office, production control and progress department. (ii) Administration Overhead. It is the indirect expenditure incurred in formulating the policy, directing the organization, controlling and managing the operations of an undertaking which is not related directly to a research, development, production or selling activity or function. It consists of all expenses incurred in the direction, control and administration (including secretarial, accounting and financial control) of an undertaking. Examples are the expenses in running the general office e.g. office rent, light, heat, salaries and wages of clerks, secretaries and accountants, credit approval, cash collection and treasurers department, general managers, directors, executives; legal and accounting machine service; investigations and experiments and miscellaneous fixed charges. (iii) Selling Overhead. It is the cost of seeking to create and stimulate demand and of securing orders and comprises the cost of soliciting and recurring orders for the articles or commodities dealt in and of efforts to find and retain customers. It refers to those indirect costs which are associated with marketing and selling (exclusing distribution) activities. Examples aare sales office expenses; salesmens salaries and commission; showroom expenses; advertisement charges; fancy packing to attract sales; samples and free gifts; after sales service.
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(iv) Distribution Overhead. It is the expenditure incurred in the process which begins with making the packed product available for dispatch and ends with making the reconditioned return empty package, if any available for reuse. It comprises all expenditure incurred from the time the product is completed in the works until it reaches its destination. Under these would be included warehouse rent; warehouse staff salaries, insurance etc.; expenses on delivery van and trucks; expenses on special packing for bulk transport like bales, crates, chests etc.; losses in warehouse stocks and finished goods damaged in transit and cost of repairing and reconditioning of empties and wastage of finished goods. (v) Research and Development Expenses. Research cost is the cost of searching for new and improved products, new applications of materials or products, and new applications and improved methods. Development cost is the cost of the process which begins with the implementation of the decision to produce a new or improved method and ends with the commencement of formal production of that product or by that method. Overheads can also be classified as indirect materials, indirect (i) Indirect Materials. Such materials refer to those materials which do not normally form a part of the finished product. It has been defined as materials which cannot be allocated but which can be appointed to or absorbed by cost centres or cost units. There are: (a) Stores used in maintenance of machinery, building etc. like lubricants, cotton waste, bricks and cements; (b) Stores used by the service departments i.e. non-productive departments like power house, boiler house and canteen etc.; and (c) Materials which due to their cost being small, are not considered worthwhile to be treated as direct materials. Examples of indirect materials are stores consumed for repair and maintenance work, sundry stores of small value expended for factory use, small tools for general use, lubricating oil, losses, deficiencies and deterioration of stores etc. (ii) Indirect Labour. The wages of that labour which cannot be allocated but which can be apportioned to or absorbed by cost centres or cost units is known as indirect labour. In order words wages paid to labour which is employed other than on production constitute indirect labour costs. Examples of such labour are: charge-hands and supervisors; maintenance workers; departmental coolies; men employed in service departments, material handling and internal transport; apprentices, trainees and instructors; works clerical staff and labour employed in time office and security office,
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(iii) Indirect Expenses. Such expenses which cannot be allocated but can be apportioned to or absorbed by cost centres or cost units as rent, rates, insurance, municipal taxes, general managers salary, canteen and welfare expenses, power and fuel, cost of training new employees, lighting and heating, telephone expenses. So, under indirect expenses two types of expenses are included; (a) such type of expenditure in respect of which payments are made for services rendered or supplies made. Amount in respect of such expenditure will be found from the voucher registers on the dates on which they are incurred, (b) such items which do not involve any payments and are mere adjustment transactions i.g., depreciation. 5.3 Classification of cost : 1. On the basis of elements: (i) Material (ii) Labour (iii) Exp. 2. On the basis of functions:(i) Factory exp.: factory exp are those which are incurred for factory. For example factory rent, depreciation on machine, power ,lighting ,fuel, etc (i) Office and administration exp.: Office rent, depreciation on furniture, printing and stationary postage and telegraph, salaries of staff, managing director salary. (ii) Selling exp.: for example discount allowed to customers, bad debts, commission to sales agents, advertisement, etc. (iii) Distribution exp.: the exp. Incurred for the distribution of products such as travelling exp., warehouse rent, etc. 3. On the basis of behaviour (i) Variable exp.: variable exp .are those exp .which varies as per production. If production increases the exp also increases and when production decreases the exp. also decreases. Units Cost Cost per unit 100 1000 10 200 2000 10 300 3000 10 50 500 10 In the above example as the units increased the cost also increased and as the units decreased cost also decreased.
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(ii) Fixed exp: Fixed exp. are those exp. which remain fixed irrespective of production. For example factory rent , supervisor salary, accountant salary. Units 100 200 300 50 Cost 1000 1000 1000 1000 Cost per unit 10 05 3.33 200
In the above example the cost remains constant irrespective of units produced. (iii) Semi- variable exp: Semi variable are the exp. Which are fixed to a certain extent after that it varies. For example telephone bill. Units Cost Cost per unit 200 2400 12 300 2600 8.66 400 2800 7 In the above example we found that there is an increased of Rs. 200/- in the cost with the increase of 100 units means the variable cost is Rs. 2/- per units and Rs. 2000/- is the fixed. 4. On the basis of controllability: (i) Controllable exp: All variable exp. are considered as controllable exp. (ii) Uncontrollable exp.: All the fixed exp. are considered as uncontrollable exp. 5. For decision making: (i) Shut down cost : The cost which is to incur for the period for which business will be closed temporily. (ii) Sunk cost: The cost incurred in the past. For example building purchased, machine purchased ,etc. (iii) Opportunity cost: For example rent on owned building used in his own business. (iv) Imputed cost : For example interest on owned capital used in his own business. (v) Differential cost: The change in cost because of change in units. 5.4 Cost Accounting:
Cost Accounting is the process of accounting for costs. It embraces the accounting procedures relating to recording of all income and expenditure and the preparation of periodical statements and reports with the object of ascertaining and controlling costs. It is thus the formal mechanism by means of which costs of products or services are ascertained and controlled.
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5.5
Cost Accountancy:
Cost Accountancy is the practice of cost accountant because he has to make constant efforts in the field of cost accountancy. The techniques of cost accounting is cost accountancy. There may be three type of businesses: (I) (II) (III) Manufacturing Trading Service rendering concerns Every business man has to use accounting. Every trader has to use Financial Accounting. Every manufacturer and service rendering concern has to follow financial as well as cost accounting also. The main objective of cost accounting is to ascertain the cost to produce a thing and the cost of a service provided by a particular service renderer, i.e. transport concern, communication, hotel, hospital etc.
Cost accounting is an art of recording material, labour and expenses employed per unit of production. Costing is the technique of ascertaining the cost per unit of a product. There are different techniques of cost accounting which are used by different type of manufacturers as per the nature of their product, The following are the various techniques of cost accounting: (i) Process costing: This method is suitable to industries where production is undertaken on mass scale and on continuous basis. Further the raw material pass through two or more processes before converting into finish products. Raw material introduced into first process are transferred after processing in the first process to the second process, they will be transferred to next process for further process and this process continues till processing in the final process to obtain finished product. Hence the output of the first process becomes the input for the second process and the output of the second process will be the input for the final product. Single costing: When the concern produces only one product of standard ones and of identical nature this method is adopted. The total cost is divided by number of units produced. This method is suitable for Mines, Quarries, Steel works, bricks etc. Contract costing: Contract costing is used by the builders constructors etc who builds and constructs. Operating costing: This method is suitable for concerns who are involved in services as doctors, hotels, communication, electricity manufacturers, transport concerns, etc. Uniform costing: The comman method followed by the concerns uniformally doing same nature of business.
(ii)
(iii) (iv) (v)
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5.6
Objectives of cost accounting: 1. To know the cost per unit: With recording all the material, labour and all the expenses the cost per unit of a product can be known. 2. To determine the selling price: We can decide the profit per unit after availing the cost per unit and can decide the selling price per product. 3. To make decisions :such as make or buy product, repair or purchase of new machinery, introduce of a new product . 4. To determine profitability: With the help of Cost Accounting profitability of the concern can be known how much profit the concern can earn. 5. To cost control: With the help of two techniques of cost accounting budgetary control and standard costing cost can be controlled.
5.7
Advantages of cost accounting: To management: (i) (ii) (iii) Planning: In Cost Accounting plan are made for sales dept., production dept, purchase dept .for which budgetary control technique is used. Controlling: With the help of standard costing comparison is analyzed with the standard made . Co-ordination: Cost Accounting provides coordination also among various depts. Production dept. depends on sales dept. and purchase dept. depends on production dept all these are coordinated with each other. Motivation: In cost accounting there are so various tools in providing wages to labourers so that they can be motivated for more production.
(iv)
To Employee: With the help of cost accounting the profit can be known and the employee can demand more salary as per their better profit. To consumer : Consumer can know the cost per product produced. To Govt.: Govt. has to impose the tax on income as well as on sales also which information can be availed with cost accounting. 5.8 Limitations of cost accounting: 1. Cost Accounting is not an exact Science. Cost Accounting aims at ascertain cost, It is impossible to ascertain the actual cost of the goods and services . In order to ascertain the cost of goods and services it is necessary to use a number of estimates bases for apportionment ,etc.
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2. Availability of a number of accounting treatments for each of a few major elements of costs results in the operating performance influenced even by accounting standards and methods . the company is free to use any method of accounting. 3. Cost Accounting identifies the deficiencies in the performance of company. But it does not provide the solution. 4. It does not record some expenses which are considered in financial accounting 5. It is based on so many assumptions so the results can not be uniform. 5.9 Difference between financial and cost accounting Basis of difference 1. Purpose Financial Accounting The purpose is to know the profit or loss and financial position of a concern. Financial Accounting is compulsory for all type of concern The period is considered of 12 months. Cost Accounting The objective is to know the cost of a product.
2. Compulsory
3. Period
Cost Accounting is mandatory for manufacturing concern. In Cost Accounting the period is considered as required.
4. Stock valuation
5. Chart
In Financial Accounting stock is valued at cost or market price whichever is less. In Financial Accounting charts are not used.
In Cost Accounting stock is valued at cost only.
In Cost Accounting break even charts are used.
6. Product wise cost
7. Analysis of profit
In Financial Accounting product wise cost is not shown. Financial Accounting analyze the profit of the concern.
In Cost Accounting product wise cost is shown. Cost Accounting analyze the profit of the product, job or service only.
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CHAPTER VI STANDARD COSTING
Objectives: 1. To understand the meaning of standard costing 2. To know the advantages and limitation of standard costing. 3. To discuss the different kinds of variances.
Standard costing are the scientifically predetermined costs of manufacturing a single unit, or a number of units of products during a specified period in the immediate future. Standard cost are the planned costs of a product under current and anticipated operating conditions. 6.1 Definitions As per Chartered Institute of Management Accountants London Standard Costing is the preparation and use of standard costs, their comparison with actual cost and the analysis of variances to their causes and points of incidence As per W.W. Bigg: Standard costing discloses the cost of deviations from standard and classifies these as to their causes so that management is immediately informed of the sphere of operations in which remedial action is necessary. 6.2 (i) (ii) (iii) (iv) 6.3 Process of standard costing The setting of standards Ascertaining actual results Comparing actual with standard and calculate the variance Investigate the variance and take corrective action to remove deviation. Advantages of standard costing
1. Formulation of price and production policies: It act as a valuable guide to management in the formulation of price and production policies. It assists management in the field of inventory pricing, product pricing, profit planning and also further reporting to higher levels.
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2. Comparison and analysis of data: standard costing provides a stable and sound basis for comparison of actual with standard costs according to different elements separately . It brings out clearly the impact of external and internal causes on the cost and performance of the concern. 3. Cost Consciousness: Cost consciousness is created among the staff , managerial as well as workmen of the business. 4. Management by exception: It helps the management in concentrating its attention on cases which are of important issues. 5. Better economy, efficiency: operations of the business are scrutinized carefully and inefficiencies are disclosed .Men, material and machines are utilized effectively. 6.4 Disadvantages of standard costing 1. Heavy costs: fixation of standards may be costly and may require high order skill and competence. Small concerns therefore feel difficulty in the operation of such system. 2. Fixation of responsibility difficult: This is very hard nut to crack to fix the responsibility of any dept, any person and process. 3. Frequent revision required: For the better results it is necessary to revise the standards frequently and revision of the standards is a costly process. 4. Unsuitable for non standardized product: The industries which deal with non standardized products and jobs which change according to customers specification may find the system of standard costs unsuitable and costly. 5. User resentment: The managers who have to use the standard they resent it because it is a threat to their freedom of action. The cost comprises with material, labour and expenses. So variances may be in the standards of material, labour and expenses. 6.5 Standard Costing and Budgetary Control Both standard costing and budgetary control achieve the same objective of maximum efficiency and cost reduction by establishing predetermined standards, comparing actual performance with the pre-determined standards and taking corrective measures, where necessary.
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Thus, although both are useful tools to the management in controlling costs, they differ in the following respects: Basis of Difference Concept Basis Budgetary Control The budgets are prepared for the concern as a whole The budget are fixed on the basis of past records and future expectations. The scope of budgetary control is much wider than the scope of standard costing. Budgets are prepared for incomes, expenditures and other activities, etc. In budgetary control, the targets of expenditure are set and these targets cannot be exceeded. In this system the emphasis is on keeping the expenditures within the budgeted figures. Budgets are set on the basis of present level of efficiency. Budgetary Control is related to financial accounts. Budgetary control deals with total variance only. The variances may be calculated for different departments or for the concern as a whole. Standard Costing The standards are set for producing a product or for providing a service. Standard costs are fixed on the basis of technical information. On the other hand standards, are set up for expenditures only and, therefore, for manufacturing departments standards are set for different elements of cost i.e., material, labour and overheads. In standard costing the standards are set and an attempt is made to achieve these standards. The emphasis is on achieving the standards.
1) 2)
3)
Scope
4)
Emphasis
5)
Objective
6) 7)
Relationship Variance Analysis
Standard costs are based on the basis of standards set by the management. Standard costing is related to the cost accounts. Standard costing variances are calculated for different elements of cost. i.e., material, labour and overheads. In standard costing variances are studied according to their causers.
6.6
Variances 1.Material variances 2. Labour variances

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3. Overhead variances 6.6.1 Material variances: Material usage variance: (SQ-AQ)SP Material Price variances Material cost variances Material mix variances : : : (SP-AP) AQ SQ.SP-AQ.AP If SM=AM, Then (SQ-AQ)SP SM AM ,then (RSQ-AQ)SP
Material sub usage variance :This variance is calculated only When SM AM, (SQ-RSQ)SP Verification: 1. Material usage variance+ Material price variance= Material cost variance 2. Material mix variance + Material sub usage variance= Material usage variance Now we will discuss these variance with the help of examples
Numerical 6.1 (when SM=AM) Material X Y SQ 100 Kg 110 Kg 210 Kg SP 5 4 AQ 120kg 90 Kg 210 Kg AP 4 3
Solution Material usage variance: (SQ-AQ)SP X (100-120)5= -100 Y(110-90)4=80 Material price variance (SP-AP)AQ X(5-4)120=120 Y(4-3)90= 90 SQ.SP-AQ.AP X(1005-1204)=20 Y(1104-90 3)=170
Material cost variance
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Material mix variance: Now SM=AM So, mix variance will be (SQ-AQ)SP X(100-120)5=-100 Y(110-90)4 = 80 Verification: Material usage variance+ Material price variance= Material cost variance -20 Numerical 6.2 (when SM AM) Material X Y SQ 110Kg 120 Kg 230 Kg SP 5 4 AQ 120 Kg 130Kg 250 Kg AP 4 3 + 210 = 190
Solution Material usage variance : (SQ-AQ)SP X (110-120)5=-50 Y(120-130)4=-40
Material price variance
(SP-AP)AQ X(5-4)120=120 Y(4-3)130=130
SQ.SP-AQ.AP X(110.5-1204)=70 Y(1204-1303)=90
Material mix variance: Now SM AM So, mix variance will be (RSQ-AQ)SP X(110/230250-120)5=-2.2 Y(120/230250-130)4=1.72
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Now we have to calculate Material sub usage variance also because mixes are not equal. Material sub usage variance : (SQ-RSQ)SP X(110-110/230250)5=-47.8 Y(120-120/230250)4=-41.72
Verification: Material usage variance+ Material price variance= Material cost variance -90 + 250 = 160
Material mix variance + Material sub-usage variance = Material usage variance -.48 Numerical 6.3 (when yield is given) Material X Y Z Total Yield Solution Remember: When yield is given in the question we have to consider SQ as per actual yield. Now we will discuss how to calculate variances when yield is given. Material usage variance : (SQ-AQ)SP X (4/1614-2)1=1.5 Y(2/1614-1)2=1.5 Z(2/1614-3)4=-5 Material price variance : (SP-AP)AQ X(1-3.5)2=-5 Y(2-2)1=0 Z(4-3)3=3 SQ 4 2 2 8 Kg 16 Units SP 1 2 4 SC 4 4 8 16 AQ 2 1 3 6Kg 14units AP 3.5 2 3 AC 7 2 9 18 -89.52 = -90
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SQ.SP-AQ.AP X(3.51-23.5)=-3.5 Y(1.752-12)=1.5 Z(1.754-33)=-2
Material mix variance
For mix variance we have to neglect yield. (RSQ-AQ)SP X(4/86-2)1=1 Y(2/86-1)2=1 Z(2/86-3)4= - 6
Now SM AM So, mix variance will be
Now material yield variance, we have to consider the standard yield as per actual yield.
Material Yield variance
(AY-SY)SC per unit (14-16/86)16/16 (14- 26)1=2
When yield is given ,no need to calculate material sub usage variance unless it is asked to calculate. Verification: 1.Material usage variance+ Material price variance= Material cost variance -2 -2 =-4
Material mix variance +Material yield variance = Material usage variance -4 Numerical 6.4 10 units of finish products are obtained from the mix and 10 mixes were completed. Actual production was 90 units. Calculate material variances. Material X Y SQ 60 80 SP .15 .20 AQ 640Kg 960Kg AP .20 .15 2 = -2
40
Z Total
100 240Kg
.25
840Kg 2440Kg
.30
Solution We will prepare the table to solve the problem. This standard quantity is given for a mix and 10 units are produced from this mix and 10 mixes are completed so picture will be: Material X Y Z Total Yield SQ 600Kg 800Kg 1000 Kg 2400 Kg 100 units SP .15 .20 .25 SC 90 160 250 AQ 640Kg 960Kg 840Kg 2440Kg 90 Units AP .20 .15 .30
Material usage variance: (SQ_AQ) SP X(600/10090-640).15=-15 Y(800/10090-960).20=-48 Z(1000/10090-840).25=15 Material price variance: (SP-AP)AQ X(.15-.20)640=-32 Y(.20-.15)960=48 Z(.25-.30)840=-42 Material cost variance: SQSP-AQAP X(540.15-640.20)=-47 Y(720.20-960.30)=0 Z(900.25-840.30)=-27 Material mix variance: Now SM AM , so it will be: (RSQ-AQ)SP X(600/24002440-640).15=-4.5 Y(800/24002440-960).20=-29.34 Z(1000/24002440-840).25=44.16
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Material yield variance: (AY-SY) SC per unit (90-100/24002440)500/100=-58.3 Verification: 1. Material usage variance+ Material price variance= Material cost variance -48 -26 =-74
Material mix variance +Material yield variance = Material usage variance 10.3 -58.3 = -48
6.6.2 Labour variance : 1. Labour efficiency variance: (ST-AT) SR 2. Labour rate variance : (SR-AR)AT 3. Labour cost variance: (STSR -ATAR) 4. Labour mix variance: (i) SM=AM, Then(ST-AT) SR (ii) SM=AM, Then (RST-AT) SR 5. Labour yield variance: (AY-SY)SC per unit Numerical 6.5 ST= 40Hrs . AT =35 Hrs SR= 5/-per hr. AR= 4/- per hr. Standard yield = 10 units Actual yield= 12 units Solution Labour efficiency variance : (ST-AT)SR ( 40/1012-35)5 Labour rate variance : ( SR-AR )AT ( 5-4)35 Labour cost variance: (ST.SR-AT.AR) (485-354) Labour yield variance: (AY-SY)SC per unit (12-10)200/10
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Numerical 6.6 (when SM=AM) Skilled Unskilled Total 1. ST 40HRS 60 HRS 100HRS SR 5 4 SC 200 240 440 AT 50HRS 50HRS 100HRS AR 4 3 AC 200 150 350
Labour Efficiency Variance:(ST-AT) SR Skilled (40-50) 5 = Unskilled (60 50) 4 = 40
2.
Labour Rate Variance: (SR-AR)AT Skilled (5 4 ) 50 = Unskilled (4 3) 50 = 50
3.
Labour Cost: STSR-ATAR Skilled (40 x 5) (50x4) = 0 Unskilled (60 x 4) - (50x3) = 90
4.
Labour mix variance: SM = AM (ST-AT) SR Skilled (40-50) 5 = -50 Unskilled (60-50) 4 = 40
Verification: 1. Labour efficiency variance + Labour Rate Variance = labour cost variance -10 100 90
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Numerical 6.7 (when SM AM) Skilled Unskilled Total 1. ST 40HRS 60 HRS 100HRS SR 5 4 SC 200 240 440 AT 50HRS 55HRS 105HRS AR 4 3 AC 200 165 365
Labour Efficiency Variance:(ST-AT) SR Skilled (40-50) 5 = Unskilled (60 55) 4 = 20
2.
3.
Labour cost variance: STSR-ATAR Skilled (40 x 5) (50x4) = 0 Unskilled (60 x 4) (55x3) = 75
4.
Labour mix variance: SM AM
(RST AT) SR Skilled ( Unskilled ( 5. ) ) ( ( ) )
Labour Revised Efficiency Variance: (ST RST) SR Skilled (40 42 ) 5 = Unskilled (60 63) 4 =
44
Verification: 1. Labour efficiency variance + Labour Rate Variance = labour cost variance 105 75
2. Labour mix variance + Labour Revised efficiency = labour efficiency variance
Numerical 6.8 (when SM=AM and yield is given) Skilled Unskilled Total Yield Solution 1. ST 40HRS 60 HRS 100HRS SR 5 4 120 units SC 200 240 440 AT 50HRS 50HRS 100HRS AR 4 3 AC 200 150 350 130 units
Labour Efficiency Variance:(ST-AT) SR Skilled ( Unskilled ( ) ) ( ( ) )
2.
3.
Labour Cost: STSR-ATAR Skilled (43.33 x 5 Unskilled (65 x 4 ) = (216.65 200) = 16.65 50 x 3) = (260 150) = 110.00
4.
(ST AT) SR
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Skilled (40 50) 5 = ) Unskilled ( 5. Labour yield Variance (AY SY) SC ( ( ) )
Verification: 1. Labour efficiency variance + Labour Rate Variance = labour cost variance 100 126.65
2. Labour mix variance + Labour yuield variance = labour efficiency variance
Numerical 6.9 (when SM AM and yield is given) Skilled Unskilled Total Yield 1. ST 40HRS 60 HRS 100HRS SR 5 4 120 units SC 200 240 440 AT 50HRS 55HRS 105HRS AR 4 3 AC 200 165 365 130 units
Labour Efficiency Variance:(ST-AT) SR Skilled ( Unskilled ( ) ) ( ( ) )
2.
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3.
Labour Cost: variance: STSR-ATAR Skilled (43.33 x 5 Unskilled (65 x 4 ) = (216.65 200) = 16.65 55 x 3) = (260 165) = 95
4.
(RST AT) SR Skilled ( Unskilled ( 5. Labour yield Variance (AY SY) SC ( ( ) ) ) 5 = (42 ) 4 = (63 )5 = )4 =
Verification: 1. Labour efficiency variance + Labour Rate Variance = labour cost variance 105 78.35
2. Labour mix variance + Labour yuield variance = labour efficiency variance
Numerical 6.10 From the following information calculate labour variances: Standard 40 skilled men @60 paise per hours for 50 hours 60 Unskilled men @40 paise per hour for 50 hours Rs. 1,200 1,200 2,400 Rs. 980 1,300 2,280
Actual 35 Skilled men @56 paise per hours for 50 hours 65 unskilled men @40 paise per hours for 50 hours
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Solution SH 2,000 3,000 5,000 Standard Mix SR (Re.) 0.60 0.40 SLC (Rs.) 1,200 1,200 2,400 AH 1,750 3,250 5,000 Actual Mix AR (Re.) 0.56 0.40 ALC (Rs.) 980 1,300 2,280
Skilled Unskilled
Labour efficiency variance SR (SH-AH) Skilled = 0.60 (2,000-1,750) = 150 Unskilled = 0.40 (3,000 3,250) = -100 Labour Rate Variance LRV Skilled Unskilled = AH (SR AR) = 1,750 (0.60 0.56) = Rs. 70 (Fav.) = 3,250 (0.40 0.40) = Nil
Labour Cost Vaariance LCV = SLC ALC = 2,400 2,280 = Rs. 120 (Fav.) Labour Mix Variance LMV Skilled Unskilled Verification: 1. Labour efficiency Variance + Labour Rate Variance = Labour cost variance 50 70 120 = SR (SH AH) = 0.60 (2,000 1,750) = Rs. 150 (Fav.) = 0.40 (3,000 3,250) = Rs. 100 (Adv.)
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Illustration 6.11
The time require to produce a product and the cost is given as below: workers Skilled unskilled Hours per unit of output 30 20 50 Rate per hour 2 3 Amount 60 60 120
In a particular period 100 units of the product were produced the actual cost of which as follows: workers Hours Rate per hour Amount Skilled unskilled 3200 1900 5100 1.5 4.0 4800 7600 12400
Solution Standard time for skilled worker was given for a product was 30 hrs for one product but the actual units were produced 100 so the standard time will be 3000 hrs similarly for unskilled worker the standard time for a product is given 20 hrs so for 100 units it will be 2000 hrs.
Workers Skilled Unskilled
ST 3000 2000 5000
SR 3 2
AT 3200 1900 5100
AR 1.5 4.00
Labour efficiency variances : (ST-AT)SR (3000-3200)2=-400
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(2000-1900)3=300 Labour rate variances: (SR-AR)AT Skilled (2-1.5)3200=1600 Unskilled (3-4)1900 = -190 Labour cost variance: (ST.SR- AT.AR) Skilled (30002- 32001.5)=1200
Unskilled (20003 -1900 4)=-1600 Labour mix variance: Skilled (RST-AT)SR (3000/50005100-3200)2 =(3060-3200)2 = -280 Unskilled (2000/50005100-1900)3 = (2040-1900)3 = 420
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CHAPTER VII BUDGETARY CONTROL
Objectives: 1. To understand the concept of budgetary control. 2. To know the advantages and limitation of budgetary control. 3. To discuss the different kinds of budgets.
There has been continuous changes in the industry society. This has been creating a number of problems to the business enterprises. Consequently if the companies fail to anticipate and recognize these changes, they will not be able to survive in the competitive era which has been transforming rapidly from healthy and constructive competition to unhealthy and destructive type of competition. Further, the companies must aim at achieving some degree of growth on consistent and continuous basis. This growth rate is influenced, to a great extent, by the profitability and profit. It is therefore, necessary for the companies to plan and work properly . This requires a careful planning and this planning for future and trying to achieve the target result is necessary for both survival and growth. 7.1 Meaning of budget, budgeting and budgetary control
Budget: Budget means a quantitative and financial statement prepared for a particular period before that period of the policies to be pursued in future for a objective. Budgeting : Budgeting involves an analysis carefully and systematically of different business operations with the sole objective of preparing specific plan for the future. Budgetary control: Budgetary control involves: (i) (ii) (iii) (iv) Preparation of budgets Measurement of actual performance at the end of the budgeted period Comparison of actual with budgeted performance Analysis of the reason of not achieving the target so that corrective measures can be taken.
7.2
Requirements of budgetary control/ Organization of budgetary control 1. Budget centers 2. Organization chart 3. Budget committee
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4. Budget Manual 5. Budget period 6. Principal Budget Factor 1. Budget centre : Budget centre means part of the organization for which budget is prepared. For example production dept, sales dept. purchase dept, Human resource dept, if budgets are for these depts. Means these are the budget centers. 2. Organization chart: For better budgetary control system it is necessary to make the position of every member very clear what they have to perform and what is their role and responsibility . organization chart is here to show the understanding of the types of budgets
Chairman
Budget Officer
Sales Manager
Production Manager
Purchase Manager
Personnel Manager
R&D Manager
3. Budget committee: Chief Executive of the organization will be the chairman of the committee and the Accounts Officer will function as Budget Officer . All the functional managers and important executives will be the members of the committee. The committee will request the functional managers to prepare and submit to it , budgets for their departments. After the receipt of these budgets committee will analyze the same and make recommendations in the budgets and reconsideration of these it will coordinate all the budgets and prepare the master budget. 4. Budget manual: Budget manual is a written document which guides and helps the executives in the preparation of the budgets . It explains the responsibilities also of executives also and the interrelationship them.
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5. Budget period: Companies prepare three types of budgets usually: (i) Weekly, Monthly (ii) Annual budgets (iii) Long term budgets 6. Principal budget factor: The factor in the activities of an undertaking which at a particular point in time or over a period will limit the volume of output. Demand for the production capacity , skilled labour force, raw material, etc. are examples of principal factor/key factor.
7.3
Objectives of budget: The objectives of budgetary control are as follows: 1) 2) 3) 4) 5) Basic Purpose: A budgetary control system serves the basic purposes, namely, planning, coordination, and control. Cooperative Spirit: Different levels of management act in a unified and cooperative manner to achieve the goals set by the budget. Budgetary control facilities this task. Maximum Profitability: Another important objective of budgetary control is to achieve a maximum profitability by planning. Centralized Control: It facilitates a centralized control with delegation of authority as well as responsibility. Coordination: The budgetary control facilitates coordination among various levels of activities, like production, purchase, administration, selling and distribution in order to achieve the targeted plan of action. Execution: Another objective of budgetary control is to see that all activities are moving in the same direction to achieve the goals and to detect any deviation from it. It aims at a proper execution by comparing the actual performance against the budget. Remedial Measures: If any deviation is noticed the role of budgetary control is to take a remedial action at the proper time. Revision: If remedial measures are not adequate, it facilitates the task of revision of budgets. Advantages of Budgetary Control Some of the advantages of budgetary control are:
6)
7) 8)
7.4
1.
Maximization of Profit: The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and cover various capital and revenue expenditures. The resources are put to the best possible use.
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2.
Co-ordination: he working of different departments and sectors is properly coordinated. The budget of different departments has a bearing on one another. The co-ordination of various executives and subordinates if necessary for achieving budgeted targets. Specific Aims: The plans, policies and goals are decided by the top management. All efforts are put together to reach the common goal of the organization. Ever department is given a target to be achieved. The efforts are directed towards achieving some specific aims. If these is no definite aim then the efforts will be wasted in pursuing different. Tool for Measuring Performance: By providing targets to various departments, budgetary control provides a tool for measuring managerial performance. The budgeted targets are compared to actual results and to the top management. This system enables the introduction of management by exception. Economy: The planning of expenditure will be systematic and there will be economy in spending. The finances will be pout to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national economy. The national resources will be used economically and wastage will be eliminated. Types of budgets: A) According to Functions B) According to flexibility C) According to time
3.
4.
5.
7.5
A) Functional budgets: 1. Sales Budget: Sales budget is one of the important functional budget. All the budgets production budget , purchase budget depends on sales budget. Sales budget means estimation of sales in advance for a particular period . Sales manager has to take the following factors into account : (i) (ii) (iii) (iv) (v) (vi) (vii) Analysis of past data Production capacity Budget factor Analysis of market trend Pricing policy Sales promotion Changes in market environment
2. Production Budget: After the preparation of sales budget production budget is prepared. Production budget shows the number of units of each of the products of the company that
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must be produced during the budget period to meet the demand for the product and to keep the units of finish goods at the desired level at the end of the budget period. In order to find out the number of units to be produced it is necessary to take into account the opening and closing stock of finish goods and the sales volume. The production manager has to consider the following factor during the preparation of production budget: (i) (ii) (iii) (iv) Sales budget Key factor Opening and closing balance Production capacity
3. Purchase budget: Once the production budget is prepared it is necessary to determine the different inputs required to carry out the production activities. One such important factor is raw material. The purchase manager considers the following factors into account: (i) Opening and closing stock of raw material (ii) E.O.Q. (iii) Seasonable availability of material 4. Personnel budget: The budget anticipates the quantity of personal required during a period for production activity . This may be further split up between direct and indirect personnel budgets. 5. Cash budget: The budget is a forecast of the cash position by time period for a specific duration of time. It states the estimated amount of cash receipts and the estimation of cash payments and the likely balance of cash in hand at the end of different periods. Methods to prepare cash budget are: (i) Receipt and payment method (ii) The Adjusted profit and loss method (iii) The balance sheet method We can discuss the concept of cash budget with following example. 1. Opening cash balance in June Rs. 7,000. 2. Cash sales for June Rs. 20,000; July Rs. 30,000 and August Rs. 40,000. 3. Wages payable Rs. 6,000 every month. 4. Interest receivable Rs. 500 in the month of August. 5. Purchase of furniture for Rs. 16,000 in July. 6. Cash Purchase for June Rs. 10,000; July Rs. 9,000 and August Rs. 14,000.
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Solution: Cash Budget for the Period June to August 2011 Particulars Opening Cash Balance Add: Cash Receipts (estimated) Cash Sales Interest Total Receipts Less: Cash Payments (estimated) cash Purchases Payment of Wages Purchase of Furniture Total Payment Closing Balance (surplus/deficit) (total receipts total payments) June 7,000 20,000 27,000 10,000 6,000 16,000 11,000 July 11,000 30,000 41,000 9,000 6,000 16,000 31,000 10,000 August 10,000 40,000 500 50,00 14,400 6,000 20,000 30,500
6. Master budget: It is a summary budget incorporating all functional budgets in capsule form. It interprets different functional budgets and covers within its range the preparation of projected income statement and projected balance sheet. B) As per flexibility: (i) Fixed budget : A budget prepared on the basis of a standard or a fixed level of activity is called a fixed budget. It does not change with the change in the level of activity. (ii) Flexible budget: A budget designed in a manner so as to give the budgeted cost of any level of activity is termed as a flexible budget. We can discuss the concept of flexible budget with the following example:
Example: For production of 10,000 XYZ Co. Ltd. The following are budgeted expenses: Direct Materials Direct Labour Variable Overheads Fixed Overheads (Rs. 1,50,000) Variable Expenses (Direct) Selling Expenses (10% Fixed) Administration (Rs. 50,000 rigid for all levels of production) Distribution Expenses (20% fixed) Total cost of sales per unit Per Unit 60 30 25 15 5 15 5 5 160
Prepare a budget for production of 6,000, 7,000 and 8,000 Irons, showing distinctly Marginal cost and total cost.
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Solution: Flexible Budget of XYZ Co. Ltd. Production Particulars 6,000 Units Total Cost Cost per Unit 3,60,000 60.00 1,80,000 30.00 30,000 5.00 25.00 13.50 4.00 137.50 25.00 8.33 2.50 1.67 37.50 7,000 Units Total Cost Cost per Unit 4,20,000 60.00 2,10,000 30.00 35,000 5.00 1,75,000 94,500 28,000 9,62,500 1,50,000 50,000 15,000 10,000 2,25,000 8,000 Units Total Cost Cost per Unit 4,80,000 2,40,,000 40,000 60.00 30.00 5.00 25.00 13.50 4.00 137.50 18.75 6.25 1.88 1.25 28.13 165.63
Direct Materials Direct Labour Direct Variable Expenses Variable Overheads: Production 1,50,000 Selling 81,000 Distribution 24,000 Marginal Cost 8,25,000 Fixed Production Overheads 1,50,000 Administration Overheads 50,000 Selling Overheads 15,000 Distribution Overheads 10,000 Fixed Cost 2,25,000 Total Cost (Marginal cost plus fixed cost) 10,50,000
25.00 2,00,000 13.50 1,08,000 4.00 32,000 137.50 11,00,000 21.43 1,50,000 7.14 50,000 2.14 15,000 1.43 10,000 32.14 2,25,000 169.64 13,25,000
175.00 11,87,500
Working Notes: Variable selling expenses per unit = = Rs. 13.50 per unit. All other variable expenses are computed on the same basis.
C) As per time: (i) Long term budget: A budget designed for a long period is termed as a long term budget. These budgets are concerned with planning of the operations of a firm over a consider ability long period of time. (ii) Short term budget: These budgets are designed for a period generally not exceeding 5 years. (iii) Current budgets: These budgets cover a very short period say a month or a quarter they are essentially short term budgets adjusted to current conditions or prevailing circumstances.
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7.6
Zero Base Budgeting:
Zero base budgeting was firstly used by U.S. Department of Agriculture as long back as in 1961 . However it was Peter A. Pyhr who designed its logical framework in 1970 and successfully developed, implemented and popularized its wider use in private sector. He is therefore rightly termed as father of Zero Base Budgeting Meaning: Zero base budgeting as name suggests examines a programme or function or responsibility from scratch . An operating planning and budgeting process which requires each manager to justify his entire budget requests in detail from scratch . Zero base budgeting is a management tool which provides a systematic method for evaluating all operations and programmes , current or new , allows for budget reductions and expansions in a rational manner and allows re allocation of sources from low to high priority programmes Advantages: 1. It provides a systematic way to evaluate different operations and programmes undertaken by the management 2. It ensures the programme is performed in the best possible way.
3. It helps in identifying the areas of wasteful expenditure. 4. It helps in management to approve the departmental budgets. 5. It coordinates budgets with the objectives of the concern. Limitations : 1. Implementation problems: For better implementation it requires the cooperation from top management and it is lacking. 2. Decision package problem: Considerable problems are faced by the managers while formulating decision packages. 3. Ranking package problem: Who will do ranking? To which extent within each organization the decision package will be ranked? 4. Cost problem : It require so much cost as well as time also.
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Process of Zero base budgeting: 1. Determination of objective of budgeting 2. Determination of the extent to which the zero base budgeting is to be introduced 3. Development of decision units. 4. Development of decision packages 5. Review and ranking of decision packages 6. Preparation of decision package 7.7 Performance Budgeting:
Performance budgeting is an important tool of management to control the activities in various respects and to help specifically in the formulation of programmes objectives and their accomplishment. The term first used by Hoover Commission in the United States of America . It was applied there in defence linking the output to input . Meaning: A budget which is based on the performance is called performance budgeting. It is a particular technique by which operations of an enterprise are to be presented in terms of functions, programmes activities and projects to be followed in a fixed period. Objectives of performance budgeting: 1. To improve budget formulation and related decision making and the review of annual programme at all levels of organization. 2. To make performance audit more effective 3. To achieve co relation between the physical and financial aspects of the programme. 4. To facilitate better appreciation and review of objectives 5. To help the measurement and assessment of actual progress achieved towards the long term objectives. Importance of Performance Budgeting: 1. Management by Objective: It enables the executives to introduce the management by objectives in their concern because it lays major emphasis on the performance of the activities of the whole enterprise or in the various units. 2. Allocation of funds to various Departments: Performance budgeting allocates a particular activity to each department to be performed in a determined period.
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3. Helpful in capital budgeting: Performance budgeting is helpful in the integration of various managerial functions as planning, budgeting , reporting and controlling in the enterprise. 4. Management Information system : Performance budgeting has become the important tool of the managerial control. It provides the various requisite informations to various levels of the management. Process of Performance Budgeting: 1. Setting of Objectives and targets 2. Formulation of Programmes and Activities 3. Execution of the budget 4. Evaluation and Appraisal Limitations of performance costing: 1. Qualitative aspect is ignored: In performance budgeting major emphasis has been given to achievement of particular activity in physical terms and the amount of expenditure incurred on that activity . In other words it analyses the performance in quantitative terms whether in amount or output. 2. No Delegation of Authority: Under performance budgeting formulation of appropriate programme or plan of action is very essential . For this purpose whole enterprise must be well organized in various departments or center. Each department must have some suitable authorities so that implementation of targets can be done effectively. 3. More emphasis on physical aspect of output only: In performance budgeting more emphasis is on physical aspect but all the activities of the enterprise can not be measured in physical terms.
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CHAPTER VIII MARGINAL COSTING
Objectives: 1. To understand the concept of marginal costing and its application in decision making. 2. To know the advantages and limitation of marginal costing. 3. To discuss the difference of absorption and marginal costing.
Marginal cost is the amount of any given volume of output by which aggregate cost are charged if the volume of output is increased or decreased by one unit. In this context a unit may be single article, a batch of article, an order , stage of production capacity or a department. It relates to change in output in the particular circumstances under consideration 8.1 Definition: 1. Marginal costing is a costing method which charges the product with only those costs that very directly with volume. - Matz, Curry & Frank 2. Marginal costing is a technique of determining the amount of change on aggregate cost due to a increase in one unit over the existing level of production. - D. Joseph 8.2 1. 2. 3. 4. 5. 6. 8.3 Advantages of marginal costing: Helpful in decision making Cost control Profit planning Guide in product pricing Helpful with budgetary control and standard costing Simplifies the overheads treatment Disadvantages of marginal costing: 1. This technique lays too much emphasis on selling function and as such production function has been considered to be less significant. 2. Valuation of stock only marginal cost financial managers view paint and this may have working capital problem. 3. This technique is not suitable for external reporting.
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4. Difficult in cost analysis 5. Not suitable for all concerns 6. Unnecessary 8.4 Difference Between Absorption Costing and Marginal Costing Basis of Difference Presentation of Cost Absorption Costing In absorption costing cost is divided into 3 major parts: factory expenses, office expenses, selling expenses. Valuation of Stock In absorption costing the stock is valued at total cost. Application Absorption costing is suited for long term pricing policy. Basis of managerial decision In absorption costing decision are based on profit. 8.5 Marginal Costing In margin costing cost is divided into two parts i.e. variable cost and fixed cost. In marginal costing the stock is valued at variable cost. Marginal costing is used for various managerial decisions. In marginal costing the decision are based on contribution.
Main area of Decision-Making and Application of Marginal and Differential Costing
Marginal costing is a very useful technique in solving various managerial problems and contributing in various area of decisions. The uses of marginal costing in following important areas are: (i) (ii) (iii) (iv) (v) 8.6 Make or Buy Decision, Change in Product Mix, Pricing Decisions, Exploring a New Market, Shut-Down Decisions.
Cost volume- profit relationship:
we have to discuss how marginal costing helps in calculation of break even sales , margin of safety ,etc Break even sales: sales at which no profit no loss. (i) (ii) (iii) (iv) (v) Break even point(units) =Fixed cost/contribution per unit B.E.P. (Rs) = Fixed cost / P/v ratio Contribution = sales variable cost (P/V ratio= c/s100 Sales at desired profit: a. Sales in units: (Fixed cost + Profit)/contribution per unit
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b. Sales in Rs. : (Fixed cost + Profit)/P/v ratio (vi) Margin of safety: margin of safety mea ns actual sales in excess of break even sales. a. Actual sales break even sales OR b. Profit/P/v ratio Now we will discuss these concepts with the help of following example:
Numerical 8.1 Sales = 1,00,000 Rs. , 10,000 units SP=10/-, V/C=6/-, Fixed cost=20,000 Solution (i) (ii) (iii) (iv) B.E.P. (rs.) = fixed cost/P/v ratio = 20,000/40% =50,000 M/o/S= Actual sales B.E.P.=1,00,000-50,000=50,000 M/O/S ratio= M/O/S/ Actual sales100=50,000/1,00,000100=50% Sales at desired profit= (Fixed cost + profit)/P/v ratio =(20,000 + 30,000)/40% = 50,000/40%
Numerical 8.2: Calculate following: (i) (ii) (iii) (iv) (v) P/V ratio Fixed cost Sales to earn Rs 5 lakhs B.E.P. M/O/S Period Sales I Sol: II 20 lac 25 lac
Profit 2 lac 3 lac
P/V ratio: = Change In profit/Change in sales100 =1/5 100 = 20% Calculation of fixed cost: We can consider the data of any year and we have to use the formula of sales at profit to calculate fixed cost. We are considering the data of Ist year.
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Sales = 20 F/C = =
(Fixed cost+Profit)/ p/v ratio (F/C+2)/20% 2 lacs Fixed cost/P/v ratio 2 lac/20% 10 lac Profit/P/v ratio 2/20% 10 lac
B.E.P. = = = M/O/S = = =
And for IInd year = = 3/20% 15 lac
Sales to earn profit of rs 5 lacs: Sales = (F/C + profit)/P/v ratio = (2+5)/20% = 35 Lac Numerical 8.3. Calculate B.E.P. at merged plant capacity and profitability at 75% of merged plant capacity. Plant I (capacity 100% 300 Lac 200 Lac 30 Lac Plant II (capacity 60%) 120 lac 60 Lac 20 Lac
Sales Variable cost Fixed cost
Sol: we have to calculate B.E.P.at merged plant capacity, before merging we have to convert the capacity of plant II at 100% Which is at 60%. Fixed cost will remain same at conversion because it does not change.
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Plant I Plant II Plant II Merged (capacity (capacity (100% plant 100%(A) 60%) Capacity(B) (A+B) Sales 300 Lac Variable 200 Lac cost Fixed 30 Lac cost (I) 120 lac 60 Lac 20 Lac 200 Lac 100Lac 20 Lac 500 Lac 300 Lac 50 Lac
75% of merged plant 375 Lac 225 Lac 50 Lac
P/V Ratio= C/S 100 = 200/500100 = 40%
(II)
(III)
B.E.P. = Fixed cost/ P/V ratio = 50 Lac/40% = 125 Lac Profitability at 75% of merged plant: Profit= Sales cost = 375-(225+50) = 100 Lac
Numerical 8.4 Two companies ABC Ltd. And XYZ Ltd. Produce and sell the same type of produce in the same market. ABC Ltd. Sales Variable cost Fixed cost Profit 2,50,000 2,00,000 25,000 25,000 XYZ Ltd. 2,50,000 1,50,000 75,000 25,000
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Calculate : (i) (ii) Solution ABC Ltd. Fixed cost Sales Variable cost Contribution P/V Ratio 25,000 2,50,000 2,00,000 50,000
50 ,000 100 2,50 ,000
P/V Ratio Break even sales
XYZ Ltd. 75,000. 2,50,000 1,50,000 1,00,000

1,00 ,000 2,50 ,000 100
=20% =40% Break even sales
fixed cost P / Vratio 25,000 = 20%

1,25,000
fixed cost P / Vratio 75,000 = 40%

1,87,500
Numerical 8.5 Mr. X has Rs. 1,50,000 invested in his business. He wants a 15% return on his money. From an analysis of recent cost figures, he finds that his variable cost of operating is 60% of sales, his fixed costs are Rs. 75,000 p.a. Show supporting computations for each of the following: (a) What Sales-Volume must be obtained to break-even? (b) What Sales-Volume must be obtained to get his 15% return on investment? (c) Mr. X estimates that even if the closed the doors of his business, he would incur Rs. 25,000 expense per year.
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Solution: i)
ii)
FixedCost 75,000 Rs.1,87,500 P / VRatio 40% P/V Ratio = 100-V/C Ratio = 100-60%=40% F / C Pr ofit 75000 22500 Sales to earn 15% Profit on investment = P / VRatio 40%
B.E.P. (In Rs.) = = 2,43,750
iii)
Shut down point = =
F / C ShutdownCost P / VRatio 75000 25000 40% 50000 Rs.1,25,000 / 40%
Numerical 8.6 A Scooter Company has presented the cost of a Scooter as under: Material Labour Variable Expenses Fixed Expenses Total Cost Profit Selling Price Rs. 4,000 1,200 2,800 1,200 9,200 800 10,000
No. of Scooters manufactured and sold 500. (A) You are required to calculate Break-even point. (B) If price is reduced by Rs. 400 per scooter, how many scooters should be manufactured and sold to maintain the present profit? Solution The information given in the question may be summarised as follows: Fixed Cost = Variable Cost per = unit
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(A)
Present profit = B.E.P. (Units) = =
(B)
Sales to maintain the present profit but after reduction in selling price by Rs. 400. Sales (Units) = =
Numerical 8.7 Calculate B.EP, P/V ratio and Marginal off Safety from the following for PARAS Ltd: The fixed cost if Rs. 1,00,000 and the variable cost per unit for the product is Rs. 12. Estimated sales for the period is Rs. 4,00,000 and the selling price of a unit is Rs. 30. Again calculate the selling price per unit if the company wants to bring down the B.E.P. at 4,000 units. Also find out the sales to earn the profit of 20% on sales. Solution I. BEP (in Rupee) = = PV Ratio = Margin of Safety = Actual Sales B.E.P. Sales = 4,00,000 1,66,667 = Rs. 2,33,333 II. Selling price if BEP is brought down to 4,000 units. Contribution for 4,000 units of BEP. C = Selling Price per unit = V + C per unit = 12 + 25 = Rs. 37 III. Sales to earn the profit of 20% on sales. Profit of 20%^ on sales = X = 60%X = 50%X = 1,00,000 X = 2,00,000
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CHAPTER IX INFLATION ACCOUNTING

Objectives: 1. To know the meaning of Inflation Accounting. 2. To know the various method of inflation accounting.
9.1
INTRODUCTION:
Inflation has an effect on consumer prices, to be sure, but there are effects on corporate finance as well. Typically, in developed countries, inflation rates are fairly steady and somewhat predictable. However, in times of hyperinflation, prices soar and corporate financial reports can be misinterpreted without accounting for inflation. Inflation accounting offers a more accurate view of a company or individuals financial situation because it looks at those finances through the lens of inflation. Inflation raises prices, thereby decreasing purchasing power. The same amount of money will not purchase the same amount of goods ten years later when inflation is taken into consideration. For instance, what would happen if an individual planning for retirement calculated the number of years he or she expected to live after retirement and multiplied their current salary by that number of years to come up with the sum total they would need to save to cover their Cost of Living for retirement? If they did not account for inflation, their retirement nest egg would dwindle long before their life ended. 9.2 DEFINITION:
Inflation accounting requires statements to be adjusted according to price indexes, rather than rely solely on a cost accounting basis. 9.3 IMPACT OF INFLATION ON CORPORATE FINANCIAL STATEMENTS
The consumer price index, and it is easier to factor looking backward on previous years than it is looking ahead to a future economic situation. Additionally, corporate financial reporting using inflation accounting will reveal differences in expenditures, sales figures and profit margins based on inflation rates. For this reason and others, it is important for accountants to include the index they used when calculating those differences with inflation in mind and should show the math in order to stay above reproach with investors and regulating officials. As beneficial as inflation accounting may be for understanding the actual financial situation of a company or individual, it leaves a considerable amount of room for fraudulent reporting under the guise of inflation accounting and thus the concept is surrounded by controversy. The impact of inflation on corporate financial statements can be summarized below:
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1. Profits Overstated: Of all the expenses charged in P& L account , one most important item is depreciation, If the amount of depreciation charged is less, profit will be more and vice-versa. Since depreciation is calculated on historical cost, in the situation of inflation happens to be less than tits present values, therefore the amount of depreciation charge in profit and loss account is also less than the real amount and to that extent the profit is overstated. 2. Understatement of Assets: It is normally felt that the balance sheet shows the true and fair view of the financial position of the concern. But the fact is that the fixed assets are shown in the balance sheet at cost less depreciation and this value is less than the present value or realizable value. 3. Valuation of stock: Under traditional accounting system stock is valued either at cost or market price, whicher is less. If during the year the prices of goods purchase or sold increase the amount of profit would be increase , if such price rise is not adjusted to valuation of stock. 4. Capital is not intact: Because of inflation the profit is less than the reported profit so dividend will be paid out of capital and not of profit so the capital will be less. 9.4 SIGNIFICANCE OF INFLATION ACCOUNTING:
An enterprise can be benefited in number of ways by employing inflation accounting. The importance among them is given below: 1. 2. 3. 4. 5. Accurate picture of Profitability True and fair view Social obligation Realistic price Helps in replacement of Assets
The significance of inflation accounting emerges from the inherent limitations of the historical cost accounting system. Following are the limitations of historical accounting: 1. Historical accounts do not consider the unrealized holding gains arising from the rise in the monetary value of the assets due to inflation. 2. The objective of charging depreciation is to spread the cost of the asset over its useful life and make reserve for its replacement in the future. But it does not take into account the impact of inflation over the replacement cost which may result into the inadequate charge of depreciation. 3. Under historical accounting, inventories acquired at old prices are matched against revenues expressed at current prices. In the period of inflation, this may lead to the overstatement of profits due mixing up of holding gains and operating gains. 4. Future earnings are not easily projected from historical earnings.
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9.5
LIMITATIONS OF INFLATION ACCOUNTING:
Though Inflation Accounting is more practical approach for the true reflection of financial status of the company, there are certain limitations which are not allowing this to be a popular system of accounting. Following are the limitations: 1. 2. 3. 4. Complicated , confusing and time consuming process Difficult to analyse, understand and interpret. Not suitable for income tax purposes. Profits are overstated when during deflation as lesser amount of depreciation is shown. METHODS/TECHNIQUS OF INFLATION ACCOUNTING:
9.6
To measure the impact of inflation on financial statements, following are the techniques used: Current Purchasing Power (CPP) Method Under this method of adjusting accounts to price changes, all items in the financial statements are restated in terms of a constant unit of money i.e. in terms of general purchasing power. For measuring changes in the price level and incorporating the changes in the financial statements we use General Price Index, which may be considered to be a barometer meant for the purpose. The index is used to convert the values of various items in the Balance Sheet and Profit and Loss Account. This method takes into account the changes in the general purchasing power of money and ignores the actual rise or fall in the price of the given item. CPP method involves the refurnishing of historical figures at current purchasing power. For this purpose, historical figures are converted into value of purchasing power at the end of the period. Two index numbers are required: one showing the general price level at the end of the period and the other reflecting the same at the date of the transaction. Profit under this method is an increase in the value of the net asset over a period, all valuations being made in terms of current purchasing power. Feature of current Purchasing Power Method: (i) (ii) Business concern should prepare the Balance Sheet and Profit and Loss Account on the basis of Historical Cost. In addition to final Accounts, the concerns should also prepare supplementary statements in which revise values of accounting items according to changes in price level should be shown. A reasonable index number should be selected for changing the figures. A separate note explaining the base of price changes should be presented to the Board of Directors.
(iii) (iv)
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Replacement Cost Accounting (RCA) Method Replacement accounting method is an improvement over current purchasing Power method. As pointed out, the main drawback of CPP is that it did not take into account the individual price index of a particular asset, on the contrary, replacement cost accounting method makes use of Individual price index numbers. Thus, under this method a number of index numbers are used. However the availability of these various index numbers is difficult in practice. Current Cost Accounting (CCA) Method The Current Cost Accounting is an alternative to the Current Purchasing Power Method. The CCA method matches current revenues with the current cost of the resources which are consumed in earning them. Changes in the general price level are measured by Index Numbers. Specific price change occurs if price of a particular asset changes without any general price change. Under this method, asset are valued at current cost which is the cost at which asset can be replaced as on a date. Features of Current Cost Accounting (CCA) Method (i) (ii) (iii) (iv) Fixed Assets are shown in the balance sheet at their values to the business and not at their depreciated original cost. Stocks are shown in the balance sheet at their value to the business and not at their original cost or net realizable value. The depreciation of the year is to be calculated in the current value of the relevant fixed assets. The effects of the loss or gain from holding monetary assets or liability will be shown separately in a statement.
Current value Accounting (CVA) Method Under this method of price Level Accounting all the assets and liabilities are shown in the Balance sheet at current value. The value of net assets both at the beginning and at the end is found out and the difference between these two values of net assets is considered as profit or loss. Here also it is very difficult to determine the relevant values of items to be shown in the Balance sheet.
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CHAPTER X FUND FLOW STATEMENT
Objectives: 3. To know the meaning of fund flow statement. 4. To know the various items of sources and applications of fund. 5. To know the advantages and limitation of fund flow statement.
Fund flow statement is a statement to show the changes in funds between balance sheet dates. Fund means working capital. Flow means inflow or outflow of funds. A statement to analyze the financial position of the concern. How the fund comes in the organization and the fund utilizes in the concern. For this we have to prepare a statement is called Fund Flow Statement. 10.1 Definition
A Statement of changes in financial position summarises for the period covered by it the changes in financial position including the sources from which funds were obtained by enterprise and the specific uses to which such funds were applied. The Institute of Chartered Accountants of India
The funds flow statement describes the source from which additional funds were derived and the uses to which there funds were put. - Robert N. Anthony 10.2 Objectives, Uses and Importance of Funds Flow Statement Following are the important objectives and uses of a funds flow statement: 1. 2. 3. 4. 5. 6. 7. 8. Helpful in Financial Analysis It provides More Reliable Figures of Profit and Loss of the Business. It Enables to Know whether the funds have been properly used. Helpful in proper management of working capital. Helps in the preparation of Budget for the Next Period. It helps a Firm in Borrowing Operations. Helpful in Determining Dividend Policy Useful to Shareholders
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10.3
Limitations of Funds Flow Statement
1. Funds flow statement ignores certain non-fund transactions (such as issue of shares in consideration of purchases of fixed assets) which have equal bearing on the financial position of the firm just like other fund transaction. 2. It reveals only the changes in working capital and does not show the changes in cash position. It is possible that there is sufficient working capital and yet the firm may be unable to meet its current liabilities due to shortage of cash. It may be due to sizeable piling up of inventories and an shortage of cash. It may be due to sizeable piling up of inventories and an increase in debtors. Hence, a cash flow statement has to be prepared. 3. It is historical in nature because it reports what has happened in the past. It is quite difficult to predict the future operations on the basis of past records. 4. Since it is based on opening and closing balance sheets and the profit and loss account, it is not an original statement which can provide an original evidence to the changes in financial position. 10.4 Preparation of Fund Flow Statement Fund flow statement Sources Fund from operations Issue of shares Issue of debentures Loan taken Share premium Sale of fixed asset Non trading receipt: Dividend received Interest received Rent Recieved Decrease in working capital Amount Applications Fund lost in operations Red. of share Red. of debenture Loan repaid Purchase of fixed asset Dividend paid Tax paid Increase in working capital Amount
We will discuss now about the following how these are calculated. (i) Fund from operations (ii) Increase/decrease of working capital (iii) Dividend paid/ Tax paid
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Fund from operations: Fund from operations means fund from operative activities of a business. There might be expenses and incomes from other activities also. So we have to adjust the profit so we can calculate fund from operations only.
Dr. Particulars To printing & stationary To Postage & telegram To telephone exp. To law charges To carriage outward To General exp. To Selling and distribution exp. To interest paid To salaries To rent To office exp. To selling exp. To Loss on sale of fixed asset To Preliminary exp. To discount on issue of share/deb To Depreciation To goodwill To profit c/d To tax To profit after tax To reserve To fund To dividend To profit
Profit and loss a/c Amount Particulars By gross profit By discount By commission By interest received By dividend received By profit on sale of fixed asset By rent received
Cr. Amount
By profit b/d
By Profit after tax
In the above P&L A/C there are some items which are from operating and some are from non operating .We have to add expense which are non funded /non operating and less incomes which are non operating from the final profit.
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Calculation of fund from operations: Profit: Add: Non funded items Loss on sale of fixed asset Preliminary exp. Dis on issue of share/deb Depreciation Goodwill Tax Reserve Fund Dividend Less: Non trading receipts Profit on sale of asset Interest received Dividend received Rent received Fund from operations
Amount
Particulars
Schedule of changes in working capital Amount at the Amount at Increase in end of the end of working previous year current year capital
Decrease in working capital
Current assets (A) Cash Bank B/R Debtors Stock Prepaid exp. Marketable securities Short term investment Accrued income (A) Current liabilities(B) Creditors B/P Outstanding exp. Income received in advance
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Bank overdraft
Current liabilities (B) Working capital(A-B) Increase or decrease in working capital Calculation of dividend and tax: We need to prepare a/c of dividend and tax for the purpose of dividend paid and made and tax paid and made. Dividend paid and tax paid is shown in the application side of fund flow statement. Divined made and tax made has been debited in p&L A/C which we have to add back in fund from operations. Now we will discuss how these figures are calculated. Dr. Particulars To cash A/c To balance c/d Provision for tax A/c/ Provision for dividend Amount Particulars By balance b/d By P&L A/c Cr. Amount
The figure in P&L a/c is added in fund from operations and of cash a/c is shown in application side of fund flow statement. If no information is given about paid and made then opening is assumed as paid and closing is treated is made. We will discuss now all the concepts with the following example. Question: Explain the concept of fund flow statement with the imaginary figures? Solution We have to take a balance sheet with the imaginary figures and then follow the procedure to prepare fund flow statement. Balance sheet as on 1980 and 1981 is given below 1980 1981 Assets 1980 4,50,000 4,50,000 Fixed assets 4,00,000 3,00,000 3,10,000 Investment 50,000 Stock 2,40,000 56,000 68,000 Debtors 2,10,000 1,68,000 1,34,000 Bank 1,49,000 75,000 10,000 10,49,000 2,70,000 12,42,000
Liabilities Share capital General reserve P&L A/c Creditors Provision for tax Loan
1981 3,20,000 60,000 2,10,000 4,55,000 1,97000
10,49,000
12,42,000
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Fund flow statement Sources Fund from operations Issue of shares Issue of debentures Loan taken Share premium Sale of fixed asset: Dividend received Interest received Rent received Decrease in working capital Amount Applications 32,000 Fund lost in operations Red. of share ------- Red. of debenture -------- Loan repaid 2,70,000 Purchase of Investment -------- Dividend paid 80,000 Tax paid Increase in working capital ------------------Amount ----------------------------------------10,000 ----------75,000 2,97,000
3,82,000
3,82,000
Working note: The above table i.e. fund flow statement is the solution but the figures shown
in this statement is calculated as below: Schedule of changes in working capital Amount at Amount at Increase in the end of the end of working previous current capital year year 2,40,000 2,10,000 1,49,000 5,99,000 Current liabilities(B) Creditors Working capital(A-B) Increase in working capital 1,68,000 4,31,000 ---1,34,000 7,28,000 ---34,000 ---2,10,000 4,55,000 1,97,000 8,62,000 ---2,45,000 48,000
Particulars
Decrease in working capital
Current assets (A) Stock Debtors Bank
30,000 -------
----
2,97,000
3,27,000
3,27,000
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Dr. Particulars To A/c To balance c/d cash
Provision for tax A/c Amount 75,000 Particulars By balance b/d
Cr. Amount 75,000
10,000
By
P&L
10,000
A/c(provision made) 85,000 85,000
Note: when no information is given about paid and made then opening balance is paid and closing balance is made. Fund from operations: Profit: Add: Loss on sale of fixed asset Preliminary exp. Dis on issue of share/deb Depreciation Goodwill Tax Reserve Fund Dividend Less: Profit on sale of asset Interest received Dividend received Fund from operations 32,000 12,000 10,000 10,000 -
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CHAPTER XI CASH FLOW STATEMENT
Objectives: 1. To know the meaning of cash flow statement. 2. To understand the difference between fund flow and cash flow.
11.1
Meaning
Cash flow statement is a statement to show the changes in cash between two balance sheet dates. Before discussing about how to prepare cash flow statement we must understand the difference between cash flow statement and flow statement. 11.2 Difference Between Fund Flow & Cash Flow Statement Basis of difference 1. Purpose Fund flow statement The purpose is to show the change in funds Fund flow statement is useful for medium and long term In fund flow statement opening and closing cash is shown in schedule of change in W/C. It is prepared on the accrual basis. In fund flow all the changes in all the resources are shown. Cash flow statement The purpose is to show the change in cash. Cash flow is useful for short term opening and closing cash is shown in cash flow statement. It is prepared on the cash basis. In cash flow statement all the changes in all the resources are not shown.
2. Term
3. Balances
4. Basis
5. Scope
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11.3 1. 2. 3. 4. 5. 6. 7. 8. 11.4 1. 2. 3. 4. 5. 6. 7. 8. 11.5
Objective of Cash flow statement To throw light on specific sources of cash flow. To Ascertain the net change in cash and equivalents. To disclose changes in cash position. To determine cash requirement. For efficient cash management To judge liquidity position. To help in short-term planning To help in Divided Decision. Utility, Importance and Advantages Cash Position. Useful in day to day cash management. Useful in preparing cash budget. Helpful in finding out cash flow from different activities. Helpful in deciding dividend. More useful in Short-term financial analysis. Helpful in financial planning. Helpful in financial control. Preparation of Cash flow Statement
Now we will discuss how to prepare cash flow statement. We have to show the flow of cash under the three headings: (i) (ii) (iii) Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities
Cash flow statement Particulars Cash flow from operating activities: Profit: Add: (+) loss on sale of fixed asset (+) Preliminary exp. Amount
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(+) Discount on issue of shares (+) Written of goodwill (+) Tax (+) Reserve (+) interest (+) Dividend (+) Fund Less: (-) Profit on sale of fixed asset\ (-) Interest received (-) Dividend received (+) increase in current liability (+) decrease in stock (-) increase in current asset (-) decrease in creditor Cash flow from operating activities before tax (-) tax paid Cash flow from operating activities after tax (A) Cash flow from investing activities: (+) sale of fixed asset (+) sale of investment (-) purchase of fixed asset (-) purchase of investment (+) interest received (+) dividend received Cash flow from investing activities(B) Cash flow from financing activities: (+) Issue of share/debentures (-) redemption of shares/debentures (+) loan taken (-) loan repaid (-) interest paid (-) dividend paid Cash flow from financing activities(C) Increase or decrease in cash during the year(A+B+C) Add: opening cash/bank Closing cash/bank Note: 1. You will not consider cash/bank as current asset at the time of calculation of cash flow from operating activities. 2. Calculation of above items has been discussed in the last chapter in fund flow statement .
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3. Now we can understand the preparation of cash flow with the help of an example.
Question : Explain the concept of cash flow statement with the help of imaginary figures: Sol: We have to take a balance sheet with the imaginary figures and then follow the procedure to prepare cash flow statement.
Balance sheet as on 1980 and 1981 is given below: Liabilities Share capital General reserve P&L A/c Creditors Provision for tax Loan 1980 4,50,000 3,00,000 56,000 1,68,000 75,000 10,49,000 1981 Assets 4,50,000 Fixed assets 3,10,000 Investment Stock 68,000 Debtors 1,34,000 Bank 10,000 2,70,000 12,42,000 1980 4,00,000 50,000 2,40,000 2,10,000 1,49,000 1981 3,20,000 60,000 2,10,000 4,55,000 1,97000
10,49,000
12,42,000
Cash flow statement Particulars Cash flow from operating activities: Profit: Add: (+) loss on sale of fixed asset (+) Preliminary exp. (+) Discount on issue of shares (+) Written of goodwill (+) Tax (+) Reserve (+) interest (+) Dividend Less: (-) Profit on sale of fixed asset\ (-) Interest received (-) Dividend received (+) increase in current liability (+) decrease in stock
Amount 12,000
(+) 10,000 (+) 10,000
(+)
30,000
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(-) increase in debtors (-) decrease in creditor
(-) 2,45,000 (-) 34,000
Cash flow from operating activities before tax (-) tax paid Cash flow from operating activities after tax (A) Cash flow from investing activities: (+) sale of fixed asset (+) sale of investment (-) purchase of fixed asset (-) purchase of investment (+) interest received (+) dividend received Cash flow from investing activities(B) Cash flow from financing activities: (+) Issue of share/debentures (-) redemption of shares/debentures (+) loan taken (-) loan repaid (-) interest paid (-)dividend paid Cash flow from financing activities(C) Increase or decrease in cash during the year(A+B+C) Opening balance Closing cash/bank
(-)2,17,000 (-) 75,000 (-)2,92,000 (+) 80,000
(-) 10,000
(+) 70,000
(+) 2,70,000
(+) 2,70,000 48,000 (+) 1,49,000 1,97,000
We have the increase of Rs 48,000 in cash during the year and last year cash was 1,49,000 so the closing cash will be: 1,49,000+48,000=1,97,000 and the closing balance given in the balance sheet is 1,97,000 .
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CHAPTER XII RATIO ANALYSIS
Objectives: 1. To understand concept of ratio and various types of ratio. 2. To understand how the ratios are used for analysis of data.
12.1
Meaning
Ratio Analysis is a technique of analyzing financial statements. It helps in estimating financial soundness or weakness. Ratio is quantitative relationship between two items for the purpose of comparison. The items presented in profit and loss account and balance sheet are related to each other . This relationship can be calculated with the help of ratios. We can discuss the various ratios only when we have the understanding of the items of Trading, Profit and Loss a/c and Balance Sheet. Dr. Particulars To opening stock To purchases To wages To carriage To Gross profit/c/d To salaries To office and adm. Exp. To advertisement To bad debts To commission paid To discount allowed To printing and stationary To postage To depreciation To goodwill To interest paid To profit Trading, P&L a/c Amount Particulars By sales By closing stock Cr. Amount
By gross profit b/d By discount received By commission By profit on sale of asset By rent received
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To tax To profit after tax To reserve To fund To dividend To profit carried to balance sheet
By profit
By profit after tax
Balance Sheet Liabilities Equity share capital Preference share capital Reserve & Surplus : share premium General reserve P&L a/c (cr.) Secured loan: Debenture Unsecured loan Current liabilities: Creditors B/P Outstanding exp Income received in advance Provisions for taxation Proposed dividend Amount Assets Fixed assets: Building Plant Furniture Goodwill Patent Trademark Copyright Investment Current Assets: Cash Bank B/R Debtors Stock Prepaid exp. Accrued income Marketable securities Fictitious assets: Discount on issue of share/deb. Underwriting commission/Brokerage Advertisement outlay Profit and loss a\c(Dr.) Preliminary exp. Amount
Classification of ratios: 12.2 Liquidity ratios: 1. Current ratio= current assets Current liabilities
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Best ratio: 2:1 means current assets should be at least two times of current liabilities. 2. Liquid ratio: = Liquid assets Current liability Liquid assets= current assets- stock-prepaid exp. Best ratio: 1:1 means liquid assets should be at least equal to current liabilities.
12.3
Leverage ratio/ Solvency ratios 1. Debt equity ratio= external equity Internal equity Internal equity/shareholder fund = equity share cap+ pref. share cap.+ reserve& surplus fictitious assets External equity = current liability + long term liabilities Best ratio is 67%
2. Proprietary ratio= shareholder fund Total assets Total asset= Total assets-fictitious assets Best ratio is 33% 3. Fixed asset to proprietor fund= fixed assets Shareholder fund Best ratio is less than 100% 4. Interest coverage ratio= profit before interest and tax x 100 Fixed interest charges 5. Capita Gearing ratio= Equity shareholder fund Preference share cap +Debenture
12.4
Turnover ratios: 1. Stock turnover ratio= cost of good sold Average stock
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Cost of good sold= op. stock+ purchases + carriage inward + wagesclosing stock OR Sales G/P 2. (i) Debtor turnover ratio= credit sales Average debtors Average debtor= (opening + closing debtors)/2
(ii) Debt collection period= 365/52weeks/12 months Debtor turnover ratio 3. Creditor turnover ratio= credit purchase Average creditor
Average creditor = (opening creditor + closing creditor)/2 4. Working capital turnover ratio= cost of good sold Average w/c 5 Fixed asset turnover ratio= cost of good sold Average fixed assets
Remember: 1. Debtors includes B/R also. And if no opening and closing is given then the figure given is placed in the formula there will not be any average. 2. If cost of good sold is not possible to calculate then sales will be taken in the formula.
12.5
Profitability ratios based on sales: (i) (ii) (iii) Gross profit ratio= gross profit x 100 Sales Net profit ratio= Net profit x 100 Sales Operating ratio= operating cost x 100 Sales Operating cost= cost of good sold+ office & adm.exp.+ selling & distribution exp.
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12.6
Profitability ratio based on investment: 1. Return on capital employed = profit before interest and tax x 100 Or R.O.I. Capital employed Capital employed = equity share cap+ pref. share cap+ reserve& surplus + long term liability- fictitious assets 2. Return on shareholder fund:= Profit after interest and tax x 100 Shareholder fund 3. Return on equity shareholder fund= Profit after tax x 100 Equity share holder fund Equity shareholder fund= equity share cap+ reserve& surplus fictitious assets 4. Earning per share= Profit after tax-pref.div. No. of equity shareholders 5. Divident per share= dividend distributed No. of equity shares 6. Dividend pay out ratio= DPS EPS 7. Dividend yield = DPS MPS 8. Earning yield = EPS MPS
Now we will discuss some important numerical on ratio analysis Illustration 12.1 From the following Balance Sheet of Rim Zin Ltd. As on 31st March, 2008, calculate (i) Current Ratio, (ii) Quick Ratio, (iii) Absolute Liquidity Ratio, (iv) Ratio of Inventory to Working Capital, (v) Ratio of Current Assets to fixed Asset, (v) Debt to Equity Ratio, (viii) Proprietary Ratio, (viii) Capital Gearing Ratio and (ix) Fixed Asset Ratio. BALANCE SHEET Liabilities Equity Share Capital 6% Preference Share Capital General Reserve Profit and Loss A/c Provision for Tax Bills Payable Bank Overdraft Creditors 12% Debentures Rs. 10,00,000 5,00,000 1,00,000 4,00,000 1,76,000 1,24,000 20,000 80,000 5,00,000 29,00,000 Assets Goodwill (At cost) Plant & Machinery Land & Buildings Furniture & Fixtures Stock-in-Trade Bills Receivable Debtors Bank Marketable Securities Rs. 5,00,000 6,00,000 7,00,000 1,00,000 6,00,000 30,000 1,50,000 2,00,000 20,000 29,00,000
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Solution (i) (ii) (iii) (iv) (v) (vi) Current Ratio Quick Ratio Absolute Liquidity Ratio Inventory to Working Capital Ratio Current Assets to Fixed Assets Debt to Equity Ratio Or (vii) Proprietary Ratio = = = = = = = = = = =
(viii) Capital Gearing Ratio (ix) Fixed Assets Ratio
ILLUSTRATION 12.2 From the following final accounts of XYZ Ltd. For the year ended 31st March, 2008, you are required to calculate the following: i) Acid test ratio ; (ii) Stock turnover ratio; (iii) Operating ratio; (iv) Debt collection period; and (v) Net profit to capital employed ratio.
BALANCE SHEET As on 31st March, 2008

Liabilities Share Capital (in shares of Rs. 10 each) General Reserve Profit and Loss A/c Sundry Creditors Rs. 5,00,000 4,00,000 1,50,000 2,00,000 12,50,000 Assets Land and Buildings Plant and Machinery Stock Sundry Debtors Cash and Bank Balance Rs. 5,00,000 2,00,000 1,50,000 2,50,000 1,50,000 12,50,000
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Opening Stock Purchases Gross Profit I/d
PROFIT AND LOSS ACCOUNT for the year ended 31st March, 2008 Rs. 2,50,000 Sales 10,50,000 Closing Stock 6,50,000 19,50,000 2,30,000 Gross Profit b/d 1,00,000 Other Income (Misc.) 20,000 3,50,000 7,00,000
Rs. 18,00,000 1,50,000 19,50,000 6,50,000 50,000
Administration Expenses Selling and Distribution Expenses Expenses of Financing Net Profit
7,00,000
Solution (i) (ii) (iii) Acid Test Ratio Stock Turnover Ratio Operating Ratio = = = = (iv) (vi) Debt Collection Period =
no of days in year days app.
= Net Profit to Capital = Employed
Illustration 12.3 The ABC companys financial statements contain the following information. 31-03-2007 Rs. 6,40,000 16,00,000 20,00,000 4,68,000 31-03-2008 Rs. 8,00,000 Cash 16,00,000 Sundry Debtors 20,00,000 Temporary Investments 8,12,000 Stock Prepaid Expenses Total Current Assets Total Assets 31-03-2007 Rs. 2,00,000 3,20,000 2,00,000 18,40,000 28,000 25,88,000 56,00,000 31-03-2008 Rs. 1,60,000 4,00,000 3,20,000 21,60,000 12,000 30,52,000 64,00,000
Current Liabilities 10% Debentures Equity Share Capital Retained Earnings
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STATEMENT OF PROFIT for the year ended 31st March, 2008 Sales Cost of goods sold Interest Net Profit for 2007-08 Taxes @ 50% Net Profit after taxes Rs. 28,00,000 1,60,000 Rs. 40,00,000 29,60,000 10,40,000 5,20,000 5,20,000
Less: Less: Less:
Divided declared on equity shares Rs. 2,20,000. From the above figures, appraise the financial position of the company from the point of view of (i) liquidity; (ii) solvency ; (iii) profitability; and (iv) activity. Solution 2007 Liquidity Ratios (a) Current Ratio= (b) Acid Test Ratio = Solvency Ratios (a) Debit Equity Ratio = (b) Interest Coverage Ratio = Profitability Ratios (a) Net Profit Ratio = (b) Return on Capital Employed Activity Ratios (a) Stock Turnover Ratio = (b) Total Assets Turnover Ratio = Comments. Companys position is sound from the point off view off (i) liquidity (ii) solvency and (iii) Profitability. However, its activity ratios do not seem to be adequate. Illustration 12.4 Calculate the following for the year 2006 and 2007 using figures made available: 2008
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(a) Return on Capital Employed (b) Current Ratio (c) Debt/Equity Ratio (d) Fixed Assets Turnover Ratio (e) Inventory Turnover Ratio (f) Earning Per Share and (g) Devided Cover. BALANCE SHEET as at 31st December
Liabilities Share Capital of Rs. 10 Each Reserves & Surplus Secured Term Loan Cash Credit from Banks Sundry Creditors 2005 800 700 800 800 1,200 2006 1,000 800 2,000 1,000 900 2007 1,000 1,000 2,400 1,500 1,100 Stock Debtors Other Current Assets Assets Fixed Assets Gross Block Less: Depreciation 2005 2,800 920 1,880 1,520 480 420 4,300 2006 3,000 1,400 1,600 2,,400 500 1,200 5,700 2007 4,000 2,000 2,000 2,800 900 1,300 7,000
4,300
5,700
7,000
EXTRACTS FROM PROFIT & LOSS ACCOUNT for the year ended 31st Dec. 2006 4,800 1,500 480 420 300 100
2006 (a) (b) (c) (d) (e) (f) Earnings available to (g)
( ( ) ( )
Sales Profit before Depreciation and Interest on Term Loans Depreciation Interest on terms Loans Tax Dividends Solution
(1)
(RS. in lakhs) 2007 7,200 2,400 600 600 600 150

2007
) )
(2) times (3)
Earnings available to
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Working Notes: 2005 (1) Capital Employed Total Assets Less: Current Liabilities Average Capital Employed (2) Fixed Assets (Net) Average : Fixed Assets (Net) (3) Earnings Available to Equity Shareholders Profit before Depreciation and Interest on Term Loans Less: Depreciation, Interest on Term Loans and Tax Illustration 12.5 From the following information, make out a statement of Proprietors Funds with as many details as possible. (i) (ii) (iii) (iv) (v) (vi) (vii) Solution Calculation of the Amount of Current Assets and Current Liabilities Current Assets Current Liabilities = Working Capital = = = Rs. 60,000 Rs. 60,000 Rs. Rs. 40,000 Current Ratio Liquid Ratio Proprietary Ratio (Fixed Assets/Proprietors Fund) Working Capital Reserve and Surplus Bank Overdraft There is no long-term loan of fictitious assets. 2.5 1.5 0.75 Rs. 60,000 Rs. 40,000 Rs. 10,000 4,300 2,000 2,300 1,880 (Rs. in lakhs) 2006 2007 5,700 1,900 3,800 3,050 1,600 1,740 7,000 2,600 4,400 4,100 2,000 1,800
1,500 1,200 300
2,400 1,800 600
Therefore, current liabilities are Rs. 40,000 (We are given the current ratio is 2.5 i.e., current assets are 2.5 times of current liabilities, So, we have taken current assets as 2.5x and current liabilities ass x).
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Current liabilities are Rs. 40,000; so current assets are Rs. 1,00,000 (i.e., 40,000x2.5) Bank overdraft is given to be Rs. 10,000; so liquid liabilities are Rs. 30,000 (i.e., Rs. 40,000 Rs. 10,000). Calculation of Closing Stock Liquid Ratio = 1.5 = Liquid Assets = Rs. 45,000 Stock = Current Assets Liquid Assets Stock = Rs. 1,00,000 Rs. 45,000 = Rs. 55,000. Calculation of the Amount of Proprietors Funds Proprietors Funds = Fixed Assets + Current Assets Outsiders Liabilities. or proprietors Funds = Fixed Assets + Current Assets Current Liabilities.
(Outsiders liabilities being only current liabilities because proprietary ratio is given to us as 0.75. = .25x = x = Rs. 1,00,000 Rs. 40,000 Rs. 60,000
So proprietors funds are Rs. 2,40,000. Reserves and surplus are given to us as Rs. 40,000; so capital is Rs. 2,00,000 (i.e. Rs. 2,40,000 Rs. 40,000). Fixed assets are .75 of proprietors funds. So fixed assets are Rs. 1,80,000 (i.e., Rs. 2,40,000 x .75)
STATEMENT OF PROPRIETORS FUNDS Rs. Proprietors Funds: Capital Reserves and Surplus Rs. 2,00,000 40,000 2,40,000 Represented by Fixed Assets Current Assets: Stock Liquid Assets Less: Current Liabilities: Rs.
1,80,000 Rs. 55,000 Rs.45,000 1,00,000
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Bank Overdraft Liquid Liabilities
Rs. 10,000 Rs. 30,000 40,000 60,000 2,40,000
Illustration 12.6 From the following information, prepare a summarized balance sheet as at March 31, 2008: Stock velocity 6 Fixed assets turnover ratio 4 Capital turnover ratio 2 Gross profit 20% Debt collection period 2 months Creditors payment period 73 days The gross profit was Rs. 60,000. Closing stock was Rs. 5,000 in excess of opening stock. Solution BALANCE SHEET As on 31st March, 2008 Liabilities Capital (3) Creditors (6) Rs. Assets 1,50,000 Fixed Assets (4) 49,000 Debtors (5) Stock (2) Cash & Bank (Balancing Figure) 1,99,000 Rs. 75,000 50,000 42,500 31,500 1,99,000
Working Notes: (1) Gross Profit at 20% of sales Sales Cos of Goods Sold (2) Stock Velocity Average Stock Closing Stock & Opening Stock Less: Excess Closing stock Hence Closing Stock = = = = = = Rs. 60,000 Rs. 60,000 = Rs. 3,00,000 Sales Gross Profit = Rs.; 3,00,000 Rs. 60,000 = Rs. 2,40,000 6 Rs. 40,000 2=Rs. 80,000 Rs. 5,000 Rs. 75,000
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(3) (4) (5) (6)
Capital turnover Ratio = Fixed Assets Turnover Ratio =
or Caital = Rs. 1,50,000
Fixed Assets = Rs. 75,000 Debt Collection Period = 2 months = Debtors = Sales Creditors Payment Period = 73 days Assuming all purchase are on credit basis Purchases = Cost of Goods Sold + Closing Stock Opening Stock = Rs. 2,40,000 + Rs. 42,500 Rs. 37,500 = Rs. 2,45,000 Creditors =
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CHAPTER-XIII
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Objectives: 1. To know the meaning of IFRS 2. To understand the difference of IFRS and GAAP
13.1 INTRODUCTION: International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries. They are progressively replacing the many different national accounting standards. The rules to be followed by accountants to maintain books of accounts which is comparable, understandable, reliable and relevant as per the users internal or external. International Financial Reporting Standards is a set of accounting standards developed by International Accounting Standard Board (IASB), based at London that is intended to be followed globally for preparation of corporate financial statements. 13.2 DEFINITION: International Financial Reporting Standards (IFRS) is a set of accounting standards, developed by the International Accounting Standards Board (IASB) that is becoming the global standard for the preparation of public company financial statements. 13.3 DIFFERENCE BETWEEN GAAP AND IFRS: Basis of difference Cost V/s Fair Value IFRS
Generally uses historical cost, but intangible assets, property, plant and equipment (PPE) and investment property may be measured at fair value. Derivatives, certain other financial instruments and biological assets must be revalued. Statement shows capital transactions with the owners, the movement in accumulated profit/loss and a reconciliation of all other components of equity.
GAAP
Uses historical cost, but Fixed Assets may be Revalued. Certain derivatives are carried at fair value. No Comprehensive guidance on derivatives and biological assets.
Statement of Changes in Equity (SoCIE)
No separate statement is required.
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Cash Flow Statements- Bank Bank Overdraft repayable on AS 3 Cash Flow Statements does demand is treated as Cash and not provide any guidance on Bank Overdraft
Cash Equivalents if they form an integral part of the entitys Cash Management There is no guidance for classifying cash flows arising due to Dividend & Interest. They may be classified as Operating, Financial or Investing
Cash Flow StatementsDividend/ Interest
Overdrafts. However, Bank overdraft are treated as Financing Activities as a normal practice Interest and Dividends paid are classified as cash flows from Financing Activities. Interest and Dividend received is classified as cash flows from Investing Activities. Only in case of a financial enterprise, interest paid, interest received and dividend received should be classified as operating Activities. Indian GAAP requires disclosure of such events in the report of the approving authority. It is not mandatory to prepare Consolidated Financial Statements under AS 21. SEBI requires From listed companies to submit Consolidated Statements. Banking Companies are also to prepare Consolidated Financial Statements.
Events after the Balance Sheet Date Non adjusting events Consolidated Financial Statements
IFRS requires disclosure of significant non adjusting event in the notes to the Financial Statements IFRS considers Consolidated Financial Statements as the General Purpose Financial Statements.
13.4 INTERNATIONAL FINANCIAL REPORTING STANDARDS: Accounting Standard IFRS 1 IFRS 2 IFRS 3 IFRS 4 IFRS 5 IFRS 6 IFRS 7 IFRS 8 IFRS 9 IFRS 10 IFRS 11 IFRS 12 IFRS 13 Name
First-time Adoption of International Financial Standards Share-based Payment Business Combinations Insurance Contracts Non-current Assets Held for Sale and Discontinued Operations Exploration for and Evaluation of Mineral Assets Financial Instruments: Disclosures Operating Segments Financial Instruments Consolidated Financial Statements Joint Arrangements Disclosure of Interests in Other Entities Fair Value Measurement
Issued 2008 2004 2008 2004 2004 2004 2005 2006 2010 2011 2011 2011 2011
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13.5 ADVANTAGES AND DISADVANTAGES OF IFRS: As the business world becomes closer in its financial and trade ties, many countries are moving towards International Financial Reporting Standards (IFRS), common accounting rules that define how transactions should be reported and what information should be disclosed in financial statements. This unitary set of standards has solved many problems while creating others. Greater Comparability Companies that use the same standards to prepare their financial statements can be compared to each other more accurately. This is especially important when comparing companies located in different countries, as they might otherwise be using different rules and methodologies to prepare their statements. This increase in comparability has helped investors better determine where their investment dollars should go. Not Globally Accepted The United States has not yet adopted International Financial Reporting Standards and other countries continue to hold out as well. This makes accounting by foreign-based companies that do business in America difficult as they often have to prepare financial statements using IFRS and another set using American Generally Accepted Accounting Principles. Manipulation There is a downside to the flexibility that IFRS allows: companies can utilize only the methods they wish to, allowing the financial statements to show only desired results. This can lead to revenue or profit manipulation, can be used to hide financial problems in the company and can even encourage fraud. For example, changing the method of inventory valuation can bring more income into the current year's profit and loss statement, making the company appear more profitable than it really is. While IFRS requires that changes to the application of the rules must be justifiable, it is often possible for companies to "invent" reasons for making the changes. Stricter rules would ensure that all companies are valuing their statements the same way. Cost A small company would be impacted by a country's adoption of IFRS in the same way a larger one would. However, small businesses do not have as many resources at their disposal to implement the changes and train staff. This results in smaller companies bringing in accountants or other outside consultants to help make the changeover. These smaller companies will bear more of a financial burden than larger ones in this area. 13.6 NEED FOR IFRS: The import need to be adopt IFRS is globalization of business and its international financial transactions. With the under mentioned reasons it can be better understanding of need of IFRS:
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1. Global Flow of Capital: Harmonization of accounting principles is necessity for getting enhanced flow of international capital. As such flow of capital investments across nations is both a fact and a necessity. The flow however gets checked owing to international diversity in accounting practices. Harmonization of accounting practices is therefore needed to help international investors get comparable financial information. with the help of IFRS there would not be misunderstanding of study of financial statements. 2. Emergence of MNC,s: Different countries follow different set of accounting rules for presentation of financial reports and as such MNC,s operating in different countries have to prepare multiple sets of its financial reports to meet the legal requirements of each individual country in which they are operating. With IFRS this problem can be solved. 3. Internationalization of Accounting profession: Harmonization of accounting practices will help in internationalizing the accounting profession . As harmonization aims at reducing the disparities in accounting practices across nations, accounting professionals operating in one nation will find it easy to operate in another nation as well. 4. Administrative Requirement: Different countries have different regulatory and administrative requirements as regards financial reporting of MNC,s. For example U.S. foreign firms are required to furnish financial information in line with the domestic firms and in accordance with the U.S. GAAP. Consequently, non U.S. firms will have to translate and reconciles their financial reports as per the U.S. accounting practices so that not only such translations would be avoided but also government and regulatory authorities would be in a better position to understand the financial reports of MNC,s and control their operations.
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CHAPTER-IV
HUMAN RESOURSE ACCOUNTING

Objectives: 1. To know the meaning of Human Resource Accounting. 2. To understand the various approaches of Human resource accounting.
14.1 INTRODUCTION:
Human resource Accounting is the process of identifying and reporting the Investments made in the Human Resources of an Organization that are presently not accounted for in the conventional accounting practices. In simple terms, it is an extension of the Accounting Principles of matching the costs and revenues and of organizing data to communicate relevant information in financial terms. 14.2 IMPORTANCE OF HUMAN RESOURCE ACCOUNTING: Human Resource Accounting provides useful information to the management, financial analysts and employees as stated below:1. Human Resource Accounting helps the management in Employment and utilization of Human Resources. 2. It helps in deciding transfers, promotion, training and retrenchment of human resources 3. It provides a basis for the planning of physical assets vis-a-vis human resources 4. It helps in evaluating the expenditure incurred for imparting further education and training of employees in terms of the benefits derived by the firm. 5. It helps to identify the causes of high labour turnover at various levels and taking preventive measures to contain it. 6. It helps in locating the real cause for low return on investment, like improper or underutilization of physical assets or human resources or both 7. It helps in understanding and assessing the inner strength of an organization and helps the management to steer the company well through the most averse and unfavorable circumstances. 8. It provides valuable information for persons interested in making long term investments in the firm. 9. It helps the employees in improving their performance and bargaining power. It makes each employee understand his contribution towards the betterment of the firm vis-a-vis the expenditure incurred by the firm on him.
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14.3 OBJECTIVES OF HUMAN RESOURCE ACCOUNTING: 1. To furnish cost value information for making proper and effective management decisions about acquiring, allocating developing and maintaining human resources in order to achieve cost effective organizational objectives. 2. To monitor effectively the use of human resources by the management. 3. To have an analysis of the Human Asset, i.e. whether such assets are conserved, depleted or appreciated. 4. To aid in the development of management principles and proper decision making for the future by classifying financial consequences of various practices. 14.4 LIMITATIONS OF HUMAN RESOURCE ACCOUNTING Human Resource Accounting is the accounting methods, systems, and techniques, which coupled with special knowledge and ability, assist personnel management in the valuation of personnel in their knowledge, ability and motivation in the same organization as well as from organization to organization. It means that some employees become a liability instead of becoming a human resource. HRA facilitates decision making about the personnel i.e. either to keep or to dispense with their services or to provide training. There are many limitations which make the management reluctant to introduce HRA. Some of the Attributes are:1. There is no proper clear cut and specific procedure or guidelines for finding costs and value of human resources of an organization. The systems which are being adopted have certain drawbacks. 2. The period of existence of Human Resource is uncertain and hence valuing them under uncertainty in future seems to be unrealistic. 3. The much needed empirical evidence is yet to be found to support the hypothesis that HRA as a tool of management facilitates better and effective management of human Resources. 4. As human resources are incapable of being owned, retained, and utilized, unlike the physical assets, there is a problem for the management to treat them as assets in the strict sense. 5. There is a constant fear of opposition from the trade unions as placing a value on employees would make them claim rewards and compensations based on such valuations. 6. In spite of all its significance and necessity, the Tax Laws dont recognize human beings as assets. 7. There is no universally accepted method of the valuation of Human Resources. 14.5 APPROACHES OF HUMAN RESOURCE ACCOUNTING:
(i) (ii) (iii)
Historical Cost Approach Replacement Cost Approach Opportunity Cost Approach
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(I) HISTORICAL COST APPROACH: The actual cost incurred on recruiting, training, placing and developing the human resources of an enterprise are capitalized and written off over the expected useful life of human resources. Any amount spent on training and developing human increases its efficiency, capitalized. the amortization of human resource assets is done in the way as that of other physical assets. If the asset is liquidated prematurely then its underwritten off amount is charged to revenue account. On the other hand, if it has a longer life than expected, its amortization is rescheduled. MERITS OF HCA: Simple to understand and easy to work out. Traditional accounting concept of matching cost with revenue is followed. Help a firm in finding out a return on human resource investment LIMITATIONS OF HCA: Very difficult to estimate the number of years an employee will be with the firm. Difficult to determine the extent to which an employee will utilize the knowledge acquired. Difficult to fix a rate of amortization Difficult to measure the contribution of each person. (II) REPLACEMENT COST APPROACH: The cost of replacing employees is used as the measure of companys human resources. The human resources of a company are to be valued on the assumption as to what it will cost the concern if existing human resources are required to be replaced with other persons of equivalent experience and talent. In this the cost of recruiting, selecting, training, etc. of new employees to reach the level of Competence of existing employees is measured. MERITS OF RCA: It has the advantage of adjusting the human value of price trends in the economy and thereby provides more realistic value in inflationary times. It has the advantage of present-oriented. LIMITATIONS OF RCA: May not always be possible to obtain such a measure for a particular employee. Not always possible to find out the exact replacement of an employee. Difficult to find out the cost of replacing human resources and different persons may arrive at different estimates.
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(III) OPPORTUNITY COST APPROACH: It is based on economic concept of opportunity cost which removes the deficiency in replacement cost approach. Measured through a competitive bidding process within the entity. STEPS-: The entity is divided into investment centers. The investment centre managers bid for scarce employees they need within the entity. The maximum bid price may be obtained by the capitalization of the excess profits generated by the employee. FOR INSTANCE Let us assume that a firm has a capital base of Rs.15,00,000 and it earned profits of Rs.2,10,000.The required rate of return is 15%.If the services of a particular manager are acquired, it is expected that the profit will rise by Rs.45000 over and above the target profits. If we capitalize Rs.45000 at 15% rate of return, it works to be Rs.3,00,000 (45000*100/15).The firm may bid up to Rs.3lakhs for the manager. The new capital base shall be Rs.18,00,000 (15lakhs+3lakhs). 15% of Rs.18,00,000 is Rs.2,70,000.Thus the excess profit earned shall be Rs.60,000(2,70,000-2,10,000) and the maximum bid may go up to the capitalized value of Rs.60,000,the excess profit to be generated by the manager; i.e. Rs.60,000*100/15= Rs.4,00,000. LIMITATIONS OF OCA: The total valuation of human resource on the competitive bid price may be misleading and inaccurate. A person may be valuable person for the department in which he is working and may have a lower price in the bid by other departments. Only scarce employees are included and as a result unscarred employees may lose their morale as they are not counted. It would be difficult to identify the alternative use of an employee in the organization.
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2005 Accounting for Managers Paper CP - 106
Note: Attempt FIVE questions in all. Question No. 1 is compulsory.
1.
Short answer questions: (a) Describe Money measurement concept. (b) Factors affecting the amount of depreciation. (c) Concept of Opportunity cost. (d) Assumptions of Break Even Analysis (e) Concept of zero base budgeting. (f) Meaning of list sheet. (g) Cash break even chart.
2.
What is accounting? What should it be studied by the students of business management? Discuss the limitation of financial accounting. Write a note on balance sheet of joint stock companies and also discuss the related provisions of the company law, 1956. Define budget, budgeting and budgetary control. Discuss the salient features of a budget. Also explain the various types of budgets. Financial accounting procedures are generally designed to ascertain the periodic profit or loss but there are important limitations and deficiencies in this system. Discuss and indicate how management accounting overcomes these limitations. Explain the meaning, procedure to compute and utility of the followings: (a) Acid Test Ratio (b) Inventory Turnover Ratio (c) Operating Ratio (d) Return on Investment (ROI).
3.
4.
5.
6.
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7.
From the following information, calculate material variances: STANDARD

Quality (Kgs) Price Rs. Total Rs.
ACTUAL
Quantity (Kgs) Unit Price Rs. Total Price Rs.
Material A Material B Material C Standard output Actual output 8.
4 2 2 8 : :
1.00 2.00 4.00 16 units 14 units
4.00 4.00 8.00 16.00
2 1 3 6
3.50 2.00 3.00
7.00 2.00 9.00 18.00
Write the help of imaginary figures, show the computation of the following:(a) Funds from operations (b) Statement of changes in Working Capital
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Note: Attempt FIVE questions in all. Question No. 1 is compulsory. 1. Short answer questions: (a) (b) (c) (d) (e) (f) (g) 2. 3. 4. What is separate entity concept? What is price-earnings ratio? What is zero-base budgeting? State the importance of according standards. What is accounting equation? What is dividend yield? What is difference between fixed cost and sunk cost?
What is Financial Accounting? Bring out its importance and limitations. Explain the different ways in which costs can be classified. What do you mean by Budget and Budgetary Control ? Explain the essential prerequisites of successful Budgetary Control System. What is Depreciation? Why should be provided? Explain various methods of providing depreciation. What is Cash Flow Statement? Discuss how it is prepared according to AS-3 (revised). Company budgets a production of 5,00,000 units at a variable cost of Rs. 20 each. The fixed costs are Rs. 20,00,000. The selling price is fixed to yield 35% on cost. You are required to calculate: (a) (b) (c) (d) P/V ratio Break-even point if selling price is reduced by 20% Find the effect of the price reduction on the break-even point and P/V ratio. The number of units required to be sold at the reduced selling price to obtain an increase of 20% over the budgeted profit.
5.
6. 7.
8.
Ganpati Ltd. Produces an article by blending the basic raw materials. It operates a standard costing and the following standards have been set for raw materials: Material A B Standard Mix 40% 60% Standard Price Per Kg Rs. 4 Rs. 3
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The standard loss in processing is 15%. During April 2006, the company produced 1700Kgs of finished output. The position of stock for the month of April 2006 is as under: Material Stock on Stock on Purchase during the month 01.04.2006 30.04.2006 Kg Cost in Rs. 800 3400 1200 3000
A B
35 40
5 50
Analysis material variances.
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Note: Attempt FIVE questions in all. Question No. 1 is compulsory. All questions carry equal marks. 1. Short Answers questions: (i) (ii) (iii) (iv) (v) (vi) (vii) 2. 3. Accounting Cycle Concept of Performance Budgeting Convention of Conservatism Need of Accounting Standards Estimated Cost and Standard Cost Break Even Point Cost Sheet and Cost Statement.
What do you mean by Financial Accounting? Explain its nature and limitations. Define and distinguish between the following: (a) (b) Management Accounting and Cost Accounting. Marginal Costing and Absorption Costing.
4. 5.
Give the specimen of Balance Sheet of Joint Stock Company. Define Budget, Budgeting and Budgetary Control. What factors should be considered for preparing the budget in a business organization? Define Funds Flow Statement. How does it differ from Cash flow Statement? Explain the procedure of preparing the funds Flow Statement. Define Standard Costing. How dies it differ from Budgetary Control? Discuss the preliminary steps for establishing a standard costing system in a business organization. Explain and illustrate the following: (a) (b) (c) (d) Current ratio Debtors Turnover Ratio Debt Equity Ratio Debt Service Ratio
6.
7.
8.
110

Note: Attempt FIVE questions in all. Question No. 1 is compulsory. All questions carry equal marks. 1. Define the following: (a) (b) (c) (d) (e) (f) (g) 2. Accounting Standard Cost Sheet Ratio Standard Cost Funds Flow Statement Cost Centre Marginal Cost.
Why are accounting concepts and conventions required? Is there a conflict between the two? What do you mean by a posting? How is posting made from the journal in the Ledgers? Explain with suitable examples. Cost may be classified in a variety of ways according to their nature and the information needs of management. Explain and discuss this statement giving examples of classifications required for different purposes. From the following information relating to Jain Co. Ltd., prepare a Balance Sheet as on 31st March, 2009: Current Rato Liquid Ratio Ne Working Capital Cost of Sales/Closing Stock Gross Profit Ratio Average Debt Cllection Period Fixed Assets/ Shareholders Net Worth Reserve and Surplus/Share Capital 2.5 1.5 Rs. 3,00,000 8 times 20% 1.5 months 0.75 0.50
3.
4.
5.
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6.
What is the purpose of preparing a Cash Flow Statement? How is it prepared? Explain and Illustrate. Define Flexible Budget. How is it drawn up and what difficulties would you expect to face in its compilation? A firm can purchase a separate part from an outside source @ Rs. 11 per unit. There is a proposal tat the spare part be produced in the factory itself. For this purpose a machine costing Rs. 1,00,000 with annual capacity of 20,000 units and a life of 10 years will be required. A foreman with a monthly salary of Rs. 500 will have to be engaged. Materials required will be Rs. 4.00 per unit and wages Rs. 2.00 per unit. Variable overheads are 150% of direct labour. The firm can easily raise funds @ 10%p.a. Advise the firm whether the proposal should be accepted.
7.
8.
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Note: Attempt FIVE questions in all. Question No. 1 is compulsory. All questions carry equal marks. 1. (a) (b) (c) (d) (e) (f) (g) (h) 2. (h) (a) (b) (c) 3. Define the following: Accounting Entity Cost Accounting Liquidity and solvency Financial statements Cost Sheet Absorption costing Fixed and variable cost Fund flow statement Explain the following; Money measurement concept Accrual concept Realization concept Cost concept What is depreciation? Why is it provided? Discuss any three methods of charging depreciation? Write notes on: a) Usefulness of cost accounting b) Accounting standards Why fund flow statement is prepared ? how is it prepared ? explain and illustrate? What is meant by profit and profitability? Explain the various profitability ratio? Mr. X has Rs. 2,00,000 invested in his business. He wants a 15% return on his money. From an analysis of recent cost figures, he finds that his variable cost of operating is 60% of sales, his fixed costs are Rs. 80,000 p.a. Show supporting computations for each of the following:
4.
5. 6. 7.
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(i)What Sales-Volume must be obtained to break-even? (ii)What Sales-Volume must be obtained to get his 15% return on investment? (iii)Mr. X estimates that even if the closed the doors of his business, he would incur Rs. 25,000 expense per year. 8. The standard cost of a chemical mixture is 40% material A at Rs 20 per kg. 60% of material B at Rs. 30 per kg. A Standard loss of 10% is expected in production . During a period, the usage of material was: 90 kg of material A at a cost of Rs. 18 per kg . 110 kg of material B at a cost of rs. 24 per kg. The weight produced was 182 kg of good product. Calculate all material variances and comment.
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Department of Business Management

Geeta Institute of Management & Technology MODEL TEST PAPER Financial Accounting (2012)(CP-106)
Note: The Examiner will set the question paper in two parts encompassing the entire syllabus. Part A will comprise 10 short answer type questions of 5 marks each. Part B will comprise of 5 questions of 10 marks each. A student is required to attempt any eight questions from the part A and any 3 questions from part B.
Section A
Q1 Q2 Q3.
What is accounting? What are the various limitations and usefulness of accounting? What is cost? Classify the cost and elements of cost? Note on following: (i) Zero base budget (ii) Performance budget (iii) Cash Budget (iii) Fixed and flexible budget
Q4 Q5 Q6 Q7.
What is budget? What are the various types of budget? What is budgetary control? What are the objects of budgetary control? What are the various requisites of an effective budgetary control? Note: (i) (ii) (iii) (iv) (v) Break even analysis Cost Sheet Cash Break even Point M/O/S P/V Ratio
Q8. Q9. Q10.
What is cost? How it can be classified? Write a note on importance of accounting standards? Note : (i) (ii) (iii) Liquidity ratio Solvency ratio Profitability ratio
115
Q11. (i) (ii) (iii) Note: IFRS Tally GAAP
Q12 a). Distinguish c) d) e) f) g) h)
Marginal and absorption costing
Distinguish Standard costing and budgetary control Distinguish marginal costing and Absorption costing Distinguish journal and ledger Distinguish ledger and trial balance Distinguish cash and accrual basis Distinguish between single entry and double entry system
Q13. Explain the rules of recording transactions? Q14. What is Marginal costing? What are the various applications of marginal costing? Q15. What are standards costing? Explain the merits and demerits of standard costing? Q16. What is inflation accounting? Explain the advantages and disadvantages of inflation accounting? Q17. What is Human Resource Accounting? Explain the merits and demerits of HRA? Q18. Explain the methods of HRA and Inflation accounting? Section B Q1. Q2. Q3. What are the various accounting concepts and conventions? Prepare the Performa of balance sheet of joint stock Company with imaginary figures? What is cost accounting? What are the objectives, advantages and limitations of cost accounting? Distinguish between financial accounting and cost accounting? Q4. Q5. Q6. Period I II Sales 20 lac 25 lac Profit 2 lac 3 lac What is cash flow statement? How the cash flow statement is prepared with imaginary figures? What is fund flow statement? How the fund flow statement is prepared with imaginary figures?
Calculate following: (i) P/V ratio (ii) Fixed cost (iii) B.E.P. (iv) M/O/S (v) Sales at a profit of Rs 5 lacs
116
Q7. 10 units of finish products are obtained from the mix and 10 mixes were completed. SQ X Y 60 80 100 Z Total 240 2440 SP .15 .20 .25 AQ 640 960 840 AP .20 .15 .30
Actual production was 90 units. Calculate material variances. Q8 . Following information is given: Production units Variable cost Fixed cost S.P 5,00,000 20/- per unit 20,00,000 25% on cost
(i) (ii) (iii) (iv) (v)
P/V Ratio B.E.P. B.E.P if S.P. is reduced by 20% on sale Effect on B.E.P and P/V ratio Number of units to be sold at reduced selling price to obtain an increase of 20% on budgeted profit.
Q9
.The standard mix and actual mix of a product is given, Calculate material variances. Material A B C Total Yield SQ 4 kg 2 kg 2 kg 8kg 16 Units SP 1 2 4 SC 4 4 8 16 AQ 2 kg 1 kg 3 kg 6 kg 14 units AP 3.5 2 3 AC 7 2 9 18
Q10 .Calculate B.E.P at merged plant capacity and profitability at 75 % of merged plant .
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Plant I Capacity Sales Variable cost Fixed cost 100% 300 Lacs 200 Lacs 30 Lacs Plant II 60% 120 Lacs 60 Lacs 20 Lacs
Q11.
Mr. X has Rs. 1,50,000 invested in his business. He wants a 15% return on his money. From an analysis of recent cost figures, he finds that his variable cost of operating is 60% of sales, his fixed costs are Rs. 75,000 p.a. Show supporting computations for each of the following:
(a) What Sales-Volume must be obtained to break-even? (b) What Sales-Volume must be obtained to get his 15% return on investment? (c) Mr. X estimates that even if the closed the doors of his business; he would incur Rs. 25,000 expense per year.
Q12. Note: (i) (ii) Responsibility accounting Human resource accounting
Q13.
What is Inflation Accounting? What is the impact of inflation on corporate financial statements?
Q14.
The ABC companys financial statements contain the following information. 31-03-2007 Rs. 6,40,000 16,00,000 20,00,000 4,68,000 31-03-2008 Rs. 8,00,000 16,00,000 20,00,000 8,12,000 31-03-2007 Rs. 2,00,000 3,20,000 2,00,000 18,40,000 28,000 25,88,000 56,00,000 31-03-2008 Rs. 1,60,000 4,00,000 3,20,000 21,60,000 12,000 30,52,000 64,00,000
Current Liabilities 10% Debentures Equity Share Capital Retained Earnings
Cash Sundry Debtors Temporary Investments Stock Prepaid Expenses Total Current Assets Total Assets
STATEMENT OF PROFIT for the year ended 31st March, 2008 Sales Cost of goods sold Interest Rs. 28,00,000 1,60,000 Rs. 40,00,000 29,60,000
Less: Less:
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Net Profit for 2007-08 Taxes @ 50% Net Profit after taxes 10,40,000 5,20,000 5,20,000
Less:
Divided declared on equity shares Rs. 2,20,000. From the above figures, appraise the financial position of the company from the point of view of (i) liquidity; (ii) solvency ; (iii) profitability; and (iv) activity. Q15. Calculate the following for the year 2006 and 2007 using figures made available:
(b) Return on Capital Employed (b) Current Ratio (c) Debt/Equity Ratio (d) Fixed Assets Turnover Ratio (e) Inventory Turnover Ratio (f) Earning Per Share and (g) Devided Cover.
BALANCE SHEET as at 31st December Liabilities Share Capital of Rs. 10 Each Reserves & Surplus Secured Term Loan Cash Credit from Banks Sundry Creditors 2005 800 700 800 800 1,200 2006 1,000 800 2,000 1,000 900 2007 1,000 1,000 2,400 1,500 1,100 Stock Debtors Other Current Assets Assets Fixed Assets Gross Block Less: Depreciation 2005 2,800 920 1,880 1,520 480 420 2006 3,000 1,400 1,600 2,,400 500 1,200 5,700 2007 4,000 2,000 2,000 2,800 900 1,300 7,000
4,300
5,700 7,000 4,300 EXTRACTS FROM PROFIT & LOSS ACCOUNT for the year ended 31st Dec.
Sales Profit before Depreciation Interest on Term Loans Depreciation Interest on terms Loans Tax Dividends
and
2006 4,800 1,500 480 420 300 100
(RS. in lakhs) 2007 7,200 2,400 600 600 600 150
Q16.
From the following information, prepare a summarized balance sheet as at March 31, 2008: 6 4 2
Stock velocity Fixed assets turnover ratio Capital turnover ratio
119
Gross profit Debt collection period Creditors payment period The gross profit was Rs. 60,000. Closing stock was Rs. 5,000 in excess of opening stock. 20% 2 months 73 days
Q17. From the following information, make out a statement of Proprietors Funds with as many details as possible. (i) (ii) (iii) (iv) (v) (vi) (vii) Current Ratio Liquid Ratio Proprietary Ratio (Fixed Assets/Proprietors Fund) Working Capital Reserve and Surplus Bank Overdraft There is no long-term loan of fictitious assets. 2.5 1.5 0.75 Rs. 60,000 Rs. 40,000 Rs. 10,000
120
REFERENCES
1. Dr. R.K. Mittal, Corporate Accounting, V.K. Publications, 2005. 2. Dr. R.K. Mittal Management Accounting and Financial Management, V.K. Publications, 2005. 3. Jain & Narang, Accounting for Managers, Kalyani Publications, 2009 4. J.H. Ghosh Rai, Accounting for Managers, V.E.I, 2009 5. Maheshwari & Maheshwari , Accounting for Managers Vikas publications,2008 6. Shashi K. Gupta Management Accounting, Kalyani Publication;2008 7. J. Made Gowda Accounting for managers, Himalaya publications,2007 8. Gupta & Kothari, Accounting for Managers, Frank Bros. & Co., 2005 9. Khan & Jain, Management Accounting, Tata Mc-Graw-Hill Publishing Co. Ltd., 2007 10. M. M. Arora, Accounting for Managers, Himalya Publications, 2010

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Financial Acccounting MBA KUK

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FINANCIAL ACCOUNTING

Lalit Wadhwa Asstt. Prof. In Management

MBA 1st Semester, Kurukshetra University

SYLLABUS FINANCIAL ACCOUNTING CP-106

6.2 6.3 6.4 6.5 6.6

Profitability Ratio based of investment 97 100

105 113 114 119 120

CHAPTER I FINANCIAL ACCOUNTING

Accounting process / Accounting Cycle

Book-keeping and Accounting

Difference between Book-keeping and Accounting

Adjustments and Rectification of errors Scope Final Accounts

Accounting as Information System

Input Business Transactions (Purchase, Sales, Exp. Income)

Process Recording Classifying, Analysing

Users of Accounting Information User with direct financial stake

Shareholders Debenture holders Lender

Press General Public

Debit the Receiver

Credit the Giver

Debit what comes in

Credit what Goes Out

Debit Expenses and Losses

Credit Incomes and Gains

CHAPTER II ACCOUNTNG PRINCIPLES

CHAPTER III FINAL ACCOUNTS OF JOINT STOCK COMPANY

CHAPTER V COST ACCOUNTING

(iii) (iv) (v)

In Cost Accounting stock is valued at cost only.

In Cost Accounting break even charts are used.

6. Product wise cost

CHAPTER VI STANDARD COSTING

Relationship Variance Analysis

Variances 1.Material variances 2. Labour variances

Material cost variance

Solution Material usage variance : (SQ-AQ)SP X (110-120)5=-50 Y(120-130)4=-40

Material price variance

(SP-AP)AQ X(5-4)120=120 Y(4-3)130=130

Material cost variance

SQ.SP-AQ.AP X(110.5-1204)=70 Y(1204-1303)=90

Material cost variance

SQ.SP-AQ.AP X(3.51-23.5)=-3.5 Y(1.752-12)=1.5 Z(1.754-33)=-2

Material mix variance

Now SM AM So, mix variance will be

Material Yield variance

(AY-SY)SC per unit (14-16/86)16/16 (14- 26)1=2

Labour Efficiency Variance:(ST-AT) SR Skilled (40-50) 5 = Unskilled (60 50) 4 = 40

Labour Rate Variance: (SR-AR)AT Skilled (5 4 ) 50 = Unskilled (4 3) 50 = 50

Labour Cost: STSR-ATAR Skilled (40 x 5) (50x4) = 0 Unskilled (60 x 4) - (50x3) = 90

Labour mix variance: SM = AM (ST-AT) SR Skilled (40-50) 5 = -50 Unskilled (60-50) 4 = 40

Labour Efficiency Variance:(ST-AT) SR Skilled (40-50) 5 = Unskilled (60 55) 4 = 20

Labour Rate Variance: (SR-AR)AT Skilled (5 4 ) 50 = Unskilled (4 3) 55 = 55

Labour mix variance: SM AM

(RST AT) SR Skilled ( Unskilled ( 5. ) ) ( ( ) )

2. Labour mix variance + Labour Revised efficiency = labour efficiency variance

Labour Efficiency Variance:(ST-AT) SR Skilled ( Unskilled ( ) ) ( ( ) )

Labour Rate Variance: (SR-AR)AT Skilled (5 4 ) 50 = Unskilled (4 3) 50 = 50

Labour mix variance: SM AM

Skilled (40 50) 5 = ) Unskilled ( 5. Labour yield Variance (AY SY) SC ( ( ) )

2. Labour mix variance + Labour yuield variance = labour efficiency variance

Labour Efficiency Variance:(ST-AT) SR Skilled ( Unskilled ( ) ) ( ( ) )

Labour Rate Variance: (SR-AR)AT Skilled (5 4 ) 50 = Unskilled (4 3) 55 = 55

Labour mix variance: SM AM