Accounting For Managers

Priyadarshini Engineering College, Vaniyambadi
Department of Management Studies
BA5103 /ACCOUNTING FOR MANAGEMENT
Lecture Notes
By
Dr.M.KRISHNAMOORTHI
AP/MBA
Dr. M.Krishnamoorthi,AP/MBA Page 1

BA5103 ACCOUNTING FOR MANAGEMENT
SYLLABUS
UNIT I FINANCIAL ACCOUNTING
Introduction to Financial, Cost and Management Accounting- Generally accepted

accounting principles, Conventions and Concepts-Balance sheet and related concepts-
Profit and Loss account and related concepts - Introduction to inflation accounting-
Introduction to human resources accounting.
UNIT II COMPANY ACCOUNTS
Meaning of Company -Maintenance of Books of Account-Statutory Books- Profit or Loss

Prior to incorporation- Final Accounts of Company- Alteration of share capital-
Preferential allotment, Employees stock option- Buy back of securities.
UNIT III ANALYSIS OF FINANCIAL STATEMENTS
Analysis of financial statements – Financial ratio analysis, cash flow (as per Accounting
Standard 3) and funds flow statement analysis.
UNIT IV COST ACCOUNTING
Cost Accounts - Classification of manufacturing costs - Accounting for manufacturing

costs. Cost Accounting Systems: Job order costing - Process costing- Activity Based
Costing- Costing and the value chain- Target costing- Marginal costing including
decision making- Budgetary Control & Variance Analysis - Standard cost system.
UNIT V ACCOUNTING IN COMPUTERISED ENVIRONMENT 12
Significance of Computerised Accounting System- Codification and Grouping of

Accounts- Maintaining the hierarchy of ledgers- Prepackaged Accounting software.

BA5103/ACCOUNTING FOR MANAGEMENT
UNIT-I
UNIT I FINANCIAL ACCOUNTING
Introduction to Financial, Cost and Management Accounting- Generally accepted

accounting principles, Conventions and Concepts-Balance sheet and related concepts-
Profit and Loss account and related concepts - Introduction to inflation accounting-
Introduction to human resources accounting.
Accounting has been termed as the language of business. The basic function of
accounting thus is to communicate the operating results of the business to the stake
holders and share holders of a business.
DEFINITION OF ACCOUNTING:
The American Institute of certified public accountants (AICPA) defined

accounting as “Accounting is the art of recording classifying and summarizing in a
significant manner and in terms of money transactions and events which are in part at
least of a financial character and interpreting the results thereof”.
OBJECTIVES OF FINANCIAL STATEMENTS
The basic objective of financial statements according to AICPA is ‘to provide

qualitative financial information about the business enterprise that is useful to
statement users, particularly owners and creditors in making economic decisions.
Apart from this the other important objectives are :
1) To provide information about the economic activities of the enterprise to several
external groups who, otherwise have no access to such information.
2) To provide useful information to investors and creditors in taking decisions
relating to investment and lending.
3) To provide information to potential investors in evaluating the earning power of
the enterprise.
4) To provide economic information to the owners to judge the management on its
stewardship of the resources of the enterprise and the achievements of the
corporate objectives.
5) To provide information which enables the investors to compare the performance
with similar other undertakings and take appropriate decisions regarding
retention or disinvestments of their holdings.
6) To provide information regarding accounting policies and contingent liabilities
of the enterprise as these have a barring in predicting, comparing and evaluating
the earning power of the enterprise.
FUNCTIONS OF FINANCIAL ACCOUNTING:
➢ Keeping systematic records

➢ Protecting the properties of the business
➢ Communicating the results to the stake holders of the business
➢ Meeting the legal requirements
LIMITATIONS OF FINANCIAL ACCOUNTING:
➢ Only transactions which can be measured in terms of money can be recorded in

the books of accounts. Events however important they may be to the business do
not find a place in the accounts if they cannot be measured in terms of money.
➢ According to the cost concept assets are recorded at the cost at which they are
acquired and therefore ignore the changes in values of assets brought about by
changing value of money and market factors.
➢ There is conflict between one accounting principle and another. For example,
current assets are valued on the basis of cost or market price whichever is less
according to the principle of conservatism. Therefore in one year cost basis may
be taken, whereas in another year market price may be taken. This principle
contravenes the principle of consistency.
➢ The balance sheet is largely the result of the personal judgment of the accountant
with regard to the adoption of accounting policies and as such objectivity factor
is lost.
➢ Financial accounting can be understood only by persons who have accounting
knowledge.
➢ Inter firm comparison and comparative study of two periods is not possible
under this system as required past information cannot be made available.
THE TERMS USED IN FINANCIAL ACCOUNTING.
* Purchase day book
This book is maintained mainly to record credit purchases of goods. The term
‘goods’ refers to all such commodities and services in which the firm normally deals.
Hence, cash purchases of goods or purchase of assets are not recorded in this book.
Entries are made in this book from inward invoices of credit purchases. It is also known
as ‘bought book’ or ‘purchase journal’ or ‘invoice book’.
* Sales day book
It is also known as ‘sold book’ or ‘sales journal’. All credit sales of goods are
recorded in this book. Cash sales and credit sales of assets are not shown in this book.
“Outward invoices” form the basis for making entries in the sales and must be
authenticated.
* Purchase return book

It is also called as ‘returns outward book’. Goods returned to suppliers which
were originally purchased on credit are recorded in this book.
* Sales return book
It is also called as ‘returns inward book’. Goods returned by customers which were
originally sold on credit are recorded in this book. Here it includes ‘credit note no’
instead of ‘debit note no.
* Bills receivable book
This is maintained to keep a detailed record of all the bills receivable received by
the firm. This book provides a medium for posting bills receivable transactions.
* Bills payable book
This book is maintained to keep a detailed record of all bills payables accepted
by the firm.
* Cash book
In most of the business concerns, the number of cash transactions will be large.
Hence, a separate cash book is maintained for recording such transactions. This keeps a
record of cash receipt and cash payment. It plays a dual role. It is a book of original
entry as well as book of final entry (ledger). There are four types of cash book.
(i) Simple cash book

(ii) Two column cash book
(iii) Three column cash book
(iv) Petty cash book
* Journal
It is a book of original entry or prime entry which records the transactions in a

chronological order.
* Ledger

It is a book of main entry. It is nothing but a summary statement of all
transaction relating persons, assets or liabilities and expenses or incomes which have
taken place during a period of time showing their net effect.
* Trial balance
It is a list of all balances standing on the ledger accounts and cash book of a
concern. It is a statement with debit and credit balance.
* Subsidiary books
In bigger concerns transactions are numerous so posting in journal and different

ledger account will be very difficult. So the journal is sub-divided into various
subsidiary books which is used for recording transactions of similar nature.
* Transactions
Transactions are those activities of businessmen, which involve transfer of

money or goods or services between to persons or to accounts. When cash paid
immediately then it is cash transaction. When cash received or paid in future data it is
credit transaction..
* Goods
The term goods include all merchandise, commodities, etc, in which a trader
deals in the normal course of business. Thus, commodities bought for resale are treated
as goods. E.g. For furniture dealer, furniture is a good and for others it is a asset.
* Book – keeping.
It means recording business transactions in a set of account books in a

systematic or proper manner.
* Assets
According to Finny & Miller ‘Assets are future economic benefits, the rights
which are owned or controlled by an organization or individual. It is also defined as
anything of value owned by a business’.
* Liabilities

According to Finny & Miller ‘Liabilities are debits, they are amounts owned to
creditors, theses the claims of those who are not owners are called liabilities’. In simple
it is a ‘debt repayable to outsiders by the businesses.
* Capital
It represents owners fund invested in a business. It may be original amount

invested by the owner or original contribution adjusted for profits and drawings. It is
also known as ‘owners equity’ or ‘net worth’.
* Revenue
It is defined as the inflow of assets which result in an increase in the owners equity. It
includes all incomes like sales receipt, etc. The receipts of capital nature like additional
capital, etc are not a part of revenue.
* Expenses
It is spent in order to produce and sell the goods and services which bring in the
revenue. Expenses may be defined as ‘the cost of the use of things services for the
purpose of generating revenue. It may be capital or revenue expenses.
* Purchase
Buying of goods with the intention of resale is called purchases. If cash in paid
immediately for the purchase, it is cash purchase. If the payment is postponed, it is
credit purchases.
* Sales
Selling of goods in the normal course of business is termed as sales. If cash is

received immediately it is cash sales. If the payment for sale is postponed, it is credit
sales.
* Purchase returns
These are the goods returned by the trader to the supplier because of poor
quality or defects in the goods, supplied. It is also known as ‘return outwards’ or ‘return
to suppliers’.

* Sales returns
When the trader receives back goods from the customer for poor quality or
defects in the goods sold out, it will be called as ‘sales return’ or ‘return inwards’ or
‘returns from customers’.
* Stock
It refers to goods lying unsold on a particular date. The stock of goods at the end
of the accounting period is called ‘closing stock’ and the stock at the beginning of an
accounting period is called ‘opening stock’.
* Debtors
A person who receives a benefit without giving money or money’s worth

immediately, but liable to pay in future is a debtor. Debtor can be a ‘trade debtor’ if he
buys goods on credit, others are non trade debtors.
* Creditors
A person who gives a benefit without receiving money or money’s worth

immediately but, liable to claim in future is a creditor. Creditor can be ‘trade creditor’ if
he supplies goods on credit. Others are non trade creditors.
* Drawings
Any amount of money or money’s worth withdrawn by the owners of the

business is termed as drawings. It is usually subtracted from capital.
* Equity or net worth
It is also known as capital.
* Turnover
It is also called as ‘sales’.
* Work – In progress

It is a value of semi or partly finished goods at the time of preparation of cost
sheet.
THE CLASSIFICATION OF ACCOUNTING
Accounting broadly classified two types are,
1. Personal Accounts
2. Impersonal Accounts – Real Account, Nominal Account
(i) Personal Account
Account of personal with which the business has dealings is known as personal
accounts. A separate account is prepared for each person.
(a) Natural Persons
The name of an individual, customer or suppliers, etc, both males and females
are included in it.
(b) Artificial persons or legal bodies:
Firms account, limited companies, educational institutions, bank account, co-

operative society, etc, are known an artificial persons account.
(c) Representative Personal Accounts
All accounts representing outstanding expenses and accrued or prepaid incomes

are representative personal accounts e.g. prepaid insurance, outstanding wages, etc.,
When a person starts a business he is called proprietor. This proprietor is

represented by capital account for all that he investor in business and by drawings
account for all that which he withdrawn from business. So, capital account and drawings
account are also personal accounts.
(ii) Real accounts
Accounts in which the business records the real things owned by it i.e., assets of
the business are known as real accounts. It is of two types, tangible and intangible real
accounts. The assets which can be touched and felt and they have no physical shape e.g
trademark, goodwill etc., are intangible real accounts.

(iii) Nominal accounts
It relates to the items which exist in name only. Accounts which record expenses,
losses, incomes and gains of the business are known as nominal accounts. E.g. rent
account, postage account, etc.The double entry system of book-keeping is a scientific
and complete system. Hence the transactions should be recorded according to the
following:
(i) Personal Accounts
“Debit the receiver, Credit the giver”.
(ii) Real Accounts
“Debit what comes, Credit what goes out”
(iii) Nominal Accounts
“Debit all expenses and losses, Credit all incomes and gains”.
These are the varies rules for making entries under double entry system.
ACCOUNTANCY PRINCIPLES (GAAP – GENERALLY ACCEPTED ACCOUNTING

PRINCIPLES)
Accounting principles, rules of conduct and action are described by various terms such
as concepts, conventions, tenets, assumptions, axioms, postulates, etc.
Accounting concepts are the assumptions or postulator or ideas which are essential to
the practice of accounting and preparation of financial statements.
(i) Business Entity concept:
Business is treated as a separate entity distinct from that of the proprietor.
(ii) Going concern concept:
It is assumed that a business unit has a perpetual succession or continued

existence and transactions are recorded from this point of view.
(iii) Dual aspect concept:

Each business transactions have two aspects i.e. benefit receiving and benefit
giving aspect.
Assets = Liabilities + Capital
(iv) Cost concept:
Assets purchased are normally entered in the accounting book at the cost at
which they are purchased. The market value in immaterial.
(v) Money measurement concept:
Accounting records only those transactions which can be expressed in terms of

money.
(vi) Realization concept:
The revenue is realized only when the sale is made.
(vii) Accrual concept:
While finalizing accounts, all expenses and losses pertaining to the accounting
period must be listed out. Outstanding and prepaid expenses and incomes also to be
recorded.
(viii) Matching concept:
The revenues earned during an accounting period are matched with the cost
associated with the period to ascertain the profit earned.
(ix) Accounting period concept: It helps to measure the income generated during the
specific accounting period which maker it possible to distribute it to the owners.
CONVENTION OF ACCOUNTING
Accounting conventions are those customs, usage and traditions that are being followed
by the accountants.
(i) Convention of conservation:

It is a policy of caution or “playing safe”. The accountants are expected not to
take into account “anticipated profits” but to provide for all possible anticipated losses’.
Window dressing in accounts is not permitted.
(ii) Convention of consistency:
Accounting practice should remain unchanged for a fairly long time. Ant they
should not be changed unless it becomes absolutely essential to change them. E.g.
Method of depreciation.
(iii) Convention of material disclosure:
Materiality means relative importance. All important items and facts should be
disclosed in accounting statements. Immaterial details should be ignored else the whole
accounting process will become highly cumbersome and meaningless.
(iv) Convention of full disclosure:
All accounting statements should be prepared honestly. This type of disclosure

needs proper classification, summarization, aggregation and explanation of the
numerous business transactions.
COST ACCOUNTING
DEFINITION: According to the Institute of Cost and Works Accountants

(ICWA),London, Cost accounting is “ the process of accounting for costs from the point
at which expenditure is incurred or committed to the establishment of its ultimate
relationship with cost centers and cost units.
In its widest usage it embraces the preparation of statistical data, the application
of cost control methods and the ascertainment of the profitability of activities carried
out or planned.”
OBJECTIVES OF COST ACCOUNTING :
1) to aid in the development of long range plans by providing cost data that acts
as a basis for projecting data for planning.
2) To ensure efficient cost control by communicating essential data costs at
regular intervals and thus minimize the cost of manufacturing.
3) Determine cost of products or activities, which is useful in the determination
of selling price or quotation.

4) To identify profitability of each product, process, department etc of the
business
5) To provide management with information in connection with various
operational problems by comparing the actual cost with standard cost, which
reveals the discrepancies or variances?
LIMITATIONS OF COST ACCOUNTING
Cost Accounting like other branches of accountancy is not an exact science but is
an art which was developed through theories and accounting practices based on
reasoning and commonsense. These practices are dynamic and evolving. Hence, it lacks
a uniform procedure applicable to all the industries across. It has to be customized for
each industry, company etc.
Management Accounting Concepts
DEFINITION: According to M.A.Sahaf Management Accounting is “ a system for

gathering, summarizing, reporting and interpreting accounting data and other financial
information primarily for the internal needs of the management. It is designed to assist
internal management in the efficient formulation, execution and appraisal of business
plans.”
Management Accounting covers not only the use of financial data and a part of costing
theory but extends beyond. It scope covers
1. Financial accounting
2. Cost accounting
3. Financial statement analysis
4. Budgeting
5. Inflation accounting
6. Management reporting
7. Quantitative techniques
8. Tax accounting
9. Internal audit
10. Office services
FUNCTIONS OF MANAGEMENT ACCOUNTING :
➢To help the management in planning, forecasting and policy formulation

➢To help in analysis and interpretation of financial information
➢To help in decision making- long term as well as short term
➢To help in controlling and coordinating the business operations
➢To communicate and report the operational results to the share and stock
holders of the business.
➢ To motivate the employees by encouraging them to look forward
➢ To help the management in tax administration
TOOLS AND TECHNIQUES OF MANAGEMENT ACCOUNTING :
➢ Financial planning
➢ Analysis of financial statements
➢ Cost accounting

➢ Standard costing
➢ Marginal costing
➢ Budgetary control
➢ Funds flow analysis
➢ Management reporting
➢ Statistical analysis
ADVANTAGES OF MANAGEMENT ACCOUNTING :
➢ It increases efficiency of business operations

➢ It ensures efficient regulation of business activities
➢ It ensures utilization of available resources and thereby increase the return on
capital employed.
➢ It ensures effective control of performance
➢ It helps in evaluating the efficiency of the company’s business policies
LIMITATIONS OF MANAGEMENT ACCOUNTING :
➢ It is based on historical data, as such it suffers from the drawbacks of the

financial statements.
➢ The application of management accounting tools and techniques requires
people who are knowledgeable in subjects such as accounting, costing,
economics, taxation, statistics, mathematics, etc.
➢ Though management accounting attempts to analyse both qualitative and
quantitative factors that influence a decision, the elements of intuition in
managerial decision making have not been completely eliminated.
➢ The installation of management accounting system is expensive and hence
not suitable for small firms.
THE USERS OF FINANCIAL ACCOUNTS

User Interest in / Use of Accounting Information
Investors Investors are concerned about risk and return in relation to their
investments. They require information to decide whether they should
continue to invest in a business. They also need to be able to assess
whether a business will be able to pay dividends, and to measure the
performance of the business' management overall. The key accounting
information for an investor is therefore:
- Information about growth - sales, volumes
- Profitability (profit margins, overall level of profit)
- Investment (amounts invested, assets owned)
- Business value (share price)
- Comparative information of competitors

Lenders Banks and loan stockholders who lend money to a business require
information that helps them determined whether loans and interest will
be paid when due. The key accounting information for lenders is
therefore:
- Cash flow
- Security of assets against which the lending may be secured
- Investment requirements in the business
Creditors Suppliers and trade creditors requirement information that helps them
understand and assess the short-term liquidity of a business. Is the
business able to pay short-term debt when it falls due? Creditors will,
therefore, be looking for information on:
- Cash flow
- Management of working capital
- Payment policy
Debtors Customers and trade debtors require information about the ability of the
business to survive and prosper. As customers of the company's
products, they have a long-term interest in the company's range of
products and services. They may even be dependent on the business for
certain products or services. Customer will be particularly interested in:
-Sales growth
- New product development
- Investment in the business (e.g. production capacity)
Employees Employees (and organisations that represent them - e.g. trade unions)
require information about the stability and continuing profitability of the
business. They are crucially interested in information about employment
prospects and the maintenance of pension funding and retirement
benefits. They are also likely to interested in the pay and benefits
obtained by senior management!. Employees will, therefore look for
information on:
-Revenue and profit growth

- Levels of investment in the business
- Overall employment data (numbers employed, wage and salary costs)
- Status and valuation of company pension schemes / levels of company
pension contributions

Government There are many government agencies and departments that are
interested in accounting information. Local government needs
information to levy local taxes and rates. Various regulatory agencies
need information to support decisions about takeovers and grants, for
example.
Analysts Investment analysts are an important user group - specifically for

companies quoted on a stock exchange. They require very detailed
financial and other information in order to analyse the competitive
performance of a business and its sector. Much of this is provided by the
detailed accounting disclosures that are required by authorities.
However, additional accounting information is usually provided to
analysts via informal company briefings and interviews.
Public at large Interest groups, formed by various groups of individuals who have a
specific interest in the activities and performance of businesses, will also
require accounting information.
PROFIT AND LOSS ACCOUNT AND RELATED CONCEPTS:
The starting point in understanding the profit and loss account is to be clear about the
meaning of "profit". Profit is the reward for taking risk. Profit has an important role in
allocating resources (land, labour, capital and enterprise). Put simply, falling profits
signal that resources should be taken out of that business and put into another one;
rising profits signal that resources should be moved into this business. The main task of
accounts, therefore, is to monitor and measure profits.
Profit = Revenues less Costs. So monitoring profit also means monitoring and
measuring revenues and costs. There are two parts to this:-
1) Recording financial data. This is the ‘book-keeping’ part of accounting.
2) Measuring the result. This is the ‘financial’ part of accounting.
Profits are ‘spent’ in three ways.
1) Retained for future investment and growth.

2) Returned to owners eg a ‘dividend’.
3) Paid as tax.
Components of Profit and Loss Account

The Profit & Loss Account aims to monitor profit. It has three parts.
1) The Trading Account: This records the money in (revenue) and out (costs) of the
business as a result of the business’ ‘trading’ ie buying and selling. This might be buying

raw materials and selling finished goods; it might be buying goods wholesale and selling
them retail. The figure at the end of this section is theGrossProfit.
2) The Profit and Loss Account: This starts with the Gross Profit and adds to it any
further costs and revenues, including overheads. These further costs and revenues
which may be in the nature of other operating, administrative, selling and distribution
expenses. This account also includes expenses which are from any other activities not
directly related to trading (non-operating).
An example is interest on investments. Thus, profit and loss account contains all other
expenses and losses, incomes and gains of the business for the accounting year for
which financial statements are being prepared. In this process, it follows the mercantile
basis of accounting (i.e, it takes into account all paid and payable expenses, and received
and receivable receipts). The net result of profit and loss account is called as net profit.
The main feature of profit and loss account is that it takes into account all expenses and
incomes that belong to the current accounting year and excludes those expenses and
incomes that belong either to the previous period or the future period.
3) The Appropriation Account. This shows how the profit is ‘appropriated’ or divided
between the three uses mentioned above.
INTRODUCTION TO THE TRADING ACCOUNT:

A Trading account is a statement prepared by a firm to ascertain its trading results for
the accounting year. Just like Profit & Loss account, it is also prepared for the year
ending. It takes into account the various trading expenses (usually all direct expenses)
and incomes. The net result will be either trading / gross profit or gross loss. In case of
a manufacturing concern, it will prepare an additional statement called a
manufacturing account. A manufacturing account is prepared by a manufacturer to
ascertain the cost of goods manufactured during the current accounting year.
FORMAT OF MANUFACTURING ACCOUNT:

Manufacturing account of ABC. Ltd for the year ending…..
PARTICULARS AMOUNT PARTICULARS AMOUNT
To work-in-process By Closing stock

(opening)
Raw materials
To Raw material consumed:
Work-in-process
Opening stock
By Cost of production
Add: Purchase of raw transferred to Profit & Loss
material account
Less: Closing stock of Raw

material

To Direct or productive
wages
To Factory overhead:
Power and Fuel
Factory rent
Carriage inwards
Octroi. Etc
TOTAL TOTAL
FORMAT OF TRADING ACCOUNT

Trading account of ABC. Ltd for the year ending…..
To Opening stock By Closing stock
To Purchases By Sales
To Direct or productive By Gross Loss transferred to

wages Profit & Loss account
To wages and salaries
To Power and Fuel
To Factory rent
To Carriage inwards
To Octroi. etc
To Gross profit transferred

to Profit & Loss account
TOTAL TOTAL
Uses of the Profit and Loss Account.
1) The main use is to monitor and measure profit. This assumes that the information
recording is accurate. Significant problems can arise if the information is inaccurate,
either through incompetence or deliberate fraud.

2) Once the profit (loss) has been accurately calculated, this can then be used for
comparison or judging how well the business is doing compared to itself in the past,
compared to the managers’ plans and compared to other businesses.
The format of a typical profit and loss account is as follows:
To Gross loss b/d By Gross profit b/d
To Salaries By interest received
To Salaries and wages By rent received
To Rent By commission received
To Commission By bad debts recovered
To Advertisement By Reserve for discount on

creditors
To Bad debts
By discount received
To Discount allowed
By gain on sale of fixed
To Reserve for bad debts
assets
To Reserve for doubtful
By net loss transferred to
debts
capital account
To Reserve for discount on
debtors
To Freight/ carriage
outwards
To loss on sale of fixed

assets
To uninsured loss due to fire
To interest on capital
To manger’s commission
To transfers to reserve
accounts
To net profit transferred to

capital account

TOTAL TOTAL
THE BALANCE SHEET AND RELATED CONCEPTS:
According to Howard, a Balance sheet may be defined as – ‘a statement which reports

the values owned by the enterprise and the claims of the creditors and owners against
these properties’.
The Balance sheet is a statement that is prepared usually on the last day of the
accounting year, showing the financial position of the concern as on that date. It
comprises of a list of assets, liabilities and capital. An asset is any right or thing that is
owned by a business. Assets include land, buildings, equipment and anything else a
business owns that can be given a value in money terms for the purpose of financial
reporting. To acquire its assets, a business may have to obtain money from various
sources in addition to its owners (shareholders) or from retained profits. The various
amounts of money owed by a business are called its liabilities. To provide additional
information to the user, assets and liabilities are usually classified in the balance sheet
as:
- Current: those due to be repaid (Current liabilities) or converted into cash within 12
months of the balance sheet date(Current Assets).
- Long-term: those due to be repaid (Long term liabilities) or converted into cash more
than 12 months after the balance sheet date (Fixed Assets).
Fixed Assets:
A further classification other than long-term or current is also used for assets. A "fixed
asset" is an asset which is intended to be of a permanent nature and which is used by
the business to provide the capability to conduct its trade. Examples of "tangible fixed
assets" include plant & machinery, land & buildings and motor vehicles. "Intangible
fixed assets" may include goodwill, patents, trademarks and brands - although they
may only be included if they have been "acquired". Investments in other companies
which are intended to be held for the long-term can also be shown under the fixed asset
heading.
Capital:
As well as borrowing from banks and other sources, all companies receive finance from
their owners. This money is generally available for the life of the business and is
normally only repaid when the company is "wound up". To distinguish between the
liabilities owed to third parties and to the business owners, the latter is referred to as
the "capital" or "equity capital" of the company. In addition, undistributed profits are
re-invested in company assets (such as stocks, equipment and the bank balance).
Although these "retained profits" may be available for distribution to shareholders - and

may be paid out as dividends as a future date - they are added to the equity capital of
the business in arriving at the total "equity shareholders' funds".
At any time, therefore, the capital of a business is equal to the assets (usually cash)
received from the shareholders plus any profits made by the company through trading
that remain undistributed
The basic functions of a balance sheet are:

1. It gives the financial position of a company on any given date
2. It gives the liquidity picture of the concern
3. It gives the solvency position of the concern
The basic components of a balance sheet are:
LIABILITIES ASSETS
1. Net Worth 1. Fixed assets

2. Non-current liabilities / long term 2. Intangible assets
liabilities 3. Current assets
3. Current liabilities 4. Deferred expenditure
5. Other assets
Pro-forma of a Balance sheet is as follows:
Balance sheet of ABC Ltd as on 31st December 2005
LIABILITIES AMOUNT ASSETS AMOUNT

(Rs) (Rs)
Capital Fixed assets
Add: Net profit for the Land & Buildings
period Plant & Machinery
Further capital Equipment
introduced Furniture & Fixtures
Interest on capital Investments:
Less: Drawings Current assets:
Interest on drawings Sundry debtors
Closing stock
Bills / Notes receivable
Net loss for the period Prepaid expenses
Loans Outstanding incomes
Other long term borrowings Cash in hand
Sundry creditors Cash at bank etc
Bills / Notes payable
Outstanding expenses
Incomes received in advance
etc

TOTAL LIABILITIES TOTAL ASSETS
COMMON ADJUSTMENTS AFFECTING THE PREPARATION OF BALANCE SHEET

ARE:
1. Income received in advance: Income received in respect of which service has

not been rendered is known as income received in advance. In order to calculate
the exact profit or less made during the year, such income should not be taken in
to account while preparing profit and loss account. Hence this amount must be
deducted from the respective income account in the profit and loss account and
must be treated as a liability in the balance sheet. The adjustment entry is
Income account Dr.
To income received in advance.
2. Closing stock : Closing stock appears on the credit side of trading account and
assets side of balance sheet if it is given in the adjustments. If it is given in the
trial balance it will appear only on the assets side of the balance sheet. The entry
passed is
Closing Stock A/c Dr.
To Trading Account.
3. Outstanding expenses : Outstanding expenses refer to those expenses which

have become due during the accounting period for which financial statements
are being prepared, but not yet have been paid. Such expenses if given in the
adjustments, should be added to the respective expenditure account on the debit
side of profit and loss account and must be shown as liabilities in the balance
sheet. If such expenses are given in the trial balance they should be recorded
only on the liability side of the balance sheet. The journal entry to be passed is
Respective Expenditure A/c Dr.
To Outstanding Expenditure
4. Pre-paid expenses : They are those expenses which have been paid in advance.
They are also known as un-expired expenses. If given in adjustments, they
should be deducted from the respective expenditure account on the debit side of
the profit and loss account and must be shown on the asset side of the balance
sheet. If given in the trial balance, they must be shown only on the asset side of
the balance sheet. The adjustment entry is
Pre-paid expenditure A/c Dr.
To Respective Expenditure
5. Outstanding or accrued income : This is the income which has been earned
during the current accounting year and has become due but not yet received by
the firm. If given in the adjustments, it must be added to the respective income
account on the credit side of the profit and loss account and must be shown on
the assets side of the balance sheet. But if given in the trial balance, it must be
shown only on the asset side of the balance sheet. The entry is
Outstanding/Accrued Income A/c Dr.
To Respective Income
6. Depreciation : It is a reduction in the value of the asset due to wear and tear,
lapse of time, obsolescence, exhaustion and accident. It is charged on fixed assets
of the business. If given in the adjustments, it must be shown on the debit side of
the profit and loss account and must be deducted from the respective asset
account in the balance sheet. If given in the trial balance, it must be shown only
on the debit side of the profit and loss account. The entry is
Depreciation A/c Dr.
To Respective Fixed Asset
7. Bad Debts : They represent that portion of credit sales (debtors) that had
become bad due to the inability of the debtor to repay the amount. It is a loss to
the business and gain to the debtor. This is a real loss to the business and as
such must be deducted from the debtors before deducting any reserves created
on debtors. If given in the adjustments it must be shown on the debit side of the
profit and loss account and must be deducted from the debtors account on the
asset side of the balance sheet. If given in the trial balance this amount must be
shown only in the profit and loss account. The entry is
Bad debts A/c Dr.
To Debtor’s personal account
8. Provision for bad debts : This represents a provision made by the business for
any potential bad debts. It is charged to the profit and loss account debit side
and must be deducted from the debtors after deducting the bad debts if any on
the asset side of the balance sheet, if given in the adjustments. If given in the trial
balance, it must be considered only in preparing the profit and loss account. The
entry is
Profit and loss A/c Dr.
To Provision for bad debts
9. Provision for doubtful debts : This represents a provision made by the

business for any potential doubtful debts. If given in the adjustments, it must be
charged to the profit and loss account debit side and must be deducted from the
debtors after deducting the bad debts (if any) and reserve for bad debts on the
asset side of the balance sheet. If given in the trial balance, it must be considered
only in preparing the profit and loss account. The entry is

To Provision for doubtful debts
10. Provision for doubtful debts : This represents a provision made by the
business for any potential discount to be allowed to the debtors. If given in the
adjustments, it must be charged to the profit and loss account debit side and
must be deducted from the debtors after deducting the bad debts (if any),
reserve for bad debts (if any) and reserve for doubtful debts (if any) on the asset
side of the balance sheet. If given in the trial balance, it must be considered only
in preparing the profit and loss account. The entry is
To Provision for discount on debtors
11. Reserve for discount on creditors: This represents a provision made by the
business for any potential discount to be allowed by the creditors of the
business. If given in the adjustments, it must be charged to the profit and loss
account credit side and must be deducted from the creditors on the liabilities
side of the balance sheet. If given in the trial balance, it must be considered only
in preparing the profit and loss account. The entry is
Reserve for discount on creditors A/c Dr
To Profit and Loss A/c
12. Interest on capital: This is the return the owners of the business will get for
investing in the business. Usually it is paid or added to the capital at a fixed
percentage. If given in the adjustments, it is shown on the debit side of the profit
and loss account and is usually added to the capital account on the liabilities side
of the balance sheet. If given in the trial balance, it must be shown on the debit
side of profit and loss account. The entries are :
Profit and Loss A/c
To Interest on capital
Interest on capital A/c Dr
To capital A/c
13. Interest on Drawings: Drawings represents the withdrawals made by the

owners during the accounting year either in the form of stock, cash or
withdrawal from bank for personal use. They must be deducted from the capital
account on the liabilities side of the balance sheet. Sometimes, firms charge
interest on such drawings made by the owners to discourage them from
withdrawing their investment. Usually it is levied as a fixed percentage. It is an

income to the business and a loss to the owner. Hence, if given in the
adjustments, it must be shown on the credit side of the profit and loss account
and deducted from the capital in the balance sheet. If given in the trial balance, it
must be shown only in the profit and loss account. The respective entries are:
Interest on Drawings A/c Dr
To Profit and loss A/c
Interest on Drawings A/c Dr
To capital A/c
INFLATION ACCOUNTING
Its normally refers to the increasing trend in general price levels. In economic
sense, it refers to a state in which the purchasing power of money goes down. According
to “American Institute of Certified Public Accountants define, ‘Inflation accounting as a
system of accounting, which purports to record as a built-in mechanism, all economic
events in terms of current cost’. It is a system of accounting like traditional accounting.
It is a method designed to show the effect of changing costs and prices on affairs of a
business unit doing the course of relative accounting period. The realization principle is
not rigidly followed, particularly in the case of recording fixed assets and long-term
loans.
REASONS FOR DISCREPENCIES IN ACCOUNTS DUE TO ADOPTION OF HISTORICAL

COST ACCOUNTS
1. Recording of fixed assets at their historical costs
2. Recording of inventory at historical cost instead of current cost
3. Recording of other assets and liabilities without taking into account their current
values
ISSUES IN INFLATION ACCOUNTING:
1. Adjustment Of Historic Cost Data: In the early days of inflation accounting

development, business houses often used to debate whether the historic cost
data should be adjusted for inflation induced price level changes or not. But,
later they started to follow it all the same while preparing their financial
statements.
2. Adjustment Items: While adjusting items for inflation, there are 2 approaches
one can take – 1) covering the adjustment of all financial items, 2) covering the
adjustment of only those items that have direct impact on financial results

3. Use Of Index No: The opinion of experts is varied on the use of index numbers
for adjusting the financial accounts. They can either use general purchasing
power index or specific index number. Mostly the use of general purchasing
power index is recommended as (a) it replaces the monetary unit of
measurement which ceases to be stable during the changing price level (b) it
provides the uniform standard of measurement for comparing diverse resources
(c) it can be used for restating assets as well as shareholders capital (d) it
communicates information regarding utilization of funds and profits gained to
the proprietors
TECHNIQUES OF INFLATION ACCOUNTING

The most important techniques developed by professional institutes and
accountants to deal with inflationary conditions are (1) Current purchasing power –
[CPP], (2) Replacement cost accounting method [RCA], (3) Current value accounting
method [CVA] and (4) Current cost accounting method [CCA].
1. Current Purchasing Power [CPP] : This is a very popular method among

professional institutes. Under this system the business keeps its accounts
maintained under financial accounting system {i.e. conventional historical cost
basis}. Then at the end of the account period supplementary statements must be
prepared showing all the items of financial statements in terms of the value of a
rupee to which they relate. These supplementary statements indicate the
changes in the financial conditions of the concern during the financial period as a
result of changes in the purchasing power of a rupee. For this purpose general
price index is used.
2. Replacement cost accounting method [RCA] : This method attempts to resolve

financial reporting problems that arise during the periods of rapidly changing
prices. It states that firms should create fixed asset replacement provision in the
Profit and loss account which is adequate to meet the requirements. Thus the
charges to profit and loss account are governed by the replacement cost of each
item rather than the depreciation cost. This concept requires that the reported
amount of expenses are to be measured at the time of asset expiration. Further
all the non-monetary items must be reported at the respective replacement cost
as on the balance sheet date.
3. Current value accounting method [CVA] : Under this method all items of
balance sheet are shown at current values. According to this method, the net
assets at the beginning and at the end of the accounting period are ascertained
and difference is implied to be profit or loss for the period. It attempts to reflect
economic reality to the preparation of financial statements by using current
values for reporting various items in the balance sheet.
4. Current cost accounting method [CCA] : This method had been suggested as a
base for financial reporting by Sandiland Committee appointed by the British
Committee in 1973 to solve the problem of price level changes. The Committee
reported that CPP may be used along with either historical cost or value
accounting.

ADVANTAGES OF INFLATION ACCOUNTING
1. It reflects an accurate picture of the profitability of the concern as it matches its
current revenues with its current costs. It keeps that capital intact as it does not
allow payment of dividend and taxes out of capital.
2. It enables a comparative study of the profitability of various concerns set up at
different periods.
3. As depreciation is charged on current value of assets, it is easier for the concern
to replace the assets.
4. By providing accurate financial information to the various interested parties, it
discharges the social obligation of the business.
5. It enables the company to realize a realistic price for its shares in the investment
market.
DIS-ADVANTAGES OF INFLATION ACCOUNTING
1. It is a complicated, confusing and time consuming process as it requires lot of

work.
2. The adjusted financial statements are difficult to be understood, analyzed and
interpreted by a common man. If proper conversion method is not adopted the
information provided may be inaccurate.
3. Income Tax Act of 1961 does not recognize the depreciation charged on current
value of fixed assets. Hence it is not suitable for tax purposes.
4. During inflation profits are overstated as lower depreciation is charged to fixed
assets.
HUMAN RESOURCE ACCOUNTING CONCEPTS
The concept of HR accounting was not known to the world till the early 60’s. During
this period, few experts like Hermanson, Hekimian, Jones andRensisLikert had
recognised HR as assets just like any other tangible or intangible assets.
Definition of Human Resource Accounting (Hra)

The term ‘HR Accounting’ implies accounting for Human resources – namely, the
knowledgeable, trained and loyal employees who participate in the earning process and
total assets. Different authors have defined HR Accounting in different terms. According
to the American Accounting Association (1973), HR Accounting is ‘the process of
identifying and measuring data about human resources and communicating the
information to interested parties’. In the words of Stephen Knauf – HR Accounting is
‘the measurement and quantification of human organization inputs, such as recruiting,
training, experience and commitment’.
Thus, HR Accounting had been defined by many authors in different ways. In essence, it
represents a systematic attempt to assess the value of human resource of an
organization.
THE PROCESS OF HRA

The process of HR Accounting includes – identification and measurement or
quantification of human resource in an organization and its reflection in its annual
reports or financial statements.
THE OBJECTIVES OF HRA
The objectives of HR accounting are:
1. To provide relevant information about the human resource to the management

and aid in its decision making
2. To help management in evaluating the performance of its personnel and calculate
its return on investment
3. To help the management in planning and controlling the various functions or
activities related with its human resource such as – man power planning, recruiting,
training and retirement etc.
ADVANTAGES OF HRA
The various advantages a firm can enjoy by establishing HR Accounting are as follows:
1. Its adoption acts as a motivating factor for the employees of the concern as it is
reflected in its financial statements
2. It helps the management in identifying and controlling several problems related
with human resources
3. It enables the management in efficiently using its man power by providing
quantified information about its HR
4. By considering HR as an asset in its financial statements, it provides a measure
of profitability
5. It helps the investors or potential investors in assessing the true value of a firm
by providing realistic information about its HR
DISADVANTAGES OF HRA
At the same time, a firm may also face certain limitations in implementing HRA such as
:
1. HR as an asset cannot be owned by any firm.

2. Quantification of HR value is subjective in nature and there is no common
valuation model existing which can be used across the industries or by all the
companies in the same industry
3. As its establishment and implementation involves huge cost, it may not suit small
firms
4. The concept of HRA is not recognized by tax authorities and has only academic
value
5. There is no objective procedure to be followed in the valuation of the HR, hence
comparative analysis may not be possible, and even if possible, may not be
reliable
TECHNIQUES OF VALUATION OF HR
There are around eight techniques for valuation of HR. They are as follows :

1. Historical cost Method: This method was developed by RensisLikert and his
associates and was adopted by R.G.Barrycorporation, Ohio, Colombia, USA, in
1968. This method involves capitalization of the costs incurred on HR related
activities such as – recruitment, selection, placement, training and learning etc,
and amortized over the expected length of services of the employees. The un
expired cost represents the firm’s investment in HR. In case an employee leaves
the organization before the expiry of the expected services’ life period, the firm
shall write off the entire amount of un expired cost against the revenue of the
period during which he or she leaves.
2. Replacement Cost Method: This method was initially developed by Hekimian

and Jones. According to this method, a firm’s HR value is its replacement cost.
According to Flamholtz, this replacement cost may be – i) individual
replacement cost – which refers to the cost of replacing an employee with an
equivalent substitute in terms of skill, ability and knowledge and ii) positional
replacement cost – which refers to the cost of replacing the set of services
expected to be rendered by an employee at the respective positions he holds and
will hold at present and in future. Thus, the HR value will appear in the financial
statements at its replacement cost.
3. Opportunity cost method: This method has been suggested by Hekimian and
Jones and refers to the valuation of HR on the basis of an employee’s value in
alternative uses, i.e, opportunity cost. This cost refers to the price other
divisions are willing to pay for the service of an employee working in another
division of an organization.
4. Capitalization of Salary method: This method had been proposed by

BaruchLev and Aba Schwartz in terms of economic value of HR. According to
them, the salaries payable to employees during their stay with the organization
may be used in valuing the HR of an organization. Thus the value of HR is the
present value of future earnings of homogeneous group of employees.
5. Economic valuation method: This values the HR of an organization by

considering the present worth of the employees’ future service expected to be
derived during their stay with the organization. Under this method, the
valuation of HR involves 3 steps – 1) estimation of employee’s future services, 2)
multiply step 1 by the employee’s rate of pay and 3) Multiply step 2 by the rate
of return on investment. This would give the present worth of employee’s
service.
6. Return on efforts employed method: Under this method, HR valuation is done

on the basis of the quantifying the efforts made by the individuals for the
organizational benefits by taking into account factors such as –positions an
employee holds, degree of excellence employee achieves, and the experience of
the employee.
7. Adjusted discounted future wages method: This model has been developed by
Roger.H.Hermanson. Under this method, HR valuation is done on the basis of

relative efficiency of an organization in the industry. This model capitalizes the
extra profit a firm earns over and above that of the industry expectations.
As such, this model involves 4 steps – 1) estimation of 5 years (succeeding)
wages and salaries payable to different levels of employees 2) finding out the
present value of such estimated amount at the normal rate of return of the
industry, 3) determining the average efficiency ratio (the co’s average rate of
return for the past 5 yrs)/ Industry’s average rate of return for the past 5 yrs)
for 5 years, 4) finding out the present value of future services of the co’sHr by
multiplying the discount value (as in 2nd step) by the firm’s efficiency ratio (as
calculated in 3rd step)
8. Reward valuation method: This model has been developed by Flamholtzand is

commonly known as – the stochastic rewards valuation model. It values the HR
of a concern on the basis of an employee’s value to an organization at various
service states (roles) that he is expected to occupy during the span of his
working life with the organization. This model involves – estimation of an
employee’s expected service life, identifying the set of service roles he may
occupy during his service life, estimating the value derived by an organization at
a particular service state of a person for the specified time period, estimating the
probability that a person will occupy at possible mutually exclusive service state
at specified future times, quantifying the total services derived by the
organization from all its employees, and discounting the total value thus arrived
at to its present value at a pre-determined rate.
Anna University Questions:
Two Marks:
1. Define Accounting? (May/June 2011)

2. Write Short note on Cost Accounting? (May/June 2011) (Jan 2013)
3. What is the Position of Ledger in Book Keeping? (May/June 2012)
4. Define Inflation Accounting? (May/June 2012),(June 2013)
5. What are the Functions of Accounting? (Apr/May 2011)
6. What is Provision for Doubtful Debts? (Apr/May 2011)
7. What is Money Measurement Concept? (Jan/2012)
8. Explain Management Accounting Information? (Jan/2012)
9. What is Profit and Loss Account? (Jan/2012)
10. What do you mean by GAAP? (Jan/2013)
11. What are the functions of Accounting? (NOV/DEC2013)
12. What is inflation accounting? (NOV/DEC2013)
13. What is financial accounting? (JAN 2014)
14. What are personal accounts? (JAN 2014)
15. What is GAAP? (MAY/JUNE 2014)

16. What is human resource accounting? (MAY/JUNE 2014)
17. Mention The objectives of accounting. (JAN 2015)

18. Define the term human resource accounting. (JAN 2015)
19. Define management accounting. (APR/MA 2015)
20. What is GAAP? (APR/MA 2015)
16 Marks:
1. Explain the difference branches of Accounting with their Significances?

(May/June 2011)
2. Evaluate the Generally Accepted Accounting Conventions? (May/June
2011),(Jan/2013)
3. What is Nature of Accounting? In What ways accounting information is Useful to
creditors, Investors and Employees of a business Enterprise? (May/June 2012),
(Jan/2012)
4. Explain the Importance of Various Accounting Concepts & Conventions?
(May/June 2012), (Jan2013)
5. Mention the Accounting Conventions and Explain? (Nov/Dec 2011)
6. Explain the concept of Inflation accounting. Discuss its Merits & Demerits?
(Nov/Dec 2011)
7. “Management Accounting is the best tool for the Management to achieve higher
profits and Efficient Operations” Discuss. (Apr/May 2011)
8. What are the Objectives, Importance & Advantages of Human resource
accounting? Explain. (Jan/2012)
9. Discuss the Brief about Accounting Concepts. (NOV/DEC2013)
10. What is Human resource accounting? State the advantages and limitations.
(NOV/DEC2013)
11. Distinguish between profit and loss account and balance sheet using an
Illustration. (JAN 2014)
12. Explain the concepts of human resource accounting. State its importance. Which
objections are generally leveled against HRA? (JAN 2014)
13. A Ltd. was registered with an authorized capital of Rs. 6,00,000 in equity
shares of Rs.10 each. The following is its Trial balance on 31st March, 2009.
(MAY/JUNE 2014)
Particulars Debit Credit

Goodwill 25,000 -
Cash 750 -
Bank 39,900 -
Purchase 1,85,000 -
Preliminary expenses 5,000 -
Share capital - 4,00,00
12% debentures - 4,00,00
Profit and loss account — 26,250
Calls in arrears 7,500 -
Premises 3,00,000 -
Plant and machinery 3,30,000 -
Interim dividend 39,250 -

SaIes - 4,15,000
Stock 75,000 -
Furniture 7,200 _
Sundry debtors 87,000 _
lVages 84,865 _
General expenses 6,835 -
Freight and carriage 13,115 -
Salaries 14,500 -
Directors' fees 5,725 —
Bad debts 2,110 -
Debenture interest paid 18,000 —
Bills payable - 37,000
Sundry creditors 40,000
General reserve - 25,000
Provision for bad debts - 3,500
12,46,750 12,46,750
Prepare Profit and Loss a/c profit and loss appropriation a/c and Balance sheet in
proper form after making the following adjustments :
(i) Depreciate plant and machinery by 15%
(ii) Write off Rs.500 from preliminary expenses
(iii) Provide for 6 months interest on debentures
(iv) Leave bad and doubtful debts provision at 5% on sundry debtors
(v) Provide for income tax at 50%
(vi) Stock on 31.3.2010 was Rs. 95,000
14. The following is the trial balance of Mr. Kumar as on 31 .t March, 2008 :
(MAY/JUNE 2014)
Debit Credit
Rs. Rs.
Sales 1,20,000
Purchases 82,000
Customs Duty 8,000
Royalty 5,000
Opening stock 12,000
Accounts receivable 22,000
Accounts payable 11,000
Bills receivable 10,000
Bills payable 8,000
Bad debts 2,000

Carriage inwards 1,000
Telephone charges 2,000
Printing and stationery 500
Investments 6,000
Interest 800
Land and buildings 40,000
Rent 3,200
Income tax paid 3,000
Cash 1,500
Furniture 5,000
Capital 57,000
2,00,000 2,00,000
Adjustments :
(i) Closing stock is valued at Rs' 22,000
(ii) Carriage on purchase outstanding amounts to Rs' 300
(iii) Interest receivable amounts to Rs ' 200
(iv) Rent received in advance amounts to Rs ' 400
(v) Depreciation @ 10% is required on furniture' Prepare Final accounts '
15. Define Cost accounting. What are the advantages of cost accounting? (JAN 2015)
16. Define management accounting. Discuss its scope. (JAN 2015)
17. Examine the various accounting concepts and conventions. (JAN 2015)
18. Explain accounting concepts and conventions. (APR/MA 2015)

UNIT-II COMPANY ACCOUNTS:
Meaning of company – maintenance in book of accounts – Statutory Books –Profit or

Loss prior to incorporation – Final Accounts of Company – Alteration of share capital –
preference allotment. Employees stock option -Buy back of securities.
NATURE OF A COMPANY.
The company is one of the forms of organization. It has its distinctive
characteristics and advantages which make it suitable for different purposes.
Legal Meaning
According to section 3(1) (i) of The Companies Act, 1956, “Company means a company
formed and registered under this Act or an existing company”.
On analyzing the aforesaid definitions the following characteristics of a company are
revealed:
1. An artificial person created by law: A company is called an artificial person
because it does not take birth like a natural person but comes into existence
through law. Being the creation of law, the company possesses only those
properties which are conferred upon it by its charter.
2. Separate Legal Entity:
A company is a separate legal entity as distinct from its members, therefore it is
separate at law from its shareholders, directors , promoters etc and as such is
conferred with rights and is subject to certain duties and obligations.
3. Perpetual Existence: The term perpetual existence means the continued

existence. The death, insolvency or unsoundness of mind of its members or
transfer of shares by its members does not in any way affect the existence of the
company. Members may come and members may go but the company goes on
forever. The company can be compared with flowing river where water
(members) keeps on changing continuously; still the identity of the river
(company) remains the same.
4. Common Seal: The term Common Seal means the official signature of the
company. Since the company being an artificial person cannot sign its name on a
document, every company is required to have its common seal with its name
engraved on the same. This seal acts as the official signature of the company. Any
document bearing the common seal of the company and duly witnessed by at
least two directors will be binding on the company.
5. Limited Liability: In case of a company limited by share, the liability of a
member is limited up to the amount remaining unpaid on the shares held by a
member.
6. Free Transferability of shares: The shares of a public company are freely
transferable. A shareholder can transfer association, even a public limited
company can put certain restrictions on the transfer of shares but it cannot
altogether stop it. A shareholder of public company possessing fully paid up
shares is at liberty to transfer his shares to anyone he likes in accordance with
the manner provided for in the articles of association of the company.
TYPES OF COMPANIES
The companies can be classified under the three categories as follows:
1. Basis of incorporation
2. Basis of liability
3. Basis of control
1. Basis of incorporation: This is further divided into three categories. They are as
follows:
a) Charted company: A company incorporated under a special charter granted by
the king or Queen of England is called “charted Company”. The familiar
examples of charted company are the East India Company and the Bank of
England. This type of company cannot now be formed in India.
b) Statutory Company: A statutory company is one which is created by a special

Act of Parliament or a state legislature. Such companies are usually formed for
achieving a purpose related with public utilities. The nature and powers of such
companies are laid down in the special Act under which they are created. A
statutory company has also a separate legal entity is conducted under the
control and supervision of the Auditor General of India and the annual report of
working is required to be placed before the Parliament or state legislature, a the
case may be. Example, Reserve Bank of India.
c) Registered or Incorporated Company: A registered company is one which is

registered in accordance with the provisions of the Companies Act of 1956 and
also includes the existing companies. Existing company means a company
formed and registered under any of the previous laws.
A registered company may either be a private company or a public company. It is
explained as follows:
1. Private Company- A private company means a company which has a minimum
paid up capital of Rs.1,00,000 or such higher paid up capital as may be prescribed,
and by its articles-
a) Restricts the right to transfer its shares, if any
b) Limits the number of its members to fifty, and

c) Prohibits any invitation to the public to shares in or debentures of the
company.
d) Prohibits any invitation or acceptance of deposits from persons other then its
members, directors or their relatives.
II- Public Company
A Public company means a company which is either

a) not a private company and has a minimum paid up capital of Rs 5,00,000
or such higher paid-up capital as may be prescribed: or

b) is a private company which is subsidiary of public company.
2. Based on Liability
On the basis of liability, an incorporated company may either be

i) A company limited by shares
ii) A company limited by guarantee
iii) An unlimited company
i) Company Limited by Shares- A Company limited by shares is a company in

which the liability of its members is limited by its memorandum to the
amount unpaid on the share respectively held by them. The companies
limited by shares may be either public companies or private companies. If a
member has paid the full amount of shares, then his liability shall be nil.
ii) Company Limited by Guarantee- A Company limited by guarantee is a
company in which the liability of its members is limited by its memorandum
to such an amount as the members may respectively undertake to contribute
to the assets of the company in the event of its being wound up.
iii) Unlimited Company- An unlimited company is a company in which the
liability of its members is not limited by its memorandum. In other words, the
liability of members is unlimited. The members of such companies may be
required to pay company’s losses from their personnel property.
3. Based on Control
On the basis of control, the companies may be grouped as follows:
1. Government Company- A government company means any company in which

at least 51% of the paid up share capital is held by the central government or by
any state government or partly by the central government and partly by one or
more state governments and includes a company which is a subsidiary of a
government company as thus defined.
Example: Hindustan Aeronautics Ltd.
2. Non-Government Company- A company which may not be termed as a

government company as defined in Section 617 is regarded as a non-government
company
3. Foreign Company- A foreign company means a company, which is incorporated
in a country outside India under the law of that country. After the establishment
of business in India, the relevant documents must be filed with the registrar of
companies within 30 days from the date of establishment.
4. Domestic Company-A company which cannot be termed as foreign company
under the provisions of the companies act as a domestic company.
5. Holding and Subsidiary Company- If one company controls the other company,
the controlling company may be termed as the “Holding Company” and company
so controlled may be termed as a “Subsidiary Company”.
6. Multi National Company
A multinational company is huge industrial organization which-
a) operate in more than one country

b) carries out production, marketing and research activities on international scale
in those countries, and
c) attempts to maximize profits world over.
THE FORMATION OF COMPANY
✓ Preparation of documents
✓ Filling of documents
✓ Payments of necessary payments
✓ Registration of a company
✓ Certificate of incorporation
Preparation and Filling of Documents:
Preparation and filling of documents for the formation of a company

following documents are filled with the registrar of joint companies of the state in which
registered office of the company is indented to be located;
a. Memorandum of association duly stamped, signed and witnessed.

b. Articles of association duly stamped, signed and witnessed.
c. A list of the directors who have agreed to become the first director of this
company.
d. Directors consent to act also take up the qualification shares.
e. A declaration by a competent person that all the requirement of this Act.
f. The agreement
Such a declaration may be given by act of the following person;
i. An advocate of the Supreme or High Court

ii. An attorney or a pleader entitled to appear before High Court
iii. A secretary or a Chartered Accountant in whole time basis and
engaged in the formation of the company
iv. A person named in the Articles of association as director or manager
or secretary of the company
Payment of fees and issue of certificate of incorporation:

• The registrar, on being satisfied, registers the Memorandum and Articles of
association and will certify under his hand that the company is incorporated and
in the case of a limited company that the company is limited. Before registration
the payment of fees is a formality.
• The certificate of incorporation is an important document in as much as it
evidences the existence of the company from the date on which the certificate
has been issued.
• It is conclusive evidence of the fact that the company has been registered the
effect of the certificate is to give the company a distinct and separate entity.
Perpetual succession. Common seal, and make all members a body corporate

• The certificate of incorporation is the conclusive evidence of the registration of
the company and cannot be cancelled afterwards even if some regulations are
subsequently detected. The only remedy for undoing the effect of registration is
to wind up the company according to provisions of the company Act.
SHARES
Total capital of the company is divided into small unit of denomination. One of
the units into which the capital of the company is divided is called a share. No trading
concern can run without capital.
Share capital constitutes the basic of the capital structure of the company.
Ownership of a company is verified in its shareholders and a share represents the
extent of ownership or interest in the assets and profits of the company. In this sense, a
share may be defined as one of the equal parts into which the capital of a company is
divided, entitling the holder of the share to a proportion of the profits.
CLASSES OF SHARES:
Companies usually issue three classes of shares, namely
a. Equity shares
b. Preference shares
c. Deferred shares
Equity shares: Equity shares are shares, one who holds are called as real owner of the
organization or company. The act defines an equity share in a negative way. An equity
share is one which is not a preference share. These are normally risk bearing shares.
In olden days the equity share holders do not receive any dividends. But in modern
days they receive substantial dividends. During liquidation of a company they are paid-
out but are usually entitled to all the surplus assets after the payment of creditors and
preference shareholders.
The value of these shares in the market fluctuates with the fortunes of the company. A
wise investor in equity shares not only receives regular dividends but is also assured of
capital appreciation.
Preference shares: Preference shares are simply called priority shares. That is at the
time of declaration of dividend and insolvency one who have priority is called as
preference share.
The company act defines a preference share as that part of the share capital of the
company which enjoy preferential right as to,
➢ The payment of dividend at a fixed rate during the lifetime of the company.
➢ The return of capital on winding up of the company.

It is expressed that a share to be called a preference share must enjoy both the
preferential rights. A preference shareholder cannot compel the company to pay
dividend. Preferential shareholders do not enjoy voting rights except when
➢ Dividend is outstanding for more than two years in the case of cumulative
preference shares.
➢ For more than three years in the case of cumulative preference shares.
TYPES OF PREFERENCE SHARES:
❖ Participating preference shares

❖ Non participating preference shares
❖ Cumulative preference shares
❖ Non cumulative preference shares
❖ Redeemable preference shares
❖ Irredeemable preference shares
a. Participating preference shares: It is otherwise called priority shares. It means

declaration of dividend and company insolvency participating preference share
holders get first priority.
b. Non participating preference shares: It is otherwise called non priority shares. In
this case the non participating preference share holders should not get any priority
to get back their dividend and other settlements.
c. Cumulative preference shares: In the case of cumulative preference shares
dividends accumulated when not paid. So when the company wants to pay any
dividend to equity shareholders, it must first pay arrears of such dividends to
cumulative preference shareholders. If the company goes into liquidation, arrears of
dividend are not payable unless they are either declared or article of association
contains express provision in this regard.
d. Non cumulative preferential shares: Non cumulative preference shares are shares
where the arrears of dividend do not accumulate. If a dividend is not declared in any
year then it lapses.
e. Redeemable preference shares: Those shares redeemable within a stipulated
period accordance with the terms of issue. After amendment in 1988 such shares
must be redeemed within a period of 10 years.
f. Irredeemable preference shares: Those shares which can be redeemed only in the
event of company’s liquidation. However, after amendment of companies Act,1988,
companies are not permitted to issue prior to the amendment of the act in 1988.
DEFERRED SHARES
These are also known as founder’s shares or management shares. These
are usually allotted to promoters and their friends at the time of formation of the
company. These share usually carry disproportionate voting rights and right to
substantial dividends from the profits left after paying off preference and equity
dividend. Public limited companies, subsidiary of such companies and private
companies deemed to be public limited companies cannot issue such shares after
the commencement of the companies act, 1956.
Private limited companies are enjoying the privilege.

THE TYPES OF SHARE CAPITAL
➢ Authorized share capital
➢ Issued share capital
➢ Subscribed share capital
➢ Called-up share capital
➢ Paid up share capital
➢ Partly paid up capital
a. Authorized share capital: this is the maximum capital that the company is
authorized to rise. This amount is stated in the memorandum of association. This
is also called as registered capital or nominal capital.
b. Issued capital: this represents the capital which is offered to public for
subscription. The difference between authorized capital and issued capital
represents the capital. The form requires the statement of different classes of
capital under the head “issued capital”.
c. Subscribed capital: subscribed capital refers to that part of the issued capital
which has been subscribed by public and also allotted to the directors of the
company. Under this capital also the company should give particulars of different
types of share capital information as must also be given regarding shares allotted
for consideration other than cash and shares allotted as fully paid up by way of
bonus shares. The sources from which bonus shares are issued must also be
stated.
d. Called-up capital: it is refers to that part of the subscribed capital which has
been called up by the company for payment.
e. Paid-up capital: it is refers to that part of the called-up which has been actually
paid up by the shareholders might have defaulted in paying the allotment or call
money. Such amount defaulted is known as calls in arrears. From the called up
capital, calls in arrear is deducted to obtain the paid up capital. Calls in arrears
due from directors have to be stated separately.
1. Explain the differentiate between partnership and company
Partnership Company
1. Act
Indian partnership Act, 1932, regulate Indian companies act, 1956 regulate the
the business business
2. Entity
Partnership business is not stable Company is a separate legal entity which
can not affected by the changes in its
membership
3. Number
The minimum member of members The minimum number of members in a
required is two public company is seven
4. Liability
In case of partnership, the liability of the In case of the company the members
partners are not limited liabilities are limited
5. Capital
Capital of the partnership firm depends The capital of the firm can be changed
upon the financial capacity of the by increasing are limited

partners
6. Profits
The profit of the partnership business are The profit of the company are disposed
distributed among the partners in the of n the firm of dividend or bonus shares
agreed ratio or equally based on
agreement
7. Management
All the partners of a firm are entitled to In an limited company the management
take part in the management of business of the business is vested in the board of
directors who are elected by the
members
8. Audit
Audit of accounts books is not It is compulsory by a practicing
compulsory Chartered accountant
9. Winding up
Partnership firm can wound up at any Winding up is done in full legal form
time
10. Insolvency
Partnership firm can be declared A company cannot be declared insolvent
insolvent due to financial difficulties
11. Registration
A partnership firm may or may not be Registration of the company is must
registered
12. Transfer of interest
Transfer of interest is not possible Transfer of interest is freely possible
13. Income tax
Paid by the partners Paid by the company
14. Commencement of business
Not required to fulfil legal formalities. Performs various legal formalities
Statutory Books
Statutory Books are the official records kept by the company relating to all legal and
statutory matters.
A company's statutory books are usually kept at the registered office of the company.
The books should be available to the general public for inspection during reasonable
office hours.
The typical contents of a company's statutory book are:
* the register of shareholders

* the register of company directors and secretaries
* the register of company directors' interests
* the register of charges
* The register of interests in shares if the company is a PLC.

LIST OF STATUTORY REGISTERS, BOOKS AND RECORDS REQUIRED TO BE
MAINTAINED BY A COMPANY UNDER COMPANIES ACT, 1956
Sr. Relevant Register/Books/Returns Inspection Fees/Charges

No. Sections for
Inspection, if
any
1. 49(7) Register of investments in Members Without any

any shares or securities and fees
not held in names its own Debenture
name holder
2 58A read with Registers of deposits Not open NA

rule 7 of the for
Companies Inspection
(Acceptance of
Deposits)
Rules, 1975) &
RBI Directions
3 77A(9) Register of securities Not open NA

Bought Back for
inspection
4 143(1) Register of charges (a) (a) Without

Member or any fees
Debenture (b) On
holder or a payment of
creditor requisite fees
(b) any
other
person
5 150(1) Register of members (a) (a) Without

Member or any fees
Debenture (b) On
Holder or a payment of
(b) any
other
person
6 151(1) Index to members (a) (a) Without

Member or any fees
Debenture (b) On

(b) any
other
person
7 152(2) Register of debenture- (a) (a) Without

holders Member or any fees
Debenture (b) On
(b) any
other
person
8 152(2) Index of debentures- (a) (a) Without

holders Member or any fees
Debenture (b) On
(b) any
other
person
9 152A Register & Index of Any Without any

Beneficial Owners Member fees
10 157 and 158 Foreign register of (a) (a) Without

members or debenture Member or any fees
Debenture (b) On
(b) any
other
person
11 159-160 Copies of Annual Return (a) (a) Without

Member or any fees
Debenture (b) On
(b) any
other
person
12 193 Minutes books of Board Members Without any

Meetings & any other General fees

meetings Meeting
13 193/196 Minutes books of General Any Without any

Meetings Member fees
14 209(1)(a)(b)(c) Proper books of account The Without any

209 (d) and cost records Directors fees
of the
Company
15 301 Register of contracts, Member Without any

companies and firms in fees
which directors are
interested
16 302(6) Register of contracts Member Without any

entered into by the fees
company for the
appointment of Manager
or Managing Director
17 303(1) Register of Member Without any

Director/Managing fees
Director/Manager/Whole
Time Director/Secretary
18 307 Register of Directors’ Member or Without any

shareholdings, etc. Debenture fees
Holders
19 370(1C) Register of loans, etc., to Member On payment of

companies under the requisite fees.
same management
20 372(6) Register of investments in Member Without any

shares of any body fees
corporate
21 372A Register of loans made, Member or Without any

guarantees given, Debenture fees
securities provided or holder
investment made by the
company
22 Rule 7(2) of the Register of renewed and Not open NA

Companies duplicate Share for
(Issue of Share certificates inspection

Certificates)
Rules, 1960
23 581-ZE(1) Books of account of the Open for Without any

Producer Company Public fees
inspection
24 581-ZL(7) Register of particulars of Member Without any

Investments of producer fees
companies
25 69-75 Register of Allotments Member or Without any

Debenture fees
holder
26 205 Dividend Register Member Without any

fees
27 192A Register of Postal Ballot
28 285 Register of Directors’ Not Open NA

Attendance for
Inspection
29 79A Register of Sweat Equity Member Without any

Shares fees
ALTERATION OF SHARE CAPITAL

-According to Section 94 a company limited by shares or guarantee and having a share
capital may alter its share capital, if authorized by AOA and by passing an ordinary
resolution in certain ways like:
• Increasing the capital by issuing new shares or

• Consolidating or dividing the share face values
• Converting fully paid shares into stock and vice versa or
• Cancelling shares not taken up
• Notice of alteration of capital should be given to roc in e-form no. 5 within thirty
days of such alteration
• Default in this case will make the company and every officer of the company
liable to a fine extending up to rs. 500 per day during which the default continues
• The power to alter should be exercised bona fide in the interest of the company
• The increased capital may consist of preference shares, provided that this is not
inconsistent with rights given by the memorandum of association.
NATURE OF STOCK

-As per Section 2(46) share includes stock except where a distinction between stock and
shares is expressed or implied. A stockholder has the same rights as to dividends as a
shareholder.
-A company can only convert fully paid shares into stock and cannot directly issue stock
REDUCTION OF SHARE CAPITAL

-It means reduction of issued, subscribed and paid-up capital of the company and as per
Section 100, it is possible if the articles of the company so authorize and when
confirmed by Court/Tribunal
-It may be necessary for various reasons like to meet trading losses, heavy capital
expenses etc
-It may be done by reducing or extinguishing the liability in respect of uncalled or

unpaid capital or by paying back paid up capital not wanted by the company or by
paying back the paid up capital on the condition that it may be called up again or by
writing off the lost
capital
-While confirming the same, the Court must ensure that the interests of creditors,
shareholders and general public must be protected
-However, in the following cases, the reduction does not call for sanction of
Court/Tribunal
--Surrender of shares (The Companies Act does not expressly provide for surrender
except that surrender is possible if AOA permits and where the shares otherwise may be
forfeited
--Forfeiture of shares
--Diminution of capital (Where the company cancels shares which have not been taken
or agreed to be taken by any person)
--Redemption of redeemable preference shares.
--Purchase of shares of a member by the Company under Section 402.
--Buy-back of its own shares under Section 77A.
-An unlimited company to which Section 100 does not apply, can reduce its capital in
any manner that its Memorandum and Articles of Association allow
-It must be ensured that the effect of a reduction does not disqualify any director when
it relates to qualification shares
-After confirming the reduction, the Court/Tribunal may also direct that the words “and
reduced” be added to the company’s name for a specified period, and that the company
must publish the reasons for the reduction with a view to giving proper information to
the public.

-The Court’s/Tribunal’s order confirming the reduction together with the minutes
giving the details of the company’s share capital, as altered, should be delivered to the
Registrar who will register them. The reduction takes effect only on registration of the
order and minutes, and not before. The Registrar will then issue a certificate of
registration which will be a conclusive evidence
Diminution of share capital is not a reduction of capital

(i) Where the company cancels shares which have not been taken or agreed to be
taken by any person [Section 94(1)(e)];
(ii) Where redeemable preference shares are redeemed in accordance with the
provisions of Section 80;
(iii) Where any shares are forfeited for non-payment of calls and such forfeiture
amounts to reduction of capital.
(iv) Where the company buys-back its own shares under Section 77A of the Act. In all
these cases, the procedure for reduction of capital as laid down in Section 100 is not
attracted.
-PENALTY: If any officer of the company knowingly conceals the name of any creditor
entitled to object to the reduction or knowingly misrepresents the nature or amount of
the debt or claim of any creditor etc, he shall be liable to be punishable with
COMPANY PROHIBITED TO BUY ITS OWN SHARES OR TO FINANCE THEIR

PURCHASE
-Section 77(1) provides that a company limited by shares, or by guarantee and
having a share capital cannot buy its own shares as that would involve a reduction of
share capital without the court’s consent.
There are, however, certain exceptions to this rule like:

(a) A company may redeem its redeemable preference shares under Section 80 of the
Act.
(b) A banking company may lend money in the ordinary course of business.
(c) A company may provide financial assistance to employees other than directors for
purchasing fully paid up shares, an amount
(d) A company may buy its own shares from any member in pursuance of a Court’s
order under Section 402 of the Companies Act.
ALLOTMENT OF SHARES
-“Allotment” of shares means the act of appropriation by the Board of directors of the
company out of the previously un-appropriated capital of a company of a certain
number of shares to persons who have made applications for shares

-The re-issue of forfeited shares does not constitute appropriation out of inappropriate
capital, and
therefore is not an allotment and a company need not file return in e-Form No. 2 in
respect of the re-issue of forfeited shares.
Notice of Allotment
-An allotment is the acceptance of an offer to take shares by an applicant, and like any
other acceptance it must be communicated by way of notice.
GENERAL PRINCIPLES REGARDING ALLOTMENT
(1) The allotment should be made by proper authority, i.e. the Board Directors or a
committee duly authorised to allot shares. – The Board should be duly constituted and a
valid resolution for allotment must be passed
(2) Allotment of shares must be made within a reasonable time
(3) The allotment should be absolute and unconditional
(4)The allotment must be communicated. – Posting to proper address is valid though

the letter may be lost in transit
(5) Allotment against a written application only
(6) Allotment should not be in contravention of any other law like allotment to a minor
STATUTORY PROVISIONS REGARDING ALLOTMENT
(a) The Company wanting to make a public issue should apply to one or more
recognized stock exchange(s) for listing u/s 73 and if listing permission is not granted
within prescribed period by any of the stock exchanges named in the prospectus, the
entire allotment is void.
(b) The company shall file with the Registrar, a prospectus or a statement in lieu of
prospectus in e-form 19 or e-form 20, as the case may be, before making an allotment
signed by every person who is named therein as a director.
(c) The company shall receive in cash, application money which shall not be less than 5
percent of the nominal value of the shares and the amount must be kept in a scheduled
bank in a separate account till the allotment is made and until the certificate to
commence business has been obtained under Section 149 of the Companies Act, 1956.
[Section 69]
(d) If minimum subscription, as provided in the prospectus, has not been received by
the company, all amounts received must be refunded and allotment, if made is void

(e) No allotment shall be made where a prospectus is issued generally until the
beginning of the fifth day after the date on which the prospectus is so issued or such
later date as may be specified in the prospectus. This date is known as the “date of
opening of the subscription list” (Section 72).
(f) Closing of the Subscription List — SEBI (Disclosure and Investor Protection)
Guidelines 2000 provide that the subscription list must be kept open for at least 3
working days and not more than 10 working days and in the case of Infrastructure
Company, the maximum period is 21 working days. In case of Rights issue, the SEBI
guidelines provide that the issue shall remain open for at least 30 days and not more
than 60 days.
(g) If the company having a share capital does not issue prospectus it cannot proceed
with the allotment unless it files with the Registrar of Companies at least 3 days before
the first allotment a Statement in lieu of prospectus in eform 20 in Schedule III and must
contain the particulars and reports set out therein.
Allotment of Shares/Debentures to be listed on Stock Exchange if made to public

after issue of prospectus
-As per Section 73, every public issue must be listed and if permission is not granted
within 10 weeks from closure of subscription list or is refused before, the allotment is
void.
-However, where a stock exchange refuses to grant an application or fails to dispose it

off within 10 weeks, the company may, under Section 22 of the Securities Contracts
(Regulation) Act, 1956 appeal to the Securities Appellate Tribunal against the refusal:
(1) Within 15 days from the date of the refusal, or
(2) Within 15 days from the date of the expiry of 10 weeks.
-As per Section 73(2) if allotment is void as above, the company must repay the
application money immediately and if it is not repaid within 8 days, the company and
every director of company who is an
Officer in default shall on and from the expiry of the eighth day, be jointly and severally
liable to repay that money with interest @ 15% p.a.
Basis of Allotment
-As per Clause 44 of listing agreement, allotment of securities offered to public shall be
made within 30 days of closure of public Issue. If it is not done so or if refund order is
not despatched to investors within 30 days from the date of closure of issue, then the
Company shall pay interest @ 15% p.a. as per the listing agreement.
Over Subscription

-As per SEBI (ICDR) Regulations, 2009 oversubscription can be retained not exceeding
10% of the net offers for the purpose of rounding off to the nearer multiple of 100.
Minimum Subscription
As per Section 69(1) no allotment can be made in a public issue until the minimum
subscription stated in the prospectus has been subscribed and the amount payable on
application has been received in cash by the company. – Such minimum subscriptions
should be 90 percent of the issue including devolvement on underwriters subscription
-As per the provisions of the Act, it must be received within 120 days of opening of issue
but as per SEBI requirements, it must be received within 60 days from closure - If
it is not so received, the amount received should be returned within next 10 days and if
not so returned, the directors are liable to return the same with interest
Letter of Allotment
-The company sends this letter to allottees and they surrender the same in exchange for
shares certificates when they are subsequently issued
Letter of Renunciation
-Under Section 81, when a Public Company makes a right issue to existing shareholders,
they have an option to renounce the shares in favour of any other person, through a
letter of renunciation – If the renounce does not accept the offer, BOD of the company
may dispose of those shares in any manner in the best interest of the company
EMPLOYEE STOCK OPTION
Employee Stock Option Scheme means the option given to the Whole Time
Directors, Officers and Employees of the Company which gives them a right or benefit to
purchase or subscribe the securities offered by the Company at a predetermined price
at a future date. The idea behind sock option is to motivate the employees by linking the
profitability of the Company.
Eligibility to participate in ESOS:-
• Option shall be granted only to the eligible permanent employees of the

Company subject to the following:-
• An employee who is a promoter or belongs to the promoter group shall not be

eligible to participate in the ESOS.
• A director who either by himself or through his relative or through any body
corporate, directly or indirectly holds more than 10% of the outstanding equity
shares of the company shall not be eligible to participate in the ESOS.
Disclosure to the Grantees:-

No ESOS can be offered by the Company unless the disclosure regarding risk
involve, brief of Company, Terms and Conditions of ESOS has been made to the
prospective grantees.
Compensation Committee:-
No ESOS can be offered unless the company has constituted a Compensation

Committee for administration and superintendence of the ESOS. The
Compensation Committee, consisting of the majority of independent directors,
shall formulate the detailed terms and conditions of the ESOS.
Shareholders Approval:-
Shares can be issued under ESOS with the approval of shareholders by way of
Special Resolution. The explanatory statement of the notice and the resolution
proposed to be passed in general meeting shall include details regarding the
ESOS. Approval of shareholders by way of separate resolution in the general
meeting shall required in case grant of option to identified employees, during
any one year, equal to or exceeding 1% of the issued capital of the company.
Variation of terms of ESOS:-
The Company, by special resolution, may variate the terms, including the pricing,
of the ESOS offered but not yet exercised by the employees provided such
variation is not prejudicial to the interest of the option holders.
Lock in Period:-
There shall be a minimum period of one year between the grant of option and
vesting of option. However the Company shall have the freedom to specify the
lock in period for the shares issued pursuant to exercise of option. The
employees shall not have any right to receive dividend or to vote or in any
manner enjoy the benefits of a shareholder in respect of option granted to him,
till the shares are issued on exercise of option.
Non transferability of option:-
The option granted to an employee shall not be transferable to any person, the
option can only be exercised by the employee to who the option is granted. The
option cannot be transferred, pledged, hypothecated, mortgaged or otherwise
alienated in any manner. This is a personal right only to the offeree.
Disclosure in Directors’ Report:-
The Board of Directors shall disclose either in Directors’ Report or in the

annexure to the Directors’ Report the details of ESOS.
Certificate from the Auditors:-

The Board of Directors shall place before the shareholders a certificate from the
auditors of the company that the scheme has been implemented in accordance
with these guidelines and in accordance with the resolution of the company in
the general meeting.
Procedure for Granting of Shares Under ESOS
1. Hold board meeting for
a. Approving the ESOS
b. Calling and Approving the notice of AGM/EGM for passing special

resolution
c. Constituting the compensation committee
2. In case of listed company advance notice to the Stock Exchange and after the
Board Meeting, outcome of the Board Meeting is also to be notified
immediately.
3. Send three copies of notice to the Stock Exchange.
4. Make disclosures to the grantees.
5. Hold general meeting and pass required special resolution.
6. Intimation to SE along with the certified copy of special resolution.
7. The company shall appoint a registered merchant banker for the

implementation of ESOS as per guidelines till the stage of framing the ESOS and
obtaining in principal approval from the stock exchange. 8. File form 23 within
30 days of the special resolution to register the resolution with ROC.
9. Obtain in principal approval from SE.
10. Prepare a list of options exercised by employees.
11. Hold board meeting for allotment of shares.
12. File a return of allotment in form 2 to the ROC within 30 days.
13. Give intimation to NSDL/CDSL regarding corporate actions.
BUY BACK SECURITIES
Buyback of Shares:
Buyback of shares means that any company may purchase their own shares or other
specified securities. According to section 77A (1) of the companies Act 1999, a company
may purchase its own shares or other securities out of:

(i) Its free reserves or
(ii) The securities premium account or
(iii) The proceeds of any shares or other specified securities.
Specified securities include employees stock option or other securities as may be

notified by the Central Government from time to time. Buyback of shares of any kind is
not allowed out of fresh issue of shares of the same kind. In other words, if equity shares
are to be bought back, preference shares or debentures may be issued for buyback of
equity shares. Companies are allowed to buyback their own shares if they fulfil certain
conditions as given in section 77A (2) of the companies Act 1999.
No company shall purchase its own shares or other specified securities unless:
(a) The buyback is authorized by its articles.
(b) A Special resolution has been passed in general meeting of the company authorising
the buyback.
(c) The buyback is for less than 25% of the total paid up capital and free reserves of the
company.
(d) It also provide that buyback shall not be exceed 25% of total paid up capital.
(e) The debt equity ratio should not be more than 2:1 after such buyback.
(f) All the shares or other specified securities for buyback are fully paid up.
(g) The buyback of the shares or other specified securities listed on any recognised
stock exchange is in accordance with the regulations made by the Securities and
Exchange Board of india in this behalf.
(h) The buyback in respect of shares or other specified securities other those specified
in clause
(i) The buyback should be completed within 12 months from the date of passing the
special resolution.
SEBI guidelines:
The following are the important points:
1. Buyback of shares cannot be from any person through negotiated deals whether on or
after stock exchange or through spot transactions or through private management.
Therefore a company is required to make public announcement in atleast one National
Daily all with wide circulation where registered office of the company is situated.
2. Public announcement among other things specify the following:
(j) Specified date i.e the date of the dispatch of the offer letter shall not be less than
earlier than 30 days but not later than 42 days.
(k) SEBI shall be informed by the company with in seven working days from the date of
public announcement.
(l) The offer for buyback shall remain open to the members for a period of not less than
15 days but not exceeding 30 days. However the opening date for the offer shall not be
earlier than 7 days or later than 30 days from the specified date.

(m) The company shall complete the verification of offers within 15 days from the date
of closure and shares lodged shall be deemed to have been accepted unless
communication of rejection is made within 15 days from the date of closure.
Advantages of Buy Back of Shares:
1. The buyback facility enable the co.’s is manage their cash effectively. Many co.’s in this
country are faced with a problem of surplus cash without having any idea of where to
invest them. It would be better for them to return surplus cash to shareholders rather
than to go on spending simply for want to alternative.
2. Companies having large amount of free reserves are free is use funds to acquire
shares and other specified securities under the buyback process.
3. Buyback shares in helpful co. to reduce its share capital.
4. Buyback of shares is helpful to improvement in the values of shares.
5. Avoid high financial risk and ensure maximum return to the shareholders.
6. Buyback of shares helps the promoters to formulate an effective defences strategy
against hostile take over bids.
Disadvantages of buy back of shares:

1. All the control of buy back of shares in the hands of promoters, so results of co.’s
which the position of minority shareholders in weak.
2. The promoters before the buy back, may understand the earnings by manipulating
accounting policies and highlight other unfavourable factors affecting the earnings.
3. High buy back of share may lead to artificial manipulation of stock prices in the stock
exchange. Confusion is much more.
MODES OF BUY BACK :
Buy back of shares or other specified securities can be done through various sources
which have been illustrated under sub section 5 of section 77A, they are as follows:-
a) From the existing security holders on a proportionate basis or
b) From the open market, through ;
i) stock market
ii) book building process
c) From odd lots, that is to say where the lot of securities of a public company, whose
shares are listed on a recognised stock exchange, is smaller than such marketable
lot, as may be specified by the stock exchange; or
c) by purchasing the securities issued to employees of the company under a

scheme
of stock option or sweat equity.

REGISTER OF SECURITIES BOUGHT BACK :
Section 77A(9) prescribes for the manner in which a register shall be maintained a
register of shares so bought back and enter therein the following particulars:-
i) The consideration paid for the securities bought back.
ii) The date of cancellation of securities
Iii) The date of extinguishing and physically destroying of securities.
iv) Other particulars as may be prescribed.
The shares or the securities so bought back shall be physically destroyed within seven
days from the last date f completion of such buy back.
ANNA UNIVERSITY QUESTIONS
PART A
1. What is preferential allotment? (APR/MA 2015)
2. What is stock option? (APR/MA 2015)
3. Define company? (JAN 2015)
4. What is ESOP? (JAN 2015)
5. What is allotment of shares? (JANUARY 2014)
6. What is forfeiture of shares? (JANUARY 2014)
7. Define a 'joint stock company'. (MAY/JUNE 2014.)
8. What do you mean by employees stock option scheme? (MAY/JUNE 2014.)
9. Distinguish between private company and public company. (NOV/DEC2013)
10. What is Buy-Back of securities? (NOV/DEC2013)
11. What is preferential allotment? (MAY/JUNE 2013)
12. Mention any two methods of alteration of share capital. (MAY/JUNE 2013)
13. What is profit and loss account? (January 2012)
14. What is compound journal entry? (January 2012)
15. What is Preferential Allotment? (MAY/JUNE 2012)

16. Describe the features of a corporate organization’s. (Jan 2011)
17. Explain why buy back of shares are done. (Jan 2011)
18. What is mean by capital reduction? ( JUNE 2011)
19. Which expenses are called as preliminary expenses? ( JUNE 2011)
20. What is meaning of company? (NOV/DEC2011)
21. Write the formula for debt-equity ratio? (NOV/DEC2011)
PART B
1. What are statutory books? Explain its types. (JAN 2015)
2. Illustrate the errors which are disclosed by the Trial Balance with suitable
examples. (JAN 2015)
3. Under circumstance of profit or loss prior to incorporation arises? What are the
accounting treatment for profit and loss prior to incorporation? (APR/MA 2015)
4. Define a company and state its essential characteristics. Explain the documents
that have to file with the Registrar of companies for getting a company in
corporate. (JANUARY 2014)
5. Explain the different modes of alteration of share capital as per the provision of
sections 94 to 97 of the companies act. (JANUARY 2014)
6. G Ltd. was registered on :1.7.07to acquire the running business of S & co. with
effect from 1.1.07. The following was the profit and loss a/c of the company on
31.12.07 (MAY/JUNE 2014.)
Particulars Rs. Particulars Rs.
To Office expenses 54,000 By Gross Profit b/d 2,25,000

To Formation expenses 10,000
To Stationery and Postage 5,000
To Selling expenses 60,000
To Director's fees 20,000
To Net profit 76,000
2,25,000 2,25,000
You are required to prepare a statement showing profit earned by the company in the
pre and post incorporation periods. The total sales for the year took place in the ratio of
1 : 2 before and after incorporation respectively.
7. Discus about the statutory Books of Accounts that are to be maintained by public
limited company. (NOV/DEC2013)

8. Discuss the provisions relating Buy-Back of securities under the company’s act
1956. (MAY/JUNE 2013)
9. Write shorts Notes on: (MAY/JUNE 2012)
1) Buy Back of Securities
2) Employees Stocks Option
3) Statutory books
4) Shares allotted on Prorata basis.
10. Why are stock option plans popular with software companies? (Jan 2011)
11. write a note on preferential allotment. (Jan 2011)
12. What are financial accounts? What purpose do they serve? Explain the various
adjustments affecting the preparation of balance sheet. (NOV/DEC2011)

UNIT III
UNIT III ANALYSIS OF FINANCIAL STATEMENTS

Analysis of financial statements – Financial ratio analysis, cash flow (as per Accounting
Standard 3) and funds flow statement analysis.
.ANALYSIS AND INTERPRETATIONS OF FINANCIAL STATEMENTS

Presentation of financial statements is the important part of accounting process.
To provide more meaningful information to enable the owners, investors, creditors or
users of financial statements to evaluate the operational efficiency of the concern during
the particular period. More useful information are required from the financial
statements to make the purposeful decisions about the profitability and financial
soundness of the concern. In order to fulfill the needs of the above. it is essential to
consider analysis and interpretation of financial statements.
Meaning of Analysis and Interpretations

The term "Analysis" refers to rearrangement of the data given in the financial
statements. In other words, simplification of data by methodical classification of the
data given in the financial statements.
The term "interpretation" refers to "explaining the meaning and significance of

the data so simplified.
" Both analysis and interpretations are closely connected and inter related. They
are complementary to each other. Therefore presentation of information becomes more
purposeful and meaningful-both analysis and interpretations are to be considered.
Metcalf and Tigard have defined financial statement analysis and interpretations
as a process of evaluating the relationship between component parts of a financial
statement to obtain a better understanding of a firm's position and performance.
The facts and figures in the financial statements can be transformed into
meaningful and useful figures through a process called "Analysis and Interpretations."
In other words, financial statement analysis and interpretation refer to the process of
establishing the meaningful relationship between the items of the two financial
statements with the objective of identifying the financial and operational strengths and
weaknesses.
Types of Analysis and Interpretations

The analysis and interpretation of financial statements can be classified into
different categories depending upon :
I. The Materials Used

II. Modus Operandi (Methods of Operations to be followed)
1. On the basis of Materials Used:

(a) External Analysis.
(b) Internal Analysis.
II. On the basis of Modus Operandi
(a) Vertical Analysis.
(b) Horizontal Analysis.
The following chart shows the classification of financial analysis:
I. On the Basis of Materials Used

On the basis of materials used the analysis and interpretations of financial statements
may be Classified into
(a) External Analysis and

(b) Internal Analysis.
(a) External Analysis

This analysis meant for the outsiders of the business firm. Outsiders may be
investors, creditors, suppliers, government agencies, shareholders etc. These external
people have to rely only on these published financial statements for important decision
making. This analysis serves only a limited purpose due to non-availability of detailed
information.
(b) Internal Analysis

Internal analysis performed by the persons who are internal to the organization.
These internal people who have access to the books of accounts and other information
related to the business. Such analysis can be done for the purpose of assisting
managerial personnel to take corrective action and appropriate decisions.
II. On the basis of Modus Operandi
On the basis of Modus operandi, the analysis and interpretation of financial

statements may be classified into: (a) Horizontal Analysis and (b) Vertical Analysis.
(a) Horizontal Analysis

Analysis is also termed as Dynamic Analysis. Under this type of analysis,
comparison of the trend of each item in the financial statements over the number of
years are reviewed or analyzed. This type of comparison helps to identify the trend in

various indicators of performance. In this type of analysis, current year figures are
compared with base year for figures are presented horizontally over a number of
columns.
(b) Vertical Analysis

Vertical Analysis is also termed as Static Analysis. Under this type of analysis, a
number of ratios used for measuring the meaningful quantitative relationship between
the items of financial statements during the particular period. This type of analysis is
useful in comparing the performance, efficiency and profitability of several companies
in the same group or divisions in the same company.
Rearrangement of Income Statements

Financial statements should be rearranged for proper analysis and
interpretations of these statements. It enables to measure the performance of
operational efficiency and profitability of a concern during particular period.
METHODS OF FINANCIAL STATEMENT ANALYSIS

Comparative Financial Statement Analysis
This is a major tool for making horizontal analysis. Under this technique, statements
(either Balance Sheets or Profit & Loss accounts) for two years or more are analysed.
The data is arranged side by side. And the changes from one period to another period
are calculated and analysed as to the reasons and suitable inferences are drawn from
them.
Comparative Financial Statement analysis provides information to assess the

direction of change in the business. Financial statements are presented as on a
particular date for a particular period. The financial statement Balance Sheet indicates
the financial position as at the end of an accounting period and the financial statement
Income Statement shows the operating and non-operating results for a period. But
financial managers and top management are also interested in knowing whether the
business is moving in a favorable or an unfavorable direction. For this purpose, figures
of current year have to be compared with those of the previous years. In analyzing this
way, comparative financial statements are prepared.
Comparative Financial Statement Analysis is also called as Horizontal analysis. The

Comparative Financial Statement provides information about two or more years'
figures as well as any increase or decrease from the previous year's figure and it's
percentage of increase or decrease. This kind of analysis helps in identifying the major
improvements and weaknesses. For example, if net income of a particular year has
decreased from its previous year, despite an increase in sales during the year, is a
matter of serious concern. Comparative financial statement analysis in such situations
helps to find out where costs have increased which has resulted in lower net income
than the previous year.
Format of Comparative Balance Sheet
Particulars First Second Increase (+) or Decrease (-)

Year Year Absolute change Percentage
(Rs) change (%)

ASSETS
Current Assets
1. Cash
2. Bills Receivable
3. Debtors
4. Stock etc
Total Current Assets
Fixed Assets
1. Land
2. Buildings
3. Plant
4. Furniture etc
Total Fixed Assets
Total Assets (Fixed Assets + Current
Assets)
LIABILITIES AND CAPITAL
Current Liabilities:
1. Bills Payable
2. Sundry Creditors
3. Outstanding payments etc
Total Current liabilities
Long Term Liabilities:
1. Debentures
2. Long term loans etc
Total Liabilities (Current Liabilities
+ Long Term Liabilities)
Capital & Reserves:
1. Preference Capital
2. Equity Capital
3. Reserves
Total Share holders Funds
Total Liabilities and Capital
Common Size Financial Statement Analysis
Common Size Statement involves representing the income statement figures as a

percentage of sales and representing the balance sheet figures as a percentage of total
assets. Financial statements represent absolute figures and a comparison of absolute
figures can be misleading. For example, the cost of goods sold might have increased but
as a percentage of sales it might have decreased. So, to have a perfect understanding
about these increases and decreases, the figures reported are converted into
percentages to some common base.
In Income Statement, Sales figure is assumed to be 100% and all other figures
are expressed as a percentage of sales. In Balance Sheet, the total of assets is taken as
100% and all other figures are expressed as a percentage of total assets. This type of
Statement so prepared is called as the Common Size Statement and the analysis
performed on the Common Size Statement is called as the Common Size Financial
Statement Analysis or otherwise called as Vertical Analysis.
Format of Comparative Common size Balance Sheet
Particulars First Year Second Year
ASSETS Amount % Amount %
Current Assets
1. Cash

2. Bills Receivalble
3. Debtors
4. Stock etc
Fixed Assets
5. Land
6. Buildings
7. Plant
8. Furniture etc
Total Fixed Assets
Total Assets (Fixed Assets + Current Assets) 100 100
LIABILITIES AND CAPITAL
4. Bills Payable
5. Sundry Creditors
6. Outstanding payments etc
Total Current liabilities
Long Term Liabilities:
3. Debentures
4. Long term loans etc
Total Liabilities (Current Liabilities + Long Term Liabilities)
Capital & Reserves:
4. Preference Capital
5. Equity Capital
6. Reserves
Total Share holders Funds
Total Liabilities and Capital 100 100
Trend Analysis
Trend analysis involves the usage of past figures for comparison. Trend
percentages are calculated for some important items like sales revenue, net income etc.
Under this kind of analysis, information for a number of years is taken up and one year,
which is usually the first year, is taken as the base year. Each item of the base year is
taken as 100 and on that base, the percentage for other years are computed. This
analysis will help in finding out the percentage of increase or decrease in each item with
respect to the base year.
Financial analysis serves the following purposes:
1. Measuring the profitability
The main objective of a business is to earn a satisfactory return on the funds invested
in it. Financial analysis helps in ascertaining whether adequate profits are being earned
on the capital invested in the business or not. It also helps in knowing the capacity to
pay the interest and dividend.
2. Indicating the trend of Achievements
Financial statements of the previous years can be compared and the trend regarding
various expenses, purchases, sales, gross profits and net profit etc. can be ascertained.
Value of assets and liabilities can be compared and the future prospects of the business
can be envisaged. Assessing the growth potential of the business. The trend and other

analysis of the business provides sufficient information indicating the growth potential
of the business.
3. Comparative position in relation to other firms
The purpose of financial statements analysis is to help the management to make a

comparative study of the profitability of various firms engaged in similar businesses.
Such comparison also helps the management to study the position of their firm in
respect of sales, expenses, profitability and utilising capital, etc.
4. Assess overall financial strength
The purpose of financial analysis is to assess the financial strength of the business.
Analysis also helps in taking decisions, whether funds required for the purchase of new
machines and equipments are provided from internal sources of the business or not if
yes, how much? And also to assess how much funds have been received from external
sources.
5. Assess solvency of the firm
The different tools of an analysis tell us whether the firm has sufficient funds to meet
its short term and long term liabilities or not.
PARTIES INTERESTED
Analysis of financial statements has become very significant due to widespread

interest of various parties in the financial results of a business unit. The various parties
interested in the analysis of financial statements are:
(i) Investors :
Shareholders or proprietors of the business are interested in the well being of the
business. They like to know the earning capacity of the business and its prospects of
future growth.
(ii) Management :
The management is interested in the financial position and performance of the

enterprise as a whole and of its various divisions. It helps them in preparing budgets
and assessing the performance of various departmental heads.
(iii) Trade unions :
They are interested in financial statements for negotiating the wages or salaries or
bonus agreement with the management.
(iv) Lenders :

Lenders to the business like debenture holders, suppliers of loans and lease are
interested to know short term as well as long term solvency position of the entity.
(v) Suppliers and trade creditors :
The suppliers and other creditors are interested to know about the solvency of the
business i.e. the ability of the company to meet the debts as and when they fall due.
(vi) Tax authorities :
Tax authorities are interested in financial statements for determining the tax liability.
(vii) Researchers:
They are interested in financial statements in undertaking research work in

business affairs and practices.
(viii) Employees :
They are interested to know the growth of profit. As a result of which they can
demand better remuneration and congenial working environment.
(ix) Government and their agencies :
Government and their agencies need financial information to regulate the activities
of the enterprises/ industries and determine taxation policy. They suggest measures to
formulate policies and regulations.
(x) Stock exchange :
The stock exchange members take interest in financial statements for the purpose
of analysis because they provide useful financial information about companies. Thus, we
find that different parties have interest in financial statements for different reasons
COMPARATIVE STATEMENT
Comparative statements are financial statements that cover a different time

frame, but are formatted in a manner that makes comparing line items from one period
to those of a different period an easy process. This quality means that the comparative
statement is a financial statement that lends itself well to the process of comparative
analysis. Many companies make use of standardized formats in accounting functions
that make the generation of a comparative statement quick and easy.
Discuss the importance of financial statement. Jan 2012
IMPORTANCE AND USES
The benefits of a comparative statement are varied for a corporation. Because of

the uniform format of the statement, it is a simple process to compare the gross sales of

a given product or all products of the company with the gross sales generated in a
previous month, quarter, or year. Comparing generated revenue from one period to a
different period can add another dimension to analyzing the effectiveness of the sales
effort, as the process makes it possible to identify trends such as a drop in revenue in
spite of an increase in units sold.
Along with being an excellent way to broaden the understanding of the success
of the sales effort, a comparative statement can also help address changes in production
costs. By comparing line items that catalogue the expense for raw materials in one
quarter with another quarter where the number of units produced is similar can make it
possible to spot trends in expense increases, and thus help isolate the origin of those
increases. This type of data can prove helpful to allowing the company to find raw
materials from another source before the increased price for materials cuts into the
overall profitability of the company.
A comparative statement can be helpful for just about any organization that has to deal
with finances in some manner. Even non-profit organizations can use the comparative
statement method to ascertain trends in annual fund raising efforts. By making use of
the comparative statement for the most recent effort and comparing the figures with
those of the previous year’s event, it is possible to determine where expenses increased
or decreased, and provide some insight in how to plan the following year’s event.
FEATURES OF COMPARITIVE STATEMENTS:-
1) A comparative statement adds meaning to the financial data.

2) It is used to effectively measure the conduct of the business activities.
3) Comparative statement analysis is used for intra firm analysis and inters firm
analysis.
4) A comparative statement analysis indicates change in amount as well as change
in percentage.
5) A positive change in amount and percentage indicates an increase and a negative
change in amount and percentage indicates a decrease.
6) If the value in the first year is zero then change in percentage cannot be
indicated. This is the limitation of comparative statement analysis. While
interpreting the results qualitative inferences need to be drawn.
7) It is a popular tool useful for analysis by the financial analysts.
8) A comparative statement analysis cannot be used to compare more than two
years financial data.
COMMON SIZE FINANCIAL STATEMENTS
Common size ratios are used to compare financial statements of different-size

companies or of the same company over different periods. By expressing the items in
proportion to some size-related measure, standardized financial statements can be

created, revealing trends and providing insight into how the different companies
compare.
The common size ratio for each line on the financial statement is calculated as follows:
Item of Interest
Common Size Ratio =
Reference Item
For example, if the item of interest is inventory and it is referenced to total assets (as it
normally would be), the common size ratio would be:
Inventory
Common Size Ratio for Inventory =
Total Assets
The ratios often are expressed as percentages of the reference amount. Common size
statements usually are prepared for the income statement and balance sheet,
expressing information as follows:
• Income statement items - expressed as a percentage of total revenue

• Balance sheet items - expressed as a percentage of total assets
The following example income statement shows both the rupee amounts and the
common size ratios:
Common Size Income Statement
Income Statement Common-Size Income Statement

Revenue 70,134 100%
Cost of Goods Sold 44,221 63.1%
36.9%
Gross Profit 25,913
SG&A Expense 13,531 19.3%

Operating Income 12,382 17.7%
Interest Expense 2,862 4.1%
Provision for Taxes 3,766 5.4%
Net Income 5,754 8.2%
For the balance sheet, the common size percentages are referenced to the total assets.
The following sample balance sheet shows both the dollar amounts and the common
size ratios:
Common Size Balance Sheet

Common-Size
Balance Sheet
Balance Sheet
ASSETS
Cash & Marketable Securities 6,029 15.1%
Accounts Receivable 14,378 36.0%
Inventory 17,136 42.9%
Total Current Assets 37,543 93.9%
Property, Plant, & Equipment 2,442 6.1%
Total Assets 39,985 100%
LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities 14,251 35.6%
Long-Term Debt 12,624 31.6%
Total Liabilities 26,875 67.2%
Shareholders' Equity 13,110 32.8%
Total Liabilities & Equity 39,985 100%
The above common size statements are prepared in a vertical analysis, referencing each
line on the financial statement to a total value on the statement in a given period.
The ratios in common size statements tend to have less variation than the absolute
values themselves, and trends in the ratios can reveal important changes in the
business. Historical comparisons can be made in a time-series analysis to identify such
trends.
Common size statements also can be used to compare the firm to other firms.
FEATURES OF COMMON SIZE STATEMENT
1) A common size statement analysis indicates the relation of each component to

the whole.
2) In case of a Common Size Income statement analysis Net Sales is taken as 100%
and in case of Common Size Balance Sheet analysis total funds available/total
capital employed is considered as 100%.
3) It is used for vertical financial analysis and comparison of two business
enterprises or two years financial data.
4) Absolute figures from the financial statement are difficult to compare but when
converted and expressed as percentage of net sales in case of income statement
and in case of Balance Sheet as percentage of total net assets or total funds
employed it becomes more meaningful to relate.
5) A common size analysis is a type of ratio analysis where in case of income
statement sales is the denominator (base) and in case of Balance Sheet funds

employed or total net assets is the denominator (base) and all items are
expressed as a relation to it.
6) In case of common size statement analysis the absolute figures are converted to
proportions for the purpose of inter-firm as well as intra-firm analysis.
Limitations
As with financial statements in general, the interpretation of common size statements is

subject to many of the limitations in the accounting data used to construct them. For
example:
1. Different accounting policies may be used by different firms or within the same
firm at different points in time. Adjustments should be made for such differences.
2. Different firms may use different accounting calendars, so the accounting periods
may not be directly comparable.
TREND STATEMENT
Trend analysis calculates the percentage change for one account over a period of time of
two years or more.
Percentage change
To calculate the percentage change between two periods:
Calculate the amount of the increase/ (decrease) for the period by subtracting the
earlier year from the later year. If the difference is negative, the change is a decrease
and if the difference is positive, it is an increase..
FEATURES OF TREND ANALYSIS
1) In case of a trend analysis all the given years are arranged in an ascending
order.
2) The first year is termed as the “Base year” and all figures of the base year are
taken as 100%.
3) Item in the subsequent years are compared with that of the base year.
4) If the percentages in the following years is above 100% it indicates an
increase over the base year and if the percentages are below 100% it
indicates a decrease over the base year.
5) A trend analysis gives a better picture of the overall performance of the
business.
6) A trend analysis helps in analyzing the financial performance over a period of
time.
7) A trend analysis indicates in which direction a business is moving i.e. upward
or downwards.

8) A trend analysis facilitates effective comparative study of the financial
performance over a period of time.
9) For trend analysis at least three years financial data is essential. Broader the
base the more reliable is the data and analysis.
RATIO ANALYSIS
A ‘Ratio is defined as an arithmetical/quantitative/numerical relationship

between two numbers. Ratio analysis is a very important and age old technique of
financial analysis.
Uses of Ratio Analysis:

There are various uses of Ratio analysis, some of which are as follows:
1. It helps in managerial decision making
2. It helps in financial forecasting and planning
3. It helps in communicating the financial strength of a concern
4. It helps in control
5. It is an essential part of budgetary control and Standard costing
6. It helps an investor/prospective investor in decision making
7. It provides information to the creditors about the solvency of the firm
8. It helps the employees by providing information about the profitability of the
concern
9. It helps the government in policy making by providing financial information about
the industry/firm etc
10. It facilitates inter-firm; intra-firm; and firm-industry comparison
Limitations of Ratio Analysis:

In spite of the various uses of ratio analysis, it suffers from certain limitations,
some of which are as under
1) Limited use of a single ratio: A single ratio does not convey any meaning.
Ratios are useful only when calculated in sufficient nos.
2) Lack of adequate standards: It is difficult to set ideal ratios for each
firm/industry. And also setting of standard ratios for all the firms in every
industry is also difficult.
3) Inherent limitations of accounting: As Ratio analysis is based on financial
statements, the analysis suffers from the limitations of financial statements.
4) Change of accounting procedure: If different methods are followed by different
firms for their valuation, comparison will practically be of no use.
5) Window dressing: Ratios based on dressed up (manipulated) financial
information are not of much use as they show unreliable position of the firm

6) Personal bias: Different people will interpret the same ratio in different ways.
Thus, there is always the possibility that interpretation of the data may be
different for different people, and this in turn may result in many inferences for
the same data, which may be confusing.
7) Price level changes are not provided for in ratio analysis which may lead to a
misleading interpretation of a business operations
8) Ignorance of qualitative factors: Ratios are tools of quantitative analysis only
and normally qualitative factors which may generally influence the conclusions,
(ex – a high current ratio may not necessarily mean sound liquid position when
current assets include a large inventory consisting mostly of obsolete items) are
ignored while they are calculated.
Interested parties:
Many parties are interested in analyzing ratios for differing purposes. The type
of ratio analysis, its nature and dimension differ from party to party according to their
objectives of financial analysis. Different ratios are used to signify different trends in
the working of the firm. Some of the distinctions of them are as follows:
Parties interested Type of ratios Purpose of
analysis
1. Short term creditors 1. Current Ratio Liquidity and
2. Investors (both current and 2. Liquid Ratio Solvency
potential) 3. Absolute Liquid Ratio
3. Money lenders 4. Proprietary Ratio
5. Assets to Proprietorship
Ratio
6. Debt-equity Ratio
7. Capital Gearing Ratio
1. Shareholders 1. Gross Profit Ratio Profitability
2. Long term creditors 2. Net Profit Ratio
3. Government 3. Operating Ratio
4. Employees 4. Return on Capital
5. Purchasers of enterprise Employed (ROCE)
5. Dividend Ratio
6. Earnings per share (EPS)
7. Dividend per share (DPS)
1. Shareholders and 1. Capital Gearing Ratio Capital Structure
2. Outsiders 2. Equity Capital Ratio
3. Long Term Loans to Net
worth
1. Management All types of Ratios Management
Efficiency

Classification of Ratios: Financial Ratios can be classified in many ways. Different
authors have classified the Ratios in different groups. The most common classification
is as follows:
1. Liquidity Ratios (Short Term Solvency Ratios): These Ratios measure the ability of
the firm to meet its current obligations. They indicate whether the firm has
sufficient liquid resources to meet its short term liabilities. The various liquidity
ratios are :-
(i) Current Ratio: This Ratio measures the ability of the firm to pay debts in the
short term
Current Ratio = Current Assets (Ideal Ratio = 2:1)
Current Liabilities
(ii) Quick / Liquid / Acid-Test Ratio: This Ratio measures the short term debt
paying ability of the firm
Quick / Liquid / Acid-Test Ratio = Quick Assets (Ideal Raito = 1:1)
Current Liabilities
(iii) Absolute Liquid Ratio / Cash position Ratio =

Cash in hand & at Bank + Short term Marketable securities
Current Liabilities
(Ideal Ratio = 0.75:1, or even 0.50:1)
(iv) Debtor’s Turnover Ratio: This Ratio is a measure of quality of Debtors and
of the effectiveness of the collection efforts.
Debtor’s Turnover Ratio = Debtors + Bills Receivable X No. of working days
Credit sales in a year
(v) Average Debt Collection Period: This Ratio measures the time taken to
collect from Debtors
Average Debt Collection Period = Average Debtors
Net Sales / 360 days
(vi) Stock / Inventory Turnover Ratio: This Ratio measures the time taken to
turn inventory into sales.
Stock / Inventory Turnover Ratio = Cost of Goods sold
Average stock
(Where Average Stock = Opening stock + Closing Stock )
2
2. Solvency Ratios (Long Term): These Ratios measure the long term financial
condition of the firm. Bankers and creditors are most interested in liquidity. But
shareholders, debenture holders and financial institutions are concerned with the
long-term financial prospects. The various Solvency Ratios are:

(i) Debt-Equity Ratio: This Ratio measures the relationship between borrowed
Capital to own Capital. There are many variations to this Ratio. But, the most
popular ones’ are:
Debt (or) Outsider’s funds (Ideal Ratio = 1:1)
Equity Share holders’ funds
(ii) Proprietary Ratio: Share holders’ Funds

Total Assets
(iii) Assets to Proprietary Ratios:

(a) Fixed Assets to Proprietor’s Fund Ratio =
Fixed Assets after Depreciation (Ideal Ratio = 60% to 65%)
Shareholders’ Funds
(b) Current Assets to Proprietor’s Fund Ratio = Current Assets

Shareholders’ Funds
(iv) Interest Coverage Ratio : This Ratio measures the ability of the firm in
meeting its interest charges and thus gives the measure of protection to creditors
for payment of interest. Interest coverage ratio less than 2.0 suggest a risky
situation
Interest Coverage Ratio = Profit before interest and Taxes

Interest Expense
3. Profitability Ratios: These Ratios measure the profitability of a firm’s business

operations. They may be related to sales (ex- Gross Profit Ratio) or investments (ex –
Return on Assets or Return on Capital Employed)
(i) Gross Profit Ratio = Gross Profit X 100
Sales
(ii) Net Profit Ratio = Net Profit X 100

Sales
(iii) Operating Ratio = Cost of Goods Sold + Operating Expenses X 100

Sales
(iv) Return on Capital Employed (ROCE) : This Ratio measures the overall
profitability and efficiency of the business.
ROCE = Net Profit + Interest + Taxes X 100
Average Capital Employed
Where Capital Employed = Fixed Assets + Current Assets – Current

Liabilities (or) Shareholders’ Funds + Long Term Liabilities.

(v) Profit Margin: This Ratio gives the amount of Net Profit earned by each
rupee of revenue.
Profit Margin = Profit after Tax
Net Sales
(vi) Asset Turnover: This Ratio measures the efficiency with which Assets
are utilized
Asset Turnover = Net Sales

Average Total Assets
(vii) Return on Assets (ROA): This Ratio measures the profitability from a
given level of investment
Return on Assets (ROA) = Profit after Tax

Average Total Assets
(viii) Return on Equity (ROE) : This Ratio measures the profitability on

Shareholders’ Funds.
Return on Equity (ROE) = Profit after Tax

Average Shareholders’ Equity
(ix) Earnings Per Share (EPS) : This Ratio measures the earnings on each
equity share
Earnings Per Share (EPS) = Profit after Tax

No of Equity Shares
4. Activity Ratios: These Ratios indicate the number of times stock is replaced during
a year. A high Ratio indicates quick movement of stock and vice-versa. i.e, Activity
Ratios measure the efficiency of asset management. The efficient utilization of assets
would be reflected by the speed with which they are converted into sales.
(i) Stock / Inventory Turnover Ratio = Cost of Goods sold

Average stock
(Where Average Stock = Opening stock + Closing Stock )
2
(ii) Debtor’s Turnover Ratio = Debtors + Bills Receivable X No. of working days
Credit sales in a year
This Ratio shows the speed with which Debtors / Accounts Receivable are
collected.

(iii) Creditor’s Turnover Ratio : This Ratio shows the no. of days taken by the
firms to pay its creditors.
Creditor’s Turnover Ratio = Creditors + Bill Payable X No of working days in a
Credit Purchases year
(iv) Fixed Assets Turnover Ratio: This Ratio indicates the sales generated by
every rupee invested in Fixed Assets
Fixed Assets Turnover Ratio = Sales
Net Fixed Assets
5. Capital Structure Ratio / Capital Gearing Ratio:

This Ratio explains the relationship between Equity Shareholders’ Funds and
Fixed interest bearing funds + Preference Share Capital. If the Ratio is more than 1, the
Capital Structure is highly geared. If it is less than 1, the Capital Structure is low geared)
Capital Structure Ratio / Capital Gearing Ratio = Preference Share Capital + Fixed
Interest Bearing Securities
Equity Shareholders’ Funds
6. Capital Market Ratios : These Ratios are usually related to the Stock Market and
are highly useful to the investors / potential investors.
(i) Price Earnings Ratio (P/E Ratio): This Ratio measures the amount investors
are willing to pay for a rupee of earnings.
Price Earnings Ratio (P/E Ratio) = Market Price per share (MPS)
Earnings per Share (EPS)
(ii) Dividend Yield : This Ratio measures the current return to investors
Dividend Yield = Dividend per Share (DPS)

Market Price per share (MPS)
Illustration problems
1. The following is the Balance sheet of a firm:
Liabilities Amount Assets Amount

Share Capital 30,000 Fixed Assets 16,500
Creditors 8,000 Cash 1,000
Bills Payable 2,000 Book Debts 6,000
Provision for Tax 3,500 Bills Receivable 2,000
Stock 17,500
Prepaid Expenses 500
Total 43,500 Total 43,500

Comment upon the liquidity of the firm
Solution:
(i) Current Ratio = Current Assets

Current Liabilities
Current Assets = Cash + Book Debts + Bills Receivable + Stock + Prepaid expenses
= (1000+6000+2000+17500+500) = Rs. 27,000
Current Liabilities = Creditors + Bills Payable + Provision for Tax

= (8000+2000+3500) = Rs. 13,500
Hence, Current Ratio = 27,000 = 2:1

13,500
(ii) Liquid Ratio = Liquid Assets

Current Liabilities
Liquid Assets = Cash + Book Debts + Bills Receivable
= (1000+6000+2000) = Rs.9,000
Liquid Ratio = 9,000 = 0.67 : 1

13,500
Comments : In this exercise, current ratio is 2 :1, which is considered satisfactory, but
quick ratio is below the optimum ratio of 1 :1. This indicates that the liquidity position
of the firm is not satisfactory as it indicates that the firm can only meet its current
obligations to the extent of 67% only. A further analysis shows that stock forms a major
part of current assets. This is a negative indication as it may imply that stock may be
slow moving. Only after further analysis of stock – its quality, its movement etc, then
only the liquidity position of the firm can be concluded.
Illustration 2: The following is the Balance sheet of a company as on 31st March
Liabilities Amount Assets Amount

Share Capital 2,00,000 Land & Buildings 1,40,000
Profit & Loss account 30,000 Plant & Machinery 3,50,000
General Reserve 40,000 Stock 2,00,000
12% Debentures 4,20,000 Sundry Debtors 1,00,000
Sundry Creditors 1,00,000 Bills Receivable 10,000
Bills Payable 50,000 Cash at Bank 40,000
Total 8,40,000 Total 8,40,000
Calculate:
i. Current Ratio
ii. Quick Ratio
iii. Inventory to Working capital
iv. Debt to Equity Ratio
v. Proprietary Ratio
vi. Capital gearing Ratio
vii. Current Assets to Fixed assets
Solution:
(i) Current Ratio = Current Assets

Current Liabilities
Current Assets = Stock + Sundry Debtors + Bills Receivable + Cash at Bank
= (2,00,000+1,00,000+10,000+40,000) = Rs 3,50,000
Current Liabilities = Sundry Creditors + Bills Payable

= (1,00,000+50,000) = Rs.1,50,000
Current Ratio = 3,50,000 = 2.33 :1

1,50,000
(ii) Quick Ratio = Liquid Assets

Current Liabilities
Quick Assets = Sundry Debtors + Bills Receivable + Cash at Bank
= (1,00,000+10,000+40,000) = Rs 1,50,000
Quick Ratio = 1,50,000 = 1:1

1,50,000
(iii) Inventory to Working capital = Inventory

Working Capital
Inventory = Stock = Rs.2,00,000
Working capital = Current Assets – Current Liabilities
= Rs.3,50,000 – Rs.1,50,000 = Rs.2,00,000
Inventory to Working capital = 2,00,000 = 1:1

2,00,000
(iii) Debt to Equity Ratio = Long Term Debt

Shareholders’ Fund
Long Term Debt = Debentures = Rs.4,20,000
Shareholders’ Fund = Capital + Reserves and Surplus
= Rs.2,00,000+30,000+40,000 = Rs 2,70,000
Debt to Equity Ratio = 4,20,000 = 1.56: 1

2,70,000
(or)

Debt to Equity Ratio = Long Term Debt
Shareholders’ Fund + Long Term Debt
= 4,20,000 = 0.6: 1
6,90,000
(iv) Proprietary Ratio = Shareholders’ Fund

Total Assets
= 2,70,000 = 0.32:1
8,40,000
(vi) Capital gearing Ratio = Fixed interest bearing securities

Equity Share capital
Fixed interest bearing securities = only debentures = Rs.4,20,000
Capital gearing Ratio = 4,20,000 = 2.1:1
2,00,000
(vii) Current Assets to Fixed assets = Current Assets

Fixed Assets
= 3,50,000 = 0.71:1
4,90,000
Illustration 3
From the following information given below, calculate (a) Current Liabilities and (b)
Inventory.
Current Ratio = 2.5
Acid test Ratio = 1.7
Current Assets = Rs.2,50,000
Solution:
Current Ratio = Current Assets
Current Liabilities
2.5 = Rs.2,50,000
Current Liabilities
Current Liabilities = Rs. 2, 50,000 = Rs.1,00,000
2.5
Acid Test Ratio / Liquid Ratio = Liquid Assets
Current Liabilities
By cross multiplication,
Liquid Assets = Liquid Ratio / Acid Test Ratio X Current Liabilities
= 1.7 X Rs.1,00,000 = Rs.1,70,000
Calculation of Inventory: Inventory = Current Assets – Liquid Assets

= Rs.2,50,000 – Rs.1,70,000 = Rs.80,000
Illustration 4
Balance sheet of ABC Ltd

Liabilities 31st Dec 31st Dec Assets 31st Dec 31st Dec
‘04 ‘05 ‘04 ‘05
Share capital 2,00,000 2,30,000 Plant & Machinery 1,90,000 2,10,000
Trade Creditors 80,000 1,00,000 Building 1,05,000 1,37,000
Bank Loan 40,000 25,000 Inventory 20,000 27,000
Mortgage - 25,000 Trade Debtors 40,000 55,000
Profit & Loss A/c 65,000 83,000 Cash 30,000 34,000
3,85,000 4,63,000 3,85,000 4,63,000
Prepare from the above comparative Balance sheet

(a) A schedule of changes in Working capital and
(b) Funds Flow Statement
Solution:
Schedule of changes in Working Capital
Items 31st 31st Dec Impact on Working

Dec ‘05 Capital
‘04 Increase Decrease
A.CURRENT ASSETS:
* Cash Balance 30,000 34,000 4,000
* Inventory 20,000 27,000 7,000
* Trade Debtors 40,000 55,000 15,000
TOTAL CURRENT ASSETS (A) 90,000 1,16,000
B. CURRENT LIABILITIES
* Trade Creditors 80,000 1,00,000 20,000
TOTAL CURRENT LIABILITIES 80,000 1,00,000
(B)
NET WORKING CAPITAL (A-B) 10,000 16,000
INCREASE IN WORKING CAPITAL
6,000 6,000
TOTAL 16,000 16,000 26,000 26,000
Calculation of Funds from operations
Particulars Amount
Net Profit / Loss as per the Profit & Loss account (Closing) 83,000
Add: 1. Items which do not result in the outflow of funds (or) all non-fund / -
non – operating items shown on the debit side of Profit and Loss account
Less: 1. Items which do not result in the inflow of funds (or) all non-fund / -
non – operating items shown on the credit side of Profit and Loss account
2. Opening Balance of Profit & Loss account

65,000
Funds from business operations 18,000
Funds Flow Statement
Sources of Funds Amount Application of Funds Amount

Share capital Plant & Machinery
(2,30,000-2,00,000) 30,000 (2,10,000-1,90,000) 20,000
Mortgage 25,000 Building (1,37,000-1,05,000) 32,000
Profits/ Funds from 18,000 Bank Loan (40,000-25,000) 15,000
operations Increase in Working capital 6,000
Illustration 5
From the following Balance sheets of XYZ Co Ltd, prepare (a) Schedule of changes in
Working capital and (b) Funds Flow Statement
Liabilities 31st Dec 31st Dec Assets 31st Dec 31st Dec
‘04 ‘05 ‘04 ‘05
Capital 1,20,000 1,50,000 Plant 1,00,000 1,25,000
Sundry Creditors 37,000 25,000 Land & Buildings 75,000 90,000
Bills Payable 15,000 17,000 Patent rights 7,000 9,500
Profit & Loss A/c 60,000 69,000 Cash 17,000 23,000
Sundry Debtors 33,000 13,500
2,32,000 2,61,000 2,32,000 2,61,000
Additional Information:
Depreciation of Rs.20,000 and Rs.25,000 have been charged on Plant, Land & Building
respectively in 2005.
Solution:
Schedule of changes in Working Capital
Items 31st Dec 31st Dec Impact on Working

‘04 ‘05 Capital
Increase Decrease
A.CURRENT ASSETS:
* Cash Balance 17,000 23,000 6,000
* Sundry Debtors 33,000 13,500 19,500
TOTAL CURRENT ASSETS (A) 50,000 36,500

B. CURRENT LIABILITIES
* Sundry Creditors 37,000 25,000 12,000
* Bills Payable 15,000 17,000 2,000
TOTAL CURRENT LIABILITIES 52,000 42,000
(B)
NET WORKING CAPITAL (A-B) (-)2,000 (-)5,500
DECREASE IN WORKING CAPITAL
(-)3,500 3,500
TOTAL (-)5,500 (-)5,500 21,500 21,500
Calculation of Funds from operations

Particulars Amount
Net Profit / Loss as per the Profit & Loss account (Closing) 69,000
Add: 1. Items which do not result in the outflow of funds (or) all non-
fund / non – operating items shown on the debit side of Profit and
Loss account
- Depreciation on Plant Rs.20,000
- Depreciation on Land & Building Rs.25,000 45,000
1,14,000
Less: 1. Items which do not result in the inflow of funds (or) all non- -
fund / non – operating items shown on the credit side of Profit and
Loss account
2. Opening Balance of Profit & Loss account 60,000
Funds from business operations 54,000
Funds Flow Statement

Sources of Funds Amount Application of Funds Amount
Capital 30,000 Purchase of Plant 45,000
Funds from Operations 54,000 Purchase of Land & Building 40,000
Decrease in Working capital 3,500 Purchase of Patents (9,500- 2,500
7000)
Working Notes:
(i) Calculation of Plant purchased during the year:
Plant Account

Particulars Amount Particulars Amount
To Balance b/d 1,00,000 By Depreciation 20,000
To cash (Balancing figure – By Balance c/d 1,25,000
purchase) 45,000
1,45,000 1,45,000
(ii) Calculation of Land & Building purchased during the year:
Land & Buildings Account
Particulars Amount Particulars Amount
To Balance b/d 75,000 By Depreciation 25,000
To cash (Balancing figure – 40,000 By Balance c/d 90,000
purchase)
1,15,000 1,15,000
FUND FLOW STATEMENT

The fund flow statement is a financial statement which reveals the methods by
which the business has been financed and how it has used its funds between the
opening and closing balance sheet dates. The statement is known by various titles, such
as, statement of sources and applications of funds, statement of changes in working
capital, where got and gone statement and statement of provided and applied.
Definition
“A statement of sources and application of funds is a technical device designed to
analyze the changes in the financial condition of a business enterprise between two
dates.” ----Foulke
“The fund flow statement describes the sources from which additional funds
were derived and the use to which these sources were put.” ----Anthony
Procedure for Preparing a Fund Flow Statement

Funds flow statement is a method by which we study changes in the financial
position of a business enterprise between beginning and ending financial statements
dates. so, funds flow statement is prepared by comparing two balance sheets and with
the help of such other information derived from the accounts as may be needed. The
preparation of a fund flow statement consists of three parts:
1. Statement or schedule of changes in working capital

2. Statement of fund from operation
3. Statement of sources and application of funds.
1. Statement or schedule of changes in working capital
Working capital = current Assets - Current Liabilities
An increase in current Assets increases working capital
A decrease in current assets decreases, working capital

An increase in current liabilities decrease working capital
A decrease in current liabilities increases working capital

Statement of Schedule Of Changes In Working Capital
Particular’s Previous Year Current Year Increase Decrease
Current Assets:
Cash in Hand
Cash at bank
Bills receivable
Sundry debtors
Temporary Investment
Stock/ Inventories
Prepaid Expenses
Accrued Incomes
Bills Payables
Sundry Creditors
Outstanding Expenses
Bank overdraft
Short term advances
Dividend Payable
Proposed Dividend*
Provision for taxation*
Total current liabilities
Working Capital (CA - CL)
Net increased or decreased in
Working Capital
*May or May not be a current liabilities

Fund from operation
Particular Amount Particular Amount

By Profit or gain on sale
of fixed asset
To Depreciation on fixed assets By Dividend received
To Loss on sale of fixed assets By Interest received of
To Under writing commissions By investment
To Discount on issue of shares & By Profit on revaluation
debentures of asset
To Preliminary expense written off By Fund from
To Deferred revenue expenses operation(B/F)
To Goodwill written off
To Patent or trademark
To Provision for taxes
(If treated non current)
Sources and Applications of Funds

This fund flow statement has two parts:
1. Sources of fund
2. Application of fund
The excess of sources of funds over uses of fund is the net increase in working
capital & excess of uses over sources of fund is net decrease in working capital.
Statement of sources and applications of funds

Particulars Amount
Sources of funds:
Funds from operations ****
Issue of share ****
Raising of long term loans ****
Receipts from partly paid up share, called up ****
Sale of non-current (Fixed) assets ****
Non-trading receipts, such as dividends received ****
Sale of investment (Long term) ****
Decrease in working capital (as per schedule of changes in working capital) ****
B/F ****
Total
Application or uses of funds: ****
Funds lost in operations ****
Redemption of preference share capital, Debentures & Long term loans ****
Purchase of non-current (Fixed) Assets, long term investments ****
Payments of dividends* ****

Payment of tax* ****
Non-Trading payments ****
increase in working capital (as per schedule of changes in working ******
capital)B/F
Total
Cash Flow Statements

Cash flow statement is not a substitute of income statement, i.e. a profit and loss
accounts and a balance sheet. It provides additional information and explains the
reasons for changes in cash and cash equivalents, derived from financial statement at
two points of time.
DEFINITIONS OF CASH FLOW STATEMENT
✓ Chas flows are inflows and outflows of cash and cash equivalents.
✓ Cash equivalents are short term, high liquid investments that are readily
convertible into known amounts of cash and which are subject an
insignificant risk of changes in value.
✓ Cash compromise cash on hand and demand deposits with bank.
✓ Investing activities are the acquisition and disposal of long term assets and
other investment not including in cash equivalent.
SCOPE CASH FLOW STATEMENT

✓ An enterprise should prepare a cash flow statement and should presents it for
each period for which financial statements are presented.
✓ Cash flow statements are interested in how the enterprise generates and uses
cash and cash equivalents.
✓ Enterprise need cash for essentially the same reasons, however different their
principal revenue producing activities might be.
✓ Enterprise need cash to conduct their operations, to pay their obligations, and
to provide returns to their investors.
Statement of cash from operation

Particulars Rs Rs
Funds From Operation ****

Add: Increase in current liabilities ******
Decrease in current assets ****** ******
Less:

Increase in current assets *****
Decrease in current liabilities ***** ******
Cash from operation(B/F) *******
RELATIONSHIP BETWEEN FUNDS FLOW STATEMENT AND CASH FLOW

STATEMENT
S.No Basis of Funds flow statements Cash flow statements

Difference
1 Concept It is based on wider concept It is based on narrower

of funds i.e. working capital concept of funds i.e. cash
2 Accounting It is based on accrual basis of It is based on cash basis of
accounting. accounting.
3 Schedule of Schedule of changes in No such schedule of changes
changes in working capital is prepared in working capital is
working capital to show the changes in prepared.
4 current assets and current
Method of liabilities. It is prepared by classifying
preparing Funds flow statement all cash inflows and
reveals the sources and outflows in term of
5 applications of funds. The operating, investing, and
net difference between financing activities. The net
Basis of usefulness sources and applications of difference represents the
funds represents net net increase or decrease in
increase or decrease in cash and cash equivalents.
working capital. It is more useful it is more
It is useful in planning useful for short term
intermediate and long term analysis and cash planning
financing. of the business.
Anna university questions

Part-A
1) What do you understand by analysis and interpretation of financial statements?

May 2011
2) Define Ratio Analysis? May 2011, Jan 2012

3) State the limitations of ratio analysis. June 2010
4) What are the objectives of financial statements? Jan 2012
5) Write the importance of Analysis and Interpretation of Financial Statements?
May 2012
6) What are financial statements? May 2013
7) What are the sources of cash inflow? May 2013
8) Write the formula for debt-equity ratio? Dec 2011
9) What is a fund flow statement? Dec 2010
10) What do you by ‘flow of funds’? June 2011
11)What are funds from operations? (NOV/DEC2013)
12)What are profitable ratios? (NOV/DEC2013)
13) Write a short note on operating ratio. (JANUARY 2014)

14)Define cash flow statement. (JANUARY 2014)
15)Define the term fund. (MAY/JUNE 2014)
16)From the following information, calculate cash from operations : (MAY/JUNE
2014)
Rs.
Funds from operation 84,000
Increase in current assets 73,000
Increase in current liabilities 21,000
Decrease in current assets 20,000
17)13. From the following information, calculate gross profit ratio (MAY/JUNE
2014)
Rs.
Sales 10,00,000
Sales returns 1,00,000
Cost of goods sold 5,85,000
18)Name the various tools used for financial statement analysis. (Jan 2015)
19)Give the meaning of Floe of Funds. (Jan 2015)
20)Define Net profit ratio. (Apr/May 2015)
21)Define fund flow statement. (Apr/May 2015)
Part-B
1) Discuss the methods of financial statement analysis. May 2011

2) Discuss the importance of financial statement. Jan 2012
3) The following is the balance sheet of a company as on 31st March;

Liabilities Rs Assets Rs
Share capital 2,00,000 Land and Building 1,40,000
Profit &loss a/c 30,000 Plant and Machinery 3,50,000
12% Debenture 40,000 Stock 2,00,000
Sundry Creditors 4,20,000 Sundry Debtors 1,00,000
Bills payable 1,00,000 Bills receivable 10,000
50,000 Cash at Bank 40,000
8, 40,000 8,40,000
Calculate:
1) Current Ratio
2) Quick ratio
3) Inventory to working capital
4) Debt to equity ratio
5) Proprietary Ratio
4) Explain the sources of funds and application of funds to be presented in Fund

Flow statement? June 2012.
5) What is meant by analysis and interpretation of financial statements? Explain the
various methods used for the analysis used for the analysis and interpretation of
financial statements? May 2013
6) What are the uses of financial statement analysis to the internal people of an enterprise?
Dec 2011
7) From the following information, you are required to prepare a balance
sheet: (MAY/JUNE 2014)
Current ratio 1.75
Liquid ratio 1.25
Stock turnover ratio (cost of sales/closing stock) 9
Gross profit ratio 25%
Debt collection Period 1.5 months
Reserves and surplus to capital 0.2
Fixed assets turnover (on cost of sales) 1.23
Capital gearing ratio (long term debt to share capital) 0.6
Fixed assets to net worth 1.25
Sales for the Year Rs. 12,00,000
8) Goodwill Ltd. supplies you the following balance sheets on 31.1

December, 20tL and 2012 : (MAY/JUNE 2014)
9)
Liabilities 2011 2012 Assets 2011 2012

Rs. Rs. Rs. Rs.
share capital 70,000 74,000 Bank Balance 9,000 7,800
Bonds 12,000 6,000 Accounts L4,900 L7,7A0
Receivable
Accounts Payable 10,360 11,840 Inventories 49,200 42,700

Provision for Doubtful 700 800 Land 20,000 30,000
Debts
Reserves and surplus 10,040 10,560 Goodwill 10?009 5,000
1,03,100 1,03,200 1,03,100 1,03,200
Following additional information has also been supplied to you :

(i) Dividends amounting to Rs. 3,500 were paid during the year 2012
(ii) Land. was purchased for Rs. 10,000
(iii) Rs.5,000 were written off on account of goodwill during the year
(iv) Bonds of Rs.6,000 were paid during the course of the year. You are
required to prepare a Cash Flow Statement'.
8. Define ratio analysis. Explain the major uses and limitations of ratio analysis.
(Apr/May 2015)
9. Explain the uses of cash flow statement an discuss the difference between cash floe
statement and fund flow statement. (Apr/May 2015)

UNIT-4
COST ACCOUNTING
Cost Accounts - Classification of manufacturing costs - Accounting for manufacturing

costs. Cost Accounting Systems: Job order costing - Process costing- Activity Based
Costing- Costing and the value chain- Target costing- Marginal costing including
decision making- Budgetary Control & Variance Analysis - Standard cost system
COST ACCOUNTING.
Cost accounting is “ The process of accounting for costs from the point at which
expenditure is incurred or committed to the establishment of its ultimate
relationship with cost centers and cost units. In its widest usage it embraces the
preparation of statistical data, the application of cost control methods and the
ascertainment of the profitability of activities carried out or planned.”
THE OBJECTIVES OF COST ACCOUNTING?

• To aid in the development of long range plans by providing cost data that acts
as a basis for projecting data for planning.
• To ensure efficient cost control by communicating essential data costs at
regular intervals and thus minimize the cost of manufacturing.
• Determine cost of products or activities, which is useful in the determination
of selling price or quotation.
THE ADVANTAGES COST ACCOUNTINGS?

a. It aids in effective decision making
b. It helps in cost reduction
c. It is helpful in fixation of selling price
d. It leads to effective inventory control
e. It helps in the reduction of wastage
THE DISADVANTAGES COST ACCOUNTING

• It is expensive and as such may not be useful for small businesses
• It is based on estimations
• It may not be applicable to all types of industries
• Sometimes, the errors in financial statements may get reflected in cost
accounts
COST CONCEPTS / CLASSIFICATION OF COSTS
a. According to functions
i. Production cost / factory cost / manufacturing cost
ii. Administration cost / office cost
iii. Selling cost

iv. Distribution cost
b. According to the nature of the costs
i. Fixed cost
ii. Variable cost
iii. Semi – variable or semi-fixed cost
iv. Step costs
c. According to the controllability
i. Controllable cost (controllable through authority and
responsibility laid down by the organizational structure)
ii. Uncontrollable cost(Un controllable through authority and
responsibility laid down by the organizational structure)
d. According to normality
i. Normal cost
ii. Abnormal cost
e. According to relevance to decision making
i. Shut down cost (fixed cost)
ii. Sunk cost (historical or past paid cost)
iii. Imputed cost (non- cash cost which is calculated)
iv. Replacement cost (cost of replacing assets)
v. Conversion cost(cost of converting raw material into finished
stock)
f. Others
i. Out of pocket cost (Cash expenses)
ii. Relevant cost and irrelevant cost (relevant to the decision at
hand)
iii. Opportunity cost (cost of an opportunity lost)
iv. Imputed or Hypothetical cost (non-cash expenditure)
v. Direct cost and indirect cost (based on traceability to the final
product or service)
vi. Product costs and period costs (fixed costs and variable
costs)
vii. Decision making costs and accounting costs
viii. Avoidable / escapable costs and unavoidable
ix. Differential, incremental or decremental costs
x. Traceable, untraceable / common costs
xi. Joint costs and common costs etc
METHODS OF COSTING:
1. Job costing:
Job costing is the basic costing method applicable to those industries
where the work consist of separate contracts, jobs, or batches, each of which is
authorized by a specific order or contract.
2. Contract costing:
It is the form of specific order costing, generally applicable where work is
undertaken to customer’s special requirements and each order is of long
duration such as a building construction etc
3. Batch costing:

It is that form of specific order costing which applies where similar
articles are manufactured in batches either for sale or for use within the
undertaking.
4. Process costing: This method of costing is applicable where goods or services
result from a sequence of continuous or repetitive operations or processes and
products are identical and cannot be segregated
5. Operation costing:
It refers to those methods where each operation in each stage of production or
process is separately calculated. Thereafter the cost of finished unit is
determined
6. Unit costing/ Output costing / Single costing:
This method is used when the production is uniform and identical and a single
article is produced. The total production cost is divided by the no of units
produced to get unit or output cost Ex: mining, breweries etc
7. Operating costing:
This method is employed where expenses are incurred for providing services
such as those rendered by transport cost, electricity cost etc
8. Departmental costing:
This refers to the method of ascertaining the cost of operating a department or
cost centre. Total cost of each department is ascertained and divided by total
units produced in that department to arrive at unit cost
9. Multiple / Composite costing:
Under this method, the cost of different sections of production are combined
after finding out the cost of each and every part manufactured. This method is
applicable to companies where a product comprises of many assembled parts.
10. Activity based costing:
Under this type of costing, costs are not allocated through various production
and service departments. Instead, they are traced to their originating activities
in the first stage and in the second stage, they are absorbed into the products
according to the extent of activities demanded by the products. The activity
based costing system is a system based on activities linking spending on
resources to the products /services produced /delivered to customers. This
system is also known as ABC /ABM system.
The major benefits of adopting this system include
i) it does not under cost complex low volume products and over cost high
volume simple products because the cost drivers used by ABC system are
unrelated to volume,
ii) It may result in improved cost control as the costs are broken into a no of
activities rather than into a few cost pools.
The major limitations of this system include –

i) It is very expensive to develop and maintain,
ii) it does not measure the incremental costs required to make a product as it
uses full costing (which includes fixed costs also) instead of using incremental
costs.
11. Target costing :

It is an integrated approach to determine product features, product price,
product costs and product design, that helps to ensure a company will earn

reasonable profit on new products. The components of the target costing
process include (1) Target cost, which is the cost of the resources that should be
consumed to create a product, that can be sold at a target price
(2) Target price – it is the estimated price for a product or service that potential
customers will pay.
(3) Target Operating Income per unit – It is the operating income that a company
aims to earn per each unit of a product or service sold.
(4) Target cost per unit – It is the estimated long run cost per unit of a product
or service that enables a company to achieve its target operating income per unit,
when selling at the target price.
COST SHEET
Cost sheet is a statement, which shows various components of total cost of a

product. It classifies and analyses the components of cost of a product. Previous
periods data is given in the cost sheet for comparative study. It is a statement
which shows per unit cost in addition to Total Cost. Selling price is ascertained
with the help of cost sheet. The details of total cost presented in the form of a
statement is termed as Cost sheet. Cost sheet is prepared on the basis of :
1. Historical Cost
2. Estimated Cost
Importance of Cost Sheet
Cost ascertainment
The main objective of the cost sheet is to ascertain the cost of a product. Cost sheet
helps in ascertainment of cost for the purpose of determining cost after they are
ncurred. It also helps to ascertain the actual cost or estimated cost of a Job.
Fixation of selling price
To fix the selling price of a product or service, it is essential to prepare the cost
sheet. It helps in fixing selling price of a product or service by providing detailed
information of the cost.
Help in cost control

For controlling the cost of a product it is necessary for every manufacturing unit
to prepare a cost sheet. Estimated cost sheet helps in the control of material cost,
labour cost and overheads cost at every point of production.
Facilitates managerial decisions

It helps in taking important decisions by the management such as: whether to
produce or buy a component, what prices of goods are to be quoted in the tender,
whether to retain or replace an existing machine etc.
SPECIMEN OF A COST SHEET
Cost sheet of ….. for the month of …….
Particulars Total cost (Rs) Cost per unit (Rs)

Direct Material xxx

xxx
Direct labor
xxx
Direct expenses
PRIME COST Xxx
Add: Works overheads:
Indirect material Xxx
Factory expenses Xxx
Power & Fuel Xxx
Insurance of factory xxx
WORKS COST xxx
Add: Administrative overheads
Office expenses xxx
Legal charges xxx
Office salaries xxx
Bank commission xxx
COST OF PRODUCTION xxx
Add: Selling & Distribution overheads
Salesmen salaries xxx
Showroom expenses xxx
COST OF SALES xxx
Add: Profit xxx
SALES XXX
1. From the following particulars of product A, prepare a production statement (cost

sheet) for the month of September 2005
Materials used in the manufacturing Rs.5,500
Materials used in packing materials Rs1,000
Materials used in selling the product 150

Materials used in the factory 75

Materials used in the office 125
Labor required in producing1,000
Labor required for supervision of the management – Factory200
Expenses – Direct factory 500
Indirect factory expenses100
Office expenses 125
Depreciation on office building and equipment 75
Factory depreciation 175
Selling expenses 350
Freight 500
Advertising 125
Assuming that all the products manufactured are sold, what should be the selling price
to earn a profit of 25% on selling price?
Solution:
Statement of Cost for product A for the month of September 2005 …….
Particulars
Direct Material
Materials used in mfg 5,500
Add: Freight 500
Materials used in packing materials 1,000 7,000
Direct labor:
Labor used in production 1,000
Direct expense - factory 500 1,500
PRIME COST 8,500
Add: Works overheads:
Material used in the factory 75
Labor for supervision of mgt – factory 200
Indirect factory expenses 100

Factory depreciation 175 550

WORKS COST 9,050
Add: Office & Administrative overheads
Materials used in the office 125
Office expenses 125
Office building & equipment depreciation 75 325
COST OF PRODUCTION 9,375
Add: Selling & Distribution overheads
Materials used in selling the product 150
Selling expenses 350
Advertisement 125 625
COST OF SALES 10,000

Add: Profit (25% on selling price) 3,333
SALES 13,333
STANDARD COSTING:
STANDARD COSTING is a technique which uses standards for costs and revenues
for the purpose of control through variance analysis. It can be used either with
operations or processes or with specific order type of cost accounting system.
A STANDARD COST is defined as ‘a pre-determined calculation of how much

costs should be under specified working conditions. It is built up from the assessment
of the value of cost elements and correlated technical specifications and qualifications of
materials, labor and other costs to the prices and / or wage rates expected to apply
during the period in which the standard cost is intended to be used.
PURPOSES OF STANDARD COSTING
1. Measuring efficiencies
2. Controlling and reducing costs
3. Simplifying costing procedure
4. Valuing inventories and
5. Setting selling prices
ADVANTAGES OF STANDARD COSTING
1. It provides a yardstick for measurement of performance

2. It facilitates ‘Management By Exception’
3. It enables the management to focus more on those expenses and activities which
indicate high favorable or adverse variances, thus saving lot of time and expense
4. It provides motivation for achieving high performance

5. It provides an opportunity for continuous re-appraisal of the methods of
production, production design, use of material etc, leading to cost reduction and
establishing new standards
6. It is easier and economical to operate.
7. It can be used as an aid to budgeting
8. It eliminates wastages by detecting variances and suggesting corrective
measures for them
LIMITATIONS OF STANDARD COSTING
1. It may be very difficult or impossible to fix standards for all operations

2. Wrong standards may result in wastage of time, money and energy
3. Standards must be reviewed from time to time, otherwise, they lose relevancy
4. It pre supposes determination of actual costs
ELEMENTS OF A STANDARD COSTING SYSTEM
1. Establishment of cost centre

2. Determination of quality of standard
3. Organization of standard costing
4. Setting of standards
5. Determination or accumulation of actual costs
6. Analyzing the variance between the standards and the actual
Variance Analysis
Standard Costing guides as a measuring rod to the management for
determination of "Variances" in order to evaluate the production performance. The
term "Variances" may be defined as the difference between Standard Cost and actual
cost for each element of cost incurred during a particular period.
The term "Variance Analysis" may be defined as the process of analyzing variance by
subdividing the total variance in such a way that management can assign responsibility
for off-Standard Performance. The variance may be favourable variance or unfavourable
variance. When the actual performance is better than the Standard, it resents
"Favourable Variance." Similarly, where actual performance is below the standard it is
called as "Unfavourable Variance."
TYPES OF VARIANCES
Variances are computed for all the three basic elements of cost – direct material, direct
labor and overhead variance
1. Direct material variance:

2. Direct labor variance and
3. Overhead variance
MATERIAL VARIANCES:

Direct Material Cost Variances (DMCV):
This variance is an overall difference in the standard direct material cost and the
actual direct material cost. This variance may exist because of difference in either the
price of the material or the quantity that is purchased.
MCV = Standard cost for actual production – Actual cost
= (Standard quantity x Standard price) – (Actual quantity x Actual price)
Based on this, this variance has two components –
i) Material Price Variance (MPV):
This may be defined as the difference between the actual price and the standard price of
the materials consumed.
MPV = Actual quantity used (Standard price – Actual price)
Reasons for Price variance may be
xii.Changes in the market price of direct material

xiii.“Emergency buying” in smaller quantities
xiv. Cash discount not availed
xv. Carriage, freight and other charges absorbed instead of being
charged to the suppliers
xvi. Claims not made on the suppliers for substandard materials
or short receipt of materials
ii) Material Usage Variance (MUV):
This is the difference between the actual quantity of material consumed and standard
quantity which should have been consumed, expressed in terms of the standard price of
the material.
MUV = Standard price (Standard quantity for actual production – Actual quantity used)
Reasons for usage variance may be
xvii. Defective material

xviii. Carelessness in the use of material
xix. Wastages due to bad methods or bad workmanship
xx. Change in the quality of materials used
xxi. Non-standard mix of materials used
Material Usage Variance can be split up further into two components (in process
industries) – a) Materials mix variance : It can be defined as that portion of direct
material usage variance which is the difference between the actual quantities of
ingredients used in a mixture at standard price and the total quantity of ingredients
used at the weighted average price per unit of ingredients as shown by the standard
cost sheet.

MMV = Standard Price (Standard Quantity – Actual Quantity)
(or) when standard is revised due to the shortage of a particular type of material
MMV = Standard Price (Revised Standard Quantity – Actual Quantity)
Where Revised standard quantity = Total weight of actual mix x Standard quantity
Total weight of standard mix
b) Direct material yield variance (MYV) : It has been defined by the ICMA, London,
as ‘the difference between the standard yield of the actual material input and the actual
yield, both valued at the standard material cost of the product’.
MYV = Standard yield rate (Standard yield – Actual yield)
(or) Standard Revised rate (Actual loss – Standard loss),
Where standard revised rate = Standard cost of standard mix
Net standard output
LABOUR VARIANCES:
Labor Cost Variance (LCV):
According to ICMA, London, ‘Labor cost variance is the difference between the standard
direct wages specified for the production achieved, whether completed or not and
actual direct wages incurred’. If the standard cost is higher, the variation is favourable
and vice versa.
LCV = Standard cost of labor – Actual cost of labor
= (Standard time x Standard rate) – (Actual time x Actual rate)
Labor Rate Variance (LRV):
According to ICMA, London, this variance is ‘the difference between the standard and
the actual direct labor rate per hour for the total hours worked’. If the standard rate is
higher, the variance is favourable and vice versa
LRV = Actual time (Standard wage rate x Actual wage rate)
Reasons for rate variance may be:
xxii. Changes in the basic wage rates

xxiii. Faulty recruitment
xxiv. Overtime work at higher or lower than the specified rate
xxv. Change in the composition of the gang at a different rate from
the standard
xxvi. Employing people of different grades than planned

xxvii. Excessive overtime
xxviii. Higher or lower rate paid to casual laborers etc
xxix.
Labor Time or Labor Efficiency Variance (LEV):
This variance has been defined as – ‘that portion of the direct wages cost variance which
is the difference between the standard direct wages cost for the production achieved
whether completed or not, and the actual hours at standard rates (plus incentive
bonus). This variance may be favourable or unfavourable.
LEV = Standard rate (Standard time – Actual time)
Reasons for efficiency variance may be:
xxx. Bad workmanship due to inefficient training or incomplete

instructions or dissatisfaction among the workers
xxxi. Bad working conditions
xxxii. Production delays and hold-ups
xxxiii. Defective equipments, tools and materials
xxxiv. Defective supervision
xxxv.
Labor Idle Time Variance (LITV):
This variance arises because of the time during which the labor remains idle due to
abnormal reasons such as – power failure, strikes, machine breakdowns etc.
LITV = Abnormal idle time x Standard hourly rate
Labor Mix Variance or Gang Composition Variance (LMV): This is that part of Labor
cost variance that results from employing different grades of labor from the standard
fixed in advance. It is the difference between the standard composition of workers and
the actual gang of workers.
LMV = (Standard cost of standard mix) – (Standard cost of Actual mix)
Labor Yield Variance (LYV): It is the difference between the standard labor output and
actual output or yield.
If the actual production is more than the standard production, it would result in
favourable variance and vice versa.
OVERHEAD VARIANCES:
Unlike direct material and labor, the manufacturing overhead is not entirely variable
with the level of production. Therefore, standard costs for factory overheads are based
upon budgets rather than standards. These variances arise due to the differences
between the actual overhead cost incurred and the standard overhead cost charged to
production. There are two components to overhead variances – i) Variable Overhead
Variances and ii) Fixed Overhead Variances.

Variable Overhead Variance (VOHV):
This variance is defined by ICMA, London, as ‘the difference between the standard
variable production overhead absorbed in the production achieved, whether completed
or not, and the actual production overhead’. This variance can be divided into – i)
Variable Overhead Expenditure Variance and ii) Variable Overhead Efficiency Variance.
VOHV= (Actual hours worked x Standard variable overhead rate per hour) – Actual
variable over heads
i) Variable overhead variance:
It is difference between actual overhead expenditure incurred and the standard variable
overheads set in for a particular period.
Variable overhead variance = (Standard variable overhead) – (Actual variable overhead)
ii) Variable Overhead Efficiency Variance:
It shows the effect of change in labor efficiency overheads recovery.
Variable Overhead Efficiency Variance = Standard rate (Standard quantity – Actual

quantity) where Standard rate = (Standard time for actual output – Actual time)
Fixed Overhead Variance (FOV) :
Fixed overhead variance has been defined by ICMA, London, as ‘the difference between
the standard cost of fixed overhead absorbed in the production achieved, whether
completed or not, and the actual fixed overhead, attributed and charged to that period’.
FOV = (Actual production x Standard fixed overhead recovery rate) – Actual overheads
incurred
This variance may be divide into – i) Fixed Overhead Expenditure Variance and ii) Fixed
Overhead Volume Variance.
i) Fixed Overhead Expenditure Variance (FOEV):
This variance has been defined by ICMA, London as ‘the difference between the budget
cost allowance for production for a specified control period and the amount of actual
fixed expenditure attributed and charged to that period’.
FOEV = Budgeted fixed overhead – Actual fixed overhead
(Or) Budgetary quantity x Standard overhead rate – Actual Fixed overhead
ii) Fixed Overhead Volume Variance (FOVV):
This variance has been defined by ICMA, London as ‘that portion of the fixed production
overhead variance which is the difference between the standard cost absorbed in the

production achieved, whether completed or not, and the budget cost allowance for a
specified control period’.
FOVV = Standard Fixed overhead recovery rate (Actual quantity – Budgeted quantity)
Fixed Overhead Volume Variance can further be divided into – i) Capacity variance and
ii) Productivity variance
i) Fixed Overhead Capacity Variance (FOCV):
overhead volume variance which is due to working at higher or lower capacity than
standard’.
FOCV= Standard recovery rate (Standard quantity – Budgeted quantity)
ii) Fixed Overhead Productivity Variance (FOPV):
overhead volume variance which is the difference between the standard cost absorbed
in the production achieved, whether completed or not, and the actual direct labor hours
worked (valued at the standard hourly absorption rate).
FOPV = Standard overhead rate (Actual quantity – Standard quantity)
Some times, another variance, called as calendar variance may also be calculated as –
Standard rate per hour (Possible hours – Budgeted hours) (or)
Standard rate per unit (Possible units – Budgeted units)
SALES REVENUE VARIANCE (SRV):
The word ‘Sales Variance’ is denoted by the expression ‘operating profit variance
due to sales’ by ICMA. It is defined as the difference between the budgeted operating
profit and the margin between the actual sales and the standard cost of those sales’.
This variance is subdivided into – i) Sales price variance and ii) Sales volume variance
i) Sales price variance (SPV): It is the difference between actual selling price and
standard selling price.
SPV = Actual quantity (Actual selling price – Standard selling price)
ii) Selling Volume Variance (SVV):
It is the difference between the actual no of units sold and the planned sale of units.
SVV = Standard selling price (Actual quantity – Standard quantity)

PROFIT VARIANCES
Sales variances are significant as they have a direct bearing on profits earned by
the organization. Hence, they can be used as the basis of determining profit variance.
The overall Profit Variance is divided into – i) Sales price variance and ii) Sales Volume
Variance, which is sub-divided into – a) Sales Price variance b) Sales Volume Variance
and iii) Cost Variance. Except Cost Variance, there is no difference between the various
Sales Variances and Profit Variances.
Overall Sales Variance = Standard / Budgeted profit – Actual profit (Unfavorable)
(Or) Actual Profit – Standard / Budgeted profit (Favorable)
Cost Variances: They arise when actual costs are different from standard costs.
Cost Variances = (Standard cost – Actual cost) Actual quantity sold (Favorable)
(or) (Actual cost – Standard cost) Actual quantity sold (Unfavorable)
CLASSIFICATOIN OF BUDGETS
Budgets can be classified on the basis of many bases. There are three popular
bases for classifying budgets. They are – time, functions and flexibility. Apart from
these classifications, several other budgets can also be found in practice such as –
performance budget, ZBB, control ratios etc
On The Basis Of Time
• Long term budget: According to National Association of Accountants, America, a

long term budget is, a systematic and formalized process for purposeful directing
and controlling future operations towards a desired objective for periods extending
beyond one year.
• Short term budget: Short term budget covers a budget period of one year or less.
• Current budget: These budgets cover a very short period such as a month or a
quarter. They are essentially short term budgets adjusted to current conditions or
prevailing circumstances.
On The Basis Of Functions
• Functional / Subsidiary budgets: A Functional budget is a budget of income or

expenditure appropriate to or the responsibility of functions, such as production,
sales, purchase etc. Each functional department prepares its own budget, and all
these functional budgets are integrated into the Master budget.
Sales budget: It gives details about volume, price and sales mix. It also gives details
about the quantity of sale, month-wise or quarter-wise, market-wise, area-wise and

on whatever other basis be important to the organization. The responsibility for
preparation of this budget falls on the sales manager. While preparing this budget,
he/she has to consider certain influencing factors such as – past sales figures and
trend, salesmen’s estimates, plant capacity, general trade practice, orders in hand,
proposed expansion or discontinuance of products, seasonal fluctuations, potential
market, availability of material and supply, finance etc.
Production budget: It includes details about the types, quantity and cost of goods
and services produced in the organization. The responsibility of preparing this
budget falls on the Works manager or departmental Works managers.
Production cost budget: It is divided into material cost budget, labour cost budget
and overhead cost budget, because cost of production includes material, labour and
overheads.
Materials budget: It includes details about the kinds and quantity of material
required, price paid for it, cost of transportation and storage, etc
Labor budget: It includes details about the types and number of workers, the
number of hours required, the wage rates and other allowances, the welfare and
other facilities provided and cost thereof etc.
Overheads budget: It gives details of items of factory overhead expenses, their

quantity and cost.
Research and Development budget: Every organization of some size, particularly,

of a manufacturing or technical type, has a Research and Development Department.
Expenses incurred by it are parts of operating cot, until efforts lead to some findings
that can be used for improvement of quality of product technology improvement,
and/or for producing something new, at which stage all expenses incurred are
capitalised.
Capital expenditure budget: This budget shows the estimated expenditure on

fixed assets such as land and buildings, plant and machinery, etc. It is a long term
budget. This budget is prepared to plan for replacement of old machines, increased
demand of products, expansion of activities, etc.
Cash budget: A Cash budget deals with cash, including its equivalent, like bank
balance and bills receivable. It shows the inflows of cash and outflows of cash
during a particular period of time. It can be prepared for a year, but for better
control and management of cash, its is normally prepared on monthly basis. It takes
into account only cash transactions.
• Master budget: This budget is prepared from, and summarises the various
functional budgets. It is also called as summary budget. It generally includes details
relating to production, sales, stock, debtors, cash position, fixed assets etc, in
addition to important control ratios.
On The Basis Of Flexibility
• Fixed budget: A Fixed budget is designed to remain unchanged irrespective of the

volume of output or turnover attained. The budget remains fixed over a given
period and does not change with the change in the volume of production or level of
activity attained.
• Flexible budget: It is also known as variable budget. A Flexible is designed to
change along with the changes in the output or turnover. It changes according to the
levels of activity.
Other Related Budgets
1. Performance budget : Performance budget involves evaluation of the performance

of the organization in the context of both specific and overall objectives of the
organization. According to National Institute of Bank Management, performance
budgeting is the process of analyzing, identifying, simplifying and crystallizing specific
performance objectives of a job to be achieved over a period in the frame work of the
organizational objectives, the purpose and the objectives of the job.
Performance budgeting requires preparation of performance reports which compare

the budget and actual data and show the variances existing between both. The
responsibility for preparing these reports lies on the respective departmental head.
Each departmental head will be supplied with a copy of the section of the master budget
appropriate to his sphere. This report may be prepared on a daily basis, weekly basis,
monthly basis or any basis based on the size of business and the budget period. The
purpose of submitting these reports is to convey promptly the information about the
deviations in actual and budgeted activity to the decision makers so that necessary
corrective actions can be taken to correct the deviations.
The various ADVANTAGES of Performance budgeting are as follows:

• It aims at continuous growth of the organisation in the long-run.
• It enables the organisation to be sensitive and adaptive, preventing it
from developing rigidities which may retard the process of growth.
• It facilitates performance appraisal
PRE-REQUISITES for a successful adoption of Performance budgeting are :
• It requires preparation of periodic performance reports.

• The accounting system should be sufficiently detailed and co-ordinated to
provide necessary data for reports designed for the particular use of the
individual or cost centres having primary responsibility for specific costs.
2. Zero base budget:
Zero base budgeting (ZBB) is a new technique which was first used by the US
Department of Agriculture in 1961. Texas instruments, a n MNC, has used it in the
private sector. But, it was Peter.A.Pyhr who had designed its logical basic framework in

1970 and successfully developed, implemented and popularized the use of ZBB in
private sector. Hence, he is known as the ‘father of ZBB’. The technique became more
popular in USA when the then President of USA, Mr.Carter, in 1979, had issued a
mandate asking for the use of ZBB through out the federal government agencies.
Though it had become popular in many countries, especially the common wealth
countries, in India, despite the various efforts of the Institute of Chartered Accountants
of India and the Institute of Costs and Works Accountants of India, it had not gained
popularity in India.
‘ZBB is a management tool which provides a systematic method of evaluating all
operations and programmes, current or new, allows for budget reductions and
expansions in a rational manner and allows re-allocation of sources from low to high
priority programmes’
A Zero base budget is not an old budget with incremental changes, as in the case of an
incremental budget. It starts with a scratch or a zero level and if an item is found to be
necessary it is included in the new budget, and if it is necessary, how much amount
should be budgeted for.
ZBB has many advantages to the management covering
1) It provides a solution for all the limitations of traditional budgeting by enabling the
top management to focus on key areas, alternatives and priorities of action throughout
the organization.
2) It enables the management to concentrate only on essential programs
3) It enables the management to approve departmental budgets on the basis of cost

benefit analysis.
4) It helps in identifying wasteful expenditure, and if desired, it can also be used for
suggesting alternative courses of action.
5) It can be used for introducing the system of Management by objectives, etc.
Even though there are many advantages with this type of budgeting, there are various
disadvantages also associated with its use. Some of them are –
1) Successful implementation of ZBB requires top management support. Its absence

may lead to implementation problems
2) There are other problems related to the implementation of the ZBB program such as
– fixing of suitable authority and responsibility for preparing the budgets, fixing the
minimum level of effort required, etc
3) It is expensive and may not suit smaller firms
4) It is time consuming and may not be relevant in taking emergency decisions. etc
3. Control ratios

Three important ratios are commonly used by the management to find out whether
the variations from budgeted results are favourable or unfavourable. These ratios are
expressed as percentages and any ratio beyond 100% is favourable and an ratio less
than 100% is unfavourable. The three ratios are :
a) Activity Ratio: It is a measure of the level of activity attained over a period.

Activity ratio = Standard Hrs. for Actual Production x 100
Budgeted Hours
b) Capacity Ratio : This ration indicates whether and to what extent budgeted
hours of activity are actually utilized.
Capacity ratio = Actual hours worked x 100
Budgeted hours
c) Efficiency Ratio : This ratio indicates the degree of efficiency attained in

production.
Efficiency ratio = Standard hours for actual prodn. x 100
Actual hours worked
7) A factory engaged in manufacturing plastic buckets is working at 40% capacity

and produces 10,000 buckets per month. The present cost break up for one bucket is as
under
Material Rs.10
Labor Rs.3
Overheads Rs.5 (60% fixed)
The selling price is Rs.20 per bucket. If it is desired to work the factory at 505 capacity,
the selling price falls by 3%. At 90% capacity, the selling price falls by 5% accompanied
by a similar fall in the price of the material.
You are required to prepare a statement showing the profit at 50% and 90% capacities
and also calculate the break even points at the capacity production.
SOLUTION: FLEXIBLE BUDGET
Particulars Capacity
40% 50% 90%
Production and 10,000 12,500 22,500

sales units
Sales price per 20.00 19.40 19.00

unit
Sales amount 2,00,000 2,42,500 4,27,500
Marginal cost
Material: Rs 10
(at 90% - Rs.9.50
per unit)
1,00,000 1,25,000 2,13,750
Labor
30,000 37,500 67,500
Variable overhead
20,000 25,000 45,000
Total 1,50,000 1,87,500 3,26,250
Contribution 50,000 55,000 1,01,250
Less: Fixed 30,000 30,000 30,000
Profit 20,000 25,000 71,250
Contribution per 5.00 4.40 4.50

unit
BEP (Units) 30,000/5 30,000/4.40 30,000/4.50
= 6,000 =6,818 =6,667
CONCEPTS OF MARGINAL COST & BREAK EVEN POINT
Meaning
Marginal Cost: The tenn Marginal Cost refers to the amount at any given volume of
output by which the aggregate costs are charged if the volume of output is changed by
one unit. Accordingly, it means that the added or additional cost of an extra unit of
output.
Marginal cost may also be defined as the "cost of producing one additional unit of
product." Thus, the concept marginal cost indicates wherever there is a change in the
volume of output, certainly there will be some change in the total cost. It is concerned
with the changes in variable costs. Fixed cost is treated as a period cost and is
transferred to Profit and Loss Account.
Marginal Costing: Marginal Costing may be defined as "the ascertainment by

differentiating between fixed cost and variable cost, of marginal cost and of the effect on

profit of changes in volume or type of output." With marginal costing procedure costs
are separated into fixed and variable cost.
According to J. Batty, Marginal costing is "a technique of cost accounting pays special
attention to the behaviour of costs with changes in the volume of output." This
definition lays emphasis on the ascertainment of marginal costs and also the effect of
changes in volume or type of output on the company's profit.
FEATURES OF MARGINAL COSTING
(1) All elements of costs are classified into fixed and variable costs.
(2) Marginal costing is a technique of cost control and decision making.
(3) Variable costs are charged as the cost of production.
(4) Valuation of stock of work in progress and finished goods is done on the basis of
variable costs.
(5) Profit is calculated by deducting the fixed cost from the contribution, i.e., excess of
selling
price over marginal cost of sales.
(6) Profitability of various levels of activity is detennined by cost volume profit analysis.
Advantages of Marginal Costing.
Important Decision Making Areas of Marginal Costing
The following are the important decision making areas where marginal costing
technique is used :
(I) Pricing decisions in special circumstances :
(a) Pricing in periods of recession;
(b) Use of differential selling prices.
(2) Acceptance of offer and submission of tenders.
(3) Make or buy decisions.
(4) Shutdown or continue decisions or alternative use of production facilities.
(5) Retain or replace a machine.
(6) Decisions as to whether to sell in the export market or in the home market.
(7) Change Vs status quo.

(8) Whether to expand or contract.
(9) Product mix decisions like for example :
(a) Selection of optimal product mix;
(b) Product substitution;
(c) Product discontinuance.
(10) Break-Even Analysis.
Limitations of Marginal Costing
(1) It may be very difficult to segregation of all costs into fixed and variable costs.
(2) Marginal Costing technique cannot be suitable for all type of industries. For example,
it is
difficult to apply in ship-building, contract industries etc.
(3) The elimination of fixed overheads leads to difficulty in determination of selling

price.
(4) It assumes that the fixed costs are controllable, but in the long run all costs are
variable.
(5) Marginal Costing does not provide any standard for the evaluation of performance
which is
provided by standard costing and budgetary control.
(6) With the development of advanced technology fixed expenses are proportionally
increased.
Therefore, the exclusion of fixed cost is less effective.
(7) Under marginal costing elimination of fixed costs results in the under valuation of
stock of
* FIXED COST: Fixed cost is a period cost and is usually unrelated to changes in
production. The total fixed cost remains constant for all levels of production whereas
the fixed cost per unit changes with changes in the production level.
* VARIABLE COST: Variable cost is a product cost and is usually directly related to
production. Total variable cost changes with changes in the production level, but
variable cost per unit remains the same for all levels of production.

* CONTRIBUTION: It is the difference between the sales and the marginal cost of sales
and it contributes towards fixed expenses and profit. It is different from the profit
which is the net gain in activity or the surplus and remains after deducting fixed
expenses from the total contribution. In marginal costing, the concept of contribution is
very important as it helps to find out the profitability of a product, department or
division, to have a better product mix, for profit planning and to maximize the profits of
a concern
Contribution = Sales – Variable cost (or) Fixed cost +Profit (or) Fixed cost – Loss
* MARGIN OF SAFETY (MOS): It refers to the difference between the actual sales and
break even sales. It represents a cushion to the creditors of the firm.
MOS = Actual sales – Break even sales (or) Profit (in Rs) (or) Profit (in units)
P/V ratio Contribution per unit
* ANGLE OF INCIDENCE : It is an angle that is formed when the total sales line
intercepts the total cost line from below in the breakeven chart. It is inferred that
higher the angle, higher is the profit, and lower the angle lower the profit.
* PROFIT VOLUME RATIO: It is also known as contribution to sales (C/S) ratio. It is one
of the most important ratios for studying the profitability of operations of a business
and establishes the relationship between contribution and sales. The inference is –
higher the P/V ratio, lesser will be the profit.
P/V ratio = Contribution x 100 (or) S –V (or) F +P (or) F-L (or) Change in profits x 100
Sales Sales Sales Sales Change in sales
* BREAK EVEN POINT: It represents a level of production where there is no loss and
there is no profit. In other words, it is a point where the total cost is equal to total sales.
Sales beyond this level represent profit and sales below this point represent loss.
BEP (in value) = Fixed cost (or) Fixed overheads (or) Fixed cost x sales
Contribution ratio 1 – Variable cost/sales Sales – Variable cost
(or) Fixed cost
P/V ratio
BEP (in units) = Fixed cost (or) Fixed cost
Contribution per unit Selling price per unit – Variable cost per unit
MERITS OF BREAK EVEN POINT

1. Margin of safety is known
2. Cost-Volume-Profit relationship is known
3. Helps in forecasting profit and growth
4. Helps in cost control
5. Helps in knowing profit at various levels
6. Helps in fixing target profit
7. Helps in forecasting the effect of change in price and angle of incidence
DEMERITS OF BREAKEVEN POINT
1. It ignores considerations such as effect of government policy changes, changes in

the marketing environment etc
2. Fixed cost, sales, total costs cannot be represented as straight lines
3. It is difficult to handle advertisement expenditure
4. Fixed costs also may change in the long run
5. It ignores economies of scale in production
6. Semi-variable costs are ignored
7. Volume of production and volume of sales are always not equal
8. Selling price may or may not be the same
UTILITY OF BREAK EVEN POINT IN MANAGERIAL DECISION MAKING
1. It helps in determination of sales mix

2. It helps in exploring new markets
3. It helps in deciding about discontinuance of a product line
4. It helps in taking make or buy decisions
5. It helps in taking equipment replacement decisions
6. It aids in investment of assets
7. It aids in decision making relating to change Vs status quo – which may include
situations like – i) adoption of new method of operation ii) overtime Vs second
shift or iii) Sale Vs further processing etc
8. It helps in making decisions as to expand or contract
9. It helps in decisions relating to shut down or continue operating
Illustrations
1. From the following particulars, calculate the break even point
Variable cost per unit = Rs.12
Fixed expenses = Rs.60,000
Selling price per unit = Ra.18
Solution:
BEP (Units) = Fixed cost
Contribution per unit

(Selling Price – Variable Cost = Contribution)
Rs.18 – Rs.12 = 6)
Rs.60,000 / Rs.6 = 10,000 units
B.E.P. Sales = 10,000 x Rs.18 = Rs.1,80,000
2. A Company estimates that next year it will earn a profit of Rs.50,000. The budgeted
fixed costs and sales are Rs.2,50,000 and Rs.9,93,000 respectively. Find out the break-
even point for the company.
Solution :
B.E.P. (in units) = FxS
Contribution
Contribution = S – V = F + P
F + P = Rs.2,50,000 + Rs.50,000 = Rs.3,00,000
B.E.P. Sales = 2,50,000 x 9,93,000
3,00,000
= Rs.8,27,500
3. From the following particulars, find out the selling price per unit if B.E.P. is to be
brought down to 9,000 units.
Variable cost per unit Rs.75
Fixed expenses Rs,2,70,000
Selling price per unit Rs.100
Solution :
Let us assume that the contribution per unit at B.E. sales of 9,000 is x
B.E.P. = Fixed Cost
Contribution per unit
Contribution per unit is not known. Therefore

9,000 units = 2,70,000
9,000 x = 2,70,000 x = 30
Contribution is Rs.30 per unit, in place of Rs.25. Therefore, the selling price should have
been Rs.105 i.e. Rs.75 + Rs.30.
1. What is activity based costing? (APR/MAY 2015)

2. What is target costing? (APR/MAY 2015)
3. Define job order costing. (Jan 2015)
4. State any four features of marginal costing. (Jan 2015)
5. From the following information, calculate gross profit ratio (MAY/JUNE 2014)
Rs.
Sales 10,00,000
Sales returns 1,00,000
Cost of goods sold 5,85,000
6. What is target costing? (MAY/JUNE 2014)

7. what are the essentials of a good costing system? ( JANUARY 2014)
8. Define process costing. ( JANUARY 2014)
9. What is Activity Based Costing? (NOV/DEC2013)
10. What is standard cost system? (NOV/DEC2013)
11. What is activity based costing? (MAY/JUNE 2013)
12. Define variance. (MAY/JUNE 2013)
13. Write about Activity Based Costing. (MAY/JUNE 2012)
14. What is Idle Time Variance? (MAY/JUNE 2012)
15. What are the functions of cost accounting? (January 2012)
16. Definition of standard costing? (January 2012)
17. What is marginal costing? (NOV/DEC2011)
18. Classify manufacturing costs. (NOV/DEC2011)
19. What is a classification of manufacturing cost? (APR/MAY 2011)
20. What are fixed and flexible budget. (APR/MAY 2011)
21. What are fixed overheads? Why are they called burdens? (Jan 2011)
22. How does the ABC differ from traditional costing approach? (Jan 2011)
PART B

1. why budgetary control important? Discuss about the process and techniques
of budgetary control. (APR/MAY 2015)
2. The product of a company passes through 3 distinct processes. The following

information is obtained from the accounts for the month ending January
31. 2008. (MAY/JUNE 2014)
Particulars Process Process Process
A B C
Direct material 7,800 5,940 8,886
Direct wages 6,000 9,000 12,000
Production overheads 6,000 9,000 12,000
8000 units @ Rs. 3 each were introduced to process I. There was no stock of
materials or work in progress. The output of each process passes directly to the next
process and finally to finished stock A/c.
The following additional data is obtained :
Process Output Units % of normal loss value scrap per unit

Rs.
Process A 2850 5 245
Process B 2520 10
Process C 2250 15
Prepare Process Cost Accounts, Normal Cost Account and Abnormal Gain or Loss
Account
2. Prepare a flexible budget for overheads on the basis of the following data
(MAY/JUNE 2014)
■
and ascertain overhead rates at 50%, and 70% capacity.
60% At 60Vo capacity
(MAY/JUNE 2014)
(MAY/JUNE
Rs. 2014)
Variable overheads :
Indirect material 6,000
Indirect labour 18,000
Semi-variable overheads : 30,000
Electricity (40Vo fixed 60% 3,000
variable)
Repairs (80% fixed 20% variable)
Fixed overheads :
Depreciation 16,500
Insurance 4,500
Salaries 15,000

Total overheads 93,000
Estimated direct labour hours 1,86,000
3. From the following, find the profit made by each product, apportioning
joint-costs on the sale-value basis. ( JANUARY 2014) (8)
Joint cost : ,Rs.
Direct materials 1,26,000
Power 25,000
Petrol, oil, lubricants 5,000
Labour 7,500
Other charges 4,100
Product X Product Y
Selling costs Rs. 20,000 Rs. 80,000
Sales Rs. 1,52,000 Rs. 1,68,000
4. From the following data, calculate the break-even point: ( JANUARY 2014)
Rs.
Selling price per unit 20
Direct material cost per 8
unit
Direct labour cost per 2
unit
Direct expenses per unit 2
Overheads per unit 3
Fixed overheads (total) 20,000
If sales are -20%, above the break-even point, determine the net profit. (8)
5. A company working at 50% capacity manufactures 10,000 units of a product.

At 50% capacity the product cost is Rs. 180 and sale price Rs. 200, the breakup of the
cost is as below ( JANUARY 2014)
Cost per unit
Material Rs. I00
Wages Rs. 30
Factory overheads Rs. 30 (40% fixed)
Administration overheads Rs. 20 (50% fixed)
At 60% working raw material cost goes up by 2% and sales price

falls by 2% at 80% working the raw material cost increases by 5%
and sale price decreases same percentage i.e., 5% Prepare a
statement to show profitability at 60% and 80% capacity.
(8)
6. Calculate the materials mix variance from the following ( JANUARY 2014) (s)
Material Standard Actual

A 90 units at 100 units
Rs.12 each at " 12 each
Rs
B 60 units at 50 units at
Rs. 15 each Rs. 16 each
7. What is variance Analysis? Discuss about various types of Variance? (NOV/DEC2013)
8. Product X is obtained after it is processed through three processes. You are required to
prepare process accounts from the following information. (NOV/DEC2013)
Process
Total I II II
Material 5,625 2,600 2,000 1,025
Direct wages 7,330 2,250 3,680 1,400
Production overheads 7,330
500 units @ Rs. 4 per unit were introduced in process I. production overhead to be
distributed as 100% on direct wages. The actual output and normal loss of the
respective process are.
Output Normal loss to input value of scrap -P.U

processI 450 10% 2
process II 340 20% 4
process III 270 25% 5
9. Explain some of the important applications of marginal costing for managerial decisions.
(MAY/JUNE 2013)
10. From the following prepare the process costing sheet. The production of each process is
moved to the next process on completion. (MAY/JUNE 2013)
Process X process Y process Z

Wages and materials 30,400 12,000 29,250
Work overhead 5,600 5,250 6,000
Production in units 36,000 37,500 48,000
Opening stock (units from preceding
Process) - 4,000 16,500
Closing stock (units from preceding
Process) - 1,000 5,500
11. The sales turnover and profit during two years were as follows: (MAY/JUNE 2012)

Year Sales (Rs) Profit (Rs)
2000 1, 40,000 15,000
2001 1, 60,000 20,000
You are required to calculate:
(1) P/v Ratio

(2) Sales required to earn a profit of Rs.40,000
(3) Profit when sales are Rs. 1, 20,000.
12. Cost Accounting is an essential tool of Management”. Give your comments on the
Statement. (MAY/JUNE 2012)
13. Describe the various methods of cost accounting. (January 2012)
14. A Ltd manufactures products X and Y. during January 1998 it expects to sell 10,000
kg of X and 40,000 kg of Y at Rs. 20 and Rs.10 respectively. Direct materials P,Q and S
are mixed in equal proportions to product X and materials Q, R & S are mixed in the
ration of 3:5:2 to product Y. There is no loss of weight in production. (January 2012)
15. Actual and Budgeted stocks in quantities and costs for the month are as follows:
Opening stock Closing stock Anticipated cost
(kg) (kg) ( per kg)Rs.
Material P-3,000 2,000 5.5
Q-2,000 4,000 5.0
R-20,000 6,000 1.0
S-10,000 12,000 3.5
Product X- 2,000 1,000 -
Y-10,000 12,000 -
You are required to prepare
(1) The production Budget and

(2) Materials purchase budget including the expenditure on raw materials for
January.
16. What is cost sheet? Draw up a cost sheet for a consumer durable product.
(NOV/DEC2011)
A factory can sell 20,000 units of its product in home market at Rs. 20 each. The marginal cost is
Rs. 14 per unit and fixed overhead Rs. 60,000. It can also sell another 10,000 units in the foreign

market at Rs. 16 per unit. The additional cost for export is Re.1 per unit. The total capacity of the
factory is 35,000 units. Is the foreign market worth trying? (NOV/DEC2011)
17. “A sound costing system must place the same emphasis on cost control as on cost
management”. Comment on the statement. (APR/MAY 2011)
18. The following budget estimates are available from a factory working at 50% of its capacity:
Variable expenses Rs. 60,000

Semi-variable expenses Rs. 20,000
Fixed expenses Rs. 10,000
Prepare a budget for 75% of the capacity assuming that semi-variable expenses increase
by 10% for every 25%. (APR/MAY 2011)
19. Slandered equipment Co. operates on standard costing system. The budgeted
overheads for the year ending March 31, were fixed at Rs. 4,20,000 with predetermined
overheads recovery rate of Rs 7 per direct labour hour. The actual direct labour hours
for the year amounted to 61,000 against which only 60,500 hours should have been
spend for the production completed during the year. The actual overhead rate worked
out at Rs. 6.75 per direct labour –hour. You are require to compute the following
variances: (JAN 2011)
a) Total overhead cost variance
b) Overhead budget variance
c) Overhead efficiency variance
d) Overhead capacity variance (Jan 2011)

Unit-V
Accounting in Computerized Environment
COMPUTER AND ITS CHARACTERISTICS.
Computer is an electronic device that can perform a variety of operations in

accordance with a set of instructions called programme. It is a fast data processing
electronic machine. It can provide solutions to all complicated situations. It accepts data
from the user converts the data into information and gives the desired result. Therefore,
we may define computer as a device that transforms data into information. Data can be
anything like marks obtained in various subjects. It can also be name, age, sex, weight,
height, etc. of all the students, savings, investments, etc, of a country.
Computer is defined in terms of its functions. Computer is a device that accepts data,
stores data, processes data as desired, retrieves the stored data as and when required
and prints the result in desired format.
CHARACTERISTICS OF COMPUTER
1. Speed
It can access and process data millions times faster than humans can. It can store data
and information in its memory, process them and produce the desired results. It is used
essentially as a data processor. All the computer operations are caused by electrical
pulses and travels at the speed of light. Most of the modern computers are capable of
performing 100 million calculations per second.
2. Storage
Computers have very large storage capacity. They have the capability of storing vast
amount of data or information. Computers have huge capacity to store data in a very
small physical space. Apart from storing information, today’s computers are also
capable of storing pictures and sound in digital form.
3. Accuracy
The accuracy of computer is very high and every calculation is performed with the same
accuracy. Errors occur because of human beings rather than technological weakness,
main sources of errors are wrong program by the user or inaccurate data.
4. Diligence

A computer is free from tiredness and lack of concentration. Even if it has to do 10
million calculations, it will do even the last one with the same accuracy and speed as the
first.
5. Versatility
Computer can perform wide range of jobs with speed, accuracy, and diligence. In any
organization, often it is the same computer that is used for diverse purposes such as
accounting, playing games, preparing electric bills, sending e-mail and so on.
6. Communication
Computers are being used as powerful communication tools. All the computers within
an office are connected by cable and it is possible to communicate with others in the
office through the network of computer.
7. Processing Power
Computer has come a long way today. They began as more prototypes at research
laboratories and went on to help the business organizations, and today, their reach is so
extensive that they are used almost everywhere. I the course of this evolution, they have
become faster, smaller, cheaper, more reliable and user friendly.
COMPONENTS OF COMPUTER
The following are the important components of computer
1. Input unit
Input is controlling the various input devices which are used for entering data into the
computer. The mostly input devices are keyboard, mouse, and scanner. Other such
devices are magnetic tape, magnetic disk, light pen, bar code reader, smart card reader,
etc. besides; there are other devices which respond to voice and physical touch. Physical
touch system is installed at airport for obtaining the online information about departure
and arrival of flight. The input unit is responsible for taking input and converting it into
binary system.
2. Central Processing Unit(CPU)
The CPU is the control centre for a computer. It guides, directs and governs its
performance. It is the brain of the computer. The main unit inside the computer is the
Central Processing Unit. Central Processing Unit is to computer as the brain is to human
body. This is used to store program, photos, graphics, and data and obey the
instructions in program. It is divided into three subunits.
a) Control Unit

b) Memory Unit
c) Arithmetic Logic Unit(ALU)
Control Unit
Control unit controls and co-ordinates the activities of all the components of the
computer. This unit accepts input data and converts it into computer binary system.
Memory Unit
This unit stores data before being actually processed. The data so stored is
accessed and processed according to instructions which are also stored in the memory
section of computer well before such data is transmitted to the memory from input
devices.
Arithmetic and Logic Unit
It is responsible for performing all the arithmetical calculations and

computations such as addition, subtraction, division, and multiplication. It also
performs logical functions involving comparisons among variable and data items.
3. Output Unit
After processing the data, it ensures the convertibility of output into human readable
form that is understandable by the user. The commonly used output devices include like
monitor also called Visual Display Unit, printer etc.
ROLE OF COMPUTERS IN ACCOUNTING
The most popular system of recording of accounting transactions is manual

which requires maintaining books of accounts such as Journal, Cash book, special
purpose books, ledger and so on. The accountant is required to prepare summary of
transactions and financial statements manually.
The advanced technology involves various machines capable of performing

different accounting functions, for example, a billing machine. This machine is capable
of computing discount, adding net total an posting the requisite data to the relevant
accounts with substantial increase in the number of transactions, a machine was
developed which could store and process accounting data in no time. Such advancement
leads to number of growing successful organizations.
A newer version of machine is evolved with increased speed, storage, and processing
capacity. A computer to which they were connected operated these machines.

As a result, the maintenance of accounting data on a real-time basis became
almost essential. Now maintaining accounting records become more convenient with
the computerized accounting.
The computerized accounting uses the concept of databases. For this purpose an
accounting software is used to implement a computerized accounting system. It does
away the necessity to create and maintain journals, ledgers, etc, which are essential part
of manual accounting. Some of the commonly used accounting software’s are Tally, Cash
Manager, Best Books, etc.
Accounting software is used to implement a computerized accounting. The

computerized accounting is based on the concept of database. It is basic software which
allows access to the data contained in the data base. It is a system to manage collection
of data insuring at the same time that it remains reliable and confidential.
Following are the components of computerized accounting software.
1. Preparation of accounting documents
Computer helps in preparing accounting documents like Cash Memo, Bills and invoices
etc., and preparing accounting vouchers.
2. Recording of transactions
Every day business transactions are recorded with the help of computer software
Logical scheme is implied for codification of account and transaction. Every account and
transaction is assigned a unique code. The grouping of accounts is done from the first
stage. This process simplifies the work of recording the transactions.
3. Preparation of Trial Balance and Financial statements
After recording of transaction, the data is transferred into ledger account automatically
by the computer. Trial Balance is prepared by the computer to check accuracy of the
records. With the help of trial balance the computer can be programmed to prepare
Trading, Profit and Loss account and Balance Sheet.
It is one of the transaction processing systems which are concerned with financial
transactions only. When a system contains only human resources it is called manual
system; when it uses only computer resources, it is called computerized system and
when it uses both human and computer resources, it is called computer-based system.
These steps can be explained with an example making use of Automatic Teller Machine
(ATM) facility by a Bank-Customer.
a. Data Entry

Processing presumes data entry. A bank customer operates an ATM facility to make a
withdrawal. The actions taken by the customer constitute data which is processed after
validation by the computerized personal banking system.
b. Data Validation
It ensures the accuracy and reliability of input data by comparing the

same with some predefined standards or known data. This validation is made by the
“Error Detection “and “Error Correction” procedures. The control mechanism, wherein
actual input data is compared with predetermined norm is meant to detect errors while
error correction procedures make suggestions for entering correct data input. The
Personal Identification Number (PIN) of the customer is validated with the known data.
If it is incorrect, a suggestion is made to indicate the PIN is invalid. Once the PIN is
validated, the amount of withdrawal being made is also checked to ensure that it does
not exceed a pre-specified limit of withdrawal.
c. Processing and Revaluation
The processing of data occurs almost instantaneously incase of online

transaction processing (OLTP) provided a valid data has been fed to the system. This is
called check input validity. Revalidation occurs to ensure that the transaction in terms
of delivery of money by ATM has been duly completed. This is called check output
validity.
d. Storage
Processed action, as described above, result into financial transaction

data i.e. withdrawal of money by a particular customer, are stored in transaction data
base of computerized personal banking system. This makes it absolutely clear that only
valid transactions are stored in the data base.
e. Information
The stored data is processed making use of the query facility to produce
desired information.
f. Reporting
Reports can be prepared on the basis of the required information content

according to the decision usefulness of the report.
NEED AND REQUIREMENTS OF COMPUTERIZED ACCOUNTING:

The need for computerized accounting arises from advantages of speed,
accuracy and lower cost of handling the business transactions.
a. Numerous Transactions
The computerized accounting system is capable of handling large number

of transactions with speed and accuracy.
b. Instant Reporting
The computerized accounting system is capable of offering quick and

quality reporting because of its speed and accuracy.
c. Reduction in Paper Work
A manual accounting system requires a large physical storage space to

keep accounting records/books and vouchers/documents. The requirement of
stationery and books of accounts along with vouchers and documents is directly
dependent on the volume of the transactions beyond a certain point. There is dire need
to reduce the paper work and dispense with large volumes of books of accounts. This
can be achieved by introducing computerized accounting system.
d. Flexible Reporting
The reporting is flexible in computerized accounting system as compared

to manual accounting system. The reports of a manual accounting system reveal
balances of accounts on periodic basis while computerized accounting system is capable
of generating reports of any balance as when required and for any duration which is
within the accounting period.
e. Accounting Queries
There are accounting queries which are based on some external

parameters. For example, a query to indentify customers who have not made the
payments within the permissible credit period can be easily answered by using the
structured query language (SQL).Support of database technology in the computerized
accounting system. But such an exercise in a manual accounting system is quite difficult
and expensive in terms of manpower used. It will still be worse in case the credit period
is changed.
f. Online Facility

Computerized accounting system offers online facility to store and
process transaction data so as to retrieve information to generate and view financial
reports.
g. Scalability
Computerized accounting systems are fully equipped with handling the

growing transactions of a fast growing business enterprise. The requirement of
additional manpower in accounts department is restricted to only the data operators for
storing additional vouchers. There is absolutely no additional cost of processing
additional transaction data.
h. Accuracy
The information content of reports generated by the computerized

accounting system is accurate and therefore quite reliable for decision making. In a
manual accounting system the reports and information are likely to be distorted,
inaccurate and therefore cannot be relied upon. It is so because it is being processed by
many people, especially when the number of transaction to be processed to produce
such information and report is quite large.
i. Security
Under manual accounting system it is very difficult to secure such

information because it is open to inspection by any eyes dealing with the books of
accounts. However, in computerized accounting system only the authorized users are
permitted to have access to accounting data. Securing provided by the computerized
accounting system is far superior compared to any security offered by the manual
accounting system.
BASIC REQUIREMENTS AND LIMITATIONS OF COMPUTERIZED ACCOUNTING.
Basic Requirements of the Computerized Accounting System
Accounting Framework
It is the application environment of the computerized accounting system.

A healthy accounting framework in terms of accounting principles, coding and grouping
structure is a pre-condition for any computerized accounting system.
Operating Procedure
A well-conceived and designed operating procedure blended with

suitable operating environment of the enterprise is necessary to work with the
computerized accounting system.

The computerized accounting is one of the database-oriented applications
wherein the transaction data is stored in well-organized database. The user operates on
such database using the required interface and also takes the required reports by
suitable transformations of stored data into information. Therefore, the fundamentals of
computerized accounting include all the basic requirements of any data base-oriented
application in computers. On the basis of the discussions, these are the following
differences between manual accounting and computerized accounting.
LIMITATIONS OF A COMPUTER AND COMPUTERIZED ACCOUNTING
1. Cost of Installation
Computer hardware and software needs to be updated from time to time with
availability of new versions. As a result heavy cost is incurred to purchase a new
hardware and software from time to time.
2. Cost of Training
To ensure efficient use of computer in accounting, new versions of hardware software

are introduced. This requires training and cost is incurred to train the staff personnel.
3. Self Decision Making
The computer cannot make a decision like human beings. It is to be guided by the user.
4. Maintenance
Computer requires to be maintained properly to help maintain its efficiency. It requires

a neat, clean and controlled temperature to work efficiently.
5. Dangers for Health
Extensive use of computer may lead to many health problems such as

muscular pain, eyestrain, and backache, etc. This affects adversely the working
efficiency and increasing medical expenditure.
DIFFERENCE BETWEEN MANUAL ACCOUNTING AND COMPUTERIZED

ACCOUNTING
1. Recording of financial data content of these transactions is through books is

stored in well designed data base of original entry.
2. Classification Transactions recorded in the no such data duplications are made.

Books of original entry are in order to produce ledger accounts further classified
by posting the stored transaction data is them into ledger accounts. Processed to
appear as classified this results in transaction so that same is presented in the
data duplicity form of report.

3. Summarizing Transactions are summarized the generation of ledger accounts to
produce trial balance by is not necessary condition for ascertaining the balances
of trial balance various accounts.
4. Adjusting entries are made. There is nothing like making entries to adhere to the
principle of adjusting entries for errors and matching rectifications.
5. The preparation of financial statements assumes the statement is independent of

availability of trial balance producing the trial balance.
2 Marks:
1. Explain the Advantages of Prepackaged Accounting Software? June 2009
2. Discuss the Significance Of Computerized Accounting System? June 2010
3. Define Computerized Accounting? Dec 2010
4. What are the uses of Accounting Software? Jan 2012.
5. Give examples for Prepackage accounting software. Jan 2013
6. What is tally? (NOV/DEC-2013)
7. What are the advantages of computerized Accounting? (NOV/DEC-2013)
8. Why is there a need for computerized accounting? (January 2014)
9. Write a note on reserved account groups. (January 2014)
10. State any two limitations of computerized accounting. ( MAY/JUNE 2014)
11. What do you mean by computerized accounting? (January 2015)
12. Define the term codification. (January 2015)
13. Define Ledger. (Apr/May 2015)
14. What is tally? (Apr/May 2015)
16 Marks:
1. Explain the Advantages of Prepackaged Accounting Software? Jan 2012, 2013
2. Discuss the Significance Of Computerized Accounting System? June 2010, June

2009,2013
3. How is codification and grouping of accounts in a Computerized Environment
different from manual accounts? June 2009
4. Do you agree that a computerized environment of accounts will ensure flawless

accounting system? June 2010.
5. Explain Accounting Software? Jan 2012
6. Discuss the steps involved introducing computerized accounting systems in

organization. (NOV/DEC-2013)
7. Discuss about the grouping of Accounts in tally. (NOV/DEC-2013)
8. What is accounting software? Why should we use it? Explain its different types.
(January 2014)
9. Describe the various facilities to be provided by the user friendly accounting

software package. (8) (January 2014)
10. Explain the procedure involved in the creation, alteration and deletion of ledger
accounts in tally. (8 ) (January 2014)
11. Explain the considerations for selecting Pre-packaged accounting software

and discuss its advantages and disadvantages. ( MAY/JUNE 2014)
12. Explain the significance of computerized accounting and role of computer in

accountancy. ( MAY/JUNE 2014)
13. Discuss the steps involved in computerized accounting system. (8) (January
2015)
14. Enumerate the features, advantages and disadvantages of conputerised

accounting system. (January 2015)
15. What is pre packaged accounting software? Discuss its merits and demerits.
What are the factors to be considered while selecting prepackaged software?
(January 2015)
16. Discuss about need and advantages of computerized accounting system.

(Apr/May 2015)
17. Explain the process of codification and grouping of accounts in accounting

package Tally. (Apr/May 2015)


Accounting For Managers

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Accounting For Managers

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Priyadarshini Engineering College, Vaniyambadi

Department of Management Studies

BA5103 /ACCOUNTING FOR MANAGEMENT

Dr. M.Krishnamoorthi,AP/MBA Page 1

UNIT I FINANCIAL ACCOUNTING

Introduction to Financial, Cost and Management Accounting- Generally accepted

UNIT II COMPANY ACCOUNTS

Meaning of Company -Maintenance of Books of Account-Statutory Books- Profit or Loss

UNIT III ANALYSIS OF FINANCIAL STATEMENTS

UNIT IV COST ACCOUNTING

Cost Accounts - Classification of manufacturing costs - Accounting for manufacturing

UNIT V ACCOUNTING IN COMPUTERISED ENVIRONMENT 12

Significance of Computerised Accounting System- Codification and Grouping of

Dr. M.Krishnamoorthi,AP/MBA Page 2

UNIT I FINANCIAL ACCOUNTING

Introduction to Financial, Cost and Management Accounting- Generally accepted

The American Institute of certified public accountants (AICPA) defined

The basic objective of financial statements according to AICPA is ‘to provide

FUNCTIONS OF FINANCIAL ACCOUNTING:

➢ Keeping systematic records

Dr. M.Krishnamoorthi,AP/MBA Page 3

➢ Only transactions which can be measured in terms of money can be recorded in

THE TERMS USED IN FINANCIAL ACCOUNTING.

* Purchase day book

* Sales day book

* Purchase return book

Dr. M.Krishnamoorthi,AP/MBA Page 4

* Sales return book

* Bills receivable book

* Bills payable book

(i) Simple cash book

It is a book of original entry or prime entry which records the transactions in a

Dr. M.Krishnamoorthi,AP/MBA Page 5

In bigger concerns transactions are numerous so posting in journal and different

Transactions are those activities of businessmen, which involve transfer of

It means recording business transactions in a set of account books in a

Dr. M.Krishnamoorthi,AP/MBA Page 6

It represents owners fund invested in a business. It may be original amount

Selling of goods in the normal course of business is termed as sales. If cash is

Dr. M.Krishnamoorthi,AP/MBA Page 7

A person who receives a benefit without giving money or money’s worth

A person who gives a benefit without receiving money or money’s worth

Any amount of money or money’s worth withdrawn by the owners of the

* Equity or net worth

It is also known as capital.

It is also called as ‘sales’.

Dr. M.Krishnamoorthi,AP/MBA Page 8

Accounting broadly classified two types are,

(a) Natural Persons

(b) Artificial persons or legal bodies:

Firms account, limited companies, educational institutions, bank account, co-

(c) Representative Personal Accounts

All accounts representing outstanding expenses and accrued or prepaid incomes

When a person starts a business he is called proprietor. This proprietor is

(ii) Real accounts

Dr. M.Krishnamoorthi,AP/MBA Page 9

(i) Personal Accounts

“Debit the receiver, Credit the giver”.

(ii) Real Accounts

“Debit what comes, Credit what goes out”

(iii) Nominal Accounts

ACCOUNTANCY PRINCIPLES (GAAP – GENERALLY ACCEPTED ACCOUNTING

(i) Business Entity concept: