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CLASSIFICATION OF COSTS: Manufacturing We first classify costs according to the three elements of cost: a) Materials b) Labour c) Expenses Product and Period Costs: We also classify costs as either Product costs: the costs of manufacturing our products! or " Period costs: these are the costs other than product costs that are charged to# debited to# or written off to the income statement each period. $he classification of Product Costs: %irect costs: %irect costs are generally seen to be &ariable costs and they are called direct costs because they are directly associated with manufacturing. 'n turn# the direct costs can include: %irect materials: plywood# wooden battens# fabric for the seat and the bac(# nails# screws# glue. %irect labour: sawyers# drillers# assemblers# painters# polishers# upholsterers %irect expense: this is a strange cost that many texts don)t include! but *'nternational +ccounting ,tandard) '+, "# for example# includes it. %irect expenses can include the costs of special designs for one batch# or run# of a particular set of tables and-or chairs# the cost of buying or hiring special machinery to ma(e a limited edition of a set of chairs.

$otal direct costs are collecti&ely (nown as Prime Costs and we can see that Product Costs are the sum of Prime costs and .&erheads. 'ndirect Costs: 'ndirect costs are those costs that are incurred in the factory but that cannot be directly associate with manufacture. +gain these costs are classified according to the three elements of cost# materials labour and o&erheads. 'ndirect materials: ,ome costs that we ha&e included as direct materials would be included here. 'ndirect labour: Labour costs of people who are only indirectly associated with manufacture: management of a department or area# super&isors# cleaners# maintenance and repair technicians 'ndirect expenses: $he list in this section could be infinitely long if we were to try to include e&ery possible indirect cost. Essentially# if a cost is a factory cost and it has not been included in any of the other sections# it has to be an indirect expense. /ere are some examples include: %epreciation of e0uipment# machinery# &ehicles# buildings Electricity# water# telephone# rent# Council $ax# insurance
narayan. $otal indirect costs are collecti&ely (nown as .&erheads. 2inally# within Product Costs# we ha&e Con&ersion Costs: these are the costs incurred in the factory that are incurred in the con&ersion of materials into finished goods. $he classification of Period Costs:


$he scheme shows fi&e sub classifications for Period Costs. When we loo( at different organisations# we find that they ha&e period costs that might ha&e sub classifications with entirely different names. 3nfortunately# this is the nature of the classification of period costs! it can &ary so much according to the organisation# the industry and so on. 4e&ertheless# such a scheme is useful in that it gi&es us the basic ideas to wor( on. +dministration Costs: Literally the costs of running the administrati&e aspects of an organisation. +dministration costs will include salaries# rent# Council $ax# electricity# water# telephone# depreciation# a potentially infinitely long list. 4otice that there are costs here such as rent# Council $ax# that appear in se&eral sub classifications! in such cases# it should be clear that we are paying rent on buildings# for example# that we use for manufacturing and storage and administration and each area of the business must pay for its share of the total cost under re&iew. Without wishing to o&erly extend this listing now# we can conclude this discussion by saying that the costs of ,elling# the costs of %istribution and the costs of 5esearch are all accumulated in a similar way to the way in which +dministration Costs are accumulated. Conse0uently# our tas( is to loo( at the selling process and classify the costs of running that process accordingly: ad&ertising# mar(et research# salaries# bonuses# electricity# and so on. $he same applies to all other classifications of period costs that we might use. 2inance Costs: 2inance costs are those costs associated with pro&iding the permanent# long term and short term finance. $hat is# within the section headed finance costs we will find di&idends# interest on long term loans and interest on short term loans. 2inally# we should say that we can add any number of subclassifications to our scheme if we need to do that to clarify the ways in which our organisation operates. We will also add further subclassifications if we need to refine and further refine out cost analysis.

COST SHEET FORMAT Particulars .pening ,toc( of 5aw Material +dd: Purchase of 5aw materials +dd: Purchase Expenses Less: Closing stoc( of 5aw Materials

+mount +mount 666 666 666 666 5aw Materials Consumed %irect Wages *Labour) %irect Charges Prime cost * ) +dd :7 2actory .&er /eads: 2actory 5ent 2actory Power 'ndirect Material 'ndirect Wages ,uper&isor ,alary %rawing .ffice ,alary 2actory 'nsurance 2actory +sset %epreciation Wor(s cost 'ncurred +dd: .pening ,toc( of W'P Less: Closing ,toc( of W'P Wor(s cost *") +dd:7 +dministration .&er /eads:7 .ffice 5ent +sset %epreciation 8eneral Charges +udit 2ees 9an( Charges Counting house ,alary .ther .ffice Expenses Cost of Production *:) +dd: .pening stoc( of 2inished 8oods Less: Closing stoc( of 2inished 8oods Cost of 8oods ,old +dd:7 ,elling and %istribution ./:7 ,ales man Commission ,ales man salary $ra&eling Expenses +d&ertisement %eli&ery man expenses ,ales $ax 9ad %ebts Cost of ,ales *;) Profit *balancing figure) ,ales 4otes:7 ) 2actory .&er /eads are reco&ered as a percentage of direct wages

: 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 666 ") +dministration .&er /eads# ,elling and %istribution .&erheads are reco&ered as a percentage of wor(s cost.

MATERIAL ) 5eorder le&el < Maximum usage 6 Maximum lead time *.r) Minimum le&el = *+&erage usage 6 +&erage Lead time) ") Minimum le&el < 5eorder le&el > *+&erage usage 6 +&erage lead time) :) Maximum le&el < 5eorder le&el = 5eorder 0uantity > *Minimum usage 6
narayan. Minimum lead time) ?) +&erage le&el < Minimum le&el =Maximum le&el " Minimum le&el = @ 5eorder 0uantity *or)

;) %anger le&el *or) safety stoc( le&el <Minimum usage 6 Minimum lead time *preferred) *or) +&erage usage 6 +&erage lead time *or) +&erage usage 6 Lead time for emergency purposes A) E.B *Economic .rder Buantity 7 WilsonCs 2ormula) < D"+.-C Where + < +nnual usage units . < .rdering cost per unit C < +nnual carrying cost of one unit i.e. Carrying cast E 6 Carrying cost of unit F) +ssociated cost < 9uying cost pa = Carrying cost pa G) 3nder E.B 9uying cost < Carrying cost H) Carrying Cost < +&erage in&entory 6 Carrying cost per unit pa 6 Carrying cost E *.r) +&erage 'n&entory 6 Carrying cost per order pa I) +&erage in&entory < E.B-" ) 9uying cost < 4umber of .rders 6 ordering cost ") 4umber of .rders < +nnual %emand - E.B :) 'n&entory $urno&er *$..) 5atio < Material consumed +&erage 'n&entory ?) 'n&entory $.. Period < :A; . 'n&entory $urn o&er 5atio ;) safety stoc( < +nnual %emand 6*Maximum lead time 7 +&erage lead time) :A; A) $otal 'n&entory cost < .rdering cost = Carrying cost of in&entory =Purchase cost F) 'nput .utput 5atio < Buantity of input of material to production ,tandard material content of actual output 5emar(s :7
narayan. ) /igh 'n&entory $.. 5atio indicates that the material in the 0uestion is fast mo&ing ") Low 'n&entory $.. 5atio indicates o&er in&estment and loc(ing up of wor(ing Capital in in&entories Pricing of material 'ssues:7 ) Cost price method:7 a) ,pecific price method b) 2irst in 2irst .ut method *2'2.) c) Last in 2irst .ut method *L'2.) d) 9ase stoc( method ") +&erage price method:7 a) ,imple a&erage price method < b) Weighted a&erage price method < $otal unit price $otal 4o. of purchases $otal cost $otal 4o. of units

c) Periodic simple a&erage price method < $otal unit price of certain period $otal 4umber of purchases of that period *$his rate is used for all issues for that period. Period means a month *or) wee( *or) year) d) Periodic weighted a&erage price method < $otal cost of certain period $otal 4umber of units of that period e) Mo&ing simple a&erage price method < $otal of periodic simple a&erage of certain number of periods 4umber of periods

f) Mo&ing weighted a&erage price method < $otal of periodic weighted a&erage of certain number of periods 4umber of periods :) Mar(et price method:7 a) 5eplacement price method < 'ssues are &alued as if it was purchased now at current mar(et price b) 5ealiJable price method < 'ssues are &alued at price if it is sold now ?) 4otional price method:7
narayan. a) ,tandard price method < Materials are priced at pre determined rate *or) ,tandard rate b) 'nflated price method < $he issue price is inflated to co&er the losses incurred due to natural*or)climatic losses ;) 5e use price method < When materials are returned *or) reKected it is &alued at different price. $here is no final procedure for this method. +9C +nalysis *or) Pareto +nalysis :7 'n this materials are categoriJed into Particulars M+N > 'mportant material M9N > 4either important nor unimportant MCN > 34 'mportant 4ote:7 ) Material recei&ed as replacement from supplier is treated as fresh supply ") 'f any material is returned from %epartment after issue# it has to be first disposed in the next issue of material :) loss in the boo( balance of stoc( and actual is to be transferred to 'n&entory adKustment a-c and from there if the loss is normal it is transferred to .&er /ead control a-c. 'f it is abnormal it is transferred to costing profit and loss a-c. ?) C'2 < Cost 'nsurance and 2reight *$his consignment is inclusi&e of prepaid insurance and freight) ;) 2.9 < 2ree on 9oard *Materials mo&ing by sea > insurance premium is not paid) A) 2.5 < 2ree on 5ail *'nsurance and freight is not borne by the supplier but paid by the company or purchase) F) 2or each receipt of goods < 8oods 5eceipt note G) 2or each issue of goods < Materials 5e0uisition note *or) Material 'ssue note +ccounting $reatment :7

Buantity IE "IE FIE

Lalue FIE "IE IE ) 4ormal Wastage < 't should be distributed o&er goods output increasing per unit cost ") +bnormal Wastage< 't will be charged to costing profit and loss a-c :) ,ale &alue of scrap is credited to costing profit and loss a-c as an abnormal gain. ?) ,ale proceeds of the scrap can be deducted from material cost or factory o&erheads. ;) ,ale proceeds of scrap may be credited to particular Kob. A) 4ormal %efecti&es < cost of rectification of defecti&es should be charged to specific F) +bnormal %efecti&es < $his should be charged to costing profit and loss a-c G) Cost of 4ormal spoilage is to borne by good units H) +bnormal spoilage should be charged to costing profit and loss a-c

LABOUR Method of 5emuneration: ) $ime 5ate system a) 2lat time 5ate b) /igh wage system c) 8raduated time rate ") Payment by 5esults a) Piece rate system i) ,traight piece rate
narayan. ii) %ifferential piece rate $aylor system Merric( system b) 8roup 9onus ,ystem i) 9udgeted Expenses ii) $owne gain sharing scheme iii) Cost efficiency bonus i&) Priest man system c) Combination of $ime and Piece rate i) 8antt tas( and 9onus scheme ii) Emerson Efficiency system iii) Point scheme 9edaux system /aynes manit system d) Premium bonus plans i) /alsey premium plan ii) /alsey weir premium plan iii) 5owan scheme i&) 9arth scheme &) +ccelerating premium bonus scheme e) .ther incenti&e schemes i) 'ndirect monetary incenti&e Profit sharing Co7partnership ii) 4on7Monetary 'ncenti&e ) $ime rate system < /ours wor(ed 6 5ate per hour *9asic wages) ") Piece rate system: i) ,traight piece rate earnings < 4umber of units produced 6 5ate per unit ii) %ifferential Piece rate a) 2.W.$aylorCs differential rate system O G:E of piece rate when below standard O ";E of piece rate when abo&e or at standard b) Merric( differential or multiple piece rate system
narayan. Efficiency le&el O up to G:E O G:E to IIE O +bo&e IIE iii) 8antt $as( and 9onus system .utput O 9elow standard O +t standard O +bo&e standard i&) EmersonCs Efficiency system Efficiency O 9elow AA.FE O from AA.FE to IIE O +bo&e IIE Payment O /ourly 5ate O /ourly rate *=) increasing bonus according to degree of efficiency on the basis of step bonus rates O /ourly rate *=) "IE 9onus *=) additional bonus of E of hourly rate for e&ery E increase in efficiency Payment O $ime rate *guaranteed) O "IE 9onus of $ime rate O "IE of ordinary piece rate Piece rate O4ormal piece rate O IE of 4ormal rate O "IE of 4ormal rate

&) /alsey Premium Plan < 9asic wages = ;IE of time sa&ed 6 /ourly 5ate &i) /alsey Weir Premium Plan < 9asic wages = :IE of time sa&ed 6 /ourly rate &ii) 5owan Plan < 9asic wages = $ime sa&ed $ime allowed 6 9asic Wages

&iii) 9edaus Point system < 9asic wages = F;E 6 9edaus point-AI 6 5ate-hr ix) 9arthCs ,ystem < /ourly rate 6 D,td time 6$ime ta(en Labour $urno&er:7 ) ,eparation rate method < ,eparation during the period +&erage 4o. of wor(erCs during the period ") 4et labour $.. rate *or) 5eplacement method < 4umber of replacements +&erage 4o. of wor(erCs during the period :) Labour flux rate < 4o. of separation = 4o. of replacement +&erage 4o. of wor(erCs during the period
narayan. +ccounting $reatment ) 4ormal 'dle time < Charged to factory o&erheads ") 4ormal but un7controllable < 't should be charged to Kob by inflating wage rate. :) +bnormal < 't should be charged to costing P P L a-c

OVER HEADS 5eapportionment of ser&ice department expenses o&er production department :7 ) %irect redistribution method: ,er&ice department costs are di&ided o&er production department. 'gnore ser&ice rended by one dept. to another ") ,tep method of secondary distribution *or) 4on reciprocal method: ,er&ice department which ser&es largest number of ser&ice department is di&ided first and go on. :) 5eciprocal ser&ice method: i) ,imultaneous e0uation method *or) +lgebraic method
narayan. E0uation is formed between ser&ice departments and is sol&ed to find the amount due.


ii) 5epeated distribution method: ,er&ice department cost separated repeatedly till figure of ser&ice dept. is exhausted or too small. iii) $rial and Error method: Cost of ser&ice department is apportioned among them repeatedly till the amount is negligible and the total is di&ided among production department. $reatment of .&er-3nder absorption of o&erheads:7 i) 'f under absorbed and o&er absorbed o&erheads are of small &alue then it should be transferred to costing profit and loss a-c ii) 'f under and o&er absorption occurs due to wrong estimates then cost of product manufactured should be adKusted accordingly. iii) 'f the same accrued due to same abnormal reasons the same should be transferred to costing profit P loss a-c +pportionment of o&erhead expenses > 9asis a) ,tores ser&ice expenses < Lalue of materials consumed b) 2actory rent < 2loor area c) Municipal rent# rates and taxes < floor area d) 'nsurance on 9uilding and machinery < 'nsurable &alue e) Welfare department expenses f) g ) h ) ,uper&ision 4umber of employees +menities to employeeCs Employees liability for insurance

K) Lighting power < Plug point () ,tores o&er heads < %irect material
narayan. l) 8eneral o&er heads < %irect wages 5eapportionment of ser&ice department cost to production department :7 ) Maintenance dept. < /ours wor(ed for each dept. ") Pay roll and time (eeping < $otal labour *or) machine hours *or) 4umber of employees in each department :) Employment *or) Personnel department < 5ate of labour $.. *or) 4o. of employees of each department ?) ,tores Qeeping department < 4o. of re0uisitions *or) &alue of materials of each department ;) Purchase department < 4o. of purchase orders &alue of materials of each department A) Welfare# ambulance# canteen# ser&ice# recreation room expenses < 4o. of employees in each department. F) 9uilding ser&ice department < 5elati&e area each dept. G) 'nternal transport ser&ice *or) o&erhead crane ser&ice < weight# &alue graded product handled# weight and distance tra&eled. H) $ransport department < Crane hours# truc( hours# truc( mileage# 4umber of pac(ages. I) Power house *electric power cost) < /ousing power# horse power machine hours# 4o. of electric points etc. ) Power house < 2loor area# cubic content.


RECONCILATION OF COST AND FINANCIAL A/C Causes of differences:7 ) Purely financial items : i) +ppropriation of profits R$ransferred to reser&es# goodwill# preliminary expenses# di&idend paid etc. ii) Loss on sale of in&estment# penalties and fines iii) 'ncome R 'nterest recei&ed on 9an( deposits# profit on sale of in&estments# fixed assets# transfer fees. ") Purely cost account items: 7 4otional 5ent - 'nterest - ,alary :) Laluation of stoc(:7 i) 5aw7material < 'n financial a-cCs stoc( is &alued at cost or mar(et &alue Whiche&er is less# while in cost a-cCs it is &alued at L'2.# 2'2. etc.
narayan. ii) Wor( in progress < 'n financial a-cCs administrati&e expenses are also considered while &aluing stoc(# but in cost a-cCs it may be &alued at prime *or) factory cost *or) cost of production iii) 2inished 8oods < 'n financial a-cCs it is &alued at cost or mar(et price whiche&er is less# in cost a-cCs it is &alued at total cost of production. ?) .&erheads: 'n financial < +ctual expenses are ta(en 'n cost < Expenses are ta(en at predetermined rate. ;) %epreciation: 'n financial < Charged in diminishing or fixed balance method 'n cost < Charged in machine hour rate A) +bnormal 8ains: 'n financial < $a(en to profit P Loss a-c 'n cost < Excluded to cost a-cCs or charged in costing profit P Loss a-c

JOB AND BATCH COSTIN With Kob costing# we are dealing with one off situations. We are dealing with organisations that carry out functions and ser&ices on a one at a time basis. 8ood examples of Kob costing situations include Kobbing builders: the builder who will pro&ide a householder# or a shop owner# or a factory owner with a ser&ice that he pro&ides for no one else. $he Kobbing builder will build an extension# or reno&ate some property to a design that will probably not be copied anywhere else at any time: it is a one off Kob. Sob costing can apply in non manufacturing situations as well as in manufacturing situations. E&en though many Kobbing enterprises are small scale# we are not suggesting that all Kobbing enterprises are small scale enterprises. +n engineering shop may be wor(ing on a Kob for a customer that ta(es se&eral months and many man and machine hours to complete. /ere are two definitions: + Kob is M+ customer order or tas( of relati&ely short durationN Sob costing is M+ form of specific order costing! the attribution of cost to KobsN
narayan. 9atch costing is not normally seen as much of an ad&ance on Kob costing.

+ batch is + group of similar articles which maintains its identity throughout one or more stages of production and is treated as a cost unit 9atch costing is + form of specific order costing! the attribution of costs to batches. Economic 9atch Buantity < E9B < D"+,-C Where + < +nnual %emand , < ,etting up cost per batch C< Carrying cost - unit of production.

!ROCESS COSTIN 2ormat of process a-c Particulars $o %irect material $o %irect Labour $o 'ndirect material $o .ther Expenses $o +bnormal gain*9-2) $otal 2ormat of +bnormal loss Particulars $o Process a-c 3n it 5s Particulars . 9y ,ale of wasted units

3n it

5at e

5s Particulars . 9y 4ormal Loss 9y 3nits transferred to other process 9y +bnormal loss *9-2) $otal

3n it

5at e

5s .

3n it

5s . 9y costing P P L a-c $otal


2ormat of +bnormal gain a-c Particulars 3nit 5s Particulars s . $o 4ormal Loss 9y Process a-c *names of different a-c process) $o costing PPla-c $otal $otal 3nit 5s s .

)$o find the cost per unit for &aluation of units to be trans. to next process and also for abnormal# loss or gain < $otal process cost > ,al&age &alue of normal spoilage $otal units introduced > 4ormal loss in units ") $o find abnormal loss *or) gain *all in units): < 3nits from pre&ious process = fresh units introduced > 4ormal loss > units transferred to next process *'f the result is positi&e then abnormal loss. 'f negati&e then abnormal gain) :) 'n case of opening W'P and closing W'P are gi&en then there are different methods of &aluation of closing W'P i) 2'2. Method ii) L'2. Method iii) +&erage Method i&) Weighted +&erage Method ?) Larious statements to be prepared while W'P is gi&en: i) ,tatement of e0ui&alent production ii) ,tatement of cost iii) ,tatement of apportionment of cost i&) Process cost a-c ;) 2'2. Method: 'n these method total units transferred to next process includes full opening stoc( units and the closing stoc( includes the units introduced during the process. 'n this method the cost incurred during the process is assumed as to be used a) 2irst to complete the units already in process b) $hen to complete the newly introduced units c) 2or the wor( done to bring closing in&entory to gi&en state of completion A) L'2. Method < Cost incurred in process is used for:
narayan. a) 2irst to complete newly introduced units b) $hen to complete units already in process in this method closing stoc( is di&ided into two : i) 3nits which represent opening stoc( but lie at the end of the period ii) 4ewly introduced units in closing stoc(. F) +&erage Method: 'n this method a) 4o distinction is made between opening stoc( and newly introduced material. b) 'n finding cost per unit# cost incurred for opening stoc( is also to be added with current cost. *$his addition is not done in L'2. P 2'2. method as cost incurred in that process is only ta(en) G) Weighted a&erage method: $his method is only used when &aried product in processed through a single process. 8eneral procedure is adopted here. a) ,tatement of weighted a&erage production should be prepared. 3nder this statement output of each products is expressed in terms of points. b) Cost of each type of product is computed on basis of Points. Points of &ital importance in case of +bnormal 8ain - Loss: a) Calculate cost per unit by assuming there is no abnormal loss - gain b) Cost per unit arri&ed abo&e should be applied for &aluation of both abnormal Loss-gain units and output of the process. c) ,eparate a-c for both abnormal loss-gain is to be prepared. JOINT !RODUCT AND B" !RODUCT COSTIN Methods of apportioning Koint cost o&er Koint products : ) Physical unit method < Physical base to measure *i.e.) output 0uantity is used to separate Koint cost. Soint cost can be separated on the basis of ratio of output 0uantity. While doing this wastage is also to be added bac( to find total 0uantity. ") +&erage unit cost method < 'n this method Koint cost is di&ided by total units Produced of all products and a&erage cost per unit is arri&ed and is multiplied With number of units produced in each product.
narayan. :) ,ur&ey method or point &alue method < Product units are multiplied by points or weights and the point is di&ide on that basis. ?) ,tandard cost method < Soint costs are separated on the basis of standard cost set for respecti&e Koint products. ;) Contribution margin method < Cost are di&ided into two categories *i.e.) &ariable and fixed. Lariable costs are separated on unit produced. 2ixed on the basis of contribution ratios made by different products. A) Mar(et &alue method:7 a) Mar(et &alue at the point of separation: Soint cost to sales re&enueT percentage is found which is called as multiplying factor < Soint cost 6 II ,ales 5e&enue Soint cost for each product is apportioned by applying this E on sales re&enue of each product. ,ales re&enue < ,ales 5e&enue at the point of separation. $his method cannot be done till the sales re&enue at the separation point is gi&en. b) Mar(et &alue after processing: Soint cost is apportioned on the basis of total sales Lalue of each product after further processing. c) 4et 5ealiJable &alue method < 2orm sales &alue following items are deducted i) Estimated profit margin ii) ,elling and distribution expenses if any included. iii) Post split off cost $he resultant amount is net realiJable &alue. Soint cost is apportioned on this basis. 9i7product U Method of accounting $reat as other income in profit and loss a-c 4et 5ealiJable &alue of 9i7product is reduced from cost of main product. 'nstead of standard process# ,tandard cost or comparati&e price or re7use price is credited to Koint process a-c.



O!ERATION COSTIN ,er&ice costing is M+ cost accounting method concerned with establishing the costs of ser&ices renderedN. ,er&ice costing is also applied within a manufacturing setting. $he %ifferences 9etween Product Costing and ,er&ice CostingV $here may be &ery few# if any# materials to worry about .&erheads will comprise the most significant portion of any costs of which# labour costs may well comprise as much as FIE 4o. Enterprise . 5ailways or bus companies ". /ospital Cost per unit Per passenger7(ilometer Per patient-day# per bed-day
narayan. :. ?. ;. A. F. G. H. I. Canteen Water supply ser&ice 9oiler /ouse 8oods $ransport Electricity 9oards 5oad maintenance department 9ric(s /otel Meals ser&ed # cups of tea Per III gallons III (g of steam Per tonne (m# 0uintal (m Per (ilowatt > hours Per mile or road maintenance .ne thousand Per room-day


'n this &arious terms such as passenger (m# 0uintal (m# tonne (m# these are all (nown as composite units and are computed in " ways: a) +bsolute *weighted a&erage): *e.g.) tones (m 7 Multiplying total distance by respecti&e load 0uantity. b) Commercial *simple a&erage): *e.g.) tonne Qm>Multiplying total distance by a&erage load 0uantity +ll accumulated cost is classified into : categories: ) ,tanding charges *or) fixed cost ") 5unning cost *or) &ariable cost :) Maintenance charges *or) semi &ariable cost 5unning charges < 2uel# %ri&er Wages# %epreciation# oil etc. Maintenance charges < ,uper&ision salary# 5epairs and Maintenance


E of factory o&erheads on direct wages E of administration o&erheads on wor(s cost E of selling P distribution o&erheads on wor(s cost E of profit on sales

.perating cost sheet :7 Particulars + ,tanding charges :7 License fees 'nsurance Premium 5oad tax

$otal cost Cost per (m 8arage rent %ri&erCs wages +ttendant7cum7cleanerCs wages ,alaries and wages of other staff $otal 9 5unning charges :7 5epairs and maintenance Cost of fuel *diesel# petrol etc.) Lubricants# grease and oil Cost of tires# tubes and other spare parts %epreciation $otal C $otal charges W *+) = *9) X


CONTRACT COSTIN Contract costing is M+ form of specific order costing! attribution of costs to indi&idual contractsN. + contract cost is M+ggregated costs of a single contract! usually applies to maKor long term contracts rather than short term KobsN. 2eatures of long term contracts: 9y contract costing situations# we tend to mean long term and large contracts: such as ci&il engineering contracts for building houses# roads# bridges and so on. We could also include contracts for building ships# and for pro&iding goods and ser&ices under a long term contractual agreement.
narayan. With contract costing# e&ery contract and each de&elopment will be accounted for separately! and does# in many respects# contain the features of a Kob costing situation. Wor( is fre0uently site based.


We might ha&e problems with contract costing in the following areas 'dentifying direct costs Low le&els of indirect costs %ifficulties of cost control Profit and multi period proKects

$he source of the following has eluded me: my sincere gratitude for whoe&er the author might be. YContract Costing such Kobs ta(e a long time to complete P may spread o&er two or more of the contractor)s accounting yearsN. F#atur#$ %f a C%ntract $he end product $he period of the contract $he specification $he location of the wor( $he price Completion by a stipulated date $he performance of the product

C%&&#cti%n %f C%$t$ : %esirable to open up one or more internal Kob accounts for the collection of costs. 'f the contract not obtained# preliminary costs be written off as aborti&e contract costs in PPL 'n some cases a series of Kob accounts for the contract will be necessary: to collect the cost of different aspects to identify different stages in the contract S'#cia& f#atur#$ Materials deli&ered direct to site. %irect expenses ,tores transactions. 3se of plant on site
narayan. T(% '%$$i)&# acc%unting *#t+%,$:


Where a plant is purchased for a particular contract P has little further &alue to the business at the end of the contract Where a plant is bought for or used on a contract# but on completion of the contract it has further useful life to the business +lternati&ely the plant may be capitalised with Maintenance and running costs charged to the contract.Y 2ormat:7 Particulars $o Materials a. Purchased directly b. 'ssue from site c. ,upplied by contractee $o Wages and salaries $o .ther direct Expenses $o ,ub7contractor fees $o Plant P Machinery *purchase price-9oo( &alue) $o 'ndirect expenditure *apportioned share of o&erheads) $o 4otional profit *,urplus) $otal Profit of 'ncomplete contract :7 ) When E of completion is less than or e0ual to ";E then full 4otional profit is transferred to reser&e. ") When E of completion is abo&e ";E but less than ;IE following amount should be credited to profit P loss a-c < -: 6 4otional Profit 6 ZCash recei&ed - Wor( certified[ :) When E of completion is more than or e0ual to ;IE then the amount transferred to profit is < "-: 6 4otional Profit 6 ZCash recei&ed - Wor( certified[ W9alance is transferred to reser&e a-cX \ E of completion < ZWor( certified-Contract price[ 6 II ?) When the contract is almost complete the amount credited to profit P loss a-c is a) Estimated total profit 6 ZWor( certified - Contract price[

5s. Particulars 9y materials returned 66 9y Material sold *cost 66 price) 66 66 9y W'P Wor( certified 66 Wor( 3ncertified 66 9y Materials at site 66 66 9y Plant and machinery*W%L) 66 $otal

5s. 66 66 66 66 66 66 66 b) Estimated total profit 6 ZCash recei&ed - Contract price[ c) Estimated total profit 6 ZCost of wor( done - Estimated total profit[ d) Estimated total profit6ZCost of wor( done6Cash recei&ed Estimated total cost 6 Wor( certified[ ;) Wor(7'n7Progress is shown in 9alance ,heet as follows:7 ,(eleton 9alance sheet Liabilities Profit P loss a-c *will include) Profit on contract *,pecify the contract number) Less : Loss on contract *,pecify the contract number) ,undry creditors *will include) Wages accrued %irect expenses accrued +ny other expenses *,pecify) A) Escalation Clause < $his is to safeguard against li(ely change in price of cost elements rise by and certain E o&er the prices pre&ailing at the time tendering the contractee has to bear the cost. *5, +sset ) Wor(7in7progress Lalue or wor( certified Cost of wor( uncertified Less :7 5eser&e for unrealiJed profit Less :7 +mount recei&ed from contractee *5s )


MAR INAL COSTIN ,tatement of profit:7 Particulars ,ales Less:7Lariable cost Contribution

+mount 666 666 666 Less:7 2ixed cost Profit 666 666


) ,ales < $otal cost = Profit < Lariable cost = 2ixed cost = Profit ") $otal Cost < Lariable cost = 2ixed cost :) Lariable cost < 't changes directly in proportion with &olume ?) Lariable cost 5atio < ZLariable cost - ,ales[ 6 II ;) ,ales > Lariable cost < 2ixed cost = Profit A) Contribution < ,ales 6 P-L 5atio F) Profit Lolume 5atio WP-L 5atioX:7 ZContribution - ,ales[ 6 II ZContribution per unit - ,ales per unit[ 6 II ZChange in profit - Change in sales[ 6 II ZChange in contribution - Change in sales[ 6 II G) 9rea( E&en Point W9EPX:7 2ixed cost - Contribution per unit Win unitsX 2ixed cost - P-L 5atio Win &alueX *or) 2ixed Cost 6 ,ales &alue per unit *,ales > Lariable cost per unit) H) Margin of safety WM.PX +ctual sales > 9rea( e&en sales 4et profit - P-L 5atio Profit - Contribution per unit W'n unitsX I) ,ales unit at %esired profit < Z2ixed cost = %esired profit[ - Cont. per unit ) ,ales &alue for %esired Profit < Z2ixed cost = %esired profit[ - P-L 5atio ") +t 9EP Contribution < 2ixed cost :) Lariable cost 5atio < Change in total cost Change in total sales 6 II

?) 'ndifference Point < Point at which two Product sales result in same amount of profit < Change in fixed cost *in units) Change in &ariable cost per unit
narayan. < Change in fixed cost *in units) Change in contribution per unit < Change in 2ixed cost Change in P-5atio < Change in 2ixed cost Change in Lariable cost ratio *in 5s.) *in 5s.)


;) ,hut down point < Point at which each of di&ision or product can be closed < Maximum *or) ,pecific *or) +&ailable fixed cost P-L 5atio *or) Contribution per unit 'f sales are less than shut down point then that product is to shut down. 4ote :7 ) When comparison of profitability of two products if P-L 5atio of one product is greater than P-L 5atio of other Product then it is more profitable. ") 'n case of 'ndifference point if ,ales ] 'ndifference point 777 ,elect option with higher fixed cost *or) select option with lower fixed cost.

STANDARD COSTIN Method one of reading:7 Material:7 ,P 6 ,B ,P 6 +B ,P 6 5,B * ) *") *:) *?) a) Material cost &ariance < * ) > *?) b) Material price &ariance < *")*?) c) Material usage &ariance < * ) > *")

+P 6 +B d) Material mix &ariance < *:) > *") e) Material yield &ariance < * ) >*:) Labour :7 ,56,$ ,56+$ *paid) ,565,$ +56+$ ,56+$*wor(ed) * ) *") *:) *?) *;) a) Labour Cost &ariance < b) Labour 5ate &ariance < c) Labour Efficiency &ariance < d) Labour mix &ariance < e) Labour 'dle time &ariance < * ) > *?) *") > *?) * ) > *") *:) > *;) *;) > *")


Lariable .&erheads cost &ariance :7 ,5 6 ,$ ,5 6 +$ +5 6 +$ * ) *") *:) a) Lariable .&erheads Cost Lariance < * ) > *:) b) Lariable .&erheads Expenditure Lariance < *") > *:) c) Lariable .&erheads Efficiency Lariance < * ) > *") WWhere: ,5 <,tandard rate-hour < 9udgeted &ariable ./ 9udgeted /ours X 2ixed .&erheads Cost Lariance:7 ,56,$ ,56+$*wor(ed) * ) *") *:) *?) *;) ,5659$ ,569$ +56+$*paid)

a) 2ixed .&erheads Cost Lariance < * ) > *;) b) 2ixed .&erheads 9udgeted Lariance < *?) > *;) c) 2ixed .&erheads Efficiency Lariance < * ) > *") d) 2ixed .&erheads Lolume Lariance < * ) > *?) e) 2ixed .&erheads Capacity Lariance < *") > *:) f) 2ixed .&erheads Calendar Lariance < *:) > *?) ,ales &alue &ariance:7 9udgeted Price69B 9P6+B 9P69udgeted mix * ) *") *:) *?) a) ,ales &alue &ariance < b) ,ales price &ariance < c) ,ales &olume &ariance < d) ,ales mix &ariance < e) ,ales 0uantity &ariance < *?)* ) *?) > *") *") > * ) *") > *:) *:) > * )

+P6+B 4ote :7 i) +ctual margin per unit *+MP3) < +ctual sale price > selling cost per unit ii) 9udgeted margin per unit *9MP3) < 9udgeted sale price > selling price per unit ,ales margin &ariance :7 9MP369B * ) *") 9MP36+B 9MP369udgeted mix *:) *?) +MP36+B


a) ,ales margin &ariance < *?) > * ) b) ,ales margin price &ariance < *?) > *") c) ,ales margin &olume &ariance < *") > * ) d) ,ales margin mix &ariance < *") > *:) e) ,ales margin 0uantity &ariance < *:) > * ) Control 5atio :7 ) Efficiency 5atio < ,tandard hours for actual output 6 II +ctual hours wor(ed ") Capacity 5atio < +ctual /ours Wor(ed 6 II 9udgeted /ours :) +cti&ity 5atio < +ctual hours wor(ed 6 II 9udgeted /ours Lerification: +cti&ity 5atio < Efficiency 6 Capacity 5atio

STANDARD COSTIN Method two of reading:7 Material:7 a) Material cost &ariance < ,C > +C < *,B6+B) > *+B6+P) b) Material price &ariance < +B *,P > +P) c) Material usage &ariance < ,P *,B > +B)
narayan. d) Material mix &ariance < ,P *5,B > +B) e) Material yield &ariance < *+^ > ,^ for actual input) ,tandard material cost per unit of output f) Material re&ised usage &ariance *calculated instead of material yield &ariance) < Wstandard 0uantity > 5e&ised standard for actual output 0uantity X 6 ,tandard price Labour :7 a) Labour Cost &ariance < ,C > +C < *,/6,5) > *+/6+5) b) Labour 5ate &ariance < +/ *,5 7 +5) c) Labour Efficiency or time &ariance < ,5 *,/ >+/) d) Labour Mix or gang composition Lariance < ,5*5,/7+/) e) Labour 'dle $ime Lariance < 'dle hours 6 ,5 f) Labour ^ield Lariance < W+ctual .utput > ,tandard output for actual inputX 6 ,tandard labour cost-unit of output g) Labour 5e&ised Efficiency Lariance *instead of L^L) < W,tandard hours for actual output > 5e&ised standard hoursX 6 ,tandard rate 4otes :7 i) LCL < L5L = LML = '$L = L^L ii) LCL < L5L = LEL = '$L iii) LEL < LML# L^L *or) L5EL .&erhead &ariance :7 *general for both &ariable and fixed) a) ,tandard o&erhead rate *per hour) < 9udgeted .&erheads 9udgeted /ours b) ,tandard hours for actual output < 9udgeted hours 6 +ctual .utput 9udgeted output c) ,tandard ./ d) +bsorbed ./ < ,tandard hrs for actual output 6 ,tandard ./ rate per hour < +ctual hrs 6 ,tandard ./ rate per hour


e) 9udgeted ./ f) +ctual ./ g) ./ cost &ariance < 9udgeted hrs 6 ,tandard ./ rate per hour < +ctual hrs 6 +ctual ./ rate per hour < +bsorbed ./ > +ctual ./

Lariable .&erheads &ariance :7 a) Lariable ./ Cost Lariance < ,tandard ./ > +ctual ./ b) Lariable ./ Exp. Lariance < +bsorbed ./ > +ctual Lariable ./ c) Lariable ./ Efficiency Lariance < ,tandard ./ > +bsorbed ./ < W,tandard hours for > +ctual 6 ,tandard rate actual output hoursX for &ariable ./ 2ixed .&erheads &ariance :7 a) 2ixed ./ Cost Lariance < ,tandard ./ > +ctual ./ b) 2ixed ./ expenditure &ariance < 9udgeted ./ > +ctual ./ c) 2ixed ./ Efficiency Lariance < ,tandard ./ *units based) > +bsorbed ./ */ours based) d) 2ixed ./ Lolume Lariance < ,tandard ./ > 9udgeted ./ < W,tandard hrs for > 9udgeted actual output hours X e) 2ixed ./ capacity &ariance < +bsorbed ./>9udgeted ./ f) 2ixed ./ Calendar Lariance < W5e&ised budgeted hrs > 9udgeted hrsX 6 ,tandard rate-hrs 4ote:7 When there is calendar &ariance capacity &ariance is calculated as follows :7 Capacity &ariance < W+ctual hours > 5e&ised 6 ,tandard *5e&ised) 9udgeted hrsX rate-hour Lerification :7 i) &ariable ./ cost &ariance < Lariable ./ Expenditure &ariance = Lariable ./ Efficiency &ariance ii) 2ixed ./ cost &ariance < 2ixed ./ Expenditure &ariance = 2ixed ./ &olume

6 standard rate &ariance iii) 2ixed ./ &olume &ariance < 2ixed ./ Efficiency &ariance = Capacity &ariance = Calander &ariance ,ales &ariances :7 $urno&er method *or) sales &alue method :7 a) ,ales &alue &ariance < +ctual ,ales > 9udgeted ,ales b) ,ales price &ariance < W+ctual Price > ,tandard priceX 6 +ctual 0uantity < +ctual sales > standard sales c) ,ales &olume &ariance < W+ctual79udgeted 0uantityX 6,tandard price < ,tandard sales > 9udgeted sales d) ,ales mix &ariance < W+ctual 0uantity > 5e&ised standard 0uantityX 6 ,tandard price < ,tandard sales > 5e&ised sales e) ,ales 0uantity &ariance < W5e&ised standard &ariance > 9udgeted 0uantityX 6 ,tandard price < 5e&ised ,tandard sales > 9udgeted sales Profit method:7 a) $otal sales margin &ariance < *+ctual Profit>9udgeted price) < Z+ctual 0uantity 6 +ctual profit per unit[7 Z9udgeted 0uantity 6 ,tandard profit per unit[ b) ,ales margin price &ariance<+ctual profit>,tandard profit < Z+ctual Profit per unit > ,tandard profit per unit[ 6 +ctual 0uantity of sales c) ,ales margin &olume &ariance < ,tandard profit > 9udgeted Profit < Z+ctual 0uantity > 9udgeted 0uantity[ 6 ,tandard profit per unit d) ,ales margin mix &ariance < ,tandard profit > 5e&ised ,tandard profit < Z+ctual 0uantity > 5e&ised standard 0uantity[ 6 ,tandard profit per unit e) ,ales margin 0uantity &ariance < 5e&ised standard profit 7 9udgeted profit < Z5e&ised standard 0uantity > 9udgeted 0uantity[ 6 ,tandard profit per unit




STANDARD COSTIN %iagrammatic 5epresentation: 7 Material Lariance: 7

narayan. Material cost &ariance < ,C > +C < *,B6+B) > *+B6+P) Labour Lariances:7


Labour Cost &ariance < ,C > +C < *,/6,5) > *+/6+5) 2ixed .&erhead Lariance : 7 a) ,tandard ./ < ,tandard hrs for actual output 6 ,tandard ./ rate per hour b) +bsorbed ./ c) 9udgeted ./ d) +ctual ./ < +ctual hrs 6 ,tandard ./ rate per hour < 9udgeted hrs 6 ,tandard ./ rate per hour < +ctual hrs 6 +ctual ./ rate per hour

e) 5e&ised 9udgeted /our < +ctual %ays 6 9udgeted /ours per day *Expected hours for actual days wor(ed) When Calendar &ariance is as(ed then for capacity &ariance 9udgeted .&erhead is *9udgeted days 6 ,tandard ./ rate per day)

narayan. 5e&ised 9udgeted /our *9udgeted hours for actual days) < +ctual days 6 9udgeted hours per day Lariable .&erhead Lariance : 7


,ales Lalue Lariances : 7

,ales &alue &ariance < +ctual ,ales > 9udgeted ,ales ,ales Margin Lariances : 7



$otal sales margin &ariance < *+ctual Profit>9udgeted price) < Z+ctual 0uantity 6 +ctual profit per unit[7 Z9udgeted 0uantity 6 ,tandard profit per unit[ WWhere :7 ,C < ,tandard Cost# ,P < ,tandard Price# +P < +ctual Price# +^ < +ctual ^ield# 5,B < 5e&ised ,tandard Buantity# ,$ < ,tandard $ime +$ < +ctual $ime 9P < 9udgeted Price# 59$ < 5e&ised 9udgeted $ime 9MP3 < 9udgeted Margin per 3nit +MP3 < +ctual Margin per 3nit 5econciliation:7 5econciliation statement is prepared to reconcile the actual profit with the budgeted profit Particulars 2a&orable 3nfa&orable *5s) 9udgeted Profit : +dd 2a&orable &ariances Less 3nfa&orable &ariances ,ales Lariances : ,ales price &ariance ,ales mix &ariance ,ales 0uantity &ariance C%$t -arianc# :. Material : Cost &ariance 3sage &ariance

+C < +ctual Cost ,B < ,tandard Buantity +B < +ctual Buantity ,^ < ,tandard ^ield ,5 < ,tandard 5ate# +5 < +ctual 5ate# 5,$ < 5e&ised ,tandard $ime# 9B < 9udgeted Buantity Mix &ariance Labour : 5ate &ariance Mix &ariance Efficiency &ariance 'dle time &ariance 2ixed o&erhead &ariance : Expenditure &ariance Efficiency &ariance 2ixed o&erhead &ariance : Expenditure &ariance Efficiency &ariance Capacity &ariance Calendar &ariance


NON.INTE RATED ACCOUNTS ,cheme of Kournal entries:7 Material: a) 2or material purchases *cash or credit) i) Material control a-c %r $o Cost ledger control a-c ii) ,tores ledger control a-c %r $o Material control a-c b) Purchases for a special Kob Wor(7in7progress ledger control a-c %r $o Cost ledger control a-c c) Material returned to &ender
narayan. Cost ledger control a-c %r $o ,tores ledger control a-c d) Material *direct) issued to production Wor(7in7progress control a-c %r $o ,tores ledger control a-c e) Material *indirect) issued to production Manufacturing o&erheads a-c %r $o ,tores ledger control a-c f) Material returned from shop to stores ,tores ledger control a-c %r $o Wor(7in7progress control a-c g) Material transferred from Sob Sob " a-c %r $o Sob a-c to Sob "


i) Material issued from stores for repairs Manufacturing o&erhead a-c $o ,tores ledger control a-c


Labour: a) %irect wages paid i) Wage control a-c %r $o Cost ledger control a-c ii) Wor(7in7progress a-c $o Wage control a-c %r

b) 'ndirect wages paid to wor(ers in Production# +dministration# ,elling and %istribution departments i) Wage control a-c %r $o Cost ledger control a-c ii) Production .&erhead a-c +dministrati&e .&erhead a-c ,elling P %istribution .&erhead a-c $o Wage control a-c

%r %r %r c) %irect Expenses on a particular Kob Sob a-c %r $o Cost ledger control a-c .&erheads:7 a) .&erhead expenses incurred Production o&erhead a-c %r +dministrati&e .&erhead a-c %r ,elling P %istribution .&erhead a-c %r $o cost ledger control a-c b) Carriage inward Manufacturing .&erhead a-c $o Cost ledger control a-c %r


c) Production .&erheads reco&ered Wor(7in7progress control a-c %r $o Production .&erhead a-c d) +dministrati&e .&erhead reco&ered from finished goods 2inished goods ledger control a-c %r $o +dministrati&e .&erhead a-c e) ,elling and %istribution .&erhead reco&ered from sales Cost of sales a-c %r $o ,elling P %istribution a-c f) 'f o&er-under absorbed amounts are carried forward to subse0uent year# the balance of each .&erhead account will ha&e to be transferred to respecti&e .&erhead suspense *or reser&e) +ccounts as follows: i) 2or o&er reco&ery : Production .&erhead a-c %r $o Production o&erhead suspense a-c ii) 2or under reco&ery : +dministrati&e .&erhead ,uspense a-c %r $o +dministrati&e .&erhead a-c ,elling P %istribution .&erhead ,uspense a-c %r $o ,elling P %istribution .&erhead a-c g) 'n case the 3nder-.&er absorbed o&erheads are transferred to costing profit P loss a-c then the rele&ant entries are: i) 2or .&er reco&ery: Production .&erhead a-c %r
narayan. $o Costing Profit P Loss a-c ii) 2or 3nder reco&ery: Costing Profit P Loss a-c %r $o +dministration .&erhead a-c ,ales:7 2or sales effected: Cost ledger control a-c %r $o Costing Profit P Loss a-c Profit - Loss: a) 'n case of profit the entry is as follows Costing Profit P Loss a-c $o Cost ledger control a-c b) 5e&erse the entry in case of loss %r


$he main accounts which are usually prepared when a separate cost ledger is maintained is as follows:7 i) Cost ledger control a-c ii) ,tores ledger control a-c iii) Wor(7in7progress control a-c i&) 2inished goods control a-c &) Wage control a-c &i) Manufacturing-Production-Wor(s .&erheads a-c &ii) +dministrati&e .&erhead a-c Liii) ,elling P %istribution .&erhead a-c ix) Cost of sales a-c x) Costing profit P loss a-c


Tran$f#r !ricing + transfer price is the amount of money that one unit of an organisation charges for goods and ser&ices to another unit of an organisation. .ne of the (ey aspects here is that a transfer price is e0ui&alent to an ordinary selling price and that any department or di&ision that sets a transfer price is effecti&ely selling its goods and ser&ices at a profit or a loss to another department or di&ision within its organisation. +ny part of an organisation using transfer pricing will be classed as a profit centre: since it is operating with a &iew to ma(ing a profit *whether positi&e# profit# or negati&e# loss). 'f goods and ser&ices are transferred between departments and di&isions at cost# then no profit or loss arises and the issue of transfer pricing does not# or should not# arise. .rganisations ha&e a system of transfer pricing# therefore# in order to assess the efficiency and effecti&eness of its department and di&isional managers. $his maybe in spite of the fact that transfer prices may be artificial in the sense that it is felt that there is no rationale for MsellingN between departments and di&isions. Criteria for fixing $ransfer Pricing:7 i) ii) External Capacity not fully utiliJed < Lariable Cost Capacity fully 3tiliJed
narayan. a) 'f single product :7 ,elling Price *>) ,elling Expenses b) 'f multiple product Lariable cost = .pportunity cost *measured on the basis of Product actually sacrificed) iii) 'f no mar(et for 'ntermediate product Cost of supplying di&ision of optimum le&el *7) Cost of the supplying di&ision at pre&ious output le&el. %ifference in .utput *$his would be e0ual to Lariable cost when 2ixed Cost is same at all le&els) 4ote:7 i) ii)


'gnore Lariable ,elling expenses on 'nter %epartment $ransfer 'n case of *ii) abo&e 'f selling expenses is not gi&en we ha&e to assume some E as selling Expenses but it should not exceed ;E . Bu,g#tar/ C%ntr%&

9udget 5atios:7 ) Capacity usage 5atio < . 9udgeted /ours . Maximum possible wor(ing hours in budget period ") ,tandard Capacity Employed 5atio < +ctual /ours Wor(ed 6 II 9udgeted hours :) Le&el of +cti&ity 5atio < ,tandard /ours for +ctual Production 6 II ,tandard /ours for 9udgeted Production ?) Efficiency 5atio < ,tandard /ours for +ctual Production +ctual /ours ;) Calendar 5atio < +ctual Wor(ing days 6 9udgeted wor(ing days _ero 9ase 9udgeting:

6 II




$he name Jero base budgeting deri&es from the idea that such budgets are de&eloped from a Jero base: that is# at the beginning of the budget de&elopment process# all budget headings ha&e a &alue of _E5.. $his is in sharp contrast to the incremental budgeting system in which in general a new budget tends to start with a balance at least e0ual to last year)s total balance# or an estimate of it. %efinition of _ero 9ase 9udgeting *_99) M+ method of budgeting whereby all acti&ities are ree&aluated each time a budget is set. %iscrete le&els of each acti&ity are &alued and a combination chosen to match funds a&ailableN.

.bKecti&es and 9enefits of _99 What Jero base budgeting tries to achie&e is an optimal allocation of resources that incremental and other budgeting systems probably cannot achie&e. _99 starts by as(ing managers to identify and Kustify their area*s) of wor( in terms of decision pac(ages *0&). +n effecti&e Jero base budgeting system benefits organisations in se&eral ways. 't will 2ocus the budget process on a comprehensi&e analysis of obKecti&es and needs Combine planning and budgeting into a single process Cause managers to e&aluate in detail the cost effecti&eness of their operations Expand management participation in planning and budgeting at all le&els of the organisation



Acti-it/ Ba$#, c%$ting 'n $raditional Method we split the .&er /ead incurred in production# based on machine hours which are not acceptable for many reasons. 'n +9C method .&er /ead are splited according to the related acti&ity# for each type of .&er /ead. .&erhead are apportioned among &arious Production cost centers on the basis of +cti&ity cost dri&ers. R#&#-ant C%$ting . $%*# t+#%r/ 'ntroduction: 7 + management decision in&ol&es predictions of costs P re&enues. .nly the costs and re&enues that will differ among alternati&e actions are rele&ant to the decision. $he role of historical data is to aid the prediction of future data. 9ut historical data may not be rele&ant to the management decision itself. Bualitati&e factors may be decisi&e in many cases# but to reduce the number of such factors to be Kudged# accountants usually try to express many decision factors as possible in 0uantitati&e terms. Meaning of 5ele&ant Costs: 7 5ele&ant costs represent those future costs that will be changed by a particular decision. While irrele&ant costs are those costs that will not be affected by a decision. 'n the short run# if the rele&ant re&enues exceed the rele&ant costs then it will be worthwhile accepting the decision. $herefore rele&ant costs playa maKor role in the decision7ma(ing process of an organiJation. + particular cost can be rele&ant in one situation but irrele&ant in another# the important point to note is that rele&ant costs represent those future costs that will be changed by a particular decision# while irrele&ant costs are those costs that will not be affected by that decision. We shall now see what are rele&ant costs and re&enues for decision7ma(ing process. 'n summary rele&ant
narayan. information concerns: .ther 'mportant $erminologies : 7 5ele&ant costs are costs appropriate to aiding the ma(ing of specific management decisions. +ctually# to affect a decision a cost must be:


2uture: Past costs are irrele&ant as they are not affected them by future decisions P decisions should be made as to what is best now. 'ncremental: $his refers to additional re&enue or expenditure# which may appear as a result of our decision7ma(ing. *+ cash flow 7 ,uch charges as depreciation may be future but do not represent cash flows and# as such# are not rele&ant.) ,un( costs: Past costs# not rele&ant for decision ma(ing Committed costs: $his is future in nature but which arise from past decisions# perhaps as the result of a contract. 5ele&ant Costs: Problem areas: Problems in determining the rele&ant costs of materials: When considering &arious decisions# if the any materials re0uired is not ta(en from existing stoc(s but would be purchased on a later date# then the estimated purchase price would be the rele&ant material cost. + more difficult problem arises when materials are ta(en from existing stoc(. 'n this situation the rele&ant cost of materials for a particular Kob *say Kob `) depends on Material is in regular use of the company Material is not in regular use of the company Material is in short supply. 'f the material is in regular use of the company then the material ta(en from existing stoc( re0uires replacement for the purpose of regular use therefore the rele&ant cost of material will be the 5eplacement cost. 'f the material is not in regular use of the company the rele&ant cost of the materials depends on their alternati&e use. $he alternati&e use of the materials will be either to sell them or to use them on other Kobs. /ence the cost of using the materials results in an opportunity cost consisting of either $he net sales re&enue if the materials were sold *or) $he expense that would be a&oided if the
narayan. materials were used on some other Kob Whiche&er is greater.


'f the material is in short supply the only way material for the Kob under consideration can be obtained is by reducing production of some other product - Kob. This would release material for the order. but the reduced production will result in loss of contribution which should be ta(en in to account when ascertaining the rele&ant costs for the specific order. $herefore the rele&ant cost will be Contribution lost *before the material cost since the material cost will be incurred in any case) will be the rele&ant cost. labour: " %etermining the direct labour that are rele&ant to short 7 term decision depends on the circumstances. Where a company has temporary sparse capacity and the labour force is to be maintained in the short 7 term# the direct labour cost incurred will remain same for all alternati&e decisions. $he direct labour cost will therefore be irrele&ant for short 7 term decision 7 ma(ing purposes. /owe&er where casual labour is used and where wor(ers can be hired on a daily basis! a company may then adKust the employment of labour to exactly the amount re0uired to meet the production re0uirements. $he labour cost will increase if the company accepts additional wor(# and will decrease if production is reduced. 'n this situation the labour cost be a rele&ant cost for decision 7 ma(ing purposes. 'n a situation where full capacity exists and additional labour supplies are una&ailable in the short 7 term# and where no further o&ertime wor(ing is possible# the only way that labour resources could then be obtained for a specific order would be to reduce existing production. This would release labour for the order. but the reduced production will result in loss of contribution# which should be ta(en in to account when ascertaining the rele&ant costs for the specific) order. $herefore the rele&ant cost will be Contribution lost *before the labour cost) will be the rele&ant cost. P5.9LEM, . 'n a firm# material + has no alternati&e uses and "II units of which lie in stoc(. $he information below has been collected. ^ou are re0uired to find the rele&ant price of "I units and ";I units respecti&ely. 9oo( &alue Current price ,ale price obtainable 5s." per (g 5s.: per (g 5s.".GI per (g ". +ssume in the abo&e problem the material is in regular use of the company :. +ssume in the abo&e problem the material is in short asupply and it is not possible to obtain the stoc( of material for some more time. +t present the material is used in another product on which
narayan. ?F a contribution at the rate of 5s. .-unit is earned *after meeting the material cost). Each unit of the product re0uires Q8 of 5aw material +.

Ca$+ an, fun, f&%( $tat#*#nt 5ules for preparing schedule of changes in wor(ing capital :7 'ncrease in a current asset# results in increase in wor(ing capital > so +dd %ecrease in current asset# results in decrease in wor(ing capital > so %ecrease 'ncrease in current liability# results in decrease in wor(ing capital > so %ecrease %ecrease in current liability results in increase in wor(ing capital > so +dd 2unds from operations > 2ormat Particulars 4et profit +dd : %epreciation 8oodwill written off Preliminary Exp. Written off %iscount on share written off $ransfer to 8eneral 5eser&e Pro&ision for $axation Pro&ision for %i&idend Loss on sale of asset Loss on re&aluation of asset 5s. 66 6 66 6 66 6 66 6 66 6 66 6 66 6 66 6 66 6 5s. 666


666 Less : Profit on sale of asset 66 Profit on 5e&aluation of asset 6 66 6 2und flow statement 2und flow statement

666 666 Particulars ,ources of funds : 7 'ssue of shares 'ssue of %ebentures Long term borrowings ,ale of fixed assets .perating profit 5s. 666 666 666 666 666 666 $otal ,ources 666 +pplication of funds : 7 666 5edumption of 5edeemable preference shares 666 5edumption of %ebentures 666 Payment of other long term loans 666 Purchase of 2ixed assets 666 .perating Loss 666 Payment of di&idends# tax etc 666 $otal 3ses 666 4et 'ncrease - %ecrease in wor(ing capital *$otal sources > $otal uses) 666 Cash flow statement Cash 2rom .peration : 7 < 4et profit = %ecrease in Current +sset = 'ncrease in Current Liability 7 'ncrease in Current +sset 7 %ecrease in Current Liability Cash flow statement ,ources .pening cash and ban( balance 'ssue of shares 5aising of long term loans ,ales of fixed assets ,hort term 9orrowings Cash 'nflow Closing 9an( .-% 5s. 66 66 66 66 66 66 66 +pplication .pening 9an( .-% 5edumption of Preference ,hares 5edumption of Long term loans Purchase of fixed assets %ecrease in %eferred payment Liability Cash .utflow $ax paid %i&idend paid %ecrease in 3nsecured loans# %eposits Closing cash and ban( balance 5s. 66 66 66 66 66 66 66 66 66 66 66




Rati% Ana&/$i$ +) Cash Position 5atio : 7 ) +bsolute Cash 5atio < Cash 5eser&oir Current Liabilities ") Cash Position to $otal asset 5atio < Cash 5eser&oir *Measure li0uid layer of assets) $otal +ssets 6 II

:) 'nter&al measure < Cash 5eser&oir *ability of cash reser&oir to meet cash expenses) +&erage daily cash expenses * +nswer in days) 4otes : 7 Cash 5eser&oir < Cash in hand = 9an( = Mar(etable 4on trade in&estment at mar(et &alue. Current liabilities < Creditors = 9ills Payable = .utstanding Expenses = Pro&ision for tax *4et of ad&ance tax) = Proposed di&idend = .ther pro&isions. $otal assets < $otal in asset side > Miscellaneous expenses > Preliminary expenses = +ny increase in &alue of mar(etable non trading 'n&estments. +&erage cash expenses <$otal expenses in debit side of P P L a-c > 4on cash item such as depreciation# goodwill# preliminary expenses written off# loss on sale of in&estments# fixed assets written off = ad&ance tax *'gnore pro&ision for tax) . $he net amount is di&ided by :A; to arri&e a&erage expenses. 5emar(s : 7 'n Comparison When absolute cash ratio is lower then current liability is higher When cash position to $otal +sset ratio is lower then the total asset is relati&ely higher.
narayan. When cash inter&al is lower the company maintain low cash position. 't is not good to maintain too low cash position or too high cash position.


9) Li0uidity 5atio : 7 ) Current ratio < Current asset Current Liability ") Buic( ratio or +cid $est ratio < Buic( +sset Buic( liability 4otes : 7 Buic( +sset < Current +sset > ,toc( Buic( Liability < Current liability > Cash credit# 9an( borrowings# .% and other ,hort term 9orrowings. ,ecured loan is a current liability and also come under cash credit ,undry debtors considered doubtful should not be ta(en as 0uic( asset. Creditors for capital W'P is to be excluded from current liability. Current asset can include only mar(etable securities. Loans to employees in asset side are long term in nature and are not part of current assets. Pro&ision for gratuity is not a current liability. 8ratuity fund in&estment is not a part of mar(etable securities. $rade in&estments are not part of mar(etable securities. 5emar(s : 7 /igher the current ratios better the li0uidity position. C) Capital structure ratios : 7 ) %ebt e0uity ratio *or) Le&erage ratio < %ebt E0uity < Long term debt Long term fund < External E0uity 'nternal E0uity < ,hare holders fund Long term fund

") Proprietary ratio < Proprietary fund $otal +ssets :) $otal Liability to 4et worth ratio < $otal Liabilities 4et worth ?) Capital gearing ratio < Preference share capital = %ebt
narayan. E0uity > Preference share capital 4otes : 7 ,hare holders fund *or) E0uity *or) Proprietary fund *or) .wners fund *or) 4et worth < E0uity share = Preference share = 5eser&es and surplus > P P L a-c > Preliminary Expenses. %ebt *or) Long term liability *or) Long term loan fund < ,ecured loan *excluding cash credit) = unsecured loan = %ebentures. $otal asset < $otal assets as per 9alance sheet > Preliminary expenses. $otal liability < Long term liability = Current liability *or) short term liability Long term fund < $otal asset > Current liability < ,hare holders fund = long term loan fund. 5emar(s : 7 'n debt e0uity ratio higher the debt fund used in capital structure# greater is the ris(. 'n debt e0uity ratio# operates fa&orable when if rate of interest is lower than the return on capital employed. 'n total liability to 4et worth 5atio < Lower the ratio# better is sol&ency position of business# /igher the ratio lower is its sol&ency position. 'f debt e0uity ratio is comparati&ely higher then the financial strength is better. %) Profitability 5atio : 7 ) 8ross Profit 5atio < 8ross Profit ,ales ") 4et Profit 5atio < 4et Profit ,ales 6 II 6 II 6 II

:) .perating Profit ratio < .perating profit ,ales

?) 5eturn to shareholders < 4et profit after interest and tax ,hare holders fund ;) 5eturn on 4et Worth < 5eturn on 4et worth 4et worth 6 II

A) 5eturn on capital employed *or) 5eturn on in&estment < 5eturn *E9'$) Capital Employed F) Expenses 5atios :7
narayan. a) %irect expenses 5atios : 7 i) 5aw material consumed ,ales ii) Wages 6 II ,ales iii) Production Expenses 6 ,ales 6 II



b) 'ndirect expenses 5atios : 7 i) +dministrati&e Expenses 6 II ,ales ii) ,elling Expenses 6 II ,ales iii) %istribution Expenses 6 II ,ales i&) 2inance Charge 6 II ,ales 4otes : 7 'n the abo&e the term MtermN is used for business engaged in sale of goods# for other enterprises the word Mre&enueN can be used. 8ross profit < ,ales > Cost of goods sold .perating profit < ,ales > Cost of sales < Profit after operating expenses but before 'nterest and tax. .perating Expenses < +dministration Expenses = ,elling and distribution expenses# 'nterest on short term loans etc. 5eturn < Earning before 'nterest and $ax < .perating profit < 4et profit = 4on operating expenses > 4on operating 'ncome Capital employed < ,hare holders fund = Long term borrowings < 2ixed assets = Wor(ing capital 'f opening and closing balance is gi&en then a&erage capital employed can be substituted in case of capital employed which is .pening capital employed = Closing capital employed " E) %ebt ser&ice co&erage ratios < Profit a&ailable for debt ser&icing Loan 'nstallments = 'nterest 4otes : 7 Profit a&ailable for debt ser&icing < 4et profit after tax pro&ision = %epreciation = .ther non cash charges = 'nterest on debt.
narayan. 5emar(s : 7 /igher the debt ser&icing ratio is an indicator of better credit rating of the company. 't is an indicator of the ability of a business enterprise to pay off current installments and interest out of profits.


2) $urno&er 5atios: 7 i) +ssets turno&er < ,ales $otal assets ,ales 2ixed assets W4umber of times fixed assets has turned into salesX

") 2ixed assets turno&er <

:) Wor(ing capital turno&er <

,ales Wor(ing capital

?) 'n&entory turno&er < Cost of goods sold *for finished goods) +&erage in&entory ;) %ebtors turno&er *or) +&erage collection period < Credit sales *in ratio) +&erage accounts recei&able *or) < +&erage accounts recei&able 6 :A; *in days) Credit sales A) Creditors turno&er *or) +&erage payment period Credit purchases *in ratio) +&erage accounts payable *or) < +&erage accounts Payable 6 :A; *in days) Credit Purchases F) 'n&entory $urno&er *for W'P) < Cost of production +&erage 'n&entory *for W'P) G) 'n&entory $urno&er *for 5aw material) < 5aw material consumed +&erage in&entory *for raw material) I) 'n&entory /olding Period < :A; . 'n&entory turno&er ratio

) Capital $urno&er ratio < Cost of sales Capital employed

narayan. 4ote : 7 Wor(ing capital < Current asset > Current liability < I."; 6 Proprietary ratio +ccounts 5ecei&able < %ebtors = 9ills recei&able +ccounts payable < Creditors = 9ills Payable


5emar(s : 7 'f assets turno&er ratio is more than # then profitability based on capital employed is profitability based on sales. /igher in&entory turno&er is an indicator of efficient in&entory mo&ement. 't is an indicator of in&entory management policies. Low in&entory holding period lower wor(ing capital loc(ing# but too low is not safe. /igher the debtors turno&er# lower the credit period offered to customers. 't is an indicator of credit management policies. /igher the creditors turno&er# lower the credit period offered by suppliers. 8) .ther 5atios: 7 ) .perating profit ratio < 4et profit ratio = 4on operating loss - ,ales ratio ") 8ross profit ratio < .perating profit ratio = 'ndirect expenses ratio :) Cost of goods sold - ,ales ratio < IIE 7 8ross profit ratio ?) Earnings per share < 4et profit after interest and tax 4umber of e0uity shares ;) Price earning ratio < Mar(et price per e0uity share Earning per share A) Pay out ratio < %i&idend per e0uity share Earning per e0uity shares 6 II II

F) %i&idend yield ratio < %i&idend per share 6 Mar(et price per share

G) 2ixed charges co&erage ratio < 4et profit before interest and tax 'nterest charges H) 'nterest co&erage ratio < Earning before interest and tax 'nterest charges I) 2ixed di&idend co&erage ratio < 4et profit

narayan. +nnual Preference di&idend ) .&er all profitability ratio < .perating profit Capital employed ") Producti&ity of assets employed < 6 II


4et profit . $otal tangible asset

:) 5etained earning ratio < 5etained earnings 6 II $otal earnings /) 8eneral 5emar(s: 7 2all in 0uic( ratio when compared with last year or other company is due to huge stoc( pilling up. 'f current ratio and li0uidity ratio increases then the li0uidity position of the company has been increased. 'f debt e0uity ratio increases o&er a period of time or is greater when comparing two ratios# then the dependence of the company in borrowed funds has increased. %irect expenses ratio increases in comparison then the profitability decreases. 'f there is wages - ,ales ratio increases# then this is to &erified a) Wage rate b) .utput - Labour rate 'ncrement in wage rate may be due to increased rate or fall in labour efficiency. +gain there are many reasons for fall in labour producti&ity namely abnormal idle time due to machine failure# power cut etc. 5eduction in 5aw material consumed - sales ratio may be due to reduction in wastage or fall in material price. 'ncrease in production expenses ratio may also be due to price raise. ,toc( turno&er ratio denotes how many days we are holding stoc(. 'n stoc( turno&er ratio greater the number of days# the mo&ement of goods will be on the lower side. 2inancial ratios are Current ratio# Buic( ratio# %ebt e0uity ratio# Proprietary ratio# 2ixed asset ratio. ,hort term sol&ency ratios are current ratio# Li0uidity ratio Long term sol&ency or testing sol&ency of the company ratios are %ebt e0uity ratio# fixed asset ratio# fixed charges co&erage ratio *or) 'nterest co&erage ratio. $o compute financial position of the business ratios to be calculated are > current ratio# %ebt e0uity ratio# Proprietary ratio# fixed asset ratio. 2ictitious asset are Preliminary expenses# %iscount on issue of shares and debentures# Profit and loss account debit balance.


A$$ign*#nt ) 9asis of $echni0ue used is minimiJation $echni0ue ") 't can also be done in maximation $echni0ue :) Larious steps in +ssignment Problem are ,tep : Chec( whether the problem is balanced or unbalanced by chec(ing whether row is e0ual to column# if unbalanced add dummy column or row to balance the problem ,tep ": 'dentify Least 4umber in each row and subtract with all number in that 5ow. ,tep :: 'dentify least number of each column and subtract with all number in that column. ,tep ?: Chec( whether solution is reached with Jero selection in one row and column# ie. Co&er all the Jero with minimum number of lines# solution is reached only when selected Jeros is e0ual to number of rows or columns or number of lines is e0ual to order of matrix. ,tep ;: 'f solution is not reached so maximum stic(ing ,tep A: ,elect the least element in within the unstri(ed Element ,tep F: $he element selected abo&e is i) ,ubtracted with all the unstri(ed element ii) +dded to all the double stri(ed element *'ntersection of two lines) ,tep G: Chec( the solution ,tep H: 'f solution is not reached continue with the process from step ;.

narayan. Lin#ar !r%gra**ing ,implex Method:7 ,teps:7 . %etermine the obKecti&e function _. .bKecti&e may be maximiJation or minimiJation. ". 2or maximation problem the constraints would be < sign. 2or minimiJation problem the constraints would be ] sign. :. 'ntroduce slac( &ariable 2or b sign > add the slac( &ariable ie. +dd , 2or ] sign > subtract the slac( &ariable and add artificial &ariable ie. ,ubtract , # add + . ?. Change the .bKecti&e function 2or , > +dd aI, C 2or + > +dd aM+ C ;. ,implex table format:7 CK Buantity Lariable Const. ` ^ _ , , ," _K CK 7 _K ," 55


A. F.

_K is arri&ed by summation of constant column with `#^#_ columns Criteria for selecting the (ey column :7 2or Maxima ion Problem > /ighest &alue of CK > _K 2or MinimiJation Problem > Lowest Lalue of CK > _K %i&ide the Buantity Column with Qey column to arri&e at 55

G. H. Criteria for ,electing the Qey row :7 2or Maximation P MinimiJation Problem > Lowest Positi&e 55 is selected I. $he Meeting Point is (ey Element . Criteria for deciding the optimal solution 2or Maximation Problem > +ll elements in CK > _K row is negati&e or Jero. 2or MinimiJation Problem > +ll elements in CK > _K row is positi&e or Jero 4ote > 2or finding whether all the elements in CK > _K row is positi&e or Jero for minimiJation problem substitute all the aMC with highest &alue. ". 'f solution is not reached next table is formed. :. 'nput for next table is 2irst (ey row in the next table is filled by di&iding all the numbers in the (ey row of the pre&ious table with the (ey element. 5emaining all the rows is arri&ed as follows: 7 Corresponding pre&ious c *Lalue relating to that 6 Corresponding $able row element row in the (ey column element in (ey row in the "nd table as filled in pre&ious step) ?. Chec( the optimal solution# if not reached form the third table. ;. 'f solution is reached then answer is amount in 0uantity column corresponding to the &ariable. .ther Points : 7 We can con&ert the MinimiJation Problem into Maximation Problem. $his is (nown as duality. We can change the ] sign to b sign to match the problem E.g. ` = ^ b II is con&erted into 7` 7 ^ ] 7 II




Tran$'%rtati%n $he procedure followed is MinimiJation Procedure Problem is generally sol&ed in LogelCs +pproximation Method*L+M) ,teps for the problem is : 7 . Con&ert profit matrix into loss matrix.

". 9alance the problem. :. +rri&e at 5ow penalty and column penalty 5ow penalty and column penalty is calculated at *"nd least > row or column.

least) in the corresponding

?. ,elect from the entire 5ow penalty and column penalty maximum number. ;. 2rom the entire 5ow or Column minimum is selected. A. ,tri(e the row or column which gets eliminated. F. Continue until the entire item in the table is stri(e. G. Write separately 'nitial solution table. H. Chec( for %egeneracy. %egeneracy occurs when all the elements in the initial solution is e0ual to *5ow = column > ) I. 'f degeneracy occurs introduce efcilon > aeC. aeC is introduced in least independent cell. . 2orm 3L Matrix. 't is formed by the element in the original solution corresponding to the element in the 'nitial solution. ". 2ind unalloted elements in the 3L Matrix :. 2ind 'K i.e.*.riginal Matrix element > 3nalloted element found abo&e)

?. Chec( for optimal solution ie. +ll items must be Jero or positi&e.
narayan. ;. 'f not reached select the maximum negati&e in 'K matrix. A. 2orm a loop and reallocate the solution. F. 5epeat from step H. 4otes: 7 . 'f there is Jero in 'K matrix while arri&ing at optimal solution then there is another solution for the problem. ". %ummy column can be introduced in profit or loss matrix.


:. 'f there is penalty-redundancy payment for unsatisfying demand etc. is gi&en then fills the dummy row or column with that amount or fill it with Jeros. ?. 'f there is constraint in the problem first satisfy the constraint and then sol&e. ;. &arious other methods for sol&ing the problem is Least cost method 4orth west corner rule A. 8enerally L+M method is used


N#t(%r0 Ana&/$i$ 1C!M/!ERT2 C!M $otal float < L, > E, *or) L2 > E2 2ree float < $otal float > /ead e&ent slac( 'ndependent float < 2ree float > $ail e&ent slac( 'n the diagram Es < Lf in the critical path Critical path is the longest duration $o find the minimum time associated cost *i.e. +dditional cost incurred per unit of time sa&ed) following formula is used :7 Crash cost per day *or) +cti&ity cost supply < Crash cost > 4ormal cost 4ormal time > Crash time 'nterfacing float < 't is the part of the total float which causes reduction in the float of the succession acti&ities. 'n other words it is the portion of acti&ity float which cannot be continued without affecting ad&ersely the float of the subse0uent acti&ity or acti&ities. ,teps in proceeding the problem : 7

". 2irst find and fill the E, and L2 column from the diagram. :. $hen find L, and E2 as follows :7 Ls < Lf > %uration Ef < Es = %uration ?. 2ind total float ;. 2ind free float. Where&er total float column has Jero free float column is also ta(en has Jero and remaining elements is filled as said abo&e A. 2ind 'ndependent float. Where&er free float column has Jero 'ndependent float column is also ta(en has Jero and remaining elements is filled as said abo&e

narayan. 4otes: 7 . E, < Earliest ,tart. 'ndicates earliest time that the gi&en acti&ity can be scheduled ". E2 < Earliest 2inish. $ime by which the acti&ity can be completed at the earliest. :. L2 < Latest 2inish. Latest allowable occurrence time of the head e&ent of the acti&ity. ?. L, < Latest ,tart.


;. $otal duration of the critical path is the maximum time-amount consumed for the acti&ity. $his should be crashed with respect to crashing days and crashing cost. $his crashing should not change the critical path. !ERT : 7 Expected *or) +&erage time is found by assigning weights as follows : 7 for optimistic ? for Most li(ely for pessimistic +&erage time < optimistic = ? most li(ely = pessimistic A ,tandard %e&iation < *Pessimistic time > .ptimistic time) A " Lariance < *,tandard %e&iation) Probability of completing the proKect in 4 days < 5e0uired time*4) *7) Expected time *critical path duration) ,tandard %e&iation W4othing but _ < *` 7 Mean) - ,tandard de&iationX < ^ *say) < 2ind _*y) < Probability E - 'f re0uired time ] Expected time then < I.; = _*^) - 'f re0uired time b Expected time then < I.; > _*^)

L#arning Cur-#

narayan. A: Learning is the process of ac0uiring s(ill# Qnowledge# and ability by an indi&idual. +ccording to learning cur&e theory the producti&ity of the wor(er increases with increase in experience due to learning effect. $he learning theory suggests that the best way to master a tas( is to Mlearn by doingN. 'n other words# as people gain experience with a particular Kob or proKect they can produce each unit more efficiently than the preceding one. $he speeding up of a Kob with repeated performance is (nown as the learning effect or learning cur&e effect. $he cumulati&e a&erage time per unit produced is assumed to fall by a constant percentage e&ery time the total output is doubled. ,o generally learning effect is found in the multiples of ". 'f learning cur&e effect is as(ed between two e&en numbers then Learning cur&e e0uation is formed ie. Learning cur&e effect is expressed mathematically as follows: Learning cur&e e0uation < ^ < a*x) 7b Where ^ < +&erage time per unit a < $otal time for first unit x < Cumulati&e number of units manufactured b < the learning cur&e index Learning cur&e index *b) < log * 7 E decrease) Log "

Manag#*#nt Acc%unting an, Financia& Ana&/$i$ Int#rnati%na& Financia& Manag#*#nt . %irect Buote *eg) d < 5s.?H
narayan. ". 'ndirect Buote *eg) 5s. < .I"I?d :. $$ 5ate < $elegraphic $ransfer 5ate ?. $.M 5ate < $omorrow 5ate ;. ,pot 5ate < $odayCs rate. 4ormally it will be :td day rate from $$ 5ate. %irect Buote is used in all country except 3Q where indirect 0uote is used. .ffer 5ate < ,elling 5ate ,pread 5ate < .ffer 5ate > 9id 5ate ,pread 5ate *E) < .ffer 5ate > 9id 5ate .ffer 5ate 6 II *


to that of 4P 5atio)

,wap points is ascending stage it is at premium. 'f it is descending stage it is at discount. 'f it is said as '45-d then the meaning is 4umerator factor < Local Currency < '45 %enominator factor < 2oreign Currency < d 2orward Buotation *E) *'.e. Premium-%iscount expressed at annualiJed E) < 2orward 5ate > ,pot 5ate 6 " 6 II *in months) ,pot 5ate n < 2orward 5ate > ,pot 5ate ,pot 5ate 6 :A; n 6 II *in days) e *pound)

'f the 0uote is direct or 'ndirect is to be found and the relation is with both direct and 'ndirect 0uote is to be said. Maturity Lalue < P * =r) n 'nterest 5ate Parity: i) %omestic 5ate b 2oreign 5ate = 2orward Premium - %iscount *'n this case in&est in foreign currency) ii) %omestic 5ate ] 2oreign 5ate = 2orward Premium - %iscount *'n this case in&est in %omestic Currency)

narayan. 2orward 5ate: 't is rate negotiated for the deli&ery to be made - ta(en on a future date for present transaction. 2uture spot rate: 't is actual rate pre&ailing on the agreed future date.


.ther points:7 Currency country which has less 'nterest rate will ha&e forward rate at premium and &ice &ersa 'f two rates ie."I.": - :; is gi&en then highest rate is offer rate# lowest rate is bid rate. 'f '45 - %8 is gi&en and we ha&e to %8 - '45 then it is - *'45 - %8) - *9id 5ate) < .ffer 5ate. - *.ffer 5ate) < 9id 5ate. 'nterest rate swap: 7 8enerally interest rate differs from company to company because of their grade *reputation) and rates can be fixed rates or floting rate. 'f there is " company under different grade and different fixed - floating rate can gin ad&antage by reducing their interest rate by M'nterest rate swapN. 'n this if aCompany +C wants to borrow at floating rate and aCompany 9C wants to borrow and fixed rate# then interest rate swap is applied by which company + borrows at floating 5ate of company 9 and company 9 borrows at fixed rate of company +. 9y this swap one company gains and other company losses. 4et gain is splited between two companies so that the two companies benefits by paying lower interest rate for their barrowing. $o loo( at the problem 0uic(ly the theory followed in M%ifference in fixed rate interest of two companies is profitN and M%ifference in floating rate interest of two companies is lossN. $hen net gain - loss are found.

Ca'ita& Bu,g#ting Process of Capital 9udgeting: /uge cash outlay. %ecision ta(en is irressable. 'n&est in lumsum the receipt is piecemeal Wrong decision will affect the &ery base of the company.
narayan. Capital 9udgeting 5ules:


'gnore accounting profit and ta(e only cash flows. $ry only incremental basis ignore +&erage calculation. Consider all incidental effects. 'gnore sun( cost *ie. Cost remain unaltered for &arious alternati&es a&ailable is sun( cost) Consider opportunity cost *.pportunity Loss is .pportunity cost) 9eware of allocated cost > 'gnore them %epreciation is an important cash flow when taxation is considered. 'f no taxation# no depreciation. 'nterest should not be considered as part of the cost# in the arri&al of cash inflow for in&esting decision problems. 'f deducted add bac( post tax interest. ,eparate in&esting decision and financing decision. 9e consistent with inflation rates. +ll future cash flows is assumed as without inflation. ,uch cash flows are referred as real cash flows. Cash flows under the influence of inflation would be referred to as money cash flows. *Money cash flows *or) 4ominal Cash 2lows *or) Mar(et cash flows) 3nless otherwise stated cost of capital is considered after tax basis because cash flows will be considered only on after tax basis. *PL factor is the in&erse of compounding factor) E0uation to find out the PL of an amount if cost of capital and 'nflation rate is gi&en * = Money 5ate) < * = 5eal %iscount rate) 6 * = 'nflation 5ate)

Method of e&aluating Capital 9udgeting: . Pay bac( method ". +nnual 5ate of 5eturn :. %iscounted cash flow 4et Present Lalue *4PL) 'nternal 5ate of 5eturn *'55) Profitability 'ndex *P') *or) 9enefit cost 5atio E0uated +nnuity Cost *E+C) *or) E0uated +nnuity 9enefit *E+9) %iscounted Pay 9ac( *or) $ime adKusted 9EP Expresse d 'n ^ears E 9ench mar( *9asis of ,election) ,hortest /ighest

2ormula 5eco&ery time of in&estment ) +5 - ''

When to use When no cost of capital is gi&en When no cost of

Pay 9ac( Period +nnual 5ate .f 5eturn 4PL '55 5s. E 8reatest Lalue /ighest ") +5 - +' %iscounted C' 7 %iscounted C. +t this rate %iscounted C' < %iscounted C. and 4PL < # P' < %iscounted C' %iscounted C. E+C < %iscounted C. PL 2actor E+9 < ) %iscounted C' +nnuity 2actor ") 4PL PL 2actor 5eco&ery time of 'n&estment capital is gi&en When two proKects is same in all aspects ie. 4o disparity 5arely used in finding Cost of Capital. ,iJe %isparity Life %isparity


Profitability 'ndex *P') E+C *or) E+9

Points 5s.

/ighest E+C < Lowest E+9 < /ighest

%iscounted Pay 9ac(



9rea( e&en time

Where: 7 +' < +&erage 'n&estment +2 < +nnuity 2actor '' < 'nitial 'n&estment

C' < Cash 'nflow C. < Cash .utflow

Error: 5eference source not found 'nternal 5ate of 5eturn *'55):7 '55 otherwise called as yield on in&estment# Marginal efficiency of capital# Marginal producti&ity of capital# 5ate of 5eturn# $ime adKusted rate of return. %iscounting = %ifference calculated in present &alue and re0uired cash outlay 2actor %ifference in calculated present &alues 6 %ifference in 5ate $o approximately locate the factor in which the amount returns 2 < ' - C Where 2 < 2actor to be located ' < .riginal 'n&estment C < +&erage Cash 'nflows per year 'n the PL table year column must be seen to trace the nearest fa(e annuity. ^ear column is the year of economic life of machine.

narayan. AG 4otes: 7 'f actual cash flow is higher than a&erage cash flows in the initial years then increase the fa(e '55 point a few E upward. 'f it is lower in the initial years then decrease the percentage few points lower to find fa(e '55 'f discount rates are not (nown but cash inflows and outflows are (nown then '55 is calculated as ' < 5 - * =r) Where ' < Cash outflow *or) 'nitial 'n&estment 5 < Cash inflow 5 < 5ate of return yielded by the 'n&estment *or '55) Calculating %iscounting 2actor:7 - * =rate) n Where n < ^ears Method of ran(ing proKects:7 %esirability factor *Profitability 'ndex) &s. 4PL Method &s. '55 ,election of proKects out of two mutually exclusi&e proKects ha&ing same funds at disposal then 4PL method is preferred. 'n '55 Method the presumption intermediate cash inflows are rein&ested at same rate i.e. '55. 9ut in 4PL method it is rein&ested at cut off rate. 5ein&estment at cut off rate is more possible than '55. /ence 4et Present Lalues being obtained from discounting at a fixed cut off rate are more reliable in ran(ing " or more proKects than '55. Models of 5is( +nalysis:7 i) /illerCs Model: /e ta(es into account mean of present &alue of the cash flows and the ,% of such cash flows. n M < i<I n

* =r)7 mi *used to determine the present &alue of mean)


* =r)7"i 6


*3sed to find the present &alue of &ariance)

i<I Where mi <Mean of cash flow in the ith period > expected cash flow for year i " Lariance in the ith period. i < r < %iscounting 2actor M < $otal of Present &alue of mean " < $otal of present &alue of &ariance 9ench mar( < ProKect with lower ,% will be preferred. ) 5eal Cash flows restated in terms of nominal cash flows as follows:7 * = inflation rate) 6 5eal cash flows
narayan. +fter this discounting cash flow is applied to find 4PL. ") Con&erting nominal discounting rate into real terms 5eal discount rate < = 4ominal discount rate 7 = inflation rate With this real discount rate the Cash 'nflows are discounted to find 4PL. :) Pay bac( reciprocal < +&erage annual cash inflows 'nitial 'n&estment *'t is used for reasonable approximation of '55)


?) $he formula for deflation is 'ndex 4umber at the beginning 6 Cash 'nflows 'ndex 4umber at the end *or) Cash 'nflows - * ='nflation 5ate) n 4ote: 'f in a problem 5eal cash flows are gi&en and 'nflation 5ate and Cost of Capital is gi&en then i) Con&ert 5eal Cash 2lows into 4ormal Cash 2lows by using formulae said in * ) abo&e. ii) +dKust for %epreciation and tax and find Cash 2low after $ax before %epreciation. iii) %eflate the amount arri&ed abo&e by using formulae said in *?). i&) With the amount arri&ed abo&e find 4PL using C.C.

,ummary:7 i) 5is( +dKusted %iscount rate approach < 4PL for C2+$ at 5is( adKusted %iscount 5ate. ii) Certainty E0ui&alent +pproach < 4PL for *Certainty E0ui&alent Coefficient 6 C2+$) at 5is( less 'nterest rate. iii) Probality %iscount approach < 4PL for *C2) at ris( less 'nterest rate.



Ana&/$i$ %f Ri$0 an, Unc#rtaint/ ) ,ensiti&ity +nalysis: 7 't pro&ides different cash flow estimates under : assumptions a. worst b. $he expected *Most li(ely) c. $he best. 4PL is found under these three assumptions and decision is ta(en. ") Precise measure of ris(:7 a) ,tandard de&iation: 7 +bsolute measure of ris(. n < D f Pi * C2 > C2 ) " i< C2 < Cash flow i < ^ear C2 < Mean cash flow *C2 of particular proKects total di&ided by number of C2) < f C2 6 P P < Probability
narayan. b) Lariance < * n ) < f i<


Pi * C2 > C2 ) "

c) Co > Lariance *a#b) < Pi * C2a > C2a ) * C2b > C2b ) d) Coefficient of correlation of two &ariable factor < Co > Lariance *a#b)
a b

e) 5eturn of portfolio < Wa 6 5a = Wb 6 5b Where f) 5is( of portfolio < D Pa" 6

" a

= Pb" 6

W > Proportion in&ested 5 > 5eturn " b = "Pa 6 Pb 6 a 6 b 6 Cor*a#b)

g) Co > Efficient of &ariation < + relati&e measure of ris(. ,tandard %e&iation L< Expected cash flow mean *or C2 *or) ) *.r) Expected 4PL *4PL ) 4PL < 4PL 6 Probability h) 5is( adKusted discount rate approach: 7 'n this ris( adKusted discount rate is ta(en as PL factor and calculated as 4PL method. <f *C2+$) t 7 C. Where Qr < 5is( adKusted discount rate * = Qr) t i) Certainty E0ui&alent *CE) approach < 5is( less Cash 2low 5is(y Cash 2low K) 'f Correlation Coefficient WCor*a#b)X is Cor*a#b) p . = *Pa 6 a) = *Pb 6 b) Wie. 'f it is perfectly positi&ely correlatedX 7 *Pa 6 a) > *Pb 6 b) Wie. 'f it is perfectly negati&ely correlatedX I +bo&e p formula will apply () Probability %istribution approach: 7 7 C. < 4PL *,% of C2) < D f p *C2 > C2)" < f C2 t * =i) Where C2 < Cash 2low C2 < Mean i.e. $otal of cash flow multiplied by probability for the period *or) expected &alue for C2+$ in period t) i < 5is( less rate of interest.



< ,% for period t *,% for particular period)

l) ,% for the probability distribution of 4PL is *ie. ,% of C2) *4PL) < D f * t") - * = i) "t *this is used for uncorrelated C2) *4PL) < f * t) - * = i) t *used for perfectly correlated C2) Where ' < 5ate of 5eturn. m) .ptimum proportion at which ris( is minimum < `a < b - * a = b) *or) a ` 7 b * 7`) < I 4PL for the period is calculated by ta(ing C2 as C2 for respecti&e period and calculated normally 4ote:7 i) 'n certainty E0ui&alent approach rate of discount is the ris( less rate of 'nterest as the ris( is adKusted with C2+$. ii) 'n this case C2+$ is multiplied with certainty e0ui&alent and PL is calculated by ris( less rate of interest. iii) 'f proKects are ran(ed with respect of ris( and return. ProKect with respect to ris( re0uires f 4PL *i.e. f*4PL 6 Probability)) and the proKect with respect to return find co7efficient of &ariation < - f 4PL

i&) Probability that 4PL would be _ero or less _ < I > 4PL $he _ Lalue is con&erted with the a_ $ableC &alues and the probability of the 4PL being Jero or less would be < I.; > *_ Lalue). &) Probability that 4PL being greater than _ero would be > *Probability less than _ero) &i) Probability that 4PL within the range ` and ^ _ < ` > 4PL _" < ^ > 4PL &ii) 'f in the 5is( adKusted %iscount approach both cost of control and 5is( adKusted discount rate is gi&en 2or the C2 of the years apply 5is( adKusted discount rate to find %iscounted C2. 2or the ,crap &alue of the machine after the end of the life the C2 on sale is discounted at cost of capital E to find %iscounted C2. &iii) 'f probability *or) Certainty e0ui&alence is gi&en then find the +dKusted C2 *C2 6 Probability) and then use the 5is( less 5ate of return to find %iscounted C2. ix) 5is( is ,tandard de&iation
narayan. ,ummary:7 i) 5is( +dKusted %iscount 5ate +pproach < 4PL for C2+$ at 5is( +dKusted %iscount 5ate ii) Certainty E0ui&alent +pproach < 4PL for *CE coefficient 6 C2+$) at 5is( less interest rate iii) Probability %iscount +pproach < 4PL for *C2) at 5is( less 'nterest 5ate


D#ri-ati-#$ Call .ption: 7 8i&es buyer M5ight but not the obligationN to buy the share. Put .ption: 7 8i&es buyer M5ight but not the obligationN to sell the share. Lalue of the Call .ption:7 i) 9lac( ,choles Model:7 Lalue of the call option < L. < W, 6 4 *d )X > W*x) 6 *e7t6rf) 6 *4 *d"))X Where d < ln *s-x) = *rf = Z " - "[) 6 t Dt ln < 4atural log d" < d 7 Dt s < Present spot rate x < 2uture stri(e *excise) price rf < 5is( free rate ,e&en step to sol&e the problem:7 i) 2ind log *s-x) ii) 2ind d iii) 2ind d"
narayan. i&) 2ind 4 *d ) &) 2ind 4 *d") i&) 2ind 4 *d ) &) 2ind 4 *d")


4ormal $able Lalue = I.;

&i) 2ind aeC &alue &ii) +pply 9lac( ,chools Model. ,ub step to step :7 a) Log *s-x) < Log s > Log x I.?:?: b) 'f x and s are " digit figure the &alue shall be * = Log table &alue). c) 'f x and s are : digit then the &alue shall be *" = Log table &alue). ,ub step to step A:7 a) 't is to find the power &alue of aeC. b) e7t6rf < = r-:A; 6 4o. of days *t)


. = r-:A; 6 4o. of Months *t)

Lalue of Put option: 7 < W*x) 6 *e7t6rf) 6 *4 *7d"))X 7 W, 6 4 *7d )X Excise price:7 't is the price at which the person writes the prices on a share to buy after a period. Expected Lalue of the share:7 't is the total of estimate mar(et price of the share multiplied with the respecti&e probability. Expiration &alue: 7 Excise price > Expected Lalue Expected *or) $heoretical &alue of the call option price at expiration *Pay off of Call option) :7 < f *Estimated mar(et price > Excise Price) 6 Probability *or) < WMax *s > x)# IX 6 Probability Pay off of call option Expected *or) $heoretical &alue of the put option price at expiration *Pay of put option):7 < f *Excise Price 7 Estimated mar(et price) 6 Probability *or) < WMax *x > s)# IX 6 Probability Pay off of Put option Where *Estimated mar(et price > Excise Price) is called pay off. 'f it is negati&e it is ta(en as Jero.
narayan. s < Estimated Mar(et Price. Put call parity < Put call parity e0uation is *Lalue of call option = Present &alue of excise price) < *&alue of put option = ,pot rate) 4ote:7 i) Changes to be made in computation of 9lac( ,choles model for di&idend stoc(s:7 ,ubstitute in all the places of MsN with Ms > PL of di&idendN ii)'n the abo&e all PL is found at 5is( free rate.


B#ta 9eta means# it measures the &olatility of securities to the changes in the mar(et. g *le&el of ris() <
s m

6 Cor *s#m)


< ,% of return on securities m < ,% of return on mar(et portfolio

" *or) Co&ariance*s#m) m g should always be applied on ris( premium and not to the entire return.

rs < rf = *rm > rf ) 6 g

Where rf < 5is( free rate rs < Expected return on securities *or) WCapital +ppreciation = %i&idend of the companyX rm < Expected return on mar(et portfolio *or) WMar(et index ZMar(et rate[ appreciation = Mar(et di&idend yield EX

Portfolio $heory *P$):7 rp *expected return under CML) < rf = *rm > rf) 6 * $he abo&e formula is based on total ris(. Where p < ,% of efficient portfolio.

When expected return under efficient portfolio is as(ed then rp *expected return under efficient portfolio) < Capital mar(et line*CML) > Express e0uilibrium price relationship between expected return and %,
narayan. Capital +sset Pricing Model *C+PM):7 rs *expected return portfolio in C+PM) < rf = *rm > rf) 6 W* *or) rf = W*rm > rf)X 6 g Where rm < rf = Mar(et premium 9eta of the portfolio < * ga 6 Pa ) = * gb 6 Pb )


)6 cor*s#m)X

Where Pa# Pb < Proportion of in&estment in Company + and Company 9. 4ote:7 i) *rm > rf) < Mar(et ris( premium *or) Compensation per unit of ris(. ii) Cor*s#m) is = under CML iii) rf = *rm > rf) 6 W* s m) 6 cor*s#m)X < $his portion in C+PM formula is ris( premium i&) *rm > rf) m < Mar(et ris( return trade off *slope). 4otes:7 $o find the in&estment to be made in ris( free in&estments to get a certain g is g of expected portfolio < *W 6 g ) =*W" 6 g") *or) < *W 6 g ) = * 7W ) g" Where W is weitage gi&en to existing securities. W" is weitage gi&en to ris( free securities. 'n this case g is g of existing securities and h" is g of rf securities *ie.I) $his can also be use to find in&estment in other then rf securities. 'n that case that g is substituted in g". $he weitage *W #W") is multiplied with mar(et &alue of existing portfolio to find the proportion of in&estment.



H%&,ing C%*'ani#$ 'ndex of Main Points:7 . 'f there is a %ebit balance in Minority 'nterest first it is adKusted against uncalled capital and balance is adKusted against reser&e. ". 'n case of Cumulati&e Preference shares of subsidiary di&idend declared must be deducted from P P L a-c of subsidiary. :. 'f no di&idend is declared in abo&e case then donCt deduct. ?. 'f di&idend is declared for Cumulati&e Preference shares then deduct from P P L a-c of subsidiary and balance is splited. 'f not declared then it must be shown outside the 9alance sheet. ;. 9ut in the case A. C2, deduct in the abo&e case whether declared or not. F. Preference shares of subsidiary held by the holding company is to be cancelled against in&estment of /olding company while preparing C2,. G. 'f /olding company sells goods below cost then unrealiJed loss is calculated by ta(ing cost or 4et 5ealiJable Lalue whiche&er is lower for &aluation. H. 'f there is difference in accounting policy between /olding and subsidiary then both should be brought under uniform policy before consolidation. I. 'f uniform policy cannot be brought then it should be disclosed. . $he effect of change in +ccounting Policy before ac0uit ion must be ta(en as pre ac0uit ion reser&e and after post ac0uit ion reser&e. ". 'f /olding Company holds %ebenture in subsidiary then while preparing C2, it should be cancelled as 'nter Company loan. :. 'n abo&e case if excess is paid for %ebenture holders then the excess is adKusted against consolidated reser&e. ?. Pre ac0uit ion reser&e and profit is treated as capital profit
narayan. FG ;. Post ac0uition reser&e and profit is treated as re&enue reser&e and re&enue profit respecti&ely. A. Miscellaneous expenses of subsidiary must be deducted against reser&e as Capital or 5e&enue 5eser&e. F. 'n case of 'nter Company transactions if it is down stream then unrealiJed profit of /olding company must be adKusted against Consolidated P P L a-c. G. 'n case of 'nter Company transaction if it is upstream it is splited into two as belonging to /olding company and Minority 'nterest and the former is deducted against Consolidated P P L a-c and Minority 'nterest is deducted from computation of $otal Minority 'nterest. H. Post ac0uit ion di&idend recei&ed is to be retained in P P L a-c. "I. Pre ac0uit ion di&idend recei&ed is to be transferred from /olding company P P L a-c to Cost of 'n&estment. " . Post ac0uit ion di&idend recei&able *Proposed) by /olding company out of subsidiary current year profit is to now credited to /olding company Consolidated P P L a-c. "". 'n case of analysis of profit Proposed %i&idend must be deducted from current year profit only. ":. 'f in the abo&e case if there is inade0uate profit for di&idend# the appropriation should be done st out of current year profits and thereafter out of b-f profit. "?. 'n case 'nter Company sale or purchase is carried between two subsidiaries then for consolidated stoc( it is considered as it is st transferred from one subsidiary to /olding > upstream rule apply and then from /olding to "nd subsidiary > %own stream rule apply. ";. 'n 'nter Company transaction if there is sale of 2ixed +sset between /olding and ,ubsidiary unrealiJed profit should be remo&ed only to the extent of unamortiJed portion. "A. 'n the absence of information regarding rate of depreciation# depreciation must be ignored. "F. 'n case of ac0uition and sale of shares# profit on such sale must be included in P P L a-c while calculating reser&es for C9,. "G. 'n the e&ent of current year di&idend is greater than the trading profits +4% if there is another source of income i.e. ,ubsidiary di&idend then the di&idend declared must be deducted only in +pportionment of profits. "H. 'nter corporate loans in general refer to borrowings from corporate bodies. :I. 'n case of re&erse wor(ing for stoc( consolidation < Company + = Company 9 > ,toc( reser&e for %ebtors and creditors < Company + = Company 9 > 'nter company consolidation transactions : . 'n case of +ssociate accounting 'nter Company transaction should not be cancelled only /olding company interest of unrealiJed profit is only ta(en. :". Losses in associate are ta(en only up to the liability in share capital. ::. Minority 'nterest calculation is not applicable in case of associate accounting. :?. 'n the case where subsidiary company is foreign company then con&ert the accounts into 'ndian Currency and remaining are same. 2or con&ersion rules applicable are:7 ,hare capital > 5ate on the date of ac0uition of share. 5eser&es > Pre > 5ate on the date of ac0uition Post > +&erage rate Current +ssets# Current liabilities > Closing rate
narayan. FH 2ixed assets# 'n&estments > 5ate on the date of ac0uition :;. Exchange rate difference which occurs on the abo&e con&ersion is to be setoff against post ac0uition Profit - 5eser&es and the balance is only to be apportioned for consolidation procedure. :A. 'n case of two or more ac0uition by /olding Co. *or) ac0uition and sale# 'n all the cases date for apportionment etc is the date of st ac0uition and share holding pattern is the final share holding pattern. :F. 'n case of +ssociate accounting# to find the carrying amount of 'n&estment of the associate in the consolidated balancesheet the calculation is similar to minority interest. .nly difference is to add the goodwill found in C.C. #ie# ,hare Capital 666 *=) Capital Profit 666 *=) 5e&enue Profit 666 *=) 8oodwill 666 666



A*a&ga*ati%n 'ndex of Main Points:7 . Points to be satisfied to treat the amalgamation in the nature of merger +ll assets and liabilities of transforer is to be ta(en o&er at their boo( &alues by resulting company +ll or at least HIE of the ,hare /olding of +malgamating Company must be the ,hare /olders of +malgamated Company. E0uity shares of selling company must be gi&en only e0uity shares of purchasing company. Liabilities of $ransferor must not be discharged! it must be ta(en o&er by the resulting company. 9ut exemption is the fraction shares can be gi&en in cash. ,ame ris( and return and nature of company must be same. ". .rder of +dKustment of consideration is first 8eneral 5eser&e and then P P L a-c. 'f the problem has statutory reser&e it should not be adKusted. 't is carried o&er as such. :. +s per ,E9' guidelines# underwriting commission is ".;E on e0uity shares and on st ;III Preference ,hares it is .;E and the balance Preference ,hares it is E. ?. Capital employed is considered as 4et 5e&aluation amount of $angible +sset. ;. 'n case purchasing company holding shares in selling company# 4et asset method is applied as usual and outside shareholders portion is calculated separately as balancing figure. A. 'f in the abo&e case# settlement of e0uity share holding of selling company is gi&en then that exchange pertains to outside share holderCs settlement and it should not be splitted. F. 'n the boo(s of selling company the shares held by the purchasing company must be cancelled by transferring it to realiJation a-c E0uity share capital a-c %r $o 5ealiJation G. 'f Preference share holders of selling company is discharged by preference share holders of purchasing company at premium then the premium portion must be transferred to realiJation a-c in the boo(s of selling company. H. 'n case of Merger while drafting Sournal Entry in the boo(s of purchasing company for 'ncorporation of +sset P Liability in the wor(ings# the consideration is aggregate consideration including shares already purchased by purchasing company and current purchase payable. I. 'n case of merger in the boo(s of purchasing company while calculation excess - shortage to be adKusted against the reser&e of selling company. $he purchase consideration is
narayan. G aggregate consideration including amount already paid *shares of selling company held by purchasing company) = amount now paid *amount paid to outsiders). . 9usiness purchase in case of shares of selling company held by purchasing company is the amount gi&en to outsiders only. ". 'f in the asset side of selling company %ebtors is gi&en as 8ross *>) 5eser&es - Pro&ision for %oubtful %ebts then in the boo(s of selling company while transferring all assets and liabilities to realiJation account %ebtors is transferred at gross amount and pro&ision is transferred along with liability. 9ut in the abo&e case in the boo(s of purchasing company while incorporating assets and liabilities of selling company debtors is ta(en net of pro&isions. :. .n entry for ta(eo&er of assets and liabilities of selling company in purchasing company boo(s > +ssets debited must be excluding goodwill in purchase method and difference in debit or credit is treated as 8oodwill - 5eser&es. ?. 'n&estment allowance 5eser&e is not a current liability. ;. When purchasing company holding shares in selling company then the shares held by purchasing company must be cancelled in the selling company boo(s. A. While canceling the shares held by the purchasing company it must be cancelled at fair &alue. F. $o bring the reser&e li(e 'n&estment allowance reser&e in purchasing company boo(s the entry will be +malgamation adKustment a-c %r $o 'n&estment allowance reser&e 'n the amalgamated 9-, in&estment allowance reser&e will appear in the liability side and amalgamation adKustment account will appear in the asset side for same amount. G. 'ncase of 'nter Company holding if di&ided is declared by any one company then di&idend recei&able by other company is to be st incorporated as pre amalgamation e&ent. %i&idend recei&able account %r $o P P L a-c Entry in the st company which has declared di&idend P P L a-c %r $o proposed di&idend H. 'n case of 'nternal reconstruction cancellation of +rrears %i&idend forgone by shareholder will not affect the 9-,. ,o no entry. 'n this case +rrears of di&idend is seaJed to be contingent liability. Preference shareholders will seiJe to ha&e the &oting right at par with e0uity shares which was a&ailable due to arrears of di&idend. "I. 'n %emerger while ma(ing transfer entry of +sset and liability in purchasing company fixed asset net is to be ta(en but while ma(ing the transfer entry in selling company fixed asset gross is ta(en in credited and pro&ision for depreciation is debited. " . 'n case of 'nter Company - ,ingle side holding etc. to find the intrinsic &alue of each company# the in&estment held by one company in the shares of other company is also to be &alued as intrinsic &alue only and not to be ta(en at boo( &alue. 2or inter company holding this intrinsic &alue of shares of each company can be found by framing a linear e0uation. "". 'n case of calculation of purchase consideration *Cross holding) $otal number of shares in selling company 666
narayan. G" *7) ,hare already held by Purchasing company 666 4umber of shares held by outsiders 666 Lalue of abo&e number of shares 5s. 666 4umber of purchasing company to be issued to selling company 666 *7) 4umber of shares already held by selling company 666 4et number of shares purchasing co. has to issue to selling co. 666 ":. 'n case of settlement of shareholders of selling company the amount will be < ,hares now recei&ed from purchasing company = Purchasing company shares already held by selling company. "?. 'n amalgamated 9-, if there is %ebit in P P L a-c it should be netted of with 8eneral 5eser&e as per schedule L'. ";. 'n case of assets and liabilities is ta(en o&er at re&alued amount it is in the nature of purchase and in the Kournal entry for incorporating account ta(eno&er only the re&alued amount is to be ta(en. "A. 'n case of selling company holding shares in purchasing company then in&estment is to be &alued at intrinsic &alue if specified. "F. 'n the abo&e case of holding company gi&es shares at particular &alue to the subsidiary company for settlement then in&estment is to be &alued at the &alue "G. When selling company holding shares in purchasing company then while transferring assets and liabilities to realiJation account in selling company boo(s# +ssets transferred must be excluding the 'n&estment in purchasing company. P5EP+'5 9^ ,+4S+^ Q3M+5